## _cr1045

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### Executive Summary
- Growth projected at ¾ percent in 2009 and expected to recover to around 3¼ percent in 2010.
- Slowdown cushioned by supportive fiscal and monetary policies and resilient remittances.
- Recovery likely led by private consumption as confidence improves; investments and exports expected to benefit from global recovery.
- Risks to the outlook are broadly balanced.
- Main policy focus: credible fiscal consolidation strategy while avoiding premature exit from other supportive macroeconomic policies; enhance financial sector stability and sustain medium-term growth.

### Growth, Prices, and External Outlook
- Growth:
  - Q1 2009: −2.1 percent (q/q).
  - Q2 2009: +1.7 percent (q/q).
  - Q3 2009: +1.0 percent (q/q).
  - Real GDP growth (selected): 2005: 5.0; 2006: 5.3; 2007: 7.1; 2008: 3.8; 2009: 0.8; 2010 (Proj.): 3.2.
  - Staff projection: ¾ percent in 2009 and around 3¼ percent in 2010.
- Inflation:
  - Consumer price inflation trended down to 3¼ percent (y/y) during January–November 2009.
  - Core inflation declined from around 7 percent (y/y) at end-2008 to 2¾ percent (y/y) as of November 2009.
  - CPI (annual average): 2005: 7.7; 2006: 6.2; 2007: 2.8; 2008: 9.3; 2009: 3.1; 2010 (Proj.): 4.3.
- External:
  - Current account: 2009: 4.6 percent of GDP; 2010 (Proj.): 3.0 percent of GDP.
  - Overall balance of payments surplus in 2009: US$5.3 billion.
  - Remittances around 10 percent of GDP; simulation shows permanent declines would materially reduce GDP and consumption over 10 years.

### Fiscal Policy — Position, Risks, and Recommendations
- 2009 fiscal outturn and stance:
  - 2009 budget target (national government, IMF definition): deficit of 3¾ percent of GDP.
  - 2009 estimated deficit outturn: about 4½ percent of GDP (overshoot).
  - Nonfinancial public sector borrowing need: 20 percent of GDP in 2009.
  - Fiscal impulse in 2009: around 2¼ percent of GDP; GIMF-implied growth impact: around 1 percentage point.
- Authorities’ plans:
  - Target deficit of 3 percent of GDP in 2010.
  - Aim to balance the budget by 2013 (delayed by three years).
- Staff recommendations (fiscal):
  - Measured fiscal withdrawal in 2010; cap the deficit at 3½ percent of GDP in 2010 (implying a negative fiscal impulse of about 1 percent of GDP).
  - Announce a credible medium-term fiscal consolidation plan in parallel with the 2010 budget anchored on revenue-raising measures.
  - Introduce new legislative and administrative revenue measures yielding about ½ percent of GDP.
  - Slow the increase in the civil service wage bill.
  - Build consolidation on revenue measures that allow more pro-poor spending and growth-enhancing investment.
  - Review tax reform strategy with IMF technical support; encourage early passage of sin tax and incentives rationalization measures.
  - Strengthen revenue administration (focus on large taxpayers).
  - Rationalize the National Food Authority through full cost recovery and limit its role to food security.
  - Strengthen finances of GOCCs; submit a medium-term budget framework alongside the budget.
  - Consider adopting a Fiscal Responsibility Law with an explicit numerical rule.
  - Closely monitor contingent liabilities, including PPP guarantees; develop integrated debt management framework.
- Staff assessment of risks:
  - Structural erosion of the tax base and proliferation of tax incentives weaken revenue prospects.
  - Planned deficit reduction in 2010 depends on ambitious revenue targets and sharp scale-back of infrastructure and maintenance spending; salary standardization law will raise personnel expenses.
  - Political difficulty of passing revenue measures ahead of May elections could impede consolidation.

### Box 2 — Fiscal Multipliers and Stimulus Effectiveness (GIMF findings)
- Short-term (1-year) multipliers for expenditure measures: 0.2 to 0.8 percent (investment spending has largest impact).
- Comparable multipliers for emerging Asia: 0.4 to 1.1 percent.
- Growth impact of general tax cuts: 0.1 to 0.4 percent.
- Economic Resiliency Plan (if fully implemented at around 2½ percent of GDP in 2009):
  - Short-term output increase: estimated 1¼ percent.
  - Medium-term output increase: estimated 2¼ percent.
  - Only around ¾ implemented, implying a smaller fiscal impulse.
- Consolidation simulations: revenue-based consolidation that protects/increases investment and targeted social transfers (strategy 4), financed by revenue measures and a relaxation of the budget target by 1 percent of GDP, yields the largest positive impact on growth and helps contain debt.

### Monetary Policy — Actions and Guidance
- BSP easing since end-2008:
  - Policy rates lowered by 200 basis points since end-2008; reverse repo rate at 4 percent.
  - Reserve requirement rate on bank deposits and deposit substitutes lowered by 2 percentage points (to 19 percent for universal/commercial banks).
  - Rediscount window tripled to P60 billion; eligibility and collateral expanded.
- Outcomes and transmission:
  - Lending rates followed policy easing closely; credit growth decelerated.
  - Inflation expectations well-anchored and consistent with BSP’s inflation target.
  - Gross official reserves rose by about US$6 billion since end-2008 to around US$44 billion as of November; forward book increased by around US$11 billion.
- Staff recommendations (monetary):
  - Premature to tighten monetary policy near-term given negative output gap and limited fiscal space.
  - Exit from accommodative policy should commence only when recovery is self-sustaining; start by rolling back liquidity-enhancing measures before raising policy rates.
  - Limit foreign exchange market intervention to smoothing excessive movements; allow exchange rate to adjust to market pressures.
  - Some further reserve buildup permissible to cover short-term debt and foreign currency deposits.
- Authorities’ stance:
  - No urgent need to tighten policy; will hold off exit until recovery self-sustains and inflation risks abate; plan to roll back liquidity-enhancing measures before policy rate hikes.

### Financial Sector — Soundness, Vulnerabilities, and Reform Priorities
- Key metrics:
  - Bank operating income (first half 2009): up 18½ percent (y/y).
  - First-half net profits: up 33 percent (y/y).
  - Capital adequacy ratio (CAR): 15.3 percent as of March 2009; consolidated CAR: 15.3 (2009 Q2); 15.7 (June 2009 cited elsewhere).
  - Tier 1 capital: 12.4 percent.
  - NPL ratio: around 4.5 percent (2009 Q2), NPL on household loans ~9 percent (June 2009); household loans account for less than 20 percent of total bank loans.
  - Total nonperforming assets (net of provisions): close to 30 percent of equity.
- Assessment and stress tests:
  - Financial sector relatively resilient; IMF staff, Fitch, Moody’s stress tests indicate resilience to adverse shocks.
  - Vulnerabilities include concentration risk driven by large conglomerates and sensitivity to a permanent jump in interest rates due to holdings of government securities.
  - Identified vulnerability to failure of one or more large conglomerates.
- Recommended micro- and macro-prudential reforms:
  - Move to risk-based capital requirements; welcome planned introduction of ICAAP (Basle II, Pillar 2) in 2011.
  - Introduce counter-cyclical macro-prudential framework (changes to required capital, collateral, liquidity, provisioning) subject to international debate.
  - Strengthen risk management, stress-testing capacity, and supervision.
- Resolution and contingency framework enhancements:
  - Strengthen PCA framework with earlier, faster, and increasingly severe action.
  - Enhance resolution tools: eliminate rehabilitation period for owners during receivership; introduce bridge-bank facility; allow more flexible purchase and assumption facility; make restructuring decisions legally irreversible; protect BSP and PDIC staff against litigation.
  - Passage of NCBA amendments important to lift bank secrecy constraints on examiners and enhance supervisory powers; authorize BSP to issue its own debt securities.
- Authorities’ actions and views:
  - Agree financial sector is sound and resilient; plan counter-cyclical liquidity framework; support NCBA amendments; progress on privatization of power companies and efforts to ensure cost recovery.

### Structural Policies — Constraints, Priorities, and Reform Agenda
- Constraints to higher investment and growth:
  - Weak business climate: corruption and high administrative burdens (e.g., procedures to start a business).
  - Low investment-to-GDP ratio and low foreign investment.
- Priorities and recommended reforms:
  - Reorient budget toward public investment (infrastructure).
  - Tackle corruption decisively; reduce administrative hurdles (streamline procedures, speed processing).
  - Strengthen corporate governance: raise disclosure requirements and director liabilities.
  - Improve bankruptcy law and reduce administrative bottlenecks.
  - Develop capital markets to improve financial intermediation.
  - Strengthen labor market flexibility (liberalize fixed-term contracts; phase out minimum wages gradually while strengthening safety nets; reduce redundancy notice periods and severance pay).
  - Improve infrastructure via larger public investment financed by a strengthened tax effort; pursue private participation in large infrastructure projects with attention to PPP fiscal risks.
- Authorities’ views:
  - Broad agreement on need for reforms to sustain medium-term growth; governance reform and fiscal room for growth-enhancing spending seen as key pillars.

### Debt, Resilience, and Risk Scenarios
- Public sector debt (percent of GDP): 2004: 95.2; 2005: 85.9; 2006: 73.9; 2007: 61.1; 2008: 60.9; 2009: 63.7; 2010 (Proj.): 62.7; 2014 (Proj.): 54.6.
- External debt (percent of GDP): 2004: 70.7; 2005: 62.7; 2006: 52.0; 2007: 45.9; 2008: 38.8; 2009: 41.2; 2010 (Proj.): 37.9; 2014 (Proj.): 33.1.
- Reserves, adjusted (US$ billions): 2005: 18.0; 2006: 23.0; 2007: 33.8; 2008: 35.9; 2009 (Proj.): 44.2; 2010 (Proj.): 49.8.
- Debt sustainability notes:
  - Baseline: uptick in debt levels in 2009–10 due to global crisis; assuming revenue reforms aiming at a 1 percent of GDP National Government deficit by 2013, NFPS debt expected to decline to pre-crisis level by 2013.
  - Without reforms, debt expected to remain elevated at 60 percent of GDP in 2013.
  - A one-time real depreciation of 30 percent estimated to entail a 22 percentage point jump in the external debt ratio from its 2008 level.

### Key Short-Term Operational Recommendations (summary)
- Fiscal:
  - Cap deficit at 3½ percent of GDP in 2010; announce medium-term consolidation plan anchored on revenue measures alongside 2010 budget.
  - Introduce revenue measures yielding about ½ percent of GDP; slow civil service wage bill growth; protect public investment and targeted social transfers.
- Monetary:
  - Delay monetary tightening until recovery is demonstrably self-sustaining; begin exit by rolling back liquidity-enhancing measures.
  - Limit FX interventions to smoothing operations; allow the exchange rate to adjust to market pressures.
- Financial sector:
  - Move to risk-based capital requirements; introduce counter-cyclical macro-prudential tools; pass NCBA amendments; strengthen PCA, resolution, and supervisory frameworks.
- Structural:
  - Reorient spending toward infrastructure; implement product market and governance reforms to improve competitiveness and attract investment; strengthen tax effort and revenue administration.

*Source: Executive Summary and selected sections from the IMF staff report (2009 Article IV staff report and informational annex) contained in the provided PDF content.*

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

### Executive Summary

### Background
- Growth is projected at ¾ percent in 2009 and is expected to recover to around 3¼ percent in 2010.
- The slowdown was cushioned by supportive fiscal and monetary policies and resilient remittances.
- The recovery will likely be led by private consumption as confidence improves; investments and exports are also expected to benefit from the global recovery.
- Risks to this outlook are broadly balanced.

### Recent Economic Trends and Outlook — Stabilization and Signs of Nascent Recovery
- Growth:
  - The economy avoided a technical recession: Q2 and Q3 GDP rebounded by 1.7 percent and 1.0 percent (q/q), respectively, following a 2.1 percent (q/q) contraction in Q1.
  - The rebound was driven by resilient remittances, supportive macroeconomic policies, and a modest sequential rebound in exports.
- Inflation:
  - Consumer price inflation trended down, reaching 3¼ percent (y/y) during January–November 2009, slightly below the middle of the BSP’s inflation target range of 3½ ± 1 percent.
  - Core inflation declined from around 7 percent (y/y) at end-2008 to 2¾ percent (y/y) as of November 2009.
- Financial markets and capital flows:
  - Market conditions normalized with equity prices at pre-crisis levels; credit spreads narrowed and corporate and sovereign bond issuances increased.
  - The Philippines experienced a resumption of foreign inflows primarily into government and corporate bond markets; stock market recovery was primarily fueled by local investors.
- Current account and exchange rate:
  - The current account held up well; exports severely affected but recovered sequentially.
  - Trade balance benefited from declines in food and commodity prices and lower imports of capital and intermediates; resilient remittances helped prop up the current account.
  - The exchange rate appreciated around 7 percent against the U.S. dollar since November 2008, but depreciated by around 2 percent on a trade-weighted basis over the same period.

### Recent Economic Trends and Outlook — Recovery Uncertainties and Medium-Term Prospects
- Baseline projection:
  - Growth is expected at ¾ percent in 2009 and to recover to around 3¼ percent in 2010.
  - Recovery in 2010 likely to be led by private consumption as confidence and remittances improve; exports and investments expected to benefit from global recovery.
- Short-term risks:
  - Risks are broadly balanced and depend largely on global economic outturn through export and remittance channels.
  - Domestic risks include higher-than-estimated output losses from recent typhoons and a wider-than-anticipated fiscal deficit that could raise risk premia.
  - Upside risk: post-typhoon rebuilding could spur investment and consumption.
- Medium-term challenges:
  - Potential growth likely lower than pre-crisis period; external demand and remittances from advanced economies could be permanently lower in the post-crisis environment.
  - Baseline already assumes 2 percent of GDP in tax measures over the medium term, partly from sin tax reform measures awaiting Congressional approval; absence of these measures would keep public debt at elevated levels (Appendix I, “no policy change” scenario).
- Reform scenario to raise growth:
  - Stepped-up fiscal reforms and strengthening of the tax base would allow higher outlays for growth-enhancing infrastructure and expanded social programs.
  - Product market and governance reforms to tackle the weak business environment could raise growth potential via stronger domestic and foreign investment and improved competitiveness.

### Policy Discussions — Overall
- Main policy focus: putting in place a credible fiscal consolidation strategy while avoiding premature exit from other supportive macroeconomic policies; enhance financial sector stability and sustain medium-term growth.

### Fiscal Policy — Balancing Stimulus and Sustainability
- 2009 fiscal stance:
  - The 2009 budget targeted a national government deficit (IMF definition) of 3¾ percent of GDP, over 2 percentage points of GDP higher than in 2008.
  - The 2009 deficit outturn is estimated at about 4½ percent of GDP, overshooting the budgeted target, driven by cyclical and legislative revenue-eroding measures (increases in personal income tax exemptions; replacement of VAT on power transmission with a franchise tax).
  - Fiscal impulse: around 2¼ percent of GDP in 2009; growth impact of around 1 percentage point based on GIMF simulations (Box 2).
- Staff recommendations:
  - Given the nascent recovery and limited fiscal space, staff recommends a measured fiscal withdrawal in 2010.
  - To demonstrate commitment to fiscal prudence, authorities should announce a credible medium-term fiscal consolidation plan in parallel with the 2010 budget anchored on revenue raising measures.
- Authorities’ stance:
  - Authorities plan to contain the fiscal deficit in 2010 but note difficulty in introducing revenue raising measures ahead of the May election.
  - They agreed a credible medium-term fiscal consolidation plan anchored on tax reform would be useful.

### Monetary Policy — Preparing Timely Exit
- Staff view:
  - Exit from supportive monetary policies should await clear signs that the recovery is on a solid footing.
- Authorities’ view:
  - No urgent need to tighten monetary policy stance given within-target inflation projected over the policy horizon.
  - Exit from supportive monetary policies should commence only when recovery is self-sustainable; mindful that premature rate hikes could attract capital inflows.
  - Exchange rate viewed as broadly in line with fundamentals; authorities will continue to limit foreign exchange interventions to smoothing operations.

### Financial Sector — Drawing Lessons from the Crisis
- Assessment:
  - The financial sector is relatively sound with banks benefiting from high capital buffers and low nonperforming loans, but some vulnerabilities remain.
- Staff recommendations:
  - Consider introducing risk-based capital requirements and a counter-cyclical macro-prudential framework.
  - Passage of amendments to the New Central Bank Act (NCBA) is key to provide supervisors with needed legal powers and protection.
- Authorities’ actions:
  - Closely following international debate on micro- and macro-prudential regulation.
  - Planning to introduce a counter-cyclical liquidity framework and eager for passage of NCBA amendments.

### Structural Policies — Rebalancing and Strengthening Growth
- Staff recommendations to shift to higher medium-term growth:
  - Reorient the budget towards public investment.
  - Revamp the weak business environment to encourage private sector activities.
  - Implement product market and governance reforms to strengthen competitiveness, tap new export markets (especially in Asia), and attract higher domestic and foreign investment.
- Authorities’ views:
  - Acknowledge structural reforms are imperative to generate higher growth.

### Staff Appraisal (Summary)
- Measured fiscal withdrawal in 2010 recommended given nascent recovery and limited fiscal space.
- Announce a credible medium-term fiscal consolidation plan with revenue measures alongside the 2010 budget to demonstrate fiscal prudence.
- Delay exit from supportive monetary policies until recovery is demonstrably self-sustaining.
- Strengthen financial sector resilience via risk-based capital rules, counter-cyclical macro-prudential tools, and passage of NCBA amendments.
- Reorient budget toward public investment and undertake structural reforms to revive investment, competitiveness, and medium-term growth.

*Source: Executive Summary, 2009 Article IV staff report.*

### 8.      The authorities have so far not faced financing constraints, but further fiscal

### _cr1045 - 8.      The authorities have so far not faced financing constraints, but further fiscal

### Fiscal position, financing, and risks
- The nonfinancial public sector borrowing need was 20 percent of GDP in 2009.
- Ample domestic liquidity and favorable international market conditions have allowed the government to easily finance that 20 percent of GDP borrowing need.
- Structural erosion of the tax base could raise investors’ concerns about fiscal sustainability and increase financing costs as they demand higher risk premia.
- Government plans:
  - Target a deficit of 3 percent of GDP (IMF definition) in 2010.
  - Aim to balance the budget by 2013.
- Planned deficit reduction is expected to be achieved through:
  - An ambitious revenue collection target well above the expected 2009 outturn in percent of GDP.
  - A sharp scale-back of infrastructure and maintenance spending.
- Offsetting factor: the salary standardization law approved this year will cause an expected increase in personnel expenses.
- The government delayed balancing the budget by three years to 2013 due to the global economic crisis; concrete measures to underpin consolidation have yet to be identified.

### Policy issues and staff recommendations (fiscal)
- Assessment of 2009 fiscal easing:
  - The fiscal policy easing in 2009 was appropriate and relatively effective, but limited fiscal space argues for a measured withdrawal in 2010.
  - Stimulus measures targeted at infrastructure and liquidity-constrained households likely supported growth in 2009 (see Box 2).
- Staff advice for 2010:
  - Cap the deficit at 3½ percent of GDP to contain the high public debt level; this would imply a negative fiscal impulse of about 1 percent of GDP.
  - Staff judged the 3½ percent of GDP target not achievable without new fiscal measures because:
    - Erosion of the tax base has weakened the fiscal position.
    - Growing proliferation of tax incentives suggests 2010 revenue will remain at best at the 2009 level.
  - Staff recommended:
    - (i) slowing the increase in the civil service wage bill; and
    - (ii) introducing new legislative and administrative revenue measures yielding about ½ percent of GDP.
  - These measures would help make room for public investment, including post-typhoon rehabilitation and reconstruction.
- Additional staff recommendations to bolster credibility and sustainability:
  - Announce a credible medium-term consolidation plan in parallel with the 2010 budget.
  - Build consolidation on revenue-raising measures that allow for more pro-poor spending and growth-enhancing investment.
  - Review broader tax reform strategy with IMF technical support; encourage early passage of sin tax and incentives rationalization measures currently before Congress.
  - Strengthen revenue administration efforts, especially for large taxpayers, to bolster tax collections.
  - Rationalize the National Food Authority (NFA) through full cost recovery and limit its role to food security.
  - Strengthen finances of other government-owned and controlled corporations (GOCCs).
  - Submit a medium-term budget framework alongside the budget to the legislature.
  - Consider adopting a Fiscal Responsibility Law, possibly with an explicit numerical rule to anchor fiscal policy.
  - Closely monitor contingent liabilities, including public-private partnership (PPP) guarantees, to enhance fiscal risk management.
- Authorities’ views (fiscal):
  - Agreed on need for measured fiscal withdrawal in 2010 to contain the deficit.
  - Opposed revenue-eroding measures passed by Congress and advocated a moratorium on such proposals.
  - Noted political difficulty of passing revenue-enhancing reforms in run-up to May elections if revenues underperform.
  - Agreed to review the decline in public investment in the 2010 budget given post-typhoon reconstruction needs.
  - Saw limited scope to compress the rapid rise in the civil service wage bill due to political constraints, but hoped to cut expenditures in other areas, especially unallocated reserves.
  - Will prepare a strategy to raise the tax effort for the new government taking office in July 2010 with FAD TA input.
  - Acknowledged challenges in rationalizing the NFA and strengthening GOCC finances; noted progress in privatization of power companies and efforts to ensure cost recovery.
  - Saw merit in gradually introducing a more formalized medium-term fiscal framework and strengthening the medium-term expenditure framework and budgeting procedures.
  - Recognized need for an integrated debt management framework to internalize risks associated with guarantees.

### Box 2 — Effectiveness of Fiscal Policy in the Philippines (key quantitative findings)
- Short-term (1-year) multipliers for expenditure measures from GIMF simulations calibrated for the Philippines range from 0.2 to 0.8 percent; investment spending has the largest impact on growth.
- Comparable estimates for emerging Asia are 0.4 to 1.1 percent.
- Growth impact of general tax cuts ranges from 0.1 to 0.4 percent.
- The government’s stimulus package, the Economic Resiliency Plan:
  - If fully implemented, around 2½ percent of GDP in 2009, could have increased output in the short term by an estimated 1¼ percent and in the medium term by 2¼ percent.
  - Only around ¾ has been implemented, implying a somewhat smaller fiscal impulse.
- Simulations of consolidation strategies suggest a revenue-based consolidation that protects or increases investment and targeted social transfers (strategy 4), financed by revenue measures and a relaxation of the budget target by 1 percent of GDP, would have the largest positive impact on growth and help contain debt.

### Monetary policy: background and recent actions
- BSP monetary easing since end-2008:
  - Policy rates lowered by 200 basis points since end-2008.
  - Reverse repo rate brought to 4 percent.
  - Reserve requirement rate on bank deposits and deposit substitutes lowered by 2 percentage points (to 19 percent for universal/commercial banks).
  - Rediscount window tripled to P60 billion, with eligibility of counterparts and collateral expanded.
- Transmission and outcomes:
  - Lending rates followed policy easing closely, supporting growth.
  - Inflation expectations remain well-anchored at a level consistent with the BSP’s inflation target.
  - Credit growth has decelerated due to key customers reaching single borrower limits, some tightening in credit standards, and substitution to corporate bond financing.
- International reserves and exchange rate:
  - Gross official reserves have risen by about US$6 billion since end-2008 to around US$44 billion as of November.
  - The forward book has increased by around US$11 billion over the same period.
  - Rise in reserves largely reflects the IMF's SDR allocation, proceeds from government bond issuance, valuation gains, and AsDB loan disbursements.
  - Appreciation of the exchange rate in recent months occurred amid rising, yet modest, capital inflows and resilient remittances.

### Policy issues and staff recommendations (monetary)
- Near-term stance:
  - It would be premature to tighten monetary policy over the near-term given the negative output gap and limited fiscal space.
  - Inflation expectations remain well-anchored, credit growth has slowed, and recovery self-sustainability is not yet assured.
  - Typhoons may temporarily raise food prices, but the impact is not expected to persist.
  - No evidence of asset market bubbles; a Taylor-rule based on projected output gap and divergence of inflation from the central bank target assesses current policy rates to be broadly appropriate.
- Exit strategy:
  - Exit from accommodative monetary policy should commence only when the recovery is on a solid footing; premature tightening might stall recovery, especially once fiscal stance becomes contractionary.
  - Higher policy rates could induce speculative inflows and currency appreciation that could slow export recovery.
  - Mopping up excess liquidity as policy tightens should not be challenging because expansion of the central bank balance sheet was very limited.
- Exchange rate and reserves policy:
  - Staff supports limiting foreign exchange market intervention to smoothing excessive movements.
  - Official international reserves accumulation has been pronounced, but the increase was only to a limited extent due to direct foreign exchange intervention.
  - BSP used foreign exchange swaps to smooth dollar liquidity volatility from short-term capital inflows and a shift in residents’ preference from dollar to peso holdings.
  - With the exchange rate assessed to be broadly aligned with fundamentals, authorities should continue to allow the exchange rate to adjust to market pressures.
  - Some further buildup in reserves could be allowed to adequately cover short-term debt as well as foreign currency deposits.

### The Authorities’ views (monetary)
- Saw no urgent need to raise policy rates over the near term.
- Emphasized inflation remained closer to the lower bound of the target range over the policy horizon.
- Noted demand-side pressures are limited and inflation expectations are well-anchored; typhoon-related price pressures likely temporary.
- Will hold off exit from supportive monetary policies until clear signs that recovery is self-sustainable and downside risks to inflation have dissipated.
- In sequencing, plan to roll back liquidity-enhancing measures before raising the policy rate.

*Source: IMF staff report excerpt contained in the provided PDF content.*

### 22.      The authorities concurred with staff’s assessment of the exchange rate. They

### _cr1045 - 22.      The authorities concurred with staff’s assessment of the exchange rate. They

### Exchange rate
- The authorities concurred with staff’s assessment of the exchange rate.
- The peso is market determined; foreign exchange market interventions are limited to smoothing excessive movements while allowing for the adequate accumulation of reserves.
- The authorities would allow the exchange rate to adjust to further upward pressures in the event of stronger balance of payments flows while allowing for a modest buildup in reserves for prudential reasons.

### Financial Sector — Drawing Lessons from the Crisis: key developments and metrics
- The financial sector has weathered the global financial crisis relatively well; balance sheet risks would appear manageable.
- Bank earnings (first half of 2009):
  - Operating income was up by 18½ percent (y/y) during the first six months.
  - First-half net profits were up by 33 percent over the same period last year.
- Capitalization:
  - Capital adequacy ratio (CAR) at 15.3 percent as of March 2009.
  - Tier 1 capital at 12.4 percent.
- Asset quality:
  - Nonperforming loans (NPLs) remain low on average but vary across institutions.
  - Thrift and rural banks (about 10 percent of banking sector assets) have relatively higher NPLs.
  - NPL ratio on loans extended to households is around 9 percent as of June 2009.
  - Household loans account for less than 20 percent of total bank loans.
  - Total nonperforming assets (net of provisions) are close to 30 percent of equity, but have declined in recent years and are often booked conservatively.
- Concentration risk:
  - Relatively high concentration risk due to large conglomerates; some banks’ exposures are concentrated on relatively few large corporate borrowers.
- Corporate sector:
  - Leverage for nonfinancial corporates is considerably lower than in the Asian crisis period.
  - The share of short-term debt has declined; liquidity risks have receded; interest coverage ratio has increased.
  - Excluding financials, net income of bourse listed companies rose by 50 percent during the first half of 2009 (year-on-year), with the industrial sector’s gains driven in large part by one-off sales.
  - Example: San Miguel Corporation in May 2009 sold a 43.25 percent share in its brewery to Japan’s Kirin for around pesos 39 billion, accounting for more than 20 percent of the first half net income of all listed nonfinancials.

### Policy issues, stress tests, and vulnerabilities
- Overall assessment:
  - The financial sector faces vulnerabilities but appears relatively resilient to downside risks.
  - Projected moderate economic growth may constrain bank earnings and could lead to deterioration in asset quality.
- Stress tests:
  - IMF staff and rating agencies (Fitch Ratings and Moody’s) stress tests suggest resilience to adverse shocks.
  - November 2009 FSSA update mission: largest banks generally resilient to adverse shocks, including relatively severe macroeconomic shocks.
  - Tests indicate vulnerability to failure of one or more large conglomerates due to concentration risks and to a permanent jump in interest rates given significant holdings of government securities.
- Identified potential vulnerability:
  - Large holdings of foreclosed properties assessed to pose less risk than previously thought because conservative book values allow for significant declines in property prices before impacting capitalization.

### Lessons and recommended reforms (micro- and macro-prudential)
- Micro-prudential regulation:
  - Move to a more risk-based approach to capital requirements to better reflect institutional risk profiles.
  - Planned introduction in 2011 of the internal capital adequacy assessment process (ICAAP) under the Basle II, Pillar 2 framework welcomed as an important first step.
  - Continue strengthening banks’ risk management capacities and authorities’ stress-testing capacities.
- Macro-prudential regulation:
  - Current regulatory tools do not sufficiently dampen pro-cyclicality of financial markets.
  - Consider changes to required capital, collateral, liquidity, or loss provisioning requirements, subject to ongoing international debate on counter-cyclical frameworks.

### Contingency, resolution, and supervisory enhancements
- Authorities’ crisis response:
  - BSP enhanced monitoring and stress-testing, and provided liquidity support.
  - Deposit insurance coverage was doubled.
- Further steps recommended:
  - Strengthen the prompt corrective action (PCA) framework by instituting earlier, faster, and increasingly severe action.
  - Enhance the resolution framework, including:
    - Elimination of the rehabilitation period for owners during receivership.
    - Introduction of a bridge-bank facility.
    - More flexible purchase and assumption facility.
    - Make restructuring decisions legally irreversible.
    - Protect BSP and Philippine Deposit Insurance Corporation staff against litigation.

### The Authorities’ views on the financial sector and reforms
- Authorities’ assessment:
  - Agreed with staff’s assessment that the financial sector is sound and resilient; their own stress-testing exercises confirmed resilience to potential deterioration in earnings and asset quality.
  - Acknowledged concentration risks but viewed them as inevitable given dominance of large conglomerates; emphasized large corporates are well-monitored and generally sound.
  - Large holdings of foreclosed properties do not present a risk to banks owing to conservative book values.
- Policy intentions and legal changes:
  - Planning to introduce counter-cyclical liquidity measures, in line with steps taken in Australia and Hong Kong SAR.
  - Passage of NCBA amendments expected to provide:
    - Lifting remaining constraints imposed by bank secrecy laws on examiners.
    - Enhanced scope for risk-based supervision.
    - Further strengthening PCA and resolution framework, including limiting shareholders’ rights when capital falls below minimum requirements.
    - Authorization for the BSP to issue its own debt securities to ensure more effective monetary management.

### Structural policies — Rebalancing and strengthening growth: background and priorities
- Global context:
  - Global financial crisis will have long-term impact on global sources of growth; Philippines could be impacted through slower growth in exports and remittances from workers in advanced economies.
  - If global rebalancing succeeds, increased domestic demand in emerging Asian economies could partly offset decline in advanced economies’ growth.
- Domestic constraints:
  - Weak business climate: lingering problems with corruption and high administrative burdens (e.g., starting a business).
  - Weak business climate reflected in a relatively low investment-to-GDP ratio and low foreign investment.
- Remittances (Box 4 highlights):
  - Remittances currently amount to around 10 percent of GDP.
  - Remittances have grown significantly over the last decade.
  - Simulation with GIMF incorporating remittances:
    - Remittances introduced as exogenous lump-sum transfers to consumers and as lump-sum taxes on households (used as transfers).
    - Net remittances added to human wealth for “optimizing consumers”; added directly to consumption for “liquidity-constrained consumers.”
    - Assumed share of liquidity-constrained households at around 60 percent.
    - Simulation shows a permanent decline in remittances could have an impact on GDP growth and private consumption, with significant welfare consequences.
  - GIMF Simulation scenario: Impact of Permanent 2.5 Percent Decline in Remittances (impact in percent relative to baseline over next 10 years) referenced.
  - Remittances for Selected Asian Countries (In percent of GDP, 2008): Philippines 9.7 (growth); table reference lists country values (as provided).
- Policy priorities to sustain recovery and raise growth:
  - Tackle corruption: decisive measures urgently needed.
  - Reduce administrative hurdles:
    - Cut number of procedures needed to start a business and speed up processing.
    - Strengthen corporate governance by raising disclosure requirements and director liabilities.
    - Improve bankruptcy law and administrative bottlenecks in the bankruptcy process.
  - Further develop capital markets to strengthen financial intermediation and transformation of savings into productive use.
  - Strengthen labor market flexibility:
    - Liberalize use of fixed-term contracts.
    - Gradually reduce or phase out minimum wages while strengthening social safety nets.
    - Reduce redundancy notice periods and severance pay.
  - Improve basic infrastructure:
    - Continued fiscal consolidation important to finance greater public investment to solicit private sector investment.

### Authorities’ views on structural reforms
- Authorities broadly shared staff’s view that reforms were needed to sustain and strengthen medium-term growth.
- Authorities will continue development strategies to improve competitiveness and investment in human capital.
- Governance reform considered crucial to strengthen the business climate and attract foreign investment.
- Making fiscal room for additional outlays on growth-enhancing government spending and continued power sector privatization viewed as key pillars.

### Staff appraisal — macro projections and policy recommendations
- Growth outlook:
  - Growth is projected to reach ¾ percent in 2009 and rise to about 3¼ percent in 2010.
  - Deceleration in 2009 is broad based; expansionary macroeconomic policies and resilient remittances cushioned the slowdown.
  - Recovery in 2010 likely to be led by consumption as confidence and remittances improve; exports and investments also likely to benefit from global recovery.
  - Risks to the outlook are broadly balanced.
- Fiscal policy:
  - Expansionary fiscal stance in 2009 was appropriate; a measured withdrawal desirable in 2010 given limited fiscal space.
  - Revenue target was breached due to a structural weakening of the tax base beyond cyclical factors.
  - Staff recommends capping the deficit at 3½ percent of GDP in 2010 to avoid jeopardizing investor confidence.
  - To achieve the cap, authorities should introduce fiscal savings measures.
  - Recommend announcing a credible medium-term consolidation plan in parallel with the 2010 budget.
  - Consolidation should build on revenue-raising measures to allow for more pro-poor spending and growth-enhancing investment.
  - Consolidation plans should focus on improving the finances of GOCCs, including NFA.
- Fiscal framework:
  - Introduction of a formalized fiscal framework would underscore credibility of consolidation plan.
  - First step: submit a medium-term budget framework alongside the budget to the legislature.
  - Supplement with an explicit numerical fiscal rule to help anchor fiscal policy.
  - Closer monitoring of contingent liabilities, including PPPs, to enhance management of fiscal risks.
- Monetary policy:
  - Exit from accommodative monetary policy should await clear signs that a sustained recovery is underway.
  - BSP cut interest rates by 200 basis points since end-2008 to cushion adverse spillovers from the global crisis.
  - Given still negative output gap and need to tighten fiscal policy, it is too early to tighten monetary policy.
  - Exit should start with a rollback of liquidity-enhancing measures.

*Italic: Source — content from _cr1045 - 22.      The authorities concurred with staff’s assessment of the exchange rate. They*

### 39.      Foreign exchange market interventions should remain limited to smoothing

### Foreign exchange market interventions should remain limited to smoothing operations

### Exchange rate and intervention policy
- Foreign exchange market interventions should remain limited to smoothing operations.
- The exchange rate is assessed to be "broadly aligned with fundamentals" and should be allowed to adjust to market pressures, including from "resurgence in capital inflows".

### Financial sector soundness and risks
- The financial sector is broadly sound and appears relatively resilient to potential downside risks.
- Banks remain "well capitalized" and "NPL ratios are low".
- Moderate economic growth will "constrain bank earnings" and potentially lead to "a deterioration in asset quality".
- IMF staff and rating agencies' stress tests suggest the financial sector is "quite robust to adverse shocks".
- The "relatively high concentration of exposures" makes banks vulnerable to tail-risk events.

### Strengthening supervision and resolution frameworks
- Current BSP initiatives are expected to further strengthen bank supervision.
- Capital requirements should be more risk-based; staff welcomes the planned introduction of the ICAAP in 2011.
- Early passage of the amendment to the NCBA currently in Congress is important to lift remaining constraints imposed by bank secrecy laws on examiners and enhance the scope for risk-based supervision.
- There is scope to further strengthen the PCA framework by allowing for earlier, faster, and increasingly severe actions.
- The resolution framework should:
  - eliminate the rehabilitation period for owners during receivership, and
  - allow the use of a bridge-bank and a more flexible purchase and assumption facility.

### Raising potential growth: investment and business environment
- To raise potential growth over the medium term, higher investment will be essential.
- Two bottlenecks to higher investment:
  - enhancing basic infrastructure, and
  - improving the business environment.
- A substantial strengthening of the tax effort will be needed to finance essential public infrastructure investments.
- It will be important to take significant steps to improve the weak business climate, including by reducing the high administrative burdens.

*IMF staff report excerpt (paragraphs 39–42).*

### 43.      Staff recommends the next Article IV consultation be on the standard 12-month

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

### Executive summary and recommendation
- Staff recommends the next Article IV consultation be on the standard 12-month cycle.  
- The Philippines is on the standard 12-month cycle; the 2008 Article IV Consultation was discussed by the Executive Board on January 16, 2009.  
- Prepared by the Asia and Pacific Department; January 4, 2010.

### Growth, prices, and short-term outlook
- Real GDP growth: 2005: 5.0; 2006: 5.3; 2007: 7.1; 2008: 3.8; 2009: 0.8; 2010 (Proj.): 3.2.  
- CPI (annual average): 2005: 7.7; 2006: 6.2; 2007: 2.8; 2008: 9.3; 2009: 3.1; 2010 (Proj.): 4.3.  
- Growth expected at 0.8 percent in 2009 and to recover to around 3.2 percent in 2010.  
- Near-term risks: sensitivity to global growth; potential larger-than-estimated output losses from recent typhoons; risk of fiscal slippage; upside from post-typhoon rebuilding.

### Key macroeconomic and structural indicators (selected)
- Nominal GDP (2008): P7,423 billion ($166.9 billion).  
- Population (2008): 90.5 million.  
- GDP per capita (2008): $1,845.  
- 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 (2008): 7.4 percent.

### Fiscal outlook and public finances
- National government balance (authorities definition): 2005: -2.7; 2006: -1.1; 2007: -0.2; 2008: -0.9; 2009: -3.9; 2010 (Proj.): -3.3 (percent of GDP).  
- National government balance (Fund definition) 1/: 2005: -3.0; 2006: -1.4; 2007: -1.7; 2008: -1.5; 2009: -4.4; 2010 (Proj.): -3.6.  
- Nonfinancial public sector balance 2/: 2005: -2.1; 2006: 0.1; 2007: 0.2; 2008: -0.3; 2009: -3.9; 2010 (Proj.): -3.0.  
- Revenue and grants (NFPS, percent of GDP): 2005: 22.1; 2006: 23.0; 2007: 24.1; 2008: 22.8; 2009: 20.5; 2010 (Proj.): 20.7.  
- Expenditure (NFPS, percent of GDP): 2005: 24.1; 2006: 22.9; 2007: 23.9; 2008: 23.1; 2009: 24.4; 2010 (Proj.): 23.8.  
- Nonfinancial public sector debt: 2005: 85.9; 2006: 73.9; 2007: 61.1; 2008: 60.9; 2009: 63.7; 2010 (Proj.): 62.7 (percent of GDP).  
- Budget (national government cash accounts, percent of GDP): Revenue and grants (Budget/Proj.): 2006: 16.2; 2007: 15.8; 2008: 15.8; 2009: 15.5; 2010 (Proj.): 14.6; 2010 BudgetProj. shows revenue and grants 15.9 and 14.9 in different presentations.  
- National government balance (Budget/Proj.): 2006: -1.4; 2007: -1.7; 2008: -1.5; 2009: -3.8; 2010 (Proj.): -4.4; On authorities' presentation 4/: 2006: -1.1; 2007: -0.2; 2008: -0.9; 2009: -3.2; 2010: -3.9.

### Public finances — fiscal risks and recommendations (IMF Executive Board)
- Fiscal stimulus in 2009 provided an effective response to the weak environment; estimated deficit 2009: 4½ percent (IMF definition), overshooting the budget target of 3¾ percent.  
- Directors emphasized the need for a measured fiscal withdrawal in 2010 given limited fiscal space.  
- Directors urged a credible medium-term consolidation plan built on revenue-raising measures and expenditure restraint focused on non-priority current spending.  
- Authorities were encouraged to request technical assistance for fiscal consolidation and to consider a formalized fiscal framework to underscore commitment to fiscal prudence.

### Monetary sector and financial system
- Broad money (M3) end-of-period percent change: 2005: 10.3; 2006: 22.7; 2007: 10.6; 2008: 15.6; 2009: 11.6 (September 2009, year-on-year).  
- Interest rate (91-day Treasury bill, end of period, percent): 2005: 6.4; 2006: 5.1; 2007: 4.2; 2008: 5.8; 2009 (Nov): 4.1.  
- Credit to the private sector (percent change, end period): 2005: -0.3; 2006: 6.7; 2007: 8.5; 2008: 16.8; 2009 (Sept): 7.9.  
- Banking sector indicators (selected, end of year): Capital adequacy ratio (consolidated basis): 2004: 18.4; 2005: 17.7; 2006: 17.6; 2007: 15.7; 2008: 15.5; 2009 Q2: 15.3. NPL ratio 2/ (NPL over total loan portfolio excluding interbank loans): 2004: 14.4; 2005: 10.0; 2006: 7.5; 2007: 5.8; 2008: 4.5; 2009 Q2: 4.5. Return on assets: 2004: 0.9; 2005: 1.1; 2006: 1.3; 2007: 1.3; 2008: 0.8; 2009 Q2: 0.9.

### External sector and reserves
- Current account (percent of GDP): 2005: 2.0; 2006: 4.5; 2007: 4.9; 2008: 2.3; 2009: 4.6; 2010 (Proj.): 3.0.  
- Export value (percent change): 2005: 3.8; 2006: 15.6; 2007: 6.4; 2008: -2.5; 2009: -20.2; 2010 (Proj.): 12.3.  
- Import value (percent change): 2005: 8.0; 2006: 10.9; 2007: 8.7; 2008: 5.6; 2009: -20.0; 2010 (Proj.): 15.6.  
- Reserves, adjusted (US$ billions): 2005: 18.0; 2006: 23.0; 2007: 33.8; 2008: 35.9; 2009 (Proj.): 44.2; 2010 (Proj.): 49.8.  
- Reserves / Short-term liabilities, adjusted: 2005: 130.6; 2006: 194.4; 2007: 240.5; 2008: 280.4; 2009: 266.1; 2010 (Proj.): 299.2.  
- Total external debt (percent of GDP): 2005: 62.7; 2006: 52.0; 2007: 45.9; 2008: 38.8; 2009: 41.2; 2010 (Proj.): 37.9.  
- Debt-service ratio 8/ (in percent of exports of goods and nonfactor services): 2005: 17.0; 2006: 15.3; 2007: 13.0; 2008: 12.6; 2009: 14.9; 2010 (Proj.): 17.0.  
- Exchange rate (period averages): Pesos per U.S. dollar: 2005: 55.1; 2006: 51.3; 2007: 46.1; 2008: 44.5; 2009 (Jan–Oct avg): 47.8.

### Debt sustainability analysis (public sector)
- Staff concludes the Philippines’ public sector debt is broadly sustainable.  
- Factors contributing to past decline in NFPS debt: fiscal reforms, strong growth, and an appreciating exchange rate.  
- Baseline: an uptick in debt levels expected in 2009–10 due to the global financial crisis; assuming revenue reforms aiming at a 1 percent of GDP National Government deficit by 2013, NFPS debt is expected to decline gradually to the pre-crisis level by 2013.  
- Without reforms, debt expected to remain elevated at 60 percent of GDP in 2013.  
- Public debt dynamics most vulnerable to shocks to the exchange rate and contingent liabilities.  
- External debt dynamics: external debt fell from nearly 80 percent of GDP in 2002 to around 40 percent at end-2008; under baseline, external debt ratio would fall to just over 33 percent in 2014.  
- A one-time real depreciation of 30 percent is estimated to entail a 22 percentage point jump in the external debt ratio from its 2008 level, which would exceed 60 percent in the medium term.  
- Debt dynamics are more resilient to interest rate and growth shocks, and only moderately affected by noninterest current account shocks.

### Debt sustainability tables — selected figures (public sector)
- Public sector debt (percent of GDP): 2004: 95.2; 2005: 85.9; 2006: 73.9; 2007: 61.1; 2008: 60.9; 2009: 63.7; 2010 (Proj.): 62.7; 2014 (Proj.): 54.6.  
- Debt-stabilizing primary balance 9/: 0.4 (percent of GDP).  
- Identified debt-creating flows (2008): -1.1 (percent of GDP).  
- Primary deficit (percent of GDP): 2008: -3.8; 2009: -0.5; 2010 (Proj.): -1.5.  
- Change in public sector debt (2008): -0.2; (2009): 2.9; (2010): -1.0 (percent of GDP).  
- Public sector debt-to-revenue ratio (2008): 266.5; (2009): 310.5; (2010): 302.2.

### External debt sustainability table — selected figures
- External debt (percent of GDP): 2004: 70.7; 2005: 62.7; 2006: 52.0; 2007: 45.9; 2008: 38.8; 2009: 41.2; 2010 (Proj.): 37.9; 2014 (Proj.): 33.1.  
- Change in external debt (2008): -7.1; (2009): 2.4; (2010): -3.4 (percent of GDP).  
- Gross external financing need (US$ billions): 2008: 4.7; 2009: 10.1; 2010 (Proj.): 7.1; 2014 (Proj.): 17.2.

### Financial sector assessment and IMF Executive Board view
- Financial sector weathered the global crisis relatively well; banks remained well capitalized with capital adequacy ratio around 15 percent and NPLs around 4 percent, though higher for thrift and rural banks.  
- Directors welcomed progress implementing 2002 FSAP recommendations; recommended further steps to strengthen supervision and the regulatory framework, including early adoption of proposed amendments to the New Central Banking Act and more risk-based capital requirements.  
- Directors recommended continued accommodative monetary policy until a sustained recovery is assured, while ensuring inflation expectations are well-anchored.  
- Directors supported limited foreign exchange interventions for smoothing operations and allowing market-driven exchange rate adjustment.

### IMF engagement and technical assistance (selected)
- The Philippines’ FSAP was conducted in 2001 with an FSAP update mission in November 2009.  
- Technical assistance provided across MCM, STA, FAD, and LEG in areas including banking supervision, payment systems, balance of payments statistics, government finance statistics, tax administration, cash management, anti-money laundering, and stress testing.  
- A Resident Representative has been stationed in Manila since January 1984; Mr. Dennis Botman assumed the post in January 2009.

*Source: Staff Report for the 2009 Article IV Consultation—Informational Annex; Prepared by the Asia and Pacific Department; January 4, 2010.*

### Introduction

### Introduction

### Recent Economic Trends
- The economy posted growth of 0.7 percent for the first three quarters of 2009, supported by monetary and fiscal stimulus measures, continued strength of overseas remittances, marked easing of inflation and stable interest rate.
- Headline inflation averaged 3.2 percent in 2009, down from 9.3 percent in 2008 and within the government’s target range.
- Overall balance of payments surplus in 2009 amounted to US$5.3 billion, bolstered mainly by the strong performance of the current account.
- International reserves were US$44.2 billion as of end December 2009, equivalent to finance 9.0 months imports of goods and services.
- Peso movement remained modest despite substantial inflows, reflecting concerns on the widening fiscal deficit.
- The local bourse showed recovery beginning July 2009; Philippine credit spreads narrowed with stable/positive outlooks from Fitch Ratings, Moody’s and Standards and Poors.

### Outlook, Challenges and Policy Thrusts
- Immediate challenge: safeguard gains and ensure sustained growth.
- 2010 growth projection: 3-4 percent.
- Fiscal authorities plan to continue stimulus spending while pursuing fiscal consolidation.
- Authorities will monitor inflation risks (including rising commodity prices) and adjust policy to achieve price stability.
- Commitment to inflation-targeting framework and a market-determined exchange rate.
- Financial sector focus: assess vulnerabilities and implement measures to keep the financial system strong to support recovery.
- Structural reforms to address constraints to growth will be pursued.

### Fiscal Policy
- Fiscal consolidation progress before the crisis: fiscal deficit declined from 5.3 percent of GDP in 2002 to 0.2 percent of GDP in 2007.
- Fiscal deficit contained at 0.9 percent of GDP in 2008 despite the crisis.
- Fiscal pressures in 2009 (stimulus, post-calamity restructuring, weak revenues) led to deficit rising to 4.3 percent of GDP for January to September 2009.
- Public sector debt fell from 110 percent of GDP in 2002 to 71 percent in 2008; higher deficits expected to increase public debt.
- 2010 fiscal proposal: fiscal deficit of 2.8 percent of GDP to sustain capital expenditures and increase pro-poor spending.
  - Tax revenues targeted at 16 percent of GDP.
  - Expenditures planned at about 19 percent of GDP.
  - If tax revenue shortfall occurs, expenditures will be adjusted to contain fiscal slippage.
- Medium-term commitment: balance the budget and reduce the debt burden to below 50 percent by 2013.
- Revenue measures and administration:
  - Intensify tax administrative measures to improve compliance and enforcement, including monitoring of large taxpayers.
  - Support Congress in enacting revenue enhancement and simplification measures.
  - Pursue privatization of some assets to augment resources.
- Expenditure measures:
  - Prioritize capital outlays to high impact infrastructure projects.
  - Rationalize operations of some public corporate entities to increase cost-recovery and reduce subsidies.
  - Payment adjustment in civil service wages (passed into law) to be implemented over four years (2009-2012).
- Debt management: restructure debt portfolio to manage payments and lengthen maturity profile of domestic and foreign debt.
- Technical assistance: Department of Finance requested IMF assistance to map a credible medium-term strategy to raise tax effort.
- Fiscal risk management: Development Budget Coordinating Committee (DBCC) approved a framework to improve contingent liability management by introducing value analysis in project assessment; government moving to review joint venture guidelines to mitigate fiscal risks to public-private partnerships.

### Monetary and External Policies
- BSP adopted an accommodative monetary policy stance during the onset of the crisis to allow monetary stimulus and maintain domestic credit flow.
- 2010 inflation target range: 3.5 – 5.5 percent.
- Monetary policy will focus on achieving price stability while supporting sustained and broad-based economic growth; timing and speed of tightening guided by inflation outlook and balance of risks.
- Policy will remain flexible to support domestic demand as long as inflation remains anchored toward the target over the policy horizon.
- Exchange rate policy: broadly aligned with fundamentals; will remain market-determined with BSP participation limited to smoothing volatilities and seizing opportunities to increase reserves as a precautionary measure.

### Financial Sector Policy
- Financial stability and a well-functioning banking system are key to supporting recovery.
- Banking system strengths:
  - Limited exposure to troubled US assets and low exposure to securitization and off-balance sheet activities.
  - Capital adequacy ratio of 15.7 percent (as of June 2009), above BSP minimum capital ratio of 10 percent and BASEL Accord standard ratio of 8 percent.
  - Tier 1 capital ratio remains significantly higher than prudential minimum.
  - Non-performing loan (NPL) ratio eased to 3.3 percent as of November 2009 from 3.8 percent a year ago.
- Stress tests by BSP indicate the financial sector is robust to adverse shocks; Fund staff and rating agencies (Fitch and Moodys) validated these findings.
- Identified vulnerabilities and supervisory responses:
  - Concentration risk from banks’ exposure to large conglomerates: failure of more than one large economic group would reduce CARs of most top 10 banks and could wipe out Tier 1 capital for some largest banks; however, stress test simulations show this impact would be less than a sharp rise in NPLs from 3 percent to 20 percent.
  - Vulnerability to interest rate movements due to growing banks' investment portfolios (double-digit growth since 2000 except 2005-2007).
  - BSP actions: implemented market risk amendments to Basel I in 2003; formed Capital Markets Specialist Group (CMSG) in 2006; issued guidelines on market risk and liquidity risk; CMSG conducts specialist on-site examinations focusing on banks' trading activities.
- Authorities will continue reforms to improve regulatory and supervisory framework, enhance risk management, improve corporate governance, and strengthen disclosure for consumer protection.

### Structural reforms
- Government focuses on improving the business environment to address constraints to investment and competitiveness.
- Economic Resiliency Plan (2009) channelled pump-priming activities to infrastructure upgrading/rehabilitation:
  - Repairs of irrigation facilities, farm-to-market roads, road widening.
  - Initial ground works for large-scale multi-year projects: construction of airports, expressways, linking of railway systems.
- Increased fiscal spending aims to prepare for recovery by addressing lack of competitiveness primarily through infrastructure development.
- 2010 approach: push for large-scale infrastructure projects with private sector participation (partnerships, joint ventures, Build-Operate-Transfer) while considering associated risks to protect macroeconomic stability.
- Governance measures: existing laws such as the Procurement Law and the Anti-Red-Tape Act will be properly implemented to improve service delivery efficiency and lower transaction costs.
- Government recognizes more work is needed to address issues that discourage prospective investors; improving competitiveness and business climate is a primary near- to medium-term objective.

### Concluding Remarks
- The economy held up relatively well under the global downturn: growth moderated as external demand weakened, but macroeconomic and financial stability remained.
- Authorities are cognizant of vulnerabilities and challenges and are committed to pursuing sound macroeconomic management and structural reforms to strengthen the economy and allow growth to revert to a sustained path.
- Authorities value the Fund’s views and intend to continue working closely with it through regular Article IV consultations and technical assistance programs.

*Source: Introduction (IMF country report excerpt).*

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