This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 05 MANILA 001987 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EAP/PMBS, EAP/EP, EB/IFD 
TREASURY FOR OASIA 
 
E.O. 12958: N/A 
TAGS: ECON KIPR PREL RP
SUBJECT: EMBRACING THE DRAGON:  THE PHILIPPINES DEEPENS 
ECONOMIC ENGAGEMENT WITH CHINA 
 
REF: MANILA 1954 
 
SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION - 
PROTECT ACCORDINGLY 
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Summary 
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¶1. (SBU) With the visit of Chinese President Hu Jintao, the 
Philippines has taken stock of its expanding economic 
relationship with China and deepened its relationship with 
its dominant neighbor with respect to investment, trade and 
economic assistance.  The glow of bilateral friendship 
encouraged a degree of hype, of course, and the impressive 
aid and investment levels totaling over $2 billion in 
official pronouncements included a good dose of recycled 
commitments, untapped loan facilities and investment 
commitments in the mining sector that face serious political 
hurdles if implemented.  At present, the PRC absorbs about 7% 
of Philippine exports, a fast growing but smaller share than 
that of the U.S. (18%) or Japan (19%).  The Greater China 
market, including Hong Kong and Taiwan, absorbs 21% of all 
Philippine exports and has collectively become the country's 
largest export market.  The "Greater China" concept, however, 
tends to exaggerate perceptions of the PRC's economic 
engagement here.  Many companies, especially those run by 
Filipinos with Chinese ancestry, have set up operations in 
China, and the Philippines anticipates increased Chinese 
commercial investments that will further strengthen ties. 
That said, small- and medium-sized manufacturers and labor 
unions remain especially concerned about the future impact of 
China's export competitiveness and labor resources. 
 
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Shared History and Ethnic Connections 
------------------------------------- 
 
¶2.  (SBU) Over the weekend prior to the Hu visit, street 
crews have lined Roxas Boulevard, one of Manila,s main 
streets, with posters bearing an image of intertwined Chinese 
and Philippine flags and the slogan &A New Golden Age of 
Partnership.8  The proximity of the two countries, their 
historical connections, and the increasing prominence of 
Filipinos of Chinese descent within Philippine society makes 
the development of a strong relationship between China and 
the Philippines a logical and pragmatic move.  Last week,s 
visit of Chinese President Hu Jintao April 26-28 coincided 
with the 30th anniversary of the diplomatic relationship 
between the Philippines and China.  Their economic 
relationship, however, has a much longer history, and recent 
scholarship substantiates a significant, though not 
continuous, trade and commercial relationship back as far as 
the seventh century. 
 
¶3.  (SBU) Xiao Qian, DCM at the PRC Embassy, emphasized to us 
that the most important substantive aspect of the visit was 
on the economic and trade side.  As China has emerged as a 
major economic power in Asia, the Philippines has recognized 
that it could stand to reap significant benefits from 
developing a closer trade relationship with China and 
attracting Chinese investments.  At the same time, the threat 
of increasing Chinese competitiveness, the relatively cheap 
and unorganized labor it offers, and the prospect of diverted 
foreign direct investment causes many Filipinos to take a 
more cautious stance towards the possibility of closer 
engagement. 
 
------------------------- 
Expanding Trade Relations 
------------------------- 
 
¶4.  (SBU) Trade relations between China and the Philippines 
have been growing at a more rapid pace since China,s 
accession to the WTO.  Data from the Philippine National 
Statistics Office (NSO) reveals that Philippine exports to 
China increased by 71% in 2002, 58% in 2003, and 24% in 2004. 
 This growth is markedly higher than the growth experience by 
Philippine exports to the world as a whole (which increased 
only by 10% in 2002, 3% in 2003, and 9% in 2004.) It is also 
much higher than the growth rate of Philippine exports to 
China prior to 2001.  A 2004 study conducted by the 
Philippine Institute for Development Studies reveals that 
total exports from the Philippines to China grew at an 
average of 13.5% over 1980-1996.  China,s accession to the 
WTO in 2001 and its subsequent actions to liberalize its 
markets has been one of the driving forces behind this 
dramatic growth in Philippine exports.  The PRC absorbs about 
7% of Philippine exports, a fast growing but smaller share 
than that of the U.S. (18%) or Japan (19%).  The Greater 
China market, including Hong Kong and Taiwan, however, now 
absorbs 21% of all Philippine exports, and these economies 
have collectively become the country's largest export market, 
so the "China market" for Filipinos is significantly much 
more than that of the PRC.  The Greater China concept, of 
course, tends to exaggerate the PRC's economic engagement 
here.  Major Philippine exports to China include 
semi-conductor devices, electronic data processing units, 
office equipment, consumer electronics, and fresh fruit. 
 
¶5.  (SBU) Imports from China have also increased 
dramatically.  Inbound shipments from China only reached $294 
million in 1994, or 1% of all Philippine imports.  In 2004, 
China accounted for $2.533 billion, or 6.3% of its imports, 
compared to the U.S. share of 16%.  Philippine imports from 
China include semiconductors, textiles, petroleum products, 
metal-based construction materials, iron and steel.  The high 
degree of intra-industry trade in this bilateral relationship 
threatens many Philippine manufacturers and exporters. 
Philippine businesses and labor unions remain concerned about 
China's growing export competitiveness and large labor 
market.  Big business, especially firms headed up by 
Chinese-Filipinos, can cope with competition through 
investments in China, but smaller firms, which make up the 
bulk of manufacturers here, will face difficult adjustments 
in the years ahead. 
 
--------------------------------------------- -- 
Smuggling: Invisible Imports Distort Trade Data 
--------------------------------------------- -- 
 
¶6.  (SBU) During Hu Jintao,s visit, both sides set targets 
of $20 billion in bilateral trade in the next two years and 
$30 billion by 2010.  The trade numbers put out by the 
National Statistics Office of the Philippine Government, 
however, do not tell the whole story of Philippine-Chinese 
trade.  Many of the goods from China entering the Philippines 
arrive in clandestine shipments and are not incorporated into 
the &official8 statistics.  The Website of the Philippine 
Embassy in Beijing draws on data from China,s General 
Administration of Customs to list the volume of 2004 
bilateral trade at $13.3 billion, more than double the $5.185 
billion cited by the RP,s National Statistics Office.  This 
discrepancy between the data collected by the Chinese and 
Philippine governments suggests that a great deal of the 
trade between these two countries is happening &under the 
radar.8  The Philippine press has recently carried stories 
about local producers of shoes, textiles, and appliances that 
have been negatively affected by the large-scale smuggling of 
Chinese goods. China is the source of a number of 
IPR-infringing items such as DVDs and designer knock-offs 
that line the stalls of some of Metro Manila,s largest 
shopping districts.  Not all pirated goods on the Philippine 
market need to be smuggled in from China to make their way 
onto store shelves.  On April 1, Philippine police raided a 
plant producing 300,000 pirated optical disks per day and 
arrested 11 undocumented aliens (it remains unclear whether 
they are Taiwanese or PRC nationals) who had staffed the 
operation. 
 
--------------------------------------------- - 
Agricultural Trade Remains a Sensitive Issue 
--------------------------------------------- - 
 
¶7.  (SBU) The Philippines enjoys a small trade surplus in its 
trade relationship with China, although it has a deficit of 
$100 million in agricultural trade.  But if anecdotal 
accounts of rampant smuggling of goods from China are 
accurate, the Philippines may actually be running a 
significant trade deficit.  Agricultural issues have figured 
prominently in the bilateral trade relationship, despite the 
fact that agriculture represents an increasingly small 
proportion of their bilateral trade relationship (electronics 
now make up more than half of all goods exchanged.) One of 
the &major concessions8 the PRC had made during Hu Jintao 
visit, Xiao Qian said, was on the &Early Harvest program,8 
a trading protocol between ASEAN Member States.  The PRC will 
now allow Philippine agricultural exports similarly 
concessional status as it already affords Cambodia, Laos, and 
Vietnam.  Qian indicated that these three countries would 
likely be unhappy with the inclusion of the more developed 
Philippines, but that the GRP had pushed hard on this issue. 
 
¶8.  (SBU)  The two governments also signed a Memorandum of 
Understanding that will allocate, on a country-specific 
basis, 25 KMT of rice to China in compliance with the 
Philippines minimum access obligations under its WTO 
accession agreement.  This MOU represents approval by China, 
as one of nine challenging WTO member countries, of the 
request by the Philippines for extension of its special 
treatment for rice under Annex 5 of the WTO Agreement on 
Agriculture. That is, for certain concessions, e.g., those 
contained in this bilateral MOU, China agrees to allow the 
GRP to continue to maintain quantitative restrictions on rice 
for an additional seven years. 
 
------------------------------------ 
Taipans Invest in the Chinese Market 
------------------------------------ 
 
¶9.  (SBU) Although Chinese merchants have long dominated the 
business community in the Philippines, they were historically 
isolated from mainstream Filipino society and barred from 
obtaining Filipino citizenship.  Most Chinese Filipinos 
migrated from the provinces of Fujian and Guangdong in 
Southern China, and have maintained strong trade connections 
with these two provinces.  The emergence of a class of 
wealthy and powerful Chinese-Filipinos known as Taipans (most 
notably Lucio Tan and John Gokongwei) who exercise 
considerable influence over business has changed the role of 
the Chinese community within the Philippines.  Although these 
families lack the bloodlines that would prime their children 
for entrance into politics, they are able to wield 
significant power over political decisions through their 
hefty political contributions.  These wealthy 
Chinese-Filipino families have recently begun to re-discover 
the potential gains associated with their connections to 
China, and have begun to make investments in China itself. 
These investors have historical ties to China, speak Chinese, 
and have, for the most part, been successful in their 
business endeavors there.  Their increasing focus on mainland 
China for their investments reflects an economic move away 
from Taiwan and towards the PRC. 
 
¶10. (U)  Mr. Carlos Chan was one of the first Filipinos of 
Chinese origin to expand successfully into the Chinese 
market.  Mr. Chan began operations for his company, Liwayway 
Food Enterprises, in 1993 and now has approximately $250 
million in yearly sales.  Other Filipinos of Chinese origin 
have followed Mr. Chan,s lead, notably his brother Ben Chan, 
the founder and chairman of Bench, the popular clothing 
brand, which has established a 8 stores in China as well as 
Lucio Tan who has recently purchased a 25,000 square meter 
plot of land to construct a hotel and department store. This 
trend of Filipino-Chinese-owned businesses looking to China 
for investments is likely to continue and become even more 
significant.  Filipinos of non-Chinese origins have also 
begun to recognize China as a business opportunity.  Pacita 
Juan, founder of Figaro Coffee Company, a local brand that 
has set up its first franchises in China, found that hiring a 
good translator was key to her success in her business 
endeavor.  She responded to the allegation that Filipinos 
investing in China will abandon their home country, assuring 
&(we can be successful and repatriate the profits.8 
 
--------------------------------------------- ---------------- 
Investment and Economic Assistance:Hype Tempered with Goodwill 
--------------------------------------------- ---------------- 
 
¶11.  (SBU) China,s economic growth has positioned more of 
its companies to invest abroad, although its investments in 
the Philippines thus far remain limited (accounting for only 
0.1% of total approved FDIs in the Philippines in 2004, 
according to a study released by the Economist Corporate 
Network in 2005), many hope that Hu Jintao,s visit will 
spark further Chinese investor interest in the area. 
According to Xiao Qian, the visit produced 15 agreements on 
various trade and investment deals.  One agreement commits 
approximately $800 million to reopen an existing nickel mine, 
which would represent the largest foreign mining investment 
in the country since the Supreme Court,s recent decision to 
open the mining industry to foreign investment.  Another 
agreement offers a "new tranche" of long-term, low interest 
credit worth $500 million for the Northern Railway project 
(in addition to an existing $400 credit that has not yet been 
touched.)  This project will build only 82 kilometers of 
railway, Qian admitted, citing the need for numerous bridges 
and flyovers as a reason for the high cost.  He also noted 
problems that GRP had faced in removing residents and 
squatters; so far the GRP had cleared only 7 kilometers of 
the route, but the GRP had assured the PRC that this was the 
most complex stretch, and the rest would go quickly. Qian 
stated that the PRC planned to use mostly Chinese equipment 
in the new construction but indicated the &possibility8 of 
using local laborers.  Another high profile deal will involve 
replacing an existing French-style cell phone system (which 
may be relocated in North Luzon) with a Chinese-build 
US-style system. 
 
¶12.  (SBU) In the context of the Hu visit, the two 
governments, of course, tended to hype potential Chinese 
investments and economic assistance.  The two sides 
highlighted the Luzon railway project during GMS's fall, 2004 
visit to Beijing and the announcements appear to be recyled 
commitments for a project that has had a very slow start with 
almost no disbursements of funds from these Chinese loan 
facilities.  The mining sector investment in nickel appears 
significant on the surface but, again, the Chinese have not 
disbursed funds and mining investments here are still subject 
to many local government and other constraints. 
 
¶13. (SBU) Ambassador Jose Antonio, Philippine Special Envoy 
to the People,s Republic of China, has stated that medical 
tourism, infrastructure, mining, and pharmaceutical 
represented areas for potential Chinese investment in the 
Philippines.  Despite the positive tone of Antonio's remarks, 
and the energy surrounding the visit of President Hu Jintao, 
many Filipinos (especially those in the shoe, garment, and 
agricultural businesses) remain apprehensive that Chinese 
success in drawing foreign investment will displace money 
that might have otherwise been invested in the Philippines. 
Ambassador Antonio dismissed these fears, summing them up as 
&fear of the unknown and fear of the Chinese as traders,8 
that would be alleviated once Filipinos recognized the 
benefits of closer engagement with China. 
 
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Comment 
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¶14.  As China continues to act as a growth-driver for the 
Asia-Pacific region, and as its increasing domestic demand 
transforms it into a consumer society in its own right, the 
Philippines is unlikely to step away from the closer 
relationship it has developed with its powerful neighbor.  As 
China offers more foreign aid to the Philippines and becomes 
an increasingly large market for Philippine goods, the 
relationship between the two countries is likely to deepen 
economically and may extend to cooperation in other areas 
(reftel).  Chinese influence in the Philippines is set to 
grow, and, as China,s production capabilities increase, its 
exports to the Philippines, both legal and illegal, are also 
likely to grow.  Filipinos, while viewing China as a 
competitor for market access opportunities as well as for FDI 
inflows, will also increasingly recognize China as an 
important economic partner. 
Ricciardone