Philippine Economy Robust But Cracks Are Appearing

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The Philippine central bank will soon have a new governor.  He inherits a robust economy, but inflation is rising and cracks are starting to appear in the budgetary and external accounts.  POLITICAL OUTLOOK

President Duterte came into office in June 2016 to serve a single 6-year term.  The next national elections will be the mid-terms in 2019.  His brash, outspoken style may be spooking foreign investors, as the Philippines is the only country in emerging Asia that has seen foreign equity outflows YTD.

Duterte ran (and won) on an anti-crime, law and order platform.  The Philippines scores poorly in both the World Bank’s Ease of Doing Business rankings (99 out of 190) and in Transparency International’s Corruption Perceptions Index (101 out of 176, tied with Gabon, Niger, Peru, Thailand, Timor-Leste, and Trinidad & Tobago).

Duterte appears to be pivoting toward China and away from the US.  Some of this appears to be bluster, such as his threats to break up its military ties with the US and end joint military exercises.  However, bilateral talks with China regarding territorial claims in the South China Sea will be held this month.  Note China has pledged funds for infrastructure projects in the Philippines.


The economy is still robust.  GDP growth is forecast by the IMF at 6.8% in 2017 and 6.9% in 2018, little changed from 6.8% in 2016.  GDP rose 6.6% y/y in Q4, just below the cycle high of 7% y/y in both Q2 and Q3.  However, China’s economy appears to be softening and so we believe there are some downside risks to the growth forecasts.

Price pressures bear watching, with CPI rising 3.4% y/y in April.  This was the highest rate since November 2014, but remains within the 2-4% target range.  The central bank forecasts inflation of 3.4% in 2017 and 3.0% in 2018.  The current outlook supports the case for steady rates for now, though low base effects suggest inflation will accelerate in the coming months and may necessitate a more hawkish stance.  Indeed, the bank said at this week’s policy meeting that it sees upside risks to inflation.

Deputy Governor Espenilla was recently named as the replacement for outgoing Governor Tetangco.  Tetangco served two full terms but cannot serve for a third due to term limits.  Espenilla will take over on July 3, ahead of the bank’s August 10 meeting.  He has worked at the bank for more than three decades, and represents continuity and credibility.  Espenilla is also the head of banking supervision since 2005, giving him great insight into the economy.

The central bank next meets June 22, no change is seen then at Tetangco’s last meeting.  The bank just met today and left rates steady, as expected.  Note that President Duterte will also name three others to the bank’s Monetary Board as their terms also expire along with Tetangco’s.

Fiscal policy bears watching.  The budget deficit came in at an estimated -2.5% of GDP in 2016, little changed from 2015.  It is expected to widen to -3% of GDP in both 2017 and 2018.  President Duterte has pledged to spend on improving infrastructure, and so we see upside risks to the deficit.

The external accounts have worsened.  Exports slowed along with China, its largest export markets, while strong growth boosted imports.  The current account was basically in balance in 2016, and is expected by the IMF to move slightly into deficit in both 2017 (-0.1% of GDP) and 2018 (-0.3%).  This would be the first shortfall since 2002, but is likely to be fully covered by FDI.

Foreign reserves have edged lower from the September peak near $86 bln.  At $81.8 bln in April, they still cover more than 9 months of import and are nearly 4 times larger than the stock of short-term external debt.


The peso continues to underperform.  In 2016, PHP fell -5% vs. USD and was ahead of only the worst performers ARS (-18%), TRY (-17%), MXN (-16%), and CNY (-6.5%).  So far in 2017, PHP is down -0.5% YTD and is ahead of only the worst performer TRY (-1.5%).  Our EM FX model shows the peso to have STRONG fundamentals, so this year’s underperformance should ebb.

USD/PHP has traded mostly in a narrow 49.40-50.40 range this year.  The pair appears on track to test the June 2006 high near 53.65.  After that, the February 2004 high near 56.50 comes into focus.  The 200-day moving average comes in near 49.09 currently.

Philippine equities continue to underperform.  In 2016, MSCI Philippines was -2.5% vs. +7% for MSCI EM.  So far this year, MSCI Philippines is up 14% YTD and compares to 17% YTD for MSCI EM.  This slight underperformance should ebb, as our EM Equity model has the Philippines at an OVERWEIGHT position.

Philippine bonds have underperformed recently.  The yield on 10-year local currency government bonds is about +9 bp YTD.  This is ahead of only the worst performers China (+62 bp), India (+43 bp), Korea (+24 bp), Czech Republic (+22 bp), and Thailand (+13 bp).  With inflation likely to continue rising and the central bank perhaps tilting more hawkish, we think Philippine bonds will continue underperforming.

Our own sovereign ratings model shows the Philippines’ implied rating steady at BBB+/Baa1/BBB+ this quarter.  There is still some upgrade potential to actual ratings of BBB/Baa2/BBB-.  However, we suspect that the agencies will remain cautious in light of the planned fiscal loosening by the Duterte government.