Philippines: Staff Report for the 2016 Article IV Consultation
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International Monetary Fund. Asia and Pacific Dept
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Publication Date:
26 Sep 2016
eISBN:
9781475541076
Language:
English
Keywords:
ISCR; CR; government; break; IMF staff projection; debt; monetary policy transmission; Bangko Sentral ng Pilipinas; output gap; short-term debt; bank credit; long-term debt; Public investment and public-private partnerships (PPP); Global
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This 2016 Article IV Consultation highlights that the Philippine economy has continued to perform strongly. Real GDP regained strength from a slowdown in mid-2015 to record a robust 5.9 percent growth rate in 2015 and 6.9 percent in the first half of 2016. Both consumption and investment grew rapidly, while net exports were held back by weak external demand. Job creation was also strong: the unemployment rate declined to 6.3 percent in 2015 and 6.0 percent in the first half of 2016. The outlook for the Philippine economy remains favorable despite external headwinds. Real GDP growth is expected at 6.4 percent in 2016 and 6.7 percent in 2017 on continued robust domestic demand and a modest recovery in exports.

Abstract

This 2016 Article IV Consultation highlights that the Philippine economy has continued to perform strongly. Real GDP regained strength from a slowdown in mid-2015 to record a robust 5.9 percent growth rate in 2015 and 6.9 percent in the first half of 2016. Both consumption and investment grew rapidly, while net exports were held back by weak external demand. Job creation was also strong: the unemployment rate declined to 6.3 percent in 2015 and 6.0 percent in the first half of 2016. The outlook for the Philippine economy remains favorable despite external headwinds. Real GDP growth is expected at 6.4 percent in 2016 and 6.7 percent in 2017 on continued robust domestic demand and a modest recovery in exports.

Context

1. The Philippine economy has performed well during the past several years and the strong macro fundamentals provide a solid foundation to meet the remaining challenges. Sound macroeconomic policies have delivered solid economic growth and reduced unemployment, low inflation, and financial stability as well as a strong fiscal position. However, underemployment and poverty rates have remained stubbornly high. Inequality remains among the highest in the region. Competition has been limited including by restrictions on foreign direct investment and by regulatory behavior.

A01ufig1

Philippines: Improvements in Economic Fundamentals

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Philippines authorities; and IMF staff estimates.
A01ufig2

Philippines: Poverty and Underemployment Rates

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Philippine authorities; and IMF staff estimates.1/ Data for 2015 is first semester estimate.2/ Data for 2009 and 2012 exclude the province of Leyte.

2. Poor infrastructure has constrained private investment and job creation, and residual excess liquidity from capital inflows following the Global Financial Crisis impede monetary policy transmission. The 2015 Article IV consultation called for increasing public infrastructure and social spending, financed by raising government revenues, to help reap the Philippines’ demographic dividend and lay the foundation for sustainable growth, along with structural reforms to increase competitiveness. Public infrastructure investment has accelerated recently but remains constrained by limited government revenue collection and incomplete public financial management (PFM) reforms, along with slow spending processes. BSP initiated an upgrade of their Interest Rate Corridor (IRC) system to improve monetary policy transmission.

A01ufig3

Overall Quality of Infrastructure, 2015-16

(Scale, 1-7; higher score indicates better infrastructure quality)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: World Economic Forum; and IMF staff estimates.

3. Rodrigo Duterte, Mayor of the Philippines’ third largest city Davao, was inaugurated as the new president in June, with a ten-point economic policy agenda calling for continuing prudent economic policies and a more ambitious inclusive growth and structural reform strategy. While primarily focusing on law and order, President Duterte tapped into a desire for change among a large part of the population to tackle the high levels of poverty and inequality that persists especially in rural areas despite years of robust economic growth. The President’s ten-point plan (Box 1) includes: accelerating infrastructure investment; raising competitiveness by relaxing constitutional restrictions on foreign direct investment; ensuring security of land tenure; strengthening the education system; implementing a comprehensive tax policy reform, modernizing tax collection agencies; and improving social welfare programs. The mission discussed the ten-point agenda with the new administration and provided a number of policy options to consider, as elaborated below.

Philippines: President Duterte’s Ten-Point Socioeconomic Agenda

  • Promoting law and order.

  • Continuing and maintaining current macroeconomic policies, including fiscal, monetary, and trade policies;

  • Instituting progressive tax reform and more effective tax collection while indexing taxes to inflation, in line with the plan to submit to congress a tax reform package by September;

  • Increasing competitiveness and the ease of doing business, drawing upon successful models used to attract business to local cities such as Davao, as well as pursuing the relaxation of the constitutional restrictions on foreign ownership, except with regard to land ownership, in order to attract foreign direct investment;

  • Accelerating annual infrastructure spending to account for at least 5 percent of GDP, with public-private partnership projects playing a key role;

  • Promoting rural and value chain development towards increasing agricultural and rural enterprise productivity and rural tourism;

  • Ensuring security of land tenure to encourage investment and address bottlenecks in land management and titling agencies;

  • Investing in human capital development, including health and education systems, as well as matching skills and training to meet the demands of businesses and the private sector;

  • Promoting science, technology, and the creative arts to enhance innovation and creative capacity towards self-sustaining and inclusive development;

  • Improving social protection programs, including the government’s conditional cash transfer program, in order to protect the poor against instability and economic shocks; and

  • Strengthening the implementation of the Responsible Parenthood and Reproductive Health Law to enable, especially, poor couples to make informed choices on financial and family planning.

Recent Developments, Outlook, and Risks

Macroeconomic developments remain favorable and the financial system is sound and stable, although there are risks. Economic growth continues to be strong as robust domestic demand offsets continued weak external demand. Inflation has been below the target band, reflecting low food and oil prices, but is expected to rise to the middle of the band in 2017. The fiscal and external positions are strong. Risks remain tilted to the downside including from global financial volatility.

A. Recent Developments

4. Growth and inflation. Real GDP regained strength from a slowdown in mid-2015 to record a robust 5.9 percent growth rate in 2015 and 6.9 percent in the first half of 2016. Both consumption and investment have grown rapidly, while net exports have been held back by weak external demand. Real GDP growth is projected at 6.4 percent in 2016 and 6.7 percent in 2017 on continued robust private domestic demand and higher public spending. Exports would recover only modestly, although worker remittances and receipts from Business Process Outsourcing would help cushion the impact of the weak external environment. The output gap is expected to remain near zero in 2016–17. Amid strong economic activity, inflation fell below the target band (3±1 percent) in 2015 and the first seven months of 2016 due to lower food and fuel prices, but is expected to return to within the target range later this year and in 2017 as commodity prices stabilize and strong economic activity continues.

A01ufig4

Contribution to GDP Growth

(In percent year on year)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Haver Data Analytics; and IMF staff estimates.

Philippines: Output Gap Estimates Under Different Models

(In percent)

article image

Using IMF, WP/15/79 priors for EM countries in Appendix Table B2.

Using a specification with both real credit growth and real equity price growth with one lag.

5. Fiscal developments. The national government budget deficit reached 1.4 percent of GDP in 2015 based on IMF staff definition, below the 2 percent medium-term target because of slow budget execution early in the year. Budget execution improved thereafter reflecting enhanced public finance and procurement management, making the 2 percent deficit target attainable in 2016. This would imply a fiscal stimulus of 0.6 percent of GDP in 2016. Indeed, there are upside risks coming from better than anticipated budget execution and a higher deficit this year. The new administration plans to increase the deficit target to 3 percent of GDP starting in 2017, to raise infrastructure and social spending, implying a fiscal stimulus of 1 percent of GDP in 2017.

A01ufig5

National Government Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Philippine authorities; and IMF staff estimates.

6. Macro-financial issues. Following the global financial crisis, the Philippines received sizeable inflows, both from remittances and portfolio investment, resulting in a buildup of reserves and persistent excess liquidity, and market interest rates have often been below the floor of the BSP’s IRC. These factors have kept effective borrowing costs at historic lows and fueled credit growth alongside real estate price inflation, albeit within a reasonable range. BSP’s macroprudential policies in 2014 on real estate lending and tightening of lending standards more generally moderated bank credit growth from 20 percent in 2014 to 13.6 percent in 2015. However, there has been some rekindling as credit grew by 17.6 percent in June 2016 (y/y), with credit to construction and real estate growing above 20 percent. This, and the rapid increase in corporate leverage, warrant close monitoring by the BSP.1 2 Financial intermediation by nonbank financial institutions, which are not regulated by the BSP, remains small but has grown rapidly in recent years. The Philippines’ stock of bank credit, at 39 percent of GDP in 2015, remains lower than in other emerging market economies, mainly reflecting still low access of households to formal financial institutions, suggesting a need for further financial deepening and inclusion. Capital flows and the exchange rate have not been significantly affected by recent bouts of global financial volatility compared to neighboring countries.

Philippines: Credit Developments

Credit growth has rekindled in 2016 after slowing in 2015. While most indicators suggest that credit growth remains below typical cutoffs for credit booms, the mixed signals provided by available indicators and the composition of credit growth across sectors warrant careful monitoring. The output gap remains near zero even when financial variables are considered in the estimation.

Credit growth has picked up in 2016. Credit growth moderated from 20 percent in 2014 to 13.6 percent in 2015 following the BSP’s decision to tighten monetary policy and raise bank reserve requirements in 2014. However, credit growth has rekindled to 17.6 percent in June 2016, especially for services (18.1 percent) and industry (17.5 percent). Moreover, credit growth for construction and real estate remained above 20 percent in June 2016, warranting close monitoring of credit developments for these sectors.

A01ufig6

Contributions to Banks Loans Growth

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Source: IMF staff estimates.
A01ufig7

Bank Credit Growth by Economic Sector

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Source: IMF staff estimates.

Credit growth remains below credit boom levels according to most but not all indicators. Staff updated last year’s estimates of credit booms.1 The approach of Mendoza and Terrones (2008), which looks at deviations of real credit per capita from trend, shows that credit growth remains in line with trend. The approach of Dell’Ariccia and others (2012), which looks at deviations of the credit-to-GDP ratio from a backward looking trend, also find no evidence of credit booms, with the growth differential between credit and GDP remaining below the 10 percent cutoff. However, the approach in Chapter 3 of the IMF’s Global Financial Stability Report of September 2011, shows that the increase in the credit-to-GDP ratio remains just below the 3 percent threshold for early warning of credit booms. Similarly, the approach of Drehmann and others (2010), which looks at deviations of the credit-to-GDP ratio from a Hodrick-Prescott trend with a high smoothing parameter, finds that the credit-to-GDP ratio barely exceeds the 10 percent of GDP cutoff in 2016.

A01ufig8

Change in the Credit-to-GDP Ratio

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Source: IMF staff estimates.
A01ufig9

Credit Neutral Output Gap

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Source: IMF staff estimates.

Financial variables contain useful information about the business cycle position. Expansions coinciding with rapid credit and asset price growth are stronger, while recessions coinciding with credit and asset price busts are longer and deeper. Staff updated last year’s estimates of the output gap using the BIS approach that integrates financial variables (real credit and stock prices) into a broader measure of the output gap. The results indicate that the output gap in the Philippines in 2016–17 is near zero, although slightly positive, consistent with the recent pickup in credit growth.

1/ Chapter 2, Philippines—Selected Issues (IMF Country Report No 15/247).
A01ufig10

Bank Credit Growth and Credit to GDP

(In percent of four quarter rolling GDP)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: CEIC Data Company Ltd; and IMF staff estimates.
A01ufig11

Philippines: Residential Real Estate Price Index

(In percent year-on-year)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Bangko Sentral ng Pilipinas (BSP).

7. External sector. The current account surplus fell to 2.9 percent of GDP in 2015 despite the large drop in fuel imports (by 1.3 percent of GDP), reflecting a deceleration in remittances, a decline in exports, and a large increase in imports of capital and intermediate goods. The current account surplus is projected to fall further in 2016–17 due to higher commodity prices and infrastructure related imports. The peso depreciated vis-à-vis the U.S. dollar in 2015 but by less than other regional currencies, and it has been stable in 2016. International reserves have remained broadly unchanged since 2012 at around US$80 billion (or 231 percent of the Fund’s reserve adequacy metric) and external debt declined to 27 percent of GDP in 2015.

B. Outlook and Risks

8. Outlook. Tables 1–8 present the staff baseline scenario with real GDP growth in the 6–7 percent range. Private credit growth is consistent with a normal pace of financial development over the medium term, remaining below estimated credit boom thresholds. This scenario assumes that the authorities implement fiscal and structural policies already committed (see Box 3), including the proposed new fiscal framework with a central government budget deficit of 3 percent of GDP in the medium term. The baseline does not include new tax policy measures being formulated, and thus the revenue-to-GDP ratio is likely to remain broadly unchanged at around 15½ percent of GDP alongside public investment at about 5 percent of GDP, which is still lower than most countries in the region.

Table 1.

Philippines: Selected Economic Indicators, 2011–17

article image
Sources: Philippine authorities; World Bank; and IMF staff projections.

Fund definition. Excludes privatization receipts and includes deficit from restructuring of the previous central bank (Central Bank-Board of Liquidators).

Includes the national government, 14 government-owned enterprises, social security institutions, and local governments.

Universal and Commercial Banks. The latest observation is June 2016 (year-on-year).

Secondary market rate. The latest observation in July 2016.

In BPM6. An increase in either assets or liabilities is always positive and a decrease is always negative. Net investment is assets minus liabilities.

Includes external debt not registered with the central bank, and private capital lease agreements.

In percent of exports of goods and nonfactor services.

Reserves as a percent of short-term debt (including medium- and long-term debt due in the following year).

Average January-June 2016.

Table 2.

Philippines: National Government Cash Accounts, 2011–17

(In billions of pesos, unless otherwise indicated)

article image
Sources: Philippine authorities; and IMF staff projections.

Projections include possible gains from tax administrative measures for 2015 and 2016.

Includes other percentage taxes, documentary stamp tax, and noncash collections. Noncash collections are also reflected as tax expenditures under current expenditures.

Includes privatization receipts as revenue and excludes the operations of the Central Bank-Board of Liquidators (CB-BOL).

Table 3.

Philippines: National Government Cash Accounts, 2011–17

(In percent of GDP, unless otherwise indicated)

article image
Sources: Philippine authorities; and IMF staff projections.

Projections include possible gains from tax administrative measures for 2013 and 2014.

Includes other percentage taxes, documentary stamp tax, and noncash collections. Noncash collections are also reflected as tax expenditures under current expenditures.

Includes privatization receipts as revenue and excludes the operations of the Central Bank-Board of Liquidators (CB-BOL).

Excludes privatization receipts from revenue.

Consolidated (net of national government debt held by the sinking fund) and excluding contingent/guaranteed debt.

Nonfinancial public sector includes the national government, CB-BOL, 14 monitored government-owned enterprises, social security institutions, and local governments. Debt is consolidated (net of intra-nonfinancial public sector holdings of debt).

Defined as the deficit, plus amortization of medium- and long-term debt, plus the stock of short-term debt at the end of the last period.

Table 4.

Philippines: General Government Operations, 2011–17 1/

(In percent of GDP)

article image
Sources: Philippine authorities; and IMF staff projections.

Based on GFSM2001. General government includes the national government, social security institutions, and local governments.

National government only. The expense item related to SSIs and local governments are not separately available and are included in the amount for expense not elsewhere classified.

Table 5.

Philippines: Depository Corporation Survey, 2011–17 1/

(End of period, in billions of pesos, unless otherwise indicated)

article image
Source: IMF, International Financial Statistics, and IMF staff projections.

It includes the Bangko Sentral ng Pilipinas (BSP), the accounts of the Central Government arising from its holdings of transactions with the International Monetary Fund, and Other Depository Corporations such as universal and commercial banks, thrift banks, rural banks, non-stock savings and loan associations and non-banks with quasi-banking functions.

Table 6.

Philippines: Balance of Payments, 2011–2017 1/

(In billions of U.S. dollars)

article image
Sources: Philippine authorities; and Fund staff projections.

In BPM6.

An increase in either assets or liabilities is always positive and a decrease is always negative. Net investment is assets minus liabilities. A negative financial account balance means that the change in liabilities is greater than the change in assets, while a positive financial account balance means that the change in assets is greater than the change in liabilities.

As a percent of short-term debt.

In percent of goods and nonfactor services exports.

Current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at the end of the previous period.

Table 7.

Philippines: Medium-Term Outlook, 2013–21

(In percent of GDP, unless otherwise indicated)

article image
Sources: Philippine authorities; and IMF staff projections.

Includes the national government, 14 government-owned enterprises, social security institutions, and local governments. Cash basis.

In BPM6.

Reserves as a percent of short-term debt (including medium- and long-term debt due in the following year).

Based on the depository corporations survey. In addition to universal and commercial banks, it includes thrift banks, rural banks, non-stock savings and loan associations and non-banks with quasi-banking functions.

Table 8.

Philippines: Baseline and Staff’s Preferred Scenarios, 2015–21 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Philippine authorities; and IMF staff calculations.

The assumptions underlying the baseline and staff’s recommended scenario are presented in Box 2. Staff’s recommended scenario includes a tax reform that raises 3 percent of GDP in extra revenue over time, in increments of 1 percentage point per year starting in 2017. The extra revenue is used to finance additional social and capital expenditure by equal amounts. The larger fiscal multipliers of investment and social expenditure than that of taxes lead to an increase in real GDP growth of 0.5 percent relative to the baseline scenario in 2017-19, with growth increasing by another 0.1 percent in 2018 and 0.2 percent in 2019 due to crowding in of private investment and enhanced public investment efficiency. Over the medium term, growth rises to 8 percent in 2020-21 due to higher public and private investment, gains in productivity associated to the liberalization of FDI and reform of land titles, and faster employment growth due to labor market reforms. Inflation raises somewhat reflecting the demand stimulus partly offset by a tightening of monetary policy and higher potential growth, and the current account surplus declines because of higher investment and lower saving.

The estimated impact of the reforms included in the staff’s recommended scenario are based on Komatsuzaki 2016 (Improving Public Infrastructure in the Philippines, IMF WP/16/39) and Dabla-Norris and others 2015 (Structural Reforms and Productivity Growth in Emerging Market and Developing Economies, IMF WP/16/15).

Philippines: Assumptions Underlying the Baseline and IMF Staff’s Recommended Scenarios

Baseline scenario. This scenario assumes that the authorities implement fiscal and structural policies already committed. In particular:

  • National government budget deficit of 2 percent in 2016, rising to 3 percent in 2017–21;

  • National government revenue projection assumes unchanged tax policies and tax administration;

  • National government expenditures reflect PFM improvements already underway, with capital and equity expenditure rising from 3.3 percent of GDP in 2015 to 5.3 percent in 2021; and

  • Structural reforms reflect measures already underway during the previous administration, including PFM and other governance reforms (e.g., the PPP and PFM laws), both in line with track records during the last few years, and structural reforms for which legislation has been passed such as the new competition law, opening up the financial sector to foreign investment, and the Right of Way law for infrastructure projects.

IMF staff’s recommended scenario. This scenario includes staff’s recommended fiscal and structural reforms aimed at achieving the authorities’ development objectives for growth and poverty reduction, building on the government’s ten-point economic agenda. In particular:

  • National government budget deficit of 2 percent in 2016, rising to 3 percent in 2017–21;

  • National government revenue projection assumes the IMF staff’s preferred revenue package, yielding 3.0 percentage points of GDP gradually over the 2017–19 period;

  • National government expenditures incorporate additional social spending of 1.5 percentage points of GDP and additional infrastructure spending of 1.5 percentage points of GDP (both relative to the baseline scenario), financed by the additional revenue collections; and

  • Additional structural reform measures, including easing foreign investor restrictions in the negative list and in the constitution, land titling reform for use of land as collateral in agriculture, and labor market reforms, which are on the President’s platform but have not yet been legislated.

9. Risks. On balance, risks to the outlook remain tilted to the downside. Upside risks include a stronger lift to domestic demand from low commodity prices and additional improvements in budget execution. On the downside, slow budget execution or revenue shortages could dampen growth. Moreover, lower growth in China and the region, tighter global financial conditions, and a surge in global financial volatility could lead to capital outflows and tightening of domestic financial conditions with attendant impacts on investment and growth, though the Philippines is less vulnerable to China and financial spillovers than the rest of the region. Risks to financial stability stem from concentration relating to the conglomerate structure and rapid credit expansion in the real estate sector, as elaborated below. Finally, natural disasters pose an ongoing risk. The Philippines is well equipped to respond if any of these risks materialize, particularly given the country’s strong fundamentals and ample policy space. For instance, in response to possible volatility or a reversal in capital flows, there is scope to allow for exchange rate flexibility, limiting intervention to smoothing excess volatility, and for easing monetary or fiscal policy if the real economy slows down significantly.

10. Scenario analysis. The baseline scenario, which only includes the fiscal and structural policies already committed, falls short of achieving the authorities’ stated development objectives for growth and poverty reduction. Table 8 and Box 3 provide a second scenario that incorporates the staff’s recommended fiscal and structural reforms aimed at achieving the authorities’ development objectives, building on the new government’s ten-point plan. Substantially higher public infrastructure spending will require raising additional revenues, supported by a more realistic fiscal framework that maintains debt sustainability. Monetary policy will need to remain vigilant given the additional fiscal stimulus and until the fiscal deficit stabilizes at a higher level. Under the staff’s recommended scenario, annual growth would be about 1 percentage point higher owing to higher investment, including private investment crowded in by higher public investment, and bolder structural reforms that increase total factor productivity (TFP) growth gradually over the medium term.3 Well-targeted and higher social spending would help reduce poverty towards the government’s target. Enhanced infrastructure investment, including in areas that have benefited little from such investment in the past, would help create jobs and make growth more inclusive. Structural reforms, such as liberalizing foreign investment and land use, would help catalyze the effects of higher government spending.

A01ufig12

Philippines: Potential GDP Growth in the Baseline and Staff’s Recommended Scenario

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Philippine authorities; and IMF staff estimates.

C. External Sector Assessment

11. The external sector balance has declined somewhat as noted above but remains moderately stronger than warranted by fundamentals and desirable policies (Appendix 3). This is primarily due to structural impediments to investment and precautionary savings to self-insure against natural disaster risk, rather than a misaligned real exchange rate level. Accordingly, the current account gap should close over the medium term as public infrastructure investment increases in line with the authorities’ plans. Staff assess the peso to be broadly in line with fundamentals and desired policies because the current account gap is due to the above-mentioned structural factors. While the level of international reserves is above the Fund’s Reserve Adequacy metric, this is broadly justified by the vulnerability to natural disasters and capital flow volatility. Staff continues to support the BSP’s view that the exchange rate should act as a buffer to external shocks and be allowed to move freely in line with market forces, with intervention limited to smoothing excessive volatility in both directions.

Authorities’ Views

12. The authorities appreciated staff’s analysis of the medium-term outlook and alternative scenarios. They are optimistic about the growth potential of the economy despite weak global prospects. Consistent with their strategy to boost infrastructure spending, they project growth at 6.0–7.0 percent in 2016, 6.5–7.5 percent in 2017, and 7–8 percent during 2018–22. The authorities also considered that the current account surplus reflects structural bottlenecks rather than exchange rate misalignment. The current account surplus should decline going forward in line with the plans to boost infrastructure investment, while exchange rate flexibility would continue.

Policies for Macroeconomic and Financial Stability

Stepping up infrastructure and human capital investment will need to be supported by strengthening the macroeconomic policy framework, while containing financial stability risks. Substantially higher public infrastructure spending will require the government to raise additional revenues, supported by a more realistic fiscal framework that maintains debt sustainability. Monetary policy will need to remain vigilant to risks of overheating given the additional fiscal stimulus and until the fiscal deficit stabilizes at a higher level. The main macro-financial risks that will need to be managed are concentration risks associated with the economy’s conglomerate structure and sectoral risks stemming from the pickup in credit growth particularly in the real estate sector.

A. Fiscal Policy

13. A two-pillar framework would suit the Philippines, with the public debt-to-GDP ratio as an anchor, complemented by a central government overall deficit as an operational target (Box 4). The debt ratio would set an upper limit to fiscal slippages and preserve fiscal sustainability, while the deficit target would provide operational guidance for policy formulation as it has a close link to debt dynamics. The operational target should be based on realistic growth and revenue projections and implemented flexibly to avoid procyclical fiscal management.

A01ufig13

Debt to GDP and Credit Risks

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Bloomberg, L.P.; Markit, and IMF staff estimates.
A01ufig14

Revenue and Expenditure

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Data provided by the authorities; and IMF staff estimates.

Philippines: New Fiscal Framework

The public debt-to-GDP ratio should serve as the fiscal anchor. This should be complemented with a flexible overall fiscal deficit-to-GDP ratio as the operational target.

Given the Philippines’ low and declining debt-to-GDP ratio, the new fiscal framework should aim to preserve fiscal sustainability, while at the same time be flexible enough to allow for fiscal space to deal with uncertainties and risks. There are four main types of fiscal rules: debt rules, budget balance rules, expenditure rules, and revenue rules. These rules have different properties with respect to debt sustainability, economic stabilization, operational guidance for fiscal policy, and transparency. Many countries combine multiple fiscal rules given the trade-offs among them.

Debt rules set an explicit limit for public debt in percent of GDP. This type of rule is the most effective in terms of ensuring convergence to a debt target. However, it does not provide sufficient guidance for fiscal policy when debt is well below its ceiling.

Budget balance rules constrain the variable that primarily influences the debt ratio and is largely under the control of policymakers. They can be specified based on the overall balance, or can explicitly account for economic shocks. The latter add flexibility, but estimating the adjustment, typically through the output gap, makes it more difficult to communicate and monitor.

Expenditure rules usually set permanent limits on total, primary, or current spending in absolute terms, growth rates, or in percent of GDP. As such, these rules are not linked directly to the debt sustainability objective since they do not constrain the revenue side. They can provide, however, an operational tool to trigger the required fiscal consolidation consistent with sustainability when they are accompanied by debt or budget balance rules. Another advantage of expenditure rules is that they are relatively easy to implement and monitoring compliance is relatively straightforward.

Revenue rules set ceilings or floors on revenues and are aimed at boosting revenue collections and/or preventing an excessive tax burden. These rules are also not directly linked to the control of public debt, as they do not constrain spending.

Staff recommends a two-pillar approach for the Philippines, with the consolidated general government debt-to-GDP ratio as an anchor, complemented by a central government overall deficit as an operational target. A natural anchor to preserve fiscal sustainability would be the debt ratio, which creates an upper limit to repeated (cumulative) fiscal slippages.1 However, the estimation of the ratio ex ante is subject to a large degree of uncertainty, and its effective implementation requires an operating target, which would be under the direct control of the government. For this operating target, a central government overall deficit is appropriate, as the authorities are used to the concept and operation, and it also has a close link to debt dynamics.

The fiscal anchor should target a broadly stable debt-to-GDP ratio at the current level of 36 percent of GDP, while the deficit target should be raised to 3 percent of GDP to allow for priority expenditures and retain some margin. A rise in the deficit target from 2 percent of GDP to 3 percent from 2017 would reduce the debt-to-GDP ratio to under 31 percent by 2021, thus providing a margin of 5 percent of GDP to respond to materialization of fiscal risks and uncertainty around the baseline projections. For instance, PPPs have continued to expand from ₱1.1 trillion in 2013 to ₱1.4 trillion in June 2016, with a proportionate increase in associated contingent liabilities. Natural disasters are also a threat and their economic cost can be large. For example, typhoon Yolanda in 2013 caused damages by 4 percent of GDP.2 Moreover, a one-standard deviation shock to GDP growth for two years (with growth falling to 4.5 percent in 2017 and 2018) would increase the debt-to-GDP ratio by 3 percentage points by 2021.

A01ufig15

Philippines; Medium-Term Fiscal Projections

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

The new administration has set a medium-term overall deficit target of 3 percent based on appropriate revenue projections. The previous administration’s fiscal deficit targets were based on aspirational revenue targets. Moreover, expenditure was withheld in case of a revenue shortfall to secure the 2 percent of GDP fiscal deficit target, which impeded efficient expenditure and risked procyclical fiscal management. In July 2016, the Development Budget Coordinating Committee (DBCC) decided to set the deficit target at 3 percent of GDP from 2017 onwards based on appropriate revenue projections. Although this initiative is likely to reduce the revenue shortfalls, these may still happen due to cyclical fluctuations, in which case staff would favor a flexible deficit target that allows automatic stabilizers to work, to avoid withholding expenditure and making fiscal policy procyclical.

Increasing flexibility in the deficit target warrants consideration. The overall deficit target has an inherent weakness because, if implemented too rigidly, it could force procyclical fiscal management. A number of options are available to increase flexibility, depending upon country circumstances. For example, an escape clause under well-defined circumstances (e.g., emergencies caused by natural disasters and exceptionally adverse national economic conditions) and clear guidelines on how to get back on the stable debt path would prevent procyclical fiscal management in severe downturns.

1/ The convergence of the debt-to-GDP ratio is the appropriate criterion for fiscal solvency because it ensures that the intertemporal budget constraint of the government is met and because GDP represents the pool of resources over which the government can potentially have claims to service the debt. 2/ EM-DAT: The CRED/OFDA International Disaster Database.

14. The fiscal anchor should target a broadly stable consolidated general government debt-to-GDP ratio at the current level (36 percent of GDP) over the medium term, while the national government deficit target should be increased to 3 percent of GDP. Public debt decreased from 44 percent of GDP in 2009 to 36 percent in 2015. While it does not need to decline further, particularly given the large infrastructure and social needs, the credibility of fiscal management earned in recent years needs to be preserved. A broadly stable debt-to-GDP ratio balances these two considerations. The deficit target of 3 percent of GDP, higher than the 2 percent under the previous administration, would allow the authorities to address the Philippines’ large infrastructure and social gaps to promote inclusive growth. It would also reduce the debt-to-GDP ratio to under 31 percent in 2021, thus providing a margin of 5 percent of GDP to respond to materialization of fiscal risks and uncertainty around the baseline projections through flexible implementation.

15. The Philippines needs to reform its tax system and administration to collect more revenue for additional infrastructure and social spending and to make it more equitable and efficient. Tax collections are low compared to neighboring countries, reflecting low compliance and extensive exemptions, yet the personal income tax brackets have crept upwards due to inflation. Staff supports the authorities’ push for a comprehensive tax policy reform that is net revenue positive with due attention paid to equity. The comprehensive tax reform package could include a reform of the personal income tax (PIT) that simplifies the rate structure, indexes tax brackets for inflation, and eliminates exemptions such as that of the minimum wage and that of the 13th month salary (Box 5).4 Revenue losses from the PIT reform could be more than offset by higher excises on fuel (including diesel, which is currently not subject to an excise tax) as well as rationalization of VAT exemptions (for senior citizens, disabled people, electricity transmission, social housing, and cooperatives),5 and excises on sweetened beverages and higher motor vehicles taxes or registration fees. The package could also include simplifying the corporate income tax (CIT) rate structure and rationalizing tax incentives. A harmonization of financial sector taxes as part of the ASEAN financial integration roadmap would reduce transaction costs and promote financial intermediation. Staff supports the Department of Finance’s efforts to amend the bank secrecy law to allow the tax authorities access to individual bank account information and make tax evasion a predicate crime for money laundering in order to improve the efficiency and equity of revenue collection. More broadly, strengthening tax administration should be a priority, although substantial revenue gains would be expected only in the longer term.

A01ufig16

Goverment Revenues, 2014

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Source: IMF, Goverment Finance Statistics.

Philippines: Comprehensive Tax Reform Package

The IMF with the World Bank proposes a comprehensive tax reform package that is net revenue positive, equitable, and efficient.

A comprehensive tax reform is needed that is net revenue positive with due attention paid to equity and efficiency. There are several important problems in the tax system, principally including: (i) the extreme erosion of the corporate income tax base through the granting of myriad investment incentives—largely in the form of long tax holidays, followed by in many cases a permanent tax rate of 5 percent in lieu of all other regular taxes; (ii) the strict banking secrecy law, which prohibits the Bureau of Internal Revenue (BIR) from obtaining any data regarding taxpayer’s income or wealth from Philippine banks; and (iii) the erosion over the last 20 years of the tax bracket levels for the personal income tax and the ad hoc adjustment of the PIT through nonsystematic exemptions and measures. The latter two problems have especially important implications for equity.

The IMF with the World Bank provided a comprehensive tax reform proposal (see table). This proposal takes as anchors: the need to reduce investment incentives—while recognizing that this is not possible in full or immediately—in order to improve economic efficiency and to permit, eventually, a reduction of the headline CIT rate;1 the need to ease the strict bank secrecy law which prevents enforcement of modern tax compliance with regard to income taxes—and which will ultimately reduce the attractiveness of the country for legitimate international investors; the goal of rationalizing the treatment of different forms of income from capital; the need to improve the logic and equity of the PIT structure; and the need to increase the level of taxation of fuel, both to raise revenue and to mitigate substantial negative externalities including health and congestion effects. All of these factors bear on the competitiveness and attractiveness of the Philippines as a location for investment.

Philippines: IMF-World Bank Comprehensive Tax Reform Proposal

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1/ In particular, reduction of the CIT rate from 30 percent to 25 percent should only be considered if fiscal incentive rationalization has already started. The Philippines already has the lowest outturn for corporate taxes in ASEAN while having the highest rate because of the numerous tax incentives from BOI, PEZA, and other regional incentive schemes (e.g., Subic, Clark and other free trade zones). Moreover, the Philippines also has the lowest FDI-to-GDP ratio even after having the most generous tax incentive structure.

16. The authorities should formulate a medium-term public infrastructure plan with clear prioritization of projects and appropriate choices between budgetary and PPP spending, with due consideration of contingent liabilities (CLs). Staff support the authorities’ target to increase public infrastructure spending to at least 5 percent of GDP over the medium term, which would still be below the average level in the rest of the region,6 and would favor higher infrastructure spending if done efficiently and if additional revenues are available to finance it. These investments would be more effective for poverty reduction if focused on areas such as telecoms, logistics, ports, healthcare and schools, particularly in rural areas and smaller cities. They should aim to encourage creation of high quality jobs, boost human capital of the growing young population, alleviate supply bottlenecks, and provide a basis for more geographically balanced development. Staff noted that the IMF, jointly with the ADB, stands ready to help the authorities increase efficiency and review investment guidelines including PPPs through a Public Investment Management Assessment (PIMA). Staff welcomed the Right of Way Act that will help speed up the implementation of public infrastructure, and support the proposed PPP Act that will strengthen the planning and implementation framework for PPPs. Regarding CLs, the temporary PPP policy guidelines that fully guarantee the debt of PPP projects should be reconsidered.

Authorities’ Views

17. The authorities appreciated the debt sustainability analysis that supported the medium-term fiscal targets and were in broad agreement with the proposed fiscal anchor. They plan to target a 3 percent of GDP fiscal deficit starting in 2017 while making revenue projections more realistic. The authorities are confident that capacity including at the level of line ministries has improved sufficiently to achieve the spending level necessary to achieve the target. A Public Investment Management Assessment (PIMA) focused on practical recommendations would be useful.

18. The government plans to prioritize infrastructure investment on inter-island connectivity, logistics, farm-to-market roads and tourism sites, and address congestion in Metro Manila and other urban areas, as well as social spending. To expedite decongestion and critical infrastructure projects, the administration has requested emergency powers from congress for a limited period of time. This would authorize the President to adopt alternative methods of procurement for the construction repair, rehabilitation, improvement or maintenance of transportation projects aimed at the reduction of traffic congestion in Metro Manila and other urban areas. These include limited source bidding or selective bidding, direct contracting or single source procurement, repeat order, shopping, and negotiated procurement.

19. The government plans to submit a tax reform plan to congress by mid-September. It would be net revenue positive and include a higher income tax threshold and lowering of the PIT tax rates coupled with expansion of the VAT base by limiting VAT exemptions, hikes in fuel excise taxes, and introduction of excise tax on sweetened beverages. They agreed that any reduction in CIT rates should be accompanied by rationalization of tax incentives.

B. Monetary Policy

20. The flexible inflation targeting regime has served the Philippines well. BSP enhanced its capacity for liquidity and inflation forecasting recently, strengthening the framework. Headline inflation has generally fallen within the target band in recent years and greater exchange rate flexibility has helped cushion the impact of external shocks. However, most of the liquidity injected by the buildup of international reserves in the period of unconventional monetary policies in the advanced economies was passively sterilized by the BSP’s Special Deposit Account (SDA) Facility. This was partly because the BSP charter limited the BSP’s ability to issue its own debt securities for monetary operations, leading to excess liquidity and lower money market interest rates that continue to impede monetary policy transmission. Staff supports the reform to the IRC that would improve the transmission of monetary policy, and recommended resubmitting amendments to the BSP charter that would allow for issuance of BSP securities, recapitalization of the BSP, and money market development plans.

21. Excess liquidity in the banking system has declined slightly since mid-2013 but is still substantial. It is currently being absorbed by the Overnight Deposit Facility (previously the SDA Facility), Overnight RRP Facility, Term Deposit Facility (TDF), and through the banks’ required reserves. In early June, the BSP introduced a new IRC, without changing the de facto monetary policy stance (Box 6). By expanding the liquidity absorption using the new TDF auctions, the IRC aims at aligning market interest rates with the policy rate and improving the transmission mechanism in line with Fund TA advice.

22. The current monetary policy stance is appropriate. Inflation is projected at the bottom of the BSP’s target range this year, and to rise to the center of the band next year, as the one-off effects of lower commodity prices dissipate and domestic demand remains strong. While Fund staff estimates show that the effective policy interest rate is broadly in line with Taylor rule implied levels, there is excess liquidity and the transition to the new IRC is ongoing. The baseline scenario incorporates the implementation of the new IRC, with market rates gradually converging to the policy rate with the scaling up of deposit auctions. Significantly faster-than-projected credit growth with inflationary pressures, or a stronger-than-expected impact of the fiscal expansion on inflation would warrant a monetary policy tightening relative to the baseline. On the other hand, the Philippines has space to loosen monetary policy should downside risks or a shortage of liquidity materialize, including by reducing the banks’ required reserve ratio, which is among the highest in the region.

A01ufig17

Philippines: Headline Inflation Projection and Target Band

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Philippine authorities; and IMF staff estimates.

Philippines: Monetary Transmission and the Interest Rate Corridor

The BSP’s IRC with liquidity operations is designed to strengthen the effectiveness of monetary policy while maintaining the current monetary policy stance. Thus far, implementation of the new IRC has proceeded smoothly.

Structural excess liquidity has caused market interest rates to trade below the BSP’s policy rate. The rate on the overnight reverse repurchase (RRP) operations is the key policy rate to signal the BSP’s monetary policy stance. However, most of the liquidity injected by the buildup of reserves in the period of unconventional monetary policies in the advanced economies was passively sterilized by the BSP’s Special Deposit Account (SDA) Facility. This reflected the limited amount of treasury securities held by the BSP for the RRP operations and inability to issue its own debt securities. Since the BSP lowered the SDA rate without changing the RRP rate in 2013, market interest rates have followed the SDA rate and remained significantly below the policy rate, with the SDA rate becoming a more relevant benchmark rate.

A01ufig18

Philippines: Main Sterilization Instruments 1/

(In billions of peso)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: BSP; and CEIC Data Company Ltd.1/ Data as of June 2016; except for forward position (as of May 2016).

BSP adopted a new IRC with liquidity operations to strengthen the effectiveness of monetary policy. On June 3, 2016, the BSP formally shifted its monetary operations to an IRC system that aims to influence short-term market interest rates to move closely with the BSP’s policy rate. The IRC is structured as a mid-corridor system, with the Overnight Lending Facility (OLF) and the Overnight Deposit Facility (ODF) (renamed from the SDA facility) forming the upper and lower bounds of the corridor, while the overnight RRP rate is set at the middle of the corridor. BSP also introduced the Term Deposit Auction Facility (TDF) as the main tool for absorbing liquidity and as a variable rate auction supporting price discovery in the money market. The initial TDF auctions have been small and were oversubscribed by a large margin and market rates have remained at the floor of the IRC. BSP is expected to increase its deposit auction volumes to promote gradual convergence of TDF and market interest rates toward the policy (RRP) rate.

The level and structure of the IRC was calibrated to the desired neutral monetary policy stance. BSP clearly communicated that the IRC reforms were primarily operational in nature and have not materially affected prevailing monetary policy settings upon implementation despite a drop in the policy rate (RRP). In particular, the interest rate at the floor of the corridor, where the bulk of BSP’s liquidity absorption with the market currently takes place, has been kept steady since the launch of the IRC system. This is consistent with staff estimates of the effective policy rate (measured by the weighted average of SDA and RRP rates) and SDA rate implied by the traditional and augmented Taylor rule reaction functions, suggesting that the IRC policy rate settings are broadly appropriate in current conditions. Once most of the liquidity is absorbed through open market operations and market rates are well anchored within the corridor, the BSP plans to reduce the relatively high required reserve ratio on banks gradually to minimize the risks of financial disintermediation.

A01ufig19

Philippines: Policy Rates, Interbank and T-Bill Rates

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Bloomberg L.P.;, Haver Analytics; and Philippine Dealing and Exchange Corp. (PDEX).
A01ufig20

Taylor Rule Estimates—Effective Policy Rate

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Authorities’ Views

23. Monetary policies of some advanced economies have led to surges in capital inflows, which continue to pose a challenge for monetary policy formulation and implementation. In their view, the favorable inflation performance suggests that the BSP has sufficiently sterilized the resulting excess liquidity through its deposit facilities. It has continued to rely on its broad toolkit for monetary policy such as the use of reserve requirements to manage liquidity and the conduct of foreign exchange operations to smooth volatility. It has also introduced new sterilization tools and instruments to actively manage liquidity under the IRC system. The new IRC is an operational adjustment designed to improve monetary policy transmission, and the experience thus far has been favorable. The BSP was in broad agreement with staff’s policy recommendations concerning monetary policy going forward.

C. Macro-Financial Linkages and Systemic Financial Stability Risks

24. The main macro-financial risks are concentration risks associated with the conglomerate structure of the economy and rapid credit growth to real estate. Building upon last year’s Article IV consultation, the staff assessed macro-financial linkages. It prepared updated estimates of credit cycles (Box 2), analyzed bank-corporate linkages more deeply and updated the corporate stress tests (Box 7), and advised the authorities to fill data gaps identified using the Fund’s Balance Sheet Approach (Box 8). Several initiatives are underway to fill these data gaps, including the Securities and Exchange Commission’s (SEC’s) efforts to enhance corporate sector balance sheet data, as well as other efforts covering shadow banking activities by real estate developers.

A01ufig21

Philippines: Macro-Financial Linkages

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Philippine Nonfinancial Corporates: Limited Aggregate Risks Mask Pockets of Vulnerability

Nonfinancial corporate debt in the Philippines is now comparable to peers although foreign exchange exposure is limited. Overall debt at risk is still low but there are pockets of vulnerability. Concentration risks warrant continued monitoring.

Aggregate debt of Philippine nonfinancial corporates (NFCs) is expanding rapidly and is now comparable to that of its peers, although foreign exchange (FX) exposure is limited. Debt of the universe of Philippine NFCs increased from around 28 percent of GDP in 2009 to just under 42 percent in 2015, driven chiefly by the issuance of corporate bonds and domestic bank loans in local currency. Consequently, although NFC debt is now at a level comparable to that of many peers, aggregate FX exposures have remained low at under 28 percent of total debt, or about 12 percent of GDP in 2015.

A01ufig22

Nonfinancial Corporate Debt, 2015

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Dealogic; Bank for International Settlements; IMF, International Financial Statistics; and IMF staff estimates.

Firm-level stress tests show that overall debt-at-risk is still low, but there are pockets of vulnerability. Staff updated last year’s stress test exercise1 for 4,083 firms covered by the Orbis database and found debt-at-risk (debt of firms with an interest coverage ratio below 1.5) is relatively modest at 32 percent of total debt under the most severe scenario—a level similar to that of other emerging market economies (EMEs) in 2013. However, risks remain concentrated in particular sectors such as real estate and other services.

Concentration risks arising from the conglomerate structure and rapid expansion of real estate developers warrant continued monitoring. Using data for 20 large Philippine corporates (9 banks, 7 real estate developers, and 4 holding companies), staff assessed whether pockets of vulnerability can pose wider systemic risks following Segoviano and Goodhart (2009).2 Staff found that systemic risk has declined since the GFC, although it has ticked up of late, but at the same time, real estate developers are becoming more systemically important. Given the rapid expansion of their activities, including shadow banking, and links through the conglomerate structure, real estate developers continue to warrant close monitoring.

A01ufig23

Debt-at-Risk Under Different Shocks 1/

(In percent of total debt)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Orbis; and IMF staff estimates.1/ “Large FX shock”: 20% earnings, 30% FX and 30% interest payment, sector-level natural hedge; “Large IR shock”: 20% earnings, 10% FX and 50% interest payment, sector-level natural hedge.2/ Median of a group of 16 EMEs in 2013.
A01ufig24

Expected Number of Corporates in Distress if at Least One Corporate Becomes Distressed

(Number of corporates out of 20)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: FSM, and IMF staff estimates.
A01ufig25

Probability That All 13 Non RE Developers Go into Distress if all Seven RE Developers Go into Distress

(In percent)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: FSM, staff estimates.
1/ Chapter 3 of Philippines—Selected Issues, IMF Country Report No. 15/247. 2/ This method estimates the joint density of portfolio returns given each firm’s individual probability of distress—the probability that returns of a firm in the portfolio are below a given threshold—using the principle of maximum entropy and a copula approach (see IMF, WP/09/04), The density is used to compute objects of interest, such as those presented in the two charts at the bottom.

Philippines: Addressing the Remaining Data Gaps Continues to be a Priority

There are significant data gaps on balance sheet exposures of other financial corporations, nonfinancial corporations, and households. Several initiatives are underway by BSP, SEC, and other agencies to fill these gaps but it will be some time before the data gaps are filled.

Staff used the Fund’s Balance Sheet Approach (BSA) to identify data gaps. The BSA is an analytical representation of the balance sheet of institutional sectors including their cross-holdings. It is typically used to assess the exposure of individual sectors to shocks as well as to study how shocks get transmitted across sectors.

Philippines: Net Intersectoral Asset and Liability Positions

(Balance Sheet Matrix)

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The main gaps pertain to “Other Resident Sectors” and the breakdown of Government assets. The Philippines does not yet systematically collect information on several resident sectors, for example it is still in the process of compiling the Other Financial Corporations Survey (OFCS). Moreover, the breakdown of external positions of the nonbank and nongovernment sectors is also not available in the International Investment Position (IIP) and balance of payments (BOP) statistics. Finally, Philippine Government Financial Statistics (GFS) only contain information on liabilities, and does not disaggregate “Other Resident Sectors.”

The Philippine authorities have several ongoing initiatives to fill these data gaps. Most importantly, the Securities and Exchange Commission (SEC) is responsible for two main parallel processes to collect financial statement data more efficiently and in greater detail: implementing the extensible business reporting language (XBRL) and the comprehensive form of financial statements (CFFS). Data collected by SEC through these initiatives will feed into several important surveys, such as OFCS, BOP, IIP, flow of funds (FOF), sectoral balance sheet (SBS), debt securities statistics, corporate leverage, and a financial social accounting matrix (FSAM). In addition, BSP is working with the Housing and Land Use Regulatory Board (HLURB) to collect standardized information about certain aspects (e.g., trade receivables) of the balance sheet of real estate developers.

Ultimately, the Philippine Statistics Authority (PSA) will consolidate the data into a sectoral balance sheet (SBS), although likely not before 2018.

Philippines: Main Ongoing Initiatives to Address Data Gaps

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Source: Bangko Sentral ng Pilipinas (BSP), Department of Economic Statistics; and discussion during the 2016 Article IV consultation.

25. Systemic risks appear contained but merit continued monitoring. While most indicators suggest that credit growth remains below typical cutoffs for credit booms, the mixed signals provided by available indicators and the composition of credit growth across sectors warrant careful monitoring to continue assessing the need for macroprudential measures, including countercyclical capital buffers (Text table), supported by strong microprudential supervision. Firm-level stress tests show that overall debt-at-risk is still low in nonfinancial corporates but there are pockets of vulnerability, where leverage has increased and is concentrated. Nonfinancial corporate debt in the Philippines is now comparable to peers although foreign exchange exposure is limited. A part of real estate financing, while likely still small, is provided by real estate developers to household borrowers who cannot yet borrow from banks but data gaps hinder further assessment. Concentration risks arising from the conglomerate structure and rapid expansion of real estate developers warrant continued monitoring. When credit growth becomes excessive for some sectors, the BSP would consider targeted macroprudential policy responses. Such measures could include higher risk weights on real estate loans and lending to real estate developers. Additionally, concentration risks associated with conglomerate structures and rising corporate leverage make it important to allow the additional Single Borrower Limit (SBL) for PPP to lapse in December 2016 as planned. Finally, the banks’ ability to absorb mark-to-market losses from higher market interest rates and corporate vulnerabilities relating to exchange rate shocks should be further assessed with enhanced balance sheet data.

Philippines: Prudential Policy

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26. The authorities’ initiatives to strengthen systemic risk monitoring are welcome. BSP recently decided to strengthen its financial stability function to mainstream macro-financial surveillance and a prudential framework, drawing on recent Fund TA. These efforts should continue to be complemented by expanding the regulatory perimeter, particularly to include real estate developers and the nexus of conglomerates and banks. In this regard, staff supports explicitly assigning a financial stability mandate to the BSP through amendments to its charter. Staff also welcomes the regulatory agencies’ concerted efforts to maintain financial stability through the Financial Stability Coordination Council (FSCC).

Authorities’ Views

27. Macroprudential policies will continue to be applied. Unconventional monetary policies in the advanced economies have placed banking supervision in emerging market economies in a more complicated situation. BSP regularly conducts real estate stress tests and requires remedial actions, including curtailing lending or raising capital. Although there are not immediate signs of vulnerabilities in the household sector relating to real estate holdings, additional targeted measures would be considered when needed. The measures already implemented, such as the real estate stress tests, have moderated bank credit growth, and the BSP considers it premature to undertake additional macroprudential measures particularly targeting the real estate sector at the current juncture. However, the BSP is enhancing monitoring of risks and will move proactively to limit them in a targeted manner like it did with setting sector-specific capital charges for nondeliverable forwards in response to systemic risks from foreign exchange exposures.

28. In order to manage concentration risks, BSP intends to allow the additional SBL limit for PPPs, adopted six years ago in the context of an underdeveloped capital market, to lapse at the time of its sunset at end-2016. The SBL exemption was a calculated move put in place without compromising the overall prudential regulation framework. Additional prudential measures were put in place to help ensure financial stability, including the implementation of strengthened capital requirements and risk management. To facilitate financing for infrastructure investments even under lowered SBL limits, the BSP recently rationalized limits on PPP project loans to related parties, by excluding properly ring-fenced project finances.

Structural Policies in Support of Inclusive Growth

29. The authorities are targeting a faster reduction in poverty than in recent years, which will require well targeted social and infrastructure expenditure, especially in rural areas where poverty incidence is highest. The Philippines’ high poverty rate fell only by 0.3 percentage points per year, from 28.8 percent in 2006 to 26.3 percent in 2015 (national definition). The new authorities target a reduction in the poverty rate of 1.25 to 1.5 percentage points per year during their term, with a cumulative decline of 7.5 percent to 9 percent in six years. Staff assessed the likelihood of achieving these ambitious targets in the staff recommended scenario.7 The results show that poverty would fall only by 0.6 percentage points per year, less than half the government’s target, through the increase in the level of expenditure per se. Therefore, in order to achieve this target, it is imperative that the scale up in social and infrastructure is well targeted to the most vulnerable, particularly in rural areas, and accompanied by strong structural policies. In this respect, staff welcomes the plans to improve the conditional cash transfer program, raise investment in education and health, promote rural and value chain development, and ensure land tenure in agriculture.

A01ufig26

Philippines: Poverty Rate

(In percent, national definition)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: Philippine authorities; and IMF staff estimates.

30. Staff supports the new administration’s priorities for structural reforms. The most macro-critical reforms include raising infrastructure investment and enhancing competition, by amending the PPP law and opening up to foreign investment with a focus on lifting the constitutional provision that prohibits more than a 40 percent foreign stake in utilities.8 Enhanced competition in the crucial transport, telecommunications, and logistics sectors should be achieved through steadfast implementation of the competition law, and also drawing up a national competition policy and avoiding regulations that unduly discourage new entrants. The recent passage of the Customs Modernization and Tariff Act (CMTA) and Cabotage Act is a welcome first step. Foreign investment could be liberalized by easing the constitutional restrictions and/or the negative list of the foreign investment act. Emerging macro-critical issues include: addressing low agricultural productivity by facilitating the transferability of land titles and for use as collateral to access credit; and addressing labor market imperfections and the skills mismatch to benefit from the demographic dividend, thereby helping to reduce poverty and youth unemployment.

31. Capital market development is crucial for growth and infrastructure investment, and for the mitigation of concentration risks in the banking system. Currently the government securities market is segmented and liquidity is low even at benchmark maturities due to an excessive number of issuances, pricing convention, and the absence of a formal primary dealer (PD) system or well-functioning market maker mechanism. Developing the capital market, including through building a reliable benchmark yield curve, is important for mobilizing saving for productive investment and growth, a key policy priority. Efforts should be also made to develop instruments that would raise additional financing for PPP infrastructure projects (Box 9). Banks are near their single borrower limits for lending to conglomerates including infrastructure PPPs. Capital market development is all the more important in view of staff’s recommendation that the BSP allow the PPP exemption from the 25 percent SBL to lapse. There is scope for financing brown field infrastructure projects by issuing nonrecourse infrastructure bonds and asset backed securities that are collateralized on the project’s future cash flows. This would allow banks to offload the brown field assets and invest in green field infrastructure projects, while staying within the reduced single borrower limits. Addressing the impediments to securitization and supporting regionally accepted ratings would be important in this endeavor. The development of an institutional investor base would also be important in this regard, including the implementation of the Personal Equity & Retirement Account (PERA) Law. Real Estate Investment Trusts (REITs) would also contribute to this end.

Philippines: Infrastructure Financing and Capital Market Development

Market-based financing can mitigate constraints in infrastructure financing. The Philippine capital market is developing but challenges remain, including the need for a deep and liquid government bond market to provide a reliable yield curve.

Opening up new avenues of financing is important for infrastructure investment in the Philippines.

Infrastructure financing in the Philippines has relied on loan syndication by banks. While some infrastructure projects have been financed through corporate bond issuances by holding companies with infrastructure exposure, project bonds have rarely been issued. However, continued reliance on bank loans for large infrastructure projects will face constraints associated with high concentration and asset-liability mismatch risks.

Market-based financing can be useful for brownfield infrastructure investments.1 During the planning and construction phases of infrastructure projects, banks usually provide the largest share of financing, reflecting their expertise in monitoring the projects and the relative ease of debt restructuring in cases of unforeseen events. Bond financing can be rather costly due to high default risk. Once the infrastructure project becomes operational and starts generating stable cash flows, bond financing becomes a natural and economically appropriate choice to refinance or securitize initial bank loans at a low cost. Such bonds will offload a pool of illiquid assets from banks and create space for new greenfield investments by banks. In addition, these bonds can be attractive for institutional investors, such as pension funds and insurance companies, who need a diversified portfolio of long-term assets to match the long-term duration of liabilities.

Countries have taken different approaches to infrastructure financing.2 Infrastructure financing is often led by the public sector because investment profiles of infrastructure investments are not conducive to purely private investments. For example, in China, loans by state-owned banks with guarantees from local governments have been a major source. In Brazil, long-term private sector corporate finance has been dominated by a publicly-owned development bank at a subsidized rate. As a result, local debt market development has lagged, although the financial sector in Brazil is otherwise sophisticated. Some countries have been successful in developing local bond markets to support long-term infrastructure projects. In particular, pension reforms in Canada and Chile have helped to provide a stable long-term investor base and assisted local capital market development. Malaysia has also successfully developed its capital market for infrastructure financing through reforms in the regulatory framework and market infrastructure developments.

In the Philippines, challenges to developing the local bond market as a source of financing for infrastructure investment remain. Deep and liquid government bond markets—anchored by a well-functioning money market—would be needed to provide a reliable yield curve, which would support the pricing of other fixed-income instruments. Addressing irregular liquidity across the yield curve by concentrating issuance and trading activity at benchmark maturities is a key priority in this regard. Other important building blocks include a prudent regulatory and supervisory framework for capital markets, key market infrastructure, and high-quality credit information services. Taxes may also affect the financial viability of investment vehicles.

1/ Ehlers, Torsten, 2014, “Understanding the Challenges for Infrastructure Finance,” BIS Working Paper No 454. 2/ Asian Development Bank, 2015, Local Currency Bonds and Infrastructure Finance in ASEAN+3; IMF, 2016, “Infrastructure in Latin America and the Caribbean,” Chapter 5 in IMF Regional Economic Outlook: Western Hemisphere; and Walsh, J.P., C. Park and J. Yu, 2011, “Financing Infrastructure in India: Macroeconomic Lessons and Emerging Market Case Studies,” IMF Working Paper No. 11/181.

32. Promoting financial inclusion is another priority. Access to formal financial services is low especially in rural areas. In addition, the cost of remittances has increased due to closure of correspondent banking relationships in the context of de-risking of banks globally. In this regard, additional new technologies for international money transfers can be usefully studied and encouraged, while monitoring their introduction to mitigate risk. Development of the insurance market would help promote inclusive growth and poverty reduction. Staff also welcomes a creation of a multiagency committee chaired by the BSP to provide strategic direction and oversight the implementation of the 2015 national financial inclusion strategy.

A01ufig27

Access to Formal Institution, 2014

(Financial institution account, in percent of population age 15+)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: World Bank, Financial Inclusion Data.1/ Developing countries only.

33. The recent theft of US$81 million from Bangladesh’s official international reserves laundered through casinos in the Philippines highlights the need to tighten anti-money laundering legislation and procedures. Staff’s view is that the AML law needs to be strengthened, along with amendment of the bank secrecy law, and is ready to provide further technical support to help formulate these amendments if desired. The amendments should include the coverage of casinos under the AML law and making tax evasion a predicate crime. The BSP and Department of Finance are already working with Congress on amendments to the AML laws. The BSP also relaxed foreign exchange regulations in August 2016 including documentary requirements for banks to migrate transactions in the informal market to the banking system.

Authorities’ Views

34. Making growth more inclusive is a key priority for the new administration. The authorities noted that poverty reduction was slow in the past, but they plan to speed it up. They welcome staff’s analysis on poverty reduction and agreed that meeting the ambitious targets would require well targeted social and infrastructure spending, particularly in the provinces. The authorities also recognize the need to develop and deepen capital markets and promote financial inclusion. The Bureau of the Treasury, together with the BSP and SEC, plan to introduce a new repo instrument and PD system. In addition, the authorities are finalizing work on other initiatives, including the introduction of an overnight index swap facility and a pricing benchmark framework. To promote financial deepening and inclusion, the BSP approved entry of a number of foreign banks to foster competition in the banking sector and provide better access and options to the underserved areas. The authorities have also resubmitted draft amendments to the AML law and the bank secrecy law to Congress. As part of its supervisory enforcement action, the BSP recently imposed a record ₱1.0 billion (US$21 million) fine against the domestic bank involved in the Bangladesh cyber heist.

Staff Appraisal

35. The Philippine economy has continued to show strong economic growth coupled with low inflation. Sound macroeconomic policies and prudent financial sector supervision have contributed to solid macroeconomic fundamentals. Strong economic growth in the first half of 2016 reflects the strength of domestic demand. Inflation is expected to move within the target range. Credit growth has picked up, but most indicators suggest that credit growth remains below typical cutoffs for credit booms. There is a continuing need to monitor macro-financial risks in light of recent rapid credit growth.

36. The favorable macroeconomic performance in recent years has not led to corresponding improvements in social indicators. Income inequality and poverty persist and the unemployment rate has come down only slowly. Staff supports the authorities’ efforts to implement reforms that would strengthen social indicators.

37. The new administration has an opportunity to put the economy on a higher and more equitable growth path while reaping the dividends from its young and growing population. Building on the Philippines’ sound macroeconomic policies, this will involve increasing infrastructure spending, facilitating PPPs and opening the economy to foreign investment, as well as improving the investment climate. Staff supports the government’s plans to improve human capital and social services for the poor. It also supports the efforts to promote development in a more geographically balanced manner.

38. Staff supports the government’s plan to raise infrastructure and social spending and increase its medium-term fiscal deficit target to 3 percent of GDP, anchored to a stable debt-to-GDP ratio. The increase in public spending in the 2016 budget is appropriate given the large infrastructure and social needs, while output is expected to remain close to potential. The new fiscal deficit target would keep the debt-to-GDP ratio stable and allows a cushion for unforeseen contingencies such as disaster risk and contingent liabilities arising from PPPs.

39. A comprehensive tax reform is needed to make the system more equitable and efficient, and to raise additional revenue to finance large infrastructure and social needs. While the authorities’ intention to pass a comprehensive tax reform package is welcome, they are further urged to eliminate the 13th month salary exemption from the PIT and raise taxes and fees on motor vehicles. It will also be very important to rationalize tax incentives at the same time as CIT rates are lowered to avoid a revenue loss and to increase efficiency. To strengthen tax collection, the tax authorities should be given access to individual bank account information and tax evasion should be made a predicate crime.

40. The authorities should formulate a medium-term public infrastructure plan with clear prioritization of projects and appropriate choices between budgetary and PPP spending, with due consideration of contingent liabilities. Staff support the authorities’ target to increase public infrastructure spending to at least 5 percent of GDP over the medium term. It will be important that such spending is done efficiently in key strategic areas and that additional revenues are available to finance it.

41. Monetary policy settings are currently appropriate. Nonetheless, the BSP should stand ready to tighten if there are signs of overheating or credit growth accelerating with inflationary pressures. The adoption of the new interest rate corridor is commendable and efforts to absorb additional liquidity through stepping up the size of deposit auctions should continue. This would allow the BSP to lower the currently high banks’ required reserve ratio over time. Passage of a new BSP charter that authorizes the issuance of central bank bills and increases BSP’s capital would help support monetary policy effectiveness. With official international reserves more than adequate, the policy of allowing the exchange rate to move freely in line with market forces, while smoothing excessive volatility in both directions, should continue.

42. Macroprudential policies should be used to guard against systemic risks to financial stability, including those relating to conglomerate structures and real estate. Staff supports the authorities’ use of targeted prudential policies to tame financial excesses, including credit surges, and strengthen resilience. More stringent prudential regulations may be needed if systemic risks become apparent. Broadening the BSP’s financial stability mandate remains a priority, and staff supports the authorities’ proposed amendments to the BSP charter. Staff also supports the authorities’ efforts to allow better access to information on conglomerates’ finances.

43. Financial deepening and inclusion are also essential elements of the authorities’ inclusive growth strategy. While the composition of credit growth including in the real estate sector should be closely monitored on an ongoing basis to avoid risks from credit booms, expanded bank lending to productive sectors will facilitate inclusive growth. Staff believes that further development of alternative forms of financing and hedging, such as new technologies to increase the access to financial services by a larger share of the population, and development of corporate bond and equity markets, is needed to support infrastructure investment.

44. Staff supports the authorities’ objective to accelerate poverty reduction. Achieving this goal will require that the scale up in social and infrastructure is well targeted to the most vulnerable, particularly in rural areas, and accompanied by strong structural policies. Staff welcomes the authorities’ initiatives in the 10-point policy agenda to increase social spending and promote rural development and agriculture.

45. Staff also supports the authorities’ efforts to step up structural reforms. Raising infrastructure investment and competition, opening the economy to foreign investment, addressing low agricultural productivity, and removing labor market imperfections and the skills mismatch to benefit from the demographic dividend, would have large growth dividends and would help lower poverty and youth unemployment.

46. The recent incident of funds being illegally shifted from Bangladesh underscores the importance of tightening anti-money laundering provisions in the Philippines. Staff strongly encourages the authorities to pass amendments to the AML law that would remove the exemption for casinos and make tax evasion a predicate crime, and ease bank secrecy laws.

47. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Figure 1.
Figure 1.

Philippines: Real Sector

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Figure 2.
Figure 2.

Philippines: Monetary and Financial Conditions

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Figure 3.
Figure 3.

Philippines: Financial Market Comparisons

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Figure 4.
Figure 4.

Philippines: Cross-Country Financial Market Developments

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Figure 5.
Figure 5.

Philippines: External Sector

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Figure 6.
Figure 6.

Philippines: Banking Sector

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Figure 7.
Figure 7.

Emerging Markets: Social Conditions and Income Distribution

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Table 9.

Philippines: Banking Sector Indicators, 2011–15

(In percent)

article image
Source: Philippines authorities, Status Report on the Philippines Financial System.

Solo refers to the head office and branches.

Nonperforming loans over total loan portfolio excluding interbank loans.

(Nonperforming loans + real and other property aquired (ROPA)) over total gross assets, where ROPA is a measure of the stock of foreclosed properties held by a bank.

Ratio of (NPLs + Gross ROPA + current restructured loans) to (Gross total loan portfolio + Gross ROPA).

Ratio of loan loss reserves to NPLs.

Ratio of valuation reserves (for loans and ROPA) to NPAs.

Table 10.

Philippines: Indicators of External Vulnerability, 2010–15

(In percent of GDP, unless otherwise indicated)

article image
Sources: Philippine authorities; and IMF staff estimates.

In BPM6.

Appendix I. Philippines—Risk Assessment Matrix 1/

article image

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Appendix II. Philippines—Debt Sustainability Analysis

Public debt in the Philippines is sustainable. Staff’s baseline scenario projects that the general government debt-to-GDP ratio will fall from 36 percent of GDP in 2015 to below 31 percent in 2021 despite the rise in the fiscal deficit target to 3 percent in 2017. The growth-interest rate differential is the main factor behind the projected fall in public debt, contributing 6.6 percentage points, as real GDP growth increases to 7 percent toward the end of the projection period. Moreover, the primary surpluses also contribute to the reduction in public debt by 2.5 percentage points. The gross financing needs remain comfortable at 4-5 percent of GDP throughout the projection period. The debt composition is also projected to remain stable with a relatively low share of short-term debt and foreign currency-denominated debt, in line with the authorities’ debt management policy.

Alternative scenarios indicate that staff’s baseline is conservative. The Philippines achieved a large scale public debt reduction in the past decade, supported by primary surpluses, high output growth, and exchange rate appreciation. The historical scenario, in which real GDP growth, real interest rates, and primary balances are equal to their 2006–2015 averages, leads to faster reduction in debt and gross financing needs than in staff’s baseline. The scenario with a constant primary surplus at the projected 2016 level of 1.9 percent of GDP also leads to lower debt-to-GDP ratios and gross financing needs than in staff’s baseline scenario.

Total external debt in the Philippines is also sustainable. External debt fell sharply in the 2000s, from a peak of 76.4 percent of GDP in 2001 to 26.5 percent in 2015, due to sustained current account surpluses, strong output growth, and currency appreciation. Under staff’s baseline scenario, these trends are projected to continue, with external debt expected to fall to 15.7 percent of GDP in 2021. Alternative scenarios suggest that staff’s baseline is conservative. The historical scenario, in which real GDP growth, real interest rates, and the non-interest current account balance are equal to their 2006–2015 averages, leads to a faster reduction in external debt than in staff’s baseline. Moreover, debt dynamics appear resilient to various shocks: one-half standard deviation shocks to interest rates, growth, and the current account lead to only modest increases in external debt ratios over the medium term. However, exchange rate volatility remains a vulnerability as a one-time real depreciation of 30 percent in 2016 would raise the external debt-to-GDP ratio by about 10 percentage points.

A01ufig28

Philippines—Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Source: IMF staff.1/ Public sector is defined as general government2/ Based on available data.3/ EMBI.4/ Defined as interest payments divided by debt stock at the end of previous year.5/ Derived as [(r-p(1+g)-g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S, dollar).6/ The real interest rate contribution is derived from the denominator in footnote 4 as r-π(1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r)8/ For projections, this line includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
A01ufig29

Philippines—Public DSA—Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Source: IMF staff.
A01ufig30

Philippines—External Debt Sustainability: Bound Test 1/ 2/

(External debt, in percent of GDP)

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

Sources: International Monetary Fund, Country desk data, an a staff estimates.1/ Shaded areas represent actual data, Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For the historical scenario, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs In 2014.

Philippines—External Debt Sustainability Framework, 2011–2021

(In percent of GDP, unless otherwise indicated)

article image

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r= nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate,

The contribution from price and exchange rate changes is defined as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε>0) and rising inflation [based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Appendix III. Philippines—External Sector Assessment

The Philippines’ external sector remains moderately stronger than warranted by fundamentals and desirable policies despite the recent decline in the current account surplus. The current account approach of the Fund’s External Balance Assessment (EBA) model, adjusted by Philippines-specific factors, shows a current account balance slightly above the level implied by fundamentals and desired policies. On the other hand, staff assess the peso to be broadly in line with fundamentals and desired policies, although subject to a high degree of uncertainty. This apparent dichotomy is because the Philippines’ current account surplus is determined by structural factors such as inadequate infrastructure, a weak business environment, and risks of natural disasters, which constrain private investment and lead to higher precautionary savings. Accordingly, the current account gap should decline once infrastructure is upgraded in line with the authorities’ plans.

  • Current account. The EBA model places the gap between the actual and the current account balance that is consistent with fundamentals and desired policies—the so called CAB norm—at 4.9 percent of GDP in 2015 (3 percentage points lower than in 2014). Deviations of policies from their desired levels explain 1.3 percent, with 0.4 percent due to a strong domestic fiscal stance and 0.9 percent to fiscal policy gaps in other countries. The other 3.6 percent of GDP is left unexplained by the EBA model. Philippines-specific factors such as natural disaster risks or worker remittances could explain between 2–3 percent, suggesting a current account balance modestly above its norm.12

  • Real effective exchange rate (REER). The REER is assessed to be broadly in line with the level implied by fundamentals and desired policies. The EBA REER approaches (index and level) point to an overvaluation of the peso. On the other hand, applying an estimated elasticity to the assessed current account gap range point to an undervaluation of about 8 percent. Two key factors that are probably not well captured by such elasticity calculations are remittances and the need for a substantial ramp-up of capital goods imports to sustain a desirable increase in investment that started in 2015. Taking all of this conflicting evidence into account, staff find it appropriate to reflect the high degree of uncertainty and assess the REER broadly in line with fundamentals and desired policies.

Table 1.

External Balance Assessment: Desk Adjustments 1/

article image
Source: IMF staff estimates.

Based on the EBA update of June 2016.

A positive REER gap indicates overvaluation.

The value for the current account regression approach corresponds to the average of the revised CAB gap (A-B-C), divided by the elasticity of the current account balance with respect to the REER, estimated at -0.31 using autoregressive distributed lag (ADL) model.

  • Addressing imbalances: The Philippines’ current account surplus reflects its low level of investment compared with other EMEs. Raising investment and thus boosting potential growth, by improving the business environment and infrastructure, would help reduce external imbalances going forward, without necessarily adjusting the exchange rate.

Figure 1.
Figure 1.

Saving Investment Gap, Median Emerging Market Economy by Region

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001

  • International reserves. The Philippines continues to have ample reserves, which stood at 229 percent of the Fund’s reserve adequacy metric in 2015. While the level of reserves is above the RA metric, it is broadly justified by the vulnerability to natural disasters and capital flow volatility. Staff agrees with the BSP that the exchange rate should continue to be allowed to move freely in line with market forces with intervention limited to smoothing excessive volatility in both directions.

  • Size and importance of capital flows. During the post global financial crisis years, the Philippines received sizeable foreign exchange inflows, both from remittances and portfolio investment, resulting in a build-up of reserves. Going forward, steady portfolio outflows are expected to continue, and gross reserves are projected to increase modestly over the medium term. The opening up of the economy may see a rise in foreign direct investment but be accompanied by higher imports of capital goods, particularly in the staff’s recommended scenario.

Figure 2.
Figure 2.

Philippines: Balance of Payments and International Reserves

Citation: IMF Staff Country Reports 2016, 309; 10.5089/9781475541076.002.A001
1

Deviations of credit-to-GDP from a backward looking trend (Dell’Ariccia and others, 2012) and cycles in real credit per capita compared to its trend (Mendoza and Terrones, 2008) show credit growth within the usual cutoffs, the increase in bank credit to GDP is just below the 3 percentage point cutoff, and the credit gap (Drehmann and others, 2010) just exceeds the 10 percent of GDP cutoff (Box 2).

2

Financial market development in the Philippines is at levels that are broadly consistent with those seen elsewhere in Emerging Asia, after adjusting for differences in per capita income (see Chapter 5 of Philippines—Selected Issues, IMF Country Report No 15/247).

3

As TFP is calculated as a residual, the short-run growth contribution from TFP in 2017 reflects higher capacity utilization.

4

The exemption for minimum wage earners effectively exempts a large share of the labor force. It also creates a vertical inequity, as those with wages earning slightly higher than the minimum wage are taxed on their full income (less the personal allowance), while those earning the minimum wage are untaxed. The 13th month salary exemption is also highly regressive.

5

Removal of exemptions for senior citizens, disabled people, and social housing could be accompanied by well-targeted transfers to help cushion the social impact. Other measures in the comprehensive tax reform package would help make the burden more equitable such as the PIT reform.

6

IMF, FAD’s Investment and Capital Stock Dataset. Available via www.imf.org.

7

Staff estimated the effect of public expenditure on poverty reduction by a two-step approach, drawing on existing studies: the first step identifies the effect of public expenditure on inequality, while the second step identifies the effect of inequality and growth on poverty. This analysis was based on “Building Inclusive Growth in the Philippines,” in Philippines—Selected Issues, Chapter 3, IMF Country Report No. 12/50; and “The Impact of Tax and Expenditure Policies on income Distribution: Evidence from a Large Panel of Countries,” Hacienda Publica Espanola 200.

8

While amending the constitution might face challenges, the Senate and House of Representatives have already agreed to form a Constitutional Assembly to this end.

1

As noted in the 2014 Philippines—Staff Report, IMF Country Report 14/245, exposure to natural disasters is an uninsurable risk for the private sector. For the Philippines, this factor adds 1.5–2 percent of GDP to the CAB norm. Worker remittances are another important factor that drive a wedge between GDP and GNI, the latter being a better measure of income and the basis for saving-investment decisions. Using GNI instead of GDP as a measure of income in the EBA model adds another 0.5–1 percent of GDP to the CAB norm.

2

Last year’s sizeable EBA current account gap has declined due to both a smaller cyclically adjusted current account balance and a slightly larger CAB norm. At the same time, the Philippines’ specific adjustments have been re-estimated and their impact is smaller than previously estimated. Therefore, the current account gap, although slightly below last year’s, does not change the staff’s bottom line assessment.

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Cover IMF Staff Country Reports
Philippines: 2016 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Philippines
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2016: Issue 309
Publisher:
International Monetary Fund
ISBN:
9781475541076
ISSN:
1934-7685
Pages:
78
DOI:
https://doi.org/10.5089/9781475541076.002

Philippines: Improvements in Economic Fundamentals

(In percent of GDP, unless otherwise indicated)

Philippines: Poverty and Underemployment Rates

(In percent)

Overall Quality of Infrastructure, 2015-16

(Scale, 1-7; higher score indicates better infrastructure quality)

Contribution to GDP Growth

(In percent year on year)

National Government Balance

(In percent of GDP)

Contributions to Banks Loans Growth

(In percent)

Bank Credit Growth by Economic Sector

(In percent)

Change in the Credit-to-GDP Ratio

(In percent)

Credit Neutral Output Gap

Bank Credit Growth and Credit to GDP

(In percent of four quarter rolling GDP)

Philippines: Residential Real Estate Price Index

(In percent year-on-year)

Philippines: Potential GDP Growth in the Baseline and Staff’s Recommended Scenario

(In percent)

Debt to GDP and Credit Risks

Revenue and Expenditure

(In percent of GDP)

Philippines; Medium-Term Fiscal Projections

Goverment Revenues, 2014

(In percent of GDP)

Philippines: Headline Inflation Projection and Target Band

(In percent)

Philippines: Main Sterilization Instruments 1/

(In billions of peso)

Philippines: Policy Rates, Interbank and T-Bill Rates

(In percent)

Taylor Rule Estimates—Effective Policy Rate

Philippines: Macro-Financial Linkages

Nonfinancial Corporate Debt, 2015

Debt-at-Risk Under Different Shocks 1/

(In percent of total debt)

Expected Number of Corporates in Distress if at Least One Corporate Becomes Distressed

(Number of corporates out of 20)

Probability That All 13 Non RE Developers Go into Distress if all Seven RE Developers Go into Distress

(In percent)

Philippines: Poverty Rate

(In percent, national definition)

Access to Formal Institution, 2014

(Financial institution account, in percent of population age 15+)
Figure 1.

Philippines: Real Sector
Figure 2.

Philippines: Monetary and Financial Conditions
Figure 3.

Philippines: Financial Market Comparisons
Figure 4.

Philippines: Cross-Country Financial Market Developments
Figure 5.

Philippines: External Sector
Figure 6.

Philippines: Banking Sector
Figure 7.

Emerging Markets: Social Conditions and Income Distribution

Philippines—Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP, unless otherwise indicated)

Philippines—Public DSA—Composition of Public Debt and Alternative Scenarios

Philippines—External Debt Sustainability: Bound Test 1/ 2/

(External debt, in percent of GDP)
Figure 1.

Saving Investment Gap, Median Emerging Market Economy by Region
Figure 2.

Philippines: Balance of Payments and International Reserves