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The Philippines: Fending Off Default

Money sent home by expatriate maids, nurses and sailors helps President Gloria Arroyo keep the economy afloat amid unrest, debt and corruption. Investors wonder how long it can last

If the Philippines avoids defaulting on its $70 billion of debt, it has people like Susan Penaflor to thank. Penaflor, 40, moved to Hong Kong 16 years ago to work as a maid for wealthy families, sending home two-thirds of her $470 a month in wages to help support her son, mother, three brothers and two sisters.

Her remittances, and those of 7.4 million other Filipinos work- ing abroad as maids, nurses and sailors, are also helping support government debt payments that amount to 40 percent of the country’s annual budget, according to a July 13 report by Zurich-based UBS AG. “I’ve heard the money I send back helps keep my country solvent,” Penaflor said on a recent Sunday—her one day off a week—as she strolled around Discovery Bay, an expatriate enclave in which cars are banned and residents zip around in golf carts.

The Philippines—where President Gloria Macapagal-Ar- royo is battling impeachment charges, “people power” street protests and cabinet defections—has tripled its debt in the past eight years. It currently amounts to 101 percent of gross domestic product. That leads some investors to worry that the government will call a moratorium on its debt, as the regime of Ferdinand Marcos did on $24.8 billion worth in 1983.

“Forty percent of revenue going to service interest repayments is alarmingly high,” says Desmond Soon, who manages $206 million of emerging-market debt at Pacific Asset Management in Singapore. “In this kind of situation, some political figure could come along and argue for a moratorium or some form of debt rescheduling.” Soon says he’s underweight Philippine debt, which accounts for 7.16 percent of the JPMorgan EMBI Plus global emerging-markets index.

President Arroyo says a default is out of the question. “The Philippines will be able to honor its international ob- ligations,” she said in an e-mailed response to written questions. Arroyo, 58, a 4-foot 11-inch economist who studied alongside former U.S. President Bill Clinton at Georgetown University in Washington from 1966 to ’68, says the Philip- pines’ foreign exchange reserves alone—$17.7 billion—more than cover three years of repay- ments. She also cites 6.1 percent GDP growth in 2004, foreign remittances, improved tax collection, a floating exchange rate and the fact that much of the debt is long- term, with repayment spread over an average of 17.7 years. “One only has to look at the resilient stock market and the peso-dollar rate to see that our economy remains dynamic enough to ride out ongoing political troubles,” she says.

So far this year, the Philippines Stock Exchange Composite Index has risen 9.2 percent to 1983 on Aug. 9. The mar- ket—with a value of $35 billion, it’s 1/30 the size of Hong Kong’s—matched gains by the Morgan Stanley Capital International AC Asia Pacific Excluding Japan Index. International investors have been net buyers of Philippine stocks, helping prop up the peso. On Aug. 9, the currency was trading at 55.89 to the U.S. dollar, slightly stronger than its rate of 56.15 at the start of the year.

Investor concern is reflected in the in- creasing cost of Philippine five-year credit default swaps, contracts that provide investors with insurance against a borrow- er’s default on its bonds. Prices of the swaps typically rise when creditworthiness worsens. The cost of a Philippine default swap climbed to 402 basis points on Aug. 9 from 371 basis points when the crisis began in June, accord- ing to JPMorgan Chase & Co. That means it cost $402,000 per year to insure $10 million of Philippine debt for five years. By comparison, Brazilian swaps traded at 311 basis points. (A basis point is 0.01 percentage point.)

There’s a 20–25 percent chance the Philippines will default, says Agost Benard, a Singapore-based sovereign-debt analyst at New York ratings company Standard & Poor’s. In January, S&P lowered its rat- ing on the Philippines’ long-term, foreign- currency debt one level to BB–, three steps below investment grade. A month later, New York–based Moody’s Investors Service cut the nation’s ratings two levels to B1, four steps below investment grade and the lowest since it began assessing the country in 1993.

Investors say the fear of default is exaggerated. “If all those workers around the world stopped sending money home, the Philippines would default on its debt for sure,” says Nicholas Field, 36, who manages $700 million of emerging- market bonds in London for WestLB Asset Management, a unit of WestLB AG, Germany’s third-largest bank. He’s betting that won’t happen. “The Philippines has its problems, but one thing they’re very good at is exporting people,” Field says. He’s invest- ed $70 million in Philippine debt, making it his second-favorite emerging market for bonds, after Russia.

Investors like Philippine government bonds because they de- liver higher returns than similar-rated debt, says Ong Sin Beng, a Singapore-based economist at JPMorgan Chase, the third-biggest U.S. bank. On Aug. 9, the 10-year, U.S. dollar–denominated Philippine bond with a coupon of 8.875 percent maturing in 2015 was yielding 8.2 percent compared with 6.9 percent for similar Turkish debt and 7.9 percent for a similar Brazilian bond. S&P rates all three countries’ debt the same. “The risk of default is quite low, so you are getting a rate of return that certainly rewards you for the perceived risk,” Ong says.

Arroyo has plenty of obstacles to overcome. On July 1, the Supreme Court temporarily blocked her plan to increase the value-added tax to 12 percent from 10 percent, after the opposition said such a rise was unconstitutional. A final decision was expect- ed by the end of August. After Arroyo was re-elected last year, her economic team promised to balance the budget by 2008, largely through tax increases. The blocked measure, which would also abolish value-added-tax exemptions for fuel and electricity, would bring in $4.2 billion a year compared with $2.35 billion in 2004 from the value-added tax, which is levied on goods as they move from the facto- ry to the consumer.

At two demonstrations in July, 40,000 protesters took to the streets to demand her resignation over allegations that she cheat- ed while votes were being counted from the May 10 presidential poll and over opposition claims that her husband, son and brother-in-law took payoffs from illegal gambling operators. Arroyo and her family members all denied any wrongdoing. Similar people power protests brought down President Marcos in 1986 and Joseph Estrada in 2001. On July 8, 10 cabinet members and other officials, including most of Arroyo’s economic team, resigned. On July 25, opposition congressmen filed an impeachment case against her.

Arroyo says she won’t bow to such pressure. “Walking away is not the quick fix you might have imagined,” she said in her e-mail. “I doubt if our people will look kindly on a leader who chose the easy way out, knowing the grave con- sequences to the nation if an elected president is deposed through unconstitutional means.”

If she stays, she will have plenty to do. The nation of 88 million people spread over 7,107 islands is one of the region’s poorest countries, with per-capita GDP of $1,000—about the same as China’s. One-third of its people live on less than 60 cents a day, according to the National Statistics Office. Tax receipts fell to 12.2 percent of GDP from 17 percent in 1997. The government is fighting an Islamic insurgency on southern Mindanao Island, where Abu Sayyaf guerrillas have links to al-Qaeda and also communist rebels. There are also personal costs for families as 9 per- cent of the population, most of which speaks English as well as one of several local languages, is forced to work overseas. “We also fully recognize that we need to provide better opportunities to entice them to stay,” Arroyo says.

The Philippines ranks 102nd—along- side Zambia and Eritrea—out of 146 nations in the 2004 Corruption Perceptions Index compiled by Transparency International, a Berlin-based research group. Giving it a score of 2.6 out of 10, Transparency described it as “rampantly corrupt.”

Approved foreign direct investment was just $2.78 billion last year, 10 per- cent less than the $3.1 billion for Thailand, a country with only two-thirds of the population. U.S. companies cite corruption and poor roads, railways and ports as among the biggest impediments, says Robert Blume, a spokesman for the American Chamber of Commerce in Manila.

In July, the Manila-based Asian Development Bank— a regional equivalent of the World Bank—warned it might stop lending to the Philippines if the country didn’t act to cut its debt. “It will no longer be business as usual,” says Sham- shad Akhtar, director general of the bank’s Southeast Asian department. “It’s critical this fiscal deficit be reversed.” The Asian Development Bank has lent the Philippines $8.1 billion since 1966; all repayments are up-to-date.

Arroyo is promising to privatize power generation as- sets and use the money, along with increased tax revenue, to improve roads, railways, airports and seaports, which fell into disrepair as the government spent an increasing slice of its budget on debt repayment. She also expects $300 million to be invested in mining following a Supreme Court decision to allow foreign investment to exploit an estimated $90 billion worth of copper, nickel, aluminum and other mineral reserves.

Mark Mobius, 68, Singapore-based managing director of Templeton Asset Management Ltd., says he’s not increasing his holdings in the Philippines. Mobius, who manages $18 billion of emerging-market securities, including $150 million worth of Philippine stocks, says he’s unhappy with the level of corruption, the absence of rule of law as personified by the street protests against Arroyo and the enduring grip on political power by a handful of wealthy families.

Although the Philippines is a democracy, 73 percent of congressmen are second-, third- or fourth-generation politicians, according to Sheila Coronel, author of The Rulemakers—How the Wealthy and Well-born Dominate Congress (Philippine Center for Investigative Journalism, 2004). Arroyo herself is the daughter of Diosdado Macapagal, president from 1961 to ’65. Her son, Juan Miguel “Mikey” Arroyo, and brother-in-law, Ignacio Arroyo, also sit in Congress. Her husband, Jose Miguel “Mike” Arroyo, 58, is a lawyer who no longer practices. “Families who have controlled the country for so long just don’t let go,” Mobius says.

“What’s more, the prices of stocks aren’t cheap,” Mobius says. On Aug. 9, the average price-earnings ratio for the 33- member Philippine Stock Exchange Composite Index was 14.36 compared with 10.69 for Singapore’s Straits Times Index and 9.77 for the Stock Exchange of Thailand Index.

Irving Ackerman, the Bronx-born chairman of I. Ackerman & Co., a Manila-based brokerage, says the Philippine exchange has strong companies such as drinks conglomerate San Miguel Corp., whose stock is up 18 percent this year, to 69.50 pesos on Aug. 9.

Investors in the country have seen so much upheaval that they don’t scare easily, adds Ackerman, 83, who first arrived in the Philippines in 1945 as a captain in the U.S. Army, which had driven out the Japanese occupation force. He recalls the first people power demonstrations in 1986, after Marcos declared himself the winner of an election against Corazon Aquino, widow of slain opposition leader Benigno Aquino, amid allegations of ballot box rigging. Hundreds of thousands of Filipinos took to the streets to confront Marcos’s troops. When the military refused to open fire on the crowd and switched sides, Marcos fled into exile and Aquino was installed as president. “It was amazing,” Ackerman says. “Nuns were giving flowers to soldiers. One trigger-happy soldier, and there could have been a massacre. Compared to those times, what’s happening now is nothing.” Aquino, now 72 and retired, survived seven coup attempts during her six-year term from 1986 to ’92.

In 2000, people power manifested itself again against President Estrada, a former movie actor. Estrada, now 68, was removed by the Supreme Court after his allies in the Sen- ate blocked an impeachment motion and the military with- drew support. He was replaced in January 2001 by his then vice president, Arroyo. Estrada has been charged by an anti- graft court with taking $80 million in kickbacks and is currently under house arrest pending trial.

In 2003, Arroyo survived a military revolt when soldiers entered the main financial district, Makati, and took over a serviced apartment block before surrendering. In May 2004, having completed Estrada’s six-year term, Arroyo ran for office against another ex-actor and friend of Estrada, Fernando Poe Jr. Arroyo was declared the victor by Congress after gaining 40 percent of the vote to Poe’s 37 percent. Poe, who died in December, aged 65,

accused her of cheating and never conceded.

In June, congressional op- position figures released tapes they said showed that Arroyo had tried to influence election officials during the count. Arroyo later acknowledged that she had made a mistake by speaking to an election com- missioner. “I recognize that making any such call was a lapse in judgment,” she said in a broadcast to the nation. “I am sorry.” She denied trying to influence the outcome.

On July 8, at a press conference at Manila’s Hyatt Hotel, resigning cabinet members said Arroyo had lost their trust. Cora Guidote, 44, a former investment banker who had been a presidential consultant on investor relations, also quit that day. “She’s no longer focusing on the economy,” Guidote says of Arroyo. “The focus is more on her political survival.” The same day, former President Aquino and the board of the Makati Business Club, a 740-member group of leading Philippine executives, called on Arroyo to step down.

Arroyo retains the support of two crucial groups: the military and the Catholic Church. Catholic bishops—who had backed the people power movements against both Marcos and Estrada in this overwhelmingly Catholic country—have refused to join calls for her resignation. The military remains behind her. “We will not get involved with this political turmoil,” army spokes- man Col. Buenaventura Pascuel says. “We will follow the chain of command from the president down to the platoon leader. We will uphold the constitution.”

Thousands of citizens have demonstrated in support of Arroyo as well as against her. “This is very different from what you saw in earlier presidential crises, when there was generally near-unanimous support for the incumbent to step down,” says Christa Janjic, Singapore-based Southeast Asia economist for UBS. “The country is divided.”

In replacing her economic team, Arroyo recruited two for- mer senior bankers. Treasury Secretary Margarito “Gary” Teves, 62, is a former chief executive officer of Land Bank of the Philippines, the country’s fourth-largest lender. Trade and Industry Secretary Peter Favila, 56, is a former CEO of state- owned Philippine National Bank, the country’s biggest lender, and chairman of the Philippine Stock Exchange. Both men have pledged to pursue policies of increasing taxes and encouraging international investment. “We have hit the ground running,” Favila says.

On July 25, Arroyo, dressed in a midnight-blue gown, took a helicopter over the heads of demonstrators to Congress, where she delivered a State of the Nation address. “We will not waver in our commitment to economic reform and fiscal discipline, no matter what the political cost,” she told Congress.

She also proposed changing the form of government from a U.S.-style presidential system to a parliamentary one favored by most developed nations. “Over the years, our political system has degenerated to the extent that it is difficult for anyone to make any headway yet keep his hands clean,” Arroyo said. Although Arroyo gave few details, former President Fidel Ramos, 77, has proposed that Arroyo preside over the transition from a government headed by a president to one headed by a prime minister. “The present incumbent would not be excluded,” he says.

Arroyo’s most urgent priority now is to get the Supreme Court ruling on the value-added tax overturned, says Ben Yuen, 36, who manages $1 billion in Asian debt as Hong Kong–based head of fixed income at First State Investments. “If the court eventually approves the VAT, it will be very positive,” he says. Yuen’s advice to bondholders: “Keep a neutral position and monitor closely.”

Meanwhile, overseas workers such as Hong Kong maid Penaflor—whom the government sometimes calls bayong bay- ani, which means new heroes—continue to do their bit to keep their country afloat. In the first half of this year, remittances from Filipinos working abroad were up 26 percent over the comparable period last year, Arroyo says. “That money is pay- ing off not only the interest but part of the principal of the debt as well,” says Aurelio Montinola, 53, who has a master of business administration from Harvard University and who is president of the Bank of the Phil- ippine Islands, the country’s second- biggest lender.

Penaflor says she has little choice but to remain overseas. “I want to start my own business, but with all this corruption and bureaucracy, even foreign investors find it hard,” she says. “So I’ll stay here in HongKong as long as employers are willing to give me a contract. My hope is that my ashes will one day be scattered in the Philippines.” Rather than be known as a hero, she says, she’d prefer the opportunity to make a decent living at home.


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