[ANALYSIS] The real score on foreign direct investments

 

"EJKs will frighten investors."

Such was the grave warning from Mahathir Mohamad at a forum in Manila in October 2017, covered by Bloomberg News. As former prime minister of Malaysia and one of the architects of its phenomenal economic rise, Mahathir oversaw the over-six-fold real increase in the Malaysian economy and the near eradication of poverty in that country.

Mahathir’s warning to the Philippines comes at a critical time, as the country’s continued economic expansion hangs in the balance against the lingering threat of terrorism taking root in the country, growing international concern over the deaths related to the government’s anti-drugs campaign, and the recent political rumblings coming from within the administration itself.

Is FDI in the Philippines catching up with ASEAN leaders?

FDI posted an increase from $US8.3 billion in 2016 to $10 billion in 2017, marking a good start for the Duterte administration. Still, it is worth noting that FDI growth in previous years was much higher than this.

Figure 1. Comparative trends of FDI inflows across neighboring countries in the first two years of Aquino and Duterte, in million US$

It is also critical to start benchmarking the Philippines’ FDI performance with other countries – including in ASEAN. Year 2010 was the onset of the rapid FDI growth in the country – the last 7 years has been a period of FDI catch-up. At an initial growth rate of 88%, FDI consistently expanded in the succeeding years at a relatively faster rate compared to its neighboring countries.

Figure 2. Growth rate (%) of foreign direct investments inflows, 2010 - 2017

Comparing the country’s performance with its neighboring countries, the FDI growth rate of Indonesia posted a phenomenal rebound at 386% in 2017 from a deep decline in 2016, while Vietnam maintained a surge of around 12%.

Nevertheless, because the base FDI stock for these ASEAN neighbors is much higher than the Philippines' – 2.2 and 1.4 times higher for Indonesia and Vietnam, respectively – the Philippines still lags behind these two ASEAN neighbors in aggregated FDI stock.

In a survey released by the Business Times – Standard Chartered Leader’s Survey on 129 leaders and business owners from various industry sectors in April 2018, foreign investors expressed a preference for Indonesia (34%), Malaysia (22%), and Vietnam (22%) as top destinations for business expansion.

Only 3% of the respondents conveyed interest in expanding business operations in the Philippines. Hence, even as FDI in the Philippines has improved, the country still needs to catch up with the more favorable investment outlook for its neighbors.

Doing business in the Philippines remains a mixed picture. The Korean Chamber of Commerce of the Philippines, for instance, reported complaints from Korean firms about the higher cost of doing business in the country as well as the lack of fiscal incentives. In 2017, several Korean firms closed down operations and moved to Vietnam, saying labor-intensive industry in the Philippines is no longer attractive as labor cost is now 3 times higher than the former.

Vietnam has now become a major investment destination in the region, especially in the manufacturing sector. The country’s ability to attract large foreign direct investment inflows fueled the surge in exports and expansion in the manufacturing sector.

Following Singapore’s high export-oriented economy, Vietnam’s rapid export boom has contributed remarkably in the growth of the economy’s GDP. It is estimated that one in 10 smartphones worldwide is now being produced in Vietnam. Some of the world’s top business firms have also found the country a favorable destination to invest high-value projects. These include Samsung, Intel, LG, Mitsubishi, Sanofi and Panasonic.

Figure 3. Exports of goods and services as % of GDP among ASEAN nations, 2010-2017

Vietnam’s success in creating an attractive business environment can be attributed to the government’s regulatory reforms to increase foreign direct investments, political stability, and commitment to strengthen and build a sustainable economy.

In the 2018 Ease of Doing Business report, Vietnam ranked higher than the Philippines in 8 out of 10 indicators, specifically in starting a business, dealing with construction permits, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, and enforcing contracts.

Some of the reform initiatives by the state include reduction of corporate income tax, provision of tax breaks to specific sectors, and support packages to foreign and domestic investors. Additionally, low labor cost, generous fiscal incentives, concessionary rates, import duty exemptions and subsidized electricity were among the key advantages that drew foreign investors to Vietnam.

Despite this competitive edge, experts believe that the Philippines still has the potential to compete with Vietnam, given its advantage as an English-speaking nation, its free market, and the availability of a skilled workforce.

Monitoring FDI pledges

We've had much ballyhooed investment missions by our presidents. President Gloria Macapagal Arroyo's trip to India in 2007 was reported to have secured $2 billion in investments from that country. In September 2010, President Benigno Aquino III visited the US and was reported to secure $2.44 billion in investments. Later in the same year he visited Japan and was further said to secure $3.44 billion. President Rodrigo Duterte's recent trip to Japan in 2017 and to China early in 2018 was supposed to have landed the Philippines up to $15.5 billion in combined investments.

The Philippine Statistics Authority (PSA) monitors pledges by foreign investors, but not all of these materialize and become actual foreign direct investments. If we focus on investment pledges, this showed initial signs of decline from 2015 to 2016 and a steeper drop in 2017 and early 2018.

col-md-6"> Figure 4. Trends in net foreign direct investment inflow and approved foreign investments by investment promotion agencies

Interestingly, much of the decline in the investment pledges was accounted for by EU member-countries and the US. While investment commitments from Japan increased by 18% from 2016 to 2017, a large continuous decline has been the trend for the EU since 2016 – a 34% drop from 2015 to 2016 and a steeper slip by about 72% in 2017.

Meanwhile, investment pledges from the US have also dropped from P31.4 billion in 2016 to P8.7 billion in 2017. Figure 5 further elaborates on the slowdown in investment pledges from the US and EU – something which should definitely be monitored by the government if they signal an eventual decline in actual FDI at some future point.

The country’s ties with the EU have chilled recently, in large measure due to human rights issues associated with the Duterte administration. This may eventually have an impact on FDI originating from these countries, as well as trade.

Last April 2018, the EU Parliament in its joint resolution reiterated its concerns over the administration’s anti-illegal drug campaign and called on the Philippines to stop the extrajudicial killings. In the same resolution, they also urged to remove human rights defenders from the list of terrorists and to release Senator Leila de Lima from detention.

The European Commission could initiate procedural steps for the temporary withdrawal of trade incentives under the Generalized System of Preferences (GSP) given to the Philippines by EU member-countries, if the Philippines does not take any action to improve its human rights situation.

Figure 5. Foreign investment pledges by source country, 2013 – 2017 (in million Php) Figure 6. Trends in approved investment pledges of selected source countries, in million PhP

Improving institutions, economic competitiveness and attracting FDI

The “long game” in FDI is not built on quick spurts – it is more amply compared to a marathon underpinned by strong institutions and fundamentals. At the onset, the administration has focused on quick solutions (i.e., “solving corruption, drugs and criminality in 3 to 6 months”) instead of paying attention to firmer institution-building reforms.

We recognize the need to deliver immediate and tangible results to the people, but this should not mean losing sight of important deeper reforms that will fundamentally affect investment prospects.

Figures 7 and 8 below reveal the dramatic improvement in the “ease of doing business” indicator for the Philippines during the Aquino administration. This is a composite indicator of regulations and public policies that directly affect investments, including those that cover acquiring a business permit, getting electricity, paying taxes, and enforcing contracts.

The “distance to frontier” represents the best performance observed on each of the indicators across all economies. 0 represents the lowest performance, 100 represents the frontier. On the other hand “percentile rank” measures the percentage share of countries/economies with lower ranks than the Philippines.

In 2014, the Philippines posted a dramatic improvement in doing business – jumping by 25 points in the ranking, or put differently, overtaking 25 countries in terms of ease of doing business.

Nevertheless, the latest EODB report in 2018, shows that the Philippines slipped from 113th place last year to 124th place (out of 190 countries ranked). Primarily, the World Bank noted that the pace of reforms in other countries was much faster than that of the Philippines.

The Department of Finance (DOF) and Department of Trade and Industry (DTI), however, criticized the report, arguing that it allegedly showed “grossly inaccurate findings for the Philippines.” They particularly pointed out the understated score in the "Getting Credit" indicator, which they attributed to the failure of the World Bank’s survey team to acquire accurate data from the country’s credit information system.

Meanwhile, in one of the EODB indicators – the number of days required to start a business, which represents the efficiency of government offices to grant business permits, the Philippines ranks as the 3rd worst country among its ASEAN neighbors. It trails Cambodia and Laos at the bottom positions.

Meanwhile, other ASEAN countries have made significant improvement in this area. Thailand decreased the number of days required from 27.5 to 4.5 days within only a year from 2016 to 2017. Likewise, Myanmar reduced the number of days from 77 to 14 days in a span of 4 years, from 2014 to 2017.

Compared to other ASEAN countries, the Philippines’ progress has been marginal. In 2015, the number of days required to start a business was 29 days. It was then reduced to 28 days in 2016 and 2017. This is fairly weak compared to Indonesia which managed to decrease the number of days required from 47.8 to 23.1 days within the same period. Furthermore, the Philippines is still very far-off from Singapore, which has consistently needed only 2.5 days to register a business since 2009.

This again emphasizes the need to benchmark reform milestones in the Philippines not simply on its past performance, but also on how well it is faring against the competition.

Figures 7 and 8. Ease of Doing Business in the Philippines, 2009/2010 to 2018 (Note that the report is named prospectively for the following year after it is published.)

Revision of the country’s fiscal incentives has also raised the specter of uncertainty for many investors. Following the government’s TRAIN1 tax reforms (comprised mainly of reforms to personal income taxes and Value Added Tax or VAT, and the introduction of additional taxes on oil and sugary drinks, among others), the strong push for TRAIN2 (recently renamed TRABAHO) – which includes a reduction in corporate income taxes as well as a recalibration of fiscal incentives for foreign investments (on the grounds that some are no longer needed) – does highlight an important discussion on the effectiveness and extent of fiscal incentives for foreign investments. Even analysts in countries like Vietnam are also thinking along these lines.

Economic managers need to more credibly manage this recalibration, given the missed assumptions (notably on inflation) that surrounded the first package of tax reforms, and the growing risk of overheating that remains unaddressed under the Duterte administration.

A survey was conducted by the American Chamber of Commerce of the Philippines Inc. (AmCham) among foreign investors who are more likely to be affected by the proposed fiscal incentive policy reforms, most of them from the Business Process Outsourcing (BPO) and manufacturing industries. A majority (around 83%) of these firms emphasized the importance of fiscal incentives in compensating for the higher cost of doing business in the Philippines. In addition, almost half or about 47%, believe that removing the fiscal incentives would have a negative impact on the country’s competitiveness in terms of attracting foreign investors.

In another survey conducted by the Ateneo School of Government (ASOG), there were 34 respondents, consisting of top officials from mostly foreign-owned companies in the Philippines. They were asked about their experiences in doing business in the Philippines and their perceptions about the issues related to the current legislation on the TRABAHO bill.

Of the 56% who contemplated expansion plans prior to the noise brought about by the bill, 44% said the planned expansions were put on hold. This uncertainty caused by the reform’s impending threats undeniably reflects declining investor confidence.

Finally, and perhaps most importantly, structural impediments in key economic sectors are embedded in our Constitution. A recent study by Ateneo and AIM researchers found evidence that lifting foreign ownership restrictions in the Constitution could improve FDI inflows in areas which are key to the country’s continued industrialization (e.g. mining, utilities, mass media, and education), notably as we seek to compete under the 4th industrial revolution. At least one international study suggests that efforts to remove ownership restrictions could help boost net FDI inflows by up to 78%.

The challenge here, of course, is how to accomplish these particular constitutional amendments credibly and carefully, without raising the specter of political opportunism in other parts of the Constitution (e.g. historically, adjusting presidential term limits always raises the specter of more political noise).

And as noted earlier, a growing number of international investors and analysts are wary of total overhauls which introduce many more uncertainties around economic, political, and other aspects of governance in the Philippines.

If we were to use a health analogy, the evidence suggests that ours is a generally healthy economy, posting impressive growth, but carrying some structural flaws. A successful cure will likely come from skilled and respected surgeons wielding scalpels, rather than axes, doing more harm than good. – Rappler.com

The views expressed in this article are the authors’ and do not necessarily reflect those of the Ateneo de Manila University. Ronald U Mendoza is the Dean of the Ateneo School of Government (ASOG); and Miann Banaag is a statistician with ASOG. Further data and references on this article are available here.