top of page
Action for Economic Reforms

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

swim.


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

depositors.”


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.”

{mospagebreak}


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

obtained.


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.”

bottom of page