Subject: In sharp contrast to what happened prior to the Asian financial crises of 1997-1998, in recent years the economy of the Philippines has grown significantly faster than those of its neighbors. Nonetheless, the Philippines suffers from a high budget deficit and serious structural problems, and the country’s sustained economic health requires that these problems beadequately addressed. On balance, however, the new situation opens up, as never before, favorable prospects that are for both Spanish exports and investments in the country.
Summary: The relatively high growth rate of the Philippine economy in 2002 (4.6%), albeit significant, is not yet safely consolidated. The country depends heavily on oil imports, exports to the US market, remittances from emigrants, and tourism, all of which are highly sensitive to the various economic effects that could result from a possible armed conflict with Iraq. Furthermore, the budget deficit and public debt have now reached worrying levels. Nonetheless, the economic prospects do seem favorable provided, of course, that serious external disturbances do not come into play. Spanish exporters and investors should take advantage of this economic expansion to increase their sales and strengthen their presence in the Philippines, which until recently has been insignificant.
Analysis: Long considered the black sheep of East Asian economies, Philippines has registered a sustained growth rate in recent years. GDP increased by an average annual rate of 3% between 1998 and 2002, higher than in any of the other three principal members of the Association of South East Asian Nations (ASEAN), i.e. Indonesia, Malaysia and Thailand. It is worth recalling that in the decade prior to the Asian crises (1987-1997), the average annual growth rate of the Philippines was less than half of that achieved by those three countries.
In 2002, GDP grew by a surprising 4.6%,compared with 3.2% in 2001. Due in large measure to the excellent results of agricultural production, this was higher than that of its neighbors, with the sole exception of Thailand. Furthermore, inflation was reduced from 6.1% in 2001 to 3.1% in 2002.
Nonetheless, this growth is not yet fully consolidated and must be viewed within a delicate macroeconomic framework. The Philippines is heavily dependent on imports of crude oil, which account for 95% of domestic fuel consumption and amount to 5% of GDP. The price of oil could increase significantly as a result of the conflict with Iraq. It is also heavily dependent on exports to the US market (which absorbs one quarter of the country’s total merchandise exports), Such demand, in turn, could be seriously undermined by the new international situation. Furthermore, as is well known, the remittances of six million Philippines working abroad come to the not inconsiderable sum of US$7bn a year (equivalent to one fifth of all merchandise exports) These could decline should there bechanges in the economic conditions of the countries absorbing this labor force.
The budget deficit is increasing (5.3% of GDP in 2002) and is now the country’s main macroeconomic problem, particularly given its structural nature. In the last financial year, the deficit far outstripped the government’s mid-year forecast of 3.3% of GDP. As a result, several ratings agencies have downgraded the Philippines which, in turn, has reduced the international credibility of the country’s economic policies, leading to a depreciation of the peso against the US dollar during the last few months. The peso’s exchange rate trend contrasts sharply with that of the currencies of Indonesia, South Korea or Singapore, which have all appreciated against a weakening dollar. Analysts believe that this trend could make the government’s recourse to foreign loans more difficult and expensive but, above all, they fail to understand why such a large imbalance in the public accounts has occurred in the context of relatively high economic growth. The size of the public deficit is due not so much to uncontrolled public spending (public expenditure accounts, in the final analysis, for only 20% of GDP) but to serious deficiencies in tax collection. Tax revenue is not only low (amounting to just under 12% of GDP) but has fallen from 17% of GDP in 1997. Furthermore, public debt has reached worrying levels: 63% of GDP in 2001 and 70% in 2002.
This would seem to rule out use of expansive fiscal policy. But such a policy might prove necessary should there be a marked deterioration in the domestic and external economic climate during 2003. It is only when it comes to monetary policy that there is some room for relaxation, given the relatively high interest rates which, at around 9%, are higher than rates in neighboring countries (excepting Indonesia) and in the world’s major economies. To bring down interest rates appreciably, however, the public deficit would have to be reduced. Even then, however, it is doubtful that this would stimulate private investment in the light of the high proportion of highrisk loans reported by banks (around 17% since the end of 2000).
The economy of the Philippines is also riddled with serious structural problems, such as endemic corruption, poor quality infrastructure and, above all, high unemployment, chronic poverty and vast inequality. The unemployment rate is over 11% — quite high for an East Asian country. Poverty, which had been substantially reduced before the Asian crisis (from 34% of the total population in 1990 to 25% in 1997) has been on the increase ever since ( at 26% in 2000). If the poverty line is set at the level of two dollars income per day, it is estimated that 44% of the population does not reach that threshold. The government has set itself the task of eradicating poverty by the year 2010, but such an objective would require average annual growth of at least 7% for the next seven years (the so-called 747 Plan of Economy Secretary, Rómulo Neri), which would seem to be very difficult -not to say impossible. Inequality is glaring, particularly for an Asian country. In 1997, according to figures released by the United Nations Development Program (UNDP), the income of one fifth of the richest households was almost ten times greater than that of 20% of the poorest -a much higher ratio than that found in Indonesia or Thailand. The expressed wish of President Gloria Macapagal Arroyo “to convert economic growth into social fairness” remains a daunting challenge indeed.
Although the government’s aim is to achieve a balanced budget by the year 2006, it is clear that it will have great difficulties in reducing the budget deficit in the short term, despite plans to raise taxes on sales of alcohol, tobacco and certain cars, and to privatize part of the electricity network. In the first place, parliamentary and presidential elections, due to be held in May 2004, could easily prevent public spending from being kept under control. In addition, the current year may well end up with lower-than-forecasted GDP growth (in January, the Asian Development Bank predicted — a forecast that must be taken with a grain of salt — that the figure for 2003 would be 3.9% — some seven percentage points lower than in 2002). Exports of goods, which increased by a healthy 4.8% last year, could fall if US growth is lower than expected. The Iraqi conflict could result not only in higher oil prices, but could also cause tourism revenues to drop, particularly if there are terrorist attacks and renewed Islamic insurgency in the south of the country. Nor should it be ruled out that the climate might not be as favorable as in 2002, thus producing negative effects on agriculture.
Supposing, therefore, that it will not be easy to reduce the budget deficit, a cut in interest rates would be hard to implement. In any case, such a policy of monetary expansion is not free from negative side effects since it would accelerate the already marked depreciation of the peso, fuel inflation and increase external debt repayments.
Nonetheless, save for an external economic catastrophe, the non-inflationary growth of the Philippines could well continue since it has been based, until now, largely on private internal consumption and on the expansion of the services sector.
The risk of a new financial crisis has also been significantly reduced largely because the ratio between short-term external debt and foreign currency reserves, which stood at 110% at the beginning of 1998, now stands at around 50%. In addition, the balance of payments continues in surplus, in contrast to its position in 1997 and 1998, although a clear negative trend is now becoming evident.
Thus, if the government manages to reduce the budget deficit by increasing tax collection without fuelling inflation, continues financial and industrial reorganization, maintains law and order, fights effectively against corruption and improves infrastructure significantly, the economic prospects of the Philippines are good in the short and medium terms. The Economist Intelligence Unit forecasts that growth for 2003 and 2004 will be 3.8% and 4.0% respectively. It is also worth bearing in mind that the decision of President Gloria Macapagal Arroyo not to stand in the 2004 elections (a decision that may yet prove temporary) makes it easier for her administration to concentrate more on promoting the health and growth of the economy. However, problems of domestic terrorism on behalf of the Abu Sayyaf group in the south of the country and the Moro Islamic Liberation Front (MILF) in Mindanao — which may well be exacerbated if the conflict with Iraq becomes more complicated — as well as the conflict with the New People’s Army (NPA) in other parts of the country, could negatively affect tourism and foreign investment.
Opportunities for Spain?
Exports of Spanish products to the Philippines are low, and recent trends seem not to have taken into account the new economic vitality of the country. The yearly average total of those exports was €118.5 million between 1999 and 2001, equivalent to 0.1% of Spain’s total exports or 0.3% of Philippine imports. Although sales of Spanish products in the Philippines rose from €116.4 million in 2000 to €127.7 million in 2001, that trend seems not to have continued in 2002, despite the fact that total Philippine imports increased by 6.2%. According to the latest figures released by the Spanish Secretary of State for Trade and Tourism (for January to November, 2002), Spanish exports amounted to €111.5 million, surprisingly lower than during the same period the year before (€121.2 million).
Imports rose to an annual average of €142 million euros in 1999-2001, implying a deficit for Spain of €23.5 million. It is equally noteworthy that in 2001 Spain had a trade surplus with the Philippines of €0.4 million that disappeared in the first eleven months of 2002 to become a deficit of €3.6 million.
Spanish exports to the Philippines are low (only 0.3% of the Philippine import market, which has to be set alongside Spain’s 1.8% share of the world market) and no advantage seems to have been taken of the country’s recent growth. It is necessary, therefore, to increase those exports. Their volume does not reflect Spain’s trading position in the world and or take into account the fact that the Philippines is growing at a relatively faster rate than that of any other country in South East Asia.
Until now, the main exports have included mechanical machinery, alcoholic drinks and plastic products whereas the main imports have consisted of electrical and electronic goods, mechanical machinery and clothing. Although it is difficult to compete with US or Australian products there is still some room to increase exports of higher value added consumer and capital goods.
Spanish direct investment in the Philippines increased on average to €98.5 million annually (or 0.14% of Spain’s total investment abroad) in the three years between 1999 and 2001. Despite being a small sum, this is nonetheless larger than Spanish investment in China, including Hong Kong, which amounted to €71.6 million euros (or 0.10% of total investment). The Philippines is, after Japan, the second largest recipient country of Spanish investment in East Asia. Economic liberalization and the country’s relatively high rate of growth in recent years offer new investment opportunities for Spanish companies, be they large, medium or small. Similarly to what occurs in other Asian countries, mixed enterprises would seem to be the best way of gaining a foothold in the Philippine market.
It is also worth bearing in mind that the Philippines, because of its historical links with Spain, is one of the three priority countries (China and Vietnam are the other two) of our cooperation efforts targeted at development in Asia.
Conclusions: The Philippines is no longer the odd-man-out in South East Asia. Its economy is growing even faster than those of Thailand or Malaysia, in stark contrast to what occured before the Asian crisis of 1997-98.
Nevertheless, the Philippine economy is quite vulnerable to the possible economic effects of a war with Iraq, since it is heavily dependent on oil imports, on exports to the US and on remittances from emigrants. Tourism might be hit hard if terrorist activities of radical Islamic groups, such as Abu Sayyaf or the Moro Islamic Liberation Front, are intensified. Furthermore, the government of President Gloria Macapagal Arroyo has still to come to grips with an excessive budget deficit.
Even under such conditions, and always provided there is no drastic external economic upheaval, it is more than possible that the Philippines will continue to grow for the next few years at around 4%, a relatively high rate for this country.
Spain, whose cultural and historical links with the Philippines are tight, should take advantage of this new situation to take stock of the fact that the country’s new-found economic vitality is an opportunity to increase our exports and investment which, until now, have been relatively insignificant and do not seem to reflect the country’s new dynamism.
Senior Lecturer in Applied Economics at Madrid’s Complutense University and Associate Researcher for Asia-Pacific at Real Instituto Elcano