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External Debt

On October 17, 1983, it was announced that the Philippines was unable to meet debt-service obligations on its foreign-currency debt of US$24.4 billion and was asking for a ninety-day moratorium on its payments. Subsequent requests were made for moratorium extensions. The action was the climax of an increasingly difficult balance of payments situation. Philippine development during the decade of the 1970s had been facilitated by extensive borrowing on the international capital market. Between 1973 and 1982, the country's indebtedness increased an average of 27 percent per year. Although government-to-government loans and loans from multilateral institutions such as the World Bank and Asian Development Bank were granted at lower-than-market rates of interest, the debt-service charges on those and commercial loans continued to mount. In 1982 payments were US$3.5 billion, approximately the level of foreign borrowing that year and greater than the country's total debt in 1970. The next year, 1983, interest payments exceeded the net inflow of capital by about US$1.85 billion. In combination with the downturn in the world economy, increasing interest rates, a domestic financial scandal that occurred when a businessman fled the country with debts estimated at P700 million, escalating unrest at the excesses of the Marcos regime, and the political crisis that followed the Aquino assassination, the debt burden became unsustainable (see table 16, Appendix).

The Philippines had turned to the IMF previously in 1962 and 1970 when it had run into balance of payments difficulties. It did so again in late 1982. An agreement was reached in February 1983 for an emergency loan, followed by other loans from the World Bank and transnational commercial banks. Negotiations began again almost immediately after the moratorium declaration between Philippine monetary officials and the IMF. The situation became complicated when it came to light that the Philippines had understated its debt by some US$7 billion to US$8 billion, overstated its foreign-exchange reserves by approximately US$1 billion, and contravened its February 1983 agreement with the IMF by allowing a rapid increase in the money supply. A new standby arrangement was finally reached with the IMF in December 1984, more than a year after the declaration of the moratorium. In the meantime, additional external funds became nearly impossible to obtain.

In each of these arrangements with the IMF, the Philippines agreed to certain conditions to obtain additional funding, generally including devaluation of the peso, liberalization of import restraints, and tightening of domestic credit (limiting the growth of the money supply and raising interest rates). The adjustment measures demanded by the IMF in the December 1984 agreement were harsh, and the economy reacted severely. Because of its financial straits, however, the government saw no option but to comply. Balance of payments targets were met for the following year, and the current account turned positive in FY (fiscal year--see Glossary) 1986, the first time in more than a decade. But there was a cost; interest rates rose to as high as 40 percent, and real GNP declined 11 percent over 1984 and 1985. The dire economic situation contributed to Aquino's victory in the February 1986 presidential election.

When Marcos fled to the United States later that month, the Philippine external debt had grown to over US$27 billion. The country's most immediate concern was with meeting debt-service payments. Reduction in the size of the debt was a longer term issue. Debt servicing, US$3 billion in 1986, was a drain on both the country's foreign-exchange earnings and its investible surplus. Technocrats in the National Economic and Development Authority recommended declaring another moratorium, this time for two years, to allow the country a breathing space. Measures were introduced in Congress in 1986 and subsequent years to cap annual debt-service payments. The Aquino administration and the Central Bank, however, consistently resisted both tactics, opting instead for a cooperative approach with the country's creditors.

Some of the government and government-guaranteed debt was incurred under questionable circumstances, and there were persistent demands for repudiation of those loans that could be shown to be fraudulent. In November 1990, the Freedom from Debt Coalition, a nongovernmental organization, presented findings from its investigation on six potentially fraudulent loans, together worth between US$4 billion and US$6 billion. The largest, a US$2.5 billion loan for the construction of the Bataan Nuclear Power Plant, involved allegations of irregularities in bidding procedures and design, overpricing, and kickbacks. The Aquino government previously had filed a civil suit in the United States against Westinghouse Corporation, the corporation with which the Marcos government had contracted to build the nuclear power plant, but the Philippines continued to pay interest payments on the nuclear plant loans of US$300,000 per day while the case was under litigation. In response to the coalition's findings, however, the president said that the country would not pay fraudulent loans, a statement interpreted as a major policy change.

Government negotiators dealt mainly with three groups of creditors in their efforts to reduce the burden of debt servicing. The first, and in some ways the most important, was the IMF, because its imprimatur was considered necessary to conclude arrangements with other creditors. The second was the Paris Club, an informal organization of official creditors. The third group was the commercial bank creditors, numbering 330 as of 1990. Bank negotiations generally were with the twelve-member bank advisory committee, chaired by Manufacturers Hanover Trust.

The standby agreement that the Marcos government had negotiated with the IMF in 1985 was discontinued shortly after Aquino assumed office. The agreed-upon targets with respect to government spending and increases in the money supply had been wildly exceeded as Marcos dipped into government coffers in a desperate effort to win the 1986 election. In addition, the government wished to negotiate a more growth-oriented arrangement. An agreement on repayment terms for US$506 million of loans was concluded eight months later in October 1986. In January 1987, an agreement was reached with the Paris Club to stretch out over ten years, with a five-year grace period, US$870 million of loans that were to have been paid in 1987 and the first half of 1988. The IMF accord also triggered the release of US$350 million in new loans by commercial bank creditors that had been held up when the agreement with the IMF broke down in early 1986. In March 1987, the Philippines and the twelve-bank advisory committee came to terms on the rescheduling of the country's US$13.2 million debt to private banks and a reduction in the rate of interest. Signing of the agreement was delayed, however, by a group of creditor banks led by Barclays Bank of Britain, who demanded that the Philippine government guarantee the US$57 million debt of a private fertilizer firm, Planters Products, Inc. An accommodation was not reached until December 1987.

A second round of negotiations began in 1989. The Paris Club restructured US$2.2 million of debt coming due between September 1988 and June 1990. The IMF and commercial bank agreements allowed the Philippines to undertake, in early 1990, a three-pronged program under Brady Plan (see Glossary) guidelines. First, the government used funds from the World Bank, IMF, and other sources to repurchase US$1.31 billion of government debt from private banks at the 50 percent discount at which they were selling on the secondary market, which action reduced the country's debt by some US$650,000, and, in the process, the number of creditor banks fell from 483 to 330. Second, debt coming due between 1990 and 1994 was rescheduled. Last, some eighty banks subscribed to US$700 million in new loans.

In July 1990, it was reported that the IMF had reviewed Philippine economic performance and found it "favorable" for the period between October 1989, when the loan agreement was reached, and March 1990. By September, however, the situation had turned around. Agreed-upon targets had not been met with respect to the sizes of the government budgetary deficit, the trade balance, or the country's international reserves. As a consequence, the IMF had refused to release the September tranche (installment of funds) to the Philippines. In turn, Manila canceled the 1989 standby agreement and reopened negotiations with the IMF. A new agreement was announced in early 1991. It involved a three-year credit package, totaling US$375 million, only one-third of the US$1.17 billion loan package suspended the previous September. Among other things, the agreement required the Philippines to implement new revenue-raising measures by the end of August 1991.

As a consequence of the country's failure to meet the September standby agreement targets, the commercial banks in February 1991 refused to disburse the last US$115 million of the US$706 million credit line agreed to in early 1990. At a meeting with Filipino officials, the bank advisory committee also declined to discuss providing some US$500 million in new funds. In February 1991, the Philippine government also said that it would ask the Paris Club for deferment of payment on US$1 billion in debts falling due from June 30, 1991 to July 31, 1992. In a measure to reduce the risk of lending to the government by commercial banks, in February 1991 the Philippines indicated that it would approach multilateral financial institutions such as the World Bank and the Asian Development Bank for cofinancing, in return for which the Philippine government would give up the possibility of rescheduling.

Efforts to reduce the external debt included encouraging direct investment in the economy. In August 1986, the Philippines initiated a debt-equity conversion program, which allowed potential investors who could acquire Philippine debt instruments to convert them into Philippine pesos for the purpose of investing in the Philippine economy. Because the value of the debt in the secondary market was substantially less than its face value (about half, at the time), the swap arrangement allowed investors to acquire pesos at a discount rate.

Most of the swapped debt was held by the Central Bank, which could provide the peso proceeds to retire the debt only through issuing new money, with obvious inflationary consequences. For this reason, the program was suspended in April 1988. At that time, US$917 million in debt reduction had taken place. Other issues were raised, however, about both the benefits to the Philippines and the fairness of the conversion program. Debt-equity swaps, it was argued, amounted to a considerable gain to investors, costing much less in dollars than was received in pesos. If an investment had taken place without the swap, a very large subsidy would not have been involved. Second, a considerable portion of the conversions appeared to have been by Filipinos bringing their wealth back into the country. Critics questioned whether those who engaged in capital flight should be awarded a premium for returning their wealth to the Philippines. There also was the question of the arbitrage possibilities of "round tripping," whereby investors with pesos engaged in capital flight to obtain foreign currency, which was used through the swap to achieve a much larger amount of pesos. Alternatively, an individual with dollars could engage in a swap and then convert pesos back into dollars through the exchange market. Although the government had some regulations concerning length of investment, the process was ripe for abuse. Nevertheless, the government resumed the program in December 1990 with an auction of US$7 million in debt paper. The new program was reported to have been altered to reduce inflationary pressures.

In March 1991, Philippine officials raised the issue of "condonation," or debt forgiveness, of Philippine debt with United States officials, requesting that the United States accord the Philippines similar treatment to that accorded Egypt and Poland. The United States resisted the entreaty, pointing out that whereas US$33 billion of Poland's US$48 billion debt was official, all but 20 percent of the Philippine debt was owed to commercial banks.

The Aquino administration spent an enormous amount of time and effort negotiating with various creditor groups to lower interest rates, reschedule the country's debt, and reduce the magnitude of the debt. A number of innovative schemes were undertaken; more were discussed. It was a process, however, that essentially meant running fast to stay in place. The size of the country's external debt in June 1990, US$26.97 billion, was about the same as the US$26.92 billion the country owed at the end of 1985, shortly before Aquino took office. Debt-service payments also changed very little: US$2.57 billion in 1985 as opposed to US$2.35 billion in 1990. The balance of payments pressures remained. The growth of the Philippine economy, however, caused the ratio of the country's debt to GNP to decline from 83.5 in 1985 to 65.2 in 1989, whereas that of debt service to exports fell from 32.0 to 26.3 over the same period. Projected debt servicing in September 1990 for the 1990s showed a rise from US$2.35 billion in 1990 to US$3.25 billion in 1995, falling off to US$2.08 billion in 1999.

Data as of June 1991


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