The fatal flaw in the Philippines’ investment-grade bid


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An underdeveloped manufacturing base and revenues dependent on remittances are holding the country back.

Before the March 27 Fitch upgrade, ratings agencies restrained themselves from handing out the much-coveted investment-grade rating to the Philippines amid howls of protests bankers, government officials and academics. They do, after all, have a convincing argument that Standard & Poor's and Moody's are now behind the curve.   The popular, democratically elected government under the leadership of president Benigno Aquino has focused with resounding success on cleaning up the mess left from the previous administration.

As a result, government revenue has increased and the investor community has shown its approval, highlighted by the fact that local-currency debt in the Philippines is much more in demand than that of its peers in Thailand and Malaysia. The Philippines has a current account surplus and is even a net lender, contributing $125 million to the IMF. Yet the Philippines has remaimed a couple of notches below investment grade. One of the issues for Standard & Poor’s is that the Philippines still has a weak fiscal profile and a high interest burden on its public debt. Part of the reason for this is because the country has a narrow revenue base. Indeed, much of the Philippines’ revenue relies heavily on remittances from Filipinos abroad and profits from business process outsourcing – essentially in both cases money generated outside the Philippines. Remittances, in particular, have driven the domestic economy.

Even with the eurozone debt crisis and the global financial crisis, remittances to the Philippines remained robust. But if and when the global economy begins to recover, the Philippines will find itself at a disadvantage because its underdeveloped manufacturing sector, limited exports and over-reliance on remittances mean that the economy isn’t diversified enough to compete at the next level. The manufacturing sector is something that the government hopes will develop faster over time. The problem is that Filipinos are sought-after workers everywhere, but working abroad often comes with better pay, and modern technology allows them to communicate with their loved ones at home. Unless there are other incentives to keep Filipino workers in their home country, the skills needed for a robust manufacturing sector, and a diversified revenue base, will remain absent.

Standard & Poor’s, and other ratings agencies, are right to withhold investment-grade status from the Philippines for this reason. The strength of remittances and the desire for a strong manufacturing base are awkwardly juxtaposed. At the moment, it seems the country cannot achieve a strong manufacturing base with all the most wanted workers stationed abroad.