Taking the plunge

Those that might have thought that the words debt relief or debt repudiation ought never to be mentioned, in much the same way that merely uttering the names of ancient Chinese emperors was punishable by a painful and horrible death, should take note of what an item in the Periscope section of the current issue of Newsweek stated.

In reporting Argentina’s largely successful debt reduction, where bondholders accepted about 30 cents to every dollar, the newsweekly quoted a senior finance official of the Argentine government who said: "The deal marks a pretty important change in the world… Sovereign debtors are realizing they have much more power than they thought."

Newsweek says economists fear that this new realization may occur next in the Philippines: "The country’s mountain of debt is higher than its annual economic output, while fiscal stringency is hurting economic activity and provoking unrest – a replay of the Argentine situation in the run-up to default in 2001."

A friend of mine pointed me to an on-line article in FinanceAsia.com written by one Jephraim Gundzik in early March. Reflecting Newsweek’s view, Mr. Gundzik said: "Just as Argentina concludes the restructuring of its defaulted external debt, another sovereign default looms in the Philippines… The risk of default in the Philippines is much higher than is generally believed."

Mr. Gundzik acknowledges familiar problems such as the large public sector debt which, on a consolidated basis, has been above 125 percent over the last five years. But what’s new, he says, is the sudden surge in public sector debt payments. Interest and principal payments on this debt, he notes, have increased from 46 percent of total national government expenditure in 2002 to 68 percent in 2004.

Gundzik continues: "With public sector debt service costs equivalent to almost 70 percent of total national government expenditure, it is painfully obvious that the Philippine debt service is unsustainable. Attempts to increase fiscal revenue by raising taxes will push economic growth lower – the net effect being further reduction of tax revenue."

The country, he says, is "squarely in a debt trap" and government efforts to extricate itself are too little and far too late. "As in the Philippines," he concludes, "Argentina’s public sector debt stock became unsustainably large long before the country’s default." And, like the Philippines, "Argentina’s attempt to tighten fiscal policy was far too late to extricate the country from its debt trap. Rather than reducing the fiscal deficit, tighter fiscal policy in Argentina reduced economic growth, making default inevitable."

The prognostications of Newsweek and Gundzik will, I’m sure, be contradicted by our financial managers who continue to insist that our country is well on the way to economic recovery. Many of us instinctively want to believe this because no one wishes a worst-case scenario for the country. We maintain an unshakeable faith in "happy endings," that everything will turn out fine and dandy in the end.

I suspect that because it is politically incorrect to be seen as a "naysayer," or one perennially worried that the sky may fall at any time, we are not prepared to face the hard choices that are even now being foisted on us, whether we’re ready or not. Much less are we primed to withstand the difficult and painful consequences of the hard and unaccustomed road we may have to travel.

But when we think about our dilemma as objectively as we can, even as we may disagree that default is necessarily inevitable, we would have to concede that Newsweek, Gundzik and others who think the same way aren’t just being melodramatic when they compare our current financial condition to a "run-up" to the Argentine situation. We would, of course, love to project a steadfast stance and insist that the run-up will end, not in an Argentine-type default, but in a new regime of fiscal discipline which convinces the international financial community of our country’s resolve.

But the point Gundzik makes is a good one, albeit arguable. He is, in effect, saying that all the revenue-raising and cost-saving measures the government is pushing through Congress will be for naught. Debt service levels are already unsustainable. Raising taxes will depress growth and, thus, actually result in lower tax revenues. Because Gundzik does not see any way out of this trap, he sees a default as inevitable.

Home-grown critics have long argued the futility of tax increases. They believe the estimates of P80 billion in new revenues are too optimistic, and contend that the government has underestimated both public opposition and the propensity of legislators to play politics with unpopular tax proposals. Some of them even suggested the exact opposite, a vigorous stimulation of the economy by lowering taxes.

Congress is still fiddling around with the proposal to increase value-added taxes and remove all exemptions from VAT. They continue to assure the President that a new, watered down but politically more palatable VAT law will be approved before the Holy Week break. This is exactly what critics like Gundzik mean by too little, too late.

If it’s true that all things considered, default is inevitable, then it becomes more urgent to begin consideration of what alternatives might be open to us. We must be clear-headed about our possible choices, weighing carefully and realistically what the consequences might be. We must decide now what our responses must be if, as can be expected, bondholders and creditors prove reluctant to enter into negotiations specifically directed at reducing or forgiving some of our national debt.

This time, a moratorium or deferment of principal only, but not of interest payments, will not do. Neither should we agree to surrender to creditors and bondholders virtually everything the country earns, while bringing our economy to a standstill.

We should, in other words, study the Argentine example and learn from it, the good as well as hard lessons. We may indeed discover that our country, a "temporarily financially embarrassed" sovereign debtor, may have much more power than it thought, as that Newsweek source suggested. Still, there are obviously pitfalls to be avoided, to the extent possible.

There will be social costs but in our present situation, our options are severely limited. On the other hand, limited options, like crises, marvelously focus the mind and illuminate the path we must follow.