Philippine President Rodrigo Duterte holds a wad of peso bills on June 20, 2017. Photo: AFP/Ted Aljibe
Philippine President Rodrigo Duterte holds a wad of peso bills. Photo: AFP/Ted Aljibe

The Covid-19 disruptions of 2020 are creating upside-down scenarios few saw coming, including a very counterintuitive rally in the Philippine peso.

The Philippine economy is flagging, Manila’s debt load is rising and a new wave of coronavirus infections is dimming 2021 economic prospects. And a bloody war on drugs is turning off longer-term investors.

Yet none of these hard realities have diminished demand for the peso.

In fact, the Philippine currency is near five-year highs, up 5.2% this year. The rally, though, isn’t all it seems. It points to a number of festering weaknesses that strongman President Rodrigo Duterte, for all his histrionics, has yet to fix.

One is that the Philippines still hasn’t developed a thriving export engine after more than a decade of trying. The other is a growth model that is too reliant on remittances – Manila’s largest source of foreign exchange after exports – from overseas Philippine workers for comfort.

In 2020, these two dynamics are colliding in unpredictable ways.

The first is economic growth has cratered. This year, the Philippines fell into recession for the first time in 29 years. That included a record 16.5% tumble in the April-June quarter from a year earlier. That essentially eliminated activity in the construction and housing industries, scuttling demand for materials from abroad.

The Philippines, says economist Nicholas Mapa of Dutch bank ING, has “crash-landed into recession” with a “GDP meltdown” showcasing the “destructive impact” of lockdowns on a consumption-dependent economy.

In October, imports dropped an unthinkable 19.5% from a year ago. That was the 18th straight monthly decline, suggesting the Philippines was stumbling before Covid-19 arrived. Sliding imports are, in turn, boosting the current account. The central bank now expects a surplus of 1.5% of gross domestic product (GDP) next year.

A ship carrying containers of Philippine products for export pulls away from the international container port in Manila. Photo: AFP/Jay Direct

‘Expect the unexpected’

That has made the peso popular with many punters. So have perceptions that remittances from overseas – and Philippine growth more broadly – are about to stage a big rebound.

Inherent to this view is that Covid-19 recedes early in 2021 and that vaccines are able to work their magic.

Yet “if 2020 has taught us anything, it’s that we should expect the unexpected,” says economist Ryan Severino of Jones Lang LaSalle. “The next six months will be telling for how the rest of 2021 goes, and 2022 for that matter.”

In both cases, though, these bets may be doomed where the Philippines is concerned.

The falling imports trend isn’t about to change. And while the currency implications are clear, falling demand for overseas goods is no reason to go long on the peso.

The bottom line: the Philippine economy is underperforming because Duterte neglected microeconomic reforms needed to stabilize the business cycle and spread the benefits of growth.

In 2016, voters elected Duterte to turbocharge predecessor Benigno Aquino’s six-year reform drive. During his time in the presidential palace, Aquino strengthened Manila’s balance sheet by going after tax cheats, improving transparency and curbing graft to win the country its first investment-grade ratings.

Aquino’s “good governance” imperative had Manila putting more services online. That act alone cut myriad levels of rent-seeking middlemen out of the process. Accountability audits, meanwhile, shined daylight on government ministries as rarely before.

By the end of his term, the Philippines, once the “sick man of Asia,” was an investment darling, growing at a China-like 8%.

To many, Duterte seemed an appropriate successor. During his 22 years as mayor of the southern city of Davao, the hard man of Philippine politics often produced growth rates above the national average. And his “Duterte Harry” tough-on-crime persona made him something of a national folk hero.

Rodrigo Duterte inherited a reasonably strong economy. Photo: AFP/Noel Celis

Lost the plot

As president, though, Duterte has lost the reformist plot.

Early on, he rested on Aquino’s laurels, benefitting from the growth inertia from the previous six years. Rather than increasing economic order, Duterte pivoted to a war of choice on the drug trade. It is still raging and still drawing outrage from Amnesty International and other watchdog groups.

Duterte has indeed accelerated efforts to upgrade infrastructure projects – and that’s a laudable goal.

Better roads, bridges, ports and power grids are vital to increasing competitiveness, reducing inflation and winning more business from multinational companies keen to diversify away from China. Infrastructure spending is now 5.4% of GDP.

The worry is not that Duterte is doing it – but how he is doing it.

From 2010 to 2016, Aquino’s government pursued a public-private-partnership model. It sought greater transparency, higher environmental standards and increased financial burden-sharing. The downside has been bottlenecks in the approval process for giant projects.

To hasten the process, Duterte reverted to the government-led model of old. That raises concerns that Manila’s debt load might surge and put its investment-grade status at risk – and that new opportunities for graft might repel global investment.

So far, the report card from Transparency International is poor. Between 2018 and 2019 alone, Manila’s grade in its corruption perceptions index plunged 14 spots to 113th, trailing Zambia and Albania. If Duterte is going to get reforms back on track before his term ends in 2022, he’ll have to act fast.

The good news for Duterte is that his man-of-the-people message still resonates with many voters, affording him latitude to accelerate reforms.

A customer holds Philippine peso notes during a bank transaction in Manila. Photo: AFP/Romeo Gacad

Basic logic

“Filipinos continue to hold their president in high regard,” says Jose Ramon Albert, a senior research fellow at the Philippine Institute for Development Studies. “Duterte’s approval ratings are higher than they have ever been, indicating that theatrics readily beats performance in an age of populism and social media.”

But that popularity aside, weakening economic fundamentals mean the peso’s gain runs against market logic.

The same could be said of hopes the remittance drought hurting GDP proves short-lived. The central bank believes remittance flows will jump 4% in 2021 after an estimated 2% decline this year.

This may be overly optimistic given the trajectory of Covid-19 infections. Vaccines aside, new strains of coronavirus are emerging in Britain and South Africa. Covid-19 second and third waves are spanning the globe at a moment when the biggest economies are already stumbling.

The US is reeling while Brexit stalks a European region staggering from one debt crisis to another. China’s roughly 2% growth rate is nice to have, but insufficient to support a regional recovery.

Meanwhile, as the peso edges ever higher, central bank Governor Benjamin Diokno says his team will continue to pursue a flexible foreign-exchange policy.

That policy has been a boon for investors in Philippine government bonds, which have returned nearly 20% this year. Yet even this windfall has an upside-down flavor to it.

Manila has been steadily boosting debt sales and projects an ever-wider budget deficit next year. The gap swelled to more than US$22 billion in the first 11 months of 2020 from $8 billion in the year-earlier period.

The Philippine stock market is paring earlier 2020 losses, too, despite Covid-19 risks. Foreign inflows have driven Philippine Stock Exchange valuations to roughly 28 times forward earnings.

Domestic workers from the Philippines in Victoria Park on Hong Kong Island. Photo: HK Government

Depleted labor pools

One of the main vulnerabilities of Duterte’s economy is that the Philippines produces few unique products needed to support global supply chains. So it has long made people its main export.

This has numerous drawbacks.

One is depleted domestic labor pools. When you export so many of your best and brightest to Hong Kong, Riyadh, Dubai and Los Angeles, your domestic workforce becomes less productive and innovative. Another problem is all this cash flowing in becomes an addiction.

Perpetuating the remittance boom has been the priority of myriad governments for decades. It really hit its stride during Joseph Estrada’s 1998-2001 presidency. It gained momentum during Gloria Arroyo’s 2001-2010 tenure. In fact, when Arroyo traveled abroad, one of her top priorities was securing more work visas for Filipinos keen to leave.

During his time in office, Aquino hoped to reverse the brain drain dynamic. Instead, his government, too, continued to export talent. Enter Duterte, who turned the strategy up to 11.

He established an Overseas Filipino Bank to service the increasing ranks of workers making a living far from home. Duterte also favors establishing a cabinet-level department to accelerate the export of human capital.

More broadly, the Philippine economy is seen returning to growth in the April-June 2021 quarter, at best. Even this half-glass-full scenario would make Duterte’s economy one of the slowest to recover from coronavirus fallout.

And whatever the downside risks, the peso is likely to keep climbing as falling imports curb demand for dollars, notes strategist Eugenia Victorino at Skandinaviska Enskilda Banken.

As 2021 beckons, the unwieldy strength of the peso will likely offer more cons than pros to the strongman in Manila.