Fitch affirms Philippines 'BBB' investment grade rating
Fitch Ratings said Monday it affirmed the Philippines' long-term foreign-currency issuer default rating at 'BBB' with a 'stable' outlook.
"The affirmation of the Philippines' 'BBB' rating and stable outlook balances modest government debt levels relative to peers, robust external buffers and still-strong medium-term growth prospects, notwithstanding the deep pandemic-induced economic contraction, against relatively low per capita income levels and indicators of governance and human development compared to peers," Fitch said in a statement.
It said the economic impact of the Covid-19 shock for the Philippines in 2020 was more significant than it had previously expected due to the domestic infection rate and government policy measures to curb the spread of the virus.
In particular, efforts to contain the virus severely affected private consumption and investment, resulting in real GDP contracting by 10% year-on-year in the first nine months of 2020. We estimate full-year GDP to have contracted by 8.5% in 2020, after accounting for an improvement in activity indicators in 4Q.
"We expect economic activity to continue to recover in the coming quarters, and project GDP to expand by 6.9% and 8.0% in 2021 and 2022, respectively. New daily recorded Covid-19 cases have been declining in recent months, reflecting an effective government response to the crisis and reducing the risk of renewed lockdowns," it said.
The authorities have also engaged in multilateral initiatives and with several pharmaceutical companies to secure vaccines, with a rollout expected to start in May 2021. The potential for a delay poses downside risks to our growth forecasts, while an effective vaccine rollout could result in a faster-than-expected recovery in growth.
"We estimate the general government deficit to have widened to 6.9% of GDP in 2020 from 1.2% of GDP in 2019. We project the deficit to widen further to 7.7% in 2021, before narrowing to 6.6% in 2022. Underlying the projections for 2021 are a central government deficit of 8.7% of GDP, up from an estimated 7.5% of GDP in 2020, as government expenditure aimed at supporting economic recovery is likely to remain high. The wider deficits reflect the authorities' policy response to Covid-19 under their four-pillar socio-economic strategy," Fitch said.
It said ur forecasts for the budget deficit assume a gradual pick-up in economic activity over the forecast horizon and continued adherence by the authorities to their prudent approach to macroeconomic policymaking. Downside risks could stem from presidential elections scheduled in May 2022 that create some uncertainty regarding the post-election fiscal strategy, or from weaker-than-expected economic growth in the aftermath of the health crisis that could make fiscal consolidation more challenging.
The Philippines entered the crisis with robust public finances, given its relatively low general government debt ratio of 34.1% of GDP in 2019 ('BBB' median: 42.2%). The pandemic shock has eroded this strength, as we estimate the debt ratio to have risen to 48% of GDP in 2020, and anticipate it will rise further and peak at around 55% in 2022 (against a projected 'BBB' median of 56.6%).
Fitch said it will monitor the post-pandemic evolution of the fiscal deficit and debt levels, as the balance between fiscal consolidation and ongoing government spending to support economic growth will be an important consideration for the rating over the medium term.
The authorities have maintained progress in their infrastructure programme despite disruptions from the coronavirus. According to official estimates, spending on infrastructure reached about 4.5% of GDP in 2020, slightly below the 2019 level of 5.4%, and is forecast to rise again to about 5.9% in 2021.
"Our projections incorporate the impact of the Corporate Recovery and Tax Incentives for Enterprises Act (CREATE) tax package, which has been passed by both houses of Congress, and also Package 2 : Sin Taxes (part of the Comprehensive Tax Reform Program) passed in early 2020. According to the authorities, revenue loss from the senate version of CREATE is projected to be about PHP133.2 billion and PHP117.6 billion in 2021 and 2022, respectively, or about 0.6% of annual GDP on average. However, CREATE also includes rationalisation of fiscal incentives that aim to establish a more competitive and level-playing field for businesses, which could improve the business environment. Our estimates are also based on the authorities' medium-term fiscal strategy, which aims to reduce the central government deficit to around 7.3% of GDP by 2022," it said.
The presidential election in 2022 creates some uncertainty about economic policies beyond the election, but we expect the medium-term fiscal framework to remain intact, based on the Philippines' track record. Another uncertainty relates to the fiscal impact of the 2018 Supreme Court ruling requiring increased revenue transfers (i.e. internal revenue allotment) from the central/national government to local government units. Implementation is likely to take effect in 2022, and the government says it plans to ensure it is fiscally neutral by transferring spending assignments to local government units in tandem.
The authorities financed the higher budget deficit in 2020 through a combination of domestic and external financing, with a borrowing mix of 76%/24%, in favour of the former. The Bangko Sentral ng Pilipinas (BSP) authorised the use of a repurchase agreement with the Bureau of the Treasury of PHP300 billion (1.5% of 2020 GDP) on a short-term basis to finance the government's urgent Covid-19-related financing needs and this was paid back to the BSP in September 2020. An additional PHP540 billion (2.7% of 2020 GDP) in the form of a provisional advance of three months maturity has recently been renewed by the BSP, within existing provisions of the BSP charter.
Fitch believes the central bank financing provisions to be temporary, driven by the unusual circumstances of the pandemic. However, ongoing recourse to direct central-bank financing of the budget deficit beyond the immediate needs of the health crisis could undermine investor confidence and financial stability by raising questions about the independence of monetary policymaking.
During 2020, the BSP cut the policy rate by a cumulative 200bp. We think space for further rate cuts is very limited in 2021. Inflation on average was 2.6% in 2020, staying within the BSP's target range of 2% - 4%.
"We estimate the current account to have reverted to surplus in 2020 as the loss of export earnings and tourism receipts was largely offset by lower imports and surprisingly resilient remittance inflows. It remains to be seen whether this resilience will endure in 2021. We expect the current account to remain in a small surplus in 2021, and then revert to a deficit by 2022," it said.
The Philippines' external finances remain a credit strength. Foreign-currency reserves remain high and gross external debt levels are manageable. Foreign exchange reserves are estimated to have increased to about USD105 billion by end-2020 from USD90 billion in 2019, supported by proceeds from global bond issuances and disbursements from multilaterals for pandemic-related spending. We expect reserve coverage of current external payments (CXP) to remain strong in 2021 and 2022 at about 9-10 months. Modest external debt-service payments relative to its foreign-currency reserves supports a strong external liquidity ratio of about 387% (measured as liquid external assets/liquid external liabilities), compared with a median of 167.8% for 'BBB' rated peers.
The Philippines' structural indicators remain weaker than peers', including per capita income, governance standards and human development as measured by the World Bank Governance Indicators and UN Human Development Indicators. Reforms undertaken in the last couple of years, such as passage of the Philippine Identification System Act of 2018, increased coverage under the National Health Insurance Program and establishment of the Presidential Anti-corruption Commission, should support stronger structural indicators over time.
Fitch's sector outlook for the Philippines banking system is stable, given prospects in 2021 are broadly similar to those in 2020. The profitability of Philippine banks is likely to stay soft, as benefits of higher loan growth and lower credit provisioning against a year ago are offset by compressed margins and the absence of outsized trading gains. The deterioration in reported asset-quality metrics is likely to accelerate in early 2021, as debt moratoria expired in December 2020, but large pre-emptive general provisioning taken by banks in the preceding year should help the major banks avert significant capital impairment.
Philippines has an ESG Relevance Score of '5' for Political Stability and Rights as well as for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. Philippines has a medium World Bank Governance Indicator ranking in the 40th percentile, reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Public Finances: Sustained broadening of the government's revenue base that enhances fiscal finances and places the government debt/GDP ratio on a downward trajectory.
-Structural: Strengthening of governance standards towards those of the rating-category peer median.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Public Finances: A sustained rise in the government/debt to GDP ratio associated, for example, with a reversal of reforms or departure from a prudent macroeconomic policy framework that leads to sustained higher fiscal deficits.
- Macroeconomic: Failure to resume historically high economic growth rates after the coronavirus shock subsides, potentially reflecting a loss of macroeconomic policy credibility or structural economic damage from the crisis.
- External: Deterioration in external indicators, including foreign-currency reserves, the current account deficit and net external debt, which lowers the resilience of the economy to shocks.
The global economy performs in line with Fitch's December 2020 Global Economic Outlook.
The principal sources of information used in the analysis are described in the Applicable Criteria.
Philippines has an ESG Relevance Score of 5 for Political Stability and Rights, as World Bank Governance Indicators have the highest weight in Fitch's SRM and are highly relevant to the rating and a key rating driver with a high weight.
Philippines has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption, as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Philippines has an ESG relevance score of '4' for Human Rights and Political Freedom, as World Bank governance indicators have the highest weight in Fitch's SRM and are relevant to the rating and a rating driver.
Philippines has an ESG Relevance Score of 4 for Creditor Rights, as willingness to service and repay debt is relevant to the rating and is a rating driver for the Philippines, as for all sovereigns.
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