EMBRACING THE DRAGON: THE PHILIPPINES DEEPENS

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
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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.

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Expanding Trade Relations
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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.

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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.

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Agricultural Trade Remains a Sensitive Issue
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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.

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Taipans Invest in the Chinese Market
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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

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Investment and Economic Assistance:Hype Tempered with Goodwill
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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