Greenspan on foreign debt and budget deficits

Budget Secretary Emilia Boncodin told ANC‘s business reporter that the budget deficit would most likely exceed the five percent of GNP that was their initial cap. You could feel that she was concerned even as she tried to project the aura of nonchalance, that it was just another day of work for her.

Earlier in the week, sources told newsmen that government‘s deficit has already exceeded P188 billion and may go as high as P223 billion. The Secretary of Finance and the National Treasurer, however, gave assurances that they can cover the gap with more borrowings, here and abroad. The foreign borrowing strategy is starting to become expensive as Philippine debt gets downgraded by rating agencies. But foreign or local, these are still debts that must be paid for at some point in time. It is a tax imposed on future generations.

Now comes a timely observation from Alan Greenspan, the chairman of the US Federal Reserve. He told attendees to an international conference last week on "Macroeconomic Stability, Financial Markets, and Economic Development in Mexico City, that "developing countries too often borrow foreign money to placate unaffordable demands made by domestic political constituents."

Greenspan observed that such countries’ leaders, rather than confronting politically difficult tradeoffs, often borrow in foreign-denominated currencies to the point of insolvency. "To close the gap between the financial demands of political constituencies and the limited real resources available to their governments, many countries too often have bridged the difference by borrowing from foreign investors. In effect, the path of least resistance has been external borrowing, usually at the lower interest rates of internationally tradable currencies, rather than confronting politically difficult tradeoffs."

I thought Greenspan’s comments sounded particularly relevant to our condition today. We do have something to worry about if government’s revenue collecting agencies continue to fail to meet their targets, year after year. Thus, we compound last year’s deficit and last year’s borrowings with this year’s deficit and this year’s borrowings. Since there is no such thing as a free lunch, time will come when a debt crisis, much like what Argentina is having now, comes home to roost.

It is at this point when things get even worse. According to Greenspan, "periodically, as an economy borrows its way to the edge of insolvency with debt denominated in foreign currency, government debt raising capacity appears to vanish virtually overnight. This vanishing capacity characterizes almost all financial crises. Lending institutions will provide funds beyond the immediate visible short term cash flow of a borrower only if they perceive that maturing debt will be rolled over. The first whiff of inadequacy in debt raising capacity induces a run to the exits not unlike a bank run."

The US Federal Reserve Chief concludes that "thus, an economy’s necessary condition for solvency, indeed, a necessary condition for economic growth, is the maintenance of significant unused financing capacity. Too often governments have endeavored to contain impending debt crises with inflationary policies that inhibit growth."

Being a former international banker, our Finance Secretary may be looking at it as a banker would: Borrow to fill the gap. He has immediate needs to fill and to hell with the future... he has no intention of being Finance Chief forever. It is clear from Greenspan’s remarks that a longer term view is necessary to keep us away from a crisis that is of our own making.

Meralco’s woes

I was mercifully abroad when the furor over the Supreme Court decision on Meralco’s rates hit the papers. It was just as well that it took me a while to get myself up to speed on the issues. In any case, anything I would have said could have been interpreted as self-serving, given my relationship with the Lopez Group.

I thought I could just let the issue pass safely on. But when I read Chit Pedrosa’s column in this paper last week which viewed the decision as "one in favor of the multitude against a powerful corporation, we have reached a watershed in our history as a nation," I knew we are in real trouble. Chit is one of the more perceptive writers around and if that’s her "broader, more philosophical view," I realize we do have a lot to explain.

It is easy to dismiss the press releases of the politicians and even of the noisy leftist groups. But Chit Pedrosa, we have to take seriously. Besides, I was getting irritated that there are those who insist Meralco cheated its consumers because it overcharged.

The truth is, Meralco was charging what it was allowed to charge by the defunct Energy Regulatory Board (ERB). The basis of charging back income tax paid to the consumers is a long held jurisprudence on the matter that is accepted not just here but abroad. While the ERB could change the rules and the Supreme Court could establish new jurisprudence, application should have been prospective so as not to create the disruption it is bound to cause.

But Chit is right that the Lopezes are incidental to the whole drama. For indeed, the new jurisprudence arising from the Supreme Court decision will have far reaching consequences on the business climate and the economic development of the country. At this point, I want to quote the portion of Ducky Paredes’s column in Malaya last week. Ducky clearly analyzed the business implications of the Supreme Court decision.

The Supreme Court decision calling on the Manila Electric Co. (Meralco) to refund P28.15 billion to its customers has a lot of implication on other power firms and other companies whose pricing is regulated by government.

The crux of the Meralco case was that the Court decided that what the firm pays in income taxes is something that it cannot pass on to its customers under the return-on-rate-base (RORB) formula that is used to compute what a public utility can charge for its services. Thus, the court ruled that the RORB is computed before tax. Whatever a utility pays as income tax is something that it must pay out of pocket. It cannot use that expense item as part of the base on which its 12- percent RORB is computed.

Thus, if Meralco will have to pay a rebate because its income taxes were treated as an expense in computing its RORB, then all of the bus, shipping, airline, telecom and power firms may also be forced to give a rebate to their customers. Why? Because, like Meralco, they also compute their RORB in the same way that Meralco computed its RORB.

There is no other way that a business can book its taxes except as part of the regular expenses of the business. The way that the Supreme Court looks at it, however, what one pays as income tax is not something that a business can treat as part of its regular expenses, chargeable as such in computing an RORB. It is not an expense item on which the customer can be charged a profit of 12 percent.

But why not? In any business, it is the consumer who eventually pays for everything. All of the expenses that are borne by the business including all taxes (income or otherwise) that the business gives to the government all come out of their customers’ pockets. Where else could they come from if not the customers?

When businesses are cited for being the top taxpayers of the country, what is really being celebrated is that they are the top tax collectors of the country.

All of their taxes – be they VAT, sales, land taxes or the customs and other duties that they pay for their imports – are actually paid for by their consumers. Eventually, whatever expense the business incurs, even to the limousines used by its top executives and the bonuses that the fat cats earn, all come from the consumer. What businesses pay in income tax is at the level of about 35 percent of its income. If this were not chargeable to its RORB, it would mean that the most that a regulated business could earn RORB would actually only be 7.8 percent. Would it still be worth the effort to invest in utilities?

If the Meralco will be made to pay back, what about Globe, BayanTel, PLDT, other power firms, the bus and shipping companies and the airlines? This could be a business-killing precedent. While it gives one a good feeling that Meralco’s noggins are being kicked in, one also realizes that it may not be such a great thing if this Supreme Court decision proves to be a disincentive to RORB investors and even those investing in other businesses.

Government philosophy

Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. – Ronald Reagan (1986)

Boo Chanco’s e-mail address is [email protected]