Angelo Taningco
Economist, Treasury Group

The Philippines has deficit positions in both the current account and fiscal balance for the past two years: as a share of GDP, the current account deficit doubled to 0.8% in 2017 from 0.4% in 2016 whereas the fiscal deficit narrowed to 2.2% from 2.4% in the same period. There are concerns that such “twin deficits” might persist and could stoke depreciation pressures on the peso.

The “twin deficits” hypothesis depicts a positive relation between the current account and the fiscal balance. This is derived from the national income accounting identity, which shows that national income is equal to aggregate demand and is also the sum of household consumption, national saving, and tax revenues. Combining these two definitions of national income, we see the current account balance—which is the difference between exports and imports to be the sum of the national saving-gross investment gap and the fiscal balance—the difference between taxes and government spending. This hypothesis has been empirically tested for countries such as the US with the studies exhibiting its existence or nonexistence with even some of the results illustrating even a negative correlation between the two variables of interest (a.k.a., “twin divergence’).

We empirically investigate the “twin deficits” hypothesis using Philippine annual data spanning the 1986-2017 period. First, we observed more deficits in the fiscal balance but greater variability in the current account. Second, there were “twin deficits” episodes during 1987-1993 and 1999-2002. Third, we saw a low negative correlation between the current account and fiscal balance for the full sample period. Finally, our regression analysis reveals that the correlation between the current account and fiscal balance is statistically insignificant.

Overall, we find that the “twin deficit” hypothesis appears to be nonexistent in the Philippine setting. This implies that the country’s current account deficit is unsustainable even if fiscal deficits would persist; we think this may be because the current account deficit is associated more with the national saving-gross investment gap. As such, we could view the current account as intertemporal trade, i.e., running current account deficits today will lead to current account surpluses in the future. We posit that such evidence ought to assuage concerns of the peso depreciation to persist over the medium to long-term.

Figure: Current Account & Fiscal Balance, 1986 – 2017

(% of GDP)

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