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Update No: 015 - (29/03/05)

While the administration of President Gloria Macapagal-Arroyo remains focused on the need for immediate reform, her token majority in Congress has not allowed her to move as quickly as she would like and Congress does not appear inclined to deliver quick results. The latest gridlock that appears to have developed is that over reforms to the VAT bill. As one commentator has described it: there is a "clash of contending mentalities and culture between the administration and members of Congress…[between] the [executive] culture seeking to deliver quick results and the parliamentary culture that makes a virtue of time-consuming parliamentary scrutiny of executive proposals."

Legislature and Executive still at odds on fiscal reform measures
A key element of the government's fiscal reform programme is the passage by Congress of eight key revenue-raising measures of which, so far, only two have been passed since the programme was announced in the third quarter of 2004. 
Despite the hope and promise that the legislature would pass a further fiscal reform measure (this time the expanded Value-Added-Tax law) prior to the Easter recess, Congress broke for the three week holiday without reconciling the different versions of the bill being promoted within the lower House and the Senate.
The administration is still some way from reaching its PhP80 billion annual target in promised new revenue-raising measures and the collection of the value-added consumption tax is considered by many to be the key to success. In fact the government wants to front-load the enhanced collection process through two measures: a twenty percent hike in the VAT rate (from the present 10 percent to 12 percent) and coupled with a removal of many of the current VAT exemptions-of which there are many. The VAT increase alone is expected to generate some PhP25 billion annually while if the exemptions are lifted collections could go as high as an additional Php60 billion for government over a twelve month period. This amount would go a long way to meeting the government's commitment. 
Not surprisingly, the VAT reform bill has become an issue of major contention within Congress with the two houses holding widely divergent views on how to increase VAT collections. Basically two entirely different VAT bills have emerged. The bill under consideration in the lower house of Congress is, by and large, the same one as proposed by the president. However, the lower house has also adopted a number of amendments to the original proposal imposing a multitiered system on some sectors presently exempted. One effect of this would be to tax energy producers while at the same time disallowing energy firms from passing on the taxes to be levied on electricity and petroleum products. In effect this means that it is no longer a revenue-neutral consumption tax that allows input-VAT to be deducted from output-VAT and becomes a tax on production. Economists have been quick to point out that whatever the merits of expanding the tax base, by disallowing "pass through" provisions, it is no longer a tax on consumption.
Many civil society groups remain opposed to the proposed measures claiming that they will hurt the poor more than the rich within society. Others claim that this is a fallacy and that as a consumption tax, by far the major burden is born by the middle-classes. A related issue is that of collection efficiency since, in the Philippines, it is estimated that actual VAT collections are only around 30-40 percent of the total. More than 60 percent of transactions go unreported. 
Heeding the views of these "pro-poor" groups, the Senate has adopted a radically different approach to VAT reform. The Senate ways and means has rejected Malacañang's proposal to increase the VAT rate in favour of fewer exemptions and an increase in the corporate income tax to 35 percent from 32 percent. Given the harsh reality of tax evasion in this country, and the inefficiencies within the collection system, few credit such a measure with any chance to produce substantial revenue gains.
With so many variants floating around, many of which appear to be arbitrary and often contradictory, it is no wonder that the Congress has been unable to reconcile the competing positions into a single VAT law that would satisfy both houses of Congress as well as the government and consumers. All versions of VAT reform at present appear to suffer from fundamental structural flaws that may well end up being challenged in the country's law courts thereby further delaying the ability of government to collect much needed revenue.
President Arroyo is expected to call a special session of Congress immediately after Holy Week and during the 3-week congressional recess in an attempt to reconcile the different versions of the VAT bill but at the present time it looks as though any compromise could be even worse than the current proposals being put around. As one commentator has put it "the different VAT proposals… are riddled with measures that are inequitable, arbitrary, or hard to enforce… [and they] contain exemptions that favour powerful but narrow interests."
Sadly, this handling of this issue has again drawn attention to the dysfunctional political system that operates in this country. Despite President Arroyo having an administration under the guidance of seasoned professional administrators (with a few notable exceptions), "control" of the Supreme Court (or at least a court that is sympathetic to her), and the numbers in both houses of Congress, she is still having the utmost difficulty in moving forward her reform agenda at sufficient pace to convince the international community that there is a changed paradigm in the Philippines. Congress simply does not share the president's sense of urgency. 
The VAT issue, arguably the most important legislative measure so far put forward during President Arroyo's second term, shows every indication of spawning a gridlock with Congress intent on using its power to subject the administration's proposal to detailed scrutiny no matter how much delay (and damage) is caused thereby. If the end result was a better piece of legislation, Congressional leaders might be forgiven for their attitude but in all likelihood, we will see a patchwork of ideas and compromise and a further example of an unworkable law coming onto the statute books. We hope we are wrong.

Progress on the budgetary front
On the positive side of the ledger, President Gloria Macapagal-Arroyo has finally signed into law the national budget for 2005 authorising expenditure of PhP907.56 billion (£.8.97 billion) It was a case of "better late than never" since the budget should have been approved by Congress last year ahead of the Christmas recess. In 2004, the government was operating on the basis of a re-enacted 2003 budget and there were fears that some members of Congress would have been quite happy to see the same situation repeated in 2005 if for no other reason than under a re-enacted budget, their allocation of "pork barrel" funds would have been preserved at their previous levels. 
Certainly, the prolonged failure by Congress to approve the new budget has caused added uncertainty in public policy at a time when the government needs more than ever to demonstrate stability and continuity in its decision making process.
One bright note to consider is that the allocation for the office of the Ombudsman has been increased by 26 percent (PhP140 million) to a total of PhP675 million. The additional funds will be utilised by the Ombudsman's Office to hire additional investigators and to strengthen probes of graft and corruption in government agencies. 
On the revenue side the government is targeting a deficit this year of PhP180 billion-revised downwards from the earlier target of PhP184.5 billion. As a percentage of the country's total economic output, the revised 2005 deficit goal is equivalent to 3.4 percent of GDP, lower than the original target of 3.6 percent. The government incurred a deficit of PhP186.1 billion last year, substantially lower than the PhP197.8 billion it was aiming for. This has put the government one year ahead of its deficit reduction schedule. The government is now hoping for a balanced budget by 2008.
The consolidated public service debt (CPSD) is expected to contract to PhP210 billion by year-end. At end 2004 it stood at around PhP317 billion of which PhP118 billion was accounted for by government owned or controlled corporations (National Power Corporation debts alone totalled PhP108 billion). 
This of course is contingent on government adhering to its reform agenda in both its fiscal and financial aspects. On the fiscal front, and as noted above, Congress continues to stall on much needed reform measures.
On the financial front, the government says it is committed to selling state-owned assets and especially those in the energy sector, both to stem the losses and put such corporations on a proper commercial footing to ensure long-term viability without further drains on the public purse. However, again there are fears that the timetable for sale and restructuring of assets may prove to be unworkable in practice.

Some headway made with non-performing loans
Another aspect of the financial reform agenda; that of reducing the non-performing loans of the financial system appears to be making some headway. Data from the Bangko Sentral ng Pilipinas (BSP) show commercial banks' bad loans ratio improved to 12.72 percent last December from 13.57 percent in November. As of end-2003, the ratio was 14.05 percent. It peaked at 18.81 percent in October 2001, from a single-digit rate prior to the 1997 Asian financial crisis. 
The substantial reduction in bad loans was due mainly to the bulk sale or about PhP16.38 billion in bad loans to asset management companies created under the Special Purpose Vehicle (SPV) Act of 2002 which is starting to have some effect. The incentives granted under that Act-including tax perks and reduced fees on the transfer of such assets and that are offered to buyers and sellers of bad loans-will expire next month. The banks now want the Act extended for a further two years. A new bill has been filed in Congress to extend the effectiveness of the SPV law by at least two years. If approved, this will increase the potential value of non-performing loans to be cleaned up from bank books. With the extension, the major banks hope to sell at a discount this year about PhP100 billion in bad loans, and another PhP100 billion worth next year. They believe that the bad loan ratio can be cut to just 5 percent by that time.

Easter Holiday passes without major incident
In this predominantly Christian country, the observance of Holy Week (this year between March 20 and 26) is one of the most important rituals of the year celebrated in much the same manner in which Confucian Asia welcomes the lunar New Year. It is a time for families to reunite. Business in the Philippines came to a grinding halt and Metro Manila largely emptied itself as families streamed back to the countryside to be with their kin. Officially the holiday period is from Maundy Thursday to Easter Sunday (Easter Monday is not observed in the Philippines) although President Arroyo, much to the chagrin of the business sector, declared at the last minute that the Wednesday of Holy Week would also be a holiday for government employees and urged business to grant a similar holiday to those working the private sector.
While declaration of a national holiday may not be considered of major significance, the manner in which it was done illustrates much of the problems facing businesses operating in the Philippines. Business requires a reasonable lead time when holidays are declared so that production schedules can be maintained. Forward planning is not a strength of this government. The presidential decree was obviously a last-minute decision intended to curry further favour with the electorate and especially government employees, although many were left wondering why the president needs to do so. In the end, government employees actually worked a half-day on the Wednesday and business largely ignored the decree. With the next two holidays (Araw ng Kagitingan-April 9 and Labour Day-May 1) falling at weekends, businesses operating in this country or those business people travelling to this country should expect similar last minute pronouncements of holidays being declared on the Monday following each of these two dates.
That the Easter break passed without major security incident was a major relief to all although according to reports, attendance at major churches was well down on previous years. Earlier Muslim extremists, most notably the Abu Sayyaf-a group that has been tagged both in this country and in the United States as a terrorist organisation-had threatened the bombing of Christian churches during Holy Week rites as retaliation against the deaths of a number of Muslims held in a Manila jail as a result of a failed breakout attempt. 

Deaths of the top Abu Sayyaf leadership
Twenty-three people, including three top leaders of the extremist Abu Sayyaf Group, were killed when police stormed a maximum security prison at Taguig in southern Manila, to end a day-old siege that began on the morning of Monday March 14. A group of 10 Islamic militants, all of them suspected members of the Abu Sayyaf, overpowered their guards during a breakfast muster in order to affect a jailbreak. Press reports suggested that the incident began when one prisoner in the group stabbed a guard with a metal spike before grabbing his gun and shooting two others dead. Two prisoners were killed in the ensuing gunbattle, police said. 
The breakout attempt was thwarted and the militants withdrew and holed up within their compound. The following day and with those inside the jail refusing to lay down their arms and come out, around 300 heavily-armed Special Forces police stormed the building using tear gas and automatic rifles. Twenty-three people including three top Abu Sayyaf leaders and one policeman were killed in the attack. The three leaders of the Abu Sayyaf kidnap group killed by police were Galib Andang, alias Commander Robot; Alhamser Limbong, alias Commander Kosovo; and Nadjmi Sabdulla, alias Commander Global. Andang had been involved in the kidnap of western tourists from Sipadan island in Malaysia in 2000, while Limbong faced trial for the bombing of a ferry in Manila last year that left over 100 people dead. Limbong was believed to be the organizer of the escape attempt. 
The incident, prompted by lax security at the detention centre comes as a further embarrassment for the Arroyo government. Many suspected the government of taking the opportunity to organise a "rub-out" of the terrorist leadership. There have been a number of high-profile terrorist incidents carried out by the Abu Sayyaf and its supporters in recent years: most recently there were the Valentines Day bombings in three cities (including Metro Manila) that left more than 12 people dead and many more injured. Prior to that the Abu Sayyaf bombed a passenger ferry in Manila Bay last year that claimed more than 100 lives as well as the kidnapping of several tourists (and the killing of one while in captivity) from a resort island in the western Philippines in 2001 and the raid on the Malaysian resort of Sipadan in April 2000.

Caution still advised
The local security authorities appear to be making headway in reducing the ability of terrorist cells to cause disruption in major urban centres in spite of the February bombings that occurred in three major cities on Valentine's Day (and reported in our March brief). Both public and private security forces remain highly visible in all major urban centres and their presence is accepted by the business community and the public at large. While a number of foreign embassies continue to urge caution in travel to the Philippines, the local community does not consider itself to be under any undue threat and is conducting business as usual. Nevertheless a measure of caution is still advised, especially if travelling to remote areas including areas of Muslim Mindanao.

Market Movements
Both the local currency and the stock market have continued to perform reasonably well in spite of local factors that have weighed on performance. Certainly uncertainties over the progress in the passage of fiscal reform measures has dampened market sentiment as has the threat of renewed bombings by terrorist cells (which, happily, so far have not come to pass). 
In early March the local currency had broken the 54.0 level against the US dollar and was trading around the 53.5 mark-due mainly to the slide in the US currency rather than local factors. However by the end of March the peso had slipped slightly although it had not lost all of its recent gains. On March 28 one US dollar purchased 54.370 pesos. As of 28 February, the rate had been 54.690 and on 31 January the rate against the peso had been 55.08. Against the British Pound the rate stood at 101.20 (105.10, 104.1894) and against the Euro the rate was 70.137 (72.795, 71.9596). 
The Philippine bourse continues to perform strongly although as with the currency, the market fell back slightly in the second half of March. Prior to the Easter break the composite stock index had fallen below the 2,000 level and was at 1999.15 (23 March).

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