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Comments on the UN Financing for Development Paper vis-à-vis Debt Issues by Maria Teresa D. Pascual, Freedom from Debt Coalition

Clearly absent in this UN discussion paper is a section that deals with how to get developing countries out of the debt trap that many already find themselves in, and how to avoid it for those developing countries not yet caught in the trap. Any serious discussion on financing for development must take this into consideration. As evidenced in the Philippines, the struggle to develop is inextricably tied to the struggle to get out of indebtedness. Yet the experts hired by the UN to draft this paper fail to recognize this. Worse, in identifying new financing for development for middle-income countries like the Philippines, the paper implicitly recommends that we simply borrow more, or enter into contracts with the private sector that have tended to be extremely disadvantageous to the government, and thereby the people. It is almost as if the UN were delivering a subliminal but cynical message to countries like ours: that there is no way out of the debt trap. But such a premise would logically lead to the conclusion that there is no way for countries like ours to develop. This would go against the UN’s own vision and mission. It is highly unusual and unfortunate that the UN paper on financing for development does not deal with the debt problem as a distinct concern. It merely incorporates this in the section on official development assistance. No mention is made of the debt crisis of the 1980s, known to many as the lost decade, and of which the Philippines was a part. Yet the repercussions of this debt crisis continue to be deeply felt especially in those countries that were hit by the crisis, including ours. The paper in fact takes up only the proposal of the World Bank and the International Monetary Fund for debt reduction of highly indebted poor countries. Known as the HIPC initiative, later renamed the ‘enhanced’ HIPC initiative, this proposal is noteworthy because of the large number of countries that it disqualifies rather than covers as potential beneficiaries. And even among the few that could qualify for debt reduction under this initiative, the amount of debt reduction is small, the benefits questionable, but the costs in terms of adjustment policies and IMF-WB conditionalities that hurt the people more than harm them, are certainly high. Much less is said about the need to reform the international financial institutions—the IMF, the World Bank and regional banks such as the Asian Development Bank—that continue to wield tremendous influence over economic decision-making in developing countries. Getting out of indebtedness also means changing global structures, including these institutions. Our country’s experience with the debt crisis and liquidity crunch of the 1980s, that led to a serious economic debacle, saw per capita real GDP fall to below the 1982 level, historically the highest per capita figure ever recorded in our postwar economic history. Since then ours has been a tumultuous climb to recover what the Marcos dictatorship wasted and the debt debacle destroyed. In the last two decades of the 20th century we have gone through a power crisis, two economic recessions and more recently under the Estrada administration, a financial crisis. We are still a long way from recovering from the fall in per capita real GDP. Breaking the chains of debt Will the Philippines ever free itself of the chains of indebtedness? This will take hard work, serious change of deeply embedded structures, relationships and ways of thinking and doing, and a completely different program for development. The Freedom from Debt Coalition (FDC) believes that the first step necessary to weaken the bonds of debt enslavement is the repeal of the provision (Section 26, Book 6) in the Revised Administrative Code of 1987 regarding automatic appropriations for debt service. Without the repeal of automatic appropriations the country will continue to stay trapped in debt. Pascual /


This repeal is necessary, but not sufficient. Years ago when President Aquino basked in the goodwill of the international community she chose not to take the historic opportunity that only her administration enjoyed, to call the international lending community to account for its part in the Marcos debt debacle. Instead she chose to “honor all debts” including the fraudulent debts of the Marcos era, thus giving the banks, the Marcoses and the cronies an easy way out. Our economy’s continued weakness is evidence of that wrong judgment. In recent years we have had another opportunity to call on the international creditors, private and public, to shoulder their share of the debt burden. This is through the global jubilee movement that has been raising the demand for the cancellation of third world debt. For the Philippine government to miss the boat a second time is not surprising, considering its debt policy has focused on ensuring continued access to new borrowings, and considering its persistent belief that it cannot live without borrowing. But to miss the boat a second time would be tragic as well, because the people are paying the price of government’s mendicant policy. So, debt cancellation would help our economy but again it would still not be enough. We need a policy that is consistently geared towards making us less addicted to debt and more capable of helping ourselves. We need a package of policies that would:  Punish perpetrators of cronyism and corruption swiftly and firmly.  Raise people’s incomes and encourage them to save.  Reduce the gap between rich and poor through social redistribution programs such as agrarian reform, housing reform, education reform, and the like.  Collect taxes from businesses and wealthy individuals, go after big-time evaders and prosecute corrupt revenue officers.  Make production less import-intensive and import-dependent.  Develop technologies that would make us more productive and build on our resources in an environmentally friendly way.  Adopt a framework of development where the poor benefit first from whatever growth is attained, where people matter more than the creditors, where growth is sustainable because it is based on empowering the poor. The character and nature of the Philippines’ debt bondage has changed over the years but many aspects of the debt problem remain the same. The sections that follow provide a background and overview of the debt situation in the Philippines. Beginnings of the debt debacle Since 1962, when the Philippines obtained its first standby loan from the IMF, it has been undergoing some kind of stabilization program with the IMF. In 1970, the private sector accounted for over half of the country’s foreign debt. This changed in the 80s when the Marcos government assumed the debts of the private sector—many incurred by his cronies and relatives—that it had guaranteed. By the time Marcos was deposed, the country’s foreign debt stood at $26 billion, of which nearly three-fourths was the debt of the government. Despite the blatantly onerous conditions that accompanied many of these debts, not to mention the highly dubious character of how many were incurred, the Aquino government declared that it would “honor all debts above all else”. It was paying, for instance, $300,000 a day for interest alone on the fraudulent Bataan Nuclear Power Plant loan. With regard the IMF’s twin, the World Bank, the Philippines has been an experimental guinea pig particularly of its structural adjustment policies since the early 1980s. Through structural adjustment lending the World Pascual /


Bank shifts macroeconomic policy as well as policies of specific sectors to be compatible with the global economy. This type of WB lending is part of a “twin” package of stabilization and adjustment about which the IMF and World Bank have become notorious. In fact WB structural adjustment lending always requires as a precondition an approved IMF stabilization program. Loans with the IMF (in million SDRs) IMF Facility 1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th 11th 12th 13th 14th 15th 16th 17th 18th 19th 20th 21st 22nd 23rd 24th 25th 26th 27th

Stand By Stand By Stand By Stand By Stand By Stand By Stand By Stand By Stand By Stand By Stand By Stand By Stand By Extended Fund Supplementary Finance Supplementary Finance Stand By Compensatory Finance Stand By Stand By Stand By Stand By Extended Fund Extended Fund Stand By Extended Fund Stand By

Date of Arrangement Apr 12 1962 Apr 12 1963 Apr 12 1964 Apr 12 1965 Apr 12 1966 Jan 05 1967 Mar 15 1968 Feb 03 1970 Feb 02 1971 Apr 27 1972 May 16 1973 Jul 16 1974 May 30 1975 Apr 01 1975 Jun 11 1979 Feb 27 1980 Mar 25 1983 Mar 25 1983 Dec 14 1984 Dec 14 1984 Oct 24 1986 Oct 24 1986 May 23 1989 May 23 1989 Feb 20 1991 Jun 24 1994 Apr 01 1998

Date of Expiration or Cancellation

Apr 11 1963 Apr 11 1964 Apr 11 1965 Apr 11 1966 Apr 11 1967 Jan 04 1968 Mar 14 1969 Feb 02 1971 Feb 02 1972 Apr 26 1973 May 15 1974 Jul 15 1975 May 30 1976 Dec 31 1978 Jun 10 1980 Dec 31 1981 Mar 28 1984 Mar 28 1984 Jun 13 1986 Jun 13 1986 Aug 23 1988 Aug 23 1988 Feb 19 1991 Feb 19 1991 Mar 31 1993 Mar 31 1998 Dec 31 2000 Total

Amount Agreed 40.4 40.4 40.4 40.4 26.7 55.0 27.5 27.5 45.0 45.0 45.0 38.8 29.1 217.0 105.0 410.0 315.0 188.0 307.5 307.5 66.8 131.2 518.0 142.6 334.2 791.2 1,020.8 5,356.0

Amount Drawn

Amount Outstanding

55.0 27.5 27.5 35.0 35.0 38.8 29.1 217.0 91.3 410.0 n/a n/a 201.5 201.5 66.8 131.2 235.9 0.0 334.2 791.2 783.2

779.0 783.2 1,562.3

Sources: International Monetary Fund (IMF); The Philippine Financial System—A Primer, Manila: IBON Databank, 1983, p. 118.

WB Structural Adjustment Loans to the Philippines After more than 10 years of WB-IMF supervision, structural adjustment and stabilization have done little to reduce poverty in the Philippines, and have failed miserably in addressing problems of inequality, which always worsen during a crisis. The bitter medicine prescribed by the IMF and WB are like a “slimming diet for the starving”. As a result of IMF and WB financing the government has had to:  withdraw subsidies for farmers and consumers;  raise indirect taxes that weigh more heavily on the poor than on the rich;  open the economy to foreign goods and services while reducing support for small producers;  surrender authority over oil pricing to giant multinational oil companies;  turn over water distribution in Metro Manila and other urban centers throughout the country to private hands (generally big Filipino corporations in joint venture with multinational water firms); Pascual /


 liberalize the capital accounts, thereby allowing the entry of short-term capital that can do serious harm as shown by the 1997 currency crisis;  allow foreign companies to exploit our mineral resources that are generally found in the ancestral domain areas of indigenous communities; and  privatize strategic companies like the National Power Corporation, without bringing down power rates that are already the second highest in Asia. TABLE ON WORLD BANK SAPs Another supposed objective of structural adjustment is to achieve sustainable high growth. Again in this regard the record of structural adjustment lending is very dismal. The Philippine economy has repeatedly gone through cycles of crisis and recovery. Official data show that between the mid-70s to the present the highest our gross domestic product (GDP) has grown is 6.75%, in 1988. We have yet to experience sustained GDP growth of over 5% for at least five consecutive years. To this day we have yet to get back to the historically highest per capita real GDP level of P12,869 attained in 1982. Even the boom of 1996 was shortlived and by now it is clear that the source of that boom was highly volatile portfolio capital inflows that fuelled the real estate sector. The subsequent disappearance of portfolio capital and the financial crisis that began in 1997 only highlight the feeble and fickle nature of such growth. Emergence of the domestic debt problem Despite Corazon Aquino’s policy to “honor all debts” of the Marcos dictatorship, and despite the international goodwill generated by her assumption to power, most creditors refused to extend new loans to her government. For this reason and also because its tax reform efforts failed, her government resorted to borrowing from the domestic market to pay for its heavy debt service. Government’s move to issue short-term treasury bills that were generally bought by the local banks and their clients meant that it was competing with private sector borrowers for peso loans. This, together with the IMF policy of keeping money supply tight, led to a rise in interest rates, thus adding to the debt service burden of the national government. Borrowing at high interest from the domestic market also meant that at a time of severe crisis, the Aquino government was giving the Filipino elite a convenient way of earning profits with the capital they invested in treasury bills. This cozy arrangement ensured the high incomes of the elite who did not have to risk investing their capital in productive ventures for as long as the government was there to pay them excessively high interest. In the meantime, the domestic debt of the national government grew to P742 billion by the end of 1996, and is a new vulnerability of the government where the debt is concerned. Latest available data show that as of the end of 2000 the national government’s domestic debt stood at P1.1 trillion pesos. This means that every time the interest rate goes up by one percent, the national government’s annual interest burden on its domestic debt increases by at least P10 billion. This shows how serious the domestic debt problem is. The Ramos government’s policy choices A return to creditworthiness under the Ramos administration led to a resumption of bank lending after a long dry spell under the Aquino government. The private sector began borrowing again, but this time dollar loans came from both foreign and domestic sources. This was a new twist from the past, one that resulted from the liberalization of capital accounts in 1992, when all restraints on the inflows and outflows of capital were removed.

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President Ramos knew that he had to attract foreign money for his economic game plan to succeed. This plan was to achieve high growth, and foreign money was to fuel it. For this purpose his technocrats kept the peso overvalued at a relatively steady rate of P26 per US dollar. They kept interest rates high at a time when prime rates around the world were low, in order to make it worthwhile for the fund managers of global capital to choose the Philippines over other markets including their own. Both these policies in the context of liberalized capital flows worked, at least for a few years. From 1992 to 1996 the inflows of portfolio investments totalled $16.4 billion, more than double the inflows of direct investments of only $6.5 billion for the same period. The unprecedented massive inflows of foreign currency between 1992 and 1996 naturally fuelled high growth. And although the high growth also meant that dollars would keep flowing out of the country in huge magnitudes to purchase imports and to service foreign debts, this hardly made a dent because the outflows were overshadowed by the massive inflows. The Ramos strategy therefore made it possible for the economy to grow much faster, chalk up more debts, register unprecedented deficits in the trade and current accounts, without experiencing a foreign exchange crisis. Thus the real cause for the triumphalism of President Ramos’s debt managers was that foreign money was pouring in, even as debt obligations and the ballooning trade deficit continued to drain the economy of its resources. A number of policies to attract money, especially dollars, to fuel high growth, caused a dramatic increase in private sector foreign debt. These policies included: high domestic interest rates on peso borrowings, the guarantee of stable exchange rates and the liberalization of capital accounts. The guarantee of stable exchange rates (implicitly pegging the peso at $26 to $1) sent signals to the private sector to go ahead and borrow dollars. This was another variation of the age-old guarantee extended by the Marcos government to the debts of the dictator’s cronies and relatives. Although both the Aquino and Ramos governments officially discontinued this practice, it actually continued albeit in another form, that is, in the form of a guaranteed exchange rate. The low interest rate on dollar loans compared to high interest rates on peso credit further encouraged the private sector to borrow in dollars. To keep the exchange rate stable and stop the peso from appreciating, the Philippine government instituted “sterilization” measures—buying dollars from the system. This kept the peso-dollar rate steady, and raised and maintained high interest rates on the peso and further increased the domestic debt, as well as attracted further dollar flows from abroad. By 1997 it had become evident that the Ramos formula for high growth was exacting a heavy toll on the economy as the bubble burst mid-1997 for various Asian countries, including the Philippines. The high level of interest rates made it expensive for investors to borrow pesos. It also discouraged investments in productive capacity, which had to show a return that was higher than investments in treasury bills and other money market instruments. But the high interest rates were the Ramos government’s key to attracting portfolio investors. And they ensured that the overvalued peso would remain steady against the dollar and other foreign currencies. Inasmuch as this was killing the domestic economy and thereby stifling growth, the Ramos government had no other formula to pursue. It was trapped in its own “miracle”. Ramos’ policies combined to reinforce the trend of: mounting trade deficits massive short-term portfolio inflows and thus, increased vulnerabilities to sudden capital flight growing dollar indebtedness of the private sector; and resurgent dependence on foreign and domestic short-term debt. Towards the end of Ramos’ debt-driven term, large capital withdrawals took place from March to June 1997 as short-term investors and speculators sensed trouble. Among others, the capital flight led to the devaluation Pascual /


of the peso and an economic recession. Even as the Ramos government bragged about exiting from IMF lending (the 23rd attempt), it was already on its way to negotiating for another standby credit arrangement with the IMF. It eventually agreed to another IMF economic program and new World Bank structural adjustment loans. To this day we have yet to break away from IMF “supervision”. (The current standby loan is the 27th facility obtained from the IMF.) Behest lending reincarnated At the same time that the Aquino government honored the fraudulent debts of the Marcos era, her government forbade the practice of extending state guarantees on private sector loans. The general thinking was that in the absence of such guarantees, behest lending would die. While the Ramos government upheld the decision of the Aquino government not to guarantee the debts of the private sector, it had in fact issued other guarantees that ensured the revenues of the private companies whom it had contracted to undertake Build-Operate-Transfer (BOT) infrastructure projects. While the government had not explicitly agreed to service the private contractors’ debt obligations, it had fully guaranteed the contractors’ incomes, thereby ensuring that the contractors’ debt obligations would be repaid. Such revenue-side guarantees meant that all costs of the contractors would be met, and subsequently, their profitability guaranteed. In effect, the private contractors became bankable. In other words, non-loan guarantees embodied in BOT contracts were an indirect way of guaranteeing the debts of the private sector. The BOT contracts enabled the Ramos government to put an end to power outages of the early 1990s. However, in order to attract private sector participation the government agreed to purchase a guaranteed level of capacity, quoted in US dollars at a price much higher than it would have cost the government to generate such capacity. The government also guaranteed fuel cost and such other business risks. This explains why electricity rates in the Philippines are the second highest in Asia, second only to Japan. The result of these non-loan guarantees is heavy obligations running to billions of pesos yearly. How much these guarantees amount to is not exactly known, even by the Government itself. But if the soon-to-beprivatized National Power Corporation were a good example, then we can expect contractual obligations to far outweigh debts. According to its audited report for the year 2000, the National Power Corporation owed P292 billion to banks by the end of that year. But it had more than this—P486 billion worth—of contractual obligations owed to independent power producers as of the same period. Ballooning deficit, ballooning debt The government’s foreign debt and the National Government’s domestic debt ballooned during the shortlived days of the ERAP presidency. While the foreign debt of the private sector fell slightly from $23.3 billion at the end of June 1998 to $23 billion at the end of 2000, that of the public sector grew from $27.9 billion to $34.4 billion over the same period. The National Government’s domestic debt likewise grew from P750 billion at end-1997 to P1.1 trillion pesos at end-2000. But the Government also has domestic dollar debts, which are generally two kinds: dollars borrowed from the foreign currency deposit units (FCDUs) of domestic banks, and dollars borrowed from Philippine residents who invested in Philippine government debt papers. Although both of these are dollar denominated debts, they are considered as domestic debts since the lenders are local residents. But since they are dollar debts they must also be repaid in dollars. According to the BSP, Philippine residents held $2.95 billion worth of Philippine government debt papers at the end of June 1998. By end-2000 this figure had grown to $4.8 billion. Furthermore, public sector debts owed to FCDUs have grown from $318 million as of end-1997 to $589 million as of end-2000.

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Altogether, as a proportion of the gross national product, the public sector foreign debt plus the National Government’s domestic debt plus the government’s domestic dollar debts were equivalent to 87.2% of GNP last year. One thing the Erap government was singularly successful in, was in bringing down the government’s tax effort, or the ratio of tax revenues to GNP. Erap may have nationalized the jueteng collections under his thumb, but he severely eroded tax collections. From a ratio to GNP of 16.3% in 1997, tax revenues fell to 12.9% of GNP in 2000. The Estrada administration revived cronyism to such an extent that it failed to meet its revenue goals. Consider the following: • In 1999, it fell short of its revised revenue target by P12 billion. The following year, 2000, total revenues actually collected were P61.3 billion short of target. (Department of Finance/DoF) • The deficit in 1999 of P113 billion was seven times the original deficit target, and more than double the 1998 deficit of P50 billion. By 2000 the National Government deficit had reached P136 billion, exceeding the target for the entire year of P62.5 billion. The deficit last year was equivalent to 4% of gross national product or GNP. • Although it had been keeping a tight rein over spending, the Estrada government ended its last year in office by spending P12 billion more than it had budgeted. The jueteng scandal exposed to the nation by Erap crony and Ilocos Sur governor Luis Chavit Singson triggered a spending spree in the last quarter of 2000. • Interest payments of the National Government alone are growing much faster than both taxes and GNP. From a low of 18.9% of tax revenues in 1998, interest payments of the National Government swelled to 31.2% of tax revenues last year. Add the principal payments to interest and we are seeing well over half of tax revenues going to creditors instead of the poor. Poor person’s burden After more than 30 years of WB-IMF supervision, little has been done to reduce poverty and to address problems of inequality. Adding to the burden, government delivery of social services (education, health and housing) and its ability to maintain adequate roads, transport and communication infrastructure remain mired in corruption and are heavily constrained by the servicing of its debt. The share of interest expense to the total budget has fallen in the 90s but remains the top item in the national budget, averaging at 33% between 1990 and 1997. TABLE ON PHILIPPINE DEBT AS OF END-2000 Although the Constitution mandates that the biggest share in National Government spending should go to education, the reality is that education spending does not enjoy top priority. Debt service does. The impact of this misplaced priority can be seen in the following: • Government spends only P4,540 per pupil enrolled in public elementary schools, a mere seventh of Thailand’s education spending of P28,000 per pupil. • According to estimates of then Education Secretary Andrew Gonzalez, government needs to spend P20 billion more each year just to overcome its backlog: a shortage of 9,760 teachers nationwide in 1999, and a backlog of 14,615 classrooms.

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Automatic Appropriations for Debt Service Crucial to the country’s continued debt addiction is a law providing for automatic appropriations for the purpose of debt service. Its origins lie in 1977 when Mr. Marcos issued presidential decree 1177 with a provision (Section 31b) that authorized automatic appropriations for debt service. The Aquino government then institutionalized the dictator’s decree by including it in the Revised Administrative Code of 1987 as Section 26 of Book 6 which effectively— • gives highest priority to debt service over all other government spending, including education, health, agrarian reform, poverty reduction, disaster relief, social safety nets, rural infrastructure, and the like • removes from Congress the authority to appropriate over 60 percent of the government’s tax revenues. The extent to which debt spending eats up precious government tax revenues is shown in the table below. TABLE ON TAXES AND DEBT SERVICE There are more insidious implications of the automatic appropriations law. For as long as it remains in effect— • government can expect to get a good credit standing from the international lending community, and therefore a “reasonable” premium over benchmark interest rates • government is not compelled to collect taxes from the rich. For as long as it fails to collect taxes from the rich, the government has to borrow, generally, from the rich. • the government’s creditors need not worry if they are lending money for an unviable project, or for something that will not be able to generate the money needed to repay the loan. In other words, the banks do not pay any price for any bad decision over any loan to the government. • there is no risk in lending to the government, even if the loan or project is tainted with fraud and corruption. Diminished space One way in which the debt was managed was to increasingly diminish the space for the government to negotiate even a simple restructuring of the debt. CHART ON DIMINISHED SPACE • The proportion of total outstanding foreign debt that was non-restructurable grew from 12 percent in 1970, to 21 percent in 1985 and 27 percent in 1991. By the end of 1999 this proportion stood at 48.9 percent. • In 1991, a recession year emerging out of a growth-stifling “honor all debts policy,” the debt service payments on non-restructurable debt were equivalent to 44 percent of all debt service payments on the country’s foreign debt. • By the end of 1999, more than half (54.1%) of all debt service payments were made on non-restructurable foreign debt. Net transfers on debt: Tale of the tape The Aquino policy of repaying the commercial banks in the hope that they would be enticed into giving substantial new money did not succeed. This is evident in the data on net transfer on debt (the residual amount obtained after deducting debt service from loan disbursements for a given time period). Pascual /


• From 1970 to 1999, the cumulative net transfer on the Philippine external debt amounted to a net outflow of $10 billion. This is equivalent to -0.84% of the cumulative gross national product or GNP for the same period. (World Bank) • Between 1986 and 1991, the net transfer on debt was negative, averaging a net outflow of $1.3 billion a year. In 1988 the level of net transfer on debt meant that 5.5 percent of the GNP was siphoned out of the economy into the vaults of the banks. TABLE ON NET TRANSFER ON DEBT UNDER VARIOUS ADMINISTRATIONS Challenges for the Macapagal-Arroyo Administration The government of President Gloria Macapagal-Arroyo faces many challenges with regard to the debt problem. Most important among these are the following:  Addressing the fiscal deficit, which had been increasing during the Estrada years. Crucial to addressing this problem would be raising the tax effort. This is as much a problem of governance as it is one of moving the economy out of its doldrums and towards a more sustainable growth and development.  Reprioritizing spending on debt service. With the peso devaluation and high premiums on government borrowing, the Philippine government’s debt service burden is increasingly becoming heavier. This is also because it has dollar-denominated domestic debts in addition to its foreign debt obligations. Repealing the automatic appropriations for debt service would give the Arroyo government a freer hand in prioritizing spending.  Dealing with the huge amounts of contractual obligations of the government. The contracts of government entities with the private sector are entailing huge contractual obligations that the government must now honor, either by directly subsidizing the government entity concerned or by incurring new borrowing so that these contractual obligations may be met. A review of these contracts is urgently needed, and a renegotiation of those contracts found to be onerous must be undertaken. At the same time, if any past (or present) officials are responsible for having placed an onerous burden on the government, and eventually, us taxpayers, then these officials must be appropriately charged in court.  Laying the ground for our long-term struggle to get the country out of the debt trap. In order for our country to develop, we must have a clearcut strategy on getting out of our economy’s addiction to debt. The Arroyo government would make history if it could lay the basis for our successful and eventual way out of the debt trap.

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PP Comments on UNFD Debt Issues