## _cr08119

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---

### Executive Summary — overview and recent performance
- Economic performance and outlook improved markedly over the past few years, founded on fiscal consolidation and strong remittance income that led to a surge in balance of payment inflows.
- Medium-term growth prospects are favorable but subject to global economic uncertainties.
- Upgrading public infrastructure is identified as a key bottleneck to catalyze private investment and rebound domestic employment.

### Executive Summary — key developments
- Fiscal turnaround:
  - Performance of public enterprises improved.
  - National government lowered its deficit through expenditure restraint and VAT reform in 2006.
  - Revenue gains from VAT reform were short lived; reversing weakening revenue collection is a key priority.
- Monetary and external:
  - Headline CPI inflation was 2.8 percent (annual average) in 2007.
  - Reserves at the Bangko Sentral ng Pilipinas (BSP) reached $33¾ billion by end-December (compared with $23 billion a year earlier).
  - The peso appreciated 16 percent against the U.S. dollar since end-2006 (9¼ percent on a real effective basis through October).
  - Continuing easing rates, capital account liberalization, and early repayments of external debt judged appropriate; greater peso-denominated financing would reduce exchange rate exposure.
- Financial sector:
  - Banking soundness improved: non-performing assets were reduced without government support; Basel II being phased in.
  - Some banks remain exposed to interest rate risks.
  - Policy priority: lift bank performance, passage of bills on creating a credit bureau and reforming insolvency rules; amend BSP charter to strengthen supervision and operations.
- Privatization:
  - Around 40 percent of power generating capacity has been sold to date.
  - Firmer peso and smaller external debt service payments helped partially offset higher commodity prices on public enterprise performance.
  - Ongoing efficiency efforts in public enterprises recommended.

### Executive Summary — outlook and risks
- Short-term forecast:
  - Staff forecasts GDP growth of 6 percent for 2008 as fiscal impetus wanes.
  - Net exports expected to contribute less to growth due to a projected mark-down of global growth in H1 2008.
- Risks and channels of adverse impact:
  - Tighter credit, a global slowdown, disorderly unwinding of currency flows (including a sizable drop in workers remittances), further rises in food and oil prices, and a large jump in the peso.
  - Improved fundamentals, prudent macroeconomic policies, and a strong reserve position should help weather shocks.

### Medium-term scenarios — baseline (selected indicators)
- Real GDP growth (percent change): 5.4 (2006), 7.3 (2007), 6.0 (2008), 6.0 (2009), Avg. 2010-2013: 6.1.
- Inflation (percent): 6.2 (2006), 2.8 (2007), 4.4 (2008), 3.8 (2009), Avg. 2010-2013: 3.5.
- Tax revenue, National government (percent of GDP): 14.4 (2006), 14.4 (2007), 14.3 (2008), 13.9 (2009), Avg. 2010-2013: 14.2.
- Net external saving (percent of GDP): -5.0 (2006), -5.2 (2007), -2.7 (2008), -1.9 (2009), Avg. 2010-2013: -0.6.
- Private sector balance (percent of GDP): 4.7 (2006), 5.2 (2007), 1.9 (2008), 1.3 (2009), Avg. 2010-2013: 0.6.
- Saving (percent of GDP): 16.9 (2006), 17.2 (2007), 14.9 (2008), 14.6 (2009), Avg. 2010-2013: 14.5.
- Investment (percent of GDP): 12.2 (2006), 12.0 (2007), 13.0 (2008), 13.3 (2009), Avg. 2010-2013: 14.0.
- General government balance (percent of GDP): 0.4 (2006), 0.0 (2007), 0.7 (2008), 0.5 (2009), Avg. 2010-2013: 0.1.
- Public sector saving and investment (percent of GDP): Saving 2.5 (2006), 2.7 (2007), 3.2 (2008), 2.6 (2009), Avg. 2010-2013: 3.1; Investment 2.1 (2006), 2.7 (2007), 2.4 (2008), 2.1 (2009), Avg. 2010-2013: 3.0.

### Medium-term scenarios — reform scenario (selected indicators)
- Real GDP growth (percent change): 5.4 (2006), 7.3 (2007), 6.3 (2008), 6.5 (2009), Avg. 2010-2013: 6.8.
- Inflation (percent): 6.2 (2006), 2.8 (2007), 4.4 (2008), 3.8 (2009), Avg. 2010-2013: 3.5.
- Tax revenue, National government (percent of GDP): 14.4 (2006), 14.4 (2007), 14.8 (2008), 14.8 (2009), Avg. 2010-2013: 15.6.
- Net external saving (percent of GDP): -5.0 (2006), -5.2 (2007), -2.6 (2008), -1.3 (2009), Avg. 2010-2013: 0.4.
- Private sector balance (percent of GDP): 4.7 (2006), 5.2 (2007), 1.7 (2008), 0.5 (2009), Avg. 2010-2013: -1.2.
- Saving (percent of GDP): 16.9 (2006), 17.2 (2007), 14.8 (2008), 14.6 (2009), Avg. 2010-2013: 14.3.
- Investment (percent of GDP): 12.2 (2006), 12.0 (2007), 13.1 (2008), 14.1 (2009), Avg. 2010-2013: 15.5.
- General government balance (percent of GDP): 0.4 (2006), 0.0 (2007), 0.9 (2008), 0.8 (2009), Avg. 2010-2013: 0.8.
- Public sector saving and investment (percent of GDP): Saving 2.5 (2006), 2.7 (2007), 3.8 (2008), 3.9 (2009), Avg. 2010-2013: 5.0; Investment 2.1 (2006), 2.7 (2007), 2.9 (2008), 3.1 (2009), Avg. 2010-2013: 4.1.

### Policy priorities and recommendations — fiscal
- Raise and sustain tax revenues and prioritize expenditure within a medium-term framework:
  - New tax measures and continued collection efforts essential to finance infrastructure without weakening fiscal discipline; implementation will take time so the planned balanced budget in 2008 will rely on expenditure-driven consolidation.
  - Shift toward local currency debt to reduce vulnerability.

### Policy priorities and recommendations — monetary and external
- Maintain current policy mix: flexible exchange rate, sterilized intervention, lowering policy rates, and capital account liberalization given strong inflows and benign inflation outlook.
- Continue scaling up buffers and managing foreign reserves; widen access to Special Deposit Account used to sterilize reserve buildup.

### Policy priorities and recommendations — financial sector and structural reforms
- Strengthen legislation to lock in benefits from improved banking supervision (credit bureau, insolvency reform).
- Amend the BSP charter to strengthen bank supervision, monetary policy operations, and economic surveillance.
- Continue privatization efforts to improve fiscal position and rationalize operations.
- Sequence reforms: while tax measures take effect, rely on expenditure restraint; catalyze private investment to reduce saving-investment surplus and support employment.

### Selected vulnerability indicators (Philippines versus emerging market medians)
- Gross reserves in percent of short-term debt: 124.2 (Philippines) versus 222.5 (median) and 139.7 (other sample point).
- Total gross external debt: 78.8 (Philippines) versus 43.3 (median) and 45.8 (other sample point).
- Current account balance (percent of GDP): 0.4 (Philippines) versus 5.2 (median) and -3.3 (other sample point).
- Gross external financing requirement: 16.5 (Philippines) versus 4.4 (median) and 15.1 (other sample point).
- Consolidated public sector gross debt: 100.8 (Philippines) versus 62.3 (median) and 41.5 (other sample point).
- Share of consolidated public sector debt exposed to exchange rate risk: 68.3 (Philippines) versus 36.4 (median) and 16.3 (other sample point).
- Share of consolidated public sector debt exposed to rollover risk: 23.2 (Philippines) versus 19.5 (median) and 6.2 (other sample point).
- Financial system indicators: capital adequacy ratio 17.4 (Philippines) versus 19.3 (median) and 13.8 (other sample point); nonperforming loans 16.1 (Philippines) versus 7.0 (median) and 3.8 (other sample point); return on average assets 0.8 (Philippines) versus 0.9 (median) and 1.7 (other sample point).

### Box 1 — Vulnerability Assessment: progress and remaining concerns
- Public debt and fiscal:
  - Nonfinancial public sector debt projected at about 64 percent in 2007 (from a peak of over 100 percent of GDP in 2003) owing to improved GOCC and SSI performance, the 2006 VAT reform, and expenditure restraint.
  - Momentum in revenue collection from VAT reform was short lived; government deficit widened to about 1½ percent of GDP in 2007.
  - Staff estimates revenue should rise by about 1½ percent of GDP, from 16¼ percent to 17¾ percent of GDP over the medium term to meet capital spending goals of about 4½ percent of GDP while balancing the budget.
- Public debt composition and risks:
  - Share of public debt exposed to exchange rate risk is well above the emerging market average; a plausible 30 percent depreciation would lift debt ratios substantially.
  - Maturity structure is tilted to the short end—almost three times the emerging market average—raising rollover vulnerability.
- Banking sector:
  - Nonperforming assets sharply reduced through Special Purpose Vehicle law without public funds.
  - NPL share still almost twice the emerging market average; banks have low profitability and large holdings of sovereign debt (banks lost just over $100 million when spreads increased sharply end-July; losses were subsequently recouped).

### Box 2 — Options for establishing a durable tax base (summary)
- Accelerate tax administration reform:
  - BIR priorities: taxpayer registration, arrears collection, improving audits.
  - BoC priorities: strengthen management controls, integrity of import/export clearance; upgrade enforcement and intelligence.
  - VAT productivity declined in 2007 despite VAT rate raised to 12 percent in 2006.
- Raise and index excises:
  - Revenue from fuel, cigarettes, and alcohol declined by about 1½ percent of GDP since 1997 largely because most excises are not indexed.
  - Unifying the four-tier tobacco rate system and raising/indexing excise rates could recover revenue lost over the past decade.
- Rationalize tax incentives:
  - DoF’s rationalization bill—phasing out tax holidays in favor of reduced corporate income tax or a 5 percent tax on gross receipts—would broadly retain current effective tax rates while enabling government to tap redundancies.

### PPPs
- Cumulative value of PPP projects grown to around 12 percent of GDP.
- Authorities foresee additional PPPs to expand capital spending.
- Staff cautioned against promoting PPPs purely for fiscal saving; recommended a single DoF unit to monitor and approve outstanding guarantees.

### Box 3 — Assessment of the level of the exchange rate
- Tentative assessment:
  - Staff estimates indicate the peso broadly in equilibrium.
  - CGER estimates range from an undervaluation of 13–14 percent to an overvaluation of 6 percent.
  - Mission team’s estimates approximate CGER; real effective appreciation of 15 percent (y-o-y) through mid-2007 narrowed undervaluation.
- Equilibrium current account and underlying balance:
  - Equilibrium current account deficit estimated at 1.4 percent of GDP under the Macroeconomic Balance (MB) approach.
  - Underlying current account surplus estimated at about 0.4 percent of GDP.
  - Temporary/cyclical factors assumed: (i) portfolio-type flows about 2 percent of GDP; (ii) slowdown in workers going abroad about 1 percent of GDP; (iii) pick up in capital goods and oil imports.
- Policy implications and recommended actions:
  - Authorities agreed real effective exchange rate broadly in line with fundamentals but were concerned about possible future overvaluation.
  - Staff supported greater peso-denominated borrowing to reduce exposure to exchange rate risk; DoF announced only $500 million in offshore commercial borrowing in 2008.
  - Staff suggested lengthening maturities to decrease rollover risk.

### Exchange rate, current account, and capital flows (selected)
- Underlying current account balance is slightly larger than the norm, suggesting the exchange rate is broadly in equilibrium.
- Policy mix recommended: flexible exchange rate with intervention limited to smoothing erratic movements and building reserves; two-step liberalization of the financial account to moderate net capital inflows.
- Government decision to tilt borrowing mix toward domestic sources is encouraging; caution warranted on food and oil price pressures.

### Financial system developments and supervision
- Banking sector improvements:
  - Disposed of non-performing assets; introduction of international accounting standards and Basel II.
  - Banks upgraded risk management, raised capital, and merged.
  - BSP reorganized supervision unit; passage of BSP Charter Amendment essential to lift threat of legal action against supervisors, facilitate monetary policy, and improve non-bank surveillance.
- Remaining vulnerabilities:
  - Remaining stock of non-performing assets is large, depressing return on assets.
  - Banks hold large stock of government debt sensitive to sovereign spreads.
- Pending legislation to improve profitability and lending:
  - Corporate Recovery Act; Credit Information Systems Act — expected to improve loan pricing and recovery rates.

### Power sector privatization and fiscal implications
- Privatization successes:
  - Sales generated more income than expected; greater debt prepayment and pricing reforms improved NPC’s financial picture.
  - Final auction of Transco welcomed.
  - These developments support efforts to prevent power shortages from impeding growth.

### Recommendation on consultation cycle
- Staff recommends the next Article IV Consultation be on the standard 12-month cycle.

### Domestic and external developments — key indicators and staff projections (selected exact figures)
- Real GDP growth (percent change): 2003: 4.9; 2004: 6.4; 2005: 4.9; 2006: 5.4; 2007 staff est.: 7.3; 2008 staff proj.: 6.0.
- CPI (annual average): 2003: 3.5; 2004: 6.0; 2005: 7.7; 2006: 6.2; 2007: 2.8; 2008 staff proj.: 4.4.
- Gross reserves (adjusted, billions of US$): 2003: 14.9; 2004: 15.2; 2005: 18.0; 2006: 23.0; 2007: 33.8; 2008 staff proj.: 38.8.
- Total external debt (percent of GDP): 2003: 78.8; 2004: 70.3; 2005: 62.4; 2006: 51.4; 2007: 43.3; 2008 staff proj.: 36.8.
- Current account balance (in billions of U.S. dollars): 2003: 0.3; 2004: 1.6; 2005: 2.0; 2006: 5.9; 2007: 7.5; 2008 staff proj.: 4.6.
- Trade balance (in billions of U.S. dollars): 2003: -5.9; 2004: -5.7; 2005: -7.8; 2006: -6.8; 2007: -7.4; 2008 staff proj.: -11.3.
- National government balance (authorities' definition, percent of GDP): 2003: -4.6; 2004: -3.8; 2005: -2.7; 2006: -0.9; 2007: -0.1; 2008 staff proj.: 0.0.
- Nonfinancial public sector debt (percent of GDP): 2003: 100.8; 2004: 95.2; 2005: 86.0; 2006: 73.9; 2007: 62.3; 2008 staff proj.: 59.0.
- Banking sector (Table 8 selected): capital adequacy ratio 2003: 17.4; 2004: 18.7; 2005: 17.8; 2006: 18.5; 2007 Q2: 19.3. NPL ratio 2003: 16.1; 2004: 14.4; 2005: 10.3; 2006: 7.5; 2007 Q2: 7.0. Return on assets 2003: 0.8; 2004: 0.7; 2005: 0.9; 2006: 1.0; 2007 Q2: 0.9.

### Appendix I — Debt Sustainability Analysis (summary and baseline)
- Baseline assumptions: recent fiscal gains sustained; no new measures over medium term apart from planned reduction in corporate income tax (CIT) rate in 2009.
- Nonfinancial public sector (NFPS) debt declines under baseline but remains high at 43 percent of GDP in 2013.
- External debt declines from nearly 80 percent of GDP in 2003 to just over 40 percent in 2007; under baseline external debt ratio falls to just below 30 percent in 2013.

### Appendix I — projected public-sector debt levels (percent of GDP, selected years)
- Public sector debt (total): 2003: 100.8; 2004: 95.2; 2005: 86.0; 2006: 73.9; 2007: 62.3; 2008: 59.0; 2009: 57.0; 2010: 51.0; 2011: 48.1; 2012: 45.5; 2013: 43.1.
- Public sector foreign-currency denominated debt: 2003: 68.3; 2004: 62.7; 2005: 45.2; 2006: 36.4; 2007: 36.1; 2008: 36.8; 2009: 32.4; 2010: 30.9; 2011: 29.0; 2012: 27.0; 2013: 25.0 (table continues as in source).
- Change in public sector debt (percent of GDP): 2003: 7.1; 2004: -5.6; 2005: -9.2; 2006: -12.1; 2007: -11.7; 2008: -3.2; 2009: -2.1; 2010: -6.0; 2011: -2.9; 2012: -2.6; 2013: -2.4.
- Debt-stabilizing primary balance (percent of GDP): -0.6.

### Appendix I — key fiscal components and macro assumptions (selected exact figures)
- Primary deficit (percent of GDP): 2003: -0.7; 2004: -1.6; 2005: -4.3; 2006: -6.0; 2007: -4.6; 2008: -5.1; 2009: -4.5; 2010: -3.9; 2011: -3.6; 2012: -3.2; 2013: -2.9.
- Revenue and grants (percent of GDP): 2003: 20.8; 2004: 20.5; 2005: 22.1; 2006: 23.2; 2007: 23.1; 2008: 23.0; 2009: 22.5; 2010: 22.5; 2011: 22.7; 2012: 22.8; 2013: 22.8.
- Real GDP growth (percent): 2003: 4.9; 2004: 6.4; 2005: 4.9; 2006: 5.4; 2007: 7.3; 2008: 6.0; 2009: 6.0; 2010: 6.0; 2011: 6.1; 2012: 6.2; 2013: 6.2.
- Average nominal interest rate on public debt (percent): 2003: 7.3; 2004: 7.3; 2005: 7.5; 2006: 7.5; 2007: 7.0; 2008: 8.0; 2009: 7.7; 2010: 7.6; 2011: 7.6; 2012: 7.6; 2013: 7.5.
- Inflation rate (GDP deflator, percent): 2003: 3.8; 2004: 6.1; 2005: 6.4; 2006: 5.2; 2007: 2.7; 2008: 4.2; 2009–2013: 3.6, 3.5, 3.5, 3.5, 3.5 respectively.

### Appendix I — external debt projections and vulnerabilities
- External debt (percent of GDP): 2003: 78.8; 2004: 70.3; 2005: 62.4; 2006: 51.4; 2007: 43.3; 2008: 36.8; 2009: 35.0; 2010: 33.7; 2011: 32.1; 2012: 30.5; 2013: 28.1.
- Gross external financing need (in billions of U.S. dollars): 2003: 13.1; 2004: 12.5; 2005: 11.1; 2006: 9.6; 2007: 6.3; 2008: 10.4; 2009: 12.0; 2010: 13.7; 2011: 15.9; 2012: 16.8; 2013: 17.7.
- Exchange rate vulnerability stress test:
  - One-time real depreciation of 30 percent estimated to entail a 15-percentage point jump in the external debt ratio from its 2008 level and remain above 50 percent in the medium term.
- Other stress tests:
  - External debt essentially unaffected by world interest rate and domestic growth shocks; moderately affected by non-interest shocks to the current account (ending up some 5 percentage points higher by 2013 in that scenario).

### Data, statistics, and methodological notes (selected)
- Trade and BOP data revisions:
  - Imports reported are about 15 percent higher than partner country data.
  - Household surveys indicate about 30 percent of remittances not channeled through banking system, suggesting remittances may have been underestimated by about US$3 billion (3.8 percent of GDP) in 2002.
- Monetary and MFS improvements:
  - Introduced Depository Corporations Survey including thrift and rural banks; uniform procedures for converting foreign currency accounts to local currency in aggregates.
  - IMD and SRFs introduced; IMD operational when BSP submits SRFs in early 2008.
- Fiscal data:
  - Budget presented on obligations basis while deficit reported on cash basis.
  - New Government Accounting System facilitates accrual accounts and cash flow statements, available six months after reference period.
- Data dissemination — Common Indicators (as of January 23, 2008):
  - Exchange Rates: Latest observation Dec. 07; Date Received Jan 7/08; Frequency D.
  - International Reserve Assets and Reserve Liabilities: Latest observation Nov 07; Date Received Jan 3/08; Frequency D; Frequency of Publication M.
  - Reserve/Base Money: Latest observation Oct 15/07; Date Received Oct 21/07; Frequency D; Frequency of Reporting W; Frequency of Publication W.
  - Broad Money: Latest observation Oct 15/07; Date Received Oct 21/07; Frequency M.
  - Consumer Price Index: Latest observation Dec/07; Date Received Jan 16/08; Frequency M; Data Quality – Methodological Soundness O; Data Quality – Accuracy and Reliability O/LO entries as shown.
  - Revenue, Expenditure, Balance and Composition of Financing – General Government: Latest observation Q2/07; Date Received Jul/07; Frequency Q; Data Quality entries LO/O as shown.
  - GDP/GNP: Latest observation Q3/07; Date Received Jan 16/08; Frequency Q; Data Quality entries LO/LNO/O as shown.
  - (Footnotes and definitions preserved in original reporting table.)

### External partners and financing (selected figures)
- World Bank (as of Sep 30, 2007):
  - Committed approximately $12 billion under IBRD loans and $239 million under IDA credits.
  - Philippines portfolio: 22 projects amounting to $1.13 billion with undisbursed balance of $854.0 million.
  - FY07 Development Policy Loan: $250 million included.
- ADB (as of Sep 30, 2007):
  - Cumulative lending: 199 loans for $9,532.8 million; 322 technical assistance grants $147 million.
  - Sector distribution (amounts in millions of US$ and percent): Energy 2,657.1 (27.9 percent); Agriculture 1,572.3 (16.5 percent); Multisector 1,175.8 (12.3 percent); Transport and Communication 996.8 (10.5 percent); Finance 1,128.0 (11.8 percent); Water 731.1 (7.7 percent); Health 317.4 (3.3 percent); Education 252.0 (2.6 percent); Industry and Trade 174.0 (1.8 percent); Law 253.0 (2.7 percent); Private Sector 275.3 (2.9 percent); Total 9,532.8 (100.0 percent).

### IMF Executive Board assessment (PIN No. 08/35, March 16, 2008) — selected points
- 2007 achievements (exact figures preserved):
  - GDP growth 7.3 percent (annual average).
  - Headline inflation 2.8 percent (annual average).
  - Current account surplus 5.7 percent of GDP in H1 2007.
  - Currency appreciated 19 percent against the U.S. dollar during 2007.
  - Government deficit (excluding privatization receipts) widened to about 1½ percent of GDP.
  - Around 40 percent of power generating capacity sold to date.
  - BSP sterilized liquidity jump using SDA and other instruments.
  - Non-performing assets of banks reduced; Basel II phased in.
- Directors’ recommendations:
  - Strengthen tax effort, prioritize spending, rationalize incentives, consider indexing excises, monitor PPP guarantees, limit FX intervention to smoothing, advance BSP Charter Amendment, and adopt Corporate Recovery Act and Credit Information Systems Act.

### Concluding remarks and policy priorities
- Continue prudent monetary and external policies, liquidity management, and reserve buildup.
- Continue fiscal reforms to broaden and sustain tax revenue base and reduce fiscal vulnerabilities by sourcing financing largely from domestic sources.
- Advance structural reforms in financial and power sectors and pursue privatization and regulatory reforms to sustain growth.
- Staff recommends next Article IV Consultation on the standard 12-month cycle.

*Source: IMF staff Executive Summary, Box 1, Box 2, Box 3, main report text, Appendix I, and Public Information Notice material contained in the provided content unit.*

### Executive Summary ......................................................................................................

### Executive Summary

### Overview and recent performance
- Economic performance and outlook improved markedly over the past few years, founded on fiscal consolidation that revived investor confidence and, together with strong remittance income, led to a surge in balance of payment inflows.
- Medium-term growth prospects are favorable but subject to global economic uncertainties.
- Upgrading public infrastructure is identified as a key bottleneck that would catalyze private investment and provide a rebound in domestic employment.

### Key developments
- Fiscal turnaround:
  - Performance of public enterprises improved.
  - The national government lowered its deficit through expenditure restraint and VAT reform in 2006.
  - Success in revenue collection from VAT reform was short lived; reversing weakening revenue collection is a key priority.
- Monetary and external:
  - Inflation remained low (headline CPI inflation was 2.8 percent (annual average) in 2007), aided by an appreciating peso and prudent monetary policy.
  - Intervention to smooth fluctuations and scale up buffers for increased currency flows resulted in a rapid increase in foreign reserves.
  - Reserves at the Bangko Sentral ng Pilipinas (BSP) reached $33¾ billion by end-December (compared with $23 billion a year earlier).
  - The peso appreciated 16 percent against the U.S. dollar since end-2006 (9¼ percent on a real effective basis through October).
  - Continuing the policy mix of easing rates, capital account liberalization, and early repayments of external debt is judged appropriate.
  - Greater peso-denominated financing would reduce exposure to exchange rate risks.
- Financial sector:
  - Banking soundness improved substantially: non-performing assets were reduced without government support; risk management facilities upgraded as Basel II is phased in.
  - Some banks remain exposed to interest rate risks.
  - Policy priority: lift bank performance, facilitated by passage of bills on creating a credit bureau and reforming insolvency rules.
  - Amending the BSP charter would help strengthen bank supervision, monetary policy operations, and economic surveillance.
- Privatization:
  - Around 40 percent of power generating capacity has been sold to date.
  - The firmer peso and smaller external debt service payments helped partially offset the effect of higher commodity prices on the performance of public enterprises.
  - Ongoing efforts to find efficiencies in public enterprises are recommended.

### Outlook and risks
- Short-term:
  - Staff forecasts GDP growth of 6 percent for 2008, as fiscal impetus wanes.
  - Net exports expected to contribute less to growth, reflecting a projected mark-down of global growth for the first half of the year.
- Risks:
  - Growing downside risk from unfolding uncertainties in the global financial market.
  - Possible channels of adverse impact: tighter credit, a global slowdown, a disorderly unwinding of currency flows (including possibly a sizable drop in workers remittances), further increases in food and oil prices pushing up inflation, and a large jump in the peso dampening exports.
  - Improved fundamentals, prudent macroeconomic policies, and a strong reserve position should help weather shocks.

### Medium-term scenarios and quantitative projections
- Baseline scenario (selected indicators):
  - Real GDP growth: 5.4 (2006), 7.3 (2007), 6.0 (2008), 6.0 (2009), Avg. 2010-2013: 6.1 (percent change).
  - Inflation: 6.2 (2006), 2.8 (2007), 4.4 (2008), 3.8 (2009), Avg. 2010-2013: 3.5 (percent).
  - Tax revenue (percent of GDP), National government: 14.4 (2006), 14.4 (2007), 14.3 (2008), 13.9 (2009), Avg. 2010-2013: 14.2.
  - Net external saving: -5.0 (2006), -5.2 (2007), -2.7 (2008), -1.9 (2009), Avg. 2010-2013: -0.6 (percent of GDP).
  - Private sector balance: 4.7 (2006), 5.2 (2007), 1.9 (2008), 1.3 (2009), Avg. 2010-2013: 0.6 (percent of GDP).
  - Saving: 16.9 (2006), 17.2 (2007), 14.9 (2008), 14.6 (2009), Avg. 2010-2013: 14.5 (percent of GDP).
  - Investment: 12.2 (2006), 12.0 (2007), 13.0 (2008), 13.3 (2009), Avg. 2010-2013: 14.0 (percent of GDP).
  - General government balance: 0.4 (2006), 0.0 (2007), 0.7 (2008), 0.5 (2009), Avg. 2010-2013: 0.1 (percent of GDP).
  - Saving and investment in public sector (selected): Saving 2.5 (2006), 2.7 (2007), 3.2 (2008), 2.6 (2009), Avg. 2010-2013: 3.1; Investment 2.1 (2006), 2.7 (2007), 2.4 (2008), 2.1 (2009), Avg. 2010-2013: 3.0 (percent of GDP).
- Reform scenario (selected indicators):
  - Real GDP growth: 5.4 (2006), 7.3 (2007), 6.3 (2008), 6.5 (2009), Avg. 2010-2013: 6.8 (percent change).
  - Inflation: 6.2 (2006), 2.8 (2007), 4.4 (2008), 3.8 (2009), Avg. 2010-2013: 3.5 (percent).
  - Tax revenue (percent of GDP), National government: 14.4 (2006), 14.4 (2007), 14.8 (2008), 14.8 (2009), Avg. 2010-2013: 15.6.
  - Net external saving: -5.0 (2006), -5.2 (2007), -2.6 (2008), -1.3 (2009), Avg. 2010-2013: 0.4 (percent of GDP).
  - Private sector balance: 4.7 (2006), 5.2 (2007), 1.7 (2008), 0.5 (2009), Avg. 2010-2013: -1.2 (percent of GDP).
  - Saving: 16.9 (2006), 17.2 (2007), 14.8 (2008), 14.6 (2009), Avg. 2010-2013: 14.3 (percent of GDP).
  - Investment: 12.2 (2006), 12.0 (2007), 13.1 (2008), 14.1 (2009), Avg. 2010-2013: 15.5 (percent of GDP).
  - General government balance: 0.4 (2006), 0.0 (2007), 0.9 (2008), 0.8 (2009), Avg. 2010-2013: 0.8 (percent of GDP).
  - Public sector saving and investment (selected): Saving 2.5 (2006), 2.7 (2007), 3.8 (2008), 3.9 (2009), Avg. 2010-2013: 5.0; Investment 2.1 (2006), 2.7 (2007), 2.9 (2008), 3.1 (2009), Avg. 2010-2013: 4.1 (percent of GDP).
- Scenario interpretations:
  - Baseline: Reforms to date allow the economy to operate at a modestly higher pace; without further revenue effort, the government cannot meet priority targets in the medium-term expenditure framework and poor infrastructure will increasingly pose a bottleneck.
  - Reform scenario: Introduction of tax policies strengthening the tax base would allow higher capital and social spending; better infrastructure expectations would catalyze private investment and a rebound in domestic employment; private capital inflows, led by FDI, would prompt faster adjustment in the external balance toward its longer-term norm.

### Policy priorities and recommendations
- Fiscal policy:
  - Meeting social and infrastructure needs while balancing the budget requires a more sustained tax effort and prioritization of expenditure within a medium-term framework.
  - New tax measures and continued collection efforts are essential to finance needed infrastructure without weakening fiscal discipline; implementation will take time, so the planned balanced budget in 2008 will have to rely on expenditure-driven consolidation.
  - Shifting toward local currency debt would reduce vulnerability.
- Monetary and external policies:
  - Maintain the current policy mix: flexible exchange rate, sterilized intervention, lowering policy rates, and capital account liberalization given strong currency inflows and benign inflation outlook.
  - Continue scaling up buffers and managing foreign reserves; widen access to Special Deposit Account has been used to sterilize reserve buildup.
- Financial sector and structural reforms:
  - Strengthen legislation to lock in benefits from improved banking supervision (credit bureau, insolvency reform).
  - Amend the BSP charter to strengthen bank supervision, monetary policy operations, and economic surveillance.
  - Continue privatization efforts to improve fiscal position and rationalize government operations.
- Short- and medium-term sequencing:
  - New tax measures will take time to implement; until effective, rely on expenditure restraint to maintain fiscal discipline.
  - Undertake reforms that catalyze private investment to reduce the saving-investment surplus and support employment.

### Selected vulnerability indicators (comparative notes)
- Indicators referenced for the Philippines and medians of a 48-country emerging market sample (selected):
  - Gross reserves in percent of short-term debt: 124.2 (Philippines) versus 222.5 (median) and 139.7 (other sample point).
  - Total gross external debt: 78.8 (Philippines) versus 43.3 (median) and 45.8 (other sample point).
  - Current account balance: 0.4 (Philippines) versus 5.2 (median) and -3.3 (other sample point) (percent of GDP).
  - Gross external financing requirement: 16.5 (Philippines) versus 4.4 (median) and 15.1 (other sample point).
  - Consolidated public sector gross debt: 100.8 (Philippines) versus 62.3 (median) and 41.5 (other sample point).
  - Share of consolidated public sector debt exposed to exchange rate risk: 68.3 (Philippines) versus 36.4 (median) and 16.3 (other sample point).
  - Share of consolidated public sector debt exposed to rollover risk: 23.2 (Philippines) versus 19.5 (median) and 6.2 (other sample point).
  - Financial system indicators: capital adequacy ratio 17.4 (Philippines) versus 19.3 (median) and 13.8 (other sample point); nonperforming loans 16.1 (Philippines) versus 7.0 (median) and 3.8 (other sample point); return on average assets 0.8 (Philippines) versus 0.9 (median) and 1.7 (other sample point).

*Source: IMF staff Executive Summary from the Philippines Article IV consultation materials.*

### Box 1. Vulnerability Assessment

### Box 1. Vulnerability Assessment

### Progress on vulnerabilities — broad findings
- The Philippines has made substantial progress addressing fiscal, external, and financial sector vulnerabilities.
- Nonfinancial public sector debt is projected at about 64 percent in 2007 (from a peak of over 100 percent of GDP in 2003) owing to improved GOCC and SSI performance, the 2006 VAT reform, and expenditure restraint.
- Since 2001, Philippine EMBI spreads have fallen by around 500 basis points and moved more closely with the overall index.
- Lower domestic interest rates have left debt relatively insensitive to increases in interest rates.

### Public debt composition and risks
- The currency and maturity structure of public debt remains a cause for concern:
  - The share of public debt exposed to exchange rate risk is well above the emerging market average.
  - A plausible 30 percent depreciation would lift debt ratios substantially (Appendix I).
  - The maturity structure of public debt is tilted toward the short end—almost three times the emerging market average—rendering debt dynamics vulnerable to a deterioration in investor sentiment.
- Central government foreign currency debt (percent of total central government debt) is shown for 2000–2007 (est.), indicating elevated FX exposure relative to comparators.

### Banking sector vulnerabilities
- Nonperforming assets have been sharply reduced through the Special Purpose Vehicle law and its successor, without relying on public funds.
- Nevertheless:
  - The share of nonperforming loans is still almost twice the emerging market average.
  - Banks continue to struggle with low profitability and difficulty in determining good credit risks (low rate of return on assets).
  - With large holdings of sovereign debt, banks lost just over $100 million when spreads increased sharply in end-July; losses were subsequently recouped, but banks could suffer more significantly if spreads widen again.

### A. Securing the benefits from fiscal consolidation — background
- The momentum gained in revenue collection from the VAT reform was short lived; the government deficit widened to about 1½ percent of GDP in 2007.
- The 2008 budget relies on expenditure-driven consolidation; new tax policy measures are minimal, and the authorities count on gains from stronger tax administration.
- Relative to 2007, infrastructure spending is set to fall as a share of GDP in the 2008 budget.
- The authorities are progressing on civil service reform; most departments and GOCCs have submitted rationalization proposals, but current savings are scheduled to be channeled to higher operating expenditures of implementing agencies.
- Public investment shortfalls—roads and irrigation by the government and power and other infrastructure by GOCCs—are frequently mentioned as a barrier to FDI.

### A. Securing the benefits from fiscal consolidation — policy issues and staff views
- Regaining momentum in tax collection is high priority. Possible causes for the decline in tax receipts include election-related tax evasion, discontent in revenue agencies, decline in compliance from repeated amnesties, lifting of the VAT input cap, peso appreciation, and higher smuggling.
- Staff recommended focusing on strengthening the tax base (see Box 2). Specific measures include:
  - Streamlining tax incentives as proposed by the Department of Finance (DoF).
  - Increasing and indexing select excises to inflation to at least partly recoup revenue lost over the past decade, amounting to 1½ percent of GDP.
  - These tax policy measures, together with accelerated reforms at GOCCs, underpin staff’s strong reform scenario, leading to higher public and, over time, private investment and growth.
- Reforming the pay-for-performance system at revenue agencies should be coupled with deeper systemic reforms, including establishing effective and systemic control processes for filing and payments.
- Resource needs and fiscal anchors:
  - Staff estimates that revenue should rise by about 1½ percent of GDP, from 16¼ percent to 17¾ percent of GDP over the medium term, to meet capital spending goals of about 4½ percent of GDP while balancing the budget.
  - These objectives align with the authorities’ Medium-Term Expenditure Framework (MTEF), although funding sources have yet to be identified.
- Staff suggested anchoring policies in a medium-term fiscal framework and improving public-financial management to better develop a debt management strategy and improve budget execution and cash management.
- The authorities plan to balance the 2008 budget while beefing up priority spending; if additional revenue is not forthcoming, expenditure restraint would be inevitable and likely across the board.
- The government targets higher capital and social spending; the DoF views privatization as a short-term measure and expects passage of revenue-enhancing fiscal bills. The MTEF would require 1½ percent of GDP additional revenue efforts.
- Staff cautioned against tax proposals that narrow the base; key legislators and DoF officials agreed on the need to reverse the decline in excise revenue and reform tax incentives.

### Box 2 (summary): Options for establishing a durable tax base
- Tax collection has trended markedly lower over the last decade. Causes include generous tax incentives, tariff reform, and erosion of excise revenue due to non-indexation.
- Options for reversing the slump in tax revenue:
  - Accelerating tax administration reform:
    - BIR priorities: taxpayer registration, arrears collection, improving audits.
    - BoC priorities (based on FAD recommendations): strengthening management controls and integrity of import/export clearance; upgrading enforcement and intelligence functions.
    - VAT productivity declined in 2007 and remains low versus peers despite VAT rate raised to 12 percent in 2006.
  - Raising and indexing excises:
    - Revenue from fuel, cigarettes, and alcohol has declined by about 1½ percent of GDP since 1997, largely because most excises are not indexed to inflation.
    - Unifying the four-tier tobacco rate system and raising/indexing excise rates could recover revenue lost over the past decade.
  - Rationalizing tax incentives:
    - Tax incentives substantially reduce effective tax rates on corporate income.
    - Staff estimates suggest the DoF’s rationalization bill—phasing out tax holidays and instead offering a reduced corporate income tax rate or a 5 percent tax on gross receipts—would broadly retain current effective tax rates while enabling the government to tap tax redundancies.

### Public-private partnerships (PPPs)
- The cumulative value of PPP projects has grown to around 12 percent of GDP.
- Authorities foresee additional PPPs as part of plans to expand capital spending.
- Staff cautioned against promoting PPPs purely as a means of fiscal saving and recommended installing a single unit in the DoF to monitor and approve all outstanding guarantees; the authorities welcomed this suggestion.

### B. Policy response to global financial pressures — background
- Monetary policy easing:
  - Headline inflation reached 3.9 percent at end-2007, slightly below the BSP’s target band of 4-5 percent.
  - Core inflation grew 2.6 percent (y-on-y) in 2007.
  - Measures of trend inflation (trimmed median and weighted median) remained below the BSP’s target in 2007 but are inching up.
  - There is no clear evidence of an emerging bubble; property prices remain below 1997 levels, while the PE ratio reached 15½ at end-2007.
  - Equity prices fell by more than 10 percent during the first three weeks of 2008, implying a PE ratio well below the worldwide average of 21 during 2001–06.
  - Policy actions: in July the Monetary Board removed tiering and set the RRP policy rate at 6 percent; late in the year the Monetary Board thrice reduced the RRP rate, leaving it at 5¼ percent by end-December.
- Exchange rate and reserves:
  - The peso appreciated significantly vis-à-vis the U.S. dollar and in nominal effective terms by 14¼ percent during 2007.
  - Gross reserves, inclusive of swap positions, doubled in 2007 to reach $44½ billion by year end.
  - The authorities prepaid external debt and relaxed limits on investment abroad in two stages.
  - The BSP expanded sterilization via widening access to the Special Deposit Account (SDA); SDA deposits offered maturity-adjusted rates for up to six months and the SDA grew quickly, reaching near 9 percent of GDP, halting M3 growth and allowing policy easing.
  - The swap facility was used more extensively to sterilize intervention.
- Money and asset indicators shown include M3, private sector credit, SDA+RRP balances, PSE Index, BSP REER, and CPI-deflated average home prices.

### B. Policy issues and staff views
- The current policy mix is broadly appropriate and the peso appears broadly in equilibrium:
  - Staff and private sector analysts forecast inflation at around 4–4½ percent in 2008 against a target of 4 percent ±1 percent.
  - The inflation target for 2009 is 3½ percent ± 1 percent.
  - Staff estimates the underlying current account balance to be only slightly larger than the norm, suggesting the current real exchange rate is only slightly undervalued or close to its equilibrium level.
  - Staff considers the de facto exchange rate regime to have remained an independent float, with intervention limited to smoothing erratic movements.
  - Staff saw merit in pre-announcing intended reserve buildup to help the market price the peso and underscore commitment to a market-determined exchange rate.
- Policy flexibility:
  - Policy should respond flexibly if capital inflows strengthen significantly; with Philippine interbank rates modestly higher than comparable rates abroad, there is scope to further ease policy should inflows strengthen.
  - Rising food prices in the region and higher international oil prices pose upside risks to the inflation outlook and warrant caution.

*IMF staff report: Box 1. Vulnerability Assessment.*

### Box 3. Assessment of the Level of the Exchange Rate

### Box 3. Assessment of the Level of the Exchange Rate

### Tentative assessment of the peso
- Tentative staff estimates indicate the current level of the peso is broadly in line with fundamentals.
- The latest CGER estimates, after adjusting for multilateral consistency, range from an undervaluation of 13–14 percent to an overvaluation of 6 percent.
- The mission team’s estimates approximate those of the CGER (see text table).
- The narrowing of the undervaluation from last year appears to be due to the strengthening of the peso, which in real effective terms appreciated by 15 percent (y-o-y) through mid-2007.
- The mission’s tentative assessment is that the current level of peso is broadly in equilibrium.

### Equilibrium current account and underlying balance
- The mission team estimated the equilibrium current account deficit at 1.4 percent of GDP under the Macroeconomic Balance (MB) approach.
- This is smaller than the norm of 1.9 percent deficit provided by the CGER as an adjustment of 0.5 percent of GDP was made to reflect precautionary savings from the overseas Filipino workers’ remittances originating from oil producing countries.
- The underlying current account surplus is estimated to be about 0.4 percent of GDP.
- This underlying surplus estimate is based on the assumption that the following temporary and cyclical factors have played out:
  - (i) portfolio-type flows in tandem with the overall reflow to Asia that started in 2005-06 (about 2 percent of GDP);
  - (ii) a slowdown in workers going abroad in response to somewhat faster domestic GDP growth (about 1 percent of GDP);
  - (iii) a pick up in capital goods and oil imports, in response to improved investor confidence and the expected stay of the further hike of petroleum prices in early 2008 over the medium term.
- Imports may have also been low in 2007 from possible under-recording due to election-related lenience this year (potentially as much as 2 percent of GDP).
- Notwithstanding relatively large margins of error surrounding such estimates, the mission’s tentative assessment is that the current level of peso is broadly in equilibrium.

### Real exchange rate / ERER and equilibrium estimates (as reported)
- Real Exchange Rate: ERER Estimations (in natural logarithms) — actual and equilibrium series shown (chart referenced).
- Equilibrium Exchange Rate Estimates (table text as presented):
  - Elasticity Underlying balance1 Equilibrium balance1 Gap2 Gap, adjusted for multilateral consistency2
  - Macroeconomic balance approach:
    - CGER 0.241.0-1.9-11.2-12.7
    - Mission team 0.240.4-1.4-6.8—
  - Equilibrium real exchange rate approach:
    - CGER ————6.0
  - External sustainability approach:
    - CGER 0.241.0-2.3-12.8-14.2
    - Mission team0.240.4-2.3-10.6—
- Sources and notes provided in the original table:
  - Sources: CGER and mission team estimates.
  - Note: Reference period for the CGER and the mission team's assessments are September and November, 2007, respectively.
  - 1 Ratio of current account balance to GDP.
  - 2 Undervaluation = "-".
  - 3 Based on medium-term projections through 2012.

### Policy implications, authorities’ views, and recommended actions
- Authorities’ and mission observations:
  - The authorities agreed that the current level of the real effective exchange rate is broadly in line with fundamentals, but they expressed concern about possible overvaluation in the future.
  - The appreciating peso has adversely affected locally sourced exporters and overseas foreign workers.
  - BSP officials emphasized that the exchange rate is market determined; intervention is aimed at smoothing volatility.
  - Authorities took the opportunity of favorable market conditions of low inflation and stronger balance of payments position to strategically build up reserves as self-insurance.
  - Despite large reserve accumulation, the peso has risen at one of the fastest paces in Asia.
  - Staff supported the BSP’s exchange rate policy and decision to continue using a mix of measures to moderate the impact of capital inflows on the economy.
  - The second round of foreign exchange liberalization was viewed as important to facilitate free capital flows and alleviate pressures on the exchange rate.
- Debt management and borrowing mix:
  - The government could adjust its borrowing mix, with greater financing from peso-denominated bonds, to reduce exposure to exchange rate risks.
  - The Philippines is somewhat of an outlier: foreign currency borrowings are large and, unlike in many Latin American countries, the share has not fallen in recent years.
  - Greater issuance in pesos would reduce vulnerabilities and improve standings with ratings agencies.
  - It would be prudent to maintain a modest foreign currency presence in international markets to allow the authorities to tap external funding sources if the need arose.
  - These moves could also be part of a broader strategy to help reduce pressures on the peso.
- Announced shifts and staff suggestions:
  - DoF officials announced that more borrowing would be sourced locally, in pesos, with only $500 million in offshore commercial borrowing in 2008.
  - The mission supported this shift to help gradually reduce exposure to currency risk.
  - Staff also suggested lengthening maturities to decrease rollover risk.

*Source: IMF staff estimates.*

### 2008. If the inflation outlook remained comfortable, and capital inflows continued to put

### _cr08119 - 2008. If the inflation outlook remained comfortable, and capital inflows continued to put

### Exchange rate, current account, and capital flows
- 37. The underlying current account balance is slightly larger than the norm, suggesting the exchange rate is broadly in equilibrium.
- Groups adversely affected by the peso’s strength have increased complaints.
- Continued use of a mix of measures is appropriate, including:
  - a flexible exchange rate with intervention limited to smooth erratic movements and build up reserves;
  - the recent two-step liberalization of the financial account, which should help moderate net capital inflows.
- The government’s decision to tilt the borrowing mix more heavily toward domestic sources is encouraging; it could reduce vulnerabilities and potentially ease pressure on the peso.
- Caution is warranted because higher regional food and oil prices could affect the inflation outlook.

### Financial system developments and supervision
- 38. The outlook for the financial system has improved substantially.
- Progress made:
  - disposing of non-performing assets;
  - introduction of international accounting standards and introduction of Basel II;
  - banks have upgraded risk management facilities, raised capital, and merged.
- Bank monitoring has improved following a reorganization that created a more streamlined and effective supervision unit at the BSP.
- Passage of the BSP Charter Amendment is essential to:
  - lift the threat of legal action against supervisors;
  - facilitate the operation of monetary policy;
  - improve economic surveillance of the non-bank sector.

### Remaining banking vulnerabilities and pending legislation
- 39. Much work remains to weather a serious turn of the credit cycle.
- Key vulnerabilities:
  - the remaining stock of non-performing assets is large, depressing the return on assets—one of the lowest in the region;
  - banks hold a large stock of government debt that is sensitive to changes in sovereign spreads.
- Pending legislation that could help improve bank profitability and lending:
  - Corporate Recovery Act;
  - Credit Information Systems Act.
- Expected effects of pending legislation: better pricing of loans and greater recovery rates from loans that sour.

### Power sector privatization and fiscal implications
- 40. Ongoing power sector privatization efforts have been successful.
- Outcomes:
  - sales of government assets have generated more income than expected;
  - greater debt prepayment and pricing reforms have allowed the NPC to improve its financial picture;
  - the final auction of Transco, after repeated failures, is particularly welcome.
- These developments should help support the government’s effort to ensure that growth is not impeded by power shortages.

*Source: _cr08119 - 2008.*

### 41.      Staff recommends the next Article IV Consultation be on the standard 12-month cycle.

### _cr08119 - 41.      Staff recommends the next Article IV Consultation be on the standard 12-month cycle.

### Domestic developments
- Real GDP growth has gained momentum, with services as the driver.
- Real GDP growth (y/y percent change) series shown for 2001–2007 (quarterly plotted).
- Production growth by sector (y/y percent change): Industry, Agriculture, Services (series shown 2001–2007).
- Real private sector credit (Dec 1999=100) plotted 2001–2007; private credit flattened after a short recovery.
- Stock market index (Composite; Composite in US$, Jan 1992=1000) surged through 2001–2008.
- Inflation remained contained well below target:
  - CPI (headline and core official measure) series plotted 2001–2008.
  - CPI (annual average) series in Table 1: 2003: 3.5; 2004: 6.0; 2005: 7.7; 2006: 6.2; 2007: 2.8; 2008 staff proj.: 4.4.
  - CPI (end year) series in Table 1: 2003: 3.9; 2004: 8.6; 2005: 6.7; 2006: 4.3; 2007: 3.9; 2008 staff proj.: 3.4.
- Monetary policy:
  - BSP cut the policy rate as inflation remained contained.
  - Interest rate series include Overnight reverse repo (policy) rate and 91-day T-bill rate (primary market).

### External developments
- Trade and reserves:
  - Merchandise trade: exports and imports (yoy percent change) and trade balance plotted 2001–2007; trade deficit narrowed in early 2007 but widened recently.
  - Gross reserves (in billions of US$) increased: Table 3 gross reserves (adjusted) series: 2003: 14.9; 2004: 15.2; 2005: 18.0; 2006: 23.0; 2007: 33.8; 2008 staff proj.: 38.8.
  - Gross reserve ratio to short-term debt (in percent, RHS) series increased.
- Swaps and sovereign spreads:
  - Net forward position (including NDFs, in billions of US$) series shown 2001–2008; stocks of outstanding swaps have come off highs but remain large.
  - Sovereign bond spreads (in basis points): Global EMBI+ and Phl EMBI+ series remained tight.
- External debt and exchange rate:
  - Peso appreciated in real and nominal terms: Nominal and real effective exchange rate (2000=100) and peso/US$ (RHS-inverted) series 2001–2008.
  - External debt series: medium & long-term and short-term (in billions of US$) and Debt-GDP ratio (in percent) plotted 1997–2006.
  - Table 3: Total external debt (in percent of GDP) series: 2003: 78.8; 2004: 70.3; 2005: 62.4; 2006: 51.4; 2007: 43.3; 2008 staff proj.: 36.8.
- Balance of payments (Table 3, in billions of U.S. dollars):
  - Current account balance: 2003: 0.3; 2004: 1.6; 2005: 2.0; 2006: 5.9; 2007: 7.5; 2008 staff proj.: 4.6.
  - Trade balance: 2003: -5.9; 2004: -5.7; 2005: -7.8; 2006: -6.8; 2007: -7.4; 2008 staff proj.: -11.3.
  - Exports, f.o.b.: 2006: 46.5; 2007: 48.8; 2008 proj.: 52.8.
  - Imports, f.o.b.: 2006: 53.3; 2007: 56.3; 2008 proj.: 64.1.
  - Transfers (net): 2003: 8.4; 2004: 9.2; 2005: 11.4; 2006: 13.2; 2007: 14.7; 2008 proj.: 15.7.
  - Overall balance (in billions of U.S. dollars): 2003: 0.2; 2004: -0.2; 2005: 2.5; 2006: 3.9; 2007: 9.2; 2008 proj.: 4.7.

### Fiscal sector
- After years of adjustment, the national government deficit has leveled off.
- National government balance (Fund staff definition) series (percent of GDP) Table 1 and Table 2:
  - Table 1 national government balance (authorities' definition): 2003: -4.6; 2004: -3.8; 2005: -2.7; 2006: -0.9; 2007: -0.1; 2008 staff proj.: 0.0.
  - Table 2 national government balance (Fund definition) series: 2003: -4.9; 2004: -4.2; 2005: -3.0; 2006: -1.2; 2007 Sept. staff: -1.3; 2008 staff proj.: -1.1.
- Revenue and expenditure (Table 2, percent of GDP):
  - Revenue and grants: 2003: 14.9; 2004: 14.6; 2005: 15.0; 2006: 16.3; 2007 Budget/Sept/Staff entries shown up to 2010.
  - Tax revenue: 2003: 12.8; 2004: 12.4; 2005: 13.0; 2006: 14.4; 2007 Sept. and projections listed.
  - Major tax components (percent of GDP) include Net Income and Profits, Excises, VAT, Tariffs, Other.
  - Expenditure and net lending: 2003: 19.8; 2004: 18.7; 2005: 18.0; 2006: 17.5; 2007 and projections in table.
  - Capital and equity expenditure (percent of GDP): 2003: 2.6; 2004: 2.7; 2005: 2.4; 2006: 2.3; 2007 entries and projections shown.
- Public debt and financing:
  - Nonfinancial public sector debt (Table 1): 2003: 100.8; 2004: 95.2; 2005: 86.0; 2006: 73.9; 2007: 62.3; 2008 staff proj.: 59.0 (percent of GDP).
  - National government debt (Table 2 memorandum): 2003: 71.4; 2004: 69.7; 2005: 62.9; 2006: 55.4; subsequent years and projections listed.
- Fiscal composition:
  - National government revenue composition (percent of GDP) plotted 1998–2007: Income and Profits; VAT; Excise; Trade & Other; Non-tax Revenue.
  - Expenditure composition plotted 1998–2007: Non-interest current; Interest; Capital and net lending.
- Note: Fund staff and authorities' definitions and adjustments specified in footnotes (e.g., excludes privatization receipts for Fund definition).

### Banking sector and financial stability
- Capitalization and asset quality:
  - Capital adequacy ratio (consolidated basis) exceeded regulatory requirement of 10% (series 2003–2007; Table 8: capital adequacy ratio 2003: 17.4; 2004: 18.7; 2005: 17.8; 2006: 18.5; 2007 Q2: 19.3).
  - Nonperforming loans (NPL) ratio and NPA/ROPA ratios improved: Table 8 NPL ratio 2003: 16.1; 2004: 14.4; 2005: 10.3; 2006: 7.5; 2007 Q2: 7.0.
  - NPL coverage ratio and NPA coverage ratio listed (Table 8).
- Profitability and margins:
  - Return on assets (average net income before taxes over average assets) series: Table 8: 2003: 0.8; 2004: 0.7; 2005: 0.9; 2006: 1.0; 2007 Q2: 0.9.
  - Return on equity series: 2003: 8.5; 2004: 7.1; 2005: 8.7; 2006: 10.6; 2007 Q2: 11.6.
  - Interest margins remain high; bank earnings rebounded (Total bank earnings after tax: return on assets and return on equity series plotted 2003–2007).
- Credit and lending patterns:
  - Money and credit growth (y/y percent change): M3, Net domestic credit, Private sector credit series 2003–2007; private sector credit growth low but recovering in parts.
  - Bank lending growth by sector (3-month moving average, y/y percent change): Services (excluding real estate and interbank loans) showed lending growth; real estate and construction lending increased more recently.
- Liquidity:
  - Ample liquidity observed despite low bank lending; real interest rates and spreads plotted.
- Depository corporations survey (Table 4):
  - Net foreign assets and net domestic assets series provided (in billions of pesos and U.S. dollars).
  - M3 (peso liquidity) and M4 series and 12-month percent change rates listed (e.g., M3 12-month percent change 2003: 4.2; 2004: 10.2; 2005: 10.3; 2006: 22.7; 2007 Jun: 9.1).
  - Exchange rate (peso per dollar; end-period) series: 2003: 55.6; 2004: 56.3; 2005: 53.1; 2006: 49.1; 2007 Jun: 46.3; 2007 Sep: 45.1; 2007 Nov: 42.8.

### Key macroeconomic indicators and projections
- Summary indicators (Table 1 and Table 3):
  - Nominal GDP (2006): P6,033 billion ($117.6 billion).
  - Population (2006): 87.0 million.
  - GDP per capita (2006): $1,352.
  - Poverty headcount ratio at $2 a day at PPP (2003): 43 percent.
  - IMF quota: SDR 879.9 million.
  - Main products and exports: Electronics and agricultural products.
  - Unemployment rate (2006): 7.9 percent.
- Short-term projections and staff estimates (selected, preserve numeric fidelity):
  - Real GDP (percent change): 2003: 4.9; 2004: 5.4; 2005: 4.9; 2006: 5.4; 2007 staff est.: 7.3; 2008 staff proj.: 6.0 (Table 1).
  - Broad money (M3) end-of-period percent change (Table 1): 2003: 4.2; 2004: 10.2; 2005: 10.3; 2006: 22.7; 2007: 9.1; 2008: ... (ellipsis as in source).
  - Credit to the private sector (Table 1): 2003: 2.8; 2004: 4.9; 2005: -0.3; 2006: 6.7; 2007: 8.5; 2008: ... .
  - Current account (percent of GDP) (Table 1): 2003: 0.4; 2004: 1.9; 2005: 2.0; 2006: 5.0; 2007: 5.2; 2008 staff proj.: 2.7.
  - Reserves, adjusted (in billions of U.S. dollars) (Table 1): 2003: 14.9; 2004: 15.2; 2005: 18.0; 2006: 23.0; 2007: 33.8; 2008 staff proj.: 38.8.
- Medium-term outlook (baseline and reform scenarios):
  - Baseline (Table 5): Real GDP growth 2008–2013: 6.0 (2008), 6.0 (2009), 6.0 (2010), 6.1 (2011), 6.2 (2012), 6.2 (2013). Reserves, adjusted (in billions of US$) 2008: 23.0; 2009: 33.8; 2010: 38.8; projections through 2013 listed.
  - Reform scenario (Table 6): Real GDP growth higher over medium term (e.g., 2008: 6.3; 2009: 6.5; 2010: 6.5; 2011: 6.7; 2012: 7.0; 2013: 7.0). FDI (net, in billions of U.S. dollars) higher in reform scenario (e.g., 2010: 4.2; 2011: 4.5; 2012: 5.0; 2013: 5.4).
  - Medium-term balance of payments outlook (Tables 7 and 3) provide projected trade balances, current account, reserves, and financing needs through 2013 (values listed in tables; e.g., Table 7 current account balance 2008: 4.6; 2009: 3.5; 2010: 2.6; 2011: 1.4; 2012: 1.0; 2013: 0.6, all in billions of US$).
- External vulnerability indicators (Table 9):
  - Gross international reserves, adjusted (in billions U.S. dollars): 2003: 14.9; 2004: 15.2; 2005: 18.0; 2006: 23.0; 2007: 33.8; 2008 staff proj.: 38.8.
  - Short-term debt (original maturity, in billions U.S. dollars): 2003: 8.2; 2004: 7.6; 2005: 9.4; 2006: 8.2; 2007: 8.5; 2008 staff proj.: 8.8.
  - Net FDI inflows (in billions of U.S. dollars): 2003: 0.2; 2004: 0.1; 2005: 1.7; 2006: 2.0; 2007: 0.5; 2008 staff proj.: 1.9.
  - Nonfinancial public sector debt (percent of GDP) (Table 9): 2003: 100.8; 2004: 95.2; 2005: 86.0; 2006: 73.9; 2007: 62.3; 2008 staff proj.: 59.0.

*Sources: Data provided by the Philippine authorities; CEIC; and Fund staff estimates, tables, and projections contained in the chapter.*

### APPENDIX I. DEBT SUSTAINABILITY ANALYSIS

### APPENDIX I. DEBT SUSTAINABILITY ANALYSIS

### Summary and baseline
- Baseline assumptions: recent fiscal gains are sustained; no new measures over the medium term apart from the planned reduction in the corporate income tax (CIT) rate in 2009.
- Nonfinancial public sector (NFPS) debt:
  - Will decline under the baseline but remain high at 43 percent of GDP in 2013.
- External debt:
  - Declined from nearly 80 percent of GDP in 2003 to just over 40 percent in 2007.
  - Under staff baseline, external debt ratio falls gradually to just below 30 percent in 2013.

### Projected public sector debt levels (selected years, percent of GDP)
- Public sector debt (total, percent of GDP):
  - 2003: 100.8
  - 2004: 95.2
  - 2005: 86.0
  - 2006: 73.9
  - 2007: 62.3
  - 2008: 59.0
  - 2009: 57.0
  - 2010: 51.0
  - 2011: 48.1
  - 2012: 45.5
  - 2013: 43.1
- Public sector debt--foreign-currency denominated (percent of GDP):
  - 2003: 68.3
  - 2004: 62.7
  - 2005: 45.2
  - 2006: 36.4
  - 2007: 36.1
  - 2008: 36.8
  - 2009: 32.4
  - 2010: 30.9
  - 2011: 29.0
  - 2012: 27.0
- Change in public sector debt (percent of GDP):
  - 2003: 7.1
  - 2004: -5.6
  - 2005: -9.2
  - 2006: -12.1
  - 2007: -11.7
  - 2008: -3.2
  - 2009: -2.1
  - 2010: -6.0
  - 2011: -2.9
  - 2012: -2.6
  - 2013: -2.4
- Debt-stabilizing primary balance (percent of GDP): -0.6

### Key public-sector fiscal and debt flow components (selected)
- Primary deficit (percent of GDP):
  - 2003: -0.7
  - 2004: -1.6
  - 2005: -4.3
  - 2006: -6.0
  - 2007: -4.6
  - 2008: -5.1
  - 2009: -4.5
  - 2010: -3.9
  - 2011: -3.6
  - 2012: -3.2
  - 2013: -2.9
- Revenue and grants (percent of GDP):
  - 2003: 20.8
  - 2004: 20.5
  - 2005: 22.1
  - 2006: 23.2
  - 2007: 23.1
  - 2008: 23.0
  - 2009: 22.5
  - 2010: 22.5
  - 2011: 22.7
  - 2012: 22.8
  - 2013: 22.8
- Primary (noninterest) expenditure (percent of GDP):
  - 2003: 20.1
  - 2004: 19.0
  - 2005: 17.8
  - 2006: 17.2
  - 2007: 18.5
  - 2008: 17.9
  - 2009: 17.9
  - 2010: 18.6
  - 2011: 19.1
  - 2012: 19.6
  - 2013: 19.9
- Automatic debt dynamics (percent of GDP):
  - 2003: 1.4
  - 2004: -4.2
  - 2005: -6.9
  - 2006: -6.4
  - 2007: -8.9
  - 2008: -1.4
  - 2009: -1.1
  - 2010: -1.1
  - 2011: -1.0
  - 2012: -1.0
  - 2013: -1.0

### Key macroeconomic and fiscal assumptions (baseline)
- Real GDP growth (percent):
  - 2003: 4.9
  - 2004: 6.4
  - 2005: 4.9
  - 2006: 5.4
  - 2007: 7.3
  - 2008: 6.0
  - 2009: 6.0
  - 2010: 6.0
  - 2011: 6.1
  - 2012: 6.2
  - 2013: 6.2
- Average nominal interest rate on public debt (percent):
  - 2003: 7.3
  - 2004: 7.3
  - 2005: 7.5
  - 2006: 7.5
  - 2007: 7.0
  - 2008: 8.0
  - 2009: 7.7
  - 2010: 7.6
  - 2011: 7.6
  - 2012: 7.6
  - 2013: 7.5
- Average real interest rate (percent):
  - 2003: 3.6
  - 2004: 1.2
  - 2005: 1.1
  - 2006: 2.2
  - 2007: 4.3
  - 2008: 3.8
  - 2009: 4.1
  - 2010: 4.1
  - 2011: 4.1
  - 2012: 4.1
  - 2013: 4.0
- Inflation rate (GDP deflator, percent):
  - 2003: 3.8
  - 2004: 6.1
  - 2005: 6.4
  - 2006: 5.2
  - 2007: 2.7
  - 2008: 4.2
  - 2009–2013: 3.6, 3.5, 3.5, 3.5, 3.5 respectively
- Growth of real primary spending (deflated by GDP deflator, percent):
  - 2003: 1.3
  - 2004: 0.6
  - 2005: -1.7
  - 2006: 1.7
  - 2007: 15.5
  - 2008: 2.8
  - 2009: 6.1
  - 2010: 10.0
  - 2011: 8.8
  - 2012: 9.2
  - 2013: 7.5

### External debt dynamics and projections
- External debt (percent of GDP):
  - 2003: 78.8
  - 2004: 70.3
  - 2005: 62.4
  - 2006: 51.4
  - 2007: 43.3
  - 2008: 36.8
  - 2009: 35.0
  - 2010: 33.7
  - 2011: 32.1
  - 2012: 30.5
  - 2013: 28.1
- Change in external debt (percent of GDP):
  - 2003: 1.1
  - 2004: -8.5
  - 2005: -8.0
  - 2006: -10.9
  - 2007: -8.2
  - 2008: -6.4
  - 2009: -1.8
  - 2010: -1.3
  - 2011: -1.7
  - 2012: -1.6
  - 2013: -2.4
- Identified external debt-creating flows (percent of GDP):
  - 2003: -3.9
  - 2004: -9.2
  - 2005: -13.6
  - 2006: -18.7
  - 2007: -17.8
  - 2008: -7.6
  - 2009: -6.5
  - 2010: -5.7
  - 2011: -4.9
  - 2012: -4.8
  - 2013: -4.7
- Current account deficit, excluding interest payments (percent of GDP):
  - 2003: -3.6
  - 2004: -4.8
  - 2005: -5.3
  - 2006: -8.3
  - 2007: -8.5
  - 2008: -5.6
  - 2009: -4.7
  - 2010: -3.9
  - 2011: -3.6
  - 2012: -3.1
  - 2013: -2.6
- External debt-to-exports ratio (percent):
  - 2003: 162.1
  - 2004: 142.8
  - 2005: 137.5
  - 2006: 114.1
  - 2007: 110.8
  - 2008: 104.9
  - 2009: 99.7
  - 2010: 96.1
  - 2011: 91.4
  - 2012: 86.7
  - 2013: 79.1
- Gross external financing need:
  - In billions of U.S. dollars:
    - 2003: 13.1
    - 2004: 12.5
    - 2005: 11.1
    - 2006: 9.6
    - 2007: 6.3
    - 2008: 10.4
    - 2009: 12.0
    - 2010: 13.7
    - 2011: 15.9
    - 2012: 16.8
    - 2013: 17.7
  - As percent of GDP:
    - 2003: 16.5
    - 2004: 14.4
    - 2005: 11.2
    - 2006: 8.2
    - 2007: 4.4
    - 2008: 6.0
    - 2009: 6.4
    - 2010: 6.8
    - 2011: 7.2
    - 2012: 7.1
    - 2013: 6.9

### Vulnerabilities and stress-test results
- Exchange rate vulnerability:
  - A one-time real depreciation of 30 percent is estimated to entail a 15-percentage point jump in the external debt ratio from its 2008 level and would remain above 50 percent in the medium term.
  - Real depreciation and contingent liabilities shocks (one-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2007) are illustrated in bound tests.
- Other shocks:
  - Rising resilience to interest rate and growth shocks owing to lengthening maturities and a tilt toward domestic financing:
    - External debt is essentially unaffected by world interest rate and domestic growth shocks.
    - External debt is moderately affected by non-interest shocks to the current account (ending up some 5 percentage points higher by 2013 in that scenario).
- Bound-test scenarios and observations (figures and notes):
  - Individual shocks shown are permanent one-half standard deviation shocks; some tests apply permanent 1/4 standard deviation shocks to real interest rate, growth rate, and primary balance.
  - Combined shocks and non-interest current account shocks are considered; one-time real depreciation of 30 percent is applied in 2008 in external-debt bound tests.

### Methodological notes (as in source)
- Nonfinancial public sector includes the national government, CB-BOL, 14 monitored government-owned enterprises, social security institutions, and local governments. Debt is gross and consolidated (net of intra-nonfinancial public sector holdings of debt).
- Revenue definition: sum of all nonfinancial public sector revenue net of intra-public sector payments; assumption that 80 percent of Bureau of Treasury revenue represents interest and dividends from other parts of the nonfinancial public sector.
- Automatic debt dynamics formula (public debt): derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).
- External-debt automatic dynamics formula and definitions provided in source (notation r, ρ, g, ε, α).

*Source: APPENDIX I. DEBT SUSTAINABILITY ANALYSIS.*

### 3.8 percent of GDP to a deficit of 8.8 percent of GDP. A comparison of the revised figures

### _cr08119 - 3.8 percent of GDP to a deficit of 8.8 percent of GDP. A comparison of the revised figures

### Trade and balance of payments data revisions
- Revised trade balances for 2001–02 are judged to be "reasonably well measured" based on comparison with partner country trade data.
- Substantial differences remain with partner country data on gross flows:
  - Imports reported are about 15 percent higher than corresponding national data.
- The BSP is conducting research on discrepancies in trade in processed goods (examples cited: electronics and textiles).
- Data from 1996–99 have not been revised and remain underestimated.
- Cross-border transactions increasingly flow through nontraditional channels since deregulation in the early 1990s:
  - Foreign Currency Deposit Units (FCDUs) account for about 70–75 percent of foreign exchange settlements and are exempt from reporting due to strict secrecy banking rules.
  - Enterprise surveys have been introduced but are voluntary and will take time to implement fully.
- Unless secrecy rules associated with FCDU accounts are modified, balance of payments compilers will continue to face challenges securing adequate source data.
- Household surveys indicate about 30 percent of remittances of Overseas Filipino Workers were not channeled through the banking system, suggesting remittances may have been underestimated by about US$3 billion (3.8 percent of GDP) in 2002.

### Monetary accounts and monetary and financial statistics (MFS)
- Compilation largely conforms to Fund methodology, with scope for improvement.
- Recent progress and measures:
  - Introduced the Depository Corporations Survey, now including thrift and rural banks.
  - Introduced uniform procedures for converting foreign currency denominated accounts to local currency in monetary aggregates.
  - October 2007 MFS mission introduced standardized report forms (SRFs) for reporting monetary statistics to the IMF and an integrated monetary database (IMD).
  - The IMD will become operational when the BSP submits data in the SRFs in early 2008.
- Remaining weaknesses:
  - Treatment of non-operational banks.
  - Valuation of securities.
  - Treatment of accrued interest.

### Fiscal data, compilation issues, and public sector financial statistics
- Fiscal transparency meets many requirements but ROSCs identified areas needing strengthening.
- Key issues:
  - Budget presented on an obligations basis while deficit is reported on a cash basis, complicating comparisons of budgets and outcomes.
  - Consolidated fiscal outturns for items other than the fiscal balance are generally unavailable for public sector levels beyond the budgetary central government.
- Actions taken and recommendations:
  - August 2004 GFS mission addressed reconciliation of debt stocks and financing flows and advised on improving public sector debt consolidation; revised nonfinancial public sector debt data published since early 2005.
  - Follow-up April 2006 mission identified reconciliation problems arising from differences in time of recording and inconsistencies in coverage and classification related to debt guarantees and assumed debt.
  - Authorities agreed to compare coverage of data in the two debt recording systems, standardize classifications, and improve recording of debt transactions per international best practice.
  - Introduction of a standardized chart of accounts and the electronic New Government Accounting System has facilitated compilation of annual financial statements for all levels of the public sector:
    - Allows compilation of accrual based accounts and a statement of cash flows.
    - These statements become available six months after the end of a reference period.
  - Revisions to chart of accounts classifications to allow consolidation of nonfinancial public sector data as a whole.
  - Recommendation to separate market and non-market activities of government-owned-and-controlled-corporations to compile consolidated general government data.
- Reporting and institutional arrangements:
  - Annual data covering only the budgetary central government are reported for publication in the GFSY; monthly budgetary central government data are published in the IFS.
  - A dedicated unit in the Department of Finance was created to compile government finance statistics in accordance with GFSM 2001 framework.

### Data dissemination and common indicators (as of January 23, 2008)
- Table of Common Indicators required for surveillance lists frequency, timeliness, and data quality assessments for a broad set of macroeconomic variables (selected entries and exact figures preserved):
  - Exchange Rates: Latest observation Dec. 07; Date Received Jan 7/08; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Latest observation Nov 07; Date Received Jan 3/08; Frequency D; Frequency of Reporting D; Frequency of Publication M.
  - Reserve/Base Money: Latest observation Oct 15/07; Date Received Oct 21/07; Frequency of Data D; Frequency of Reporting W; Frequency of Publication W.
  - Broad Money: Latest observation Oct 15/07; Date Received Oct 21/07; Frequency M; Frequency of Reporting M; Frequency of Publication M.
  - Central Bank Balance Sheet: Latest observation Sep/07; Date Received Oct 26/07; Frequency M; Frequency of Reporting M; Frequency of Publication M.
  - Consolidated Balance Sheet of the Banking System: Latest observation Sep/07; Date Received Nov/07; Frequency M; Frequency of Reporting M; Frequency of Publication M.
  - Interest Rates: Latest observation Dec/07; Date Received Jan 16/08; Frequency D; Frequency of Reporting D; Frequency of Publication D.
  - Consumer Price Index: Latest observation Dec/07; Date Received Jan 16/08; Frequency M; Frequency of Reporting M; Frequency of Publication M; Data Quality – Methodological Soundness O, O, O, O; Data Quality – Accuracy and Reliability O, LO, O, LO, LO.
  - Revenue, Expenditure, Balance and Composition of Financing – General Government: Latest observation Q2/07; Date Received Jul/07; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q; Data Quality – Methodological Soundness LO, LO, O, O; Data Quality – Accuracy and Reliability LO, LO, LO, LO, LO.
  - External Current Account Balance: Latest observation Q2/07; Date Received Oct 26/07; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q; Data Quality – Methodological Soundness O, LO, LO, LO; Data Quality – Accuracy and Reliability LNO, LO, O, LO, LO.
  - GDP/GNP: Latest observation Q3/07; Date Received Jan 16/08; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q; Data Quality – Methodological Soundness LO, LO, O, LO; Data Quality – Accuracy and Reliability LNO, LNO, O, LO, O.
- Footnotes and methodological points preserved exactly in reporting table:
  - Definitions and notes 1 through 10, including references to Adjusted Reserves and short-term liabilities, are part of the dataset.

### Relations with the World Bank Group
- Since inception, World Bank committed approximately $12 billion under IBRD loans and $239 million under IDA credits (less cancellations).
- As of September 30, 2007:
  - Philippines portfolio: 22 projects, amounting to $1.13 billion with an undisbursed balance of $854.0 million.
- Lending levels and composition:
  - Lending rose from around $100 million–$200 million a year from FY03 to FY05, to $410 million in FY06 and $395 million in FY07.
  - FY07 figure includes a first Development Policy Loan ($250 million) after an 8-year lull in policy-based lending and three investment operations.
- Portfolio by sector (net commitments, current portfolio):
  - Infrastructure: $334 million, 30 percent.
  - Human development: $326 million, 29 percent.
  - Rural development and environment: $338 million, 30 percent.
  - Social development: $100 million, 9 percent.
  - Governance and economic management: $32.9 million, 3 percent.
- Country Assistance Strategy (CAS):
  - Objective: improve lives through sustainable economic growth and greater social inclusion; fiscal stability and public institutions are critical.
  - CAS supports “Islands of Good Governance.”
  - CAS lending envelope during extended period scaled up to between $0.8 billion to $2.2 billion for remaining two years; original conservative envelope up to $1.8 billion for FY06–08.
  - Lending linked to fiscal performance; only operations with adequate governance and anti-corruption safeguards considered.
- Analytical and knowledge activities:
  - Major analytical pieces delivered in FY07: Agricultural Public Expenditure Review; Environment Monitor focused on Environmental Health; Investment Climate report; Development Policy Review for the Philippines Development Forum.
  - Knowledge for Development Centers (KDCs): ten centers around the country.
  - Partnership with Asian Institute of Management (AIM) to create a Global Distance Learning Network.

### Relations with the Asian Development Bank (ADB)
- In 2006:
  - ADB approved new loans for $650 million and disbursed $750 million; net resource transfer was positive ($269 million).
- Cumulative AsDB lending to the Philippines (as of September 30, 2007):
  - 199 loans for a total of $9.53 billion; 322 technical assistance grants amounting to $147 million.
  - Sector distribution (amounts in millions of US$ and percent by amount preserved):
    - Energy: 25 loans, 2,657.1, 27.9 percent.
    - Agriculture: 47 loans, 1,572.3, 16.5 percent.
    - Multisector: 28 loans, 1,175.8, 12.3 percent.
    - Transport and Communication: 23 loans, 996.8, 10.5 percent.
    - Finance: 19 loans, 1,128.0, 11.8 percent.
    - Water: 20 loans, 731.1, 7.7 percent.
    - Health: 6 loans, 317.4, 3.3 percent.
    - Education: 8 loans, 252.0, 2.6 percent.
    - Industry and Trade: 5 loans, 174.0, 1.8 percent.
    - Law: 2 loans, 253.0, 2.7 percent.
    - Private Sector: 16 loans, 275.3, 2.9 percent.
    - Total: 199 loans, 9,532.8, 100.0 percent.
- ADB engagement priorities:
  - Support for fiscal consolidation, improving the investment climate, and faster achievement of the Millennium Development Goals.
  - Continued emphasis on policy-based lending calibrated against progress on fiscal consolidation and sector reforms.
  - 2007 support: Development Policy Support Program loan ($250 million).
  - Power sector support: Power Sector Development Program loan ($450 million), approved December 2006.
  - Local government: planned policy-based loan for Local Government Financing and Budget Reform Program ($300 million).
  - Other areas: justice reform, urban services for the poor, agrarian reform, coastal resources, upland agriculture, and customization of the Paris Declaration on Aid Effectiveness.

### IMF Executive Board assessment and economic background (PIN No. 08/35, March 16, 2008)
- Background economic developments:
  - GDP growth accelerated to 7.3 percent (annual average) in 2007.
  - Headline inflation was 2.8 percent (annual average) in 2007.
  - Current account surplus reached 5.7 percent of GDP in the first half of 2007 on high transfers from overseas workers.
  - Currency appreciated 19 percent against the U.S. dollar during 2007.
  - Government deficit (excluding privatization receipts) widened to about 1½ percent of GDP; debt-to-revenue ratio remained high relative to other countries.
  - Around 40 percent of power generating capacity has been sold to date via privatization.
  - BSP sterilized jump in liquidity from foreign exchange intervention using Special Deposit Account facility and other instruments.
  - Non-performing assets of banks were reduced; Basel II was phased in.
- Executive Directors’ main assessments and recommendations:
  - Commended authorities for impressive performance: strong growth, low inflation, sustained fiscal consolidation, improved investor confidence, and improved banking sector health and supervision.
  - Encouraged authorities to address remaining challenges and vulnerabilities: infrastructure bottlenecks, social needs, further financial sector strengthening to weather global financial turmoil.
  - Praised fiscal adjustment efforts, welcomed 2005 and 2006 tax reforms, and efforts to control spending.
  - Viewed government's plan to attain a balanced budget in 2008 within a firm medium-term framework as important.
  - Recommended strengthening tax effort and placing priority spending on a sustainable footing; suggested legislation to restore tax base by rationalizing fiscal incentives and adjusting excise taxes.
  - Noted Public-Private Partnerships can be useful but require close monitoring, especially where guarantees are involved.
  - Advised continuation of policy of limiting foreign exchange intervention to smoothing erratic movements within a flexible exchange rate regime and welcomed foreign exchange liberalization steps.
  - Encouraged passage of BSP Charter Amendment to lift threat of legal action against supervisors, facilitate monetary policy operations, and improve surveillance of the non-bank sector.
  - Called for adoption of legislation such as the Corporate Recovery Act and the Credit Information Systems Act.

### Selected economic indicators (2003–2008, staff estimates and projections)
- Growth and prices (in percent change):
  - GDP growth: 2003: 4.9; 2004: 6.4; 2005: 4.9; 2006: 5.4; 2007: 7.3; 2008 Staff Est. 6.0.
  - CPI inflation (average): 2003: 3.5; 2004: 6.0; 2005: 7.7; 2006: 6.2; 2007: 2.8; 2008 Staff Est. 4.4.
- Public finances (in percent of GDP):
  - National government balance (authorities' definition): 2003: -4.6; 2004: -3.8; 2005: -2.7; 2006: -0.9; 2007: -0.1; 2008 Staff Est. 0.0.
  - National government balance (IMF definition)2/: 2003: -4.9; 2004: -4.2; 2005: -3.0; 2006: -1.2; 2007: -1.6; 2008 Staff Est. -0.7.
  - Nonfinancial public sector balance3/: 2003: -5.6; 2004: -5.0; 2005: -2.1; 2006: 0.2; 2007: -0.1; 2008 Staff Est. 0.6.
  - Revenue and grants4/: 2003: 20.8; 2004: 20.5; 2005: 22.1; 2006: 23.2; 2007: 23.1; 2008 Staff Est. 23.0.
  - Expenditure5/: 2003: 26.4; 2004: 25.5; 2005: 24.2; 2006: 22.9; 2007: 23.2; 2008 Staff Est. 22.4.
- Money and credit:
  - Broad money (M3)6/: 2003: 4.2; 2004: 10.2; 2005: 10.3; 2006: 22.7; 2007: 9.1 (As of November 2007).
  - Interest rate (91-day Treasury bill, end period, in percent): 2003: 6.5; 2004: 8.4; 2005: 6.4; 2006: 5.1; 2007: 4.2.
  - Credit to the private sector (net): 2003: 1.9; 2004: 4.6; 2005: -1.5; 2006: 6.0; 2007: 6.8 (As of September 2007).
- Balance of payments (in percent of GDP):
  - Trade balance: 2003: -7.3; 2004: -6.5; 2005: -7.9; 2006: -5.8; 2007: -5.2; 2008 Staff Est. -6.5.
  - Current account balance: 2003: 0.4; 2004: 1.9; 2005: 2.0; 2006: 5.0; 2007: 5.2; 2008 Staff Est. 2.7.
- Gross international reserves:
  - In billions of U.S. dollars: 2003: 17.1; 2004: 16.2; 2005: 18.5; 2006: 23.0; 2007: 33.8.
  - Adjusted, in billions of U.S. dollars9/: 2003: 14.9; 2004: 15.2; 2005: 18.0; 2006: 23.0; 2007: 33.8.
  - Adjusted, in percent of short-term liabilities10/: 2003: 124.2; 2004: 125.8; 2005: 120.1; 2006: 166.6; 2007: 222.5.

### Statement by the Philippine Executive Director (March 12, 2008) — Key points
- Continued implementation of prudent macroeconomic policies and structural reforms led to milestone achievements despite shocks.
- 2007 highlights (exact figures preserved):
  - Philippine economy grew by 7.3 percent in 2007.
  - Inflation averaged 2.8 percent, its lowest in 21 years.
  - Budget deficit reduced to 0.1 percent of GDP, the lowest in 10 years.
  - Foreign exchange reserves stood at $33.8 billion.
  - Philippine Stock Exchange Index (PSEI) reached an all-time high of 3873.5 index points in October 2007.
- Authorities’ priorities in response to near-term global volatility and long-term objectives:
  - Implement additional reforms, particularly in the fiscal and financial sectors.
  - Enhance governance practices to further improve the business environment.

*Source: IMF staff report and Public Information Notice material contained in the provided content unit.*

### Introduction

### Introduction

### Overview
- The Philippine authorities welcomed the exchange with Fund staff and the papers on selected issues that support proposed policy measures, particularly in the fiscal sector.
- The authorities value staff advice drawing on cross-country experiences as inputs for future decisions.

### Macroeconomic performance and external sector
- Growth:
  - The economy grew by 7.3 percent in 2007, the highest in 31 years.
  - Growth was broad-based and led by the fast expanding services sector.
- Inflation and outlook:
  - Inflation at 2.8 percent was well below the target range for 2007 and the lowest annual average in 21 years.
  - Headline inflation is expected to be within target of 4 ± 1 percentage point in 2008.
  - Headline inflation rose to 4.9 percent in January 2008 and 5.4 percent in February 2008, driven by elevated prices of food items, fuel, transportation and communication services.
- External payments and reserves:
  - Gross international reserves reached $33.8 billion at end-December 2007.
  - Foreign exchange reserves further rose to $34.8 billion in January 2008.
  - Reserves at end-December 2007 could adequately cover 5.9 months of imports of goods and payments of services and income.
  - Reserves at end-December 2007 are equivalent to 4.9 times the country’s short-term external debt based on original maturity and 3.0 times based on residual maturity.
- Exchange rate and FX flows:
  - The peso recovered from previous undervaluation and appreciated 18.8 percent for the year.
  - The authorities maintain a market-determined exchange rate while smoothing volatilities and increasing reserves as a precaution.
  - In 2007, the country prepaid $2.8 billion of the medium and long term external debt of both the public and private sectors.
  - Two phases of FX liberalization measures were implemented to allow freer flow of FX in current and capital accounts; BSP will continue reviewing FX regulatory framework to further relax rules.

### Monetary policy, liquidity management, and financial stability
- Liquidity and monetary operations:
  - Rapid money supply growth driven mainly by FX inflows peaked at 26.1 percent year-on-year in April 2007 and slowed to 9.0 percent in December 2007.
  - BSP widened access to its Special Deposit Account (SDA) facility to include trust offices of financial institutions supervised by the BSP to help sterilize liquidity.
  - The BSP implemented twin monetary policy moves in July 2007 lifting the tiering scheme and adjusting policy rates.
  - The BSP reduced its key policy rates by 25 basis points four times for a total of 100 basis points; the latest reduction was implemented in January 2008.
  - The BSP will continue to be attentive to inflationary risks and calibrate monetary policy to maintain price stability.
- Financial sector reforms and supervision:
  - BSP’s medium-term strategic plan establishes a four-pronged approach: enhance regulatory framework, promote corporate governance, implement consolidated and risk-based supervision, and advance capital market reform initiatives.
  - Full implementation of Basel II for the standardized approach occurred in July 2007; the advanced internal ratings based approach is targeted for full implementation after 2010.
  - BSP advocates amendments to the Central Bank Act to strengthen supervisory powers, develop capital markets, allow the inflation targeting framework to determine limits on monetary and price indicators, remove restrictions on BSP’s issuance of its own securities, and expand authority to obtain data from the non-bank sector.
- FX risk mitigation:
  - BSP promoted hedging products offered by banks to reduce FX risk for dollar earners.
  - Development Bank of the Philippines (DBP) offered a hedging program for exporters providing FX insurance and forward FX rate protection products.
  - Commercial banks initiated public information campaigns to popularize hedging facilities.

### Fiscal developments, consolidation, and reforms
- Fiscal outcomes and targets:
  - National Government (NG) deficit was recorded at 0.1 percent of GDP in 2007.
  - The consolidated public sector recorded a surplus of P52.8 billion as of end-September 2007, compared with P8.9 billion surplus for the same period in 2006.
  - National Government debt as percent to GDP dropped to 59.4 percent in 2007 from 66.9 percent in 2006 and is expected to go down further to 54 percent in 2008.
- Revenue and tax policy:
  - Tax revenues increased by 13 percent on an annual basis in 2007.
  - Tax effort slightly declined to 14 percent in 2007 from 14.3 percent in the prior year.
  - Government’s goal is to achieve a 16 percent tax effort by 2010 or close to pre-crisis (1996) levels of 16.9 percent.
  - Ongoing tax administration reforms are expected to yield dividends.
- Structural fiscal measures and incentives:
  - With major privatizations completed in 2007, emphasis is on building a sustained tax revenue base.
  - Priorities include streamlining fiscal incentives, particularly phasing out the income tax holiday:
    - National Government proposes to phase out the income tax holiday within three years from the effectivity of the proposed regulation.
    - In lieu of the income tax holiday, eligible enterprises will be given a choice of either a reduced income tax rate (partial income tax holiday) or a gross income tax package.
    - The proposed tax incentive package is to run for 20 years.
  - Proposed simplification of excise tax on tobacco entails reduction in number of tax brackets applied to both tobacco and alcohol products plus provisions to simplify excise tax administration.
- Tax enforcement and governance:
  - Governance measures to be intensified include Revenue Protection Integrity Service (RIPS) with 82 cases filed to date, Run After Tax Evaders (RATE) with 87 cases filed, and Run After the Smugglers (RATS) with 60 cases filed.
- Expenditure and budget stance:
  - Expenditure compression observed in previous years was reversed in 2007 as authorities implemented projects to improve infrastructure and social spending.
  - The 2008 budget is up by 8 percent from 2007 with strong emphasis on upgrading infrastructure.
  - In response to the slowdown in the US, authorities intend to frontload expenditures, particularly for infrastructure, to alleviate external shock impacts and help reduce the deficit.
  - Lower interest costs and the peso appreciation helped reduce the NG’s financing requirement.

### Structural reforms and sectoral developments
- Banking and financial sector:
  - BSP aims to develop a stronger and more efficient banking system to meet medium-term development needs via regulatory enhancement, corporate governance, consolidated risk-based supervision, and capital market reforms.
  - BSP supports passage of legislation to strengthen supervisory and regulatory powers and modernize the institutional framework.
- Power sector and privatization:
  - The Wholesale Electricity Spot Market (WESM) helped bring down power cost; the WESM rate was P3.38/kwh in January 2008, an all-time low since July 2006.
  - PSALM sold at least 10 plants equivalent to 42 percent of the generating assets of the National Power Corporation in 2007.
  - PSALM plans to sell 10 more plants to reach 70 percent of its privatization target, the trigger level for implementing open access.
  - A pending bill in Congress seeks to lower the trigger level to 50 percent to speed implementation of open access for all residential and industrial users.
  - Efforts are underway to reduce power rates in ecozones to make electricity rates more competitive.

### Risks, challenges, and policy priorities
- External and global risks:
  - The global financial turmoil stemming from the subprime mortgage crisis in the US had little direct impact on the Philippine financial system in 2007, but may dampen export growth and remittances due to a slowdown in the US and the rest of the world.
  - Continued high and volatile global oil and non-oil commodity prices, including food, may put pressure on domestic inflation.
- Policy priorities:
  - Continue prudent monetary and external sector policies, including liquidity management and reserve buildup.
  - Continue fiscal reforms to ensure consolidation and sustainability, broaden and sustain the tax revenue base, and reduce fiscal vulnerabilities to exchange rate movements by sourcing financing largely from domestic sources.
  - Advance structural reforms in the financial and power sectors and pursue privatization and regulatory reforms to sustain growth.

### Concluding remarks
- After a long series of critical setbacks, the Philippine economy has taken off.
- Authorities emphasize the need for further reform efforts and continued policy discipline to maintain the upward course amid external headwinds.
- Authorities intend to continue working closely with the Fund through regular Article IV consultations and technical assistance programs.

*Source: _cr08119 - Introduction.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08119.pdf_