Financial Market

New ADB loan will generate more value than cost

GIVEN the degree to which government debt has become a popular concern of late, the announcement by the Asian Development Bank (ADB) earlier this week that it had approved another $400-million loan to the Philippines was likely not well-received by many people. However, this is one instance in which government borrowing will truly be an investment that will return much more to the economy than it costs.

The policy-based loan, which is officially called the “Support to Capital Market-Generated Infrastructure Financing Program, Subprogram 2,” is described by ADB as intended “to help the Philippine government further deepen the country’s domestic capital markets and increase the supply of long-term finance, especially for infrastructure development, which is crucial for the country’s sustained economic growth.” The program aims to “build an efficient domestic debt market and increase institutional participation in the market, especially from insurance and pension funds.”

In its press release announcing approval of the new loan, ADB noted that the Philippines’ infrastructure funding gap is estimated to be P2 trillion per year through 2030. The ultimate reasoning behind the loan is that domestic funding sources are the best option for financing infrastructure development, as well as, presumably, other development initiatives of the government. In order to tap those domestic resources, however, the Philippines’ seriously underdeveloped financial markets need to expand and improve, thus that is the focus of the new loan.

A key focus of the policy loan is to facilitate expansion and reforms of the Philippines’ financial markets to take advantage of a great deal of currently untapped resources in pension funds and the insurance sector. In other countries, these make up the majority of domestic capital that is invested in government financing instruments such as bonds, but the opposite is true here in the Philippines. In Malaysia, for example, pension funds and insurance make up nearly 80 percent of the domestic capital market; in the Philippines, these account for just 12 percent.

Likewise, the coverage of pension funds and insurance is among the lowest in Asean, and public expenditure on social protection and other benefits for people above the statutory retirement age is among the lowest in the world at a mere 0.6 percent of gross domestic product (GDP).

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Thus, the objective of enhancing and expanding the financial market through focusing on pension funds and insurance seeks to “kill two birds with one stone,” so to speak. One outcome would be the increase in domestic capital invested in instruments that can be used to finance infrastructure and other development. The second outcome, which is perhaps more important, is to improve the financial condition of Filipino retirees, the majority of whom have grossly inadequate incomes and must rely on their families for basic support. As ADB points out, the majority of pension assets under management in the Philippines are from public funds (SSS and GSIS), but only about 38.4 percent of the “economically active” population participates in these, compared with over 92 percent in the US, 61 percent in Singapore, and 46 percent in Malaysia. Worse still, less than 20 percent of the population aged 60 or older receives benefits from these funds.

What the government will specifically use the fresh funding from ADB for has not entirely been fleshed out, but one area strongly recommended by ADB is the comprehensive improvement of the Social Security System (SSS). This would entail, among other things, expansion of its coverage, rationalization of benefits — which in this case mainly refers to significantly increasing them — and most likely, increasing premiums to ensure its long-term sustainability. Where enhancing the financial markets come into this picture is in providing SSS (as well as other institutional and individual investors) more accessible investment options.

Thus, while it may be alarming to some that the government has taken on another sizable chunk of debt with the new ADB loan, this particular borrowing offers the prospects of broad economic gains many orders of magnitude greater than the loan’s cost, which in any case has been offered on terms that are far more accommodating and cheaper than most other debt incurred by the government.

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