The Philippines is Buffeted by Stormy Politics and Natural Disasters
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The Philippines is a key participant in Asia’s growth story: one of the few countries that can be described as a former US colony, it has many characteristics that should make investors at least pause to investigate. The US colonial heritage, for one, has left in place an economic culture favoring markets and capitalism. Low-cost, relatively educated, English-speaking labor has meant that Philippine call centers and other business-service providers can compete with India for business from firms that are offshoring their business processes. Extensive mineral deposits can also feed China’s voracious commodity appetite. Nonetheless, political and geographic factors create risks that have handicapped economic performance to below what traditional economic indicators would suggest is possible.
Currently the world’s 12th most populous country, ranked between Mexico and Vietnam, the Philippines is home to 98 million people. Its GDP—US$318 billion in 2008—is roughly the size of Switzerland’s or Austria’s, and a little larger than Hong Kong’s. Nonetheless, with a 2008 per capita GDP of US$3,300, the Philippines is a relatively poor country, comparable to Iraq and Mongolia, and somewhat wealthier than India (US$2,900). In the 1950s, the Philippines was the second wealthiest country in Asia after Japan on a per capita basis. It has progressed since 1950 in terms of wealth and living standards, but several other countries have since overtaken it. Table 1 compares the Philippines to several others.
Table 1: Comparative Data on the Philippines vs. Other Countries
A substantial proportion of Filipinos live abroad, particularly in the US, Japan, and other Asian countries. Remittances represent a substantial economic inflow (about 10% of GDP in 2008), helping to stabilize the currency at the same time that emigration has eased unemployment (7.4% in 2008) at home.
The Philippines was annexed by the US from Spain following the 1898 Spanish-American war, and governed as a US territory until the Japanese invaded in World War II. Recovered in the last year of the war, the US granted the Philippines independence shortly thereafter on July 4, 1946. Although the Philippines is noteworthy for being one of the first decolonizations in the postwar period, and for achieving it through a largely peaceful process, independence did come with some strings attached, notably long-term leases for US military stations and economic commitments not to compete with key American products. The US did provide substantial postindependence reconstruction aid, which helped make the Philippines the second-wealthiest Asian country in 1950, and a relatively warm postcolonial relationship has continued since then.
Like other emerging markets, the Philippines experimented with ISI (import substitution industrialization) in the 1950s and 1960s, but the tariff and exchange-rate controls required by ISI hurt the agricultural and mining sectors, and weakened Philippine terms of trade. By the Marcos era in the 1970s and 1980s, it was clear that state-controlled ISI was not raising living standards, and the economy sank into recession and suffered inflation as high as 50% in 1984.
The People Power Revolution that ended the dictatorship of Ferdinand Marcos in 1986 resulted in a shift away from state-centered development toward more export-oriented growth models. It was easier to make the case for dismantling ISI in the Philippines because it was so closely associated with the endemic corruption of the Marcos regime, and because the sale of public companies provided a source of government revenue other than taxation.
Since Marcos’s expulsion, the Philippines has been governed in a largely democratic manner by presidents supporting an open and liberalized economy, even though progress has been gradual and the banking sector in particular could be more liberalized. Corruption remains a serious challenge at many levels. In 2001 President Joseph Estrada was removed from power following an impeachment on corruption charges. His successor and the current president, Gloria Macapagal-Arroyo, while a capable leader, has been suspected of manipulating her reelection, and there have been a number of unsuccessful coup attempts in the interim that cast some doubts on future political stability.
Figure 1 shows the growth of the Philippine economy from 1981 to 2009. The chart clearly shows the contraction in economic output that eventually led to Marcos’s 1985 expulsion and the subsequent expansion catalyzed by liberalization. The figure also shows the effects of the Asian crisis in 1998 and the slow recovery following. Since 2003 the Philippine economy has continued to expand, and a trade deficit has become a trade surplus in recent years.
Figure 1: Evolution of GDP since 1980
Source: Economist Intelligence Unit (accessed November 17, 2009). Note: The 2009 figures are EIU estimates; the USD base year is 1985.
Figure 2 shows the real GDP growth rate, inflation rate, and several key interest rates from 1980 to 2009. The overall trend for the period has been toward higher growth, lower interest rates, and lower volatility. Inflation has trended downward over time too, although it spiked upward last year, as it did across the rest of the world. Thus, despite political turbulence, economic conditions have been improving steadily over time.
Figure 2: Philippine GDP Growth, Inflation, and Interest Rates (1980–2009)
Source: Economist Intelligence Unit (accessed November 17, 2009). Note: The 2009 figures are EIU estimates.
The Internet and telecommunications revolutions combined with widespread use of English have made the Philippines a key player in modern business outsourcing: call centers, medical and legal transcription, etc. As one of the most mineral-rich countries in the world, mining is a key sector likely to feed into China’s development needs. In manufacturing, the Philippines is a center for electronics and automobile production. Finally, Economist Intelligence Unit research identifies the tourism sector as relatively underdeveloped with high potential. In all these areas, except perhaps business services, the Philippines’ aging and limited physical infrastructure is a major constraint on profitability.
The Philippine stock exchange is relatively small, with a market capitalization of US$52.1 billion at the end of 2008 (CIA World Factbook), down from US$103.2 billion at 2007 year end. Over the last decade, Filipino equities have ebbed and flowed roughly in line with Asia’s fortunes. Ten years ago, in 1999, the Asian financial crisis was in full swing, and the Philippine economy was wracked by both currency depreciation and equity losses as portfolio investors raced out of the country, driven by contagion fears. In the four years from 1999–2003, the stock market lost more than 75% of its value, followed by four years of growth in 2003–2007 delivering more than 450% in total returns. In the current financial crisis, the market experienced a 60% drawdown in 2008, but at the time of writing, it has recovered nearly 80% off of its November 2008 lows. Figure 3 shows the Philippines’ total return performance compared with other regional and global indices.
Figure 3: MSCI Equity Total Return Indices (Gross) in USD
Source: Bloomberg (accessed November 19, 2009). Note: Returns based on weekly closing values normalized to 100 for the week ending January 3, 2004, in order to facilitate comparability with the start of the MSCI BRIC data series. Data as available: April 5, 1997–November 14, 2009.
Figure 4: Risk-Return Chart for Several Equity Indices (January 2001–October 2009)
Source: Bloomberg (accessed November 19, 2009). Note: Return and volatility data based on weekly returns: January 6, 2001–October 31, 2009.
Quantitative analysis from Figure 4 and Table 2 shows that the Philippine equities are relatively nonvolatile compared to other emerging markets and only somewhat more volatile than MSCI’s broadly diversified EM index. Absolute returns have been reasonable over the time frame (based on weekly close data from January 2001 to October 2009). However, the long decline initiated by the Asian currency crisis, followed by the tech bubble burst and September 11th recession, means that the average return is highly sensitive to the data series starting date. (This series starts about halfway through the initial drawdown.)
Table 2: Quantitative Comparison of the Philippines and Several World Markets
Source: MSCI Total Return Indices (Gross) in USD, via Bloomberg (accessed November 19, 2009).
Table 2 indicates that while the Philippine equity index can be acceptable as small allocation to long-only portfolios on an absolute-returns basis, it does appear to underperform most other emerging markets—and even the US—on a risk-adjusted basis, indicated by the Jensen's alphas. Given the sensitivity of the realized return to analysis start dates, the alphas are especially useful indicators.
The Philippines does have an advantage in possessing relatively low correlations to other indices, indicating that, despite a low Sharpe ratio, it can still make sense to include the index as a diversifier in some portfolios. Indonesia and the BRIC index would not benefit from being combined with a long allocation to the Philippines, but other indices in Table 2 likely would.
The Philippines has gone through up and down cycles over the last few decades, and both run-ups and drawdowns have been sizeable. While it is true that the Philippines has not been a dramatic outperformer, it does have its place in a diversified emerging-markets portfolio; the argument for its inclusion is based more on diversification benefits than on outsized returns. There may be an argument for strategies that focus on particular sectors, although many of these are likely already well represented in public indices.
In terms of the macroeconomy, it is clear that much progress has been made toward moderating inflation, keeping government budgets and tax rates under control, and maintaining steady rates of real economic growth approaching 5% per annum, even if those rates look small compared with China’s near 10% growth rate. In quantitative terms, the Philippine macroeconomy looks positive, more stable, and continuing to improve in the long term.
The risks to the economy and—by extension—investments are mostly political and geographic. Although the dictatorship of Ferdinand Marcos was overthrown more than 20 years ago, support for democratic processes is tentative, as demonstrated both in public-opinion polls and in the fact that coup d’état attempts need to be repressed on an almost regular basis. A successful coup, should one occur, is unlikely to result in severely antimarket measures, given the general cultural affinity for markets, but a great deal of policy uncertainty could make investors stampede to the exits.
A key challenge in the Philippines is chronic underinvestment in infrastructure. Keeping budget deficits under control is an admirable feat, but it has come at the expense of infrastructure maintenance and expansion. Key industries such as mining and tourism will not achieve their potential without better infrastructure spending. Corruption among the business and government community is rampant, complicating infrastructure development projects, as well as other aspects of business development.
Finally, the Philippines is located in a region frequently struck by typhoons, and there is increasing volcanic and seismic activity since the reawakening of Mount Pinatubo in 1991. Although disaster-recovery spending nominally increases GDP, the destruction of physical and human capital that prompts this spending means that subsequent growth compounds off of a lower base than if it had not been necessary in the first place. The Philippines is a net loser from global warming: it is threatened by sea level rise, increased storm activity, and increased transport costs. These islands indeed weather a sea of storms.
–Bruce P. Chadwick, PhD, CFA, is principal at Chadwick Consulting, an independent consulting firm specializing in macro strategy, including quantitative, emerging market, and SRI research.