Philippine Markets Newsletter

MONDAY MACRO: Even with a 21% increase in national debt this year than last year, current debt-to-GDP ratio is still manageable as this metric signals

October 19, 2020

This unit investment trust The Philippine government has been actively borrowing funds from creditors, raising concerns about a growing national debt.

With the national debt now over PHP 9 trillion as of August, fulfilling the repayment obligations also becomes more challenging. Will the government’s borrowing spree bring more harm to the economy than good?

Today, we look at a certain metric to see if the steep increase in outstanding government debt is actually something to worry about.

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Sovereign debt instruments such as government bonds are regarded as one of the safest investments due to a government’s ability to print more of its currency when needed. However, there are instances when a country can no longer rely on that strategy, eventually defaulting on its debt obligations.

An example of this is Greece.

The Euro currency supply of each European Union member country is heavily regulated by the European Central Bank (ECB). In 2015, Greece defaulted on its loans as it missed its payments to the International Monetary Fund (IMF). However, it also had structural problems prior to this event, such as a high budget deficit and weak economic prowess.

Any country considering increasing the money supply should consider its potential economic repercussions. If the economy’s output—the quantity of goods and services provided—does not grow relative to the increase in money supply, producers will likely raise prices, eventually leading to lower consumer demand. This relationship was previously discussed in our October 5th article.

As producers will likely raise prices and therefore inflation, increasing money supply hence also impacts the cost of borrowing for the government. As the monetary value decreases due to a higher inflationary environment, investors will then require higher or better compensation through bond yields. In other words, borrowing becomes more expensive the next time they raise funds through debt financing.

With businesses operating at a limited capacity, government collection from business taxes has declined while financial aid to households increased. Because of the unexpected increase in the net outflow from government countermeasures in response to the pandemic and weaker revenue generation from an increase in financial subsidies and lower tax collections, the government had been actively accumulating debt.

As of August 2020, total government debt accumulated is at PHP 9.6 trillion, an increase of 21% from the same month last year. However, if we look at this with other data, this is not actually concerning.

To best understand the national debt metric, we need to look at data to help give context to the full macroeconomic environment.

One important metric we need to look at is the country’s credit default swap (CDS).

A CDS is a financial derivative that allows the holder of the instrument to “swap” its credit risk to another investor for a premium. Another way to put it is that the holder of the CDS can insure its bond against the potential event of a default or any other stated credit event that the counterparty will compensate the holder for.

The premium to be paid to the insurer will depend on the credit risk of the underlying debt obligation. Just like in insurance, a higher expected risk (credit risk) means that a higher premium must be paid. Therefore, the higher the CDS, the riskier the debt involved.

Hence, the CDS is a market-driven indicator of potential credit event risks as investors who trade these express their credit views on the issuer.

If we look at the CDS chart of the Philippines, in 2004, CDS was at an all-time high of 513 basis points (bps). CDS is denominated in bps and one basis point is read as 0.01%. In this instance, the CDS of 513 bps would mean, to insure the bond, the insurer or seller will require the bondholder to pay 5.13% of the notional amount.

The 513 bps is considered high considering its historical CDS levels. The Philippine government back then was facing a challenging situation from mounting debt accumulated over the years as an aftermath of the 1983 global conflagration. Debt to GDP by the end of 2004 was 71.60%, the highest the country had ever seen.

During the Global Financial crisis in 2008-2009, the CDS rose from average monthly CDS of 138 bps in 2007 to 413 bps in November 2008, nearly breaching its all-time high level as global investors became concerned about credit risk.

With elevated credit concerns among investors, sentiment toward the domestic equity market also turned negative. In effect, the Philippine stock market index declined by 90% in the same period.

The CDS stayed elevated until the first quarter of 2009 and then eased off to a 12-month average CDS of 155 bps in 2010. The cost of insuring government-issued debt since then has trended lower.

It has been nearly two quarters since the global health crisis started and over two months since the country was officially in a recession. Philippine sovereign CDS reached its 3-year high of 110 bps as the lockdowns due to the COVID-19 raised investors’ concerns on companies’ capability to generate cash flow. However, this is still nowhere near historical distressed levels.

As of September 30, 2020, the metric is at 54 bps, reverting to its pre-COVID recent average levels. In 2019, the average CDS was at 51 bps. This implies that credit investors are not as concerned at the moment about the credit health of the Philippine economy as in the 2008-2009 recession. Investors are not requiring higher compensation in absorbing the country’s credit exposure.

Even with higher debt levels, the Philippines is nowhere near becoming the next Greece. Aside from the Philippines’ expected earnings rebound next year, sovereign credit concern also looks to be minimal. Credit rating agencies such as Fitch and Moodys’ continue to retain the country’s investment-grade rating.

Credit investors may have been also factoring in that the Philippines’ debt-to-GDP ratio is still substantially lower than a decade ago. If we look at its historical values, the highest debt-to-GDP ratio was at 71.1% in 2003, which is substantially higher than the current 48.1%.

We continue to reiterate that a recession that is not credit-driven will likely see a V-shaped recovery. Even if the country has higher levels of debt, if all other factors contributing to economic growth and stability remain attractive, a prolonged economic crisis is unlikely to happen.

About the Philippine Markets Daily
“The Monday Macro Report”

When just about anyone can post just about anything online, it gets increasingly difficult for an individual investor to sift through the plethora of information available.

Investors need a tool that will help them cut through any biased or misleading information and dive straight into reliable and useful data.

Every Monday, we publish an interesting chart on the Philippine economy and stock market. We highlight data that investors would normally look at, but through the lens of Uniform Accounting, a powerful tool that gets investors closer to understanding the economic reality of firms.

Understanding what kind of market we are in, what leading indicators we should be looking at, and what market expectations are, will make investing a less monumental task than finding a needle in a haystack.

Hope you’ve found this week’s macro chart interesting and insightful.

Stay tuned for next week’s Monday Macro report!


Angelica Lim
Research Director
Philippine Markets Daily
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