Public Information Notice: IMF Concludes 2003 Post-Program Discussion with the Philippines

August 13, 2003

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

On August 1, 2003, the Executive Board of the International Monetary Fund (IMF) concluded a Post-Program Monitoring discussion on the Philippines based on information available through that date.1


With the external outlook worsening due to the Iraqi conflict and growing concerns about public finances, the Philippines experienced renewed pressure in financial markets in early 2003. Investor sentiment soured reflecting the Philippines' dependence on oil imports and overseas remittances, as well as on the government's ability to maintain market access and secure large external financing requirements as global risk aversion heightened. Sentiment was also adversely affected by the threat of sanctions by the Financial Action Task Force (FATF), stemming from deficiencies in the anti-money laundering law. Moreover, investors continued to be concerned about the outlook for public finances, namely, whether the 2002 deficit overrun was to be repeated in 2003. As a result, the peso depreciated by 3¼ percent since early 2003, to reach a near-record low of P 55 per U.S. dollar by mid-March. Short- and long-term yields on government securities also rose markedly, while the government's external commercial financing had to be scaled back due to a sizable increase in sovereign spreads.

Facing mounting pressure, the authorities implemented several measures to restore stability. Initially, the Bangko Sentral ng Pilipinas (BSP) acted to stabilize the foreign exchange market, including with several administrative measures aimed at reducing the demand for foreign exchange. With pressure unabated, the BSP tightened monetary policy sharply on March 20, 2003, by removing the three-tiered rate scheme for banks' deposits with the BSP, and raised liquidity requirements for deposits by 1 percentage point to 8 percent.

Thanks to the quick resolution of the Iraqi conflict, amendments to the anti-money laundering legislation, and a renewed enthusiasm in emerging markets, financial market pressure abated. Investor confidence was also buttressed by improvements in budget performance in recent months, which helped bring the deficit to well below the target in the first six months of 2003. The peso bounced back to its end-2002 levels, domestic interest rates declined to pre-financial market pressure levels, and sovereign spreads also narrowed markedly, despite recent downgrades by credit rating agencies. Gross foreign reserves of the BSP have recovered to US$16 billion, above short-term debt. In its June and July 2003 policy meetings, the BSP eased monetary policy, returning monetary conditions back to the early 2003 levels. However, following a recent short-lived military mutiny, financial market pressure returned, with the peso depreciating to a four-month low and sovereign spreads widening somewhat.

Economic growth has remained strong and inflation subdued over the past year. The low inflation-cum-interest rate environment, together with steady growth in foreign remittances, has provided considerable stimulus to private consumption and investment. Economic growth was 4½ percent on average in 2002. During the first quarter of 2003, real GDP declined (at an annualized rate of 2 percent), largely reflecting an unwinding of the exceptional performance of the agricultural sector during the fourth quarter of 2002, but real GDP was still 4½ percent higher than in the first quarter of 2002. However, the external sector withdrew some stimulus, reflecting the impact of weak activity in the United States and Japan and buoyant growth in imports. Since the second half of 2002, inflation has hovered around 2¾ percent, well below the official target range of 4½-5½ percent for 2002-03.

Despite recent events, Philippines' macroeconomic conditions are likely to remain favorable in the near term. Interest rates in advanced economies are expected to remain low and sentiment on emerging markets has improved. Also, liquidity in the domestic banking system is ample, partly reflecting a steady growth in deposits and subdued lending to the private sector. These conditions are likely to support low domestic interest rates and sustain the current expansion. Nonetheless, there are downside risks stemming from the uncertain outlook in the United States and Japan and its impact on exports, particularly for the electronics sector. The staff expects growth in 2003 to remain around its recent pace of 4 percent. With oil prices receding from recent peaks and absent renewed downward pressure on the peso, inflation should remain close to 3 percent in 2003. The current account surplus is projected to narrow modestly, reflecting some deterioration in the trade balance.

Executive Board Assessment

Executive Directors observed that the Philippines emerged from financial market pressures in early 2003 largely unscathed, with continued robust economic growth and low inflation. Directors commended the authorities for the timely monetary tightening and strengthening of the anti-money laundering legislation, and were encouraged by the improvement in budgetary performance in recent months. With a supportive external financing environment, near-term macroeconomic conditions are expected to remain generally favorable.

Notwithstanding these favorable developments, Directors underscored the need to address vulnerabilities. The increase in the deficit target for 2003 and the postponement of the target year for balancing the budget from 2006 to 2009, which followed last year's deterioration of fiscal performance, have heightened the urgency of steps to safeguard the credibility of fiscal policies and ensure sustainability. Directors also expressed concern about the continued worsening of the financial condition of the power sector, and underscored the importance of decisive further actions that need to be taken to strengthen the banking system.

Directors called on the Philippine authorities to move decisively to strengthen the medium-term fiscal outlook and strengthen structural reforms in the power and banking sectors in order to address vulnerabilities, contain the rapid increase in public indebtedness, and increase the economy's resilience to shocks. They welcomed the authorities' commitment to reform, and urged them to continue to work vigorously to mobilize the political and public support that will be needed for advancing the reform agenda, particularly during the coming pre-election period.

Directors were encouraged by the improvements in budgetary performance over recent months stemming from the authorities' stronger tax administration and success so far in containing expenditure. They highlighted the importance of sustaining the recent improvements in revenue collection to halt the declining trend of the revenue-GDP ratio over the past few years. In order to minimize the risk of breaching the deficit target, the authorities will also need to implement the expenditure-restraining measures under consideration.

Looking further ahead, Directors welcomed the authorities' commitment to improve fiscal performance and urged them to build a consistent track record of fiscal prudence based on a viable and credible strategy to balance the budget over the medium term. They expressed concern that the current strategy relies heavily on expenditure compression involving undesirable reductions in capital expenditure. Such a strategy may seriously impair growth prospects over the medium term and become unsustainable. Directors therefore saw a significant strengthening of the revenue effort as critical for bringing public finances and indebtedness to a more sustainable path. They urged the authorities to implement fundamental tax policy measures to complement the ongoing efforts to strengthen tax administration. Measures with a significant potential for strengthening revenue include an increase and indexation of taxes on cigarettes and alcohol, higher oil excises and value-added tax rates, and efforts to rationalize fiscal incentives. Directors also underscored the need for prudent foreign borrowing policies.

Directors commended the successful implementation of inflation targeting by the Bangko Sentral ng Pilipinas. They agreed that steady progress in fiscal consolidation would support market confidence and the peso, providing scope for easing monetary policy without threatening the inflation target. Directors stressed that intervention in the foreign exchange market should continue to be used sparingly, and that the authorities' focus should remain on the consistent implementation of the inflation targeting regime. They considered, however, that the Bangko Sentral ng Pilipinas would have room to buy foreign exchange from the market to avoid a decline in official foreign reserves.

Directors expressed concern about the sharp deterioration of the financial condition of the National Power Corporation and the difficulties the authorities are facing in privatizing its transmission assets. They underscored the importance of a stable and transparent regulatory framework to attract much needed investments into the power sector. Directors also emphasized the need to provide the Energy Regulatory Commission with sufficient independence to better balance the interests of producers and consumers, while acknowledging that power rates will need to be increased to restore the financial soundness of the sector.

Directors urged the authorities to strengthen their reform efforts in the financial sector, contain risks from regulatory forbearance, and ensure that banks strengthen their capital. They stressed the need to strengthen the regulatory powers of the Bangko Sentral ng Pilipinas and the Philippines Deposit Insurance Corporation, and to provide regulatory supervisors with adequate protection from legal challenges. Directors welcomed the enactment of the Special Purpose Vehicle Act, and urged the authorities to ensure that its implementation facilitates proper valuation of non-performing assets, and, eventually, contributes to the strengthening of bank capital. To ensure effective restructuring of the banking system, Directors highlighted the importance of a strong and independent appraisal mechanism of nonperforming assets to be transferred to special purpose vehicles, supported by a transparent and consistent application of the guidelines on the valuation of such assets. They encouraged the authorities to sustain their strong efforts to combat money laundering and the financing of terrorism.

Directors welcomed the progress made on strengthening the reliability of the statistics, and looked forward to continued further efforts in this area.

Philippines: Selected Economic Indicators, 1998-2003









IMF Staff




Growth and prices (in percent change)


GDP growth








CPI inflation (average)








Public finances (in percent of GDP)


National government balance 1/








Total revenues








Total expenditures and net lending








Underlying consolidated public sector balance 1/








Money and credit (in percent change)


Broad money 2/








Bank credit to private sector








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









Balance of payments (in percent of GNP)


Trade balance








Current account balance








Gross official reserves


Unadjusted, in US$ billions








Adjusted, US$ billions 5/








Adjusted, in percent of short-term liabilities 6/








Sources: The Philippine authorities; IMF staff estimates.

1/ IMF definition. Excludes privatization receipts of the National Government, and includes net deficit from the 1993 restructuring of the central bank.

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

3/ Auction on July 21, 2003.

4/ End-June 2003. Unadjusted gross official reserves were US$16.1 billion as of end-July 2003.

5/ Adjusted for gold and securities pledged as collateral against short-term liabilities.

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

1 Post-Program Monitoring provides for frequent consultations between the Fund and members whose arrangements have expired but who continue to have Fund credit outstanding. Particular focus is placed in these consultations on policies that have a bearing on external viability.


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