Bernardo M. Villegas
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PH Glass More Than Half-Filled (Part 2)

          Dr. Jim Walker of ASIANOMICS is generally positive about Philippine economic prospects.  In my own words, he is of the opinion that the Philippine economic glass is more than half-filled although we have to be keenly aware that it is also partly empty.  Having known him to be one of the most accurate observers of the Philippine economy for over the last twenty years, let me share with our readers his reasons to be only cautiously optimistic about the Philippines. 

         The first reason he cites for more caution is the clear sign of overheating that he sees in the economy.  In his words: “The latest June 2018 consumer price rate—5.2% YoY—is just one signal of the overheating afflicting the Philippines at present.  A worsening trade balance and faltering return on credit are two more indications that fast growth is not always the right route.  In order to sustain the long-term positive trajectory for the Philippines we would be advocating a more cautious approach in the near term.  That would include raising policy rates substantially and cooling the boom for a year or so.  Not that will happen.  Politicians never reverse the boom early enough.  The result will be more aggressive rate rises and a weaker peso (hopefully not a banking sector crisis) than need be the case.  With every boom comes a bust.”

         His main source of unease about the Philippine economy is the very conflicting signals given by the Central Bank about interest rates.  There is general consensus among foreign observers of the Philippine economy (and some local economic analysts) that the Central Bank has been woefully behind the curve.  Interest rates should have been increased much earlier and more frequently.  Both public officials and businessmen should take note of his trenchant observation: “Philippines real lending rates, over the period (2012 to 2018) have been consistently the lowest in ASEAN.  In fact, for most of the last seven years they have been in what we call ‘malinvestment’ territory, i.e. too negative for their own good.  Real lending rates below our threshold of -2% have a tendency to encourage investment spending without regard to future returns.  So far, that unhappy outcome is unfolding.  There is plenty of credit available but the returns on equity are subdued for this point in the cycle.”  For this reason, Jim advises the authorities to raise lending rates by policy action.  If they don’t, real lending rates are likely to rise anyway but more through a slowdown in nominal GDP growth as companies shelve unprofitable expenditure plans and cut capital spending to improve probability.  I would apply this advice especially to high-end real estate investments.  Despite protestations to the contrary, there is already an oversupply of high-end condominium units.  Thanks to POGO (Philippines Offshore Gaming Operations), the glut has not yet led to a real estate bubble.  Thousands of Chinese workers are gobbling off the condominium units.

         Jim rightly points out that POGO is helping to prevent a bubble in the real estate market.  From interviews he had with those in the know, he reports the following:  “Fifty licenses have been granted to predominantly Chinese companies to provide ‘online gaming’, i.e., virtual gambling casinos, which can be accessed by Mainland Chinese employees of these POGOs (the hosts have to be able to speak Mandarin) in Manila.  This has knock on benefits for Philippines companies and discretionary spending in the country. For example, the POGO employees receive paid accommodation.  Chinese online gaming companies have been major buyers in the Manila condo market for the last two years (rescuing developers from a potential market oversupply prospect).  The employees also reportedly make around P50,000 per month.  All of that is available for discretionary spending in the Philippines.”  That may be like manna from heaven for the real estate industry.  But, like the original manna, it can also quickly disappear.  There is no substitute to prudence in monetary policy.  The Central Bank should try to be ahead of the curve, responding to expectations that there will be two more rate increases (one of them could be 50 basis points) and even more next year.  Fortunately, we have Central Bank officials who are flexible enough to admit that they have been behind the curve and adjust to the unfolding inflationary pressures in the coming months.

         Philippine business should especially pay attention to Jim’s analysis of the profit cycle in the Philippine economy.  By analyzing the return on equity in the stock market, Jim came to the conclusion that the news on that front is not good:  “The 2015/16 investment boom has not been profit driven, it has been credit driven.  Unlike almost every other country in Asia, 2015/2016 did not mark the bottom of the profit cycle for the Philippines (even as exports boomed along with the rest of the region).  Despite all of its stellar growth, profit performance has been on the slide since 2012.  This is a classic sign of a malinvestment boom:  capacity is being put in place at a breakneck pace because the returns outlook looks good but it is creating problems such as cost escalation and overcapacity that are crimping overall profitability.  Inadvertently, policy has exacerbated this with efforts to ‘regularize’ employment contracts and raise wages.  In some sectors, real estate, for example, excess supply is producing price competition which, in turn, is damping returns.  From an equity market perspective this is not attractive, in the short run at least.”

         At the micro level, I would suggest that in the ongoing budgeting process of Philippine business, they be more selective in capital budgeting especially in the real estate sector which would include shopping malls and other retailing outlets.    There should be greater emphasis on innovations in technology and ways of doing business that increase productivity and reduce costs of operation in order to improve profitability.  In the same way that growth at the macro level should be accompanied by a more equitable distribution of income, growth at the micro level should not be at the expense of profitability   We are now at the phase of the business cycle in which businesses should show sufficient returns on capital to be able to counter the massive outflow of funds resulting from the strong U.S. dollar.  We should take very seriously the warnings about “malinvestment” given by my friend Jim Walker.  Philippine businessmen should try their best to help convince people like Jim to once more give an overweight assessment to the Philippine capital market.   For comments, my email address is bernardo.villegas@uap.asia.