Investing: It’s More Frustrating in the Philippines

 

Manila needs to attract long-term investors before short-term money flees.

Few investment stories in Asia were quite as exciting as the Philippines last year. The headline growth rate increased dramatically, to 6.6% in 2012 from 3.9% the year before. And the government of President Benigno S. Aquino III, elected in 2010, launched several encouraging measures to tackle endemic corruption and jumpstart long-overdue public-works projects. Foreign capital has flooded into the Philippines. This is a boon for the Philippines, but also a significant challenge.

The problem is the kind of investment the Philippines is attracting. Nearly $4 billion flowed into its asset markets last year from hedge funds, mutual funds, pension funds and the like, fueling a greater than 40% run-up in stock prices. This portfolio investment may accelerate later in the year if, as is expected, the Philippines attains an investment-grade rating on its sovereign debt, which global investors would interpret as a sign of economic strength.

Although portfolio investment is often decried as short-term speculation, it does serve a useful purpose. A buoyant stock and bond market enables local companies to raise more capital at a lower cost to fund pro-growth expansion.

But as a coalition of foreign chambers of commerce note in a report released this week, the country’s $2 billion in foreign direct investment (FDI) in 2012—longer-term capital that builds factories, opens offices or expands retail stores—lagged both the Philippines’ intake of portfolio money and the FDI of its Southeast Asian peers. Although there’s some dispute about the precise numbers, by consensus the reality of direct investment falls short of the country’s potential.

The shortfall in direct investment could have debilitating consequences for the economy if Manila doesn’t address it. For one thing, it represents a serious missed opportunity to import foreign management expertise and competition to build a stronger economy. This is a necessary step to develop an economy that’s more resilient in the face of external shocks.

Meanwhile, the Philippines is hardly the only Southeast Asian country to experience an investment mania in recent years. Vietnam has found itself in the limelight several times. Indonesia was a global darling for a while. Those booms frequently turn to busts, and can do so very quickly since portfolio money is highly mobile.

Direct investment serves as a buffer against rapid portfolio outflows, since it operates on a longer time horizon. During the global financial crisis, for instance, Asia except Japan and China witnessed significant net outflows of portfolio investment, but only a somewhat slower rate of increase in direct-investment inflows, according to HSBC.

In essence, Manila is in a race against time to deepen its base of direct investment before portfolio investors find a new flavor of the month. Unfortunately, attracting portfolio money is relatively easy. Winning direct investment is a lot harder.

Consider some of the reforms Manila needs to undertake to boost long-term investment in key industries. The constitution prohibits foreign ownership of land, with residential condominiums being the only exception in practice. Foreigners wishing to buy property must find a local partner to formally own the land, and then sign a long-term lease with that partner.

Manila also maintains some of the most restrictive policies in Asia on foreign investment in specific industries. In areas such as telecommunications, electricity transmission, media and banking, the Philippines imposes tighter caps on foreign investment than its peers, according to the World Bank’s “Investing Across Borders” survey.

Such restrictions can have knock-on effects that work at odds with Manila’s other economic goals. The government is anxious to develop the tourism industry, and this should be a natural growth area. But since foreign hotel and resort developers can’t own their properties outright, they are less willing to invest in the Philippines—making it harder for the country to develop the high-quality facilities that attract more travelers from overseas. Lower-than-the-Asian-average caps on foreign ownership of airport operators and airlines deter foreign investment in transport services.

There are other examples of how investment protectionism affects even those industries that are open to foreign investment. Manufacturing is almost entirely open to 100% foreign ownership, but electricity transmission remains highly restricted and thus uncompetitive. This means that even though a potential direct investor can own his factory outright, he may well have to pay higher electricity prices if he builds his factory in the Philippines compared to other locations.

Mr. Aquino appears to understand this, or at least several of his high-profile appointees do. Trade Secretary Gregory L. Domingo said this week that the government is preparing legislation that would cut the length of the negative investment list of industries from which foreigners are barred. But such liberalization is invariably contentious, and will require concerted political will. Officials hope to pass reforms this year, but there’s no telling whether they will succeed.

That makes 2013 a high-stakes year for the Philippine economy. Continued low interest rates in the West and a probable credit upgrade for Manila will incline a growing number of long-term investors to give the Philippines a serious look. Manila needs to undertake the reforms that will leave those investors liking what they see.

 

 

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Source: Joseph Sternberg, The Wall Street Journal, 27 February 2013