‘The changing international economic environment around us’

The international economic environment is important to us. An economy as open to the world like ours is influenced by the international flow of goods and services through trade (import and exports), through investment and labor flows and through finance.

“The open economy.” We seek foreign investments, financing for our development projects, and our workers look for jobs abroad as well as at home. We know we want more foreign direct investments. When put all together, Filipinos working in other economies have a sizable impact on Philippine payments, through remittances.

In two earlier columns, I paid attention to two important influences: the US economic recovery and growth (October 1, 2014)and Europes’ double-dip recession and growth woes (October 8, 2014). Today I sum up the impact of these two major forces of influence and bring in other important developments that we should pay attention to.

Some of these influences are due to short-term factors. Others are the result of prolonged long-term adjustment and response to historical forces that these economies experience. To these, our economy has to make its own adjustment and response.

“Prelude: Outlook from IMF.” The International Monetary Fund (IMF) – the institution that reviews and oversees the macroeconomic course of member nations – had reversed its early optimistic outlook of the first semester and concluded that downside risks for the world economy have arisen. So, it reduced its forecast.

In particular, world economic growth is projected in 2014 to grow only at 3.3 per year, cutting it from a more hopeful 3.7 percent. This cut by 0.04 percentage points might appear small, but it represents a drop in growth expectations of 11 percent. Thus, it is not as trivial as it might seem.

Several reasons account for this reduced forecast: a rise of volatility stemming from increased financial risks in principal groups of countries; uneven economic performance, principally the US (growth) and Europe (structural problems); and increased geopolitical economic tensions, both in the Middle East and the rebirth of East-West tensions (though minor at this stage).

But however much reduced is the growth expectations for the world economy, countries differ in their economic performance. The Philippine economy is seen as positive and optimistic within this pessimistic picture. Yet, even for us, IMF made a reduced forecast of growth, as it did for a lot of high growth economies largely in the Asian region.

Below, I comment on a number of major developments that have a direct effect on Philippine economic performance.

“Falling world energy prices.” For years, world energy prices have slowly crept up and remained high, but lately they have steadied and then recently, they have fallen. Until June this year, we were anchored to expectations of crude oil being in the range of $120 to $115 per barrel. Today, oil prices have gone down to $80 per barrel.

The price outlook would continue to be weak as long as the world economy remains weak. The price of oil could fall even more if world economic recovery worsens. Some analysts have not ruled out that energy price could even drop further to $70 per barrel.

The fall of energy prices is the outcome of the altered world supply and demand in this commodity. Let’s briefly examine the supply and demand picture.

On the supply side, discoveries of new world sources have led to significant new producers and this has weakened the oil cartel’s hold on supply maintenance. New supply sources have come from Africa, Latin America, the northern arctic and offshore frontiers, and Russia.

Moreover, technological developments, principally “fracking”, has led to a leap in crude energy production in the US economy, making it less dependent on imported fuels.

All these have weakened the critical hold of the Middle East on world energy supplies despite the presence of continued political conflagrations in the region.

On the demand side, because of poor world growth conditions, demand simply has not caught up with rising world supply. Poor conditions in Europe, the drop in growth rates in China, the slow US economic recovery, have accounted for weak aggregate world demand.

From the viewpoint of Philippine growth prospects, the drop in oil prices is good. Still a major oil importer, the fall in world oil prices is helpful to us. Proof of this is that gasoline prices have recently been falling despite the recent domestic inflationary pressures and the weakened peso.

“Heightened financial risk and volatility: US growth.” A definite move by the US central bank (The Fed) this month of October to reduce its quantitative easing program signalled that it now foresees that US economic recovery is taking root confidently.

Recall that last year, when the Fed simply just announced that it was considering to taper its policy of quantitative easing, world capital markets reacted with shifting expectations. Thus, increased volatility returned to financial markets.

This makes it possible for higher economic returns on US assets because of rising interest rates. Liquid private asset holdings located in other countries – including those in emerging markets – could move back to the US for higher earnings.

The Philippine authorities, through the Bangko Sentral, have undertaken defensive action so that the country does not get deserted by these investors. The reactive defense means having to raise domestic interest to stem the drastic flows of capital.

“…Europe’s weak adjustment.” From Europe, however, comes the weight of additional financial uncertainty. High economic risks stem from structural problems that countries in Europe, including principally the Eurozone countries, are faced with. Long delayed actions on their part have led to poor economic performance with recessionary conditions dominating.

The economic imbalance between Europe and the US has led to a fall (depreciation) of the euro and the corresponding rise of the US dollar.

This has also affected the Philippine peso. Changes in the peso exchange rates have been wide. In June, 2014, the peso was 43.8 to the dollar. Yesterday, it was 44.8.

Between January 2013 and Oct. 27, 2014, the peso exchange rate to the dollar ranged between 40.7 to 44.8 to the dollar. Fluctuations in these rates also happened, affected fundamentally by the interplay of the dollar with the euro.

Over the same period, the peso has weakened relative to the dollar but it has strengthened relative to the euro. The main drama, however, is the fact that over this period, the US dollar has strengthened relative to the euro.

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