On the Application of European Union (EU) State Aid Rules in the Philippine Rice Sector

Similarly, the imposition of tariffs on rice imports by the private sector may discourage importation thereby potentially affecting trade between the Philippines an[r]

On the Application of European Union (EU) State Aid Rules in the Philippine Rice Sector

Vincent Jerald R Ramos1

The National Food Authority (NFA) is a state-owned enterprise with the mandate of ensuring national food security and stable supply and prices of rice NFA’s financial viability has been consistently questioned given its main market function of buying unhusked rice (paddy) and sells milled rice at set prices regardless of costs incurred A sizable chunk of NFA’s operational expenses (25 percent on average from 2013-2017) are shouldered by two kinds of subsidies from the national government—income and tax subsidies This paper attempts to look into the value and nature of the subsidy granted to the NFA with respect to the State Aid rules adopted by the European Commission Using the EU Guidelines for State Aid Evaluation, the paper preliminary finds that the NFA has benefited from market-distorting Aid which is not available to other players in the sector and that alternative policy instruments which have less impact on market competition can be adopted On top of the elimination of this Aid, reforms and effective law enforcement are necessary to effectively minimize market distortions in the rice sector Further, the Association of Southeast Asian Nations (ASEAN) region, in light of its further integration, can look into how State Aid regulations can be integrated in the mandate of the national competition authorities and how Member States can advocate for and promote competitive neutrality in their Aid instruments

1 Introduction

The European Union (EU) implemented the State Aid Law to prevent member states from providing intervention which distorts competition This “intervention” can come in the form of subsidies, incentives, tax breaks, preferential treatment, among others The goal of the policy is to ensure a level playing field among entities within the EU

The National Food Authority (NFA) is the only state-trading enterprise notified by the Philippines to the World Trade Organization (WTO) and its mandate is to ensure national food security and stable supply and prices of staple cereals, including rice NFA’s financial

performance has been consistently questioned given its main market function of buying unhusked rice (paddy) and sells milled rice at set prices regardless of costs incurred

This paper attempts to look at the value and nature of the subsidy granted to the NFA with respect to the State Aid rules adopted by the European Commission The first screen is whether this aid qualifies as “State Aid” under the formal definition adopted by the EC The second screen is the notifiability of such aid The third screen is the compatibility test of the said Aid Using the EU Guidelines for State Aid, the paper preliminary finds that the NFA has benefited from market-distorting Aid, composed of income and tax subsidies, which are not available to other players in the sector and that alternative policy instruments which have less impact on market competition can be adopted Further, policy reforms and effective law enforcement are necessary to effectively minimize market distortions in the rice sector

The paper concludes by recommending that the removal of Aid given to the NFA should not be a singular decision It should be part of a package of policy reforms including a change in policy and more effective law enforcement Further, in light of heightened integration within the Association of Southeast Asian Nations (ASEAN) region, the ASEAN Experts Group on Competition can look into how State Aid regulation can be integrated in the mandate of the national competition authorities and how they can advocate for competitive neutrality within their respective countries

2 Philippine Rice Sector

The surge in rice prices in the first half of 2018 revived the discussions on rice policy in the Philippines, with past studies pointing to different reasons on why rice production remains inefficient, why rice farmers remain among the poorest and most vulnerable workers, and why rice prices are among the highest in Southeast Asia

Rice is the primary staple food and the most widely grown crop in the Philippines and its price and stability of supply have been important considerations in the formulation of agricultural and economic policies in the country In 2016, the Philippines ranked eighth (8th) among the

hectares of paddy planted which translate to an average yield of 3.9 T/ha.2 In 2017, Philippine

rice production increased by 9.6 percent, along with a corresponding increase in national yield to 4.0 t/ha.3

The rice sector employs 2.1 million farmers, 42% of which are reported to live below the poverty line4 Rice also accounts for 25% of food expenditures of the poorest 30% of the

national population5 Given these indicators, the economic importance of rice cannot be

overstated and the literature points to two main causes for the sector’s sad state—the first is the alleged existence of a rice cartel and the second is the protectionist government policies

An Alleged Rice Cartel

The importance and widespread availability of rice makes it a political crop There have been numerous attempts to look into the existence of cartel, as portrayed in mainstream media However, the literature offers conflicting evidence A study by Tadem6 finds that rice

farmer-cooperatives face difficulties in marketing paddy because of well-established rice cartels that control trade and dictate prices Intal and Garcia7, refer to a so-called “rice cartel” composed of

seven Chinese families concentrated in Binondo amid a high concentration of large rice wholesalers in the area On the other hand, studies by Dela Peña8 and Briones9 find no direct

evidence of cartel-like behavior considering the abundant number of players and insights from accredited entities themselves Hayami and Kikuchi10 also describe paddy trading at the

grassroots as being highly competitive

Food cartels directly impact consumers such that they bear the high price which they would not have paid in a competitive market This harm was evident in Italy when the average increase in

2 Source of raw data is the Food and Agriculture Organization of the United Nations, FAOSTAT Open Access Dataset

3 Philippine Statistics Authority Raw data on paddy production and area harvested (2011-2017) 4 Reyes, C.M., et.al 2012 Poverty and Agriculture in the Philippines: Trends in Income Poverty and

Distribution Discussion Paper Series No 2012-09 Quezon City: Philippine Institute of Development Studies 5 Balisacan, A.M & Sebastian, L.S 2006 Securing Rice, Reducing Poverty: Challenges and Policy Directions Published by: SEARCA, PhilRice, and DA-BAR

6 Tadem, T., 2002 NGOs Organizing Cooperatives: The Philippine Case In: Asian Review 2002, Vol 15: Popular Movements Institute of Asian Studies, Chulalongkorn University, Bangkok pp 62-77

7 Intal P & Garcia, M 2005 Rice and Philippine Politics Discussion Paper Series No 2005-13 Quezon City: PIDS

8 De la Peña, B 2014 Rapid Appraisal of the State of Competition in the Rice Value Chain Discussion Paper Series No 2014-25 Quezon City: PIDS

9 Briones, R., and de la Peña, B 2015 Competition reform in the Philippine rice sector Discussion Paper Series No 2015-04 Quezon City: PIDS

the wholesale and retail prices of pasta reached 51.8 and 36 percent respectively.11 This

occurred when large pasta manufacturers entered into a price coordination agreement with the industry association from 2006 to 2009 Similarly, bread prices increased by 70 percent in Romania because of a cartel between 49 bakeries.12

In this regard, competition policy is a tool used by governments to ensure the availability and affordability of food in the market and scrupulous practices are penalized In Europe, the food sector is one of those where national competition authorities have been most active From 2004 to 2011, European competition authorities have looked into over 180 antitrust cases across all levels of the food supply chain, with the highest number of cases in the processing level (28%), followed by retail (25%), manufacturing (16%), and primary production (12%) The “transformative” part of the supply chain (processing and manufacturing) accounts for 44%, or almost half, of all cases13

It is the experience of Europe where competition policy has effected changes in the food sector that the Philippines can learn from Given that competition law is nascent in the Philippines, it is inevitable that it will gain its fair share of successes and failures in enforcement in the coming years The Philippine Competition Commission (“PCC”) notes that the rice sector is among its priority sectors and the agency is expected to have an answer to the decades-long debate on whether rice cartels exist or have existed and whether its existence have adversely affected the rice sector

Protectionist Government Policies

While and potentially anticompetitive conduct in the rice sector cannot be ruled out, imported rice may serve as a source of competitive pressure Following the law of one price, domestic and border prices tend to equalize14 if foreign supply can freely enter the market This

occurs since the entry of cheaper rice from more cost-efficient rice producing countries compels local players to produce at less cost and streamline distribution channels

11 Chauve, P., Parera, A., & Renckens, A 2014 Agriculture, Food and Competition Law: Moving the Borders

Journal of European Competition Law & Practice, 2014, Vol 5, No Pp 304-313

12 Id

13 ECN Subgroup Food 2012 ECN Activities in the Food Sector: Report on competition law enforcement and market monitoring activities by European competition authorities in the food sector

However, in the case of the Philippines, rice importation has been restricted The National Food Authority (NFA), a state-trading enterprise and the rice sector regulatory body, has jurisdiction over the volume of imports and accreditation of importers Based on data from the Philippine Statistics Authority (PSA), imports account for an average of only 10 percent of the rice supply in the country from 1990 to 2016

The limited quantity of imported rice that enters the Philippines is due to the Minimum Access Volume (MAV) commitment of the Philippines to the World Trade Organization (WTO) Under this commitment, the NFA allows the private sector to import a predetermined volume of rice, effectively restricting the free entry of sizable imports In addition, the government has been pursuing a rice self-sufficiency policy, which aims to boost local production and limit reliance on importation

Private traders who want to import rice are subject to the import permit allocation guidelines of the NFA The annual volume cap of rice to be imported as well as the period when imports can arrive in the country are determined by the NFA Council In 2018, this volume cap was set at 805,200 MT15 Of the said volume, 50,000 MT is allotted for Omnibus Origin (any country)

while the rest are country-specific quotas (CSQs) This policy has been crafted by the NFA, citing their mandate of ensuring food security and stabilizing the price and supply of rice

3 The Aid Under Question

NFA’s financial performance has been consistently questioned given its main market function of buying unhusked rice (paddy) and sells milled rice at set prices regardless of costs incurred A sizable chunk of NFA’s operational costs are shouldered by two kinds of subsidies from the national government—income and tax subsidies In 2017, income subsidy of NFA amounted to PHP 5.1 billion (approx USD 100 million) and constitutes 64 percent of all subsidies granted to State-Owned Enterprises in the agricultural sector Based on publicly available data, these are the subsidies received by the NFA from 2013 to 2017

Figure Subsidies Received by NFA, 2013-2017, in million PHP (in million USD)16

15 National Food Authority (24 May 2018) General Guidelines in the Importation of 805,200 MT under the Minimum Access Volume (MAV) for CY 2017-2018 by the Private Sector

16 Subsidies Received by NFA, 2013-2017, in million PHP

Year Income Subsidy Tax Subsidy Total Subsidy

2013 2,145.913 1,303.00 3,448.913

Source: NFA Audited Financial Statements

The income subsidy is used to support the two main commercial functions of the NFA—buying palay from the farmers and selling milled rice to consumers From 2013 to 2017, as covered in the figure above, the procurement price for palay was set at PHP17.00/kg (plus a PHP0.30/kg cooperative development incentive fee, PHP0.20/kg delivery incentive, and a PHP0.20/kg drying incentive)17 The NFA procures from farmers at this fixed rate regardless of the

prevailing market price of dry palay and the prices offered by private traders This procurement price is also fixed regardless of the geographic origin of the palay

Meanwhile, the subsidized wholesale and retail prices of commercial rice were set at PHP27/kg and PHP32/kg This is the fixed price of rice regardless of the prevailing market price of commercial rice sold by private traders and regardless of whether the costs exceed these set prices Further, under the buffer stock scheme, NFA keeps a year-round 15-day strategic rice reserve (SRR) in government depots to be deployed in times of emergency and a 30-day government rice buffer stock (GRBS), inclusive of the 15-day SRR18

The tax subsidy, on the other hand, is used to cover the payment of import duties levied on rice imports made by the NFA In effect, the NFA does not pay duties for any of its rice importation

2015 4,250.00 9,468.974 13,718.974

2016 4,250.00 6,396.652 10,646.652

2017 5,100.00 1,782.089 6,882.089

17 WTO 2018 “Trade Policy Review - Report by the Secretariat - The Philippines.” WT/TPR/S/368 World Trade Organization <https://www.wto.org/english/tratop_e/tpr_e/s368_e.pdf>

18 Ibid

0 2.000 4.000 6.000 8.000 10.000 12.000 14.000 16.000 18.000

2013 2014 2015 2016 2017

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Income and Tax Subsidy of the NFA, 2013-2017

activities Meanwhile, imports by private players under the Minimum Access Volume (MAV) import quota are levied a 35% tariff

This paper examines the income and tax subsidy as one form of “Aid” since both subsidies have the common aim of sustaining the financial viability of NFA by minimizing both deficits and liabilities The income subsidy is meant to defray operating expenses (e.g procurement, milling, personnel services, etc.) while the tax subsidy is solely the payment for its import duties Thus, the state aid under question is the income and tax subsidy given to NFA from 2013 to 2017 amounting to PHP 50.054 billion

3.1 Is it “State Aid”

Article 107 of the Treaty of the Functioning of the European Union (TFEU) listed four features of what constitutes State Aid The table below summarizes each feature and a description of whether the aid under question satisfies the same

Table Features of State Aid

Features Description of the Aid under question

(1) An intervention by the State or through State resources

The Aid is provided by the State, through its National Expenditure Program approved by the Philippine Congress and signed by the Philippine President This Aid uses State Resources and is considered a government expenditure

(2) Gives the recipient an advantage on a selective bias

The Aid given to the NFA is meant to support its legal mandate of ensuring food security and stabilizing price and supply of rice Among players in the rice sector, only the NFA has legal basis to receive such Aid

(3) Distorts or threatens to distort competition

Private players in the rice sector have not received such Aid—either in income subsidy or tax exemption This implies that, for instance, for the same commercial activity such as importation, private players are levied a 35 percent tariff while the NFA receives a tax subsidy This creates an unequal playing field between private sector and the state-trading enterprise thereby potentially distorting competition

(4) Affects or potentially affects trade among Member States

to the Blueprint 2025, which aims to institute measures that further integrate policies and priorities across member states

In this context, the Aid under question prioritizes and incentivizes the purchase and sale of local rice, regardless of its price relative to the price of foreign rice In effect, if the NFA can purchase its milled rice from Thailand or Vietnam, it will have to continue procuring palay from farmers even if they operate at a loss Similarly, the imposition of tariffs on rice imports by the private sector may discourage importation thereby potentially affecting trade between the Philippines and other rice producing countries in ASEAN

Based on the discussion above, the subsidy in question qualifies as State Aid under the definition of the same in EU Law

3.2 Is it Notifiable?

The general rule is that States must notify Aid before the European Commission Therefore, the follow-up question is: will it be evaluated by the European Commission? First, there is a need to ascertain whether the Aid falls under the following: general and agricultural block exemption regulations (GBER/ABER) as stipulated in Commission Regulations 651/2014 and 702/2014 as well as the general and agricultural de minimis regulations as stipulated in Commission Regulations 1407/2013 and 1408/2013

GBER/ABER are the legal bases for an Aid’s exemption from notification and approval of the Commission prior to the consummation or provision of the Aid Instead, the Member State can implement the Aid, provided that it is in accordance with the regulation, and notify the EC within a maximum of six months.19 The list of categories of aid (in the general and agricultural

sectors) that may be compatible with the internal market is an exhaustive one The Aid does not fall into any specific category or subcategory in Regulations 651/2014 and 702/2014

However, Art 107(3)(a) of the TFEU notes that “aid to promote the economic development of

areas where the standard of living is abnormally low or where there is serious underemployment…” may be considered compatible with the internal market This is a potential

19 EC Staff 2014 “Common Methodology for State Aid Evaluation” European Commission Staff Working

justification for the provision of the said Aid considering the high poverty and underemployment levels among rice farming households in the Philippines and the high cost of rice sold in the market These policy objectives are the bases for the provision of the said Aid and will be weighed against its potential effect on competition in the latter part of this paper Meanwhile, de minimis aid are “small” amounts of aid granted to a specific entity Given its small absolute amount, it is not expected to distort competition Thus, de minimis aid is not state aid based on EU guidelines The de minimis ceiling for the agriculture sector is EUR 20,000 for a single undertaking over a period of three fiscal years20 Meanwhile, the ceiling for

all other general sectors is EUR 200,000 for a single undertaking over a period of three fiscal years.21 One can argue that the Aid is used to support the primary production of an agricultural

product (rice) and on the other hand, it is also used as a subsidy for the wholesaling and retailing of a commodity (rice) However, we not aim to distinguish in this paper whether this aid falls under the agriculture or general de minimis rule because based on either threshold, the NFA subsidy far exceeds the ceiling

3.3 Is it Allowable?

The benchmark of allowability in the European Commission’s (EC) evaluation of Aid is whether or not it is compatible with the internal market In doing so, the EC tries to balance the negative effects of the aid on trade and competition in the common market against the positive effects in achieving its policy objectives For the conduct of Aid evaluation, the EC has established a “balancing test” composed of various questions If the answers to all these questions, especially number (3), then this becomes the economic justification for the Aid’s compatibility with the internal market An answer of NO to any question, especially number (3) becomes a justification in finding that the Aid is not compatible with the internal market The table below outlines the evaluation questions, a discussion, and an answer to the question Table Aid Evaluation Framework

Evaluation Question Discussion YES/NO

(1) Is the Aid measure aimed at a well-defined objective of common interest?

The NFA charter is clear on its functions: ensuring

food security, stability of supply and price of rice YES (2) Is the Aid measure

well-designed to deliver the

Buying palay and selling rice at a fixed price is not fiscally sound policy And Aid that supports this

NO

objective of the common interest (does it address the market failure)?

policy approach is likely not a well-designed one Having fixed prices does not incentivize farmers to sell to NFA if the NFA price is lower than the private market price For commercial purposes, having a stable price of rice gives consumers an option, especially for those who cannot afford rice sold by private traders

(2.1.) Is the aid an

appropriate policy

instrument to address the

policy objective

concerned?

The budget can be better allocated to Research and Development and direct farm intervention, crop insurance, agricultural credit, seed development, farm schools, etc

Other policy instruments: rice trade liberalization, rice sector competitiveness enhancement fund

NO

(2.2.) Is there an incentive effect, i.e does the aid change the behavior of the aid recipient?

The main recipient of Aid is NFA and this Aid changed the behavior of the recipient for the worse The Aid augmented financial losses of the NFA instead of making their operations financially viable while performing their mandate Thus, we find that the Aid even has a disincentivizing effect to NFA

NO

(2.3.) Is the aid measure proportionate to the problem tackled, i.e could the same change in behavior not be obtained with less aid?

The same, and even better conditions can be obtained with less or even no aid However, the removal of aid should be complemented by a change in policy and more effective law enforcement

NO

(3) Are the distortions of competition and effect on trade limited, so that the overall balance is positive?

Rice is a highly tradable good and is a stable commodity in the region where the Philippines belongs On the part of NFA, its functions set forth in the NFA chapter and the Aid given to augment the costs affect the level and state of competition in the sector as well as the trade of rice with other countries

On the other hand, its perceived benefits are non-existent In fact, the Aid given to NFA which it used to support its commercial function of selling milled rice at fixed prices in the market has resulted in Filipino consumers spending more on rice Briones22 finds that the price of milled rice in

Thailand plus freight and ancillary costs and tariffs will be the within the PHP 25-27 per kilogram price range, lower than the NFA-set price of PHP 27-32/kg Thus, it is not only the said Aid that is problematic but also the import monopoly policy of the NFA

NO

Note that this test was developed in the context of multiple economies sharing a common international market However, the questions are general enough to be applicable in assessing Aid for a State-Owned enterprise operating in one sub-sector in agriculture in the Philippines The criteria will need to be nuanced to be suitable to a given context For instance, on the first criterion, the “common interest” as used must have referred to those of the members of the EU In the case on NFA, common interest can be defined to mean interest of the general public Question (3) refers to competition among the members of the EU and can be defined in the context of Philippines’ trading of rice with other countries in Southeast Asia (ASEAN) Based on the discussion above, there is clear justification to support the finding that the effects of the Aid on competition and trade outweigh the benefits, if any Briones23 finds that the import

monopoly of the NFA, which essentially represents its functions, have caused Filipinos to pay higher prices than what they would have otherwise paid under a liberalized regime

Meanwhile, the Aid has been able to raise the relative cost of production for players in the private sector and it has caused distortions in prices being paid to farmers for their palay and paid by consumers for their rice Finally, the Aid, which is composed of an income and tax subsidy, is meant to augment the NFA’s financial losses incurred by performing functions that have made the sector worse off

The budget used for the Aid can be better allocated towards non-Aid distorting measures to improve the competitiveness of the sector such as farm intervention and mechanization, expanded crop insurance program that is easily accessible, agricultural credit with even lower interest rates, seed testing and development, and establishment of farm schools, among others Other policy instruments that could be implemented on top of rechanneling the Aid are the full liberalization of rice trade by lowering tariffs and busting NFA import monopoly, rice grains classification standardization, and streamlined registration process for potential entrants in the rice sector

Further, law enforcement should be made more effective The Philippine Competition Commission (PCC) has to lead efforts towards the investigation of the alleged rice cartel The

Bureau of Customs (BOC) has to lead efforts towards the curbing of smuggling and ensure the correct payment of tariff duties Finally, the Department of Agriculture has to lead efforts in reforming NFA so its functions are supportive of a liberalized rice sector and that its operations remain financially viable

4 Implications for ASEAN

The Association of Southeast Asian Nations (ASEAN) Economic Community Blueprint 2025 is a ten-year roadmap that outlines initiatives on how to improve the harmonization of economic policies and indicators Zeroing in on competition policy, the ASEAN Experts Group on Competition (AEGC) released a Competition Action Plan 2016-2025 which outlines the strategic measures that individual competition authorities will work on, namely:

1 Put in place competition laws for all remaining ASEAN Member States that not have them, and effectively implement them in all Member States;

2 Strengthen capacities of competition-related agencies by establishing and implementing mechanisms necessary for enforcement of these laws including technical assistance and capacity building;

3 Establish platforms for regular exchange and engagement, encourage competition compliance and enhanced access to information for businesses, reach out to relevant stakeholders through an enhanced regional web portal for competition policy and law, outreach and advocacy to businesses and government bodies, and sector-studies on industry structures and practices that affect competition;

4 Establish Regional Cooperation Arrangements on competition policy and law by establishing competition enforcement cooperation agreements;

5 Achieve greater harmonization of competition policy and law in ASEAN by developing a regional strategy on convergence;

6 Ensure alignment of competition policy chapters that are negotiated by ASEAN under the various FTAs with Dialogue Partners and other trading nations with competition policy and law in ASEA; and

7 Continue to enhance competition policy and law in ASEAN taking into consideration international best practices.24

Note that there is no mention of State Aid or a discussion of subsidies in any of the following documents: the CAP 2016-2025, ASEAN Economic Community 2025 Consolidated Strategic Action Plan, and the ASEAN Economic Community Blueprint 2025 Thus, it appears that while ASEAN is harmonizing in terms of vision, it is not harmonizing in terms of actual policy This can mean two things in relation to State Aid First, the introduction of State Aid rules is a long way to go The ASEAN market has to first complete its liberalization initiatives and establish their national competition authorities It is only when State Aid can potentially come into the discussion Second, State Aid regulation is a blind spot that has to be discussed and addressed in ASEAN now As we have seen in the case of the Philippine Rice Sector, the Aid provided would have qualified as incompatible with the internal market should ASEAN decide to adopt a similar evaluation framework Aid that distorts competition and trade should not be brushed off by Member States The average rate of inter-ASEAN trade in goods of a Member State is 22.9 percent This implies that there is room for growth in the volume of goods that ASEAN countries trade with one another

Table ASEAN Trade Key Indicators 201725

Unfortunately, the political landscape of ASEAN makes it not too conducive for the introduction of a policy as encompassing as State Aid rules Currently, ASEAN lacks a “leader” that is steering ASEAN towards greater integration Further, Member States would have reservations in giving power to a supranational agency that can request and access their data, rule on the legality of a local program or policy, and order the prohibition of the said program or policy

Notwithstanding, State Aid should be subject for further research most especially by the AEGC The topic is promising and, as seen in this hypothetical exercise, can show the distortionary effects of an Aid Should ASEAN, in the future, decide to act as one economic community indeed, the Member States would have already been disciplined as to implementing Aid that is neutral, targeted, and effective

5 Conclusion

The removal of Aid given to the National Food Authority should not be a singular decision It should be part of a package of policy reforms on the rice sector The removal of the said Aid should be complemented by a change in policy and by more effective law enforcement Not doing any of these three will result to sluggish reforms in the sector On the other hand, State Aid should be subject for further research in ASEAN through the ASEAN Experts Group on Competition (AEGC) The AEGC can look into how State Aid regulation can be integrated in the mandate of the national competition authorities and how they can advocate for competitive neutrality within their respective countries