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Investing a mountain of debt?


In a sense, it was something to be proud of, that Department of Finance announcement the other day that investors swamped the National Government’s second overseas $3-billion bond sale. The bond sale consisted of three buckets of maturities with interest rate ranging from 4.74% to 5.5%. Oversubscription at $28.2 billion allowed our Treasury to upsize the offering from $2 billion to $3 billion.

This bond sale followed the maiden offering of the Bongbong Administration amounting to $2 billion in October 2022. The pricing was reportedly tighter than expected, with strong support from institutional investors.

In the many times in the past that we participated in similar fund-raising exercises for the Republic, such robust demand would indeed be considered as “a strong vote of confidence by foreign investors.” For National Treasurer Leah de Leon, it was a reaffirmation that Philippine credit is a favored proposition during these uncertain times and dimming global prospects.

But why is a resilient and favored economy like the Philippines borrowing big from the external capital markets?

This is to help finance the budget deficit.

For 2023, the Development Budget Coordination Committee (DBCC) announced that the National Government (NG) is looking at a fiscal deficit of P1.471 trillion or a huge 6.1% of GDP as a result of the large excess of public spending, programmed at P5.177 trillion, over public revenues, expected at P3.707 trillion.

This new borrowing, plus all other prospective borrowings from both local and foreign capital markets, will increase the stock of public debt that will have to be serviced as they fall due. The latest Treasury report put the outstanding NG debt at a record-high P13.644 trillion as of the end of November 2022. The latest bond sale will increase the external debt component that reached P4.22 trillion or 31% while domestic debt ended November 2022 at P9.43 trillion or 69%.

The estimated NG debt-to-GDP ratio as of the end of September 2022 was nearly 64% compared to only 40% prior to the pandemic in 2019. For external debt alone, the estimated ratio with GDP was 20% against 2019’s 13%. While elevated, these debt ratios remain manageable because of the prospects of sustained economic growth for the next six years.

The DBCC also announced the target real GDP growth of 6-7% this year and 6.5-8% for 2024 through 2028. Fiscal deficit is expected to taper off from 6.1% this year down to the pre-pandemic levels of 3% by 2028. With lower fiscal overhang, the propensity to borrow is expected to decline.

From a sustainability perspective, these growth and fiscal deficit projections are highly desirable.

What is also promising is the implementation of the 2022-2028 Medium-Term Fiscal Framework (MTFF) that aims at consolidating the resources of the NG to be better used. This is expected to usher in a high-growth path that is sustainable through 2028 as it ensures consistency of budget programs with the MTFF.

It would certainly bring in a lot of public goods if the top five priorities are pursued and attained: education, public works and infrastructure, health, social welfare, and agriculture.

What are the wild cards, the risks, to this positive scenario for the next six years?

Last year, the Philippine Institute for Development Studies (PIDS) released an analysis of the 2023 President’s Budget authored by Justine Diokno-Sicat, Robert Palomar, and Mark Ruiz. In this paper, the three authors projected that the Philippines’ debt to GDP ratio would peak at 66.2% in 2024. Henceforth, it would gradually decline. Following another recent PIDS paper on assessing public debt sustainability in the Philippines by Margarita Debuque-Gonzales, Diokno-Sicat herself, and John Paul Corpus, they also identified several risks to the country’s goal to attain fiscal and debt sustainability.

A major risk is the possibility of a policy reversal that “would compromise the previous improvement of Philippine debt.” A good example of policy reversal is the proposed Maharlika Investment Fund because it would effectively deprive the NG of some of its precious revenue sources that include dividends from the Bangko Sentral ng Pilipinas (BSP), LandBank, Development Bank of the Philippines (DBP) and other government-owned and -controlled corporations including the Philippine Amusement and Gaming Corp. (Pagcor) and other public gambling casinos. Instead of being counted as revenues, their dividends will be earmarked directly to fund the Maharlika fund.

We are not talking of peanuts here.

Between 2016 and 2021, total dividends of corporate public agencies averaged P69 billion. If we add the BSP’s average remittances of nearly P14 billion during the same period, we are looking at over P80-billion foregone revenues that would have to be covered by higher borrowings. In six years, they sum up to around P480 billion. At an exchange rate of P55 to a dollar, that means the NG will have to sell bonds worth more than $8.7 billion.

It is not a stretch but we need to stress that what the Maharlika effectively does is to push NG to borrow money to compensate for that part of its revenues that would be sequestered by Congress to fund Maharlika. The authors of the bill should be able to demonstrate that the fund, under a global recessionary condition, could generate a return to investment higher than, for instance, the all-in cost of the latest bond sale of the Republic.

With all the fundamental objections to its concept, viability, and even governance, it would be difficult to support its potential benefit in mitigating the country’s debt and fiscal deficit. It needs to make a mountain of debt to have the funds to invest. That is the long and short of Maharlika.

The other risk comes from macro-fiscal shocks. We believe the likelihood of this risk materializing is quite high because the pandemic is still around and raging in countries close to the Philippines. The peso-dollar rate remains precarious because the country’s current account and overall balance of payments positions are both in deep negative territory. Policy rates are also likely to continue rising because inflation is entrenched above the 2-4% inflation target. Geopolitical tension remains high because aside from the Ukraine and Russian hostilities, China and the US are engaged in some low-intensity conflict. Aggregate demand could be undermined because inflation remains elevated while the global economy is preparing for a recession.

The implementation of the Supreme Court’s ruling on the Mandanas-Garcia case is also a budget nightmare. As we wrote two years ago in this column, between the goal of helping grow the economy and keeping fiscal sustainability, the Supreme Court’s ruling “threw big rocks at the wheels.” The High Court prescribed that the calculation of the local government’s share or what is now called the National Tax Allotment (NTA) should be changed from 40% of national internal revenue taxes collected by the Bureau of Internal Revenue (BIR) to 40% of “all” national taxes including those coming from import duties and other taxes collected by Customs.

An earlier PIDS paper written by Rosario G. Manasan cited a DBCC estimate that the NTA allocation would increase from P847.4 billion in 2021 to P1.1 trillion in 2022. For 2023, some P820 billion is envisioned for distribution to local government units. That is easily 21% of the P5.268-trillion national budget. This is an incremental expense that would be carved out of the national budget. With all those intelligence, confidential, and pork barrel funds tucked into the budget, the NG would literally squeeze blood from stone. As usual, borrowing is easier done than introducing new tax measures when the population could hardly afford onions, sugar, rice, and corn.

Finally, the PIDS paper identified two additional risks: net losses of PhilHealth (Philippine Health Insurance Corp.) and the military and uniformed personnel pensions. Our own take is that while the alleged net losses of PhilHealth, amounting to as much as P154 billion, has been the subject of controversy, some independent actuarial assessments consider PhilHealth non-viable if all claims are serviced promptly by the state insurance.

On the other hand, the cost of the military and police pension immediately hurts the budget. As it is unfunded and non-contributory, the retirement benefits are indexed to the plantilla position of the incumbent so that the payout literally explodes at some point. If this set-up is not restructured, this pension system would likely incur a P9.6-trillion unfunded reserve deficit. As expected, Congress is now apprehensive that the budget will fail to meet this enormous funding requirement.

This is indeed “an imminent existential threat.”

All up, while the Philippine government currently runs a sustainable fiscal position, the fiscal space might start dwindling. What is worrisome is that the ability of the government to raise revenue, or tax buoyancy, is higher in the short run than the long run which is more relevant for building fiscal sustainability.

While sustained economic growth is quite promising because of the resiliency brought about by past policy and structural reforms, the risks are rather formidable and they are easy to materialize into real challenges. We might end up incurring more debt to keep the momentum of growth, or keep the image of an investing economy in this uncertain and unfriendly new world.

Diwa C. Guinigundo is the former deputy governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was alternate executive director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.

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