What Makes a Country Look Good?
Improving the Credit Rating of Philippine Sovereign Bonds

In 2004, the top three credit rating agencies, Standard and Poor’s, Moody’s and Fitch Ratings, have lowered the credit rating of the Philippine government’s short- and long-term bonds. As a result, costs of external borrowing increases as announcements of downgrade are always followed by wider credit spreads. The downgrade in 2004 caused the country 80 basis points in additional interest, or almost US$32 million in incremental deficit. Correspondingly, the reversal in US Federal Reserve stance on the Philippine sovereign bonds from easy to neutral is expected to increase base by 100 basis points.

The low credit rating does not only result in higher borrowing costs for the government, it also affects other sectors of the economy. Domestic private sector’s access to international capital market becomes costly because sovereign risk is associated with country risk especially when little is known about the country. Credit ratings are also believed to be pro-cyclical—they are higher than what macroeconomic fundamentals would predict during good times but lower during bad times, which could lead to massive reversal of capital flows when economic condition of a country changes.

The increasing costs of borrowing faced by both public and private sector due to low credit ratings and the sensitivity of capital flows to perceived country risk can have huge ripple effects on the entire domestic economy. These include disruption to financial system functioning, inadequate resources to finance the government’s economic and social spending, slowdown of private sector investments, and overall economic downturn. External borrowing, however, is inevitable. The Philippines has relied on external financing because of inadequate sources of revenues from the domestic economy given the required level of spending and because the government avoids crowding out the domestic private investments.

To reduce the borrowing costs face by the country and to minimize the economic impact of low credit ratings, the Philippine government must therefore take action to improve the credit ratings of its sovereign bonds. The purpose of this paper is to identify factors that could potentially affect changes in credit ratings so that the Philippine government can prioritize its strategies in order to make the country look good to its potential creditors. Using the data of 52 developing countries that have access to international financial markets and whose sovereign bonds are rated by Fitch Ratings, ordered probit estimation showed that faster real GDP growth, lower external debt to exports ratio, and slower depreciation rate in a particular year increase the likelihood of being upgraded the following year.

For the last three years, the economic condition of the country has been favorable in terms of real GDP growth and currency depreciation rate. The level of external debt relative to exports, however, has been rising, which, according to the findings of this paper increases the likelihood of being downgraded. It must be the case, therefore, that the reason for the downgrade is the increasing level of external debt combined with the uncertainty of inflows of foreign currency to meet the country’s increasing financial obligations.

The paper recommends that the Philippine government focus on generating foreign exchange through expansion of its exports sector which is the stable source of foreign inflows. Reliance on foreign borrowing should also be reduced by improving revenue collection, exploring other sources of revenues, and eliminating the inefficiencies in the financial system to translate savings into investments. In monitoring of the level of external debt, the Philippine government must pay closer attention to external debt to exports ratio, real GDP growth and exchange rate depreciation as they significantly affect changes in ratings. Furthermore, in the planning process the government has to set macroeconomic targets on GDP, nominal exchange rate, level of exports and external financing requirement such that the combination of these variables result in an upgrade.