Financial costs trending higher on strong economic backdrop
ING Bank Philippines Senior Economist and Strategist Joey Cuyegkeng is optimistic on the Philippine economic growth. But he cautioned that expectation of higher financial costs due to higher yields and a weak peso are headwinds in the financial markets.
Sustained consumption growth, accelerated government spending, and strong investments will drive the economy to grow 6.5% in the next six years, according to Mr. Cuyegkeng. Looking more closely on investments, he projects that its contribution to the economy will approach 30% of gross domestic product (GDP) in 2020, coming from 26.9% in 2016. He is optimistic on President Duterte’s infrastructure program, which aims to increase infrastructure spending above 5% of GDP in the next few years. As he expects private sector spending to follow suit, he projects the construction sector to register 15.9% annual growth, higher than the 8.6% average annual growth during former President Aquino’s administration.
He highlighted, however, that while these tailwinds will propel growth, the economy will be confronted with headwinds. In the medium term, combined structural inflows from OFW remittances and BPO revenues is expected to normalize to single- digit growth ( 2017-2022), coming from double- digit growth from 2011 to 2014. This is a downside risk to consumer spending that accounts for 70% of the economy. Nevertheless, the government’s effort to seek financing from Japan and China may provide some support to the government’s infrastructure program.
He expects yields to rise as he believes that the monetary policy setting will change from neutral to hawkish in 2017. This is driven by inflation rate moving near the upper limit of BSP’s target ( 2% to 4%) and rising interest rates in the United States. As money supply starts to stabilize this year, inflation pressure will result in higher yields as market players try to maintain positive real interest rates. In the medium term, the government needs to manage its fiscal position more efficiently. Fiscal slippage may lead to higher inflation, need for larger government financing, and less favorable credit rating.
He expects the Philippine peso to depreciate further due to factors both here and abroad. Yields in the US will continually increase with the market pricing in two Fed rate hikes (total of +50 bps) and the Fed looking at three rate hikes (total of +75 bps). Uncertainties surrounding the political landscape in Europe may result in investors buying safer haven assets — a US Dollar positive. In the local front, recent developments in the government resulted in souring sentiment and market commanding higher risk premium. This, together with narrowing current account balance, adds depreciation pressure to the local currency.