Positive sentiment: Strong fiscal situation despite slowing demand for exports

Although economic headwinds have thrown international markets off course, the Philippine economy has managed to stay on a relatively even keel. Local authorities note that while real GDP growth slowed in 2011 relative to 2010 due to weak external demand and government underspending, household consumption has continued to see strong growth due to a burgeoning middle class and robust overseas remittance flows. In addition, consumer and business sentiment remains upbeat thanks to manageable inflation rates, improving employment conditions and strong credit activity.

Nonetheless, the Philippines has not avoided the fallout of the eurozone debt crisis nor the fiscal deficit problems in the US, as shown by sluggish demand in 2011 for its exports, notably electronics. The tsunami and nuclear disaster in Japan, the country’s largest trading partner, also negatively affected export levels.

KICK-START: Activity in the country’s construction sector, meanwhile, slowed in 2011 due to cutbacks in government spending on infrastructure as implementing agencies carefully reviewed projects and processes. This is expected to be only a temporary blip, however, as spending should pick up considerably in 2012 as the administration plans to kick-start its public-private partnership (PPP) programme. President Benigno Aquino III, who was elected in 2010 on a platform to stamp out corruption, had reined in public spending in first half of 2011 in order to create a transparent bidding process, root out corruption and eliminate sources of bad governance before projects begin.

The administration is keen to get PPPs started quickly to attract more investments. According to the UN Conference on Trade and Development, from 1970 to 2009 the Philippines attracted only $32.3bn worth of foreign direct investment (FDI), compared to a total of $285.8bn for Singapore and $104.1bn for Thailand. Net FDI did see an uptick in the first half of 2011, amounting to $779m, an increase of some 16.4% on the same period in 2010, according to the Bangko Sentral ng Pilipinas (BSP). The growth was attributed in part to an increase in inter-company borrowing/lending between parent companies and their Philippine subsidiaries and affiliates. By year end, FDI levels reached P256.1bn ($5.81bn), the highest level posted since 1996, driven by a 42.2% year-on-year increase in the fourth quarter compared to the same period in 2010.

MODERATE GROWTH: The Philippine economy grew by 3.7% in 2011, within the 3.6-4% growth forecast from the National Economic and Development Authority (NEDA). However, this is below the Development Budget Coordination Committee (DBCC) growth assumption of 4.5-5.5%, which is used for budgeting purposes, and the Philippine Development Plan growth target of 7%. This is also well below the country’s economic performance in 2010 when, according to the IMF, GDP grew by 7.6% – the highest rate in more than 30 years – generated by a combination of tourism, electronics and agri-businesses.

Yet prudent handling of the economy means the Philippines is in good shape and the country’s fiscal situation remains strong. Officials believe future growth will be buttressed by increased infrastructure spending in 2012. “Moving forward we expect public spending will accelerate,” Diwa Guinigundo, the BSP’s deputy governor, told OBG. He said the president “has made it clear that he wants the right project at the right cost with the right people and delivered at the right time. The quality of the projects must be ensured to get a better bang for the buck.” A faltering global recovery prompted President Aquino to unveil a P72.1bn ($1.6bn) spending package in the fourth quarter of 2011, targeting infrastructure projects and poverty-alleviation programmes. Under the scheme the government has allocated P6.5bn ($147.6m) to local government units, to meet infrastructure and social welfare needs, as well as P5.5bn ($124.9m) for infrastructure projects under the Department of Public Works and Highways and P11.1bn ($227m) to resettle those in danger zones. “The criteria we used to choose these projects were simple,” the president told a press conference. “The funds will be spent on projects that will have high macroeconomic impact and will help the poor.” This expenditure has been met from government savings and funds from programmes with no new borrowing.

RENEWED CONFIDENCE: Greater confidence in the economy going into 2012 has boosted the employment outlook, according to a survey of the country’s publicly listed companies taken by the BSP, which showed the employment outlook index reaching 24% in the second quarter of 2012, matching the same level registered during the third quarter of 2010. The BSP noted the outlook was buoyed by a higher number of firms with expansion plans in the coming quarters. Brighter employment prospects were expected to spread across sectors, as companies get ready for an anticipated pickup in demand starting in the second quarter, the BSP said. About three in every 10 respondent firms in the industry sector (28.8%) indicated expansion plans in the second half of 2012, according to the survey. The mining and quarrying sub-sector posted the largest number of total responses of 47%, up from the 41.1% recorded in the first quarter. Nevertheless, the companies surveyed also highlighted a raft of hurdles they need to overcome such as competition, weak demand and financial problems. The BSP did note that these business risks are moderating. Access to credit is also an oft-cited challenge. However, Rosabel Guerrero, director of the Department of Economic Statistics, pointed out that respondents continued to report easier access to credit compared to the beginning of the year.

BY THE NUMBERS: The service sector accounted for 56% of GDP in 2011, according to NEDA. The service sector has performed better than other parts of the economy and is driven by real estate, renting and business activities, other services, financial services and trade. The sector grew by 5% in 2011 against 7.2% in 2010 and contributed 2.8 percentage points to GDP for the year. The service sector has also become the main source of employment, generating 715,000 new jobs according to the National Statistics Office (NSO). The sector also accounts for just over half of the country’s workforce. Business process outsourcing (BPO) has undoubtedly played a large role in this as it is the fastest-growing industry in the Philippines.

The Business Processing Association of the Philippines (BPAP) says the sector employs some 708,000 full-time staff, with 350,000 working in the country’s call centre industry. This makes the Philippines the call centre capital of the world, overtaking India, which employs 330,000 call centre workers. Revenue generated by the IT-BPO industry was expected to grow by 22% to about $10.9bn in 2011. The industry is forecast to post roughly 20% revenue growth for 2012.

The agriculture, hunting, forestry and fishing sector likewise buoyed full-year economic activity, supported by a robust recovery in sugarcane, palay and corn production due to favourable weather conditions that boosted yield levels. Agriculture grew by 2.6% in 2011, a notable improvement on the 0.2% contraction the previous year. The sector contributed 0.3 percentage points to GDP growth for the year, according to NEDA.

Agriculture employs about one-third of the country’s workforce. Yet there is a large incidence of poverty among farmers. To help address this, the government in 2010 moved to boost rural credit and announced new investments in rural infrastructure. Drought plagued farmers in 2010, and real output fell by 0.2%.

Meanwhile, the industrial sector grew by 1.9% in 2011, a slowdown from the 11.6% growth posted in the previous year, due to the contraction in construction and utilities. The industry sector accounted for 32% of total GDP, according to NEDA. It noted that construction posted the largest contraction owing to the fall in public construction projects and the slowdown of private construction activities. Manufacturing activity dropped to 4.7% in 2011 from 11.2% in 2010. Growth came mainly from food manufactures, furniture, fixtures, chemical products and beverages.

Local analysts note that as China is moving up the value chain it cannot turn out basic manufactured goods as cheaply as it used to, as costs are increasing. This gives the Philippines a chance to fill this void, Karl Kendrick Chua, a country economist at the Poverty Reduction and Economic Management Network of the World Bank, told OBG. He added, however, that questions of getting the national logistics infrastructure up to par and lowering the cost of power domestically (both of which have reduced manufacturers’ profit margins) will need to be answered first.

CONSUMPTION: Consumer expenditure plays a much greater role in the Philippines than in other Asian countries and has been underpinned by improvements in the labour market as well as the large flow of remittances sent from workers overseas. Indeed, the growth of household consumption expenditure continued to accelerate by 6.1% in 2011 compared to 3.4% in 2010.

Moreover, bank lending has been on the increase due to growing domestic demand. Despite slower economic growth in 2011, bank lending grew at a broadly steady pace in January 2012, relative to the previous month’s growth. From 19.3% in December 2011, the outstanding loans of commercial banks, net of reverse repurchase (RRP) placements with the BSP, increased by 19.1% in January 2012. Likewise, the growth in bank lending inclusive of RRPs was stable at 16.6% from 16.4% the previous month.

Commercial banks’ loans have been growing at double-digit rates since January 2011. The growth in consumer loans accelerated to 19.9% in January 2012 from 17.3% in December 2011, reflecting the expansion of lending across all types of household loans. But international lenders say there is little fear of a credit bubble since credit growth started from a low base.

“The sustained expansion in bank lending supports the view that underlying domestic demand remains strong, coupled with positive expectations on the economy by both businesses and consumers,” Amando Tetangco Jr, the BSP governor, said in a formal statement. Loan growth has been a step in the right direction and as most banks are working on loan-to-deposit ratios of below 60%, there is sufficient capacity and liquidity. Since 1997, loan growth has been mostly depressed. Only in 2008 was there a loan surge, but this was mostly among top corporations which were chasing liquidity in the wake of the Lehman Brothers collapse, and the sudden surge petered out quickly.

REMITTANCES: The Philippines has enjoyed hefty surpluses in its balance of payments as well current account thanks to a steady stream of remittances sent home by overseas Filipino workers (OFW). About 9.4m Filipinos – or about 10% of the total population – are currently working abroad, and OFW remittances account for around 10% of GDP, according to the Philippine Overseas Employment Administration (POEA). Even at the height of the global slowdown, Filipino workers were in demand. According to the POEA, the rising Filipino employment in alternative labour markets has compensated for the adverse impact of the weak US and eurozone economies on remittances. This is reflected in the estimated $20.1bn in remittances during 2011. According to the BSP, further demand for Filipino labour may see remittances grow by 5% in 2012 to reach $21.1bn. Growth in remittances has been attributed to the high skill levels and diverse geographical distribution of OFWs. In addition, more workers are entering non-cyclical industries such as education and health care. Filipino workers are widely dispersed, in locations such as the US, Canada, Saudi Arabia, the UK, Japan, the UAE, Singapore, Italy, Germany and Norway.

Consumer purchasing power has been greatly bolstered by remittances, and low- to middle-income households with family members working abroad are now able to afford goods and services previously considered luxuries. On the recent Consumer Expectations Survey conducted by the BSP for the fourth quarter of 2011, more respondents considered the present a favourable time to buy big-ticket items as the buying conditions index reached its highest level in four years. Consumers’ outlook on buying conditions was most upbeat for real estate. While a significant portion of OFW remittances are being poured into real estate investments, Bernardo Villegas, a senior vice-president and director at the University of Asia and the Pacific, told OBG a real estate bubble is currently not a danger “as most of the people who are buying are moving in and are not using the property for speculation”. The country’s balance-of-payments surplus, underpinned by remittances, reached $10.2bn in 2011, while the current account surplus reached $7.1bn. But despite the current-transfers surplus, the trade balance has remained in deficit as the economic slowdown in the US and the eurozone continues to sap international demand for products from within the country.

TRADE WOES: Weak demand for high-tech products in the developed economies of Europe and the US as well as the disasters in Japan have undermined demand for electronics, the country’s leading export. This has put a substantial dent in foreign-bound shipments. Indeed, total receipts from merchandise exports for 2011 fell by 6.9% to $48bn, down from the total of $51.5bn reported in the previous year, due to weak demand from advanced economies led by the US, according to figures from the NSO.

Electronics exports accounted for 45.6% of the total exports revenue in December 2011, according to the NSO. The result brought 12-month sales to a total of $23.7bn, down 27.3% from a year earlier. The slight monthly declines may be a sign that Philippine exports are on the brink of recovery as the US economy, one of the biggest markets for Philippine goods, is beginning to show flickers of life. According to the BSP the decision of the US Federal Reserve to keep interest rates at historic lows through late 2014 should mean more robust consumption and investment demand. Consequently, US demand for imported goods may also rise, the BSP said. Japan is still the country’s top market, accounting for 17.7% of exports, followed by China with 14.1% and the US at 13.4%.

Commenting on the slowdown in exports, Edwin Lacierda, a spokesperson for the president, said, “It is a reflection of the slowdown in the global economy experienced, for instance, in Europe, Greece and Japan. Our exports of semiconductors are strong with respect to Japan [but they weakened] because of the incident in Japan… the earthquake... the nuclear meltdown [and] the nuclear facility [that was endangered by the quake].

So [the plummeting of the exports] is primarily an effect of the downturn in the global economy.” Benjamin Diokno, an economist at the University of the Philippines, said that a “quick recovery” in export growth is not likely since troubles continue to roil European markets and the US economy is not expected to see truly robust growth anytime soon.

NEW OPTIONS: Meanwhile, local manufacturing has been at a disadvantage as power costs are high and many smaller companies lack economies of scale. Some observers here note a resurgence of the mining industry could turn exports around.

In early 1980s the Philippines was one of the biggest mining countries in the world, but as commodity prices collapsed in the 1990s so too did the industry. However, as commodity prices have rebounded there is a chance to reopen the mines. However, the future of the industry is still up in the air. In early 2012, the government was considering drastically increasing taxes imposed on mining firms, even exploring a 50:50 revenue sharing agreement, while also introducing tougher environmental restrictions on their operations.

While total exports fell by 5.6% to $44.6bn in January to November 2011, imports grew by an annual 11.1% to $55.5bn in the same period. Thus, the Philippines posted a trade deficit of $10.9bn for the first 11 months of 2011, compared to a $2.7bn deficit during the same period in 2010. Electronics were the largest category of imported items in January-November 2011 and accounted for 29.8% of the total, followed by mineral fuels, lubricants and related materials.

MONETARY EASING: The BSP has focused on growth, cutting interest rates during two consecutive board meetings in the first quarter of 2012, as inflation worries eased. The BSP cut its main policy rate for the first time in two-and-a-half years in January 2012, reducing it by 25 basis points. This brought the overnight borrowing rate to 4.25% from 4.5% and the overnight lending rate to 6.25% from 6.5%. As the inflation outlook remained low, the BSP further reduced the cost of money during its next monetary board meeting in March 2012, when it cut an additional 25-basis points, bringing the key policy rate down to 4%. Philippine monetary officials said the lower interest rates would encourage individuals and enterprises to begin to borrow more from banks for new projects.

Despite rising oil prices, inflationary pressures are not expected to be a concern in the short term. The BSP’s governor has said the Philippines will likely meet its inflation targets in 2012 and 2013. Price gains have averaged around 4.5% in 2011 and forecasts point to 3.1% in 2012 and 3% in 2013, according to the central bank.

FISCAL STATE: The government posted a record high budget deficit of 3.7% of GDP in 2009 as it implemented the P330bn ($7.49bn) Economic Resiliency Plan, including increased spending on infrastructure and social services to prime the economy and to minimise the global economic slowdown’s impact in the market.

The Aquino administration vowed to pursue fiscal consolidation and has stepped up efforts to narrow the deficit gap for 2011, notably by improving revenue collection – which in the past has been inefficient due to instances of tax dodging. To this end, the Bureau of Internal Revenue (BIR) has been busy pursuing tax evasion cases, and the efforts have met with some success. According to the government’s figures, revenue collection in the first 11 months of 2011 rose by 13.1% against the same period in 2010.

Moreover, the government’s key administrative measures, such as the BIR’s Run after Tax Evaders with 87 tax evasion cases amounting P36.1bn ($819.5m) as of January 31, 2012, and the Bureau of Customs’ Run After the Smugglers programme with 66 smuggling cases amounting to a total of P59.7bn ($1.36bn) as of February 15, 2012, are expected to help further encourage other taxpayers to pay their correct obligations. Further, in early 2012, the BIR sought the arrest of a businesswoman found guilty of tax evasion; this would make her the first person in the country’s history to be jailed for evading taxes.

The government’s efforts to improve the fiscal deficit did not go unnoticed by international ratings agencies. Indeed, Fitch raised the country’s debt rating to BB+ with a stable outlook in June 2011, bringing it to one step below investment grade. Earlier that month, Moody’s upgraded the Philippines to Ba2 with a stable outlook, the highest level since the start of 2005. Standard & Poor’s increased the nation’s rating to the second-highest non-investment grade in November 2010 and changed the outlook to positive from stable in December 2011. Philippine officials had told the ratings companies that improving revenue collections and “prudent spending” mean that the country does not need new or higher taxes. The rates in the Philippines are already relatively steep with value-added tax at 12% and a corporate income tax of 30%.

The Department of Finance has programmed a P286bn ($4bn) budget deficit ceiling for 2012, equivalent to 2.6% of GDP. Gil Beltran, undersecretary at the Department of Finance, told reporters the goal would be feasible if the country achieves economic growth of 5.5% and keeps inflation at 3%.

OUTLOOK: Going forward, private consumption is expected to grow steadily, buoyed by lower unemployment (which fell to 7% in 2011 from 7.3% in 2010), higher government spending and a continued steady flow of remittances. The government is set to boost spending in 2012 to catch up on the delayed implementation of infrastructure projects.

Thus, domestic investment is set to expand further to some 23.1% in 2012, up from 22.2% of GDP and 20.8% in 2011 and 2010, respectively, according to NEDA. As the economic outlook continues to seem bleak for members of the eurozone, low demand for the country’s exports could continue to weigh on economic growth, but improved business sentiment suggests this is not a significant cause for concern.

Indeed, according to the Business Expectations Survey, a quarterly survey conducted by the BSP of firms drawn at random from the Securities and Exchange Commission’s top 7000 corporations, business sentiment continued to improve in the fourth quarter of 2011, with the confidence index rising to 38.7% from 34.1% in the third quarter of 2011. Respondents had cited the implementation of government projects, including the PPP programme, sound macroeconomic fundamentals, business expansion arising from investment inflows and the steady stream of overseas remittances all as reasons for their continuing optimism.