THE FINANCIAL EXECUTIVE
Business World
With the government's debt stock at alarming levels, there have recently been increased calls for debt relief, not just from the usual suspects, but even from well-regarded professionals in the economics field. I find this bother-some as it lends credibility to something that has heretofore been rightly brushed aside. Speaker Jose de Venecia has even come up with a "Debt-for-MDG-Investments" (MDG referring to the UN's Millennium Development Goals) proposal, which has reportedly been warmly received by international bodies such as the UN and IMF.
While it is possible to do debt swaps here and there of a largely symbolic nature, it is not realistic to expect anything of the magnitude envisioned in the Speaker's proposal (i.e., free up some $2.25 billion in debt service annually for MDG projects for the Philippines). Especially not when from official creditor sources, one cannot (a) expect to free up much from bilateral (other government) debts since debt service on these loans are already low given their concessionality, nor (b) expect multilateral creditors to actively participate since they themselves are constrained by reliance on capital market access for 90% of their lending.
Where debt relief can be significant is on foreign-exchange denominated capital market debts, which make up 53% of outstanding government foreign debt. But here is precisely where calls for debt relief (default call, really) are counterproductive as these may send signals to the financial markets that the country is unable or unwilling to honor its debts. Debt relief calls can raise the cost of financing with a one-notch rating downgrade expected to increase interest cost by P550 million to P690 million based on the country's annual US$4-5 billion refinancing requirement. If taken seriously as a government position, it may lead to unintended payments crisis and may even trigger a banking crisis as Philippine banks hold a large percentage of outstanding Philippine foreign paper. Banks are leveraged institutions and even a small loss due to new mark-to-market valuation regulations can lead to capital impairment and bank runs.
Thus, not only would a debt relief operation be self-defeating for the Philippines, but it is difficult to imagine why, on purely economic grounds, official creditors would want to participate in a voluntary debt swap. After all, there is no default or immediate threat of default at this time, and as observed above, a contemplated default would put the banking system at peril.
Nevertheless, there may be some noneconomic reasons that would motivate official creditors/donors to participate in a debt swap. However, the only way this would not be costly for both sides is if amounts involved are small relative to total debts. But then, such token amounts will largely be insignificant and irrelevant to solving the country's debt problem. Moreover, the Philippines may lose overall in the likely event that an offsetting amount is carved out of the aid budget and with friction costs of doing a complex debt swap, the country will end up with less than what it would have gotten from a straight grant. This is even without counting any adverse impact such token deals can have on the cost of capital access not just to government but to the private sector as well.
Indeed, there are only two sensible ways of reducing the debt burden - to grow out of it through higher economic and export growth, and working towards reducing government's deficits over time, i.e., increasing the primary balance (equivalent of EBITDA). Thus, the energies of both the executive and legislature are better spent ensuring the attainment of these two goals rather than crafting and marketing debt swap deals that may lull the financially nonliterate to think there is a magic wand somewhere.
Mr. Bernardo is the president of Lazaro Bernardo Tiu & Associates, Inc. He was Finance undersecretary and ADB alternate executive director
