With the current crisis in the Middle East and in Japan; and with the prices of commodities and oil going higher; what is in store for SMEs? I asked Romy Bernardo, one of the country’s top economists and a former Finance top official who is also an Independent Director of the RFM Board, about his views and this is what he has to say:

The BSP recently reported that pessimism has substantially increased among Filipino consumers, amidst continued price increases and unrest spreading in the Arab world. The confidence index (CI) weakened from -8.5 percent in Q4 2010 to -23.1 percent in Q1 2011, indicating that the number of pessimists increased during the quarter relative to the number of optimists. Households polled during the 3rd week of March cited continued increase in the prices of petroleum products, the high cost of goods and services, and the rise in household expenses as the reasons behind their weaker outlook. The outlook was aggravated by the tensions in the Middle East and North Africa.

This pessimism is a big reversal from where we were early in the year—coming from a 7.3 percent output growth. There was also the positive sentiment coming from record investment inflows last year to emerging Asia, including us, which boosted the Philippine stock market prices by an average of 50 percent. Furthermore, signs of recovery in the developed world were beginning to firm up.

What a difference a couple of months make! Need we worry?

Inflation woes

Prices have been widely expected to creep up this year as world and food prices began rising in the latter half of 2010. This was driven primarily by the expected increase in demand with the global recovery, supply disruptions related to weather in major food producing countries like flooding in Australia and Brazil, and also partly speculation in financial markets.

February inflation for the Philippines was already a big surprise at 4.3 percent versus the official forecast of three to four percent. This inflation number prompted the BSP to raise policy interest rates ( i.e. what they charge the bank for providing short term money, as well as what they pay for Special Deposit Accounts—SDAs ) by one fourth of one percent, the first time they have raised rates since the global financial crisis started in 2008. The BSP is expected to continue to use its interest rate policy to manage inflation, which is expected by most analysts for now to only be slightly higher than the five percent average for the year, peaking somewhere during the 3rd quarter, assuming oil prices don’t skyrocket. The BSP will likely also allow the exchange rate to appreciate to help blunt the inflation impact—my guess would be around P 42 to $ 1.

I too do not expect Philippine inflation to go double digit as it did in 2008. Oil prices then peaked at $ 130 per barrel, much higher still than the current $ 108. More importantly, global rice prices then exceeded $ 900 per ton, twice what it is now. The price of rice, which account for a tenth of the CPI, will likely be stable, thanks to a healthy rice harvest, and no repeat of quirky NFA bidding behavior in world rice market.

The MENA wild card

The continuing civil unrest in the Middle East and North Africa has furthered fuelled inflation worries, especially as it spread to oil producers Libya and Bahrain. While these countries account for only a small share of world oil production (two to three percent), this easily translated to nervousness in oil markets, and thus pushed the price of crude from $90 per barrel in February to $108 currently. The key is, of course, the world’s largest oil exporter Saudi Arabia (14 percent of total world production), and the major source for the Philippines. Saudi Arabia is also the world’s “swing producer”, having moved quickly to cover the shortage due to Libya’s civil war. Thankfully, the situation in Saudi Arabia so far looks manageable with the reform minded, even if aging, leadership still enjoying the support of Saudi nationals, something fortified recently by liberal use of largesse (over $35 billion). Many of us take comfort in the belief that the world’s only super power has the capability to make sure that things do not get out of hand there, for everyone’s sake.

Output growth risks

Until the recent spate of bad news, the consensus forecast for GDP growth of most analysts, including us, was at five to 5.5 percent growth–going back to normal, after the one-offs that led to a 7.3 perscent growth last year, like election spending and electronics inventory re-stocking. Government is aspiring for six to seven percent. What may affect the outcome include the following.

1) Remittances from MENA. –The troubled countries account for only 0.5 percent of remittances OFW remittances. Saudi Arabia again is key—over a million OFW’s there accounting for 13 percent, possibly 20 percent after correcting for misclassifications, of total remittances. Provided political stability keeps, higher oil prices may actually lead to more deployment and remittances, as had happened in the past, as this fuels increased economic activity there.

2) Japan Disaster— While, the cost of the damage from the earthquake and the tsunami is estimated at as high as three percent of Japan’s GDP, it is not expected that damage due to loss in productive capacity will have a medium term impact on Japan growth. (Though we need to closely observe how the damage on the nuclear plants unfolds.) Some rebuilding that should commence later half of the year will have positive impact on growth. Philippine growth is closely linked to Japan’s (second only to the US’s) via exports, investments, official development assistance and to a lesser extent, remittances.

3) The conjoined effect of bad news on business and consumer confidence globally. The recovery in the US is still fragile, the financial problems of the PIGS (Portugal, Ireland, Greece and Spain) countries in the Eurozone have not been fully sorted out, and spill over effects from Japan’s nuclear plants are factors that play on business and consumer psychology, and may nip nascent global exit from recession.

My guess is, however, that all things considered, this will only shave at most one percentage point from current Philippine GDP growth forecasts. Even if worse happens globally, as did happen when the financial tsunami affected every country in 2008/09, I believe we will keep afloat with positive GDP growth. We can count on:

a) Resilience of OFW earnings, and of the OFW s, coupled with dynamic BPO and KPO sectors. More broadly, we now have crisis tested financial/corporate sectors that have been careful and nimble in adjusting to changes in environment .

b) Improved economic policies taken over the years—that allowed greater openness to competition, a deregulated oil market, a flexible exchange rate regime, strengthened banking supervision, lower debt ratios, especially external debt, of both of government and corporate/banks.

c) Finally, first class economic managers in current administration, including the BSP governor, who have been working as a team, and are intent in pushing economic reforms. We are seeing this in the tax administration, in encouraging private investments including through a transparent and competitive PPP program, in the adoption of tourism friendly open skies policy, in energy policy including well targeted subsidies rather than price controls, in budget reform that saw the passage of a budget law for the first time in a decade, and in adopting a progressive social safety net program.

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