US embassy cable - 05MANILA4935

UNCLAS SECTION 01 OF 03 MANILA 004935 
 
SIPDIS 
 
Sensitive 
 
STATE FOR EAP/MTS, EAP/EP, EB/IFD 
STATE ALSO PASS EXIM, OPIC, AND USTR 
STATE ALSO PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE 
TREASURY FOR OASIA 
USDOC FOR 4430/ITA/MAC/ASIA & PAC/KOREA & SE ASIA/ASEAN 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, EINV, PGOV, RP 
SUBJECT: Supreme Court Clears Expanded VAT Law 
 
Refs:  A) Manila 4112 
       B) Manila 4528 
       C) Manila 2879 
       D) Manila 2167 
 
Sensitive But Unclassified.  Protect Accordingly 
 
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Summary 
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1.  (SBU)  The Philippine Supreme Court upheld the 
legality of the Expanded Value Added Tax (EVAT) law, the 
key element in President Arroyo's revenue-enhancement 
agenda, boosting the credibility of her economic reform 
efforts.  This measure could reduce debt accumulation and 
fund increases in social expenditures and infrastructure 
from the expected 80 billion pesos ($1.4 billion) in 
additional revenue in 2006.  Financial markets responded 
positively to the Court's decision.  The Government 
expects political opposition and possibly militant groups 
to hold street protests opposing the measure.  End 
Summary. 
 
2.  (U)  On October 18, the Philippine Supreme Court (SC) 
upheld with finality its September 1 decision declaring 
the EVAT law constitutional (Ref A) and lifted the 
Temporary Restraining Order (TRO) it had issued July 1. 
The decision effectively rejected three motions for 
reconsideration. 
 
3.  (U)  According to Department of Finance (DOF) 
officials, the amended EVAT law will be implemented on 
November 1.  To address business concerns, the GRP will 
refine the implementing rules and regulations (IRRs) to 
provide a more liberal interpretation of the measure 
capping input VAT credits during any given quarter to 70% 
of output VAT.  Under the revised IRRs, input VAT may be 
credited in full as long as the input VAT does not exceed 
the output VAT due.  DOF officials expressed confidence 
that this language would spare the GRP from the tedious 
process of seeking legislative amendments. 
 
4.  (U)  The GRP did not assume any revenues from the 
EVAT in its 2005 fiscal program.  The incremental 
revenues during the last two months of 2005 
-- estimated at 4-6 billion pesos -- will go to reducing 
the 2005 fiscal deficit further.  The GRP budget expects 
to generate an additional 80 billion pesos ($1.4 billion) 
for the full year in 2006 and will apply this revenue to 
increase spending on infrastructure and social services 
while keeping the GRP's fiscal deficit in check and 
tempering the pace of debt accumulation (Ref B). 
 
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No to Deferment of EVAT on Electricity and Fuel 
--------------------------------------------- -- 
 
5.  (SBU)  DOF Undersecretary Emmanuel Bonoan -- who 
shepherded the GRP's centerpiece tax measure through the 
legislature and helped defend it before the Supreme Court 
-- downplayed initiatives in both houses of Congress 
seeking to defer to June 2006 the implementation of the 
amended EVAT law on the previously exempt petroleum and 
electricity sectors.  U/S Bonoan told econoffs that 
following mixed signals from the Palace, the chairs of 
the Ways and Means Committees of both houses of Congress 
met with President Macapagal-Arroyo to urge her support 
for implementing the EVAT law in full.  According to U/S 
Bonoan, DOF's marching orders are now clear:  a) to 
implement the EVAT in its entirety;  b) to continue to 
promote a deeper understanding and awareness of the 
measure and of its importance to longer-term fiscal 
consolidation and macroeconomic stability; and 
c) to collect the targeted incremental revenues. 
 
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Financial Markets React Positively 
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6.  (U)  The Supreme Court decision elicited some 
positive reaction from the stock and foreign exchange 
markets, although concerns over the political backlash, 
uncertainties over the short-tem impacts on inflation and 
the economy, and some reservations on the GRP's ability 
to effectively implement the new tax measure may have 
tempered the optimism.  The local currency, which closed 
at 55.815 pesos/$ on October 17, strengthened to as high 
as 55.670 pesos/$ during afternoon inter-bank trades on 
October 18 before closing at 55.780.  The peso closed at 
55.765 on October 19.  Stock market trades (which end at 
noon daily) had closed before the Supreme Court issued 
its decision in the afternoon of October 18, but closed 
on October 19 at 1,954.29, up 0.4% from October 18's 
closing level.  Foreign bond markets rewarded the Supreme 
Court's final ruling with narrower bond spreads.  At 
about mid-afternoon Manila time, spreads on New York 
trades for Philippine sovereign bonds maturing in 2010 
and 2019 and 2025 had narrowed by 9 basis points and for 
bonds maturing in 2025 by 6 basis points. 
 
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GRP Vows to Monitor Prices Closely... 
------------------------------------- 
 
7.  (U)  The GRP has vowed to monitor prices of basic 
commodities closely to prevent unscrupulous traders and 
businessmen from taking advantage of the amended EVAT law 
to justify significant price increases.  The law 
continues to exempt basic agricultural food products 
(i.e., rice, corn, fish, vegetables, chicken, pork) from 
the tax and the Department of Agriculture estimates that 
potential price increases for such commodities (mainly 
from higher distribution costs) should not exceed 0.5% 
when the law goes into effect.  Department of Trade and 
Industry officials estimated that processed food products 
consumed by low-income groups (i.e., sardines, noodles, 
milk, cooking oil, etc.) would increase by 2% or less. 
(Note:  Food items make up 50% of the Philippines' 
consumer price index.  End Note.)  GRP officials also 
continue to stress that other vital services will remain 
exempt from the new tax measure, including low-income 
rentals and sales of low-cost housing units; educational 
services; and books, newspapers, magazines.  (Refs C-D) 
 
8.  (U)  Imposing VAT on the previously exempt fuel and 
electricity sectors at a time of high and volatile world 
oil prices remains the most politically contentious 
issue.  The Department of Energy (DOE) estimates that the 
reducing excise taxes, eliminating the franchise tax on 
power distribution utilities, and lowering tariffs on 
fuel imports back to 3% should keep petroleum prices from 
increasing by the full 10% VAT.  The DOE expects the cost 
of diesel to rise by 2.5%, unleaded gas by 8.2%, kerosene 
by 6.1%, bunker fuel by 6.6%, and liquefied petroleum gas 
by 7.9%. 
 
9.  (U)  The Department of Energy is asking the Energy 
Regulatory Commission to approve revisions in the scheme 
to discount electricity rates for poor households (i.e., 
"lifeline rates").  The proposal includes doubling the 
eligibility threshold for electricity consumption to 200 
kwh/month.  However, more affluent households (i.e., 
those consuming more than 1,000 kwh/month) will have to 
absorb higher electricity rates (roughly 75 
centavos/kwh), as will commercial/industrial customers 
(by roughly 85 centavos/kwh).  (Note:  Investors here 
continue to air concerns about high power rates in the 
Philippines as a competitiveness issue.  The country 
currently has the second highest average electricity rate 
among ASEAN member countries, after Cambodia.  End Note.) 
 
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...While Opposition Lashes Out 
------------------------------ 
 
10.  (SBU) While President Arroyo's supporters have by 
and large supported implementation of the EVAT law, the 
Opposition has consistently criticized it in the harshest 
terms.  The opposition swiftly condemned the Supreme 
Court's October 18 decision to lift the temporary 
restraining order and promised a "national day of 
protest" in response.  Representative Crispin Beltran of 
leftist Anakpawis party called the tax "blood money," and 
leftist Bayan Muna Representative Teodoro Casino warned 
that the Court's decision would "worsen the political 
situation."  Catholic Church Archbishop Oscar V. Cruz, a 
cleric who leans toward the Opposition, also asserted 
that the decision would fuel unrest and increase 
opposition to the Arroyo administration.  The Opposition 
is certain to take this issue to the streets and use it 
as a rallying point to sustain its efforts -- reflected 
in its almost daily street protests, which so far remain 
quite small -- to oust President Arroyo. 
 
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Comment 
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11.  (SBU)  The Government has gone on road shows over 
the past few months to promote a better understanding of 
the amended EVAT law.  The business sector, financial 
market players, and economists have generally accepted 
the measure as a bitter fiscal pill that will benefit the 
economy over the longer-term.  Ordinary, non-militant 
citizens seem resigned although not necessarily accepting 
of the measure, reflecting disenchantment with 
corruption, waste, and tax collection inefficiencies. 
The opposition can be expected to hammer on these 
weaknesses to continue to embarrass and discredit 
President Macapagal-Arroyo.  Given the fractious 
political climate and the likelihood of more intense 
public scrutiny, the challenge for the Administration 
will be to concretely demonstrate that the short-term 
pains will indeed redound to longer-term gains.  Jones