Can Duterte's finance chiefs make him the great reformer?
The world sees Rodrigo Duterte as a hothead populist, waging a bloody drugs war against insurgents, but to most of his compatriots, he’s the reformer the country needs. His aims, including shaking up taxes to pay for infrastructure and targeting an energy revolution, are bold. His choices for the crucial finance ministry and central bank roles look sound. But will they succeed?
|Illustration: Pete Ellis|
There are few more divisive politicians in Asia than president Rodrigo Roa Duterte. Depending on who you ask, the president of the Philippines is either a rabble-rousing populist who uses death squads to clean up crime, or the great reformer who has promised to tackle inequality, overhaul the tax system, generate jobs and patch up the country’s creaking infrastructure.
Since his election in May 2016, this mercurial figure, roaring and raging one moment, smiling and sweet the next, has come to dominate and define his country. He has insulted former US president Barack Obama, cozied up to China and derided North Korean’s Kim Jong-un as a “chubby fool”.
To many, he can seem a loose cannon who speaks before thinking – the region’s answer to the equally filter-free Donald Trump. But is he someone that lenders, companies and investors – whether at home or abroad – can trust with their money?
Let’s start with the economy, the president’s self-confessed weak point. Unlike Trump, Duterte did not tout his business credentials on the campaign trail, in large part because he had none. Rather, the trained lawyer presented himself as a law-and-order president who would, once in office, leave the running of the economy to the experts.
As the election loomed last year, the business elite woke up to the prospect of a new president many neither knew nor liked. Corporate vassals were sent out to Davao, the largest city on the island of Mindanao where Duterte had been mayor for three decades. And what they found surprised them.
“When he was campaigning, we wanted to get a sense of how he approached the business community,” says Nestor Tan, chief executive of BDO Unibank, the country’s largest lender. “He was seen in Davao as an enabler, ensuring permits and licences were acted on in a timely manner.”
|Duterte's main reform efforts|
• The Comprehensive Tax Reform Programme aims to raise P133.8 billion ($2.6 billion) in additional revenues in 2018, rising to P375 billion a year by 2020 – 1.7% of GDP.
• Corporate tax rates fall to 25% from 30%, in line with the region; taxes on cars, fuel and tobacco rise. Taxes on annual salaries of over P5 million rise to 35% from 30%; the threshold at which income tax starts rises to P250,000 from P125,000. Average take-home pay set to rise 7%.
• Duterte will widen fiscal deficit to 3% by 2022, from 2.4% in 2016, and raise infrastructure spend to 7.4% of GDP, from 5.2% in 2016.
•12 infrastructure projects worth $4.4 billion are planned, including a $3 billion railway line, a $374 million dam in Quezon and the expansion of Clark airport.
• On June 28, Duterte signed an order to boost energy-sector investments by cutting approval time for big projects to 30 days
• In August, he signed into law a Universal Education Act that aims to provide free tuition for students in 112 state colleges and universities.
Once in office, Duterte proved as good as his word, turning for economic advice to trusted confidantes. First on his call sheet was Carlos Dominguez, his childhood friend from Mindanao. Dominguez has the trust of the private sector; he made his money in banking, tobacco and retail, and has spent the last half-century running 20 big firms, including BPI Agricultural Development Bank. The president lost no time in signing him up as finance minister.
Dominguez was seen as a canny pick. He was still close to Duterte and had overseen the president’s campaign finances. And he’d long proven his ability to manage both up and down, spending three years in the 1980s running two ministries for former president Cory Aquino.
“Their relationship works both ways,” says Alfred Olmedo Dy, head of Philippines research at CLSA. “Duterte can tell Dominguez what he wants, but Dominguez can also feel free to speak his mind. The president is a strong character, so he needs someone who can speak truth to power. And Dominguez knows the bureaucratic maze that is Manila. He knows how to get things done – and that’s a big bonus.”
Dominguez in turn helped the president fill out the rest of his economic team, starting with a successor to Amando Tetangco, the long-standing central bank governor.
“I told the president before the election this was the most important single choice he would make,” the finance minister tells Asiamoney during a long interview in Manila. “I gave him a list of candidates and he mulled it over for months.”
Dominguez’s shortlist was packed with strong names, including former president Gloria Macapagal Arroyo, EastWest Bank CEO Antonio Moncupa, and former trade and industry secretary Peter Favila.
The president startled many with his final choice, Nestor Espenilla, who was deputy governor of the central bank at the time and considered a worthy candidate. Duterte liked Espenilla’s track record on financial inclusion and his willingness to play the bad cop with errant lenders.
In his capacity overseeing the banking sector, Espenilla was ruthless with rule-breakers. In 2011, he shut down Banco Filipino Savings and Mortgage Bank for mismanaging deposits and excessive lending to connected parties.
More recently, he hit Rizal Commercial Banking Corp (RCBC), which is controlled by the powerful Yuchengco family, with a P1 billion ($19.5 million) fine over the $81 million Bangladesh Bank heist, after some of the stolen money passed through RCBC accounts.
Bankers have warmed up to the relatively youthful governor at the BSP (Espenilla is in his late 50s, while both Duterte and Dominguez are in their early 70s).
“He’s a very good choice, very competent,” says BDO Unibank’s Tan. “He’s a progressive thinker, like his predecessor, and he engages with the industry. It’s not a case of him living in an ivory tower – he meets with bankers, listens to us, talks about how we can work together to advance the economy.”
|Carlos Dominguez, minister of finance
The president “made no secret coming into power that he would focus on law and order, on drugs, and on tackling corruption,” says Cezar ‘Bong’ Consing who, like many Filipinos, usually goes by his nickname. The president and CEO of the Bank of the Philippine Islands (BPI), the country’s second-largest lender by assets, says Duterte’s strength is that “he is letting professional managers like Dominguez and Espenilla get on with running the economy. They have their say on how we allocate resources. My sense is that Duterte recognizes his real strengths, and knows it is more valuable to let others make the money.”
The economy was certainly doing pretty well under Duterte’s predecessor, former president Benigno Aquino, and in the safe hands of Tetangco at the central bank. Economic output expanded 6.8% in 2016, with inflation steady at 1.8%.
Since Duterte took over, investors have fretted about the peso, which lost 6.5% against the dollar through the first eight months of 2017. By contrast, Malaysia’s ringgit and Indonesia’s rupiah have stabilized or strengthened against the dollar. In a report published in June this year, BDO said it expected the peso to continue to weaken in the second half of 2017 before stabilizing next year.
The picture presented by other indicators and data looks rosier. The Philippine Stock Exchange is up by nearly a fifth this year, driven by outperforming banking and consumer stocks. The IMF expects economic growth of 6.8% in 2017 and 6.9% in 2018, rising to 7% by 2022, making the Philippines one of the emerging world’s faster-growing economies. Foreign direct investment jumped 41% in 2016 from 2015, according to central bank data.
When pushed, bankers say the business environment has improved since the election.
“The best indicator of the way [Duterte] has managed the economy is how our clients have reacted, particularly the best entrepreneurs,” says BDO Unibank’s Tan. “They have actually started to invest, and in the words of one or two of them, they love the fact that he has left them alone. If we are lending and clients are borrowing, that means more growth and more optimism.”
So far, so good, but peppy growth data and a lively stock market only go so far. Duterte and Dominguez have a hellishly long and complex to-do list, at the top of which sit infrastructure construction and tax reform.
These are related issues: successive governments were unable to raise enough money to stitch the country together. Rather than tackle both issues separately, Duterte’s government opted to lump them together. Step one is the rollout of Duterte’s comprehensive tax reform programme, introduced as a bill in January, passed by the lower house of parliament in May, and now working its way through the senate.
In its current guise, the package aims to generate P133.8 billion ($2.6 billion) in additional revenues in 2018, rising to P375 billion a year by 2020, or 1.7% of GDP, according to CLSA.
The reforms are intended to shift the tax burden away from the lowest-income earners to the wealthier workers in a country with a labour force of about 44 million people. For example, by raising the threshold at which Filipinos start to pay income tax from P125,000 ($2,450) to P250,000 ($4,900) a year, the number of people exempt from paying tax will rise from 2 million at present to 6 million. At the same time, the tax rate on those earning P5 million ($98,000) or more – an income level that applies to just 7,230 people, or 0.007% of the population – will increase to 35%, from 30%.
Consumption taxes on cars, fuel and tobacco will rise, while the corporate tax rate will fall to 25% from 30%, bringing the Philippines in line with the rest of the Asean region.
This is the big financial play for Duterte’s economic team, and much is riding on its success. The current tax code, which has changed little in the last 20 years, is riddled with loopholes and carve-outs that benefit the wealthy and well-advised, but do little to broaden or deepen the economy.
“There are so many exemptions and leakages in the system, particularly in the area of value-added tax,” Dominguez laments. He points to Thailand, a larger economy with a smaller population, which generates 4.3% of GDP from a sales tax of 7%. “We raise the exact same amount, even though our VAT rate is 12%,” he adds, a reflection of how inefficient the country is at collecting such taxes. Singapore’s goods and services tax is 7%, while in Indonesia and Vietnam the tax is 10%.
There is also a clear desire to be proactive on this issue, rather than (as was the case with previous administrations) reacting to crises.
“This is the first tax reform we have done on our own, without coercion from outside, without the IMF holding a gun to our head,” Dominguez says. “We want to raise money to pay for infrastructure, to plug loopholes, to make the system fair – and to show we don’t have to listen to the IMF to know what we’re doing.”
Duterte’s financial team has two other goals in mind: they want to see a sustained bump in retail sales, a vital component of the economy but one that consistently underperforms, and they want the Philippines’ credit rating to improve.
The tax bill could lift retail sales in a heartbeat with a welcome bump in take-home pay, thanks to a tax cut for the majority of workers translating into higher consumer spending.
|Main economic reform aims|
• Annual economic growth to rise to 8% by 2022 from under 7% in 2017.
• Infrastructure spending-to-GDP ratio rising to 7.4% by 2022 from 5.4% in 2017.
• Fiscal deficit of P776.6 billion in 2022, from P482.1 billion in 2017.
• Debt-to-GDP ratio falling to 36% in 2022 from 42% in 2017.
• Unemployment rate to remain in the 3% to 5% bracket through 2022.
• Reduce poverty rate to 14% by 2022 from 21.6%
• Total infrastructure spend between 2017 and 2022
of P8 trillion.
CLSA reckons the tax bill will boost average take-home pay by 7%, and benefit the stock prices of a host of locally listed firms, including Ayala Corporation, Globe Telecom, Jollibee Foods, Metro Pacific and Robinsons Retail, along with lenders such as Security Bank.
The expectation of greater spending power is already having an impact on consumer sentiment. The central bank’s consumer expectations survey indicator hit an all-time high of 13.1 in July. The quarterly indicator, which maps consumer confidence, broke into positive territory for the first time ever in the third quarter of 2016, after Duterte’s election victory.
Then there’s the country’s credit rating, which finally scraped into investment-grade territory in 2013 under president Aquino. It was a welcome vote of confidence in the Philippines, long-regarded as the sick man of Asia, and Dominguez is keen to see an upgrade or two over the coming years.
“Investors need to be able to look at our credit rating and say: ‘Hey, these guys are serious, they can take care of themselves, they don’t have to be led everywhere by the hand. They’re mature and fiscally responsible, and we have confidence in them’.”
It’s a reasonable ambition, according to Kim Eng Tan, senior director of sovereign and international public finance ratings at S&P Global Ratings.
The country’s revenue base is “too narrow, constraining the government’s ability to spend money on things that improve people’s lives,” says Tan. The ratio of tax revenue to GDP, at 14.4%, is one of the lowest in the region, behind Malaysia (15.5%) and Thailand (17%), and light years below the likes of China and Japan.
But pass the tax package into law and translate those reforms into additional income and the state could be in line for a ratings bump, Tan admits.
“No [Philippines] government has attempted a set of reforms on this scale before,” he says. “If the reforms are carried out, and if the money is spent well and doesn’t go into fuel subsidies, the support for a ratings upgrade will increase.”
The tax bill is far from a done deal. Congress ushered it through with barely a pause for breath, but the upper house has pushed back against the tax on car ownership and a proposed levy on sugary drinks, which is forecast to raise P47 billion a year but which opposition lawmakers view as a tax on the poor. In August, Dominguez agreed to rethink the so-called sugar tax.
That’s probably wise. Passing the tax bill in its current form will be tricky. Aquilino Pimentel, senate president, is a member of the PDP-Laban, Duterte’s party. But the upper house is a hotchpotch of liberals, conservatives and independents, with the PDP controlling just four of the 24 seats. A consensus agreement is the most likely outcome, with the law passed by the end of the year. But Duterte’s government will need to tread carefully as it needs this political win.
The worst outcome for the president, notes S&P’s Tan, “is for all the measures that reduce revenues to be passed, and all the measures that raise revenues to be rejected”.
Assuming the tax bill is passed in an acceptable form, inquiring minds will turn to infrastructure. Simply put, it is in an appalling state, crimping productivity and growth. One’s first impression of the country is usually through the lens of the Ninoy Aquino International Airport, all 1970s-era gloom and decay. From there, visitors struggle through the capital’s interminable traffic, endure endless delays at third-rate airports and judder down patchy highways that peter out.
Infrastructure is central to this administration.
“People ask me why we are so focused on infrastructure, and my answer is that the opposition lost the election because they didn’t focus on it,” says finance minister Dominguez. “It’s vital to everything we do. Everything is at overcapacity here, from our clogged roads to the lack of railways or schools, clean water or flood controls.”
|Duterte's infrastructure commitment: Gamble or grand plan?|
He pledges to widen the fiscal deficit to 3% by 2022, from an average of 2% over the last five governments, and increase annual spending on infrastructure to 7.4% of GDP by 2022, from 5.2% in 2016. To do that, and to keep the Philippines as one of the world’s fastest-growing economies, he needs to find $160 billion in new funding – which is where the tax bill comes in.
But freeing up new capital at home will only get the president so far. Manila desperately needs outside help, from private investors and multilaterals. Critics have accused the finance minister of falling out of love with the kind of chunky public-private partnerships (PPPs) so beloved of his predecessor, Cesar Purisima.
Dominguez, a sunny presence even in the gloomiest of rooms, frowns at the suggestion and rattles off a few numbers: “The fact is that the last government only completed four PPPs, and one of them was a four-kilometre-long highway along a flat stretch of land. We reviewed every PPP and concluded that most of them took too long, taking an average of 30 months from drawing board to start of construction. We can cut that to 12 months. Projects may be done as PPPs, but if it makes sense, we will look to bid them out entirely to the private sector.”
A harsh assessment but one that a local analyst deemed fair enough.
There are other avenues of opportunity. Duterte lost no time once in power in cozying up to China and president Xi Jinping – though to many, the president was simply making up for lost time.
“The criticism that can be fairly leveled at past governments is that they didn’t have a China policy,” says BPI’s Consing. “While the rest of the region was relying on China as an engine of growth, we were economically the least linked – and that cost us.”
|Nestor Tan, chief executive of BDO Unibank
Drawing closer to Beijing also means easier access to Chinese aid, whether in the form of capital from the likes of China Development Bank and the Asian Infrastructure Investment Bank (AIIB), or labour via the construction firms that specialize in big-ticket infrastructure projects.
So, will Manila opt for the PPP approach to infrastructure funding, or choose the official development assistance route, tapping up the AIIB, Asian Development Bank, World Bank, and a host of European and Japanese agencies?
“There is a bit of a debate going on,” says Consing. “But the funding needs are so large and the infrastructure deficit so acute, that we need both approaches.”
Either way, the Philippines’ desire to build an economy fit for purpose will be a boon for multilaterals, investors and debt bankers.
Foremost on the to-do list, says Dominguez, are 12 projects worth a combined $4.4 billion. They include: a 653-kilometre-long, $3 billion north-south railway line; a rail link connecting Manila with the city of Clark; a $374 million dam in Quezon province; and the expansion of Clark airport.
“We want to expand airports across the country to get our tourism industry going and improve our logistical backbone,” Dominguez says.
This is where the president’s credentials as a genuine reformer come into play. It’s still early days, but many of the measures so far introduced focus on lifting growth rates, creating new jobs and reducing inequality.
True, some attempts to burnish his populist credentials have been more miss than hit. In August, he signed a law abolishing tuition fees, a move more likely to benefit richer than poorer students, and cost the state between P30 billion and P100 billion (between $590 million and $1.95 billion) a year. And he has pledged to crack down on temporary work contracts, an idea favoured by his political base, but unlikely to create many jobs.
Fists and wit
It is easy to overlook the genuine sense of change that Duterte brings to the Malacañang Palace, the official presidential home.
He grew up on the wrong side of the tracks in Davao, protecting himself with his fists and sharp wit. As a child, he lived around the corner from Dominguez, and the two spent their time clubbing together in the evening and shooting birds on the telephone wires. The pair remained firm friends, but while Dominguez spent his college years at Stanford Business School before moving to Manila, Duterte rarely ventured outside his hometown.
As a lawyer, then as mayor, Duterte saw first-hand the iniquities of life in Mindanao, one of the country’s poorest and most lawless regions, and the damage done by crystal meth. He pledged to eradicate drugs, and has been true to his word. In the first year of his presidency, according to the Philippine Information Agency, more than 5,600 people were killed in drug raids.
The campaign drew praise from Filipinos tired of living in a broken society, while surveys show overwhelming support from the public and the corporate world.
“Whatever your politics, whether you are left or right or centre, you cannot deny the positive effects of having less drugs on the streets and more law and order,” says BPI’s Consing.
Jose Sio, chairman of the board at SM Investments, a finance-to-property group that controls BDO Unibank and China Banking Corporation, also supports Duterte’s crackdown: “If we don’t solve our problems now, we will be in a far deeper hole three or five years from now.”
Duterte’s boldness could prove his downfall. Few nations have successfully prosecuted a war on drugs: witness the US, which has been fighting its own version since 1971. It starts out tough and rarely gets easier, with entrenched interests fighting back against the state. The inevitable unrest has so far been restricted to Mindanao. In July, parliament extended martial law on one of the island’s biggest cities, Marawi, part of which is now occupied by Islamic State.
The finance minister draws a direct line between the drugs war and the rise of a local IS chapter: “What broke out in the south is partly due to the [drugs war]. IS started as gangsters, moved on to dealing crystal meth, and when Duterte cracked down, they looked around for funding, and for a base from which to operate. They aren’t terrorists.”
But he points to the cultural and economic divisions and lack of opportunity that breed anger in poorer regions far from the wealth and privilege of the capital.
Mindanao, Dominguez says, suffers from “decades of entrenched inequality that cross religious lines”.
The Philippines is overwhelmingly Christian, with a smaller and poorer Muslim population, and neglect in those regions has, he adds, “given birth to the conflicts we see in Marawi, where Muslim communities feel abandoned.”
The average classroom size in Christian areas is between 50 and 60, he says; in Muslim areas, it’s between 90 and 120. The average wage in Manila is P400,000; in Mindanao, it’s P26,000. “It’s like going from Kuala Lumpur to Kabul. Eventually frustration spills over into violence,” says Dominguez.
Manila’s elites have long been blind to the resentment festering in the country’s poorest and most deprived areas, and this ignorance explains why Duterte’s rise took the establishment so completely by surprise. If they weren’t listening before, they are now.
Duterte hails from Davao, a region of Mindanao described by finance minister Dominguez as the “poster boy for neglect”. So too do Pimentel and Pantaleon Alvarez, respectively senate president and speaker of the house of representatives.
“We are saying: ‘It’s about time you guys in Manila listen to what the hicks from the sticks have to say’,” notes the finance minister.
|Ian Gisbourne, UBS
Politically, Duterte’s war on drugs is a big risk. Yes, it’s a bold and daring attempt to resolve a problem long seen as intractable and endemic. But if he fails to win it he will lose public support.
The same is true with his tax bill, and the regular vows, from him and his economic team, to build new roads and airports.
Even infrastructure is a gamble. Filipino presidents are limited to a single, six-year term in office, in large part to prevent another dictator like former president Ferdinand Marcos from becoming entrenched. But the single term also explains why previous governments soft-shoed the issue of infrastructure.
“It’s a long-term process, so the benefits are only visible when you are long gone,” says S&P’s Tan. “Where’s the benefit in doing something that reaps political benefits for others down the line?”
Perhaps Duterte is willing to think differently and embark on grand projects that may only see the light of day once he’s retired, such as the construction of a rail line that extends around the entire island of Mindanao.
“We won’t finish it during this administration, but we can certainly make a start,” says Dominguez.
Successive presidents have lamented the state of the nation’s infrastructure, while doing little to remedy the situation. The same is true with the tax system. Get all of this right and in theory, the investment dollars, yen and renminbi will flow in, creating new jobs and lifting all boats.
Since this rough-and-tumble president came to power last year, the world has tended to see a pugilistic rabble-rouser. It’s easy to overlook Duterte’s evolving credentials as the reformer the Philippines has needed for so long.
“People focus on his populist rhetoric and war on drugs,” says Ian Gisbourne, head of Asean research at UBS. “They don’t focus on what he’s actually doing on the economy: looking to cut poverty, build infrastructure and improve the government’s finances. If you apply that can-do approach to institutional reform and macro policy, you can argue that the Philippines is an exciting story and one that people are overlooking.”