Capital flows and the Philippines’ growth forecasts

Two days ago, the broadsheets reported that for June 2024, net inflows of foreign direct investment (FDI) stood at $394 million, a huge 29% drop from $555 million in June last year. Similarly, the June 2024 FDI level was more than 27.5% lower than the May level of $510 million. The decline was felt in all major FDI components.

Non-residents’ net investments in debt instruments, net investments in equity capital other than reinvestment of earnings, equity capital placements and reinvestments of earnings all retreated by double digits.

So, what happened to all those investment roadshows and global tours to bring in more foreign capital to augment domestic savings, help transfer technology and secure the growth momentum? Pledges are welcome, but the Philippines needs cash. Sustained growth is essential if we are to mitigate joblessness and poverty in this archipelago.

Yes, the June FDIs “might just be a data quirk and not a symptom of a broader slump.” In fact, for the first half of the year, net inflows of FDI actually rose, from $4.1 billion in the 1st half of 2023 to $4.4 billion in the 1^st half of 2024, or an expansion of 7.9%.

But we rule out the explanation offered by some market players that the decline in FDIs in June was due to the uncertainty in the direction of policy rates of both the Bangko Sentral ng Pilipinas (BSP) and the US Fed. Philippine inflation rates on a monthly basis for the first six months of the year were already recorded at less than 4%, while the balance of risks moved to the downside as early as June. There was very little doubt the BSP would start easing last month. Inflation in the US was a narrative of sustained decline starting mid-2022. At least 25 basis points (bps) reduction is in the cards next week for the US Fed.

We don’t have to hammer it, but FDIs are for the long haul. They might be sensitive to changes in macroeconomic policy like the BSP’s policy rate, but they have been found to be more attentive to good governance, rule of law, quality of labor and infrastructure, as well as ease of doing business. Focus on these fundamentals, stay the course for the entire political cycle, and half of the battle for sustained growth should be won. Liberalizing markets and facilitating entry into various economic sectors can throw in bonuses. Since we have practically promoted the contestability of markets, short of amending the 1987 Philippine Constitution, it is our deficits in those fundamentals that continue to pull back our growth potential.

For instance, on the global good governance index in 2024, the Philippines’ ranking dropped four slots to 67^th out of 113 countries, the worst in three years. This is based on the 4^th edition of the Chandler Good Government Index. We scored lower in leadership and foresight, financial stewardship, and global influence and reputation. We lagged behind Malaysia, Indonesia, and Vietnam.

On rule of law, it is sad to note that based on the report of the World Justice Project, the Philippines’ Rule of Law Index in 2023 fell three ranks from 2022. Our score was lowest for criminal justice, fundamental rights, and corruption. We ended up 13^th out of 15 countries in the East Asia and the Pacific region, and 100^th out of 142 countries. These rankings are disturbing; they show we have one of the weakest rule of law. When the Alice Guos and Apollo Quiboloys of this world could be so blatant in their disregard of our legal and justice system, this is not surprising.

These two metrics alone were time and again among the subjects of foreign investors’ reservations. Based on past surveys of the World Economic Forum’s Global Competitiveness Report, while the Philippines was commended for inflation management and progress in credit rating, the following were the negatives: inefficient government bureaucracy, inadequate infrastructure, corruption, tax regulation, and tax rates.

In fact, the country’s National Competitiveness Council had alerted us that Brunei and Vietnam “have now overtaken the Philippines to take the 5^th and 6^th position in the region.”

If we go by the country’s savings rate, foreign capital continues to be indispensable. With a 24.4% savings rate in 2023, the country has not recovered from the economic scarring of the 2020 COVID-19 pandemic. It’s way below the three-year average of more than 30% prior to it.

The persistent current account deficit reflects this chronic savings-investment gap. External financing through foreign investments or foreign loans cannot be avoided if the National Government sustains its deficit spending policy while avoiding new or higher taxes in favor of intensified tax collection and remittances from government-owned and -controlled corporations (GOCCs).

And naturally, the fiscal space could only shrink. The fiscal deficit remains substantial as a percent of GDP while National Government (NG) debt has exceeded the P15 trillion mark at P15.7 trillion now, presumably close to 61% of GDP. For the first seven months of 2024 alone, NG debt servicing stood at P851 billion, more than double the P411 billion of a year ago.

Therefore, the least we should be doing is hope and pray that the National Economic and Development Authority’s (NEDA) fearless forecast of faster growth in the 2nd half of 2024 comes to pass. NEDA believes its likelihood is “very high” considering that inflation has trended down and within the target to 2-4%, allowing the BSP to start on its easing cycle. Lower interest rates are expected to affect the macroeconomy by motivating higher investment activity and economic growth. The challenge here is for the banks to follow the price lead of the monetary authorities as soon as possible, and carefully ease on their lending policy. Unless we see these happening, the BSP’s decision to be less cautious in August, and perhaps next month, would be of very little use.

More pro-active actions by the financial institutions are crucial if we want to see the contraction in the Philippines’ overall Purchasing Managers’ Index (PMI) for July reversed. All the covered sectors of manufacturing, services, retail and wholesale trade registered a retreat from expansion. The PMI has been a good leading indicator of economic growth.

All up, the BSP’s growth forecasts appear more firmly anchored, indicating a possible performance of within 6-7% this year, but the momentum may not hold for 2025 and 2026. Now using the Policy Analysis Model for the Philippines, the central bank pins its hopes on the positive impact of its recent shift in monetary stance in terms of higher consumption, supported by gains in real wages and sustained OFW remittances. The BSP is also sanguine about the improving labor market conditions and, of course, higher inflows of foreign capital.

The latest assessment of Singapore-based AMRO coincides with both the NEDA and BSP’s projections. AMRO places the country’s 2024 growth at 6.1% and 6.3% in 2025 on the strength of public spending, despite the limited fiscal space, private consumption, due to lower inflation, more jobs and robust OFW remittances. Considering the risks of price resurgence, AMRO’s 2025 forecast is slightly below the Government’s 6.5-7.5% target for next year.

Back to capital flows, the IMF recently proposed that the Fed Rate cuts “may help revive bond flows to emerging, developing economies.” Observing that the recent tight monetary policies across the globe sent borrowing costs for the smaller economies through the roof, there was a sharp slowdown in their Eurobond issuances. The Fund was quick to add that in addition to high borrowing cost, emerging and developing economies’ pre-existing vulnerabilities, including weak policy frameworks and governance, prevented them from tapping global capital markets. As a result, lower investment produced lower economic growth. Those with stronger fundamentals succeeded in tapping their own domestic capital markets.

The Philippines should therefore maximize the forthcoming inflows of foreign capital, both direct and portfolio, not only by persuading the BSP to sustain its easing cycle but also to address in a very decisive, singular manner our persisting vulnerabilities. And remember, they are numerous and rather interlinked with one another, with politics and vested interests.

Diwa C. Guinigundo is the former deputy governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was alternate executive director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.