Friday, December 16, 2011

Pilipinas Forum 23: On Debt Repudiation

As of end-September 2011, total debt of the national government was P4.87 trillion. This is P206 billion (or 4.4 percent) larger than its year ago level. See the Bureau of Treasury (BTr) Press Release last December 09.

As of October 2011, there were 38.5 million employed Filipinos. This means that each employed Filipino, young and old, fully- or under-employed, is indebted by P126,515.00. And it's not even personal or household debt. It is government debt, to be passed on to each taxpayer in this country. That's how great, sensitive and welfarist the government is.

And there's more debt: contingent debt, mainly guarantees by the national government which can become part of the outstanding debt stock if the guarantee recipient (a government corporation or financial institution, etc.) cannot pay its debt. This is P583 billion as of September 2011. And that's how great, sensitive and welfarist the government is.

More than seven years ago, we have a lively exchange of ideas on the question: Is repudiation of public debt a good option? That was in, an online discussion group which I formed and co-moderated since 1999. The voices of "repudiate the debt" are still with us until now, coming from different sources. So perhaps these exchanges will help clarify the issue.

This is more than 20 pages long, so get your most liked snacks. Special thanks to Dr. Butch Arroyo, my batchmate from UP School of Economics in 1984, for his elaborate discussion of the subject. Butch is an Economics Professor at the Johns Hopkins Univ. in Washington, DC.

On Debt Repudiation
March 2004

About debt repudiation, I am attaching below Butch Arroyo's posting in PF about the subject. He posted this in reaction to a privilege speech given by Sanlakas party-list Cong. JV Bautista, arguing for "selective debt repudiation".

Butch made a good analogy here: "debt is much like garbage in a dumpsite. Where does the garbage come from? It is a by-product of often necessary human activity. Where does debt come from? It is one of the things that goes along with modern commercial activity..."

And the question, "Why Not Just Burn the Damn Pile? (or) why not just default on the debt?" The man outlined the potential consequences, as well as other options aside from just burning the damn garbage pile. I say "Amen" to most of the points raised by the man here, so I won't make additional comments at the moment.

- Nonoy Oplas

2. On Debt and Deficits: I have remarked in a previous posting with the PF that the total public debt is the accumulation of all government deficits, past and present. Railing against the amount of total public debt is, effectively, railing against all the budget shortfalls there ever were, past and present. In complaining, one's vitriol is usually directed towards the current administration, as though the current level of debt was solely caused by it, and is therefore solely responsible for it. But the truth is, every administration past and present made some contribution (though not in equal parts) to the total public debt. Or at least, every administration starting from the Marcos regime circa 1974, which is probably around when Philippine public debt levels began to take off. It would be interesting if someone would put together an analysis showing which of the regimes starting from as far back as data allows added the most to debt (per capita, per year in office, adjusted for inflation and exchange rate changes)-- but that's for some other day, and maybe for someone else.

Let me suggest an analogy: I think debt is much like garbage in a dumpsite. Where does the garbage come from? It is a by-product of often necessary human activity. Where does debt come from? It is one of the things that goes along with modern commercial activity--to undertake spending you can't support out of current funds, you borrow. Does one have to borrow to sustain economic activity? No, but one would have to be willing to curtail economic activity levels so as not to require debt finance. Where does public debt come from? From a sequence of administrations that have spent beyond their ability to generate revenues. Does government have to borrow? No, but it would have to curtail its activities to hold down its debt levels. This it might do willingly if there were political incentives for it to do so. There are almost none.

But back to the analogy: when the garbage pile is not substantial, there are few complainers. It's when it piles up to Smoky Mountain stature that it becomes (1) obvious, (2) offensive, and (3) a problem that everybody thinks needs to be dealt with, but nobody wants to touch. But how does garbage pile up to such proportions in the first place? Well, most of the time it happens by increments. The point is that everyone criticizes the pile, but far fewer question the increments, even though these are what really make up the pile. The same seems to me true about the public debt. Everybody complains when confronted with the enormity of it, but people tend to be more cavalier about the annual increments that add to the pile, i.e., the annual budget deficit. To most people, the budget deficit doesn't seem that big (what, after all, does 4-5% of some amorphous thing like GDP mean to the layman?), plus all of the items in it are almost surely justifiable, and anyway Erap or GMA or FPJ looked so sincere in presenting the case for such programs at their SONA, etc., etc. But consider the net future value (i.e., the reverse of the net present value) of any current budget item that will be financed from general revenues (and hence will add to the deficit). Counting all its annual additions to future debt service, the actual impact on debt levels even just ten years out can be substantial. Thus the real question to me is: is the current spending worth the debt service it generates?

Even among us more educated types, very few view debt this way. And if we don't, you can bet the masa don't. So we all just mostly smell the pile and complain.

But part of the solution must entail something that not just reduces the debt, but also controls the increments--the budget deficits--regardless of of what future administrations might come into power. So here's a two-part suggestion: (1) pass a law that requires all government departments to finance current spending out of current revenues (taxes, tolls, user fees, etc.), and only allow capital spending items (i.e., public investment expenditures) to be financed with borrowing, foreign or domestic. (2) Follow this up with a law that establishes extremely strict standards for what qualifies as capital expenditure, and applies strong independent oversight on capital expenditure disbursements. The hope is that at least some of the capital expenditures of the public sector will be revenue-enhancing, and this will help with the repayment of the associated debt.

Strange? Impossible? The UK has such a law. We could have one too.

3. Why Not Just Burn the Damn Pile? This brings me to the next issue, which is why not just default on the debt? This is one of the congressman's less-than-humble suggestions: "This representation, then, puts forth this humble first step. Investigate and audit all past and present debts. The aim of the Congressional inquiry and audit is to ascertain the legitimacy of these debts, make transparent the payment of debt obligations, determine which are fraudulent, behest and onerous, and consequently repudiate such."

First off, let me say that I have nothing against the spirit behind the principle behind the idea behind this suggestion. Yes, to me there comes a point when "selective default"--or "selective repudiation" if you like--has to be put on the table. Maybe we are at or near that point.

But before you or I start jumping on that bandwagon, let's consider this: who really are the major claimants on the Philippine government? The congressman suggests (later on) that the dirty transnational corporations and local robber barons are the ones who have a choke-hold on the Philippine government's ability to spend more on needed social services. He holds out the dubious hope that we might subject these vile characters to a congressional audit of loans made and, if impropriety, fraud, or outright graft is discovered in direct relation to these loans, repudiate these debts, and this would greatly alleviate matters. "The end result of the debt inquiry and audit should be a significant increase in funds for genuine development and social services, and the restoration of the national budget as a tool for development.")

When I read this section of the Congressman's proposal, I was reminded of something H. L. Mencken said: "For every human problem there is an easy solution. And it is almost always wrong." Well, this is one such easy solution, and maybe it is not entirely wrong-headed, but to me it seems mostly wrong. Consider this: what if the holders of most of the Philippine government's bonds and other instruments of indebtedness are institutions like the SSS, the GSIS, PNB, and the major domestic banks, besides the usual suspects, a.k.a., the IMF, the WB, the IFC, the ADB, etc. If you were to repudiate a class of bonds—say Philippine Treasury bonds of a certain series--that Congress determined were issued on behalf of some "illegitimate" programs or some illegitimate regime, you would need to repudiate across the board. You couldn't really say--okay, we will not pay out on Treasury obligations issued in 1999 held by the IFC or by international banks, but we will pay out on those held by the SSS. By what principle of jurisprudence could you argue for this kind of discriminatory repudiation and win in a court of law, even in the Philippines? So maybe you have to repudiate across the board. But then what happens to those people whose pensions are tied to the solvency of institutions like the SSS and GSIS, whose assets will take a hit when the Philippine government says it will refuse to pay out on these obligations? Or to the depositors of banks that might fail as a consequence of this policy? Or, if either a pensioner or depositor bailout occurs, the taxpayers who must fund such a bailout?

The only kind of debt you could possibly "selectively repudiate" are behest loans that are held narrowly, i.e., by a small set of individuals or institutions. And even then not all of these will institutions will be "illegitimate". Moreover, some such illegitimate debts may have passed on in the financial markets to legitimate individuals or institutions who would be unfairly penalized for a legitimate transaction. So how big a fraction of total current debt would the remaining amount of indubitably dubious debt comprise? I suspect this will not be a large proportion. In any case, the bulk of outstanding obligations of the Philippine government is probably general indebtedness like Treasury obligations, not behest loans. Of course once you have uncovered some dubious behest loans, you should repudiate them. Or should you?

First let me assume (unrealistically, of course) that there is enough political will right now to actually consider repudiation of such illegitimate debt. This is probably unrealistic because not twenty years ago we actually had a golden opportunity to conduct such a repudiation--when Cory came to power we could have repudiated a significant amount of Marcos-era debts--and we failed to do it. And today we have less internal unity and external support for this idea.

So back now to the analogy of the garbage pile--why not just set the damn thing on fire, and reduce it to ash? Well, I would think there are consequences to thoughtless debt repudiation, just as there are consequences to burning garbage thoughtlessly. The environmental costs of uncontrolled incineration as a mode of waste disposal find their analog in the financial costs of indiscriminate debt repudiation, or as creditors would call it, default. Just thinking out loud, I would point out that Peru declared a broad unilateral suspension of debt repayments in the 80s (1986, I think). So did Bolivia. Come to think of it, so did we for a time. And there are more recent cases. Somehow I haven't heard any claims of resounding economic successes arising from any of these historical attempts at unilateral debt reduction. Instead I have heard resounding complaints about the high domestic interest rates that arose from the delinking of these countries from world capital markets in the aftermath of their defaults. In fact, if the default--sorry, repudiation--is too broad and not carefully targeted or well-explained to the markets, you may as well ask for a run on the currency and devaluation on international markets (as international creditors panic and sell off all forms of Philippine government issue) and at home a run on domestic banks (whose assets include holdings of government issues).

So what kind of selective repudiation can one actually hope for? Some behest loans, probably most of which are domestic, which would then become the subject of legal challenges. This doesn't seem like a lot to me. But I think this should still be done anyway as its symbolic value could be significant--doing so would send a strong signal that creditors cannot assume that debt contracts entered into under highly questionable circumstances will be honored by subsequent administrations or Congresses.

In short: I don't expect much debt reduction from this approach if it is done right, though you could gain from better future behavior from creditors. On the other hand if it is not done right (too indiscriminately), I expect much economic dislocation for a time, then slow recovery over a 5-10 year span, in exchange for a modest reduction in overall debt levels. This would be a good thing in the very long run, but a generation's welfare may have to be sacrificed to achieve it.

4. How About Debt Conversion? So maybe a different tack is called for here. Maybe what should be pursued more is not debt repudiation but debt conversion (i.e., debt-for-equity, debt-for-tax amnesty, or given how inefficient the tax collections mechanisms are, maybe even debt-for-tax credits). These could apply to a broader class of loans and claims, and not just the ones that one can repudiate with least cost after much wringing of Congressional hands.

5. Hyperbole? The good Congressman's rhetoric goes: "In flesh and blood terms, every peso that goes to the coffers of foreign and local creditor banks is a textbook, desk and chair taken away from choolchildren in our remote barangays. Every dollar siphoned out of the country by transnational creditor banks is another burden on the backs of teachers who have teach oversized classes of 50 to 70 students. Every rise in the stock market index points of the country's creditor banks means a drop in school attendance for Filipino children and youth. Every peso that goes to debt servicing is a peso taken away from a rural health center, a housing unit for our homeless, a school building in a far-flung barangay, and farmland redistributed to a landless farm worker. It is not a hyperbole to say that putting a premium on debt servicing over providing social and economic services is a heinous crime tantamount to plunder."

Well, no disrespect intended to the good Congressman but to me each of the statements just made is, in fact, a hyperbole. Can any of us who knows the meaning of words like "hyperbole" seriously believe that there is a DIRECT trade-off involving ONLY debt service and social spending (on books, teachers, hospitals, or for that matter, congressional pork or white elephant projects)? Let me be more plain: First, debt service is one among a number of spending items from among which any administration must prioritize. A peso saved from not paying our debts could go to more books, yes, but it could just as easily go to the defence or security budget, or any other items that the congressman considers less desirable than books or teachers or hospitals or even congressmen. If the military is presumed by him to be corrupt, is throwing more money in their direction a better thing than say, paying out debt service to creditors like
the SSS, GSIS, PNB, IFC, ADB, etc.? The real trade-off to me is not between debt service and social programs, but between a variety of social programs and an equal plethora of non-social programs, and then maybe, just maybe, debt service. No one, myself included, considers paying off our debts an enjoyable exercise. But we do it to protect our creditworthiness in case of future exigencies. Because in an emergency, access to credit markets has almost paramount value.

Secondly, to suggest that all debt service represents, effectively, food or necessities taken off the plates of the poor is populist argumentation at its worst. As Nonoy O. also pointed out some of what now comprises our stock of debt financed our past needs (yes, those of the poor too), needs that we could not have left unmet. And sure, some of it did not. But unless you can distinguish clearly which piece of garbage came from where, I wouldn't start burning up debt paper indiscriminately. You could end up just getting burned.

6. So What to Do? I have read elsewhere that the current approach being taken by the government is to close the budget gap mainly through expanding the tax base (via the proposed tax amnesty program, the closing of certain tax loopholes, and expanding the coverage of certain business taxes), increasing collection efficiency (especially at Customs), and privatization (mainly by selling off government-held shares of various corporations). These all make sense to me. However, as mentioned in the foregoing, we might now also consider:

* Debt conversions of all sorts (e.g., debt-for-equity or debt-for-tax amnesty or maybe even debt-for-tax credits)
* (Highly) selective repudiations
* Increased scrutiny over off-budget expenditures (and here I agree with the Congressman)
* Laws to restrict public borrowing to support only capital and emergency expenditures

The bottom line is that there are few easy solutions here, but at least some of them have a chance of being right.

Sorry if this posting is overly long, but I try to map out my thoughts in some detail before presenting them in this Forum. Feel free (anyone) to comment either way on any of these ideas, and maybe we can keep the discussion going, and also hear from the other minds in the PF.

Regards to all,

-- Butch Arroyo

Noy, medyo mahaba yung note so may i just comment a bit on the more glaring points? I am not sure if the garbage analogy was accurate. Burning the damn thing is different from recycling the damn thing. My comment was more in the recycling lines. When you repudiate debt, my impression is that you free your cashflows. That cashflow will not disappear as in burning the damn garbage. It can be plowed back into the system as higher social service support, or higher government salary and higher teachers pay or more rooms for students or more farm to market roads or simply more money for pumpriming the economy. The point is that the debt payment money would go back into the system.

I agree that debt is like garbage in the sense that it is an intertemporal pile. But i think managing a garbage dump supporting one city would be far more manageable than managing a garbage dump supporting two or more cities ... especially if these other cities do not pay user fees. Cheers!

- Ricky Lozari

Folks, just a quickie. Members of Congress may not be that credible when they suggest things like debt repudiation, no matter how selective. For they actually imply realigning the debt service to their pork barrel, meaning an attempt to remove debt service from the automatic appropriation in the national budget.

Consequently the President vetos such provision in the national budget (meaning the debt service stays as an automatic appropriation), but the result is that the legislators are happy that their pork barrel becomes larger. The Executive Branch is also pleased that it could still borrow to settle the debt service. This actually happened. The end result was that the budget got bloated. The purported solution in fact aggravated the fiscal problem.

Such was a Punch and Judy show, a thrilling entertainment for the people at the latter's sad expense. Cheers,

- RoyPicart

If I may respond quickly to a few points that were raised by Ricky L:
I don't follow how repudiating debt is tantamount to "recycling" it. By repudiating debt, essentially you unilaterally decide not to honor some or all of a certain class of debt. It's as simple as announcing to the investor community: "The government of the Philippines has decided that it will not pay this-or-that debt". This is pretty much like burning up the garbage, not recycling it.

I made the earlier analogy of debt as a garbage pile to illustrate the idea that public debt was the built-up consequence of years of budget deficits, and that if you want to fix the problem at the source, the solution is to work to reduce the budget deficit. Analogy is not argument, and I don't want to waste people's time defending an analogy I made mainly for illustrative purposes. Rather I want to restate several of my arguments for why repudiating debt won't really fix anything and will create problems of its own.

1. First off, which debt will you repudiate? I made this point in my earlier posting, but let's hear it from the former BSP Governor:

" will you restructure or renegotiate when most of the borrowings now are in the form of bonds in the hands of the public? You don't even know who are the holders unlike in 1983 when our lenders were the banks. We knew who were our creditors,"

Here, Gabby Singson is referring to restructuring rather than repudiation. But if, as he says, our debt is now more broadly-held, who will you hurt if you did repudiate? It isn't only international investors who hold our sovereign debt but also domestic banks and institutions (e.g., SSS, GSIS). More on this below.

2. But suppose for argument that foreigners held most of the debt you want to repudiate, is it costless to repudiate those debts? I think not. On the other hand, Ricky is of the view that our sovereign bonds are already rated below investment grade, so it won't hurt much more. (By the way, just because our bonds are below-investment grade does not mean there no one wants them. Just the other day we floated $500 million of these bonds at 9% interest on the international markets). Well, here again is the former BSP Governor:

"'It was very painful,' he said.

"In 1983, he recounted that the Philippines declared a debt moratorium, which was followed by several waves of restructuring until it ended in the issuance of the Brady-type or high-yield bonds.

"'We were not able to go back to the voluntary financial market until 1992, the last quarter, and we raised only 50 million dollars. So from 1983 to 1992, or for almost 10 years, we were shut off from the international market,' he noted."

So basically, HISTORY shows that repudiation is likely to land us in the same class of international borrowers as Somalia, Sudan, and now Argentina. Lending and investment flows to the Philippines would dry up; if the sovereign bonds of the Philippine government--normally the safest Philippine investment vehicle for international investors--become "junk" or below-"junk", could you think of any other Philippine asset that international investors would willingly hold? If we take the above historical numbers literally, over the next 10 years we would get something like one-tenth of the $500 million we raised just a few days ago. How well can we run an economy on that?

Let's imagine a few more scenarios. Suppose that the Philippines was forced to accept a sharp depreciation of the peso in the aftermath of the capital flight that normally follows a repudiation. Say the peso goes to PHP 70 to USD 1. How will that affect the cost of living in the Philippines? Also, if international funds dry up, the only recourse for local borrowers will be local lending. How high might domestic lending rates go, then? Does 45% sound too high? This was around where it was in the mid-80s when we declared a debt moratorium. I can see no way that our corporates would be able to get cheap financing anywhere, be it from abroad, the government, or local lenders.

Worse, now imagine that over the longer term the Philippine economy were to start growing again and say at that point we needed to import more oil or power to support this spurt of growth. We would have to put the foreign currency up front to buy the oil, or go without. Where would we get it?

3. Finally, I would like to reiterate that the debt of the Philippine government is not to be thought of as foreign debt! In fact, Philippine government indebtedness is split about 50-50 between domestic and foreign debt. So if you want to make an impression on total debt, you might have to also consider domestic debt repudiation. This, as I said, can be quite painful, since Filipinos either directly or indirectly through corporations and institutions like the SSS or GSIS are the holders of this debt.

Here are the exact numbers on our stock of public debt, courtesy of the Bureau of the Treasury's website (

(Outstanding Government Debt, in Million Pesos)

            Total                Dom/ Debt      Foreign Debt
1997    1,350,574           749,608           600,966
1998    1,496,222           850,931           645,291
1999    1,775,356           978,404           796,952
2000    2,166,710        1,068,200        1,098,510
2001    2,384,917        1,247,683        1,137,234
2002    2,815,468        1,471,202        1,344,266

4. Maybe what Ricky has in mind is more along the lines of "debt restructuring" rather than repudiation. That's a bit more like the "recycling" idea. Restructuring will lengthen the repayment term of our debts and soften the debt service in the immediate years. So the day of reckoning can be postponed for a while (not indefinitely). But the debt does not go away. In fact restructuring is likely to increase the total amount of debt service payments made over the new extended term of the obligation.

More importantly, unless you stop the annual parade of budget deficits (which debt restructuring does not do), the build-up of public debt will proceed unabated. Either we pay it now, or pay for it when we are older and more vulnerable to adverse economic shocks, or we get our children to pay for it. Choose.

Best regards to all,

- Butch Arroyo

Thanks Butch, Your note is enlightening.

I was not careful when i wrote my email. It was a from the hip kind of thing. But what i really meant was repudiation, not restructuring. Recycling came to mind because there was a call to choose which debt not to pay and which ones we should pay. If the analogy was wrong, I apologize. I just did not like the idea of paying for something that did not benefit our country.

The arguments against repudiation is and has always been strong. I think everything revolves around the main theme that it would greatly increase our country risk. As you mentioned, some say that capital flight would ensue and that the biggest losers would be the Filipinos themselves. I am not an expert on this so it would be interesting to know if a selective repudiation has already been done in the past and whether it did result in capital flight. And whether such financial crisis lasted long.

Your point that the debt moratorium resulted in a financial crisis, to me only bolstered my growing impression that selective repudiation may be the key. You see, the debt moratorium happaned in the 80s and just within a decade, the economy again rebounded. And to think that it was during these times when we had to endure the assasination of Ninoy, the EDSA revolution and the successive coup's. So to me, there will be life after debt (repudiation):) Much more if it were selective!

My impression is that the memory of the financial universe is short and is further shortened by greed. I doubt if no one would lend to a PLDT, for example, if the government chose not to pay for a debt related to, say, the construction of the Palace in the Sky. Or if the foreign shareholders of BPI would dump their shares if we said that we wanted to renege on our obligation to pay for debt related to the construction of the Bataan nuclear plant (if the debt is still existing, anyway). My point is that i doubt if the private sector would die if we selectively repudiated.

I also doubt that investors would no longer lend to the GOP. (In fact, if the premise of the repudiation was to free us some needed cashflow then the question would be ... would the GOP have any immediate need for debt after the repudiation, in the first place?) Country risk may have gone up, yes, but that is just one part of the risk return story. Moreover, if the money saved from repudiation would result in the improvement of governance for example, i doubt if no one would lend to the GOP. In fact, if the repudiation were selective, then lenders would start looking deeper into the proceeds of the loan and would become more proactive in ensuring that the debt would go to where it was intended to go. Maybe that would even make the private sector more involved in the fight against corruption. And that would make the GOP more concerned about making sure that the money would go into the projects and not into some people's pockets. Cheers!

-- Ricky Lozari

Ricky, Noy, Butch's points are well supported by data.
Point #1 which debt to repudiate?

using BSP data, i derived the ff percentages:

Creditor by Percentage share to total foreign debt
Creditor           1991    1994    1997    2000    2003
Banks              31%     12%     20%     18%     15%
WB                  13%     13%     9%       7%       6%
IMF                  4%       3%       2%       4%       2%
ADB                8%       9%       7%      6%      6%
Export agency  12%    12%     10%     4%       4%
Others             19%     27%     19%     26%     25%
Bondholders    3%       12%     24%    27%     29%

Looking closely at this table, a significant shift had happened in our creditor base in the last decade. It used to be that bulk of our foreign debt is owed to foreign banks, but this has since been reduced drastically.If we have paid a significant portion of these debts, it is because we have simply extended their maturities by raising bonds. Not only did we "democratize" our creditors, but we also have extended them further down the future. Note that from a measly 3% in 1991, bondholders now hold 29% of our foreign debt. Likewise, contrary to the constant whipping boys of the Left, our combined debt to the WB/IMF is only 8% down from 17% in 1991. Another significant increase can be attributed to bilateral agreements. Most of this were as a result fo the return of the country to the foreign debt market in 1994. SO in this case, how much of the debt can you selectively repudiate since a significant portion of its holders are bilateral and bondholders. We run a serious risk of diplomatic problems with each of the bilateral holders. On the other hand, we cannot repudiate the bonds since we know that as sovereign debt we cannot escape payment.

On this note, i am quite concerned with the general statement issued by the camp of FPJ regarding his planned restructuring of the debt. If it is restructuring to mean a change in the creditor base and lengthening of maturity, we have seen that this has already been done from the time of FVR up to today. So there is really nothing new in that aspect. I wonder if his economic team has another meaning for restructuring. I am quite sure though that repudiation, selective or otherwise, is out of the question. Butch had already expounded on the possible scenarios that would come out of it.

Point #2, Our Foreign Debt is not solely GOvernment's...

Percentage Share of Foreign Currency Borrower Phils

            1991    1994    1997    2000    2003
Banks 25%     11%     23%     18%     19%
Public 62%     72%     49%     55%     55%
Private 13%    8%       28%     27%     26%

Contrary to the common notion, that the $56B is government debt, only 55% of that (or 60%, including government banks) is government's. The rest is from the banking system and the private sector. In fairness to the FVR watch, we have seen a significant decline in public foreign debt in 1997 and a significant shift in borrowing by the private sector. This is clearly a result of the overvalued peso at that time. SO if we follow the 2003 figures (this is as of sept 2003), then government can realistic restructure or repudiate only 55% of the total foreign debt and using the same percentages, 29% of this is due to bondholders so there is really a small window to restructure or repudiate.

This is only 1/2 of the total debt stock as mentioned by Butch half is domestic in nature. I think apart from extending the maturity, there is not much restructuring you can do as regards foreign debt.

Former BSP GOv Singson is correct as mentioned by Noy that it is really only in the area of taxation and reducing expenditures that we can do something drastic.

God bless the Philippines,

- Alvin Ang

I agree that debt repudiation is not costless. Last Friday, Dr. Felipe M. Medalla had a seminar at UPSE on the sustainability of public debt. He mentioned at least three disincentives to repudiate:

- More than 80% of the debt is domestic or owed to bilateral and multilateral institutions
- Maybe one third to one half of the "ROP's" are owned by residents and domestic banks
- Initial effect of repudiation on macroeconomic stability may result in large decline in GNP in the short run.

You may download the powerpoint presentation he used by clicking the links below:
(pdf only of the PPT)
with powerpoint, excel and word documents)

- Ferdz Co

Ricky, a rejoinder--

>"I was not careful when i wrote my email. It was a from the hip kind
>of thing. But what i really meant was repudiation, not restructuring.
>Recycling came to mind because there was a call to choose which debt
>not to pay and which ones we should pay. If the analogy was wrong, i
>apologize. I just did not like the idea of paying for something that
>did not benefit our country."

Apologies unnecessary, my friend! We're just discussing here. No personal attacks on either side, so no problem! But on your latter statement: "I just did not like the idea of paying for something that did not benefit our country"-- neither do I! But the fact is that it is very difficult to separate out which piece of debt was used for what purpose, and that's what makes it difficult to be "selective" in repudiating debt. This was another point I made in my original posting of Jan. 11. Let's look at data that Nonoy Oplas provided in his follow-up posting:

Foreign debt service of regular liabilities of the National Govt., by Creditor, 2004, in US$ Million. (selected items)

A. From ADB -- total (principal + interest) of $214.92 million

1. Power sector reform program, 30.47
2. M.Mla air quality improvt sec. devt., 16.80
3. Sixth road project, 11.15
4. Grains sector devt. program, 7.68
5. Pasig river env'l. program, 7.28

B. From Japan (JBIC, formerly OECF) -- total of 362.39

1. Economic support fund, 36.48
2. Financial sector adjustment loan, 23.28
3. Mt. Pinatubo disaster rehab., 16.24
4. Reform program for govt. corps., 14.24
5. Elementary educ. project, 11.95
6. Econ. support fund (Forestry), 9.57

C. From IBRD (WB) -- total of 308.13

1. Financial sector adjustment loan, 33.68
2. Econ. recovery program, 24.84
3. Reform program for govt. corp. 20.13
4. Debt mgt. loan, 19.78
5. Second elem. educ. project, 17.06
6. Housing sector project, 12.68
7. Third elem. educ. project, 7.27

D. From foreign denominated securities -- total of 1,883.46

1. Euro 350M Euro bonds due 2004, 392.36
2. USD 200M floating rate notes, 204.40
3. USD 200M zero coupon T-bills, 200.00
4. USD 1B GB due 2025, 106.25
5. USD 1B GB due 2024, 95.60
6. USD 1B GB due 2009, 83.75
7. USD 750M GB due 2017, 70.31
8. USD 690m GB due 2016, 60.38

The above is a representative portfolio of debt service items the government of the Philippines makes each year (note: the numbers reported above are annual debt service payments, not the original loan amounts). Maybe someone can tell which one of these debt items was used improperly or did not benefit us. I can't.

>"The arguments against repudiation is and has always been strong. I
>think everything revolves around the main theme that it would greatly
>increase our country risk. As you mentioned, some say that capital
>flight would ensue and that the biggest losers would be the Filipinos
>themselves. I am not an expert on this so it would be interesting to
>know if a selective repudiation has already been done in the past and
>whether it did result in capital flight. And whether such financial
>crisis lasted long.

We both agree that our risk premium will likely rise following repudiation, and with this the entire profile of our interest rates. But I am much less sanguine than you are about a quick rebound following repudiation, even if I accept that the Philippine economy remains a resilient one.

Right now I have no estimate of what our risk premium might look like if we were to repudiate (it probably depends on what is repudiated, and how it is represented to the markets, and if anything is done in the background to convince markets that we are moving towards fiscal consolidation and will be a better debtor in the future). But if we go by our own experience declaring a broad debt moratorium (an act that is slightly less extreme than an outright repudiation of debt) we could see interest rates on foreign borrowing rising from the prevailing 9% to maybe something like 40-50%. Maybe something more selective would produce interest rates of 25-35%. That's still high. But these are just rough guesstimates.

What is more certain, though, is that capital flows will dry up for a few years. Using balance of payments data (source Intl Financial Statistics Yearbook, 2002) I calculate the following numbers--

Time Period Average Annual Capital Flow
(This is the so-called "Financial Account" Balance of the BOP)

1980-1982 $2.516 Billion
(pre-debt crisis)

1983-1987 .237 Billion
(debt crisis, run-up to EDSA I)

1988-1992 2.023 Billion
(Cory govt and recovery)

1993-1997 6.294 Billion
(Emerging market boom)

1998-2000 -2.415 Billion
(Asian crisis, Erap)

Looking back at the 1983-87 crisis period, capital inflows shrank to about a tenth of what they normally were. It didn't go all the way to zero or go negative, I grant you. But it was clearly a sharp contraction by comparison to the norm. You can guess which direction domestic lending rates might go in response to this. Moreover it lasted a good 5 years, and capital inflows resumed only after a historic regime change in the form of EDSA I.

Interestingly, Peru also unilaterally suspended its debt service payments in the mid-eighties (I think it was in 1986). It seems that it also took about 5 years before capital returned to Peru. During the 5-year span 1986-91, Peru's annual capital flows averaged -$ 1.374 Billion (yes, that's a negative sign). In the next 3 years (which was a huge boom period for the rest of Latin America), Peru's capital flows averaged a very modest $ .581 Billion a year.

What does this all suggest? Maybe that 5-7 years is the timeframe one can expect for the fallout from a large repudiation to dissipate. This roughly conforms to what I said in my original posting of Jan. 11, where in reference to selective repudiation, I said:

'I don't expect much debt reduction from this approach if it is done right, though you could gain from better future behavior from creditors. On the other hand if it is not done right (too indiscriminately), I expect much economic dislocation for a time, then slow recovery over a 5-10 year span, in exchange for a modest reduction in overall debt levels.'

>"My impression is that the memory of the financial universe is short
>and is further shortened by greed. I doubt if no one would lend to a
>PLDT, for example, if the government chose not to pay for a debt
>related to, say, the construction of the Palace in the Sky.

Yes, and along with economists like Ben Bernanke (ex Vice-Chairman of the US Federal Reserve), I agree with you about short-term financial market memory. I also heartily agree that competition and greed plus our own creativity will create opportunities for us to find alternative sources of financing if we really need it. But this does not imply that there exist a repudiation strategy that will be worth the short-to-medium run costs for the period that the market does remember!

Yes, the economy of Peru didn't die after their debt repudiation, and yes, neither did our own more dynamic and resilient economy in our turn. But we suffered heavily for 5 years of high interest rates, slow growth, and high unemployment. It then took another 5 years to slowly recover. And that is really the point. Is the modest reduction in debt levels worth all that? Understand that there may be a cheaper alternative: fix the public debt problem at its source by containing the budget deficit, maybe by containing unjustifiable public spending. If it were possible to just balance the Philippine government budget, that would lower the public sector borrowing requirement by about $1 billion a year (i.e., the value of an annual budget deficit of PHP 56 billion, which is about where Cong. JV Bautista said it will likely be next year). This is about $115 million more than the cash flows you would free up by repudiating ALL of the instititutional debt to IMF, WB, ADB, and JBIC noted above (= $ .885 billion). You could even apply the extra $115 million or so to accelerate the debt reduction process.

>"I also doubt that investors would no longer lend to the GOP. (In
>fact, if the premise of the repudiation was to free us some needed
>cashflow then the question would be ... would the GOP have any
>immediate need for debt after the repudiation, in the first place?)
>Country risk may have gone up, yes, but that is just one part of the
>risk return story. Moreover, if the money saved from repudiation
>would result in the improvement of governance for example, i doubt if
>no one would lend to the GOP. In fact, if the repudiation were
>selective, then lenders would start looking deeper into the proceeds
>of the loan and would become more proactive in ensuring that the debt
>would go to where it was intended to go….

Unfortunately, here is where I am most pessimistic. The government is already in budget deficit and without any new constraints (legal or otherwise) on Congressional and executive spending, is likely to remain in a deficit position. The cash flows that repudiation would free up would first likely go towards covering this ongoing deficit. If there are any freed-up cash flows left over from that, I see them being used to accommodate post-election political payoffs, congressional discretionary spending, and image-building projects. I'd like to be as optimistic as you, but I have yet to meet a public official who didn't like their pork. Oh well.....

Best regards,

- Butch Arroyo

Butch, Alvin, Thanks for the replies.

The data are interesting and helpful, thanks. I think we all agree that we must contain the runaway deficit soon. The issue we are trying to discuss, I believe, pertains to how this feat can be done. The way I understand it is that you are looking at solving the problem from the expense side. But you are not looking to reduce expenses from the debt payment angle. So to me your strategy is to reduce services.

You were diligent enough to discuss the problems of determining which debt we could repudiate, considering the numerous reasons you have enumerated. My question then is: Which government service are you planning to penalize with the belt-tightening strategy? If there is a Pecking Order Theory in corporate finance, I think there ought to be one in fiscal management as well, and if it exists, my bet is that those services which matter most to the masa would be the first to suffer. I think the theory would say that the government would not dare touch those services, which benefit those who matter most during election time. Contrary to perception, I too am almost sure that that pork will stay no matter what. If that is constant in the equation then, which other parts are not? I am not being naive here, but given a choice between penalizing big businesses via selective repudiation and penalizing social services, I would choose the former anytime.

I attended this political meeting just recently and the candidate was talking about reducing taxes. He kept on lambasting the incumbent for raising taxes. As if waiting for a deafening NOOOO! response, he asked the audience if they could still bear the rising taxes. Unfortunately, the audience was silent. He wondered about this until I told him after the meeting that the audience was silent because they represented the local leaders of the informal settlers association. They were not aware of the rising taxes because they did not pay taxes.

I was not aware of the 45% interest rate in the mid-80s because we did not borrow from the bank ... we could not afford to borrow. But I was able to get education from public schools, was able to get medical services from the barangay clinic, and was able to get potable water from the public faucet. If you told me then that I would have to suffer because you did not want interest rates to go up to 60%, I would not even know what you were talking about. My parents were contractual government employees. If you told me then that you did not want inflation to go up because our monthly income would be able to buy less and less goods, I would probably see some logic in that. But if your way of curtailing spiraling inflation was to fire my parents from work, I would say I would rather face shrinking purchasing power than a zero purchasing power. Cheers!

- Ricky Lozari
Hi Ricky, Let me answer your questions to Butch and Alvin.

"Which government service are you planning to penalize with the belt-tightening strategy?... my bet is that those services which matter most to the masa would be the first to suffer."

If you remember pre, we have a discussion here earlier re. merging of some line departments. among them:
1. DA + DENR
6. DTI + DOLE.

We also have earlier discussions about privatization of perennially losing govt. corporations -- NFA, NPC, some specialized govt. hospitals, etc. The NPC in fact has become a "major perennial deficit generator".

Also, earlier discussion about corporatization of those state universities and colleges (SUCs). At the moment, they're about 80-85% dependent on state subsidies, despite the SUC modernization law which allows them to raise revenues on their own. The really poor students don't reach college; they drop out even before finishing elementary or high school...

Also, I have mentioned in past postings the possibility of corporatizing (if not privatizing) the Philippine Military Academy (PMA) campus in Baguio City, like Fort Bonifacio, Subic, Clark, and John Hay. We only need a strong AFP, but not necessarily a military academy. We also don't need to perennially subsidize the Natl. Defense College of the Phils. (NDCP).

Finally, if we should trim the fat in the Executive branch, we should also cut the pork in the Legislative branch. I'm more convinced that we need constitutional change to abolish the Senate and the party-list system in Congress. These days, many people think they're "marginalized" so they want to become "Honorable Congressmen/women" also. The physicians and doctors thought they're "marginalized", so the Phil. Medical Assn. (PMA) was registered as a partylist. The architects thought they're also marginalized, so the United Architects of the Phils (UAP) or similar organization was also registered as party-list. The coconut farmers (including those owning thousands of hectares of coconut plantation in Quezon and Mindanao) also think they're "marginalized", so they have their Cocofed as partylist. More on this in another posting...

Lots of pork to trim from this government, pre. That's why I think it's really unfair and lacking in balls thinking those govt. policies to run continuous budget deficit, to borrow more, to tax further the productive and tax-paying sectors of this country.

Finally pre, nothing personal here against your parents who are government personnel. But people should not think that they're meant to be govt. personnel for the rest of their lives. Or jeepney drivers should think they're jeepney drivers forever even if commuters prefer trains and air-con buses if these are available on certain routes. Or rice farmers thinking they're rice farmers forever even if consumer demand has shifted to cheaper Thai rice; or even if there's new opportunities in producing high-value vegetables, aquaculture, poultry, etc.

What if taxpayers would decide, "I'll cheat on taxes because I won't send my children to public school anyway; I won't go to public hospitals when I get sick anyway; I won't rely on govt. for my household garbage collection, community streetlighting and street patrolling anyway..."

- Nonoy Oplas

Noy, my problem with your idea is that i do not believe in market determined government management eh. I do not think the market should be left on its own if social services ang usapan. Kahit naman sa welfare economics problema yang issue ng equity at efficiency di ba? The market may be efficient pero is there equity? Ipasok mo pa yung problem na is the market efficient to begin with? Sa pagkakaalam ko, market efficiency is assumed lang. Pero is it realistic?

Dun sa issue ng trimming the fat, yes, we can probably get lucky in choosing the right budgetary items to cut down. Pero the question is, when has it ever been the norm in government to do the correct thing anyway? My impression is that government does what is popular not necessarily what is right. By popular, i mean popularity among the voting blocks, not necessarily the voting population ha?! So when we make suggestions, i would think that it would more prudent to assume this norm.

Kaya nga sabi ko, my fear about reducing the deficit via reducing expenses is that the first to go would be the masa services. Why? Kasi walang boses ang masa eh. Walang aangal kung baga. We were just discussing yesterday about GSIS. I'm not sure if i got the story right, pero mukhang wala na atang lumpsum retirement fund ngayon. Parang retirees yata, would be forced to get their retirement fund on monthly basis na. Kasi dati daw, the lumpsum amount is taken out of the national budget, pero ngayon, mukhang sa GSIS na. Eh wala naming pera ang GSISI. The issue is not whether this policy is right or wrong, or if it is the legal thing to do. To me, the issue is whether or not this is an indication of the "pecking order theory of fiscal management" ... if ever there is such a thing. Cheers!

- Ricky

nonoy, riki, butch, alvin, et. al.,

thank you for the incisive analysis of the options to the widening fiscal gap (stemming largely from debt servicing automatically provided each year). i agree that the options are not mutually exclusive.

i am more concerned on the team that would execute the strategy. baliktad. normally (i.e. under ideal conditions ;^) ), one looks at the environment, internal and external factors and map out a strat plan. then one works out one's ass to attain objective. pero sino ang mag-hihinete sa kabayo? Kung bangka man yan, papaano magiging on-synch ang sagwan at ang timon?

sa dami ng nagsasabing magaling sila, marami din ang nagsasabing mas magaling sila sa iba. kahit sinong magaling ang umupo, laging may asong ulol na tahol ng tahol sa labas. ang ikinakahol eh mas magaling daw sya o yung bata nya at dapat daw palitan yung nakaupo sa loob. kung magtagumpay yung asong ulol, magpapalit lang sila ng papel nuong sinipa nya. sa tingin ko yan ang nanganga-ilangan ng solusyon kung hahanapan natin ng remedyo ang fiscal gap and the looming debt crisis.

hindi ko na ihahain ang "superhero" scenario (i.e. na isang politikal mesaya ang tutubos sa atin -- na pinaghalong leekwanyu-mahathir-gandhi-thatcher-soros-etc ang susunod nating pangulo). no brainer na kwento ito. ang anggulo na maaring merong pag-asa ay yung "executive capacity for consensus-building", "exercise of political will", o "confidence-building leadership" type ng scenario. yung bang sa halip na tayo-tayo ang maglaban, ang susunod na administrasyon ay magkaroon ng capasidad o abilidad o bayag na pumito ng malakas, "taympers boys ang girls! eto ang team natin, tulungan natin silang magtagumpay" or an ek-ek like that.

it looks like we have a detente syndrome. walang masyadong makaporma kasi patas ang laban. hindi masyadong maka-isa si GMA; hindi rin masyadong makaporma si FPJ o si Roco o si Lacson. balance of terror. again, normally, maganda kung merong magsasanib ng pwersa. pero dahil pare-pareho silang naniniwala that each is the savior, walang gustong maging john 'd baptist o kaya simon peter. anthropologically, mutiple messiah at hindi reluctant messiah ang sintomas natin.

the challenge after winning the election is governing, cracking the whip if necessary, and mobilizing a decent majority to support difficult and unpopular decisions. maybe none of the present crop of candidates can do it well, kaya may panahon pa for a creative solution, sabi nga ni monching.

baka maganda rin to consider changing religion. yung walang messiah. Ang assumption kasi na kinalakhan natin laging meron tayong kasalanan, original sin man yan o venial o capital, such that nangangailangan ng messiah. Kaya pati sa usaping pulitikal, apektado pa rin tayo ng kaisipang ito.

siguro, ang magandang itayo mo Nonoy ay relihiyon o kulto na babali sa ganitong paniniwala upang palayain ang pananaw ng pinoy. yun bang liberating ng konti. sa halip na kasalanan ang ipagdidikdikan sa tao, eh kakayahang lumilok ng pagbabago, gumawa ng magaling para sa lahat, etc. isang relihiyon o kilusan o kulto na magpapayabong sa ating social capital such that we begin to trust each other more, do business with each other more, etc.

imagine, high priest si monching! sangkatutak ang temple prostitutes that you'll need to chase away. pero wag ka mag-alala, market-oriented pa rin ang sistema. he who demands more from government should pay the appropriate price, but each one will have the equal opportunity to make an offer. And by the way, sale is always with recourse ;^)

- Citizen Kori

Friends, A short note, following several postings on the subject of government deficits and the level of public debt.

This is the link to Inquirer's article on the recent Maynilad takeover by MWSS.

To me, this is an good example of the kind of government transaction that deserves more energetic scrutiny, given that it is likely to add to rather than reduce future deficits and future debt.

The takeover of Maynilad by MWSS is itself merely a conversion of a receivable held by the Philippine government into an equity claim. This of its own shouldn't create any additional government outlays immediately and probably won't have much impact on this year's budget deficit. HOWEVER any future losses by Maynilad will likely be subsidized by the next administration and end up on their future budgets (or off-budgets). Also, as pointed out by the Water for the People group, included in the costs that reduce Maynilad's bottom-line is the debt service on remaining debts of Maynilad, which are now obligations of the national government through MWSS (an additional PHP 11 billion, by estimates). This alone probably translates to an additional PHP 1 billion (my guess) to annual debt service in the budget, and this is separate from the impact of subsidizing any operating losses! This one transaction alone may well increase the public deficit by about 2%.

What I wonder is, what were the alternatives to MWSS taking over Maynilad? Were there no other private groups who were in a position to take over Maynilad's concession? Was there no other choice? And would people really have gone without water if this arrangement were not entered into? And now that people have been assured of their supply of affordable potable water, who really is going to pay for it? If the Lopez group couldn't expect to turn a future profit from Maynilad, how does the administration figure it will achieve that?

And where were all the noisy Congressmen when this deal was being worked out? This could very well turn out to be a "behest" transaction, the very kind whose claims are difficult to repudiate once agreements are reached and contracts are signed. Was this discussed in Congress at all? Also, anybody know any inside story to this takeover?

- Butch

Thank you Butch for that thoughtful, carefully-crafted and caring post on the debt repudiation issue. Your post is a 'keeper' for me. I can only hope that others will read carefully throught it, setting aside (for the moment) any emotional or ideological stake on the issue (i would not go so far as to presume that some members of this list hold a myopic, 'populist' agenda, and are trying to sneak *that* past us PF folks ;-).

Reality-checks are the "pause that refreshes". Again, thanx,

- Wyn Yu

Butch, Wyn could not have said it any better. Your post is a model for all of us to follow. You managed to share your thoughts, heart and passion without offending nor confusing anyone. Perhaps a result of your pure and sincere intentions.

Thanks and keep up the hope and patriotism.

- Emil Suntay

No comments: