The Philippine economy has been on a track of high growth since 2012, with great potential for consumption growth, but its chronic problems such as poverty, the income gap, illegal drugs, delayed industrialization, and poor infrastructure, remain unsolved. Against this backdrop, in 2016, the former Dabao Mayor Rodrigo Duterte won the overwhelming support of the reform-minded electorate and was elected as the 16th President of the Philippines. In 2017, infrastructure projects and economic reforms are expected to accelerate. As for diplomatic policy, the Duterte administration is derailing his predecessor, Benigno Aquino’s pro-America and anti-China stance while trying to repair ties with China in pursuit of economic benefit. Yet, the Philippine’s sudden pivot from Washington to Beijing, the possibility is low but, will bring both political and economic risks to the country.

Giving the Drug War the Highest Priority

Mr. Duterte had served a total of seven terms (21 years) as Davao mayor, during which, on top of attracting investment, he had committed to restoring law and order and fighting drug war by exacting draconian punishment on criminals and offenders. During the presidential campaign, he pledged to adopt the methods he had employed as mayor in combatting crimes and corruption for the President’s Office, and, in the end, was elected to the presidency. The very first thing he worked on after his inauguration on June 30, 2016 was the anti-drug crackdown, and he ordered the national police to kill suspects of drug trafficking under the “war on drugs” campaign. From July 1 through December 25 of that year, 2,150 suspects were killed by the police, 42,470 were arrested, and additionally, more than 3,849 were killed by vigilante groups. President Duterte vehemently denied the accusation against his extra-judicial killing, and domestically he fired back against critics like Vice President Robredo and Senator Leila de Lima, while externally he counterattacked the United Nations and the Western countries by denouncing their warnings as meddling, and his insulting remarks at then US President Obama and others often caused diplomatic friction.

It is the Philippine people’s strong support for President Duterte that bolsters his continued hostility. With 4 million drug addicts across the country, drug abuse and related crimes are the most serious and immediate issue in the everyday life of local residents. The war on drugs has brought certain results. Since the campaign started in July 2016, around 980,000 narcotics users and traffickers have reported themselves to the police and this effectively helped largely cut the drug demand by over 40%. According to the survey results by a private research firm, Social Weather Station, in September and December 2016¹, approximately 85% of respondents said they were satisfied with the ongoing anti-drug crackdown. However, as it revealed the fact that 94% think it is important suspects be caught alive and the majority consider the extralegal killing a serious problem, the administration’s continued heavy-handed crackdown may put itself at risk of losing public support. On January 31, 2017, Duterte announced that he would temporarily dissolve all police units involved in enforcing his war on illegal drugs after rogue officers were implicated in the murder of a South Korean businessman in October 2016. He strongly denounced the police corruption and decided to let only the military and the drug enforcement agency (PDEA) be engaged in the crackdown until internal investigation and anti-corruption measures were completed. In the meantime, he has vowed to continue his war on drugs until the end of his term in 2022.

Duterte also acted quickly in terms of implementing anti-corruption efforts. In late July of 2016, he signed the Freedom of Information Order (the Executive Order No. 2, s. 2016) to require all executive departments, agencies, bureaus, and offices to make public records, contracts, transactions, and any information requested by a member of the public, except for matters affecting national security, and this took in effect late November that year. In late August 2016, the president’s office issued a memorandum circular to solicit the resignation of about 6,000 government officials appointed by the former administration on the grounds of corruption still being rampant in the government agencies. Prior to this circular, high-ranking officers of the Land Transportation Franchising and Regulatory Board (LTFRB) were dismissed. At the end of August 2016, the Bureau of Internal Revenue (BIR) created a Special Disciplinary Committee to probe tax examiners on questionable tax audits and investigations. In November 2016, the Department of Finance investigated officials of the Bureau of Customs on their personal assets, which included checking their bank accounts, and the number of vehicles in their possession. In addition to that, the government included in the tax reform package the revision of the Bank Secrecy Law that makes probing into bank accounts difficult and thus impedes the fight against wrongdoing such as money laundering, tax evasion, or corruption.

Duterte’s Risky America-China Rebalance

As the Philippines will chair the ASEAN, its diplomatic policy in 2017 will be of great significance internationally. Since President Duterte has vowed to pursue an “independent foreign policy”, he has already reversed his predecessor’s anti-China stance. In July 2016, although the Permanent Court of Arbitration in The Hague rejected China’s claims in the South China Sea and ruled in favor of the Philippines, Duterte practically shelved the ruling and agreed with China’s proposal for bilateral talks to settle the dispute. In return, he received a total of around USD 2.4 billion worth of financial assistance from China during his visit to China in October 2016. In December 2016, the Philippine’s formal participation in China-led Asian Infrastructure Investment Bank (AIIB) was approved, whereby Manila intends to receive USD 300 to 500 million in loans for the first year of membership. President Duterte is also advocating building a better relationship with Russia. At the APEC summit in Lima, Peru in November 2016, he met not only his Chinese counterpart, President Xi Jinping, but also Russian President Vladimir Putin, in an effort to agree on trade and investment promotion as well as further economic partnership. On the military front, the Duterte administration has reconsidered the predecessor Aquino’s pro-US policy through defense cooperation, and decided to pivot away from the US, as evidenced in Duterte’s remarks of calling for earlier than scheduled withdrawal of the US military from the country. However, considering such US economic presence that the US is already a major trade partner of the Philippines, makes up 15% of total Philippine merchandise exports, plays a significant role in ensuring investment and employment in the Philippines’ business process outsourcing (BPO) industry, and there are around 3.5 million overseas Filipino workers (OFWs) living in the US. Moreover, taking into account that the local people generally have a feeling of trust toward America and Japan, while a feeling of mistrust exists toward China and Russia in contrast², President Duterte’s repeated anti-American remarks, or his overly compromising attitude toward China, is likely to threaten the Philippine economy, and may cause sharp declines in his approval rating which will undermine political stability.

Consumption-driven Growth

While Thailand and Malaysia experienced a wave of foreign investor-led and export-oriented industrialization in the 1980s, the Philippines lagged behind in this industrialization, and had long suffered from low GDP growth that averaged 2.0% in the ’80s, and 2.8% in the ’90s. Under protectionist policies, the local conglomerates and landowners had dominated the Philippine economy, while worsening security, and a series of natural disasters had deterred foreign investment. Due to the limited domestic employment opportunities, and also helped by government support, an increasing number of Filipinos sought jobs outside the country, by taking advantage of their good English skills acquired through the educational system inherited from the American colonial period. The number of OFWs as of the end of 2013 was approximately 10.24 million, or around 10% of the population, and their remittances back to the Philippines in 2015 amounted to USD 25.6 billion or nearly 10% of GDP, which supports private consumption as well as the current account surplus. In the 2000s, on top of remittances by OFWs, the fast-growing BPO industry helped the country stay on track with stable GDP growth of 4.5% on average. During the former Aquino regime, expansive public investment accelerated GDP growth over 6% per year from 2012. The main driver of growth, private consumption, contributes to the nation’s GDP by 69% (2015), leaving Indonesia (54%) and Thailand (52%) far behind. The fact that consumer price inflation remained stable due to lower oil prices (1.4% for 2015, and 1.8% 2016), is another contributor to the Philippines’ growth. Despite weak external demands amid the slowdown of the global economy, 2016 saw 6.8% growth in real GDP, exceeding the previous year’s 5.9%.

Full-fledged Economic Reforms Expected for 2017

Amid a stable and favorable economic environment, the Duterte administration is basically taking on the predecessor’s macro-economic policies. The former Aquino administration achieved certain results in its anti-drug campaign, improvements to public finances, and infrastructure projects, although the nation’s investment ratio (share of gross fixed capital formation as a percentage of GDP) for 2017 is estimated to be 24.7%, still below that of Indonesia (35.0%) or Vietnam (28.7%) (see table). To maintain a rate of high growth over 6%, further investment is absolutely necessary. Also, there are many challenges facing the plan to reduce the poverty rate³ from the current 25% to 16% by 2022, as announced by Finance Minister Carlos Dominguez in July 2016. According to the Global Competitiveness Report of the World Economic Forum in September 2016, the Philippines fell in the ranking of the global competitiveness index (GCI)⁴ from the previous 47th to 57th out of 138 nations in total for that year . Among other things, inefficient bureaucracy, poor infrastructure, corruption, and high taxes are the major constraints to business operation. The Philippine’s significant lack of infrastructure both in quality and quantity makes it rank lowest among the major ASEAN countries in terms of infrastructure. Metropolitan Manila (638 square kilometers) is slightly larger than the urban area covered by the 23 wards of Tokyo with a population of around 12.9 million (2015 census), making it one of the most densely populated cities in the world. As evidenced by the lack of capacity at the Ninoy Aquino International Airport (NAIA), where the number of passengers amounted to 37 million in 2015 and exceeded the maximum capacity of 35 million, congestion of transportation infrastructure, whether for roads, airports, or seaports, has proven serious. As for electricity, besides the short supply, the electricity business has been monopolized by a few local conglomerates, and the rates are the highest among the major ASEAN nations.

The Duterte administration plans to raise the share of public infrastructure spending as a percentage of GDP, from 4% in 2015 to 5 to 7%, which would total 8.2 trillion Philippine pesos (PHP) during the 2017 to 2022 period. Looking at the 2017 budget, infrastructure spending is to increase by 14% from the previous year to PHP 86.07 million (5.4% of GDP), of which around 40% has been allocated for transportation infrastructure, including the Metro Manila and Mindanao Transport Master Plan, and the local port construction plans. Public-private partnership (PPP) will continuously be promoted as did the former administration; nine PPP projects, with a total value of PHP 17.11 million, including the NAIA re-development plan, were approved in September 2016. Another eight, equaling PHP 27 million, received approval in November of the same year. Examples of these are the South Line of the North-South Railway Project connecting Metro Manila and Legazpi City, and the new Cebu container port project. This implies that more opportunities will be created for foreign investors. The government has also decided to ease restrictions on foreign investment in any economic activities other than land ownership. This necessitates amendments to the constitution that places a restrictive cap on foreign ownership of 40%, and the lower house (House of Representatives) already approved a resolution for Congress to convene a constituent assembly for amendments, while the Senate started discussions on constitutional amendments at the beginning of 2017. Moreover, the Congress is scheduled to approve a road map for tax reforms in mid-2017. A reduction of both corporate and personal income taxes with exemption for low income earners is to be proposed, whereas broadening of the tax base of VAT and tax hike on petroleum products and vehicles (excluding trucks and Jeepneys), so as to balance trade-offs, will also be on the table.

The population of the Philippines exceeded 100 million in 2014, and has since continued increasing by 2% a year. The median age there is 24.2 years. Given the long-term high growth potential of its consumer market, the country can expect more investment to keep flowing into consumer goods manufacturing and the consumer services industry. However, the fact is that, compared with neighboring countries with an equivalent level of income to the Philippines, Indonesia or Vietnam is preferred over the Philippines for direct investment in the manufacturing sector, as Indonesia has larger market size and more integrated industries and Vietnam has political stability and geographically close to China’s southern region⁵\. In order to compete with neighboring countries in terms of attracting investment, the Philippines needs to ensure political stability and also to actively promote economic reforms and infrastructure building. In January 2017, Japanese Prime Minister Abe visited the country and pledged to provide JPY 1 trillion worth of development assistance over the next five years, focusing on infrastructure projects, through both the public and private sectors. For Japanese companies, this is expected to offer more investment opportunities in the area of infrastructure.

1. The number of valid responses in the September 2016 survey was 1,200, and there were 1,500 in the following December survey.
2. According to the survey results by Pulse Asia Research Inc. in December 2016 (valid responses: 1,200), the US (at 76%) and Japan (at 70%) were most trusted by Filipinos, while China (at 61%) and Russia (at 58%) were least trusted.
3. The percentage of the population living below the national poverty line (the minimum income required to meet basic food needs and other non-food requirements; PHP 1,813 per month in 2015).
4. http://reports.weforum.org/global-competitiveness-index/
5. The United Nations Conference on Trade and Development (UNCTAD) stated in its World Investment Report 2016 that foreign direct investment (FDI) made in 2015 were USD 15.5 billion in Indonesia, USD 11.8 billion in Vietnam, while USD 5.2 billion in the Philippines. Also, the Philippine Statistics Authority reported that approved FDI during January through September 2016 amounted to PHP 93.3 billion (around USD 1.9 billion), down 12.4% from the same period the previous year. Growing uncertainties over the Duterte administration’s foreign policy was considered to be the main reason for investors’ wait-and-see attitude.