Subic Freeport Fuel and Vehicle Smuggling

UNCLAS SECTION 01 OF 03 MANILA 003387

SIPDIS

SIPDIS
SENSITIVE

STATE FOR EAP/MTS, EAP/EP, EEB/IFD/OMA
STATE PASS EXIM, OPIC, AND USTR
STATE PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE
TREASURY FOR OASIA
USDOC FOR 4430/ITA/MAC/ASIA & PAC/KOREA & SE ASIA/ASEAN

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV PGOV RP
SUBJECT: Subic Freeport Fuel and Vehicle Smuggling

SENSITIVE BUT UNCLASSIFIED

--------------
Summary
--------------


1. (SBU) Lack of political will and weak law enforcement has
allowed wide-spread smuggling of refined petroleum products and
second-hand vehicles through the Subic Freeport, seriously hurting
legitimate businesses. The Government is also losing badly-needed
revenues (equivalent to between 4%-5% of tax collections and at
least 0.6% of Gross Domestic product during 2006). We are exploring
ways to assist the American Chamber of Commerce and U.S. companies
to advocate for a determined anti-corruption campaign targeting
smuggling. End Summary.

-------------- --------------
Car Manufacturers Up Against Used-Vehicle Imports
-------------- --------------


2. (U) Foreign automobile manufacturers in the Philippines
complain that they were enticed to invest here with assurances of
market protections, such as a general prohibition on entry of
second-hand vehicles. However, vehicle importers in the Subic
Freeport (a former U.S. naval facility) challenged this restriction,
arguing that the freeport is not part of the Philippine customs
territory under the Bases Conversion Development Act (Republic Act
7227) and that second-hand automobiles could legally be brought into
Subic and sold in the domestic market, provided appropriate taxes
and duties are paid.


3. (U) Philippine lower courts ruled in favor of Subic?s
used-vehicle importers. The Supreme Court subsequently ruled in
February 2006 that second-hand vehicles could be imported into Subic
but that it would be illegal to move them out of the freeport. The
Supreme Court upheld its decision in August 2006 in response to a
motion for reconsideration. The Department of Finance instructed
the Bureau of Customs to issue a Customs Memorandum Circular to
implement the Supreme Court decision since court procedures do not
allow a second reconsideration. However, the vehicle importers then
filed a "motion for clarificatory ruling."


4. (SBU) According to officials from the Car Manufacturers
Association of the Philippines (CAMPI),this latest motion merely
repeats the used-vehicle importers? arguments. However, because the
Supreme Court allowed the parties to comment on the motion, the
Customs Bureau has delayed implementing the earlier Supreme Court
ruling on the matter.

Converted Vehicles Illegally Sold in Domestic Market
-------------- --------------


5. (U) Car manufacturers also stressed that most used vehicles
enter the Subic Freeport with right-hand drive (mostly from Japan),
then are converted to left-hand drive and auctioned. Republic Act
8506, issued in February 1998, prohibits the importation of
right-hand automobiles, mainly for safety reasons. However, a 1999
Department of Justice (DOJ) opinion declared that it was legal to
import right-hand drive vehicles into the country's freeports,
provided that they are re-exported.


6. (SBU) The re-export requirement has been poorly enforced and
many converted vehicles are illegally smuggled into Philippine
customs territory. A 2005 Senate hearing estimated that only about
130 (0.1%) of about 90,000 right-hand drive vehicles that entered
the Subic Freeport from 2001-2003 were re-exported.


7. (SBU) Car manufacturers here estimate that roughly 70% of
foreign-origin used vehicles flow through Subic. The Port of Irene
in the Cagayan Freeport Zone (about 600 kilometers north of Manila)
is another major entry point of converted right-hand drives
illegally sold in the Philippine market.

Vehicle Manufacturing Weakest in South East Asia
-------------- --------------


8. (SBU) Ford Motor Philippines officials told us that the illegal
sale of converted, second-hand automobiles is their priority issue.
They expressed alarm that the second-hand vehicle "gray market" has
grown to about as large as the sum of local manufacturing and
legally imported finished automobiles. They noted the large
discrepancy between new vehicle registrations with the Land
Transportation Office (174,108 units in 2006) versus legal sales

MANILA 00003387 002 OF 003


(99,541 units),attributing most of that difference to used-vehicle
imports. The Ford officials estimated that the Philippine vehicle
manufacturing industry is operating at only 30% capacity.


9. (U) Other industry sources noted that in 2006, vehicle
production in the Philippines was less than 10% of Thailand's, and
less than 15% of Indonesia and Malaysia?s production volumes. They
noted that these countries have been more effective in implementing
restrictions on second-hand vehicle imports.

--------------
Fuel Smuggling: Another Serious Concern
--------------


10. (U) Chevron Philippines executives noted that Republic Act
8479 (the Downstream Oil Industry Deregulation Act) opened the
downstream oil industry to greater competition in the mid-1990s.
The law attracted investments from both foreign and local companies
in oil refining, fuel storage, distribution infrastructure,
transport and marketing. However, smuggling of refined oil products
creates unfair competition for legitimate refiners and importers.
Although the Subic Freeport is the focal point of smuggling, the
problem also exists in a number of other ports in the country.


11. (SBU) The Chevron executives observed that Subic imports far
more fuel than it consumes. Much of the fuel is improperly declared
in terms of volume, value, and/or fuel type to avoid the appropriate
duties, value-added and/or excise taxes, and then enters Philippine
customs territory. Fuel also leaves the Subic Freeport for other
tax-free export zones managed by the Government's Philippine
Economic Zone Authority, but the products are diverted to retailers
instead.

Fuel Statistics Reveal Smuggling
--------------


12. (U) Citing data from the Philippine government's Land
Transportation Office, Chevron officials told us that vehicle
registrations over the last ten years increased by nearly 7%
annually; on the other hand, gasoline demand expanded by only 0.6%
per year. They also said that oil fuel sales declined by an average
7.7% over the past two years according to Philippine Department of
Energy data while the Philippine economy averaged 5.8% real Gross
Domestic Product (GDP) growth.

-------------- --------------
Smuggling Robs the Government of Badly-Needed Revenues
-------------- --------------


13. (SBU) In addition to harming legitimate businesses, fuel and
used-vehicle smuggling are robbing the government of badly-needed
revenues. The car manufacturing industry estimates the Philippine
government lost 5-10 billion pesos in taxes during 2006 on smuggled
cars. The Petroleum Institute of the Philippines (an organization
of downstream oil companies) estimates that fuel smuggling deprived
the Philippine government of nearly 30 billion pesos in revenues
last year. The combined revenue loss from used?vehicle and fuel
smuggling equaled about 0.6% of Philippine GDP and more than 4% of
tax collections. The Federation of Philippine Industries estimates
that the Government could be losing well over 100 billion pesos
annually from smuggling in general.

--------------
Still a Question of Political Will
--------------


14. (SBU) The joint foreign chambers in Manila and affected
industry groups have intensified efforts in recent months to urge
the Philippine government to enforce laws and regulations to curb
the illegal sale of converted second-hand vehicles and smuggling of
fuel products, especially through the Subic Freeport. It remains to
be seen whether the newest anti-smuggling task force, headed by a
new anti-smuggling czar, will yield better results. Despite
frequent industry and business chamber representations with senior
Philippine government officials, including President Gloria
Macapagal-Arroyo, political will seems to be lacking. Lack of more
rigorously-estimated business and revenue impacts makes it difficult
to determine whether the situation has worsened or improved through
the years. Nevertheless, legitimate businesses consider smuggling a
major challenge and feel that anti-smuggling campaigns have not been
pursued with vigor.

--------------

MANILA 00003387 003 OF 003


Comment
--------------


15. (SBU) The persistence of smuggling in the Philippines not only
hurts legitimate businesses and cuts into much needed revenues for
the Government, but also casts a cloud over the investment climate
and calls into question the Government's sincerity to fight
corruption. We will continue to work with the American Chamber of
Commerce, other business and industry associations, and affected
U.S. companies to keep government attention on the problem of
second-hand vehicle and fuel smuggling and to advocate for a
determined anti-smuggling campaign in the Subic Freeport. We are
also exploring ways to use the U.S. technical assistance projects to
keep pressure on for a more sincere and vigorous anti-smuggling
drive. End Comment.

Jones