Fitch Ratings revise Philippines rating from positive to stable

May 8, 2020

Fitch Ratings on Thursday has revised the outlook on the Philippines' Long-Term Foreign-Currency Issuer Default Rating (IDR) to stable from positive, and affirmed the rating at 'BBB'.

Key rating drivers

The revision of the outlook reflects deterioration in the Philippines' near-term macroeconomic and fiscal outlook as a result of the impact of the global COVID-19 pandemic and domestic lockdown to contain the spread of the virus.

Fitch projects the economy will contract this year, and that fiscal relief measures will contribute to a widening of the 2020 general government deficit by more than 3.5 percent of GDP.

The affirmation of the 'BBB' rating reflects the Philippines' fiscal and external buffers, including its lower government debt/GDP ratio compared with peer medians and net external creditor position, as well as its still-strong medium-term growth prospects.

Fitch projects the economy to contract by 1 percent in 2020, after expanding by 6 percent in 2019. The 2020 forecast is uncertain and subject to considerable downside risks depending on how the virus runs its course globally and domestically and the possibility of a further extension or re-imposition of lockdown measures.

The pace of newly reported cases shows signs of flattening, but the virus nevertheless continues to spread, and partial lockdown measures that were introduced in mid-March have been extended through at least May 15.

Private consumption, which accounts for 72 percent of GDP, is likely to stay muted with the social distancing measures and lockdowns in place.

We expect remittance inflows, which account for about 8% of GDP, to contract by 2.5 percent reflecting the impact of the health crisis in overseas locations (remittances from the oil-sensitive Middle East accounted for about 20 percent of the total in 2019).

We also forecast tourism receipts, which account for 2.5 percent GDP, to contract by about 70 percent before beginning to recover gradually later in the year.

The current account deficit is forecast by Fitch to widen to about -1.6 percent of GDP in 2020, from -0.2 percent in 2019, driven by the decline in tourism receipts and remittances.

Exports are also projected to contract by about 2 percent on account of weak external demand. Sharply lower oil prices and lower import demand mitigate the impact on the current account.

Under our baseline, we assume a gradual economic recovery from Q320, and we expect growth of 7 percent in 2021. Our baseline forecast assumes a gradual recovery in tourism and remittance inflows, along with firming exports, as the global economy begins to recover in line with our latest Global Economic Outlook (www.fitchratings.com/site/re/10119280).

These projections, however, remain highly uncertain and subject to downside risks.

The authorities have been proactive in implementing policies to counter the economic effects of the virus, with a combined fiscal and monetary support package amounting to 8 percent of GDP, with the fiscal component assumed by Fitch to be recorded partly on-budget and partly as off-budget or below-the-line spending.

We now expect the general government deficit to increase to -4.9 percent of GDP in 2020 from -1.2 percent in 2019. This compares with our projection for 2020 of -1.2 percent of GDP when we affirmed the rating in February.

Our projection of the central government deficit is -6.5 percent of GDP in 2020, somewhat above the authorities' projection of -5.3 percent, as we assume a sharper decline in revenue collections and slightly higher expenditure.

Our central government fiscal projections incorporate the on-budget portion of our assumption of the fiscal component of the authorities' four-pillar socio-economic strategy against COVID-19 amounting to about 2.3 percent of GDP.

Fitch expects the authorities to finance the higher deficits through a combination of domestic and external financing, in line with their planned borrowing mix of 70 percent/30 percent split in favour of the former.

The Bangko Sentral ng Pilipinas (BSP) has authorised the use of a repurchase agreement with the Bureau of the Treasury, of P300 billion of government securities since March.

Fitch understands the facility has been authorised on an exceptional and short-term basis to help meet the government's urgent COVID-19-related financing needs. Meanwhile, we expect external funding to be met through international bond issuance and multilateral loans, including from the Asian Development Bank and the World Bank in response to the health crisis.

Under our baseline assumptions, we expect the general government debt/GDP ratio to rise to about 46 percent of GDP by 2021, from about 35 percenr estimated by Fitch for end-2019, which would be below the projected 2020 'BBB' median.

The scale of this projected increase in the debt ratio exceeds the size of our forecast of the fiscal deficit, reflecting the proportion of the fiscal support package assumed by Fitch that will be recorded off-budget or as below-the-line spending.

The debt ratio could rise further if the virus outbreak persists or returns, necessitating further lockdowns. Over the medium term, we expect the debt ratio to decline gradually to 41.7 percent by 2023, in line with the authorities' intention to consolidate the deficit once the effects of the pandemic recede.

The Bangko Sentral Ng Pilipinas (BSP) has cut the policy rate by 125bp since the beginning of the year to a historic low of 2.75 percent, including an off-cycle 50bp cut on April 16.

The BSP has also reduced the reserve requirement by 200bp so far this year. There may still be room for limited monetary easing as inflation declines, in Fitch's view. We expect inflation to end the year at the lower end of the central bank's 2 percent-4 percent target range.

The 'BBB' IDR also reflects the following key rating drivers:

The Philippines' structural indicators are weaker than peers, including per capita income, governance standards and human development. Reforms undertaken in the last couple of years, such as passage of the Philippine Identification System Act of 2018, increased coverage under the National Health Insurance Program and establishment of the Presidential Anti-corruption Commission, could lead to improved structural indicators over time.

Foreign-currency reserves and gross external debt levels remain healthy. Despite global financial market volatility, foreign reserves have been stable this year, at USD89 billion as of end-March. Modest external debt-service payments relative to its foreign-currency reserves also support a strong external liquidity ratio of about 372 percent (measured as total external assets/liabilities), compared with 148 percent for the 'BBB' median.

We project foreign-currency reserves of around $90billion at end-2020, equivalent to about eight months of current external payments (CXP).

This assumes proceeds of global bond issuances of about $3.7 billion and possible disbursements from multilaterals of around $6 billion for the whole year.

Tax reform has supported an improvement in the Philippines' government revenues and the central government revenue/GDP ratio rose further, to 16.1 percent of GDP by end-2019 from 15.6 percent in 2018 (based on the newly rebased GDP series).

The Philippines' general government revenues are still weaker than the peer median, although we expect further progress on tax reforms to lead to higher revenues over time.

Fitch understands that the authorities remain committed to passing the remaining tax packages of the comprehensive tax reform program (CTRP), notably packages two, three and four, before the next presidential election in 2022.

Fitch revised the Philippine banking sector's outlook to negative in March, reflecting our expectation that the pandemic will weigh on banks' asset quality and profitability. The economic contraction expected in 2020 implies that loan delinquencies and credit costs will rise, especially as asset quality associated with recent rapid credit growth has not been tested through the cycles.

The lower interest-rate environment and slower economic activity will also pressure the banks' profitability. That said, the commercial banks' sector-wide total capital-adequacy ratio of 16 percent as of December 2019 provides loss absorption buffers to withstand moderate credit stresses in the system.

ESG - Governance: Philippines has an ESG Relevance Score of '5' for Political Stability and Rights as well as for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. Philippines has a medium World Bank Governance Indicator ranking in the 40th percentile, reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.



Sovereign Rating Model (SRM) and Qualitative Overlay (QO)

Fitch's proprietary SRM assigns the Philippines a score equivalent to a rating of 'BBB-' on the Long-Term Foreign-Currency (LT FC) IDR scale.

Fitch's sovereign rating committee adjusted the output to arrive at the final Long-Term IDR by applying its QO, relative to rated peers, as follows:

- Macro: +1 notch for strong and sustainable levels of projected GDP growth over the medium term, combined with a sound policy framework.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.



Rating Sensitivities

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- A resumption of strong economic growth following recovery from the pandemic, while maintaining macroeconomic stability.

- Strengthening of governance standards towards those of the rating-category peer median.

- Sustained broadening of the government's revenue base that enhances fiscal finances and places the government debt/GDP ratio on a downward trajectory.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Reversal of reforms or a departure from the existing policy framework that leads to macro instability or weaker fiscal or economic outcomes.

- Deterioration in external indicators, including foreign-currency reserves, the current account deficit and net external debt, that lowers the resilience of the economy to shocks.

- Deterioration in banks' asset quality that leads to instability or stress in the financial system.