Solid Foundations For An Investment Boom
BMI View: Stability on the political front, improvements in cleaning up corruption and strengthening the business environment, and prudent macroeconomic policies look set to underpin continued strong growth in the Philippines economy. Notwithstanding the risks, which come in the form of another global credit crunch and/or a collapse in the country's main trading partner, Japan, we are forecasting GDP to grow by an average of 11.2% in US dollar terms over the next five years.
Last month we wrote an article on Indonesia's medium-term economic growth prospects, explaining the basis of our bullish outlook and outlining key risks that could derail the positive story. We attempt to use the same blueprint to assess growth prospects in the Philippines in this article, where the outlook is equally bright. As in the case of Indonesia, sound monetary policy is underpinning the current investment boom. Great leaps are being made on the fiscal front too to encourage crowing in of private investment. These macro-prudential policies, together with rare stability on the political front, are feeding through into a dynamic corporate sector that looks set to sustain the investment boom over the coming years. We are forecasting GDP to grow by an average of 11.2% in US dollar terms over the next five years.
|Future Looks Bright|
|Philippines - Real & Nominal GDP Growth, %|
Risks do exist, however, and although the Philippines is more insulated from global trade and credit cycles than its regional peers, it is not immune. An additional threat is posed by the potential for large-scale economic dislocation in the country's main trading and investment partner, Japan. Furthermore, we are concerned by the potential for political change at the top once President Benigno Aquino's term ends in 2016, given how instrumental his reform drive has been in supporting the economy.
Political Stability And Support For Reform
Recent surveys suggest that President Aquino's leadership continues to witness strong support. According to the latest Pulse Asia survey, Aquino had a net performance rating of 72%, up by four percent from February's 68%. The President also sustained 74% satisfaction rating based on the Social Weather Stations (SWS) survey. Efforts to tackle high-level corruption have been the major focus of Aquino's first three years at the helm, and will likely dominate the last three. Although there is much more work to be done, marginal improvements are being seen, particularly in terms of public procurement, which has traditionally been a source of intense corruption and inefficiency. With a strong mandate to continue implementing economic reforms over the remainder of his term, Aquino is set to foster greater confidence among domestic and international investors.
Regulatory Efficiency Is Sorely Lacking But Things Are Looking Up
It is no secret that the Philippines's business environment leaves a lot to be desired. The country sits at the lower end of our Business Environment ratings, with a score of 49 out of 100, and scores equally poor in other internationally-recognised ranking systems. The World Bank's Doing Business Report shows that starting a business remains woefully difficult, paying taxes is burdensome, and resolving insolvency is problematic.
|Lots Of Work To Be Done|
|Asia - Business Environment Scores|
On a more positive note, the Heritage Foundation's Index of Economic Freedom showed an increase for the second consecutive year, as improvements in 'rule of law' and 'limited government' outweighed the deterioration in 'regulatory efficiency'. While there is work to be done, things are heading in the right direction. We are confident that with the recent reduction in corruption, as seen in leap in rankings according to Transparency International's Corruption Perceptions Index (from 135 th only three years ago to 105th in 2012), the Philippines's business environment will continue to make steady improvements.
|Things Are Looking Up|
|Philippines - Index Of Economic Freedom|
Monetary Policy: A Solid Performance
One of the things that has impressed us about the Indonesian growth story is that it has been built on a foundation of stable monetary policy, and the same can be said for the Philippines. The Bangko Sentral ng Pilipinas has managed to buck the regional trend and keep real interest rates in positive territory most of the time in recent years. The accompanying chart shows two measures of real interest rates. Firstly, the difference between the policy rate and consumer price inflation (CPI) has been in positive territory more often than not over recent years. Secondly, the difference between actual lending rates and M3 money supply growth has not moved too far into the red, except for brief periods in 2006 and 2008. Total private sector credit as a share of GDP had grown only marginally in recent year, and is one of the lowest in the region at 36%. Relatively prudent monetary policy has allowed inflation to remain low and has prevented the build up of distortionary bubbles within the economy.
|Relatively Prudent On The Monetary Front|
|Philippines - Real Interest Rates, %|
Fiscal Policy: Double Edged Sword
Philippines fiscal policy has come on by leaps and bounds in recent years. With the exception of 2009 and 2010, the government has run primary surpluses for the past decade, reducing the country's debt burden to 50% of GDP from 74% 10 years ago. As a result, interest rates and interest costs have fallen creating a virtuous cycle and freeing up cash to be spent in other areas. However, in contrast to most governments around the world, Manila has a problem with spending to little rather than too much.
|Major Progress On the Fiscal Front|
|Philippines - Total Government Debt, % of GDP|
Gross fixed capital formation came in at just 6.0% in 2012, and a major factor for its underperforming the headline GDP growth rate was the failure of the government to execute its capital spending plans. Since the public-private partnership (PPP) programme was announced in November 2010, only two projects have been awarded, while only another eight projects were released for tender in December 2012. The government has put a great deal of effort into reducing corruption in the procurement/bidding processes for capital spending projects, and this continues to result in major project delays. Indeed, as it stands, it is becoming increasingly unlikely for the eight projects under tender to start major construction works in 2013 due to delays in their pre-qualification process. However, we view this as a necessary obstacle, given the deadweight loss that will eventually be reduced from more efficient practices. While progress still needs to be done to clear up the process, any improvement made from here will show up in greater investment spending, given the very low base that the country is starting from.
Strong Corporate Sector Suggests Boom But No Bubble
We do not see a great deal of evidence to suggest that the current investment pick-up is unsustainable. While prime location real estate has seen some impressive price growth and the equity market is one of the most expensive in the world, these largely reflect the improving underlying fundamentals. Stable monetary and fiscal policy have prevented the kind of distortionary signals that have led to widespread malinvestment in the likes of China, and the corporate sector's solid balance sheet is testament to this fact. For example, if we look at the companies listed on the Philippines Composite (PCOMP), corporate cash flows are booming and are still a healthy margin above net income. Meanwhile, leverage is low, with debt-to-assets at just 70% versus 90% for the MSCI Asia Ex-Japan. From an investment perspective we believe that the market has been bid up to a point at which the positive earnings outlook is already 'baked into the cake'. However, we are confident that the tremendous price gains in the index since late-2008 reflect the bright future for Philippine economic growth, rather than a bubble set to burst.
Risks: Japan Tops The List Of Concerns
The Philippines has struggled to attract foreign investment in recent years, and despite the recent pick-up it remains very low relative to other fast-growing emerging markets. Japan has been one of the few countries investing substantial amounts in the country in recent years, ranking behind only the US. With Japan's economy likely to face a fiscal crisis over the coming years, foreign investment inflows may well be curtailed. The country is also the Philippines' main export market, making up roughly 28% of total exports. A further plunge in the value of the Japanese yen, and/or a fiscal crisis-induced economic crash, could leave the Philippines's major export industries facing a huge shortage of demand.
Finally, despite being less exposed to global credit conditions than its ASEAN neighbour Indonesia, the country has seen large inflows into domestic financial assets over recent years. With foreigners holding an increasing amount of local government bonds, another global credit crunch could seriously undermine local financial assets as foreign investors could be tempted to sell en masse, putting upward pressure on interest rates and crimping domestic investment.