For Philippine economy, harsh remedies pay off
By James Hookway, Wall Street Journal Asia
MANILA, Philippines (13 September) -- The perpetual sick man of Asia is making an unexpected recovery.
Once among Asia's most prosperous nations, the Philippines had languished economically for decades while neighboring countries, big and small, raced ahead. But for the past two years -- almost lost amid the international excitement about the growth of China, India and Vietnam -- the Philippines has been rebounding.
This year, the nation's economy is expected to post its fastest growth rate since the early 1990s, despite the economic shadow cast by the global credit squeeze sparked by problems in the U.S. mortgage market. The Philippine economy grew at a 7.5% annual rate in the second quarter.
The stock market has soared over the past two years, although it has faltered recently. Foreign investors are coming back, attracted by the Philippines' young population -- the average age of its 89 million people is 22 -- and the widespread use of English, a legacy of its past as an American colony. The call-center business is thriving, some of it poached from India.
Not long ago, Fort Bonifacio, a sprawling old military base in the heart of Manila, was an emblem of economic malaise -- a stalled redevelopment taken over by cyclists, skateboarders and kite enthusiasts. Now, office towers, embassy buildings and shopping malls are going up there. Nike Inc., Starbucks Corp. and Nokia Corp. have opened stores, and the Manila stock exchange will be joining them soon.
"The Philippines could be the next India in terms of its ability to surprise," says Adrian Mowat, a stock strategist at J.P. Morgan Securities Ltd. in Hong Kong.
Gloria Macapagal Arroyo, the country's 60-year-old president, gets much of the credit for the turnaround. Two years ago, with thousands of street protestors threatening to oust her and the country drifting toward a financial crisis, she pushed a higher sales tax through Congress and signed it into law over the objections of her advisers. The move raised the tax to 12% from 10% and expanded it to a range of new products and services, including gasoline.
That politically risky step showed investors the nation was serious about putting its house in order after years of half-hearted attempts to cut its budget deficit, crack down on corruption, and do something about its decaying ports and power grid. A J.P. Morgan report in May predicted that the Philippines could have a balanced budget by next year and a budget surplus by 2009.
"I knew the risks, but I decided that if we had to bite the bullet, then that's what we would do," said Ms. Arroyo in a recent interview.
The nation's economic comeback shows the kinds of remedies that struggling developing nations must consider competing in the global economy. Following China's rise as a manufacturing power, the nations of Southeast Asia -- once one of the world's most popular manufacturing hubs -- have been trying to make themselves more attractive to foreign investors and markets.
"The whole region is going through the same process, and it's all in response to China," says Luz Lorenzo, an economist who covers the region for ATR-Kim Eng Securities Inc. in Manila. "How do these countries survive China?"
Many problems remain in the Philippines. One of the richest countries in Asia before World War II, the Philippines saw its economy deteriorate during decades of misrule, punctuated by military coups and economic mismanagement. Ms. Arroyo herself has survived two attempts by military officers to grab power. The country has called in U.S. military advisers to help tackle a persistent Islamist insurgency, and it continues to be criticized widely for human-rights abuses and corruption.
The recent economic progress could be undermined by problems that have long plagued the economy. The country has a legacy of crony capitalism that has left former business associates of late President Ferdinand Marcos in powerful positions in the business sector. Political analysts say Ms. Arroyo must avoid spending the growing tax receipts on unnecessary projects that benefit her own political supporters. And questions remain about the government's ability to collect corporate taxes.
Moreover, the Philippine economy is heavily dependent on exports, which account for around 40% of gross domestic product. A significant economic slowdown in the U.S. could harm that sector. But economists contend that domestic investment and demand has become a more important driver of the economy -- and could help buffer it from global economic problems. "The growth story here is changing from one which is export driven to one which is domestic led," says Ms. Lorenzo of ATR-Kim Eng.
Ms. Arroyo's current six-year term expires in 2010. It's unclear whether the next president will continue her economic policies, or will resort to past practices. Prior governments have limited the business opportunities available to foreign companies, allowing local tycoons to build lucrative monopolies.
Ms. Arroyo's father, Diosdado Macapagal, was president of the Philippines in the early 1960s. After studying economics at Georgetown University, she returned home to teach at the University of the Philippines, then entered politics.
She was elected vice president in 1998. She quickly set about distancing herself from her unpopular boss, President Joseph Estrada, a former action-movie star who became embroiled in a series of corruption scandals. In 2000, she openly began plotting his removal. In January 2001, after the armed forces joined hundreds of thousands of demonstrators in the streets of Manila to force him from office, she was sworn in as his successor.
Ms. Arroyo, whose short fuse has led her to slam cell phones on tables and publicly berate her deputies for making mistakes, has proved to be a tough political infighter. She's stood up to two failed military-coup attempts by rallying her allies in the armed forces and the powerful Roman Catholic Church, of which she is a devout member. When the business dealings of her husband began drawing political heat in 2005, she exiled him to the U.S. for several months until the fuss subsided.
Her priority after winning the 2004 presidential election was to put the nation's chronically ailing finances in order. A key problem: anemic tax revenues due to endemic corruption among tax officials and loopholes in the tax code. In 2003, tax revenues were 14.8% of GDP. That's a lower rate than in poverty-ridden countries such as Indonesia and India, and far below rates in developed countries such as the U.S., where government revenue totaled 25% of GDP in 2006.
A combination of weak state revenues and high foreign debt -- 70% of the government's budget went to paying interest in 2005 -- was spooking investors. They worried that too much of the government's budget went to service debt, and not enough to fix roads, schools and the power supply. Japan's Toshiba Corp. shut down its Philippine laptop factory in 2004 and moved the operation to China.
The Situation: After languishing for years, the Philippine economy is showing signs of renewal.
The Background: President Arroyo pushed through higher taxes, which helped persuade foreign investors she was serious about economic reform.
What's Next: Like other Southeast Asian nations, the Philippines is worried about a potential economic slowdown in the U.S.
"Our country was going through a credibility gap with the institutional and financial community globally," says Jaime Augusto Zobel de Ayala, chief executive officer of Ayala Corp., one of the companies redeveloping Fort Bonifacio. The Philippines, he says, "needed to send a signal."
Ms. Arroyo warned in 2005 that if the Philippines didn't act decisively to improve its tax-collection rate, it risked becoming the next Argentina, where economic problems led to a currency collapse. She and her advisers began looking for ways to raise new money.
She increased tobacco and alcohol taxes, but that wasn't enough. She and her economic team began working to push another unpopular measure through Congress in 2005: an expanded sales tax.
Demonstrators took to the streets to contest her tax plans. One of her advisers, former stock analyst Joey Salceda, suggested that she limit the new sales tax to soften the political backlash. Gasoline prices, he said, should be excluded because they were already spiking. She ignored the advice.
"I was determined not to sacrifice long-term gains for political expediency, even though we had to do it at the worst possible time," Ms. Arroyo says.
At first, the sales tax hike appeared to make things worse. Her opponents challenged the legality of the legislation, and the Supreme Court suspended the tax law the day it was to take effect in July 2005. Stock prices slumped at the Philippines Stock Exchange, and ratings agencies Moody's and Standard & Poor's lowered their already dim outlooks on the nation's ability to pay its debt. Ms. Arroyo's popularity took a pounding.
Eventually, the Supreme Court dismissed the objections and the tax hike took effect in early 2006. That greatly reassured business leaders and foreign investors, who were worried about the burden of the government's $54 billion in foreign debt.
"The single turning point that changed people's minds about the Philippines was that she was able to pull off the expanded tax, and at such a difficult time," says Fernando Zobel de Ayala, brother of Ayala's CEO and head of its Ayala Land unit.
The tax take in 2006 was 22% higher than in 2005, lifting government revenue to 16.3% of GDP. To further reduce the deficit, Ms. Arroyo started privatizing the nation's debt-burdened power industry in 2005. In addition, she encouraged foreign investment in the mining sector -- which antimining activists and the Catholic Church had blocked for years.
Since then, institutional investors have been returning to the country's bond and stock markets. Since the new tax took effect in January 2006, the Philippines Stock Exchange Index has climbed 58%, outstripping most Asian markets over the same period. Net stock investment by foreign investors hit a record $870.8 million in June, according to the Philippine Stock Exchange, up from just $12.9 million in January 2004. The Philippine peso has risen 13.6% against the U.S. dollar since the tax took effect, partly due to the inflows of foreign money. The peso is the second best performing currency in Asia this year, after the Indian rupee.
Rather than borrowing overseas, local companies are once again turning to the stock market to raise funds. There were numerous initial public offerings on the Philippines Stock Exchange in 2005 and 2006, following years in which offerings were rare. Eight 2006 offerings were aimed specifically at foreign investors, raising $1.56 billion. So far this year, five IPOs have hit the market.
With business confidence on the mend, inflation and interest rates have declined.
Local and foreign businesses have begun investing again, and multinational companies are adding plants and shipyards. In May, Texas Instruments pledged $1 billion to build a new chip testing and assembly plant at the old U.S. Air Force base at Clark Field, 62 miles north of Manila, to complement a plant it already has here.
Kevin Ritchie, Texas Instrument's senior vice president for technology and manufacturing, said at the time that the country's skilled work force encouraged the company to raise its investment. Philippine officials said the company was also looking for reliable power and water, which are more available now that power privatization is under way.
One of the world's largest shipping companies, Beijing-based China Ocean Shipping Co., is studying whether to build a multibillion-dollar cargo hub near Manila, company officials say. South Korean shipbuilder Hanjin Heavy Industries & Construction Co. is investing $1.7 billion in a new shipyard at a former U.S. Navy base at Subic Bay. It was attracted by the skilled, English-speaking work force and low costs, a company official says.
Filipino expatriates -- more than 10 million work abroad -- have taken notice. They are now sending home $14 billion a year, double what they sent five years ago, government figures indicate. Economists see this as a relatively secure source of revenue. While 35% of these expatriates work in the U.S., there are also large pockets in Europe, the Middle East and East Asia. That geographical diversity could provide some insulation against a downturn in the U.S.
The remittances aren't just going to support families, but into the stock market and property investments. Ayala Land, one of the country's biggest real-estate companies, says that in 2006, 37% of revenue came from Filipinos overseas buying land and condominiums, up from 26% the year before and just 16% in 2004. The company's chief financial officer, Jaime Ysmael, told shareholders on Tuesday that if economic problems in the U.S. deepen, Ayala Land can still count on Filipinos working in Europe and the Middle East.
Norma Ravanzo, a 58-year-old retired nurse from Houston, is one such investor. An American citizen for more than 30 years, Ms. Ravanzo is planning to return to her homeland with her husband, who was also born in the Philippines. Encouraged by the economic progress and improving living conditions, Ms. Ravanzo bought property in Cebu City, Manila's financial district, and a retirement home in Subic Bay. "It's like living in a first-world community at third-world prices," she says.
(First published by Wall Street Journal Asia, August 31, 2007)