SLUGGISH GROWTH IN ELECTRONICS HIGHLIGHTS POWER AND

UNCLAS SECTION 01 OF 03 MANILA 004600

SIPDIS

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

E.O. 12958: N/A
TAGS: ETRD EINV PREL ECON RP
SUBJECT: SLUGGISH GROWTH IN ELECTRONICS HIGHLIGHTS POWER AND
LABOR ISSUES

REF: MANILA 02304

--------------
SUMMARY
--------------

1. Philippine semiconductor and electronics exports, 70% of
total exports, are growing slightly in 2005 despite the
closure of a major Toshiba laptop factory in late 2004.
Growth in semiconductor exports offset a decline in other
electronics categories caused by Toshiba's departure. The
industry remains highly dependent on large producers and
vulnerable to declines in international demand. In a
positive sign, investment in the electronics sector in 2005
outpaced 2004 levels. However, poor infrastructure and
inconsistent tax policies continue to discourage new
investments. Looming power shortages, higher electricity
prices and shortages of skilled labor are the main industry
concerns that may impede further growth and new investment.
As the Philippines' biggest export, electronics could play
an important role in counteracting the negative effects of
rising oil prices on its trade balance.

--------------
BACKGROUND
--------------

2. EconOff recently discussed industry trends with Ernesto
Santiago, Executive Director of the Semiconductor and
Electronics Industries in the Philippines, Inc (SEIPI).
Semiconductors and electronics dominate Philippine trade and
account for roughly two-thirds of export earnings and half
of all imports. This high degree of dependency on this
sector makes Philippine exports vulnerable to changes in
consumer demand in its major markets, which include the U.S.
and to a lesser extent Japan and the European Union.
Semiconductors provide the largest share of electronics
exports - 70% of the combined category - while remaining
categories (consumer electronics, automotive electronics,
electronic components) provide the rest. The sector
employed 374,000 workers in 2004, 12% of industrial
employment and roughly half the size of the workforce in the
garments and textiles sector.


3. Electronics exports have grown rapidly from $4 billion in
1993 to $27 billion in 2000 before falling to $22 billion in
2001 following the dot-com crash in 2000. Growth has
resumed since 2002 and SEIPI expects exports to surpass $26
billion in 2005. Although electronics provided 70% of
export revenues in 2004, its share in value-added terms may
be closer to 50%. SEIPI estimates that electronics exports
include 30% value-added, less than most other export
categories. Philippine trade data has consistently reported
exports several billion dollars lower than figures from its
trading partners with the US alone reporting $2 billion
additional exports to the US in 2004, primarily in the
electronics category. The US and Japan are the RP's largest
trading partners, though the US share has recently declined.

--------------
RECENT PERFORMANCE:
--------------

4. Despite media reports of a potential decline in
electronics exports, SEIPI reported an overall year-on-year
increase of 1% in exports for the first half of 2005. An 11%
increase in semiconductors (which account for 70% of total
electronics exports) offset a 21% decline in other
categories. The decline in other categories was largely due
to a decision by Toshiba to transfer its laptop
manufacturing operation to China at the end of 2004. This
factory produced up to 150,000 laptops per month, providing
nearly $1 billion per year in export revenues. In September,
SEIPI lowered its projection for export growth from 10% to
between 0 and 5% in 2005 due in part to disappointing first
semester performance. Recent growth in electronics will not
be enough to offset the effects of rising oil prices on the
Philippines' trade balance. The global impact of higher oil
prices could also reduce demand for electronics in
Philippine export markets. Although the trade deficit is
widening, the Philippines continues to have a balance of
payments surplus due to strong growth in remittances from
overseas workers.


5. According to SEIPI, after declining from $1.2 billion in
2000 to $220 million in 2003, investment in the electronics
sector rose to $420 million in 2004 and is on track to reach
$500 million in 2005. Most of this is capital investment by
existing companies including investment of retained earnings
to renew or upgrade their facilities. Investment has risen
despite the continuing stagnation of FDI reported in reftel.
Texas Instruments is upgrading a production facility in
Baguio to increase production capacity by 50%. Santiago
commented that after an initial surge of investment towards
China following its accession into the WTO, investors have
begun to look again at alternative countries in Asia. He
lamented that few new companies have arrived since the
government discontinued its successful investment missions
of the 1990s.

--------------
ENERGY AND LABOR ISSUES:
--------------

6. Due to delays in energy sector reforms, the electronics
industry is likely to face electricity shortages and rising
energy costs during the next five years. Power costs are
already high compared to other regional countries and they
are expected to rise further as the GRP eliminates cross
subsidies, raises generation rates, and imposes taxes on
electricity and fuel. Energy supply disruptions have
impeded production and contributed to a recent breakdown in
the supply of liquefied nitrogen to the semiconductor
industry. To reduce costs and guarantee a supply of
electricity for its members, SEIPI is promoting a scheme to
offer discounted electricity rates for large power consumers
with constant demand. The Energy Regulatory Commission (ERC)
recently rejected an initial proposal from an electricity
distributor to offer discounted rates, but SEIPI believes
the ERC may be more receptive to proposals coming from
Independent Power Providers (IPPs) if broader discounts are
offered that would include consumers outside of the
electronics industry.


7. SEIPI is soliciting support for training programs to
increase the supply of skilled workers for member companies.
Santiago emphasized that skilled workers are the main
comparative advantage that has drawn SEIPI members to the
Philippines but industry growth is constrained by shortages
of engineers. To help address this problem, SEIPI
established the Advanced Research and Competency Development
Institute (ARCDI) in 2004, to promote training and research.
SEIPI has also asked its members and the government to fund
a $25 million program to provide foreign training for 600 BS
graduates and 200 PhDs to meet industry demand. Santiago
requested help from the Embassy in identifying potential
sources of US assistance for this program.

-------------- --------------
INTEL HIGHLIGHTS INVESTMENT CLIMATE CONSTRAINTS
-------------- --------------

8. In a position statement submitted recently to the
Philippine Congress, Intel highlighted several issues that
are critical to maintaining the competitiveness of RP's
electronics sector. Noting its substantial economic
contributions to the Philippine economy and its sizable
investment budget, Intel identified infrastructure,
regulatory and tax policy issues that may discourage new
investments in the RP. While citing power supply issues as
the most critical concern, Intel also underscored the need
for continued investment in transportation and
telecommunications infrastructure to match regional
competitors. Secondly, Intel stressed the need for an
improved regulatory environment, notably through more
consistent tax policies, and simplified implementation. In
one example, Intel argued that poor implementation of value-
added tax policies has negated the impact of tax incentives.
Intel also underscored the importance of offering
competitive investment incentives.


9. COMMENT: Strong performance in semiconductors should
continue to drive modest growth in electronics exports,
although the industry remains vulnerable to market trends
and power outages that can affect production. While
semiconductor producers remain competitive, Toshiba's
departure suggests that other product categories may be
losing out to foreign competition, particularly in finished
products. It also highlights the importance of ensuring a
competitive investment climate to attract new investment and
prevent further migration abroad. Energy sector reforms and
technical training programs can help to maintain the
competitiveness of the Philippines' main export industry.

JOHNSON