By Oonagh Leighton
Can the Philippines avoid Argentina’s fate of defaulting on debt repayments?
When a country’s president talks of the impending threat of default, you know that times are tough.
In something that is beginning to resemble Groundhog Day for the Philippines, this is what happened in February when President Gloria Arroyo warned that the country could face a debt crisis like Argentina’s if fiscal reforms were not accelerated. A similar announcement was made last August.
“It is not a complicated story: everyone knows the problems, and everyone knows the solutions,” says Agost Benard, senior analyst, Philippines at Standard & Poor’s, which lowered the sovereign’s long-term foreign currency rating to BB- from BB in January. The solution is reform. But progress is slow. “This is fairly and squarely a fiscal and revenue problem. The difficulty lies in the political wrangling that is slowing the reform process down,” he adds.
Timing is tight. Arroyo says that crunch time will arrive within two years if urgent measures are not taken to raise revenues and cut the budget deficit, which is forecast to be 4.1% of GDP this year.
In a statement made in February, Arroyo said: “The bottom line is we need to raise Ps80 billion [through] legislative measures and Ps100 billion [through] administrative measures. Otherwise in two years’ time we will be an Argentina.”Tom Byrne, senior credit analyst at Moody’s Investors Services, however, says that the country is unlikely to go down the road of the Latin nation. “The Philippines has some important differences: relatively strong GDP growth, a current account surplus, no IMF programme, and a flexible exchange rate. These help reduce vulnerability to external shocks, and give the authorities some leeway to focus on the domestic fiscal problem.”
Maybe ...
Christa Janjic, economist at UBS in Singapore, is also cautiously upbeat about the country’s prospects. “Our latest visit to the Philippines leaves us more confident with our recently changed more positive view on the country’s perennial fiscal issues.”
She says that 2005 could be a good year. “Budget targets, calling for a further reduction in the deficit, look achievable, and the high debt-to-GDP ratio could start falling,” says Janjic. She warns, however, that fiscal reform is critical. “A failure to pass a meaningful VAT bill would probably not put this year’s targets at risk, but would stall any further progress beyond 2005.”
The country’s debt burden is stark. Net general government debt (excluding guaranteed contingent liabilities of non-financial public enterprises) was about 73% of GDP last year, according to S&P. This compares with a median level of 39% for similarly rated sovereigns. Non-financial public sector debt was about 110% of GDP in 2004. That’s almost twice that of the double-B rated median, said the ratings agency in the report that announced the sovereign’s downgrade.
Another problem is that interest payments are likely to consume 40% of central government revenue this year. This is substantially higher than the 22% spent in 1999, says S&P.
Pivotal to curbing this debt mountain is the successful implementation of the government’s fiscal reform programme. A total of eight tax reform measures have been put forward. So far only two have passed into law, both substantially watered-down versions of the original: the Excise Bill, otherwise know as the ‘sin tax bill’ and the Lateral Attrition Bill.
“The government is serious about solving the fiscal sector problem. Measures are in place to correct the fiscal gaps through improved revenue collection and progress in the legislation of tax bills,” says Gabriel Singson, who is the under-secretary responsible for privatization at the ministry of finance.
“The strong pick-up in revenue collections are a reflection of both the administrative and the newly legislated measures that are now in place, such as the increase in excise taxes for alcoholic beverages and tobacco products. [In addition] the passage of the Lateral Attrition Law provides for sanctions against underperformance in the two major revenue agencies, the Bureau of Internal Revenue and Bureau of Customs.”
Third dimension
The sticking point lies in the third reform measure aimed at hiking VAT from 10% to 12%. “This is by far the most important of these reforms. It is expected to raise between Ps30 and Ps65 billion in taxes, depending upon the form under which it is passed. It is significant not only because of the magnitude of revenues it will raise but also because of the relative ease of administration,” says Benard.
In February the Senate passed its version of the bill and it is now in discussion with Congress. “Some sort of compromise between the House and the Senate version is almost certain,” says Janjic. “At best we believe we will see a 1% increase in the VAT rate and removal of all exemptions.” She estimates that the removal of exemptions would boost tax revenue by 0.2% to 0.3% of GDP and a 1% increase in the tax rate would generate 0.25% of GDP.
Overall tax collection must improve. “If you consider that in a country of 85 million people only 3-3.5 million are registered taxpayers, you can see that there is a major problem in tax collection. It is just not happening,” says Benard.The privatization of the National Power Corporation is also urgent. Fixed electricity tariffs mean that the company is not able to break even, let alone make a profit.
Some positive news came with the sale of one of the company’s power generators for $570 million at the beginning of this year but much remains to be done.
Under-secretary Singson says that the government intends to sell several big ticket assets. “Some of these are the government shares in the Philippine National Bank (PNB), Philippine National Oil Company – Energy Development Corporation and Manila Electric Company. We also plan to dispose of certain big real estate properties.”