The Philippines beaten by global headwinds in 3Q11

While domestic demand was robust, goods and services expliorts declined sharply due to sluggish global demand.

Although the PHP 72 bn stimulus package and increased remittances should bolster growth in Q4, they will unlikely be enough to completely offset the impact of weak exports. This makes for a very difficult decision when the monetary board meets on Thursday, as inflation remains above the target range and the growth outlook turning increasingly challenging.

Facts
The economy decelerated to 3.2% y-o-y in Q3, versus 3.1% y-o-y in Q2, revised down from 3.4%, below consensus expectations of 4.1% y-o-y but above our expectation of 3.0%. On a quarter to quarter basis, the economy also slowed from 0.5% seasonally adjusted to 0.3%.

Private consumption rose 7.1% y-o-y in Q3, versus 5.5% in Q2 and government consumption rose 9.4% y-o-y, versus 4.3% in Q2.

In contrast, construction investment contracted for a second straight month by 10.6% y-o-y in Q3, versus a decline of 21% in Q2. Net exports declined by 13.1% y-o-y in Q3 in comparison to an expansion of 1.4% in Q2. Both goods and services contracted on the quarter by 14.8% y-o-y and 2.5%, respectively, from -0.3% and 9.2%.

Implications
The BSP faces a difficult decision this Thursday. Growth has slowed more than expected for a second straight quarter, making growth likely to average below 4.0% for 2011 and less than the government's official 2011 growth target of 4.5-5.0%. At the same time, inflation has yet to let up - it crawled back up above the BSP's target range of 3-5% in October to 5.2% y-o-y, and will likely stay above the target range again next month.

Most of the drag to growth this year has come from the Philippines' exposure to external demand. Merchandise exports have contracted for five consecutive months, with most of the decline coming from weakening global electronics demand. Services exports, primarily of business process outsourcing services, also declined. Given China's slowdown, Europe's recession, and sluggish growth elsewhere, these trends will unlikely reverse anytime soon.

The one bright spot for the Philippines - domestic demand - continued to support growth in Q3. This reflects robust remittance inflows, which make up almost 10% of GDP and are expected to increase in the coming months due to the Christmas season.

However, should global conditions worsen beyond current expectations, this may decelerate as
well.

Although government spending is expected to pick up in Q4 with October's stimulus, total spending for the year will likely still be below target; thus proving only a modest boost to growth.

Looking ahead, growth should pick up, on both a sequential and y-o-y basis, in Q4 on the back of resilient domestic demand and increased government spending, but net exports will remain a drag on the economy. Given a worsening global outlook, we remain cautious on Philippine growth outlook for next year.

Bottom line: Growth decelerated more than expected in Q3, reflecting sharp contractions in both exports and construction investment. Domestic demand, however, picked up on the back of robust remittances and increased government spending.

Looking ahead, we expect growth to accelerate in Q4, albeit modestly.