Philippines: Staying Strong

We have revised our 2016 GDP growth forecast to 6.6% from 6.3% previously. Growth may moderate going forward, as the May election effect fades. Nevertheless, domestic demand should continue to drive 6-plus percent GDP growth into 2017.

Over the past three quarters, investment has grown by 26% (y-o-y), driven by frontloading ahead of the May election (Chart 1, below). Imports of capital goods rose 61% in 1H16, far outpacing the 24% and 7% recorded for consumer and intermediate goods respectively. Businesses sentiment remains firm, given government promises to be more aggressive in executing budget allocations.

Overall liquidity conditions remain supportive. Loan growth inched higher to 16.2% (y-o-y) in 2Q16, the fastest since 4Q14. As business conditions start to normalize, expect some moderation in investment. Still, investment growth should average 10% over the next year, similar to the pace seen before the spike in 4Q16.

Note also that inventory build-up has continued up to 2Q16 (Chart 2, below). We have yet to see any material de-stocking activities since end-2013, making this the longest stretch of inventory build-up in the past 10 years. As and when the de-stocking eventually starts, a moderation in investment growth will follow.

Chart 1: Robust Investment Growth in the Past Year

Source: CEIC Data, Bloomberg and DBS Group Research

Household consumption growth has also been robust. Consumption grew a record-high 7.2% (y-o-y) in 1H16. Non-food consumption lead overall consumption growth, at 7.4% in the period (Chart 3, page 20). Demographic dividends remain highly supportive of consumption growth, also evidenced in motor vehicle sales, which continued to grow at circa 25% annual pace. Other high frequency data, including retail sales and imports of consumer goods, suggest the outlook remains positive.

We reckon household consumption growth may remain in excess of 6% for the coming years. Positive spillovers from robust foreign remittances persist. Additionally, President Duterte’s efforts to raise economic growth outside Metro Manila also deserve a closer watch. The government is currently mulling over whether to set equal minimum wages for Metro Manila and the regional provinces. If successful, this may boost consumption growth in the rural areas.

Focus on Government Policies
The implementation of Duterte’s economic policies will also have a bearing on how much longer investment growth remains in double-digit territory. The new government aims to accelerate its public-private partnership projects, 12 of which, with a total cost of more than US$5bn, are currently at different stages of procurement.

Meanwhile, the current 2017 budget proposal sets a 12% increase in expenditure, raising the infrastructure budget to 7% of GDP. As promised, the budget deficit target is raised to 3% of GDP starting next year. This is well above the average of only 1.6% of GDP in 2006-2015.

It is also important to monitor the pace of fiscal expenditure going forward. Total fiscal spending growth averaged 6.8% during Aquino’s terms, almost half the pace of revenue growth at 11.8% (Chart 4, below). The Duterte administration is hopeful that its focus on regional development will help to speed up budget spending.

Chart 2: Change in Inventories

Source: CEIC Data, Bloomberg and DBS Group Research

Lastly, the government also aims to bring in more foreign direct investment. Amongst others, there are plans to adjust the cap on foreign ownership of local companies from 40% to 70%. Limits on property land-lease could also be raised to 40 years from 25 currently. The government is also mulling over plans to lower the corporate tax rate from the current 30%. These are potentially significant. While foreign direct investment (FDI) increased several folds during Aquino’s term, it remains low compared to the rest of the region.

Current Account Surplus to Narrow
Expect exports to fall by 5% this year. Weakness is prevalent across sectors. Exports of electronic products were down by 8% (y-o-y) in May-Jul16, a worrying sign given their importance to exports overall. After 3 years of strong growth, electronics exports could fall by 3% this year.

Ironically, this has pulled overall GDP growth down. Growth has averaged 6.4% over the past 3 years, even as net exports of goods and services have been persistently negative during the period. The more notable impact will be on the current account. Even though foreign worker remittances are likely to hit a record-high US$26bn this year, the current account (C/A) surplus is set to narrow to about 1.3% of GDP.

As evidenced in the growth of imported capital goods, the narrowing of the C/A surplus merely reflects the increase in domestic investment. For now, we reckon there is still no reason to worry on the external liquidity front, especially considering that the foreign reserves to short-term external debt ratio is still above 5.

Chart 3: Non-Food Consumption Strong

Source: CEIC Data, Bloomberg and DBS Group Research

Interest Rate Hikes Likely in Early-2017
Aug16 core inflation came in at 2.0% (y-o-y), the highest this year. Core inflation seems to have bottomed out in 2Q16. Not only has underlying demand remained strong, but price expectations also seem to have inched up in recent months alongside the rise in food prices. Food inflation is currently trending around 3%, offsetting some of the drag prevalent in the housing/utilities and transport components of the CPI.

Given that the distortion from low oil prices is likely to dissipate going into 2017, CPI inflation should average 2.6% next year, up from a projected 1.6% this year. Core inflation is also set to be steady within the 2.5-3% range by the mid-year.

While Bangko Sentral ng Pilipinas (BSP) seems fairly comfortable with the current inflation trajectory (the inflation target is 2-4%), expect the monetary policy bias to turn increasingly hawkish going into 2017. Look for the BSP to continue to drain excess liquidity from the system. This is mainly done by gradually increasing the volume of its term deposit facility auction higher in the coming months, in an effort to pull short-term rates closer to the current policy rate of 3%. An upward adjustment in the policy rates may then follow. At this juncture, expect the BSP to raise its policy rates to 3.5% by mid-2017.

Chart 4: Spending vs. Revenue Growth

Source: CEIC Data, Bloomberg and DBS Group Research