Internal Strength, External Risk

Cebu, PHILIPPINES, March 27, 2015 – Last Tuesday BSP Governor Tetangco stated his confidence that the Philippine economy would reach the raised growth target of 7-8% in 2015 (this despite most other agencies downgrading their targets following a 3Q slowdown last year – Li & Hungerford project growth of between 6.8%-7%) based on the fundamental internal strength of the economy and a resumption in government spending.

Cautious confidence characterized in the decision of the BSP to hold interest/borrowing rates on Thursday (RRP remains at 4%. The overnight rate remains at 6%) based on falling inflation (2.5% YtD) and a stable Peso, despite disappointing trade and remittance figures, which have been waved off as temporary, related to the oil price and the holiday period. However, here in lies the fears of the BSP, reflected by Tetangco’s statements on Tuesday, which he described as the interplay of the following:

  • Patchy global economic growth
  • Uncertainty of the oil price path and the ambiguity of the underlying drivers of the oil price decline
  • Divergence in monetary policy stance among major advanced economies

Central to the success of the Philippine economy is the alignment of external factors (that neither the Philippine government, nor the Central Bank can influence) in such a way as to allow it to flourish.

Despite global economic growth being patchy, the Philippines is not tied strongly to every economy in the world. Our major trading partners remain Japan, the US, China and Hong Kong (the four account for 49% of our exports), and, including our ASEAN trading partners and Singapore, account for almost 87% of the 0.5% fall in export growth since January 2014. As you can see, apart from the historical ties the Philippines have with the US, we are most strongly connected to the South-East Asian sphere, which is in the ascendancy. Despite the problematic roll-out of Abenomics in Japan and a slowing China transitioning to a consumption driven economy, the region has contributed the lions share to global growth since the GFC (60% of the world’s 4.0% growth last year according to the ADB 2015 outlook released on Thursday, and Japan has been in a decades long recession), and looks to continue to do so (the ADB predicts stable growth of 6.3% in Asia at least until 2016), with the growth of emerging economies (like the Philippines) picking up the slack and positive signs that India, led by the business friendly Modi, is coming out of its slumber.

There is of course short term volatility associated with diverging monetary policies in the advanced economies where much of the world’s capital originates. Analysts expect the US Fed to begin ratcheting up the interest rate sometimes towards the end of 2015 or even the first half of 2016, however, Yellen has been less hawkish than she initially positioned herself, keen to let the steady, if somewhat uneven (based on employment figures) recovery of the US economy continue. As a beneficiary of the largess that cheap credit has bought (exports to the US are up 15.1% from this time last year), the Philippines would prefer an interest rate hike later rather than earlier, as would many investors. Should the opposite occur, the risk would not just be limited to a stalling of the US economy, but capital flight from developing economies is likely to ensue, particularly hurting economies such as the Philippines, desperate for FDI as a newly industrialized economy. The Philippines, unlike many other developing nations, however, has the unique phenomena of OFW remittances (8% of GDP) mitigating exposure to this risk.

No, the greatest uncertainty comes from oil. Not simply its price, but the factors that push and pull on that price, and the follow-on effects that could have.

Make no mistake, the price of oil is now taking cues from the worsening situation in the Middle East, and it affects our whole region. Before, its fall could be attributed to a generally predictable market reaction to vast untapped reserves in North America coming online, and OPEC refusing the cut production, leading to a glut in supply and the plummet in pricing. But, having hit the bottom, the foot pedal controlling the speed of its rebound is being controlled by the sectarian violence engulfing the Middle East, in what is turning out to be quagmire of religiously motivated brutality. There in lies the difficulty of predicting the movements of the market. ADB modelling showed a slow recovery in the price of oil to between $70-80 per barrel by the time 2017 rolls around, however, they showed alternate modelling that could see it rise to over $100 per barrel at the same time if sectarian violence in the region worsened, restricting the supply of oil and increasing uncertainty. Oddly enough, this would suit OPEC nations just fine, as a high price on oil would be able to sustain the fiscal positions they have previously been accustomed to, and the Saudis need that extra revenue considering the military outlay they have recently committed themselves to. As an ominous sign of things to come, just last Thursday, Saudi Arabia launched air strikes on the Houthi rebels in the rapidly deteriorating Yemen. In response, the price of Brent Crude shot up by 6% to just under $60 per barrel.

While Yemen itself is a small player in the global market, this marks the first time the Saudis have led a direct intervention in the regional conflict, which has until now been a war by proxy between Sunni/Wahhabi dominated Saudi Arabia and Shia dominated Iran. For now, analysts are predicting that the slow rise in the price of oil should continue as little of the global oil supply is threatened by the Yemeni conflict (and apparently tankers have just been avoiding the neighboring Bab el-Mandeb strait and the Houthi rebels have no maritime ability to speak of), should the conflict in the Middle East escalate however, a rapid rise as projected by the ADB could threaten growth within the South East Asian region, where most of the countries are net importers of oil (the Philippines imports 90% of its oil supply).

In the Philippines this could mean a drop of 1.1% in GDP growth, the rising cost of energy in an already inefficient system, biting hard. In a world where globalization is ever present, the health of the Philippine economy lies in the hands of the armies and rebels now roaming the Middle East.

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