REPORT

WALLACE REPORT

WHITHER THE PHILIPPINES

THE WALLACE
THE

BY

PETER WALLACE
September 2004

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A BRIEF ASSESSMENT

Gloria Macapagal-Arroyo was elected as President of the Philippines on June 30, and will
serve for 6 years. She had been president for the past 3½ years during which time economic
growth was desultory, and overly focussed on achieving political gain.

Now that elections are over her supporters claim she will eschew the populist approach and
effect the tough reforms the country must experience if it is to break out of the 4-5% growth
pattern of the past. Actually in the past 30 years the average has only been 3%.

Her critics, however, believe she’ll be unable to change and, hence, will continue to pander to
the public and the politicians. It’s, as yet, a little early to say which is the more likely scenario.
In fact something in between would have the highest probability, although to which end it
would tend is yet to emerge.

What does stand out is that her leadership style needs to change if the more positive
scenario is to be achieved. She announced a 10-point agenda and a 5-point economic reform
programs (see boxes) which although desirable actions to achieve don’t properly address the
fundamental reform the country needs to match the growth of its neighbours. Which is to
achieve a GDP growth in excess of 7% on a sustained basis.

We have argued that the fundamental reform that is needed is the following:

WHAT’S WRONG
1. Politics

2. Population growth

3. Educational system

4. Corruption

5. Infrastructure

6. Agriculture

7. Job creation

8. Judiciary

9. Security

10. Good governance

11. The negative approach of the Church

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The President has chosen instead to focus on more immediate concerns although she has
included some parts of the fundamental changes necessary, but not in a sufficiently
meaningful way.

She started with the following:

THE PRESIDENT’S 10-POINT AGENDA

1. Creation of 6-10 million jobs in 6 years

2. Upgrading the public school system – 100% school participation
rate with enough classrooms
3. Achieving a balanced budget
4. Development of a network of transport and digital infrastructure
5. Power and water to all barangays
6. Decongesting Metro Manila
7. Development of Subic and Clark as international service and
logistics centers
8. Computerization of the elections
9. Completion of the peace process
10. Final settlement of conflicts arising from EDSA 1, 2 and 3

Then added (in her SONA):

5-POINT ECONOMIC REFORM PACKAGE

1. Job creation and economic growth

2. Anti-corruption and good governance

3. Social justice and basic needs

4. Education improvement and youth opportunity

5. Energy independence and savings package

Two of the 5 points are in the 10 points, 3 are not. So it’s a little unclear what, finally, is her
agenda. A medium-term development plan is currently in the works that may clarify it – or add
to the confusion.

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To achieve these goals will need an ability to raise greater levels of revenues, containment of
the budget deficit and, an improvement in the investment climate. The President has
recognised two of these in, requesting Congress to agree to 8 new tax measures and by
publicly declaring the country is facing a fiscal crisis.

8 TAX REFORM MEASURES

1. Indexation to inflation of the excise tax on tobacco and alcoholic beverages

2. A shift to gross income taxation
3. Tax Amnesty
4. Franchise Tax on telecommunication companies
5. Increase in the expanded value added tax (EVAT) rate to 12-15% from 10%
6. Performance -related attrition system in the government
7. Petroleum excise tax
8. Rationalization of fiscal incentives

Although it was said, there is not, as yet, a fiscal crisis, but there well could be within the next
2 or 3 years if urgent action is not taken now. It was this urgency of action that the President
was highlighting. But whether it is having the desired effect is a matter for conjecture.
Congress said it would consider revoking, or reducing its “pork barrel” but, it seems, will still
get most of it by introducing line budgeting (inserting their pet projects into the lines no
doubt). As to the taxes, it’s unlikely to pass the taxes the President wants except for perhaps
two or three in the next six months, four at most.

The critical economic issues that must be addressed in the next 18 to 24 months include:

§ The government deficit, and attendant high debt level

§ The looming shortage of power
§ Managing the high-cost of oil products
§ Reviving investor interest

The government debt is some P3.36 trillion, to which must be added contingent liabilities of
government-owned or controlled corporation (GOCC’s) that could bring the indebtedness to a
little over P5 trillion.

Fortunately the schedule of debt repayment is stretched over time in a payable manner – if
controls are maintained.

The plan is to balance the budget by the end of her term, 2010. We believe this can’t be
done, but as long as the deficit is kept below GDP growth a debt crisis can be avoided (3%
would be a good number). It is something that will have to be watched very carefully.

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Some power shortages are expected sometime around 2007/08 (in some parts of the
Visayas and Mindanao they are already occurring). The government is aware of this, but
needs to break out of the normal bureaucratic and legal strictures if it is to order sufficient
base load capacity so as to keep the period of shortages as brief as possible. And ordering is
the wrong word. The government has to “entice” BOT investors, something that won’t be
easy to do, given the treatment of this sector in the recent past.

The privatization of the National Power Corporation (NPC) and its transmission arm, Transco,
is a necessary part of the solution. And, again, government is working on it, but finding
buyers willing to pay an acceptable price may prove difficult. Something the government has
yet to accept: that the important thing is to dispose of the assets quickly to private sector
operators that can do the necessary upgrades, not maximise the cash collection today. A fire
sale if you must.

Oil prices are, of course, outside the control of the government. And if the current high prices
are maintained it could knock 0.2% to 0.5% off GDP growth.

As to investor interest, it is at the lowest level (US$ 624 million last year) since the financial
crisis of 1997 much of it due to poor image problems, political uncertainty and changes in
policy by the government. Added to this is inadequate infrastructure and uncertainties
introduced by intervention of the Courts in a number of business decisions.

Despite these handicaps existing businesses have done quite well with modest growth in
sales and (to a lesser degree) profits.

Call centers and backroom operations, and telecoms have done particularly well as have
logistics/distribution services, and export of electronic products. While the construction
industry is witnessing some recent improvement.

We expect the foreign exchange rate to be still driven by political events and sentiment, but
also fundamentals. And to be less volatile. Interest rates should settle slightly above current
prevailing rates and follow the trend of US/global interest rates. Inflation also will be a little
higher, its final level much influenced by the cost of oil.

So, overall the economy should grow at around 5 to 5.5% and remain relatively stable with
the budget deficit gradually reduced, the debt situation manageable, no chronic balance of
payments deficit (even slight surpluses in some years). And some improvement in the
perception of the country, but dependent on Ms. Arroyo taking a firm leadership role

GDP growth could be a couple of percentage points or so higher or lower than this depending
on what happens to the global economy and how well Ms. Arroyo leads. And this will be
critical to watch – how the President develops her leadership style, or doesn’t.

The early actions in this regard, except for the declaration of a fiscal crisis, have not been too
promising.

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THE CENTRAL ECONOMIC FORECAST SUMMARY

(% REAL GROWTH RATE)
2004
2005 2006 2007
Sept June

GDP 5.6 5.5 5.0 5.4 5.1

GNP 6.2 6.2 5.5 6.1 5.5

Consumer Spending 6.0 6.0 5.6 5.6 5.7

Gov’t Current Exp. 0.6 3.5 2.0 2.4 3.0

Fixed Investment 5.0 4.8 5.8 6.8 6.9

Export G&S 12.4 11.5 11.5 9.3 8.2

Import G&S 7.4 7.4 9.2 9.6 8.3

Agriculture 5.2 5.2 3.4 3.6 3.0

Industry 4.7 4.5 4.4 5.2 4.9

Services 6.3 6.3 6.1 6.3 6.1

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