Overview

As reflected in its per capita GDP of just over US $1,000, the Republic of the Philippines remains a poor country. The vast majority of the labor force is still engaged in traditional occupations in agriculture, fishing, and forestry. About one-third of the population lives in poverty, while the gap between rich and poor is pronounced and not getting any narrower.

As discussed in the Economic Capsule, the Philippines was more resilient than most of its neighbors in the wake of the Asian crisis. Although foreign investment fell off substantially, from over $2 billion to $671 in the midst of the crisis, major players continue to invest in the Philippines (e.g., Intel, Texas Instrument, Fujitsu, Hitachi, National Semiconductor, Epson). However, as a cautionary note, it should be noted that numerous others have pulled out or scaled back significantly.

Foreign currency deposits remained stable throughout the crisis, although non-performing loans increased from 2.8% of total loans in 1996 to 14.4% in August, 1999. The Bangko Sentral raised the minimum capital requirements for banks in an effort to encourage more consolidation in this crucial sector. There have been a number of bank mega-mergers/consolidations since 1997 (e.g., the merger of the Bank of the Philippines Islands (BPI) and Far East and Equitable taking a majority stake in PCIBank). This trend is continuing.

One promising sign is that Philippine corporations are not as indebted as their counterparts in most neighboring countries. In part, this reflects (a) the fact that they have traditionally had less access to domestic and foreign capital markets, and (b) their historical preference for relying on internally generated funds due to high interest rates The Philippines still needs to raise its investment rate. The annual savings rate in the country has historically been far below that of its neighbors (estimated in 2000 at 20.3% of GDP, compared to 49.0% in Singapore, 46.1% in Malaysia, and 33.0% in Thailand).

The Arroyo Administration's Performance

Upon gaining office in the tumultuous People Power II, the Arroyo administration faced significant economic challenges, including an out-of-control budget deficit, below-target revenues, huge borrowings, a volatile forex rate, and low investor confidence. Given the magnitude of those problems, most experts feel that GMA and her economic "Dream Team," which includes seven Harvard and two Wharton graduates, have done better than might have been expected.

The administration's generally well co-ordinated fiscal and monetary policies have been recognized and appreciated by people who matter. In October, Fitch Ratings of London issued a "Stable Outlook" rating for RP, citing three factors: (a) a flexible exchange rate regime, with a comfortable international liquidity position; (b) relatively modest public external financing needs in 2002 (estimated at US $2.7 b., about half of which will come from development assistance); and (c) diminished political risk given GMA's strong political mandate and the sound fiscal and monetary policies of the administration.

The government is making progress on the deficit, and during 2001 stayed within a strict budget-deficit ceiling of $2.79 billion. Inflation targets were also exceeded; year-on-year inflation in November was only 5%.

The administration is finally beginning to address the growing problem of non-performing loans (NPLs), which have been steadily rising since the 1997 crisis, standing at around 18% as of the end of October, 2001. The administration is pushing legislation to create an asset-management company (AMC) to absorb risky debt, while stressing that this is not a bailout for banks. The proposed AMC would be private sector funded, with new rules allowing foreign companies to buy distressed real-estate assets. This would have the benefit of helping troubled banks to raise lots of bucks without a government bailout.

A recent briefing paper by the Federation Institute of Business and Economic Research praised the country's balanced debt profile, described as a "healthy mix" in terms of maturity and creditor base. Only 10% of the country's debt is short-term; 56% is dollar-denominated, 26% yen-denominated; creditors are bilaterals (30%), bond/note holders (26%), banks and financial institutions (22%), and multilaterals (19%).

Given the inescapable reality that one-third of Filipinos continue to live in poverty, the administration appears committed to finding resources to help the poor. GMA's proposed package includes cutting pharmaceutical prices in half, diverting excise taxes for housing projects, and providing microfinancing in rural provinces. Despite her aristocratic origins, few (even in the belligerent opposition) doubt that she does really care about the plight of the poor.

On December 10, 2001, President Arroyo hosted a national socio-economic summit to assess the performance of and prospects for the Philippines economy. Held at a glitzy Manila hotel, the atmosphere was upbeat in the wake of her highly successful trip to the states in November, a trip during which she was well-rewarded for her support and cheerleading for Uncle Sam's global war on terrorism (see The Philippines Economy at Year-end 2001 and Random Christmas Reflections for some details). Outside the hotel, about 300 protesters made plenty of noise about globalization and the long-term damage that can be expected from the government's continued policies of trade liberalization, but that's another story altogether and one subject to unending debate.

In 2002, the administration will reportedly give priority to creating reforms to further strengthen the banking sector, addressing deficiencies in corporate governance, and expanding revenue sources.

The Economic Weather Forecast

The President seems to have some right to gloat, given the difficulties of year 2001 and the fact that, for a change, the Philippines is one of the best economic performers in the region rather than one of the worst. According to the National Economic and Development Authority (NEDA), GDP grew at an average of 2.9% in the first three quarters, 2001. This can be compared to Indonesia (2.4%), Thailand (1.5%), Hong Kong (0.3%), Singapore (-0.5%), and Malaysia (-1.3%).

Other good news for GMA came in a December 26th issue of London's prestigious Financial Times naming her as on of the world's top-five political leaders. Rumor has it that she is basking in the descriptive tag line: "Iron Lady of Asia".

Given that the Philippines primary export is electronics components and its main export markets are America and Japan, one might have expected major retrenchment in the wake of the global recession. However, exports are not as important to the Philippines as they are for, say, Singapore and the country has remained largely still an agricultural economy. This is proving to be a strength, as the agricultural sector has helped the RP stay afloat. Agriculture grew by 2.9% during 1-3 Q 2001, with all four major subsectors (crops, livestock, poultry, fishery) showing higher output levels. Crops were particularly strong, with expanded production of corn, pineapple, coffee, and mango.

Another positive development is that Lehman Brothers reportedly intends to invest $1 billion in mass housing, home mortgages, and NPLs of local banks. According to an official letter from Jasitt Bhattal (Lehman's head man in Asia Pacific) to GMA, the investment bank is ready to inject "similar levels of capital and expertise" as they have previously done in Japan, South Korea, Thailand, and Indonesia. Reportedly, other investment houses (like Merril Lynch and Goldman Sachs) are also interested in the "asset management and disposition" business, as they say in the trade.

While the capital injections are welcome, and the impact will lessen troublesome NPL rates and free up domestic capital, the country has to be careful it doesn't turn into a outright fire sale that unnecessarily transfers control of large amounts of prime (or at least past-prime) real estate into foreign hands.

The final quarter of year 2001 saw evidence of renewed investor interest, most prominently in Kirin Brewery's decision to invest in San Miguel (about 15% of the company worth) (see Random Christmas Reflections). Although there has been controversy and debate about the deal (as always in the Philippines, and for reasons too complex to analyze here), word from the Palace is that GMA badly wants the deal to go through before the upcoming state visit of Prime Minister Koizumi. Another positive development is that Ford Philippines is starting to manufacture cars and SUVs for the Thai and Indonesia markets, creating more factory jobs.

As documented in various Pearl columns, the call center and outsourcing industry here are booming (see Globalization Revisited and Random Christmas Reflections; direct links for government and private sector resources are available in Resources). According to Trade Secretary Mar Roxas: "Our policy initiative is to promote and develop a skills-intensive service sector. This means looking for investments... that require small capital expenditure but with big potential to create more jobs..." DTI's stated priority areas are now: motor vehicle parts; micro-electronics; construction material; giftware and holiday décor; IT products and services; food products; marine products; home furnishings; and organic and natural products.

GMA's stoic and unquestioning support of Uncle Sam's war on terrorism is paying off, both politically and economically. George Dubya announced that quotas for Filipino textile and apparel exports (into the US market) would increase 27% beginning January 2002. The Bush administration is seeking $29 million from Congress for development aid and poverty alleviation, while the Overseas Privates Investment Corporation (OPIC) will extend a special line of credit to RP to the tune of $200 million for private sector investments.

The Requisite Cautionary Notes

Despite such positive developments, Moody's says the RP's economic prospects remain gloomy for the next year and a half, and the upcoming Standard and Poor's review is also likely to be decidedly on the downside. And there are always reasons to be cautious in evaluating the Philippines economy.

One impediment to economic growth, grudgingly admitted by the administration and adamantly denied by the Catholic Church, are the rapid rates of population growth. Estimated at 2.4% per annum, that's three times the global average and twice that of Asia as a whole. Over half the population is under age 19, average age 17.5 years, creating a dangerous demographic bulge and obstacle to longer-term economic and social development. Nearly a million people enter the job market each and every year, and unemployment and underemployment will be chronic concerns over the years to come. The country, like a gerbil in a cage, must keep running at a certain rate just to stay in the same place. Philippines' exports are heavily dependent on the electronics sector (currently constituting about 70% of exports, most of it in microchips and non-value added assembly work). According to the World Bank, the Philippines has the highest proportion of high-tech products to overall export ratio in the world. Not much of a problem as long as the world economy in general and the American economy in particular continued to boom. Growth in this sector was 33% in 1998 and 20% in 1999, blossoming from $3 billion in 1992 to $20 billion in 1998.

However, in the wake of the current meltdown, the lost export earnings are hurting. This suggests that economic policy should encourage diversification into such areas as consumer electronics, auto components, and medical equipment, and that trade policy should encourage diversified trading partners in the EU and elsewhere in ASEAN. The Philippines remains highly dependent on a limited number of trading partners. In terms of exports, the rank order is USA, Japan, EU (other than Germany and UK), Germany, and UK. America and Japan alone account for about 50% of export earnings, and everybody knows what happening economically in those countries. One promising sign is that the share of exports going to Asian neighbors (Singapore, HK, Taiwan, Malaysia and Taiwan) has been rising (at least prior to the current recession).

It is also important to at least mention the long-term ecological problems facing the Philippines, although in fairness one should note that these same issues exist throughout Southeast Asia. As much of 90% of the forests have been cut down, and over 90% of the coral reefs are gone. The historical practice of kaingin (slash-and-burn) farming, prevalent among upland peoples throughout the country, involves the clear cutting of forests, then burning the remaining cover. While this facilitates the short-term growing of rice, corn, cassava, taro, and yams, those crops are mostly for subsistence or barter. After no more than 3-4 years, the farmers move on, leaving behind useless fields that are quickly overgrown with coarse grass. The resulting severe soil erosion has a lot to do with the increasingly more devastating ecological disasters (floods mostly) of recent years. To make matters worse, the country's rapid population growth puts tremendous pressure on this marginal land.

This review of Philippines economic prospects will not dwell in depth with the kind of structural critique offered by astute observers such as Peter Wallace of the Economic Intelligence Unit. However, it is only right to acknowledge the huge underlying problems that are holding this country back: the short list includes a terminally bloated bureaucracy, pervasive and hard-to-eradicate corruption in both public and private sectors, a nonfunctional legal system and woeful judiciary, serious levels of crime and violence, and ongoing Muslim insurgencies and kidnap-for-ransom activity. Although GMA's heart is in the right place and her administration is infinitely better than that of her predecessor, it is an open question whether those obstacles can be overcome.

In Summary:

Keys to future growth, then, would seem to be:

• Ensuring macroeconomic stability
• Containing the budget deficit and effectively managing foreign and domestic debt
• Continuing structural reforms (modernizing the financial system and especially improving the regulatory environment in a transparent direction)
• Increasing government revenues (tax collections by the Bureau of Internal Revenue are among the lowest anywhere)
• Paying careful attention to intermediate sector linkages, with an eye to attracting more foreign direct investment, perhaps based on mergers and acquisitions
• The peace and order situation must eventually be addressed; otherwise there is little hope that the tourism industry can emerge as a driver of growth
• Continuing to attract foreign capital, thus enhancing the efficiency of domestic firms and eventually helping them aspire to becoming regional or global "players" Most fundamentally, future economic prospects depend on the administrations' ability to maintain social, economic, and political stability, while continuing to make progress in improving living standards.

Clarence Henderson, Henderson Consulting International

Note/Disclaimer