Teaser: For several years now, the Philippines has been one of the countries with the highest GDP growth in the world and the government is pushing for the story to continue, but right now there is a backlash.
Last year, I had the impression that Philippine officials believed that all economic pleasures could be enjoyed without consequence. To the enjoyment belonged an already high GDP growth, a significant increase in public investments, an unchanged low interest rate, the country’s peso depreciating in value, and an increasing trade deficit. The government has an understandable desire to bring more households up and into the middle class income segment. But if one browses through the economic history of any country for the past couple of hundred years, I do not think that it’s possible to find any country wherein such a plan has succeeded.
Foreign funds have pulled so much out of Philippine securities that they have gone from overweight to underweight the Philippines in their portfolios. As graphic one shows, the inflation in 2018 has now reached 5.7 pct. In addition, the GDP growth dropped to 6 pct. in the second quarter and the peso remained under pressure – it is far from the government’s plan, though it would have been a surprise if a country could enjoy that cocktail of economic initiatives without any hangovers.
Some of the government’s plans have not materialised as expected. Public investments in infrastructure are now the second largest expenditure in the public budget, but several projects are delayed due to bureaucratic issues, which I think in the end is the government’s responsibility. In addition, public investments have led to a sharp rise in imports, which contributes to the increasing trade deficit.
I am still assessing the tax reform, which entered into force on 1st January (TRAIN 1) as a major economic step forward for the middle class, but the package also contained a number of taxes that pushed inflation higher. Some sectors should have received a compensation for the tax increases, though this part of the plan has only been partially successful. Here, the public administration should be able to do a better job in getting this issue solved.
But inflation is unfortunately another and more serious subject which has also been a continuous theme most of the time when I was in the medias in the Philippines during the past week. That TRAIN 1 would lead to higher inflation was foreseen, but at the same time, food prices have risen, so that the poorest families now experience an inflation rate of 7.5 pct.
The Philippine central bank, Bangko Sentral ng Pilipinas (BSP), cannot fight higher oil and food prices with monetary policy. However, throughout 2017 and until May this year, BSP failed to raise interest rates even though the American central bank (Fed) was very active on this front despite a weaker inflation trend compared to the Philippines (graphic two). In parallel, the peso lost in value which led to inflation, though it could possibly have been avoided by hiking interest rates. The central bank showed a weak hand and came behind the curve with the needed interest rate hikes. The high inflation could mean that consumers are increasingly pessimistic – in the second quarter, it was the first time since 2015 that the consumer index FTCR dropped under 50, which is negative territory.
I do not argue that the Philippine economy is sinking into a dark hole, but there are signs of stress. Overall, the headwind will continue to blow over Emerging Market countries during the coming six months, though the Philippines’s own situation does not contribute positively.
I see the very rapid rate hikes totalling one pct. since May as a sign of the Philippine central bank being behind the curve in tightening the monetary policy. Further, the BSP has gotten itself in a situation where it demonstrated a lack of sovereignty in conducting a superb monetary policy.
If the Philippines wants foreign investors to overweight the country’s stocks and bonds again, then it will be essential that the central bank shows more sovereignty and is at the forefront of developments. This means more interest rate hikes, though it is not enough, as the BSP also clearly needs to communicate what plan it follows. Part of the inflation in the Philippines a central bank cannot fight via monetary policy, but the BSP could for example, say that they will work to reverse the negative trend for the peso, which may be a longer journey. On Tuesday the 28th August, the BSP took a step in this direction by clearly communicating to the financial markets that it is ready to raise interest rates as much as needed. However, the central bank has lost some of the confidence that has been built over the recent years, which was unfortunate and unnecessary.
During 2018 USD / PHP so far has reached 53.50 and I maintain my forecast from the start of the year that 55.00 is most likely outcome. However, aggressive rate hikes from the BSP can change this view. After the next six months, accompanied with continued nervousness, many stocks will again turn interesting, and for those investing in Philippine government bonds, I expect that seven to eight-year maturities will be particularly attractive again.
If food prices, especially rice, remain high, or rise further for the rest of the year, I will give this more attention, unfortunately towards a more worrying direction. Despite the less positive mood among consumers, my assessment is still that the domestic driven growth is strong and therefore I remain fundamentally optimistic of the Philippine economy. Despite of the 10 pct. drop in the stock market this year, many stocks are still priced in the upper-end, but a number of corporate results on the other hand have remained strong in the second quarter.
I am excited on how the real estate market will react to possible further interest rate hikes, which makes me less optimistic for this sector.
Overall, it is still my expectation that foreign investors will return to the Philippines at some point, though an economy can only be pushed to a certain limit, and public investments must be chosen and well-considered.
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