PHILIPPINES ECONOMIC UPDATE STAYING THE COURSE AMID GLOBAL UNCERTAINTY October 2018 Macroeconomics, Trade & Investment Global Practice East Asia and Pacific Region 3 PREFACE PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY The Philippines Economic Update (PEU) summarizes key economic and social developments, important policy changes, and the evolution of external conditions over the past six months. It also presents findings from recent World Bank analysis, situating them in the context of the country’s long-term development trends and assessing their implications for the country’s medium term economic outlook. The PEU covers issues ranging from macroeconomic management, financial-market dynamics to the complex challenges of poverty reduction and social development. It is intended to serve the needs of a wide audience, including policymakers, business leaders, private firms and investors, and analysts and professionals engaged in the social and economic development of the Philippines. The PEU is a biannual publication of the World Bank’s Macroeconomics, Trade & Investment Global Practice (MTI), prepared in partnership with the Poverty & Equity, Finance & Markets, and Social Protection & Labor Global Practices (GPs). This edition is prepared by Rong Qian (Senior Economist), Kevin Chua (Economist), Kevin Cruz (Research Analyst), and Karen Lazaro (Consultant) from the MTI GP, Pablo Ariel Acosta (Senior Economist) from the Social Protection & Labor GP, Isaku Endo (Senior Financial Sector Specialist) from the Finance & Markets GP, Lewis Hawke (Lead Public Sector Specialist) from Governance, Gabriel Demombynes (Program Leader), Xubei Luo (Senior Economist) and Sharon Faye Alariao Piza (Economist) from the Poverty & Equity GP. Ndiame Diop (Practice Manager for the MTI GP) and Birgit Hansl (Lead Economist and Program Leader) provided guidance. The report was edited by Oscar Parlback (Consultant), and the graphic designer was Christopher Carlos (Consultant). Peer reviewers were Richard Record (Lead Economist, GMTP2) and Derek Hung Chiat Chen (Senior Economist, GMTP2). Logistics and publication support were provided by Maria Consuelo Sy (Program Assistant) and Reinaluz Ona (Program Assistant). The Manila External Communications Team, consisting of Leonora Gonzalez (Senior Communication Officer), David Llorito (Communications Officer) and Stephanie Anne Margallo (Team Assistant) prepared the media release, dissemination plan, and web-based multimedia presentation. The team would like to thank Mara Warwick (Country Director for Brunei, Malaysia, Philippines and Thailand) for her advice and support. The report benefited from the recommendations and feedback of various stakeholders in the World Bank as well as from the government, the business community, labor associations, academic institutions, and civil society. The team is very grateful for their contributions and perspectives. The findings, interpretations, and conclusions expressed in the PEU are those of the World Bank and do not necessarily reflect the views of the World Bank’s executive board or any national government. If you wish to be included in the email distribution list for the PEU and related publications, please contact Maria Consuelo Sy (msy@worldbank.org). For questions and comments regarding the content of this publication, please contact Rong Qian (rqian@worldbank.org). Questions from the media should be addressed to David Llorito (dllorito@worldbank.org). For more information about the World Bank and its activities in the Philippines, please visit www.worldbank.org/ph. 5 TABLE OF CONTENTS PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY PREFACE 3 TABLE OF CONTENTS 5 LIST OF FIGURES 6 LIST OF TABLES 8 LIST OF BOXES 8 EXECUTIVE SUMMARY 9 PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS 10 GROWTH: INVESTMENT-LED GROWTH AMID A WEAKENING EXTERNAL SECTOR 12 THE EXCHANGE RATE AND THE EXTERNAL SECTOR: WIDENING BALANCE OF PAYMENTS DEFICIT 16 FINANCIAL MARKETS AND MONETARY POLICY: AN ACTIVE MONETARY POLICY TO MANAGE PERSISTENT HIGH INFLATION 18 FISCAL POLICY: SUSTAINING THE REFORM AGENDA 21 EMPLOYMENT AND POVERTY: LABOR MARKET CONDITIONS CONTINUE TO REMAIN TIGHT 24 PART 02: OUTLOOK AND RISKS 28 GROWTH OUTLOOK 30 POVERTY AND SHARED PROSPERITY OUTLOOK 37 RISKS AND POLICY CHALLENGES 39 PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH 42 INTRODUCTION 44 GROWTH DRIVERS IN THE PHILIPPINES SINCE THE EARLY 1980S 44 PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY 47 PATTERNS AND DRIVERS OF PRODUCTIVITY AT THE INDUSTRY AND FIRM LEVEL 49 POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES 54 ACHIEVING THE AMBISYON NATIN 2040 TARGET 64 IMPLICATIONS FOR POVERTY REDUCTION 65 REFERENCES 67 6 LIST OF FIGURES LIST OF FIGURES Figure 1. In the first half of 2018, capital formation growth drove economic growth 13 Figure 2. …while growth in the service sector fueled growth on the production side 13 Figure 3. Manufacturing activity slowed in the first half of 2018… 14 Figure 4. …as well as trade activity. 14 Figure 5. New orders of electronics equipment have decelerated in 2018… 15 Figure 6. …leading to a decline in electronics equipment output globally. 15 Figure 7. Philippine exports have been contracting since January 2018. 16 Figure 8. The Philippine peso depreciated in the first eight months of 2018 in both nominal and real terms. 16 Figure 9. Headline inflation breached the BSP’s target range in the first seven months of 2018. 19 Figure 10. The commercial loan portfolio is dominated by the real estate, utilities, transport, and ICT sectors. 19 Figure 11. The Philippines’ credit-to-GDP ratio remains low, and its rate of non-performing loans is among the lowest in the region. 19 Figure 12. Higher food prices drove more than half of the August year-to-date inflation. 20 Figure 13. The combined contribution of energy and transport prices to inflation has steadily risen since March. 20 Figure 14. The government’s budget deficit reached 2.3 percent of GDP on the back of an expansionary fiscal policy… 21 Figure 15. ...with external financing playing a larger role in the overall financing mix. 21 Figure 16. While the unemployment rate remained around 5.5 percent in the first half of 2018, underemployment increased slightly... 24 Figure 17. …and the labor force participation rate remained below its 12-year average in the same period. 24 Figure 18. Between 2017 and 2018, new jobs were created in the construction and public services sectors… 25 Figure 19. …while the professional services subsector experienced the highest job expansion among services 25 Figure 20. The average real daily wage increased in the first month of 2018 compared to 2017 average… 26 Figure 21. ...while the average wage declined compared to the same period a year ago 26 Figure 22. The share of wages in total household income has increased over time. 26 Figure 23. The share of transfers and remittances in the income of households in the bottom quintile nearly tripled in 2007-17. 26 Figure 24. Incomes of households in the bottom quintile are growing at a faster rate than the income of the average household. 27 Figure 25. The Philippines’ Growth Trajectory is Positive but Lower than Expected 30 Figure 26. Global growth in 2018 is projected to grow at the same rate as in the previous 32 Figure 27. Global trade is expected to slow down in 2018. 32 Figure 28. Top Recipients of the National Budget (2018 & Proposed Cash-based 2019). 35 Figure 29. Poverty reduction will likely continue in the coming years 37 Figure 30. Prices of basic commodities are increasing… 38 Figure 31. …and poor households are affected 38 Figure 32. Degree of similarity between export baskets to the U.S. for affected Chinese products. 40 Figure 33. Potential replacement of Chinese exports to the U.S. by countries in the East Asia Pacific. 40 Figure 34. Capital accumulation in the Philippines, as a share of GDP, is the lowest among peers… 45 Figure 35. …and the inflow of net FDI is also low relative to peers. 45 Figure 36. The level of public investment in the Philippines is among the lowest in the region… 45 Figure 37. …and significantly low relative to structural peers. 45 Figure 38. TFP’s contribution to growth has increased since 2010… 46 Figure 39. …after it declined temporarily in 2009 at the height of the global recession. 46 Figure 40. Contribution of TFP to economic growth was higher in the Philippines than in many regional peers… 46 Figure 41. …as well as in many structural peers. 46 Figure 42. Labor productivity in the Philippines is below the average of regional peers… 47 Figure 43. …but above the average of structural peers. 47 Figure 44. Most sectors in the Philippines experienced labor productivity growth in 2010-16 48 7 LIST OF FIGURES PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Figure 45. Labor is transitioning from agriculture to more productive sectors. 48 Figure 46. Most firms are small in the manufacturing sector… 49 Figure 47. …as well as in the service sector. 49 Figure 48. Large firms are more productive than small and medium-sized firms in manufacturing… 50 Figure 49. …as well as in services. 50 Figure 50. Firms in the Philippines are growing at a healthy rate. 50 Figure 51: The share of firms with foreign ownership remains small. 51 Figure 52. Foreign ownership is high in some services and manufacturing sectors. 51 Figure 53. Firms with foreign ownership are on average more productive than fully domestically owned firms. 52 Figure 54. Foreign ownership is correlated with higher productivity. 52 Figure 55. The share of Philippine firms that export declined in 2010-14. 52 Figure 56. Firms that export are on average more productive than firms that focus on the domestic market. 52 Figure 57. The misallocation of resources has declined in Philippine manufacturing since 2009… 53 Figure 58. …and is in line with selected regional peers. 53 Figure 59. Philippine manufacturing markets are more concentrated than peers’… 55 Figure 60. …and they have become more concentrated in recent years. 55 Figure 61. Competition is perceived to be low in the Philippines 55 Figure 62. …which is related to vested interests and unfair competitive practices. 55 Figure 63. The Philippines has a liberalized trade regime reflected in its low average most-favored-nation rates among structural peers… 56 Figure 64. …as well as among regional peers. 56 Figure 65. The Philippines’ level of trade openness has been declining… 57 Figure 66. …to well below that of regional peers. 57 Figure 67. More Philippine trade companies face NTM-related obstacles compared with companies in peers. 58 Figure 68. Philippine importers face more domestic NTMs than importers in peers. 58 Figure 69. Net inflow of FDI into the Philippines has been increasing… 59 Figure 70. …but is still low relative to regional peers. 59 Figure 71. The level of FDI in the country’s economic sectors remains small… 59 Figure 72. …and most investment was concentrated in the service sector in recent years. 59 Figure 73. The availability and quality of research capital in the Philippines is low. 60 Figure 74. More collaboration between universities and industry could yield better technology diffusion. 60 Figure 75: The Philippines lags behind regional peers in the availability of information technology… 61 Figure 76: …and the cost of telecommunications services. 61 Figure 77: High costs and lack of funds are the most prominent factors hampering innovation. 61 Figure 78. Labor regulations in the Philippines are more restrictive than in peers. 62 Figure 79. Wage determination is also more restrictive in the Philippines compared with peers. 62 Figure 80. Informal employment is high in the Philippines. 63 Figure 81. Informal employment is high among non-college graduates. 63 Figure 82. A large share of Philippine migrants is highly educated… 65 Figure 83. …and those planning to emigrate have the highest levels of educational attainment. 65 Figure 84. Real wages have remained flat despite rising GDP and productivity growth. 66 Figure 85. Agriculture experienced minor real wage growth despite its low productivity. 66 Figure 86. Real wage growth in industry has remained flat despite rising productivity… 66 Figure 87. …and a similar pattern holds true in the service sector. 66 8 LIST OF TABLES LIST OF TABLES / LIST BOXES Table 1. Balance of Payments, H1 2016 – H1 2018 17 Table 2. Actual and Programmed Public Expenditures in the Philippines, H1 2016 - H1 2018 22 Table 3. The Philippine Government’s Fiscal Position, H1 2016 – H1 2018 23 Table 4. Corporate Income Tax Efficiency, 2006-16 (Average) 23 Table 5. Real GDP Growth Rates, Recent and Projected 32 Table 6. Projects Pending NEDA’s Board Approval under the Build, Build, Build Program 33 Table 7. Flagship Projects with Target Implementation under the Build, Build, Build Infrastructure program 33 Table 8. Economic Indicators for Baseline Projection 36 LIST OF BOXES Box 1. Recent Global Developments 14 Box 2. The cyclical downturn of electronics exports in 2018 15 Box 3. The Drivers of Inflation in the Philippines since January 2018 20 Box 4. The Global Economic Outlook 31 Box 5. Progress on the Build, Build, Build Program 33 Box 6. The 2019 National Budget: Moving From Obligations to Annual Cash-based Budget Appropriations 34 Box 7. The Proposed 2019 National Budget 35 Box 8. Potential Impact of the US-China Trade War on the Philippines 40 Box 9. Human Capital and the Philippines 64 Box 10. Stagnant Real Wage with Rising Labor Productivity 66 9 EXECUTIVE SUMMARY PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Heightened global market uncertainty and rising domestic inflation 6.6 percent in 2020. The baseline investment growth outlook is positive and weighed on the Philippines’ economy in the first half of 2018. An increase in planned senatorial and local elections in May 2019 are expected to lead to inflationary pressure since early 2018 along with rising interest rates in the higher public spending and higher private consumption. However, persistent United States and slowing global trade, weakened the demand for Philippine high domestic inflation could have a dampening effect on consumption and exports, fueling at the same time capital outflows and a depreciation of investment growth. Also, a faster normalization of monetary policy in the the peso. Growth moderated in the first half of 2018 to 6.3 percent, from United States and an increase in global uncertainty, including trade tensions, 6.6 percent in the same period in 2017. Meanwhile, domestic demand could not only worsen external financing conditions for emerging market continued to be driven by robust private consumption—partly due to lower economies like the Philippines but also elicit additional domestic interest income taxes, higher public wages, and strong remittance inflows—and an rate hikes that could raise domestic borrowing costs for businesses acceleration in public investment spending. Furthermore, strong domestic and households. demand coupled with supply capacity limits, contributed to higher inflation. In the short term, it is prudent to maintain Philippines’ strong In response to the buildup of inflationary pressure, Bangko Sentral ng macroeconomic fundamentals. The country is fairly resilient to capital Pilipinas embarked on a monetary policy tightening cycle. Inflation rose reversals given its large foreign reserves, flexible exchange-rate regime, from an average of 2.8 percent in the first eight months of 2017 to 4.8 percent low public debt, and robust remittance inflows. At the present juncture, in the same period in 2018. Higher food prices accounted for about half of the preserving the country’s resilience rests in large part on preventing the rise in headline inflation, owing to weak agricultural and fisheries supply and current-account deficit from widening too much and too fast. Given that a rise in demand, which was fueled by a reduction of personal income taxes export growth is not expected to accelerate in the medium term, future that benefitted over sixty percent of wage earners. Higher global oil prices, import growth driven by public investment will need to be monitored closely a weaker peso, and new excise taxes also contributed to higher inflation. To to manage the pace of current account deficit widening to prevent external reduce inflation expectations, the central bank raised its key policy rate to funding gap challenges. 4.5 percent—a cumulative increase of 150 basis points since May—to signal its commitment to price stability, but with limited impact so far. The central For the Philippines to expand its long-term economic growth potential to bank also intervened in the exchange-rate market to smooth excessive reach the Ambisyon Natin 2040 vision, deep structural reforms are needed to volatility. Still, the demand for U.S. dollars increased due to an increase in increase both productivity growth and capital accumulation. Priority policy imports of capital goods, widening the current-account deficit. Meanwhile, areas include improving market competition through regulatory reforms, the capital account worsened due to interest rate hikes by the United States’ improving trade and investment climate policies and regulations, and Federal Reserve and increased trade tensions leading to capital outflows, reducing labor market rigidities and costs. In addition, the Philippines needs further weakening the peso. to address structural deficiencies in the agriculture sector to prevent future food supply constraints. Reforms aimed at boosting domestic growth and Fiscal policy has focused on accelerating public spending, especially in reducing vulnerabilities in the agriculture sector will be essential to sustain infrastructure while the implementation of the first tax package has helped high and inclusive economic growth. increase government revenue. In line with the government’s ambition to reduce the country’s infrastructure gap, public infrastructure expenditure While progress on poverty reduction is likely to continue as the economy grew by 41.6 percent in the first half of 2018, compared to 8.8 percent in the maintains its high growth rates, high food inflation will disproportionately same period in 2017, driven largely by numerous small public works projects. affect poor and vulnerable households. Recent data from the 2017 Annual Moreover, the wage bill increased by 20.1 percent in the first half of the year, Poverty Indicators Survey suggests that the income of the bottom 40 percent partly due to the implementation of the ongoing salary standardization. On of the population grew at a faster rate than that of the average population. the revenue side, higher tax collection boosted overall revenue growth and Thus, while there is no official household survey data on poverty since 2015, helped contain the fiscal deficit at 2.3 percent of GDP in the first half of 2018, the poverty rate likely continued to fall until 2017. However, rising inflation in below the government’s deficit ceiling of 3.0 percent for 2018. 2018 may negatively impact the welfare of poor and vulnerable households, as they spend over two-thirds of their total expenditure on food and fuel, the The Philippines’ economic growth outlook remains positive, yet downside main drivers of higher inflation in the first eight months of 2018. In addition, risks have increased. An expected slowdown in global trade in the medium the recent typhoon Ompong may have had a disproportional impact on term is likely to further dampen Philippine exports. Nevertheless, baseline these households, as they are not only more exposed to shocks from natural economic growth is projected at 6.5 percent in 2018, 6.7 percent in 2019, and disasters but also have a lower capacity to cope with their impact. PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS 10 11 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS The Philippine economic growth moderated from 6.6 percent year-on-year in the first half of 2017 to 6.3 percent in the same period in 2018, driven by export growth moderation. Meanwhile, inflation increased from an average of 2.8 percent in the first eight months of 2017 to an average of 4.8 percent in the same period of 2018 due to food supply constraints, higher global oil prices, continued peso depreciation, new excise taxes, and a rise in demand. To manage inflation expectations, the country’s central bank embarked on a tightening cycle by increasing policy rates four times so far in 2018—from 3.0 percent in May to 4.5 percent in September, with limited impact so far. The Philippine peso continued to depreciate and reached a 12-year low in July 2018 influenced by the ongoing monetary policy normalization in the United States, uncertainties created by the United States-China trade tensions, and a strong demand for capital imports while exports growth moderated. 12 GROWTH: INVESTMENT-LED GROWTH AMID A WEAKENING PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS EXTERNAL SECTOR Philippine economic growth moderated to 6.3 percent in the first half of 2018 supported by robust private consumption and an acceleration in public investment spending. However, net export growth decelerated due to a slowdown in global electronics products demand. The country’s economic growth moderated in the first half of 2018. declined from -0.9 percent in the first half of 2017 to -3.9 percent in The economy expanded by 6.3 percent year-on-year in the first six the same period in 2018. months of 2018, moderating from 6.6 percent in the same period in 2017 and well-below the government’s 7-8 percent target for the Capital formation was the principal driver of growth in the first year. Since early 2018, the observed slowdown was mainly driven half of 2018, as investments in durable equipment and construction by the weak performance of net exports that started in early 2018. increased significantly (Figure 1). Fixed capital formation growth Economic growth was driven by investment spending in the first accelerated from 10.4 percent year-on-year in the first half of half of 2018, supported by a sharp increase in investments in durable 2017 to 14.8 percent in the same period of 2018 driven by a growth equipment and buoyant activity in the construction sector. acceleration in durable equipment and construction. Investments In addition, public consumption growth accelerated in the first half in durable equipment, which made up around 60 percent of fixed of 2018, as the government continued to ramp up public spending in capital formation, expanded by 17.1 percent year-on-year in the first line with its expansionary fiscal policy stance. Private consumption half of 2018 compared to 11.0 percent a year ago. Investments in growth also remained robust despite increased inflation, supported industry-specific machinery drove durable equipment growth, as by a stable labor market and a steady inflow of remittances. firms continued to invest in additional productive capacity given growing capacity constraints.2 Construction accelerated from 7.5 A softening in global trade on electronics coupled with recent global percent year-on-year in the first six months of 2017 to 11.6 percent growth weakening has resulted in lowered export growth (Box 1, Box in the same period in 2018. Faster growth in the construction 2). Export growth declined from 19.5 percent year-on-year in the first sector was mainly due to a 22.1 percent year-on-year surge in public half of 2017 to 9.8 percent in the same period of 2018. The moderation construction spending in the first half of 2018, more than double was driven mainly by growth moderation of electronics components the 9.3 percent registered in the previous year, fueled by the faster exports, the Philippines main export goods, which constitute implementation of the government’s infrastructure program mainly more than half of the Philippines’ total goods exports. Electronics due to completion of many numerous small public work projects, export expanded 11.9 percent year-on-year in the first half of 2018, and without a significant contribution yet from “Build Build Build”.3 half of the 23.0 percent in the first six months of 2017. This is the result of the cyclical global softening in demand for electronics. Private consumption growth moderated in the first half of 2018. Philippines, due to its high concentration of electronics products in Private consumption, which accounts for around two-thirds of the its export basket, has been affected more intensely by this cyclical country’s total GDP, expanded by 5.7 percent year-on-year in the demand moderation than other countries in the region. In addition, first six months of 2018, moderating from the 5.9 percent in the agricultural exports contracted by 14.4 percent year-on-year in same period of 2017. A rising inflation rate, which increased from 2.8 the first half of the year, reversing the 34.1 percent growth in the percent in the eight months of 2017 to 4.8 percent in the same period previous year. Meanwhile, import growth moderated but remained of 2018, contributed to the moderation in private consumption strong and far outpaced export growth. Imports moderated slightly growth. Yet, despite the uptick in inflation, private consumption in the first half of 2018, expanding by 14.6 percent year-on-year, growth remained at a relatively strong level, supported by a steady compared to 18.6 percent a year ago.1 As result of export moderation job market, a continuous inflow of remittances coupled with a and robust import growth, net export contribution to growth weaker peso,4 personal income tax reform that became effective 1 Electronics imports, particularly components/devices (semiconductors) continued to grow at a rapid pace in the first half of 2018, expanding by 26.5 percent year-on-year, down from 31.6 percent a year ago. Meanwhile, imports of office equipment, machinery and mechanical appliances, and electrical machinery expanded by double-digits in the first two quarters of 2018, supported by the strong increase in capital formation. 2 Investment growth in machinery specialized for particular industries accelerated from 16.4 percent year-on-year in the first six months of 2017 to 26.5 percent in the same period in 2018. 3 In the first six months of 2018, disbursements of public infrastructure outlays increased by 41.6 percent year-on-year in nominal terms. 4 Remittances increased by 6.8 percent year-on-year in peso terms as a result of a 7.3 percent depreciation of the peso in the first half of 2018. 13 Figure 1. In the first half of 2018, capital formation growth drove Figure 2. …while growth in the service sector fueled growth on the PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY economic growth production side DEMAND SIDE: CONTRIBUTION TO GDP GROWTH (PERCENTAGE POINT) SUPPLY SIDE: CONTRIBUTION TO GDP GROWTH (PERCENTAGE POINT) 15 8 10 6 5 4 0 2 -5 0 -10 -2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 Private consumption Government consumption Agriculture Other industries Investments Discrepancy Services GDP Growth Net exports GDP Growth Manufacturing Source: Philippines Statistics Authority (PSA) Source: PSA Note: Other industries are mining and quarrying, construction, and electricity, gas and water. in 2018, which benefitted more than sixty percent of wage income second largest component of industry, accelerated from 6.4 percent earners,5 and a double digit growth in consumption loans. year-on-year in the first half of 2017 to 11.5 percent in the same period of 2018. The acceleration was driven mainly by public construction Growth in the service and industry sectors remained robust in the while private construction activity improved slightly. first half of 2018 (Figure 2). The service sector, which contributed 3.7 percentage points to the country’s GDP in the first six months The agriculture sector underperformed in the first half of 2018 of 2018, grew at 6.5 percent, lower than the 6.7 percent in the same compared to the same period last year due to weather conditions period in 2017, driven by continued robust growth in the wholesale and persistent productivity challenges in the sector. Agriculture and retail trade, real estate, and finance subsectors. Industry growth sector growth weakened significantly from 5.6 percent year-on-year remained largely the same in the first half of 2018 (7.0 percent in the first half of 2017 to 0.7 percent in the first half of 2018. The year-on-year) as in the first half of 2017 (6.9 percent), although with slowdown was the result of a contraction in both the crops and a slight change in the composition. Growth in the manufacturing fisheries subsectors. The crops subsector, which account for over sector, the main growth driver of the industry, moderated from 7.8 half of the country’s agriculture output, contracted by 0.5 percent percent year-on-year in the first six months of 2017 to 6.6 percent year-on-year in the first half of 2018, a sharp reversal from the 9.5 in the same period of 2018. Weaker manufacturing growth was percent growth registered in the previous year.7 The fisheries the result of growth moderation in the food manufacturing and subsector, which account for 12.7 percent of the country’s total radio, television, and communications equipment and apparatus agricultural output, contracted by 1.7 percent year-on-year in the industries, which cumulatively accounted for nearly two-thirds of first six months of 2018, worse than the contraction of 0.8 percent in total manufacturing output.6 Growth in the construction subsector, the same period in 2017.8 5 Under TRAIN program those earning an annual salary of Php250,000 or below will no longer pay any income tax. 6 Food manufacturing, which makes up about half of total manufacturing, expanded by 5.1 percent year-on-year in the first half of 2018, down from 6.6 percent in the previous year. Growth in the radio, television, and communications equipment and apparatus subsector, which includes the manufacture of electrical components, decelerated from 7.7 percent year-on-year in the first half of 2017 to 6.1 percent in the first half of 2018. 7 Contraction in crop was mainly because rice and corn farmers shifted to higher valued crops and planted early in the last quarter because of weather conditions and trade prices. In Q2 2018, rehabilitation and closure of some irrigation canals also contributed to the reduction in rice planting. In the same quarter, the decline in corn production was also attributed to early plantings due to government distribution of seeds in Cagayan Valley. Other corn farmers also shifted to other crops such as ginger, tobacco, pineapple, banana and watermelon. In Mindanao, insufficient rains were blamed for the reduction in area planted and harvested, and some areas of the region where corn used to be intercropped with rubber, coffee and oil palm were reported to be no longer viable for corn production. (PSA, 2018b) 8 In Q1 2018, fewer fishing trips brought about by weather disturbances in the Visayas regions resulted to lower production of commercial and municipal fisheries, and a newly imposed regulation by Laguna Lake Development Authority caused a delayed stocking in freshwater pens in southern Luzon. A disease also affected seaweed farms in some parts of Visayas. In Q2 2018, weather condition is still principally blamed for the reduction in fish supply, aside from water pollution, high costs of feeding materials, high cost of fuels, repair of fishing nets, and decrease in fishing trips due to dry-docking. (PSA, 2018a and 2018b) 14 PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS Box 1. Recent Global Developments Global growth remains robust but has softened in recent months, as manufacturing activity and trade have shown signs of moderation (Figure 3 and Figure 4). After a period of synchronized global upturn, economic activity appears to be slowing. The deceleration is especially noticeable for global trade as trade volumes contracted in April for the first time since mid-2016. The slowdown reflects softening demand for imports in advanced economies – with the exception of the United States, as well as rising barriers to trade, moderating growth in China, higher energy prices, and elevated policy uncertainty. While global demand appears to be decelerating, labor markets remain tight and inflation is on an upward trajectory in many countries. Figure 3. Manufacturing activity slowed in the first half of 2018… Figure 4. …as well as trade activity. MANUFACTURING PMI INDEX (50+ = EXPANSION) NEW EXPORT ORDERS INDEX (50+ = EXPANSION) 58 57 56 55 54 53 52 51 50 49 48 47 JAN 2016 MAR 2016 MAY 2016 JUL 2016 SEP 2016 NOV 2016 JAN 2017 MAR 2017 MAY 2017 JUL 2017 SEP 2017 NOV 2017 JAN 2018 MAR 2018 MAY 2018 JUL 2018 JAN 2016 MAR 2016 MAY 2016 JUL 2016 SEP 2016 NOV 2016 JAN 2017 MAR 2017 MAY 2017 JUL 2017 SEP 2017 NOV 2017 JAN 2018 MAR 2018 MAY 2018 JUL 2018 Global Advanced Economies EMDE Global Advanced Economies EMDE Source: Haver Analytics Source: Haver Analytics Advanced economies continue to grow above their potential, notwithstanding some recent moderation. Although recent indicators in advanced economies suggest some growth moderation, they continue to point to solid investment and above-potential growth in 2018 across countries. Growth in the United States reached 2.3 percent in 2017, supported by broad-based strength in domestic demand, especially investment. However, the economy may be near its productive potential as both capacity utilization and the employment rate are nearing the peaks attained prior to the financial crisis.9 There has been a slowdown in economic activity in the euro area since the beginning of 2018, particularly as manufacturing purchasing managers’ index values have continued to decline. Moreover, while Japan’s economy grew by 1.7 percent in 2017, underpinned by supportive financial conditions and strong exports, it contracted at the beginning of 2018. Among emerging market and developing economies (EMDEs), commodity exporters seem to have lost some momentum in the first half of 2018, while solid domestic demand and elevated energy prices are leading to rising inflation in many commodity importers. In Brazil, new data showed industrial production contracting by 10.9 percent (month-on-month) reflecting disruptions from the truckers’ strike in late May, while the composite PMI fell to 47 in June, down significantly from a recent high of 53.1 in February. In Russia, the manufacturing PMI continued its downward slide, falling to 49.5 in June. Meanwhile, growth in commodity importers remains strong, although it is moderating somewhat this year in part due to capacity constraints. With output gaps closed, or in many cases positive, capacity constraints are becoming increasingly binding. With price and wage pressures rising, amid markedly higher oil prices and increasingly binding capacity constraints, several large commodity importers have begun to tighten their monetary policies (e.g., Georgia, Pakistan, the Philippines, Romania, and Turkey). Rising policy uncertainty amid elevated protectionist sentiments have led to a moderation in global trade growth in 2018. Following a prolonged period of marked weakness since 2012,10 a cyclical recovery in global manufacturing and investment propelled global goods trade growth to 4.6 percent year-on year in 2017, three times the pace observed in the previous year. Since the beginning of the year, the United States has imposed tariffs on more than $90 billion of its imports, with other countries retaliating with tariffs on more than $70 billion worth of U.S. exports. The country subject to the newest tariffs is China, with tariffs imposed on about $37 billion worth of its exports, with another $16 billion coming into effect in coming weeks. On July 10th, the United States announced its intention to assess tariffs on an additional $200 billion worth of goods from China. More broadly, new trade restrictions have been on the rise in the G20, with the number of new import tariff measures nearly tripling in the most recent six months (October 2017 to May 2018) compared to the previous six months. As a result, new export orders have been decelerating in recent months, suggesting that the momentum has been slowing. Overall global trade growth is expected to ease to 4.3 percent year-on-year in 2018, down from a six-year high of 4.8 percent in 2017. Source: World Bank (2018a, 2018b, and 2018c) 9 Capacity utilization in April 2018, reached 78.0 percent, approaching the 81.1 percent peak capacity utilization prior to the financial crisis. Meanwhile, the employment to working-age population ratio reached 79.2 percent, approaching the peak of 80.3 percent prior to the global financial crisis. 10 Global trade grew at an average of 1.9 percent year-on-year since 2012. 15 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Box 2. The cyclical downturn of electronics exports in 2018 In 2017, the Philippines benefitted from the global technological cycle, driving faster exports of machinery, electronics, and integrated circuits. The Philippines, as a key player in the global value chain (GVC) for electronics products, was among the countries in the region that benefitted the most from the pickup in the global technological cycle, significantly accelerating export growth in electronics, and driving total merchandise export growth in 2017.11 In 2017, real value of electronics components exports (semiconductors) expanded by 23.8 percent year-on-year, compared to 7.8 percent in 2016. As electronics exports make up more than half of total goods exports in the Philippines, overall merchandise export growth expanded by 20.9 percent year-on-year in 2017, substantially higher than the 8.4 percent average between 2011-17. However, the completion of technology inventory restocking has seen electronics exports soften markedly through 2018. Globally, the expansion of new orders of electronics equipment have softened significantly since January 2018, resulting in the deceleration of the manufacture of electronics equipment over that same period (Figure 5 and Figure 6). As a result, growth of exports of electronics products in the Philippines weakened to 11.9 percent year-on-year in the first half of 2018 compared to 23.0 percent a year ago. The growth moderation in electronics products was the primary reason for the softening of merchandise export growth, which decelerated to 8.9 percent year-on-year in the first six months of 2018 from 22.7 percent a year ago. Figure 5. New orders of electronics equipment have decelerated in 2018… Figure 6. …leading to a decline in electronics equipment output globally. NEW ORDERS, ELECTRONICS (GLOBAL PMI, ELECTRONICS) MANUFACTURE OF ELECTRONIC EQUIPMENT (GLOBAL PMI, OUTPUT) 60.0 60.0 55.0 55.0 50.0 50.0 45.0 45.0 JAN 2015 APR 2015 JUL 2015 OCT 2015 JAN 2016 APR 2016 JUL 2016 OCT 2016 JAN 2017 APR 2017 JUL 2017 OCT 2017 JAN 2018 APR 2018 JUL 2018 JAN 2015 APR 2015 JUL 2015 OCT 2015 JAN 2016 APR 2016 JUL 2016 OCT 2016 JAN 2017 APR 2017 JUL 2017 OCT 2017 JAN 2018 APR 2018 JUL 2018 Source: Haver Analytics Source: Haver Analytics Note: A value of 50 and above in the Purchasing Mangers’ Index (PMI) signifies an expansion. Note: A value of 50 and above in the Purchasing Mangers’ Index (PMI) signifies an expansion. The vulnerability of the Philippines’ exports to global demand fluctuations highlights weaknesses in key areas of trade competitiveness, global value chain (GVC) integration, and product-space evolution. A product-space analysis reveals that the range of products exported by the Philippines has remained broadly constant over time, suggesting that the country did not pursue an appropriate diversification strategy. Having diversified only at the periphery, where products are less sophisticated and have less potential for transformation, the Philippines is less able to capture value addition and leverage transformative activities to create jobs and increase income. As a result, the Philippines is more exposed to both demand-based external shocks, as it is harder to quickly reallocate labor and capital to related products, and price volatility, as there are few intermediate industries to buffer the impact of volatile commodity prices. Finally, the Philippines has become more of a GVC taker, as it is increasingly exposed to the decisions of actors down the value chain, and less of a GVC maker, when it would be directing the market. Sources: IMF (2017), World Bank (2017a, 2018d, and 2018e) 11 China (including Hong Kong SAR, China), Malaysia, and the Philippines are among the top 10 exporters of integrated circuits. While their share in global markets is relatively low, exports of broadcasting equipment, computers, and other final electronic products represent more than 10 percent of total exports in Vietnam, Thailand, the Philippines, and Malay- sia. These countries benefited disproportionately from the pickup in the global cycle due to their competitiveness and established capacity and experienced an acceleration of exports in these categories. 16 THE EXCHANGE RATE AND THE EXTERNAL SECTOR: PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS WIDENING BALANCE OF PAYMENTS DEFICIT Softening global growth and trade along with heightened uncertainty in the external sector have resulted in further depreciation of the peso. The Philippine peso depreciated in the first eight months of 2018, The current account deficit widened in the first half of 2018 due weakening to a 12-year low. The peso depreciated, in nominal terms, to a larger trade deficit. The country’s current account deficit by 7.0 percent year-to-date as of end-August 2018, from Php/US$49.96 registered US$3.1 billion (1.9 percent of GDP) in the first half of 2018, in end-December 2017 to Php/US$53.47 in end-August 2018 (Figure substantially higher than the US$0.1 billion (0.1 percent of GDP) 8). It breached the Php/USD$53.60 mark in August, its weakest in 12 deficit in the first half of 2017. The wider deficit was attributed to a years. Similarly, the real effective exchange rate depreciated by 5.0 larger trade deficit which reached 14.7 percent of GDP in the first percent year-on-year in the first seven months of 2018, more than half of 2018, compared with 12.1 percent of GDP deficit in the same the 4.0 percent depreciation in the first seven months of 2017. The period of 2017. Exports contracted by an average of 4.2 percent on the weakening of the peso was influenced by the ongoing monetary first half of 2018 from an expansion of 21.5 percent during the same policy normalization in the United States, increased uncertainly period last year. Meanwhile, import remained robust by expanding over United States-China trade tension, and the widening current 13.4 percent year-on-year, higher than last year’s 12.3 percent (Figure account deficit. In addition, the slowdown on electronic export 7). The wider trade deficit was not offset by the net service export growth coupled with the sustained growth of imports of capital growth of 55.0 percent in the first half of 2018, an impressive goods and raw materials raised the demand for U.S. dollars. As a acceleration from the 9.2 percent growth in the same period in result, the country’s level of international reserves steadily declined 2017, as tourist arrivals increased and sustained export revenue in in the first eight months of the year, falling from US$81.7 billion in the business process outsourcing (BPO) industry.12 The growth of August 2017 to US$77.8 billion in August 2018. At its current level, personal remittances moderated from 5.5 percent year-on-year in the reserves can cover 7.5 months’ worth of imports, down from 8.4 the first half of 2017 to 2.8 percent in the same period in 2018.13 months in August last year and the historical average of 10.3 months in 2010-17. Figure 8. The Philippine peso depreciated in the first eight months of 2018 in both nominal and real terms. Figure 7. Philippine exports have been contracting since January 2018. US FEDERAL RESERVE RATE HIKES EXPORT AND IMPORT GROWTH RATES (PERCENT) 100 98 JUL 2018 96 JUN 2018 94 MAY 2018 92 APR 2018 90 MAR 2018 88 FEB 2018 86 JAN 2018 84 DEC 2017 82 NOV 2017 80 OCT 2017 78 SEP 2017 76 AUG 2017 74 JUL 2017 72 AUG 2013 NOV 2013 FEB 2014 MAY 2014 AUG 2014 NOV 2014 FEB 2015 MAY 2015 AUG 2015 NOV 2015 FEB 2016 MAY 2016 AUG 2016 NOV 2016 FEB 2017 MAY 2017 AUG 2017 NOV 2017 FEB 2018 MAY 2018 AUG 2018 JUN 2017 -10 0 10 20 30 40 50 Nominal Exchange Rate (January 2013: indexed to 100) Imports Exports Real Effective Exchange Rate Source: Philippines Statistics Authority (PSA) Source: BSP Note: Decrease denotes depreciation. 12 Travel exports expanded over 50 percent in the first quarter of 2018, faster than the 35 percent recorded in 2017. In addition, tourist arrivals to the Philippines rose by 10.2 percent year-on-year to 3.2 million visitors for the period January-May 2018. See https://www.dti.gov.ph/resources/statistics/tourist-arrivals. 13 Growth in the first quarter of 2018 was dragged lower by the 9.9 percent year-on-year contraction of personal remittances in March driven by base effects, the Holy Week holidays, and repatriations from Kuwait. 17 Capital inflows slowed down in the first half of 2018. Net inflows As a result, the surplus in the country’s capital and financial PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY of foreign direct investment rose to US$5.8 billion (3.6 percent of accounts softened in the first half of 2018 to US$0.3 billion (0.2 GDP) in the first half of 2018 from US$4.0 billion (2.7 percent of percent of GDP) from a surplus of US$0.7 billion (0.5 percent of GDP) GDP) in the same period in 2017. However, net foreign portfolio and in the first half of 2017. The reduction of the capital and financial other investments registered outflows due to the ongoing policy accounts’ surplus and the larger current-account deficit led to a normalization by the U.S. Federal Reserve, coupled with global widening of the balance of payments deficit from US$0.7 billion (0.5 trade uncertainties. This is reflected in the persistent decline of the percent of GDP) in the first half of 2017 to US$3.3 billion (2.1 percent Philippine Stock Exchange Index which started in January, with net- of GDP) in the same period of 2018. foreign selling in the first seven months of 2018.14 Table 1. Balance of Payments, H1 2016 – H1 2018 in millions US$ / in percentage of GDP H1 2016 H2 2016 H1 2017 H2 2017 H1 2018 Current account (543) (0.4) (656) (0.4) (133) (0.1) (2.030) (1.2) (3.087) (1.9) Goods (17,349) (11.8) (18,199) (11.5) (18,238) (12.1) (22,267) (13.7) (23,324) (14.7) Exports 20,327 13.8 22,407 14.2 25,738 17.1 26,126 16.0 25,339 16.0 Imports 37,677 25.7 40,606 25.7 43,976 29.2 48,394 29.7 48,663 30.7 Services 3,465 2.4 3,578 2.3 3,785 2.5 5,465 3.4 5,867 3.7 Primary Income 1,333 0.9 1,247 0.8 1,544 1.0 1,466 0.9 1,347 0.8 Secondary Income 12,008 8.2 12,719 8.1 12,777 8.5 13,307 8.2 13,023 8.2 Capital and Financial accounts 1,423 1.0 (1,536) (1.0) 745 0.5 1,976 1.2 251 0.2 Capital account 30 0.0 32 0.0 24 0.0 33 0.0 (1) (0.0) Financial account (1,392) (0.9) 1,567 1.0 (720) (0.5) (1,944) (1.2) (252) (0.2) Direct investment (3,600) (2.5) (2,282) (1.4) (3,160) (2.1) (3,385) (2.1) (4,080) (2.6) Net Acquisition of financial assets 769 0.5 1,628 1.0 881 0.6 2,632 1.6 1,675 1.1 Net incurrence of liabilities 1/ 4,369 3.0 3,911 2.5 4,041 2.7 6,016 3.7 5,755 3.6 Portfolio investment 2,326 1.6 (846) (0.5) 2,867 1.9 (358) (0.2) 3,094 2.0 Financial derivatives 57 0.0 (89) (0.1) (137) (0.1) 86 0.1 (53) (0.0) Other investments (174) (0.1) 4,784 3.0 (290) (0.2) 1,712 1.1 787 0.5 Net unclassified items 2/ (246) (0.2) 520 0.3 (1,318) (0.9) (104) (0.1) (421) (0.3) Overall BOP position 634 0.4 (1,672) (1.1) (706) (0.5) (157) (0.1) (3,257) (2.1) Memo: Basic Balance 3,058 2.1 1,626 1.0 3,028 2.0 1,355 0.8 993 0.6 1/ Net incurrence of liabilities refers to net foreign direct investment to the Philippines. 2/ The term “Net unclassified items” is a balancing figure. There are two methods of computing the BOP position: tyhe first approach uses in net international reserves due to transactions, while the second approach computes the sum balances of the current account, capital account less financial account. The two measures do not necessarily tally. The BSP uses the first approach to determine the overall BOP position. 14 The Philippine Stock Exchange index declined from 8,724 in January 1, 2018 to 7,766 in August 24, 2018. Net-foreign selling averaged Php9.5 billion per month between January and July 2018. 18 FINANCIAL MARKETS AND MONETARY POLICY: AN ACTIVE PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS MONETARY POLICY TO MANAGE PERSISTENT HIGH INFLATION Inflation continued to rise in the first eight months of 2018, driven by rising food prices, higher global oil prices filtering through a weaker peso, new excise taxes, and a demand rise. The central bank started in May a monetary tightening cycle to manage inflation expectations. The Philippines’ financial system remains stable and well capitalized. Inflation pressures intensified in the first eight months of 2018 due occurred in 2015, Typhoon Lando (international name Koppu) in to food supply constraints, higher global oil prices, a weaker peso, Northern and Central Luzon. Agriculture damage was new excise taxes, and a demand rise. The headline inflation rate USD 233 million and infrastructure damage about USD 74 million.18 averaged 4.8 percent in the first eight months of 2018, substantially After Typhoon Lando, food inflation increased mildly but overall higher than the average of 2.8 percent in the first eight months of inflation, which was lower at the time, remained below the central 2017 (Figure 9). It rose from 3.4 percent at the beginning of the year bank target. to 6.4 percent in August, breaching the Bangko Sentral ng Pilipinas (BSP) target range of 2-4 percent.15 Higher food prices accounted for Credit growth remained strong in the first half of 2018. Credit more than half of the rise in the inflation rate, followed by higher growth was not affected by the recent monetary policy rate energy and transportation costs. Lingering effects of weather increases. It accelerated slightly from 17.2 percent year-on-year disturbances led to a tighter supply of agricultural products in in June 2017 to 17.7 percent in the same month of 2018. Domestic the first quarter, raising the prices of key products such as fish, liquidity (M3) continued to grow and reached Php11.1 trillion pesos corn, fruits, and vegetables (Box 3).16 In recent months, rice supply with the growth rate of 11.7 percent year-on-year in June 2018, a reached low levels raising the price of rice. Energy and transport deceleration from 13.4 percent growth in June 2017. Production credit prices increased, due to the rising price of international crude oil, grew by 18.0 percent year-on-year in June 2018, up from 16.8 percent a weaker peso, the effect of excise taxes on fuel, and the upward in June 2017. Similarly, household credit growth accelerated from 16.8 adjustment of electricity prices. In addition, reduction in personal percent year-on-year in June 2017 to 18.0 percent in the same month income taxes benefitted over sixty percent of wage earners, boosting of 2018. While the sectoral composition of firms’ loan portfolios private demand. Core inflation, which does not include volatile food has remained broadly unchanged, lending in agriculture, forestry, and energy items, averaged 3.7 percent in the first eight months of and fishery and administrative and support services declined by 2018, compared to 2.5 percent in the same period in 2017, which is an 7.5 percent and 49.4 percent year-on-year, respectively, in June 2018 indication of demand-driven pressures of an economy operating (Figure 10). The credit-to-GDP ratio continued to rise and reached near its capacity limits. To manage inflation expectations, the BSP 67.5 percent in June 2018 compared to 63.7 percent in June 2017. raised its key policy rate by a total of 150 basis points four times so far in 2018, from 3.0 percent in May to 4.5 percent in September, but The Philippines’ financial system remains resilient. The share of with limited impact so far.. non-performing loans remained at a low level of 1.9 percent in June 2018, similar to the level in June 2017, among the lowest in The recent Typhoon Ompong may have a further impact on food the region (Figure 11). Philippine banks are well capitalized, with a inflation given crop damages in the affected area. Typhoon Ompong total capital adequacy ratio of 14.7 percent in March 2018, well above (internationally known as Mangkhut) struck Northern Luzon in the regulatory minimum of 10 percent, but slightly lower than the mid-September, causing widespread agriculture and infrastructure 2017 average of 15.2 percent. While profitability remains high in the destruction especially in hard-hit Cordillera Autonomous Region. banking sector, with return on equity at an average of 9.8 percent Damage to agriculture is estimated as of September 19, 2018 at and return on assets at an average of 1.2 percent, banks’ profitability USD 265 million and damage to infrastructure at USD 42 million.17 showed a slight decline in the second quarter of 2018. Similarly, the Damage to rice, corn and vegetable supplies might place additional share of interest income to total operating income was 75.2 percent pressure on food inflation at a time when the country is already in the first half of 2018, a slight decline from an average of 74.7 experiencing escalating prices. As a reference point, a similar event percent in 2017. 15 Inflation rate in August 2017 was 2.6 percent. 16 In the second quarter, rice prices increased amid a tight domestic supply and lower inventory levels. 17 NDRRMC Situation Report No. 27, September 19, 2018. 18 NDRRMC Final Report, October 2015. 19 18+12+832115111713E Figure 9. Headline inflation breached the BSP’s target range in the first Figure 10. The commercial loan portfolio is dominated by the real estate, PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY eight months of 2018. utilities, transport, and ICT sectors (June 2018). YEAR-ON-YEAR INFLATION RATE (2012=100) SECTOR SHARES FROM COMMERCIAL LOAN PORTFOLIO 7 13% 6 OTHER PRODUCTION ACTIVITIES AND LOANS TO 18% NON-RESIDENTS REAL ESTATE ACTVITIES 5 4 3 17% 12% UTILITIES, MANUFACTURING 2 TRANSPORT, AND ICT 1 0 8% 11% FINANCIAL AND INSURANCE ACTIVITIES -1 HOUSEHOLD CONSUMPTION -2 3% CONSTRUCTION AUG 2014 NOV 2014 FEB 2015 MAY 2015 AUG 2015 NOV 2015 FEB 2016 MAY 2016 AUG 2016 NOV 2016 FEB 2017 MAY 2017 AUG 2017 NOV 2017 FEB 2018 MAY 2018 AUG 2018 2% AGRICULTURE, FORESTRY & FISHING 15% 1% MINING AND QUARRYING Headline inflation Core inflation Key policy rate WHOLESALE AND RETAIL TRADE, HOSPITALITY INDUSTRY Source: BSP Source: BSP Figure 11. The Philippines’ credit-to-GDP ratio remains low, and its rate of non-performing loans is among the lowest in the region. DOMESTIC CREDIT TO PRIVATE SECTOR BY BANKS (PERCENT SHARE FROM GDP) RHS: NON-PERFORMING LOANS RATIO (PERCENT) 180 4.5 160 4.0 140 3.5 120 3.0 100 2.5 80 2.0 60 1.5 40 1.0 20 0.5 0 0 2010 2011 2012 2013 2014 2015 2016 2017 China Malaysia Thailand Philippines Indonesia China (RHS) Malaysia (RHS) Thailand (RHS) Philippines (RHS) Indonesia (RHS) Notes: Domestic credit to private sector by banks (% of GDP) data for Malaysia in 2017 is not yet available. Source: WDI 20 PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS Box 3. The Drivers of Inflation in the Philippines since January 2018 Rising food prices were the main drivers of inflation since the beginning of 2018. The year-to-date inflation rate reached 4.8 percent in August 2018, breaching the BSP’s 2-4 percent target range. Items that are highly volatile, including food and energy, were the main drivers of inflation in the first eight months of 2018. More than half of the year-to-date inflation was attributed to rising food prices caused mainly by higher prices of rice and fish—the staples of Filipino food (Figure 12). The country’s rice supply reached critical levels earlier this year, as delays in the import of rice by the National Food Authority (NFA) exacerbated the supply shortfall. In February, the NFA’s rice reserves could only satisfy the country’s requirement for two days.19 Rice imports only arrived toward the end of the second quarter. To temper the rise in rice prices, the president has prioritized the rice tariffication bill, which is currently pending legislative deliberation. Meanwhile, fish prices have increased, as a dwindling catch, a fishing ban in the Visayas, and reduced fishing grounds in the West Philippine sea led to a 1.7 percent year-on-year contraction of fishing output in the first semester of 2018. Figure 13. The combined contribution of energy and transport prices to Figure 12. Higher food prices drove more than half of the August year-to- inflation has steadily risen since March. date inflation. CONTRIBUTION TO INFLATION (PERCENT SHARE) 50+7+1182119E COMMODITY GROUP SHARES FROM YEAR-TO-DATE INFLATION (PERCENT) 1.20 1.00 9% 0.80 RESTAURANT AND MISCELLANEOUS GOODS AND SERVICES 50% 0.60 FOOD AND NON- 0.40 11% ALCOHOLIC BEVERAGES TRANSPORT 0.20 0.00 4.8% -0.2O JAN 2018 FEB 2018 MAR 2018 APR 2018 MAY 2018 JUN 2018 JUL 2018 AUG 2018 Food and Non-Alcoholic Beverages 18% Alcoholic Beverages and Tobacco HOUSING, WATER, ELECTRICITY, GAS AND Clothing and Footwear OTHER FUELS Housing, Water, Electricity, Gas and Other Fuels Furnishing, Household Equipment and Routine Maintenance of the House 7% Health ALCOHOLIC BEVERAGES Transport AND TOBACCO Communication Source: PSA Recreation and Culture Education Restaurant and Miscellaneous Goods and Services Source: PSA Rising housing, water, electricity, gas and other fuel, and transport prices constituted more than a quarter of the year-to-date inflation (Figure 13). Domestic energy prices rose in tandem with rising global crude oil prices coupled with the continued weakening of the peso. Upward adjustments in electricity rates made early in the year as well as the implementation of the new excise tax on oil and fuel contributed to energy inflation. The higher fuel prices consequently led to higher transport prices. For instance, the Land Transportation Franchising and Regulatory Board (LTFRB) approved a provisional fare increase of Php1.0 for public utility jeepneys in Metro Manila and adjoining provinces in July, which will effectively lead to a further increase in transport prices.20 Besides the BSP raising its key policy rate, the government is proposing legislative and trade measures to temper rising inflation. The BSP raised its key policy rate four times in 2018, from 3.0 percent in May to 4.5 percent in September, in a bid to manage inflation expectations. The administration also plans on lowering inflation through other measures. One such measure is House Bill 7735, or the Revised Agricultural Tariffication Act, which Congress passed on August 14 and replaced the 805,200-ton limit on rice imports with a general tariff. The bill will allow more entry of rice into the country, effectively lowering the price of rice. A senate bill counterpart is currently being deliberated. Moreover, an executive order has been approved to ease importation of fish, vegetable, meat, and other food products to supplement the domestic supply shortage. Source: BSP 19 Domingo (2018). 20 Cabrera (2018). 21 FISCAL POLICY: SUSTAINING THE REFORM AGENDA PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Fiscal policy has focused on accelerating public spending, especially in infrastructure while the implementation of the first tax package has helped increase government revenue. The fiscal deficit widened in the first half of 2018 as the government The government continued to mainly finance its fiscal deficit with continued its expansionary fiscal path for the third year in a row domestic resources, although the share of foreign financing in the (Figure 14). Public expenditure growth accelerated driven by an total financing mix has increased significantly in 201821, from 81:19 acceleration in infrastructure spending. Higher tax collection in favor of domestic financing in 2017 to 64:36 in 2018 (Figure 15). boosted revenue growth, partly due to Tax Reform for Acceleration Despite continued public borrowing, the Philippine government’s and Inclusion (TRAIN) taking into effect in January 1, 2018. The fiscal overall debt-to-GDP ratio remained at 42.5 percent of GDP in the deficit increased from 2.0 percent of GDP in the first semester of 2017 first half of 2018, as nominal GDP growth continued to outpace to 2.3 percent of GDP in the same period in 2018, still well below the growth in the government’s debt stock. government’s deficit ceiling of 3.0 percent of GDP for 2018. Figure 14. The government’s budget deficit reached 2.3 percent of GDP Figure 15. …with external financing playing a larger role in the overall on the back of an expansionary fiscal policy… financing mix. REVENUE AND EXPENDITURE AS PERCENT OF GDP NET FOREIGN AND DOMESTIC FINANCING VIS-A-VIS BUDGET SURPLUS/DEFICIT (IN PHP BILLION) RHS: FISCAL BALANCE AS PERCENT OF GDP 260 25 0.0 240 220 -0.5 200 20 180 -1.0 160 15 140 -1.5 120 100 10 -2.0 80 60 5 40 -2.5 20 0 0 -3.0 2013 2014 2015 2016 2017 2016 H1 2017 H1 2018 H1 (20) (40) (60) Revenues Expenditure Fiscal Balance (RHS) (80) Source: Bureau of the Treasury (BTr) (100) (120) (140) JAN 2016 JUL 2016 JAN 2017 JUL 2017 JAN 2018 Net Foreign Financing Net Domestic Financing Budget Surplus/Deficit Source: Bureau of the Treasury (BTr) 21 In the first six months of 2018, net domestic financing, which accounted for 80.0 percent of total financing, fell by 16.8 percent year-on-year in nominal terms to Php304.2 billion compared to Php365.7 billion in the first half of 2017. The decline in domestic financing coincided with the sharp increase in net foreign financing, which more than doubled in the first half of 2018 to reach Php75.8 billion, up from Php28.2 billion in the first six months of 2017. 22 Expenditure growth accelerated in first six months of 2018, driven in public-sector salaries due to the implementation of the third PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS by higher infrastructure outlays and wage bill (Table 2). In the first tranche of the adjustment to the salary standardization law and the half of 2018, national government expenditures increased by 20.5 increase in pay of military and uniformed personnel. percent year-on-year in nominal terms to reach 19.5 percent of GDP compared to 17.6 percent of GDP in the first six months of 2017. The Revenue expansion accelerated significantly, driven by recent tax increase was driven by significant growth in capital outlays,22 which reform and robust economic growth, containing the fiscal gap (Table accounted for nearly a third of total public spending in the first half 3). In the first six months of 2018, public revenue increased by 19.9 of 2018.23 In particular, infrastructure spending increased from 8.8 percent year-on-year in nominal terms to reach 17.1 percent of GDP percent year-on-year in the first semester of 2017 to 41.6 percent in compared to 15.6 percent of GDP in the same period of 2017. Strong the first half of 2018, driven by ongoing projects at the Department growth in revenue collection was supported by a robust increase of Public Works and Highways on road improvement, flood control, in tax revenue, which grew by 17.4 percent year-on-year in nominal and maintenance of bridges and school facilities. At the same terms in the first six months of 2018, nearly twice the 8.8 percent in time, recurrent public spending on wage bill which accounted for the first six months of 2017. The rise in tax revenue is in large part a third of total public spending in the first half of 2018, increased due to the implementation of the first package of the government’s significantly from 13.3 percent year-on-year as of June 2017 to 20.1 Comprehensive Tax Reform Program (CTRP), which generated percent as of June 2018, primarily as a result of the increase Php33.7 billion (0.4 percent of GDP) in additional tax revenue. Table 2. Actual and Programmed Public Expenditures in the Philippines, H1 2016 - H1 2018 LEVEL GROWTH H1 2016 H1 2017 H1 2018 H1 2017 H1 2018 Program Actual Program Actual Program Actual Program Actual Program Actual Current operating expenditures 1,409 923 1,013 1,001 1,138 1,155 -3.4 8.5 12.3 15.4 Personal services 396 339 402 383 436 461 1.4 13.1 8.5 20.1 Maintenance and other operating expenditures 237 217 216 208 238 242 -8.8 -3.9 10.3 16.3 Subsidy 39 37 27 58 68 68 -30.8 59.0 152.8 16.3 Allotment to Local Government Units 171 171 196 195 212 211 14.7 13.7 7.8 8.1 Interest Payments 194 154 164 152 173 166 -15.9 -1.4 5.8 9.2 Tax Expenditures 12 5 9 5 8 8 -21.7 -11.3 -8.9 74.5 Capital Outlays 329 295 311 331 448 448 -5.3 12.4 43.8 35.1 Infrastructure and other capital outlay 261 229 237 249 353 353 -9.3 8.8 49.1 41.6 Equity 10 9 2 3 4 3 -77.2 -62.4 60.9 -18.8 Capital transfer to local government units 58 57 72 79 92 92 25.2 37.9 28.0 17.0 Net Lending 9 4 13 -1 1 1 45.3 -131.7 -88.8 -207.7 Total 1,386 1,221 1,337 1,331 1,569 1,604 -3.5 9.0 17.4 20.5 Source: DBM 22 Capital outlays are expenditures on goods and services, the benefits of which extend beyond the fiscal year and add to the government’s assets, including investments in the capital stock of government-owned and controlled corporations and their subsidiaries. The following expense classes are included in capital outlays: i) infrastructure outlays; ii) equity; and iii) capital trans- fers to local government units. Source: https://www.dbm.gov.ph/wp-content/uploads/BESF/BESF2015/GLOSSARY.pdf. 23 Capital outlays grew by 35.1 percent year-on-year in the first half of 2018, nearly five times the growth rate in the same period in 2017. 23 Additional tax-policy and administrative reforms are currently highest in the region, the tax collection suffers from the lowest tax PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY undergoing legislative review. The government’s second package of efficiency among peers (Table 4). The government aims to ratify its CTRP is one of eight priority bills for the rest of 2018. The second the second package in November 2018. In addition, complementary package aims to improve the equity and efficiency of the corporate package 1B (i.e., HB 7105) was filed in Congress on February 6, income tax (CIT)24 and increase public revenue by rationalizing tax 2018 and aims to improve the tax administration by relaxing the incentives while gradually lowering the CIT rate from 30 percent country’s bank secrecy law and encouraging new listings through a to 20 percent by 2029 under the House of Representatives’ version, general tax amnesty and estate tax amnesty. Also, it aims to increase while the Senate version cuts the CIT rate to 25 percent in the first revenue collection through an adjustment of the motor vehicle year of its implementation. While the Philippines’ CIT rate is the user charge. Table 3. Actual and Programmed Public Expenditures in the Philippines, H1 2016 - H1 2018 in billions PHP Growth (percent) Percent to GDP H1 2016 H1 2017 H1 2018 H1 2016 H1 2017 H1 2018 H1 2016 H1 2017 H1 2018 Revenues 1,101 1,176 1,411 1.4 6.8 19.9 16.0 15.6 17.1 Tax Revenue 983 1,069 1,255 10.1 8.8 17.4 14.3 14.2 15.2 Non-tax Revenue 118 107 156 -38.8 -9.0 45.2 1.7 1.4 1.9 Expenditures 1,221 1,331 1,604 13.9 9.0 20.5 17.7 17.7 19.5 Current operating expenditures 923 1,001 1,155 6.1 8.6 15.3 13.4 13.3 14.0 Personal services 339 383 461 4.4 13.1 20.1 4.9 5.1 5.6 Maintenance and other operating expenditures 217 208 242 20.8 -3.9 16.3 3.1 2.8 2.9 Subsidy 37 58 68 -16.8 59.3 16.1 0.5 0.8 0.8 Allotment to Local Government Units 171 196 211 9.9 14.2 7.6 2.5 2.6 2.6 Interest Payments 154 159 166 1.5 3.1 4.4 2.2 2.1 2.0 Tax Expenditures 5 5 8 -41.8 -11.3 74.5 0.1 0.1 0.1 Capital Outlays 295 331 448 -47.2 12.3 35.3 4.3 4.4 5.4 Infrastructure and other capital outlay 229 249 353 52.4 8.8 41.6 3.3 3.3 4.3 Equity 9 3 3 2,733.3 -62.4 -18.8 0.1 0.0 0.0 Capital transfer to local government units 57 78 92 15.6 37.1 17.7 0.8 1.0 1.1 Net Lending 4 -1 1 57.7 -131.7 -207.7 0.1 0.0 0.0 Budget surplus/deficit -120 -154 -193 -975.3 28.4 25.0 -1.7 -2.1 -2.3 Source: BTr. Table 4. Corporate Income Tax Efficiency, 2006-16 (Average) Corporate Income Tax Philippines Indonesia Thailand Malaysia Vietnam Tax Rate 30% 25% 20% 24% 20% Revenue (% of GDP) 3.5 2.7 5.0 7.6 6.7 Tax Efficiency 11.6 10.8 25.0 31.8 33.5 Source: Haver Analytics, Bureau of Internal Revenue, KPMG, and Deloitte. Notes: Tax Efficiency is calculated as the ratio of tax revenue as a share of GDP divided by the tax rate. 24 On September 10, 2018, the House of Representatives approved the second package of the government’s CTRP, House Bill (HB 8083) also known as the Tax Reform for Attracting Better and High-quality Opportunities (TRABAHO). The corresponding senate version (i.e., Senate Bill No. 1906), known as the “Corporate Income Tax & Incentives Reform Act,” was filed on August 2, 2018 and is currently undergoing hearings in the Senate Ways and Means Committee. 24 EMPLOYMENT AND POVERTY: LABOR MARKET CONDITIONS PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS CONTINUE TO REMAIN TIGHT The unemployment rate inched further down to 5.5 percent in the first half of 2018, indicating continued labor market tightness. Sustained growth in real household income among the poor suggests that poverty may have declined further until 2017. A continuous decline in labor force participation has contributed Unemployment rate hovered around 5.5 percent since 2016 (Figure to the persistent low unemployment rate. Labor force participation 16). The unemployment rate stood at 5.5 percent in April 2018, in the Philippines continued its declining trend in the first half of slightly lower than the 5.7 percent in April 2017. Ilocos (7.3 percent), 2018 (Figure 17). It dropped sharply from 63.5 percent in 2016 to 61.2 CALABARZON (6.6 percent)26, and National Capital Region (NCR) percent in 2017, before falling to 60.9 percent (43.3 million people) (6.4 percent) were the regions with the highest unemployment rates in the first four months of 2018, well below the long-run average of in April. About 52,000 net jobs were created on average each month 63.9 percent during the period 2005-2017. This was partly the result between April 2017 and April 2018. The industry sector expanded of a newly created senior high school program that extended basic its share of total employment to 19.7 percent in April (compared education with an additional two years.25 The recent estimate of 39.5 to 18.5 percent in April 2017), mostly due to employment growth in percent for the cohort 15-24 years old is 5.4 percentage points lower the construction subsector. The service sector continues to employ than it was in April 2016 a few months before the senior high school more than half of the population, with a 56.4 percent share in April was implemented. However, the Philippines’ female labor force 2018, slightly higher than the 55.4 percent in April 2017. Meanwhile participation rate (46.5 percent) continues to rank among the lowest employment in agriculture continued to contract, from 26.1 percent in the East Asia Pacific region, behind that of Cambodia (84 percent), in April 2017 to 23.9 percent in same month in 2018. Vietnam (78 percent), China (69 percent), Thailand (68 percent), and Myanmar (65 percent). Figure 16. While the unemployment rate remained around 5.5 percent in Figure 17. …and the labor force participation rate remained below its the first half of 2018, underemployment increased slightly… 12-year average in the same period. UNEMPLOYMENT AND UNDEREMPLOYMENT RATES (PERCENT) LABOR FORCE PARTICIPATION RATE (PERCENT) 25 67 66 20 Underemployment Rate 65 64 15 63 62 10 61 Unemployment Rate 60 5 59 58 0 57 JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR 2015 2016 2017 2018 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Labor Force Survey (various rounds), PSA. Source: Labor Force Survey (various rounds), PSA. 25 The first cohort of grade 12 students graduated in March 2018. 26 The region comprises five provinces: Cavite, Laguna, Batangas, Rizal, and Quezon. 25 Figure 18. Between 2017 and 2018, new jobs were created in the Figure 19. …while the professional services subsector experienced the 31+2+613471758E PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY construction and public services sectors… highest job expansion among services. SHARE OF NEW JOBS BY SECTOR (PERCENT) JOB CREATION GROWTH BY SUBSECTOR (PERCENT) 8% MANUFACTURING 33% Electricity, gas, steam, and airconditioning... CONSTRUCTION INDUSTRY Construction Water supply; sewerage, waste management... Manufacturing Professional, scientific and technical activities Arts, entertainment and recreation Human health and social work activites SERVICES 18% 6% Public administration and defense; compulsory... TRANSPORTATION AND Financial and insurance activities PUBLIC ADMINISTRATION STORAGE AND DEFENSE; COMPULSORY SOCIAL Administrative and support service activities SECURITY 3% Other service activities FINANCIAL AND INSURANCE ACTIVITIES 7% 4% Real estate activities ADMINISTRATIVE AND PROFESSIONAL, SCIENTIFIC, SUPPORT SERVICE ACTIVITES AND TECHNICAL ACTIVITES Information and communication Transport and storage 0 5 10 15 20 25 30 35 40 45 Source: Labor Force Survey (April 2017 and 2018), PSA. Source: Labor Force Survey (April 2017 and 2018), PSA. While the underemployment rate remained relatively high at 17 While real wage growth remained flat in the first month of 2018, percent, the quality of jobs showed signs of marginal improvement. wage income remained the main source of income for households The underemployment rate declined from 18.0 percent in January in 2017. In January 201828, the real daily wage averaged Php282.4, a 2018 to 17.0 percent in April 2018, yet still higher than the average of slight decline from same period in 2017 of Php285, but higher than 16.2 percent in 2017. Nevertheless, there were some indications that 2017 average of Php281.8. (Figure 20 and Figure 21). Meanwhile, the quality of jobs is improving. First, most of the rise in overall the movement of workers from agricultural employment to underemployment was in service sector. Share of underemployment non-agricultural wage jobs has continued in recent years and it is in services increased from 44.4 percent in April 2017 to 47.1 percent reflected in the structure of household incomes. Based on estimates in April 2018.27 Second, a third of 625,000 net jobs created between from the Annual Poverty Indicators Survey,29 the share of wages in April 2017 and April 2018 were in construction, followed by 18 percent household income has increased over time, and wages accounted in public administration, defense, and social security (Figure 18). for about 50 percent of total household income in 2017 from 44 Jobs in construction are on average higher paid jobs than non- percent in 2007 (Figure 22). This has been especially evident among skilled service jobs. There was also an increase in high-skilled jobs households in the bottom quintile where the share of wages in total in sectors such as professional services in the same period. While income increased from 32 percent in 2007 to 44 percent in 2017. The professional services jobs represented only 4 percent of all new World Bank’s recent poverty assessment for the Philippines shows jobs created between April 2017 and April 2018, they grew by 22 that the movement of labor out of agriculture and increase in wage percent in the same period (Figure 19). Third, the share of workers income, government transfers, and remittances were the key drivers in private establishments increased from 48.8 percent in April 2017 of poverty reduction in the last decade.30 to 50.3 percent in the same month of 2018, whereas the share of self- employed workers without pay and family workers declined in the same period. 27 Services sector tends to have the lowest quality job among non-agriculture jobs. 28 Latest available Labor Force Survey data. 29 Conducted by the Philippine Statistics Authority in non-Family Income and Expenditure Survey years. The survey collects an abridged version of the FIES modules on household income and expenditure. Though since 2014, the food expenditure module is the same as that of the FIES. Unlike the FIES, the reference period for the APIS is only for the first half of the year. This series is used in this analysis to reflect more recent information on welfare. 30 World Bank (2018a). 26 Figure 20. The average real daily wage increased in the first month of Figure 21. …while the average wage declined compared to the same PART 01: RECENT ECONOMIC AND POLICY DEVELOPMENTS 2018 compared to 2017 average… period a year ago. AVERAGE DAILY REAL WAGE (MEASURED IN CONSTANT 2006 PHP) AVERAGE DAILY REAL WAGE (MEASURED IN CONSTANT 2006 PHP) 290 500 280 256 285 282 300 270 100 260 250 0 240 -100 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 230 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Q1 Overall Private Household Private Establishment Public Family worker in Family Business Source: Staff estimates using Labor Force Survey (various rounds), PSA. Source: Staff estimates using Labor Force Survey (various rounds), PSA. Figure 22. The share of wages in total household income has increased Figure 23. The share of transfers and remittances in the income of over time. households in the bottom quintile nearly tripled in 2007-17. SHARE OF WAGE INCOME TO TOTAL HOUSEHOLD INCOMES (PERCENT) SHARE OF TRANSFERS AND REMITTANCES TO TOTAL HOUSEHOLD INCOMES (PERCENT) 60 18 16 50 14 40 12 10 30 8 20 6 4 10 2 0 0 BOTTOM QUINTILE ALL HOUSEHOLDS 2007 2008 2010 2011 2013 2014 2016 2017 2007 2008 2010 2011 2013 2014 2016 2017 2007 2008 2010 2011 2013 2014 2016 2017 BOTTOM QUINTILE ALL HOUSEHOLDS Source: Annual Poverty Indicators Survey, various rounds Domestic Foreign Source: Annual Poverty Indicators Survey, various rounds 27 While there is no definitive poverty data yet from the official Figure 24. Incomes of households in the bottom quintile are growing at PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY household survey for the period since 2015, there are indications a faster rate than the income of the average household. that poverty has been reduced until 2017. For instance, information from the 2017 Annual Poverty Indicators Survey suggests household HOUSEHOLD INCOMES BY QUINTILE (SCALED TO 2007 VALUES (2007=100)) per capita income continued to increase faster than inflation and 150 the income of the bottom 40 percent of the population grew at a faster rate than that of the average population. (Figure 24). 140 130 120 110 100 90 2007 2008 2010 2011 2013 2014 2016 2017 Bottom quintile 2nd 3rd 4th Top quintile All households Note: Real household income scaled to 2007 values. Source: Annual Poverty Indicators Survey, various rounds PART 02: OUTLOOK AND RISKS 28 29 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY PART 02 OUTLOOK AND RISKS The Philippines’ medium term economic growth outlook remains positive, yet downside risks have increased. World Bank baseline economic growth is projected at 6.5 percent in 2018, 6.7 percent in 2019, and 6.6 percent in 2020. The baseline investment growth outlook is positive and planned senatorial and local elections in May 2019 are expected to lead to higher public spending and higher private consumption. However, persistent high domestic inflation could have a dampening effect on consumption and investment growth. Also, a faster normalization of monetary policy in the United States and an increase in global uncertainty, including trade tensions, could not only worsen external financing conditions for emerging market economies like the Philippines but also elicit additional domestic interest rate hikes that could raise domestic borrowing costs for businesses and households. While progress on poverty reduction is likely to continue as the economy maintains its high growth rate, persistent high food inflation presents a risk to poverty alleviation in 2018 as food items represent over two-thirds of the total expenditure of poor households. 30 GROWTH OUTLOOK PART 02: OUTLOOK AND RISKS Economic growth in 2018 is projected to recover from a slowdown in the first half of the year to reach 6.5 percent for the whole year, driven by a rise in public investment and a robust private demand. The World Bank expects growth of 6.7 percent in 2019 and 6.6 percent in 2020. The government is expected to continue its expansionary fiscal policy while monetary policy will continue to manage inflation expectations. The Philippines’ medium term growth outlook remains strong, supported by an expected rise in public investment spending and a robust private demand. The World Bank baseline forecast projects the Philippines economy to expand by 6.5 percent year- on-year in 2018, 6.7 percent in 2019, and 6.6 percent in 2020 (Figure 25).31 GDP growth is expected to accelerate in the second half of 2018 and in early 2019, boosted by upcoming senatorial and local pre-election spending and continued strong public investment growth. This is consistent with the government’s plan to speed up the implementation of its infrastructure program. Investment spending is expected to accelerate import growth, while export growth is expected to remain moderate given the slowdown in global trade. Private consumption growth is projected to remain strong, supported by a steady labor market, a continued inflow of remittances, and inflation easing. financing conditions related to monetary policy normalization in Global growth is expected to moderate in the medium term, driven the United States. The expected slowdown in global trade will mute by a gradual slowdown in advanced economies and a moderate the growth prospects of Philippine exports. GDP growth projections slowdown in global trade (Box 4). Although global growth is assume similar export growth of the second quarter of 2018 in the expected to remain strong at 3.1 percent year-on-year in 2018, it is medium term, as no rapid recovery in global trade is expected in the expected to moderate in both 2019 and 2020. Underlying factors for next couple of years. the moderation include a slowdown in global trade and tightening Figure 25. The Philippines’ Growth Trajectory is Positive but Lower than Expected. ACTUAL AND FORECAST GROWTH (IN PERCENTAGE) 9 8 6.9 7 6 6.5 6.7 6.6 6.1 5 4 3 2 1 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2017 2020 Source: PSA, World Bank staff estimates 31 31 The current-account deficit is expected to widen as export growth accelerate in 2019 (Box 5). This is reflected in the proposed 2019 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY moderates while import growth remains strong. While export budget as it increases the share of allocated cash-based expenditure growth is expected to remain moderate given the slowdown on public works and transportation. The share of expenditure in global trade, import growth is likely to remain strong, as the allocated to public works is set to increase from 13.3 percent in government is expected to speed up the implementation of its 2018 to 14.8 percent in 2019, while the share for transportation will infrastructure investment plan. This is consistent with the recent increase from 1.2 percent to 2 percent in the same period (Box 6). acceleration in public construction growth, which accelerated from 9.9 percent year-on-year in the first half of 2017 to 15.9 percent in the The government’s proposed 2019 national budget of Php3.76 trillion first half of 2018. In addition, public spending on infrastructure and (around 19.4 percent of GDP) focuses on ramping up investments in capital outlay increased by 41.6 percent year-on-year in the first half infrastructure and education. The proposed 2019 budget will shift of 2018, substantially higher than the 8.8 percent in the same period to an annual cash-based budget for the first time in history. The in 2017. The growth momentum in investment spending is expected proposed budget was submitted to Congress by the Department to continue in the coming years as the government’s infrastructure of Budget and Management on July 23, 2018 and is 13.0 percent investment projects gain traction. larger than the 2018 cash-based equivalent. It continues the government’s spending priorities from previous years, focusing The World Bank’s growth forecasts for the Philippines assume an on increasing investments in infrastructure and education to acceleration in public investment growth in the medium term. achieve rapid and sustained inclusive growth for the country Public consumption growth is expected to sustain at a high level (Box 7). The transition to a cash-based budget aims to improve until the first half of 2019, driven by upcoming senatorial and local fiscal discipline and accountability in the national government to pre-election spending, and is likely to remain at high levels in the improve underspending in the government through reforming the medium term as the government continues to focus on closing the budget process (Box 6). The budget is currently undergoing parallel human and physical capital gap. Meanwhile, the implementation deliberations in the House of Representatives and the Senate of of projects under the Build Build Build program is expected to the Philippines. Box 4. The Global Economic Outlook Global growth is projected to remain strong in 2018, but early indicators hint of slowing Global financing conditions are expected to tighten over the medium term more rapidly than economic activity. Global growth is expected at 3.1 percent year-on-year in 2018—the same previously envisioned. Following a prolonged period of stable and favorable global financing growth rate as the 2017 projection for 2018 (Figure 26 and Table 5). However, growth projections conditions, prospects of a faster normalization of monetary policy in advanced economies have for 2019 and 2020 have softened to 3.0 percent and 2.9 percent, respectively, as trade and led to rising global borrowing costs since the start of 2018. These prospects combined with investment growth moderate and financing conditions tighten. Economic growth in advanced fears of escalating trade tensions and rising geopolitical risks sparked bouts of volatility in economies is expected to decelerate toward their potential rates, as monetary policies global equity markets in the first half of 2018. normalize and the effects of fiscal stimuli wane. By contrast, growth in emerging market and developing economies (EMDEs) is expected to rise in the next three years, reflecting sustained In the medium to long term, policymakers in advanced economies and EMDEs need to prioritize, growth among commodity importers and rising growth among commodity exporters. among others, structural reforms to boost productivity. In the short term, monetary policy in advanced economies will gradually become less accommodative, as output gaps close The pace of global trade growth is expected to moderate. The global trade of goods and and inflation picks up. As monetary and fiscal stimuli wane and potential growth softens, services is expected to grow by 4.3 percent year-on-year in 2018, down from a six-year high of the outlook is expected to weaken, highlighting the need for structural reforms to boost 4.8 percent in 2017 (Figure 27). A projected decrease in capital spending in China and in most productivity and labor force participation. Meanwhile, EMDEs need to be able to cope with advanced economies will contribute to more moderate global trade growth in the short term. monetary policy normalization in advanced economies as well as manage possible bouts of Over the medium term, structural factors such as slower growth of global value chains and a financial market volatility and inflation risks. Furthermore, deteriorating debt dynamics have reduced appetite for further trade liberalization will constrain global trade growth. On the policy reduced fiscal space in many countries, underlining the importance of revenue mobilization front, the outcome of some trade negotiations remains uncertain, and the risk of escalating and medium term fiscal frameworks to rebuild fiscal buffers. EMDEs face various structural trade restrictions has intensified, as new tariff announcements by the United States have led to challenges to achieve long-term growth, including the need to improve skills and retaliatory responses by major trading partners. adaptability to confront rapid technological change, promote regional trade integration, and enhance productivity. 32 PART 02: OUTLOOK AND RISKS Box 4. The Global Economic Outlook (continued) Figure 26. Global growth in 2018 is projected to grow at the same rate as in Figure 27. Global trade is expected to slow down in 2018. the previous. AGGREGATE GROWTH RATES (IN PERCENTAGE) GLOBAL TRADE AND INVESTMENT (AVERAGE OF EXPORT AND IMPORT VOLUMES) 8 5 4 6 3 4 2 2 1 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 World Advanced Economies EMDEs Trade Investment Notes: EMDEs = emerging market and developing economies. Shaded area indicates forecasts. Aggregate growth Notes: Shaded area indicates forecasts. Trade measured as the average of export and import volumes. rates calculated using constant 2010 U.S. dollar GDP weights. Data for 2017 are estimates. Source: GEP June 2018 Source: GEP June 2018 Table 5. Real GDP Growth Rates, Recent and Projected 2015 2016 2017e 2018f 2019f 2020f World 2.8 2.4 3.1 3.1 3.0 2.9 Advanced economies 2.3 1.7 2.3 2.2 2.0 1.7 Emerging market and developing Economies 3.7 3.7 4.3 4.5 4.7 4.7 Developing East Asia & Pacific 6.5 6.3 6.6 6.3 6.1 6.0 Philippines 6.1 6.9 6.7 6.7 6.7 6.6 Note: Developing East Asia & Pacific includes Cambodia, China, Fiji, Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea, Philippines, Solomon Islands, Thailand, Timor-Leste, and Vietnam. Source: World Bank (2018c) 33 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Box 5. Progress on the Build, Build, Build Program As of July 27, 2018, seven out of 75 flagship projects under the Build, Build, Build program have and another four in 2021 at an estimated cost of Php12.1 billion. These projects are targeted for begun implementation.32,33 Out of 75 infrastructure projects (amounting to Php-9 trillion), 35 completion between 2021 and 2025. The government expects construction activities to have (totaling Php1.24 trillion) have received approval from the board of directors of the National started for a majority of the 35 approved projects by the end of 2018. However, only seven Economic and Development Authority (NEDA) (Table 6). 31 projects, at an estimated cost of projects have been implemented since 2016. Right-of-way issues, contractors’ lagging schedule, Php624.5 billion, are still under review, and the remaining nine projects do not require approval and delays in fund disbursements were some of the reasons for the setbacks.34 Moreover, from NEDA’s board. 17 out of the 35 approved projects are targeted to be implemented in 2016-18 procurement laws that restrict foreign contractors, a supply shortage of local contractors, and (Table 7). Nine projects with approved infrastructure plans are expected to start in 2019 at an inefficient domestic construction firms also contributed to the delays.35 estimated cost of Php418 billion, five more in 2020 at an estimated cost of Php13.7 billion, Table 6. Projects Pending NEDA’s Board Approval under the Build, Build, Build Program Target start of implementation Project cost (Php billion) Number of projects 2018 254.8 12 2019 232.1 10 2020 55.5 5 2021 10.5 1 TBD 71.6 3 Total 624.5 31 Table 7. Flagship Projects with Target Implementation under the Build, Build, Build Infrastructure program Target start of implementation NEDA Board-Approved For NEDA Board’s approval Not for NEDA Board’s approval Total 2014 1 1 2016 1 1 2017 2 1 3 2018 14 12 4 30 2019 9 10 19 2020 5 5 1 11 2021 4 1 5 TBD 3 2 5 Total 35 31 9 75 Source: NEDA 32 Source: NEDA. Infrastructure Flagship Projects as of July 27, 2018. Available at: http://www.neda.gov.ph/wp-content/uploads/2017/07/IFPs-as-of-July-27-2018-final.pdf 33 Gonzales (2018), Rivas (2018), and Velasco (2018). 34 Velasco (2018). 35 Torres (2018). 34 PART 02: OUTLOOK AND RISKS Box 6. The 2019 National Budget: Moving from Obligations to Annual Cash-based Budget Appropriations The Philippines government will change the basis of public budget appropriations in 2019. budget year. The move to annual cash appropriations is an extension of the gradual firming Congress has previously approved budgets on an obligations basis, meaning that agencies up of appropriations that has occurred in the last few years. In 2017 the budget moved from a were authorized to spend cash and enter into contractual commitments during the budget 2-year obligation based budget to a 1-year obligation-based budget. year up to a limit of the budget approved by Congress. ‘Obligated’ amounts do not have to be paid during the budget year. Moreover, goods and services under ‘obligated’ contracts do not The government has made special provisions for multi-year activities by establishing a multi- necessarily have to be delivered in the budget year and payments can be made in future years year obligational authority (MYOA), drawing on an existing policy included in procurement law within the conditions set in contracts and annual budget laws. (RA 9184). This will enable agencies to plan and commit expenditures beyond the budget year for activities covered by the MYOA. Annual cash appropriations will require agencies to obtain and pay for goods and services within the relevant budget year. In 2019 the Philippines government proposes to allow a three This change in appropriations will bring the Philippines into line with most other countries month ‘extended payment period (EPP)’ after the end of the budget year for payments on goods and will institute a generally accepted good practice in budget discipline. It will provide accepted by December 31 of the budget year. This may be continued for future years, subject to greater certainty to Government and Congress on the expected amount of disbursements budget policy. during the budget year. It will also benefit agencies as it will provide more focus on planning and implementing the current year’s budget. It will facilitate better aggregate cash planning This change of appropriations will entail a significant tightening of the timeframe for and may result in savings from more predictable cash balances. At the agency level, it will expenditures compared with obligation-based appropriations. This aims to increase discipline encourage greater focus on accurate planning, timely procurement and budget execution, and in agencies to plan, execute and pay for their expenses during a single year. This will have cash monitoring. little impact on agencies whose expenses are primarily recurrent outlays such as salaries and existing contractual arrangements, it will require robust estimates of the timing for contract award, delivery, and payment for capital investments and new major procurements during the Source: Department of Budget and Management. 35 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Box 7. The Proposed 2019 National Budget The 2019 national government budget continues to build on the Duterte Administration’s budget priorities from past years, following the government’s 0-10 Point Socioeconomic Agenda. The proposed budget, amounting to PhP3.76 trillion, represents a 13.0 percent expansion compared to the Php3.32 trillion cash-based equivalent in 2018. Similar to the previous year’s budget, the proposed 2019 budget prioritizes investments in infrastructure and education (Figure 28). On a cash-appropriation basis, the education budget is set to increase by 12.3 percent year-on-year in nominal terms compared to its 2018 cash-based equivalent, to reach Php659.3 billion in 2019, which represents around 17.5 percent of the proposed total 2019 budget—similar to the 17.7 percent share of the education budget in the total 2017 budget. In addition, the 2019 budget for the government’s flagship infrastructure program “Build, Build, Build” amounts to Php909.7 billion, roughly a quarter of the proposed total 2019 cash-based budget and equivalent to around 4.7 percent of GDP.36 Through the government’s “Build, Build, Build”, initiative, the Philippine government continues to focus on improving logistics connectivity through an improvement in the country’s road, air, and sea transport networks. Figure 28. Top Recipients of the National Budget (2018 & Proposed Cash-based 2019). RECIPIENTS OF NATIONAL BUDGET (PERCENT SHARE FROM TOTAL) 2018 2019 17.7% 17.5% 14.8% 13.3% 6.0% 5.2% 4.9% 5.9% 4.6% 4.7% 4.1% 3.8% 2.0% 1.2% 1.2% 1.3% 1.1% 1.0% 0.7% 0.9% Education Public Works DILG Defense Social Welfare Health Transportation Agriculture Judiciary ARMM A commitment to maintain fiscal discipline is central to the government’s programmed budget and its medium term fiscal stance. As the government continues to increase spending in priority sectors, it raised its fiscal deficit target from 3.0 percent of GDP in 2018 to 3.2 percent of GDP in 2019. Despite raising the fiscal deficit target, the government remains committed to maintaining the overall fiscal health of the Philippines, and it aims to lower the overall fiscal target back to 3.0 percent of GDP in 2020 and 2021. To that end, the government seeks to pass additional revenue-generating tax-policy reforms and improve the tax administration through passing the comprehensive tax reform package 1B and continuing to implement package 1A of the TRAIN law. Packages 1A and 1B are expected to raise additional revenue of Php181.4 billion in 2019 (around 0.9 percent of GDP), which is expected to help keep the government’s fiscal balance at a manageable level. Source: Department of Budget and Management. 36 The allocation for the ‘Build, Build, Build’ program in 2018 amounted to Php1.1 trillion on an obligation basis (around 28.4 percent of the total budget, or 6.1 percent of GDP). 36 Inflation is expected to remain above the central bank’s target to 5.8 percent in 2020. In addition, a faster implementation of PART 02: OUTLOOK AND RISKS in 2018 and 2019, before gradually declining to below 4.0 percent infrastructure projects will support growth in the construction in 2020. The recent rise in inflation was driven by supply-side sector and generate job opportunities. Furthermore, a sustained factors in agriculture, higher global oil prices filtering through a inflow of remittances and inflation easing up will support robust weaker peso, new excise taxes, and demand-driven pressures. As private consumption. supply restores and various measures to temper inflation become effective37, inflation is projected to decline gradually from an The services sector is expected to remain the main growth engine in average of 5.2 percent in 2018 to 4.4 percent and 3.8 percent in 2019 the medium term while growth in manufacturing and agriculture and 2020, respectively. These projections are in line with those of follows recent trends. The upcoming elections in 2019 and an the BSP, which estimates that the inflation rate will remain above acceleration in public infrastructure projects implementation is target range in 2018 and 2019, before falling to below 4.0 percent expected to accelerate service growth to 6.8 percent year-on-year 2020. The decline in inflation is expected to be gradual, as global in 2018 from 6.7 percent in 2017, and 6.9 percent in 2019, before oil price is forecast to remain high and fuel excise tax rates will moderating to 6.7 percent in 2020. Government services and the be updated in 2019 and 2020.38 Higher fuel costs would spill into trade, transport, commerce, and storage sectors are expected to the rest of the economy. In addition, crop damages caused by new sustain their 2018 growth rates, 14.2 percent and 6.4 percent in the weather disturbances such as the recent Typhoon Ompong might first half of 2018, respectively (7.1 percent and 3.8 percent over the add additional pressure to food inflation. As a result, inflation rate same period in 2017). In addition, growth in the financial sector is is expected to remain relatively high during the forecast period. expected to remain strong. Industry growth is expected to accelerate Nevertheless, the BSP is committed to closely monitor inflation slightly from 7.2 percent year-on-year in 2017 to 7.3 percent in 2018, developments and manage inflation expectations by raising the key and to 7.6 percent in 2019 and 2020, driven by a dynamic construction policy rate. sector. Meanwhile manufacturing growth is projected to remain strong, although at a lower level relative to previous years, as global Private consumption growth is expected to remain strong in the trade is expected to slow down. Growth in the agriculture sector medium term, supported by a steady labor market, a continued is expected to recover slightly from 0.7 percent year-on-year in the inflow of remittances, and inflation easing. Growth in private first six months of 2018 to average 1.0 percent in 2018 and 1.1 percent consumption is expected to accelerate slightly from 5.7 percent in both 2019 and 2020. The slow projected recovery in agriculture year-on-year in the first half of 2018 to 5.9 percent in the second half growth is partly related to the high base in 2017 (4 percent year-on- of 2018 as economic growth accelerates driven by an acceleration year), the sector’s unresolved productivity challenges, and in public spending and inflation rate eases. It is expected to remain increasing loss from natural disasters, the most recent one being strong at around 6.0 percent year-on-year in 2019 supported by a Typhoon Ompong. boost from pre-election activities, before decelerating slightly Table 8. Economic Indicators for Baseline Projection 2015 2016 2017 2018f 2019f 2020f Real GDP growth, at constant market prices 6.1 6.9 6.7 6.5 6.7 6.6 Private Consumption 6.3 7.1 5.9 5.8 5.9 5.8 Government Consumption 7.6 9.0 7.0 12.8 11.9 9.8 Gross Fixed Capital Investment 16.9 26.1 9.5 16.2 15.0 15.0 Exports, Goods and Services 8.5 11.6 19.5 11.4 13.0 13.0 Imports, Goods and Services 14.6 20.2 18.1 15.7 15.7 15.3 Inflation (period average) 0.7 1.3 2.9 5.2 4.4 3.8 National government balance (% of GDP) -0.9 -2.4 -2.2 -2.5 -2.8 -2.8 Current account balance 2.5 -0.4 -0.8 -1.1 -1.3 1.4 Source: PSA, BSP, BTr, World Bank Staff estimates 37 The BSP raised its key policy rate from 3.0 percent to 4.5 percent in a bid to manage inflation expectation. The government also banks on other measures to temper rising inflation. One such measure is House Bill 7735 or the Revised Agricultural Tariffication Act, to lift the 805,200-ton limit to rice imports and replace with a general tariff. The bill will allow more entry of rice into the country which will lead to lowering of the price of rice. A senate bill counterpart is currently being deliberated. Moreover, an executive order has been signed to ease restriction on the importation of fish, vegetable, meat and other food products is to manage food prices. . Meanwhile, social mitigation measures such as the unconditional cash transfer are being fast-tracked, and transport-related subsidies under the TRAIN law being considered to address the soaring prices. 38 The excise tax rate for regular gasoline will increase from Php7.0 per liter in 2018 to Php9.0 and Php10.0 per liter in 2019 and 2020, respectively, while the rate for diesel fuel will increase from Php2.5 per liter in 2018 to Php4.5 and Php6.0 per liter in 2019 and 2020, respectively. 37 POVERTY AND SHARED PROSPERITY OUTLOOK PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Household incomes will continue to grow but persistent high inflation may slow down poverty reduction Inclusive growth is likely to continue to contribute to poverty Figure 29. Poverty reduction will likely continue in the coming years reduction. Sustained high economic growth will facilitate growth of household incomes through wages and sustained domestic ACTUAL AND PROJECTED $3.20-A-DAY POVERTY RATES remittances. Social cash transfers from government are likewise 50% expected to continue in the coming years. Based on economic 40% growth outlook, poverty rate based on the lower middle-income poverty line of US$3.20/day, is projected to decline from 27.0 percent 30% in 2015 to 23.0 percent in 2018, 21.8 percent in 2019, and 20.9 percent 20% in 2020. These projections would imply a continuing trend of one million Filipinos being lifted out of poverty each year (Figure 29). 10% 0% However, rising inflation may negatively impact the welfare of 2006 2008 2010 2012 2014 2016 2018 2020 the poor. The increase in inflation is to large extent due to higher Source: Staff estimates prices of basic commodities such as food and non-alcoholic beverages and fuel. These prices picked up by the first half of the surge after the typhoon, the poor and vulnerable households year at a faster rate than the average in 2017. Poor households would be disproportionally more affected as a larger share of their are disproportionately affected by the increasing prices since consumption is on food. they spend a significant share of their incomes on these basic commodities. Estimates from APIS 2017 show that about 67 percent Mitigation measures are being roll out for the poor households. The of expenses of households in the bottom quintile are on food government has started to roll out the unconditional cash transfer and transportation. program. Existing 4Ps beneficiary households have started to receive cash grants of Php200 per month since February 2018. The The recent Typhoon Ompong might have impacted the poor and government has allocated Php25.7 billion for the program this year vulnerable households disproportionately. As of September 19, there and 10 million households are expected to benefit from the program. are 264,304 family affected, about a third of the number of families In 2019, the unconditional cash transfer program will increase affected during Typhon Lando. A large share of the population the transfer amount to Php300 per month. Other counteracting displaced and affected by Typhoon Ompong are farmers and factor to the high inflation includes farm gate prices co-moving vulnerable groups. Given the poor households are more likely to with increasing food prices resulting to income gain of farming live in fragile housing, have less savings and insurance, and have households. In addition, the government has rolled out fuel voucher less resources, they are more exposed to the shocks and have lower cards to public utility jeepney drivers and operators to mitigate the capacity to cope. Many displaced households lost their jobs and impact of recent oil price increase and higher excise taxes.39 incomes, or even family members. In addition, if food prices 39 On August 28, 2018, the government has started the distribution of the first tranche of the of fuel vouchers to jeepney drivers and operators national wide. It provides a lump sum subsidy of Php5,000 until the end of 2018. In 2019, a second tranche is expected to be distributed to each beneficiary amounting Php20,514,82 for the year. 38 Figure 30. Prices of basic commodities are increasing PART 02: OUTLOOK AND RISKS CONSUMER PRICE INDEX (2012=100) 215 195 175 155 135 115 95 75 JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB MAR APR MAY JUN JUL 2017 2018 Alcohol & tobacco Food All items Housing and utilities Transport Source: PSA Figure 31. …and poor households are affected HOUSEHOLD EXPENDITURE SHARES BY INCOME QUINTILE (PERCENT) TOP QUINTILE 4TH 3RD 2ND BOTTOM QUINTILE 0% 20% 40% 60% 80% 100% Food Housing and utilities Miscellaneous Transport Alcohol and tobacco Others Source: Annual Poverty Indicators Survey 2017, PSA 39 RISKS AND POLICY CHALLENGES PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Economic growth outlook is subject to several downward risks. External risks include a rapid slowdown in global trade and a tighter than expected financing conditions. Domestic risks include persistent high inflation and slower than expected implementation of the government investment program. Pace of current account deficit widening will need to be monitored closely to preserve macroeconomic fundamentals. External risks have increased. Protectionist sentiments have the inflation rate to the 2-4 target range in 2020. However, delays intensified in some advanced economies recently, and a further in resolving the economy’s supply constraints including the escalation of the ongoing trade war remains a possibility. In added pressure by the recent Typhoon Ompong, and the further addition, there is a risk of disruption in financial markets, as the depreciation of the pesos may raise inflation in the medium term. situation in Turkey worsens and contagion fear in emerging markets Persistent high inflation may slow private consumption growth. triggers faster capital reversals. These risks affect the Philippines Recent high inflation was mainly driven by rising food prices, and through trade and financial markets. A slowdown in Chinese it disproportionally affected vulnerable households, as they spend exports may indirectly impact Philippine exports, as the country more than half of their budget on food, eroding real income and is integrated into China-led value chains. While the impact of the depressing demand. Higher inflation may also trigger further policy risk through trade is currently small, they are not negligible if trade rate increases that in turn will increase overall financing costs and disputes escalate (Box 8). decelerate private investment growth. In particular, financial risks are high as the Philippines is more The investment growth outlook depends on the timely and effective vulnerable to capital flows than neighboring countries. Philippines implementation of government investment program. Although data has a relatively low “basic balance”, that is the difference between from early 2018 showed signs of improvement in budget execution, foreign direct investment and current account balance compared underspending remains a concern for the national government, to Malaysia and Thailand. This implies that the Philippines peso particularly in terms of its Build, Build, Build infrastructure is more sensitive to changes in portfolio capital flows of smaller program. In an effort to improve budget execution and program magnitude as equity flows are the main “mover” of the peso. For implementation, the government transitioned to a cash-based instance, the uncertainty in global financial markets has led to budget for 2019, which limits the validity of the national budget foreign capital outflow from the Philippines Stock Exchange, whose to one year, compared to the multi-year validity of the previous index dropped from above 9,000 in January 2018 to 7,856 in August obligation-based budget. The government hopes that a cash-based 2018. The intensified net portfolio investment outflow and the budget will improve budget execution by ensuring that only deceleration in net export growth further weakened the peso, which implementation-ready projects are included in the budget. It also depreciated by 7.0 percent year-to-date in the first eight months of expects that this will improve the planning and fiscal discipline 2018. Therefore, an increased uncertainty in the financial markets among public agencies. However, binding constraints to efficient and weakened investor sentiments toward emerging markets may budget execution must be addressed at the agency level to ensure have a large impact on the Philippines, resulting in more capital a smooth transition to the cash-based system. Specifically, the outflows, higher financing costs, and a further pressure on the peso. government needs to tackle issues related to weak program and project design, procurement difficulties, and limited The effect of persistent high inflation on private consumption absorptive capacity. growth constitutes a domestic risk to economic growth. The BSP is committed to managing inflation expectations and lowering 40 PART 02: OUTLOOK AND RISKS Box 8. Potential Impact of the United States-China Trade War on the Philippines40 The United States-China trade war raises fear of global trade disruptions and slower global growth. A recent World Bank simulation shows that the trade war between the United States and China could reduce global exports by up to 3.0 percent and global income by up to 1.7 percent, with losses across all regions.41 The trade dispute threatens the world economy by increasing the costs of inputs and final products, dampening investors’ sentiment and disrupting trade. Many countries in the East Asia Pacific (EAP) region are particularly exposed to the trade war, given their integration into the global economy via trade and investment linkages. The Philippines is no exception and can potentially be impacted by the trade war through financial market, investment, and trade channels. The escalating trade war heightens uncertainties in financial markets and weakens investor sentiments toward emerging markets like the Philippines. Although recent financial market volatility in the Philippines and capital outflows from the country were initially driven by tighter monetary policy in the United States, the threat of trade wars has contributed to heightened uncertainty. This uncertainty contributed to foreign capital outflows from the Philippine Stock Exchange, whose index steadily dropped from an all-time high of 9,058 in January 2018 to a low of 6,923 in June 2018. This divestment of assets, a result of investors flying to ‘safe havens,’ also contributed to a further weakening of the peso, which depreciated by 4.1 percent year-on-year in the first seven months of 2018. In general, the trade tension can spillover into a moderate loss of investor confidence, leading to a reduction in global investment, which can have a negative impact on the country’s financial market. While heightened uncertainty dampens investment prospects in the short term, the United States-China trade war could lead to the relocation of direct investment away from China. Heightened uncertainty could induce producers and traders to postpone both investment plans and trade in the short term. Nonetheless, by raising the cost of serving the U.S. market from China, the trade war could lead to a diversion of investments toward Chinese competitors in the medium term. The extent to which investment may relocate to other countries would partly depend on each country’s ability to produce the same affected products. Among the Philippines’ southeast Asian neighbors, Vietnam and Malaysia are best positioned to host these investments, followed by Indonesia, Thailand, and the Philippines (Figure 33). If the relocation of investment is driven by Chinese investors, countries which are already large recipients of Chinese outward FDI would be in a better position to capture such flows. Again, Malaysia and Vietnam were the largest recipients of Chinese FDI in 2017, followed by Indonesia, Thailand, and the Philippines. In general, the Philippines is behind its southeast Asian neighbors in the potential relocation of direct investment away from China. The impact of United States and Chinese tariff increases is expected to be relatively small on the Philippines’ export. The July tariff hike is expected to generate a US$11.4 billion drop in Chinese exports to the United States, concentrated in capital equipment and electronics goods. This could slightly reduce Chinese demand for intermediate goods in EAP countries, including the Philippines, which are integrated in China-led value chains. However, the expected drop in exports to the United States represents less than 1.0 percent of Chinese manufacturing exports and an even smaller proportion of total Chinese manufacturing production. As a result, the rise in tariffs is likely to have a small or negligible impact on the Philippine export, especially as the Philippines has a lower exposure to Chinese imports of intermediates compared with Vietnam, Malaysia, Thailand, and Indonesia. The Philippines is also less likely than peers to take advantage of the potential diversion of United States imports from China. The trade diversion will depend on the similarity of export baskets between EAP countries and China. Of the 1,153 products targeted against China, only 362 of the Philippines’ export product lines are similar, compared with Malaysia’s 590, Thailand’s 553, and Vietnam’s 415 product lines. Given the different export baskets between China and the Philippines, the probability of supplying the United States market with alternative Philippine-sourced products is relatively low. Based on World Bank estimates of potential export markets (as a percentage of GDP), Vietnam has the largest potential to replace China in terms of satisfying the demand in the United States, followed by Malaysia, Thailand, and the Philippines (Figure 33). Figure 32. Degree of similarity between export baskets to the U.S. for Figure 33. Potential replacement of Chinese exports to the U.S. by affected Chinese products. countries in the East Asia Pacific. PAIRWISE US IMPORT CORRELATION POTENTIAL EXPORT MARKETS AS PERCETANGE OF GDP VIETNAM 4.0% 3.5% MALAYSIA 3.0% 2.5% INDONESIA 2.0% 1.5% THAILAND 1.0% 0.5% PHILIPPINES 0.0% Vietnam Malaysia Thailand Philippines Indonesia 0 0.1 0.2 0.3 0.4 0.5 Potential exp mkt (X>0) (% GDP) Source: World Bank estimates on the basis of U.S. Bureau Census of Statistics, index of correlation at HS-8 digit. Potential exp mkt (X>US$1 million) (% GDP) *For affected products as of July 2018. Exp to US in affected products in 2017 (% GDP) Source: World Bank estimates. 40 The content of this box has largely been drawn from “Potential Impact of the Trade Wars on East Asia and the Pacific,” a note prepared by Max Cali et al., under the guid- ance of Ndiame Diop. 41 “U.S.-China Trade War Scenarios: Impacts on Global Trade and Income”, a note prepared by C. Freund, et al. 41 Given increased global uncertainties and inflation pressures, In addition, keeping a healthy recurrent expenditure growth will be PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY medium term fiscal sustainability is crucial to allow for important to retain fiscal flexibility. Wage bill expenditure increased countercyclical fiscal policy. Fiscal deficit widened in the first half over 20 percent in the first half of 2018 and it is expected to increase of 2018. As the government continues its expansional fiscal policy, by 11.7 percent in the proposed 2019 budget. While the rapid increase fiscal deficit is expected to further widen which will reduce fiscal was related to the expected public workers’ salary increase approved space needed for countercyclical fiscal policy amid negative shocks. in 2016, it is crucial to contain recurrent expenditure growth at For instance, the government plans to allocate more resources for similar rate of the economy growth. This is because if recurrent its ambitious infrastructure agenda and raise public-sector wages spending grows at a higher rate than the overall expenditure, the in 2019.42 To keep the fiscal deficit within the target of 3.2 percent in proportion of rigid expenditure increases43, thus it reduces fiscal 2019 and 3.0 percent in 2020, the government will need to improve space needed to adopt countercyclical measures under a revenue collection. While additional revenue will be generated from negative shock. TRAIN (estimated at Php144. billion, approximately 0.7 percent of GDP) in 2019, the government is also expected to generate Php37.2 To sustain high inclusive growth in the medium term, the billion (0.2 percent of GDP) from package 1B of the CTRP, which Philippines needs to accelerate structural reforms to boost will help contain the fiscal deficit in 2019. However, the government productivity growth. External environment is expected to be less needs to ensure that the second package of the CTRP, which favorable going forward as global growth and trade activities introduces reforms to the corporate income tax and fiscal moderate. While the country has been shown to be resilient, the incentives, remains revenue neutral to maintain the country’s government needs to speed up the implementation of structural overall fiscal health. reforms to boost productivity growth if it is to meet the goals set out in the AmBisyon Natin 2040. Priority policy areas include: i) Furthermore, as global financing conditions tightens, it would be improving market competition through regulatory reforms; ii) prudent to monitor the pace of current account deficit widening to improving trade and investment climate policies and regulations; maintain macroeconomic stability. The country is fairly resilient to and iii) reducing labor market rigidities and costs (see Chapter 3: capital reversals given its large foreign reserves, flexible exchange- Special Focus Note for more details). In addition, the Philippines rate regime, low public debt, and robust remittance inflows. At the needs to address structural vulnerabilities in the agriculture sector present juncture, maintaining the country’s resilience rests in large to mitigate the negative effects of weather conditions on the sector part on preventing the current-account deficit from widening too and to increase domestic supply. much and too fast. Given that export growth is not expected to accelerate in the medium term, future import growth driven by public investment will need to be monitored closely to manage the pace of current account deficit widening to prevent external funding gap challenges. 42 2019 is the last tranche of public workers salary increase that was approved in 2016. The proposed budget for personnel expenditures is 11.7 percent higher than the programmed budget for 2018 Source: http://www.officialgazette.gov.ph/2016/02/19/executive-order-no-201-s-2016/ 43 High rigidity expenditures include personnel expenditure (permanent), net-lending and loans outlays, and interests payments. Medium high rigidity expenditures include personnel expenditure (temporary), current transfers to educational institutions. Medium rigidity expenditures include non-staff services and other current transfers. Low rigidity expenditures include con- sumption goods, other current expenditure, non-financial direct investment, financial investment, and other capital transfers. PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH 42 43 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY PART 03 SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH 44 The Philippines has experienced impressive economic growth in the last two decades partly as a result of past structural reforms and the government’s commitment to macroeconomic and fiscal stability. The country aims to continue its growth success by tripling its income per capita by 2040 through the government’s growth plan AmBisyon Natin 2040. Accelerating capital accumulation and sustaining high TFP growth are essential to achieve the government’s goals. This focus note highlights four policy reform areas that are crucial to sustaining high TFP growth in the Philippines: i) improve market competition through regulatory reforms; ii) improve trade and investment climate policies and regulations; iii) create an enabling environment for innovation; and iv) reduce labor market rigidities and costs. Market competition coupled with a flexible labor market and abundant labor supply allows higher productivity to reduce product prices, which raises the real incomes of workers. As result of more and higher paid jobs, more people will be able to move out of poverty, helping the government achieve the AmBisyon Natin 2040 and realize its vision of a society free of poverty. 44 This special focus is based on a World Bank Report (2018h). 44 INTRODUCTION GROWTH DRIVERS IN THE PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH The Philippines has become a strong growth performer since 2010, as the government implemented business-friendly reforms PHILIPPINES SINCE THE and the external environment improved. The country’s volatile macroeconomic and political environment in the 1980s resulted EARLY 1980S in low and highly volatile growth rates that averaged 2.5 percent Structural reforms played a key role in the Philippines’ economic per year in 1980-1997,45 much lower than the average of 4.6 percent growth recovery and acceleration. The reforms initiated in the late among structural peers and 7.6 percent among regional peers in the 1980s and the 1990s were important for the country’s initial growth same period.46,47,48 However, the Philippines experienced relatively recovery and subsequent acceleration two decades later. They also high economic growth between 1998 and 2009, as the government highlight the existence of a time-lag between the implementation implemented trade, investment, and privatization reforms in the late and payoff of reforms, as reforms started to have an impact only in 1980s and the 1990s. Moreover, economic growth benefited from a the second half of the 2000s. The growth recovery in the late 1990s commitment by the government to strengthen macroeconomic sta- was driven by trade openness, gradual financial sector opening bility. Favorable domestic and external conditions allowed economic and deepening, and infrastructure development that boosted the growth to accelerate to an average annual rate of 6.3 percent in 2010- Philippines’ external competitiveness. The cumulative effect of past 16, surpassing the average of both structural and regional peers. reforms coupled with prudent fiscal and macroeconomic policies re- The Philippines has articulated an ambitious goal of tripling the sulted in an impressive acceleration of economic growth in 2010-16. country’s income per capita and transforming the country into a Macroeconomic stability is a necessary (albeit not sufficient) prosperous middle-class society free of poverty by 2040 (AmBisyon condition for sustained growth. In the 1980s, the Philippines Natin 2040). The Philippines tripled its GDP per capita in the past 20 experienced a debt crisis (1983) and multiple coup d’état attempts years as result of strong economic growth, which the government (1986-1990), leading to growth contracting by 7.6 percent in 1984- aims to repeat in the next 20 years. The government’s goal is based 85 and a “lost decade” in terms of economic growth. As a result, on a set of household consumption and asset-ownership targets, GDP per capita fell from US$1,687 in 1980 to US$1,57249 in 1999. By including “owning a house and a car and having the ability to send contrast, the economic recovery of the 2000s was preceded by a children to college while maintaining a middle-class lifestyle.” This restoration of fiscal discipline and a reduction of inflation. Moreover, focus note shows that the Philippines will need to sustain high growth acceleration in 2010-16 coincided with the continuation productivity growth for the next two decades if it is to triple its GDP of macroeconomic stability and favorable external conditions. per capita, which will require substantial reform efforts. Greater macroeconomic stability coupled with the implementation of structural reforms in 2000-16 led to a near-doubling of the Philippines’ GDP per capita— from US$1,607 in 2000 to US$2,753 in 2016. 45 The Philippines experienced a debt crisis in 1983 that led to an economic contraction of 7.6 percent in 1984-85; multiple coup d’état attempts in 1986-90 that led to the 1991 recession; and the Asian financial crisis in 1997 that resulted in a 0.6 percent contraction in economic growth in 1998. 46 Bangladesh, Kenya, Morocco, Pakistan, Sri Lanka, and Vietnam are defined as the Philippines’ structural peers based on the following criteria: a) they are lower-middle-income coun- tries; b) their natural resource exports are lower than 20 percent of total exports; c) they score above average on the Natural Disaster Risk Index; d) each country’s population is above 20 million; e) they are all oil importers; f) their exports are not concentrated according to the Herfindahl index; and g) they are not landlocked countries, small states, or fragile states. China, Indonesia, Malaysia, Thailand, and Vietnam are identified as regional peers. 47 The regional peer average, with the exception of China, was 5.0 percent over the same period. 48 The Philippines’ growth volatility in the 1980s was five times the average of structural and regional peers, while growth volatility was around the average of structural peers but higher than the average of regional peers in subsequent decades. 49 GDP per capita (constant 2010 US$), WDI. 45 Figure 34. Capital accumulation in the Philippines, as a share of GDP, is Figure 35. ...and the inflow of net FDI is also low relative to peers. PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY the lowest among peers… GROSS CAPITAL FORMATION: THE PHILIPPINES AND REGIONAL PEERS GROSS CAPITAL FORMATION: THE PHILIPPINES AND STRUCTURAL PEERS (% OF GDP, 1998-2016 AVERAGE) (% OF GDP, 1998-2016 AVERAGE) 45 35 40 30 35 25 30 25 20 20 15 15 10 10 5 5 0 0 Gross Capital Formation Net FDI Gross Capital Formation Net FDI Philippines Malaysia Thailand Pakistan Kenya Philippines Bangladesh Indonesia Vietnam China Sri Lanka Morocco Vietnam Source: WDI. Source: WDI. Capital accumulation has been relatively limited in the Philippines investment, averaging only 2.5 percent of GDP each year in 1998-2015, compared to peers. The Philippines had the lowest level of capital much lower than the annual average of 8.6 percent and 3.8 percent accumulation among peers between 1998 and 2016, which was among regional and structural peers, respectively (Figure 36 and exacerbated by low net FDI inflows, averaging a mere 1.5 percent Figure 37). While the level of private investment in the Philippines of GDP per year in 1998-15 (Figure 34 and Figure 35). The low was similar to the average of peers, it was insufficient to compensate investment rate was mainly driven by the low level of public for the low level of public investment. Figure 36. The level of public investment in the Philippines is among the Figure 37. ...and significantly low relative to structural peers. lowest in the region… PUBLIC INVESTMENT IN THE PHILIPPINES AND REGIONAL PEERS (% OF GDP) PUBLIC INVESTMENT IN THE PHILIPPINES AND STRUCTURAL PEERS (% OF GDP) 25 25 20 20 15 15 10 10 5 5 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2007 2008 2009 2010 2011 2012 2013 2014 2015 1998 1999 2000 2001 2002 2003 2004 2005 2006 1998 1999 2000 2001 2002 2003 2004 2005 2006 Philippines China Malaysia Philippines Bangladesh Morocco Vietnam Indonesia Thailand Vietnam Kenya Pakistan Sri Lanka Source: WDI. Source: WDI. 46 Nevertheless, capital accumulation has been the main driver to economic growth in the Philippines has increased since 2000, PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH of economic growth in the Philippines since the 1980s. A mirroring the evolution of the country’s economy over the last two decomposition of real GDP growth shows that capital accumulation decades (Figure 38 and Figure 39). TFP consistently contributed to has consistently been the main driver of economic growth in the growth during the economic recovery and growth acceleration of country, contributing about three-fifths of the growth between 1981 the 2010s, contributing one-third of growth on average during this and 2016. By contrast, labor accumulation, defined as the increased period. Furthermore, the contribution of TFP to growth was higher labor employed in the economy, contributed 31.3 percent of the in the Philippines than in regional peers in 1995-2010, with the only growth in the same period, and its contribution to growth has exception of China (Figure 40 and Figure 41). The growth in TFP steadily declined in the past three decades. reflects the implementation of a wide range of structural reforms since the 1990s, as these reforms increased not only economic Total factor productivity (TFP) has been the second largest growth but also the contribution of TFP to growth. contributor to growth since the 2000s. The contribution of TFP Figure 38. TFP’s contribution to growth has increased since 2010… Figure 39. ...after it declined temporarily in 2009 at the height of the global recession. REAL GDP GROWTH AND CONTRIBUTION (PERCENTAGE POINTS) REAL GDP GROWTH AND CONTRIBUTION (PERCENTAGE POINTS) 15 8.0 15 10 10 6.0 8 10 6 5 4.0 5 4 0 2.0 2 0.0 0 -5 0 -10 -2.0 -5 -2 1981-1986 1986-1991 1991-1996 1996-2001 2001-2006 2006-2011 2011-2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1998 1999 2000 2001 2002 2003 2004 2005 2006 Total Factor Productivity Capital Real GDP (RHS) Total Factor Productivity Capital Real GDP (RHS) Human Capital per Labor Labor Human Capital per Labor Labor Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. Figure 40. Contribution of TFP to economic growth was higher in the Figure 41. ...as well as in many structural peers. Philippines than in many regional peers… CONTRIBUTION TO GROWTH, THE PHILIPPINES AND REGIONAL PEERS, 1995-2010 (%) CONTRIBUTION TO GROWTH, THE PHILIPPINES AND STRUCTURAL PEERS, 1995-2010 (%) 120 120 100 100 80 80 60 60 40 40 20 20 0 0 -20 Philippines China Malaysia Thailand Indonesia Vietnam Philippines Bangladesh Kenya Morocco Pakistan Sri Lanka Vietnam Capital Stock Labor Capital Stock Labor Human Capital per Labor Total Factor Productivity Human Capital per Labor Total Factor Productivity Source: Staff calculations based on PSA data and WDI. Source: Staff calculations based on PSA data and WDI. 47 PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Although labor productivity growth has accelerated in the The improvement in labor productivity in the Philippines mainly Philippines, it remains low compared to that of peers, suggesting an reflects a rise in within-sector productivity growth. Sector-level opportunity to increase growth by closing productivity gaps. The productivity growth was the main driver of the country’s labor county’s labor productivity growth has been consistent with the productivity growth between 1998 and 2016, which was reflected evolution of its TFP growth. It accelerated substantially from an in the increased contribution of many individual sectors to average annual rate of 1.6 percent in 1998-2004 to 3.6 percent in 2010- aggregate productivity over time. In 1998-2016, mining, transport, 16. However, productivity growth was still lower in the Philippines communication and storage, utilities, and manufacturing were than in regional peers (Figure 42 and Figure 43). For instance, China the sectors with the highest annual growth in labor productivity. and Vietnam’s labor productivity growth reached 7.6 percent and 4.2 By contrast, real estate, renting and other business activities, and percent, respectively, in 2010-16. As a result, the labor productivity construction experienced negative productivity growth in the gap remains wide between the Philippines and many regional peers. same period (Figure 44). The Philippines relies more heavily on The country’s low labor productivity has been partly caused by within-sector productivity growth than other countries in East Asia, historic low levels of capital accumulation, resulting in low capital including China, Indonesia, Malaysia, and Thailand.50 per worker, which limits labor productivity growth despite higher TFP growth. This represents an opportunity for the Philippines to increase labor productivity growth by increasing capital accumulation and sustaining high TFP growth. Figure 42. Labor productivity in the Philippines is below the average of Figure 43. ...but above the average of structural peers. regional peers… VA PER WORKER: THE PHILIPPINES VS. REGIONAL PEERS (CONSTANT 2011 PPP $) VA PER WORKER: THE PHILIPPINES VS. STRUCTURAL PEERS (CONSTANT 2011 PPP $) 35,000 60,000 30,000 50,000 25,000 40,000 20,000 30,000 15,000 20,000 10,000 10,000 5,000 0 0 Vietnam Philippines Indonesia China Thailand Malaysia Bangladesh Kenya Vietnam Pakistan Philippines Morocco Sri Lanka 1998 2016 1998 2016 Source: WDI. Source: WDI. 50 World Bank (2017b). 48 Figure 44. Most sectors in the Philippines experienced labor productivity growth in 2010-16 PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH ANNUALIZED LABOR PRODUCTIVITY GROWTH BY SECTOR (PERCENT) 1998-2004 2005-2009 2010-2016 10 8 6 4 2 0 -2 -4 -6 -8 Real Estate, Construction Government Mining and Agriculture Other Services Finance Wholesale and Manufacturing Utility Transport, Total Renting, and Services Quarrying Retail Trade Communication and Business Activities Storage Source: Staff calculations based on PSA data. The steady shift in employment from agriculture to services be in either the top-right corner (e.g., services) where labor shifts underpins the productivity gains from structural change. Figure 45 into relatively high-productivity sectors, or in the third quadrant shows changes in employment shares and the relative productivity (e.g., agriculture) where labor shifts out of low-productivity sectors. of sectors, measured as log of the ratio between sectoral productivity Structural change contributed around 0.3 percentage points and 1.1 and economy-wide average productivity between 1998 and 2016. For percentage points per year to labor productivity growth in 1998-2009 positive gains to occur through structural change, sectors need to and 2010-16, respectively. Figure 45. Labor is transitioning from agriculture to more productive sectors. CHANGES IN AVERAGE EMPLOYMENT SHARE AND DEVIATION FROM AVERAGE VA PER WORKER, 1998-2016 (RATIOS) 1.2 1 Electricity, Gas and Water Log (sector productivity/average productivity) 0.8 Finance Real Estate, Renting and 0.6 Business Activities Manufacturing 0.4 Mining 0.2 Construction Government services 0 Transport, Communication Trade and Storage Other services -0.2 -0.4 Agriculture -0.6 -0.8 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 Change in employment share (1998-2016) Source: Staff calculations based on PSA and WDI. Note: The figure plots the logarithm of sectoral VA per worker (relative to the average across all sectors) and the change in the employment share for 11 economic sectors in 1998-2016. The size of the circle reflects the employment share in 2016. On the vertical axis, sectors above zero are more productive than the average sector in the economy. On the horizontal axis, sectors to the right of zero have had increases in their employment shares. 49 PATTERNS AND DRIVERS OF PRODUCTIVITY AT THE INDUSTRY PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY AND FIRM LEVEL Firms contribute to aggregate productivity growth through the Firm Characteristics and Productivity capacity of markets to efficiently allocate resources across firms (i.e., allocative efficiency) and the evolution of firm productivity (i.e., The Philippine economy is dominated by small firms that are less technical efficiency). Allocative efficiency involves the allocation productive than medium and large firms. In 2014, two-thirds of the of resources to the most productive activities and firms, while country’s manufacturing firms and over 80 percent of services firms technical efficiency occurs when firms generate more output from employed less than 20 workers (Figure 46 and Figure 47). Yet, small the same level of input. To improve overall productivity through firms are on average less productive than medium or large firms in better resource allocation, resources from firms with low returns both manufacturing and services (Figure 48 and Figure 49). This is on production factors need to flow to firms with high returns in the also common in other countries, as larger firms tend to have better same or different sectors. access to credit and technology, benefit from economies of scale, and be more resilient to shocks than smaller firms. However, a large share of small firms in an economy can be an indication that firms are suffering from stunted growth. Figure 46. Most firms are small in the manufacturing sector… Figure 47. ...as well as in the service sector. MANUFACTURING FIRMS BY SIZE SERVICES FIRMS BY SIZE 12,000 180,000 160,000 10,000 140,000 8,000 120,000 100,000 6,000 80,000 4,000 60,000 40,000 2,000 20,000 0 0 2001 2009 2014 2012 2013 2014 100 and above 20-99 workers 1-19 workers 100 and above 20-99 workers 1-19 workers Source: PSA. Source: PSA. 50 Figure 48. Large firms are more productive than small and medium- Figure 49. ...as well as in services. PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH sized firms in manufacturing… PRODUCTIVITY BY FIRM SIZE IN MANUFACTURING (LOG OF VA PER WORKER) PRODUCTIVITY BY FIRM SIZE IN SERVICES (LOG OF VA PER WORKER) 14.0 12.0 12.0 11.5 10.0 11.0 6.0 10.5 2.0 10.0 0.0 9.5 2012 2013 2014 2012 2013 2014 100 and above 20-99 workers 1-19 workers 100 and above 20-99 workers 1-19 workers Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. The relationship between the age and size of firms differs across differences across sectors. In manufacturing, for example, old textile sectors in the Philippines. When product and factor markets work firms are on average smaller than younger firms, while old firms in efficiently, unproductive firms exit the market while more efficient the motor vehicles industry are 21 times larger than younger firms. firms remain and expand. This pattern is observed in the United In services, old financial firms are 13 times larger than younger States where old firms (i.e., firms 40 or more years old) are about firms, while firms in administrative and supporting services do not eight times larger than firms with less than five years in the market. seem to grow over time. The distinct growth patterns of firms in In the Philippines, the economy-wide ratio of average employment different sectors could be caused by differences in sectors’ product to young firms shows a similar pattern, as old firms are about seven and/or factor market efficiencies. times larger than young firms (Figure 50). However, there are vast Figure 50. Labor is transitioning from agriculture to more productive sectors. AVERAGE EMPLOYMENT BY AGE RELATIVE TO EMPLOYMENT OF YOUNG FIRMS (ALL FIRMS) 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0 <5 5-9 10-14 15-19 20-24 25-29 30-34 35-39 >=40 2014 Manufacturing 2014 Services 2014 Economy-wide Source: Staff calculations based on PSA data. 51 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY The share of firms with foreign capital remains small in the overall Firms with foreign ownership are on average more productive economy, although the degree of foreign ownership is relatively than fully domestically owned firms. Between 2010 and 2014, firms high in some services and manufacturing sectors. Less than 10 with foreign capital were more productive than firms with 100 percent of all firms in the Philippines have some degree of foreign percent domestic capital (Figure 53). In addition, firm productivity ownership, with most foreign owners in industry (their share has, tends to increase with more foreign ownership (Figure 54). For however, declined in recent years) (Figure 51). Across sectors, firms instance, Philippine firms in agriculture with between 50 percent in manufacturing and services that have foreign ownership, such and 75 percent foreign capital were substantially more productive as in information and communication technologies (ICT) and than firms with only domestic capital during this period, which is professional services, receive on average more than 50 percent of consistent with evidence from other developing countries. their capital from foreign sources (Figure 52). Figure 51. The share of firms with foreign ownership remains small. Figure 52. Foreign ownership is high in some services and manufacturing sectors. COMPOSITION OF FIRM OWNERSHIP BY SECTOR (IN PERCENT) AVERAGE FOREIGN OWNERSHIP BY SECTOR (IN PERCENT) 100 80 90 70 80 60 70 50 60 40 50 30 40 20 30 10 20 0 10 Information and communication Manufacturing Professional, scientific and technical services Transportation and storage Water supply, sewerage, waste management, and remediation services Mining and quarrying Wholesale and retail rrade Administrative and support service activities Accommodation and food services Education Construction Eelectricity, gas, and air-conditioning Supply Financial and insurance activities Arts, entertainment and recreation Other services Agriculture, forestry and fishing Human health and social work activities Real estate activities 0 2010 2014 2010 2014 2010 2014 Agriculture Industry Services 100% Filipino firms Firms with foreign ownership Source: Staff calculations based on PSA data. 2010 2014 Source: Staff calculations based on PSA data. 52 Figure 53. Firms with foreign ownership are on average more Figure 54. Foreign ownership is correlated with higher productivity. PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH productive than fully domestically owned firms. PRODUCTIVITY AND FIRM OWNERSHIP (ECONOMY-WIDE LOG OF VA PER WORKER, 2012-14) PRODUCTIVITY BY DEGREE OF FOREIGN OWNERSHIP AND SECTORS (LOG OF VA PER WORKER, 2014) 12.5 16.0 12.0 14.0 12.0 11.5 10.0 11.0 8.0 6.0 10.5 4.0 10.0 2.0 0.0 9.5 Agriculture Industry Services Manufacturing Total 2012 2013 2014 excluding Manufacturing 100% Filipino firms Firms with foreign ownership 0% >5% & <25% >=25% & <50% >=50% & <75% >=75% Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. While the number of exporting firms remains small across sectors, similar trend can be observed in industry: the share of exporting they are on average more productive than firms that only focus on firms declined from 10 percent in 2010 to 7 percent in 2014. The share the domestic market. Consistent with aggregate data, firm-level of export service firms also remains small, declining from 2 percent data show that the share of firms that export remains small in the in 2010 to 1 percent in 2014. Yet, firms that export are on average Philippines (Figure 55). In agriculture, a mere 5 percent of sampled more productive than firms that focus on the domestic market firms exported in 2014, down from less than 10 percent in 2010. A (Figure 56). Figure 55. The share of Philippine firms that export declined in 2010-14. Figure 56. Firms that export are on average more productive than firms that focus on the domestic market. SHARE OF FIRMS BY EXPORT STATUS (IN PERCENT) PRODUCTIVITY AND EXPORT STATUS (ECONOMY-WIDE LOG OF VA PER WORKER) 12.5 100 90 12.0 80 70 11.5 60 50 11.0 40 10.5 30 20 10.0 10 0 9.5 2010 2014 2010 2014 2010 2014 2012 2013 2014 Agriculture Industry Services Firms with zero export sales Firms with non-zero export sales Firms with zero export sales Firms with non-zero export sales Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. 53 A better allocation of resources could help expand more productive such as macroeconomic stability and a gradual and continuous PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY firms and raise sector-level productivity. While firms that are large, implementation of structural reforms are driving this trend rather export, and have foreign ownership are more productive than firms than improvements within individual subsectors. A comparison that are small, domestically owned, and focus exclusively on the with peer countries shows that the misallocation of manufacturing domestic market, they represent a very small share of all firms in the resources in the Philippines are in line with that of China in 2005 Philippines. This is not likely to be the result of lack or insufficient and Malaysia in 2010 but lower than that of Kenya in 2010 (Figure 58). policies to support specific industries but might be explained by inefficient allocation of resources. The removal of distortions in Still, productive manufacturing firms face more distortions the economy will increase the likelihood that resources for the than less productive firms in the Philippines, preventing faster production of goods and services (i.e., capital and labor) will flow economic growth. Evidence suggests that productive firms face from less to more productive firms. larger idiosyncratic distortions than less productive firms in manufacturing,51 which means that productive firms are “taxed” Factor misallocation in Philippine manufacturing has improved in at a higher rate in term of distortions. As a result, productive firms recent years. The misallocation of resources in the manufacturing could have expanded their production more if they had acquired sector declined from 180 percent in 2009 to 98 percent in 2014 more resources. Examples of distortion include preferential market (Figure 58), which was consistent with positive labor productivity access and preferential tax incentives to certain firms, which lead growth at the sector level. This also confirms that within-sector productive firms to produce below their optimal levels. However, productivity growth was driven by both improvements in within- this could also mean that unproductive firms continue to operate firm productivity growth and factor allocation across firms in the and use resources in the economy, as their output is possibly being same sector, resulting in reduced misallocation. The improvement subsidized. The constraints faced by productive firms will ultimately in the allocation of resources, which started in 2010, is consistent worsen the economy’s overall productivity growth. across manufacturing subsectors, suggesting that macro factors Figure 57. The misallocation of resources has declined in Philippine Figure 58. …and is in line with selected regional peers. manufacturing since 2009… HYPOTHETICAL PRODUCTIVITY GAIN (IN PERCENT) HYPOTHETICAL PRODUCTIVITY GAINS (IN PERCENT) 200 180 180 160 160 140 140 120 120 100 100 80 80 60 60 40 40 20 20 0 0 2006 2008 2009 2010 2012 2013 2014 United States China Malaysia Philippines Kenya 1997 2005 2010 2014 2010 Source: Staff calculations based on PSA data. Source: Data for the Philippines are based on staff calculations using PSA data, Shieh and Klenow (2009), Nguyen, H., T. Note: Figure only includes formal firms and sectors with more than 10 firms. Sectors with less than 10 firms have been Taskin, and A. Yilmaz (2016), Chuah et al (2018). excluded to avoid results that are driven by outliers. 51 There is a statistically significant positive relationship between firm productivity and firm distortion. Restuccia and Rogerson (2008) argue that productivity losses due to misallocation would be even more significant if distortions are correlated positively with firm productivity. 54 POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH ECONOMIC GROWTH IN THE PHILIPPINES Government policies affect how resources are allocated across firms power. There has also been a recent increase in the number of and the efficiency with which firms use resources. A preferential monopolies and duopolies in Philippine manufacturing markets policy treatment of unproductive firms allows them to remain (Figure 60). As a result, market competition is perceived to be weak in operation (or even thrive) and deny market shares to more in the Philippines. The country ranked 114th out of 138 economies productive firms that could use the resources more efficiently. on market dominance in the World Economic Forum’s 2016-17 Meanwhile, policies that encourage firms to improve their Global Competitiveness Report, which was below the average of the managerial quality, access technology, and innovate contribute to countries in the sample and lowest among regional peers (Figure higher within-firm productivity. Government policies can be divided 61). Limited competition affects business risks, especially related to into measures that affect the external environment of firms, such vested interests and unfair competitive practices (Figure 62).52 as the policy environment for (i) competition and private-sector investment; (ii) trade integration; (iii) foreign investment; (iv) access Anticompetitive restrictions in the service sector not only to finance and capital allocation; and (v) education quality and distorts the services business but also sectors that use services labor market regulations, and those that influence firms’ internal as production inputs such as manufacturing. The results from an operations, notably innovation and managerial quality. This section analysis of input-output linkages that measured the trickle-down will provide policy options for boosting productivity growth in impacts of regulatory barriers to competition in the service sector the Philippines. on manufacturing suggest a misallocation of resources. Specifically, downstream manufacturing sectors, for which the incidence of Improve market competition through regulatory anti-competitive restrictions in services is higher, tend to have reforms productivity distributions that are more dispersed and skewed to the left, which is an indication that resources are potentially Market rules and regulations may be hindering competition in misallocated. This suggests that anticompetitive regulations in the Philippines. In manufacturing, Philippine markets are more service sectors may in fact be acting as a form of friction that concentrated than those of regional peers and have a higher prevents the allocation of resources to more productive firm, proportion of monopoly, duopoly, and oligopoly markets (Figure 59), thereby hampering productivity performance at both the firm and which are typically more prone to collusion and abuse of market aggregate level. 52 Interpreting concentration measures as an indicator of competition and the extend of dominance demands a complementary analysis of market characteristics, including economies of scale and barriers to entry and rivalry. World Bank (2018g) 55 Figure 59. Philippine manufacturing markets are more concentrated Figure 60. …and they have become more concentrated in recent years. PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY than peers’… MARKET CONCENTRATION IN MANUFACTURING IN THE PHILIPPINES AND SELECTED EAP COUNTRIES EVOLUTION OF MARKET CONCENTRATION IN MANUFACTURING IN THE PHILIPPINES (IN PERCENT) IN 2015 (IN PERCENT) 20 18 100 16 90 14 80 12 70 60 10 50 8 40 6 30 4 20 10 2 0 0 Philippines Indonesia Malaysia Cambodia Monopoly Duopoly Oligopoly (3-6) Monopoly Duopoly Oligoply (3-6) Many 2009 2015 Source: Fostering Competition in the Philippines, World Bank (2018g). Source: Fostering Competition in the Philippines, World Bank (2018g). Note: Regional peers were selected among those countries with available information from the World Bank’s Enterprise Survey. In addition to sector-specific restrictions, the cost of doing business system of licenses and permits raises the complexity of regulatory is high in the Philippines. High entry costs discourage firms from procedures. In addition, high barriers to FDI due to constitutional entering markets, dampening the productivity enhancing effect and legislative limitations for foreign participation in selected of creative destruction. The Philippines ranked 173st out of 190 sectors and economic activities have resulted in low levels of FDI economies in the ease of starting a business in the World Bank’s in the country. These barriers to entry limit competition and could Doing Business report in 2018. According to product market raise input costs for Philippine firms. regulation (PMR) indicators, the absence of simplifying tools in the Figure 61. Competition is perceived to be low in the Philippines Figure 62. …which is related to vested interests and unfair competitive practices.. MARKET DOMINANCE (1= DOMINATED BY A FEW BUSINESS GROUPS; 7 = SPREAD AMONG MANY FIRMS) 12 Malaysia 10 China 8 Indonesia 6 Morocco Kenya 4 Pakistan 2 Vietnam 0 Sri Lanka Sri Lanka China Malaysia Philippines Thailand Vietnam Kenya Morocco Pakistan Indonesia Bangladesh Thailand Bangladesh Philippines Vested interests/cronyism Discrimination against foreign companies Unfair competitive practices Price controls 0 2 4 6 Source: Fostering Competition in the Philippines, World Bank (2018g). Source: WEF, 2017-2018. Note: The index is constructed by adding the individual values of each indicator in a 0-4 scale. 56 The Philippines could accelerate GDP growth by removing Improve trade and investment climate policies and PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH restrictions in the service sector. Evidence suggests that an regulations improvement of sector-wide PMR indicators of 10 percent would result in an increase of TFP by at least 1.3 percentage points.53 The Philippines’ level of trade openness has been declining over the Results from a simulation performed by the World Bank in 2017 past two decades despite its relatively low tariff rates. The country based on enhancing the regulatory environment in the service has a liberalized trade regime reflected in its low most-favored- sector implied that the Philippines could move from the fourth to nation tariff of 6.3 percent in 2016, the lowest among structural the second quartile in terms of PMR indicators if 86 restrictions peers and only slightly higher than Malaysia’s among regional mapped by the PMR indicators were lifted. Moreover, a reduction of peers (Figure 63 and Figure 64). By contrast, its trade openness, PMR restrictiveness in key service sectors (i.e., energy, professional measured as the share of total trade to GDP, declined from 98.7 services, transportation, and communications) could add US$0.6 percent in 1998 to 64.9 percent in 2016 (Figure 65 and Figure 66). billion (0.2 percent of GDP) to the country’s annual GDP by boosting From being considered a pioneer of trade openness in the late 1990s, competitiveness in downstream industries that use these services. the Philippines currently ranks below both Vietnam and Morocco and in line with the average of structural peers. The country’s trade openness also ranks below the average of regional peers. Figure 63. The Philippines has a liberalized trade regime reflected in its Figure 64. …as well as among regional peers. low average most-favored-nation rates among structural peers… SIMPLE AVERAGE TARIFF RATES: THE PHILIPPINES VS. STRUCTURAL PEERS (IN PERCENT) SIMPLE AVERAGE TARIFF RATES: THE PHILIPPINES VS. REGIONAL PEERS (IN PERCENT) 16 12 14 10 12 8 10 8 6 6 4 4 2 2 0 0 Philippines Sri Lanka Vietnam Morocco Kenya Bangladesh Malaysia Philippines Indonesia Vietnam China Thailand Source: World Integrated Trade Solution (WITS). Source: World Integrated Trade Solution (WITS). Note: latest data available. Note: latest data available. 53 IMF et. al (2014). 57 Figure 65. The Philippines’ level of trade openness has been declining… Figure 66. …to well below that of regional peers. PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY TRADE AS SHARE OF GDP, THE PHILIPPINES VS. STRUCTURAL PEERS (IN PERCENT) TRADE AS SHARE OF GDP, THE PHILIPPINES VS. REGIONAL PEERS (IN PERCENT) 200 250 200 150 150 100 100 50 50 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1998 1999 2000 2001 2002 2003 2004 2005 2006 1998 1999 2000 2001 2002 2003 2004 2005 2006 Philippines Bangladesh Morocco Vietnam Philippines China Malaysia Kenya Pakistan Sri Lanka Indonesia Thailand Vietnam Source: WDI. Source: WDI. The country’s export competitiveness is impeded by high trade costs. Trade costs in the Philippines are among the highest in the Association of Southeast Asian Nations, according to the 2016 Doing Business report. Investors in the Philippines pay twice as much to export or import a shipping container as investors in Thailand. In addition, the Philippines ranks lowest among peer countries on the World Bank’s Logistics Performance Index,54 and it scores especially low on connectivity to international markets. The Global Competitiveness Index shows that trade is affected by the country’s government regulations, overall infrastructure quality, and customs procedures. Non-tariff measures (NTMs) are also high in the Philippines. Besides tariffs, importing and exporting firms need to comply with NTMs, which encompass a wide range of requirements, including technical regulations, product standards, and custom procedures. NTMs have become an increasingly important obstacle to trade in the Philippines. A survey conducted by the International Trade Center in 2015 showed that 60.7 percent of Philippine exporters and 69.6 percent of importers reported obstacles due to NTMs, relatively high among peers (Figure 67). Furthermore, almost all NTMs faced by Philippine importers are obstacles within the home country, the highest among peers (Figure 68). 54 The index measures the timeliness of deliveries, the quality of infrastructure assets, logistics quality and competence, and the ability to track and trace shipments. 58 Figure 67. More Philippine trade companies face NTM-related obstacles Figure 68. Philippine importers face more domestic NTMs than PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH compared with companies in peers. importers in peers. SHARE OF COMPANIES AFFECTED BY NTM-RELATED OBSTACLES (IN PERCENT) SHARE OF NTM-RELATED OBSTACLES EXPERIENCED AT HOME BY IMPORTERS (IN PERCENT) 100 100 90 98 80 96 70 94 60 92 50 88 40 86 30 84 20 10 82 0 80 Philippines Morocco Indonesia Thailand Sri Lanka Kenya Bangladesh Philippines Indonesia Kenya Sri Lanka Thailand Bangladesh Morocco Exporters Importers Source: ITC NTM Survey. Source: ITC NTM Survey. Note: Sri Lanka (2010), Kenya (2011), Morocco (2011), Indonesia (2013), Thailand (2014), Bangladesh (2015), Note: Sri Lanka (2010), Kenya (2011), Morocco (2011), Indonesia (2013), Thailand (2014), Bangladesh (2015), Philippines (2016). Philippines (2016). While the inflow of FDI into the Philippines increased during the last two decades, it remains low relative to many peers. Net FDI in the Philippines increased by 74 percent between 1999 and 2016, the largest increase among structural peers, with the exception of Morocco (Figure 69). However, the level of FDI in the country is still low relative to many regional peers (Figure 70). For instance, net FDI in the Philippines reached 2.6 percent of GDP in 2016, up from 1.5 percent in 1999, while it represented around 4.3 percent of GDP in Malaysia. Moreover, a decomposition of net FDI into direct-equity and inter-company borrowing reveals that direct-equity investment in the Philippines’ economic sectors fell from 0.8 percent of GDP in 2005 to 0.7 percent of GDP in 2016 (Figure 71). Most of the increase in net FDI was due to an increase in inter-company investment through debt instruments, which increased from 0.3 percent of GDP in 2005 to 1.7 percent of GDP in 2016.55 55 Debt instruments include the borrowing and lending of funds— including debt securities and suppliers’ credits—between direct investors and subsidiaries, branches, and associates. Debt instruments include loans, debt securities, financial leases, and suppliers’ credit (trade credit and advances). 59 Figure 69. Net inflow of FDI into the Philippines has been increasing… Figure 70. …but is still low relative to regional peers. PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY NET FDI INFLOW: THE PHILIPPINES VS. STRUCTURAL PEERS (PERCENT OF GDP) NET FDI INFLOW: THE PHILIPPINES VS. REGIONAL PEERS (PERCENT OF GDP) 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 Philippines Bangladesh Kenya Pakistan Sri Lanka Morocco Vietnam -1 -2 Philippines Indonesia Malaysia Thailand China Vietnam 1999-2014 2005-2010 2011-2016 Source: WDI. 1999-2014 2005-2010 2011-2016 Source: WDI. Figure 71. The level of FDI in the country’s economic sectors Figure 72. …and most investment was concentrated in the service remains small… sector in recent years. NET FDI DECOMPOSITION (% OF GDP) NET FDI TO ECONOMIC SECTORS (3 YEAR AVERAGE, % OF GDP) 3.0 0.9 0.8 2.5 0.7 2.0 0.6 1.5 0.5 1.0 0.4 0.3 0.5 0.2 0.0 0.10 -0.5 0.0 2005-2007 2008-2010 2011-2013 2014-2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2005 2006 Agricultural sector Non-agricultural sector Services sector Others, not elsewhere classified Reinvestment of earnings Source: PSA. Debt instrument Investment into sector Source: PSA. 60 Create an enabling environment for innovation As a result, Philippine firms lag behind peers in adopting existing PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH technologies. On the 2017 Global Innovation Index, the Philippines The country’s innovation infrastructure is of poor quality. In 2017, ranked 73rd out of 128 countries, behind regional peers such as the World Economic Forum ranked the Philippines 74th out of Thailand (51st), Vietnam (47th), Malaysia (37th), and China (22nd). The 137 countries on the availability of scientists and engineers and country’s underperformance in innovation can be partly explained 75th on the availability and quality of research capital, lower than by low spending on R&D, merely 0.1 percent of GDP, compared most peers (Figure 73). Similarly, the availability of information with an average of 0.9 percent of GDP among regional peers and an technology infrastructure, such as mobile subscriptions and average of 0.4 percent of GDP among structural peers. In addition, internet access, was lower in the Philippines than in many regional Philippine firms are less likely to adopt existing technologies than peers while its cost was higher (Figure 75 and Figure 76). Market firms in peer countries. For instance, only 8.8 percent of firms in the dominance and business regulations are also not conducive to Philippines have internationally recognized quality certifications creating an enabling environment for innovation, as uncontested and only 11.2 percent of firms use technology licensed from foreign markets with high profit margins provide little incentives for companies, lower than in most peers. innovation and productivity growth. Finally, the country’s low level of trade openness and FDI limits knowledge spillover. Figure 73. The availability and quality of research capital in the Figure 74. More collaboration between universities and industry could Philippines is low. yield better technology diffusion. AVAILABILITY AND QUALITY OF RESEARCH CAPITAL (7=BEST) UNIVERSITY-INDUSTRY COLLABORATION IN R&D (7=BEST) 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 Malaysia China Indonesia Kenya Sri Lanka Thailand Pakistan Philippines Bangladesh Vietnam Malaysia China Indonesia Kenya Thailand Sri Lanka Philippines Vietnam Pakistan Bangladesh Source: World Economic Forum. Availability of scientists and engineers Quality of scientific research institutions Source: World Economic Forum. 61 Figure 75. The Philippines lags behind regional peers in the availability Figure 76. …and the cost of telecommunications services. PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY of information technology… MOBILE SUBSCRIPTION AND INTERNET ACCESS, 2015 PRICE OF TELECOMMUNCIATIONS SERVICES AS SHARE OF GNI PER CAPITA, 2015 160 10 140 8 120 100 6 80 60 4 40 2 20 0 0 China Philippines Thailand Vietnam Indonesia Malaysia Malaysia China Thailand Indonesia Vietnam Philippines Mobile subscription Mobile Internet access Fixed broadband Source: Access to telecommunications, International Communication Union (2015). Source: Price of telecommunications, International Telecommunication Union. Measuring the Information Society Report 2016. High costs, insufficient resources, market dominance, and lack of funds from within firms and external sources. Moreover, market of skills are the most prominent factors that prevent firms from dominance and lack of qualified personnel are also important innovating in the Philippines (Figure 77). Firms point to the high factors that discourage innovation, especially among micro, small, cost of innovation as the primary factor that prevent them from and medium enterprises (MSMEs). engaging in innovation activities in the country, followed by lack Figure 77. High costs and lack of funds are the most prominent factors hampering innovation. FACTORS HAMPERING INNOVATION ACTIVITIES (PERCENT) Innovation costs too high Lack of funds within establishment or enterprise Lack of finance from sources outside enterprise Market dominated by established enterprises Lack of qualified personnel Uncertain demand for innovative goods or services Lack of information on technology Difficulty in finding cooperation partners for innovation Lack of information on markets 0 5 10 15 20 25 30 35 40 45 50 MSMEs Large firms Source: 2015 Survey of Innovation Activities, Philippine Institute for Development Studies. 62 Reduce labor market rigidities and costs the employee, hearings, and payment of separation benefits. PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH Furthermore, an employee has the right to contest the validity of Employers find labor regulations in the Philippines more restrictive the dismissal through a dispute resolution mechanism, which could than in peer countries. On the Global Competitiveness Index, the be lengthy and costly and whose decision often favors the employee. Philippines ranked 77th out of 137 countries on the ease of hiring As result of high dismissal costs, the incidence of non-regular and firing, more restrictive than in peers (Figure 78). Specifically, employment is increasing and reached about 40 percent of all wage the country suffers from long administrative processes for regular employment in 2013. However, workers under non-regular contracts employment. In addition, the Philippines ranked 86th out of 137 have less employment security and receive lower wages.57 Their countries on wage determination, which makes it less flexible turnover is also expected to be higher, and there is less job-training than the average of both structural and regional peers (Figure and learning, limiting their contribution to productivity growth. 79). Moreover, the country’s minimum wage is considered high by several measures, both relative to Filipino worker productivity The Philippines’ restrictive labor regulations and high labor costs and to the minimum wage of other countries with similar income have contributed to the growth of the country’s large informal levels.56 Finally, redundancy costs are very high in the Philippines, sector. High minimum wages and dismissal costs discourage 27 weeks of salary, resulting in a rank of 118th out of 136 countries. the formalization of jobs. Informal employment represents 76.3 Of all the indicators in the index, the ease of hiring and firing has percent of total employment in the country.58 Even excluding the progressed the least in the Philippines since 2007. agriculture sector, 66.8 percent of total employment is informal, which is relatively high among peer countries (Figure 80). Moreover, High dismissal costs have led to an increase in temporary informality occurs across age and education groups: around employment, which discourages on-the-job training and learning. 30.8 percent and 63.2 percent of employed college graduates and The dismissal of an employee with a regular employment contract undergraduates, respectively, have informal employment (Figure 81). involves a long administrative process that includes notices to However, it is especially high among non-college graduates. Figure 78. Labor regulations in the Philippines are more restrictive than Figure 79. Wage determination is also more restrictive in the Philippines in peers. compared with peers. EASE OF HIRING AND FIRING (7=BEST) FLEXIBILITY OF WAGE DETERMINATION (7=BEST) 6 6 5 5 4 4 3 3 2 2 1 1 0 0 Malaysia China Indonesia Thailand Kenya Bangladesh Vietnam Pakistan Philippines Sri Lanka Morocco Malaysia Morocco Bangladesh Kenya Sri Lanka Vietnam Philippines China Indonesia Thailand Pakistan Source: World Economic Forum. Source: World Economic Forum. 56 World Bank (2013); Betcherman (2014). 57 World Bank (2016). 58 Informal employment refers to the total number of persons with informal main jobs. A job is informal when it lacks basic social or legal protections or employment benefits and may be found in the formal sector, informal sector, or households. Persons in informal employment include the following types: wage workers, self-employed workers, and unpaid family members. First, wage workers are categorized as formal if they meet at least two of the following three criteria: (1) have a written employment contract, (2) have employer-provided social insurance, or (3) are protected from arbitrary dismissal. Otherwise, they are categorized as informal. Second, self-employed workers are formal if they maintain a proper bookkeeping system. If not, they are classified as informal. Finally, unpaid family members are informal by definition. This definition is based on the World Bank’s Philippine Labor Market Review from 2016. 63 PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Figure 80. Informal employment is high in the Philippines. Figure 81. Informal employment is high among non-college graduates. INFORMAL EMPLOYMENT (SHARE OF NON-AGRICULTURAL EMPLOYMENT, IN PERCENT) INFORMALITY BY EDUCATION LEVEL (IN PERCENT) 90 100 80 90 70 80 60 70 50 60 40 50 30 40 20 30 10 20 0 10 China Sri Lanka Vietnam Philippines Indonesia Pakistan 0 No Grade Elementary High School College Completed Informal employment: Outside informal sector Formal Informal employment: Informal sector Informal Source: Informal Sector Survey (ISS) 2008. Source: Informal Sector Survey (ISS) 2008. 64 ACHIEVING THE AMBISYON NATIN 2040 TARGET PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH The Philippines will need to reach a GDP per capita of about US$9,350 by 2040 to meet the goals set out in the AmBisyon Natin Box 9. Human Capital and the Philippines 2040.59 This is a rough target that is aligned with the government’s goal of tripling per capita income from its current level. Assuming that net factor income from abroad represents 15 percent of GNI, Human capital encompasses the health, nutrition, skills, and experience of a country’s people. Boosting human capital is not just good for the people but also critical to the per capita GDP of US$9,350 corresponds to a per capita GNI of achieving growth as it contributes to the productivity of the next generation of workers. US$11,000, which is nearly the threshold for a high-income country.60 This is more the case at present moment as good jobs are increasingly found in knowledge-based sectors of the economy. A long-term growth model was used to evaluate and assess ways to achieve the growth target by 2040. The model assessed various The World Bank is developing a new Human Capital Index that will measure the human growth scenarios and the potential mix of growth drivers needed to capital that a child born today can expect to achieve by age 18, given prevailing conditions for health and education61. The Human Capital Index will bring together reach the government’s goals. A baseline scenario was created based nutrition, education quality, and other aspects of human capital into a measure on the premise that key growth drivers such as labor, human capital that illustrates how investment in human capital pays off in productivity of the next (Box 9), investment, and technology sustain their historical growth generation of workers. The intent is for the index to help policymakers recognize the rates. Various scenarios were then created relative to this baseline, beneficial effects that investing in human capital has on worker productivity, so that and growth rates of select variables were adjusted to assess the they see a child’s learning in school as providing the foundation for economic growth most realistic combination that will help the country achieve the just as much as the asphalt that goes into a new roadway. Greater investments in human capital will help prepare everyone to compete and thrive in the economy of the future— AmBisyon Natin 2040. whatever that may turn out to be. Simulations show that sustaining high TFP growth will be crucial A notable weak point for the Philippines in those conditions is the very poor state of to achieve the GDP per capita target by 2040. The GDP per capita child nutrition. One in three children under the age of 5 is stunted—a key marker of target can be reached if the Philippines manages to sustain a TFP malnutrition—and there has been no progress over a decade. Children who are denied growth rate of 1.8 percent per year for decades to come, which is proper nutrition and stimulation in utero and during early childhood fail to develop a full set of neural connections. Those children face cognitive impairment, perform poorly in lower than the annual average of 2.2 percent in 2011-16. However, this school, and are more likely to drop out earlier, resulting in limited job opportunities and will be a challenge as experiences from other countries, such as the income throughout their lives. fast-growing Asian Tigers and China, show that continuous efforts to remove constraints and distortions in the markets are needed to In terms of education, the country has achieved gains in access to schooling but still lags sustain high TFP growth in the long term. in quality. Increased resources to education, mandatory kindergarten, and the creation of senior high school have been important steps to increase schooling. However, schooling Moreover, accelerating capital accumulation in the medium term is not the same as learning. Students may sit for years in classrooms without achieving basic numeracy and literacy. The most recent international test scores for the Philippines will be critical to achieve the government’s target. This will require show the country ranking towards the bottom among countries in East Asia. the investment-to-GDP ratio to grow by 3.0 percent per year until 2022 (through public and/or private investment) followed by the historical annual rate of 0.8 percent until 2040. This will result in an investment-to-GDP ratio of 33.6 percent of GDP in 2040, higher than the average of many peers. This level of capital accumulation will require a TFP growth rate of 1.5 percent per year to achieve the GDP per capita target by 2040. 59 The base year corresponds to the per capita GDP of US$2,892 in 2017. 60 NFIA totaled about 18.4 percent of GNI in 2000-16. A lower ratio 15.0 percent is assumed in the long term considering the declining trend of remittance growth coupled with the outlook of fewer Filipinos seeking employment abroad as the domestic economy strengthens. 61 The index will be launched at the Bank’s annual meetings in October 2018. 65 IMPLICATIONS FOR POVERTY REDUCTION PHILIPPINES ECONOMIC UPDATE | STAYING THE COURSE AMID GLOBAL UNCERTAINTY Higher productivity growth would help to accelerate poverty A lack of product market competition is likely contributing to real reduction by creating more well-paying jobs. The reduction in wage stagnation in the Philippines. There is a positive relationship poverty that occurred between 2006 and 2016 in the Philippines between labor productivity growth and real wage growth in was driven by an increase in wage income, a movement of labor an environment of competitive labor and product markets, as out of agriculture, government transfers, and remittances.62 An competition normally leads to lower output prices. Nonetheless, increase in productivity would raise wages and create new jobs, there can be an observed correlation between sectoral productivity contributing to poverty reduction. It will be especially important gains and real wages or profit when either labor or product to increase productivity growth in low-productivity sectors such markets are not perfectly competitive. While the Philippines’ labor as agriculture, as it would primarily benefit the poor and most supply is abundant, and its labor market is somewhat competitive vulnerable population. Furthermore, accelerating structural change considering its informal sector, product markets are not competitive (i.e., movement of labor out of agriculture) would also contribute in many sectors. Market dominance, the presence of monopolies and to faster poverty reduction, as productivity (and thus wages) is on duopolies, and high entry costs contribute to a lack of competition in average higher in non-agricultural sectors. many sectors. As result, productivity gains are not always reflected in real wages but rather in profit, which is consistent with the Improving the link between labor productivity and real wage increasing share of capital in the Philippines’ national income. growth will be critical. Real wages have been stagnant in the Philippines despite improvements in labor productivity (Box 10). An inability to create well-paying jobs and lift real wages is likely Aggregate real wages remained flat in 2001-16, with real wages to further encourage emigration, limiting productivity growth. falling in 7 out of 15 years. Meanwhile, labor productivity increased Productivity growth requires a process of efficiently combining by 57 percent in the same period. Except for public workers, the human and physical capital. However, over 15 percent of the pattern of stagnant real wages and increasing labor productivity Philippines’ total labor force emigrates each year, higher than in growth has been consistent across employees’ level of education, many peers. More than half of all emigrants are under the age of work status (permanent or short-term contracts), and class of work thirty and hold college or higher degrees (Figure 82 and Figure 83). (private household, private establishment, or family operated). It This human capital flight features a vicious cycle of high emigration has also been true across sectors (agriculture, industry, or services) due to limited domestic job opportunities, which leads to an and regions. Therefore, poverty alleviation efforts need to include insufficient supply of skilled workers for firms to expand and grow. policies that would allow a rise in labor productivity to result in Therefore, it is crucial for authorities to increase both productivity higher real wages. and real wage growth by encouraging greater market competition. Figure 82. A large share of Philippine migrants is highly educated… Figure 83. …and those planning to emigrate have the highest levels of educational attainment. SHARE OF REGISTERED FILIPINO EMIGRANTS BY EDUCATIONAL ATTAINMENT PRIOR TO MIGRATION SHARE OF INDIVIDUALS PLANNING TO EMIGRATE BY EDUCATION LEVEL (IN PERCENT) (IN PERCENT) 30 100 25 80 20 60 15 40 10 20 5 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 1998 1999 2000 2001 2002 2003 2004 2005 2006 No formal Primary Lower Higher Post-secondary education education secondary secondary education education education Elementary or below High school and vocational College or above Source: Commission on Filipinos Overseas. Source: Commission on Filipinos Overseas. 62 World Bank (2018a) 66 PART 03: SUSTAINING HIGH PRODUCTIVITY FOR LONG-TERM GROWTH Box 10. Stagnant Real Wage with Rising Labor Productivity The disconnect between real wages and labor productivity is consistent across sectors. The divergence between labor productivity and real wages can also be observed in the Surprisingly, agriculture, the sector with the lowest labor productivity growth, was the only country’s various regions. While there has been an increase in labor productivity across sector that experienced minor real wage growth in 2001-16 (Figure 86). While real wages in the most regions, real wages have been stagnant. Moreover, real wages have been declining in agriculture sector grew by barely 6 percent during this period, they declined by 5 percent in the Autonomous Region in Muslim Mindanao, the country’s poorest region in 2015. The gap industry and remained flat in services (Figure 87 and Figure 88). Within industry, real wages between labor productivity and real wages has been widening over time. By 2015, three of declined in all subsectors (i.e., mining, manufacturing, construction, and utilities) while labor Mindanao’s six regions were among those with the largest gap, while regions in Luzon had the productivity increased, especially in manufacturing and mining. In services, there was a large smallest. Rising labor productivity and sluggish real wages can help to explain the situation in disparity among subsectors. For instance, real wages in transport, government services, and Mindanao, while stagnation in both labor productivity and real wages may explain the situation renting of non-real estate and other business activities increased along with labor productivity. in Luzon. However, trade and finance experienced positive labor productivity growth while real wages declined. In real estate, labor productivity experienced its biggest decline in the services sector while real wages experienced their biggest increase. Figure 84. Real wages have remained flat despite rising GDP and Figure 85. Agriculture experienced minor real wage growth despite its low productivity growth. productivity. GROWTH TRENDS (YEAR 2001 = 100) AGRICULTURE GROWTH TRENDS (2001 = 100) 280 230 180 180 130 80 80 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Real GDP (constant 2000 prices) Real Agriculture VA (constant 2000 prices) Labor Productivity (constant 2000 prices) Agriculture Labor Productivity (constant 2000 prices) Real Wage Real Wage (Agriculture) Employment Employment (Agriculture) Figure 86. 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