Cablegate: Pain Now, Worse Pain Later for the Philippine Economy

DE RUEHML #2532/01 3150551
O 100551Z NOV 08





E.O. 12958: N/A

REFS: A) Manila 2340, B) Manila 2174, C) Manila 1050


1. (SBU) Summary: The impact of the U.S. slowdown and global
financial problems on the Philippines has so far been felt mostly
through the fall of the stock market and of the value of the peso.
Real economic pain, though, is coming. Contacts in business and
government tell us they are bracing for serious setbacks. While
there is no expectation of a banking or financial crisis, effects
will likely include scaling down of production and layoffs in the
electronics and semiconductor sectors, a significant slowdown in
construction, and slower growth in remittances from Filipinos
overseas. Revenue challenges and increasing costs of borrowing will
constrain fiscal policy. Slower GDP growth will constrict
employment opportunities and poverty will likely increase for the
Philippines's rapidly growing population. End Summary.

Direct Exposure to Problematic Investments Limited...
--------------------------------------------- --------

2. (U) During the initial months of financial turbulence, the
Philippines has been shielded from the most direct effects of
financial troubles in the United States (Refs A and B). Its
relatively inward-looking banking and insurance industries have
relatively little exposure to foreign financial instruments,
generally placing over 90% of their loans and domestic investments.
Reinforcing domestic financial stability were remittances from
overseas Filipino workers, which have been growing by more than 17%
year-on-year thus far and are expected to contribute more than $16
billion to the Philippine economy during 2008.

Stocks/Peso Suffer Most Obvious Setbacks...

3. (U) The more immediate and significant effects of the external
financial shock have thus far been on the Philippine stock and
currency markets. For the first time since December 2006, the
Philippine peso fell back to 49 pesos to U.S. dollar territory
during the last week of October, after peaking at around 40 to the
U.S. dollar this past February, prompting the Central Bank to dip
into its $37 billion stock of reserves. On November 7, the peso
closed at 48.81, 3.9% weaker than at the end of September 2008 and
18.2% weaker from the end of 2007.

4. (U) The local stock market has been volatile since
mid-September. On Monday, October 27, the Philippine Stock Exchange
composite index experienced a 12.3% one-day decline to 1713.83,
slipping to its lowest level in more than four years. Stock
Exchange officials imposed a mandatory 15-minute halt to trading in
order to stop a wave of panic selling (a "circuit breaker" strategy
agreed upon by stock exchange members should the index fall by 10%
or more from its previous day's close). The main index of the
Exchange slipped by another 0.5% to 1704.41 on October 28, before
rising in subsequent days in response to the Federal Reserve's
announcement of an interest rate cut. At the close of trading on
November 7, the index stood at 1921.34, compared to 3621.60 at the
end of 2007 (a 46.9% drop year-to-date). The stock index has
declined by more than 26% over the past six trading weeks alone.

5. (SBU) Though systemic risk seems manageable at this point, there
may be specific companies or financial institutions where risk is
concentrated. One example may be the Lopez group of companies,
owners of the electricity distribution company for Manila, which has
high dollar-denominated debts. Between devaluation of the peso and
the decline of equity prices, the Lopez group has seen the value of
the collateral for its loans fall to 10% of outstanding loans.

...But Adverse Impact on Real Economy Emerging
--------------------------------------------- -

6. (SBU) Though government statements about the impact of global
developments on the Philippines have been predictably sanguine,
businesspeople are nervous and pulling back. Jaime Zobel de Ayala,
one of the most respected businessmen in the country, told
Ambassador that his companies are pulling back assets and minimizing
risk. Ernie Santiago, President of the industry association
representing the semiconductor and electronics industries of the
country (the largest concentration of U.S. investment) told Econoff
that association members will be cutting back production in coming
months. They have scheduled a meeting of their members to discuss
how to deal publicly with the significant layoffs participants in
the industry will have to announce soon.

MANILA 00002532 002 OF 003

7. (U) Contacts in the construction and tourism industries have
also expressed to us their concern about their sectors.
Construction, in particular, expects to be hit by cutbacks in the
private sector and in government investment spending, as well.

8. (SBU) One of the President's most trusted economic advisors,
Joey Salceda, told us that he expects the impact on the Philippines
to be very significant. He expects 2008 growth to fall by at least
half it's 2007 three-decade high of 7.2 percent. He predicts
overseas worker remittances, which have seen growth approaching 20
percent per year recently, will slow to single-digit growth over the
coming year. Increasing tax revenue will be challenging. The
"flight to quality" by investors has already begun to exert upward
pressure on domestic and foreign interest rates and may tighten the
Government of the Philippines's access to financing. At a time when
he would like to advise President Arroyo to spend and stimulate the
economy, most likely there would be not choice but to cut spending
on infrastructure.

9. (SBU) In a separate meeting, Finance Secretary Gary Teves agreed
with Salceda's conclusions, stating that he is facing an
increasingly tough budget cycle, with a number of factors
exacerbating revenue pressures in an already challenging
environment. The corporate income tax rate (raised from 32% to 35%
under the reformed value added tax law as a form of "burden
sharing") falls to 30% in 2009. A tax relief measure signed into
law in response to high food and fuel inflation took effect in July
2008, exempting minimum wage earners from income tax and increasing
personal deductions.

Impact on Poverty

10. (SBU) While lower prices for energy and food (the price of rice
is now half what it was at its peak earlier this year) will provide
some relief, poverty will certainly increase with the slowing of the
economy. Salceda predicted 310,000 job losses, including 50,000 for
overseas Filipino workers, - about 1% of total employment in the
Philippines. Combined with more than 1 million new entrants in the
Philippine job market annually, the unemployment rate could inch up
to between 9%-10% over the coming year, from 7.6% currently.
Measurements of poverty and hunger are both likely to increase as a

Recent GRP Responses

11. (U) On October 23, the Central Bank issued Circular 627,
launching a dollar-denominated repurchase facility to help ease the
"uneven distribution" of foreign exchange among banks and temper
pressure on the peso. On October 23 and 31, the monetary authority
also issued Circulars 626 and 628, respectively, providing
guidelines for financial institutions to reclassify certain
financial assets from categories recorded at fair market value to
categories recorded at amortized cost. Allowing the
reclassification of non-derivative financial assets conforms with
revisions issued in October 2008 by the International Accounting
Standards Board -- purposely to help promote confidence in financial
markets by tempering potentially sharp deteriorations in balance
sheets and incomes from the current global financial turbulence. As
additional regulatory relief, the Philippine monetary authority also
allowed the reclassification, until mid-November 2008, of credit
link notes and similar products underpinned by Republic of the
Philippines bonds. In response to emerging tightness in the
interbank credit market, the Philippine Central Bank announced on
November 7 a two percentage point cut in required reserve
requirements effective November 14, and doubled resources under its
rediscounting facility to 40 billion pesos (about $816 million).

12. (U) Salceda told us that, given limits to government spending,
the government would attempt to prioritize strictly its budget for
2009. In particular, he saw increases focusing on agriculture,
including more purchases of rice from farmers (buying high and
selling low in order to subsidize both producers and consumers),
education (scholarships) and healthcare. He said that President
Arroyo continues to support the Doha Round. For his part, he said,
"A new WTO deal would do more than all the bailouts in helping the
real economy, as it would optimize the positive impacts of stimulus

Comment: Combating Poverty Still on the To Do List
--------------------------------------------- -----

13. (U) The Philippines is likely to weather the downturn

MANILA 00002532 003 OF 003

reasonably well, mostly thanks to the stabilization of the
macroeconomic situation -- the most important accomplishment of the
Arroyo government. Nonetheless, the desperate poverty which
afflicts about 45% of the population of this country (measured
against the $2/day international poverty line) will worsen (Ref C).
The need for selected reforms and for further opening of the economy
to combat poverty will continue to grow.


© Scoop Media

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