Press Release No. <a name="P16_75"></a>05/259

"The 2005 Article IV and post program monitoring mission visited Manila during November 10-22, 2005. The discussions focused on the macroeconomic and structural policy challenges facing the Philippines. The mission's findings will be reported to the Executive Board of the IMF in February 2006, but the preliminary assessment is as follows:

"Significant progress with economic reforms has been made since the new administration took office in 2004 (See PIN No. 05/141). The first phase of the Expanded Value Added Tax law (EVAT) was implemented November 1, and the mission welcomes the clear commitment made to raising the VAT rate on February 1 next year. These developments have lifted sentiment, with the stock market rallying, sovereign bond spreads tightening, and the peso appreciating. Reforms have also advanced in the electricity and financial sectors, including through the increase in average generation tariffs and sales of banks' nonperforming assets under the Special Purpose Vehicle (SPV) framework. Looking ahead, the challenge is to sustain the economic reform momentum.

"The economy has performed well. Growth in remittances has helped to offset the impact of oil prices and indirect taxes on consumption, and the economy is projected to grow about 5 percent this year and next. The National Government budget deficit has been below target through October, aided by tight control over expenditures and a recent pick up in revenue collections. Foreign portfolio investment has responded favorably to the positive fiscal news and gross reserves have risen above US$18 billion.

"There are risks to the outlook, however. These include a possible softening of foreign demand for Philippine exports due to increased competition in the electronics sector. A further spike in oil prices or Avian flu could also take a toll on the real economy, while adverse developments in international capital markets could raise external borrowing costs. However, the economy's improving fundamentals should provide for a better shock absorber in case such risks materialize. At the same time, additional reforms are necessary to decisively reduce vulnerabilities.

"A significant reduction in the public sector fiscal deficit is in prospect for 2005, aided by lower losses at the National Power Corporation (NPC). Looking ahead, the full implementation of the EVAT reform will allow for a further reduction in the deficit in 2006, while at the same time providing resources for increased expenditure on infrastructure and social services. Strong tax administration will be crucial to ensuring that the gains from EVAT are realized and an IMF/World Bank technical assistance mission is currently focusing on ways to improve tax administration. Over the medium term, balancing the budget will require additional measures, including a rationalization of tax incentives. Also, other parts of the public sector, such as the government-owned and controlled enterprises (GOCCs), should be monitored closely so that the ongoing fiscal consolidation effort is not undermined by individual enterprises.

"Although inflation has started to ease, it has remained above target reflecting the impact of supply shocks, and may rise again when the VAT rate is increased. Continued above target inflation can pose a risk to inflation expectations while narrow interest rate differentials can lead to exchange rate volatility and affect inflation. The BSP has appropriately acted to guard against the risks to inflation expectations by raising policy rates, most recently in October, and markets have welcomed these actions.

"In the power sector, privatization of generation and transmission assets would help to mobilize additional investments, and efforts to strengthen the regulatory framework would reduce uncertainties for investors.

"The mission welcomes recent positive developments in the banking system including sales of nonperforming assets and developments in bank consolidation. Accelerating the passage of BSP charter amendments, which would strengthen legal protection for bank supervisors and the prompt corrective action framework, remains an important reform priority.

"The IMF will continue a close policy dialogue with the Philippine authorities."