The Philippines' recent high economic growth rates may be sustainable

The Philippine economy continues to enjoy a period of rapid, broad-based growth as the business process outsourcing (BPO) sector and growing remittances from overseas workers drive growth in consumer-oriented industries and construction. Although real growth decelerated in 2014 to 6.1%, it remained higher than Southeast Asian peers, and it is expected to remain near 6% for the remainder of the decade.

The economy is overly concentrated in the Metro Manila region, and major challenges lie ahead in overcoming long-standing infrastructure bottlenecks, and developing stronger energy and manufacturing sectors. Yet the government is increasing its efforts to spread manufacturing and BPO growth across the country, and clear obstacles to developing other sectors where outlying regions have strong potential.

LAGGARD TO LEADER: The Philippines’ emergence as a growth leader has been building gradually since the 1990s, after a long period of low growth and political upheaval during which Philippine economists began to refer to their own country as “the sick man of Asia,” borrowing a label originally applied to 19th-century China. Until the early 1990s the Philippines was dogged by persistent high inflation, which averaged 14% in the 1980s, according to the IMF. Real growth averaged just 2% in the 1980s, while peers Malaysia, Indonesia and Thailand all grew at average paces of more than 5.5%.

A breakthrough came in the 1990s as the central bank, Banko Sentral ng Pilipinas, gained greater independence and inflation slowed to single digits. Some of the large foreign investments flowing into South-east Asia started to reach the Philippines, and the country began to develop into a significant player in manufacturing of parts for the globalising electronics industry. As domestic money flowed into the banking system, growth gained momentum and averaged 2.75% for the decade. The Asian financial crisis of 1997-98 was a setback but less of one than for other South-east Asian countries.

During the 2000s the Philippines found itself in the middle of the pack of South-east Asian middle-income countries in terms of its pace of growth, which averaged 4.5% over the decade, but failing to close the gap that had opened during the long period of slow growth. During this decade the Philippines’ growth model of domestic consumption driven by labour exports began to emerge as overseas workers moved into higher-paid professions and Philippine call centres overtook their Indian competitors in the US market.

In the 2010s improved governance under the administration of President Benigno Aquino III has helped to further accelerate foreign direct investment (FDI) in BPO while reviving FDI into the manufacturing sector. That and a demographic bulge in the young adult bracket helped bring the average pace of growth in the first half of the 2010s to 6.3%, beating all of the country’s main South-east Asian peers. That compares to 6% average growth in Indonesia in 2010-14, 5.8% in Malaysia and Vietnam, and 3.6% in Thailand. Across Asia, only three countries with higher GDP per capita than the Philippines – China, Mongolia and Sri Lanka – grew faster.

CONSUMER-DRIVEN: Consumer-oriented sectors are the largest and fastest-growing, reflecting the economy’s dependence on labour exports through BPO and overseas workers. Household consumption came to 72.5% of GDP in 2014, according to the Philippine Statistics Authority (PSA), an extraordinarily high number for an emerging market economy. The trade sector produced P2.2trn ($49.5bn) – or 17.8% of GDP at current prices – in 2014, with real growth of 6%, after 5.7% growth in 2013.

In other mainly consumption-oriented service sectors, transport and storage accounted for P445bn ($10bn) of gross value added or 3.5% of GDP in 2014, with real growth of 10.9%, after 6.6% growth in 2013. Growth has slowed, however, in the communications sector, which had P343bn ($7.72bn) of gross value added – or 2.7% of GDP – in 2014 and real growth of 4.1%, following 5% growth in 2013.

Food processing is another major growth sector as rising incomes and urbanisation fuel purchases of packaged food. Processed food, beverages and tobacco accounted for P1.3trn ($29.3bn) of gross value added, or 10.2% of GDP, in 2014. The sector’s real growth was 8.5% in 2014, up from 3.6% in 2013. Many of the country’s largest business groups began as food or drinks makers, including its largest company, San Miguel Corporation, primarily a beer and packaged foods maker. The sector is also a successful exporter, with $3.6bn of exports in 2013, according to UN Comtrade data.

SERVICES: Services sectors overall accounted for 57.5% of the economy at current prices in 2014, up from 55.1% in 2010, according to PSA data. Besides consumer-oriented services and the financial sector, which is heavily invested in them, the export-oriented, foreign investment-driven BPO sector accounts for a large share of services growth. After many years of explosive growth, the BPO sector’s expansion moderated slightly in 2014, while remaining rapid. Service export categories in the BSP’s balance of payments (BOP) data closely corresponding to BPO – “business services exports” and “computer services exports” – showed $12.1bn of export revenues in the first nine months of 2014, up 10% year-on-year in dollar terms. The $15.2bn of exports in those categories in 2013 represented the vast majority of the $15.5bn of total BPO revenues counted by the Information Technology and Business Process Association of the Philippines (IT-BPAP), the main industry association. BPO sector revenues grew by 17.4% in dollar terms in 2013, according to IT-BPAP.

The financial sector produced P984bn ($22.1bn) of gross value added, or 7.8% of GDP, in 2014, with real growth at 6.7%, down from 12.6% in 2013. The burst of growth in 2013 was driven by a change in monetary policy as the BSP freed up sterilised funds, which poured into bank deposits and gave banks surplus liquidity.

The BSP’s conservative regulation of the sector, including an in-process early adoption of Basel III minimum capital standards, is driving consolidation among smaller banks. In addition, it pushed much of 2014’s surplus liquidity into the emerging corporate bond sector. Annual inflation surged to 4.9% in July and August of 2014, after registering a low of an average of 3% in 2013. After two 25 basis-point hikes of BSP benchmark rates and the collapse of oil prices late in 2014, annual inflation fell to a new annual low of 2.4% in January 2015, according to the PSA.

Cristina S Ulang, the head of research at First Metro Investment Corporation, told OBG; “There is a lot of liquidity in the banking system and that has been holding real interest rates at very low levels. To make sure that doesn’t result in misallocation, the central bank has been tightening rates and clamping down on banks with stricter capital requirements and real estate exposure stress tests.”

Education accounted for 3.9% of GDP in 2014, with real growth of 2% after 10.3% growth in 2013, driven by private investment in higher education. Bernardo Villegas, an economist who chairs the Centre for Research and Communication at the University of Asia and the Pacific, told OBG; “Our most important challenge is to continue improving our education system to advance the skills of our young, growing, English-speaking population. This country thrives on its human capital.” Tourism is also important, accounting for 6% of gross value added in 2013 and growing by 9.1% that year. The health care sector, however, is unusually small even for an emerging market country, accounting for P195.7bn ($4.40bn) of gross value added (1.5% of GDP) in 2014, although real growth was strong for 2014, at 16.5%, after 8.7% growth in 2013.

INDUSTRY: Industrial sectors accounted for 31.2% of nominal GDP in 2014, which is among the lowest shares in Asia. Yet these have been bouncing back since 2010. As a whole they recorded 7.5% real growth in 2014 and 9.3% in 2013, ahead of the services sectors, which recorded 6% real growth in 2014 and 7.2% in 2013.

Electronics and electrical goods is the largest export industry, with $37.6bn of exports in 2013, according to Comtrade, equal to 13.8% of GDP. The sector’s exports grew by 8.1% in 2014, according to figures from the PSA, which, however, significantly undercounts export volumes at $25.9bn in 2014 and $23.9bn in 2013.

Although industry observers told OBG that 2014 was a better year, the sector has struggled with relatively high energy, labour and transport costs compared to regional peers, and exports had been falling steadily from a peak of $47bn in 2007, according to Comtrade. The rebound in 2014 was led by diversification away from the sector’s traditional dependence on semiconductors into storage, printers and other higher-value-added parts and devices.

Chemicals and chemical products are among the other main products, accounting for P471bn ($10.6bn) of gross value added or 3.7% of GDP. Petroleum and other fuel products, another important segment, recorded 5.4% real growth in 2014 after a 51% growth burst in 2013 as new plants came on-line. Gross value added by the total manufacturing sector, including food processing, came to P2.59trn ($58.3bn) or 20.5% of GDP in 2014. The sector recorded 8.1% real growth in 2014, down from 10.3% in 2013.

Construction has been a key growth driver, with gross value added of P814bn ($18.3bn), or 6.4% of GDP, in 2014, and real growth at 8.5%, down from 9.6% the previous year. Gross sector output came to P1.42trn ($32bn) – 11.2% of GDP – in 2013, and recorded 10% real growth in 2014, down from 10.4% in 2013. The construction sector is especially driven by the BPO sector’s demand for office space and its workers’ need for apartments and desire for retail outlets.

Mining has been a disappointment relative to its potential, and the general trend of rising prices enjoyed by the sector since 2009 reversed in late 2014 as Chinese demand slowed. The sector produced P124bn ($2.8bn) of gross value added, or 1% of GDP, in 2014, with 3.5% real growth, after 1.2% growth in 2013.

ENERGY: The electric power segment has also seen weak growth, with gross value added of P339.3 ($7.6bn), or 2.7% of GDP, in 2014. Sector growth was just 2.6% in 2014 after 5.2% in 2013, and the industry was expecting shortages in the 2015 dry season. Investment is expected to catch up with demand by 2017 after a number of coal power projects cleared bureaucratic hurdles. Shanaka Jayanath Peiris, resident representative of the IMF, told OBG; “There are two stories behind the slow investment in energy. One is that regulatory clearances are slow. The other is the cosy relationship between a few players. It’s a kind of monopsony.”

AGRICULTURE: The weight of agriculture in the economy is shrinking but still large. Agriculture, hunting, forestry and fishing accounted for P1.43trn ($32.2bn) of gross value added, or 11.3% of GDP, in 2014, but recorded only 1.1% real growth, down from 1.9% in 2013. Raw agricultural products are a major export, with $3.4bn worth in 2013, according to figures from Comtrade. Plantation forestry and wood products are also significant, and the latter is growing very quickly. Furniture and other manufactured wood and paper products accounted for P98bn ($2.21bn) of gross value added, or 2.7% of GDP, and recorded 24.5% real growth in 2014 and 24% in 2013.

The Aquino administration has been widely commended for its efforts to improve business conditions and reduce corruption, while a relatively conservative fiscal policy has helped boost the economy’s credibility and steer investment into the private sector.

The national government deficit has dropped from 2.0% in 2011 to 0.6% in 2014, which has helped reduce national government debt from 51.0% in 2011 to 45.4% in 2014. However, when computed at the general government level, general government debt to GDP declined from 41.4% in 2011 to 37.3% as of end-September 2014. The IMF in October 2014 forecast general government debt to drop to 27% by 2019. Even compared to other Asian emerging markets, the public sector is small, but has been growing as revenue collection has improved. Total national government expenditures came to 16.3% of GDP in 2013, and were projected by the government to reach 19.9% in 2017.

RATINGS WAR: The improved governance and sounder debt profile led ratings agencies to upgrade the Philippines’ sovereign rating to investment grade in 2013, a landmark event in the country’s economic history. In 2014 two major agencies raised its rating again: Standard & Poor’s upgraded it to BBB and Moody’s to Baa2, both one notch above the agencies’ minimum investment grade ratings. Ulang told OBG, “The Aquino administration’s biggest achievement is the huge increase in investor confidence, reflected in credit ratings upgrades.”

Ratings in international surveys of business conditions have also been rising rapidly. The Philippines made the biggest upward move of any country in the world in the World Economic Forum’s Global Competitiveness rankings between 2010 and 2014, according to the group’s 2014 report. It climbed to 52nd of 144 countries in 2014, from 85th of 139 in 2010. The upgrade was mainly for improved institutions and reduced perceptions of corruption. Yet the Philippines still ranks behind Malaysia, Thailand and Indonesia, which placed 20th, 31st and 34th in the 2014 report, respectively.

The Philippines was also the most improved country in the Heritage Foundation’s Economic Freedom rankings between 2010 and 2015, rising from 115th to 76th. In Transparency International’s annual Corruption Perceptions Index, it climbed from 134th in 2010 to 85th in 2014. The Philippines has also improved its rankings in the World Bank’s “Doing Business” survey, which judges conditions for new small firms. It climbed to 95th of 189 countries in the 2015 survey, from 144th of 183 in 2010. It has also improved its ratings in the World Bank’s Worldwide Governance Indicators, especially in controlling corruption and rule of law. The National Competitiveness Council, set up in 2006, is tasked with advising on how to improve the country’s score in “Doing Business” and other global surveys.

CURRENT ACCOUNT: Another reason for the country’s improving credit ratings is its relatively healthy balance of payments, supported by large inflows of remittances from overseas workers and émigrés. Remittances came to $23bn in 2013, equal to 8.4% of GDP, according to the BSP’s BOP data. Remittances came to $17.6bn in the first nine months of 2014, up 6.1% over the same period of 2013, while in 2013 remittances were up 6.8% from 2012. Remittances have allowed the Philippines to avoid relying on inward investment to fund imports. This ability to fund imports from current income is remarkable for a rapidly growing, highly consumerist country that must import most of its fuel. It has been crucial in helping the Philippines to avoid an outright retreat of foreign financial capital since global investors began positioning for a strengthening dollar in 2013 and reducing their exposure to emerging markets.

The trade deficit is difficult to measure, as the PSA’s trade data based on Customs reports undercounts both imports and exports. Guided mainly by other BOP flows, the BSP estimated the overall trade deficit in 2013 at $10.65bn, or 3.9% of GDP, including a $17.7bn merchandise trade deficit and a $7bn services trade surplus. The BSP estimated an overall trade deficit of $11.0bn (3.9% of GDP) for 2014. Over the same period, larger remittance inflows brought the current account surplus to $12.7bn (4.4% of GDP), up from $11.4bn (4.2% of GDP) in 2013. Yet other data, including a gradual decline of the BSP’s foreign exchange reserves since 2013, suggest the trade deficit is larger than estimated. UN Comtrade put the merchandise trade deficit at $27.3bn (10% of GDP) in 2013. BOP data includes $5.5bn of “net unclassified items” and a $2.86bn drop in net reserves in 2014.

If those discrepancies in the BOP data were attributed to underestimation of imports, it would suggest a 2013 merchandise trade deficit of $26.6bn, roughly in line with Comtrade data. That would in turn suggest the overall trade deficit was closer to 7.5% of GDP and the current account balance was less than 0.5% of GDP. Likewise, BOP data for the first nine months of 2014 continued to show very large “net unclassified items” of $4.7bn. If those represent undercounted imports, the overall trade deficit in the first nine months of 2014 would have been more than 7% of GDP and the current account surplus around 1% of GDP.

STABLE PESO: The trade deficit has been exacerbated by the BSP’s policy of holding the peso roughly steady against the dollar during the retreat of global financial capital markets since 2013, which resulted in steep devaluations of many emerging market currencies and would have devalued the peso by more had the BSP not supported it. The BSP’s foreign reserves fell from a peak of $85.3bn in January 2013 to $81.3bn in February 2015. During 2013 the BSP’s interventions held the peso to a gradual weakening from 40.57 to the dollar in January 2013 to 45.4 to the dollar in January 2014. And as of February 2015 the BSP was holding the peso in the range of 44 to 44.5 to the dollar.

The pressure on the peso reflected a near stop of investment inflows other than foreign direct investment (FDI) as global financial investors fled beginning in mid-2013 from the emerging market asset class. Investment inflows other than FDI averaged $8bn a year from 2010-12, but dropped to $758m in 2013 and a $1.8bn outflow in 2014, according to BOP data. Those include foreign holdings of Philippine equities and bonds, and foreign bank credit to Philippine banks and companies.

FDI: Strategic foreign investors, however, are increasing their commitment to the Philippines, lifting FDI from $3.2bn in 2012 to $3.7bn in 2013, and to $4.9bn in the first nine months of 2014. The Philippines had long been the least successful major South-east Asian economy in attracting FDI, due in large part to legal restrictions, including a 40% cap on foreign investment in companies that own land. The acceleration of FDI in 2014 brought the Philippines up to a pace that is now comparable – relative to population – with Indonesia, but still behind Malaysia, Thailand and Vietnam.

The peso’s relative stability against the US dollar contrasts with most Asian currencies, and largely reflects the Philippines’ large trade exposure to the US and China, which also has not devalued. China is the main market for the Philippines’ merchandise exports, taking together with Hong Kong a 32.7% share of the total in 2013, Comtrade data shows. The US took some 12.9% of merchandise exports in 2013, according to Comtrade, and the US takes approximately 80% of BPO exports, according to industry estimates.

INFRASTRUCTURE GAP: The main disappointment in recent years has been the slow pace of investment, especially in infrastructure, which has long been one of the economy’s weakest points and a major problem for global supply chain manufacturers. Public sector construction accounted for P279bn ($6.28bn), or 20% of the P1.4trn ($31.5bn) of gross value added by the construction sector, in 2014, according to PSA data.

Low public investment is one of the main reasons why overall investment is persistently low, although it is gradually rising. The share of fixed capital formation in GDP reached 20.5% in 2014, up from 19.6% in 2012. That compared to shares in the 26-29% range in Malaysia, Thailand and Vietnam, and 34% in Indonesia, according to World Bank data for 2013.

Some analysts argue that the Philippines’ low savings and investment rates reflect the economy’s focus on labour exports and the fact that investments in human capital are treated by conventional statistical methodology as consumption.

Jose Cruz, the president and CEO of investment house Amalgamated Investment Bancorporation, told OBG, “There’s a stereotype that overseas workers’ remittances are all being spent on consumption but a lot of them are paying for private education for their children, nephews and nieces.”

Villegas told OBG; “Using GDP as the denominator to calculate the savings rate is very misleading, because roughly 10m people are working abroad. If their income is taken into account and gross national product is used as the denominator, the figure is around 32%.”

The Aquino administration drafted very ambitious plans to accelerate infrastructure investment through public-private partnerships (PPPs) using the build-operate-transfer (BOT) model, but it has been slow in bringing them to fruition.

As of March 2015 only nine PPP projects – with estimated costs totalling P136bn ($3.06bn) – had been awarded, led by a P44.65bn ($1bn) extension of Manila’s light rail system to southern suburbs. Peiris told OBG, “The biggest disappointment is that the expectations for PPPs were overblown. They were trying to do it in the right way, and it is not easy to ramp these things up quickly.”

The administration is now rushing to bid and/or award 16 more projects with total estimated costs of P604.9bn ($13.61bn), which were being bid out or were in final stages of preparation as of March 2015, according to the government’s PPP Centre. The largest project out to bid was a P123bn ($2.77bn) highway through a major suburban zone south of Manila. The highway will run along the west shore of the Laguna de Bay, a large lake, and will serve as a dyke to control flooding.

Several major conglomerates were reported to be bidding. However, the majority of another 33 PPP projects at less-advanced stages were likely to be left for the next president to complete, as Aquino’s term will come to an end in 2016 and second terms are not permitted under the constitution.

OUTLOOK: The Philippine economy is in a strong position with many factors in its favour, from positive demographics and growing bank penetration to improving revenue collection and public governance. Risks exist – for example, remittances could stop growing, or recent growth in real estate prices could lead to over-investment. However, the authorities are generally looking after them and taking a cautious stance. There are no obviously unsustainable factors behind the country’s recent high growth, and the diverse range of organisations reporting an improvement in its prospects are unlikely to all be wrong. After too long spent as the slowest-growing major economy in South-east Asia, the Philippines can finally look forward to catching up.