As predicted by pre-election polls, Ferdinand Marcos Jr won the Philippines’ presidential election in a landslide victory. Sara Duterte, his running mate and the daughter of the incumbent president Rodrigo Duterte, has been elected vice-president. We see few obstacles at this point that would inhibit Marcos Jr, the son of the former dictator, from proceeding with his political agenda.
Exhibit 1: Fiscal space set to remain limited for several years to come
The election results remove the uncertainty as to who will be ruling the Philippines for the next six years. But there are still questions over what form the incoming President’s economic policies will take, as few details about Marcos Jr’s policy agenda have emerged so far.
That said, we do expect some policy continuity including the “Build, Build, Build” infrastructure programme, with capital outlays worth PHP981 billion (5% of GDP) pencilled in for this year. This bodes well for the investment and construction outlook, despite the rising costs of construction. Macros Jr has also discussed introducing more rice subsidies, likely in the form of cash handouts we have seen already this year, to mitigate the squeeze of higher food prices on household incomes.
Beyond this, and some emphasis on digital infrastructure, the fiscal agenda is unclear. This is likely to leave some businesses and investors sitting on the fence until the new cabinet is formed and a statement on fiscal policy is delivered, which could take up to seven weeks.
Limited fiscal space with the deficit still above 7%
New fiscal policies will come at a time when fiscal space is already very limited. The pandemic pushed fiscal authorities globally to adopt huge fiscal stimulus packages to counter the impacts of COVID-led restrictions on economic growth at a time when revenues also plunged. This resulted in a sharp widening in fiscal deficits. The Philippines was already running fiscal deficits prior to 2020, and the pandemic has pushed the deficit deeper into the red to 7.6% of GDP in 2020. The deficit widened further to 8.5% last year as revenue collections remained meagre amid lower corporate tax rates (Exhibit 1). This is despite a significant proportion of the past two budgets not having been spent due to COVID restrictions on activity.
What’s more, we see scant evidence that the fiscal situation has meaningfully improved in the first three months of this year. Ongoing pandemic-related support and additional cash handouts to help offset the rise in the costs of living have contributed to the average monthly budget deficit in Q1 hovering around PHP106 billion, versus the pre-pandemic monthly average of PHP55 billion in 2019.
The wider fiscal deficit over the past two years has pushed up gross government debt-to-GDP to over 60% as of Q4 2021, from under 40% of GDP pre-pandemic. Authorities are banking on a pickup in economic activity to help contain this metric to 61% by year-end. But while we forecast growth and revenue collections will improve, we still expect both the deficit and overall debt levels to remain at dangerously elevated levels (Exhibit 2).
Exhibit 2: We forecast government debt-to-GDP ratio to peak this year at 63.8%
It’s also possible that Macros Jr announces a more expansionary fiscal agenda than we currently forecast. We anticipate spending of 23.8% of GDP, or PHP5.012 trillion this year, only marginally less than indicated by the FY2022 budget. But the new administration could increase spending on items such as more cash handouts to reduce the rising cost of living facing households or tax relief, without any substantial revenue generating policies or clarity over the path of medium-term fiscal consolidation.
While the additional fiscal spending would support the recovery, it would undoubtedly catch the attention of the major rating agencies. Fitch already lowered the Philippines outlook to negative in July last year. A possible outlook revision by other rating agencies or an outright rating downgrade would push up borrowing costs that have already risen significantly this year, amid tighter global monetary conditions (Exhibit 3). This would weigh on our projected recovery in domestic demand for this year.
Exhibit 3: Monetary conditions have tightened
External vulnerability adds to the downside risks
Further complicating the macroeconomic policy and growth picture is a worsening in the current account deficit. A recovery in domestic demand over 2021 has seen the current account balance swing back into deficit. As a net energy importer, the rise in energy prices has further pushed up import receipts this year. We expect domestic demand, on average, to grow by 7.3% in 2022 as the economy continues to reopen. Meanwhile, although oil and commodity prices are likely to gradually ease over the second half, prices look set to remain high. Overall, we expect import receipts to rise this year.
Conversely, the outlook for exports has softened given the weaker global economic outlook due to the Russia-Ukraine war, US monetary tightening, and the partial lockdowns in China. This will further exacerbate supply chain disruption as well as weigh on Chinese demand for Philippines’ goods. We expect slower export momentum and strong imports will combine to push the trade deficit up to $65.3 billion this year, for which overseas remittances will only partly offset the trade gap. As such, we expect the current account deficit to widen to 5.2% of GDP this year from 1.7% in 2021 – above the five-year average prior to the pandemic (Exhibit 4).
Exhibit 4: Stronger domestic demand and higher commodity prices will weigh on current account deficit
The combination of a larger current account deficit and rising debt will lead to a further deterioration in the Philippines’ external financing position. This leaves it more at risk of large foreign outflows and higher bond yields should risk aversion increase, which is putting the peso under pressure (Exhibit 5).
Exhibit 5: Philippines has one of the lowest external financing buffers in the region
Indeed, a hawkish US Fed, higher global uncertainty due to the Russia war, and Chinese lockdowns have already contributed to a 2.6% depreciation in the peso against the US dollar since the start of the year.
While we expect the Bangko Sentral ng Pilipinas (BSP)—the central bank of the Philippines—will tolerate a weaker peso up to a point, with inflation jumping to 4.9% y/y in April and globally commodity prices still elevated, we have brought forward the first rate hike to June from the third quarter previously. We expect the policy rate to be raised 25bps to 2%, with a further 50bps in rate hikes this year and another 75bps in 2023 (Exhibit 6). This will help limit the narrowing in the interest rate differential with the US, where we expect the US Fed to raise interest rates by a total of 200bps to 2.125% this year, and a further 25bps in 2023.
Exhibit 6: Interest rate differential to narrow in the short term
Still, amid a broadly stronger US dollar and a deterioration in the Philippines’ external financing position, we think the country is more vulnerable to capital outflows in the event of further global risk-off sentiment or market jitters over a possibly expansionary fiscal agenda under the new president. This could prompt a more aggressive front-loading of rate hikes. As such, we believe Marcos Jr will need to balance the risks of a deteriorating external financing position against providing ongoing support for the recovery.
Sian has over 15 years of experience in macroeconomic research and forecasting across emerging markets. She is currently a Lead Asia Economist for Oxford Economics responsible for the forecasts and research across key ASEAN economies. She specialises in macro-modelling and scenario analysis aimed at quantifying risks to the short- and medium-term outlook on different economies. Prior to joining Oxford Economics, Sian worked for Lloyds Bank as the lead emerging market economist. Sian spent the first five years of her career as an economist at the Australian Federal Treasury.