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The Philippines: worth it at the right price.
In 2009, most Asian economies went one of two ways. Some – including China, India and Indonesia – managed something close to a normal growth rate. This was down to both government-directed investment and strong domestic consumption.
The more export-dependent countries saw their economies shrink sharply, as global trade went into freefall. This hit large economies such as Japan as badly as smaller ones such as Singapore. However, in most cases, these countries rebounded quickly in the second half of the year.
The Philippines was different. It fell somewhere in the middle - it wasn't immune, but it wasn't as hard hit as many. Its GDP shrunk in the first quarter only, and it is likely to show a 1%-2% gain for the whole year.
That makes the Philippines unusual by Asian standards. So this week, I'll be taking a closer look to see whether it merits a place in an Asia portfolio …
A very domestically-driven economy
The first thing that jumps out is that the Philippines is far more dependent on domestic demand than most of Asia. Private consumption accounts for around 70% of GDP. To an extent, this reflects its large population of more than 90 million. It's the world's 12th most-populous country.
But it remains poor. GDP per head is around $3,500 at purchasing power parity (which adjusts for differences in the cost of goods between countries). That puts it near the bottom of the scale for Asia (see chart below - figures in dollars).
That headline figure disguises major regional variations. About half of the population lives on the main island of Luzon and the capital Manila. These are the most developed and economically important areas. Many other parts of the archipelago lag a long way behind.
Export manufacturing focuses on semiconductors, electronic products and textiles. The country is also a big commodity exporter. But – again, unusually for Asia – services are more important. These account for more than half of GDP and an even higher level of employment.
English is widely spoken, so the Philippines has done well from foreign firms outsourcing operations such as call centres. Tourism is also a key sector. Lastly, remittances from Filipinos who live and work overseas play a major role in propping up household spending. These account for around 10% of the economy.
Since the Asian crisis of 1997-1998, the economy has seen average growth of around 5% a year (see chart below). All of which may make it sound like an attractive investment.
After all, the biggest criticism of many Asian economies is that they depend too much on manufacturing rather than domestic consumption. The Philippines doesn't have this issue, so could help to diversify a portfolio. But it has some deep-rooted problems of its own.
What went wrong for the Philippines?
One fact says it all. Back in the sixties, the Philippines was reckoned to be the second-wealthiest country in Asia, after Japan. So what went wrong?
A good part of the blame can be laid on the presidency/dictatorship of Ferdinand Marcos from 1965 to 1986. Most of Southeast Asia is held back by corrupt relationships between politicians and businessmen. This results in too many monopolies and cartels, and a corporate sector that enriches a few powerful families at the expense of the overall economy. Under Marcos, crony capitalism plumbed new depths of larceny and incompetence.
Still, the situation was bad in the Philippines even before then. This perhaps reflects two things. First, the key business families are also the key political families, rather than their associates, and so are even closer to the heart of government. Second, its history as a Spanish colony means its systems are closer to those of Latin America than the rest of Asia, which was mostly colonised by Britain, France and the Netherlands. So it shares many of that region's governance problems.
Despite economic reforms in the mid 1990s, the economy is still a mess. Corruption remains a huge issue. As you can see below, it has one of the worst scores in Asia.
Among other things, this had led to underinvestment. Gross fixed capital formation was just 15% of GDP in 2009, well below the Asian average. The private sector is reluctant to invest in such a corrupt environment. Meanwhile, the government has failed to do so, so infrastructure remains poor. This is an especially pressing problem in a mountainous country which is spread over hundreds of islands. Substantial mineral resources also remain underexploited.
On top of this, the country's politics are often appallingly violent. There is an ongoing problem with terrorism, mostly from Islamic extremists, especially on Mindanao, the second-largest island. Many politicians have their own militias. Elections often involve serious trouble, most recently the massacre of 57 people as they tried to file nomination papers, by a rival candidate. Attempted coups, plots and rebellions are frequent, with at least three in the last five years.
But things don't look so bad in the near term
In a climate like this, it's amazing that the Philippines has performed as solidly as it has. So the economy clearly has some strengths. And there have been some recent positive trends.
To begin with, the bank system seems to be in decent shape. Private sector credit is only around 30% of GDP, so there is no need for businesses and households to pay off piles of debt. Government debt is high by Asian standards at 56% of GDP. But that's down from around 80% in 2004. This has probably been the main accomplishment of outgoing president Gloria Macapagal Arroyo.
However, more political and economic reform is needed. Deregulation, privatisation and reducing the power of big family-controlled corporate groups should be a priority. But, as noted above, all these problems are tightly tied into the political system. And there are no signs that any of the main contenders in May's presidential elections will shake things up much.
Without reform, there are concerns over the long-term position of the Philippines. It faces growing competition from elsewhere in Asia. In electronics, for example, it will be harder to keep pace with China. And India is a huge rival in the crucial outsourcing services market.
But in the nearer term, the Philippines should be able to grow at 5% a year or so in the coming years. That'll look pretty decent by the sluggish standards of the rest of the world. And the Philippines Composite benchmark is not expensive. It's on a price/earnings ratio of around 13 times next year's consensus forecasts.
The Philippines could be a prime candidate for a bubble
Given the possibility of a bubble developing in Asia at some point, it's also worth remembering that the Philippines is a place where things could get carried away. That's because it's one of the smaller markets in the region, as the chart below shows.
And as the chart below from UBS suggests, the smallest emerging markets are likely to develop the biggest bubbles. Speculative inflows – especially from foreign investors – will tend to be bigger relative to the size of the market, so will have a much greater impact.
So although I have some doubts as to whether the Philippines will get it together enough to move towards developed status any time soon, I'd consider investing in the market at the right price. It's not a core holding. But it offers useful diversification, the small chance of major reforms at some point, and the potential of being able to sell out in a bubble.
The snag is that there is no ideal way to invest. As yet, there's no dedicated exchange-traded fund (ETF). Global X Management, a US-based niche ETF provider, registered one in early 2009, but so far it hasn't been launched. Nor is there an easily available unit trust (the only one I know of is a Singapore-based one from Lion Global).
The only major Philippines stock with an international listing is the former telecoms monopoly Philippines Long Distance Telephone (PLDT), which has a US-listed depository receipt. A handful of other firms such as rival Globe Telecom and brewer San Miguel sometimes trade over the counter, but don't have a full listing.
PLDT is reasonably attractive stock on its own merits. The p/e is around 12.5, the dividend yield is 5.5% and the financials are fairly solid. And because it accounts for around 25% of the benchmark, it's sometimes used an approximation of the market by international managers.
But for me it doesn't quite suit. There are other interesting telecoms stocks around Asia and I wouldn't want to be overweighted in the sector. Instead, I'd suggest waiting to see if an ETF emerges in the near future. I suspect it's only a matter of time.
If you do know of a fund I've overlooked or have another suggestion on how to play this market, please add it in the comments.
• This article is from MoneyWeek Asia, a FREE weekly email of investment ideas and news every Monday from MoneyWeek magazine, covering the world's fastest-developing and most exciting region. Sign up to MoneyWeek Asia here
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