Philippine Economic Developments and Outlook for 2020

 The Philippine economy expanded by 5.8% in the first 3 quarters of 2019, below the 6-7% target of the
government. The following table shows the growth of the major GDP components during the first 9 months
vs. the same period in 2018.

 Growth slowed down as investment spending weakened. Capital formation contracted for the first time in 7
years as demand for machinery and equipment declined. Corporates may have postponed or scaled down
the purchase of durable equipment given the elevated global growth uncertainties and expectations of
lower interest rates in the coming months. Meanwhile, public construction posted a 13.6% contraction as a
result of government underspending. The budget impasse and election spending ban in the first half of the
year prevented the government from spending on new infrastructure projects. On the positive side,
household consumption recovered as inflation slowed down.
 Among the 3 major sectors of the economy, services outperformed with 6.9% growth. Retail trade grew at a
faster pace with the help of lower inflation, while financial intermediation recorded higher growth given
wider interest margins and trading gains resulting from the bond market rally. The industry sector slowed
down amid the weakness in manufacturing and construction. Global trade uncertainties weighed down
manufacturing growth despite the stability shown by household consumption.

 The country’s economic growth may improve in 2020 despite the global headwinds that could emerge.
Household consumption will likely continue to be the main driver of growth with support from OFW
remittances and manageable inflation. Meanwhile, investment spending may recover on the back of low
interest rates and moderate recovery in public spending. Corporates need to expand their productive
capacity through the purchase of fixed assets in order to meet the requirements of consumers. Hence, the
fundamentals of the economy still provide the necessary conditions for investment spending. Once interest
rates bottom out, businesses may ramp up capital spending once gain and implement the expansion plans
that they postponed in the past months due to expectations of lower financing costs in the future. However,
achieving higher growth in 2020 also depends on the ability of the government to spend on infrastructure.
As we have seen in 2019, delays in the implementation of infrastructure projects could pull down growth
and derail the momentum of the economy.

 Inflation decelerated in 2019 after the rice quotas were removed while global oil prices remained subdued,
with average inflation at 2.4%. As a result, the BSP decided to pursue monetary easing with the intention of
supporting growth. Given the liquidity challenges being faced by the economy, the Monetary Board reduced
the policy rate by 75 bps from 4.75% to 4.00% and brought down the reserve requirement ratio (RRR) by
400 bps from 18% to 14%.

 Inflation may climb back to the 3-4% level in 2020 as base effects from oil and rice disappear. Global oil
prices may rise with upward pressure from changes in shipping regulations and production cuts from oil
producing countries. However, global trade uncertainties may temper the increase in oil prices. BPI’s
average inflation forecast for 2020 is currently at 3.1%.
 The BSP may resume its monetary easing given its expectation that inflation would remain within its 2-4%
target. However, higher inflation in 2020 may prevent the central bank from bringing the policy rate all the
way down to 3% since this may lead to a negative real policy rate (when policy rate is below inflation). Local
financial markets are usually volatile when the real policy rate is negative.

 Short term interest rates may fall if the BSP cuts its policy rate further in 2020. Nevertheless, higher inflation
may exert an upward pressure on the long end of the yield curve. Players in the local bond market may take
profit once they see that inflation is on an uptrend once again. Moreover, a recovery in private sector loan
demand and a sizeable issuance of government securities may pressure interest rates to rise. Hence, we
expect yields at the long end of the curve to go higher in the coming months.

 USD/PHP continues to trade in the 50-51 level with the current account still in the negative territory. The
exchange rate moved below the 51 level in 2019 as foreign portfolio inflows supported the local currency.
Foreign fund managers saw the inflation slowdown and the credit rating upgrade given by S&P as
opportunity to enter the local financial markets. At the same time, import growth slowed down as a result of
the delay in the implementation of infrastructure projects, tempering the demand for Dollars and pulling
down the exchange rate. With substantial Dollar inflows from portfolio managers, the BSP’s gross
international reserve climbed to $86.2 Bn in 2019 from a low of $74.7 Bn in 2018.

 The Peso may strengthen in the short term with support from positive trade developments and portfolio
inflows driven by low inflation. However, with the country still having a current account deficit, the
fundamentals still point to a depreciation trend for the Peso in the medium term. A recovery in public and
private sector investment spending may cause a significant increase in imports and Dollar demand in 2020,
which in turn could drive the depreciation of the Peso. While USD/PHP market is closer to the 50 level at
present, we expect a return to the 52-53 level in 2020, reflecting the recovery of investment spending.

Economic Forecasts:

2018 2019F 2020F 2021F

Real GDP 6.2 5.9 6.3 6.3
Inflation 5.2 2.5 3.1 3.3
BSP Policy Rate 4.75 4.00 3.75 4.00
10-YR BVAL Rate 7.07 4.46 5.10 5.80
Reserve Requirement 18.00 14.00 12.00 10.00
USD/PHP (end-of-period) 52.580 50.635 52.900 53.400
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