The Manila Times Internet Edition | BUSINESS > Inflation may blot credit ratings

In a statement, Fitch said inflation can have an insidious impact by lowering countries’ credit ratings due to heightened incidence of macroeconomic volatility. A lower rating will in turn affect government’s borrowing costs when tapping offshore lenders.

Finance Secretary Margarito B. Teves earlier said the government may resume its foreign borrowings in the remainder of the year due to skyrocketing commodity prices. The resumption of its foreign commercial borrowing program comes after the government postponed to 2010 its plan to balance its budget. The Philippines had planned to bridge its fiscal gap this year, but higher inflation and a slowdown in its biggest export market, the US, has forced the government to raise spending and cushion the impact of these macroeconomic events.

Fitch said rising fuel and food prices are also placing government budgets under pressure as subsidies become more expensive.

Higher inflation has been at the forefront of several negative rating actions by Fitch in recent months.

Fitch also said the global credit crunch has so far had no noticeable impact on private sector credit growth which remains strong, even as rising commodity prices have boosted incomes in resource-rich emerging economies.

But the credit rating company warned that the full impact of the downturn in the US and other advanced economies has yet to be fully felt in terms of reduced export demand.

The company said commodity prices are expected to moderate from current levels but central banks nonetheless are being forced to tighten monetary policies in response to the upsurge in inflationary pressures.

“It is the surge in inflation, rather than the direct consequences of the global credit crunch, that is the principal threat to macroeconomic and financial stability in many emerging markets,” David Riley, Fitch’s Sovereigns team managing director said.

“The risk faced by several central banks is that the failure to contain inflationary pressures will result in downward pressure on exchange rates—especially if the Fed surprises with earlier rises in US interest rates —leaving policymakers with the unenviable choice of either allowing currencies to depreciate, which in turn will stoke inflation further, or intervening in support of their currencies and raising interest rates much more aggressively with negative consequences for growth,” he added.

The Bangko Sentral ng Pilipinas (BSP) earlier raised its inflation forecast to between 7 percent and 9 percent this year, surpassing its inflation target of 4 percent to 6 percent.

It raised by 25 basis points its overnight borrowing and lending rates to 5.25 percent and 7.25 percent, respectively. The increase was based on the policy-making Monetary Board’s assessment that there are already early signs of supply-driven pressures feeding into demand.

“The 25 basis points increase is enough because it’s only recently that second round effects is becoming apparent and the inflation process continues to derive from the supply side,” BSP Deputy Governor Diwa Guinigundo said.

The International Monetary Fund, which currently conducts Article IV consultations with the Philippines, recently said that the country may be behind the curve in terms of interest rate policy.

Higher oil and commodity prices have been driving inflation, with the index seen hitting the double-digit territory in the third quarter of the year.

Consumer price increases accelerated to a nine-year high of 9.6 percent in May, breaching the BSP’s forecast for the month.

RP rating affirmed, with stable outlook

Despite its warning about the credit impact of high inflation, Fitch said it maintained its stable outlook for the Philippines, even though the country’s credit rating compares unfavorably with its rating peer group on account of a higher debt burden.

In a separate statement, Fitch affirmed the country’s long-term foreign currency issuer default rating at ‘BB,’ or below investment grade. The outlook remains stable, it added.

The agency said the Philippines’ relatively strong external financial position continues to support its sovereign credit ratings.

“Ongoing current account surpluses, driven largely by overseas workers’ remittances, are contributing to a steady reduction in the country’s external debt ratios, and have allowed for a significant increase in official foreign exchange reserves,” Franklin Poon, Fitch’s Sovereign group director said.

Fitch forecasts an increase in the merchandise trade deficit to more than $10 billion this year, as export growth slows and imports increase on the back of higher oil prices. Even assuming a slowdown in the growth rate of remittances, they are expected to exceed $16 billion this year, equivalent to 9 percent of the economy and more than offsetting the trade deficit.

Remittances are forecast to increase gradually in next year and 2010, and the current account surplus is projected to be about 2.5 percent to 3 percent of gross domestic product (GDP).

Net capital flows are forecast to be much weaker this year, as the Philippines is affected by the reduction in global investors’ risk appetite amid slowing growth in advanced economies and lingering uncertainty in credit markets.

Net portfolio equity inflows averaged about $2.4 billion annually between 2005 and last year, but are projected to fall to $250 million this year.

The country’s gross external financing requirement is forecast at only $660 million this year, which is low relative to other ‘BB’-rated sovereigns, and especially low for a net oil importer.

Fitch also forecasts the fiscal deficit will widen to 2.1 percent of GDP, or equivalent to P157.5 billion this year. The finance department has projected that the country will end the year with a P75-billion budget gap.

The country’s rating peer group median was virtually unchanged at 1.9 percent of GDP over the same period.

Fitch retains the view that Philippine public finances are fundamentally weak and in need of a significant boost in revenue. Forecast at 16 percent of GDP, government revenue is much lower than the peer group median of 26 percent.

“It is critical that the various measures to enhance revenue collection begin to deliver more meaningful results, as spending pressures, which have been carefully managed in recent years, mount,” it said.

The government has an aggressive—and much-needed—infrastructure development plan, and has recently announced a series of subsidies to alleviate the effects of higher inflation on the poor.

Consolidated general government debt declined from 63 percent in 2005 to 49 percent of GDP last year, though it is still much higher than the ‘BB’ median of 34 percent.

Continued reductions in government debt ratios depend on containing the budget deficit, which, in turn, will require increased revenue to offset anticipated spending increases.

Fitch expects further monetary tightening, as real policy rates remain negative. It forecasts a slowdown in economic growth this year to 5.3 percent from 7.2 percent last year.

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