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RIM March 1999, No.43

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Philippine Resiliency to the Asian Financial Crises

Sakura Institute of Research, Inc.
Roy Mijares


Over the past decade, attention was focused on Asia as the fastest growing region in the world. Then, in 1997, many of these fast-growing economies, seemingly without warning, turned around and faced economic collapse as a result of financial and currency crises that spread all over Asia as well as other emerging markets in the world.

One of the basic causes of the crises is that the affected currencies had pegged their exchange rates to the U.S. dollar, which led to overvalued currencies and growing trade deficits. Cheap short-term foreign currency funds led to overexpansion in non-profitable plant investments as well as speculation in real estate and the stock market, leading to an asset bubble. When the bubble burst, the firms, banks and investors that relied on external borrowing could not easily repay the large stock of short-term foreign debt that was called. There were excess debt and weaknesses in the financial system. The simultaneous rush to cover foreign currency liabilities once the currencies started to depreciate exacerbated the fall in the currencies.

As the currency depreciated, the real burden of the debt denominated in foreign currencies dramatically increased and led to further financial crisis for banks and firms. Devaluations in one country led to competitive devaluations and contagion across Asia. Finally, stringent IMF conditions, which were imposed in order to stabilize the exchange rate and reform the financial system, led to closures of troubled financial institutions, a tightening of credit, and high interest rates, which severely affected even the viability of previously healthy companies.

In an environment with large devaluations and tightened monetary policy, interest rates increased, which further weakened financial institutions, corporate borrowing, business activity, employment and the general economy. Compared to the high growth in 1997, GDP is expected to have declined drastically in 1998 in Indonesia (from 4.6% in 1997 to -13.7% in 1998), South Korea (from 5.5% to -6.1%e(1)), Malaysia (from 7.7% to -6.4%e), and Thailand (from -0.4% to -7.9%e). Even Singapore experienced a slowdown, growing only 1.5% in 1998, compared to 7.8% in 1997. The Philippines had a -0.5% growth for 1998, compared to 5.1% in 1997.

El Nino, which started in the first quarter, and very bad typhoons in the fourth quarter hit the agricultural sector very hard for a -6.6% decline (the quarterly year-to-year growth rates were: -3.8%, -11.5%, -3.0% and -7.6%) and had the effect of reducing GDP by about 1.3%-points in 1998. Thus, if it were not for the devastating effects of the weather, growth would have been positive. Additionally, export growth may be very much understated (see section II.1 of this report). GDP growth for 1999 is expected to range from about 2.5-3.5%.

Why was the Philippines not as badly affected as its Asian neighbors? How did conditions in the Philippines differ from its Asian neighbors? What is its future outlook?

I. The Philippines Compared to Its Asian Neighbors

1. Exchange Rates Pegged to the U.S. Dollar

Many Asian economies had pegged their currencies to the U.S. dollar. However, a relatively fixed exchange rate encourages large capital inflows, and leads to nominal appreciations and overvalued currencies. As can be seen from Fig. 1, except for Indonesia and the Philippines, depreciation rates had been moderate in the 1980s and steadied considerably in the 1990s. The South Korean won appreciated against the dollar from 1987 to 1989 and in 1995; and the Thai baht had negligible changes since 1986.

The Philippine government is also guilty of having a policy of maintaining a steady peso-dollar rate. Peso depreciations directly affect inflation and public sentiment towards government officials. Additionally, a depreciating peso increases the cost of the government in servicing its foreign currency borrowings. A pegged rate has always resulted in an overvalued peso and unsustainable current account deficits. However, after the political crisis in the 1980s, the peso only started to stabilize in 1992 (with the central bank maintaining the same policy of pegging the peso to the dollar via a dirty float), and the Philippines was able to return to the international capital markets only around 1993.

While the "Asian miracle" was boosting the economies of its neighbors, which encouraged them to borrow, the Philippines was labeled "the sick man of Asia." In the early 1980s, confidence in the Marcos regime deteriorated, and it was made worse by the assassination of Benigno Aquino in 1983; the peso plunged 30% in 1983, and a further 50% in 1984. The whole economy was falling apart, and naturally, no one would lend to the Philippines. Thus, Philippine companies could not borrow foreign currency as early as those from the other countries until the economy and currency had stabilized. Additionally, there were many veteran bankers who experienced the turmoil of the 1980s, which made them more prudent both in their borrowings as wellas lendings.

2. Excess Debt and Profitability and Bankruptcy

Exceedingly high leverage often is a symptom of excessive risk taking, and can often hide low underlying profitability. With excessively high debt ratios, capital will be insufficient to support any downturns. Much of the foreign debt of Asian companies was unhedged (since hedging brings the cost up to equal or almost equal to local currency borrowing costs), and much of it was short-term (since long-term debt is usually much more expensive).

There were very high leverage ratios in the corporate sector. For example, in South Korea, the top 30 chaebols had an average debt ratio of 387% in 1997, which shot up to 519% in 1998. By mid-1997, eight of the 30 largest conglomerates were bankrupt.

The debt/equity ratio of samples of Asian companies as of the end of 1997 are as follows: South Korea, 6.4; Thailand, 4.1; Indonesia, 2.3; Malaysia, 2.2; and the Philippines was the lowest at 1.9; (Japan was 4.3). Naturally, high debt results in large interest expenses, which are sustainable if profits are high enough. However, in 1996 and 1997, when profits were dropping, the proportion of interest expenses to income before interest, taxes and depreciation (NBITD) increased. In 1997, the interest expense as a percentage of NBITD reached 73% for the Thai sample and 88% for South Korean sample, both of which countries had high leverage companies. Those with lower debt levels such as Indonesia (49%), the Philippines (46%) and Malaysia (34%) fared better (Fig. 2). From 1994 to 1997, the return on assets (ROA) dropped from a positive 5.5% to a -13.1% in Thailand and 1.9% to -0.9% in South Korea. During the same period, Malaysia had an average ROA of 6.1; Indonesia. 4.8, and the Philippines, 4.7 (Fig. 3).(2)

Altman's Z-score(3) rates the financial soundness of firms and their likelihood of bankruptcy. A Z-score above 2.99 indicates financial stability, a score between 1.81 and 2.99 indicates vulnerability, and a score below 1.81 indicates a company that is financially distressed. The 1996 Z-score of samples of companies in general manufacturing, extractive industries, utilities, and consumer goods are shown in Fig. 4.(4) The Z-score for Malaysia and the Philippines (and the United States) indicates soundness; the ones for Indonesia (and Japan) indicate vulnerability; and the ones for Thailand and South Korea (in 1995) indicate that they are distressed. Interest coverage [earnings before interest, taxes and depreciation allowances (EBITDA) to interest expense payable] is also dangerously low for the sample companies in Thailand and South Korea.

3. Foreign Borrowings

Rapid reversals of the capital inflows occurred as domestic and international investors panicked and dumped currencies, stocks, and other regional assets. The first wave of depreciations in mid-1997 changed the relative real exchange rates and cost-competitiveness of the countries in the region. As the currencies of countries that were competing in the same world markets came under attack and depreciated sharply, the fundamental value of the other currencies that had not depreciated started to deteriorate, and come under pressure to also depreciate.

Although the ratio of the total external debt to GDP in the Philippines was high, much of this was in the form of government debt to multilateral aid agencies. In terms of private non-guaranteed debt (PNG) to GDP, as of the end of 1996, it was only about 6% compared to about 20% for Thailand, 16% for Indonesia, and 13% for Malaysia. Furthermore, the proportion of short-term debt (STD) to total debt (TD) was also low. At the end of 1996, it was about 19%, while that for South Korea was 48%, Thailand was 41%, Malaysia was 28%, and Indonesia was 25% (Fig. 5).

The currencies were vulnerable as the ratio of short-term foreign liabilities to foreign exchange reserves became quite low. By mid-1997, South Korea's short-term borrowings amounted to about 2.1 times its reserves; Indonesia, about 1.8 times, and Thailand about 1.5 times; the Philippines about 0.9 times, and Malaysia about 0.6 times.(5)

If we consider the total foreign exchange liabilities of commercial banks in the Philippines, 52% were owed to residents, compared to less than 1% in Thailand, as of the first quarter of 1996. In other words, 99% of Thailand's foreign exchange liabilities were owed to foreigners. In terms of foreign currency deposit liabilities in the Philippine commercial banking system, more than 86% were owed to residents (depositors), and only less than 14% to non-residents, as of the end of 1996, and many of these residents were exporters. Thus, the Philippine deposit system was less subject to capital flight compared to Thailand. By borrower, the largest share of Foreign Currency Deposit Unit (FCDU) loans were availed of by exporters. As of September 1996, 60% of FCDU loans were drawn by exporters, which were adequately hedged against export earnings.(6)

4. Real Estate Bubble

There was nothing fundamentally wrong with the Malaysian economy in that it did have a good manufacturing sector and there were many foreign direct investors. However, there have been accusations of crony capitalism, and it also had the same problem of unproductive investment in property as well as massive showcase infrastructure projects, such as the world's tallest building, the world's longest building, and unprofitable toll roads.

In Thailand, instead of going into more productive assets, excess funds were flowing into real estate and the stock market. Much of it also was funded by debt, and some of it in foreign currency. When asset prices stopped increasing, sales slowed, loans could not be repaid, and the bubble burst. The 15% vacancy rate in the central business district (CBD) of Bangkok from 1996 to 1997, which immediately led to Thailand's financial crisis, is evidence of Thailand's real estate bubble (Fig. 6). Many of the real estate projects in Thailand were funded by bank loans, some of which were in foreign currency. In fact, as a precursor to the crisis, in February 1997, Somprasong Land defaulted on its US$80 million Eurobond debt and worries regarding $4 billion in bad property debt from financial institutions began to grow.

On the other hand, the boom in real estate in the Philippines was basically due to real demand (although by the middle of 1997, there were signs of the beginning of a bubble at the high-end residential market). As the economy recovered in the early 1990s and foreign and domestic investments increased, the central business districts (CBDs) of Greater Manila (Makati and Ortigas) began to face office shortages as well as residential shortages due to the lack of investment in real estate projects during the turmoil of the 1980s. In June 1997, office vacancy rates for Makati were extremely low at 0.9%, while that of Kuala Lumpur was 1.6%, Jakarta was 11.2%, and Bangkok was 13.6%. As of September 1998, the Makati area still had a low vacancy rate of 5.8% compared to Kuala Lumpur's 13.6%, Jakarta's 20.0%, and Bangkok's 28.7%.

Bank lending to the real estate sector in the Philippines was lower at 15-20% (12.4% as of the second quarter of 1997, and 13.8% as of the third quarter of 1998(7))of total assets in 1997, compared to other countries such as Malaysia and Thailand, both at 30-40%. Additionally, collateral valuation in the Philippines is more conservative at 70-80% of market value, compared to 80-100% for the others (Fig. 7).

5. Non-performing Loans Effect on Economy

There was overinvestment in excess productive capacity or low growth projects resulting in low or negative profitability. Much of these overinvestment were due to a pegged exchange rate policy that kept borrowing costs low; political pressures to increase capital accumulation to accelerate economic growth; and the low interest rates in Japan that led to large capital inflows to the higher yielding Asian countries. These investments in productive capacity could only be justified by very high growth rates, which could not continue forever.

In Thailand, much of the unproductive investment went to real estate and the stock market. In South Korea, the top 30 chaebols expanded to many unrelated businesses; they had 819 subsidiaries in total in 1997, which went down slightly to 804 in early 1998. That is an average of 27 subsidiaries per chaebol; many grew for growth's sake, and many were in areas unrelated to their core business. In 1996, 20 of the largest 30 conglomerates in South Korea had a rate of return on invested capital (ROIC) below the cost of capital.

In the Philippines, the bulk of bank credits were given to productive sectors of the economy such as manufacturing. As of January 1997, manufacturing accounted for the largest share of total loans at 32.0%; financial institutions, real estate, and business services, 22.6%; and wholesale and retail trade, 15.9%. A survey covering the period ending December 1996 showed that the real estate lending of 21 commercial banks comprised of 10.9% of their total loans portfolio.

In Thailand, bank exposure to the real estate sector was also around the same level at 9.4% of total bank loans in 1995. However, Thai finance companies had relatively higher real estate exposure. In Thailand's 41 listed finance and securities companies, about 24% of their total loans went to the real estate sector. In contrast, Philippine finance companies are not significantly engaged in real estate lending.

In South Korea, about 35-50% of total loans was estimated to be non-performing; in Thailand, it was about 48-55%; in Indonesia, it was about 61-75%; and in Malaysia, it was 33-35%.(8) In the case of the Philippines, it was less than 5% before the crisis; however, by the third quarter of 1998, problem loans did increase to about 11.5% and is expected to peak at around 15-16% in 1999 (Fig. 8).

When banks are undercapitalized, have lax lending standards, and are subjected to weak supervision and regulation, they become a source of domestic and international systemic risk. Current account deficits were financed with short-term and unhedged foreign-currency denominated liabilities. These liabilities were again mismatched by longer-term domestic loans. Furthermore, short-term interbank funding is subject to financial confidence. If banks are the main or only source of financial intermediation, their breakdown dramatically weakens economic growth. Fig. 9 shows the importance of the banking industry to the economy. In South Korea, bank assets amounted to 75% of GDP in 1994; in Malaysia, it was 100%; in Thailand, 110%. In the Philippines, it was much lower at 54%.

In return for its bailout, the IMF insisted on closing down troubled financial institutions as well as requiring very high real interest rates to stabilize the currency, which often created a general panic among domestic and international depositors, lenders, and investors in the country. With very high interest rates, previously healthy companies but had high debt were now losing money. Additionally, even loans to companies with sales orders were cut; since these companies could not process orders without funds for working capital, more companies started to face insolvency. As bad loans increased, the banks themselves began to face insolvency risk, as other domestic and foreign banks cut or reduced their credit lines, continuing the vicious circle of panic, illiquidity, and insolvency.

In Japan, bank assets amounted to about 150% of GDP. One can easily see the effect of the Japanese banking crisis on its economy. One can see the devastating effect of the closure of a major bank in Hokkaido on the local economy. Yet, the percentage of non-performing loans (NPLs) in Japan is only about 16% of total loans, and the resolution cost is only about 3% of GDP. In contrast, it is estimated that the cost to resolve the banking crisis in terms of GDP could amount to 45% for Malaysia and Thailand; 50% for Indonesia; and 60% for South Korea.(9) Thus, it is not difficult to imagine the extent of damage to an economy when 33-75% of its bank's loans are non-performing, especially when banks (and finance companies) are practically the only source of funds and when resolution costs amount to 45-60% of GDP. In the Philippines, since the start of the crisis, only one medium-sized bank was recommended to be closed (in October 1998), while two small regional banks were closed earlier.

The main reason that the Philippines was more resilient to the Asian crisis compared to its Asian neighbors was due to its stronger financial system; thus available credit was not reduced to the extent as its neighbors. The Philippines had much less short-term foreign currency borrowings, and half of the foreign currency liabilities of the private sector were to its residents/depositors, and most of the FCDU loans were to exporters, who are providing a natural hedge. Compared to the others, most of the loans in the Philippine banks were made to the more productive sectors of the economy such as manufacturing. Its loans to the real estate sector were relatively smaller, and the growth in real estate investment was basically due to real demand.

Moody's bank financial strength ratings (BFSRs) are intended to provide investors and cross-border interbank lenders with a measure of a bank's intrinsic safety and soundness on an entity specific basis; it provides an indication of a financial institution's ability to withstand stress. Fig.10 shows the average financial strength rating across banks within each country. As these ratings show, Philippine banks in general are more stable than those in Malaysia, South Korea, Thailand, and Indonesia. It is interesting to note that the average BFSR for Philippine banks is also higher than that of Japan.(10)

II. Other Factors

1. Exports

One major sector that is supporting the Philippine economy is exports, which accounts for about half of GDP. In 1997, merchandise exports grew 22.2% in (nominal) U.S. dollar terms, which is higher than South Korea, Malaysia, Indonesia, and Thailand. In 1998, while the merchandise export growth of the other countries turned negative, that of the Philippines still grew, although at a slower rate of 16.1% (in nominal dollar terms) (Table 1). In terms of constant 1985 (peso) prices, however, merchandise exports grew only 3.6% compared to 14.6% growth in 1997. The writer believes that this is very much understated and may be one result of having a base year that is 13 years old.(11)

Top export earners such as semiconductors and electronic microcircuits (+7.8%) and finished electrical machinery (+22.1%) continued to grow, but garments (-0.9%) suffered a slight decline.

As Table 2 shows, 39% of the Philippines' exports in 1997 went to the the United States, which is experiencing strong economic growth; in contrast to about 14-19% for the the U.S. export share of the other countries. Asia, with its financial crisis, only accounts for 28% of the Philippines' exports compared with the 34-46% Asian share for the other countries. Thus, stronger trading ties with the the United States, combined with strong economic growth in the the United States, had compensated for the declines in exports to Asia.

2. Overseas Filipino Workers(OFWs)

Net factor income/payments added to GDP results in GNP. For the Philippines, in 1997, this is a positive figure amounting to about 4% of (nominal) GNP. In the same year, for Indonesia, it was -3.0%; for Malaysia, it was -5.7%; for Thailand, it was -3.1%; and for South Korea, it was -1.2%. This positive figure for net factor income is due to the remittances of overseas Filipino contract workers as well as migrants, mostly living in the United States.

In 1997, there were about 748,000 Filipino contract workers deployed overseas. As of January to July 1998, there were 420,000, down by 0.7% as compared to 423,000 in the same period in 1997. The crisis has affected deployment in Asia, which decreased by about 4.6%, mostly from Hong Kong and Malaysia. Deployment in the Middle East also decreased by 3.6%, mostly from Saudi Arabia due to its "Saudization" policy (hire local workers instead of foreign workers). However, these reductions were offset by increases in Africa (164%), North America (23%) and the Trust Territories (40%).

Remittances (including resident aliens, such as Filipino permanent residents and naturalized citizens living in the United States) sent through banks amounted to $5.74 billion in 1997; for the first half of 1998, it amounted to $2.65 billion. A large portion of remittances are not reflected in official statistics, since they are not coursed through banks, but are often sent through friends or through unofficial remittance services. It has been said that total remittances, including funds the worker brings when he/she returns to the Philippines, can amount to 2-3 times the official figures.

Although overseas workers sent to the Americas per year account for only about 1.5-3.0% of the total, remittances from the Americas account for 60-80% of total remittances. One possible reason is that most of these remittances are from Filipino immigrants and naturalized citizens living in the United States and Canada. Another possible reason is that it may be easier (accessibility to bank branches and language) and/or less costly for the remitter to send funds through the banking system in North America than in the Middle East or Asia.

Electronics and components are the top manufactured exports of the Philippines, amounting to $11.1 billion (of the $25.2 billion total merchandise exports) in 1997. Electronics, however, have a high import content, estimated to run from 70-80%. Thus, the direct contribution of remittances to the economy can be more than double that of electronics exports.


In summary, the Philippines was more resilient to the Asian crisis compared to its Asian neighbors, since most of the loans went to the productive sectors of the economy, its financial system was more robust, and available credit to businesses did not contract to the same extent as its neighbors. Its export growth is also strong, as it has stronger trading ties with the United States. Finally, it has a large overseas workforce remitting foreign currency that more than covers its present interest payments on public debt.

What is the outlook for 1999? Much depends on outside factors. Exports should continue to increase, although at a slower rate. Remittances in peso terms may also grow at a slower rate as the peso appreciates. Assuming there will be no repeat of weather disasters as in 1998, agriculture should recover. As agriculture recovers, inflation should continue to move down. Food accounts for half of personal consumption expenditure (which accounts for about 75% of GDP); and food, beverages and tobacco (FBT) make up about half the CPI index. The rates for FBT slowed down from 13.0% in January to 11.2% in February; as a result, inflation fell from 11.5% to 9.9% in February.

On the domestic front, there also are some favorable signs. In line with a stable peso, the central bank lowered its overnight borrowing rates and reserve requirements in January and February to increase liquidity and encourage banks to increase lending. In early March, the 91-day treasury bill yield moved to about 12.5%, the lowest level since the crisis (highest average level was in January 1998 at 19.1%). Lower inflation and interest rates will increase earnings and encourage investment. Generally, the outlook is positive and encouraging.

End Notes
  1. "e" stands for estimate or preliminary announcement.
  2. Cheng Hoon Lim (IMF); Charles Woodruff (World Bank), Managing Corporate Distress in the Philippines: Some Policy Recommendations (IMF Working Paper); and S. Clasessens, S. Djankov, and L. Lang, "East Asian Corportes: Growth Financing and Risks over the Last Decade," World Bank, mimeo, 1998.
  3. Edward I. Altman, The Z-Score Bankruptcy Model: Past, Present, and Future, John Wiley & Sons, New York, 1977.
  4. Michael Pomerleano, The East Asia Crisis and Corporate Finances -The Untold Micro Story, 1998.
  5. Institutional Investor, Sept. 1998.
  6. Views from BSP Governor Gabriel C. Singson, May 7, 1997.
  7. BSP/PIDS, Philippine Institute of Development Studies.
  8. Barclays Capital, IMF (Asian Wall Street Journal, Oct. 22, 1998); and Lehman Brothers.
  9. ibid
  10. Jerome S. Fons, Moody's Investors Service, Improving Transparency in Asian Banking Systems, 1998.
  11. Many problems exist in the measurement of expenditures at constant prices. New products are introduced and old ones undergo quality improvements that cannot be measured. Although merchandise exports increased 16.1% from 1997 to 1998 in U.S. dollar terms, merchandise exports computed in 1985 constant peso prices, yielded an increase of only 3.6%. This writer believes that this may be too low. A possible explanation is that the base year is too old, at 1985, and is causing large distortions in the implicit price deflator for exports, particularly semiconductors and electronic microcircuits. The actual mix of exports for 1998 is most likely to be very different from 1985. About 40-45% of merchandise exports in 1998 are made up of semiconductors and electronic microcircuits. Due to rapid advances in technology, semiconductors and electronic microcircuits quickly become obsolete.
    New products have increased capability (value added) at the same or lower cost or weight. If a large proportion of these semiconductor exporters suddenly changed their export mix from lower-value-added items to higher-value-added items (with higher prices per unit), then exports in dollar terms could increase, while export volume in unit terms could remain the same or even decrease. Even if the new product may have twice the capability of the old one, or may be half the size or weight, it is not unusual for it to be counted as the same as the old product. Present measurements of export output may not accurately capture these changes.

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