MANILA, Philippines - Moody’s Investors Service expressed concern over the “worsening” Islamist insurgency in the country, which could lead to the expansion of martial law, but it affirmed the Philippines’ credit rating and maintained the stable outlook.

In a statement, Moody’s said yesterday that it has affirmed the country’s Baa2 long-term issuer and senior unsecured debt rating and maintained its outlook for the Philippines at stable.

A stable outlook balances positive and negative developments in the credit profile, while Baa2 is the lowest investment grade.

Moody’s said the downside risks include the Islamist threat and martial law expansion that could undermine domestic business confidence and disrupt economic activity.

However, the credit watcher said political developments could potentially undermine institutional strength and economic performance.

“The affirmation of the Baa2 rating and the assignment of a stable outlook balance positive and negative factors,” Moody’s said.

“On the positive side, Moody’s expects that the Philippines’ economic performance will remain strong while debt consolidation will continue and foster further convergence of key fiscal metrics versus corresponding peer medians,” it added.

According to Moody’s, it expects the Philippine economy to sustain its growth at above six percent annually over the next two years, driven mainly by the private sector.

“In particular, we forecast that household consumption will continue to be supported by the stability of remittances from overseas Filipino workers,” it said.

Moreover, foreign direct investment (FDI) inflows, which saw a record high in 2016 of $7.9 billion, will provide ongoing diversification of the economy, Moody’s said.

“Furthermore, the improvement in the external environment is positive for goods exports and business process outsourcing (BPO) receipts, which comprise the bulk of services exports,” it added.

In the long run, the credit watcher said the Philippines also stands to benefit from a young and growing population. It added that the government’s move to improve spending growth, particularly in infrastructure development, could raise GDP growth toward its target range of seven percent to eight percent.

Moody’s also noted the government’s fiscal strength, which is reflected in low government debt, low debt affordability and an elevated vulnerability to exchange rate depreciation.

“The health of the banking system and the external payments position dampen the Philippines’ susceptibility to event risks,” it added.

Moody’s said any further shocks in the Gulf countries could potentially reduce remittance inflows, while US policies that encourage onshoring of jobs could negatively impact the BPO sector.

“While broad macroeconomic stability has been maintained so far, a number of metrics indicate material capacity constraints that signal a risk of overheating,” Moody’s said.

These constraints are represented by rising inflation and the reemergence of a current account deficit.

“High credit growth in excess of GDP growth since 2014 also exposes the banking system to unseasoned risk,” Moody’s added.

However, the Bangko Sentral ng Pilipinas’ policy tightening, as well as other factors such as the considerable capital and liquidity buffers of banks and foreign exchange reserve, has been effective in mitigating these consequences, it noted.

“Looking ahead, the government’s ability to continue to contain these rising pressures will depend in part on its efforts to raise investment in order to enhance infrastructure and address economic bottlenecks. The government’s plans in this respect are ambitious and unlikely to be achieved in their entirety,” Moody’s said.

Aside from its credit rating and outlook, Moody’s said it has also affirmed the government’s local currency and foreign currency senior unsecured ratings at Baa2, foreign currency senior unsecured shelf rating at (P)Baa2 and the senior unsecured ratings for liabilities of the BSP at Baa2. The outlook on BSP has been removed.

“The Philippines’ country ceilings remain unchanged. The long-term foreign currency bond ceiling remains at A3, and the short-term foreign currency bond ceiling at P-2. The long-term foreign currency deposit ceiling remains at Baa2, and the short-term foreign currency deposit ceiling at P-2. Furthermore, the long-term local currency bond and deposit ceilings remain unchanged at A2,” Moody’s said.