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Philippine Stocks Crash: Symptom of Growing Economic Imbalances

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After three years of bullish run, the Philippine Stock Exchange (PSE) is on the downhill. Featuring among the emerging markets' hottest for almost 12 months, the PSE is now, however, filled with among the most overpriced stocks in Asia and beyond. And quite predictably, investors are desperate to get rid of them. Fund managers have issued "sell" rating on Philippine stocks, signaling more troubles in the days ahead.

It all happened too fast. Since the election of the reformist administration of Benigno Aquino III, the PSE has been on steroids. Thanks to a string of Quantitative Easing (QE) in the West, with central banks desperate to stimulate flailing economies through monetary injections (as opposed to much-needed fiscal expansionary policies) on an unprecedented scale, a capital glut has plagued the global financial markets. This has, in turn, sparked a tidal wave of 'hot money inflow' into emerging markets like the Philippines, whereby record-low interest rates, high economic growth, business (over)optimism and macroeconomic stability has created a new haven for portfolio investors -- as opposed to desperately needed 'green field' investment, primarily to jump-start manufacturing in the country -- eager to make whopping profits overnight.

Since the election of the reformist administration of Benigno Aquino III, the PSE --- repeatedly vaunted by Filipino mandarins as a symbol of rising prosperity and economic resilience -- has beaten expectations year after year, almost breaching the elusive 7,000 points after 84 record-highs. Impressive indeed. But then it crashed. During his speech in the Euromoney Philippines Investment Forum 2013 (EPIF), Aquino made an ambitious bid to attract foreign investments, with the PSE' (pre-crash) performance featuring among his administrations' crowning achievements.

Was the stock crash a shocking development? Not really. The Philippines had it coming, and regulators failed to catch up.

Few months before the PSE nosedive, there were already signs of trouble, with 'insider' reports of fraudulent activities, regulatory capture, and a string of short-run price propositions by opportunistic investors eager to reach new highs. And Filipino officials' proud references to the PSE only encouraged continuous wild runs in the PSE. Stubbornly refusing to learn from the lessons of the 2008 Great Recession, Philippine authorities also pushed for the PSE to seek the help of Singapore Exchange (SGX) to set-up a derivatives market.

The PSE amid External Vulnerabilities

The problem is that the rise of the PSE was accompanied by macroeconomic imbalances. The Philippine Peso (PHP) has been on a relatively steep rise for almost a year, hurting electronics exports, which dipped by a staggering 32 percent early this year. To put this into context, in recent years semi-conductors and electronics have constituted around 40 percent of the Philippines' total exports, which breached the $50 billion mark in 2012. The Philippine government, along other emerging markets such as South Korea, has tried to pre-empt the deleterious impact of rising Peso on exports, but a stubbornly conservative monetary policy has done little to reverse a tide of hot money inflow and currency appreciation. While the government has struggled to attract beyond $1.5 billion in Foreign Direct Investments (FDI), but 'hot money inflow' in January 2013 alone was $2.8 billion. By no means is the country attracting the right kind of foreign investors, at least not yet, to become a true tiger economy.

However, in a telling sign of global investors' premonition of trouble in the Philippines, net portfolio inflow in February actually shrank to a four month-low. But of course, the party went on.

On the other hand, the Philippines may have proven to be relatively more resilient than its peers in the Asia-Pacific region, thanks to booming consumer spending buoyed by a steady inflow of remittances, which the HSBC expects to top 6 percent in this year, but time and again 'external shocks' have slashed Philippines' growth rates. This occurred not only in 2008, but also in 2011, especially due to the twin tsunami-nuclear disasters in Japan and unprecedented flooding in Thailand, which led to large-scale disruptions in East Asian manufacturing production chains, into which the Philippines is firmly integrated. After a decent growth rate in 2010, aided by low-base recovery and the delayed impact of earlier stimulus packages, the Philippines growth in 2011 amounted to only 3.7 percent. For a country that is in the income bracket of $2,000-$5,0000 per head, with an almost 2 percent annual population growth, the Philippines needs to grow between 6-8 percent annually in order to genuinely improve conditions on the ground and steadily raise per capita incomes.

This year, an inconclusive elections in (too-big-to-fail and too-big-to-bail out) Italy, giving birth to a hung parliament in the eurozone's third largest economy, has proven to be a serious 'external shock' to the Philippines, precipitating (along with concerns over profit-taking) the PSE' continuous slide in recent days. On March 12, the bellwether PSE index and the broader all-share index slipped by 0.4 percent, followed by a 1.21 percent dip two days later. The slide has continued since then.

Back to Reality

Admittedly, I have been among the more optimistic analysts, albeit cautiously, with respect to the Philippines' potential to become a real 'tiger economy.' To be fair, I have also -- along other experts and economists -- repeatedly underscored the country's underlying structural economic imbalances and in-built vulnerabilities to external shocks. Slowly, it is becoming clear that my earlier fears of overconfidence and naïve optimism over the country's growth trajectory are coming to fruition.

After a year of better-than-expected economic performance, with the island-nation registering a 6.6 percent GDP growth in 2012, this year started with the bang of rosy-eyed projections. The Philippine government is targeting 6-7 percent growth this year, against the New York-based consultancy Global Source' 6.1%, World Bank's 6.2%, and the First Metro Investment Corp's (FMIC) 7.5-8%. Indeed, quite an upbeat string of forecasts. But more recently the HSBC (despite a slight upgrade) and the Institute of Chartered Accountants in England and Wales (ICAEW) are looking at 5.9 percent and 5.2 percent growth rates respectively .

Latest assessments, perhaps, suggest further downward revisions in coming months, especially in light of PSE' nosedive and growing troubles in the eurozone. What must be noted is that the PSE is far from an accurate indicator of the country's economic realities. Yet, it's recent nosedive indicates greater vulnerabilities lurking beneath the surface.

It's Inclusive-Sustainable Growth, Stupid!

Looking at the Forbes latest annual rich list, the growing fortunes of a narrow clique of Filipino business tycoons provide a better glimpse of the true breakdown of the Philippines economic newfound prosperity. It also underscores the structural imbalances within the economy. There report highlights basically two fundamental problems with the Philippines.

First, far from trickling down, most of the wealth generated by the Philippine economy is confined to the coffers of few enterprising tycoons, with the right connections, ruthless cost-cutting strategies, and impressive business acumen. Lucio Tan and Henry Sy, the country's richest men, control up to 6 percent of the country's GDP, with a combined net wealth of $13.6 billion.

In 2011, Motoo Konishi, Workd Bank's Philippine Director, revealed that their data suggest 40 richest families control up to 76 percent of the GDP - the highest rate of 'wealth concentration' in Asia. By many estimates, 25 percent of the Filipino population is living under $1 per day. Frankly, based on this statistics, it's hard to avoid the impression that the Philippine government is merely a watchman amid the rising tiger drama, while much of the population is a bystander. Robust domestic consumption, a main driver of growth, owes much to encouraging macroeconomic and political stability as well as growing inflow of remittances from about 10 million Filipino Overseas Workers (OFW) spread across the world.

Second, much of the wealth is generated in retail, real estate, tourism, and low- and medium-end services. Meanwhile, manufacturing and agriculture have been neglected. The problem with this situation is that the Philippines is creating value in areas where speculative practices are rampant and income-generation is unstable (as in real estate and tourism), employment-generation is weak or limited (as in retail, tourism and other services), and there is hardly an economies of scale.

In contrast, manufacturing allows a country to create employment for a growing chunk of the population, maximize economies of scale, and ensure the gradual emergence of a vibrant middle class (basically what all the Newly Industrialized Countries have done). Most recent studies indicate that developments in the global economic structure, notably the trade in chains of productions, allows a country to turbo-charge industrialization within a relatively brief period (as in Thailand and China). As for the Philippines developmental paradigm, such strategy is not in the cards. No wonder, the most recent surveys by the Social Weather Station(SWS) suggest that while more people are optimistic about the economy, there has been a decline in employment availability outlook among citizens.

Thanks to a steady improvement in good governance initiatives, intensification of infrastructure projects (notwithstanding delays in actual implementation), and a seemingly irreversible process of democratic deepening, the Aquino administration is highly popular. Yet, in absence of much needed structural economic reforms, the recent PSE crash is just the tip of the iceberg.