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Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Directorate of I Confidential inteui ence x: r The Choices Ahead and Economic Policy The Philippines: Foreign Debt State Dept. review completed Confidential EA 82-10080 July 1982 Copy 314 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Directorate of Intelligence The Choices Ahead The Philippines: Foreign Debt and Economic Policy Southeast Asia Division, OEA welcome and may be addressed to the Chief, Analysis. It was coordinated with the National Intelligence Council. Comments and queries are Confidential EA 82-10080 July 1982 the Office of East Asian Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential The Philippines: Foreign Debt and Economic Policy- The Choices Ahead Key Judgments Manila's 1981 foreign debt of $15.8 billion does not pose an insurmount- able immediate problem, but the government's options in formulating economic policy will narrow rapidly during the next several years because of debt management considerations. Even under favorable circumstances, debt service costs will triple by the end of President Marcos's current term in office in 1987, when they will equal about half of projected export earnings versus 30 percent at present. Manila has managed its official foreign debt-slightly more than half the total-reasonably well, but the private sector is on precarious financial footing because of world recession, longstanding government economic policies that have discouraged industrial efficiency, and a rapidly growing short-term debt. The escalation in short-term debt concerns the interna- tional financial community because much of the borrowing has been used for projects that will not produce income for several years. Also it may be larger by $2 billion than Manila's estimate of $4.5 billion. Manila has pledged a series of reforms to international creditors in return for balance-of-payments assistance, but it is giving in to pressure from the business community for short-term financial relief and long-term invest- ment capital. The government is thus converting private-sector foreign debt problems into public-sector responsibilities. This undercutting of economic reform poses a danger that the government may commit financial resources to economic activities in which the Philippines is not internationally competitive. Under these circumstances, adjustments in economic policy required to avert debt rescheduling by mid-decade could be even more socially and politically disruptive than the current reform program, even if a recovery in the international economy begins soon. Information available as of 15 June 1982 has been used in the preparation of this report. Confidential EA 82-10080 July 1982 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential Key Judgments iii Growth of Foreign Debt 1 Issues in Debt Management 7 Looking Down the Road 9 1. The Philippines: Holders of Foreign Debt 3. The Philippines: Foreign Debt by Sector 6. The Philippines: Successful Adjustment 7. Import Equivalent of Estimated Short-Term Debt for Selected 15 Asian Countries 1. The Philippines: Balance-of-Payments Summary 3. The Philippines: The International Financial Community 8 4. The Philippines: Estimated Short-Term Foreign Debt 5. The Philippines: Is a Debt Crunch Looming? Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Appendixes A. Estimating the Size and Significance of the Philippines' Short-Term Foreign Debt 13 B. Tests Designed To Forecast Impending Debt Problems: Applications to the Philippines 17 C. The Philippines: Selected Private Commercial Borrowers, 1977-81 19 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential The Philippines: Foreign Debt and Economic Policy- The Choices Ahead Growth of Foreign Debt The Philippines has one of the most rapidly growing foreign debts and one of the most unstable balance of payments in non-Communist Asia. The official debt has nearly doubled since 1978, reaching $15.8 billion by the end of 1981.2 in mid-1981 the Philippines owed private foreign bankers nearly $10 billion, international financial institutions nearly $3 billion, and foreign governments about $2 billion on official development assistance loans (figure 1). American banks and government institutions are the leading creditors, holding claims of over $6 billion, or slightly less than half the total loans outstanding. The Philippines, in turn, occupies a prominent position in the global loan portfolios of US commercial banks, ranking ahead of Chile, Taiwan, Indonesia, Poland, East Germany, and Yugoslavia 25X1 (figure 2). We believe the foreign debt is a potentially serious problem for the Philippines and for its foreign credi- tors because the funds borrowed have not succeeded in raising and sustaining the economy's growth rate. Moreover, the economy has slowed since 1979 while growth of the foreign debt has accelerated. Although this was initially a response to the shock of signifi- cantly higher international oil prices, the Philippine economy, unlike the economies of South Korea, Tai- wan, and much of the rest of Asia, has since shown signs of shar deterioration instead of the beginnings of recovery, 25X1 ast year was especially traumatic. Some $2.8 billion in new foreign loans and about $500 2 Government authorities have revised estimates of the foreign debt downward since the end of 1981. Because these revisions are not consistent with Philippine balance-of-payments statistics, we have used the government's original estimates of Bch thedet and the balance of payments throughout this paper.) Figure 1 The Philippines: Holders of Foreign Debt Million US $ Private banks; other nonofficial financial institutions International financial institutions EZM Bilateral development assistance Non-US banks and financial institutions: 4,417 Other-.68 Japan: 767 US Government: 919 Other international financial institutions: 77 The Asian Development Bank: 358 The World Bank: 1,082 The International Monetary Fund: 1,148 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Figure 2 US Bank Exposure in Selected Countriesa Asia South Korea Philippines Taiwan Latin America Brazil Argentina Chile Africa Oil Exporters: Mexico Venezuela Indonesia Ecuador Algeria Eastern Europe Yugoslavia Poland East Germany Hungary ments imbalance became too large for a recovery in international commodity prices to eliminate (table 1). The economy has posted eight consecutive deficits in the current account since 1973 and we project another large one in 1982. The Philippines has chosen to finance these deficits primarily by foreign borrowing rather than by increasing exports as many of its Asian neighbors have done." In addition, import prices have increased faster than export prices since 1979, rein- forcing the need for new policies to control the current account deficits. Last year the balance-of-payments deficit would have exceeded $800 million had the Central Bank not sold gold from official reserves at over three times the usual rate. If direct foreign investment had not far exceeded previous levels- because of a significant drop in repatriated profits- the overall deficit would have been as high as $1.1 billion. At yearend 1981, international reserves had declined about $500 million to $2.7 billion. This level 25X1 is nearly twice the level reserves averaged in 1975-77. 587012 7-82 million in drawdowns of international reserves by the Central Bank failed to restore the 6.4-percent annual growth the economy averaged during the 1970s.F Growing Trade Dcits. Part of the external account problem is cyclical. Because manufactures constitute less than a third of export earnings, the balance of payments is highly sensitive to the vagaries of interna- tional commodity markets. The world commodity boom provided the Philippines its best economic year in 1973-a $275 million merchandise trade surplus and 9.6-percent economic growth. OPEC oil price hikes in 1973-74 rapidly consumed the foreign ex- change windfall, however, and the Philippine pay- ' After twice revising their figures, Philippine Government authori- ties estimate 1981 growth at 3.8 percent. This figure is not consistent with other economic data reported by the government, however, and is questioned by the International Monetary Fund and the World Bank. On the basis of export performance and tax collections, we place 1981 real growth between -1 and 1 percent. Public and Private Borrowing. Philippine Govern- ment reports show that public foreign debt has grown somewhat more rapidly than private foreign debt since 1972. Still, foreign obligations at yearend 1981 were almost evenly divided between public- and pri- vate-sector borrowers. Much of the public-sector debt-which we believe remains reasonably well man- aged-reflects a decade of project-oriented borrowing by such government institutions as the Philippine National Oil Company, Philippine Airlines, and the National Power Corporation. A substantial portion of public foreign debt, however, results from relending operations by government banks and investment institutions to private-sector borrowers. The Central Bank reports that since 1978 its Consolidated Foreign Borrowing Program alone has obtained $400-600 million annually in medium- and long-term credits for relending. To this extent the "IMF statistics show that Philippine exports per capita are now 25X1 exceeded by those in South Korea, Taiwan, Malaysia, Singapore, Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84S00554R000100020001-5 Confidential 1975 1976 1977 1978 19,79 1980 1981a 1982b Current account -923 -1,101 -828 -1,172 -1,576 -2,072 -2,589 -2,600 Merchandise trade -1,197 -1,113 -840 -1,307 -1,541 -1,939 -2,667 -2,550 Exports f.o.b. 2,262 2,519 3,075 3,425 4,601 5,788 5,733 5,650 Coconut products 468 537 729 812 965 759 756 780 Sugar 616 451 527 213 238 474 609 600 Copper concentrates 212 270 280 250 330 679 544 650 Forest products 229 268 261 324 484 433 383 400 Manufactures 374 573 770 1,076 1,520 1,135 1,294 1,400 Other 363 420 508 750 1,064 2,308 2,147 1,920 Imports f.o.b. 3,459 3,632 3,915 4,732 6,142 7,727 8,400 8,200 Oil 814 936 1,019 1,030 1,385 2,248 2,565 2,400 Services (net) -44 -257 -248 -178 -390 -555 -392 -500 Transfers (net) 318 269 260 313 355 422 470 450 Capital account 438 937 1,379 1,086 964 1,564 1,629 1,850 Direct investment (net) 98 144 216 171 99 49 407 200 Medium and long term (net) c 420 1,014 670 891 1,180 1,061 1,185 1,350 Short term d -80 -221 493 24 -315 454 37 300 Monetization of gold 110 214 79 32 41 127 400 150 Balance -375 50 630 -54 -571 -381 -560 -600 a Estimated. b Projected. c Includes allocation of SDRs. d Includes errors and omissions. government, rather than the private sector, bears a 25X1 major share of the financial risk imbedded in Philip- pine foreign liabilities Major Philippine private corporations also have been active direct foreign borrowers in the last several Philippines' top 20 companies by sales. Government loan guarantees have helped these and other private- sector borrowers secure foreign credit on substantially more favorable terms than otherwise would have been 25X1 years. since 1976 such Deteriorating Terms on New Credits. Even with firms as San Miguel, Construction and Development adroit use of loan guarantees and the Central Bank's Corporation of the Philippines, Marinduque Mining monitoring of foreign borrowing, Philippine commer- and Manufacturing, and Atlas Consolidated Mines all cial borrowers have secured credits on increasingly have secured large medium- and long-term syndicated loans (appendix Q. Each of these firms ranks in the Approved For Release 2008/09/29: CIA-RDP84S00554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Figure 3 The Philippines: Foreign Debt by Sector Billion US S Figure 4 The Philippines: Foreign Debt by Maturitya o Long-term debt = Medium-term debt (1-5 years) M Short-term debt aEstimated. bProjected. ePrivate sector debt includes government guaranteed private debt. 58,013 7-82 less attractive terms since late 1980, new loans have shortened while other measures of bankers' risk assessments-spreads and management fees-have increased.' Euromoney, an international financial industry magazine, early this year rated the Philippines as one of the developing world's most rapidly deteriorating credit risks on the basis of maturities and spreads obtained on foreign loans during 1981 At the same time, rapidly expanding private credit needs and reduced creditworthiness have combined to force private borrowers into the short-term market since mid-1979 (figure 4). During the first six months of 1981, short-term debt grew at an alarming annual rate of over 46 percent; by yearend it reached nearly ' Spreads and fees have risen recently for several other LDCs in financial trouble, such as Mexico and Argentina, but have re- main steady for most East Asian countries except South Korea. 1979 1980 1980 1981 1981b Dec Jun Dec Jun Dec aEnd of period. bEstimated; revised downward in April1982 by Philippine authorities. $4.5 billion, according to official government statis- tics.6 Had Philippine borrowers used short-term and revolving credits to finance foreign trade (as is usually the case), we estimate that the short-term debt would have been about $2.9 billion. The Central Bank traditionally has paved the way for other Philippine borrowers by securing highly publi- cized syndications on premium terms early in each calendar year. Early in 1982 Manufacturers Hano- ver-which has led the first Central Bank syndication 6 The actual size of the short-term foreign debt is in doubt and could exceed government estimates by as much as one and a half Confidential 4 25X1 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 25X1 25X1 Approved For Release 2008/09/29: CIA-RDP84S00554R000100020001-5 Confidential Syndication Syndication participants LIBOR Spread tion to earning interest on the portion of the loan amount it supplies. The process by which a leading Risk bank recruits other banks to con- tribute funds to the amount pledged to the borrower. The bank selected by the borrow- Maturity er to market a loan. The lead bank receives a syndication or marketTigfee-a percentage of the loan's total value-in addi- Other banks that agree to provide a portion of the loan amount in return for sharing the syndication fees. Comanagers in turn hope to recruit other banks as syndica- tion participants. Banks that provide a smaller share of a syndicated loan. London Interbank Offered Rate. The interest rate London banks pay for US dollar deposits. Most syndicated loans are made at a contracted spread over LIBOR. The spread remains fixed over the life of the loan, but LIBOR is free to vary as market conditions dictate. The percentage interest rate above LIBOR that borrowers pay. The banker's subjective assess- ment of the unexpected, ex- pressed via the interest rate or other terms of the loan. Length of a loan commitment. Shorter maturities can indicate bankers' lack of faith in a coun- try's longer term economic or political prospects. Short-term loans Loans with an original maturity of one year or less. Reschedule An agreement between borrower and lender to place repayment on more manageable terms. Country limit The maximum value of outstand- ing loans to all borrowers in a given country that a banker is willing to accept. Self-imposed. Debt service ratio A ratio intended to measure the burden on the economy offoreign debt repayment (principal and in- terest). Variously defined as: (a) Medium- and long-term re- payments as a share of merchan- dise exports. (b) Medium- and long-term re- payments as a share of the previ- ous year's balance-of-payments earnings (the definition used by the Philippines). Philippine law limits the ratio to 20 percent, but it will rise to at least 22 percent for 1982. Approved For Release 2008/09/29: CIA-RDP84S00554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84S00554R000100020001-5 The Philippines: The Burden of Debt Service Medium- and long-term debt service 1,007 1,252 1,418 1,703 2,241 Principal 730 760 804 850 950 Interest 277 492 614 853 1,291 Interest on official short-term debt c 93 172 363 620 630 b Projected. each year since 1978-managed a $325 million syndi- cation on the most favorable terms the Central Bank had obtained since the late 1970s-a split spread of five-eighths and three-fourths percentage points over the London Interbank Offered Rate for the duration of the 10-year term of the loan. Even so, Manufactur- ers Hanover had to share management fees with 14 comanagers before filling out the syndication, accord- ing, to the financial press. The Central Bank, more- over, had to promise syndication participants for the first time in writing to stay out of the market for new loans until late in the year. The Growing Burden of Debt Service. The annual cost of debt service has nearly tripled since 1977. Even though Manila took advantage of relatively low world interest rates during 1978 and 1979 to engage in substantial refinancing, medium- and long-term debt service consume 30 percent of merchandise export earnings last year-the largest share in a decade (table 2). If short-term debt service were included, the share of export earnings would reach 40 percent. Interest payment obligations made up one-third of total debt service in 1978 but will constitute two- thirds of total debt service in 1982. As a share of ' The large short-term debt is cause for concern because we believe much of it was used to finance investment projects that will not export earnings, interest payments are rising even more rapidly. The Philippine Central Bank reports that for the first quarter of 1982, interest payments amounted to 27 percent of exports, compared with 16 percent in the first quarter of 1981. We believe this trend is both the most accurate and the most alarming measure of the net resource drain that debt service imposes on the economy. Philippine law limits the burden of medium- and long- term debt service by requiring that repayment obliga- tions on loans not exceed 20 percent of the previous year's balance-of-payments earnings. Even using this definition, however, the debt service burden is rising. Medium- and long-term repayment obligations in 1981 reached 19.4 percent of 1980 balance-of-pay- ments earnings. We expect the statutory limit will be breached in 1982 because medium- and long-term debt service will increase by more than $500 million,' as grace periods on old loans expire and interest costs rise; in addition, export earnings fell last year. 'As a share of national income, interest payments were less than 2 per in 1978 but will reach 5 percent of GNP this year ' Either o two amendments to the law would prevent this by 25X1 keeping 1982 debt service under 20 percent: the denominator of the fraction could be increased by changing the balance-of-payments calculation to the current year, or the numerator could be reduced by excluding certain kinds of debt service. Both approaches have Confidential 25X1 Approved For Release 2008/09/29: CIA-RDP84S00554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential Issues in Debt Management Managing Repayment Capacity. We believe the re- cent record of economic growth in the Philippines is one of the most anemic in East Asia and results from industrial and trade policies since the 1960s that have kept resources from their most efficient uses. Our analysis indicates that Manila has indirectly subsi- dized capital-intensive manufacturing industries in which the economy could not compete international- ly." The government has discriminated against ex- porters and subsidized importers of capital goods and raw materials with exchange rate policies that over- valued the peso." At the same time, high tariffs and foreign exchange controls have protected inefficient local manufacturers of such products as cement, steel, textiles, paper, chemicals, and processed foodstuffs. Combined with underdeveloped local financial mar- kets, these policies ensured the continuing presence of a private sector prone to repayment difficulties in international capital markets. tariffs and liberalize foreign exchange controls. Ac- companying tax reform is to replace funds lost to import duty reductions. These measures represent a sharp departure in Philippine policy because they favor enterprises and activities that do not depend on political connections. World Bank have sett Even with the restrictions on its policymaking, the government will receive a substantial dividend from Bank and Fund balance-of-payments assistance. Pri- vate foreign banks-which say they provide the Phil- ippines two-thirds of its foreign credit-will be much more receptive to making new Philippine loans if Philippine economic policies continue to bear the imprimatur of international financial institutions. The Bank and the Fund have taken steps to ensure this occurs by providing financial assistance in stages. The Bank's 1981 Structural Adjustment Loan was the first installment of $600 million in such credits. Manila is currently negotiating another IMF standby loan and will remain dependent on IMF assistance throughout the early 1980s. Further balance-of-pay- ments support will depend on whether Manila imple- ments the reforms and meets the targets the IMF and In exchange for balance-of-payments assistance, the International Monetary Fund and the World Bank have extracted promises from Manila for far-reaching economic reforms to solve these problems (table 3). An IMF Extended Fund Facility credit of $400 million covering 1978-79 and a Supplementary Financing Facility loan covering 1980-81 required Manila to pursue an exchange rate policy that does not seriously overvalue the peso and to protect export competitive- ness from the effects of domestic inflation by restrain- ing growth of the money supply. Manila also agreed to promote development of the local capital market by deregulating interest rates and to limit foreign com- mercial borrowing to keep debt service manageable. Last year a World Bank Structural Adjustment loan 25X1 of $200 million further required that Manila reduce provides an exporter with 5 pesos for each dollar of export earnings while a lower exchange rate of 10 pesos per dollar gives him twice as many pesos for the same dollar's worth of exports. The importer ing the amount of domestic currency earned per dollar of exports. For example, an overvalued exchange rate of 5 pesos per dollar Managing the Demand for Foreign Credit. The Private Sector. Manila is making slow progress cor- recting the policy excesses that lie at the root of its balance-of-payments problems. The Central Bank al- lowed the exchange rate to depreciate fairly rapidly against the US dollar during the second half of 1981, but a strong dollar meant that the peso appreciated- by over 3 percent on average-against the currencies of most of the Philippines' other trading partners. According to public statements by government offi- cials, Manila is reluctant to allow rapid depreciation because it would reverse the effects of the govern- ment's primary policymaking victory in the last two years-cutting the inflation rate by half to 12 percent in 1981. The Philippine Chamber of Commerce and Industry has protested the depreciation that has oc- curred because of the profits squeeze experienced by large private firms that buy imported raw materials and capital goods. Early this year the government Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 The Philippines: The International Financial Community The International Provides medium-term balance-of-payments assistance in exchange for pledges by Philippine authorities Monetary Fund to make corrective changes in economic policy. Now negotiating $500 million credit with Manila. Its 1982 review of the Philippine economy gave Manila the equivalent of a C for economic management. Largest Philippine aid donor. Chairs Consultative Group-the Philippines' consortium of aid donors meeting in June 1982. Also provides balance-of-payments loans in exchange for adjustments in economic policy. Its $200 million structural adjustment loan will require that Manila cut domestic energy subsidies and continue reform of industrial policy. Private bankers believe it essential that Manila follow World Bank and IMF advice. The private international banking Lends on medium- and long-term basis to various Philippine borrowers. Lends on short-term basis to fi- community a nance international trade. Places informal pressure on Manila's formulation of economic policy. Private banks provide about two-thirds of the flow of credit to the Philippines. a US banks usually lead syndications, but Japanese and Middle Eastern banks are increasingly prominent participants. began lowering tariffs and liberalizing foreign ex- change controls in an effort to force manufacturers to cut costs, but local opposition to these measures is substantial. According to the Manila press and to embassy reports, domestic producers of durable con- sumer goods recently obtained the Central Bank's pledge that foreign exchange licensing would be reim- posed on household appliances, and the garment and textile industries are pressing for similar relief. Progress promoting the development of local financial markets-the most obvious alternative to foreign fi- nancing for the private sector-also is slow despite vigorous government efforts. Last year, following a domestic financial crisis, Manila deregulated domes- tic interest rates and adopted a series of financial reforms designed to place corporate finances on a sounder footing." Although the reforms have restored order in the local financial community, the new interest rate regulations have yet to generate an increase in the supply of loanable funds because private banks in a cartel-like action have held interest rates on savings deposits to 9 percent. The Philippine press has pronounced financial reform a failure, but the government-owned Philippine National Bank is trying to encourage higher rates for depositors by raising its own rates. The Public Sector. To trim its foreign borrowings, Manila has sharply scaled back a controversial heavy industry program for the 1980s. Planned outlays of $6 billion have been reduced to $4 billion as a result of cuts in an overly ambitious gasohol program and the size of a proposed $1 billion integrated steel mill. A proposed $320 million petrochemical complex and a $450 million aluminum smelter probably will not be built. Nonetheless, Manila's growing budget deficits remain a cause for concern in the international financial community. In 1981 the government's operating defi- cit ballooned in the face of declining tax collections, reaching 3.9 percent of GNP-the highest since the mid- 1970s, and budget perfomance continued to dete- riorate early in 1982. The deficit soaked up 15 percent of domestic savings last year, three times the level Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential recorded in 1980. This has largely offset the effects of financial reform aimed at promoting local sources of credit. Moreoever, near-term tax collection is unlikely to dramatically improve in view of World Bank- 25X1 mandated reductions in foreign trade taxes. One means of reducing the financial burden of foreign 25X1 borrowing would be increased direct foreign invest- According to reports provided by Phillipine techno- crats to the IMF and the World Bank, Manila is counting on eventual reductions in government food and energy subsidies to help cut the budget and the deficit. These moves will pit the technocrats, led by Prime Minister Virata, against a variety of important political constituencies. To keep prices down Virata has reduced fertilizer subsidies and even threatened local producers with import competition. He has also announced reductions in domestic sugar and rice subsidies, even though these moves will raise prices for urban consumers. Manila was to have pledged reductions in electricity subsidies this summer in exchange for a second $200 million World Bank Structural Adjustment Loan, but local business inter- ests successfully lobbied against the move, and a planned increase in electricity rates has been post- poned indefinitely according to Philippine press re- ports. continuing world recession." Manila is moving ahead with management reorganization and financial re- structuring of several major firms. One result of its corporate rescue program, however, is growing expo- sure to the private-sector's financial problems The outlook is bleak for the balance of payments this year. Philippine Central Bank reports show the first- quarter payments deficit reached $539 million-near- ly equal the deficit for all of 1981, one of the worst years in the country's postwar economic history. Interest payments on the foreign debt this year will rise by about $450 million, but the decline in interna- tional oil prices will not offer much relief because most of the Philippines' oil import contracts are long- term deals unaffected by international oil price reduc- tions. The Central Bank, moreover, probably will not want to sell gold at anywhere near last year's rate because of the diminished world price. For its part, the IMF is calling for immediate reduc- tions in the current account and in the overall pay- ments deficit because of the mid-decade cost in added debt service that will result from heavy current borrowing. To this end, Prime Minister Virata has announced a $2.4 billion foreign borrowing limit for 1982, with only $1.4 billion reserved for the private sector. If the new limits are adhered to, they would stabilize the trade deficit, but at the cost of denying the private sector needed financing in the face of weak domestic and international sales. Central Bank Gov- ernor Jaime Laya admitted as much in a speech earlier this year. We believe, moreover, that the loan limits may be too low to accommodate borrowing planned by government banks for private corpora- tions. Manila hopes the 12-percent cut in government expenditures it announced in April 1982 will ease the ment. Although Manila is reviewing its investment regulations, the process is unlikely- significant streamlining. Tariff reductions on raw materials, however, promise to enhance the profitabil- ity of investing in the Philippines. Government plans envisage $400 million in foreign direct investment this year, but we believe Manila will have to resolve increasingly unsettled labor relations before attract- ing anywhere near that amount. Looking Down the Road We believe that recent developments at home and abroad have increased the urgency of placing the country's external accounts on a sound footing. The embassy reports that the financial positions of the top firms in the private sector-and thus its prominent private foreign borrowers-remain precarious in the wake of last year's domestic financial crisis and the problem by reducing public-sector competition with the private sector for scarce investment funds. " Philippine corporations experiencing severe financial distress in 1981 and early 1982 include six of the country's top 25 firms according to sales. Using this criterion, a somewhat analagous situation in the United States would be for Gulf Oil, Atlantic Richfield, General Electric, DuPont, Tenneco, and Getty Oil to teeter simultaneously on the verge of insolvency, avoiding bank- ruptcy only by transferring existing equity to federal government Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 The Potential Debt Service Burden." Much of the Philippines' debt service burden later in the decade will depend on variables we cannot forecast with any precision. A strong economic recovery in the United States-the Philippines' leading trade partner- would help ease short-term financial problems, for example. International interest rates and other terms available to Philippine commercial borrowers also will be important determinants of Philippine borrowing activity and subsequent repayment obligations. Nevertheless, a major portion of the debt service burden through the mid-1980s will be determined by repayment obligations on loans Philippine borrowers have already secured. Furthermore, Manila is pursu- ing a wide range of policies that will shape its borrowing needs regardless of the performance of the international economy. Not the least of these is exchange rate policy-which will determine the econ- omy's near-term balance-of-payments prospects-and ongoing industrial restructuring-which will shape the balance-of-payments prospects by mid-decade If Manila responds to the current international eco- nomic environment by placing economic reform on hold, we believe the effects on the current account deficit and on borrowing requirements could be devas- tating (figure 5). We project that the trade deficit under these circumstances could rise from $2.6 billion in 1982 to over $4 billion by 1985; debt service on medium- and long-term loans, even assuming some easing in international interest rates, would reach $4.9 billion, with over half the total outflow used for repaying loans obtained after 1981. The outstanding medium- and long-term foreign debt would reach nearly $25 billion, with debt service rising to about 70 percent of merchandise export earnings. To the extent that the current short-term debt is refinanced with new medium- and long-term borrowing, debt service and the debt would be even larger. "The discussion in this section should not be interpreted as a formal forecast of the growth of foreign debt, debt service, or current account balances through 1985. As developments in the international economy in the 1970s show, unexpected events can play havoc with any forecast, no matter how sophisticated the economic modeling. The discussion is intended to illustrate poten- tial repayment problems in the next few years that are built into existing foreign loan agreements and into Philippine current indus- trial restructuring policies.F__~ If the international economy rebounds sharply, if interest rates moderate further, and if Manila contin- ues economic reform through 1985, we believe there will be an opportunity to stabilize the slide in the country's external accounts. For example, assuming the current account deficit stabilizes this year and 'improves dramatically after 1984, debt service could reach $4.2 billion in 1985 (figure 6). Because of the repayment burden on loans contracted prior to Janu- ary 1982 and the lack of immediate improvement in the trade deficit, the foreign debt and the debt service burden would continue to rise through the mid-1980s but at a slower pace. Debt service would peak at roughly 50 percent of merchandise export earnings in 1984. The burden would drop thereafter, but would remain above current levels through 1987-the end of President Marcos's current term in office. 25X1 Tests Ahead. We believe Marcos's complete domina- tion of Philippine politics probably will enable him to continue economic reform through its most painful period in the next two years. He has displayed a 25X1 flexibility in formulating economic policy-at the behest of his technocrats-that should enable the Philippines to cope with growing financial strains. Indeed, Marcos announced in March 1982 that chief technocrat Cesar Virata will keep the post of Prime Minister, rather than rotate out, as had been sched- uled, in July The world recession may nevertheless have forced Manila into a preoccupation with short-term econom- ic problems that will compromise long-term debt management. We believe the government could ne- gate the benefits of overhauling tariff policy and of foreign exchange liberalization if it chooses to bail out firms that cannot survive on their own. Bailouts are proving an expensive proposition for the government, and the financial drain could grow rapidly in the next few years. Marcos thus will have to choose more carefully during the 1980s than he did in the 1970s between heavy foreign borrowing, corporate bailouts, indulging inef- ficient state enterprises and powerful private monopo- lies, on the one hand, and reform and the forces of the Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential Figure 5 The Philippines: Incomplete Adjustment The Philippines: Successful Adjustment Current Account Million US $ Current Account Million US $ Exports 5,733 5,650 5,932 6,229 6,852 7,537 8,290 Exports 5,733 5,650 6,215 6,836 8,204 9,844 11,813 Imports 8,400 8,200 9,020 9,922 10,914 12,006 13,206 Imports 8,400 8,200 8,610 9,471 10,418 11,460 12,606 Services (net) -392 -500 -550 -605 -666 -732 -805 Services (net) -392 -500 -525 -551 -579 -608 -638 Transfers (net) 470 450 495 544 599 659 725 Transfers (net) 470 450 495 544 599 659 725 Current Account -2,589 -2,600 -3,143 -3,754 -4,129 -4,542-4,996 Debt Service on Medium-and Long-term Loans Billion US $ 0 1981 82 Debt Service Ratio Share of Export Earnings .90 .80 .70 .60 .40 1 I I .30 1981 82 83 84 85 86 87 Medium-and Long-Term External Debt Billion US $ Assumptions: In projecting the current account, we assume a slow recovery from world recession, stable terms of trade, and incomplete adjustment of the Philippine economy. Export growth is 5% in 1983-84 (from a 1982 base) and'10% thereafter. Imports, services, and transfers all grow by 10% a year. All new borrowings have 8 year maturities, an average interest rate of 10%, and a one year grace period for repayment of principal. 587015 7-82 25X1 11 Service on probable borrowings, 1982-87 Debt Service on Medium-and Long-term Loans Billion US $ 0 1981 Debt Service Ratio Share of export earnings .40 Ll__071~_ I I I 1 1 .30 1981 82 83 84 85 86 87 Medium- and Long-Term External Debt Billion US $ Assumptions: In projecting the current account, we assume a moderate recovery from world recession, a slight improvement in the terms of trade, and successful adjustment. Export growth is 10% in 1983-84 (from a 1982 base) and 20% thereafter. Import growth is 5% in 1983 and 10% thereafter. Services grow at 5% and transfers at 10%. New borrowings have 8 year maturities in 1982-84 and 10 years thereafter; the average interest rate is 7% and there is a one year grace period on repayment of principal. Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 free market on the other. The President and his technocrats, moreover, will have to maneuver among an increasingly restrictive set of options to make these choices. High world interest rates, for example, make it impractical for the Philippines to refinance its current foreign debt. We believe retarding import growth by deliberately slowing the economy is an option that Marcos wants to avoid because of its prohibitive political costs. Among other consider- ations, we believe the resulting high unemployment would probably increase the attractiveness of the Communist Party and affiliated labor and student front groups in urban areas where heretofore their success has been limited. In addition, growing imports of capital will be necessary for restructuring the manufacturing sector to increase international com- petitiveness and for continuing the major industrial projects in which Marcos's cronies have large stakes. Largely for these reasons, we believe it likely that Marcos will decide to take a middle path-initiating enough reform to maintain support from the interna- tional financial institutions, but not enough to upset his political base-and hope to muddle through. If short-term economic or political problems lead Mar- cos to either defer reform or to assume responsibility for all private foreign debt problems, however, we believe that by mid-decade he could find a socially disruptive slowdown in development his only alterna- tive. Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential Appendix A Estimating the Size and Significance of the Philippines' Short-Term Foreign Debt The Philippine Central Bank puts the short-term foreign debt at $4.5 billion at the end of 1981. Our estimate-based on Bank for International Settle- ments data-has the short-term debt significantly higher, probably as high as $6.8 billion.' The BIS provides data on short-term bank claims against the Philippines from mid-1978 to mid-1981. The data must be adjusted in a number of ways to estimate the Philippines' short-term debt: o The most important problem is the omission of claims against the Philippines held by non-BIS (mostly Middle Eastern) banks. We adjusted the BIS numbers for short-term claims upward by our estimates of 10 percent in 1978-79 and 30 percent in 1980-81. The higher adjustment for 1980-81 re- flects increased financing of higher priced oil imports. ? The BIS data do not include suppliers' credits provided by private firms. Our best estimate is that these credits are equal to one month's imports, and we make this adjustment to the BIS short-term claims. ? BIS data on short-term claims include claims with a residual maturity of one year or less. Some of these claims reflect maturing medium- and long-term loans. Therefore, we adjusted the BIS data down- ward by an estimate of longer term claims maturing that year. This estimate was derived from the BIS category of claims with residual maturity of be- tween one and two Years from the report of the preceding year ' The Bank for International Settlements in Switzerland-a clear- inghouse for Central Banks-reports bank claims against as well as liabilities to the Philippines. Reporting banks include those from most of the industrialized Western countries. The data include claims and liabilities of all affiliates of US banks, no matter where located, and affiliates of other reporting banks located in major Our adjustments and final estimate of the Philippine short-term debt from mid-1978 to mid-1981 are shown in table 4.Z To obtain the estimate of the short- term debt for the end of 1981, before adjusting for offshore banking arrangements, we increased the mid- 1981 figure by 14 percent, a conservative estimate based on the growth of the official short-term debt by Our estimate, however, may need to be adjusted slightly up or slightly down because of the existence of various offshore banking arrangements, which may produce some BIS claims on the Philippines that do not arise from Philippine foreign borrowing: ? Offshore banking units (OBUs) are affiliates or subsidiaries of foreign banks that are given special incentives to locate in the Philippines. ? Foreign currency deposit units (FCDUs) are banks, both foreign and Philippine, that are allowed to accept foreign currency deposits and make foreign currency loans up to the amount of their deposits. ? Deposit-taking corporations (DTCs) are Philippine companies located primarily in Hong Kong that 25X1 accept deposits and then lend the funds to both Philippine and non-Philippine borrowers. The existence of these arrangements creates the possi- bility that some of the BIS-reported claims may be interbank deposits that reflect Philippine deposits being lent ultimately to Philippine borrowers. It is also possible that some of the BIS-reported data are interbank deposits that reflect foreign deposits ulti- mately being lent abroad. Our best guess, based on other data, is that the magnitude of these transactions was no larger than $2 billion in 1981. I Even with these adjustments, our estimate could still be off because of incomplete data and financial transactions such as pre- payments and rescheduling that we are not aware of. Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 BIS reporting banks' short-term claims against the Philippines Adjustment for non-BIS bank claims Adjustment for nonbank suppliers' credits Adjustment for longer term claims matur- ing this year Subtotal Adjustment for BIS short-term claims that reflect either domestic intermediation of lending by Philippine institutions to foreigners Mid- 1978 End 1978 Mid- 1979 End 1979 Mid- 1980 End 1980 Mid- 1981 End 1981 2.2 NA 0.2 NA 0.3 0.4 1.3 1.6 1.7 0.4 NA 0.5 0.5 0.6 0.6 0.7 -0.4 NA -0.4 -0.4 -0.3 -0.3 -0.4 2.4 NA 3.4 4.5 6.1 7.4 7.7 8.8 -0.1 -0.5 -0.5 -1.0 -1.0 -2.0 -2.0 Significance of Short-Term Debt Debt analysts do not treat an economy's short-term foreign debt the way they treat medium- and long- term debt for two reasons: statistics on short-term foreign debt are notoriously unreliable, and short- term loans are usually considered self-financing. Banks feel secure in extending short-term credits because such loans consist almost entirely of revolving or tirade credits used to finance imports. These credits are considered self-liquidating; that is, they are to be repaid out of the proceeds of the sale of the imports they were used to finance. By any of the conventional measures, the Philippine short-term debt is much larger than would be expect- ed if the debt consisted primarily of revolving credits used to finance imports. The usual rule of thumb is that a country requires trade financing equal to approximately four months' imports. By our estimates the Philippine 1981 short-term foreign debt is equal to about 10 months' imports. (Even the official short- term debt is equal to over six months' imports.) In any case:, the ratio of short-term debt to imports is much higher for the Philippines than for other Asian coun- tries (see figure 7). There are several reasons why the short-term debt has grown so rapidly. Part of the Philippines' high de- mand for short-term credit springs from the inability or unwillingness of private companies to borrow long term at current high rates. More worrisome is the possibility that the demand for short-term credit is the result of distress borrowing by firms whose working capital is being depleted, or even the result of distress lending by banks unwilling to push Philippine custom- ers into bankruptcy by withdrawing loans. In the latter event, banks are advancing money to troubled companies to pay interest obligations on outstanding loans. Such abnormally heavy short-term borrowing over the long run adds to the already severe financial problems of many firms. If this is the case, much of the short-term foreign debt-probably about $4 bil- lion-is not self-liquidating and adds to the basic current debt service burden. Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential Figure 7 Import Equivalent of Estimated Short-Term Debt for Selected Asian Countries' Philippines South Korea Thailand Taiwan Indonesia Sri Lanka Malaysia aEnd of 1980. Based on Bank for International Settlements data. Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential Appendix B Tests Designed To Forecast Impending Debt Problems: Applications to the Philippines In 1975-80, 11 developing countries experienced mul- tilateral debt renegotiation, involving both public and private creditors. Although it is difficult to identify leading indicators that can be used to forecast an impending debt crisis with any degree of confidence, IMF analysts have isolated several characteristics exhibited by most of the developing countries that underwent debt rescheduling.' We apply these criteria to the Philippines in the following table. A summing up of the factors in the table suggests that the Philippines will face serious balance-of-payments problems within the next few years but will not encounter a debt crunch. Compared to most of the countries that rescheduled in this period, the Philip- pines has a more diversified economic base and is trying, with some success, to broaden its exports. Philippine imports have not grown as rapidly as ' Bahram Nowzad, Richard C. Williams and others, External Indebtedness of Developing Countries. International Monetary imports of the rescheduled group, nor have inflows of capital been as variable. In addition, Manila has asked for and has received IMF and World Bank financial assistance and technical advice-in time, perhaps, to implement the necessary structural reform of the economy. The government has already shown both the willingness and the ability to intervene to prevent widespread financial collapse-in the wake of the 1981 domestic financial scandal. Most important- ly, Manila possesses a set of highly competent eco- nomic managers, technocrats who realize the implica- tions of the large foreign debt and who-in the right political climate-can design measures to manage it. Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554ROO0100020001-5 Deteriorating balance of payments: ? Expansionary monetary and fiscal policies producing rapid import growth ? Sharp rise in imported oil prices ? Slow growth in output and exports ? Fluctuations in workers' remittances and tourist earnings ? Decline in official long-term capital inflows ? Slower growth or decline in private capital inflows Rapid expansion of private bank borrowing: ? Large increase in share of external debt held by private banks ? Rapid expansion of medium-term syndicated loans at terms slightly less favorable than those accepted by other non-oil- developing countries ? Bank lending tended to be procyclical and move with the commodity price cycle ? Periods of peak borrowing associated with rapid increases in government expenditure and a decline in the domestic savings rate ? Marked shortening of maturities ? Banks tended to react to payments difficulties by running down trade credits Borrowed funds generally invested in projects not productive enough to generate sufficient foreign currency earnings to repay the loans Accumulation of payments arrears. Countries which rescheduled had payment arrears approaching 40 percent of merchandise export earnings Erosion of international financial community's confidence in bor- rowing country's economic management. Reflected in slowdown of loan growth and hardening of terms The Philippines has run increasingly large balance-of-payments deficits since 1979: ? Expansionary fiscal policies were in evidence in 1981, bqt monetary policy was restrictive and imports grew less than 10 percent ? OPEC price hikes have accounted for the bulk of the trade deficit since 1979. ? Exports fell in 1981 and output grew at most 1 percent. Export revenue is highly variable because it consists heavily of primary commodity earnings ? Workers' remittances are buoyant and tourist receipts reasonably steady ? Official long-term inflows are steady at $1.1 billion a year ? Private medium- and long-term capital flows are holding steady. Short-term capital inflows are rising. Private banks hold about 70 percent of the Philippines' external debt: ? Terms on Philippine loans are not as good as those of 1980, but re- main better than those for many LDCs ? Medium- and long-term lending increased in 1980 and held steady in 1981. The Philippine Central Bank is trying to limit borrowing in 1982, but may not be able to do so. ? Borrowing is procyclical and corresponds to rise of government budget deficits, which is due to poor tax performance ? Government expenditure held steady in 1981, and President Marcos has announced efforts to trim outlays in 1982: ? Maturities have shortened considerably since 1980, and short-term debt is growing rapidly ? Philippines is still an excellent short-term risk Investment in the Philippines for a decade has been inefficient in generating output. Foreign borrowing has also been inefficient. The country is in the middle of a structural adjustment program to correct this problem, but results are not expected for several years Private-sector arrears are growing rapidly, particularly among firms which depend on government business. Payments by the public sector are on schedule, however, and total arrears are a small fraction of export earnings. International financial community downgrades Philippine cre- ditworthiness in 1981. Loan terms deteriorating in 1982. Doubts surfacing about Manila's economic management. Several large private corporations are currently rescheduling their loans. Government finances are on a firm footing, however. Approved For Release 2008/09/29: CIA-RDP84SO0554ROO0100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554ROO0100020001-5 Confidential Appendix C The Philippines: Selected Private Commercial Borrowers, 1977-81 Amount (million US $) Spread (percentage points) Maturity (years) Construction and Development Corporation of the Philippines Manager: Republic National Bank of Dallas Philippine Long Distance Telephone Company Manager: European Asian Bank Guaranteed: The Development Bank of the Philippines 130.0 1.250 1.375 1.500 5.0 3.0 2.5 Manager: Citicorp International Group; Bank America International Group; BT Asia, Ltd.; Chase Manhat- tan Asia, Ltd. Construction and Development Corporation of the Philippines Grace period 4.0 years Guaranteed: Philippine National Bank Atlas Consolidated Mining and Development Corporation Grace period 3.0 years 49.1 1.000- 1.125 8.0 Over six months SIBOR rate varies between 1.0 and 1.125 Construction and Development Corporation of the Philippines Standby guarantee facility Guaranteed: Philippine National Bank Construction and Development Corporation of the Philippines Grace period 3.0 years Guranteed: Philippine National Bank Construction and Development Corporation of the Philippines Manager: Citicorp International Group; Amex Bancom, Ltd. San Miguel Corporation Grace period 2.0 years Signed in Hong Kong 300.0 0.750- 0.850 6.0-6.0 Manager: Private Investment Company for Asia, Philippine Investments Systems Organization Manila Electric Company 47.0 0.875-1.00 4.0-6.0 Philippine Associated Smelter and Refining 85.0 0.750- 0.875 6.0-9.5 Landoil Resources Corporation 50.0 NA Standby guarantee facility for borrower's activities in Saudi Arabia Various Philippine contractors 20.0 0.875 8.0 Manager: Arab banks Dupax Rubber Corporation 18.5 1.00 8.0 Margin above SIBOR Guaranteed: Development Bank of the Philippines Landoil Resources Corporation 26.0 1.00 Manager: Credit Suisse First Boston Marinduque Mining and Manufacturing 83.0 0.875- 1.00 4.0-4.0 Guaranteed: Development Bank of the Philippines Approved For Release 2008/09/29: CIA-RDP84SO0554ROO0100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Amount million US $ Spread (percentage points) Maturity (years) Remarks 19111 Asia Breweries 60.0 1.00 8.0 Manager: Marine Midland Construction and Development Corporation of the Philippines 46.5 1.00 7.0 Guaranteed: Philippine Export and Foreign Loan Guarantee Corpora- tion; US EXIM Bank Philippine Long Distance Telephone Company 76.8 1.125 8.0 Manager: European Asian Bank 17.0 1-1.125 5.0-3.0 Manager: Credit Suisse First Boston Guaranteed: Philippine Export and Foreign Loan Guarantee Corporation 20.0 1.00 4 Manager: Al Bahrain Arab African Bank E Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Confidential Confidential Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5 Approved For Release 2008/09/29: CIA-RDP84SO0554R000100020001-5