Before the political deterioration began, Arroyo had appeared to be making some headway against the country's economic woes. Her government had gotten the country's fiscal deficit under control through budget cuts and better tax collection, says James McCormack, sovereign analyst at Fitch Ratings in Hong Kong. Plus, says Socioeconomic Planning Secretary Romulo L. Neri, "our privatization program was getting in shape, and we have been building necessary infrastructure like ports and highways."
Then the economic picture suddenly darkened. On July 1, the Philippines Supreme Court suspended implementation of a value-added tax law -- a cornerstone of Arroyo's economic policy. Although the government is appealing the decision, Manila stands to lose up to $90 million a month as long as it is unable to collect the vat, says Finance Secretary Cesar A. Purisima. That makes it difficult for Arroyo to meet her goal of cutting the budget deficit from $3.4 billion to $2.8 billion this year, which would take it below 3% of gross domestic product.
The reaction to the court ruling was swift. On July 4, the first trading day after the court handed down its decision, the benchmark Manila composite index dropped by 4.5% -- wiping out the year's gains in just three hours -- and the peso fell nearly 2%. "The markets don't like uncertainty," says Alex Pomento, strategist for Macquarie Equities in Manila. "Foreign investors want a semblance of stability, implementation of vat, reduction of the budget deficit, and a change in the way we conduct politics in our country before they start looking at us seriously."
The troubles may be compounded by higher borrowing costs. The central bank's key lending rate is now 9.25%, but Singapore's DBS Bank is predicting a half-point increase to contain inflation and support the weakening peso. And though the country hasn't defaulted on its international loans since the 1980s, Moody's Investors Service in February cut the Philippines' sovereign rating to four notches below investment grade because it didn't think Arroyo was moving fast enough on fiscal reform. Then in June it put the country under watch because of the latest political unrest. "Unless the political crisis and implementation of vat are resolved quickly, we could well see a vicious circle of rising local interest rates, a falling peso, and falling stock prices," says Alfred Dy, head of research at CLSA Emerging Markets in Manila.
Even remittances from the million-plus Filipinos working abroad could aggravate the Philippines' economic difficulties. Overseas workers sent home $8.5 billion, or nearly 10% of GDP, last year, and the amount could top $10 billion this year. While that helps cover the country's current-account deficits, it also fuels inflation, since the money typically is spent on private consumption. That, in turn, could mean still-higher interest rates, which could choke off growth.
Given the accusations of election-rigging, Arroyo is likely to spend more time saving her presidency than working on the economy. However, she can't ignore it. GDP grew a healthy 6.1% last year but could slow to just 4.3% this year. The protests calling for Arroyo's resignation have so far been smaller than those that toppled Marcos and Estrada. But analysts say that if she is to keep her fragile political base intact, she must address the fiscal situation. The Philippines can barely handle a political crisis, let alone an economic one. By Assif Shameen in Singapore