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. http://www.atimes.com/atimes/Southeast_Asia/HH24Ae02.html [Non-text portions of this message have been removed] -------------------------- Want to discuss this topic? 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