Growing an impressive 7.2%, the Philippines was one of Asia’s best-performing economies in 2013. As growth has given rise to increased business activity and boosted consumer spending power, the question that arises is whether this newfound domestic demand will be for goods and materials produced locally or exported from abroad. This is an issue that will become even more important in 2015 as ASEAN Economic Community (AEC) integration further opens the market to imports from regional manufacturing powerhouses.

While the Philippines boasts a large domestic population, a competent and proficient workforce, and proximity to fast-growing Asian markets, it also faces challenges that erode its manufacturing competiveness and limit investor confidence when it comes to committing capital expenditure to plants and facilities. In particular, supply deficits and high costs associated with power and logistics are two of the main issues that will need to be addressed going forward.

SUPPORT FOR MANUFACTURING: The administration of President Benigno Aquino III aspires to achieve inclusive, broad-based growth, a goal which necessitates a strong manufacturing base that presents employment prospects for skilled, semi and unskilled workers. According to the Philippine Statistics Authority, services account for nearly 57% of total GDP, which is nearly double that of industry (31%). Crisanto Frianeza, secretary-general of the Philippine Chamber of Commerce and Industry, believes that the gap between the two needs to be closed, as an over-reliance on the services sector to fuel the economy is risky and could ultimately be less sustainable. “Much of our GDP expansion has come from the business process outsourcing (BPO) sector and foreign remittances. Our worry is that the BPO sector, especially call centres, is plateauing. More efforts should be exerted to shore up manufacturing to achieve inclusive growth,” he told OBG. Barring food processing and electronics, most of the Philippines’ manufacturing segments, especially those that are labour-intensive, have been facing stagnation or decline since the turn of the millennium. This is a trend that industrial policy is looking to reverse and combat through industry-specific road maps that target moving into higher-value activities. It appears that revitalisation is on track. Manufacturing growth of 12.3% for 2013 far surpassed the 5.5% recorded in 2012, and more broadly, the sector expanded by an average of 7.9% in value added terms between 2009 and 2013, according to Deloitte.

OPPORTUNE TIMING: Food manufacturing, which accounts for around 45% of output, makes up the largest production segment. This is followed by radio, TV and communication equipment and apparatus ( otherwise commonly referred to electronics and semiconductors), and the chemical and chemical products subsector. According to figures from the National Statistical Coordination Board, food manufacturing experienced a three-year average growth rate of 5% between 2010 and 2013, electronics and semi-conductors grew 3%, while chemical and chemical products expanded by 39%. The most rapidly growing subsector over this period, albeit from far a lower base, was furniture and fixtures, which was up by 57%.

With approximately 90% of the Philippine food and beverage processing industry’s output consumed domestically, strong growth of the segment is likely to continue thanks to economic growth and the large consumer base. “A and B clients are more health-conscious and inclined to the market of global brands like Coca-Cola and Pepsi. Smaller local players focus on the C and D markets, which comprises the bulk of the population and has led the global brands to diversify their products to try to tap them,” Gerry T Garcia, executive vice-president and chief operating officer of Asiawide Refreshments Corporation, told OBG.

Meanwhile, investment rating upgrades and the improvement in the World Economic Forum (WEF) competitiveness rankings from 59th to 52nd place in 2014-15, which is based on an evaluation of continued enhancements in corporate governance and business friendliness, put the Philippines in a strong position to attract manufacturing capital. In 2013, investment in capital formation for durable equipment expanded by 14.4% compared to 8% in 2012.

There is cause for optimism about inbound investments as regional producers seek alternatives to their traditional manufacturing bases. China, due to wage increases, is facing rising costs, while Thailand continues to be affected by political instability. According to research from Deloitte, manufacturing unit costs in China have gone up by around 50% since 2008 compared to 6% in the Philippines, with wages expected to rise by a factor of three until 2033 against a factor of two for the Philippines. “We don’t want to wish anyone ill, but issues around unrest in Thailand and anti-dumping laws being levied against China present us with an opportunity,” Dan C Lachica, the president of the Semiconductor and Electronics Industries in the Philippines Foundation (SEIPI), told OBG.

EXPORTS: According to statistics from the OECD, around one-third of total gross exports are comprised of foreign inputs, while the share of domestic value added to gross exports is 61.6%. This demonstrates strong integration into global value chains.

With a population approaching 100m, the 12th largest in the world, and an expanding middle class, the Philippines is fortunate to have a domestic market that provides sufficient economies of scale for affordable mass-market consumer goods such as food and beverages. Others, such as electronics, rely primarily on overseas markets. According to the Department of Trade and Industry (DTI), merchandise exports reached $53.29bn in 2013, up 3.6%. This fell short of the 10% target set out and was lower than the 7.6% growth posted in 2012. The drop-off could be attributed to a slowdown in expansion in China and the US, two key trading partners, as well as a 2.5% decline in electronic exports. Electronics exports constitute around 45% of all exports, and the industry is currently undergoing a trying period as it adapts to a shift in demand for component parts away from laptops and towards tablets and smartphones (see analysis). Looking forward, factors that could impact export swings in 2015 include Japan’s quantitative easing and a further depreciation of the yen, as the Philippines is a significant supplier of parts to Japanese exporters. The performance of the peso may also play a role too. Following a marked appreciation in 2012 that negatively impacted exports, however, the peso has since held relatively steady within a comfortable band relative to the dollar.

LABOUR ABSORPTION: The population has a median age of 23, according to the 2010 census, and 34% of Filipinos are under the age of 15. Accordingly, the Philippines’ youthful make-up could prove to be either a major asset or a significant burden, with much riding on the degree to which its future graduates can find adequate employment. Formal unemployment for the country is measured at around 8%, with approximately 3m Filipinos considered jobless and an additional 7m deemed to be underemployed. Of the 500,000 college graduates coming to the labour market each year, manufacturing is said to absorb just around 20,000. It is estimated that in total for the country, an additional 14.6m jobs will need to be created by 2016.

In the WEF competitiveness rankings, the Philippines ranked 91st in the labour market category. While faring relatively well in the assessment of wages and productivity, rigid labour regulations are considered to hamper its overall labour competiveness and deter some prospective investors from labour-intensive industries. Another challenge facing the labour market is that the country’s reputation for good workers results in a large number of the more talented Filipinos opting to work overseas in countries where they can earn higher salaries. “When the AEC happens, the brain drain could be even worse,” said SEIPI’s Lachica, referring to the liberalisation of regional labour mobility that will come about once ASEAN integration takes effect.

POWER PROBLEMS: Power and logistics are invariably cited as the two primary concerns by manufacturers OBG has spoken with, and President Aquino, in a speech delivered at the 40th Philippine Business Conference in October 2014, acknowledged that both inputs need to be addressed going forward.

Electricity costs in the Philippines are among the highest in the world, and its power rates are considered to be the most expensive in Asia. Electricity for general use in Manila comes out to $0.23 per KWh, compared to $0.07 in Hanoi and Ho Chi Minh, $0.08 in Bangkok and $0.11 in Kuala Lumpur. The higher rates stem in part from higher production costs due to a lack of domestic hydrocarbons resources, while they also have to do with a conscious decision on the part of the government not to subsidise tariffs for end-users.

The government argues that offering energy subsidies provides industry with an artificial, unsustainable advantage and would contribute to an unmanageable current account deficit in the long term.

Advocates of a subsidy regime counter that the cost has to be weighed against the benefits in terms of job creation and the economic multiplier effect. “Despite some of the advantages of the Philippines, Samsung recently chose Vietnam over us for a $2bn smartphone manufacturing facility purely because of more favourable energy costs,” SEIPI’s Lachica told OBG. “Whether or not you agree with government’s rationale to reduce electricity subsidies, Samsung is not here contributing to the economy, and that’s what matters.”

In 2015, electricity availability rather than price is likely to dominate the narrative. A supply shortfall in the most populated and main industrial province of Luzon is expected to lead to rolling brownouts of one to three hours a day from March to May. The president is seeking approval from Congress for emergency powers permitting the government to pursue power purchase and generation deals for the first time since the power sector was privatised in 2001. As an interim measure and a potentially more achievable solution, it has been indicated that large companies within the province will be called to run their own stand-by diesel-fuelled generators to ease demand on the provincial grid, which is responsible for supplying electricity for nearly half of the country’s households (see Energy chapter).

LOGISTICS: The WEF index ranks the Philippines 91st out of 144 countries surveyed for its infrastructure competitiveness, with its airports (108th) and seaports (101st) in the bottom third. The majority of cargo-bound imports and exports, which grew by 8.3% and 5.4%, respectively, through the first six months of 2014, depart from the Port of Manila. With a utilisation rate exceeding 100%, the gateway port is facing major strain. Inefficiency is compounded by congestion, particularly given delays to an elevated road network connecting the ports to other parts of the capital. According to a September 2014 article in the Philippine Economic Zone Authority (PEZA) has said that port congestion resulted in 20,000 private sector workers being laid off from economic zones around Manila, while the Bureau of Internal Revenue attributes falls in tax revenue to the same problem.

In February 2014, the mayor of Manila declared a ban on heavy vehicles (those weighing over 4500 kg) from driving on city thoroughfares between 5am and 10am and from 3pm to 9pm on Monday to Saturday. While intended to reduce gridlock on the road network, the controversial truck ban, which was lifted in mid-September, came at a substantial cost for firms reliant on in- or outbound shipments. The Philippine Franchise Association stated that its members suffered P3bn ($67.5m) in losses as a result of having to pay more for imported goods, while SEIPA reported that the disruption in the delivery of raw materials cost electronics companies as much as $100,000 a day.

To ease congestion and migrate cargo traffic from the Port of Manila to the nearby ports of Subic and Batangas, the alternate ports have been designated as extensions of the city of Manila. Meanwhile, higher storage fees for the Port of Manila have been imposed as a means of discouraging cargo owners from using its terminals as virtual warehouses.

A MATTER OF PREFERENCE: The EU was the Philippines’ fourth-largest trade partner in 2013, with total trade valued at $15.10bn. The Philippines has qualified under the EU’s generalised system of preferences (GSP), which affords 2442 products duty-free export status to the 28-nation bloc. In 2015 the Philippines is expect to accrue an even more favoured trade position when the EU parliament ratifies its status as the first Asian country to be included in the list of GSP+ beneficiaries. Under the GSP+ regime, the number of products eligible for duty-free status is set to reach 6247, and a selection of industries are expected to grow their export volumes to the EU as a result. The DTI forecasts that exports to the EU will expand by 20%, in turn creating as many as 270,000 additional jobs. The industrial sectors expected to benefit most from the removal of tariffs are textiles and garments, bicycles, processed fruits and fisheries. Under GSP, textiles and garments, which accounted for $150m worth of exports in 2013, are subject to tariffs in the 8-10% range, while duties levied against processed fruit and fruit juices stand at 30%. The fisheries sector faces 20% tariffs, and the country’s tuna industry could stand to gain substantially as the EU is the world’s biggest market for canned products. “In the case of Ecuador, tuna processing capacity significantly increased when GSP+ status was conferred,” Christopher Po, the president and CEO of Filipino food company Century Pacific Food, told OBG. The Philippines exported $230m worth of fish product in 2013 to the EU in 2013, with the bloc consuming around 40% of the country’s tuna catch.

There is concern, however, that it could miss out on the preferential status if it fails to meet an EU ultimatum to rein in illegal fishing, which could result in import bans and sanctions. In 2012 fish products from Belize, Cambodia and Guinea were sanctioned when they did not adhere to the stipulations.

ASEAN INTEGRATION: Closer to home, AEC integration provides the opportunity for the Philippines to penetrate fast-growing regional markets and reduce its reliance on exports to the EU and US. The run-up to AEC implementation has generated considerable debate over which members stand to gain and lose the most from intra-regional trade liberalisation, and in the Philippines’ case, there are concerns that the country may be in a slightly disadvantageous position.

“Places like Thailand are far ahead of the curve when it comes to industrialisation and will enjoy first-mover advantage,” the Chamber of Commerce’s Frianeza told OBG. “That said, we need to learn to compete with others and raising our standards compliance both for goods and services is critical if the Philippines is to maximise benefits from this regional trade arrangement. In the long run, it can only help.”

SME BACKBONE: Around 99.6% of companies in the county are small and medium-sized enterprises (SMEs), of which 89.8% qualify as micro-SMEs (MSMEs), according to DTI statistics. Many operate in the informal sector, and according to Frianeza, “If we do not prepare them for the AEC, they will get run over. We must expose them to technology and guide them on quality. Chambers of commerce can provide the networks for MSMEs to access best practices, technology and other expertise needed to compete under this arrangement.”

As is the case in many emerging markets around the world, problems accessing finance, insufficient training and administrative burdens are considered to be barriers to the development of SMEs. “At the moment, the supply chain does not integrate well with SMEs. Companies like Canon are instead bringing in their own suppliers from overseas,” Lachica of the SEIPI told OBG when discussing the local electronics manufacturing landscape. “Our SMEs lack funding and are unable to meet original equipment manufacturer standards. The threat is that with ASEAN integration, even more foreign suppliers will arrive to take their place.”

In anticipation of the AEC and to support local SMEs in gaining a foothold in overseas markets, the Department of Science and Technology (DOST) has initiated the Small Enterprise Technology Upgrading Programme, which aims to assist SMEs at becoming more technologically adept. The programme provides training and support in the areas of product standardisation, laboratory testing and analysis, packaging and labelling. “For small food and cosmetics cosmetic companies, accreditation and certification can be an expensive process, the same with packaging and patent registration. Chambers of commerce can work with DOST to provide MSMEs with the common service facilities needed to achieve efficient production and also compliance with required standards,” said Frianeza.

ZONING IN: To promote export-oriented manufacturing, a number of locations around the country have been designated for tax and other fiscal and non-fiscal incentives by the PEZA. PEZA-designated zones and concessions also extend to the services sector, in particular the BPO sector (see BPO chapter), as well as some tourism and medical related investments. There are currently around 300 designated zones – actual office spaces in city centres can be afforded status on their own as IT parks/buildings – catering to more than 3300 companies. PEZA-registered investments rose 6.2% year-on-year from January through September 2014 to reach an investment total of P148.21bn ($3.3bn) compared to 139.59bn ($3.1bn) over the same period in 2013. According to the authority, around 60-65% of the funds went to expansion plans for existing locations.

OUTLOOK: The country’s demographic dividend, attractive workforce, projected economic growth and the continued improvement of its business environment are combining to generate investor interest. Industrial policy and road maps, formulated and implemented with input and buy-in from industry associations, will support the country as it works to develop segments that have high job absorption capacity, multiplier effects and scope for growth. However, until power and logistics deficiencies are addressed, some manufacturers will remain reluctant to commit significant capital expenditure to plants and facilities. Meanwhile, ASEAN integration offers newfound market access to a wide and emerging consumer base, and the Philippines will need to ramp up its manufacturing competitiveness to ensure it becomes a net exporter, rather than a pure importer, of value-added products moving throughout the region.