Public finance less of a drag

Credit rating agency Fitch Ratings yesterday said in a new report that the Philippines’ public finances have become less of a drag on the sovereign credit profile.

He said that the uplift of the revenue base merely replaces revenues foregone from measures taken by previous administrations.

The Aquino administration, he pointed out, has improved the quality of public spending by increasing fiscal transparency and reducing corruption leakages to deliver more equitable economic growth.

“In 2011, these efforts impeded budgetary execution and dragged on GDP growth. Subsequent acceleration of spending has supported GDP growth in 2012 and the effectiveness of expenditure appears to have improved. This should enable greater levels of public investment over the long term and may support higher trend GDP growth,” Colquhoun said.

He also said that gains have been achieved in the absence of a formal fiscal framework. While not a constraint to the ratings, he said that establishing a formal fiscal framework could ease concerns about the durability of improvements in the public finances, especially as institutional structures in the Philippines are regarded as weaker than those of many peers.

Strong GDP growth and the implementation of active liability management have also strengthened the public finances.

“The average maturity of national government debt was lengthened to 11 years by mid-2012 from 7 years at end-2007. Officials have also reduced foreign-currency denominated debt as a share of the total. Continuation of such efforts could bolster the sustainability of public finance and support the sovereign profile in the years ahead,” he said.

However, he also said the fiscal revenue base remains the outstanding weakness in the public finances.

A key weakness of the sovereign credit profile is a narrow revenue base compared with ‘BB’ range peers. Structural factors such as low per capita income, a weak investment climate, and the Philippines‟ large informal economy impede the sovereign ability to mobilise revenues. Thus, while Fitch expects fiscal liquidity metrics, such as debt/revenues, to improve over the next two years, they will remain weaker compared to peers,” Colquhoun said.

Estimated at 18.4 percent of GDP in 2012, it is well below both the ‘BB’ and ‘BBB’ range peer medians of 27 percent and 34 percent.

“This impedes fiscal liquidity, reflected in a debt/revenue ratio of 220 percent, significantly above the ‘BB’ range median of 163 percent. It also potentially constrains fiscal resources for public investment in the infrastructure, health and education sectors of the economy. The implementation of revenue-enhancing measures, such as the recently passed “sin tax” bill, is potentially credit-positive, though execution risks remain high,” he said.

Fitch also noted that the country’s gradually increasing reliance on local-currency debt, whether through onshore issuance or global peso notes (GPN), has reduced foreign-exchange risk.

However, the creation of onshore debt instruments denominated in US dollars may slow this process.

Fitch said that such instruments can strengthen the sovereign’s external finances and deepen domestic capital markets. In particular, it may reduce incentives for local banks to purchase the sovereign’s offshore external issuances to offset US dollar liabilities. This could potentially reduce capital outflows, strengthening the balance of payments and the net external debt position.

The report added that the substantial lengthening of the maturity profile of national government debt (NGD) to 10.7 years at end-2012 from 7.1 years at end-2007 is supportive of sovereign creditworthiness.

This compares to ‘BB’ and ‘BBB’ range medians of 3.5 years and 5.4 years respectively.

Also, macro-prudential measures, such as reserve requirements, are seen reducing onshore refinancing risk and insulating the public finance from potential funding shocks.

Such measures allow the sovereign to utilize the banking system as a captive investor base to support sovereign financing flexibility in domestic debt markets.

“Based on the size of deposit liabilities in Q312, Fitch estimates that required reserves for universal and commercial banks (UCB) would be equal to 8.3 percent of GDP. This is equivalent to about one-quarter of onshore sovereign debt issuance,” Fitch said. –JIMMY CALAPATI, Malaya