National Economic and Development Authority

fa Republic of the Philippines National Economic and Development Authority National Planning and Policy Staff NEDA s Inputs the Project Link s Country Report October 2016 I. Recent Trends 1. The Philippine economy grew robustly over the last six years, marked by structural transformation. The Philippine economy grew by an average of 6.2 percent in the last six years, the strongest since the mid-1970s. In 2015, real GDP accelerated by 5.9 percent primarily contributed by the services and industry sectors on the supply side and by household consumption on the demand side. In the first half of 2016, the economy grew by an average of 7.0 percent as the previous year s drivers of growth continued to expand, further propelled by government spending as expected during election season. 1 2. Strong domestic demand and the resurgence of manufacturing fuel growth. The economy has started to transform towards being more investment- and industry-driven as reflected in the increasing contribution to growth of capital formation on the demand side. In fact, in 2015 and the first half of 2016, fixed capital formation registered growth rates of 15.2 percent and 27.7 percent, respectively. In 2015, this amounted to 23.1 percent of GDP, from only 18.7 percent in 2009. On the supply side, there is the growing significance of industry, especially local manufacturing, and within the services sector, business process management and tourism-related subsectors. In other words, we are in the process of structural transformation, from a consumption-based economy to being more and more investment-led and from a services-oriented economy to re-focusing on the industry sector. This pivot in the structure of the economy is crucial for sustaining growth and generating quality jobs. 3. Near-term performance remains upbeat notwithstanding the weak global economy. For the first half of 2016, the Philippine economy sustained its growth momentum with real GDP accelerating to 7.0 percent in the 2 nd quarter of 2016, from 6.8 percent in the previous quarter and from 5.9 percent in the same quarter of 2015. This can be attributed to the strength of domestic demand particularly household consumption, government spending, and fixed investment on the production side. Moderating the country s economic growth is the weak external demand affecting merchandise exports. On the supply side, services continue to be the growth driver, increasing by 8.4 percent; industry growth also remained robust at 6.9 percent. On the contrary growth in the agriculture sector fell anew due to lingering effects of the El Niño phenomenon. 4. The Philippines recent performance makes it one of the most bullish economies in Asia. Among the major Asian economies, the Philippines grew fastest second to India (7.1%), and ahead of China (6.7%), Vietnam (5.6%), Indonesia (5.2%), Malaysia (4.0%), and Thailand (3.5%). 2 1 National and local elections in the Philippines were in May 2016. 2 Data provided are country estimates for the 2 nd quarter of 2016. Page 1 of 6

Table 1. Recent Economic Performance (constant 2000 prices, growth rate in %) Sector: FY 2015 1H 2015 1H 2016 Supply side Agriculture 0.1 0.5-3.3 Industry 6.0 5.7 7.9 o.w. Manufacturing 5.7 5.3 7.2 Services 6.8 6.2 8.0 Demand side Private consumption 6.3 6.3 7.2 Government consumption 7.8 1.4 12.7 Capital Formation 15.1 16.7 27.1 o.w. Fixed capital formation 15.2 10.7 27.7 Exports 9.0 7.7 7.0 Imports 14.0 12.4 19.9 Gross Domestic Product 5.9 5.5 6.9 5. Macroeconomic fundamentals support growth, while tempering exposure to risks. Robust economic growth in the last six years was supported by low and stable inflation, prudent fiscal policy, healthy external accounts, and a stable banking system. Inflation has remained benign largely due to the central bank s appropriate and timely monetary policy actions. Moreover, this year, the central bank has introduced a new monetary policy framework, the interest rate corridor (IRC). The IRC is a system for guiding short-term market interest rates towards the central bank s target/policy rate. This new system is intended to help ensure that money market interest rates move within a reasonably close range around the policy rate. The country s fiscal position continues to improve (especially after the fiscal crisis of 2004). Revenue effort, albeit lower than Asian peers, continues its upward trajectory, leading to modest fiscal deficits and declining public debt and interest payments. The efforts to put the government s fiscal house in order continues to be recognized by credit rating agencies and is reflected in the country s relatively low prices of credit default swaps. The increase in revenue collections has opened room to invest more in social spending and infrastructure investments, crowding in private investments. Aside from these, structural reforms were put in place and institutionalized through laws to ensure continuity. Among these are the reproductive health law, competition law, reforms of the cabotage law, full liberalization of foreign banking, and customs modernization and tariff act, among others. The current account surplus has been accompanied by resilient remittances from Filipinos overseas, strong business process outsourcing or BPO earnings, and rising tourism receipts. In fact, revenues from BPOs is set to overtake remittances in a few years as the primary driver of the current account. The persistent surpluses in the current account and balance of payments have led to accumulation of reserves, equivalent to 10.5 months of imports in July 2016, providing cushion to external shocks. The financial system, largely banking in the Philippines, continues to grow with credit growth (gross loans of universal and commercial banks) registering 16.2 percent growth in Page 2 of 6

the last 3 years. Notwithstanding the vigorous growth, the non-performing loans of the banking system remain low at 1.65 percent of total loans as of June 2016. II. Assumptions on National Policy and External Environment 6. Macroeconomic parameters/assumptions are regularly reviewed/discussed through the Development Budget Coordination Committee (DBCC). The DBCC is composed of several agencies that manage the macroeconomy: (i) the National Economic and Development Authority (NEDA); (ii) the Department of Budget and Management (DBM); (iii) the Department of Finance (DOF) and its attached bureaus and agencies, and the (iv) the Bangko Sentral ng Pilipinas (BSP) as a resource institution. The latest emerging near-term macroeconomic assumptions are given in the table below. Table 2. Macroeconomic Assumptions 2014 2015 2016 2017 2018 Particulars Actual Actual Target Latest Actual Target Target Gross Domestic Product (% growth), real 6.2 5.9 6.0-7.0 6.9 (Jan-Jun) 6.5-7.5 7.0-8.0 Inflation, CPI (%, 2006=100), average 4.1 1.4 2.0-4.0 1.5 (Jan-Aug) 2.0-4.0 2.0-4.0 364-Day Treasury Bill (%) 1.8 2.0 2.0-4.0 1.724 (as of Aug 8) 2.0-4.0 2.0-4.0 Foreign Exchange Rate (P/US$), low 44.4 45.5 45-48 46.9 (Jan-Aug) 45-48 45-48 LIBOR Rate, 6 Months (%) 0.3 0.5 0.8-1.8 0.5 (as of Sep 9) 1.0-2.0 1.5-2.5 Dubai Oil Price (US$/Barrel) 96.7 51.2 35-50 38.36 (Jan-Aug) 40-55 45-60 Exports of Goods (PSA) Level (in US$ Bn) Growth Rate (%) 62.1 9.5 58.8-5.3 61.0 4.0 31.5 (Jan-Jul) -8.3 65.2 7.0 71.1 9.0 Imports of Goods (PSA) Level (in US$ Bn) Growth Rate (%) 65.4 4.8 71.1 8.7 70.6 8.0 45.5 (Jan-Jul) 14.4 78.4 11.0 7. Together with the above targets, the fiscal sector is expected to be more accommodative with increases in spending and a comprehensive tax reform. The government recognizes equity considerations alongside revenue generation and efficiency. It has a positive view on broadening the tax base and simplifying the tax system. Some of the legislative proposals include a comprehensive tax reform which targets to correct the effects of bracket creep on income tax liabilities of workers, i.e. adjusting to inflation; and rationalization of fiscal incentives. 87.8 12.0 III. Forecast Summary 8. The strong growth recorded in the first semester increases the probability of attaining the full year growth of 6.0 to 7.0 percent in 2016. A second semester growth of only 5.1 percent is needed to attain at least the low-end of the growth target for the year. While it is normal to see a slowdown in the second semester during election years (possibly 1.5 to 2.0 ppt lower than the first half), the smooth transition of power of the Duterte Page 3 of 6

administration and the assurance of macroeconomic policy consistency of the new administration is expected to continue to buoy business and consumer confidence to meet the county s economic growth targets. 9. The expenditure side of the economy will likely continue to be driven by domestic demand, led by household consumption, investment, and supported by government expenditure. The consumer expectations survey point to increasing positive consumer sentiment. Meanwhile, the momentum of government spending is expected to continue in the following quarters particularly for personnel services and maintenance and operating expenses. The fiscal stance of the current administration promotes more inclusive tax rates/brackets which will be reflected in an upcoming comprehensive tax reform package. This will include a cut in personal and corporate income taxes (one of the highest in the region) while increasing sin taxes and streamlining fiscal incentives. In the case of investment, the strong construction activity will be reinforced by increased spending in durable equipment, especially with the administration s recognition of infrastructure needs of the country. From infrastructure spending equivalent to 2.7 percent of GDP, the current administration plans to boost this to 5.1 percent of GDP in 2017 and 5.4 percent of GDP in 2018. The increasing role of investment is further reflected by the continued rise in imports of capital goods such as telecommunication equipment & electrical machinery, power generating & specialized machines, land transport equipment, as well as office & electronic data processing machines. Meanwhile, the sluggish global economy continues to hamper merchandise exports. The Semiconductor and Electronics Industries in the Philippines Inc. (SEIPI) for instance, indicated that they forecast export growth of semiconductors to fall just between 2.0 to 5.0 percent as global demand for electronics remain weak. On the bright side, exports of services is expected to compensate for the grim outlook in merchandise exports. For 2016, the tourism industry targets 6.5 million international tourists. Moreover, the performance of the country s BPO sector remains bright as revenues for the industry is expected to overtake remittances from overseas Filipinos in the next few years. For 2016, the BPO sector is expected to bring US$25 billion worth of revenues. 10. On the supply side, the waning effects of El Niño is expected to be favorable to the agriculture and fisheries sectors, not discounting the increasing probability of La Niña in the second half of the year though. In the second semester of 2016, palay and corn are expected to expand by 6.7 percent and 9.0 percent, respectively. Other high-value crops, poultry, and livestock are seen to post positive growth rates in the second half given the uptick in seasonal demand. Manufacturing will continue to contribute positively to growth as the reconfiguration of global value chains continues with the sustained implementation of the Comprehensive National Industrial Strategy. Construction will also remain to be a major contributor of growth in the second half on the back of an aggressive public infrastructure program. Utilities will continue to take its cue from the power sub-sector as more power plants are expected to commence commercial operations within the year. Across services sub-sectors, growth will remain firm due to the favourable prospects of from wholesale and retail trade, renting and business activities (notably from BPOs), and other services particularly those related to tourism such as hotels and restaurants, as well as recreational activities. 11. Over the medium-term, the administration is aiming for gradual acceleration of GDP growth towards 7.0 to 8.0 percent, supported by institutional reforms such as a Page 4 of 6

comprehensive tax reform, sustained investments in infrastructure, easing of restrictions on foreign investments, and reduction in the cost of doing business in the country. IV. Policy Issues and Uncertainties 12. Despite the economy s positive outlook in the medium term, authorities remain vigilant about the downside risks to growth. On the external front, we see slow recovery from major economic partners, such as the United States, Japan, and the European Union. Moreover, China s economic rebalancing, and hence, a slowdown in its demand, has also affected the country s growth forecasts. The IMF expects a more gradual growth in the world economy, in particular, the US economy is estimated to grow just a bit higher in 2016 and 2017 to 2.2 and 2.5 percent, respectively from 2.4 percent in 2015; China to decelerate from 6.9 percent in 2015 to 6.6 percent in 2016 and 6.2 percent in 2017; and Japan to decelerate from its 0.5 percent growth in 2015 to 0.3 percent 2016 and contract by 0.1 percent in 2017. 3 Moreover, asynchronous monetary policies in major developed economies, such as the effect of a possible Federal Reserve tightening of its monetary policy, negative interest rates in Japan and other EU economies, and impending exit of the United Kingdom from EU, could raise volatility of capital flows, particularly portfolio capital. Meanwhile, low oil prices and weakness in the economies in the Middle East have affected the earning potential of overseas Filipinos. Moreover, a sudden turnaround of oil prices or a sudden jump could affect consumer spending in the country. Another risk is the maritime dispute in the West Philippine Sea or South China Sea. External Domestic Table 3. Downside Risks to Growth Fragile growth in developing economies, such as the US, Japan, and EY Slowdown in large emerging economies, particularly China Asynchronous monetary policies in major developed economies, which could raise volatility of capital flows, particularly portfolio capital Geopolitical tensions in the Middle East Maritime dispute in the West Philippine Sea Natural hazards including the El Niño and La Niña phenomenon Delays in peace process Delays in infrastructure and reconstruction projects Logistics bottlenecks Closure of mines Domestically, we continue to be concerned about: natural hazards including the El Niño and La Niña phenomenon and the ability of the country to cope with droughts and floods; delays in the peace process and handling of insurgents; and delays in infrastructure and reconstruction projects. Logistics bottlenecks also remain an issue, requiring a long-term solution. Lastly, our thin power reserves presents a risk, especially given the potential impact of El Niño on hydropower. V. Summary Table for Forecast 13. Real GDP growth is projected to grow by at least 7.0 percent until 2018. Strong domestic absorption remains as the key driver of the economy with a projected build-up in fixed investments due to the huge appetite of the manufacturing sector. Private and public 3 Latest IMF estimates as of 12 September 2016. Page 5 of 6

consumption expenditures are expected to grow robustly due to better employment opportunities, sustained remittance inflows and large fiscal space. Meanwhile, services will continue to grow due to the surge in inbound tourists, real estate and BPO expansion, growing retail market and expansion of financial institutions. Table 5. Summary Real GDP Growth Projection, 2016-2018 ITEMS 2016 2017 2018 GROSS NATIONAL INCOME 5.7 5.8 6.6 GROSS DOMESTIC PRODUCT 6.0 6.5 7.0 Net Primary Income 3.8 2.4 4.8 EXPENDITURE SIDE Household Final Consumption Expenditure 6.1 6.6 6.9 Government Final Consumption Expenditure 8.1 5.4 7.1 Gross Domestic Capital Formation 10.7 12.6 11.4 Exports 5.0 6.2 7.1 Imports 11.3 8.4 9.3 PRODUCTION SIDE Agri., Hunting, Forestry and Fishery -1.8 4.0 2.5 Industry 7.6 7.1 8.5 Services 6.4 6.5 6.8 Page 6 of 6