Fitch affirms Philippine debt grade but slashes growth forecast further

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GLOBAL DEBT WATCHER Fitch Ratings, Inc. on Thursday affirmed the Philippines’ long-term foreign-currency issuer default rating at “BBB” — still a notch above minimum investment grade — with a “stable” outlook, meaning the rating is likely to be sustained in up to two years, but further slashed its gross domestic product (GDP) projection for the country.

The notice came as the central bank announced that May price data which the government is scheduled to report on June 5 can be expected to show inflation ending six straight months of easing.

“The ratings balance the Philippines’ prospects of strong sustainable growth and high levels of foreign-exchange reserves against relatively low per-capita income, governance indicators, and government revenue,” Fitch explained in its rating action commentary that was e-mailed to journalists on Friday.

It said it expects the Philippine economy “to expand by more than six percent per year over the medium term, well above the current peer median”, but further reduced its GDP growth projection for the country for this year to “6.1%” from the 6.2% it indicated in its APAC Sovereign Credit Overview 2Q 2019 report in April and the 6.6% projection it gave in December 2018.

Still, Fitch said that overall economic “momentum is likely to recover after a slowdown to 5.6% [the slowest pace in four years] year on year in the first quarter from weaker exports and government spending due to the delay in the passage of the 2019 budget”, adding that “[g]rowth will remain supported by strong private consumption and the government’s public-investment program, which targets an increase in infrastructure spending to about seven percent of GDP by 2022 from 4.5% in 2017.”

At the same time, China’s slowing economy — expanding by 6.4% last quarter, flat from the fourth quarter of last year but slower than the 6.8% clocked in 2018’s first three months — and “spillovers from escalating US-China trade tensions” pose risks to the Philippines’ growth prospects.

The debt watcher also noted that “overheating risks have subsided’ following the Bangko Sentral ng Pilipinas’ (BSP) cumulative 175 basis-point hike through five meetings of its Monetary Board last year.

Headline inflation slowed for six straight month to a 16-month-low three percent in April from a nine-year-high 6.7% in September and October last year — facilitated by the lifting of rice import restrictions, while credit growth has slowed “significantly” — but the year-to-date 3.6% pace compares to the BSP’s 2.9% forecast average for 2019 and lies near the higher end of monetary authorities’ 2-4% target range for the year.

“Credit growth decelerated in 1H19 and we forecast only a modest recovery, contained by tighter liquidity conditions after an extended period of fairly high loan growth,” Fitch said.

In the face of easing inflation and slowing economic growth, the BSP partially dialed back its 2018 tightening in its May 9 policy review that slashed benchmark interest rates by 25 bp, while banks’ reserve requirement are now undergoing a phased 200 bp reduction, after a cumulative cut of the same magnitude last year.

The central bank announced on Friday that inflation could have ended its downward trajectory in May within a 2.8-3.6% band.

“The BSP Department of Economic Research projects May 2019 inflation to [have] settle[d] within a 2.8-3.6% range,” the central bank said in an e-mail to reporters.

In coming up with its May estimate, the BSP unit cited base effects; lower rice and domestic fuel pump prices as well as electricity rates that were offset by higher jeepney fare in Central Visayas — which rose 23% to P8 for the first five kilometers from P6.50 — and a pickup in prices of select food items.

Bills of the Manila Electric Co. — the country’s biggest electricity distributor — declined by P0.2728 per kilowatt-hour (/kWh) to P10.2866/kWh, on the back of lower generation charge due to lower charges from independent power producers and power supply agreements.

Energy department data also show that, as of May 28, year-to-date fuel adjustments at the pump amounted to net increases of P7.20/liter for gasoline, P5.75/liter for diesel and P4/liter for kerosene, compared with P8.80/liter for gasoline, P6.20/liter for diesel and P4.95/liter for kerosene as of April 30.

Meanwhile, PSA data show retail price of regular milled rice declined 3.7% to P38.75/kg in the third week of May from P40.23/kg a year ago, while that of well-milled rice shrank 1.9% to P43.07/kg from P43.92/kg in the same comparative periods.

Rice accounts for 9.59% of the theoretical basket of goods used by a typical household that is the basis for computing year-on-year price changes, while liquid fuel, solid fuel, gasoline and electricity contribute 0.13%, 1.22%, 1.28% and 4.8%, respectively.

Should BSP’s projection be realized, year-to-date inflation would clock in at 3.46-3.62%.

Fitch expects the first of up to five planned tax reform packages — which slashed personal income tax rates but increased or added levies on various goods and services when it took effect in January 2018 — to improve state revenue collections “to around 17% of GDP by 2021 from 16.4% in 2018”, noting that “[g]ross general government revenues, at 19.7% of GDP at end-2017, were below the ‘BBB’ median of 27%”.

The credit rater also projects the state budget deficit to be equivalent to 3.1% of GDP this year — “close to the government’s target of 3.2%” — rising slightly to 3.2% in 2020 as infrastructure spending picks up, to be offset by a rise in government revenue.

It sees government debt-to-GDP ratio remaining “broadly stable at around 36% of GDP”.

“The recent Supreme Court ruling requiring increased revenue transfers from the central to local government units starting in 2022 could, in the absence of offsetting measures, put upward pressure on government deficits and create challenges for effective public-finance management,” Fitch noted.

“We understand the government is seeking to address these risks, possibly by shifting spending assignments in tandem with revenue transfers to local governments.”

It also expects the country’s buffers to external financial shocks to remain adequate, with gross international reserves remaining “adequate at more than six months of current external payments in 2019-2021”.

“The Philippines also remains less vulnerable to large outflows compared with some of its neighbors in the region due to lower non-resident holdings of domestic debt.”

Fitch also expects the current account gap to stabilize at around 2.5% of GDP, “after a substantial widening from 0.7% in 2017”, with imports remaining strong amid the government’s infrastructure push, against offsetting by growing remittances from Filipinos abroad and service exports from business-process outsourcing and tourism.

At the same time, the country’s “structural indicators continue to lag behind those of rating category peers”, with 2019 GDP per capita expected to reach $3,358, less than a third of the current “BBB” category median of $11,353.

“Standards of governance and human development are also weaker than the peer median,” Fitch said, noting that the Philippines “ranks in the 41st percentile of the World Bank’s governance indicators, compared with the 56th percentile of the current peer median.”.

It also noted that the banks’ adequate profitability, capital and liquidity buffers underpin the sector’s ability to withstand downturns, with a sector-wide common equity Tier 1 ratio of 13.8% at end-2018 — well above the regulatory minimum — and end-March 2019 loan/deposit ratio of 77%.

Fitch enumerated factors which, individually or collectively, could trigger positive rating action as continued strong growth while maintaining macroeconomic stability, strengthening of governance standards and sustained broadening of the government’s revenue base that enhances fiscal finances.

Those, however, that could trigger a rating downgrade are: reversal of reforms or a departure from the existing policy framework that leads to macroeconomic instability, deterioration in external balances that reduces resilience of the economy to shocks and instability in the financial system, possibly triggered by a sustained period of high credit growth.

Responding to the rating affirmation by Fitch, Finance Secretary Carlos G. Dominguez III said in a press release issued by the government’s Investor Relations Office: “We are glad Fitch has taken note of the Philippine economy’s resilience to both external and domestic headwinds.”

“In part, the strength of the economy is credited to… implementing unpopular game-changing reforms to sustain the growth momentum and achieve financial inclusion for all,” he added, citing “[t]he first package of the comprehensive tax reform program and the liberalization of the rice sector, among a long list of reforms implemented recently” as “vital structural changes that will keep the economy on its high growth path, create more jobs and improve the living standards of Filipinos.”

He said that despite external and internal financial threats, economic growth can be expected to gain more traction as the government starts catching up with its infrastructure spending program and human capital development “to reverse the lower-than-expected expansion in the year’s first quarter, brought about in large part by the congressional delay in the approval of the 2019 national budget”.

The same statement quoted BSP Governor Benjamin E. Diokno as saying: “As recognized by Fitch, following the implementation of decisive actions by national government to address supply-side issues, including decisive policy rate hikes by the BSP last year to anchor inflation expectations and contain any second-round effects, inflation has reverted to within-target level this year.”

“The much improved inflation outlook, including better anchored inflation expectations, has allowed the BSP to cut policy rates by 25 bps and to cut the reserve requirement ratio in May. Guided by its price stability mandate, the BSP will continue to adhere to the conduct of sound monetary policy, making sure it is properly calibrated to provide an environment that enables sustainable economic growth.” — with Karl Angelo N. Vidal