LITTLE ECONOMIC IMPACT SO FAR FROM ARROYO'S WOES

UNCLAS SECTION 01 OF 03 MANILA 003045

SIPDIS

SENSITIVE

STATE FOR EAP/PMBS, EAP/EP, EB/IFD, EB/TPP/BTA/ANA
STATE PASS USTR FOR BWEISEL, DKATZ AND JMURPHY
STATE PASS USAID AND OPIC
USDA FOR TERPSTRA, SHEIKH
TREASURY FOR OASIA FOR AJEWELL
USDOJ FOR MCRAWFORD
USDOC FOR 4430/ITA/MAC/DBISBEE
TREASURY FOR OASIA

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV RP
SUBJECT: LITTLE ECONOMIC IMPACT SO FAR FROM ARROYO'S WOES

REFS: A) Manila 2993

B) Manila 2970
C) Manila 2670
D) Manila 2475
E) Manila 2167

SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION


1. (SBU) Summary. The Peso broke the PhP56/$1 mark on
June 29, but has marginally recovered. The stock market
continued to slide lower on concerns about the President's
future, but most local analysts said that the situation
remains manageable. The Philippine business community
appears to be sticking with its support of President
Arroyo, but remains cautious about the future due to
lingering concerns about corruption and its impact on
business. Agriculture Secretary Yap announced his
resignation on June 30 in the wake of tax evasion charges
filed against him. His departure should have no serious
political or economic ramifications, as would potentially
the departure of economic stars in the Cabinet such as
Finance Secretary Purisma, who remains a cheerleader for
the Administration. End Summary.

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Markets Nervous, But Holding
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2. (U) Despite GRP efforts to assure the business sector
that the Arroyo Administration remains committed to
economic reforms, the financial markets remained jittery
after the President's announcement at a business forum on
June 29 that her husband would leave the country (ref a).
Amid the political drama, the local currency hit an intra-
day low (and closing level) of PhP56.05/$1 on June 29, the
weakest recorded since January 12. At that rate, the peso
had depreciated by 0.8% (PhP0.54) in two days, from June
27's closing rate of PhP55.51/$1. The peso fell further to
a low of PhP56.26/$1 in morning inter-bank trades on June
30 (not too far off the Php56.45/$1 historical low recorded
before the May 2004 elections) before recovering to
PhP56.00/$1 by day's end, reportedly because of Central Bank
intervention. On July 1, the peso opened trading at
PhP56.05/$1, but recovered to end the day's trading at
PhP55.87/$1.


3. (U) As for other indicators, the Philippine Stock
Price Index (Phisix) closed July 1 at 1,895.25, down 3.48%
from June 27. On the downtrend for several months,
domestic interest rates also have come under pressure these
past three weeks. Despite excess financial market
liquidity and perceptions of improved fiscal prospects,
securities dealers jacked up bid rates for the Government's
treasury bills, particularly for the longer-term papers,
prompting the Government to reject most of the bids
offered.


4. (SBU) Foreign exchange and securities traders and
analysts commented that the markets are understandably
nervous but described the situation as "still manageable."
While more investors may opt to stay on the sidelines until
the political dust settles, some observers noted that the
markets were not yet seeing a massive sell-off of peso
assets, probably due to improved economic fundamentals and
especially efforts to address the public sector's chronic
budget deficit. The business community remains concerned
about the lingering effect of corruption on the economic
climate, according to observers.


5. (SBU) However, analysts warned that the economic
situation could worsen should protracted political
controversies seriously put to question the
Administration's ability to pursue bold reforms and move
the economy forward. Already, the opposition and militant
cause-oriented groups have again begun to lambast as "anti-
poor" the amended Value Added Tax law (ref e),which took
effect on July 1, further to fuel furor against the Arroyo
presidency and urge her to resign. Several opposition
members of Congress have petitioned the Supreme Court to
halt the implementation of the new VAT law, claiming that
it amounts to an unconstitutional delegation of taxing
authority to the Executive. Although Finance Secretary
Cesar Purisima has stressed repeatedly that the President
will indeed use the standby authority granted by the law to
increase the VAT rate by two percentage points to 12% in
2006 to secure fiscal stability, observers have expressed
doubt as to whether the President will be able to do so as
her popularity weakens.

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Purisima Remains Optimistic
--------------


6. (SBU) At the Business Leaders Forum on July 29,
Secretary Purisima focused on the positive developments in

SIPDIS
the Philippine economy and reiterated support for the
President and her commitment to economic reforms. Urging
that the Philippines must "get out of the cycle of deficit
it has been in," he stated that the country could balance
its budget earlier than its target date of 2010 through a
series of "front-loaded deficit reductions."


7. (U) Purisima also emphasized the importance of recent
efforts to prosecute tax evaders, which, if sustained, will
"show people that it is no longer business as usual."
Purisima also emphasized that the Department of Finance
would begin to take "a closer look" at the country's
government-owned and controlled corporations (GOCCs),
specifically the National Food Authority; the GOCCs
contributed significantly to the public sector deficit, he
stressed. Purisima also stated that an ambitious
privatization scheme would leave the Government "more
freedom to invest in infrastructure," paving the way for a
brighter future for the country.

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New Central Bank Governor Promises Consistency
-------------- -


8. (SBU) Central Bank Governor Amando Tetangco, who
officially assumed his post as the new governor of the
Philippine Central Bank on July 1 but has been acting
governor for several weeks, also delivered a positive
message about prospects for the Philippine economy at the
July 29 event, stressing that his bank's policy direction
would emphasize "continuity and consistency." While noting
that inflation in the Philippines had continued to rise
over the last several months (due mainly to increasing
world oil prices and the increasing transportation and
energy prices that follow suit),Tetangco stated that the
Central Bank's policy rates had remained steady since April
2005 (at 7% for borrowing and 9.25% for lending). The
Central Bank forecasts that inflation rates will average
7.9% for 2005 and 7.5% for 2006. Tetangco said the Bank's
international reserve levels have recently risen to
historical highs and the balance of payments yielded a
surplus of $1.6 billion during January-May 2005. He
downplayed the negative implications of high Philippine
debt levels for the future of the country's economy,
emphasizing that 90% of the country's foreign debt is made
up of medium to long-term loans, nearly half to bilateral
and multilateral lenders and carrying concessional interest
rates.

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Santos Projects Trade Growth
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9. (SBU) According to Secretary of Trade and Industry Juan
Santos, recent trends reflected a "return of confidence" in
the Philippine economy. Philippine exports grew by 9.3%
last year; Santos is aiming for a 10% increase this year.
(Note: January-May 2005 exports were up 4.8% year-on-year.
End note) Santos acknowledged that electronics dominate
the RP's exports (accounting for some 70% of total
exports),but stated that the country is attempting to
shift its manufacturing focus toward highervalue-added
goods. Santos emphasized the importance of investments in
the call center industry but noted that other forms of
business process outsourcing such as automotive design and
computer graphics could also attract new investors to the
country.

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Agriculture Secretary Resigns
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10. (U) Agriculture Secretary Arthur Yap resigned on June
30, saying that tax evasion charges recently filed against
him and his father left him no choice. Yap, while
maintaining his innocence, admitted that staying on while
the case is heard would create a "no-win" situation for
both him and President Arroyo because, even if cleared of
the charges, the opposition would claim it is only a GRP
"whitewash." He insisted that his resignation was not in
response to mounting pressure on President Arroyo to step
down. According to media reports, Arroyo is also
contemplating additional cabinet changes. Yap announced
that he will remain in his job until Malacanang names a
successor.

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Comment
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11. (SBU) Economic fundamentals have not changed
significantly in the wake of the President's recent
difficulties, and the business community appears to remain
mostly supportive of her, likely because there are no
alternative economic plans from other potential leaders
that would better address business concerns. Business
leaders place their confidence less in Arroyo than in
Purisima and the other members of her economic team, but
doubt is growing about the GRP's ability to implement its
economic reform package because of the President's
political baggage. Departure of any of these key economic
players would probably foretell a death knell for the
Arroyo Administration, at least from the standpoint of the
influential business community. Yap and the others rumored
to be part of the potential cabinet reshuffle are not/not
seen are among those key players; his (and potentially
their) departure should not affect the business and
economic environment.

Mussomeli