FACTBOX: Key political risks to watch in the Philippines

MANILA, Philippines – Six months into power, Philippine President Benigno Aquino III continues to face many old problems: a large budget deficit, endemic corruption, widespread poverty, poor infrastructure and long-running insurgencies.

Following is a summary of political risks to watch:

Government effectiveness

Aquino, son of two heroes of the Philippines’ democracy movement, won the presidency at elections in May 2010 after campaigning as a man who would fight corruption, respect human rights and deliver honest and transparent government.

His win was due at least in part to the family name — he was not a candidate until his mother’s death in August 2009 sparked an outpouring of emotion and a push for change after two administrations dogged by allegations of corruption and mismanagement.

There is an enormous weight of public expectation for him to deliver despite a lacklustre career before he won office. There are concerns he lacks the political nous to take on entrenched interests and push his agenda through Congress, where allegiances are loose and personalities matter more than political beliefs.

Aquino was seen to have failed his first major test, when the bungled handling of a deadly bus hijacking in August exposed inadequacies in government and security forces.

There are doubts about Aquino’s ability to push through with his plan to investigate his predecessor, Gloria Macapagal Arroyo, and he has run into obstacles in a court system and bureaucracy dominated by appointments made by Arroyo.

Three executive orders have already been challenged in the Supreme Court.

His latest legal setback came in December when the Supreme Court struck down Aquino’s executive order creating the Truth Commission to investigate Arroyo and her administration, declaring it unconstitutional.

Aquino maintains widespread popular support, but Arroyo remains politically powerful. She won a seat in the lower house in May elections, from where she could marshall opposition.

What to watch:

– Competing interests among Aquino’s supporters, including his family and relatives. There is talk that rival factions are already creating administrative gridlock, which could thwart the reform agenda.

– Aquino has to move beyond his campaign rhetoric, and start delivering on policy and his legislative agenda. Inaction may erode his support.

– Aquino needs to build closer working relations within the court system, which he wants to reform, to garner support for his plans to investigate Arroyo and officials in several unresolved high-profile corruption and rights abuses cases.

Fiscal challenges

The Philippines, Asia’s largest sovereign issuer of offshore debt, is on course to post its second successive record budget deficit in nominal terms this year, largely because state revenues remain weak despite a major sales tax reform in 2005.

The deficit in the first 11 months of the year was P269.8 billion ($6.7 billion), 10 percent lower than the programmed shortfall of 300.2 billion pesos for the period. The full-year target is 325 billion pesos.

The government has kept the budget in check in recent months largely by limiting spending, but the tighter state spending, after heavy pump-priming by the previous administration and election spending in the first half of the year, was a factor in a third-quarter contraction in growth.

The shortfall in revenue, due mainly to a narrow tax base and chronic evasion and corruption, limits the government’s ability to spend on social services and upgrade infrastructure, which acts as a long-term drag on growth.

The government plans to raise tax revenue through better enforcement and a crackdown on evasion and smuggling, before considering any tax increases.

However, six months after tax evasion and smuggling cases began to be filed with the Department of Justice, not a single one has gone to court. Aquino has signed the 1.645 trillion peso budget for 2011, and the government plans to frontload spending to start on its social programmes and support growth.

What to watch:

– Without success in improving tax collection, the deficit is unlikely to fall as expected and could widen further.

– Moves to dismantle the bureaucratic structures that allow corruption to flourish, seen as a key to strengthening revenues.

– How any new spending in the budget will be funded, and what assumptions the figures are based on. The government was targeting the fastest growth in 35 years in 2011, although it has a more conservative forecast in the budget.

– Markets would like a rise in tax rates and expansion of the tax base to more sustainably support state spending. Until then, the Philippines is likely to remain plagued by fiscal problems.

Internal security

Security remains poor across the Philippines, which is struggling with two long-running insurgencies by Muslim separatists in the south and Maoist guerrillas as well as a persistent risk of Islamic militancy.

In November, a number of countries including the United States updated travel advisories for the Philippines due to reports attacks may be imminent in Manila, but the government said the advisories were unfounded and unfair.

Aquino has unveiled the military’s new counter-insurgency plan, focusing on measures to cut poverty to defeat Maoist and Muslim rebels.

He has also promised to re-start peace negotiations with rebel groups, saying a secure and sustained peace is needed to foster growth and investment, and created new peace panels to negotiate with Muslims and Maoist guerrillas.

Talks with the Moro Islamic Liberation Front (MILF), the largest Muslim rebel group, were bogged down on issues such as territory, wealth and power-sharing, although a shaky ceasefire was re-established in mid-2009.

The talks have yet to restart under the new government, and the government’s attempts to replace a senior Malaysian facilitator is opposed by the MILF.

Maoist guerrillas have agreed to a 19-day Christmas ceasefire to pave way for the resumption of peace talks in Norway next month. However, the prospects of a deal are seen as small, as the Maoists have not amended their demands.

The smaller but deadlier Abu Sayyaf group still presents a problem despite some tactical successes by U.S.-backed Filipino troops

What to watch:

– Evidence showing serious attempts to address root causes of armed conflicts to end extortion from businesses, reduce the kidnapping threat to businesspeople and open up resource-rich Mindanao to investment would be broadly positive for markets.

– Fresh approaches by Aquino to re-start talks with Muslim separatists, which have so far failed to get off the ground, and the progress of negotiations with communist rebels in 2011.

– Aquino’s appointments to security agencies and plans to increase spending could help keep soldiers and police forces onside and negate a potentially destabilising force. He has also doubled soldiers’ combat pay and promised housing and medical benefits as well. –Manny Mogato, Reuters