The Philippines’ way forward with China amid sea dispute

The Philippines relies rather heavily on China for goods trade. China is the country’s largest trading partner, accounting for 20 per cent of its total foreign trade to overtake Japan in the last decade.

China has also emerged as a preferred source of financing for public sector projects especially between 2016-2022 under the leadership of former President Rodrigo Duterte. The country joined the ranks of Japan, as well as the Asian Development Bank and the World Bank, as key sources of development aid.

However, the opposite is true as far as geopolitical relations are concerned. China is the Philippines’ greatest rival at the South China Sea, with Beijing refusing to let go of its sweeping claim of ownership over these waters despite a 2016 ruling from an international tribunal that favoured Manila’s exclusive economic rights in maritime features adjacent to Philippine coastlines.

This sea dispute has since escalated, with repeated standoffs between the Philippine and Chinese Coast Guards that saw Beijing’s vessels chasing away Philippine ships and fishing boats, the seizure of supplies meant for Filipino soldiers on patrol, and very recently a violent exchange that injured members of the Philippine Navy. The Philippine government has repeatedly responded by filing diplomatic protests and issuing statements of condemnation. In response, Beijing denies such allegations and claims that their actions were warranted responses to the Philippines’ supposed illegal manoeuvres in these disputed waters.

President Ferdinand Marcos, Jr. issued his strongest stance yet on the sea dispute, saying in his 22 July national address that Filipinos cannot yield nor waver in asserting ownership over the West Philippine Sea, even when his government recently struck an agreement with Chinese counterparts to let resupply missions of Philippine troops to pass without incident.

This brings into question how investors should navigate this unique and complicated relationship between the Philippines and China.

Arm’s length

Despite the escalating standoff at sea, we believe there is ample room for the Philippines to treat economic opportunities and geopolitical strain separately. The Philippine government under President Ferdinand Marcos, Jr. said it seeks to “appropriately” manage its differences with China by maintaining bilateral economic ties despite the protracted territorial row.

Economic ties between the Philippines and China are hard to untie after decades of entanglement. Graph 1 shows the increasing reliance on merchandise imports from China, with 2020 as an exemption when both domestic production and international trade significantly slowed due to mobility restrictions during the COVID-19 pandemic. Still, China remained the Philippines’ biggest trading partner and largest source of merchandise imports that year. Meanwhile, exports to China have declined over the past five years based on government data.

China is also the second biggest destination of Philippine exports in 2023, accounting for 14.8 per cent of the total. In tourism, China is consistently among the top five sources of foreign travellers entering the Philippines over the past few years – a trend that is likely to be sustained given mainland China’s population of 1.4 billion.

The debt crisis gripping Chinese real estate developers – coupled with deflated household spending, high global interest rates, and weak goods exports – led to a sluggish 5.2 per cent GDP growth in 2023. Still, it is a respectable pace for the global manufacturing powerhouse. After all, China remains the second-largest economy in the world which continues to drive global economic activity.  

Balancing act

The Philippine government is constantly navigating the middle ground as it steers this odd set-up with China, knowing that it cannot cut off China as a trading partner given its might as a global manufacturing hub and huge consumer market. However, there is political pressure to push back against mainland China’s advances in the South China Sea (the parts claimed by Manila are collectively referred to as the “West Philippine Sea”).

While some fear that China will take years to recover from its current downturn, its economy will remain a global growth leader as developed nations struggle with aging populations, high borrowing costs, and stubborn consumer demand.

Duterte’s pivot to China showed a surge in both approved investment pledges and actual net foreign investment flows between 2018 and 2019. However, this increase was not sustained and has considerably declined since, with net investment flows from China settling even lower than pre-pandemic levels as seen in Graph 2.

The Philippines appears to be pulling back its reliance on Chinese development aid for the ambitious “Build Better More” public infrastructure program, which is viewed by some as the manifestation of Manila taking a stand on the sea dispute. In 2023, the Philippines announced it is no longer pursuing Chinese funding for three railway projects under the Belt and Road Initiative, citing a lack of progress in loan negotiations. This could benefit the Philippines considering the availability of cheaper loans from other countries and development agencies and China’s domestic debt predicament.

Clearly, a clean break from China is not doable. However, the Philippines stands to benefit from deepening its trade ties with other economies to diversify its import sources, secure more favourable loan terms, and expand its income base.