S&P retains RP’s sovereign rating despite Camacho exit

Standard & Poor’s Ratings Services has decided to maintain the Philippines’ sovereign credit ratings despite the resignation of Finance Secretary Jose Isidro Camacho.

However, the credit rating agency expressed concern that the personality-oriented nature of Philippine politics and the fractiousness of its bureaucracy could eventually derail the economy.

In a statement, S&P said Camacho’s resignation had, by itself, no direct impact on its sovereign credit ratings on the Philippines at BB/Stable/B for foreign currency and BBB/Stable/A-3 for local currency borrowings.

According to S&P, the country’s increasing debt levels have been considered when it downgraded its ratings last April, as well as the government’s difficulty in maintaining fiscal discipline.

S&P said there have been improvements in tax collections but the agency said there was no indication that Camacho’s resignation would lead to unfavorable economic or fiscal results, despite the fact that the initial deterioration and subsequent pickup of tax collections occurred during his tenure.

"Nevertheless, we have noted in the past that the personality-based nature of Philippines politics, and the weakness and fractiousness of the country’s institutions, are factors that can undermine confidence and the predictability of economic policy," said Chih Wai Liew, credit analyst at S&P’s sovereign ratings group.

With much of the country’s external debt denominated in foreign currency, S&P warned that any collapse in confidence and rapid fall in the value of the peso could cause financial disruption. To date, S&P described the market reaction to Camacho’s resignation as "modest."

"Given the uncertain political landscape, S&P’s will continue to evaluate fiscal policy in particular, as well as trends in the exchange rates, in the run-up to next year’s presidential election," Liew said.

S&P had warned earlier this year that the Philippines’ rating will remain below investment grade without substantial improvement in its fiscal profile and external liquidity, adding that failure to adhere to credible fiscal strategy could renew pressure on the currency.

In a report prepared by S&P analyst Takahira Ogawa and Joydeep Mukherji, the agency said the country’s stable outlook was based on expectation that government will slowly stabilize the erosion of public finances witnessed in recent years.

According to Ogawa, the fiscal deficit is likely to peak at 5.4 percent of gross domestic product in 2003 and moderate over the medium term through greater efforts at raising tax revenue.

Ogawa said the privatization in the energy sector combined with the reduction in banking-sector nonperforming assets, and renewed export growth could boost the country’s trend rate of economic growth, consolidating its credit standing.

"Conversely, failure to adhere to a credible fiscal strategy could again place pressure on the currency," he said. "With more than one half the government’s debt denominated in foreign currencies, a sharp depreciation of the peso would raise debt-servicing costs, worsen fiscal rigidity, and potentially hurt the country’s credit rating."

Ogawa explained that S&P’s "stable" outlook rating was supported by adequate external liquidity, with total debt service (including short-term debt) as a share of current account receipts projected at 38 percent while the total external debt is projected at 131 percent of current account receipts this year.

However, Ogawa said the rating was constrained by high fiscal debt and fiscal inflexibility. He pointed out that government debt was approaching 90 percent of GDP this year, compared with the median level of 51 percent for similarly rated sovereigns. "Interest payments are likely to consume about 37 percent of central government revenue, up substantially from 22 percent in 1999," Ogawa said.

Ogawa explained that the weak fiscal profile and continuing dependence on external capital was raising the vulnerability of Philippine financial markets to adverse external development, and constraining macroeconomic stability.

He said the narrow tax base had also contributed to weak public finances. Tax revenues have fallen by more than three percentage points as a share of GDP since 1997, due largely to shortfalls in collections by the Bureau of Internal Revenue.

There have been improvements in revenue collections that allowed the Arroyo administration to pare the deficit below its target for the whole year but Ogawa said the public sector deficit could be substantial at about seven percent of GDP, mainly because of the deteriorating financial position of public companies such as the National Power Corp.

"The mutiny in August 2003 will not have a significant impact on the economy this year, but could affect foreign direct investments because confidence in the country has been shaken," he said, adding that the recent Court of Appeals decision to suspend the central bank governor and four central bank officials for one year could also hurt confidence in the country.

Ogawa also said that the faster growth in imports (9.9 percent year-on-year) compared with exports growth (2.2 percent) in the first half of 2003 was a factor to watch. "Although a major part of the increase could translate into future exports of goods and boost the economy of the country, it could destabilize the Philippine peso against major currencies, because the larger trade deficits will adversely affect the size of the current account surplus," he explained.

The trade deficit for the first half of 2003 has increased to US$1.5 billion from US$185 million in the same period of 2002.

"So far there is no clear picture for the presidential election, scheduled in May next year. There is no clear leading candidate, who can get overwhelming support, although there are several potential contenders judging by opinion polls so far," Ogawa noted.

S&P said political succession could further delay the privatization process of the power sector and implementation of other structural reforms.