The Amber Light

A situation report on Philippine foreign debt and financial markets

By Rafael B. Buenaventura

The Philippine foreign debt situation is at an amber light with a twist. It is up to us whether the light turns red or green. In spite of everything, the Philippine monetary situation is in decent shape, but we are at a crossroad. Does the situation improve or deteriorate? Right now, we have the good fortune to be in a globally benign financial environment where we have low interest rates, low inflation, and face a tsunami of liquidity seeking good yields. This has provided a healthy framework of demand for our debt paper—so far!

However, there are warning signs. We are assuming global financial markets remain benign with high liquidity levels seeking higher-yielding debt paper like ours. Now, Governor Singson could have said all is well in June 1997, but by August 1997, after the initially Thai, then Asian crisis, that was no longer the case. So unfortunately, things can change almost overnight in the global financial markets.

We are also assuming the political situation in the Philippines does not undergo another major crisis. President Marcos could have said all was under control on August 20, 1983. By September, that was no longer the case. Regardless of who runs the country, like it or not, the Philippines is an inherently volatile place and clearly unpredictable.

We continue to run budget deficits and our cost of borrowing keeps creeping up. The spreads over Treasuries keep slowly increasing. They are merely masked by the fact that yields on the underlying U.S. Treasuries keep dropping.

Here is classically what a debt crisis is, which clearly we are not yet in today.

Maturities of most of our debt are long-term and spread out. However, yearly maturities, while manageable, are totally reliant on the international bond and loan markets remaining open to our debt paper. So even if we start running budget surpluses now, we are far from doing away with foreign borrowing.

And although our balance of payments position and increasing overseas Filipino workers’ remittances have contributed to our higher reserves level, let us not be complacent. While our total external debt to gross national income ratio is below that of Argentina and Indonesia, it is above other comparative countries.

What to do and not do

We have to close our fiscal gap and stop running budget deficits over the next few years. Our enormous financial needs and refinancing requirements require us to continue our foreign borrowings, but if we can limit them to refinancings and for capital development (new infrastructure), we should be fine.

We need more banking reforms and broader financial reforms. Banking reform is clearly under the Bangko Sentral ng Pilipinas’ agenda, where a lot has been done. But what remains to be done which is now part of Governor Tetangco’s agenda are Phase 2 of the asset clean-up, strengthening the legal protection of the BSP and other regulators, implementing a comprehensive credit information system, and further consolidation in the banking sector.

Outside of purely banking system reform, there are two major and glaring weaknesses of the financial system which are absolutely necessary and preconditions to growth and prosperity: capital markets development for both equities and debt. However, unlike banking reform, where the BSP has a clear mandate and responsibility, the development of the domestic capital market has far more stakeholders with overlapping interests. In such complex calculus, forging a common reform agenda has been more difficult.

The BSP can hardly distance itself from this challenge given its responsibility for maintaining overall financial stability and considering the major role played by banks in the broader financial market.

It is also clear that the economy cannot rely mostly on the banking system for financing development without creating a fundamentally unstable financial system. Long-term needs require long-term finance in the form of equity and long-term debt securities. We need to achieve a better balance. I also firmly believe that full development of the domestic capital market is key to achieving a more resilient financial system, more stability in the exchange rate, and better public-sector financial management.

I have always been impressed by the achievements of Mexico that had, in a space of two decades, broken free from heavy foreign indebtedness and developed its domestic capital market to the point that foreign investors now flock to it and happily take on long-term Mexican debt in local currency. This has enhanced a virtuous cycle of development for that economy. There’s no reason why we cannot duplicate this feat.

Developing the capital market

Vital reforms are needed in the government securities market that is the foundation of the capital market. We need to develop a market-based, reliable, and reasonably long-term yield curve. That requires reforms starting from the issuance process; the secondary trading, clearing and settlement of securities; and the development of mechanisms to ensure market liquidity and proper price discovery. This also requires better protection of investors through proper delivery of securities, and full transparency. The capital market will never take off unless it is widely perceived to be inherently fair and efficient by investors, domestic and foreign, institutional and retail.

The institutionalization of capital market reforms inevitably requires legislation. Many of the critical pieces have already been identified. What is needed is decisive political will to get the necessary laws in place at the soonest possible time. Much of the heavy work on capital market reform is still ahead of us. Nonetheless, I am a little bit encouraged that there is now far more interest in this task and some concrete progress in recent years than there had ever been in the past. We must not lose focus this time.

Excerpts of a speech before the business community on 22 September 2005