Philippines Philippines at a Glance: 2004-05

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Country Report

Philippines Philippines at a glance: 2004-05

OVERVIEW The outlook for the Philippines will remain very uncertain until the result of the May 10th 2004 presidential election is known. The current president, Gloria Macapagal Arroyo, has drawn level in surveys of voting intention with her main challenger, a populist film star, Fernando Poe, but the result of the presidential race remains difficult to predict. Violent crime will be a campaign issue, and an array of insurgencies will continue, especially in the south of the country. Long-delayed peace talks may be held with the Moro Islamic Liberation Front in April. GDP growth will be relatively strong in both 2004 and 2005, and the current account will continue to run a surplus, although this will fall to 1% of GDP in 2005.

Key changes from last month Political outlook • The arrest of three military officers in mid-February 2004 on charges of planning political protests in the event of Mr Poe!s disqualification as a candidate in the presidential election confirms the Economist Intelligence Unit!s forecast that political instability will continue throughout the election campaign. Economic policy outlook • The decision of the Bangko Sentral ng Pilipinas (the central bank) to raise banks! liquidity reserve requirements in early February in order to ward off any inflationary impact from the weakness of the peso highlights the impact of political tensions on the economy. The outcome of the election will be the key to restoring international confidence in the Philippines. Economic forecast • Export data for January 2004 showed a year-on-year increase of only 4.1%, a figure dragged down by sluggish electronics exports. The more rapid rate of increase in imports may point to a recovery in exports later in 2004. Private consumption and government consumption growth may be firm in an election year, but sluggish trade data support our view that, given the political risks that weigh on the macroeconomic forecast for the Philippines, it is too early to consider raising the GDP forecast for 2004.

March 2004

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Outlook for 2004-05

Political outlook

Domestic politics The outlook for the Philippines is clouded by the uncertainty surrounding the forthcoming presidential and parliamentary elections, due on May 10th 2004. The presidential election is the more important of these contests, as presidents tend to attract a greater following in Congress (the legislature) than indicated by the party affiliations of members of parliament (MPs), at least in the early years of their terms. The outcome of the presidential race remains open, but the incumbent, Gloria Macapagal Arroyo, will be one of the front-runners, having drawn level with her populist challenger, a movie star, Fernando Poe, according to surveys of voting intention conducted in late February and early March. Political instability may increase in the run-up to the election. If a populist candidate such as Mr Poe is chosen, international confidence in the Philippines will be damaged. The arrest of a small number of junior officers on January 29th on charges of inciting rebellion was followed by the arrest of a further three officers in mid- February on charges of attempting to destabilise the government, in particular by planning anti-government protests over legal moves to disqualify Mr Poe as a presidential candidate on the grounds that he was not a "natural-born" Filipino. The ousted former president, Joseph Estrada, had predicted "civil war" if his associate, Mr Poe, were disqualified. The Supreme Court has now ruled that Mr Poe is Filipino, but the government will continue to be anxious to prevent any repeat of the attempted mutiny in July 2003 by junior officers. Counter-insurgency efforts will continue in the south of the Philippines, where a number of Islamist groups operate, although repeatedly delayed peace talks with the Moro Islamic Liberation Front (MILF) may be held in April 2004 following successful exploratory talks in Malaysia in February. The New People!s Army, the military wing of the Communist Party of the Philippines (CPP), is responsible for a recent series of terrorist attacks, but talks with the National Democratic Front (which represents the CPP) will be held in China at the end of March. Although the Economist Intelligence Unit expects the government to hold together until the May poll, political or military tensions could flare up suddenly. In addition to insurgencies in various parts of the country, violent crime is a major problem, and is likely to figure prominently as an issue in the election campaign. Ms Macapagal Arroyo bowed to pressure from Chinese-Filipino businessmen to reintroduce the death penalty, following the kidnapping and killing of a businesswoman in November in the 156th reported case of kidnapping in 2003. The president seemed to have reintroduced capital punish- ment for political reasons"a rival in the presidential contest, Panfilo Lacson, is running on a tough anti-crime platform with support from Chinese-Filipinos" and has attracted criticism from the Roman Catholic Church as well as the EU. However, no executions have yet been carried out. The government said that election-related violence had led to 20 deaths by mid-February. Further killings are likely: 98 people lost their lives in poll-related violence in 2001.

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In focus

The May 2004 presidential election The candidacy in the presidential election of Fernando Poe, who is an associate of the ousted former president and fellow film star, Joseph Estrada, has attracted attention, as he is without experience of political office. Mr Poe will be one of the front-runners in the presidential poll, although in early March there were signs in surveys of voting intention that the incumbent president, Gloria Macapagal Arroyo, had drawn level with him, or even overtaken him by a small margin. The decision of a senator and TV personality, Noli de Castro, to join Ms Macapagal Arroyo!s presidential bid as her running mate has boosted her standing in the opinion polls, although current indications are that the outcome of the presidential race will be close. Mr Poe!s political inexperience and his reluctance to take part in a television debate with Ms Macapagal Arroyo on April 13th may have damaged his standing with some voters. A further factor in the loss of momentum of his campaign has been allegations that he is not a "natural-born Filipino" and is therefore ineligible to stand. The Supreme Court ruled on March 3rd that Mr Poe is Filipino, and his candidacy is therefore back on track, although further appeals over the issue by his detractors are likely. Splitting the opposition vote is the candidacy of Panfilo Lacson, the former police chief during Mr Estrada!s administration. Mr Lacson is currently polling poorly, but his candidacy will serve to highlight the issue of violent crime during the election campaign. Of more concern to Ms Macapagal Arroyo is the former education secretary, Raul Roco, who is standing on an anti-corruption ticket. Mr Roco is thought not to have the same level of financial backing as the president, and has slipped to third place in the opinion polls. Mr Roco and Mr Lacson were given the support of 18% and 11% respectively of those surveyed in a late-February poll. The other two candidates, an evangelical Christian, Eduardo Villanueva, and a businessman, Eddie Gil, make up the numbers. In February the Supreme Court abrogated the P1.2bn (US$22m) automated polling contract between the Commission on Elections and the Mega Pacific eSolutions Consortium on the grounds of irregularities in the bidding process. The poll will now be counted manually; the full result may take days or weeks to emerge. International relations The Philippines has emerged as a leading participant in the US-led "war on terror", as insurgent groups in the south of the country are thought to have links with the al-Qaida terrorist network and Islamist groups such as Jemaah Islamiah operating elsewhere in South-east Asia. The deployment of US troops in the Philippines, as well as exciting popular indignation, raises major constitutional issues, as the constitution forbids foreign troops from engaging in combat on Philippine soil. Even so, relations between the two countries are now warmer than at any time since the closure of the US military base at Subic Bay a decade ago. The Philippines has also been pressing for a regional response to terrorism, as militants move with ease across international borders, especially that between Mindanao in the south of the Philippines and North Sulawesi in Indonesia. The Association of South-East Asian Nations (ASEAN) is discussing the establishment of a joint peacekeeping force.

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The diplomatic importance of the Philippines was further emphasised on January 1st 2004, when the country took up its two-year position as a non- permanent member of the UN Security Council. Japan and the Philippines began free-trade negotiations in February: a free-trade deal may be agreed some time during the next 12 months.

Economic policy outlook

Policy trends The possibility that a populist president will be elected is the main risk to our central budget deficit forecast. In 2003 the deficit remained large, at an estimated 4.6% of GDP, helping to lift public debt to around 71% of GDP, compared with 59% as recently as 1999. Even the relatively benign scenario outlined in our forecast shows that public debt is set to rise to 74.7% of GDP in 2005. However, the true level of public-sector indebtedness is much higher than these figures indicate: according to the former treasurer, Sergio Edeza, when debts run up by the National Power Corporation, or Napocor, and other contingent liabilities are included, the public debt total is equivalent to around 115% of GDP. If the new government fails to get to grips with the public finances, confidence in the Philippines will be severely undermined, with knock-on effects throughout our macroeconomic forecast. In the longer term the government needs to tackle the fundamental problems of the revenue- raising system, notably systemic corruption in the bureaucracy, corporate tax evasion, complex tax regulations, inadequate tax assessment and collection systems, and a narrow tax base that is heavily reliant on manufacturing. Progress on other aspects of economic reform has slowed since the first months of Ms Macapagal Arroyo’s presidency, and the impending presidential election will delay policy initiatives. The government has failed in its repeated attempts to sell off the National Transmission Corporation (Transco), originally part of Napocor, through a public bidding process; a fresh privatisation attempt will be made this year.

Fiscal policy The 2003 budget deficit came in at P199.8bn (US$3.7bn), comfortably within the P202bn target. An improvement in the public finances in 2004-05 will depend on continued vigilance by the authorities and a swift reinstatement of the economic reform programme following the May 2004 presidential election. The current government’s 2004 budget provides for a deficit of P197.8bn, which would equal around 4.2% of GDP. In the run-up to the election, it is reasonable to expect higher government expenditure. Government revenue fell to an average of 14.3% of GDP in 2002-03, compared with the 15.3% of GDP raised as recently as 2001, which indicates that, politics permitting, there is scope for an improvement in revenue collection. We therefore forecast a deficit outturn of P203bn in 2004, which would reduce the deficit to 4.3% of GDP. A stabilisation of the deficit at around this level in 2005 would allow the deficit as a proportion of GDP to fall to 4.1%. In both years of the forecast period, therefore, GDP growth alone will be relied upon to cut the deficit as a proportion of GDP.

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Monetary policy Philippine monetary policy is carefully balanced between a desire to support domestic demand and the need to address the weakness of the currency and ward off any inflationary impact therefrom. As the exchange rate hit fresh lows in January and February 2004, the Bangko Sentral ng Pilipinas (BSP) increased banks! liquidity reserve requirements by 2 percentage points to 10%, to counter- act the inflationary effect of a weaker exchange rate. However, policy interest rates were later held steady at 6.75% in the case of the overnight borrowing rate and 9% for the overnight lending rate. Political factors weigh heavily on the exchange rate, money supply growth remains modest and the outlook for inflation is subdued, and the BSP will therefore attempt to maintain an easy monetary policy in order to support investment and credit demand.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2002 2003 2004 2005 Real GDP growth World 2.9 3.7 4.4 4.0 OECD 1.6 2.0 2.9 2.5 EU 1.0 0.7 1.9 2.1 Exchange rates ¥:US$ 125.3 115.9 104.8 106.5 US$:€ 0.945 1.132 1.350 1.377 SDR:US$ 0.772 0.714 0.649 0.644 Financial indicators € 3-month interbank rate 3.33 2.33 2.00 2.23 US$ 3-month Libor 1.80 1.21 1.29 3.24 Commodity prices Oil (Brent; US$/b) 25.0 28.8 24.9 20.9 Gold (US$/troy oz) 310.3 362.8 421.3 375.0 Food, feedstuffs & beverages (% change in US$ terms) 12.7 5.8 3.4 7.1 Industrial raw materials (% change in US$ terms) 2.2 12.3 11.4 -0.1 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. A global economic recovery is now well under way, underpinned by faster growth in the US and steady growth in Japan. US GDP growth will increase to 4.5% this year, up from 3.1% in 2003, but a deceleration to 3.1% in 2005 is likely as the impetus provided by earlier tax cuts fades and interest rates rise. Japanese GDP growth will reach 2.8% this year, slightly up from 2.7% in 2003, before slowing to 1.3% in 2005. Consequently, although world GDP growth will rise to 4.4% in 2004 and 4% in 2005, from 3.7% last year, the recovery in world trade growth will not be spectacular. World trade growth will rise from 4.6% in 2003 to 7% and 6.6% in 2004 and 2005 respectively, well below the 12.9% rate of expansion recorded in 2000. We expect annual average crude oil prices (dated Brent Blend) to slide sharply from an average of US$28.83/barrel in 2003 to US$24.90/b in 2004 and US$20.94/b in 2005.

Economic growth Gross domestic product by expenditure (P bn at constant 1985 prices; % change year on year in brackets unless otherwise indicated) 2002a 2003a 2004b 2005b Private consumption 810.8 852.2 894.5 933.0 (4.1) (5.1) (5.0) (4.3) Public consumption 77.2 75.0 76.7 78.2 (2.4) (-2.8) (2.2) (2.0) Gross fixed investment 236.7 238.6 245.8 258.1 (2.4) (0.8) (3.0) (5.0) Final domestic demand 1,124.6 1,165.9 1,217.0 1,269.3 (3.6) (3.7) (4.4) (4.3) Stockbuilding -1.2 8.1 1.0 4.0 (-1.4)c (0.9)c (-0.6)c (0.3)c Total domestic demand 1,123.5 1,173.9 1,218.0 1,273.3 (2.3) (4.5) (3.8) (4.5) Exports of goods & services 445.8 460.7 492.9 526.6 (3.6) (3.3) (7.0) (6.8) Imports of goods & services -532.2 -587.0 -629.8 -679.9 (4.7) (10.3) (7.3) (7.9) Foreign balance -86.3 -126.4 -136.9 -153.3 (-0.9)c (-3.8)c (-1.0)c (-1.4)c GDP 1,046.1 1,093.3 1,142.5 1,190.1 (4.4) (4.5) (4.5) (4.2) a Actual. b Economist Intelligence Unit forecasts. c Contribution to real GDP growth. Philippine GDP grew by an unexpectedly healthy 4.5% in 2003. The prospects for GDP growth over the 2004-05 forecast period are partly dependent on how quickly the country returns to a more stable political situation following the May 2004 presidential election, and on the resumption of the economic reform programme. On the assumption of an upturn in confidence in the Philippines early in the forecast period, and a long-awaited uptick in export growth in 2004 in line with stronger demand for electronic products in the main OECD markets, GDP growth in 2004 should maintain the 4.5% pace recorded last year, and should remain above the 4% mark in 2005. There are concerns in the Philippines about the country!s ability to compete with China in OECD markets for electronic goods. However, it is still reasonable to expect a better export performance over the forecast period. Ms Macapagal Arroyo stands a good chance of winning the presidential election; such a result would reduce the current political uncertainty, paving the way for foreign direct investment to return. Inflows of remittances from overseas Filipino workers will support private consumption and thereby also buoy the services sector. Fixed investment growth will accelerate in both years of the forecast period. There will be no boom, however, since government investment spending will be constrained by budgetary problems, and private- sector investors will remain deterred even after the presidential election both by the security situation in the country and by faltering progress on privatisation, as well as by general uncertainty about the government’s economic policy. Weaker OECD growth in 2005 is likely to feed through into a slower rate of increase in exports and remittances from overseas workers, and government consumption will also rise more slowly as the new administration

attempts to rein in the budget deficit. These factors will lower GDP growth in the Philippines to 4.2% in 2005.

Inflation The year-on-year rate of consumer price inflation as measured by the 1994- based consumer price index (CPI) rose to 3.4% in January 2004 from 3.1% in December, and remained steady in February as stable food and clothing prices and lower services prices offset higher inflation for fuel and construction materials. Planned adjustments in power tariffs, the weaker peso and the relatively healthy outlook for economic growth in 2004-05 will provide some support for prices over the forecast period, although average oil prices in particular are expected to fall sharply in 2004. We expect only modest rises in inflation in 2004 and 2005, to 4% and 4.5% in the two years respectively, compared with the average for 2003 of 3.1%.

Exchange rates The Philippine peso fell sharply against the US dollar as a result of the attempted coup at the end of July 2003, and the currency remains vulnerable to further sharp movements as a result of concerns over the outcome of the forthcoming presidential election and security developments, despite good news on the budget deficit and the surge in workers’ remittances. The currency ended 2003 at P55.57:US$1, but fell to P56.12:US$1 on January 29th 2004 following the news that a group of junior soldiers had been arrested for inciting rebellion. The peso has remained below P56:US$1 since mid-February and was trading at P56.21:US$1 on March 10th. We forecast a further depreciation in the peso to annual averages of P55.60:US$1 in 2004 and P56.00:US$1 in 2005, compared with P54.20:US$1 in 2003.

External sector The Philippine export sector performed more poorly than expected in 2003. Expectations of a recovery in exports to take advantage of higher demand in the key US market were repeatedly dashed. However, the government expects a recovery in exports in the early part of 2004 as OECD economies reach a trend pace of GDP growth. In addition, assuming that the political scene will appear considerably more stable once the outcome of the May presidential election is known, both foreign and domestic investment is likely to return. As a consequence, we expect exports to increase to US$37.9bn in balance-of- payments terms in 2004, up from US$34.8bn in 2003, with a further increase to US$41.8bn in 2005. As exports are dependent on imported components, the uptick in exports will be accompanied by an increase in imports, with the result that the merchandise trade deficit may widen slightly over the forecast period. The trade deficit will be more than offset by the large surplus on the income account, supported by inflows of remittances from Filipinos working overseas, which reached US$7.6bn in 2003. The overall result will be a further fall in the current-account surplus from US$3.1bn (3.9% of GDP) in 2003 to US$864m (1% of GDP) in 2005.

Forecast summary (% unless otherwise indicated) 2002a 2003b 2004c 2005c Real GDP growth 4.4 4.5a 4.5 4.2 Gross agricultural production growth 3.3 3.9a 3.5 3.3 Unemployment rate (av) 11.4 11.4 9.8 9.2 Consumer price inflation (av) 3.1 3.1a 4.0 4.5 91-day Treasury-bill rate 5.5 5.9 7.1 8.0 Government balance (% of GDP) -5.3 -4.6 -4.3 -4.0 Exports of goods fob (US$ bn) 34.4 34.8 37.9 41.8 Imports of goods fob (US$ bn) 34.0 36.0 39.3 43.4 Current-account balance (US$ bn) 4.2 3.1 1.8 1.1 Current-account balance (% of GDP) 5.4 3.9 2.1 1.2 External debt (year-end; US$ bn) 53.9b 57.4 62.1 63.9 Exchange rate P:US$ (av) 51.60 54.20a 55.60 56.00 Exchange rate P:¥100 (av) 41.17 46.77a 53.08 52.58 Exchange rate P:€ (year-end) 55.68 70.09a 77.00 75.84 Exchange rate P:SDR (year-end) 72.19 82.57a 86.21 86.67 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Editors: David Webb (editor); Graham Richardson (consulting editor) Editorial closing date: March 4th 2004 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule