Why the Philippines needs a financial crisis
 
Philip Bowring IHT
Tuesday, August 31, 2004
Disastrous debt
 
HONG KONG The Philippines needs a real financial crisis, and the earlier the better. Unless there is a minor crisis soon that brings Philippine politicians and international lenders to their senses, a much worse one awaits. There would be major global reverberations from default by a major borrower that has been under the wing of the International Monetary Fund for so long. It would be another reminder of how little the international financial architecture has been reformed since the Asian and Argentine financial crises.
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When President Gloria Macapagal Arroyo said last month that the Philippines was "in the middle of a fiscal crisis" her words caused a small drop in the peso and a rise in Philippine government dollar bond yields. The market reaction seems modest if one were to take her words at face value. And it was unfortunate that the general political reaction in Manila was that the newly elected president was scaremongering in an attempt to persuade Congress to approve tax increases.
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Arroyo was speaking the truth, knowing that unless she gets a grip on the fiscal situation the crisis could be of Argentine proportions, perhaps sweeping away her government as well as much else. Arroyo's warning originated not from a foreign hedge fund or think tank or an international lending institution but from a sober study of the fiscal arithmetic by a group of the Philippines' most respected economists, some with ministerial experience.
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The Philippines' crisis is a one-off situation, brought about by government debt, and does not threaten a return of the Asian crisis, which was mostly caused by private debt. While the rest of Asia has been on a recovery path since 1997 and 1998, Philippine finances have been gradually deteriorating. This may not be obvious given that growth of gross domestic product has been running at a respectable rate, by Philippine standards, of 4.5 percent. And the Philippines' current account is, unusually, in surplus.
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The crisis is summed up in a single figure: accumulated public sector debt estimated at 130 percent of GDP. Of this, two-thirds is government debt - half in foreign currency - and the rest that of state-owned, quasi-commercial entities. A portion dates from the 1980s, but the Marcos era is now an outworn excuse. Despite constant promises to improve tax collection and raise prices for utilities, the annual total public sector deficit is stuck at 6 percent of GDP.
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The deficit is not primarily caused by profligate spending. Although "pork" for local politicians has been growing, outlays on education and vital infrastructure have been declining. Government revenues have fallen from 17.5 percent of GDP in 1997 to 12.5 percent. This is partly the result of high levels of tax evasion and corruption. But these have always existed. Equally important have been a raft of tax concessions willed by a weak executive and irresponsible Congress. Meanwhile, public debts off the balance sheet have escalated because of the government's deliberate failure to raise power tariffs, fuel and vehicle taxes and other imposts that mainly hurt metropolitan higher-income earners.
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The situation has been gradually deteriorating despite years of IMF programs and surveillance. For a mix of reasons - including Manila's relationship with the United States and the IMF's fear of attracting the kind of unpopularity that the Asian crisis brought - the Fund has not been using a big stick.
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Meanwhile, inward private capital flows have continued to be driven by the needs of the international investment banks to receive bond sale mandates. No matter to them that their clients know little of the unvarnished truth of Philippine public finances and are taking on risk out of all proportion to the interest differential on Philippine paper. Yields on Philippine government dollar bonds are now double those on U.S. equivalents and even above those on Indonesian debt. But they need to go a lot higher to reflect the real risk, or to drive the government out of the bond market and force a reality check on the nation.
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Ease of access to foreign capital for nonspecific purposes is a snare for the borrower. Neither the Asian nor Argentine crises have changed the international financial culture of lending dollars to fill budget gaps rather than increasing investment in income-generating projects. Big dollar debt means that the Philippines cannot readily inflate its way out of its national debt problem. The resultant sharp decline in the currency would simply increase the cost of servicing the foreign portion.
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If Philippine politicians and officials do not bite the bullet soon, watch out for a peso collapse and an Argentine-style foreign debt default long before Arroyo has served her term.



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