AN ANALYST AT a US investment bank is cutting about the Philippines government. “They have no credibility,” she says. “They are so bad that I can’t even bring myself to listen to them any more. And my clients are losing faith.”
Unfortunately for the Philippines, this is not a lone renegade voice condemning the performance of president Gloria Macapagal Arroyo’s administration. It’s a view echoed by many. The head of global markets at another bank with pan-Asia coverage says: “On paper the players look technically very impressive, and they give the best Powerpoint presentations, but they continually fail to deliver. Their credibility is severely stretched.”
In just two years, the goodwill and support that Arroyo and her band of technocrats claimed when she stepped into the shoes of the disgraced Joseph Estrada have been frittered away. Her plans to stamp out corruption, increase tax revenues, rein in a stampeding budget deficit, privatize state assets and tackle poverty are in tatters. “There’s a real danger that Arroyo’s legacy will just consist of a boulevard named after her father on a piece of reclaimed land,” says a disheartened banker in Metro-Manila.
For all Arroyo’s efforts, corruption is still endemic. Funds collected by the Bureau of Internal Revenue are, as a percentage of GDP, at 14-year lows, struggling at around 14%. And last month, anti-money-laundering legislation, watered down by vested interests, was rejected by the Paris-based Financial Action Task Force. If amendments are not received by FATF by March 15, damaging sanctions will be imposed on the Philippines that, among other things, will affect the $6 billion lifeline of remittances from expatriate Filipino workers.
In addition to these problems, the budget deficit as a proportion of GDP is the largest since 1985. The target set by the government was P130 billion. It came in at a disastrous P212 billion ($3.9 billion) or 5.4% of GDP. The public debt burden grew by 13% last year to 79.5% of GDP, of which 56% is foreign-held debt. It was announced in the middle of February that 29% of this year’s budget would go towards interest payments on its debts. And the long-awaited privatization of the National Power Corporation seems to come up against obstacle after obstacle. A downgrade by the rating agencies is believed to be only a matter of time, making it more expensive for the sovereign to issue debt in order to plug the holes.
And the peso is coming under greater pressure. It now hovers at a two-year low against a globally depreciating US dollar. In February it slipped through the key P54 to the dollar mark, a decline of just under 10% since the middle of last year. Its performance against the euro has been even poorer, slumping 24%. Many economists and analysts predict further weakening, heaping yet more pressure on the sovereign as it attempts to service its foreign-currency debt obligations.
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Central bank governor Rafael Buenaventura seems unconcerned and publicly blames the fall in the value of the peso on external rather than internal problems. “Confusion and the fear of the unknown are causing exaggerated reactions,” he says. “Have people forgotten that two years ago it was at 55 and people were saying it was going to 100. It’s a question of will there be war and will there be oil disruption? Obviously that means higher expenditure, inflation and interest rates. So it should be at this level where we are today.”
Arroyo and her team, however, know that they are running out of time and space to manoeuvre as investors and the markets get ever more jittery. Finance secretary Jose Camacho tells Euromoney: “We are concerned about the credibility issue and the views of the market but all we can do is change their views with better performances.”
On December 30 2002 this culminated in Arroyo standing before her compatriots to announce that it was time to get serious. She would not, she claimed, be seeking re-election in 2004, freeing her from politicking to concentrate on policies. She called on all Filipinos to join her in the fight to stamp out corruption and tax evasion and so regularize the country’s finances once and for all.
Speculation about motives
But just two months after her declaration many are beginning to question her motives as investors and bankers wait for the dividends to appear. Cynics say that withdrawing her name from the race is an easy way not to be beaten. After all, her popularity rating is on the slide. Others believe she has only succeeded in throwing away any political strength she may still have possibly held, so reducing her effectiveness. The head of debt at a European house says: “I don’t quite understand why she would want to make herself a lame duck 18 months before the next election. Who will align themselves with her now? I can’t see how this helps the country. They have foreign debt and it makes us nervous.” Although some investors are still prepared to wait a little longer on the promises that the corner is about to be turned, others are beginning to slap the table. Last month, Wilshire Associates, adviser to California Public Employees Retirement System (CalPERS), described the Philippines to its client as “one of the least investable emerging markets”. If finance secretary Isidro Camacho had not immediately flown the US to soothe the nerves of those managing the $133 billion fund, $30 million would have quickly disappeared out of the country’s bonds, sending yet another stark message to other investors.
For analysts, though, it’s the budget deficit and lack of revenues that cause most concern. And whether the administration likes it or not this fiscal deficit is regarded as the litmus test for Arroyo’s and Camacho’s ability to manage the economy.
Under Estrada the deficit was getting out of control. Arroyo, in her first year, was not able to reduce it but at least held it to 3.3% of GDP. It was heralded as a success and there was a premature belief that the Philippines could shed its reputation as a country of unfulfilled potential.
But in 2002 the government target was missed by P82 billion, destroying the good work of the previous year and damaging reputations. “Whatever targets you set yourself you had better come close to hitting them or you will be criticized for not running the economy correctly. And unfortunately it missed them by a large margin. And while everyone else knew that the targets weren’t going to be hit the government kept insisting it would,” says Tom Crouch, director of the Philippine country office at the Asian Development Bank, based in Manila.
In an attempt to massage the costly failure, the spin doctors went into overdrive. When the government realized that its claims of being able to hit the target were becoming indefensible, the now irrelevant number of P130 billion was described as a fighting target. “It was a case of them realizing that they were going to miss it, but that they needed to have some sort of benchmark,” says Crouch.
Towards the end of the year, when it was apparent that this was starting to sound ridiculous too, the peso value of the deficit was dropped in favour of describing it in terms of a percentage of GDP. But all this really did was to further call into question the credibility of those in charge. “Investors are clearly concerned about the Philippine government’s ability to restore fiscal discipline following the 2002 budget deficit blowout. It is important for 2003 government spending to stay within plan, particularly since 2002 expenditure exceeded projection by 3.2%. The government’s credibility is also on the line in respect of the revenue side. The market will be looking for revenue improvement driven by measures introduced last year to address deficiencies at the Bureau of Internal Revenue (BIR) and Bureau of Customs (BOC). It is noteworthy that collections at the BOC are above plan for the first two months of 2003 but the BIR revenues were below plan in January,” said Dilip Shahani, senior fixed-income analyst at HSBC.
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Manila market street: As the economy grows |
The bitter reaction of analysts and investors is a wake-up call. And it has prompted a re-examination of what can be achieved. So now the new and supposedly more realistic target set for the 2003 budget deficit is P202 billion, or 4.7% of GDP. But in the market there are few who believe that the number set is achievable. JPMorgan, for example, believes that by the end of the year it will be closer to P240 billion. The market’s average forecast is P220 billion.
Even though many bankers agree that a somewhat more realistic target has been set, merely setting it still doesn’t address the fundamental issues. And the Philippines will still have to finance the shortfall somehow, cementing its reputation as the most frequent Asian sovereign borrower in international markets. “Yes, admittedly it doesn’t solve the issue of the deficit,” says Sergio Edeza, treasurer of the Philippines, when it’s suggested that even if the government comes close to the target this year it still has a problem. “However,” he says, “the shortfalls last year were because the revenue targets were set to an ambitious level. So efforts are being exerted to improve revenue collections.”
Something has to be done quickly because very bearish credit analysts are starting to draw alarming comparisons. “I think the Philippines is going under,” says one. “It’s just like Argentina. It kept borrowing money too and ignored the reality that it was heading for meltdown.” Though this is an extreme opinion, there’s a growing sense that the present state of affairs can’t continue.
Since the second half of last year the sovereign has been to the international markets six times, the issues having included two $500 million deals in November and January and a disappointing e300 million issue in February that failed to attract the expected demand. “While its debt levels are serviceable for now, the concern is that the country may get trapped in an ever growing debt spiral a few years down the road if the debt levels are not tightly managed,” says Michael Hellbeck, Deutsche Bank’s Philippines chief country officer, though he adds, “however such a scenario is in our opinion unlikely.”
The head of one of the country’s lead investment bank advisers says: “If they continue borrowing substantially more than their revenues for two more years it will be OK. But in year three if the markets are choppy and the problems aren’t addressed, investors will stop putting money into the tale, just like they did with Argentina.”
With all the uncertainties arising from the possibility of war in Iraq and knowing that the country has this shortfall to finance, the Philippines has grabbed as much money as it can as fast as possible. Of the declared $2.4 billion that the government says it will need to borrow this year, it has already managed to secure $1.5 billion. The borrowing team has been busy.
In the Intramuras, set in the old section of Metro-Manila, state treasurer Edeza sits in an understated office, which has a large community room next door where some 40 women are singing – sometimes screeching – karaoke. He doesn’t raise his voice but just leans forward and stares straight ahead as he discusses the state of the Philippines’ finances. “Because of the uncertainty we believe it is best to borrow now,” he says calmly, with the beat of a Filipino love song playing in the background. “It means that the pressure to borrow in the coming few months will not be as great. We will be in the market for a further $900 million but we will be watching the market for the next two or three months to see how the Iraqi situation will be resolved.” In the background faint clapping and lots of laughter can be heard.
Sovereign credit analysts remain unconvinced. One says: “They tell everyone that they have done half of their borrowing and it’s not even February. They will then go out and get the $900 million and then brag that they have done it all. But everyone knows that they have to pre-fund 2004 as well. And in an election year, because of the uncertainty, they have to pre-fund this in the second half of this year. It’s a never-ending cycle.”
Strangely, the Philippines is presently enjoying one advantage: there are fewer places for emerging-market investors seeking high yield to park their money. Argentina is defunct and for many Brazil is too speculative. This really only leaves Turkey and the Philippines. But for these sovereigns funding is starting to come only at a price. The Philippines’ December Eurobond was priced at around 8.5%. This year’s deals are up to around 9%.
Observers believe that if this trend continues it will soon become too expensive. “I don’t think that the Philippines will go the way of Argentina because I think it will go double digit and it will just be priced out of the market,” says a regional head of debt. “I also think that they will have a deal that goes horribly wrong and will be forced to borrow internally.”
The investment banks’ own desperation for business further clouds the picture. And bond investors should be wary that while country and credit analysts discuss comparisons with Argentina on a not-for-attribution basis, their banks are still pitching like crazy for mandates. Caveat emptor.
A banker from a firm that worked on the country’s last bond issue just says that when one of the deals does go wrong, there will be some unfortunates left holding a lot of paper. It won’t, he says, be a pretty picture. When asked if he believes that the banks are in some way responsible for dragging the Philippines into a quaqmire of debt by continually pitching cheap deals, he shifts the blame. “I may supply the heroin,” he says, “but I’m not responsible for creating the addiction.”
The government still has a domestic market full of liquidity that it could fall back on. But even here there are warning signs of investor resistance. On the past couple of international offerings the domestic banks have been a little more hesitant to step up to the plate and take down the sovereign’s paper. Offers by the local banks for government treasuries are for now being rejected.
Edeza says: “They are not of the same calibre as the international banks. They are testing to see how much we are willing to pay. They think that we will budge and give them a higher rate. We will not back down and they will start buying again. The market cannot bluff for long and they will have to invest eventually.”
If these disagreements are to become a thing of the past, the government needs to start concentrating on revenue collection rather than improved methods of borrowing. But as is pointed out by many, the Philippines has a reputation for waiting for near-disaster before any action is taken. “If we were writing it we would say that there is a lack of proactivity rather than that,” says the ADB’s Crouch. “But that sums it up pretty nicely.”
And a degree of complacency can perhaps be explained because the country has shown reasonable macroeconomic indicators apart from the deficit. The economy grew 4.6% last year, although this was mainly consumption-driven.
Crouch says worryingly: “We don’t see the pillars or foundation that will allow growth sufficient to make serious inroads.”
Arroyo has 15 months left in which to build them. Following her announcement that she will not be running for office in 2004 will she just become the lame duck that some people suggest? Secretary Camacho thinks that’s unfair.
“It’s a comment from someone who does not appreciate our challenges. She has made a sacrifice and recognized the need to step down because politicking was blocking the agenda. There is a push for key legislation that prior to her announcement might have faced more resistance.”
