Debt free?

Ronald U. Mendoza, PhD

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Should our goal necessarily be to diminish debt to zero? There are good reasons for countries to possess some level of debt—not too much, but not too little either.

Ronald U. Mendoza, Ph.D.Recent moves by the Bangko Sentral—including its US$1-B contribution to a multilateral initiative to assist troubled European economies—as well as pronouncements by the Department of Finance that the country’s public debt will continue to decline seem to suggest that the country’s national public debt woes are behind us.

Before the freedom from debt advocates start to dust off their resumés, here are a few facts and figures on Philippine debt, coupled with an argument on why we need to recalibrate our view of public debt.

The Philippines settled its outstanding loans to the International Monetary Fund (IMF) in December 2006, and in late 2010 became a net lender to the IMF by participating in its financial transactions plan for financial crisis-stricken countries. (Essentially the IMF passed the hat to all the countries with sufficient foreign reserves to see if they could lend that money to Europe, instead of parking those reserves in US treasury securities.)

According to various sources, the Philippines had roughly about $100-B in public sector debt in 2011. (Estimates vary slightly based on the reporting source due to exchange rate and other adjustments.) This debt seems large when compared to the estimated $30-B public debt that the first Aquino administration inherited from Marcos.

Economists, however, find it more useful to express the debt as a share of Gross Domestic Product (GDP) for various reasons. Doing so recognizes the difference in the size of the post-Marcos economy when compared to the much larger one we have today. It also acknowledges that countries with higher levels of economic wealth and productivity are able to sustain and put to good use slightly higher levels of public debt.

Expressed as a share of GDP, the country’s total public debt was about 65% in 1986 when Cory Aquino took over, 76% in 1992 at the beginning of the Ramos administration, and 66% when Estrada became president. Public debt as a share of GDP increased to about 78% in 2004, and has started declining since then.

The investment bank JPMorgan estimates that it was about 50% of GDP in 2011, and it is forecast to decline further to about 48% of GDP in 2012.

Analyzing the changes in the debt-to-GDP ratio across Philippine Presidents from Quirino (1948-1953) all the way to President Benigno Aquino III also shows that the largest increase in debt as a share of GDP occurred during the Marcos administration. It’s important to consider that the increase in debt and the contraction in the economy likely conspired to exacerbate the debt-to-GDP spike during that period.

Fiscal and other reforms instituted and continued from 1986 onwards (clearly with varying degrees of emphasis and effectiveness across the last 4 administrations) appear to be bearing fruit as the debt ratio has since declined (on average) and appears on a path to continue to do so.  

In addition, total external (public and private) debt (mostly denominated in foreign currency) ballooned from about 33% of GDP in 1970 to almost 100% of GDP by the end of the Marcos administration. However, this debt indicator has since also declined to roughly about 40% of GDP by the late 2000s.

External debt is an important aspect of a country’s total public debt, as any adverse movement in the country’s currency exchange rate could rapidly expand external debt payments. The decline in external debt as a share of GDP could be traced to a number of factors, including the strengthening peso and pre-payment of external debt.

If the government stays the course, as far as its fiscal reforms are concerned, and steps up its growth- and productivity-enhancing investments with stronger urgency, we may yet see these debt figures decline even further.

Higher growth obviously means a lower debt ratio and stronger capacity to pay for and sustain any given level of debt. That might also help bring about our long-sought investment grade credit rating, which would in turn lower borrowing costs and bring further gains in debt sustainability.

Declining debt as a share of GDP due to various reforms that minimize inefficiency is therefore good news. So is an improvement in the debt structure, by diminishing the share of foreign currency denominated debt.

Debt strategy

But should our goal necessarily be to diminish debt to zero?

There are good reasons for countries to possess some level of debt—not too much, but not too little either. With the rising aversion to public sector debt given the challenges of countries like Portugal, Italy, Greece and Spain (indeed even the United States), as well as our country’s own recent legacy of debt challenges exacerbated by corruption and mismanagement, it’s important to have a balanced view of our debt strategy.

The private sector cannot be expected to make all the necessary investments that the country needs to boost inclusive growth. Typically the private sector has a poor track record in investing in public goods, for example. Without these types of investments, there would be little impetus to “crowd-in” private sector investments into key sectors that they otherwise would not have noticed (e.g. agriculture).

Thus, having too little debt may raise the risk of high opportunity costs from underinvestment.

Another important point here is that not all investments may be possible to structure as public-private-partnerships.

Our own research at AIM suggests that Public-Private Partnerships (PPPs) across sectors, across Asia, follow a pattern whereby certain types of projects with strong “excludability features” (i.e. those projects whose usage can be controlled and charged for) tend to fare well and dominate the sample of successful PPPs. Those that are much less excludable and economically feasible (i.e. those with weaker revenue stream potential) are far more difficult to structure as PPPs (if at all).

It is critically important for the public sector to invest in certain areas with stronger public good benefits and which are less likely to crowd-out and more likely to crowd-in private sector investments.

Investments in research and development, economic diversification, as well as stronger economic governance capacities are among these areas for investment. Since the pay-off from these activities involve a much longer time horizon, it is not unreasonable to consider borrowing from future generations—this is de facto what public debt is—in order to also benefit them through these investments.    

So in the end, reducing excessive and inefficiently structured debt is a good thing.

Let’s make sure we don’t miss this point though – underinvestment is just as (if not more) costly compared to a debt crisis. “Matuwid na daan”—or better economic governance—should not lead to underinvestment, and should in fact be used to trigger more effective public spending, including those financed through public debt.

Otherwise, what’s the point? –

(The author is Associate Professor of Economics at the Asian Institute of Management and Executive Director of the AIM Policy Center. The article represents his views and not necessarily of AIM. The author thanks Ailyn Lau for excellent research assistance. For questions and comments, please send your email to or visit

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