Economic Analysis - Growth To Moderate But Remains A Regional Outperformer - APR 2018

BMI View: The Philippine economy grew by 6.7% in 2017, whic h was in line with our estimate, and we forecast real GDP growth to moderate to 6.3% in 2018 given the deterioration in the business environment. However, we note that this is still a very respectable growth figure, which will be supported by positive demographics, the strong public infrastructure drive, and increasing trade links with China.

The Philippines posted real GDP growth of 6.6% y-o-y in Q417, down from an upwardly revised 7.0% y-o-y in Q317. This brought the full-year economic expansion to 6.7% in 2017 (compared with 6.9% in 2016), which was exactly in line with our expectations. Previously, we pointed out that the strong Q3 results were unlikely to continue as leading financial market indicators were showing signs of fatigue while the business environment has been deteriorating (s ee ' Solid Growth To Continue But Acceleration Unlikely ' , November 17 , 2017). We continue to expect the economy to grow at a more moderate pace over the coming quarters and maintain our real GDP forecast at 6.3% in 2018 and 6.2% in 2019. That said, we emphasise that the 6+% GDP expansion is still strong by regional and historical standards and this will be supported by positive demographic trends, a strong public infrastructure drive, and deepening economic cooperation with China.

Below Consensus For 2018 & 2019
Philippines - GDP At A Glance
Source: BMI, Bloomberg

Looking at GDP by expenditure in real terms, household spending grew by 5.8% in 2017, down from 7.0% in 2016, while government consumption growth slowed to 7.3%, from 8.4% over the same period. The slowdown in government consumption was largely a result of high base effects due to election spending in 2016, and came despite Duterte's expansionary fiscal plans and the war against Islamic militants in Mindanao. Therefore, barring any unforeseen resurgence of extremist activities in the Southern Philippines, we expect the unfavourable base effects to be carried forward into 2018 and forecast government consumption growth to slow further over the coming quarters.

Exports A Key Driver Of Growth
Philippines - Contribution To Real GDP Growth, percentage points

Deterioration In Business Environment To Weigh On Private Investment

We also expect the worsening business environment to continue to weigh on private sector investment over the coming quarters. Fixed capital formation already slowed to 10.3% in 2017, from 25.2% in 2016. Looking at the breakdown, construction only grew by 5.7% in real terms, down from 15.1% in the previous year, while durable equipment expanded by 12.2%, down from 34.5%.

In our view, the slowdown in investment is indicative that the Duterte administration's violent anti-drug war has likely had a negative impact on investor sentiment, while a rise in Trump's protectionist rhetoric has led many US investors adopting a wait-and-see approach with regards to new ventures in locating their business offshore. We believe that these concerns will continue to weigh on new investment commitments into the BPO sector in 2018, particularly given that the US is one of the largest investors in the Philippines' business processing sector.

Meanwhile, in terms of the ease of doing business in the country, the Philippines saw the biggest deterioration in ASEAN, sliding by 14 positions in the 2018 World Bank's Ease Of Doing Business ranking to 113th position globally. In absolute terms, it also seems like the Philippines backtracked on reforms, with its distance to frontier score falling from 60.4 in 2017 to 58.7 in 2018. The key drags on the Philippines' overall score include the ease of starting a business in which the archipelago ranks a grim 173 out of 190 countries, getting credit (142), enforcing contracts (149), and protecting minority investors (146).

Growth To Still Average Above 6%

While growth headwinds are mounting in the near-term as the business environment deteriorates, we believe that the Philippine economy will continue to be buoyed by strong demographic trends supporting savings, increased trade and investment links with China and Japan, as well as a strong public infrastructure drive. This should see real GDP growth in the Philippines average above 6% over the medium term.

Indeed, exports surged by 19.2% in both real and nominal terms in 2017, on the back of a cumulative 30.8% y-o-y increase in outbound shipments to Hong Kong in January-November, and a 10.8% y-o-y increase in exports to China in the same period. Together, both economies account for 24.5% of total exports from the Philippines, with Hong Kong serving largely as a transit point for trade with Mainland China. This chimes with our long-held view that improving bilateral relations with China will be beneficial for trade and investment, which will in turn act as a tailwind for growth ( see ' Duterte ' s Pivtot To China: What Is The Significance ' , October 21, 2016).

Furthermore, on the fiscal reform front, the government has overhauled the tax system, which is expected to boost government revenue and create a more equitable and efficient tax system. This should allow the government to carry out its ambitious public infrastructure development plans. The first tax reform package has been signed into law and is estimated to generate additional revenue of PHP82.3bn for the government. This will likely go some way in improving the country's poor infrastructure, which has long prevented the Philippines from reaching its growth potential.