NUMBER 121 * EPrecis \ Operations Evaluation Department June 1996 Debt Management in the Philippines The first debt and debt service reduc- monetary problems and instabil- well underway, aided by greater tion operation the World Bankfi- ity. The resulting increase in in- political stability. nanced was the Debt Mantagement flation forced the government to Program Loani to the Philippines, ap- rein in the economy, suppressing The Debt Management Pro- proved in 1990. Its main objective growth; the currency tended to gram Loan followed six other ad- was to help restore the Philippines' appreciate and the new loans justment operations that the Bank creditwvorthiness by reducing the de- tended to substitute for public carried out to help the country in stabilizing pressuires exerted by an sector savings. Clearly, in debt this process. By 1986, the ratio of excessive debt-service burdeni. The restructuring exercises, foreign external debt to GNP in the Phil- government, having inherited a huge creditors must give only enough ippines had peaked at 97 percent debt service obligation, formulated a assistance to avoid destabilizing (see Figure 1). To reduce the debt restructuring program for the pressures; the full benefits of heavy debt-service burden- country and a request for debt-relief debt restructuring can be cap- which was concentrated in the from creditors, with assistanzce from tured only in a stable economic public sector-the government, the Bank and the IMF. environment. the Bank, and the IMF agreed to combine general macroeco- Several events helped improve Background nomic reform with a debt reduc- the Philippines' creditworthiness. tion agreement with the gov- Three of them are particularly rel- In the ten years after 1986, ernment's creditors. The Debt evant to the operation. First, the when the Marcos regime fell, the Management Program Loan, government adopted a program Philippines has carried out a re- complemented by other IMF and of deep structural and macroeco- markable program of economic bilateral funds, provided $200 nomic reform. Second, it reduced liberalization and moderniza- million in 1989-91 toward $1.46 the debt stock by about $650 mil- tion, initiated in the midst of a billion of debt buybacks at a 50- lion equivalent, or about 2.3 per- deep economic and political cri- cent of its outstanding debt at the sis that started in the late 1970s. time, using Bank and IMF financ- The crisis had serious macroeco- ing to buy back $1.46 billion of nomic manifestations-including 'Performance,iit aluit teport. debt from commercial banks at 50 high inflation, large current ac- PhiIippi.is: Debt Manage- percent discount. And finally, by count deficits, and huge arrears Phelt Pprines " bang Luis signaling confidence in the Philip- in external debt. But its source Li,ieiit, andog Mam,el HindLs, pines' commitment to sound was the misallocation of re- Re'jort No. 14811,June30 macroeconomic reform, the Debt sources embedded in the model 1995. Nt1 ],June at, Management Loan opened up in- of development then applied in por5ts art a ncielc to Bank re - ternational financial markets for the country, a model based on t'pt it'a' avirlable rt Bd7 k staff the country. pervasive state intervention and erom the Internal Dociirsetaff overprotection of industry. froit atuln trcna Reylonl lDftor-t However, the program's suc- Reaching a path of sustainable mlat ind Sfroic' s CRql'tels. cess also led to a new problem. It growth required both macroeco- Precis written by Pat encouraged new loans and other nomic stabilization and deep inflows of capital, which eventu- structural reforms. By the mid- AINces. ally became a major source of 1990s, this transformation was Economic growth and external debt burden the effect that greatly increased 1 - 0.1 capital inflows had on macroeco- 0.9 - A L.os nomic stability. The authorities could not foresee their own suc- 0.8 ' 0.06 cess when they began negotiating 0.7 -0.04 8 for additional capital as part of - 0.6 - -a\ their debt reduction exercise. t4 0.5-- / 0 / \ / ;0.02 < Facing uncertainty, it made sense z 0.5 0 r\ for the government to err on the i 0.4 - side of exaggerating the need for 0.3 ~ ~ ~ ~ ~~~~~~~~~O~-.02 capital inflows. But as the debt -0.3 0 reduction exercise coincided 0.2 1 with falling US interest rates 0.1 -0.06 and a subsequent boom in pri- 10~ ''i5 198 r , | | I , r , S , , , , -0.08vate capital flows to developing 1970 197;5' 1980 1985. . . 1990 countries, new loans began enter- ing the Philippines in record vol- - Debt/GNP --Rate of growth of GDP ume, eventually becoming a source of financial instability. Partly for this reason, the Bank correctly decided not to partici- percent discount from low-expo- support and the other to the pate in the second, larger, debt sure commercial banks. operation's success in increasing and debt service reduction oper- capital inflows. ation. Providing even more Project goals balance-of-payments support In the original design, the Bank would have increased inflation- The main objective of the had not intended to attach condi- ary pressures. loan was to help restore the tions to the operation, because country's creditworthiness by debt reduction was meant to Outcomes reducing the destabilizing pres- complement ongoing structural sures that an excessive debt- reforms, and those reforms were The Debt Management Loan service burden exerted on already being monitored by the helped improve the country's macroeconomic management. preceding Bank loans. In the end, creditworthiness in two ways. The loan was consistent with however, the Bank decided to First, it reduced the burden on the Bank's strategy of helping attach similar conrditions to the the government from external the Philippines to achieve a sus- Debt Management Program debt, which had produced desta- tainable path of growth by Loan. But those conditions were bilizing fiscal and quasi-fiscal making investments more effi- unnecessary because they basi- deficits. Second, it signaled to in- cient. It complemented ongoing cally restated what was already ternational markets that the Bank Bank support to improve the covered elsewhere, and some trusted the policies the govern- government's investment plan- of them entailed institutional ment was pursuing and was will- ning and procurement, liberal- changes that by definition take a ing to increase its exposure in izing trade and banking, and long time to implement. They thus the country. This opened up in- continuing with privatization. were not appropriate for an opera- ternational financial markets for tion of a commercial type, which the Philippines. Although the Implementation requires quick response to market operation's impact on institu- conditions. tional development was negli- The debt reduction exercise gible, the operation was started with a 1990 pilot pro- Added to this, the Bank applied cost-effective. gram, which was supported by its standard disbursement proce- the Bank loan. The intention dures, which are too slow for an The objective of reducing the was to follow with a second, operation requiring speed of ac- debt burden was important and, larger, debt and debt service tion. These design flaws delayed on the whole, the outcome of the reduction operation. However, disbursement, thus preventing the Philippines' debt management the pilot program encountered central bank from taking full ad- program was satisfactory. In par- two major problems-one re- vantage of rapidly changing mar- ticular, the program helped to lated to the design of the Bank ket conditions. make Philippine investments June 1996 more efficient, decrease the risk premium required for interna- tional financing of investments, Box: The causes of the declining risk premium on reduce the external debt burden Philippine debt service to manageable levels, and attract large capital inflows. The path of the decline in the Second, the decline in the Equally important, these objec- risk premium on Philippine risk premium coincided with a tives were attained while the debt paralleled the decline in general increase in demand country was resolving serious interest rates on the US dollar, for investments in developing political problems. which meant that the yield in- countries, largely associated ternational investors required with the decline in US dollar in- But the huge inflow of capital on Philippine debt fell from terest rates. had a destabilizing effect on the 17.2 percent in the first quarter economy in the 1990s. In re- of 1989 to 8.3 percent in the That is not to say that govern- sponse, monetary authorities third quarter of 1993. There is ment action in the Philippines found it necessary to adopt re- no doubt that falling US interest was no factor in the success of strioied ecredipoici growthihor- rates had an important, positive the country's debt reduction sunatelow teo goverowth.aFor effect on the outcome of the program. For one thing, only tunately, the government has recently taken corrective action Philippine reform program. countries that carried out cred- to help stabilize the economy, But two points must be kept in ible efforts to stabilize their thus creating a sounder basis mind in analyzing cause and economies and made them more for the resumption of foreign effect. efficient shared in the boom of investment. investment in developing coun- First, the risk premium fell tries. And changes in the dis- Lessons only after the second, larger count applied to Philippine debt reduction exercise took debt mirrored the country's Thefull benefits of a debt re- place, in 1992. After the first macroeconomic performance, structuring operation can be cap- debt reduction loan, the pre- increasing initially as perfor- tured only in a stable economic mium actually increased sub- mance deteriorated and then environment. Aiming to maxi- stantially, probably because of declining as the government mize the volume of new lending the slowdown in the nation's established a credible stabiliza- to the debtor country in a debt growth rate and the outburst of tion program and began the reduction exercise can result in macroeconomic instability in second stage of its debt reduc- capital inflows greater than 1991-92. tion program. the country can safely absorb, leading to macroeconomic in- stability and the substitution of The declining risk premium of Philippine debt foreign savings for public sector 0.7 - 16 savings. Agreement signed 0.6- -14 E * Increases in capital inflows should not be used as a measure of E 0.5 -II- the benefits from a debt reduction YYV exercise, for three reasons. (1) The 0.4 - new resources are liabilities on 8 the country's balance sheet. In- 0.3- creasing indebtedness is a neu- tral activity; its value to the .0.2- country depends on the use to 4 which the new loans are put. In 0.1 - -2 the Philippines in the 1990s, ex- cessive capital inflows brought 0 - 9 9 1991- 0 about serious macroeconomic 1988 1989 1990 1991 1992 1993 problems. (2) The dynamic ben- - Risk premium - Market price efits the new loans are sup- Note: Risk premium is the difference between implicit yield in Philippine debt and yield posed to measure-improved on 10-year US Treasury bonds. Market price of Philippine debt, as percent of face value. access to international financ- ing-are captured by the reduc- OED Precis tion in the international risk tional markets. (3) Excessive capital * The Bank should adopt streamlined premium(seebox).Theinstability inflows can become destabilizing. procedures for debt reduction opera- of the 1990s threatened the Philip- The Bank should make sure that tions. In debt relief and debt swaps, pine program's sustainability, so capital inflows are monitored and speed is important. Bank proce- domestic financial markets did should suggest restricting those dures caused delays, which pre- not immediately benefit from the attracted by government negotia- vented the Central Bank from reduction in the risk premium im- tions when they become a source of taking full advantage of rapidly posed on the country in interna- instability. changing market conditions. OED Precs is produced by the Operations Evaluation Department of the World Bank to help disseminate recent evaluation findings to development professionals within and outside the World Bank. The views here are those of the Operations Evaluation staff and should not be attributed to the World Bank or its affiliated organizations. This and other OED publications can be found on the Internet, at http:// www.worldbank.org/html/oed. Please address comments and enquiries to the managing editor, Rachel Weaving, G-7137, World Bank, telephone 473-1719. Internet: rweaving@worldbank.org June 1996