IMF Executive Board Concludes Mid-2006 Post-Program Monitoring Discussions with the Philippines

Public Information Notice (PIN) No. 06/114
October 12, 2006

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. The Staff Report for the 2006 Article IV Consultation with the Philippines is also available.

On October 11, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Mid-2006 Post-Program Monitoring discussions on the Philippines based on the information available through that date.1


Considerable progress has been made with reforms, despite significant obstacles. Implementation of the far-reaching package of economic reforms launched in 2004 was initially slow due in part to political events. At the same time, surging international oil prices threatened to derail the extension of VAT to energy products, a key component of the fiscal reforms. Nevertheless, the non-financial public sector deficit was cut to 2 percent of GDP in 2005, 3½ percentage points below the 2003 level, reflecting tight controls on government spending and a marked turnaround in the finances of the National Power Corporation following a series of tariff hikes. The VAT reform, which took full effect in February 2006, looks set to further reduce the deficit this year, and has the potential to permit much-needed increases in spending on social services and infrastructure. Steps have also been taken to strengthen the banking system.

GDP growth in the first half of the year was 5.6 percent, with growth in agriculture particularly strong. Despite higher oil prices and the VAT reform, private consumption has been the main growth driver, buoyed by rapid growth in remittances. While investment has remained weak, exports have rebounded from last year's poor showing. Inflation remains above the Bangko Sentral ng Pilipinas (BSP)'s inflation target of 4-5 percent for 2006, but this is due largely to base effects from oil shocks and the VAT rate hike, and inflation has been easing in recent months.

The national government deficit fell to P 147 billion (2.7 percent of GDP) in 2005, from 3.8 percent of GDP in 2004. Through August this year, the cumulative deficit was P 34.2 billion, P 46.6 billion lower than in the corresponding period in 2005 and substantially below the full year target of P 125 billion (2.1 percent of GDP). With revenue collection broadly on target, the faster-than-expected pace of adjustment stems from the deadlock over the 2006 Budget, which was not passed by Congress; as a result, the 2005 Budget has been re-enacted which has constrained spending. The authorities are making efforts to increase social and infrastructure spending, including through the supplemental budget.

The strong performance of remittances and exports has helped to insulate the current account from surging oil prices. There has also been a pick-up this year in foreign direct investment. The Philippine peso was negatively affected by the emerging market sell-off in mid-May, but has since recovered strongly. This has allowed the BSP to resume its accumulation of reserves, which adjusted for pledged assets reached $21.5 billion at end-August, up from $18.0 billion at end-2005. The authorities have also used the greater availability of foreign exchange to prepay short-term external debt.

A key challenge for the Philippine economy will be to sustain the reform momentum, which will help maintain the confidence of markets and insure against market volatility. On current policies, growth is expected to increase to 5½ percent in 2007, but could be significantly higher over the medium term on the back of additional reforms that put public debt on a steeper downward path and boost investor confidence and investment. The main downside risks to the outlook are a renewed surge in oil prices and a slowdown in the global economy.

Executive Board Assessment

Executive Directors commended the Philippine authorities for the strong macroeconomic performance-including robust growth, moderating inflation, and an improved external position-as well as the progress made in structural reforms. In particular, they welcomed the large fiscal adjustment in 2005 and the further decline in the fiscal deficit in prospect this year, aided by the VAT reform, which has also contributed to improving market confidence. In addition, the oil price shock had been well-handled, and important steps are being taken to strengthen the banking sector.

While stronger fundamentals have made the Philippines more resilient and less vulnerable to shocks, Directors cautioned that important vulnerabilities remain. Although on a declining path, the public debt is still high, with external commercial borrowing requirements continuing to be sizeable. Against this backdrop, Directors encouraged the authorities to sustain fiscal consolidation and other reform efforts to ensure debt sustainability, maintain the confidence of markets, and spur investment and the rate of economic growth.

Directors were encouraged to see tax revenues this year running significantly ahead of GDP growth for the first time in a decade, due primarily to the VAT reform. They looked forward to further improvements in tax administration, in particular through full operationalization of the Bureau of Internal Revenue reform program that is being developed with donor assistance.

Directors judged the authorities' fiscal plans for the current year to strike a good balance between further adjustment and much-needed expansion in capital and social spending, financed by a portion of the proceeds from the VAT reform. Given that the 2006 budget was not passed by Congress, the authorities' efforts to increase priority infrastructure and social spending through a supplemental budget and the public enterprises are understandable. However, Directors emphasized that any off-budget expenditures should be transparent and well-contained.

Directors welcomed the authorities' plans to balance the budget by 2008, as well as to significantly increase social services and capital spending over the medium term. They observed, however, that achieving both objectives will require further increases in revenue. While strengthening tax administration has the potential to yield part of the needed additional resources, Directors were of the view that additional tax measures will also be needed for sustainable fiscal consolidation.

Directors considered the monetary policy stance to be appropriate, with risks to the inflation outlook being evenly balanced. While inflation is above target due to past oil price hikes and the VAT reform, there appears to be little evidence that supply shocks are having second-round effects, and inflation is expected to return to target in 2007. However, Directors concurred that the BSP should remain vigilant against possible price pressures.

In the banking sector, Directors were encouraged by progress made toward resolving the non-performing assets (NPA) problem, and looked forward to significant additional NPA sales facilitated by the extension of the Special Purpose Vehicle (SPV) framework. Directors also welcomed the recent consolidation in the banking industry and efforts by banks to raise new capital. Nonetheless, they urged the BSP to maintain pressure on banks to strengthen capital and pursue sound risk assessment practices. Raising capital will be particularly important for those banks that are shown to be undercapitalized based on new accounting standards, and in light of the pending introduction of Basel II. Directors stressed that any regulatory relief provided to banks that require time to comply with the new regulatory standards should be tied closely to clear and transparent recapitalization plans. To ensure full effectiveness of the strengthened regulatory framework, Directors encouraged the authorities to continue pressing for the passage of long-delayed amendments to the BSP Charter that would strengthen the legal protection for supervisors and increase their leverage over problem banks.

Directors supported the priority which the authorities are assigning to promoting financial market development. While the recent disruption in the trust industry carries lessons for investors, it has also highlighted the need to improve disclosure of risks and take better account of customer risk appetite. Directors considered recent debt swaps to be important for the development of the domestic debt market. They looked forward to progress with legislative initiatives designed to foster domestic financial market development, including measures to create a credit information bureau and promote retirement saving vehicles.

Directors regarded the sharp reduction in power sector losses since 2004 as a key achievement in the authorities' reforms. They emphasized that close monitoring of the National Power Corporation's (NPC) finances going forward will be essential to ensure that this improvement is maintained. While recognizing the challenges involved in power sector privatization, Directors underscored the importance of pressing ahead with the sale of power sector assets.

Philippines: Selected Economic Indicators, 2002-07
  2002 2003 2004 2005   2006   2007
            Staff proj. 1/

Growth and prices (in percent change)


GDP growth

4.4 4.9 6.2 5.0   5.0   5.4

CPI inflation (average)

3.0 3.5 6.0 7.6   6.7   5.0

Public finances (in percent of GDP)


National government balance


(authorities' definition)

-5.3 -4.6 -3.8 -2.7   -1.7   -1.9

National government balance 2/

-5.6 -4.9 -4.2 -3.0   -2.1   -2.3

Nonfinancial public sector balance 3/

-5.7 -5.6 -5.0 -2.1   -1.8   -2.3

Revenue and grants 4/

20.9 20.9 20.5 22.1   22.8   22.4

Expenditure 5/

26.6 26.4 25.5 24.2   24.6   24.6

Money and credit (in percent change)


Broad money (M3)

9.5 3.3 9.2 9.0   12.3



Interest rate (91-day Treasury bill, secondary market,


end period, in percent)

5.9 6.5 8.4 6.4   6.2



Credit to the private sector (net)

1.2 1.8 4.6 -1.5   -1.0



Balance of payments (in percent of GDP)


Trade balance

-7.2 -7.3 -6.6 -7.7   -6.8   -6.3

Current account balance

-0.5 0.4 1.9 2.4   2.4   1.7

Gross international reserves


In billions of U.S. dollars

16.2 16.9 16.2 18.5   21.5



Adjusted, in billions of U.S. dollars 9/

14.3 14.7 15.2 18.0   21.5



Adjusted, in percent of short-term liabilities 10/

123.9 122.9 122.9 133.0   ...   ...

Sources: The Philippine authorities; IMF staff estimates and projections.

1/ Projections are based on currently identified measures.

2/ IMF definition. Excludes privatization receipts of the national government, and includes net deficit from restructuring the central bank.

3/ Includes the national government, Central Bank-Board of Liquidators, 14 monitored government-owned enterprises, social security institutions, and local governments.

4/ 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.

5/ Defined as difference between nonfinancial public sector revenue and balance.

6/ As of June 2006.

7/ As of September 2006.

8/ At end-August 2006.

9/ 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.

10/ Short-term liabilities include medium- and long-term debt due in the following year, exclude loans backed by gold and securities pledged as collateral and include estimates of non-monitored debt.

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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