The Philippines’ plan to temper spending on public goods and services in a bid to narrow its budget deficit to pre-pandemic levels may slow economic growth, according to the think tank Capital Economics.

“Monetary easing across the region should support consumption and investment, but tighter fiscal policy will partly offset this boost, especially in the Philippines and Malaysia,” Capital Economics senior Asia economist Gareth Leather, markets economist Shivaan Tandon, and assistant economist Joe Maher said in a June 26 report.

Capital Economics had projected Philippine gross domestic product (GDP) growth to slide to 5.3 percent this year from 5.7 percent last year. If the think tank’s forecast materializes, it would be the slowest economic expansion since reopening from the most stringent Covid-19 lockdowns, while also falling short of the government’s downgraded target range of 5.5 to 6.5 percent.

Despite the less optimistic and below-goal projection, Capital Economics said it expects this year’s GDP growth to “remain healthy.”

In fact, another Capital Economics report on emerging markets (EMs), also published on June 26, showed that the Philippines is poised to be the fastest-growing EM even among those with a slowing growth outlook.

“A key boost will come from consumption, which is being helped by a combination of lower inflation and interest rate cuts,” Capital Economics said.

“Price pressures are very low—headline inflation has fallen from a peak of 8.7 percent year-on-year in 2023 to just 1.4 percent last month—and is likely to remain within the BSP’s [Bangko Sentral ng Pilipinas] two- to four-percent target over the coming year,” the think tank noted, as it estimated the annual rate of increase in prices of basic goods and average to average only 1.6 percent in 2025.

Amid easing inflation, Capital Economics forecasts 50 basis points (bps) more of BSP interest rate cuts before year-end, to bring the policy rate down to 4.75 percent from 5.25 percent at present—a more dovish expectation than market consensus.

In particular, it expects the next 25-bp reduction in key interest rates to happen in the third quarter, or during the BSP’s Aug. 28 meeting on the monetary policy stance.

The think tank nonetheless cautioned that the consumption boost from downward inflation and interest rates “will be offset by drags from elsewhere.”

For one, “fiscal policy is due to be tightened,” Capital Economics noted, citing that ”debt shot up during the pandemic and the government is trying to bring it down steadily.”

It was referring to the Marcos Jr. administration’s medium-term fiscal program, which aims to narrow the budget deficit to 4.3 percent of GDP by 2028, when the President steps down from office.

Capital Economics projected the fiscal deficit to gradually decline from 3.9 percent of GDP last year to 3.2 percent this year, 2.5 percent next year, and two percent in 2027.

But the Cabinet-level Development Budget Coordination Committee (DBCC) on Thursday, June 26, announced that this year’s budget deficit would reach ₱1.562 trillion, equivalent to 5.5 percent of GDP.

The updated official fiscal deficit projection for 2025 is larger than the previous program of ₱1.538 trillion, equivalent to 5.3 percent of GDP, even as the economic team said that “fiscal consolidation remains a cornerstone of the government’s medium-term strategy.”

“The national government is committed to reducing the fiscal deficit... while simultaneously ramping up investments in infrastructure, human capital, and social services. This well-calibrated approach reflects our strong resolve to uphold fiscal discipline without compromising our goals of inclusive and sustainable development, even amid a more challenging global landscape,” the DBCC said in a June 26 statement.

“Revenue collections are expected to increase steadily throughout the period, reaching 16.3 percent of GDP by 2028. Key drivers include the implementation of recently enacted revenue reforms, such as the value-added tax (VAT) on non-resident digital service providers (DSPs) and capital markets efficiency promotion as well as sustained improvements in tax administration, compliance enforcement, and digitalization initiatives,” it said.

“National government (NG) disbursements will remain a major growth driver over the medium term, averaging 21.1 percent of GDP annually. Infrastructure spending will be sustained at five to six percent of GDP each year, ensuring continued improvements in physical connectivity. Public investments will also focus on education, healthcare, agriculture, digital transformation, and social protection, as reflected in the priorities under the Philippine Development Plan (PDP) 2023-2028,” it added.