Fiscal Policy and Stock Market Movement in the Philippines
Deborah Kim S. Sy De La Salle University, Manila Philippines [email protected]
ThePhilippinegovernmenthassufferedgreatlyfromfiscalimbalancesforthepastfewdecades.ThelargestfiscaldeficitwasrecordedatPhP112billionin2017.Fiscalreformsledtoaconsiderabledeclineofthenationalgovernmentdebtfrom52.4%ofGDPin2010to44.8%in2015. ThestudyaimstoinvestigatethePhilippinefiscalpolicyanditslinktoassetprices,asmeasuredbythechangesinthePhilippineStockExchangeIndex(PSEI).Quarterlyobservations from2001 to2017ofmonetary,fiscal,andeconomicvariableswereusedonavectorerrorcorrectionmodel(VECM)toobservetheirlong-runrelationshipwiththestockmarketindex. Theresultsindicatethatpolicyrates,governmentrevenue,inflationrates,andGDPinfluencestockpricespositively,but foreign interest rates and government expenditures have a negative effect on the stock exchange in the long run.All of these are in accordancewith a priori expectations except for the inflation rates.This study also confirms theexistence of a long-run relationship between all of the variables and the PSEI.The empirical evidence nonethelesssuggests that 28%of the deviations of thePSEI from its long-run equilibriumdue to short-run shocks are correctedafteraquarter.Hence,itwilltakeaboutthreetofourquartersforthePSEItogobacktoitsequilibriumlevel.
ThePhilippines still lags behindother countriesinAsia in terms of revenue generation and publicspending on education, health, and infrastructure.WorldBank (2019) showed that in 2000, 15.21%ofthetotalPhilippinegovernmentexpenditurewasappropriated for education, but inMalaysia andThailand, itwas21.39%and28.36%,respectively.The Philippines allotted around 8.42% of its
government expenditures on healthcare,whereasThailandallocated12.08%.Infrastructurespendingas a percentage of gross domestic product (GDP)wasatalow1.5%comparedtothoseofThailandat3.6%andMalaysiaat5.4%.RevenueofthePhilippinegovernment,ontheotherhand,was14.2%ofGDP,but for theMalaysian andThai government, itwas17.5and15.5%.
Fiscal Policy and Stock Market Movement in the Philippines 129
Thecountryhadundergoneseveralfiscalreformssincethe1980s.Toreducetheburdenonitsbudget,thegovernment-initiatedprivatizationprogramswherebyittransferredownershipofgovernmententitiestotheprivate sector.Tax rateswerealsoamended.Value-addedtax(VAT)rateincreasedfrom10%to12%in2005.Corporateincometaxwassubsequentlyreducedfrom 35% to 30% in 2009.According toDiokno(2010),oneofthemostimportantaspectsoftaxdesignwastheadministrativecapacityofthegovernmenttocollecttaxesproperly.Ifthegovernmentisableandinformationiscomplete,aprogressiveformofdirecttaxwouldbethebestscheme.Otherwise,itmaybebettertodependmoreonindirecttaxes.
The Philippines is increasingly dependent onfinancingfromabroadtoaugmentlowdomesticcapitalaccumulationandobtainforeignexchangetopayforcurrentexpenditures.Tothisend,thecountryborrowsmoretopayforolderdebtsinaviciouscycleofdebt.Although thecountry’sdebt-to-GDPratio improvedfrom2010 to2012due to robusteconomicgrowth,thedebt-to-revenueratiowentupashighas539%in2004.AsofMarch2018,theratiois268.6%comparedtothepreviousyear’s273.9%.
InNovember2017,a taxreformbillwaspassedbyCongress that seeks tocorrect somedeficienciesinthetaxsystemtomakethesystemsimpler,fairer,andmoreefficient.TheTaxReformforAccelerationandInclusion(TRAIN)lawwassignedbyPresidentRodrigoDuterte inDecember2017andhasalreadytakeneffectsinceJanuary2018.
As formonetarypolicy, its impact usually takeseffectafteranestimatedlagof12to15months,whichisinlinewiththetypicalpolicyhorizonofonetotwoyears(Geraats,2006).TheBankoSentralngPilipinas(BSP)alsoannouncestheinflationtargettwoyearsinadvanceandcommitstoachieveitoverthetwo-yearhorizon.PromotingpricestabilityistheBSP’smainpriority, and these targets serve as a guide for thepublic’sexpectationoffutureinflationforthemtoplanwithgreatercertainty(BSP,n.d).
Figure 1 shows themovement of thePhilippinegovernmentexpenditures, inflationrate,andreverserepurchase rates through the years. ReplacingtheAquino regime, theDuterte administration iscurrentlyembarkingonanexpansionaryfiscalpolicytofinancethe“Build,Build,Build!”programwhereapproximatelyPhP9trillionwouldbespentonpublicinfrastructureandmass transportationsystems from2017to2022.
Inflationary pressuresmid-2008were apparentinFigure1astheglobalrecessionwasaffectingthecountry through the tradechannels.Worldpricesofgrainsandpetroleumrose,whichcontributed to theslowdownoftheGDPgrowthto3.7%.Asseeninthetimeseries,itwasnotuntiltheendofthecrisisthatpolicyrateshadstabilized.In2017,policyrateswerekeptat3%butwereincreasedby50basispointsto3.5%asofJune2018.Thisisduetotheexpectationthatinflationratesaretoincreaseby1.5%atmostastheTRAINlawtakeseffect.However,inflationratesrosedramaticallyto6.4%inAugust2018.
In November 2017, a tax reform bill was passed by Congress that seeks to correct some
deficiencies in the tax system to make the system simpler, fairer, and more efficient. The Tax
Reform for Acceleration and Inclusion (TRAIN) law was signed by President Rodrigo Duterte in
December 2017 and has already taken effect since January 2018.
As for monetary policy, its impact usually takes effect after an estimated lag of 12 to 15
months, which is in line with the typical policy horizon of one to two years (Geraats, 2006). The
Banko Sentral ng Pilipinas (BSP) also announces the inflation target two years in advance and
commits to achieve it over the two-year horizon. Promoting price stability is the BSP’s main
priority, and these targets serve as a guide for the public’s expectation of future inflation for them
to plan with greater certainty (BSP, n.d).
Figure 1. Time series plot of Philippine government expenditures, inflation rates, and reverse repurchase rates from
1995 to 2017. Author’s calculation.
Figure 1 shows the movement of the Philippine government expenditures, inflation rate,
and reverse repurchase rates through the years. Replacing the Aquino regime, the Duterte
administration is currently embarking on an expansionary fiscal policy to finance the “Build, Build,
Build!” program where approximately PhP9 trillion would be spent on public infrastructure and
Inthispaper,Iexaminehowfiscalshocksinfluencethe Philippine stockmarket, notwithstanding theeminentfiscal lag effects that occur in governmentpolicy-making. In addition, I also integrate severalmacroeconomic aggregateswith fiscal policy andexamine their long-term effects on the Philippinestockmarketbyusingavectorerrorcorrectionmodel(VECM) framework inwhich the interactionof thevariablescanbeanalyzed.
Therestofthispaperisasfollows:Section2re-examinesthefindingsofotherstudiesrelatedtofiscalpolicyandtheirlinktoeconomicactivity.Section3presents the data used, andSection 4 expounds ontheeconometricmethodologyandempiricalanalysis.Lastly,Section5providessomeinsightsaswellastheconclusionofthepaper.
Review of Related Literature
InthePhilippines,theinteractionofmonetaryandfiscal policy has largely depended on the structuraladjustments and reformation of government andfinancialinstitutions(Halcon&DeLeon,2004),whichmake themanagement of these policy instrumentsdifficult.Althoughmonetary andfiscal policies areimplemented by two different entities, they are farfrombeingindependent.ResultsofGuinigundo(2012)impliedthatthePhilippinegovernmentandtheBSPhad coordinated their policy actions so that policysterilizationisavoided.
Theeffectoffiscalpolicyhasreceivedlessattentiondespitethetheoreticalbasisofhowitcanbeusedtoresuscitateaneconomyfroma slump incontrast toa large number of empirical studies on the effectsofmonetary policy on economic activity.Thiswasbecausemacroeconomic variables reactedmore tomonetary policy and thatmonetary policy changestook effect faster (Guinigundo, 2012).Therefore,fiscal policy has been overlooked in representingpolicyactionsthataffectstockreturns.Intheory,theimpactoffiscalpolicydependsonwhetheronetakesaKeynesian,classicalorRicardianview.
TheKeynesian school of thought insisted thatincreasinggovernmentspendingenhancesaggregatedemand in times of economic distress and, in turn,potentially driving stock prices higher. Classicaltheoryconsideredpotentialcrowding-outeffectsdueto the increasing government demand for loanablefundsandthedecreasingsupplyofthefundsavailable
for the productive sectors such as the stockmarket(Chatziantoniou,Duffy,&Filis,2013).Barro(1979)disproved both with his Ricardian equivalenceproposition, stating that fiscal policywas deemedineffectiveandthatitwouldnotaffectstockmarkets.
Auerbach (2005) claimed that fiscal adjustmentpromotedshort-termoutputgrowth,especiallyafterfinancial crises.He further claimed that it couldbeactive and responsive to economic conditions, andthat policy lags did not seem to impede the use ofdiscretionary policy for stabilization (Auerbach,2005).Infact,fiscalpolicycouldhavealargerapidimpactoneconomicactivitythroughitsdirecteffectson government spending and output.Auerbach(2005)furtheraddedthatfiscalpolicywassometimescounterproductiveateconomicstabilizationdependingonthecountry’scircumstancesandtheidentificationof the restrictions.Discretionaryfiscal policy, then,wastakenmuchmoreintoconsiderationtostabilizeeconomiesbecausethe typicalmonetarystancewasexpansionary during and after crises,which oftenresultedinliquiditytraps.Taylor(2000)alsoaddedthatoncemonetarypolicyfollowsawell-designedinterestraterule,fiscalpolicyshouldbelimitedtominimizingdistortionsandtolettingautomaticstabilizerswork.
haveoccurredsince1964(Harris,1995).Themodelmakes use of the concept of cointegration thatwasdevelopedbyEngleandGranger(1987).
UsingtheVECM,BekhetandOthman(2012)foundlong-run relationships among theMalaysian stockindex,fiscal andmonetary tools, and thatmonetarytoolsworkedfasterthanfiscaltools.Thanh,Thuy,Anh,ThiandTruong(2017)confirmedthatbothmonetarypolicyandfiscalpolicyinVietnamnotonlyaffectedthestockmarketontheirownbutalsoimpactedthestockmarketthroughtheirinteraction.
In the Philippine setting, Guinigundo (2012)showed that Philippine public spending had beencyclical,anditneededtoadoptamorecountercyclicalstancetosupporttheeconomyagainstcountercyclicalspendingshocks.HalconandDeLeon(2004)reportedthat thePhilippinefiscal policy possessed long-runeffects on real growth rather thanmonetary policy.Giventhatthebasicfoundationsonmonetaryandfiscalframeworks are still being adjusted, it is likely thatrealgrowthisprofoundlyinfluencedbyfiscalactions
Fiscal Policy and Stock Market Movement in the Philippines 131
Tomyknowledge, therehasneverbeena studythatassessedthelong-runrelationshipsoffiscalandmonetarypolicieswiththePhilippineStockExchangeIndexusingtheVECMapproach.Hence,thisis thefirst paper to 1) obtain quantitative indicators thatcanbeusedtoconfirmthelong-runrelationshipsofthe variables; and2) identify how the policy tools,togetherwithmacroeconomicvariablessuchasGDPandinflationrates,affectthePhilippinestockmarketindex.Thetimeperiodcoversmajorevents,includingtheglobaleconomicdownturnof2001andtherecentglobalfinancialcrisisin2008.
Data
Inthisstudy,Iusequarterlydatafrom2001to2017toaccuratelycapturethetimingoffiscaladjustmentsand consider seven variables to represent differentsegmentsoftheeconomy.ThesewereobtainedfromtheBSP,PhilippineStatisticsAuthority(PSA),BureauofTreasury (BoT), andPhilippineStockExchange(PSE).
Foreign interest rates will be proxied by theinterestratesoftheUnitedStates,itbeingthelargesteconomyatthetime.ThisisalsobecausethefortuneofasmalleconomylikethePhilippineswillmostlikelybedrivenbylargeeconomiesduetoglobalization(DiGiovanni&Shambaugh,2008).
Intheliterature,governmentexpenditures,ratherthangovernmentrevenues,weremostlyusedas thefiscalvariable.Changesingovernmentspending,ratherthanchangesinthetaxrate,weregenerallyassociatedwithgovernmentdebtbecausethedebtwasnormallymanagedthroughprudentspendingsoastopreservea stable and reasonable tax rate over time (Choi&Devereux,2006).InthestudybyAlesinaandArdagna(2010), they discovered that tax cutsweremoreexpansionarythanspendingincreasesinfiscalstimuli,butspendingcutsweremorecontractionarythantaxincreasesinfiscalstabilization.Consideringthatbothrevenuesandspendingmayaffecttheeconomy,Iusegovernment revenuefromtaxes(dlrev,inmillionPhP)andproductivegovernment expenditures(dlexp,inmillionPhP),whichiscalculatedbydeductinginterestpayments fromgovernment expenditures.Becausedeficit is calculated as government revenue less
expenditures,itwillnotbeusedinthestudytoavoidmulticollinearity.The variables have been adjustedforseasonality.
Under openmarket operations by theBSP, thereverse repurchase rate (rrp) is the rate atwhichgovernment securities are issued to influence thesupply ofmoney. It is also the primary instrumentemployedbytheBSPtostabilizeinflation,whichistheBSP’smainobjective.ThedecisiontoraiseorreducethepolicyratesdependsontheBSP’sassessmentoftheoutlookforinflationandGDPgrowthinthenextsucceedingyears.
The core inflation rate (inf) is ameasure ofinflationthateliminatestransitoryeffectsonthebasketofgoodsincludedintheconsumerpriceindex(CPI)thataresubjecttovolatilepricefluctuations.Iuseittoprovideamoreaccurategaugeofthefundamentalmovementsincommodityprices.
Forrealeconomicactivity,Imakeuseofseasonally-adjustedreal GDP(dlgdp,inmillionPhP)asameasureof the aggregate output and incomeof the country.I also use quarterly closing prices from January 1,2001,andDecember31,2017,ofthePhilippineStockExchangeIndex,takenonthefirstWednesdaysofthemonthorthepreviousbusinessdayifWednesdayisaholidaytoavoidtheweekendeffectandtheturn-of-the-montheffectphenomena.
Proposed Econometric Methodology
First,IspecifytheunderlyingVARmodel.Aftertestingforstationarityandselecting theoptimal laglength using the information criteria, I check forcointegrationusingtheJohansen’stest,autocorrelationusing the Lagrangemultiplier test, the residualnormality,andstabilityofthemodel.Lastly,Iproducetheimpulseresponsefunctions(IRFs).
TheVARapproachhasadesirablecharacteristicthat itdoesnot involve identification restrictionsofany kind. It is also often characterized as amodelthat lacks economic content because there are noeconomicrestrictions(Enders,2014).AmodifiedVAR,thestructuralvectorautoregression (SVAR),canbeused to assess the effect of unanticipated shocks togovernmentspendingandtaxes(Bouakez,Chichi,&Normandin,2014).Moreover,imposingrestrictionsinlinewitheconometrictheoryorspecificattributesofaparticularcountryinanSVARmodel(asopposedtoaVARmodel)helpsidentifytherandom,unanticipated,
132 D.K.S. Sy
exogenousstructuralcomponentofthemacroeconomicvariables (or the structural shocks in reduced formresiduals;Fontana,2009).
Most of the variables are not stationary in theirlevelforms.Thus,IobtainthefirstdifferenceofthevariablesusingtheAugmentedDickey-Fullertestandfindintegrationtothefirstorder.However,Sims,Stock,andWatson(1990)recommendedagainstdifferencingthe variables as itmay result in a loss of long-runinformation regarding the co-movements of data.Hence,IuseJohansen’sapproachtocointegration.Incasesofdoingfirstdifferencinginnon-stationarydataseriesintheirlevelforms,cointegrationtestsmustbeapplied tosee if thereexistsa long-runrelationshipbetweenthevariables(Engle&Granger,1987).
As cointegration is present in themodel, I useVECM instead of the SVARmodel.Cointegratingrelationsamongthevariablessuggestnotonlylong-termrelationshipsbutalsoshort-termdeviationsfromtheequilibriumthatarecorrectedintheend.
Figures2, 3, and4 show the time series plot ofsuspectvariablesthatexhibitalong-runrelationshipthroughouttheyears.
When two time-series are I(1) but cointegrated,theyarenon-stationary.Inotherwords,theymoveinasimilarway.Hence,thereisarelationshipbetweenthemthatconnectsthemovertime.
Let ty and tzθ betwotime-seriesvariablesthatarenotstationarybutcointegratedwhereqisacoefficientthatdeterminestherelationshipbetween
ty and tz .Iftheyareplottedinthesamegraph,itisexpectedthatthepathundertakenby ty and tz willbeclosetoeachother,thatis,uptoanerrorterm, tu .
Therefore,thelong-termrelationshipisrepresentedby
1 1t t ty z uθ− −= + (1)
As cointegration is present in the model, I use VECM instead of the SVAR model.
Cointegrating relations among the variables suggest not only long-term relationships but also
short-term deviations from the equilibrium that are corrected in the end.
Figures 2, 3, and 4 show the time series plot of suspect variables that exhibit a long-run
relationship throughout the years.
Figure 2. Time series plot of government expenditures Figure 3. Time series plot of reverse repurchase and revenues. rates and inflation rates.
Figure 4. Time series plot of gross domestic product and Philippine Stock Exchange Index.
When two time-series are I(1) but cointegrated, they are non-stationary. In other words,
they move in a similar way. Hence, there is a relationship between them that connects them over
time.
Let ty and tz be two time-series variables that are not stationary but cointegrated where
is a coefficient that determines the relationship between ty and tz . If they are plotted in the
Fiscal Policy and Stock Market Movement in the Philippines 133
Inequation(1), tu hastobestationarytosignifythattherelationshipdoesnotchangeovertime.Ifthevariabledeviatesfromthisrelationshipinoneperiod,suchwillbecorrectedinthesucceedingperiods.Thenumberofperiodsdependsonthespeedofadjustmentor λ .Forinstance,anyunitincreasein ty higher than whatwasexpectedinthelong-runrelationshipleadsto
tu =1,soitisanticipatedthat 1 0t ty y− − < inthenextperiodandthevalueofty willbecorrecteddownwards
where λ is thecoefficientthatdenotesinformationabouthowquicklythedeviationiscorrected.
TheVECM,ontheotherhand,hastheform
1
11
k
t j t j t tj
y y y ε−
− −=
∆ = Γ ∆ + ϒ +∑ (3)
InaccordancewithJohansenandJuselius(1990),thematrices jΓ containinformationabouttheshort-runadjustmentprocess.Theterm 1ty −ϒ ,ontheotherhand,presents theerrorcorrectionrelationshipamong theseries, therebycontaining the informationabout thelong-run equilibrium of the variables (Lutkepohl,2005).Therankofthematrixϒ also reveals the number of cointegratingvectors in themodel.That is, howmanylinearlyindependentequationsthevariablescanformorhowmanylong-runequilibriumrelationshipsthereareinthemodel.
As all k variables, k signifying the number ofvariables in themodel, are I(1) but cointegratingrelationsexistamongthem,thecointegratingrelationdepictedbyϒ withdimensionkxrnowhastheformof
'αβΠ = (4)
where:α is a k x r matrix which denotes theaverage speed of convergence towards long-runequilibriumorthespeedofadjustmenttoequilibrium after a short-run deviation fromthelong-runrelationship;and β isakxrmatrixwhichdenotestheparametersofthecointegratingvectors.
Finally,Iusethemaximumlikelihoodestimationtocomputethevaluesofα and β .
criteria,aretwoandfive.Johansen(1992)proposedthattheoptimallaglengthbeselectedatastagewhereVAR residuals are not serially correlatedwith oneanother.However, low lag lengthsmaybring forthserialcorrelation,whereashighlaglengthsmaycauseinfinite sample bias.Hence, I decide on five lags,as indicatedby theLikelihoodRatio (LR)Test andAkaike’sinformationcriterion(AIC).Thereisnoserialautocorrelationpresentatlagorder5,accordingtothe LagrangeMultiplier(LM)Test.
Thestabilityconditionismetbecausethemodulusof the unit roots is less than one.All unit roots liewithinthecircle,andthespecificationimposessix-unitmoduli.TheJarque-BeraandtheKurtosistestsindicatethenormalityoftheresidualsofallvariablesexceptforthepolicyrates.Non-normalityofresidualsofonevariable isnot ahindrance to the studyas itwouldeventuallyberesolvedbyincreasingthesamplesize.
08 08 08669.774 825.814 4.65 7.80 0.001 1.48 14542.46tu psei fint rrp e rev e exp inf e gdp− − −= + − − + − − +
08 08 08669.774 825.814 4.65 7.80 0.001 1.48 14542.46tu psei fint rrp e rev e exp inf e gdp− − −= + − − + − − + (5)
Normalizing the variable PSEI by Johansen’smethod and transposing the error term to the right-handside,Ihave
08 08 08669.774 825.814 4.65 7.80 0.001 1.48 14542.46 tpsei fint rrp e rev e exp inf e gdp u− − −= − + + − + + − −08 08 08669.774 825.814 4.65 7.80 0.001 1.48 14542.46 tpsei fint rrp e rev e exp inf e gdp u− − −= − + + − + + − − (6)
To assesswhether coefficients are statisticallysignificant, I lookedat theircorrespondingp-valuesgenerated by theVECM. I found that all of thecoefficientswerehighlysignificantanddifferentfromzeroatthe5%significancelevel.Equation(6)impliesthepositiverelationshipPSEIhaswithrrp, rev, inf,andGDP.Ontheotherhand,fintandexpaffectPSEInegativelyinthelongterm.
134 D.K.S. Sy
Next, Igenerate the impulse response functions.Thesegraphicallyrepresentthecointegrationequations,display thepathofhowavariablereacts toanothervariable, and, ultimately, uncover their relationshipovertime.
When the Federal Reserve tapering started toinducefears inemergingmarketsafewyearsback,investorsreactedquicklytoitbyrelocatingtheircapitalfromtheU.S.tootheremergingmarketssuchasthePhilippines.This explainswhy shocks in theU.S.interestratesaffectthePhilippinestockmarketindexpositively after the thirdquarter inFigure5. In thelongrun,however,therelationshipbetweenfintandPSEIbecomesnegative,asshowninequation(6)due
Non-normality of residuals of one variable is not a hindrance to the study as it would eventually
be resolved by increasing the sample size.
Results
The cointegration equation generated by the VECM is as follows:
08 08 08669.774 825.814 4.65 7.80 0.001 1.48 14542.46tu psei fint rrp e rev e exp inf e gdp− − −= + − − + − − + (5)
Normalizing the variable PSEI by Johansen’s method and transposing the error term to the right-
hand side, I have
08 08 08669.774 825.814 4.65 7.80 0.001 1.48 14542.46 tpsei fint rrp e rev e exp inf e gdp u− − −= − + + − + + − − (6)
To assess whether coefficients are statistically significant, I looked at their corresponding
p-values generated by the VECM. I found that all of the coefficients were highly significant and
different from zero at the 5% significance level. Equation (6) implies the positive relationship
PSEI has with rrp, rev, inf, and GDP. On the other hand, fint and exp affect PSEI negatively in the
long term.
Next, I generate the impulse response functions. These graphically represent the
cointegration equations, display the path of how a variable reacts to another variable, and,
ultimately, uncover their relationship over time.
Figure 5. Response of PSEI to a shock in fint. Figure 6. Response of PSEI to shock in inf and rrp. Figure 5.ResponseofPSEItoashockinfint. Figure 6. ResponseofPSEItoshockininfandrrp.
Figure 7. Response of PSEI to a shock in GDP. Figure 8. Response of PSEI to a shock in exp and rev.
Figure 9. Response of short-term domestic interest rates to a shock in exp.
Shocks or innovations, as mentioned several times henceforth, are defined as the part of a
variable that cannot be explained by its lagged values or by other variables in the system.
When the Federal Reserve tapering started to induce fears in emerging markets a few years
back, investors reacted quickly to it by relocating their capital from the U.S. to other emerging
markets such as the Philippines. This explains why shocks in the U.S. interest rates affect the
Philippine stock market index positively after the third quarter in Figure 5. In the long run, however,
the relationship between fint and PSEI becomes negative, as shown in equation (6) due to the U.S.
becoming more attractive as an investment haven.
Figure 6 shows the expected positive long-run relationship between rrp and PSEI, whereas
inf surprisingly affects PSEI positively in the long run, as presented in equation (6). Stock markets
usually react negatively to inflationary pressures (Fama, 1981), as seen after a quarter and a half
in Figure 6. In the long run, however, the stock market is unexpectedly shown to be positively
Figure 7. Response of PSEI to a shock in GDP. Figure 8. Response of PSEI to a shock in exp and rev.
Figure 9. Response of short-term domestic interest rates to a shock in exp.
Shocks or innovations, as mentioned several times henceforth, are defined as the part of a
variable that cannot be explained by its lagged values or by other variables in the system.
When the Federal Reserve tapering started to induce fears in emerging markets a few years
back, investors reacted quickly to it by relocating their capital from the U.S. to other emerging
markets such as the Philippines. This explains why shocks in the U.S. interest rates affect the
Philippine stock market index positively after the third quarter in Figure 5. In the long run, however,
the relationship between fint and PSEI becomes negative, as shown in equation (6) due to the U.S.
becoming more attractive as an investment haven.
Figure 6 shows the expected positive long-run relationship between rrp and PSEI, whereas
inf surprisingly affects PSEI positively in the long run, as presented in equation (6). Stock markets
usually react negatively to inflationary pressures (Fama, 1981), as seen after a quarter and a half
in Figure 6. In the long run, however, the stock market is unexpectedly shown to be positively
Figure 6 shows the expected positive long-runrelationship between rrp and PSEI, whereas infsurprisinglyaffectsPSEIpositively in the long run,as presented in equation (6). Stockmarkets usuallyreactnegativelytoinflationarypressures(Fama,1981),asseenafteraquarterandahalfinFigure6.Inthelongrun,however,thestockmarketisunexpectedlyshowntobepositivelyaffectedbyshockstoinflation.Otherthanpriceinstabilityandthedropinthevalueofmoney, unexpected inflation can also result invariouseconomicdistortionssuchasuncertaintiesinthereturnsofinvestments,highercostsofborrowingmoney,andhigherwages.
Becauseof theseconcerns, individualsdecide todetercurrentconsumptiontosaveorinvestforfutureconsumption.With their savings, banks are able tochannelthefundsforcompaniesthatneedit.Atthesame time, investing is another option as thePSEIhistoricallyhasperformedfavorablyinthepastdecadeby generating an average growth of 1%, comparedtoahypothetical5%increaseininflation,providinginvestors a long-run hedge against inflation.Bothoftheseactions,ineffect,enhancetheoperationsofthe stockmarket and explain the long-run positiverelationship between rising inflation and the stockmarket.
As for monetary policy, although it may becounter-intuitive that a tightpolicy stance increasesthe stock index, it can possibly be the case in thePhilippinesbecausetheBSPseldomaltersthepolicyrates (unless therearesubstantial reasons todoso),and the country remains as a small open economywith little capital control. Slightmovements in thepolicyrates,suchasanincreaseintherates,areabletodepressstockpricesatfirstduetonegativeinvestorsentiment on the effect of contractionarymonetarypolicyoneconomicactivity(Sy&Hofileña,2014).Nevertheless,theessenceofmonetarytighteningistoreducethethreatofimpendinginflationarypressures,whichwouldbefavorabletotheinvestorsinthelongterm.This explainshow rrppositively affectsPSEIovertime.
of production and economic activity.The resultsconform to the expectation that an increase in theproductionofgoodsandserviceswillbereflectedintheperformanceoftheindexasinvestorswillbeconfidentandoptimisticaboutthereturnontheirinvestments.
Governmentexpenditures,ingeneral,canbeusedasadirectinstrumenttopromoteaggregatedemandandresuscitateaneconomy.Thisexplainstheupwardsurgeoftheindexafteraquarterinresponsetoashockinspending,asshowninFigure8.Atfirst,bothlocalandforeigninvestorswillbeoptimisticaboutanincreaseinproductivegovernmentspendingas theseactionsare deemed to boost economic activity.Yet, hugegovernment spending, in theory, also raises interestrates as the government demands funds thatwouldhavebeenavailablefortheprivatesector(crowding-outeffect). Investorsfacinghigher interest ratesarenowhesitanttocontinueinvesting,especiallyinthestockmarket.Ineffect,investmentspendingisreduced,whichwilleventuallydampeneconomicactivityanddistress the stockmarket, as seen in the downwardsurgeoftheindexafterthesecondquarter.
InFigure9,higherinterestrates,asaresultofhighergovernmentspending,dampeneconomicactivityandstrains the stockmarket.The stockmarket slightlyrecuperatesduetothecommitmentofthePhilippinegovernmenttofiscalconsolidationinthelongrunasitvowstoreducethenationaldebtby2020.Sofar,thenationaldebtasaproportionofGDPsustaineditslevelat42.1%againstthetargetof40.7%.However,thedebtincreasedby9.25%orPhP562.17billion,partlyduetocurrencydepreciation.AsofDecember2017,thedebtwasvaluedatPhP6,652.43billion(BoT,2019).
Highgovernmentrevenuesbymeansofhightaxratesdampenconsumptionandinvestmentspendingasthesearedeemedaburdenonconsumersandinvestors,thereby constituting an unfavorable investmentclimate.Thecorporate tax rate in thePhilippines isat30%,whereasthepersonalincometaxrateis32%.Intuitively,ataxcutindevelopingeconomiessuchasthePhilippineswherethetaxratesarerelativelyhighcompared tootherSoutheastAsiancountrieswoulddramaticallystimulatedemand.Hence,shockstorevnegativelyimpactPSEIinthelongrun.
takesthreetofourquartersforthePSEItogobacktoitsinitialequilibriumlevel.Thenegativesignoftheerror correction term implies that if PSEI is aboveits equilibriumvalue, the error termwill definitelydecreaseinthenextperiodsandrevertbacktozerotorestoretheequilibrium.
Conclusion
Thestudyaimstoexplorethelinkbetweenfiscalpolicyandstockprices in thePhilippines.Thegoalis to determinewhether a variable affects the stockmarketpositivelyornegativelyusingaVECMafterestablishing theexistenceofa long-runrelationshipbetweenthevariablesandthestockmarket.
Initially,byusingtheVAR,Iconfirmthesignificantrelationship between reverse repurchase rates andinflationrates,expendituresandgovernmentrevenues,andGDPandthestockmarketindex.Intheshortrun,apositiveshocktothereverserepurchaseratesaffectsinflationratesnegativelyafterthreequarters,althoughagovernmentexpenditureshockimpactsgovernmentrevenuespositivelyafterthreequartersaswell.Lastly,in themedium run, a positive shock toGDPhas apositiveeffectonthestockmarketindexandisseenafterninequarters.
The results of theVECM, on the other hand,indicate that although policy rates, governmentrevenue,inflation,andGDPinfluencethestockmarketindexpositively,foreigninterestratesandgovernmentexpenditureshaveanegativeeffectontheindexinthelongrun.Theresultsareinaccordancewithaprioriexpectationsexceptfortheinflationrates.
Becauseofeconomicuncertaintiesbroughtaboutbyunexpectedinflation,individualseithersaveforthefutureorputtheirmoneyininvestmentswhereinflationshocksarecompensatedfor in therateof return. Ineffect,thesesavingsandinvestmentsboostthestockmarket, confirming a positive relationship betweeninflationandstockreturnsinthelongrun.
Slightmovementsinthepolicyrates,suchasanincreaseintherates,areabletodepressstockpricesat first due to negative investor sentiment on theeffectoftightmonetarypolicyoneconomicactivity.However,themainreasonfordoingsuchanincreaseis torestrainemerginginflationarypressures,whichwouldultimatelyenhancetheperformanceofthestockmarket index.This justifiesthepositiverelationshippolicyratesandstockreturnshave.
Even though having higher interest rates as a result of higher government spendingdampens economicactivityandstrainsthestockmarketactivityatfirst,thestockmarketisexpectedtorecuperateduetothecommitment of thePhilippinegovernment tofiscalconsolidationinthelongrun.
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Appendix
Table 1 Augmented Dickey-Fuller Test for Unit Root
