Public Information Notice No. 02/41

Public Information Notice: IMF Concludes Post-Program Discussion on the Philippines

April 9, 2002

On March 6, 2002, the Executive Board of the International Monetary Fund (IMF) concluded a Post-Program Monitoring discussion on the Philippines based on information available through that date.¹

Background

The Philippine economy faced several challenges in 2001. Starting in February, exports began falling at a double digit rate, as the global IT industry contracted. Then, in July, sentiment toward emerging markets suddenly deteriorated, effectively shutting the Philippines out of international capital markets. Finally, in September, came the terrorist attacks on the United States, intensifying global risk aversion and the ongoing slowdown of the world economy.

Nonetheless, the Philippine economy turned in a robust performance. GDP is estimated to have grown by around 3_ percent, as services and agriculture continued to expand rapidly. Inflation, meanwhile, decelerated to 4 percent (y/y) by the end of the year. The overall balance of payments ended the year near balance, and adjusted gross reserves at end-2001 amounted to $13.3 billion, more than sufficient to cover short-term debt.²

Several factors helped the Philippines accomplish this. Most significantly, the new government adhered to its fiscal target, keeping the deficit to the planned 4½ percent of GNP. The central bank pursued a carefully balanced monetary policy, tightening its stance significantly in July, when the exchange rate came under attack, then gradually relaxing as the pressure eased and inflation came into line with the targets. The administration secured passage of a landmark power reform bill, providing an impressive demonstration of the administration's commitment to reform. Finally, the shift in global market sentiment toward the end of the year also helped, allowing the authorities to replenish their reserves and partly pre-finance the 2002 budget.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They observed that the Philippines had weathered the global storm of 2001 reasonably well. Despite a sharp export contraction and volatile conditions in external financial markets, the country ended the year with solid growth, low inflation, and a comfortable level of reserves. Directors attributed this achievement to the authorities' strategy of market-oriented reform and macroeconomic prudence, including a rigorous pursuit of their fiscal deficit target.

Looking ahead, Directors noted that further efforts were needed to strengthen the macroeconomic position and limit vulnerability to adverse shocks. Continued erosion of tax revenues had undermined the fiscal position, contributing to an upward drift in public debt, while nonperforming assets had become a sizable burden on the banking system. Vigorous action is therefore needed in both areas.

Directors saw reversing the long slide in fiscal revenues to be a key challenge. They welcomed the authorities' determination to increase revenues, as part of their planned strategy for balancing the budget by 2006. To do this, the authorities would need to implement promptly their envisaged tax administration reforms especially for strengthening revenues. In addition, it would also be important to follow through with plans to restore selected excise taxes, and to extend this measure to include petroleum excises. Over the medium term, the authorities should consider other measures, including raising the VAT rate.

Directors supported the authorities' plans to limit spending. They expressed concern, however, that any restraint might be difficult to reconcile with the government's plans for reducing poverty, further stimulating growth and improving infrastructure. They also noted that further spending pressure is likely to arise from contingent liabilities, notably those of the social security system and National Power Corporation. Directors recommended that the authorities free up funds for priority spending by implementing the long-planned government streamlining, and protect the budget by restoring the social security system to financial health. Even with these measures, Directors considered, a greater focus on revenues will ultimately be needed if the desired fiscal consolidation is to be achieved.

Directors emphasized that strengthening the health of the banking system remains a priority. While welcoming efforts to facilitate loan workouts, through proposed legislation to facilitate the formation of private asset management corporations and to modernize the bankruptcy code, Directors stressed the importance of pushing through the proposed amendments to the central bank charter, to give supervisors greater power to deal with problem banks. They also suggested strengthening the prompt corrective action framework, so that such banks could be required to take action at an early stage.

Directors commended the Bangko Sentral for its prudent conduct of monetary policy, and welcomed the adoption of a formal inflation-targeting framework in January 2002.

Directors stressed the need for continued progress with other structural reforms. They supported the issuance of rules and regulations to accompany the landmark power sector reform law, since a well-designed privatization and deregulation strategy could pay dividends in higher investment and growth.

Noting that the Philippines remains on the Financial Action Task Force list of non-cooperative countries, and the need to put in place measures to combat the financing of terrorism, Directors welcomed the introduction of an anti-money laundering law, as well as the authorities' plans to take additional steps to bring it into line with the guidelines of the Financial Action Task Force.

Finally, Directors welcomed the authorities' efforts to improve longstanding weaknesses in statistics, including with respect to the balance of payments and the national accounts, and encouraged them to speed further progress by devoting additional resources to this task.