By Benjamin E. Diokno
THE BENEFITS of the first ever investment-grade upgrade are grossly exaggerated. The behavior of the stock market last Monday, rising tentatively, retreated, and finally fell, supported this view. The stock markets’ hyperactive reaction to the upgrade before the Holy Week break was totally irrational.
I see the upgrade as a ray of hope, however. But the gains from the upgrade can be large or small depending on what public authorities will do next. The costs of the upgrade (for example, the peso appreciation owing to the tidal wave of “hot” money), may be mitigated or magnified depending on fiscal and monetary authorities’ moves.
In brief, the final outcome will depend on how competent and nimble the economic managers are in responding to the challenges that lie ahead as a result of the upgrade.
The first major benefit of an investment upgrade is that the government can now borrow at lower costs than before (when the government was rated at speculative grade). This is likely to be a small gain. Because of the ongoing world crisis, the cost of borrowing money is at its historic low. Hence, the difference between borrowing at BB+ rating and borrowing at BBB- rating is practically nil.
Moreover, since the upgrade to investment grade has long been anticipated, expectations for a ratings upgrade has been built-in in the sovereign bond markets, limiting the scope for further gains. Before the upgrade, long-date Philippine sovereign bonds have been trading with a yield spread of just 92 basis points over 30-year US treasuries, compared to 135 basis points for Indonesia bonds. Indonesia is an investment-grade country.
Only recently, Philippine fiscal authorities have made a policy decision to finance the deficit through domestic borrowing. They have committed not to borrow from abroad. I consider this a rightful decision, and it would be a monumental folly to reverse it as a result of the credit upgrade.
Why? Because the Philippines is awash with dollars and pesos at home. There are $84 billion in gross international reserves and another 1.8 trillion SDA balances. Borrowing money from abroad will only lead to further peso appreciation.
Moreover, borrowing from abroad carries with it foreign exchange risk. Given these economic realities, it is not smart to borrow from abroad to finance government deficits and to service our dollar debt. In fact, it’s not smart to continuously renegotiate to extend the maturity of existing foreign debt. We should pay the debt when it’s due. We should even prepay high-interest debts.
The second major benefit of the upgrade is that it could lead to brisker stock market through the massive inflow of “hot” money. The entry of “hot” money will lead to further strengthening of the peso.
The continuing appreciation of the peso ranks among the top problems of the Aquino administration. A strong peso diminishes the economic well-being of the families of overseas Filipino workers (OFWs) and worsens unemployment in export-oriented firms.
The impact of the upgrade on the stock market is grossly exaggerated. Why? Again because the upgrade has long been anticipated, and built-in in the market. Existing valuations are too high after the benchmark index rallied 18% in the first quarter, according to market analysts.
“The Philippines is over-rated and over-extended and over-owned like Indonesia and Thailand… there is serious potential for correction,” said David O’Neil, chief investment officer at ASEAN Investment Management in Hong Kong.
JOBS, JOBS, MORE JOBS
FDIs create a lot of jobs; “hot” money that often goes into the stock market don’t.
The promise of higher foreign direct investment and greater foreign engagement in public-private partnership projects is purely speculative.
I disagree with the assessment that the credit upgrade would result in a surge of FDIs into the Philippines. FDI inflows depend on a different set of variables such as cost of doing business, state of public infrastructure including existence of sufficient, affordable and reliable power supply, policy consistency and credibility.
Moreover, some restrictive provisions in the Constitution will continue to deter foreign investors from making long-term commitments to the Philippines. A foreign director investor will take a long, hard look before investing into the country if he is not sure that he will be able to control and manage his company — whether its a utility firm, a modern farm, a university, or a media outfit.
The Philippines’ net foreign direct investments (FDIs) have remained dismal while non-investment grade economies realized higher inflows. From 2010 to 2012, $5.2 billion entered the Philippines. Vietnam, a highly speculative country, attracted $23.5 billion during the same period. The Philippines has attracted the least FDIs among its ASEAN-5 peers.
The important lesson is that FDIs, the type of investments that create a lot of jobs because investments flow in factories and modern farms, are attracted into a country for reasons other than its investment grades.
“[T]he upgrade significantly improves the climate for financial investments, but for brick and mortar FDI, market size and competitive production costs are more critical factors than financial ratings,” said American Chamber of Commerce of the Philippines senior adviser John D. Forbes.
European Chamber of Commerce of the Philippines (ECCP) executive vice-president Henry J. Schumacher clearly pointed out that: “not having investment grade was not the reason for extremely low foreign direct investments. Those reasons need to be addressed to achieve productive investments leading to job generation and inclusive growth,” referring to infrastructure bottlenecks and red tape in government.
The harsh reality is that the Philippines slipped in its performance as a business-friendly location, down two notches in the 2013 Ease of Doing Business report of the World Bank.
OFWS DESERVE THE CREDIT
The face of the Philippine economy has changed significantly in recent years: from a net debtor to a net creditor, from a dollar-deficient to a dollar-surplus economy.
The investment grade simply means “the capacity for timely payment of financial commitments is considered adequate.” The upgrade may be attributed largely to the steady and crisis-resilient flow of remittances from overseas Filipinos.
I consider the more than $20-billion annual inflows coming from the sweat and blood of hard-working OFWs as the most important factor for the investment upgrade. Ironically, it’s primarily the spouses, sons and daughters of these OFWs who will bear the brunt of adjustment should the monetary authorities fail to stem the appreciation of the peso as a result of the tidal wave of “hot” money that will be induced by the upgrade.
Benjamin Diokno was secretary of budget and management from 1998 to 2001. He is professor of Economics at the University of the Philippines School of Economics.
Source: Benjamin E. Diokno, Core. BusinessWorld. 2 April 2013.
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