06/25/2013 10:28 am ET Updated Aug 25, 2013

Philippine Stocks Dip: Taming Irrational Exuberance

Enjoying an upward trend in recent years, the Philippine Stock Exchange (PSE) has, in recent months, begun to display bubble-like properties, raising alarm bells among investors and market watchers.

After suffering a cumulative 6% drop in March, the PSE went on to break new records, confidently breaching the 7,000 mark. Then came the mid-June hammer fist, with the PSE experiencing a 442 points drop in a single day, the biggest percentage loss since the Great Recession of 2008 and the biggest points dip in the institution's history. By late-June, the PSE dropped below the 6,100 mark, probably dropping to as low as 5,800 points this year.

The Philippine peso, suffering from over-appreciation for quite sometime, has also seen a sharp drop in its value against the U.S. dollar, limiting investors' ability to adjust accordingly and raising concerns over dollar-denominated debt obligations.

Filipino officials and veteran brokers, in an effort to stymie panic among investors, have adamantly ruled out a sustained downward trend in the PSE, citing the 'strong fundamentals' of the Philippine economy. An outright crash, they correctly point out, is most likely out of question, but what needs to be emphasized here is the broader trend of a massive 'capital outflow' battering emerging markets, from Turkey, and Thailand to Malaysia, India and the Philippines. Giant emerging economies of Brazil and China have also suffered a downward growth forecast. Emerging markets, on the whole, have been under siege, as global investors decouple in anticipation of new opportunities arising from the U.S. Federal Reserve's Quantitative Easing (QE) retreat.

There are basically two lesson to draw here: (a) the Philippines' insulation from global shifts in capital flows is limited, and (b) there is a necessity to establish less risky and more sustainable investment opportunities to channel new wealth and spur endogenous growth.

Far from Insulated

Although touted for its supposed 'resilience' against external shocks, thanks to the government's balanced fiscal sheet, monetary moderation, and stable balance of payments (BOP), it is increasingly clear that the PSE is significantly influenced by global systemic developments, largely driven by monetary policies in center-economies. A more careful look at capital flows shows that external factors largely explain the PSE bonanza in recent memory.

Confronting the prospect of a global depression after the downfall of the Lehman Brothers, a mid-scale institution crucial to the integrity of the global financial chains, the center-economies, led by the Federal Reserve's Chairman Ben Bernanke, opted for a massive expansionary program to stave-off an all out meltdown. Such bold decision successfully averted a global depression, but failed to prevent the emergence of a "new normal": sluggish growth and high unemployment among center-economies. When the emergency funding windows for banks fell short of unclogging the pipes of the global financial system, with bank lending and consumer spending in state of shock, Bernanke opted for a more aggressive approach that, among other things, kept interest rates close to zero and escalated QE. The result was a spike in 'hot money' inflow into emerging markets offering higher yields, including the supposed 'new tiger' economies such as the Philippines.

Recent months, however, have seen a noticeable uptick in the U.S. and Japan, while emerging markets began to stumble. Turkey, for instance, is struggling with a growing trade deficit and massive protests in response to the government's autocratic tendencies, while the likes of Brazil and India have been facing structural constraints restraining growth. The Philippines, meanwhile, saw rising concerns over inflation, but more importantly over imbalanced growth and lingering dismay with the overall climate of investment. The massive protests engulfing key emerging economies such as Brazil and Turkey reflect the dark underbellies of the recent growth spurt in the Global South - perhaps an indicator of what awaits other emerging economies such as the Philippines in absence of inclusive and sustained development.

In contrast, center-economies have begun to experience encouraging trends. In May, the U.S. Consumer Confidence Index reached its highest level (84.5) since the advent of the financial crisis in 2007, with housing investment growing at over 12% in the first quarter of 2013. Boosted by fiscal tightening, the first quarter also saw GDP growth accelerating to 2.4%, considerably higher than the 0.4% growth rate in the previous quarter. Japan's "Abenomics," anchored by a three-prong program of structural reform, fiscal stimulus, and aggressive monetary expansion, boosted investor sentiments and spurred a wild run in the stock markets, with the GDP expected to grow by 1.7% in 2013. Thus, the sudden drop in the currencies and stock market of emerging economies such as the Philippines should be seen as the result of a knee-jerk exodus of investors eying higher yield in a post-QE, recovering U.S.

JPMorgan's index of emerging-market sovereign bonds fell by 6% and the MSCI's emerging-market stock index is down 10% for this year, while the developed markets' jumped by 9%, with private investors selling a record $30.8 billion in Treasury debt in April. In the first quarter, hot money inflow into the Philippines posted an 8.5% year-on-year dip.

The Federal Reserve, however, isn't expected to initiate a steep, sudden rollback in QE, while a stronger U.S. economy bodes well for export-oriented emerging economies in the long run.

Signal for Policy Retooling

The recent boom in the PSE reflected the growing (over)optimism in the country's economic fortunes. So, quite naturally, a dip in the stock markets could theoretically have an impact on or alternatively mirror deficiencies in the real economy -- and, more extensively, affect how global investors view the Philippines' economic potentials.

In terms of policy response, the Philippines has limited options. If it raises interest rates to dampen capital flight, it would further hurt its flagging exports and choke off internal growth. Exports in the first quarter experienced a 6.2% year-on-year drop, with merchandize exports suffering a 12.8% year-on-year decline in April. The country's gross international reserves (GIR), accordingly, plunged to a seven-month low of $82.892 billion. The growth in remittances has also tapered off. So far, it seems that the authorities have opted to maintain interest rates steady and not contain peso-depreciation, primarily concerned with rescuing falling imports early this year. Fears over inflation have withered away, mainly thanks to falling food prices in international markets.

But a major point of concern, not only for investors but policy-makers in general, is the pattern of incongruous growth at home, whereby a relatively sustained period of output expansion and PSE boom has failed to translate into encouraging improvements in pivotal macroeconomic and developmental indicators.

Buoyed by record-high elections spending, the first quarter of 2013 saw the country emerge as Asia's fastest growing economy, with this year's growth projected to exceed 7%, but the same period also saw reversals in manufacturing exports, employment-generation, and hunger-alleviation.

Thus, instead of spinning facts and allaying anxieties over the PSE' dip, the Aquino administration should recognize that not only is the country far less insulated (from external shocks) as previously assumed, but also in need of critical reconfiguration in its economic policy paradigm. Growing volatility in the PSE should be taken as a signal -- a constructive motivation, for that matter -- to revisit fundamental assumptions, in turn ensuring that irrational exuberance is kept under check. After all, the recurrent reversals in the PSE should be taken as a series of delayed self-corrections.

Now, the government, amid the stocks' turbulence, might find little reason in narrowly citing the PSE as the shining symbol of the country's economic turnabout, especially since recession and stock boom can go hand in hand, but that also means that it can now focus on the real economy. Sustainable growth on the ground could spur long-term expansion in the PSE, but absent balanced improvements in the real economy the stock market will be a hostage to the whims of international capital flow and the monetary policies of center-economies. Financial markets are crucial to capitalist development, but their value should be pegged to how they stir sustained growth in the real economy, rather than reflecting the investment mania of few domestic growth sectors and a bunch of casino-style global investors.

We should bear in mind that the former President Gloria Macapagal Arroyo, in her final years in office, was responsible for a set of policy reforms, which allowed the current administration to attain enough fiscal and monetary stability to court an investment grade status. Therefore, the Aquino administration, intent on addressing inherited developmental deficiencies and differentiating itself from its predecessors, should move towards the next phase of reform -- one that ensures a much more systematic, sustained trickling down of economic expansion, decoupled from the irrational exuberance that has dominated the stock markets.