PHILIPPINES: SLOW PACE OF ECONOMIC REFORM

UNCLAS SECTION 01 OF 03 MANILA 004503

SIPDIS

SENSITIVE

STATE FOR EAP/EP, EB/TPP
STATE PASS USTR FOR BWEISEL AND DKATZ
STATE PASS USAID AND OPIC
TREASURY FOR OASIA FOR AJEWELL
USDOC FOR 4430/ITA/MAC/DBISBEE

E.O. 12958: N/A
TAGS: ECON ETRD PREL KIPR TBIO TSPL RP APEC WTRO
SUBJECT: PHILIPPINES: SLOW PACE OF ECONOMIC REFORM

REFS: A) MANILA 4278, B) MANILA 4112

SENSITIVE BUT UNCLASSIFIED: NOT FOR INTERNET DISTRIBUTION


1. (SBU) Summary: Philippine government and private
sector leaders told U.S. Senior Official for APEC Michael
Michalak that the Philippines continues to face problems
with inefficient courts and corruption in general. Poor
implementation and unpredictable enforcement of laws
remain disincentives to investment. They offered a more
optimistic assessment of the country's fiscal situation,
although many raised concerns about the implementation of
the new expanded Value Added Tax (EVAT). The Millennium
Challenge Account (MCA),many said, is an encouraging
development that could lead to much needed structural
change. End Summary.

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Informing about APEC
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2. (SBU) During his September 19-20 visit to Manila,
U.S. Senior Official for APEC Michael Michalak briefed
GRP leaders on U.S. priorities in APEC. He told them
that the U.S. will pursue three key objectives at the
high-level APEC meetings in November: 1) advancing the
Doha Development Agenda in preparation for the December
WTO Ministerial in Hong Kong; 2) addressing energy
security in the region, especially related to high oil
prices and the impact on the regional economy; and 3)
formulating a strong response to the potential Avian
Influenza pandemic. He also sought their views on the
U.S.-RP economic relationship and encouraged them to use
the funds available under the MCA to implement needed
structural reforms.

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Good laws, lousy implementation
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3. (SBU) Former Trade Secretary Senator Manuel "Mar"
Roxas, who chairs the Trade and Commerce and the Economic
Affairs committees in the Senate, told Michalak that
implementing legislation and fighting corruption are the
GRP's biggest challenges. The GRP must take structural
approaches to combating smuggling and improve the
country's trade outlook, according to Roxas. However,
the level of corruption in the Bureau of Customs (BOC)
makes reform progress difficult, he said. Roxas was
eager to explore possibilities of linking APEC security
measures to initiatives detecting smuggling. Because
corruption is so much a part of the BOC culture, he said,
the GRP must, in effect, create an external mechanism to
police the BOC. Michalak urged Roxas to partner with the
business community on such initiatives and to solicit its
input on which structural reforms are most needed. Roxas
was optimistic that some of the GRP's MCA programs could
be used to address these issues.


4. (SBU) Roxas said there is a perception in the RP that
trade liberalization has failed to deliver promised
benefits, but acknowledged this is due largely to the
oligarchic power structure and GRP's failure to implement
necessary structural reforms. The GPR should have done
more to solidify reform and ensure competition in the
domestic market at the same time it was lowering tariffs,
he admitted. Roxas told Michalak that he now espouses a
more cautious approach to liberalization because of these
structural shortcomings. Citing the GRP's lack of
expertise in trade negotiations, he said he is submitting
legislation to create a "Special Trade Representative"
similar to USTR. The position may be an office in the
Department of Trade and Industry or a separate official
under the Office of the President, he said, but would
focus exclusively on the RP's international trade agenda.

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EVAT will be implemented
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5. (SBU) Senator Ralph Recto, chairman of the Senate
Ways and Means Committee, told Michalak he is optimistic
that the EVAT will be implemented in full within the next
two to three weeks (ref B). The conditions have already
been met, said Recto, for President Arroyo to
automatically trigger the VAT rate increase to 12% from
10% in January 2006. Recto estimated the EVAT will
generate 80-100 billion pesos (1.4-1.8 billion dollars)
in additional revenues in 2006 and will enable the GRP to
address many of its current fiscal difficulties.


6. (SBU) Recto discounted attempts to pass a joint
resolution delaying the imposition of VAT on fuel and
electricity until June 2006. He said the House will be
too preoccupied with passing the budget and debating
Constitutional changes to push the issue much further.
He finds it frustrating, he told Michalak, that President
Arroyo is now sending mixed signals on whether Congress
should delay EVAT implementation, especially after she
pressed lawmakers to pass a tax increase they did not
favor. Recto said he has always favored expanding the
tax base over increasing rates and fears that a delay in
lifting exemptions on fuel and electricity could erode
the effectiveness of the new measure.

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Cha-Cha could open markets
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7. (SBU) Recto told Michalak that redrafting the
Constitution could offer opportunities on trade and
investment liberalization. Michalak encouraged Recto to
support liberalization and said this may be an
opportunity to update provisions related to the business
climate in a very positive way. Recto agreed. He linked
the emigration of many talented Filipinos to investment
climate problems that he said are related to
constitutional limits on foreign ownership of land and
certain businesses and the entry of non-Filipinos into
certain professions. Charter change does not currently
have enough support to receive the necessary two-thirds
of votes in the Senate, he said, but he and others may be
open to the change if restrictions on foreign investment
are lifted. This is the only way, according to Recto, to
increase foreign investment in the Philippines, which is
lagging far behind neighboring countries.

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GRP needs more revenue
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8. (SBU) House Committee on Trade and Investment
Chairman Congressman Junie Cua told Michalak that, amidst
the difficulties the RP now faces, even small statements
of U.S. support help. The Philippines continues to be
interested in a free trade agreement with the U.S., he
said, but would be very cautious in negotiating on
agriculture issues. Michalak replied that the U.S. will
likely continue to work through the current Trade and
Investment Framework Agreement (TIFA) instead of
immediately engaging on FTA discussions, but emphasized
that the Millennium Challenge Account is a sign of how
serious the U.S. is about assisting the Philippines.


9. (SBU) The GRP budget deficit continues to be of
concern, Cua said, and the government needs to generate
more revenue. However, the imposition of the EVAT will
be "hard" and it might be "politically desirable" to
delay the VAT on electricity and gasoline to let recent
political turbulence cool off. He said it looks like tax
and customs collection figures are improving, but he
admitted there is still much to do on this front. On
IPR, he said that members of Congress want to ensure that
the legislation they provide (such as the Optical Media
Act) is enforced. Oversight, he said, will be more
vigorous because "if we just pass legislation and there
is no follow-through it won't be worth it."

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Need more anti-corruption justices
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10. (SBU) Ombudsman Simeon Marcello told Michalak his
greatest obstacle to prosecuting corruption cases is the
low number of cases the Philippine corruption court
("Sandiganbayan") is able to handle. The key to change
is increasing the number of justices and allowing single
justices to hear cases instead of using the current panel
system, he said. Acknowledging the need to improve anti-
corruption efforts, Marcello asked, "How can I fight a
war without soldiers?" The budget now before Congress
increases his office's funding by enough to add an
additional 48 prosecutors and 200 investigators to his
staff, but according to Marcello, that is still not
enough. He estimated he needs another 100 prosecutors to
effectively pursue all of the cases the Ombudsman's
office should be prosecuting. Even with the increased
budget, he said it will be difficult to find enough
qualified individuals to fill the new positions because
authorized salaries are low. He also said that if he
files more than the current number of cases each month,
the court would not have the capacity to hear all of the
cases. He was hopeful that some of the MCA money the
Philippines may receive will be used to address these
inadequacies.

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Business leaders pessimistic
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11. (SBU) Michalak also met with American and Filipino
Business leaders during his visit. They welcomed the
news that APEC is pursuing action on Avian Flu,
underscoring that a widespread outbreak could be
devastating for the region (ref A). There was limited
awareness of APEC's activities among leaders not already
engaged on APEC, but APEC Business Advisory Council
(ABAC) members are influential in Philippine circles.
Former Foreign Affairs Secretary and ABAC member Roberto
Romulo told Michalak he thinks trade facilitation should
be the top priority for APEC. He noted that the growing
number of FTAs in the region sometimes disrupts trade
more than stimulates it. Templates for WTO-plus
agreements from APEC could prove useful in ensuring that
these trade pacts harmonize. Michalak told ABAC members
that the U.S. hopes to see ABAC more active in APEC
deliberations.


12. (SBU) Concerning the economic situation in the
Philippines, the business leaders were uniformly critical
of the Philippine courts and the BOC. Potential
investors need more predictability from both regulatory
agencies and the courts in interpreting laws, they said.
While agreeing that East Asia will be a growth driver for
firms, both American and Filipino business executives
expressed concern that the Philippines is becoming
marginalized. Business leaders said the Philippines does
not stack up against other investment destinations
because of the unpredictable implementation of laws and
regulations as well as rising labor costs.

Johnson