Financing Dutertenomics

The Forbes article about the potential foreign debt of the Philippines warns about a debt crisis in the future (New Philippine Debt of $167 Billion Could Balloon To $452 Billion: China Will Benefit—May 13). It assumes that China will be the main lender of the $167-billion infrastructure program under the Duterte administration. It concludes that this “will put the Philippines into a virtual debt bondage if allowed to proceed”. Do we agree with this prognosis?

This article seems to miss two interrelated critical points, the Philippine external debt experience and the investment grade rating of the country. First, the Philippines had a difficult external debt condition that was experienced severely in the 1980s through the mid-1990s. With low levels of dollar revenues and falling foreign exchange reserves, the peso has to be devalued a number of times leading to spiraling price increases. Furthermore, the questionable nature of the use of the foreign debt proceeds all the more created political and economic instability. That debt crisis limited the ability of government to deliver basic services, leading, for instance, to massive brownouts in the 1990s. These painful lessons of our overborrowing in the past are in our databases and written in our history. A significant number of people experienced these crises, and many of them would not want a repeat of these. This is why data would show that previous administrations have done their best to steer the country away from incurring more external debts and restructuring them toward the long term. The chart below would show that from highs of close to 100 percent of Gross National Income (GNI) in 1986, the external debt ratio has fallen to its lowest level of about 20 percent of GNI in 2013. It is also important to note that the Philippines has the lowest external debt to GDP ratio among the Asean countries at 24.5 percent of GDP. Malaysia has 71 percent, Indonesia has 34 percent and Thailand has 32 percent. With this backdrop, it is our view that the current administration will be prudent not to go into a borrowing spree without carefully considering our capacity to pay. As for borrowing capacity, the current administration had capped government deficit to GDP ratio to 3 percent. At present, there is enough room to borrow, because the last six years have seen the deficit hover from -0.6 percent to -2.4 percent, which allows for accommodating another 0.5 percent of deficit.

Second, because of improved government financials, the Philippines was able to achieve investment-grade status in 2013. Investment grade essentially refers to the quality of a country’s credit capacity based on its financial strength, future prospects and history. With investment grade also comes better terms for borrowing and wider acceptance. Thus, while the Philippine government has expressed its preference for Chinese funding, it is unlikely that the rates agreed upon will be higher than the investment-grade rates the Philippines should be getting from the financial markets. Currently, comparable 3-year sovereign bonds issued by the Philippine Government is yielding at 1.894 as against Indonesia’s 3.198. The Philippine bond has a spread of 40 basis points, or 0.4 percent higher than the comparable US Treasury Bond of 1.489. The comparable Indonesian bond has a spread of 171 basis points, or 1.71 percent higher. The article assumes interest rates not based on investment-grade rating of the Philippines.

Based on these, we do not agree with the analysis of the article about a looming debt trap. Nonetheless, the article raises a point in regard to the country’s choice of its possible approach in accessing the international market to fund its infrastructure program. The latest government pronouncement about nonacceptance of aid from the European Union may limit market reach from broader sources. It is possible that it could result to a slowing down of new investments from EU, or for EU lenders and investors to ask for a higher rate of return. Hence, it could lead to an increase in interest rates spread notwithstanding the country’s credit rating, making it expensive to access foreign funds.

This move should lead to the government ensuring a better internal financial-generation capacity. This means that the tax-reform package currently being deliberated in Congress had to be passed soonest, and that it will not be significantly watered down. The huge financing requirements of this infrastructure program should be supported internally and externally without unduly passing on the burden to the future generation. With still good GDP numbers (first quarter 2017 at 6.4 percent), the growth momentum is expected to draw more interest into the country in terms of foreign investments and better trade. An interesting development in this first-quarter growth is the strong rebound of the agriculture sector. Its sustained growth could lead to broader and more inclusive development that could support the needed resources for infrastructure investments without need for heavy borrowing.

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Alvin P. Ang, PhD, is a professor of economics at the Ateneo de Manila University and a senior fellow of Eagle Watch, the school’s macroeconomic research and forecasting unit.