1. ECONOMIC SCENARIO AND FUNDAMENTALS
With a nominal per capita income of $1,220 (in 1997), the Philippines falls in the category of the lower-middle income countries. This income level is higher than the average for the East Asia and Pacific economies, as defined by the World Bank. Around 32 percent of the population were classified as poor in 1997; two-thirds of them lived in the rural areas and relied primarily on agro-based activities. The medium-term (1999-2004) development plan for the Philippines, therefore, focuses on promoting broad-based rural growth with greater equity.
The economy withstood the recent (1997-98) regional financial crisis better than most Southeast Asian economies. Banking and corporate sectors resisted the type of systemic collapse witnessed elsewhere in the region. Export growth remained robust, and the social repercussions of the financial crisis have been less severe than in several other regional economies. The more resilient response to the crisis in the Philippines reflected the shorter period of rapid credit expansion and debt accumulation by the private sector, stronger capitalization of major banks and lower levels of corporate leverage, greater private sector experience with previous crises, and a favorable macroeconomic policy response to the crisis.
Real GDP growth rate declined from 5.2 percent in 1997 to -0.5 percent in 1998. The economy was weighed down by a severe drought which reduced agricultural production by 7 percent. Unemployment and inflation both were high, particularly in 1998. Private investment fell sharply, and non-performing loans rose. Reflecting a higher level of financial stress, investors remained cautious towards initiating new projects and bankers remained reluctant to extend credit to new borrowers. The real GDP growth rate for 2000 has been estimated at 3.8 percent. It is being supported by resilient agriculture.
2. MACROECONOMIC POLICY STANCE
The policy responses to the crisis were basically sound, particularly when taking into account the low level of foreign exchange reserves and the need to balance the damaging effects of sharp depreciation and high interest rates on banking, corporate and public sectors. Periodic bouts of speculative attacks on the peso were blunted through a mix of short-term interest rate adjustments, tightening of liquidity, relatively mild intervention, use of moral suasion with market leaders and collaborative initiatives with the Bankers Association of the Philippines (BAP), but without resort to capital controls. Government expenditures were cut sharply from initial appropriations as tax revenue fell, but once the extent of economic weakening became apparent, selective adjustments to better project social expenditures were enacted.
Weak customs revenues because of sluggish imports and stagnant income tax receipt-due mainly to loopholes and exemptions-have succeeded in widening the fiscal deficit during January-September 2000. The ?tax and duty exempt imports? under various laws have caused a great deal of loss of revenue. These exemptions were reportedly granted to pump-prime the economy immediately after the crisis. Whether this action was well designed is questionable as many of such exemptions simply relate to imported consumer goods to be sold in duty free shops in Clark and Subic Bay areas. Income earned in the services sector and agricultural sector is also not effectively taxed. There are many legal loopholes for avoidance of tax payments. Budgetary support to a large number of Government-owned corporations is another major financial hemorrhage plaguing the economy. In general, these public sector corporations are not run in an efficient manner.
In the past privatization moved with a slow pace. At present, when there is a strong willingness in the Government to privatize, it is not the best time to sell public assets. The ?Jueteng crisis? has depressed market sentiment and has stalled the momentum for privatization, given the unwillingness of the authorities to off-load public assets at the prevailing low prices. The large fiscal deficit has now become an area of concern. The Bureau of Internal revenue cited the shortfall in revenue collection as the reason for widening deficit. For the month of September alone, the deficit was PHP13.2 billion. This was higher than the deficits in July (PHP 12.02 billion) and August (PHP 10.08 billion). The original full-year target was breached by August. Between January and November 2000 it ballooned to PHP 114.4 billion. Without severe belt-tightening, the deficit in 2001 appears set to widen well past the PHP 125 billion mark.
As for the belt-tightening noted above, those who watch the Philippine economy believe there is little scope for it without cutting into the social sector. In addition, two areas in the economy need immediate attention of policy makers. First, for improving the environment for corporate investment and bank lending, financial stress needs to be alleviated. Second, private capital flows need to be strengthened.
3. EXTERNAL SECTOR
The external sector has recently provided some of the dynamism which the domestic market lacked. Two factors came into play. First, buoyant export performance and, second, favorable terms-of-trade developments as commodity prices declined in international markets. Reflecting these two factors and a deepening import decline due to weak domestic demand, trade balance swung into surplus. The current account recorded a healthy surplus of 8 percent or above. In fact, a surplus in the current account after the crisis was seen for the first time since 1993. Rising exports and declining imports were responsible for this situation.
There is a downside to the current account surpluses. The large surplus is being offset by larger capital outflows. The current account recorded a large surplus of $3.6 billion (or 9.5 percent of the GDP) in the first half of 2000. But the overall balance of payments surplus was only $205 million, which was aided by $1.4 billion of sovereign bond issuance.
Electrical goods and electronics ($17 billion) overwhelmingly dominated exports, followed by machinery & transport equipment ($3.3 billion). Around 34 percent of exports were destined for the United States, followed by Europe (20 percent) and Japan (14 percent). Major Imports were raw materials ($10.4 billion), parts, intermediate goods and supplies for manufacturing electronics ($4.6 billion), telecoms & electronics ($6.9 billion). Origin of imports are the hard currency countries with US (22 percent) and Japan (20 percent) being the major trading partners.
From a policy maker?s perspective, successful electronics exports conceal something important. Having missed out on the first phase of Asia?s manufactured export boom, the Philippines had ample room to catch up. Productivity growth was stellar in the electronics sector, as its exports grew strongly despite strengthening of the real effective exchange rate (REER). But the manufacturing sector-with the exception of electronics-barely grew during the 1990s. This has had a particularly negative impact over the fiscal balance. The electronics sector is located almost entirely in export processing zones like Subic Bay, Clark Base, and other zones. Imports of capita- and intermediate-goods in these zones are duty free. These zones also receive tax holidays for 10 years. Consequently, government revenues are virtually untouched by the dynamism of the electronics sector.
4. EXCHANGE RATE
While the exchange rate has been an important issue in the press, the peso has performed in line with the currencies of the other crisis affected countries, except right after the start of the ?jueteng crisis?. The Peso performed better than the Euro until the ?jueteng crisis? broke out. Although the Peso did depreciate, its fall until this point has largely to be blamed on the strength of the US dollar.
There is no doubt that the ?Jueteng crisis? has had a negative impact on the currency. Certainly, there was an ?ERAP component? in the depreciation of the Peso. The Bangko Sentral ng Pilipinas (BSP) acted decisively to tighten liquidity. During September and October, overnight borrowing and lending rates were raised by 500 bp. Banks? liquidity reserve requirement ratio was also raised twice since early October, to 7 percent. T-bill yields have risen less sharply since the 500 bp hike in the overnight rates, with the 91-day rate rising by just 97 bp, to 9.892 percent, and the 364-day rate rising by 223 bp to 13.498 percent. At that time, the BSP monetary board had indicated that they were prepared to raise overnight rates further to stave off speculative pressures on the peso. The ?Jueteng-crisis? notwithstanding, the peso has now stabilized. Its nadir was reached at the end of October when it touched 51.70 to the dollar. It is currently (January 2000) rading at 52 to the dollar.
It has been noted that non-electronics exports were in the doldrums for a while. Sharp depreciation of the Peso compensated for many of the structural problems. The 10 percent depreciation of the Peso during the second quarter of 2000 contributed to a pick up in manufacturing growth of 23.9 percent YOY in July, the strongest performance in five years.
The stock price index moved more or less in line with those of the other Asian economies, except for Indonesia, which declined 40 percent more than the others. The non-performing loans (NPLs) were comparatively low-just above 15 percent. They increased a bit, partly because of re-definition of NPLs. However, NPLs may increase further if the high level of interest rates, established by the BSP to defend the speculation against the Peso, prevails for a longer period.
5. AREAS OF GRAVE CONCERN
One major issue is that due to fiscal slippage the International Monetary Fund (IMF) has decided not to disburse the last tranche of $314 million of their standby credit facility. This was largely because the Government could not achieve its fiscal deficit target of PHP 136 billion. The IMF could not take a compassionate stance because the Philippines has had a long history of not complying with committed targets.
The Philippines has to reduce its domestic debt level over the medium-term as they have reached a level where concerns should set in. They are now at the highest level in the region. The target for the next year is PHP85 billion, lower than that of this year?s. However, it seems difficult to achieve this target if the tax revenue situation does not improve.
Foreign direct investment (FDI) has been falling, and has reached a dangerous level. In addition, at present FDI is not flowing into the IT sector. Other promising regional economies like Vietnam are drawing FDI away from the Philippines. Extraordinary efforts will be required by both public and private sectors to retain the Philippine?s share in the IT and electronics markets. These are vitally important sectors for the Philippines and were responsible for the export boom in the past. The Philippines needs to brace itself to enter the higher grade production elements and development in these sectors, which requires substantial efforts and investment as well as honing human resources.
Another area of concern is the unemployment rate, which is the highest in the region and rising. The Philippines also has the lowest savings ratio in the Region. There is obviously a dilemma as an increase in savings reduces domestic demand which is needed for generating increased production. A major long-term weakness is income inequality and skewed ownership distribution of productive assets.
Public and corporate governance is another area of concern. On this account, the Philippines scores very low. Although on paper the Philippines has a reasonably good corporate governance framework, high corporate ownership concentration results in poor corporate governance in practice. It also leads to inadequate protection of minority shareholders, inadequate investor protection in the stock market, and weak market for corporate takeovers, all leading to an inefficient corporate sector-the engine of growth in a modern economy.
6. FOREX RESERVES & MULTILATERAL RESOURCES
Foreign reserves dropped by $2.8 billion since September 2000 leaving them at the level of $12.6 billion by yearend. This level of reserves still provides more than five months of import cover. The steady decline in reserves is the consequence of a massive scale of continued capital outflows from the country. There was a significant current account surplus. For the January-June 2000 period, it stood at $3.5 billion, or 9.5 percent of GDP. But this surplus was continuously being used for paying off external debt.
The major bilateral and multilateral donors for the Philippines are the Japan Bank of International Co-operation (JBIC), the Asian Development Bank (ADB) and the World Bank, accounting for 96 percent of the current portfolio. But the portfolio performance is less than satisfactory. Presently, there is an undisbursed amount of roughly $8.0 billion. The three major donors have coordinated their efforts for portfolio improvement and a joint meeting now being held with the Government. A committee has been made for this purpose which has met four times. It has prepared an action plan to tackle the issue of poor disbursement. The Government on its side has established a task force to closely supervise the progress of the major projects so the funds in the pipeline can be drawn down.
Conditional upon the receipt of the IMF tranche, a $200 million loan was to be made available by the World Bank. A JBIC loan was conditional upon the successful privatization of the Philippine National Bank. In addition, an ADB and JBIC loan of $200 million was to be made available, which was conditional upon the passage of the Omnibus Power bill. As the IMF is not releasing its tranche and other conditions have not been met, it seems likely that the Philippines would not get any of these promised multilateral funds.
To bolster the steadily declining foreign reserves level, the Government signed a $400 million loan in foreign currency deposit units (FCDU) with 17 foreign and local banks during the third week of October. The cost of such external funding has gone up sharply for the Philippines in the recent months. The Government is likely to tap increasingly into the FCDU to fund the fiscal deficit. Capital outflows are at a significant level, and the IMF has decided not to assist any further. This may lead to further deterioration of external liquidity position and would certainly raise the cost of foreign borrowings. However, analysts do not expect foreign exchange reserves to decline to the point where sovereign default would become a likely possibility.
7.CHALLENGES AHEAD
The macroeconomic scenario for the Philippines is full of challenges. Few short-term measures can be taken to ameliorate the situation. However, to turn the economy around concerted endeavors are needed to be focused on the following areas.
Macroeconomic Measures
Measures to increase the savings rate should include: (i) maintain confidence in the country?s banking system and the currency, (ii) diversify savings instruments by broadening and deepening the capital market, and (iii) reduce the age-dependency ratio by vigorous population control measures.
Promote broad-based rural growth. Bring down food prices through trade liberalization (rice price in the Philippines is about double that in Thailand and much higher than in other countries in the region) and, thereby, enhance the savings capabilities of the middle class.
Enhance competitiveness. The Government needs to improve basic education, which was an asset in the past but is languishing now.
Infrastructure improvement and encouragement of the private sector to upgrade technologies and move up in the production value chain within the traditional sectors as well as in IT and communications sectors.
Improve Investor confidence:
Foremost task is to resolve the present ?Jueteng-crisis? as soon as possible but within the constitutional framework, without major ?on-street? activities or calls for civil disobedience.
Resolve the Mindanao crisis on a sustainable basis.
Shrink, streamline and re-engineer the bureaucracy.
Pursue the on-going reform of the judiciary system.
Drastically improve public and corporate governance. It is essential to pursue recent cases of bad governance (e.g. stock market insider trading; Lucio Tan tax issue).
Improve the general environment to stimulate private capital inflows.
Improve physical infrastructure (which includes airport, roads, access to airport).
Accelerate sector reforms:
Improve the environment for bank lending as well as the institutional aspects of banking and financial sectors by passing the General Banking Act (to strengthen central banking supervising authority), promote 100 percent foreign ownership of commercial banks and pass the Securities Act (to improve functioning of the stock market).
The Philippines still provides opportunity for money laundering. Measures should be taken to stop it forthwith.
Parallel efforts to reform corporate debt resolution and the passing of the Omnibus Power Bill, which would allow privatization of this sector and improvements in public procurement and audit areas.
Time is essential here, as the competing regional economies are reforming and the Philippines should not loose its edge in these areas.
Budget Deficit
The government has to exert all efforts to balance the budget. This will be difficult, as tax increases are difficult to achieve and not much support can be expected from multilateral donors, like the ADB, the IMF, and the WB as most of their program loans are in abeyance. Efficient collection of the tax revenue should have the highest priority.
Broaden the liberalization of the economy. This will improve the local production standards. Immediate reduction or abolition of a number of tariffs is required for this purpose.
Budgetary support to Government owned corporations, particularly those that are being run in an inefficient manner and are incurring losses, must be terminated.
External Sector
Conserve the remarkable export performance, but in this effort the Government should be cautioned against premature graduation for traditional labor-intensive activities outside the IT and electronics sectors.
Diversification of trade partners is necessary. Over dependence on a single market (like the US) must be avoided. A good sign is the recent increase of exports to the EU, but more efforts could be made in this direction.
A more pro-active attitude from European investors is also called for, as Europe seems to have neglected this part of Asia.
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