Information about Asia and the Pacific Asia y el Pacífico
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Philippines

Author(s):
International Monetary Fund
Published Date:
March 2011
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I. INTRODUCTION

1. The Philippine economy is poised at a key moment as the recovery from the global downturn and positive sentiment in the country provide a window of opportunity for moving ahead decisively with reforms to raise inclusive growth. After slowing sharply in 2009, economic growth recovered to 7½ percent (year/year) during the first three quarters of 2010. The smooth passage of the presidential and legislative elections in May 2010 and transition to a new administration in July 2010, as well as the government’s resolve to address longstanding impediments to investment and growth, have buoyed confidence. Meanwhile, inflation has remained low and burgeoning external inflows have contributed to a sizable balance of payments surplus. In November 2010, Standard and Poor’s upgraded to BB its rating of Philippine long-term foreign currency debt in recognition of the country’s stronger financial position.

2. Against this background, the discussions focused on the challenge of preserving macroeconomic stability and enhancing the prospects for medium-term growth. Meeting this challenge will require carefully managing the exit from stimulus policies in a complicated external environment, while addressing long-standing obstacles to higher investment, job creation, and productivity. The authorities and staff generally agreed on the nature of the policy challenges, although the authorities viewed as less pressing than staff the need to unwind stimulus measures based in part on a higher assessment of the economy’s supply potential and rising investor confidence.

II. RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK

A. A Strong Recovery

3. Economic activity recovered strongly in the first three quarters of 2010 (Figure 1). Growth was broad-based across private consumption, investment, and exports, and was helped by continued policy stimulus, a temporary spending boost ahead of the May elections, and the re-stocking of global and regional inventories. These forces offset the adverse impact on growth of the El Niño drought in the first half of 2010. Business confidence and consumer sentiment continued to improve and employment increased. The unemployment and underemployment rates remained high, however, at nearly 7 percent and 18 percent, respectively, as of the third quarter. Private consumption has been supported by robust remittances, and investment by reconstruction following the late 2009 typhoons as well as growing interest in the business process outsourcing (BPO) sector. Exports have grown strongly on the back of recovering demand from advanced economies as well as other Asian countries, including China. In the third quarter of 2010, growth in the Philippines moderated, as it did in the rest of Asia, toward a more sustainable but still robust pace (6½ percent) as industrial production softened with the completion of the inventory cycle and government spending slowed.

Figure 1.Philippines—Economic Recovery

Sources: CEIC Data Company Ltd.; and IMF, WEO database.

4. The external surplus continued to grow in 2010, underpinned by both the current and financial account (Figure 2). The surplus has reflected strong exports, remittances, sovereign bond issuance, and other capital inflows. Capital inflows have risen substantially since September as abundant global liquidity continues to find its way to emerging economies, including the Philippines, that have relatively strong growth prospects and offer favorable returns. Portfolio inflows, in particular, rose markedly in September and have continued to increase in recent months. Key sources of such inflows include the United States, United Kingdom, Hong Kong SAR, and Singapore. International reserves rose by about $17 billion during January–November, to $61 billion (10 months of imports), and the BSP forward book by about $10 billion during January-October. The peso appreciated by around 4 percent in both nominal and real effective terms during January-November. The EMBI spread narrowed to 150 basis points as of late December, from around 250 points in June.

Figure 2.Philippines—Balance of Payments and External Adjustment

Sources: CEIC Data Company Ltd.; IMF, WEO database; and IMF staff calculations.

5. Financial conditions remain accommodative, partly reflecting external inflows. Credit growth has picked up since mid-2010, and benchmark government bond yields have fallen to historical lows amid ample liquidity and rising foreign demand.

6. Inflation has nonetheless been moderate. Headline inflation has remained well within the BSP’s 3½–5½ percent target in recent months, and averaged 3.8 percent (year/year) during January-November 2010 (Figure 3). Food inflation remained subdued owing to favorable domestic supply conditions, and core inflation (excluding volatile food and energy items) was contained in the 3-4 percent range in part reflecting exchange rate appreciation. Inflation expectations over the coming year remain within the target range according to the BSP’s December inflation report.

Figure 3.Philippines—Monetary Policy and Inflation

Sources: Bloomberg; CEIC Data Company Ltd.; IMF, Asia and Pacific Regional Economic Outlook (October 2010).

7. Notwithstanding the strong recovery, fiscal revenue fell short of budget targets in January-September (Figure 4). The budget targets were ambitious, but the underperformance also owed to various revenue-eroding measures that remain in place. The national government deficit, however, came in slightly below the targeted level (3.3 percent of GDP) owing to a sharp slowdown in spending in the third quarter. Financing conditions have been comfortable, and in September 2010 the Philippines became the first emerging Asian country to issue a local currency-denominated global bond.

Figure 4.Philippines—Public Finances

Sources: CEIC Data Company Ltd.; IMF, WEO database; and IMF staff calculations.

B. A Favorable Near-Term Outlook and Medium-Term Prospects

Staff’s Views

8. The near-term outlook is generally positive. Growth is projected to be 7 percent in 2010 and to moderate to a still robust 5 percent in 2011. The projected moderation reflects a waning of the policy stimulus and a dissipation of temporary factors, such as the pre-election spending and post-typhoon reconstruction that supported the cyclical recovery in early 2010. While inflation has been low, pressures may start to build during the coming quarters and, in the staff’s view, some tightening in financial conditions is likely needed to keep inflation within the target range over the next two years. The balance of payments is projected to remain in surplus as remittances and export diversification support the current account balance and the Philippines continues to attract capital inflows.

9. Risks to the outlook are broadly balanced. The positive economic sentiment in the country may boost private investment more than expected. However, renewed shocks to global growth and financial markets would affect Philippine exports and remittances. Meanwhile, surges in capital inflows could lead to asset price booms and busts, as well as raise the potential for future destabilizing outflows. Although historically the Philippines has not been a large recipient of capital inflows, the historical experience does not include a comparable period of abundant global liquidity.

10. Over the medium term, the staff expects growth to continue at 5 percent annually (Box 1). The projection is in line with the Philippines’ regional peers and is somewhat higher than the staff’s projections for the October 2010 World Economic Outlook. The projection is, however, lower than the authorities’ 7-8 percent target, which would require additional measures to attain in the staff’s view. Measures will be needed to rebalance the economy toward investment, particularly to improve the climate for private investment and strengthen public infrastructure, and to address impediments to greater job creation and productivity.

Authorities’ Views

11. The authorities shared the staff’s broadly positive outlook, although they expect growth to be even higher. Growing confidence, new initiatives such as PPPs, a continued diversification of exports, and robust remittances could contribute to raise growth to the 7-8 percent range in 2011 and the medium term. The authorities’ more positive assessment of the economy’s growth potential also contributed to their more benign near-term inflation outlook than staff, with inflation projected to stay well within the target range. The authorities broadly shared the staff’s views on the risks to the outlook, although they emphasized concerns about capital inflows, as the easing of monetary policy in advanced countries could exacerbate future inflows to emerging Asia, including the Philippines.

III. POLICIES—preserving macroeconomic stability and enhancing growth

Preserving macroeconomic stability and enhancing medium-term growth prospects will require carefully managing the exit from stimulus policies in a challenging external environment, while moving ahead with long-awaited structural reforms to enhance investment, jobs, and productivity.

Box 1.Philippines—Potential Growth and Prospects1

Potential growth in the Philippines has increased since the late 1990s. Estimations based on a simple filtering approach, a production function approach, and a multivariate time-series model approach suggest that potential growth has risen from 3-4 percent in the 1990s to 4½-5 percent in recent years. The sources of growth in the Philippines have changed somewhat over time, in line with other ASEAN economies, with a rise in the contribution of total factor productivity (TFP) and a fall in the contribution of capital.

TFP growth is aided by improvements in human capital and institutional quality and transition from agriculture to industry. Results from a cross-country panel regression suggest that, for the Philippines, an increase in average secondary schooling years and a transition of economic activity from agriculture to industry and services during 1996-2005 could be associated with an improvement in TFP growth by 1 percentage point.2 In addition, an improvement in institutional quality during the same period could be associated with an improvement in TFP growth by 0.1 percentage point.

Potential Growth Contribution: Capital, Labor, and TFP

(In percent)

Source: IMF staff estimates.

An illustrative reform scenario that would see potential growth rise to the authorities’ target of 7-8 percent could include the following elements:

  • Productivity. Based on the regression estimates, continued investment in human capital, further transition of economic activity from agriculture to industry and services, and improvements in institutional quality could raise the growth contribution of TFP from historical averages.
  • Investment. Fiscal reforms and improvements in the business climate that raise the investment rate from its historical average of 15 percent of GDP to 19½ percent by 2015 could raise the growth contribution of capital from 1 percent historically to 2 percent by 2015.
  • Employment. In addition to job creation, improvements in labor market flexibility and active labor markets measures such as job training and search assistance would be needed to increase the growth contribution of labor.
Growth Contribution Under a Reform Scenario
2000-09

(average)
2015

(reform)
Potential growth (percent)4.67.0
Contribution of TFP (percent)2.03.0
Contribution of capital (percent)1.02.0
Contribution of labor (percent)1.62.0
Source: IMF staff estimates.
Source: IMF staff estimates.
1 See Selected Issues Paper for details.2 The share of agriculture value added to GDP is used as a proxy to measure this transition.

A. Normalizing the Monetary Stance

Background

12. Monetary policy responded well to the crisis and has helped foster the recovery. A 200-basis-point cut in policy rates during December 2008-July 2009, and additional crisis-related liquidity support measures, helped to cushion the economy against the downturn. With the recovery underway, the BSP appropriately started to unwind its liquidity support measures since early 2010. In July, it extended through 2014 the 3-5 percent inflation target for 2011.

Staff’s Views

13. The BSP’s holding stance has been appropriate, but it remains important going forward to respond proactively to price pressures. The stance has been justified by the soft inflation data during most of 2010, uncertainties in the outlook, and relatively short lags in the Philippines between policy moves and inflation outturns.

14. While inflation has been moderate so far, pressures could build during 2011. Financial conditions remain accommodative, with real policy rates close to zero and below a Taylor-rule implied “neutral” rate and treasury bill yields falling below policy rates in mid-November (see Selected Issues Paper, Chapter 2). Moreover, rising external inflows could further fuel asset prices, depress local long-term yields, and stimulate domestic demand. A potential widening of the positive output gap amid accommodative monetary conditions suggests that monetary policy tightening likely needs to start in the near term in order to head off inflation risks. Should a tail risk materialize, such as renewed global turmoil, the timing of the monetary normalization could be recalibrated.

Authorities’ Views

15. The authorities appreciated the staff’s assessment of monetary policy so far, but, looking forward, they saw the current monetary stance as being consistent with both low inflation and economic expansion. The BSP saw inflation as remaining well within the target range in 2011-12 in the absence of adverse shocks. They felt that the economy’s productive capacity had increased and would keep inflation well contained. The sharp fall in treasury yields since November was seen as temporary and liquidity as being broadly in line with economic activity. The authorities noted, however, that inflation risks were finely balanced and that generally higher global food and oil prices, as well as stronger demand momentum, could add to inflationary pressure. They emphasized that they stood ready to respond proactively should such pressure emerge.

B. Managing External Inflows

Background

16. The authorities have sought to strike a balance between various measures in their toolkit for managing external inflows in recent years. They further liberalized controls on capital outflows in October and have not modified regulations on capital inflows. They have had in place for some years macro-prudential measures that have worked well and have sought to prepay some external debt. The exchange rate has appreciated in nominal and real effective terms, although by somewhat less than in neighboring economies. Reserves have risen to high levels. Reserve coverage in the Philippines is now comparable to that in regional peers, but it is high in comparison to the past and would seem to be comfortable according to standard prudential metrics.

Net International Reserves(End-2009)
In months of

imports
In percent of short-

term debt
In percent of broad

money
In percent of short-

term debt and

foreign currency

deposits
Indonesia7.1204.134.096.9
Malaysia8.0363.229.4227.3
Philippines9.7389.146.3126.2
Thailand10.6374.345.3339.3
Source: CEIC Data Company Ltd.
Source: CEIC Data Company Ltd.

The BSP has sterilized much of the reserve buildup in order to avoid an undue expansion in monetary aggregates, and sterilization costs have increased as domestic-foreign yield differentials have widened.

Staff’s views

17. The real exchange rate remains broadly in line with its medium-term fundamentals. A panel estimation of the standard macro-balance, external sustainability, and equilibrium exchange rate approaches indicates a wide range of results with, on average, the peso not far from its medium-term fundamental level (around 6 percent below). An alternative estimation that takes into account long-term trends in remittances and the current account that may differ substantially from medium-term outcomes supports the conclusion that the exchange rate is close to its equilibrium level (Box 2).

Real Exchange Rate Assessments

(Deviation from equilibrium, in percent)

Source: IMF staff estimates.

1/ This approach derives a current account norm by smoothing remittance income to yield a constant real income stream per capita.

18. With reserves at comfortable levels according to standard metrics and the exchange rate not overvalued, there is scope to shift the policy emphasis away from reserve accumulation and toward other measures in response to external inflows going forward. The staff continues to support the authorities’ stated policy of limiting foreign exchange market intervention to smoothing operations. In this context, greater exchange rate flexibility should be considered. Exchange rate appreciation also offers an important buffer that would help to tighten monetary conditions in a way that lessens speculative inflow pressures. Moreover, appreciation would be a necessary part of the adjustment to inflows that are likely to be sustained (Box 3).

Box 2.Philippines–Implications of Long-Term Trends in Remittances for the Equilibrium Exchange Rate

International migration is a prominent feature of the Philippine economy and remittances have played an important role in external balances. In recent years, strong growth in remittance inflows has contributed to a rising current account surplus, making the Philippines one of the largest recipients worldwide. A question that this raises is what the implications are for the equilibrium current account balances and, therefore, for the equilibrium exchange rate.

Remittances and CurrentAccount Balance

From a long-run perspective, remittances are likely toprove an exhaustible resource, with implications for external sustainability. According to U.N. estimates, outward migration rates from the Philippines climbed steadily from the late 1960s through the early 1990s, contributing to a rise in the number of migrants and in remittances. Going forward, the U.N. projections envisage a slowing population growth rate that contributes to a gradual decline in migration rates. Retirement by existing migrants, along with declining migration rates, would contribute over time to a decline in the number of overseas foreign workers (OFWs) and, accordingly, in remittance inflows. For example, a 3 percent annual retirement rate would contribute to a decline in remittances to 5 percent of GDP by 2050 from 13 percent of GDP in 2010.

In the face of a long-term decline in remittance receipts, intertemporal consumption smoothing would call for an accumulation of assets in the short and medium term. A balance sheet-based methodology, similar to that for oil producing countries, can help indicate an optimal intertemporal allocation of temporary income. The allocation would seek to save some of the remittances in order to generate a steady stream of income over time. The stream of income (an annuity) could be defined at different levels—a constant real annuity per capita; a constant annuity in percent of GDP; or a constant real annuity.

Achieving a constant real annuity in per capita terms is the base case. For each desired level of future income, the equilibrium current account is determined as the difference between consumption and income and remittance flows. The table summarizes the main results. Achieving a constant real per capita annuity requires a medium-term current account surplus of 1.8 percent of GDP. Achieving a constant ratio of annuity income to GDP requires much higher saving through a large current account surplus, while achieving merely a constant annuity in real terms allows a current account deficit as remittances are projected to continue to grow in the near future.

Intertemporal Consumption Smoothing of Remittances
Equilibrium Current
Account Balance
(percent of GDP)
Constant real per capita annuity1.8
Constant annuity/output ratio8.5
Constant real annuity-1.3
Source: IMF staff estimates.
Source: IMF staff estimates.

Intertemporal consumption smoothing of remittances income, as specified above, implies that the real exchange rate is broadly aligned with medium-term fundamentals. Stripping the Philippines’ current account balances of temporary factors yields a medium-term current account balance of 1.9 percent of GDP, in line with the desired level of the current account balance, at 1.8 percent of GDP. Hence, the real exchange rate is assessed to be broadly in line with long-term fundamentals based on this methodology.

Box 3.Capital Flows to the Philippines: Determinants and Risks

Capital flows to the Philippines can be attributed to both external “push” factors and domestic “pull” factors. Results from a quarterly time series Exponential Generalized Autoregressive Conditional Heteroskedasticity (EGARCH) model of non-FDI inflows to the Philippines during 1990-2010 suggest that the key determinants of net capital inflows are the growth differential relative to advanced countries, interest rate differentials, the degree of global risk aversion (proxied by the VIX index), and exchange rate changes.

The outlook for capital flows to the Philippines is strong given expected patterns for the key determinants. Sizable growth- and interest rate differentials between the Philippines and advanced countries are likely to persist for some time, suggesting that the impetus for capital inflows should remain strong in 2011 and the medium term. At the same time, shocks to global risk aversion could lead to sudden stops or capital flow reversals.

Capital inflows present opportunities, but they can also pose macroeconomic and financial risks. The inflows, if channeled effectively, represent an opportunity to address long-standing investment needs, such as in infrastructure. However, capital inflows need to be managed carefully in order to avoid macroeconomic and financial risks. Inflows can increase liquidity and boost domestic demand and asset prices. In the Philippines, the empirical relationship between non-FDI capital inflows and domestic demand is strong (text chart). The main channel through which the relationship seems to work is by expanding credit and reducing the cost of finance. Although portfolio inflows have not so far led to overheating pressures, liquidity is unusually high and the government bond yield curve has fallen to historical lows, complicating the task of monetary policy. Asset price increases in recent quarters have been confined to equities, where, however, valuations are broadly in line with historical averages.

Response to Cholesky One S.D. Innovations ± 2 S.E.

Authorities’ views

19. The authorities emphasized that their response to capital inflows was based on achieving a balance among various measures in the traditional toolkit. The balance had been right in their view between exchange rate appreciation and reserve accumulation. Reserves had provided an important buffer during the crisis. They were studying the issue of reserve adequacy and recognized the costs of reserve accumulation. However, particularly in a volatile external environment, they would be reluctant to conclude too quickly that reserves were at adequate levels. Moreover, if a significant component of the inflows were transitory and driven by cyclical factors, then it was appropriate to smooth the impact on the exchange rate. At the same time, the authorities were looking for ways to increase the absorptive capacity of the economy and harness capital flows to support investment and potential growth.

C. Fiscal Consolidation through Higher Revenue

Background

20. The authorities aim to reduce the national government deficit from 3.9 percent of GDP in 2010 to 2 percent from 2013. Fiscal consolidation over the medium term would help to create more fiscal space for the budget to be able to respond effectively to future shocks. Consolidation would improve medium-term growth prospects by lowering sovereign risk and enhancing investment and it would reduce the share of debt service in government expenditure (see Selected Issues Paper, Chapter 3). It would also help in managing the macroeconomic impact of external inflows.

21. The main elements of the authorities’ fiscal plans are stronger tax administration, a reorientation of expenditure towards social sectors and infrastructure, and a public debt management strategy that reduces the share of external debt and lengthens the maturity structure. A revenue based consolidation is envisaged that relies primarily on tax administration efforts, which will include technical assistance from the U.S. Millennium Challenge Corporation compact and the Fund. The authorities have pledged not to raise taxes at least until 2012. Expenditure plans include a greater emphasis on basic education, an expansion of the conditional cash transfer program and health insurance coverage, and a reduction in subsidies for rice imports and rail transportation. Efforts are underway to expand PPP projects for infrastructure with partial government investment being mobilized from government financial institutions and social security institutions. The civil service wage bill, however, continues to increase rapidly and accounts for over 40 percent of primary expenditure. While debt sustainability is not an immediate concern, the authorities are focused on reducing the debt burden as public debt stands at nearly 60 percent of GDP and 3 times fiscal revenue. Debt service absorbs a quarter of primary expenditure.

22. Consistent with their medium-term consolidation goal, the authorities are planning a fiscal withdrawal in 2011. The 2011 budget targets a reduction in the national government deficit to 3.2 percent of GDP (authorities’ definition, includes privatization receipts). The deficit reduction would imply a withdrawal of fiscal stimulus of about ½ percent of GDP, which is roughly in line with the pattern in regional peers (Figure 4). However, given expenditure plans, the 2011 deficit target would require a substantial increase in fiscal revenue, which fell short of targets in 2010. Under the staff’s baseline forecast, which assumes no additional revenue measures to those that are already planned, the deficit could remain slightly above 3½ percent of GDP.

Staff’s Views

23. The authorities’ medium-term consolidation plan is a welcome marker of the policy direction that would help improve investor confidence further and increase the government’s ability to respond to shocks. Public debt would, however, still be relatively high (nearly 50 percent of GDP and 200 percent of revenue by 2015, see Appendix I), government gross financing requirements substantial, and interest expenditure still a large share of the budget, suggesting that further debt reduction could be considered going forward. In 2011, with growth envisaged to remain robust and in light of the need to make credible progress toward medium-term consolidation, a greater withdrawal of fiscal stimulus could be considered.

Link between Debt Ratio and Funding Needs

(In percent of GDP)

Source: IMF, Fiscal Monitor.

24. In order to achieve fiscal consolidation and scale up social expenditure and public investment, it will be essential to raise the tax effort. The authorities’ intention to focus initially on improving tax administration is appropriate and should help over time to enhance revenue collection. To make substantive gains in revenue, early actions to broaden the tax base and simplify the tax system should complement the planned tax administration measures, whose full effect will take time to materialize. In particular, in keeping with the advice of Fund technical assistance to the Philippines, reforms are needed to strengthen excise taxes, rationalize fiscal incentives, and address inefficiencies in the VAT.

25. On the expenditure side, the reorientation of spending should help to support inclusive long-term growth. Given the low levels of social spending, the staff supports the authorities’ plans to limit rice and transport subsidies by public enterprises and move instead to more targeted conditional cash transfer programs. The roll-out of Public Private Partnerships should help to improve infrastructure, although these projects should be evaluated using sound cost-benefit analyses and the fiscal risks associated with them reflected in the fiscal accounts. The staff cautioned against the rapid growth in the civil service wage bill, and suggested a faster implementation of the government’s plan to rationalize public services.

26. The staff supports the government’s recent initiatives to strengthen the fiscal framework. A fiscal responsibility law is being proposed that should help impose greater fiscal discipline by requiring that new budget proposals are deficit neutral. The authorities’ ongoing efforts to strengthen public financial management, publish a fiscal risk statement, and focus debt management on reducing currency and maturity risk should help to further strengthen the public finances. Meanwhile, a medium-term budget framework would be very helpful for anchoring fiscal consolidation as well as improving fiscal planning and raising confidence among investors.

Authorities’ Views

27. The authorities reiterated their firm commitment to medium-term fiscal consolidation. Recent debt management operations had gone some way to reduce currency and rollover risks, and in this light they viewed the medium-term target of 2 percent of GDP as achieving a good balance between fiscal consolidation and an appropriate level of development spending. While acknowledging that the 2011 deficit target would require a substantial revenue effort, the authorities noted that they would consider taking spending measures to meet the target should revenues underperform. On the other hand, they felt that any positive revenue surprises should be allocated not to deficit reduction but to meet spending needs.

28. The authorities agreed that fiscal consolidation should be based primarily on revenue measures. While they do not envisage any increase in tax rates in the near term, they have agreed on principles to limit tax exemptions and incentives. Proposals to reform excise taxes are under consideration in Congress.

29. The authorities reiterated their commitment to a continued reorientation of expenditure toward social objectives. A spending review that is ongoing under the “zero-based budgeting” approach should help to identify areas where there may be scope for savings. The authorities agreed that the size of the civil service would need to be carefully managed in order to restrain the public wage bill over the medium term.

D. Maintaining and Strengthening Financial Sector Resilience

Background

30. The Philippine financial sector withstood the crisis well, and developments in recent quarters continue to support the January 2010 Financial System Stability Assessment (FSSA) that it remains sound (Figure 5). The sector was relatively unaffected by global market turbulence last summer, as its direct exposure to Europe and reliance on foreign wholesale funding are limited. Universal and commercial banks’ non-performing loan ratios have remained low (3.2 percent on average as of October 2010) and banks’ capital adequacy ratios high at about 16 percent as of June (latest data available). Banks’ profitability has improved, with net income growing by 22 percent (year/year) in the first half of 2010.

Figure 5.Philippines—Financial Stability and Asset Prices

Sources: Bloomberg; CEIC Data Company Ltd.; and Philippine authorities.

31. Asset price bubbles have not been a concern so far, but surges in external inflows could pose a challenge. Stock prices have risen rapidly since early 2010, with the Philippine stock market among the strongest performing in Asia, and price-earnings ratios have regained their pre-crisis levels. However, valuations are in line with long-run historical averages. Property prices remain moderate, particularly for commercial real estate. In recent months, prices have firmed in some segments, such as low-to-middle income housing, but existing prudential measures like the loan-to-value ratio and cap on real estate loans have kept prices in check. External inflows could, however, further fuel liquidity and swamp local financial markets, particularly the bond and swap markets, which are relatively small.

Staff’s Views

32. Two key risks to the financial system, as flagged in the 2010 FSSA update, are concentration risk and interest rate risk. These risks are particularly relevant in the Philippines because of, respectively, the dominant role of conglomerates in corporate and bank ownership (which magnifies “connected” lending in banks’ portfolios) and the large share of securities in banks’ assets. The staff welcomes the authorities’ continued vigilance over these sources of vulnerability. In November, the BSP approved a separate single borrower limit for infrastructure and development PPP projects, under which banks can extend loans and guarantees for such projects up to 25 percent of their net worth. The move will facilitate these projects, but such lending should be monitored for concentration risk and maturity mismatches.

33. Further financial market development could be helpful for channeling the external inflows toward productive investment, such as infrastructure. Infrastructure financing has specific requirements such as long-term funds and lumpy investment that are best met by private capital markets. However, the Philippine financial system remains bank dominated. Capital market development would benefit from a harmonizing of the various taxes and a lowering of the regulatory burden on some products and services. In particular, corporate bond and derivative markets would benefit from measures to further develop a benchmark yield curve, enhance third-party credit (such as bond insurance), develop hedging tools for investors and traders, and reduce the time and expense of new debt offerings.

34. The Philippines has made significant gains in improving the supervisory and regulatory framework in recent years. These gains helped the financial sector to remain resilient during the global crisis and to support the recovery. Looking ahead, it remains critical to further strengthen the banking supervisory and regulatory framework. In particular:

Supervision: Proposed amendments to the BSP Charter should be promptly approved. The amendments would provide the supervisory authorities with stronger legal powers and protection as well as lift the remaining constraints imposed by bank secrecy laws on examiners. The amendments would also allow the BSP to issue its own debt securities, which would further strengthen monetary management.

Prudential regulation: A more risk-based approach to capital requirements is essential to better reflect banks’ risk profiles. In this context, the staff welcomed ongoing efforts to introduce the internal capital adequacy assessment process (ICAAP) under Basel II in 2011. Banks’ high levels of capital, particularly Tier 1 capital, and relatively low loan-to-deposit ratios should position them well to handle new global financial regulations, including Basel III.

AML/CFT regime: The authorities have submitted bills to Congress in recent months to address the gaps noted by the Financial Action Task Force (FATF) in adequately criminalizing money laundering and terrorist financing and identifying and freezing related assets.

Authorities’ views

35. The authorities broadly agreed with the staff’s assessment of financial sector soundness. Although they agreed that concentration risk and interest rate risk merited attention, they emphasized that supervisors pay close attention to the way systemically important conglomerates interface with banks. They noted that the sources of conglomerates’ revenue were diversified across different business lines, which served to mitigate concentration risk.

36. The authorities saw no indication of asset price bubbles. The recent increase in stock prices was broadly in line with the economic recovery. They also highlighted that the existing prudential measures were adequate and they did not plan to resort to capital controls. The authorities were eager to find ways to harness the capital inflows for productive investment. In this context, they appreciated the staff’s suggestions on financial market development.

37. The authorities agreed that further strengthening the supervisory and regulatory framework would be important. The BSP also emphasized that the introduction of ICAAP under Basel II in 2011 was on track and recognized that banks’ internal risk management had improved. With respect to Basel III, the authorities did not see any immediate challenges since universal and commercial banks have adequate capital buffers.

E. Setting the Stage for Faster and More Inclusive Long-Term Growth

Background

38. Low investment is a long-standing constraint to higher growth in the Philippines. The level of investment is lower than its regional peers as both public and private investment have been anemic over the years, held down by revenue slippages and relatively poor perceptions of the business climate, respectively. In addition, unemployment and underemployment remain high, particularly among younger people.

Staff’s Views

39. In order to boost growth potential, rebalancing growth by relying more on investment will be critical. Raising investment will also help to create more job opportunities and will go hand in hand with structural reforms to raise total factor productivity. Accordingly, all three pillars of long-term growth need to be strengthened:

Investment. Higher public investment is needed in order to strengthen infrastructure and the provision of other key public goods. Ultimately, however, the main source of higher investment will have to be the private sector. In this context, the authorities’ emphasis on tackling corruption and reducing red tape is well placed. Developing capital markets would also be helpful as a way of expanding firms’ access to finance for funding investment.

Employment. Higher investment would contribute to job creation, which is both a social priority and necessary for raising potential growth. In addition, measures may be needed to lower redundancy costs and step up job training and search assistance.

Productivity. The most sustainable source of faster growth is improvements in total factor productivity. In this context, improving human capital and institutional quality, and moving up the value chain from agriculture to industry and services would help raise total factor productivity.

Authorities’ Views

40. The authorities agreed that higher investment would be critical to raise potential growth. In this context, they stressed that the planned PPP projects would play an essential role for improving infrastructure such as airports and roads. The 2010-16 Medium-Term Philippine Development Plan (MTPDP), which is due in early 2011, would outline general strategies for raising medium-term growth and lowering unemployment and poverty.

IV. STAFF APPRAISAL

41. The strong recovery and positive sentiment in the country provide a window of opportunity for moving ahead decisively with reforms to raise inclusive growth. The smooth transition to the new administration and the government’s focus on addressing long-standing impediments to investment and growth have strengthened confidence.

42. The economic outlook remains generally favorable. The staff projects growth to moderate to a still robust 5 percent in 2011. Over the medium term, a similar rate of growth should prevail, which is in line with the Philippines’ regional peers and higher than previous Fund projections. Inflation has been low in recent months, but pressures could start to build during 2011 if financial conditions are not tightened. Meanwhile, potential surges in capital inflows could lead to asset price and macroeconomic volatility.

43. In this setting, a key policy challenge for the Philippines remains to preserve macroeconomic stability while enhancing medium-term growth. Meeting this challenge will require carefully managing the exit from stimulus policies in a challenging external environment, while moving ahead with reforms to rebalance the economy toward higher investment and improve job creation and productivity.

44. Monetary policy responded well to the downturn, and has kept inflation low while fostering the recovery. Going forward, it will be important for the BSP to remain ready to respond proactively to price pressures. The monetary stance likely needs to tighten in the near term in order to head off liquidity and inflation risks. If a tail risk were to materialize, such as renewed global turmoil, the timing of policy normalization could be recalibrated.

45. The task of normalizing the policy stance is complicated by external inflow pressures. The staff supports the BSP’s stated policy of allowing the exchange rate to adjust to market pressures and limiting exchange market intervention to smoothing operations. The staff estimates that the real effective exchange rate of the peso is broadly in line with medium-term fundamentals. With reserves at comfortable levels on the basis of standard prudential metrics, greater exchange rate flexibility should be considered in response to additional inflows. Exchange rate appreciation would also help to tighten monetary conditions in a way that lessens speculative inflow pressures. The staff welcomes the authorities’ moves to further liberalize the regulations for foreign exchange outflows and avoid capital controls.

46. The government’s focus on medium-term fiscal consolidation is appropriate given the need to expand fiscal space and strengthen the ability of the budget to respond effectively to future shocks. The authorities’ intention to reduce the national government deficit to 2 percent of GDP by 2013 is a welcome marker of the policy direction and should help to anchor expectations and reduce public debt. The public debt would, nonetheless, remain relatively high and further debt reduction would be useful going forward.

47. With the recovery well under way, the time is right for a measured withdrawal of fiscal stimulus. The staff welcomes the authorities’ plan to reduce the national government deficit to 3.2 percent of GDP in 2011 that would imply a small withdrawal of stimulus. The 2011 budget targets entail a significant increase in tax revenue that may require more measures to achieve than are currently envisaged. At the same time, with growth expected to remain robust, some additional withdrawal of stimulus could be considered in order to facilitate policy normalization.

48. In order to achieve fiscal consolidation and scale up social spending and public investment, it will be essential to raise the tax effort further. The staff considers as appropriate the government’s intention to strengthen tax administration, which is being supported by scaled-up Fund technical assistance. In addition, the agenda will need to be complemented by early actions to reform excise taxes, rationalize fiscal incentives, and address distortions in the value added tax. Such actions will be important for supporting the authorities’ plans to increase much-needed spending on health, basic education, conditional cash transfers, and infrastructure.

49. The staff welcomes the government’s initiatives to strengthen the fiscal framework. A Fiscal Responsibility Law and Fiscal Risk Statement would be important steps in this context. A medium-term budget framework would also be very helpful for anchoring the fiscal consolidation plan.

50. The financial sector withstood the crisis well, and developments in recent quarters continue to support the January 2010 Financial System Stability Assessment that it remains sound. Banks’ non-performing loan ratios have stayed low and capital adequacy ratios high. The staff welcomes the authorities’ careful monitoring of two key sources of vulnerability highlighted in the 2010 FSSA, namely interest rate- and concentration risk. Asset bubbles have not been a concern so far, but asset price movements warrant careful attention in an environment of rising external inflows. Further financial market development would help for effectively channeling inflows toward long-term investments such as infrastructure.

51. To further strengthen the banking supervision framework, it remains critical that the proposed amendments to the BSP Charter be approved. Banks seem well placed to handle new global financial regulations, including Basel III, given their high levels of capital, particularly Tier 1 capital.

52. In order for growth to rise to a higher level and to be more inclusive, it will be critical for the government to continue with efforts to rebalance the economy toward investment as well as address impediments to job creation and productivity. Raising government revenue will be important for providing the needed fiscal space. Ultimately, however, the more sustainable expansion in investment will have to come from the private investment, which would be facilitated by improvements in the business climate, infrastructure, and power supply as well as by deeper capital markets.

53. It is recommended that the next Article IV consultation take place on the standard 12-month cycle

Table 1.Philippines: Selected Economic Indicators, 2007-11

Nominal GDP (2009): P7,679 billion ($161.2 billion)

Population (2009): 92.2 million

GDP per capita (2009): $1,748

Poverty headcount ratio at $2 a day at PPP (2003): 43 percent

IMF quota: SDR 879.9 million

Main products and exports: Electronics and agricultural products

Unemployment rate (2009): 7.5 percent

20072008200920102011 1/
Staff Proj.
GDP and prices (percent change)
Real GDP7.13.71.17.05.0
CPI (annual average)2.89.33.23.83.9
CPI (end year)3.98.04.33.04.5
Investment and saving (percent of GDP)
Gross investment15.415.314.615.215.4
National saving 2/20.317.520.120.719.7
Public finances (percent of GDP)
National government balance (authorities’ definition)-0.2-0.9-3.9-3.8-3.2
National government balance (IMF definition) 3/-1.7-1.5-4.0-3.8-3.3
Total revenue and grants15.815.814.614.515.5
Total expenditure17.417.318.618.418.9
Non-financial public sector balance 4/0.2-0.3-3.4-2.6
Non-financial public sector debt61.060.760.758.0
Monetary sector (percent change, end of period)
Broad money (M3)10.615.68.37.7 5/
Interest rate (91-day treasury bill, end of period, in percent) 6/4.25.84.31.8 7/
Credit to the private sector8.516.88.110.1 5/
External Sector
Export value (percent change)6.4-2.5-22.133.810.2
Import value (percent change)8.75.6-24.024.913.0
Current account (percent of GDP)4.92.25.55.44.3
Capital and financial account (US$ billions,
excluding errors and omissions)3.5-1.6-1.17.46.3
Direct investment (net)-0.61.31.61.92.0
Other4.1-2.9-2.75.64.3
Errors and omissions (US$ billions)-2.1-1.9-1.3-1.50.0
Overall balance (US$ billions)8.60.16.416.114.8
Total external debt (percent of GDP) 8/46.339.240.238.639.2
Debt-service ratio 9/13.012.714.313.512.3
Reserves, adjusted (US$ billions) 10/33.835.944.262.978.4
Reserves/short-term liabilities, adjusted 11/240.5284.4389.1498.6595.4
Exchange rate (period averages)
Pesos per U.S. dollar46.144.547.645.2 12/
Nominal effective exchange rate (2005 =100)114.4113.5106.8
Real effective exchange rate (2005 =100)119.6124.4121.2
Sources: Philippine authorities; and IMF staff projections.

Public finance projections reflect the 2011 budget.

The saving rate is calculated as the sum of the investment rate and the current account balance (all as a percent of GDP).

Excludes privatization receipts and includes deficit from restructuring of the central bank (Central Bank-Board of Liquidators).

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

October 2010 (year-on-year).

Secondary market rate.

November 2010.

Includes liabilities of foreign banks in the Philippines to their headquarters, branches and agencies, external debt not registered with the central bank, and private capital lease agreements.

In percent of exports of goods and non-factor services.

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

Short-term liabilities include medium- and long-term debt due in the following year.

Average for January to November 2010.

Sources: Philippine authorities; and IMF staff projections.

Public finance projections reflect the 2011 budget.

The saving rate is calculated as the sum of the investment rate and the current account balance (all as a percent of GDP).

Excludes privatization receipts and includes deficit from restructuring of the central bank (Central Bank-Board of Liquidators).

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

October 2010 (year-on-year).

Secondary market rate.

November 2010.

Includes liabilities of foreign banks in the Philippines to their headquarters, branches and agencies, external debt not registered with the central bank, and private capital lease agreements.

In percent of exports of goods and non-factor services.

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

Short-term liabilities include medium- and long-term debt due in the following year.

Average for January to November 2010.

Table 2.Philippines: National Government Cash Accounts, 2007-11(In percent of GDP; unless otherwise noted)
20072008200920102011
Auth.StaffAuth.Staff
BudgetProj.BudgetProj.
Revenue and grants15.815.814.615.614.515.514.9
Tax revenue14.014.212.813.913.014.113.3
Net income and profits6.46.55.75.96.06.0
Excises1.01.01.01.11.2
VAT4.14.03.93.94.1
Tariffs1.01.20.90.90.8
Other 1/2/1.41.41.31.21.2
Non-tax revenue1.71.71.81.71.61.51.6
Of which revenue measures0.00.0
Expenditure and net lending17.417.318.619.618.418.918.4
Current expenditures14.414.115.015.614.915.114.7
Personnel services5.35.15.45.95.56.05.9
Maintenance and operations1.91.92.32.32.32.32.3
Allotments to local government units2.32.32.62.62.52.52.5
Subsidies0.30.20.20.20.20.10.1
Tax expenditure0.50.80.70.50.50.20.2
Interest4.23.83.74.03.94.03.9
Capital and equity expenditure 3/2.93.03.63.83.43.63.5
Net lending0.10.20.10.20.10.20.2
Balance-1.7-1.5-4.0-4.0-3.8-3.3-3.5
On the authorities’ presentation 4/-0.2-0.9-3.9-3.9-3.8-3.2-3.4
Memorandum Items:
Non-financial public sector balance 5/0.2-0.3-3.4-2.6-2.4
Consolidated public sector balance 5/0.30.0-3.2-2.4-2.2
Primary national government balance2.52.3-0.30.00.10.70.3
National government debt 6/47.848.749.247.447.1
(percent of NG revenues)303.4307.4336.7326.4317.0
Non-financial public sector debt 7/61.060.760.758.057.3
(percent of NFPS revenues)253.5264.7293.1279.6273.4
National government gross financing requirement 8/17.815.018.916.516.2
GDP (in billions of pesos) 9/6,6497,4097,6798,3168,4859,0459,262
Sources: Philippine authorities; and IMF staff projections.

Projections do not include possible gains from tax administrative measures.

Includes other percentage taxes, documentary stamp tax, and non-cash collections. Non-cash collections are also reflected as tax expenditures under current expenditures.

Excludes purchase of National Power Corporation securities and other onlending; includes capital transfers to LGUs. May exceed public investment in years when capital transfers to LGUs exceed their reported capital spending.

Includes privatization receipts as revenue and excludes the operations of the Central Bank-Board of Liquidators (CB-BOL).

Excludes privatization receipts from revenue.

Consolidated (net of national government debt held by the sinking fund) and excluding contingent/guaranteed debt.

Non-financial public sector includes the national government, CB-BOL, 14 monitored government-owned enterprises, social security institutions, and local governments. Debt is consolidated (net of intra-non-financial public sector holdings of debt).

Defined as the deficit, plus amortization of medium- and long-term debt, plus the stock of short-term debt at the end of the last period, plus market financing on behalf of NPC.

For the budget, the lower bound of the range of GDP estimates.

Sources: Philippine authorities; and IMF staff projections.

Projections do not include possible gains from tax administrative measures.

Includes other percentage taxes, documentary stamp tax, and non-cash collections. Non-cash collections are also reflected as tax expenditures under current expenditures.

Excludes purchase of National Power Corporation securities and other onlending; includes capital transfers to LGUs. May exceed public investment in years when capital transfers to LGUs exceed their reported capital spending.

Includes privatization receipts as revenue and excludes the operations of the Central Bank-Board of Liquidators (CB-BOL).

Excludes privatization receipts from revenue.

Consolidated (net of national government debt held by the sinking fund) and excluding contingent/guaranteed debt.

Non-financial public sector includes the national government, CB-BOL, 14 monitored government-owned enterprises, social security institutions, and local governments. Debt is consolidated (net of intra-non-financial public sector holdings of debt).

Defined as the deficit, plus amortization of medium- and long-term debt, plus the stock of short-term debt at the end of the last period, plus market financing on behalf of NPC.

For the budget, the lower bound of the range of GDP estimates.

Table 3.Philippines: Balance of Payments, 2007-11(In billions of U.S. dollars)
20072008200920102011
Staff proj.
CURRENT ACCOUNT BALANCE7.13.68.810.28.5
Trade Balance-8.4-12.9-8.9-7.7-10.1
Exports, f.o.b.49.548.337.650.355.4
Imports, f.o.b.57.961.146.558.065.6
Services (net)2.21.21.61.41.5
Receipts9.89.710.211.913.4
Payments7.58.68.710.511.9
Income-0.90.10.0-0.9-1.6
Receipts, of which:5.46.05.75.96.2
Remittances of resident workers abroad 1/3.04.14.64.85.0
Payments6.35.95.76.87.7
Interest payments3.63.32.63.23.9
Transfers (net)14.215.216.117.418.7
Receipts, of which:14.615.816.718.119.5
Non-resident workers remittances 1/13.314.515.116.718.0
Payments0.40.50.60.70.8
CAPITAL AND FINANCIAL ACCOUNT3.5-1.6-1.17.46.3
Capital Account0.00.10.10.10.1
Financial Account3.5-1.7-1.27.36.2
Direct Investment-0.61.31.61.92.0
Portfolio Investment4.6-3.60.34.03.7
Equity3.1-1.2-1.10.50.5
Debt1.5-2.41.43.53.2
Financial Derivatives-0.3-0.10.00.00.0
Other Investment, of which:-0.20.8-3.11.50.5
Currency and deposits-3.2-3.73.9-0.5-0.4
ERRORS AND OMISSIONS-2.1-1.9-1.3-1.50.0
OVERALL BALANCE8.60.16.416.114.8
OVERALL FINANCING-8.6-0.1-6.4-16.1-14.8
Monetization of gold and revaluation2.22.21,82.50.7
Change in Net international reserves (increase =-)-10.8-2.3-8.2-18.6-15.5
Memorandum items:
Current account/GDP4.92.25.55.44.3
Short-term debt (original maturity)9.910.06.57.58.4
Short-term debt (residual maturity)14.014.311.412.613.2
Gross reserves33.837.644.262.978.4
Adjusted gross reserves 2/33.835.944.262.978.4
(in percent of st. debt by res. maturity) 3/240.5284.4389.1498.6595.4
Net international reserves33.736.044.262.978.4
Monitored external debt (in billions) 4/66.765.364.972.178.4
(in percent of GDP)46.339.240.238.639.2
Debt service ratio 5/13.012.714.313.512.3
Export value (percent change)6.4-2.5-22.133.810.2
Import value (percent change)8.75.6-24.024.913.0
Gross external financing needs 6/4.710.45.52.04.1
Remittances value (percent change)13.213.75.68.17.6
Sources: Philippine authorities; and IMF staff projections.

The 2003-04 revisions to the data separate remittances made by Filipino residents working abroad (income), and non-resident workers’ remittances (transfers).

Gross reserves less gold and securities pledged as collateral against short-term liabilities.

As a percent of short-term debt excluding pledged assets of the central bank.

Monitored external liabilities are defined as external debt plus liabilities of foreign banks in the Philippines to their headquarters, branches and agencies, some external debt not registered with the central bank, and private capital lease agreements.

In percent of goods and non-factor services.

Defined as the current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at the end of the previous period.

Sources: Philippine authorities; and IMF staff projections.

The 2003-04 revisions to the data separate remittances made by Filipino residents working abroad (income), and non-resident workers’ remittances (transfers).

Gross reserves less gold and securities pledged as collateral against short-term liabilities.

As a percent of short-term debt excluding pledged assets of the central bank.

Monitored external liabilities are defined as external debt plus liabilities of foreign banks in the Philippines to their headquarters, branches and agencies, some external debt not registered with the central bank, and private capital lease agreements.

In percent of goods and non-factor services.

Defined as the current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at the end of the previous period.

Table 4.Philippines: Depository Survey, 2007-10(In billions of pesos; unless otherwise noted)
2007200820092010
Dec.Dec.Dec.Mar.Jun.Sep.
Net foreign assets1,6591,9312,4202,4942,6482,610
Central bank1,3651,6862,0282,0372,2342,335
Net international reserves1,3971,7172,0542,0642,2612,360
Medium- and long-term foreign liabilities323126272725
Deposit money banks294245392457414275
Net domestic assets2,4222,7382,6382,5312,4862,547
Net domestic credit3,1623,6913,9634,0014,1094,134
Public sector credit1,0271,1991,2691,3571,3701,371
National government7678919701,0551,0311,029
Credits1,0821,2231,3591,3861,3901,436
Foreign exchange receivables000000
Treasury IMF accounts-51-58-57-54-54-54
Deposits-265-274-331-277-305-354
Local government and others261308299302339342
Private sector credit2,1342,4922,6942,6432,7392,763
Other items net-740-953-1,325-1,469-1,623-1,587
Total liquidity4,0814,6695,0585,0255,1345,157
M43,9254,6104,9974,9535,0785,098
M3 (peso liquidity)3,1743,6683,9723,8943,9724,056
Foreign currency deposits, residents7519421,0261,0581,1061,042
Other liabilities1555860725660
Annual percent change
Net foreign assets21.416.425.318.022.712.8
Net domestic assets-1.013.1-3.72.4-0.95.1
Net domestic credit5.216.87.48.68.59.4
Public sector-1.216.75.89.19.49.0
Private sector8.516.88.18.38.19.5
M45.517.58.49.910.38.9
M310.615.68.310.310.310.5
Sources: Philippine authorities (New Depository Corporation Survey); and CEIC Data Company Ltd.
Sources: Philippine authorities (New Depository Corporation Survey); and CEIC Data Company Ltd.
Table 5.Philippines: Baseline Medium-Term Outlook, 2008-15(In percent of GDP, unless otherwise indicated)
20082009201020112012201320142015
Staff Proj.
GDP and prices
Real GDP (percent change)3.71.17.05.05.05.05.05.0
GDP per capita (US$)1,8421,7481,9882,0852,2002,3092,4272,550
CPI (percent change, average)9.33.23.83.94.74.04.04.0
Investment and saving
Gross investment15.314.615.215.415.715.916.116.3
Private12.311.612.412.512.612.712.913.1
Public3.03.12.92.93.13.23.23.2
National saving 1/17.520.120.719.719.419.018.418.0
Private14.520.220.218.918.016.916.316.1
Public3.0-0.10.50.71.42.12.11.9
Foreign saving-2.2-5.5-5.4-4.3-3.7-3.1-2.3-1.7
Public finances
Non-financial public sector balance 2/-0.3-3.4-2.6-2.4-1.9-1.4-1.3-1.5
Primary balance3.90.71.61.72.12.42.32.0
Revenue and grants 3/22.920.720.721.022.022.922.922.8
Expenditure (primary) 4/19.120.019.219.319.920.520.620.8
Interest4.14.14.24.14.03.73.63.5
Non-financial public sector gross financing14.919.315.915.613.311.111.111.0
Domestic13.915.011.612.810.58.38.58.6
Foreign currency1.04.34.32.82.72.72.62.4
National government balance (authorities’ definition)-0.9-3.9-3.8-3.4-2.7-2.0-2.0-2.0
National government balance (IMF definition) 5/-1.5-4.0-3.8-3.5-2.7-2.0-2.0-2.1
Non-financial public sector debt 6/60.760.758.057.355.753.751.449.4
External sector
Export value (percent change)-2.5-22.133.810.26.55.65.55.5
Import value (percent change)5.6-24.024.913.07.37.07.37.1
Trade balance-7.7-5.5-4.1-5.1-5.3-5.6-6.1-6.5
Current account2.25.55.44.33.73.12.31.7
Direct investment (net, US$ billions)1.31.61.92.02.02.12.22.2
Reserves, adjusted (US$ billions) 7/35.944.262.978.493.4107.6120.6132.4
Reserves / Short-term liabilities, adjusted 8/284.4389.1498.6595.4640.8693.8726.3751.4
Gross external financing requirements (US$ billions) 9/10.45.52.04.15.17.49.712.0
Total external debt (in percent of GDP)10/39.240.238.639.239.439.539.439.1
Debt service ratio (in percent of exports of G&S)12.714.313.512.311.211.310.810.2
Sources: Philippine authorities; and IMF staff projections.

The saving rate is calculated as the sum of the investment rate and the current account balance (all as a percent of GDP).

Non-financial public sector includes the national government, CB-BOL, 14 monitored government-owned enterprises, social security institutions, and local governments.

The sum of all non-financial 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 non-financial public sector. Privatization receipts are excluded.

Defined as the difference between non-financial public sector revenue and primary balance.

Excludes privatization receipts of the national government, and includes net deficit from restructuring the central bank.

Net of intra-non-financial public sector holdings of debt.

Gross reserves less gold and securities pledged as collateral against short-term liabilities.

Reserves as a percent of short-term debt (including medium- and long-term debt due in the following year). Both reserves and debt were adjusted for gold-backed loans.

Current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at the end of the previous period.

Defined as external debt plus liabilities of foreign banks in the Philippines to their headquarters, branches and agencies, some external debt not registered with the central bank and private capital lease agreements.

Sources: Philippine authorities; and IMF staff projections.

The saving rate is calculated as the sum of the investment rate and the current account balance (all as a percent of GDP).

Non-financial public sector includes the national government, CB-BOL, 14 monitored government-owned enterprises, social security institutions, and local governments.

The sum of all non-financial 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 non-financial public sector. Privatization receipts are excluded.

Defined as the difference between non-financial public sector revenue and primary balance.

Excludes privatization receipts of the national government, and includes net deficit from restructuring the central bank.

Net of intra-non-financial public sector holdings of debt.

Gross reserves less gold and securities pledged as collateral against short-term liabilities.

Reserves as a percent of short-term debt (including medium- and long-term debt due in the following year). Both reserves and debt were adjusted for gold-backed loans.

Current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at the end of the previous period.

Defined as external debt plus liabilities of foreign banks in the Philippines to their headquarters, branches and agencies, some external debt not registered with the central bank and private capital lease agreements.

Table 6.Philippines: Banking Sector Indicators, 2007-10(Percent)
2007200820092010
Q1
Capital adequacy
Total capital accounts to total assets11.710.611.111.4
Capital adequacy ratio (consolidated basis)15.715.515.816.0 1/
Asset quality
NPL ratio 2/5.84.14.14.5
NPA ratio 3/5.85.14.54.5
Distressed asset ratio 4/12.510.89.39.9
NPL coverage ratio 5/81.586.093.194.0
NPA coverage ratio 6/39.845.048.750.2
Profitability
Return on assets1.30.81.21.3
Return on equity10.76.910.811.4
Cost-to-income ratio65.274.065.865.2
Liquidity
Liquid assets to deposits51.952.552.757.3
Loans (gross) to deposits70.969.768.165.0
Source: Philippine authorities (Status Report on the Philippine Financial System).Note: ROPA = Real and Other Property Acquired. ROPA is a measure of the stock of foreclosed properties held by a bank.

As of March 2010.

Non-performing loans (NPL) over total loan portfolio excluding interbank loans (TL).

(Non-performing loans + ROPA) over total gross assets.

Ratio of (NPLs + Gross ROPA + current restructed loans) to (Gross total loan portfolio + Gross ROPA).

Ratio of loan loss reserves to NPLs.

Ratio of valuation reserves (for loans and ROPA) to NPAs.

Source: Philippine authorities (Status Report on the Philippine Financial System).Note: ROPA = Real and Other Property Acquired. ROPA is a measure of the stock of foreclosed properties held by a bank.

As of March 2010.

Non-performing loans (NPL) over total loan portfolio excluding interbank loans (TL).

(Non-performing loans + ROPA) over total gross assets.

Ratio of (NPLs + Gross ROPA + current restructed loans) to (Gross total loan portfolio + Gross ROPA).

Ratio of loan loss reserves to NPLs.

Ratio of valuation reserves (for loans and ROPA) to NPAs.

Table 7.Philippines: Indicators of External Vulnerability, 2007-11(In percent of GDP, unless otherwise indicated)
20072008200920102011
Staff Proj.
External indicators (including external liquidity):
Gross international reserves, adjusted (US$ billions) 1/33.835.944.262.978.4
Maturing short-term debt (US$ billions)9.910.06.57.58.4
Amortization of medium and long-term debt (US$ billions)4.14.14.35.65.1
Net direct investment inflows (US$ billions)-0.61.31.61.92.0
FX deposits residents (US$ billions) 2/19.520.622.824.7
Total gross external debt46.339.240.238.639.2
Public sector indicators:
Overall balance0.2-0.3-3.4-2.6-2.4
Primary balance4.83.90.71.61.7
Non-financial public sector debt (NFPSD)61.060.760.758.057.3
NFPSD denominated in FX or linked to the exchange rate (in percent of NFPSD)57.258.558.858.056.5
Short-term general government debt (original maturity, in percent of NFPSD)17.219.014.915.015.2
Average effective interest rate of government debt (in percent)7.56.86.87.27.1
Amortization of total debt18.314.615.913.313.2
Sources: Philippine authorities; and IMF staff projections.

Gross reserves less gold and securities pledged as collateral against short-term liabilities.

As of June 2010.

Sources: Philippine authorities; and IMF staff projections.

Gross reserves less gold and securities pledged as collateral against short-term liabilities.

As of June 2010.

Appendix I. Debt Sustainability Analysis

The outlook for public debt dynamics is favorable. Non-financial sector public debt has been steadily declining from over 100 percent of GDP in 2003 to below 60 percent of GDP in 2010. Based on the government’s medium-term objective of a national government deficit to 2 percent of GDP, public debt is projected to continue this declining trend to 47 percent of GDP by 2015. Gross financing need is also expected to decline from 16 percent of GDP in 2010 to 11 percent of GDP by 2015. If the deficit were to remain 1 percent of GDP higher than currently projected or if medium-term growth were lower by 1 percent, debt levels would remain stable but at an elevated level above 55 percent of GDP through 2014. Given the high share of foreign currency debt, the main vulnerability arises from exchange rate risk.

Projected external debt dynamics are stable. In recent years, external debt has steadily declined, from nearly 80 percent of GDP in 2002 to just over 40 percent of GDP at end-2009. Under the staff’s baseline scenario, the external debt ratio is projected to remain stable, a result of debt creating capital inflows. Further, the debt dynamics appear to be relatively resilient to various shocks: one-half standard deviation shocks to interest rates, growth, and the current account lead to only a modest deterioration in the debt ratios over the medium term. However, exchange rate volatility remains a vulnerability as a one-time real depreciation of 30 percent would entail an 18 percent jump in the external debt ratio from its end 2009 level.

Table A1.Philippines: Public Sector Debt Sustainability Framework, 2005-2015(In percent of GDP, unless otherwise indicated)
ActualProjections
20052006200720082009201020112012201320142015Debt-stabilizing
primary
balance 9/
1Baseline: Public sector debt 1/85.973.961.060.760.758.057.355.853.751.547.10.0
Of which foreign-currency denominated52.345.334.935.535.733.632.431.630.930.028.1
2Change in public sector debt-9.3-11.9-12.9-0.40.0-2.7-0.7-1.5-2.1-2.3-4.4
3Identified debt-creating flows (4+7+12)-10.9-12.1-13.6-0.9-0.5-3.2-2.8-2.9-3.2-2.9-2.7
4Primary deficit-4.3-5.8-4.8-3.8-0.8-1.5-1.5-2.0-2.5-2.2-2.1
5Revenue and grants22.123.024.122.920.720.720.821.922.922.922.9
6Primary (noninterest) expenditure17.817.219.319.019.919.219.319.920.520.620.8
7Automatic debt dynamics 2/-6.9-6.2-9.12.71.1-1.6-0.8-1.2-1.0-0.9-0.8
8Contribution from interest rate/growth differential 3/-3.6-2.6-2.3-2.12.0-1.6-0.8-1.2-1.0-0.9-0.8
9Of which contribution from real interest rate0.61.62.4-0.12.62.21.91.41.61.51.5
10Of which contribution from real GDP growth-4.2-4.2-4.8-2.0-0.6-3.8-2.7-2.6-2.6-2.5-2.4
11Contribution from exchange rate depreciation 4/-3.3-3.7-6.84.8-0.9
12Other identified debt-creating flows0.40.00.20.2-0.90.0-0.50.30.20.20.2
13Privatization receipts (negative)0.0-0.1-1.4-0.40.00.0-0.10.00.00.00.0
14Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
15Other (specify, e.g., bank recapitalization)0.40.11.60.6-0.90.0-0.40.30.30.30.3
16Residual, including asset changes (2-3)5/1.60.10.70.60.60.42.11.41.10.6-1.7
Public sector debt-to-revenue ratio 1/389.5321.5253.5265.2293.3280.0275.3255.0234.3225.0205.6
Gross financing need 6/24.324.218.114.919.215.915.813.411.111.110.9
In billions of U.S. dollars24.028.426.124.931.029.831.528.825.427.328.9
Scenario with key variables at their historical averages 7/58.055.853.751.448.743.6-0.3
Scenario with no policy change (constant primary balance) in 2010-201558.056.455.354.252.648.80.0
Key Macroeconomic and Fiscal Assumptions Underlying Baseline
Real GDP growth (in percent)5.05.47.13.71.17.05.05.05.05.05.0
Average nominal interest rate on public debt (in percent) 8/7.57.56.87.57.07.67.77.77.37.37.4
Average real interest rate (nominal rate minus change in GDP deflator, in percent)1.02.33.90.14.54.33.73.03.33.33.4
Nominal appreciation (increase in U.S. dollar value of local currency, in percent)6.08.018.7-12.82.4
Inflation rate (GDP deflator, in percent)6.55.12.97.52.63.33.94.74.04.04.0
Growth of real primary spending (deflated by GDP deflator, in percent)-1.71.820.62.15.73.05.88.38.05.76.0
Primary deficit-4.3-5.8-4.8-3.8-0.8-1.5-1.5-2.0-2.5-2.2-2.1

Coverage of public sector is for non-financial public sector gross debt.

Derived as [(r - π(1+g) - g + αε(1 +r)]/(1 +g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and δ = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1 +g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium- and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Coverage of public sector is for non-financial public sector gross debt.

Derived as [(r - π(1+g) - g + αε(1 +r)]/(1 +g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and δ = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1 +g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium- and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure A1.Philippines: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Sources: International Monetary Fund, country desk data, and staff estimates.

1/ Shaded areas represent actual data.Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projectionsfor the respective variables in the baseline and scenario being presented. Ten-year historical average forthe variable is also shown.

2/ Permanent 1/4 standard deviation shocksapplied to real interest rate, growth rate, and primary balance.

3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2010, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Table A2.Philippines: External Debt Sustainability Framework, 2005-2015(In percent of GDP, unless otherwise indicated)
ActualProjections
20052006200720082009201020112012201320142015Debt-stabilizing

non-interest
current account 6/
1Baseline: External debt62.952.146.039.040.138.639.239.439.539.439.1-2.4
2Change in external debt-7.8-10.7-6.1-7.01.1-1.50.60.10.1-0.1-0.3
3Identified external debt-creating flows (4+8+9)-13.7-19.1-16.3-8.4-4.4-9.1-7.6-6.8-6.1-5.4-4.7
4Current account deficit, excluding interest payments-5.2-7.3-7.4-4.1-7.0-6.9-6.2-5.4-4.6-3.9-3.1
5Deficit in balance of goods and services9.25.64.37.04.53.43.94.34.85.25.7
6Exports45.345.141.134.829.732.933.032.932.832.632.4
7Imports54.550.745.441.834.236.336.937.237.637.838.0
8Net non-debt creating capital inflows (negative)-3.2-4.5-1.70.0-0.3-1.2-1.2-1.1-1.1-1.1-1.0
9Automatic debt dynamics 1/-5.3-7.2-7.1-4.32.9-0.9-0.1-0.2-0.3-0.4-0.6
10Contribution from nominal interest rate3.22.82.51.91.61.51.71.61.51.41.3
11Contribution from real GDP growth-3.1-2.8-3.0-1.5-0.4-2.4-1.8-1.8-1.8-1.8-1.8
12Contribution from price and exchange rate changes 2/-5.4-7.2-6.6-4.81.7
13Residual, incl. change in gross foreign assets (2-3) 3/5.98.410.21.45.57.68.26.96.25.34.5
External debt-to-exports ratio (in percent)138.8115.7111.9112.1134.9117.4118.8119.8120.6121.0120.9
Gross external financing need (in billions of U.S. dollars) 4/10.99.34.710.45.52.03.64.97.49.411.6
in percent of GDP11.07.93.36.23.41.11.82.33.23.84.4
Scenario with key variables at their historical averages 5/38.640.140.539.838.436.1-2.8
Key Macroeconomic Assumptions Underlying Baseline
Real GDP growth (in percent)5.05.37.13.71.17.05.05.05.05.05.0
GDP deflator in U.S. dollars (change in percent)8.312.914.511.5-4.38.41.82.52.02.12.1
Nominal external interest rate (in percent)5.15.35.84.94.04.34.64.34.13.93.4
Growth of exports (U.S. dollar terms, in percent)4.618.311.9-2.2-17.428.47.47.16.66.66.5
Growth of imports (U.S. dollar terms, in percent)7.210.59.86.5-20.822.98.78.58.17.97.9
Current account balance, excluding interest payments5.27.37.44.17.06.96.25.44.63.93.1
Net non-debt creating capital inflows3.24.51.70.00.31.21.21.11.11.11.0

Derived as [r - g - ρ(1 +g) + εα (1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1 +g) + εα(1 +r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε> 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The keyvariables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that keyvariables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - ρ(1 +g) + εα (1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1 +g) + εα(1 +r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε> 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The keyvariables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that keyvariables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure A2.Philippines: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes representaverage projections for the respective variables in the baseline and scenario being presented.Ten-year historical average for the variable is also shown.

2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current accountbalance.

3/One-time real depreciation of 30 percentoccurs in 2010.

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