Philippines - A review of external debt

Report No. 4912-PH FILE COPY The Philippines A Review of External Debt November 2, 1984 East Asia and Pacific Regional Office FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS US$1.0 = P 20.0 P 1.00 = US$0.05 ABBREVIATIONS BOP - Balance of Payments CFBP - Consolidated Foreign Borrowing Program D/As - Documents Against Acceptance DBP - Development Bank of the Philippines DOD - Debt Outstanding and Disbursed DRS - Debtor Reporting System (World Bank) DSC - Debt Servicing Capacity DSR - Debt Service Ratio FCDU - Foreign Currency Deposit Unit ICc - Investment Cordination Committee ICOR - Incremental Capital-Output Ratio IMF - International Monetary Fund MEDIAD - Management of External Debt and Investment Accounts Department, Central Bank MlT - Medium- and Long-term M V - Manufacturing Unit Value NEDA - National Economic and Development Authority NIDC - National Industrial Development Corporation O/As - Open Accounts OBU - Offshore Banking Unit OIDC - Oil Importing Developing Country PDCP - Private Development Corporation of the Philippines PNB - Philippine National Bank SAL - Structural Adjustment Loan SMNP - Subcommittee on Major National Projects  FOR OFFICIAL USE ONLY PREFACE This report presents the findings of a mission which visited Manila in April 1983 to study the size, structure, and policy implications of the country's rapidly growing external debt. The mission consisted of Sarshar Khan (Chief), Jayati Datta Mitra, Beatriz Florendo (Bank staff), and Christopher Browne (IMF). The study was originally designed for the internal use of the Government and the Bank to provide policy guidance. The analysis for the study was, therefore, completed in mid-1983 and its results were discussed with Government officials in September. Subsequently, because of the balance of payments crisis in late 1983 and wider interest in the study, it was agreed with the Government that the study may be finalized and circulated more widely. The full report was discussed with Government officials in March 1984 and the final draft shown to them in July-August 1984. The economic situation has changed considerably since the completion of the major part of the analysis in 1983. First, the balance of payments crisis occurred in October 1983 and attempts to resolve it are still con- tinuing. Second, the data on the balance of payments, reserves, and debt came under closer scrutiny and are being revised; some revised data have recently become available. The economic situation is still fluid and economic pros- pects not yet clear. These developments are being covered in detail in the Bank's Country Economic Memorandum currently under preparation. As such, a complete revision of this report has not been attempted; its focus remains on he analysis of developments from mid-1970s through 1982. However, revised data (as of August 1984) have been used wherever possible, and the 1983 crisis, together with its policy implications, has been discussed briefly. The report consists of summary and conclusions and the main report. Chapter 1 of the main report reviews the economic background and the emergence of current account deficits in the mid-1970s. Chapter 2 analyses the growth and structure of external debt and the resulting debt service burden. Chapter 3 relates the external borrowing of the public and private sectors to their pattern of investment and savings. Chapter 4 reviews the institutional framework and performance of the country's debt management sys- tem. Chapter 5 draws implications of the debt analysis and recent economic events and suggests policy and institutional improvements. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  I  TABLE OF CONTENTS Page No. PREFACE ........................ .... ................................. SUMMARY AND CONCLUSIONS .......... . .. . .. . .. . . ........................ ........ i-vi 1. SETTING THE STAGE .......................................... o ................... 1 Economic Background ...................... ....... , ..... ........... 1 Sources of Change in Current Account Deficits .................... 2 Macroeconomic Adjustments .*.................... ..... . ..... 5 Financing the Current Account Deficit ......... ................... 5 2. TRENDS IN EXTERNAL DEBT ....................... . . ................ 6 An Overview ................................... ,,.................. 6 The Evolution of External Debt ......................... 6 Assessing Debt Levels .................................................. 10 Interpreting the Trends in Philippine Exposure .................. 12 Financing Patterns .. ......... .......................... .... ............. . 14 The Structure of Borrowers ....... ............. * ........ .., 19 The Structure of End-Users ............... ..... ................... 21 Debt Service Obligations . . .... ........... ......... . ........................ 24 3 * INVESTMENT AND SAVINGS .....................,. . ..... 28 Investment and Savings Behavior .... .............. . .... 28 Resource Use by the Public Sector ................................ 30 4. DEBT MANAGEMENT ................... . ...... *.... ............. 37 The Institutional Framework * ... ...... ................ ..... .*.. 37 MEDIAD's Functions .......................... . .38................ .. 38 ICC and Macroeconomic Management .............. . .................. 42 Debt Management: Scrutinizing the Record ......................... 43 5. IMPLICATIONS FOR THE FUTURE ............................... ..... 46 Macroeconomic Policy and Foreign Borrowing ....................... 46 Institutional Framework ... .. . ... ......................... o....*.*... 48 STATISTICAL APPENDIX .................. .............. * . 51  Page No. LIST OF TEXT TABLES Table 1.1: Sources of Change in Current Account Deficits, 1977-82 4 Table 1.2: Growth Rates of Consumption, Investment, and GNP ........ 5 Table 2.1: Structure of Debt,1970-82 ........................... 7 Table 2.2: External Debt and Banking System Liabilities, 1976-82 9 Table 2.3: Debt Indicators ......................................... 11 Table 2.4: Share of Banks and Other Financial Institutions in Official Short-Term DOD .......... . ..............0. 13 Table 2.5: Structure of MLT Debt by Creditor ............. . ........ 15 Table 2.6: Distribution of Public Sector Debt By Concessional/Non-Concessional Categories ........ 16 Table 2.7: Currency Distribution of Public Sector Commitments ...... 18 Table 2.8: Structure of MLT Debt by Borrower . ................. 20 Table 2.9: Total Outstanding Borrowings Under the CFBP ... o...o.... 22 Table 2.10: Share of the Private Sector as an End-User in MLT Debt ... 23 Table 2.11: Official Non-Oil Short-Term Debt . ................ 24 Table 2.12: External Debt Service Ratios, 1977-82 ... ................. 26 Table 2.13: Public Sector Debt Service Paymients .... ...... .......... 27 Table 3.1: Investment and Savings ..o ................... 29 Table 3.2: Investment and Savings by Sectors ......... .......... 31 Table 3.3: Financing of National Government Capital Expenditures Equity Contributions and Net Lending .............. ..... 33 Table 3.4: Major Non-Financial Public CorporatioDns: Summary of Operations ......................................... 34 Table 3.5: GDP Growth Rates and Economy-Wide ICORs .........o..... 36 Table 4.1: Refinancing, Restructuring and Repayment of Principal, 1976-82 ..... . 40  SUMMARY AND CONCLUSIONS In recent years, the Philippine economy has had to weather a number of adverse exogenous developments: the second round of oil price increases of 1979-80, a sharp deterioration in the terms of trade, international recession, and an associated drop in the demand for Philippine exports. These develop- ments, combined with expansionary demand policies, led to an increase in the country's current account deficit and a rapid accumulation of external debt. Recognizing the emerging problems, the Philippine Government invited a World Bank mission to examine the growth and structure of the Philippine debt, analyze the policy implications of the country's debt burden, and assess the institutional framework for debt management. Growth and Structure of External Debt The Philippine external debt has grown tremendously since the early 1970s. Medium- and long-term (MLT) debt increased six times during 1970-82. Its ratio to GNP increased from 26% to 33%. During the period 1976-82 (for which the relevant data are available) the ratio of total debt (including all IMF obligations and net external liabilities of the banking system) to GNP increased from 24% to 49%, and the ratio of this debt to exports increased from 123% to 239%. Both of the end-period ratios were too high and affected outside perceptions of the country's creditworthiness. At the same time, the country's debt structure became increasingly skewed toward short-term debt, and the share of financial institutions in the credit mix rose markedly. By 1982, the share of short-term debt and gross banking system liabilities had risen to nearly 47% of the total, and about 68% of total obligations were owed to banks and financial institutions. This greatly increased the vulnerability of the country to short-run international market developments. In addition, the Philippines' dependence on credit rollovers increased at a time when international banks became increasingly concerned about their exposure in developing country borrowers, including the Philippines. Two implications of the above are noteworthy. The predominance of financial institutions in the creditor mix led to a rise in the share of non-concessional debt in total commitments with the consequent rise in the country's interest service obligations. Moreover, the continuing use of some of the short-term credit for financing working capital needs, normally not a cause for undue alarm, rendered non-bank Philippine borrowers vulnerable to dislocations in productive activity in the face of possible disruptions in credit rollovers. The rapid growth of total external debt in recent years, the preponderance of financial institutions in the credit mix, and the decelera- tion in export growth led to a sharp deterioration in the debt service ratio (DSR). Between 1977 and 1982, the DSR for MLT debt increased from 12% to 27% and for the total debt from 15% to 38% (the latter DSR includes MLT debt service, IMF repurchases and charges, and interest payments on revolving short-term debt and on gross banking system liabilities).  t- ii - Macroeconomic Aspects of Debt The underlying reasons for the massive growth of the Philippine external debt can be traced partly to external factors and partly to domestic policies. After the payments crisis of 19693-70, and the corrective measures taken in the form of devaluation and an imlproved debt management system, the country's current account deficit was roughly in. balance during 1970-74. Helped by the improved terms of trade, the country even ran a current account surplus in 1973. However, the account became negative in 1974, and the deficit quickly expanded, reaching 6% of GNP in 1980-81 and over 8% in 1982. On the external side, the most immediate cause for these large deficits was a loss in the terms of trade of 60% during 1974-77 and (after a gain of 15% in the next two years) 39% in 1979-82. In the latter period alone, this loss accounted for about $1.4 billion increase out of a total of $2.4 billion increase in the current account deficit.l/ Another $1.7 billion was accounted for by increased interest payments. Thus, it appears that the external factors were mainly responsible for the increase in the current account deficit (and consequent debt accumulation) in recent years. However, a closer examination shows that domestic policy variables, besides the longstanding structural problems of the economy, also contributed to these deficits. First, the import volume increased substantially during 1978-82, contributing about $1.8 billion to the increase in the current account deficit and offsetting an otherwise good performance oF exports (whose volume increase had a positive contribution of nearly $1.3 billion). This increase in imports was due to a number of factors, including the easy availability of private foreign credit, appreciation (by about 20%) of real effective exchange rate, and maintenance of relatively high investment and consumption levels. The domestic investment level 2/ has remained high relative to both GNP and national savings (and relative to the rates in other countries). The investment/GNP 3/ ratio, which had remained around 21% during 1970-73, jumped 1/ The various components of the increase in the current account deficit discussed here do not add up to $2.4 billion because of the small surplus experienced on account of services (excluding interest payments) and transfers. 2/ Refers to total investment. The fixeBd investment ratio shows a similar trend. 3/ It is believed that the investment and savings data are overstated in the Philippines. We understand that these are being scrutinized and might be revised downwards. The gap is, however, riot likely to be significantly affected.  - iii - to 27% in 1974 and to over 30% in subsequent years. But the national savings rate lagged behind and the investment-savings gap expanded from less than 1% to 5% or more, translating into the current account deficits discussed above. A major part of this investment-savings gap was attributable to the public sector (in fact, to public corporations) which ran increasingly large deficits during the period. The external debt data show that the national government and public corporations were also expanding their share in the use of foreign funds during 1978-82. Although investment rates had been reasonably high in the early 1970s and jumped up significantly in the mid-1970s, they do not appear to have contributed sufficienty to higher growth rates towards the end of the 1970s. This was at least partly due to the long gestation periods of a large number of infrastructure projects undertaken during the 1970s. The ICOR has remained high, growth rates have dropped (in part on account of the international recession and low export demand), and debt servicing capacity expanded insufficiently, contributing to the current payments crisis. These issues involve macroeconomic policies beyond the scope of this study, but they under- score the need for the Government to reexamine the pattern and efficiency of investment, and the relationship between debt management and economic management. Even if investment efficiency had been higher, the country could still run into difficulty for lack of appropriate response to the worsened international financial climate. The sizeable domestic resource gap discussed above continued to be filled in by foreign resources at an increasing cost and risk. With the decline in international inflation rates during the 1980s, real interest rates became positive and high, and the country could no longer benefit from the eroding real burden of foreign debt. Simultaneously, because of the changed external environment, the country had to depend increasingly on commercial loans, variable interest loans, and short-term financing. Their combined effect was that the total debt service increased dramatically and the country became increasingly dependent on credit rollovers and vulnerable to short-term changes in international financial markets. Under the prevailing external economic conditions, more active and stronger domestic adjustment policies were needed. Some adjustment took place during 1980-82 when the growth rates of GNP, investment, and consumption fell. But the adjustment was not sufficient to prevent an expanding current account deficit. The public sector remained largely unresponsive to the changed situation, failing to curtail investment sufficiently or generate adequate resources. Debt Management Following the 1969-70 crisis, the Philippines had established a competent institutional framework for external borrowing and debt manage- ment. In fact, this framework is considered to be among the better ones in LDCs. The Management of External Debt and Investment Accounts Department (MEDIAD) in the Central Bank collected and categorized data for both MLT and short-term debt. It was also responsible for screening applications for  - iv - foreign borrowing, determining borrowing terms, monitoring debt service liabi- lity (as defined by law), and formulating future borrowing strategies. Many of these functions, especially regarding data management, were performed com- petently. But the system proved to be inadequate in the changed circumstances of the early 1980s. It was especially inadequate in exercising control on foreign borrowing (particularly, the short-term and public sector borrowing), in signalling emerging debt service problems (partly because of the inadequacy of the official debt service ratio), and in failing to take into account the burden of banking system liabilities. The latter are supervised by a different department of the central Bank. Discrepancies between the MEDIAD and BOP data on both MLT and short-term capital flows and uncertainty about the banking system's external liabilities created doubts about the reliability of the debt data and affected the country's creditworthiness. More importantly, the system was not closely linked to the broader tasks of macroeconomic management. It performed only a limited role in assessing the full implications of the magnitude and structure of private borrowing, monitoring the public sector's access to foreign resources, highlighting potential problems (such as those stemming from relatively high foreign bank exposure and a large share of the short-term debt), and in charting foreign borrowing options and strategies. Implications for the Future Recent Developments and the 1983 Crisis. Drawing policy implica- tions for the future needs to take into account not only the longstanding problems but also the more recent developments. As mentioned above, the current account deficit had expanded substantially in 1982. Because of the constraints on the availability of MLT funds, the country relied on short-term credit lines, and the net international reserve position became negative. In 1983, despite some additional restrictives policies adopted towards the middle of the year, the balance of payments position worsened. The public sector demand (primarily investment outlays of public sector corporations) remained strong, generating pressures for imports. Export performance, however, remained weak. The current account deficit expanded from 8.1% of GNP in 1982 to 8.2% in 1983. Furthermore, due to both political and economic uncertainties, capital flight increased, foreign credit availability decreased, and international reserves feLl sharply. Consequently, the Government sought a moratorium on debt repayments to commercial banks, further devalued the peso, reimposed foreign exchange controls, reduced public invest- ment program, increased import duties, and opened discussions with the commercial banks for debt rescheduling. At the end of 1983, gross external obligations had increased to $25 billion, up from $24.3 billion in 1982, and the total debt service ratio (on the basis of scheduled payments) remained high at 36%. Implications for Macroeconomic Policy. In the context of this study, one of the main objectives of the Government's adjustment efforts will have to be to improve the country's creditworthiness: for example, the net official reserves need to be built up to cover about three months of imports, the short-term debt and commercial banks" liabilities need to be reduced, and the ratios of debt and debt service to exports need to drop significantly. This, in turn, would imply adoption of policies (with somewhat different  policy mix for the short- and medium-term) to curtail current account deficits and arrange requisite capital inflows at reasonable terms. In the short-term, the country will need to restrain domestic demand sufficiently to limit the annual current account deficit to about $1-1.5 bil- lion. This would imply increased domestic savings, lower public sector defi- cits, a tight monetary policy, continued price corrections, and little or no growth during 1984-85. The demands of medium-term adjustment would be somewhat different. In view of the high level of country's indebtedness and debt service payments, the scope for additional borrowing will remain limited through the early 1990s. The proposed rescheduling of debt will ease the immediate payments problem but will necessarily cause a hump in the late 1980s and stretch out the debt service payments into the 1990s. The country will, therefore, have to follow a very careful course of macroeconomic (including debt) manage- ment. First, domestic absorption will have to remain constrained and savings increased. Second, a delicate balance will have to be maintained in external borrowing. Sufficient capital infLows (foreign savings) will be needed to resume growth, but too much borrowing (given the existing large debt), if available, could damage creditworthiness. On the other hand, lack of access to foreign capital could reduce investment levels, constrain growth of output and exports, and prevent a long-term resolution of the debt problem. Third, as a corollary of the above, investment efficiency will need to be improved, import growth restrained, and determined efforts made to expand exports. Export growth will play an especially crucial role in the economic recovery by facilitating necessary growth in iMports and investment. Continuation of structural reforms and of the recent movement towards flexible exchange rate should facilitate achievement of these objectives. Simultaneously, the Government will need to tighten its debt management and utilize foreign savings efficiently as discussed below. Implications for Debt Management. Several steps appear to be needed for improving the country's debt management to face the challenges of the late 1980s. First, the Central Bank will need expanded capacity and facilities for data management and forecasting and more adequate control over all debt data: MLT debt, short-term debt, and the banking system's liabilities and assets. Some improvements in this area were initiated in 1983. The Central Bank should also adopt more appropriate tools of analysis (e.g., a comprehen- sive debt service ratio and other debt indicators) to help chart future borrowing policies. Second, to perform the enhanced debt management func- tions, MEDIAD's status may have to be upgraded and its coordination activities vis-a-vis other agencies more firmly defined. Third, the country's debt and debt service burden relative to its GNP and exports is too high. Debt managers, therefore, need to plan to zeduce the level of this exposure over time. Fourth, debt management needs to be fulLy integrated with macroeconomic management within a framework of multiyear programming. The system of public sector project approval, and consideration of their foreign exchange require- ments, needs to be streamlined and strengthened. The present system, focused on the Investment Coordination Committee (ICC), Twas intended to take hold of the overall process of resource budgeting but has not been able to do so. It needs to be made more effective and linked to the budgetary process. The task  - vi - of debt management, being closely linked to macroeconomic management, needs political commitment and support of the highest levels of the Government.  1. SETTING THE STAGE Economic Background 1.01 The size and pattern of external borrowing essentially reflects developments elsewhere in the economy. Therefore, to put external debt issues in perspective, it islbest to begin by reviewing the relevant economic trends and policy responses.- 1.02 The acute balance of payments difficulties of 1968-69 (characterized by a rapid growth of external debt, particularly short-term debt) were followed by an initial period of modest recovery and subsequently by a sharp increase in the level of economic activity in the Philippines in 1973-74. The strong recovery in 1973 was led by an international commodity boom. The consequent improvement (28%) in the Philippines' external terms of trade boosted its export earnings and led to expansion in domestic output and in public and private investment. The growth in real GNP, which had been about 5% a year in 1970-72, nearly doubled in 1973. 1.03 This situation was soon reversed, however. There was an abrupt deterioration in the country's terms of trade as recession hit the Philippines' key trading partners. The Government responded by using the strong balance of payments position of 1973 to maintain the flow of imports and the momentum of growth. Though the growth rate dropped from the peak registered in 1973, a 6% growth rate was maintained during 1974-79, partly through increasing recourse to foreign savings. 1.04 The external accounts of the economy had been kept roughly in balance during 1970-72; in contrast, the sizable current account surplus of 1973 was followed by a continuous series of current account deficits, ranging around 5% of GNP and reaching 8.1% in 1982. Moreover, despite the fairly high overall growth rate sustained by the economy in the second half of the 1970s, the pattern of growth was marked by certain structural rigidities and inefficiencies: the relatively slow growth of the manufacturing sector (at about the same rate as GNP), its pronounced orientation toward the domestic market, the relatively low efficiency of investment, reduced but still heavy reliance on primary exports and on energy imports, and inadequate domestic resource mobilization. 1.05 These structural inadequacies left the Philippine economy somewhat ill-prepared for the adverse external developments that marked the post-1979 period: the oil price increases of 1979-80, the accompanying recession in the OECD countries, a sharp deterioration in the terms of trade, and disruptions 1/ For a more detailed account of earlier years, see The Philippines: Priorities and Prospects for Development, Report No. 1095a-PH, Vol. I, World Bank, Washington, D.C., 1975, and'The Philippines: Selected Issues for the 1983-87 Plan Period, Report No. 3861-PH, World Bank, Washington, D.C., 1982.  - 2 - in the demand for the Philippine exports. Moreover, the domestic policy adjustments undertaken in response to these changes proved inadequate. The consequent widening of the current account deficit led to a rapid growth in the country's external debt. The rapidity of this growth, the renewed re- course to short-term loans, the growing reliance on commercial bank credits, and the persistence of high interest rates in the international financial markets caused Philippine debt indicators to deteriorate markedly during 1980-82. 1.06 Before proceeding to analyze the growth and structure of debt (see Chapter 2), it would be useful to examine more (closely the factors that were responsible for the persistent current account deficits in the post-1970 period and the macroeconomic policies that influenced the evolution of the Philippine external debt. Sources of Change in Current Account Deficits 1.07 The current account was roughly in baLance during the period 1970-74 when rising export volumes, export prices, or transfers tended to offset other adverse developments (see Tables A.1 and A.2, Statistical Appendix). The real effective exchange rate was also fairly stable except in 1974 when it appreciated, and the country experienced a significant deficit in trade and current accounts (both import volume and import price indices increased sharply). The current account deficit increased to nearly 6% of GNP during 1975-76, largely due to the terms of trade loss, before declining to 3.6% of GNP in 1977. 1.08 The current accotnt deficit shifted up in 1978 and continued to increase in successive years, reaching over 8% of GNP in 1982. Whereas the average current account deficit to GNP ratic was 1.5% in 1970-77, it nearly quadrupled to 6.1% during 1978-82. There appear to be three main reasons for this sharp deterioration in the current account deficit during the latter period. First, the real effective exchange rate appreciated by about 20% which tended to encourage imports and reduce the profitability of exports. Second, the terms of trade deteriorated by about 32%. Third, the nominal (and real) interest rates on foreign loans increased sharply. 1.09 Table 1.1 provides a decompositioDn of the sources of increase in the current accunt deficit for the period 1978-82. Out of the total increase in the deficit, $1.4 billion was accounted for by the decl;ne in the terms of trade and $1.7 billion by increased :Lnterest payments.2 The changes in trade 2/ These figures add up to more than the total change of $2.4 billion in the deficit due to the surplus on accournt of the remainder of services and net transfers.  -3- volume accounted for only $0.5 billion. This, however, masks the fact that import volume incrt4ses were substantial, but were largely offset by increases in export volume. - 1.10 Overall, it appears that the external factors (the terms of trade loss and higher interest payments) were mainly responsible for expanding the current account deficits and the consequent accumulation of debt. The sharply increasing debt burden (analyzed in the next Chapter) was having a snow- balling effect: interest payments due on the previous debt were contributing to the further expansion of the debt. However, domestic factors also contri- buted to these deficits. The domestic demand continued to grow at a relative- ly high rate despite worsened external environment which resulted in substan- tial import volume increases. This was partly due to the fact that suffici- ently strong corrective measures were not adopted in terms of controlling public sector deficits (discussed in Chapter 3), adjusting exchange rates, and responding to the harder terms of foreign loans. The following section sheds further light on the macroeconomic changes during 1978-82. 3/ The largest single increase (of over $1.0 billion) in the current account deficit occurred in 1982. The major changes in this year were increases in import volume and interest payments, and a drop in service receipts. The import volume increase occurred mainly in intermediate goods and food: fertilizer, iron and steel, iron ore, wheat, and corn (see Table A.27, Statistical Appendix). The drop in service receipts was mainly on account of a drop in interest receipts. Thus, the change in the current account deficit during 1982 was spread over a number of items, partly reflecting the cumulative debt service burden and partly increased imports to maintain consumption and (agricultural) growth.  - 4 - Table 1.1: SOURCES OF CHANGE IN CURRENT ACCOUNT DEFICITS, 1977-82 US$ millions % share 1977-82 1977-82 Increase in the Current Account Deficit 2,448 100.0 A. Price Effects 1,388 56.7 Import Price Effect 1,974 80.7 Export Price Effect -586 -23.9 B. Volume Effects 494 20.2 Import Volume 1,778 72.6 Export Volume -1,284 -52.4 C. Interest Payments 1,719 70.2 D. Service Payments Excluding Interest 971 39.7 E. Service Receipts -1,898 -77.5 F. Net Transfers -226.0 -9.2 Note: Changes in the current account, services and transfers were calculated in nominal terms relative to 1977. Price and volume effects for exports and imports were calculated by distributing the value increase in proportion to the increases in price and volume indexes. Source: Central Bank; mission estimates.  -5- Macroeconomic Adjustments 1.11 The large and persistent current account deficits raise questions about the nature of macroeconomic adjustments undertaken during the late 1970s and early 1980s. In such an adjustment process, economic growth may need to be curtailed while investment may need to be protected to some extent to protect future growth. This would, in turn, imply greater restraints on consumption. As Table 1.2 shows, the GNP growth rate dropped only moderately, and the burden of this adjustment was borne unequally by consumption and investment. Though the growth rate of personal consumption fell steadily in 1980-82, it remained higher than the growth rate of GNP. The growth of 0ov- ernment consumption actually accelerated towards the end of the period.- On the other hand, the growth rate of total fixed capital formation dropped sharply during 1979-82 and was significantly lower than that of consumption. Furthermore, almost all of the increase in investment occurred in the public sector (see Chapter 3). Thus, it appears that the magnitude and mode of adjustments undertaken in the face of persistent and rising current account deficits were inadequate. Table 1.2: GROWTH RATES OF CONSUMPTION, INVESTMENT, AND GNP (% per annum) 1978 1979 1980 1981 1982 Total Consumption 4.9 4.4 4.8 3.8 3.6 Personal Consumption 5.1 4.6 5.0 3.9 3.1 Government Consumption 4.0 2.6 3.8 3.6 7.0 Total Fixed Capital Formation 11.7 15.7 2.7 3.1 1.3 GNP 6.8 6.7 4.4 3.7 2.8 /a At 1972 prices. Source: National Economic and Development Authority; mission estimates. Financing the Current Account Deficit 1.12 The expanding current account deficit was financed by foreign borrowings, drawing down of reserves, and monetization of gold. All these sources of finance increased steadily (see Table A.3, Statistical Appendix), but the largest increases occurred in foreign loans and banking system liabilities which are discussed in the next chapter. 4/ This was mainly due to increased interest payments.  -6- 2. TRENDS IN EXTERNAL DEBT An Overview 2.01 A number of conclusions emerge from a review of the growth and structure of the Philippine external debt during 1970-82. Fir 7, the coun- try's total debt had reached $24.4 billion at the end of 1982,- amounting to about 62% of CNP. Second, the rapid expansion of this debt during 1979-82 suggests that the Philippine authorities were not sufficiently responsive to the sharp rise in real interest rates in the international markets in the post-1978 period. Third, beginning in 1979, the country's debt structure became increasingly skewed toward short-term maturities, rendering the economy particularly dependent on credit rollovers. Fourth, the share of financial institutions in the credit mix increased substantially. This was responsible, in part, for the rise in the share of non-concessional funds in total commit- ments. Fifth, a review of the borrower structure suggests that the public sector has been claiming an increasing share of foreign resources, particu- larly since 1979. Finally, these changes in the size and structure of debt have resulted in a sharp increase in the debt service ratio particularly in the last three years. The service obligations on MLT, IMF, and fixed short- term debt, interest obligations on short-term revolving credits, and interest obligations on net banking system liabilities yields a debt service ratio of 38% in 1982. The share of the public sector, both a major borrower and a major end user of foreign resources, in the total debt service obligations reached about 50% in 1982. The Evolution of External Debt 2.02 Following the balance of payments crisis of 1968-69, MLT and offi- cial short-term debt grew at fairly modest rates during 1970-74. The pace of growth of total debt, and of short-term debt in particular, quickened after the first oil crisis of 1973-74 (see Table 2.1). Though the growth rate slackened thereafter, it was obvious that by 1980-82 the debt had become very large relation to the size of the economy. In absolute terms, total MLT debt, - which stood at only $2.3 billion in 1974, jumped almost five-fold to $12 billion in 1982. During the period 1974-82, the growth rate of official short-term debt was even higher than that of medium- and long-term debt. Consequently, aggregate MLT and official short-term debt grew about six-fold since 1974 to $16 billion in 1982. 5/ Includes gross short-term liabililties of the Central Bank and of commercial banks. The total debt had reached $25 billion by the end of 1983. 6/ Including the IMF's Trust Fund, but excluding all other IMF obligations which are included in the net international reserves of the banking system.  Table 2.1: STRUCTURE OF DEBT, 1970-82 (US$ million) Annual growth rate (%) 1970 1974 1980 1981 1982 1970-74 1974-80 1980-82 Medium- and Long-Term (MLT) /a 11671 2,264 8,746 10,204 12,103 7.9 26.0 17.6 Total Public and Publicly Guaranteed Debt n.a. 1,456 6,776 8,049 9,757 n.a. 29.0 20.0 Public Debt /a 631 1,051 6,292 7,443 8,874 13.6 35.0 18.8 Publicly Guaranteed Private Debt 405 484 606 883 3.0 35.0 1,040 3.9 Private Nonguaranteed Debt 808 1J970 2,155 2,346 16.0 9.1 Official Short-Term Debt /b 309 331 2,548 3,664 3,993 2.3 40.0 25.0 Revolving 255 324 2,477 3,552 3,919 6.2 40.0 26.0 Fixed Term 54 7 71 112 74 -65.0 47.0 2.1 Total MLT /a and Official Short-Term Debt 1 80 2,59 294 13,868 i1659 7.0 28.0 19.4 Memorandum Items Other IMF Obligations 108 131 936 1,030 908 4.9 39.0 -1.5 Total MLT Debt Includin IL778 2,395 9j6 1 1233 13,010 7.7 26.0 15.9 IMF Obligations Total MLT Debt, All IMF 2,087 2,726 12 330 14,898 172004 6.9 29.0 17.4 Obligations and Official Short-Term Debt /a Including IMF Trust Fund, but excluding other IMF obligations. /b Excluding International Reserve Liabilities. Source: Statistical Appendix, Table A.4.  2.03 These figures, since they exclude IMF obligations other than the Trust Fund and the short-term external liabilities of the banking system, present only part of the picture. From a "purist" point of view, there may be grounds for excluding IMF obligations and the Wnking system's short-term external liabilities from the capital acc:ount.- However, to gain a comprehensive view of the country's external debt, both of these obligations should be taken into account. 2.04 At the end of 1982, the gross external liabilities of the country's banking system stood at $7.3 billion and its obligations to the IMF (excluding those to the Trust Fund) totalled nearly $1 billion (see Table 2.2). This brings the country's total gross external, obligations to about $24.3 billion in December 1982. Netting out the external assets of the banking system reduces the banking system's liabilities to $2.1 billion and brings the total net external obtigations of the Philippines at the end of 1982 to about $19.0 billion.- 7/ The rationale for omitting banking system liabilities from the debt statistics is simple. In countries where the banking system's foreign exchange position is under the Central Bank control, changes in the short-term external liabilities of commercial banks are considered as monetary movements and are recorded as changes in international reserve liabilities. Similarly, IMF obligations other than the Trust Fund are not considered debt, since the Fund borrower "purchases" foreign exchange with its own currency. 8/ An alternative measure of the short-term liabilities of the banking sys- tem would comprise the net external liabilities of the commercial banks ($2,233 million in 1982) and the grfoss external liabilities of the Central Bank, ($2,214 million in 1982) on the assumption that Central Bank assets should be available to cover imports. According to this measure, the short-term liabilities of the banking system totalled $4,447 million in 1982, implying that total external debt in 1982 amounted to $21,451 million.  Table 2.2: EXTERNAL DEBT AND BANKING SYSTEM LIABILITIES, 1976-82 (US$ millions, end of period) 1976 1977 1978 1979 1980 1981 1982 External Debt & Gross Banking System Liabilities 6,745 8,048 10,772 13,314 17,238 20,655 24,336 Medium- & Long-Term 4,382 5,580 6,910 8,001 9,682 11,234 13,011 Debt (3,932) (5,024) (6,283) (7,283) (8,746) (10,204) (12,103) IMF obligations (450) (556) (626) (718) (936) (1,030) (908) Short-Term 2,363 2,468 3,863 5,313 7,556 9,421 11,325 Official short-term (715) (1,009) (1,357) (1,813) (2,548) (3,664) (3,993) Center Bank (566) (40) (153) (522) (1,321) (1,575) (2,214) Commercial banks (1,082) (1,419) (2,353) (2,978) (3,687) (4,182) (5.118) Short-Term as percent of Total 35.0 30.7 35.9 39.9 43.8 45.6 46.5 External Debt and Net Banking System Liabilities 4,225 9,583 12,179 1 9 9113 Medium- & Long-Term 4,382 5,580 6,909 8,001 9,682 11,234 13,011 Debt (3,932) (5,024) (6 ,283) (7,283) (8,746) (10,204) (12,103) IMF obligations (450) (556) (626) (718) (936) (1,030) (908) Short-Term -157 204 668 1,582 2,497 4,095 6,102 Official short-term (715) (1,009) (1,357) (1,813) (2,548) (3,664) (3,993) Central Bank (-1,076) (-1,485) (-1,730) (-1,901) (-1,834) (-1,132) (-124) Commercial banks (518) (680) (1,041) (1,670) (1,783) (1,563) (2,233) Short-Term as Percent of Total -3.7 3.5 8.8 16.5 20.5 26.7 32.1 Source: DRS; Central Bank.  - 10 - Assessing Debt Levels 2.05 A convenient method of assessing the growth of debt burden is to compare debt magnitudes to GNP. Since GNP, provides a convenient measure of the country size, the ratio of debt outstanding and disbursed (DOD) to GNP provides a neat summary indicator of the economy's debt-carrying capacity. 2.06 In the Philippines the ratios of DOD/CNP shifted up significantly during the late 1970s (see Table 2.3). Before 1{78, the ratios of both MLT debt - to GNP and of MLT and total short-term 10/ debt to GNP were below 25%. After 1978, the ratios were consistently above this level. Moreover, between 1981 and 1982, due partly to the decline in the growth rate of GNP, both ratios increased sharply, reaching their highest yoint since the start of the 1970s. In 1982, the ratio of total MLT DOD!Ny - was 33% and that of the aggregate of MLT and short-term debt to GNP 2 was 49%. 2.07 The ratios of debt to an alternative scalar - exports of goods and services - further illustrate the critically high levels of debt reached by 1982 (see Table 2.3). The ratio of the aggregate of MLT debt, IMF obliga- tions, official short-term debt, and the banking system's net external liabilities to export earnings had reached the high level of 239% and affected outside perceptions of the country's creditworthiness. 9/ Including total IMF obligations. 10/ Including the net liabilities oE the banking system. 11/ Including total IMF obligations. 12/ Including the net liabilities of the banking system.  Table 2.3: DEBT INDICATORS (%) 1970 1974 1976 1978 1979 1980 1981 1982 DOD/GNP Total MLT Debt and IMF Obligations /a 25.7 16.3 24.6 28.6 26.7 27.4 29.2 33.1 Total MLT Debt, IMF Obligations, /a Official Short-term Debt, Net NA NA 23.7 31.4 32.0 34.5 39.9 48.6 Banking System Liabilities DOD/Exports of Goods and Services H Total MLT Debt and IMF Obligations /a 132.6 67.3 127.2 140.7 127.9 120.9 130.4 162.5 Total MLT Debt, IMF Obligations,/a Official Short-Term Debt, Net NA NA 122.6 154.3 153.2 152.0 177.9 238.8 Banking System Liabilities /a Including all IMF obligations. Source: Statistical Appendix, Table A.18.  12 - Interpreting the Trends in Philippine Exposure 2.08 / Given the fairly high inflation rates that characterized the 1970s,- the Philippine recourse to heavy external borrowing had its benefits. Developing countries which accurnulated debt during the inflationary period of the 1970s were able to receive a sizable trvsfer of resources with only modest acceleration in their real debt burdens.l1 Their borrowing capacities were obviously supported by the high nominal growth rates for their exports. The Philippines falls in this category, and, like other major developing country borrowers, it was able t:o increase its growth rate by borrowing abroad during 1970-78 when real interest rates were relatively low or even negative. 2.09 This position, however, reversed starting in the late 1970s and the Philippine debt indicators worsened substantially. After 1978, the inter- national financial markets entered a periocl of rising real interest rates. Some developing countries which had borrowed heavily in the early 1970s, when international liquidity was ample and real interest rates were low, had to adopt adjustment measures and restrain foreign borrowing after the second oil shock. The Philippines, however, continued to expand its foreign debt at a relatively high rate d yite high real interest rates and shortening maturi- ties of foreign loans. _ 2.10 The pronounced growth of short-te!rm maturities in the Philippine debt structure is especially noteworthy. Ihe share of short-term debt and gross liabilities in the total debt of the Philippines rose from 35% in 1976 to 47% in 1982 (see Table 2.2 above). In general, the financial markets interpret a ldden accretion of short-term debt as a sign of reduced credit- worthiness.! At this stage, a debtor is often faced with restrictions on the type of credits available, with creditcrs showing a preference for short- term rather than medium-term commitments. Thus, a country with an increasing share of short-term borrowings in its debt portfolio faces a serious dilemma: lenders' perceptions of its creditworthiness erode as the weight of short-term borrowings increases; on the other hand, in order to service the 13/ The MUV index (the unit value cf manufactured exports from developed to developing countries) rose almost three-fold between 1970 and 1979. 14/ The growth rate of "real" debt during the 1970s turns out to have been quite modest, when debt outstanding and disbursed is deflated by any of three major price indicators. See Table A.17, Statistical Appendix. 15/ The Philippine was by no means alone in this category. Other East Asian countries, such as Korea and Thailand, also continued to borrow heavily abroad. 16/ IMF, "Fund Policies and External Debt Seirvicing Problems," SM/83/45, March 1983, Washington, D.C., p.4.  - 13 - debt and thereby maintain creditworthiness, the borrowing country's dependence on short-term rollovers continues to grow. 2.11 In the Philippines in 1982, foreign financial institutions appeared to be cutting back on new commitments of MLT loans and increasing short-term lines of credit. New commitments of MLT loans from financial institutions had increased fairly steadily during 1977-79, exceeding $1 billion in 1978. During 1980-82, however, commitments fluctuated, dropping from $1.1 billion to $0.9 billion in 1982. Over this same three-year period, short-term debt from banks and financial institutions registered a phenomenal rise in terms of both absolute amounts and shares in (a rapidly expanding) total official short-term debt (Table 2.4). This expansion of the share of financial institutions in short-term debt increased the country's dependence on credit rollovers and made the country seriously vulnerable to international financial market fluctuations. Table 2.4: SHARE OF BANKS AND OTHER FINANCIAL INSTITUTIONS IN OFFICIAL SHORT-TERM DOD /a 1979 1980 1981 1982 Absolute Amounts (US$ millions) 819 1,494 2,628 3,449 Shares in Total Short-Term Debt (%) 45.2 58.6 73.7 77.3 /a Export credits account for the remainder of official short-term DOD. Source: MEDIAD 2.12 The utilization pattern of the short-term debt has also added to the economy's vulnerability. Prior to 1979, oil imports had been financed primarily by trade credits (O/As and D/As) 17' extended by the major oil suppliers. However, following the second oil crisis, the Philippine oil importers were obliged to turn to financial institutions to refinance out- standing trade liabilities. In 1982, approximately 40% of official short-term credit was used to finance oil imports. In fact, about 85% of oil imports in that year were financed by short-term credits. The excessive use of financial intermediaries in oil financing could potentially subject the Philippines to the uncertainties of the international financial markets. 2.13 Certain weaknesses are also apparent in the Philippine short-term borrowings to finance non-oil imports. While official approval for short-term borrowings is granted mainly for trade credits, it appears that, particularly 17/ Open Accounts and Documents Against Acceptance.  - 14 - in 1981-82, some short-term credits were not trade-related, but were obtained to replace maturing longer term debts, and that: some producers in both the public and private sectors used short-term credits to continually finance their working capital needs. Under normal circumstances, and if short-term exposure were low, this would not be a cause for alarm. But the country's (and some firms') creditworthiness had already worsened, making it difficult to obtain rollovers; moreover, when short-term credits are locked up in longer term investments, they render firms doubly vulnerable. Financing Patterns 2.14 The mix of creditors has varied substantially over time. In part because of heavy borrowing in the private financial markets in the late 1960s and the resulting debt crisis of 1969, the Philippine authorities tried, in subsequent years, to retain the bulk of foreign borrowing in public hands to control the credit mix and the terms of foreign borrowing. In addition, with public enterprises controlling major capital intensive industries, the share of debt directly incurred by the public sector (general government and public sector entities) increased substantially. This- share rose from 38% in 1970 to 50% in 1975, reaching the level of about 74% between 1979 and 1982 (see Table 2.5). 2.15 The government control strengthened in part because of the high and steady contribution of foreign official debt to the Philippine public and total MLT debt. Throughout the 1970s, the Government made assiduous efforts to tap official sources, and the share of official debt in total MLT debt was consistently above 31% since 1975. Within the official source debt, the multilateral debt grew the fastest, its share in the total increasing from 8% in 1970 to nearly 20% in 1980-82. This was partly due to the overall expan- sion of multilateral lending during the 1970s and partly due to the slowdown of bilateral lending. 2.16 The Philippines also began testing the international bond market in the early 1970s. By 1979-80, it h1d begun to draw about 10% of total MLT resources in the form of bonds. 18 18/ Smaller institutional lenders less well-equipped with country research facilities than the major commercial banlcs interpreted the Philippines' penetration of bond markets as recognition. by the international financial markets of the country's growing creditworthiness.  Table 2.5: STRUCTURE OF MLT DEBT BY CREDITOR A. Share in percent 1970 1975 1979 1980 1981 1982 Total MLT Debt 100.0 100.0 100.0 100.0 100,0 100.0 Public Sector /a 38.3 50.2 71.4 72.5 73,3 73.7 Official Source 15.5 31.5 31.9 31.1 33.6 32.1 Multilateral 8.1 12.2 16.3 16.8 19.4 19.2 Bilateral 7.4 19.3 15.6 14.3 14.2 12.9 Private Source 22.8 17.9 39.4 41.3 39.7 41.6 Bonds 0.7 0.8 10.8 10.1 8.2 7.3 Financial Institutions 17.9 14.6 25.1 28.0 28.5 31.6 Suppliers' Credits 4.2 2.5 3.5 3.2 2.9 2.7 Publicly Guaranteed Private Debt 20.6 17.1 5.7 5.4 6.6 7.7 Private Non-Guaranteed /b 41.1 33.5 23.0 22.1 20.1 18.6 Memorandum Item: Public and Publicly Guaranteed 58.9 66.05 77.0 77.9 79.9 81.4 Private Non-Guaranteed 41.1 33.5 23.0 22.1 20.1 18.6 Banks/Financial Institutions n.a. 41.3/c 50.3 50.9 50.3 51.8 B. Average Nominal Growth Rates (I p.a.) 1970-75 1975-80 1980-82 Total MLT Debt 13.3 26.2 16.0 Public Sector /a 19.2 36.2 16.9 Official Source 30,6 25.9 17.7 l4ultilateral 23.0 102.4 23.8 Bilateral 37.2 18.8 10.2 Private Source 8.0 49.2 16.3 Bonds 15.7 109.2 -1.4 Financial Institutions 8.8 43.8 23.1 Suppliers Credits 2.4 32.7 6.3 Publicly Guaranteed Private Debt 9,2 0.3 38.0 Private Non-Guaranteed /b 8.8 16.1 6.6 Public and Publicly Guaranteed 16.1 30.2 18.4 Memorandum Item: Total MLT and Officiel Short Term Debt 11,8 28.9 19.8 /a Including IMF Trust Fund, but excluding other IMF obligations. T7 Information on the creditor structure of private guaranteed and non-guaranteed debt is not available in the DRS, Ic Data relate to 1976. Source) Table A.8, Statistical Appendix.  - 16 - 2.17 Despite the expansion of direct fore:ign borrowing by the public sector and the fairly large share of official source debt, the Philippine credit mix has some worrying features. In terrns of the sources of debt, by far the fastest growing debt category has been that of banks and other finan- cial institutions whose share in total outstanding MLT debt had reached about 32Z in 1982 (Table 2.5). If both the officiaLLy recorded short-term borrowing and the net external liab ilities of the banking system are taken into account, the share of banks and other financial institutions was almost three-fifths of the total outstanding external obligations of the Philippines in 1982. 2.18 This situation is of concern for several reasons. As mentioned earlier, the increase in the dependence on financial institutions has coincid- ed with the rise in nominal and real interest rates in the international markets that began in 1978. This, in turn, led to a rise in the share of non-concessional funds in the Philippines' public debt (see Table 2.6), as well as in the interest service ratio. The share of non-concessional debt, which was already very high, rose to about 87% in 1982, precisely the period of the Philippines' switch to a heavier reliance on financial institutions. Table 2.6: DISTRIBUTION OF PUEILIC SECTOR DEBT BY CONCESSIONAL/NON-CONCESSIONAL CATEGORIES (percent) 1975 1979 1980 1981 1982 Concessional 16.5 14.6 15.3 10.5 12.6 O:fficial 16.5 14.6 13.9 10.5 12.6 Private Source - 0.1 1.4 - - Non-Concessional 83.5 85.4 84.7 89.5 87.4 Official 35.8 23.0 43.4 38.9 38.9 Private 47.7 62.3 41.3 50.7 48.5 Total Public Sector Debt 100.0O 100.0 100.0 100.0 100.0 Souirce: DRSO  - 17 - 2.19 During the last few years, some countries have tried to counteract the impact of higher interest rates by switching to credits denominated in the curren i s of countries with low inflation and consequently low interest rates. 9 Although there is some evidence that the Philippines may have done this during 1979-81, when the share of borrowings in currencies with low interest rates almost doubled, the share of borrowings in currencies with high interest rates has remained fairly large and increased dramatically in 1982 (see Table 2.7). Obviously, the interest rate is only one of a number of determinants of the currency mix of a country's borrowing program. Others are the rates of change in the exchange rates of specific currencies, the currency composition of the import basket 2gd of debt service obligations, the currency composition of export earnings, -, and the market receptivity (e.g., lenders' considerations of country exposure and creditworthiness). 19/ This appeared to be the case in Thailand. See World Bank, "Public Foreign Borrowing in Thailand," mimeo, April 30, 1983, Washington, D.C., p. 8. 20/ See Donogh C. McDonald, "Debt Capacity and Developing Country Borrowings: A Survey of the Literature," IMF, Washington, D.C., August 17, 1982. The theoretical literature has tended to concentrate on the currency composition of reserves. In applying optimizing principles to the currency composition of debt, a number of factors need to be borne in mind: (1) the past portfolio is not necessarily a good guide to the present; (2) the net position in different currencies is more important than the gross; (3) at the short end of the spectrum, it is important to focus on the combined currency composition of reserves and credits; and (4) the literature on the optimum composition of reserves tends to focus on the interest rate, changes in exchange rates and the import currency basket. Obviously, the range and complexity of the variables does not allow simple qualitative judgments. An adequate treatment of the problem requires a properly specified model for optimizing behavior and the existence of computer simulation capabilities.  - 18 - Table 2.7: CURRENCY DISTRIBUTION OF PUBLIC SECTOR COMMITMENTS (in. perceit) 1975 1976 1977 1978 1979 1980 1981 1982 Low Interest Rate 29.4 27.7 58,9 25.8 44@8 55.0 46.4 21.5 French Franc /a 14.6 1.1 0.2 - 2,3 - - - Deutsche Mark - 0.1 3.0 2.3 1.5 - 1.6 0.7 Yen 14.8 8.1 6D4 23.5 21.3 14.5 19.6 20.8 Multiple /b - 18.4 - - 19.7 39.5 25.2 - High Interest Rate 70.1 69.9 35.8 72.9 54.7 40.0 51.9 75.1 US Dol.lar 44.8 69.9 (49.3)/c 49.0 54,7 40.0 51.9 46.6 Multiple /b 25.3 - 35.8 21.6 - - - 25.9 TOTAL Id 1000. 100.0 100.0 100l 0 100.0 100.0 100.0 100.0 /a Subsidized French credits. /b Includes commitments denominated in multiple currencies, Note that in some years this category is in the Low Interest Rate groap and in other years in the High Interest Rate Group. This classification was based on a comparison of the average interest rate associated with loans denominated in multiple currencies, with the average interest rate characteristic of the specific year's total commitments. /c Figures in parentheses denote loans for which average interest rates were lower than on total commitments. Totals in the second category have been adjusted to exclude them, /d The sum of the two main categories does not: add ap to 100% due to the exclusion of a few small loans. Source: DRS  - 19 - 2.20 Finally, although the high share of financial institutions in the creditor structure of the Philippines' external debt has ha1 ittle or no adverse effect on the average maturity of public MLT debt, - it has affected the maturity structure of overall debt via a change in the mix of MLT and short-term debt. As was pointed out before, this trend has greatly increased the economy's vulnerability to developments in international markets which have become particularly sensitive to creditworthiness issues on account of their recent experiences in other debtor LDCs. The Structure of Borrowers 2.21 External debt data, broken down by major borrowers (see Table 2.8), show that the principal borrowers have been public sector institutions. During 1970-75, th7 debt of official development banks22 grew the fastest (40% per annum).2 In the next five-year period, government corporations, as several of them became increasingly better known, took the lead in borrowing abroad and doubled their share of MLT debt. By 1980, they accounted for a little under a third of the total MLT debt. By contrast, in the following two years, 1980-82, the public corporations were induced to rein in their direct borrowing activities, as the central government and the Central Bank took the lead in foreign borrowing. These two institutions, which had themselves engaged in fairly heavy borrowing abroad during the 1975-80 period, expanded their activities as intermediaries for channelling foreign funds to domestic users. Even the role of the official development banks as purveyors of foreign funds was severely curtailed - the growth rate of their debt in 1980-82 was down to about 9% per annum while the public sector borrowing as a whole was still growing at about 17% per annum during the same period. 21/ With the exception of 1977, the average maturity of total public debt commitments has been in excess of 15 years throughout the period 1975- 82. Indeed, the average matturity period of commitments made in 1982 almost equalled the peak maturity registered in 1975. Even the average maturities obtained from financial institutions were confined to the narrow band of 10-11 years all through the 5-year period 1978-82. 22/ The Philippine National Bank (PNB), the Development Bank of the Philippines (DBP), and their subsidiaries. 23/ Their low base of debt in 1970 was, of course, a contributing factor.  - 20 - Table 2.8 STRUCTURE O'P MLT DEBT BY BORROWER A. STRUCTURE (%) 1970 1975 1978 1979 1980 1982 Total 100,.0 100.0 100.0 100.0 100.0 ao0.0 Public Sector 38.3 49.3 66.9 71.4 72.5 73.7 Total Government 26.9 26.5 31.0 32.2 34.4 39.1 Central Government (10.8) (13.8) (19.3) (19.6) (21.6) (23.7) Local Government (0.1) (0.0) (0.0) (0.0) (0.0) (0.0) Central Bank (16.0) (12.7) (11.6) (12.5) (12.7) (15.4) Public Corporations 9,.0 16.1 29.8 32.9 32.7 29.9 Official Development Banks 2.4 6.8 6.2 6.4 5.4 4.7 Private Sector 61.7 50.6 33.1 28.6 27.5 26.3 Publicly Guaranteed Debt 206 17.1 6.8 5.7 5.4 7.7 Private Non-guaranteed Debt 41.1 33.5 26.3 23.0 22.1 18.6 B. GROW`FH RATES (Z p.a.) 1970-75 1975-80 1980-82 Public Sector /a 19.2 36.2 16.9 Total Government 13.0 33.0 23.6 Central Government 18.9 38.1 21.4 Local Government _ /b Central Bank 8.2 26.4 27.3 Public Corporations 27.2 45.4 10.8 Official Development Banks 40.0 20.4 8.8 Private Sector 8.9 11.7 13.4 Publicly Guaranteed Debt 9.2 0.3 38.0 Private Non-guaranteed Debt 8.8 16.1 6.6 /a Includes IMF Trust Fund but excludes other IMF obligaticins. /b Calculated at 56.4% per annum for 1980-1982, but the amounts are insignificant. Note: This table is based on the old (1983) debt data series. For details see footnote to Table A.8, Statistical Appendix. Source: DRS and MEDIAD.  - 21 - 2.22 Compared to the public sector borrowing, the private sector's direct access to foreign funds remained modest. The Central Bank's approval process combined with the Government's role as an intermediary for foreign funds constrained direct borrowing by the private sector. The Structure of End-Users 2.23 The structure of major borrowers described above does not reflect the ultimate pattern of use of MLT funds. Since the Government is empowered by the Foreign Borrowing Act of 1970 to undertake foreign borrowing to lend to the private sector, the direct borrowings of the private sector do not fully reflect its access to foreign finance. 2.24 The Government's on-lending program has taken three forms: first, the official development banks have been a major vehicle for channelling for- eign funds to private sector end-users; second, the central government and Central Bank have, from time to time, channelled concessional funds from bila- teral and multilateral donors, as well as long-term export credits, to private entrepreneurs; and, finally, the Central Bank in 1978 expanded its on-lending activities through the Consolidated Foreign Borrowing Program (CFBP). 2.25 The CFBP was established by Presidential Decree No. 1309 of March 1978. It enabled the Central Bank to on-lend foreign funds to banking insti- tutions either to finance development projects which had not obtained conces- sionary financing or to refinance existing debt. Since the Central Bank was the direct borrower, the amounts involved were large. By pooling demands in the "jumbo loans," the Central Bank was able to reduce the number of competi- tive and simultaneous approaches to the market by individual Philippine borrowers and obtain better terms than would be available otherwise. 2.26 The total funds raised under the CFBP through 14 loans amounted to $1.9 billion during the period 1978-82. (An additional $300 million was raised in early 1983.) Over 50% of these funds were re-lent to private sector borrowers (See Table 2.9).  - 22 - Table 2.9: TOTAL OUTSTANDING BORROWINGS UNDER THE CFBP (US $ milLions) 1978 197'3 1980 1981 1982 Total 384.0 680.0 937.0 1,198.3 1t848.6 y type Revolving 100.0 100.0 100.0 100.0 100 Fixed Term 284.0 580.0 837.2 1,098.3 1,748.6 Loans from FCDUs /a 16.8 18.7 33.3 44.1 78.8 Loans from Foreign Banks/OBUs /b 267.2 561.3 803.9 1,054.2 1,669.8 CFBP Loans Included in Fixced Term External Debt, by Sector Loans from Foreign Banks/ OBUs 267.2 561.3 803.9 1,054.2 1,669.8 Add (Deduct) Currency Revaluation Adjustments - (8.8) 4.3 (2.4) (6.6) Adjusted Total 267.2 552.5 808.2 1,051.8 1,663.2 Not On-Lent - - 0.3 5.6 - Re-Lent 267.2 552.5 807.9 1,046.2 1,663.2 Private Sector 180.8 327 .3 505.0 725.3 961.9 Public Sector 86.4 225.2 302.9 320.9 701.3 /a Foreign currency deposit units of the local commercial banks. lb Offshore banking units. /c The figures in parentheses refer to the share of the private sector in relent CFBP funds. Source. MEDIAD.  - 23 - 2.27 Despite the onlending activities of the public sector described above, the share of the private sector as end-user in total MLT debt has dropped over the years. As Table 2.10 shows, this share (which includes direct borrowing and funds on-lent by the Central Bank, the central government, and official development banks) averaged about 43.8% during 1979-82 compared to 56% during 1976-77. This reflects the increasing involvement of public enterprises in capital investment financed by foreign borrowing. 2.28 A similar picture emerges in the area of short-term debt. Abstract- ing from the short-term debt incurred by the oil companies, the data on the non-oil sector (Table 2.11) indicate that the private sector's share of short- term foreign borrowing has been sharply curtailed as the public sector's recourse to foreign finance has risen. While performance in individual years tends to fluctuate, the private sector's share shows an overall downward trend. Table 2.10: SHARE OF THE PRIVATE SECTOR AS AN END-USER IN MLT DEBT (percent) 1976 1977 1978 1979 1980 1981 1982 Funds Re-Lent by Public Sector 46.1 43.1 14.3 14.6 16.0 16.8 17.6 Direct Borrowing by Private Sector 10.9 13.8 33.3 28.5 28.1 27.0 26.4 Total Private Sector /a Use of Foreign Funds 57.0 56.9 47.6 43.1 44.1 43.8 44.0 Source: MEDIAD. /a Includes funds relent in addition to CFBP (Table 2.9) the breakdown of which was not available.  - 24 - Table 2.11: OFFICIAL NON-OIL SHORT-TERM DEBT (percent; US$ million) 1976 1977 L978 1979 1980 1981 1982 Non-Oil Sector 463 759 1,313 1,563 1,838 2,144 2,411 Share of: Public Sector(%) 10.8 18.2 21.8 20.2 12.9 31.7 36.0 Private Sector(Z) 89.2 81.8 78.2 79.8 87.1 68.3 64.0 Source: MEDIAD. 2.29 Data on loans extended by the foreign currency deposit units (FCDU) to Philippine borrowers are not available on an end-user basis. Interviews with FCDU banks reveal, however, that a large part of their lending has been directed to private sector units in the mining and manufacturing sectors. The published data also reveal that the growth of the FCDU system has slowed in recent years. Assuming that relative public/private sector access to FCDU lending has not changed drastically in the rectent period, the slower growth of the system would imply that private sectcr borrowing from the FCDUs has also slowed. 2.30 In terms of the use of all three types of foreign finance - medium- and long-term funds, short-term credits and foreign loans intermediated through the FCDU system - it is evident that the private sector demand for foreign funds slowed down considerably. This perhaps reflected the combined effect of domestic recession, increased government use of foreign funds, take- over of private concerns by public enterprises, and the private sector's response to hardening of loan terms. It would be useful in this context to further investigate if the private sector was really responsive to the changed economic and financial conditions and whether the public sector failed to do so. Debt Service Obligations 2.31 The rapid growth of the Philippine foreign debt and the changes in its structure have led to a steep rise in the country's debt service obliga- tions during the last few years. Although deficient in several respects, the debt service ratio (DSR), especially its trend over time, serves as a good indicator of the country's ability to service its debt. Combined with an analysis of export trends, import needs, and level of reserves, it can serve as a reliable indicator of emerging payments difficulties. 2.32 Table 2.12 presents alternative DSRs (see footnotes to the Table for their definitions). The top row presents the official Philippine DSR using a statutory definition laid down in 1970. The second block of DSRs gives  - 25 - alternative definitions used in the World Bank which are increasingly comprehensive in descending order. An examination of the various DRSs, especially the more comprehensive ones, leads to the following conclusions. First, the burden of debt shows an upward trend during 1977-82. This trend reflects the increasing share of commercial debt mitigatged by a moderately high growth rate of foreign exchange earnings/receipts through 1980. Second, the debt service burden rose sharply starting in 1981 (the Bank DSRs are more indicative here). This was both due to a continued rise in the debt service payments for the reasons given earlier and a slow-down of export receipts in 1981 and a drop in 1982. The DSRs thus clearly show that the economy had become vulnerable towards the end of the period on account of the increased debt service burden. 2.33 Here, it would be useful to discuss the relative merits of various definitions of DSR. It is worth noting, for example, that the divergence among various DSRs increases substantially between 1977 and 1982. Although the trends of the Bank DSRs are similar (and therefore anyone of them could have indicated the increasing debt service burden), alternative IIc appears to be the most comprehensive which captures all service Wbilities and shows how much of export receipts would be pre-empted by them .- In retrospect, we could say that this definition was the most relevant to the Philippine situa- tion in the last few years and could have signaled the emerging payments difficulties of the country. By the same measure, the official definition (see Table 2.12, footnote /a) was the least satisfactory. The official DSR did not show any significant rise even in the critical years of 1981-82 when the other DSRs increased sharply. Even conceptually, debt service obligations should be related to current receipts (which are used to discharge them) rather than to the last year's, and to export earnings rather than to all receipts. The official DSR also does not include interest payments on short- term revolving debt and banking system liabilities which have clearly become important in recent years. In view of these shortcomings, the Philippine Government should reexamine the use of this definition. Even if the legal requirement were to remain the same, at least for analytical and policy purposes the Central Bank should use the more commonly accepted definitions, such as those given in block II, Table 2.12. 24/ An even more stringent definition would be if the reduction in short-term debt or banking liabilities, forced or discretionary, were to be included in the debt service.  Table 2.12: EXTERNAL DEBT SERVICE RATIOS, 1977-82 (%) 1977 1978 1979 1980 1981 1982 I. Philippines debt service ratio as statutorily defined /a 13.8 18.0 18.6 18.7 19.1 19.4 II= World Bank debt service ratios lb a. MLT debt 12.1 1.6.0 16.1 14.6 18.3 27.0 b. MLT debt, IMF obligations, ofricial short-term debt, and net banking system liabilities /c 14.6 19.0 19.4 18.2 20.0 32.8 c. Same as b. but based on gross banking system liabilities Ic 15.3 20.0 20.1 20.9 25.2 38.1 O Ia Ratio of interest and principal payments on MLT debt, IMF obligations and fixed short-term debt (primarily bridge financing of development projects) to the previous year's total foreign exchange receipts. lb Ratio of principal and interest payments to exports of goods and services. Prepayments are excluded. /c Only interest payments have been included for revolving credits (other than D/As and 0/As) and banking system liabilities. Source: Table A.21, Statistical Appendix.  - 27 - 2.34 The preceding sections have pointed to the large role played by the public sector both as a borrower and as an ultimate user of foreign resources. Reflecting this position, T,ble 2.13 shows that the public sec- tor's share in debt service payments 25 has generally been above 45% during 1977-82 and that the trend has been sharply upward during the last three years. Table 2.13: PUBLIC SECTOR DEBT SERVICE PAYMENTS (US$ millions percent) Alternative IIb Ia 1977 1978 1979 1980 1981 1982 Total Debt Service Payments 324.4 681.3 766.0 720.7 1,029.0 1,479.6 MLT Debt Principal and Interest 315.7 644.7 805.4 585.3 850.3 1,029.0 IMF Obligations 48.3 92.2 91.5 194.9 123.1 148.7 Official Short-Term D bt 51.4 94.4 85.1 179.5 231.6 319.9 Interest Payments u7 6.0 14.5 18.0 63.4 146.1 239.2 Principal Payments on Fixed Short-Term Debt 45.4 79.9 67.1 116.1 85.5 80.7 Net Liabilities of the Central Bank -91.0 -150.0 -216.0 -239.0 -176.0 18.0 Public Sector Debt Service Ratio (%) 7.7 13.9 12.2 9.0 11.9 18.5 Share of Public Sector Debt Service in Total Debt Service (x) 47.1. 46.2 44.3 43.0 47.8 49.8 Memo: Public Sector's Share of Official Short-Term Debt (Z) 28.6 42.6 52.8 58.2 59.4 60.7 /a See Table 2.12 for the explanation of components of Alternative IIb. Prepayments could not be excluded for this table. Therefore, the debt service payments and ratios are overstated especially for 1978 and 1979. /b Determined on the basis of the public sector's share in short-term debt. Source: DRS, MEDIAD, IMF. 25/ Calculated according to Alternative IIb.  - 28 - 3. INVESTMENT AND SAVINGS Investment and Savings Behavior 3.01 A fuller analysis of recent trends in the Philippine debt needs to take into account the behavior of investment and savings in the economy. Table 3.1 presents the investment and savings data for the Philippines for recent years and for the middle income oil-importing developing countries (OIDCs) for 1979. These data show that comparea to the middle income OIDCs, the Philippines sustained a significantly higher investment/GNP ratio during 1978-82. Even the oil crisis of 1971I80 and subsequent recession does not appear to have affected this ratio.- At'the same time, the share of gross national savings in GNP has been decLining since! 1979. Consequently, the gap between gross domestic investment and gross national savings (i.e., the current account deficit) has been met by an expanding inflow of foreign resources. Whereas in 1978 the share of foreign resources in GNP was 4.5%, by 1982 it was over 8%.27/ 26/ The decline in the rates of gross deomestic investment of 2 percentage points during 1979-82 was primarily due to the decline in stock accumula- tion rates. The stock figures, as well as overall investment figures which are considered to be somewhat overstated, are being scrutinized by NEDA. Even if the investment series is revised downwards, its trend is likely to remain unaffected. Similarly, the investment-savings gap may remain unaffected since savings are a residual and will also have to be revised downwards. 27/ The investment-savings gap predates the period discussed here. The investment/GNP ratio (including changes in stocks) had increased from 21.5% in 1973 to 26.9% in 1974 anct then settled around 30% for the remainder of the period. National savings also increased but not suffi- ciently to offset the increase in investment. (These sharp jumps in investment and savings may partly be a statistical phenomenon.) The result was that the domestic investment and savings gap which was negligible during 1970-74, expanded to over 5% of GNP in subsequent years. Thus, the investment-savings gap had become significant starting in 1974 which ties in with the analysis of Chapters 1 and 2 showing that the sizable capital inflows and the build-up of the external debt had started in the mid-1970s. However, this Chapter focuses on the period 1978-82 because adequate breakdown of the macro data was not available for the earlier years and the major build-up of the external debt occurred in these years.  - 29 - Table 3.1: INVESTMENT AND SAVINGS (% of GNP) Middle-Income Philippines OIDCs /a 1979 1978 1979 1980 1981 1982 Gross Domestic Investment 25e0 29.0 31.1 30.7 30.7 28.9 Total Fixed Investments NA 23.8 26.0 25.7 26.1 25.8 Public Fixed Investment NA 6.3 6.4 7.2 8.4 8.2 National Government Capital Expenditures NA 2.5 2.3 3.2 4.2 3.0 Local Government Capital Expenditures NA 0.2 0.2 0.2 0.2 0.2 Government Corporation Capital Expenditures NA 3.6 3.9 3.8 4.0 5.0 Private Fixed Investment NA 17.8 19.6 18.5 17.8 17.6 Increase in Stocks NA 5.2 5.2 5.0 4.6 3.1 Gross Savings 25.0 29.0 31.1 30.7 30.7 28.9 Foreign Savings 3.0 4.6 5.0 5.4 5.4 8.1 Gross National Savings 22.0 24.4 26.1 25.3 25.3 20.8 Total Government Savings NA 4.2 5.7 5.8 5.0 3.6 National Government Savings NA 2.9 4.2 4.0 3.2 2.1 Local Government NA 0.1 0.2 0.3 0.2 0.2 Current Surpluses Social Security Surpluses NA 0.6 0.8 0.8 0.9 0.7 Government Corporation Savings NA 0.5 0.5 0.8 0.7 0.6 Total Private Savings NA 20.2 20.4 19.5 20.3 17.2 /a Middle income oil-importing developing countries. Note: The data on investment and savings are being scrutinized by NEDA and may have to be revised. Source: NEDA and mission estimates.  - 30 - 3.02 To identify the sources of investment-savings gap, we have decom- posed it into sectoral investment-savings deficits: those of the privat 8/ sector (an amalgam of the household and the private corporate sectors);- the government sector (comprising national government, local government, and the Social Security Administration); and the governiment corporations sector (see Table 3.2). 3.03 Several conclusions emerge from the decomposition of the investment- savings gap. First, the public sector gap was relatively high (especially if some increases in stocks were to be attributed to the public sector) through- out the period 1978-82 and more than tripled by the end of the period. Second, the major increase in the public sector gap occurred on account of government corporations whose investment growth was not matched by their savings growth. Third, the private sector gap was relatively low during the period. Overall, we could say that, during 1978-82, the major source of the country's investment-savings gap was the public sector. This corroborates the findings of Chapter 2 that the share of public sector as an end-user of foreign resources increased during 1978-82. Resource Use by the Public Sector 3.04 We have seen above that the public sector investment-savings gap was the main source of the national gap. A further analysis of this gap points towards some other weaknesses of the public sector program in the context of external debt and debt service capacity. 28/ Although investment data for the Philippines do not permit the private sector to be disaggregated into households and corporations, it is expec- ted (as is generally true of other countries) that the Philippine house- hold sector is a net saver and that there is a net demand for savings originating from the private corporate sector.  - 31 - Table 3.2: INVESTMENT AND SAVINGS BY SECTORS (billion pesos) 1978 1979 1980 1981 1982 Public Sector General Government Surplus (- deficit) 1.4 5.7 4.0 -0.6 -0.3 Investment 4.7 5.4 8.9 13.4 10.7 Savings 6.1 11.1 12.9 12.8 10.4 Government Corporations Surplus (- deficit) -6.9 -8.7 -11.9 -14.9 -19.3 Investment 7.8 9.8 13.5 16.8 21.3 Savings 0.9 1.1 1.6 1.9 2.0 Total Public Sector Surplus (- deficit) -5.5 -3.0 -7.9 -15.5 -19.6 Investment 12.5 15.2 22.4 30.2 32.0 Savings 7.0 12.2 14.5 14.7 12.4 Private Sector /a Surplus (- deficit) -4.7 -8.1 -8.4 -2.6 -7.9 Investment/b 39.2 53.6 58.7 63.1 65.2 Savings 34.5 45.5 50.3 60.5 57.3 Total Surplus (- deficit) -10.2 -11.1 -16.3 -18.1 -27.5 Investment 51.7 68.8 81.1 93.3 97.2 Gross national savings 41e5 57.7 64.8 75.2 69.7 /a It is assumed that no investment is undertaken by the household sector. /b Increases in stocks were not available separately for the public and private sectors. Therefore, all increases in stocks have been included here. Obviously, proper attribution of increases in stocks would lower private sector deficits and increase public sector deficits. Source: World Bank, Public Expenditures and their Financing, 1984, Report No. 4919-PH, Table 1.2.  - 32 - 3.05 National Government. According to the government budget, capital expenditures include capital outlays for infrastructure and non-infrastructure as well as for capitalization (equity contributions). Another element of expenditure which is similar to capital expenditure is net lending or advances to special funds such as the Industrial Rehabilitation Fund. The task at hand is to assess the relative importance of these capital expenditure categories, and to examine their financing with the object of identifying the respective roles of the current cash surplus, net foreign borrowings, and domestic financing. 3.06 Table 3.3 shows that during 1978-82 the share of direct capital outlays had declined while the shares of equity contributions and net lending had increased significantly. In 1978, the latter categories accounted for 37% of the aggregate of capital expenditures: by 1982 their share had risen to about 54%. 3.07 Among the financing sources, the contribution of the cash surplus, which in the initial years was well in excess of the total of equity contribu- tions and net lending, declined over the period: by 1982 the latter had out- stripped the former. The sharp decline of the cash surplus in 1981-82 was attributable in large part to the sluggish growth of tax revenues. 3.08 Thus, over the last three years, capitalization and net lending has acquired greater share in government capital expenditures, and the latter have been increasingly financed by foreign and domestic borrowing. The share of foreign borrowing was sizable; in 1978-79, it financed about a third of the total capital expenditures and net lending. Domestic financing assumed greater importance in 1981-82.297 The banking system's contributions were particularly large in the same two-year period. The non-bank sector's contri- bution rose to a substantial level by 1982 owing to its increased absorption of Treasury bills, which was related to the Government's continuiniefforts to develop the securities market as a tool of open market operations.J