VZCZCXRO0652
OO RUEHCHI RUEHDT RUEHHM
DE RUEHML #5050/01 3550333
ZNR UUUUU ZZH
O 210333Z DEC 06
FM AMEMBASSY MANILA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4344
RUEATRS/DEPT OF TREASURY WASHINGTON DC IMMEDIATE
INFO RUCPDOC/USDOC WASHDC IMMEDIATE
RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS IMMEDIATE
RHHMUNA/CDR USPACOM HONOLULU HI//FPA// IMMEDIATE

UNCLAS SECTION 01 OF 03 MANILA 005050 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/MTS, EAP/EP, EB/IFD 
STATE ALSO PASS EXIM, OPIC, AND USTR 
STATE ALSO PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE 
TREASURY FOR OASIA 
USDOC FOR 4430/ITA/MAC/ASIA & PAC/KOREA & SE ASIA/ASEAN 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV PGOV RP
SUBJECT: UPBEAT ECONOMIC NEWS BUT UNDERLYING PROBLEMS 
 
REFS:  A) Manila 4878 
       B) Manila 4687 
 
¶1.  Summary:  The Philippines is ending 2006 with good economic 
news.  Growth is exceeding expectations, inflation and domestic 
interest rates are declining, the peso is strong, the stock market 
is soaring, international reserves are at an all-time high, and the 
balance of payments shows a hefty surplus.  Unfortunately, the 
long-term prognosis is not nearly as positive.  The privatization of 
the power sector, legislatively mandated years ago, is far behind 
schedule.  Infrastructure is crumbling and government investment in 
education has not been sufficient to give all children classrooms, 
let alone materials and qualified teachers.  Necessary 
constitutional changes to liberalize the investment regime are not 
being discussed as part of the on-going debate over constitutional 
reform.  And corruption continues to drain away many of the 
resources the GRP does devote to resolving these serious problems. 
End Summary. 
 
---------------------------------- 
Growth Rate Good; Inflation Easing 
---------------------------------- 
 
¶2.  This year's economic results are impressive.  Growth projections 
for 2006 are now 5.5%, spurred by a recovery in exports and 
resilience in agriculture despite inconsistent rainfall in some 
areas and a spate of damaging typhoons.  The economy is anchored by 
the 15% increase in remittances from Overseas Filipino Workers' 
(OFW) this year and a booming business process outsourcing (BPO) 
sector.  The International Monetary Fund and the World Bank recently 
upgraded their GDP growth forecast for 2007 from earlier projections 
of between 5.5% and 5.6% to between 5.7% and 5.8%.  Stable food 
prices, a stronger local currency, moderating oil prices, and 
responsible monetary policy brought consumer price inflation down to 
4.7% in November 2006, the lowest rate since mid-2004. 
 
------------------------------------- 
Highs for Stock Market and Forex Rate 
------------------------------------- 
 
¶3.  The foreign exchange rate has risen steadily to a six-year high 
of 49.31 pesos to the dollar in December while the Philippine stock 
market index hit a nine-year high recently.  Domestic Treasury bill 
rates, the benchmark for interest rates on loans, are at a four-year 
low.  Another indication of optimism is that the premium the 
government must offer to borrow money -- the interest rate 
differential between comparable U.S. and Philippine government 
foreign bonds in the secondary market -- has been narrowing since 
¶2003.  In fact, the risk premium on bonds maturing between 2008 and 
2025 has tightened significantly from more than 500 basis points at 
the end of 2002 to between 50 and 220 basis points at the end of 
November 2006. 
 
----------------------------------------- 
Fiscal Deficit Falls Fourth Straight Year 
----------------------------------------- 
 
¶4.  The government's budget deficit will shrink for the fourth 
consecutive year after peaking above 5% of GDP in 2002.  The deficit 
is likely to end 2006 at barely 100 billion pesos, below 2% of GDP, 
following greater revenue generation from new tax measures.  The 
amended value added tax (VAT) law will generate about $1.5 billion 
in additional revenue for the year.  The tax-to-GDP ratio will 
increase to more than 14.5% this year from just 12.3% in 2004, about 
halfway to the government's goal and former high-water mark of 17%. 
 
 
----------------------------------------- 
BOP Surplus Boosts International Reserves 
----------------------------------------- 
 
¶5.  The Philippines is poised to end 2006 with the highest balance 
of payments surplus in seven years -- about $3 billion.  Although 
the total value of imports rose from the high price of oil, the 
country benefited from strong merchandise exports (up 16.4% as of 
October) and OFW remittances (up 16.6% as of October).  Up by 12% 
thus far, the number of overseas workers has topped the 1 million 
mark.  Higher tourism receipts and increased foreign direct 
investment also helped boost the balance of payments.  As a result 
of the hefty surplus, the central bank's gross international 
reserves hit a record $23 billion, equivalent to 4.5 months of 
imports and double the country's short-term foreign debt. 
 
----------------------------------- 
 
MANILA 00005050  002 OF 003 
 
 
Public Sector Debt Ratios Improving 
----------------------------------- 
 
¶6.  The government's success in reducing the fiscal deficit and the 
improved financial performance of state-owned companies has slowed 
the expansion of public sector debt.  As a result, the ratio of 
public sector debt to GDP declined from nearly 118% in 2003 to below 
90% this year.  The government used its strong international 
reserves to retire about $1.8 billion in foreign debt in 2006 to 
eliminate future interest payments on those loans and to reduce 
potential risks from the two-thirds share of foreign debt in the 
public sector's loan portfolio.  Taking advantage of the improved 
appetite for longer debt maturities, the government also swapped 
about $3 billion in domestic and foreign debt for longer-term loans. 
 
 
------------------------------ 
Non-Performing Loans Declining 
------------------------------ 
 
¶7.  Commercial banking system non-performing loan and non-performing 
asset ratios continue to decline after reverting to single-digits in 
mid-2005.  According to the central bank, the ratio of 
non-performing loans to total loans has tapered off to just 7.2% 
from a high of almost 19% in 2001.  The ratio of non-performing 
assets (which includes loans and foreclosed properties) to total 
resources has declined to 7.5% after hitting a high of over 14% in 
¶2001.  Over the next two years, the central bank expects these 
ratios to fall closer to the 3% to 4% range they were in before the 
Asian economic crisis of 1997. 
 
--------------------------- 
Better Outlook and IMF Exit 
--------------------------- 
 
¶8.  Moody's Investors Service improved its rating outlook on the 
Philippines from "negative" to "stable" in early November because of 
the country's fiscal progress.  Moody's action followed similar 
moves by four other major credit rating agencies (Standard & Poors, 
Fitch, Japan Credit Rating Agency, and Rating & Investment 
Information, Inc.) during the first half of 2006.  According to BSP 
officials, the Philippine Government expects to exit from four 
decades of direct IMF oversight when the current post-program 
monitoring arrangement ends in April 2007. 
 
------------------------------- 
But Long-Term Challenges Remain 
------------------------------- 
 
¶9.  Despite the recent good news, the country's long-term economic 
prognosis is shaky.  For example, poverty remains a serious problem 
with almost 40% of the population (about 33.4 million Filipinos) 
living on less than $2 per day.  Polls indicate that a larger 
percentage of Filipinos are having trouble making ends meet than in 
the past and a larger percentage are experiencing hunger.  In 
addition, the country is not attracting sufficient amounts of 
foreign direct investment.  The Philippines will receive less than 
$2 billion in foreign direct investment (FDI) in 2006.  Although a 
significant increase from previous years, it is still small compared 
to total FDI flows to the region or compared to any reasonable 
assessment of potential. 
 
¶10.  By concentrating its efforts in the following four areas, the 
Philippine government could demonstrate its will and ability to 
overcome institutional hurdles and pave the way for reduced poverty 
and expanded FDI: 
 
--  Stalled Privatization:  The delay in selling government power 
plants threatens public sector finances and undermines the long-term 
supply of affordable and reliable electricity.  Even after the 
recent sale of two hydropower plants, the GRP has off-loaded less 
than 5% of its power generating assets - well below the 70% required 
by law.  Many of these plants are old, inefficient and heavily 
subsidized, keeping electricity prices among the highest in Asia. 
By privatizing these assets, the government could save money, 
attract investment in new and more efficient power plants, and 
encourage an open, competitive market. 
 
--  Crumbling Infrastructure:  Government austerity to control the 
budget deficit has constricted the funding needed to improve 
infrastructure.  Corruption keeps those funds which are appropriated 
from making the difference they should.  In a 2006 World Bank study, 
the Philippines ranked last among 61 countries in physical 
infrastructure and near the bottom in educational facilities, 
 
MANILA 00005050  003 OF 003 
 
 
science and technology, and health.  President Arroyo has reiterated 
at recent public events her intention to boost spending on roads, 
ports, and airports and increase budgetary resources for schools and 
clinics, in part to raise the country's low competitiveness ratings 
(ref a). 
 
--  Corruption:  Corruption is a major deterrent to raising 
government revenue, delivering vital social services such as health 
and education, improving infrastructure, and attracting foreign 
investment.  The Philippines ranked 121st among 163 countries in 
Transparency International's 2006 Corruption Perceptions Index. 
According to a recent academic study, the country loses $8 billion a 
year in hidden international transactions.  Although the 
government's previous anti-corruption drives have not improved 
perceptions, efforts have been reinvigorated with the U.S. 
Millennium Challenge Account's Threshold Program which focuses on 
transparency in revenue generation and combating corruption. 
 
--  Liberalizing Restrictions on FDI:  The 1987 Constitution places 
limits on the ability of foreigners to own land and to participate 
in various sectors of the Philippine economy.  Although there is 
widespread understanding in Philippine policy circles of the severe 
damage this does to the country's competitiveness as a destination 
for investment, revision to these provisions is not being discussed 
as part of ongoing wrangling over possible constitutional reform. 
 
------- 
Comment 
------- 
 
¶11.  To sustain the current economic momentum, the government must 
maintain high quality spending and resist loosening its purse 
strings during the 2007 mid-term election campaign and the 
controversial initiatives to change the constitution.  Over the 
long-term, the government must stick with its reform efforts so the 
Philippines can catch up with its regional neighbors in spurring 
investment, stimulating growth, creating jobs, and alleviating 
poverty. 
 
KENNEY