Buenaventura comfortable with budget gap

MANILA, Philippines, Aug. 1 (UPI) -- Given the current low inflation environment and interest rate differentials with the United States, Philippine monetary policy could accommodate a slight widening of the government's budget deficit, central bank governor Rafael Buenaventura said.

"From a monetary perspective, we can afford a situation where [the Finance Department] overshoots its budget by 10-20 percent. From a prospective point of view, it's not as good, as a failed target this year could mean a failed target next year," Buenaventura told United Press International in an interview.

The ballooning fiscal deficit has become a thorny issue for the administration, as the federal budget deficit for the first half of the year was 50 percent above-target, at 119.7 billion pesos. This was 92 percent of the full-year target of 130 billion pesos, a figure that many believe the government will be unable to reach.

For the first half of 2001, the deficit was 77.8 billion pesos.

The Finance Department has stressed that it remains committed to fiscal discipline. On Tuesday, the government announced a 2003 target deficit of 138 billion pesos, which would mean a slight tightening of the budget gap as a ratio of gross domestic product from 3.3 percent this year to 3.2 percent next year.

Buenaventura said that this year's inflation rate was expected to be "well under 4 percent," compared with an official forecast of 5-6 percent. During the first half, the consumer price index rose 3.5 percent.

"Next year's inflation target is 4.5-5.5 percent, but I still think we will be under 5 percent. With spare capacity available in the manufacturing sector and moderate growth in loan demand in the private sector, my own initial reaction to the new budget target means it probably will not have too much of an impact on our interest rates and our monetary policy," Buenaventura said.

He also noted that the impact of the El Nino weather phenomenon is now expected to be moderate next year, "so the question of food supply and its effect on inflation will not be dramatic."

Even if the budget deficit is a little above target this year, this should not have "a clouding effect on the banking sector, because loan demand from the private sector is quite weak. This means we should be able to be accommodative to the government," he added.

Buenaventura stressed that it was more important to see the two years' budgets and deficits relative to GDP, rather than as just simple numbers. He said that the trend remains consistent, with the government's plan to achieve budget balance by 2006.

Another important thing, he said, was whether the deficit was a function of "unbridled spending or not. And clearly, this year and next year, expenditures are not out of control," he noted.

But he also acknowledged that the government would have to make serious efforts on the revenue front. "I suspect there is a need to change our revenue sourcing, because the economy has changed," he said.

Since the 1997 Asian financial crisis, the Philippine economy has changed dramatically. Growth is now coming from agriculture, information and communications technology, exports, and service industries. These sectors, he said, generate less tax revenue than the previous engines of growth -- banking and manufacturing.

"There is a need for the government to focus their efforts on how they will collect revenues [and] their ability to capture indirect taxes," Buenaventura said.

Buenaventura said he is also comfortable with current interest rate differentials with the U.S.

The differential between the Philippine central bank's policy rates and the U.S. federal funds rate has remained unchanged at 525 basis points.

The Philippines' overnight rates are 7 percent and 9.5 percent for borrowing and lending facilities, respectively

He said that a Fed rate hike was unlikely "until the second half of next year, so this gives us some cushion" on the rate differential.

Buenaventura added that if the Fed cut interest rates again before the end of the year, as some predict, any change in the Philippines' rates would depend on the budget position at the time.

"If the budget deficit is not doing well, then I would probably leave interest rates unchanged," he said.

Regarding the banking sector, Buenaventura acknowledged that commercial banks' non-performing loan ratio was high at around 18.5 percent. But he was optimistic that the expected passage of legislation to establish asset management companies would lead to a sharp reduction in that ratio.

The law, the Special Purpose Asset Vehicle Act, will establish a legal framework to set up asset management companies to manage problem loans. The bill, which has been delayed by the Senate for six, is now expected to pass by the end of the year.

"My feeling is that we could reduce that ratio to 9-11 percent within 12 months of the law being passed," he said.

Discussing the prospects for an Asian common currency, he said that it would eventually happen because of the tangible benefits it could offer: stability, efficiency and competitiveness.

"Unfortunately, this will take time because we have such disparate levels of development," he noted.

He said that the building blocks toward this common goal were important, and he pointed to the Chiang Mai Initiative, which covers bilateral currency swap agreements, as a good start.

Malaysia and the Philippines have also agreed to accept each other's currencies in some trade deals, although little had been done on this front to date.

"But as exporters begin to feel more comfortable with the exchange rate regime of each country, eventually you will see them using the money they got from exports for their imports," he predicted.

Buenaventura also pointed to the need for Asian central banks to start investing international reserves in Asian international bond issues, as well as developing local capital markets.