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Philippines Review 2003 William R. Thomson Chairman of Momentum Asia Ltd 18 August, 2003 Political developments President Arroyo - or GMA as she is universally known to friend and foe alike - was born and bred for the job but has disappointed her supporters with her seeming inability to effect needed changes in economic policies and the political set-up. Realistically, no one should be surprised since the presidency is a poisoned chalice that has proven to be a challenge too far for most of her predecessors as well - with the honourable exception of President Ramos. On 30 December 2002 at ceremonies to honour the national hero in the fight against the Spanish, President Macapagal Arroyo dropped a bombshell by announcing that she did not intend to run for re-election in May 2004 but would use her remaining time in office to govern non-politically and try and effect needed but stalled political and economic reforms. At the time of her announcement she had been in office for just two years and by enjoying the advantages of incumbency was the favourite to win in 2004. Her opponents treated the announcement with an equal measure of joy and cynicism. The cynics believe this was a ruse and, if conditions permitted, she would accede to the calls of the populace for her to run again. Terrorism, Muslim insurgency and military unrest The first half of 2003 has not been easy for President Arroyo. A devout Christian - as are more than 90 percent of the country's inhabitants - she is fighting a revived Muslim insurgency in the southern island of Mindanao and has aligned herself closely - too closely many think - with the Bush Administration's global fight on terrorism in order to obtain US support in her internal struggles with indigenous Muslims. Some opponents oppose military assistance from the US because of their colonial overtones, whilst others fear that the Philippines will inevitably become more likely to be a target for large-scale urban terrorism on the scale of Bali or worse. Indeed, the Philippines has both porous borders and corrupt law enforcement officials that have allowed considerable numbers of Arabs, with dubious pasts, to enter Manila as well as Indonesian Islamic troublemakers. Some of the perpetrators of the original New York City World Trade Center bombings in 1993 lived in Manila where they planned multiple and simultaneous aircraft hijackings that became the model for 911. Perhaps nothing better demonstrated the corruption within Philippine law enforcement when the most wanted Indonesian terrorist, Fathur Rohman al-Ghozi a leader of the Jamaah Islamyiah terror group, being held at Philippine police headquarters, escaped from custody the same day the Australian Prime Minister Howard was in Manila to sign a mutual assistance pact against terrorism. In July, President Arroyo faced a mutiny within the armed forces when dissidents took over the commercial centre of the capital briefly. It ended without bloodshed but the action was reflective of considerable discontent with her Administration within the junior officer ranks of the forces. Whilst the mutiny had comic opera aspects, it had the support of well-known and well-financed characters opposed of democracy, including figures close to deposed President Estrada such as Ramon Cardenas, and at least one possible presidential candidate, Senator (formerly Police General) Panfilio Lacson. Another Senator, Gregorio Honasan, the 1989 attempted coup leader, another Estrada crony, was also close to this year's mutineers. President Arroyo's approach to the rebels in Mindanao followed the Bush line of military bravado and threats. However, with obvious disgruntlement in the ranks the policy has transformed itself into offers of mediation. As in Northern Ireland, there can be no absolute military solution to ancient enmity between two such different religions and, realistically, negotiations are needed to realise an acceptable modus vivendi. President Arroyo therefore acceded to Malaysian Prime Minister Mahatir's offer in July 2003 to broker negotiations between the Moro Independent Liberation Force (MILF) and the Philippines Government. The subsequent death of the MILF's leader may complicate these negotiations. Elections 2004 Presidential and Congressional elections are scheduled for May 2004 with the winners due to take office at midyear with potential candidates having to declare their intent to stand by December 2003. Pre-election politics is likely to predominate in this period with little expected on the legislative front and unrest within the military probable. At the present time it is very difficult to predict who will run for President in 2004 and even harder to estimate the likely winner. A number of candidates have expressed interest including a former Senator and Cabinet Minister Raul Roco. Senator Lacson, an Estrada crony, has seemed likely to run, if his legal problems do not overwhelm him. Former Marcos crony and San Miguel Chief Executive Danding Cojuanco will probably run, if President Arroyo finally decides not to run. There will also be a plethora of minor candidates with the winner the candidate with the most votes on the first and only round. It is quite possible that the winner be a candidate receiving as little as 20 percent of the popular vote. Constitutional changes The Philippine Constitution was drawn up in 1987 in the wake of Marcos' fall and is modelled on the US Constitution in terms of the division of Executive and Legislative responsibility with a Lower and Upper House. It is deeply flawed and contains many economic prescriptions - such as defining the limit of foreign ownership of natural resources and utilities to no more than 40 percent - that should properly be the remit of legislatures where they can be amended as appropriate and have no place in a modern constitution. In addition, the US model is designed for weak and divided, rather than decisive, government, which may be appropriate for the US but is inappropriate for a developing country such as the Philippines. Many political observers believe a Westminster-style Prime Ministerial unicameral arrangement would provide more decisive government. One idea being mooted is for the 2004 elections to be held as a referendum on constitutional reform with the Congress then spending the next three years rewriting the constitution. This seems a long shot since it would require the members of the Senate - who have conspicuously large egos - to vote for their extinction something that has been characterised as likely as turkeys voting for Christmas. Economic developments Despite the generally adverse external economic environment and continued threats to peace and order, the Philippines' economy turned in its best performance since the 1997 Asian financial crisis in 2002 with GDP growing at a 4.4 percent rate compared with a 3.2 percent rate in 2001. The improvement was supported by a recovery in exports that grew by 3.6 percent compared with a 4 percent fall in 2001. Electronics and garments were the primary drivers of the export recovery, which also greatly assisted the modest recovery in manufacturing growth. However, the services sector, which grew strongly by 5.4 percent, remained the main growth pillar of the country's economic growth, driven by the transportation and communications sub-sectors. Agriculture slowed to 3.5 percent from 3.9 percent in 2001 although the second half was much stronger than the first half. Consumption was helped by a generally lax fiscal policy that, in turn, was primarily caused by a collapse in revenue collection. Plagued by morale and political problems with the Bureau of Internal Revenue, revenues declined to around 13 percent of GDP, compared with 16-17 percent in the Ramos era, and the deficit expanded to 5.3 percent. After Ramos, revenue collections declined sharply in the Estrada era and, despite efforts, the present Government has been unable to reverse the trend. The fiscal deficit and financing costs The expanded budget deficit is a real problem. With debt service accounting for over one third revenues there is insufficient to finance necessary infrastructure to meet the needs of the growing population - estimated at over 81 million at year end 2002 and growing by 2.3 percent annually. Public debt has been on a strong growth path and had reached around 72 percent GDP up from 66 percent at the end of 2001. On present projections it could be reaching close to 80 percent GDP by 2005. This is hardly sustainable and is raising considerable concerns about the quality of the country's external debt. The credit rating agencies in May 2003 lowered the rating to BB, barely above junk status. Fortunately, the lowering of global interest rates and an increased appetite for emerging market debt has allowed the country's interest spreads to improve and lowered financing costs. The country's external bonds were trading at an 800 basis point spread over US Treasuries at the end of the Estrada era. That improved to 250 basis points in mid-2002, although it has since expanded to around 500 basis points with recent concerns. Another indicator flashing warning signs is the debt service ratio where the steady growth of the external debt has this to rise from 12.8 percent in 1998 to 19.4 percent at the end of 2002. The external sector Whilst exports grew at 9.4 percent, imports grew even more rapidly causing the trade balance to fall from deeper into the red to a negative USD 2.1 billion although the current account balance was still positive at 1.6 percent GDP. Foreign direct investment (FDI) continued a disappointing decline to a disappointing USD 700 million. As usual the country remains highly dependent on the USD 6 billion or so of remittances that flow through official channels from the Filipino diaspora. Including informal channels, the true remittance figure is considerably higher. Employment The total labor force in 2002 of 33.9 million rose by 3.4 percent from the prior year's level. Employment growth, though, was a relatively sluggish 3.1 percent. With employment growing slowly, unemployment increased marginally to 11.4 percent. The Philippine unemployment rate remains the highest among ASEAN members. It has been exacerbated by the fastest growth in the labor force within ASEAN of over 3 percent and by relatively slow growth in recent years. Employment growth has been primarily in the services sector. This lack of opportunities at home coupled with an education system designed to train for lower skilled jobs abroad in fields such as medicine (nurses and carers), construction and the services sectors continues to fuel the skilled emigration that in turn provides the remittances the country is now utterly dependant upon. Economic prospects and challenges The current year promises to be a difficult one and economic growth may fall to around 2.5 percent. Fears of terrorism after the Bali bombings and the regional impact of SARS are expected to take their toll on tourism in particular and confidence in general. The mild upturn in the US economy is expected to lead to an improvement in exports. But little headway can be expected on longstanding difficulties, such as improvements in infrastructure, given the cash strapped nature of Government finances and the inability to attract FDI given regulatory uncertainties. External debt and the debt service ration are expected to continue their inexorable climb upwards. Improving tax revenues is critical. To that end the Government has been trying to reform the BIR into an autonomous effective agency. However, legislators are reluctant to make this agency effective since they themselves would be targets of an honest agency. This reflects a deep-seated cultural problem with no easy, quick solutions but one that must be tackled anyhow. Outlook for the stock market and investment It is sometimes observed that the Philippines has an inbuilt ability to shoot itself in the foot and snatch defeat from the arms of victory. This was demonstrated last year in spades in the case of FDI on which the country's economic growth prospects are, in no little amount, dependent. The country has long been a regional leader and initiator in the field of Build Operate and Transfer. However, the fiasco over the Piatco contract for the new Airport Terminal at Manila's International Airport has given the country a black eye as an attractive locale for this type of investment. The Frankfurt Airport Authority had invested several hundred million dollars in the project as a co investor with a local Chinese Filipino, begun during the Estrada Presidency. Right on completion the politically influenced courts declared the contract invalid on the basis of alleged corruption by the local investor and the Germans faced forfeiture of their investment. Such actions represent the political risk of investing in emerging markets, especially in long gestation infrastructure projects. But if the sanctity of contracts is in doubt investment will look for more attractive climes of which their are many. Further investment in the power and infrastructure sectors, already extremely difficult because of a general lack of enthusiasm for emerging markets in the wake of the Asian crisis, is unlikely in the near future in the Philippines. Eventually, investment guaranteed by western agencies such as the World Bank, or its affiliates MIGA and the IFC, as well as the Asian Development Bank and the USAID and OPIC will be essential to attract new large scale investment. On the other hand, the country is being successful in attracting small-scale investment into the business processing and outsourcing sectors. This sector includes the ubiquitous call centres primarily for international clients, largely North American based but with a growing European element. This builds on the country's skills in the service sectors, including the English language, in which India is the leader and only Asian competitor at the present time. But the higher value added is in business processing outsourcing which includes all back office functions for the insurance and banking industries, legal and accountancy work. In these areas, the Philippines probably has an edge over India. President Arroyo's warm embrace of the Bush Administration's war on terrorism has yet to bring substantial gains in American investment. First, the US is still suffering the effects of the collapse of the investment bubble and, secondly, US investors are concerned about the Philippines' competitiveness as well as sharing the usual security concerns. Indeed, the warm embrace may instead suffocate large-scale investment. As a classic 'weak state' the Philippines debates reform endlessly but makes little headway since vested interest are usually able to prevent any loss of privilege even when it would be to the common good. The mining sector is a case in point. The Philippines has some of the world's larger gold deposits but the regulatory climate - constitutionally 40 percent must be held by local interests - prevents an effective development of these resources. President Arroyo has made efforts to work around the problem but as yet to no avail. This is unfortunate since the world may be on the verge of a new mining boom. The Philippine stock market has lagged its regional competitors, especially Thailand but even Indonesia - despite the Bali and Marriott hotel bombings and continued unrest. The market seems to have developed a floor around 1000 on the index- down 70 percent in local terms and 85 percent in USD terms from the 1997 highs. But the global 'Baghdad bounce' enjoyed by markets since March 2003 has been anaemic by comparison with Manila rising only about 25 percent - half as much as some other regional markets. The uncertainty hanging over the local market is likely to persist until it is clearer who will lead the country post mid-2004 and how the hoped for - but long delayed - global economic recovery develops. Whilst value exists there are better opportunities elsewhere for overseas investors within Asia. Political and Economic Risk Ratings: Economic Stable but weak Political Underlying stability with increasing uncertainties Regional Stability Satisfactory (but Fragile) Stock Market Improving William R. Thomson wrthomson@btconnect.com Tel: 44 1483 440825 Bill Thomson is Chairman of the Siam Recovery Fund and advises governments and several asset management companies and institutions in Asia. He was formerly Vice President of a major international bank in Asia and is a former US Treasury official. He writes widely and we really appreciate his words of wisdom at 321gold. 321gold Inc Miami USA