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p. 27 of 69 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia Cambodia Indonesia Lao People's Democratic Republic Malaysia Myanmar Philippines Singapore Thailand Viet Nam South Asia Central Asia The Pacific III. Foreign Direct Investments in Developing Asia

Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : Southeast Asia

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Philippines

Stronger consumer spending lifted growth slightly in 2003 and is expected to do so again in 2004. For the economy to move to a more rapid growth path, however, the Government will have to address the heavy fiscal deficit and consequent debt burden, poor investment climate, lack of capacity of the economy to generate employment, and a high rate of population increase. Only then can per capita income growth rates of above 2.5% be achieved and poverty be reduced significantly.

Economic Assessment

Little changed from the 2002 rate, GDP grew by 4.5% in 2003, while GNP growth strengthened to 5.5% on the back of continued rapid expansion in remittances from overseas workers (7 million citizens work abroad). On the demand side, these increased remittances and fairly stable price levels led to a 5.1% rise in private consumption expenditures, the fastest rate since 1990 and the main driver of the economy. In particular, spending rose on food and on transport and communications services. Private consumption spending contributed 4.0 percentage points to overall GDP growth. Government consumption fell by 2.8% following efforts to contain the budget deficit. Gross fixed capital formation rose by just 0.8%, which resulted in a meager contribution of 0.2 percentage point to GDP growth. Exports of goods and services increased by 3.3%, and imports by 10.3%.

By sector, agriculture, fisheries, and forestry grew by 3.9%. Industry expanded by 3.0%, propelled by manufacturing’s 4.2% rise. Construction fell by 5.9%, mainly because of a 17.9% drop in public construction caused by government efforts to restrain its budget deficit. Private construction, in contrast, experienced a third year of recovery to register 7.4% growth after the monetary authorities widened the availability of housing loans. Services, the fastest-expanding sector in 2003 and the largest contributor to GDP growth from the supply side, grew by 5.9%, spurred by a recovery in the financial sector and by rising ownership of dwellings and real estate.

Unemployment remains high and is a major cause of poverty. In 2003, the economy generated 566,000 new jobs, of which 60% were in the services sector. Despite this, since new entrants numbered 624,000, unemployment rose. Unemployment stood at 11.4% of the labor force, a reflection of the country’s lack of capacity to generate enough employment to keep up with labor force growth, itself a function of the rapidly rising population. This lack of employment also results in emigration. Likewise, underemployment, defined as the percentage of those employed who want to work additional hours, is also high at 17%. In 2002, one in three Filipinos lived below the annual per capita poverty threshold of P11,906.

As a share of GDP, the national Government’s budget deficit for the year declined to 4.6% from 5.2% in 2002. Although tax revenues strengthened by 8.3% in 2003 and total revenues were P42.5 billion above target, poor revenue collection, rather than growth in domestic spending, remained the main cause of the deficit, thereby underscoring the need for more effective mechanisms to enhance tax collection. Ongoing reforms aimed at broadening the narrow tax base and efforts to collect unpaid taxes were apparently responsible for the upturn in revenues, even though Congress failed to pass several legislative bills aimed at raising more revenue. The net effect was that revenue raised (which includes taxes, fees charged by the Government, plus items such as interest earned by the Treasury) remained at about 14% of GDP. Likewise, the tax effort stood at a low 12.3% of GDP, unchanged from 2002. The inability of the Government to raise revenues further has led to an increasing reliance on borrowings. Debt service payments climbed to 27.4% of total outlays in 2003 from 23.9% in 2002, and to 42.1% of tax revenues from 37.4% in 2002. In fact, the outstanding national government debt has been rising since 1997, reaching about P3.4 trillion at end-2003 or 77% of GDP (50.8% was domestic). The debt service ratio stood at 11% of GDP.

Price stability, the primary mandate of Bangko Sentral ng Pilipinas (BSP), was maintained in 2003. The CPI rose by 3.1%, within BSP’s target and the same as the previous year. This, together with low international interest rates, contained upward pressures on interest rates caused by the budget deficit. The 91-day treasury bill rate averaged 6.0% (5.4% in 2002), which was lower than expected. Private sector construction and personal consumption spending received a mild lift from this.

BSP was involved in the currency market to reduce volatility in the exchange rate. The peso weakened against the dollar in 2003 by about 5%, reaching an average of P54.2/$1, and, in a bid to curb this weakness, BSP raised commercial banks’ liquidity reserve requirement early in 2004, thereby reducing the excess liquidity that could be used for speculation. The average nominal and real effective exchange rate indexes calculated by BSP depreciated against a basket of currencies of major trading partners.

Loan growth in 2003 was around 5%; domestic liquidity growth (the sum of cash, savings and time deposits, and marketable securities) rose by 3.3%, though this has slowed markedly in recent years from an annual average of 19.8% in 1990-1997. The main reason for this slowing is a combination of reduced credit to the private sector, as banks have become more cautious in lending due to the high levels of NPLs, together with lower private sector demand for loans as firms refrained from undertaking expansion plans or making new investments because of spare manufacturing capacity. The recent increase in the banks’ liquidity reserve requirement had the effect of tightening the supply of credit, further exacerbating the problem of facilitating credit. As of December 2003, the commercial banks’ NPL ratio was 14.1%, down slightly from 15.0% the previous December.

On the external front, lackluster results in 2003 from some of the main merchandise exports, such as electronics, produced a disappointing 3.3% rise in exports of goods and services. This calls attention to the need for broadening the country’s export base. Exports of nonfactor services grew by 3.4%, mainly due to an 8.2% increase in income from private business services, which includes call centers and business outsourcing services. Exports to the PRC soared by 60% to $2.2 billion, while imports surged by 43.2% to $1.8 billion, nearly quadrupling the 2002 trade surplus with that country. Total imports rose at a double-digit rate because of higher imports of goods and nonfactor services.

Remittances from overseas workers increased by 6.3% to reach $7.6 billion in 2003, equivalent to 7.5% of GDP. Remittances are of paramount importance because they enable the economy to run a current account surplus, in 2003 at 4.2% of GDP, down from 5.6% a year earlier.

Inward FDI collapsed to $319 million, from $1.8 billion in 2002, largely due to political uncertainties that deterred investors. Moreover, investors do not regard the country as competitive, in part because of a lack of good infrastructure, so FDI would seem to have been lost to other locations such as the PRC. This is damaging because FDI contributes to technical progress as well as capital formation.

Foreign reserves in 2003 increased by $686 mil­lion to $16.8 billion, equivalent to about 5 months of imports.

Policy Developments

Although the economy has recorded growth of above 4% in 3 of the past 4 years, structural problems forestall any end to the boom-bust cycle that has afflicted it for the past two decades and that prevents it from moving to higher and sustained growth rates. Some initiatives taken by the Government, e.g., facilitating financial assistance to small and medium enterprises and making housing loans more widely available, will have a positive impact, as will the expected opening this year of a new terminal at Manila’s international airport. However, other long-term issues still to be addressed include the backlog in physical infrastructure, the need to upgrade technological capabilities, and an appropriate population management program, of which better education is the pillar.

The most important constraints on growth are shortages of capital and technology. Therefore, the question is how to increase investment to accelerate the expansion of productive capacity, which is indispensable to achieving rapid national income growth. The key to achieving higher long-run growth rates of both GDP and labor productivity (which today is below the level of 1980) lies in (i) increasing the investment-to-GDP ratio, currently below 20%; and (ii) increasing the rate of capital accumulation, from its current low rate (even negative some years) to an annual rate of around 8-9% for a sustained period. This would improve the stagnant capital-labor ratio-the most important determinant of labor productivity, which in turn is the source of long-run growth-and help the country shift from consumption- to investment-led growth.

The lack of investment stems from a series of mutually reinforcing factors. For a start, the budget deficit results, directly, in low levels of public investment. The lack of public investment in infrastructure deters private investors. Then, the financing of the large deficit keeps interest rates relatively high for private investors and reduces funds available for private investment. The large deficit puts upward pressure on rates even when the central bank is trying to lower rates to keep inflation in check. The authorities have little room to maneuver given that nearly a third of the budget is dedicated to debt servicing, such that other government spending has to be restricted to control the deficit. In a year of election-related spending, fiscal policy seems to be pro-cyclical.

The budget deficit has become a chronic and structural feature of the macroeconomic landscape. Since 1970, the country has had only 6 years with budget surpluses and since 1998 the deficit has increased fourfold (in absolute terms) while the deficit-to-GDP ratio has risen from 1.9% to 4.6%. Moreover, government corporations, such as the National Power Corporation and the Philippine National Bank, often incur losses that need to be covered by off-budget borrowings that create a contingent liability for the national Government.

The chronic budget problem has several ramifications. First, the portion of the budget automatically appropriated for debt servicing is increasing, so that expenditure on much-needed social programs has declined (Figure 2.10). Interest payments in the proposed 2004 budget represented 31.4% of total projected budget outlays, and 76.6% of the proposed increase in outlays was needed to pay interest. Moreover, capital spending in 2004 is programmed to fall below the 2002 level and the proposed budget dedicates a smaller share of total national government spending than in 2002-2003 to social development and infrastructure. Second, the budget should have an important redistribution impact by raising taxes on the wealthy groups and focusing spending on the needy members of society. However, the tax collection step in this procedure is inadequate, so the redistribution impact is limited.

Third, the chronic budget deficit is the source of the country’s high stock of debt. In the past, high inflation rates lowered real debt levels. Now, with greater emphasis on stabilization through monetary policy, real debt has become a more pressing problem. Maturing obligations and interest payments of the national Government in 2004 will amount to about P540 billion, or close to $10 billion. According to the 2004 budget figures, new gross borrowings for 2004 will amount to P411.9 billion. This will bring the total debt of the national Government at end-2004 to about P3.5 trillion (about 52% domestic), an increase of about P152 billion from 2003. This raises the question of the country’s capacity to repay and refinance the debt in the future. Total public sector debt (national government plus government corporation debt) doubled after 1997 to about P5.4 trillion ($100 billion) by September 2003; about 72% is national government debt. This is about 120% of GDP, or twice IMF’s “prudent” debt ceiling for developing countries.

Although the debt is prudently managed (only about 10%, or around $6 billion of the total external debt, is short term) and the current level of reserves is sufficient to cover short-term debt payments, the total level of debt must be reduced. The high debt-to-GDP ratio and a relatively small primary surplus (government income less expenditure, excluding debt payments) make the economy vulnerable to external shocks. If the peso continues depreciating, the large external debt would leave the economy in a weak position as the repayment burden in pesos would increase and interest rates could rise at the same time. An added element is that foreign reserves fell in February 2004, a decline likely exacerbated by external debt service payments. If the reserves continued to decline, BSP’s ability to intervene in the market to reduce exchange rate volatility would be constrained. Also, financial markets would receive a strong negative signal. International credit rating agencies downgraded the country’s sovereign debt rating in 2003 and early 2004, and the ratings will continue to be under threat if the deterioration in public finances persists through the next 2 years.

Furthermore, the fiscal problem and associated lack of funds for public investment damage the already poor climate for private investment. It will be difficult for the private sector to initiate investment unless the public sector takes the lead and provides, for example, adequate basic infrastructure. This is a necessary requirement to attract firms and thus to create employment.

To ensure that the fiscal problem does not deteriorate further, the Government needs to increase revenue collection by improving the reporting of income by taxpayers, broadening and deepening the tax base, and reducing corruption. One key reform measure yet to be passed by Congress is the National Revenue Authority Bill, which would transform the Bureau of Internal Revenue into a semi-independent body that would be better able to pursue revenue collection. The Government also needs to consider measures to reduce borrowing expenses.

Improving the investment climate requires greater attention to a wide range of areas, including competition policy, antitrust legislation, impartial implementation of laws, anticompetitive practices (collusion and price fixing), bankruptcy procedures, labor markets, bank intermediation and capital markets, customs regulations, and security.

The low investment level has several implications. It has led to a low rate of capital accumulation and to a low capital-labor ratio, which directly affect output growth. It also makes it difficult to generate new employment. Unemployment and underemployment in the Philippines result from the shortage of capital, and the solution is to increase the productive capacity of the country.

The high rate of population growth is an underlying constraint: labor supply is outstripping labor demand (2.3% a year on average in 1998-2002 versus 1.7% a year for employment). It would be difficult to accommodate all the new entrants to the work force even if economic growth accelerated. Rapid population growth retards development in the country for two interrelated reasons: first, it does not permit a rise in per capita incomes sufficient to provide the savings necessary among the poorest for the required amount of capital formation for growth; second, as it outstrips the capacity of industry to absorb new labor, urban unemployment and rural underemployment are compounded, depressing productivity in the agriculture sector.

On current population and GDP growth trends, per capita income cannot rise by more than 2-2.5% a year, which is not enough to significantly reduce poverty. Hence, unless major economic and political reforms are accomplished, it will be extremely difficult for the country to lift its potential growth rate, which is about 5% now; or to escape the vicious cycle where capital scarcity implies low incomes, low incomes imply a limited capacity to save among the poor, and limited savings lead to limited investment and capital scarcity. In the end, low rates of growth have led to the budget deficit. The solution consists not only in implementing the necessary microeconomic measures to spur investment, but in simultaneously achieving a big push in investment, combined with a reduction in population growth. This requires an awareness that the main purpose of the development of genuine market-economy institutions is to facilitate the process of capital accumulation. It also requires a coherent plan in terms of a partnership between the public and private sectors. In this regard, an option worth considering would be to try to design policies so as to channel worker remittances, most of which are used for consumption, into development capital, i.e., investment, perhaps through microfinance or other financial institutions.

A significant reduction in unemployment and underemployment will require an expansion of jobs in both manufacturing and agriculture, together with an adequate population management program. The economy has relatively few linkages across sectors and its output grows faster than employment. As a result, a significant expansion in manufacturing production has only a limited effect on the rest of the economy and on the absorption of labor from rural areas (one third of the labor force is in agriculture).

For this reason, it is necessary to pursue a complementary policy of increasing physical productivity in agriculture with a view to raising wages in the sector. This may be achieved by labor-intensive investment in rural infrastructure and better supply of farm inputs, and by such methods as small-scale irrigation, proper use of manure, crop rotation, application of fertilizers, and improved seeds. For example, in 2004, land planted to genetically modified corn could expand to 50,000 hectares as more farmers adopt a newly developed technology, “Bt corn,” whose yield is much higher than that of the traditional corn variety. However, one main obstacle to an increase in agricultural production is the prevailing institutional conditions (e.g., incomplete land reform).

The economy has run current account surpluses since 1998, together with budget deficits. Gross national savings have increased from 17.7% of GNP in 1997 to 25.6% in 2003. Yet gross national investment decreased from 23.8% of GNP to 17.4% in that period. These figures reinforce the view that although the savings rate is lower than that in other developing Asian countries, the country’s critical problem is its lower and decreasing investment rate. Also, the savings-investment gap of the private sector is substantial (between 4.3% and 13.3% of GDP since 1998) and has more than compensated for the public sector’s deficit. It is paradoxical that the country is, via a deficit on its capital account, financing others’ current account deficits. This indicates a failure of the financial sector to channel investment, combined with a lack of capacity to attract foreign investment.

Outlook for 2004-2005

Growth is likely to improve slightly in 2004-2005, with consumer spending the main factor. Expected better weather and higher election spending during the first half of 2004 will contribute to expansion, although some investors are holding back until the election is over in May. Brisk growth in the rest of Asia, particularly the PRC, and an improved global demand for electronics products, which represent about 70% of total exports, will help, too.

In both 2004 and 2005, growth is expected to be in the range of 4.5-5.5% for GDP and 5.2-5.8% for GNP. At the sector level, agriculture is projected to pick up by 3.7-4.7%. Industry is expected to improve by 3.6-4.8%, led by stronger manufacturing as a result of stronger global demand, and a rise in public construction from election-related spending. The services sector is expected to grow by 5.5-6.3%.

On the expenditure side, growth in private consumption is projected to remain strong at 5.5%, while government consumption will register slight growth of about 1.5%. Gross fixed capital formation is expected to recover and expand by 6%. Private investment will likely grow by about 6% and public investment will stage a recovery, rising by 7.5%.

Over 2004-2005, exports of goods and services are expected to grow faster than in 2003, by around 8%, pulled by the recovery of semiconductor exports and exports of nonfactor services arising from the income of IT-related services, call centers, and business outsourcing services. Imports are forecast to grow by around 10%, the same pace as 2003, because of higher prices for oil and other commodities, a need for more electronics components as inputs for the electronics-export industry, and a rise in equipment imports related to the expected increase in investment.

Inflation is projected to be in the range of 4.0-5.0%. This target considers the impact of the continuing high prices of oil and the lagged effect of the weaker peso in 2003. Unemployment is likely to remain at around 11%.

The growth forecasts are based on the assumption of a smooth transition to a new Government after the 2004 elections and no external shocks. An improved performance in 2004-2005 will be determined by progress in key economic legislation and policy reforms; improvement in security and law and order; and the country’s capacity to take advantage of developments abroad, such as PRC growth and outsourcing by industrial countries. Uncertainties relate to the recovery of the US economy, the oil price outlook, the extent of peso depreciation, the budget deficit, and the outcome of the elections.

The key variable to monitor during 2004-2005 is the fiscal situation. For 2004, the Government’s target is to achieve a public deficit equivalent to 4.2% of GDP. To monitor the evolution of the deficit, the authorities have set quarterly deficit targets, and the first quarter target was met. However, the task remains very difficult, given election spending and a low tax revenue target of 13.6% of GDP for 2004. The Bureau of Internal Revenue will probably not meet its initial revenue target because Congress did not pass the Indexation of Sin Taxes Bill to restructure the excise tax on distilled spirits, which will deprive the Bureau of about P7 billion in potential revenues. Without additional tax measures, the Government may miss its target. Moreover, the proposed 2004 budget was not approved for political reasons and, consequently, the Government had to reenact the 2003 budget. This has not sent any message of confidence to the market.

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