RP Blessing

Commentary: For the Philippines, credit downgrades may be a blessing

By William Pesek Jr. Bloomberg News

ING Bank analysts recently made an odd announcement: Philippine dollar-denominated bonds are the "most attractive" among Asia's sovereign debt issues. Didn't they notice that two major international rating companies had recently downgraded the credit of the Philippines?

 

Actually, ING's analysts are well aware of the country's fiscal difficulties.

 

Budget deficits here are bloating the national debt, which has risen 75 percent since Gloria Arroyo became president in January 2001. Yet ING analysts may be justified in giving Arroyo, a trained economist, benefit of the doubt.

 

"We believe 2005 could be a breakthrough year for the Philippines, when growth breaks out on the upside and fiscal woes diminish," ING said in a recent report.

 

There are myriad reasons to be skeptical about an economy that is increasingly referred to as the Argentina of Asia. Investors do not soon forget when nations declare a moratorium on foreign debt payments, as the Philippines did 20 years ago and Argentina did in 2001.

 

Convincing markets that Philippine debt will not spiral out of control is a challenge in the best of times. But these are reasonably good times for the Philippines. The economy is growing at a pace of around 6 percent, a rate that the United States, Europe and Japan can only dream of. And Arroyo isn't facing an election, as she did in 2004.

 

The Philippines now has an opportunity to reduce the budget deficit and ensure that more of its 86 million people share in the economy's growth. It should also remind investors that the nation has solid, investment-worthy companies, as well as outsourcing industries with attributes they may not find in China, India or Malaysia.

 

The government should also inform travelers that Indonesia, Thailand and Vietnam don't have monopolies on beautiful tourist destinations. In short, this is an occasion to remind the world why it should not sell the Philippines short.

 

Will the government take advantage of this opportunity? There is reason to be optimistic, and, as counterintuitive as it may seem, the Philippines has Moody's Investors Service and Standard & Poor's to thank for that.

 

Both rating companies cited the nation's deficit when they cut their Philippine ratings this year. Just 10 days after the downgrade from S&P, the House of Representatives voted to increase the value-added tax to 12 percent from 10 percent. Doctors, lawyers and oil importers are being called upon to pay taxes for the first time.

 

A sense of crisis is sometimes needed to prod politicians into action. Only such pressure, it appears, will force this nation's bureaucracy to make necessary compromises.

 

Let's hope that dynamic stays in place. If the Philippines can't get things on the right track while its economy is growing at 6 percent, when can it?

 

Unfortunately, the Senate ended a recent special session without passing the House of Representatives' tax bill. Doing so would not only bolster tax revenue to narrow the budget deficit and ease concern that the nation will default on its debt, but it would also send a message that the government is committed to reform efforts.

 

Explaining why it didn't happen, the president of the Senate, Franklin Drilon, said: "We don't want to rush."

 

Yes, you do want to rush, Senator. Otherwise, markets will grow even more impatient.

 

So far, investors do not seem to be panicking. The difference in yield between the Philippines' 8.25 percent bond due in 2014 and comparable U.S. Treasuries has shrunk to 3.99 percentage points from 4.24 percentage points four months ago.

 

Yet investor tolerance is a finicky thing. When it comes to budget deficits, the Philippines really is different. The United States, which has no track record of default, gets the benefit of the doubt from investors even as its record budget deficit widens apace. The Philippines lacks the same fiscal latitude.

 

In January, the Philippines held its biggest overseas debt issue, selling $1.5 billion of 25-year debt. It may sell another $2 billion by the third quarter. Showing global markets evidence of fiscal progress would lower its financing costs.

 

A third of the annual budget now goes to interest payments. Lower borrowing costs would leave one of Asia's more fragile economies more money for schools, health care, roads and bridges. Considering that a third of its population lives on less than 60 U.S. cents a day, the Philippines could use all the extra cash it can find.

 

Like all windows of opportunity, this one may not stay open for very long. If the Philippines uses it wisely, its bondholders could be a happy bunch.