Asiamoney, August 2011
Asiamoney meets Secretary of Finance Cesar Purisima in a booth in a Hanoi conference centre, promoting Manila’s role as the next host of the Asian Development Bank annual meeting. He is flanked by images of the rolling chocolate hills of Bohol, while a TV shows idyllic beaches. It’s an agreeable backdrop and, given the Aquino government’s push to boost tourism infrastructure, not wholly incongruous. But it’s in contrast to the more rugged challenges that Purisima faces in dealing with the Philippine national finances.
Foremost among them is the tension between two competing goals. On one hand, the country’s GDP deficit – 3.74% of GDP at the end of 2010 – takes valuable money out of the country and pours it down the black hole of interest payments; clearly that deficit has to come down. But on the other hand, there is a need for investment in almost all areas of the Philippine economy, so as to foster growth. Doing both seems a near-impossible trick, while oil and food inflation make matters harder still.
But Purisima, who projects an enthusiastic calm, is full of ambitious targets – not least a sovereign upgrade to investment grade. He points out that a 3.74% deficit was actually better than the country’s 3.9% target last year, and that this year’s target is 3.2%: Ps300 billion, but coming down. The long term aim is to get it down to 2% of GDP by 2013.
But must that come at the cost of impeding vital spending? He says not. “When that [his 2% target] happens, our interest to GDP ratio will go down, creating more fiscal space for additional investment,” he says. “And when you do that, you get into a more virtuous circle. Our hope is we will be rewarded with an upgrade to investment grade.”
At a time when the US, Japan and a host of European economies are staring down the barrel of a downgrade, Purisima’s hopes seem unusual. But he’s not that far out of line, and indeed Fitch Ratings upgraded the sovereign to BB+, the highest level before an investment grade rating, in June. Standard & Poor’s and Moody’s are the next notch down. Purisima is a keen student of peer country economic indicators, and sees a mismatch: for example, debt to GDP, at 56.5% in the Philippines, is almost identical to India’s 55.9%, yet India is investment grade. Furthermore, if a sinking fund for bond redemption is netted out, he says, the real figure is just 43%. “We have never defaulted in our long history,” says Purisima. “We have proven to be good creditors. And all our numbers have been improving dramatically: foreign exchange reserves are at historic highs, NPL ratios are below 3%, our industries are growing and we have a favourable demographic.”
“The market is already allowing us to borrow at close to investment grade prices,” he says. And an upgrade would have a dramatic impact on the Philippines. “The flow of investments will increase, more jobs will be created, more taxes, less deficit, and less debt. That will be crucial in reducing poverty in the Philippines.”
Analysts do see some progress. “The budget deficit has improved a lot,” says Luz Lorenzo, economist at ATR Kim Eng in Manila. “This year in particular it’s way below what the government was targeting.” But she doesn’t accept that it’s come without reducing spending. “It’s mainly because spending has actually been contracting. Revenues are growing, so that’s fine, but spending has been cut drastically.” Since the government has pledged no new taxes, the best way to reduce spending without reducing growth is to cut corruption, and that has been the government’s focus to date.
Will that be enough in the long run? “Fiscal consolidation is important to ensure that debt levels come down further,” says Prakriti Sofat at Barclays. “Rating agencies are also focusing on the fiscal/debt trajectory closely. The administration is going after tax evaders and we are seeing some traction with revenue growth being robust.” But she is not sure the tax promise is sustainable. “In order to really boost the tax to GDP ratio to create the fiscal space to increase infrastructure spending, our sense is that some increment in tax will be needed.”
One of the ways in which this government, and others before it, have sought to improve the lot of the Philippines has been to increase the role of the local currency, the peso, in debt markets funding. In July – subsequent to our interview with the finance secretary – the Philippines completed a record peso bond exchange, which extended maturities by an average of two years. More than Ps100 billion of shorter-dated notes were exchanged for new 10.5 and 20-year bonds, which had the dual effect of freeing funds for investment today, and improving liquidity at the longer end of the curve in the Philippines generally. It was the sixth such swap the Philippines has attempted, and they are proving increasingly successful: a previous deal, in December, attracted Ps50 billion of demand for a 2020 bond and Ps150 billion for 2035, in stark contrast with a local currency swap deal launch in Indonesia around the same time, which failed.
In July another exchange was announced, this time from dollar bonds into global peso notes, in an attempt to reduce further the foreign debt load. Already, the yields on local currency debt are looking very favourable, from a state perspective: 4.68% on its January 2016 bonds in July, compared to well over 6% earlier in the year.
When we spoke with Secretary Purisima, he said the aim was to borrow 73% of funds in pesos in 2011, and 27% from foreign markets, compared to 67/33 the previous year – which was, itself, a heavily local split compared to previous years. Purisima says his long term goal is for foreign currency debt to account for just 20% of total national debt.
“In the first months of the Aquino administration we have floated peso bonds twice: once for 10 years and once for 25, the first in Asia to do so,” he says, referring to the December fundraising (as the July swap took place after our interview). “We plan to continue to do that, especially for liability management.”
These efforts have impressed the investment community. “The Aquino administration has a clear strategy to improve the debt dynamics of the sovereign by not only reducing reliance on external borrowing but also making a concerted effort to diversify the sources of funds and extend duration of debt,” says Sofat at Barclays. And it’s not just handy because it alleviates foreign exchange exposure, but has a potentially very important impact elsewhere.
One of the reasons Purisima is so keen to shift to peso funding is because he believes a long-dated curve in pesos will help with infrastructure development. “Opening up the 25-year market was a move in preparation for infrastructure financing. That will allow project proponents to fund projects in pesos, matching their revenues in costs.”
This is a familiar subject in the Philippines – and frankly one that causes foreign investors to roll their eyes. Successive administrations have shared grand visions for public private partnerships and infrastructure finance in the Philippines; most efforts have foundered.
The Aquino government is no less optimistic than predecessor governments; Purisima says there are 73 PPP projects in a preliminary list, to be updated each quarter, with a thrust in tourism, airports, roads and ports, along with energy, mass transit and tollways. There are also PPPs planned in education and hospitals. “It’s a broad effort,” he says. “We are confident we have made enough changes in our PPP framework to make it attractive.”
What changes? Examples include Aquino guaranteeing that approvals will come within six months for solicited projects; a steady pipeline of projects (“so that companies will be willing to invest in a theme in the Philippines, knowing that if they lose in one project there will be others to follow”); the opening of the capital markets to longer term borrowing; greater transparency; and centralizing the unit for processing approvals under one roof. “We are doing a lot of things. The Philippines is now open for business under management, better governance, and an environment that offers a great future with the integration of Asean.”
That’s the sort of quote that’s designed to wrap up interviews, and indeed articles. But not everyone shares his enthusiasm. Asked what is happening in privatization, Lorenzo says: “Nothing. This is the biggest disappointment from this government.”
But, that said, she hasn’t given up on them. “On the other hand, they say they want to get it right. The PPPs are actually an offshoot of the BOT programs from before, so it’s not as if this is totally new; in the past it has been filled with corruption, with a lot of unnecessary spending, and they want to get it right and to make sure the right safeguards are in place. That’s a valid reason.” If it results in proper projects, then the slow progress can be understood, she says. “If you have to face up to delays in projects but the trade-off is that they will more efficiently administered, with spending that is more productive than in the past, then that’s a good trade.” There is something of a precedent here: privatization in the power industry was expected to bloom after legislation was passed in 2001, but nothing happened until 2004, and even then only with small plants. “People were asking why it was such slow going, and they said: we were trying to get it right. Then the sales became much faster and there’s no taint of corruption in those transactions.” It will be a while before it becomes clear if the government is going slow to get things right, or just going slow.
Another challenge the Philippines faces is inflation. It’s not as intense as in some places in Asia, as the country has enjoyed strong rice harvests and so has had relatively stable food prices, but fuel is a consistent challenge. Purisima says he believes the Philippines is “ahead of the curve”, but Bangko Sentral ng Pilipinas opted to keep its policy rate steady (at 4.5%) at the last meeting when some, like Barclays, had expected a hike. After the meeting, the assistant governor of the BSP called policy setting “a balancing act”, between price pressures and supporting growth. It is also concerned about, to use his words, “a flood of inflows”, and inflation is running above the bank’s 3-5% target, though it forecasts a full-year number of 4.7%. In truth, the Philippines is being saved from greater inflationary pressure by a strong peso and a weak dollar, mitigating the cost of imported items. And since that clearly can’t be relied upon forever, Aquino has pledged to improve agricultural productivity, something that is probably going to need greater access to financing among farmers and a lot more investment in irrigation. “If there is going to be sustained pressure, it will have to be productivity that delivers,” says Purisima.
Aquino took power with the largest ever mandate of a Philippine president; so what’s he doing differently? Purisima says his priorities are corruption, infrastructure and some policy issues. Previous administrations have already proven the country is quite capable of building strong new industries out of nowhere: BPO outsourcing is the obvious example, but it’s increasingly true of shipbuilding too. And, beneath these images of Boracay and Bohol, it’s clear that tourism is being relied upon to deliver a lot of growth. Purisima calls it “a low hanging opportunity”, partly because he expects the number of traveling Chinese tourists do double to 100 million, “and the Philippines is well positioned to take advantage of that.” The skies around Metro Manila have been opened to allow new airlines to fly in – Air Asia will be the latest example, following ANA – and there is an initiative to position the Philippines as “right in the centre of the coral triangle”, as Purisima puts it. Much of the proposed infrastructure PPP work revolves around infrastructure to drive those tourism arrivals. “The beauty of tourism is it is 100% value added,” he says. “Jobs will be created all over the Philippines, in rural areas where poverty is highest, and you have multiplier effects into food, services and tourism. We’re hopeful our 3.5 million tourist arrivals will double within a short period of time. There’s no reason why we can’t reach that number.”
Purisima is also pinning a lot on integration of Asean, where he claims a level of seamlessness which is not always apparent to the outside world. “You’ve seen it in the electronics industry,” he says. “People used to say our industry was not sustainable because the supply cluster and the customer cluster were not there. But it’s one of the 11 industries to be integrated in advance of 2015 integration, and now moving products from Manila to Penang to Singapore is like moving them from Chicago to the Silicon Valley. It’s harmonized. It’s all efficient now.” He is clearly a believer in Asean as a powerful, homogenous bloc. “ You’re going to have an economy worth $1.6-1.8 trillion, a very favourable demographic. And the Philippines is very well positioned to participate in that: we have a 100 million population, who are very mobile – 10 million of them are outside the Philippines right now – and speak English.”
This brings us to the extraordinary Philippine diaspora: Lorenzo estimates that remittances from overseas Filipinos make up 12-13% of national GDP. And it’s the very first thing she mentions when asked about threats to the Philippines. “The main concern right now is the appreciation of the peso because we have such a huge dependence on our overseas workers.” She’s also troubled to see Saudi Arabia seeking to use more Saudi nationals rather than migrant workers; a wider use of that policy could have a significant impact on the Philippine economy.
So is the juggling act of reducing the deficit, maintaining spending and not raising taxes achievable? It all depends on how successful Aquino is in cutting corruption from the system. “The drive to reduce corruption is the main platform of this government, and an important one,” says Lorenzo. “When investors talk about the Philippines, one of the usual complaints is the level of corruption: the difficulties and high costs involved in doing business here. If it is reduced, it may be a catalyst for the Philippines finally making it on to foreign direct investors’ maps.”