Institutional Investor Asean report: Philippines

Institutional Investor, September 2011

The Philippines is attempting a difficult double-act: reducing its budget deficit while maintaining spending to drive growth. It’s going to be challenging to do both, but the new administration of President Benigno Aquino III is nothing if not ambitious.

The deficit, at 3.74% of GDP at the end of 2010, is rightly a priority since interest payments on debt take money out of the country that is badly needed elsewhere. Already, there has been progress: this year’s target is 3.2% (equating to Ps 300 billion) and looks likely to be beaten, while the long term aim is 2% by 2013.

The theory that this can be done without curtailing growth rests on the creation of a virtuous circle: lower interest costs mean more fiscal space for investment. Indeed, Secretary of Finance Cesar Purisima is so convinced of its merits that he is widely lobbying for a rating agency upgrade, eventually to investment grade (Fitch has it at BB+, the other two at BB).

Is that realistic? “It’s doing well, but it hasn’t established the same sort of track record of success in key areas such as the fiscal deficit that Indonesia has,” says Robert Prior-Wandesforde at Credit Suisse. “While the trend is clear, and there may well be further upgrades, it’s going to be a fairly slow process and I don’t think we will see the Philippines at investment grade for some years yet.” But progress is good. “It’s certainly true to say that the new government has been surprisingly and impressively tight as far as fiscal policy is concerned. A budget deficit of around 3% of GDP, in the context of what’s happening to growth internationally, is not a bad performance.”

It’s the second part of the deal – maintaining spending – where analysts have more doubts. Deficit reduction is “mainly because spending has actually been contracting,” says Luz Lorenzo, economist at ATR Kim Eng in Manila. “Revenues are growing, so that’s fine, but spending has been cut drastically.” Since the government has pledged no new taxes, it has instead focused on reducing corruption.

One of the keys to the Philippines realising its goals is going to be an improvement in infrastructure development. For years, successive governments have tried to get public-private partnership (PPP) initiatives off the ground, to little effect. The Aquino administration has 73 projects in a preliminary list, with a strong focus on tourism, airports, roads, ports and energy. Companies in vogue among investors today, such as Metro Pacific and SM Investments, tend to be exposed to this infrastructure theme. But can headway be made?

On the positive side, the Philippines has made great strides in developing the local currency bond markets, and in particular long-term bonds – which will be a vital source of funding for infrastructure development. Borrowers can now raise funds in decent size up to 25 years domestically, with no foreign exchange risk. This has impressed the market. “The Aquino administration has a clear strategy to improve the debt dynamics of the sovereign by not only reducing reliance on external borrowing but also making a concerted effort to diversify the sources of funds and extend duration of debt,” says Prakriti Sofat, analyst at Barclays.

And new policies ought to help: the government guarantees approvals will come within six months for solicited projects, for example. But it will take time to see if this will fare any better than previous initiatives under other governments. “I went to the Philippines in 2001 and didn’t return until this year,” says Tay at UBS. “In 10 years, nothing had changed. In order for growth to be sustainable in the Philippines, you also need sustainable growth in infrastructure.”