A new central bank governor, Benjamin Diokno, was appointed on 5 March (following the death due to illness of the previous incumbent) and concerns over a shift to an excessively loose (pro-growth) and less independent monetary policy prompted a 1% drop in the FX rate.
Diokno advocated fiscal expansion in his most recent stint, since June 2016, as Secretary of the Department of Budget and Management (the equivalent of the finance ministry in Philippines' presidential system). This leads some to fear that interest rates will be cut too fast to spur growth. Diokno attempted to allay this fear today in his public comments (reiterating the inflation target, suggesting it is too early to cut rates until inflation data supports this) but he will likely have to prove his prudent credentials. The next monthly rate-setting meeting is on 21st March (rates have been unchanged in the last three).
In the first three quarters of 2018 the Philippines central bank was viewed as being behind the curve in dealing with, at that time, accelerating inflation, and the Peso devalued 8%. Inflation peaked at 6.7% in Q3 18. Interest rates were tightened 175bp to 4.75% from March to November (and have been kept constant since) and inflation has decelerated after October 2018 (the latest inflation figure for February 2019 was 3.8%, back within the central bank's target range of 2% to 4%. The IMF forecasts inflation should decline from over 5% at the end of 2018 to under 4% at the end of 2019. With a benign global backdrop, in terms of US rate and US$ expectations, the Peso is now up 1% ytd.
Top-down, we remain positive on Philippines equities (although our top markets in Asia are Vietnam and Bangladesh). The PSEi equity index is up 3% in US$ total return terms ytd, compared to MSCI Asia ex Japan up 10% and MSCI EM up 9%. Trailing PB is 2.1x (with 11% ROE), a 16% discount to the last 5-year median, and forward PE is 16.5x (with 11% consensus earnings growth). Top-down, we are positive on Philippines equities. Apart from cheap valuation relative to history, we point to the following factors:
(1) Structural improvements in infrastructure, tax collection and domestic security.
(2) Prudent re-balancing of external geopolitical relations with the US and China.
(3) Although the real effective exchange rate implies a risk of 10% devaluation in the FX rate, this is mitigated by low external debt (c25% of GDP), FX reserves import cover of over 6 months, and, on average in 2019 and 2020, according to IMF forecasts, macro metrics which are still benign (albeit not as strong as in, for example, 2016 and 2017) with GDP growth high (6.6%), inflation low (3.5%), current account deficit low (0.7% of GDP), and fiscal deficit low (1.4%).
We acknowledge that identifying bottom-up value in individual equities is challenging; our screen for value, on trailing metrics, highlights RLC in real estate, MBT and UBP in Banks and MWC in Utilities.
Philippines policy rate, inflation and FX rate