Philippines: Background Papers

This Background Paper analyzes the Philippines's experience with capital inflows. It compares the episode of 1993–95 with the pre-debt crisis period, and makes the case that the recent inflows are in important respects more benevolent than in the past. The paper concludes that inflows are consistent with a balanced and sustainable revival in the Philippines economy, and indeed are most likely contributing to recovery. This paper also examines financial reintermediation and new challenges to monetary policy. Requirements and plans for the fiscal reform in the medium term are also described.


This Background Paper analyzes the Philippines's experience with capital inflows. It compares the episode of 1993–95 with the pre-debt crisis period, and makes the case that the recent inflows are in important respects more benevolent than in the past. The paper concludes that inflows are consistent with a balanced and sustainable revival in the Philippines economy, and indeed are most likely contributing to recovery. This paper also examines financial reintermediation and new challenges to monetary policy. Requirements and plans for the fiscal reform in the medium term are also described.

III. Fiscal Reform in the Medium Term: Requirements and Plans25

Over the past five years, the Philippine authorities have made substantial progress in reducing the fiscal deficit. By 1994, the government budget had been brought nearly into balance, compared with a deficit of 3 1/2 percent of GNP in 1990 (Chart III.1). 26 Notwithstanding this progress, the country’s long-standing fiscal problem has not been resolved, for several reasons. First, enduring measures are required to sustain the recent improvement (Section A). Over the medium-term, some revenue sources are expected to decline, while certain expenditure obligations will increase—and, in the meantime, the budget will remain exposed to unfavorable interest rate developments. Second, fiscal reform is required to promote national saving and investment, key ingredients in securing the authorities’ objective of achieving sustainable growth (Section B). 27 To address both these requirements, the authorities have developed a comprehensive program of tax and expenditure reform (Section C). Over the medium-term, this program should fundamentally transform the fiscal position (Section D).

A. Risks to the Fiscal Position

There are a large number of factors, particularly on the revenue side of the budget, that are likely to weaken the fiscal position over the medium-term. As a result, increases in the domestic tax effort will be necessary even to maintain the present tax revenue-to-GNP ratio. And an even larger effort will be required to prevent a deterioration in the fiscal balance.

1. Nonrecurrent revenues

One risk to the fiscal position lies in the current dependence on non-recurrent revenues. Chart III.1 shows the recent revenue trends. Since 1990, the revenue-to-GNP ratio has increased by nearly 3 percentage points (to 19 1/2 percent), about half of which is due to higher tax revenues. The other half of the increase, however, stems from non-tax revenues—and virtually all of this is from three non-recurrent sources. In 1994, the budget benefitted from: (1) privatization receipts of 1 1/2 percent of GNP; (ii) large interest earnings on its deposits at the central bank; and (iii) significant collections from fees and charges, owing to a large one-time adjustment designed to reverse a steady erosion in real rates.


PHILIPPINES: Key Fiscal Indicators, 1990–95

(In percent of GNP)

Citation: IMF Staff Country Reports 1995, 114; 10.5089/9781451831252.002.A003

Source: Data provided by the authorities and staff estimates.1/ Consolidated public sector deficit.2/ Excludes privatization revenue.

All of these are likely to decline as a ratio to GNP over the medium-term. First, the privatization program is nearly completed: after the remaining payment (of nearly 1 percent of GNP) on the sale of Fort Bonifacio—a large military base in a prime area of Manila—is made in 1996, subsequent receipts are likely to be minor. 28 Second, interest receipts are likely to fall. Until recently, the Government maintained a policy of building up its cash balances at the central bank, in order to help the latter absorb liquidity created by purchases of foreign exchange—and by the latter’s own operating losses. However, following the central bank’s financial restructuring in late 1993, this policy is no longer necessary, and the Government has quickly run down its balances to minimum operating levels, thereby reducing future interest earnings. 29 Third, revenues from fees and charges are unlikely to keep pace with GNP, unless future discretionary adjustments ensure that fees increase in line with prices.

Consequently, starting as early as 1997 the government will need to find a minimum of about 1 1/2 percent in GNP from other sources, merely to maintain the current revenue-to GNP ratio.

2. Taxes on international trade

A second risk to the revenue position comes from the authorities’ program of tariff reduction. Under this program, the maximum standard tariff rate will be reduced from 50 percent to 30 percent in 1995, and then further lowered to 10 percent by the year 2003. From 2004, a uniform tariff of 5 percent would be adopted. A simple calculation illustrates the potential consequences for customs revenue—which currently accounts for about one-third of total tax receipts. 30 If a uniform tariff of 5 percent were to have been levied comprehensively on 1994 non-oil imports, revenue would have been 0.7 percentage point of GNP lower than actual receipts. This estimated revenue shortfall is, however, an absolute minimum compared to the revenue loss that might have been incurred under the proposed tariff regime. The reason is that the 5 percent duty is unlikely to be comprehensive. For example, if exemptions continue to amount to nearly half of imports, as they did last year, the loss would be double—i.e., 1 1/2 percent of GNP.

3. Tax buoyancy

A third reason why the revenue-to-GNP ratio might fall is the low buoyancy of the tax system, owing to weaknesses in administration and the narrowness of the base. In the Philippines, few tax fraud investigations are conducted, even fewer court cases are filed and publicized criminal cases are almost nonexistent. Partly as a result, rates of compliance are exceptionally low. 31 For example, less than one-tenth of the labor force files income tax returns, while corporate taxpayers comprise only one-third of registered corporations. Estimates of revenue loss on account of administrative problems vary, but it is widely accepted that such losses are significant—on the order of several percentage points of GNP. Moreover, these losses may increase as the economy recovers, since declared incomes may not rise in step with actual ones.

Another factor reducing tax buoyancy is the narrow tax base, reflecting the widespread practice of granting tax exemptions. Revenue foregone from tax incentives has more than doubled since the late 1980s, to an estimated P 32 billion (1.8 percent of GNP) in 1994, according to the estimates of the Presidential Task Force on Tax and Tariff Reform. About two thirds of the losses stem from incentives granted by the Board of Investments (BOI), which include duty exemptions on capital goods and spare parts (granted to projects registered prior to January 1995) and income tax holidays of up to eight years. The remaining losses result from numerous legislative and executive provisions, which provide duty and income tax exemptions to various entities and selected goods.

4. Transfers to local government units

On the expenditure side, the main risk to the fiscal position comes from the growing amount of transfers that the National Government must make to local government units. In 1991, Congress passed a new local government code, which specified that by 1994 such transfers would need to amount to 40 percent of the internal revenue (tax revenues excluding international trade taxes) collected by the National Government three years previously. 32 As this formula has been gradually phased in, transfers to local government units have increased rapidly, from 1/2 percent of GNP in 1991 to 2 1/2 percent of GNP in 1994. In the process, not only have other expenditures been compressed, but the budget has become increasingly inflexible, limiting the scope for the fiscal stance to be adjusted in response to macroeconomic shocks. By 1994, nondiscretionary expenditures—transfers, interest payments, and wages 33—were absorbing nearly three-quarters of the total budget.

Without action, this situation may well become worse over the medium term. The problem is that the composition of the government’s revenues will inevitably shift toward internal sources, on account of the tariff reform discussed above. Consequently, a growing share of revenues will not be available for the National Government, but will need to be transferred to other jurisdictions. The result is likely to be a further squeeze on the budget. For example, if the tax revenue-to-GNP ratio remains stable, the already low level of discretionary expenditure will need to be cut by 0.4 percentage point of GNP for every percentage point of GNP that international trade tax revenues decline. Even if the tax ratio is raised, only 60 percent of the revenue generated could be used to maintain discretionary expenditures. As a result, some combination of revenue measures and additional transfer of responsibilities to local jurisdictions is likely to be necessary—or else the budget balance will deteriorate.

5. Public debt and interest rates

Finally, the budget could be undermined by a reversal of favorable interest rate trends. The National Government is saddled by a substantial stock of public debt, amounting to about 70 percent of GNP in 1994, which generates interest costs that absorb nearly one third of the government budget (Chart III.2). External debt is largely bilateral fixed rate debt, and thus less subject to interest rate risk although, of course, exchange rate developments are important. But domestic debt, which accounts for more than half the total stock and four-fifths of interest payments, is virtually all short-term, rendering the budget highly sensitive to shifts in monetary policy and investors’ confidence.


PHILIPPINES: National Government Debt, Balances, and Interest Payments

(In percent of GNP)

Citation: IMF Staff Country Reports 1995, 114; 10.5089/9781451831252.002.A003

Source: Data provided by the authorities and staff estimates.1/ As percent of total expenditure.

Chart III.2 illustrates the recent evolution of the budget deficit, broken down into interest payments and the primary balance. As the chart makes clear, the fiscal improvement has been aided by a decline in interest payments, from 6 1/2 percent of GNP in 1990 to 6 percent of GNP in 1994—reflecting a sharp decline in interest rates as inflation has fallen to single digits and confidence has improved. 34 If the current economic recovery is sustained, risk premia on interest rates should continue to decline, while government debt should decline as a share of rapidly rising GNP. However, if inflation were to accelerate or confidence to falter, interest payments could rise again, putting pressure on the budget.

The relationship between interest rates and the budget runs the other way, as well: should the budget deficit worsen for any reason, interest rates are likely to rise. Chart III.3 shows the consolidated public sector deficit and real Treasury bill interest rates (shown by 91-day treasury bill yields adjusted by the average change in the consumer price index) over the years 1985 to 1994. Although interest rates are evidently influenced by other factors, there is also a clear link between the size of the deficit and the level of the real interest rate.


PHILIPPINES AND SELECTED ASEAN COUNTRIES: Fiscal Indicators, Interest Rates, and National Savings, 1985–94

Citation: IMF Staff Country Reports 1995, 114; 10.5089/9781451831252.002.A003

Sources: IMF, World Economic Outlook, the Philippine authorities; and staff estimates.1/ CPSD refers to consolidated public sector deficit.

B. Saving and Investment Requirements

Fiscal reform is also required to promote national saving and investment, which are indispensable for sustaining a higher rate of economic growth.

1. Public saving

To achieve growth rates comparable to that in neighboring countries, the Philippines will need to raise its saving rate, which is well below the ASEAN average (Chart III.3). This, in turn, will require an improvement in public saving, which averaged just under 2 percent of GDP during 1990–93. 35 In other ASEAN countries the level of public saving has been many times greater: during 1990–93, it averaged 8 percent of GDP in Indonesia, and 12 percent-13 percent of GDP in Malaysia, Singapore, and Thailand. These high ratios have boosted national savings, helping to finance high levels of investment without strain on the external current account. 36

2. Public investment

The Philippines also needs to raise its level of public investment, which according to empirical analyses of economic growth, is complementary to private investment. 37 Over the past decade, Philippine government capital spending has averaged only around about 2 1/2 percent of GDP. 38 As Chart III.4 shows, this level is the lowest among the ASEAN countries: 39 the ten-year average capital spending-to-GDP ratio is marginally higher in Thailand; 5 percent of GDP in Malaysia; 7 percent of GDP in Singapore; and 9 percent of GDP in Indonesia.


PHILIPPINES AND SELECTED ASEAN COUNTRIES: Public Expenditure and Fiscal Revenues, 1990–93

(Ten year average in percent of GDP)

Citation: IMF Staff Country Reports 1995, 114; 10.5089/9781451831252.002.A003

Sources: IMF, Government Finance Statistics, World Economic Outlook, the Philippine authorities; and staff estimates.

Even when measured in relation to total public expenditure, capital spending in the Philippines compares unfavorably to other ASEAN countries—largely because so much of the budget must be devoted to debt service. Capital spending has accounted for between 15 and 18 percent of the Philippines’ public spending in recent years. By contrast, capital spending in Indonesia has consistently comprised 45 to 50 percent of expenditures. In Singapore, after peaking at 40 percent of expenditure, capital expenditure has declined to about 23 percent of total public expenditure. In Thailand and Malaysia, the share of capital expenditure has been in the range of 20 to 25 percent.

C. Fiscal Reform Plans

For all the above reasons, a comprehensive effort to mobilize resources will be required over the medium-term (Table III.1). With these considerabtions in mind, the Philippine authorities have already embarked on a comprehensive reform to overhaul the tax system and restructure government expenditure.

Table III.1.

Philippines: Medium-Term Scenario, Fiscal Balances

(As a percent of GNP)

article image
Sources: Data provided by the Philippine authorities; and staff estimates.

1. Resource mobilization

Over the medium-term, the burden of resource mobilization is likely to fall mainly on the tax system. Once again, the other ASEAN countries provide a useful point of comparison. As shown in Chart III.4, the tax-to-GDP ratio during 1990–93 was about 15 percent in the Philippines, whereas it ranged from 17 percent of GDP in Thailand to just over 20 percent of GDP in Malaysia.

At the same time, several avenues for increasing taxation to ASEAN levels are currently closed. As noted above, there is no scope to increase international trade taxes. Rather, these will decline over time as tariff levels fall—a pattern already evident in the other ASEAN countries. Neither can nontax revenues be easily increased to the levels in other ASEAN countries: Singapore receives a large investment income from its sizeable reserves and overseas investments, while Indonesia and Malaysia benefit from large petroleum-related receipts.

Consequently, tax efforts will need to focus mainly on domestic taxes. Income taxes are a major revenue source in Singapore, Indonesia, and Malaysia, accounting for at least 8 percent of GDP, compared to 5 percent of GDP in the Philippines. Other countries also are moving toward the VAT, which already raises almost 8 percent of GDP in Thailand,40 well above the 5 percent of GDP earned by the Philippines. Singapore recently introduced a VAT, albeit at low rates, and Malaysia has also announced an intention to adopt a VAT suggesting that they too may place greater reliance on indirect taxes in the future.

2. Tax reform program

The Philippine authorities are implementing a two-part tax reform program aimed at improving the tax-to-GNP ratio by expanding the revenue base and simplifying the system. The first—VAT reform—has already commenced and the second—reform of the direct tax system, including tax incentives—has been submitted to Congress. The objectives of the reform are to increase the tax revenue-to-GNP ratio and to broaden the effective tax net by simplifying the tax system—for taxpayer and administrator—so as to improve its elasticity.

a. Value-added tax

Reforms of the VAT are focused on improving the weak revenue productivity of this tax. Currently, the ratio of VAT collections to GNP is only about one half of that recorded by countries with comparable tax rates, largely because the base excludes many services, creating “leakages” from the system and making administration more difficult. In 1994, Congress addressed this problem by expanding the tax base to cover professional services, real estate, hotels and restaurants. This extension was expected to raise revenues equivalent to 0.4 percentage points of GNP—but implementation has been put on hold by the Supreme Court, since it is currently reviewing a challenge to the new law’s constitutionality.

b. Direct tax reform

In early 1994, the President established a Task Force on Tax and Tariff reform. This Task Force has now completed its work, on the basis of which a package of reforms was submitted to Congress in mid-1995. The reform package—which aims to increase revenue by P 16 billion (0.8 percent of GNP)—covers taxation of individual and business income; rationalization of tax incentives; excise reform; and tax administration. 41 The main features of the Task Force’s proposed tax reform (described elsewhere in detail) 42 are summarized in Table III.2.

Table III.2.

Summary of Government Tax Reform Proposals

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3. Public expenditure reform

Public expenditure efforts are focussing on two main areas: civil service reform and local government reform. A key objective is to restructure the budget to permit greater resources to be devoted to productive capital expenditures.

a. Civil service reform

The Government has adopted a plan of civil service reform known as “streamlining the bureaucracy.” So far, the plan has relied largely on natural attrition, based on 1992 legislation that prevents outside hiring to replace departing or retiring civil servants. 43 In 1995, however, a bill permitting the Government to undertake more sweeping civil service reorganization was submitted to Congress, in the hope that it can be implemented in 1996. This reform would scale back the size of the civil service, thereby freeing up resources for spending on priority budget classifications. Allowance for needed redundancy payments is provided for in the draft 1996 budget.

b. Local government

Additional measures to alleviate the pressure of transfers to Local Government Units on the National Government budget are now planned as part of the broader civil service reform. Additional functions—as yet unspecified—will be devolved to local governments, to better match their responsibilities to the resources made available to them. Moreover, a cost sharing plan has been developed for capital expenditures. Under this plan, in 1996 larger jurisdictions would contribute from their own funds 20 to 30 percent of capital project costs, while smaller jurisdictions would contribute 10 percent of project cost. Urbanized jurisdictions could cover 50 percent of project cost. The share of cost borne by local government unit is to increase further in 1997 and 1998.

D. Conclusion

The message of this paper is that fiscal policy faces a variety of challenges. Without action, the fiscal postion may well deteriorate over the medium term: non-recurrent revenues will disappear; trade taxes—one third of present tax revenue—will decline on account of trade liberalization; direct taxes are unlikely to keep pace with GNP, owing to weaknesses in administration; and non-discretionary expenditures may account for a growing share of the budget. At the same time, in order to meet the objective of sustaining a high rate of economic growth, the government must raise its levels of savings and investment.

The authorities have charted a course which can deliver a sustainable fiscal position, as well as contribute to higher growth. A scenario, based on the reforms discussed in this paper, is set out in Table III.l. This involves eliminating the consolidated public sector deficit, mainly by strengthening the position of the National Government.

Under the scenario, the successful implementation of the present tax reform package and the expanded VAT will be sufficient to boost the tax revenue-to-GNP ratio by almost two percentage points to 17 1/2 percent of GNP over the remainder of the decade. On the exenditure side, efforts to scale back the civil service will be sufficient to maintain noninterest current outlays at their current level of 10 percent of GNP, despite rising transfers to local government units and higher wages. Meanwhile, a virtuous circle of lower deficits, declining debt, and lower domestic interest rates should enable interest payments to fall sharply, creating room for infrastructure spending to almost double to 5 1/2 percent of GNP by the end of the decade.

Achievement of this scenario, however, cannot be taken for granted. Over the past decade, fiscal reform has proved an intractable problem, even as reforms in the external, financial, and other sectors have proceeded apace. Many of the (mainly political) obstacles to fiscal reform still remain, and it will take a determined effort to overcome them. Yet if they are overcome, the Philippines would finally have resolved the last major impediment to sustained economic growth.


  • Lahiri, Ashok, K.,Dynamics of Asian Savings: The Role of Growth and Age Structure”, Staff Papers, International Monetary Fund, Vol. 36, Washington D.C., March 1989.

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  • Larrain, Felipe and Vergara, Rodrigo,Investment and Macroeconomic Adjustment: The Case of East Asia”, Striving for Growth After Adjustment: The Role of Capital Formation, World Bank, 1993.

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  • “The Philippines Country Economic Report”, World Bank Report No. 10056 (February 1992)

  • “The Philippines An Opening for Sustained Growth”, World Bank Report No. 11061 (April 1993).

  • “The East Asian Miracle: Economic Growth and Public Policy”, A World Bank Policy Research Report, World Bank, Washington D.C., 1993.

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Prepared by David Nellor.


As this has occurred, the consolidated public sector deficit has declined commensurately, to 1 percent of GNP.


The role of saving and investment, in defining the prospects for Philippine economic development, has been presented in several World Bank reports. See, for example, The Philippines Country Economic Report, No. 10056 (February 1992) and The Philippines: An Opening for Sustained Growth, Report No. 11061 (April 1993).


The authorities also plan to privatize many of the assets of the National Power Corporation (NPC), but receipts from this exercise may be retained by the enterprise itself, to improve its weak balance sheet.


Of course, to the extent that the balances have been used to repay debt—as was largely the case in 1994—there will also be a compensating expenditure saving, in the form of lower interest payments.


Two factors could boost revenues from international trade taxes in the short term; first, replacement of quantitative restrictions by tariffs and second, the rationalization of incentives, including duty free importation of capital goods.


For this reason, direct tax revenues depend heavily on withholding taxes, especially on wages.


The formula also provides, under RA 7171 and RA 7160, for some minor tax revenues to be transferred to local governments. The allotment to local government units is divided into current and capital transfers, with the former typically accounting for about four-fifths of the total.


Two factors hamper the government’s ability to adjust the wage bill. Annual wage increases are constrained to be in line with the 1994 Salary Standardization Law (SSL II), which specifies that the salary of most civil servants must be doubled over a four-year period. Employment levels, meanwhile, cannot be changed radically until Congress passes the government reorganization bill that was submitted in mid-1995.


At the same time, the primary balance, indicating the role of noninterest fiscal developments, has shown less improvement. In fact, the primary balance recorded a surplus of 4 1/2 percent of GNP in 1992 and, in the absence of privatization receipts, would not have been as large since.


In 1994, the public saving rate increased to 3 percent of GDP.


See, for example, Larrain and Vergara (1993, pages 264–5), who examine this relationship for some Asian economies.


More recently, the average has increased to over 3 percent of GDP.


This comparison with ASEAN countries, as well as subsequent comparisons, draw on IMF data for purposes of cross-country comparability. The data may not be consistent with data used elsewhere in this report.


Including receipts from excises.


The IMF provided technical assistance to the authorities in these areas.


See “Philippines - Staff Report for the 1995 Article IV Consultation and Review Under the EFF Arrangement” (EB S/95/153, 9/12/95).


Exemptions are provided for the Department of Education and Local Government Units.

Philippines: Background Papers
Author: International Monetary Fund
  • View in gallery

    PHILIPPINES: Key Fiscal Indicators, 1990–95

    (In percent of GNP)

  • View in gallery

    PHILIPPINES: National Government Debt, Balances, and Interest Payments

    (In percent of GNP)

  • View in gallery

    PHILIPPINES AND SELECTED ASEAN COUNTRIES: Fiscal Indicators, Interest Rates, and National Savings, 1985–94

  • View in gallery

    PHILIPPINES AND SELECTED ASEAN COUNTRIES: Public Expenditure and Fiscal Revenues, 1990–93

    (Ten year average in percent of GDP)