Jan 14, 2012
Debt and denial: Or how to make sure that the Philippines will end
by Walden Bello
FINANCE Secretary Cesar Purisima recently characterized the Philippines’ debt burden as a “lingering issue.” This reflects not so much the nature of our debt problem but that the government is in denial. The truth is, the Philippine national debt that has now reached 3.8 trillion pesos, or 69 billion dollars, is out of control. Total public sector debt is now estimated at 130 percent of GDP as of the end-2003.
Of the 3.8-trillion-peso debt, 1.8 trillion pesos, or nearly half, is foreign debt, according to the official story. However, according to some sources, about 80 percent of the total debt is owed to foreign creditors, including resident foreigners.
These are indicators not of a “lingering problem” but of the biggest economic problem we face. We are staring default in the face. Yet our policymakers are paralyzed.
Let me clarify: An effective solution to our current fiscal crisis would consist of three prongs: raise revenue, cut borrowings, rein in debt service. The firsttwo do not elicit much controversy, though there is little confidence that the government will be effective in either raising its revenue collection or refraining from going to local and international capital markets to finance its deficit. When it comes to renegotiating the debt, however, there is strong resistance in influential circles.
For instance, at a recent forum sponsored by the Management Association of the Philippines in which I participated, former central bank governor Gabriel Singson and World Bank country chief Joachim von Amsberg warned us not to even raise the possibility of debt renegotiation as an option. Why is the foreign debt such a sacred cow?
To answer this and understand the deleterious impact of our debt policy on the economy, we need to reach back into recent history. It is time we stop blaming all our debt-related ills on the Ferdinand Marcos regime. The Corazon Aquino administration and its successors played a key role in aggravating the situation. And the IMF and Mr. Amsberg’s institution, the World Bank, also figured prominently.
Crossroads in the mid-1980s
Let me focus on the foreign debt. At the beginning of the Aquino period, the Philippines’ foreign debt had risen to over 26 billion dollars from 21 billion dollars in 1981. This led the World Bank and the IMF, under strong pressure from the big commercial creditors, to put the emphasis on debt repayment in their agenda for the new administration of President Corazon Aquino. Fairly quickly, international finance faced the fledgling democratic administration with an unpalatable choice: either limit debt service payments or fully comply with debt obligations in order to preserve creditworthiness even at the risk of throttling growth.
The first position was espoused by Solita Monsod, who became director of the National Economic and Development Authority (NEDA) and some of her colleagues at the University of the Philippines School of Economics, who wrote: “The search for a recovery program that is consistent with a debt repayment schedule determined by our creditors is a futile one and should therefore be abandoned.” The central bank and the Department of Finance, dominated by figures with links to international finance, lined up behind the second position. Then-governor “Jobo” Fernandez of the now-defunct Central Bank, a Marcos holdover, “warned of the risk of ‘economic retaliation against the country’ should it take unilateral actions in defiance of its creditors. Trade credit lines could be withheld ‘paralyzing foreign trade,’ and foreign assistance could be terminated.” Then Citibank President John Reed visited the Philippines and warned that debt repudiation “would produce immense suffering and difficulty for the people.”
The so-called “model debtor” strategy won out, partly because proponents of the opposite position like Monsod did not put up more than token resistance. This was a mistake, notes economist Jim Boyce, in the light of concurrent developments:
The credibility of these threats is … open to serious doubt. Brazil defied its commercial creditors for 18 months, beginning with the unilateral suspension of debt service announced in February 1987. Its defiance provoked much posturing by the banks, but little genuine retaliation. The holders of paper assets proved to be paper tigers. Similarly, the well publicized but less drastic debt service ceiling imposed by Peruvian President Alan Garcia did not bring grievous penalties; the Garcia government’s heterodox economic program ultimately failed despite the debt policy, not because of it. More quietly, Bolivia halted most debt service payments in 1984, and three years later won [a] very favorable debt buy-back deal.
The “model debtor” strategy was inaugurated with President Corazon Aquino’s Proclamation 50, which committed the government to honoring all of the Philippines’ debt, including odious debts like those contracted to build the Bataan Nuclear Power Plant as well as the so-called “behest loans” made by cronies of the Marcos dictatorship. The strategy was institutionalized by Executive Order 292, which affirmed the “automatic appropriation” of the full amount needed to service the debt from the budget of the national government that was originally mandated by Marcos’ Presidential Decree 1177.
Impact of the model debtor strategy
A financial hemorrhage marked the succeeding years, with the net transfer of financial resources to external creditors coming to a negative 1.3 billion dollars a year on average between 1986 and 1991. In late eighties, foreign debt servicing came to 3.5 billion dollars a year, or about 10 percent of the country’s gross domestic product. A decade later, in 1999, the level of outflow of financial resources continued to be massive. The fundamental irrationality of the process was underlined by the fact that as overseas workers were remitting hard earned dollars into the country, an equal if not greater amount was leaving it.
Making constantly rising debt payments a sacred cow legally not only made the national budget structurally prone to deficits. Government is usually the biggest and most important investor in developing countries like the Philippines. Owing to the prioritization of foreign debt repayment, government spending has been, over the last two decades, confined largely to financing salaries and other operating expenses. For the last 18 years, very little of the budget could be devoted to capital expenditures, thus practically eliminating government spending as an engine of development. In our neighboring countries, in contrast, government spending became the catalyst of development and sizzling economic growth.
Along with the structural adjustment measures imposed under the guidance of the World Bank and the International Monetary Fund, the strategy of making debt repayment the national priority — which has been followed by every administration since Marcos — has created a condition of structural stagnation — what Massachusetts Institute of Technology economist Rudiger Dornbusch describes as a low-level trap in which low investment, increased unemployment, reduced consumption, and low output interacted to create a vicious cycle of stagnation and decline. This is the source of what we have called in a recent book the permanent structural crisis of the Philippine economy.
Almost 20 years after the beginning of the Aquino presidency, our foreign debt has nearly trebled, from 26 billion dollars to 69 billion dollars. We are still servicing the debt incurred for the mothballed Bataan Nuclear Power Plant! This is a case of skipping the possibility of death through a nuclear accident for the certainty of slow death through debt repayment. Debt servicing rose from 46 per cent of national government expenditure in 2002 to 81 percent in 2004 and is expected to hit 89 percent in 2005, according to former National Economic and Development Authority head Cielito Habito.
Another way of looking at this is that in order to enable the government to keep functioning, we must resort to borrowing from foreign and local creditors to stay current on our debt servicing. However one reads them, the figures underline one thing: We are essentially back where we were in the early 1980s, which is that of borrowing new money at increasingly disadvantageous rates to pay off old debts. And so long as our debt service remains uncontrolled, any sort of measures on the revenue side, such as more effective tax collection, tobacco and alcohol taxes, or the value-added tax will have little impact in terms of stabilizing government finances. Sure, some of these measures must be implemented, but they must go in tandem with debt devaluation.
Our policymakers, however, are still talking about maintaining the model debtor strategy that has brought us so much grief. Again Finance Secretary Purisima: “[W]e need to be responsible players in the international financial community, and honoring our obligations is one that we need to take pride in.”
The lessons of Argentina
The example of Argentina is often cited as the future of the Philippines. Just recently, Finance Asia predicted an “eventual public sector debt default.” Argentina, in fact, has both negative and positive lessons for the Philippines. The negative lesson is that if you do nothing about your deteriorating debt profile because you want to preserve your access to international capital markets, you will certainly collapse. The main reason for the collapse of the Argentine economy was the policy of being a good debtor even when it was clear that servicing the debt was dragging the economy over the cliff. When Argentina defaulted on its foreign debt in 2002, it was because it could no longer service it at the onerous terms imposed by the creditors.
Now to the positive lessons. First, with the millstone of debt service removed, the economy can grow. After the collapse of 2002, Argentina grew by 8 per cent in 2003 and 2004. The New York Times has rightly analyzed Argentina’s success as due to its “ignoring or defying economic or political orthodoxy.”
The second positive lesson is that being hard on your creditors pays. When the current president Nestor Kirchner took over, he told bondholders that they had to take a loss on their loans on the order of 70-75 percent. The bondholders howled, and asked the IMF to punish him. Kirchner stood his ground. The IMF blinked and gave him a loan of 3.3 billion dollars that had previously been agreed upon. In the next few days, an announcement is expected that 70 percent of the country’s bondholders have agreed to swap defaulted debt for new bonds, taking a breathtaking devaluation of their original bonds of 75 percent.
Doing something drastic with our debt does not mean we go unilateral. Of course not. We must negotiate. But negotiate hard. As former NEDA head Solita Monsod once said, “If you don’t know how to negotiate, you’re dead. You capitulate immediately.”
Some concrete measures
Along with repeal of the automatic appropriations law, which would free up a lot of funds for development purposes, we might consider negotiating hard along the following lines, among others:
• freezing or reducing payments to the World Bank and the IMF, to whom we owe 22. 8 percent of our public debt, as Prof. Habito, suggests;
• ending payments on illegitimate debts like the ones the Marcos government incurred to set up the Bataan Nuclear Power Plant, knowing full well that there is the established doctrine on “Odious Debt” that we can base this action on;
• renegotiating, as Argentina did, to devalue the debt held by our bondholders both foreign and local; or
• tying our debt repayments to a certain percentage of our export earnings, perhaps no more than five percent of this in contrast to the current 22 percent.
There are other mechanisms. These moves need not necessarily provoke a hardline response. Indeed, most of Argentina’s creditors, including the IMF, elected not to take a hard line. The reason for this is that, after the experience of the 1990s, there is now a great awareness in the world’s financial centers that financial crises will continue to erupt. Indeed, former US treasury secretary Robert Rubin says, “Future financial crises are almost surely inevitable and could be even more severe.” Thus there is now felt to be an urgent need to create multilateral mechanisms to deal with such events as the Argentine default.
One of the ideas that has been mooted is the creation of a Sovereign Debt Restructuring Mechanism (SDRM) that would allow countries in the throes of or entering a financial crisis like the Philippines to freeze or reduce their repayments with full legal protection as well as with financial support from the IMF while they undergo an orderly restructuring of their debt with their creditors. Surprisingly, the otherwise orthodox Deputy Director of the IMF Ann Krueger of the United States has become the main proponent of this idea, though the Bush administration continues to reject it.
The point in raising this is not to support the current SDRM proposal (which we feel is still inadequate for effectively dealing with crisis) but to emphasize that no one wants another Argentina, and the Philippines must capitalize on this mood to push its creditors to negotiations to radically restructure and devalue its debt at this point.
The mechanisms for reducing our devaluing our debt are many, and it is tactical considerations that must determine the choice of instruments. The critical thing is political will: Can the government generate the political will to take the necessary measures to stanch the continuous hemorrhaging of our financial resources in the form of uncontrolled debt service?
I really am skeptical and pessimistic on this score. I, in fact, think that our policymakers will till the end exhibit “fear and trembling,” to borrow from Kierkegaard, when dealing our creditors. Argentines learned the hard way. Perhaps only an experience like Argentina’s will teach us Filipinos the appropriate lessons. Unfortunately.
(Published in: Focus on the Philippines No. 5, http://focusweb.org/oldphilippines/content/view/92/6/)