Impact of QE taper on the Philippines and other emerging markets

James Ryan Jonas

The beginning of the end is here.
The widely-anticipated taper of the U.S. Federal Reserve’s Quantitative Easing program or QE3 will finally begin early next year, the US Fed announced today at the conclusion of the two-day Federal Open Market Committee (FOMC) meeting.
Starting January 2014, the Fed will slightly reduce the amount of its monthly bond purchases, down $10 billion to $75 billion every month. In the past year, the Federal Reserve has been buying in the open market Treasuries and mortgage bonds in the amount of $85 billion in a bid to inject liquidity into the sluggish U.S. economy.

Primer on the Fed’s QE3 program

For a primer on the meaning and timeline of the QE3 program, read our past articles on the topic:

Reasons for QE taper

Improvements in the U.S. job market and economic growth were primarily cited as reasons for initiating the reduction in the Fed’s asset purchases.
Unemployment in the United States dropped to a five-year low of 7.0% in November, three percentage points lower than the recorded jobless rate of 7.3% in the previous quarter. The Fed sees U.S. unemployment rate to further drop to 5.8% to 6.1% by the end of 2015, and 5.3% to 5.8% during the fourth quarter of 2016.
The country’s GDP also grew at a better-than-expected annual rate of 2.8% during the third quarter, registering its third consecutive quarter of increasing GDP growth.
In a statement, the FOMC justified its decision to start the taper by citing “cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions”, thus convincing the committee “to modestly reduce the pace of its asset purchases.”

Improved US economy

Basically what this means is that the Federal Reserve sees a much improved US economy compared to its recession-plagued state in the past years. The economy and labor market do appear to be gaining strength, but overall it still remains uncertain if full economic recovery will continue in the long-term.
The FOMC panel believes this the case although this outlook is not shared by all FOMC members. In the two-day FOMC meeting, Boston Federal Reserve President Eric Rosengren was the lone dissenter in the taper decision, arguing that tapering the bond-buying program is still “premature until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate.”
The decision to start the QE taper may be Fed Chairman Ben Bernanke‘s swan song. Bernanke’s term as head of the US Federal Reserve will expire at the end of January 2014. The Vice Chair of the Fed’s Board of Governors, Janet Yellen, has been appointed by US President Barack Obama as Bernanke’s successor. She is set to be confirmed by the Senate before taking office in February 2014.

Impact of taper on the Philippines and other emerging markets

The slowdown of the Fed’s billion-dollar monthly asset purchase will surely have an impact on emerging markets such as the Philippines.
One obvious consequence would be the outflow of portfolio funds which initially flocked to the Philippines and to other emerging markets in the past years due to higher yields. Because interest rates in the US dropped to near-zero levels and the US economy is failing to show signs of growth, investors then decided to place their money elsewhere, betting on emerging markets to provide higher returns for their investment.
The influx of foreign funds into Philippine stocks is one of the reasons why the Philippine Stock Exchange index (PSEi) rose to all-time high levels in 2012 and in the early months of 2013. (See Philippines one of Top 10 stock markets in 2012)
Some market analysts earlier this year even predicted the PSEi to top 7,000-8,000 this year on the heels of strong foreign buying, backed by solid economic fundamentals and riskier investment appetite of local investors.

“Hot money” may leave the Philippines

Most foreign funds, however, are considered “hot money” because once investors see other places with better investment opportunities, these funds are easily taken out of the country and moved somewhere else. This is the same fear described for emerging markets once the US taper begins in 2014.
With the taper the Fed is saying the US is already showing signs of recovery, thus, investors may decide to pull their funds out of emerging markets and plow it back into the US. The result? Portfolio outflow could lead to an immediate pullback in the stock market and depreciation of the local currency. This means the PSEi may not grow as fast as in the past years and the Philippine Peso may further depreciate to the P45-46 or even lower levels.

But the Philippines may still be one of fastest growing economies

The good news is that most market analysts currently see the Philippines as better prepared to weather this potential storm versus other emerging markets. With the country’s relatively huge current account surplus and GDP growth dependent on consumption rather than on investments, the Philippines is predicted to suffer less compared to India, Indonesia and Hong Kong — emerging countries with ballooning current account deficits and potential real estate bubbles due to humongous inflow of foreign funds into property.
The Philippines, in fact, has been cited as “fastest growing economy in Southeast Asia” for several quarters now, despite widespread recession in other parts of the world including the European Union. Recently the country booked an unprecedented 7% GDP growth in the 3rd quarter while other countries are barely growing or even registering negative growths.
Credit rating agency Moody’s even announced this week that it expects the Philippines to outperform this year, with GDP growth predicted to hit a full-year growth of 7% despite impact of typhoon Yolanda and other natural calamities. Moody’s also believes the Philippines will continue to be “one of the world’s fastest growing economies in 2014.”
Supertyphoon Yolanda (Haiyan) may have brought massive destruction in several cities in the Philippines last month and is expected to negatively impact the country’s GDP growth in 2013, but analysts see it as actually benefiting the country in the long run as it will require infrastructure spending from the government which will fuel the GDP growth further. The Aquino administration said it would cost around P360 billion to rebuild areas in the Visayas badly hit by the typhoon.
More readings about the US Federal Reserve’s QE program!

Images Source: CNN

James Ryan Jonas teaches business management, investments, and entrepreneurship at the University of the Philippines (UP). He is also the Executive Director of UP Provident Fund Inc., managing and investing P3.2 Billion ($56.4 Million) worth of retirement funds on behalf of thousands of UP employees.