Philippines’ strongest economic growth thrust now on hold

AMERICA’S cold is putting a damper on what the World Bank calls “the strongest pace of economic expansion in three decades” in the Philippines.

In its East Asia and Pacific Update, the latest half-yearly assessment of the region’s economic health, the World Bank says economic growth in the country slowed this year.

Real GDP growth slowed to 4.6 percent in the first nine months of 2008 from 7.2 percent in 2007 as a whole. Higher prices for food and fuel hurt real household incomes, reducing the pace of expansion in private consumption.

Government consumption and investment, meanwhile, contracted in the first half of the year before improving significantly in the third quarter.

The recent global slowdown has taken a toll on export growth and has put downward pressure on foreign investment inflows.

“Despite these challenges, the economy is expected to remain resilient, although growth is projected to slow substantially,” observes the report released this week. “In the long term, the sustainability of growth will depend critically on improvements in the investment and governance climate.”

After a period of falling inflation in the last three years, prices started rising rapidly in early 2008 as inflation breached the central bank’s 4-percent to 5-percent target as prices for food and oil surged.

Higher food and fuel prices were initially muted by the strong peso, which appreciated by a fifth over the last two years. Inflation eventually peaked at 12.5 percent in August.

While headline inflation has receded since, without respite from rising prices of basic consumer goods, prices of other goods have also risen rapidly, causing core inflation to more than double from the start of the year to 7.9 percent year-on-year in November 2008.

Higher inflation prompted the central bank to hike interest rates by a cumulative 100 basis points in three steps during mid-2008.

Toll

The financial crisis is taking a toll on the balance of payments but is projected to remain in surplus. The current account surplus narrowed to 2 percent of GDP in the first half of 2008 from 4.4 percent in 2007, as the widening merchandise trade deficit offset robust growth in remittances.

The trade deficit surged to 6.9 percent of GDP in the first half, reflecting slower export growth and a jump in imports because of higher prices for imported food and energy.

Remittances grew 17 percent year-on-year in the first nine months of the year, reaching a record monthly inflow of $1.5 billion in June alone.

Positive net capital inflows in the first quarter more than offset modest outflows in the second quarter, but outflows are likely to have intensified since midyear.

Domestic financial markets have been relatively resilient in the face of the global financial turmoil. While the direct impact on the banking system from the turmoil has been marginal, as overall exposure to structured products is estimated at about 2 percent of banking assets, banks are nonetheless affected through their large holding of Philippine sovereign paper whose price has fallen substantially because of the global turmoil.

Equity prices have fallen by more than 40 percent in 2008, and the currency weakened by 18 percent against the dollar since the start of the year.

Improved tax collection and moderate spending limited the fiscal deficit to 0.7 percent of GDP in the first nine months of 2008.

The tax-to-GDP ratio improved noticeably in the first half of 2008, in part reflecting the government’s renewed focus on tax administration reforms that began in late 2007 but also higher domestic and import (especially commodities) prices.

Tax collection has slowed in recent months, however, in part reflecting slower economic growth, decreased commodity prices, the introduction of tax cuts and the non-indexation of specific excises amid high inflation.

Higher inflation and slower economic growth have significantly increased the hardships faced by the poor despite robust remittance inflows. Given the large share of food in the poor’s consumption basket, there are indications that the inflation faced by the poor rose faster and remains higher than the headline inflation reported by the statistics office.

The government has responded by postponing its goal to balance the budget in 2008 to allow for increases in infrastructure and social protection spending and subsidies to the poor.

Moreover, to mitigate the rise in fuel prices, the government gradually reduced the tariff on imported oil and asked oil companies to cross-subsidize diesel oil. With the decline in oil prices, the tariff was resumed in November.

The ameliorative effect of the decline in price of food and oil since midyear notwithstanding, the pace in poverty reduction will slow in the Philippines, as in other countries, as real GDP growth is expected to slip to about 3 percent to 4 percent in 2009 from 4 percent to 4.5 percent in 2008. World Bank