S&P issues downgrade warning

The Philippines, although still enjoying investment-grade status, may face a downgrade contingent on the results of the last elections.

Standard & Poor’s (S&P) issued the warning due to inherent defects in the country, such as the lack of infrastructure support and deficient energy outlook and low export volumes.

However, there are still optimistic signs in the economy, S&P said, although it did not discount the possibility of a possible upgrade.

While credit watchdog S&P Ratings maintained an investment grade on the Philippines, it cited conditions favoring a downgrade, particularly based on the results of the last elections.

S&P said it may lower the ratings “if the administration’s reform agenda stalls or if a successor administration reverses recent gains in the Philippines’ fiscal or external positions.”

The conditions for an upgrade—further institutional and structural reforms to boost investment and economic growth prospects, or changes in governance and the policy environment leading to a better assessment of institutional and governance effectiveness were “unlikely over the next year,” it said.

S&P also maintained that a stable outlook on the country, which it based on rising foreign-exchange reserves and low external debt that offset its low income and developing institutional and governance framework over the next 18 months.

The economy has a low income level, but it is comparatively diversified.

“We estimate its gross domestic product (GDP) per capita will rise by 4.5 percent to about $3,000 this year, from 4.3 percent in 2014,” S&P said.

S&P projects GDP per capita to average 4.4 percent over 2016-2019, reflecting the modest outlooks for the Philippines’ trading partners.

High household consumption, investment, and exports (mainly of electronics, commodities, and services) continue to support economic activity.

S&P said strengths of the economy will likely be underpinned by strong household and company balance sheets; sound growth in jobs and income; high inward remittance flows; and an adequately performing financial system.

“Uncertain conditions in export markets and inadequate infrastructure, mainly in transportation and energy, are the main factors that add downside risks to our growth outlook,” it said.

It noted that, without the closure of infrastructure gaps and improvements in the business climate through regulatory reforms, the Philippines may not achieve lower-middle-income status in 2016, when per-capita GDP exceeds $3,000.

“We believe the government’s fiscal and economic development plans also provide useful policy anchors, while keeping the inflationary environment favorable. The government has made advances in fiscal consolidation, with fiscal deficits averaging 2 percent of GDP over 2010-2014, compared with an average of 4 percent for the past decade,” it noted.

S&P forecast its fiscal deficits to average one percent over 2015-2019 that will result in the net general government debt burden peaking at 27 percent of GDP in 2014 before declining. “That said, while the institutional and governance settings of the Philippines are broadly effective, its ability to develop and implement swift policy responses has not been proven,” S&P said.

S&P expects the current account to likely remain in surplus, averaging 4.7 percent of GDP annually to 2019, reflecting robust services exports including mainly tourism and business-process outsourcing; large and rising remittances, and lower oil prices.

Labor costs in the country remains competitive relative to peers such as Thailand and Indonesia, and a large young educated labor market imply further strength in services exports over the next five years.

Participation in free-trade agreements could provide further upside to the country’s export earnings.

“We expect the Philippines to remain in a net external creditor position. It has narrow net external debt (the ratio of gross external debt less official reserves and financial sector external assets to current account receipts [CARs]) averaging negative 42.2 percent over 2016-2019,” it said. A negative number indicates net external lending.

External liquidity, which is measured by the ratio of gross external financing needs to current account receipts and useable reserves, will also remain a sound 61.4 percent on average over the period.

“We do not envisage a marked deterioration in the country’s external financing from a shift in foreign direct investments or portfolio equity investments, or from a reduction in disbursements from donors,” it said.

Other factors that mitigate risks associated with the Philippines’ international liabilities include a very low reliance on external savings by its bank and company sectors, as well as the low and mainly long-term nature of the government’s external borrowings. Philippine banks benefit from being mainly deposit funded, with high liquidity and limited linkages to global markets.

S&P added that the strengthened oversight of the financial sector by the Bangko Sentral ng Pilipinas (BSP), combined with modest growth in private-sector debt and real-estate prices have also contributed to improved system stability in recent years.

It said relaxed underwriting standards, a weak payment culture, cross-ownership and connected lending heighten credit risks.

“We regard the BSP’s ability to support sustainable economic growth while attenuating economic or financial shocks to be broadly neutral to our ratings. This reflects the central bank’s sound record in keeping inflation low, its history of independence and use of market-based instruments to conduct policy,” S&P added.

“In our opinion, a deeper and more diversified financial and capital market would improve the effectiveness of policy transmission and facilitate improved credit metrics,” it said.