Philippines Economic Update : Staying in the Course Amid Global Uncertainty

Executive Summary 

Heightened global market uncertainty and rising domestic inflation weighed on the Philippines’ economy in the first half of 2018. An increase in inflationary pressure since early 2018 along with rising interest rates in the United States and slowing global trade, weakened the demand for Philippine exports, fueling at the same time capital outflows and a depreciation of the peso. Growth moderated in the first half of 2018 to 6.3 percent, from 6.6 percent in the same period in 2017. Meanwhile, domestic demand continued to be driven by robust private consumption—partly due to lower income taxes, higher public wages, and strong remittance inflows—and an acceleration in public investment spending. Furthermore, strong domestic demand coupled with supply capacity limits, contributed to higher inflation.

In response to the buildup of inflationary pressure, Bangko Sentral ng Pilipinas embarked on a monetary policy tightening cycle. Inflation rose from an average of 2.8 percent in the first eight months of 2017 to 4.8 percent in the same period in 2018. Higher food prices accounted for about half of the rise in headline inflation, owing to weak agricultural and fisheries supply and a rise in demand, which was fueled by a reduction of personal income taxes that benefitted over sixty percent of wage earners. Higher global oil prices, a weaker peso, and new excise taxes also contributed to higher inflation. To reduce inflation expectations, the central bank raised its key policy rate to 4.5 percent—a cumulative increase of 150 basis points since May—to signal its commitment to price stability, but with limited impact so far. The central bank also intervened in the exchange-rate market to smooth excessive volatility. Still, the demand for U.S. dollars increased due to an increase in imports of capital goods, widening the current-account deficit. Meanwhile, the capital account worsened due to interest rate hikes by the United States’ Federal Reserve and increased trade tensions leading to capital outflows, further weakening the peso.

Fiscal policy has focused on accelerating public spending, especially in infrastructure while the implementation of the first tax package has helped increase government revenue. In line with the government’s ambition to reduce the country’s infrastructure gap, public infrastructure expenditure grew by 41.6 percent in the first half of 2018, compared to 8.8 percent in the same period in 2017, driven largely by numerous small public works projects. Moreover, the wage bill increased by 20.1 percent in the first half of the year, partly due to the implementation of the ongoing salary standardization. On the revenue side, higher tax collection boosted overall revenue growth and helped contain the fiscal deficit at 2.3 percent of GDP in the first half of 2018, below the government’s deficit ceiling of 3.0 percent for 2018.

The Philippines’ economic growth outlook remains positive, yet downside risks have increased. An expected slowdown in global trade in the medium term is likely to further dampen Philippine exports. Nevertheless, baseline economic growth is projected at 6.5 percent in 2018, 6.7 percent in 2019, and 6.6 percent in 2020. The baseline investment growth outlook is positive and planned senatorial and local elections in May 2019 are expected to lead to higher public spending and higher private consumption. However, persistent high domestic inflation could have a dampening effect on consumption and investment growth. Also, a faster normalization of monetary policy in the United States and an increase in global uncertainty, including trade tensions, could not only worsen external financing conditions for emerging market economies like the Philippines but also elicit additional domestic interest rate hikes that could raise domestic borrowing costs for businesses and households.

In the short term, it is prudent to maintain Philippines’ strong macroeconomic fundamentals. The country is fairly resilient to capital reversals given its large foreign reserves, flexible exchange-rate regime, low public debt, and robust remittance inflows. At the present juncture, preserving the country’s resilience rests in large part on preventing the current-account deficit from widening too much and too fast. Given that export growth is not expected to accelerate in the medium term, future import growth driven by public investment will need to be monitored closely to manage the pace of current account deficit widening to prevent external funding gap challenges.

For the Philippines to expand its long-term economic growth potential to reach the Ambisyon Natin 2040 vision, deep structural reforms are needed to increase both productivity growth and capital accumulation. Priority policy areas include improving market competition through regulatory reforms, improving trade and investment climate policies and regulations, and reducing labor market rigidities and costs. In addition, the Philippines needs to address structural deficiencies in the agriculture sector to prevent future food supply constraints. Reforms aimed at boosting domestic growth and reducing vulnerabilities in the agriculture sector will be essential to sustain high and inclusive economic growth.

While progress on poverty reduction is likely to continue as the economy maintains its high growth rates, high food inflation will disproportionately affect poor and vulnerable households. Recent data from the 2017 Annual Poverty Indicators Survey suggests that the income of the bottom 40 percent of the population grew at a faster rate than that of the average population. Thus, while there is no official household survey data on poverty since 2015, the poverty rate likely continued to fall until 2017. However, rising inflation in 2018 may negatively impact the welfare of poor and vulnerable households, as they spend over two-thirds of their total expenditure on food and fuel, the main drivers of higher inflation in the first eight months of 2018. In addition, the recent typhoon Ompong may have had a disproportional impact on these households, as they are not only more exposed to shocks from natural disasters but also have a lower capacity to cope with their impact.

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