Cablegate: Buffeted, Buffered, Challenged: The Economy of The

DE RUEHML #2740/01 3530913
O 180913Z DEC 08





E.O. 12958: N/A
SUBJECT: Buffeted, Buffered, Challenged: The Economy of the
Philippines in 2008-2009

REFS: a) Manila 2725, b) Manila 1050, c) Manila 2532, d) Manila
02731, e) Manila 2731, f) Manila 01618, g) Manila 01802, h) Manila

1. (SBU) Summary: In 2008 the Philippines saw its growth rate
fall, inflation jump, assets lose value and poverty increase,
primarily as a result of global economic conditions. Nonetheless,
the country continues to be reasonably well placed to weather the
shocks which have so far occurred. With wealth and economic and
political power highly concentrated, and relatively insulated from
important aspects of globalization, the Philippines has some room to
maneuver in a global downturn. The same features of the country's
economy also mean that the Philippines will continue to under
perform its neighbors once the world economy begins again to grow.
The country's ossified economic structure has resulted in desperate
poverty for more than one third of Filipinos. U.S. policy and
assistance have been crucial for those few economic reforms which
have been implemented and our subtle help and prodding will continue
to be important to helping the country take advantage of the
opportunities which the continuing process of globalization will
afford it. End Summary.

2008 Buffeted, But Buffered

2. (SBU) The past year was challenging for Philippine policy
makers. Coming off a spectacular (for the Philippines) 2007 growth
rate of 7.2% to about 4% was tough enough. Worse, the unprecedented
price increases, especially in the principal foodstuff of the
country, rice, threatened to leave much of the population
increasingly hungry. Unfortunately, the government itself reacted
with panic and government actions in the international rice market
are believed by many analysts to have driven prices even higher.

3. (U) Considering the unfavorable external shocks of the past
year, the Philippines has done relatively well. Export growth,
although still up somewhat (1.8%) during the first ten months of the
year, contracted sharply (14.9%) in October, its worst performance
in seven years. Accounting for about two-thirds of annual export
revenues, electronics exports were down nearly 4% over the first ten
months of the year, with exports in October logging a sharp 18.9%
year-on-year drop. The uncertain global environment also pulled
down foreign direct investment flows and triggered a withdrawal of
foreign portfolio capital. As of September, net foreign direct
investment had plunged by 46% year-on-year to $1.4 billion and net
withdrawals of portfolio capital stood at $1.3 billion. The
national income accounts show that investments in durable equipment,
up 6% in real terms during the first half of 2008, slowed to no
growth during the third quarter.

4. (U) The conservative nature of the Philippine banking sector, a
drag on economic growth in good times, is now serving as a buffer
against the financial crisis in the U.S. Banks are well capitalized
and relatively unexposed to foreign risk (ref a). Financial assets
nonetheless, have taken a beating. As of mid-December, the stock
market has lost some 48% of its value since end-2007, and the peso
fell nearly 17% against the dollar.

5. (U) Job losses so far may be counterbalanced by the continuing
announcements of major new hiring in the business process
outsourcing sector. However, poverty worsened over the past year,
especially because of the food price shocks of 2008. The latest
official poverty statistics for 2006, released in early 2008,
estimated that poverty rose from 30% of the population in 2003 to
33% -- equivalent to 3.8 million more poor Filipinos (ref a).
Although official poverty estimates are conducted only every three
years, our rough estimate using a recent World Bank impact analysis
of food inflation is that the Philippine poverty rate may have
increased by another 3 percentage points between 2006 and 2008
(equivalent to roughly 5 million more Filipinos joining the ranks of
the poor).

2009: Slow But Steady

6. (U) The hallmark economic reform of the Arroyo administration,
the 2005 increases in, and broadening of, the value added tax, has
been the key to the recent economic stability of the country and is
crucial to the ability of the government to remain afloat as the
economy slows and private debt financing becomes difficult or
impossible to obtain. Most analysts believe that the remittances of
overseas workers, up by more than 17% as of September 2008, will
continue to grow, albeit slowly, over the next year. In 2009,
increased public sector expenditures and remittances should allow
both government and individuals to continue the consumption which is

MANILA 00002740 002 OF 004

the basis for Philippine economic stability. The government
officially abandoned its goal to balance the budget in 2008, opting
instead for deficits in 2008 and 2009.

7. (U) Growth will continue to slow -- to about 3% in 2009, while
inflation also slips down to about 6%, per consensus forecasts,
reflecting softer food and fuel prices. We expect that job growth
will turn negative, with significant job losses in the electronics
sector, slowing growth and the return of some overseas workers from
abroad. The booming business process outsourcing sector will buck
the trend, continuing to generate new jobs, and softening the
employment impact of the slowdown. Nonetheless, with continued high
population growth resulting in about a million new workers entering
the labor force every year, we expect higher unemployment and
further increases in poverty (ref b).

Fundamental Constraints to Growth and Development
--------------------------------------------- ----

8. (U) Unfortunately, while the isolated and underdeveloped nature
of the Philippine economy results in relative stability in the
current global economic turmoil, it is also a key reason why this
country has gone from being one of the richest in Asia in the 1950s
to one of the poorest, today. By almost any measure, the
Philippines has consistently failed to provide a competitive
investment climate and, as a result, has slipped further behind its
neighbors in a famously dynamic region of the world.

9. (U) The Philippines has tremendous economic potential. Sitting
at the epicenter of marine biodiversity, it has fisheries potential.
The ninth most mineralized country in the world, it has tremendous,
mostly untapped, mineral wealth. Mindanao and parts of Luzon have
important agricultural resources. With uncounted miles of beautiful
white sand beaches, many of them sitting on tranquil protected seas,
the country boasts great tourism possibilities. Finally, though the
education system has deteriorated over the 62 years since
independence, the country still boasts a relatively well-educated,
English-speaking, hard working and service oriented population.
Most U.S. investors here tell us that the number one attraction of
the Philippines is the workforce. Nonetheless, more than 45% of the
population subsists below the $2 a day international poverty
benchmark. The great challenge of the Philippines is to unleash its
potential and thus create opportunities for all of its population.

10. (U) A 2008 Policy Research Working Paper of the World Bank
(#4472, Rising Growth, Declining Investment: The Puzzle of the
Philippines, available at
describes the Philippine problem quite well. The Philippines has
consistently attracted far less investment, both foreign and
domestic, than almost any other country in the region. While a
number of factors are involved, one stands out. Investment is low
in the country as a result of elite capture of the levers of
government and oligopoly in key sectors of the economy. With
government assistance, elite monopolies and oligopolies provide key
inputs (transportation and cement, for example) at prices which make
other sectors of the economy less competitive and less attractive
for investment than they otherwise would be. Economic growth is
maintained at a level which has been politically sustainable (and
has sustained elite profits) via emigration of workers and creation
of export-oriented industries which operate mostly outside of the
domestic economy.

11. (U) Economic researchers identify the weak Philippine state as
a key aspect of the problem. Heavily controlled by and dependent
upon the elite, government has been unable to increase tax effort
above 17%, a historic peak achieved in 1997 which lags most
countries in the region. Tax effort has since fallen back to about
14% in 2008. As a result, public infrastructure, public education
and health care have also been chronically under funded, resulting
in the degradation of what was one of the best education systems in
Asia and extremely poor infrastructure in an archipelagic and
mountainous country in which transportation infrastructure is of
critical importance.

12. (SBU) Unsurprisingly, government investment has been
particularly low in the more remote and distant reaches of the
country. Nowhere is investment in infrastructure, education, and
health care more lacking than in the conflict-affected areas of
Mindanao, populated by a Muslim majority. For example, while some
70% of students nationwide complete their primary education, only
30% of students in the Autonomous Region of Muslim Mindanao
accomplish that goal.

Overcoming Constraints with U.S. Assistance

MANILA 00002740 003 OF 004


13. (SBU) In this environment, achieving real reform is a daunting
task, and yet meaningful reforms have taken place, primarily by
building strong connections to pro-reform constituencies. The USG
has played an important, though unheralded, role in these reforms.
(Note: The USG role in many of these reform initiatives is very
discreet. Nationalist reactions can reduce or eliminate our
effectiveness. Please protect information on the USG role in
initiatives as noted in SBU paragraphs below.)


14. (SBU) In 2001, Congress enacted the Electric Power Industry
Reform Act, which had been drafted with substantial technical
assistance from USAID. Under the Act, and with continuing USAID
assistance, the government has established an electricity wholesale
market which is viewed as a model around the world. Some 72% of
state-owned generating assets have been privatized, as has the
electric grid. The government is now on the verge of establishing
"open access," to allow large consumers of energy to contract
directly with producers. Reform of this sector has the potential to
substantially reduce currently high electric costs, a key constraint
to growth (ref c). Likewise, USAID provided technical assistance in
the drafting of new region-leading legislation on alternative fuels
in 2007 and renewable energy in 2008 (ref d). With our assistance,
coalitions of energy users have formed and been able to negotiate
with the monopoly distribution company reductions in rates of as
much as 10%.

Civil Aviation

15. (SBU) After supporting a new legal and regulatory framework for
liberalized aviation, USAID continued to work with a broad coalition
of economic interests centered on the Diosdado Macapagal
International Airport at the former Clark Airbase to win new,
liberalized air service agreements with numerous countries including
South Korea, Macau, Hong Kong, Thailand, Malaysia, and Japan (ref

16. (SBU) Improved air transport through the Clark Airport has led
to a more competitive market and many more flights--at cheaper
rates--for tourists, business travelers, and Filipinos traveling to
work overseas. As a result, passenger arrivals to the Diosdado
Macapagal International Airport at Clark have increased ten-fold
since 2004, and the airport is fast emerging as an alternative to
the congested airport in Manila. More importantly, this activity
broadens the base of constituents supporting liberalized air travel
and transportation nationwide and supports the dynamic development
taking place outside of Metro Manila. We are now working to
identify the potential for similar coalitions to lobby for more
liberal policies for airports in Cebu, Davao, and other major

Maritime Shipping

17. (SBU) Maritime shipping suffers from oligopoly pricing which is
actually supported by current legislation. Understanding that a
direct attack on that legislation would be unsuccessful, USAID
pushed instead a scheme for roll-on, roll-off transport in which
land transportation was supplemented by a network of ferry ports
allowing land/ferry transportation between almost any two points in
the Philippines. As a result, domestic shipping costs are estimated
to have fallen by nearly 45% on key routes while allowing smaller
scale producers to participate in inter-island commerce for the
first time (ref f). We are simultaneously working on increasing
competition in port services. In an archipelagic nation such as the
Philippines, increasing efficiency in domestic shipping is crucial.


18. USAID assistance supported a high-level, inter-agency
infrastructure monitoring task force to analyze and address the
range of legal, logistic, and financing issues impeding the timely
implementation of high-priority infrastructure projects. In less
than two years this group became instrumental in resolving many
long-standing project implementation issues, leading to the
successful completion of dozens of projects including toll roads,
airports and sea ports, collectively worth more than $1.5 billion.
Acting directly to deal with the lack of publicly-funded
infrastructure in one of the poorest regions of the country, USAID
has invested $59.8 millionover the past5 years in infrastructure
in Mindanao.

Banking and Finance

MANILA 00002740 004 OF 004

19. (SBU) USAID technical assistance to the Rural Banking
Association has been crucial to helping rural banks become efficient
lenders to micro-enterprise. From practically nothing a decade ago,
there are now hundreds of rural banks participating in microlending.
They have made some 1.5 million loans over the last ten years,
totaling about $325 million, to almost half a million borrowers.
The program is growing rapidly, with about a third of the lending
taking place over the past two years. In 2008 the Philippine
Congress passed two pieces of legislation which were the result of
USAID technical support and which have the potential to make major
contributions to development. The Personal Equity Retirement
Account Act creates a framework for private retirement savings, much
like the U.S. 401K system. The Credit Information System Act
creates a system for exchange of credit information, much like
credit bureaus, to make lending more secure and credit more


20. (SBU) Econ, USAID, FCS and FAS are all involved in our
interagency efforts to protect U.S. investment here and improve the
Philippine investment climate. Substantial restrictions on foreign
investment are written into the Philippine Constitution and laws.
The effort to raise the profile of these investment restrictions and
build support for their elimination seems to have gained steam this
year, and the issue has come into mainstream discussion over the
past few months. While complicated domestic politics makes a
revision of these provisions unlikely in the short term, we will
continue to press the issue as it will benefit U.S. investors and,
by bringing outside competition into the domestic market, also holds
great potential to increase competition in the domestic market and
increase the competitiveness of the economy as a whole.


21. (SBU) Likewise, freer trade has the potential to increase
competition and thus help to overcome the key constraints on the
domestic economy. In 2008 the Philippines completed ratification of
its first bilateral free trade agreement. The Japanese- Philippine
Economic Partnership Agreement is quite limited in scope and
potential and was a challenge for the government to negotiate and
ratify (ref h). Nonetheless, it represents important progress. We
continue to work on preparing the Philippines, both economically and
politically, for eventual free trade with the U.S.

Comment: An Important Economic Partner Facing Challenges
--------------------------------------------- ----------

22. (U) The Philippines remains an important market, particularly
for U.S. agriculture. It has the potential to be an even more
important market. However, breaking down the anti-competitive
structures of this market takes time and imagination. Our
investment thus far has been substantial and has led to important
reforms. We expect that to continue.


© Scoop Media

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