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IMF wants tax reforms as overheating antidote

By Luis Leoncio

The International Monetary Fund (IMF) raised the possibility of the economy overheating amid the successive strong growth as the demand for goods and services may outstrip supply thus leading to higher prices.

The IMF in its latest assessment of the economy indicated growth to remain strong at 6.6 percent this year and 6.7 percent next year.

It noted that risks to the economy stem mainly from external sources but said overheating of the economy is possible as a result of a “combination of high credit growth, buoyant private investment, and fiscal expansion.”

The IMF cited the need for tax reform, which remains pending in the Senate, to counter possible overheating.

“On the upside, approval of the first tax reform package would lead to a sustainable increase in infrastructure investment,” it said.

The IMF noted, however, that the Philippines is well equipped to respond if risks materialize given its strong fundamentals and available policy space.

The IMF said that while it supports the Duterte administration’s ambitious development agenda, it recommends calibrating fiscal policy to balance against the risk of overheating.

“The increase in priority spending should be financed through additional revenue mobilization, including by widening the tax base, so that the fiscal stance remains broadly neutral,” it said.

It said the BSP should be ready to tighten monetary policies if there are signs of overheating.

“The external sector remains moderately stronger than warranted by fundamentals and desirable policies. The current account balance (CAB) remains above its estimated norm, largely due to inadequate infrastructure, and the gap is expected to close over time as infrastructure is upgraded,” it added.

The undervaluation of the real effective exchange rate is estimated between zero and 4 percent, considering the estimated CAB gap and the structural impediments to investment meaning the peso has the potential to strengthen with an improvement the business environment to attract direct foreign investments..

“Foreign reserves remain sizable, but this is broadly justified by the country’s exposure to natural disaster and capital flow volatility,” it added.

The latest IMF review of the economy was completed last October 26 and the multilateral lender issued a prognosis that the economy has continued to perform well.

“Real gross domestic product (GDP) growth reached 6.9 percent in 2016 and 6.4 percent in the first half of 2017, led by robust domestic demand, a recovery in exports, and a fiscal impulse,” it noted.

It added that inflation have remained near the center of the target band reflecting stable commodity prices and a near zero output gap.

“The unemployment rate remains low at 5.5 percent. The external and fiscal positions are robust, with the current account balance near zero, gross international reserves at $81 billion equivalent to 8.7 months of imports of goods and services, the national government deficit at 2.4 percent of GDP, and the general government net debt at 34.6 percent of GDP,” the IMF said.

3 sources of concerns

It noted as a concern credit growth which has accelerated but it added that most indicators “find no evidence of credit booms so far.” Some indicators, however, suggest that credit gaps could approach early warning levels in 2017 to 2018, it noted.

Another concern is poverty and inequality which remain high despite the strong economic growth in the recent years.

The IMF said more jobs should be created for the young and growing population.

It said that the first tax reform package once approved is designed to create additional fiscal space, and encourages the authorities to consider additional revenue measures.

“The ambitious development agenda depends on a series of comprehensive tax reforms that could create additional fiscal space. Staff appreciates the breadth of the envisaged tax reforms, but cautions that reform efforts may have a lower revenue yield than originally projected because of dilution in Congress. Accordingly, staff encourages the authorities to consider lowering the threshold for personal income tax, raising the value added tax (VAT) rate, rationalizing tax concessions and exemptions, and accelerating the implementation of new excises on automobiles and petroleum products.

It said the main systemic risks to financial stability are high credit growth and concentration.

“High credit growth, especially to the real estate and household sectors, merit continued monitoring. In addition, some conglomerates and real estate developers have leveraged significantly, while shadow-banking activities have expanded,” it said.

The IMF said the conglomerate structure and data gaps generates challenges to measure concentration but capital market development could help reduce bank loan concentration by diversifying the sources of funding for large conglomerates.

The IMF said it supports government’s efforts to have legal access to information on conglomerates’ finances.

Macroprudential policies should be used to address systemic risks to financial stability, it said.

In case of a broad-based credit boom, the BSP should raise capital requirements, supported by monetary policy tightening if accompanied by overheating, it added.

Other IMF proposals included:

* Amendments to the BSP Charter which it said would greatly benefit financial stability. The Charter should be amended to better serve the needs of a modern financial sector and economy. The IMF said it supports the proposed revisions that introduce a financial stability mandate; extend the supervisory perimeter; establish legal protection for supervisors; increase the BSP’s capital; and allow the BSP to issue its own securities.
It added that it welcomes the recent amendment to the Anti-Money Laundering Act to include casinos. “Notwithstanding this notable progress, the AML/CFT framework could be strengthened further by amending the bank secrecy law and making tax evasion a predicate crime,” it added.

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