Can the government and private sector keep deflation at bay?

The Philippine economy showed great promise before getting derailed by COVID-19. From 2010-2019, we had not grown as fast since the 1950s.

_{Source: Source: Bangko Sentral ng Pilipinas, Philippine Statistics Authority, PwC Analytics}

COVID-19 changed everything. The government implemented the extended community quarantine (ECQ) in Luzon (which accounts for 70% of national GDP) to counter the spread of the virus. Economic activity slowed down dramatically as production and labor in non-essential industries ground to a virtual halt.

2020 GDP growth forecasts from the World Bank and similar organizations adjusted accordingly. Before COVID-19, the World Bank forecasted 2020 GDP growth for the Philippines at 6.1%.¹ In recent months the GDP growth forecasts for the Philippines have come down significantly.

Latest GDP growth forecasts for the Philippines

_{Source: World Bank, Asian Development Bank, Bangko Sentral ng Pilipinas, NEDA, AMRO}

The dramatic slowdown in labor, output, income, and spending raises a more sustained problem than economic recovery post-COVID-19, the dreaded d-word among economists: deflation.

Imagine a situation where the economy slowly emerges from the gloom created by COVID-19. Workers and consumers, less confident than before, hesitate to spend. Enterprises react by seeking to stimulate revenues by lowering prices; and yet, the desired effects do not occur.

This creates a cycle where consumers delay purchases and look forward to even lower prices. Businesses delay investing in growth; and cut wage increases and hiring plans to conserve cash and maintain profits. Households respond by increasing yet their resolve to hold off spending in anticipation of lower prices and as a hedge against hardship.²

Entire economies have a tough time breaking out of that downward deflationary spiral.The U.S. economy needed the New Deal to break out of the deflationary environment in the 1930s. Japan refers to the 1990s as the lost decade when it experienced a similar phenomenon of dropping prices, shrinking wage growth, a steadfast resolve among consumers not to spend, and lesser availability of credit.³    

Recent data shows that consumers are already changing their spending plans by delaying major purchases. 33% of those surveyed will hold off making major purchases in specified categories until the pandemic ends globally; while another 29% will delay such spending until the pandemic ends in the Philippines.⁴

_{Source: GlobalWebIndex}

The change in consumer spending plans comes to a certain extent from the anticipation of wider job losses and lower income. The Asian Development Bank estimates that Asia will lose approximately 68 million jobs because of COVID-19 and the Philippines’ share of this will total about 739,000 jobs.⁵ The Department of Labor and Employment (DOLE) estimates a higher number of displaced workers: 1.05 million.⁶

These job losses mirror the dramatic slowdown in manufacturing activity. The manufacturing purchasing managers’ index (PMI) for the month of March 2020 dropped to 39.7.⁷ Any reading below 50.0 indicates a contraction in manufacturing activity.

_{Source: IHS Markit ASEAN Manufacturing PMI}

The contraction in economic activity, production, jobs, earnings, and spending, has already hit certain industries harder than others, particularly those in the discretionary spending categories. These include airlines; casino and gaming; leisure facilities; auto parts and equipment; and oil and gas drilling.⁸

The top three industries (airlines; casino and gaming; and leisure facilities - like hospitality, dining, and mass gathering events like concerts and cinema) fall into the intersection between high discretionary spending levels and minimal social distancing. Consumers are prioritizing spending on necessities, hence lower demand for automobiles and accessories. Diminished mobility due to the ECQ and similar stay at home orders lowered demand for fuel which has contributed to the worldwide glut and price crash in oil and petroleum related products.

Firms in these industries are already feeling the effects of lower demand, lower revenues, and losses attributable to COVID-19, despite their best efforts to manage expenses. Listed firms in these industries have already reported losses and further losses are expected to be reported as we work our way through scheduled earnings releases.

The losses extend to the government. From 1 January to 17 April of this year, government tax collections from the Bureau of Internal Revenue and Bureau of Customs dropped by 26.3% to PH₱641.6 billion, also 40% lower compared to the PH₱1.1 trillion target.⁹

The urgency to mitigate further losses and a possible deflationary spiral galvanizes the government to work in concert with the private sector in implementing measures to jump start the economy as it emerges from the anticipated end of COVID-19. The Bangko Sentral ng Pilipinas (BSP) already responded with at least PH₱300.0 billion in loans to the government, lowering reserve requirements, and lowering its overnight lending rate to make available additional credit to the private sector.

Also, the Philippine Economic Stimulus Act (PESA), legislation still under discussion, seeks to provide government financial support, coupled with private sector initiative, to get the Philippine economy back on its growth track.

The PESA features three levels of policy intervention: transitional, sectoral, and structural. Transitional measures aim at protecting employment and wages on a temporary basis. Sectoral measures feature support directed towards specific critical industries, like agriculture or tourism, Structural supports seek to provide institutional intervention to shore up economic resilience against future economic disruptions.¹⁰

The initiative of the private sector and the support packages readied by the government are likely formidable measures against deflation, and yet the key ingredients are likely to be more basic and integral to the human spirit.

Confidence and the availability of credit constitute two vital weapons against deflation. Workers and consumers will begin spending again when they feel confident about their employment prospects and income. Entrepreneurs and business will expand capital spending and hire again when they feel confident about the availability of credit; and future revenues they can generate from their customers. That mutual confidence depends to a certain extent on the government’s ability to execute policy interventions that will support private industry and citizens.