Recent economic developments and outlook

The Philippine economy continued to grow despite difficult external and domestic economic environments in 2011. The country’s GDP grew at a modest pace of 3.7 percent in 2011, lower than the government’s growth assumption of 4.5-5.5 percent for 2011 and less than half of the 7.6 percent growth in 2010. A myriad of external shocks has buffeted the economy since the beginning of the year, starting from the MENA crisis and the resulting high oil prices, the tragedies experienced by some countries in the region with their resulting supply chain disruptions, and the overall weakness of the world economy. In addition, natural calamities in the Philippines affected agriculture and infrastructure in 2011. A silver lining, however, has been the resilience in private consumption which continued to advance strongly, indicating the strength of consumer spending despite strong external headwinds and lower-than-program fiscal spending.

Macroeconomic conditions have continued to remain sound in 2011. Notwithstanding a fluid environment, authorities have successfully kept inflation within the target range of 3-5 percent for 2011 at 4.4 percent and 4.8 percent using the 2000-based Consumer Price Index (CPI) series and 2006-based CPI series, respectively. At the same time, the healthy external payments position of the country—indicated by a continued balance of payments (BOP) surplus—remained a source of resilience for the economy. Meanwhile, the Philippine banking system continued to be sound and robust, exhibiting steady asset growth, a growing deposit base, ample liquidity, sustained improvement in asset quality, and above-standard solvency ratios. The cash operations of the National Government yielded a lower deficit representing 1 percent of GDP due mainly to lower expenditures.

Authorities expect the economy to gain momentum, even as global growth continues to weaken in 2012. Economic growth is expected to accelerate to 5-6 percent on the strength of sustained public spending, timely start up of projects under the public-private partnerships (PPPs), supportive monetary policy and robust remittances. Headline inflation is expected to settle within the targeted range of 3-5 percent for 2012-2013. The fiscal deficit is anticipated to increase to 2.6 percent of GDP in 2012 even as revenue continues to rise with the pickup of expenditures after their temporary drop in 2011. On the external front, the balance of payments is anticipated to remain in surplus buoyed by higher remittances and service exports as well as capital inflows.

Macroeconomic policies

Strong economic fundamentals arising from sound policy management and commitment to the reform process have engendered confidence of both domestic and foreign investors as evidenced by positive business and consumer sentiment, capital flows and ratings upgrades of the country and the banking sector in 2011. Responsible macroeconomic management has also afforded authorities with adequate policy maneuverability to respond to external shocks in the period ahead.

On monetary policy. The Bangko Sentral ng Pilipinas (BSP) remains faithful to its mandate of maintaining domestic price stability while allowing room for non-inflationary economic growth. The BSP, therefore, continues to be watchful of evolving price and output conditions both on the global and domestic fronts, to ensure that monetary policy settings remain appropriate.

In the early months of 2011, authorities started monetary tightening on signs of broadening inflation pressures and substantial upside risk to the inflation outlook by raising policy rates twice by 25 basis points each in March and May 2011. The BSP also raised the reserve requirements by 1 percentage point each in June and August 2011 as a preemptive move to counter any additional inflationary pressures from excess liquidity. These preemptive actions have helped forestall inflation pressures. Subsequently, with demand-pull pressures expected to ease on prospects of slower output growth both globally and in the domestic economy, authorities decided to pause from their monetary tightening mode and assess the outlook for inflation and growth in the second half of 2011. In particular, renewed uncertainty over the strength and pace of the global economic recovery posed downside risk to the domestic economy. While initial assessment suggests that there should be no immediate concern for the observed uptrend in bank lending growth, such a condition required the maintenance of a prudent monetary policy stance to contain any upward pressures on asset prices. At the same time, authorities were also mindful of the remaining upside risks to inflation, including the potential impact of strong net capital inflows on domestic liquidity, pending petitions for electricity rate adjustments, and possible higher global rice prices.

Authorities would like to point out that since the time when the 2011 Article IV Consultation mission was concluded in Manila last December 13, 2011, the overall balance of global economic activity has tipped towards a further slowdown in 2012. Moreover, actual inflation turned out lower than expected in the Philippines, along with economic growth in 2011. In light of this, authorities decided to reduce policy interest rates by 25 basis points on January 19, 2012 based on its assessment that the inflation outlook remains comfortably within the target range, with expectations well-anchored. However, authorities remain cognizant that strong capital flows and their impact on domestic liquidity as well as disruptions in global oil supply continue to pose upside risk to inflation.

On fiscal policy. Authorities assure their unwavering commitment to achieve fiscal sustainability within the medium term and create fiscal space that will allow higher investment in infrastructure and social services. This commitment, along with the improvement of public debt profile resulting from prudent debt management have been recognized by markets and credit rating agencies.

In 2012, improvements in tax administration and the implementation of tax policy reforms, including the rationalization of the fiscal incentives system and the restructuring of the excise tax on alcohol and tobacco products, would aid in the attainment of the fiscal deficit target which is equivalent to 2.6 percent of GDP. In the event that these revenue gains are not sufficient to meet the fiscal objectives, authorities will reduce non-priority expenditure or speed up privatization to support planned spending. Authorities would reflect on other tax reforms after maximizing the gains from improved tax administration and simplified tax system.

On the expenditure side, with the new budget processes in place and greater transparency in public spending, enhanced efficiency in the implementation of public projects will help budget spending to meet the targeted level to boost domestic demand in 2012. In this regard, authorities have nearly released the total budget for 2012 to implementing agencies as early as January 2012. On the civil service wage bill, we would like to point out that the wage bill is merely a part of the general objective to transform the Executive branch into a more effective and efficient branch of government through the implementation of rationalization program that aims to build a leaner and well-motivated bureaucracy.

On foreign exchange policy. Authorities remain committed to a flexible exchange rate system whereby the determination of the exchange rate is left to market forces. Participation in the foreign exchange market by the BSP is limited to temper sharp fluctuations in the exchange rate for an orderly adjustment of the exchange rate to reflect current economic fundamentals. Authorities would like to emphasize that in managing protracted surge in capital flows, exchange rate adjustment and reserve accumulation are just among the broad range of measures in their toolkit. There are prudential and regulatory measures that have been effective in helping cope with the strong surge in capital flows and minimizing their negative implications on the conduct of monetary policy and financial stability during the 2008-2009 global financial crises. Authorities believe that this range of measures remain useful in the current setting. Moving forward, authorities will continue to monitor developments in the international financial markets with the view to better understand the underlying drivers of capital flows in the country to determine the appropriate policy responses to preserve macroeconomic and financial stability.

On financial sector policies. Significant headway has been achieved in improving risk management systems, strengthening the supervisory process, instituting good financial governance, enhancing coordination among financial regulators, and aligning accounting rules with international standards in recent period. These reforms have all contributed to the continued stability and soundness--balance sheets kept growing, asset quality continued to improve, and bank profitability continued to strengthen--of the Philippines banking system, amidst global economic slowdown in 2011. It is for this reason that an international credit rating agency has maintained a “stable” outlook on Philippines banks in 2011 noting that Philippine banks are likely to remain in relatively good shape even with the lingering uncertainties in the global environment.

The more recent banking reforms announced by authorities last January 2012 include: (1) requiring stand-alone thrift banks, rural banks and cooperative banks to be covered by the Basel 1.5 framework that upgrades them to higher capital adequacy standards (2) requiring banks to set aside more funds to cover non-deliverable forwards or NDFs for “net open positions” to reduce potential systemic risk and curb speculation (3) adoption of the more stringent standards of Basel 3 by commercial and universal banks in 2014, four years ahead of the timeline set by the Basel Committee on Banking Supervision and (4) adoption of a new set of enhanced standards on corporate governance in banks, as well as rules to strengthen banks’ compliance systems.

Concerns have been raised about the potential spillovers from global financial disruptions, real estate exposures, rapid credit growth and concentration and interest rate risk in the banking sector. In this regard, authorities stressed that European banks operating in the Philippines are liquid, have access to a large deposit base and have not displayed signs of stress. Trade finance and dollar funding continues. Likewise, bonds and other instruments issued from the euro zone and held by domestic banks accounted for only 1.4 percent of their total assets as of June 30, 2011. While it is true that the Philippine banking system is not totally immune to concentration risk due to the conglomerated construct of the Philippine economy at large, the BSP has been resolute in instituting reforms to effectively mitigate such risks. One step toward this end is to efficiently monitor and identify the potential extent of exposure of the banking system to financial conglomerates through conglomerate maps. Moreover, conglomerates’ revenue is well diversified, which mitigates concentration risk. Authorities would like to stress that the banking system is not securities-heavy and interest rate sensitive as banks’ holdings of debt securities constitute only 22.2 percent of their total assets. Meanwhile, authorities continue to monitor signs of potential risks that rapid credit growth may pose for lending standards and asset quality.

An important next step for bank supervision will be prompt Congressional approval of the amendments to the New Central Banking Act (NCBA) that would enhance supervision by providing supervisors with greater legal powers and protecting them from litigation, lifting the remaining constraints of bank secrecy laws on examiners, further strengthening the prompt corrective action and bank resolution framework and prescribing higher ratios for individual financial institutions which are deemed to be exposed to more than normal risks as the FSSA Update recommended. The amendments should also allow the BSP to issue its own debt securities, providing a much-needed instrument to strengthen liquidity management and enhance the effectiveness of monetary policy.

Building inclusive growth

Authorities acknowledge that while some progress had been achieved in alleviating poverty in recent decades stronger actions and more sustained efforts in promoting inclusive growth are necessary if poverty incidence was to be reduced significantly in the Philippines.

Authorities believe that to achieve inclusive growth, the country needs to attain a high and sustained growth path, provide equal access to development opportunities across social spectrum, and implement responsive social safety nets that would assist those who are left behind by the character of growth. Authorities pointed out that building inclusive growth is a key part of their medium-term development plan that focuses on five cross-cutting key strategies, namely: (a) boosting competitiveness to generate employment; (b) improving access to financing; (c) investing massively in physical infrastructure; (d) promoting transparent and responsive governance; and (e) developing human resources through improved social services.

In this regard, the 2012 National Budget is reflective of the desire of the authorities to address poverty through greater focus in funding and fulfilling anti-corruption and good governance, empowerment of the poor, inclusive economic growth, just and lasting peace and the rule of law and integrity of the environment. The 2012 budget also sustains the tradition of transparency, accountability and citizen participation in public expenditure. Consistent with the goal to ensure ample education, public health and social protection for the poor, spending on the Social Services sector receives a significant share of the 2012 National Budget. Significant portion of the 2012 National Budget also went to Economic Services Sector to support rapid, sustained and inclusive growth. Taken together, these two expenditure items constituted more than half of the 2012 National Budget. Moreover, public-private partnership (PPP) Strategic Support Fund has been funded for various PPP ventures and for the preparation of business cases and feasibility studies.

On financial inclusiveness, the BSP has been implementing programs that facilitate access of certain sectors of the economy such as the small and medium enterprises (SMEs) and the agriculture sector to formal credit and financing. This includes microfinance which provides the country’s entrepreneurial poor access to collateral-free loans and various financial services, including deposits, payment services, money transfers and insurance. The BSP’s regulatory framework for the development of microfinance has been rated as the world’s best, for three years in a row for pioneering in advocating use of responsible microfinance while ensuring adherence to safe and sound banking practices. To broaden access by small and medium-enterprises to collateral-free loans, the BSP has facilitated the development of credit surety funds or CSFs. Authorities have also intensified Economic and Financial Learning Program or EFLP which integrates all of BSP’s educational outreach activities across different sectors of the society. For the BSP, having financially-literate Filipinos is a basic foundation in building a strong and inclusive financial system.

Final Remarks

Authorities see sustained growth for the Philippine economy in 2012 even as global outlook continues to weaken. This optimism is derived from the fact that the economy has stronger foundations to endure external shocks resulting from a long history of structural reforms that they continue to pursue and home-grown sources of resilience. Authorities also see that the simultaneous running of both monetary and fiscal engines will allow for economic recovery to proceed at a more vibrant and sustainable pace.