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Rating Action:

Moody's affirms Philippines' Baa2 rating, maintains stable outlook

20 Jul 2018

Singapore, July 20, 2018 -- Moody's Investors Service ("Moody's") has today affirmed the Government of the Philippines' long-term local currency and foreign currency issuer and senior unsecured debt ratings at Baa2 and maintained the outlook at stable.

The Baa2 rating incorporates a number of very positive credit features, including the high economic strength derived from a large and fast-growing economy, as well as improving fiscal strength based on moderate government debt levels and gains in debt affordability. These are balanced against more negative features which constrain the rating, principally low per capita incomes and, relatedly, still low revenue-raising capacity as compared to similarly rated peer countries.

The stable outlook also balances positive and negative factors. Moody's expects that growth will remain robust and that the Philippines' fiscal metrics will strengthen somewhat as the government continues to make progress on its socioeconomic reform agenda, but these trends are likely to fall short of bringing the Philippines' credit profile in line with higher-rated countries. At the same time, policymakers face challenges in managing the current inflationary pressures. In addition, domestic political developments and prospective changes to governance frameworks, including a shift to a federal form of government, present downside risks to the country's institutional and fiscal profile.

Moody's has also affirmed the government's foreign currency senior unsecured shelf rating at (P)Baa2 and the senior unsecured ratings for the liabilities of the country's central bank, Bangko Sentral ng Pilipinas (BSP), at Baa2. In Moody's view, the credit quality of the central bank is closely aligned with that of the government.

The Philippines' country ceilings remain unchanged. The long-term foreign currency bond ceiling remains at A3, and the short-term foreign currency bond ceiling at P-2. The long-term foreign currency deposit ceiling remains at Baa2, and the short-term foreign currency deposit ceiling at P-2. Furthermore, the long-term local currency bond and deposit ceilings remain unchanged at A2.

RATINGS RATIONALE

RATIONALE FOR THE AFFIRMATION OF THE Baa2 RATING

The Philippines' Baa2 rating reflects a number of credit strengths, including limited vulnerability to external shocks, balanced by longstanding structural credit constraints resulting from some of its economic, fiscal and institutional features.

The credit strengths include a relatively large economy and high growth potential that support the economy's capacity to absorb shocks. They also comprise a long track record of sustaining macroeconomic and financial stability, with policies that continue to deliver stable and relatively low debt levels. Moody's projection of the Philippines' general government debt at around 38% of GDP in 2017 is about 10 percentage points below the median Baa-rated sovereign. The country's favorable demographics support steadily rising labor inputs and potential growth, while reducing the burden of ageing-related costs on government finances. In addition, the long average residual maturity of the Philippines' government debt, at around 12 years for its external obligations and 7.6 years for its domestic issuances, limits recurrent borrowing needs and strengthens the stability of these needs.

Moreover, large foreign exchange reserves and low economy-wide external debt contribute to macroeconomic stability. More generally, relatively low reliance on either foreign sources of income or financing insulates the Philippines from the direct impact of abrupt changes in the global macroeconomic and financial environment.

At the same time, the Philippines' low per capita income relative to peers, at roughly $8,300 in 2017 at purchasing power parity compared with around $23,400 for the median Baa-rated sovereign, is an important constraint on both economic strength and the rating. A related and equally important constraint is the government's limited capacity to generate revenue, which principally reflects the population's low incomes and the large informal economy. Despite recent and prospective improvements, government revenue as a share of GDP remains well below the Baa-median as of 2017. This means that despite moderate debt levels, interest payments absorb a relatively large share of the comparatively narrow revenue base. Finally, and contrasting with increasingly effective policymaking, relatively weak rule of law and control of corruption weigh on the Philippines' institutional capacity as compared to peers.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook balances positive and negative developments in the Philippines' credit profile.

PROGRESS ON REFORM AGENDA SUPPORTS FISCAL STRENGTH BUT WILL NOT REMOVE STRUCTURAL CONSTRAINTS

The government has made progress on several facets of the socioeconomic reform agenda that was unveiled at the outset of the term of President Rodrigo Duterte. In particular, tax reform has complemented faster implementation of infrastructure development. As a result, Moody's expects a broadly stable government debt burden at moderate levels, below 40% of GDP, improving debt affordability, and sustained high GDP growth.

The first package of the Tax Reform for Acceleration and Inclusion (TRAIN), effective at the beginning of 2018, represents a comprehensive overhaul of the tax code and has already had a pronounced impact on the government's revenue performance in the first half of the year. Moody's estimates that government revenue will rise to 16.2% of GDP in 2018 and 16.7% in 2019, from 15.6% last year, largely as a result of TRAIN1.

Further ahead, Moody's expects a structural improvement in revenue as a result of the broadening of the tax base under TRAIN, including its next phase currently under discussion -- TRAIN2 -- as well as ongoing efforts to enhance tax administration. In turn, this will improve debt affordability, measured as interest payments as a share of government revenue, albeit from moderate levels, leading to an increase in the Philippines' fiscal strength.

A permanently higher revenue intake will provide some additional fiscal room for higher spending, in particular on infrastructure. In this respect, the government has also improved budget execution, supporting its drive to boost infrastructure spending to over 7% of GDP by 2022, up from around 5% in 2017 and as low as 1% in 2011. This will contribute to the strengthening trend in gross fixed capital formation and, consequently, potential growth.

However, these positive trends are likely to fall short of bringing the Philippines' per capita incomes or debt affordability in line with higher-rated countries.

POLICY CHALLENGES FROM INFLATIONARY PRESSURES

The Philippines is buffeted by a number of headwinds that contribute to inflationary pressures. Based in part on the strong track record of BSP in maintaining monetary and financial stability, Moody's expects the rise in inflation since the beginning of 2018 to be transitory. However, significant capacity constraints related to the Philippines' topography, possibly persistent pressure on the currency and capital inflows, and a current account balance in slight deficit, pose material challenges to policymakers in ensuring that inflation expectations and inflation pressure are contained.

Coinciding with these pressures, the peso has depreciated by around 7.0% against the US dollar year-to-date, while benchmark 10-year government bond yields have fluctuated and are around 60-70 basis points higher than at the end of last year.

Although not our base case, indications that monetary policy may not prevent a sustained rise in inflation above our current expectations -- and beyond the one-off impact of the increase in excise taxes from TRAIN1 -- would likely exacerbate upward pressure on both market interest rates, capital outflows, and downward pressure on the exchange rate. In the context of a widening trade deficit that has led to a reversion of the current account to a deficit in recent years, the susceptibility of the balance of payments to capital outflows has increased.

In mitigation, the stock of foreign exchange reserves remains well above the country's cross-border debt servicing requirements, as well as the entire amount of the country's external debt. As defined by Moody's External Vulnerability Indicator, the Philippines' external debt repayment obligations due during 2018 amount to only a quarter of its foreign currency reserves as of the end of 2017, denoting ample reserve coverage.

DOMESTIC POLITICAL DEVELOPMENTS AND POTENTIAL GOVERNANCE CHANGES POSE DOWNSIDE RISKS

The Philippine president's contentious policies on law and order over the past two years as well as other political controversies may have a negative impact on the Philippines' attractiveness to financial and physical asset investors.

In addition, prospective changes to governance frameworks could have negative implications for public finances. These include the recent Supreme Court ruling that redefines the share of national government revenue to be transferred to local levels of government, as well as the proposed shift to a federal form of government from the current centralized form of government.

In each of these cases, the fiscal impact will in part be determined by the degree to which spending commitments will be devolved to the local levels of government. The shift to federalism would also likely incur an expansion in the aggregate size of the government and, hence, public expenditure. At the same time, there may be a gap between the national and local levels of government with respect to their ability to manage fiscal resources, posing a risk to the improved fiscal discipline that has characterized national government finances over the past decade.

WHAT COULD MOVE THE RATING UP/DOWN

The Philippines' credit profile has a number of features which compare well with higher-rated peers, but is principally constrained by relatively low wealth and revenue-generating capacity. Marked convergence of per capita incomes and revenue generation, and as a result debt affordability, with higher-rated peers would likely prompt Moody's to upgrade the rating. This could materialize over time through continued progress on the government's reform agenda, while policymakers avoided a build-up of inflationary pressures.

Conversely, the rating would likely be downgraded if macroeconomic stability were to be threatened by unabated overheating pressures leading to a deterioration in fiscal and government debt metrics and an erosion of the country's external payments position. The reversal of reforms that have supported recent gains in economic and fiscal strength, and/or the implementation of prospective changes in governance structures in a way that diminishes fiscal strength would also likely lead to a downgrade.

GDP per capita (PPP basis, US$): 8,315 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 6.7% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.9% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -2.2% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -0.8% (2017 Actual) (also known as External Balance)

External debt/GDP: 23.3% (2017 Actual)

Level of economic development: Moderate level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 18 July 2018, a rating committee was called to discuss the rating of the Philippines, Government of. The main points raised during the discussion were: The issuer's fiscal or financial strength, including its debt profile, has materially increased. Other views raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Christian de Guzman
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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