Markets stirred; economy to chug along

Business World
Introspective

JUST TWO weeks after the government announced a much-better-than- expected 7.8% GDP growth in 1Q2013 that bucked the regional growth slowdown, local stock prices grabbed headlines with the worst one-day dive since the Lehman crisis in October 2008. Many were stunned by the steep fall, especially following a new round of upgrades in analysts' growth forecasts. Some feared that the much talked about asset bubble had finally burst. Still others, who had missed the amazing bull run, are wondering if now is a good time to buy.

In truth, financial market volatility has greatly increased since the US Fed started hinting at slowing down its bond buying program with worries about a rapid rise in interest rates exacerbated by the Bank of Japan's recent decision not to expand its monetary stimulus. Thursday's 442-point drop (6.7%) in the Philippine Stock Exchange Index (PSEi) followed a month- long downtrend that saw the PSEi losing a cumulative 15% since a 7,403 intra-day record high was reached last May 15. The losses extend to the bond and currency markets with local interest rates having risen by over 70bp on average since mid-May and the peso losing about 5% against the dollar over he same period.

Rather than a change in internal fundamentals, we think that the drop in the equity, bond and peso markets are more a reflection of portfolio flows going back to the US with its emergent recovery and expectations of an end to the Fed's quantitative easing. Compared with other emerging markets, local financial prices may have been affected more because Philippine assets are among the most overvalued (e.g., very high price- earnings ratios) due in large part to past capital inflows attracted to the country's growth story and prospect of investment grade ratings. With the upgrade to investment grade already achieved and no clear further upside play, foreign players appeared to have decided to cash in earnings, with recent data releases showing poor numbers for FDI and exports as well as the World Bank's downward revision of world growth used as reasons for players to exit.

In fact, we are looking at significant upward adjustments to our growth forecasts for this year (from 6.1% to 7.2%) and next (from 5.8% to 6.2%.

But this is mostly based on the business cycle rather than a permanent structural shift that prospective investors, including a new class of players that can only invest in investment grade markets, may be waiting for. Our GDP revisions reflect largely the high current election-related spending growth, including likely frontloading in public infrastructure that may last only up to this quarter, and the ongoing private construction boom, a lagging indicator of past investment decisions in residential and business buildings that according to industry experts, take two to three years to complete.

The maturing of this cycle and rising interest rates will bring growth back to more normal levels, perhaps as early as late 2014 or early 2015. The much-hoped for revival of investments in PPP or in industrial zones may not be significantly large to keep growth high beyond 2015.

Meanwhile, the Monetary Board has kept its policy stance unchanged, with key borrowing and lending rates at 3.5% and 5.5%, respectively and the SDA rate at 2%. It had previously slashed the SDA rate by a cumulative 150bp and last month announced limits to trust accounts' access to the facility which will be phased over the next six months. In light of the capital outflows, the monies expected to be pushed out of the SDA facility are not expected to be inflationary and given their conservative risk profile, will likely have limited impact on prices of risky assets. The peso's depreciation is also welcome news. Both developments (SDA changes and weaker currency) will help to repair the BSP's balance sheet and increase policy flexibility.

This column was culled from a recent GlobalSource report written by Christine Tang and the columnist. Romeo Bernardo is Philippine GlobalSource advisor and is a board director of IDEA.