August 22, 2021 | 6:07 pm
Introspective By Romeo L. Bernardo
I am pleased to share with readers excerpts
from a note sent September 2020 to subscribers of GlobalSource Partners upon
the release of the Development Budget Coordination Committee’s Fiscal Risk
Statement (DBCC FRS). Christine Tang and I, assisted by Charles Marquez, are their
Philippine Advisers.
The
2020 DBCC FRS (https://www.dbm.gov.ph/wp-content/uploads/DBCC_MATTERS/FiscalRiskStatement/Fiscal-Risks-Statement-2021-for-Circulation.pdf)
expounded on the impact of the COVID-19 pandemic on government’s fiscal health
over the medium-term. Below are our key takeaways of fiscal risks to keep watch
on over the medium-term. (Verily, the finance/economic team of the next
administration have their work cut out for them!)
1. The DBCC expects the
National Government debt-to-GDP ratio to swell from below 40% last year to 53%
this year due to the emergency borrowings made to finance the suddenly
wider budget deficit. The debt ratio will continue to climb with “moderate
risk” of exceeding 60% as soon as next year. A reversal to a downward path for
the debt ratio depends on GDP growth and the fiscal deficit returning to their
pre-crisis averages over the medium-term.
The higher debt will need closer monitoring as it
translates into much higher annual gross financing needs, exceeding 10% this
year and next. Rollover risks are partly mitigated by looser monetary policies
everywhere that will keep interest costs low, with the foreign currency share
making up only about a third of total National Government debt, a portion of
which is held by residents. The Philippines also has a robust external payments
position that provides fundamental support to the currency.
2. National Government revenues, forecast to fall to
13.6% of GDP this year or 2.7ppt below the pre-crisis level, will
not return to pre-crisis levels in the foreseeable future. Following the
declaration of a state of emergency, government was able to secure more than
P100 billion (0.5% of GDP) in unprogrammed revenues from public corporations in
the form of dividends. This amount is one-off, with non-tax revenues expected
to be lower by 1% of GDP by next year. The passage of CREATE lowering corporate
income taxes will further erode tax revenues with compensatory inflows from the
rationalization of fiscal incentives expected to be pushed back. No new taxes
are likely under the current economic crisis, especially with the
administration in its penultimate year.
3. With lower revenues, the fiscal space for
discretionary spending is expected to shrink further. Even
before the pandemic, the National Government was already grappling with how to
deal with (a.) ballooning pension costs of military and uniformed personnel,
estimated at P114 billion (about 0.6% of GDP) and growing by 3-4% annually,
and, (b.) a Supreme Court ruling (Mandanas case) requiring increased annual
transfers to local government units amounting to 0.9% of GDP starting 2022.
Moving forward, interest payments on the larger national debt will take up an
increasing share of the budget (from 9.5% in 2019 to 12.9% by 2022) which
however is well below the 30% share recorded in the mid-2000s. On the other
hand, some cutback in infrastructure spending may already be seen in programmed
disbursements falling to 4.5% of GDP by 2022 from over 5% next year. Proposals
to address (a.) and (b.) will gain more urgency to enable government to do more
to hasten post-crisis recovery.
4. Fiscal risks from other parts of the public
sector have likewise risen due in part to off-budget financing of COVID-19
expenses. Social security institutions were the first to
see surpluses reverse to deficits (close to 0.5% of GDP this year) due to
substantially higher medical and unemployment insurance payouts, while the
aggregate surplus position of frontline local government units is expected to
halve this year (from 1.3% of GDP in 2019) and further deteriorate next year to
0.5% of GDP. Government financial institutions (GFIs), in addition to providing
debt moratoriums and other temporary relief measures, are also being tapped to
finance the post-crisis recovery effort with the financial impact of
developmental lending and guarantee activities dependent on safeguards that
will be put in place during program design. Other major corporations,
particularly in the transportation (aviation, ports) and energy sectors, have
also seen revenues from operations drop with economic contraction.
Although most of these represent contingent liabilities that may never
materialize, some parts would require major reforms to correct structural
defects and avoid recurring National Government subsidies, equity infusion or
advances for debt service. (At risk of requiring more government support at
this time, is the health insurance agency which aside from a spike in
COVID-related payables, will see revenues drop with corporate bankruptcies and
higher unemployment to the detriment of universal healthcare goals.) Even
before the pandemic, government had outstanding guarantees on public
corporations’ debts and contractual obligations equivalent to 3.3% of GDP which
it was servicing through “advances” amounting to 1.4% of GDP in 2019. Over the
last 10 years, net budgetary flows to the corporate sector have been negative,
ranging from 0.1% to 0.6% (2019) of GDP.
Local
government units would separately need attention considering their high
dependence on National Government transfers for operating income (60%) and with
anticipated increases in revenues from the Mandanas ruling likely short-lived
given the COVID-19 shock to the National Government’s own revenues.
5. Contingent liabilities associated with
contractual obligations under public-private partnership (PPP) projects
likewise need monitoring as the risks
are expected to be correlated with the state of the economy, with the downturn
adversely affecting projects’ revenue flows and/or proponents’ balance sheets,
thus potentially impacting project viability. Based on the 41 projects for which
information is available, a worst-case outcome involving termination payments
will cost government the equivalent of 1.7% of 2020 GDP although an assessment
of contingent liabilities based on project-specific probable risk factors yield
an estimate that is only a tenth of that.
6. Aside from GFIs, government also has explicit
(through deposit insurance) and implicit guarantees over the rest of the
banking sector that require closer monitoring of individual and
system-wide bank risks as asset quality and profitability deteriorate with
weakened economic prospects. The risks are mitigated by ample capital buffers
and increased provisioning for bad loans. Going into the crisis, the capital
adequacy ratio of the big universal/commercial banks stood at 16% (consolidated
basis) with high-quality Tier 1 capital at 14%, well above the BSP (Bangko
Sentral ng Pilipinas) and BIS (Bank for International Settlements) prescribed
thresholds of 10% and 8%, respectively. These banks have also increased loan
loss provisions by 64% in the year to July, providing over 1.2x coverage for
bad loans slightly up from below 1.1x at end-2019. While the risk of
system-wide stress is low, it would nonetheless be impossible to discount
problems at the individual bank level, especially those that have not developed
strong credit disciplines. Separately, operational risks associated with
cybercrimes have also gained prominence.
BOTTOMLINE VIEW
At
the same time, a more deliberate and comprehensive analysis of fiscal risks
associated with needed new programs to hasten economic recovery and job
creation, e.g., by providing liquidity to distressed firms, would help in
managing and mitigating these risks over time and avoid abrupt and harmful
threats on fiscal sustainability. Lastly, with the pandemic’s harsh impact
especially on the poor and with elections less than a year away, fiscal
sustainability also requires extra vigilance on the part of economic managers
to ensure that new social programs are not just timely and targeted but
temporary.
Romeo
L. Bernardo was finance undersecretary during the Cory Aquino and Fidel Ramos
administrations.
