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PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas

Vol. XXIV No. 1

DEVEL O PMENT RESEARCH NEWS January - February 2006

ISSN 0115-9097

Driving the Philippine economy in 2006

Editor’s Notes The usual question is: what awaits the Philippines this year?

Josef T. Yap1

For the past years, Dr. Josef Yap has written fearless forecasts for the country and discussed the various issues confronting both the economic and government sectors. He has laid out recommendations to address the ills plaguing the country. This year, as the newly installed president of the Philippine Institute for Development Studies (PIDS) and the fifth since 1978, he delivers a nearly positive outlook for the country. He starts out with a statement of a “less tumultuous” political situation in 2006 compared to 2005. Although the hike in the oil industry will bring down growth prospects, he says that recovery in the agriculture sector and a strong performance of the manufacturing sector will even things out. He also says that a lackluster performance in some areas and a possible reenactment of the 2005 budget will set off negative outcomes. However, Yap still sees the silver lining in these activities and forecasts a generally positive 2006, even seeing an encouraging investor confidence this year. Perhaps, after all the struggles of every Filipino and the Philippine government in 2005, there is much to look forward to in 2006.

New PIDS books ❂

Sustainable tourism: challenges for the Philippines edited by Ramon Benedicto Alampay

Financial liberalization: managing risks and opportunities edited by Ponciano Intal Jr.

Rural finance in the Philippines: issues and policy challenges by Gilberto Llanto

A

fter posting a 6 percent gross domestic product (GDP) growth in 2004, the Philippine economy slowed down last year as widely predicted. However, the 5.1 percent GDP growth in 2005 was significantly lower than most forecasts made at the beginning of the year.2 Poor agriculture performance in the first three quarters of 2005 and the spike in international oil prices were the main drivers of the slowdown. Meanwhile, the unexpected contraction in investment, higherthan-anticipated fuel prices, and heightened political tensions exacerbated the situation, pulling growth below initial forecasts. Despite the uncertainty surrounding political developments and the behavior of oil prices, there is enough reason though to expect that GDP growth will be higher in 2006. Agriculture production is expected to recover, the fiscal situation has improved significantly and should further consolidate after the increase in the value added tax rate, the financial sector has undergone major restructuring and is poised to facilitate greater economic activity, and consumer spending is likely to remain robust. Moreover, on balance, the risk is in the upside since momentum in the last quarter of 2005 is likely to carry over into the first half of 2006 and there is scope for investment to grow. The latter would largely depend on addressing structural factors and improving the macroeconomic environment. While the political situation remains a concern, it should be much less tumultuous in 2006 compared to last year. Developments in 2005 After contributing to economic growth for six consecutive quarters—spanning the last half of 2003 and the whole of 2004—gross fixed investment

1

President, Philippine Institute for Development Studies. The author benefited from the comments and insights of PIDS Past President Dr. Mario B. Lamberte and Jose Antonio R. Tan III. Iris L. Acejo contributed to the box on trends in oil prices. The excellent research assistance of Fatima Lourdes E. del Prado, Merle G. Galvan, and Ma. Teresa Dueñas-Caparas is gratefully acknowledged. The usual disclaimer applies. 2 The writer’s forecast was 5.6 percent GDP growth. The National Economic and Development Authority set a target of 5.7-6.3 percent, which was eventually scaled down to 5.3 percent.


DEVELOPMENT RESEARCH NEWS

Amid the political furor and economic adversity, the manufacturing

sector

managed to post an encouraging growth rate of 5.6 percent in 2005, making the industry the only major sector to manage a higher growth rate compared to 2004.

2

contracted in 2005, declining by 4.3 percent compared to a robust 9.5 percent expansion in 2004 (Table 1). This was the principal reason for the economic deceleration last year. While the investment/GDP ratio has historically been low in the Philippines compared to the other advanced countries in Southeast Asia, the decline for four consecutive quarters in 2005 should be viewed with apprehension. One major reason is that the drop in investment occurred despite improved corporate profitability.3 Investors likely reacted negatively to the sharp rise in fuel prices and political uncertainty. Other possible factors contributing to the disappointing investment performance will be explored in the section on key issues. Meanwhile, growth of personal consumption expenditures slowed to 4.9 percent last year compared to 5.8 percent in 2004 owing to higher inflation, a decline in confidence, higher taxes, and lower income growth. On the production side, the effects of El Niño were more severe than anticipated and the low growth of the agriculture sector extended into the third quarter. Agriculture growth dropped to two percent last year compared to 4.9 percent in 2004. The services sector also slowed down considerably, from 7.1 percent growth in 2004 to 6.3 percent last year. There was a marked deceleration in the transport, communications and storage sector. However, the communications sector maintained its pace, posting an overall growth of 14.8 percent in 2005 compared to 15.6 percent in 2004, allaying fears of ‘digital fatigue.’ The reason for the slowdown of the aggregate sector was the contraction in the land and water transport service sectors. The latter can be attributed to the jump in fuel prices. Meanwhile, the sharp deceleration of communication services in the third quarter of 2005, where growth in value added was only 9.7 percent compared to the average of 16.5 percent in the other three quarters, should be noted. Yearon-year growth for this sector was lowest in the third quarter. This was true of other key sectors— construction, electricity, gas, and water, trade services, and private services—as well as for overall GDP growth. The implication is that the po3

The World Bank in its November 2005 East Asia update, for example, reports that the average return on equity of companies included in the MSCI index is projected to be 12.6 percent in 2005 as compared to 11.4 percent in 2004.

January - February 2006 litical uncertainties that began in June, had a substantial impact on economic activity, particularly in the third quarter of 2005. Amid the political furor and economic adversity, the manufacturing sector managed to post an encouraging growth rate of 5.6 percent in 2005, making the industry the only major sector to manage a higher growth rate compared to 2004. Food manufactures continued their steady expansion, although the six percent growth last year was lower than the 8.8 percent expansion in 2004. This can be attributed to the slowdown in agriculture, rise in oil prices, and lower growth in consumption spending. Meanwhile, the furniture and fixture sector grew by a hefty 30.9 percent. The factors behind this phenomenon were cited in last year’s report: strong growth in the industrialized countries and more innovative designs and better use of traditional materials. Higher oil prices did benefit at least one sector as products of petroleum and coal grew by 23.2 percent. The Philippines was not spared the negative effects of the cyclical slowdown in the global electronics market. Aggregate export growth in dollar terms fell to 3.4 percent and value added in the electrical machinery dropped to 3.0 percent last year, compared to 8.8 percent and 13.6 percent in 2004, respectively. As expected, average inflation accelerated to 7.6 percent last year compared to 6 percent in 2004. The effects of higher oil prices were compounded by the rise in taxes toward the end of the year. As a result, inflation in 2005 stabilized from July to November after falling in June. However, inflation eased to 6.6 percent in December after oil prices fell from record highs and the peso strengthened. The exchange rate resumed its downward trajectory after political jitters subsided. The peso appreciated sharply toward the end of the year aided by the influx of remittances from overseas Filipino workers (OFWs), portfolio capital, and foreign borrowing. Tighter monetary policy also contributed to the strength of the peso. It should be noted that the peso appreciated against the US dollar despite the appreciation of the latter vis-à-vis other major international currencies. Key global developments and issues Global economic activity in 2005 was lower compared to 2004 owing to higher fuel prices, the rise in interest rates, and the cyclical slowdown


3

DEVELOPMENT RESEARCH NEWS

January - February 2006

Table 1. Selected macroeconomic indicators, forecasts for the Philippines in 2006: Annual growth rates and share to GDP (in italics) 2000-2005, at constant 1985 prices 2000

2001

2002

2003

2004

2005

2006 Forecast

Gross National Product

6.9

3.5

4.5

5.6

6.2

5.7

6

Gross Domestic Product

6.0

3.0

4.4

4.7

6.0

5.1

5.4

Agriculture, Fishery and Forestry

4.3

3.7

3.3

3.8

4.9

(share to GDP)

19.78

19.92

20.05

18.42

18.20

Agriculture and fishery Forestry

4.6

3.9

3.7

3.7

4.8

19.64

19.82

19.99

18.35

18.11

-19.5

-27.3

-66.4

23.2

29.8

2.0 2.2 17.50 -36.5

0.14

0.10

0.07

0.07

0.09

Industry Sector

9.0

0.9

3.7

3.8

5.2

5.30

(share to GDP)

35.46

34.76

33.75

31.14

30.84

30.71

Mining and quarrying

11.3

-6.5

51.0

16.8

2.6

9.30

1.48

1.53

1.11 Manufacturing Construction

1.48

1.54

0.05

5.6

2.9

3.5

4.2

5.1

24.39

24.37

24.45

22.65

22.42

26.3

-5.0

-3.3

-2.6

7.4

4.30

6.11

4.52

3.92

3.97

3.91

6.62 Electricity, Gas and Water

1.01

5.60

4.2

0.7

4.3

3.2

4.2

2.50

3.27

3.31

3.03

2.98

2.89

Service Sector

4.4

4.3

5.4

5.8

7.1

6.30

(share to GDP)

44.76

45.32

46.19

43.40

43.77

Transport, communication

10.4

8.8

8.9

8.6

11.2

7.41

7.82

7.55

7.01

Trade

7.90

7.10

5.6

5.8

5.7

6.8

5.80

16.12

16.53

15.52

15.61

15.61

0.9

1.2

3.4

7.1

8.4

15.40

4.80

4.72

4.74

4.51

4.60

5.02

Ownership of dwellings

0.0

-0.5

1.7

4.0

5.3

5.00

and real estate

4.97

4.80

4.74

4.38

4.35

4.32

Government services

5.5 4.5 2 6 6.8

8.00

5.2

Private services

15

44.0

15.72 Finance

5.5

22.38

3.35

and storage

3.8

17.55

4.8

4.4

5.5

5.1

6.7

4.50

7.28

7.38

7.55

7.06

7.09

7.01

1.7

0.9

4.7

2.9

2.2

1.30

5.19

4.88

4.81

4.39

4.22

4.04

5.6 10 4 5 5

Personal Consumption Expenditure

3.5

3.6

4.1

5.3

5.8

4.9

77.30

77.77

78.49

73.43

73.15

72.60

Government Consumption

6.1

-5.3

2.4

0.5

0.0

2.7

(share to GDP)

8.19

7.53

7.03

6.40

6.03

5.86

(share to GDP)

Capital Formation

11.4

13.6

-3.5

0.1

9.5

(4.30)

(share to GDP)

22.08

24.36

20.38

18.52

19.10

17.28

Exports (nominal $)

8.7

-15.6

9.5

2.9

8.8

3.40

Imports (nominal $)

2.1

-5.9

7.2

5.8

10.5

7.10

Inflation (2000=100) (average)

4.0

6.8

3.0

3.5

6.0

91-Day Treasury Bill Rate (average)

9.9

9.9

5.4

5.5

7.3

Nominal Exchange Rate (average)

44.2

51.0

51.6

54.2

56.0

Source:

5.2 5 5 10 12

7.6

6.4.-6.7

6.20

6.5-7.0

55.1

52.2

National Accounts of the Philippines, National Statistical Coordination Board; Selected Philippine Economic Indicators, Bangko Sentral ng Pilipinas; Forecasts of J.T. Yap


4

DEVELOPMENT RESEARCH NEWS

January - February 2006

in the electronics market (Table 2). All these factors were cited in last year’s outlook. However, rapid economic growth in China and India plus the resurgence in Japan have partially offset lower growth in the United States, the European Union, Korea and Southeast Asia. Economic growth in the US fell slightly to 3.5 percent in 2005 after the surge in 2004. Higher fuel prices, tighter monetary policy and the disaster spawned by hurricanes Katrina and Rita contributed to the slowdown. While the impact of the latter was localized, the hurricane damaged refinery production leading to a temporary increase in fuel prices. Nevertheless, economic growth remained robust owing to the bullish housing market, high corporate profitability and strong consumer spending. These same factors are expected to drive the economy in 2006. Japan has been experiencing a resurgence in economic activity. Successful restructuring in the banking and corporate sectors along with high corporate profitability have fueled business investment while higher employment growth has led to a recovery in private consumption spending. However, a mildly deflationary situation still prevails, leading the Bank of Japan to maintain its accommodative stance. The higher differential between domestic and international interest rates has led to a depreciation of the Japanese yen. This is expected to boost net exports, which is expected to contribute more to economic growth in 2006. The mild rebound of the Eurozone economies in 2004 was short-lived. Despite rising net exports and improved corporate profitability, business investment and consumer spending remain sluggish. While the surge in oil prices and short-term political factors—the rejection

Table 2. GDP growth for major industrialized countries and regions

World US Japan Euro Zone

2001

2002

2003

2004

0.8 0.4 1.9

1.9 0.1 0.9

3.9 2.7 1.8 0.7

5.0 4.2 2.7 1.7

2005e

2006f

4.4 3.5 2.5 1.2

4.3 3.5 2.7 1.8

e – estimate; f – forecast Source: World Bank East Asia Update November 2005, IDE-JETRO 2006 Outlook for East Asia

of the EU constitution by France and the Netherlands and the failure to agree on the EU budget—have influenced investor and consumer confidence, the lack of internal dynamism is largely caused by the slow pace of economic reform. In particular, the labor sector is still constrained by structural factors, preventing a rise in labor utilization. This makes it unlikely for many countries to achieve the Lisbon target of an employment rate of 70 percent by 2010. The foremost global economic issue remains to be the trans-Pacific macroeconomic imbalance. This issue was discussed extensively in the two previous outlook papers. To address this global risk, there should be concerted policy action among the US, EU nations, and economies of East Asia. Meanwhile, the renewed surge in oil prices has revived concerns about prospects of stagflation, particularly in developing countries. A more detailed discussion is shown in Box 1, which includes Figure 1. Similar to the issue of global macroeconomic imbalance, addressing the problem of rising oil prices requires concerted action among nations of the world. This would include structural policies to further reduce oil intensity. Key domestic issues: focus on interest rate behavior Many important economic issues have already been presented and discussed in past editions of this outlook. This would include structural factors that have prevented high and sustainable economic growth in the Philippines. Some of these factors—physical infrastructure, sound institutions and good governance—directly affect investment decisions. A summary of constraints based on a World Bank report was presented in last year’s outlook. The discussion was put in the context of nurturing the rebound in private investment. Unfortunately, the recovery in investment spending was not sustained and this can be partly attributed to the persistence of the aforementioned constraints. However, another important factor may be the inconsistent signals sent by monetary and fiscal policy in terms of interest rates. Figure 2 shows the yield curve in the Philippines based on Treasury bill rates. Between 2004 and the last quarter of 2005, interest rates were generally falling. It should also be noted that interest rates in 2004 were rising. The curve in 2005 became steeper in the second half as


DEVELOPMENT RESEARCH NEWS

5

January - February 2006

Box 1. The trend and impact of international oil prices

International crude oil prices—as represented by the Brent price—have risen sharply since the start of 2004 (Figure 1). From $29.62 per barrel, the price peaked at $67.49 at the end of August 2005 before falling to $52.70 at the end of November. However, after this brief respite, oil prices began to climb again and stood at $65.43 on January 31, 2006. The surge in oil prices is not a new phenomenon, with episodes of oil crises occurring in 1973 and 1979. However, earlier spikes in oil prices were primarily supply-driven. When Middle-Eastern countries cut off petroleum exports to Western nations and Japan, the resulting steep oil prices led to higher production costs, lower profit margins and a world recession. The rationing of petroleum imports in the 1970s significantly affected global economic activity. In contrast, the significant increase in crude oil prices since 2003 is largely demand-driven and can be attributed to the increase in consumption of OECD countries and Asian countries, particularly North America and China. Despite lower global economic growth in 2005, the impact of higher oil prices is actually less compared to the 1970s. Moreover, because the recent increase has largely been demand-driven, there have been no major repercussions.Several other factors prevented disastrous effects in the world economy. One, the considerable decline in oil intensity or the average oil consumption per unit of economic output softened the impact of high crude oil prices. Global oil intensity is around 38 percent lower compared to the 1970s.* Moreover, more reliable monetary policy in industrial countries has sustained the confidence in the international currencies. It should also be noted that the current oil price is still approximately 15 percent below the peak reached in 1980 in real terms.Nevertheless, the impact across countries will vary. On the whole, developed countries are less likely to be affected by the oil price hikes compared to developing countries. Important economic features such as the degree of oil dependency, balance of terms of trade, supply of foreign exchange reserves and fiscal conditions will ultimately determine the influence of oil price hikes to an economy. For the Philippines, the surge in oil prices since 2003 raises concerns on the growth and inflationary effects.The Philippines, a heavy importer of crude oil, faces pressure on the peso as the import bill rises. The pass-through of higher oil prices into the production costs of exporting enterprises may possibly create less competitive export products in the world market. In the local markets, this may translate to more expensive domestic goods in an economy already reeling from the recently approved expanded VAT law.Meanwhile, NEDA’s estimate of the price elasticity suggests that every 10 percent rise in oil price results in a 0.2 percentage point reduction in Philippine Figure 1. Crude oil spot prices, 2004-2005 (US$ per barrel) GDP. However, the implementation of various pro80 grams such as energy diversification, demand manage70 ment and energy efficiency use is expected to moderate 60 the country’s dependency on 50 oil and hence temper down oil price hike impacts in the me40 dium-term horizon. 30

20

10

0 1/2/2004 1/17/2004 2/1/2004 2/16/2004 3/2/2004 3/17/2004 4/1/2004 4/16/2004 5/1/2004 5/16/2004 5/31/2004 6/15/2004 6/30/2004 7/15/2004 7/30/2004 8/14/2004 8/29/2004 9/13/2004 9/28/2004 10/13/2004 10/28/2004 11/12/2004 11/27/2004 12/12/2004 12/27/2004 1/11/2005 1/26/2005 2/10/2005 2/25/2005 3/12/2005 3/27/2005 4/11/2005 4/26/2005 5/11/2005 5/26/2005 6/10/2005 6/25/2005 7/10/2005 7/25/2005 8/9/2005 8/24/2005 9/8/2005 9/23/2005 10/8/2005 10/23/2005 11/7/2005 11/22/2005 12/7/2005 12/22/2005 1/6/2006 1/21/2006

*As stated in “Economic Prospects and Policy Issues” International Monetary Fund, September 2005. http:// www.imf.org/external/pubs/ft/ weo/2005/02/pdf/ chapter1.pdf.

Brent

Dubai


DEVELOPMENT RESEARCH NEWS

6

Figure 2. Philippine yield curve

the 91-day rate fell sharply. Two observations can be made based on additional data. First, the yield curve is much steeper than the one prevailing in the US (Figure 3). Moreover, the latter has also shifted upward consistently since 2004 while the reverse is true in the Philippines. Second, while the correlation between the Central Bank (CB) discount rate and inflation has been relatively steady, the correlation between the 91-day Treasury bill (T-bill) rate and inflation has fallen sharply. The 91-day Tbill rate has also declined despite the fiscal probFigure 3. US Treasury yield curve

January - February 2006 lems confronting the Philippine economy. The correlation between the CB rediscount rate and the 91-day Tbill rate has also declined recently (Figure 4). The data presented imply that the level and term structure of interest rates in the Philippines are not grounded on fundamentals, at least in the last two years. Short-term interest rates have been lower than warranted and long-term interest rates have been higher than warranted. In this situation, investors would have likely shifted their funds toward bonds with longer maturities beginning in the latter part of 2004. This would partly explain the fall in investment in 2005. To address this policy inconsistency, the Department of Finance (DoF), particularly the Bureau of Treasury, must adjust interest rates to reflect market conditions. This requires closer coordination between the DoF and the Bangko Sentral ng Pilipinas (BSP). Meanwhile, the BSP must have a good gauge of inflationary expectations in order to calibrate its interest rate policy accordingly. Any over-reaction on the BSP’s part— the risk is on the upside because of the spike in oil prices—will artificially drive interest rates up. One likely result would be an overvalued peso. There are other indicators of inconsistency in macroeconomic policy. One reason the Treasury may have been able to force bids down is because banks are fairly liquid. The data in Table 3 show a consistently falling ratio of gross loans to deposits. However, this situation will reverse once investment picks up and/or banks resume normal lending activity. A major reason why banks have been reluctant to lend has been the relatively high nonperforming loan ratio which peaked at 16.4 percent in December 2001. This has been brought down to single digits in 2005, with the latest figure being 9.2 percent in November. With the expected extension of the SPV law, it is likely that the ratio will fall further. This development augurs well for a revival of bank lending. Proper cognizance of this eventuality should have led to a flatter yield curve. Prospects for 2006 The likely hike in oil prices this year will put a cap on the growth prospects of the Philippine economy. However, the predicted percentage


7

DEVELOPMENT RESEARCH NEWS increase in average oil prices between 2005 and 2006 will be much lower than the increase between 2004 and 2005 (Table 4). This is reflected in a lower inflation forecast of 6.4-6.7 percent. Hence, GDP growth rate this year is expected to be in the vicinity of 5.4 percent, higher than last year’s figure but lower than the government target of 5.7 to 6.3 percent (as shown in Table 1). The sector most affected will continue to be transport services. Value added in this sector is expected to contract further, accompanied by slower growth in trade services. The recent surge in the financial sector and the sustained growth in communications will not be enough to offset the adverse impacts of the oil price increase. Hence growth in the aggregate services sector is expected to fall to 6 percent. The resurgence of the financial sector in the past three years has been due mainly to income from government securities and fee-based transactions. This is consistent with the relatively steep yield curve prevailing in the economy. However, successful bank restructuring has also contributed significantly in the past year. The establishment of the Fixed-Income Exchange Infrastructure is expected to provide a further stimulus to the financial sector.

January - February 2006

Table 3. Ratio of gross loans to total deposits (in percent)

Year

1995 1996

1997 1998

Ratio

95.5 106.9 104.5 97.0

1999 2000 2001

2002

2003

2004

2005

90.3

77.8

79.9

72.4

73.7

85.5

81.2

Note: All figures for December of that year except for 2005, which shows June figure. Source: PDIC

The slowdown in the services Table 4. Average crude oil prices sector will be compensated by the (in USD/barrel) continued strong performance of the manufacturing sector. The new impetus will be the rebound in the global 2004 2005 2006f electronics market as the furniture sector is not likely to experience simiBrent 38.32 54.51 60-65 lar high growth rates in the future. Dubai 33.46 49.44 57-62 Meanwhile, growth in food manufacf tures will be boosted by the recovery forecast in the agriculture sector. Source: Bloomberg Manufacturing will not be the only driver of the industry sector. The mining sector will continue to expand as projects in this area will continue and new investments

Figure 4. Moving correlation among inflation, 91-day T-bill rate, and CB rediscount rate (Value at time t is correlation for past 24 months


8

DEVELOPMENT RESEARCH NEWS

STAFF BOX Editorial Board: Dr. Josef T.Yap, President; Mr. Mario C.

DEVELOPMENT RESEARCH NEWS Vol. XXIV No. 1 January - February 2006 ISSN 0115 - 9097

Feranil, OIC Vice-President and Director for Project Services and Development; Ms. Jennifer P.T. Liguton, Director for Research Information; Ms.Andrea S.Agcaoili, Director for Operations and Finance; Atty. Roque A. Sorioso, Legal Consultant. Staff: Jennifer P.T. Liguton, Editor-in-Chief; Genna J. Estrabon, Issue Editor; Sheila V. Siar, Jane C. Alcantara, Claudette G. Santos, Ma. Gizelle G. Manuel, and Edwin S. Martin, Contributing Editors; Valentina V.

January - February 2006

DEVELOPMENT RESEARCH NEWS is a bimonthly publication of the PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES (PIDS). It highlights the findings and recommendations of PIDS research projects and important policy issues discussed during PIDS seminars. PIDS is a nonstock, nonprofit government research institution engaged in long-term, policy-oriented research. This publication is part of the Institute's program to dissemi-

nate information to promote the use of research findings. The views and opinions expressed here are those of the authors and do not necessarily reflect those of the Institute. Inquiries regarding any of the studies contained in this publication, or any of the PIDS papers, as well as suggestions or comments are welcome. Please address all correspondence and inquiries to: Research Information Staff Philippine Institute for Development Studies Room 304, NEDA sa Makati Bldg., 106 Amorsolo Street, Legaspi Village 1229 Makati City, Philippines Telephone numbers 892-4059 and 893-5705 Telefax numbers (632) 893-9589 and 816-1091 E-mail address: publications@pidsnet.pids.gov.ph Reentered as second class mail at the Business Mail Service Office under Permit No. PS-570-04 NCR. Valid until December 31, 2006. Annual subscription rates are: P200.00 for local subscribers and US$20.00 for foreign subscribers. All rates are inclusive of mailing and handling costs. Prices may change without prior notice.

Tolentino and Rossana P. Cleofas, Exchange; Delia S. Romero, Galicano A. Godes, Necita Z. Aquino and

Outlook 2006 from previous page

Alejandro P. Manalili, Circulation and Subscription; Genna J. Estrabon, Layout and Design.

are contracted. Construction activity may be adversely affected by the peso appreciation because OFW remittances are a significant source of funding for private residential construction. There is also the uncertainty spawned by the possible re-enactment of the 2005 budget which will restrain government capital expenditures. However, the improved political situation and economic environment should keep growth in construction value added stable. The agriculture sector is expected to revert to its long-term growth rate of 3.5 percent with better weather conditions. There is room though for a higher growth since last year’s base is relatively low. The point forecast used is 3.8 percent. Consumption expenditure will likely climb back to 5.2 percent despite the lower peso equivalent of OFW remittances. The projected rise in the remuneration of government employees, lower inflation, and greater confidence should offset the effects of the higher VAT rate. Meanwhile, predicting the growth of investment

is rather tricky since there has been no major breakthrough in terms of addressing structural problems. This outlook is also constrained by lack of information at the grass roots—i.e. provincial and municipal—level where a substantial part of increased economic activity is taking place. The uncertainty over the national government budget is also another factor. However, it is likely that fixed capital will expand in 2006 because of greater investor confidence and a more dynamic financial sector. The forecast growth rate is five percent. In the external sector, the growth of exports and imports will benefit from the rebound of the global electronics market. Exports are predicted to grow by 10 percent while growth rate of imports will likely increase to 12 percent. The exchange rate should stabilize at around the P52 to P52.50 level since the peso has appreciated significantly in real terms following the nominal appreciation and increase in inflation.4 Any sizeable nominal appreciation beyond P52 will likely cause the peso to be overvalued. DRN

4 Between January and November 2005, the peso appreciated by 9 percent in real effective terms.

Driving the Philippine Economy in 2006  

Vol. XXIV No. 1 January - February 2006 ISSN 0115-9097 The usual question is: what awaits the Philippines this year? P HILIPPINE I NSTITUTE...

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