The Philippines in 2011: All Eyes on Infrastructure Investment and Inflation

by: Zhong Jin

Inflation in emerging markets is accelerating. China raised its interest rate by 25 bps at the end of the Spring Festival holidays. Indonesia just raised its official interest rate by 25 bps last week, the first time since August 2009. In the Philippines, the January inflation rate surprisingly rose to 3.54% from 3% in December.

The Philippines is one of the few economies in emerging Asia with a favorable demographic trend. Its youth dependency ratio is higher than 0.8 in 2010, one of the highest in the world. Youth dependency ratio is defined as the population aged 19 years and under, compared to the population aged 20−65 years.

The Philippine economy has mostly relied on domestic consumption in the past two decades. In 2008, private consumption accounted for 71% of Philippine GDP, while most other ASEAN countries relied more on export and investment as the engine of economic growth.

Table 1: Consumption in GDP

Household income in the Philippines grew by nearly 20% from 2006 to 2009. More importantly, the income growth is faster in low income groups than that in high income groups in the Philippines. The lowest income group saw household income increasing by more than 28% from 2006 to 2009, while the highest income group experienced a 17% income increase during the same period.

Table 2: Philippine Household Income Growth, 2006-2009

Going forward, the Philippines badly needs more investment to upgrade its poor infrastructure. The current basic infrastructure in the Philippines is so insufficient that it ranked bottom among Asia-Pacific economies according to the World Competitiveness Yearbook 2009. The Philippines clearly has realized this problem and explored its options. In 2011, the Philippine government plans to attract private investments to finance more than (USD) $3 billion in infrastructure projects, including several privatization projects. Transportation has been the dominant sector that received the bulk of the investment. The Department of Public Works and Highways has decided to allocate (USD) $1.4 billion (67% of its annual budget) on road construction in 2011.

Two major IPOs related to infrastructure (Cebu Air Inc. and Nickel Asia Corporation) in 2010 contributed significantly to the record portfolio investment inflow (USD $13 billion) to the Philippines. The 2010 net inflow of portfolio investment also set the record: (USD) $4.6 billion. Two-thirds of the net portfolio investment inflow happened in the fourth quarter of 2010, taking advantage of the infrastructure-oriented development strategy established by the new Philippine government.

Philippine stock market performance in 2010 surely showed that investors had noticed the government’s strategy on infrastructure investments. Upon President Benigno Aquino’s election at the end of June 2010, the Philippine stock market index (PSE) had risen from 3321 to 4413 in early November, a 33% increase in five months. During the same period, USDPHP dropped from 46.56 to 42.27, the lowest level since June 2008.

The Philippine stock market index hit its 2010 peak days after the Philippine currency PHP reached its peak against USD in early November. Since then, both PSE and PHP trended downward. By the end of January 2011, PSE had dropped by 10% from its peak and USDPHP had risen by 5% from its peak in 2010. The correction of Philippine asset prices is not a surprise as the larger trends of emerging economies include rising inflation, tightening monetary policies and risk aversion. “Hot money” had begun to reduce holdings in broad emerging market assets.

The correction in emerging markets is unlikely to end any time soon. The Philippines has more room than many other emerging economies to maneuver and continue its growth. Even when the Philippine January annual inflation rate is up to 3.54%, it still falls into the range of target inflation rates set by the central bank (3.5%-5.5%). Philippine finance secretary Cesar Purisima recently told reporters “I want to send a clear message that inflation fears at this point are unwarranted. When you look at the whole economy, we are in a sweet spot where interest rates are low and inflation manageable. Right now, there is no reason to adjust the policy rate.”

As the biggest rice importer in the world, the Philippines is always vulnerable to food inflation. The latest example was 2008, when local food price inflation surged to 12.8% from 3.3% in 2007 when world rice prices hit a record high. In 2010, the Philippines imported a record 2.4 million metric tons of rice and the official reserve had a huge stockpile of rice. Right now, annual food inflation is 3.06%, still lagging behind the overall inflation, though rising from last month.

Compared with double digit food inflation in China and India, the Philippines right now is indeed in a good position. The investment led growth relies less on external demand. The return of investment on infrastructure is still high in the Philippines as the fixed investment is severely undeveloped. Upgraded infrastructure will in turn improve the long term sustainability of Philippine economic growth. Construction, transportation and utility companies are most likely to benefit from this infrastructure investment boom in the Philippines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.