Foreign loan guarantees as an instrument of economic policy in the Philippines, 1970-1986

Abstract

This research documents the major features and avowed rationale of the foreign loan guarantee program in the Philippines during the period 1970-86. It also examines the program's impact on participants (guaranteed firms, guarantors and-to a limited extent-the foreign lenders) by studying the terms and conditions under which the foreign loan guarantees were provided. The research argues that weaknesses in the program were manifold. The program was beset with problems from the start because its very premises were flawed-that is, that the government had the ability to identify firms engaged in projects that yielded positive externalities or that faced financing constraints, and that government officials were better than private financial markets at evaluating and managing the risks of lending to these firms. To ascertain whether the government was correct in its assessment that foreign lenders were unduly pessimistic about the prospects of domestic firms, and whether it was better placed to evaluate and manage the risks of exposure to these firms, the research examines two measures. The first is the sustainability of the operations of the guarantors, and the second is the failure rate of guaranteed firms in meeting their debt obligations. The research argues that the notion that the guarantors were ' better bankers' is contradicted by the heavy losses that they incurred. Income from guarantee premiums and the sale of seized collateral assets were inadequate to cover claims arising from the guarantees and cost of operations. Collateral arrangements proved to quite relaxed. Hence, the guarantors were unable to collect a large part of the sums they advanced against guaranteed loans that went into default. Moreover, since there was a lack of thorough economic analysis to validate the existence and extent of market failures that could have justified the provision of the guarantees, guarantors had little guidance in identifying when intervention was necessary. The research also examines the impact of the program on the buyers of the guarantees (the guaranteed firms). If market failures limited the access of inherently viable firms to foreign loans, then it is important to know whether the more generous lending policy proved helpful to guaranteed firms in the sense that they were able to proceed with their investments and operate them profitably. In this regard, the research examines the failure rate of guaranteed firms in meeting their debt obligations relative to the guarantee premiums charged by, the guarantors, and in comparison with the failure rate of other types of firms in meeting their debt obligations. The research finds that the incentives for selecting good investments and operating them efficiently were weaker if these were funded with borrowings that were guaranteed, and that this resulted in lower rates of return from investments and higher failure rates than the guarantors had estimated. A probit model is presented to provide further insight into the relevance of firms' foreign loan guarantee status on their propensity to default. To shed light on why the program led to risk-accentuating behaviour on the part of guaranteed firms, the research examines the terms and conditions under which the guarantees were provided. The research finds that weaknesses in the imposition of guarantee fees and collateral requirements, and in the treatment of errant borrowers combined to reduce the incentives for adopting well-chosen investments and managing them efficiently. As a result, the moral hazard that characterised loans carrying public guarantees was left largely unchecked. The research also finds that there were factors, other than economic ones, that affected the program. On certain occasions, political variables impinged on the implementation of the program, and circumscribed the actions of the guarantors-such as in their decisions on who received the guarantees, under what terms the guarantees were provided, and how cases of default were handled. Show more