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Economic Update: Strong Domestic Economy vs External Volatility

Ms. Luz Lorenzo Economist and Head of Research, Maybank ATR KimEng Securities
PNB 2015 Strategic Planning Kickoff
September 22, 2015___________________________________________________________________
The general theme for the Philippines economic situation is: Strong domestic economy amidst external
The Philippines faces a challenging environment. The current external volatility is brought about by the
following: (1) the growth slowdown in China; (2) imminent tweak in the US Federal Reserve policy rates;
(3) volatility coming out of Europe, partly due to the Greek debt crisis; and (4) domestically, the elections
in 2016.
However, the Philippine economy is in a strong position and factors that will be affected by what happens
externally are, to a certain extent, limited in movement. Among the recent developments are as follows:
1. Slide 1: The weak global economy slowed the countrys goods exports growth...

With weaker global demand, growth of Philippine exports has been slowing down. In the first
half of 2015, exports declined 3% compared to positive growth in 2014 attributed to the
slowdown in China, the country second-biggest market for goods exports (after US).

2. Side 2: but current account remains in surplus...

Weak goods exports, however, is counteracted by the current account - a more wholistic
picture of trade (consisting of both goods and services) that showed a surplus of USD3.3
billion in the first quarter of 2015. In comparison, some neighbors in the ASEAN who had
current account surpluses before now experience current account deficits - Indonesia being
the most prominent example.

The reason the Philippines is able to sustain its surpluses is that surpluses is driven by
services, as opposed to the case of Indonesia (and some Latin American countries which
exports are heavy on commodities) where surpluses have disappeared as a result of the
prevailing lower commodity prices.

3. Slide 3: ...keeping peso better supported than other regional currencies

Due to the surplus in the current account, the Philippine peso has remained fairly stable. As
of September 2015, the peso has depreciated the least - at about 5% - among the 5 ASEAN
currencies since the end of 2014 (even stronger than the Singapore dollar which is also
supported by large current account surplus). The Malaysian ringgit have depreciated the
most by almost 20%. Considering the external volatility, the peso has been one of the most
stable currencies in Asia.

The support for peso also comes from the fact that unlike other central banks around the
world that have lowered policy rates to support growth, the Bangko Sentral ng Pilipinas (BSP)
has not changed its rates. This, in itself, is a sign of strength because this shows that the
Philippine economy does not need the support of lower interest rate for economic growth.

4. Slide 4: Goods deficit with China so renminbi devaluation is positive for Philippines

In August 2015, monetary authorities in China devalued the renminbi which has sent major
reverberations throughout the world. Looking at the trade balance, the Philippines runs a
trade deficit with China. Therefore, devaluation in the renminbi is seen to benefit the
Philippines as this will make imports from China cheaper. Furthermore, while most currencies
including the peso - depreciated in the aftermath of Chinas devaluation, its impact on the
local currency is not as strong (as noted earlier).

5. Slide 5: International reserves remain higher than external debt

The effect of a depreciating peso on external debt, i.e. it becomes more expensive to service
such debt, is tempered by the fact that external debt peaked in 2012 at USD80 billion. Right
now, external debt is around P75 billion, so the negative effect of the weaker peso in terms of
servicing such debt is smaller than it was in 2012. Moreover, international reserves continue
to exceed total external debt, so the countrys capability to service such debt remains intact.
The international reserves come from, among other things, the current account surplus. It can
be noted that in 2013, international reserves slightly declined attributed to capital outflows
which came about when the US Federal Reserve announced that it will taper its quantitative
easing. This shows that while the country is not insulated from what is happening in the
global economy, the impact to a certain extent is minimal because of these factors.

There has been a decline in the Philippines external debt-to-GDP ratio over many years due
mainly to two factors: (1) debt has actually been going down in recent years, and; (2) the
growth in GDP has been outpacing the growth in external debt. Such is not the case for many
countries especially those in Europe and other smaller countries where debt-to-GDP ratio has
been going up as a result of the recent global financial crisis which they have yet to
completely recover from.

6. Slide 6; Abundant liquidity amid low inflation and interest rates

One of the negative effects of the imminent increase in US Fed policy rates is capital outflows
which the Philippines has not been spared from. For economies where liquidity is not very
abundant to start with, such outflows put pressure on the financial system, an effect of which
is interest rates will go up.

In the case of the Philippines, there is abundance in financial liquidity with a large part
coming from SDAs (special deposit accounts) which peaked at P2.0 trillion in 2013. The BSP
restricted access to SDAs, releasing liquidity into the financial system resulting in a 38%
growth in money supply in 2013-2014. Similarly, loans and deposits notched strong
expansion in the same period.

Even with the strong liquidity, the BSP does not see the need to increase policy rates with
inflation continuing to fall. In fact, the impending increase hike in the US Fed policy rates is a
welcomed action for the BSP with capital outflows in favor of the US to drain liquidity in the
local financial system. Rather than increasing policy rates to safeguard the financial system,
the BSP instead put in place macroprudential measures especially on real estate and other
sectors that are vulnerable to asset inflation, i.e. similar to that of the US subprime crisis in
2008. Such move also makes growth sustainable over a long period of time.

While it is widely expected that the US Fed will raise interest rates soon, it is viewed that the
BSP will keep its current policy stance unchanged until late-2016 under the following
conditions: (1) low inflation will continue; (2) liquidity will remain sufficient; (3) government will
not need to borrow so much to finance expenditures; and (4) current account will not need to
support the peso.

7. Slide 7: Domestic demand offsets weak external demand

Private consumption, which is 70% of Philippine GDP, is the bedrock of the economy
providing stable and strong growth. In the last two quarters (1Q and 2Q 2015), private
consumption has grown at a much faster pace due in large part to stronger buying power
resulting from lower oil prices. The Philippine economy - mainly driven by domestic demand has grown strongly even with the weak external demand.

The weak link in domestic demand has been government spending. Since 2013, government
spending had been on a downward trend up to 2014 (due to DAP and PDAF) but has slightly
picked up in the first half of 2015.

Talking points: (1) weakness in the global economy does not mean weakness in the
Philippine economy since we are not dependent on external demand, and; (2) economic
growth will be much faster if government spending picks up.

8. Slide 8: Improved pace of government spending

In the first quarter of 2015, national government expenditures went up by only 4.5% year-onyear while infrastructure/other capital outlays (IOC) declined 11.3%. In second quarter 2015,
however, expenditures rose 12.4% and IOC reversed to growth of 37.2%. In July 2015,
expenditures grew 25% - the highest monthly growth in the last 12 months while IOC
surged 92%. It is expected that government spending will be much faster in the second half of
2015, bringing GDP growth expectation to 6.0% in second half 2015, from the actual 5.5% in
the first half, and go to 6.0% in 2016.

Private consumption and private investments are fairly predictable with recent surveys
showing that consumers and business are optimistic and will continue to invest but what will
be crucial is government spending. If the government is able to maintain the same spending
pace in the second half of 2015 and into 2016, GDP growth will be faster next year.

9. Slide 9: Robust pipeline of PPP projects

Part of the governments CAPEX program is the PPP [public-private partnership] program
which has started slow but has eventually picked up speed. So far, projects worth close to
P300 billion have been approved but have yet to start implementation. However, projects
under procurement (those that are yet to be approved) are actually larger than what has
already been approved (cumulatively worth P807 billion). The results of the forthcoming
elections will be crucial in the approval and implementation of these pipeline projects.

Talking points: While the administration has changed over the years, policies that cover
implementation of PPP projects have been relatively consistent. The primary concern is on
implementation, specifically the speed of how these projects are processed. The
implementation of these PPP projects will likely determine the pace of economic growth given
these projects tremendous multiplier effect on the economy.

10. Slide 10: Strong GDP growth in regions outside Metro Manila

There are many regions in the Philippines that are experiencing strong growth (CARAGA 5year GDP CAGR at 9.34%, Central Visayas GDP CAGR at 9.01%, etc.). Growth has to be
dispersed (across regions) to be sustainable. In terms of their CAPEX plans, the countrys
blue-chip companies are considering expansion in the provinces as Metro Manila is
anticipated to run out of growth sources. In the case of Eastern Visayas the slowest
growing region - the flattish growth of -0.01% GDP CAGR came as a result of supertyphoon
Yolanda in 2013.

11. Slide 11: Rising income, falling unemployment positive for domestic demand

Rising income can only be positive for companies that operate in the Philippines. For a long
time, the countrys unemployment rate is at 7%. However, latest data shows that
unemployment rate has declined albeit still high to around 6.5% in first half 2015 while per
capita income has risen. This implies better purchasing power, better capability of consumers
to generate demand for the economy.

12. Slide 12: Demographic profile is favorable for long-term growth

Another optimistic view of the Philippines is through its demographic profile. The 2010 profile
shows that the working age (aged 15-60) are supporting many young dependents. However,
as the country transitions to a different demographic profile as what is happening right now,
the ratio of persons dependent to persons of working age (dependency ratio) go down.

This can only be favorable for the economy as there will be more disposable income for
consumption and investment. However, it will still take a long time for the Philippines to
achieve this. The chart shows that such transition may happen by 2040.
13. Slide 13: IT-BPO industry revenues growing faster than OFW remittances

These demographic dividends are not automatic, and that working age bracket must be
employed to generate income. The challenge, therefore, is to find ways to generate these
jobs. One success story in the Philippines is the BPO sector which has generated many jobs.

In terms of revenues, BPO industry revenue CAGR was at 31% from 2004-2014. In 2014,
growth was at 23% (at USD19 billion) and it is projected that revenues will increase to USD21
billion for 2015. In comparison, OFW remittances hit USD24 billion in 2014, and have been
growing by around 5% in July 2015. Given the trajectory of how both industries are growing, it
is expected that BPO revenues, at some point, will overtake OFW remittances.

The projected deceleration in the growth of OFW remittances (+5% in 2015, +4% in the
following year, etc.) is based on the outlook that the Philippine peso will appreciate. Under the
premise of a strong peso, there will be lesser incentives for Filipinos to go abroad (as the
advantage of earning in USD becomes eroded).

The BPO industry offers both employment opportunities and, at the same time, a major
source of foreign exchange. The outlook is that the peso will be well-supported as both BPOs
and OFWs will provide stable sources of foreign exchange (BSP projects around USD50
billion per year total for the two sectors).

In terms of employment, the BPO sector has employed around 1.1 million jobs in 2014 with
the sustainable rate of new jobs generated per year at 150,000.

Aside from successfully generating new jobs and foreign exchange, the BPO sector has been
successful in increasing income. The average per capita income of a BPO employee is
USD5,000, whereas the national average per capita income is USD2,600.

In conclusion, while there is so much volatilities and uncertainties in the global market,
the Philippines has some positive domestic factors that will help reduce the adverse impact of
such volatilities in the Philippine economy.