Political uncertainty is likely to rise ahead of the May 2016 presidential elections, as a credible successor to President Aquino remains elusive. However, underlying fundamentals remain strong and should help cushion the country in the upcoming year.
President Aquino is nearing the end of his 6-year term, constitutionally barred from running again. As the official deadline to declare candidacy ended in October, there appear to be only three viable candidates to replace Aquino: Vice President Binay, Senator Poe, and Davao Mayor Duterte. Duterte is running as a substitute for another candidate. The latest polls show Duterte with 38% support, well ahead of Binay and Poe with 21% support each. Aquino’s favored candidate Mar Roxas is trailing as distant fourth at 15%. Poe and Roxas are seen as the most market-friendly choices. Official campaigning starts in February.
Given the ongoing territorial spats with China in the South China Sea, we expect the Philippines to maintain strong relations with the US. The nation also appears to be allying itself with other countries in the region that also object to China’s claims, including Vietnam and Japan.
The economy has held up well, with GDP rising 6.0% y/y in Q3. The IMF expects 2015 and 2016 growth of 6% and 6.3%, respectively. Investment is seen bolstering growth ahead, as the government follows it Public-Private Partnership (PPP) scheme to boost infrastructure improvements.
Price pressures remain surprisingly tame. CPI rose only 1.1% y/y in November, well below the 2-4% target, while core CPI rose only 1.8% y/y. El Nino remains an upside risk to inflation, but so far, the impact has been limited. The food and non-alcoholic beverages component of CPI rose only 1.7% y/y in November, down from a peak of 8.3% y/y in August 2014.
The central bank has remained cautious, keeping the policy rate at 4% since the last 25 bp hike back in September 2014. With inflation risks fairly balanced right now, we see steady rates for the time being. However, the bank could tilt more dovish in 2016 if the economy starts to falter and/or the El Nino risks fail to materialize.
The external accounts remain in healthy surplus. The current account surplus is forecast at 5% of GDP this year and next, up from 3.8% in 2014. Exports are contracting y/y, but the outlook is improving as electronics imports (typically processed for re-export) have recovered sharply in H2 2015. Overseas remittances remain robust, while foreign reserves were $81 bln in November (near all-time highs and covering over ten months of imports).
The budget is in good shape, but the numbers are deteriorating. Revenue growth is slowing, even as expenditures are rising at a nearly 20% y/y pace in recent months. The IMF forecasts a shortfall equal to about -1.5% of GDP this year and -2% next year, up from -0.6% in 2014. However, we think the risks are for a somewhat greater shortfall. Still, our own sovereign ratings model shows the Philippines as A/A2/A. This is well above actual ratings of BBB/Baa2/BBB- and so substantial upgrades are warranted.
The peso is one of the best performers in EM this year, -5.25% YTD against the dollar. This is behind only CNY (-3.6%) and TWD (-3.7%). We believe PHP outperformance will continue in 2016, as our EM FX model shows it to be backed by VERY STRONG fundamentals. Still, the peso will not be immune to the selling pressures on EM. USD/PHP made a new high for this cycle in November near 47.35, the highest since 2009. From a longer-term perspective, charts point to a test of the November 2008 high near 50.17.
Philippine equities have outperformed within EM. MSCI Philippines is down -5.4% YTD, and compares to -17.7% YTD for MSCI EM. This outperformance could ebb a bit, as our EM Equity model has the Philippines at a NEUTRAL position, down from OVERWEIGHT the previous quarter.
Philippine bonds have done all right this year. The yield on 10-year local currency government bonds is up about 25 bp YTD. This is in the middle of the pack. Compare this to the worst performers Brazil (+339 bp), Turkey (+235 bp), and South Africa (+187 bp), as well as the best performers Russia (-329 bp), China (-61 bp), and Bulgaria (-56 bp). With inflation likely to remain low, we think Philippine bonds could start outperforming more.