Currency Forecast - PHP: Neutral Near-Term, Outperformance In Total Return - MAR 2018


Philippines Currency Forecast
Spot 2018 2019
Source: BMI, Bloomberg. Updated: January 4, 2018
PHP/USD, ave 49.72 49.78 49.58
PHP/EUR, ave 60.04 54.75 57.01
BSP Rate, % eop 3.00 3.50 3.50

BMI View: Following PHP ' s strong showing in Q417 , we expect the currency to trade sideways in the near-term as expectations of BSP's rate hikes are likely to be offset by a continuous deterioration in the terms of trade and a likely rise in market expectations regarding US Fed rate hikes. Over the long-term, we expect the peso to outperform the US dollar in total return terms given the superior economic growth outlook.

Short-Term Outlook (three-to-six months)

In line with our view, the Philippine peso has strengthened by more than 2.0% in spot terms against the US dollar since our last currency forecast in late-September when we called for a halt to peso weakness ( see ' Weakness Has Run Its Course, Gradual Strength Ahead ' , September 28 2017). Following the rebound, we now hold a neutral view on the currency, expecting the currency trade sideways over the near-term.

Looking Technically Constructive
Philippines - Exchange Rate, PHP/USD
Source: BMI, Bloomberg

On the positive side, the peso is looking technically constructive and looks like it could strengthen further towards resistance at around PHP48.50/USD. At the same time, we forecast the Bangko Sentral Ng Pilipinas to tighten its monetary policy (entailing policy rate hikes of 50bps to 3.50%) over the coming months, which will likely be supportive of the currency.

On the flipside, however, we note that the ongoing price rally in oil prices is negative for the Philippines terms of trade. Furthermore, dollar weakness across the board suggest market complacency with respect to the trajectory of US Fed rate hikes. According to Bloomberg, around 20% of market participants expect one or less interest rate hike this year, while another 40% expect only two rate hikes, as compared with US policymakers who have penciled in three hikes for 2018. Should market expectations catch up with the Fed, this could see the dollar weakness reverse.

Long-Term Outlook (six-to-24 months)

From a structural perspective, we expect the peso to continue to outperform the US dollars in total return terms on account of a stronger economic growth outlook. This should lead to a higher fair value for the currency over the long term, and allow the government to keep interest rates higher than that in the US. We forecast real GDP in the Philippines to expand by 6.3% over 2018-2019 thanks to a strong public investment drive which will help address the acute infrastructure deficit, and deepening economic cooperation with China and Japan, which should be supportive of trade and investment. Although economic growth over the coming quarters will likely moderate slightly from the 6.7% estimate in 2017, this will nevertheless be much stronger than US' average growth forecast of 2.1% in the same period.

Near Long-Term Average
Philippines - Real Effective Exchange Rate
Source: BMI, Bloomberg

That said, we believe that the peso's gain against the greenback in spot terms, albeit positive, is likely to be limited given that the currency's real effective exchange rate (REER) is trading around its 10-year moving average, suggesting that the currency is fairly valued. Accordingly, we now forecast the exchange rate to come in at PHP49.70/USD at end-2018, slightly stronger than the end-2017 figure of PHP49.85/USD.

We also expect inflation in the Philippines to average 4.0% over the next two years, as compared with just 2.1% in the US. The Philippines is experiencing a credit boom and this is likely to put upside pressure on core inflation over the coming quarters. This means that the peso would gradually lose external competitiveness if the currency did not depreciate. Therefore, even if the peso faces upside pressure from remittances and investment inflows, policymakers are likely to intervene to temper peso strength.

CDS Spreads At A Record Low
Philippines - Credit Default Swap, bps & Exchange Rate, PHP/USD
Source: BMI, Bloomberg

Risks To Outlook

While we are forecasting a largely stable outlook for the peso in spot terms, we believe that risks are tilted to the downside. Firstly, any signs of global credit stress could put the dollar on the front foot. Indeed, the Philippines' 5-year credit default swap is trading at rock-bottom, suggesting that perceptions of a default risk are extremely low and should be viewed from a contrarian perspective. Secondly, although the war against Islamic militants in Marawi City is over, risks of terror threats in the Southern Philippines remain salient. Finally, President Rodrigo Duterte's poor track record with human rights and relentless lambasting of the EU and other western organisations have damaged the country's international relations and could lead to a roll back of preferential trade arrangements like the GSP+, which could undermine the peso.