RISKY
BUSINESS Crisis brewing in the
Philippines By Jephraim P
Gundzik
Investors are greatly
underestimating the risks associated with the
Philippines.
The probability of terrorist
strikes is growing, while the country's volatile
political and social environments appear set to
destabilize significantly. Terrorism and
destabilization could further undermine the
country's already weakening economy, leading to
much slower-than-expected economic growth in 2006
and possibly a
recession in 2007.
Foreign and domestic investors alike have
built significant positions in equities, domestic
fixed-income securities and international bonds
based on overly optimistic economic assumptions.
These positions may be dumped in dramatic fashion
as perceptions of investment risk become more
realistic in the months ahead, leading to
substantial and destabilizing capital outflows.
Philippine security and government
officials regularly play down the threat of future
terrorist strikes, but the picture could be far
less rosy than these officials are willing to
admit publicly. In mid-2006, the US State
Department's coordinator for counter-terrorism,
Henry Crumpton, noted this about the terrorism
potential in the Philippines: "The threat is very
serious if you look at recent events, the
intention of enemy forces, their collaborating
with affiliates all around the region, and their
technical skills, especially in bomb-making, their
tradecraft skills."
Crumpton was referring
to the well-established nexus between
international and domestic terrorist organizations
in the Philippines. The home-grown Abu Sayyaf and
the Rajah Solaiman Movement (RSM) are believed to
be combining resources and expertise with the
Indonesia-based terror group Jemaah Islamiya (JI),
which is believed to have ties with al-Qaeda. The
Abu Sayyaf and RSM probably have more 2,000
hardcore members combined. Meanwhile, security
experts believe that at least 40 JI operatives are
currently in the Philippines training jihadis in
the finer points of bomb-making.
The
presence of JI operatives in the Philippines was
made apparent last month when the military
launched a joint offensive with the US aimed at a
terrorist training camp on Jolo Island. In
addition to targeting the Abu Sayyaf's leadership,
the joint Philippine-US military action was meant
to capture two leading JI members, Dulmatin and
Umar Patek. These JI leaders, who are believed to
have played key roles in the 2002 Bali bombings in
Indonesia, were apparently encamped with the Abu
Sayyaf. No high-ranking Abu Sayyaf or JI leaders
were captured or killed, however.
In late
July, Philippine defense officials announced that
US commando teams would be deployed during the
second half of 2006 and the first half of 2007 to
hold "anti-terror" drills with Philippine troops.
These drills are to take place in the western and
central parts of Mindanao, where Abu Sayyaf and JI
militants are based, and are likely to mark the
beginning of a broad and potentially violent
US-backed offensive. It can be assumed that the
government of President Gloria Macapagal-Arroyo
would not be expanding the military offensives
against the Abu Sayyaf and JI if these
organizations were in decline.
The budding
Abu Sayyaf-JI relationship also appears to have
embraced the RSM. The RSM, which was established
in 2002, originated among a small group of Balik
Islam members in the Philippines. Balik Islam is a
legal organization composed of Christian converts
to Islam and has more than 200,000 members, many
of whom are concentrated in the traditionally
Catholic regions of Luzon and Manila. Balik Islam
is said to have gained strength in recent years
with the return of Filipino workers from the
Middle East.
For instance, the RSM is
believed to have participated in the bombing of
SuperFerry 14 in February 2004 and in the February
2005 multiple bombings in Manila, General Santos
City and Davao. Being composed of non-ethnic
converts to Islam and located in predominantly
Catholic regions of the Philippines, the RSM's
members can more easily blend in with the
country's urban population than their ethnically
different counterparts. For this reason, the RSM
could pose a significant and increasing security
threat to large metropolitan areas, including
Manila.
High political risk On
the surface, the Arroyo government appears strong
and capable and has used its legislative majority
to implement highly unpopular economic reforms.
Arroyo has demonstrated a unique ability to deepen
her support within the power structures of the
Philippines despite allegations of vote-rigging
and corruption.
The Arroyo government's
inroads with the power elite, however, belie very
weak popular support. Widespread anti-government
protests, repeated efforts to impeach the
president and numerous attempted coups indicate
that anti-Arroyo sentiment runs very high among a
large and diverse proportion of the electorate.
Opinion polls conducted over the past 18 months
have shown popular support for the president
ranging between 25% and 35%.
Making the
disparity between her legislative and popular
support sharper have been other opinion polls that
consistently show that since 2005, more than half
of the electorate believes the president should be
impeached. Arroyo's legislative alliances have
been built by patronage, and with mid-term
elections scheduled for next May, these alliances
could become increasingly shaky as self-interested
legislators weigh whether abandoning Arroyo would
improve their own re-election prospects.
Faced with potential defeat in May, Arroyo
is seeking to postpone or cancel the mid-term
elections through an amendment to the 1987
constitution. The proposed charter changes were
initially broached late last year by a 55-member
Consultative Commission appointed by Arroyo. Among
other suggestions, the commission controversially
recommended that the 2007 mid-term elections for
the House of Representatives and Senate be
canceled and that current elected legislators
combine to form an interim parliament charged with
overseeing reforms.
Protests against that
plan staged early this year played a role in
triggering the state of emergency Arroyo
controversially declared in February. That
opposition forced the government at least
temporarily to backtrack on the charter-change
initiative and recommend that the 2007 mid-term
elections go ahead as constitutionally mandated.
The government is now exploring other legal
avenues to change the constitution.
Even
if next year's elections go ahead, growing
political and social polarization could spur more
violence and instability - a situation that could
be exploited either by terrorist organizations or
by the country's leftist insurgents. After the
February coup plot, the Arroyo government
undertook a crackdown on her leftist opponents in
Congress.
In mid-June, the government
launched a military offensive against the
Communist Party of the Philippines and its armed
wing, the New People's Army, marking a significant
escalation in a decades-old conflict. The NPA is
active in 69 of the Philippines' 79 provinces,
suggesting that the government's military
offensive could spark a sharp escalation in
violence throughout the country.
Economic
soft spots If so, political and social
instability could negatively impact economic
growth throughout 2007. Strong growth in personal
consumption expenditure, sustained almost
exclusively by rising foreign worker remittances,
is the country's main economic engine. Though
expanding exports have supported economic growth
in the first half of this year, exports are likely
to weaken as US and global economic growth slows
in the second half of 2006 and into 2007.
Remittance dependency has also increased
the Philippines' vulnerability to external
economic shocks. Economic weakness in countries
hosting Filipino workers reduces external
employment and remittances. In 2006, the growth of
remittances from overseas Filipino workers is
expected to weaken in accordance with slowing
economic growth in the US, where most remittances
originate. Already in the first half of 2006, the
growth of foreign worker remittances slowed to 15%
from 24% from the same period in 2005.
Meanwhile, domestic investment in the
Philippines is chronically weak, having contracted
in real terms by a cumulative 4% between 1999 and
2005. Contracting investment has contained
employment growth and pushed real wages lower.
Fiscal austerity undertaken by the Arroyo
government, under the guidance of the
International Monetary Fund, has reduced and will
continue to reduce public-sector consumption and
investment expenditure.
Despite
overwhelming evidence of economic weakness,
government officials, multilateral lenders and
economic analysts still believe real growth will
remain above 5% in 2006 and even accelerate in
2007. But if the US economy continues to slow in
2007, a notion supported by America's weakening
housing market and spiking international oil
prices, the Philippine economy could easily fall
into recession.
Extremely optimistic
economic-growth forecasts for the Philippines and
distorted risk perceptions have encouraged
substantial inflows of foreign portfolio
investment to the country over the past 18 months.
In 2005, net foreign portfolio investment jumped
by US$2.8 billion. In the first quarter of 2006,
net foreign portfolio investment increased by a
further $2.2 billion. Of this $5 billion of
inflows, only about one-half originated from real
foreign investors. The other half, it appears,
originated from exchange-rate arbitrage in
international currency markets conducted by
Philippines-based banks.
Banks have been
borrowing abroad, mainly in Japanese yen but also
in US dollars, and investing the proceeds in
short-term domestic fixed-income securities. The
surge of external borrowing by banks can be
clearly discerned in the external-debt statistics
of the Philippines. In 2005, for instance, the
external debt of private banks increased to $6.4
billion from $3.7 billion in 2004. Foreign banks
in the Philippines accounted for about $2 billion
of the $2.7 billion increase in the banking
sector's external debt over that period. With real
domestic credit and investment contracting sharply
in 2005, it is highly unlikely that any of the
external funds borrowed by banks were used for
anything other than arbitrage bets.
This
arbitrage was a significant factor behind the
sharp appreciation of the peso, especially against
the yen, in 2005. In addition to banks, foreign
investors also targeted short-term domestic
fixed-income securities in 2005. In the first
quarter of 2006, heavy foreign portfolio and
domestic bank arbitrage inflows continued. These
inflows probably reversed somewhat in May and
June, when the peso weakened sharply. However, the
renewed strength of the peso in July suggests some
of these positions have been rebuilt.
In
addition to producing peso appreciation and
sharply negative real domestic interest rates,
foreign portfolio investment inflows and domestic
bank arbitrage plays have also propelled the
equity market higher and tightened spreads on the
Philippines' international bonds. When foreign and
domestic investors meet economic - and potentially
a jarring political - reality, a large-scale
correction in asset values and the exchange rate
will follow.
Jephraim P Gundzik
is president of Condor Advisers, which provides
investment risk analysis to individuals and
institutions worldwide.
(Copyright
2006 Asia Times Online Ltd. All rights reserved.
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