Reforms pushed through by President Benigno Aquino have put the Philippines back on the map for international investors but authorities are struggling to control an inflow of capital that has pushed up the currency and threatens asset price bubbles.
The central bank cut interest rates last week to deter hot money but economists say inflows will remain a problem, especially with the U.S. Federal Reserve pumping money into its struggling economy, some of which will spill into attractive emerging markets.
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Other Asian countries are trying to control capital inflows too as they provide an oasis of resilience at a time when the European debt crisis is dragging heavily on the global economy.
Singapore and Hong Kong, major destinations for foreign investors, have introduced property curbs to prevent their real estate sectors from overheating. By some measures, the Philippines has more reason to be worried though, as investors show an enthusiastic response to the president's attempts to turn around an economy long considered the "sick man" of Asia.
The peso is the strongest emerging market currency in Asia this year as foreign direct investment has more than doubled. The country's main stock index is up nearly 25 percent this year, a standout performance against other emerging markets, and in dollar terms it is the strongest in Asia.
On Tuesday, Amando Tetangco, the governor of the central bank, Bangko Sentral ng Pilipinas (BSP), said the monetary authorities needed to be more "creative" in managing inflows of capital and could not rely on interest rate differentials alone.
Few expect that to mean any move towards capital controls, especially when the Philippines is an active issuer of sovereign debt in global markets.
Instead, the central bank could simply be signaling a pause in monetary loosening after cuts totaling 1 percentage point brought the policy rate to a record low of 3.5 percent this year.
"The BSP will be looking at using a suite of tools in combination rather than one tool, given the multitude of risks and the complexity of managing it," said Vishnu Varathan, an economist at Mizuho Corporate Bank in Singapore.
He said the central bank could impose different reserve requirements for assets in foreign and local currencies, for example, and it might allow the peso to appreciate further to dampen the value of Philippine assets in dollar terms.
However, it will have to tread carefully: a rise in the currency makes Philippine exports expensive and reduces the local value of the remittances from overseas Filipinos -- a tenth of the population -- that millions of people rely on back home and which underpin domestic consumption.
Jose Mario Cuyegkeng, an economist at ING Bank in Manila, said the BSP might want tighter limits on banks' real estate loans or higher capital adequacy ratios to reduce speculative activity, but he did not rule out further interest rate cuts.
With inflation expected to remain on target through 2014, the central bank can be flexible with monetary policy, analysts said.
In August, the central bank said it would tighten rules on banks' real estate exposure to address the financial system's vulnerability to asset bubbles. Housing loans surged to their highest in four years at the end of June.
The central bank has said it was considering new liquidity ratio requirements for banks under international Basel III rules. It has already set a capital adequacy ratio for banks at 10 percent, above a requirement of 8 percent under Basel II.
Radhika Rao, an economist at Forecast PTE, said the BSP may further ease rates on its short-term special deposit account (SDA) window that had attracted record inflows of nearly 2 trillion pesos ($48 billion) as of October.
The facility offers rates higher than short-term Treasury bills, with the seven-day term paying 3.53125 percent against just 0.3 percent for the 91-day bill in the secondary market.
In July, the BSP started lowering rates on SDAs after tightening access to the facility to ensure it remained closed to foreign investors.
Analysts generally rule out capital controls because such drastic measures could push investors elsewhere.
"It will dampen the interest of investors coming in and it will also cut capital inflows, especially for much-needed projects that the government has for infrastructure," Roland Avante, head of the Philippine Business Bank, told local TV.
The economy's improvement has also been recognized by ratings agencies. On Monday, Moody's Investors Service raised its credit rating for the Philippines to match that of rivals Standard & Poor's and Fitch Ratings.
They all now rate the country just one notch below investment grade, a level that would attract further inflows from funds mandated to invest in top-rated assets only.
The Philippines was one of the wealthiest nations in Asia in the 1950s before it lost its way to become heavily reliant in recent years on debt as other economies in Asia jumped ahead.
The ratings moves are an endorsement of Aquino's efforts to narrow the budget deficit and deal with other perennial problems; corruption and tax dodging, weak infrastructure and a lack of investment in social services in a country where a third of the population live below the poverty line.
His reforms have underpinned a rise of 6 percent in the peso this year. The stock market has risen by nearly a quarter, a big gain compared with a 9 percent increase in the MSCI emerging markets index .
Foreign direct investment nearly doubled in the first seven months of the year to $1.03 billion, well on track to eclipse the 2011 total of $1.3 billion. Much of the success has come from business process outsourcing firms attracted by low costs.
When Aquino assumed power in 2010, net portfolio inflows into the Philippines surged more than three times and were the highest in Southeast Asia after Thailand. The flow slowed in 2011 because of global uncertainties but have shown signs of recovery in the third quarter of this year.
(Reporting by Rosemarie Francisco and Erik dela Cruz; Editing by Alan Raybould and Neil Fullick)