US embassy cable - 05MANILA4109

UNCLAS SECTION 01 OF 05 MANILA 004109 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EB/IFD/OMA, EB/ESC 
STATE PASS EXIM, OPIC AND USTR 
STATE PASS USAID FOR AA/ANE AND AA/G 
STATE PASS USTR FOR BWEISEL AND DKATZ 
DOE FOR TOM CUTLER 
TREASURY FOR OASIA 
USDOC FOR 4430/ITA/MCA/ASIA & PAC/KOREA & SE ASIA/ASEAN 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ENRG, PREL, EINV, RP 
SUBJECT: CHARGE CALLS ON KEY GRP FINANCIAL OFFICIALS 
 
Sensitive but Unclassified -- Not for Internet -- Protect 
Accordingly 
 
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Summary 
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1.  (SBU)  In separate meetings with the Charge, both Central 
Bank Governor Tetangco and the Finance Secretary Teves 
described what they see as good prospects for steady economic 
growth, financial stability, and continued progress on fiscal 
reforms.  Tetangco, in particular, downplayed recent 
"political noise" and attributed any weakness in the peso 
almost exclusively to uncertainty over the Supreme Court's 
ruling, expected soon, on the expanded VAT.  Both Tetangco 
and Teves expressed confidence that the expanded VAT would 
meet with court approval.  Teves said he was very pleased 
that the Philippines could become a Millennium Challenge 
Account (MCA) Threshold Country.  Tetangco and Teves stated 
their strong commitments to fiscal reform and anti-corruption 
efforts.  Tetangco underscored his commitment to maintain 
progress on anti money-laundering, especially as a recent 
Egmont Group member.  These two key financial officials will 
be in New York in mid-September when President Arroyo is at 
the UNGA meetings, and both will be meeting with members of 
the financial community to try to boost confidence in the 
Philippine economy.  Teves is intensely focused on fiscal 
reforms, especially improving revenue collection, and less on 
"business climate" issues outside of the DOF's immediate 
territory.  End Summary. 
 
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Participants 
------------ 
 
2.  (U) -- U.S. Participants at Central Bank and DOF 
Meetings: The Charge, USAID Director Jon Lindborg and 
Economic Counselor Robert Ludan. 
-- GRP participants at Central Bank: Governor Amando "Sy" 
Tetangco and Deputy Governor Diwa Guinigando. 
-- GRP participants at DOF: Finance Secretary Margarita 
"Gary" Teves and Deputy Secretary Roberto Tan. 
 
--------------------------------------------- ---------- 
Central Bank Governor Sees 5 Percent GDP Growth in 2005 
--------------------------------------------- ---------- 
 
3. (SBU) In the Charge's August 25 call, Amando Tetangco, 
recently appointed Governor of the Bangko Sentral ng 
Pilipinas (BSP), noted that the overall macroeconomic numbers 
looked good.  GDP growth in the first quarter was 4.6 percent 
and the still unannounced figure for the second quarter 
appeared to be about the same.  Surging oil prices had the 
effect of reducing initial 2005 growth estimates to the lower 
end of the forecast range (5.3 percent - 6.3 percent), but 
growth of about 5 percent for the entire year would be 
"respectable" in view of oil prices, according to Tetangco. 
The balance of payments situation for the first half of 2005 
was in surplus by about $1.9 billion due to stronger than 
expected remittance inflows, up 21.5 percent in the first 
half, though initially projected to grow by only 10 percent. 
The $10 billion in remittances in 2005, compared to $8.5 
billion in 2004, would offset the higher cost of oil on the 
balance of payments.  Tetangco explained that the market 
response to higher oil prices was much quicker than expected 
and demand had already declined.  The GRP has already funded 
the National Power Corporation (NPC) through the end of the 
year so the current account surplus was set to increase. 
Barring an "accident," Tetangco predicted the current 
account, at year's end, would remain in surplus by $850 
million, which would be higher than initial forecasts. 
 
4. (SBU) Turning to exchange rates, Tetangco noted that BSP 
reserves were $17.7 billion and that the peso, trading at 
about 56 pesos/dollar that day, would be slightly stronger, 
perhaps about 54 pesos/dollar, if it were not for current 
political uncertainties.  He noted that the peso had traded 
at 53 pesos/dollar on July 1 prior to the temporary 
restraining order and Supreme Court review, which froze 
implementation of the expanded VAT.  The pending Supreme 
Court decision on the VAT, however, was a much more important 
factor than the recent "political noise," which the markets 
tended to ignore, according to Tetangco.   Markets and the 
BSP now expect a favorable decision on the expanded VAT and 
slight strengthening of the peso. If the Supreme Court 
decision strikes down the expanded VAT, Tetangco admitted 
that markets would react negatively and that the GRP and the 
BSP would have to redirect their attention to stimulate 
stronger economic demand and growth. 
 
5. (SBU) Tetangco said that the BSP does not target a 
specific exchange rate for the peso.  The peso trades within 
a range of values against the dollar.  The BSP, however, 
would work to counteract "sustained unidirectional movement" 
in the currency.  "We want orderly exchange rate adjustment," 
he said.  The foreign exchange rate should be "basically 
market-determined."  "We do not want volatility."  He 
insisted that the BSP had not engaged in large scale 
intervention to prop up the currency during the recent 
political turbulence and commented that there had been no 
such need.  He pointed out that central bank reserves were at 
an all time high, $17.7 billion, indicative of 
non-intervention. 
 
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Banking Sector Reforms 
---------------------- 
 
6. (SBU) BSP has continued to work with the commercial banks 
to clear out bad assets and reduce nonperforming loans.  The 
BSP plans to strengthen the capital position of the banks to 
ensure that they move to Basel II standards by 2007.  The BSP 
is working with the Congress on legislation that would amend 
the BSP charter and, separately, upgrade the availability and 
quality of credit information for the banking system.  Under 
current conditions, the lack of reliable credit information 
penalizes creditworthy borrowers.  The BSP is also seeking 
legislation that would update the legal framework for 
bankruptcy cases.  The current bankruptcy law dates back 
about one-hundred years to the early 20th Century and, he 
said, overprotects large creditors and borrowers.  Other 
needed legislation includes pension fund reforms that would 
encourage higher savings rates. 
 
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Nonperforming loans 
-------------------- 
 
7.  (U) The NPL situation has improved significantly over the 
last year, with BSP data indicating a peak of 18.2 percent of 
credit assets in the NPL category in October 2001 but a 
current level of 9.2 percent.  The goal is to reduce the 
level to 5 percent, where it was prior to the Asian financial 
crisis.  Removing an additional 100 billion pesos in NPLs in 
the coming year would reduce the rate to 7 percent.  Housing 
loans are beginning to support new construction and overseas 
foreign workers (OFWs) and other overseas Filipinos have 
recently shown strong interest in the housing market, though 
still on a small scale. 
 
8.  (U) Capitalization is generally high in the banking 
system, but certain banks are weak, according to Tetangco. 
The BSP is encouraging mergers among the banks, and the broad 
goal is to have fewer but bigger banks.  At present, 42 
domestic and foreign commercial banks operate in the 
Philippines, of which about 20 are foreign (including 
Citibank, JP Morgan Chase, and Bank of America).  Only ten of 
the banks are authorized to operate branches.  Citibank and 
HSBC have acquired savings banks here to enter the retail 
banking market. 
 
9.  (U) Tetangco asked if it might be possible to establish 
remittance centers in the United States to facilitate such 
flows to the Philippines.  The BSP is seeking ways to reduce 
the transfer fees for remittances.  The Charge replied that 
each state may have different rules with respect to 
capitalization requirements and other standards for such 
enterprises and that such centers would have to consider the 
rules in each state.  Deputy Governor Guinigando explained 
that the average remittance transfer is about $400 and that 
the average fee is 3-4 percent of the amount transferred. 
Singapore appears to be the most efficient at a cost of 1.4 
percent, with average transfers of about $200, while Italy is 
the most expensive at 5 percent. 
 
------------------------------------ 
Commitments on Anti Money-Laundering 
------------------------------------ 
 
10.  (SBU) The Charge noted that a weak banking system could 
encourage money laundering.  Tetangco confirmed that the BSP, 
as it works on financial sector reforms, is determined to 
continue to strengthen its Anti-Money Laundering Council 
(AMLC) and that AMLC is strongly committed to its work.  He 
thanked the Charge for USG recognition of the Philippines' 
progress on anti-money laundering and support on its Egmont 
membership.  Deputy Governor Guinigando noted that AMLC has 
recently closed some accounts in Philippine banks because of 
suspicious transactions originating in the U.S. that proved 
to be innocent.  He added that even when the suspicions are 
cleared, those Philippine banks encounter difficulties with 
future transfers from the U.S. to the Philippines.  The 
Charge offered to try to help if the BSP can provide 
specifics, which Guinigando said he would do. 
 
-------------------------------------------- 
Back Taxes Owed on Foreign Currency Accounts 
-------------------------------------------- 
 
11.  (SBU) Tetangco expressed the hope that the Bureau of 
Internal Revenue (BIR) would favorably interpret the law to 
allow tax exemptions for the foreign currency deposit units 
(FDCU) of the banks for the period 1997-2003.  He said that 
he believed the authors of the 1997 comprehensive tax reform 
law did not intend to eliminate tax exemptions for FCDUs 
during the period in question.  Tetangco stated that the 
Congress needed to clarify the intent of the legislators in 
1997.  The Charge stated that progress on this issue would 
help to improve investor confidence in the regulatory 
environment and in the consistency of tax laws. 
 
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Tax Evasion 
----------- 
 
12.  (SBU) Tetangco said that he expected Finance Secretary 
Teves would give strong support to programs in the BIR and 
the Bureau of Customs (BOC) to fight tax evasion and 
corruption.  He said that efforts by the Finance Department, 
though critical, were not sufficient and that the GRP needs 
more consistent follow up action from the judicial sector. 
When authorities identify tax evaders or corrupt officials, 
the public needs to see prompt prosecutions and resolutions 
of these cases, he noted.  Without that sense of finality, 
the GRP cannot create the deterrent effect so critical to 
changing current patterns, he admitted. 
 
--------------------------------------------- --- 
Finance Secretary Teves Focused on Fiscal Reform 
--------------------------------------------- --- 
 
13.  (SBU) In the Charge's August 25 introductory call, Teves 
underscored that his long-term objective was to ensure a 
balanced budget by 2008 and that the expanded VAT would help 
significantly.  He hoped that a favorable Supreme Court 
decision on the VAT's constitutionality would permit 
implementation by the first or second week of September. 
(Note: Supreme Court decided this case on September 1. 
Septel reports details.  End note.)  The delay since early 
July has already cost about 10 billion pesos in lost 
revenues.  Although revenues from the expanded VAT are not 
included in the estimated 280 billion peso deficit for 2005, 
the best case scenario would now result in the expanded VAT 
reducing the deficit by 17.5 billion pesos for the remainder 
of this year.  The decision to reduce petroleum duties (from 
5 percent to 3 percent) would be 2 billion pesos less in 
revenue intake per month, so the net effect of the expanded 
VAT and petroleum tax reduction would be an additional 11 
billion pesos in 2005 revenues, according to Teves's 
back-of-the-envelope calculation.  He underscored that the 
key to maintaining progress would be the performance of the 
BIR and BOC, under his management. 
 
14.  (U) Teves estimated that government spending declined by 
32 billion pesos ($580 million) in 2005, and, with 
implementation of the expanded VAT, the deficit in 2005 would 
be about 180 billion pesos ($2.7 billion).  If oil prices 
stay within the $65-70 bbl. range, the GDP growth forecast 
would be in the range of 5.0 - 5.3 percent, with higher 
growth associated with lower oil prices. 
 
15.  (U) Teves said he saw no need for new taxes in 2006.  He 
wants to focus on the sale of government assets, improved tax 
collection, and better monitoring of performance in the 
government owned and controlled corporations (GOCCs).  The 
government's recent divestiture of shares in the Philippine 
National Bank, he said, would send a strong signal to 
investors that the GRP wants to sell off more of the GOCCs. 
Echoing Tetangco's sentiments, he said that commercial banks 
need to consolidate and merge and that, with greater 
financial sector stability, risk premiums might be reduced. 
 
---------------------------------- 
Millennium Challenge Account (MCA) 
---------------------------------- 
 
16.  (SBU) The Charge informally notified Teves that the 
Millennium Challenge Corporation had approved the GRP's 
concept paper for the MCA Threshold Country Program.  We 
would receive official notification soon.  USAID Director 
added that the Philppines would now become eligible to submit 
a Threshold Country Plan for a possible initial grant to 
support fiscal reforms and anti-corruption programs designed 
to boost revenue capacity and other activities outlined in 
the GRP's concept paper submitted in June.  Teves was very 
pleased that the Philippines could become an MCA Threshold 
Country and introduced Deputy Finance Secretary Roberto Tan 
as the GRP lead on MCA.  Teves said he planned to meet with 
MCC officials when he is in Washington in September for the 
World Bank/IMF meetings.  Teves underscored his government's 
commitments to fiscal reform and anti-corruption efforts. 
 
--------------------- 
Attracting Investment 
--------------------- 
 
17.  (SBU) Teves interpreted the approximately 10 percent 
increase in the Manila stock market since the beginning of 
the year as a sign of investor confidence.  Net portfolio 
capital inflows have reached about $1.9 billion this year. 
However, he acknowledged that money moving in quickly can 
just as quickly move out and that foreign direct investment 
has hardly grown this year.  He blamed low levels of 
infrastructure investment and continued fiscal weakness for 
the lackluster FDI record.  Although remittance flows are 
very important, he said, the GRP needs to create more 
opportunities to channel OFW remittances into investment. 
Remittances do provide foreign exchange and funds to rural 
areas especially, but mostly for consumption, he added. 
 
18.  (SBU) Teves cited his priority legislative initiatives 
in Congress: a new securitization law that would further 
clarify legal protections for lenders and facilitate 
investment as well as legislation on insurance, capital 
markets, and pension funds.  He said he would wait for a lull 
in Congress and then try to move quickly on legislation.  He 
acknowledged that a number of recent Supreme Court and other 
court rulings had created difficulties for foreign direct 
investors but claimed that the Finance Department was unable 
to influence those situations.  The Supreme Court ruling that 
the Clark Economic Zone's tax incentives were 
unconstitutional has affected 350 investors there, including 
firms from the United States, EU, and Japan, but this was a 
matter for the courts, he insisted.  Teves also showed little 
interest in other ways to improve the business climate such 
as stronger IPR protection.  He said that he would remain 
focused on fiscal reforms, especially improving revenue 
collection, and not on areas outside the direct authority of 
the Finance Department.  The Charge commented that improving 
the business climate would reinforce investment inflows and 
that the MCA Threshold program could be especially useful in 
backstopping GRP efforts to improve the capacity of its 
revenue agencies. 
 
--------------------------------------------- - 
Visit to New York to Boost Investor Confidence 
--------------------------------------------- - 
 
19.  (SBU) Tetangco and Teves plan to visit New York in 
mid-September with President Arroyo when she attends the UNGA 
meetings.  They will meet with members of the financial 
community in New York, where the Philippines will probably 
soon try to raise additional funds through the sale of 
dollar-denominated government bonds.  They want to update 
potential investors, including those in the bond market, on 
Philippine economic developments and to confirm GRP 
commitments to fiscal reform.  They will also travel to 
Washington for World Bank/IMF meetings on September 24-25. 
Except for Teves's meeting with MCC officials, they have not 
made requests yet for meetings with USG officials. 
 
 
 
 
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