## 1phlea2021003

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---

### POTENTIAL OUTPUT AND SCARRING EFFECTS

- Recent developments
  - The COVID-19 pandemic led to a major economic downturn in the Philippines.
  - Real GDP in 2020 decreased by 9.6 percent.
  - Unemployment rate rose to 10.4 percent in 2020 from 5.1 percent in 2019.
  - Recovery started in the second half of 2020 but a second wave in 2021 slowed recovery:
    - Real GDP level in Q1 2021 was still 4.2 percent lower than in Q1 2020.
    - Unemployment rate remained at 8.2 percent in the first five months of 2021.
  - Sectoral impacts were asymmetric:
    - Nonessential and contact-intensive services (tourism, entertainment, transportation) were most severely affected.
    - Construction and manufacturing also suffered from declining demand and containment measures.
    - Information, financial services, and public administration output increased, although employment in these sectors decreased.
    - Some unemployed workers appear to have moved into employment in agriculture.
  - Corporate sector health:
    - Profitability of firms deteriorated sharply in 2020.
    - Interest coverage ratios (ICRs) of most firms remain relatively stable.
    - Liquidity shortfalls and deep recession stress may have increased insolvency risks, especially for micro, small and medium enterprises.
    - FSAP assessment indicates distress to large nonfinancial corporates (increases in shares of debt-at-risk and firm-at-risk) could be widespread even in the baseline and sharply rise in adverse scenarios.
  - Inflation:
    - Headline inflation rates rose to an average of 4.4 percent in the first half of 2021.
    - Core inflation rates averaged 3.3 percent in the same period.
    - Inflation in 2020 annual average was 2.6 percent.

- Economic outlook and scarring effects
  - GDP growth projections:
    - 5.4 percent for 2021.
    - 7.0 percent for 2022.
  - Government vaccination target and risks:
    - Authorities aim to secure 148 million doses of vaccine in 2021 to inoculate about 70 percent of the population within the year; program still in early phase.
  - Potential output and drivers:
    - Potential output is estimated to have declined by 1.2 percent in 2020.
    - Total factor productivity (TFP) decreased significantly, contributing around −2.8 percentage point to the reduction in potential growth.
    - Investment declined by −27 percent in 2020.
    - Decline in effective labor may have contributed as much as 0.5 percentage point to lower potential output growth in 2020.
    - Capital accumulation is expected to have contributed around 2 percentage points to potential growth in 2020 (average 3.4 percentage points in 2015−2019).
  - Medium-term outlook:
    - Potential output growth expected to remain low for several years before returning to previous trend rate of 6.5 percent in the medium term.
    - Real GDP level in 2025 is projected to be 15 percent below that of the pre-COVID-19 path (January 2020 WEO).
  - Conditions that could mitigate scarring:
    - Early quelling of virus spread, achieving vaccination targets, recovery of external demand as advanced economies recover, infrastructure push in 2021, and structural reforms.
  - Historical context:
    - Past large recessions in the Philippines (1984–85; 1997 Asian financial crisis) showed long-lasting losses in potential output.
    - Global literature finds output levels after deep recessions often 4 to 9 percent below pre-recession trends.

- Policy recommendations
  - Fiscal policy
    - Active fiscal action is needed to support recovery and build productive capacity.
    - With a debt-to-GDP ratio below the EM average, Philippines has fiscal policy space to support recovery and avoid premature consolidation.
    - Increased spending in public works and transportation, continuing projects at advanced stages, to create jobs.
    - Renewed infrastructure push in digitalization, healthcare, and climate change to support post-pandemic reorganization and medium-term productive capacity.
  - Corporate sector support
    - Provide targeted support to viable firms and facilitate exit of unviable ones for efficient resource reallocation.
    - Credit guarantee scheme to encourage bank lending by mitigating credit risks to lenders.
    - Consider equity injections for systemically important corporates.
    - Provide more liquidity and solvency support than usual, except for firms already insolvent before the crisis.
    - The GUIDE Bill (under parliament consideration) would provide additional financial resources to government financial institutions to assist firms with temporary solvency issues due to the pandemic.
  - Labor market policies
    - Active labor market policies including retraining programs to reduce skill mismatch and support reallocation.
    - Well-designed and targeted subsidies for hiring to encourage firms to hire new workers.
    - More flexible labor regulation (e.g., dismissal procedure, minimum wage) to facilitate labor relocation.
    - Ensure adequate safety nets and more coverage for informal workers.
  - Structural reforms
    - Intensify economic reform momentum: implement national ID system and financial inclusion initiative to aid social assistance targeting and delivery.
    - Effective implementation of ease of doing business and CREATE laws to alleviate burdens on MSMEs.
    - Further lift restrictions on inbound foreign direct investment to rekindle investment and employment.
    - Accelerate planned digitalization of public administration.
    - In the medium term, allocate more resources and incentives for climate change adaptation and mitigation to induce investment and emission pattern changes.

### UNDERSTANDING THE TURNAROUND IN THE CURRENT ACCOUNT BALANCE

- Recent developments
  - CA was in surplus until 2015, averaging 3 percent of GDP in 2011−2015.
  - CA moved into deficit in 2016−2019 (average 1.1 percent of GDP).
  - CA returned to a large surplus in 2020 (3.6 percent of GDP).
  - Primary driver:
    - Fluctuations mainly explained by widening and narrowing deficits for trade in goods.
    - Balances in services, primary and secondary income changed relatively little.
  - Services and remittances:
    - Service exports increased faster than service imports during 2016−2019, partially offsetting deficits.
    - Travel exports decreased from US$9.8 billion in 2019 to US$2.0 billion in 2020.
    - Travel imports also decreased sharply; trade deficit in tourism and travel was broadly unchanged in 2020 compared to 2019.
    - Remittances oscillated through 2020 but total remittances in 2020 were almost similar to 2019, keeping primary and secondary income balances.
    - Remittances from overseas workers decreased by 9.8 percent (year-on-year) in Q2 2020 and then increased by 4.2 percent (year-on-year) in Q3 2020.

- Drivers of the current account changes
  - Larger downturn and containment policies:
    - Philippines experienced a larger economic downturn (Real GDP decreased by 9.6 percent in 2020) with significant local transmission and stringent containment compared to peers.
    - Gross fixed capital formation declined by 27 percent in 2020 after averaging growth of 12 percent in 2016−2019.
  - Saving-investment dynamics:
    - The increasing CA deficit in 2016−2019 mirrored an investment boom: investment ratio increased from 21 percent of GDP in 2015 to 27 percent of GDP in 2018, while aggregate gross savings barely changed.
    - Public investment under the Build Build Build program contributed importantly to the investment boom.
    - In 2020, the sharp decline in investment—an import-intensive component—accounted for a larger share in the turnaround in the current account balance than aggregate savings.

- Terms of trade and exchange rate
  - Terms of trade deteriorated by an average of 2.7 percent per year between 2016 and 2019, widening CA deficits.
  - In 2020, the terms of trade improved because of the decline in the price of oil and commodity prices.
  - Changes in exports and imports in 2020 were more driven by volumes than by prices.
  - Nominal goods exports in the national accounts (in national currency) decreased by 13.2 percent in 2020, with 8.6 percentage points accounted for by the decline in real imports.
  - Real goods imports (in national currency) contributed 20.3 percentage points out of 24.5 percent decrease in nominal imports in 2020.
  - The external value of the peso declined gradually in 2016−2018 but has appreciated since 2019.
  - The appreciation of the peso in 2020 could have been driven in part by the factors behind the large current account surplus and continued capital inflow.

- Regression analysis and decomposition
  - Estimation period: 1982:Q1 to 2020:Q4 using quarterly data from Haver Analytics and IMF WEO database.
  - Variables included: current account, investment shares, fiscal balance (percent of GDP), real exchange rates (trade-partner weights, CPI-based), fiscal balance (central government budget surplus or deficit), second order of growth rates, interbank call loan rates (interest rates).
  - Expected relationships:
    - Exchange rates, terms of trade, and fiscal balances: positively related to the current account balance.
    - Real GDP growth rate and domestic interest rates: negatively related to the current account balance.
  - Empirical findings:
    - The positive coefficient associated with the lagged current account variable indicates persistence in effects.
    - Improving terms of trade or depreciation of the real effective exchange rate (REER) lead to increases in the current account balance.
    - An expansionary fiscal stance or high real GDP growth decrease the current account balance.
    - High interest rates are related with declining current account balance (acknowledged literature uncertainty on this effect).
    - When the investment-to-GDP ratio increases, the current account balance decreases due to implied increases in imports.
    - Estimation note: Lagged exchange rate is used to avoid endogeneity between current account and REER.
  - Decomposition results:
    - The turnaround to a CA surplus in 2020 was mainly driven by the economic recession and the associated composition in aggregate demand, notably the sharp decline in investment relative to other components.
    - The deficit in 2016−2018 was primarily driven by booming investment.
    - Average CA change (quarterly, year-on-year) in 2016−2019 was −0.8 percent of GDP. Main drivers implied by the model: persistence (−0.6 percentage points of the change), investment increases (−0.2 percentage points), low interest rate (−0.1 percentage point) and expansionary fiscal stance (−0.1 percentage point).

- Prospects for the current account
  - The large CA turnaround in 2020 is expected to be largely temporary and start reversing in 2021 with the economic recovery.
  - Near-term factors:
    - Health measures and the vaccination program should allow further economic reopening, supporting recovery in consumption, investments, and imports.
    - Recent rise in oil and other commodity prices should result in higher import values.
    - In the near term, the current account is expected to remain in surplus given a relatively gradual domestic recovery in 2021 and a relatively stronger rebound in advanced economies boosting external demand and exports.
  - Medium-term outlook:
    - The current account balance is expected to return to a deficit in the medium term due to rekindling investments.
    - Government increased public spending on infrastructure through the Build Build Build program (transportation, water resources, energy) to address infrastructure gaps.
    - Ongoing structural reforms (ease of doing business improvements and tax reductions under the CREATE law) and envisaged increase in public investment from 2021 should rekindle investment and likely contribute to a reversal from surplus to deficit.
  - Fiscal context linked to CA and investment dynamics:
    - Due to delays in parliamentary approval of the 2019 budget, aggregate investment slightly declined to 26 percent of GDP that year.
    - The external balance assessment (EBA) model finds the cyclically adjusted CA in the Philippines in 2020 is larger than the CA norm, with the gap mainly related to less expansionary fiscal policies in the Philippines than in other countries, especially advanced economies.
    - The regression analysis highlights large effects of the economic downturn and the decline in investments on the CA in 2020; the pandemic’s large effects on investment in the Philippines may be captured by fiscal stance differences in the EBA model.

*PHILIPPINES — INTERNATIONAL MONETARY FUND*

### References__________________________________________________________________________________ 7

### POTENTIAL OUTPUT AND SCARRING EFFECTS

### A. Recent Developments
- The COVID-19 pandemic led to a major economic downturn in the Philippines.
- Real GDP in 2020 decreased by 9.6 percent.
- Unemployment rate rose to 10.4 percent in 2020 from 5.1 percent in 2019.
- Recovery started in the second half of 2020 but a second wave in 2021 slowed recovery:
  - Real GDP level in Q1 2021 was still 4.2 percent lower than in Q1 2020.
  - Unemployment rate remained at 8.2 percent in the first five months of 2021.
- Sectoral impacts were asymmetric:
  - Nonessential and contact-intensive services (tourism, entertainment, transportation) were most severely affected.
  - Construction and manufacturing also suffered from declining demand and containment measures.
  - Information, financial services, and public administration output increased, although employment in these sectors decreased.
  - Some unemployed workers appear to have moved into employment in agriculture.
- Corporate sector health:
  - Profitability of firms deteriorated sharply in 2020.
  - Interest coverage ratios (ICRs) of most firms remain relatively stable.
  - Liquidity shortfalls and deep recession stress may have increased insolvency risks, especially for micro, small and medium enterprises.
  - FSAP assessment indicates distress to large nonfinancial corporates (increases in shares of debt-at-risk and firm-at-risk) could be widespread even in the baseline and sharply rise in adverse scenarios.
- Inflation:
  - Headline inflation rates rose to an average of 4.4 percent in the first half of 2021.
  - Core inflation rates averaged 3.3 percent in the same period.
  - Inflation in 2020 annual average was 2.6 percent.

### B. Economic Outlook and Scarring Effects
- GDP growth projections:
  - 5.4 percent for 2021.
  - 7.0 percent for 2022.
- Government vaccination target and risks:
  - Authorities aim to secure 148 million doses of vaccine in 2021 to inoculate about 70 percent of the population within the year; program still in early phase.
- Potential output and drivers:
  - Potential output is estimated to have declined by 1.2 percent in 2020.
  - Total factor productivity (TFP) decreased significantly, contributing around −2.8 percentage point to the reduction in potential growth.
  - Investment declined by −27 percent in 2020.
  - Decline in effective labor may have contributed as much as 0.5 percentage point to lower potential output growth in 2020.
  - Capital accumulation is expected to have contributed around 2 percentage points to potential growth in 2020 (average 3.4 percentage points in 2015−2019).
- Medium-term outlook:
  - Potential output growth expected to remain low for several years before returning to previous trend rate of 6.5 percent in the medium term.
  - Real GDP level in 2025 is projected to be 15 percent below that of the pre-COVID-19 path (January 2020 WEO).
- Conditions that could mitigate scarring:
  - Early quelling of virus spread, achieving vaccination targets, recovery of external demand as advanced economies recover, infrastructure push in 2021, and structural reforms.
- Historical context:
  - Past large recessions in the Philippines (1984–85; 1997 Asian financial crisis) showed long-lasting losses in potential output.
  - Global literature finds output levels after deep recessions often 4 to 9 percent below pre-recession trends.

### C. Policy Recommendations
- Fiscal policy:
  - Active fiscal action is needed to support recovery and build productive capacity.
  - With a debt-to-GDP ratio below the EM average, Philippines has fiscal policy space to support recovery and avoid premature consolidation.
  - Increased spending in public works and transportation, continuing projects at advanced stages, to create jobs.
  - Renewed infrastructure push in digitalization, healthcare, and climate change to support post-pandemic reorganization and medium-term productive capacity.
- Corporate sector support:
  - Provide targeted support to viable firms and facilitate exit of unviable ones for efficient resource reallocation.
  - Credit guarantee scheme to encourage bank lending by mitigating credit risks to lenders.
  - Consider equity injections for systemically important corporates.
  - Provide more liquidity and solvency support than usual, except for firms already insolvent before the crisis.
  - The GUIDE Bill (under parliament consideration) would provide additional financial resources to government financial institutions to assist firms with temporary solvency issues due to the pandemic.
- Labor market policies:
  - Active labor market policies including retraining programs to reduce skill mismatch and support reallocation.
  - Well-designed and targeted subsidies for hiring to encourage firms to hire new workers.
  - More flexible labor regulation (e.g., dismissal procedure, minimum wage) to facilitate labor relocation.
  - Ensure adequate safety nets and more coverage for informal workers.
- Structural reforms:
  - Intensify economic reform momentum: implement national ID system and financial inclusion initiative to aid social assistance targeting and delivery.
  - Effective implementation of ease of doing business and CREATE laws to alleviate burdens on MSMEs.
  - Further lift restrictions on inbound foreign direct investment to rekindle investment and employment.
  - Accelerate planned digitalization of public administration.
  - In the medium term, allocate more resources and incentives for climate change adaptation and mitigation to induce investment and emission pattern changes.

---

### UNDERSTANDING THE TURNAROUND IN THE CURRENT ACCOUNT BALANCE

### A. Recent Developments
- Current account (CA) fluctuations:
  - CA was in surplus until 2015, averaging 3 percent of GDP in 2011−2015.
  - CA moved into deficit in 2016−2019 (average 1.1 percent of GDP).
  - CA returned to a large surplus in 2020 (3.6 percent of GDP).
- Primary driver:
  - Fluctuations mainly explained by widening and narrowing deficits for trade in goods.
  - Balances in services, primary and secondary income changed relatively little.
- Services and remittances:
  - Service exports increased faster than service imports during 2016−2019, partially offsetting deficits.
  - Travel exports decreased from US$9.8 billion in 2019 to US$2.0 billion in 2020.
  - Travel imports also decreased sharply; trade deficit in tourism and travel was broadly unchanged in 2020 compared to 2019.
  - Remittances oscillated through 2020 but total remittances in 2020 were almost similar to 2019, keeping primary and secondary income balances.
  - Remittances from overseas workers decreased by 9.8 percent (year-on-year) in Q2 2020 and then increased by 4.2 percent (year-on-year) in Q3 2020.

### B. Drivers of the Current Account Changes
- Larger downturn and containment policies:
  - Philippines experienced a larger economic downturn (Real GDP decreased by 9.6 percent in 2020) with significant local transmission and stringent containment compared to peers.
  - Gross fixed capital formation declined by 27 percent in 2020 after averaging growth of 12 percent in 2016−2019.
- Saving-investment dynamics:
  - The increasing CA deficit in 2016−2019 mirrored an investment boom: investment ratio increased from 21 percent of GDP in 2015 to 27 percent of GDP in 2018, while aggregate gross savings barely changed.
  - Public investment under the Build Build Build program contributed importantly to the investment boom.
  - In 2020, the sharp decline in investment—an import-intensive component—accounted for a larger share in the turnaround in the current account balance than aggregate savings.

*Source: IMF staff compilation from the Philippines country chapter (July 8, 2021).*

### 6.      The terms of trade also contributed to

### 6.      The terms of trade also contributed to

### Terms of trade and recent current account (CA) fluctuations
- The terms of trade deteriorated by an average of 2.7 percent per year between 2016 and 2019, widening CA deficits.
- In 2020, the terms of trade improved because of the decline in the price of oil and commodity prices.
- Changes in exports and imports in 2020 were more driven by volumes than by prices.
- Nominal goods exports in the national accounts (in national currency) decreased by 13.2 percent in 2020, with 8.6 percentage points accounted for by the decline in real imports.
- Real goods imports (in national currency) contributed 20.3 percentage points out of 24.5 percent decrease in nominal imports in 2020.
- Terms of trade are calculated by export deflator divided by import deflator from the national accounts.

### Exchange rate movements and the peso
- The external value of the peso declined gradually in 2016−2018 but has appreciated since 2019.
- The appreciation of the peso in 2020 could have been driven in part by the factors behind the large current account surplus and continued capital inflow.
- Other ASEAN peers experienced currency depreciation due to increased uncertainty during the pandemic.
- Note: There is a mutual effect between exchange rates and the current account: appreciation can reduce exports and increase imports, while a CA surplus can raise exchange rates (appreciation).

### Regression analysis: determinants of the current account balance
- Estimation period: 1982:Q1 to 2020:Q4 using quarterly data from Haver Analytics and IMF WEO database.
- Variables included: current account, investment shares, fiscal balance (percent of GDP), real exchange rates (trade-partner weights, CPI-based), fiscal balance (central government budget surplus or deficit), second order of growth rates, interbank call loan rates (interest rates).
- Expected relationships:
  - Exchange rates, terms of trade, and fiscal balances: positively related to the current account balance.
  - Real GDP growth rate and domestic interest rates: negatively related to the current account balance.
- Empirical findings:
  - The positive coefficient associated with the lagged current account variable indicates persistence in effects.
  - Improving terms of trade or depreciation of the real effective exchange rate (REER) lead to increases in the current account balance.
  - An expansionary fiscal stance or high real GDP growth decrease the current account balance.
  - High interest rates are related with declining current account balance (acknowledged literature uncertainty on this effect).
  - When the investment-to-GDP ratio increases, the current account balance decreases due to implied increases in imports.
- Estimation note: Lagged exchange rate is used to avoid endogeneity between current account and REER.

### Decomposition of recent CA dynamics and drivers
- The turnaround to a CA surplus in 2020 was mainly driven by the economic recession and the associated composition in aggregate demand, notably the sharp decline in investment relative to other components.
- The deficit in 2016−2018 was primarily driven by booming investment.
- Average CA change (quarterly, year-on-year) in 2016−2019 was −0.8 percent of GDP. Main drivers implied by the model: persistence (−0.6 percentage points of the change), investment increases (−0.2 percentage points), low interest rate (−0.1 percentage point) and expansionary fiscal stance (−0.1 percentage point).
- All decomposition components are calculated by changes in variables (quarterly, year-on-year basis) multiplied by model coefficients.

### Prospects for the current account
- The large CA turnaround in 2020 is expected to be largely temporary and start reversing in 2021 with the economic recovery.
- Near-term factors:
  - Health measures and the vaccination program should allow further economic reopening, supporting recovery in consumption, investments, and imports.
  - Recent rise in oil and other commodity prices should result in higher import values.
  - In the near term, the current account is expected to remain in surplus given a relatively gradual domestic recovery in 2021 and a relatively stronger rebound in advanced economies boosting external demand and exports.
- Medium-term outlook:
  - The current account balance is expected to return to a deficit in the medium term due to rekindling investments.
  - Government increased public spending on infrastructure through the Build Build Build program (transportation, water resources, energy) to address infrastructure gaps.
  - Ongoing structural reforms (ease of doing business improvements and tax reductions under the CREATE law) and envisaged increase in public investment from 2021 should rekindle investment and likely contribute to a reversal from surplus to deficit.

### Fiscal context linked to CA and investment dynamics (selected points)
- Due to delays in parliamentary approval of the 2019 budget, aggregate investment slightly declined to 26 percent of GDP that year.
- The external balance assessment (EBA) model finds the cyclically adjusted CA in the Philippines in 2020 is larger than the CA norm, with the gap mainly related to less expansionary fiscal policies in the Philippines than in other countries, especially advanced economies.
- The regression analysis highlights large effects of the economic downturn and the decline in investments on the CA in 2020; the pandemic’s large effects on investment in the Philippines may be captured by fiscal stance differences in the EBA model.

*PHILIPPINES — INTERNATIONAL MONETARY FUND*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1phlea2021003.pdf_