Philippine Growth Target Cut, Fiscal Deficit Up

UNCLAS SECTION 01 OF 03 MANILA 001351

SENSITIVE

SIPDIS

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
PACOM FOR FPA

E.O. 12958: N/A
TAGS: EFIN ECON ECIN RP CN XE XD
SUBJECT: Philippine Growth Target Cut, Fiscal Deficit Up

REFS: A) Manila 1192, B) Manila 0680, C) 08 Manila 2740

SENSITIVE BUT UNCLASSIFIED


1. (SBU) Summary: The Philippine government further cut economic
growth targets and increased its budget deficit ceiling after
disappointing first-quarter economic growth data (Ref A). The
official unemployment rate has tapered, but more Filipinos are
working fewer hours. While some groups push for "buy Filipino"
government procurement, the government reaffirmed its commitment to
ASEAN tariff reductions. Although most forecasts still see the
economy mustering some expansion in 2009, the IMF and World Bank now
predict negative GDP growth. Fiscal sustainability will be a
serious challenge. End Summary.

Government Slashes Growth Target...
--------------


2. (U) Following disappointing first-quarter economic growth
numbers, the Philippine government announced that it had slashed its
targeted 2009 GDP growth range to 0.8%-1.8%. Barely two months ago,
the government expected 2009 GDP to expand between 3.1%-4.1%. The
International Monetary Fund and the World Bank now predict 2009 GDP
will contract by 1% and 0.5%, respectively. Most other forecasts
see growth around the lower end of the government's new 0.8%-1.8%
range.

And Hikes Fiscal Deficit Ceiling
--------------


3. (U) The lower growth forecast spurred the government to raise
its programmed 2009 deficit to 3.2% of GDP (about pesos 250
billion),up from 2.5% of GDP (pesos 199 billion) programmed in
April. The larger deficit reflects a desire to preserve the 2009
"stimulus" budget (Ref B) despite weaker revenues. According to
senior Department of Finance officials, credit rating agencies and
debt markets appreciate the importance of fiscal pump-priming and
have expressed "tolerance" for a deficit-to-GDP ratio of up to 3.5%.


Medium-Term Fiscal Scenario Precarious
--------------


4. (SBU) Food, oil and global financial shocks interrupted the
downward trend in the government's deficit-to-GDP and debt ratios in
2008 and 2009 and frustrated hopes of balancing the budget last
year. In a meeting with econoffs, Department of Finance senior
officials lamented recent laws (including a five percentage point
reduction in corporate income tax rate and tax relief for individual
income tax payers) that could cost the government 65 billion pesos
(about 0.7% of GDP) in annual revenues. The officials said the
government hopes to resume fiscal consolidation in 2010, but they do
not expect to balance the budget without new revenue measures or
severe belt-tightening. The Department of Finance has appealed to
congressional leaders for action on pending proposals to increase
excise taxes for tobacco and liquor and other revenue enhancement
measures, and for a moratorium on revenue-losing bills.


5. (SBU) In meetings with econoffs, credit-rating agencies
(including Fitch and Standard & Poor's) expressed more concern over
medium-term revenue and fiscal prospects than over the Philippines'
ability to weather the current economic storm. They fear that
reduced revenue collections and higher debt ratios will threaten the
government's credit rating (already below investment-grade). This
could limit access to low-cost financing, constrain economic growth,
and undermine macroeconomic stability.

Remittances Grow, Exports Fall, Reserves Stable
-------------- --


6. (U) Overseas remittances have slowed from the double-digit
growth rates of the past several years but continue to expand.
Cumulative January-April remittances of $5.5 billion increased 2.6%
from 2008's comparable period, according to recent data. This
translates to 19.3% year-on-year growth in nominal peso terms
(because of a weaker local currency) and, net of inflation, 12.3%
growth in real peso terms from 2008. January-April exports declined
36.4% from 2008's comparable four-month level and electronics
exports (which contribute over 60% of annual export revenues)
declined by 40.2%. Preliminary indications from the local
electronics industry association are that orders have improved
month-on-month since April, raising hopes the export slump has begun

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to bottom out.


7. (U) The Philippines's merchandise import bill (down 35%
year-on-year as of April) has also contracted because of the heavy
dependence on imported inputs of the country's major exports. Net
foreign direct investments sputtered to barely $45 million during
the first quarter of 2009. The balance of payments remains in
surplus ($2 billion as of May 2009) and the Central Bank's gross
international reserves are stable at $39.3 billion (equivalent to
more than six months of merchandise and service imports and three
months of private and public sector debt payments falling due over
the next twelve months).

Unexpected Drop in Unemployment
--------------


8. (U) The unemployment rate declined from 8.0% to 7.5% between
April 2008 and April 2009 according to the government's latest
quarterly labor force survey. The total employed expanded 4.4%
year-on-year, equivalent to more than 1.4 million more jobs.
However, underlying statistics indicate a soft job market and a
deteriorating quality of employment. Those working less than the
regular 40-hour workweek increased from 35.6% (April 2008) to 41%
(April 2009) of the total employed. Wage and salary workers
declined from 52.9% to 51.9% over the same period, while
self-employed and unpaid family workers (a rough proxy for
employment in the Philippines's informal sector) increased from 47%
to 48% and accounted for more than 70% of net job creation between
April 2008 and April 2009.

Scope for Monetary Easing; Deposit Insurance Doubled
-------------- --------------


9. (U) Philippine Central Bank officials hint of further interest
rate cuts to the cumulative 175 basis-points reduction since
December 2008. On May 27, President Arroyo signed into law a
doubling of deposit insurance coverage to 500,000 pesos (roughly
$10,500). Government officials cited the law as a "pre-emptive"
measure to maintain confidence in the banking system in the midst of
global financial uncertainties.

Philippines to Honor AFTA-CEPT Commitments
--------------


10. (SBU) Under pressure from groups opposing trade liberalization,
Philippine Trade Secretary Peter Favila publicly floated the idea of
delaying tariff cuts set for January 1, 2010 under the ASEAN Free
Trade Area-Common Effective Preferential Tariff (AFTA-CEPT)
agreement. However, President Gloria Macapagal-Arroyo announced
soon afterwards that the Philippines would implement its AFTA-CEPT
commitments as scheduled. An executive order on the scheduled
tariff cuts is pending her signature. Trade items affected by the
tariff cuts include wheat, chicken/poultry, pork, dairy products,
and fruits and vegetables, as well as the automobile and electronics
sectors. Agricultural interests generally oppose the liberalization
while the auto and electronics industries here favor the ASEAN-wide
tariff reductions. There could be a significant negative impact on
U.S. agricultural exports to the Philippines (septel).

"Buy Filipino" for Government Procurement?
--------------


11. (SBU) Citing the U.S. "Buy America" procurement policy, two
business chambers known for protectionist leanings continue to urge
the government to purchase Philippine-made products. Current
government regulations specify preference for majority
Filipino-owned suppliers, but there are no guidelines requiring
preference for locally-made (over imported) products. The
Philippines is not a signatory to the WTO government procurement
agreement. Officials from the Government Procurement Policy Board
told econoffs that revised procurement guidelines are targeted for
release in September, but details are still being worked-out.

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


12. (SBU) Mildly negative or mildly positive growth will make
little difference for a predominantly low-income population growing
at more than 2% per year, more of who are expected to fall into
poverty. Economists, investors, creditors and other Philippine
observers are most concerned about addressing long-standing
constraints to growth, competitiveness, and poverty alleviation (Ref

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C). The fiscal sector and remittances bear close watching.

Kenney