Credit Upgrade: What happens next

The recent credit rating upgrade given to the Philippines has been a landmark achievement by the current administration. Let us hope the upgrade is followed by a host of other government action needed to attract the huge investments for the ultimate benefit of creating more jobs needed in the country.

From BusinessWorld Philippines

By Raul V Fabella

April 03, 2013

Investment grade: boon or bane?

THE ANNALS of underdevelopment are filled with chapters on failures due to wasted opportunities, with hardly any account of failure due to scarcity of resources.

The stellar performers in development were indeed countries most initially challenged by dearth of resources, but whose people bore down to transform native adversities into opportunities. Such for example were Japan and South Korea bereft of fertile arable land and the Netherlands struggling mightily to wrest some land from the raging North Sea.

In stark contrast, counter-Reformation Spain wallowing in New World gold left its mercantile and industrial innards to rot while soaking up on wool imported from England, thereby sinking into 200 years of decay.

I hasten to point these historical episodes out because the Philippines is notable for wasting opportunities. Gunnar Myrdal of the then celebrated Asian Drama fame and an early Nobel Laureate, boldly predicted in the 1960s that the two countries in the region that will forge ahead of the rest were Burma and the Philippines, while South Korea will eat their dust.

The advantages of land resources and colonial pedigree were such that the call should be then obvious. It was not yet clear in the 1960s that Quezon’s rhetorical flourish would be fulfilled (“I prefer a Philippines run like hell by Filipinos to one run like heaven by Americans.”) Nor was it apparent that post-independence Burma will be hijacked by a military junta gripped by a poisonous brew of socialism and jingoism. Myrdal simply failed to account for the unlimited capacity of even well-meant politicians and juntas to fritter away initial advantages.

In the late 1970s, the Philippines faced the opportunity of almost unlimited foreign borrowing at negative real interest rate. The authorities borrowed to the hilt among others to finance the ill-fated 11 industrial projects,mostly tradable import substitutes (cement, petrochemicals, steel, copper, etc). These didn’t stand a chance between two grindstones: the anti-Filipino strong peso policy and the additional cost of up-front payolas.

Taiwan had at the same time a program of 10 major industrial projects, most of which were public infrastructure (highways, airports, etc) that paid for themselves and then some.

Paul Volcker’s war on inflation sent global interest rate soaring and doomed the Philippine’ major projects to sudden demise. The resulting debt overhang was the millstone that mocked the Cory Aquino economic recovery. Unable to show convincing economic dividends from restored democracy, it became hostage to the misguided ambitions of the Enrile-Honasan clique.

In the 1990s, at the height of excitement over the Ramos capital account liberalization and deregulation, foreign resources were once more knocking at the door.

But the tsunami was dominated by portfolio investment which cared little for good roads, the price ofpowerand stable regulatory environment. They instead cared for and helped along price bubbles in the stock and real estate markets.

The Philippines was then forex-indigent and any forex inflow, however laced with deadly mercury, was welcome. Exuberant but unthinking monetary authorities, obliged by maintaining a high interest rate and letting the peso appreciate — heart-warmers all for portfolio investors.

Foreign direct investment (FDI), by contrast, kept well clear, frightened by the strength of the peso, the grossly inferior regulatory and physical infrastructure.

To confound matters,the 1990 Supreme Court decision on the “Garcia versus DTI” case cynically wrested the location decision of a petrochemical project from investors who promptly packed their bags.

When business complained of high interest rate, the Bangko Sentral ng Pilipinas (BSP) advised them to borrow cheap dollars abroad which they did with vengeance. This poisoned borrowing eventually aborted the promising Ramos recovery.

More resources without firm safeguards against misuse are Trojan horses for disaster.

On March 27, 2013, Fitch Ratings elevated the Philippines to investment grade, a first in its history.

“A landmark,” crowed BSP. “A reclamation of our national pride,” chimed the President Aquino, adding: “The perennial laggard of Asia is taking off.” The chorus of paeans is deafening.

More dollar loans at cheaper price! But wait a second: Are we not now just coming to a consensus to borrow less from abroad?

A conspiracy theorist would saythat this is to dissuade us from that right path, borrowing more in-shore.

Some thoughtful commentators (see, among others, Habito, Philippine Daily Inquirer, 4/2/13, “An early Easter gift”; BusinessWorld, 4/1/13, “Peso, assets get mild tonic”) have defied the tide to say that the benefits of the Fitch move should not be exaggerated since (i) a second credit rating agency has to confer the same status for institutional investors to move our way, (ii) investors have anticipated and thus priced in the effect of the announcement, (iii) the Fitch announcement itself contained a caution: the Philippines’per capita income is $2,600 versus an average of $10,300 for countries in same investment grade, and (iv) the more beneficial FDI flow may not spike.

Put simply, it is not a bouquet of roses at the finish line; it is an encouraging “vamos” after the first of many laps.

This commentary is not about the boon that may not materialize; it is about the bane that can be visited on the economy by the investment grade.

While the investment grade status is a first and has strictly no formal parallel in Philippine history, at its barest it is no more than a signal for increased resource flow.

As such, its core dynamic has many parallels. The stories recounted above — the capital account liberalization in the ’90s and the petro-dollar borrowings in the ’70s — were all resource flow episodes. These first warmed the heart before clogging the arteries and causing cardiac arrest. To render the resource flow beneficial requires understanding of the its dynamic and taking hard resolute action.

The signs are not comforting.

That Malacañang counts the record levels reached by the Philippine Stock Exchange (PSE) as a vote of confidence betrays a want of understanding. Stock market bubbles in history have been mostly portents of doom. Wealth generated from asset price and financial bubbles is hogged by the rich. Job creation and inclusiveness are not among the fruits of bubbles. And their association with portfolio investments is well known.

It is no surprise that the PSE climb to peaks coincided with a portfolio investment spike to $3.8 billion in 2012 from $0.4 billion in 2011. Even more will now trek our way.

The resulting peso appreciation has hit the most buoyant job-creators, dollar earners all, and job creation is anemic.

How about FDI which creates jobs?

On March 22, 2013, the Supreme Court released an advisory regarding its decision to review again the constitutionality of the 1995 Philippine Mining Act. This involves the contract on the Tampakan gold and copper mine project in Mindanao, a $6-billion foreign investment which has passed all the national requirements but whose construction has been halted by a provincial ordinance proscribing open-pit mining.

Now, the contract itself is going to be reviewed after the project has spent hundreds of millions of dollars on set up facilities. This is plain vanilla regulatory hold-up. Forgotten is the lesson of the infamous 1990 “Garcia versus DTI” decision by the Supreme Court which effectively killed the petrochemical project and any hope for a FDI revival for that decade.

On top of the festering NAIA Terminal 3 compensation issue, the message to the world is clear: regulatory fragility and hold-up is still rife the Philippines! Which explains why FDI flow was a puny $1.5 billion in 2012.

Investment grade or not, FDIs would rather be elsewhere.

How about resolute action? The Department of Finance has, after much foot-dragging, announced the intent to increase further the proportion of its borrowing from the domestic market. The BSP leadership is aware of the dangers of Dutch Disease and instability from short-term flows but has deployed primarily macro-prudential measures to protect the banking sector.

Vitamins and health foods are good but if you face the Russian winter, you will need industrial-grade overcoats. The BSP may now need to transcend its traditional toolbox to effectively engage the oncoming new turbulence. It may need to drop the special deposit account-open market nexus and do what has always been obvious to Hong Kong monetary authorities: print money to buy up increased forex inflow. Hong Kong’s average inflation rate in the past three years has been 3.9% — about the same as the Philippines’ — while its exchange rate has remained between HK$7.76 and HK$7.78 to US$1.

If additional intake is mostly fat and bad cholesterol, the investment grade will bring the economy closer to economic thrombosis rather than catharsis.

So will investment grade be a bane?

Yes, unless we learn and act decisively on lessons of the capital account liberalization in the ’90s and the petrodollar borrowing in the ’70s.

The author, a National Scientist and a professor at the University of the Philippines School of Economics, is a member of BusinessWorld’s editorial and corporate boards.

Article location : grade: boon or bane?&id=68138

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