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The following item is a Memorandum of Economic and Financial Policies of the government of the Philippines, which describes the policies that the Philippines intends to implement in the context of its request for financial support from the IMF. The document, which is the property of the Philippines, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

March 11, 1998



1. In recent years, the Philippine economy has made impressive progress, reflecting the implementation of prudent macroeconomic policies and sound structural reforms, as well as a favorable external environment. By 1996, GNP growth had accelerated to nearly 7 percent, led by exports and investment; inflation had fallen to well within single digits; and the external position had strengthened with rapid export growth, increasing reserves, and a steady reduction of the debt burden.

2. During 1997, economic conditions became markedly more difficult with the onset of the regional currency crisis. Particularly since the floating of the Thai baht last July, financial markets have been under severe pressure. Economic and financial policies have been adjusted to manage these pressures, contain their impact on the real economy, and prepare for an early return of confidence. In particular, the peso has been allowed to float, accompanied by a tightening of fiscal and monetary policies, while we have moved forward with our structural reform agenda notwithstanding the difficult economic environment.

3. Our efforts, which were supported by an extension and augmentation of the Philippines' extended arrangement with the Fund, have met with considerable success. In particular, economic growth held up well in 1997 (real GNP grew by nearly 6 percent), inflation (5 percent average) was contained below the target, and the depreciation of the peso, although substantial, has been less than that of some other currencies in the region. Critical in this respect has been the limited damage so far to our financial and corporate sectors, which, although facing strains, have weathered the crisis relatively well. While much of the resilience of the economy is rooted in the successful reform policies of the 1990s, the pragmatic and flexible policy response in recent months has contributed as well.

4. The economy is now at a delicate juncture. While the regional crisis has not cut as deep as in some countries, some risks remain and we must guard against further shocks in the months to come. The economic environment remains challenging, and further shifts in confidence are possible. While the priority is to manage the present crisis effectively and restore confidence as soon as possible, we also recognize that recent developments have exposed certain vulnerabilities of our economy. Our goal is to contain these risks through an economic program that involves a tightening of fiscal and monetary policies; continuation of the floating exchange rate regime; bolstering our pro-active strategy to strengthen the banking sector; and pursuing other structural reforms.

5. Beyond the immediate concerns of crisis management, economic policies are being focused to address the remaining barriers to sustained rapid growth and poverty reduction. Key medium term requirements in this respect are to raise domestic saving, strengthen the financial system, reduce external vulnerability, and ensure fiscal sustainability. In order to support our economic program and bolster market confidence in these uncertain times, we wish to support our efforts through a precautionary arrangement in the form of a two-year stand-by arrangement with the Fund.


A. Program Objectives

6. The main economic objectives for 1998-99 are to:

  • Contain the slowdown of real GNP growth to 3 percent in 1998, followed by 5 percent in 1999 and 6 percent thereafter;
  • Limit average inflation to around 8 percent in 1998, 6-7 percent in 1999, and 5 percent in subsequent years; and
  • Reduce the current account deficit to 3.1 percent of GNP in 1998 and to 2.7 percent in 1999, and increase reserve cover to 1.9 months of imports in 1998 and to 2.3 in 1999.
In order to achieve these goals, we have formulated a comprehensive policy package centered on: (i) prudent macroeconomic policies; (ii) accelerated banking sector reform; and (iii) other reforms to address the structural impediments to sustained high growth.

B. Fiscal Policy

7. An immediate priority is to arrest the deterioration in the fiscal accounts that occurred in 1997, mainly as a result of worsening economic conditions and continuing weaknesses in tax administration. Although some deviation from the medium-term consolidation path envisaged earlier is unavoidable in current circumstances, the government remains committed to the longer-term goals of raising public sector saving and achieving overall fiscal surpluses. We consider these commitments as integral to our broader goals of rapid economic growth, external viability, and successful poverty reduction.

8. After registering a deficit of P 21.8 billion (0.9 percent of GNP) in 1997, the consolidated public sector position in 1998 will be limited to a deficit of P 26.5 billion (0.9 percent of GNP) and to balance in 1999. While these targets are somewhat less ambitious than envisaged earlier, they require a major effort in light of the recent deterioration in the fiscal accounts. Besides, they still imply sizable primary surpluses in both years (4.2 percent of GNP in 1998, and 4.7 percent of GNP in 1999). Consistent with the overall fiscal targets, the National Government budget seeks to attain a small surplus in 1998 (P 5 billion, including privatization receipts and excluding (negative) net income from the CB-BOL) and a significantly larger surplus of P 22 billion (0.7 percent of GNP) in 1999. The fiscal plan for 1998-99 has been drawn up in line with our medium-term fiscal strategy (Paragraph 26).

9. Although the budget submitted to Congress for 1998 envisaged a surplus of P 16 billion, the revenue assumptions underlying the budget have been undermined by the sharp deterioration in the economic environment and the lower than expected net revenue impact of the final version of the CTRP. Moreover, the tariff exemptions for agriculture and fisheries enterprises adopted by Congress recently risk reducing revenues further, although their implementation is expected only in the second half of 1998. Furthermore, the expenditure program has been burdened substantially by the impact of the depreciation of the peso and higher interest rates on interest payments. In the absence of corrective action the budget deficit for this year could reach P 50-60 billion (1 1/2 - 2 percent of GNP). Faced with this prospect, and with Congress adjourned until after the May elections, the government has adopted the following emergency measures:

  • a 25 percent mandatory reserve on all expenditures, including government-owned and controlled corporations other than personnel and debt service (Paragraph 11);
  • a 10 percent deferment in the internal revenue allocation (IRA) for local government units;
  • suspension of all tax subsidies of National Government agencies, government owned and controlled corporations, and local government units;
  • continuation of the selective ban on the creation of new civil service positions as well as restrictions on the filling of vacant positions (exempting health, education, and peace and order);
  • suspension through Presidential veto of P 14.4 billion of new programs and projects from the 1998 budget; and
  • a renewed effort to strengthen tax administration, following an action plan drawn up in collaboration with the Fund (Paragraph 12);
10. The above measures are sufficient to keep the fiscal program on track at least until mid-year when the new government and Congress take office. However, to reach the targeted surplus of P 5 billion for the year as a whole, and to complete the structural reforms in our budget, additional measures will be needed during the second half of the year. These could include legislative revenue measures such as a restructuring of motor vehicle taxes and a rationalization of fiscal incentives with a view to making them more transparent and limited. In particular, the plan is to re-submit to Congress legislation to rationalize and limit the wide range of tax incentives for both public and private businesses. Adoption of an appropriate package of measures if necessary to achieve the P 5 billion target for 1998 will be a condition for completion of the second program review. Quantitative limits on the public sector borrowing requirement have been established as a performance criteria under the program.

11. In implementing the 25 percent cut in discretionary expenditures, the government will make best efforts to protect social programs, especially those directed at poverty reduction. Measures are being pursued by the government to minimize, if not insulate, poverty alleviation programs from the budgetary cuts, particularly those for the 21 poorest provinces and the fifth and sixth class municipalities. And should fiscal developments during the year permit a relaxation of the cuts, affected social programs will be the first to be restored. Given the predominant need to stabilize macroeconomic conditions, such relaxation will only be envisaged, however, once all measures are in place to ensure attainment of the fiscal target for the year as a whole.

12. The improvement in the fiscal position under the program depends critically on implementation of the action plan to strengthen tax administration drawn up in collaboration with the Fund. We have requested follow-up technical assistance from the Fund to help with implementation of this plan. In this regard, particular emphasis will be given to strengthening the BIR's focus on large taxpayers as well as to a comprehensive audit plan to enhance taxpayer compliance. Specifically, a large-taxpayer unit will be re-established and made fully operational at BIR headquarters by the time of the first program review. The unit will be empowered to supervise all aspects of large taxpayers' compliance including the conduct of audits. A comprehensive audit program will be reinstated and the pending audit of one of the large tobacco excise taxpayers will be promptly completed and appropriate follow-up action taken. A mechanism to monitor tax credits issued will be set up, and action is under way to speed up the transfer of tax revenues from commercial banks to the Treasury. To further improve customs administration the government will curtail sharply the scope of duty-free shopping facilities that have proven to add leakages to the system. To allow time for these reforms to be implemented, the scheduled reorganization of the regional and district offices of the BIR will be put on hold.

13. The government is committed to further strengthening the social safety net and reducing poverty, issues of particular relevance as we strive to cushion the impact of the regional crisis on the most vulnerable. Under the Social Reform Agenda initiated in 1994, we are committed to reducing the incidence of poverty through better provision of social services and more effective poverty alleviation programs. We plan to take further measures in this area, in addition to trying to minimize, as described in Paragraph 11, the effect of the emergency budget cuts on the poor. In particular, we are ensuring the availability of rice stocks especially in poor communities and developing livelihood and training programs with focus on small farmers and fisher folks. Beyond these immediate concerns, poverty reduction continues to pervade the government's economic strategy as an over-arching goal. Besides the major importance of sustained rapid growth, we consider the following medium-term policies, among others, as appropriate to reduce poverty: (i) reforms and higher budgetary allocations for education and health, with a focus on rural areas; (ii) development of the agricultural sector requiring, in particular, improvements in rural infrastructure and extension services, and (iii) improved targeting and efficiency of government programs directed at poverty reduction.

C. Monetary and Exchange Rate Policy

Monetary policy

14. The task of monetary policy during 1998 is to restore confidence in the peso. The proximate goals in this regard are to stabilize the external position and contain the inflationary impact of the recent peso depreciation. In pursuit of these objectives, interest rate policy will be guided primarily by the targets established for base money and international reserves (NIR). Accelerated banking sector reforms, described in Paragraph 25, will support these policies by ensuring the continued safety and soundness of the system.

15. Consistent with the program's objectives for growth and inflation, broad money growth during 1998 is projected to decelerate to 17 percent in 1998 (from 21 percent in 1997). Base money is to grow by 15.6 percent (test period basis), and net international reserves (NIR) are targeted to rise by around $920 million. In line with this, quarterly limits have been placed on the stock of base money during 1998, and monthly indicative limits have been set to guide policy implementation. Monetary targets for 1999 will be established during the third program review.

16. The BSP will set its overnight and term interest rates in a manner consistent with achieving the base money and NIR targets. In setting policy interest rates on a day-to-day basis, emphasis will be given to the signals from market interest rates and the exchange rate, recognizing the relationship between interest rates and exchange rate stability. The central bank will adjust interest rates as necessary during the program period, especially if the peso comes under renewed pressure. In view of possible shifts in the demand for money, monetary targets may have to be revised during the program period, in consultation with the Fund.

17. To reduce the intermediation bias against the peso, among other measures (Paragraph 22) the central bank intends to reduce gradually the reserve requirements on peso deposits. As a first step, and taking into account the current need for a tight monetary policy stance, we intend to reduce the statutory reserve requirement from 13 percent to 10 percent with a simultaneous increase in the liquidity reserve requirement from 4 to 7 percent during the program. In addition, prior to the end of the program the plan is for a reduction in the total reserve requirement (statutory plus liquidity), depending on monetary developments under the program. The central bank will ensure, through open market operations, that any reduction in total reserve requirements will be implemented in a manner that will avoid any undesired liquidity expansion.

Exchange rate policy

18. In current circumstances the Philippine economy is best served by a floating exchange rate. Thus, our policy is to limit intervention in the foreign exchange market to what is necessary to achieve the NIR target under the program, minor "smoothing" operations, and intervention to maintain orderly market conditions during periods of market turbulence. Monthly indicative targets have been set for NIR of the BSP, which the BSP will aim to meet as a prime objective of monetary and exchange rate policy under the program. Consistent with these targets, quarterly floors on NIR have been set as performance criteria under the program. Deviations from the indicative NIR targets will not be sterilized, with base money targets to be adjusted accordingly.

19. To improve the functioning of the foreign exchange market and to increase flexibility of the exchange rate, the volatility band established by the Bankers' Association of the Philippines (BAP) will be reviewed by the BSP in consultation with BAP with a view to phasing it out as soon as possible, but not later than by end-1998. In the meantime, measures will be taken to ensure that trading outside the band will not be stopped for more than an hour. Outstanding contracts under the nondeliverable forward (NDF) facility will be unwound gradually over the next 18 months and no new contracts (except roll-overs) or similar schemes will be undertaken by the BSP. The BSP henceforth will channel all its spot foreign exchange transactions (except those with the government) through the Philippine Dealing System (PDS).

D. External Debt Management

20. Given the recent experience in a number of emerging market economies, strengthening external debt management is a particular focus under the program. This includes an enhanced effort both to improve the monitoring of debt flows and stocks, especially of short-term debt. Regarding debt statistics, the BSP is using a computerized debt management system to facilitate the compilation of statistics. We are also considering the use of survey methods to add a further dimension to our monitoring effort. In this context, ongoing technical assistance from the Fund in the area of balance of payments statistics will pay particular attention also to the debt statistics. To ensure that the private sector bears the full risks of its borrowing, the government will continue to refrain from providing any explicit or implicit guarantees on their external loans.

21. We are taking a number of steps to reduce short-term debt and encourage a better maturity structure of debt flows as well as higher non-debt creating flows. These include, in particular, several measures to diminish the disincentives to peso intermediation. In this regard, in addition to the measures described in paragraph 17, foreign currency deposits of residents have been made subject to a 7.5 percent tax on interest income, and a 15 percent liquid-asset cover requirement, to be raised to 30 percent by mid-1998, has been introduced on foreign currency deposits. (This is in addition to the 100 percent cover requirement on foreign currency deposits.) New official external borrowing will be subject to quantitative ceilings under the program.

E. Financial Sector Reform

22. Notwithstanding the sharp deterioration of the economic environment, we are confident that the Philippine banking system can weather the resulting difficulties and emerge from the regional crisis in a healthier position. Nevertheless, to maintain the fundamental health of the system, and to guard against the risk that could arise from a further economic downturn, we are fully committed to accelerating ongoing efforts to improve our prudential and supervisory systems as well as to resolve without delay any problems that might emerge in individual institutions.

23. There are four main elements to our banking reform strategy. First, we are enhancing the banks' capacity to withstand shocks by raising their capital and encouraging some consolidation in the industry. Second, bank risks are being reduced by tightening provisioning requirements and strengthening regulatory oversight. Third, we are leveling the playing field between different types of instruments, especially with a view to reducing disincentives to peso intermediation. And fourth, our bank resolution strategy is geared to the twin objectives of dealing expeditiously with any problem banks while safeguarding the soundness of the banking system. To support implementation of this plan, we have requested an FSAL from the World Bank as well as follow-up technical assistance from the Fund/World Bank.

F. Structural Reforms

Medium-term fiscal sustainability

24. Our medium-term fiscal strategy envisages an increased revenue effort in order to achieve higher public savings while also allowing room for increased public investment in infrastructure and human capital. Accordingly, the medium-term framework provides for the overall public sector balance to gradually turn from a deficit of 0.9 in 1998 to a surplus of 0.9 in 2003. Over the same period, investment in infrastructure by the national government will increase from the 1998 level of 2 percent of GNP to 3.2 percent in 2003. Underlying this framework are measures to increase the tax ratio, as well as a re-prioritization of expenditures through containing public sector personnel costs, and rationalizing the transfer of funds and responsibilities to local governments.

25. Major tax policy reform in all areas - income taxes, excises, tariffs and VAT - has taken place over the past four years, most recently with the passage in December 1997 of the final phase of the Comprehensive Tax Reform Package (CTRP, the income tax component of reform). This latter package will have a positive impact on revenues in the medium term, based on a more rational tax structure. Moreover, the adoption of revenue enhancing measures such as the planned rationalization of fiscal incentives (paragraph 12) will have a significant revenue impact over the medium term. Overall, these measures should permit an increase in the tax revenue to GNP ratio of about 1.8 percentage points over the medium term.

26. Medium-term expenditure reforms to be initiated during the program period will include shifting to a medium-term budgeting framework under which appropriations will be defined within a three-year rolling macroeconomic framework. This will ensure that the future financial implications of new expenditure decisions in each budget are made in the context of the medium-term macroeconomic program. It will also help arrest key sources of expenditure drift, including the growth of personnel expenditures and of transfers to local governments. Implementation of this framework is being targeted for 1999 with the assistance of the World Bank in the contest of the Public Sector Adjustment Loan (PSAL).

27. We will endeavor to move forward the Government Re-engineering Program which was initiated in 1994. We will re-submit to Congress before the end of 1998, the "Re engineering the Bureaucracy" Bill in order to obtain full authority to restructure the Executive Branch of government. We expect the reduction in staffing will result from the merger or abolition of redundant agencies, the devolution of activities and programs to local governments, and the further privatization of public services to improve the effectiveness and efficiency of government. Pending the passage of this Bill, overall national government staffing will continue to be held down. However, efforts have been undertaken to rationalize compensation in government to narrow the gap with those of the private sector. With low and middle level salaries now broadly in line with the private sector, attention can be focused on the remaining issues of raising civil service executive compensation, de-compressing the salary structure, and improving overall personnel management.

28. Increased infrastructural investment is critical to our medium-term growth and development prospects. While part of the increase must come from the National Government (the medium-term fiscal plan provides for an increase of 0.5 percent of GNP), the private sector and local governments will need to play a more active role as well. We shall further strengthen the environment for investment in general, and for private sector investment in infrastructure in particular.

Strengthening the corporate sector

29. Our structural reform agenda will increase the resiliency of the corporate sector mainly by improving the enabling legal framework, continuing trade and investment liberalization, developing the domestic capital market, additional privatization, and further strengthening external debt management.

30. Significant liberalization of the trade regime has been achieved in recent years through continued tariff reform and steady elimination of nontariff barriers. The average nominal tariff rate was reduced from 28 percent in 1990 to 13 percent in 1997, with the maximum tariff rate (which applies to a few agricultural products) lowered from 100 percent in 1996 (after WTO tarification) to 80 percent in 1997. Quantitative import restrictions were lifted on all agricultural imports (except rice) in March 1996, accompanied by their tarification as agreed under the WTO.

31. Trade liberalization will continue in 1998-99 and beyond. The average nominal tariff rate has been reduced to 11.2 percent in 1998, and will be lowered to 10.2 percent in 1999 and to 9.1 percent in 2000. The maximum tariff rate (which applies to some agricultural imports) will be reduced to 65 percent in 1999. We are also taking measures to increase the transparency of quota allocation under the minimum access volumes arrangements. Furthermore, in the context of the WTO, we are committed to reviewing the restriction on rice imports by 2004.

32. We are continuing to make best efforts toward creating an attractive environment and liberal regime for investment. To this end, further simplification and liberalization of registration requirements will be implemented during the program period. We intend to liberalize the retail trade sector, particularly to investments in medium-and large-scale firms; draft legislation to this end will be submitted to Congress during the program period. Investment houses are being opened up further to foreign investment based on a law passed in late 1997 which raises the foreign equity participation from 49 percent to 60 percent voting shares.

33. The government remains committed to carrying forward its privatization plans in the coming years. In 1998, the privatization program is expected to generate P 7 billion, most of which will come from the completion of the sale of the Fort Bonifacio property. Going forward, privatization efforts will focus on disposing of remaining major items which are strategically vital to industrial development particularly the National Power Corporation (paragraph 36). Other key assets remaining to be sold include the PNOC-Energy Development Corporation and the Food Terminal.

34. A comprehensive restructuring reforms of the electric power sector has been pursued by the government, possibly with assistance from the World Bank and ADB. Under this restructuring reform, the government intends to pursue wholesale competition and produce implementation of retail competition through the following strategies, among others: (a) separating (unbundling) the transmission activities of NPC from its generation activities and establishing them as a separate legal corporate entity; (b) establishing generation companies, followed by incorporation and subsequent privatization of certain generation companies; (c) refocusing the role and functions of National Electrification Administration (NEA); (d) encouraging the consolidation/merger of distribution entities; (e) applying unbundled tariffs at generation, transmission, sub-transmission, and distribution levels; and (f) strengthening the Energy Regulation Board's organizational and regulatory capacity.

35. To implement this restructuring program, the Omnibus Electricity Bill will be resubmitted to Congress before end-1998. Based on the new framework, and in close collaboration with the World Bank and the ADB, an action plan to restructure and privatize the NPC will be launched.

Oil Deregulation

36. A key plank of our structural reform agenda has been the deregulation of the oil sector. The downstream oil industry was fully deregulated in February 1997, but, effective December 8, the Supreme Court ruled parts of the deregulation law unconstitutional. A new law was passed in February 1998, restoring most of the deregulation provisions of the original law while correcting its constitutional deficiencies. As part of the new regime, a transition period of up to 5 months was introduced during which prices of domestic petroleum products remain regulated and limited subsidies can be provided, at the discretion of the President, for the most socially-sensitive products (liquefied petroleum gas, kerosene, and regular gasoline). By March 15, the President will issue an Executive Order terminating the transition period for all products except for the most socially sensitive products. For these latter products, prices will remain regulated until July 1998, at which time they will also be freed. The cost of any price subsidies for socially-sensitive products will not exceed P 2.9 billion during 1998. This amount will be accommodated within the revised fiscal program for 1998. Moreover, the outstanding balance under the Oil Price Stabilization Fund (OPSF) (P 2.6 billion at end-1997) will be gradually repaid through the application of reimbursement certificates, following the provisions of RA 8479. The total amount used under the new buffer fund for socially sensitive products will not exceed P 2.9 billion, as a performance criterion under the program.

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37. In the current environment of regional uncertainty, close monitoring of developments under the program will be critical. We are also committed to consulting closely with the fund on progress with implementing the program. Accordingly, quarterly reviews are envisaged under the program. The first review, to be completed in May 1998, and subsequent reviews will focus on (i) implementing the financial program including interest and exchange rate policies, as well as on (ii) progress with banking reforms and (iii) tax administration. In addition, the second review, to be completed by August 1998, will provide an opportunity to discuss the new government's economic agenda, including the measures needed to meet the fiscal target for 1998.