The Philippines: Back in business?

THE FINANCIAL EXECUTIVE
Business World


A few weeks ago, Ambassador Bobby Romulo invited me to present an overview of the Philippine economy to a small group of business leaders. From the flow of discussions that followed, there seemed cautious optimism all around.

Let me share a few highlights of my presentation:

I. IS IT TIME TO LOOK AT THE PHILIPPINES?

The Philippines was reported to have grown by 6.9% last quarter on the back of a 5.4% growth in 2006 (GNP at 6.2%), the first time that the country recorded three consecutive years of over 5% growth since the 1970s. This robust and resilient growth was achieved on the back of a major fiscal adjustment and relative political and governance "unease." (This prompts the question of how well the country could be doing if these were absent!) Hurdle rates to investments are also lowest in years, driven by fundamental improvement in macro risk profile and an increase in global liquidity looking for investments in emerging markets.

Macroeconomic risks have been significantly reduced: The country has a record surplus in the consolidated public sector balance in 2006 (from a deficit of around 5% of GDP in 2004); sustained low inflation and interest rates; a strong current account position (4% of GDP in 2006); record BSP reserves, covering over 2-1/2 times short-term maturing debt; and much reduced financial sector risk as banking system has become healthier now than it has ever been in a decade.

Relative political calm can be expected. The President has weathered the political crisis that reached its height with the resignation of 10 of her key cabinet secretaries in July 2005. The midterm elections were relatively orderly and calm. And while the election results were mixed - the administration overwhelmingly won the local government and House of Representative posts, and the opposition, the Senate - there is no reason to believe that there can be any chance of successful challenges to the President through extraconstitutional means (people power, coups, etc.) or revival of an impeachment case against her.

While there may be a wild card in terms of how the case against former President Estrada will play out, the expectation is that all eyes are now on the 2010 elections and for a peaceful turnover to a new administration which will preserve this administration's good legacies, e.g., in the fiscal front.

II. DRIVERS TO GROWTH: ROBUST AND SUSTAINABLE?

Recent performance has been driven on the demand side by double-digit growths (20% and 15%, respectively) in remittances (fueling consumption growth, balance of payments stability, and unemployment and social/political safety nets) and exports. On the supply side, growth was led primarily by the services sector.

My own assessment is that remittances will continue to grow, perhaps not as robustly as in the past couple of years but will endure for sometime still, constrained perhaps over the very long term only by the inability of the educational system to produce skilled workers - a problem that has been recognized and will hopefully be addressed.

The electronics sector's resiliency may be due to the way production in the region has become network based (i.e., Philippine exports/imports consist mainly of parts and components e.g., 56% of total exports in 2003 vs. 20% in 1990), with comparative advantage built over time for being "first mover" in particular niches. The recent large ($1.8 billion) investment of Texas Instruments, bagged by public-private collaboration led by Trade and Industry Secretary Peter Favila, well illustrates this continuing competitiveness (which government needs to work on to sustain).

The Philippines is very competitive in BPO services, ranking second in an IMF list of countries based on an aggregate assessment of such factors as people, service maturity, financial benefit, and infrastructure. The sector is forecast to continue expanding quite rapidly through 2010.

III. RESIDUAL RISKS?

Fiscal Reform Sustainability. The expanded VAT, fully supported by both branches of government, as well as business, academe, and responsible civil society, together with correct pricing of power and some expenditure compression, improved the fiscal picture immensely over the last two years. This year, however, there were some slippages in collection, leading to the replacement of the BIR chief. I believe this demonstrates the resolve of the current administration to preserve its fiscal legacy. With the current financial/economic team, it is highly unlikely this will be compromised.

With no new taxes contemplated, the Department of Finance is focused on improving the administrative efficiency of tax collection. Continuing efforts on this is critical for the following reasons: the tax-to-GDP ratio, at 14%, is still low; debt-to-GDP ratio is still high; and the country has been under-investing, not just in physical infrastructure but also in social capital, especially education.

Power. The only thing to flag is the obvious one: if the Philippines aspires to grow at high levels, new power plants will have to be built pretty soon. The critical period by Department of Energy estimates is 2010, and there seems to be an indication that at least small ("peaking") plants are already being built to respond to this need.

Inflation/Asset Bubble? Is an asset bubble building on the back of high liquidity growth (26% in April)?

Not at this point. Office rents in Makati and stock prices are still roughly 40-50% below where they were in 1997, when corrected for inflation. Moreover, banks continue to be cautious in lending, and price multiples are nowhere near those observed in other regional equities markets, especially China. More fundamentally, in contrast to 1997, asset price increases are being driven by real economic activity rather than hot money.

Globally, while risks continue to arise from crash landings in the US housing sector, disorderly unwinding of global imbalances, and bursting of bubbles elsewhere in the world (notably, China), most of these have receded somewhat from conditions in September last year as noted in the latest IMF World Economic Outlook.

IV. WHAT IS THE OUTLOOK?

Private GDP forecasts range from 5.3% to 6.4% in 2007 and from 5.4% to 6.4% in 2008. It should be clear though that most analysts appreciate that the Philippines has momentum. Whether this translates to improved long-term performance depends on whether the opportunities created by this momentum, improved fiscal space, and favorable external environment are used by government to bring the economy to the next level through strong reforms, sound policies, and truly wise development spending. In short, the "legacy thing."