AT the onset of the Papal visit last week, a major event occurred in Europe that rattled world financial markets. The Swiss Franc was effectively de-linked from the Euro in a surprise move by the European Central Bank. The delinking caused significant negative movements across financial markets around the world. It was fortunate that the Philippine markets were closed for the Papal visit and was spared the impact of the shock. The Swiss Franc has been capped at 1.20 per euro in the last three years as it has been appreciating sharply after the global financial crisis. The capping was to prevent its further appreciation which is hurting its exports. A week after, the markets around the world remain jittery. What does this event tell about the performance of the Philippine financial markets in 2015?
Firstly, it is critical to note that with the integration of the financial economy through the internet, markets are uniquely connected to each other almost in real time. Under this condition, the action of one economy, whether big or small, can cause ripples or shocks as the case maybe. Second, this recent action of the Swiss Central Bank and the corresponding responses of other central banks in the world show that the central banks are no longer aligned. This means that each one is on the lookout for opposing currents resulting to divergence among countries. Finally, it had to be recognized that with this recent event, short term volatilities will be the order of the markets. Under these conditions, our own financial markets are exposed to differing risks and therefore require that market players are well-abreast of fast changing events.
For the Philippines, there are areas where the economy has distinct advantages that may help cushion and compensate for any ripples and shocks. These advantages are uniquely present for the Philippines. For instance, we see that the investment grade euphoria will start to add more expected foreign investments. Foreign direct investment (FDI) most likely reached $6 billion in 2014 and at base scenario would remain the same. Supporting FDI for inflows will be the remittances and business process outsourcing (BPO) contribution. While remittances are reaching maturities of about 4 percent to 6 percent growth per year, the BPO sector is strongly testing 2/3 of total remittances. All of these combined will already add a steady stream of close to $50 billion per year. During the 2009 crisis, we were shielded mainly by the wide distribution of overseas Filipino workers around the world compensating for the weakness in Taiwan and the Middle East. Hence, the economy held on despite massive shocks. This time, the Philippines is in a better position structurally because of the underlying economy and the contributions of the investment grade status and BPO companies.
Furthermore, monetary policy has been prudent with liquidity growth back to single digit levels and the loan growth at 20 percent. What is more encouraging is that loans to production have diversified to more sectors than before assuring a more balanced production growth.
With these conditions, it is very likely that local interest rates will be hovering lower than their current levels. This is more so because we see inflation weakening to even below 2 percent at best scenario. Best scenario assumes that the current oil price levels continue to weaken by one half percent per month and that the port congestion is responded at a much faster rate than current. As regards the peso-dollar rate, the short term will see volatilities but the general direction is that of a weakening considering that the US economy has been rebounding at a sustained pace. This will most likely lead to a tightening of US interest rates within the year. A higher US interest rates may attract funds back to the US. But this is a question of flight to quality. The Philippines is no longer a junk grade economy so it will not necessarily lead to a lot of funds moving out. Besides, the strong compensatory effect of the unique feature of our economy will ensure that any depreciation will be mild and will be helpful to make our exports competitive—this will be a movement between 1 percent to 2.5 percent.
As regards the equities, 2014 saw a banner year with the PSEi hitting more than the 20-percent return. The concern is that if earnings will remain at their current levels, we will be expensive compared with our neighbours. For the last three years (2011-2014), the Philippines is the 13th best performing equities market in the world. There is still room to go up considering that current PE levels of 20 percent is well within the 20 year average. Hence, we see the PSEi moving up by 5 percent at base scenario to 7,600 and a maximum of 10 percent at 8,000. There maybe still room for a Papal Bull Run!
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Alvin P. Ang, PhD, is professor of Economics and senior fellow of Eagle Watch, Ateneo de Manila University’s macroeconomic forecasting unit.