Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with the Philippines

March 6, 2006

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2005 Article IV Consultation with the Philippines is also available.

Public Information Notice (PIN) No. 06/25
March 6, 2006

On February 13, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Philippines.1


Since mid-2004, when the current administration took office, economic reforms have moved ahead. In particular, power generation tariffs have been raised to substantially cut the losses of the National Power Corporation (NPC). The VAT reform has been fully implemented, including an extension of VAT to energy products in November 2005 and an increase in the VAT rate from 10 to 12 percent on February 1 of this year. Economic reforms were, however, temporarily blown off course in mid-2005 by political turbulence following allegations of wrongdoing against the President. During this period, key members of the economic team resigned and the VAT reform was suspended by the Supreme Court. The authorities quickly regrouped and succeeded in keeping fiscal consolidation on track. Impeachment charges were dismissed by Congress in September, and political uncertainties have since receded.

GDP grew by 5.1 percent y/y in 2005, down from 6 percent in 2004. Weak exports and a decline in investment served as a drag on activity. Private consumption has been supported by surging remittances and, to date, has shrugged off the effects of high petroleum prices. On the production side, services such as business process outsourcing, telecommunication, and tourism remain key growth drivers. Due in large part to the oil price shock, average inflation for the year was 7.6 percent, significantly above the target range of 5-6 percent.

Fiscal performance in 2005 was substantially better than target. The National Government deficit amounted to 2.7 percent of GDP, substantially below the target of 3.4 percent of GDP, and a pronounced improvement relative to the 2004 outturn (3.9 percent of GDP). Buoyant revenues and expenditure under-runs contributed about equally to the overperformance. The deficit of the 14 monitored Government Owned and Controlled Corporations fell sharply, led by National Power Corporation, which is estimated to have cut its losses to ½ percent of GDP in 2005, a third of the 2004 level. In addition, increased surpluses are expected for the social security institutions reflecting lower net lending and increased contributions, including from overseas workers. Taken together, the nonfinancial public sector deficit is estimated at 2.7 percent of GDP in 2005, compared to 5 percent of GDP in 2004.

Export growth was 2½ percent in the first 11 months of 2005 y/y, weighed down by anemic electronics growth which has lagged the region. Oil-related imports are estimated to be US$1.3 billion higher in 2005. However, this has been offset by a jump in remittances. There have also been sizable equity inflows, while the government has successfully tapped sovereign bond markets, most recently with a US$2.1 billion issue in early January. Foreign reserves (adjusted for pledged assets) reached US$18.0 billion at end-2005, US$2.8 billion above the end-2004 level.

A risk to the near-term outlook for the Philippine economy is that political events, such as possible constitutional change, serve to sideline economic reforms. If reforms were to stall, investment is likely to remain subdued, and GDP growth will likely remain below 5 percent in 2006. The outlook would be brighter were strong reforms to continue. The heavy reliance on external commercial borrowing also puts the Philippines at risk should there be a reversal of the currently benign environment in emerging markets. Avian flu poses another risk, although there has yet to be a case in the Philippines.

Executive Board Assessment

The overall performance of the Philippine economy in 2005 was positive, with solid economic growth despite weaker investment and net exports, and moderating inflation. Moreover, notwithstanding higher oil prices and intense regional competition, the balance of payments remained strong. Directors commended the authorities for steadying the economic ship after the political turbulence in mid-2005 and for regaining momentum on their reform agenda—as evidenced by the sharp reduction in power sector losses and the full implementation of the landmark VAT reform law. Directors welcomed the large reduction in the public sector fiscal deficit in 2005. These policies have helped to turn around investor sentiment, boost market confidence, and strengthen the peso.

Directors considered that notwithstanding these notable achievements, the Philippines faces two key challenges going forward—namely, to strengthen its defenses against the remaining significant short-term vulnerabilities, and to move the Philippine economy to a higher and more sustained economic growth path. Directors noted that with its still high debt levels, the Philippines remains vulnerable to a sudden turn in the current benign external financing environment. In addition, further spikes in oil prices or an outbreak of avian flu pose additional near-term risks. Directors therefore urged the authorities to sustain the reform momentum by completing the remaining agenda for fiscal and other structural reforms and thereby enhance the economy's ability to absorb such shocks.

Directors underscored the importance of further enhancing the investment climate to set the stage for higher economic growth and substantial reduction in poverty. They expressed concern about the recent weakening in export performance, and stressed that a stable macroeconomic environment, increased infrastructure investment, a stronger financial system, and improved governance, including in the area of property rights, will be key to increasing the rate of investment and enhancing competitiveness over the medium term. By contrast, Directors did not consider the recent appreciation of the exchange rate as a threat to the economy's competitiveness. Directors welcomed the priority the authorities attach to raising public awareness of the benefits of reform, pointing in this context to the recent positive experience that has highlighted how improved market confidence can reduce the costs of tough but necessary policy measures.

Directors welcomed the sharp reduction in the nonfinancial public sector deficit that is underway. They underlined the importance of the steps being taken to strengthen tax administration to ensure that the recent VAT reform package translates effectively into commensurately higher VAT revenue. Directors noted that balancing the budget over the medium term will require additional measures. They therefore encouraged the authorities to consider and pursue additional tax policy measures, such as a sufficiently ambitious rationalization of tax incentives, to broaden the tax net and improve efficiency and equity.

Directors agreed that rebalancing the composition of public expenditure, with reduced current outlays providing space for capital and social spending, should form an integral part of the fiscal consolidation. In this regard, many Directors welcomed the planned use of part of VAT reform proceeds for the financing of priority infrastructure projects and social programs.

Directors supported the authorities' plans to continue closely monitoring the performance of the major Government Owned and Controlled Corporations (GOCCs). They observed that firm-specific deficit targets can contribute to their improved governance and enhanced performance. In this context, it will be important to ensure that the turnaround in National Power Corporation's finances is sustained, and that the National Food Authority's losses are minimized by improved targeting of food subsidies.

Directors welcomed the recent interest rate actions by the Bangko Sentral ng Pilipinas (BSP) consistent with its commitment to price stability and with a view to ensuring the credibility and effectiveness of the inflation targeting regime. They also welcomed the authorities' commitment to raise rates promptly to bring inflation down within target by 2007 should inflationary pressures emerge and the inflation forecast look less favorable, for example due to second-round effects of the rise in oil prices or the VAT reform. However, Directors noted the possibility that inflation could return to target more rapidly if improving market sentiment propels higher capital inflows and peso appreciation.

Directors stressed that power sector privatization should be accelerated. They considered that, in order for needed investment in the power sector to be made, the challenge will be to shift sufficient power sector assets into private hands. This will require reducing the uncertainties that have so far deterred potential deals. Most Directors believed that successful bidding of Transco might break this deadlock. The importance of designing a comprehensive regulatory framework for the power sector, based on lessons from similar experiences in other countries, was also underscored.

Directors underlined the importance of strengthening and deepening financial and capital markets and enhancing financial sector soundness. They welcomed the recent initiatives to strengthen bank balance sheets, the progress toward bank consolidation, and the steps taken to reduce nonperforming assets including through the special purpose vehicle framework. Nevertheless, the banking sector remains fragmented and some banks weak, with the still significant level of non-performing assets (NPAs) inhibiting bank lending. Some Directors suggested that greater pressure should be exerted on weak banks to raise capital and that mergers should be encouraged. Noting the large stock of Republic of the Philippines (ROP) bonds held by domestic banks, Directors urged supervisors to monitor potential risks.

Directors expressed concern that passage of the amendments to the BSP Charter aimed at strengthening bank supervision has made little progress through Congress over the last few years, and urged the authorities to redouble their efforts to pass this legislation to permit a durable improvement in the soundness of the banking system. Provision of appropriate legal protection for financial supervisors should remain a critical element of this effort.

Directors noted that effective enforcement of the International Financial Reporting Standards (IFRS) could provide an opportunity for bank recapitalization. They suggested that any regulatory relief that may be granted by the BSP to give time to banks to comply with the IFRS should be transparent to the markets and be made conditional on a clear recapitalization plan.

Directors considered that improving the capacity of financial institutions to price credit, based on risk, would strengthen financial intermediation. Improved transparency and more complete and accurate information disclosure by banks and other market participants will be key in this regard. Directors considered that the financial difficulties being experienced by pre-need firms, while probably not of systemic concern, illustrate the need to strengthen the supervisory and regulatory framework for the industry. On Anti-Money Laundering/Combatting the Financing of Terrorism (AML/CFT), Directors welcomed the progress being made with streamlining the reporting of suspicious transactions and accelerating the processing of cases.

Directors observed that strengthening governance will be central to the Philippines' development. This will facilitate the delivery of essential public services, and contribute to a supportive business climate. A predictable regulatory environment should enhance efficiency, boost confidence, and attract investment.

Directors noted that data provision for surveillance purposes is adequate overall, and welcomed the authorities' efforts to effect required strengthening, particularly in the balance of payments data. In this context, Directors encouraged the authorities to take on board the recommendations of Fund technical assistance missions.

Directors agreed to continue post-program monitoring (PPM) for an additional year. Although the significant progress in reform and the low level of the Philippines' outstanding borrowing from the Fund have reduced the need for PPM, Directors saw merit in extending PPM for another year in light of its facilitating role in reducing the country's remaining fiscal and external vulnerability.

Philippines: Selected Economic Indicators, 2002-06

  2002 2003 2004 2005




        Staff Est.   Staff Proj.


Growth and prices (in percent change)


GDP growth

4.4 4.5 6.0 5.1   5.0  

CPI inflation (average)

3.0 3.5 6.0 7.6   7.4  

Public finances (in percent of GDP)


National government balance (authorities' definition)

-5.3 -4.7 -3.9 -2.7   -2.1  

National government balance 2/

-5.6 -5.0 -4.2 -3.1   -2.5  

Nonfinancial public sector balance 3/

-5.7 -5.6 -5.0 -2.7   -2.3  

Revenue and grants 4/

20.9 21.0 20.7 21.8   22.8  

Expenditure 5/

26.6 26.6 25.7 24.4   25.1  

Money and credit (in percent change)


Broad money (M3)

9.5 3.3 9.2 14.1



Interest rate (91-day Treasury bill, secondary

market, end period, in percent)

5.9 6.5 8.4 6.4   6.1


Credit to the private sector (net)

1.2 1.8 4.6 2.1



Balance of payments (in percent of GDP)


Trade balance

0.5 -6.9 -7.4 -6.5   -6.9  

Current account balance

5.7 1.8 2.7 3.0   2.1  

Gross international reserves


In billions of U.S. dollars

16.2 16.9 16.2 18.5   20.5


Adjusted, in billions of U.S. dollars 8/

14.3 14.7 15.2 18.0   ...  

Adjusted, in percent of short-term liabilities 9/

123.9 122.9 121.2 131.1   ...  

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

1/ Projection assumes that reforms proceed.

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

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

4/ 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.

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

6/ As of September 2005.

7/ At end-January 2006.

8/ 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.

9/ 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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