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Monday, October 23, 2017 | MANILA, PHILIPPINES
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   banking report
Date posted: Tuesday, August 30, 2016 | Manila, Philippines

2nd Quarter Banking Report (2016)

FINANCIAL MARKET OUTLOOK: Brexit adds spice to already testy markets

GLOBAL MARKETS again are on the rocks, as advanced economies stumble on their way to recovery from the world’s worst financial crisis this century. And it’s not just governments and central banks that are to blame, but the public as well, as they withhold spending at a time when their economies need it the most.

Financial market volatility picked up in the run-up to the June 23 British referendum on the future of the European Union (EU), the so-called “Brexit” vote. When all the votes were cast, the United Kingdom (UK) opted to leave by a margin of 4% over those wanting to stay within the world’s largest trading bloc. The panic, however, was short-lived after market players realized that the exit process would take two years.

But even long before Brexit, the EU has been battling the pressure of deflation. Running out of options, the European Central Bank (ECB) cut interest rates to negative territory as early as 2014.

This year, the Bank of Japan (BoJ) followed suit. After earlier ruling it out, BoJ Gov. Haruhiko Kuroda surprised the markets in January when he announced below-zero interest rates for the world’s third largest economy. As if this was not enough, Japanese Prime Minister Shinzo Abe’s cabinet approved early this month a $275-billion stimulus package aimed at accelerating infrastructure and fiscal spending. This is in order to revive a slowing economy with falling prices and a greying population.

On the other side of the globe, the US continues to show signs of recovery. However, a supposed rate hike in June (after a series of improving data) was put to a halt when non-farm payrolls increased only by 24,000 from an expected 162,000 jobs. The month of June and July registered better figures of 292,000 and 255,000 respectively, bringing back speculation of at least one rate increase taking place within the year.

MINIMAL IMPACT
The turnout of the British referendum could be a threat to global trade and may even add to the dim outlook for global growth. But the Philippines, for now, remains cushioned against these shocks due to the country’s limited exposure to the UK.

“While the Philippines is not expected to be completely immune from any negative spillovers from Brexit, the direct impact on the real economy should be minimal as Philippine trade with UK as well as remittance business coming from the UK are relatively small,” Bangko Sentral ng Pilipinas (BSP) Governor Amando M. Tetangco, Jr. told BusinessWorld in an e-mail.

In the first half, cash remittances by overseas Filipinos (OFs) based in the UK totaled $694.8 million, down by 6.4% from $742.2 million during the same period last year. UK’s share to the total remittances stood at 5.27%.

“Despite expectations of increased market volatility in the near term, the Philippine economy should be able to ride this out because of strong domestic demand, improved debt dynamics and fiscal condition, as well as adequate foreign exchange reserves,” Mr. Tetangco said.

The country’s gross international reserves (GIR) stood at $85.49 billion as of end-July, enough to cover 10.5 months of imports and payments of services and income. At this amount, the country has the ability to pay sixfold its short-term external debt.

CONTAGION
“What we are more mindful of are the second round effects, i.e., should Brexit have a significant impact on EU’s growth, and even trigger other EU members to leave the EU,” Mr. Tetangco said.

“These could have a more significant impact on Philippine trade. The country’s exports and imports to EU (excluding UK) amount to 11.5% of total exports and 8.5% of total imports,” he said.

Bank of the Philippine Islands (BPI) lead economist Emilio S. Neri, Jr. pointed to three stages of Brexit’s impact should the situation worsen.



“First would be on the direct trade and investment transactions of the Philippines with the United Kingdom. The second level, if the desire [of member countries] to separate spreads to the rest of the EU. Finally, in the financial sectors. We know that London is a very important financial sector and a lot of European financial institutions who have located in London are actually servicing European clients,” Mr. Neri said.

As a trade bloc with a population of more than 500 million, the EU already surpassed the US as the world’s largest economy as early as 2014, with the euro area having a gross domestic product (GDP) of $18.517 trillion, in nominal terms. Last year, this, however, contracted by 12.4% to $16.229 trillion, even as the US economy grew 3.45% to $17.947 trillion.

Second to Germany with $2.85 trillion in GDP, UK comprises 18% of the bloc’s combined output. Its departure would leave the EU with 27 member states. While it may take two years for Britain’s departure to take full effect, candidates for the next “exit” appear as early as now.

Italy, for one, will be holding a referendum on constitutional reform this October that would include limiting the powers of the Senate. A “no” vote could force Italian Prime Minister Matteo Renzi of the Democratic Party to resign, giving way to the euroskeptic Five Star Movement for the next elections.

In France, inroads by the far-right National Front Party led by Marine Le Pen suggest that it could be next in line. With her strong euroskeptic and anti-immigration stance, Le Pen’s popularity continues to grow after a series of terror attacks that killed hundreds since last year.

Other potential contenders for a Brexit-like episode are Greece, Spain, Ireland and Portugal whose seemingly unsustainable debt can either force or prevent them from leaving the EU.

MORE LIQUIDITY
HSBC economist Joseph F. Incalcaterra said that Brexit’s impact may be negative for the global economy and the financial services sector, “but for the Philippines, it can almost be seen as positive.”



“The reason is that global central banks are gonna keep monetary policy even more accommodative far longer. Fed’s not gonna be raising rates so that means we’ll probably continue to see liquidity inflows into the Philippines,” he told a briefing last month.

Jonathan L. Ravelas, chief market strategist at BDO Unibank, Inc., agrees that the Federal Reserve is unlikely to raise interest rates soon.

“The market is not convinced of a hike within the year. But looking at the fundamentals of the US, the tightening labor conditions, rising inflation and modest growth, one cannot discount a rate hike of at least one this year,” he said.

A tightening move by the Fed signals a stronger US economy that could trigger outflows from emerging markets like the Philippines. This liquidity, mainly in the form of portfolio investments, but also fueled by remittances and business process outsourcing (BPOs) earnings, had helped the country achieve manageable inflation and low interest rates.

Portfolio investments, also known as “hot money” given the ease they can be taken in and out of the country, registered $169.63-million net inflow in the second quarter. At the end of the second quarter, money supply had grown by 12.4% to P8.71 trillion from P7.76 trillion a year ago and by 1.96% from P8.55 trillion in the first quarter.

In an effort to make use of the excess liquidity, the BSP last June introduced the term deposit facility (TDF), which allows banks and trust entities to bid interest rates for funds they park at the central bank with seven- and 28-day durations.

Post-Brexit and the delayed Fed liftoff, local bond yields trended downwards as prices rose given the Philippines’ positive landscape. As of Aug. 16, the yield of the 91-day Treasury bill lost 52.14 basis points (bps) since the disappointing release of May US jobs data while that of the 10-year bond dropped as much as 127.78 bps, a reflection of increased appetite for domestic government securities.

“In general, markets tend to view any delay to further Fed hikes as an opportunity for ‘risk on’ trades, which could then mean inflows to EMEs (emerging market economies) like the Philippines,” BSP’s Mr. Tetangco said.

“On the other hand, should the Fed statements indicate more strongly that a hike is forthcoming, that could trigger ‘risk off’ trades, and a global move towards US assets,” he added.

‘GOLDEN AGE’
The country’s plentiful liquidity is also supportive of the Duterte administration’s plan to accelerate infrastructure spending, although there are risks to the country’s surplus position of current account, which measures trade inflows and outflows.

Budget Secretary Benjamin E. Diokno described the Duterte years as the “golden age of infrastructure,” which will require massive importation of materials for construction. The government will allot up to P890 billion next year to build roads, bridges, ports and railways -- a pace that will be sustained for the rest of President Rodrigo R. Duterte’s term.

Infrastructure spending’s share is estimated at 5.2% of GDP for 2017 and is forecast to expand as much as 7% thereafter.

“The one headwind we see is the current account -- we think will moderate over the next two years,” said HSBC’s Mr. Incalcaterra. “[But] for a country like the Philippines which has significant investment requirements, a weaker current accounts surplus is in line with fundamentals.”

He said the Philippines wouldn’t even need external funding in the near future due to ample liquidity: “The Philippines doesn’t need foreign funds right now. There is enough liquidity domestically that can do it by itself. The fact that there’s too much liquidity in the Philippines, it’s an opportunity because it’s not just government debt but also private funding of infrastructure. It necessitates more long-term financing -- corporate bonds and project finance. There’s very little of that in the Philippines still.”

BDO’s Mr. Ravelas agrees that the government has leeway to tap the domestic market given ample liquidity: “Growing out a deficit to at least three percent but investing it for infrastructure, that is a very much needed investment in our country.”

COMPETITIVE PESO
With imports seen accelerating because of the infrastructure build up, the need for more dollars will also increase. Add to that, a series of US rate hikes in the coming years will put downward pressure on emerging currencies like the peso.

As soon as the Fed announced that the US economy was back on track for the normalization of its monetary policy, the foreign exchange has hovered at P47-to-the-US dollar, similar to what happened at the height of the global financial crisis in 2009.

“[But] the weaker peso this year and next year will not necessarily translate to the worsening of the growth trajectory,” said BPI’s Mr. Neri.

“It is not an indication of weakness. It’s actually an indication of competitiveness,” he said, adding that this would make the local currency more competitive.

A weaker peso makes it competitive towards other currencies, and that means it would be more favorable for foreign investors and exporters. BPOs, for one, can benefit from lower labor costs. A competitive peso will provide a lift to exports, which have been contracting since last year due to weak global demand, as well as encourage overseas Filipinos to send home more money, knowing their remittances will enjoy stronger buying power when converted into the local currency.

UPBEAT
“I think Vietnam and India proved that with a weakening currency, you don’t necessarily have to see a decline in the stock market,” said BPI’s Mr. Neri.

“We are at parity with India four years ago, close to 40. Now they’re 67. Is that a sign of weakness? No. The fastest growing economy is India. Second fastest is Vietnam which is also allowing their currency to weaken against the dollar,” he said.

At the start of the year, the Philippine Stock Exchange index (PSEi) dropped to almost two-year lows amid worries over a China slowdown. It has bounced back above 8,000, or the levels achieved in April last year.

Moreover, the Duterte administration’s plan to raise the budget deficit to three percent of GDP on greater spending for infrastructure and social services has brought back confidence to market players.

“All these is keeping the market interested. This is helping the market to be on the upbeat,” said BDO’s Mr. Ravelas, who forecast the main index settling around 8,000 by yearend on expectations of more reforms out of the new administration.

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