External uncertainties, headwinds and push factors in 2016 for the Phl economy

At the start of 2016, external factors produced shock waves to the economy. These were the same factors that bothered us during 2014 and 2015, only this time they produced sharper volatility.

Financial markets register the first indicators of shocks. Just a day before Christmas 2015, the Philippine stock market index (PSEi) closed at 7,002 points. January opened with a fall below 6,900. By Jan. 21, the index was at 6,084. Yet by Jan. 25, the index closed at 6,400. These are very large swings.

These developments were also experienced elsewhere in varying degrees – in East Asia (from Shanghai and Tokyo to Hongkong and Singapore), in New York, and in European capitals.

Shocks show strong intensity.  The following factors imparted a uniformly bearish mood in world financial markets as they jointly produced large volatility.

First, China’s economic slowdown appears to have settled closer to six percent per year when the world expected more and this fanned financial unrest. Moreover, its internal debt finances are showing continued instabilities. During the last year, this was demonstrated by the collapse of its equity market from early highs.

Second, a large drop in oil prices, reaching $28 per barrel of crude broke the recent norm of nearly $40 per barrel, unshackling financial reactions of all kinds.

Finally, the US Fed policy that was initiated early in the year toward positive interest rates from near zero has continued to draw varied reactions from market shakers. (Since I have discussed this issue recently, I will not touch on it directly for today’s essay.)

Philippine macro-economic fundamentals still appear strong despite these developments. However, they could affect a change in existing assumptions behind business and economic decisions. Some have sharply negative directions, others favorable.

China’s certain slow-down.   China’s slow-down from the historical 10 percent growth of recent decades has now come closer to earthly numbers. Slowing down toward six percent annual growth – still high by world standards – is a significant come-down from heavenly levels.

As a giant economy, China’s trade with the world has significant impact on other countries. They are part of the industrial production chain, either directly or even only indirectly. Such links are reflected initially in the market through financial market disturbances.

The Philippines is linked to China, like all other East Asian countries, in the trade flows, although this might not appear to be large. This is both in terms of final goods and in raw materials. Inevitably, they are interminably connected with capital and labor markets, as this economic interdependence influence also the productive factors.

As costs in China rise, Philippine labor improves in competition if remaining relatively unchanged. That is why some foreign investments located in China have, and are contemplating to move out their plants to lower labor-cost countries like the Philippines. In fact, some Japanese labor intensive manufacturing plants have done so.

Reacting to its own problems, China made decisions that resulted in depreciating its currency. Such moves produced shock waves across countries and markets for currency and finance.

Drastic fall of oil price due mainly to supply factors.   As usual, price outcome is the result of supply and demand. The reduced growth of world demand for oil is partly to blame: China’s reduced growth and the world’s continuing poor economic performance.

The supply factor for oil, however, has made a very big difference. The world economy has experienced streams of large discoveries of oil and technological changes favorable to supply expansion. Years of high oil prices have brought this on .

Moreover, short-term political factors are helping further. OPEC (Organization of Petroleum Exporting Countries), the cartel of oil-exporting countries, has maintained its supply levels to the world market in hopes of driving out oil coming from competing regional sources.

In particular, Saudi Arabia (OPEC’s leader) has a strategic plan of forcing the US fracking industry (the major source of new supply competition that significantly reduced US oil dependence on the world) out of business. But so far, this has failed.

Another major factor in the oil supply equation is the return of Iran to the oil market supply in 2016. With the nuclear deal that it signed with Western powers in late 2015, economic sanctions on Iran were recently lifted. This means Iran’s re-entry of its massive oil industry into the world’s oil market.

Secondary impact of oil price decrease.  With oil prices falling to record lows since late 2014, the high profits from oil that producers of the Middle East earned from high prices have been depleting.

Such profits have built Middle East prosperity among the oil producers unaffected by civil war in that region. This has led them amass large “sovereign wealth funds” that fuelled financial booms across the world’s capital markets as they recycled their profits.

That was then. Now, with oil prices falling very sharply, the high level of fiscal expenditures of these governments have been put in unsustainable positions.

Added extreme volatility of world stock markets has been fanned also by the actions of these Saudi, United Emirate, Qatari and Kuwaiti sovereign wealth funds unloading their holdings of large economic assets to shore up their fiscal finances.

Fall in oil price a ‘net enabler’ for the country. The large drop in oil prices is a positive enabler of more growth for the Philippines.

Infrastructure investment would be cheaper to construct, since costs based on energy would fall. Many goods – both in industry and in agriculture -- depend on oil as a raw material.  Cheaper oil will bring down transport costs and raw materials imbedded in goods that are produced.

Thus, a lot of “net good” can come out from balancing the benefits of cheap oil with the instabilities that accompanies its wake.

One dangerous impact for the Philippines is the likely fall in demand for OFW labor in the Middle East. This could trigger the return of many once-highly employed Filipinos working abroad. It could possibly lead to a fall of future OFW remittances.

We cannot for the moment quantify these uncertainties, but they are real for the Philippines. This is a problem that all stakeholders will have to calculate as the year rolls on and as government recalculates where it is moving from.

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