ECONOMISTS expect local financial markets to rebound this year following a challenging 2018 even as uncertainties both at home and abroad remain.
“In the last three months of 2018, financial markets were weighed down on the domestic front by: rising domestic inflation and interest rates; the moderation in the Philippine economic outlook; and expectations of the delayed approval of Philippine Government’s budget. At the same time, on the external front, slowing global growth due to fresh geopolitical tensions and normalizing US [Federal Reserve] monetary policy also helped dampen investor sentiments,” the Bangko Sentral ng Pilipinas (BSP) said in an email to BusinessWorld.
In the fourth quarter, the peso averaged P53.26:$1, appreciating 0.52% from the previous quarter’s average of P53.54:$1, BSP data showed. Meanwhile, a separate data by the Department of Finance showed the peso depreciating by 5.43% to the US dollar by yearend to P52.56, marking the fourth-worst performance among 12 Asian currencies after India’s rupee (9.23%), Indonesia’s rupiah (6.16%) and China’s yuan (5.69%), and faring worse than a 3.03% average depreciation among the currencies covered.
Meanwhile, in the secondary market, government debt yields for all maturities increased in December 2018 by a range of 175 bps for the 25-year tenor to 301.5 bps for the one-year paper compared to the same period in 2017, according to data from the Philippine Dealing & Exchange Corp.
For equities, the Philippine Stock Exchange index (PSEi) closed the fourth quarter at 7,466.02, up 2.6% from the third quarter and an improvement from the third quarter’s 1.2% gain.
The PSEi opened the quarter on a downtrend as it reflected global trends that were mostly driven by the ongoing US-China trade war and subdued global economic growth. A slight rally was observed in November but was tempered following concerns of a reenacted national budget. Local shares finally rebounded in December on news of slowing domestic inflation and the cooling off of trade tensions between the world’s two biggest economies.
The national government has been operating under a re-enacted budget with the latest spending plan yet to be signed by President Rodrigo R. Duterte, since Congress ratified the 2019 budget only last Feb. 8 following months of bicameral bickering over alleged irregular fund insertions. This has left new programs and projects unfunded at least for the first quarter – which would likely hurt growth for the period.
At the external front, the last three months of 2018 saw the US Fed raise its benchmark interest rate by a quarter-point – the fourth time in 2018 and the ninth since it began normalizing rates in 2015. The US central bank forecasted two more rate hikes this year, lower than the three rate hikes that was previously expected.
Lingering geopolitical risks also continue to affect the market. “The continued trade tensions between the US and China, fresh geopolitical tensions between the US and several other counties like Iran, North Korea, and Syria weighed on markets,” the BSP said.
“In December, rising optimism over possibly warmer trade relations between the United States and China following their decision during the G20 Summit to suspend the imposition of new tariffs until January next year and positive comments made by President Trump on reaching a trade deal with China provided a boost to markets in the last month of the year,” the BSP added.
WORST IN DOMESTIC INFLATION ALREADY SEEN
Last year saw inflation picking up for nine straight months, peaking at a nine-year-high 6.7% in September and October before easing to 6% in November and 5.1% in December. This brought the full-year 2018 average at 5.2% against the Bangko Sentral ng Pilipinas’ (BSP) 2-4% target range for 2018 and was the fastest since 2008’s 8.2%.


This easing trend prompted central bank officials to keep interest rates steady in their Dec. 13 meeting with expectations that inflation will decelerate over the next two years. Likewise, the market expects inflation to be on its downward trend amid dropping world crude oil prices as well as normalizing food prices.
Prior to the December decision, the BSP raised interest rates five consecutive times since May, with two straight hikes worth 50 basis points (bps) launched in August and September as inflation surged followed by a 25-bps increase in its Nov. 15 meeting.
For 2018, benchmark interest rates have risen by a total of 175 bps, with the key policy rate now at 4.75% — the highest in nine years.
Economists are in agreement that inflationary pressures would ease this year.
“Average inflation is projected to revert to the target range in 2019 at 3.2% (from 3.5%) and 2020 at 3% (from 3.3%),” the BSP said.
The central bank attributed the downward adjustment primarily to the decline in global crude oil prices, the lower-than-expected inflation in November last year, the approved rollback in jeepney fares, and the monetary policy adjustments that led to a stronger peso and slower domestic liquidity growth.
Dubai crude, which is the benchmark for local fuel prices, averaged $66.70 per barrel (/bbl) in the fourth quarter, 9.9% down compared to the previous quarter’s $74.03/bbl average. The last three months saw the oil price peak at $83.95/bbl in Oct. 3 before settling at $53.02/bbl by the last day of 2018.
ING Bank N.V. Manila senior economist Nicholas Antonio T. Mapa said that aside from easing oil prices, inflation will likely slow down on base effects and lower food prices through the rice tarrification law: “All in all, we expect inflation back within target by early second quarter 2019,” he said.
For Rizal Commercial Banking Corp. (RCBC) economist Michael L. Ricafort, “the worst in inflation has already been seen.”
When inflation was rising in the early part of 2018, the local financial markets posted declines in terms of price. Now that inflation has already sustained its declining trend, the local financial markets have already bottomed out and led to further price gains,” he added.
For Mr. Ricafort, the inflation rate could go down to average 3.5% or even lower once the tariffication law takes effect in the early part of 2019.
“With the sustained decline in inflation rate, local interest rates could fundamentally continue to go down as well, leading to lower bond yield, higher prices of equities, and a stronger peso,” he said.
President Rodrigo R. Duterte signed into law the rice tarrification bill earlier this month. The law effectively liberalizes the import process for rice while taking away the role in importing of the National Food Authority. In place of the old system, private importers will pay a tariff of 35% on grain shipped from Southeast Asia, raising revenue for the government and also funding a rice industry competitiveness fund.
Emilio S. Neri, Jr., lead economist at the Bank of the Philippine Islands (BPI) said that with the possibility of inflation returning to the BSP target and with sustained economic growth, the central bank has “little reason” to adjust key rates throughout this year.
“We think that reducing the policy rate is still premature considering the uncertainties abroad which could lead to a sharp peso depreciation. The current level of rates allows the central bank to prevent foreign exchange volatility while it rebuilds its foreign reserves,” he said.
The BPI economist said that the BSP will “likely pick low hanging fruits” before cutting policy rates. Among these include cutting the reserve requirement ratio (RRR) by two percentage points or more this year and non-sterilized purchases of foreign currencies in the spot foreign exchange market.
“Even without a premature cut in the BSP’s policy rate, we expect benchmark interest rates to drop to more accommodative levels in 2019 given the RRR cut and GIR (gross international reserves) purchases of the BSP. This should allow both the public and private sectors to carry on with their much needed expansion projects to help the Philippines catch up with its richer ASEAN neighbors,” Mr. Neri said, referring to the Association of Southeast Asian Nations.
“The biggest risk to the rates outlook could come from a significant breach of the government’s fiscal deficit target of 3% and the resulting surge in its borrowing activity,” he added.
Ruben Carlo O. Asuncion, chief economist at Union Bank of the Philippines, Inc. echoed this sentiment: “With the latest US Fed’s very dovish policy stance, BSP is expected to hold policy rates for the first six months this year before considering to cut RRP (reverse repurchase) rates. It seems the priority of BSP is addressing market liquidity while securing price stability after the challenges of 2018.”
The central bank has slashed the RRR in two moves last year and now require universal and commercial banks to hold on to just 18% of their deposits from 20% previously, leaving them with more or less an additional P200 billion which they can lend to borrowers.
This is in line with the late BSP Governor Nestor A. Espenilla, Jr.’s long-term goal to bring back the reserve standard to single-digits by 2023 – around the time his six-year term as central bank chief ends.
The BSP has long clarified that any RRR cut signifies an “operational” change rather than a shift in their policy stance, although market players view it as an easing. Nevertheless, the central bank has put further reserve cuts in the back burner following the surge in consumer prices, which led to the five rate hikes last year.
GDP GROWTH STILL ROBUST, BUT EXPECTATIONS MIXED
The Philippine economy expanded 6.1% in the fourth quarter of 2018 — a pace slower than expectations. For 2018, economic growth averaged 6.2%, missing the downward-revised 6.5%-6.9% government growth target for 2018.
While economists expect economic growth to remain robust this year, their expectations on whether or not the government target of 7%-8% will be met is mixed.
For BPI’s Mr. Neri, growth is expected to grow by at least 6.5% in 2019: “With inflation now in a downtrend, the economy has the opportunity to return to the sweet spot of low-inflation and high growth just as election spending boosts overall demand…,” he said, noting that growth is usually faster in election years.
“The expected decline in long term market interest rates due to lower inflation and the forthcoming [RRR] cuts of the BSP would also support capital expenditures.”
UnionBank’s Mr. Asuncion looks at 2019 economic growth to clock in at 6.8% driven by increased government spending and election-related spending while tagging agriculture and net exports as primary drags to growth.
Meanwhile, RCBC’s Mr. Ricafort looks at the economy growing at 6.5%-7% on account of easing inflation, lower interest rates, higher government spending on infrastructure projects amid plans to exempt these from the election ban and election-related spending, among others.
ING’s Mr. Mapa said that the economy breaching the growth target is possible, but only if the economy “fires on all cylinders” through both monetary and fiscal stimuli.
“[G]iven that economic growth does appear to be losing some steam and with inflation returning back to target, perhaps the BSP can look to afford the economy some breathing space with their price stability mandate safeguarded,” ING’s Mr. Mapa said.
“The budget delay and the election ban may throw a monkey wrench into the fiscal boost and we might have to hope that the economy can quickly absorb the likely ‘back-loaded’ fiscal push in the second half,” he said.
Monetary policy stimulus can help boost consumption and private investments, the ING economist added.
“If it remains in its current not so accommodative state, we can only expect the recent aggressive tightening to continue to feed into the economy and slow it down further given its 9-12 month lag effect,” he added.
The national government has been operating under a re-enacted budget with the latest spending plan yet to be signed by President Rodrigo R. Duterte, since Congress ratified the 2019 budget only last Feb. 8 following months of bicameral bickering over alleged irregular fund insertions. This has left new programs and projects unfunded at least for the first quarter – which would likely hurt growth for the period.
“Without the infrastructure budget of close to about P1 trillion in 2019, the implementation of the ‘Build, Build, Build’ program is expected to slow down. This delay will be detrimental to the nation’s growth performance and likely temper investor sentiments,” the BSP said.
With these developments, how would local financial markets perform in the coming months? Below are the outlooks for each of the key markets.
EQUITIES MARKET
• BSP: “Investor sentiments at the start of 2019 appeared more optimistic. Easing domestic inflation, lower crude oil prices, election-related spending and continued ramping up of infrastructure and capital goods spending point toward stronger domestic demand and earning prospects, providing impetus for a rebound in the equities market in the first quarter of 2019. However, potential challenges to the uptick of local shares include: the late approval of Philippine Government’s budget; the late approval of the US Federal Government budget that resulted in a partial US government shutdown; continuing tensions between the US and China; and the likelihood of further US Fed rate hikes than the two originally forecasted for the year.”
• ING’s Mr. Mapa: “Positive, but with signs of slowing growth both onshore and globally, it will be hard to see the [PSEi] push much further unless we see some form of stimulus, from abroad (Fed turns extremely dovish) or domestically (BSP rate cuts and or strong data).”
• RCBC’s Mr. Ricafort: “Easing inflation and consistent net foreign buying of Philippine stocks since the start of 2019 would support further upside for the local stock market. Lower inflation increases corporate profits and reduces borrowing/financing costs of companies, thereby leading to higher valuations, assuming all other factors are the same.”
• UnionBank’s Mr. Asuncion: “If the inflation continues to ease, a recovery in equities market is expected. The market will be advanced by the strong earnings of domestic companies and the strength of foreign corporations.”
• BPI’s Mr. Neri: “The local stock market may outperform its regional counterparts this quarter given the foreign inflows brought by lower inflation.”
FIXED-INCOME MARKET:
• BSP: “The Philippine bond market is expected to be influenced mainly by issuances of government securities. It is further expected that the government will continue to favor domestic borrowings from foreign sources to limit the country’s exposure to foreign exchange risks.”
“Meanwhile, some corporations might tap the debt securities market to support their funding requirements. This may be limited as we remain a bank centric economy where it is easier and less costly to avail bank financing than to issue bonds.”
“It may be noted that there have been continuing efforts to further develop the Philippine capital markets. For example, the BSP issued Circular 983 that set a zero-percent reserve requirement ratio on repo transactions to encourage more players and in turn enhance price discovery and liquidity in the market. This complements the decision of the Bureau of Internal Revenue (BIR) to exempt repo transactions under the program from documentary stamp tax (DST). These initiatives will reduce transaction costs for the repo market and encourage debt issuances by corporations.”
• ING’s Mr. Mapa: “Likely still to be positive, but rally appears to be past its peak.”
• RCBC’s Mr. Ricafort: “[The] sustained decline in inflation [and a] more dovish US Federal Reserve amid the US-China trade war… would correspondingly lead to the continued easing trend in bond yields, provided that the peso exchange rate remains relatively stable or stronger. Possible cut in banks’ RRR and key policy rates especially if inflation goes back to the 2%-4% target range in the coming months of 2019 could lead to further declines in bond yields.”
• UnionBank’s Mr. Asuncion: “High interest rates tend to encourage investors to invest them in fixed-income securities like bonds. The upward pressure on yields is mainly due to inflation which consequently keeps upward pressure on yields.
• BPI’s Mr. Neri: “Local [government securities’] yields may decline modestly especially on the long end of the [yield] curve because of lower inflation expectations. However, upward pressure may come from the borrowing activities of the government, especially if the [Bureau of the Treasury] does a huge [Retail Treasury Bond] issuance that could tighten liquidity. The yield curve may remain flat this [first] quarter, but it may steepen slightly in the succeeding months once inflation is within target.”
FOREIGN EXCHANGE MARKET
• BSP: “Over the next few months, the peso’s flexibility can partly reflect external developments that may relatively affect local market sentiment. These include: i) shift towards protectionism; ii) faster-than-expected monetary policy normalization in the US; iii) aggressive rollback in financial regulations in the US; iv) greater-than-expected slowdown in China; v) weak demand, low inflation and weak balance sheet in advanced economies; and vi) non-economic factors including geopolitical concerns.“
“However, over the policy horizon, the peso is expected to be broadly stable and reasonably flexible to reflect changing demand and supply conditions in the foreign exchange market. The expected growth in foreign exchange inflows from overseas Filipino (OF) remittances and Business Process Outsourcing (BPO) revenues in 2019 of 3.0 percent and 8.0 percent, respectively; the sustained inflows from foreign direct investments, tourism receipts; the ample level of the country’s gross international reserves; and most importantly, the country’s firm macroeconomic fundamentals are expected to provide support to the peso. Likewise, the credit rating upgrades that the country earned over the last few years and reaffirmed in recent months are expected to sustain market confidence towards the Philippine financial markets and provide stability to the local currency.”
• ING’s Mr. Mapa: “Peso is seen to move sideways with a weakening bias as portfolio inflows are unable to offset current account woes.”
• RCBC’s Mr. Ricafort: “Lower inflation increases the purchasing power of the peso exchange rate versus the US dollar. Consistent net foreign portfolio investment inflows since the start of 2019 [would] also support the peso… This partly offsets the effects of a relatively wider trade deficit.”
“On external factors, a more dovish US Federal Reserve… amid the lingering US-China trade war and the record 35-day US government shutdown that both resulted to slower US economic growth prospects, supported the recent declines of the US dollar versus major global currencies.”
• UnionBank’s Mr. Asuncion: “The peso will continue to depreciate due to this huge infrastructure development. Seasonal and intermittent strengthening periods are anticipated due to the inflows of personal remittances from overseas Filipinos, and service sectors (such as BPO and Tourism).”
• BPI’s Mr. Neri: “[Peso-to-US dollar exchange rate] may trade within the P52:$1 to P53:$1 range in the near term with peso support coming from foreign buying in the local stock market. However, we expect the peso to depreciate in the medium term as fundamentals remain the same, i.e., the country’s substantial trade deficit would continue to drive the depreciation of the peso.” – Marissa Mae M. Ramos