Sunday, April 07, 2013

On the Fitch Ratings Upgrade

* This is my article in last Friday.

Fitch Ratings’ upgrade of the Philippine economy from non-investment grade BB+ to investment grade BBB is indeed good news.

For starters, there are three other investment grade status that the Philippine economy and Philippine-based companies can aspire to reach: A, AA and AAA, with the latter as the most stable, most reliable status. There are intermediates of +/- between these grades, like A-, A,  A+.

For the non-investment grade, the rates range from D (defaulted on some obligations and can default more) to C (vulnerable to bankruptcy) to CCC, B and BB. Again, there are intermediates between these rates.

There are two important factors why this upgrade to investment status of the Philippines was made.

First, internally, the Philippines’ macroeconomic fundamentals have indeed improved, like high GDP growth, low inflation and interest rates, sustained current account surplus (CAS) with high remittances from OFWs, and so on. These were elaborately discussed by Fitch in its  Full statement on the Philippine ratings upgrade.

Second, the external environment in the major economies like the Eurozone and North America remains unstable if not weak. Fitch has mentioned this only in passing. Financial instabilities like the cases of Cyprus and the PIIGS (Portugal, Ireland, Italy, Greece, Spain), many businesses there want to get out and  countries  abroad that offer certain stability and protection of investments and profit are potential target as destination economies.

The Philippines has several economic and policy gaps that appear “far out” compared to many economies that are given the ‘BBB’ investment grade. These include:

* Low per capita income, only $2,600 vs. ‘BBB’ range median of $10,300 in 2012.
Level of human development index (HDI) as measured by the UNDP is less of an outlier against ‘BBB’ range peers.

* Low fiscal revenue of only 18.3 percent of GDP in 2012 vs ‘BBB’ range median of 32.3 percent.

Still, Fitch was not deterred from upgrading the country’s status to an investment grade.

Actually, the reason why the country’s Tax revenue / GDP ratio remains “small” and below 20 percent for many years now is because they only compute national government tax revenues and not tax and other revenues by the local government units (LGUs). The big cities in Metro Manila for instance earn a lot of local revenues from business permit taxes and fees, real property tax and other revenues. If those revenues by LGUs are included in the numerator, the T/GDP ratio can easily reach 20+ percent of GDP.

Advantages of Ratings Upgrade

The advantages are obvious. For one, it improves the overall business and economic environment of the country. It’s a “vote of confidence” and more investors, bringing in either  direct or portfolio investments, will come to see and feel the various business indicators on the ground.

Two, it reduces the interest rates of PH government and corporate debts, present and future. Thus, for firms that think they have a good business project and cannot raise enough local funds, borrowing abroad will be easier and cheaper.

Three, it inspires the local players, private and public, to work harder and more efficiently as more eyes around the world are looking at them.

There are certain threats of course, not necessarily disadvantages, as a result of this investment upgrade.

One is moral hazards problem. If it is cheaper now to borrow because of the lower interest rates, then the government and some corporations will be tempted or encouraged to borrow more than what they need and hence, raise or the debt stock instead of retaining or reducing it.

Two, it may divert the attention of the government and private players away from certain structural reforms and just focus on the plus factors listed by Fitch. Such as encouraging more OFWs and attracting more BPO companies that significantly improve the country’s CAS.

Among these important structural reforms are the reduction in business bureaucracies and red tape, and government corruption in general, improvement in power supply and road infrastructures, and removing foreign equity restrictions in the Constitution.

The elections this coming May will be observed by many investors abroad who are still on the Wait-and-See attitude. Not so much of who won, but how credible and honest the conduct of election was. Because it is an important indicator or proxy for how much the country’s political institutions promulgate the rule of law and how much they will protect contracts, private property and profits.


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