Reports of new loan issuances over the past months have been met with much trepidation online, compounding the already widespread anxiety caused by news of rising COVID case counts, mounting business closures, and soaring unemployment. The COVID-19 pandemic has imposed severe fiscal strain on public coffers, leading many to worry that all this borrowing and spending will deplete state funds and place the country in dire economic straits.
But does the Philippines really face a looming debt problem?
In this article, we explain why government borrowing, although not without risks, isn’t inherently problematic. Many times, and especially during times of crisis, it is necessary and even beneficial.
Public debt comes in myriad forms, most notably Treasury bills, bonds, and foreign loans. Here we focus primarily on external debt, or money owed to foreign governments, private commercial banks, and international finance institutions such as the Asian Development Bank (ADB) and the World Bank (WB).
According to the COVID-19 Citizens’ Budget Tracker, we have secured PHP476 billion in foreign loans and grants related to COVID-19 since March.
However, we should not take this number at face value as the absolute amount of debt alone cannot tell us very much. Instead, below are three questions to ask when examining debt and assessing whether there is cause for concern.
1. Debt ratios: How burdensome is the debt?
Indeed, what matters is not the absolute amount of debt, but its sustainability—that is, whether the government has the ability to meet its current and future debt obligations (or, in layman’s terms, its responsibility to pay off debt on schedule) without requiring debt relief (forgiveness or cancellation of debt) or restructuring (renegotiations of terms). A small country with little savings would understandably have a more difficult time paying off a billion dollar loan than another country with an economy that is double its size and with more savings in its chest.
Thus, rather than total debt, much more useful indicators to look at are debt relative to the country’s total economic output (the total value of goods and services produced in the country for a given year, as measured by the gross domestic product) and our stock of foreign reserves.
Debt-to-GDP: Downward trend
Our external debt-to-GDP ratio has been muted below 40% level over the past 10 years, thanks to our decade-long GDP growth streak from 2009 to 2019. During this period, GDP growth averaged an appreciable 7.1% per year. Our total debt-to-GDP (including domestic borrowings) of 43.3% as of the end of March 2020 is one of the lowest ratios we have had since 1986; and in fact, the last time our total debt breached the 50% mark was in 2002.
But while our debt-to-GDP ratios have been low, a high ratio is not necessarily a bad sign for a country so long as the economy is growing. If we were to make an analogy to personal finance, this would be similar to paying off a loan while we are employed and expect future salary increases.
But what happens when we unexpectedly lose our job or receive a pay cut? It is true that a high and increasing debt-to-GDP ratio may pose a risk to fiscal stability and sovereign credibility when growth is curbed due to external shocks such as the present pandemic. Forecasters expect our economy to shrink this year by a margin of 1% (Bangko Sentral Ng Pilipinas) to 3.8% (ADB).
Fortunately, we have some breathing space. The relatively low ratio that we maintained in the years preceding the current crisis has given us the flexibility to borrow more now, precisely when we need it the most. Recent tax reform efforts—including the administration’s landmark TRAIN Law and efforts by its predecessors to strengthen tax administration and enforcement—deserve credit for placing us in a relatively secure fiscal position by shoring up government revenues.
Compared to our developing country peers in Southeast Asia, our total debt-to-GDP ratio in 2019 of 41.5% was close to the average. While recent borrowings are expected to lift this ratio, the government plans to keep this ratio at a maximum of 47%, capping additional borrowings in 2020 to around PHP1 trillion.
Compared to the rest of the world, our GDP growth outlook also appears to be more resilient: we are expected to contract slower in 2020 and recover faster in 2021 and beyond.
Foreign reserves: A hefty war chest
Aside from robust economic growth, the government’s borrowing capacity is bolstered by the hefty foreign exchange reserves it has amassed. Bangko Sentral ng Pilipinas recently published that foreign reserves (as of the end of May) reached its highest record so far at US$93.29 billion, exceeding the US$90 billion target for 2020. These reserves, called Gross International Reserves (GIR), comprise foreign currencies, other assets denominated in foreign currencies, gold reserves, special drawing rights, and reserve positions in the International Monetary Fund (IMF), among others. Technicalities aside, the GIR level essentially represents our external liquidity buffer. It can be thought of as a safety net that can cushion our economy against external shocks even when we have no export earnings or new foreign loans.
The relatively low ratio that we maintained in the years preceding the current crisis has given us the flexibility to borrow more now, precisely when we need it the most.
At its current level, BSP said our GIR are sufficient to cover 8.4 months worth of imports of goods and services, higher than the international standard of 3 months. Any GIR level is also considered adequate if it provides at least 100% debt cover. At US$93.29B, our reserves are more than enough to cover 7x of our external debts that are due within the next 12 months, based on their original maturity.
2. Terms of the loans: What are the strings attached?
But of course, knowing that we are borrowing at a sustainable level does not tell us much about the quality of the debt. All loans are not made equal, so we must also be mindful of the terms and conditions attached to each one. To put it in simpler terms, even if someone has the ability to pay off a “⅚” loan or high credit card interest rates, they would be better off taking out a bank loan with less onerous terms or switching to a credit card with more competitive rates. Here, there are four main aspects to consider: amortization profiles (financespeak for repayment schedules), loan maturities (final due dates for loan payments), interest rates, and other fees.
COVID-19 Loans Since March 2020
*In addition to these signed loans, the ADB has also committed to extending policy-based loans totalling US$1.1 billion and a $500 million disaster resilience finance program loan.
As far as amortization profiles go, what is particularly important to examine is the timing and pattern of repayments for the initial or principal amount borrowed. As seen in the table above, the WB and ADB loans have “grace periods” during which we will only need to make payments for accrued interest on borrowings but not for the principal amounts. Grace periods are generally desirable in that they allow the borrower to use the borrowed funds for their intended purpose, in our case COVID-19 programs, rather than for servicing the debt.
The loans differ in the length of their grace periods. For example, the first principal repayment for the COVID-19 Active Response and Expenditure Support Program Loan with ADB is scheduled to start in two years (April 2023) while the WB Third Disaster Risk Management Development Policy Loan has a 10-year grace period that extends until 2031.
The maturity periods of our newly availed loans for COVID-19 likewise vary, ranging from 5 years to 29 years. Note that a longer maturity period—which allows governments to spread out loan payments over a longer period and thereby focus spending on COVID-19 initiatives—is not necessarily better for the borrower, as they also typically come with higher premiums. Indeed, both the WB and ADB follow maturity-based pricing and charge higher maturity premiums for loans with longer average maturities. And maturity premiums imputed on the interest rate can be significant.
The WB, for example, does not charge a maturity premium for loans with average maturities of less than 8 years, but can charge as much as 1.15% in maturity premium for loans with average maturities of 18 to 20 years—a significant amount when dealing with billions of pesos. Ultimately, the decision to accept loans with shorter maturity periods as opposed to longer ones should consider various factors such as the purpose of the loan and the overall manageability of government liquidity (cash availability).
Third, we must consider the interest rates. Our loans with the ADB and the WB are floating rate loans, which means that their interest rates are not fixed over the term of the loans. Rather, at each interest period, interest is calculated based on a reference rate plus a spread or margin.
Reference rates refer to benchmark rates that are calculated by independent organizations. For our ADB and WB loans, the reference rate is generally the London Inter-bank Offered Rate (LIBOR), an interest rate benchmark that is calculated daily based on rates submitted by a group of leading, internationally-active banks. Meanwhile, the spread is an amount added on top of the reference rate. It can be a fixed rate, like in the case of the ADB loans with a fixed spread of 0.6% less a credit of 0.1%. It may also be variable like in the WB loans where the spread is periodically adjusted depending on the World Bank’s cost of borrowing.
What is key to know about floating interest rates on debt is that they expose the borrower to changing market and general economic conditions. This can go both ways. It can be advantageous to the borrower when market interest rates are decreasing, but we also assume the risk of making higher interest payments when market interest rates are increasing.
The good news is that the WB and ADB loans contain interest conversion provisions wherein we can request the multilaterals to convert the interest rate from floating rate to fixed rate or to fix the variable spread over the reference rate should we elect to do so. This can help us manage the interest rate risk presented by the floating rates on the loans.
Overall, whether fixed or floating, our debts do not appear to be too taxing to service thanks to good credit ratings and global benchmark interest rates that are at historic lows. We have recently clinched an “A” credit rating from Japan Credit Rating Agency as our economy is seen resilient due to our adequate reserves and fiscal stimulus packages whose cumulative value is approaching 10% of GDP. Fitch and S&P Global have also maintained their investment-grade ratings for the Philippines at “BBB” and “BBB+”, respectively, on the expectations of strong economic rebound after the pandemic-driven crisis. Having an investment-grade rating means that we have a relatively attractive credit quality, with low risk of default.
Lastly, we also need to be mindful of other charges imputed by lenders that increase our cost of borrowing. The WB charges a front-end fee of 0.25% on the committed loan amounts, the payment of which is required before the first withdrawal of the loan. Additionally, the WB and the ADB both charge a commitment fee on the undisbursed amount of their loans at 0.25% and 0.15%, respectively. Sometimes exceptions are made. The WB notably waived the commitment fee during the first year for funds borrowed under the COVID19 Emergency Response Project.
Perhaps the easiest way to determine whether the rates and loan terms we have received are fair is to check how they stack up against those imposed by our lenders on comparable countries.
The WB and the ADB both classify member countries according to factors such as income level and creditworthiness. The groupings influence the pricing and terms of extended loans as well as financial products made available to the member country. Both multilaterals have grouped the Philippines with Thailand and Indonesia in their respective classification systems, meaning that our loans are similarly priced as those extended to these other countries. From this perspective, there is no indication that the loans extended to the Philippines—at least from these lenders—are more onerous compared to those extended to other countries with a similar level of income and creditworthiness.
World Bank Pricing Groups
*Most high-income countries have graduated from borrower status and are now donors/lenders. These HICs were not classified by the World Bank into the pricing groups. For example, Japan and South Korea graduated from borrower status in 1967 and 1995, respectively.
3. Spending plan: What will the money be spent on?
Finally, and perhaps most importantly, we must ask how the borrowed funds will be spent. At the end of the day, borrowing only makes sense if the money is used to execute policies, programs, and projects that are evidence-based, value-adding, and part of a coherent strategy to help us respond and recover from the devastating impact of COVID-19. In the realm of personal finance, there is a big difference between taking out a loan to buy new clothes versus borrowing in order to pay for school tuition.
Unlike the debt burden and loan terms, however, evaluating spending can be a subjective exercise. There aren’t straightforward benchmarks that we can use to check whether our spending priorities are in order, until perhaps after they have been implemented and outcomes are measurable. Nevertheless, using expert consensus and the experience of other countries as a guide, we can attempt to make value judgments on the urgency (and relative unimportance) of items on our spending agenda. Based on available social and health indicators as well as published spending reports, we can also evaluate whether the government is spending quickly enough to provide needed relief and support to sufficiently test, trace, and treat.
As discussed in a previous article, we know that the national government is primarily spending on two broad areas as part of its immediate response efforts: namely, social amelioration and health. The support it has extended to LGUs in the form of the PHP37 billion Bayanihan grant has likewise been availed for these purposes.
The debt that the government has recently taken out appears to be in line with this trend, with the majority of loans earmarked for specific purposes related to these two areas, from the procurement of PPE and medical supplies to the provision of cash subsidies for vulnerable families.
Classification and Purpose of COVID-19 Loans Since March 2020
By all indications, this appears to be the correct approach. A scan of the IMF’s policy tracker, which documents the policy responses of various nations against the COVID-19 pandemic, reveals that other countries are broadly prioritizing the same spending areas, albeit with varying specifics: health spending; support for affected workers businesses from hard-hit sectors; and aid for vulnerable groups. Prominent Filipino economists have likewise endorsed spending “to save people's lives, provide subsistence, preserve employment, and affirm social solidarity". Given that the current crisis is primarily one of health and that the resulting recession is not of the conventional sort, it is apt that the government is presently channeling most of its resources toward the provision of medical and economic life support.
In terms of transparency, we can take heart in the fact that multilateral lenders such as the ADB typically provide guidance for and track spending. At least for these loans, we can be reassured there are mechanisms for monitoring in place.
Still, we need to remain vigilant and continue to keep watch of how the government elects to spend all of its current and future loans, especially the ones that are unconditional and allow for government discretion.
Rate of spending
The question of whether we are spending quickly enough is another matter, however. To be sure, the processing of loans can take time; according to the CCBT, none of the recently secured loans are confirmed to have actually been remitted to the Treasury at this time.
However, if ongoing programs for which there is readily available cash are any indication, it isn’t clear that the government is even prepared to spend all these borrowed funds once they come through. As of June 29 or 14 weeks after the passing of the Bayanihan to Heal As One Act, the government across national and local levels has only spent 63% of its PHP390 billion response budget. The second tranche of emergency subsidies, which was slated for full disbursement by the end of May, only began large-scale rollout last week.
In its 13th Bayanihan Report to Congress, the Office of the President details why there has been a delay in the distribution of aid under the social amelioration programs (SAPs) of the Department of Social Welfare and Development (DSWD).
It is a tough balancing act for the government to protect the safety and security of the frontliners who implement these programs while meeting the urgent needs of their intended beneficiaries. Still, these challenges must be resolved sooner rather than later because thousands of individuals haven’t received the help that they were promised and desperately need.
You may also like:
- What the COVID-19 budget tracker tells us about government spending so far
- The COVID response budget for PH is actually bigger than P275B—it’s P380B, says budget tracker
- This guy created a budget tracker that traces where government funds for COVID-19 goes
- While NCR has the most cases, it has one of the fewest quarantine beds
- Tracking the COVID budget: Second portion meant to aid millions by end of May has not been released
As for health spending, while reported spending has recently increased and is up to 66% (PHP54 billion out of PHP82 billion), we still do not have enough data to tell what the exact hold-ups have been and if the reported data reflects on-the-ground realities. Thus, as we take stock of how our funds are being sourced and spent, let us demand the data that we need in order to make a fair and accurate assessment.
Given the unprecedented damage inflicted by COVID-19, it is imperative that we maximize cash resources so that we can readily support programs that save lives and livelihoods. Now is not the time to scrimp. Even the richest countries of the world need debt—it is a given when a country needs to finance costly programs, from relief aid to much needed infrastructure.
At the level and with the terms that the government is borrowing, we seem to be in safe territory. At least for now, there is no real reason to panic, as all indicators suggest that we have the capacity to pay off our loans.
At the level and with the terms that the government is borrowing, we seem to be in safe territory.
However, we must also ensure that these borrowed funds are spent wisely and in a timely manner.
Although recovery plans—once finalized—warrant additional and separate scrutiny, the current plan for response and relief spending appears to be aligned with global consensus.
Yet even the most sound and data-driven of plans can be rendered ineffective by spending that cannot keep up.
One day all our borrowed funds will be spent. But when tens of thousands are sick and millions are starving today, delays are costly and “eventually” is not good enough.
To learn more about the status of the government’s Covid-19 budget, visit covidbudget.ph.
Raya Buensuceso is a finance and economic analyst at Polestrom, an infrastructure advisory firm that specializes in public-private partnerships. She was formerly a research fellow at the Asia Center of the Milken Institute, a US-based policy and economic think tank, and graduated from Princeton University in 2017.
Jan Michael Saniel is a corporate finance manager at KPMG Singapore, specializing in valuations within deal advisory. He was formerly a senior equity research analyst at BPI Securities Corporation. He graduated with a master’s degree in finance from University of the Philippines Diliman and bachelor’s degree in accountancy from University of the Philippines Visayas.
Jerard Megg Cordero is a director at SyCip Gorres Velayo & Co. He specializes in the audit of financial institutions including banks and insurance companies. He graduated from University of the Philippines Visayas and placed 3rd in the October 2012 CPA board examination.
Any opinions are made in the authors’ personal capacity, independent from their affiliations.