The S&P upgrade

TO BE SURE the recent credit upgrade the Philippines obtained from Standard and Poor’s (S&P) is welcome news. With a long-term sovereign rating of BBB from BBB- and a short-term sovereign rating of A-2 from A-3, the Philippine rating is a notch above investment grade or two notches above the non-investment grade, which is likewise called the junk status. This recent upgrade has been the best credit rating that the Philippines has ever received.

A long-term rating of BBB, according to S&P, means that the Philippines has “adequate capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.” Similarly, the short-term rating of A-2 means that S&P believes that the Philippines has the capacity to service its debt but qualifies that this can be affected by unfavorable economic conditions.

Based on the S&P statement released to the media, three factors account for the upgrade.

The first factor, to quote S&P: “We raised the ratings because we now believe the ongoing reforms to address shortcomings in structural, administrative, institutional, and governance areas will endure beyond the current administration.”

We can interpret this as a commendation of the PNoy administration’s core program as encapsulated in the slogans “daang matuwid” (straight path) and “kung walang corrupt, walang mahirap” (no corruption, no poverty).

In concrete terms, the administration has relentlessly pursued anti-corruption and tax evasion cases. Gloria Arroyo is in jail for charges related to plunder. The Department of Justice has filed corruption charges against several elected public officials, including senators, government employees and private individuals.

The administration has likewise promoted the open governance program, which will hopefully result in the legislation of the freedom of information and open data.

The second factor, to quote again S&P: “In turn, we believe the resulting gains in government revenue generation, spending efficiency, and the improvements in public debt profile and investment environment will at least be preserved in the medium term under the next administration.”

In this regard, credit goes to the following:

• The tax administration reforms engineered by the Bureau of Internal Revenue Commissioner Kim Henares, resulting in revenue collection growth that outperforms the nominal GDP (gross domestic product) growth rate.

• The passage of the sin tax law, which in its first year generated incremental revenues amounting to more than P45 billion (or equivalent to about 0.5% of GDP).

• The expenditure reforms introduced by Budget Secretary Butch Abad, leading to budget transparency, effectiveness and efficiency.

• The corresponding budgetary increases, especially for universal health, education, infrastructure and the modernization of the Armed Forces of the Philippines.

We can expect further advances on the fiscal front. The robust generation of incremental revenues from the sin tax law will translate into dramatic higher spending for universal health coverage, the health workforce and facilities.

Moreover, the Executive has recently announced some of its legislative priority measures, which will all the more boost tax effort. These are the rationalization of fiscal incentives, the transparency of fiscal incentives or tax expenditures, the increase in the mineral tax, and the modernization of the Bureau of Customs.

And the S&P’s third factor: “The Philippines’ strong external profile is an important credit support. With a long track record of balance of payments (BOP) surpluses, the Philippines has accumulated a substantial foreign exchange reserve buffer. That buffer affords an import coverage ratio above prudential norms and low refinancing risk.”

Here, the Bangko Sentral ng Pilipinas (BSP) deserves credit. Not only has the BSP generated huge foreign reserves, which will protect the economy from shocks. It has likewise been able to stem the appreciation of the Philippine currency and has managed the exchange rate to be competitive. It can be argued, however, that the peso depreciation can be mainly attributed to external factors like the winding down of quantitative easing in the United States.

Nevertheless, we must be aware of the tradeoff and the costs that arise from the BSP’s approach of purchasing dollars (which is alright, to curb the peso appreciation) but soaking up the liquidity through the higher interest rates of Special Deposit Accounts (SDAs). The interest rates for SDAs are bigger than the regular Treasury bills. And the BSP shoulders the costs in giving the higher interest rates.

In a word, the BSP has to employ other instruments, not just to rely on the SDAs, to counteract the adverse effects of foreign currency inflows.

Indeed, with the recent S&P upgrade, we can expect a new round of portfolio inflows, which will again lead to the strengthening of the peso. This ironically is the effect of credit upgrades.

The challenge is how to discourage the unproductive, even speculative short-term inflows and encourage the direct investments. It has been a perennial problem, which the PNoy administration has to decisively address in its last two years.

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