Philippines Economic Update JUNE 2021 EDITION Navigating a Challenging Recovery PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 1 PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION I Preface The Philippines Economic Update (PEU) summarizes key economic and social developments, important policy changes, and the evolution of external conditions over the past six months. It also presents findings from recent World Bank analyses, situating them in the context of the country’s long-term development trends and assessing their implications for the country’s medium-term economic outlook. The update covers issues ranging from macroeconomic management and financial-market dynamics to the complex challenges of poverty reduction and social development. It is intended to serve the needs of a wide audience, including policymakers, business leaders, private firms and investors, and analysts and professionals engaged in the social and economic development of the Philippines. The PEU is a biannual publication of the World Bank’s Macroeconomics, Trade, and Investment (MTI) Global Practice (GP), prepared in partnership with the Finance, Competitiveness and Innovation (FCI); Poverty and Equity; Social Protection and Jobs (SPJ); and Governance Global Practices. Lars Christian Moller (Practice Manager for the MTI GP), Souleymane Coulibaly (Lead Economist and Program Leader), and Rong Qian (Senior Economist) guided the preparation of this edition. The team consisted of Kevin Chua (Senior Economist), Kevin Cruz (Economist), Karen Lazaro (Research Analyst), Eduard Santos and Ludigil Garces (Consultants) from the MTI GP, Isaku Endo (Senior Financial Sector Specialist) and Heejin Lee (Private Sector Specialist) from the FCI GP, Nadia Belghith (Senior Economist) and Sharon Piza (Economist) from the Poverty & Equity GP, Yoonyoung Cho (Senior Economist), Ruth Rodriguez (Social Protection Specialist), and Arianna Zapanta (Consultant) from the SPJ GP, and Ronald Mutasa (Program Leader), Ramana Gandham (Consultant), Ekaterina Vashakmadze (Senior Economist), and Ergys Islamaj (Senior Economist). Kevin Cruz, Karen Lazaro, Cha Crisostomo (Consultant), and Eduard Santos prepared the Special Focus Note on the Local Public Service Delivery in the Context of the Mandanas Ruling with inputs from Ahya Ihsan (Senior Economist), Blane Lewis (Consultant), Eli Weiss (Senior Agriculture Economist), and Lewis Hawke (Lead Public Sector Specialist), and under the guidance of Rong Qian, Madhu Raghunath (Sector Leader), and Lewis Hawke. The report was edited by Oscar Parlback (Consultant), and the graphic designer was Pol Villanueva (Consultant). Peer reviewers were Yue Man Lee (Senior Economist), Chadi Bou Habib (Lead Economist), and Kai Kaiser (Senior Economist). Logistics and publication support were provided by Elysse Miranda (Team Assistant) and Kristiana Rosario (Team Assistant). The Manila External Communications Team, consisting of Clarissa David (Senior Communications Officer) and David Llorito (Communications Officer), prepared the media release and web-based multimedia presentation, and Stephanie Margallo provided team assistance. The team would like to thank Ndiame Diop (Country Director for Brunei, Malaysia, Philippines, and Thailand) for his advice and support. The report benefited from the recommendations and feedback of various stakeholders in the World Bank as well as from the government, the business community, labor associations, academic institutions, and civil society. The team is grateful for their contributions and perspectives. The findings, interpretations, and conclusions expressed in the PEU are those of the authors and do not necessarily reflect the views of the World Bank’s executive board or any national government. If you wish to be included in the email distribution list for the PEU and related publications, please contact Elysse Miranda (emiranda2@worldbank.org). For questions and comments regarding the content of this publication, please contact Mr. Kevin Chua (kchua1@worldbank.org). Questions from the media should be addressed to David Llorito (dllorito@worldbank.org). For more information about the World Bank and its activities in the Philippines, please visit www.worldbank.org/ph. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION II Table of Contents Preface II Table of Contents III List of figures IV List of tables V List of boxes V Abbreviations and acronyms VI Executive Summary VII Part I. Recent Economic and Policy Developments 1 1.1 Economic Growth: Cost of Containment 2 1.2 The Exchange Rate and the External Sector: Stable Peso Amid Recovery 6 1.3 Inflation and Monetary Policy: Accommodative Policy Amid Rising Inflation 10 1.4 Fiscal Policy: Balancing Support and Sustainability 14 1.5 Employment and Poverty: Rise of Low-Paying Jobs Despite Labor Market Rebound 15 Part II. Outlook and Risks 17 2.1 Growth Outlook 18 2.2 Poverty and Shared Prosperity 27 2.3 Risks and Policy Challenges 28 Part III. Understanding the Fiscal Impact of the Mandanas Ruling 30 3.1 Revisiting Decentralization in the Philippines 31 3.2 Unfulfilled Promise of Decentralization 34 3.3 The Mandanas Ruling: Policy Challenges and Initial Response 37 3.4 Potential Fiscal Impact of the Mandanas Ruling 38 3.5 Policy Recommendations 45 Annex 1: Methodology in Estimating Post-Mandanas Budget Execution Rates 50 References 51 PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION III List of figures Figure 1. The Economy contracted for the fifth consecutive quarter. 2 Figure 2. The contraction was broad-based. 2 Figure 3. The global economy contracted 4.3 percent in 2020. 4 Figure 4. The global trade in goods has returned to December 2019 levels. Figure 5. From mostly sharp contractions throughout 2020, both imports and exports of goods indicate recovery in early 2021 7 Figure 6. The contraction in FDI was less pronounced in the Philippines than in many other regional peers in 2020. 7 Figure 7. Across key sectors, the FDI regulatory framework is more restrictive in the Philippines than in regional peers. 8 Figure 8. The financial system appears to have adequate capital buffers. 11 Figure 9. NPLs remain manageable but asset quality needs close monitoring. 11 Figure 10. Firms experiencing financial constraints (% firms). 12 Figure 11. Absolute Change in Nominal Credit Growth in Select EAP countries January 2020 Latest available month (percentage points). 12 Figure 12. Inflation breached the BSP’s target range in the first three months of 2021. 13 Figure 13. The past-due loans ratio and the share of non-performing loans rose. 13 Figure 14. The fiscal deficit reached a record high in 2020 amid a sharp rise in public spending. 14 Figure 15. The debt-to-GDP ratio rose to its highest level since 2006. 14 Figure 16. Labor Force Participation Rate, January 2018–March 2021. 15 Figure 17. Unemployment and Underemployment Rates, January 2018–March 2021. 15 Figure 18. Economic growth is expected to recover in the medium term. 18 Figure 19. Consumer sentiments remained in negative territory in early 2021. 18 Figure 20. Regional comparison of vaccine doses administered per 100 people. 20 Figure 21. Cumulative vaccine doses administered per 100 people. 20 Figure 22. While the global economy is expected to grow by 4.0 percent in 2021, … 23 Figure 23. … there are downside risks to the projections. 23 Figure 24. The Philippines may benefit from an increase in exports to the US and other advanced economies. 26 Figure 25. Faster global growth could lead to an increase in overseas remittance inflows. 26 Figure 26. Actual and projected $3.20-a-day povery rates (%) 27 Figure 27. Despite devolution, public spending remains heavily centralized in the Philippines… 31 Figure 28. …even for heavily devolved sectors such as health and economic services. 31 Figure 29. The Mandanas Ruling will lead to a sharp increase in Internal Revenue Allotment allocations… 33 Figure 30. … which is projected to increase the share of Internal Revenue Allotment in 2022. 33 Figure 31. Spending on general public services represents the largest share of local government budgets. 35 Figure 32. Poorer local governments need to allocate a larger share of their budgets to general services. 35 Figure 33. Following devolution, there has been a mismatch between local governments’ ability to generate own revenues and their expenditure responsibilities. 35 Figure 34. Local governments in the Philippines rely on intergovernmental transfers to bridge the fiscal gap, similar to other countries. 35 Figure35. City governments are less dependent on the Internal Revenue Allotment than their provincial and municipal counterparts. 35 Figure 36. Poorer local governments are almost solely reliant on the Internal Revenue Allotment to finance spending. 35 Figure 37. The size of the budget is one of the key drivers of budget execution among local government units. 38 Figure 38. The execution of capital outlays is far lower than that of recurrent spending. 39 Figure 39. A higher share of the capital outlays is associated with lower budget execution rates (ER) regardless of sector…39 Figure 40. …a trend also observed across local government levels. 39 Figure 41. Change in budget, capital outlay share, and execution rates under Case 1 41 Figure 42. Change in budget, capital outlay share, and execution rates under Case 2 41 Figure 43. Budget execution is expected to fall post-Mandanas Ruling, as the share of capital outlays rise. 42 Figure 44. Existing vertical imbalances among local government units are likely to widen with the implementation of the Mandanas Ruling. 43 Figure 45. Internal Revenue Allotments are expected to represent an even larger share of local government PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION IV units’ total revenues following the Mandanas Ruling. 44 Figure 46. The horizontal gap between the spending per capita of rich and poor local governments is expected to persist post-Mandanas. 44 List of tables Table 1. Balance of Payments, 2016–2020 7 Table 2. Foreign Equity Limits on FDI among ASEAN Countries. 8 Table 3. Economic Indicators for the Baseline Projections. 22 Table 4. Real Growth Projections. 24 Table A1. Estimating elasticities of total budget on total revenue using ordinary least squares regression 50 Table A2. Estimating elasticities of total budget execution rate on capital outlay budget share using ordinary least squares regression 50 List of boxes Box 1. Recent Global Developments 4 Box 2. Foreign Direct Investment Restrictiveness in the Philippines 8 Box 3. Recent Developments in the Financial System 11 Box 4. The Impacts of COVID-19 Vaccination on the Economy Match its Impacts on Public Health 20 Box 5. Global Economic Outlook 23 Box 6. Spillover to the Philippines from the U.S. Fiscal Stimulus 25 Box 7. The 1991 Local Government Code. 32 Box 8. Case Studies of Select local government units focusing on key drivers of budget execution 40 Box 9. Local Infrastructure Project Implementation Challenges 43 Box 10. The Philippine Rural Development Program: A model for Capacity Building 47 Box 11. Impact of the Government Responses to the Mandanas Ruling in BARMM 48 PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION V Abbreviations and acronyms ACT Access to COVID-19 Tools FPI Foreign portfolio investments ASEAN Association of Southeast FSI Financial soundness Asian Nations indicators ASF African swine fever FSSA Financial system stability BARMM Bangsamoro Autonomous assessment Region in Muslim Mindanao GDP Gross domestic product BLGF Bureau of Local Government GOP Government of the Finance Philippines BOP Balance of payments GPS General public services BPO Business process outsourcing IIF Institute of International BSP Bangko Sentral ng Pilipinas Finance CAR Capital adequacy ratio IMF International Monetary Fund CDPs Community development plans IRA Internal revenue allotment CEPI Coalition for Epidemic LFPR Labor force participation rate Preparedness Innovations LFS Labor force survey CIT Corporate income tax LGC Local government code CLUP Comprehensive land use plan LGUs Local government units COA Commission on Audit MOOE Maintenance and other COs Capital outlays operating expenses COVAX COVID-19 Vaccines Global NDVP National deployment and Access vaccination plan COVID-19 Coronavirus disease 2019 NEDA National Economic and CREATE Corporate Recovery and Tax Development Authority Incentives for Enterprises Act NG National government DA Department of Agriculture NGAs National government DBM Department of Budget and agencies Management NHA National Housing Authority DILG Department of the Interior NPL Non-performing loans and Local Government OECD Organisation for Economic DOF Department of Finance Cooperation and DOH Department of Health Development DPWH Departments of Public Works OFWs Overseas Filipino workers and Highways PCIP Provincial commodity DTP Devolution transition plans investment plans EAP East Asia and the Pacific PMI Purchasing Managers’ Index ECQ Enhanced community PRDP Philippine Rural Development quarantine Project EMDEs Emerging market and PS Personnel services developing economies PSA Philippine Statistics Authority EO Executive order RTLA Retail Trade Liberalization Act ERs Budget execution rates U.S. United States FDI Foreign direct investment UNCTAD United Nations Conference FIA Foreign Investment Act on Trade and Development FINL Foreign investment WHO World Health Organization negative list PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION VI Executive Summary Recent Developments The resurgence of COVID-19 cases and reimposition The central bank continues to be accommodative despite of more stringent quarantine measures held back the inflation breaching the target range. The Bangko Sentral early signs of an economic rebound. The downside ng Pilipinas (BSP) maintained its key policy rate at 2.0 risk of a resurgence of infection, identified in the PEU percent throughout the first four months of 2021 to support December 2020 edition, has unfortunately materialized. the economic recovery. This is despite headline inflation The number of daily cases increased from an average of averaging 4.5 percent in the first four months, breaching 1,400 in December 2020 to nearly 10,000 in April 2021. The the 2-4 percent inflation target range. Elevated food prices surging cases prompted the authorities to reimpose stricter were caused by harvest losses due to typhoons in end- quarantine measures in Metro Manila and nearby provinces 2020, and lower pork supply due to a disease outbreak. for more than one-and-a-half months between April and Stable core inflation and supply-driven price pressure May. Since then, daily cases have gone down gradually solidified the view that the uptick in inflation is transitory. and critical care occupancy rates have eased. However, In addition to keeping the key policy rate steady, the BSP the quarantine and movement restrictions have hampered has previously engaged in open market operations, and people’s mobility, adversely affecting domestic activity. continued the implementation of regulatory measures to minimize the economic fallout of the pandemic, suchas the The economy contracted by 4.2 percent year-on-year in zero percent risk weight for the guaranteed loans of micro, the first quarter of 2021 amid prolonged implementation small, and medium-sized enterprises,and the fee waivers for of containment measures. The country registered the fund transfer transactions through the BSP’s payment and worst growth performance among peers in the region settlement system. such as Thailand (-2.6 percent), Indonesia (-0.7 percent), Malaysia (-0.5 percent), and Vietnam (4.5 percent). The Despite signs of a labor market recovery in the first growth contraction was fueled by weak domestic demand, quarter of 2021, the quality of jobs is of concern. The labor driven by the combination of containment measures, weak force participation rate reached 65.0 percent in March 2021, confidence, and rising inflation. Meanwhile, tepid external surpassing the pre-pandemic level of 61.7 percent in January demand was driven by the sharp contraction in services 2020 and peaking to its highest level since January 2018. exports amid lingering restrictions and weak demand Notwithstanding the increasing number of workers in the for international tourism while goods exports recovered. labor force, the unemployment rate decreased to 7.1 percent The public sector was the main driver of growth with an in March 2021 after remaining steady at 8.7-8.8 percent in expansionary budget. the past five months. Among the employed, however, there was an increase in the share of self-employed and non-paid The authorities are supporting the economic recovery workers, while the share of part-time workers remained by accelerating public spending. Stimulus spending and significantly higher than the pre-pandemic level. Likewise, infrastructure investment drove public spending from 19.1 the underemployment rate remained at around 16-18 percent percent of GDP in the first quarter of 2020 to 23.4 percent in the first quarter of 2021, higher than the pre-pandemic of GDP in the same period in 2021. The spending is in level. line with the continuing implementation of the pandemic response measures under the “Bayanihan to Recover as Outlook and Risks One” Law (Bayanihan 2) which was extended to June 30, 2021. The higher spending comes at a time when public The growth prospects hinge on the country’s ability revenues fell from 17.2 percent of GDP in the first quarter of to manage the COVID-19 health crisis. The medium- 2020 to 16.0 percent of GDP in the same period in 2021. term growth trajectory depends on effective pandemic This resulted in an increase in the fiscal deficit to 7.4 percent containment, delivery of mass vaccination, and further of GDP in the first quarter of 2021 from 1.9 percent of GDP loosening of mobility restrictions. The sudden surge in a year ago. The widening deficit was accompanied by an COVID-19 cases in March-April 2021 showed the difficult increase in the public debt ratio from 54.5 percent of GDP challenge at hand. While mass vaccination began in March, by end-2020 to 60.4 percent of GDP as of end-March 2021. global vaccine supply constraints and vaccine hesitancy PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION VII among Filipinos may delay widespread local inoculation. Filipinos to get vaccinated. Following the government’s vaccination plans, the growth projection assumes that vaccination will accelerate in The effective delivery of social protection programs will the second half of 2021 with the arrival of more vaccine help to reduce the extent to which the crisis adversely supplies.. Consequently, domestic demand is expected to affects long-term human capital accumulation. COVID-19 gradually pick up this year, before accelerating in 2022. pandemic-related shocks, including hunger incidences, have manifested in higher levels of child malnutrition, especially The economy is projected to expand at 4.7 percent in among the poor. It is important to reduce the extent of these 2021, before accelerating to 5.9 percent in 2022 and losses, and mitigate the shocks from resulting in a persistent 6.0 percent in 2023. The recovery is anchored on an impact on wellbeing and future economic opportunities. anticipated global rebound, including in the country’s Social programs, including cash transfers, can help alleviate key trading partners. This will translate into higher export food and subsistence conditions. However, moving swiftly demand and better prospect of remittances. Domestically, as to provide transfers and support to poor households will vaccination efforts progress and the rate of infection slows, require an improvement in the government’s delivery and consumer and business confidence will gradually improve implementation capacity. National and local government and normalize. The administration’s continued commitment authorities need to coordinate their efforts to ensure timely to delivering infrastructure projects will contribute to public and efficient deployment of public programs. investment growth. However, market uncertainty and weaker lending activities may temper private investment. Following Mobilizing private sector participation in public the deep contraction in 2020, a base effect will also infrastructure projects will be important as the contribute to increased growth in 2021, while the national government faces limited fiscal space in the short term. election is projected to boost economic activity in 2022 as it The public financing needs will remain elevated as public has done in previous election cycles. revenues are tempered by the weak economy while public expenditures increase to address the pandemic. The Growth prospects are subject to significant downside limited fiscal space will compel the authorities to pursue risks. A resurgence of infection due to the entry of new fiscal consolidation in the medium term. The government’s virus variants is the most significant risk, which may yet infrastructure investment agenda will strongly benefit from overwhelm the healthcare system. Scaling up testing, greater private sector participation through a renewed focus tracing, isolation, and treatment measures, along with the on public-private partnership, for which the country has rollout of the vaccination program are key to the public successful experience. Part of the formula s relaxing foreign health response. However, tight global production supply direct investment (FDI) restrictions. Regulations related to and vaccine nationalism risk delaying the arrival of vaccines. foreign investments remain restrictive in the Philippines. Failure to effectively contain the virus or implement the The Philippines faces even tighter competition, as some mass vaccination program may extend mobility restrictions, regional peers also recently implemented various incentives which could lead to further job and income losses, disrupt to attract investors. The passage of three investment reform businesses, and delay economic recovery. There are also bills: Public Service Act, Retail Trade Liberalization Act, and external risks including the risk of a slower-than-expected the Foreign Investment Act, will help improve the country’s global recovery, disruptions in international logistics and competitiveness in the region. global value chains, and trade protectionism. Special Focus: Subnational Finance The key health policy response remains the management of the virus spread, complemented with the roll out of The authorities need to prudently manage institutional the vaccination program. Public health protocols such as changes including the implementation of the Mandanas mask wearing and physical distancing remain the first line of Ruling in 2022. The Mandanas Ruling will raise Internal defense to manage the spread of the virus specially as case Revenue Allotment transfers to LGUs by 55 percent in numbers remain elevated. Testing, tracing, isolation and case 2022, reaching Php1.08 trillion (4.8 percent of GDP) from 3.5 management have to be scaled up, along with expedient roll percent of GDP in 2021. The substantial increase in transfers out of vaccines. The vaccination program requires stringent has prompted the national government to rethink its planning, effective implementation, and more importantly, approach towards decentralization, which remains below its seamless coordination between the national government, local potential for effective service delivery. The implementation government units (LGUs), and the private sector. As vaccine of the Ruling comes at a time of limited fiscal space. hesitancy remains high, the authorities may consider dialogue- Moreover, the Philippines’ experience in decentralization has based or incentives-based interventions to encourage more demonstrated significant gaps in the effectiveness of local PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION VIII public service delivery. and quantity of service delivery. Lastly, the mechanisms for holding local chief executives accountable for Effective service delivery has been constrained by four performance are weak and frequently ineffective. structural challenges that have negatively affected the incentives and capacity of local governments to fulfill Overcoming the structural challenges while managing their primary role as basic service providers. First, LGUs the transition towards increased decentralization collect insufficient revenues and this contributes to a require the following: (i) address horizontal inequity mismatch given service delivery responsibilities. Second, the through strong fiscal equalization; (ii) provide capacity intergovernmental fiscal transfer system creates horizontal building support to LGUs; and (iii) create an environment fiscal imbalances and inequality across local governments. of increased demand for transparency and accountability. Third, overlapping service delivery responsibilities across In the short-term, addressing the implementation different levels of government diffuse accountability. Fourth, challenges due to the Mandanas Ruling requires LGUs continue to depend on national government for the immediate clarification on the re-devolved functions, and delivery of devolved public services due to the lack of communicating these clearly to national government technical capacity. agencies and LGUs. In the medium-term, the national government must provide strong fiscal equalization In addition to these structural weaknesses, the by continuing to support LGUs that lack capacity and government faces several policy challenges in resources. The national government and implementing implementing the Mandanas Ruling. To maintain agencies could strengthen local government capacity fiscal sustainability, the increase in inter-governmental on providing an enabling environment for LGUs that fiscal transfers need to be compensated by additional assigns responsibilities according to available capacity revenue or expenditure reducing measures. As a result, and ensures a highly participatory process involving the national government plans to transfer devolved learning by doing. In the long-term, revisiting the Local functions currently assumed by the national government Government Code is needed to address systemic back to local government units equivalent to 1 percent issues on own-source revenue generation, address of GDP during the implementation of the Ruling. the horizontal fiscal imbalances created by the current However, coordination challenges between the national Internal Revenue Allotment formula, and clear assignment government and LGUs could jeopardize the quality of service delivery responsibilities. Photo: Michael D Edwards PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION IX Part I Recent Economic and Policy Developments The recent surge in COVID-19 cases and the return to strict containment measures in Metro Manila and nearby provinces have derailed the early signs of an economic rebound. Rising inflation, driven by higher food prices, has also emerged as a key challenge in early 2021. While there have been improvements in job creation and labor force participation in recent months, underemployment and the share of part-time workers have risen. The authorities have continued to support the economy by expanding public spending, led by stimulus and other support measures as well as infrastructure spending, while maintaining an accommodative monetary policy stance. Photo: ultramansk PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 1 1.1 Economic Growth: Cost of Containment The Philippines registered a contraction for the fifth consecutive quarter in Q1 2021, the longest recession since the 1985 debt crisis. The contraction was driven by the continued slump in private domestic demand amid rising inflation, income losses, and continued implementation of containment measures. The resurgence of new COVID-19 cases has derailed The economy contracted by 4.2 percent in the first the early signs of the country’s economic rebound in quarter of 2021 amid prolonged implementation of 2021. The gradual reduction in new COVID-19 cases from containment measures and a deterioration in domestic the initial peak of 4,477 per day in mid-August to around demand conditions. The country registered the worst 1,100 in January 2021, led to a relaxation of restrictions growth performance among peers in the region in Q1 2021 on the economy. This improvement paved the way for a such as Thailand (-2.6 percent), Indonesia (-0.7 percent), rebound in mobility and economic activity in early 2021. Malaysia (-0.5 percent), and Vietnam (4.5 percent growth). As lockdown restrictions were relaxed, employment and The pandemic continues to impact the economy through earnings generally improved though not enough to offset both external and domestic channels. Through the external the earlier declines. Moreover, the Philippines benefited channel, services exports contracted sharply owing to from an improved external environment, as goods trade lingering restrictions and weak demand for international expanded amid an improving global environment. High tourism and travel while goods exports recovered. Through frequency data in the first three months of 2021 suggested the domestic channel, the Philippines continues to a recovery in economic activity was on its early stages. implement containment measures, which further tightened However, the surge in COVID-19 cases beginning in March, towards the end of the first quarter amid a surge in cases to and rising inflation derailed the recovery momentum as a peak of about 15,000 in early April. The public sector was economic growth fell short of market expectations. the main driver of activity, benefitting from an expansionary budget which aims to support economic recovery. Figure 1. The Economy contracted for the fifth consecutive Figure 2. The contraction was broad-based. quarter. 10 15 8 10 6 5 4 0 2 Percentage point Percentage point 0 -5 -2 -10 -4 -15 -6 -20 -8 -25 -10 Agriculture -12 Manufacturing -30 -14 Other industries Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Services 2018 2019 2020 2021 -16 GDP growth -18 Net exports -20 Investments Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Government Consumption 2018 2019 2020 2021 Household Final Consumption Expenditure GDP Growth Source: Philippine Statistics Authority (PSA). Note: Other industries are mining and quarrying, construction, electricity, gas, and water. Source: PSA. 1 All growth numbers are year-on-year unless otherwise stated. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 2 Private domestic demand continued to drive the growth On the production side, strict containment measures and contraction. Private consumption contracted by 4.8 percent weak demand led to the decline in industry and services in the first quarter of 2021 driven by movement restrictions output. Soft demand and production disruptions resulted in that suppressed consumption, and declining incomes the contraction of industry output by 4.7 percent in the first amid poor employment outcomes and rising inflation. The quarter of 2021. The decline in output was led by the large consumption of non-essential goods and services and those contraction in the private construction sector, likely driven impacted by mobility restrictions continued to experience the by delays and postponement of construction projects2. sharpest contractions. Meanwhile, investment activity was Improved global trade led to a slight uptick in manufacturing dampened by elevated levels of uncertainty, a deterioration output (0.5 precent), the first expansion since the fourth in business confidence, loss of revenue and incomes, quarter of 2019. Meanwhile, the services sector contracted and limited access to finance. Investment contracted by by 4.4 percent, impacted by mobility restrictions, falling 18.3 percent, in which, investments in private construction incomes, and a change in consumer behavior. However, and durable equipment fell by nearly 30 percent. sectors such as health, information, communication, and finance registered positive growth, benefitting from Despite a recovery in goods exports, services trade increased reliance on their services. In particular, both the remained depressed owing to lingering restrictions in communication and finance sectors benefitted from the shift travel and tourism. Exports fell by 9.0 percent in the first of many activities online, adapting to ‘new normal’ conditions. quarter of 2021, driven by the 21.0 percent contraction in services exports. Travel restrictions weighed heavily on Agricultural output fell for the second consecutive travel and transport exports services, which contracted by quarter, driven by the contraction in livestock and poultry 97.7 percent and 34.1 percent, respectively, in the first quarter supply. The agriculture sector contracted by 1.2 percent, of 2021. However, merchandise exports expanded by 2.4 primarily due to a significant contraction in livestock (-23.2 percent in the first quarter of 2021, benefitting from the percent) and poultry (-7.4 percent) output.3 In particular, the recovery in global economic activity (Box 1). In particular, the sharp decline in livestock output was driven by the ongoing goods trade has shown signs of recovery since late 2020 outbreak of the African Swine Fever which has affected as the country benefitted from a recovery in global demand around one-third of the country’s hog population. Meanwhile, for its exports, particularly in electronic products. Meanwhile, crop production recovered in the first quarter of 2021, as imports declined by 8.3 percent, driven by the sharp crop output grew by 3.5 percent. Crop output benefitted contraction in services imports (-33.2 percent), most notably from relatively fair conditions in the first quarter of 2021, in in travel and transportation, amid ongoing travel restrictions contrast to the previous quarter, as output suffered from and weak demand for international tourism. Meanwhile, damages due to several strong typhoons. merchandise imports contracted marginally by 1.6 percent. Photo: Stephane Bidouze 2 Approved construction projects fell by nearly 40 percent in 2020, based on approved building permits collected by the PSA. 3 These sectors account for roughly a fifth of total agricultural output. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 3 Box 1. Recent Global Developments. Following a heavy contraction in 2020, the global homogeneous across countries, with China and advanced economy recovered in the first few months of 2021. economies largely leading the rebound. Furthermore, the The global economy contracted 4.3 percent in 2020, rapid recovery in trade has led to a sharp increase in freight with advanced economies and emerging markets and prices amid congestions at shipping ports, which, together developing economies (EMDEs) contracting by 5.4 percent with supply chain disruptions, contributed to moderating and 2.6 percent, respectively (Figure 3). Nonetheless, the momentum. Finally, trade in services remains subdued, China’s economy was already recovering in the second half with tourist arrivals remaining way below their January 2020 of 2020 and was a notable exception among EMDEs, which levels. collectively experienced an economic contraction more severe than previously forecasted. Recent high-frequency Financial markets expect an economic recovery as the data, such as the purchasing managers index (PMI), point spread between short- and long-term interest rates toward a broad recovery. The global PMI rose to 54.8 in widen, although EMDEs face mounting headwinds as March—a 79-month high—as advanced economies and capital inflows slow down. The widening of short- and EMDEs, especially in East Asia and the Pacific (EAP), ramped long-term interest rates has been observed across most up their manufacturing production. advanced economies and has reduced negative-yielding debt since January, with significant spillover effects on other The economic recovery has been uneven across financial markets. In the United States, 10-year US Treasury countries. The recovery in some advanced economies is yields have increased by 33 basis points, their sharpest supported by fiscal support packages and loose monetary increase in five years. Yields on local currency and dollar- policy. The manufacturing sectors of advanced countries denominated bonds of EMDEs are also increasing, although and EMDEs in EAP have continued to recover on the back capital inflows lost momentum due to rising global yields of stronger external demand. The United States’ recovery and concerns over a tightening of monetary policy in the is accelerating due to an uptick in the rollout of vaccines United States. Finally, more subdued recovery projections and renewed fiscal support. Stimulus checks pushed retail for EMDEs relative to advanced economies were reflected in sales upward by 9.8 percent in March, a notable turnaround the decrease in bond issuance across EMDEs in February. from the -8.7 percent in March 2020. Still, a resurgence of COVID-19 infections in some large euro area economies is The recovering global environment has had impact on weighing on economic activities and forcing governments the Philippines. Merchandise exports expanded in the first to maintain stringent lockdowns. The euro area composite quarter of 2021 as the country benefitted from a recovery PMI rose slightly in February but remained in contractionary in global demand for its exports, particularly in electronic territory at 48.8. Among EMDEs, commodity exporters such products. This contributed to the recovery in manufacturing as Russia, Saudi Arabia, Nigeria, and South Africa have activities which grew by 0.5 percent in the first quarter of benefited from the broad-based increase in commodity 2021 from a 3.3 percent contraction in the same period prices. The recovery in commodity importers is also gaining in 2020. Still, given continuing restrictions in international traction due to reduced drag from the pandemic and travel and closed borders in many countries, tourism and spillovers from the global recovery. the deployment of overseas Filipino workers remain weak relative to pre-pandemic levels. Global trade has largely recovered to pre-pandemic levels (Figure 4). The rapid recovery of the global trade in Source: Global Economic Prospects, January 2021; and goods has largely mirrored the rapid recovery in industrial Global Monthly, March 2021. production. The recovery has not, however, been Photo: Chema Grenda PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 4 Figure 3. The global economy contracted 4.3 percent in Figure 4. The global trade in goods has returned to 2020. December 2019 levels. Global Trade (Index, December 2019 = 1) 1.1 Percent World 1.05 8 Advanced economies 100 1 EMDEs 90 0.95 80 4 0.9 70 0.85 60 0.8 0 50 0.75 40 0.7 30 Jan-20 Feb-20 Apr-20 May-20 Jun-20 Sep-20 Oct-20 Jan-21 Mar-20 Jul-20 Aug-20 Nov-20 Dec-20 Dec-19 -4 20 10 -8 0 World Adva nced Economies 2010 2012 2014 2016 2018 2020 2022 EMDE Eme rgin g Asi a (excl . Chin a) Source: World Bank. Source: World Bank. Photo: Michael D Edwards PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 5 1.2 The Exchange Rate and the External Sector: Stronger Stable Peso Amid Recovery The balance-of-payments (BOP) surplus more than doubled to 4.4 percent of GDP in 2020, driven by a substantial current-account surplus due to a double-digit import contraction. This led to a steady appreciation of the peso throughout 2020, which remained stable in the first four months of 2021. The trade deficit narrowed substantially in 2020, The Philippine peso appreciated in nominal and real resulting in a current-account surplus. The current account terms in the first four months of 2021. The peso improved from a deficit of 0.8 percent of GDP in 2019 to surplus appreciated by 4.4 percent in nominal terms in 2020 of 3.6 percent of GDP in 2020, driven by a significant narrowing amid weak imports, capital inflows, and weakness in the of the trade deficit (Table 1). In 2020, goods imports saw steeper U.S. dollar. In the first four months of 2021, it registered an declines than exports as domestic economy collapsed, and average of 5.5 percent year-on-year gains against the U.S. global demand weakened. Yet in early 2021, both recovered with dollar on the back of narrower merchandise trade deficit6 goods exports growing faster than imports in March 2021 due and higher remittances. On a monthly basis, the peso began to improving global demand (Figure 5). Meanwhile, net services to gradually depreciate amid merchandise import recovery7, exports grew by a mere 0.3 percent in 2020, a substantial drop rising U.S. Treasury yields, and global oil prices returning to from 12.3 percent in 2019, as travel restrictions crippled the pre-pandemic levels. The country’s real effective exchange tourism sector4 and the business process outsourcing (BPO) rate also appreciated during the first four months of 2021 at a sector recorded lower earnings.5 Moreover, remittances only time when the currencies of regional peers depreciated. This grew at 0.8 percent in 2020, compared to 3.9 percent in 2019, may adversely impact the country’s exports competitiveness. due to the repatriation of more than 325,000 overseas Filipino After reaching an all-time high of US$110 billion by end- workers, mostly from Middle Eastern countries. Nonetheless, total 2020, gross international reserves fell to US$107.2 billion remittances has reached US$8.5 million as of March 2021, 2.9 in April 2021, equivalent to 12.3 months’ worth of imports percent higher than remittances inflow in the first quarter of 2020. of goods and payments of services and primary income. Smaller but sustained net capital inflows contributed to the BOP surplus in 2020. Net inflows to the capital and financial accounts softened to US$4.7 billion (1.3 percent of GDP) in 2020, as FDI fell by 24.6 percent to US$6.5 billion (Figure 6). This was partly due to the weak external environment and the country’s poorer FDI attractiveness compared to most regional peers, driven in part by restrictions on FDI (Box 2). Net portfolio investments (FPI) registered net outflows of US$0.5 billion (0.1 percent of GDP) in 2020, stemming from the increase in foreign debt securities investments by the BSP. Meanwhile, an increase in public and private foreign loans led to substantial net inflows in the other investments account. This contributed to the overall BOP surplus more than doubling to US$16.0 billion (4.4 percent of GDP) in 2020. However, preliminary data indicate a cumulative BOP deficit of US$2.8 billion in Q1 2021, as the government repaid its maturing foreign Photo: Michael Leslie loans and the external goods trade posted a deficit. 4 Tourist arrivals plummeted by 83 percent between 2019 and 2020. Source: Department of Tourism http://tourism.gov.ph/Tourism_demand/Arrivals2020.pdf. 5 Villanueva, Joan. “Economist sees new record-highs for PH foreign reserves.” Philippine News Agency. March 12, 2021. https://www.pna.gov.ph/ articles/1133440. 6 In the first two months of 2021, total goods imports amounted to US$16.0 billion, 5.6 percent lower relative to the value of goods imported during the same period in 2020. Likewise, goods exports contracted by 3.6 percent in the first two months of the year to US$10.8 billion, resulting in a merchandise trade deficit. 7 In Q1 2021, goods imports amounted to US$25.6 billion, 3.2 percent higher than the value of imports in Q1 2020. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 6 Table 1. Balance of Payments, 2016–2020 In percentage of GDP 2016 2017 2018 2019 2020 Current account -0.4 -0.7 -2.6 -0.8 3.6 Goods -11.2 -12.2 -14.7 -13.1 -8.8 Exports 13.4 15.8 15.0 14.2 13.1 Imports 24.6 28.0 29.7 27.3 21.9 Services 2.2 2.6 3.3 3.5 3.6 Primary Income 0.8 1.0 1.1 1.4 1.2 Secondary Income 7.8 8.0 7.7 7.4 7.6 Capital and Financial accounts -0.0 0.9 2.7 2.2 1.3 Capital account 0.0 0.0 0.0 0.0 0.0 Financial account 0.1 -0.9 -2.7 -2.1 -1.3 Direct investment -1.8 -2.1 -1.7 -1.4 -0.8 Net acquisition of financial assets 0.8 1.0 1.2 0.9 1.0 Net incurrence of liabilities / 1 2.6 3.1 2.9 2.3 1.8 Portfolio investment 0.5 0.7 0.4 -0.7 0.1 Financial derivatives -0.0 -0.0 -0.0 -0.0 -0.1 Other investments 1.4 0.5 -1.4 -0.0 -0.5 Net unclassified items 2/ 0.1 -0.5 -0.8 0.7 -0.4 Overall BOP position -0.3 -0.3 -0.7 2.1 4.4 Memo: Basic Balance 1.5 1.5 -0.9 0.6 4.4 Gross International Reserves (in billions US$) 80.7 81.6 79.2 87.8 110.1 Import Coverage (in months) 8.8 7.8 6.9 7.6 12.6 1/ Net incurrence of liabilities refers to net foreign direct investment (FDI) to the Philippines. 2/The term “Net unclassified items” is a balancing figure. There are two methods of computing the BOP position: the first approach uses the change in net international reserves due to transactions, while the second approach computes the sum balances of the current account, capital account less financial account. The two measures do not necessarily tally. The BSP uses the first approach to determine the overall BOP position. Note: Following the BSP presentation, the BOP balance = Current Account Balance + Capital Account Balance - Financial Account Balance + Net Unclassified Items. Source BSP. Figure 5. From mostly sharp contractions throughout Figure 6. The contraction in FDI was less pronounced in 2020, both imports and exports of goods indicate recovery the Philippines than in many other regional peers in 2020. in early 2021. FDI flows as share of GDP 35 7 6 15 5 4 Percent 3 -5 Percent 2 1 -25 0 2010-2020 2019 2020 -1 Export growth -2 -45 Import growth Philippines Thailand Indonesia Malaysia Vietnam -65 M 0 -19 N 0 M 19 21 1 Ju 0 Se 9 N 9 - 19 M 0 Se 0 0 -2 2 -2 2 l-1 -2 -2 1 l-2 - p- n- ar ar p- ay n- ov Ju ar ay ov Ja Ja M M Source: BSP. Source: Institute of International Finance (IIF). PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 7 Box 2. Foreign Direct Investment Restrictiveness in the Philippines. The Philippines lags its regional peers in FDI inflows, framework (Figure 7) and the most stringent foreign equity which increases the risk that the country may be unable limits among peers (Table 2). The restrictive foreign equity to leverage key growth opportunities during the economic limits have caused the domestic industries to miss out recovery. From 2010-2019, the Philippines received US$45 on capital, technology, and productivity gains through billion worth of FDI, lagging behind Indonesia (US$178 knowledge spillovers. Moreover, the outdated framework billion), Viet Nam (US$112 billion), Malaysia (US$96 billion), will potentially limit the country’s ability to leverage growth and Thailand (US$74 billion). An outdated legal and policy opportunities during the recovery, including the potential framework has limited the inflow of FDI for decades. In 2019, spillover effects from the US$1.9 trillion U.S. stimulus through the Philippines had the most restrictive regulatory investment channel. Figure 7. Across key sectors, the FDI regulatory framework is more restrictive in the Philippines than in regional peers. Overall FDI Regulatory Restrictiveness Index (select sectors and total, 2019) 0.8 0.7 0.6 Closer to 1 = Most restrictive 0.5 0.4 0.3 0.2 0.1 0.0 Retail Road transport Water transport Fixed telecoms Mobile telecoms Total FDI Index Philippines Indonesia Thailand Malaysia Vietnam Source: Organisation for Economic Cooperation and Development (OECD). Table 2. Foreign Equity Limits on FDI among ASEAN Countries. Telecomunications- Telecomunications - Trasportation - Trasportation - Fixed Mobile Road Water Indonesia 67% *** 49% 49% Malaysia 100% 100% 49%** 49%** Philippines 40% 40% 40% 27.3 Thailand <50% <50% 60%-75% 60%-75% Vietnam 49% 49% 49%* 49%* Source: OECD FDI Regulatory Restrictiveness Index 2019 and local laws. Note: * ASEAN: 51 percent; **Depending on license and subsector; *** No information indicated in the OECD FRI PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 8 Three bills that aim to ease restrictions on FDI are supported by an annual review of the foreign investment currently pending in Congress. The president recently negative list (FINL), regular updates to the declaration certified these bills as urgent, effectively allowing of policy to incorporate the current dynamics of global Congress to fast-track their passage. These three bills and regional economies, and the establishment of a joint amend the Public Service Act, Retail Trade Liberalization web portal that will serve as a one-stop shop for foreign Act (RTLA), and the Foreign Investment Act (FIA). investors. Aside from attracting FDI, the amended FIA also aims to increase foreign skilled labor in the country by The amendment to the Public Service Act is envisioned removing the practice of profession from the negative list. to augment infrastructure investments. Foreign The influx of foreign professionals could help to reduce ownership caps on public utilities are limiting the size the shortage of skilled labor in the country, and potential of foreign investment in critical infrastructure like water, knowledge spillovers would help to upskill Filipino workers. power, transportation, and telecommunication. In the amended bill, only three sectors are identified as public Finally, the amended RTLA aims to increase utilities: the transmission of electricity, distributions of competition in the retail sector. The senate bill aims to electricity, and water works and sewerage systems, which increase the foreign participation in retail by reducing will still face foreign ownership caps. To ensure flexibility, the required minimum paid-up capital from US$2.5 future legislation can classify additional sectors as public million to US$300,000. There are also several deleted utilities, and the National Economic and Development provisions in the revised bill, including: (i) the 60 percent Authority (NEDA) is mandated to recommend the limit on the foreign ownership of local retailers; (ii) the classification of a business, or service as a public utility requirement that retail trade enterprises, of which 80 to Congress. Additionally, the bill contains a clause percent of the stocks are foreign owned, need to offer a for creating an appropriate mechanism for fixing rates minimum of 30 percent of their equity to the public within based on reasonable returns and the efficiency of public 8 years of starting their operations; (iii) the requirement service delivery. Moreover, administrative enforcement that foreign retailers need to have a minimum net worth will be strengthened to disincentivize investor neglect. of US$200 million in its parent corporation for those classified under categories B and C and US$50 million The amended FIA aims to increase investments and for those under category D; (iv) have 5 retail branches attract foreign skilled professionals. To attract FDI, the or franchises anywhere around the world, with at least employment threshold for non-Filipinos investing at least one store capitalized at a minimum of US$25 million; and US$100,000 in small and medium-sized enterprises will (v) have a 5-year track record in the retail business. be lowered from 50 to 15 direct employees. This policy is Photo: By Walter Eric Sy PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 9 1.3 Inflation and Monetary Policy: Accommodative Policy Amid Rising Inflation Rising food prices due to supply shocks brought by a series of typhoons in 2020 and the outbreak of African Swine Fever (ASF) pushed inflation above the BSP target in the first four months of 2021. Despite inflationary pressure, the BSP kept its key policy rate steady to support the economy. Inflation breached the upper bound of the BSP target support the economic recovery. Stable core inflation, along range in the beginning of 2021 due to food supply with the government’s adoption of trade and other shocks. The headline inflation rate averaged 4.5 percent in measures to address the low pork supply, solidified the the first four months of 2021, higher than an average of 2.6 view of the BSP that the uptick in inflation is transitory. The percent during same period in 2020 and above the BSP’s BSP has previously engaged in open market operations inflation target range of 2-4 percent (Figure 12). Elevated and also continued the implementation of other regulatory food prices, caused by harvest losses due to a series of measures to minimize the economic fallout of the COVID-19 typhoons in 2020, and a lower pork supply, caused by pandemic, such as adopting zero percent risk weight for the outbreak of ASF, were the main drivers of inflationary the guaranteed loans of micro, small, and medium-sized pressure. Transport inflation also rose due to higher fares enterprises, as well as waiving the fees for fund transfer brought on by the implementation of quarantine restrictions, transactions through the BSP’s payment and settlement and the rise of global oil prices back to pre-pandemic system. levels.8 Excluding volatile food and energy items, the core inflation averaged 3.5 percent in the first four months of The Philippine financial system maintains a high level 2021, slightly higher than the average of 3.1 percent in the of liquidity, but banks remain risk averse to lending. same period last year. The small increase in core inflation Domestic liquidity remained high at Php14.0 trillion in suggests that rising food prices had little spillover effects February 2021, despite liquidity growth declining year- to other goods and services. Compared to neighboring on-year from 16.2 percent in June 2020 to 9.4 percent in countries, domestic inflation is higher than Indonesia (1.4 February 2021. Banks continue to be risk averse, with the percent), Malaysia (1.7 percent), Thailand (3.4 percent), and outstanding loans of universal and commercial banks falling Vietnam (2.7 percent). by 2.7 percent between February 2020 and 2021 to reach Php8.9 trillion. Credit to private sector sharply shrank amid The BSP continued its accommodative policy stance by the COVID-19 pandemic and is expected to further decline keeping the key policy rate unchanged. It maintained the due to the renewed lockdown in April 2021. Credit to private key policy rate at 2.0 percent in March 2021 to continue to sector contracted by 2.4 percent in February 2021 (Box 3). Photo: Walter Eric Sy 8 Transport inflation averaged 12.7 percent in the first four months of 2021, partly due to the increase in global oil prices, with the Brent crude oil price benchmark growing by 20 percent, quarter-on-quarter. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 10 Box 3. Recent Developments in the Financial System The financial system has broadly withstood the impact The economic contraction is elevating credit risks, especially of COVID-19 but it faces significant downside risks due from the corporate sector. As noted by the recent IMF Financial to uncertainty around the pace of recovery and high System Stability Assessment (FSSA),10 non-financial corporates interconnectedness with non-financial corporates. The are highly interconnected with the financial system through banking sector’s overall capital adequacy ratio (CAR) remains mixed conglomerate structures. While banks can withstand stable at about 16 percent, well above BSP’s regulatory the exceptionally severe shocks in the baseline scenario, they threshold of 10 percent (Figure 8). The overall liquidity of could experience a systemic solvency impact if additional the banking sector is sufficient to absorb funding shocks downside risks materialize. The firms are likely to experience with a liquidity coverage ratio of above 150 percent. In terms substantial distress even in the baseline scenario. The GDP of asset quality, The gross NPL ratio rose to 4.1 percent as shocks are expected to reduce corporate earnings across of end-February 2021 compared to about 2.2 percent as different sectors as well as the debt servicing capacity of the of the end of February 2020 (Figure 9). Furthermore, the corporates. Moreover, the recent national COVID-19 survey banking system saw a significant increase in its restructured conducted in November 2020, indicates that a large share loans, from 0.4 percent in January 2020 to 1.9 percent in of firms reported acute liquidity constraints, with reports of December 2020. As a result, the capital at risk ratio (NPL net not having enough cash and have fallen behind in payments of provision to capital ratio)9 has risen from 4.6 percent at the (Figure 10). Thus, the negative impact of COVID-19 on the end of 2019 to 6.2 percent at the end of 2020. solvency of non-financial corporates poses significant risks to the financial system. Figure 8. The financial system appears to have adequate Figure 9. NPLs remain manageable, as in most capital buffers. regionalpeers, but asset quality needs close monitoring. Regulatory Capital to Risk-Weighted Assets Nonperforming Loans ratio, %, February 2021 (or latest available) 25 20 Mongolia 11.8 Brunei 3.7 15 Philippines 4.1 10 Thailand 3.2 Laos 3.2 5 Indonesia 3.2 0 Vietnam 2.1 China 1.8 am e es a sia na a nd di or si Cambodia in i 1.8 la ay ne bo tn Ch ap pp ai e al do m ng Th Malaysia Vi ili M 1.6 Ca Ph In Si Singapore 1.3 Regulatory Capital to Risk-Weighted Assets Korea 0.2 Basel III minimum 0 5 10 Source : International Monetary Fund (IMF) FSI (Q4 2020 or latest available) Source : World Bank staff calculations; Haver Analytics 9 This indicator measures the capacity of bank capital to withstand losses from NPLs, once specific provisioning has absorbed part of those losses. 10 IMF, Philippines Financial System Stability Assessment, April 2021. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 11 Figure 10. Firms experiencing financial constraints (% firms). Figure 11. Absolute Change in Nominal Credit Growth in Select EAP countries (January 2020, latest available month, percentage points). 4 80% 2.5 1.8 67% 2 70% 66% 60% 0 48% -0.1 50% -2 42% 40% Percent -4 30% -6 20% -8 -6.7 10% 0% -10 Less than 1 Already Currently in Delayed month of adjusted loan arrears payment from -10.9 -12 cashflow repayment client Thailand China Malaysia Indonesia Philippines terms Source: Philippines COVID-19 Firm Survey, Nov 2020, World Bank Source: FCI GP Macro-Financial Unit, March 2021. The decline in economic activity, limited operations through court processes. Accordingly, banks are reluctant by firms, and increase in firms’ insolvencies have led to use formal proceedings. Thus there is a need to develop to a sharp contraction in credit. Since January 2020, judicial capacity in insolvency law, promote alternate dispute the Philippines has experienced a decline in private resolution mechanisms, strengthen qualification criteria credit growth of -10.9 percentage points, which is higher for insolvency practitioners and implement an insolvency relative to other large EAP economies (Figure 11 ). Over regulatory authority with adequate supervisory powers.12 the same period, China and Thailand have seen a 1.8 and 2.5 percentage points increase, Malaysia has seen a -0.1 percentage points decline whereas Indonesia has recorded a decline of -6.7 percentage points. As noted by the aforementioned COVID-19 survey, 7 percent of firms reported having closed permanently.11 Moreover, while more firms were in operation compared to July 2020, about 9 out of 10 firms were operating at below capacity. The increase in firms’ insolvencies and NPLs, underscore the need to strengthen the insolvency practice that is currently limited. The Philippines has a relatively robust legislative framework for debt enforcement and collective insolvency proceedings. However, due to weak implementation of the legislation and challenges with the supporting professionals and institutions, credit recovery is relatively low. For instance, the 2019 Doing Business Insolvency credit reports that creditors recover 21.1 cents on the dollar on average, compared to 92.1 cents on the dollar in Japan and 84.3 cents on the dollar in South Korea. There is no insolvency regulatory authority and no professional associations for insolvency practitioners. One Photo: structuresxx of the major obstacles reported is the length of time to go 11 This is a lower figure compared to 16 percent in July 2020, which may be explained by a likelihood that firms that permanently closed in March and April 2020 may have been less likely to participate in the survey in November 2020. 12 World Bank ‘Review of Philippines Insolvency and Debt Enforcement’, forthcoming. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 12 Photo: By CaveDweller99 Philippine banks remain capitalized amid deterioration percent in February 2021 from 3.0 percent in February 2020 in bank asset quality. The banking system total capital (Figure 13). A large share of firms reported acute liquidity adequacy ratio (CAR) rose to 16.7 percent in December 2020 constraints. 66 percent of firms did not have enough cash to from 15.6 percent in December 2019.13 This is above the 10 pay all costs and payments such as payroll, suppliers, taxes percent regulatory minimum requirement. Bank profitability, or loan repayment beyond 1 month.15 Gross non-performing however, has declined with the return on asset from 1.3 loans (NPL) also continues to rise to 4.1 percent in February percent to 0.8 and return on equity by 10.5 percent to 6.6 2021 from 2.2 percent in the same month last year. The percent. The risk aversion of lenders was compounded by enacted Financial Institutions Strategic Transfer Act enables the deteriorating asset quality of banks. After the expiration financial institutions to dispose their non-performing assets of a 60-day loan moratorium under performing assets and and non-performing loans to special asset management non-performing loans to special asset management firms firms. Bayanihan 2,14 past due loan began to increase, reaching 5.2 Figure 12. Inflation breached the BSP’s target range in Figure 13. The past-due loans ratio and the share of the first three months of 2021. non-performing loans rose. Percent 12 6 10 5 8 6 4 Percent 4 3 2 2 0 1 -2 Jun-18 Mar-19 Mar-21 Mar-18 Mar-20 Dec-19 Dec-18 Dec-20 Sep-19 Jun-19 Sep-18 Sep-20 Jun-20 0 Jan-19 Jan-21 Jul-19 Jul-20 Mar-19 Jan-20 Sep-19 Nov-19 May-19 Sep-20 Nov-20 May-20 Mar-20 Core Inflation Headline Inflation Food & Non-alcoholic beverage Past Due Ratio Gross NPL Ratio BSP Key policy rate Source: Philippines COVID-19 Firm Survey, Nov 2020, World Bank Source: FCI GP Macro-Financial Unit, March 2021. 13 The latest available figure as of April 20, 2021 14 Loan payment for principal or interest, including amortizations, that fell due between September 15 and December 31, 2020 may be paid after 60 days, without incurring interest on interests, penalties, fees or other charges. 15 Monitoring COVID-19 Impacts on Families and Firms in the Philippines: http://www.worldbank.org/philippines/covidmonitor. Firm Survey Results: Round 2 – November 2020 PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 13 1.4 Fiscal Policy: Balancing Support and Sustainability The national government’s fiscal balance continues to show signs of deterioration in early 2021, as revenue generation remained subdued. The authorities continue to increase public spending, led by the implementation of stimulus and other support measures as well as infrastructure spending. The fiscal deficit continued to widen in the first quarter of GDP a year ago.16 The uptick in tax collections was driven in part by 2021, leading to an increase in public debt. The fall in public improved collections from the Bureau of Customs, as merchandise revenues and the surge in public spending led to an increase in trade improved and base effects from a sharp downturn in tax the fiscal deficit in the first quarter of 2021 to 7.4 percent of GDP collections in the latter half of Q1 2020. from 1.9 percent of GDP a year ago (Figure 14). The widening deficit resulted in the public debt ratio reaching 60.4 percent of The growth in public spending accelerated, anchored GDP as of end-March 2021 (Figure 15), the highest level since on continuing fiscal stimulus measures and a resumption 2005. Publicly guaranteed debt remained low at 2.5 percent in public investment. NG spending rose from 19.1 percent of of GDP as of March 2021. While a portion of the debt mix relies GDP in the first quarter of 2020 to 23.4 percent of GDP in the on external funding, 72.5 percent of outstanding debt is peso- same period in 2021, driven by the adoption of stimulus measures denominated, and long-term debt accounts for about 94.2 and infrastructure spending. The rise in public spending was percent of the external portfolio, as of March 2021. fueled by a surge in capital outlays as the government continued to implement the “Bayanihan to Recover as One” Act (Bayanihan Public revenues remain weak amid a sharp decline in non-tax 2) after it was extended to June 30, 2021. In particular, strong revenues and subdued economic activity. National government disbursement growth was boosted by several Bayanihan 2 (NG) revenues fell to 16.0 percent of GDP in the first quarter of programs such as the release of equity infusions to several public 2021 from 17.2 percent in the same period in 2021, as non-tax financial institutions, the Rice Resiliency Program, and various revenues were halved to 1.6 percent of GDP in the first quarter of health programs of the Department of Health. Public spending also 2021 owing to the base effect of large dividend remittances a year benefitted from the resurgence in infrastructure outlays in the first ago. Meanwhile, tax revenues inched up by 0.9 percent to reach quarter of 2021 and steady growth in recurrent spending. 14.4 percent of GDP in the first quarter of 2021 from 14 percent of Figure 14. The fiscal deficit reached a record high in Figure 15. The debt-to-GDP ratio rose to its highest level 2020 amid a sharp rise in public spending. since 2006. 70 4.0 25 3.5 Fiscal balance (Percent of GDP) 60 3.5 20 1.5 50 -0.5 3.0 15 40 Percent of GDP -1.9 Percent of GDP Percent of GDP -3.1 -2.5 2.5 10 -3.4 30 -4.5 2.0 20 5 -6.5 1.5 10 -7.6 -7.4 0 -8.5 0 1.0 2018 2019 2020 Q1 Q1 2018 2019 2020 Q1 Q1 2020 2021 2020 2021 External Debt Revenues Expenditure Fiscal Balance (RHS) Domestic Debt NG Guaranteed debt (RHS) Source: Department of Budget and Management (DBM), PSA. Source: DBM, PSA. 16 To offset the anticipated shortfall in tax collections due to the impact of the pandemic and containment measures, non-tax revenues nearly doubled in the first quarter of 2020 due to early dividend remittances from the BSP and government-owned and controlled corporations to the Bureau of Treasury. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 14 1.5 Employment and Poverty: Rise of Low-Paying Jobs Despite Labor Market Rebound Improvements in job creation and labor force participation have been tempered by a rise in the share of part-time workers and underemployment. A fall in earnings, business income, and remittances, along with new community quarantines in April 2021, will likely contribute to elevated levels of poverty despite the government’s mitigation efforts. More people started looking for work as the economy in the past five months (Figure 17).17 While the unemployment gradually re-opened. The labor force participation rate (LFPR) rate in March 2021 is higher than the pre-pandemic level (5.4 reached 65.0 percent in March 2021, surpassing the pre- percent recorded in January 2020), it is significantly lower than pandemic level of 61.7 percent in January 2020 and peaking to the level recorded during the peak of community quarantines its highest level since January 2018 (Figure 16). This translates in April 2020 (17.6 percent). The youth unemployment rate into about 3.5 million people entering the labor market between averaging around 19 percent between October 2020 and January and March 2021. The increase in the LFPR is observed February 2021 also dropped to 15.4 percent in March 2021. By for both men and women, with the latter driving the significant gender, the unemployment rate in March 2021 is slightly higher increase. Notwithstanding the increasing number of workers among women (7.8 percent) than men (6.6 percent), with the in the labor force, the unemployment rate decreased to 7.1 gender gap widening starting from February 2021. percent in March 2021 after remaining steady at 8.7-8.8 percent Figure 16. Labor Force Participation Rate, January 2018– Figure 17. Unemployment and Underemployment Rates, March 2021. January 2018–March 2021. 80.0 20 75.0 18 70.0 16 14 65.0 12 60.0 Percent 10 Percent 55.0 8 50.0 6 45.0 4 2 40.0 0 35.0 Jan Apr Jul Oct Jan Apr Jul Oct Mar* Feb* July Jan Apr Jan July July Oct Jan Jan Apr Apr Oct Oct Unemployment Underemployment 2018 2019 2020 2021 2018 2019 2020 2021 Male LFPR Overall Female LFPR Source: LFS (various rounds) and PSA. Note: /Population projections based on the 2015 Population Census has been Source: PSA-LFS Labor Force Survey (LFS) (various rounds). adopted to generate the labor force data. Note: a/Population projections based on the 2015 Population Census has *Starting February 2021, the LFS is conducted on a monthly basis to produce more been adopted to generate the labor force data. timely data. 17 The unemployment rate increased slightly to 8.8 percent in February 2021 from 8.7 percent in January 2021. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 15 Job creation has accelerated between October 2020 and share of elementary occupations (commonly associated March 2021. About 5.5 million jobs were added during with low-pay jobs) increased from around 25.6 percent in this period, with about 40 percent of the new jobs (2.2 October 2020 to 27.3 percent in January and to almost 30 million) added between February and March 2021. Gains percent in March 2021. in jobs creation were driven by the service sector,18 which accounted for 48 percent of the increase in jobs between The increase in underemployment, the fall in hours October 2020 and March 2021. However, the boost worked, the shift to non-wage employment, and between February and March 2021 came from construction agricultural disruptions have contributed to earnings which explains over half of new jobs added during that time. losses and the fall in household income. The nationwide Meanwhile, some sectors, such as education and real estate high-frequency monitoring household survey conducted activities, experienced employment losses in the midst of between December 2020 and January 2021 shows that overall gains. The shedding of jobs in education was likely more than 40 percent of households reported lower associated with the limited school and training operations as incomes and earnings compared to the pre-pandemic level, well as reduced enrollment due to the pandemic.19 despite a rise in employment. While this share is significantly lower than 57 percent reported in July 2020, it reflects Despite signs of a labor market recovery, the quality of ongoing financial distress among households. jobs is of concern. The underemployment rate remained at around 16-18 percent in the first quarter of 2021, higher than The significant fall in household earnings, combined in the last quarter of 2020 (14.4 percent in October 2020) with reduced business income and remittances, will and the pre-pandemic level (14.8 percent in January 2020). likely lead to an increase in poverty despite government The newly underemployed came from the agriculture sector, assistance. The COVID-19 pandemic may have resulted in which may be in part attributed to temporary disruptions in the national poverty rate increasing from 16.7 percent in 2018 agricultural output caused by the outbreak of ASF. Among to an estimated 21.0 percent in 2020, even after accounting the employed labor force, the share of part-time workers for the effects of government subsidies (e.g., the social -- those working less than 40 hours a week -- remained amelioration program). With an increase in employment significantly higher (around 38 percent in January and and a rebound in earnings, the poverty rate was initially February 2021 and 36.7 percent in March 2021) than the pre- projected to be marginally lower in 2021 if no further pandemic level (31.6 percent in January 2020). Moreover, quarantine measures were imposed. However, the adoption the share of wage and salary workers and employers in the of new enhanced community quarantine (ECQ) in NCR and total labor force was 63.7 percent in March 2021, almost 4 neighboring provinces in April 2021, along with a relatively percentage points lower than before the pandemic (67.6 low level of public assistance, risk raising the poverty rate percent in January 2020) with an increase in the share of further. self-employed and non-paid workers. By occupation, the Photo: Ezra Acayan 18 In particular, wholesale and retail trade, and repair of motor vehicles and motorcycles added a significant number of jobs (about 1.9 million) between Octo- ber 2020 and March 2021. 19 Based on enrollment data for school year 2020-2021, enrollees in private schools dropped by 48 percent from last year, while public school reported a 10 percent drop. In addition, of the total 14,435 private schools in the country, 865 did not operate this school year. Of these, 374 schools were forced to suspend operations due to low or no enrollment and another 333 schools would be non-operational due to COVID-19 pandemic. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 16 Part II Outlook and Risks The economy is projected to grow at 4.7 percent this year, before accelerating to 5.9 percent in 2022. The prospect hinges on the effective pandemic containment, mass vaccination, and further loosening of mobility restrictions, which will result in the return of domestic activity. An improving external environment will also lend a boost. Risks, however, are tilted on the downside with the potential entry of more contagious virus variants, and the tight global supply of vaccines that can slow progress in mass vaccination. A prolonged pandemic will adversely impact firm solvency, resilience in the banking sector, public financing needs, and debt levels. A commitment to structural reforms, easing of foreign investment restrictiveness, and addressing the socioeconomic impact of the pandemic must remain priorities of the government. Photo: Jed Regala PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 17 2.1 Growth Outlook Economic growth is expected to recover to 4.7 percent in 2021 and 5.9 percent in 2022, alongside an improvement in the external environment and the return of domestic activity, predicated on the ability to effectively manage the COVID-19 pandemic and deliver vaccines in a timely manner. Growth prospects hinge on the ability to manage the published in the World Bank East Asia and Pacific Economic COVID-19 health crisis. The medium-term growth trajectory Update in April 2021. The downward revision for this year was depends on effective pandemic containment, mass driven by the larger-than-expected contraction in the first vaccinati on, and further loosening of mobility restrictions. quarter,20 the realization of case resurgence and reimposition The surge in COVID-19 cases in March and April has of stricter quarantines, and the lingering challenges from momentarily derailed the country’s economic recovery elevated inflation and household income losses. Nonetheless, as tighter community quarantine measures have been the growth trajectory is positive over the forecast horizon implemented. While mass vaccination began in March, and is expected to close in on the potential growth of 5.7 global vaccine supply constraints and vaccine hesitancy percent over 2020-2029. It anchors on the global recovery, among Filipinos may delay widespread local inoculation including with key trading partners, which will translate into (Box4). Following the government’s vaccination plans, the higher export demand and better prospect of remittances. growth projection assumes that vaccination will accelerate in Domestically, as vaccination efforts progress and the infection the second half of 2021 the arrival of more vaccine supplies. rate slows, household confidence returns while business confidence improves driving more robust activity (Figure 19). The economy is expected to recover over 2022-2023, The administration’s commitment to deliver infrastructure following the deep recession in 2020. Economic growth is projects will contribute to investment growth. Following the projected at 4.7 percent in 2021, before accelerating to 5.9 deep contraction last year, a base effect will also contribute percent in 2022 and 6.0 percent in 2023 (Figure 18). These to increased growth in 2021, while the national election is projections reflect downward revisions from the forecast projected to boost economic activity in 2022.21 Figure 18. Economic growth is expected to recover in the Figure 19. Consumer sentiments remained in negative medium term. territory in early 2021. Philippine GDP Growth Projections Overall Consumer Confidence Index (Current quarter) Forecast Overall Business Confidence Index (Current quarter) 9.0 80 7.0 5.0 60 3.0 40 1.0 Percent -1.0 20 Percent -3.0 0 -5.0 -7.0 -20 -9.0 -40 -11.0 2020 2022 2023 -60 2010 2015 2016 2019 2012 2021 2018 2013 2014 2017 2011 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Actual growth April 2021 projections 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 June 2021 projections Source: PSA; World Bank staff estimates. Source: BSP. 20 The economy contracted 4.2 percent year-on-year in the first quarter of 2021 against an expected 3.0 percent drop. 21 The national election can boost economic activities from moneys spent on campaign activities, media advertisements, ballot printing, among others. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 18 The growth projection assumes that the fiscal deficit recovery and better external environment are expected to remains elevated in 2021 but declines over the medium lead to increased tax collection on consumption and trade. term. The fiscal deficit is projected to stay elevated at In terms of expenditures, public capital outlays are expected 7.3 percent in 2021 from 7.6 percent in 2020 because of to grow faster in 2021, but the pace will slow in succeeding continued public spending to address the pandemic. In years, constrained by the narrower fiscal space. The the medium term, however, the fiscal deficit is expected government remains committed to pursue its infrastructure to decline as the government winds down its pandemic investment agenda, with infrastructure spendingrepresenting response and the economic recovery contributes to higher 5.4 percent of GDP in the 2021 budget, although public revenues. In particular, the expected domestic expected to fall to 5.1 percent of GDP in 2022.22 Photo: Ezra Acayan 22 The projected decline is the result of an increase in transfers from the central government to LGUs beginning in 2022, which are expected to encoun- ter challenges to fully absorb the capital outlays transferred to them. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 19 Box 4. The Impacts of COVID-19 Vaccination on the Economy Match its Impacts on Public Health. The resurgence of COVID-19 cases in March-April for the Philippines. Vaccination makes strong economic prompted a reimposition of stricter lockdown. Average sense. The IMF estimates cumulative global losses of US$12 daily infection cases rose from around 1,600 in January trillion over the period 2020-2025, relative to pre-pandemic 2021 to around 9,600 in April, before slowing to 6,700 projections.23 These losses are compounded several-fold by mid-May. Cases of deaths followed a similar trajectory if we consider the long-term effects of the pandemic on averaging 131 in April, before slowing to 123 by mid-May. In education, health services, and lost human capital. early April, the authorities responded with the resurgence of cases by placing Metro Manila and adjoining provinces The Philippines must accelerate vaccinations and under enhanced community quarantines that limited catch up with its East Asian peers (Figure 20 and people’s mobility and hampered the virus spread. Unlike in Figure 21). With limited COVID-19 treatment options and lockdowns in 2020, however, the quarantine measures were therapeutics, safety behaviors—such as mask wearing, recalibrated and allowed for more activities in construction, handwashing, and physical distancing—and rapid roll- manufacturing, and public transportation. As a result, the out of vaccinations have emerged as the primary tools 26.6 percent average drop in community mobility in non- to fight the pandemic. At present, the principal goal of residential areas in April 2021 was less severe than the 66.0 vaccination is to prevent disease and death among the percent drop in April 2020. most vulnerable populations. While evidence on duration of efficacy and impact on infectivity is still limited, wider Mounting an effective response to contain the and more equitable vaccination coverage is expected pandemic is the foremost challenge and prerequisite to help containment by enhancing population immunity. for economic recovery. Only then can policy makers The government of the Philippines (GOP) has in place a create conditions to safely reopen the economy and National Deployment and Vaccination Plan (NDVP) which families to resume normal lives. Scaling-up testing, tracing, was developed and approved during the first quarter of and case management, along with rolling out a well- 2021. The NDVP lays out an ambitious plan to vaccinate coordinated and prioritized vaccination program, form approximately 71 million adult Filipinos within the shortest the most critical immediate health emergency response possible time, subject to availability of vaccines. Figure 20. Regional comparison of vaccine doses Figure 21. Cumulative vaccine doses administered per administered per 100 people. 100 people. 35 0.6 30 0.5 25 0.4 20 0.3 0.2 15 0.1 10 0 5 0 21 21 21 21 1 1 1 1 1 1 /2 /2 /2 /2 /2 /2 1/ 8/ 5/ 3/ 15 22 29 12 19 26 1/10/2021 3/10/2021 5/10/2021 3/ 3/ 4/ 5/ 3/ 3/ 3/ 4/ 4/ 4/ Indonesia Malaysia Philippines China Indonesia Malaysia Thailand China South Korea Philippines South Korea Thailan d Source: Our World in Data. Source: Our World in Data. 23 G. Gopinath; “A Race Between Vaccines and the Virus as Recoveries Diverge; IMF blog; 26 January 2021. https://blogs.imf.org/2021/01/26/a-race-between- vaccines-and-the-virus-as-recoveries-diverge/ PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 20 However, the Philippines is navigating a complex global Ramping up the pace and geographic coverage of the vaccine market. The Philippines—under the Vaccination vaccination program involves addressing a host of Task Force—has had to navigate a tight vaccine supply challenges. By end-April, the Philippines has administered market heavily skewed in favor of vaccine manufacturers more than 1.8 million doses to Priority Group A beneficiaries and richer nations. The GOP has adopted a portfolio- in the first two months of vaccine deployment.25 based approach to its vaccine procurement as a way to Deployment of vaccines to the general population is ensure that the country can access vaccines for its target expected to ramp up from the second quarter of 2021 in population within the shortest possible time. A portfolio- light of an anticipated increase in vaccine deliveries to the based approach enables the Philippines to access approved country. In addition to tight supply markets, governments vaccines from various suppliers and to deploy them across must overcome vaccine hesitancy. About six in ten Filipino the country concurrently. However, deployment of a portfolio adults polled in February did not want a COVID-19 vaccine, of vaccines requires robust planning and responsive delivery about a quarter of Filipino adults were unsure whether they systems to avoid risks of comingling vaccines in the supply would get vaccinated, while 16 percent affirmed that they chain system. More importantly, sound planning enables would.26 The situation is further complicated by the mix of systematic administration of two-dose vaccines and tracking vaccines offered, and that vary in cold chain requirements, of any adverse events following inoculation. The portfolio dosing, and adverse events. Although the GOP has of vaccines is being developed through: direct bilateral progressed vaccine procurement through development purchase agreements with vaccine manufacturers; bilateral and roll-out of a comprehensive vaccine delivery road map, agreements with governments to purchase excess stock; varied capacities of LGUs, risks for a fragmented private and pooled arrangements such as the COVAX Facility.24 As sector roll-out, and delays in operationalizing a robust IT an eligible COVAX Advance Market Commitment Facility infrastructure (for registration, scheduling, supply logistics, country, the Philippines has signed agreements with the digital vaccine certification, and data analytics) could COVAX Facility to cover 20 percent of the population. impede efficient planning and delivery. Photo: Ezra Acayan 24 COVAX is the vaccines pillar of the Access to COVID-19 Tools (ACT) Accelerator and is co-led by Gavi, the Coalition for Epidemic Preparedness Innovations (CEPI), and the World Health Organization (WHO). Its aim is to accelerate the development and manufacture of COVID-19 vaccines, and to guarantee fair and equitable access for every country. https://www.gavi.org/covax-facility. 25 This top priority group of beneficiaries—including healthcare workers on the frontline, senior citizens, and individuals with comorbidities. 26 Asia Research’s February 2021 Ulat ng Bayan Survey: Media Release on COVID-19 26 March 2021. Vaccine hesitancy has been relatively higher in the Philippines than with regional peers. Studies show that the vaccine acceptance rate in Malaysia is at 94.3 percent, China at 72.6 percent, and Singapore at 67.9 percent. See M. Sallam, COVID-19 Vaccine Hesitancy Worldwide: A Concise Systematic Review of Vaccine Acceptance Rates, Vaccines 2021, February 2021. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 21 The projection assumes an accommodative monetary A conducive external environment will improve the policy as headline inflation is managed within the growth prospects for Philippine exports. The global target range. Headline inflation is expected to reach economy is expected to grow at 4.0 percent in 2021, an average of 4.0 percent in 2021, the upper bound of driven by recoveries in advanced economies specially the 2-4 percent inflation target range, before declining the United States and large EMDEs like China.27 Annual in succeeding years. The rise in inflation this year is growth in advanced economies is projected to rebound projected to be driven by supply-side constraints on key from -5.4 percent in 2020 to 3.3 percent in 2021 (Box 5). food commodities and the rise in global oil prices. The This expansion will help to prop up demand for Philippine global average crude oil price is expected to increase from goods exports, as roughly 70 percent of the country’s US$41.3/bbl in 2020 to US$56.0/bbl in 2021, as trade and exports are destined for high-income economies. Net industrial activity recover. As the government addresses services exports will also benefit from the BPO sector domestic supply constraints and oil prices stabilize starting capitalizing on sustained demand, but tourism may be next year, inflation is expected to retreat to within the muted, as some international travel restrictions could target range. The central bank is expected to keep its remain. Meanwhile, import growth will likely accelerate accommodative monetary policy stance to support the this year as the government implements infrastructure weak economy. Likewise, monetary policy accommodation projects, with renewed demand for capital goods, especially in advanced economies is expected to continue, construction materials. As a result, the current-account especially as the U.S. Federal Reserve has indicated that surplus is expected to narrow to 1.3 percent this year, interest rates will be kept near zero in the near term. before turning to deficits in 2022 onwards (Table 3). Table 3. Economic Indicators for the Baseline Projections. 2018 2019 2020 2021 2022 2023 Actual Projected Real GDP growth, at constant market prices 6.3 6.1 -9.6 4.7 5.9 6.0 Private Consumption 4.2 4.3 -5.7 3.4 4.0 4.3 Government Consumption 1.5 1.1 1.3 1.3 1.4 1.2 Capital Formation 2.9 0.9 -9.1 1.8 3.3 2.7 Exports, Goods and Services 3.4 0.8 -4.7 2.0 2.9 2.7 Imports, Goods and Services 5.7 1.0 -8.7 3.9 5.8 4.9 Real GDP growth, at constat factor prices 6.3 6.1 -9.6 4.7 5.9 6.0 Agriculture 0.1 0.1 00 0.1 0.2 0.1 Industry 2.2 1.7 -4.0 1.5 1.7 1.7 Services 4.0 4.3 -5.6 3.0 4.0 4.1 Inflation (period average) 5.2 2.5 2.6 4.0 3.2 3.0 National government balance (% of GDP) -3.1 -3.4 -7.6 -7.3 -6.5 -5.5 Current account balance (% of GDP) -2.6 -0.8 3.6 1.3 -0.9 -1.4 Source: PSA; World Bank staff estimates. Note: Growth sub-components show contributions to growth Photo: Ungureanu Catalina Oana 27 See Global Economic Prospects, June 2021 edition for the updated global growth projections. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 22 Box 5. Global Economic Outlook. The global economy is projected to expand over the to be subdued at 1.6 percent in 2021 (Figure 23). forecast horizon, but the recovery is likely to be uneven. Global economic output is expected to grow by 4.0 percent International trade is expected to improve, but the in 2021 and 3.8 percent in 2022, predicated on an effective services trade will likely remain muted. After contracting management of the pandemic, progress in the vaccination by 9.5 percent in 2020, global trade is expected to increase rollout, and continued monetary policy accommodation by 5.1 percent in 2021. The rebound in trade is due to the (Figure 22). Additional fiscal stimulus in a few large easing of restrictions and the pickup in economic activity. economies, including the United States, is expected to While manufacturing will likely be the primary beneficiary of have positive spillovers on other countries, which will the economic recovery, the services trade like international further boost global growth. However, the path to recovery tourism is expected to recover tepidly amid persisting will be uneven across economies. Advanced economies, fears of COVID-19 and restrictions on international travel. where vaccination efforts are ramping up, are expected to grow by 3.3 percent in 2021, while EMDEs are projected to Financial markets are recovering, but vulnerabilities expand by 5.0 percent, driven by the economic rebound persist. The unprecedented support of monetary authorities of China (Table 4). Excluding China, the economic recovery around the world prevented the global financial system of EMDEs will be more muted at 3.4 percent in 2021. from collapsing in 2020. In advanced economies, monetary policies are expected to tighten in 2021 as inflation The global recovery remains fragile, as the COVID-19 expectations rise due to improvements in economic pandemic continues to pose downside risks. A surge prospects. Global yield curves steepened in the first quarter in COVID-19 infections could lead to the resumption of of 2021 as financial markets priced in the recovery of United lockdowns and other mobility restrictions, putting the States, an early indication of optimism. However, there are recovery at risk. The emergence of new SARS-CoV-2 challenges to this outlook. For EMDEs, these developments variants that could be more infectious, lethal, and resistant could adversely affect their economic recovery, as higher to available vaccines is the biggest challenge to pandemic interest rates could dampen investment spending, while containment measures in 2021. Consequently, countries the expectation of tighter monetary policy in advanced with slow vaccination efforts and a poor pandemic economies could slow capital inflows. Globally, the response will be more vulnerable to outbreaks continued rise of debt burdens to historic levels, along with and economic downturns. If high COVID-19 infections the deterioration of bank asset quality and bank profitability, materialize, global economic growth is forecasted could threaten the resilience of the global financial system. Figure 22. While the global economy is expected to grow Figure 23. … there are downside risks to the projections. by 4.0 percent in 2021, … 6 6 4 4 2 2 Percent Percent 0 0 -2 -2 -4 -4 -6 -6 2018 2019 2020 2021 2022 2020 2021 2022 World Baseline Advanced economies Downside Emerging market and developing economies Severe downside Source: Global Economic Prospects January 2021. Source: Global Economic Prospects January 2021. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 23 Table 4. Real Growth Projections. 2018 2019 2020e 2021f 2022f World 3.0 2.3 -4.3 4.0 3.8 Advanced economies 2.2 1.6 -5.4 3.3 3.5 Emerging market and developing economies 4.3 3.6 -2.6 5.0 4.2 East Asia and Pacific 6.3 5.8 1.2 7.4 5.4 Philippines 6.3 6.0 -9.6 5.5 6.3 Note: Developing East Asia & Pacific includes Cambodia, China, Fiji, Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea, Philippines, Solomon Islands, Thailand, Timor-Leste, and Vietnam. Source: Global Economic Prospects January 2021; East Asia and Pacific Economic Update April 2021. Private consumption is expected to rebound this year as Services and manufacturing activities are expected to economic conditions improve, but weakness is expected rebound and drive growth in 2021. The services sector in the first half of the year due to inflation and higher is expected to lead the growth recovery in 2021. The COVID-19 cases. Household consumption is expected to reopening of the economy and loosening of restrictions recover this year as remittances recover and employment bode well and will bring vitality for transportation, restaurant slowly improves. It may, however, weaken in the first half of and food services, and wholesale and retail trade. Some the year amid higher inflation and the resumption of a strict subsectors have strongly withstood the pandemic and community quarantine in the National Capital Region and expected to sustain its growth such as the information and nearby provinces. Consumer confidence levels remained in communication, and financial and insurance. However, as negative territory in the first quarter of 2021. The loosening some social distancing measures will likely remain, the of restrictions is expected to revitalize business activities, expected 5.0 percent growth in the services sector in 2021 which would help create jobs and address household is lower than pre-COVID levels. Meanwhile, manufacturing income losses, while a recovery of foreign markets is likely activities will likely gather steam as domestic and external to lead to an increase in the demand for overseas Filipino demand return, benefitting from the economic recovery workers. Private consumption is anticipated to expand by 4.7 in China and the U.S. fiscal stimulus-induced consumption percent in 2021, before accelerating to 5.4 percent in 2022, which will increase demand for Philippine exports (Box supported by election-related activities and spending. 6). Construction activities will have to rely on public infrastructure investments as private investors remain Following a significant contraction in 2020, capital cautious of the uncertain environment. Finally, agriculture formation is projected to recover in the next two years. is expected to grow at 1.1 percent in 2021, but unresolved Capital investment is estimated to expand by 8.3 percent in productivity challenges and vulnerability to weather-related 2021 from a contraction of 27.5 percent in 2020, driven by shocks preclude a growth acceleration in the near term. the rollout of public infrastructure investment projects. The government remains committed to pursuing its infrastructure investment agenda, as ramping up capital spending will help to restore business confidence and accelerate the economic recovery. However, private investment spending may remain tepid this year due to uncertainty and subdued bank lending. Some large corporations continue to see a deterioration of their balance sheets amid the ongoing pandemic. Nonetheless,as economic conditions improve and business sentiment strengthens, private investment is expected to contribute more strongly to capital formation next year. It will be important to attract private sector investment, including FDI, as the government’s fiscal space continues to dwindle Photo: Jed Regala because of increasing pandemic-related expenditures. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 24 Box 6. Spillover to the Philippines from the U.S. Fiscal Stimulus. The U.S. fiscal stimulus is expected to boost global Spillovers to FDI inflows could be growth which will generate spillover effects on the marginal as binding constraints such as restrictive FDI Philippine economy. The US$1.9 trillion (9 percent of GDP) regulations are among the major reasons behind lagging additional fiscal stimulus in the United States will support FDI inflows. The Philippines ranked as the most restrictive global recovery and materially raise global growth.28 The relative to its peers per OECD’s FDI restrictiveness stimulus will boost incomes and raise U.S. consumption index. Several restrictions relate to equity restrictions, for both domestic and imported goods, which bodes stemming from the foreign ownership limitation of 40 well for countries with strong linkages to the U.S. The percent across multiple sectors, the lowest allowed Philippines can potentially benefit from positive spillovers share of foreign ownership among regional peers. from the U.S. fiscal stimulus through the trade, investment, Domestic business regulations are also highly restrictive, remittance, and confidence channels. At the same time, and the Philippines has one of the highest levels of the stimulus-driven demand amid fast vaccination rollout in market concentration among major ASEAN countries. major advanced economies, may lead to higher transitory inflation and push interest rates higher earlier-than- There is risk that foreign capital may leave emerging expected. If the global steepening of yield curves or earlier- markets and return to safer advanced economy markets, than-expected tightening of global financing conditions resulting in financial turbulence. The Philippines may triggers an abrupt market correction, capital inflows suffer from episodes of capital outflows from emerging could decline sharply, and cause financial turbulence. markets such as those seen during the 2018 U.S.-China trade war and 2013 taper tantrum. This divestment of assets, The Philippines is likely to experience favorable spillovers a result of investors flying to safer markets, can contribute through the trade channel as the U.S. fiscal expansion to swings in the foreign exchange market and weaken boosts global and Philippine exports. As with most of its the peso. For instance, the increase in U.S. treasury bond regional peers, the Philippines is integral to the East Asian yields during the 2013 taper tantrum resulted in a 24.0 regional value chain with its exports mainly going to advanced percent decline in the Philippine Stock Exchange index, economies. In 2020, 15.2 percent of the country’s exports (2.7 and a 7.2 percent depreciation of the peso by end-2013. percent of GDP) went to the U.S., 15.5 percent (2.7 percent of These adverse developments, though not expected to GDP) to Japan, and 10.7 percent (1.9 percent of GDP) to the impact growth directly, may cause financial volatility and European Union (Figure 24). Estimates based on pre-pandemic may compromise the country’s macrofinancial stability. data suggest that the direct impact of the U.S. stimulus and the indirect impact through the increased growth among Overseas remittance inflows are an important channel trade partners on Philippine exports could boost GDP growth through which the stmulus can impact the Philippines. in the Philippines by an additional 0.6 percentage points per The U.S. has been a significant source of remittances to the year over the next two years. Exports of services are likely Philippines. In 2020, nearly 40 percent of total remittances to remain muted, though. Tourism activities are unlikely (3.2 percent of GDP) came from the U.S. (Figure 25). The to restart in 2021 as international travel and routes remain flow has continued in the first two months of 2021 where closed. However, the BPO sector is likely to grow as the U.S. remittances from the U.S. grew 6.5 percent year-on-year in accounts for 60 percent of BPO services in the Philippines. the first two months of 2021. In addition, positive spillovers to Considering the offsetting impact on tourism and BPO, the the global economy could further boost remittance flows in net impact on services exports is expected to be small. general, given the diversity in overseas Filipino deployment in terms of occupations and country of deployment. The Philippines may benefit, but only marginally, The resilience of remittances amid the pandemic likely from increased FDI inflows. The growth contribution rests on a number of factors including the strong familial of foreign capital is relatively limited for the Philippine ties among Filipinos, and increased digital adoption economy with foreign direct investments (FDI) of financial technology that formalizes the remittance representing only 1.8 percent of GDP. channel, and the countercyclical nature of remittances.29 28 Please see the Global Economic Prospects, June 2021, for the revised World Bank global forecast. 29 OECD, 2017. “Interrelations between Public Policies, Migration and Development in the Philippines,” Paris: OECD. See also E. Tan, 2006. “Overseas Filipinos’ Remittance Behavior,” UPSE Discussion Paper 2006-03. Quezon City: University of the Philippines PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 25 Figure 24. The Philippines may benefit from an increase Figure 25. Faster global growth could lead to an increase in exports to the U.S. and other advanced economies. in overseas remittance inflows. Goods Exports by Country Remittances by Country 15 9 8 7 In percent of GDP In percent of GDP 10 6 5 5 4 3 2 0 1 2019 2020 0 Goods Exports to Other countries 2019 2020 Goods Exports to EU Goods Exports to USA U.S. Middle East Europe Other countries Goods Exports to China Source: PSA. Source: BSP. Photo: SasinTipchai PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 26 2.2 Poverty and Shared Prosperity The pandemic continues to put pressure on household income which posts further risks to household welfare. Poverty is estimated to increase by around 1.4 percentage points, representing about 2.0 million more poor Filipinos, between 2018 and 2020, before declining and maintaining a downward trend to 2022. The recent surge in COVID-19 pandemic posts further households reported that their school-aged children risks to household welfare. The return to stricter were enrolled but effectiveness of distance learning was community quarantine measures that began in end-March a big concern especially among poor households. Lack and the uncertainty as to when these will be relaxed, of internet access likely explains the gap in access to further push back the rebound of economic activities. Like various types of learning modalities. Only 40 percent of last year, this will result in job losses and further erosion the poorest households had internet access compared of household incomes. Findings from the World Bank to the 70 percent share of the richest households. These COVID-19 monitoring surveys (December 2020 – January strains to human development will likely lead to adverse 2021) show that households continue to experience outcomes affecting human capital and productivity. income losses, with 41 percent of households reporting decreased or no income compared to their pre-pandemic Continued pressure on household income will likely usual income. cause the poverty to increase in the short term. Poverty is estimated to increase by around 1.4 percentage points Without sufficient support from government, poor and between 2018 and 2020 (based on the lower middle- vulnerable households are likely to experience food income poverty line of 3.2 dollars a day, 2011 PPP). This insecurity and further inequities to social and human represents around two million more poor Filipinos in development. In the most recent World Bank household 2020 than in 2018. The reimposition of stricter community survey, 2 in 5 households were worried of not having quarantines risks raising poverty further. However, if wage enough food for the following week. Households had and nonfarm employment increase with the anticipated difficulty accessing health services due to lack of finances. GDP growth and inflation is stable, the poverty rate will Three in five households cited this reason for not likely decline back to its 2018 level by 2021 and maintain obtaining the needed medical treatment. Most of a downward trend through 2022 (Figure 26). Figure 26. Actual and projected $3.20-a-day povery rates (%) 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 2006 2009 2020 2008 2022 2023 2007 2010 2015 2016 2019 2012 2021 2018 2013 2014 2017 2011 Source: World Bank Staff Estimates PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 27 2.3 Risks and Policy Challenges Emerging virus variants, tight global vaccine supply, and slower progress towards mass vaccination are key downside risks to the growth projection. These may prolong the pandemic which will adversely impact firm solvency, banking sector resilience, public financing needs, and debt levels. Risks also emanate from the external sector through a slower-than-expected global recovery, trade disruption, and trade protectionism. A commitment to structural reforms, easing of foreign investment restrictions, and addressing the socioeconomic impact of the pandemic must remain priorities of the government. The most significant downside risk remains to be the A slower growth recovery risks widening the fiscal resurgence of COVID-19 cases. Flattening the infection deficit, resulting in the need for more aggressive fiscal curve is the primary challenge for the authorities amid the consolidation. Slower economic growth, resulting from recent news of a more contagious virus variant that has a prolonged health crisis, could widen the deficit through entered the Philippines. A potential resurgence of infection a decline in tax revenues, increasing the pressure on the may yet overwhelm the country’s healthcare system. country’s increasingly limited fiscal space. In response, Testing, tracing, isolation, and treatment measures, along the government would likely resort to more aggressive with the vaccination program are key to the public health fiscal consolidation to ensure long-term fiscal response; however, tight global production supply and sustainability. 32 This approach could further dampen the vaccine nationalism risk delaying the arrival of vaccines. country’s short-term growth prospects, as fiscal policy Failure to effectively contain the virus or implement the has largely been supportive of growth in recent years. In mass vaccination program may extend mobility restrictions, particular, the implementation of the country’s infrastructure which could lead to more losses of jobs and income, investment program, which is expected to slow in 2022 delaying the domestic economic recovery. due to re-devolution in relation to the Mandanas Ruling, 33 could dampen the country’s short and long-term growth The impact of the health crisis on firms poses a risk to the prospects. financial system. In a national COVID-19 survey conducted in November 2020,30 a large share of firms reported acute Public debt remains sustainable, predicated on the liquidity constraints, including not having enough cash and expected growth recovery and fiscal consolidation. With falling behind in payments. About two-thirds of respondent the anticipated high financing needs in the near term, the firms did not have enough cash to service obligations such debt-to-GDP ratio is projected to increase from 54.5 percent as payroll, suppliers, taxes, or loan repayment beyond a in 2020 to nearly 60.0 percent in 2023. Yet, debt remains month. This low solvency among firms poses significant risks sustainable, as debt dynamics are expected to revert to a to the financial system. Moreover, the financial system is downward trajectory after 2023 due to fiscal consolidation highly interconnected with non-financial corporates through and the return to a positive interest-growth differential. To mixed conglomerate structures.31 With a significant share of keep debt levels sustainable, the government is expected assets in the banking sector related to mixed conglomerates, to temper the growth of public expenditure and increase a key source of contagion among banks is their common tax revenues. While a portion of the debt mix relies on exposure to large conglomerates. In 2018, about 80 percent external funding, 69.4 percent of outstanding debt is peso- of bank loans in the Philippines went to non-financial denominated, and long-term debt accounts for about 94 corporates, higher relative to regional and international percent of the external portfolio, as of end-2020. The debt peers, reflecting in part the country’s underdeveloped composition is expected to remain stable, with low shares of corporate debt and equity markets. short-term debt and foreign-currency-denominated debt, in 30 Monitoring COVID-19 Impacts on Families and Firms in the Philippines: http://www.worldbank.org/philippines/covidmonitor. Firm Survey Results: Round 2 – November 2020. 31 This interconnectedness is characterized with overlapping ownerships between banks and non-bank companies, and the provision of loans from banks to conglomerates. 32 The fiscal adjustment needs to protect in the short term those categories of spending with critical impact on service delivery and long term economic and social development. Those lines are often related to the provision of inputs and maintenance. These categories of spending have several characteristics: (1) they are critical for the operation of sectors (internal efficiency) and for the continuation of service delivery (social returns); (2) they often have a relatively low amount of funds; and (3) they are much easier to reduce or cut and constrain than the more politically sensitive wages and subsidies. 33 Set for implementation in 2022, the Mandanas Ruling clarifies that the Internal Revenue Allotment share of LGUs should come from all national taxes, such as customs duties, and not just from taxes collected by the Bureau of Internal Revenue. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 28 line with the government’s debt management strategy. regional peers. The Philippines faces even tighter regional competition, as its regional peers recently implemented There are also external risks. The risk of a slower-than- various incentives to attract investors. For example, expected global recovery, arising from new waves of Indonesia’s recent Omnibus Law on Job Creation removed COVID-19 cases in some major economies, may lead to critical restrictions on investment, while Vietnam’s retail trade sluggish demand for Philippine exports and lower levels sector only has a minimum paid-up capital of US$10,000. of FDI and remittance inflows. Disruptions in international The urgent passage of three investment reform bills, which logistics and global value chains, if not timely resolved, may seek to relax FDI restrictions, will help improve the country’s heavily impact the country’s external trade. With international competitiveness in the region (Box 2). flights still limited, the prospect for international tourism remains weak, which affects the Philippines, where tourism Drawing in greater private sector participation in represented 12.7 percent of GDP in 2019. Moreover, trade public infrastructure projects will be important as the protectionism may intensify, given ongoing trade tensions government faces limited fiscal space in the short term. between the United States and China and emerging vaccine The public financing needs will remain elevated as public nationalism, with supplies cornered by wealthy countries. revenues are tempered by the weak economy while public expenditures rise to address the pandemic. The limited The key health policy response remains the management fiscal space will compel the authorities not only to improve of the virus spread, complemented with the roll out of the efficiency in public expenditures, but also cut on public the vaccination program. Public health protocols such as investments. While the government remains committed to mask wearing and physical distancing remain the first line of pursue its infrastructure investment agenda, it is advisable defense to manage the spread of the virus specially as case to draw in greater participation from the private sector numbers remain elevated. Testing, tracing, isolation and case through a renewed focus on public-private partnership, for management have to be scaled up, along with expedient which the country has successful experience. Ramping up roll out of vaccines. The vaccination program requires infrastructure spending will accelerate the recovery through stringent planning, high fidelity of stringent planning, effective job creation, and narrow the infrastructure gap to boost implementation, and more importantly, implementation, productivity growth and expand growth potential in the long and more importantly, seamless coordination between the term. national government, local government units, and the private sector. As vaccine hesitancy remains high, the authorities may The authorities need to prudently manage institutional consider dialogue-based or incentives-based interventions to changes in 2022 and address challenges related to encourage more Filipinos to get vaccinated. upcoming institutional transitions. There are two key institutional changes in 2022: the change in administration The effective delivery of social protection programs will and the implementation of the Mandanas Ruling. The help to reduce the extent to which the crisis adversely national election will usher in a new administration, but affects long-term human capital accumulation. COVID-19 not without raising temporary uncertainty surrounding the pandemic-related shocks, including hunger incidences, direction of future economic policy. Swiftly and decisively have resulted in higher levels of child malnutrition, especially establishing policy clarity will help to reassure the domestic among the poor. It is important to reduce the extent of and foreign business community. The Mandanas Ruling, these losses, and mitigate the shocks which may lead to which will increase transfers to LGUs, represents a risk to a persistent impact on wellbeing and future economic budget execution and service delivery. The implementation opportunities. Social programs, including cash transfers, can of the ruling will result in an additional increase in Internal help alleviate food and subsistence conditions. However, Revenue Allotment allocations to LGUs of around 1.0 percent moving swiftly to provide transfers and support to poor of GDP beginning in 2022. Several national government households will require an improvement in the government’s agencies will re-devolve the funding and execution of delivery and implementation capacity. National and local programs, projects, and activities back to LGUs. However, government authorities need to coordinate their efforts to the transition toward re-devolution comes with several ensure timely and efficient deployment of public programs. operational challenges. Part III of this report discusses the likely impact of the transition and explores policy options to Relaxing restrictions on FDI is expected to boost manage the transition and maximize the unrealized potential the economic recovery. Regulations related to foreign of increased devolution in the Philippines. investments remain more restrictive in the Philippines than in PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 29 Part III Understanding the Fiscal Impact of the Mandanas Ruling This chapter assesses the potential fiscal impact of the Mandanas Ruling using a novel subnational fiscal database. Local government units will receive a permanent and substantial increase in fiscal transfers starting in 2022 of around 1 percent of GDP (Php234 billion in 2022). This increase is due to a decision by the Supreme Court (the Mandanas Ruling) that increased the share of national government tax revenue transferred to local governments. This development has prompted the national government to revisit its approach towards decentralization and paves the way for the country to address long-standing structural challenges which have limited the full potential of decentralization. However, while the Mandanas Ruling provides an opportunity to strengthen decentralization, a poorly managed implementation of the Mandanas Ruling represents a significant risk to local development. In particular, local governments are likely to face issues on weak budget execution, while the transition towards re-devolution could lead to gaps in service delivery. Overcoming these structural challenges while managing the transition towards increased decentralization requires several short and long-term policy recommendations focused on building capacity, improving horizontal equity through strong fiscal equalization, and improving transparency and accountability. The chapter is structured as follows. Section 3.1 provides the historical context and recent developments of decentralization in the Philippines. Section 3.2 describes the four key structural challenges of decentralization which has led to its underperformance. Section 3.3 provides the key policy challenges in the implementation of the Mandanas Ruling. Section 3.4 uses the information provided by the subnational fiscal database to estimate the potential fiscal impact of the Mandanas Ruling. Section 3.5 provides policy recommendations. Photo: Michael D Edwards PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 30 3.1 Revisiting Decentralization in the Philippines The passage of the 1991 Local Government Code marked Three decades since the passage of the Local Government a significant shift in the approach to local development Code, decentralization has fallen short of its potential to and service delivery. It provided the framework for the improve service delivery. Local government spending in the devolution of local public administration and service delivery Philippines remains low compared to peer countries that have responsibilities to local government units (Box 7). It also provided undergone decentralization (Figure 27). While a large set of local governments with enhanced revenue-mobilization basic services has been devolved to local governments, the powers and access to financing, which would accompany national government continues to spend an overwhelmingly the increase in spending on devolved mandates. The large share on local public expenditure. This is true even for objectives were to improve local service delivery and facilitate heavily devolved sectors such as health, economic services widespread socioeconomic development by bringing resource (e.g., agricultural extension and local public works), and social allocation and prioritization closer to constituents. However, services (Figure 28). decentralization under sub-optimal conditions could lead to inefficient outcomes, particularly in terms of service delivery.34 Figure 27. Despite devolution, public spending remains Figure 28. …even for heavily devolved sectors such as heavily centralized in the Philippines… health and economic services. Subnational government spending by income country groups vs the Phiippines 29.7 25.1 23.9 20.3 97% 96% Percent 87% 13.8 14.3 79% 13.2 69% 60% 8.3 9.0 55% 7.5 6.3 2.5 2.8 1.7 Low Low Upper High All 95 Philippines Philippines income middle middle income countries (BLGF (COA Economic Social Education Health Social General Total income income 2013) 2015-2018 Services Services Security Public averange) Share of GDP Share of public expenditure National government spending in regions LGU spending Source: IMF; DBM; and Bureau of Local Government Finance (BLGF). Note: 2013 data was used for the income country country groups and 95 countries in the OECD 2016 paper. Source: DBM and BLGF. Photo: Michael D Edwards 34 However, the potential trade-offs, especially under weak institutional settings, include hold-ups in decision-making processes (Treisman, 2007), lower economies of scale for service deliveries (Bardhan and Mookherjee, 2006), or higher local elite captures in developing countries (Reinikka and Svensson, 2004). Note: 2013 data was used for the income country country groups and 95 countries in the OECD 2016 paper. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 31 Box 7. The 1991 Local Government Code. The Local Government Code transfers statutory with taxes representing the largest share. Provinces responsibility for providing and financing several basic and cities are authorized to levy real property taxes, services from the national level to local government while municipalities and cities can levy community and units. The local government structure in the Philippines local business taxes (Manasan 2004; UN Habitat 2011). is composed of three levels, with provinces and highly Meanwhile, external-source revenues include grants and urbanized cities at the highest level, followed by aid to local governments, loans and borrowing, and a municipalities and component cities, and barangays (or share of national tax revenue specified by law. Shares villages) at the bottom tier (Atienza 2006, OECD 2016). from national taxes include the Internal Revenue Allotment Devolved mandates to local government units include as well as allocations from specific tax sources. local public works, health services, social welfare services, land-use planning, agricultural extension and on-site The Internal Revenue Allotment comprises around 90 research, community-based forestry, waste management percent of external-source revenues and accounts for systems, and the operation and maintenance of various around 60 percent of all local government revenues. water supply systems. Functions are assigned based on The Internal Revenue Allotment is an unconditional grant the incidence of benefits, with provinces mandated to given by the national government, which is mandated deliver intermunicipal services such as bridges tertiary by law to share 40 percent of all national taxes to local health services, low-cost housing, and intermunicipal government units. The distribution of the Internal Revenue infrastructure for telecommunications and waterworks. Allotment across local governments is based on a formula Municipalities and barangays provide “proximity services” that depends on the type of local government, population such primary health care, municipal/barangay roads and size, land area, and equal sharing considerations. bridges, and solid waste collection.35 While cities provide The Code also mandates the automatic release of the services of both provinces and municipalities. Internal Revenue Allotment. Apart from fiscal transfers, credit financing is another external source of funds, To complement the increase in spending mandates, the which usually take the form of loans. However, the Code Code expanded the resource base of local government imposes several restrictions on borrowing by local units. Sources of revenue are classified into own-source governments and is, therefore, rarely used as a means of and external-source revenues.36 Own-source revenues augmenting funds.37 are largely comprised of tax and non-tax revenues, Yet, large regional disparities in local service delivery 2012; Cuenca 2020). Similar outcomes can be seen in local still persist since the passage of the Local Government public works: road density varies across regions, and there Code. In the health sector, while several studies note some is a sizable local infrastructure investment gap that needs improvement in child health outcomes, such as infant to be addressed to improve local road infrastructure (World mortality,38 the quality of health services remains uneven Bank 2011; Diokno-Sicat et al. 2020a). across the country (Capuno 2008; Cuenca 2018). For example, bed capacity has declined since 1990 despite The Mandanas Ruling provided the impetus for the devolution.39 Overall, the weak relationship between local national government and local government units to revisit government spending and health service delivery and decentralization in the Philippines. In April 2019, the outcomes is attributed to: (i) disparities in local government Supreme Court confirmed its 2018 decision in favor of the unit spending; and (ii) a mismatch between the cost of petitions raised by governors Hermilando Mandanas and devolved functions and sources of financing (Uchimura Enrique Garcia Jr., who contended that local governments 35 Proximity services include services whose benefits are limited to a specific area. 36 The Bureau of Local Government Finance (BLGF) provides detailed information on the sources of revenue. Source: https://blgf.gov.ph/wp-content/up- loads/2015/08/SIE_CY_2004_Volume_1_new.pdf. 37 Under the Code, local governments are constrained by a legal borrowing capacity and can only borrow from national lending institutions. A more detailed description of the restrictions is available in section 2 of PD No. 752. 38 The number of infant deaths has declined from around 40,000 in 1990 to around 20,000 in 2016. 39 Bed capacity per 1,000 population declined from around 14.4 in 1990 to 9.9 in 2014. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 32 have not received their just share of national tax collections budget execution rate, undermining effective service through the Internal Revenue Allotment system.40 As a delivery. The analysis presented in this chapter shows that result, Internal Revenue Allotments are programmed in local government units suffer from low budget execution, the 2022 national budget to increase by 55 percent, particularly in terms of capital outlays, which are likely to reaching Php1.08 trillion (4.8 percent of GDP) compared worsen post-Mandanas Ruling. Recent experience of local to 3.5 percent of GDP in 2021 (Figure 29 and Figure 30). government units that received a large increase in their The substantial increase in transfers has prompted the budgets shows that they have limited absorptive capacity to national government to rethink its approach towards effectively manage and implement large budget increases, decentralization, by first re-devolving service delivery leading to idle resources and delays in service delivery. mandates currently funded and executed at the national level. For local government units, the increase in resources In the midst of the country’s worst socioeconomic and addresses one of the key binding constraints towards health crisis brought on by the COVID-19 pandemic, low efficient service delivery. However, further strengthening budget execution denies the Filipino people of much decentralization will require collaboration between the needed services. Fiscal space is currently more limited, as national government, national government agencies41, fiscal balances have deteriorated amid a historic recession. and local government units in order to create an enabling Limited fiscal space has resulted in a competition for public environment in delivering meaningful decentralization to its resources at a time when public health is under constant people. threat and poverty is worsening. Under these challenging times, it is important to ensure proper allocative and However, the large increase in the budget of local implementation efficiency to respond to the needs of the government units raises concerns on local absorptive people and improve service delivery. In the short-term, this capacity and inefficient budget implementation. Many means properly leveraging the increased local government local government units, often smaller rural ones, are revenues to help restore inclusiveness and strengthen ill-equipped to assume devolved responsibilities. Local resilience as the country recovers from the COVID-19 crisis. governments often lack the manpower and technical In the long-term, doing so would require a collaborative capacity to properly plan, prepare, implement, and relationship between the national government and local monitor projects and services. This limitation in capacity government units to understand who needs to spend on is reflected in underspent budgets as measured by the what, and determine at what level of devolution. Figure 29. The Mandanas Ruling will lead to a sharp Figure 30. … which is projected to increase the share of increase in Internal Revenue Allotment allocations… Internal Revenue Allotment in 2022. 2021 vs 2022 Projected Internal Revenue Increase in Internal Revenue Allotment in 2022 Allotment 450 450 1,200 1080 400 400 1,000 350 350 77 151 In billions Php In billions Php 300 300 800 695 In billions Php 250 131 250 600 200 200 150 150 88 400 100 100 234 200 50 88 50 0 0 0 By LGU Type By Source 2021 2022 Barangay Municipality Increase in tax collections Province City Municipality Barangay City Province Mandanas Ruling Source: DBM and World Bank staff calculations Source: DBM and World Bank staff calculations 40 The Mandanas Ruling mandates the inclusion of customs duties and several other national taxes in the computation of the IRA beginning in 2022. Tax revenues from the Bureau of Customs account for roughly 20 percent of total tax collections. 41 National Government Agencies refer to units of the national government, including executive departments created by law and the bureaus and offices that fall under their respective departments. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 33 3.2 Unfulfilled Promise of Decentralization Existing Weaknesses in Decentralization Design and Implementation42 Effective service delivery has been constrained by the This vertical fiscal gap leads to a large share of spending four structural challenges that have negatively affected on general public services at the expense of spending on the incentives and capacity of local governments to devolved mandates. The limited resources for local fulfill their primary role as basic service providers. These governments leads to general public services accounting structural challenges weaken the mechanisms for ensuring for a large share of local government spending (Figure 31). accountability from local governments which are important For example, spending on sectors such as health and social to ensure that increased decentralization translates into services is lower than general public services. Moreover, the improved service delivery. First, the lack of mobilization of share of spending on general public services is relatively own revenues by local government units which contributes large for local governments with limited resources. This leads to a substantial vertical fiscal gap (i.e., the mismatch between to lower levels of spending on key sectors for resource- spending responsibilities and own-source revenues). Second, constrained local government units. For areas with a high the design of the intergovernmental fiscal transfer system, poverty incidence, a high share of spending on general which creates horizontal fiscal imbalances. Third, overlapping public reservices results in less spending on key sectors service delivery responsibilities across different levels of such as social services (Figure 32). These spending dynamics government which diffuse accountability. Fourth, the lack of contribute to the uneven outcomes typically associated with technical capacity at the local level resulted in their continued inefficient decentralization and lead to persistent inequities dependence on national government agencies in the delivery across regions in the Philippines. of devolved public services. Weak revenue generation has led local government units The vertical fiscal gap faced by local government to rely on external-source revenues to bridge the fiscal units is among the main factors preventing them from gap (Figure 34). To address this vertical fiscal gap, the fulfilling their devolved mandates. Total local government Local Government Code provides increased access to fiscal spending increased from 1.6 percent of GDP in 1992 to 3.2 transfers, primarily through the Internal Revenue Allotment. As percent of GDP by 2019. However, own-source revenue own-source revenue generation remains relatively weak, local generation by local government units remained limited, governments are typically highly dependent on the Internal as several aspects of the Local Government Code limited Revenue Allotment (representing over 60 percent of revenues, the revenue generating powers of local government units on average) to finance local spending. Across local government (Figure 32). For example, the Local Government Code units, city governments are the least reliant on internal revenue substantially limits the power of local government units to allotments, benefitting from their productive resource base and set local tax rates, further contributing to their weak revenue more expansive taxation powers, as their own-source revenues generation capacity.43 In addition, while local tax assignment account for more than half of total revenues. In addition, own- is generally consistent with the criteria of appropriateness source revenues usually represent only a small share of total (economic efficiency, equity, and administrative feasibility), revenues for many rural local governments, leading to an even the most productive tax bases are left to the national greater dependency on the Internal Revenue Allotment for the government (Manasan 2004; World Bank 2010). Among country’s poorest local governments (Figure 35 and Figure 36). local taxes, only the real property tax and business tax generate substantial revenues. Photo: Pal Nikolaisen 42 This section reviews existing literature on decentralization in the Philippines, focusing on core governance issues that constrain efficient local service delivery. Established findings are supported by recent LGU fiscal data from the Commission on Audit. 43 First, the LGC fixes the tax rates of some taxes that are assigned to LGUs (e.g., the Special Education Fund, the real property tax, and the community tax). Second, the LGC sets limits (floors and ceilings) on the tax rates that LGUs may impose under their discretion. Finally, the LGC mandates that tax rates can only be adjusted (Manasan 2004). PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 34 Figure 31. Spending on General Public Services Figure 32. Poorer local governments need to allocate a represents the largest share of LGU budgets. larger share of their budgets to general services. LGU Spending by Sector (Average, 2015 - 2018) Share of Spending by Sector Across Poverty Quintiles (1 = Richest LGUs) 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 40% 50% 30% 40% 20% 30% 10% 20% 0% Total LGU Province City Municipality 10% General Public Services Economic Services 0% Others Health 1 2 3 4 5 20% Development Fund Social Services & Welfare Education DRRM GPS Soc. Services Econ. Services LDRRMF 20% DF Others Source: Commission on Audit (COA) and World Bank staff calculations. Source: COA, PSA, and World Bank staff calculations Note: Local governments are divided into quintiles based on local poverty incidence and the type of local government.. Figure 33. Following devolution, there has been a Figure 34. Local governments in the Philippines rely on mismatch between local governments’ ability to generate intergovernmental transfers to bridge the fiscal gap, own revenues and their expenditure responsibilities. similar to other countries. 4.0% Revenue Sources of Subnational Governments 3.5% 3.0% 10% 8% 7% 20% 2.5% Percent of GDP 2.0% 1.5% 66% 75% 51% 87% 1.0% 0.5% 24% 29% 0.0% 17% 5% 2000 2006 2002 2008 2004 2010 1992 1992 2016 2012 2018 1992 1992 2014 Philippines Indonesia Colombia Peru (2015-2018) (2015-2018) (2015-2018) (2015-2018) Own source revenue Local expenditures Taxes Grants Other revenue Internal Revenue Allotment Source: BLGF. Source: IMF and DBM. Figure 35. City LGUs are less dependent on the IRA than Figure 36. Poorer LGUs are almost solely reliant on the their provincial and municipal counterparts. IRA to finance spending. LGU Revenue and Borrowing LGU Revenue and Borrowing (2018, Tenth Poverty Decile) 100% 100% 90% 80% 80% 70% 60% 60% 50% 40% 40% 30% 20% 20% 10% 0% 0% City Municipality Province City Municipality Province Total Local Source Other External Source Total Local Source Other External Source Internal Revenue Allotment Total Acquisition of Loans Internal Revenue Allotment Total Acquisition of Loan Source: World Bank staff calculations; PSA; and DBM. Source: World Bank staff calculations; PSA; and DBM. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 35 The dependence of local government units on Internal assuming devolved functions. The Local Government Revenue Allotments leads to weak incentives for own- Code allows national government agencies to provide revenue mobilization. Low own-revenue mobilization services and infrastructure if local governments do not weakens the link between citizen tax/charge payments have sufficient resources and technical capacity.44 This and local government spending and service delivery, incentivizes national government agencies to keep local which constrains horizontal accountability. Moreover, as government technical capacity low to retain a large share local authorities are reluctant to increase tax collection of service delivery responsibilities and resources. As given its political implications, the most common a result, many national government agencies, such as coping strategy is to lobby the national government or the Departments of Public Works and Highways, Health, Congress to allocate discretionary funds to finance local Agriculture, and the National Housing Authority, retain infrastructure or services, perpetuating patronage and a substantive role in local service delivery and have a reducing allocative efficiency. much larger budget than local government units. This has resulted in a complex institutional arrangement that has led In addition, the Internal Revenue Allotment formula to fragmentation in the planning, budgeting, and delivery of fails to address the horizontal fiscal imbalance across services and diffused lines of accountability. local government units. The current formula does not compensate for the varying levels of fiscal capacity Lastly, the lack of local technical capacity perpetuates between local government units, often worsening the the dependence of local governments on the national horizontal imbalance among local government units at the government (World Bank 2016). Local government units, same level (Manasan 2007; World Bank 2010). Moreover, particularly smaller and rural local governments, are not the Internal Revenue Allotment fails to equalize the equipped to assume the responsibilities mandated under vertical (across different income classes) and horizontal the Local Government Code. They lack the manpower and (within the same income class) discrepancies, as it does technical capacity to adequately plan, prepare, implement, not consider varying levels of poverty (World Bank 2016). and monitor service delivery. Local development plans are These inefficiencies in the broad intergovernmental often developed without adequate citizen participation and fiscal system hinder its main purpose of addressing lack accountability to address local needs. Implementation inequalities across local governments in a comprehensive often lacks transparency, resulting in citizens being and systematic way, constraining rural and poorer local uninformed about what is being provided and at what cost. government units from delivering adequate services. This has led to a situation where national government agencies do not relinquish their responsibility over service Overlapping service delivery responsibilities between delivery due to lack of local capacity, but the capacity of different levels of government diffuse accountability local government units are not improved because they and disincentivizes local government units from fully continue to depend on the national government. Photo: Frolova_Elena 44 Section 17(c) of the LGC provides the legal justification for NGAs to continue implementing devolved public services as long as these are funded by the NG under the General Appropriations Act, special laws, or executive orders, or funded by foreign sources. Section 17(f) allows the NG or the next higher level of LGU to “provide or augment the basic services and facilities assigned to a lower level of local government unit when such services or facilities are not made available or, if made available, are inadequate to meet the requirements of its inhabitants.” PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 36 3.3 The Mandanas Ruling: Policy Challenges and Initial Response While the four structural challenges mentioned in the transition plans to ensure proper continuity in the provision previous section are expected to persist beyond 2022, the of public goods and services at the local level. The transition Mandanas Ruling provides its own unique set of challenges. plans would identify national government programs, projects, From a fiscal perspective, the national government’s initial and activities that would be re-devolved (in both funding policy challenge is to maintain its fiscal health. Internal Revenue and execution) to local government units beginning in 2022. Allotments are set to increase by 1.7 percent of GDP in 2022, National government agencies will take on a more strategic of which around 1.0 percent of GDP is due to the ruling. role, with an increased emphasis on their oversight and This increase in transfers can lead to a wider fiscal deficit, steering functions and provision of capacity building support exacerbating fiscal sustainability risks during a historic recession to local government units. and global health crisis. In this context, the national government has two options to ensure fiscal sustainability: (i) raise additional However, local government units have raised concerns revenues worth 1.0 percent of GDP; or (ii) cut spending on with the national government’s approach in managing functions already devolved to local governments. However, the transition45. Although the process towards re-devolution under the current socioeconomic and political climate, only the has started at the national level, local government units have second option is feasible. As a result, the national government raised concerns regarding the uncertainty surrounding the plans to ensure fiscal sustainability by re-devolving functions to process of re-devolution. For instance, there are reports of local government units equivalent to 1 percent of GDP during local governments being approached by various national the implementation of the Mandanas Ruling. government agencies to discuss functions which will be re-devolved, some of which are not covered by the Local Beyond the immediate fiscal implications, the government Government Code. In addition, there is a lack of clarity in faces several challenges which could compromise which functions would be devolved to local government service delivery. Coordination challenges between the units. Some local governments have also raised concerns national government, which plans to reduce spending on that the fiscal cost of re-devolution may outweigh the devolved services, and local government units, which are increase in resources. These issues highlight the need for expected to bridge the financing gap through an increase increased planning and coordination between all levels of in Internal Revenue Allotments, could undermine the quality government to ensure a successful transition towards re- and quantity of service delivery, as evidenced by past devolution and improved service delivery post-Mandanas experience (World Bank 2011). Moreover, local governments Ruling. suffer from weak budget execution capacity, which will likely constrain the effectiveness of re-devolution. Lastly, the mechanisms for holding local chief executives accountable Photo: Tashatuvango for performance are weak and frequently ineffective. Therefore, efforts are needed to implement mechanisms that can incentivize local governments to improve service delivery, such as strengthening demand-side accountability from citizens. The national government is taking steps to manage the transition to increased decentralization. To facilitate the transition towards increased devolution, the national government is expected to issue a forthcoming executive order that transfers national government spending on devolved functions back to local government. As part of the executive order, the national government has instructed national government agencies to prepare devolution 45 This paragraph benefitted from insights from a round table discussion with different local government executives. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 37 3.4 Potential Fiscal Impact of the Mandanas Ruling The Mandanas Ruling is expected to raise local the implementation of the Mandanas Ruling. government spending due to the increase in local resources, although concerns regarding absorptive Drivers of Local Government Unit Budget Execution: capacity and fiscal imbalances remain. Using the Budget Size and Capital Outlays subnational fiscal database, the analysis shows that, underspending by governments is likely to worsen post- Large and increasing budgets lead to lower budget Mandanas Ruling as many local governments do not have execution due to weak absorptive capacity of local the capacity to absorb a significant increase in revenues. governments government units. Between 2015 and 2018, As previously mentioned, limited absorptive capacity is a the budget execution rates of local government units have product of incentives for national government agencies declined as their budgets have steadily increased (Figure to keep local government technical capacity low to retain 37). However, the decline in budget execution rates has a large share of service delivery responsibilities and been smaller for municipal governments than for their city resources. Moreover, the analysis in this section applies and provincial counterparts, as municipal budgets increased to all types of local government units, as results were at a relatively lower rate. On average, budget execution robust to different local government type and capacity. rates for municipal governments were around 10 and 5 In addition, estimates on aggregate local government percentage points higher than that of city and provincial spending show that the vertical fiscal gap and horizontal governments, respectively. In addition, this discrepancy can fiscal imbalances are not addressed by the Mandanas be partly explained by the substantial disparity in the size of Ruling. This section discusses these issues in detail, local government budgets. highlighting the likely risks faced by local governments in Figure 37. The size of the budget is one of the key drivers of budget execution among local government units. Province Local Government Units City Local Government Units Municipality Local Government Units Budget and Execution Rates Budget and Execution Rates Budget and Execution Rates 3.0 !$' !#$ !#% 3.0 !$' !#% 3.0 !$' !#% 76 72 !## !#" 68 68 69 !## !#$ !#" !#+ 79 78 76 76 78 !#$ !## !#" 74 70 70 !#+ !#* !#( !#) !#( 71 70 !#* !#) !#( !#( !#& !#+ !#* !#( !#) !#( 2.5 !#& !#' !"$ !"% !"$ 2.5 !#' !"% !"$ !"$ !"# 2.5 !#& !#' !"% !"$ !"$ !"# !"+ !"" !"* !"" !"+ !"* !") !"# !"+ !"" !"* !") !"& !"( !"' !"( !"& !"' !+$ !+% !") !"( !"' !"& !+% !+$ !+# !+" !+% !+$ In Php billion !+" !+# 2.0 !+" !+# In Php billion 2.0 In Php billion 2.0 !++ !+* !++ !+* !+) !+( !++ !+* !+) !+( !+) !+& !+' !+& !*% !+' !+( !+& !+' !*% !*$ !*% !*# !*# !*" !*+ !*# !*$ !*# !*" !*+ !*# !*$ !*# !*+ !*" 1.5 !** !*) 1.5 !** !*) !*( !*& !*' 1.5 !** !*) !*( !*& !*( !*& !)% !*' !)% !)$ !)# !*' !)% !)$ !)# !)" !)# !)$ !)+ !)" !)" !)+ !)* !)) !)+ !)* !)) 1.0 !)* !)) !)( !)& 1.0 !)& !)( !)' !(% 1.0 !)( !)& !(% !)' !)' !($ !(% !(# !(" !($ !(" !(# !(" !(+ !($ !(# !(" !(" !(+ !(" !(+ !(* !() !(( !(* !(( !() !(& !(* !() !(( !(' !(& 0.5 !(& !(' !&% !&$ 0.5 !(' !&% !&$ !&" !&# 0.5 !&% !&$ !&# !&" !&+ !&# !&" !&+ !&* !&+ !&* !&( !&) !&& !&* !&) !&( !&& !&' !&) !&( !&& !&' !% !&' !% !# !$ - !% !$ !" !# - !# !$ !" - !" 2015 2016 2017 2018 Average 2015 2016 2017 2018 Average 2015 2016 2017 2018 Average Budget Execution Rate (percent) Budget Execution Rate (percent) Budget Execution Rate (percent) Source: World Bank staff calculations using COA LGU Financial Statements. Photo: wutzkohphoto PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 38 Constraints to absorptive capacity are also reflected capital outlays. However, the budget for capital outlays is in lower budget execution rates as the budget share significantly higher at the national level than at the local of capital outlays increases. In general, capital outlays government level. An ordinary least squares regression have significantly lower budget execution rates than using the subnational fiscal database revealed a significant personnel services or maintenance and other operating inverse relationship between that budget execution expenses (Figure 38). As a result, a larger share of capital rates and capital outlays budget shares (Annex 1, Table outlays in the budget results in overall lower budget A2). Case studies of select local government units are execution, regardless of sector and local government type likewise conducted to further investigate the relationship (Figure 39 and Figure 40). This is not surprising given the (Box 8). Low budget execution could, therefore, indicate complexity of capital spending, nor is this outcome unique delayed, incomplete, or unimplemented capital-intensive to local governments, as certain national government infrastructure projects. agencies have similar, if not lower, execution rates for Figure 38. The execution of capital outlays is far lower Figure 39. A higher share of the capital outlays is asso- than that of recurrent spending. ciated with lower budget execution rates regardless of sector…46 Average Budget Execution Rate by Expense All Local Government Units Class 100% (Average 2015-2018) 75% 92% 88% 86% Percent 79% 81% 80% 50% 55% 25% 50% 47% 0% g uc lt h F PS on r al DF bo sin M ci Ed Ec ea G RR 20 La So ou H LD H Capital Outlays Personnel services Maintainance Capital outlay spending Maintenance and Other Operating Expenses Personnel Services City Municipality Province Execution Rate Source: World Bank staff calculations using COA LGU Financial Statements. Source: World Bank staff calculations using COA LGU Financial Statements. Figure 40. …a trend also observed across local government levels. Province City Municipality Average 2015-2018 Average 2015-2018 Average 2015-2018 1.2 1.2 1.6 1 1.4 Budget Execution Rate (percent) Budget Execution Rate (percent) Budget Execution Rate (percent) 1 1.2 0.8 0.8 1 0.6 0.6 0.8 0.6 0.4 0.4 0.4 0.2 0.2 0.2 0 0 0 0 0.2 0.4 0.6 0.8 0 0.2 0.4 0.6 0.8 1 0 0.2 0.4 0.6 0.8 CO Budget Share (percent) CO Budget Share (percent) CO Budget Share (percent) Source: World Bank staff calculations using COA LGU Financial Statements. 46 The chart presents 2015-2018 average expense class shares from sector budgets as well as sector budget execution rates of an average local government unit. Sectors are categorized as general public services (GPS); education services (educ); health services (health); labor and employment (labor); housing and community development (housing); social services and social welfare development (social); economic services (econ); Local Disaster Risk Reduction Management Fund (LDRRMF); and 20% Development Fund (20DF). PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 39 Box 8. Case Studies of Select LGUs on Falling Budget ERs Associated with Budget Increases and Higher Allocations to COs47 The experience of select local government units that additional shares from the national government’s excise had significant increases in funds could provide insight tax collections on tobacco products, which expanded its into how similar local governments may respond to the budget by 105 percent. Province A’s budget execution rate Mandanas Ruling. The granular nature of the subnational fell by 25 percentage points (ppt). Similarly, Municipality B fiscal database allows for an analysis of local government experienced a sizeable increase in locally sourced revenue units that have received a large increase in their budgets. (77 percent) that led to an 87 percent increase in its budget. The database was built from audited financial statements Its budget execution rate then dropped by 32 percentage with budget and spending data of local governments points. Also, Municipality C and X saw significant rise in their from 2015 to 2018. The team selected local governments shares from national government tax collections in 2016 of different types and capacity48 to observe how local and 2017, respectively. Their budgets subsequently inflated governments of different levels have responded in the by 209 and 65 percent, respectively. Their respective past to a substantial increase in revenues. Results indicate budget execution rates dropped double-digits. This result that even for local governments with excess absorptive is consistent with other countries, where revenue windfall capacity (lower-than-average budgets but higher-than- is associated with reduced efficiency in spending.49 average execution rates), budget execution rates fell as the local government budget is increased. Declining execution Higher allocations to capital outlays that accompanied rates is also associated with higher budget allocations the budget increase contributed largely to the sharp for capital outlays. A review of audited local government declines in budget execution rates. Although the financial reports reveal implementation issues for local selected local government units’ (Figure 41) recent infrastructure projects, challenges that are also relevant performance suggests that they could accommodate to the national government’s infrastructure programs. additional resources, the increase in their budgets was too large and led to significant underspending. Most of the A surge in new revenues may lead to a significant decline additional resources went to the budget for capital outlays. in budget execution, even for local governments with For instance, Province A saw its capital outlay budget the capacity to absorb more resources (Figure 41). For share climb by 38 ppt given the surge in its revenues. instance, Province A (name withheld) seemed to have Likewise, faced with more funds, Municipalities B, C, and additional capacity to absorb more resources. Between X also increased their budgets for capital outlays. These 2015 and 2017, Province A’s budget execution rate was increased capital outlay allocations contributed to the greater than that of its peers, though its total budget was deterioration of budget execution rates partly due to the below the provincial average. In 2018, Province A received complexity of capital outlay project implementation (Box 9). Photo: Sasithorn Sareesuk 47 The local government units included in the case study and whose COA reports were closely reviewed by the team are anonymously referred to as Province A, Municipality B, Municipality C, Municipality X, Province E, Municipality F, and City G. 48 Proxied by budget execution rates. 49 Studies in Latin America show reduced efficiency in subnational spending following fiscal windfalls (Ardanza & Tolsa ,2015; Manzano & Gutierrez 2019). both their budgets and allocations to capital outlays. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 40 Figure 41. Change in budget, capital outlay share, and Figure 42. Change in budget, capital outlay share, and execution rates under Case 1 50 execution rates under Case 2 51 Case 1: Local Government Units with Existing Capacities that saw Case 2: Local government units with Weak Capacities that Lower Execution Rates due to Budget Increases and Higher CO continued to have Lower executiin rates due to Budget Increases Budget Shares and Higher Capital Outlay Budget Shares Percentage point change in Capital Outlay Budget and Percentage point change in Capital Outlay Budget and 60 87 209 30 120 115 105 65 74 38 40 20 20 10 Execution Rate (ppt) Execution Rate (ppt) - - -20 -10 -40 -20 -60 -30 -80 -40 -100 -50 Province A Municipality B Municipality C Municipality X Province E Municipality F Municipality F City G (2018) (2017) (2018) (2016) (2017) (2017) (2018) (2016) Change in Capital Outlay Budget Share (ppt) Change in Capital Outlay Budget Share (ppt) Change in Execution Rate (ppt) Annual Increase in Total Budget (percent) Change in Execution Rate (ppt) Annual Increase in Total Budget (percent) Source: World Bank staff calculations using data from COA financial Source: World Bank staff calculations using data from COA financial statements. statements. Budget execution rates of local governments with budget execution rate by 26 ppt. Meanwhile, Municipality weak capacity further declined as higher capital F’s revenue from other national taxes increased in outlay allocations accompanied their budget increases 2016, while both its local and external revenues grew in (Figure 42). Province E registered a below average local 2018. Municipality F then more than doubled its budget government execution rate of 46 percent in 2016 despite and increased CO budget shares, in 2016 and 2018, its below average budget, which suggests already existing respectively. As expected, its below average budget capacity challenges. In 2017, Province E expanded its execution rates fell further. Lastly, due to higher own-source budget by 74 percent as both local and external sources revenues in 2018, City G also ramped up its budget by of revenues increased. The province also decided to raise 38 percent and increased its capital outlay budget share. the budget for capital outlays, reducing its already low Thus, its low budget execution rate further dropped. Potential Impact of the Mandanas Ruling: Lower Budget severe capacity constraints than provinces and cities. As Execution and Unaddressed Fiscal Imbalances expected, budget execution is expected to improve as local governments reduce their budget allocations to capital An increase in local government budgets following outlays (Scenarios 2 and 3 in Figure 43). the Mandanas Ruling is likely to result in lower budget execution rates unless capacity concerns are addressed. As infrastructure projects tend to involve complex procurements and implementation capacity constraints (Box 9), budget execution rates are expected to deteriorate if local governments continue to allocate most budget increases to capital outlays. For example, allocating the entire increase in the budget to capital outlays52 is projected to reduce budget execution rates by an average of 14 and 13 ppt for province and city governments, respectively (Figure 43). The decline in budget execution is projected to be even more substantial for municipalities, at around 24 ppt, Photo: Aldrinho suggesting that municipal governments face more 50 Case 1 LGUs: LGUs with capacity (low budget and high execution rates) in the previous year but lower ERs in the current year increased their budgets and allocations to capital outlays. 51 Case 2 LGUs: LGUs with weak capacity (low budget and low execution rates) in the previous year and even lower ERs in the current year increased 52 Under this scenario, the capital outlay budget shares in 2022 compared to 2021 are expected to increase by an average if 22, 18, and 21 percentage points for provinces, cities, and municipalities, respectively. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 41 Figure 43. Budget execution is expected to fall post-Mandanas Ruling, as the share of capital outlays rise.53 Budget Execution Rates and Capital Outlay Budget Shares 85% 70% 80% 60% 75% CO share from Total Budget 50% Budget Execution Rate 70% 65% 40% 60% 30% 55% 20% 50% 10% 45% 40% 0% 2015-2018 2021 (estimate) 2022 2022 - 2022 - 2022 - (actual) (baseline) Scenario 1 Scenario 2 Scenario 3 Execution Rate Province Execution Rate City Execution Rate Municipality Capital O utlay Share Province Capital O utlay Share City Capital O utlay Share Municipality Source: COA; BLGF; and World Bank staff estimates. The vertical fiscal gap will widen following the Mandanas generate own-source revenues. This will result in a larger Ruling, increasing the dependence of local governments vertical fiscal gap post-Mandanas Ruling (Figure 44). The wider on the Internal Revenue Allotment. The increase in local vertical fiscal gap will be addressed by an increase in Internal government budgets is projected to increase total local Revenue Allotments, resulting in a much higher dependency government expenditure to Php962 billion (4.5 percent ratio54 across all local governments (Figure 45). A stronger of GDP) by 2022. However, the taxing powers of local dependence on the Internal Revenue Allotment may further governments will remain anchored on the provisions laid out weaken local fiscal autonomy and accountability (UN-HABITAT by the Local Government Code, which historically have not 2011). improved the ability of local governments to significantly Photo by: EzracAcayan 53 Baseline refers to post-Mandanas estimates. Scenario 1 considers all budget increases are allocated to CO budget. Scenario 2 assumes that only 75 percent of total budget increase goes to CO budget. Lastly, Scenario 3 assumes 50 percent of the increase is earmarked for CO. 54 IRA dependency was computed by dividing the IRA received by the LGU by its total revenue. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 42 Box 9. Local Infrastructure Project Implementation Challenges Government infrastructure projects typically suffer For instance, a survey of 1,373 municipalities reveal that from poor budget execution. They need to be carefully only 5 percent of oversight agencies have an updated planned and coordinated due to their complex and capital- comprehensive land use plan, while only 40 percent of intensive nature, the involvement of several authorities, and the comprehensive development plans are recent and their long implementation period. Infrastructure projects updated (Diokno-Sicat, et. al. 2020a). Lack of concrete also involve complex procurement processes, as they plans leading to project delays can be attributed to a highly require large public investments. However, implementing discretionary project prioritization, heavily influenced by agencies that lack the technical capacity to create, execute, local chief executives (Province A). Difficulty in complying and maintain an investment plan face challenges in fully with national government agency-mandated project briefs implementing quality projects on time. Delayed, incomplete, can likewise contribute to substandard planning quality or unimplemented infrastructure projects contribute to poor (Diokno-Sicat, et. al. 2019). Inadequate budget preparation budget execution at the national and local level. The select planning can also lead to unmet project needs and local governments featured in the case studies highlight contribute to poor, uneven, or unimplemented projects several issues faced in terms of infrastructure project (Municipalities B and X). Lastly, lack of coordination can implementation that contribute to poor budget execution. delay or even cancel projects of local governments due to similar projects implemented by the national government Weak technical capacity, leading to low budget in the same area (Province A and Municipality C). absorption, is a major reason for delayed implementation of local infrastructure projects in the Philippines (Manasan Poor adherence to procurement processes and and Mercado 2001). For instance, multi-year development questionable administrative procedures were also plans by even the largest city local governments were notable pain points in the implementation of not backed by investment cost estimates or operating infrastructure projects. A complex procurement process expenditure implications (World Bank 2010). Lack of skilled has long been recognized as one of the main bottlenecks personnel is a commonly cited factor that weighs heavily on in the execution of infrastructure projects. Under the most the technical capacity of local governments. Without enough ideal scenario, in which there are no procurement mistakes, skilled manpower to properly account for, evaluate, and the whole bid process would take one month (Diokno-Sicat, monitor ongoing projects, it would be difficult to ascertain if et. al. 2020b). In the sample of local government units expenses are utilized according to their intended purposes, analyzed, procurement issues can be largely divided into: or if a project was completed properly and completely (i) administrative lapses in procurement (Municipality C); (ii) (e.g., Province A, Municipality C and Municipality X). unclear or non-conformance to key performance indicators when disbursing funds (Municipality F); (iii) delays in the Poor planning and weak coordination can also delivery of goods and services (City G); and (iv) the selection adversely affect implementation. In 2016 and 2017, of non-experts or unqualified contractors to implement the Commission on Audit identified poor planning, projects (Province E). Moreover, general administrative monitoring, non-prioritization in the implementation lapses can be categorized into: (i) lousy record keeping, of development projects, as the main drivers of the which prevents the Department of the Interior and Local low utilization rate of the Local Development Fund for Government to evaluate certain projects (Municipalities C several local governments, which is mostly comprised of and X); and (ii) the non-transmittal of records and financial spending on capital outlays (Diokno-Sicat, et. al. 2020a). statements to Commission on Audit (Province E). Photo: Jed Regala PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 43 Figure 44. Existing vertical imbalances among LGUs are likely to widen with the implementation of the Mandanas Ruling. Province Municipality City 4 3 300 3 3 250 3 In million Php In billion Php In billion Php 2 200 2 2 150 2 1 100 1 1 50 1 - - - Local Funds Spending Local Funds Spending Local Funds Spending Local Funds Spending Local Funds Local Funds Local Funds Local Funds Local Funds Local Funds Local Funds Local Funds Spending Spending Spending Spending Spending Spending Spending Spending 2015-2018 2015-2018 2022 2022 2015-2018 2015-2018 2022 2022 2015-2018 2015-2018 2022 2022 Average (estimate) (No (With Average (estimate) (No (With Average (estimate) (No (With Mandanas) Mandanas) Mandanas) Mandanas) Mandanas) Mandanas) Source: BLGF; COA; and World Bank Staff Estimates Figure 45. Internal Revenue Allotments are expected to In addition, existing horizontal fiscal imbalances among represent an even larger share of local government units’ local governments are expected to persist following total revenues following the Mandanas Ruling. the Mandanas Ruling. At present, the Internal Revenue Allotment formula has been found to be counter-equalizing Internal Revenue Allotment Dependency (Manasan 2004), as it does not consider poverty levels or the local governments’ revenue mobilization capacity. 90% This has led to a horizontal fiscal gap55 across local 80% governments, as reflected by higher total per capita spending among richer local government units (Figure 46). 70% The disparity between richer and poorer local governments is more pronounced among provinces and municipalities 60% relative to cities. This is due to cities’ larger tax base, allowing them to generate higher levels of own-source 50% revenues, and their higher population resulting in higher 2015-2018 2021 2022 2022 Average (estimate) Pre-Mandanas Post-Mandanas Internal Revenue Allotment allocations. These observations highlight the inequities caused by the Internal Revenue City Municipality Province Allotment system (National Tax Research Center, 2008), which are expected to persist even after the implementation Source: COA; BLGF; and World Bank staff estimates of the Mandanas Ruling since no changes will be made to the current Internal Revenue Allotment formula.56 Figure 46. The horizontal gap between the spending per capita of rich and poor local governments is expected to persist post-Mandanas. Ratio of Per Capita Spending of Ratio of Per Capita Spending of Richest to Poorest Quintile Richest to Poorest Quintile (Local Source Revenue Per Capita Quintile) (Total Revenue Per Capita Quintile) 6 6 4 4 2 2 0 0 Pre-Mandanas Pre-Mandanas No Mandanas Post-Mandanas Pre-Mandanas Pre-Mandanas No Mandanas Post Mandanas (2015-2018) (2021) (estimate) (2022) (estimate) (2022) (estimate) (2015-2018) (2021) (estimate) (2022) (estimate) (2022) (estimate) (actual) (actual) Province City Municipality Province City Municipality Source: COA; BLGF; and World Bank staff estimates. Source: COA; BLGF; and World Bank staff estimates. 55 A horizontal fiscal imbalance occurs when jurisdictions within the same local government level do not have the same capability to raise own revenues, which could be due to difference in capacity or the different needs of geographical areas. For example, richer municipalities that have a broader tax base and are able to generate own-source revenues are likely to have higher per capita expenditure than poorer municipalities 56 Internal Revenue Allotments are distributed as follows by local government type: Province and City (23 percent), Municipality (34 percent), and Barangay (20 percent). It is further distributed by population (50 percent), land area (25 percent), and equal sharing (25 percent). PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 44 3.5 Policy Recommendations The increase in Internal Revenue Allotment allocations to Short-Term Policy Recommendations local governments in 2022 due to the Mandanas Ruling represents a significant risk to local development if not The national government should clearly define re-devolved managed properly. This analysis highlighted the main functions and communicate these clearly to both national drivers of poor budget execution and the extent of its impact government agencies and local government units. National on local government spending. From a fiscal perspective, government agencies are currently in the process of preparing the main drivers of poor budget execution at the local level their respective devolution transition plans. Improving are: (i) the size of the local government budgets; and (ii) the coordination and alignment between national government share of capital outlays in the budget—both of which are agencies and local government units, and between local expected to increase significantly following the Mandanas government units of different tiers, especially in identifying the Ruling. While the Mandanas Ruling partly addresses the functions to be re-devolved, could improve allocative efficiency. resource challenges faced by local governments, it does The authorities need to ensure that the development goals not address the four structural challenges which have of the national government and local governments are well- constrained effective service delivery and led to an inefficient aligned, and that service delivery gaps are minimized. This will decentralization. Moreover, the Mandanas Ruling does not require the national government and local government units to address existing issues related to vertical and horizontal fiscal review the division of labor between the national government imbalances that have significant equity implications in terms of agencies and local government units in re-devolving functions, overall socioeconomic development. while keeping fiscal and absorptive capacity in mind. Lastly, ensuring that this process is supported by the national Minimizing service delivery risks requires a change in the government budget is important, to avoid implementation approach towards decentralization by both the national overlaps and inefficiencies given the likelihood of budget and local government. The national government, which insertions. has focused on addressing the fiscal sustainability risks associated with the Mandanas Ruling, has started to identify Channeling the increase in Internal Revenue Allotments spending responsibilities for select devolved mandates to allocations towards local government’s COVID-19 response be transferred back to local government.57 However, local efforts to mitigate budget execution risks while providing governments, have raised concerns surrounding financial much needed support to local constituents. This chapter and technical capacity to absorb re-devolved mandates, has argued that increasing the share of capital outlays in local while maintaining full autonomy in planning and managing the government budgets may lead to a fall in budget execution. additional resources from the Mandanas Ruling. As a result, Moreover, local governments have the propensity to channel the re-devolution process could lead to a large gap in service revenue increases toward capital outlays. Idle resources and delivery, as a lack of coordination between the national and allocative inefficiencies are particularly harmful during the local government and weak implementation capacity could COVID-19 pandemic, as the opportunity cost for inaction is a delay the transition towards increased decentralization. further deterioration in poverty levels. As such, the increase in Addressing these weaknesses in planning and coordination resources for local government units post-Mandanas Ruling is a first step towards improving decentralization outcomes is an opportunity to provide immediate relief while managing and managing the transition towards re-devolution. However, budget execution risks. For example, a highly urbanized overcoming the structural challenges of decentralization city government revealed that in 2019, the city government requires several short and long-term policy recommendations scrapped numerous capital outlay projects in favor of social focused on improving horizontal equity, building capacity, and services in order to build proper technical capacity and ensure improving transparency and accountability. efficient use of public resources. Local governments could benefit from a similar approach to the increase in resources in To effectively address challenges related to the Manandas 2022 to improve budget execution while providing immediate Ruling and decentralization in general, the authorities relief to their constituents. This process is not without risk, should consider: as local governments have struggled to effectively provide 57 The extent of which remains unclear, as devolution transition plans of various NGAs are currently being prepared. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 45 support to their constituents. Local governments, particularly government, national government agencies, and local those with low capacity, would need support from various government units, as well as among local governments. national government agencies in properly designing and In the medium term, national government agencies need implementing appropriate response programs. to regularly share their country development plans and milestones with local governments and review their Medium-Term Policy Recommendations development plans to improve alignment. For example, local government units could be involved in developing Providing capacity building support to local government local indicators, baselines, and targets, which could also units to improve their implementation capacity and overall help identify priority areas in their jurisdiction and the local service delivery. This includes capacity building support government’s contribution to national development. This focused on augmenting local government’s manpower needs requires that local government units and implementing and technical skills in core public financial management national government agencies work in close coordination functions, including budget and project preparation and with the national government oversight agencies (National medium-term planning. However, capacity building support Economic and Development Authority, Department of must go beyond training human resources. Effective capacity Interior and Local Government, Department of Budget and building requires a change in the national government’s Management, and Department of Finance). Meanwhile, to approach, focusing on providing an enabling environment for maximize economies of scale, coordination issues between local government units that assigns responsibilities according local government units within the same geographical region to available capacity and ensures a highly participatory must be addressed, which requires a strategic approach that process involving learning by doing. The Philippine Rural leverages provincial governments. For example, findings from Development Project (PRDP) provides a useful model for field case studies have shown that development-oriented capacity building, as this shows that a collaborative approach and resourceful provincial governors have the ability to between the national government, national government initiate and support inter-local government initiatives (e.g., agencies, and local government units could improve service South Cotabato’s common solid waste management facilities) delivery, dramatically improving service outcomes (Box 10); and align municipal priorities with provincial objectives and strategies (World Bank 2010); Planning and coordinating the work between the national Photo: r.nagy PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 46 Box 10. The Philippine Rural Development Program: A Model for Capacity Building The PRDP is the national government’s flagship project 10 City Commodity Investment Plans that are anchored for agriculture and rural development and provides on 125 value chain analyses covering 74 commodities. best practice examples for capacity building. The PRDP The PRDP has advocated learning-by-doing approaches promotes sustainable and equitable growth in productivity in order to build local government capacity, while and the income of farmers and fisherfolks through science- strengthening transparency and accountability. The project based planning and synergistic partnerships among guided the transition from national government agency- national government agencies, provincial and municipal implemented to local government-implemented rural governments, and the private sector. The PRDP has infrastructure and enterprise development. With technical championed the local government’s adoption of science- guidance from the PRDP, local government units —as co- based tools and provided them with the capacity to establish financers of investments—gained the capability to carry out systematic and objective decision-support platforms devoid subproject planning, procurement, and engineering. The of political biases. This has allowed local government’s to project also introduced cutting-edge digital solutions to design holistic roadmaps for local agricultural development, improve local government accountability and transparency.58 which are embodied in the Provincial Commodity Investment The PRDP was able to mainstream many innovations and Plans. The PRDP has also improved the technical capacity best practices into the regular functions of the Department for planning and subproject implementation of all 81 of Agriculture and local government units to shift public provincial local government units in the country, producing investments toward a modern, value-chain oriented, a total of 81 Provincial Commodity Investment Plans and and climate-resilient agriculture and fisheries sector. Addressing horizontal inequity through strong fiscal Understanding the unique challenges faced by local equalization and gradual re-devolution. The transition government units in the Bangsamoro Autonomous Region to increased decentralization in 2022 and beyond needs in Muslim Mindanao (BARMM) region, for example, should to consider the fiscal capacity of local government units be a point of emphasis for the national government, as the to prevent worsening inequities across regions. The Mandanas Ruling will have implications beyond the Internal national government aims to address this issue partially Revenue Allotment to BARMM local government units through the creation of a growth equalization fund.59 (Box 11). In rolling out its transition plan for re-devolution, However, the scale of this fund is unlikely to be enough to the national government and national government result in a robust fiscal equalization. As such, the national agencies must manage the pace of re-devolution while government must continue to provide support to local considering the capacity limits of local government units; government units that lack proper capacity and resources. Photo by: Amors photos 58 These digital tools and innovations for enhanced governance include: (i) a geographic information system analysis, satellite imagery overlays, and utilization of drones for subproject approval, and monitoring and impact assessments; (ii) geo-tagging and geo-videos for real-time subproject implementation monitoring; and (iii) best practices for social and environmental safeguards measures. 59 The forthcoming Executive Order will create a growth equalization fund that seeks to address the vertical and horizontal fiscal imbalances present in the current system. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 47 Box 11. Impact of the Government Responses to the Mandanas Ruling in BARMM The precise impact of the government’s response to linkages. Some of the main questions include: (i) how the Mandanas Ruling in BARMM is not completely pre-existing partial devolution arrangements will be clear, as it will involve further analysis at all affected in areas such healthcare; (ii) what will be the levels of government on the benefits and burden impact on supplementary support to local governments of reallocated funding and responsibilities. from the regional government, including support for At the aggregate level, there will be an increase in funding staff salaries and other operating expenses; (iii) how for the BARMM regional government, offset to some will it change the various approaches to implementing extent by the reduction in the block grant it receives from national programs in BARMM; and (iv) what will be the national government. Based on the current allocation needed in terms of recalibrating programs and resource formula, the Internal Revenue Allotment is projected to allocation in response to an expansion or contraction increase by around 55 percent in 2022, while the BARMM of available funds at all levels of government. block grant is projected to be reduced by around 10 percent in the same year. In later years, the peso-value of An important consideration in assessing the impact the Internal Revenue Allotment will fall due to the sharp on the BARMM region is the extent to which local contraction in national tax collections due to the COVID-19 governments will be able to fill the gaps in quality and crisis. The impact on the BARMM block grant after 2022 availability of services they are responsible for by law. will be a further reduction in the peso-value of the grant. Research have highlighted the relative disadvantages and weaker response of poorer regions to significant The impact of the government’s response to the changes in funding levels, particularly in the context of Mandanas Ruling on services in the BARMM region COVID-19. BARMM contains many local government is more complicated. It will require a careful analysis units with fragile economic, social, and environmental and discussion among stakeholders at all levels of conditions that present major challenges for the government due to the many interrelated potential efficient and effective use of government resources. Long-Term Policy Recommendations the ideal reform would be to revise the Internal Revenue Allotment formula in the Code to strengthen its equalization Addressing fundamental weaknesses in fiscal properties. This would address issues related to the decentralization, which have constrained local horizontal fiscal imbalance caused by the current system. government units from fulfilling their responsibilities, Moreover, introducing a performance element into the by amending the Local Government Code.60 First, the Internal Revenue Allotment conditional on service delivery authorities need to review the Code to clarify expenditure could further incentivize local government performance and assignments across different levels of government strengthen service delivery; and (national government vs. local government units, and for different tiers of local government units) in order Creating an environment that fosters increased to address unnecessary overlap between national demand for transparency and accountability. The lack government agencies and local governments (World Bank of accountability between local chief executives and 2016). Second, the revenue mobilization ability of local their constituents is among the key binding constraints governments needs to be strengthened in the Code to to efficient service delivery. Targeted interventions promote their fiscal autonomy and improve accountability. aimed at achieving greater supply-side accountability As Manasan (2004) proposes several amendments are extremely complex and rigid, particularly as tools that would provide local government units with greater that could improve vertical accountability are complex discretion in setting tax rates and increasing own-source and hard to change. Demand-side accountability revenues.61,62 In terms of intergovernmental transfers, can be strengthened using mechanisms that improve 60 These recommendations draw heavily from the established literature on addressing accountability failures to improve service delivery. 61 These include raising the ceiling on tax rates, adjusting the frequency in which local governments can adjust tax rates, and relaxing restrictions on the size of the tax rate adjustments that LGUs can make. 62 Although this study is nearly two decades old, the study continues to be relevant given the absence of changes to the Local Government Code, three decades since its passage. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 48 citizens’ demand for accountability. Although the goal should also provide citizens with more information through of strengthening transparency and accountability is open data initiatives to increase transparency, allow seen as a long-term agenda, number of quick wins citizens to hold the local governments accountable, and could be implemented in the short to medium-term, increase citizen participation in the process to minimize especially in the context of improving digitalization. discretionary prioritization by the Local Chief Executives. In the short-term: Leveraging on previous open data In the long-term: There are currently several bills63 in initiatives and the shift towards increasing digitalization the legislative pipeline that aim to strengthen the links could help strengthen and improve transparency between transparency, accountability, and improved and accountability. This includes initiatives aimed at governance which could strengthen service delivery. In strengthening of citizen participation in budgeting and addition, establishing a subnational database that goes expenditure processes; public hearings on budget beyond fiscal indicators and includes service delivery information; civic monitoring of intergovernmental transfers; outcomes would provide citizens with the information and monitoring of local service provision. The government needed to hold local executives accountable. Photo: Leo Altman 63 These include the Freedom of Information Bill, the Anti-Political Dynasty Bill, and the The People’s Participation in Budget Deliberations Bill. PHILIPPINES ECONOMIC UPDATE JUNE 2021 EDITION 49 Annex 1: Methodology in Estimating Post-Mandanas Budget Execution Rates Local government budgets were estimated by deriving with respect to total budget obtained from the data. the revenue elasticity of budget from the 2015-2018 subnational fiscal dataset and using this to project Different hypothetical scenarios regarding increases budgets. The Internal Revenue Allotment to be received in capital outlay budgets were tested to estimate by each local government was calculated using the the effect on execution rates. Following the earlier current distribution formula and national tax collections approach, the budget execution rate is regressed with in 2019. Other revenue sources were assumed to follow the capital outlay’s budget share for each level of local the nominal growth of the national economy, given the government to calculate the relevant elasticities (Table lack of output data beyond regional aggregates. These A1). Three scenarios were considered, each varying in the projected revenue components were summed up to obtain allocation of the additional budget to capital outlay. The the total revenue for each local government. From the shares assumed for the three scenarios are 100, 75 and subnational fiscal data, local government budgets were 50 percent respectively. As the capital outlays’ budget then estimated using elasticities obtained from ordinary share was adjusted, the residual budget was distributed least squares regression of budgets on revenues for each among the other expense classes assuming they maintain local government type: province, city, and municipality their historical distribution. With the estimated elasticities, (Table A1). The capital outlay budgets in 2022 were the budget execution rates for each scenario with similarly estimated using capital outlay budget elasticity varying capital outlay budget shares were estimated. Table A1. Estimating elasticities of total budget on total Table A2. Estimating elasticities of total budget execution revenue using ordinary least squares regression rate on capital outlay budget share using ordinary least squares regression. Dependent variable: log(total budget) Dependent variable: log(total budget execution rate) Independent Province City Municipality Independent Province City Municipality variable variable log 1.0584*** 1.0371*** 0.8800*** log(capital -0.1826*** -0.1862*** -0.0683*** (total revenue) (0.0242) (0.0220) (0.0138) outlay budget (.0163) (0.0149) (0.0043) share) -1.0535** -.5771 2.2806*** Constant (0.5102) (0.4583) (0.2564) -0.5909*** -0.6268*** -0.4087*** Constant (0.0253) (0.0212) (.0093) Observations 314 522 5,158 Observations 313 518 5,070 R-squared 0.8601 0.8102 0.441 R-squared 0.2867 0.2322 0.0472 Note: Standard errors are indicated in parentheses. Note: Standard errors are indicated in parentheses. * Significant at 10 percent level, ** at 5 percent level, and *** at 1 percent level * Significant at 10 percent level, ** at 5 percent level, and *** at 1 percent level Source: COA and WB Staff Calculations. Source: COA and WB Staff Calculations. 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