Ensuring debt sustainability through fiscal consolidation


The pre-pandemic period has often been cited as one of the most successful episodes of fiscal consolidation in the Philippines. This was attributed to the government’s prudent fiscal policy which led to the steady reduction in the public debt-to-GDP ratio over the years.

Since 2020, the earmarked fiscal cushion has helped Filipinos weather the pandemic storm and spurred the recovery of the Philippine economy through fiscal stimulus. As a result, the ratio of public debt to GDP has risen sharply. In response, the government plans to undertake fiscal consolidation to ensure public debt sustainability.

With strong economic recovery momentum and the government’s fiscal consolidation efforts, the Philippines’ debt-to-GDP ratio is expected to gradually decline over the medium term, after peaking at around 60% in 2023 (Chart 1). AMRO’s stress test results under various shock scenarios reveal that the leverage ratio remains below the 70% threshold, as recommended by the International Monetary Fund (IMF) for emerging market economies.

The baseline projection and stress tests for gross financing needs, defined as the sum of fiscal deficit and amortization, also demonstrate low financing stress. (Figure 2).

In addition, the market’s perception of the sovereign risk of the Philippines is considered low, as evidenced by the stability of the Emerging Markets Bond Index (EMBI), the Global Spread and the Credit Default Swap Spread. credit (CDS).

Despite rising debt, the scars of COVID-19 and the headwinds of the ongoing war in Ukraine, the Philippines has also managed to maintain investment grade sovereign credit ratings by major credit agencies.

In addition, the Philippines’ debt profile is sound overall. External financing needs remained low, due to the stability of the public and private external debt amortization schedule. The share of external debt has fallen at 30%, mainly long-term and at 44% on concessional terms, implying low liquidity risk resulting from sudden changes in the risk appetite of foreign investors. The contribution of short-term debt is only 6.8%, which makes it less sensitive to refinancing risk.

Overall, public debt sustainability risk in the Philippines is rated low in all respects—solvency, liquidity, and debt profile vulnerability.

Given that the economic growth momentum could be subdued in a context of high uncertainty, the government’s fiscal consolidation plan aimed at gradually reducing the budget deficit is considered reasonable. Given concerns about shrinking fiscal space and limited buffers to deal with future unforeseen shocks, the pace of fiscal consolidation should be accelerated once private sector growth becomes self-sustaining.

While unwinding COVID-related spending, the government should continue to strengthen revenue-enhancing measures; broadening the tax base, in particular for VAT, and improving the efficiency of tax administration, including the digitization of tax and customs collection. An increase in excise duty rates and the introduction of new taxes on digital services could also be considered.

The government should also ensure the credibility of the fiscal consolidation plan.

The public debt-to-GDP ratio is projected based on underlying macroeconomic forecasts and fiscal plans. Realistic macroeconomic forecasts and achievable fiscal plans are key to setting achievable public debt-to-GDP ratio targets as part of the fiscal consolidation process. Any significant error in public debt forecasts can undermine the credibility of fiscal plans and cause market sentiment to falter.

AMRO assessed public debt forecast errors and identified sources of error in the Philippines using forecasts from official budget documents from 2009 to 2021 (Figure 3). He revealed that the forecast error in projections of the debt-to-GDP ratio was not negligible. In particular, the inflation of the GDP deflator has been systematically overestimated, while the deficit of revenues and the underspending of expenditures have been observed for many years.

During the 2009 global financial crisis and the onset of the COVID-19 pandemic in 2020, the collapse in real GDP growth was the main source of forecast error. The results suggest that there is room to improve macroeconomic forecasts and improve revenue collection and expenditure disbursement.

In conclusion, the great fiscal prudence of the past decade has allowed the Philippines to maintain debt sustainability despite the pandemic. Today, the government launched a new round of fiscal consolidation efforts to restore the shrunken fiscal buffer. On its way forward, establishing a credible plan based on realistic medium-term macroeconomic projections and accelerating its implementation, depending on economic developments, are necessary to ensure success.

Dr. Byunghoon Nam is a Senior Economist at the ASEAN+3 Macroeconomic Research Office (AMRO).

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