AWorld Rank ' = Dcrelopmeni:Currency Unit E;: - Peso - : $1.00 ;PhP1.OO - PhP51.36 US$0.0195 [FISCALYA E R January 1 - December 31 ASEAN Association of Southeast NCR National Capital Region AsianNations NGAS New Government Accountirlg AMC Asset Management Company System BIR Bureau of Internal Revenue NGO Non-Government Orgarrization I BOC Bureau of Customs hIPL Non-Performing Loan ; BOT Build Operate Transfer NRM National Resource and I ' BSP Bangko Sentral ng Pilipinas Management j CMDC Capital Markets Development NSCB National Statistical I Corporation Coordination Board 1 COA Commission on Audit NSO National Statistics Office 1 COP Committee on Privatization ODA Overseas Development 1 CSC Civil Service Commission Assistance j DBM Department of Budget and OPIF Organizational Performance I Management Indicator Framework I j DOF Department of Finance PDIC Ph~lippineDeposit Insurance / DST Documentary Stamp Tax / Corporation EKB Expanded Commercial Bank PCEG Presidential Committee on / EPR Effective Protection Rate Effective Governance Reform , FIES Family Income and PPI Private Participation in 1 Expenditure Survey Infrastructure GAAP Generally Accepted Accounting PSE Philippine Stock Exchange Principles PSISSA Public Sector Institutional GDP Gross Domestic Product Strengthening and GNP Gross National Product Streamlining Agenda GOCC Government Owned and ROPOA Real and Other Properties Controlled Corporation Owned and Acquired HSRA Health Sector Reform Agenda ROSC Report on Standards and IOSCO International Organization of Codes Securities Commissions SEC Securities and Exchange IRA Internal Revenue Allotment / LGC Commission Local Government Code SEER Sector Effectiveness and / LGU local government unit Efficiency Reviews \ 1 LTDO Large Taxpayer District Office SSS Social Security System 1 MTPDP Medium Term Philippine VAT Value Added Tax Development Plan WTO World Trade Organization Vice-President: Jemal ud-din Kassum, EAP Country Director: Robert Van Pulley, EACPF Sector Director: Homi Kharas, EASPR Task Manager: Lloyd Mcl%ly, EACPF Contents TABLE oF :EXECUTIVESUMMARY................................................................... 1. DEVELOPMENTACHIEVEMENTSMIXSUCCESS AND DISAPPOIBfThIl .. 1 A. RECENT ECONOMIC PERFORMANCE HAS BEEN MODEST AND FR / B POVERTY REDUCTION HAS STAGNATED .............................................. . 1 C. POLICY DISCUSSION ............................................................................... 1 D CONCLUSIONS ........................................................................................... . I 2 POLICYAND INSTITUTIONALACTIONS TO DELIVER RESULTS . ....................10 I A STRENGTHEN FISCAL MANAGEMENT . ............................................................. 10 Rebuilding revenues ................................................................................... 13 Containing contingent liabilities and managing fiscal risks ................................16 B. IMPROVE GOVERNANCE AND PUBLIC SECTOR PERFORMANCE ..........................16 Overview of governance outcomes ...............................................................17 Public financial accountability and management .............................................19 Re-engineering government ........................................................................2 1 Judicial reform ......................................................................................... -24 C STRENGTHEN PRIVATE SECTOR DEVELOPMENT ..............................................24 . Protection of property rights ........................................................................25 Corporate governance ................................................................................ 25 Creditor rights and insolvency law ................................................................27 Competitive environment: foreign trade and investment regime .......................28 Infrastructure provisions .............................................................................30 Rural development ..................................................................................... 3 1 I D STRENGTHEN AND DEEPEN THE FINANCIAL SECTOR . .................................... 33 Banking system performance .......................................................................34 Policy environment for banking ....................................................................35 Capital markets ......................................................................................... 37 Improving access to financing for SMEs and strengthening microfinance ............39 E. EMPOWER AhlD PROTECT THE POOR .............................................................39 Education ................................................................................................. -40 Health care ............................................................................................... 4 1 Ensuring access t o other assets ...................................................................42 Social protection ........................................................................................ 4 2 Population growth ...................................................................................... 43 ' . I I 3 PROSPECTSARE CONTINGENTON ACTION AND CONTINUEDSUPPORT 44 .. / A ECONOMIC DEVELOPMENT PROSPECTS........................................................ 44 . ./ B POVERTY REDUCTION PROSPECTS . ...............................................................46 C THE IMPORTANCE OF DONOR SUPPORT . .........................................................46 (Thisreport is prepared by a team led by Lloyd 1 I McKay which included Joven Balbosa, Milan / Brahmbhatt, Gaurav Datt, Michael Engelschalk, I /Teresa Ho, Dana Weist, and Cheloy Tria. Other I I i major contributors were Richard Anson, Aldo 1I Baietti,Jayshree Balachander, Craig Burnside, i /Gary Fine, Sudarshan Gooptu, Arvind Gupta, 1 Vijay Jagannathan, Amitabha Mukherjee, Keith i j Oblitas, Rajashree Paralkar, Elliot Riordan and Chuck Woodruff. Vikram Nehru, Sean Nolan and / Zia Qureshi served as peer reviewers. / /Supervision from Sanjay Dhar, Homi Kharas and i Ivan Pulley is gratefully acknowledged. I EXECUTIVE 1. Post-1997 Development Outcomes 5. The Medium Term Philippine Devel Disappoint. From 1994 to 1997, Philippine Plan (MTPDP) growth targets of economic growth averaged 5 percent per percent per year are attainable, but annum and the incidence of poverty fell the key building blocks for sustained gr quickly, from 32 percent to 25 percent. an environment conducive to During these years, the government budget investment and productivi was balanced, exports were growing at private and public sectors-are around 20 percent per annum, investment And stronger growth must be was 23 percent of gross national product by increased participation in d (GNP), and there was optimism about the the poor to attain the desired prospects for lasting peace throughout the in poverty. Anything less country. further disappointment. 2. I n contrast, from 1998 to 2001, economic 6. Key Policy Issues. Securing the sustaine growth averaged 2.5 percent and poverty increase in growth and ~ a r t i c i ~ a t i obv n th reduction stagnated. Confidence was poor that is central to the MTPDP is likely to undermined by governance concerns which require further prompt action on priority culminated in impeachment proceedings issues in five critical areas: against former President Estrada, uncertainty Continue to strengthenfiscal management with regard to macroeconomic stability and reduce the fiscal deficit while arising from falling tax revenue and large maintaining strategic expenditures in fiscal deficits, rising stress in the banking education, health, social protection, sector; and renewed concerns regarding agriculture support services, and peace and the rule of law. Investment fell to infrastructure. This entails tax policy 17-18 percent of GNP. I n 2001, these measures and public sector reforms to domestic difficulties were aggravated by a enhance revenues, to improve expenditure deteriorating external environment, which management and public procurement triggered a 16-percent decline in export (including a new procurement law), and earnings. Yet, despite these difficulties, gross strengthen the management of contingent domestic product still grew at 3.4 percent in liabilities. 2001, the highest among market economies Improve governance and public sector 1 in the region. jkctioning. I n addition to the reforms of 3. Following the transfer of power in January public financial management noted above, 2001, the government has managed to there are two other areas of governance lessen macroeconomic concerns by reform that are key to strengthening the essentially meeting its budget deficit target, investment climate and improving delivery o'f containing inflation, and overseeing a return public services. These are, first, improving to financial market stability. Moreover, the rule of law, for example, by further improving governance and reducing poverty addressing law-and-order issues, have been reinforced as national priorities. A anticorruption efforts and the implementing capacity to move forward with structural planned judicial reform. The second is civil reforms was demonstrated by passage of service reform and bolstering the important power sector legislation. Together implementation capabilities of provincial and these initiatives have improved policy municipal local government units (LGU)s. credibility, but much still remains to be done. Strengthen private sector development. Continued efforts to strengthen corporate 4. Looking forward, the external environment governance and property rights, implement for the Philippines is expected to improve as insolvency law reform and strengthen global recovery takes hold from the second creditor rights are particularly important, and half of 2002. The improving economic will be enhanced by better enforcement environment should further enhance the capacity resulting from improvements in the climate for further reforms which are needed judicial system. A second area of focus is the to again achieve rapid poverty reduction. need to further improve private-public sector partnerships to alleviate infrastructure growth would reduce poverty from 26 percent deficiencies. Achieving the objectives of the of the population in 2000 to 18 percent by recent power sector law is particularly 2005, a decline of about 5 million in the important. A third area of special relevance number of poor. I f combined with for the poverty reduction agenda is more complementary programs to improve equity rapid rural development. This calls for (e.g., effective human resource investments continued land reform, sustainable credit and and actions to improve access by the poor to microfinance provisions, and improvements productive assets and markets), poverty in agricultural extension and rural could be reduced even more rapidly. I n infrastructure. Fourth, further trade reform contrast, average growth of only 3 percent and deregulation are needed to strengthen per annum would mean only modest poverty competition, especially for heavily protected reduction. agricultural goods such as rice and service sector activities such as transport. 9. The major risks to the success of this Strengthen and deepen theJinancial sector renewed fight against poverty are slippages to improve financial intermediation and to in the implementation of policy reforms, mobilize savings. Further banking sector inadequate progress in addressing law-and- reforms are needed to facilitate intervention order problems and achieving peace, and in and rapid resolution of distressed banks, exogenous factors such as El Nino or other strengthen the effectiveness of consolidated natural disasters, a prolonged downturn in supervision, and enhance financial sector world growth, or increased risk aversion vis- transparency and governance. And action is a-vis emerging economies in global capital needed to reduce the prevalence of non- markets. Any combination of these would performing loans. Needed capital market lessen or defer success. The current development calls for institutional government's commitment to reform does strengthening in several of the areas already lessen the risk of policy slippage, but even mentioned: corporate governance, creditor this cannot fully insulate against the rights, insolvency law implementation, and possibility of exogenous shocks. the enforcement of shareholder rights. 10. Support from international development Empower and protect the poor. This partners continues to be needed in two necessitates improvements in the quality of principle areas: resources to help sustain education combined with a fall in the school critical public expenditures while domestic dropout rate; improved funding for priority revenues are being rebuilt, and technical health programs, including sound assistance to help implement effective policy reproductive health strategies, and enhanced and institutional reforms. The national decentralised capacity to improve the government faces large financing needs in delivery of health services; improved assess the medium term-about $5.7 billion in 2002 to productive assets especially for the poor; alone-arising from the budget deficit and and expansion of effective social protection rising amortisation obligations. The amount of programs. overseas development assistance needed is at least $1.5 bill~on;it is anticipated that the 7. Prospects Depend on Actions. None of rest can be mobilized from domestic and these five key areas for continued reform is commercial offshore sources. Increasing the sufficient by itself to achieve the desired share of program lending in overall donor sustained increase in growth with equity. But assistance for the next couple of years would they are each necessary. Together they would qreatly assist the qovernment in its efforts to provlde a framework for stronger growth and malnt'ain strategic expenditures while Increased partlclpatlon by the poor, Implementing pol~cyand inst~tutlonalreforms. consistent with MTPDP targets. 8.Average real economlc growth of over 5 percent per year IS feaslble and would reduce poverty slgnlflcantly. Projections based on household survey data lndlcate that such . ., ., .,, . . -,,,,,,,,* , a A ,, , ,, ,, , , 1 A, ,,,> ,,.*,, 4 .< ,,.A "6 ,/ P' ,' ' 3 , , {j+?,J!",?+ t*:'",dY&, ./,,;, . f,, 9 / / ;d$fi6 ,&, $$&7;, --.- a, PHILIPPINES An Oppom ityfor RenewedPavmy Reduction SUMMARY of KEY T h i s report contains many policy recommendations which are recognized by the Government, but they cannot all be implemented at once. While the Government has made progress in addressing a number of these issues, a well phased and coordinated implementation plan is needed to build the momentum necessary to achieve the MTPDP growth and poverty reduction targets. Listed below are the key recommendations for priority attention. Strengthen fiscal management: Take actions consistent with increasing the tax-to-GNP ratio by at least 3 percentage points by 2005. Support public expenditure reforms with a new Procurement Law. Ensure sustainability of public pension funds and contain other contingent liabilities. Improve governance and publicsector performance: Re-engineer and strengthen the civil service to improve service delivery. This includes rationalizing, moving to a more meritocratic civil service, implementing performance management, and strengthening capacity at LGU levels. Design and implement further anticorruption actions, including improvements in audit performance and reforms in the Bureau of Internal Revenue exemplifying the government's commitment to anticorruption efforts. Implement the Action Program for Judicial Reform. Enhance civil peace and personal security. Strengthen privatesector development: Establish effective private-public sector partnerships to alleviate infrastructure deficiencies, with particular attention to urban infrastructure; pursue specific reform agendas in individual infrastructure sectors, in particular by establishing implementing rules and regulations to achieve the objectives of the Power Sector Law. Strengthen property, contractual, and creditor rights to improve corporate governance and deepen capital markets. Broaden access to land by relaxing land market restrictions; better targeting the landless in implementing agrarian reform; and strengthening agricultural extension, microcredit, capacity creation at LGU levels, rural infrastructure, and support to community-based development activities. Introduce further trade and regulatory reforms to strengthen competition, especially for heavily protected agricultural goods such as rice and service sector activities such as shipping. Strengthen and deepen to financialsector: Facilitate the resolution and disposition of nonperforming loan Strengthen supervision effectiveness, protection of bank su and regulatory capacity to intervene En and rapidly resolve d acquiescence of existing owners. Implement effective anti money-laundering provisions. Empower and protect the poor: Improve the quality of basic education and reduce Ensure resources for priority health programs, i program, and strengthen local capacity to improve ,..,, ,..~F",~>~ e,"d'.": '.Z*d&3?. ",,a~,*&~e,.~~*-~dAa"~v~~?,~.-.',m~~"."~~3.~~ec~~,,<.,~&,rd DEVE IENT ACHIEVEMENTS Mix Saccess and Disdppoin 1.1 The Philippines regained a modest efforts of the preceding decade were starting growth rate of about 3.5 percent per annum to yield results in the form of a higher trend for the 1999-2001 period, but has not yet rate of growth. Since the regional crisis, managed to reduce the incidence of poverty however, the country has regained only a from its 1997 level. Investment remains modest-though fairly stable- growth rate of conspicuously low at 17-18 percent of gross 3-4 percent (see Table 1.1). I n 2001, growth national product (GNP), compared with 23 reached 3.4 percent-a pace swifter than in percent of GNP in the mid-1990s. Export other market economies in the region-despite growth fell to single digits in 2000 for the the steep downturn in exports. Indeed, the first time since 1992 and contracted by about Philippines' modest but more stable growth 16 percent (in US dollars) in 2001, due to path actually resulted in higher average the sharp slowdown in the world economy growth than most of those economies in the and, in particular, in the world electronics period 1997-2001 (see Table 1.2). The trade, on which the country has a high problem, of course, is that the associated export reliance. per-capita GNP growth rate of about 0.8 percent a year since 1998 is insufficient by 1.2 This modest growth has limited poverty itself to deliver a rapid and sustained reduction, as employment creation has been reduction in poverty. similarly modest and public investments in human resources, social protection, and itargeted poverty reduction programs have TABLE 1.1: GROWTH COMPONENTS (% l?k) faced resource constraints. The incidence of /poverty has changed little from the 25 percent of 1997. Health indicators have improved since the mid-1990s: the maternal mortality rate fell from 180 in 1995 to 172 in 1998, while the infant mortality rate fell from 49 per 1,000 live births in 1995 to 35 per 1,000 live births in 1998. Participation in school has increased at the primary level, but the dropout rate has risen at both primary and secondary levels. ntment with these modest social achievements, together concern over the governance I/ Goo& in US dollar t e r n social tensions high throughout Source: NCSB, MTPDP rs. I n addition, the continuing rts of Mindanao and elsewhere development efforts in the TABLE 1.2: GDP GROWTH BY COUNTRY (Yo l?k) ONOMIC PERFORMANCE ESTAND FRAGILE hieved GDP growth the period 1994-97 usly affected by the than Association of s (ASEAN) partners Soz~rce:National data,World Bank estimtes, CON- Forecmts. abilization and structural reform 1.5 Fixed investment has dipped to a 1.7 Overall growth in recent years sluggish 17-18 percent of GNP in the last supported by continued expa three years, creating concern about the agriculture and services, offsetting business prospects, in particular as concerns contracting by 6.2 percent, the about governance and associated political sector recovered quickly in 199 uncertainty delayed the rebuilding of maintained strong growth (see sources, as foreign interest and capital the agricultural labor force. inflows evaporated until late 2001. been uneven across regions (s TABLE 1.3: INVESTMENT (O/o OF GNP) TABLE1.5: REGIONALGROWTHRATES (%PA.) Source:MTPDI: BSP and staff estimates. 1.6 Viewed in a longer-term perspective, fixed investment has averaged in the low 20 percent of GNP range in the 1980s and 1990s, compared to a 30-40 percent range in other major East Asian countries. This is estimated to have translated into a rate of growth of real physical capital stock in the 3- 5 percent range (Table 1.4), compared to a 7-11 percent range in the other countries, which, in a growth accounting sense, is one factor explaining the lower long-run trend of growth in the Philippines. The other factor is low total factor productivity (TFP) growth, which in fact is estimated to have been negative in both the 1980s and 1990s, and for the most part, significantly below TFP growth rates in other major economies in the region. By reducing rates of return to capital, 1.8 Inflation has remained reasonably low TFP growth in the Philippines is also modest, in part because of growth in likely to have contributed to weak agricultural production, especially good rice investment growth. and corn harvests (see Figure 1.1). Wage moderation also helped. However, risinq crude oil prices and the deterioration of the TABLE 1.4: ACCOUNTING FOR GROWTH (%) peso against the dollar in 2000 added to the inflationary pressures. This favorable inflation outcome is also the result of sound monetary policy. Most recently, monetary policy was tightened during the latter part of 2000 but then progressively relaxed during 2001, with reserve requirements and interest rates both being eased. The peso has been relatively stable in 2001 (see Figure 1.2). Source: World Bank staffeshmates. - --w-*,-- -3 1.9 Exports continued their double-digit growth until 2000 (see Figure 1.3), driven largely by the electronics and IT-related industries, which account for about 60 percent of Philippine exports. Export growth slowed in 2000 and moved to double-digit contraction in 2001. Electronics, the very sector that supported rapid growth in the mid-1990s, is leading the downturn as the market for electronics has cooled worldwide. 1.10 I n addition, although worker remittances have stayed at US$5.5 billion to 1 Source:NationalStatrrtics $6.5 billion annually, their growth has w e (NSO) I ceased. The US recession and sluggish 1 FIGURE 1.2: NOMINAL AND growth in Singapore and Hong Kong and Middle East countries- traditional destinations i REAL EFFECTIVEEXCHANGE RATE of overseas Filipino workers-have significantly affected the income of land- based workers. At the same time, sea-based workers are affected by the lack of growth in global trade and travel (see Figure 1.4). 1.11 The years 1999-2000 saw the emergence of surprisingly large trade and current account surpluses (Figure 1.3 and Table 1.6). I n 2001, the trade surplus contracted sharply, with exports falling by 16 percent, capital flows remaining weak, and 1 1 Source: Note: REER Index is period average, Nominal is endperiod the overall balance of payments SelectedPhilippine Economic Indicators SPEO-BSI? deteriorating. Portfolio investments, trade credits, and currency deposits registered FIGURE1.3: MERCHANDISEEXPORTS large net outflows in 2000 and 2001. With &IMPORTS (%YOY) ANDTRADE BALANCE continued uncertainty in emerging markets, (IN US$ MNI aggravated by the law-and-order problem in Mindanao and kidnappings by armed bandit groups, portfolio inflows declined to their lowest level in more than a decade. Nevertheless, since late 2001 signs of improving investor sentiment have become more evident, including greater access and reduced cost of borrowing in the global bond markets and a recovery in the local equity market. TABLE 1.G: BALANCE OF PAYMENTS (US$ BILLION.) Source:National Statistics W c e (NSO) FIGURE1.4: OVERSEASWORKERS Source: MTPD1: BSP and sxaffesiim.ater. Source: SPEI-BSI? I / In Goods. 2/ Includeserrors and omirsiont. 1.12 The magnitude of this large rise and fall TABLE 1.7: TRENDS I in the trade and balance of payments sur~lusesis auestionable. thouah. First. I rather than giviLg rise to a ;harp i6crease in international reserves, these surpluses have HeadcountIndex (%) been associated with large errors and Poverty Gap ,",, omissions in the international accounts. Second, national accounts data do not SquaredPowltyGa~Ifidex(%) suggest that domestic savings have risen and Number ofpoor(pi~ I investment fallen sufficiently to offset such a large fall in foreign savings from 1998 to Meanc0nsumpti0n(1997 2000. The largest source of error (as Peso/person/month\ indicated in partner country trade data) is thought to originate from a substantial s,,, ~ , ~ u ~ ~ , ~ Puuerty iAssessment.2001:~ ~ ~ , .. ~ h l i ~ ~ i underestimation of electronics imports, staffestimates based on FZES 2000 data. suggesting that the magnitude of the recorded current account surpluses and private capital outflows may both be FIGURE 1.5: SELF-RATED POVERTY overstated. (IN PERCENT) 1.13 Until 2001 the debt service ratio remained comfortable at about 12 percent of exports of goods and services, but it rose quite sharply in 2001 as debt service obligations rose and export earnings declined (see Table 1.6). I n addition, the very high import content of many Philippine exports, especially electronics, means that this statistic can be a little deceiving, as the ratio of debt servicing to domestic value added is much higher than the ratio of debt service to gross export earnings. Overall, it is likely that Philippine exports are on average only about 60 percent domestic value added. As a Source: Social Weather Station result, debt servicinq to domestic lvalue added.of exports is close to 30 percent. 1.15 The stagnation of poverty reduction is also evident in the absence of any fall in the B. POVERTYREDUCTION HAS percentage of people living on less than $1 STAGNATED per day and less than $2 per day (see Table 1.8). I n addition, the fact that some 45 1.14 The incidence of poverty in the percent of the population live on less than $2 Philippines fell sharply in the first part of the per day highlights that there are a very large 1990s, dropping from 34 percent in 1991 to number of near poor in the Philippines. These 25 percent in 1997, with much of the people can slip into poverty with a relatively improvement occurring in 1995-97 (Table modest reduction in income, thus illustrating 1.7). Since then, however, poverty reduction the importance of development to reduce has stagnated, with preliminary data from their vulnerability. the Family Income and Expenditure Survey (FIES) 2000 suggesting that poverty incidence in 2000 of around 26 percent was a little above the 1997 level.2 Similarly, over the past four years there has been a rising perception among the respondents surveyed by the Social Weather Station of being poor3 2 The preliminary official poverty estimates using income-based (Figure 1.5). poverty lines indicate a somewhat larger increase in poverty incidence, from 36.8 percent of the population to 40.0 percent. The FIES 2000 estimates of inflation-adjusted average family income indicate a decrease of 3.9 percent over the same period. l A debt service ratio (DSR) adjusted in this manner should not Averagefamily incomes declinedin 10 of the 16regions. be comparedwith the conventionalDSR for other countries. 3 Recent data, as of July 2001, showed self -rared poverty measures s~gn~ficantlyrising. .. --- - PHILIPPINESAn oppomcutyfor kcncwedPoverty Reduchon ----/- -a , 1 TABLE 1.8: THERE ARE 1.18 I n terms of health indicators, there has 1 MANY NEAR POOR been steady improvement in the maternal mortality rate, but this progress has been slow compared to the rate of decline achieved in Thailand and Vietnam. The two main causes of maternal mortality are (a) inadequate access to emergency care in cases where the mother suffers from complications related to pregnancy, labor, and delivery; and (b) the incidence of pregnancies that have abortive outcomes. The first points to the continuing lack of access to emergency hospital care, given the growing cost of health care; low rates of health insurance / Overuiew,East Asia and~ a ~ R+O%~ 0ctober 2001. i f ; coverage (7 percent in the country, and 58 percent f0.r the formal sector); and poorly 1.16 The explanation for the stagnation in equipped and stocked public hospitals. The poverty reduction in the last few years is second underscores the importance of a reasonably straightforward. Per-capita GNP strong family planning program that is growth in 1995-97 in the Philippines anchored on education and family planning averaged almost 3 percent a year, whereas in services to help prevent high-risk and 1998-2000 it averaged only 0.8 percent. unwanted pregnan~ies.~The National Economic growth slowed while the population Demographic and Health Survey of 1998 growth remained over two percent per shows a gap of one child between desired annum. Thus, a strong revival of growth and actual family size (2.7 vs. 3.7). The remains central to the poverty reduction country has fared better in infant mortality, challenge. Nevertheless, growth alone does with a reduction in the rate from 49 per not seem to provide a complete explanation 1,000 live births in 1995 to 35 per 1,000 live of what happened to poverty, since there births in 1998. This can be attributed to seems to have been a greater amount of improved child care practices and the effects poverty reduction for a given amount of of the government's immunization program. growth in the earlier period than in the latter. Of late, however, the government has been However, the underlying reasons for this encountering difficulties in procuring difference are not well understood, and vaccines. Unless addressed immediately, the constitute a priority area for future research. loomina shortaae of vaccines could I undermine earlie; gains in reducing child 11.17 As the farm sector absorbs about 38 morbidity and mortality. i Dercent of em~lovment, the recovery in 1.19 The picture in education shows participation rates climbing steadily, but dropout rates also rising. Retention of children in school or the cohort survival rate shows how hard-pressed poor households are to sustain their children's education. Participation in school has increased at the primary level (97 percent in the 1999-2000 school year, up from 92.7 percent in 1995- 96 and 95.1 percent in 1996-97). The cohort survival rate, however, shows a decline in both primary and secondary level^.^ Three out of ten pupils who enroll in Grade 1do not 4 ~ hunmet need for family planning services remains high at 19 e percent (Source: 1998 National Demographic and Health Survey). Source: Department of Education 2000. The primary school completion rate has fallen fron 72.1 percent in 1996-97 to 69.3 percent m 1999-2000. The secondary school complet~onrate fell from 48 4 percent In 1995-96 ro 47 6 In 1996-97 and then to - 46.4 In 1999-2000 - -s=-.4 -=7,- - - = - * - m - - ~ . ~ ~ , ~ ~ - r < d .mra . - - - ~ ~ - v m a - ~ - = ~ 2.26 The administration of President governance. Transparency International's Macapagal-Arroyo came to power on an "Corruption Perception Index" for 2001 ranks anticorruption platform and stresses good the Philippines 65th out of 9 1 countries, at a governance as one of its highest priorities. par with Guatemala, Senegal, and Arguably, a "window of opportunity" for Zimbabwe, and below countries like Thailand, reform now exists as a result of the Ghana, Malawi, and Latvia. And not only are appointment of a cabinet with a shared corruption ratings relatively poor, they vision, widespread public demand for better deteriorated in 2000, due to the perception governance, better cooperation among of increased corruption partially reversing a government agencies, and greater steady improvement over the previous seriousness about re-engineering within these decade. (see Figure 2.3). asencies. The MTPDP notes several broad - strategies for pursuing good governance, including improving service delivery, raising 2-3: ethical standards, strenqtheninq public and INTERNATIONALCORRUPTION private sector institutions, and imdrovins law PERCEPTION INDEX order, although, for the most part, ineonly rly general way. Further, the government as taken credible steps to launch reforms nd has made some progress in specific areas uch as budgeting and procurement reform. rward, the discuss that the design, s ntation of verviewof governanceoutcomes well beyond corru policies that con of public oversight and external accountability mechanisms. countability. Of these of governance, the ternational Country Risk Guide risk ratings, ing Countries Combat corruption,"The World Bank for example, give the Philippines 5 out of a the judicial system. On the othe possible 6 for democratic accountability. rate of success in criminal pro Oversight and accountability are facilitated by corruption in the courts (co a major expansion of the non-government example, to Hong Kong) organization (NGO) movement after the People Power revolution of 1986 and by laws and institutions that exist on pa freedom of the press. The lanuary, 2001 EDSA2 demonstrations are an indication of the value of such institutions in curbing FIGURE2.4: EASTASIAPACIFI corruption and other governance GOVERNANCERATINGS dysfunctions. 2.31 Rule of Law. However, important aspects of the functioning of the state itself are generally assessed as a good deal more problematic. Figure 2.4 shows ratings for some 16 East Asian and Pacific countries on two dimensions of governance, "government effectiveness" and the "rule of law" Rule of law in this context includes perceptions of the prevalence of violent and nonviolent crime, the effectiveness and predictability of the judiciary, and the enforceability of contracts. The quality of the rule of law in the Philippines was rated 12th out of the 16 East Asian countries shown here. Current ICRG ratings also give the Philippines only 2 out of a possible 6 for rule of law. Perhaps the most obvious symptom of weak rule of law is that the Philippines is one of only a limited number of East Asian countries still affected I by some form of chronic terrorist violence or Government Effectiveness as depicted in armed insurgency. This represents a failing to Figure 2.4 combines perceptions of the some extent in the core function of any state, quality of public service provision, quality of to provide civil peace and physical security the bureaucracy, competence of civil for its citizens. servants, independence of the civil service from political pressures, and the credibility of 2.32 Evidence on weaknesses in the legal the government's commitment to its policies. and judicial system was summarized in a Figure 2.4 shows the Philippines as 9th out of recent World Bank Social and Structural 16 East Asian countries in terms of ~eview.l' Problems include a sharp rise in government effectiveness, although this court backlogs and delays over the course of perhaps understates weaknesses in such the 1990s, and significant uncertainty or areas as public financial accountability and capriciousness in court decisions. The management, administration, and civil evidence also suggests an important two-way service quality. The impact of these interplay between judicial system weakness weaknesses is better seen, for example, and corruption. On the one hand, bysignificant contribution of weaknesses in arbitrariness in court decisions is linked in revenue administration to the dramatic part to perceptions of significant corruption in deterioration in the country's fiscal position over the last four years (See section 2A above for a fuller discussion). 2.33 The following sections review policy 16Kaufmann, Daniel, Aart Kraay, Paulo Zoido-Lobaton, developments and the outstanding reform Aggrgating Gouenurnce Indicators, World Bank Working Paper agenda in major areas of governance, adding 2195, Washington DC. 1999. The value of this study lies in its further information on existing institutional use of statistical techniques to create aggregate governance weaknesses where appropriate. indicators from a very wide range of indicators drawn from 13 separate cross-country governance surveys. This approach may minimize h e biases or idiosyncrasiesof any one survey. Philippines: Growth with Equity-The Remaining Agenh, A Wodd Bank Socialand Structural Review, May 2000. ktinpguide: = high,O=medium, += low. Source: PublicFinamlAccountabilityin EartAsia. World Bank. October2001. aurce: Mounrfie(r3;PublicFi~nrinlhcountabilityin EartArk World Bank, October, 2001. 'ublic financial accountability and 2.36 Expenditure Management. The Philippines nanagement embraced the idea of performance budgeting as early as the 1950s, and passed legislation to !.34 Better, more accountable management of facilitate annual budgeting in a medium-term ~ublicexpenditures, revenues, and debts are expenditure framework as long ago as 1987. :ritical to curb corruption, reduce waste, and But it is only recently that these ideas have rnprove the volume and quality of public begun to be implemented. DBM is implementing iervices. Its importance to a very wide range of a Public Expenditure Management Improvement itakeholders-taxpayers, consumers of public Project designed to encourage hard budget iervices, businesses, investors-also makes constraints; restore fiscal discipline; and ~ublicfinancial accountability important for increase transparency, accountability, and ~oliticallegitimacy and stability. predictability in budgeting. The main activities include: !.35 A recent World Bank study rated East isian countries on nine aspects of public (a) Establishing a Medium-Term Expenditure inancial accountability, drawing on the Bank's Framework that links planning and budgeting in :ountry Financial Accountability A~sessrnents,~~ a three-year rolling budget (first introduced in 'ublic Expenditure Reviews, and Country 2001) and a Medium-Term Fiscal Plan to 'rocurement Assessments18 (Table 2.5). No promote greater discipline. ~spectof public financial accountability in the 'hilippines receives a "high' rating. Most (b) Introducing Sector Efectivenessand Eficiency lspects that receive a "medium" rating refer to Reviews (SEER)to enhance prioritization, assess he quality of external scrutiny, for example, by the effectiveness of agency programs, and he legislature or NGOs. However, most aspects strengthen evaluation within agencies. ~f the administrative machinery itself get a low" rating, for example, internal financial and ~erformance management systems, public iector accounting and auditing, and the public ~rocurementregime, with only the quality and Ipenness of the budget process being rated 18 medium". Edward Mountfield.Public FinancialAccountability in EastAsia, World Rank, October 2001. (C) Developin an Organizational audited received a clean bill of health. P e ~ r m a n c e~nJcatorFramework (OPIF) Accountability for performance is difficult in that re-orients budgeting towards outputs these circumstances. I n the past, the and outcomes, introduces performance government's external auditor, the indicators, and links these with Commission on Audit (COA), has also been organizational performance, so that obliged to undertake extensive internal agencies can be held accountable for their control and accounting functions, although performance. it has been gradually disengaging from these functions over the course of the (d) Incorporating contingent liabilities into 1990s. the budget process. 2.39 Two major financial management (e) Rationalizing the budget process by reforms are underway at present: first, strengthening budget formulation and revising the government's accounting streamlining budget execution procedures, system, including simplification and shifting especially regarding accountability reports, public sector accounting towards a modified funds release procedures, and overall cash accrual system; and second, reorganizing management. COA to improve its audit services and effectiveness. 2.37 At present there is little reality checking as to whether programs, once 2.40 COA is computerizing the accounting approved, do in fact deliver expected system at all levels. It has designed a benefits. Thus, establishing even modified accrual accounting software rudimentary performance indicators and the system-the New Government Accounting capacity to evaluate government agencies System (NGAS) -which is being pilot-tested according to these indicators would in five agencies, and is planned to be rolled represent an advance in creating a out to all agencies by 2003. The NGAS will performance culture. After a pilot phase, integrate financial oversight agencies (e.g., DBM should aim to implement OPIF COA, DBM, DOF) and provide uniform government-wide. It should also develop databases and reporting for central more fully the evaluation component of government agencies and departments, SEER, including designing a capacity- enterprises, and LGUs. building program to strengthen evaluation in line agencies and local government units 2.41 Public procurement. A 1999 review of (LGUs). Efforts to engage civil society and the public procurement system concluded the private sector in budget formulation and that the system was beset with problems, monitoring should be deepened (e.g., including inconsistent and fragmented rules through the Budget Advocacy Project and and regulations, inefficient and the Government Watch Project). Among nontransparent practices, and abnormally emerging issues is the need to strengthen long approval processes,1g DBM began links between national level and local procurement reforms in 1999, focusing on government level planning (see below). I n two tracks. The first track deals with addition, international experience suggests changing administrative rules and that success in a performance budgeting implementing regulations governing the approach needs to be founded on sound procurement of goods, supplies, materials, internal financial controls and accounting and civil works to increase competition, and auditing systems. reduce delays. and limit the discretion of bids and aka;ds committees, all of which j / 2.38 Financial Management. Inherited are expected to reduce corruption. Initial public sector accounting and monitoring results have shown declining procurement systems are complex, unwieldy, too costs with International competltlve bidding I cumbersome to yield timely information, leading to a 40 percent reduction in J and poorly connected to the budget textbook costs and a 27 percent decline in 1 execution system. As a result, fiscal drug costs. I managers are forced to pilot the budget "blind," and, when they have to contain aggregate spending, to resort to the crude ...............................................................*.. instrument of cash rationing. Financial management and internal control at the LGU level remains extremely weak. I n 19 "liiodem~~auon l'ubl~cPro~urrmtox,"1W9, Codsdwt of 2000, for example, only 250 of 1,689 LGUs Srudy undcr rhe AGIlL projccr of USAID Y ,-,,.* ,"&,..&. ,i&,.V I 12.42 The government launched an was the fate of the Re-engineering the 1 Electronic Procurement Service in December Bureaucracy effort, for which enabling ' 2000. This provides a Public Tender Board, legislation was passed in 1994. / an electronic suppliers registry, and an electronic catalogue. As a result there is 2.45 Most recently, the PCEG was faster supplier verification (from 3 weeks to established in 1999 to oversee bureaucratic an average of 1 hour), and faster reforms to strengthen institutional capacity processing of expressions of interest (from and improve service delivery. Six technical 7 months to 30 minutes by e-mail). The teams representing the key oversight and 1 government is taking a cautious approach in line agencies have assisted the PCEG in / managing electronic procurement, and is drafting a Public Sector Institutional 1 building from a year of experience in Strengthening and Streamlining Agenda change management before introducing (PSISSA), which covers reforms in service 1 electronic bidding. delivery, organizational structuring and staffing, financial management, personnel 2.43 The second track is t o reform management, change management, and legislation. An omnibus bill-the Government information and communication technology. Procurement Reform Bill of 2000-was Once the PSISSA and various sector reviews approved by the lower House and reached have been approved, a detailed Integrated firstreadingintheSenate.Asimilarbillhas Administrative Reform Plan will be now been submitted to the new Congress. formulated. 1 In the meantime, an Executive Order was issued in late 2001 that strengthens 2.46 I n general, a two-track approach to re- transparency and competition in engineering has been proposed: a procurement procedures. Reinforcing this comprehensive restructuring under new with approval of a law is a high priority. I n legislation, and institutional strengthening the medium term, DBM should define and streamlining within the existing legal programs to professionalize public framework. The first "legislative track" has procurement personnel and extend a history of various drafts of relevant procurement improvements to LGUs legislation that have been stalled in through capacity-building programs. successive congresses for several years. Involvement of civil society and the private Thus, the second "administrative track" is sector (e.g., through Procurement Watch, the current focus. Clearly, given past Incorporated) in monitoring procurement experience, it will require strong, sustained should also be enhanced. political leadership and quick action to ensure that the current re-engineering Re-engineering government effort is not also stifled under an accumulation of committees and reports 2.44 The overall size of government in the that do not result in actual change. I n Philippines is not exceptional, whether particular, a suitable management structure measured in terms of government t o guide the actual implementation of expenditure relative t o GDP (about 18 reform needs to be determined. Given the percent), or in terms of civil service need for coordination and the prominence numbers relative to the population (about 2 of governance as a feature of these percent). The Philippines Social and reforms, the PCEG seems to be a natural ed, with a very departments and agencies participate, us, offices, cou estimate the costs of implementing the S, agencies, and s reforms, draft performance agreements, ies-some 400 to and establish suitable monitoring and evaluation systems t o assess agencies' reform progress. PHILIPPINES An OppormnltyforRenewedPove~tyRedllcgon ~ i P 1 - . - ~ a - ~ ~ ~ a a n ^ " , ~ ~ ~ ~ ~ - ~ ~ ~ ~ ~ ~ , ~ ~ - ~ " ~ - ~ - 2.47 Civil Service Reform. Studies have implementing regulations; providing for linked the gap in bureaucratic capability clear delineation of professional and political between the Philippines and some other positions, making the former subject t o East Asian countries to the extraordinary meritocratic recruitment and career prevalence of political patronage in civil advancement; and a more streamlined service appointments, and the consequent position classification system. Compensation much more limited role of meritocracy in policy (including for GOCCs and government recruitment and promotion.20 Salary financing institutions) should be reformed to compression means that senior and enhance transparency and competitiveness professional positions are significantly and to decompress salary bands. For LGUs, underpaid compared to the private sector. given their resource constraints, the At the same time, there is a proliferation of appropriate size and affordability of the civil increasingly nontransparent pay service at the LGU level must also be "allowances." Overall, the civil service has reviewed. DBM and the CSC must determine become a significant fiscal burden, with whether a single salary structure should be "personal services" accounting for 35 retained for all government personnel or percent of national government whether multiple salary structures should be expenditures in 2000, even leaving out local implemented. At both national and LGU government salaries funded by the center. levels, measures to improve organizational and individual accountabil~ty and 2.48 A broad package of civil service professionalism-a long-term process- need reforms to address these issues is therefore to be developed in step with reforms in an important priority. These reforms will budget management and service delivery need t o be sequenced and implemented standards and indicators. Sequencing, concurrently with budget reforms intended stamina, resourcing, and sustainability will t o clarify the roles and mandates of state be key to the entire process. entities, and with administrative reforms aimed at eliminating duplication and overlap 2.50 Decentralization. The Philippines Local of functions. I n the short term, the Government Code (LGC) of 1991 is one of government must develop an impact the most far-reaching decentralization mitigation program and implementation reforms in the developing world. The reform strategy that defines the potential resources established three layers of LGUs: provinces, required to compensate workers leaving the cities and municipalities, and barangays, to government (e.g., severance payments, which it devolved important responsibilities retraining/retooling expenses, and other in areas such as agriculture, environment, benefits). Proper separation arrangements natural resource management, health, and are necessary t o mitigate resistance t o public works and highways, as well as up to reform from within the bureaucracy. Such a 40 percent of national government program should be carefully costed and revenues. piloted in selected agencies before being applied government wide. A key analytical 2.51 So far there has been no systematic tool for estimating such costs is the Civil evaluation of how local governments have Service Simulation Model that is under performed under the reform. Anecdotal development for the DBM and Civil Service evidence suggests that decentralization has Commission (CSC); an initial version of this encouraged greater innovation at the local model has been completed and is being level (i.e., the Galing Pook awards), pilot-tested in the BIR. Refinement of the strengthened local management capability, model in the short run will be critical to and promoted greater cooperation with the developing the impact mitigation program private sector and other LGUs. However, and strategy. preliminary evidence also suggests that, despite these achievements, the expected 2.49 Priority reforms over the medium term benefits of decentralization have yet to be include modernizing the legal framework of fully realized. the civil service and the related (a) hzstitutional arrangements for service delivery remain uncledr in many cases, with national agencies still playing a significant 'O For example, The State in a Changing World, World role in some functions that should have Development Report 1997, World Bank, and Phllipp~ne: been fully devolved Growth w ~ t hEqu~ty--TheRemaining Agenda, World Bank Social and Structural Renew, May 2000 - . - - o & . = - ~ - , ~ m ~ s ~ w , ~ , to LGUs. I n addition, unfunded mandates equalization, including the possibility of from the national government, such as the establishing a separate equalization transfer. Salary Standardization Law, increase the LGC provisions regarding local taxation and cost of local services and impede local fiscal matters should be reviewed to ensure autonomy. that all possible sources of local revenues can be accessed by LGUs. Such information (b) Research has shown that the increase in could be used to clarify LGU responsibilities, u p g a t e Internal Revenue dlot~nent(IRA) (e.g., by defining expenditure requirements to provinces, cities, and municipalities and service standards by sector) and assess exceeded the cost of devolved functions and the need for transfers from the national other mandates, even when adjusted for government. inflation and population growth.21 Despite this aggregate funding "surplus," it is clear 2.53 I n the medium term, a high priority is that sufficient resources are not being to improve local fiscal and performance channeled to poorer LGUs, and the national information, including updating the income government's ability t o equalize fiscal classification system and establishing local capacity and monitor the financial government information as part of the performance of LGUs is weak. Government Financial Management Information System. The Bureau of Local (c) The overall share of revenues mobilized Government Finance should build on its fi-om local sources rehtive to GDP is not work now underway to computerize local Te zficant4 greater now than it was b4ore accounts and develop a comprehensive t Local Government Code. I n many cases, information system on LGU finances. IRA transfers have created disincentives to Performance evaluation is already being mobilize local revenues. Better tax piloted in 2002 and some capacity and administration could mobilize much greater institutional building is being undertaken by local revenue. While there have been some the Local Government Academy and the improvements in local real property tax Department of Interior and Local collections, efficiency remains low and Government. Enhancing LGU resource property valuation methods need to be mobilization is al improved. medium term. enhancing LGU r (d) LGUs are limited in their ability to be re-examined, manage and develop their human resources: fees and inco management but weakens local medium term to accountability. I n addition, LGUs' capacity level approaches for expenditure management is uneven, local capacity, especially in planning, investment appraisal, accountability. financial management, and personnel functions. LGU financial integrity is often weak; COA reports have cited numerous LGUs for inadequate financial management. decentralization would clearly I n the short term, in particular, which national government ag actually devolved to LGUs and t of the IRA transfer system conducted. The review of the identify opportunities fo 21 Manasan, Rosario G., (1999), "Impact of L Code and Proposed Amendments on Abl Infrastructure: Towards a Framework for rnimeo. Judicialreform systems to strengthen t disciplinary processes. As pa 2.54 Under the widely praised leadership of the Supreme Court has (a) ag Chief Justice Hilario Davide Jr., the Supreme NGO, 'Bantay Katarungan, " Court has adopted an Action Program for proceedings and screen Judicial ~ e f o r m . This ~ ~ is a comprehensive positions in the Regional these problems, this judicial reform against 230 judges by either dismissal or 1 program includes actions to streamline and administrative sanctions on graft and ( strengthen administrative and operating corruption charges.23 systems; strengthen human resources and 1 improve their management; address C. STRENGTHEN PRIVATE SECTOR infrastructure deficiencies (building an DEVELOPMENT information and com~munications technology); and improve access by the 2.57 The Philippines is an example of a poor, public information, and civil society largely private sector-led and market-based collaboration. This reform program has very economy that has achieved relatively widespread support, including explicit mediocre rates of productivity growth and support from the President.Moreover, this capital accumulation over several decades. judicial reform program is receiving There are several broad reasons that help substantial support from donors. However, explain this. First, macroeconomic stability, its ultimate success will depend on effective an important condition for private sector implementation of change and this will development, remains elusive, as shown by depend on broad involvement by the emergence of large fiscal deficits and stakeholders. the surge in public indebtedness over the last several years (see Section 2A). 2.55 Court congestion and associated case delay has been a perennial problem, 2.58 Second, weaknesses in governance commonly attributed to an array of factors undermine public sector performance (see including vacancies in judge positions, lack Section 2B) and have a direct bearing on of information technology, outmoded private sector development. This section procedures, and a flood of cases involving discusses how improvements in property checks drawn without sufficient funds. rights, corporate governance, trade and Further detailed analytical work involving investment policies, infrastructure, and rural more than 2,000 recent cases is currently sector support arrangements are needed as under way by the Supreme Court, with part of the overall effort to attain a higher technical assistance to refine the diagnosis growth path and broaden participation in of this problem and develop a solution. This development. information needs to be used to refine the reform program already under way. 2.59 Good corporate governance is necessary for the development of capital 2.56 Widespread perceptions of corruption markets that mobilize and channel savings in the judiciary are reflected in successive into productive investment. I n the surveys indicating that more than half of all Philippines, the formal rules for corporate Filipinos think that "some" or "quite a few" governance, such as shareholder protection judges accept bribes. The weak disciplinary and accounting and auditing, are not process and enforcement of the tode of exceptionally weak by international ethical standards among judges, and others standards, but their value is undermined by in the judiciary and the lack of transparency weaknesses in enforcement. I n addition, the in and public awareness about court high concentration operations, have seriously undermined the integrity of the courts. Fully solving this problem involves fundamental changes in '* Supreme Courr of the Philippines, Action Program for ' 23"Policing the Judic~ary,"by Franc~sIntorio In Benchmark, Jud~c~alReform,Augusr 2001 Centennial Issue, Vol I1 (3),May-June2001. j . - - s z " ~ v G - - - - P - - = e - m - - = - P - % - - - = < PHIUPPlNESAn Opportuniryfar Renewed PO"& Reductioo of share ownership in the hands of large, Corporate governance dominant, and politically well-connected shareholders also undermines protection for 2.63 The mobilization and channeling of a minority shareholders and creditors. growing volume of savings into profitable investment is essential for the Philippines to 2.60 Private sector growth and productivity achieve its growth targets. For this to occur, also depend on the extent t o which suppliers of capital-be they individual businesses are kept on their toes by shareholders, institutional investors, mutual competition. Traditionally, competition in or portfolio funds, banks, or financial markets for many goods and services in the institutions-need assurance that the Philippines has been muted by high market companies in which they invest will act in concentrations, trade and investment their interests, protecting and generating an restrictions, and other barriers to entry. The adequate return on their funds. However, foreign trade and investment liberalization those in operational control of firms (e.g., of the 1990s has increased competition, but professional managers or dominant it is likely that the benefits of these reforms shareholders) typically have an incentive to have yet to be fully realized, due to the divert funds provided by outside suppliers external shocks of 1997-98 and 2001. of capital to their own ends. 2.61 Third, the private sector's contribution 2.64 Corporate governance broadly defined to development also naturally depends on comprises those aspects of the economic infrastructure services. I n spite of environment, laws, procedures, and considerable progress in developing common practices that provide an incentive infrastructure during the 1990s, largely framework for companies to maximize long- through innovative reforms to attract PPI, term value for shareholders, while significant infrastructure deficiencies adequately protecting the interests of other persist. stakeholders, for example, lenders and other creditors. Corporate governance in 1 Protection of propertyrights the Philippines is given a particular twist by relatively high ownership concentration in 1 2.62 Property and contractual rights are firms, second only to Indonesia in the East j protected by the Constitution, the Civil Asia region. The top 15 business families in 'Code, and a 1996 law protecting intellectual the country are, for example, estimated to ,property such as patents and copyrights. account for 55 percent of ownership in ,However, laws are effective in protecting listed companies.25 High ownership jcontractual rights only if they can be concentration tends to have a double-edged enforced, and enforcement remains weak in effect on corporate governance, alleviating the Philippines. Table 2.6 shows the results some problems while exacerbating others. of a survey of 49 countries concerning the On the one hand, it gives majority owners a enforcement of investors' rights, including strong incentive t o closely monitor the such critical variables as the efficiency of activities of professional managers. But the judiciary, rule of law, and absence of dominant shareholders with strong I c o r r ~ ~ t i o nThe~Philippines obtained the . ~ operational control of firms also have more /lowest or nearly lowest ranking in terms of incentive and ability to abuse the interests all of the variables. It was found that, of other suppliers of capital, such as compared to other countries, investors in minority shareholders and creditors. the Philippines faced a substantial risk of Without adequate safeguards in the form of icontract repudiation and expropriation. I n high quality accounting and auditing particular, firms that are politically well- standards, strong codes of corporate can sometimes exploit conduct, and effective legal protection, such damage or suppress abuses can stunt the emergence of a broad influential domestic or shareowning culture, as well as of markets Iforeign challengers. for bank lending and other forms of credit. 24 La Porta, Raphael, Florencio Lopez-de-Silanes, Andre 25Corporate ownership parterns are reviewed in detail in Shleifer, and Robert W. Vishny, The Journal of Political Philippines: Growth with Equity--The Remnining A g e d , World Economy, 106:6 (December 1998),pp. 1142-1143. Bank Social and Structural Review, 2000. 2.65 Broadly speaking, the statutory codes for and the central bank. (See Appendix 2. accounting and auditing standards and more detailed outline of this ROSC.) shareholder rights are reasonably well elaborated for a country at the Philippines' level 2.67 Shareholder Protection. The study of I of development, but there are problems at the investor rights by La Porta et. al. cited above / level of implementation and enforcement. gave shareholder rights in the Philippines a / rating of 3 out of a possible 7, scoring it higher 1 2.66 Accounting and auditing standards. The than Indonesia, Thailand, and Korea in the survey by La Porta et. al., encapsulated in Table region. Several other studies also note that the 2.6, found the accounting standards in the corporate laws already contain many features Philippines to be near the middle of the pack, standard in other countries covering protectior~ of minorities and the fiduciary duties of1 I both in a sample of 43 countries and among East Asian countries. But while statutory directors, but that the prevalence of large! accounting guidelines in the Philippines are shareholders in most companies requires 1 sound, the accounting profession is well additional strengthening in these areas.26 PLI established, and companies listed on the stock recent ROSC on Corporate Governance exchange are subject to disclosure recommends a number of measures for 1/ requirements, there is little capacity to enforce improvement, including better public disclosure accounting guidelines and disclosure of share ownership, greater empowerment of i requirements. I n practice, auditors may choose minority shareholders (for example, in terms of from a wide range of disclosure style and their rights regarding shareholder meetings and reporting standards, for example, local in situations where the majority has a conflict of generally accepted accounting principles interest), higher standards of performance and ' (GAAP), International Accounting Standards, or disclosure by boards of directors, higher U.S. GAAP. Penalties for poor conduct of audits standards of disclosure and performance for by independent auditors, and the mechanism auditors, and stronger powers for the S for imposing them is weak. I n spite of the many the Philippine Stock Exchange (PSE) to well-known cases of poor quality audited regulations and impose sanctions. financial statements that caused losses for Appendix 2.2 for a more detailed outline o investors, the SEC and Philippine Institute of ROSC on Corporate Governance.) Chartered Public Accountants have not publicly sanctioned any auditor in the past. Furthermore, many companies prepare different financial statements for different end users. A recently completed Report on the Observation of Standards and Codes (ROSC) on accountancY / n*s.*me*+." *m*me*s**,," *#".." **A,"""~* # * x * ~ ~ s a < s ~ ~ ~ ~ . b #*.m*mpm*," n ~ ~ . . , , in the Philippines therefore recommends the i adoption of international accounting and auditing standards without modification, 26Fogarty,Ke~in,"'CorporareGovernanceinthePhilipp~e strengthening the standards for training and Assessmenr of Needed Reform Effom," USMD, 1999; and quality assurance, and strengthening the Saldaoa, "PhilippinesCorporateGovernance Environmenrand regulatory and enforcement capacity of the SEC and their Impact on Corporare Pedomance and Finance,"" Asian Developrnenr Bank, 1999. m T A ~ ~ - ~ . " . ~ . . ~ . L m ~ - * ' - - ~ s ~ . % . ~ ' ~ . ~ < ~ ~ m ~ ~ - r E L ~ < - ~ ~ - ~ r ~ . ~ ~ - m ~ ~ ~ - a s ~ , TABLE2.7:MEkSURESFOR PROTECTING CREDITOR RIGHTS Source: Ln Porta et. aL (1998). ! ! Creditor rights and insolvency law to be quite unsatisfactory, due to long delays in I SEC decisions on cases, during which time 2.68 I n general, the protection of creditors creditors were unable to pursue their claims 'under law as well as under bankruptcy and often suffered deterioration in the value of protection and workout arrangements in the their assets. Hardly any companies were Philippines has been among the weakest in the successfully rehabilitated. world. A survey of creditor protection frameworks by La Porta et. al. cited above 2.69 Since the 1997-98 regional financial crisis, found the Philippines at the bottom in a several steps towards reform have been taken. comparison of about 50 countries. Secured I n December 1999, the SEC adopted "Rules and creditors do not have adequate protection from Procedures on Corporate Recovery," but these stay of foreclosure and do not necessarily enjoy still failed t o address the most serious a priority in payment. Creditors do not have an deficiencies relating t o creditor rights. The adequate say in the reorganization of distressed adoption of the Securities Regulation Code in borrowers, or over management (see Table July 2000 moved the venue for distressed 2.7). Most default cases are settled through companies seeking suspension of payments dacion en pago, without recourse to foreclosure from the SEC to the Regional Trial Courts. To be mechanisms, under which debtors are generally successful, this will require that Regional Trial able to extract concessions from creditors. This Court judges are adequately trained to weak state of creditor rights and insolvency law administer them effectively and expeditiously. tends to prevent the development of deep This training has begun. markets in arm's length bank lending. Until lrecently, corporate insolvency wascovered by a 2.70 Effective December 15, 2000, the sidential decree of 1981 (PD 902-A), which Supreme Court adopted Interim Rules of t y for dealing with distressed Procedure on Corporate Rehabilitation. These This arrangement turned out rules are an improved version of the SEC's December 1999 Rules and Procedures on Corporate Recovery, and are to apply until the proposed Corporate Recovery Act is adopted by the legislature. The Interim Rules are considered deficient relative to international best practices in a number of areas. I n particular, there are no provisions for creditors' committees t o be able t o select the rehabilitation receiver or to be consulted or heard in key decisions in the proceedings. There is no provision for creditors to vote by classes on the adoption of rehabilitation plans, and the rules allow the court to cram down stays and debtor rehabilitation plans against the wishes of the majority of secured creditors. Leaving such discretionary powers with judges is not only Competitive;environment:-foreign trade at variance with best practices, but also can and investhemregime lead to serious abuses of creditors' rights. Further, in April 2001, the interim rules 2.72 Competition in markets for many were amended t o restore the former goods and services is muted, due in part to practice under the SEC of appointing the absence o f pro-competition laws and in management committees to oversee the part to the domination of several markets implementation of rehabilitation programs. by a small rtumber o f suppliers that are Unlike a receiver, who is subject to conflict often m M i b e r s of family-based of interest rules, the management conglomerates. Market concentration is committees are comprised of the interested particularly high in such sectors as food, parties, the creditors and debtors. tobacco, beverages, coconut oil, glass, paper, interisland shipping, and pipelines. 2.71 Looking forward, the proposed And some of these sectors, including some Corporate Recovery Act seems much closer food products, are sheltered from import to international best practices. However, it competition. Interisland shipping is could be further strengthened in a number protected by a law that inhibits competition, of areas, including and this has ~esultedin higher costs. (a) Facilitating the exit of nonviable 2.73 While the position of family group- companies. It is recommended that the Act based companies has been eroded by clarify that a company is insolvent if it is liberalization of trade and foreign unable to pay its creditors and is unlikely to investment IEberalization (see below), they be able to do so in future, and it should often remain in a position of market compel a company to file for bankruptcy dominance. Their ownership of the major immediately upon becoming insolvent. banks and preferential access to financing Directors of companies that continue to also affords them a strong competitive trade while insolvent could be made advantage an& represent$ a possible barrier personally liable for any additional losses to the entry of new firms. The sizable that are suffered by creditors. To prevent investment in logistics made by dominant banks from lending to related insolvent suppliers in order t o distribute their companies, director, owner, shareholder and products among the islands may also related interest ceilings on bank lending represent a significant. barrier t o should be strictly applied. Through strict competitibn from imports Cji to the entry of PHILIPPrnS AnOpportunityfor Renewed Pove Reduction *---w-----m ~ a w * * - * - - m v m ~ m w - - - 2.74 Foreign Trade. Trade liberalization programs launched in the early 1990s hav significantly simplified tariff structu reducing it from a five-level rate schedule one with three. The number of Harmon down, especially in manufactu average MFN rate in Philippines in 10 percent, compared to 13.5 p Indonesia, 9.5 percent in Malaysia, an percent in Thailand. The weighted average effective protection rate (EPR) also fell from 24.8 percent in 1995 to 14.4 percent in ho 2000, with this decline in effective ab protection being most pronounced in ag manufacturing. However, progress on trade its reform has not been entirely uniform: there Organization ( ~ 0 )~t.delays the migration was some backsliding in 1998, when 22 of resources from agriculture t o other domestic industries received additional activities. ~t reduces the international Protection through higher import tariffs, competitiveness of manufacturing by raising Looking forward, the Tariff C~mmission labor costs, and it disproportionately hurts estimated in February 2001 that EPRs the poor, who spend more of their income ~ o u l dfall t o 14.1 Percent in 2001, 12 on food and are, in general, net buyers of Percent in 2002, 11.77 Percent in 2003, food. Further liberalization of trade in and 10.8 Percent in 2004. I n 2004, a agriculture should be pursued, as it is a uniform tariff of 5 percent will apply, though promising source of economic gains in the some goods are still likely to receive non- future. I n this context, recent moves to tariff protection. allow the private sector to import rice is a positive step. 2.75 Agricultural protection constitutes an important exception to the general trend of 2.76 Investment Regime. The foreign lower trade restrictions. The government investment regime is fairly liberal. I n most retains a monopoly of imports of rice and sectors, loo-percent foreign ownership is effective protection rates for agriculture permissible. Foreign firms can lease land for have fallen much more slowly than for up to 75 years. The investment regime manufacturing. The 2004 EPRs in guarantees freedom from expropriation agriculture and food processing are without nationalization and the right t o estimated to be 20.1 Percent and 21.5 remit profits, dividends, capital gains, and percent respectively. Agricultural protection sale proceeds from investments. However, has Several economic ill effects. It stifles the Philippines does maintain two negative development in downstream industries such lists that restrict or limit foreign a s food manufacturing and beverages. It investments in certain sectors and for ,diverts production from exports t o the certain activities (Appendix 2.3). Sectors many smaller providers. Telecommunication reform agenda. Several key proble services have grown rapidly. Competition has to be addressed in the next stage o emerged in all segments of the market. The National Telecommunication provides regulatory oversight Infrastructureprovisions will require the government to absorb some 2.77 The Philippines made co progress in developing its infrastru the course of the 1990s, although, as Table 2.8 large open-ended financial commitments to suggests, it still lags behind other middle- support PPI in future. income countries in the region in several respects. (b) PPI has been skewed to hrge urban areas and / has made Little contribution in rural or more 2.78 Achievements. A key force in this remote areas. After the decentralization law of development was the attraction of PPI after the 1991, local governments assumed the main l I passage of the BOT law of 1993. Over the past responsibility for infrastructure development I decade, the government, in partnership with and maintenance, but few have the financial or the private sector, has initiated about 111 management capacity to undertake this task. 1 infrastructure projects with a capital cost of $26 billion, mainly in four sectors: power, water, (c) There transport, and telecoms. rephtory and infrastructure sectors, as well as 2.79 EmergingIssues. Despite these advances, strengthening of institutions to handle the Philippines' infrastructure needs remain infrastructure development as a whole. large, and financing for them scarce. The World Bank estimates needed investments over the next 10 years at $35 billion-$45 billion. Given 1 TABLE2.8: INFRASTRUCTUREINTHEPHILIPPINES 1 - 2.80 Policy Agenda. The Philippine dependence on short-term foreign government has made infrastructure currency borrowing. development and revitalization of PPI a priority in 4% MTPDP. The World Bank has (b) Institutional reforms. Apart from p~ovidedcontinuing support and advice on strengthening local government capacity, the PPI reform agenda, in particular through other institutional reforms that could help a recent Country Framework Report on infrastructure development, include Private lnuestpent. The report proposes a ,threerpointstrategy: Strengthening the role of the Committee on Privatization (COP). Privatization of (a) Financial ip!~rm.Given the buildup of existing assets is a key element of the PPI , PPI-related contingent liabilities and the agenda. International experience shows weak capacity af local govm-nments to the importance of letting the pace of participate in infrastructure development, privatization be driven by a strong central there is a clear need for greater fiscal unit with direct access to key decision discipline and the development of a makers, rather than by self-interested line framework to1 reduce dependence on agencies. I n the Philippines, the COP can national government resources. I n play this role, building on its impressive particular: , - experience in privatizing many GOCCs in I - the early 1990s. D&ne thx &asisiuf $nancial rejorm. The 1 government needs t o better define the Review thefiture role of the BOT center. A bas~s,rationale, pricing, and management distinction should be made between the for guarantees and other financial "sell" and "buy" side of the PPI process. enhancemenfs. A greater emphasis on While the COP should be the main entity privatization woutd also help minimize the for disposing of government assets, the need for guarantees. BOT should focus essentially on promotion , - to potential investors. * Strengthen LGUs' capctcity fur irpfiastrztctzcrc,developmentl This can be Consistently apply competitive bidding done by- improving their1,Pinancial procedures. Infrastructure privatization management, investment planning, and should be done under a competitive and accounting~cap.adfyand by @,vjmga bigger transparent bidding process. The process share ofx.central,block transfee t o smaller, for selecting, soliciting, evaluating, and poorer LGUs. -Benchmarking hperformance awarding projects should be simplified, indicators f9r tGtrs and paking these standardized, and made more available tn ,t==e,publicw,oudd increase transparent. transparency and accountability of LGUs and mayors. Establish urns-length reguhtory agencies. I Investors are aware of ~oliticalDressures diversification, and little, if any, competition, diversification, and incr"l improvement in productivity. About one ~roductivitv. Second. the aovernm&ht%;id$ fourth of the rural labor force is support strategy is underemployed, and a large number implementation is (especially youth) continue to be limited funding bit also be unemployed.27 governance and implementa LGU levels, exacerbated by t 2.82 Key natural resource issues include the level capacity of national destruction of old growth forests; low-input agencies. shifting agriculture that has severely degraded the uplands; and rampant illegal 2.84 Policy, institutional, a over-fishing, destruction of coral reefs, and reforms are needed to remove ma degradation of mangrove areas. While the distortions, lower transaction costs, a Philippines is rich in natural resources and provide an improved and more sustainab has one of the highest biodiversity in the incentive framework conducive to marke world, the increasing demands of a growing led improvements. In this context, it population has caused rapid depletion of suggested that quantitative imp0 natural resources especially those that restrictions on rice be converted to a provide for our basic needs such as food, import tariff and that there be a clear an water and shelter. The Philippines simple plan to reduce this over time. Thi Environment Monitor 2000 identified three would reduce rice prices, which are s broad environmental challenges for the important to the poor (see Figure 2 country: urban air and water pollution, contribute to much-needed c natural resource degradation and the diversification and be consistent with declining quality of coastal and marine national commitment to WTO principles resource^.^^ While some improvements in reduced import barriers. Phasing out marke natural resource management (e.g., high distortions for sugarcane would als deforestation and fish depletion rates are increase competition and productivity an declining) are emerging, available data encourage value added and diversification i suggest continued threats requiring more farm incomes. Updating and implementi aggressive and appropriate interventions to the action for restructuring/ privatizing t strengthen environmental management. National Food Authority (NFA) is an integ Forest management policy needs to be part of needed agricultural policy reforms updated, water/irrigation sector policy help generate a more dynamic rural sector. revisited, and further coordinated action is needed to ensure environmental sustainability. FIGURE 2.5: DOMESTICWHOLESALE PRICES OF RICE (IN PHP PER KILO) 2.83 Rural development and poverty alleviation are stated top priorities of the Philippine government, as reflected in its recently updated MTPDP (2001-2004). Available recent analyses of the Government's rural development/ national resource and management programs suggest uneven performance in addressing the above-mentioned issues.29 The overall conclusion is, first, that the policy environment needs reform to facilitate 'As ofJune 2001. Source:ADB-DOF-DA Grains Polby and InsiitutionalR.fonns 27See Philippine,: Equitable Deuehpment Strate0 World Bank, May, Aduirory TPchnicalArrirtanceReject, Jan. 31,2002. 1998; Philippine. RD/NRM Shatpgy Implementation and Framwork Pe+nnance Indicator System,World Bank,June, 2000. 28 The Philippines Environment Monitor Series is an short annual World Bank publication reportingon variousenvimnmend issues. 29 Medium Term Investment Plan for the R u d Senor and SEER (National Economic DevelopmentAuthoriry, Sept.2001). t the same time, targeted serious instability and crises, the origin of ent support for community-based which lies in the asymmetric information ion, production-to-market strong prudential regulation and supervision of agricultural services financial sector. . So will initiatives to of the rural poor to 2.88 The Philippines' financial system is ts, especially land, and dominated by banking. Deposit money bank the need for an updated assets. Banking itself is highly ensive Agrarian Reform Law to concentrated, with the largest six instrument for supporting percent of all bank assets. Commercial tation. Broadening access to land banks are often parts of family-owned ng land market restrictions and business conglomerates, and tend to targeting the landless in operate as in-house banks for the nonbank iness and commercial operations of the 1 important part of this. Additional resources, controlling families. Short-term commercial i 1 as planned by the government, are needed bank lending of at most 90 days' maturity j to accelerate the purchase of private lands, provides the main source of external j and appropriate institutional reforms in land finance for corporations, which tend to be administration and management are less heavily leveraged and more reliant on needed. retained earnings to finance investment than in most East Asian countries. The 12.86 Effective delivery of this support will contractual savings sector (public and i /necessitate strengthened institutional private pension plans, life insurance 'arrangements, coordination, and more companies) makes up a second and much effective private-public sector partnerships. smaller segment of the financial system. Improved public expenditure reforms in the Capital markets are even less significant as 1 rural sector agencies, to achieve more a source of financing for the private sector. effective and accountable devolution to local They cater primarily t o government governments and communities, would be domestic borrowing. Several features of the part of this. Government support is financial system, such as the demonstrated in the President's underdevelopment of capital markets, the lcommitment to provide PhP2O billion focus on short-term financing, and the bias annually in public investments as part of towards intragroup (as opposed to arms- the Philippine Agriculture and Fisheries length) lending, result, to a considerable Modernization Plan 2001-2004. However, extent, from the serious weaknesses in improved policies and enhanced funding investor protection and creditor rights must be complemented by aggressive discussed in Section 2C above. efforts to enhance the implementation {capacity of local governments, as well as linkages with national agencies. ' D. / STRENGTHEN AND DEEPEN THE FINANCIALSECTOR 2.87 A large body of evidence now documents the close association between deep, well-functioning financial systems and more rapid economic growth. When it functions well, the financial system mobilizes resources, allocates them to their ..............* ..... ...................meea. e.ess* best use, and monitors the efficiency with which those resources are used. It creates 30 ~~~~~~~~i~ informationis a situationin which one party tools for hedging and trading risks, and to a transactionhas more accurate information than the other. provides efficient ways to make payments Thus, a borrower typically has better information about the for goods and services. However, financial potential risks and returns of the investment to be undrtaken markets also harbor the potential for h, does,hesupplierofcapital. PHILE'PWES An Oppormqtty for Renewed Povc~tyRcduct~on L-= TABLE 2.9: NPLS OF CRISIS-AFFECTED COUNTRIES (PERCENT OF TOT= LOANS) I (a) First line uses "stringent" definition of NPL; second line excludes transfers to Indonesian Bank Reconstruction Agency. (b) NPL figures use FLC I since Dec.1999. (c) Includes commercial banks, finance companies, merchant banks, and Danaharta. (d) ReEers to commercial banks. (e) First Line I includes commercial banks, finance companies, and estimated NPL transferred to wholly-owned private asset management companies (AMCs). * Data for November2001. Source: Natioruldarn of various countries. I Banking system performance rose from 15 percent at the end of 2000 to 19 percent in November 2001 (Table 2.9). The 2.89 The Philippines did not experience a deterioration has not been uniform and NPLs systemic financial crisis in 1997-98, in part range through 4.9 percent for foreign bank because of financial sector restructuring and branches; 18.6 percent in government banks; / reform undertaken after the debt crisis of the 20.7 percent in Expanded Commercial banks 1 early 1980s and stronger capital positions and (EKBs) to 22.2 percent in other commercial 1 better portfolio quality among its banks. banks. j Nevertheless, the 1997-98 regional crisis, the I greater economic volatility, and a weakened 2.92 Concurrent with the growth in NPLs has 1 / pace of activity have contributed t o a been widespread foreclosure on other assets, deterioration in performance indicators for and thus the resulting real and other properties Philippine banking. And 2001's steep fall in owned and acquired (ROPOA), together with export industries, the weak peso, high interest loans that have been restructured, now account 1 rates, and low equity prices have contributed to for another 15 percent of total loans. Overall, 1 further stress. approximately 35 percent of total loans are i under some form of stress, while 2.90 Indicators for the banking sector suggest a nonperforming assets as a proportion of total continued weakening. While most banks report assets have risen to about 30 percent. adequate capital, it is not clear by international Provisioning against this loan quality amounts standards that in fact sufficient capital is being to approximately 44 percent of NPLs plus maintained. Asset values are not clearly ROPOA combined, in part reflecting the fact established and banks' balance sheets show a that provisioning rules in the Philippines require slow but increasing level of foreclosed assets. provisioning against ROPOA only if the market value of foreclosed assets falls below book 2.91 Asset quality and provisioning. The asset value in the course of five years.31 quality of banks has declined over the last several years. Commercial bank NPLs rose from 4-5 percent at the end of 1997 to 13 percent by early 1999, as a result of the economic slowdown and financial volatility experienced during the 1997-98 regional financial crisis. . L O . I I D Y I . * a . U ~ . m l l ~ ~ ~ m ~ ~ ~ ~ . ~ ~ ~ ~ ~ . ~ . ~ ~ ~ " " ~ ~ ~ ~ ~ ? # ~ ~ ~ ~ # ~ , ~ ~ * ~ ~ ~ ~ ~ * ~ . * ~ . ~ * ~ , , ~ ~ ~ NPLs stabilized during 1999, but began drifting higher in 2000 and 2001, reflecting slower 31~anksare permitted to retain ROPOA and to count it toward economic growth, market instability and capital. Banks are therefore reluctant to dispose of these assets, as they interest rate increases, although some part of would be forced to recognize losses immediately. Keeping ROPOA the deterioration may also reflect tighter results in less provisioning and thus little impact on capital. reporting standards. Commercial bank NPLs 2.93 Problems among larger banks. Two supervision, and transparency. The General 1 large institutions (The Philippine National Banking Act enacted in May 2000 Bank [PNB] and Equitable-PCI) experienced represents a considerable improvement over ja deterioration of depositor confidence in the previous 1949 law and lays the basis for late 2000 and early 2001, leading to the a major overhaul of prudential regulation injection of substantial emergency funding and supervision. Nevertheless, further from the BSP and PDIC. Equitable-PC1 has action is needed to strengthen the repaid all of its liquidity support. At PNB, legislative power of the central bank and /whichis affected by high NPL levels and low other regulatory authorities to deal with /earnings, the government has attempted distressed or failing institutions, better 'various strategies to rehabilitate the bank, 1 including protect their staff from lawsuits, and encouraging the provision of promote further consolidation of the sector. additional capital from private sources, but Banks have been urged to improve their has been hampered by the lack of adequate credit risk management and the authorities legal tools to overcome the resistance of the should closely monitor these efforts. existing owners. Measures are also needed to further strengthen training of supervisors; improve 2.94 Profitability and Earnings. There has analytical and early warning tools; promote been a steady decline in return on asset better corporate governance, disclosure and (ROA) and return on equity (ROE) indicators market disciplining of banks; and speed since 1997, paralleling the deterioration in disposal of intervenedldistressed asset quality. ROA and ROE levels have institutions. 'fallen from 2.2 percent and 15.9 percent in 1996 to 0.6 percent and 4.3 percent, 2.97 Prudential Regulation and respectively, in June 2001. The underlying Supervision. Prudential regulations have decline in profitability is even more marked improved via higher capital norms, tighter if it is noted that net income has been loan classification and provisioning rules, largely supported by extraordinary gains in better consolidated reporting, more recent years. conservative loanlvalue ratios for real estate, greater alignment with international 2.95 Capital Adequacy. Capital levels were norms, and efforts to enhance risk reported at approximately 17 percent in management by banks. Rules for June 2001, substantially higher than the qualifications and fitness of directors and Basle standard of 8 percent. Again, there is officers have been spelled out and related- ,some variation across banking categories, party lending standards have been with the highest reported capital being held tightened, but may need further review. by foreign bank branches (22.3 percent) Recent regulations include the uniform and the lowest in ordinary commercial implementation of the 6-25 percent banks and EKBs. While capital adequacy allowance for probable losses on loans trends have been positive, they need to be classified "substandard-secured," adoption sed on 'Bank provisioning arrangements, and the fact re s for borrowings paya that, with profitability as low as it is, the ly, or semimonthl likelihood of banks' augmenting ca through earnings is small. Th introduced a new risk-based adequacy requirement for banks step in bringing the qualit authorities' prudential supervisi the international capital adequa set by the Basle Committee. Policy environmentfor banki 2.96 The Philippine auth the years since 1997-98 banking system improvements in pruden 2.98 The supervisory powers of the BSP supervisory powers to the BSP to deal have been enhanced and made more undercapitalized banks. But the effe explicit. On- and off-site supervision has implementation of these new tool improved and a system for monitoring the hampered by the lack of suf top 200 borrowers has been put in place. A power for the supervisor to inte basic early warning system has been is needed is explicit authority rating system is being put in place. Greater proceed with restructuring, mer financial transparency and disclosure will be liquidating it without undue inte sought through quarterly publication of from shareholders. Adequate financial statements. The law also protection for BSP and PDIC official establishes the basis for greater competition possible litigation by an ' in the banking system by further liberalizing shareholders is also the entry of foreign banks (permissible deposit secrecy laws prev foreign ownership has been raised to 40°/o transferred to another ins of voting stock and, after seven years, up to of failure resolution and loans lingering in the failing I 2.99 Asset Restructuring. The Philippines the cost to taxpayers and shoul has not adopted a centralized approach for addressed. For example, government eff dealing with NPLs and repossessed assets to rehabilitate PNB have been hampered on the books of the banks. Its approach lack of sufficient authority to force reflects the less severe impact of the crisis current majority owner to inject cap on Philippine banks and firms, the difficult dilute his position through a strat fiscal situation, and the view that private investor, or to sell his position. initiatives may be best suited to address the nonperforming asset situation. Following 2.101 Anti-Money Laundering Act. An this approach, the government is currently anti-money laundering bill (Act 9160) was working on legislation allowing banks to sell passed into law just before the September assets to a specially designed asset 30 deadline imposed by the Paris-based management company (AMC) or special Financial Action Task Force (FATF), although , purpose vehicle. Property ownership laws the bill's implementing rules and regulations may be amended to let foreigners be have yet to be carried out. FATF is assessing majority owners of AMCs that own real the law for compliance with its standards, 1 estate for a limited period of time as part of and will probably have comments and their disposal strategy. The current proposal recommendations to further strengthen the would permit a transfer of the assets at net law. I n the meantime, the Anti-Money 1 I book value. The compensation for this Laundering Committee, made up of the / transfer would be divided into two Governor of BSP, the Chairwoman of the components: cash for the value estimated SEC, and the Chairman of the Insurance by the owners of the AMC as the real value Commission, is seeking to appoint an of the assets, and the difference in executive director who will lead efforts to subordinated notes. These notes would interpret and implement the legislation. provide an incentive for bank owners who Clltimately, it will be implementation that feel that the assets are worth more than determines how significantly the Act helps what is being offered, by giving them an in combating criminal money laundering. opportunity to participate in a later rise in asset prices. It does, however, also provide 2.102 Issues raised by conglomerate the banks yet another opportunity to delay banking structure. The conglomerate loss recognition in the hopes of a speedy structure of banking in the Philippines raises recovery, as the evaluation of the notes will a number of policy-relevant issues. As be delayed by one year and resulting losses noted, the financial industry is dominated will be phased in over a five-year period. by six commercial banks, which own trust, investment, securities, insurance, foreign 2.100 Failure Resolution. The lack of currency deposit, and thrift subsidiaries, as adequate legal powers to address and well as corporations and real estate resolve problem financial institutions development projects. This structure continues to hamper BSP and PDIC. The facilitates the arbitraging of financial 2000 General Banking Act adopted an early opportunities created by differential warning system and a prompt corrective action regime, giving strengthened egulatory, capital, and tax Capitalmarkets ts in the Philippines, and by the rent regulators and 2.105 Equity and debt markets capable of es with differing providing long-term financing have e is invariably effected achieved only limited development in the conglomerates with Philippines. As previously noted, the e conglomerates assume development of these markets has been ance, as they are invariably hampered in part by institutional nt clearing banks in the weaknesses in such areas as corporate yments system, accounting for governance, creditor rights, insolvency law, ent transactions. and the enforcement of shareholder rights. 3 While profit-efficient, the 2.106 Recent Developments. The PSE has connectedness of the conglomerates not fully recovered from the flight of foreign makes banks vulnerable to problems in investors in 1997. After a rebound in the i d i a r i e ~ . ~Moreover, * their systemic first part of 1999, equity prices fell portance assumes a "too big t o fail" substantially till late 2001. Confidence was hazard, which, coupled with the lack of shaken by the BW Resources market lintervention authority and lack of protection scandal, involving alleged price ifrom litigation for those responsible for manipulation by brokers and allegations of jtroubled institution resolution, has too often political interference in the SEC's /resulted in resort to liquidity support from investigations. Domestic political tension, ithe central bank in lieu of adequate slower growth, and reduced corporate / resolution. earnings have also taken their toll. Average ! daily trading volumes fell to less than $10 12.104 The conglomerate structure is also a million, and market depth is limited. The !challenge to effective supervision, which is top 10 percent of companies account for complicated by a fragmented regulatory nearly 90 percent of trading volume. Net structure within the BSP and across the new listings have averaged only around five ~ndustry. Some transactions of the a year. Three international financial firms 'intermediaries are supervised by the SEC, have closed their securities and brokerage 'others by the Insurance Commission, and operations in the Philippines. The corporate still others by different supervisory units debt market in the Philippines has not /within the BSP. I n the latter case, shared in the growth in these markets after supervision is still conducted on the basis of 1997, as observed in countries such as the license type of the institution-EKBs, Malaysia and Thailand. This appears in part commercial banks, thrift, rural-even where the result of high taxes and fees these are part of the same conglomerate, discouraging trading. Lack of laws and Some rationalization will be necessary if regulations and absence of market consolidated supervision is to be effective.33 infrastructure have also deterred primary Overlaying the capacity for effective market issues and secondary market /supervision is the rigid depositor secrecy trading. ,legislation still operational in the /philippines. While aspects of secrecy are 2.107 Policy Environment. Enactment of 1 addressed in the recently passed anti- capital market reforms has been much money laundering legislation, the capacity slower than banking reforms. A revised / f o r supervisors t o assess funding Securities Regulation and Enforcement Act /concentration is still compromised. that would strengthen regulatory, disclosure ' Moreover, 1 the institutional structure renders and governance requirements for securities more serious weaknesses in transparency companies has languished in Congress since ' and information disclosure. 1 1997. Proposed changes to the Investment Companies Act have met a similar fate. I 32 In the case of Urban Bank, funding problems initially surfaced in the investment subsidiary. The bank was forced to provide liquidity to the affiliate and acquire its NPLs. The liquidity problem eventually overwhelmed the bank, prompting BSP inrervention. 33 Recent steps were taken to improve interagency collaboration wirh the formation of an Inter-Agency Committee. PHILIPPNES An Opporruhq fur Renewed Paverri Reductloll - ~ > ~ z - ~ . ~ ~ ~ P . n ~ < ~ *~ -~ ~ ~* ~ 4~ ~ ~~ ~~ ~~ ~~ ~ ~< ~ ~& ~ ~ v ~ - ~ - ~ ~ ~ ~ ~ ~ ~ ~ ~ * ~ ~ . ~ - ~ ~ ~ ~ ~ ~ * w ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ - - ~ ~ ~ * ~ ~ - ~ - 2.108 However, a new Securities Regulation (e) A Corporate Recovery Act, as discussed in 1 Code based on the proposed revised Securities Section 2C. i Act was adopted in July 2000. Under the law, ! the SEC is to be reorganized to focus on 2.111 Legislation to change documentary 1 securities market regulation, while its previous stamp taxes and facilitate the establishment of 1 quasi-judicial functions such as the resolution special purpose vehicles is already underj of intra-corporate disputes, suspension of preparation. j payments, and private damage actions are to i be removed and transferred to the courts. 2.112 Looking forward, the development of Implementing regulations have also been active equity and debt markets is likely to issued. Both the code and the implementing require complementary advances across a regulations adopt many of the practices broad front of reforms. These include the recommended by the International institutional reforms discussed in Section 2C Organization of Securities Commissions strengthening financial transparency, disclosure (IOSCO). The implementing regulations and corporate accounting and auditing enhance SEC's powers to provide additional standards; improving corporate governance; protection to investors, define prohibited and enhancing the legal provisions for and market practices, monitor and take action enforcement of shareholder protection, creditor against abusive market practices, promote self- rights, insolvency and corporate recovery. In regulation by market participants, manage addition, the independence and authority of systemic risks in the brokerage industry, and regulators of corporate debt and equity markets investigate and enforce disciplinary proceedings need to be at the same level as is accorded to against market participants. BSP for the banking industry. The proposed revised Securities Act needs to be passed by 2.109 I n addition, the PSE was demutualized Congress at an early date. I n addition, and reorganized as a stock corporation that is completing the initiatives suggested by the 100 percent owned by its 184 member-brokers. CMDC and others should be given high priority. At present, however, it is not clear if the PSE Collaboration with IOSCO and with international will be financially viable, since top Philippine credit agencies could be useful in ensuring that companies may find it easier to maximize laws and regulations are up to international shareholder value by listing in New York or standards from the outset. Thailand's Singapore. The credibility of the SEC and PSE experience in systematizing its domestic bond as regulators is likely to remain in doubt until market after 1997 could also prove useful. the stock fraud and manipulation case of BW Resources is fully prosecuted. Im roving access to financing for SMEs of these institutions in total deposits and an strengtheningmicrofinance B loans is small, and since they do not pose a ! systemic risk, the best approach at present 2.113 Small and microfirms constitute 99 may be to adopt only a light regulatory percent of registered firms in the touch (that would become more intensive as Philippines. For these firms, bank borrowing the institution becomes larger), with will remain the most realistic source of periodic surveillance to prevent fraud and external financing. However, banks typically abuse. At this point, it may be more place zero value on assets such as valuable to put greater focus on capacity inventories and accounts receivable for the building and training. purpose of collateral, though these are often the main tangible assets held by E. EMPOWER AND PROTECT THE SMEs. This problem could be addressed by POOR amending the Civil Code to facilitate floating charge instruments or general assignments 2.117 The MTPDP is right in highlighting the of accounts receivable and inventories. importance of human resource development, as experience around the 2.114 Farmers' access to credit could also world demonstrates that it is critical for be enhanced through a more systematic use sustained poverty reduction. Improved of warehouse warrant financing in the human capital needs to be a central building agriculture marketing chain. Warehouse block of Philippine efforts to achieve warrants are an easily tradable title to sustained poverty-reducing development. harvested crops that provide secure The acquisition of education within family collateral for bank lenders. Developing an units is highly correlated with escaping from effective system of warehouse financing poverty, and the strengthening of workplace requires establishing a proper framework skills in general is critical to the economy's for grading, sorting, warehouse standards, international competitiveness. Lessening bail-bonding, etc. Warehouse financing is a illness would reduce absences and dropouts common form of financing agriculture in at school and in the workplace. Moreover, most developed countries and it has been improvements in public education and successfully introduced in developing health services are critical to ensure access countries such as India, Uganda, and Chile. by the poor. And effective safety net It is already used to some extent in the provisions are important for the vulnerable. Philippines, and, as the government withdraws from directed credits, developing 2.118 Actually achieving the desired rate of a fully functioning warehouse warrant improvement in human resources, though, financing system could be a powerful has been elusive. Social sector instrument for expanding credit to farmers. performance in the Philippines can best be characterized as satisfactory on average but 2.115 A framework for encouraging inequitable. By international standards, the microfinance institutions has now been Philippines is classified as a medium established. The Monetary Board has performer in respect of the Human i ~ partially lifted the general moratorium on Development Index, a composite indicator the licensing of new thrift and rural banks to measuring health, education, and minimum allow the entry of microfinance-oriented basic needs. When the indicators are rural banks will also be eligible for some rediscounting with BSP. This is to encourage Visaya rural banks and cooperative rural banks to support microfinance activities by providing them additional liquidity to fund their lending operations. there should be uniform minimum standards for microfinance institutions and who should regulate them. Since the share Cambodia. Life expectancy ranges from only F 52 years in Tawi-Tawi to 7 1 years in a Pampanga, and elementary school p enrollment from 43 percent in Sulu to 99 a percent in the NCR.34 Poor families also p have significantly less access to health and education than well-off households. I n Educatio about 75 percent of households that are poor, the head of household has no more 2.121 than an elementary education. Infant mortality rates in the poorest quintile are twice as high as that of the richest q ~ i n t i l e . ~ ~ i n the budget (excluding IRA and debt percent of tot service) under the 1987 Constitution. The attributed to share of social expenditures in the national (both actual and local government budgets has reason for dr increased by about 25 percent and 100 percent, respectively, over the last decade. 2.122 Recent However, absolute levels of public curriculum, text expenditure on the social sectors remain and educational quite low and there has been a serious Education Sector shortage of cash t o cover non-personnel in all these aspects and made the following expenditures.36 Equally important, recommendations: intrasectoral allocations are inefficient and internal efficiency indicators are poor. For (a) unsatisfactory deployment of teachers example, the share of elementary education and poor training and preparation need to in total education has steadily decreased be addressed, distractions that limit actual from about 70 percent in the early 1990s to time spent on teaching removed, and about 60 percent in 2000, and public health incentives for good performance and for programs account for only about 20 percent serving in remote locations provided; of the Department of Health (DOH) budget. 1 Unit cost ratios for most public social (b) the primary curriculum is overcrowded services are higher than in the private and needs to be streamlined, while science sector, due t o weak expenditure and math instruction at the secondary level management. need t o be properly sequenced and t o stress problem-solving approaches; and 2.120 I n the recent Filipino Report Card on Pro-Poor service^,^' beneficiaries of public (c) textbook provision, which had fallen social services reported high utilization but precipitously and well below adequate low satisfaction with thes&.:services. standards, needs to be increased. According to this survey, 100 percent,of all I 2.123 The report also recommended the use of the vernacular, rather than English or / Filipino, as the medium of instruction in the Y O I ~ I I * L ~ L I L * s I U . . O " ~ " . * ~ m ~ m ~ m ~ ~ . ~ . e " ~ " * ~ ~ ~ ~ a ~ ~ * e ~ ~ ~ . * * ~ ~ ~ * ~ ~ e a * ~ first three grades of school and the strengthening of the national student 34 United Nations Development Programme, Philippines Human Dwelopment Report,2000. 35 World Bank, Philippines Poverty Assessment, 2000. 36 World Bank, Philippines SocialExpenditure Review, 1998, ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ - ~ 37World Bank, Fillpino Report Card on Pro-Poor Services. 2002. 38 World Bank and Asian Development Bank, 1998. \> assessment system so it can better serve as Health care a standard for measuring education effectiveness. Efforts to improve efficiency 2.126 Vital health indicators such as infant in resource allocation and service delivery in mortality rates, maternal mortality rates, the public education sector are essential to and life expectancy have improved attaining universal access to quality significantly in the Philippines in the past 20 education. years. However, the country has performed poorly when compared with its Southeast 2.124 In terms of structure and Asian neighbors. Moreover, the resurgence management, the Department of Education of some infectious diseases remains a is complex, due to its size and geographic threat and degenerative diseases are on the spread. Financial management is weak, rise.39 making it difficult to monitor the implementation of specific programs and 2.127 Public primary care health facilities ensure that resources are used as intended. are overwhelmingly used by the poor and Successive administrations, including the rural residents. But the quality of primary current one, have embarked on a variety of care is so poor that people frequently efforts to curtail mismanagement, but this bypass them and go directly to government appears to be a deeply-rooted problem that hospitals. Satisfaction with government will demand systematic and concentrated health services is low, particularly on attention from the highest levels of account of waiting time, lack of medicines, leadership in the sector. and poor facilities. Poor households spend much less than the rich on health care 2.125 For children in the poorest (about one tenth), suggesting that their households, extraordinary measures will be access is severely restricted by costs. required to ensure that they stay in school. Payments for health care by the poor are The fact that economic factors are the main almost entirely out of pocket, effectively reason for dropping out of school makes it limiting their use of adequate and quality imperative to reduce the economic burden care. of school attendance. The current [administration has taken a first step in this 2.128 The devolution of health services to direction by prohibiting the imposition of LGUs in 1991 was intended to make school fees in all public schools, and strict primary health care more responsive to enforcement of this policy should help local users. However, LGUs were reduce dropout rates. However, there will inadequately prepared to take over the continue to be families that will choose to responsibility, and DOH was ill-equipped to keep children out of school to help in play its new role as facilitator and regulator ousehold, farm, or other productive rather than as service provider. The result and these families could be offered was inefficient policy and allocation I help to compensate for the decisions. Secondary hospitals were badly c loss to them of sending the child affected as their financing was transferred I. Such programs must be designed to provincial governments that had little incentive to fund institutions located within city government jurisdictions. The effectiveness of the decentralized primary and secondary health care delivery system has also been compromised by the lack of coordination and cooperation among LGUs. Regulation of the quality and cost of health services and health products remains weak. Meanwhile, public resources for health remain below average by almost any indicator, and the funding that is available is inequitably spent. 39 DOH, Kepublic of the Philippines, National Objectives for Health, 1999-2004,1999 2.129 To address these problems, DOH has the poor with increased access to productive embarked on a Health Sector Reform Agenda assets. (HSRA) to introduce major organizational and policy changes and public investments t o 2.132 More generally, the simplification of improve the way health care is delivered, regulations advocated in section 2C, and the regulated, and financed.40 Five major areas of provision of small-scale and microfinance reform are proposed in the HSRA and discussed as part of section 2D, are important reaffirmed as the core strategy for enhancing for fostering small-scale enterprises. The highly health care in the MTPDP: concentrated nature of the Philippine economy, with large interconnected conglomerates (a) Provide fiscal autonomy to government dominating, together with the importance of hospitah, to reduce their dependence on direct SMEs as a source of employment growth, subsidies from the government. amplifies the importance of these initiatives. The opportunities for small-scale enterprises (b) Secure finding for priority public health must be improved by removing impediments programs, using multi-year budgeting to that needlessly prevent their becoming guarantee the needed continuity in resource competitive. This is not a matter of providing availability. explicit incentives for SMEs, but it does call for a review of regulations at the national and LGU (c) Promote the development of local health level to ensure that they do not unduly impede systems. SMEs. (d) Strengthen the capacity of health reguktory Social protection agencies, with special emphasis on the Bureau of Food and Drugs. 2.133 The Department of Social Welfare and Development's programs systematically target (e) Expand the coverage of the National Health poor, disadvantaged, and extremely vulnerable Insurance Program. populations, thus providing some measure of a safety net. But the need is great, and much Implementing this five-part reform program in more than the department can meet with its cooperation with local governmen would do much to improve health services, but agency's budget is alloc resource limitations will constrain the scope and Comprehensive and Integrated pace of reforms. Social Services, which aims to through services provided by lo 2.130 DOH estimates the cost of implementing governments and NGOs and empower the HSRA during the five-year period 2000- (needs assessment, program 2004 at PhP112 billion, or roughly PhP22.4 and monitoring by comm billion per year (US $2.1 billion for 5 years). I n programs could be scaled contrast, DOH'S budget allocation for 2000 was resources were available around P h P l l billion. Accordingly, DOH has responsible for the developed an implementation plan to introduce Childhood Development reforms in a phased manner in "convergence integrate child-oriented zones" around the country. education, and parent s community level, as we1 Ensuring access to other assets out to out-of-school youth. 2.131 While worldwide research indicates that the provision of access to basic education and health is central to long-term poverty reduction, access to productive assets and markets is also important. I n view of the fact that most of the poor are still in rural areas, the provision of improved farm-to-market roads, technical support, and land reform discussed as part of section 2C are an important part of providing .a*.. O L O ~ . " . Y I I ~ I O ~ ~ " ~ ~ ~ * ~ ~ s . ~ ~ ~ ~ . . " . ~ ~ * ~ . e a * ~ . . ~ " . ~ ~ . ~ * " m * ~ ~ , ~ * ~ ~ . ~ * . ~ ~ * 4 0 ~Republic of,rhe Philippines, Healrh Secror Refor ~ ~ Philippines 1999-2004, December 1999. * T ~ - ~ ~ w s , ~ - . ~ ~ - ~ ~ - - ~ ' ~ - 2.134 Support is also needed so the social bias to development," and calls for a "working poor" in the informal labor sector, population management program as part of who have little security of tenure and live on its fight against poverty. With population the borderline of poverty, can reduce their growth rates among the highest in East Asia vulnerability. These people need help with and the Pacific (2.1 percent in 1999, against job search and demand-oriented job a regional average of 1.1 percent), this training t o ease transition between jobs in clear statement is a welcome sign that the an unstable market. But these programs current administration is prepared to tackle cannot rely on government revenues for this important, but culturally sensitive, financing. They would benefit from stumbling block to growth with equity. government endorsement or sponsorship, DOH'S National Family Planning Policy and some degree of subsidization, but statement of September 17, 2001 has all limitations on government funding will mean the characteristics called for in the MTPDP. that these programs will inevitably rely It is based on sound reproductive health heavily on community and private sector strategies, presents a menu of family support. planning services, respects cultural and religious beliefs, and guarantees access to /Populationgrowth family planning services for the poor. Implementation of this policy with the full 12,135 The MTPDP refers to rapid population backing of the administration would fill a big igrowth as "a binding constraint to the gap in the country's program to reduce efforts of the administration in infusing a poverty. PROSPECTS ARE CONTINGENT ON ACTION And Contilzzled Support! 3.1 The Philippines' development potential resources. Precise sequencing of these reforms remains bright, as there are no impediments will largely be governed by what is that cannot be overcome and the country is administratively and politically feasible. Policy well endowed with resources, especially makers need to design and implement a human resources, the most critical of all. coordinated package of measures to reinforce Moreover, the government is committed to and accelerate progress through 2001 to addressing existing problems. But the facilitate the desired expansion in investment, ultimate fulfillment of this potential for more productivity and employment, and to broaden rapid poverty-reducing development depends participation in economic activity. heavily on the implementation of effective actions to address current impediments. With 3.4 Export markets are adversely affecting resolve to implement actions in the key areas short-term development prospects, but the discussed in the previous chapter, there would current downward pressure is likely to be be renewed rapid poverty reduction. Without short-lived and export growth will continue to such action, future poverty reduction would play an important role. With the continued be limited and disappointing. integration of East Asian as well as world markets, a substantial share of new A. ECONOMICDEVELOPMENT investment is likely to be in exporting PROSPECTS activities. This is especially true for foreign investment. 3.2 Specifically, the MTPDP growth scenario of over 5 percent per annum (see Table 3.1) is 3.5 Achieving growth of over 5 percent per achievable, but only if there is concerted annum would require a sharp rise in action along the lines discussed in Chapter 2. investment and productivity. Unless the Only with such action is it realistic to investment rate can be raised to the 23-25 anticipate a sharp departure from recent percent range of the mid-1990s, achieving trends in investment, employment creation, growth of over 5 percent will necessitate a growth, and poverty reduction. very sharp increase in productivity. Resources would need to be moved from relatively low- TABLE 3.1: MTPDP GROWTH SCENARIO productivity activities such as subsistence (% P.A.) agriculture to higher-productivity off-farm activities at higher rates than was achieved in the early to mid 1990s. 3.6 Financing this needed rise in investment necessitates a commensurate rise in savings. As much as possible, this needs to be mobilized domestically with a rise in public sector savings complemented by a rise in private savings. But the rise in public savings will be limited by the need to concurrently Figures are mid-point estimates ofMTPDPprojections. increase social expenditures. Renewed inflows I/ Eiports and Imports of Goohand Services. of foreign financing will be needed to help Source: NEDA; MTPDP. finance this growth (see Table 3.2). While 3.3 Renewed investment and increased commercial bond spreads have fallen by over productivity will be critical, so sound 200 basis points in the last year, they remain confidence-building macro management will high by historical standards and still impede be vital. But so will governance the objective of reducing public debt. This improvements, structural reforms to calls for an acceleration of reforms, to facilitate strengthen private sector development, both a further lowering of commercial spreads infrastructure improvements, financial sector and to increase access to balance-of-payments strengthening, and investments in human support from official sources. ---,-~<.*-=*--*~~,r--,~-~r--~-T*<-- ' I vulnerable to commodity price changes than TABLE 3a2 MTPDP BALANCEOF PAYMENT that of many other developing countries, as ($ BILLION) commodities comprise a small share of exports. On the import side, the recent reduction in oil prices, if maintained, will be of benefit, as oil constitutes some 10 percent of merchandise imports. A one-dollar change in the price of oil results in a change of about $120 million in the import bill. Furthermore, new natural gas exports will provide a boost. 3.11 World economic prospects for 2002 are for recovery to begin during the second half I/ Exports and Impom of Good Source: MTPDP. of the year and for US growth of 3 percent per annum by the end of the year. Positive 3.7 Risks and Opportunities. The most influences include bottoming out of the conspicuous risk arises from the possibility of inventory cycle, low energy prices easing, the insufficiently aggressive policy and significant fall in interest rates and the institutional reform. Hence it is within the anticipated effects of a fiscal stimulus. The national capacity to address this risk. Without firming of global production should translate reforms to improve governance, strengthen into growth in the Philippines' export market competition, and rebuild confidence, of about 9 percent by 2003. investment will continue to languish and economic growth is likely to remain little 3.12 The semiconductor cycle that is so higher than population growth. I n such a important to Philippine exports is now situation, the low investment and growth showing signs of bottoming out, with positive path would be self-perpetuating, due to growth in worldwide sales in October. The key persistent social tension and a continued lack question will be the strength of the rebound. of business confidence. The fact that the It seems likely that the sector will witness government is committed to reforms lessens more subdued growth than in the 1990s, this risk. National support from outside the because the market is more mature, with government, together with support from high penetration of computers, the Internet, international development partners, lessens and cellular phones in the industrial this risk further by helping to ensure that economies and in many of the upper-middle there is support to implement reforms. income countries. Thus growth in the market will rely more on replacement rather than 3.8 The persistent absence of peace and penetration, unless new products security, particularly in the south, is a second revolutionize the market again. But there are risk to the attainment of potential still wide differences in market penetration, development. This clearly limits both the and there are huge markets to be fulfilled rebuilding of confidence and investment, and among emerging economies such as China efforts to achieve broad participation in and India. development. 3.13 Two particular external trade factors are 3.9 I n addition, there are a number of the entry of China into the WTO and exogenous risks. These include a protracted continued integration within ASEAN. Both will downturn in the global economy, adverse increase competitive pressure for Philippine interest rate movements, or greater risk producers, but will also expand potential aversion in capital markets. The Philippines' export markets. Their net effect will depend large medium-term external financing on how well Philippine firms rise to the export requirements and open economy make it challenge, and on the attractiveness of the particularly susceptible to such external risks. Philippines as a destination for export- fz! oriented FDI. 13.10 By contrast, the current account is less 3.14 Weak global conditions, in particular the 3.18 I n contrast, if softening of the US labor market and the percent, the rate of p slowing of world trade,41 are likely to delay be modest. By 2005, t with the expected return of world economic percent of the population (Scenario I1 in1 growth in 2003, renewed growth in these Table 3.3). I n this case, there would be little/ transfers seems likely. change in the number of poor people.! Moreover, without the needed resocrces for1I 3.15 With much lower interest rates in targeted poverty-focused programs,' i international markets and a compression of inequality could increase, and poverty levels1 spreads, the Philippines should be able to could indeed rise. A moderate increase in! mobilize substantial external financing in the Gini indices within the three main economic1 immediate term. The January 2002 issuance sectors (2 percent annually) could not only! of a $750 million bond reflects this. The wipe out all poverty reduction, it could1 feared contagion from problems in Argentina increase the incidence of poverty to about 281 and Turkey has not materialized. percent and the number of poor to nearly 251 Complementing this renewed flow of private million by 2005 (Scenario I11in Table 3.3). i lending with a concurrent rise in equity I investment/FDI will also be required to TABLE 3.3 POVERTY PROJECTIONS 1 support higher growth. UNDERALTERNATIVE SCENARIOS '; 3.16 The possibility that several of the above risk factors may occur together cannot be ruled out, as indeed several are correlated. The best response to mitigate the adverse impact on the economy of such risks is to press ahead with an aggressive package of structural reforms and fiscal deficit reduction, while maintaining the present flexible monetary and exchange rate policy stances. B. POVERTYREDUCTION PROSPECTS 3.17 The prospects for poverty reduction depend critically on the attainment of the targeted higher economic growth and the broadening of participation to increase equity. Real economic growth of 5 percent ScenarioI is based on MTPDP growth rates as in Table 3.1. per annum, on a sustained basis, would ScenarioIlassumes lower growth rates (3 percent insteadof 5 reduce poverty significantly. Projections percentin overallGDP). Scenario111has the same growth rates based on household survey data indicate a as scenarioIl,but additionallyassumes the Gini indices within reduction in poverty from 26 percent of the each sector increase by 2% annually during 2000-05 population in 2000 to 18 percent by 2005 Source: Stafestimates. (Scenario I in Table 3.3). Correspondingly, the number of poor could be expected to C. THE IMPORTANCE OF decline by about 5 million, from 20.4 million DONOR SUPPORT to 15.6 million. I f this economic growth is i combined with complementary programs to 3.19 International development partner!I improve equity (e.g., effective human support is needed in two principal areas-/ resource investments and actions to improve resources to help sustain critical publicj access by the poor to productive assets and expenditures while domestic revenues are/ markets), poverty could be reduced even being rebuilt, and technical assistance to help I more rapidly. implement effective policy and institutionall reforms. The need for overseas development/ ~ s a ~ * e * ~ a ~ e * ~ ~ ~ a ~ . ~ ~ ~ ~ * * ~ * e * " , ~ * * ~ ~ ~ * * m ~ ~ ~ * ~ * ~ * b ~ ~ * ~ ~ ~ ~ ~ ~ ~ e m ~ m ~ ~ ~ * * s assistance (ODA) .financing over the next! / 41 The US is rhe slngle largest source of worker remittances, at around $3 billion per year, while seamen contr~buteroughly $800 couple of years is quite large because of the million per year. i --- 4 /combination of the fiscal deficit and rising or more of this required $5.7 billion financing !debt service. I f policy makers deliver sound come from ODA sources. Given the /implementation of a sound reform program, government's commitment to reducing the l it is vital that international development fiscal deficit over the coming years to achieve /partners respond with appropriate financial a balanced budget by 2006, the need for and technical assistance. Anything less ODA financing will fall over the next few would hamper the nation in its pursuit of years. poverty reduction. 3.23 The form of this assistance is also 3.20 Government financing. I n 2002, the important. Increasing the share of program Philippines' financing requirements will be lending in overall donor assistance for the idriven primarily by the needs of the next couple of years would assist the /government, rather than the balance of government in its efforts to maintain i payments. The government's financing need strategic expenditures while implementing 1 is a combination of the fiscal deficit and its policy and institutional reforms. It is /amortization obligations. The amount of ODA suggested that donors make every effort to /needed also depends on how much of this increase the share of program support at this 1 overall need can be met from domestic and time, in an effort to jointly provide about half jother international capital markets. To of this needed ODA assistance in the form of /facilitate a recovery in private sector fast-disbursing budgetary support. :investment, it will be important to avoid /excessive government borrowing. And to 3.24 For its part, the government needs to I keep near-term debt service obligations to a ensure that the implementation of policy 1 manageable level, it is important that a reforms keeps the public expenditure /substantial proportion of this need be met program on track so that public resources 1 through medium- and long-term financing. reach their targeted beneficiaries, and that I steps are taken to increase public revenues j 3.21 Even though the government managed as quickly as possible. Joint actions are also 1 to contain the budget deficit in 2001, its high needed to increase disbursements from the 1 level,together with amortization payments, existing ODA portfolio from their current low !created a need for about $5.0 billion in new level. /borrowings. I n 2002, the government is /committed to a reduction in the fiscal deficit, 3.25 As efforts to increase domestic revenue 1 but this is more than offset by a rise in begin to yield results and the fiscal deficit 1 amortization payments. As a result, the total contracts in 2003 and beyond, the share of /financing needs of the national government fast-disbursing "program support" in overall 1 are expected to rise to about $5.7 billion assistance can shrink again. But for this I finance to have maximum development 13.22 The Philippines has managed in recent impact, it would need to be guided by well- 1 years to mobilize a substantial share of designed sectoral strategies prepared by the Igovernment financing needed from domestic government in consultation with all /sources. I n addition, it has been able to stakeholders (including international 1 mobilize resources from private external development partners) and with civil society. j sources. However, external commercial 1 financing carries higher inter-et rates and 3.26 Technical Assistance. Given the be for shorter terms than official ambitious program of policy and institutional el thus leaving government finances reforms needed to achieve the targeted to rollover risk. Increased donor increase in development outcomes, there t this time would assist the will be a need for much technical assistance. to sustain strategic poverty- 'This includes support for efforts to improve hile taking action to governance, reform the judiciary, increase finances remain public resource mobilization at both the the MTPDP, it is national and local government level, ts of $1.5 billion improve public expenditure and financial management, manage fiscal risks, winning the war against poverty will require strengthen the financial sector, improve time and a sustained effort to generate a infrastructure, modernize agriculture, and higher growth path with broad participation hasten development in post-conflict parts of to increase equity. This necessitates ............................. Mindanao. sustained policy and institutional reforms along the lines outlined in this review. 3.27 Commitment from national leadership coupled with 2001 achievements suggests that the potential for rapid and sustained poverty reduction in the Philippines is attainable. Fortuitous circumstances could yield higher growth for a year or two. But List ofTables and Appendices TABLES Table 1: National Accounts. 1995-2001............................................................... 50 Table 2: Consolidated Public Sector Financial Position. 1995-2000 ..........................51 Table 3: Outstanding Public Sector Debt. 1995-2000 ............................................ 52 Table 4: National Government Cash Operations. 1995-2000 ...................................53 Table 5: Monetary Survey. 1995-2000 ................................................................ 54 Table 6: Exchange Rates. Inflation and Selected Interest Rates. 1998-2001..............54 Table 7: Balance of Payments. 1995-2000 ........................................................... 55 Table 8: Exports and Imports by Major Commodity Group. 1995-2000 ....................56 Table 9: External Debt. 1995-2000..................................................................... 57 Table 10: Loans Outstanding of Commercial Banks. 1995-2000 .............................. 58 Table 11: Labor Market Developments. 1995-2000 ............................................... 58 APPENDICES Appendix 2.1. Report On the Observance of Standards and Codes on Accountancy ...59 Appendix 2.2: Report On the Observance of Standards and Codes on Corporate Governance Reforms .................................................................... 60 GDP at market prices 4.8 5.7 5.2 -0.5 3.4 4.0 Agriculture 0.8 3.8 2.9 -6.6 6.5 3.3 Industry 7.0 6.2 6.1 -1.9 0.9 3.9 Mining and quarrying -0.8 -4.8 1.7 2.8 -8.4 10.0 Manufacturing 6.8 5.6 4.2 -1.1 1.6 5.6 Services 5.0 6.4 5.5 3.5 4.0 4.4 Imports of GNFS 16.0 16.7 13.5 -14.7 -2.8 4.0 Exports of GNFS 12.0 15.4 17.2 -21.0 3.6 17.7 Total consumption Public Private Gross do mestic investment Fixed Capital Construction Durable Equipment Breeding Stock & Orchard Development 8.5 0.2 1.2 Gross national product 5.3 0.1 3.7 (as percentage of GNP) GDP at market prices 96.0 95.2 94.9 Net Indirect Taxes 9.3 8.1 7.6 Indirect taxes 9.7 8.3 7.8 Subsidies 0.5 0.2 0.2 GDP at factor cost 86.7 87.1 87.4 Agriculture 17.9 16.1 16.3 Industry 30.9 30.0 29.1 Mining and quarrying 0.7 0.7 0.6 Manufacturing 21.4 20.8 20.5 Services 47.1 49.1 49.6 Imports of GNFS 57.0 55.9 48.7 Exports of GNFS 47.1 49.6 48.9 Total Consumption 82.5 83.3 81.3 Public 12.7 12.7 12.4 Private 69.8 70.7 68.9 Statistical discrepancy -0.5 -1.2 -4.4 Gross domestic investment 23.9 19.4 17.8 Fixed Capital 23.5 20.1 18.1 Construction 10.7 9.6 8.8 Durable Equipment 11.3 9.1 8.0 Breeding Stock & Orchard Development Changes in stocks Net factor income GNP (billion ~esosl 1,959 2,283 2,523 2,802 3,136 - - GDP = gross domesticproduct;GNFS =goodsand nonhctor services;GNP = gross national product. Source: National Statistical Coordination Board I Table 2: ConsolidatedPublicSector Financial Position, 1995 2000 - (in billion pesos) 1995 1996 1997 1998 1999 2000 National Government (NG) 11.1 6.3 1.6 -50.0 -111.7 -134.2 Monitored GOCCs -1.3 -11.2 -17.2 -38.0 -4.6 -19.2 Central Bank Restructuring -20.0 -13.8 -25.7 -26.4 -20.5 -19.1 Oil Price Stabilization Fund (OPSF) a -9.2 4.8 -0.8 0.7 1.9 0.3 Adjustment to GOCCS 2.8 1.5 2.5 0.9 3.0 4.2 Other Adjustments 0.0 0.0 0.0 1.5 -6.1 -6.6 Public Sector Borrowing Requirement (PSBR) -16.7 -12.4 -39.6 -111.3 -138.0 -174.6 SSSIGSISIPHIC 0.0 8.5 3.9 17.8 36.4 15.5 Bangko Sentral ng Pilipinas 3.6 -2.3 2.2 3.2 -4.0 0.2 Government Financial Institutions 5.0 8.4 4.3 5.4 3.3 2.8 Local Go vernment Units 1.9 5.7 4.2 2.0 3.2 3.8 Time Adj. of Interest Paymenh to BSP 1.5 -0.7 2.3 -0.3 -2.3 0.5 Other Adjustments 0.6 0.0 0.0 0.0 0.8 0.1 / Consolidated Public Sector (CPS) -4.0 7.3 -22.7 -83.2 -100.5 -145.1 I (in percent of GNP) 1995 1996 1997 1998 1999 2000 - National Government Monitored GOCCs Central Bank Restructuring OPSF a Adjustment to GOCCs Other AdjustmentsC Public Sector Borrowing Requirement (PSBR) -0.8 -0.5 -1.6 -4.0 -4.4 -5.0 1 SSSIGSIS 0.0 0.4 0.2 0.6 1.2 0.4 Bangko Sentrai ng Pilipinas 0.2 -0.1 0.1 0.1 -0.1 0.0 Government Financial Institutions 0.3 0.4 0.2 0.2 0.1 0.1 Local Government Unih 0.1 0.3 0.2 0.1 0.1 0.1 Time Adi. of Interest Pavmenh to BSP 0.1 0.0 0.1 0.0 -0.1 0.0 Consolidated Public Sector (CPS) -0.2 0.3 -0.9 -3.0 -3.2 -4.2 ineHealth InsuranceCorporation;BSP = Bangko oration;PNB = Philippine National Bank ,andadjustmentsforPNOCshareofOPSFbalance. transfersto NG, NG transfersto PNOCand PNB transfersto NG. ,reconciliationofcashaccountswithbankdataandothmadjusunenu. National Government (NG) 2A/ 1,326 1,332 1,624 1,800 2,142 National Government 281 1,103 1,107 1,283 1,421 1,693 Domestic 2/ 725 748 757 860 987 External 3/ 601 584 867 941 1,156 (US$ billion) 22.9 22.2 21.7 24.1 28.7 14 Monitored GOCCs 4/ Domestic External (US$ billion) Central Bank/CBBOL 5/ Domestic External (US$ billion) Bangko Sentral (BSP)5/ Domestic External (US$ billion) Government Financial Institutions (GFIs) 384 268 350 397 475 Domestic 344 221 275 328 380 External 41 46 75 69 95 (US$ billion) 1.6 1.8 1.9 1.8 2.4 Less: GOCC Debt Onlent or Guaranteed by NG 6/ 222 225 341 379 450 Domestic 6 6 8 9 8 External 216 218 333 371 441 (US$ billion) 8.2 8.3 8.3 9.5 10.9 MEMORANDUM ITEMS Exchange Rate (P/US$l) End of Period 26.21 26.29 39.98 39.09 40.31 Average 25.71 26.22 29.97 40.89 39.09 NG Debt Stock/GNP (%) 2B/ 56.3 49.0 50.9 50.9 54.0 NG Domestic Debt (%) 2B/ 36.7 32.8 29.7 30.5 31.2 NG External Debt (%) 281 19.6 16.2 21.1 20.4 22.8 Public Sector Debt Stock/GNP 1/ (%) 110.7 98.9 105.8 105.6 116.9 Public Sector Domestic Debt 1/ (%) 74.2 66.5 62.9 61.6 70.0 Public Sector External Debt 1/ (%) 36.4 32.5 42.9 44.0 46.9 Nonfinancial Public Sector 7/ (Pbn) 1,529 1,638 2,017 2,167 2,698 O hof GNP 78.1 72.4 79.9 77.6 86.0 GOCC = government-owned and operated corporation;CB-BOL = Central BankBoard of Liquidators;pbn = pesos per billion. 11IncludesNationalGovernment,14 monitored GOCC, CBICB-BOLIBSPand GFIs. 21Includes direct, assumed and contingent liabilities. 2.41 Includes direct, assumed and contingent liahilities. 2Bl Exdudes onlentand contingzndguaranteedliabilitieswhich have not beenassumed. 31Includesdirect,guaranteed and assumed liabilities. 41 Includes borrowings relendguaranteed by NG. 51 Liabilitiesless currencyissue and intergovernmentaccounts. 61Includesrelent,guaranteedand contingent liabilities. 71Includes NG debt, 2B1, 14 monitored GOCCsand CB-BOL. Source: DOE Table 4: National Government Cash Operations, 1995-2000 (inbillion pesos) -- -- 1995 1996 1997 1998 1999 Total Revenue Tax Revenue Bureau of Internal Revenue Bureau of Customs Other OfFices Nontax Revenue Total Expenditure Current Expenditure Personnel Services Maintenance and Operations Subsidies Allotment to LGUs Interest Payments Tax Expenditures Capital Expenditure and Net Lending 73 76 99 84 119 110 Capital Expenditure 64 70 94 83 114 107 Infrastructure and Other Capital Outlays 53 58 79 65 97 87 Transfers to LGUs 12 12 15 18 18 20 Equity and Net Lending 8 3 6 1 5 3 CARP Land Acquisition and Credit 0 3 0 0 0 2 0 0 0 0 0 0 Overall Surplus/Deficit 11 6 2 -50 -112 -136 0 0 0 0 0 0 Financing -11 -6 -27 89 182 198 =ComprehensiveAgricultural ReformProgram;LGU=local governmentunit; Table 5: MonetarySurvey, 1995-2000 1995 1996 1997 1998 1999 2000 (in billions of pesos; end of period) Total Liquidity 786 914 1,174 1,219 1,431 1,493 Broad Money (M3) 761 881 1,066 1,145 1,365 1,427 Other Liabilities 25 33 108 75 66 66 Net Foreign Assets O/W Central Bank Deposit Money Banks 11 Net Domestic Assets 1,197 1,685 1,670 1,761 Net Domestic Credit 1,508 1,932 1,869 1,920 Public Sector 377 477 460 529 Private Sector 1,131 1,455 1,409 1,391 Other Items (net) -311 -247 -199 -160 Foreign Currency Deposits, residents -318 -433 -478 -522 (annual percentage change; end of period) Broad Money 15.8 20.9 7.4 19.3 Net Domestic Assets 39.1 48.2 -3.8 5.5 Private Sector Credit 51.0 28.7 -3.1 -1.3 (in percent of GNP) Broad Money 38.6 42.3 41.0 43.5 Net Foreign Assets 3.1 -3.0 5.0 10.5 Net Domestic Assets 52.4 66.8 59.8 56.1 Private Sector Credit 38.2 49.5 57.7 50.4 44.3 43.2 11revised ro redasslfy accounts of residents from foreign accounr5 to domestic . Source:BangkoSenna1 ng Pilipincu (ESP). Table 6: Exchange Rates, Inflation and Selected Interest Rates, 1998-2001 Exchange Rates: Period Average (Pesos/$) 40.9 39.1 44.2 49.2 50.7 52.2 51.6 End of Period (Pesos/$) 39.1 40.3 50.0 49.4 52.4 51.4 51.2 Real Effective (Dec 1980=100) 72.0 70.3 66.9 70.2 68.3 65.1 61.5 Inflation: CPI (1994=100) Year change ( O h ) Interest Rates: (average) (end of period) Manila Reference Rates: All Maturities 15.4 10.4 9.4 10.8 9.1 9.8 9.9 Bank Lending Rate (all maturities) 18.4 11.8 10.9 12.2 11.1 12.2 13.0 llme Deposits: Short-Term ( c 1yr) 12.7 9.1 8.0 9.4 8.4 8.0 10.2 Long-term ( > 1yr) 13.2 12.8 10.5 11.5 10.5 10.5 10.6 91-day Treasury Bill Rate 15.3 10.2 9.9 9.7 8.8 9.5 8.9 Reverse Repurchase Rate (Term) 14.3 9.8 10.2 10.6 9.1 9.1 8.1 Repurchase Rate (Term) 15.8 14.5 14.4 13.2 11.4 11.3 10.3 Interbank Call Loan Rate 13.8 10.8 10.6 10.6 9.1 9.2 8.9 CPI = Consumer PriceIndex. Sources: SelectedPhil+pine Economic Indicators (SPEI)-BSP;NatiomlStatktics W c e(NSO). Table7: Balance of Payments, 1995-2000 (inbillionsof US$) 1995 1996 1997 1998 1999 2000 Trade balance % of GNP Exports (fob) Imports (fob) Services (net) 4.8 6.8 5.7 1.1 2.4 2.0 Receipts 14.4 19.0 22.8 13.9 2.9 12.0 o/w OFW remittances 3.9 4.3 5.7 4.9 6.8 6.1 Payments 9.6 12.2 17.1 12.8 10.5 9.9 o/w Interest 2.2 2.2 2.6 2.3 2.5 2.7 / Transfers (net) 0.9 0.6 1.1 0.4 0.5 0.4 Current Account Balance % of GNP Foreign investment (net) Direct Investment Portfolio Investment MLT borrowing (net) Inflows Outflows ' Short-term Capital (net) Trading in bonds in secondary market Changes in Commercial Banks' NFA 0.6 4.2 1.2 -1.3 -1.8 -2.4 (- indicates increase) Errors and Omissions Others /a I 1 Changes in net reserves /b -0.6 -4.1 3.4 -1.4 3.8 0.4 (-indicates increase) GNP = gross national ~roduct;OFW= Overseas Filipino Worker;fob 4 h e on boaod;MtT =medium Table 8: Exports and Imports byMajor Commodity (in billionsofUS$) Coconut Products 1.0 0.7 0.8 0.8 Sugar and Products 0.1 0.1 0.1 0.1 Fruits and Vegetables 0.5 0.5 0.5 0.4 Other Agm-Based Products 0.6 0.5 0.5 0.5 Forest Products 0.0 0.0 0.0 0.0 Mineral Products 0.9 0.8 0.8 0.6 0.6 0.7 Petroleum Products 0.2 0.3 0.2 0.1 0.2 0.4 Manufactures 13.9 17.1 21.5 25.8 31.3 34.0 O.W. Elect. & Elect. Equipments 7.4 10.0 13.0 17.1 21.2 22.2 Garments 2.6 2.4 2.3 2.4 2.3 2.6 Others 0.4 0.5 0.8 1.1 1.4 0.5 Total Expo* 17.4 20.5 25.2' 29.5 35.0 37.3 Imports 1995 1996 1997 1998 1999 2000 Capital Goods Raw Materials & Intermediate Goods Mineral Fuels and Lubricants Consumer Goods Durable Non-durable Others Total Imports Some: BSP. Table 9: External Debt, 1995-2000~' (in billions of US$) By Type of Debt Medium- and Long-Term 21 Short-Term Trade Nontrade By Borrower Banking System 31 Bangko Sentral ng Pilipinas (BSP) Commercial Banks Public and Private Public Private By Creditor Commercial Banks Other Financial Institutions Suppliers' Credits Multilateral o/w IBRD AD6 IMF Bilateral Export Agencies Others Others Memo Items: Debt service 41 5.0 5.0 5.6 5.1 6.2 6.2 Debt service/ Exports of Goods and Services 15.8 12.7 11.6 11.7 13.4 12.6 Total external debt / GNP (YO) 51.7 48.6 53.1 70.0 64.7 65.6 1 Total external debt / EXPO& (%) 123.7 105.9 94.5 110.1 149.0 136.7 IBRD = International Bank for Reconstmaionand Oewlopment; ADB = Asian Develo~mentBank; IMP = International Monetary Fund; GNP = gross national product. 11 Excludesliabilities of foreign banks in the Philippinesto their headquarters, branches, and agencies, some external debt not regimeredwith BSP, and private capitallease arrangements. 21 Includes cumulativeforeign exchange revaluation of US$-denominated multi-currency loans from the World Bank and Asian Development Bank of $433 million and $384 million,respectively, for end-1991. Table 10: Loans Outstanding of Commercial Banks, 1995- ECONOMIC ACTIVITY Growth rates (% on year earlier) Agriculture, fisheries, & forestry Mining and quarrying Manufacturing Electricity, gas & water Construction Wholesale & retail trade Transportation, storage & communication Fin. inst., real estate & business services Community, Social & Personal services TOTAL Share of Total Loans (010) Agriculture, fisheries, & forestry Mining and quarrying Manufacturing Electricity, gas & water Construction Wholesale & retail trade Transportation, storage & communication Fin. inst., real estate & business services Community, Social & Personal services TOTAL Source: BSP. Table 11: Labor Market Developments, 1995-2000 1995 1996 1997 1998 1999 2000 (in thousands of persons) Population 70,267 71,899 73,527 75,138 76,792 78,289 Total Labor Force 28,380 29,733 30,354 31,054 32,081 31,829 Unemployed 2,704 2,546 2,640 3,144 3,102 3,542 Unemployment Rate (%) 9.5 8.6 8.7 10.1 9.7 11.1 Total Employed 25,676 27,187 27,716 27,912 28,980 28,287 Agriculture 11,147 11,645 11,314 10,933 11,624 10,736 Industry 4,139 4,430 4,631 4,583 4,533 4,472 Mining and Quarrying 100 113 130 120 100 110 Manufacturing 2,696 2,696 2,732 2,716 2,746 2,737 Construction 1,230 1,504 1,637 1,605 1,543 1,501 Utilities 114 118 132 142 144 124 Services 10,392 11,112 11,771 12,389 12,823 13,079 Transport and Communications 1,487 1,631 1,742 1,849 1,942 2,009 Trade 3,790 4,013 4,138 4,312 4,500 4,588 Finance 534 615 688 672 720 713 Government Services 4,569 4,850 5,196 5,555 5,654 5,762 Other 12 4 6 6 8 7 (in percent of total employment) Total Employed 100 100 100 100 100 100 Agriculture 43.4 42.8 40.8 39.2 40.1 37.0 Industry 16.1 16.3 16.7 16.4 15.6 15.4 Mining and Quarrying 0.4 0.4 0.5 0.4 0.3 0.4 Manufacturing 10.5 9.9 9.9 9.7 9.5 9.4 Construction 4.8 5.5 5.9 5.8 5.3 5.2 Utilities 0.4 0.4 0.5 0.5 0.5 0.4 Services 40.5 40.9 42.5 44.4 44.2 45.1 Trans~ortand Communications 5.8 6.0 6.3 6.6 6.7 6.9 ~ r a d e ' Finance Government Services Other Sources: Department of labor and Employment -Bureau of Labor and Employment Statistics (BLES); Statistical Yearbook forpopukztionf;gures). Appendix2.1: Report On the Observance of StandardsandCodeson Accountancy A recent report on the observance of standards and codes (ROSC) on accountancy in the Philippines contained a number of recommendations aimed at improving the quality of corporate financial statements. The following recommendations were included. (i) Amend the 1975 Revised Accountancy Law and the Professional Regulation Commission (PRC) Act of 2000 to strengthen the Board of Accountancyis (BOA) capacity to license and regulate the accounting profession, while delegating some of its duties and responsibilities to the Philippine Institute of Chartered Professional Accountants (PICPA). (ii) Strengthen the enforcement capacity of the Securities and Exchange Commission (SEC) and the Bangko Sentral ng Pilipinas (BSP). (iii) Strengthen coordination among BOA/PRC, the Commission on Higher Education, SEC, BSP, and the Bureau of Internal Revenue leading to dissemination (a) of laws, rules, regulations, standards and guidelines affecting the practice of accountancy, and (b) of a master list of all certified public accountants (CPAs). Also, arrangements are needed for immediately informing BOA/PRC when any of the regulatory bodies detect infractions by CPAs. (iv) Adopt in full international standards in accounting (IAS) and auditing (ISAs), without any modification or adaptation. Improve competence of auditors by (a) requiring practical experience before issuance Appendix 2.2: Report On the Observance of Standards Corporate Governance Reforms A report on the observance of standards and codes (ROSC) governance was recently completed and contained a number strengthen corporate governance. These focused on disclosure of the rights of minority shareholders, the role of the board of direct the audit, and the strengthening the powers of the Securities an (SEC) and the Philippine Stock Exchange (PSE) to enfo is reco companies in the Philippines be encouraged to adopt internationa corporate governance. I n particular they would voluntarily agree to: (i) Disclose on a publicly available Internet site the beneficial ownership of in excess of 5 percent. (ii) Empower their minority shareholders to (a) convene a meeting without having to petition the regulator; (b) put items on the agenda; (c) review provisions governing the duties of the majority shareholder towards the minority; (d) limit voting rights on matters where the majority has a conflict of interest; (e) review the minimum free float for listed companies to ensure that it is sufficient to provide special voting protection for minority shareholders; (f) vote by mail; (g) establish an association or institution dedicated to the protection of minority shareholder rights; and (h) obtain from fiduciary investors, such as pension funds, a clear disclosure of their policy on corporate governance and a commitment to exercise their voting rights in the sole interests of the beneficiaries. (iii) Strengthen the mechanisms by which boards of directors govern the affairs of companies, while putting in place or strengthening provisions to (a) prohibit self- dealing by directors and conflicts of interest; (b) permit shareholders to assess the independence of directors; (c) require disclosure of board practices on corporate governance benchmarked against international best practices and explanation of any variances; (d) establish minimum qualifications for outside directors; (e) ensure that directors have a full understanding of their duties and liabilities; and (f) require directors to review and sign off on the auditoris long form report. (iv) Require with respect to the audit that (a) auditors disclose all personal or business relationships, past or current, between the audit firm, its partners, the company, its directors and all related parties; (b) auditors disclose all audit and nonaudit fees paid to the audit firm by the company and its related parties; (c) independence of the audit is maintained by rotating the audit partner or auditing firms; (d) internal and external audit committees be established and that independent directors constitute the majority of their membership, with members requiring training to ensure financial numeracy. PHILlPPINWAn Opporruoltyfor dentwed poverty Reductlo" --. I Appendix 2.3: Restrictions on Foreign Investment /The Philippines maintains two lists restricting foreign investments. Some of the main 1 activities/sectors where foreign investment is restricted areas follows: I 1 E L r e i g n equity Mass media, except recording Engineering services, medical and allied professions, accounting, and other professional services. Retail trade enterprises with paid-up capital of less than $ 2.5 million Cooperatives 1 Small-scale mining Utilization of marine resources in archipelagic waters, territorial sea, and the exclusive economic zone Up to Twenty-Five Percent (25%) Foreign Equity Private recruitment, whether for local or overseas employment Contracts for construction and repair of locally funded public works, except infrastructure/development projects and projects that are foreign-funded or assisted and required to undergo international competitive bidding Up to Thirty Percent (30%) Foreign Equity Advertising Up to Forty Percent (40%) Foreign Equity Exploration, development, and utilization of natural resources Ownership of private lands Operation and management of public utilities Ownership/establishment and administration of educational institutions Rice and corn industry Contracts for the supply of materials, goods, and commodities to a government-owned or-controlled corporation, company, agency, or municipal corporation Project proponent and facility operator of a BOT project requiring a public utilities franchise Operation of deep-sea commercial fishing vessels Ownership of condominiums Up to Sixty Percent (60%) Foreign Equity Financing companies regulated by the Securities and Exchange Commission (SEC) Investment houses regulated by the SEC Retail trade enterprises with a minimum paid-up capital of $2.5 million, but less than $7.5 million I List 6: Foreign Ownership is Limited for Reasons of Security, Defense, Risk to Health and Morals, and Protection of Small and Medium-Scale Enterprises steam bath houses, massage clinics, and other similar activities regulated by e of risks they impose to public health and morals s of gambling, e.g., race track operation arket enterprises with paid-in equity capital of less than the equivalent of rket enterprises with paid-in equity capital of less than the equivalent of that involve advanced technology or employ at least fifty (50) direct - P - e - a - - e n - m P - - m - - - - * The water sector faces substantial service deficits. Reform should address two private participation in infrastructure (PPI) policies. First, there should be a shift in emphasis from build-operate-transfer (BOT) projects to privatization of existing assets. Although BOT projects being pursued outside Metro Manila will enhance supply capacity, they fail to address fundamental problems such as inadequate investment; inefficient operations; and deficiencies in maintenance, management of the distribution system, billings, and collection. Privatization of existing assets addresses these issues while removing the gap between bulk and retail tariffs. Second, the government should move toward transparent and Water solicited bidding, t o ameliorate the present problem of too many unsolicited bids tying up the sector. There is also a need to reassess the role of the League of Water Utilities Administration (LWUAs) and other agencies in the sector. I n the long run, it is best to separate regulatory, policy, and operational functions of government agencies (e.g., LWUA, National Water Resources Board, Manila Water and Sewerage System, and Subic Bay Management Authority, and t o establish an independent national utility regulator. I n the near term, the government should focus on (i) assessing the feasibility of PPI in regional airports and ports; (ii) strengthening local government units's capacity to manage PPI; (iii) encouraging solicited, competitive, and transparent bidding processes in the sector; (iv) Transport improving coordination between greenfield and privatization projects; (v) separating regulatory, policy, and operational functions of PPA, ATO, and the Department of Public Works and Highways; and (vi) clarifying the commitment to financing right-of-way obligations. 1 Reforms in the sector should (i) standardize interconnection agreements; (ii) consider auctioning the use of the frequency spectrum, t o allow Telecoms greater flexibility in allocation of frequency; and (iii) ensure that new technologies are licensed promptly.