MERALCO ANNOUNCES POWER RATES INCREASE UNTIL FEBRUARY 2014

Summary

Power distribution firm Manila Electric Company (Meralco) announced that it will increase electricity prices starting this month due to the maintenance shutdown of the Malampaya natural gas facility. The temporary shutdown of the Malampaya natural gas facility which is the main natural gas supplier of power generating and producing firms Santa Rita and San Lorenzo plants that in turn supply electricity to Meralco will reduce the overall level of Metro Manila power supply. The power producers can still produce electricity to supply to Metro Manila; however, they will have to use the more expensive diesel fuel (instead of natural gas). The spot market, another supplier of Meralco, was also forced to increase its prices since many power plants are on regular maintenance shutdown.

All these changes will consequently increase electricity rates in the next few months. Meralco announced that approximately the increase will range from PhP2 to PhP4 per kilowatts per hour. Meralco estimated that this increase will mean an additional PhP700 for those consuming 200 kilowatts per hour, PhP1,050 for 300 kilowatts per hour, PhP1,400 for 400 for kilowatts per hour, and PhP1,750 for 500 kilowatts per hour. Meralco assured the public that the electricity rates will go back to normal levels during the first quarter of 2014.

Analysis

The recent announcement from Meralco will definitely have significant implications. It will negatively affect both the household consumers and the business sectors. More importantly, at least in the short term, it will negatively impact the Philippine economy. As it is, the Philippines already has one of the highest electricity rates in Southeast Asia, effectively making the country one of the most expensive places to conduct business for foreign investors in the region. Therefore, any increase in electricity rates will potentially affect not just household and business consumers, but the economy in general.

The increase in Meralcos electricity rates will be analyzed using the aggregate demand and aggregate supply framework. The increase in electricity rates will create, at least in the short term, an economic fluctuation. The economic fluctuation will occur since there will be changes in normal conditions. Households and businesses will bear the brunt of these changes. Both will have to shoulder the increase of electricity rates, which will definitely affect them negatively. Households will have less disposable income to spend, while businesses will have no option but to incur the additional operating cost.

On the one hand, households will have to cut back on their other expenses or use hard earned savings to pay for electricity. On the other hand, businesses will have to factor in bigger budget for operations, which will mean they will have to consume less electricity or cut their expenses in other areas in order to accommodate this and pay for their electricity consumption. Businesses are also more sensitive to electricity rates increases, considering electricity as an essential factor

of their production. Assuming all things equal, the electricity rates increase will negatively affect the overall price level and real output of the economy. This can be graphically seen and explained through the following graphs:

Figure 1

Figure 2

Figure 1 illustrates the intersection point of aggregate supply (AS) curve 1 and aggregate demand (AD) curve 1. This shows the equilibrium price level (P1) and the real output (Y1) of the economy before the increase of electricity rates in Metro Manila. With the recent announcement of Meralco, the overall price level will definitely move up. This is shown in Figure 2, wherein the overall price level has gone up to P2 since households and businesses will have to shoulder the increase and pay more at their current consumption levels.

However, because of the expected increase in overall price level, businesses will have to cut back on the quantity of goods and services that they supply. They will have to do this in order to save up on costs. If they do not do this, businesses run the risk of inflating their operations cost

and increase the likelihood of losing a lot of money (and possibly declaring bankruptcy). As seen in Figure 2, the increase in the overall price level from P1 to P2 will drive down the real output from Y1 to Y2. This essentially means that the AS1 will shift to the left, thus creating a new equilibrium.

After all these developments, AD1 will now shift to the left since households and businesses will have less disposable income and less budget for investment, respectively. The new intersection point of AD2 and AS2 will then set the new equilibrium price level (P3) and real output (Y3). The slight decrease in price level will not reach the previous price level (P1), but will settle at a price below P2. The new real output (Y3), on the contrary, will continue to go down. Assuming all things equal, this means that overall consumption and investment activities will go down.

Figure 3

Households and businesses will have no choice but to adjust accordingly. This will likely mean that, while businesses continue their operations, they would have to defer any plans of increasing

production or even defer any plans to expand operations. For example, business process outsourcing (BPO) firms, which consider electricity, along with telecommunications, as essential factors for business operations, will grapple with high operating costs due to their round-theclock operations. The recent announcement from Meralco will likely be met with apprehension as this will post an increase in the cost of doing business in the country, particularly in Metro Manila, where most of the BPO firms are located.

FILINVEST ANNOUNCES PLAN TO BUILD COAL PLANT WORTH PHP40 BILLION

Summary

Diversified company Filinvest Development Corporation (FDC) recently announced plans to build a new coal-fired power plant in Misamis Oriental. The project involves the construction of a three-unit, coal-fired power plant in Villanueva Town, Misamis Oriental in northern Mindanao. The coal plant, which is expected to produce 405 megawatts of power (consisting of three power plant units producing 135 megawatts each), is worth approximately PhP40 billion. The construction of the coal plant will take place in the next three years. The coal plant is expected to commence operations by 2016. The entire project will be spearheaded by Filinvests FDC Utilities Incorporated and FDC Misamis Power Corporation.

FDC said that the construction and operation of the PhP40 billion, 405 megawatts coal plant will greatly benefit the country, particularly Mindanao. The construction of a coal plant itself will boost the local economy of Misamis Oriental, as well as its neighbors in the form of taxes and employment. More importantly, the operation of a coal plant in the area will significantly improve the overall power supply of Mindanao, which is currently continuously experiencing recurring power shortages and rotating blackouts. Ultimately, with a stable power supply in Mindanao, it can spur the growth of the business sector, which can improve socio-economic conditions across the island, particularly in impoverished, rural areas.

Analysis

The plan of Filinvest to build a new coal-fired power plant in Mindanao will positively impact the Philippine economy. It may not be as significant compared to other similar developments in different parts of the country, but its long term impact both directly and indirectly especially in Mindanao is something that bodes well for the country. First and foremost, the construction of coal-fired power plant in Mindanao will help stabilize the power supply in the area. It is a huge step towards energy security in the country. It can help reduce rotating blackouts, which is a big concern for households, businesses, and local governments across Mindanao. The establishment of a power plant will not just stabilize power supply, but also show that Mindanao is indeed open for business. With all the negative news about insurgency and terrorism activities in Mindanao, the investment coming from Filinvest will help show the country, and even the entire world, that conditions in Mindanao have gone back to normalcy.

Filinvests plan to build a new coal-fired power plant in Mindanao will be analyzed using the concepts and principles behind the gross domestic product (GDP) accounting. The construction of the new power plant will definitely be counted in the GDP. However, there are several questions that need to be addressed regarding its inclusion in the GDP. These questions include the following:

! ! !

Under what type of expenditure will the coal plant be included? When will the coal plant be counted in the GDP? In what other ways can the coal plant contribute to the GDP?

Are there costs to constructing the coal plant that are not captured in the GDP?

The GDP accounts for the market value of all final goods and services produced within the country in a given period of time (Mankiw, 2012). It can be accounted in different ways. But for the purpose of this analysis, the focus will be on the GDP as the total expenditure in the economy. GDP is computed by calculating and adding its four components: consumption (C), investment (I), government spending (G), and net exports (NX).

Computing the GDP

Y = C + I + G + NX

The construction of a new coal-fired power plant in Mindanao will be included in the GDP as an investment item. Investment is generally defined as the purchase of goods and services that will be used to produce more goods and services. It is the sum of purchases of capital equipment, inventories, and structures (Mankiw, 2012). The coal plant is considered as an investment since the company that will finance its construction is not building the plant just for the sake of having it in the area. Filinvest is building the coal plant in the next three years so that by 2016 it can start its operation. In this case, its operation will involve the generation and production of electricity. This will be the coal plants main product that it will sell to the government (spot market) and the electric cooperatives for the duration of its contract period. In this case, Filinvest has 25 years to operate the coal plant after building it in 2016.

The next important question pertains to the time when the coal plant will be counted in the GDP. The coal plant will be included into the GDP at the time it is constructed. Therefore, Filinvests

PhP40 billion coal plant will be counted in the GDP in the next three years or as the company spends its money for the construction of the plant. If in the first year of construction (2014) Filinvest spent only PhP20 billion of the allotted PhP40 billion budget for the coal plant, then only PhP20 billion will be counted in the GDP for that year. If in the following year (2015) the company spent PhP15 billion, then only that amount will be counted in the GDP of that same year.

The GDP of that year will not include anymore the PhP20 billion spent for the construction of the coal plant during the previous year since it was already counted during the previous year. This will also be the case for the GDP accounting for the final year of construction. In the final year (2016) if the company spent PhP5 billion, then only that amount will be counted in the GDP of that year. In all, the coal plant has a market value of PhP40 billion; however, its inclusion in the GDP depends on when the company actually spent the money to finance the project.

It is now important to examine and analyze the different ways the coal plant can directly or indirectly contribute to the Philippines GDP accounting. After its construction is completed in 2016, the coal plant will produce electricity. This electricity will be sold to the government and the electric cooperatives. Electricity will then become its main product, a good that it will be sold to consumers. Its electricity output will then be counted into the GDP as it is purchased by the coal plants customers, in this case the government and the electric cooperatives. If the coal plant offers other services that are related to the electricity business including transmission or even logistics then the revenue from these services will be counted in the GDP as well.

The construction and operation of the coal plant can also indirectly contribute to the GDP accounting. If the electricity it supplies to electric cooperatives are bought directly by big businesses in the area for example mall operations in urban areas or mining firms in rural areas then the coal plant has indirectly contributed to the GDP by supporting the operations of these firms. These firms will be able to have more reliable and cheaper electricity, which will dramatically improve their operations. Similarly, the households that benefit from the electricity generated by the coal plant can directly contribute to the GDP. With the availability of electricity in the area, they can opt to purchase, for example, televisions or refrigerator, for private use since they already have a steady and cheap supply of electricity. These purchases are definitely counted in the GDP.

To graphically illustrate the projected impact of the coal plant when it begins its operations in 2016, the following aggregate demand and aggregate supply graphs will show the coal plants effects on Mindanao, particularly in the area where it is operating and where its product will be sold:

Figure 1

Figure 2

Figure 1 shows the equilibrium price level and real output prior to the commencement of the coal plant in 2016. Figure 2 shows the shift of aggregate supply (AS) curve 1 to the right, which will create AS2. The shift to the right is of AS1 is basically due to the improvement, in terms of reliability and cost, in the supply of electricity to Mindanao. As mentioned, this improvement will have positive impact to businesses, among others. Because of this, the overall price level will go down, while the real output will improve. This scenario will create a new equilibrium price level and real output. Generally, because of the associated costs to transmission and distribution, the proximity of consumers to a power plant can determine the electricity rates they are paying. The closer the consumers are to the power plant, normally, the cheaper their electricity bills are.

However, while there are numerous possible positive contributions a coal plant can give, there are also several costs to building a coal-fired power plant. Particularly the negative impact to the environment, most of these costs are not reflected in the GDP accounting. For example, a coalfired power plant will need a steady supply of coal, which is obviously an essential component for the power plants operation. However, producing coal will require massive mining operations. Unfortunately, while it is heavily regulated, mining in the Philippines is severely damaging the environment, particularly in areas where small-scale miners are operating. In the end, these types of costs are not reflected in the GDP accounting of the Philippines.

NEDA EXPECTS THE ECONOMYS GROWTH RATE IN Q4 TO SLOW DOWN

Summary

The socio-economic planning agency National Economic and Development Authority (NEDA) said that it is expecting a slower growth rate of about 4% in the fourth quarter of this year. NEDA said that the fourth quarter economic growth may only settle at that rate because of the extent of damage left by super typhoon Haiyan/Yolanda in the Visayas, particularly in the provinces of Samar and Leyte. As of the first week of December, official government figures revealed that at least 5,700 people have died and as much as PhP34 billion worth of private properties, public infrastructure, and agricultural crops were damaged.

According to NEDA, the hardest hit areas Eastern, Western, and Central Visayas account for only 12.5% of the countrys overall economic output. Because of this, the impact of the super typhoon may not be as significant, especially in the short term. Also, NEDA said that the countrys growth rates in the first two quarters of the year, which stood at 7.7% and 7.5%, may be enough to meet the governments full year target of 6% to 7% if the economy grows only by at least 4% in the fourth quarter. As a side note, the Philippine economy grew by 7.0% in the third quarter, giving the country an average of 7.4% in the first three quarters of the year.

Analysis

The recent assessment of the NEDA is likely to create concerns over the strength of the Philippine economys growth in the past quarters. Indeed, there have been persistent concerns that the economys growth is hollow, and that there is a likelihood that this empty growth is a bubble that is about to burst. In the past five quarters from third quarter of 2012 to third quarter of 2013 the Philippine economy has been growing by at least 7%. If the countrys growth rate indeed slows down and settles at 4% in the fourth quarter of 2013, then this will be the lowest growth rate per quarter in the last two years. As a side note, the Philippines recorded a 3.0% growth rate in the third quarter of 2011 (Rappler.com, 2013).

While the devastation caused by the super typhoon in the Visayas is catastrophic, it is however unlikely to significantly drag down the economy this year. At least in the fourth quarter, the remittances coming from overseas-based Filipinos and the usual holiday spending of Filipinos will likely help spur the economy. Aside from this, the business sector is still upbeat, riding from the strong momentum of the economy throughout the last two years. Also, the private sector and government spending in relation to the relief and rehabilitation efforts can help boost the economy. Combined together, all these factors will likely help the Philippine economy in the fourth quarter of 2013 and probably even in the first quarter of 2014. However, the long term implications of the devastation caused by the super typhoon are likely severe and could potentially undo any significant gains of the Philippine economy in the last two years.

NEDAs assessment regarding the economys fourth quarter growth rate will be analyzed using the GDP accounting framework. To illustrate this situation, the Bathtub Model will be used to graphically analyze the level of economic activity in the Philippines throughout the year. Additionally, the aggregate demand and aggregate supply framework will be used to analyze the impact of increased government spending in the area, especially in relation to the relief and rehabilitation efforts.

Figure 1

Used and popularized by the late economist Kenneth Boulding, the Bathtub Model graphically represents the level of activity in an economy. Figure 1 illustrates the Philippine economy in 2013. During the first quarter to the third quarter of the year, the economy grew between 7.0% to 7.7%. The 7.7% growth rate in the first quarter is shown through the red dotted line. The 7.5% growth rate in the second quarter is shown through the green dotted line. The 7.0% growth rate in the third quarter is shown through the blue dotted line. Consistent throughout the first three

quarters is the fact that investment and government spending were fueling the economy. These faucets are figuratively pumping in the most amount of water into the bathtub.

Focusing on the fourth quarter growth rate, the NEDA expects that the Philippine economy will grow only at about 4%. This is represented in the graph by the yellow dotted line. Since the expected 4% growth rate is a significant decline from the previous quarters growth rates, the yellow dotted line is shown markedly below the other dotted lines. This essentially means that there will be less inflows during the fourth quarter of the year, which makes the water in the bathtub less than it previously had.

In all likelihood, a significant amount of water in the bathtub will be coming only from government spending. This is likely since the government is currently heavily spending for the relief and rehabilitation efforts in the Visayas. As of the moment, the Philippine government, specifically the Congress, has already approved a supplemental budget to augment government funds for the relief and rehabilitation efforts.

Another major scenario in the fourth quarter of the year is the decrease in the contribution of exports. As it is, the Philippines is currently importing, rather than exporting, more goods. This essentially means that the amount of water coming into the bathtub from the exports faucet is significantly less than the amount of water coming out of the bathtub through the imports drainage. In the case of the devastated parts of the Visayas, many of the damages were agricultural produce, including palay, coconut, corn, and other high value crops. The damages

will not only affect the domestic market for these goods, but also the international market as some of these goods are being exported.

However, while it is likely that the Philippine economy will slow down in the fourth quarter, it is still possible to grow more than 4% and meet the governments target set for this year. Graphically, the biggest possible contributor aside from government spending is the investment faucet. Remittances from overseas Filipinos and businesses resuming or expanding their operations in the area will be accounted into the bathtub through the investment faucet. These will help offset what the exports faucet cannot bring in and complement what the programmed public sector expenditure is bringing in. Also, the fact that the overall contribution of the Visayas into the countrys GDP is relatively small compared to other areas makes the situation regarding the fourth quarter growth rate a little positive.

Figure 1

Figure 2

The governments plan to increase its spending for relief and rehabilitation efforts will have significant impact to the overall price levels. The governments ultimate goal aside from

helping the victims of the super typhoon by providing them with food and basic necessities is to stimulate and boost economic activity in the affected areas. The increased government spending in the next couple of months will create employment and business opportunities for many people. This will increase the overall real output. Figure 1 shows the intersection between aggregate demand (AD) curve 1 and aggregate supply (AS) curve 1, illustrating the equilibrium price level and real output. With the increase in government spending, Figure 2 illustrates the shift of AD1 to the right, creating AD2. While this means that the overall real output, the Philippine GDP, will increase, the overall price level will also increase. Essentially, as the economy grows, even at a modest pace, prices will naturally go up as well.