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Fitch investment grade rating: The collapse of credibility

fitch_ratingsRecently, amid reports of increasing self-rated involuntary hunger indices, the increasing poverty statistics and high unemployment rates, the Department of Finance (DOF) had virtually gone to town on the news that the economy was granted its first-ever investment-grade rating.

Taking into account the three international credit rating agencies that comprise approximately 90% of the global credit rating agency market, Standard and Poor’s continues to rank the Philippines at BB+, a junk bond grade or below investment grade, Moody’s Investor Services rates us at Ba1, also a junk bond grade and below investment grade, and Fitch at BBB-, the lowest level investment grade. In detail, the Fitch ratings upgrades were specifically and solely on the Philippines’ long-term, foreign currency-denominated debt upgrading from BB+ to BBB-, and long-term local currency-denominated debt upgrading from BBB- to BBB.

To appreciate what these ratings represent and from which bases they are computed, it is important to understand exactly what specific instruments ratings rate and were granted upgrades. Nothing more and nothing less.

The ratings agency however issues its own warnings as to the extent of its accuracy. On this, Fitch makes the following declaration, “Neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports.”

This rests the credibility on the issuer of the debt instruments and the rating is thus only as good as the credibility of the issuer that pays for the rating. It is worth repeating that not all of the data that Fitch relies on will be accurate and complete.

Moreover, because ratings embody predictions, these cannot be verified as facts until they actually occur. Thus, the track record of ratings agencies is important only in retrospect. Given all three major ratings agencies failed to foresee the 2008 Global Financial Crisis and had maintained some of the highest ratings for distressed financial issuers that had weeks later gone bankrupt should be food for thought.

daangmatuwudNow note the DOF’s official verbiage in reaction to the Fitch rating. “After successfully reversing a decade of decline in our credit ratings, President Aquino’s tuwid na daan has led us to investment grade rating for the first time in our history. This is the clearest and most definite affirmation that good governance is indeed good economics. Indeed, another historic first under the Aquino administration and a landmark achievement!”

From the preceding statement, politics cannot be denied as the obvious reference to the current dispensation appears as the substance of the investment rating as if such ratings are knee-jerk reactions to current events. These are not. As the ratings have a predictive value and, as opined by the ratings agencies themselves, based on historical data and progression analysis, the rating per se cannot be verified as facts.

Using the words of the rating agency against those from Aquino’s bureaucratic factotum specially coinciding with midterm elections, let us get to the truth behind the bunk. The analysis of ratings as well as pronouncements from economic managers must be tested for truth lest both succumb to a crisis of credibility. Specifically, let us address the DOF statement that, one, there was “a decade of decline in our credit ratings”, and two, “Aquino’s tuwid na daan has led us to investment grade rating”.

sona2012-president_aquinoHere we presume that the terms “tuwid na daan” refer to the centerpiece anti-corruption campaign upon which the Aquino government founds its presidency. Likewise, a decade of decline places the regression as starting from 2003 when, ironically, the DOF’s current head was likewise Gloria Arroyo’s appointee.

The official records show that on June 12, 2003 Fitch rated our foreign currency denominated debt at BB and our long term local currency-denominated debt at BB+. Those are the facts. Each year thereafter, from December 7, 2004 onwards both types of debt instruments were repeatedly rated at exactly these levels and remained unchanged. More important, they did not deteriorate. The DOF states that there was a “decline” during this period. The term decline is defined as deterioration from a previous state. The BB and BB+ ratings were constant. Thus, 2003 to 2013 was hardly a “decade of decline”.

Let us now tackle the question of the rating’s inherent substantiation, disregarding what spins and politics enter from the side of the issuer of the instruments.

From Fitch itself, referring to their report verbatim, there are three principal bases which stand out.

One, Fitch found a “persistent current account surplus (CAS), underpinned by remittance inflows, has led to the emergence of a net external creditor position worth 12% of GDP by end-2012, up from 6% at end-2010. Remittance inflows were worth 8% of GDP in 2012 and proved resilient even through the shock of the global financial crisis.”

Two, Fitch stated that “Improvements in fiscal management begun under (former) President (Gloria) Arroyo have made general government debt dynamics more resilient to shocks. Strong economic growth and moderate budget deficits have brought the general government (GG) debt/GDP ratio in line with the ‘BBB’ median. The sovereign has taken advantage of generally favorable funding conditions to lengthen the average maturity of GG debt to 10.7 years by end-2012 from 6.6 years at end-2008. The foreign currency share of GG debt has fallen to 47% from 53% over the same period.”

Three, Fitch further stated that “favorable macroeconomic outturns have been supported in Fitch’s view by a strong policy-making framework. Bangko Sentral ng Pilipinas’ (BSP) inflation management track record and proactive use of macro-prudential measures to limit the potential emergence of macroeconomic and financial imbalances is supportive of the credit profile.”

gloria-macapagal-arroyo-3On Fitch's first basis we all know that the Philippines was a net borrower from the International Monetary Fund (IMF) up until 2006 under Gloria Arroyo, when, through a series of fiscal reforms initiated in 2004 from the expansion of the value added tax to the revised excise tax laws, all coupled with a policy of reserve accumulation from export earnings and inward remittances, the country prepaid all its outstanding IMF obligations. By 2010, the final year of the Arroyo incumbency and before the Aquino government had taken over, the Philippines became a net creditor to the IMF when it participated in the Financial Transactions Plan (FTP), a lending facility of the IMF.

The doubling of the ratio of the Philippines’ net creditor position’s value to GDP from 6% to 12% was a result, not of policy adjustments under Aquino as the DOF would have us believe- policies which had not changed substantially from the previous Arroyo years – but were more likely largely due to the increasing absence of viability from the offshore economies from which those remittances emanated, namely the American, Japanese and European economies.

In other words, it made little sense for those remitting earnings from these recession-ridden hemispheres to retain funds where they were earned. It made more sense to remit back to the Philippines because of the increasing domestic unemployment, the hunger index and the poverty incidences which perpetuated under Aquino. It is the continuing destitution within the domestic Philippine economy under Aquino where offshore earnings continue to be critical inflows that ensure the importance of a persistent current account surplus enough to compel Fitch’s ratings outlook.

International_Monetary_Fund_logo.svg On the second basis for the Fitch upgrade, the verbiage of Fitch is self-explanatory. It was indeed the improvements in fiscal management after the serious fiscal crisis experienced under Arroyo that compelled an economy-wide increase in tax collection through the Expanded Value Taxation route that was not only continued by Aquino but had in fact tempered budget deficits to the levels of the BBB median. Add here the retirement of high cost debt, Arroyo's aggressive replacement of these with lower costing sovereign liabilities and the establishment of the country as an IMF net creditor that the basis for the Fitch upgrade is established.

These are the same macroeconomic policy framework provisions the Aquino government adopted from Arroyo, continued and expanded by the same leadership of the BSP appointed during the Arroyo incumbency and simply perpetuated by Aquino.

Reading through the Fitch analysis, the substance of the BBB+ rating were policies from the previous government (repaying debt, high external position, high dollar reserves, etc.) and simply continued by a current hierarchy headed by an Arroyo appointee.

It is now apparent that a dispensation created from soundbytes and hollow imagery perpetuates on the basis of its original fundamentals. As the Fitch default colatilla illustrates, ratings are only as credible as the data provided it by the issuer. All told and as evidenced by the continuing global financial crisis spawned from the same sponsors of an investment grade rating there lies the collapse of credibility.


Dean dela Paz is an investment banker. He is a consultant in the fields of finance and banking and has packaged some of the most prolific public offerings in the Exchanges. He is a member of the Executive Committee and sits in the Board of one of the oldest financial institutions in the country. He is likewise an energy consultant having served on the Boards of several foreign-owned independent power producers and as CEO of a local energy provider.

He is currently the Program Director for Finance in a UK-based educational institution where he also teaches Finance, Business Policy and Strategic Management. A business columnist for the last fifteen years, he first wrote for BusinessWorld under the late-Raul Locsin and then as a regular columnist for the Business Mirror and GMANews TV. He also co-authored a book and policy paper on energy toolkits for a Washington- based non-government organization. He likewise co-authored and edited a book on management.

Stock photos rom Blog Watch. Some rights reserved.

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