GRP RESPONSE TO RISING FOOD AND FUEL PRICES

UNCLAS SECTION 01 OF 03 MANILA 001775

SIPDIS

SENSITIVE

STATE FOR EAP/MTS
STATE PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE
TREASURY FOR OASIA

E.O. 12958: N/A
TAGS: ECON EFIN EAGR EPET ENRG RP
SUBJECT: GRP RESPONSE TO RISING FOOD AND FUEL PRICES

REF: A) Manila 1050, B) Manila 1031, C) Manila 0838

SENSITIVE BUT UNCLASSIFIED


1. (SBU) Summary: Rising food and fuel prices in the Philippines
have pushed up consumer price inflation to a fourteen-year high.
The Philippine government continues to provide cheap rice for the
poor and has scrapped duties on fuel, granted tax relief to personal
income taxpayers, and postponed its balanced-budget goal in order to
boost pro-poor spending. The government has been resisting calls to
scrap the value added tax on fuel and electricity, impose price
controls on basic commodities, and repeal the law that deregulated
the downstream oil industry. Although President Gloria Arroyo's
popularity rating is low, anti-government rallies thus far have been
sporadic, contained, and led mainly by the political opposition and
fringe groups. End Summary.

Food and Fuel Push Up Consumer Prices
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2. (U) Accelerating since September 2007, year-on-year consumer
price inflation climbed further to 11.4% in June, a 14-year high.
The food index (47% of the consumer basket of a typical Filipino
household) increased 17.4% year-on-year; rice prices soared by 43%.
Rapidly rising international oil prices also are working their way
into general price levels through increasing retail fuel prices,
higher rates for electricity and public utilities, increased
transportation costs and rising production and operating expenses.
Domestic prices of diesel and unleaded gasoline are, for example,
now about 64% and 48% higher than they were a year ago (currently
about $5.15 per gallon for unleaded gas and about $4.88 per gallon
for diesel).

Central Bank Shifts to Monetary Tightening Mode
-------------- --


3. (SBU) Year-on-year inflation averaged 7.6% during the first half
of 2008. The Philippine Central Bank now forecasts that average
inflation for the full-year will range from 9%-11%, up sharply from
the original 3%-5% targeted range. For the first time in nearly
three years, the monetary authority raised policy rates by 25 basis
points in June and by another 50 basis points in July and has hinted
of further monetary tightening to manage inflation expectations.

Food, Fuel and Poverty
--------------


4. (U) Rising food and fuel prices will aggravate poverty in a
country where a third of the population already live below
government-estimated poverty thresholds and more than 40% below the
$2/day international poverty benchmark (Ref A). Asian Development
Bank economists recently estimated that every 10% hike in food
prices pushes 2 million more Filipinos into poverty.

Government Rice Subsidies Continue
--------------


5. (U) Currently the world's largest rice importer, the Philippine
government continues to sell rice at 18.25 pesos per kilogram (about
$0.41 at current exchange rates) -- less than half of average
commercial prices -- to impoverished families (Ref B). The National
Food Authority (NFA),the state's grains trading firm -- already
struggling with a negative $1.2 billion net worth and $1.7 billion
in outstanding liabilities as of end-2007 -- expects its deficit to
balloon to between 35-40 billion pesos (roughly $770-880 million)
during 2008. NFA's debts represent contingent obligations on the
part of the National Government.

Zero Tariffs on Oil and Personal Income Tax Relief
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6. (U) In January 2008, President Gloria Macapagal-Arroyo issued an
executive order directing modifications on the 3% duty on imported
petroleum products based on international oil price triggers. The
tariff fell to 0% starting June 1. Department of Finance (DOF)
officials estimate the measure could cost the government about 18
billion pesos ($400 million) in foregone revenues, but expects 37
billion pesos ($820 million) in "windfall" collections from the
value-added tax on a higher-than projected oil and fuel import bill.



7. (U) In mid-June 2007, President Arroyo also signed a law
(Republic Act 9504) providing relief to personal income tax payers

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by increasing allowable deductions and exempting minimum wage
earners from income tax. DOF officials expect 7 billion pesos ($155
million) in foregone revenues during 2008 from the income tax
relief. They hope that accompanying provisions in the legislation
to plug income tax leakages for the self-employed and corporate
sectors will result in a revenue neutral legislation.

Heightened Monitoring but No to Price Controls...
-------------- --------------


8. (U) The Government has resisted calls by some groups to impose
price controls on basic commodities, but holds frequent dialogues
with major manufacturers and oil firms to delay and/or temper price
adjustments. In a recent initiative, the Department of Trade and
Industry has been working with manufacturers to publish suggested
retail prices and announced they would consider deviations beyond
10% from suggested prices in retail outlets as a red flag for
profiteering.

...And to Repeal of Oil Deregulation Law
--------------


9. (SBU) The Philippine government also has resisted calls
(including bills in the Philippine Congress) to repeal the 1998
Downstream Oil Industry Deregulation Act, as well as clamors from
left-of-center groups to nationalize the Philippine oil industry.
Convinced that such a response would only restrict supply and jar
investor confidence, the government has depended mainly on moral
suasion for oil companies to stagger price increases to appease
public sentiment. Department of Engergy officials noted that
vehicular traffic has eased in Metro Manila while metro-railway
usage has risen by 20% to 500,000 passengers per day, suggesting
that market-based fuel prices encourage conservation. The
government plans to purchase more than 70 new light rail coaches in

2009.


10. (SBU) Warning of further, staggered adjustments, oil firms here
note that domestic price increases are lagging international oil
price trends. Results of a study commissioned by the Department of
Energy, which looked at price trends and financial data from 2006 to
early 2008, echoed this observation and cleared oil companies of
abusive pricing behavior. Energy and Chevron officials told
econoffs that oil companies have been partially cross-subsidizing
more socially sensitive petroleum products (such as diesel and
kerosene) with gasoline prices. Chevron officials claim that oil
companies have had under-recoveries for diesel and kerosene since
February.

Keeping VAT on Fuel and Electricity
--------------


11. (SBU) The political opposition, emerging presidential
candidates for the 2010 elections, and some members of the Catholic
clergy have joined the clamor by fringe consumer, transport, and
student groups to scrap the 12% value added tax on fuel and
electricity. Legislation to this effect has already been filed in
the Philippine Congress. Scrapping the VAT would reduce current
diesel and gasoline prices by between 6 to 7 pesos ($0.13-0.16) per
liter (equivalent to $0.50-0.60 per gallon). President Arroyo and
her economic team have countered that such a move would mainly
benefit the better-off segments of Philippine society (who consume
more than 80% of fuel and power); derail fiscal stabilization
efforts; rattle financial and credit markets; and deprive the
government of nearly 100 billion pesos ($2.2 billion) in revenues to
fund critical infrastructure and social spending programs during a
globally challenging time.


12. (U) After offsetting estimated revenue losses from the
scrapping of import duties on oil/fuel, the Philippine government
expects about 19 billion pesos ($420 million) in net "windfall"
gains during 2008 from the value-added tax on oil products. The
Philippine government reported that the 8 billion pesos ($178
million) in excess value-added tax collections during the first half
of the year have funded cash transfers to small electricity
consumers; loans and scholarships for poor but deserving college
students; the conversion of engines used by public transport
vehicles to alternative-fuel use; the conversion from incandescent
to fluorescent bulbs in government offices and public places;
livelihood programs for families of public transportation drivers;
upgrading of provincial hospitals; and disaster relief and
rehabilitation.

Balanced-Budget Goal Deferred to 2010

MANILA 00001775 003 OF 003


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13. (U) The Philippine government has officially pushed back its
2008 balanced-budget goal to 2010, but still hopes for fiscal
deficits for 2008 and 2009 below 1% of Gross Domestic Product. For
2008, the government has announced it is prepared to hike the
current budget by up to 75 billion pesos ($1.7 billion) to support,
among others, agricultural productivity and food security goals and
expand social safety nets for vulnerable sectors.

Silver Lining: An Opportunity for Reforms?
--------------


14. (SBU) The food and fuel-price issue is spurring action on
long-stalled reforms such as passage of a renewable energy bill.
Food security concerns have highlighted the role of biotechnology
for boosting rice and food crops productivity. Linking
over-population to poverty and food security, a number of
legislators have vowed to push for more aggressive family planning
and reproductive health bills, although this remains a contentious
issue even among Cabinet officials. Government officials told
econoffs that the President is seriously considering airing her
support for natural family planning during the July 28 State of the
Nation Address to improve strained relations with the influential
Catholic Church.


15. (SBU) As part of ongoing negotiations between the government
and World Bank for a food security loan, policy commitments may
include rice policy reforms that would liberalize rice trade; allow
private sector participation in rice importation; reduce the tariff
(currently 50%) for rice; lift quantitative restrictions on rice
over the medium-term; and limit the role of the financially-strapped
National Food Authority to buffer stocking (Ref C). These measures
adopt reforms recommended a few months ago by a team of
rice/agricultural experts funded by joint World Bank-USAID technical
assistance.

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


16. (SBU) The country's leading social survey institution reported
recently that President Arroyo's popularity rating has sunk to the
lowest level recorded by a Philippine president since 1986.
Nevertheless, more pragmatic businesspeople and economists, as well
as international credit rating and multilateral donor agencies,
credit President Arroyo for resisting populist proposals that could
spell fiscal disaster and spook investors. Political rallies thus
far -- led mainly by the political opposition and left-of-center
groups -- have been sporadic and relatively contained, although
anti-Arroyo forces may converge during the President's July 28 State
of the Nation Address. As household budgets tighten, effective and
transparent implementation of pro-poor strategies will gain in
importance.

Kenney