Journal Issue

Improved growth performance: After escaping effects of Asian crisis, Philippines must avoid return to past boom-bust cycles

International Monetary Fund. External Relations Dept.
Published Date:
January 2000
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Over the past two decades, the Philippines has come out of a long period of slow growth and economic imbalances to become a dynamic emerging market economy. Skillful crisis management largely allowed it to escape the recent turbulence in Asia, further enhancing its image as a strong and vigorous economy.

GDP growth(percent change)
Data: IMF, Occasional Paper No. 187
Data: IMF, Occasional Paper No. 187

Reforms under way since the late 1980s (and supported in the 1990s by an Extended Fund Facility and a Stand-By Arrangement from the IMF) continue to bear fruit, but events over the past two years also highlight what remains to be done. The task now is not only to restore growth and investor confidence but also to sustain momentum. The Philippines must prevent a return to the boom-and-bust cycles of the past and ensure the country benefits fully from integration into the global marketplace. Accomplishing this will mean tackling the still-pervasive legacy of the past—notably, low savings, widespread poverty, accommodation of rent-seeking activities, and structural weaknesses in the public sector. This article, based on IMF Occasional Paper No. 187, Philippines: Toward Sustainable and Rapid Growth, looks at the achievements and the challenges ahead for the Philippine economy.

Philippines: public and national government debt

(percent of GNP)

Data: IMF, Occasional Paper No.187

Economic growth

Weaker growth rates have long set the Philippine economy apart from many of its Asian neighbors, but its recent performance offers grounds for optimism. The benefits of reform are being felt through higher growth, particularly since 1993, and the country exhibited a new resilience during the Asian crisis (see table, this page). At the height of the crisis, Philippine real GDP declined by only 1/2 of 1 percent in 1998, compared with declines of 6-14 percent in the countries most heavily affected by the crisis. Productivity growth appears to have picked up, and there has been some movement away from the Philippines’ past reliance on a capital-intensive, import-competing system of production. Empirical work by IMF staff, presented in the Occasional Paper, suggests that the improved performance has its roots in the economy’s increasing openness, stable investment rates, and expanded foreign direct investment.

Sustained growth will be contingent on continuing outward-oriented and market-driven policies. To raise saving and investment rates and improve productivity, it will be essential to return to fiscal consolidation and streamline the public sector; maintain prudent monetary policies; create a level playing field through continued trade liberalization and the strengthening of governance; improve prudential, supervisory, and debt resolution frameworks in the financial and corporate sector; and implement policies to reduce poverty and improve equity.

Public finance

In the early 1990s, the Philippines’ fiscal accounts improved significantly. The improvement reflected not only a strong consolidation in the national government budget and a substantial reduction in the deficit of the government-owned and -controlled corporations, but also the improved position of other public sector entities. As a result, public debt has fallen significantly from the highs in the mid-1980s (see chart, this page). Since 1997, however, fiscal balances have moved back into higher deficits, as fiscal policy turned expansionary to support domestic demand. Although a widening of the fiscal deficit in line with the slowing economy was appropriate, a larger fiscal stimulus could have been pro-vided—and expenditure cuts in 1998, avoided—if the tax collection effort had yielded stronger results.

Major tax reforms in recent years have improved the tax structure, but revenue efforts need further strengthening. Rationalizing incentives that currently erode the tax base would create a less distortionary and more efficient tax system, and further reform of the tax administration system would boost revenues and ensure transparent and uniform treatment of taxpayers.

While some progress has been made in scaling down unproductive expenditures, additional steps to improve the quality of expenditure are needed—notably, a rationalization of the structure and size of the civil service and a reform of the inefficient system of intergovernmental finances. Such measures would free upresources for more growth-oriented spending on infrastructure and human development. Reforms in the wider public sector are also urgently needed, particularly in the power sector, where the finances of the National Power Corporation are unsustainable. Draft legislation enabling power sector reforms is expected to be approved by mid-2000.

Fiscal sustainability has improved considerably in recent years, but the fiscal situation remains vulnerable to shocks. Strong economic growth and continued fiscal reforms would keep public sector debt on a sustainable path over the medium term.

Monetary and exchange rate policy

By the end of the 1990s, the Philippines’ monetary policy institutions had evolved into a well-functioning system. Over the past 15 years, the country has reformed its monetary framework and policy instruments and created the Bangko Sentral ng Pilipinas (BSP). Since replacing the old (and insolvent) Central Bank of the Philippines in 1993, the BSP has become an independent monetary authority with full administrative autonomy and a clear legal mandate to pursue price stability. It has kept a sharp focus on macroeconomic stability, responding flexibly to new challenges.

Since 1984, the Philippines has formally based its monetary policy on a floating exchange rate and monetary targets.While this provides an appropriate overall framework for monetary policy, the BSP at times has appeared to follow multiple objectives—for example, adopting a de facto peg of the exchange rate in laet 1995 while retaining base money targets. Even so, the BSP has been largely successful in recent years: it was able to reduce inflation in the face of the policy challenges posed by capital inflows and instability in money demand in the mid-1990s and successfully managed monetary policy during the Asian crisis—combining exchange rate flexibility with a relatively tight interest rate policy.While not aggressively defending a particular level of the peso, the BSP used interest rates to lean against the wind of exchange market pressure and intervened only to build up reserves and maintain orderly market conditions. After the crisis abated and stabilization was well under way, the central bank shifted its stance to support economic recovery and reduced interest rates to below precrisis levels.

In the period ahead, the main challenge for the BSP will be to maintain price stability—a statutory goal reflected in its recent decision to move toward inflation targeting in the coming year. Such a framework will allow the BSP to implement monetary policy in a consistent and transparent framework well understood by the public.

External sector

The Philippines’ external sector came under heavy pressure during the Asian crisis, but it proved less vulnerable than in the most heavily affected countries in the region. Lessons learned from earlier crises, particularly in external debt management and banking policies, obviously helped contain the buildup of imbalances in the mid-1990s. Nevertheless, large capital inflows in this period nearly overwhelmed the policy framework and led to an overvaluation of the peso (see chart, this page), a growing current account deficit, and rapidly rising short-term debt.When the tide turned in 1997 as capital flows reversed direction, the authorities reacted quickly by floating the peso, raising interest rates, and accelerating structural reforms. These policies stabilized the external position without the severe disruption experienced in some other countries affected by the crisis. By 1999, the current account had shifted into a sizable surplus, boosted by strong export performance throughout the crisis period and sluggish imports. During this period, the country built up its international reserves to record levels.

Philippines: exchange rates

Note: An upward movement indicates an appreciation of the peso.

Data: IMF, Occasional Paper No.187

interest rates, and accelerating structural reforms. These policies stabilized the external position without the severe disruption experienced in some other countries affected by the crisis. By 1999, the current account had shifted into a sizable surplus, boosted by strong export performance throughout the crisis period and sluggish imports. During this period, the country built up its international reserves to record levels.

Continued and significant trade liberalization has induced favorable structural changes since the 1980s. The average tariff rate fell to 10 percent in 1999. And Philippine exports have increased strongly, reflecting their rapidly growing global market share in electronics and electronic components (see chart, page 160). Although such growth has come partly at the expense of some of the more traditional exports (such as garments and minerals), the country has demonstrated its capacity to compete successfully in one of the most dynamic export markets in the world.

Despite this improvement in the external position, a challenging policy agenda for the medium term is to reduce the country’s vulnerability to shocks. Macroeconomic policies will need to combine prudent demand management with exchange rate flexibility to support sustained rapid growth and prevent the buildup of excessive leverage and debt. To sustain gains in market share, the Philippines will need to assist its export sector through increased infrastructure investments, enhanced access of small and medium-sized enterprises to finance, and improved services, including in the area of public administration. Moreover, to encourage further integration with global markets, trade liberalization will need to continue in line with the country’s commitment to reduce the general uniform tariff to 5 percent.

Financial and corporate reforms

As economic performance improved in the 1990s, the banking sector also became more efficient and more resilient in coping with shocks. Financial sector reforms prior to the 1997 crisis encouraged greater competition, strengthened supervisory and regulatory systems, and streamlined the tools of monetary policy. These reforms substantially improved the system’s financial intermediation and payment flows and helped shield the Philippine banking system from the worst effects of the Asian crisis in 1997-98. Nonetheless, the ratio of non-performing loans to total loans rose from 4 percent precrisis to a peak of 14!/i percent in early 1999. In response, the authorities initiated further reforms to bolster the banks’ capacity to face adverse shocks, enhance supervisory capabilities, and reinforce the institutional framework to deal with troubled banks.

To further strengthen the system, reinforce supervisory capabilities, and bring supervisory standards up to best international practices, continued reforms will need to reduce distortions in financial intermediation (such as eliminating mandatory credit allocation programs), enhance prudential and supervisory frameworks, streamline the process of bank exit and resolution of problem banks, and restore the only large bank in diffi-culty—the Philippine National—to a sustainable financial position (together with its full privatization, for which an action plan has recently been adopted).

Philippine companies, which had manageable levels of total indebtedness and exposure to foreign debt at the beginning of the crisis, weathered the tumult fairly well. But reforms to bring corporate governance into line with best international practice could help build market confidence and encourage stable, long-term investment. Other reforms could usefully address the protection of creditor and minority shareholder right, debt resolution and insolvency, enforcement of accounting standards and disclosure rules, and adherence to standards for borrowing and lending (particularly with respect to insider loans).

Equity and growth

As the Philippines’ growth performance has improved, the incidence of poverty has declined—from 44 percent in 1985 to 32 percent in 1999. But poverty remains high, particularly in the rural areas, and income distribution is very unequal. Poverty indicators appear to reflect policies in agricultural, fiscal, and external areas that are biased against the rural sector. In the agricultural sector, heavy regulation and uncertainty concerning the implementation of land ownership reform have hampered much-needed investment. In the fiscal area, the share of education expenditures has risen, but concerns remain about quality and distribution. In addition, spending on health and nutrition remains low by regional standards and is biased toward personal health care rather than preventive care. In the external sector, exchange and trade policies historically would contribute to inequity by protecting manufacturing at the expense of agriculture. In addition, protection and other incentives encouraged the manufacturing sector to substitute capital for labor.

Philippines: selected export components

(million dollars)

Data: IMF, Occasional Paper No.187

While high growth has previously helped to reduce poverty, attaining the government’s targets for poverty alleviation (poverty incidence of 25-28 percent by 2004) will likely require, in addition to high growth, targeted interventions in the rural areas as well as higher-quality and better targeted fiscal expenditures directed to social objectives and further reductions in protection.

Overall, the Philippines has made great strides in the past 15 years, achieving strong and comprehensive reform and minimizing the disruption from the Asian crisis. At the same time, however, the crisis exposed structural weaknesses on which further progress will have to be made in order to achieve sustained rapid growth and significant poverty reduction.

Copies of IMF Occasional Paper No. 187, Philippines: Toward Sustainable and Rapid Growth, by Markus Rodlauer, Prakash Loungani, Vivek Arora, C. Christofides, Enrique G. de la Piedra, Piyabha Kongsamut, Kristina Kostial, Victoria Summers, and Athanasios Vamvakidis, are available for $18.00 (academic rate: $15.00) each from IMF Publications Services. See page 152 for ordering details.

Ian S. McDonald


Sara Kane

Deputy Editor

Sheila Meehan

Senior Editor

Elisa Diehl

Assistant Editor

Sharon Metzger

Senior Editorial Assistant

Lijun Li

Editorial Assistant

Jessie Hamilton

Administrative Assistant

Philip Torsani

Art Editor/Graphic Artist

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