MANILA, Philippines — President Duterte’s contentious policies on law and order over the past two years as well as other political controversies could have a negative impact on the country’s attractiveness to financial and physical asset investors, Moody’s Investors Service said.

The debt watcher before the weekend said the domestic political developments and potential governance changes pose downside risks on the country’s credit rating that was maintained at Baa2 or a notch above minimum investment grade.

Moody’s said prospective changes to governance frameworks could have negative implications for public finances.

It cited the recent Supreme Court ruling that redefines the share of national government revenue to be transferred to local government, as well as the proposed shift to a federal government from the current centralized form.

“In each of these cases, the fiscal impact will in part be determined by the degree to which spending commitments will be devolved to the local levels of government. The shift to federalism would also likely incur an expansion in the aggregate size of the government and, hence, public expenditure,” it said.

The rating agency said there could be a gap between the national and local levels of government with respect to their ability to manage fiscal resources, posing a risk to the improved fiscal discipline that has characterized national government finances over the past decade.

No less than Socioeconomic Planning Secretary Ernesto Pernia earlier warned of the ill effects of the planned shift to federalism on the Philippine economy.

Pernia pointed out the expenditure would be immense as the fiscal deficit is set to widen to about six percent of gross domestic product (GDP) or more if the planned shift to federalism materializes.

The cabinet secretary said the surge in expenses could result in the downgrade of the country’s credit rating as economic managers through the Cabinet-level Development Budget Coordination Committee (DBCC) have penned a spending cap of 3.2 percent of GDP in 2019.

President Duterte is expected to endorse to Congress a draft federal charter in his State of the Nation Address (SONA) on July 23. According to the draft federal constitution, the country would be divided into 18 regions that would have greater control over their own affairs.

“The Baa2 rating incorporates a number of very positive credit features, including the high economic strength derived from a large and fast-growing economy, as well as improving fiscal strength based on moderate government debt levels and gains in debt affordability,” Moody’s said.

The strengths, Moody’s added, are balanced against more negative features that constrain the rating: principally low per capita incomes and, relatedly, still low revenue-raising capacity as compared to similarly rated peer countries.

“The stable outlook also balances positive and negative factors. Moody’s expects that growth will remain robust and that the Philippines’ fiscal metrics will strengthen somewhat as the government continues to make progress on its socioeconomic reform agenda, but these trends are likely to fall short of bringing the Philippines’ credit profile in line with higher-rated countries,” it said

The rating agency also lauded the ability of the Bangko Sentral ng Pilipinas (BSP) in maintaining monetary and financial stability.

“The Philippines is buffeted by a number of headwinds that contribute to inflationary pressures. Based in part on the strong track record of BSP in maintaining monetary and financial stability,” it added.