Risk watch: Key political and economic developments in the PHL

President Benigno Aquino III wants to win the Philippines a credit rating update and bring in more foreign investment, and he claims to have made progress in his campaign against corruption.

At the start of July, Standard & Poor’s raised its rating to one notch below investment grade, but said further upgrades depend on Manila raising income levels or sustaining revenue reforms.

The Filipino economy grew by 3.7 percent in 2011, well below a government target of between 4.5 and 5.5 percent, but officials say this year’s figures will be better.

Still, in a reminder that much of the capital city is dilapidated and vulnerable to natural disaster, heavy rains in August swamped huge swathes of Manila, killing at least 145 people and leaving hundreds of thousands homeless.

Assessments of damage to farmland and housing are still at an early stage, but repairs and rebuilding could prove costly to the government, which plans $8.4 billion of infrastructure works in the next four years to end perennial flooding in the capital and nearby provinces.

Internationally, by far the greatest concern is the South China Sea, contested waters where the US-backed Philippines are increasingly running up against China.

Ratings (Unchanged unless stated):

S&P: BB+ (upgraded from BB on July 4)

MOODY’S: Ba2

FITCH: BB+

Following is a summary of political risks to watch:

South China Sea

The Philippines is at the center of Asia’s most likely military flashpoint: the South China Sea. In July, a regional summit failed to agree on a position on competing claims of various nations, and what appears to be the increasing alignment of Washington with Manila risks infuriating China.

In July, Aquino told Reuters the Philippines may ask the United States to deploy spy planes over the South China Sea to help monitor the waters.

That announcement came only months after its foreign minister said it is offering the US greater access to its airfields and may open new areas for soldiers to use.

The US pledged to triple military aid to Manila in 2012 after high-level talks in Washington on April 30, raising the risk of further speeding a regional arms buildup that is already underway.

Manila will not surrender claims to its exclusive economic zone, as defined by the United Nations, but it cannot hope to confront China militarily.

Beijing wants one-one-negotiations, but Manila and other claimants prefer a multilateral approach, which opens the way for an indirect role for the United States. China wants the United States to stay out of the dispute.

What to watch:
New security arrangements between Washington and Manila to increase the US military footprint in the Philippines, and the US fighter jets and warships the Philippines is able to buy.

Fresh approaches by Manila to pursue its claims on the disputed Spratly Islands. Aquino has said Manila is looking into at least five other options to pursue its claims after China rejected arbitration.

Commercial activity in the South China Sea. Manila has accepted exploration bids on two oil and gas in the disputed areas, and an Anglo-Filipino company may start drilling oil wells later this year in the Reed Bank, another area claimed by China.

Spending on upgrades of air and naval equipment, including radar stations. The Philippines says it needs to build a basic defense capability, and its actions are in no way aggressive.
Mining investment, economic growth

Mining firms want the Philippines to lift an 18-month moratorium on new projects, but this will not happen until lawmakers approve new legislation on mineral revenues and a presidential executive order is signed.

Congressional approval is likely to hold up permits further, stalling up to $12 billion in new investments planned over the next five years, including Southeast Asia’s biggest undeveloped copper-gold mine, the $5.9 billion Tampakan project by global miner Xstrata Plc and Australia’s Indophil Resources NL in the south of the country.

Still, the economy is performing well, helped by low interest rates, improved fiscal management, and an increasingly confident middle class whose spending is underpinned by the huge $1.6 billion in monthly remittances from millions of Filipinos working overseas.

The economy grew 6.4 percent in the first three months of the year, second only to China among Asian economies, and Aquino expects that rate to accelerate in the second quarter.

The government is aiming for an expansion of 5-6 percent in 2012, making the Philippines a rare example of growth in contrast to Europe and the United States. Inflation hit a six-month high in July, though the central bank said it was expected to remain manageable.

The arrest in November of former Philippine leader Gloria Macapagal- Arroyo for vote rigging has put Aquino’s anti-graft stance firmly back in the public eye, but there is also a risk that the Arroyo case could create uncertainty for investors if it becomes a protracted political and legal battle, and prove a distraction from the work of economic reform.

In early August, Aquino’s allies in the lower house of Congress voted to speed up the passage of a highly controversial reproductive health bill, moving it closer to approval.

What to watch:
Passage of a new tax of alcohol and cigarettes. Ratings agencies say the new tax is crucial if the Philippines is to secure investment grade status.

When the mining moratorium is lifted, and quickly resources firms start work on new projects.

Progress of the Arroyo case in court, and potential political fallout from removal of the country’s top judge.

Growth figures, and central bank policy moves.

Political fallout from Aquino’s challenge to the influential Roman Catholic bishops in pushing reform of contraception laws. The bill would require government to provide free reproductive health services, an idea which has been blocked by the religious lobby for nearly 20 years.
Internal security

Internal security remains a weak spot, persistently highlighted by foreign embassies in travel advisories, with law enforcement hobbled by corruption, lack of police resources, and easy availability of guns on the street.

Aquino held talks with the Moro Islamic Liberation Front’s (MILF) leader in Tokyo last year to accelerate the peace process. In late March, negotiators from the two sides signed a document in Kuala Lumpur, agreeing on at least 10 points that will set the direction of the peace talks.

The rebels also secured the government’s commitment to set up a new political entity for Muslim minority in the south of the mainly Catholic state in Southeast Asia.

MILF is not the only active rebel group. In October, around 200 Maoist guerrillas attacked three private mining projects on southern island Mindanao, destroying around $70 million worth of equipment, and threatening more attacks.

In late March, communist rebels from the New People’s Army (NPA) threatened to attack power companies in the south. Talks with the main communist rebel group remained stalled since 2011.

What to watch:
The army’s patience with the peace process, and with Aquino. Coup attempts are not unknown in the Philippines, and some within the army are angry with Aquino for not taking a tougher line with MILF, though an overthrow seems very unlikely.

Any more attacks on mines or other businesses, and how investors respond. The Philippine army has said it lacks the resources, so has asked firms to hire private militias to guard their businesses. — Reuters