US embassy cable - 05MANILA4600

UNCLAS SECTION 01 OF 03 MANILA 004600 
 
SIPDIS 
 
STATE FOR EAP/PMBS, EAP/EP, EB/IFD, EB/TPP/BTA/ANA 
STATE PASS USTR FOR BWEISEL, DKATZ, JMURPHY 
STATE PASS USAID AND OPIC 
STATE PASS USDA/FAS FOR SHEIKH 
TREASURY FOR OASIA FOR AJEWELL 
USDOJ FOR MCRAWFORD 
USDOC FOR 4430/ITA/MAC/DBISBEE 
 
E.O. 12958: N/A 
TAGS: ETRD, EINV, PREL, ECON, RP 
SUBJECT: SLUGGISH GROWTH IN ELECTRONICS HIGHLIGHTS POWER AND 
LABOR ISSUES 
 
REF: MANILA 02304 
 
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SUMMARY 
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1. Philippine semiconductor and electronics exports, 70% of 
total exports, are growing slightly in 2005 despite the 
closure of a major Toshiba laptop factory in late 2004. 
Growth in semiconductor exports offset a decline in other 
electronics categories caused by Toshiba's departure.  The 
industry remains highly dependent on large producers and 
vulnerable to declines in international demand.  In a 
positive sign, investment in the electronics sector in 2005 
outpaced 2004 levels.  However, poor infrastructure and 
inconsistent tax policies continue to discourage new 
investments.  Looming power shortages, higher electricity 
prices and shortages of skilled labor are the main industry 
concerns that may impede further growth and new investment. 
As the Philippines' biggest export, electronics could play 
an important role in counteracting the negative effects of 
rising oil prices on its trade balance. 
 
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BACKGROUND 
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2. EconOff recently discussed industry trends with Ernesto 
Santiago, Executive Director of the Semiconductor and 
Electronics Industries in the Philippines, Inc (SEIPI). 
Semiconductors and electronics dominate Philippine trade and 
account for roughly two-thirds of export earnings and half 
of all imports.  This high degree of dependency on this 
sector makes Philippine exports vulnerable to changes in 
consumer demand in its major markets, which include the U.S. 
and to a lesser extent Japan and the European Union. 
Semiconductors provide the largest share of electronics 
exports - 70% of the combined category - while remaining 
categories (consumer electronics, automotive electronics, 
electronic components) provide the rest.  The sector 
employed 374,000 workers in 2004, 12% of industrial 
employment and roughly half the size of the workforce in the 
garments and textiles sector. 
 
3. Electronics exports have grown rapidly from $4 billion in 
1993 to $27 billion in 2000 before falling to $22 billion in 
2001 following the dot-com crash in 2000.  Growth has 
resumed since 2002 and SEIPI expects exports to surpass $26 
billion in 2005.  Although electronics provided 70% of 
export revenues in 2004, its share in value-added terms may 
be closer to 50%.  SEIPI estimates that electronics exports 
include 30% value-added, less than most other export 
categories.  Philippine trade data has consistently reported 
exports several billion dollars lower than figures from its 
trading partners with the US alone reporting $2 billion 
additional exports to the US in 2004, primarily in the 
electronics category.  The US and Japan are the RP's largest 
trading partners, though the US share has recently declined. 
 
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RECENT PERFORMANCE: 
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4. Despite media reports of a potential decline in 
electronics exports, SEIPI reported an overall year-on-year 
increase of 1% in exports for the first half of 2005. An 11% 
increase in semiconductors (which account for 70% of total 
electronics exports) offset a 21% decline in other 
categories. The decline in other categories was largely due 
to a decision by Toshiba to transfer its laptop 
manufacturing operation to China at the end of 2004. This 
factory produced up to 150,000 laptops per month, providing 
nearly $1 billion per year in export revenues. In September, 
SEIPI lowered its projection for export growth from 10% to 
between 0 and 5% in 2005 due in part to disappointing first 
semester performance.  Recent growth in electronics will not 
be enough to offset the effects of rising oil prices on the 
Philippines' trade balance.  The global impact of higher oil 
prices could also reduce demand for electronics in 
Philippine export markets.  Although the trade deficit is 
widening, the Philippines continues to have a balance of 
payments surplus due to strong growth in remittances from 
overseas workers. 
 
5. According to SEIPI, after declining from $1.2 billion in 
2000 to $220 million in 2003, investment in the electronics 
sector rose to $420 million in 2004 and is on track to reach 
$500 million in 2005. Most of this is capital investment by 
existing companies including investment of retained earnings 
to renew or upgrade their facilities. Investment has risen 
despite the continuing stagnation of FDI reported in reftel. 
Texas Instruments is upgrading a production facility in 
Baguio to increase production capacity by 50%.  Santiago 
commented that after an initial surge of investment towards 
China following its accession into the WTO, investors have 
begun to look again at alternative countries in Asia.  He 
lamented that few new companies have arrived since the 
government discontinued its successful investment missions 
of the 1990s. 
 
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ENERGY AND LABOR ISSUES: 
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6. Due to delays in energy sector reforms, the electronics 
industry is likely to face electricity shortages and rising 
energy costs during the next five years. Power costs are 
already high compared to other regional countries and they 
are expected to rise further as the GRP eliminates cross 
subsidies, raises generation rates, and imposes taxes on 
electricity and fuel.  Energy supply disruptions have 
impeded production and contributed to a recent breakdown in 
the supply of liquefied nitrogen to the semiconductor 
industry.  To reduce costs and guarantee a supply of 
electricity for its members, SEIPI is promoting a scheme to 
offer discounted electricity rates for large power consumers 
with constant demand. The Energy Regulatory Commission (ERC) 
recently rejected an initial proposal from an electricity 
distributor to offer discounted rates, but SEIPI believes 
the ERC may be more receptive to proposals coming from 
Independent Power Providers (IPPs) if broader discounts are 
offered that would include consumers outside of the 
electronics industry. 
 
7. SEIPI is soliciting support for training programs to 
increase the supply of skilled workers for member companies. 
Santiago emphasized that skilled workers are the main 
comparative advantage that has drawn SEIPI members to the 
Philippines but industry growth is constrained by shortages 
of engineers. To help address this problem, SEIPI 
established the Advanced Research and Competency Development 
Institute (ARCDI) in 2004, to promote training and research. 
SEIPI has also asked its members and the government to fund 
a $25 million program to provide foreign training for 600 BS 
graduates and 200 PhDs to meet industry demand.  Santiago 
requested help from the Embassy in identifying potential 
sources of US assistance for this program. 
 
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INTEL HIGHLIGHTS INVESTMENT CLIMATE CONSTRAINTS 
--------------------------------------------- ---- 
8. In a position statement submitted recently to the 
Philippine Congress, Intel highlighted several issues that 
are critical to maintaining the competitiveness of RP's 
electronics sector.  Noting its substantial economic 
contributions to the Philippine economy and its sizable 
investment budget, Intel identified infrastructure, 
regulatory and tax policy issues that may discourage new 
investments in the RP.  While citing power supply issues as 
the most critical concern, Intel also underscored the need 
for continued investment in transportation and 
telecommunications infrastructure to match regional 
competitors.  Secondly, Intel stressed the need for an 
improved regulatory environment, notably through more 
consistent tax policies, and simplified implementation.  In 
one example, Intel argued that poor implementation of value- 
added tax policies has negated the impact of tax incentives. 
Intel also underscored the importance of offering 
competitive investment incentives. 
 
9. COMMENT: Strong performance in semiconductors should 
continue to drive modest growth in electronics exports, 
although the industry remains vulnerable to market trends 
and power outages that can affect production.  While 
semiconductor producers remain competitive, Toshiba's 
departure suggests that other product categories may be 
losing out to foreign competition, particularly in finished 
products.  It also highlights the importance of ensuring a 
competitive investment climate to attract new investment and 
prevent further migration abroad.  Energy sector reforms and 
technical training programs can help to maintain the 
competitiveness of the Philippines' main export industry. 
 
JOHNSON