Key political risks to watch in the Philippines

MANILA – In October, the government and the country’s largest Muslim rebel group agreed a preliminary deal that may end a 40-year conflict that has killed more than 120,000 and displaced 2 million.

President Benigno Aquino hopes this will pave the way for economic growth and development in the south, a poor region but one that sits on considerable resources.

Moody’s upgraded its ratings of the county in October, following Standard & Poor’s in July, though S&P said further upgrades depend on Manila raising income levels or sustaining revenue reforms.

The economy grew by 6.1 percent in the first half of 2012, and the government is targeting full-year growth of 5-6 percent, much higher than last year’s 3.9 percent.

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.

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

RATINGS: (Unchanged unless stated:)

S&P: BB+

MOODY’S: Ba1 (Upgraded from Ba2 on Oct. 29)

FITCH: BB+

Following is a summary of political risks to watch:

Internal security

Negotiators from the government and the Muslim rebel group Moro Islamic Liberation Front (MILF) reached a deal on a roadmap to set up a new autonomous Bangsamoro region in the south of the mainly Roman Catholic state, signalling an end to a long insurgency.

Still, the 11,000-member MILF is not the only active rebel group. Maoist guerrillas have attacked private mining projects on southern island Mindanao, destroying around $70 million worth of equipment, and threatening more attacks.

In general, internal security remains weak, 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.

What to watch:

– Implementation of the political deal to set up an autonomous region. This will include the demobilization, disarmament and reintegration of former Muslim rebel fighters, imposition of local taxes to cut government subsidies, and revenue-sharing arrangements with oil and gas producers.

– 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.

– Outcome of the next round of peace negotiations in November in Kuala Lumpur, intended to spell out details of the political deal to end the conflict.

West Philippine 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 a position on the competing claims of various nations, and what appears to be the increasing alignment of Washington with Manila risks infuriating China.

In July, President Benigno 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 U.S. greater access to its airfields and may open new areas for soldiers to use.

The U.S. 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.

In September one of Aquino’s trusted political advisers, Interior Secretary Manuel Roxas, met with China’s leader-in-waiting Xi Jinping to discuss ways to normalize relations. Roxas agreed not to internationalize the Scarborough Shoal issue and to keep talks at a bilateral level while Manila is drafting a policy on territorial disputes in the West Philippine Sea.

What to watch:

– New security arrangements between Washington and Manila to increase the U.S. military footprint in the Philippines, and the U.S. 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, including asking for intervention from the International Tribunal on the Law of the Sea (ITLOS) in Germany. 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 plans to roll out $1.8 billion in defense spending in the next four years, but says its actions are not aggressive.

Mining investment restart, 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 that were cut in October, 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 government is aiming for an expansion of 5-6 percent in 2012, which would make the Philippines a rare example of growth in contrast to Europe and the United States, so much so that overheating may be one of the greatest economic risks.

Authorities are struggling to control an inflow of capital that has pushed up the currency and threatens asset price bubbles.

The arrest last year of former Philippine leader Gloria Macapagal Arroyo for vote-rigging 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 October this year, the anti-graft court ordered Arroyo’s arrest over the misuse of state lottery fund, an offence that could put her back under police detention.

In 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 law raising tax rates on alcohol and cigarettes. Ratings agencies say the tax reform measure will help the Philippines achieve investment grade status. When the mining moratorium is lifted, and how 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. (Editing by Daniel Magnowski) –Manuel Mogato, Reuters