NSCB - Technical Notes - Composite Leading Economic Indicators

Technical Notes on the Computation of the
Composite Leading Economic Indicator

The Philippines Leading Economic Indicators System (LEIS)
Third Quarter of 2006 Release

A. Background

The Leading Economic Indicators System (LEIS) was developed jointly by the National Statistical Coordination Board (NSCB) and the National Economic and Development Authority (NEDA) to serve as basis for short-term forecasting of the macroeconomic activity in the country. The NSCB has since been compiling data for the 11 identified leading economic indicators and generating the Composite Leading Economic Indicator on a quarterly basis.

The LEIS involves the study of the behavior of indicators that consistently move upward or downward before the actual expansion or contraction of overall economic activity. The system is based on an empirical observation that the cycles of many economic data series are related to the cycles of total business activity, i.e. they expand in general when business is growing and contract when business is shrinking. The LEIS was institutionalized to provide advance information on the direction of the country’s economic activity/performance in the short run.

B. Computation of the Composite Leading Economic Indicator

The computation of the composite leading economic indicator involves the use of a reference series and eleven leading economic indicators, namely: (1) consumer price index, (2) electric energy consumption; (3) exchange rate, 4) hotel occupancy rate, 5) money supply; 6) number of new business incorporations, 7) stock price index, 8) terms of trade index, 9) total imports, 10) tourist arrivals, and 11) wholesale price index.

The reference series used is the non-agriculture component of GDP, or the gross value added (GVA) of the industry and services sectors. This is so because the cycles of GDP and non-agriculture GVA (industry and services) show the same pattern. The cycle of the agriculture GVA when compared to the cycle of GDP, on the other hand, shows a different pattern.

The LEIS methodology includes the decomposition of the reference series and each of the eleven indicators by doing the following steps:

Seasonally adjust and smoothen using X11ARIMA to obtain the cycle-trend component for each of the eleven leading indicators and the reference series (non-agriculture component of the GDP)

Remove the trend component from the seasonally adjusted and smoothened series to obtain the cycle component of each of the indicators by using the Hodrick-Prescott (HP) Filter Method. Starting with the Q1 2004 LEI estimate released on 12 February 2004, the computation of the LEI adopts a new detrending procedure called the Hodrick-Prescott (HP) Filter Method, which has effectively addressed observed limitations in the method used for the estimation of the LEI prior to 2004.
Correlate the cycle of each indicator with the cycle of the non-agriculture GDP (reference series) to obtain the lead period. The lead period determines the number of quarters the cycle series for each indicator is moved forward.
The index is computed as the linear combination of the indicators using correlation coefficients of the indicators with the non-agriculture GDP as weights. In determining the relationship between the GDP and the composite indicator, the following simple linear regression model is used:

where:

= Cycle component of the Non-Agriculture GDP
= Amount of increase in the cycle component of the Non- Agriculture GDP per unit increase in the composite LEI
= Composite Leading Economic Indicators
= Error term

The result yielded an adjusted R2 value of 0.64 as shown below:

Summary Output of the Regression Analysis Between the Composite LEI and the Non-Agriculture GDP Cycle Component, Third Quarter of 2006

C. Definitions: The 11 leading economic indicators

Consumer Price Index (CPI)
Is a general measure of the average monthly and annual changes in the retail prices of commodities commonly purchased by households reckoned from a base year and weighted by the consumption pattern or basket of the households.

The computation of LEIS uses the 2000 based CPI.
Compiling agency: National Statistics Office (NSO)
Electric Energy Consumption (ELECON)
Refers to the quantity of energy consumed measured in gigawatt-hours. It covers the consumption of residential, commercial, industrial, utilities/transport services.

Compiling agency: National Power Corporation (NPC) and Manila Electric Company (MERALCO)
Peso-Dollar Exchange Rate (EXCRATE)
The price of a country’s money (currency) in relation to another country’s money. As used in the LEI, exchange rate is expressed as the value of one US dollar in terms of the peso. The average monthly exchange rate for the quarter is used in the analysis.

Compiling agency: Bangko Sentral ng Pilipinas (BSP)
Hotel Occupancy Rate (HOTOCC)
Number of rooms occupied for the month over the number of rooms available for sale for the month.

Hotel occupancy rate as used in the LEI covers that of Metro Manila hotels only. The monthly hotel occupancy rate is computed as the overall average of the hotel occupancy rates of the four classes of hotels, namely, De Luxe Class, First Class, Standard Class and Economy Class.

Compiling agency: Department of Tourism (DOT)
Money Supply – M1 (MONSUP)
Is defined under M.B. Res. 404 dated 14 February 1975 as consisting of currency in circulation and peso deposits subject to check of the monetary system.

Real money supply is used in the LEI and is computed as the ratio of money supply M1 over CPI multiplied by 100.

Compiling agency: Bangko Sentral ng Pilipinas (BSP)
Number of New Business Incorporations (NEWBUS)
Total of new corporations and partnerships with initial paid-up capital registered with the Securities and Exchange Commission (SEC) during the reference month. The quarterly data is obtained by summing the monthly data.

Source of basic data: Securities and Exchange Commission (SEC)
Stock Price Index (STKPRC)
Measure of the changes in and a tracing of the movement of the average prices, value and volume of company shares of stock traded within the Manila and Makati Stock Exchanges.

Compiling agency: Bangko Sentral ng Pilipinas (BSP)
Terms of Trade Index (TTRADE)
Measures the changes in the prices received for exports in relation to prices paid for imports and is computed by getting the ratio of the export price index to the import price index.

Formula Used:
Total Merchandise Imports (IMPORTS)
Goods coming from foreign countries through a seaport or airport of entry and properly cleared by the Bureau of Customs or remaining under its control, whether these are for direct consumption, merchandising, warehousing, or further processing.

Compiling agency: National Statistics Office (NSO)
Tourist/Visitor Arrivals (TOURAR)
Visitors staying at least 24 hours in the country upon arrival for business purposes, health reasons, official missions or conventions and holiday spending. Excluded from the list are “transit visitors” (change-plane passengers within port facilities); aliens with prearranged employment or any form of remuneration in the country even if length of stay is less than 59 days; overseas Filipinos in home visit; and returning residents of the Philippines.

Compiling agency: Department of Tourism (DOT)
Wholesale Price Index (WPI)
Actual “spot” transaction price imposed by wholesalers or distributors. It is the sum of the producer’s price, wholesale trade margin, tax markups and distribution costs of the wholesaler.

The computation of LEIS uses the 1998 based WPI.
Compiling agency: National Statistics Office (NSO)

D. Limitations In the Computation of the Composite LEI

The main limitation of the LEIS is the use of forecast data for some of the indicators that are not yet available at the time of the LEI compilation/computation. The use of forecast data is resorted to in order to address the timeliness of the release of the composite indicator. As the composite indicator is supposed to provide advance information on the direction of the country’s economic activity/performance in the short run, it is but proper to release it ahead of the reference quarter. The LEIS currently uses the X11 ARIMA software for forecasting data.

The LEI compilation for the third quarter of 2006 made use of X11 ARIMA-forecast data for three indicators, (a) money supply, (b) total merchandise imports, (c) number of new business incorporations and (d) wholesale price index.

Table 4 shows the latest available data for each of the eleven indicators vis-à-vis the minimum requirements.

Table 4. Data Requirements for the Seasonal Adjustment and Computation of the Composite LEI for the Third Quarter of 2006

Indicators		Lead Quarter	Minimum Data Required	Data Available (As of July 20, 2006)	Data Used in Deseasonalization	Data Used in Composite LEI
1.	Terms of Trade Index	8	Q3 2004	Q1 2006	Q1 2006	Q3 2004
2.	Electric energy consumption	2	Q1 2006	Q1 2006	Q1 2006	Q1 2006
3.	Money supply	1	Q2 2006	May 2006	Q2 2006 forecast	Q2 2006 forecast
4.	Total merchandise imports	1	Q2 2006	Apr. 2006	Q2 2006 forecast	Q2 2006 forecast
5.	Tourist arrivals	2	Q1 2006	May 2006	Q1 2006	Q1 2006
6.	Consumer Price Index *	2	Q1 2006	Q2 2006	Q2 2006	Q1 2006
7.	Foreign exchange rate	2	Q1 2006	Q2 2006	Q2 2006	Q1 2006
8.	Number of new business incorporations	2	Q1 2006	Q4 2005	Q1 2003 to Q1 2006 forecast	Q1 2006 forecast
9.	Stock Price Index	3	Q4 2005	May 2006	Q1 2006	Q4 2005
10.	Hotel occupancy rate	5	Q2 2005	Apr. 2006	Q1 2006	Q2 2005
11.	Wholesale Price Index **	2	Q1 2006	Q4 2005	Q1 2006 forecast	Q1 2006 forecast

* CPI (2000=100).
** WPI (1998=100).

Sources of Basic data

Terms of Trade Index – National Statistics Office (NSO)
Electric energy consumption - Department of Energy (DOE)
Money supply - Bangko Sentral ng Pilipinas (BSP)
Total imports - National Statistics Office (NSO)
Tourist arrivals - Department of Tourism (DOT)
Consumer Price Index (CPI) - National Statistics Office (NSO)
Exchange rate - Bangko Sentral ng Pilipinas (BSP)
Number of new businesses incorporations - Securities and Exchange Commission (SEC)
Stock Price Index (SPI) - Bangko Sentral ng Pilipinas (BSP)
Hotel occupancy rate - Department of Tourism (DOT)
Wholesale Price Index (WPI) - National Statistics Office (NSO)

Updated: 31 July 2006