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Public Information Notice (PIN) No. 04/29
March 30, 2004
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with the Philippines

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On March 5, 2004, the Executive Board of the International Monetary Fund (IMF) concluded discussions on the 2003 Article IV consultation with the Philippines.1


The Philippine economy encountered recurrent episodes of market turbulence in 2003. Early in the year, financial markets were unsettled by concerns about worsening public finances, the potential impact of the looming war in Iraq, and the threat of international sanctions due to deficiencies in the Philippine anti-money laundering law. As a result, the peso depreciated significantly against the U.S. dollar, domestic treasury bill rates rose, and sovereign bond spreads widened. Swift policy response by the authorities, including amendments to the anti-money laundering legislation, diffused the pressure. However, adverse events set off renewed instability in the second half of the year. An unsuccessful military mutiny in July, legal challenges against central bank officials, a failed attempt to impeach the Supreme Court Chief Justice, and the resignation of the Finance Secretary, all contributed to renewed market pressure. The peso fell to record lows in November, and then again in late February on account of a ratings downgrade by Moody's and heightened uncertainty ahead of the May 2004 election.

Despite the volatility in the financial markets the economy grew a healthy 4½ percent in 2003. GDP growth was supported by rising agriculture production and remittances by overseas Filipinos helped sustain consumption growth. By contrast, export performance, particularly of the electronics sector, has been weak and contributed to the narrowing of the current account surplus. Reflecting in part increased public sector borrowing, gross reserves rose to US$16.9 billion by year end, well above short-term debt.

The national government's fiscal performance improved during 2003. As a result of tight control over spending and improved tax administration, the national government reduced its deficit to 4.9 percent of GDP in 2003, compared to 5.5 percent of GDP in 2002.2 However, losses of the National Power Corporation (NPC) increased, and as a result, the nonfinancial public sector deficit is estimated to have remained close to 6 percent of GDP in 2003, while nonfinancial public sector debt rose to about 108 percent of GDP.

Monetary policy was conducted in the context of the BSP's inflation targeting framework. Inflation remained subdued at an average of 3 percent in 2003, well below the BSP's target range of 4.5-5.5 percent. In this environment, the BSP aimed to maintain monetary conditions supportive of economic activity, but tightened policy in periods of market pressure to dampen exchange market volatility and stem the potential pass through to inflation. When the peso came under sustained pressure in the first quarter of 2003, the BSP absorbed liquidity by increasing the liquidity reserve ratio from 7 to 8 percent and abolishing the tiering system. With market pressure subsiding, tiering was reintroduced in June and the policy rate was lowered by 25 basis points in July. In response to further peso instability in August, the BSP abolished tiering again, and strengthened restrictions on foreign exchange purchases by residents. The peso came under renewed pressure in early 2004. In response, the BSP raised the liquidity reserve ratio to 10 percent to limit the possible inflationary impact.

The economic outlook for the Philippines is likely to remain subject to considerable uncertainty in the period ahead. In particular, the uncertain political environment ahead of the elections brings downside risks to the outlook. Nonetheless, economic growth should continue to be favorable, owing to the recovery in the global economy. The staff expects growth of around 4½ percent in 2004. Inflation is likely to edge up, but should remain below, or within, the official target range of 4-5 percent for 2004.

Executive Board Assessment

Executive Directors noted that the Philippine authorities have undertaken important economic reforms in recent years, and that macroeconomic performance has been favorable, with sustained growth and declining inflation. However, key areas of weakness and vulnerabilities remain. In particular, Directors pointed to the still large fiscal deficit and heavy debt burden, slow progress in structural reforms in the power and banking sectors, and the uncertain investment climate.

Directors observed that without comprehensive reforms, the economy's vulnerabilities would further increase. They therefore underscored the urgent need for the authorities to implement comprehensive reforms, in order to set the economy on a high and sustainable growth trajectory, reduce the still pervasive poverty, and improve debt sustainability and the economy's resilience to adverse shocks. They also urged the authorities not to loosen policies in the pre-election environment.

Directors commended the Bangko Sentral ng Pilipinas for its conduct of monetary policy, which had helped to contain financial market pressure during 2003, within the inflation targeting framework. While noting that the interest rate differential has helped to strengthen foreign exchange reserves, they welcomed the authorities' objective to focus on price stability and to tighten monetary policy should pressure in the foreign exchange market pose a threat to the inflation target.

Directors expressed serious concerns about the high levels of the public sector deficit and debt. They welcomed the authorities' efforts to reduce the central government deficit in 2003. They commended the strengthening of tax administration, which had helped to halt the declining trend in the revenue-to-GDP ratio. They also welcomed the tight control over spending, but cautioned that further expenditure compression risked degrading the quality of infrastructure and worsening the investment climate. They endorsed the recent procurement reform, and encouraged further progress in strengthening expenditure management. They welcomed the inclusion of collective action clauses in the recent sovereign bond issue.

For 2004, Directors recommended a more ambitious reduction in the deficit than that contemplated in the draft budget, as this would bolster the credibility of the government's fiscal strategy. They also supported faster fiscal consolidation over the medium term than in the authorities' plan. Directors stressed that fundamental revenue measures were needed for fiscal consolidation. In particular, Directors urged the authorities to increase and index excise taxes on cigarettes and alcohol, raise petroleum excises and the value-added tax rate, and rationalize and limit tax incentives. They advised the authorities to resist any proposals for a tax amnesty.

Directors highlighted the need for reform of the power sector, noting, in particular, the contribution of low power rates to the sharp deterioration of the financial condition of the National Power Corporation. They urged the authorities to raise these rates and implement a universal charge, while attempting to shield the poor from the burden of higher prices. Directors also stressed the need to tighten the National Power Corporation's budget constraint by limiting its recourse to external borrowing and government guarantees of its debts. In view of the importance of selling off public power assets in encouraging private investment, they regretted delays in privatization in the power sector. They also reiterated the need to ensure that the Energy Regulatory Commission has sufficient independence to set appropriate tariff rates.

Directors underscored the importance of improving the climate for private investment to support sustainable economic growth. They urged the authorities to strengthen transparency, governance, and the rule of law, and reduce corruption and excessive regulation. Directors noted the importance of investing in infrastructure and human resources. They also expressed concern about the declining competitiveness of the economy.

Directors emphasized the need to strengthen the banking system. They welcomed the steps taken to strengthen regulations on large exposures and credit risk concentrations, as well as to monitor bank holdings of high-risk instruments. Nonetheless, Directors expressed concern about the high level of support being extended to problem banks by the Philippine Deposit Insurance Corporation. In this regard, they reiterated their long-standing call for legislation to strengthen bank regulatory and supervisory powers and to fortify the framework for undertaking prompt corrective action.

Directors noted that little use had been made of special purpose vehicles intended to support bank asset restructuring, with banks unwilling to participate due to their lack of readiness to recognize past losses. They encouraged the authorities to step up the pressure on banks to recognize bad loans, fully provision against the latent losses from nonperforming assets, and raise their capital. Directors advised that the granting of any further incentives to facilitate the disposal of nonperforming assets should be accompanied by strong corrective actions by banks and sharing of the burden by bank shareholders.

Directors underscored the importance of fully implementing the 2003 anti-money laundering law and satisfying the conditions to become fully compliant with the Financial Action Task Force's recommendations. They also supported removing barriers to overseas workers channeling remittances through the formal financial sector.

Directors urged the authorities to resist trade protectionist pressure, in view of their past success in rapidly liberalizing trade. They saw the recent increases in import tariffs as providing a poor substitute for critical structural reforms, and urged the authorities to reverse them soon. They pointed to the need for diversification and strengthening of the export base, particularly in light of the end of the Multi-Fiber Agreement in 2005.

Directors welcomed the authorities' participation in recent reviews of standards and codes for data and fiscal policy. They encouraged the authorities to sustain their efforts to further enhance the reliability of the statistics.

Directors concurred with the authorities' intention to extend Post-Program Monitoring. They noted the importance of maintaining a close consultation with the Fund until the fiscal position strengthens.

Philippines: Selected Economic Indicators, 1999-2004












Growth and prices (in percent change)


GDP growth








CPI inflation (annual average)








Public finances (in percent of GDP)


National government balance 1/








Total revenues








Total expenditures and net lending








Nonfinancial public sector balance 2/








Money and credit (in percent change)


Broad money (M3) 3/








Credit to the private sector








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









Balance of payments (in percent of GDP)


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; and IMF staff estimates.

1/ IMF definition. Excludes privatization receipts of the National Government, and includes operations of Central Bank-Board of Liquidators.

2/ Nonfinancial public sector includes the national government, Central Bank-Board of Liquidators, 14 monitored government-owned enterprises, social security institutions, and local governments.

3/ For 1999 and 2000, adjusted for the estimated effects of Y2K.

4/ End-January, 2004.

5/ Auction rate as of February 16, 2004.

6/ End-February, 2004.

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 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.
2 The figures correspond to the IMF's definition, which excludes privatization receipts from revenues and includes the operations of the Central Bank-Board of Liquidators.


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