On debt forgiveness

The author is Senior Research Fellow of the Philippine Institute for Development Studies.  This article was published in the Yellow Pad column of BusinessWorld, 18 October 2004 edition.

It would be difficult to say anything new about the fiscal situation of
the Philippines. After all, this topic has been analyzed fully even
before the current controversy. What I would like to do is consider the
option of debt forgiveness, which in its extreme form is equivalent to
debt repudiation. We deal solely with the pros and cons that surround
this issue. I would consider my arguments a feeble attempt to situate
my remarks in the context of the lectures during the past week which
focused on the inequities in the international financial system.

What are the arguments against debt forgiveness?

First, any talk of debt forgiveness brings about a negative knee-jerk
response among international and domestic creditors, businessmen, and
almost all the country’s economic managers. They warn of the dire
consequences of explicitly considering this approach: rising risk
premia, reduction in access to foreign capital, economic contraction,
and a fall in the standard of living.

These are “scare” tactics that have been effective in the Philippines.
For example, despite the golden opportunity to devise a progressive
debt strategy, President Aquino instead issued Proclamation 50, which
mandated the government to honor all Philippine debt and thus
legitimized the assumption of debts by the National Government
including private loans. We will let history be the judge whether or
not this was the prudent course of action.

The second argument against any form of debt forgiveness takes a leaf
from the concept of moral hazard. In its strict sense, “Moral hazard
exists when the provision of insurance against risk encourages a
behavior that makes that risk more likely to occur.” In this context,
moral hazard exists because the National Government will likely become
lax in its reform efforts-particularly in the area of revenue
generation – if creditors reduce the debt burden of the government.
Think of a person who is thrown into the middle of the sea with a 100
kg weight strapped to his leg. To save him, the 100 kg weight can be
cut off, but that would be useless if it turns out that person cannot

The third argument is based on a statement in the paper written by the
11 faculty members of the UP School of Economics. They state that “a
crisis would not be averted if government sought relief by reneging
only on debt held by its own citizens (this might prove tempting since
Filipinos hold most of the government’s peso-denominated debt as well
as a good chunk of dollar denominated-debt). Even that would also cause
major difficulties and bankruptcies for the domestic banking system,
which holds a large amount of government paper, and ruin millions of

The UPSE paper did not even consider the alternative of seeking relief
from foreign creditors. But even this course of action has its
difficulties. For one thing, as Lidy Nacpil of the Freedom from Debt
Coalition pointed out during an open forum, a sizable amount of
government debt is in the form of bond issues and there is no
established mechanism of negotiating with bondholders. Moreover, it
seems to be conventional wisdom among our economic managers that asking
for debt relief from foreign creditors is an exercise in futility.
Based on the Inquirer article published on Sept. 26, 2004, it seems
even Professor Solita Monsod has conceded this point. To quote: “We
have been overtaken by events. We should have done something 17 years
ago. To say something now, no one is going to be sympathetic.”
What are the counter-arguments?

First of all, we should all realize that a sizable amount of our
existing debt came in the form of “loan pushing.” According to the FDC,
they have recorded some anecdotal evidence but only from the Marcos
era. I personally have heard a lot of stories about the activities and
corruption in Napocor and MWSS and I am certain that if the proposed
debt audit will encompass this concept we will be able to elicit more
stories, or evidence if you will.

I would even go beyond the term “loan pushing” a term I first heard
from Professor James Boyce of the University of Massachusetts. For
example, it has always been argued that some of the foreign loans were
used to prop up dictatorships and authoritarian regimes. I would even
argue the reverse: that many of these dictatorships and authoritarian
regimes were actually established to facilitate the entry of foreign
loans. The increase in the indebtedness of the National Government is
part of the evolution of the dominance of finance in the global economy
or what the economist Ricardo French-Davis terms “financierism.”
Incidentally, It can be argued that about half of National Government
debt in the Philippines is domestic debt. However, in the years
immediately following the downfall of the Marcos regime, there was a
substantial portion of external debt that was transformed into domestic
debt. This phenomenon could be described more strongly as “financial
warfare” – a term used by Professor Michel Chossudovsky of the
University of Ottawa-which is being waged against developing countries.
Indeed, President George W. Bush was mistaken when he tried to find
weapons of mass destruction in Iraq.

Not only did the Philippine government borrow heavily, it assumed
responsibility over many debts extended to the private sector. Thus in
the late 1980s the National Government moved to clean the books of the
Philippine National Bank and in the process absorbed the loans of
private entities. Then in the mid-1990s the National Government
absorbed the bad loans of the Central Bank of the Philippines.

Second, we consider the argument of moral hazard, which I believe is a
valid argument. Hence we can make any form of debt forgiveness
contingent on a reasonable set of tax measures. (But it would still be
difficult to learn to swim with a 100 kg weight strapped to your leg.)

Third, I would be very hesitant to show compassion to our commercial
banks and even our foreign creditors. After all, between 1986 and 2003
the National Government paid the equivalent of $83.5 billion as debt
service. This is equivalent to about 7%-8% of gross domestic product
(GDP) on an annualized basis, or an average of $12.7 million a day for
the last 18 years. Assuming the exchange rate is an accurate way of
translating past amounts into present value terms, then the government
has already shelled out P4.5 trillion in debt service between 1986 and
2003, an amount higher than, suing an average exchange rate of 54.2,
the outstanding National Government debt of P3.36 trillion at the end
of 2003. If the peso-denominated amounts are carried over into 2003
using the consumer price index, the amount of P4.4 trillion is
Should not this be considered a blatant case of immoral transfer of wealth?

Some of the main reasons for the rising debt service are: 1) “loan
pushing” as mentioned earlier; and 2) borrowing to compensate for the
relatively low tax effort.

However, another reason for the rising debt service is the so-called
risk premium which creditors add in order to assure a profit even if
the borrower defaults. But think of it this way: Creditor A charges
Malaysia 5% while it charges the Philippines 10% for a 10-year loan.
The situation would be fair if the Philippines does default after five
years. But suppose the Philippines religiously honors its debt as what
has happened in the last 21 years? Shouldn’t the National Government be
entitled to some sort of refund at the end of the loan period? The risk
premium should just play the role analogous to “bail,” which is
refunded after the accused goes through the whole judicial process.

Finally, I would just like to point out that resolving the debt
situation would take more than earning the sympathy of the
international community. After all, there is the Jubilee Movement to
rely on and the Odious Debt Doctrine to provide legal backing. Using
one of the slides presented by Professor Joseph Lim in his lecture
recently, what is sorely lacking among us Filipinos in this type of
initiative and I would say throughout our history, is “unity,
cooperation and political will.”

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