VZCZCXRO9377
OO RUEHCHI RUEHFK RUEHHM RUEHKSO RUEHNAG RUEHPB
DE RUEHML #2740/01 3530913
ZNR UUUUU ZZH
O 180913Z DEC 08
FM AMEMBASSY MANILA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 2716
INFO RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUEHZU/ASIAN PACIFIC ECONOMIC COOPERATION
RHHMUNA/USPACOM HONOLULU HI

UNCLAS SECTION 01 OF 04 MANILA 002740 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR EAP/MTS, EAP/EP/ EEB 
STATE PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ENRG EAIR ETRD EINV PGOV RP
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 
02419 
 
¶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 http://go.worldbank.org/NQQO5TWHR0) 
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.) 
 
Energy 
 
¶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 
e). 
 
¶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 
destinations. 
 
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. 
 
Infrastructure 
 
¶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 
available. 
 
Investment 
 
¶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. 
 
Trade 
 
¶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. 
 
Kenney