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p. 1 of 4 BACK | NEXT I. Development Situation II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Lending Levels

Country Strategy and Program Update 2002-2004: Philippines

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I. Development Situation

A. Recent Political and Social Developments

1. The new Government assumed office in January 2001 and has finalized an agenda that addresses problems of poverty and unemployment, and aims to improve political and economic governance. This is embodied in the Medium-Term Philippine Development Plan (MTPDP) 2001-2004, which was approved by the administration and will be endorsed to the coming legislature. This agenda needs to be enunciated in the next few months to ensure the achievement of its development objectives as outlined in the MTPDP. Efficient measures to deal with the hostage crisis and security problems are necessary to strengthen investors’ confidence.

2. Social indicators for the Philippines have improved in recent years despite the slowdown of economic growth. According to the 2000 United Nations Human Development Report, the Philippines ranked 70th out of 162 countries in terms of human development, as measured by the human development index,¹ a significant improvement from 82nd in 1998. During 1985-1997, the proportion of Filipino families living below the poverty line decreased from 44.2 percent in 1985 to 31.8 percent in 1997. The general decline in poverty incidence notwithstanding, income inequality worsened, with the Gini Coefficient reaching 48.7 in 1997. Moreover, rural-urban disparities persist and poverty remains largely rural. However, increasing urbanization has been exacerbated by rural to urban migration in search of employment opportunities. The growing number of urban poor living in informal settlements has severely strained the ability of urban centers to provide basic services, particularly housing.

B. Economic Assessment and Outlook

3. In 2000, the economy continued to recover from the Asian crisis with gross domestic product (GDP) growth of 4.0 percent, compared with 3.4 percent in 1999. The agriculture, industry, and service sectors grew in 2000 by 3.3, 3.9, and 4.4 percent, respectively. However, gross national product (GNP) per capita in US dollar terms decreased from $1,045.0 in 1999 to $1,007.3 in 2000, mainly due to the depreciation of the peso coupled with high population growth (2.36 percent in 2000). While gross domestic investment declined marginally from 17.8 percent in 1999 to 16.9 percent of GNP in 2000, gross domestic savings increased from 27.3 percent in 1999 to 28.3 percent, leaving a savings-investment surplus of 11.4 percent of GNP derived from the large current account surplus. The economic growth for 2001 is expected to be lower with the slowdown of the United States (US) and Japanese economies. The Government has adjusted the growth targets to 3.3–3.8 percent for 2001. The inflation rate was 6.6 percent at the end of 2000, compared with 6.7 percent in 1999. The unemployment rate increased from 9.8 percent in 1999 to 11.2 percent in 2001. The economic indicators of the Philippines are given in Appendix 1.

4. The Government budget deficit of P134.2 billion in 2000 far exceeded the stipulated fiscal deficit target of P62.5 billion agreed under the International Monetary Fund (IMF) program.² The fiscal deficit continued to widen from 1.9 percent of GDP in 1998 to 4.1 percent of GDP in 2000. While part of the deficit was due to some sectors that were lightly taxed, a deterioration of tax effort from 17 percent in 1997 to just 13.6 percent in 2000 should cause concern. The Government expected to keep the fiscal deficit to 4.0 percent of GDP or P145 billion in 2001. On the monetary side, political instability in the last quarter of 2000 affected the interest rate level and the exchange rate. After a temporary rise in the last quarter of 2000, interest rates gradually dropped 600 basis points to 9.0 percent for the overnight borrowing and 11.25 percent for overnight lending in May 2001. Since the end of June 2001, the peso depreciated to about P52 to one US dollar in line with the movement of the currencies in the region. Due to poor portfolio management by the commercial banks, the non-performing loans ratio continued to increase from 14 percent in early 2000 to 16.7 percent in May 2001.

5. With imports remaining slow, the current account surplus reached 11.5 percent of GNP in 2000. While medium-term loans and direct investment flows were positive in 2000, portfolio and other capital outflows increased sharply. Thus, the overall balance of payments was in deficit by $512 million, equivalent to 0.6 percent of GNP, which is not significant. In 2001, the external current account is expected to continue to be in surplus, but the decrease in imports and exports will make the prospect of the external trade uncertain and this may lower economic growth. At the same time, the outlook for the capital account, which depends on investor confidence in portfolio and direct investment, will likely remain weak.

6. The economic outlook for 2001 is modest and activity could slow further if the demand exports continue to decline more than anticipated due to a prolonged slowdown of the US and Japanese economies. Prospects for the Philippine economy to move forward depend on several key factors. Political stability is an important element to promote economic growth and restore investors’ confidence. To accelerate sustainable growth, economic fundamentals including prudent budget management, control of inflation, stable exchange rate, and low interest rate setting need to be improved to strengthen investors’ confidence. Economic policy reforms, including reforming the tax collection system, strengthening governance, implementing institutional reforms, and enabling economic security, should be carried out in a timely manner. Strategic policies need to be formulated to address structural weakness, strengthen public sector services, and maintain sustainable growth for the country.

7. The MTPDP spells out the strategies for poverty reduction and formulates the development framework for the Government. The MTPDP is anchored on four strategies: (i) macroeconomic stability and equitable growth by undertaking well-coordinated fiscal, monetary, and exchange rate policies to achieve a low inflation rate and a sound balance of payments position and to avoid unexpected surges in unemployment and declines in income; and modernization of all sectors through human resource development and technological progress; (ii) poverty reduction and comprehensive human development by accelerating the asset reform program; providing human development services, particularly basic education, health, shelter, water, and electricity; strengthening social protections for the most vulnerable sectors through the social welfare system, local safety nets, and social security; and promoting the participation of the poor in governance and protection against violence; (iii) agriculture modernization with social equity by accelerating agrarian reforms, improving rural infrastructures, and implementing land reforms; and (iv) good and effective governance by improving transparency, implementing measures to reduce graft and corruption, strengthening partnerships with civil society and business, carrying out consultation with people, and promoting peace and security.

C. Implications for the Country Strategy and Program

8. Despite the political events of 2000, culminating in the change in the administration, the basic tenets embodied in the MTPDP have remained consistent with those of the previous administrations. The new Government has extensively reviewed the MTPDP to ensure its relevance, particularly to prioritize and optimize public investment in view of the fiscal deficit. The country operational strategy (COS) of the Asian Development Bank (ADB) for the Philippines was prepared in 1998 and aims to reduce poverty, promote equity growth, improve social services delivery, protect the environment, and promote good governance. The COS is closely aligned with the Government’s development objectives elaborated in the updated MTPDP. In mid-2002, ADB will complete a new CSP, which will define ADB’s strategy for its assistance to the Philippines for 2003-2007 and support the Government’s priorities stated in the MTPDP. ADB recognizes the current budget constraint and is working with the Government to improve the situation, help restore investor confidence, and facilitate economic growth. Under the poverty partnership agreement to be signed in October 2001, ADB and the Government will focus their efforts to minimize inequality by directing resources to the poor in the most needed area.

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