THE PHILIPPINES faces rising capacity constraints and political risks that nevertheless have not dented the economy’s prospects, Moody’s Investors Service said in a Sept. 14 report showing the country’s “Baa2” credit rating – a notch above minimum investment grade – and “stable” outlook still reflect a balance of strengths and weaknesses.

“The Philippines’ credit profile balances sound economic and fiscal fundamentals against structural challenges to competitiveness and rising political risks,” Moody’s said in its annual credit analysis, more than two months after it affirmed the country’s credit grade and outlook.

A “stable” outlook signals that the credit rating will likely be maintained in the next 1-2 years.

“We expect robust economic growth to be sustained over the next few years, aided by the government’s focus on infrastructure development, buoyant private sector investment, and the recovery in external demand,” Moody’s added, saying it still expected gross domestic product (GDP) growth to clock 6.5% this year – the floor of the government’s 6.5-7.5% target range – and 6.8% in 2018, short of an official 7-8% goal.

GDP expansion has placed the Philippines either second- or third-fastest growing major Asian economy behind India and China this year, so far, with last semester’s 6.45% average pace approximating the lower end of the government’s target.

“Our assessment of the Philippines’ economic strength is ‘high’, which reflects its capacity to absorb shocks thanks to its rapid growth, large scale and economic diversification, although this is somewhat undermined by low income levels,” the debt watcher said, citing the country’s young, growing population, robust private investment growth, rising public spending, “potential” improvements in large infrastructure, strong domestic demand and low inflation as strengths.

But the Philippines’ $7,728 GDP per capita puts it at the bottom fifth of rated economies, “posing a prominent constraint to economic strength”.

The country has a “moderate (+)” score in terms of institutional strength, reflecting policy effectiveness, as suggested by slow, stable inflation, that is offset by below-median grades in terms of government effectiveness, rule of law and control of corruption when compared to similarly rated peers.

Much now depends on President Rodrigo R. Duterte’s ability to push his socioeconomic agenda, Moody’s said, noting that “[p]rogress on this agenda is likely to ultimately depend on whether the president deploys his considerable political capital towards these reforms”.

The Philippines has a “moderate (-)” assessment in terms of fiscal strength, with its low public debt burden compared with similarly rated peers balanced against currency risk caused by relatively high foreign currency-denominated debt. While the country’s government debt-to-GDP ratio is below median and state interest payments-to-GDP ratio is at the median, government debt as well as state interest payments in relation to revenues are above the same.

“We project the Philippines’ indebtedness to remain relatively low over the medium term,” the report read, adding that Moody’s expects the fiscal deficit “to remain around the government’s target of three percent of GDP”, keeping the recent trend of debt consolidation intact.

Finally, the country’s “susceptibility to event risk” – sudden events may severely strain public finances, thus increasing the country’s probability of default – has been marked “low (+)”

Under this indicator, Moody’s recently revised upwards its assessment of domestic political risk to “low (+)” from a mere “low” in the face of the battle against Islamic State-inspired militants in Marawi City that is nearing the end of its fourth month, the consequent declaration of martial law over all of Mindanao, Mr. Durterte’s preoccupation with law and order and his bloody campaign against the narcotics trade.

“Prior to the attack on Marawi by Muslim insurgents, the president had suggested that martial law, together with expanded emergency powers, could address issues other than domestic terrorism or rebellion, including the war on drugs and traffic congestion in Metro Manila,” Moody’s recalled.

“An unchecked expansion of the president’s authority could weaken constitutional checks and balances, and undermine the buoyant private sector sentiment that has underpinned the Philippines’s robust economic performance,” it warned.

“Moreover, while we expect strong economic and fiscal governance to remain, a prolonged focus on political matters could draw attention away from the government’s reform agenda, particularly economic and fiscal reforms including” tax reforms.”

And while “[t]he re-emergence of conflict in the southern Philippines and the administration’s focus on the eradication of illegal drugs represent a rising but unlikely risk to economic performance and institutional strength… A rapid escalation of domestic political conflict that undermines institutional strength and the government’s reform agenda would be credit-negative”.

The debt watcher said further that while the banking system is well-capitalized, profitable, competently managed and very liquid, “thus posing limited contingent risks to the government… [h]igh credit growth since 2014… exposes the banking system to unseasoned asset quality risk.”

Moody’s also cautioned that “capacity constraints are emerging – including labor shortages in certain sectors – and these could prove more stringent than we currently envisage…”

To Bangko Sentral ng Pilipinas Deputy Governor Diwa C. Guinigundo, however, recent economic growth – clocking 6.9% last year and averaging 6.2% in 2010-2015 – has increased capacity.

“In terms of capacity, the potential growth of the Philippines has gone up compared to previous years. The balloon has grown. So even if you pump in more water or air, it can accommodate. It has the bigger capacity to do that without going into capacity constraint,” Mr. Guinigundo said in a press conference yesterday.

“What brought about the increase in potential output is the increase in total factor productivity, the economy has become more productive, and also in terms of capital productivity,” he explained.

“When you are going into capacity constraint, the telltale sign is very clear: mataas ang growth mo (economic growth is fast), and if you have capacity constraint, then it should tell on your inflation. Inflation should be surging, but it’s not,” he noted, referring to headline inflation rate that, while picking up from last year, has averaged 3.1% in the eight months to August against the central bank’s 3.2% full-year forecast for 2017. – with E. J. C. Tubayan

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