THE PHILIPPINES: GROWING FINANCIAL STRAINS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00553R000100190001-8
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 14
• Document Creation Date: December 21, 2016
• Document Release Date: August 4, 2008
• Sequence Number: 1
• Publication Date: April 1, 1983
• Content Type: FORM

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STAT
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Directorate of l.onIlaential
Intelligence
The Philippines:
Growing Financial Strains
Confidential
EA 83-10064
April 1983
Copy 3 5 2
25X1
m
STAT
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Directorate of Confidential
Intelligence.
The Philippines:
Growing Financial Strains
This assessment was prepared by
Office of East Asian Analysis. Comments and queries
are welcome and may be directed to the Chief,
Southeast Asia Division, OEA
This paper was coordinated with the National
Intelligence Council.
Confidential
EA 83-10064
April 1983
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The Philippines:
Growing Financial Strain
Key Judgments We believe there is a high risk that the Philippines will experience serious
Information available foreign debt repayment problems in the next two years. According to the
as of 11 March 1983 International Monetary Fund, last year's current account deficit of $3.3
was used in this report.
billion-a record 9 percent of GNP-is three times the level sustainable. A
repeat of this performance would almost certainly require a rescheduling of
the country's foreign debt repayment obligations because of the already
heavy debt service burden.
Several measures would enable Manila to buy some time and avoid a
foreign exchange crunch during 1983. Debt service obligations of $3.2
billion will be manageable this year if the government follows up on plans
to exercise financial discipline. Reserves are also probably sufficient to
cushion the effects of refusals by smaller US and West European banks to
roll over existing short-term obligations-a process we now see occurring
for the first time. However, running down reserves largely avoids necessary
financial adjustment measures, and in our judgment would almost certain-
ly produce a repayments crisis in 1984, when National Assembly elections
will be President Marcos's overriding concern.
If a financial crisis occurs, we believe it will start in the private sector.
Many large corporations are vulnerable because of the domestic business
slowdown and their own mounting foreign debt service obligations. Unfor-
tunately for Manila, the decisive actions necessary to ease balance-of-
payments strains-rapid exchange-rate depreciation and slow economic
growth-will make the private sector even weaker over the short run.
Manila, however, has little choice but to take these actions, hoping that the
private sector's financial problems do not become so unmanageable that
rescheduling the sector's entire foreign debt becomes necessary. Over the
longer term, Manila faces the need to restructure the economy if balance-
of-payments considerations are to allow the country to resume the 6-
percent annual real growth that Filipinos grew accustomed to during the
mid-1970s.
iii Confidential
EA 83-10064
April 1983
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The Philippines:
Growing Financial Strains'
at the end of 1980 (table 1).
international reserves to $1.7 billion, which equaled
10 percent of the foreign debt, down from 22 percent
Financial Developments in 1981-82
After surviving slowing growth, rising unemployment,
and the near collapse of domestic financial markets in
1981, the Philippines last year posted its worst bal-
ance-of-payments performance ever. The current ac-
count deficit ballooned to $3.3 billion-a record
9 percent of GNP-at the same time that net direct
foreign investment inflows dropped by half and the
Central Bank reduced sales of domestically produced
gold. As a result, financing the deficit required that
the volume of new foreign loans grow by nearly $300
million in a year when government technocrats insist-
ed it was imperative to reduce the level of borrowing.
What is worse, by yearend the Central Bank ran down
Controversy over government national accounting
data and Central Bank foreign debt figures, coupled
with friction with both the IMF and the World Bank
over the conduct of economic policy, made a terrible
year even more painful for government policymakers.
Government financial and trade data placed the total
foreign debt at yearend 1982 at $17.2 billion-about
55 percent higher than at the end of 1980 (figure 1).
Estimates by private consulting firms place the debt
as high as $18.5 billion, however. Our own methodolo-
gy places the debt at about $18.8 billion-about 50
percent of GNP. By this standard, the Philippines is
now in the same league as Brazil, Mexico, Venezuela,
and Argentina, although safely below the level of
Chile.'
share of GNP were 29 percent in Brazil, 49 in Mexico, 41 in
Argentina, 46 in Venezuela, and 75 in Chile. The Philippines's
repayment schedule is more manageable, however, and thus its
Figure 1
The Philippines: Alternative Estimates
of the Foreign Debt
Central
Bank of the
Philippines
Commercial Resources
Bank
s^ Medium and long term
1'.:3 Short term
Method A-Cumulative sum of the current account deficit, additions to
reserves, and errors and omissions, less direct foreign investment since
1975, plus official estimates of the foreign debt at the end of 1975-
$3.8 billion.
Method B-Medium- and long-term foreign debt as reported by the Central
Bank, plus short-term claims against the Philippines as reported by the
Bank for International Settlements, less $2 billion in double-counting
errors and offshore bank lending to foreigners.
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Table I
The Philippines: Balance-of-Payments Summary
Current account
-1,101
-828
-1,172
-1,576
-2,072
-2,589
-3,347
-3,100
Trade balance
-1,113
-840
-1,307
-1,541
-1,939
-2,667
-2,805
-2,450
Exports f.o.b.
2,519
3,075
3,425
4,601
5,788
5,733
4,995
5,500
Of which:
Coconut products
537
729
812
965
759
756
647
700
Sugar
451
527
213
238
474
609
324
325
Copper concentrates
270
280
250
330
679
544
340
500
Forest products
268
261
324
484
433
383
340
400
Manufactures
573
770
1,076
1,520
1,135
1,294
1,050
1,245
Imports f.o.b
3,632
3,915
4,732
6,142
7,727
8,400
7,800
7,950
Oil
936
1,019
1,030
1,385
2,248
2,458
2,396
2,190
Others
2,696
2,896
3,702
4,757
5,479
5,942
5,404
5,760
Services (net)
-257
-248
-178
-390
-555
-392
-992
-1,000
-258
-302
-440
-591
-846
-1,101
-1,811
-1,900
1
54
262
201
291
709
819
900
Transfers (net)
269
260
313
355
422
470
450
350
Capital account
1,151
985
1,162
997
1,720
2,029
2,212
2,600
Of which:
Direct investment (net)
. 144
216
171
99
49
407
259
300
Medium and long term (net)
1,014
859
908
1,061
1,044
1,185
1,252
1,600
Short term (net)
-87
-90
83
-193
446
437
423
400
Balance
50
157
-10
-579
-352
-560
-1,135
-500
a Estimated.
b Projected.
Includes errors and omissions.
The Old Problems
The Philippines's balance-of-payments problems, for
the most part, are an outgrowth of adverse price
developments in international markets over the last
decade. The terms of trade-the ratio of export prices
to import prices-have slipped 33 percent over the last
four years to the lowest point of the postwar period.
This means that Philippine exports are worth about a
third fewer goods in international trade than they
were four years ago (figure 2).
Part of the decline is cyclical; export prices have
slumped because of the recession. Last year, for
example, the terms of trade declined by 8 percent.
More serious from a balance-of-payments perspective,
in our judgment, are permanent changes in the prices
of several key internationally traded goods, notably
imported petroleum. Even with current weak oil
prices, for example, Saudi crude oil now sells for
about three times as much as it did in 1975. The 1975
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Figure 2
The Philippines: Terms of Trade
Developments
400
i Lumber
0 1976 77 78 79 80 81 82 83a
I I I I I I I 1
1976 77 78 79 80 81 82 83a
0 :976 77 78 79 80 81 82 83a
level, in turn, was about five times the level of 1972.
As for exports, prices of sugar and coconut are very
low, partly because of increasing industrial use of
high-fructose corn sweeteners and new competition
from other LDC producers of edible oils. Coconut oil,
sugar, and crude petroleum account for about 26
percent of the Philippines's total foreign trade turn-
over.
The New Problems
The source of 1982's burgeoning financing require-
ments represents a historic watershed in the Philip-
pines's external accounts. In previous years, OPEC
price hikes swelled the oil-import bill by nearly
$1 billion, ballooning the trade deficit even as rising
remittances from workers in the Middle East buoyed
the service and transfer account. Last year, in con-
trast, oil imports were down in both value and volume
as the recession slowed demand, new geothermal
fields began production, and the government oil com-
pany drew down inventories. However, this accom-
plishment was more than offset as repayment obliga-
tions on the foreign debt, itself the cumulative result
of previous oil import-based foreign trade deficits,
increased the service account deficit by $600 million.
As interest payments grew sharply, medium- and
long-term principal payments in 1982 grew by over
$200 million as a result of the shortening term
structure of the debt.
Controversy over the actual size of the short-term
debt first arose in the international financial commu-
nity early in 1982, and agreement continues to elude
both the Central Bank and private analysts. Interna-
tional short-term claims against the Philippines rose
to nearly $6.9 billion in mid-1982, according to Bank
for International Settlements data, and this is nearly
twice the government's June figure of $3.6 billion.'
Even if the Central Bank figures are accurate, howev-
er, the short-term debt is now three times the level of
' The BIS data include double counting errors and foreign debts
covered by foreign assets, but also exclude several categories of
legitimate short-term debt, such as claims against the Philippines
by banks that are not members of the BIS reporting system and 25X1
supplier loans. Philippine Government data, on the other hand,
exclude short-term obligations by domestic financial institutions
relent to the government and private firms. Much of this relending
is on a medium- and long-term basis, so that much of the risk is
borne by the domestic financial institution extending the credit.F_
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the Central Bank's international reserves. Further-
more, we believe that the Philippines's gross financial
requirements, including repayment obligations on
medium- and long-term foreign loans, renewals of
outstanding short-term credits, and the trade deficit
itself, reached nearly $9 billion last year, representing
a $1 billion increase from 1981.
Financial strains have been accompanied by a slide in
international creditworthiness now common to heavily
indebted LDCs.
the Philippines's credit rating also has been adversely
affected by Manila's unwillingness to accede to new
IMF and World Bank demands on domestic economic
policy during negotiations that were stalemated
throughout most of 1982. Short-term Philippine cred-
its on average now carry a full percentage-point
spread over the London Interbank Offered Rate
(LIBOR), up nearly
1 percentage point from last year. Furthermore, the
Central Bank's first syndication of 1983-a $300
million credit with a maturity of eight years signed in
early February-for the first time required a tranche
based on the US prime rate. Because the US prime
rate exceeds Eurodollar rates, the loan will carry an
interest rate spread initially equal to 1.625 percentage
points over LIBOR, the highest spread the Central
The Near-Term Financial Outlook
External Factors. On balance, we believe the Philip-
pines's financial problems will be only slightly eased
by international economic recovery this year. Philip-
pine Government agencies and the US Embassy
calculate on the basis of studies of previous business
cycles that six months will be required for the benefits
of economic recovery in industrial economies to be felt
in the Philippines, through higher prices for industrial
raw materials and agricultural products. Even the
Philippine commercial press reports that most busi-
nessmen have already written off 1983.
At the same time, we believe that the service account
is almost certain to continue to deteriorate. Even as
international interest rates decline, our calculations
show that interest payments on the medium- and
long-term foreign debt will rise by at least $140
million because of the higher level of outstanding
foreign debt, while principal repayments on the debt
will rise by about $300 million. Philippine press
reporting suggests that Manila itself believes remit-
tances from overseas workers have seen their peak
with the construction slowdown in Saudi Arabia and
an increasing Saudi disenchantment with Philippine
workers
reserves.
Of greater potential short-run consequence is the
beginning of refusals among small US and West
European banks to roll over existing short-term credit
obligations. US banking sources indicate that the
largest US banks, which hold about 40 percent of the
Philippine external commercial debt, are aware of this
problem and increasingly concerned about it. The
mystery surrounding the actual size of the short-term
debt makes this potentially a far more serious problem
than official data suggest. Nonetheless, we believe
that the exposure of the small banks is sufficiently
small that the Central Bank could continue drawing
down reserves to prevent a foreign exchange crisis. In
our judgment, however, this would leave the Central
Bank in a very weak position by early 1984, unable to
intervene further to defend the peso because of low
On the plus side, we expect international commodity
price developments to halt the four-year slide in the
terms of trade by yearend. Firmed up copper prices
would reduce financial strains in the mining industry,
for example. We expect weak international oil prices
to allow the government to cut the imported oil bill for
the second consecutive year, although it also faces the
need to rebuild inventories. An appreciating yen may
bolster Japanese imports of Philippine mineral and
agricultural products.
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The Philippines's external accounts will be helped
further by new loan agreements with the Fund and
the World Bank. Manila obtained a 12-month $347
million IMF standby loan in February, a $208 million
credit from the Fund's Compensatory Financing Fa-
cility to replace the shortfall in export earnings, and
resumed negotiating a $300 million Structural Ad-
justment Loan from the World Bank. As in the past,
the Fund's program will require limits on foreign
borrowing, domestic credit creation, and Central
Bank credit to the public sector.
Economic Management Options. The IMF, however,
has left Manila no margin for error in trimming the
current account deficit by requiring that it implement
appropriate adjustment policies. Although Manila's
record of implementing specific reforms mandated by
the IMF and World Bank is good, disbursement of
most of the IMF loan will be held in abeyance
pending a comprehensive late 1983 review of Philip-
pine budgetary performance, exchange rate manage-
ment, interest rate policy, external borrowing activity,
and efforts to curtail the growth of the short-term
debt. The World Bank loan will require reform of
energy pricing, further liberalization of trade policy,
and a long-promised streamlining of foreign'invest-
ment regulations
All of the measures required to stabilize the balance
of payments carry a potentially heavy political price
that Manila has no choice but to pay. Reducing the
overall payments deficit means rapid exchange rate
depreciation in accordance with the IMF's wishes,
and thus higher domestic prices. Reducing financial
support to the private sector as a means of reducing
the budget deficit-a move also pledged to official
creditors-will produce new corporate bankruptcies
and, coupled with reduced investment in state enter-
prises, higher unemployment.
Marcos's political agenda could be decisive in deter-
mining the timing of the actions Manila takes to avert
more serious financial problems than it faces alread9
Marcos will almost certainly want to avoid more
unemployment, slowing growth, and accelerating in-
flation in 1984-when he faces the first National
Assembly elections since he dismantled martial law
two years ago. Amid recurring charges by his political
opponents that he has mortgaged the Philippines's
future to multinational corporations and foreign
bankers, Marcos will also want to avoid a reschedul-
ing of the foreign debt over the next year.
Accordingly, Manila has already implemented sharp
cutbacks in capital spending and Prime Minister
Virata has announced a ceiling of $2 billion on new
foreign loans for 1983. The Central Bank is also
moving to curtail the expansion of short-term debt by
announcing new restrictions on foreign loan applica-
tions of less than one-year maturity. Furthermore, in
a move that according to US Embassy officials sur-
prised both the business community and the country's
official creditors, Manila is placing a 3-percent duty
on most categories of imports, introducing a prepay-
ment system of import duties designed to ensure
customs collections and make import financing more
expensive, and implementing a lottery system de-
signed to channel more remittances from overseas
workers through the government banking system.'
We believe, however, that these moves alone are not
sufficient to assure that the Philippines can meet its
international financial obligations over the next two
years-even with a recovery in the international
economy. As matters now stand, Manila would have
to exceed either its own ceiling on new medium- and
long-term foreign loans or-what is more likely in our
view-violate the IMF's ceiling on short-term borrow-
ings to get by. Additional breathing room would be
created if Manila took stronger measures to trim the
trade deficit, notably suitable exchange rate deprecia-
tion during the next two years. This will be the key to
averting repayments crisis and the critical step toward
capitalizing on any upturn in industrialized economies
beyond 1983 (table 2).
' The new import duties run counter to the spirit if not the letter of
the coordinated program of tariff reductions and foreign exchange
deregulation pledged to the IMF and the World Bank. We believe
that they will not jeopardize further balance-of-payments loans,
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We believe that Manila will walk a tightrope manag-
ing the balance of payments during the next year,
and-with luck-it may scrape by without a foreign
exchange crisis. Various international and domestic
economic developments could change this baseline
assessment, however.
On the positive side, there is evidence of a recovery in
industrial economies that-coupled with financial
discipline by Manila-could ease the Philippines's
external payments strains considerably by 1984. In-
ternational prices for industrial raw materials, in-
cluding copper, have firmed somewhat during the
past several months, although inventories in industri-
al countries remain large. The Philippines also has
the capacity to sharply boost the output of some raw
material products, including timber, to take advan-
tage of any rise in export demand. On balance, we
believe that a strong recovery in industrial economies
would provide the Philippines with windfall annual
export earnings of $450-600 million by 1984.
At the same time, OPEC remains in disarray, and we
believe that international oil prices are unlikely to
firm immediately. Because Manila imports about
200,000 barrels per day of oil, mostly from Saudi
Arabia, the OPEC price reductions will provide con-
siderable balance-of-payments relief. We estimate
that this could reach about $350 million over the
next 12 months if Saudi Arabia's benchmark price
stabilizes at $29 per barrel.
Further easing of international interest rates would
provide similar relief. We estimate that each reduc-
tion of I percentage point in LIBOR reduces the
Looking Further Ahead
Even though we are confident that a recovery of some
commodity export prices will occur during the next
year, Manila still faces the need to restructure the
economy, thereby alleviating fundamental balance-of-
payments problems attributable to an uncompetitive
manufacturing sector and changes in the international
petroleum, sugar, and coconut oil components of the
Philippines's interest repayment obligations by about
$95 million when foreign debt obligations of all
maturities are considered. Thus, an international
interest rate reduction of 4 percentage points would
outweigh even the effects of lower oil prices.
In our judgment, however, it is unlikely that OPEC
price reductions, global declines in real interest rates,
and a strong recovery in industrial economies could
coexist for very long. Sustained recovery in the
industrial economies, when it occurs, will tighten
both the international oil market and international
credit markets. Furthermore, Japan, rather than the
United States, is the Philippines's leading market for
raw material exports, and its economic rebound
normally lags behind that of the United States. Thus,
it is possible that the Philippines would benefit only
marginally over the next 12 months from even an
immediate economic recovery in the United States.
With continued sluggish domestic growth on the
horizon, we believe it is almost certain that private
Philippine firms will bear the initial burden of bal-
ance-of-payments adjustment. As it is, several large
firms already have begun rescheduling negotiations
with their creditors. The government also has been
active bailing out financially weak firms since early
1981. The government-owned Development Bank of
the Philippines, for example, has a loan portfolio of
about $4 billion, of which it has classified $3 billion
as aid to distressed firms. Dramatically increased
private-sector financial distress would thus quickly
involve the government.
terms of trade. The Philippines's official creditors
recognized the need for this in 1979 when the IMF
negotiated the first of a series of credits intended to
facilitate Manila's gradual adjustment to higher oil
prices and the World Bank committed up to $650
million over five years in the form of a "structural
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uuiiueuual
Corporate financial problems probably have not
peaked, in our judgment. Most Philippine industrial
firms buy raw materials in the international market
and carry foreign debts denominated in US dollars,
but sell their products for pesos in the domestic
market. As the peso depreciates over the next year, as
we believe it is certain to do, corporate cash flow
positions will deteriorate further.
The greatest danger, in our judgment, is that the
extent of the private sector's financial distress-
which we believe Manila cannot gauge precisely-is
already so severe that a private-sector financial crisis
cannot be avoided. If so, corporate bankruptcies and
new requests to the government for financial assist-
ance over the next year would grow beyond Manila's
financial management capacity. In our judgment,
there is ample reason to fear this, given the poor state
of the government budget and the fact that the
technocrats are having difficulty coping with even the
private sector's present difficulties.
Short-term financing problems could also be exacer-
bated in the aftermath of the continuing foreign debt
crisis in several Latin American countries. A refusal
by a growing number of small US regional and West
European banks to roll over existing credit lines to
the Philippines, especially to the private sector, could
provoke the very liquidity crisis that commerical
bankers fear.
Table 2
Philippines:
The Debt Service Outlook
Million US $
(except where noted)
Total debt service 1,624 2,245 2,833 3,193 3,566
Medium- and long-term 1,260 1,652 2,313 2,732 3,105
debt service b
Outstanding medium- 8,550 10,050 12,959 15,759 18,259
and long-term foreign
debt
Official short-term debt 2,548 3,567 4,162 4,662 41*662
Interest service on 364 593 520 461 461
short-term debt d
a Projected. Assumes current account deficit of $3.1 billion in 1983
and $2.5 billion in 1984.
b Including obligations to the IMF.
c Assumes six-month LIBOR of 10 percent. We estimate that each
1-percent drop in LIBOR would have the following impact on
medium- and long-term interest service: in 1983, $57 million, in
1984, $68 million.
d Calculated on the basis of six-month LIBOR.
The process of adjustment will be painful, however,
and to complete it, the Philippines must sharply boost
the share of GNP it exports if it hopes to repay
financial obligations incurred during the late 1970s
and early 1980s. At a minimum, this will entail
prolonged exchange rate depreciation, and thus infla-
tion rates that will probably exceed 15 percent annu-
ally even with low international inflation and tight
domestic money policies. On paper, Marcos, the IMF,
adjustment" program, which requires reform of in-
dustrial policies and the development of labor-inten-
sive export manufacturing. If the coordinated pro-
gram succeeds, it will largely mitigate the effects on
the balance of payments of higher oil prices and weak
international agricultural prices.
steer the Philippines back to balance-of-payments
stability. But we believe at least several years will be
required before balance-of-payments strains ease suf-
ficiently to allow a resumption of the 5- to 6-percent
annual real growth that the Philippines posted in the
mid-1970s. This, in turn, does not bode well for
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The Terms of Trade and Foreign Borrowing
US Embassy officials believe
Had the terms of trade developments of the last that economic factors are the root cause of the recent
decade been entirely cyclical, Manila could have growth of the Communist insurgency, especially in
avoided slowing economic growth (as a way of cur- coconut- and sugar-growing areas of the countryside.
tailing imports) by running down its foreign exchange
reserves when economic activity in industrial coun-
tries contracted and replenishing reserves during sub-
sequent international business expansions. We believe
the Central Bank failed to appreciate the fundamen-
tal nature of the international commodity price devel-
opments, however, and the exchange rate has been
overvalued during the last 10 years, thus promoting
imports and discouraging exports. This has meant
that as terms of trade deteriorated the Philippines
financed imports not by increasing exports, but by
increasing foreign borrowing-in effect pledging to
trim the trade deficit later, when the debt would be
repaid. Although adverse terms of trade develop-
ments have been beyond Manila's control, in our
judgment Manila has implemented adjustment meas-
ures too slowly, promoting expansion of both the
foreign debt and debt repayment obligations. This in
turn accounts for much of the Philippines's current
financial distress.
prospects for political stability in the mid-1980s,
when, among other things, the World Bank projects
that labor force growth will reach 3.7 percent annual-
ly-Asia's highest.
US Interests. The United States has many reasons to
monitor Manila's success in managing the balance of
payments during the next few years. As a result of
previous current account financing, Philippine bor-
rowers now owe US banks roughly $6 billion in debts
of all maturities. Bilateral trade exceeds $3 billion
annually, and the Philippines is a traditionally strong
market for US capital goods. Furthermore, US inves-
tors have a $1 billion equity stake in the Philippine
economy.
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