Here's what happens next after Philippines' impressive 7.8% GDP

Slower growth forecast for next year.

According to UBS Investment Research, Philippines real GDP famously outpaced all the larger economies in Asia, including China, in Q1 2013. Spending ahead of the May mid-term elections and a boom in construction helped push real GDP growth to 7.8% on the year, handily surpassing expectations of circa 6%. We revise our 2013 real GDP growth forecast higher (again) to 7.0% from 6.3%, but look for slower growth of 6.0% in 2014 (up from 5.5%).

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This is partly due to slower government spending post elections and because we do not think the pace of expansion in construction – which we link to low interest rates – will be sustained.

This said, benign inflation, a current account surplus, a bullish government and a dovish central bank suggests Philippine policy settings are among the most likely in ASEAN-5 to provide insurance against downside risks to growth.

The key risk we see is that Philippine interest rates are overly low and may prove vulnerable either to a rise in global rates or a surprisingly rapid decline in Philippines’ savings surplus (current account balance). We forecast a slightly weaker peso against the US dollar in 2014 on these concerns.

UBS economists project the Fed to begin tapering their QE programme early next rather than this year and even then Fed asset purchases are projected to last into 2015.

Even so, with investors positioning to anticipate stronger US growth and higher US dollar interest rates, the room for Philippine interest rates to fall further without weakening the currency is probably limited. That said, the current account surplus and low inflation mean Philippine fiscal and monetary policymakers have room to boost domestic growth if external demand more broadly remains lacklustre.

This might include easier fiscal policy (budget due to be submitted to Congress in August) or further efforts by the BSP to drive banking system reserve money growth through a reduction in SDA balances.

We judge the Debtopia theme to be less advanced in the Philippines, but not less applicable. For now low interest rates seem likely to support growth in the Philippines.

The key risks are upward pressure on local interest rates because global interest rates rise faster than we expect or because Philippines’ surplus savings (current account balance) diminish faster than we expect due to weak exports or overly strong domestic demand.