HSBC: inflows still a ‘pesky’ problem

HSBC analyst said that the country’s disproportionate reliance on remittances as the key growth driver means its current account will likely stay in surplus for years to come, putting further pressure on the peso. This will effectively raise production costs in the Philippines, making its manufacturing sector less competitive, the analyst said.

Inflows remain a pesky problem as they are structural in nature, according to the latest report of Hong Kong and Shanghai Banking Corp. (HSBC).

Because of this, HSBC analysts see the Bangko Sentral ng Pilipinas (BSP) will not counter the effects of heavy capital inflows with monetary policy.

“When the BSP meets this Thursday, the biggest concern will be capital inflows, as they continue to put upward pressure on the peso.

Rates will likely stay low at 3.50 percent for most of the year, provided inflation remains contained,” Trinh D. Nguyen, HSBC economist said.

Nguyen said with high demand for Filipino workers overseas and limited employment opportunities locally, remittances will rise, boosting current account surplus this year.

Cheap credit in the developed world will likely also find its way into the country.

“But BSP is unlikely to use monetary policy to stem inflows. Some policy fiddling is expected in 2013 but drastic measures are unlikely as the BSP remains cautious by nature,” Nguyen said.

She stressed that “an aura of euphoria currently surrounds the Philippines.”

“Domestic demand was strong, supported by low interest rates (achieved via 100bp of cuts in 2012), as inflation hugged the bottom of the BSP’s 3-5 percent target for most of 2012,” Nguyen said.

She added that the government helped boost growth by spending more.

“But last year’s budget deficit will likely still come in below 3 percent of GDP, allowing the country to reduce its national public debt steadily.

By the second half of the year, the Philippines could reap the reward of its fiscal consolidation efforts by being awarded a sovereign upgrade to BBB- from the current BB+,” Nguyen added.

Nguyen said that with the BSP able to build a foundation, “it’s time to pass the baton.”

“Few countries can simultaneously boast of accelerating growth and slowing inflation. But the Philippines can, partly thanks to the BSP’s hard work last year. Sterilizing inflows helped to keep money supply growth contained, putting less pressures on prices. At the same time, their support for the country’s agriculture sufficiency policy, especially rice, improved food supply in the country, reducing inflationary pressures on 39 percent of the total CPI basket. As a result, headline inflation has stayed largely on target since end 2009, an impressive feat for a country at the Philippines’ stage of development,” Nguyen said.

That said, Nguyen thinks the BSP is unlikely to make any significant moves this year.

“Nguyen said that the Aquino government, rather than the BSP, is in a better position to deliver.

“Indeed, the government has already started to make steady progress, but more is still needed. Efficiency raising measures helped to increase revenue collection last year as well as reduced waste in expenditure spending. This is why the budget deficit as a percentage of GDP will likely come in under 3 percent despite last year’s much faster pace of spending, something that should have also pushed public debts to shrink as a percentage of GDP in 2012,” Nguyen said.

Other reforms such as the passage of the Sin Tax (on cigarettes)—which will likely raise revenue collection by 1.8 percent—should also be considered positive, according to her.

“The government has already made a start on consolidating its fiscal position; important ground work for more reforms to come. But the main issue in the Philippines remains weak investment growth, in comparison to its infrastructure needs and to the regional average. The private-public partnership initiative, while laudable, has performed significantly below target, with only two projects awarded in 2012. While more projects are expected to be rolled out in 2013, the PPP initiative will not be enough to significantly improve the infrastructure of the country,” Nguyen said.

“More reforms are needed to improve the business environment if domestic investment is to pick up,” she stressed.

While the government made good progress on improving the country’s fiscal position, Nguyen said not enough was done to improve the overall business environment – something that contributed to the Philippines’ two notch decline in the 2013 World Bank Doing Business ranking.

Nguyen also noted that recent corporate lending has decelerated, pointing to slowing corporate investment.

“This means that the public sector will have to pick up the slack, if current investment growth rates are to be sustained. At the moment, it is unclear where the government is going to find additional funding sources to boost public investment given President Aquino’s pledge to not raise taxes and the stalling of previous mining sector reform plans,” Nguyen said.

“The Philippines is indeed doing well thanks to its skilled labor force, booming BPO sector, robust remittances growth, expanding population, and consumption-oriented culture. But a disproportionate reliance on remittances as the key growth driver means that the Philippines’ current account will likely stay in surplus for years to come, putting further pressure on the PHP. This will effectively raise production costs in the Philippines, making its manufacturing sector less competitive,” Nguyen said. –Malaya