HIGHLIGHTS OF THE REPORT

The Philippines’ economy posted robust growth in early 2010, in part due to large one-off factors.  As did many countries in the region, the Philippines benefited from a strong rebound in global trade. Manufacturing and investment activity expanded briskly as a result. Private consumption continued to expand, as consumer confidence improved. Growth also benefited from election-related spending. Expansionary (and now pro-cyclical) fiscal policy continued to support growth. Despite a withdrawal of liquidity-enhancing measures and a stronger peso, a closing output gap meant that monetary policy remained accommodative.

Led by emerging markets, the global recovery is under way, but signs of fragility remain; domestic reforms would be a catalyst to higher growth.  While large fiscal risks in some European countries have dampened growth prospects in that region, the global growth outlook remains favorable, especially for emerging markets. In the Philippines, while growth surged in early 2010, it is projected to ease as both monetary and fiscal policies normalize. We project GDP growth of 4.4 percent for 2010 and 4.0 percent for 2011, with risks being equally distributed—on the downside, these are primarily external (linked to developments in Europe), while on the upside they are internal (e.g., progress by the new Aquino government in achieving quick gains against corruption, the introduction of a strong reform program, and fiscal consolidation). Consumption is projected to benefit from better labor market performance, but to receive less support from remittances as their real peso value is projected to be broadly flat (against 10 percent growth in 2009). The inflation outlook is benign given the relatively soft labor market due to a rapid increase in the potential labor force and a stable outlook for key imported commodity prices (e.g., petroleum products and rice).

Remittances are projected to grow by 8 percent in 2010 following the large deployment of emigrants in 2009.  A World Bank study of Philippines migration pattern during the global recession reveals that deployment of overseas foreign workers (OFWs) actually accelerated during the crisis. Partly this reflected the fact that the top OFW destinations were not as affected as the rest of the world. The most affected OFWs were males, production workers (especially construction workers) and new hires. By contrast, females, services workers, seafarers and rehires proved resilient to the crisis or even benefited from it (e.g., demand for Filipino seafarers expanded sharply despite a sharp contraction in the shipping industry).

Globally, less tolerance towards weak public finances is expected, raising the need to introduce a credible medium-term fiscal consolidation plan for the Philippines.  Running a pro-cyclical fiscal policy with relatively high debt and limited fiscal space—as undertaken in the first-half of 2010—raises risks and should be reverted. Credibility towards such a goal could be achieved, for example, by designing a comprehensive multi-year reform package. The Aquino government’s focus on creating fiscal space through higher revenue and expenditure efficiency is welcome and should generate notable gains given the political capital invested in fighting corruption. To further strengthen the government’s goal of reducing the fiscal deficit to 2 percent of GDP within three years, contingency measures could usefully be identified and adopted as part of a comprehensive package. Stronger public finances—including by reducing overall fiscal risks—would enable the Philippines to (1) regain policy flexibility to tackle both downside risks (such as a deepening of the European sovereign debt crisis) and upside risks (such as the attraction of large capital inflows into the region), and (2) create more fiscal space for priority programs. Sound public finances would also provide the BSP with more flexibility in setting policies, as well as in managing such capital flows.

As the output gap closes, the accommodative monetary policy introduced in 2008 would need to be gradually unwound, starting by reaching a broadly neutral stance in 2010.  An increase in policy rates—currently negative or slightly positive—could achieve such a goal.

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