Fitch airs concern over RP budget gap

International rating agency Fitch Ratings kept mum on the possibility of downgrading the country’s sovereign rating, reiterating its concern over the government’s fiscal deficit.

Finance Secretary Jose Isidro Camacho met with Fitch representatives in London early this week, in an attempt to allay their fears over the worsening budget deficit which increased to P144 billion in the first eight months, against the full year target of P130 billion.

Camacho told reporters in a teleconference that Fitch raised questions about the deficit but there was no mention of a possible downgrade despite the agency’s earlier concerns that the rating would be under threat if the deterioration in public finances persisted through the next two years up to the Presidential elections in 2004.

According to Camacho, they were able to explain to Fitch that the Arroyo administration was undertaking several measures to improve revenue collection, such as the crackdown on tax mis-declarations and the attempts to recover diverted tax payments.

"We talked about our efforts to collect value added tax from companies that have been mis-declaring their claims and we talked about the August performance of the Bureau of Internal Revenue," Camacho said. "We also talked about stop-filers and how we’re going after those diverted funds–nothing really dramatic," he added.

According to Camacho, there was no mention of the possible downgrading and Fitch officials only wanted to be fully informed of the government’s medium term efforts to make sure that revenue flows would be sustainable.

"The London crowd was more calm and subdued," Camacho said of the meeting. Camacho, together with Bangko Sentral ng Pilipinas (BSP) Governor Rafael Buenaventura, left London and flew to New York yesterday to meet with more investors there before going to the annual meeting of the International Monetary Fund (IMF) and the World Bank (WB).

Camacho’s meeting with Fitch was one of the highlights of the London trip, especially after Fitch warned the government that the Philippines needed to restore its fiscal credibility.

Fitch said the government’s failure to meet its deficit target did not immediately threaten the country’s credit rating outlook but the government’s deficit and the resulting public debt made it potentially vulnerable to contagion and underscored the need for "credible domestic macro-economic policy framework."

According to Fitch, 50 percent of the country’s public debt was denominated in foreign currency and this has made the country vulnerable to contagion, especially since the government needed at least $2 billion from the international financial market every year.

In 2003, the government planned to borrow $2.3 billion in order to finance its deficit which was expected to run up to P142 billion.

"The Arroyo administration is finding it much harder than it expected to expunge the fiscal legacy of the Estrada regime," said Fitch. "Although it remains committed to a target budget deficit of P130 billion, the chances of realizing this now are slight."

According to Fitch, the government would have difficulties holding the deficit below P155 billion and even this would demand a significantly better revenue performance during the remaining months of 2002 as well as deep expenditure cuts.

Moreover, Fitch said the government had a limited window of opportunity to bring the public finances back on track if it wants to avoid making difficult political choices in 2003.

If the government fails to increase revenues in the second half of 2002, Fitch said this would reverse the decline in debt to GDP (gross domestic product) ratio recorded in 2001.

"Such events would complicate fiscal management next year as there would be little political appetite for consolidation in the run up to presidential elections in 2004," Fitch said.

If the deterioration in public finances were to persist through 2003 and into 2004, Fitch said the Philippines’ international credit standing and sovereign ratings would be under threat.

Considering the events in Latin America, Fitch said the country’s fiscal woes could not have come at a worse time, leading investors to draw parallels with Brazil. The agency argued, however, that the Philippines had none of the unstable debt dynamics found in Brazil and Turkey such as pervasive indexation, short maturities and high real interest rates.

"Having said that, foreign currency denominated debt accounts for 50 percent of government debt and half of this is owned to bond holders," Fitch pointed out, explaining that this left the Philippines potentially vulnerable to contagion and loss of market access.

Working in its favor, on the other hand, was the fact that the country’s demands on the international capital markets were still modest.

The Philippines also has a comfortable external liquidity and it had no external financing gap in 2002-2003.

"On past occasions when the Philippines has been shut out of the international capital market, it has encountered little difficulty refinancing debt in the domestic market," Fitch said.