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Blind debt in the
Philippines
By Jephraim P
Gundzik
By all accounts, the public sector
debt burden of the Philippines is unsustainable.
The fiscal deficit, as measured by the
all-inclusive public sector borrowing requirement
(PSBR), has averaged 5.7% of gross national
product (GNP) over the last four years. During the
same period, the average annual rate of real GNP
growth has been a modest 4.6%. So economic growth
has not been strong enough to offset the growth of
PSBR. As a result, the public sector debt stock
has increased from 123% of GNP in 2001 to an
estimated 143% of GNP at the end of 2004.
Interest and principal payments on the
public sector debt have increased from 39% of
total national government expenditure in 2001 to
68% of total national government expenditure in
2004. The growing burden of public sector debt
service has led to sharply lower public sector
investment and severe cuts in social expenditure.
Contracting investment and social expenditure has
weighed on economic growth, helping to push the
debt stock higher.
The foreign debt of the
public sector is equivalent to about 60% of the
total public sector debt. About half this foreign
debt is dollar-denominated, while the rest is
primarily yen- and euro-denominated. The weakness
of the peso against the dollar, yen and euro over
the past several years has pushed both the foreign
debt stock and foreign debt service payments
higher. Similarly, an increase in the annual
average interest rate for 91-day Philippine
T-Bills from 5.43% in 2002 to 7.34% in 2004 has
increased the cost of domestic public sector debt
service.
The public sector debt burden has
grown sharply since the coup that placed Gloria
Macapagal-Arroyo in the presidency in 2001. The
stock of public sector debt has grown inexorably
while the cost of public sector debt service has
leaped higher. Only sharply higher economic
growth, declining domestic interest rates and peso
appreciation can stop the deterioration in public
finances. Unfortunately, such a confluence of
positive events is extremely improbable.
The Arroyo government and the
economy
Although the Arroyo government
increased excise and corporate taxes in 2004 and
2005 and won the ability from congress to raise
VAT (value-added tax) rates in 2006, these
measures are unlikely to improve the state of
public finances. The increase in excise tax
revenue is relatively small, while higher
corporate taxes will undermine investment,
employment and wages, pushing economic growth
lower. Slower economic growth will reduce fiscal
revenue, just as social unrest sparked by an
eventual VAT rate hike will undermine economic
growth and fiscal revenue. Increasing political
instability will both weigh on economic growth and
paralyze government policy.
President
Arroyo has been on the ropes since her re-election
last May. Charges of electoral fraud from Arroyo's
main rival in the presidential election, Fernando
Poe, dissipated only to be replaced with growing
social instability. This instability, reflected in
widespread and violent labor strikes in protest
against low wages and increasing energy prices,
further undermined the already weak legitimacy of
the Arroyo government in 2004.
This year,
social instability has been attenuated by the
Arroyo government's fiscal policy and the
continued rise of energy prices. At the same time,
accusations of corruption leveled against Arroyo's
family members have become persistent. Ironically,
identical accusations of corruption, centered
around jueteng (underground lottery) payoffs,
brought down Arroyo's predecessor Joseph Estrada.
Finally, last year's charges of electoral
fraud have come home to roost again. If President
Arroyo survives, which appears increasingly
improbable, her ability to govern the Philippines
will be severely limited. The result will be
further deterioration in public finances. If
popular revolt drives the collapse of the Arroyo
government, as happened to Ferdinand Marcos in
1986 and Joseph Estrada in 2001, first aid for the
Philippines' public finances is by no means
guaranteed. Economic growth only accelerated
modestly in 1987 and 2002.
A repeat of
such modest growth acceleration is likely in 2006
but only after economic growth slows in 2005. More
interestingly, Arroyo's political opposition has
toyed with the idea of default as a means to boost
economic growth and social welfare. This idea has
gained momentum in the Philippines following
Argentina's successful debt restructuring that
reduced that country's external debt burden by
about 70% and boosted economic growth.
It's midnight, do you know what your
bonds are worth?
Investors appear oblivious
to the precarious public finances of the
Philippines and the growing probability that the
public sector debt stock and debt service costs
will increase further over at least the next 18
months. In fact, with Philippine international
bond spreads hovering around 430 basis points over
US Treasuries, the country's external bond prices
reflect zero risk that public finances will
continue to deteriorate and result in default.
Investors were equally blind to the risks
of deteriorating public sector finances and
default in Russia in 1998 and in Argentina in
2001. In January 1998, Russia's international
bonds were trading around 800 basis points over US
Treasuries. Despite weakening domestic economic
conditions and falling international oil prices,
Russia's bond spreads tightened to 750 basis
points over Treasuries in May 1998. The collapse
of Russia's stock market in August 1998 pushed
bond spreads to 1,000 over Treasuries, about where
they were when Russia announced its default in
September 1998.
Argentina's international
bonds were priced to yield about 500 basis points
over US Treasuries in February 2001. Increasing
political and social instability pushed
Argentina's bond spreads to about 800 over
Treasuries by mid-2001. The country's mega debt
swap in July 2001, which actually increased debt
service costs, pulled bond spreads back under 600
basis points over Treasuries. By November 2001,
spreads were about 1,800 basis points over
Treasuries, where they stayed until the country's
default in December 2001.
International
bonds of both Russia and Argentina traded around
7,000 basis points over US Treasuries within three
months of each country's default. Eventually
Russia restructured its defaulted external debt,
giving investors about 55 cents on the dollar.
Argentina paid about 30 cents on the dollar in its
restructuring. Default in the Philippines is not
only possible, it is probable over the next 12
months. Tight spreads for the Philippines
international bonds today may well prove a
contraindicator for what these bonds will be worth
in 2006.
Jephraim P Gundzik is
president of Condor Advisers Inc,
which provides emerging markets investment risk
analysis to individuals and institutions
worldwide.
(Copyright 2005 Asia Times
Online Ltd. All rights reserved. Please contact us
for information on sales, syndication and republishing.) |
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