Philippines: Entering 2015 on a high Asia Pacific Economic Outlook, Q2 2015

The Philippines’ positive momentum is likely to continue in the medium term as policymakers try to set the foundation for sustainable manufacturing and services activity.

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For a long time, the Philippines was in the shadow of some of its more illustrious neighbors in Southeast Asia. Poverty, poor infrastructure, and workers migrating to greener pastures abroad had left the economy stranded. But things started changing in the past decade, especially the last few years; between 2010 and 2014, real GDP expanded on average 6.3 percent every year. The positive momentum is likely to continue in the medium term as policymakers try to set the foundation for sustainable manufacturing and services activity. Aiding the economy will be continued large remittances from overseas Filipino workers (OFWs). At last count, there were about 10 million of them.

Economy picked up pace in Q4 2014

Real GDP grew 6.9 percent year over year in Q4 2014, up from 5.3 percent in Q3. This took annual GDP growth in 2014 to 6.1 percent, yet another year of strong economic growth in a challenging global environment. Growth in Q4 2014 was primarily driven by exports, government expenditure, and private consumption (figure 1). Total exports grew 15.5 percent in Q4, up from 9.9 percent in Q3. External demand will remain healthy in 2015 as well, with a strong US economy likely to offset the impact of a slowing China and a weak Eurozone.

APAC-Q2_2015_Figure1_GDP-growth

Government consumption grew 9.8 percent in Q4 2014, a reversal from the 2.8 percent decline in Q3. Spending had slowed in previous quarters as legal challenges resulting from allegations of corruption had hampered the allocation of contracts. This seems to have changed in Q4, and it is a positive development, given the need to improve infrastructure. Fixed investment growth was also strong in Q4 at 8.5 percent but was a tad lower than the previous quarter’s 10.5 percent. However, with businesses optimistic about future economic prospects, private sector investment will remain strong in 2015, most likely in the range of 8–9 percent.

With remittances set to stay high amid improving economic prospects, it is no surprise that consumer confidence in the Philippines is high.

Support from personal consumption continues

Private consumption growth also edged up in Q4 2014 to 5.1 percent from 5.0 percent in Q3; the overall rise in private consumption in 2014 was 5.4 percent. Consumers benefitted from strong economic growth, increased access to credit, rising remittances, and low inflation. A tighter labor market also helped. For example, the unemployment rate fell to 6.0 percent in Q4 2014 from 6.7 percent in Q3. This has kept income growth high, with the pace not likely to slow down in the near term. According to Oxford Economics, nominal personal disposable income will rise 9 percent in 2015, similar to figures for 2013–2014.1

Consumers also benefitted from real income gains late last year due to declining inflation. With energy prices staying low, this trend is likely to continue in 2015. The other key contributor to personal consumption growth in 2014 was remittances, which went up 5.8 percent to $24.3 billion last year (figure 2). With remittances set to stay high amid improving economic prospects, it is no surprise that consumer confidence in the Philippines is high. In Nielsen’s Q4 2014 survey, the Philippines’ consumers rank second along with Indonesia on the confidence list; India leads the tally.2

APAC-Q2_2015_Figure2_Remittances

A few worries for remittances

There are, however, risks related to remittances this year. A slow European economy, which accounts for more than 15 percent of remittances, is a worry (figure 3). In 2014, inflows from Europe fell 5.5 percent. Inflows in US dollar terms have also been complicated by the euro’s weakness relative to the dollar (as well as the Philippine peso). This could get worse, especially as the US Federal Reserve (Fed) looks at hiking interest rates and the European Central Bank continues quantitative easing.

Figure 3

In 2014, 21.6 percent of remittances came from the oil-rich countries of the Gulf Cooperation Council (GCC); Saudi Arabia and the United Arab Emirates accounted for a large share of that.3 Unlike the euro, currencies in the GCC are largely pegged to the US dollar and hence pose no threat to the value of dollar remittances. However, falling hydrocarbon prices could dent growth in the GCC, resulting in reduced job opportunities and lower pay hikes for OFWs.

These concerns notwithstanding, remittances by OFWs will remain strong in the near term due to strong growth in the United States, which accounts for 42.7 percent of remittances by OWFs. Interestingly, as economic prospects at home improve for Filipinos in the medium to long term, the role of remittances in economic growth will slowly decline.

BSP has the upper hand in the inflation fight

The Bangko Sentral ng Pillipinas (BSP) kept interest rates unchanged for the second straight time in February 2015. BSP had raised rates twice last year (a total of 50 basis points) to keep price pressures in check after inflation rose to a three-year high of 4.9 percent in July 2014. Currently, BSP will be less concerned about inflation, given slowing energy and food prices. In January 2015, inflation came in at 2.4 percent, the lowest since August 2013. And although the figure edged up a bit to 2.5 percent in February 2015, it is comfortably within the BSP’s target range of 2–4 percent for 2015 and 2016 (figure 4).

Figure 4

With the near-term inflationary outlook not likely to change much, BSP will keep rates on hold for now. Any change this year, if it comes, will follow a possible rate hike by the Fed later this year. BSP will, however, be less worried about the impact of the Fed’s rate move on the peso than some other emerging economies will. The peso has strengthened by about 1.4 percent as markets take a positive view of Philippines’ economic potential, current account surplus, sizable reserves, and steady fiscal health.

Hoping for better fiscal management and policy continuity

Public finances continue to be affected by a weak tax regime and failure to achieve spending targets. Corruption has also been an issue, with legal challenges in recent times threatening to derail the government’s focus on much-needed infrastructure spending. Fortunately, national accounts data for Q4 2014 reveal that government spending is back on track. The announcement of a number of public-private partnership projects in February 2015 also suggests that the government has likely left behind some of its troubles.

On the tax side, however, there are concerns about the increasing demand for a reduction in tax rates and extension of tax breaks to more sectors. Such moves, without improvements in revenue collection, are fraught with medium-term risks to fiscal sustainability. The Philippines needs revenues to augment infrastructure and human capital, and to fight poverty. The other big medium-term challenge is policy continuity as President Benigno Aquino leaves office in 2016. With presidents limited to one term, economy watchers will be anxious that the new administration does not lose the strong gains made in the last decade.