Report No. 23629-PH Philippines Development Policy Review An Opportunity for Renewed Poverty Reduction Februarty 22, 2002 Poverty Reduction and Economic Management Sector Unit East Asia and Pacific Regional Office Document of the World Bank CURRENCY EQUIVALENTS (As of Feb 22, 2002) Currency Unit - Peso $1.00 PhP51.36 PhP I.00 = US$0.0195 FISCAL YEAR January I - December 31 ACRONYMS AND ABBREVIATIONS ASEAN Association of Southeast Asian MTPDP Medium Term Philippine Nations Development Plan AMC asset management company NCR National Capital Region BIR Bureau of Internal Revenue NGAS New Government Accounting BOC Bureau of Customs System BOT build-operate-transfer NGO Non-government organization BSP Bangko Sentral ng Pilipinas NPL Non-performing loan CMDC Capital Markets Development NRM National Resource and Management Corporation NSCB National Statistical Coordination COA Commission on Audit Board COP Committee on Privatization NSO National Statistics Office CSC Civil Service Commission ODA overseas development assistance DBM Department of Budget and OPIF Organizational Performance Indicator Management Framework DOF Department of Finance PDIC Philippine Deposit Insurance DST Documentary Stamp Tax Corporation EKB expanded commercial bank PCEG Presidential Committee on Effective EPR effective protection rate Governance Reform FIES Family Income and Expenditure PPI private participation in infrastructure Survey PSE Philippine Stock Exchange GAAP generally accepted accounting' Public Sector Institutional principles PSISSA Strengthening and Streamlining GDP gross domestic product Agenda GNP gross national product ROPOA Real and Other Properties Owned and GOCC government-owned and controlled Acquired corporation ROSC Report on Standards and Codes HSRA Health Sector Reform Agenda SEC Securities and Exchange Commission IOSCO International Organization of SEER Sector Effectiveness and Efficiency Securities Commissions Reviews IRA Internal Revenue Allotment SSS Social Security System LGC Local Government Code VAT value-added tax LGU local government unit WTO World Trade Organization LTDO Large Taxpayer District Office Vice-President: Jemal ud-din Kassum, EAP Country Director: Robert Van Pulley, EACPF Sector Director Homi Kharas, EASPR Task Manager Lloyd McKay, EACPF TABLE OF CONTENTS EXECUTIVE SUMMARY ...................I 1. DEVELOPMENT ACHIEVEMENTS MIX SUCCESS AND DISAPPOINTMENT . 1 A. RECENT ECONOMIC PERFORMANCE HAS BEEN MODEST AND FRAGILE .I B. POVERTY REDUCTION HAS STAGNATED .4 C. POLICY DISCUSSION .6 D. CONCLUSIONS .9 2. POLICY AND INSTITUTIONAL ACTIONS TO DELIVER RESULTS .10 A. STRENGTHEN FISCAL MANAGEMENT .10 Rebuilding revenues .13 Containing contingent liabilities and managing fiscal risks .16 B. IMPROVE GOVERNANCE AND PUBLIC SECTOR PERFORMANCE .16 Overview of governance outcomes. 1 7 Public financial accountability and management .19 Re-engineering government .21 Judicial reform .24 C. STRENGTHEN PRIVATE SECTOR DEVELOPMENT .24 Protection ofproperty rights .25 Corporate governance .25 Creditor rights and insolvency law .27 Competitive environment: foreign trade and investment regime .28 Infrastructure provisions .30 Rural development .31 D. STRENGTHEN AND DEEPEN THE FINANCIAL SECTOR . 33 Banking system performance .34 Policy environmentfor banking .35 Capital markets . 37 Improving access to financingfor SMEs and strengthening microfinance .39 E. EMPOWER AND PROTECT THE POOR .39 Education .40 Health care .41 Ensuring access to other assets .42 Social protection .42 Population growth .43 3. PROSPECTS ARE CONTINGENT ON ACTION AND CONTINUED SUPPORT . 44 A. ECONOMIC DEVELOPMENT PROSPECTS .44 B. POVERTY REDUCTION PROSPECTS .46 C. THE IMPORTANCE OF DONOR SUPPORT .46 Acknowledgement This report is prepared by a team led by Lloyd McKay which included Joven Balbosa, Milan Brahmbhatt, Gaurav Datt, Michael Engelschalk, Teresa Ho, Dana Weist, and Cheloy Tria. Other major contributors were Richard Anson, Aldo Baietti, Craig Burnside, Gary Fine, Sudarshan Gooptu, Arvind Gupta, Vijay Jagannathan, Amitabha Mukherjee, Rajashree Paralkar, Elliot Riordan and Chuck Woodruff Vikram Nehru, Sean Nolan and Zia Qureshi served as peer reviewers. Supervision from Sanjay Dhar, Homi Kharas and Van Pulley is gratefully acknowledged EXECUTIVE SUMMARY 1. Post-1997 Development Outcomes 5. The Medium Term Philippine Disappoint. From 1994 to 1997, Philippine Development Plan (MTPDP) growth targets of economic growth averaged 5 percent per annum over 5 percent per year are attainable, but only if and the incidence of poverty fell quickly, from 32 the key building blocks for sustained growth-an percent to 25 percent. During these years, the environment conducive to increased investment government budget was balanced, exports were and productivity within both private and public growing at around 20 percent per annum, sectors-are firmly in place. And stronger growth investment was 23 percent of gross national must be complemented by increased participation product (GNP), and there was optimism about the in development by the poor to attain the desired prospects for lasting peace throughout the country. rapid reduction in poverty. Anything less would result in further disappointment. 2. In contrast, from 1998 to 2001, economic growth averaged 2.5 percent and poverty reduction 6. Key Policy Issues. Securing the stagnated. Confidence was undermined by sustained increase in growth and participation by governance concerns which culminated in the poor that is central to the MTPDP is likely to impeachment proceedings against former require further prompt action on priority issues in President Estrada, uncertainty with regard to five critical areas: macroeconomic stability arising from falling tax Continue to strengthen fiscal management revenue and large fiscal deficits, rising stress in and reduce the fiscal deficit while the banking sector; and renewed concerns maintaining strategic expenditures in regarding peace and the rule of law. Investment education, health, social protection, fell to 17-18 percent of GNP. In 2001, these agriculture support services, and domestic difficulties were aggravated by a infrastructure. This entails tax policy deteriorating external environment, which measures and public sector reforms to triggered a 16-percent decline in export earnings. enhance revenues, and to improve Yet, despite these difficulties, gross domestic product still grew at 3.4 percent in 2001, the (including a new procurement law), and highest among market economies in the region. management of contingent liabilities. 3. Following the transfer of power in January * Improve governance and public sector 2001, the government has managed to lessen functioning. In addition to the reforms of macroeconomic concerns by essentially meeting public financial management noted above, its budget deficit target, containing inflation, and there are two other areas of governance overseeing a return to financial market stability. reform that are key to strengthening the Moreover, improving governance has become a investment climate and improving delivery of national priority, although so far discussion has public services. These are, first, improving outstripped concrete action. A capacity to move the rule of law, for example, by further forward with structural reforms was demonstrated addressing law-and-order issues, by passage of important power sector legislation. anticorruption efforts and the implementation Together these initiatives have improved policy of planned judicial reform. The second is credibility, but much still remains to be done. civil service reform and, in the context of decentralization, bolstering the 4. Looking forward, the external implementation capabilities of provincial and environment for the Philippines is expected to municipal local government units (LGU)s. improve as global recovery takes hold from the * Strengthen private sector development. second half of 2002. The improving economic Efforts to strengthen corporate governance environment should further enhance the climate and property rights need to be continued, and for further reforms which are needed to again will be enhanced by better enforcement achieve rapid poverty reduction. capacity resulting from improvements in the ii judicial system. Implementation of insolvency participation by the poor, consistent with MTPDP law reform and strengthening of creditor rights targets. needs particular attention in this regard. A 8. Average real economic growth of over 5 second area of focus is the need to further percent per year is feasible and would reduce improve private-public sector partnerships to poverty significantly. Projections based on alleviate infrastructure deficiencies. Among household survey data indicate that such growth pending reforms in individual infrastructure would reduce poverty from 26 percent of the sectors, achieving the objectives of the recent population in 2000 to 18 percent by 2005, a power sector law is particularly important. A decline of about 5 million in the number of poor. third area of special relevance for the poverty If combined with complementary programs to reduction agenda is rural development, improve equity (e.g., effective human resource including land reform, sustainable credit and investments and actions to improve access by the microfinance provisions, and improvements in poor to productive assets and markets), poverty agricultural extension and rural infrastructure. could be reduced even more rapidly. In contrast, Fourth, further trade reform and deregulation average growth of only 3 percent per annum are needed to strengthen competition, would mean only modest poverty reduction. especially for heavily protected agricultural goods such as rice and service sector activities 9. The major risks to the success of this such as transport. renewed fight against poverty are slippages in the * Strengthen and deepen the financial sector to implementation of policy reforms, inadequate improve financial intermediation and to progress in addressing law-and-order problems mobilize savings. Further banking sector and achieving peace, and exogenous factors such reforms are needed to facilitate intervention in as El Nino or other natural disasters, a prolonged and rapid resolution of distressed banks, downturn in world growth, or increased risk strengthen the effectiveness of consolidated aversion vis-a-vis emerging economies in global supervision, and enhance financial sector capital markets. Any combination of these would transparency and governance. Needed capital lessen or defer success. The current government's market development calls for institutional commitment to reform does lessen the risk of strengthening in several of the areas already policy slippage, but even this cannot fully mentioned: corporate governance, creditor insulate against the possibility of exogenous rights, insolvency law implementation, and the shocks. enforcement of shareholder rights. 10. Support from international development * Empower and protect the poor. This partners continues to be needed in two principle necessitates improvements in the quality of areas: resources to help sustain critical public education combined with a fall in the school expenditures while domestic revenues are being dropout rate; actions such as improved rebuilt, and technical assistance to help funding for priority health programs including implement effective policy and institutional sound reproductive health strategies, and reforms. The national government faces large enhanced decentralized capacity to improve financing needs in the medium term-about $5.7 the delivery of health services, especially for billion in 2002 alone-arising from the budget the poor; and expansion of effective social deficit and rising amortization obligations. The protection programs. amount of overseas development assistance needed is at least $1.5 billion; it is anticipated 7. Prospects Depend on Actions. None of that the rest can be mobilized from domestic and these five key areas for continued reform is commercial offshore sources. Increasing the sufficient by itself to achieve the desired sustained share of program lending in overall donor increase in growth with equity. But they are each assistance for the next couple of years would necessary. Together they would provide a greatly assist the government in its efforts to framework for stronger growth and increased maintain strategic expenditures while implementing policy and institutional reforns. iii Summary of Key Recommendations This report contains many policy recommendations, which cannot all be implemented at once. Here are listed key recommendations for priority attention. It is recommended that the government design a phased program of reforms, including these suggestions, to build the momentum needed to achieve the MTPDP growth and poverty reduction targets. Strengthen fiscal management: o Take actions consistent with increasing the tax-to-GNP ratio by at least 3 percentage points by 2005. o Support public expenditure reforms with a new Procurement Law. O Ensure sustainability of public pension funds and contain other contingent liabilities. Improve governance and public sector performance: o Re-engineer the civil service to strengthen decentralization and improve service delivery. This includes moving to a meritocratic civil service, implementing performance management, and strengthening capacity at LGU levels. o Design and implement further anticorruption actions, including improvements in audit performance and actions making the Bureau of Internal Revenue an example of the government's commitment to anticorruption efforts. o Implement the Action Program for Judicial Reform. O Enhance civil peace and personal security. Strengthen private sector development: o Establish effective private-public sector partnerships to alleviate infrastructure deficiencies, with particular attention to urban infrastructure; pursue specific reform agendas in individual infrastructure sectors, in particular by establishing implementing rules and regulations to achieve the objectives of the Power Sector Law. o Strengthen property, contractual, and creditor rights to improve corporate governance and deepen capital markets. o Broaden access to land by relaxing land market restrictions; better targeting the landless in implementing agrarian reform; and strengthening agricultural extension, microcredit, capacity creation at LGU levels, rural infrastructure, and support to community-based development activities. O Introduce further trade and regulatory reforms to strengthen competition, especially for heavily protected agricultural goods such as rice and service sector activities such as shipping. Strengthen and deepen to financial sector: o Facilitate the resolution and sale of nonperforming loans in the banking system. o Strengthen consolidated supervision effectiveness, protection of bank supervisors against litigation, and regulatory capacity to intervene in and rapidly resolve distressed banks without the acquiescence of existing owners. o Implement effective anti money-laundering provisions. Empower and protect the poor: o Improve the quality of basic education and reduce the school dropout rate. O Ensure resources for priority health programs, including a sound reproductive health program, and strengthen local capacity to improve service delivery. 1. DEVELOPMENT ACHIEVEMENTS MIX SUCCESS AND DISAPPOINTMENT 1.1 The Philippines regained a modest Indonesia, Malaysia, or Thailand. This relatively growth rate of about 3.5 percent per annum for robust performance suggested that the the 1999-2001 period, but has not yet managed stabilization and structural reform efforts of the to reduce the incidence of poverty from its 1997 preceding decade were starting to yield results in level. Investment remains conspicuously low at the form of a higher trend rate of growth. Since 17-18 percent of gross national product (GNP), the regional crisis, however, the country has compared with 23 percent of GNP in the mid- regained only a modest-though fairly stable- 1990s. Export growth fell to single digits in growth rate of 3-4 percent (see Table 1.1). In 2000 for the first time since 1992 and contracted 2001, growth reached 3.4 percent-a pace by about 16 percent (in US dollars) in 2001, due swifter than in other market economies in the to the sharp slowdown in the world economy region-despite the steep downturn in exports. and, in particular, in the world electronics trade, Indeed, the Philippines' modest but more stable on which the country has a high export reliance. growth path actually resulted in higher average growth than most of those economies in the 1.2 This modest growth has limited poverty period 1997-2001 (see Table 1.2). The problem, reduction, as employment creation has been of course, is that the associated per-capita GNP similarly modest and public investments in growth rate of about 0.8 percent a year since human resources, social protection, and targeted 1998 is insufficient by itself to deliver a rapid poverty reduction programs have faced resource and sustained reduction in poverty. constraints. The incidence of poverty has changed little from the 25 percent of 1997. TABLE 1.1: GROWTH COMPONENTS (% P.A.) Health indicators have improved since the mid- 1997 1998 1999 2000 2001 1990s: the maternal mortality rate fell from 180 in 1995 to 172 in 1998, while the infant GDP (real) 5.2 -0.6 3.4 4.0 3.4 Agriculture 2.9 -6.2 6.5 3.3 3.9 mortality rate fell from 49 per 1,000 live births Industry 6.1 -2.1 0.0 3.9 1.9 in 1995 to 35 per 1,000 live births in 1998. Services 5.5 3.4 4.0 4.4 4.3 Participation in school has increased at the Exports(S) 1/ 22.8 16.9 18.8 9.0 -15.6 primary level, but the dropout rate has risen at both primary and secondary levels. Memo items Investment 11.7 -16.3 -2.9 2.3 4.3 Consumption 5.0 3.4 2.6 3.5 3.4 1.3 Disappointment with these modest Employmnent 1.9 0.7 3.8 -1.0 2.8 economic and social achievements, together GNP 5.3 0.1 3.7 4.5 3.7 GNP/capita 3.0 -2.1 1.5 2.3 1.5 with growing concern over the governance l/Goods in US dollar terms deficit, kept social tensions high throughout Source: NCSB, MTPDP recent years. In addition, the continuing conflict in parts of Mindanao and elsewhere has TABLE 1.2: GDP GROWTH BY COUNTRY (%P.A.) constrained development efforts in the south. 2001 1997- 1997 1998 1999 2000 (prel.) 2001 A. RECENT ECONOMIC PERFORMANCE HAS Indonesia 4.7 -13.1 0.8 4.8 2.9 0.0 BEEN MODEST AND FRAGILE ~~~Korea 5.0 -6.7 10.9 8.8 2.0 4.0 BEEN MODEST AND FRAGILE Malaysia 7.3 -7.4 6.1 8.3 0.2 2.9 Philippines 5.2 -0.6 3.4 4.0 3.4 3.1 1.4 The Philippines achieved GDP growth Thailand -1.4 -10.8 4.2 4.3 1.1 -0.5 averaging 5 percent in the period 1994-97 and Source: National data, World Bank estimates, Consensus Forecasts. was also less seriously affected by the regional financial crisis than Association of Southeast 1.5 Fixed investment has dipped to a Asian Nations (ASEAN) partners such as sluggish 17-18 percent of GNP in the last three 2 years, creating concern about the prospects for 1.7 Overall growth in recent years has been future growth (see Table 1.3). Firms remained supported by continued expansion in agriculture cautious about longer-term business prospects, and services, offsetting weaker industrial in particular as concerns about governance and growth. After suffering from the effects of a associated political uncertainty delayed the severe El Nino in 1998 and contracting by 6.2 rebuilding of investor interest until 2001. percent, the agriculture sector recovered quickly Concerns about the world economy and the in 1999 and has maintained strong growth (see deteriorating fiscal position at home also eroded Table 1.1), helping bolster domestic demand. confidence. What investment there was has been Slow industrial growth in recent years has financed largely from domestic sources, as limited industrial employment, which, as of foreign interest and capital inflows evaporated 2000, remained below its 1997 level, limiting a until late 2001. key potential source of employment opportunity for the agricultural labor force. Growth has also TABLE 1.3: INVESTMENT (% OF GNP) been uneven across regions (see Table 1.5). 1997 1998 1999 2000 200 prel. TABLE 1.5: REGIONAL GROWTH RATES (% P.A.) Investment 23.8 19.3 17.8 16.9 16.6 o.w. fixed capital 23.5 20.1 18.1 17.1 17.0 1990 to 1995 1995 to 2000 Public 4.8 4.6 5.2 4.6 4.5 Private 19.0 14.8 12.6 12.3 12.1 NCR Metro Manila 1.6 4.3 Source: MTPDP, BSP and staff estimates. CAR Cordillera CAR Cordillera 4.4 5.8 1.6 Viewed in a longer-term perspective, 1. Ilocos Region 1.8 4.8 II. Cagayan Valley 1.2 5.6 fixed investment has averaged in the low 20 III. Central Luzon 2.8 1.6 percent of GNP range in the 1980s and 1990s, IV. Southem Tagalog 2.9 2.8 V. Bicol Region 1.6 2.0 compared to a 30-40 percent range in other TotalLuzon 22 3.6 major East Asian countries. This is estimated to VI. Westem Visayas 2.6 3.1 have translated into a rate of growth of real VII. Central Visayas 2.2 4.3 VIII. Eastern Visayas 2.3 3.5 physical capital stock in the 3-5 percent range Total Visayas 24 3.6 (Table 1.4), compared to a 7-11 percent range in IX. Westem Mindanao 0.6 4.4 the other countries, which, in a growth X. Northem Mindanao 1.5 -2.26 accounting sense, is one factor explaining the XI]. Central Mindanao -2.3 2.9 lower long-run trend of growth in the ARMM 1/ 10.2 2.9 Philippines. The other factor is low total factor Total Mindanao 2.1 1.5 ALL REGIONS 2.2 3.2 productivity (TFP) growth, which in fact is I/ ARMM data starts 1993. estimated to have been negative in both the Source: Statistical Yearbook, NSCB. 1 980s and 1 990s, and for the most part, significantly below TFP growth rates in other 1.8 Inflation has remained reasonably major economies in the region. By reducing modest, in part because of growth in agricultural rates of return to capital, low TFP growth in the production, especially good rice and corn Philippines is also likely to have contributed to harvests (see Figure 1.1). Wage moderation also weak investment growth. helped. However, rising crude oil prices and the deterioration of the peso against the dollar in TABLE 1.4 ACCOUNTING FOR GROWTH(%) 2000 added to the inflationary pressures. This 1970s 1980s 1990s favorable inflation outcome is also the result of sound monetary policy. Most recently, monetary GDP Growth 5.8 2.0 2.9 policy was tightened during the latter part of Capital Stock 7.3 4.7 3.5 Human Capital 4.8 3.4 3.7 2000 but then progressively relaxed during TFP Growth 0.0 -1.9 -0.8 2001, with reserve requirements and interest Source: World Bank staff estimates. rates both being eased. The peso has been relatively stable in 2001 (see Figure 1.2). 3 FIGURE 1.1: INFLATION RATE FIGURE 1.3: MERCHANDISE EXPORTS & IMPORTS (percent year on year, 1994=100) (% YOY) AND TRADE BALANCE (IN US$ MN) 301 3000 I142 i 20 \ _ 2500 1 2 2000 G - 10 11 20 500 4- -01 -2 01 02 4 01 02 Q3 041Q, 12 03 04 Qi Q2 Q3 04 -30 1 --1000 98ga 99 00 01 1Q1 Q2 Q3 Q4 Q1 02 03 Q4 01 Q2 Q3 041 99 1 00 I 01 1 - All Hems Food & Beverage - - -Utildies r| -Trade bal. (rhs) - Exports (lhs) - Imports (Ihs)l Source: National Statistics Office (NSO). Source: NSO. FIGURE 1.2: NOMINAL AND REAL EFFECTIVE FIGURE 1.4: OVERSEAS WORKERS REMITTANCES EXCHANGE RATE (12-MONTH MOVING SUM) REER Index US$/PhP 7.0 40 100 145 901 -40 6.5 - 30 801 6.0 US$bn (Ihs) ,r20 601 -3010 501 -25 . 401 20 30 -15 5.0- .1 20 - 10 % yoy (rhs) 10 - -5 4.5 I-20 0 - 0-0 98 99 00 01' 94 95 96 97 98 99 00 01 'as of August 2001 Note: REER Index is period average, Nominal is end-period Source: SPEI-BSP Source: Selected Philippine Economic Indicators (SPE1)-BSP. 1.11 The years 1999-2000 saw the 1.9 Exports continued their double-digit emergence of surprisingly large trade and growth until 2000 (see Figure 1.3), driven current account surpluses (Figure 1.3 and Table largely by the electronics and IT-related 1.6). In 2001, the trade surplus contracted industries, which account for about 60 percent of sharply, with exports falling by 16 percent, Philippine exports. Export growth slowed in capital flows remaining weak, and the overall 2000 and moved to double-digit contraction in balance of payments deteriorating. Portfolio 2001. Electronics, the very sector that supported investments, trade credits, and currency deposits rapid growth in the mid-1990s, is leading the registered large net outflows in 2000 and 2001. downturn as the market for electronics has With continued uncertainty in emerging cooled worldwide. markets, aggravated by the law-and-order problem in Mindanao and kidnappings by armed .10 In addition, although worker remilttances bandit groups, portfolio inflows declined to their have stayed at US$5.5 billion to $6.5 billion lowest level in more than a decade. annually, their growth has ceased. The US Nevertheless, since late 2001 signs of improving recession and sluggish growth in Singapore and investor sentiment have become more evident, Hong Kong and Middle East countries- including greater access and reduced cost of traditional destinations of overseas Filipino borrowing in the global bond markets and a workers-have significantly affected the income recovery in the local equity market. of land-based workers. At the same time, sea- based workers are affected by the lack of growth in global trade and travel (see Figure 1.4). 4 TABLE 1.6: BALANCE OF PAYMENTS B. POVERTY REDUCTION HAS STAGNATED (US$ BILLION.) 1 .14 The incidence of poverty in the 1997 1998 1999 200 r2001 Philippines fell sharply in the first part of the 1997 19980 (pre) 1990s, dropping from 34 percent in 1991 to 25 Exports 1/ 25.2 29.5 34.2 37.3 31.3 percent in 1997, with much of the improvement Imports 1/ 36.4 29.5 29.3 30.4 28.7 Services (net) 5.7 1.1 -2.7 -1.9 -2.2 occurring in 1995-97 (Table 1.7). Since then, Current account -4.4 1.5 7.6 9.3 4.1 however, poverty reduction has stagnated, with Capital 2/ 1.4 0.5 -3.3 -9.3 -5.1 preliminary data from the Family Income and Official (net) .. .. 2.9 2.5 Private (net) .. .. -6.2 -11.8 -0.3 Expenditure Survey (FIES) 2000 suggesting that Change in GIR -3.0 2.0 4.3 0.0 -1.0 poverty incidence in 2000 of around 26 percent Debt service ratio2 (in%XGS) 11.6 11.7 13.4 12.6 17.4 was a little above the 1997 level.2 Similarly, Source: hlTPDP, BSP and staffestimates. over the past four years there has been a rising 1/In Goods. 2/Includes errors and omissions. perception among the respondents surveyed by the Social Weather Station of being poor3 1.12 The magnitude of this large rise and fall (Figure 1.5). in the trade and balance of payments surpluses is questionable, though. First, rather than giving TABLE 1.7: TRENDS IN POVERTY rise to a sharp increase in international reserves, 2000 these surpluses have been associated with large 1991 1994 1997 (prel.) errors and omissions in the international accounts. Second, national accounts data do not Headcount Index (%) 34.3 32.1 25.1 26.1 accounts. Second, ~~~~~~~~~~~~~Poverty Gap Index (%) 10.6 8.7 6.4 6.8 suggest that domestic savings have risen and Squared Poverty Gap Index (%) 4.5 3.4 2.3 2.5 investment fallen sufficiently to offset such a Number of poor (mil.) . 22.6 18.4 20.4 Mean consumption (1997 1671 1633 1974 1948 large fall in foreign savings from 1998 to 2000. Peso/person/month) The largest source of error (as indicated in Source: World Bank, Philippines Poverty Assessment, 2001; staff partner country trade data) is thought to estimates based on FIES 2000 data. originate from a substantial underestimation of FIGURE 1.5: SELF-RATED POVERTY (IN PERCENT) electronics imports, suggesting that the magnitude of the recorded current account 68 surpluses and private capital outflows may both 66 be overstated. 64 A 62 / 1.13 Until 2001 the debt service ratio 60- remained comfortable at about 12 percent of 56 exports of goods and services, but it rose quite 54 sharply in 2001 as debt service obligations rose 52 and export earnings declined (see Table 1.6). In i ' > z E D 0 D l - addition, the very high import content of many 98 99 00 01 Philippine exports, especially electronics, means that this statistic can be a little deceiving, as the ratio of debt servicing to domestic value added is much higher than the ratio of debt service to gross export earnings. Overall, it is likely that Philippine exports are on average only about 60 percent domestic value added. As a result, debt servicing to domestic value added of exports is 2 The preliminary official poverty estimates using income-based close to 30 percent.' poverty lines indicate a somewhat larger increase in poverty incidence, from 36.8 percent of the population to 40.0 percent. The FIES 2000 estimates of inflation-adjusted average family income indicate a decrease of 3.9 percent over the same period. Average family incomes declined in 10 of the 16 regions. 'A debt service ratio (DSR) adjusted in this manner should not be 3 Recent data, as of July 2001, showed self-rated poverty measures compared with the conventional DSR for other countries. significantly rising. 5 1.15 The stagnation of poverty reduction is calamities and has relatively low wages and also evident in the absence of any fall in the productivity. Meanwhile, labor absorption in percentage of people living on less than $1 per nonfarm activities has been modest, limiting the day and less than $2 per day (see Table 1.8). In decline in unemployment rate in recent quarters addition, the fact that some 45 percent of the (see Figure 1.6). population live on less than $2 per day highlights that there are a very large number of FIGURE 1.6: UNEMPLOYMENT RATE (IN PERCENT) near poor in the Philippines. These people can slip into poverty with a relatively modest 16- reduction in income, thus illustrating the 14] importance of development to reduce their 12 vulnerability. 1 TABLE 1.8: THERE ARE MANY NEAR POOR fl4uH ftiu % below US$1 / day % below US$2 / day 2l 1985 22.8 61.3 X a O 1990 19.1 53.5 99 00 01 1991 19.8 55.0 1994 18.4 53.1 Source: NSO 1996 14.8 46.5 1997 12.1 45.2 1.18 In terms of health indicators, there has 1998 14.6 47.7 been steady improvement in the maternal 2000 12.7 459 mortality rate, but this progress has been slow Source: World Bank (2001), East Asia Update: Regional compared to the rate of decline achieved in Overviewv, East Asia andPacific Region, October 2001. Thailand and Vietnam. The two main causes of maternal mortality are (a) inadequate access to 1.16 The explanation for the stagnation in emergency care in cases where the mother poverty reduction in the last few years is suffers from complications related to pregnancy, reasonably straightforward. Per-capita GNP labor, and delivery; and (b) the incidence of growth in 1995-97 in the Philippines averaged pregnancies that have abortive outcomes. The almost 3 percent a year, whereas in 1998-2000 it first points to the continuing lack of access to averaged only 0.8 percent. Economic growth emergency hospital care, given the growing cost slowed while the population growth remained of health care; low rates of health insurance over two percent per annum. Thus, a strong coverage (7 percent in the country, and 58 revival of growth remains central to the poverty percent for the formal sector); and poorly reduction challenge. Nevertheless, growth alone equipped and stocked public hospitals. The does not seem to provide a complete explanation second underscores the importance of a strong of what happened to poverty, since there seems family planning program that is anchored on to have been a greater amount of poverty education and family planning services to help reduction for a given amount of growth in the prevent high-risk and unwanted pregnancies.4 earlier period than in the latter. However, the The National Demographic and Health Survey underlying reasons for this difference are not of 1998 shows a gap of one child between well understood, and constitute a priority area desired and actual family size (2.7 vs. 3.7). The for future research. country has fared better in infant mortality, with a reduction in the rate from 49 per 1,000 live 1.17 As the farm sector absorbs about 38 births in 1995 to 35 per 1,000 live births in percent of employment, the recovery in 1998. This can be attributed to improved child agriculture in 1999 played a big role in bringing down unemployment levels. But agricultural employment remains vulnerable to natural 4 The unmet need for family planning services remains high at 19 percent (Source: 1998 National Demographic and Health Survey). 6 care practices and the effects of the expected, a global recovery begins in the second government's immunization program. Of late, part of 2002 and in 2003. however, the government has been encountering difficulties in procuring vaccines. Unless 1.21 However, domestic factors have also addressed immediately, the looming shortage of been a major influence on the economic vaccines could undermine earlier gains in performance of recent years. These include the reducing child morbidity and mortality. crisis of political leadership of 2000 and the associated governance deficit, the burgeoning 1.19 The picture in education shows fiscal imbalance (see Figure 1.7), and banking participation rates climbing steadily, but dropout and financial market uncertainties. In addition, rates also rising. Retention of children in school more long-standing institutional and governance or the cohort survival rate shows how hard- problems and issues in areas such as pressed poor households are to sustain their infrastructure and the framework for private children's education. Participation in school has sector development have also contributed to a increased at the primary level (97 percent in the weaker long-run performance than elsewhere in 1999-2000 school year, up from 92.7 percent in the region. Addressing these domestic issues 1995-96 and 95.1 percent in 1996-97). The forcefully will be critical in allowing the country cohort survival rate, however, shows a decline in to capitalize fully on the expected improvement both primary and secondary levels.5 Three out in the world economy, and to achieve sustained of ten pupils who enroll in Grade I do not long-run growth and poverty reduction. Chapter complete Grade 6. In secondary school, less than 2 provides a detailed discussion of five major half of the first-year students complete the fourth policy areas: fiscal policy, governance and the year. The Department of Education has taken public sector, private sector development, the steps to minimize the direct costs of education financial sector, and social sectors. Here we by eliminating school contributions. Studies provide a brief overall assessment of how show, however, that apart from these direct costs domestic policies and conditions have combined of keeping children in school, there are related to influence growth and poverty outcomes. indirect and opportunity costs. The dropout rate shows that the poor are increasingly having FIGURE 1.7: NATIONAL GOVERNMENT REVENUE difficulty coping with these costs. AND EXPENDITURE (IN PERCENT OF GNP) 20- C. POLICY DISCUSSION 19 - 1.20 Philippine economic performance in 18 E recent years has been hampered by a 171 combination of external and domestic factors. The impact of the regional financial crisis in 16 1 1998 can be viewed to a large extent as an 151! external shock that originated elsewhere in the l region. From late 2000 through 2001, the severe 14 Pevenue recession in the world electronics industry and 13 the general downturn in the world economy have 96 97 98 99 00 01 prel. caused a steep decline in exports. By the same token, though, the external environment for Source: DOE Philippine growth should improve if, as 1.22 Fiscal Policy. A long fiscal adjustment effort allowed the Philippines to eliminate its chronic fiscal deficits by the mid-1990s, but this Source: Department of Education 2000. The primary school hard-fought improvement has unfortunately completion rate has fallen from 72.1 percent in 1996-97 to 69.3 been entirely reversed in subsequent years. percent in 1999-2000. The secondary school completion rate fell from 48.4 percent in 1995-96 to 47.6 in 1996-97 and then to 46.4 While some expansion in the deficit was to be in 1999-2000. 7 expected following the regional crisis, the recent 1.24 The government has recognized these deficits have been much larger and more dangers by breaking with the past to meet the protracted than warranted, mainly due to a steep 2001 deficit target and targeting budgetary fall in revenues. Public sector debt reached 126 balance in the medium term. But attaining the percent of GNP by the end of 2000 (see Table goal of progressively lower deficits will require 1.9).6 implementing both revenue policy initiatives and administrative improvements on an urgent basis. TABLE 1.9: NATIONAL GOVERNMENT AND PUBLIC SECTOR DEBT (% OF GNP) 1.25 Governance. Concerns about what has 1996 1997 1998 1999 2000 come to be called the "governance deficit" have also curbed business confidence, particularly in National Government 1/ 49 511 51 54 59 1999 and 2000. Charges of graft and corruption Domestic 1/ 32 30 32 31 31 Extemal 1/ 16 21 20 23 29 aganst the former President led to a Senate Total Public Sector 2/ 99 106 106 117 126 investigation in late 2000, public unrest, and the Domestic 2/ 67 63 62 70 73 fall of the administration. Stock market External 2/ 33 43 44 47 53 confidence was shaken by the allegations of Nonfinancial Public Sector 3/ 72 80 78 86 94 1/ Excludes onlent and contingent/guaranteed liabilities which stock manipulation by brokers in the BW have not been assumed. Gaming Resources scandal, and of political 2/ Includes National Govemment, 14 monitored GOCCs, CB/CB- interference in the subsequent Securities and BOLiBSP and government financing institutions. 3/ Includes national government debt, 14 monitored GOCCs and Exchange Commission (SEC) investigation. CB-BOL. Source: DOF. 1.26 These instances are, of course, also 1.23 Prevailing public deficit and debt levels reflections of widespread underlying can inhibit growth in a number of ways. In the hamperu developent p ormance that event that a private-led recovery does take hold, mult de els.mOnerorea ncernuis the government's large borrowing requtrementsea . .n could begin to crowd out private demand and the low international rating of the Philippines for reverse the recent decline in interest rates. From the rule of law, encompassing such matters as the prevalence of violent and nonviolent crime; a medium-term perspective, investor confidence th efetvees predctablity an oeso can be sapped by worries about the sustainability the effectiveness, predictability, and honesty of ca pb s edby-wortrie abou the sustainabilty the judiciary; and the enforceability of contracts. of ~ ~ ~ ~ ~ . pulcdb-atclrywe .h oeta The resultin lack of personal securit and weak Impact of future contingent liabilities is factored g ty in-and by conc s aenforcement of property, contract, investor, and in-and by concerns about the credlbloityiof creditor rights is a disincentive not only to engoernmerIn policiesot the fisca positio business enterprise and investment at all levels engenders. In addition,ithe costso debt of society, but also to activities that determine sicingt and of reckon withdoningen TFP growth, such as technology acquisition, liabilities weighampertheavily gon iminte fis reallocation of resources between sectors, and resources and hamper the government's ability to finance critical reforms of the public sector management efforts to improve efficiency at the firm level. The economic dominance of closely and governance, or to undertake key publc held family business groups encompassing investpmentsor invironmenfrasprotrcture, sall of corporations and banks can also be viewed as, in development, ore rnt protein, alo part, an adaptation to the weakness of formal whuichbly shared ipon-rtnt frorwsustai a property rights enforcement, and is a feature of the Philippine political economy that then has its own additional ill effects on economic performance. In addition, weak rule of law fosters corruption, which increases the cost of doing business and, when it affects policy 6This includes the unadjusted stream of payments for build- making, leads to harmful distortions of and operate-transfer projects with take-or-pay provisions. Hence, care heightened uncertainty about policies. Efforts to should be exercised in comparing this with other countries. 8 improve the rule of law-for example to better make headway in getting their NPLs back under combat crime, kidnapping, and corruption, and control, the situation of some of the problematic to pursue legal and judicial reform-will not be banks remains precarious. In tackling these easy, but would yield high retums in both the issues there has been considerable progress in short and longer terms. recent years to strengthen prudential regulations and the supervisory powers of the central bank, 1.27 A second broad area of institutional the Bangko Sentral ng Pilipinas (BSP). But concern covers weaknesses in public sector further reform is still needed, including actions administration. As noted, poor public financial to strengthen the legal power of the management, particularly in revenue BSP/Philippine Deposit Insurance Corporation administration and management of contingent (PDIC) to forcefully and swiftly resolve or liabilities, has been an important factor in the restructure distressed or failing institutions. fiscal deterioration of recent years. Programs to reform revenue administration, expenditure FIGURE 1.8: CAPITAL ADEQUACY, RETURN ON management, and public procurement have been EQUITY AND LIQUIDITY OF THE PHILIPPINE in place, in some cases, for several years, but the BANKING SYSTEM (IN PERCENT) pace of practical implementation and actual 2 change has often been slow. These efforts need 1- -42 to move into high gear. 1- 40 121 -38 1.28 Infrastructure Deficiencies. The a 32 Philippines made considerable progress on 4 infrastructure development through the course of 2 Sep Dec Mar JunSep Dec Mar J.n Sep Dec 30 the 1990s, in particular through pioneering 1 Ju private participation in infrastructure (PPI). 98 _ 55_Oo_lo1_ Nevertheless economic performance is still - C -Capes Adeq (fh) ROE(lhr) -Liquadfty (rhe) hampered by its lagging behind other middle- l I income countries in several infrastructure areas. Source: BSP The pace of new PPI initiatives has waned as investors have become more risk averse and the 1.30 Development of capital markets more government has been burdened by contingent broadly has been hampered by the weaknesses in liabilities arising out of the first wave of PPI enforcement of creditor and shareholder rights projects. Revitalization of infrastructure noted above in the discussion of rule of law. In development and the PPI initiative is therefore the area of creditor rights, however, problems an important priority. This will entail extend beyond lack of enforcement to include strengthening financial management capacity at significant weaknesses in the existing insolvency both national and local government levels, law itself. The Philippines' legal framework for moving ahead with well-managed privatization creditor protection is rated as among the weakest of infrastructure assets, improving public in the world. Several steps have been taken to regulation of infrastructure sectors, and pursuing improve the insolvency framework since the a range of sector-specific reforms. financial crisis, but more needs to be done. Further strengthening, passage, and 1.29 Financial sector weaknesses. On face implementation of the proposed Corporate value, capital adequacy ratios are well above Recovery Act is an important priority in this Basle standards and the liquidity position of area. banks has improved sharply (see Figure 1.8). However, recent nonperforming loan (NPL) data show continuing weakening of bank portfolios, due to a combination of rising NPLs and little new lending (see Figure 1.9). Furthermore, while some of the prime banks are beginning to 9 FIGURE 1.9: COMMERCIAL BANK NON- valuable and critical for the nation's PERFORMING LOANS RATIO (IN PERCENT) international competitiveness. Moreover, education for the poorer segments of society l 19 1 | remains critical to their ability to escape poverty, | 17 2 _ _ _ _ | so sustained participation by the poor must be a 15 ~~~~~~~~~~~~~national priority. l 13 j _ _ l 1.33 Sustained actions are thus needed in five critical areas for the Philippines to achieve the 7 e } growth with equity adopted as the central l 5 L--------------| objective of the MTPDP: IQl Q2Q3Q4.Q1Q2Q3Q4Q0 Q2Q3Q4 Q1 Q2Q3Q4a 9 1 99 0o 01 (a) Continued improvements in fiscal 98 _ _ _ management, to ensure fiscal sustainability Source: BSP and increase public sector savings, while maintaining strategic poverty-reducing D. CONCLUSIONS expenditures in education, health, social protection, and infrastructure. 1.31 The Philippines must increase private and public sector productivity and investment to (b) Improving governance by strengthening achieve the Medium Term Philippine law-and-order, increasing anticorruption Development Plan (MTPDP) growth targets of efforts and implementing judicial reform, over 5 percent per annum. And it must while pursuing public sector reforms to complement this higher growth with increased improve public procurement and financial equity to achieve the desired rapid reduction in management and service delivery. poverty. Anything less would result in further (c) Structural reforms to improve the disappointment and frustrated expectations. investment environment, competitiveness, and productivity of the private sector, in 1.32 Increasing productivity and investment particular by further tackling infrastructure necessitates renewed confidence and more development. efficient technical use and allocation of resources. The achievements of2001 need to be (d) Financial sector strengthening and followed with further actions to improve fiscal deepening to reduce risk, improve financial policy on a sustained basis; strengthen the rule intermediation, and mobilize savings. of law, governance and public sector (e) Social sector policies to empower and performance; and foster private sector protect the poor. competitiveness, in particular by enhancing public-private partnership in infrastructure 1.34 These five areas are expanded upon in development and by enhancing the soundness Chapter 2 as an integrated set of actions to and depth of the financial system. In the social deliver development results. None of these is sectors, not only does the rate of investment in sufficient by itself to achieve the desired growth education and health need to be sustained, but with equity. But they are each necessary and the quality and relevance of education needs to together they would be sufficient, provided some be strengthened. The quality of human skills unforeseen problem does not emerge to offset acquired through education is both intrinsically such an integrated set of initiatives. 10 2. POLICY AND INSTITUTIONAL ACTIONS TO DELIVER RESULTS of 2000. This compares poorly to other A. STRENGTHEN FISCAL MANAGEMENT countries in the region: only Indonesia is more indebted, while Malaysia, Thailand, and Korea 2.1 After much progress in the mid-1990s all have much lower government debt to GDP with efforts to strengthen fiscal balances, the ratios. Philippines once again has a relatively weak FIGURE 2.1: FISCAL BALANCES fiscal situation characterized by high public indebtedness, significant fiscal deficits, large % f GNrP contingent liabilities, and declining public 4 revenues. Overcoming this challenge necessitates 2 - actions to o -- (a) reverse the recent decline in public revenues -2- to restore fiscal balance while maintaining -4 priority expenditures, and -6 - 91 92 93 94 95 96 97 98 99 00 01p (b) contain contingent liabilities and manage fiscal risks to avoid their leading to new - - NGvrWrpus public sector obligations. _| CoolIadyedPubluCSector 2.2 Without actions to reverse the decline in Source: DOF. public revenue and strengthen fiscal management, macroeconomic stability would be 2.5 Low revenues are a real problem. threatened, the ability of the public sector to While part of the decline in public revenue over sustain strategic poverty-reducing expenditures the past four years can be attributed to the would be increasingly constrained, and national consequences of the Asian financial crisis, targets for poverty reduction would be missed. In much is due to a combination of policy and recognition of its importance, fiscal consolidation administrative causes. There has been a was adopted as a central part of the MTPDP. substantial and permanent decline in customs revenue due to commendable cuts in import 2.3 Fiscal balances have deteriorated. As tariffs (see Table 2.1). And excise tax revenues noted in Chapter 1, a temporary deterioration in have fallen since 1997, due to specific rate fiscal balances was anticipated following the East excise taxes' remaining constant in nominal Asian crisis of 1997. But this has continued for terms and the removal of the special levy on much longer than was expected, and the national oil. The fall in the value-added tax (VAT) from government deficit reached almost 4 percent of both the Bureau of Internal Revenue (BIR) and GNP in 2000 and 2001 (see Fig. 2.1) Likewise, Bureau of Customs (BOC) suggests a there has been a sharp deterioration in the deterioration in compliance and hence in consolidated public sector balance, which administration. The revenue shortfall continued reached a deficit of 4.4 percent of GNP in 2000. in 2001, and the collection targets for the BIR were revised downwards from PhP408 billion 2.4 The deteriorating fiscal picture is also to PhP388 billion as growth targets were reflected in the stock of national government debt revised downwards. Collection targets for rising to 59 percent of GNP at the end of 2000, 2002, set at PhP447 billion, would require an up about 10 percentage points from the end of increase in collection results of 15 percent, 1996 (see Table 1.9 in IC). This debt has come which will require policy and administrative from a combination of off-budget sources such as charges to be made quickly. debts incurred in the liquidation of the old central bank in the early 1990s, depreciation of the peso, and fiscal deficits. Total nonfinancial public sector debt reached 94 percent of GNP by the end 7 In the early 1990s, BInOC2000it represented less than 20 percento 11 TABLE2.1: SOURCESOFNATIONALGOVERNMENT of newly issued debt securities. Fortunately, a REVENUE (% OF GNP) substantial portion of external debt is 1990 1994 1997 2000 denominated in long-term bonds or sourced from multilateral and bilateral institutions. Total Revenues I/ 16.3 17.6 18.3 14.5 Tax Revenues 14.2 15.6 16.3 13.2 Nxetvncmes and4.6 15.3 16.7 5.8 2.9 Fiscal risks remain and they threaten Net Income and Profits 4.6 5.3 6.7 5.8 Excise taxes plus special levy on oil 2.7 3.1 2.5 1.8 sustainability. Three sources of risk are Import Duties 3.1 2.6 2.2 1.5 particularly important: contingent liabilities Sales Taxes, VAT & Licenses 3.1 3.4 4.1 3.4 arising from government guarantees, the Other Taxes 0.7 1.3 0.9 0.6 Nontax Revenues 1/ 2.1 0.0 1.9 1.4 impicit need to meet the oblgations of the Total Revenues (in PhP bn) 174 306 461 507 major pension scheme (the Social Security GNP (Nominal, in PhP bn) 1,071 1,736 2,523 3,491 System [SSS] and Government Service 1/ excludes privatization proceeds and grants. Insurance System), and obligations arising from Source: DOF the financial sector. 2.6 While revenue fell, there was no 2.10 Guarantees to the creditors of commensurate reduction in expenditure, which goverment-owned and -controlled has remained at 18 to 19 percent of GNP per corporations (GOCCs) and to build-operate- annum throughout the 1990s (see Figure 1.7 in transfer (BOT) projects, typically in the power IC). But the composition of expenditures has and transportation sectors, currently amount to changed, first for the better and more recently for about PhP465 billion or overentlyercent oo the worse. Rising interest payments may13preto sheriously constaing thengoernment's provisi ofy GDP. The two largest sources of its debts are bseriouy svcestaIn addtheigovemmen'sin p service the National Power Corporation and the basic services. In addition, rising debt Development Bank of the Philippines. While obligations and other statutory obligations (e.g., the goverment does charge fees in exchange pensions and salaries) leave little flexibility for for its guarantee, they are not risk adjusted. adjusting spending in line with falling revenue. In 2000, interest payments comprised a quarter of 2.11 According to the goverment's own national government expenditure. estimates, SSS has a large stock of unfunded 2.7 CredIbility of fiscal management liabilities. In 1999, the Secretariat of the deteriorated until 2001. In 1999 and 2000 Presidential Retirement Income Commission deternorated utisl 2001.ts Inre 1999 subandt2000estimated that the implicit public debt of the government fiscal targets were so substantially pension system was about 42 percent of GDP missed that they left the credibility of fiscal and that benefit payments would start dipping management at a low ebb. In 2000, the deficit into reserves by 2003 and would exhaust them was more than twice its target. Shortfalls in by 2011. Contribution rates to the system are revenue from the BIR and privatization were the by at ontrcention rat ios are lretcontributors. This decline in credibility low at only 8.4 percent, and benefit ratios are largest when the decin redibility5 high (see Table 2.2). While changes in social was arrested when the deficit target of P145 security systems are always politically billion in 2001 was essentially met, by sensitive, the task faced by Philippine policy compressing expenditures slightly and keeping makers is not overwhelming. The implicit total overall revenue close to the original target. public pension debt for the Philippines is about 2.8 This loss of credibility in fiscal 107 percent of GDP, but this compares managementgave rise to higherriskpremiums in favorably with a number of systems in miancag t gmarkets. In particular, the secondary emerging markets (see Table 2.3). But action financial mare arto the seconts to bring benefits and contributions in line are bond market spread rose to 644 basis points nnteesugnl edd towards the end of 2000. It fell back to between nonetheless urgently needed. 550 and 600 points for much of 2001, and about 413 points in February 2002. This is still relatively high and adds substantially to the price 12 TABLE 2.2: FEATURES OF MANDATORY PENSION SCHEMES Length of Combined Average Average Real Rate Retirement Service for Contribution Replacement of Return on Age Pension (years) Rate (%) Rate Investments Admin. Costs China 60/55 5-15 20 60-102 (M) Often negative high 80-90 (F) Indonesia 55 - 5.7 10 (est.) Poor High Korea 60 20 9 60 (proj.) Poor Malaysia 55 (50) - 23 20-25 3.44% Low Philippines 60 10 8.4 89 Poor High Singapore 62 - 30 20-30 2% Low Thailand 55 15 5 15 (proj.) Poor medium Source: Holzmann, Robert, Ian W MacArtjir, and Yvonne Sin, "Pension Systems in East Asia and the Pacific: Challenges and Opportunities,' Social Protection Unit, The World Bank, June 2000. 2.12 Finally, as in most emerging markets, TABLE 2.3: IMPLICIT PENSION DEBT IN 26 the government is exposed to significant implicit EMERGING MARKETS (percent of GDP) and explicit risk from the financial system. Brazil 330 Explicit risk arises from the deposit insurance Macedonia 291 system. Deposit insurance is limited to deposits Slovenia 298 under PhP100,000 (or about US$2,000). Under Romania 256 the assumption that existing deposits would not Poland 261 be split in anticipation of a bank run, the Portugal 233 maximum exposure faced by the system is about Malta 234 PhP352 billion, or 10 percent of GNP. In Slovakia 210 contrast, the deposit insurance fund has reserves Hungary 203 Uruguay 214 of only PhP20 billion, so the failure of any of the Kyrgyz Rep. 185 country's larger banks would probably exhaust Croatia 201 this reserve. Estonia 189 Moldova 159 2.13 There is also an implicit risk from the Nicaragua 131 possibility of a "too big to fail" bank facing a Turkey 146 bank run or imminent failure. While it is Costa Rica 121 difficult to assess the probability of such an Philippines 107 event occurring, there are troubled banks in the Argentina 85 Philippines. While overall banking system Ecuador 63 capital is still strong, at over 15 percent, non- Senegal 51 performing assets have been on the rise since Mauritius 47 1997 and have reached 28 percent of total assets, Korea 33 or 12 percent of GDP. Moreover, neither the Morocco 32 capital nor the non-performing assets are evenly Source: Holzmann, Robert, Ian W MacArtir, and Yvonne Sin, spread among the banks. In a study based on "Pension Systems in East Asia and the Pacific: Challenges and 1999 data, Standard and Poor's estimated that Opportunities," Social Protection Unit, The World Bank June the Philippine banking system's gross 2000. problematic assets would be 15 to 30 percent of 2.14 Fiscal sustainability. The sustainability all banking system assets in the event of a of Fisc al depen ds crital na th "worst-case scenario." By their estimate, this of fiscal balances depends critically on the would lead to a fiscal cost to the government of primary fiscal balance, the difference between between 7 and 15 percent of GDP in the event of economic growth and the interest rate, the a systemic crisis. This would be roughly the magnitude of off-budget losses, and the volume magnitude of Mexico's crisis in 1994-95 and larger than estimates of the fiscal cost of the Philippine banking crisis in the 1 980s. 13 of privatization receipts.8 If the nominal growth administration reforms are both progressing rate and the nominal interest rate are roughly slowly. Tax policy reform was initiated by the offsetting, a modest primary surplus is sufficient Comprehensive Tax Reform Program, launched to reduce the public-debt-to-GDP ratio, as long in 1994, and is still ongoing. Tax administration as it is not undertnined by off-budget losses. reform has made progress with the creation of a This is illustrated in Figure 2.2 and the Large Taxpayer Service and the attempt to assumptions are given in Table 2.4. However, if computerize tax administration procedures. The growth languishes, protracted uncertainty creates current government signaled its commitment to a gap between growth and the interest rate, and take actions to improve revenue performance off-budget losses continue to lead to new debt, when the President made it a high priority in the modest primary surpluses would not be 2001 State of the Nation Address, appointing a sufficient to ensure fiscal sustainability. This new BIR commissioner and a team to prepare a illustrates the fact that reversing the recent tax administration reform strategy. Moreover, in deterioration in fiscal management necessitates October, 2001, the Presidential Committee on increasing public revenues and the containment Effective Governance Reform (PCEG) endorsed of off-budget losses. the major elements of BIR reform and key TABLE 2.4: SCENARIO ASSUMPTIONS (%) stakeholders (especially the Department of Finance [DOF] and the Department of Budget Attainable Pessimistic and Management [DBM]) have indicated their Real growth rate 5 3 support for implementation of the reform. In Real int. rate to govemment 3 4.5 addition, DOF has prepared draft legislation for Privatization rev./GDP 2 0 the reclassification and indexation of excise Off-budget losses/GDP 0.1 0.8 taxes on alcohol and tobacco products, restoring the real value of these taxes to their January 1, 1997 levels. BIR has issued revenue regulations FIGURE 2.2: FISCAL SUSTAINABILITY IS substantially increasing the rates of withholding ATTAINABLE taxes for specific businesses9 and has Gm D. I GNP (%) accelerated the deadlines on filing of returns and 100 tax payments. These measures should result in short-term increases in tax collection. Efforts 80 4 under way to halt the proliferation of industrial 60 __ __ _ incentives through tax exemptions needs to be continued and tax incentives wound back 40 Ab through a rationalization of these incentives. 20 0 -_. 2.16 Following the initial focus on tax policy reforms for improving revenue collections, the I ", 0X 'tO 'fo fdo I government now has identified fundamental Source: Philippine government data and staff simulation. reforms in tax administration to improve compliance and full implementation of tax laws Rebuilding revenues as a key priority of its fiscal reform program. The transformation plan for BIR includes as its 2.15 Reversing the steady decline in public key elements the restructuring of tax revenue depends on a combination of policy, . administration and a fundamental change in its legislative, and administrative actions. Such human resource management, including the actions are under way, but tax policy and 9 Following Intemational Monetary Fund recommendations, 8 The change in the ratio of govemment debt to GDP d, = d,(i,-g,) - creditable withholding taxes have been increased from October primary fiscal surplus - privatization receipts + off-budget losses; 2001 by 100% for payments to, e.g., entertainers and athletes, where i is the average interest rate paid on government debt, g is insurance and real estate brokers, and contractors. Further the annual growth rate, and all other variables are ratios of GDP. withholding tax increases for other sectors are in preparation. 14 preparation of an early retirement program to January 1997 level. This is understandably a support staff reduction, and the introduction of a sensitive political issue, but the fall in oil prices performance-based compensation scheme. during the second half of 2001 should make implementation easier. And the restoration of 2.17 Launching fundamental reform of the these tax rates would complement efforts to tax administration to complement tax policy improve the environment and impact the rich reforms is important for achieving a sustained and middle class more than the poor. Moreover, increase in revenue collection. As past petroleum excise rates should be indexed to experience has shown, isolated reforms on the avoid future erosion. policy or administrative side are not sufficient to increase the tax-to-GDP ratio. The combination (b) Computerization of BIR operations. The of appropriate tax policy and administration BIR has a modeis and high-capacity computer reform measures is particularly important in the system, which Is not sufficiently used. Some of area of indirect taxation, where both the the problems: roll-out of the back-end performance of the VAT and of the excise tax application modules of the Integrated Tax regime are disappointing. But there are a]so System has been limited," serious tax return regmejo r concerns in direct taxation, where encoding problems persist and the BIR does not major concemls indict a xa ti on have the necessary resources to outsource the collection results indicate an unfair distribution encoding, BIR staff are not sufficiently trained of the tax burden, with very little income tax incoding, th syta em toits fuff entl, and collection from the self-employed and small and in applying the system to ItS full potential, and medium-sized businesses. Fiscal year 2000 the financial resources needed to maintain the colecton esutsshow corporate income tax system and replace outdated hardware are not collection results 2.7 corpof ind tax available. Moreover, the computerized data collections of 2.7 percent of GDP and wage exchange with other government agencies withholding tax collections of 1.8 percent of (Finlink) still is not operating, except for data GDP, while income tax collections from ecag ihB C unincorporated businesses and the self- exchange with BOC. employed amount to 0.2 percent of GDP. This (c) Administration of large taxpayer units. indicates a major tax evasion problem in the The Large Taxpayer Service in BIR's small business/self-employed sector and results headquarters and the Large Taxpayer District in a comparatively unfair taxation of salaried Office in Makati are still not fully staffed12, and versus self-employed taxpayers.'0 the creation of two further offices has been postponed. Hence, the expected 8-percent 2.18 In practice, despite the clear reform growth in tax collection from large taxpayers has commitment by government and BIR senior not been achieved. management, delays in the implementation of ongoing reform plans will be difficult to avoid (d) Increasing the VAT yield. Improved and some areas appear to be neglected. administration and broadening coverage are both Particular areas of concern are important for increasing VAT revenue from its current level of less than 4 percent of GDP.'3 (a) Excise taxes on petroleum products. The inflation adjustment of excise taxes currently under way refers only to sin-product excises and not to excises on petroleum products, though a At present, only the large taxpayer operations and the regional 36-percent increase in specific rates would be office in region 8 (Makati) are fluily computerized. necessary to restore their real value to the 12 Total staffing of the Large Taxpayer Service as of September 28, 2001 was 561, compared to approved staffing of 672. 13 Proposals have been floated recently suggesting abolishing VAT and moving back to the previous system of tumover taxes. This would mean a huge step backward in efforts to modemize the '0 In the recent SWS survey on taxpayer perception, 80% of Philippines' tax system. Intemational experience has shown that respondents argued that tax evasion is unfair. While the BIR tends apart from the advantage of higher neutrality, VAT has a to interpretthisas an indication ofagenerally compliant attitudeof considerably higher revenue potential than tumover taxes. The taxpayers, other survey feedback indicates dissatisfaction by challenge for the Philippines currently is not to look for salaried employees who find it hard to evade taxes. altematives to a value-added tax, but to fully implement the tax. 15 (e) Rationalizing tax incentives. A review of changes made instead of being initiated tax incentives is ongoing and DOF has adopted a immediately. careful approach to granting new tax incentives. (h) Teamwork between DOF, BIR, and BOG. However, there remains strong pressure from the Effective working relationships to share business community and the Department of information and develop shared goals (e.g., for Trade and Industry to grant more incentives to tax collections at all levels of DOF and BIR investors. This highlights the need for a sound tax xpenitue bugetng sstemto raceand (not just senior management) is needed. The tax expenditure budgeting system to trace and recently established interagency task force to document the costs of tax incentives as well as look at revenue forecasting models should of other preferential tax regimes. Preparations look a n fortity todeas the for tax expenditure budgeting have started and poie a potnt o ices h regular tax expenditure budgetingrtsve sted ad transparency of the target-setting process and to regular tax expenditure reports should be discuss data reliability issues. This requires an produced as soon as possible. appropriate use of the task force and active BIR (f) Increasing collections from as well as DOF participation. unincorporated businesses and the self- (i) Budget provisions for BIR. Budget employed. The goveblment has proposed allocations to BIR continue to be extremely low addressing this problem by applying the by international standards.14 They hardly finance corporate tax regime to unincorporated current operations and will need to be increased businesses. But this would increase the tax burden on unincorporated businesses and create to support the transformaton program. additional disincentives for businesses to register (j) Appropriate compensation for BIR staff and thus would further promote the growth of The bonus and incentive scheme for BIR should the underground economy. Instead, this problem be refined as a way to reward performance, key needs to be addressed by designing a tax system responsibilities in the administration, and that facilitates compliance for small businesses, successful management and implementation of as well as implementing improved measures to the transformation program. A properly detect non-filers. A simplified presumptive tax administered compensation system with a strong system for small businesses and certain groups performance-oriented component can have a of self-employed and simplified accounting and much greater impact on staff motivation and filing rules are a possible response to the output than a general salary increase. In challenge of taxing this sector of the economy. conjunction with this, performance measures for (g) Reform of tax administration. Sustainable BIR should be broadened from collection targets improvements in revenue performance will also and reflect the responsibilities of BIR more require a focus on fundamental 'tax comprehensively. administration reforms. The transformation plan (k) Lack of a comprehensive anticorruption for the BIR is an important step to prepare for strategy. The tax administration reform strategy such reforms. While the BIR reform approach includes some key elements of an anticorruption initially emphasized autonomy as a key strategy: namely. the strengthening of the instrument for increasing tax collection internal audit function, the design of a new code efficiency, it now concentrates more on of conduct for BIR staff, and the reduction of procedural reforms and improvements in the discretionary elements in the tax system. It does human resource management system within not aim at a comprehensive approach to fighting given civil service standards. This has corruption in the BIR, however. The design and considerably lowered the risk that other promulgation of a comprehensive anticorruption government departments will oppose the BIR strategy would give a strong signal to reform plans. Clarifications have also been made regarding the sequencing of reform measures, and it is now clear that changes in staffing will ' Given the revised collection targets for fiscal year 2001, BIR be determined by organizational and procedural core budget allocations in 2001 (exclusive of tax refunds) amount to 0.69% of projected BIR revenue collections. For fiscal year 2002, the allocation amounts to 0.74% of projected collections. 16 stakeholders and to BIR staff of the commitment 2.22 The government has already taken some of BIR management to fight corruption. important steps in the right direction. The DOF Investment Coordination Committee has created (1) Reformmanagement.teaminBIR l Ae nessytron a Technical Working Group to help it complete management team in BIR will be necessary to .. . manage the change process. The reform cannot an inventory of contingent liabilities, review the be implemented by a small number of sources of contingent liabilities, develop means headquarters staff on a part-time basis. of minimizing and sharing risk across government and quasi-governmental 2.19 Finally, it is clear that the tax organizations, monitor projects guarantees, and administration reform program cannot be build institutional capacity to effectively implemented without sufficient technical implement a contingent liability framework. assistance. It is expected that the International The government has recognized the complexity Monetary Fund will provide further technical of many contingent liabilities, is devoting assistance to assist in the improvement of VAT resources to the difficult tasks of measuring and excise administration. Additional assistance them, and as mentioned earlier, has begun will be required to review the design and provisioning for them. implementation of individual components of the tax administration reform strategy. 2.23 The banking system urgently needs strengthening. Cross-country evidence suggests Containing contingent liabilities and that timely rehabilitation is one of the key managing fiscal risks factors in determining the success of bank rehabilitation efforts. At current levels of asset 2.20 Explicit and implicit contingent performance, the system could face severe liabilities must be contained and fiscal risks difficulty if another major external shock such as effectively managed if the overall effort to that of 1997 were to occur, or if the economy's strengthen fiscal management is to be growth slowed substantially. The government is successful. currently attempting to encourage private sector- driven measures to restructure the banks. In the 2.21 Guarantees to GOCCs and BOTs need meantime, the government should continue its to be more tightly managed and monitored. efforts to improve capital standards and Decisions pertaining to contingent liabilities supervision (see section 2D for a fuller should be subject to the same budget review discussion). process as normal expenditures. Fees are charged for guarantees and the recently 2.24 Reducing the risk arising from un- introduced 1-percent budget provisioning is a funded or under-funded pension liabilities is positive move. But these charges are modest and urgent. Contribution rates need to be increased the uniform provisioning does not reflect an to reduce the current gap between contributions assessment of the differing risk characteristics of and benefits, especially for the SSS. Second, the projects or loans being guaranteed. In the management of the investment portfolio of the short term, the government should reserve fund needs to be fully professionalized systematically assess the financial health of and insulated from political interference. GOCCs and enforce its existing guarantee limits. In the medium -term, the charters of GOCCs B. IMPROVE GOVERNANCE AND PUBLIC need to be amended as necessary, to ensure that SECTOR PERFORMANCE guarantee limits apply to all GOCCs. Where 2.25 Weaknesses in goverance are an feasible, GOCCs could be privatized to important source of the relatively lackluster permanently avoid this risk. Financially weak development performance of the Philippines in GOCCs need to be strengthened, with costs ' ~~~recent decades. They seem to have been contained, or closed. In general, the process by particularly influential since the East Asian which GOCCs are audited needs to be improved financial crisis. The Philippines' relatively poor and risk-based fees charged for all guarantees. 17 ranking on international corruption ratings is underlying institutional weaknesses in perhaps the best-known symptom of deeper governance. Transparency International's institutional weaknesses in such areas as the "Corruption Percertion Index" for 2001 ranks judicial system, public financial accountability the Philippines 65 out of 91 countries, at a par and management, administration, and the civil with Guatemala, Senegal, and Zimbabwe, and service. These underlying weaknesses in turn below countries like Thailand, Ghana, Malawi, affect the general climate for private sector and Latvia. And not only are corruption ratings investment, the fiscal position of the state, and relatively poor, they deteriorated in 2000, due to the government's ability to deliver public the perception of increased corruption partially services. reversing a steady improvement over the previous decade. (see Figure 2.3). 2.26 The administration of President FIGURE 2.3: TRANSPARENCY INTERNATIONAL Macapagal-Arroyo came to power on an CORRUPTION PERCEPTION INDEX anticorruption platform and stresses good governance as one of its highest priorities. (O=Most Corrupt; 10=Least Corrupt) Arguably, a "window of opportunity" for reform 7 . P p - . > ~~~~~~~~~~~~~~~~~.-Philipph,es -o -Thailand now exists as a result of the appointment of a 6 --l-Malaysia -m-- Indonesia cabinet with a shared vision, widespread publicn demand for better governance, better cooperation among government agencies, and 4 greater seriousness about re-engineering within 3 these agencies. The MTPDP notes several broad 2 = strategies for pursuing good governance, / / including improving service delivery, raising ethical standards, strengthening public and 0 -198 1986- 1996 1997 1998 1999 2000 2001 private sector institutions, and improving law 85 92 and order, although, for the most part, in only a Source: Transparency International, Inc. fairly general way. Further, the government has taken credible steps to launch reforms and has 2.29 Experience in many countries suggests made some progress in specific areas such as that tackling corruption entails a long-term effort budgeting and procurement reform. to improve a broad array of underlying governance institutions whose quality has 2.27 Looking forward, the discussion of this economic and social implications that extend section suggests that the design, sequencing, and well beyond corruption itself.'5 These include implementation of sustained improvements in policies that concentrate public activity on governance and public sector performance is an essential or core functions of government, important strategic task for the country. allowing limited administrative resources to be International experience suggests that such focused on performing these key functions well; reforms will take time, sustained effort, administrative and civil service reform; public resources, strong political leadership, a financial accountability and management;' the willingness to tackle deeply entrenched vested quality of legal and judicial systems (or the rule interests, and an ability to take advantage of of law); and the extent of public oversight and fluctuating political and bureaucratic external accountability mechanisms. opportunities. The history of the Philippines contains many ambitious public sector reform 2.30 Voice and Accountability. Of these plans that have ended without delivering much. various dimensions of governance, the Philippines is typically rated quite highly in Overview of governance outcomes 2.28 Corruption. Corruption is perhaps the best-known reflection of the Philippines' 15 "Helping Countries Combat Comiption," The World Bank. 2000. 18 cross-country ratings for voice and democratic and delays over the course of the 1990s, and accountability. The current Intemational significant uncertainty or capriciousness in court Country Risk Guide risk ratings, for example, decisions. The evidence also suggests an give the Philippines 5 out of a possible 6 for important two-way interplay between judicial democratic accountability. Oversight and system weakness and corruption. On the one accountability are facilitated by a major hand, arbitrariness in court decisions is linked in expansion of the non-government organization part to perceptions of significant corruption in (NGO) movement after the People Power the judicial system. On the other hand, a low rate revolution of 1986 and by freedom of the press. of success in criminal prosecutions for The January, 2001 EDSA2 demonstrations are corruption in the courts (compared, for example, an indication of the value of such institutions in to Hong Kong) dulls the effectiveness of the curbing corruption and other governance extensive anticorruption laws and institutions dysfunctions. that exist on paper. 2.31 Rule of Law. However, important FIGURE 2.4: EAST ASIA PACIFIC GOVERNANCE aspects of the functioning of the state itself are RATINGS generally assessed as a good deal more I I problematic. Figure 2.4 shows ratings for some I Govemment Effectiveness versus Rule of Law 16 East Asian and Pacific countries on two 2.-0 ** _ew Zealand dimensions of governance, "government -------- "2.0- + Singapore, effectiveness" and the "rule of law" 16 Rule of 1j.5 Japan Austlnli law in this context includes perceptions of the Hong Kong (SAR) prevalence of violent and nonviolent crime, the *. KoWe 1lataiwyn' China i effectiveness and predictability of the judiciary, China 05 Thailand and the enforceability of contracts. The quality Mongolia 01.0 1.0 2.0 3; of the rule of law in the Philippines was rated P20 Ng * 12 12th out of the 16 East Asian countries shown j Philippines l here. Current ICRG ratings also give the iyanmr lndonesi6'o I Philippines only 2 out of a possible 6 for rule of . .. .. . law. Perhaps the most obvious symptom of weak Govemment Effectiveness rule of law is that the Philippines is one of only a Source: Kaufmann, Kraay, and Zoido-Lobaton, Aggregating limited number of East Asian countries still Governance Indicators, World Bank Working Paper 2195, 1999 affected by some form of chronic terrorist Government Effectiveness as depicted in violence or armed insurgency. This represents a failing to some extent in the core function of any Figure 2.4 combies perceptions of the state, to provide civil peace and physical quality of public service provision, quality security for its citizens. of the bureaucracy, competence of civil servants, independence of the civil service 2.32 Evidence on weaknesses in the legal and from political pressures, and the credibility judicial system was summarized in a recent of the government's commitment to its World Bank Social and Structural Review."7 policies. Figure 2.4 shows the Philippines Problems include a sharp rise in court backlogs as 9th out of 16 East Asian countries in terms of government effectiveness, although this perhaps understates weaknesses in such 16 Kaufmann, Daniel, Aart Kraay, and Paulo Zoido-Lobaton, areas as public financial accountability and Aggregating Governance Indicators, World Bank Working Paper * * * *i- 2195, Washington DC. 1999. The value ofthis study lies in its use management, adminstraton, and civl of statistical techniques to create aggregate governance indicators service quality. The impact of these from a very wide range of indicators drawn from 13 separate cross- weaknesses is better seen, for example, by country govemance surveys. This approach may minimize the biases or idiosyncrasies of any one survey. 7 Philippines: Growth with Equity-The Remaining Agenda, A World Bank Social and Structural Review, May 2000. 19 TABLE 2.5: RATINGS OF PUBLIC FINANCIAL ACCOUNTABILITY IN TEN EAST ASIAN COUNTRIES Elements of a sound Korea, Lao public financial system China Indonesia Philippines Thailand Rep of Malaysia Cambodia PDR Vietnam 1. Quality and openness * ) 3 * 0 0 + * of the budget process 2. Intemal financial and C * * + * C performance management 3. Public procurement * * C C * regime 4. Public sector accounts +* * * * * and management information 5. Corporate accounting, *C) * auditing and governance 6. Effectiveness of C+ * * . * public external audit and evaluation 7. Adequacyof * * O C O O legislative scrutiny 8. Rightandaccessof * C C 0 C * * * the public to information 9. Monitoring capacity * C C C C C * * of NGOs and CBOs OVERALL * + C C C/@ C/9 * * Ratings guide: * = high, O = medium, + = low. Source: Public Financial Accountability in East Asia. World Bank. October 2001. Source: Mountfield, Public Financial Accountability in East Asia, World Bank, October, 2001. significant contribution of weaknesses in revenue financial accountability, drawing on the Bank's administration to the dramatic deterioration in the Country Financial Accountability Assessments, country's fiscal position over the last four years Public Expenditure Reviews, and Country (See section 2A above for a fuller discussion). Procurement Assessments18 (Table 2.5). No aspect of public financial accountability in the 2.33 The following sections review policy Philippines receives a "high' rating. Most developments and the outstanding reform agenda aspects that receive a "medium" rating refer to in major areas of governance, adding further the quality of external scrutiny, for example, by information on existing institutional weaknesses the legislature or NGOs. However, most where appropriate. aspects of the administrative machinery itself get a "low" rating, for example, internal Public financial accountability and financial and performance management management systems, public sector accounting and auditing, and the public procurement regime, with only 2.34 Better, more accountable management of the quality and openness of the budget process public expenditures, revenues, and debts are being rated "medium". critical to curb corruption, reduce waste, and improve the volume and quality of public 2.36 Expenditure Management. The services. Its importance to a very wide range of Philippines embraced the idea of performance stakeholders-taxpayers, consumers of public budgeting as early as the 1950Os, and passed services, businesses, investors-also makes legislation to facilitate annual budgeting in a public financial accountability important for medium-term expenditure framework as long political legitimacy and stability. ago as 1987. But it is only recently that these 2.35 A recent World Bank study rated East Asian countries on nine aspects of public " Edward Mountfield. Public Financial Accountability in East Asia, World Bank, October 2001. 20 ideas have begun to be implemented. DBM is the Government Watch Project). Among implementing a Public Expenditure Management emerging issues is the need to strengthen links Improvement Project designed to encourage hard between national level and local government budget constraints; restore fiscal discipline; and level planning (see below). In addition, increase transparency, accountability, and international experience suggests that success predictability in budgeting. The main activities in a performance budgeting approach needs to include be founded on sound internal financial controls and accounting and auditing systems. (a) Establishing a Medium-Term Expenditure Framework that links planning and 2.38 Financial Management. Inherited budgeting in a three-year rolling budget (first public sector accounting and monitoring introduced in 2001) and a Medium-Term Fiscal systems are complex, unwieldy, too Plan to promote greater discipline. cumbersome to yield timely information, and poorly connected to the budget execution (bfi intyRouing Sor SEffetiveness and system. As a result, fiscal managers are forced Efiociency Reviews (SEeR) to enhance to pilot the budget "blind," and, when they have prioritization, assess the effectiveness of agency to contain aggregate spending, to resort to the prograes, crude instrument of cash rationing. Financial agencies. management and internal control at the LGU (c) Developing an Organizational level remains extremely weak. In 2000, for Performance Indicator Framework (OPIF) that example, only 250 of 1,689 LGUs audited re-orients budgeting towards outputs and received a clean bill of health. Accountability outcomes, introduces performance indicators, and for performance is difficult in these links these with organizational performance, so circumstances. In the past, the government's that agencies can be held accountable for their external auditor, the Commission on Audit performance. (COA), has also been obliged to undertake .... Incorpratin cotiextensive internal control and accounting budgeIcrporating contingent liabilities into the functions, although it has been gradually disengaging from these functions over the (e) Rationalizing the budget process by course of the 1 990s. strengthening budget formulation and streamlining budget execution procedures, 2.39 Two major financial management especially regarding accountability reports, funds reforms are underway at present: first, revising release procedures, and overall cash management. the government's accounting system, including simplification and shifting public sector 2.37 At present there is little reality checking accounting towards a modified accrual system; as to whether programs, once approved, do in fact ancond ing A to improve its deliver expected benefits. Thus, establishing even audit services and effectiveness. rudimentary performance indicators and the capacity to evaluate government agencies 2.40 COA is computerizing the accounting according to these indicators would represent an system at all levels. It has designed a modified advance in creating a performance culture. After accrual accounting software system-the New a pilot phase, DBM should aim to implement Government Accounting System (NGAS) - OPIF government-wide. It should also develop which is being pilot-tested in five agencies, and more fully the evaluation component of SEER, is planned to be rolled out to all agencies by including designing a capacity-building program 2004. The NGAS will integrate financial to strengthen evaluation in line agencies and local oversight agencies (e.g., COA, DBM, DOF) government units (LGUs). Efforts to engage civil and provide uniform databases and reporting society and the private sector in budget for central goverment agencies and formulation and monitoring should be deepened departments, enterprises, and LGUs. (e.g., through the Budget Advocacy Project and 21 2.41 Public procurement. A 1999 review of and the private sector (e.g., through the public procurement system concluded that the Procurement Watch, Incorporated) in system was beset with problems, including monitoring procurement should also be inconsistent and fragmented rules and enhanced. regulations, inefficient and nontransparent practices, and abnormally long approval Re-engineering government processes.19 DBM began procurement reforns in 1999, focusing on two tracks. The first track 2.44 The overall size of government in the deals with changing administrative rules and Philippines is not exceptional, whether implementing regulations governing the measured in terms of government expenditure procurement of goods, supplies, materials, and relative to GDP (about 18 percent), or in terms civil works to increase competition, reduce of civil service numbers relative to the delays, and limit the discretion of bids and population (about 2 percent). The Philippines awards committees, all of which are expected to Social and Structural Review 2000 did, reduce corruption. Initial results have shown however, note that the core machinery of declining procurement costs with international government is unusually fragmented, with a competitive bidding leading to a 40 percent very large number of bureaus, offices, councils, reduction in textbook costs and a 27 percent centers, commissions, agencies, and sundry decline in drug costs. administrative bodies-some 400 to 500 under the Office of the President and the main 2.42 The government launched an Electronic executive departments. As a result, there is Procurement Service in December 2000. This duplication and staff have often been too thinly provides a Public Tender Board, an electronic spread to deliver quality service. There have suppliers registry, and an electronic catalogue. As been at least six efforts at government a result there is faster supplier verification (from reorganization since the 1930s, but these have 3 weeks to an average of 1 hour), and faster often been blocked and frustrated by the processing of expressions of interest (from 7 protracted opposition of bureaucratic vested months to 30 minutes by e-mail). The interest groups. This was the fate of the Re- government is taking a cautious approach in engineering the Bureaucracy effort, for which managing electronic procurement, and is building enabling legislation was passed in 1994. from a year of experience in change management before introducing electronic processing. 2.45 Most recently, the PCEG was established in 1999 to oversee bureaucratic 2.43 The second track is to reform legislation. reforms to strengthen institutional capacity and An omnibus bill-the Government Procurement improve service delivery. Six technical teams Reform Bill of 2000-was approved by the lower representing the key oversight and line agencies House and reached first reading in the Senate. A have assisted the PCEG in drafting a Public similar bill has now been submitted to the new Sector Institutional Strengthening and Congress. In the meantime, an Executive Order Streamlining Agenda (PSISSA), which covers was issued in late 2001 that strengthens reforms in service delivery, organizational transparency and competition in procurement structuring and staffing, financial management, procedures. Reinforcing this with approval of a personnel management, change management, law is a high priority. In the medium term, DBM and information and communication should define programs to professionalize public technology. Once the PSISSA and various procurement personnel and extend procurement sector reviews have been approved, a detailed improvements to LGUs through capacity- Integrated Administrative Reform Plan will be building programs. Involvement of civil society formulated. 2.46 In general, a two-track approach to re- engineering has been proposed: a "Modemization of Public Procurement," 1999, Consultant Study compreering unde n under the AGILE project of USAID. comprehensve restructurmg under new 22 legislation, and institutional strengthening and priority. These reforms will need to be streamlining within the existing legal framework. sequenced and implemented concurrently with The first "legislative track" has a history of budget reforms intended to clarify the roles and various drafts of relevant legislation that have mandates of state entities, and with been stalled in successive congresses for several administrative reforms aimed at eliminating years. Thus, the second "administrative track" is duplication and overlap of functions. In the the current focus. Clearly, given past experience, short term, the government must develop an it will require strong, sustained political impact mitigation program and implementation leadership and quick action to ensure that the strategy that defines the potential resources current re-engineering effort is not also stifled required to compensate workers leaving the under an accumulation of committees and reports government (e.g., severance payments, that do not result in actual change. In particular, a retraining/retooling expenses, and other suitable management structure to guide the actual benefits). Proper separation arrangements are implementation of reform needs to be necessary to mitigate resistance to reform from determined. Given the need for coordination and within the bureaucracy. Such a program should the prominence of reforms in control agencies, be carefully costed and piloted in selected the Development Budget Coordinating agencies before being applied government Committee could be the appropriate entity to wide. A key analytical tool for estimating such oversee implementation, with regular reporting to costs is the Civil Service Simulation Model that the PCEG. Such an entity would need to agree on is under development for the DBM and Civil which departments and agencies participate, Service Commission (CSC); an initial version estimate the costs of implementing the reforms, of this model has been completed and is being draft performance agreements, and establish pilot-tested in the BIR. Refinement of the suitable monitoring and evaluation systems to model in the short run will be critical to assess agencies' reform progress. developing the impact mitigation program and strategy. 2.47 Civil Service Reform. Studies have linked the gap in bureaucratic capability between 2.49 Priority reforms over the medium term the Philippines and some other East Asian include modernizing the legal framework of the countries to the extraordinary prevalence of civil service and the related implementing political patronage in civil service appointments, regulations; providing for clear delineation of and the consequent much more limited role of professional and political positions, making the meritocracy in recruitment and promotion.20 former subject to meritocratic recruitment and Salary compression means that senior and career advancement; and a more streamlined professional positions are significantly underpaid position classification system. Compensation compared to the private sector. At the same time, policy (including for GOCCs and government there is a proliferation of increasingly financing institutions) should be reformed to nontransparent pay "allowances." Overall, the enhance transparency and competitiveness and civil service has become a significant fiscal to decompress salary bands. For LGUs, given burden, with "personal services" accounting for their resource constraints, the appropriate size 35 percent of national government expenditures and affordability of the civil service at the LGU in 2000, even leaving out local government level must also be reviewed. DBM and the CSC salaries funded by the center. must determine whether a single salary structure should be retained for all government 2.48 A broad package of civil service reforms personnel or whether multiple salary structures to address these issues is therefore an important should be implemented. At both national and LGU levels, measures to improve organizational and individual accountability 20 For example, The State in a Changing World, World and professionalism-a long-term process- Development Report 1997, World Bank; and Philippine: Growvth need to be developed in step with reforms in wvith Equity-The Remaining Agenda, World Bank Social and Structural Review, May 2000. budget management and service delivery 23 standards and indicators. Sequencing, stamina, capacity and monitor the financial performance resourcing, and sustainability will be key to the of LGUs is weak. entire process. (c) The overall share of revenues mobilized 2.50 Decentralization. The Philippines Local from local sources relative to GDP is not Government Code (LGC) of 1991 is one of the significantly greater now than it was before the most far-reaching decentralization reforms in the Local Government Code. In many cases, IRA developing world. The reform established three transfers have created disincentives to mobilize layers of LGUs: provinces, cities and local revenues. Better tax administration could municipalities, and barangays, to which it mobilize much greater local revenue. While devolved important responsibilities in areas such there have been some improvements in local as agriculture, environment, natural resource real property tax collections, efficiency remains management, health, and public works and low and property valuation methods need to be highways, as well as up to 40 percent of national improved. government revenues. (d) LGUs are limited in their ability to 2.51 So far there has been no systematic manage and develop their human resources: evaluation of how local governments have local treasurers are appointed by the DOF, performed under the reform. Anecdotal evidence which potentially strengthens financial suggests that decentralization has encouraged management but weakens local accountability. greater innovation at the local level (i.e., the In addition, LGUs capacity for expenditure Galing Pook awards), strengthened local management is uneven, especially in planning, management capability, and promoted greater investment appraisal, financial management, cooperation with the private sector and other intersofnel cions. LGU financial LGUs. owever preliinary videnc also integrity is often weak; COA reports have cited LGUs. However, preliminary evidence also g ty suggests that, despite these achievements, the numerous LGUs for inadequate financial expected benefits of decentralization have yet to management. be fully realized. 2.52 A more thorough stocktaking of the last ten years' experience with decentralization (a) Institutional arrangements for service would clearly be of value. In the short term, in delivery remain unclear in many cases, with particular, a review of which national national agencies still playing a significant role in government agencies have actually devolved to some functions that should have been fully LGUs and the adequacy of the IRA transfer devolved to LGUs. In addition, unfunded system should be conducted. The review of the mandates from the national government, such as IRA should identify opportunities for greater the Salary Standardization Law, increase the cost equalization, including the possibility of of local services and impede local autonomy. establishing a separate equalization transfer. (b) Research has shown that the increase in LGC provisions regarding local taxation and aggregate Internal Revenue Allotment (IRS4) to fiscal matters should be reviewed to ensure that provinces, cities, and municipalities exceeded the all possible sources of local revenues can be cost of devolved functions and other mandates, accessed by LGUs. Such information could be even when adjusted for inflation and population used to clarify LGU responsibilities, (e.g., by growth.21 Despite this aggregate futnding defining expenditure requirements and service "surplus," it is clear that sufficient resources are standards by sector) and assess the need for not being channeled to poorer LGUs, and the transfers from the national government. national government's ability to equalize fiscal 2.53 In the medium term, a high priority is to improve local fiscal and performance information, including updating the income 21 Manasan, Rosario G., (I999),"Impact of Local Govemment Code classification system and establishing local and Proposed Amendments on Ability to Finance Infrastructure: government information as part of the Towards a Framework for LGU Finance," mimeo. 24 Government Financial Management Information 2.55 Court congestion and associated case System. The Bureau of Local Government delay has been a perennial problem, commonly Finance should build on its work now underway attributed to an array of factors including to computerize local accounts and develop a vacancies in judge positions, lack of comprehensive information system on LGU information technology, outmoded procedures, finances. Performance evaluation is already being and a flood of cases involving checks drawn piloted in 2002 and some capacity and without sufficient funds. Further detailed institutional building is being undertaken by the analytical work involving more than 2,000 Local Government Academy and the Department recent cases is currently under way by the of Interior and Local Government. Enhancing Supreme Court, with technical assistance to LGU resource mobilization is also a high priority refine the diagnosis of this problem and over the medium term. Existing action plans for develop a solution. This information needs to enhancing LGU resource mobilization should be be used to refine the reform program already re-examined, adjusted to include user fees and under way. income-generating activities like local markets, and given renewed priority. Finally, effort should 2.56 Widespread perceptions of corruption be made over the medium term to replicate in the judiciary are reflected in successive innovative LGU-level approaches and practices surveys indicating that more than half of all to building local capacity, fiscal integrity, and Filipinos think that "some" or "quite a few" accountability. judges accept bribes. The weak disciplinary process and enforcement of the code of ethical Judicial reform standards among judges, and others in the judiciary and the lack of transparency in and 2.54 Under the widely praised leadership of public awareness about court operations, have Chief Justice Hilario Davide Jr., the Supreme seriously undermined the integrity of the Court has adopted an Action Program for Judicial courts. Fully solving this problem involves Reform.22 This is a comprehensive integrated fundamental changes in systems to strengthen program of actions to address an array of known transparency and disciplinary processes. As judicial problems, including the two dominant part of this effort, the Supreme Court has (a) long-standing concerns of case delay and agreed to let an NGO, "Bantay Katarungan," longstion.In concessin these delay and monitor court proceedings and screen judicial reform program includes actions to applicants to positions in the Regional Trial streamline and strengthen administrative and Courts and Courts of Appeal; and (b) stepped- operating systems; strengthen human resources up disciplinary actions against corrupt judges. orating stem; stheir management; address Between Nov 30, 1998 and April 2, 2001, the and improve deienci e ng an Supreme Court took disciplinary action against infrastructure deficiencies (building an 230 judges by either dismissal or administrative information and communications technology); sanctions on eit dismion arges.t23 and improve access by the poor, public sanctions on graft and corruption charges. information, and civil society collaboration. This reform program has very widespread support, C. STRENGTHEN PRIVATE SECTOR including explicit support from the President. DEVELOPMENT Moreover, this judicial reform program is receiving substantial support from donors. 2.57 The Philippines is an example of a However, its ultimate success will depend on largely private sector-led and market-based effective implementation of change and this will economy that has achieved relatively mediocre depend on broad involvement by stakeholders. rates of productivity growth and capital accumulation over several decades. There are 22 Supreme Court of the Philippines, Action Program for Judicial 23 "Policing the Judiciary," by Francis Intorio in Benchmark, Reform, August 2001. Centennial issue, Vol. 11 (3), May-June 2001. 25 several broad reasons that help explain this. First, 2.61 Third, the private sector's contribution macroeconomic stability, an important condition to development also naturally depends on for private sector development, remains elusive, infrastructure services. In spite of considerable as shown by the emergence of large fiscal deficits progress in developing infrastructure during the and the surge in public indebtedness over the last 1990s, largely through innovative reforms to several years (see Section 2A). attract PPI, significant infrastructure deficiencies persist. 2.58 Second, weaknesses in governance undermine public sector performance (see Protection of property rights Section 2B) and have a direct bearing on private sector development. This section discusses how 2.62 Property and contractual rights are improvements in property rights, corporate protected by the Constitution, the Civil Code, governance, trade and investment policies, and a 1996 law protecting intellectual property infrastructure, and rural sector support such as patents and copyrights. However, laws arrangements are needed as part of the overall are effective in protecting contractual rights effort to attain a higher growth path and broaden only if they can be enforced, and enforcement participation in development. remains weak in the Philippines. Table 2.6 shows the results of a survey of 49 countries 2.59 Good corporate governance is necessary concerning the enforcement of investors' rights, for the development of capital markets that including such critical variables as the mobilize and channel savings into productive efficiency of the judiciary, rule of law, and investment. In the Philippines, the formal rules absence of corruption.24 The Philippines for corporate governance, such as shareholder obtained the lowest or nearly lowest ranking in protection and accounting and auditing, are not terms of all of the variables. It was found that, exceptionally weak by international standards, compared to other countries, investors in the but their value is undermined by weaknesses in Philippines faced a substantial risk of contract enforcement. In addition, the high concentration repudiation and expropriation. In particular, of share ownership in the hands of large, firms that are politically well-connected dominant, and politically well-connected "insiders" can sometimes exploit judicial shareholders also undermines protection for rulings to damage or suppress competition from minority shareholders and creditors. less influential domestic or foreign challengers. 2.60 Private sector growth and productivity Corporate governance also depend on the extent to which businesses are kept on their toes by competition. Traditionally, 2.63 The mobilization and channeling of a competition in markets for many goods and growing volume of savings into profitable services in the Philippines has been muted by investment is essential for the Philippines to high market concentrations, trade and investment achieve its growth targets. For this to occur, restrictions, and other barriers to entry. The suppliers of capital-be they individual foreign trade and investment liberalization of the shareholders, institutional investors, mutual or 1990s has increased competition, but it is likely portfolio funds, banks, or financial that the benefits of these reforms have yet to be institutions-need assurance that the companies fully realized, due to the external shocks of 1997- in which they invest will act in their interests, 98 and 2001. 24 La Porta, Raphael, Florencio Lopez-de-Silanes, Andre Shleifer, and Robert W. Vishny, The Journal of Political Economy, 106:6 (December 1998), pp. 1142-1143. 26 TABLE 2.6: VARIABLES AFFECTING THE ENFORCEMENT OF INVESTORS' RIGHTS Average Score Average Score Ranking of for 49 Countries Score for the for 8 Other East Philippines out Variable (Out of 10) Philippines Asian Countries of 49 1. Efficiency of judicial system 7.67 4.75 7.19 48 2. Rule of law 6.85 2.73 7.08 46 3. Absence of corruption 6.90 2.92 6.52 48 4. Low risk of expropriation/nationalization 8.05 5.22 8.40 49 5. Low risk of contract repudiation 7.58 4.80 8.45 48 6. Accounting Standards 6.09 6.5 6.84 20 (out of 43) Source: La Porta et. al. (1998). protecting and generating an adequate return on of a broad shareowning culture, as well as of their funds. However, those in operational markets for bank lending and other forms of control of firms (e.g., professional managers or credit. dominant shareholders) typically have an incentive to divert funds provided by outside 2.65 Broadly speaking, the statutory codes suppliers of capital to their own ends. for accounting and auditing standards and shareholder rights are reasonably well 2.64 Corporate governance broadly defined elaborated for a country at the Philippines' level comprises those aspects of the economic of development, but there are problems at the environment, laws, procedures, and common level of implementation and enforcement. practices that provide an incentive framework for companies to maximize long-term value for 2.66 Accounting and auditing standards. shareholders, while adequately protecting the The survey by La Porta et. al., encapsulated in interests of other stakeholders, for example, Table 2.6, found the accounting standards in the lenders and other creditors. Corporate governance Philippines to be near the middle of the pack, in the Philippines is given a particular twist by both in a sample of 43 countries and among relatively high ownership concentration in firms, East Asian countries. But while statutory second only to Indonesia in the East Asia region. accounting guidelines in the Philippines are The top 15 business families in the country are, sound, the accounting profession is well for example, estimated to account for 55 percent established, and companies listed on the stock of ownership in listed companies.25 High exchange are subject to disclosure ownership concentration tends to have a double- requirements, there is little capacity to enforce edged effect on corporate governance, alleviating accounting guidelines and disclosure some problems while exacerbating others. On the requirements. In practice, auditors may choose one hand, it gives majority owners a strong from a wide range of disclosure style and incentive to closely monitor the activities of reporting standards, for example, local professional managers. But dominant generally accepted accounting principles shareholders with strong operational control of (GAAP), International Accounting Standards, firms also have more incentive and ability to or U.S. GAAP. Penalties for poor conduct of abuse the interests of other suppliers of capital, audits by independent auditors, and the such as minority shareholders and creditors. mechanism for imposing them is weak. In spite Without adequate safeguards in the form of high of the many well-known cases of poor quality quality accounting and auditing standards, strong audited financial statements that caused losses codes of corporate conduct, and effective legal for investors, the SEC and Philippine Institute protection, such abuses can stunt the emergence of Chartered Public Accountants have not publicly sanctioned any auditor in the past. Furthermore, many companies prepare different financial statements for different end users. A 25 Corporate ownership pattems are reviewed in detail in recently completed Report on the Observation Philippines: Growth wvith Equity-The Remaining Agenda, World of Standards and Codes (ROSC) on Bank Social and Structural Review. 2000. o tnad n oe RS) o 27 TABLE 2.7: MEASURES FOR PROTECTING CREDITOR RIGHTS Availability of Number of Number of Measure in the Countries with Countries Measure for Creditor Protection Philippines Measure without Measure I. Secured creditors protected from automatic stays of foreclosure. No 27 24 2. Secured creditors paid first No 42 9 3. Creditor consent required for reorganization of distressed companies. No 30 21 4. Creditors empowered to change management of companies under reorganization. No 25 26 5. Availability of at least 3 of the 4 protective measures No 21 30 Source: La Porta, et. al. (1998). accountancy in the Philippines therefore detailed outline of the ROSC on Corporate recommends the adoption of international Governance.) accounting and auditing standards without modification, strengthening the standards for Creditor rights and insolvency law training and quality assurance, and strengthening the regulatory and enforcement capacity of the 2.68 In general, the protection of creditors SEC and the central bank. (See Appendix 2.1 for under law as well as under bankruptcy a more detailed outline of this ROSC.) protection and workout arrangements in the Philippines has been among the weakest in the 2.67 Shareholder Protection. The study of world. A survey of creditor protection investor rights by La Porta et. al. cited above frameworks by La Porta et. al. cited above gave shareholder rights in the Philippines a rating found the Philippines at the bottom in a of 3 out of a possible 7, scoring it higher than comparison of about 50 countries. Secured Indonesia, Thailand, and Korea in the region. creditors do not have adequate protection from Several other studies also note that the corporate stay of foreclosure and do not necessarily enjoy laws already contain many features standard in a foreclonured do not haven other countries covering protection of minorities a priority in payment. Creditors do not have an and the fiduciary duties of directors, but that the adequate say in the reorganization of distressed prevalence of large shareholders in most borrowers, or over management (see Table compralnies requirges additionalreholr ing oin 2.7). Most default cases are settled through companies requires additional strengthening dacion en pago, without recourse to foreclosure these areas. A recent ROSC on Corporate mechanisms, under which debtors are generally Goverpance recommends a number of measures able to extract concessions from creditors. This for improvement, including better public weak state of creditor rights and insolvency law disclosure of share ownership, greater tends to prevent the development of deep empowerment of minority shareholders (for markets in arm's length bank lending. Until example, in terms of their rights regarding recently, corporate insolvency was covered by shareholder meetings and in situations where the a presidential decree of 1981 (PD 902-A), majority has a conflict of interest), higher which gave responsibility for dealing with standards of performance and disclosure by distressed firms to the SEC. This arrangement boards of directors, higher standards of disclosure turned out to be quite unsatisfactory, due to and performance for auditors, and stronger long delays in SEC decisions on cases, during powers for the SEC and the Philippine Stock which time creditors were unable to pursue Exchange (PSE) to enforce regulations and their claims and often suffered deterioration in impose sanctions. (See Appendix 2.2 for a more the value of their assets. Hardly any companies were successfully rehabilitated. 26 Fogarty, Kevin., "Corporate Governance in the Philippines: An 2.69 Since the 1997-98 regional financial Assessment of Needed Reform Efforts," USAID, 1999; and C.G. crisis, several steps towards reform have been Saldana, "Philippines Corporate Governance Environment and Policy and their Impact on Corporate Performance and Finance," taken. In December 1999, the SEC adopted Asian Development Bank, 1999. 28 "Rules and Procedures on Corporate Recovery," its creditors and is unlikely to be able to do so but these still failed to address the most serious in future, and it should compel a company to deficiencies relating to creditor rights. The file for bankruptcy immediately upon becoming adoption of the Securities Regulation Code in insolvent. Directors of companies that continue July 2000 moved the venue for distressed to trade while insolvent could be made companies seeking suspension of payments from personally liable for any additional losses that the SEC to the Regional Trial Courts. To be are suffered by creditors. To prevent banks successful, this will require that Regional Trial from lending to related insolvent companies, Court judges are adequately trained to administer director, owner, shareholder and related interest them effectively and expeditiously. This training ceilings on bank lending should be strictly has begun. applied. Through strict provisioning requirements, banks should be encouraged to 2.70 Effective December 15, 2000, the petition for the liquidation of nonviable Supreme Court adopted Interim Rules of companies with NPLs. Procedure on Corporate Rehabilitation. These rules are an improved version of the SEC's (b) Facilitating the rehabilitation of viable rulesmarer 19 i Rules and Procedures on companies. Greater clarity is required December 1999Rue an Prcdeso concerning the implementation of a Corporate Recovery, and are to apply until the rehabilitation pan. Ideall the law should proposed Corporate Recovery Act is adopted by reh a mean. really,ah law of the legislature. The Interim Rules are considered provide a means for regular monitoring of deficient relative to international best practices in progress during the plan, allow creditors to a number of areas. In particular, there are no amend the plan and for provisions for creditors' committees to be able to possible termination of the plan and for select the rehabilitation receiver or to be liquidation of the borrower. In addition, the conseletthed orehearbiin reydecivions to te new law could address the problem of access to consulted or heard in key decisions in the nefudsbycmaisnerogcut-r procedigs.There is no provision for creditors new funds by companies undergoing court- or proceedings. is o provi pion of SEC-supervised rehabilitation programs. to vote by classes on the adoption of Unlike in the USA, there is no legal provision rehabilitation plans, and the rules allow the court U ntin the in teris o repal to to cram down stays and debtor rehabilitation for granting priority in terms of repayment to plans against the wishes of the majority of lenders willing to provide new loans to a secured creditors. Leaving such discretionary a companyundergoingrehabilitation. In addition, powers with judges is not only at variance with at present any new loan to a borrower in best practices, but also can lead to serious abuses bankruptcy would have to be classified as of creditors' rights. Further, in April 2001, the substandard and provisioned accordingly, thus interim rules were amended to restore the former immediately affecting the bank's bottom line. practice under the SEC of appointing .. management committees to oversee the Competetve environment: foreign trade and implementation of rehabilitation programs. Unlike a receiver, who is subject to conflict of 2.72 Competition in markets for many interest rules, the management committees are goods and services is muted, due in part to the comprised of the interested parties, the creditors absence of pro-competition laws and in part to the domination of several markets by a small 2.71 Looking forward, the proposed Corporate number of suppliers that are often members of Recovery Act seems much closerto international family-based conglomerates. Market best practices. However, it could be further concentration is particularly high in such strengthened inanumber ofiareas, including sectors as food, tobacco, beverages, coconut oil, glass, paper, interisland shipping, and (a) Facilitating the exit of nonviable pipelines. And some of these sectors, including companies. It is recommended that the Act clarify some food products, are sheltered from import that a company is insolvent if it is unable to pay competition. Interisland shipping is protected 29 by a law that inhibits competition, and this has estimated to be 20.1 percent and 21.5 percent resulted in higher costs. respectively. Agricultural protection has several economic ill effects. It stifles development in 2.73 While the position of family group-based downstream industries such as food companies has been eroded by liberalization of manufacturing and beverages. It diverts trade and foreign investment liberalization (see production from exports to the home market, below), they often remain in a position of market for example, hampering the ability of the dominance. Their ownership of the major banks Philippines to exploit opening agricultural and preferential access to financing also affords markets in China in the wake of its accession to them a strong competitive advantage and the World Trade Organization (WTO). It delays represents a possible barrier to the entry of new the migration of resources from agriculture to firms. The sizable investment in logistics made other activities. It reduces the international by dominant suppliers in order to distribute their competitiveness of manufacturing by raising products among the islands may also represent a labor costs, and it disproportionately hurts the significant barrier to competition from imports or poor, who spend more of their income on food to the entry of new domestic competitors. and are, in general, net buyers of food. Further liberalization of trade in agriculture should be 2.74 Foreign Trade. Trade liberalization pursued, as it is a promising source of programs launched in the early 1990s have economic gains in the future. In this context, significantly simplified tariff structure, reducing recent moves to allow the private sector to it from a five-level rate schedule to one with import rice is a positive step. three. The number of Harmonized System lines was reduced from 6,197 in 1990 to 5,725 in 2000. 2.76 Investment Regime. The foreign Tariffs have come down, especially in investment regime is fairly liberal. In most manufacturing. The average MFN rate in sectors, 100-percent foreign ownership is Philippines in 1999 was 10 percent, compared to permissible. Foreign firms can lease land for up 13.5 percent in Indonesia, 9.5 percent in to 75 years. The investment regime guarantees Malaysia, and 17 percent in Thailand. The freedom from expropriation without weighted average effective protection rate (EPR) nationalization and the right to remit profits, also fell from 24.8 percent in 1995 to 14.4 dividends, capital gains, and sale proceeds from percent in 2000, with this decline in effective investments. However, the Philippines does protection being most pronounced in maintain two negative lists that restrict or limit manufacturing. However, progress on trade foreign investments in certain sectors and for reform has not been entirely uniform: there was certain activities (Appendix 2.3). Sectors where some backsliding in 1998, when 22 domestic restrictions are significant include the services industries received additional protection through sector. In retail trade, for example, an enterprise higher import tariffs. Looking forward, the Tariff can be wholly foreign-owned only if it has Commission estimated in February 2001 that paid-in capital of at least US$7.5 million and EPRs would fall to 14.1 percent in 2001, 12 the foreign investor has a net worth of at least percent in 2002, 11.77 percent in 2003, and 10.8 US$200 million. Regulatory changes to percent in 2004. In 2004, a uniform tariff of 5 facilitate entry into services and increase percent will apply, though some goods are still competition in service sector activities should likely to receive non-tariff protection. be pursued, as it would induce increased productivity and reduce costs for users. 2.75 Agricultural protection constitutes an Interisland shipping has been liberalized and a important exception to the general trend of lower number of private shipping companies have trade restrictions. The government retains a entered the market. But this increased assess monopoly of imports of rice and effective has yet to result in the expected reduction in protection rates for agriculture have fallen much costs. Hence this warrants further examination, more slowly than for manufacturing. The 2004 as the low-cost movement of goods is EPRs in agriculture and food processing are important for market integration and 30 international competitiveness. The aviation sector Private sector enthusiasm for PPI also appears is in private hands after the privatization of to have waned as risk perceptions increased Philippine Air Lines. The telecommunications after the Asian financial crisis. Other than the sector has undergone far-reaching liberalization Electric Power Industry Reform Act of June since 1993. Some 11 new licenses were awarded 2001, which aims to restructure and privatize for basic telephony and cellular and international the National Power Corporation's generating gateway facilities, leading to almost four million assets, create a wholesale market for power, new lines' being installed by the end of 1998. and foster competition in retail customer There are now 76 local exchange carriers, five markets, there have been few recent initiatives cellular providers, and many smaller providers. on the PPI reform agenda. Several key Telecommunication services have grown rapidly. problems will need to be addressed in the next Competition has emerged in all segments of the stage of reform: market. The National Telecommunication Commission provides regulatory oversight (a) The government assumed heavy contingent liabilities in the first wave of PPI Infrastructure provisions projects (see section 2A). The Electricity Industry Reform Act will require the 2.77 The Philippines made considerable government to absorb some $2.5 billion-$3.75 progress in developing its infrastructure over the billion of stranded costs. Given the course of the 1990s, although, as Table 2.8 government's highly constrained fiscal suggests, it still lags behind other middle-income position, it would be unwise to continue large countries in the region in several respects. open-ended financial commitments to support PPI in future. 2.78 Achievements. A key force in this development was the attraction of PPI after the (b) and has been skewed to large urban passage of the BOT law of 1993. Over the past are and areas. Aftthe ontribu tion decade, the government, in partnership with the or more remote areas. A ter the decentralization private sector, has initiated about 111 law of 1991, local governments assumed the infrastructure projects with a capital cost of $26 main responsibility for infrastructure billion, mainly in four sectors: power, water, development and maintenance, but few have transport, and telecoms. the financial or management capacity to transport, and telecoms. undertake this task. 2.79 Emerging Issues. Despite these (c) There remain significant needs for advances, the Philippines' infrastructure needs further regulatory and other reform in each of remain large, and financing for them scarce. The the main infrastructure sectors, as well as for World Bank estimates needed investments over strengthening of institutions to handle the next 10 years at $35 billion-$45 billion. infrastructure development as a whole. Given fiscal constraints, the government will not have the resources to fund the backlog itself. TABLE 2.8: INFRASTRUCTURE IN THE PHILIPPINES Middle Philippines Indonesia Malaysia Thailand Korea Income Per capita power consumption (kwh) 451 320 2554 1345 4497 1367 Trans & Distribution losses (%) 16 12 7 9 7 11 Access to power (%households) 65 39 92 87 97 Urban water access ( %pop) 92 91 95 89 97 93 Rural water access (% pop) 80 65 94 77 71 68 Paved Roads (% 95-99) 20 46 76 97 75 48 Telephone mainlines per 1000 39 27 203 86 438 121 Source: World Development Indicators. 31 2.80 Policy Agenda. The Philippine be driven by a strong central unit with government has made infrastructure development direct access to key decision makers, rather and revitalization of PPI a priority in its MTPDP. than by self-interested line agencies. In the The World Bank has provided continuing support Philippines, the COP can play this role, and advice on the PPI reform agenda, in building on its impressive experience in particular through a recent Country Framework privatizing many GOCCs in the early Report on Private Investment. The report 1990s. proposes a three-point strategy: Review the future role of the BOT center. A distinction should be made between the (a) Financial reform. Given the buildup of "sell" and "buy" side of the PPI process. PPI-related contingent liabilities and the weak While the COP should be the main entity capacity of local governments to participate in for dis osing of government assets, the infrastructure development, there is a clear need BoT shosing of govessent onsets,othe for greater fiscal discipline and the development BOT should focus essentially on promotion of a framework to reduce dependence on national to potential investors. government resources. In particular: * Consistently apply competitive bidding * Define the basis of financial reform. The procedures. Infrastructure privatization government needs to better define the basis, should be done under a competitive and rationale, pricing, and management for transparent bidding process. The process guarantees and other financial enhancements. for selecting, soliciting, evaluating, and A greater emphasis on privatization would awarding projects should be simplified, also help minimize the need for guarantees. standardized, and made more transparent. * Strengthen LGUs' capacity for infrastructure * Establish arms-length regulatory agencies. development. This can be done by improving Investors are aware of political pressures their financial management, investment that regulators face and of the vulnerability planning, and accounting capacity and by of their long-term immobile investments. giving a bigger share of central block The government needs to make a credible transfers to smaller, poorer LGUso commitment to respect regulators' trnsenmrsing to rfosmaller, podiore for LUindependence and autonomy and clarify the Benchmarking performance indicators for "rules of the game." LGUs and making these available to the public would increase transparency and (c) Sectoral reforms. There are many accountability of LGUs and mayors. pending items for deepening and broadening * Incentives for long-term domestic financing reforms in each of the infrastructure sectors. of infrastructure need to be improved, for Thesearenoted inmoredetail inAppendix2.4. example from the contractual savings sector, Rural development while reducing dependence on short-term foreign currency borrowing. 2.81 Rural sector performance has been (b) Institutional reforms. Apart from limited by constraints on assess to land, capital, strengthening local government capacity, other and finance; still weak government support, institutional reforms that could help infrastructure limiting smallholder capacity to adopt development, include productivity-enhancing technologies; and the continued deterioration of the country's natural * Stengtenln theroleof te Comztte on resources. There has been a lack of commodity Privatization (COP). Privatization of existing andoince diersicaon a little, ifmany assets is a key element of the PPI agenda. and income diversification, and little, if any, asseatsisnal keypeleente of ow the PPIagena. improvement in productivity. About one fourth International experience shows the of the rural labor force is underemployed, and a importance of letting the pace of privatization o h ua ao oc Sudrmlyd n 32 large number (especially youth) continue to be implementation is poor, partly because of unemployed.27 limited funding bit also because of weak governance and implementation capacity at 2.82 Key natural resource issues include the LGU levels, exacerbated by the limited field- destruction of old growth forests; low-input level capacity of national rural support shifting agriculture that has severely degraded the agencies. uplands; and rampant illegal over-fishing, destruction of coral reefs, and degradation of 2.84 Policy, institutional, and regulatory mangrove areas. While the Philippines is rich in reforms are needed to remove market natural resources and has one of the highest distortions, lower transaction costs, and provide biodiversity in the world, the increasing demands an improved and more sustainable incentive of a growing population has caused rapid framework conducive to market-led depletion of natural resources especially those improvements. In this context, it is suggested that provide for our basic needs such as food, that quantitative import restrictions on rice be water and shelter. The Philippines Environment converted to an import tariff and that there be a Monitor 2000 identified three broad clear and simple plan to reduce this over time. environmental challenges for the country: urban This would reduce rice prices, which are so air and water pollution, natural resource important to the poor (see Figure 2.5), degradation and the declining quality of coastal contribute to much-needed crop diversification and marine resources.28 While some and be consistent with the national commitment improvements in natural resource management to WTO principles of reduced import barriers. (e.g., high deforestation and fish depletion rates Phasing out market distortions for sugarcane are declining) are emerging, available data would also increase competition and suggest continued threats requiring more productivity and encourage value added and aggressive and appropriate interventions to diversification in farm incomes. Updating and strengthen environmental management. Forest implementing the action for restructuring/ management policy needs to be updated, privatizing the National Food Authority (NFA) water/irrigation sector policy revisited, and is an integral part of needed agricultural policy further coordinated action is needed to ensure reforms to help generate a more dynamic rural environmental sustainability. sector. 2.83 Rural development and poverty FIGURE 2.5: DOMESTIC WHOLESALE PRICES OF alleviation are stated top priorities of the RICE (IN PHP PER KILO) Philippine government, as reflected in its recently 16 updated MTPDP (2001-2004). Available recent analyses of the Government's rural development/ 14 \ Philippines national resource and management programs 12 - suggest uneven performance in addressing the 10- above-mentioned issues.29 The overall conclusion 8 - Thailand is, first, that the policy environment needs reform - to facilitate competition, diversification, and 6 - Vietnam increased productivity. Second, the government's 4 support strategy is broadly appropriate, but 2 O0- 97 98 99 00 01* 27 See Philippines: Equitable Rural Development Strategy, World Bank, May, 1998; Philippine. RD/NRM Strategy Implementation * As ofJune 2001. and Framework Performance Indicator System, World Bank, June, Source: ADB-DOF-DA Grains Policy and Institutional Reforms 2000. Advisory Technical Assistance Project, Jan. 31, 2002. 28 The Philippines Environment Monitor Series is an short annual World Bank publication reporting on various environmental issues. 2.85 At the same time, targeted government 29 Medium Termn Investment Plan for the Rural Sector and SEER support for community-based programs (Natioanal Economic Development Authority, Sept. 2001). 33 focusing on resource management, small-scale financial system mobilizes resources, allocates farmer diversification, production-to-market them to their best use, and monitors the linkages to facilitate access to markets, and efficiency with which those resources are used. improved delivery of agricultural services It creates tools for hedging and trading risks, remains essential. So will initiatives to improve and provides efficient ways to make payments access of the rural poor to productive assets, for goods and services. However, financial especially land, and sustainable access to rural markets also harbor the potential for serious finance. This suggests the need for an updated instability and crises, the origin of which lies in Comprehensive Agrarian Reform Law to remove the asymmetric information problems that are distortions and establish a more effective endemic to these markets.30 These problems instrument for supporting implementation. indicate that strong prudential regulation and Broadening access to land by relaxing land supervision are a basic prerequisite for a market restrictions and better targeting the healthy financial sector. landless in implementing agrarian reform would be an important part of this. Additional resources, 2.88 The Philippines' financial system is as planned by the government, are needed to dominated by banking. Deposit money bank accelerate the purchase of private lands, and assets make up over 80 percent of financial appropriate institutional reforms in land assets. Banking itself is highly concentrated, administration and management are needed. with the largest six commercial banks controlling around 60 percent of all bank assets. 2.86 Effective delivery of this support will Commercial banks are often parts of family- necessitate strengthened institutional owned business conglomerates, and tend to arrangements, coordination, and more effective operate as in-house banks for the nonbank private-public sector partnerships. Improved business and commercial operations of the public expenditure reforms in the rural sector controlling families. Short-term commercial agencies, to achieve more effective and bank lending of at most 90 days' maturity accountable devolution to local governments and provides the main source of external finance for communities, would be part of this. Government corporations, which tend to be less heavily support is demonstrated in the President's leveraged and more reliant on retained earnings commitment to provide PhP20 billion annually in to finance investment than in most East Asian public investments as part of the Philippine countries. The contractual savings sector Agriculture and Fisheries Modernization Plan (public and private pension plans, life insurance 2001-2004. However, improved policies and companies) makes up a second and much enhanced funding must be complemented by smaller segment of the financial system. aggressive efforts to enhance the implementation Capital markets are even less significant as a capacity of local governments, as well as linkages source of financing for the private sector. They with national agencies. cater primarily to government domestic borrowing. Several features of the financial D. STRENGTHEN AND DEEPEN THE FINANCIAL system, such as the underdevelopment of SECTOR capital markets, the focus on short-term financing, and the bias towards intragroup (as 2.87 A large body of evidence now documents opposed to arms-length) lending, result, to a the close association between deep, well- considerable extent, from the serious functioning financial systems and more rapid weaknesses in investor protection and creditor economic growth. When it functions well, the rights discussed in Section 2C above. 30 Asymmetric information is a situation in which one party to a transaction has more accurate information than the other. Thus, a borrower typically has better information about the potential risks and retums of the investment to be undertaken than does the supplier of capital. 34 TABLE 2.9: NPLs OF CRISIS-AFFECTED COUNTRIES (PERCENT OF TOTAL LOANS) 1997 1998 1999 2000 2001 Dec. Dec. Mar Jun Sept. Dec Mar. Jun. Sept. Dec. Mar. Jun. Sept Indonesia(a) -- -- -- -- -- 64 62.4 63.5 61.7 57.1 54.4 52.6 50.5 Excl. IBRA 7.2 48.6 58.7 39 38.9 32.9 32.1 30 26.9 18.8 18.1 17.6 14.7 Korea(b) 8 16.1 17 16.4 15.9 20.5 22.7 20.1 18.8 17.5 17.0 15.3 ex. KAMCO/KDIC 5.9 10.4 11.4 11.3 10.1 14.9 15.3 13.6 12.3 10.4 9.6 8.0 Malaysia (c ) 6 21.1 24.1 23.3 23.3 23.4 23.5 23.2 23 22.5 23.2 24.2 Excl. Danaharta -- 18.9 18.2 18.1 17.8 16.7 16.2 16.2 16.1 15.5 16.2 17.1 Philippines (d) 4.7 10.4 13.2 13.1 13.4 12.3 14.0 14.6 15.7 15.1 16.6 17 17.9 Thailand (e) -- 45 47 47.4 44.7 41.5 39.9 34.8 34.3 29.7 29.3 28.9 29 Excl. AMCs -- 45 47 47.4 44.7 38.9 37.3 32 22.6 17.7 17.4 13 13 (a) First line uses "stringent" definition of NPL; second line excludes transfers to Indonesian Reconstruction for Banking Agency. (b) NPL figures use FLC since Dec.1999. (c) Includes commercial banks, finance companies, merchant banks, and Danaharta (d) Refers to commercial banks. (e) First line includes commercial banks, finance companies, and estimated NPLs transferred to wholly-owned private asset management companies (AMCs). * Data for November 2001. Source: National data of various countries. although some part of the deterioration may also reflect tighter reporting standards. 2.89 The Philippines did not experience a Commercial bank NPLs rose from 15 percent at systemic financial crisis in 1997-98, in part the end of 2000 to 19 percent in November because of financial sector restructuring and 2001 (Table 2.9). The deterioration has not reform undertaken after the debt crisis of the been uniform and NPLs range through 4.9 early 1980s and stronger capital positions and percent for foreign bank branches; 18.6 percent better portfolio quality among its banks. in government banks; 20.7 percent in Expanded Nevertheless, the 1997-98 regional crisis, the Commercial banks (EKBs) to 22.2 percent in greater economic volatility, and a weakened pace other commercial banks. of activity have contributed to a deterioration in 2.92 Concurrent with the growth in NPLs performance indicators for Philippine banking. And 2001's steep fall in export industries, the has been widespread foreclosure on other interest~~~ ~ ~~ rae,adlweut assets, and thus the resulting real and other weak peso, high properties owned and acquired (ROPOA), prices have contributed to further stress. together with loans that have been restructured, 2.90 Indicators for the banking sector suggest now account for another 15 percent of total a continued weakening. While most banks report loans. Overall, approximately 35 percent of adequate capital, it is not clear by international total loans are under some form of stress, while standards that in fact sufficient capital is being nonperforming assets as a proportion of total maintained. Asset values are not clearly assets have risen to about 30 percent. established and banks' balance sheets show a Provisioning against this loan quality amounts slow but increasing level of foreclosed assets. to approximately 44 percent of NPLs plus ROPOA combined, in part reflecting the fact 2.91 Asset quality and provisioning. The that provisioning rules in the Philippines asset quality of banks has declined over the last require provisioning against ROPOA only if the several years. Commercial bank NPLs rose from market value of foreclosed assets falls below 4-5 percent at the end of 1997 to 13 percent by book value in the course of five years.3' early 1999, as a result of the economic slowdown and financial volatility experienced during the 1997-98 regional financial crisis. NPLs stabilized during 1999, but began drifting higher in 2000 Banks are permitted to retain ROPOA and to count it toward and 2001, reflecting slower economic growth, capital. Banks are therefore reluctant to dispose of these assets, as market instability and interest rate increases, they would be forced to recognize losses immediately. Keeping ROPOA results in less provisioning and thus little impact on capital. 35 2.93 Problems among larger banks. Two Policy environment for banking large institutions (The Philippine National Bank [PNB] and Equitable-PCI) experienced a 2.96 The Philippine authorities have used deterioration of depositor confidence in late 2000 the years since 1997-98 to strengthen the and early 2001, leading to the injection of banking system by promoting improvements in substantial emergency funding from the BSP and prudential regulation, supervision, and PDIC. Equitable-PCI has repaid all of its liquidity transparency. The General Banking Act enacted support. At PNB, which is affected by high NPL in May 2000 represents a considerable levels and low earnings, the government has improvement over the previous 1949 law and attempted various strategies to rehabilitate the lays the basis for a major overhaul of prudential bank, including encouraging the provision of regulation and supervision. Nevertheless, additional capital from private sources, but has further action is needed to strengthen the been hampered by the lack of adequate legal tools legislative power of the central bank and other to overcome the resistance of the existing owners. regulatory authorities to deal with distressed or failing institutions, better protect their staff 2.94 Profitability and Earnings. There has from lawsuits, and promote further been a steady decline in return on asset (ROA) consolidation of the sector. Banks have been and return on equity (ROE) indicators since 1997, urged to improve their credit risk management paralleling the deterioration in asset quality. ROA and the authorities should closely monitor these and ROE levels have fallen from 2.2 percent and efforts. Measures are also needed to further 15.9 percent in 1996 to 0.6 percent and 4.3 strengthen training of supervisors; improve percent, respectively, in June 2001. The analytical and early warning tools; promote underlying decline in profitability is even more better corporate governance, disclosure and marked if it is noted that net income has been market disciplining of banks; and speed largely supported by extraordinary gains in recent disposal of intervened/distressed institutions. years. 2.97 Prudential Regulation and 2.95 Capital Adequacy. Capital levels were Supervision. Prudential regulations have reported at approximately 17 percent in June improved via higher capital norms, tighter loan 2001, substantially higher than the Basle standard classification and provisioning rules, better of 8 percent. Again, there is some variation consolidated reporting, more conservative across banking categories, with the highest loan/value ratios for real estate, greater reported capital being held by foreign bank alignment with international norms, and efforts branches (22.3 percent) and the lowest in to enhance risk management by banks. Rules ordinary commercial banks and EKBs. While for qualifications and fitness of directors and capital adequacy trends have been positive, they officers have been spelled out and related-party need to be viewed in the context of the overhang lending standards have been tightened, but may of distressed assets, some probable under- need further review. Recent regulations include reporting of problem assets, existing provisioning the uniform implementation of the 6-25 percent arrangements, and the fact that, with profitability allowance for probable losses on loans as low as it is, the likelihood of banks' classified "substandard-secured," adoption of a augmenting capital through earnings is small. new risk-based capital adequacy requirement The BSP introduced a new risk-based capital based on Bank for International Settlements adequacy requirement for banks effective July standards; redefinition of NPLs for borrowings 2001. This measure is an important step in payable in daily, weekly, or semimonthly bringing the quality of the authorities' prudential installments; and the marking to market of debt supervision closer to the international capital and marketable equity securities. adequacy standards set by the Basle Committee. 36 2.98 The supervisory powers of the BSP have hamper BSP and PDIC. The 2000 General been enhanced and made more explicit. On- and Banking Act adopted an early warning system off-site supervision has improved and a system and a prompt corrective action regime, giving for monitoring the top 200 borrowers has been strengthened supervisory powers to the BSP to put in place. A basic early warning system has deal with undercapitalized banks. But the been implemented and a bank performance rating effective implementation of these new tools is system is being put in place. Greater financial hampered by the lack of sufficient legal power transparency and disclosure will be sought for the supervisor to intervene. What is needed through quarterly publication of financial is explicit authority to suspend operations of a statements. The law also establishes the basis for distressed institution and proceed with greater competition in the banking system by restructuring, merging, or liquidating it without further liberalizing the entry of foreign banks undue interference from shareholders. (permissible foreign ownership has been raised to Adequate legal protection for BSP and PDIC 40% of voting stock and, after seven years, up to officials from possible litigation by an 100%). intervened bank's shareholders is also needed. Current deposit secrecy laws prevent deposits' 2.99 Asset Restructuring. The Philippines being transferred to another institution at the has not adopted a centralized approach for time of failure resolution and lead to dealing with NPLs and repossessed assets on the performing loans lingering in the failing books of the banks. Its approach reflects the less institution. This delay in bank and asset severe impact of the crisis on Philippine banks resolution increases the cost to taxpayers and and firms, the difficult fiscal situation, and the should be addressed. For example, government view that private initiatives may be best suited to efforts to rehabilitate PNB have been hampered address the nonperforming asset situation. by lack of sufficient authority to force the Following this approach, the government is current majority owner to inject capital, dilute currently working on legislation allowing banks his position through a strategic investor, or to to sell assets to a specially designed asset sell his position. management company (AMC) or special purpose vehicle. Property ownership laws may be 2.101 Anti-Money Laundering Act. An amended to let foreigners be majority owners of anti-money laundering bill (Act 9160) was AMCs that own real estate for a limited period of passed into law just before the September 30 time as part of their disposal strategy. The current deadline imposed by the Paris-based Financial proposal would permit a transfer of the assets at Action Task Force (FATF), although the bill's net book value. The compensation for this implementing rules and regulations have yet to transfer would be divided into two components: be carried out. FATF is assessing the law for cash for the value estimated by the owners of the compliance with its standards, and will AMC as the real value of the assets, and the probably have comments and recommendations difference in subordinated notes. These notes to further strengthen the law. In the meantime, would provide an incentive for bank owners who the Anti-Money Laundering Committee, made feel that the assets are worth more than what is up of the Governor of BSP, the Chairwoman of being offered, by giving them an opportunity to the SEC, and the Chairman of the Insurance participate in a later rise in asset prices. It does, Commission, is seeking to appoint an executive however, also provide the banks yet another director who will lead efforts to interpret and opportunity to delay loss recognition in the hopes implement the legislation. Ultimately, it will be of a speedy recovery, as the evaluation of the implementation that determines how notes will be delayed by one year and resulting significantly the Act helps in combating losses will be phased in over a five-year period. criminal money laundering. 2.100 Failure Resolution. The lack of 2.102 Issues raised by conglomerate adequate legal powers to address and resolve banking structure. The conglomerate structure problem financial institutions continues to of banking in the Philippines raises a number of 37 policy-relevant issues. As noted, the financial supervision is the rigid depositor secrecy industry is dominated by six commercial banks, legislation still operational in the Philippines. which own trust, investment, securities, While aspects of secrecy are addressed in the insurance, foreign currency deposit, and thrift recently passed anti-money laundering subsidiaries, as well as corporations and real legislation, the capacity for supervisors to estate development projects. This structure assess funding concentration is still facilitates the arbitraging of financial compromised. Moreover, the institutional opportunities created by differential reserve, structure renders more serious weaknesses in regulatory, capital, and tax requirements in the transparency and information disclosure. Philippines, and by the existence of different regulators and supervisory bodies with differing Capital markets capabilities. Arbitrage is invariably effected through banking conglomerates with subsidiaries. 2.105 Equity and debt markets capable of The conglomerates assume systemic importance, providing long-term financing have achieved as they are invariably the dominant clearing only limited development in the Philippines. banks in the Philippine payments system, As previously noted, the development of these accounting for most settlement transactions. markets has been hampered in part by institutional weaknesses in such areas as 2.103 While profit-efficient, the corporate governance, creditor rights, interconnectedness of the conglomerates also insolvency law, and the enforcement of makes banks vulnerable to problems in shareholder rights. subsidiaries.32 Moreover, their systemic importance assumes a "too big to fail" hazard, 2.106 Recent Developments. The PSE has which, coupled with the lack of intervention not fully recovered from the flight of foreign authority and lack of protection from litigation investors in 1997. After a rebound in the first for those responsible for troubled institution part of 1999, equity prices fell substantially till resolution, has too often resulted in resort to late 2001. Confidence was shaken by the BW liquidity support from the central bank in lieu of Resources market scandal, involving alleged adequate resolution. price manipulation by brokers and allegations of political interference in the SEC's 2.104 The conglomerate structure is also a investigations. Domestic political tension, challenge to effective supervision, which is slower growth, and reduced corporate earnings complicated by a fragmented regulatory structure have also taken their toll. Average daily trading within the BSP and across the industry. Some volumes fell to less than $10 million, and transactions of the intermediaries are supervised market depth is limited. The top 10 percent of by the SEC, others by the Insurance Commission, companies account for nearly 90 percent of and still others by different supervisory units trading volume. Net new listings have averaged within the BSP. In the latter case, supervision is only around five a year. Three international still conducted on the basis of the license type of financial firms have closed their securities and the institution-EKBs, commercial banks, thrift, brokerage operations in the Philippines. The rural-even where these are part of the same corporate debt market in the Philippines has not conglomerate. Some rationalization will be shared in the growth in these markets after necessary if consolidated supervision is to be 1997, as observed in countries such as Malaysia effective.33 Overlaying the capacity for effective and Thailand. This appears in part the result of high taxes and fees discouraging trading. Lack of laws and regulations and absence of market infrastructure have also deterred primary 32 In the case of Urban Bank, funding problems initially surfaced in market issues and secondary market trading. the investment subsidiary. The bank was forced to provide liquidity to the affiliate and acquire its NPLs. The liquidity problem eventually overwhelmed the bank, prompting BSP intervention. 2.107 Policy Environment. Enactment of 33 Recent steps were taken to improve interagency collaboration capital market reforms has been much slower with the formation of an Inter-Agency Committee. 38 than banking reforms. A revised Securities well as on the borrowing and lending of Regulation and Enforcement Act that would securities. strengthen regulatory, disclosure and governance (b) A Securitization Act to allow the creation requirements for securities companies has of special purpose vehicles as the transferee of languished in Congress since 1997. Proposed assets and the issuer of securities. changes to the Investment Companies Act have met a similar fate. (c) A Revised Investment Company Act to create an environment more conducive to the 2.108 However, a new Securities Regulation development of the Philippine mutual fund Code based on the proposed revised Securities industry, while strengthening investor Act was adopted in July 2000. Under the law, the protection. SEC is to be reorganized to focus on securities (d) A Personal Equity Retirement Account market regulation, while its previous quasi- Act that would create a new form of long-term judicial functions such as the resolution of intra- savingsg corporate disputes, suspension of payments, and savings. private damage actions are to be removed and (e) A Corporate Recovery Act, as discussed transferred to the courts. Implementing in Section 2C above. regulations have also been issued. Both the code 2.111 Legislation to change documentary and the implementing regulations adopt many of stamp taxes and facilitate the establishment of the practices recommended by the International stam p ose vehcle is eadyishmer Organization of Securities Commissions special purpose vehicles iS already under (IOSCO). The implementing regulations enhance preparation. SEC's powers to provide additional protection to 2.112 Looking forward, the development of investors, define prohibited market practices, active equity and debt markets is likely to monitor and take action against abusive market require complementary advances across a broad practices, promote self-regulation by market front of reforms. These include the institutional participants, manage systemic risks in the reforms discussed in Section 2C strengthening brokerage industry, and investigate and enforce disipinry proeeins gaist make financial transparency, disclosure and corporate discilipnary proceedgs agaist market accounting and auditing standards; improving corporate governance; and enhancing the legal 2.109 In addition, the PSE was demutualized provisions for and enforcement of shareholder and reorganized as a stock corporation that is uI00 protection, creditor rights, insolvency and percent owned by its 184 member-brokers. At corporate recovery. In addition, the present, however, it is not clear if the PSE will be independence and authority of regulators of financially viable, since top Philippine companies corporate debt and equity markets need to be at may find it easier to maximize shareholder value the same level as is accorded to BSP for the by listing in New York or Singapore. The banking industry. The proposed revised credibility of the SEC and PSE as regulators is Securities Act needs to be passed by Congress likely to remain in doubt until the stock fraud and at an early date. In addition, completing the manipulation case of BW Resources is fully initiatives suggested by the CMDC and others prosecutedi should be given high priority. Collaboration with IOSCO and with international credit 2.1 1 0 The Capital Markets Development agencies could be useful in ensuring that laws Commission (CMDC) has also recommended and regulations are up to international standards several legislative proposals to the govemmentd from the outset. Thailand's experience in These include systematizing its domestic bond market after 1997 could also prove useful. (a) Elimination of the Documentary Stamp Tax on secondary trading of financial instruments, as 39 Improving access to financing for SMEs and 2.116 There is an ongoing debate in the strengthening microfinance Philippines on such questions as whether there 2.113 Small and microfirms constitute 99 should be uniform minimum standards for percent of registered firms in the Philippines. For microfinance institutions and who should these firms, bank borrowing will remain the most regulate them. Since the share of these teas firms, brr wll rmaning tHevmos institutions in total deposits and loans is small, banks typically place zero value on assets such as and since they do not pose a systemic risk, the inventories and accounts receivable for the best approach at present may be to adopt only a invenorie and ccouts reeivale fo the light regulatory touch (that would become more purpose of collateral, though these are often the intensiveoas th itituton become lare main tangible assets held by SMEs. This problem intensive as the institution becomes larger), could be addressed by amending the Civil Code with periodic surveillance to prevent fraud and to facilitate floating charge instruments or general abuse. At this point, it may be more valuable to assignments of accounts receivable and put greater focus on capacity building and inventories. training. 2.114 Farmers' access to credit could also be E. EMPOWER AND PROTECT THE POOR enhanced through a more systematic use of 2.117 The MTPDP is right in highlighting the warehouse warrant financing in the agriculture importance of human resource development, as marketing chain. Warehouse warrants are an experience around the world demonstrates that easily tradable title to harvested crops that it is critical for sustained poverty reduction. provide secure collateral for bank lenders. Improved human capital needs to be a central Developing an effective system of warehouse building block of Philippine efforts to achieve financing requires establishing a proper sustained poverty-reducing development. The framework for grading, sorting, warehouse acquisition of education within family units is standards, bail-bonding, etc. Warehouse highly correlated with escaping from poverty, financing is a common form of financing and the strengthening of workplace skills in agriculture in most developed countries and it has general is critical to the economy's been successfully introduced in developing interational competitiveness. Lessening illness countries such as India, Uganda, and Chile. It is would reduce absences and dropouts at school already used to some extent in the Philippines, and indue absence. dro povements s s r s. s ~and in the workplace. Moreover, improvements and, as the goverment withdraws from directed in public education and health services are credits, developing a fully functioning warehouse critical to ensure access by the poor. And warrant financing system could be a powerful effective safety net provisions are important for instrument for expanding credit to farmers. the vulnerable. 2.115 A framework for encouraging 2.118 Actually achieving the desired rate of microfinance institutions has now been improvement in human resources, though, has established. The Monetary Board has partially been elusive. Social sector performance in the lifted the general moratorium on the licensing of Philippines can best be characterized as new thrift and rural banks to allow the entry of satisfactory on average but inequitable. By microfinance-oriented banks on a selective basis. interational standards, the Philippines is Markets not yet fully served by existing rural classified as a medium performer in respect of banks will be given preference. Microfinance the Human Development Index, a composite loans extended by rural banks and cooperative indicator measuring health, education, and rural banks will also be eligible for rediscounting minimum basic needs. When the indicators are with BSP. This is to encourage rural banks and disaggregated by region, though, marked cooperative rural banks to support microfinance disparities are apparent. While the index of the activities by providing them additional liquidity National Capital Region (NCR) is higher than to fund their lending operations. those of Thailand and Malaysia, that of some provinces in Mindanao and Western Visayas is 40 comparable to those in Laos and Cambodia. Life schools, but parents are dissatisfied with class expectancy ranges from only 52 years in Tawi- size, availability of textbooks, and facilities in Tawi to 71 years in Pampanga, and elementary public schools. school enrollment from 43 percent in Sulu to 99 percent in the NCR.34 Poor families also have Education significantly less access to health and education than well-off households. In about 75 percent of 2.121 Enrollment rates are high, with almost households that are poor, the head of household all children enrolling in primary school, mostly has no more than an elementary education. Infant in public schools, and an overwhelming mortality rates in the poorest quintile are twice as majority of primary school graduates high as that of the richest quintile.35 progressing to secondary school. However, one third of those who enter the primary cycle drop 2.119 The Philippine Government has accorded out before finishing grade 6. Although the relatively high priority to the social sector. government guarantees "free" basic education, Education receives the largest share in the budget about 2 percent of total household expenditure (excluding IRA and debt service) under the 1987 is attributed to basic education, and costs (both Constitution. The share of social expenditures in actual and opportunity) are a major reason for the national and local government budgets has dropping out of school. increased by about 25 percent and 100 percent, respectively, over the last decade. And social 2.122 Recent performance on both national sector expenditures have been largely protected and international standardized tests has been since the 1997-98 East Asian crisis, although poor, raising issues about the quality of there was a small decline in their share of the education. Quality is determined by factors 2001 budget. However, absolute levels of public such as teacher effectiveness, the curriculum, expenditure on the social sectors remain quite textbooks, learning materials, and educational low and there has been a serious shortage of cash facilities. The Philippines Education Sector to cover non-personnel expenditures.3 Equally Study38 noted deficiencies in all these aspects important, intrasectoral allocations are inefficient and made the following recommendations: and internal efficiency indicators are poor. For (a) unsatisfactory deployment of teachers example, the share of elementary education in and poor training and preparation need to be total education has steadily decreased from about addressed, distractions that limit actual time 70 percent in the early 1990s to about 60 percent spent on teaching removed, and incentives for in 2000, and public health programs account for good performance and for serving in remote only about 20 percent of the Department of locations provided; Health (DOH) budget. Unit cost ratios for most public social services are higher than in the (b) the primary curriculum is overcrowded private sector, due to weak expenditure and needs to be streamlined, while science and management. math instruction at the secondary level need to be properly sequenced and to stress problem- 2.120 In the recent Filipino Report Card on solving approaches; and Pro-Poor Services, 37 beneficiaries of public ( t social services reported high utilization but low pcipitboul andvwell belw hadeqate satisfaction with these services. According to this precspntously and well below adequate survey, 100 percent of all Filipino children from poor households attend public elementary 2.123 The report also recommended the use of the vernacular, rather than English or Filipino, as the medium of instruction in the first three grades of school and the 34 United Nations Development Programme, Philippines Human Development Report,2000. '3 World Bank, Philippines Poverty Assessment, 2000. 36 World Bank, Philippines Social Expenditure Reviewv, 1998. 3World Bank, Filipino Report Card on Pro-Poor Services. 2002. 38 World Bank and Asian Development Bank, 1998. 41 strengthening of the national student assessment remains a threat and degenerative diseases are system so it can better serve as a standard for on the rise.39 measuring education effectiveness. Efforts to improve efficiency in resource allocation and 2.127 Public primary care health facilities are service delivery in the public education sector are overwhelmingly used by the poor and rural essential to attaining universal access to quality residents. But the quality of primary care is so education. poor that people frequently bypass them and go directly to government hospitals. Satisfaction 2.124 In terms of structure and management, with government health services is low, the Department of Education is complex, due to particularly on account of waiting time, lack of its size and geographic spread. Financial medicines, and poor facilities. Poor households management is weak, making it difficult to spend much less than the rich on health care monitor the implementation of specific programs (about one tenth), suggesting that their access is and ensure that resources are used as intended. severely restricted by costs. Payments for Successive administrations, including the current health care by the poor are almost entirely out one, have embarked on a variety of efforts to of pocket, effectively limiting their use of curtail mismanagement, but this appears to be a adequate and quality care. deeply-rooted problem that will demand systematic and concentrated attention from the 2.128 The devolution of health services to highest levels of leadership in the sector. LGUs in 1991 was intended to make primary health care more responsive to local users. 2.125 For children in the poorest households, However, LGUs were inadequately prepared to extraordinary measures will be required to ensure take over the responsibility, and DOH was ill- that they stay in school. The fact that economic equipped to play its new role as facilitator and factors are the main reason for dropping out of regulator rather than as service provider. The school makes it imperative to reduce the result was inefficient policy and allocation economic burden of school attendance. The decisions. Secondary hospitals were badly current administration has taken a first step in this affected as their financing was transferred to direction by prohibiting the imposition of school provincial governments that had little incentive fees in all public schools, and strict enforcement to fund institutions located within city of this policy should help reduce dropout rates. government jurisdictions. The effectiveness of However, there will continue to be families that the decentralized primary and secondary health will choose to keep children out of school to help care delivery system has also been in household, farm, or other productive chores, compromised by the lack of coordination and and these families could be offered financial help cooperation among LGUs. Regulation of the to compensate for the economic loss to them of quality and cost of health services and health sending the child to school. Such programs must products remains weak. Meanwhile, public be designed to carefully target the truly needy resources for health remain below average by families. almost any indicator, and the funding that is available is inequitably spent. Health care 2.126 Vital health indicators such as infant 2.129 To address these problems, DOH has mortality rates, maternal mortality rates, and life embarked on a Health Sector Reform Agenda expectancy have improved significantly in the (HSRA) to introduce major organizational and Philippines in the past 20 years. However, the policy changes and public investments to country has performed poorly when compared improve the way health care is delivered, with its Southeast Asian neighbors. Moreover, the resurgence of some infectious diseases 39 DOH, Republic of the Philippines, National Objectives for Health, 1999-2004, 1999. 42 regulated, and financed.40 Five major areas of improved farm-to-market roads, technical reform are proposed in the HSRA and reaffirmed support, and land reform discussed as part of as the core strategy for enhancing health care in section 2C are an important part of providing the MTPDP: the poor with increased access to productive assets. (a) Provide fiscal autonomy to government hospitals, to reduce their dependence on direct 2.132 More generally, the simplification of subsidies from the government. regulations advocated in section 2C, and the provision of small-scale and microfinance (b) Secure funding for priority public health discussed as part of section 2D, are important programs, using multi-year budgeting to for fostering small-scale enterprises. The highly guarantee the needed continuity in resource concentrated nature of the Philippine economy, availability. with large interconnected conglomerates dominating, together with the importance of (c) Promote the development of local health SMEs as a source of employment growth, systems. amplifies the importance of these initiatives. The opportunities for small-scale enterprises (d) Strengthen the capacity of health regulatory must be improved by removing impediments agencies, with special emphasis on the Bureau of that needlessly prevent their becoming Food and Drugs. competitive. This is not a matter of providing explicit incentives for SMEs, but it does call for (e) Expand the coverage of the National Health a review of regulations at the national and LGU Insurance Program. level to ensure that they do not unduly impede SMEs. Implementing this five-part reform program in cooperation with local government authorities Social protection would do much to improve health services, but resource limitations will constrain the scope and 2.133 The Department of Social Welfare and pace of reforms. Development's programs systematically target poor, disadvantaged, and extremely vulnerable 2.130 DOH estimates the cost of implementing populations, thus providing some measure of a the HSRA during the five-year period 2000- safety net. But the need is great, and much 2004 at PhP112 billion, or roughly PhP22.4 more than the department can meet with its billion per year (US $2.1 billion for 5 years). In modest resources. About one third of the contrast, DOH's budget allocation for 2000 was agency's budget is allocated to the around PhP1I billion. Accordingly, DOH has Comprehensive and Integrated Development of developed an implementation plan to introduce Social Services, which aims to reduce poverty reforms in a phased manner in "convergence through services provided by local and national zones" around the country. governments and NGOs and empowerment (needs assessment, program implementation, Ensuring access to other assets and monitoring by communities). Such programs could be scaled up if additional 2.131 While worldwide research indicates that resources were available. The agency is also the provision of access to basic education and responsible for the Government's Early health is central to long-term poverty reduction, Childhood Development Program, which aims access to productive assets and markets is also to integrate child-oriented health, nutrition, important. In view of the fact that most of the early education, and parent support services at poor are still in rural areas, the provision of the community level, as well as programs to reach out to out-of-school youth. J DOH, Republic of the Philippines, Health Seclor Reform Agenda, Philippines 1999-2004, December 1999. 43 2.134 Support is also needed so the "working development," and calls for a population poor" in the informal labor sector, who have little management program as part of its fight against security of tenure and live on the borderline of poverty. With population growth rates among poverty, can reduce their vulnerability. These the highest in East Asia and the Pacific (2.1 people need help with job search and demand- percent in 1999, against a regional average of oriented job training to ease transition between 1.1 percent), this clear statement is a welcome jobs in an unstable market. But these programs sign that the current administration is prepared cannot rely on government revenues for to tackle this important, but culturally sensitive, financing. They would benefit from government stumbling block to growth with equity. DOH's endorsement or sponsorship, and some degree of National Family Planning Policy statement of subsidization, but limitations on government September 17, 2001 has all the characteristics funding will mean that these programs will called for in the MTPDP. It is based on sound inevitably rely heavily on community and private reproductive health strategies, presents a menu sector support. of family planning services, respects cultural and religious beliefs, and guarantees access to Population growth family planning services for the poor. 2.135 The MTPDP refers to rapid population Implementation of this policy with the full growth as "a binding constraint to the efforts of backing of the administration would fill a big the administration in infusing a social bias to gap in the country's program to reduce poverty. 44 3. PROSPECTS ARE CONTINGENT ON ACTION AND CONTINUED SUPPORT 3.1 The Philippines' development potential will largely be governed by what is remains bright, as there are no impediments that administratively and politically feasible. Policy cannot be overcome and the country is well makers need to design and implement a endowed with resources, especially human coordinated package of measures to reinforce resources, the most critical of all. Moreover, the and accelerate progress through 2001 to government is committed to addressing existing facilitate the desired expansion in investment, problems. But the ultimate fulfillment of this productivity and employment, and to broaden potential for more rapid poverty-reducing participation in economic activity. development depends heavily on the implementation of effective actions to address 3.4 Export markets are adversely affecting current impediments. With resolve to implement short-term development prospects, but the actions in the key areas discussed in the previous current downward pressure is likely to be short- chapter, there would be renewed rapid poverty lived and export growth will continue to play reduction. Without such action, future poverty an important role. With the continued reduction would be limited and disappointing. integration of East Asian as well as world markets, a substantial share of new investment A. ECONOMIC DEVELOPMENT PROSPECTS is likely to be in exporting activities. This is especially true for foreign investment. 3.2 Specifically, the MTPDP growth scenario of over 5 percent per annum (see Table 3.1) is 3.5 Achieving growth of over 5 percent per achievable, but only if there is concerted action annum would require a sharp rise in investment along the lines discussed in Chapter 2. Only with and productivity. Unless the investment rate such action is it realistic to anticipate a sharp can be raised to the 23-25 percent range of the departure from recent trends in investment, mid-1990s, achieving growth of over 5 percent employment creation, growth, and poverty will necessitate a very sharp increase in reduction. productivity. Resources would need to be TABLE 3.1: MTPDP GROWTH SCENARIO(% P.A.) moved from relatively low-productivity activities such as subsistence agriculture to 2002 2003 2004 2005 higher-productivity off-farm activities at higher GDP (real) 4.3 5.7 6.0 6.4 rates than was achieved in the early to mid Agriculture 3.2 3.9 4.4 4 4 1990S. Industry 4.2 6.0 6.4 7.0 Services 4.8 6.1 6.4 6.8 Exports ($) 1/ 1.5 9.2 9.6 9.8 3.6 Financing this needed rise in Imports ($) 2.6 9.3 9.5 9.4 investment necessitates a commensurate rise in Memo items savings. As much as possible, this needs to be Investment 4.8 9.4 13.1 16.7 mobilized domestically with a rise in public Consumption 3.6 4.1 4.3 4.5 Employment 3.2 3.7 3.8 n.a. sector savings complemented by a rise in Figures are mid-point estimates of MTPDP projections. private savings. But the rise in public savings 1/ Exports and Imports of Goods and Services Source: NEDA; MTPDP. will be limited by the need to concurrently increase social expenditures. Renewed inflows 3.3 Renewed investment and increased of foreign financing will be needed to help productivity will be critical, so sound confidence- finance this growth (see Table 3.2). While building macro management will be vital. But so commercial bond spreads have fallen by over will governance improvements, structural reforms 200 basis points in the last year, they remain to strengthen private sector development, high by historical standards and still impede the infrastructure improvements, financial sector objective of reducing public debt. This calls strengthening, and investments in human for an acceleration of reforms, to facilitate both resources. Precise sequencing of these reforms a further lowering of commercial spreads and 45 to increase access to balance-of-payments support of many other developing countries, as from official sources. commodities comprise a small share of exports. On the import side, the recent reduction in oil 3.7 Risks and Opportunities. The most prices, if maintained, will be of benefit, as oil conspicuous risk arises from the possibility of constitutes some 10 percent of merchandise insufficiently aggressive policy and institutional imports. A one-dollar change in the price of oil reform. Hence it is within the national capacity to results in a change of about $120 million in the address this risk. Without reforms to improve import bill. Furthermore, new natural gas governance, strengthen competition, and rebuild exports will provide a boost. confidence, investment will continue to languish and economic growth is likely to remain little 3.11 World economic prospects for 2002 are higher than population growth. In such a for recovery to begin during the second half of situation, the low investment and growth path the year and for US growth of 3 percent per would be self-perpetuating, due to persistent annum by the end of the year. Positive social tension and a continued lack of business influences include bottoming out of the confidence. The fact that the government is inventory cycle, low energy prices easing, the committed to reforms lessens this risk. National significant fall in interest rates and the support from outside the government, together anticipated effects of a fiscal stimulus. The with support from international development firming of global production should translate partners, lessens this risk further by helping to into growth in the Philippines' export market of ensure that there is support to implement reforms. about 9 percent by 2003. TABLE 3.2: MTPDP BALANCE OF PAYMENTS 3.12 The semiconductor cycle that is so (S BILLION) important to Philippine exports is now showing 2000 2001 2002 2003 2004 signs of bottoming out, with positive growth in actual Proj. pro;.- proj. proj. worldwide sales in October. The key question Exports I/ 37.3 31.7 31.7 34.9 38.8 will be the strength of the rebound. It seems Imports 30.4 29.5 30.4 33.7 37.7 likely that the sector will witness more subdued Services (net) -1.9 -2.2 -2.5 -2.9 -3.4 growth than in the 1990s, because the market is Current acc. 9.3 4.1 2.4 2.2 1.4 DRS (%o Of more mature, with high penetration of XGS) 12.6 17.4 21.3 19.9 17.4 computers, the Internet, and cellular phones in I/ Exports and Imports of Goods. the industrial economies and in many of the upper-middle income countries. Thus growth in 3.8 The persistent absence of peace and the market will rely more on replacement rather security, particularly in the south, is a second risk than penetration, unless new products to the attainment of potential development. This revolutionize the market again. But there are clearly limits both the rebuilding of confidence still wide differences in market penetration, and and investment, and efforts to achieve broad there are huge markets to be fulfilled among participation in development. emerging economies such as China and India. 3.9 In addition, there are a number of 3.13 Two particular external trade factors exogenous risks. These include a protracted are the entry of China into the WTO and downturn in the global economy, adverse interest continued integration within ASEAN. Both will rate movements, or greater risk aversion in increase competitive pressure for Philippine capital markets. The Philippines' large medium- producers, but will also expand potential export term external financing requirements and open markets. Their net effect will depend on how economy make it particularly susceptible to such well Philippine firms rise to the export external risks. challenge, and on the attractiveness of the Philippines as a destination for export-oriented 3.10 By contrast, the current account is less FDI. vulnerable to commodity price changes than that 46 3.14 Weak global conditions, in particular the actions to improve access by the poor to softening of the US labor market and the slowing productive assets and markets), poverty could of world trade,41 are likely to delay further be reduced even more rapidly. growth in worker remittances. But with the expected return of world economic growth in 3.18 In contrast, if growth were only 3 2003, renewed growth in these transfers seems percent, the rate of poverty reduction would be likely. modest. By 2005, the incidence of poverty would be projected to decline, but only to 23 3.15 With much lower interest rates in percent of the population (Scenario II in Table international markets and a compression of 3.3). In this case, there would be little change in spreads, the Philippines should be able to the number of poor people. Moreover, without mobilize substantial external financing in the the needed resources for targeted poverty- immediate term. The January 2002 issuance of a focused programs, inequality could increase, $750 million bond reflects this. The feared and poverty levels could indeed rise. A contagion from problems in Argentina and moderate increase in Gini indices within the Turkey has not materialized. Complementing this three main economic sectors (2 percent renewed flow of private lending with a annually) could not only wipe out all poverty concurrent rise in equity investment/FDI will also reduction, it could increase the incidence of be required to support higher growth. poverty to about 28 percent and the number of poor to nearly 25 million by 2005 (Scenario III 3.16 The possibility that several of the above in Table 3.3). risk factors may occur together cannot be ruled TABLE 3.3 POVERTY PROJECTIONS UNDER out, as indeed several are correlated. The best ALTERNATIVE SCENARIOS response to mitigate the adverse impact on the economy of such risks is to press ahead with an GDP growth (% p.a. Scen. Scen. Seen. aggressive package of structural reforms and during 2000-05) I nI III fiscal deficit reduction, while maintaining the Agricultural Sector 3.8 1.7 1.7 Industry Sector 5.2 3.0 3.0 present flexible monetary and exchange rate Services Sector 5.6 3.5 3.5 policy stances. GDP Growth 5.1 3.0 3.0 Gini index (levels) 0.43 0.43 0.46 B. POVERTY REDUCTION PROSPECTS Projections 1997 2000 2005 2005 2005 Headcount Index 25.1 26.1 18.0 23.0 27.6 3.17 The prospects for poverty reduction Poverty Gap Index 6.4 6.8 4.1 5.7 8.6 depend critically on the attainment of the targeted Squared Poverty Gap 2.3 2.5 1.4 2.0 3.8 higher econmic growthand the bradening of Index higher economic growth and the broadening of Number of poor (mil) 18.4 20.4 15.6 20.0 24.6 participation to increase equity. Real economic Mean consumption 1974 1948 2275 2048 2048 growth of 5 percent per annum, on a sustained ('97 Peso/person/mth) Scenario I is based on MTPDP growth rates as in Table 3.1. basis, would reduce poverty significantly. Scenario 11 assumes lower growth rates (3 percent instead of 5 Projections based on household survey data percent in overall GDP). Scenario III has the same growth rates indicate a reduction in poverty from 26 percent of as scenario 11, but additionally assumes the Gini indices within each sector increase by 2% annually during 2000-05. the population in 2000 to 18 percent by 2005 Source: Staffestimates. (Scenario I in Table 3.3). Correspondingly, the number of poor could be expected to decline by C. THE IMPORTANCE OF DONOR SUPPORT about 5 million, from 20.4 million to 15.6 3.19 Interational development partner million. If this economic growth is combined is nt e dain twoprint arer with complementary programs to improve equity support is needed in two principal areas- (e.., ffetiv huan esorceinvstmntsand resources to help sustain critical public (e.g., effective human resource investments and expenditures while domestic revenues are being rebuilt, and technical assistance to help The US is the single largest source of worker remittances, at implement effective policy and institutional around $3 billion per year, while seamen contribute roughly $800 reforns. The need for overseas development million per year. 47 assistance (ODA) financing over the next couple disbursements of $1.5 billion or more of this of years is quite large because of the combination required $5.7 billion financing come from of the fiscal deficit and rising debt service. If ODA sources. Given the government's policy makers deliver sound implementation of a commitment to reducing the fiscal deficit over sound reform program, it is vital that the coming years to achieve a balanced budget international development partners respond with by 2006, the need for ODA financing will fall appropriate financial and technical assistance. over the next few years. Anything less would hamper the nation in its pursuit of poverty reduction. 3.23 The form of this assistance is also important. Increasing the share of program 3.20 Government financing. In 2002, the lending in overall donor assistance for the next Philippines' financing requirements will be couple of years would assist the government in driven primarily by the needs of the government, its efforts to maintain strategic expenditures rather than the balance of payments. The while implementing policy and institutional government's financing need is a combination of reforms. It is suggested that donors make every the fiscal deficit and its amortization obligations. effort to increase the share of program support The amount of ODA needed also depends on how at this time, in an effort to jointly provide about much of this overall need can be met from half of this needed ODA assistance in the form domestic and other international capital markets. of fast-disbursing budgetary support. To facilitate a recovery in private sector investment, it will be important to avoid 3.24 For its part, the government needs to excessive government borrowing. And to keep ensure that the implementation of policy near-term debt service obligations to a reforms keeps the public expenditure program manageable level, it is important that a on track so that public resources reach their substantial proportion of this need be met through targeted beneficiaries, and that steps are taken medium- and long-term financing. to increase public revenues as quickly as possible. Joint actions are also needed to 3.21 Even though the government managed to increase disbursements from the existing ODA contain the budget deficit in 2001, its high level, portfolio from their current low level. together with amortization payments, created a need for about $5.0 billion in new borrowings. In 3.25 As efforts to increase domestic revenue 2002, the government is committed to a reduction begin to yield results and the fiscal deficit in the fiscal deficit, but this is more than offset by contracts in 2003 and beyond, the share of fast- a rise in amortization payments. As a result, the disbursing "program support" in overall total financing needs of the national government assistance can shrink again. But for this finance are expected to rise to about $5.7 billion to have maximum development impact, it would need to be guided by well-designed 3.22 The Philippines has managed in recent sectoral strategies prepared by the government years to mobilize a substantial share of in consultation with all stakeholders (including government financing needed from domestic international development partners) and with sources. In addition, it has been able to mobilize civil society. resources from private external sources. However, external commercial financing carries 3.26 Technical Assistance. Given the higher interest rates and tends to be for shorter ambitious program of policy and institutional terms than official assistance, thus leaving reforms needed to achieve the targeted increase government finances exposed to rollover risk. in development outcomes, there will be a need Increased donor support at this time would assist for much technical assistance. This includes the government to sustain strategic poverty- support for efforts to improve governance, reducing expenditures while taking action to reform the judiciary, increase public resource ensure that public finances remain sustainable. As mobilization at both the national and local part of the MTPDP, it is suggested that government level, improve public expenditure 48 and financial management, manage fiscal risks, growth for a year or two. But winning the war strengthen the financial sector, improve against poverty will require time and a infrastructure, modernize agriculture, and hasten sustained effort to generate a higher growth development in post-conflict parts of Mindanao. path with broad participation to increase equity. This necessitates sustained policy and institutional reforms along the lines outlined in 3.27 Commitment from national leadership this review. coupled with 2001 achievements suggests that the potential for rapid and sustained poverty reduction in the Philippines is attainable. Fortuitous circumstances could yield higher 49 STATISTICAL ANNEXES List of Tables and Appendices TABLES Table 1: National Accounts, 1995-2001 ...................................................... 50 Table 2: Consolidated Public Sector Financial Position, 1995-2000 .................................. 51 Table 3: Outstanding Public Sector Debt, 1995-2000 ...................................................... 52 Table 4: National Government Cash Operations, 1995-2000 .............................................. 53 Table 5: Monetary Survey, 1995-2000 ...................................................... 54 Table 6: Exchange Rates, Inflation and Selected Interest Rates, 1998-2001 ....................... 54 Table 7: Balance of Payments, 1995-2000 ...................................................... 55 Table 8: Exports and Imports by Mayor Commodity Group, 1995-2000 ............................ 56 Table 9: External Debt, 1995-2000 ....................................................... 57 Table 10: Loans Outstanding of Commercial Banks, 1995-2000 . ....................................... 58 Table 11: Labor Market Developments, 1995-2000 ..................................... 58 APPENDICES Appendix 2.1: ROSC on Accountancy ...................................................... 59 Appendix 2.2: ROSC on Corporate Governance Reforms .................................................. 60 Appendix 2.3: Restrictions on Foreign Investment ...................................................... 61 Appendix 2.4: Required Reforms in Infrastructure Sectors ................................................. 62 50 Table 1: National Accounts, 1995-2001 1995 1996 1997 1998 1999 2000 2001 (real growth rates) GDP at market prices 4.8 5.7 5.2 -0.5 3.4 4.0 3.4 Agriculture 0.8 3.8 2.9 -6.6 6.5 3.3 3.9 Industry 7.0 6.2 6.1 -1.9 0.9 3.9 1.9 Mining and quarrying -0.8 -4.8 1.7 2.8 -8.4 10.0 -5 Manufacturing 6.8 5.6 4.2 -1.1 1.6 5.6 2.2 Services 5.0 6.4 5.5 3.5 4.0 4.4 4.3 Imports of GNFS 16.0 16.7 13.5 -14.7 -2.8 4.0 0.5 Exports of GNFS 12.0 15.4 17.2 -21.0 3.6 17.7 -3.2 Total consumption 4.0 4.6 4.7 2.9 3.0 3.1 3.1 Public 5.4 3.9 2.0 -2.1 6.7 -1.1 0.1 Private 3.8 4.6 5.0 3.4 2.6 3.5 3.4 Gross domestic investment 3.5 12.5 11.7 -16.4 -2.0 2.3 4.3 Fixed Capital 4.7 12.0 11.5 -11.4 -2.3 0.0 -0.6 Construction 7.9 15.9 14.6 -5.9 -0.3 -3.7 0.5 Durable Equipment 2.2 9.6 9.2 -18.1 -5.0 3.6 -2.7 Breeding Stock & Orchard Development 3.9 6.0 8.5 0.2 1.2 3.7 5.8 Gross national product 5.0 7.2 5.3 0.1 3.7 4.5 3.7 (as percentage of GNP) GDP at market prices 97.3 96.2 96.0 95.2 94.9 94.6 94.4 Net Indirect Taxes 10.6 10.0 9.3 8.1 7.6 7.0 Indirect taxes 11.0 10.3 9.7 8.3 7.8 7.2 Subsidies 0.4 0.3 0.5 0.2 0.2 0.2 GDP at factor cost 86.7 86.2 86.7 87.1 87.4 87.6 Agriculture 21.0 19.8 17.9 16.1 16.3 15.1 14.4 Industry 31.2 30.8 30.9 30.0 29.1 29.5 29.8 Mining and quarrying 0.9 0.8 0.7 0.7 0.6 0:6 0.6 Manufacturing 22.4 21.9 21.4 20.8 20.5 21.4 21.5 Services 45.1 45.4 47.1 49.1 49.6 50.1 50.2 Imports of GNFS 43.0 47.3 57.0 55.9 48.7 47.5 44.8 Exports of GNFS 35.4 38.9 47.1 49.6 48.9 53.3 46.5 Total Consumption 83.2 82.0 82.5 83.3 81.3 79.0 77.9 Public 11.1 11.5 12.7 12.7 12.4 12.1 11.5 Private 72.1 70.5 69.8 70.7 68.9 66.9 66.4 Statistical discrepancy 0.1 -0.6 -0.5 -1.2 -4.4 -7.1 -1.8 Gross domestic investment 21.8 22.8 23.9 19.4 17.8 16.9 16.6 Fixed Capital 21.6 22.3 23.5 20.1 18.1 17.1 16.2 Construction 9.4 10.1 10.7 9.6 8.8 8.0 7.9 Durable Equipment 10.7 10.7 11.3 9.1 8.0 7.8 7.0 Breeding Stock & Orchard Development 1.5 1.4 1.5 1.4 1.3 1.3 1.3 Changes in stocks 0.2 0.6 0.3 -0.7 -0.2 -0.2 0.4 Net factor income 2.7 4.0 4.0 4.9 5.1 5.4 5.6 GNP (billion pesos) 1,959 2,283 2,523 2,802 3,136 3,491 3,861 Source: NSCB. 51 Table 2: Consolidated Public Sector Financial Position, 1995-2000 (in billion pesos) 1995 1996 1997 1998 1999 2000 National Govemment 11.1 6.3 1.6 -50.0 -111.7 -134.2 Monitored GOCCs -1.3 -11.2 -17.2 -38.0 -4.6 -19.2 Central Bank Restructuring -20.0 -13.8 -25.7 -26.4 -20.5 -19.1 Oil Price Stabilization Fund (OPSF)a -9.2 4.8 -0.8 0.7 1.9 0.3 Adjustment to GOCCs b 2.8 1.5 2.5 0.9 3.0 4.2 Other Adjustments' 0.0 0.0 0.0 1.5 -6.1 -6.6 Public Sector Borrowing Requirement (PSBR) -16.7 -12.4 -39.6 -111.3 -138.0 -174.6 SSS/GSIS/PHIC 0.0 8.5 3.9 17.8 36.4 15.5 Bangko Sentral ng Pilipinas 3.6 -2.3 2.2 3.2 -4.0 0.2 Govemment Financial Institutions 5.0 8.4 4.3 5.4 3.3 2.8 Local Govemment Units 1.9 5.7 4.2 2.0 3.2 3.8 Time Adj. of Interest Payments to BSP 1.5 -0.7 2.3 -0.3 -2.3 0.5 Other Adjustments 0.6 0.0 0.0 0.0 0.8 0.1 Consolidated Public Sector (CPS) -4.0 7.3 -22.7 -83.2 -100.5 -145.1 (in percent of GNP) 1995 1996 1997 1998 1999 2000 National Govemment 0.6 0.3 0.1 -1.8 -3.6 -3.8 Monitored GOCCs -0.1 -0.5 -0.7 -1.4 -0.1 -0.5 Central Bank Restructuring -1.0 -0.6 -1.0 -0.9 -0.7 -0.5 Oil Price Stabilization Fund (OPSF) -0.5 0.2 0.0 0.0 0.1 0.0 Adjustment to GOCCs b 0.1 0.1 0.1 0.0 0.1 0.1 Other Adjustments' 0.0 0.0 0.0 0.1 -0.2 -0.2 Public Sector Borrowing Requirement (PSBR) -0.8 -0.5 -1.6 -4.0 -4.4 -5.0 SSS/GSIS 0.0 0.4 0.2 0.6 1.2 0.4 Bangko Sentral ng Pilipinas 0.2 -0.1 0.1 0.1 -0.1 0.0 Govemment Financial Institutions 0.3 0.4 0.2 0.2 0.1 0.1 Local Govemment Units 0.1 0.3 0.2 0.1 0.1 0.1 Time Adj. of Interest Payments to BSP 0.1 0.0 0.1 0.0 -0.1 0.0 Other Adjustments 0.0 0.0 0.0 0.0 0.0 0.0 Consolidated Public Sector (CPS) -0.2 0.3 -0.9 -3.0 -3.2 -4.2 a. Includes OPSF balance, transfers between NG and OPSF, and adjustments for PNOC share of OPSF balance. b. Includes NG transfers to monitored corporations, NPC transfers to NG, NG transfers to PNOC and PNB transfers to NG. c. Includes adjustments for net lending for debt buyback, reconciliation of cash accounts with bank data and other adjustments. Source: DOF. 52 Table 3: Outstanding Public Sector Debt, 1995-2000 (year end, in billions of pesos) 1995 1996 1997 1998 1999 2000 Total Public Sector 1/ 2,167 2,237 2,669 2,952 3,666 4,397 Domestic 1,454 1,503 1,587 1,721 2,197 2,542 External 713 735 1,083 1,230 1,470 1,855 (US$ billion) 27.2 27.9 27.1 31.5 36.5 37.1 National Govemment 2A/ 1,326 1,332 1,624 1,800 2,142 2,649 National Government 2B/ 1,103 1,107 1,283 1,421 1,693 2,074 Domestic 2/ 725 748 757 860 987 1,081 Extemal 3/ 601 584 867 941 1,156 1,568 (US$ billion) 22.9 22.2 21.7 24.1 28.7 31.4 14 Monitored GOCCs 4/ 343 453 622 644 931 1,119 Domestic 206 312 436 419 645 811 External 137 141 186 225 286 308 (US$ billion) 5.2 5.4 4.7 5.8 7.1 6.2 Central Bank/CB-BOL 5/ 83 77 112 102 75 82 Domestic External 83 77 112 102 75 82 (US$ billion) 3.2 2.9 2.8 2.6 1.9 1.6 Bangko Sentral 5/ 254 332 339 388 493 588 Domestic 186 227 126 123 194 203 External 68 105 176 264 299 385 (US$ billion) 2.6 4.0 4.4 6.8 7.4 7.7 Government Financial Institutions 384 268 350 397 475 535 Domestic 344 221 275 328 380 461 Extemal 41 46 75 69 95 74 (US$ billion) 1.6 1.8 1.9 1.8 2.4 1.5 Less: GOCC Debt Onlent or Guaranteed by NG 6/ 222 225 341 379 450 575 Domestic 6 6 8 9 8 13 External 216 218 333 371 441 562 (US$ billion) 8.2 8.3 8.3 9.5 10.9 11.2 MEMORANDUM ITEMS Exchange Rate (P/IUS$1) End of Period 26.21 26.29 39.98 39.09 40.31 50.00 Average 25.71 26.22 29.97 40.89 39.09 44.19 NG Debt Stock/GNP (%) 2B/ 56.3 49.0 50.9 50.9 54.0 59.4 NGDomesticDebt(%/.) 2B/ 36.7 32.8 29.7 30.5 31.2 30.6 NG External Debt (%) 2B/ 19.6 16.2 21.1 20.4 22.8 28.8 Public Sector Debt Stock/GNP 1/ (%) 110.7 98.9 105.8 105.6 116.9 126.0 Public Sector Domestic Debt 1/ (%) 74.2 66.5 62.9 61.6 70.0 72.8 Public Sector External Debt 1/ (%) 36.4 32.5 42.9 44.0 46.9 53.1 Non-financial Public Sector 7/ (Pbn) 1,529 1,638 2,017 2,167 2,698 3,275 %ofGNP 78.1 72.4 79.9 77.6 86.0 93.8 1/ Includes National Government, 14 monitored GOCCs, CB/CB-BOL/BSP and GFIs. 2/ Includes direct, assumed and contingent liabilities. 2A/ Includes direct, assumed and contingent liabilities. 2B/ Excludes onlent and contingent/guaranteed liabilities which have not been assumed. 3/ Includes direct, guaranteed and assumed liabilities. 4/ Includes borrowings relent/guaranteed by NG. 5/ Liabilities less currency issue and intergovemment accounts. 6/ Includes relent, guaranteed and contingent liabilities. 7/ Includes NG debt, 2B/, 14 monitored GOCCs and CB-BOL. Source: DOF 53 Table 4: National Government Cash Operations, 1995-2000 (in billion pesos) 1995 1996 1997 1998 1999 2000 Total Revenue 361 410 472 463 479 513 Tax Revenue 311 368 412 417 432 460 Bureau ofintemal Revenue 210 261 315 337 341 361 Bureau of Customs 98 105 95 76 86 95 Other Offices 3 3 3 3 4 4 Non-Tax Revenue 51 43 60 46 47 53 Total Expenditure 350 404 470 512 590 649 Current Expenditure 277 318 371 428 471 536 Personnel Services 109 135 173 194 203 225 Maintenance and Operations 47 49 52 70 71 80 Subsidies 4 6 6 5 7 7 Allotment to LGUs 41 45 56 60 79 80 Interest Payments 73 77 78 100 106 141 Tax Expenditures 4 7 6 0 6 4 OPSF 0 10 0 0 1 0 Capital Expenditure and Net Lending 73 76 99 84 119 110 Capital Expenditure 64 70 94 83 114 107 Infrastructure and Other Capital Outlays 53 58 79 65 97 87 Transfers to LGUs 12 12 15 18 18 20 Equity and Net Lending 8 3 6 1 5 3 CARP Land Acquisition and Credit 0 3 0 0 0 2 0 0 0 0 0 0 Overall Surplus/Deficit 11 6 2 -50 -112 -136 0 0 0 0 0 0 Financing -11 -6 -27 89 182 198 Net Domestic Financing 2 0 -20 77 99 119 Net Foreign Financing -13 -6 -7 12 83 79 Memo Items: (in % of GNP) Total Revenue (% ofGNP) 18.4 18.0 18.7 16.6 15.3 14.7 TaxRevenue(%ofGNP) 15.9 16.1 16.3 14.9 13.8 13.2 CurrentExpenditure(%ofGNP) 14.2 13.9 15.6 15.4 15.0 15.4 Capital Expenditure and Net Lending (% of GNP) 3.7 3.3 3.9 3.0 3.8 3.2 Overall Surplus/Deficit(%ofGNP) 0.6 0.3 0.1 -1.8 -3.6 -3.9 Source: Bureau of Treasury. DOF, IMF. 54 Table 5: Monetary Survey, 1995-2000 1995 1996 1997 1998 1999 2000 (in billions of persos; end of period) Total Liquidity 786 914 1,174 1,219 1,431 1,493 Broad Money (M3) 761 881 1,066 1,145 1,365 1,427 Other Liabilities 25 33 108 75 66 66 Net Foreign Assets 118 70 -77 141 329 343 o/w Central Bank 156 264 267 248 367 430 Deposit Money Banks 1/ 11 -130 -251 -108 -38 -87 Net Domestic Assets 907 1,197 1,685 1,670 1,761 1,737 Net Domestic Credit 1,084 1,508 1,932 1,869 1,920 2,089 Public Sector 335 377 477 460 529 582 Private Sector 749 1,131 1,455 1,409 1,391 1,507 Other Items (net) -177 -311 -247 -199 -160 -352 FCDs, residents -207 -318 -433 -478 -522 586 (annual percentage change; end of period) Broad Money 25.3 15.8 20.9 7.4 19.3 4.6 Net Domestic Assets 32.0 39.1 48.2 -3.8 5.5 -1.4 Private SectorCredit 43.5 51.0 28.7 -3.1 -1.3 8.3 (in percent of GNP) Broad Money 38.9 38.6 42.3 41.0 43.5 40.9 Net Foreign Assets 6.0 3.1 -3.0 5.0 10.5 9.8 Net Domestic Assets 46.3 52.4 66.8 59.8 56.1 49.7 Private Sector Credit 38.2 49.5 57.7 50.4 44.3 43.2 1/ revised to reclassify accounts of residents from foreign accounts to domestic . Sources: BSP. Table 6: Exchange Rates, Inflation and Selected Interest Rates, 1998-2001 1998 1999 2000 2001 Ql Q2 Q3 Q4 Exchange Rates: Period Average (Pesos/$) 40.9 39.1 44.2 49.2 50.7 52.2 51.6 End of Period (Pesos/S) 39.1 40.3 50.0 49.4 52.4 51.4 51.2 Real Effective (Dec 1980=100) 72.0 70.3 66.9 70.2 68.3 65.1 61.5 Inflation: CPI (1994=100) 136.9 146.0 152.3 159.2 160.5 162.8 163.6 Year change (%) 9.8 6.6 4.3 6.8 6.7 6.4 4.6 Interest Rates: (average) (end of period) Manila Reference Rates: All Maturities 15.4 10.4 9.4 10.8 9.1 9.8 9.9 BankLendingRate(allmaturities) 18.4 11.8 10.9 12.2 11.1 12.2 13.0 Time Deposits: Short-Term ( < I yr) 12.7 9.1 8.0 9.4 8.4 8.0 10.2 Long-term(> I yr) 13.2 12.8 10.5 11.5 10.5 10.5 10.6 91-day Treasury Bill Rate 15.3 10.2 9.9 9.7 8.8 9.5 8.9 Reverse RP Rate (Term) 14.3 9.8 10.2 10.6 9.1 9.1 8.1 Repurchase Rate (Term) 15.8 14.5 14.4 13.2 11.4 11.3 10.3 Interbank Call Loan Rate 13.8 10.8 10.6 10.6 9.1 9.2 8.9 Sources: SPEI-BSP, NSO. 55 Table 7: Balance of Payments, 1995-2000 (in billions of US$) 1995 1996 1997 1998 1999 2000 Trade balance -8.9 -11.3 -11.1 0.0 5.0 6.9 %ofGNP -11.7 -13.1 -13.0 0.0 6.1 8.7 Exports (fob) 17.4 20.5 25.2 29.5 34.2 37.3 Imports (fob) 26.4 31.9 36.4 29.5 29.3 30.4 Services (net) 4.8 6.8 5.7 1.1 2.4 2.0 Receipts 14.4 19.0 22.8 13.9 12.9 12.0 o/w OFW remittances 3.9 4.3 5.7 4.9 6.8 6.1 Payments 9.6 12.2 17.1 12.8 10.5 9.9 o/w Interest 2.2 2.2 2.6 2.3 2.5 2.7 Transfers (net) 0.9 0.6 1.1 0.4 0.5 0.4 Current Account Balance -3.3 -4.0 -4.4 1.5 7.8 9.3 % of GNP -4.3 -4.6 -5.1 2.3 9.0 11.8 Foreign investment (net) 2.9 3.6 0.8 2.0 1.6 1.6 Direct Invesment 1.5 1.5 1.2 1.8 1.1 1.6 Portfolio Investment 1.5 2.1 -0.4 0.3 0.5 0.0 MLT borrowing (net) 1.3 2.8 4.8 2.7 4.7 5.5 Inflows 3.9 6.5 7.7 6.0 9.3 10.2 Outflows 2.7 3.7 2.9 3.3 4.6 4.7 Short-term Capital (net) -0.1 0.5 0.5 -1.5 -3.6 -5.8 Trading in bonds in secondary market 0.0 -0.7 -1.1 0.1 0.0 Change in Commercial Banks' NFA 0.6 4.2 1.2 -1.3 -1.8 -2.4 ( - indicates increase) Errors and Omissions 0.5 -3.0 -5.2 -0.8 -4.2 -3.0 Others /a 0.1 0.0 -0.4 0.1 0.3 0.3 Changes in net reserves /b -0.6 -4.1 3.4 -1.4 -3.8 0.4 ( - indicates increase) a. Includes monetization of gold, revaluation adjustments and $469 million purchase of collateral in 1992. b. Net reserves of the BSP includes net credit of IMF. Source: BSP 56 Table 8: Exports and Imports by Major Commodity Group, 1995-2000 (in billions of US$) Exports 1995 1996 1997 1998 1999 2000 Coconut Products 1.0 0.7 0.8 0.8 0.5 0.6 Sugar and Products 0.1 0.1 0.1 0.1 0.1 0.1 Fruits and Vegetables 0.5 0.5 0.5 0.4 0.5 0.5 Other Agro-Based Products 0.6 0.5 0.5 0.5 0.5 0.5 Forest Products 0.0 0.0 0.0 0.0 0.0 0.0 Mineral Products 0.9 0.8 0.8 0.6 0.6 0.7 Petroleum Products 0.2 0.3 0.2 0.1 0.2 0.4 Manufactures 13.9 17.1 21.5 25.8 31.3 34.0 o.w. Elect. & Elect. Equipments 7.4 10.0 13.0 17.1 21.2 22.2 Garments 2.6 2.4 2.3 2.4 2.3 2.6 Others 0.4 0.5 0.8 1.1 1.4 0.5 Total Exports 17.4 20.5 25.2 29.5 35.0 37.3 Imports 1995 1996 1997 1998 1999 2000 Capital Goods 8.0 10.5 14.4 12.1 11.8 12.2 Raw Materials & Intermediate Goods 12.2 14.1 14.6 11.6 12.6 12.1 Mineral Fuels and Lubricants 2.5 3.0 3.1 2.0 2.4 2.4 Consumer Goods 2.8 3.3 3.1 2.6 2.6 2.5 Durable 1.5 1.6 1.5 0.9 1.1 1.1 Non-durable 1.3 1.7 1.6 1.7 1.5 1.4 Others 0.9 1.0 1.2 1.2 1.2 1.1 Total Imports 26.4 31.9 36.4 29.5 30.7 30.4 Source: BSP. 57 Table 9: External Debt, 1995-2000" (in billions of US$) 1995 1996 1997 1998 1999 2000 By Type ofDebt 39.4 41.9 45.4 47.8 52.2 52.1 Medium and Long-Term 2/ 34.1 34.7 37.0 40.6 46.5 46.1 Short-Term 5.3 7.2 8.4 7.2 5.7 5.9 Trade 2.7 4.1 4.2 2.6 1.8 1.6 Non-Trade 2.6 3.1 4.3 4.6 3.9 4.3 By Borrower 39.4 41.9 45.4 47.8 52.2 52.1 Banking System 3/ 5.5 8.6 10.7 11.2 9.9 9.4 Bangko Sentral 1.2 1.4 2.5 3.4 3.0 2.9 Commercial Banks 4.2 7.2 8.2 7.8 6.9 6.5 Public and Private 33.9 33.2 34.8 36.6 42.3 42.6 Public 26.7 24.1 22.3 24.5 29.1 28.5 Private 7.3 9.1 12.5 12.1 13.3 14.1 By Creditor 39.4 41.9 45.4 47.8 52.2 52.1 Comm. Banks 5.1 7.4 8.9 8.6 8.9 9.5 Other Finan. Inst. 1.2 1.0 1.3 1.1 1.4 1.7 Suppliers' Credits 2.6 2.6 2.4 1.6 1.7 1.6 Multilateral 9.6 8.6 8.6 10.1 10.2 9.7 o/w IBRD 5.0 4.7 4.1 4.3 4.1 3.6 ADB 2.6 3.1 3.1 3.5 3.5 3.3 IMF 0.8 0.4 0.9 1.6 1.8 2.0 Bilateral 14.4 13.4 13.3 14.9 16.4 15.3 Export Agencies 3.9 4.7 4.7 5.3 2.1 1.9 Others 10.5 8.8 8.6 9.6 14.3 13.4 Others 6.4 8.8 11.0 11.6 13.5 14.3 Memo Items: Debt service 4/ 5.0 5.0 5.6 5.1 6.2 6.2 Debt service/ Exports ofGS 15.8 12.7 11.6 11.7 13.4 12.6 Total extemal debt/GNP (%) 51.7 48.6 53.1 70.0 64.7 65.6 Totalextemaldebt/Exports(%) 123.7 105.9 94.5 110.1 149.0 136.7 1/ Excludes liabilities of foreign banks in the Philippines to their headquarters, branches, and agencies, some extemal debt not registered with the central bank, and private capital lease arrangements. 2/ Includes cumulative foreign exchange revaluation of US$-denominated multi-currency loans from the World Bank and Asian Development Bank of $433 and $384 million, respectively, for end-1996. 3/ Effective July 3, 1993, accounts of old CB were split between Bangko Sentral ng Pilipinas and Central Bank - Board of Liquidators. 4/ From 1990 onwards, figures represent principal and interest payments after rescheduling. Source: BSP. 58 Table 10: Loans Outstanding of Commercial Banks, 1995-2000 1995 1996 1997 1998 1999 2000 ECONOMIC ACTIVITY Growth rates (% on year earlier) Agriculture, fisheries, & forestry 19.6 6.4 11.5 -11.0 -6.5 5.5 Mining and quarrying 55.9 9.4 70.3 23.5 -17.9 28.5 Manufacturing 33.9 42.5 17.3 -15.7 6.9 5.7 Electricity, gas & water 24.7 90.6 34.0 12.5 12.7 41.5 Construction 37.4 74.2 19.6 6.6 -2.9 -12.1 Wholesale & retail trade 37.3 38.1 28.0 -8.9 -3.3 -1.0 Transportation, storage & communication 72.0 53.3 47.7 -2.6 -7.7 9.5 Fin. inst., real estate & business services 24.8 97.2 42.6 -0.3 -1.3 12.9 Community, Social & Personal services 61.8 57.6 11.4 13.6 2.5 0.6 TOTAL 35.8 51.9 26.5 -4.8 0.4 7.2 Share of Total Loans (%) Agriculture, fisheries, & forestry 8.1 5.7 5.0 4.7 4.3 4.3 Mining and quarrying 1.2 0.9 1.1 1.5 1.2 1.5 Manufacturing 34.4 32.3 29.9 26.5 28.2 27.8 Electricity, gas & water 2.2 2.8 3.0 3.5 3.9 5.2 Construction 3.4 3.9 3.6 4.1 3.9 3.2 Wholesale & retail trade 17.7 16.1 16.3 15.6 15.0 13.9 Transportation, storage & communication 6.1 6.1 7.1 7.3 6.7 6.9 Fin. inst., real estate & business services 16.8 21.8 24.6 25.8 25.3 26.6 Community, Social & Personal services 10.2 10.5 9.3 11.1 11.3 10.6 TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 Source: BSP. Table 11: Labor Market Developments, 1995-2000 1995 1996 1997 1998 1999 2000 (in thousands of persons) Population 70,267 71,899 73,527 75,138 76,792 78,289 Total Labor Force 28,380 29,733 30,354 31,054 32,081 31,829 Unemployed 2,704 2,546 2,640 3,144 3,102 3,542 Unemployment Rate (%/) 9.5 8.6 8.7 10.1 9.7 11.1 Total Employed 25,676 27,187 27,716 27,912 28,980 28,287 Agriculture 11,147 11,645 11,314 10,933 11,624 10,736 Industry 4,139 4,430 4,631 4,583 4,533 4,472 MiningandQuarrying 100 113 130 120 100 110 Manufacturing 2,696 2,696 2,732 2,716 2,746 2,737 Construction 1,230 1,504 1,637 1,605 1,543 1,501 Utilities 114 118 132 142 144 124 Services 10,392 11,112 11,771 12,389 12,823 13,079 Transport and Communications 1,487 1,631 1,742 1,849 1,942 2,009 Trade 3,790 4,013 4,138 4,312 4,500 4,588 Finance 534 615 688 672 720 713 Government Services 4,569 4,850 5,196 5,555 5,654 5,762 Other 12 4 6 6 8 7 (in percent of total employment) Total Employed 100 100 100 100 100 100 Agriculture 43.4 42.8 40.8 39.2 40.1 37.0 Industry 16.1 16.3 16.7 16.4 15.6 15.4 Mining and Quarrying 0.4 0.4 0.5 0.4 0.3 0.4 Manufacturing 10.5 9.9 9.9 9.7 9.5 9.4 Construction 4.8 5.5 5.9 5.8 5.3 5.2 Utilities 0.4 0.4 0.5 0.5 0.5 0.4 Services 40.5 40.9 42.5 44.4 44.2 45.1 Transport and Communications 5.8 6.0 6.3 6.6 6.7 6.9 Trade 14.8 14.8 14.9 15.4 15.5 15.8 Finance 2.1 2.3 2.5 2.4 2.5 2.5 Government Services 17.8 17.8 18.7 19.9 19.5 19.9 Other 0.0 0.0 0.0 0.0 0.0 0.0 Source: DOLE-BLES, Statistical Yearbook (for population figures). 59 APPENDIX 2.1: ROSC ON ACCOUNTANCY A recent report on the observance of standards and codes (ROSC) in accountancy in the Philippines contained a number of recommendations aimed at improving the quality of corporate financial statements. The following recommendations were included. (i) Amend the 1975 Revised Accountancy Law and the Professional Regulation Commission (PRC) Act of 2000 to strengthening the Board of Accountancy's (BOA) capacity to license and regulate the accounting profession , while delegating some of its duties and responsibilities to the Philippine Institute of Chartered Professional Accountants. (ii) Strengthen the enforcement capacity of the SEC and BSP (central bank and bank regulatory agency) (iii) Strengthen coordination among Board Of Accountants (OA)/Philippine Regulatory Commission (PRC), the Commission on Higher Education, the SEC, BSP and the Bureau of Internal Revenue leading to dissemination: (a) of laws, rules, regulations, standards and guidelines affecting the practice of accountancy; and (b) of a master list of all Certified Public Accountants (CPAs). Also, there need to be arrangements for immediately informing BOA/PRC when any of the regulatory bodies detect infractions by CPAs. (iv) Adopt in full international standards in accounting (IAS) and auditing (ISAs) without any modification or adaptation. (v) Improve competence of auditors by: (a) requiring practical experience before issuance of a practicing license; (b) require that existing practicing licenses be renewed and renewal be subject to completion of a continuing professional education program; and (c) retrain existing CPAs on IAS and ISA implementation guidelines; (vi) Amend the 1975 Revised Accountancy Law to provide for the creation of a Quality Assurance Review mechanism. (vii) Create an independent research organization to monitor the quality of information contained in published financial statements. (viii) Improve accountancy education by revising curriculum in accordance with international guidelines. (ix) Revitalize Philippine Institute of Chartered Public Accountants (PICPA) to make it function as an effective professional body which could assist in the regulation of CPAs. 60 APPENDIX 2.2: ROSC ON CORPORATE GOVERNANCE REFORMS A ROSC dealing corporate governance was recently completed and contained a number of recommendations to strengthen corporate governance. These focused on disclosure of non-financial information, the rights of minority shareholders, the role of the board of director, the independence of the audit and strengthening the powers of the SEC and the Philippine Stock Exchange (PSE) to enforce regulations and impose sanctions. It is recommended that listed companies in the Philippines be encouraged to adopt international best practices in corporate governance. In particular they would voluntarily agree to: (i) disclose on a publicly available internet site, the beneficial ownership of share holdings in excess of five percent; (ii) empower their minority shareholders to: (a) convene a meeting without having to petition the regulator; (b) put items on the agenda; (c) review provisions governing the duties of the majority shareholder towards the minority; (d) limit voting rights on matters where the majority has a conflict of interest; (e) review the minimum free float for listed companies to ensure it is sufficient to provide special voting protection for minority shareholders; (f) vote by mail; (g) establish an association or institution dedicated to the protection of minority shareholder rights; and (iii) obtain from fiduciary investors, such as pension funds, a clear disclosure of their policy on corporate governance and a commitment to exercise their voting rights in the sole interests of the beneficiaries; (iii) strengthen the mechanisms by which boards of directors govern the affairs of companies while putting in place or strengthening provisions to: (a) prohibit self-dealing by directors and conflicts of interest; (b) permit shareholders to assess the independence of directors; (b) require disclosure of board practices on corporate governance benchmarked against international best practices and explanation of any variances; (c) establish minimum qualifications of outside directors; (d) ensure directors have a full understanding of their duties and liabilities; and (e) require directors to review and sign-off on the auditor's long form report; and (iv) require with respect to the audit that: (a) auditors disclose all personal or business relationships, past or current, between the audit firm, its partners, the company, its directors and all related parties; (b) auditors disclose all audit and non-audit fees paid to the audit firm by the company and its related parties; (c) independence of the audit is maintained by rotating the audit partner or auditing firms; (d) internal and external audit committees be established and that independent directors constitute the majority of their membership, with members requiring training to ensure financial numeracy. 61 APPENDIX 2.3: RESTRICTIONS ON FOREIGN INVESTMENT The Philippines maintains two lists restricting foreign investments. Some of the main activities/sectors where foreign investment is restricted is as follows: List A: No foreign equity * Mass Media except recording * Engineering Services, Medical and Allied Professions, Accounting, and other professional services. * Retail Trade enterprises with paid-up capital of less than $ 2.5 million * Cooperatives * Small-scale Mining * Utilization of Marine Resources in archipelagic waters, territorial sea, and exclusive economic zone Up to Twenty-Five Percent (25%) Foreign Equity * Private recruitment, whether for local or overseas employment * Contracts for construction and repair of locally-funded public works except infrastructure/development projects; and projects which are foreign funded or assisted and required to undergo international competitive bidding Up to Tkirty Percent (30%) Foreign Equity * Advertising Up to Forty Percent (40%) Foreign Equity * Exploration, development and utilization of natural resources * Ownership of private lands * Operation and management of public utilities * Ownership/establishment and administration of educational institutions * Rice and corn industry * Contracts for the supply of materials, goods and commodities to government-owned or controlled corporation, company, agency or municipal corporation * Project proponent and facility operator of a BOT project requiring a public utilities franchise * Operation of deep sea commercial fishing vessels * Ownership of condominiums Up to Sixty Percent (60%) Foreign Equity * Financing companies regulated by the Securities and Exchange Commission (SEC) * Investment houses regulated by the SEC * Retail trade enterprises with a minimum paid-up capital of $2.5 million, but less than $7.5 million List B: Foreign Ownership is Limited for Reasons of Security, Defense, Risk to Health and Morals and Protection of Small and Medium-Scale. Up to Forty Percent (40%) Foreign Equity * Explosives and Munitions * Manufacture and distribution of dangerous drugs * Sauna and steam bath houses, massage clinics and other like activities regulated by law because of risks they impose to public health and morals * Other forms of gambling, e.g., race track operation * Domestic market enterprises with paid-in equity capital of less than the equivalent of US$200,000 * Domestic market enterprises which involve advanced technology or employ at least fifty (50) direct employees with paid-in equity capital of less than the equivalent of US$ 100,000 Source: Board of Investments. 62 APPENDIX 2.4: REQUIRED REFORMS IN INFRASTRUCTURE SECTORS Sector Required Sector Reforms The passage of the Electric Power Industry Reform Act lays the foundation for creating a more competitive power sector and for moving ahead on the privatization of NPC. However there is still a need to address the poor financial Power and managerial performance of electric cooperatives (Ecs), and to encourage greater private sector participation in the operations and financing of this sector. There is also a need to: (i) strengthen the Energy Regulatory Commission; (ii) restructure the National Electrification Administration; (iii) rationalize franchise areas and open up unserved areas to qualified new entrants; (iv) improve the efficiency and finances of weak Ecs; (v) rationalize tariff and subsidy policy; and (vi) encourage privatization of NPC-SPUG operations. The water sector faces substantial service deficits. Reform should address two PPI policies. First, there should be a shift in emphasis from BOTs to privatization of existing assets. Although BOT projects being pursued outside Metro Manila will enhance supply capacity, they fail to address fundamental problems such as inadequate investment, inefficient operations, and deficiencies in maintenance, management of the distribution system, billings and collection. Privatization of Water existing assets addresses these issues while removing the gap between bulk and retail tariffs. Second, the government should move towards transparent and solicited bidding, to ameliorate the present problem of too many unsolicited bids tying up the sector. There is also a need to reassess the role of LWUA and other agencies in the sector. In the long run, it is best to separate regulatory, policy and operational functions of government agencies (e.g. LWUA, NWRB, MWSS and SBMA) and to establish an independent national utility regulator. In the near term the government should focus on (i) assessing the feasibility of PPI in regional airports and ports; (iii) strengthening LGUs capacity to manage Transport PPI; (iii) encouraging solicited, competitive and transparent bidding process in the sector; (iv) improving coordination between greenfield and privatization projects; (v) separating regulatory, policy and operational functions of PPA, ATO and DPWH; and (vi) clarifying the commitment to financing right of way obligations. Reforms in the sector should (i) standardize interconnection agreements; (ii) Telecoms consider auctioning the use of the frequency spectrum, to allow greater flexibility in allocation of frequency; and (iii) ensure new technologies are licensed promptly. PHILIPPINES OimF i-it i: ' hi- CtJ.I~~~~~~~~~~~~~~~~~~~~~~~~~~~iT.d I ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ t I2~~~~~~~~~~~~~~~~~~~~~~~~~~~~i ~~~-A R ~ ~ ~ ~ - Regions and Provinces. I- I - - - i-k - I'~~~~~~~~~~~~~~ETROPOLITAN III~~~~~~~ -' F~~~~~~~~~~~ VIIi -:1 -- 'ii'~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~xi ii ... / VIII~~~~~~~~~~~~~~~xi I --~~~~~~A IV Zi-a* 4 . 4~~~~~~~~~xi .1~~~~~~~~~~~x AR M ..