[MANILA] The Philippines kept its investment-grade rating at Moody's Investors Service, but not without a caution about threats posed by elevated inflation and political risks, including a potential shift to a federal form of government.

Moody's kept a stable outlook on its Baa2 rating on Philippine debt, saying it expects economic growth to remain robust and that some fiscal numbers will improve. Still, these gains are unlikely to bring the nation's credit profile in line with higher-rated countries, it said.

"At the same time, policymakers face challenges in managing the current inflationary pressures," it said in a statement Friday night.

"In addition, domestic political developments and prospective changes to governance frameworks, including a shift to a federal form of government, present downside risks to the country's institutional and fiscal profile."

Higher oil and rice prices and a peso near a 12-year low pushed Philippine inflation to 5.2 per cent in June, the fastest pace in at least five years. It looks like two successive 25 basis point interest-rate increases were unable to contain the price pressures, with the Department of Finance predicting the inflation rate will quicken to 5.3 per cent this month.

CHARTER CHANGE

President Rodrigo Duterte will ask Congress on Monday to support his plan to change the constitution and shift to a US style federal structure that will create 18 regions. Critics of the plan by the 73-year-old leader, including former Supreme Court Chief Justice Hilario Davide, said that changing the charter could allow Duterte to extend his reign beyond 2022.

"The Philippine president's contentious policies on law and order over the past two years as well as other political controversies may have a negative impact on the Philippines' attractiveness to financial and physical asset investors," Moody's said. The proposed federal shift and a recent Supreme Court ruling that may force the government to transfer more tax revenue to towns and provinces could adversely affect public finances, it said.

The rating agency also flagged that "relatively weak rule of law and control of corruption weigh on the Philippines' institutional capacity as compared to peers".

Finance Secretary Carlos Dominguez defended Duterte in a statement Saturday, saying that "political chatter emanating from certain quarters has failed to dampen the interest of the international business community in the Philippines exciting growth narrative". Foreign direct investment climbed to a record US$10 billion in 2017, Mr Dominguez said.

Tax reform that policy makers refer to as TRAIN will boost government revenue to 16.2 per cent of GDP this year and to 16.7 per cent in 2019, supporting the drive to boost infrastructure and keep debt at moderate levels, Moody's said.

The economic growth potential, track record of sustaining financial stability, keeping debt ratios modest and favorable demographics augur well for the Philippines, Moody's said.

SUSTAINED INFLATION

"Although not our base case, indications that monetary policy may not prevent a sustained rise in inflation above our current expectations - and beyond the one-off impact of the increase in excise taxes from TRAIN1 - would likely exacerbate upward pressure on both market interest rates, capital outflows, and downward pressure on the exchange rate," Moody's said.

The peso has depreciated by more than 6.5 per cent this year, among the worst performers in the region, while benchmark 10-year bond yields are 60 to 70 basis points higher than the end of 2017. Persistent pressure on the currency and a current account deficit "pose material challenges to policymakers in ensuring that inflation expectations and inflation pressure are contained," Moody's said.

Bangko Sentral ng Pilipinas Governor Nestor Espenilla reiterated on Saturday his commitment to bring inflation back into the central bank's target band of between 2 per cent and 4 per cent target by 2019.

"The BSP is ready to take follow-through actions to the policy rate hikes done in May and June 2018 to further anchor inflation expectations and address any brewing demand-side pressures," Mr Espenilla said in a statement sent by the country's investor relations office.

BLOOMBERG