Public Information Notice: IMF Executive Board Concludes June 2005 Post-Program Monitoring Discussions with the Philippines

October 12, 2005

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report for the Article IV consultation with the Philippines may be made available at a later stage if the authorities consent.

On September 19, 2005, the Executive Board of the International Monetary Fund (IMF) concluded Post-Program Monitoring discussions with the Philippines based on the information available through that date.1


Following President Arroyo's election victory in May 2004, economic reforms advanced at a significant pace. In the power sector, average generation tariffs were raised by half, substantially cutting losses of the state-owned National Power Corporation. In the financial sector, the Special Purpose Vehicle framework set up to facilitate the sale of nonperforming assets began to gain traction. In the fiscal area, several tax measures were taken, culminating in Congress passing a landmark expanded VAT (EVAT) law in May 2005 that has the potential to sharply reduce the fiscal deficit. Subsequent events, however, interrupted the economic reform momentum. Allegations against the President led to impeachment complaints being filed before Congress, key Cabinet members resigned, and the Supreme Court issued a temporary restraining order on July 1 that stopped implementation of the new VAT law. The authorities quickly took steps to calm financial markets, including the appointment of a new economic team. On September 1, the Supreme Court declared the EVAT law to be constitutional, but retained the temporary restraining order in place for 15 days to allow for any appeals. Meanwhile, the impeachment charges against President Arroyo were dismissed by the House of Representatives on September 6, and with the political uncertainty having receded somewhat, financial markets have stabilized.

GDP grew by 4.8 percent y/y in the second quarter, above staff and market expectations, and up from 4.6 percent y/y in the first quarter. Buoyant services continued to underpin growth. Private consumption showed resilience to high oil prices, partly reflecting strong inflows of remittances. Headline inflation rose to 7.2 percent in August (y/y), up from 7.1 percent in July, and inflation through August averaged 8.1 percent. With inflation running at well above the target range of 5-6 percent for 2005, the Bangko Sentral ng Pilipinas (BSP) raised policy rates by 25 basis points in April to avert a rise in inflation expectations. In addition, reserve requirements were lifted by 2 percentage points in July to prevent excess liquidity feeding into peso depreciation and creating inflationary pressure.

Aided by continued compression of capital spending, the National Government budget through August appears to be on course to achieving the 2005 deficit target of 3½ percent of GDP (authorities' definition). In conjunction with reduced losses by the National Power Corporation, this would allow the nonfinancial public sector (NFPS) deficit to be reduced to 4 percent of GDP in 2005, compared to a little over 5 percent of GDP in 2004. An increase in tax revenues earlier this year coincided with a high profile campaign to pursue tax evaders that began in April and quickly showed up in monthly collections. After a deceleration in the growth of tax revenues in July, preliminary data indicate that tax collections recovered in August. The better fiscal performance in 2005, aided by strong portfolio inflows, has kept financial markets liquid; the 91-day treasury bill rate has declined about 200 basis points in 2005 to date.

The balance of payments recorded a surplus of $2 billion in the first half of the year; this primarily reflected a rise of more than one-fifth in overseas worker remittances (y/y), and a jump in net portfolio inflows to $1.9 billion, compared with $0.1 billion in the same period in 2004. Events since June have led to a marked slowing in portfolio inflows. Exports grew by only 4½ percent through July as a result of soft market conditions for Asian electronics, compounded by the lagged effects of relatively low investment in production capacity in recent years. Despite higher oil prices, imports remained virtually flat. Nonetheless, reserves (net of pledged assets) were US$17.5 billion at end-August, well above the end-2004 level of $15.2 billion.

The primary risk to the near-term outlook for the Philippine economy is that the prevailing state of uncertainty proves to be protracted and sidelines economic reforms. If reforms were to stall, investment is likely to remain subdued, and GDP growth of 4¾ percent is projected for 2005 and 2006. The outlook would be much brighter were strong reforms to resume. Soaring oil prices are a threat to the outlook, particularly if they serve to soften demand for Philippine exports. Adverse developments in international capital markets are another potential risk.

Executive Board Assessment

Executive Directors commended the authorities for the significant progress with much needed economic reforms that was achieved in the first year of the new administration. Furthermore, recent political uncertainties have receded, paving the way for improved market stability and resumed reform momentum. Directors cautioned, however, that the country's external debt and financing requirements are large and, despite its resilience, the economy remains vulnerable to external shocks, especially changes in market sentiment and increases in global interest rates and oil prices. In light of these concerns, Directors stressed the importance of the authorities pressing ahead with the implementation of their comprehensive reform package in the fiscal, power, and banking sectors, in order to reduce the vulnerabilities of the Philippine economy, achieve public debt sustainability over the medium term, and improve the investment and business climate for higher and sustainable growth. They emphasized that an accelerated pace of reforms would send a strong signal to markets and boost investor confidence.

Directors underscored the crucial importance of meaningful fiscal consolidation and debt reduction for enhancing stability and growth prospects. They considered the expanded Value Added Tax (EVAT) reform, including the envisaged VAT rate increase, as the best option to reduce the fiscal deficit. Directors therefore expressed concern that the EVAT implementation has been further delayed due to an appeal made to the Supreme Court, and urged the authorities to consider alternative revenue-raising measures in case the EVAT law cannot be implemented in full in the end. Directors also urged the authorities to continue their efforts to resist pressures to exempt energy products from the VAT increase. They recognized however, that adding taxes to already high energy prices will imply hardship for the poor, and accordingly supported the authorities' plans to consider well-targeted and affordable mitigating measures that would preserve the integrity of the EVAT law.

Directors noted that, even with the full and successful implementation of the EVAT law, the authorities will still have a gap to fill if they are to achieve their goal of balancing the budget by 2010. Directors therefore encouraged the authorities to plan additional measures, such as a sweeping rationalization of tax incentives. Expenditure reforms, including rationalizing and improving the targeting of rice subsidies, were also seen as essential. Directors commended the authorities' intention to continue to allow full pass through of high oil prices in domestic fuel prices, thereby avoiding provision of any subsidies, which would help prevent a reversal of fiscal consolidation.

Directors viewed the significant increases in generation tariffs awarded to the National Power Corporation as an important contribution to the fiscal consolidation effort. They encouraged the authorities to protect these gains by adjusting tariffs in the future in a timely manner. They supported the authorities' plans for developing medium-term deficit targets for Government-Owned and Controlled Corporations, as this would be essential to support fiscal consolidation.

Directors noted that civil service and pension reforms are critical for achieving sustainable fiscal consolidation. They welcomed the efforts being made by the authorities to reform the civil service and offer an affordable severance package. Directors also looked forward to the results of the actuarial review of the social security system that should pave the way for placing public pensions on a sustainable footing.

Directors stressed that power sector privatization is essential to restore the financial viability of the sector and to facilitate the investments needed to ensure adequate power supply. In this regard, they expressed concern about the delays in the bidding process for the transmission assets, and urged the authorities to finalize the agreements holding up the privatization of the generation assets. Directors underscored that the privatization process should be embedded in a sound regulatory framework.

While noting that a series of supply shocks have been the root cause of the rise in inflation, Directors were concerned that interest rate differentials were narrowing at a time when the Philippines' risk premium may have risen due to political uncertainties, which could lead to a weakening of the exchange rate and further additional inflationary pressure. Directors were also concerned that the persistence of above-target inflation for a prolonged period—even when caused by temporary factors—might lead to an upward and permanent revision of inflationary expectations, especially if the effects of higher oil prices, a weaker exchange rate, and the planned VAT increases are taken into account. Notwithstanding the recent increase in reserve requirements, they considered that a case still does exist for tightening monetary policy to guide inflation expectations down. Directors therefore welcomed the authorities' readiness to monitor developments closely.

Directors welcomed progress in banking sector reform, including the continued decline in nonperforming loan ratios. They were encouraged that banks have begun to use the special purpose vehicle (SPV) framework set up to facilitate the sale of nonperforming assets. Directors supported the authorities' plans to extend the SPV framework, and encouraged them to closely monitor developments in the trust and pre-need sectors. They also welcomed the privatization of the Philippine National Bank and recent acquisition announcements that would pave the way for necessary banking consolidation. However, Directors expressed concern that the amendments to the central bank's charter, which are critical to strengthening bank supervision, are still pending in Congress, and stressed the need for early approval. They also looked forward to the adoption of the International Financial Reporting Standards by the end of the year, which should lead to much needed improvements in transparency of banking sector indicators. Directors welcomed the continued progress made by the authorities in strengthening the anti-money laundering/combating the financing of terrorism regime.

Directors welcomed the authorities' efforts to further strengthen financial and balance of payments statistics.

Philippines: Selected Economic Indicators, 2002-05







IMF Staff Proj.

Growth and prices (in percent change)


GDP growth






CPI inflation (average)






Public finances (in percent of GDP)


National government balance (authorities definition)






National government balance 1/






Nonfinancial public sector balance 2/






Revenue and grants 3/






Expenditure 4/






Money and credit (in percent change)


Broad money (M3)






Interest rate (91-day Treasury bill, end period, in percent)






Credit to the private sector (net)







Balance of payments (in billions of U.S. dollars)


Trade balance






Current account balance






Gross international reserves


In billions of U.S. dollars






Adjusted, in billions of U.S. dollars 7/






Adjusted, in percent of short-term liabilities 8/






Sources: The Philippine authorities; IMF staff estimates and projections.
1/ IMF definition. Excludes privatization receipts of the national government, and includes operations of Central Bank-Board of Liquidators.
2/ Includes the national government, Central Bank-Board of Liquidators, 14 monitored government-owned enterprises, social security institutions, and local governments.
3/ The sum of all nonfinancial public sector revenue net of intra-public sector payments. It is assumed that 80 percent of Bureau of Treasury revenue represents interest and dividends from other parts of the nonfinancial public sector. Privatization receipts are excluded.
4/ Defined as the difference between nonfinancial public sector revenue and balance.
5/ As of June 2005.
6/ At end-August.
7/ In addition to monitoring the level of gross international reserves (GIR), the IMF also monitors Adjusted Reserves, which are calculated by subtracting from GIR the value of the BSP's foreign assets that have been pledged as collateral for short-term liabilities. These pledged assets (gold and other securities) remain foreign reserve assets of the BSP and so are considered part of GIR. However, they are not as readily usable as other components of GIR since pledged assets must be set aside while the short-term liabilities they secure remain outstanding.
8/ Short-term liabilities include medium- and long-term debt due in the following year, and exclude loans backed by gold and securities pledged as collateral.

1 Post-Program Monitoring provides for frequent consultations between the Fund and members whose arrangements have expired but who continue to have Fund credit outstanding. Particular focus is placed in these consultations on policies that have a bearing on external viability.


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