CHARGE CALLS ON KEY GRP FINANCIAL OFFICIALS

UNCLAS SECTION 01 OF 05 MANILA 004109

SIPDIS

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STATE FOR EB/IFD/OMA, EB/ESC
STATE PASS EXIM, OPIC AND USTR
STATE PASS USAID FOR AA/ANE AND AA/G
STATE PASS USTR FOR BWEISEL AND DKATZ
DOE FOR TOM CUTLER
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USDOC FOR 4430/ITA/MCA/ASIA & PAC/KOREA & SE ASIA/ASEAN

E.O. 12958: N/A
TAGS: ECON EFIN ENRG PREL EINV RP
SUBJECT: CHARGE CALLS ON KEY GRP FINANCIAL OFFICIALS

Sensitive but Unclassified -- Not for Internet -- Protect
Accordingly

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Summary
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1. (SBU) In separate meetings with the Charge, both Central
Bank Governor Tetangco and the Finance Secretary Teves
described what they see as good prospects for steady economic
growth, financial stability, and continued progress on fiscal
reforms. Tetangco, in particular, downplayed recent
"political noise" and attributed any weakness in the peso
almost exclusively to uncertainty over the Supreme Court's
ruling, expected soon, on the expanded VAT. Both Tetangco
and Teves expressed confidence that the expanded VAT would
meet with court approval. Teves said he was very pleased
that the Philippines could become a Millennium Challenge
Account (MCA) Threshold Country. Tetangco and Teves stated
their strong commitments to fiscal reform and anti-corruption
efforts. Tetangco underscored his commitment to maintain
progress on anti money-laundering, especially as a recent
Egmont Group member. These two key financial officials will
be in New York in mid-September when President Arroyo is at
the UNGA meetings, and both will be meeting with members of
the financial community to try to boost confidence in the
Philippine economy. Teves is intensely focused on fiscal
reforms, especially improving revenue collection, and less on
"business climate" issues outside of the DOF's immediate
territory. End Summary.

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Participants
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2. (U) -- U.S. Participants at Central Bank and DOF
Meetings: The Charge, USAID Director Jon Lindborg and
Economic Counselor Robert Ludan.
-- GRP participants at Central Bank: Governor Amando "Sy"
Tetangco and Deputy Governor Diwa Guinigando.
-- GRP participants at DOF: Finance Secretary Margarita
"Gary" Teves and Deputy Secretary Roberto Tan.

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Central Bank Governor Sees 5 Percent GDP Growth in 2005
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3. (SBU) In the Charge's August 25 call, Amando Tetangco,
recently appointed Governor of the Bangko Sentral ng
Pilipinas (BSP),noted that the overall macroeconomic numbers
looked good. GDP growth in the first quarter was 4.6 percent
and the still unannounced figure for the second quarter
appeared to be about the same. Surging oil prices had the
effect of reducing initial 2005 growth estimates to the lower
end of the forecast range (5.3 percent - 6.3 percent),but
growth of about 5 percent for the entire year would be
"respectable" in view of oil prices, according to Tetangco.
The balance of payments situation for the first half of 2005
was in surplus by about $1.9 billion due to stronger than
expected remittance inflows, up 21.5 percent in the first
half, though initially projected to grow by only 10 percent.
The $10 billion in remittances in 2005, compared to $8.5
billion in 2004, would offset the higher cost of oil on the
balance of payments. Tetangco explained that the market
response to higher oil prices was much quicker than expected
and demand had already declined. The GRP has already funded
the National Power Corporation (NPC) through the end of the
year so the current account surplus was set to increase.
Barring an "accident," Tetangco predicted the current
account, at year's end, would remain in surplus by $850
million, which would be higher than initial forecasts.


4. (SBU) Turning to exchange rates, Tetangco noted that BSP
reserves were $17.7 billion and that the peso, trading at
about 56 pesos/dollar that day, would be slightly stronger,
perhaps about 54 pesos/dollar, if it were not for current
political uncertainties. He noted that the peso had traded
at 53 pesos/dollar on July 1 prior to the temporary
restraining order and Supreme Court review, which froze
implementation of the expanded VAT. The pending Supreme
Court decision on the VAT, however, was a much more important
factor than the recent "political noise," which the markets
tended to ignore, according to Tetangco. Markets and the
BSP now expect a favorable decision on the expanded VAT and
slight strengthening of the peso. If the Supreme Court
decision strikes down the expanded VAT, Tetangco admitted
that markets would react negatively and that the GRP and the
BSP would have to redirect their attention to stimulate
stronger economic demand and growth.


5. (SBU) Tetangco said that the BSP does not target a
specific exchange rate for the peso. The peso trades within
a range of values against the dollar. The BSP, however,
would work to counteract "sustained unidirectional movement"
in the currency. "We want orderly exchange rate adjustment,"
he said. The foreign exchange rate should be "basically
market-determined." "We do not want volatility." He
insisted that the BSP had not engaged in large scale
intervention to prop up the currency during the recent
political turbulence and commented that there had been no
such need. He pointed out that central bank reserves were at
an all time high, $17.7 billion, indicative of
non-intervention.

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Banking Sector Reforms
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6. (SBU) BSP has continued to work with the commercial banks
to clear out bad assets and reduce nonperforming loans. The
BSP plans to strengthen the capital position of the banks to
ensure that they move to Basel II standards by 2007. The BSP
is working with the Congress on legislation that would amend
the BSP charter and, separately, upgrade the availability and
quality of credit information for the banking system. Under
current conditions, the lack of reliable credit information
penalizes creditworthy borrowers. The BSP is also seeking
legislation that would update the legal framework for
bankruptcy cases. The current bankruptcy law dates back
about one-hundred years to the early 20th Century and, he
said, overprotects large creditors and borrowers. Other
needed legislation includes pension fund reforms that would
encourage higher savings rates.

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Nonperforming loans
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7. (U) The NPL situation has improved significantly over the
last year, with BSP data indicating a peak of 18.2 percent of
credit assets in the NPL category in October 2001 but a
current level of 9.2 percent. The goal is to reduce the
level to 5 percent, where it was prior to the Asian financial
crisis. Removing an additional 100 billion pesos in NPLs in
the coming year would reduce the rate to 7 percent. Housing
loans are beginning to support new construction and overseas
foreign workers (OFWs) and other overseas Filipinos have
recently shown strong interest in the housing market, though
still on a small scale.


8. (U) Capitalization is generally high in the banking
system, but certain banks are weak, according to Tetangco.
The BSP is encouraging mergers among the banks, and the broad
goal is to have fewer but bigger banks. At present, 42
domestic and foreign commercial banks operate in the
Philippines, of which about 20 are foreign (including
Citibank, JP Morgan Chase, and Bank of America). Only ten of
the banks are authorized to operate branches. Citibank and
HSBC have acquired savings banks here to enter the retail
banking market.


9. (U) Tetangco asked if it might be possible to establish
remittance centers in the United States to facilitate such
flows to the Philippines. The BSP is seeking ways to reduce
the transfer fees for remittances. The Charge replied that
each state may have different rules with respect to
capitalization requirements and other standards for such
enterprises and that such centers would have to consider the
rules in each state. Deputy Governor Guinigando explained
that the average remittance transfer is about $400 and that
the average fee is 3-4 percent of the amount transferred.
Singapore appears to be the most efficient at a cost of 1.4
percent, with average transfers of about $200, while Italy is
the most expensive at 5 percent.

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Commitments on Anti Money-Laundering
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10. (SBU) The Charge noted that a weak banking system could
encourage money laundering. Tetangco confirmed that the BSP,
as it works on financial sector reforms, is determined to
continue to strengthen its Anti-Money Laundering Council
(AMLC) and that AMLC is strongly committed to its work. He
thanked the Charge for USG recognition of the Philippines'
progress on anti-money laundering and support on its Egmont
membership. Deputy Governor Guinigando noted that AMLC has
recently closed some accounts in Philippine banks because of
suspicious transactions originating in the U.S. that proved
to be innocent. He added that even when the suspicions are
cleared, those Philippine banks encounter difficulties with
future transfers from the U.S. to the Philippines. The
Charge offered to try to help if the BSP can provide
specifics, which Guinigando said he would do.

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Back Taxes Owed on Foreign Currency Accounts
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11. (SBU) Tetangco expressed the hope that the Bureau of
Internal Revenue (BIR) would favorably interpret the law to
allow tax exemptions for the foreign currency deposit units
(FDCU) of the banks for the period 1997-2003. He said that
he believed the authors of the 1997 comprehensive tax reform
law did not intend to eliminate tax exemptions for FCDUs
during the period in question. Tetangco stated that the
Congress needed to clarify the intent of the legislators in

1997. The Charge stated that progress on this issue would
help to improve investor confidence in the regulatory
environment and in the consistency of tax laws.

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Tax Evasion
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12. (SBU) Tetangco said that he expected Finance Secretary
Teves would give strong support to programs in the BIR and
the Bureau of Customs (BOC) to fight tax evasion and
corruption. He said that efforts by the Finance Department,
though critical, were not sufficient and that the GRP needs
more consistent follow up action from the judicial sector.
When authorities identify tax evaders or corrupt officials,
the public needs to see prompt prosecutions and resolutions
of these cases, he noted. Without that sense of finality,
the GRP cannot create the deterrent effect so critical to
changing current patterns, he admitted.

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Finance Secretary Teves Focused on Fiscal Reform
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13. (SBU) In the Charge's August 25 introductory call, Teves
underscored that his long-term objective was to ensure a
balanced budget by 2008 and that the expanded VAT would help
significantly. He hoped that a favorable Supreme Court
decision on the VAT's constitutionality would permit
implementation by the first or second week of September.
(Note: Supreme Court decided this case on September 1.
Septel reports details. End note.) The delay since early
July has already cost about 10 billion pesos in lost
revenues. Although revenues from the expanded VAT are not
included in the estimated 280 billion peso deficit for 2005,
the best case scenario would now result in the expanded VAT
reducing the deficit by 17.5 billion pesos for the remainder
of this year. The decision to reduce petroleum duties (from
5 percent to 3 percent) would be 2 billion pesos less in
revenue intake per month, so the net effect of the expanded
VAT and petroleum tax reduction would be an additional 11
billion pesos in 2005 revenues, according to Teves's
back-of-the-envelope calculation. He underscored that the
key to maintaining progress would be the performance of the
BIR and BOC, under his management.


14. (U) Teves estimated that government spending declined by
32 billion pesos ($580 million) in 2005, and, with
implementation of the expanded VAT, the deficit in 2005 would
be about 180 billion pesos ($2.7 billion). If oil prices
stay within the $65-70 bbl. range, the GDP growth forecast
would be in the range of 5.0 - 5.3 percent, with higher
growth associated with lower oil prices.


15. (U) Teves said he saw no need for new taxes in 2006. He
wants to focus on the sale of government assets, improved tax
collection, and better monitoring of performance in the
government owned and controlled corporations (GOCCs). The
government's recent divestiture of shares in the Philippine
National Bank, he said, would send a strong signal to
investors that the GRP wants to sell off more of the GOCCs.
Echoing Tetangco's sentiments, he said that commercial banks
need to consolidate and merge and that, with greater
financial sector stability, risk premiums might be reduced.

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Millennium Challenge Account (MCA)
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16. (SBU) The Charge informally notified Teves that the
Millennium Challenge Corporation had approved the GRP's
concept paper for the MCA Threshold Country Program. We
would receive official notification soon. USAID Director
added that the Philppines would now become eligible to submit
a Threshold Country Plan for a possible initial grant to
support fiscal reforms and anti-corruption programs designed
to boost revenue capacity and other activities outlined in
the GRP's concept paper submitted in June. Teves was very
pleased that the Philippines could become an MCA Threshold
Country and introduced Deputy Finance Secretary Roberto Tan
as the GRP lead on MCA. Teves said he planned to meet with
MCC officials when he is in Washington in September for the
World Bank/IMF meetings. Teves underscored his government's
commitments to fiscal reform and anti-corruption efforts.

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Attracting Investment
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17. (SBU) Teves interpreted the approximately 10 percent
increase in the Manila stock market since the beginning of
the year as a sign of investor confidence. Net portfolio
capital inflows have reached about $1.9 billion this year.
However, he acknowledged that money moving in quickly can
just as quickly move out and that foreign direct investment
has hardly grown this year. He blamed low levels of
infrastructure investment and continued fiscal weakness for
the lackluster FDI record. Although remittance flows are
very important, he said, the GRP needs to create more
opportunities to channel OFW remittances into investment.
Remittances do provide foreign exchange and funds to rural
areas especially, but mostly for consumption, he added.


18. (SBU) Teves cited his priority legislative initiatives
in Congress: a new securitization law that would further
clarify legal protections for lenders and facilitate
investment as well as legislation on insurance, capital
markets, and pension funds. He said he would wait for a lull
in Congress and then try to move quickly on legislation. He
acknowledged that a number of recent Supreme Court and other
court rulings had created difficulties for foreign direct
investors but claimed that the Finance Department was unable
to influence those situations. The Supreme Court ruling that
the Clark Economic Zone's tax incentives were
unconstitutional has affected 350 investors there, including
firms from the United States, EU, and Japan, but this was a
matter for the courts, he insisted. Teves also showed little
interest in other ways to improve the business climate such
as stronger IPR protection. He said that he would remain
focused on fiscal reforms, especially improving revenue
collection, and not on areas outside the direct authority of
the Finance Department. The Charge commented that improving
the business climate would reinforce investment inflows and
that the MCA Threshold program could be especially useful in
backstopping GRP efforts to improve the capacity of its
revenue agencies.

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Visit to New York to Boost Investor Confidence
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19. (SBU) Tetangco and Teves plan to visit New York in
mid-September with President Arroyo when she attends the UNGA
meetings. They will meet with members of the financial
community in New York, where the Philippines will probably
soon try to raise additional funds through the sale of
dollar-denominated government bonds. They want to update
potential investors, including those in the bond market, on
Philippine economic developments and to confirm GRP
commitments to fiscal reform. They will also travel to
Washington for World Bank/IMF meetings on September 24-25.
Except for Teves's meeting with MCC officials, they have not
made requests yet for meetings with USG officials.




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