POLICY REFORM IN THE PHILIPPINES:

C O N F I D E N T I A L SECTION 01 OF 04 MANILA 000103 SIPDIS STATE FOR EAP/MTS AND EB/TRA SINGAPORE AND TOKYO FOR FAA COMMERCE FOR BERLINGUETTE STATE PASS USAID FOR EGAT AND ASIA BUREAU E.O. 12958: DECL: 01/14/2019 TAGS: EAIR ECON ETRD RP SUBJECT: POLICY REFORM IN THE PHILIPPINES: CIVIL AVIATION AND TOURISM AS AN ENGINE FOR DEVELOPMENT REF: A. MANILA 1618 ¶B. MANILA 1653 Classified By: Larry Memmott, Economic Counselor, reasons 1.4 b and d. 1.C) Summary: USG policy reform efforts in the Philippines are resulting in a significant opening in the international civil aviation regime of the country, contributing to growth in the tourism industry and the economic development of the country. A USAID project aimed at introducing greater competition into the market for civil aviation services helped to build the pressure from civil society which has resulted in signature by the Philippine Government of eleven bilateral and three ASEAN civair agreements espousing liberalization over the past two years. This is a reversal of at least a decade of severely restrained growth in air transportation to the country. End Summary. Tourism as a Driver of Economic Development -------------- ¶2. (U) The Philippine tourism industry took in some %5.5 billion in 2007 and employed some 1.3 million people, supported by 3 million international tourist arrivals. Visitors to resort areas and undeveloped areas of the country are impressed by its potential as a destination for tourism. With uncounted miles of beautiful white sand beaches, coral reefs as yet not fully explored, and a workforce with an excellent service ethic, the Philippines would seem well placed to ride what is likely to be a wave of new international tourism from increasingly prosperous Asian countries once current global economic difficulties are overcome. ¶3. (U) Tourism has the potential to make an important contribution to Philippine development. Local economists have estimated that each foreign tourist who visits the Philippines for a week spends enough to pay the wages of one tourism-sector employee for a year. With the prospect of millions of new international tourists being created by the growing economies of Asia over the coming years, there is certainly an important opportunity on the doorstep of the country. ¶4. (U) The Philippine's most developed tourist destination, the tiny island of Boracay, serves as to illustrate the tourism potential of the Philippines. Introduction of competition in the domestic civil aviation market led to substantial reductions in the airfares after 1995 allowing tourist visits to the island to grow from 50,000 in 1995 to 600,000 in 2007. Increasing openness in the international civil aviation market has allowed Boracay to attract a growing number of foreign tourists. Koreans flock to the resort during much of the year now, and visits by high-spending Russians coming in on charters from Vladivostok have gone from nothing in 2005 to 1500 arrivals in the last three months of 2008. Growth Limited by Restricted Air Access -------------- ¶5. (U) Civil aviation policy in the Philippines has been geared towards protecting domestic airlines (mostly Philippine Airlines (PAL),but also, occasionally, the other, smaller domestic carriers). PAL in particular has benefited from the high prices which have resulted from very restricted frequencies and market access. A simple fare comparison undertaken by Filipino economists last year showed that, on a seat/mile basis, airfares were twice as high from Japan to the Philippines than from Japan to Thailand. Similarly, airfares were three times higher from China to the Philippines than from China to Bali. Clearly these prices affect the potential of tourism. PAL's President told EconCouns last year that the airline's most profitable destination was Japan, as a result of the limited seats available on the route. ¶6. (U) Traditionally, Philippine tourism has suffered not only MANILA 00000103 002 OF 004 from the limited number of seats allowed, but also from centralization of arrivals in Manila. The local airlines, of course, benefit from this restriction, since only they are allowed to provide the connecting flights necessary to get tourists to their final destinations, almost always distant from Manila. Although eight airports have been constructed around the Philippines and designated as "international" , only four are allowed to receive scheduled traffic directly from abroad. Manila International Airport, already functioning at full capacity and with no potential for expansion, has served as another constraint on competition. ¶7. (C) Recognizing both the potential and the constraints on the tourism sector, USAID established in 2006 an economic policy reform project aimed to enhance competition and increase international air access to the Philippines (among other program areas). USAID made liberalization of traffic into the airport at the former U.S. base at Clark, now named Diosdado Macapagal International Airport, its initial target. USAID grantees identified and supported a broad coalition of local interests centered on Clark and individuals and groups interested in increased civil aviation liberalization nationwide in pushing for liberalization of the regime for Clark. ¶8. (C) As a result of the work of USAID through this informal coalition, in January 2006, President Arroyo singed Executive Order 500, allowing unlimited flights to Clark by domestic and international air carriers from all countries. As a result of this innovation, arrivals at Clark grew by more then 70 percent from 55,000 in 2005 to 93,000 in 2006 generating an additional estimated $200 million in earnings from tourism in 2006. Budget carriers took advantage of the liberal regime to establish hubs in Clark, carrying passengers on routes between other countries, such as Macau-Clark- Singapore. Increased arrivals to Clark fed a rapidly growing domestic network of connecting flights to final tourist destinations. For example, one low cost domestic company Seair increased its flights from Clark to Boracay from 74 in 2005 to 142 in 2006 and 369 in 2007. ¶9. (C) A wide open Clark clearly benefited the tourism industry and the Philippines as a whole. However, the effect on Philippine air carriers was mixed. Philippine Airlines, which has never seen itself as a low cost airline, resisted forcefully. It was able to bring along most of the rest of the local carriers with the argument that, by abandoning reciprocity in civair negotiations, the government would allow their international competitors to get the jump on them. Under pressure, the government pulled back from the most liberal aspects of EO 500, issuing a new order, EO 500A, which retracted the rights necessary for foreign carriers to operate an international hub (fifth freedom) and allowed only carriers designated by states with civair agreements with the Philippines to serve Clark. ¶10. (U) Both sides of the fight took their arguments public with newspaper ads and public pronouncements. Proponents of liberalization proposed another executive order (500B) to reverse 500A. Opponents of liberalization were able to restrain the growth of the smaller budget airlines by lobbying the bureaucracy to hold up permits and, in one spectacular case, cancel the permit of Tiger Airways, stranding hundreds of passengers (ref. b). While EO 500B still has not been signed, charters continue to support growth, though at a slower pace, in Clark arrivals. ¶11. (SBU) Under pressure to advance liberalization at Clark, but unwilling to take on the domestic airlines, the GRP hit upon a middle road in mid-2007. Rather than unilateral opening of specific airports, the GRP began to conduct bilateral civil aviation negotiations with an eye toward limited liberalization of its international civil aviation market. ¶12. (SBU) From 1997 to 2007, the Philippine government had negotiated an average of only one bilateral air service agreement per year. As a result of its reversal in policy, MANILA 00000103 003 OF 004 between May 2007 and December 2008, the Philippine government signed eleven bilateral air service agreements. Allowed seat number under all bilateral agreements increased by 150 percent from 50,000 to 125,000 seats per week. The Korea agreement was the turning point. Its doubling of seats was resisted furiously both behind the scenes and in the press by Philippine Airlines. However, Cebu Pacific, the country's second largest carrier, supported the government's policy. As Lance Gokongwei, President and owner of Cebu Pacific told EconCouns he would support liberalization in order to begin to take his airline international. The unilateral liberalization of Clark did not do that, but civair negotiations would. Cebu Pacific also recognized its own interest in reducing the monopoly rents earned by Philippine Airlines, its principal competitor on domestic routes. Going Multilateral -------------- ¶13. (SBU) In November 2008, the Philippines hosted ASEAN transportation ministers who signed three air transport agreements: the ASEAN Framework Agreement on the Facilitation of Inter-State Transport, the ASEAN Multilateral Agreement on the Full Liberalization of Air Freight Services and the ASEAN Multilateral Agreement on Air Services. These agreements are designed to gradually simplify and harmonize transport, trade and customs regulations and improve the efficiency and competitiveness of the region's air travel. The agreements provide for unlimited flights between capital cities beginning in December, 2008. The right to pick up passengers in a third country before proceeding to the final destination (fifth freedom) between capital cities is to be implemented without restriction by 2010. The ultimate goal is to achieve a unified ASEAN market in civil aviation by 2015. ¶14. (C) With USAID support, advocates for liberalization are pressing to maximize the potential benefits of the ASEAN open Skies Agreement via designation of Clark as an airport serving Manila, thus bringing it into the ASEAN Open Skies regime. USAID also continues to support advocates of unilateral liberalization at Clark, and is now working with other cities and economic hubs to broaden the coalition of interests that support enhanced competition and increased liberalization. Comment: Flexibility and Determination Pay Off -------------- - ¶15. (C) Our assistance to local forces working for liberalization has paid off, if not in the expected currency. By helping them build support in civil society for liberalization, we put the government into the position of looking for ways to please both the forces of liberalization and the entrenched interests. In this case, we discovered that the airlines could be broken apart. Some of the smaller airlines have been induced to support and even spearhead increased competition and liberalization. Most important was the decision by Cebu Pacific to support liberalization via air service agreements. ¶16. (C) As in other cases, we have found that State Department advocacy efforts and USAID policy reform project can support each other very effectively. In this case, the Economic Section met frequently with representatives of the domestic airlines discussing and exploring their positions and with Department of Transportation and Department of Tourism officials to promote liberalization, while USAID was building grass-roots support for more liberal policies. To advocate policy reform in the very resistant environment of the Philippines we have to attack the problem simultaneously from as many angles as possible. (Embassy Manila's economic policy reform efforts are reported continuously on the Intellipedia at http://www.intelink.sgov.gov./wiki/Philippine s_Economic_P riorities.) MANILA 00000103 004 OF 004 KENNEY