The Philippine economy remained buoyant at the start of 2017, but the loose fiscal stance of the current administration and sustained revenue shortfalls could prompt revisions to its credit ratings, global lender Deutsche Bank said over the weekend.

The bank pointed out that one of the recent indicators, the manufacturing PMI, while staying expansionary, dropped to 52.7 in January, shedding 3 points from the preceding month —the slowest pace in 13 months—as spare capacity and higher inflation led firms to cut back on hiring and input purchases.

“The slowdown may be related to the slight easing in private sector financing in December, where growth moderated to 16.2 percent year-on-year from 17.2 percent year-on-year in November. In fact, domestic demand already peaked in early 2016, with both growth in consumption and durable equipment purchases apparently reverting to trend after the spike approaching the general elections,” Deutsche Bank said.

Given this, Deutsche Bank reiterated its view that normalization is likely to guide a slower pace of growth in 2017.





Some upside to consumer spending can be expected from the recently approved pension increases for Social Security System beneficiaries and the planned salary increases for military and civil servants, it said.

“But we are not keen to revise up our 5.8 percent growth outlook just yet, given risks of private sector investment deceleration amid concerns over President [Rodrigo] Duterte’s controversial drug war and protectionist moves under a Trump-led US,” it said.

The German bank said it had previously flagged the contraction in approved investments in the third quarter of 2016 and the declines in business sentiment in the last two quarters of 2016, which, while currently not its baseline scenario, bear the risk of further dragging down investment growth in 2017.

“Moreover, the impact of the government’s drive to end illegal forms of contractual employment schemes (locally termed “endo” or end-of-contract), as well as the crackdown on predatory lending (mainly geared towards the ‘5-6’ lending scheme that charges a 20 percent monthly interest rate) remains uncertain, in our view,” it added.

For one, the bank explained, these measures could, in the near term, hurt businesses that previously gained from temporary employment—without the benefits accorded to permanent employees—or those micro, small, and medium enterprises without ready access to formal financing channels.

Deutsche Bank added that the closure of several mining operations around the country after the Department of Environment and Natural Resources audit could also dampen domestic demand.

Tax reform

Deutsche Bank said a development worth watching in 2017 is the likely passage of the Duterte administration’s first major economic reform, or the first package of the comprehensive tax reform proposal, which is slated to be passed by Congress by June 30 and implemented between late 2017 and early 2018.

“We agree with the DoF [Department of Finance] and the BSP [Bangko Sentral ng Pilipinas] that the net effect of the first package, if implemented simultaneously, would be a boost in disposable incomes,” it said.

Citing the BSP’s estimates, the global lender said the tax reform would add 0.6 percentage point (ppt) to the 6.5 percent to 7.5 percent gross domestic product (GDP) growth in 2017, if implemented this year, and another 0.2 ppt to the 7 percent to 8 percent outlook in 2018.

“In our view, the passage of the first package would be a welcome development to a low-income country with one of the highest income tax rates in Asia. It would also give the Duterte government the momentum to push for the rest of the tax reforms in the pipeline, in turn, helping to counter downside risks to investments,” it stressed.

But given its loose fiscal stance, Deutsche Bank pointed out that the government would face market scrutiny over its ability to shore up revenues this year even before the reforms kick in, and to keep the deficit within the 3 percent-of-GDP ceiling.

Should the deficit further rise to 4 percent-of-GDP in 2018 to 2019, because of revenue shortfalls, the national government debt would climb 5 ppts towards 50 percent of GDP five years later, it estimated.

The debt-to-GDP ratio is an indicator used by credit rating agencies such as Fitch Ratings, Moody’s Investors Service and Standard and Poor’s (S&P) Global Ratings to assess the creditworthiness of sovereigns. At present, the Philippines enjoys an investment grade credit ratings from these major credit raters.

“These projections rest on the assumption that GDP growth prints 5.8 percent to 6.5 percent within 2017 to 2021, the deflator stabilizes at 1.5 percent, the PHP/USD weakens to 52, and the effective nominal interest rate advances 200bps [basis points] to 7.5 percent between now and 2021,” it said.

Under the Deutsche Bank baseline scenario where the deficit stays at 3 percent-of-GDP, the debt ratio would broadly stay at 45 percent of GDP in 2017 through the next five years.

This German bank’s estimate compares with the 35.5 percent general government debt to GDP as of end-September 2016.

“We are less worried about the government’s ability to pay, given ample fiscal buffers such as savings in the Bond Sinking Fund and a low debt ratio to begin with,” it said, noting that under the 4 percent-of-GDP deficit scenario, for instance, interest payments would only increase from 14 percent of revenues currently to 19 percent by 2021, still a far cry from the 37 percent peak in 2005 during the fiscal crisis.

However, it warned that rising debt ratios does send the signal that the near- term economic gains from the government’s spending push would come with long-term pains as interest payments increasingly eat into the annual budgets.

It also added that a weakening fiscal position would only add to the stress from the erosion of the current account surplus, which may have already reverted to a deficit last quarter of 2016.

The BSP has yet to release the full-year 2016 current accounts data, but based on its third-quarter report, the main component of the balance of payments remained in surplus at $979 million, equivalent to 1.3 percent of GDP.

Deutsche Bank’s view on the country’s credit ratings is consistent with a recent commentary by Moody’s, which said that credit outcomes in 2017 would be determined by the effectiveness of ongoing reform efforts and the evolution of political risks in the Philippines.

It also shared S&P’s statement that the Philippines should not expect credit upgrade in the next two years and that it may even cut the ratings if the government reform agenda stalls.