Public Information Notice: IMF Executive Board Concludes 2004 Article IV Consultation with the Philippines

March 20, 2005

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 March 7, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Philippines.1


Since taking office in July 2004, the new administration has formulated a set of reforms to address the Philippines' long-standing problems in the fiscal, power, and banking sectors. Two of President Arroyo's proposed tax reform bills have been enacted including increasing alcohol and tobacco excises. In the power sector, a 40 percent hike in generation tariffs has been provisionally awarded, while the sale of a large generation plant has also been announced. In the banking sector, the disposal of nonperforming assets has begun. However, these are a small component of the total reform required. In fact, while financial markets have been relatively stable since the election, rating agencies have recently downgraded the sovereign rating on the grounds that the tax reforms to date have been inadequate.

GDP growth has exceeded expectations, but unemployment remains high. With exports staging a recovery and consumption boosted by overseas remittances and the election, GDP grew by 6.1 percent in 2004, up from 4.7 percent in 2003. On the production side, the growth drivers were strong performances by agriculture and services such as telecommunications, business process outsourcing, and tourism. Employment increased by 3.6 percent in 2004, mainly reflecting the rapid creation of services sector jobs. Even so, unemployment averaged 11.8 percent in 2004, up from 11.5 percent in 2003.

Inflation has risen above the target range. The rate of inflation (1994 base) climbed to 7.9 percent y/y in December, from 3.1 percent y/y in December 2003, causing average inflation to increase to 5.5 percent, above the Bangko Sentral ng Pilipinas (BSP)'s target range of 4-5 percent. The primary cause was a succession of supply shocks, led by a jump in meat and fish prices and followed by the surge in world oil prices and, more recently, the hike in power tariffs. Nonetheless, some signs have emerged of more broad-based inflationary pressures, including a rise in core inflation. The BSP has so far kept policy rates on hold, preferring to wait for more definitive evidence that inflation is becoming generalized before taking monetary policy action.

The national government deficit (authorities' definition) is estimated to have declined to 3.8 percent of GDP in 2004, below the budget target of 4.2 percent of GDP, and down from 4.6 percent of GDP in 2003. Revenue is estimated to have remained broadly unchanged as a share of GDP, while primary spending has been compressed. The major sources of expenditure savings were personnel services, due to the absence of a general wage increase for the second consecutive year, and transfers to local government units staying fixed in nominal terms as a result of the re-enactment of the 2003 budget. However, power sector losses expanded to 1.5 percent of GDP in 2004, from 1.1 percent of GDP in 2003, and the nonfinancial public sector deficit is estimated to have only declined to 5.3 percent of GDP in 2004, compared to 5.6 percent of GDP in 2003.

The balance of payments proved fairly resilient in 2004. Strong growth of exports, tourism receipts, and remittances more than offset higher oil imports, causing the current account surplus to increase slightly to an estimated 4½ percent of GDP in 2004. For much of the year, this surplus looked insufficient to finance net capital outflows and negative errors and omissions, and a loss of foreign exchange reserves was expected. However, in the fourth quarter, the weak U.S. dollar took pressure off the peso and allowed the BSP to make modest purchases of foreign exchange. As a result, reserves, adjusted for pledged assets, ended the year up slightly at US$15 billion (119 percent of short-term debt by residual maturity).

The near-term outlook for the Philippine economy is clouded by the uncertain external environment. The rapid growth in 2004 is unlikely to be sustained, particularly given slowing global demand in the information technology sector and rising interest rates. Thus, staff expects GDP to grow at a more moderate 4¾ percent in 2005. However, there are uncertainties on both the upside and downside, depending on oil price movements, the strength of world demand, and weather conditions (which affect agriculture production). Staff expects inflation (using the new 2000 base) to remain above the target range of 5-6 percent in 2005.

Executive Board Assessment

Executive Directors noted that the economy has recorded strong economic growth in 2004, mainly driven by a recovery in exports and consumption, but that inflation has risen and unemployment has remained high. Directors welcomed the efforts being made by the administration to lay out a comprehensive package of reforms aimed at addressing the country's long-standing problems in the fiscal, power, and banking sectors, and in reducing its high debt levels. They praised the authorities' commitment to win the necessary political support for key reform measures, and were encouraged by a number of recent developments, including the passage of the bill raising alcohol and tobacco excises, and the recent increase in duties on oil and petroleum imports. Directors also welcomed the provisional tariff increase awarded to the National Power Corporation (NPC), and the recently announced sale of a large power plant.

Notwithstanding these welcome steps, Directors cautioned that, with the major part of the reform agenda still unfinished, vulnerabilities arising from the country's large external debt and financing requirements remain high. Thus, the economy remains susceptible to external shocks, especially changes in market sentiment and increases in global interest rates and oil prices. Moreover, Directors noted that, even with benign global conditions, the Philippines could find it difficult to meet its large external borrowing needs should the reform momentum falter.

Against this background, Directors regarded the full and quick implementation of the authorities' reform package as essential to reduce the vulnerabilities of the Philippine economy, achieve public debt sustainability over the medium term, and improve the investment and business climate. In particular, they attached importance to the passage of further tax measures with a clear and certain revenue yield, and also called for sustained reforms in other areas, such as the power sector, financial sector, and pension funds. Directors noted that such reforms will set the stage for higher economic growth, sustained reductions in unemployment and poverty, and achievement of the Millennium Development Goals. They therefore urged the authorities to take advantage of the unique opportunity afforded by the favorable post-election political environment to make a decisive break from the past and implement the urgently-needed reforms. It was also suggested that account should be taken of the economy's capacity to absorb reform measures, and the need to provide adequate safety nets.

Directors commended the authorities for maintaining control over the budget in 2004 despite election-related pressures, and for resisting pressures to limit the domestic pass-through of higher global oil prices in 2004, since the fiscal costs would have been unaffordable. However, with regard to 2005, most Directors emphasized the importance of a strong and front-loaded fiscal adjustment, so as to send a strong signal to markets about the commitment to tackling the fiscal problem.

Directors looked forward to the passage of additional revenue-raising measures as early as possible in 2005. In this context, Directors particularly welcomed the consideration being given to raising the VAT rate and repealing VAT exemptions. Directors noted that a substantial revenue yield from these measures will allow an aggressive upfront reduction in the deficit, as well as some additional spending in priority areas including infrastructure and social programs. In order to facilitate further fiscal consolidation over the medium term, Directors urged that additional steps be taken to improve tax administration, such as improved audit strategies and increased prosecution of evaders. In this context, several Directors warned against the introduction of a tax amnesty, which they believed will discourage future tax compliance.

Directors welcomed the efforts being made by the authorities to reform the civil service and improve the delivery of services, but emphasized the need for the reform to be underpinned by an affordable severance package. Directors also looked forward to the development of pension reforms that will place public pensions on a sustainable footing.

Directors viewed the significant increase in generation tariffs provisionally awarded to the NPC as an important contribution to the fiscal consolidation efforts. While welcoming the recent progress, Directors urged the authorities to accelerate the pace of power sector privatization, which is essential to restore the financial viability of the sector and to facilitate the investments needed to ensure adequate power supply. Directors looked forward to the authorities achieving their objectives of selling the transmission assets as soon as possible, and privatizing the majority of generation assets by the end of 2005. With regard to energy regulation, Directors stressed the importance of building a track record of adherence to a predictable rules-based framework so as to improve the investment climate.

Directors agreed that supply shocks have been the root cause of the inflation target having been missed in 2004, but pointed to a number of signs that price pressures have spread. Directors were also concerned that the persistence of above-target inflation for a prolonged period might lead to an upward revision to inflationary expectations. A number of Directors supported the approach of the BSP to continue to closely monitor inflationary pressures--in particular, weigh the evidence for inflation having become more generalized--and to take prompt action as needed. Many other Directors, however, took the view that the balance has already tipped, and that an increase in policy rates is required to guide inflationary expectations down. More generally, Directors welcomed the BSP's clear communication to the public that monetary policy will be guided by the inflation objective, as well as its commitment to continuing to manage the exchange rate flexibly.

Directors were encouraged that banks have begun to use the special purpose vehicle framework to dispose of nonperforming assets. They also welcomed the submission to Congress of amendments to the BSP Charter that are critical to strengthening bank supervision, and the efforts that have been taken to tighten regulation of the banks' trust operations. Directors viewed these steps as crucial to facilitating consolidation and recapitalization of the banking system, thereby fortifying the banking system and enabling it to fully contribute to economic growth. However, Directors noted that attempts to empower bank supervisors have repeatedly failed in the past, and that significant efforts will be needed to ensure that the current amendments are accepted. Directors commended the authorities for strengthening the anti-money laundering regime and welcomed the removal of the Philippines from the Financial Action Task Force's list of Non-Cooperative Countries and Territories. The authorities were also encouraged to take steps to further deepen financial markets, including the domestic capital market.

Directors welcomed the recognition in the Medium-Term Philippine Development Plan of weaknesses in the investment climate, and urged the authorities to push ahead with the needed reforms. In this regard, they attached importance to measures with respect to bankruptcy resolution, contract enforcement, and business entry regulation.

Directors welcomed the authorities' attempts to further strengthen statistics and looked forward to continued implementation of the recommendations of recent Fund technical assistance on balance of payments and public debt statistics.

Philippines: Selected Economic Indicators, 2000-05













IMF Staff









Growth and prices (in percent change)

GDP growth







CPI inflation (1994 base; annual average)







Public finances (in percent of GDP)

National government balance (authorities definition)







National government balance 1/







Nonfinancial public sector balance 2/







Revenue and grants 3/







Expenditure 4/







Money and credit (in percent change)

Broad money (M3) 5/







Credit to the private sector (net)







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








Balance of payments (in percent of GDP)

Trade balance







Current account balance







Gross international reserves

In billions of U.S. dollars







Adjusted, in billions of U.S. dollars 7/







Adjusted, in percent of short-term liabilities 8/















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

1/ IMF definition. Excludes privatization receipts of the national government, and includes operations of Central Bank-Board of Liquidators.

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

3/ The sum of all nonfinancial public sector revenue net of intra-public sector payments. It is assumed that 80 percent of Bureau of Treasury revenue represents interest and dividends from other parts of the nonfinancial public sector. Privatization receipts are excluded.

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

5/ For 2000, adjusted for the estimated effects of Y2K.

6/ Auction result on January 17.

7/ In addition to monitoring the level of gross international reserves (GIR), the IMF also monitors Adjusted Reserves, which are calculated by subtracting from GIR the value of the BSP's foreign assets that have been pledged as collateral for short-term liabilities. These pledged assets (gold and other securities) remain foreign reserve assets of the BSP and so are considered part of GIR. However, they are not as readily usable as other components of GIR since pledged assets must be set aside while the short-term liabilities they secure remain outstanding.

8/ 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 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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