Financial crises have a domino effect. A seemingly small event in one country can have far-reaching consequences around the world. We’ve seen it in the 1997’s Asian Financial Crisis and again in the global financial crisis of 2009.
Sri Lanka is experiencing its worst financial crisis since gaining independence in 1948. For years, Sri Lanka spent more than it earned and covered the gaps with debts. When President Gotabaya Rajapaska was elected in 2019, he ordered deep tax cuts as a populist move instead of adopting policies to narrow the country’s gaping deficits. With that, it was only a matter of months before the country depleted its cash reserves. With more than $50 billion in foreign debts and a shortage of cash, the country struggles today to pay for essential imports like food, medicines, and fuel for its power plants. Sri Lanka’s 22 million people are starving and this has triggered civil unrest.
Consequently, credit rating agencies downgraded Sri Lanka’s debts to default levels. Access to new money is few and far between. The country must pay $7 billion worth of debt this year but only has $1.6 billion in its treasury. It can no longer borrow its way out of its woes. Last month, it had no choice but to default on its loans. Sri Lanka is now looking at the IMF for a bailout.
Sri Lanka has fallen. Will other economies follow?
Yes, according to the IMF.
Last February, the international lender flagged 70 economies as being in danger of going Sri Lanka’s way, what with ballooning debts, shrinking cash reserves, and large trade and budgetary deficits. The list includes the Philippines. Others in danger are Egypt, Tunisia, Lebanon, Argentina, El Salvador, Peru, Ghana, Kenya, South Africa, Ethiopia, and formerly mighty Turkey. Within the next 12 months, economies in debt distress will be unable to meet their obligations and will default, the IMF foretells. This will usher in the largest debt crisis of this generation.
How did we get here? It was a confluence of events. It started with easy access to loans primarily from China. Xi Jinping’s belt and road initiative lured countries to acquire massive amounts of debt to fund infrastructure. These debts, however, carried steep repossession clauses in case of default. Worse, debts from China include clauses that allow them to interfere in the foreign and domestic policies of the borrowing country. China led many counties into a debt trap.
Trade sanctions are more prevalent than we realize. There are 20,000 trade sanctions currently in force and these have dragged on global trade. Low- and middle-income economies are the most affected by these sanctions. For those unaware, trade sanctions are enforced by larger economies as a way to control the politics of smaller ones.
All these were exacerbated by the pandemic. Countries like the Philippines had no choice but to acquire piles of new debt to weather the crisis. This, coupled with a standstill in economic activity and drop in revenues, eroded the financial standing of many nations.
Vladimir Putin’s war was the final nail in the coffin. The war choked the global supply of wheat and fuel causing steep price hikes across the globe. Supply chains were disrupted and financial markets went into disarray.
THE PHILIPPINE ECONOMY UNDER MARCOSMarcos will be inheriting a weaker economy than President Duterte did in 2016. Debts are at a maximum tolerable level of 63.5% of gross domestic product as of March 2022. The budget deficit is now wider than ever at $33 billion or 8.6% of GDP as the end of 2021. Exports are tepid while imports are voracious — the merchandise trade deficit was at $43.13 billion last year. Our manufacturing and agricultural sectors have eroded to such a point that we are now import-dependent on practically all our needs including rice and flour. As if this weren’t enough, unemployment stands at 6.4% while 23.7% of the population lives in poverty.
Our saving grace is healthy Government International Reserves (GIR) which stand at $108.5 billion as of last March, which is sufficient for 9.6 months of imports. We have the toil of our OFWs to thank for this.
What must Marcos do to prevent the Philippines from going the way of Sri Lanka? I recommend eight policies and/or action points.
First. Shun populist policies that erode national incomes and those that make the country less conducive to doing business.
Second. Prudent financial management. Prioritize spending and forgo budget insertions that are frivolous, excessive, or dispensable. Clamp down on budget leaks attributed to graft and corruption. If borrowing is necessary, source domestically whenever possible.
Third. Increase government revenue to GDP ratio from 15.5% to at least 17%. This necessitates increasing tax collection efficiency. To do this, Marcos must come down hard on smugglers, tax delinquents, and tax evaders. But Marcos will not have the moral high ground to do this unless he first settles his own tax obligations. So, squaring-off his own tax debt is the first order of the day. Not to do so will erode his credibility and embolden the rest of society to ignore their tax obligations.
Fourth. Narrow the trade gap. There is no getting away from it — we must wean ourselves away from import dependence and pivot from being a consumer-led economy to one that is production lead. To do this we must foster a manufacturing resurgence. We need not re-invent the wheel. In 2013, the Department of Trade and Industry launched a manufacturing resurgence program that involved the crafting of some 80 industry roadmaps. The program was so successful that in 2014 and 2017, the growth of industry outpaced the growth of services for the first time in our post-war history. The manufacturing resurgence program simply needs an update and a renewed commitment.
Fifth. We cannot do it alone. We need foreign direct investments (FDIs) to pull off a manufacturing resurgence. But FDIs will not come unless there is confidence in Marcos’ leadership. Thus, Marcos must prove that his motives for national development are pure. This will be evident by leading by example. He must prove that cronyism and entitlement will not be hallmarks of his administration. He must prove that the rule of law will be applied to all, especially those in the axis power including the houses of Duterte and Marcos.
Sixth. We must work double-time to develop the industries where the Philippines has a competitive advantage. This includes IT-KPO’s (Information Technology-Knowledge Process Outsourcing, the development of which was neglected by the Duterte administration), maritime industries, mining, electric vehicles and parts, aerospace, food manufacturing and agro-processing, construction, creative industries, e-commerce, and data centers, among others.
Seven. Revive agriculture. There are a multitude of factors that impede agricultural development, not the least of which are the limiting effects of CARP (Comprehensive Agrarian Reform Program) on economies of scale, the lack of infrastructure and technology, and expensive farm inputs. The Marcos administration must find ways to circumvent these obstacles. One way is by the establishment of Agri Hubs. I explained this concept at length in this corner on April 25.
Eight. Accrue foreign exchange earnings wherever we can get it. One of the low hanging fruits is tourism. As a tourism product, the Philippines is a triple-A threat. The impediment to the influx of foreign visitors is connectivity (or lack of direct flights) and ease in domestic connections.
There is so much more to be done. Suffice to say that it all boils down to fiscal prudence and the aggressive pursuit of national revenues. The financial tsunami is coming. Let’s hope Marcos prepares for it.
Andrew J. Masigan is an economist