PHILIPPINE QUARTERLY UPDATE Investing in Inclusive Growth Amid Global Uncertainty July 2012 71300 1 2 PHILIPPINE QUARTERLY UPDATE Investing in Inclusive Growth Amid Global Uncertainty July 2012 World Bank Office Manila www.worldbank.org.ph Investing in Inclusive Growth Amid Global Uncertainty Preface The Philippine Quarterly Update provides an update on key economic and social developments, and policies over the past three months. It also presents findings from recent World Bank studies on the Philippines. It places them in a longer-term and global context, and assesses the implications of these developments and policies on the outlook for the Philippines. Its coverage ranges from the macro-economy and financial markets to indicators of human welfare and development. It is intended for a wide audience, including policymakers, business leaders, financial market participants, and the community of analysts and professionals engaged in the Philippines. The Philippine Quarterly Update was prepared by Soonhwa Yi (Task Team Leader), Marianne Juco (Co-Task Team Leader), Joseph Louie Limkin and Tehmina Khan, under the guidance of Rogier van den Brink. The following contributed to the special focus section and box: Nataliya Mylenko on Access to Finance and Annalyn Sevilla on DPWH program. This report has benefited from comments from Alan Townsend, Bert Hofman, Kai Kaiser, Karl Kendrick Tiu Chua, Leyla Castillo, Lynnette Dela Cruz Perez, Motoky Hayakawa, Motoo Konishi, Nazmul Chaudhury, Sudhir Shetty, and Victor Dato. Secretarial and publication support by Nenette Santero is gratefully acknowledged. In addition, special thanks go to David Llorito and Justine Letargo of the Communications Team in Manila for the content review, media release, dissemination, and multimedia products for the web. The findings, interpretations, and conclusions expressed in this report are those of World Bank staff and do not necessarily reflect the views of the Executive Board of the World Bank or the governments they represent. For information about the World Bank and its activities in the Philippines, please visit www.worldbank.org/ph. To be included in the email distribution list of the Philippine Quarterly Update and related publications, please contact Nenette Santero (nsantero@worldbank.org). For questions and comments on the content of this publication, please contact Marianne Juco (mjuco@worldbank.org). Questions from the media can be addressed to David Llorito (dllorito@worldbank.org). i PHILIPPINE QUARTERLY UPDATE - July 2012 Table of Contents Preface i Executive Summary iv Recent Economic and Policy Developments 1 Output and Demand 1 Employment and Poverty 3 External Accounts 5 Financial Markets 7 Fiscal Policy 9 Inflation and Monetary Policy 10 Prospects 12 Output and Demand 12 Employment and Poverty 13 External Accounts 14 Fiscal Policy 15 Inflation and Monetary Policy 17 Possible Downside Scenarios for the Philippines 17 Special Focus 19 I. Access to Basic Financial Services in the Philippines 19 II. Building Human Capital – Education 22 Data Appendix 25 Selected Special Focus from Previous Quarterly Updates 27 Selected Recent World Bank Publications on the Philippines 30 Figures Figure 1. The Philippine Economy Grew Faster than Its ASEAN Neighbors in 1Q2012. 2 Figure 2. GDP Growth has been Buoyed by Rising Net Exports, and Domestic Consumption. 2 Figure 3. Fixed Investments Remain Low 2 Figure 4. The Service Sector Supports Growth on the Supply Side 2 Figure 5. More Job Creation and Lower Unemployment Rate. 3 ii Investing in Inclusive Growth Amid Global Uncertainty Figure 6. Around 60 Percent of the Poor will Bene�t from the Cash Transfer Program 3 Figure 7. BOP Strengthened in 1Q2012 6 Figure 8. Philippine Exports Show Increasing Dependence on China 6 Figure 9. The Euro Zone Crisis Takes its Toll on Remittances 7 Figure 10. Reserves Remain at a Healthy Level 7 Figure 11. The Flattening of the Yield Curve Suggests that Investors are More Cautious 8 Figure 12. Sovereign Spreads have Increased Slightly, the Exchange Rate Remains Stable 8 Figure 13. Inflation has Remained Subdued 11 Figure 14. Consumer Loans Posted a Modest Increase 11 Figure 15. Job Losses in Manufacturing are Absorbed by Agriculture and Low Skilled Services 14 Figure 16. National Government Debt and Debt Service Sustainability Outlook 16 Tables Table 1. World Growth Projections Under the Base-Case Scenario 12 Table 2. Implications of Low- and Worst-Case Scenarios 18 Table 3. Philippines: Selected Economic Indicators, 2009-13 25 Table 4. Philippines: National Government Cash Accounts (GFS Basis), 2008-12 26 Boxes Box 1. Spatial Growth Disparity: An Update 4 Box 2. The Bullish Philippine Equity Market 8 Box 3. Early Results of the DPWH Transformation Program 9 iii PHILIPPINE QUARTERLY UPDATE - July 2012 Executive Summary Despite heightened global economic uncertainty, the Philippine economy grew by 6.4 percent in the first quarter of 2012, a solid recovery from the relatively low 3.9 percent outturn for 2011. Higher growth was driven by a recovery in net exports and government spending, and robust private consumption. Meanwhile, low inflation rates, below 3 percent since February this year, have allowed the central bank to ease policy rates by 50 basis points to 4.0 percent. In addition, ample liquidity exists in the domestic market to finance both public and private sector investment. We project the economy to expand by 4.6 percent for 2012, with growth increasing to 5 percent in 2013. However, the ongoing European debt crisis and the slowdown in China pose significant downside risks to growth. The main channels of contagion to the Philippines are direct exports and remittance linkages to Europe, and indirect impact through regional production networks centered on China. Relatively sound macroeconomic fundamentals (a current account surplus, high international reserves, robust domestic demand, and a healthy banking system) should help the country to withstand a severe deterioration in the global economic climate. Nevertheless, there remain vulnerabilities, which were evident at the end of last year when exports, particularly of electronic goods to advanced economies, sank, hurting manufacturing jobs. While remittances were resilient during the 2008/09 global crisis, inflows from Europe have started to contract and a decline in overall flows cannot be ruled out in case of a serious global downturn. The challenge for policymakers is to cushion the economy from potential external shocks, while ensuring that the Philippines invests in inclusive growth. Efforts to increase the pace and efficiency of public spending seem to be paying off, as expenditures on maintenance and operating expenditures, infrastructure and social protection were ramped up, while improving efficiency. Government spending rose by 13 percent year-on-year through May, with revenue mobilization keeping pace due to improved tax administration and implementation of the Run After Tax Evaders program. Revenue collection is expected to further improve in 2013 due to additional, inflation-indexed, excise duties on alcohol and tobacco. However, further improvements in tax administration and tax policy reforms will be needed to allow the government to fund its priority spending targets for investments in human capital and public infrastructure, while ensuring fiscal sustainability and preparing for a prolonged global slowdown. Political commitment and strong macroeconomic fundamentals provide a window of opportunity for investing in inclusive growth by accelerating the implementation of reforms that improve the business environment for firms of all sizes, and boosting public investment in key infrastructure. Faster human capital accumulation will enhance productivity and drive growth in the medium term by enabling the country to shift gears towards higher value-added activities and more innovation. iv Investing in Inclusive Growth Amid Global Uncertainty Recent Economic and Policy Developments Output and Demand 1. Globally, downside risks are significant and large, and near-term visibility remains 1 low. Turbulence in global financial markets has increased following a brief respite in the first quarter when policy interventions in advanced economies helped to stave off the risks of disorderly default in the Euro zone. Although somewhat less vulnerable than other regions, the East Asia and Pacific (EAP) region remains exposed to headwinds from advanced economies through trade, financing and funding linkages, and to a slowdown in China through regional trade linkages. While the trend growth rates of advanced and emerging economies have decoupled over the past decade, cyclical correlations have grown even stronger. Given this, EAP, including the Philippines, is vulnerable to growth shocks in advanced economies. Over the near to medium term, EAP will likely contend with the new global reality: advanced economies are facing a period of prolonged deleveraging across three sectors simultaneously - the public sector, banking systems and consumers. Accordingly, the region, including the Philippines, needs to find new sources of growth through higher investment and resource mobilization. 2. The Philippine economy grew by 6.4 percent in the first quarter of 2012 (1Q2012) year- on-year (y-o-y), following an outturn of 3.9 percent in 2011.2 Growth last year had been pulled down by significant contractions in electronics exports and government spending.3 This solid performance within the Southeast Asian region (Figure 1) was driven by rising net exports with further support from private consumption and government spending (Figure 2). Net exports rebounded very strongly, contributing 5.2 percentage points (ppt) to GDP growth, the highest in the last five quarters. The recovery in exports can be attributed to the improvement in demand from North American manufacturing firms4 and the resolution of supply-side disruptions following the twin disasters in Japan and the flooding in Thailand. Negative import growth in recent months also helped boost net exports. Household consumption remained robust in 1Q2012, contributing 4.6 ppt, on the back of sustained inflows of remittances. Government spending (mainly on social protection and infrastructure) grew by 28 percent y-o-y, contributing 2.9 ppt to GDP growth. 3. Overall investment was pulled down by a drawdown in inventories, while fixed investments recovered. Total capital formation fell by 24 percent as a result of a 70 percent decline in the inventory stock. This pulled GDP growth down by 6.2 ppt. However, fixed 1 Key risks in the global economy include that in the Euro Zone, intensified adverse feedback loops between sovereign and bank funding pressures that could trigger larger protracted bank deleveraging and sizable contractions in credit and output; and slow progress in developing medium-term fiscal consolidation in advanced economies, including the US and Japan. 2 The original target for 2011 was GDP growth of between 7 and 8 percent. 3 As a result, the poor performance of last year has also helped boost this year’s growth numbers. 4 For instance, the April Book-to-Bill Report by SEMI reports that North American semiconductor industry posted a book-to-bill ratio of 1.10 in April (3-month average), compared with 0.98 in April, 2011 (3-month average), showing a sign of recovery in the industry. 1 PHILIPPINE QUARTERLY UPDATE - July 2012 investment5 continued to recover from its slowdown in 2011, growing by a modest 2.8 percent on the back of a 3.6 percent growth in durable equipment such as industrial machinery (Figure 3). Construction remained sluggish at around the 2011 level, growing negligibly by 0.3 percent. Private construction growth contracted for the third consecutive quarter, offsetting a 62 percent growth in public construction6 which was driven by the acceleration of government disbursements. Figure 1. The Philippine economy grew faster than its Figure 2. GDP growth has been buoyed by rising net ASEAN7 neighbors in 1Q2012. exports, and government and private consumption. Demand Side: Contribution to GDP Growth 20 Regional GDP Growth Rates (%) 15 15 10 Percentage point 10 5 5 Percent 0 0 -5 -5 -10 China Indonesia Malaysia -10 Philippines Thailand Vietnam Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 -15 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2010 2011 2012 Private Consumption Govt Consumption Investment Discrepancy 2009 2010 2011 2012 Net Exports GDP growth Source: Haver Analytics, Reuters Source: National Statistical Coordination Board (NSCB) Figure 3. Fixed investments remain low Figure 4. The service sector supports growth on the but are recovering supply side Supply Side: Contribution to GDP Growth Fixed capital formation contribution to 10 4 GDP growth 30 8 3 20 Percentage point 6 2 Percentage point 10 4 1 Percent 0 2 0 -1 0 Construction -10 -2 Durable equipment -2 Growth in fixed investment (rhs) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 -3 -20 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2010 2011 2012 2009 2010 2011 2012 Agriculture Industry Services Source: NSCB Source: NSCB 4. On the supply side, the service sector continued to be the key driver of growth (Figure 4). The real estate, renting and business activity subsector grew at around 8 percent, driven by strong demand from the fast growing business process outsourcing (BPO) industry. Manufacturing grew by 5.7 percent, and contributed 1.3 ppt to GDP growth. The revival in the manufacturing sector also raised demand for power, resulting in output growth in the utilities 5 This excludes inventory and intellectual property products. 6 Private construction accounts for some 7.2 percent of GDP while public construction for 2.4 percent of GDP in nominal terms. 7 This refers to the Association of Southeast Asian Nations comprising of Brunei, Cambodia, Indonesia, Laos, Malaysia, Philippines, Singapore, Thailand, and Vietnam. 2 Investing in Inclusive Growth Amid Global Uncertainty sector by 8 percent (from a meager 0.6 percent in 2011). Typhoons in December continued to take their toll on agriculture which grew by 1 percent (Figure 4), considerably lower than the 4.4 percent expansion registered in 1Q2011. A modest 2 percent growth in crops and livestock was offset by the unabated decline in fish production since 2009. The latter reflects overfishing and the effects of fishing bans in parts of the Celebes Sea and Panatag Shoal.8,9 Employment and Poverty 5. Higher growth yielded modest employment gains, while youth unemployment and the shares of self-employed and unpaid family workers remain high. Approximately 1 million jobs were created during April 2011 - April 2012, mostly in the service sector which accounted for some 587,000 of these new jobs, in particular, in BPO, hotels and restaurants, construction, and transport sectors.10 Agriculture remains an important source of employment, creating 337,000 new jobs, even though its contribution to GDP growth is low. Underemployment remains high, with a small improvement of 0.1 ppt to 19.3 percent of the employed. Formal sector employment11 is yet to show any significant improvement as it expanded only marginally to 55.5 percent in April from 55 percent last year. The shares of self-employed and unpaid family workers remain high, at 11 and 30 percent, respectively – or 422,000 out of the new jobs. The potential labor force (working age Filipinos) increased by the same amount as total new jobs - 1.1 million, while the unemployment rate eased to 6.9 percent in April from 7.2 percent last year (Figure 5). Half of the unemployed belong to the age group of 15-24 years. Figure 5. More job creation and lower Figure 6. Around 60 percent of the poor unemployment rate.12 will benefit from the cash transfer program Labor Force and Job Creation as it expands in scope and budget in 2012. 2,100 95.0 1,600 CCT Coverage and Budget Thousands 1,100 Percent 4 50 92.5 600 40 Million household 3 100 PHP billion 30 2 -400 90.0 20 Apr 08 Apr 09 Apr 10 Apr 11 Apr 12 1 10 Change in potential labor force (pop 15 years and over) - - Change in actual labor force 2007 2008 2009 2010 2011 2012 Job Creation Employment Rate (rhs) National Coverage Budget (rhs) Source: National Statistics Office (NSO) Source: General Appropriations Act (GAA) and Department of Social Welfare and Development (DSWD) 8 Fishing bans on the Celebes Sea and Panatag Shoal are brought about by claims of ownership by Indonesia and China, respectively. 9 Source: Bureau of Fisheries and Aquatic Resources. 10 The BPO sector alone generated some 200,000 new jobs in 2011. 11 These are wage and salary workers. 12 Potential labor force is also working age population. 3 PHILIPPINE QUARTERLY UPDATE - July 2012 4 Investing in Inclusive Growth Amid Global Uncertainty 6. Preliminary, new results from an Impact Evaluation (IE) analysis13 indicate that the government’s conditional cash transfer (CCT) program has been effective in improving the welfare of the poor in the short term. CCT is the largest social protection program in the Philippines with a budget of PhP39 billion for 2012 (Figure 6). The program grants up to PhP1,400 (US$33) per month to the mother of each beneficiary household, conditional on her children’s school attendance and regular visits to health clinics. Currently, 3 million out of the 5.2 million poor households (or 6.5 million children) benefit from the program. In areas where the program has been implemented, preliminary IE analysis finds higher expenditures in education and health, greater school enrollment and attendance, and increased health visits by pregnant women and children. External Accounts 7. Strong exports, sustained remittance inflows, and increased foreign direct investments led to a recovery in the balance of payments (BOP) in 1Q2012. The balance of payments surplus had sharply fallen in 4Q2011 to 0.7 percent of GDP driven by a widening trade deficit and increased capital outflows brought about by heightened risk aversion in response to the prolonged Euro zone crisis. In 1Q2012, however, the BOP surplus improved to 2.2 percent of GDP as the trade deficit narrowed. Remittances and services exports (growing by 12 percent in 1Q2012, y-o-y, mainly from the expanding BPO sector and greater tourist arrivals14) continued to support the surplus. With portfolio and foreign direct investments (FDI) rebounding, the capital account also improved although the surplus remains lower than in 1Q2011 (Figure 7), reflecting heightened market risk aversion. FDI inflows doubled in 1Q2012, y-o-y. However, a total of US$850 million worth of FDI remains low compared to neighboring countries. 8. Net exports rebounded strongly during January-April, reflecting a recovery in demand for Philippine goods from North American manufacturing firms and negative growth in imports. Following a 32 percent decline in the second half of 2011, electronics exports (accounting for 52 percent of total exports15) grew by 0.5 percent y-o-y in the year to April, leading to a fall in domestic inventories. The bounce in electronics (mainly semiconductors) seems to be in response to inventory restocking in the US and a post-tsunami rebound in Japan. The surge in manufacturing net exports also reflected negative growth in imports, especially raw materials.16,17 Export markets for the Philippines are highly concentrated on the US and 13 Chaudhury and Okamura, Conditional Cash Transfer and School Enrollment: Impact of the Conditional Cash Transfer Program in the Philippines, forthcoming August 2012; Impact of the Conditional Cash Transfer Program on Household Welfare in the Philippines: Findings from a Randomized Control Trial and Regression Discontinuity Study; Social Protection, East Asia and Pacific Region, World Bank; forthcoming December 2012. 14 Tourist arrivals registered 1.15 million in 1Q2012, and 1.5 million through April. 15 The share of electronics exports used to be as high as 70 percent of total exports in pre-crisis 2007. 16 Raw material and intermediate goods imports have posted negative growth since December last year. 17 Analysis indicates that build-up of raw material inventories occurs three months ahead of their electronics exports. 5 PHILIPPINE QUARTERLY UPDATE - July 2012 electronics assembly hubs (China,18 Japan, and Singapore) (Figure 8). Exports to Thailand have recovered and are now at par with pre-flooding levels.19 Figure 7. BOP strengthened in 1Q2012, Figure 8. Philippine exports show albeit lower than 1Q2011 in light of increasing dependence on China. heightened Euro zone concerns. Balance of Payments 10 Top five Philippine merchandise exports 8 20 destinations 6 16 2010 2011 Q1 2012 USD billion 4 Percent of total 2 12 0 -2 8 -4 Others Financial Account Current Account Overall BOP 4 -6 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 0 2008 2009 2010 2011 2012 JPN USA CHN HKG SGP Source: Bangko Sentral ng Pilipinas (BSP) Source: NSO 9. Remittances in nominal dollar terms continued to expand, albeit below the average pace of 2011 – at around 5.4 percent in January-April (y-o-y) (Figure 9), reflecting the deteriorating conditions in host economies. In real peso terms, remittance growth remained flat, thanks to the depreciating peso and lower inflation. Remittances from Spain, Norway and Netherlands saw a sharp dip, but, owing to sustained inflows from Germany, Italy and the UK, the contraction of remittance inflows from Europe was limited to 6 percent (y-o-y). In spite of continued political turmoil in the Middle East region and the implementation of Saudi Arabia’s moratorium on work permits for Filipinos (the Nitaquat program), remittances from this region expanded modestly by 5 percent (y-o-y). Despite the challenging external environment, worldwide deployment of Filipino workers continued to expand by an annual 17 percent or 1.3 million in 2011. 10. Gross international reserves (GIR) remain at high levels, and exceeded the country’s external debt in 1Q2012 (Figure 10). Reserve accumulation was supported by sustained inflows of remittances, exports and income from the Bangko Sentral ng Pilipinas’s (BSP) investments abroad. GIR slightly declined to US$76 billion in May (from US$77 billion in January) due to the revaluation of the BSP’s gold holdings, reflecting lower gold prices in the global market. 18 Given that around 20 percent of Chinese exports (re-exports) make its way to the EU market and another 20 percent goes to the US, prolonged weakness in exports demand from US and EU hence will have secondary effects to the Philippines through this channel. 19 The average monthly exports value to Thailand is at around US$180-200 million, but it dropped to US$100-120 million in the fourth quarter of 2011 as factories remained closed. However, its impact on Philippine exports was small as exports to Thailand account for only 4-5 percent of total exports, on average. For a more thorough discussion on the effects of the Thai and Japanese natural disasters on East Asia’s manufacturing supply chain, see World Bank (2012), EAP Regional Economic Update, May. 6 Investing in Inclusive Growth Amid Global Uncertainty Nonetheless, GIR is 21 percent higher than the country’s external debt which stood at US$63 billion in March 2012.20 As of March 2012, it could cover 11.2 months worth of imports, or 630 percent of the country’s short-term external debt based on residual maturity. Figure 9. The Euro zone crisis takes Figure 10. Reserves remain at a healthy level. its toll on remittances. Gross International Reserves Remittance Growth 120 Months of import (rhs) 25 ST external debt cover (rhs) 1/ 12 100 NIR + Forward Books (lhs) 20 80 GIR (lhs) Billion USD 15 8 60 Percent 10 5 40 0 4 20 -5 -10 - 0 Apr-09 Apr-10 Apr-11 Apr-12 Jul-09 Jul-10 Jul-11 Oct-09 Oct-10 Oct-11 Jan-09 Jan-10 Jan-11 Jan-12 May-10 May-11 May-12 Sep-10 Sep-11 Jan-10 Jan-11 Jan-12 Nominal USD Nominal PHP Real PHP Source: BSP Source: BSP 1/ Based on residual maturity Financial Markets 11. Domestic liquidity expanded by 5.6 percent in March (y-o-y), indicating ample liquidity in the domestic financial system to finance higher levels of investment, including the country’s much needed infrastructure projects. Short-term rates of Treasury bills fell below the policy rate in May, signaling a recovery in the economy.21 Yet, uncertainty remains high given that the banking and sovereign debt crisis in the Euro zone has yet to be fully resolved and this has been reflected in the relatively flatter yield curve than end-2011 (Figure 11) and a recent uptick in Philippine sovereign spreads (Figure 12). Deposits in the central bank’s special deposit accounts continue to expand, which is twice as large as the total required reserves of depository institutions22 and grows faster than net domestic credit. 12. The equity market reached new highs in 1Q2012, but has since fallen back as global volatility increased. After stagnating in 4Q2011, the Philippine stock exchange index breached the 5,300 level in 1Q2012. It closed at 5,000 in mid-June after dipping to the 4,900 level (Figure B2.1). Net foreign buying was at its highest since the 2007 pre-crisis peak, amounting to PhP33 billion for the first half of the year, double the amount from the same period last year.23 While 20 According to the government’s definition. 21 The narrower the differences between short-term rates and the policy rate, the tighter the lending conditions. Thus, a steeper yield curve sends a signal of an economic expansion and a flatter one signals uncertainty in the economy. 22 Filardo, Andrew and James Yetman, 2012, “The expansion of central bank balance sheets in emerging Asia: What are the risks,� BIS, June. 23 Net foreign buying for the first half of 2007, 2010, and 2011 are PhP68, 16.6 and 16.8 billion respectively. In 2008 and 2009, net foreign selling equivalent to PhP14.4 and 11.2 billion, respectively. 7 PHILIPPINE QUARTERLY UPDATE - July 2012 8 Investing in Inclusive Growth Amid Global Uncertainty 9 PHILIPPINE QUARTERLY UPDATE - July 2012 10 Investing in Inclusive Growth Amid Global Uncertainty contributes to wage restraint so that wages do not respond much to fluctuations in economic activity (Cacnio, 2012).28,29 16. The BSP’s monetary policy stance remains accommodative. The BSP has cut policy rates twice since the start of the year by a total of 50 basis points to 4 percent and, in response, household lending has accelerated, growing by an average of 20 percent through March (Figure 14), albeit starting from a low base. The reserve requirement ratio was cut by 3 ppt since the beginning of the year to 18 percent but its impact is somewhat offset by changes in the reserve requirement framework, including those to remove the remuneration of banks’ unified reserve deposits and exclude cash in vaults from the computation of compliance of the reserve requirements. The financial system remains broadly stable with capital adequacy ratios of banks above the BSP’s minimum ratio of 10 percent, well above the Basel Accord’s 8 percent. Figure 13. Inflation has remained subdued, averaging Figure 14. Consumer loans posted a modest at the low end of the central bank’s target increase in the face of a low interest rate regime. . Contribution to YoY Inflation Consumer Demand Indicators Others Transport 3mma percent change 6 Fuel, Light and Water Food and Beverage 50 Inflation Rate 30 Percentage points 4 percent 10 2 -10 Credit Card Loans Auto Loans Total Production Loans Total Household Loans 0 -30 Mar-09 Mar-10 Mar-11 Mar-12 Dec-08 Dec-09 Dec-10 Dec-11 Sep-09 Sep-10 Sep-11 Jun-09 Jun-10 Jun-11 Apr-11 Aug-11 Apr-12 Jan-11 Jan-12 Feb-11 Jul-11 Sep-11 Nov-11 Feb-12 May-11 May-12 Jun-11 Mar-11 Dec-11 Mar-12 Oct-11 Source: NSO and BSP Source: BSP 28 Cacnio, Faith Christian Q. 2012. “Inflation Dynamics and Unemployment Rate in the Philippines,� BSP Economic News Letter No. 12-02. 29 However, the increase in the minimum wage brings the minimum wage much closer to the average wage, thereby distorting the wage distribution. For example, minimum wage workers who have worked for 10 years are just paid slightly higher than new hires. For further discussions, see World Bank (2012), Philippine Development Report, forthcoming. 11 PHILIPPINE QUARTERLY UPDATE - July 2012 Prospects Output and Demand 17. We have revised our growth forecast upward to 4.6 percent from 4.2 percent for 2012 (Table 1), reflecting higher growth in Q1. However, this projection does not yet factor in a possible intensification of the crisis in Europe and a further slowdown in China. The global economy is projected to expand at a slower pace this year at 2.5 percent compared to 2.7 percent in 2011.30 A positive current account balance, ample reserves (the country is a net external creditor), and a flexible exchange rate provide buffers for the Philippines in case the external economic environment deteriorates. A relatively low share of exports in total GDP compared to its neighbors, and remittances which remained stable in the 2008-09 global financial crisis, suggest that the country is moderately vulnerable to heightened global risks. That said, export markets are highly concentrated: nearly 40 percent of all exports were shipped to the G3 in 2011, with another fifth to China. And manufacturing exports (mainly electronics) have proven highly susceptible to a fall in global demand, which would cause severe job losses in the sector. Table 1. World growth projections under the base-case scenario1 2007 2008 2009 2010 2011 2012F World output 5.2 3.2 -0.7 4.1 2.7 2.5 Advanced economies 2.7 0.9 -3.7 3.0 1.6 1.4 USA 2.0 1.1 -3.5 3.0 1.7 2.1 Euro Area 2.7 0.9 -4.3 1.8 1.6 -0.3 Japan 2.4 -0.6 -6.3 4.5 -0.7 2.4 Emerging and developing economies 8.3 6.1 2.8 7.4 6.1 5.3 China 13.0 9.0 9.2 10.4 9.2 8.2 ASEAN 5 6.3 4.9 1.7 7.1 4.3 5.0 Philippines 6.6 4.2 1.1 7.6 3.9 4.6 Source: World Bank (2012), Global Economic Prospects, June. For the Philippines, it is based on World Bank staff projections. ASEAN 5 refers to Philippines, Indonesia, Malaysia, Thailand, and Vietnam. 1/ The base-case scenario assumes a mild recession in Europe. For the Philippines, the base-case scenario adds the country’s above-expectation growth in 1Q2012. 18. Domestic demand will continue to support growth in the near term. Domestic business sentiment continued to remain buoyant in 2Q2012 supported by strong private and public sector spending. Going forward, domestic consumption is expected to remain robust for the rest of 2012 driven by higher government spending31 on the back of continuing improvements in the pace and efficiency of disbursements and robust private consumption.32 The latter is 30 Using 2005 PPP weights, the global economy is estimated to expand by 3.3 percent in 2012 compared to 3.7 percent in 2011. 31 See World Bank (2012), Philippines Quarterly Update, March, p.17 for a discussion on the correlation between government spending and GDP growth. 32 For instance, the Chamber of Automotive Manufacturers in the Philippines Inc. forecasts an 8 to 9 percent growth in car sales this year, from contracting by 4 percent in 2011. 12 Investing in Inclusive Growth Amid Global Uncertainty expected to increase at a pace similar to that of last year, supported by continued remittance inflows (albeit at a slower pace). Net exports are likely to be subdued reflecting the unfavorable external environment, suggesting large downside risks to growth in the manufacturing sector. Prospects on the service sector remains favorable, benefiting from solid growth forecast of the BPO industry, which expanded even during the global financial crisis. The agriculture sector will remain susceptible to climate change and adverse weather conditions unless there are corresponding investments to improve risk mitigation and policies to promote productivity. 19. With significant global headwinds likely to persist in the near future, the Philippines will need to raise investments to sustain growth. Currently, recovering consumer confidence and positive business sentiment coincide with strong macroeconomic fundamentals, improved efficiency in public spending, and the tackling of corruption at the highest levels. However, further deterioration in the global economic outlook can escalate downside risks to growth. To seize the current window of opportunity and prepare for a global slowdown, the government should continue to accelerate the implementation of its reform agenda. This includes improving the investment climate for firms of all sizes in order to increase private investment in the economy, and ramping up public investments in infrastructure and human capital. Employment and Poverty 20. As in 2008-09, the level and quality of employment will be adversely affected if another global economic crisis materializes. However, the public sector can help cushion the impact through accelerated spending on infrastructure and social protection. Manufacturing jobs will likely be hard-hit by lower external demand for Philippine products, with laid-off formal, skilled and full-time workers being absorbed by the low-productive agriculture sector, the unpaid family worker segment, and the informal sector (Figure 15). This would be a repetition of the impact seen during the global financial crisis, with attendant negative impact on real wages. However, due to the projected increase in government spending and continued growth in BPO services, net job creation in the service industry is expected to remain relatively resilient to significant global headwinds. The BPO sector expects to create 100,000 new full- time, skilled positions in 2012, in spite of the weak global environment. A slowdown in private construction is expected to release a large number of temporary workers. This could be compensated by accelerating public infrastructure projects, including those in the public- private partnership (PPP) pipeline. 21. In the event of a major global crisis, the government’s social protection programs will be important in shielding the poor from the fallout. The expanded CCT program and other priority poverty reduction programs will ease the recipients’ hardship in the short term and, 13 PHILIPPINE QUARTERLY UPDATE - July 2012 Figure 15. In times of crises, job losses in the manufacturing sector are absorbed by agriculture and by conditioning assistance on health and low skilled services. education, can build the foundation for Change in sectoral employment significant poverty reduction in the long term. (between 2007 peak to 2009 crisis) Slower growth in remittances would bear a Manufacturing limited direct impact on poverty. Our analysis Private household suggests that, even in the worst-case scenario – Public admin Transport, storage & comm i.e., a 20 percent reduction in remittances, the Hotel & restaurant overall poverty headcount is estimated to Wholesale, retail trade increase by a modest 1 percent.33 The most Agriculture affected will be those in urban areas (where -200 -100 0 100 200 300 400 500 households source 9 percent of their total Employment in thousands income from remittances) and those living just Source: NSO above the poverty line (the 4th decile). However, these estimates take into account only the direct effect of remittances, and therefore, exclude the economy-wide impact through the multiplier effect of remittances. External Accounts 22. Remittances will help keep the current account in small surplus. In our worst-case scenario, global remittances to developing countries are projected to contract by 6 percent.34 In our baseline scenario, we expect remittances to the Philippines to be somewhat more resilient thanks to a continued expansion of deployment of overseas Filipino workers (OFWs) and OFWs’ diverse occupations and destinations, slowing to 5 percent in 2012 and 4 percent in 2013, lower than historical growth rates. Merchandise exports are projected to grow slowly by 4.9 and 7.5 percent respectively in 2012 and 2013, reflecting weak prospects for semiconductor exports (accounting for 50 percent of merchandise exports), but with some offsetting demand from the recovery in Japan and Thailand. Services exports will continue to record a surplus, supported by further expansion of the BPO sector. 23. Reform efforts to improve the investment climate need to be accelerated to attract more foreign investment. Even though foreign portfolio inflows will likely retreat in case of an intensifying Euro zone crisis, over the medium to longer term, the positive earnings differential between developing and advanced economies as well as the Philippine’s relatively stable macroeconomic environment could help attract foreign investments. Similarly, regional economic developments could also result in higher FDI inflows to the Philippines in the medium term. For instance, China’s eroding manufacturing competitiveness due to rising wages may drive offshore companies to look for cheaper alternatives, presenting a new opportunity for the 33 The estimates do not in any way factor in multiplier effects of the contraction in foreign remittance flows. 34 The worst-case scenario assumes that the freezing up of credit is to spread to two larger Euro economies (equal to around 30 percent of Euro area GDP), generating similar declines in GDP and imports of those economies. For more details, see World Bank (2012), Global Economic Prospects, June. 14 Investing in Inclusive Growth Amid Global Uncertainty Philippines.35 More importantly, however, seizing these new opportunities depends on acceleration of concrete reforms to improve the investment climate. Fiscal Policy 24. Higher tax revenues are needed to sustainably ramp up job-creating infrastructure spending and social protection measures, if a severe global crisis materializes. The projected 4.6 percent growth for 2012 assumes sustained government spending from the continuing appropriations of last year’s Disbursement Acceleration Plan, which would mitigate the impact of a projected 2012 global slowdown. While two public-private partnership (PPP) projects have been bid-out this year (Daang Hari and the schools project) with the bidding of Daang Hari completed, the PPP program is yet to have a significant impact on investments. Further acceleration of speding will be an important factor to boost growth in the second half of the year. 25. Under the base case, the fiscal deficit for this year is expected to widen to 3.0 percent of GDP from 2.1 percent last year (GFS basis). Controlling the deficit for 2013 would hinge on additional tax collections (equivalent to some 0.3 percent of GDP) from inflation-indexed excise duties on alcohol and tobacco,36 in addition to incremental gains from improved tax administration (at least by 0.2 percent of GDP). Subsidies to government-owned and controlled corporations are expected to increase during the remaining year, particularly additional allocations to PhilHealth37 for its health insurance program. 26. The deficit will likely rise further in case of a severe global downturn. Weaker domestic economic activity due to declining exports and remittances, falling corporate profitability and job losses in manufacturing will all take a toll as automatic tax and spending stabilizers come into play. As a result, the deficit could conceivably rise by 0.3 ppt in the worst-case scenario, from a projected 3.0 percent of GDP in the base case, on account of higher interest payments. This could create funding pressures for the government in the short term, with fiscal space further constrained by the relatively high debt service-to-revenue ratios (discussed below). 27. Risks inherent in public debt structure can be mitigated by modifying the debt structure, taking into account the cost of doing so, and by lining up contingent financing.38 Debt re-profiling needs to be assessed within a broader framework of its balance sheet and the nature of its revenues and cash flows. Our debt sustainability analysis shows that, even under a 35 China’s cost advantage has been eroding relative to domestic manufacturers in advanced economies and to competing low-cost destinations. Source: Hackett Group 36 The estimated 0.3 percent of GDP comes from the current version of the Abaya Bill passed in Congress, as opposed to 0.5 percent of GDP from expected revenues of the original version. 37 It stands for Philippine Health Insurance Corporation. 38 As part of the government’s debt liability management, the government recently signed a debt-for-development swap agreement with Italy. The government’s other debt liability management initiatives include a domestic debt swap to lengthen maturities and the issuance of peso-denominated global bonds. 15 PHILIPPINE QUARTERLY UPDATE - July 2012 worst-case scenario,39 public debt dynamics are favorable – reaching around 50 percent of GDP but below its historical highs (Figure 16.a). On the other hand, the debt service-to-revenue ratio (DSR) of 53 percent in 2011 is rather high by international standards,40 albeit declining, and could increase fiscal vulnerability to a rising interest rate. Severe shocks on real interest rates (i.e., an increase by 2 standard deviations) could keep the DSR at the current elevated level for the remainder of the year before it starts to decline (Figure 16.b). The composition of debt service payments has shifted in the past ten years and is now primarily comprised of principal payments (61 percent of total debt service)41 largely on domestic debt, given the increasing share of domestic debt in total debt. Figure 16. National government debt and debt service sustainability outlook in response to exogenous interest rate shocks (a) Debt-to-GDP ratio 1/2 SD 1 SD 2 SD 80 80 80 Baseline 2.7 Baseline 2.7 Baseline 2.7 70 Scenario 3.5 70 Scenario 4.2 Scenario 5.7 70 Historical 3.2 Historical 3.2 Historical 3.2 60 60 60 i-rate i-rate i-rate shock shock shock 50 50 50 46 50 45 Baseline Baseline Baseline 40 43 40 43 40 43 30 30 30 2006 2008 2010 2012 2014 2016 2006 2008 2010 2012 2014 2016 2006 2008 2010 2012 2014 2016 (b) Debt service-to-revenue ratio 1/2 SD 1SD 2 SD 100 100 100 Baseline 3.1 Baseline 3.1 Baseline 3.1 80 Scenario 3.8 80 Scenario 4.6 80 Scenario 6.0 Percent of total revenues Percent of total revenues Percent of total revenues Historical 3.2 Historical 3.2 Historical 3.2 60 60 60 i-rate i-rate i-rate shock 44 shock shock 39 37 40 40 40 34 34 34 20 Baseline 20 Baseline 20 Baseline 0 0 0 2006 2008 2010 2012 2014 2016 2006 2008 2010 2012 2014 2016 2006 2008 2010 2012 2014 2016 Source: World Bank staff estimates Notes: 1/ Shaded areas represent actual data. 2/ Permanent shocks are applied to real interest rates. 39 It assumes a shock on interest rates by 2 standard deviations. 40 International standards of the DSR refer to debt service of general government debt, while the Philippine DSR includes debt services of national government debt only. 41 In 2000, principal payments comprised only 38 percent of total debt service. 16 Investing in Inclusive Growth Amid Global Uncertainty Inflation and Monetary Policy 28. Policy rates are expected to remain unchanged in the near term and our inflation projection remains unchanged at 3.5 percent, at the low end of the BSP’s inflation target, with risks to inflation mixed. Inflation for the year is projected to be low due to lower food prices given ample domestic supply, as the La Nina weather phenomenon weakens.42 On the other hand, downside risks stem from higher electricity rates as local power remains in short supply. 29. Financial sector risks are low. The domestic banking sector has proven its resilience during the global financial crisis. Hence, under our baseline scenario, the Euro zone crisis would be unlikely to affect the economy through the direct banking/liquidity channels as Philippine banks’ exposure to European banks is low. The sector is still at the nascent stage with about US$150 billion worth of total assets (70 percent of GDP). Non-performing loans are relatively low and banks have been shoring up capital in reaction to the continued global volatility and in anticipation of the adoption of Basel III.43 Domestic credit growth has been at manageable levels and foreign exposures are limited to 10 percent of total liabilities. 30. However, a negative shock to the real sector may expose weakness in the financial system. For instance, a large supply of real estate in the pipeline may put downward pressure on real estate prices, which would increase risks in the financial system directly and indirectly, especially through real estate developers who are using their balance sheets to provide in- house financing to their real estate buyers. The central bank is aware of the risks in the financial system and has put in place conservative supervisory and macro-prudential policies to mitigate these risks. Possible Downside Scenarios for the Philippines 31. The Philippine economy is estimated to expand slower by 3.1 to 2.5 percent in 2012 in case the Euro zone crisis worsens (i.e., under our low and worst-case scenarios, Table 2). Our low case scenario assumes a relatively orderly crisis in Europe characterized by a credit squeeze in one or two European economies; and the worst-case scenario refers to a disorderly crisis characterized by a full-blown freezing up of credit spreading across two larger European economies, causing possible second-round impacts through China. The Philippines is vulnerable to the Euro zone crisis through trade and remittance linkages. In the worst case, global trade is projected to fall by 10 percent and remittances to developing countries to contract by 6 percent. For the Philippines, goods exports in 2012 are projected to contract by 12 to 16 42 La Niña is the weather phenomenon characterized by heavy rain. 43 Basel III is a comprehensive set of reform measures, developed by the Bank for International Settlements (BIS) Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. 17 PHILIPPINE QUARTERLY UPDATE - July 2012 percent (Table 2).44 With remittance inflows from Europe accounting for 16 percent of total remittances, we project 3.6 percent growth for 2012 and further deceleration in 2013-14 under the worst-case scenario. Together, the combined shock to exports and to remittances should undermine household incomes, spending and sentiment, limiting the support to growth from private domestic consumption. 32. Capital outflows from the Philippines are expected to bear a limited economic impact, but heightened risk aversion could take a toll on private investment. Current levels of FDI are low, and despite some volatility, portfolio inflows are likely to return to the Philippines because of growth rate, interest rate, and risk differentials. Nonetheless, the impact on investor sentiment, particularly in equity markets, should not be discounted. This could discourage businesses from investing, which is already subdued, particularly if the ability of firms to raise funding from equity markets is also affected. Table 2. Implications of Low- and Worst-Case Scenarios1, 2 Historical Base case Low case Worst case Key variables 2008 2009 2010 2011 2012 2013 2014 2012 2013 2014 2012 2013 2014 GDP growth 4.2 1.1 7.6 3.9 4.6 5.0 5.0 3.1 4.2 4.7 2.5 1.6 3.4 Current account balance (% of GDP) 2.2 5.6 4.2 3.1 1.8 2.2 2.9 1.4 2.2 3.1 0.9 0.3 0.2 Exports goods growth -2.5 -22.1 34.8 -6.9 4.9 7.5 8.0 -12.0 -6.6 1.9 -15.9 -25.5 3.1 Import goods growth 5.6 -24.0 31.5 11.1 7.5 8.4 7.0 -9.5 -3.8 0.5 -12.3 -13.6 5.7 Remittance growth 13.7 5.6 8.2 7.2 5.0 4.0 3.0 4.1 2.6 1.8 3.6 1.7 0.3 Source: NSCB and BSP for historical, World Bank staff estimate for projections 1/ All scenarios are consistent with those presented in World Bank (2012)’s Global Economic Prospects (June). 2/ Note that the low- and worst-case scenarios should be interpreted together with a range of outcomes and not necessarily point estimates. 33. The challenge for policymakers is to cushion the economy from potential external shocks while ensuring that the Philippines continues to improve its competitiveness. Political commitment and strong macroeconomic fundamentals provide a window of opportunity to accelerate the implementation of reforms to improve the business environment for firms of all sizes, and to boost public investment in key infrastructure and human capital accumulation. Faster human and physical capital accumulation will enhance productivity and drive growth in the medium term by enabling the country to shift gears towards higher value-added activities and more innovation. 34. Improved productivity and higher revenues would help prepare the country in case of a prolonged global slowdown. The ability of the government to fund its priority spending targets for investments in human capital and public infrastructure, while ensuring fiscal sustainability, will require improved tax administration and policy reforms, through broadening the tax base and improving efficiency and transparency in tax collections. 44 In estimating this, we used an elasticity and input demand approach. The elasticity model uses an estimate of partner import and GDP growth to PHL export and GDP growth. The input models are i) a regression of the North American book to bill ratio to PHL electronics exports, and ii) a regression of PHL import of electronic parts to PHL electronic exports. All models are significant and give a high correlation. 18 Investing in Inclusive Growth Amid Global Uncertainty Special Focus This Special Focus section concentrates on two building blocks for inclusive growth: better access to financial services for the poor and human capital accumulation through reforms in education. I. Access to Basic Financial Services in the Philippines45,46 1. Financial inclusion, or broad access to basic formal financial services, supports inclusive growth as it assists individuals to mitigate risks and smooth consumption. Savings, credit, and insurance services enable individuals to smooth consumption, which for the vulnerable can mean not falling back into poverty. Financial services offered by formal financial institutions47 are also safer and cheaper than informal alternatives which are often the only available option for the poor, and enable micro-entrepreneurs to integrate into a formal economy. Recent research shows that low-income entrepreneurs given access to a formal bank account invest more in their businesses, consume more, and are less prone to sell business assets to deal with health emergencies.48 Figure S1.1 Less than a third of Filipinos have an Figure S1.2. In the Philippines, only 10 percent of low account in a formal financial institution. income adults have an account with a financial institution. Account at a formal financial institution (% age 15+) United States 88 United States Taiwan, China 87 Taiwan, China Mongolia 78 Mongolia Thailand 73 Thailand Malaysia 66 Malaysia China 64 China Lao PDR 27 Lao PDR Philippines 27 Philippines 40 10 Vietnam 21 Vietnam high income Indonesia 20 Indonesia low income Cambodia 4 Cambodia 0 20 40 60 80 100 0 20 40 60 80 100 45 This section reports analytical findings from the World Bank’s Findex database (2012), which for the first time allow for a comparison of the use of the basic financial services by individuals across countries and regions. 46 In this analysis, access to financial services refers to actual use of financial services rather than the possibility of using financial services. For definitions, see Beck, Demirguc-Kunt and Peria (2005), “Reaching out: Access to and use of banking services across countries,� World Bank Policy Research Working Paper 3754. 47 Formal financial institutions include commercial, rural, and cooperative banks, savings and credit cooperatives, microfinance NGOs, registered lending investors, and savings and loan associations. 48 Caskey, John, Clemente Ruiz Duran, and Tova Maria Solo. 2006. “The Urban Unbanked in Mexico and the United States.� Policy Research Working Paper 3835. World Bank. Dupas, Pascaline, and Jonathan Robinson. 2009. “Savings Constraints and Microenterprise Development: Evidence from a Field Experiment in Kenya.� NBER Working Paper 14693. Karlan, D., Ashraf, N., & Yin, W. (2007) Female Empowerment: Impact of a Commitment Savings Product in the Philippines. Center for Global Development, Working Paper No. 106. 19 PHILIPPINE QUARTERLY UPDATE - July 2012 2. In the Philippines, actual use of formal financial services is low, particularly among low income groups. First, less than a third of Filipinos (27 percent) have an account with a formal financial institution such as commercial, rural or cooperative banks, and savings and loans cooperatives (Figure S1.1). The overall size of the banking system is small, with total assets of some US$150 billion (or 74 percent of GDP). Second, the share of account holders is as low as 10 percent among lower income population,49 and the Philippines exhibits the widest gap between high and low income groups in terms of account access in the East Asia and Pacific region, mirroring broader economic inequality (Figure S1.2). 3. Savings and money transfers including receipt of government payments contribute to the broader use of formal financial services, with more women than men owning an account. In the Philippines, accounts with formal financial institutions are mostly used to save money and to receive remittances, especially among adults in the low income group (Figure S1.3). The Philippines stands out in that more women have accounts than men – 34 percent compared to 19 percent; and they use their accounts to save, receive remittances, receive government payments and manage business expenses. Figure S1.3. The accounts are mostly used to save money and to receive remittances. % adults % adults save in FI 11 4 18 receive remittances 19 receive remittances 10 receive govt payment 3 15 7 8 save in FI 3 receive wages 9 24 receive wages 2 receive govt payment 4 13 7 male 1 low income send remittances business 4 9 7 high income female business 1 5 10 send remittances 6 0 5 10 15 20 25 0 5 10 15 20 25 Note: sorted by female use Note: sorted by low income use Source: Findex database, World Bank (2012) Source: Findex database, World Bank (2012) 4. Most Filipinos rely on a wide range of informal services to save and borrow. Only about 15 percent of Filipino adults use formal financial institutions to save and the pattern is more prominent in the low income group and in rural areas (Figure S1.4). Similarly, only a fraction of Filipinos (14 percent) borrow from the formal financial institutions, the second lowest in East Asia and Pacific, after Indonesia. Instead, they rely heavily on a wide range of informal sources for borrowing money, including friends, stores, private lenders and employers (Figure S1.5). The reliance on informal sources of credit is likely a reflection of many factors 49 “Low income� refers to the bottom 40 percent of the income distribution and “high income� to the top 60 percent of the income distribution. 20 Investing in Inclusive Growth Amid Global Uncertainty including the lack of suitable credit products, limited credit supply especially for lower income borrowers, or a preference to avoid borrowing from banks owing to the lack of collaterals or banks’ cumbersome procedural requirements. Figure S1.4. Majority save outside of Figure S1.5. Most Filipinos borrow the formal financial system. from informal sources. Taiwan, China formal FI+credit car rural 10 32 Mongolia employer urban 22 29 Thailand friends low income 3 30 Malaysia private lender high income 24 32 Lao PDR store female 18 27 Cambodia male Vietnam 11 35 China Philippines 15 31 Philippines 14 12 39 13 27 0 10 20 30 40 50 60 Indonesia Save in Fin. Inst. Saved money NOT in Fin. Inst. 0 20 40 60 80 100 120 Note: region median values Note: categories are not exclusive Source: Findex database, World Bank (2012) Source: Findex database, World Bank (2012) 5. Health and education expenditures are the most cited reasons for borrowing, partly owing to low health insurance coverage and limited buffers for eventualities.50 Micro-insurance is expanding in the Philippines following the introduction of enabling regulations in recent years.51 Though products are mostly limited to life insurance thus far, a number of providers are experimenting with health insurance products which target the low income market. 6. High mobile phone connectivity contributes to expanding access to financial services. The Philippines is a leader in the East Asia and Pacific region in terms of introducing money transfer and payments through mobile phone network (e.g., BDO’s GCash). The number of people using mobile phones to receive remittances and to make payments supersedes the number of people using accounts in financial institutions, notably in rural areas and in the low income group. Thus, the introduction of new technologies, such as money transfers through mobile phone network and linking of these services to other financial services, holds a great promise in improving access to financial services. 7. While access remains low, the government has implemented a number of important reforms aiming to improve access to basic financial services. Through the implementation of the Microfinance Strategy and introduction of enabling environment for mobile banking, the Philippines is recognized as one of the pioneers in exploring innovative approaches to improve financial inclusion. Efforts to promote favorable business conditions for privately provided microfinance earned the Philippines international recognition from the Economic Intelligence 50 The questionnaire did not ask questions on vehicle or consumer goods financing. 51 As of June 15, 2012, micro-insurance products are offered by 6 life insurance entities, 12 non-life insurance entities and 19 mutual benefit associations (MBAs). Micro-insurance products approved are 33 life insurance, 16 non-life and 19 MBA products. 21 PHILIPPINE QUARTERLY UPDATE - July 2012 Unit, the business information arm of The Economist Group. In the Global MicroScope 2010, the Philippines was recognized to have the best regulatory environment for microfinance among 54 countries. This is a good starting point to attain the vision of the Philippine Development Plan: “a regionally-responsive, development-oriented and inclusive financial system which provides for the evolving needs of its diverse public.� II. Building Human Capital – Education52 1. The Philippines has embarked on providing quality education to all. Quality education is a pathway out of poverty, as it enables children to accumulate knowledge and develop lifelong skills that allow them to take advantage of opportunities for gainful employment in a dynamic globalized economic environment. Education increases opportunities for higher income/earnings. For instance, in the Philippines, in their 40s, college graduates earn nearly three times more than high school graduates (Figure S2.1). Thus the implementation of the new K-12 program, which adds a full two years to secondary school, would augment higher income opportunities.53 Our preliminary results indicate that an additional year of high school increases productivity and an additional 2 years of schooling has an estimated return of about 28 percent on average. 2. The Philippines’s education system faces major challenges in the following areas: (i) Access to education. Slow progress in net enrollment rates is largely a result of a rapidly growing school-going age population. Net enrolment significantly increased from 84.33 percent in school year (SY) 2005-6 to nearly 90 percent in SY 2010-11, thanks to the extensive efforts of the government to enhance access to basic education through formal and non-formal delivery modes and through demand-side interventions (such as the government’s CCT Program.) However, the net enrollment rate is still below the 1990s level (Figure S2.1), as this has barely kept pace with the fast growth in the school-going age population. The cohort survival rates improved little over the period with only about five out of ten elementary graduates making it to the tertiary level (Figure S2.1). Elementary completion rates slightly improved from 70.2 percent in SY 2003-4 to 72.1 percent in SY 2010-11.54 In general, school enrollment rate 52 This section is heavily drawn from World Bank (2011), “Medium Term Spending Plan for Basic Education, 2012- 17, Draft; World Bank (2012), �Private Internal Rate of Return to Additional Two Years of Education,� Preliminary draft; and “World Bank (2010), Discussion Notes. 53 Prior to the K-12 program, the Philippines’s basic education has covered 6 years of primary school and 4 years of high school. The K-12 program covers kindergarten and 12 years of basic education (6 year of primary education, 4 years of junior high school and 2 years of senior high school. 54 This is based on DepEd’s completion rate formula which looks at efficiency (i.e., those who completed primary school in accordance with the required number of years). The elementary completion rate is higher than 90 percent as of the previous school year, according to the WB/UNESCO Institute of Statistics formula for Primary Completion Rate (i.e., calculated by taking the total number of students in the last grade of primary school, minus the number of repeaters in that grade, divided by the total number of children of official completing age). 22 Investing in Inclusive Growth Amid Global Uncertainty positively correlates with income.55 For instance, in the ARMM, one of the poorest regions, only 82.9 percent of children 16 years or younger attended school compared to the national average of 91 percent. (ii) Quality of education. While results have started to improve at the national level, overall school achievement levels continue to be a major concern, especially at the secondary level. Table S2.1 shows that average test scores of Grade 6 students improved from 54.7 percent in SY2003-4 to 68 percent in SY2009-10. However, those for high school students have remained flat and only 4 percent of examinees in 2008 obtained average scores higher than 75 percent. The average achievement level improved slightly for Mathematics and Science (Table S2.1). In the 2003 Trends in International Math and Science Study, the average test score of Filipino eighth graders was only 378 in Mathematics against the international average of 466, and 377 in Science against the average of 473 of participating countries. The quality of higher education institutions also shows shortcomings, as indicated by the low passing rate of graduates in professional examinations.56 (iii) Insufficient school infrastructure. Higher spending on basic education in recent years eased input deficits in public schools. However, basic education budget per student has been persistently low, fluctuating within the PhP5,000 – PhP6,000 band in real terms (measured in 2000 prices) since 2000, while school-age population has been growing rapidly. As the education budget has yet to catch up with population growth, schools still cannot find sufficient space to teach their children. According to DepEd, in SY2011-2, overall, public schools lack education materials, 48,802 classrooms, 132,564 teachers, and 106,604 toilets. Figure S2.1. College graduates earn far more Figure S2.2. Declining school enrollment rates than high school graduates. (y=PhP, x=age) 220000 100 200000 180000 90 160000 140000 80 120000 100000 80000 70 60000 40000 60 20000 0 50 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 2003-4 2006-7 2007-8 2008-9 2009-10 2010-11 HS grad 2yrs Coll 2yrs PS college Elementary level cohort survival rate Secondary level cohort survival rate Elementary level participation level Secondary level participation level Source: World Bank (2012), preliminary Source: Department of Education (DepED) 55 The school enrollment rate increases by household expenditure levels, from 85 percent in the poorest quintile to 98.1 percent in the richest. 56 Orbeta, Aniceto (2008). Background Paper on Higher Education. Manila. Unpublished. 23 PHILIPPINE QUARTERLY UPDATE - July 2012 Table S2.1. Student achievement indicators, 2003-9 2003-4 2006-7 2007-8 2008-9 2009-10 Grade 6 Achievement (2005) 1/ 54.7 59.9 64.8 66.3 68.0 Mathematics 53.7 60.3 63.9 68.7 63.3 English 54.1 60.8 61.6 62.1 67.8 Science 46.8 51.6 57.9 59.6 63.1 Hekasi (Social Studies) 59.5 61.1 67.4 69.0 70.9 Secondary school Year 2 Achievement (2005) 1/ 44.3 46.7 49.3 47.4 45.5 Mathematics 47.8 39.1 42.9 39.5 39.6 English 47.7 51.8 53.5 52.4 46.8 Science 38.0 42.0 46.7 43.4 43.7 Hekasi (Social Studies) .. 51.5 55.6 50.5 39.3 Source: DepED. Note: 1/ Assumes the National Education Testing and Research Center will test equate to allow valid comparisons across years; only means reported for 2004-2005. 3. Given these existing challenges, additional resources for the basic education sector are needed. The new K-12 program is expected to further increase the resource requirements, especially from 2016 onwards when the students currently in secondary school year 1 reach year 5 for the first time in the secondary education system. The necessary budgetary increases to achieve these spending targets must come from both the central and local governments. This requires, among others, motivating the local government units to invest more of their own resources in local education improvements and supporting the empowerment of schools and communities.57 The government can also promote private involvement in basic education to help share necessary resource requirements with the private sector, though this requires an effective audit and fraud monitoring mechanism in place. The Education Service Contracting Program has been shown to be a cost-effective scheme compared to the alternative option of building new schools and classrooms and hiring new teachers to accommodate the growing number of enrollees in public schools.58 As higher spending does not automatically translate into better education outcomes, it is important to address institutional and policy issues to improve access to education across regions and the quality of education. 59 57 For detailed recommendations in this regard, see World Bank (2010), Discussion Notes:Education. 58 Patrinos,Harry Anthony, Lynnette Perez, Juliana Guaqueta, Emilio Porta, Honesto Nuqui, and Michael Alba (forthcoming). “Philippines Education Service Contracting Study.� Draft. 59 Hanushek (2007) find that teacher upgrading, across-the-board salary increases, and higher teacher-student ratios have little impact on learning achievement in the medium term. 24 Investing in Inclusive Growth Amid Global Uncertainty Data Appendix Table 3. Philippines: Selected Economic Indicators, 2009-13 2009 2010 2011 2012 2013 Actual Prel. Act. Projection Growth and inflation (in percent of GDP, unless otherwise indicated) Gross domestic product (% change) 1.1 7.6 3.9 4.6 5.0 Inflation (period average) 3.2 3.8 4.8 3.5 4.0 Savings and investment Gross national savings 22.1 24.8 24.9 24.3 25.6 Gross domestic investment 16.6 20.5 21.8 22.5 23.6 Public sector National government balance (GFS basis) 1/ -3.9 -3.6 -2.1 -3.0 -2.8 National government balance (Govt Definition) -3.7 -3.5 -2.0 -2.9 -2.7 Total revenue (Govt Definition) 14.0 13.4 14.0 14.0 14.6 Tax revenue 12.2 12.1 12.5 12.8 13.4 Total spending (Govt Definition) 17.7 16.9 16.0 16.9 17.3 National government debt 54.8 52.4 51.1 49.0 48.0 Balance of payments Merchandise exports (% change) -22.1 34.8 -6.8 4.9 7.5 Merchandise imports (% change) -24.0 31.5 2.6 7.5 8.4 Remittances (% change of US$ remittance) 5.6 8.2 7.2 5.0 4.0 Current account balance 5.6 4.2 3.1 1.8 2.0 Foreign direct investment (billions of dollars) 1.6 1.2 1.3 1.5 2.5 Portfolio Investment (billions of dollars) -0.6 4.0 5.5 4.0 4.0 International reserves 2/ Gross official reserves (billions of dollars) 44.2 62.4 75.0 78.1 82.0 Gross official reserves (months of imports) 8.7 9.6 11.1 11.1 11.0 External debt 3/ 37.3 36.3 34.8 33.3 32.1 Source: Government of the Philippines for historical, World Bank for projections 1/ Excludes privatization receipts and includes CB-BOL restructuring revenues and expenditures (in accordance with GFSM) 2/ Includes gold 3/ Based on World Bank definition. The difference with central bank definition is that it includes the following: i) Gross--Due to Head Office/Branches Abroad of branches and offshore banking units of foreign banks operating in the Philippines, which are treated as quasi-equity in view of nil and/or token accounts of permanently assigned capital required of these banks, ii) Long-term loans of non-banks obtained without BSP approval which cannot be serviced using the foreign exchange resources of the Philippine banking, and iii) Long-term obligations under capital lease agreements. 25 PHILIPPINE QUARTERLY UPDATE - July 2012 Table 4. Philippines: National Government Cash Accounts (GFS Basis), 2008-12 2008 2009 2010 2011 2012 Jan-Apr Year Jan-Apr Budget WB proj. (in percent of GDP, unless otherwise stated) Revenue and grant 15.2 14.0 13.4 4.7 14.0 4.9 14.2 14.0 Tax revenue 13.6 12.2 12.1 4.0 12.3 4.2 13.1 12.8 Net income and profits 6.2 5.2 5.4 2.0 5.9 2.0 5.9 6.1 Excise tax 0.8 0.7 0.7 0.2 0.7 0.2 0.6 0.9 Sales taxes and licenses 2.3 2.7 2.4 0.8 2.4 0.9 2.7 2.5 Others 0.8 0.6 0.7 0.2 0.7 0.2 0.6 0.8 Collection from Customs 3.4 3.1 2.9 0.9 2.7 0.9 3.3 2.5 1/ Nontax revenue 1.6 1.7 1.3 0.7 1.6 0.7 1.1 1.2 Grant 0.0 0.00 0.0 0.0 0.0 0.0 0.0 0.0 2/ Total expenditure 16.7 17.9 17.0 4.8 16.1 4.9 16.9 17.0 Current expenditures 13.6 14.3 13.8 4.1 13.3 4.2 13.4 13.5 Personnel services 4.9 5.2 5.2 1.5 5.1 1.5 5.4 5.4 MOOE 1.8 2.1 2.0 0.5 2.1 0.7 2.4 2.5 Allotment to LGUs 2.2 2.5 2.4 0.8 2.4 0.7 2.0 2.0 Subsidies 0.2 0.2 0.2 0.1 0.5 0.1 0.2 0.3 Tax expenditures 0.8 0.6 0.5 0.1 0.3 0.1 0.3 0.3 Interest payment 3.7 3.7 3.4 1.1 3.0 1.1 3.1 3.0 Capital outlays 2.9 3.4 3.1 0.6 2.6 0.7 3.3 3.3 Net lending 0.2 0.2 0.1 0.1 0.2 0.0 0.2 0.2 Balance (GFS definition) -1.5 -3.9 -3.6 0.0 -2.1 -0.1 -2.7 -3.0 Balance (GOP definition) -0.9 -3.7 -3.5 0.0 -2.0 0.0 -2.6 -2.9 Primary Balance (GFS) 2.2 -0.3 -0.2 1.0 0.8 1.1 0.4 0.0 Memorandum items Privatization receipts (PHP billion 31.3 1.4 0.9 0.7 0.9 0.0 2.0 2.0 CB-BOL interest payments (% of GD 0.2 0.2 0.1 0.0 0.1 0.0 0.1 0.1 3/ Nominal GDP (PHP trillion) 7.7 8.0 9.0 9.7 9.7 10.6 11.0 10.6 Source: Department of Finance, Bureau of Treasury, and Department of Budget and Management 1/ This excludes privatization receipts. These are treated as financing items in accordance with the Government Financial Statistics Manual (GFSM). 2/ Data are sourced from the Department of Budget and Management. Allocation to local government (LGUs) units excludes capital transfers to LGUs. They are included in national government capital outlays. 3/ Nominal GDP is based on World Bank staff estimate. 26 Investing in Inclusive Growth Amid Global Uncertainty Selected Special Focus from Previous Quarterly Updates March 2012 PQU: From Stability to Prosperity for All Financing the Economic Costs of Disasters in the Philippines: Challenges and Opportunities. The Philippines is one of the most disaster-prone countries in the world. It is regularly hit by earthquakes and typhoons. These natural disasters, in particular typhoons, have grave social and economic consequences for the country. About 1,000 lives are lost every year and the estimated cost to the economy is almost one percent of GDP per year. The fiscal capacity of the general government to mitigate risks and address these costs is limited. The amount of funds available is well below 10 percent of the total direct property damages incurred annually. Recent disasters suggest that the country needs up to five percent of GDP to mitigate risks and rebuild damaged properties. Recognizing this shortcoming, the government recently revamped its disaster and risk management strategy from ex- post reconstruction to ex-ante preparedness. Moreover, the Philippine government is preparing an analytic framework and strategy to explore the feasibility of disaster risk financing and transfer options to address the layers of risks faced by the country. In this process, the government could employ a risk layering methodology, commonly adopted in corporate risk management, to improve overall risk management. Cycles of Conflict and Displacement in Mindanao. This special focus summarizes the results of a major survey conducted in and around the Autonomous Region in Muslim Mindanao (ARMM) to understand the people’s experience of conflict and displacement in the past decade. The findings are analyzed in a joint World Bank-World Food Programme (WB-WFP) report entitled “Violent Conflicts and Displacement in Central Mindanao: Challenges for Recovery and Development.� The results highlight the frequency and prevalence of displacement, and the damage done to livelihood, access to services, and social cohesion. The study makes some recommendations on how to improve support to vulnerable households and shape strategies for sustainable peace. The Philippine Real Estate Market: A Cause for Concern? The real estate market plays a unique role in economic development and financial stability. Boom-bust cycles are intrinsic in real estate markets and impact the economy directly and indirectly through other sectors such as construction and finance. Real estate is often the largest store of wealth in any economy. In the Philippines, households tend to have greater preference for holding wealth in the form of real estate rather than equities. Given these, a closer look at real estate market developments is a critical element of ensuring macroeconomic stability. The Philippine real estate market today is largely driven by BPOs and remittances and less on investors seeking higher returns. Borrower leverage is low and banks have more prudential measures in place. Overall, systemic risks are fairly low, although the residential segment may face downside risks arising from oversupply, hence, the need for careful monitoring. Stepping Up Disbursements by Improving Absorptive Capacities in Agencies. Weak public spending, especially in the first half of 2011, slowed down Philippine economic growth last year. In October 2011, the Aquino government launched the PhP 72 billion Disbursement Acceleration Plan (DAP). The DAP strategy entailed identifying slow-moving projects, including unspent allocations, and then realigning them to i) agencies that can quickly disburse funds, ii) programs and projects that have poverty reduction impact, and iii) programs and projects that have big multiplier effects. While the strategy helped to boost public spending in the last quarter of 2011, the mere realignment of funds does not 27 PHILIPPINE QUARTERLY UPDATE - July 2012 guarantee sustained improvement in public spending to address growth and poverty targets. A long- term strategy should address internal bottlenecks in national government agencies, which include low absorptive capacity of agencies and weak monitoring and evaluation system, among others. December 2011 PQU: Sustaining Growth in Uncertain Times Raising Excise Taxes on Tobacco and Alcohol Products. The real revenue yield from excises on tobacco and alcohol has declined significantly since 1997. As a result, from 1997 to 2009, excise collection as a share of GDP fell by about 0.6 percentage points from an already low yield of 1.2 percent of GDP. Quite alarming, Philippine tobacco excise tax rates and burden are among the lowest in South East Asia. Raising excise tax revenues requires i) shifting from multiple to uniform excise tax rates, ii) raising excise tax rates closer to international benchmarks and indexing to nominal GDP growth thereafter, and iii) improving tax administration to minimize leakages from smuggling and evasion. A first best reform would yield as much as 1.3 percent of GDP in additional revenues over the next five years. This incremental revenue would enable the government to increase its human and physical investment to improve the country’s growth and development prospects. Philippine Exports: Where Do They Stand? Despite being an open economy, the Philippines’ openness to trade is lower than its neighbors and its exports have been growing slower than GDP. Export diversification has improved in terms of market destination (e.g., more exports to China and other emerging markets and less to the US) but not in terms of product line. The global market share of its main export, semiconductors, has continued to decline. This is in part due to the adverse external environment, changing technology that the Philippines has yet to fully adopt (e.g., new generation gadgets such as tablet computers and smart phones), and stagnant physical capital per worker. In terms of exports survival, the Philippines scores the lowest among comparable ASEAN countries. Thus, improving the country’s business environment, particularly in non-PEZA areas, will be essential to boost physical investments, encourage innovations, and promote investments in human capital so that the country can better internalize and harness advanced technologies and business know-how embedded in foreign direct investments. In terms of services exports, a more efficient regulatory system would improve the industry’s productivity, thus improving its competitiveness. September 2011 PQU: Solid Macroeconomic Fundamentals Cushion External Turmoil External Spillovers to Philippine Growth. During 1997-2011, shocks from East Asian-3 economies, China in particular have become more important for ASEAN-5 including the Philippines than those from the United States and the Euro zone. Spillovers of East Asian economies’ shocks are channeled to the Philippines through trade, while the United States and the Euro zone shocks are transmitted largely through financial variables. The findings suggest that vigorous growth in the East Asian economies can cushion declines in demand from the West. The 2012 Proposed National Government Budget. The 2012 national budget is a results-focused budget and calls for higher spending in general, particularly on social services. The budget will rest on increased revenue collection efficiency by broadening the tax base and improving tax administration and collection efforts. The Administration aims to lower government debt payment for 2012, which would release additional resources available for priority spending. The budget continues to employ the zero- based budget approach to rationalize expenditures and includes reforms to make further progress in improving spending efficiency, transparency, and accountability. Some of the major reforms include (i) 28 Investing in Inclusive Growth Amid Global Uncertainty fleshing out lump sum funds and (ii) tightening the use of savings, particularly from unfilled authorized positions. The reform in the use of savings implies that the government agencies and institutions, in particular those in the education sector, need to speed up on hiring. For poverty reduction and inclusive growth, higher spending on priority areas (education and health in particular) is required – an increase to 5-7 percent of GDP. To support this additional spending needed, the government needs to continue to strive for heightened revenue mobilization. June 2011 PQU: Generating More Inclusive Growth Poverty and Inequality in the Philippines. The recently released 2009 poverty estimates and household survey (FIES) provide a much needed update on poverty, inequality and income dynamics in the Philippines. The FIES reveals that in contrast with previous trends, household per capita incomes grew from 2006 to 2009 and that, remarkably, rural and poorer households strongly outperformed. However, despite this increase and a resilient economy poverty incidence continued to increase through 2009 though, some improvements occurred in both the gap and severity of poverty. Therefore, poverty, and especially poverty dynamics, in the Philippines remains worse than its neighbors. Spatially, poverty remains highly concentrated in rural areas and in terms of sectors, households that rely on agricultural income are significantly more likely to be poor than other households. From 2006 to 2009, poverty in urban areas increased more rapidly, became more severe, and contributed more to the continuous increase in poverty. Across regions, 10 of the 17 administrative regions experienced an increase in poverty incidence. The Service Sector in the Philippines. The service sector has the potential to play an important role in promoting inclusive growth in the Philippines. The sector is already large and has been an important driver of employment and GDP growth. However, this has not necessarily led to a rise in the average quality of jobs or productivity gains. Unshackling the constraints on services as a source of inclusive growth will require broad-based policy action: providing higher quality education for all to meet the demand for skills as services move up the value chain; improving infrastructure and enabling policies to facilitate agglomeration economies; removing investment climate distortions to allow services firms to invest and innovate. The 2011 National Accounts Revisions (1998-2010). The Philippines recently revised its national accounts series for the period 1998 to 2010. The revisions involve shifting to a new base year (from 1985 to 2000) and adopting most of the recommendation of the System of National Accounts (SNA) 1993 and some recommendations of SNA 2008. The new series shows roughly the same GDP growth though sectoral growth varies. The revisions led to a significantly higher investment-to-GDP ratio and to a higher level nominal GDP—of about 6 percent for 2010. Finally, the previously large statistical discrepancies between the production and the expenditure accounts have largely been eliminated through a methodological improvement that made use of the supply-and-use table. 29 PHILIPPINE QUARTERLY UPDATE - July 2012 30