Solid Macroeconomic Fundamentals Cushion External Turmoil

Philippines Quarterly Update (September 2011)

The slowdown in the United States and Europe is affecting Philippine exports but the country’s strong macroeconomic fundamentals are cushioning the impact of the global economic turmoil on the local economy, says the Philippines Quarterly Update (PQU) released by the World Bank.

Executive Summary

• Due to sluggish exports and government spending, economic growth was lower than expected. It stood at 3.4 percent (year-on-year) in the second quarter (Q2) of the year, the slowest pace since the fourth quarter of 2009. While private consumption grew at the fastest pace since the fourth quarter of 2007, the other components of aggregate demand have fallen. After expanding briskly in 2010, construction spending declined, pulling down overall investment spending. Public construction contracted by 51.2 percent in Q2 (year-on-year), while exports declined in July for the third-consecutive month, with the continued weaknesses in the economies of the Philippines’ main trading partners, aggravated by the twin disasters in Japan that disrupted manufacturing supply chains. On the supply side, services posted 5 percent growth, outpacing industry, and agriculture expanded for the third-consecutive quarter, favored by good weather conditions.
• The Philippines’ external position and macroeconomic fundamentals remain strong. The current account surplus increased by 20 percent in Q2 (year-on-year), owing to higher remittances and net services receipts. Net foreign direct investments (FDI) increased in the first half, although lagging behind neighboring countries. Foreign reserves have surged to record highs thanks to strong capital inflows as well as sustained growth of remittances and income from investments abroad. Attracted by relatively higher growth prospects and yield differentials, net foreign portfolio inflows soared through August, at US$3.1billion, more than triple last year’s amount. These inflows have since become more volatile, however, due to higher risk aversion among foreign investors, in light of slowing global growth and continued Euro zone uncertainty. The Peso appreciated modestly against the US dollar during the first half of the year.
• Monetary policy remains accommodative, while the fiscal deficit is likely to fall below target. After two consecutive rate hikes, the central bank (Bangko Sentral ng Pilipinas, BSP) left policy rates unchanged in June and July. Instead, the Bank raised the regular reserve requirement twice by 1 percentage point each, bringing it back to the pre-crisis level of 21 percent of gross deposits. Inflation eased to a four-month low in August and remains contained within the BSP target range. The BSP is likely to keep the monetary policy accommodative until the economy shows signs of stronger growth. The fiscal balance has improved sharply, with a deficit of 0.5 percent of GDP during January – July, due largely to government under-spending as revenue collection remained on-track. Although this improves the fiscal balance and may eventually lead to higher quality public spending, it also reduces economic growth and could weaken potential growth as the country’s large deficiencies in infrastructure remain unresolved. Meanwhile, revenue mobilization has recorded promising signs of growth, rising ahead of nominal GDP growth and indicating that the efforts to improve tax compliance are starting to pay off.
• After a strong rebound in 2010, economic growth in 2011 is likely to remain around 5 percent with downside risks. In response to the slower growth and the weaker economic outlook in advanced economies, we revise our growth forecast downward from 5.0 percent to 4.5 percent for 2011 and from 5.4 percent to 5.0 percent for 2012. The Philippines is enjoying relative political stability and its fiscal position has improved. Capital inflows are expected to continue, but FDI is projected to moderate as foreign investors have become more cautious in light of the recent financial turmoil. Consumption is expected to be buoyed by falling unemployment, the government’s expansion of the conditional cash transfer program, and sustained remittance inflows. The current account surplus is projected to rise driven by remittances. The trade deficit is likely to expand as imports pick up, but this is partly offset by robust services exports, particularly from business process outsourcing. Increased uncertainty about global demand and a further slowdown in domestic investments pose significant downside risks to our GDP growth forecast.

• The challenge for policymakers is to ensure that the Philippines continues to improve its competitiveness, while cushioning the economy from adverse external shocks. To strengthen its resiliency to external shocks, the government needs to accelerate public spending. Raising more revenues through improved tax administration and reforms is imperative in enabling the government to meet its priority spending targets, especially in infrastructure and human capital investment.

For more information on World Bank-supported projects and programs in the Philippines, visit: www.worldbank.org.ph

Press release
Philippines Quarterly Update (September 2011)