Deutsche Bank On The Philippine Economy: Chicken Little meets Pollyanna

The Philippine Star’s Boo Chanco commented on a recent study by Deutsche Bank on the state of the Philippine Economy with respect to the global economic crisis:

I came across an analysis of the Philippine situation in the context of the global financial crisis that’s the best I have seen so far. It was prepared by Deutsche Bank – Equity Research about two weeks ago. The title of this column today is from that study and I think it captures the picture. I want to share it with our readers in the public interest because it would help them get the proper perspective of where we are at.

See ther rest of Chanco’s comments here.

Below is the Deutsche Bank analysis referenced in Chanco’s article.

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Chicken Little meets Pollyanna

Opinion is sharply divided over how hard the local economy will be hit by global recession.

• Last week the elite Makati Business Club (MBC) reported that 87% of its members surveyed expect the domestic economy to sink into recession in 2009. 60% said they would be retrenching early in the new year.
• At around the same time, a Nielsen survey showed that consumers’ confidence about the future was not only holding but actually improving. What gives? Are consumers in denial, or have businessmen simply lapsed into the “error of pessimism” that typically marks a severe bear market?

Let me tell you about the very rich . . .

Bleak as things may be, we believe that the depressed mood among the upper classes reflects not so much the health of the general economy but the state of their personal investment portfolios. To those who do not yet know it, the financial fallout from sub-prime US mortgages did hit Philippine shores. But it did so under the radar, at the personal rather than corporate level, via private banking channels through which local savings were parked (and lost) abroad.

Quantifying the extent of the wealth destruction involved is tricky, but anecdotal evidence suggests that we are not talking loose change.

• The Philippines is one of Asia’s oldest and largest offshore private banking markets. Given their country’s long history of instability and currency volatility, wealthy Filipinos customarily park a large portion of their liquid assets abroad.
• Foreign banks have in recent years been immensely successful in spreading the joys of investing offshore beyond the usual privileged class. With their annexation of the so-called “mass affluent”, Philippine private assets held abroad have by some estimates risen to a staggering US$60bn, or close to a third GDP (most likely a pre-mark-to-market number).
• Investments in “toxic assets” were many times leveraged in order to “supercharge” returns. Credit was of course provided by the friendly private banks.

It is through these backdoor channels that Filipinos became unlikely lenders to American homeowners, Russian moguls and Kazakhstan banks, the consequences of which we are all too familiar with. But as we are talking about a mere one percent of the population and a small handful of adventurous local banks, the fallout here may be more damaging to animal spirits than to aggregate consumption. After all, in this country, it is unlikely that money parked abroad was ever meant for domestic consumption or investment.

Yes, they had more money

Meanwhile, it is perfectly plausible to tie in the Nielsen consumer survey results with what is going on outside of the collapse in asset prices.

• The “mass non-affluent” classes have little or no savings.
• The end of the “commodity super cycle” has boosted real disposable incomes of the common wage-earner. From their respective peaks earlier in the year, rice prices have halved and oil prices are down 60%. Food comprises 50% of the CPI basket, and fuel and fuel-related products some 12%.
• The Peso’s 20% depreciation against the US Dollar this year is a windfall. In previous cycles, pre-globalization, the average household was a net importer that lost out from devaluation. Today, with an estimated one in four families receiving remittances from relatives working abroad, it is effectively a labor exporting unit. Overseas worker remittances are up 17% in US Dollar terms, year-to-date.

To be sure, unemployment has crept up this year and will likely continue to rise in 2009. But the losses from job layoffs are narrow and specific, whilst the gains from disinflation and higher remittances are more broadly felt.

All told, down at the grass roots, it feels far from a crisis situation. Indeed, in an unexpected way, the global crisis has done more to reduce the gap between rich and poor than the benevolence of the many governments that preceded it.

Will it last?

But will remittances hold up as global recession reaches a crescendo next year? Unlikely, but the maths show that the brunt of the fall-out here could be pushed out onto 2010, by which time the worst for the investment and export sectors may be over.

• The Peso’s depreciation was most pronounced in the last few months. The full year translation effects will hence be most effective next year. Figure 1 below shows that even in the unlikely event that the Peso were to stop depreciating today, it would take a 12% drop in US Dollar remittances for aggregate Peso receipts to decline in 2010.

• Moreover, it is far from certain that Dollar remittances are about to come off just yet. As one might expect at the top of a bull market, an unusually large number of Filipino workers – over a million as of end-September — were recruited to work abroad this year, over 60% of them in the Middle East. These people’s full-year contributions next year will offset curtailments we may see from the 8.7 million workers already employed abroad as of end-2007..

Make no mistake, we are not falling into Pollyanna’s camp. It is inevitable that seamen and construction workers serving the would-be financial centers in the Middle East will lose their jobs as the construction boom there fizzles out. But there is a good chance that this could happen closer to 2010. The denial stage, after all, is usually a long one. Especially when edifices are involved.

In between Chicken Little and Pollyanna – Case for the “U” scenario

Following from this discussion, the emerging scenario is one of an economy that continues to slow in line with declining investments and exports, but for which growth remains well in the black. The delayed effect of lower Peso remittances means that the trough could extend well into 2010, forming the base of our imagined “U-shaped” recovery.

The pillars supporting our conclusion:

• Private consumption spending will hold. Low income levels and large family sizes, mean very little discretionary consumption to curtail at the household level (e.g. food is 50% of the CPI basket). Should unemployment rise and real wages fall, families will dis-save, as they did in 1998. More likely, they will divert their OFW remittances away from property purchases.
• Investment will be soft but will not collapse, for similar reasons. The current Investment-to-GDP ratio (18%) already hovers at a decade-long bottom. This suggests that the bulk of current investment is already for essential maintenance purposes.
• Exports will continue to fall, but the importance of the sector to the whole equation is, in our view overstated. On paper, merchandise exports account for nearly 40% of GDP. But their low value-added means that dislocation from slowdown will not upset the applecart.
• Government spending will rise ahead of the elections. In the long-run, this is a mixed blessing, given the likely high leakage factor and consumption bias. But in the short-run, it will exert a stimulative influence.