Since Rodrigo Duterte became president, much of the news about the Philippines has focused on the large number of extrajudicial killings that appear to be connected to his controversial war on drugs. Duterte’s vituperative statements against US President Barack Obama have also made headlines. More recently, former president Fidel Ramos — whose words still command respect in the country — criticised Duterte for being a “huge disappointment and letdown” because he had wrongly prioritised the war on drugs at the expense of issues such as poverty, living costs, foreign investment and jobs.

Our view is that, with a promising economic policy team and agenda, the sound economic foundation that his predecessor president Benigno Aquino had left him, and immense popularity that allows him to overcome resistance to reforms, Duterte has a unique opportunity to take the country to unprecedented heights. However, there are legitimate concerns that the current approach to the rule of law and foreign policy may cause the country to lose out on this historic opportunity.

The positive case: Duterte can bring about fundamental changes

Some of the ingredients necessary to bring the Philippines to a much higher level of economic potential could fall into place as a result of Duterte’s rise to the presidency.

First, because Duterte is not from the traditional political elite and because he is a very determined and bold leader, he can shake up a system that has been dominated for too long by vested interests whose distorting grip on economic policy and the government has held the country back.

Second, he has put together an experienced and respected economic team led by Finance Secretary Carlos Dominguez and Budget Secretary Benjamin Diokno. Despite their age, they are seen as highly competent and have the confidence of the Philippines’ international interlocutors. This team has rolled out a 10-point socio-economic agenda which systematically addresses the main constraints that have held the country back.

•     Reviving infrastructure development: With solving traffic congestion a priority, road and expressway projects are being commissioned in addition to the upgrading of rail networks. Amendments to the Public Private Partnership (PPP) Law should see infrastructure development broaden across more sectors. Efforts to improve the planning and implementation of PPPs and a Right of Way Act that are underway will help speed up the implementation of public infrastructure programmes.

•     Reforming tax policy in four key areas: First, the personal income tax rate will be cut over time to 25% from 32% currently, except for high income earners. Second, corporate tax rates will be cut to 25%, while simplification of procedures will help to improve taxpayer compliance. Third, the value added tax base will be expanded by reducing exemptions. Fourth, excise taxes will be restructured, including raising the fuel excise tax and imposing a levy on sweet products.

•     Easing investment restrictions to attract foreign investment: The proposals to amend constitutional limits on foreign investment and the negative list are encouraging but will be politically challenging. Tax incentives are also being offered to foreign operators, and have already resulted in an uptick in investment in the manufacturing sector.

•     Reducing the regulatory burden on business: Duterte has a proven track record while running Davao City of improving the business environment, for example by reducing the number of days to open and close a business. Implementation of the competition law should enhance efficiency and reduce costs as well.  

•     Generating a peace dividend by ending insurgencies: The peace process in the South has an excellent chance of being resolved under Duterte given the respect he has from the Muslim and Communist insurgents. Peace in the South will be a game changer as Mindanao not only has one of the highest concentrations of mineral resources in the world but is also less susceptible to typhoons that cast a dark cloud over agricultural potential in the Philippines.

•      Addressing the laggard agricultural sector: The severe under-employment in agriculture (which still employs 26% of the workforce) explains much of the high inequality and poverty that still prevails. Clarifying land ownership is fundamental to creating better incentives to improve agricultural productivity — as the Thai experience has shown. But that would be only a first step — there is still too little support for modernising agricultural techniques and a huge effort is needed to provide the logistical and connectivity support the sector needs to become more competitive.

•      Passing necessary social reforms, which include a 13% increase in the national conditional cash transfer programme, should also improve prospects for equitable growth.

Short-term economic risks containable but structural weaknesses are more difficult

•     Short-term deceleration likely: The boost from election-related spending in early 2016 will fade soon but this near-term hit to growth will reverse by next year. Of more concern is the short-term damage from some of the new policies. The new environment secretary’s vigorous measures to address environmental concerns in the mining sector could set the mining sector back badly. This may be a necessary price to pay to arrest the environmental degradation caused by misconduct by some mining companies, but if the policies are not crafted judiciously, a key potential growth engine could be compromised. Moreover, the war on drugs has raised concerns among investors about respect for the rule of law and could weaken investment. There will also be a temporary hit to agriculture as quantitative restrictions on rice imports will soon be replaced with tariffs. Even though this reform will be implemented in gradual phases starting next year, the initial impact could cause some disruption among rice farmers. But, with rice prices in the Philippines around 50% higher than international prices, the poor who spend 60% of their income on food are unfairly penalised — so this is a small price to pay for a long-term good.

•     Current account deficit possible: Because financial investors have got used to the Philippines running a current account surplus for more than a decade, a deficit caused by the surge in imports and slower remittances could rattle them. We are not concerned. After all, it is quite appropriate for the Philippines to run a deficit so long as it is caused by productive investments. The high credibility that the central bank, the Bangko Sentral Pilipinas, commands in financial markets will also help contain this risk.

•     Services sector is not sufficiently diversified: Services sector growth has depended excessively on business process outsourcing. But while BPO is climbing up the value ladder to provide more sophisticated services touted as ‘BPM IT’ (business process management information technology), the sector remains susceptible to technological changes such as artificial intelligence which could weaken a key driver of the Philippines’ services sector.

•     Inefficiencies which raise costs must be tackled: Electricity costs in the Philippines are around three-to-four times those in Malaysia, Vietnam and Indonesia largely because of the monopolistic structure of electricity distribution. Consequently, electricity can account for as much as 50% of total operating costs for businesses. This is one reason why export-oriented manufacturing remains weak, depriving the country of a major engine of growth.  

•     Banking sector needs reforms: Limited access to credit suppresses economic activity and investment. Too large a proportion of the population remains unbanked: 37% of Filipino cities and municipalities have no access to banks. The banking sector remains fragmented and cost-income ratios are significantly higher than Asian peers.

Will political risks set the Philippines back yet again?

Duterte has started strongly and generated political momentum, which is a huge political asset for a new leader. He has a high public approval rating and much of the political class has quickly rallied to his side, as often happens with a new president in a system where the rewards from presidential patronage are valued over ideological purity or party loyalties.

•     But to sustain his momentum, he needs to ensure that his popularity does not fall significantly below a certain level, say 60%-70%. If it does, then the current backing he has in Congress could evaporate.

•     The rash of extrajudicial killings accompanying the war on drugs is deeply troubling. It is unclear who has directed these killings and who has carried them out. For now, the shock effect of these killings and greater police visibility in crime-stricken areas have reportedly reduced crime, strengthening Duterte’s popularity among the poor. But if the drug trade persists and a still-corrupt police force is running rampant and hurting the security of ordinary folks, the sentiment in favour of Duterte could turn.

•     Duterte has chosen to take on substantial vested interests, whether in the drug trade or in mining. A backlash from these still-powerful interest groups could trip him up. Or they could simply undermine his legislative agenda. For example, vested interests could deconstruct the tax package, cherry-picking the populist tax cuts but not allowing the offsetting revenue measures.

•     Duterte seems to be viscerally anti-American and more willing to contemplate a closer relationship with China, while also attempting to work out a peace deal with Communist insurgents. Both these initiatives could be unsettling for the military and broader security establishment. Many Filipinos remain steadfastly pro-American and deeply suspicious of China. A misjudged move to get closer to the Chinese, say, by making concessions on the legal victory the Philippines secured against China in the Permanent Court of Arbitration over the South China Sea disputes, could provoke a strong reaction against Duterte.

The bottom line: Economic growth canaccelerate if governance is improved in all aspects

The Philippines has enjoyed near 7% growth even with the considerable weaknesses described above and with disruptive El Niño weather patterns. If the Duterte administration can plug some of the holes as we think it can, growth can only accelerate further, leveraging off some of the country’s strengths:

•     Demographic dividend: With adolescents and young people comprising over 20% of the population, the Philippines will have an increasing demographic advantage over its peers.

•     Robust domestic spending: The household sector is considerably under-leveraged and incomes are rising; there is significant potential for household spending to drive growth.

•     Improved infrastructure and an easier business environment in which costs fall will boost competitiveness and allow new niches of competitiveness to emerge over time — in areas such as export-oriented manufacturing and higher value agricultural crops for the booming Asian economies surrounding the Philippines.

•     A well-crafted public investment programme will help crowd in private investment and, combined with the easing of restrictions on foreign investment, will raise the investment/GDP ratio, which would translate into higher GDP growth.

However, there is a material risk of increasing political challenges for Duterte, which could result in policy incoherence and a loss of business confidence. The Philippines could lose a once-in-a-generation chance for higher growth if the administration does not refine its approach to governance.

Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy

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