Maritime Dispute Raises China Sanctions Risk

BMI View: Escalating tensions between China and the Philippines in the South China Sea may spur Beijing to impose economic sanctions on the Philippines. This would pose downside risks for our 2014 real GDP growth forecast of 6.3%.

There is no end in sight to the maritime dispute between China and the Philippines over their sovereign claims to the Scarborough Shoal and Spratly Islands in the South China Sea. Bilateral talks have proved futile thus far in resolving the dispute, and while the Philippines has sought arbitration at the United Nations, China has reiterated that it will not participate in any of the legal proceedings. With tensions rising between both countries, we believe that the Philippines is facing an increasing risk of economic sanctions by China. The recent request by the arbitral tribunal for China to submit its side of the argument by the December 15 deadline will also likely be rebuffed by Beijing.

China's Growing Assertiveness Raises Regional Tensions

Strong Trade Ties With China
Philippines - Exports To China (LHS) & Imports From China, % Total

BMI View: Escalating tensions between China and the Philippines in the South China Sea may spur Beijing to impose economic sanctions on the Philippines. This would pose downside risks for our 2014 real GDP growth forecast of 6.3%.

There is no end in sight to the maritime dispute between China and the Philippines over their sovereign claims to the Scarborough Shoal and Spratly Islands in the South China Sea. Bilateral talks have proved futile thus far in resolving the dispute, and while the Philippines has sought arbitration at the United Nations, China has reiterated that it will not participate in any of the legal proceedings. With tensions rising between both countries, we believe that the Philippines is facing an increasing risk of economic sanctions by China. The recent request by the arbitral tribunal for China to submit its side of the argument by the December 15 deadline will also likely be rebuffed by Beijing.

China's Growing Assertiveness Raises Regional Tensions

Meanwhile, China has continued to exert a growing influence in the South China Sea, making it increasingly difficult for neighbouring countries to stake their claims to parts of the disputed waters. In addition to enhancing its military presence in the South China Sea, China has allegedly been carrying out land reclamation works on several disputed reefs in the Spratly Islands recently. There is speculation that the land reclamation operation that has reportedly taken place on the Mabini (Johnson South) Reef could be for the establishment of an Air Defense Identification Zone (ADIZ), which would greatly increase tensions in the region. Beijing's declaration of an ADIZ in North East Asia last November raised tensions with Japan and South Korea ( see 'China's New Air Defence Zone: Seven Crucial Factors', December 4, 2013). In light of these developments, the Philippines has in recent months filed protests against China for the reclamation works, and we believe this will further undermine the already fragile nature of Sino-Philippine relations. Tensions have also been rising in the South China Sea recently between China and Vietnam following China's deployment of an oil rig off Vietnam's coast. Indeed, Vietnamese protesters burnt down several Chinese factories and forced the closure of several more in protest of China's oil rig deployment.

We expect China's growing assertiveness in the South China Sea to persist over the coming years. As China will be a major force driving economic growth in Asia, other regional countries which are also embroiled in the South China Sea dispute may become reluctant to confront Beijing, for fear of risking their economic ties with the People's Republic. China has also been expanding its military capabilities, and this will act as a strong deterrent to neighbouring countries. While a full-scale war is unlikely, occasional military skirmishes in the South China Sea will remain a salient risk in our view. In addition, while the US is attempting its 'pivot' towards Asia, we believe that it is unlikely to intervene militarily in such naval skirmishes.

Economic Sanctions Remain A Risk

From an economic perspective, we note that ongoing sea territorial dispute has not impacted trade flows between China and the Philippines. According to data released by the National Statistics Office (NSO), Philippine exports to China rose by 15.6% year-on-year to USD1.7bn in Q114 as compared to Q113. Meanwhile, Philippine imports from China jumped 30.0% y-o-y to USD2.2bn, from USD1.7bn in Q113. In addition, we note that Philippine exports to China have remained broadly stable at about 12% of total outbound shipments over recent years, while the proportion of Philippine imports coming from China has been on the rise, and accounted for about 13% in 2013.

Strong Trade Ties With China
Philippines - Exports To China (LHS) & Imports From China, % Total

That said, economic sanctions by China will remain a salient risk in our view, as the ongoing maritime dispute has the potential to escalate to the heightened levels that we have seen between Vietnam and China in recent months. Given the close trade relations between China and the Philippines - China is the third largest export destination for the Philippines, while also the largest source of imports for the country - trade sanctions would pose clear downside risks to our real GDP growth forecast, which currently stands at 6.3% in 2014 and 6.0% in 2015.

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Sector: Country Risk
Geography: Philippines
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