Philippines 2009 Economic Wrap-up and 2010 Way Ahead

UNCLAS SECTION 01 OF 04 MANILA 000038

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

E.O. 12958: N/A
TAGS: EFIN ECON ETRD ECIN RP CN XE XD
SUBJECT: Philippines 2009 Economic Wrap-up and 2010 Way Ahead

REFS: A) 09 Manila 2281 B) 09 Manila 1737

SENSITIVE BUT UNCLASSIFIED


1. (SBU) Summary: The Philippine economy is poised for moderate
growth in 2010 after avoiding most of the effects of the world
recession in 2009. Although buffeted by two extremely damaging
storms in the final trimester, the Gross Domestic Product (GDP)
expanded overall in 2009, while neighboring economies in the region
contracted. The Philippine stock market's main index grew over 60
percent, foreign reserves are at a record high; foreign direct
investment is rebounding, the local business community continues to
build and invest, and remittances are increasing. The banking
sector is sound, and the government's fiscal deficit is manageable.
Spending on the May 2010 presidential elections is also set to boost
the economy and create jobs. However, inefficiency, corruption,
misdirected government and private spending, high population growth,
and other impediments will continue to constrain growth and
prosperity, and will inhibit efforts to reduce poverty for the
foreseeable future. End Summary.


Economy Growing Despite Natural Disasters
--------------



2. (SBU) The Philippine Gross Domestic Product (GDP) grew
approximately 1.4 percent in 2009, and will more than double that
rate in 2010, according to World Bank and Asian Development Bank
(ADB) estimates. The Philippines avoided most of the effects of the
global financial crisis because it is less dependent on
international trade than other economies in the region, and did not
suffer unduly when demand from the United States and other trade
partners contracted in 2009. These growth figures take into
consideration the damage caused by two large storms in September and
October, which resulted in USD four billion in losses and reduced
2009 GDP by nearly half a percentage point. Poverty, which already
afflicts one-third of the Philippines' 90 million people, increased
by one half of one percent due to the damage caused by the storms.
However, the energetic response to these disasters by individual
Filipinos, as well as domestic and international charities, donor
nations and multilateral development banks resulted in a large
injection of cash into the economy that helped cushion the economic
downturn and promote reconstruction of houses, farms and businesses.
The World Bank estimates that growth in 2010 could actually exceed
its pre-disaster estimates, largely due to spending on
disaster-related recovery and reconstruction.

Budget Deficit Growing But Manageable
--------------


3. (SBU) Another result of the natural disasters is a
larger-than-anticipated 2009 budget deficit. A fall in imports
reduced collections by the customs bureau, and revenue-eroding
measures passed by Congress, such as tax breaks for minimum-wage
earners and businesses affected by the storms, further cut
government income. Special tax exemptions for favored sectors or
projects added to the government's revenue woes, and unexpected
spending on rescue and relief efforts pushed the government further
into the red. However, the overall deficit, when fully tabulated,
is unlikely to exceed four percent of GDP in 2009, which is
considered manageable by most macroeconomists and is substantially
less than the fiscal deficits of the United States and Japan, which
were approximately 10 percent of GDP in 2009.

Good Financial Management
--------------


4. (SBU) The Philippine government (GRP) has financed its deficit by
taking advantage of low-interest borrowing from world capital
markets flush with cash. It has a debt portfolio balanced between
short-, medium- and long-term obligations, which has helped it avoid
liquidity crises by spreading out repayments. Its debt offerings
have been oversubscribed on a regular basis, which allows it to pay
lower interest rates to the many investors bidding for its bonds.
The government, expecting interest rates to rise in 2010, has likely
saved millions by pre-financing much of 2010's anticipated budget
shortfall with this low-cost domestic and foreign capital. Finance
Secretary Teves, who the Financial Times Group named best finance
minister in Asia in 2008, has also obtained concessional loans from

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the Asian Development Bank to finance infrastructure projects, and
was the first to take advantage of the ADB's counter-cyclical or
stimulus spending loan offering in 2009. The Philippine Central
Bank is conservatively managed and well regarded, and although it
suffered currency exchange losses from its moderate interventions in
the market, it increased its investment profits and reduced expenses
in 2009. It is expected to maintain relatively low interest rates
through most of 2010, which will further stimulate the economy by
reducing startup costs to new entrepreneurs and allowing lower-cost
expansion of existing businesses.

Campaigning and Other Growth Engines
--------------


5. (U) Spending on the May 2010 presidential and congressional
campaigns has already begun, and will provide an estimated half
point boost to the GDP by increasing consumption and providing jobs.
The three major presidential candidates are seen as relatively
pragmatic in terms of economic policy, which has helped business
sector and investor confidence. Several economic sectors are
booming, such as business process outsourcing (BPO),which grew over
20 percent and employs hundreds of thousands of mostly young
Philippinos in call centers. Banking and financial institutions
have increased profits, and growth in construction and real estate
is driven in part by remittances from overseas Philippine workers,
which grew by about four percent in 2009 and are expected to show
even stronger growth in 2010. A new law allowing the establishment
of Real Estate Investment Trusts (REITs) will attract additional
investors into the housing market, and offers incentives to spur
construction of low-cost housing.

Trade Down, But Showing Signs of Recovery
--------------


6. (U) The value of exports and imports of goods dropped between 20
and 30 percent in 2009. Part of the reduction in imports was caused
by lower world oil prices, but the main drag on trade was weak
global demand for the Philippines' primary exports of semiconductors
and electronics. However, industry associations reported moderate
growth in this sector by the end of the year due to renewed demand,
and some analysts see growth up to 10 percent in 2010. Texas
Instrument's plant in Baguio is ramping up chip production and may
increase sales enough to fill the gap in export value created by the
mid-year closure of an Intel chip plant. Its neighbor in Baguio,
U.S. company Moog Systems, is expecting to hire more workers as
demand for its aviation hydraulic/electrical components increases
with the rollout of the Boeing 787.

Stock Market Rebounds; Investment Climate Improves
-------------- --------------


7. (SBU) The Philippine Stock Exchange index -- which closed down
48% in 2008 -- gained 63% in 2009. Foreign portfolio capital flows
reversed from a severe outflow in 2008 to a moderate inflow in 2009
- a turnaround that may top one billion dollars. Many investors,
both foreign and domestic, seeking higher yields than in U.S. or
European markets, earned substantial profits in Philippine stocks
and bonds. Although investment is still hampered by constitutional
limitations on foreign ownership of businesses, and judicial
processes are torturously slow and subjective, the overall
investment regime has improved. Congress passed a modern renewable
energy law that offers investment incentives; protection of
intellectual property rights improved incrementally; and the Central
Bank eased procedures for businesses remitting profits out of the
country. The government has also responded to Embassy efforts to
mediate several investment disputes involving U.S. companies, and
quickly resolved a major case in the power generation sector late in
the year. Foreign direct investment, although down for the year,
continues to flow into dynamic sectors, such as power generation,
transmission and distribution, BPOs, real estate and consumer goods.


ASEAN FTAs Enter Into Force
--------------


8. (U) The Philippines is one of six members of the Association of
Southeast Asian Nations (ASEAN) that moved towards free trade by
eliminating duties on more than 99 percent of products on January 1,

2010. On the same date, the ASEAN-China Free Trade Agreement, and
the ASEAN-Australia-New Zealand Free Trade Agreement entered into

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full force. The new free trade area will rival the European Union
and the North American Free Trade Area in terms of value and surpass
those markets in terms of population. The effects of these
agreements will not likely be apparent for months or even years, but
they will certainly increase trade, lower prices to consumers, and
increase business opportunities throughout the region. However,
Philippine manufacturers will have to compete with low-cost
producers in China and elsewhere in the region, and are already
discussing the use of anti-dumping rules and other trade remedies to
reduce expected competition. These agreements may also reduce the
competitiveness of U.S. agricultural products in the Philippines and
the region (reftel B).

Not All News from 2009 Was Good
--------------


9. (SBU) The long-term trend is for manufacturing to move out of
the Philippines towards lower-cost countries such as Vietnam,
Indonesia and China, but this is a gradual movement that will occur
over decades. However, the global financial crisis/world recession
accelerated this process in 2009. Intel closed its semiconductor
plant after 35 years in-country, and Goodyear also shut its tire
plant after 53 years of manufacturing in the Philippines. The ADB
estimates that, besides the half percent overall poverty rate
increase in 2009 caused by natural disasters, the country's slow
long-term rate of poverty reduction has brought about a net increase
in the absolute number of poor people since 1990. The Philippines
also declined in several competitiveness indexes, with respondents
complaining about deficient infrastructure and corruption. In
addition, new barriers have cropped up in agricultural trade,
affecting U.S. exports. The sudden emergence of price controls on
fuel and food reminded entrepreneurs that the government does
intervene in markets in ways that affect profits and undercut
investor confidence. And finally, companies continue to become
entangled in investment disputes. The resultant judicial processes
are costly and slow-moving, with officials often susceptible to
political or economic influence.


Prospects for 2010
--------------


10. (SBU) For the short term, the key players in the Arroyo
Administration's economic team, such as the secretaries of Finance,
Agriculture and Trade, have told us they will stay in office until
the May elections. This may help restrain government spending
intended to influence voters during the elections, and will likely
mean sensible management of the economy for the first trimester.
The Central Bank, which is apolitical, will remain under the same
management and will continue its cautious approach of containing
inflation and intermittently intervening in the market to prevent
wild fluctuations in exchange rates. Portfolio capital will
continue to buoy the stock and bond markets, although yields will
not match those of 2009. Exchange rates are likely to remain
stable, especially if the U.S. dollar remains weak, and remittances
will continue to offer a steady flow of foreign exchange and boost
consumption. The Millennium Challenge Corporation reselected the
Philippines as eligible for a compact in 2010, which could boost
confidence and result in an inflow of several hundred million
dollars dedicated to infrastructure and revenue management if an
accord is reached. The possibility of reaching a peace accord with
rebels in the resource-rich island of Mindanao would also create
business opportunities and further improve investor confidence.
Local business tycoons indicate they will continue investing in
their own country, and significant development aid from multilateral
development banks, non-governmental organizations and donor nations
will continue to flow. And finally, meteorologists say the El Nino
weather phenomenon may result in fewer and weaker typhoons affecting
the Philippines in 2010.

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


11. (SBU) Although there is a strong element of uncertainty to any
economic forecast, there are enough indicators and trends to suggest
that 2010 will be a relatively good year for the Philippine economy.
However, there remain many pitfalls that will continue to constrain
growth. Investor confidence, always precarious, could vanish
quickly if political instability were to become widespread. The
volatile art of politics is closely entwined with economics in the

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Philippines, so any growth in 2010 will be influenced greatly by the
conduct and results of the elections, as well as the natural
disasters that regularly afflict this archipelago. End comment.


Kenney