Philippines Update – It’s the Politics, Stupid!

philippines flag Illustration

President Dutarte inherited a robust economy. Strong fundamentals should remain in place, but the political outlook is a growing concern and appears to be scaring investors away. This focus on politics is likely to continue weighing on Philippine assets.

POLITICAL OUTLOOK

President Duterte’s recent clash with US President Obama is a reminder that political risk should not be discounted. The US cancelled the formal meeting that had been scheduled, prompting Duterte to issue a half-apology. We don’t think relations between the two countries has been damaged, but the US is surely

The source of the tensions is noteworthy as well. The US and many other nations have expressed concern with the spike in extra-judicial killings since Duterte’s election victory. Also worrisome are signs that Duterte will push for improved political ties and free trade agreements with China and Russia.

Duterte changes the dynamic with regards to the South China Sea conflict. Before he was elected, the UN issued a verdict in favor of the Philippines in its case against China’s maritime claims. With Duterte trying to improve ties with China, it’s not clear whether the UN verdict will be enforced.

ECONOMIC OUTLOOK

The economy remains robust. GDP growth is forecast by the IMF to decelerate modestly to around 6% in 2016 from 6.3% in 2015. GDP rose 7.0% y/y in Q2, the strongest since Q2 2013. Coupled with 6.8% growth in Q1, the risk to the growth forecasts is to the upside.

Price pressures are still low, with CPI rising 1.8% y/y in August. This is still below the 2-4% target range, and has remained below it since May 2015. The central bank next meets November 10, and no change is expected. The central bank has been on hold since the 100 bp cut back in May. While that was part of a move to a rates corridor, it nonetheless was seen as stealth easing.  The bank has been discussing cut in reserve requirements, but we think it will hold off on this until the economy slows.

Fiscal policy was prudent, but bears watching. The budget deficit came in around -1% of GDP in 2015. It is expected to widen slightly to around -1.5% this year and nearly -2% in 2017. However, there are upside risks after President Duterte said he plans to expand the budget deficit to -3% of GDP in the coming years.

The external accounts remain solid. Low energy prices have helped reduce imports. The current account surplus gap was about 3% of GDP in 2015, and is expected to narrow slightly to around 2.5% in both 2016 and 2017. Foreign reserves rose to a record high $85.9 bln in August. They cover over 10 months of imports and are almost 4 times larger than short-term external debt.

INVESTMENT OUTLOOK

The peso has underperformed this year after outperforming last year. In 2015, PHP lost -5% vs. USD. This was behind only the best performers TWD (-4%), CNY (-4.4%), and INR (-5%). So far this year, PHP is -2.3% YTD and is ahead of only the worst performers ARS (-15%), MXN (-13%), and CNY (-3%). Our EM FX model shows the peso to have STRONG fundamentals, so this year’s underperformance is unexpected.

USD/PHP just made new highs for the year near 48.44. That’s the highest since September 2009, and charts point to a test of the November 2008 high near 50.17. Some intermediate highs near 49.00 from 2009 come in first.

Philippine equities have underperformed this year after outperforming in 2015. Last year, MSCI Philippines was -3% while MSCI EM was -17%. So far in 2016, MSCI Philippines is up 9% YTD and compares to up 13% YTD for MSCI EM. This underperformance should ebb a bit, as our EM Equity model has Philippines at an OVERWEIGHT position.

Data from the Philippine Stock Exchange show that foreigners have been net sellers of Philippine equities for 23 straight sessions and in 29 of the past 30. YTD inflows peaked at $1.3 bln in mid-August but have since fallen. At $674 mln through today, the Philippines remains one of the least favored in emerging Asia. Only Sri Lanka and Vietnam are seeing less inflow.

Philippine bonds have performed poorly this year. The yield on 10-year local currency government bonds is about -16 bp YTD. This is ahead of only the worst performers Poland (-15 bp), China (-13 bp), and Mexico (-13 bp). With inflation likely to remain low and the central bank on hold, we think Philippine bonds can start outperforming more.

Our own sovereign ratings model shows the Philippines’ implied rating at A-/A3/A-. This points to upgrade potential to actual ratings of BBB/Baa2/BBB-. However, we suspect that the agencies will wait to gauge the potential impact of the planned fiscal loosening by the new government.