THE PHILIPPINES: LAYING THE FOUNDATION FOR AN ECONOMIC RECOVERY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88T00539R000600790002-7
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 20
• Document Creation Date: December 27, 2016
• Document Release Date: December 15, 2011
• Sequence Number: 2
• Publication Date: July 1, 1987
• Content Type: REPORT

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Directorate of
Intelligence
The Philippines:
Laying the Foundation
for an Economic Recovery
ecret
Secret
EA 87-10031
July 1987
Copy 3 4 2
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25X1
Intelligence
The Philippines:
Laying the Foundation
for an Economic Recovery
This paper was prepared byl Office of
East Asian Analysis. Comments and queries are
welcome and may be directed to the Chief, South
Asia Division, OEA
Secret
EA 87-10031
July 1987
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The Philippines:
Laying the Foundation
for an Economic Recovery
Scope Note
This new Assessment looks at the economy and the
status of Manila's reform program. It also examines t e outlook through
1990, outlines the remaining tasks facing the administration, and discusses
the potential impact of the new Congress.
Probably the bi est unknown is the role of the Congress in economic
policy making.
~ relations
between Aquino and the Congress will be strained, as both sides adjust to
the transfer of legislative power." On economic matters in particular, the
legislature will have an input into debates on the national budget, foreign
debt, land reform, foreign investment, and the Military Bases Agreement
with the United States. As the year goes on and Congress carves out its
role in the political process, information on congressional tactics and
positions in these areas would aid our analysis of the country's economic
prospects.
Secret
EA 87-10031
July 1987
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The Philippines:
Laying the Foundation
for an Economic Recovery
Key Judgments Since coming to power one and a half years ago, the Aquino administration
Information available has made encouraging progress in turning around the Philippine economy
as of 29 July 1987 and laying the groundwork for a sustainable economic recovery. Manila's
was used in this report.
strategy emphasizing market-oriented policies and less government inter-
vention, favorable international factors, and the delayed effects of a 1983
economic austerity program combined to bring about slight economic
growth late in 1986, after two years of decline. We believe the recovery is
continuing in 1987, with real growth likely to reach 3 to 4 percent. That es-
timate is lower than Manila's overly optimistic projections, but we believe
it is evidence of solid economic gains.
If the administration can fully implement its remaining economic reforms,
maintain workable relations with the new Congress, and benefit from a
favorable international economy, our econometric model indicates the
economy could grow about 5 to 6 percent annually during the period
1988-90. More probably, however, all the pieces will not fall into place, and
growth over the rest of the decade probably will average closer to 4 percent
annually. In either case, the rural economy probably would be a major
beneficiary of the economic expansion, boosting Manila's efforts to
improve living standards of the country's poorest and counter the Commu-
nist insurgency.
But the 1988-90 growth rate we project will not be strong enough to
seriously undercut the insurgency. Even if economic growth averages
5 percent a year after 1987, per capita income levels would not return to
their 1981 peak until 1994. Progress against the insurgency will be
measured as well by the extent to which the government can implement a
land reform program and guarantee justice and security throughout the
country. Indeed, issues such as these are more important for their
propaganda value than for their impact on the economy.
The Philippine Congress will become a new and potentially key variable in
economic policy making when it convenes in July, and, if history is any
guide, it will probably hinder rather than facilitate the administration's
economic plans. Although many of the new legislators ran on the Aquino-
backed slate, they come to office from widely different backgrounds and
with various agendas. As a result, we believe the Congress may be eager to
show its independence from the executive branch on economic issues such
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as the national budget and foreign investment. In addition, it is increas-
ingly clear that the administration is leaving the politically sensitive issue
of land reform to the Congress to decide. If so, we doubt much progress
will be made because most congressmen are either large landowners or owe
their election to wealthy landowners.
No matter how the economy fares over the next few years, we believe
Manila will continue to press Washington for additional financial assis-
tance for both budgetary support and development projects. Moreover, it is
probable that the aid discussions will become contentious at times,
primarily because of the Philippines' unrealistic expectations of US largess.
Manila may well use the prospect of difficult renegotiations of the Military
Bases Agreement as leverage to try to obtain more money. The Aquino
government probably will also try to gain US concessions on bilateral trade
issues, such as US imports of textiles and sugar, in an effort to improve the
prospects for economic recovery.
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Contents
Scope Note
Key Judgments
The Economy Shows Some Life
Trade and Investment Policy 4
Government Finances 4
Agricultural Productivity
A New Environment for Economic Policy Making 6
Treating the Debt Hangover
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The Philippines:
Laying the Foundation
for an Economic Recovery
The Economy Shows Some Life
Signs of a turnaround in the Philippine economy,
debilitated by years of mismanagement and abuse
under Ferdinand Marcos, began to show up in Mani-
la's statistics in the latter half of 1986. By the fourth
quarter, all sectors of the economy were expanding,
fueled in part by the accelerated release of funds from
the Aquino administration's $200 million rural infra-
structure spending program, increased consumer con-
fidence following the ouster of Marcos, and a signifi-
cant improvement in the Philippine terms of trade.
Growth for the quarter was almost 2 percent, making
possible a small gain for the year and reversing the
9-percent fall in national output in 1984-85. The
agricultural sector-benefiting from unusually good
weather-was especially healthy in 1986, averaging a
5-percent gain in the second half of the year. The US
Embassy reports that purchasing power and retail
sales in the countryside have picked up, and, in some
areas, farmers are enjoying higher prices for their
crops after several profitless years. The current ac-
count also registered a sharp turnaround, producing a
$1 billion surplus. In addition, inflation and interest
rates continued to fall, the peso remained stable, and
the Philippine stock market boomed.
International economic developments proved benefi-
cial for the new government's efforts to revive the
economy. Despite higher import volumes, lower oil
prices allowed Manila to save about $500 million on
its oil import bill, held down inflation, and helped
reverse the country's current account deficit. Lower
global interest rates cut about $200 million from
Philippine interest payments on its foreign debt. In
addition, the Aquino government assumed power at
an opportune time in the business cycle, as the
contractionary effects of the Marcos administration's
necessary 1983 economic austerity program began to
In addition to the external factors, we believe the
Aquino administration's economic reforms, especially
in the agricultural sector, played a significant role in
the turnaround. For example, the coconut industry,
which accounts for at least 20 percent of Philippine
agricultural production, benefited from a combination
of the government's dismantling of the coconut mo-
nopoly and increases in world demand for Philippine
coconut products. In addition, freer markets resulted
from the elimination of protective barriers granted to
business associates of Marcos.
In our view, the recovery is continuing in 1987, but
Manila probably will not reach its 6- to 7-percent
target for economic growth because some factors
outside the government's control-such as weather,
oil prices, and world interest rates-have turned less
favorable. In addition, Manila has instituted few
economic reforms in recent months and has been
unable to administer successfully some of its earlier
reforms such as the grain price stabilization fund. We
believe that, as a result, the economy will probably
expand at a 3- to 4-percent rate this year, while
inflation and interest rates remain moderate.
According to Philippine Government statistics, the
economy grew 5.5 percent in the first quarter of this
year over the same period in 1986. The data, however,
appear to overstate the upturn. For one thing, the 25X1
economy during the first quarter of 1986 was strug-
gling from the effects of the February revolution.
Thus, growth in the same quarter this year looks
particularly healthy in comparison. In addition, in-
creased government spending on rural infrastructure
projects and campaign spending for this May's na-
tional election probably provided an extra boost to the
economy. Furthermore, recent revisions to the
national economic statistics have lowered the level of
economic output recorded for 1986 and thereby in-
creased the rate of economic growth reported for this
year. 25X1
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Figure 1
Philippines: Economic Indicators, 1981-87
-8198182 83 84 85 86 87a
"Estimated.
Although the Aquino government has made progress
in restoring the economy, much work remains if the
Philippines is to set in place a system of economic
incentives needed to achieve sustained economic
growth and political stability. The magnitude of Man-
ila's task is clear:
? Per capita income has fallen about 15 percent since
1981, coinciding with the rapid growth of the
Communist insurgency.
? More than two-thirds of all rural Philippine families
are at or below the World Bank's poverty level of
$150 per year in income, according to Philippine
academics.
? Philippine Government statistics indicate the per-
centage of the agricultural population without land
has grown from less than 10 percent in 1950 to
almost 35 percent in recent years.
? The country is overborrowed; interest payments of
$1.9 billion on Manila's $28 billion foreign debt
absorbed more than 40 percent of Philippine mer-
chandise export earnings in 1986, while exports
have fallen at an average annual rate of almost 3
percent since 1980.
How quickly and to what extent Manila makes
progress alleviating these problems will be a function
of the Aquino government's economic reform pro-
gram. Liberalization of trade and investment policies,
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Figure 2
The Philippines: Status of Key Economic Reforms
Government moving slowly, implementation will take time.
Little accomplished so far, progress unlikely.
Fiscal Policy Widen tax base, raise efficiency of tax
Tax reform enacted July 1986, policy
collection.
implementation underway.
Privatize government financial and nonfinancial
Committee on Privatization and Assets
corporations.
Privatization Trust created, but moving slowly.
Investor interest in purchasing assets low.
Trade and Investment Lower tariffs, eliminate quantitative
Government continuing liberation begun
Policy restrictions and other nontariff barriers on
under Marcos. Reforms slowed by Trade
imports.
Department and industry.
Encourage foreign investment through tax
Draft code under debate. Finance, Budget
credits, increased incentives, less government
Departments protesting that code continues
intervention.
strong government role. Investors tired of
uncertainty.
Agricultural Policy Dismantle sugar and coconut monopolies.
Combination of Manila's reforms, favorable
international conditions have helped country's
1.4 million coconut farmers.
Eliminate export taxes on all agricultural
products
exce
t lo
s
Agricultural exports register a small gain in
1986
after a 25 percent dro
in 1985
,
p
g
.
,
p
.
Remove impediments to fertilizer imports.
Fertilizer import industry grew from
5 firms in 1984 to 44 firms in 1986.
Prices fell, consumption rose.
Rural Economy Enact land reform program.
Aquino probably will let Congress decide
O
about land reform. If so, progress is unlikely.
Strengthen rural banking system.
Only 25 percent of rural banks sound;
O
budget constraints limit Manila's efforts.
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for example, is designed to attract overseas invest-
ment, increase the competitiveness of Philippine man-
ufacturers, and return the country to export-based
growth. The sale of government-owned corporations
will help ease Manila's budget deficit and free funds
for other government programs, in addition to forcing
the corporations to produce more efficiently. The
success of Manila's agricultural and land reform
programs is especially critical to government efforts to
reduce poverty in the countryside and to counter the
Communist insurgency.
Trade and Investment Policy
Despite stiff opposition from the Department of Trade
and Industry and from protected industries, the gov-
ernment has pushed ahead with its trade liberalization
plan and has continued to carry out commitments
made to the World Bank and the International Mone-
tary Fund (IMF) in 1981 to reform tariff and quota
policies. Longstanding export duties have been re-
moved from all agricultural products except logs. The
elimination of import licensing requirements on over
1,200 products is also continuing. The outstanding
question is the order and pace at which the remaining,
more sensitive products, such as beef and fruit, will be
decontrolled. Although affected industries will try to
delay for as long as possible implementing measures
that would open their products to competition, we
believe Philippine officials will stick to the timetable
for completing the trade program by 30 April 1988.
The Aquino administration has made renewal of
foreign investment a priority, but has not decided on a
comprehensive plan to open up the investment market.
The government has announced measures to attract
overseas business, such as "one-stop" investing to
reduce some of the bureaucratic redtape. A draft
investment code developed by the Department of
Trade and Industry, however, has come under attack
from other government departments, according to the
US Embassy:
? The National Economic and Development Author-
ity (NEDA) and the Departments of Finance and
Budget are upset that the Trade Department's
Board of Investments would retain strong regulatory
powers, including approval rights over potential
investments.
? The Labor Department believes the code's incen-
tives favor capital-intensive rather than labor-inten-
sive investment.
The Trade Department is trying to garner private-
sector support for the code's immediate implementa-
tion. Debates continue, however, and we believe the
issue probably will be left to the new Congress to
decide. Indeed, we believe Congress probably will
take up foreign investment even though Aquino en-
acted the code by executive order before Congress
convened on 27 July 1987. The US Embassy reports
many in the local business community fear that, if the
code is left to the Congress, economic nationalists in
the legislature opposed to the presence of multination-
al corporations in the Philippines would further slow
implementation. In any case, some newly elected
congressmen have said the legislature would review
any executive order on investment and modify it as
appropriate.
Foreign investors recognize the code's defects, such as
the Board of Investments control over investments in
"overcrowded" industries, but they also believe Mani-
la's uncertainty is deterring potential investors, ac-
cording to the Embassy. In our view, however, the
code's implementation probably will not bring an
immediate rush of investment. US and foreign busi-
nessmen have told US officials they remain concerned
about the Communist insurgency, political instability,
labor unrest, electric power shortages, and the lack of
a bilateral investment treaty. As a result, potential
investors apparently have waited for "the other guy"
to invest before committing resources themselves, and
we expect this trend to continue.
Government Finances
Manila has had mixed results in trying to reduce the
twin burden on the budget of an inefficient tax system
and a large group of financially troubled government
corporations. The Cabinet passed a plan to revamp
the Philippine tax system in July 1986, broadening
the tax base, enhancing collection efforts, and making
the system more equitable. Indeed, Philippine Gov-
ernment statistics indicate that domestic-based tax
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believe the government will continue its efforts.
revenues in 1986 rose 10 percent from a year earlier.
Although some measures have yet to be implemented,
Manila has made a good start on tax reform, and we
Manila's financially troubled corporations, however,
remain a problem. For example, the Philippine Na-
tional Bank (PNB) and the Development Bank of the
Philippines (DPB), which represent about one-third of
the Philippine financial system's assets (excluding the
Central Bank), are technically insolvent. In 1986,
government support to these banks alone was about
$850 million, equivalent to almost two-thirds of the
entire budget deficit. Despite the obvious drain, Man-
ila's program to sell 121 corporations owned or con-
trolled by government entities, such as PNB, DPB,
and the National Development Corporation, did not
get under way until late last year, when the "Commit-
tee on Privatization" and the "Assets Privatization
Trust" (APT) were created. The major financial and
nonfinancial public corporations scheduled for sale to
the private sector include:
Petrophil Corporation Philippine National Oil
Corporation (PNOC)
or another entity for sale to the private sector-has
turned over more than $5 billion in nonperforming
assets to the Trust since December 1986. US
Embassy officials say, however, that Manila estimates
it will recover only about $1 billion from these assets.
Given the generally weak balance sheets of these
firms, the APT has found it difficult to attract buyers.
Manila has also run into resistance from some of the
affected corporations. For example, a US bank's
efforts to buy shares of Commercial Bank of Manila,
owned by the Government Service Insurance System
(GSIS), were held up for several months by a GSIS
director who would have lost his vice-chairmanship at
the Philippine bank, according to the US Embassy. In
addition, according to the US Embassy, APT Chair-
man Sycip believes procedural bureaucratic problems
may slow a timely implementation of the privatization
program. To create a greater constituency for divesti-
ture, the government announced this spring that all
proceeds earned by the APT would finance the politi-
cally important Philippine land reform program. But
we believe the tying of the two programs probably will
not overcome the hesitancy of potential buyers.
Land Reform
Aquino made land reform one of the primary issues
while campaigning for the presidency, and her admin-
Philippine Airlines Government Service Insurance istration has often stated that the problem of landless
System (GSIS) farmers is her government's highest priority. During
Commercial Bank of
Manila
GSIS the administration's first year, however, Manila gave
Manila Hotel Corporation GSIS
Pilipinas Bank Philippine National Bank
Associated Bank Development Bank of the
Philippines
Republic Planters Bank Sugar Regulatory Administration
National Steel Corporation National Development Company
(NDC)
Philippine Phosphate NDC
Fertilizer Corporation
(PHILPHOS)
Philippine Association NDC
Smelting and Refining
Corporation (PASAR)
Philippine International NDC
Corporate Bank
The Committee-a Cabinet-level group tasked with
proposing to Aquino which government assets should
be abolished, consolidated, or transferred to the APT
land reform little more than lipservice. Indeed,
Aquino took six months to appoint Heherson Alvarez
to head the Department of Agrarian Reform; he
resigned this spring to run for the Senate, and a
successor has not been named. Manila did not focus
on plans for land reform until early this year, respond-
ing in large part to a bloody confrontation between
farmers and security forces in Manila. In March, the
Cabinet drafted a six-year, $3 billion program to
distribute 5.3 million hectares of land in four phases
to small farmers and landless agricultural workers.
The government has refined the program a number of
times to cut costs and increase coverage, according to
the US Embassy.
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many members of
the Cabinet, including Finance Secretary Ongpin,
want Aquino to use her executive authority and put
the land reform program into place before the Con-
gress convenes, despite a lack of detail on funding,
compensation for landholders, and land valuation.
The US Embassy says Ongpin believes about half of
the current $2.2 billion cost could come from the sale
of nonperforming assets under Manila's privatization
scheme, even though APT Chairman Sycip has told
US officials that the flow of funds from divestiture
will always be "lumpy" and unpredictable. Manila is
also asking for $500 million from its key bilateral and
multilateral aid donors, but the US Embassy reports
that foreign donors are reluctant to directly finance
some parts of the program, such as the costs of land
transfer and compensation. In addition, the World
Bank believes that instead of a four-phase, six-year
approach, Manila should implement all parts of its
program simultaneously and said it would not provide
any financial help if the Philippines enacts the pro-
gram as it stands.
Despite Cabinet pressures, it was increasingly clear
that Aquino could not initiate a complete land reform
program before Congress convened. According to the
US Embassy, government lawyers advised her that an
executive order concerning acreage limits, priority
crops, and other key issues would illegally usurp
congressional powers under the new Constitution. In
addition, any action she took probably would have to
be modest, given the imminent convening of Congress,
and the potential backlash from the landless (who
have high expectations) and small landed farmers
(who are afraid of losing their property). As a result,
the executive order issued covered the country's rice
and corn lands as well as sequestered, foreclosed, and
idle lands, leaving Congress the unenviable task of
dealing with the highly political sugar and coconut
lands, where some of the country's most powerful
interest groups hold sway.
Agricultural Productivity
Despite the uncertainty that remains on land reform,
the Aquino administration's commitment to agricul-
ture remains strong. Manila dismantled the coconut
and sugar monopolies, lifted the ban on- the export of
copra (the raw meat from which coconut oil is
milled), deregulated the fertilizer industry, and abol-
ished export duties on all Philippine agricultural
exports except logs.
Still on the government's announced agenda for agri-
cultural reform are plans to increase the availability
of credit for farmers and to diversify agricultural
production away from rice, corn, and coconuts. Ac-
cording to Philippine Government statistics, these
three crops, which account for 85 percent of harvested
land area, have an average production value only one-
tenth that of crops such as mangoes, pineapple, and
onions. Implementation of credit and diversification
programs has been slow, however, because of inade-
quate funding and budget deficits. In our view, budget
constraints probably will continue to hamper move-
ment on these issues. The Philippine Agriculture
Department, for example, estimates that the demand
for agricultural credit in 1987 will be at least
$3 billion. As of September 1986, however, Manila
had only $300 million available in agricultural loan
funds, and only about $34 million of that total was
controlled by the Agriculture Department. In addi-
tion, the country's extensive rural banking system is
nearly bankrupt, with less than 25 percent of rural
banks being financially sound
A New Environment for Economic Policy Making
Manila's ability to push ahead with its economic plans
will depend in large part, we believe, on the govern-
ment's capacity to work as a team, both within the
Cabinet and between the executive and legislative
branches. Judging from past experience, however, we
expect discord and confusion to be more common than
harmony. The Aquino administration's economic
policy making team has never shown much aptitude
for working together and, in our view, it is unlikely
that this situation will change soon. Indeed, the public
disputes among Finance Secretary Ongpin, Executive
Secretary Arroyo, NEDA Director General Monsod,
and Trade Secretary Concepcion have grown more
acrimonious in recent months. We are particularly
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Secret
Aquino's Economic Team: Esprit de Corps?
Almost from the beginning of its term, the Aquino
administration's economic policy making team has
been wracked by dissension. Differences in philosophy
and personality between Cabinet members have been
aired regularly in the Philippine media and show no
signs of stopping:
? Finance Secretary Ongpin, the leading advocate of
market-oriented policies, and Executive Secretary
Arroyo, who has a nationalist bent, routinely clash
over the direction of Manila's economic reforms.
Ongpin is particularly upset with his rival's delay-
ing tactics in implementing fiscal and tax programs,
even after Cabinet approval, as well as Arroyo's
increasingly imperious manner. Indeed, the US
Embassy reports Arroyo reorganized the Finance
Department without obtaining Ongpin's approval.
? Ongpin and Director General Monsod of the Na-
tional Economic and Development Authority dis-
agree over possible solutions to the country's for-
eign debt problem, with Monsod occasionally
concerned that Arroyo-who has his own, primarily
nationalist, views of government policy and who, fre-
quently obstructs the flow of business to and from the
President-remains in good graces with Aquino and
secure in his position, according to the US Embassy.
In contrast, we believe Ongpin is growing tired of the
Cabinet infighting and may not stay in the govern-
ment, or may be forced out, should the quarreling
continue. If Ongpin leaves, it may signal a turn
toward more nationalist economic policies.
When it convenes, the Congress will be a new vari-
able, and potentially major participant, in economic
policy making. For example, under the new Constitu-
tion, the administration must submit the 1988
national budget to the legislature within 30 days of
convening. Although the Constitution is vague over
the congressional role regarding the foreign debt,
saying only that a report detailing "loans to be
calling for a repudiation of selected foreign loans
and Ongpin opposing such a move because of the
damage it would bring to Manila's relations with
the international banking community. Arroyo also
has publicly lambasted Ongpin over the latter's
handling of the debt negotiations with Manila's
commercial lenders, but he and Monsod are not
allies. In a well publicized incident earlier this
year, Monsod kicked Arroyo in the shin during a
Cabinet meeting because he delayed one of her
policy recommendation papers for several months,
rather than passing it on for Aquino's approval.
? Trade Secretary Concepcion, reflecting the concerns
of many in the Philippine business community, has
tried to slow Monsod's and Ongpin's efforts to
remove Manila's restrictions on imports. On the
other hand, Monsod and Ongpin have criticized the
Trade Department's plans to implement an omni-
bus investment code, claiming Concepcion's depart-
ment would retain strong regulatory powers over
potential investors.
contracted or guaranteed by the government ...
which would have the effect of increasing the foreign
debt" must be submitted to the legislature, we believe
nationalists in the Congress probably will be eager to
get involved in the debt issue and may try to use their
budgetary powers as leverage. Most congressmen will
almost certainly resist meaningful land reform be-
cause they are either major landholders whose inter-
ests are ill served by such a program, or they owe their
election to wealthy landowners, and we doubt much
progress will be made. The legislature probably will
also use the reactions of Aquino and her family to the
possible disposal of their own substantial landholdings
as a gauge for congressional plans.
Using history as a guide, we believe the Congress will
be an obstacle rather than a facilitator of the govern-
ment's economic plans. Although many of the new
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legislators ran on the Aquino-backed slate, the "pro-
government" affiliation probably has little political
relevance because Aquino's coalition was never united
behind a platform. Congressional members also come
to office from widely different backgrounds and with
various agendas. In addition, a number of congress-
men probably will use their office to establish their
own presidential credentials. As a result, we believe
the legislature will be contentious and eager to show
its independence from the executive branch. Even
Aquino's 22-member Senate "team" probably will not
be a rubberstamp for the President's policies. Unless
Aquino and her aides can adapt and engage in
traditional Philippine congressional horsetrading, key
economic initiatives probably will languish.
If the administration can implement its economic
reform program, maintain workable, if not cordial,
relations with the Congress, and benefit from the
international economy, our econometric model indi-
cates that the economy could grow 5 to 6 percent
annually during the period 1988-90. More probably,
however, all the pieces will not fall into place, and
growth over the rest of the decade probably will
average closer to 4 percent. Even this lower rate
probably would help to sustain political stability. For
one thing, rural Filipinos most likely would be the
major beneficiaries of the growth, giving Manila's
efforts to counter the Communist insurgency a boost.
But the growth rate we project during the next few
years will not be strong enough by itself to seriously
undercut the insurgency. Even if economic growth
averages 5 percent a year after 1987, per capita
income levels would not return to their 1981 peak
until 1994. Moreover, economic growth is only one
aspect of the counterinsurgency; progress will be
measured, too, by the extent to which the government
can guarantee justice and security throughout the
country. Indeed, we believe some economic policies,
such as land reform, probably would have a greater
impact on civilian attitudes toward the insurgency
because of their propaganda value than on the
economy itself.
The international economy must be favorable if the
Philippine economy is to have a sustained expansion,
but the good fortune Manila enjoyed in 1986 is
unlikely to last. World economic growth, for example,
will have to be strong enough to allow Philippine
exports to increase. In particular, Philippine commod-
ities exports-which account for approximately 40
percent of total export earnings-almost certainly
cannot afford another precipitate drop in prices such
as occurred in the early 1980s. Global interest rates
must also remain moderate.
a per-
centage-point increase in world interest rates adds
about $130 million to Manila's annual debt service.
Moreover, international oil prices will have to stay
relatively soft to avoid bloating the Philippines' fuel
import bill.
Implications for the United States
No matter how the economy fares over the next
several years, we believe Manila will continue to press
Washington for additional financial assistance for
both budgetary support and development projects.
Moreover, it is probable that aid discussions will
become contentious at times, primarily because of the
Philippines' unrealistic expectations of large amounts
of aid from the United States. In our judgment, many
members of the Aquino government believe Manila
deserves special treatment from Washington because
of the country's special relationship with the United
States, the presence of US military facilities, and the
Philippines' attempt to restore democracy.
In addition, Manila may well use the prospect of
contentious renegotiations of the Military Bases
Agreement as leverage to try to obtain more aid. The
agreement calls for a review every five years-with
preliminary discussions of the next review likely to
begin later this year-and is subject to termination
with one year's notice in 1991. For example, Presiden-
tial Press Secretary Benigno hinted at a news confer-
ence in April that Manila would take a potential US
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Congressional rejection of $50 million in supplemen-
tary military aid to the Philippines in 1987 into
account when it prepares its negotiating position for
the coming talks.
Besides financial aid, we believe the Aquino govern-
ment will try to engage US help on other bilateral
economic issues. Manila has expressed disappoint-
ment with the limited increase in the Philippine share
of US quotas on textile and sugar imports for this
year, believing Washington should have treated the
Philippines more favorably because of Manila's ef-
forts to reform the economy. In addition, Philippine
officials, concerned over possible protectionist trade
legislation, told a visiting US Congressional delega-
tion early this year that they hoped Washington
would give Manila exceptional trade concessions simi-
lar to those granted under the Caribbean Basin
Initiative, such as duty-free access to US markets.
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Appendix
Treating the Debt Hangover
Patient History
Underlying Manila's attempts to restore long-term
economic stability is the country's $28 billion (and
still growing) foreign debt, which was brought about
largely by the Marcos government's high-investment
growth strategy of the 1970s and early 1980s. Gov-
ernment guarantees to private Philippine borrowers
linked to the Marcos administration and Manila's
support for an overvalued peso-which artificially
cheapened imports-spurred a spending spree and
increased the debt tenfold during the period 1970-84.
In the early 1980s the borrowing binge was aggravat-
ed by rising global interest rates, lower prices for
Philippine commodity exports, and the 1981-82
worldwide recession. Under Marcos's austere 1983
economic program, tight fiscal policies cut govern-
ment spending, while restrictive monetary policies
brought about higher domestic interest rates. The
cumulative impact fell mostly on investment; from
1983 to 1986, domestic investment decreased almost
20 percent annually. Foreign investment also fled the
country as the political situation deteriorated.
Manila will need $1.5 billion in
new loans by the middle of 1988, or maybe even as
early as the end of 1987, and up to $7 billion between
1988 and 1992 to meet debt service obligations. A
recent Philippine National Economic and Develop-
ment Authority study forecasts an external financing
gap of $6.6 billion in 1987-92, according to the US
Embassy. The study stresses that failure to fill this
gap may keep Manila from achieving its development
targets, and calls for new money commitments from
the Philippines' commercial creditors.
Possible Remedies
Rescheduling. Manila's traditional solution has been
to reschedule its repayments when financial crunches
are imminent. Manila calculates that its recent agree-
ment with commercial creditors will save almost $2
billion over the 17-year life of the agreement as well
as postpone over $9 billion in principal amoritizations
during the seven-and-a-half-year grace period. On the
other hand, Manila recognizes that renegotiations
merely put off the inevitable and that sustained
economic growth is the only lasting solution to the
Symptoms
Despite the recent $10.3 billion rescheduling agree-
ment reached with its commercial creditors, which
lowered the interest rate on the commercial loans and
put off principal repayments for seven and a half
years, Manila continues to suffer the impact of its
enormous foreign debt.
We estimate that interest payments in 1987 will equal
about $1.8 billion, or almost 40 percent of merchan-
dise exports, and probably will exceed $1.5 billion
annually in 1988-90. By pinching the resources avail-
able for investment, consumption, and government
spending, this annual debt service burden threatens to
draw the Philippines into a vicious cycle: low eco-
nomic growth leading to budgetary gaps that can only
be filled by new loans that raise the debt servicing
obligations, further inhibiting growth.
debt crisis.
Economic Growth. If the economy could sustain a
high growth rate into the next decade, additional debt
might not be necessary. In fact, a moderate increase
in foreign debt might even be desirable if it ensures
growth. According to our model of the Philippine
economy, an economic expansion of as much as 5 to 6
percent annually in 1987-90-compared to our base-
line estimate of 3 to 4 percent-would gradually
reduce Manila's debt-to-GNP ratio from 85 to about
70 percent.
Export Growth. Although many Philippine-manufac-
tured exports have a high import content-75 percent
in electronics and over 50 percent in clothing, for
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Econometric Model of the Philippines
To analyze the impact on the Philippine economy of
external changes as well as Manila's ability to tailor
economic policies to its political needs, we have
extensively overhauled our econometric simulation
model in recent months.
Recent improvements include:
? Refining the data base from updated National
Income Accounts through the end of 1986 and
improving the price deflators used to adjust for
inflation.
? Refining the behavioral equations to markedly
improve the model's predictive ability.
? Reestimating all the behavioral equations using the
new data.
example-our model indicates a robust 10-percent
annual increase in exports over the rest of the decade
would easily outpace import growth, keeping the
current account in surplus. Short-term debt probably
would rise along with the higher imports, but Manila
would still be able to pay its annual obligations.
Nonetheless, we do not believe exports will grow quite
this fast, in large measure because of the mediocre
global outlook for commodities exports, which ac-
count for about 40 percent of Philippine exports.
Foreign Investment. Constrained from boosting public
investment because of the lack of money, the Aquino
administration has counted on a resurgence of foreign
investment to fuel growth. To attract overseas inves-
tors and reduce its debt burden, Manila is using both
traditional and new financial instruments. Debt-for-
equity swaps allow investors to purchase Philippine
debt from commercial creditors or financial institu-
tions at a discount. The investor can then redeem the
Even with these improvements, however, the model
contains several weaknesses, requiring additional
analysis outside the framework of the model to
simulate outcomes:
? Because of a lack of data, the model's ability to
predict the impact of a policy change on the mone-
tary sector is weak. For example, the increased
dollar inflow from a rise in exports probably will
not be reflected fully in the money supply, under-
stating the inflation rate as a result.
? The model does not explicitly track individual
sectors of the economy, such as agriculture, indus-
try, mining, or services. It does not, for example,
simulate how the output of an agricultural crop
would respond to changes in agricultural prices.
or political uncertainty.
? The model does not easily simulate the economic
effects of such factors as the Communist insurgency
debt at the Central Bank for pesos for conversion into
equity in Philippine projects. In this way, debt is
extinguished and new investment flows into the coun-
try. According to recent Philippine Government data,
more than $350 million in debt-for-equity conversion
applications had been filed with the Central Bank
through mid-May 1987. Although Manila has ap-
proved less than $95 million in swaps so far, bankers
estimate $200-500 million may be converted by the
end of 1987.
Under Manila's recent debt rescheduling agreement
with its commercial creditors, the banks have the
option of converting some of their interest receipts
into Philippine Investment Notes (PINs). Those banks
purchasing the six-year, dollar-denominated PINs-
sold at about 90 percent of their face value-may
hold the note to maturity and receive full value, trade
25X1
25X1
25X1
25X1
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it in secondary markets, or redeem it for pesos before
maturity and use the proceeds to invest under Mani-
la's debt-for-equity program. The government hopes
the innovative plan will conserve up to $50 million a
year in foreign exchange as well as attract new
investment. The plan's success, however, is not en-
sured. For one thing, the small amount of trading in
other Third World debt instruments suggests that the
necessary resale market may not develop
foreign investment regulations.
Even if Manila's debt-to-equity and PINs programs
are successful in attracting new investors, we believe
they will not be enough to solve the government's debt
woes. In our view, foreign investment would have to
increase at unrealistic rates to have much of an
impact on the debt. For example, an annual
25-percent increase in foreign direct investment in
1987-90 probably would add less than 0.5 percentage
point to annual economic growth, according to our
model. A 50-percent boost in foreign investment, on
the other hand, would add 1.5 to 2 percentage points
to our baseline growth figures, beginning in 1988. We
believe such rapid growth of investment is unlikely,
however, given political uncertainty as well as the
government's continuing problems with liberalizing its
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