An economic show

Michael Alan Hamlin

Posted on September 17, 2008

Please, get serious…

Today, President Gloria Macapagal-Arroyo and her economic managers will tell members of the Manila Overseas Press Club and the Foreign Correspondents Association of the Philippines that the administration has undertaken and followed through on key reforms that have enhanced the Philippines’ attractiveness to foreign investors. While the Philippines is an attractive investment alternative for many investors, other observers believe the Arroyo administration comes up short on doing what it can, or should, to achieve the Philippines’ investment potential.

Some sobering investment data shows that the Philippines is struggling mightily to attract investment. According to the Bangko Sentral ng Pilipinas (BSP), foreign direct investment (FDI) in the first half of 2008 fell almost 60% to just $813 million from $1.93 million a year earlier. That’s especially alarming because the Philippines was the worst performing country in Asia Pacific for 2007 in terms of attracting FDI.

If circumstances don’t improve, a bad year for foreign investment is going to be followed by an even worse year. Indeed, BSP already forecasts full-year FDI will fall short of last year’s $2.7 billion by $100 million. Expect that forecast to be revised regularly, and probably downward. Portfolio investment is also expected to be two thirds lower than the originally anticipated $3.5 billion at $1.1 billion for the year.

According to the administration, the investment downturn is due to the global financial malaise brought on by the subprime debacle in the U.S. which continues to fell Main Street’s oldest and once mightiest investment banks. But if anything, that downturn should be helping spur investment in the Philippines by companies anxious to offshore and outsource manufacturing and business processes to lower costs.

And the Philippines is a perennial last-place performer in the competition for FDI. It has trailed every other nation in Southeast Asia in FDI except Laos and Cambodia since 2004. If reforms were taking hold, the Philippines would be gaining ground on its regional competitors. Instead, FDI has been flat for two years, and it is expected to be among the worst performers in the region again this year.

It wasn’t expected to be this way. According to the Department of Trade & Industry, committed investment in the first six months of 2008 jumped an eye-popping 270% compared to the year earlier. Close scrutiny of those commitments, however, shows that they were driven by anticipated investment in the energy sector; more specifically, in electricity generation and oil exploration.

Why haven’t those investments materialized? There are a number of factors involved, as it turns out. Administration moves to amend the 2001 Electric Power Industry Reform Act(EPIRA) has frightened investors who purchased generating assets from the National Power Corporation, or were planning to build new capacity, and are dismayed that the regulatory environment is shifting even before EPIRA is fully implemented. To make matters worse, Global Source economists Romeo Bernardo and Marie-Christine Tang, government is subsidizing electricity generation at state-owned plants, undermining the market and state investment in social services.

The call to amend EPIRA is political, and being justified on the basis of high electricity prices. The Philippines has the second highest cost of electricity in Asia, twice the cost of electricity in Thailand, and more than twice the cost of electricity in Malaysia, China, and Indonesia. But how can electricity be so expensive when 65% of the fuel used to generate electricity is indigenous to the Philippines?

One of the principal reasons prior to rapid increases in the price of oil this year is income tax and royalties paid to government. Those costs make indigenous natural gas 500% more expensive than imported liquid natural gas. Geothermal energy is 1.5 to 3.5 times more expensive than imported diesel. If government wants to meaningfully addressing the high cost of electricity, the way to start bringing down prices is to adjust high royalties and taxes on indigenous sources of energy. It costs less to produce natural gas in the Philippines than in Thailand. But royalties and taxes on natural gas here are P1.46/kWh while in Thailand they are virtually non-existent.

Reducing royalties and taxes, however, would not make the Department of Finance (DOF) and multilateral financial institutions like the World Bank, which are concerned with fiscal policy issues, happy. These institutions are not investor friendly. DOF, with World Bank support, has persistently lobbied other executive departments and Congress to “rationalize” investor incentives with the aim of increasing taxes levied on investors. To do so would even further undermine Philippine competitiveness in attracting investment.

If government is serious about increasing foreign investment, then it should be serious about addressing investor concerns. Changing the rules, backtracking on reforms, and removing incentives are not the way to impress investors.

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