Angelo Taningco
Economist, Treasury Group

Key points

• Disinflation manifests in the US and the euro area; inflationary pressures picking up in China and Japan

• US monetary policy normalization continues; monetary policy divergence arises as monetary policy stance unchanged in other major economies

• US fiscal policy uncertainty remains on lack of progress in tax reform, healthcare and financial regulation reforms pushed; Brexit negotiations initiated

• Inflation falls in May, seen to decelerate further in June; BSP keeps monetary policy settings unchanged, likelihood of future adjustments diminishing

• Record-high consumer confidence for Q2 2017 and faster manufacturing expansion in May bode well for second-quarter’s GDP growth

• Merchandise trade deficit and growth, OFs remittances down in April; might have rebounded in May

• FDI net inflows surge in March and Q1 2017, growth likely to have been sustained in April; FPI net outflows evident in May, likely to persist in June

• BOP at deficit position in Q1 2017, shifts to surplus in April and reverts to deficit in May; deficit likely to stay in June

• GIR rises in May despite BOP deficit, could reverse in June; foreign reserve adequacy remains high

• Fiscal deficit recorded in May, could widen in June

• First tax reform package approved in House of Representatives, to be deliberated in Senate by late July; House’s substitute bill to generate lower government revenues relative to DOF-endorsed version; tax reform’s effects mixed for households

Global Developments

Disinflation manifests in US and in euro area, inflation edges up in China and in Japan. Inflationary pressures have abated in the United States (US) with the headline Consumer Price Index (CPI) inflation rate falling for the third-consecutive month in May to reach 1.9% year-on-year (yoy) from its highest level for the year at 2.7% yoy recorded in February while the core CPI inflation rate dropping for the fourth-consecutive month in May, down to 1.7% yoy for the month coming from 2.3% yoy in the first month of the year (Figure 1a). Likewise, both headline and core personal consumption expenditures (PCE) inflation rates fell for the second-consecutive month in April, to 1.7% yoy and 1.5% yoy, respectively, and are widely expected to decline further in May, consistent with the trend in CPI inflation. The continual weakening of US inflationary pressures over the past couple of months can be attributed to moderating oil prices as well as price decreases in prescription drugs and wireless telephone services.

In the euro area, the headline Harmonised Indices of Consumer Prices (HICP) inflation rate backpedaled in May as it fell 0.5 percentage points from April to 1.4% yoy largely due to slower energy price increases while core HICP inflation declined 0.3 percentage points from the previous month to 0.9% yoy due to lower services inflation.

Figure 1a: Consumer Price Inflation in US and euro area Jan. 2016 – May 2017
(yoy %)

 
Inflationary pressures continued to edge up in the two largest economies in Asia, albeit still weak relative to government’s inflation targets (Figure 1b). In China, consumer price inflation continued its uptick, with CPI inflation up to 1.5% yoy in May, which is the third-consecutive monthly increase. In Japan, the headline CPI inflation rate stood at 0.4% yoy in May, unchanged from April, but its core CPI inflation rate edged up to 0.4% yoy from 0.3% yoy.

Figure 1b: Consumer Price Inflation in China and Japan Jan. 2016 – May 2017
(yoy %)

 
Monetary policy tightens in US, unchanged in other major economies; monetary policy divergence unfolds. The Federal Open Market Committee (FOMC) decided during its 13-14 June monetary policy meeting to raise the target range of the federal funds rate by 25 basis points (bps), the second rate hike for the year and the third since December. The FOMC’s monetary policy decision was made given the committee’s assessment of moderate economic expansion and despite recently declining inflation-which was deemed to be “transitory”-with expectation that its gradual adjustments to its monetary policy stance will lead the economy to expand moderately, the labor market to strengthen further, and inflation to remain below its 2% inflation target in the near term but would reach its target in the medium term. In that meeting, eight of the nine FOMC members voted for the monetary policy action with the lone dissenter being Minneapolis Fed President Neel Kashkari, who preferred to maintain the same rate level largely due to softening inflation.

The FOMC also provided an addendum to its Policy Normalization Principles and Plans, in which the new details encompass caps on the payments of principal the Federal Reserve gets from its maturing securities holdings with the initial cap amounts at $6 billion for Treasury holdings and $4 billion for holdings of agency debt and mortgage-backed securities to be increased in increments of the same respective amounts at 3-month intervals over twelve months to reach $30 billion and $20 billion, respectively.

The Federal Reserve’s latest economic projections that were released following the FOMC’s 13-14 June meeting show revisions to some of its forecasts, specifically, an upward revision in the 2017 US GDP growth rate to 2.2% from its previous forecast of 2.1% made in March; downward revisions to the unemployment rate over the 2017-2019 period; a downward revision to the 2017 core PCE inflation rate to 1.7% yoy from 1.9% yoy; and downward revision to the 2019 median forecast of the federal funds rate to 2.9% from 3.0% (Table 1).

Table 1: Federal Reserve’s Economic Projections
2017 – 2019

 
Following the FOMC’s June 13-14 meeting, various FOMC members and Fed officials have shared their individual views on the future path of US monetary policy. Janet Yellen, Chair of the Federal Reserve and of the FOMC, said on 27 June that it would be appropriate for the FOMC to increase the federal funds rate “very gradually” and to trim the Federal Reserve’s balance sheet “gradually and predictably”. Patrick Harker, another FOMC member and Philadelphia Fed President, stated on 27 June that he still supports a gradual removal of US monetary accommodation and that he sees another rate hike this year and commencement of the Federal Reserve’s balance sheet normalization. In an interview conducted a couple of days earlier, Harker said he prefers the FOMC starts with the balance sheet normalization by September to be followed by another policy rate hike in December.

San Francisco Fed President John Williams on 26 June said the process of US monetary policy normalization will be “gradual, predictable, and transparent”. Meanwhile, St. Louis Fed President James Bullard on the 23rd and 29th of June said the federal funds rate is at an appropriate level given the current economic data, and suggests the FOMC should adopt a “wait-and-see approach” in relation to the policy rate. FOMC member and New York Fed President William Dudley in his 19 June speech gave hawkish comments about US monetary policy, specifying that US monetary policy will continue to tighten “very judiciously”. Charles Evans, FOMC member and Chicago Fed President said on 19 June that the current economic environment of the US supports “very gradual” policy rate increases and “slow preset reductions” in the Federal Reserve’s balance sheet.

We do not think the FOMC will adjust its monetary policy stance in its upcoming monetary policy meeting on 25-26 July; we however believe that it will thereafter decide to again conduct a gradual monetary policy tightening via another 25 bps hike in the federal funds rate as well as commence with its balance sheet normalization process before this year ends.

Meanwhile, other major advanced economies have not adjusted their monetary policy settings in June. For instance, the Governing Council of the European Central Bank (ECB) in its 8 June meeting decided to keep the ECB’s key interest rates and asset purchase program unchanged, reporting the need for inflationary pressures to gain traction via a “very substantial degree of monetary accommodation”. On 27 June, ECB President Mario Draghi explained that even though the central bank’s monetary policy has been effective in raising aggregate demand in the euro area, the transmission of higher aggregate demand to rising inflation has been “more subdued”, and thereby cites the need of persistence and prudence in its conduct of monetary policy. With this, we do not expect any change in ECB’s monetary policy stance in the Governing Council’s upcoming meeting on 20 July.

The Bank of Japan’s Policy Board has decided during its 15-16 June meeting to maintain its monetary policy stance-keeping both its yield curve control and asset purchase program unchanged-in order to attain its core CPI inflation target of 2.0%. Since the actual inflation rate is still way below the BOJ’s price stability target, we expect the Board to decide in its upcoming meeting on 19-20 July to continue with the same monetary policy settings.

US fiscal policy uncertainty remains, financial regulation and healthcare reforms pushed; Brexit negotiations initiated. There’s lack of progress in connection with the tax reform plans of the Trump administration as disputes on how much corporate tax cuts ought to be made are hounding Republican leaders. As US fiscal policy hasn’t changed yet, the International Monetary Fund (IMF) decided to revise downward its US GDP growth forecasts to 2.1% in 2017 (from 2.3%) and in 2018 (from 2.5%).

On healthcare reform, Senate Republicans unveiled their draft bill-known as the Better Care Reconciliation Act of 2017-on 22 June and this aims to end the obligation of individuals and employers to avail healthcare insurance; repeal taxes on insurers and medical device sales; and phase down Obamacare’s Medicaid expansion after 2020. However, it suffered a blow when the Congressional Budget Office (CBO) and Joint Committee of Taxation in Congress have jointly estimated an increase of 19 million uninsured individuals by 2020 to go up to 22 million by 2022. It also estimated a $321 billion reduction in the US fiscal deficit over the 2017-2026 period.

Meanwhile, formal Brexit negotiations between UK and the European Union (EU) were initiated on 19 June, soothing expectations of a -soft- Brexit, which initially was a major concern given the 8 June snap general election results of a hung parliament where no political party including that of Prime Minister Theresa May’s won an election majority.

Philippine Developments

Inflation moderates in May, seen to decelerate further in June. Inflationary pressures abated in May with the headline CPI inflation rate down to 3.1% yoy for the month from 3.4% yoy in April and core CPI inflation at 2.9% yoy in May compared with 3.0% yoy in April. The moderation in headline inflation was brought about by slower price hikes in eight out of eleven commodity groups in the CPI, led by food and non-alcoholic beverages and transport: the contribution of food price inflation to the headline CPI inflation rate fell to 1.4 percentage points in May from 1.6 percentage points in April while that for transport slipped to 0.2 percentage points from 0.3 percentage points in the same period (Figure 2).

Figure 2: Headline and Core CPI Inflation
Jan. 2016 – May 2017
(% yoy)

 
For the month of June, we forecast headline inflation at 2.9% yoy based on our observations of electricity rate cuts and petroleum price rollbacks as well as relatively stable food price inflation and an increase in the cost of education during the month. Meanwhile, the Bangko Sentral ng Pilipinas (BSP) has lowered its inflation forecast for 2017 to 3.1% yoy from 3.4% yoy and maintained its 2018 projection of 3.0% yoy. We still hold our 3.3% yoy inflation forecast for 2017 and penciled in a 3.6% yoy forecast for 2018, as we think stronger inflationary pressures will be present next year once the first package of the tax reform will be implemented by then.

BSP keeps monetary policy settings unchanged, likelihood of future adjustments diminishing. Key interest rates and reserve requirement ratios were kept unchanged by the Monetary Board of the Bangko Sentral ng Pilipinas (BSP) during their 22 June meeting given manageable inflation and inflation expectations firmly anchored to the government’s inflation target range of 3 percent – 1 percentage point. We do not think that the BSP’s Monetary Board will adjust the monetary policy settings in its upcoming meeting scheduled on 10 August. Partly in line with inflation remaining modest, we revise downward our interest rate hike forecast for the year to 25 bps. We still think the hike in key interest rates could manifest later this year especially if inflation gains traction and further US monetary policy tightening occurs in the same period, although we note its likelihood has been diminishing lately.

Manufacturing expansion accelerates in May, likely to be sustained in June. Nikkei Philippines Manufacturing Purchasing Managers’ Index (PMI) rose to a 5-month high of 54.3 in May on the back of monthly increases in the indices for output, inventories, supplier delivery time, and employment (Figure 3). This indicates the sector grew at its fastest pace since the start of the year. Moreover, we think the manufacturing sector will continue to expand in a robust pace in June.

On average, the PMI is higher in the first two months of the second quarter than in Q1 2017, suggesting that the current quarter’s pace may be stronger than the previous quarter. This bodes well for the country’s second-quarter GDP growth since manufacturing gross value added (GVA) accounts for 20% of the overall economic size and that the sector’s GVA growth in the first quarter of 7.5% yoy has contributed 1.9 percentage points to the real GDP growth of 6.4% yoy.

Figure 3: Nikkei Philippines Manufacturing PMI
Jan. 2016 – May 2017

 
Consumer confidence for Q2 2017 a record-high, bodes well for household spending. Consumer confidence for the current quarter posted an index of 13.1%, a record-high as consumers were generally optimistic about domestic economic conditions and their families’ financial situation. However, consumer outlook is mixed, with the index for the next quarter down whereas that for the next four quarters was up (Figure 4a).

Figure 4a: Consumer Confidence Indices
Q1 2007 – Q2 2017
(percent)

 
We think the improvement in consumer confidence for the current quarter will boost household spending growth, especially since our regression model depicts a highly significant and positive relationship between consumer confidence and household consumption growth in the same quarter (Figure 4b).

Figure 4b: Consumer Confidence & Household Spending Growth

 
Labor market improves in April on lower unemployment, underemployment. The labor market improvement was evident in the lowering of both the unemployment and underemployment rates in April, the former at 5.7% from 6.6% three months prior and the latter at 16.1%, the lowest since January 2005 (Figure 5). We calculated the average unemployment rate for the year to be at 6.2%, and thus, we still think there is potential for the unemployment rate to go down further for the remainder of the year; thus, we maintain our full-year unemployment rate forecast of 5.7%. For 2018, we penciled in a 5.5% forecast to the unemployment rate on the belief that the domestic economy will grow faster-with our real GDP growth forecast higher for that year at 6.8% yoy-on the back of more vibrant aggregate demand bolstered by stronger household consumption, healthier business investment, and upswing in government spending given the implementation of the first tax reform package and bigger infrastructure spending.

Figure 5: Unemployment & Underemployment Rates, Jan. 2010 – Apr. 2017
(percent)

 
Trade-in-goods deficit and OFs remittances down in April, could rebound in May. The merchandise trade deficit plunged 20.5% yoy to $2.1 billion in April on positive export growth (12.1% yoy) and a slip in import growth (-0.1% yoy). Merchandise trade growth, however, decelerated to 4.6% yoy in April from 18.0% yoy in March on slower export growth and shift to negative import growth. In January-April, the trade-in-goods deficit was bigger by 2.4% yoy at $8.6 billion given yoy growth in cumulative merchandise exports and imports of 15.3% and 11.1%, respectively (Figure 6). For the month of May, we suspect import growth to have rebounded and export growth remaining steady, and thus, maintaining a deficit position in the merchandise trade balance for the month and thereby widening the cumulative trade-in-goods deficit level.

Overseas Filipinos (OFs) personal remittances fell 5.3% yoy to $2.3 billion in April, with OFs cash remittances down 5.9% yoy to $2.1 billion for the month (Figure 7). We conjecture both the Philippine peso’s appreciation vis-à-vis the US dollar and disinflation were party responsible for the drop in OFs remittances during the month. As a result, the cumulative OFs personal remittances grew 4.7% yoy to $10.0 billion in January-April, with OFs cash remittances up 4.2% yoy to $9.0 billion. We retain our full-year OFs cash remittance forecast of $28.6 billion with growth at 6.5% yoy.

Figure 6: Merchandise Trade
Jan. 2016 – May 2017

Figure 7: OFs Personal Remittances
Jan. 2015 – Apr. 2017
(%)

 
FDI net inflows surges in March and Q1 2017, may have remained strong in April; FPI net outflows posted in May, could persist in June. Foreign direct investment (FDI) net inflows surged in March and in Q1 2017 on the back of foreign investors’ positive sentiment on the domestic economy amid its healthy macroeconomic fundamentals. FDI net inflows soared 30.6% yoy to $509 million in March, leading its Q1 2017 level to reach $1.6 billion, which is 16.6% higher from four quarters ago (Figure 8).

Figure 8: FDI Net Inflows
Q1 2015 – Q1 2017
($ million)

 
In contrast, foreign portfolio investment (FPI) reverted to net outflow position worth $24 million in May from its $51 million net inflow level in April, resulting in a bigger cumulative FPI net outflow level of $540 million spanning the January-May period (Figure 9). By instrument, net outflows in May came from the government securities market potentially arising from expectations of interest rate hikes and that this thwarted the net inflows in the equity market.

Figure 9: FPI Flows
Jan. 2015 – May 2017
($ million)

 
BOP deficit in Q1 2017 and in May, likely to persist in June; GIR rises in May but could slip in June, remains adequate. The balance of payments (BOP) was in a deficit position in Q1 2017 amounting to $994 million (−1.4% of GDP) largely due to a current account deficit (−0.4% of GDP) and net outflows in its financial account (Figure 10). The current account deficit was a result of a trade-in-goods deficit that was partly offset by combined net receipts in trade-in-services, primary income, and secondary income. The financial account’s net outflow position offspring from bigger net portfolio investment outflows compared to combined net inflows in direct investments, financial derivatives, and other investment accounts.

Figure 10: BOP and Current Account
Q1 2015 – Q1 2017
(% of GDP)

 
The BOP then recorded a $917 million surplus in April followed by a $59 million deficit in May, leading its cumulative level to reach a deficit of $136 million in January-May. Meanwhile, the BSP’s gross international reserves (GIR) went up by $51 million in May to end the month at $82 billion; despite the BOP deficit and the GIR’s monthly increase in May, the correlation between the BOP and the GIR’s mom change remains strong and positive (Figure 11). For the month of June, we think the BOP may again succumb to a deficit position given the likelihood of a trade-in-goods deficit and net outflows in its financial account for the month. With this, we expect the GIR to incur a monthly decline in June. Nevertheless, we continue to expect the BOP to post a full-year surplus position with our 2017 and 2018 forecasts at 0.1% and 0.3% of GDP, respectively.

Figure 11: BOP and ∆GIR
Jan. 2014 – May 2017
($ million)

 
Fiscal balance reverts to deficit in May, year-to-date fiscal deficit below government’s target. The fiscal balance reverted to a deficit of PHP33.4 billion in May from a PHP52.8 billion surplus in April as government revenues slipped 3% mom to PHP228.3 billion while government expenditures jumped 43% mom to PHP261.7 billion amid relatively large increase in spending for personal services (ex. mid-year bonus for government employees) and for maintenance of infrastructure facilities and in other operating expenditures, including those for education and health (Figure 12).

The cumulative fiscal deficit for January-May of PHP63.6 billion remains small in comparison to the full-year government’s fiscal deficit target of PHP478.1 billion (3.0% of GDP). We posit a bigger fiscal deficit could be witnessed in June on potential pick up in government spending. However, we believe it would be improbable for the fiscal balance to reach the government target, hence, we maintain our fiscal deficit forecast of 2.0% of GDP for the year. Meanwhile, we believe the government’s infrastructure spending program will start to accelerate next year, and thereby will fuel government expenditures by then; against this backdrop, we are forecasting the fiscal deficit to climb to 2.7% of GDP in 2018.

Figure 12: Fiscal Indicators
Jan. 2016 – May 2017
(PHP billion)

 
First tax reform package approved by House of Representatives, to be deliberated in Senate by July; estimated income effects positive for government, mixed for households. The House of Representatives approved on 31 May the Tax Reform for Acceleration and Inclusion Act (TRAIN) through House Bill (HB) No. 5636, which is a substitute bill that consolidates 55 tax-related bills including HB 4774, which is the mother bill that’s endorsed by the Department of Finance (DOF). A comparison of the potential benefits and costs between the two legislative bills reveal lower net revenues to be generated by HB 5636 (PHP134 billion in 2018, PHP1,164 billion in 2018-2022) versus HB 4774 (PHP157 billion in 2018, PHP1267 billion in 2018-2022) (Figure 13). The DOF intends to promote HB 4774’s provisions in the Senate during its second regular session to open on 24 July.

Meanwhile, the first tax reform package’s potential income effects on households are mixed (Figure 14): according to the DOF’s estimates, the tax reform coupled with tax transfers for the five relatively poor household groups will benefit ten of the fourteen household groups in terms of higher annual take home pay whereas the four-richest household groups will experience a negative change in their respective income levels.

Figure 13: Estimated Government Revenues and Costs from TRAIN, 2018-2022
(PHP billion)

Figure 14: Projected Annual Change in Household Income from TRAIN in 2018
(%)

Philippine Economic Forecast Summary

 
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