THE PHILIPPINE ECONOMY: OUTLOOK AND KEY ISSUES

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000606300003-3
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 6
• Document Creation Date: December 22, 2016
• Document Release Date: April 4, 2011
• Sequence Number: 3
• Publication Date: August 29, 1986
• Content Type: MEMO

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I I
Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
29 August 1986
The Philippine Economy: Outlook and Key Issues
Summary
Having come to power in the wake of the worst peacetime
recession in recent Philippine history, Aquino political success will in large
part depend on improving living standards, which have sunk by 15 percent
since 1981. Nonetheless, there are no easy methods for repairing the
economy. Under these circumstances, we believe that Manila will continue
to emphasize its need for more aid from the United States and other
foreign donors and avoid politically unpalatable economic policies, such as
devaluation.
Investment is critical to the economic outlook. In our view,
maintaining business confidence and encouraging foreign investment
require keeping a lid on labor militancy, setting policies that provide
even-handed treatment of the private sector and foreign investors, and
demonstrating political stability. Our econometric analysis shows that, if
Aquino can manage investment-related issues, the economy can grow by
more than 2 percent this year and by as much as 7 percent next year.
This memorandum was prepared by I Office of East Asian Analysis.
Information available as of 29 August 1986 was used in its preparation. Comments and
queries are welcome and may be directed to the Chief, Islands Branch, Southeast Asia
Division, OEA
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Sustaining a recovery beyond 1987, however, will require wide-ranging economic
reforms that increase agricultural productivity, improve international competitiveness,
narrow the budget deficit, and rescue the failing banking system. Achieving these
objectives demands considerable political leadership, since each would adversely affect
key interest groups in the short run.
Economy Holds Promise in the Near Term
President Aquino comes to power at an opportune time in the Philippine business
cycle--the two-year recession bottomed out late last year. If investor confidence firms,
the economy could grow by 2.6 percent this year, according to our econometric
simulations; we estimate that GNP grew by 2 percent in the first guarter of this year.
Moreover, with favorable external economic conditions, national output could bounce
back by nearly 7 percent next year.
? Key economic indicators have been positive since the "February revolution". The
small local stock market is up over 60 percent, foreign exchange reserves have
grown by 80 percent to $1.6 billion, and inflation has been stopped--in June,
consumer prices fell at a 10-percent annual rate. Moreover, our index of leading
economic indicators suggests that an upturn in the economy is under way.
? Foreign exchange inflows will be sufficient to meet debt servicing and import
requirements. Aid donors have pledged to deliver over $750 million in financial
assistance this year, agreement is near on a new $500 million IMF program, and,
in our judgment, negotiations with foreign commercial banks later this year will
result in a rescheduling of debt payments due between 1987 and 1991.
According to US Embassy reporting, Aquino's economic advisers believe that an
economic recovery can begin only with increased government, spending and that it must
subsequently be sustained by a reinvigorated private sector. A growth-oriented strategy
for government spending means that Manila will run large budget deficits this
year--equal to nearly 5 percent of national output--and increase the money supply by
as much as 15 percent. Manila's foreign creditors, including the IMF and commercial
banks, worry that such a policy course would reignite inflation and undermine the
improved foreign payments position of the government. According to Budget Minister
Romulo, however, the Philippines can no longer afford the social fallout of poor
economic performance.
One bright spot is the performance of the agricultural economy. According to
Philippine Government data, agricultural output in the first quarter of this year was 2.5
percent higher than in the same period in 1985, while the output of industry and
services fell by 3 percent. Production of rice and corn--the two crops most commonly
grown--increased by 8 and 13 percent, respectively, aided by good weather and
government credit programs. The sector's only production decline was registered by
sugar, where output dropped 10 percent in response to record low prices on the world
market. Although agriculture's current gains are modest compared with the 5-percent
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annual growth rates achieved a decade ago, they have helped many Filipinos adjust to
widespread unemployment in urban areas.
But Many Serious Problems Remain
A long-term economic recovery is not ensured. Consumers, small businessmen,
and organized labor are likely to resist tax reforms, trade and foreign investment
liberalization, a floating exchange rate, and revamping government financial institutions.
Furthermore, Manila's economic planners cannot count on sustaining growth with
exports; commodity prices this year are at historically low levels, and most economists
expect little improvement for at least the next few years.
Another constraint to economic growth is that the Philippines is
overborrowed--servicing its $27 billion foreign debt absorbs nearly 40 percent of export
earnings. Moreover, despite a recent buildup of its foreign exchange reserves to levels
equal to four months of import requirements, Manila's dependence on
balance-of-payments loans from the IMF and a rescheduling its foreign exchange gap
will continue.
In our judgment, the Philippines has three critical economic problems that must
be addressed by government policymakers in the near term--stimulating investment,
restraining labor militancy, and improving the economy's international competitiveness.
Stimulating Investment. In our judgment, the prospects for economic recovery
depend crucially on increasing private-sector investments, especially by local
businessmen. Manila will find it difficult to use more traditional methods of export
growth or expansionary fiscal and monetary policy to prime the economy. The IMF, for
example, has set budget and money ceilings for Manila. As long as businessmen believe
that Aquino's government is biased against the private sector, encourages radical leftist
unions, is ambivalent toward foreign investments, and lacks long-term direction,
investment outlays are likely to remain low.
Lessons from other Asian nations--including South Korea, Singapore, and
Malaysia--suggest that taking advantage of global economic trends requires an
economic and political environment that attracts the private sector--both domestic and
foreign.
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? Public-and private-sector investment--which totaled more than $5 billion last
year--is essential to reviving the industrial sector, improving agricultural
productivity, and generating new jobs. Gross investments have taken a nosedive
in recent years, dropping from 29 percent of national output in 1980 to 14
percent last year, according to Philippine Government data. Aquino is
increasingly impatient with the wait-and-see attitude of local investors and has
said so publicly. Investments during the first five months of this year are little
more than half the level achieved during the same period last year and, by all
indications, have not picked up since the business-supported revolution that
swept Aquino to power. Moreover, according to US Embassy reporting, the small
but influential Chinese business community is postponing business spending until
the country's political and economic prospects improve.
Philippines.
investment outlays, in part because of the low level of confidence in the
government exhibited by the Philippine business community. Foreign corporate
investments since January are running at half of last year's rate. The $125
million in foreign capital inflows last year--concentrated in export-oriented
industries-- contributed only 2 percent to the investments made in the
overseas businessmen also are postponing
government to impose sweeping limitations on foreign investment.
Aquino's government appears to be indifferent to foreign investment. For
example, the government's draft five-year plan suggests that foreign investment
will be channelled into sectors where domestic investment is inadequate and
denied entry into other sectors. In addition, nationalists are pressuring the Aquino
Restraining Labor Militancy. Philippine businessmen report that labor militancy
is largely responsible for the poor investment outlook. In particular, businessmen are
concerned with Labor Minister Sanchez's sympathy for leftist unions and his support of
policies, such as radical profit-sharing plans, that they believe encourage
labor-managment strife. More than 330 strikes during the first half of this year--60
percent higher than in the same period in 1985--involved over 90,000 workers.
According to press reports, there is widespread criticism in the business community that
the Ministry of Labor is helpless in preventing strikes.
The leftist KMU (Kilusang Mayo Uno) labor alliance is widely held responsible for
the increased labor militancy. Believed by many observers to receive policy guidance
from Communist front groups, the KMU advocates a struggle against the Philippine
military, elites, multinationals, and the US Government.
Improving International Competitiveness. In our judgment, most Philippine
manufacturing firms are uncompetitive in world markets because of tariff and nontariff
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barriers to both imports and exports. As a consequence, the growth of manufactured
Philippine exports has been the lowest among developing countries in East Asia over the
last several years. Moreover, the nature of world trade is changing because of weaker
world demand for exports from developing countries, more emphasis on manufactured
products, greater protectionism, and more trade competition among countries. Although
Manila is taking steps to lift import restrictions and tariffs that have protected inefficient
domestic manufacturers, local businessmen are likely to mount a stiff resistance to
sweeping trade liberalization and, in our judgment, end up diluting the benefits of such
policies. Agricultural products and raw materials account for about one-third of total
exports. Because of our projected decline in US demand for such products, however,
the Philippines cannot continue to rely on its traditional commodity exports to the
United States, such as coconut oil, sugar, and forest products, as a major source of
foreign exchange.
The developing countries that have been successful in registering steady
economic growth have all adopted an export-oriented development strategy. The typical
package of outward looking growth policies includes an exchange-rate policy geared to
making exports more competitive; a fairly tight monetary and fiscal policy to control
inflation, favor production for exports, and strengthen export competitiveniness; and
some measures to promote private and foreign investment.
Policy Options for a Rural-Based Economic Recovery
Despite these gains in agricultural production, rural incomes have been depressed
by rapid population growth and corrupt marketing monopolies. In our judgment,
increasing the standard of living in the countryside--where 70 percent of the population
resides and which contributes over a quarter of the national output-- and combating
propaganda gains by the Communist insurgents require, among other things, agricultural
growth rates in excess of four percent annually.
Accordingly, President Aquino's economic advisers are weighing a commitment to
rural development as the cornerstone of the government's program for economic
recovery. They realize that declining support for the Marcos government and the rapid
escalation of the Communist insurgency after 1981 coincided with the rural economy's
sharp decline.
One reason to adopt a rural strategy is that traditional development programs will
not significantly improve the living standards of the average Filipino.
Import-substitution policies of the Marcos government, for example, left large segments
of the manufacturing economy plagued by high costs, discouraged agricultural export
production, and created few industrial jobs. Moreover, Aquino's economic planners
cannot count on sustaining growth by exporting unprocessed agricultural commodities
or manufactured goods; commodity prices this year are at their lowest levels relative to
those of manufactures since the 1930s, and most economists expect little improvement
for at least the next few years. Furthermore, the low cost of Philippine labor is no
longer sufficient to ensure the competitiveness of manufactured goods because, for over
a decade, new production technologies have lowered labor's contribution to total
manufacturing costs.
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Alternatively, by boosting rural output and incomes through improved rural
infrastructure, agricultural extension services, and appropriate pricing policies, we believe
the Philippines could develop an internal market capable of sustaining economic growth.
A necessary component of this strategy would be an exchange-rate depreciation that
directly raises incomes for rural exporters and makes it profitable to invest in
agribusiness enterprises. We believe the peso's nearly 50-percent devaluation since
late 1983, for example, helped boost agricultural output by nearly 5 percent during
1984-85--despite a 10-percent decline in the economy's overall production.
Aquino's government faces numerous political hurdles in carrying out a rural
development strategy. Urban interest groups--which were responsible for ousting
Marcos--are likely to oppose exchange rate, tariff, pricing, and tax policies designed to
encourage agricultural production and boost rural incomes if they believe those policies
will hurt urban industries or raise consumer prices. Furthermore, Aquino's economic
team--comprising businessmen, bankers, and academics with little experience in
small-scale agriculture--may not be sufficiently committed to rural development to
overcome lobbying by urban interest groups. Complicating the picture is the time it
takes for rural development to succeed under even the best of circumstances, and
Aquino has said publicly that she has to deliver tangible benefits quickly in the
countryside.
Manila's projected large budget deficit this year--probably more than 4 percent
of national output--will also restrict the scope of the government's rural development
effort. A high-impact rural development program requires large outlays for roads,
post-harvest food storage, irrigation, and a revitalized agricultural extension service. In
addition, improving farmers' welfare will require a costly effort to coordinate disparate
civilian and military counterinsurgency programs.
As a consequence of Manila's budget constraints, financial aid is likely to become
a contentious and troublesome issue between Manila and its aid donors. We believe
that Manila may come to the view the Military Bases Agreement as the key source for
the funding it believes is needed to finance its rural development strategy.
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