Fiscal Road Map to Economic Recovery
The COVID-19 pandemic and its economic consequences have caused potential output in many countries to sharply decline. To provide a perspective, the Philippine economy plunged into recession as private consumption and investment contracted in the first half of 2020. Projections for full-year 2020 GDP contraction will likely settle at 9%-10% from an expansion of 6% in 2019. If realized, this would be the first decline since 1998 (0.5%) and the steepest on record, surpassing the 7% and 6.9% in 1984 and 1985, respectively.
The economy--and the rest of ASEAN--is projected to rebound in 2021 because of this year’s low base, the expectation for the pandemic to be contained with the roll-out of vaccines, and as more government stimulus measures are implemented. But recovery comes at a great cost. Fiscal deficit is already seen to increase by an average of 6 to 7 percentage points of GDP from the pre-pandemic level, and government debt level to expand above 50% of GDP. The uncertainty associated with the pandemic remains high, and its full social and economic costs are yet to be determined.
This underscores the role of fiscal policy to stabilize the economy amid the pandemic. With the appropriate mix of revenue and expenditure measures, these can be applied to “get the economy going again”. However, it is essential to understand that growth-friendly fiscal reforms may require fiscal space. Fiscal space implies a lack of binding constraints from financing requirements such as a large pre-existing deficit, a heavy debt burden or excessive short-term liabilities.
Creating fiscal space through revenue measures should focus on less distortionary taxes and base-broadening measures. For example, the increased use of digital services may provide a new impetus for expanding revenue sources (e.g., VAT on digital transactions). But this has huge implications for business models going forward. As such, this makes it more urgent to find solutions on taxing the digital economy that are equitable for both source and market jurisdictions. Some are also exploring carbon pricing tax measures as a way to combine revenue-raising objectives with a more fundamental, long-term structural reform. Re-focusing reform efforts on revenue administration is key to safeguard tax collection, restore revenue systems to normalcy, and reinstate taxpayer compliance to pre-crisis levels. This will be crucial to secure the much-needed revenue by the government, especially in this time of weakened fiscal capacity, and expanding social protection programs.
Another viable option to use fiscal policy is to implement a broad-based fiscal stimulus. The size, timing, and composition of fiscal stimulus are important elements for an effective stimulus package. With current trends considered, the Philippines need to do more to ensure that better spending outcomes are achieved. Compared with four ASEAN countries and South Korea, the packages for the Philippines and Indonesia are substantially smaller in percent of GDP (5.5% and 5.8%, respectively), and in per capita terms ($188 and $299, respectively). Malaysia’s COVID-19 response alone is much larger ($2,296) than the combined per capita spending of the two countries.
Timely fiscal intervention is also crucial to mitigate the economic cost of the pandemic. This means not delaying it too long and spending on infrastructure investments that are quick to implement, (e.g., shovel-ready). However, if you look at how fast the government spends the money, it leaves much to be desired. The total 2020 COVID-19 budget was 3.2% of GDP but spending is slow with only 1.8% of GDP reportedly spent. This could be in part an issue of weak absorptive capacity of the government’s implementing agencies. Finally, the composition of fiscal stimulus matters as well. The fiscal multiplier is higher when government spending is targeted towards capital expenditures. Prioritizing infrastructure development can create conducive environments that can reduce cost of production, and encourage firms to get back into business. However, while it is strategic to invest on items that increases the productive capacity of the economy, we should not lose sight of the needs of the vulnerable sectors as inequality is expected to worsen in times of crisis.
Undoubtedly, the stimulus spending combined with weak revenue performance has resulted in record-breaking deficit levels. As of December 2020, the government estimated fiscal deficits to hit P1.4 trillion in 2020 and P1.8 trillion in 2021. These figures are the highest on record, and more than twice the deficit level in 2019. This underlines the negative effects of the pandemic on the country’s fiscal position and the need for significant borrowings to finance government operations.
The high reliance on debt-financing will lead to an increase in government debt in the next two years, as it will likely breach 50-60% of GDP. Once the pandemic subsides, the country must start rebuilding its fiscal policy space by prioritizing fiscal discipline and prudent debt management. Policy efforts should be focused on enhancing debt sustainability by slowing debt increases, while also improving debt profiles and mitigating the risks to financing capacity. To this end, a strong commitment to a well- designed medium-term plan to reduce fiscal deficits and improve debt management with transparent and credible debt targets will help foster market confidence.
A final matter to point out in the fiscal roadmap is the need for an adequate public financial management system to ensure transparency and accountability objectives are met. The COVID-19 pandemic requires massive public funding to ensure a comprehensive response. Moreover, reprioritizing public spending to bolster the economy and the health system requires timely action and a supportive public finance environment. Adjustments are required on the revenue side of budgets (e.g., loans) to account for these new economic and fiscal constraints. Quick decision-making on the expenditure side is also needed.
As such, ensuring an appropriate balance between flexibility and accountability is relevant under these exceptional circumstances. The Executive and Congress need to ensure sufficient budgetary funds by reprogramming existing spending and earmarking additional funds. Funds need to be made available rapidly to the frontlines while setting effective expenditure tracking mechanisms to guarantee the effective use of resources and accountability.
NOVEL V. BANGSAL is Executive Director in the Congressional Policy and Budget Research Department, House of Representatives. He finished his MA in Development Economics from UP School of Economics and MA in Public Administration from UP NCPAG. He earned his Diploma in Public Management Development Program (Senior Executive Class) at the Development Academy of the Philippines in 2016. Opinions contained herein are solely his and do not represent any of his affiliations.