Impulsores de riesgo y perspectiva general

  • President Aquino’s strong mandate bodes well for political stability and making progress in addressing poverty and corruption issues. Security concerns on the island of Mindanao persist.
  • Philippine electronics exports are affected by a gloomier global economic climate. Economic and geographical diversification and resilient remittances fuelling household consumption are likely to mitigate the impact on the current account from the eurozone crisis and China’s soft landing.
  • A stimulating policy mix combined with investments in social programmes and infrastructure aim to support the economy.
  • Despite public debt having nearly halved since 2003, Manila needs further fiscal consolidation.
  • Capital repatriation by European banks is the main downside risk for a more solid domestic banking sector.
  • Record foreign exchange reserves provide a valuable cushion against external shocks.

Hechos y cifras

Pros

  • Resilient and sharp overseas workers’ remittances
  • Strong balance of payments
  • Large external liquidity
  • Flexible and skilled labour force

Contras

  • Growth constrained by infrastructure gap, low investment & savings rate
  • Vulnerable to foreign demand of electronic goods
  • Persisting high poverty
  • Low tax base

Main export products

  • Electronic products (35.5% of current account receipts), business services (9.5%), tourism (3%), articles of apparel & clothing accessories (1.9%), coconut oil (1.4%)

Income group

  • Lower middle income

Per capita Income (USD)

  • 2,060

Population

  • 93.3 m

Description of electoral system

  • legislative: held every 3 years; next election: May 2013

Description of electoral system

  • presidential: 6-year term; next election: 2016

President (head of State and of government)

  • Benigno Aquino III

Evaluación Riesgo País

President Aquino, an opportunity for stability and reforms

In June 2010, opposition leader Benigno Aquino III was elected President. With 42% of the vote, the largest score in the country’s history, he recorded an unusual landslide victory. The success lied in the popularity of his late mother and former President Corazon Aquino, and was a clear expression of the desire for a change of power after nine years of corruption scandals under Gloria Macapagal Arroyo’s previous administration. Two years later, Aquino remains extremely popular and enjoys a strong mandate to focus  on his two top priorities: tackling widespread poverty and large-scale corruption. The lack of a majority for his Liberal Party in Congress might nevertheless be an obstacle to his reform program until at least the  May 2013 mid-term elections.

So far, the crack-down on corruption and good governance policy have led to symbolic results with the prosecution of dozens of officials, the impeachment of Chief Justice Mr Corona – an Arroyo ally - and the arrest of former president Arroyo on the accusation of electoral fraud. These convictions will inevitably lead to political tensions and strained relations with elites over time.

Aquino’s large success is a landmark milestone in the Philippine political history as the country has often been characterised by political instability and state coups. Although political stability and policy continuity are likely in the medium-term, the Philippines still face frequent local political violence.

Main security risks in Mindanao

Security risks remain high in southern – on the island of Mindanao - and western provinces, where militant groups with different demands such as more autonomy operate. This is the case for terrorist groups such as Abu Sayyaf, Jemaah Islamiya and Moro Islamic Liberation Front (MILF). The latter is the biggest Muslim rebel group and represents the main threat as it kidnaps people for ransom, attacks public targets and sporadically fights government troops.

Some progress has been made through continued peace talks but, even in spite of a recent agreement, any acceptable compromise on both sides might still prove difficult to implement. The same applies to the NPA (New People’s Army) communist group, which is the only group active throughout the whole country and with which peace talks to end a decades-long conflict have so far been inconclusive. Even though NPA’s insurgency and threat have declined in past years, they may still be a source of instability, as shown by occasional attacks of NPA guerillas against the mining industry.

Philippine foreign policy is characterized by tight collaboration with traditional ally the United States on anti-terrorism policy, which also allows the Philippines to cope with China’s rising assertive stance in South-east Asia. This was highlighted when tensions rose over sovereignty of the Spratly Islands last year and currently around Scarborough Shoal in the South China Sea. Territorial disputes with China in other naval areas that are said to be rich in fish and/or oil and gas are expected to occur in the future and represent a risk of naval clashes. However, all in all, the Philippines have no interest in a conflict with its third trade partner.

Volatile export performances, robust economic fundamentals

The ups and downs the Philippine economy has experienced since the 2009 global recession highlighted the high cyclicality of its exports when faced with external shocks. After a GDP surge in 2010 boosted by high consumer confidence and rebounding exports following a very weak 2009, the Philippine economy has been among those that were affected the most by the progressive slowdown in Asia until end 2011.

GDP growth fell from 7.6% in 2010 to 3.7% in 2011, which was mainly due to a 23% drop in exports of electronic goods to which the Philippine export sector heavily depends. These products account for 35% of total exports and are significantly harmed by a decline in global demand for durable goods. Moreover, supply chain disruptions following Japan’s huge natural disasters in March 2011 affected Philippines-based Japanese subsidiaries in the manufacturing sector, which affected economic output.

Philippines_Graph1EN

Therefore, strong consumer demand supported by robust overseas workers’ remittances and rather low inflation, has been the main driver of growth as the country is coping with a gloomier global environment, being the euro area crisis impact on trade flows, fragile US recovery and particularly China’s soft landing. Thus, even though GDP is forecast to average 4.5-5% in the medium-term and the Philippines seek new market destinations, a central issue is the resilience of electronics exports amid possibly prolonged weaker global economic conditions. Given its narrow export base, more emphasis is consequently put on developing further promising sectors such as tourism, agribusiness and obviously business process outsourcing, which is expected to continue its rapid growth.

With less favourable trade developments, the current account balance has deteriorated but is still in surplus - the last deficit dates back from 2002- and is expected to stay around 2% of GDP in the coming years. The positive setting is maintained thanks to the compensation from resilient Filipinos’ remittance inflows that originate largely from the US market. These rose by 7% year-on-year in 2011 and remain an essential source of current receipts for the country as they amount to 25% of their total.

Philippines_Graph2EN

As an open economy, the Philippines are also vulnerable to capital outflows that are triggered by the euro area turmoil and capital repatriation by banks. The potential magnitude of the financial shock spillover on the Philippine economy is however expected to be mitigated by the Philippines’ strong balance of payments and lower dependence on external financing.

Stimuli and reforms to offset a gloomier global climate

The economic outlook for the Philippines will largely depend on how the economies of its top markets (Euro zone, US, Japan and China) will perform, and especially on the fate of the euro area and its spillover effects. Nonetheless, thanks to good fundamentals, national authorities have policy tools at their disposal to weather external shocks as witnessed in the aftermath of the 2008 crisis. Given moderate growth, the authorities have shifted to a stimulating policy mix.

On the one hand, authorities have opted for monetary loosening as inflation abates and is expected to stay around an average of 4% in the coming years. On the other hand, the government has extended its social welfare programme with a particular focus on education and poverty alleviation, and so promoting more inclusive growth. This is of primary importance for a country with one of the youngest and poorest populations in Asia -about 1/3 of the population below the poverty line-, and the existence of high revenue inequalities that are slowing down the rise of a large middleclass.

Another stimulus will come from an ambitious infrastructure programme (roads, railways, airports…) aimed to support medium-to long-term growth and offset lower export performance. Structurally low public investments and private investor mistrust towards corrupted officials have kept infrastructure underdeveloped and lagging well behind regional peers. The reform momentum has raised investor confidence as shown by increasing investment in infrastructure via public-private partnerships, which are supported by a more business-friendly environment. However, the process needs to be accelerated as underspending is sustaining a substantial gap between planning and implementation.

Medium-term plans to further tackle weak public finances

The budgetary boost to growth, through the infrastructure package and higher social expenditures, goes hand in hand with a government commitment to medium-term fiscal consolidation. Making public finances sustainable is a major government objective as it is the Philippines’ persisting main macroeconomic weakness. It has to be acknowledged though that thanks to continued good economic management, the public finance situation has improved over the years.  The budgetary adjustment has already brought the consolidated public sector deficit – at 4% of GDP in 2010 – to lower levels. The government focuses on improving tax administration, on raising tax and customs receipts, on fighting tax evasion and continuing improved monitoring of spending (with possibly some slippages in the run up to the 2013 elections though).

Philippines_Graph3EN

More remarkably, the public debt ratio has been constantly reduced since 2003 as it has nearly been halved, falling to 51.3% of GDP last year. Although the government is determined to continue on that downward trend, public debt still amounts to 280% of revenues.

This clearly shows how insufficient public revenues are, thereby keeping the high interest payment burden, which is expected to eat up 18.8% of revenues this year. A higher risk comes from the considerable share (more than half) of the public debt that is denominated in foreign currency, leaving it vulnerable to peso depreciation. The latter is nevertheless limited by the Philippines’ robust balance of payments, lowered vulnerability to volatile capital outflows and the country’s potential to attract more FDI and portfolio inflows in the future thanks to the infrastructure programme, an improving business environment, growth prospects and relatively higher returns.

A sounder banking sector facing euro zone crisis spillover

Since the 97-98 Asian crisis, the domestic banking system has gained strength and has become sounder so that it was barely affected by the latest financial crisis. It is more liquid, relies on better risk management practices, which leads to a decade-low NPL ratio (around a mere 2% of total loans in 2011), and has an improved supervisory system. Banks seem resilient enough to withstand external shocks such as the euro zone turmoil thanks to stronger balance sheets and minor exposure to euro-denominated assets. Capital withdrawals from European banks might nevertheless represent a significant vulnerability as their loans amount to about 10% of GDP. In the meantime, as a sign of the sector’s good health, Basel III capital requirements are planned to be adopted already as from 2013.

Comfortable external liquidity to cope with external shocks

The Philippines’ financial risk is low. External debt ratios have constantly declined since the Asian crisis but the downward trend was reversed with the 2009 global recession.

Compared with the debt-to-GDP ratio of 37.4%, down from 82% in 1998 and expected to go down slowly in the medium-term, the debt-to-exports ratio is indeed forecast to increase slightly from 87.3% in 2011 to 93.3% by 2015 as a partial consequence of lower export growth. This is however not too concerning as debt dynamics are rather stable over time even when external shocks take place.

The Philippines’ external liquidity has never been as favourable. Foreign exchange reserves are at a record high of USD 66.28 billion, which allows for close to nine months of import cover and more than four times short-term debt. Monetary authorities have therefore leeway to manage exogenous shocks, capital outflows and a sudden strong depreciation of the peso, which is particularly valuable in times of global uncertainty. External debt servicing is not problematic either as the debt service-to-exports ratio is moderate, under 10%, and forecast to remain low in the future.

Philippines_Graph4EN

Risk outlook

In the short term, political and commercial risks are likely to deteriorate as a result of the global slowdown and negative effects of the euro zone crisis. However, these risks will be mitigated by the Philippines’ good fundamentals and record external liquidity. In the medium- to long-term, political risk evolution will mainly depend on the fiscal consolidation process, developments of external demand for electronic products and Aquino’s ability to keep his reform programme on track.

Analyst: Raphaël Cecchi, r.cecchi@credendogroup.com