February 06, 2013

Michael McDonough: Philippines Consumption Reliance May Restrain Growth

Bloomberg Economist Michael Mcdonough made a recent commentary Philippines consumption reliance.

Here is his commentary:

"The Philippines' reliance on consumption to drive its economy, coupled with a lack of foreign direct investment, may challenge policy makers seeking to attain and hold an investment-grade credit rating. Credit-default swaps imply investors may already believe the country's debt deserves that coveted status. The Philippines has one of the fastest-growing economies thanks to smart fiscal planning, robust domestic demand and relatively favorable external conditions. This is likely to persuade Standard & Poor's, Moody's and Fitch to raise their ratings on the country's debt to investment grade from one level below that threshold.

The pace of growth may not be sustainable, though Philippine policy makers have made strides toward improving the economy by increasing tax collection and rationalizing spending. The country depends on consumption to drive growth, unlike China, which relies heavily on investment to support its economy. Philippine investment contributed to less than 20 percent of the country's GDP growth in 2012, far below the average for a country in its stage of development and among the lowest ratios in Asia. China had a ratio of about 50 percent in 2011. The Philippines has seen a deluge of portfolio inflows, which have helped the peso appreciate by 9 percent in the past two years.

The Philippines Stock Exchange PSEi Index has gained almost 65 percent in the same period. These capital flows tend to be speculative and short-term, meaning a shift in investor sentiment or an external shock may lead to a run on risky assets. That may have a devastating effect on the country's capital account. Foreign institutional investor purchased a net $2.5 billion of Philippine equities last year and have increased that position b $600 million so far in 2013. Foreign interest has also helped push down the Philippine 10-year bond yield to about 4.2 percent from more than 8 percent in February 2010. Long-term capital inflows through FDI have been minimal.

The country's FDI totaled $1.9 billion in 2011, according to World Bank data, only slightly higher than in Myanmar, at $1 billion, and a fraction of China's total, at$220 billion. Indonesia, a fellow member of the Association of Southeast Asian Nations, saw more than $18 billion in long-term inflows. An expansion of foreign-ownership rights in the Philippines
would probably help increase the share of net GDP that comes from investment. This would attract much-needed FDI to the country and improve the sustainability of growth.

In most sectors, foreigners aren't permitted to own more than 40 percent of a company, and strict land rules prevent foreign purchases. As Asean integration continues, these regulations may reduce the Philippines' competitiveness and cause some foreign investors to choose other countries. The Philippines may also hold the world's third - or fifth -largest copper reserves, according to estimates, in addition to substantial gold deposits, all largely untapped. An important catalyst for future growth may be a combination of foreign capital, geopolitical stability and better infrastructure to tap into these resources.

An integrated Asean may take over as the world's largest economic engine as China's growth begins to slow and the country moves toward consumption-led growth. The Philippines has the potential to lead the region, with its young, educated, underemployed population and substantial natural resources. Policy makers have been successful so far in supporting the economy. As long as they continue on this trajectory, the country is likely to see growth accelerate and quality of life improve further, with investment-grade status achieved."

Michael McDonough is an economist for Bloomberg based
in Hong

To contact him: +852-2977-6733 or