A new vision for the Philippine economy after Covid-19

The Philippines is one of the fastest-growing economies of the past decade, averaging 6.4% growth per year in 2010-19. Indeed, an expanding and youthful population, combined with reforms and an ambitious infrastructure programme, have made it an enticing investment destination. Nevertheless, as is often the case in emerging markets, challenges regarding inequality – particularly the distribution of wealth and services – remain barriers to growth. The Covid-19 pandemic tested the country’s resilience in 2020, impacting major sectors. However, the government mobilised to support vulnerable industries with two major stimulus bills, which aim to create jobs and sustain growth into 2021.

Structure

The Philippines has shifted from an agricultural to a broadly services-focused economy. According to the central bank, Bangko Sentral ng Pilipinas (BSP), in 2019 agriculture, forestry and fisheries made up 9.2% of GDP, behind industry (30.2%) and services (60.6%). Services overtook industry as the leading contributor to GDP in the 1980s and accounted for almost 60% of total employment by 2019 – highlighting the growing importance of IT-business process outsourcing (IT-BPO). In addition to IT-BPO, export services, including those delivered by overseas Filipino workers (OFWs), play a significant role. Remittances from OFWs reached a record $33.5bn in 2019, representing 9.3% of GDP.

Industry accounted for 19.1% of workers in 2019 and is centred around manufacturing and agri-business. The development of a number of special economic zones should help bolster industrial growth in the years to come. The agriculture sector, which has shrunk considerably since 1980, has nevertheless been highlighted as a strategic sector for economic recovery amid Covid-19: the government identified food security as a primary concern. The sector employed 22.9% of workers in 2019, and its main products include rice, coconuts, maize, sugarcane, bananas, pineapples and mangoes.

Government Oversight

The Philippines’ primary socio-economic and policy planning body is the National Economic and Development Authority (NEDA). President Rodrigo Duterte has been head of the Cabinet since 2016, serving a six-year term, and also chairs the NEDA board. Karl Kendrick Chua occupies the positions of vice-chairperson and acting socio-economic secretary. The board includes the heads of various government departments, the governor of the BSP and the chairperson of the Mindanao Development Authority.

Development Plans

The Philippine Development Plan (PDP) 2017-22 is the medium-term economic blueprint for inclusive growth. Its primary aims include tackling poverty and regional growth disparities, and transforming the nation into a globally competitive knowledge economy. Its three pillars are building trust and transparency between government and society; reducing inequality and increasing opportunities; and accelerating growth through innovation and human-capital development. Prior to the pandemic, goals included achieving upper-middle-income status, reducing the poverty rate to 14%, and lowering rural poverty from 30% in 2015 to 20% by 2022. As of mid-2020 revisions to PDP targets were under discussion in light of the pandemic; however, poverty-reduction goals look set to remain a priority. In July 2020 Chua stated that “the immediate objective under the PDP will now focus on a healthy and more resilient Philippines”. Furthermore, in October 2020 NEDA and the World Bank published a report underscoring the importance of digitalisation and digital adoption, and decreasing the digital divide to meet economic aspirations.

Longer-term planning is anchored in the AmBisyon Natin 2040 vision, formulated in 2016, which aims to eradicate poverty and create a middle-income country. This would require tripling GDP per capita from $2892 to $9350 by 2040, and growing the economy by an average of 6.5% per year from 2018. Priority sectors highlighted under the plan include manufacturing, health, agriculture and financial services. The plan, which is being implemented by NEDA, is aligned with the administration’s 10-point socio-economic agenda, which includes tax reforms and improvements to the ease of doing business, and the UN 2030 Sustainability Development Goals. In July 2020, at an online World Bank forum, Chua said the country had achieved seven of the 10 points on the socio-economic agenda, highlighting the passage of the Tax Reform for Acceleration and Inclusion (TRAIN) among other reforms.

2019 Performance

Average economic growth of 6.4% in 2010-19 was up from 4.5% over the previous 10 years. Indeed, despite subdued global growth and uncertainty, GDP growth of 6% in 2019 – while slightly down from 6.3% in 2018 – marked the Philippines as one of the fastest-growing nations in the world. These fundamentals were reflected on the World Bank’s ease of doing business index in 2020: the Philippines rose 29 places to rank 95th out of 190. The bank highlighted improvements in starting a business, dealing with construction permits and protecting minority investors.

Economic expansion in 2019 was driven by the services sector, which grew by 7.5% to total P11.7trn ($232.7bn), according to the BSP. This was propelled by growth in numerous subsectors, notably public administration, defence and social security, which grew by 13.4%, and financial and insurance activities, up 11.9%. The IT-BPO segment grew by 7.1%, recording $26.3bn in revenue, according to figures from the IT and Business Process Association of the Philippines.

Meanwhile, industry growth eased from 7.3% to 4.7%, to reach P5.8trn ($115.4bn). Expansion was driven by construction (7.8%); electricity, steam, water and waste management (6.6%); mining and quarrying (3.6%); and manufacturing (3.2%). Construction’s growth rate, while high, was down from the 14.3% growth seen the previous year due to the delayed passage of the 2019 budget and the subsequent ban on public works during the mid-term election in May 2019. Likewise, manufacturing grew slower than the 5.1% expansion seen in 2018, marking the weakest growth for the subsector since 2009 (see Industry and Agri-business chapter).

Agriculture posted growth of 1.2% in 2019, up from 1.1% in 2018, to contribute P1.9trn ($37.8bn). Performance was attributed to key agricultural products such as maize, which expanded by 3.3%; mangoes (4.3%); and poultry and eggs (5.8%). However, contractions in segments such as sugarcane (-8.9%), palay (unhusked rice) (-5.9%) and bananas (-2.1%) weighed on growth, prompting the government to rethink agricultural programmes and projects that favour resilient crops.

Impact of Covid-19

The first case of Covid-19 on Philippine soil was confirmed in January 2020, and strict quarantine measures were imposed to varying degrees from mid-March onwards. As a result, the economy shrunk by 0.7% year-on-year (y-o-y) in the first quarter, 16.5% in the second and 11.5% in the third – a stark contrast to the 5.4% growth seen in the second quarter of 2019. This was driven by weaker remittances from OFWs, which were down 9.3% y-o-y in the second quarter, and slower growth in investment, exports and tourism earnings. According the IMF’s October 2020 “World Economic Outlook”, real GDP is forecast to contract by 8.3% in 2020 – the largest drop in Southeast Asia. This projected recession is deeper than the IMF’s June forecast of -3.6%, as the country continued to face one of the highest confirmed case rates in ASEAN, with over 435,000 cases as of December 2020.

Services, meanwhile, contracted by 15.8% y-o-y in the second quarter, compared to growth of 7.5% one year earlier. Given its sizeable share of GDP, the segment’s contraction translated into a 9.7-percentage-point drop in overall GDP, primarily due to stay-at-home measures and the grounding of land, sea and air travel. However, certain segments posted positive growth, including financial and insurance activities (6.8%) and ICT (6.6%), with e-commerce platforms moving customers to online transactions and e-payments (see Digital Economy chapter). Industry, for its part, contracted by 22.9% y-o-y, compared to growth of 2.5% in the same quarter of 2019. The decline shaved 6.9 percentage points off overall GDP, with construction and manufacturing contracting by 33.5% and 21.3%, respectively, due to restrictions on non-essential services under enhanced community quarantine (ECQ) – the country’s strictest lockdown category. However, as with services, certain segments grew during this period: pharmaceutical products and preparations, for example, expanded by 7.7%, following 27.3% y-o-y growth in the first quarter. Lastly, the agriculture sector, driven mainly by higher palay, maize, sugar cane and rubber production, grew by 1.6% y-o-y. The sector will continue to play an important role in economic recovery due to its connection to food security and poverty reduction.

Government Response

In response to the pandemic, and following a sharp increase in community transmission, ECQ was enforced across the most populous island of Luzon from March 16. The lockdown prompted the government to pass the Bayanihan to Heal as One (Bayanihan 1) Act on March 25, 2020, which granted President Duterte emergency powers to address the crisis. Among the mitigation efforts was a P595.6bn ($11.8bn) fiscal package for vulnerable individuals and groups, which included P205bn ($4.1bn) in cash aid for 18m low-income households; some P57bn ($1.1bn) in social-protection measures for workers; over P58bn ($1.2bn) for the medical response; and a P120bn ($2.4bn) credit guarantee for small and medium-sized enterprises (SMEs) and support for agriculture.

The Bayanihan to Recover as One Act (Bayanihan 2) was subsequently signed into law on September 11 to extend emergency relief, expand health care, and help businesses and OFWs. The P165.5bn ($3.3bn) stimulus included P140bn ($2.8bn) for hard-hit industries and a standby fund of P25.5bn ($507.2m) for the government to spend until the 2021 budget takes effect (see analysis). “Under Bayanihan 2 we allotted P820m ($16.3bn) to boost assistance to OFWs. OFW remittances will always be a significant factor in our post-pandemic recovery, as these will support consumption, savings and investment,” President Duterte told OBG. “We have therefore launched programmes such as the BaLinkBayan Portal and the Overseas Filipinos Remittances for Development project, which aim to harness remittances for investment and capital mobilisation.”

Other legislative measures include the Corporate Recovery and Tax Incentives for Enterprises ( CREATE) bill, which includes gradually lowering corporate income tax from 30% to 20% by 2027, among other pro-business incentives, and is the second package of the Comprehensive Tax Reform Programme (CTRP). Now approved by both the House of Representatives and the Senate, it is set to be enacted before the end of 2020 (see analysis). In a similar vein, in August 2020 the Securities and Exchange Commission (SEC) issued a regulatory framework for the creation and operation of a new corporate debt vehicle intended to support medium and large firms dealing with liquidity issues. “In addition to CREATE and Bayanihan 2, the government has worked on corporate debt vehicle programmes that are attractive to local and foreign investors,” Jose Luis Gomez, president and CEO of RCBC Capital, told OBG.

Fiscal Policy

Government spending had been increasing in the years leading to 2020 due to major infrastructure upgrades called for under the PDP 2017-22. Full-year public expenditure amounted to a record P3.8trn ($75.6bn) in 2019, or 19.5% of GDP, up 11.4% on the previous year. According to the Department of Budget Management, the bulk of public spending went to infrastructure projects under the Build, Build, Build programme, which increased by 9.7% to P881.7bn ($17.5bn) in 2019. With regard to public sector inflows, tax revenue grew by 10.2% and non-tax revenue by 8.9%, leading to overall government revenue growth of 10.1%, totalling P3.1trn (P61.7bn). Overall, however, this amounted to a budget deficit of 3.2% of GDP, equivalent to 2018. Meanwhile, the government’s outstanding debt-to-GDP ratio fell from 41.9% in 2018 to 39.6% in 2019, the lowest since 1986. Tax reform under TRAIN contributed to overall state revenue and narrowed the fiscal gap, enabling the Philippines to enter 2020 in a relatively strong position, with a P4.1trn ($81.5bn) state budget – up 12% on the amount earmarked in 2019.

Government expenditure rose by 7% and 22.1% in the first and second quarters of 2020, respectively, due to the pandemic. Total expenditure equated to a deficit of P473.3bn ($9.4bn) in the second quarter, reversing the P47.6bn ($946.7m) surplus one year earlier and equivalent to 11.4% of GDP. On the income side, revenue stood at P690.2bn ($13.7bn), or 16.6% of GDP, down 17.7% y-o-y. Higher spending was attributed to Bayanihan 1 and measures to protect vulnerable industries. By the end of August the deficit had risen to P740.7bn ($14.7bn), state revenue was down 8.3% and spending had increased by a further 20.8%. However, while state revenue in January-August fell by 12.2% y-o-y, a combined P1.6trn ($31.8bn) was collected, exceeding the period’s adjusted target by 7.2%.

In October 2020 the House of Representatives approved the 2021 budget and the Senate gave its approval in late November. Set at P4.5trn ($89.5bn), the budget – which will undergo a final review in December – is 9.9% larger than in 2020 and equal to 21.8% of projected GDP for 2021. It includes P203.1bn ($4bn) for health care to address the pandemic and P1.1trn ($21.9bn) for infrastructure to kick-start the economy.

Monetary Policy

Headline inflation decreased from an average of 5.9% in 2018 to 2.5% in 2019 – which sits within the BSP’s target range of 3% plus or minus one percentage point – and was attributed to slower price increases for food and energy items. In turn, household spending grew by 5.9% in 2019, with food and non-alcoholic beverages up 5.1%, and housing, water, electricity, gas and other fuels rising by 6.3%. Over the course of 2019 the BSP cut the key policy rate by 75 basis points (bps) as inflation eased, bringing the overnight reverse repurchase rate to 4%. In addition, after a cumulative 200-bp cut to the banking reserve requirement ratio (RRR) in 2018, it made 400 bps of cut in 2019, bringing the rate to 14% (see Financial Services chapter). To soften the impact of Covid-19, the BSP cut the RRR by 200 bps in March 2020, releasing P200bn ($4bn) into the financial system, with a maximum of 400 bps in cuts authorised for the year. This followed a reduction in the key policy rate by 50 bps in March to 3.25%. In the second quarter of 2020 the bank reduced its key policy rate by a further 100 bps, bringing the overnight reverse repo rate to 2.25%, a historic low. In October 2020 the BSP decided to hold the rate at 2.25%. Headline inflation, meanwhile, eased to 2.4% in the second quarter, down from 2.7% in the first quarter of 2020.

Trade & Investment

Despite sluggish global growth and trade uncertainty arising from US-China tensions, the Philippines exported $70.3bn of goods in 2019, up from $69.3bn in 2018, according to the Philippine Statistics Authority (PSA). This narrowed the trade deficit from $43.5bn to $37.1bn, marking a shift away from the deficit pressure of construction materials imported for the Build, Build, Build programme. The top-three export destinations were the US, up 7.7% at $11.46bn; Japan (3%, $10.63bn); and China (9.2%, $9.63bn). The top-three export groups were electrical products, at $40bn, or 57% of the total; other manufactured goods ($4.2bn, 6%); and machinery and transport equipment ($2.8bn, 4%). Imports, meanwhile, totalled $107.4bn, down from $112.8bn in 2018. The top-three import markets were China, up 11.5% at $24.5bn; Japan (-6.4%, $10.1bn); and South Korea (-27.2%, $8.2bn). The top-three import groups were electronic products, at $28.1bn, or 26% of the total; mineral fuels, lubricants and related materials ($12.8bn, 12%); and transport equipment ($11bn, 10.2%). Foreign direct investment (FDI), however, dipped to $7.7bn in 2019, a four-year low. Despite marking a 21.3% drop, the total was nonetheless higher than the $6.8bn forecast. Stakeholders attributed uncertainty over the passage of CREATE as one reason for the subdued FDI inflows. While the delay from its first approval in September 2019 may have caused some investors to adopt a wait-and-see approach, there is optimism that the lower tax rates and incentives outlined in the act will boost investment appeal in the longer term – strengthening the Philippines’ bid to attract players seeking to diversify operations away from China.

International trade faced a challenging environment in 2020 as Covid-19 curtailed economic activity. The Philippines recorded steep contractions in both imports and exports in the first eight months of the year, according to the PSA. Export earnings totalled $39.3bn in January-August, a 16.6% y-o-y decrease. FDI inflows, meanwhile, were down 11% y-o-y in January-July, at $3.8bn, according to the BSP. On a positive note, however, FDI net inflows rose for the third consecutive month in July on the back of improving investor sentiment due in part to easing of containment measures.

Labour Market

The labour market, characterised by a young and English-speaking workforce, has long been attractive. Efforts are under way to unlock further potential, such as digitalisation initiatives to upskill the IT-BPO workforce and modernise agriculture via innovation. In 2019 the labour participation rate was 61.3%, with 42.4m employed. As a result of Covid-19 and related lockdowns, unemployment rose to 17.7% in April 2020 – and the labour participation rate dropped to 55.6%. Declines were seen across the main economic sectors: services registered a 22.8% decrease in employment; industry fell by 28.2%; and agriculture was down 9.5%. On a positive note, according to the PSA, things have improved somewhat, with an additional 7.5m employed in July compared to April. Gains were seen across virtually all regions and sectors. Notably, agriculture saw an increase of 2.1m due to higher output, and construction registered an additional 1.2m employees as construction activity resumed. The passage of Bayanihan 2 is expected to offset some employment losses through subsidies and cash relief for affected households and workers. Around 50,000 micro- and SMEs, for example, should benefit from a further P10bn ($198.9m) allocation under the stimulus.

Outlook

While 2020 was a challenging period for the Philippine economy, the government is striving to turn the pandemic into opportunity. The signing of Bayanihan 1 and 2, the reopening of vital industries and the imminent passage of the CREATE bill should support recovery. While 2020 GDP is forecast to contract significantly, the Asian Development Bank expects a rebound in 2021, with GDP growth projected at 6.5%.