Moody’s flags added political risk as it affirms Philippines’ investment grade

MOODY’s Investors Service on Friday affirmed Philippines’ “Baa2” rating — one notch above minimum investment grade — and “stable” outlook, citing the economy’s overall strength, even as it flagged risks from rising inflation and the planned shift in government form.
The rating action comes two days after Fitch Ratings did the same.
“The ‘Baa2’ rating incorporates a number of very positive credit features, including the high economic strength derived from a large and fast-growing economy, as well as improving fiscal strength based on moderate government debt levels and gains in debt affordability,” Moody’s said in its statement.
It noted, among others, that its estimate of the Philippines’ general government debt at around 38% of gross domestic product (GDP) in 2017 is “about 10 percentage points below the median Baa-rated sovereign”.
Moreover, relatively large foreign exchange reserves and low foreign debt support macroeconomic stability. “… [R]elatively low reliance on either foreign sources of income or financing insulates the Philippines from the direct impact of abrupt changes in the global macroeconomic and financial environment,” Moody’s explained.
These strengths, it said, “are balanced against more negative features which constrain the rating, principally low per capita incomes and, relatedly, still low revenue-raising capacity as compared to similarly rated peer countries.”
The Philippines’ $8,300 per capita income last year, Moody’s noted, compared with around $23,400 for median Baa-rated peers, while “revenue as a share of GDP remains well below the Baa-median as of 2017”.
“This means that despite moderate debt levels, interest payments absorb a relatively large share of the comparatively narrow revenue base.”
The debt rater said policymakers also face challenges in managing rising inflation pressures, while “domestic political developments and prospective changes to governance frameworks” — including weak rule of law and control of corruption as well as a planned shift to a federal form of government — “present downside risks to the country’s institutional and fiscal profile”.
Supporting the “stable” outlook — meaning the credit rating will likely be sustained in the next 12 months — is the current government’s push of tax reforms in order to help finance infrastructure development.
As a result of tax reforms, Moody’s “expects a broadly stable government debt burden at moderate levels, below 40% of GDP, improving debt affordability, and sustained high GDP growth”.
Because of Republic Act No. 10963 — or the Tax Reform for Acceleration and Inclusion Act that slashed personal income tax rates to push household spending and raised or added taxes on a host of items when the law took effect on Jan. 1 — Moody’s now projects state revenues in proportion to GDP to rise to 16.2% this year and further to 16.7% in 2019, from 15.6% last year.
In the political sphere, Moody’s said President Rodrigo R. Duterte’s “contentious policies on law and order over the past two years as well as other political controversies may have a negative impact on the Philippines’ attractiveness to financial and physical asset investors”.
“In addition, prospective changes to governance frameworks could have negative implications for public finances”, since a bigger share of national government revenues may go to local units.
“The shift to federalism would also likely incur an expansion in the aggregate size of the government and, hence, public expenditure,” Moody’s explained further.
“At the same time, there may be a gap between the national and local levels of government with respect to their ability to manage fiscal resources, posing a risk to the improved fiscal discipline that has characterized national government finances over the past decade.”
“Marked” improvement in per capita income and revenue generation, as a result of progress in the government’s reform agenda, could fuel a credit upgrade, Moody’s said, while a downgrade could be warranted “if macroeconomic stability were to be threatened by unabated overheating pressures leading to a deterioration in fiscal and government debt metrics and an erosion of the country’s external payments position”.
“The reversal of reforms that have supported recent gains in economic and fiscal strength, and/or the implementation of prospective changes in governance structures in a way that diminishes fiscal strength would also likely lead to a downgrade.”