Differentiated

THE BETTER-THAN-EXPECTED 7.5% 2Q13 growth certainly brought cheer to local stocks battered by two weeks of bad news. The main stock index rose a cumulative 6.0% in the past two days following the announcement last August 29 that the local economy bested other Southeast Asian countries where growth ranged from 2.8% (Thailand) to 5.8% (Indonesia) during the period.

Several foreign analysts have announced upward adjustments to their growth forecasts, bringing their full year numbers closer to our earlier forecast of 7.2%. The local economy’s resilience in the face of external turbulence reinforces our view that the Philippines is somewhat differentiated from its peers not only by having a structural current account surplus, fueled by remittances and BPO earnings, but also by having local growth drivers, mainly public spending and private investments, to lean on. The latter may be traced to local economic authorities’ ability to pursue accommodative policies given a benign inflation outlook and manageable public debt.

While we are keeping our 2013 GDP forecast for now, we anticipate the pace of growth to fall below 7% starting this quarter. This is due primarily to the disappearance of election-related stimulus and its impact on government and household spending. Moreover based on the just released numbers, we see some downside risks, including:

(a) Decelerating year-on-year consumption growth over the past four quarters. It is hard to tell at this time if the peso depreciation’s boost to incomes from dollar remittances can reverse the trend;

(b) Likely more timid spending by the government moving forward in the wake of the still-unfolding major multibillion pork barrel scandal;

(c) Dampened investor confidence due to recent financial market developments. 2Q13 data already reflect a significant slowdown in private construction — from over 20% real growth since 3Q12 to just 9% last quarter — and the BSP Business Expectations Survey, released August 30, reveals a less-upbeat mood for 3Q13. Expected increases in borrowing costs due to withdrawal of liquidity from emerging markets may dampen moods further;

(d) Weakness in imports, including of inputs to electronics goods, makes a convincing export recovery story still elusive, despite improving growth indicators in the US and China. The country’s export promise has in recent years switched to the BPO sector, which continues to show growth. In 2012, on a 30% value-added rule of thumb, the electronics sector pulled in $6 billion, about half of the $11.6-billion haul of BPO services.

2014 AND BEYOND
Will the country sustain the 7% growth trajectory in 2014 and next? Given the disappearance of one-offs (elections) in the near future and maturing business cycle, it is highly doubtful to maintain such feat. Moreover, recent delays in infrastructure projects may further derail the economy on its high growth track. On our part, we see above-trend growth for 2014 (6.2%), still outpacing other emerging markets, because healthy macroeconomic fundamentals and consumption will likely underpin growth in the future.

While our forecasts are a shade higher than the consensus, we share the view that growth will decelerate over time. The main reason is that despite being encouraged by optimism, we think that other than in real estate which analysts, including ourselves, estimate to be in it seven-year mid cycle, private investments particularly FDI will realistically be more modest than what the government is hoping for. To be sure, investors are trooping into town and the high registration numbers recorded in the country’s economic zones since 2010 reveal genuine intent to set-up shops locally. However, these plans will take time to complete and actual inflows as reflected in FDI numbers have yet to impress. Moreover, we are told that business park locators are starting to look into possible problems associated with the industrial zones’ absorptive capacity, not only in terms of space limitations but also congestion due to inadequate supporting infrastructure, notably in transport, ports and power. For instance, the energy secretary has warned that if growth stays on its current path, the Luzon grid would face supply tightness in 2015 particularly in the summer months.

Meanwhile, infrastructure PPPs continue to face delays, with bidding failures and push out of bidding schedules. In our view, this is due to, among others, over-cautiousness and underpricing of opportunity cost of delays at top level/s, lack of technical capability of implementing agencies, and misallocation of risks between government and the private sector. One example of the last is on risks arising from potential new local real property taxes on rail or airport assets. These are risks that should be born by government, based both on logic of efficient risk allocation (party that can best bear/manage the risk should carry it ) and on past experience where power and rail assets became the object of such form of “hostage taking” by local governments units. Surprisingly, the draft contracts for bidding load such risk on the bidders; unsurprisingly, no shows and further delays.

In another instance, perceptions of regulatory risks were heightened by recent populist public bashing by the agency-in-charge, echoed by a chorus of legislators, of a highly successful 15 year internationally recognized water PPP for Metro Manila. This became the subject of a statement of concern by four national business organizations, and is now inexorably headed for international arbitration.

With investors expected to increasingly fret about the outcome of the 2016 presidential elections, economic growth further out would depend in our view on government’s ability to crystallize a convincing follow-on story in support of the investment grade rating that investors can anchor their decisions on. This is emerging to be a truly challenging task in the current external environment and local political landscape. The latter is complicated by a serious “pork barrel” scandal, and the accompanying public disaffection and government distraction, with no clear closure in sight.

Part of this column came from GlobalSource reports entitled “Differentiated” (August 30, 2013) and “In a Good Place” (August 8, 2013), both written by Christine Tang and the columnist. Romeo Bernardo is a board director of IDEA. He served as Undersecretary of Finance during the Aquino 1 and Ramos administrations. –Romeo L. Bernardo, Businessworld