High Inflation and Rising Political Risk Keep Us Cautious on the Philippines

Philippine inflation is running at its highest since March 2009. The central bank is falling further behind the curve even as political risk is picking up modestly. We are positive on the peso, neutral on equities, and negative on bonds.


President Rodrigo Duterte took office in June 2016 after being elected by a plurality. He won with 39% of the vote, beating out Mar Roxas with 23.5% and Grace Poe with 21%. The incumbent Benigno Aquino III could not run again due to the one-term limit. Roxas’ Liberal Party won the most seats in the parliamentary elections.

Duterte has recently been saying that he might step down. Indeed, he has offered to quit several times since he was inaugurated. His reasons have often changed but right now, it seems to boil down to handing over the reins to someone of his choosing. If Duterte did step down, the presidency would be filled by Vice President Leni Robredo until the next presidential election scheduled for 2022. Midterm elections for the Senate and House will be held in 2019.

Due to a peculiarity in the electoral system, the Vice President is chosen by a separate vote. Vice President Robredo hails from Mar Roxas’ opposition Liberal Party. She won with 35.1% of the vote, beating out independent candidate Bongbong Marcos by only 260,000 votes. Bongbong asked for a recount and lodged a formal protest.   Believe it or not, that manual recount is still going on.

It seems that Bongbong is Duterte’s first choice to succeed him. Bongbong is the son of former dictator Ferdinand Marcos (more on him below). The Marcos family remains popular but polarizing. Bongbong’s sister Imee came under criticism recently for suggesting the nation “move on” and forget about her father’s controversial rule.

Duterte is waging a long-running battle against Islamic extremists in the south. He placed the southern island of Mindanao under martial law in May 2017, and at times has threatened to extend it to the entire nation. His strongman image is reminiscent of Ferdinand Marcos and suggests why Duterte might favor Bongbong as his successor.

The Philippines scores poorly in the World Bank’s Ease of Doing Business rankings (113 out of 190). The best components are getting electricity and resolving insolvency, while the worst are starting a business and enforcing contracts. The Philippines equally poorly in Transparency International’s Corruption Perceptions Index (111 out of 180).



The US annexed the Philippines in 1898 after winning the Spanish-American War. After centuries of colonization by Spain, Filipinos were in no mood to remain under anyone’s yoke. As such, the Philippine-American War began in 1899 as a fight for independence. The war officially ended in 1902 with a US victory, but rebel forces continue to fight in the remote areas until their final defeat at the Battle of Bud Bagsak in 1913.

The US started laying the groundwork for eventual independence for the Philippines with the passage of several acts by the US Congress, but the process was slow. In 1916, Congress passed the Philippine Autonomy Act that was the first formal commitment to grant independence. Congress finally passed the Philippine Independence Act in 1934, which established a firm timeline for the process. Independence was planned for 1944, but this was interrupted by World War II. It was finally granted on July 4, 1946 with the signing of the Treaty of Manila.

Elections were quickly held, and Manuel Roxas became the first president of the newly independent Republic of the Philippines. He won with 54% of the vote. Roxas died of a heart attack in 1948 and was succeeded by Vice President Elpidio Quirino, who completed the term and then won the presidency outright in the 1949 elections.

Quirino ran for reelection in 1953 but was defeated by Ramon Magsaysay. One of Magsaysay’s notable policies was the resettlement of poor northern Catholics into the Muslim south. This eventually led to religious tensions (more on this below). Magsaysay pursued close ties with the US until his death in March 1957 due to a plane crash. Vice President Carlos Garcia finished out the last eight months of the term and then was elected president that year. Garcia ran for reelection in 1961 but was defeated by Diosdado Macapagal.

Macapagal ran for reelection in 1965 but was defeated by former ally and Senate President Ferdinand Marcos. After a successful first term in which he started an ambitious public works and infrastructure program, Marcos became the first president to be reelected in 1969. However, he had to contend with increased student demonstrations and violent guerrilla attacks in the urban areas.

Indeed, the growing communist movement as well as attacks by the Muslim Moro National Liberation Front insurgency led to increasing civil strife. A bomb attack in August 1971 first led Marcos to assume emergency powers and suspend the writ of habeas corpus. Marcos then declared martial law in September 1972 after an alleged assassination attempt on Defense Secretary Juan Ponce Enrile. He immediately imprisoned his political opponents, shut down the press, and basically suspended civil rights.

Despite being given virtually unlimited powers under martial law, Marcos pushed through a new constitution giving him even greater powers. It is widely acknowledged that Marcos committed widespread human rights abuses during his rule. Martial law was officially lifted in January 1981, but Marcos won reelection that year facing only token opposition. Marcos continued his authoritarian rule since most institutional checks had been eliminated. Cronyism and corruption festered.

In 1983, opposition leader Benigno Aquino Jr. was assassinated at the Manila airport as he returned from exile abroad. A snap presidential election was held in February 1986. Marcos beat Aquino’s widow Corazon, but the vote was marred by massive fraud and irregularities. General Fidel Ramos and Defense Minister Juan Ponce Enrile withdrew their support for Marcos. The so-called “People Power Revolution” saw Marcos forced into exile at the urging of the US, and Corazon Aquino became president by the end of that eventful month. A new constitution was passed in 1987.

During Aquino’s term, there were six coup attempts by various members of the armed forces. Those were all quashed, and the Philippines has since seen many peaceful transfers of power.



The economy remains robust. GDP growth is forecast by the IMF at 6.7% in 2018 and 6.8% in 2019 vs. 6.7% in 2017. GDP rose 6.0% y/y in Q2, the weakest since Q2 2015. With growing headwinds on the economy, so we see some downside risks to the growth forecasts.

Price pressures are rising. CPI rose 5.7% y/y in July, the highest since March 2009. Inflation has remained well above the 2-4% target range since March. PPI inflation is accelerating. Although it rose only 1.1% y/y in June, the positive readings come after a protracted deflation period for PPI.

The central bank started the tightening cycle with a 25 bp hike to 3.25% in May. It followed up with a 25 bp hike in June and then a 50 bp hike to 4.0% in August. Next policy meeting is September 27 and another hike then is likely. The real rate currently in excess of -2% is too low.

The fiscal outlook bears watching. Duterte has made good on his pledges to boost spending on infrastructure. However, without any offsetting revenue measures, this will put upward pressure on the deficits. The budget deficit came in at -2.2% of GDP in 2017, and the Bloomberg consensus expects it to widen to -2.8% in 2018 and -2.9% in 2019. We see upside risks to the forecasts.

The external accounts bear watching. The current account deficit was -0.8% of GDP in 2017, and the IMF expects the surplus to narrow modestly to -0.5% of GDP in 2018 and -0.6% in 2019. Exports have contracted y/y for six straight months through June, while imports have been elevated by high oil and energy prices. This is putting further pressure on the trade balance, and the 12-month total of -$35.7 bln in June is the highest on record. As such, we see risks of wider than expected deficits ahead.

Foreign reserves have dropped from their peak but remain relatively high. In July, reserves stood at $76.7 bln, the lowest since June 2012. They cover over 7 months of imports and are equivalent to almost 4 times the stock of short-term external debt. Lastly, the Philippines’ Net International Investment Position (NIIP) is only around -10% of GDP. Overall, its external vulnerabilities are low.



The peso is in the middle of the EM pack after underperforming last year. In 2017, PHP was -0.5% vs. USD and was ahead of only the worst EM performers ARS (-14.5%), TRY (-7%), BRL (-1.5%), and IDR (-1%). So far in 2018, PHP is -6.5% and is in the middle of the pack. Compare this performance to the worst performers ARS (-41%), TRY (-39%), and BRL (-20%) as well as the best performers MXN (+4%), COP (+1%), and THB (flat). Our EM FX model shows the peso to have STRONG fundamentals, and so we expect it to outperform ahead.

USD/PHP traded at a cycle high on July 19 around 53.64 before stalling out. For now, the market has been unable to break above the June 2006 high near 53.65. With pressure on EM expected to continue, we see this pair eventually breaking above and moving even higher. The all-time high near 56.50 from February 2004 is the next target.

Philippine equities are performing close to the wider EM after underperforming last year. In 2017, MSCI Philippines was up 23% vs. 34% for MSCI EM. So far this year, MSCI Philippines is -8% YTD and compares to -7% YTD for MSCI EM. Our EM Equity Allocation Model puts the Philippines at NEUTRAL, and so we expect Philippine equities to continue their middling performance.

Philippine bonds have underperformed. The yield on 10-year local currency government bonds is +118 bp YTD. This is behind only the worst EM performers Turkey (+934 bp), Argentina (+605 bp), Brazil (+168 bp), Indonesia (+160 bp), and Hungary (+134 bp). With inflation likely to continue rising and the central bank forced to tighten further, we think Philippine bonds will continue to underperform.

Our own sovereign ratings model shows Philippines’ implied rating steady at BBB+/Baa1/BBB+. There is still some modest upgrade potential to actual ratings of BBB/Baa2/BBB.