Moody's: Philippines' credit profile balances sound fundamentals against structural challenges

Moody's Investors Service says that the credit profile of the Philippines (Baa2 Stable) balances sound economic and fiscal fundamentals against structural challenges to competitiveness and rising political risks.

We expect robust economic growth to be sustained over the next few years, aided by the government's focus on infrastructure development, buoyant private sector investment, and the recovery in external demand.

The re-emergence of conflict in the southern Philippines, as well as the Duterte administration's focus on the eradication of illegal drugs, represents a rising but unlikely risk of a deterioration in economic performance and institutional strength.

Moody's conclusions are contained in its just-released annual credit analysis, "Government of the Philippines -- Baa2 Stable". The report elaborates on the Philippines' credit profile in terms of economic strength, High; institutional strength, Moderate (+); fiscal strength, Moderate (-); and susceptibility to event risk, Low (+). These are the four main analytic factors in Moody's Sovereign Bond Rating Methodology.

We project real GDP growth to be broadly stable in the remainder of 2017 and to average 6.5% for the year as a whole, which is at the lower end of the government's forecast range of 6.5%-7.5%.

We have also retained our projection for 2018 at 6.8%, below the government's target of 7.0%-8.0% given continued uncertainties regarding the proposed comprehensive tax reform program (CTRP), which is currently being considered by the upper house of Congress.

In the absence of a significant boost to government revenues from the passage of the CTRP, the government will likely pare back its plan to aggressively increase its spending on infrastructure.

Other downside risks include a worsening of the Islamist insurgency in Mindanao that could lead to an expansion of martial law, undermine both foreign and domestic business confidence, and disrupt economic activity in other parts of the country.

Fiscal deficits are also widening, but ongoing debt consolidation and improving debt affordability give the government fiscal space to accommodate higher infrastructure spending and wider budget deficits.

Further improvement in fiscal metrics will largely depend on whether the proposed tax reforms can effectively bolster revenue generation. Administrative reforms have led to higher government revenue in recent years, but revenue remains low as a share of GDP compared to peers, which in turn constrains room for greater spending.

However, fiscal strength remains weak compared to similarly rated peers.

The stable outlook on the Philippines' rating indicates that upside and downside risks are balanced. On the upside, strong GDP growth could accelerate even further, especially if the government achieves higher investment spending.

On the downside, capacity constraints are emerging and could prove more stringent than we currently envisage, giving rise to inflationary pressure. High credit growth since 2014 also exposes the banking system to unseasoned asset quality risk.