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Dutertenomics -- less than meets the eye

Western investors are holding back due to concerns over rule of law and tax plans

| Philippines
Philippines' new taxes on business process outsourcing and other growth sectors have put off some foreign investors.   © Reuters

For all the political controversy he has generated, Philippine President Rodrigo Duterte is overseeing a period of rapid economic growth. After two strong years, the Philippines is expected in 2018 to remain Southeast Asia's fastest-growing economy, with a forecast increase in gross domestic product of 7%. Globally, it is behind only India.

But the newfound prosperity remains vulnerable. Much of the growth is built on the macroeconomic reforms of Duterte's predecessors. The uncertainty he has generated with his attacks on major business leaders as well as traditional external partners, notably the U.S. and Europe, has been compounded by plans for wide-ranging tax reforms that could hit inward investors hard, especially in the key job-creating business outsourcing sector.

Far from extending the boom, Duterte's policies could undermine long-term growth prospects. American and European companies could be driven away, leaving the Philippines relying on Japan and China, which has yet to really deliver on the big promises it has made.

Under Duterte's watch, the overall policy landscape has been mixed. His administration has received much-deserved credit for continuing the macroeconomic reforms of the Gloria Macapagal-Arroyo (2001-2010) and Benigno Aquino (2010-2016) administrations. The president, as he did as mayor of Davao, has also promised to cut red tape and fight corruption in state institutions. Duterte has placed capable individuals in charge of budget, finance and development agencies.

The Duterte administration has also forged ahead with the ambitious "build, build, build" infrastructure project, which carries a whopping tag price of $180 billion. The aim is to enhance the country's investment attractiveness, generate large-scale employment, and address long-term public transportation woes.

Yet, the Tax reform for Inclusion and Acceleration (TRAIN) bill, which was passed last year to fund the infrastructure bonanza, has created unintended consequences.

It has unleashed an inflationary surge by raising taxes on, among others, fuel and sugar. As a result, the price of basic goods increased well beyond the government's initial forecasts. Inflation breached the 4% upper limit of government's target in March.

This has been exacerbated by a depreciating currency, which stands at its weakest in 11 years (against the U.S. dollar) and is widely expected to be the worst performing in Asia this year. Import costs have risen as has the cost of servicing dollar-denominated debt.

A widening current-account deficit could further expand in coming months, as the country struggles with more expensive debt servicing and a weak currency for imports. Debt obligations hit a new record high of 6.821 trillion Philippine pesos in February this year. Meanwhile the domestic economy faces shrinking flexibility in production -- the World Bank has warned about the prospect of overheating, as industrial capacity utilization reaches a peak of 84.1%.

Now foreign business faces a further shock in the form of corporate tax reforms, which will, rightfully, reduce the burden on smaller companies -- but at the cost of removing tax privileges long enjoyed by inward investors, especially in business process outsourcing.

For long, foreign investors were lured not only by the relatively cheap and highly skilled labor in the Philippines, but also tax holidays offered in new boom sectors as well as affordable office rent and real estate costs. Now, these attractions are under question, as the government raises operating costs by slashing tax privileges and levies new taxes on real estate.

New taxes on the growth sector such as business process outsourcing has put off some foreign investors. In particular, this has hit American companies, which have been a leading source of investments in the Philippines throughout history.

During Duterte's first year in office (mid-2016 to mid-2017), American investments dropped by 62% from 2016 to a 13-year low of 8.357 billion pesos ($160 million) in 2017.

The greater loss was among South Korean investors, which are eyeing more attractive nearby destinations such as Vietnam, where there is greater regulatory predictability and more affordable labor costs.

South Korean investment in the Philippines collapsed by as much as 92.61% in the same period, from a high of 11.82 billion pesos in 2016 to only 873.15 million pesos.

Separately, the Philippine Statistics Authority calculates that approved foreign investments, or so-called investment pledges, fell by 51.8% last year to 105.6 billion pesos. That was the lowest level in 12 years.

Adding to the Philippines' investment woes is the deepening diplomatic crisis between Duterte and the European Union. In early April, Philippine immigration authorities unceremoniously expelled a high-level EU party official, Giacomo Filibeck, who has been a vocal critic of Duterte's drug war.

Filibeck hails from the Party of European Socialists (PES), the second largest bloc in the European Parliament. In response, the European Parliament has called for a temporary withdrawal of the EU's preferential trading arrangements with the Philippines.

Under the union's Generalised Scheme of Preferences Plus program, the Philippines enjoys zero tariff on almost all exports to the trading bloc. The EU is the Philippines' largest export market, worth $10 billion last year.

Withdrawal of the preference scheme could dramatically weaken the competitiveness of Philippine exports, particularly in sectors such as textiles, agricultural products, fisheries and furniture. In a sign of the growing tensions, the EU commission has effectively frozen negotiations with the Philippines over a proposed free trade agreement.

A once-blossoming economic relationship is now in jeopardy. Under Duterte's watch, hardly any major European business delegation has visited Manila, due to concerns over rule of law as well as the bilateral diplomatic spats.

With Western investors increasingly holding back, the Philippines has to rely on new partners such as China to join Japan as a reliable source of capital. Yet, Beijing has yet to translate its pledges into actual investments.

The success of Duterteconomics is increasingly coming under question. It requires regulatory certainty, predictable tax policies, a rapid infrastructure buildup, the slashing of red tape, improvements in the rule of law, and diversified foreign economic partners.

The GDP numbers may look good, for now, but the prospect of sustained and inclusive development still remains elusive.

Richard Heydarian is a Manila-based academic, columnist and author; his latest book is "The Rise of Duterte: A Populist Revolt Against Elite Democracy" (Palgrave Macmillan).

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