US embassy cable - 05MANILA5505

UNCLAS SECTION 01 OF 03 MANILA 005505 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EB/IFD/OIA, 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/MC/ASIA & PAC/KOREA & SE ASIA/ASEAN 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ENRG, PREL, EINV, RP 
SUBJECT: FINANCE SECRETARY NONCOMMITAL ON DOHA ROUND; 
FOCUSED ON FISCAL IMPROVEMENTS 
 
 
Sensitive but Unclassified -- Not for Internet -- Protect 
Accordingly 
 
------- 
Summary 
------- 
 
1.  (SBU) Finance Secretary Teves acknowledged to Charge that 
the GRP needs to do more to address public skepticism over 
the benefits of lower tariffs and progress in the WTO Doha 
Round.  Teves was grateful for U.S. assistance and advice on 
improving the efficiency of revenue collection, a key area 
for fiscal reform.  Teves said that the recent strengthening 
of the peso would be useful for debt as well as deficit 
reduction.  With implementation of the new VAT, Teves said he 
would focus efforts on revenue collection.  Teves expressed 
his commitment to improving the business climate as a way to 
promote investment and expand the tax base.  He noted his 
interest in working with commercial banks to channel more 
overseas remittances into investment, not just consumption. 
Total 2005 remittance inflows through formal banking channels 
will exceed $10 billion, with an additional estimated $3 
billion through informal channels, according to Teves.  The 
DOF expects GDP growth to increase to about 6 percent in 2006 
with increased investment in IT-enabled services and mining. 
DOF also expects a global pick up in the electronics sector 
and increased domestic agricultural production as the "El 
Nino" effect diminishes. 
 
2.  (U) USG Participants: Charge Paul W. Jones; USAID 
Director Jon Lindborg; and Econ Counselor Robert Ludan.  GRP: 
Finance Secretary Margarito "Gary" Teves; Undersecretary for 
Domestic Finance Gil Beltran. 
 
---------- 
Doha Round 
---------- 
 
3. (SBU) The Charge, in a November 16 meeting, urged Teves to 
play a more active role in the Doha Round, including with the 
EU.  He said that the Philippines would benefit from lower 
subsidies and tariffs on agricultural goods.  Teves replied 
that although the Department of Trade and Industry has the 
lead on this issue, he had consistently advocated trade 
liberalization as long as it was reciprocal.  The Charge 
noted that the U.S. has advanced bold proposals after 
consultations with Congress and that the U.S. has pressed the 
EU to follow that lead; the Philippines, he said, as a G20 
and Cairns Group member, could voice its views more actively. 
 Teves said that the GRP needs to address public skepticism 
with respect to the benefits of lower tariff rates.  In 
addition, the GRP needs to convince important vested 
interests, such as the sugar industry, that liberalization is 
in its long term interest. 
 
--------------------------- 
Economic and Fiscal Reforms 
--------------------------- 
 
4.  (SBU) Teves was grateful for U.S. assistance and advice 
on improving the efficiency of revenue collection, a key area 
for further reform in the Philippines.  He mentioned ongoing 
discussions with the World Bank and IMF to determine the best 
approach, including possibly working with the U.S. Internal 
Revenue Service on technologies and methods to fight tax 
evasion.  Teves said that DOF had filed tax delinquency cases 
with the GRP Justice Department, but remained concerned about 
public support and confidence in the program.  With the 
implementation of the new VAT, the DOF message to the 
Congress and public now is that the focus should be on 
efficiency of revenue collection and not on additional new 
taxes.  Teves agreed that consistent information to the 
public and transparency of government operations were vital. 
He was pleased that the Millennium Challenge Threshold 
Program would promote these improvements in the revenue 
system.  The Charge underscored that the USG wanted to be as 
helpful as possible with respect to fiscal reforms. 
 
5.  (SBU) Teves explained that finding ways to work under the 
current Constitution was preferable to amending it.  Steps to 
promote liberalization, including the entry of U.S. and other 
foreign firms, is a key economic goal.  Teves noted that 
economic liberalization and improvements in governance in the 
1980s had promoted growth and job creation during the 1990s. 
Teves agreed with the Charge that improvements in the 
business climate would also improve the fiscal situation. 
Teves underscored that it was important for the DOF to 
provide better explanations to the public on budget 
expenditures.  To improve taxpayer compliance, the DOF needed 
to be more accessible, open, and accountable about how funds 
are spent, he admitted 
 
6.  (SBU) Teves said that the recent strengthening of the 
peso against the U.S. dollar would be useful for debt 
reduction and not only for reducing the deficit.  An 
increasing amount of VAT revenues would also be directed to 
fund social services and infrastructure.  Teves expressed the 
hope that these investments will improve GDP growth along 
with a sustained decline in both the deficit and the debt. 
Continuity and certainty would be important elements in 
financial policies.  At present, interest and principal 
payments on the consolidated national debt consume about 86 
percent of national government revenues.  Teves stated that a 
deficit should be below 3% of GDP.  The 180 billion peso 
deficit ($3.3 billion) at the end of 2005 would be 3.4 
percent of GDP but that a deficit of 2.0-2.1 percent is 
achievable in 2007, according to Teves.  He insisted that the 
DOF would focus on revenue collection and not sacrifice 
social spending to achieve that goal. 
 
--------------------------------------------- --- 
Remittances from Overseas Foreign Workers (OFWs) 
--------------------------------------------- --- 
 
7.  (SBU) As the former head of the Land Bank of the 
Philippines, a government financial institution with 350 
branches charged with rural development, Teves said that it 
was important to identify OFW investment opportunities and 
wider use of bank deposits by OFWs.  Banks could be more 
active and improve the efficiency OFW funds transfers and 
investments.    He said that the DOF expected about $3 
billion in remittance inflows through informal channels in 
2005 in addition to the $10 billion through formal banking 
channels.  He credited the 20-30 percent year-on-year 
increase in remittances in 2005 to the increased number of 
overseas workers, now over 8 million. 
 
--------------------- 
Investment Incentives 
--------------------- 
 
8.  (SBU) Teves pointed out that business-oriented senators 
like Ralph Recto are working to ensure regulatory consistency 
and stronger investment incentives, but he noted that many 
economic policies were driven by Supreme Court decisions.  He 
observed that, in contrast to the Philippines, China moved 
quickly to transform its economy once it embraced capitalism. 
 Teves explained that in the Philippines, officials are 
reluctant to interfere in sensitive Supreme Court 
deliberations, and he had been hesitant to approach the Court 
on the new VAT law when the temporary retraining order was in 
place while the Court determined constitutionality.  Finally, 
he said, the Court approached him and asked if the VAT was 
indeed important to the economy, to which Teves responded 
affirmatively.  The Court lifted the restraining order but 
cautioned Teves to communicate accurately the rationale for 
the VAT to the public and to ensure that the implementing 
rules were clear. 
 
------------------- 
Banking Regulations 
------------------- 
 
9.  (SBU) The Charge noted that the controversy over back 
taxes owed by foreign currency deposit units (FCDUs) of 
foreign and domestic banks remains unresolved.  Teves said 
that Congress needed to amend the banking law, and that an 
earlier proposal to clarify the intent of the 1998 law might 
be insufficient.  (Note: This tax issue involves FCDU tax 
exemptions that were explicit in the Philippine banking law 
until 1998, when Congress passed an updated law.  The Bureau 
of Internal Revenue interpreted the exemptions in the new law 
as implicitly present, based on continued GRP interest in 
making the Philippines a center for international banking. 
After five years of tax exemptions during 1998-2003, a 
further update of the law in 2003 made the tax exemptions 
explicit again.  At that time, the Bureau of Internal Revenue 
suddenly announced that the implicit tax exemption in the 
1998 law had been misinterpreted and insisted that banks pay 
back taxes on FCDU profits for 1998-2003, which BIR estimated 
to be about $700 million for all banks.  End note.) 
 
------------------------- 
Higher GDP Growth in 2006 
------------------------- 
 
10.  (SBU) Undersecretary Beltran explained that the DOF 
expects faster growth in the coming months as investment in 
IT-enabled services such as call centers increases sharply 
along with more investment in the mining sector.  Electronics 
exporters had sensed a general recovery taking place in the 
second half of 2005, but those forecasts of annual growth at 
more than 10 percent have been pushed back to 2006.  As the 
El Nino effect subsides, agricultural production should 
return to the normal 3-4 percent annual growth rate.  For 
2006, the current outlook is for 5.7-6.3 percent GDP growth. 
Beltran's optimism extended to the inflation forecast.  He 
said he expected prices to fall slightly, perhaps by 0.6 - 
0.8 percentage points, even with the expanded VAT, as oil 
prices decline.  He said that 2006 will be a better year for 
the economy and that DOF views are consistent with those of 
the World Bank and IMF.  Although credit demand remains very 
weak, he expected increased investment in mining and 
manufacturing, the latter long overdue for new investment as 
private sector capacity utilization reaches its limits. 
Beltran said that with infrastructure spending at 2.0 - 2.7 
percent of GDP in 2006, demand for construction materials and 
related industries would also contribute to GDP growth. 
 
------- 
Comment 
------- 
 
11.  (SBU) With increased revenues from the new VAT along 
with savings due to peso appreciation, interest rate 
declines, and a declining budget deficit, the GRP appears to 
be poised to apply some of its "savings" towards reduction of 
its debt stock.  Teves's remarks and recent public statements 
by Central Bank Governor Tetangco reflect that possibility. 
President Arroyo has also publicly remarked on possible 
pre-payment of portions of the national debt as the GRP 
outperformed its deficit reduction forecasts by 40 billion 
pesos ($730 million). The GRP, however, has not outlined a 
clear commitment or plan.  So far this year, debt service 
payments appear to have declined by about 4 billion pesos 
($73 million) because of a combination of lower interest 
rates and stronger peso.  That amount, however,  still 
remains a very small portion of the GRP's consolidated public 
sector debt of over $80 billion.  The GRP deficit is 3.4 
percent of GDP, and, though the deficit is declining, the 
government will require about $4-5 billion in new borrowing 
in 2006.  Pre-payment of government debt may also involve 
legal hurdles because holders of those instruments would 
probably have to be  involved in a decision. 
 
 
 
 
 
 
 
 
 
 
 
Jones