The Philippines: Going good in turbulent times Asia Pacific Economic Outlook, Q4 2015

Despite global economic uncertainty, the Philippines appears to be doing well, benefitting from strong domestic demand and a rise in public spending. With its fundamentals solid, the Philippines is likely to ride out this sluggish phase of the world economy.

Philippines_interior-imageThese are testing times for the world economy. Sluggish growth in the United States and Europe, a slowing China, uncertainty over monetary policy tightening in the United States, and a sudden yuan devaluation in August have dented financial markets and currencies. In particular, GDP growth is likely to be a casualty for many emerging economies. In such an uncertain environment, the Philippines appears to be doing well. The economy posted healthy growth in Q2, backed by solid domestic demand. With presidential elections slated for May 2016, public spending is also set to rise. Add to it solid external balances, low inflation, and rising remittances, and the economy looks poised to ride out the current global uncertainty. There are, however, two points of caution. First, elections next year will likely bring policy uncertainty, thereby weighing on private investments. Second, slow growth in China will impact Filipino exports. Consequently, annual GDP growth for the Philippines is likely to fall short of the government’s 7 percent target in 2015 and will instead end up in the 5.5–6.0 percent range.

GDP growth picks up pace in Q2 2015

In Q2, the economy expanded by 5.6 percent year over year, up from 5.0 percent in Q1. Strong domestic demand came to the economy’s aid in the face of a weak external sector. Private consumption growth rose to 6.2 percent in Q1 from 6.0 percent in Q1. Consumers benefitted primarily from low inflation and healthy remittances. Government consumption more than doubled to 3.9 percent in Q2 from Q1 due to speedier disbursements of funds for infrastructure. According to the Department of Budget and Management, government spending on infrastructure and capital outlay went up by 37.3 percent in Q2.1 Fixed investment growth slowed down a bit in Q2. However, at 8.9 percent, the figure is still a healthy one.

Philippines_Figure1_Private-consumption

Exports grew a muted 3.7 percent in Q2, down from 6.4 percent in Q1. This was the slowest pace of export growth since Q4 2013. Slow growth in China, the third-largest market for exports from the Philippines, has been weighing on export growth in recent times. In June, goods exports fell 1.8 percent, continuing from a 17.4 percent decline in May. Slowing exports are also reflected in weak manufacturing data. In June, manufacturing output fell by 3.6 percent, the second straight month of contraction.

Philippines_Figure2_Declining-exports

BSP to keep rates on hold in 2015

In its August meeting, the Bangko Sentral ng Pilipinas (BSP) decided to maintain its current stance on monetary policy. Pressure has mounted on the BSP in previous months to ease rates due to slowing exports and their impact on GDP growth. Price pressures have also been low, with inflation below the lower threshold of the BSP’s 2–4 percent target since May. However, the BSP has been cautious due to a weakening peso even though the currency has fared better than peers such as the Malaysian ringgit and the Indonesian rupiah. Speculation related to a US Federal Reserve (Fed) hike and the sudden yuan devaluation in August has forced the peso down by 4.6 percent against the US dollar this year. Also, despite low inflation, BSP is worried that an elongated dry season could impact grain prices and hence push up inflation. Most importantly, the logic of a rate cut is in contrast to strong domestic demand growth (above 6 percent so far this year). In such a scenario, the BSP is not likely to ease rates in the near term. Instead, it will keep an eye on moves by the Fed and its impact on the peso. In fact, a Fed hike could prompt the BSP to hike rates in 2016 to maintain the current interest rate differential.

Philippines_Figure3_The peso fell

Although price pressures are likely to bottom out in the coming months, inflation will remain relatively low this year, thereby aiding consumer finances.

Private consumption to remain a key growth driver

Consumers, yet again, are expected to be the bulwark of the economy this year. The unemployment rate (seasonally adjusted) fell to 6.2 percent in Q2 from 6.4 percent in Q1.2 The labor market is likely to improve further if the pace of government spending, especially on infrastructure, increases. Consumers will also continue to benefit from low inflation. In August, headline inflation was a mere 0.6 percent, continuing its steady decline since January. Slowing food and fuel prices have percolated down to core inflation (1.6 percent in August) as well. Although price pressures are likely to bottom out in the coming months, inflation will remain relatively low this year, thereby aiding consumer finances. Remittances will also add to strength in private consumption. Remittances by overseas Filipino workers (OFW) grew 6.3 percent year over year in June and are up by about 5.8 percent in the first half of the year.

Philippines_Figure4_Inflation-has-gone-down

Philippines_Figure5_Remittances

The need to keep up the momentum

One of the weak links of the country has been government spending, which, as a share of GDP, is much lower than regional peers’. In Q1, low government spending was a key factor weighing on economic growth. There are signs, however, that public spending growth is slowly recovering. For example, public construction went up by 20.4 percent year over year in Q2, reversing from a sharp fall in Q1. The budget for FY 2016 has also been passed with large outlays for economic and social spending. But, the budget itself might not be enough. The government could benefit from speeding up implementation of planned public-private partnership (PPP) schemes. A move in July to initiate bidding for a key railway project is a welcome breather.

Accelerating the pace of implementation of such projects is also important given that presidential elections are due in 2016. As these elections draw near, political uncertainty could increase, thereby forcing businesses to deter investment plans. Already, this appears to be a factor weighing on net foreign direct investment (FDI), which fell by 41.9 percent year over year in the first five months of 2015. It is critical for policymakers not to lose the economic momentum of the past few years until a new government takes over in 2016. This is particularly true when economic fundamentals in the country are still strong, with a strong current account surplus, a healthy fiscal balance, and low household debt.

Any new administration will have to continue to focus on making the economy more competitive in the medium to long term. It will help the Philippines move up the value chain in both services and manufacturing. Such a strategy will not only provide jobs and aid small and medium enterprises, but will also help to enhance the country’s economic prowess within Asia, a region set to emerge as the nerve center of global growth over the next decades.