Economic Modernization through Efficient Reforms and Governance Enhancement (EMERGE) Unit 2003, 139 Corporate Center, 139 Valero St., Salcedo Village, Makati City 1227, Philippines

Tel. No. (632) 752 0881 Fax No. (632) 752 2225

First American Chamber of Commerce Abroad

Technical Report

INVESTMENT CLIMATE IMPROVEMENT PROJECT (ICIP) MONITORING REPORT MARCH 2006 FEBRUARY 2007 by Arlan Z. I. Brucal

Prepared for The American Chamber of Commerce of the Philippines Submitted for review to USAID/Philippines OEDG

April 2007

Preface

This report is the result of technical assistance provided by the Economic Modernization through Efficient Reforms and Governance Enhancement (EMERGE) Activity, under contract with the CARANA Corporation, Nathan Associates Inc. and The Peoples Group (TRG) to the United States Agency for International Development, Manila, Philippines (USAID/Philippines) (Contract No. AFP-I-00-00-03-00020 Delivery Order 800). The EMERGE Activity is intended to contribute towards the Government of the Republic of the Philippines (GRP) Medium Term Philippine Development Plan (MTPDP) and USAID/Philippines Strategic Objective 2, Investment Climate Less Constrained by Corruption and Poor Governance. The purpose of the activity is to provide technical assistance to support economic policy reforms that will cause sustainable economic growth and enhance the competitiveness of the Philippine economy by augmenting the efforts of Philippine pro-reform partners and stakeholders. The American Chamber of Commerce in the Philippines (AmCham) submitted an unsolicited proposal to EMERGE on January 25, 2006, for a grant to set up a mechanism to identify and communicate to the Philippine Government activities that will generate additional investments and jobs in the country. It was called the Investment Climate Improvement Project (ICIP), and the key actors were Mr. Robert M. Sears, AmCham Executive Director, Mr. John D. Forbes, AmCham Legislative Committee Chairman, and Mr. Robert W. Blume, AmCham Desk Officer at the Philippine Board of Investments (BOI). Mr. Richard Umali was added to the team as a Project Assistant. EMERGE subsequently hired Mr. Arlan Z. I. Brucal to help AmCham draft this and other summary reports. The views expressed and opinions contained in this publication are those of the author and are not necessarily those of USAID, the GRP, AmCham, EMERGE or the latters parent organizations.

Table of Contents Executive Summary iii I. Introduction 1 II. Conceptualizing the Investment Climate 2 III. Analysis of the Philippine Investment Climate 3 A. Governance 3 B. Infrastructure 5 IV. Recent Developments in Investment Climate Components 6 A. Governance 6 (i) Reduction in Bureaucracy and Corruption 6 (ii) Improvements in Judicial, Regulatory and Enforcement 7 B. Infrastructure 7 (i) Power Sector 7 (ii) Biofuels Sector 8 (iii) Transportation 8 (iv) Financing 9 V. Investment Situation in the Philippines 11 A. Approved Investments 11 B. Approved Foreign Direct Investment 13 C. Domestic Capital Formation 17 VI Investment Situation and Challenges in Key Sectors 21 A. Health and Retirement Sector 21 B. Information and Communication Technology 23 C. Manufacturing 25 D. Mining 27 E. Tourism 31 VII. Achieving Targets for Local and Foreign Direct Investment 32

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Executive Summary As part of ICIP, the American Chamber of Commerce of the Philippines (AmCham) organized and spearheaded an informal network of private sector business firms or their associations, with the aim of developing an effective capability in the private business sector to monitor the business environment that affects investment decisions. This Investment Climate Monitoring Report looks at the key developments in the investment climate in the country during the project period. As conceptualized by the World Bank and the Asian Development Bank, the investment climate is composed of three broad sets of factors: (1) macro-fundamentals, (2) infrastructure, and (3) governance and institutions.1 Analysis on the Investment Climate of the Philippines. Reports from internationally recognized surveys and publications, including, among others, The Global Competitiveness Report 2006-2007, IMD World Competitiveness Yearbook, WB Doing Business 2007, and 2006 Index of Economic Freedom, place macroeconomic instability and inadequate infrastructure among top concerns of the business sector in the Philippines. Indeed, the Philippines continues to lag behind on key investment indicators, such as in government efficiency, corruption, and tax administration. Meanwhile, the country belongs to the lowest quartile in terms of access to physical assets and to adequate and inexpensive financing. Recent Developments in Investment Climate Components. In the governance component, much of the government intervention centered on efforts to reduce red tape and corruption. Presidential Task Forces have been formed, such as the Anti-Red Tape Task Force and the National Competitiveness Task Force, in order to promote and develop result-oriented economic reforms and programs that will help improve the investment climate in the Philippines. The year 2006 also saw consensus building exercises among public and private organizations, resulting in numerous development agenda and, most importantly immediate government actions such as executive issuances and memorandum orders that addressed major concerns raised in the events. As regards infrastructure, mixed progress in the power sector occurred in 2006. These developments centered on lowering power prices through (a) National Power Corporation (NPC)s time-of-use program, which allows lower pricing during periods of low demand, (b) lower-price power for commercial and industrial consumers using 1KW+ monthly, and (c) start of Wholesale Electricity Spot Market (WESM) operations. Unprecedented interest in the biofuel investment was also noted, particularly in biofuel production for domestic use and for export, in anticipation of the mandatory blending requirements stipulated in the Biofuels Act. In transportation sectors, major financed projects have started construction (Subic-Clark-Tarlac Expressway and Northrail). However, work on many others has barely started (the South Luzon Expressway (SLEX) rehabilitation). The expropriated Ninoy Aquino International Airport (NAIA) International Passenger Terminal 3 remained unopened while the LRT1 extension, MRT3 Phase 2, MRT7 and the C-5 to NLEX connection road project remain stagnated in their development phase. 1 World Development Report 2005-A Better Investment Climate for Everyone (2005). Washington, D.C.: The World

Bank. Improving the Investment Climate in the Philippines (2005). Manila: Asian Development Bank.

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In finance, development was focused on two laws implemented in 2006. One was the legislated Expanded Value-Added Tax (EVAT) that improved public financing in 2006. Also in 2006, President Arroyo signed Republic Act (RA) 9343 extending the Special Purpose Vehicle (SPV) Law, which expired in April 2005, to help reduce the bad loan ratio of banks and free unused capital and assets. Investment Situation in the Philippines. Investment pledges for the first nine months in 2006 stood at Php 283 billion, 88 percent more than the Php 150 billion reported for the equivalent period. An upsurge in local investments was reportedly boosted by a BOI-approved project to engage in power generation valued at Php 44 billion, representing 60 percent of total pledges from Filipino nationals. Approved FDI for the first nine months of the year posted a 156 percent growth, totaling Php 152 billion compared to the Php 60 billion worth of FDI approvals in the same period of 2005. Such robust growth rate was driven by the manufacturing sector which gained cumulative approved FDI of Php 106 billion, an expansion of 163 percent over 2005. The cumulative projected employment for FDI was estimated at 110,279 jobs, 45 percent higher than 2005. Meanwhile, domestic capital formation increased to Php 215 from Php 219 billion in 2005, posting a 2 percent rise in real terms, reflecting strong confidence in future economic conditions. Foreign capital inflows increased, in line with global trends of increased capital flows into ASEAN and other emerging markets. FDI as measured by the BSP for the first nine months of 2006, rose to Php 85 billion, an encouraging increase of 54 percent from the net inflow of Php 55 billion in 2005. In March 2007, the BSP announced that total net FDI inflow into the Philippines in 2006 reached $2.35 billion, up by $491 million from the previous year level of $1.85 billion. While the recent improvement in investment is encouraging, there were also investment plans that were cancelled, if not deferred. A good example would be Tiger Airways decision of not pursuing the intended setting up of its $300M regional hub and base at least six new Airbus 320s for Asia-Pacific operations in Clark as a result of policy reversals in the aviation industry. BOI also reported a number of failed investment plans in the power sector due to financial difficulties encountered. Investment Situation and Challenges in Key Sectors Health and Retirement. Contrary to the growing retirement, second-home and health tourism industry in some successful developing countries, the Philippine retiree program has had limited success, while medical tourism is just beginning. In 2006, Philippine investment, both domestic and foreign direct investment, has been modest in this sector while other important investment in the sector are still in the pipeline as foreign and local inventors expressed their intention to either expand existing facilities or put up new ones in the country. The sector faces serious challenges, including the absence of quality transportation infrastructure coupled with an apparent lack of effective strategy to market the country as an alternative destination in Asia. Restrictive laws

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prohibiting foreign professionals and foreign ownership of hospitals and retirement homes are a deterrent to FDI in the sector. Information and Communication Technology. In ICT, continuing strong activity in fast-growing IT-enabled services (ITES) was seen particularly in 2006. Meanwhile, FDI in ICT industry showed a 96 percent increase in 2006 while Filipino nationals pledged less investment in ICT with a decline of 41 percent from 2005s commitments. The declining quality of English language proficiency continuously threatens this promising sector. Also included among the top concerns is the need to encourage the growth of a national cyber services corridor that will eventually yield to job creation and less concentration in Metro Manila. Finally, it was suggested that the Philippines should also aim to move up the value chain, following Indias effort to move to Knowledge Process Outsourcing (KPO). Manufacturing. BOI and PEZA data show continuing modest expansion of many existing export manufacturing plants and some new firms locating in the country. A few export plants have closed to centralize operations elsewhere in ASEAN after low AFTA tariffs created regional economies of scale. Manufacturing for the domestic market appears to be in gradual decline as cheaper goods from China are competing in local markets. The growth in manufacturing is led by the electronics sector. Semiconductor and Electronics Industries in the Philippines, Inc. (SEIPI) reported in the first quarter of 2006 that Philippine Economic Zone Authority (PEZA)-registered new investment by 20 semiconductor and electronic firms totaled Php 4.4 billion, compared to Php 663 million during the same period in 2005. For all of 2006, SEIPI estimated $1 billion new investment. There are numerous challenges facing the growth of manufacturing, and several are reflected under most of the main ICIP reform clusters: red tape, power and transportation infrastructure, and education. Mining. The future of mining was thrown into question after the suspension of operations following minor spill at the Australian Rapu Rapu mine in Albay but rebounded before the second half of 2006. Thereafter, the country experienced an influx of new investment projects, such as the Berong nickel project of TMM Management in Palawan; the gold project of Greenstone Resources, Red V and JCG Resources (Australian) in Surigao del Norte; the copper-gold project of Colet Mining and Development in Negros Occidental; the Tampakan copper project of Sagittarius Mines in South Cotabato; and the copper project of Silangan Mindanao Mining in Surigao del Norte, among others. Strict implementation of the Mining Act remains to be the top challenge for the industry to attract investments in the coming years. Tourism. The potential for tourism in the Philippines to grow to volumes as high as Malaysia and Thailand has remained unrealized. The total number of visitor arrivals in the Philippines reached to a new record high of 2.8 million in 2006, an increase of 8.4 percent from the 2.6 million in 2005 (including balikbayans), still below the Department of Tourism (DOT)s target of 3 million foreign tourists. With the increased tourist influx to the Philippines, the number of new accommodation facilities has increased, while existing hotels are venturing into expansion and refurbishment. Major challenges to tourism growth include inadequate infrastructure, internationally substandard tourist facilities and services, internal security and restrictions on foreign nationals owning land for resorts and to engage in retail services (restaurants, rentals, tourist operations, etc) by the high investment threshold ($2.5 million) of the Retail Trade Act.

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Achieving Targets for Local and Foreign Direct Investment. Following the better performance of investment in the country, the government set its investment target at a modest 12 percent expansion, which translates to at least Php 306 billion target in 2007 for commitments to establish new or expand existing business ventures in the country. However, according to a Workshop on FDI held on October 5, 2006 by the Joint Foreign Chambers of Commerce of the Philippines, an estimated $9 billion in FDI could possibly flow into the Philippine economy every year over the next four years if the countrys investment climate, labor quality and physical infrastructure continue to improve. These investments, if realized, would generate over 2.9 million direct and indirect jobs annually from 2007-2010. ICIP believes that these targets are attainable if significant economic reforms are sustained and further developed. Priority and support for the development of infrastructure, especially in strategic and industrial areas is essential. The government should also consider looking at the impediments to entry and restrictions to foreign investors as FDI, particularly those coming from developed countries, prefer investing in a country without these restrictions. The political will to implement economic reforms and pro-business policies is also necessary to improve the investment climate in the Philippines. Overall, the ICIP envisions that the country will have a more encouraging investment climate in the future, driven by proactive government actions, stronger private sector participation and better infrastructure and physical and human resources.

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I. Introduction Overview of ICIP. The American Chamber of Commerce of the Philippines (AmCham) Investment Climate Improvement Project (ICIP) is intended to correct factors impeding domestic and foreign investment in the Philippines. Through ICIP, AmCham pinpoints problems in the Philippine investment environment, assesses their importance to the investment climate and works toward finding and implementing effective solutions. Commencing on March 1, 2006, after the signing of the grant agreement with the United States Agency for International Development (USAID) EMERGE Project on February 28, 2006 (which was followed by the signing of a ceremonial Memorandum of Agreement between the United States Ambassador to the Philippines Kristie Kenney and AmCham Vice President Henry Co on April 19, 2006), this 12-month long project already identified impediments and disincentives that hindered domestic and foreign investment inflows to the Philippines. The ICIP, through its advocacies and network alliances, has been instrumental in identifying and communicating to the Philippine Government activities which have high potential of generating additional investment and jobs as well. Core Components. ICIP has three core components: (1) networking and investment climate monitoring, (2) policy research and analysis and (3) investment climate reform advocacy. These are explained in the ICIP Advocacy Plan2, which identifies 6 reform clusters (red tape and corruption, education, power infrastructure, Subic-Batangas transport corridor, judicial reforms, legislative priorities, and political stability and security) and 5 reform sectors (healthcare and retirement, information and communications technology, manufacturing, mining, and tourism) as ICIP priorities, which closely adhere to the analysis and recommendations of the Roadmap II More Foreign Investment3 released in June 2004 (with the exception of population policy). Methodology. The ICIP implementation methodology employed several strategies to advance ICIP reform advocacies. Within AmCham, firm members and committees and the American Desk at the Board of Investments applied their resources and networks. Outside AmCham, reform alliance partnerships were joined with other foreign chambers of commerce, Philippine business associations, academics, foreign governments and multilateral aid groups and influential individuals and firms. Voicing reform advocacies in the domestic and international media was an especially effective method to influence target opinion and decision makers. Information regarding ICIP reform advocacies was disseminated in multiple forms and through multiple channels. Letters to and meetings with senior GRP officials in the Executive and Congress were used to explain the importance of reforms to investment. Media releases, comments and interviews were especially effective in presenting ICIP positions and often triggered additional comments in editorials and columns. Four workshops were held, all but one with published recommendations. All letters, reports and statements were made publicly available on the AmCham website and through other means of distribution.

2Investment Climate Improvement Project Advocacy Plan (2006). Makati City: The American Chamber of

Commerce of the Philippines. 3Roadmap II More Foreign Investment (2004). Makati City: The American Chamber of Commerce of the

Philippines.

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As part of the ICIP activities, AmCham organized and spearheaded an informal network of private sector business firms or their associations, with the aim of developing an effective capability in the private business sector to monitor the business environment that affects investment decisions. This Investment Climate Monitoring Report is the culmination of all the efforts of involved business organization in the ICIP project, with greater thrust on key developments in the investment climate in the country during the project period. In particular, it intends to analyze available data on new investments, disinvestments, and failed investment plans, covering both domestic and foreign direct investment while focusing on the five reform sectors of ICIP. Moreover, it also aims to analyze emerging problems that prevent new investments or drive existing businesses out of the country. Finally, this report seeks to provide recommendations for improving the investment climate in the Philippines. II. Conceptualizing the Investment Climate

In 2005, the World Bank (WB) and the Asian Development Bank (ADB) released reports on the investment climate. With the theme A Better Investment Climate for Everyone, the World Development Report 2005 described the investment climate as that which reflects the many location specific factors that shape the opportunities and incentives for firms to invest productively, create jobs, and expand.4 More specifically, the ADB identified three broad sets of factors that make up the investment environment: (i) macro fundamentals, (ii) infrastructure, and (iii) governance and institutions. Macro fundamentals include macroeconomic stability (e.g., reasonable fiscal and external balances, realistic exchange rate, low inflation and interest rates), competitive markets, and social and political stability. Infrastructure has to do with availability and quality of physical infrastructure, such as transportation (roads and ports), telecommunications, power and water supply. Governance and institutions refer to transparency and efficiency in regulation, taxation, and legal system; strong and well-functioning financial sector; labor market flexibility and skilled labor force.5

Given the conceptualization above, this report proceeds with the assessment of the Philippine investment climate during the project period by focusing on two major components: (a) Governance, which include macroeconomic and political stability, bureaucratic regulation, legislation, and the judicial system; and (b) Infrastructure, which include hard infrastructure particularly power, airports, seaports, rails, and roads, and soft infrastructure specifically education and English. The same components are also considered in assessing the status of the ICIP reform sectors.

4World Development Report 2005-A Better Investment Climate for Everyone (2005). Washington, D.C.: The World Bank. 5Improving the Investment Climate in the Philippines (2005). Manila: Asian Development Bank.

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III. Analysis of the Philippine Investment Climate The metrics used in analyzing the investment climate of the Philippines is based on the results of internationally recognized surveys, including, among others, the WEFs Global Competitiveness Report, the IMD World Competitiveness Yearbook, and the WB Doing Business report. A. Governance The ADBs Asia 2015 conference in 2006 showed that macroeconomic instability was the top concern of most firms in the Philippines (see Figure 1).6 Nearly 40 percent of firms reported that macroeconomic stability in the Philippines is an impediment to business, third to Indonesia (50%) and Bangladesh (40%). In contrast, India is reported to have the least concern in both uncertainties in macroeconomic and regulatory policy.

Source: Asia Conference 2015 (2006).

Figure 1. Percentage of firms reporting political or economic risk as impediment to business

Institutions are also seen as a major concern in the Philippines in 2006. The Global Competitiveness Report 2005-2006 indicated that the country ranked 89th out of the 117 surveyed countries in terms of competitive institutions. The Philippines also ranked low in terms of overall government efficiency in the 2006 IMD World Competitiveness Yearbook, brought about by the very low rankings in risk of political instability, bribing and corruption, customs authorities, public service and country credit rating (see Table 1). Other international publications also support the claim that governance is a major deterrent of investment and business growth in the Philippines. For example, the report in the Corruption Perceptions Index 2005 stressed that corruption remains a problem in the country as it ranked 117th out of the 146 rated nations, even lower that Vietnam which ranked 107th. At the extreme, the Global Competitiveness Ranking of the World Economic Forum (WEF)s 2005-2006 Global Competitiveness Ranking rated the Philippines second to the worst for corruption among 102

6 ASIA 2015 Promoting Growth, Ending Poverty (2006). Asian Development Bank.

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surveyed countries, and its corruption ranking was the 60th of the 61 countries in the 2006 World Competitiveness Yearbook.

Source: Forbes (2006). Trends in international rankings of the Philippines. Presentation during the Workshop on FDI.

Table 1. Survey results on Philippine Government Efficiency, IMD-WCY, 2006

The Philippines remains inefficient and uncompetitive in terms of the cost of doing business. The 2005-2006 Global Competitiveness Ranking of the World Economic Forum (WEF) placed the Philippines 98th among the 102 surveyed countries in red tape, while 2005 Asian Development Bank poll of 1,000 private sector firms operating in the Philippines revealed firm managers spent 9% of their time dealing with bureaucrats. Meanwhile, the ADB reported that tax rates and tax administration are also major constraints of the investment climate in the country as tax forms one significant part of the set of regulations facing businesses. A heavy tax burden generally increases production costs, while inefficient tax administration increases compliance costs, discouraging investment. A weak judicial system is also a major impediment to business in the country, according to the World Investment Climate Survey (Phillips, 2006). In particular, the arbitrariness of local systems of justice and the great variation in the interpretation of laws have contributed to the low confidence of investors in the judicial system of the country.

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B. Infrastructure Access to and quality of physical assets roads, ports, power, water, telecommunications are perceived to be relatively worse in the Philippines than in more competitive economies. In the recent Global Competitiveness Report, the Philippines ranked 90th out of the 117 countries rated. The country ranked 94th in overall infrastructure quality, 103rd in railroad infrastructure development and 93rd in terms of telephone lines (see Table 2). Electricity remains a major concern to business in the Philippines, followed by transportation, according to 2006 World Bank Investment Climate Survey. This translates to reduction in global competitiveness, particularly for the electronics and semiconductor industry which utilizes electricity as a significant percentage in the cost of production.

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IV. Recent Developments in Investment Climate Components A. Governance Reduction in Bureaucracy and Corruption Since mid-2006, the highest levels of the government have begun efforts to reduce red tape and attendant corruption. Alarmed by the low ranking for the Philippines (49th of 61 countries) in the 2006 World Competitiveness Yearbook, President Arroyo in May 2006 asked the Philippine Chamber of Commerce and Industry (PCCI), Export Development Council (EDC) and National Economic and Development Authority (NEDA) to organize public-private sector task forces to review actions needed to improve Philippine competitiveness weaknesses. The initiative led to the holding of the first National Competitiveness Summit in October 2006 in Malacaan Palace. With 300 high-level participants both from the government and private sector, the Summit tackled competitiveness issues and developed an action agenda pertaining to better public and private sector management, and improved transaction flows and costs, among others. At the Summit, President Gloria Macapagal-Arroyo issued:

Administrative Order No.161, institutionalizing quality-systems management in government;

Memorandum Order No. 228, directing all departments, bureaus, commissions, agencies, offices and instrumentalities of the national government to improve transaction costs and flows in order to enhance Philippine competitiveness;

A Memorandum directing the department of Transportation and Communication (DOTC) to provide seamless infrastructure networks to enhance Philippine competitiveness;

A memorandum directing the Department of Energy (DOE), the Philippine National Oil Company (PNOC) and the National Power Corporation (NPC) to lower the cost of and ensure self-sufficiency in energy to enhance Philippine competitiveness;

A memorandum directing the Department of Education (DepED), the Commission on Higher Education (CHED) and the Technical Education and Skills Development Authority (TESDA) to develop programs to improve the students proficiency in English, Science and Math in order to enhance Philippine competitiveness; and

EO 571 which creates the public-private sector task force on Philippine competitiveness attached to the Office of the President (OP). The task force shall promote and develop national competitiveness by seeing the implementation of the action agenda for competitiveness resulting from the National Competitiveness Summit.

In May 2006, President Arroyo issued EO 428 instructing all government offices to simplify rules and regulations and reduce reporting requirements to facilitate business and encourage investments. The initiative was further strengthened with the Presidents State of the Nation Address (SONA) in July 2006, highlighting her agenda of reducing red tape intended to reduce business costs and increase competitiveness. Following this, President Arroyo issued EO 557

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which created the Anti-Red Tape Task Force (ARTFF) headed by Department of Trade and Industry (DTI) Secretary Peter Favila. In the same month, PCCI and AmCham ICIP organized the Anti-Red Tape and Corruption Workshop, which generated recommendations for the passage of the anti-red tape bill and strengthened Ombudsman, e-governance, e-procurement to reduce agency-level corruption. Aiming to streamline further business processes in the country, President Arroyo signed EO 587, ordering DTI to establish and manage a Philippine Business Registry system to increase commercial activities by facilitating a seamless transaction environment for business registration across government agencies such as the DTI, SEC, BIR and SSS. Workshops and several consensus building activities are being conducted among concerned government agencies and the private sector to formulate and develop an action plan towards establishing and implementing this system. Improvements in Judicial, Regulatory and Enforcement Few indications of major improvements have been noted in the areas of judiciary, regulatory and enforcement in 2006. A glairng failure has been unhindered smuggling of used vehicles. In 2006, the Supreme Court (SC) affirmed its decision of upholding right of the Philippine government to prohibit the importation of used motor vehicles from freeports into the country customs territory. However, smuggling continues up to the present as officials at Subic Bay Metropolitan Authority (SBMA) purportedly have not received instruction from Manila to enforce the SC decision, according to AmCham. In line with enforcement, some low and mid-level customs personnel were suspended or dismissed as the result of life-style checks, although no cases were brought against the so-called big fish. Several convictions were also reported in 2006, including, among others, the conviction of a Union Bank branch manager for violating the anti-money laundering law. B. Infrastructure Power Sector In 2006, progress in the sector centered on lowering power prices through (a) NPCs time-of-use (TOU) program, which allows for lower pricing during periods of low demand, (b) lower-priced power for commercial and industrial consumers using more than 1 kilowatt-hour (KW) monthly, and (c) commencement of Wholesale Electricity Spot Market (WESM) operations. In addition, the Energy Regulatory Commission (ERC) continued to strengthen its role as industry regulator, and the Supreme Court avoided any disruptive interventions. In 2006, the NPC and the Manila Electric Company (MERALCO) signed a Memorandum of Agreement (MOA) allowing customers consuming at least one megawatt-hour (MW) to choose their own power supplier. MERALCO also introduced its Consumer Choice program, which functions similarly with NPCs TOU. Moreover, dialogue among MERALCO, NPC and large power consumers also intensified regarding lower rates during the period.

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WESM started commercial operations in mid-2006 and by end of year had sizeable suppliers and customers trading power at reduced rates. WESM is a centralized venue for buyers and sellers to engage in the trading of electricity as a commodity. It is, in effect, a market for electricity. The success of WESM signals the governments effort to level the playing field for all industry players and is likely to provide confidence for investors in the power sector to finance future merchant plants, thus giving opportunity for the country to provide new power supply to the Luzon grid and avoid future power shortages.

In sum, the power sector investment climate still needs to advance faster towards open access and privatization. 2007 will be a critical year for the Power Sector Assets and Liabilities management Corporation (PSALM) to demonstrate real progress on sales of generation and transmission assets. DOE estimates that the country needs over $4 billion in energy sector investments to meet estimated needs by 2014. Biofuel Sector Unprecedented interest in biofuels investment was observed in 2006, particularly in biofuels production for domestic use and for export, in anticipation of the mandatory blending requirements stipulated in the Biofuels Act. Large new investment projects in 2006 include the development of a $140M cane-based ethanol plant in Pampanga for export through Subic to Japan by the US-based Far East Biofuels; the opening of the P1-billion Filipino-owned Chemrez coco-biodiesel plant in Quezon City; and the committed P2-billion bio-ethanol project of San Carlos Bio-Energy, a joint venture between National Development Corporation (NDC) and Bronze Oak Philippines, in Negros Occidental. International donor agencies including the WB/IFC also expressed interest in funding and financing biofuels development projects and renewable energy opportunities in the country. The government, through the Land Bank, also supported the initiative as it allocated $350M of funds for loans to proponents of biofuel and renewable energy projects. Transportation More high-level attention was given to major infrastructure modernization, especially in transportation, in 2006 than at any other time since the 1997 Asian financial crisis. Indeed, President Arroyo, in her 2006 SONA, committed to prioritize a large array of transportation and other projects spread throughout five super-regions7, which would cost nearly P2 trillion over the next four years, of which 65 percent will be funded by the government and the remaining 35 percent by the private sector. The goal is raise future total infrastructure spending to a respectable 5 percent of GDP, while creating a conducive environment for Public-Private Partnership (PPP).

7 The creation of super regions in the Philippines was made by President Gloria Macapagal-Arroyo in her July 2006 State of the Nation Address. These regions are the (1) North Luzon Agribusiness Quadrangle, (2) Metro Luzon Urban Beltway, (3) Central Philippines, (4) Mindanao Super Region, and (5) Cyber Corridor.

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Government initiatives in increasing infrastructure projects strengthened when the Infrastructure Monitoring Task Force was established as a result of the issuance of Executive Order No. 553. The Task Force, headed by Presidential Management Staff (PMS) chief Arthur Yap, shall take steps to speed up the implementation of projects by regularly monitoring and resolving problems of major infrastructure projects, especially in the transport sector. Starting from the expropriated Ninoy Aquino International Airport (NAIA) International Passenger Terminal (IPT) 3, the Philippine government paid Philippine International Airport Terminal Corporation (PIATCO) P3 billion initial payment for the GRP to operate it. NAIA IPT-3 opening was postponed to March 2007 to allow for repairs. While some financed projects had started construction such as the Subic-Clark-Tarlac Expressway and Northrail, work on others barely started including the South Luzon Expressway (SLEX) rehabilitation. Another group (LRT-1 south extension which will connect Manila to Cavite, MRT-3 Phase 2 Edsa North Transit, MRT-7 in Manila and the C-5 to NLEX road connector) remained short of financial closure and start of construction. While it is laudable that the government has targeted hard infrastructure modernization programs and plans, the government has failed to improve the policy framework to increase competition and a regulatory environment to promote productivity and competitive costs to spur investments. At the top of these concerns was the sudden policy reversal that occurred in the air transport sector in the latter part of the 2006. The protectionist EO 500-A signed by President Arroyo in mid-2006 reversed EO 500, which allowed pocket open skies for foreign airlines at Clark and Subic airports, under which Clark has rapidly developed as low-cost airline hub. The measure impedes permanent access to Clark for carriers not covered by GRP bilateral air agreements, including Tiger Airways which was given a 5-year permit by the Civil Aeronautics Board. The incidence also made the company defer its intention to set up its $300M regional hub for Asia-Pacific operations in Clark. Financing Significant reforms in public sector financing were observed in 2006, which resulted in generally better credit standing for the Philippines as a whole. For instance, reports from AmCham stated that increased revenues from the legislated Expanded Value-Added Tax (EVAT) allowed the Philippine government to budget counterpart funding, to resume availment of Japan Bank for International Corporations (JBIC) project loans as well as to fund more projects internally. Also related to financing was the proposed Corporate Recovery Act, which was strongly pushed for enactment by the Bangko Sentral ng Pilipinas (BSP) in 2006. The bill seeks to improve the process of corporate restructuring and bankruptcy by increasing legal options for distressed indebted enterprises. The proposed Corporate Recovery Act offers different means of relief namely Court Rehabilitation, Pre-negotiated Rehabilitation, Fast-Track Rehabilitation, and Dissolution and Liquidation. Another proposal pending in committee in both chambers was the Personal Equity Retirement Account (PERA) bill which seeks to create a tax-free individual retirement program similar to

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the US IRA. PERA accounts can be managed by BSP-accredited banks or trust companies, investment companies, investment houses accredited by the Securities and Exchange Commission, and life insurance and pre-need companies accredited by the Insurance Commission. PERA would strengthen the capital market and provide an investment for remittances of overseas Filipinos. Finally, President Arroyo signed in 2006 Republic Act 9343 extending the Special Purpose Vehicle (SPV) Law, which expired in April 2005, to help reduce bank bad loan ratio. SPVs acquire non-performing assets at substantial discounts and seek to sell them later for a profit. Based on BSP estimates, the extension will enable the banking industry to dispose of P100 billion more of non-performing assets by granting tax exemptions and reduced registration and transfer fees.

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V. Investment Situation in the Philippines Approved Investment Reports from the National Statistical Coordination Board (NSCB) reveal that investment pledges for the first nine months in 2006 grew to Php 283 billion, 88 percent more than the Php 150 billion reported for the equivalent period (see Table 3). The Board of Investments (BOI) was the top source of project approvals for the combined investment of Filipino and foreign nationals, with total value of Php 142 billion in the first nine months of the year. This was 26 percent higher than Php 113 billon for the same period in 2005. Other investment promotion agencies (PEZA, SBMA and CDC) likewise recorded significant improvements in cumulative values of their investment approvals with a combined worth of Php 140 billion.

Table 3. Total Approved Investments by Nationality (Filipno and Foreign) and by Promotion AgencyJanuary to September 2005 and 2006(in million Pesos)

Total Filipino* Foreign Total Filipino* Foreign Total Filipino ForeignBOI 113,239.3 82,266.7 30,972.6 142,341.4 105,584.6 36,756.9 25.7 28.3 18.7 PEZA 35,640.2 8,074.1 27,566.1 58,102.5 19,035.1 39,067.4 63.0 135.8 41.7 SBMA 1,032.1 297.1 735.0 69,943.0 1,526.9 68,416.1 6,676.7 413.9 9,208.7 CDC 434.6 252.8 181.8 12,316.8 4,512.2 7,804.6 2,734.0 1,684.9 4,192.8 Total 150,346.2 90,890.7 59,455.5 282,703.7 130,658.7 152,044.9 88.0 43.8 155.7 % Share to Total 100.0 60.5 39.5 100.0 46.2 53.8

Source: National Statistiscal Coordination Board* includes al committed investments of Filipnos in wholly or partially owned companiesNote: details may not add up to totals due to rounding.

Growth rateJan-Sept. 2005 - Jan.-Sept. 2006Agency

Approved Investments2005 2006

The total cumulative projected employment from investment commitments from January to September 2006 reached 125,665, a 39 percent increase from last years 90,487 jobs. The Philippine Export Zone Authority (PEZA) topped in the generation of potential jobs with a total of 62,215 employment opportunities. PEZAs employment potential represents 50 percent of the total projected employment for the period. Meanwhile, FDI comprised 54 percent of the total investment pledged in the first nine months of 2006, with 45 percent or Php 68 billion of the Php 152 billion approved through SBMA. Pledges from Filipino nationals stood at Php 131 billion, 81 percent or Php106 billion of which were approved by BOI. Notably, approved investments by Filipino nationals in the third quarter of 2006 surged to Php 72 billion, more than 9 times its year-ago level of Php 8 billion. This upsurge in local investments was reportedly boosted by a BOI-approved project, which engages Filipino investors in power generation valued at Php 44 billion, representing 60 percent of total pledges from Filipino nationals in the quarter.

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Table 4. Total Approved Investments (Filipino and Foreign) by IndustryJanuary to September 2005 and 2006(in million Pesos)

2005 2006

Agriculture 93.9 4,660.5 1.6 4,863.8 Mining 602.3 3,671.4 1.3 509.6 Manufacturing 111,809.6 118,424.2 41.9 5.9 Electricity 17,473.5 45,352.6 16.0 159.6 Gas 90.2 - - - Water - - - - Construction 83.3 180.0 0.1 115.9 Trade 303.9 26,151.7 9.3 8,506.2 Transportation 941.5 1,677.9 0.6 78.2 Storage 25.2 25.7 - 2.0 Communication 2,019.5 38,982.1 13.8 1,830.3 Finance and Real Estate 5,523.6 19,529.1 6.9 253.6 Services 11,379.6 24,048.6 8.5 111.3 Total 150,346.2 282,703.7 100.0 88.0

Source: National Statistiscal Coordination BoardNotes: Details may not add up to totals due to rounding.The services industry includes hotels/restaurant businesses, computer software development, health care program services, renting and leasing of water sport equpment, training services,protection/security training course, college education and other services.

Industry

Approved InvestmentsPercent to total Jan-Sept. 2006

Growth Rate Jan-Sept. 2005 - Jan. Sept. 2006

January - September

Of the sectors, manufacturing, the largest proportion of approved investment, rose by 6 percent in the first three quarters of 2006, reaching Php 118 billion from Php 112 billion in 2005 (see Table 4). Pledges to the electricity and communication sectors were also substantial at Php 45 billion and Php 39 billion, respectively, comprising almost 30 percent of total investment pledged during the period. Approved investment plans in services reached Php 24 billion, more than doubling the Php 11 billion in the equivalent period in 2005. Strong growth was observed in agriculture, trade (wholesale and retail), and communication. Improvement in trade could be attributed to the booming franchising industry. In 2006, franchising outlets reached 100,000 in the country while franchising concepts reached 850. In particular, several retailers such as HBC (personal care), Bayo (womens ready-to-wear), 7-eleven (convenience store), and PR Gaz Haus Holdings, Inc. (liquefied petroleum gas company) expanded their market through franchising during the period. Improved investment in communication is driven mainly by the surge in FDI in the information and communication technology (ICT) sector from Php 12 billion in 2005 to Php 24 billion this year, a 96 percent growth rate. The introduction of the third-generation (3G) mobile technology partly helped to boost the sector. In 2006, more than nine companies signified interest in becoming 3G operators.

12

Approved Foreign Direct Investment Approved FDI for the first nine months of the year posted a 156 percent growth, totaling 152 billion compared to the Php 60 billion approved FDI approvals in the same period in 2005 (see Figure 2).

F i g u r e 2 . A p p r o v e d f o r e i g n d i r e c t i n v e s t m e n t s : J a n u a r y - S e p t e m b e r 2 0 0 5 a n d 2 0 0 6

5 9 . 5

1 5 2 . 0

-

5 0 . 0

1 0 0 . 0

1 5 0 . 0

2 0 0 . 0

J a n - S e p t . 2 0 0 5 J a n - S e p t . 2 0 0 6

S o u r c e : N a t io n a l S t a t is t ic a l C o o r d in a t io n B o a r d

i n b i l l i o n P h P

The cumulative approved FDI from January to September 2006 for the manufacturing sector reached Php 106 billion, an expansion of 163 percent over Php 40 billion in 2005 (see Table 5). FDI pledges to the sector comprised 7o percent of the total investment commitments for the period. Meanwhile, the trade sector was the second top recipient of investment commitments in the first nine months of 2006, growing to Php 20 billion from Php 84 million in 2005. The services sector likewise improved to Php 16 billion, more than doubling its level of Php 7 billion last year.

13

Table 5. Total Approved Foreign Direct Investments by IndustryJanuary to September 2005 and 2006(in million Pesos)

2005 2006

Agriculture 330.2 2,355.8 1.5 6,986.5 Mining 225.3 724.1 0.5 221.4 Manufacturing 40,243.9 105,902.7 69.7 163.2 Electricity 10,863.5 439.0 0.3 (96.0) Gas 90.2 - - - Water - - - - Construction 33.9 80.5 0.1 137.4 Trade 84.0 19,542.5 12.9 23,170.9 Transportation 339.6 887.3 0.6 161.3 Storage 0.1 8.9 - 7,237.3 Communication - 2,669.7 1.8 - Finance and Real Estate* 128.0 3,516.1 2.3 2,646.3 Services 7,413.8 15,918.1 10.5 114.7 Total 59,455.5 152,044.9 100.0 155.7 * Includes Economic Zone Development and Industrial ParkSource: National Statistiscal Coordination BoardNotes: Details may not add up to totals due to rounding.The services industry includes hotels/restaurant businesses, computer software development, health care program services, renting and leasing of water sport equpment, training services,protection/security training course, college education and other services.

Industry

Approved InvestmentsPercent to total Jan-Sept. 2006

Growth Rate Jan-Sept. 2005 - Jan. Sept. 2006

January - September

Among the investment promotion agencies, SBMA approved the most FDI, with 45 percent or Php 68 billion of total FDI approved in the first nine months of 2006 (see Table 6). The positive growths in FDI pledges approved by BOI and PEZA and the significant improvement in approvals by CDC further boosted the collective January-September results. Table 6. Total Approved Foreign Direct Investments by Promotion Agency

January to September 2005 and 2006(in million Pesos)

2005 2006BOI 30,972.6 36,756.9 24.2 18.7 PEZA 27,566.1 39,067.4 25.7 41.7 SBMA 735.0 68,416.1 45.0 9,208.7 CDC 181.8 7,804.6 5.1 4,192.8 Total 59,455.5 152,044.9 100.0 155.7

Source: National Statistiscal Coordination BoardNotes: Details may not add up to totals due to rounding.

Growth Rate Jan-Sept. 2005 - Jan. Sept. 2006

AgencyApproved FDI

January - SeptemberPercent to total Jan-Sept. 2006

In terms of country-specific investors, Koreans were the top source of FDI commitments in the first three quarters of 2006 with Php 53 billion, constituting 35 percent of the FDI for the period (see Table 7). The USA and China with Php 35 billion and Php 18 billion worth of commitments, respectively, followed in second and third places. Japan, in the fourth place, closely followed China with Php 17 billion. Together, the top four contributed 81 percent of potential FDI for the period. China, the UK, and Malaysia also posted high growth rates in 2006. China pledged to inject Php 18 billion, all of which is committed to the manufacturing sector, according to the NSCB (see Table 8). Moreover, significant investment commitments from China were also reported in the latter part of 2006 in the infrastructure, mining, and energy sectors. Britains major investments in the Philippines concentrated in financial and other services. Table 8 shows that British investors were the largest in finance and real estate, with investments reaching to Php 3 billion, during the first three quarters. In addition, British firms are also interested in entering into joint ventures with call center and business process outsourcing companies, and in pharmaceutical ventures in the Philippines. .

14

15

T a b le 7 . T o t a l A p p r o v e d F o r e ig n D ir e c t In v e s t m e n t s b y C o u n t r y o f In v e s t o rJ a n u a r y t o S e p t e m b e r 2 0 0 5 a n d 2 0 0 6( in m i l l io n P e s o s )

2 0 0 5 2 0 0 6

A u s t r a l ia 5 5 8 .9 5 7 7 .7 0 .4 3 .4 B r . V i r g in I s . 4 0 9 .0 6 2 8 .4 0 .4 5 3 .6 F r a n c e 2 2 .5 4 2 .5 - 8 8 .7 G e r m a n y 3 9 8 .4 9 3 .5 0 .1 ( 7 6 .5 ) H o n g K o n g 1 4 .0 4 5 6 .7 0 .3 3 ,1 6 7 .4 I n d o n e s ia - 1 1 .0 - - I t a ly 7 .7 1 8 .4 - 1 4 0 .1 J a p a n 2 3 ,5 0 3 .6 1 7 ,4 8 1 .4 1 1 .5 2 5 .6 K o r e a 1 0 ,5 1 6 .2 5 2 ,7 1 5 .3 3 4 .7 4 0 1 .3 M a la y s ia 1 9 .5 8 3 3 .3 0 .5 4 ,1 7 8 .1 N e t h e r la n d s 7 ,5 9 0 .7 7 ,0 3 9 .0 4 .6 ( 7 .3 ) P R O C 8 2 .3 1 7 ,7 9 3 .6 1 1 .7 2 1 ,5 1 4 .1 S in g a p o r e 2 6 6 .6 6 ,1 2 4 .5 4 .0 2 ,1 9 7 .6 S w e d e n - - - - S w it z e r la n d 8 1 7 .2 5 3 1 .4 0 .3 ( 3 5 .0 ) T a iw a n 1 ,1 5 2 .0 1 ,0 6 6 .6 0 .7 ( 7 .4 ) T h a i la n d 1 ,5 3 3 .5 2 2 .2 - ( 9 8 .6 ) U K 1 0 2 .2 9 ,0 1 4 .9 5 .9 8 ,7 1 7 .5 U S A 1 0 ,2 3 7 .2 3 4 ,7 1 1 .8 2 2 .8 2 3 9 .1 M a n x - - - - N a u r u - 4 3 9 .0 0 .3 - C a y m a n I s la n d s - 3 8 4 .0 0 .3 - O t h e r s 2 2 3 .9 2 ,0 5 9 .4 1 .4 ( 7 .4 ) T o t a l 5 9 ,4 5 5 .5 1 5 2 ,0 4 4 .9 1 0 0 .0 1 5 5 .7

S o u r c e : N a t io n a l S ta t is t is c a l C o o rd in a t io n B o a r dN o te : D e ta i ls m a y n o t a d d u p t o to ta ls d u e t o ro u n d in g .

C o u n t r y

A p p r o v e d In v e s t m e n t sP e r c e n t t o t o t a l J a n - S e p t . 2 0 0 6

G r o w t h R a t e J a n - S e p t . 2 0 0 5 - J a n . S e p t . 2 0 0 6

J a n u a r y - S e p t e m b e r

16

Table 8. Approved Foreign Direct Investments, by Nationality and by SectorJanuary - September 2006

Nationality Manufacturing Mining Commu-nicationFinance &

Real Estate ServicesCons-

tructionTrans-

portation TradeAgri-

culture Storage Electricity

Australia 53.2 413.4 - - 109.8 1.2 - - - - - 577.7

Br in Is 33.2 - - - 595.2 - - - - - - 628.4

Cayman Islands 150.6 - - 156.6 76.9 - - - - - - 384.0

France 16.8 - - - 12.7 - - 13.0 - - - 42.5

- - - - 85.8 - - 7.7 - - - 93.5

Hong Kong 29.2 - - - 160.6 - - 266.9 - - - 456.7

Indonesia 2.7 - - - 8.4 - - - - - - 11.0

Italy 2.7 - - - - 15.7 - - - - - 18.4

Japan 16,991.8 - - 159.8 319.9 - 9.9 - - - - 17,481.4

Korea 52,444.8 - - 156.6 113.9 - - - - - - 52,715.3

Malaysia 90.9 - - 1.2 741.2 - - - - - - 833.3

Nauru - - - - - - - - - - 439.0 439.0

Netherlands 434.9 - - - 469.2 - - 6,135.0 - - - 7,039.0

PROC 16,629.6 - - 8.1 277.8 14.4 854.4 9.3 - - - 17,793.6

Singapore 495.5 - 1,920.0 1.2 1,352.1 - - - 2,355.8 - - 6,124.5

Sweden - - - - 0.0 - - - - - - 0.0

Switzerland 4.7 - - - 526.7 - - - - - - 531.4

Taiwan 1,017.2 - - - 5.2 - 0.5 34.7 - 8.9 - 1,066.6

Thailand 22.2 - - - - - - - - - - 22.2

UK 65.6 - - 2,631.4 2,800.5 - 21.3 - - - - 5,518.9

USA 17,209.1 - - 335.5 4,092.6 - 1.0 13,073.6 - - - 34,711.8

Others 208.0 310.7 749.7 65.7 673.6 49.2 - 2.5 - - - 2,059.4

Grand Total 105,902.7 724.1 2,669.7 3,516.1 12,422.1 80.5 887.3 19,542.5 2,355.8 8.9 439.0 148,548.9

SectorsTOTAL

Germany

Virg

Domestic Capital Formation In 2006, domestic capital formation increased to P224 from P220 billion in 2005, posting a sluggish but positive 2.1 percent growth in real terms (see Table 9). Fixed capital grew by 0.6 percent, recovering from a negative growth rate of 3.9 percent in 2005, but still the lowest since 2002. Public construction spending grew by 13 percent, although private construction remained sluggish and further slipped by 3 percent. Durable equipment spending continues to remain low.

Table 9. Domestic Capital Formation, 2002-2006.

(Levels in Million Pesos)AT CONSTANT 1985 PRICES 2002 2003 2004 2005 2006

Capital Formation 212,081 218,412 234,065 219,926 224,583 A. Fixed Capital 213,270 221,286 224,176 215,399 216,593 1. Construction 96,337 95,154 94,402 93,550 96,196 2. Durable Equipment 100,593 109,869 113,359 105,298 103,849 3. Breeding Stock & Orchard Dev't 16,340 16,263 16,415 16,551 16,547 B. Changes in Stocks -1,189 -2,874 9,889 4,527 7,991GROSS DOMESTIC PRODUCT 1,034,094 1,085,072 1,152,174 1,209,473 1,274,415Net factor income from abroad 71,601 86,359 98,014 111,208 128,312GROSS NATIONAL PRODUCT 1,105,695 1,171,431 1,250,188 1,320,681 1,402,727

(Growth Rates)AT CONSTANT 1985 PRICES 2002 2003 2004 2005 2006

Capital Formation (4.3) 3.0 7.2 (6.0) 2.1 A. Fixed Capital 2.1 3.8 1.3 (3.9) 0.6 1. Construction (0.7) (1.2) (0.8) (0.9) 2.8 2. Durable Equipment 4.8 9.2 3.2 (7.1) (1.4) 3. Breeding Stock & Orchard Dev't 3.3 (0.5) 0.9 0.8 (0.0) B. Changes in Stocks (109.3) 141.7 (444.2) (54.2) 76.5 GROSS DOMESTIC PRODUCT 4.4 4.9 6.2 5.0 5.4 Net factor income from abroad 0.5 20.6 13.5 13.5 15.4 GROSS NATIONAL PRODUCT 4.2 5.9 6.7 5.6 6.2

(GDP-based Percent Distribution)AT CONSTANT 1985 PRICES 2002 2003 2004 2005 2006

Capital Formation 20.5 20.1 20.3 18.2 17.6 A. Fixed Capital 20.6 20.4 19.5 17.8 17.0 1. Construction 9.3 8.8 8.2 7.7 7.5 2. Durable Equipment 9.7 10.1 9.8 8.7 8.1 3. Breeding Stock & Orchard Dev't 1.6 1.5 1.4 1.4 1.3 B. Changes in Stocks (0.1) (0.3) 0.9 0.4 0.6 GROSS DOMESTIC PRODUCT 100.0 100.0 100.0 100.0 100.0

Source: National Accounts of the PhilippinesNational Statistical Coordination Board

Actual foreign capital inflows increased, in line with global trends of increased capital flows into ASEAN and other emerging markets. FDI, as measured by the BSP for 2006, rose to Php 85 billion, an encouraging increase of 54 percent from last years net inflow of Php 55 billion, and even higher than the global FDI inflow growth rate of 34 percent (see Table 10). Contributing significantly to the rise in FDI inflow was the reversal of the other capital account to a net inflow of Php 37 billion from last years net inflow of Php 10 billion.

17

18

able 10. Balance of Payments Foreign Direct Investments*nuary to September 2005 and 2006

in million Pesos)

2005 2006

n-residents' investments in the Phils. 55,140.6 85,006.1 100.0 54.2 uity Capital (net) 56,817.7 48,863.0 57.5 (14.0)

einvested Earnings** 7,877.9 (588.8) (0.7) (107.5) ther Capital 9,555.0 36,731.9 43.2 484.4

ource: Bangko Sentral ng Pilipinas Date last updated: 11 December 2006* data includes reinvested earnings from banks only

January to September Percent to total Jan-Sept. 2006

Growth Rate Jan-Sept. 2005 - Jan. Sept. 2006

T Ja ( No Eq R O S * *

Failed investment plans Probably the biggest failed investment plan in the country in 2006 occurred during the latter half of the year, when President Arroyo amended EO 500 - a law which liberalizes air access of international passengers to the Diosdado Macapagal International Airport (DMIA) and the Subic Bay International Airport (SBIA), and gave airlines some assurance of permanent permits to operate there - by signing EO 500-A, even before the former was implemented. As discussed previously, EO 500-A essentially reverses EO 500 as it specifies that only designated airlines from 60 countries with existing Air Service Agreements with the Philippines can operate at DMIA and SBIA, but limited to only third and fourth freedoms. EO 500-A restricted the expansion plans of Tiger Airways, a Singaporean company, because it is not a designated carrier like other foreign airlines currently operating at DMIA. In 2006, Tiger Airways deferred setting up its $300M regional hub and base at least six new Airbus 320s for Asia-Pacific operations at Clark. Tiger Airways was estimated to generate some 10 million passengers over a five-year period and expand its network to cover routes between Clark and Thailand, Macau, China, Taiwan, Korea, Malaysia and Indonesia and, possibly, Vietnam and Australia. Data on cancelled registered investment at BOI is not well-maintained. What is available for 2006 is presented in Table 10. Most of these consist of capital-intensive geothermal power activities which indicated financial difficulty as main reason for their failure to start operations. Other problems include conflict between the investor and the local community and unfavorable economic development.

Firm Ownership CR No./ Date Activity/ Capacity Plant Location

Target Operation Date

Project Cost (P000)

Reason(s) for Non-Implementation

1. Natural Resources Mining Devt. Corp.

Filipino 100% 2005-162/ 28-Oct-05

Exploration Project Sitio Depot, Monkayo, Compostela Valley, Davao

June 2005 204,300

Temporarily stopped operations since last quarter 2006 due to financial problems

2. Goldsun Cement Corp. Taiwanese-50% Res. Chinese50% 98-027/ 28-Jul-98

Cement / 1,600,000 MTPY

Sitio Abagatanen, Brgy. Macaboboni, Agno, Pangasinan

January 2004 12,766,231

Problems with local residents regarding environmental concerns

3. LMI Holdings Corp. Filipino 100% 98-075/ 21-Aug-98 Cement / 1,500,000 MTPY Cebu Province February 2000 6,565,000

Due to unfavorable economic development for the industry

4. TVI Resource Devt. Phils., Inc.

Canadian 40% Filipino 60%

95-192/ 13-Oct-95

Mining Exploration/ 5,000 HAS. Rapu-Rapu, Albay July 1995 44,364

Peace and order problem in firms exploration sites

5. Ilocos Norte Power Corp. Filipino 100% 97-092/ 14-May-97 Bunker-C fired power plant/ 60MW

Brgy. Of Alejo - Malasig, Municipality of Vintar, Province of Ilocos Norte

December 2001 2,123,460 Financial Difficulty

6. PNOC Energy Devt. Corp. Filipino 100%

2001-138/ 07-Sep-01

New operator of geothermal power plant/ 40MW

Bo. Saoit & Pagali Pagudpud, Ilocos Norte October 2004 2,171,400 Financial problems

7. PNOC Energy Devt. Corp. Filipino 100%

95-378/ 24-Sep-96

New operator of geothermal power plant/ 120 MW

Labo, Camarines Sur December 1998 6,045,040 Technical problems

8. PNOC Energy Devt. Corp Filipino 100% 2004-059/ 21-May-04

New operator of geothermal power plant/ 26MW

Palinpinon, Southern Negros March 2006 2,580,000 Financial problems

9. PNOC Energy Devt. Corp Filipino 100% 2004-056/ 12-May-04

New operator of geothermal power plant/ 54MW

Mailum, Bago City, Negros Occidental July 2006 7,414,000 Financial problems

10. Talisay Bioenergy Inc. Filipino 100% 2004-124/ 28-Oct-04

New operator of cogeneration power plant/ 30 MW

Barangay Dos Hermanas, Talisay City August 2006 3,141,800 Financial problems

11. Agusan Power Corp.

Filipino 95% American 5%

2002-058/ 16-Apr-02

Hydro Power Plant/ 22 MW

Magdagooc, Jabonga, Agusan del Norte July 2004 703,763 Financial problems

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Source: Board of Investments

Table 10. BOI-registered mining and infrastructure projects canceled as of December 2006

V. Investment Situation and Challenges in Key Sectors Health and Retirement Sector The health and medical tourism industry is growing globally, with growing spillover effects on tourism spending. In fact, tourism may be combined with wellness and medical treatment. The report from the October 2006 Workshop on FDI estimated that the global healthcare tourism industry is estimated at $40 billion, with close to 50% in wellness and spas. The senior market (65 years and above) is growing significantly over the last decade. Henry Schumacher, executive vice president of the European Chamber of Commerce of the Philippines, estimated that Japan would have 30 percent of its population belonging to the senior market by 2010 from 21 percent in 1996; Germany would have 25 percent in 2010 from 21 percent in 1996; and Italy would have 26 percent in 2010 from 22 percent n 1996. With demographic aging in developed countries, the growth potential for retirement and medical tourism in low-cost tropical countries is considerable. Several tropical developing countries (e.g. Costa Rica, Malaysia, Mexico and Thailand) have been successful in attracting considerable numbers of retired residents from developed countries. India, Singapore and Thailand are attracting increasing numbers of visitors seeking inexpensive medical and dental services.

Table 11. Prices of Selected Medical Treatments in Asia, 2003.

21

Thailand has taken a leading position in Asias medical and cosmetic tourism markets. Thailand is stealing a lead on its competitors as it successfully attracts Western and non-Western patients for low cost treatments with packages that offer post-recovery resort stays (see Table 11). The Philippines has yet to leverage its strengths to carve out a share of this growing market. The Philippine retiree program has had limited success, while medical tourism is just beginning. With more than 1,200 hospitals and many medical and nursing schools, the country has a considerable health infrastructure, including several modern facilities located in Metro Manila. However, few non-resident foreigners receive treatment in the country. In 2006, Philippine investment, both domestic and foreign, has been modest in this sector. Only a few major investments occurred in 2006, including:

The Php 3 billion earmarked funds of UST Hospital for upgrading facilities as a medical tourism destination; and

The Php 350 -billion-worth Benavides Cancer Institute recently opened by UST, the first of its kind in the country.

Other investment for the sector are reportedly still in the pipeline as foreign and local inventors expressed their intention to either expand their existing facilities or put up new ones in the country. Some of which were:

Cebu Doctors Hospitals plan to put up an integrated retirement village facility in Naga, utilizing the 250-bed Cebu Doctors' South General Hospital as medical component;

Investment plan of Asian Hospital to expand its operation under a partnership with Thailands leading hospital group;

Cardiovascular Hospitals of Americas investment plan to establish a P1B medical facility in Cebu.

The new Philippine law on dual citizenship may encourage some Philippines-American doctors to return as health care investors. Meanwhile, a large number of Filipinos that have worked in health care services in the US and other countries could be a great potential to be medical service providers in the Philippines if they return home. In 2006, the President declared the retirement industry a flagship program. The new government retirement agency chief, former Philippine National Police (PNP) head Aglipay, and new Philippine Retirement Inc. head Ordonez announced an extremely ambitious target goal of one million foreign retirees by 2015. This initiative is supported by the JFC. The sector faces numerous challenges. For example, a study of the University of Asia and the Pacific (UA&P) in 2006 pointed out problem areas in medical tourism including the absence of good infrastructure coupled with an apparent lack of effective strategy to market the country as alternative destination. The restrictive laws covering practice of foreign professionals and foreign ownership of hospitals and retirement homes also deter FDI in the sector. AmCham member Palafox Associates, for example, told press that the Philippines could miss out on the $42 billion market for second homes of foreigners if GRP does not repeal obsolete laws. The same concern was also raised

22

during the Workshop on FDI in October 2006. Concerns over the deteriorating transportation infrastructure remain, particularly in Metro Manila and Cebu. Aside from the processing, maintenance and other fees charged to retirees, there is also a growing concern over the tedious and costly processing of visas and other required documents for foreign nationals to enter the country. Information and Communication Technology After India, the Philippines is viewed as the best low-cost location although far smaller than India in terms of the size and skills of its workforce for the growth of internetenabled services, such as call centers, business processing, animation, medical transcription, engineering/design and other services provided remotely over the internet. Several new locations in low-cost countries are entering the market, adding to the competition. Nevertheless, the demand for such work to be performed in the Philippines exceeds the supply and will only be met by improvements in the skills of the workforce, both near-term remedial training and longer term through reversing the decline of education in the country. In March 2006, President Arroyo committed to prepare one million Philippine workers by 2010 for jobs in the rapidly-growing call center and business process outsourcing sector, up from the 200,000 currently working. While such a five-fold increase is optimistic, the government has made a good start by establishing a remedial training scholarship fund for 100,000 ICT near-hires who failed to obtain jobs because of deficient language or IT skills. The DepEd is also working to improve the poor quality of English, math and science teachers. PEZA prepared an attractive mix of incentives for new investors in the sector, while Department of Labor and Employment (DOLE) consistently grants waivers for female employees to work at night. PEZA designated as IT Zones 3 buildings in NCR including Market! Market! shopping mall. Related to this, President Arroyo signed eight proclamations for new PEZA IT zones in Metro Manila and Cebu. The first half of 2006 saw continuing strong activity in the fast-growing IT-enabled services (ITES) sector with many investor inquiries, firms visiting to evaluate and announcements of start of operations and expansions. Two of the largest Philippine companies are buying into established BPO firms. Data from the NSCB showed that approved FDI in the ICT industry showed a 96 percent increase, from Php 12 billion in 2005 to Php 24 billion this year. Filipino nationals pledged less investment in ICT during the period, with only Php 2 billion, a decline of 41 percent from Php 3 billon in 2005. Of the total FDI investment approvals in ICT as of September 2006, 53 percent of Php 13 billion was intended for manufacturing. Investments in IT services reached Php 11 billion while the trade subsector stood at Php 3 million worth of FDI. There were no FDI investment applications for the telecommunications sector during the period.

23

Table 12. List of reported investments in ICT

Actual Planned $10+ million investment of Bigfoot

Entertainment in digital entertainment production facility in Cebu.

Dell dedicated new customer care

center located in Mall of Asia, employing 1,400 call center personnel; Dell later announced 2nd RP call center at Eastwood SEZ.

GE Indian affiliate GENPACT opened

500-person shared services center.

ICT Group opened 3rd contact center located in a former textile plant in Marikina. ICT Group announced it will add 800 more seats at Philippine call centers.

P1B facility of Sutherland Global

Services at Clark SEZ, its 3rd in RP.

Clark Cyberservices and Shogee Studios announced $10M computer movie studio project at Clark to employ 500.

AmCham member Accenture will

invest $20M over next 18 months, expanding workforce to 12,000 from current 7,500.

People Support to invest $15 M to add

2,000 seats in 2006. Araneta Center plans to invest P4B in a

Cyber Park of 11 low-rise buildings, located near MRT3 and LRT2.

Ayala Land announced plans to spend

$10M for two BPO campuses.

AmCham member Convergys dedicated a new facility in Makati. It also announced the opening of its 2nd call center in Cebu and 8th in RP with 700 employees.

AmCham member TeleTech plans to

open 4 more call center sites and increase its workforce from 8,000 to 15,000.

Ayala Land plans to invest P6B in

science and technology park on 38-ha property of UP Diliman campus.

Source: American Chamber of Commerce, 2006. Despite these strong positive developments, there are ICT sector weaknesses restraining growth. T declining quality of English language proficiency continuously threatens this promising sector. As such, more private sector involvement is highly recommended to undertake improvement in the quality of Filipino English-speakers. The government should also consider review, assessment and improvement in the College Curriculum gearing towards enhancing demand-driven education.

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The Philippines should also struggle to move up the value chain, following Indias efforts to progress from business process outsourcing to knowledge process outsourcing. This can be done through continuous improvement in the productivity of workforce through training, capability building efforts, etc. Specialization and market-niche targeting (i.e., wireless apps, gaming, medical transcription, etc.) could also benefit the development of the Philippine ITES sector. Manufacturing BOI and PEZA data show a continuing modest expansion of many existing export manufacturing plants and some new firms locating in the country (see Figure 3). A few export plants have closed to centralize elsewhere in ASEAN after low AFTA tariffs created regional economies of scale. Manufacturing for the domestic market appears to be in gradual decline as cheaper goods from China are competing in local markets.

Figure 3. Total Approved FDI in Manufacturing, by Agency, 1996-2006 Although local manufacturing continued to decline, manufactured exports increased, led by electronics, and foreign investment in the sector strengthened. Several large foreign manufacturing investments were announced. The electronics industry association predicted its members will invest up to $1 billion this year to meet growing global demand.

SEIPI reported in the first quarter of 2006 that PEZA-registered new investment by 20 semiconductor and electronic firms totaled P4.4 billion, compared to Php 663 million in the same period in 2005.

There are numerous challenges facing the growth of manufacturing, and several of these are reflected under most of the main ICIP reform groups: red tape, power pricing and availability, education, security and transportation infrastructure. Wages are not a major concern for exporters, although there are concerns to limit minimum wage increases; labor and immigration laws need modernization. The Philippines retains potential to grow export manufacturing

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significantly if labor untry a more efficient oper

During the October n the country include:

Modernize th Allow foreig Reduce smug Train more e Develop elec Hold/Stop i Resolve issue Be and be pe A unified gov

Finally, consensus w eness Summit for the fast NA, both in the short- and

Recent Major Appr

PEZA-appcomprised

SBMA-apwhich con

New and Planned I

Cold chain Colgate Pa Ford Philip

investmen Hanjin He Hebei Jing Honda ina Hyundai M Temic Au Tsuneishi Wistron in BOI appro

pioneer sta Ichia Tech

circuit boa Investment Opportu

Componen Higher Va

product de Original E

automotiv Electronic Original D

productivity can be increased and reforms implemented to make the coating location.

2006 Workshop on FDI, recommendations to improve manufacturing i

e Labor Code; n ownership of commercial, industrial and residential land; gling and hijacking;

ngineers and scientists; tronics testing and R & D subsectors; nvestment-unfriendly legislations; on constitutional barriers;

rceived as a stable government; ernment-senate/congress/executive healthy working relationship.

as achieved both in the Workshop on FDI and the National Competitiv and seamless delivery of infrastructure projects in the Presidents SO medium-term.

Box 1. Significant Developments in the Manufacturing Sector

oved FDI in Manufacturing roved project to engage in the fabrication of solar wafers, worth Php14 billion which almost 50% of FDI pledged in Q4 2005 to the manufacturing sector proved project involving the manufacture of glass products, worth Php 16 billion stituted 66% of FDI pledged in Q2 2006 to the manufacturing sector

nvestment Projects facilities being constructed in 3 cities in Mindanao lmolive Philippines to undertake $40 M expansion pines launched FFV (Flexible Fuel Vehicle) Technology. Ford plans $40 M

t to manufacture FFV engines in Philippines

avy Industries began work on $1B shipyard at Subic to employ up to 20,000 niu Group said going ahead with $312M glass project at Subic ugurated $25 M motorcycle plant otor may assemble vehicles; Philippine 2005 sales doubled

tomotive plans 4-year, 77M investment program for parts manufacturing Heavy Industries committed to invest $100M to expand Cebu shipyard vesting additional P400M to assemble GPS devices at Subic ved P12B investment of SW Cement in new clinker-based cement plant in Cebu with tus but granted non-pioneer ITH nologies expressed interest to build $60M manufacturing facility for keypad and rds in RP

nities in the Electronics Industry ts/ Parts Manufacturers: Plastics, metals, cables, PCBs, flex circuits, etc. lue Services Providers for the Semiconductor Industry: test engineering, design and velopment services, etc. quipment Manufacturers (OEMs): Computing, communications, consumer, e, industrial, and medical electronics s Manufacturing Services (EMS) Providers esign Manufacturers (ODMs)

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Mining For more than a century, American firms have been involved in developing Philippine natural resources in mining, petroleum and natural gas, the later involving the largest investment project in Philippine history. A 2004 Supreme Court decision that affirms foreign participation in mining has kindled considerable international interest in several dozen potential projects. Mining has the potential to create a considerable number of jobs and provide the government with large royalty income. While the government is generally supportive, there is strong distrust of the mining industry among local communities, including Roman Catholic bishops in dioceses where the mining projects are located. Based on widespread abusive environmental practices of extractive mining and logging activities in the past, the bishops remain to be convinced that future projects will benefit local communities and protect the environment. A waste dam overflow at a foreign mining project in Albay in early 2006 created considerable negative publicity. Other foreign projects in Nueva Ecija and Zamboanga have elicited local protest.

Source: Philippine Mineral Exploration Association

Figure 4. Mineral Potential Map of the Philippines

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Box 2. Significant Developments in the Mining Sector Major Mining Investment/Operations Coral Bay Nickel in Palawan silver-gold project Rapu-Rapu Polym gold project of Lep copper mine expan

O going Constructions and

copper-gold projec nickel project of S

In final feasibility and finan

gold project of Fil Carmen copper pro Nonoc nickel proje King King copper Far Southeast Gold Itogon gold projec cement project of

New and Planned Investme

GRP l proposal to Lepanto to resume Philex Mining to r TVI Resources to Filminera Resourc

involving $100 mi MRI Resources AG Rio Tinto Group (

nickel mining in R AngloGold, MRI R Subject of pre-feas

Management in Padel Norte; copper-copper project of Sin Surigao del Nor

Indophil ResourceXstrata QueenslanCotabato), Columbreached to $1.4 bil

Berong Nickel - suin Palawan

Philnico agreed toFerrous Metals (PR

of TVI Resource Development in Zamboanga del Norte etallic project of Lafayette in Albay anto in Benguet sion of Philex Mining in Benguet

Development: t of Australasian Philippines Mining in Didipio, Nueva Vizcaya urigao Integrated Resource in Surigao del Norte

cing stage minera Resources in Masbate ject of Atlas in Cebu ct of Pacific Nickel Philippines in Surigao del Norte project of Benguet and NDC in Mindanao project of Lepanto in Benguet

t of Itogon Suyoc Mines in Benguet Eagle Cement in Bulacan

nt Projects Jinchuan Non-Ferrous Metals to take over Philnico for $1 billion investment copper operations in Benguet as global prices rise evive Bulawan gold mine project in Surigao invest $23 million for Canatuan, Zambales gold mine es said it will start Aroroy gold mining project in Masbate in first quarter of 2007, llion in new investment

in talks to provide financing to Atlas Consolidated Mining Australian) and Chemical Vapour Metal Refining to invest as much as $3 billion in P esources, Harmony Gold Mining expressed interest in mining projects

ibility studies and advance exploration are: Berong nickel project of TMM lawan; gold project of Greenstone Resources, Red V and JCG Resources in Surigao gold project of Colet Mining and Development in Negros Occidental; Tampakan agittarius Mines in South Cotabato; and copper project of Silangan Mindanao Mining te s completed pre-feasibility study in So