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PHILIPPINES QUARTERLY UPDATE SUSTAINING GROWTH IN

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					PHILIPPINES QUARTERLY UPDATE
SUSTAINING GROWTH IN UNCERTAIN TIMES




December 2011




Poverty Reduction and Economic Management Unit
East Asia and Pacific Region




Document of the World Bank
                                          Preface
The Philippines Quarterly Update provides an update on key economic and social developments,
and policies over the past three months. It also presents findings from recent World Bank
studies on the Philippines. It places them in a longer-term and global context, and assesses the
implications of these developments and policies on the outlook for the Philippines. Its coverage
ranges from the macro-economy and financial markets to indicators of human welfare and
development. It is intended for a wide audience, including policymakers, business leaders,
financial market participants, and the community of analysts and professionals engaged in the
Philippines.

The Philippines Quarterly Update is a report of the World Bank’s Philippine Poverty Reduction
and Economic Management (PREM) team. It was prepared by Karl Kendrick Chua (Country
Economist and Task Team Leader), Marianne Juco (Research Analyst), and Soonhwa Yi
(Economist), under the general guidance of Rogier Van Den Brink (Lead Economist).

The findings, interpretations, and conclusions expressed in this Update are those of World
Bank staff and do not necessarily reflect the views of its management, Executive Board, or the
governments they represent.

For information about the World Bank and its activities in the Philippines, please visit
www.worldbank.org/ph.

To be included in the email distribution list of the Philippines Quarterly Update and related
publications, please contact Nenette Santero (nsantero@worldbank.org). For questions and
comments on the content of this publication, please contact Karl Kendrick Chua
(kchua@worldbank.org). Questions from the media can be addressed to David Llorito
(dllorito@worldbank.org).

Cover photo credits:

   1) Noel del Castillo (“Bills”); 2) Eric Le Borgne (“Construction”); 3) Soonhwa Yi (“Rice
      Fields”); and 4) Jurgen Dezso (“Parol”).
                                                                                    TABLE OF CONTENTS

  PREFACE ............................................................................................................................................................................ 2
  EXECUTIVE SUMMARY ............................................................................................................................................... 5
  RECENT ECONOMIC AND POLICY DEVELOPMENTS ...................................................................................... 6
OUTPUT AND DEMAND........................................................................................................................................................................................................ 6
EMPLOYMENT AND POVERTY ............................................................................................................................................................................................ 7
EXTERNAL ACCOUNTS ......................................................................................................................................................................................................... 8
FINANCIAL MARKETS ......................................................................................................................................................................................................... 10
INFLATION AND MONETARY POLICY ............................................................................................................................................................................. 12
FISCAL POLICY ..................................................................................................................................................................................................................... 13
  PROSPECTS ..................................................................................................................................................................... 16
OUTPUT AND DEMAND...................................................................................................................................................................................................... 16
EMPLOYMENT AND POVERTY .......................................................................................................................................................................................... 17
EXTERNAL ACCOUNTS ....................................................................................................................................................................................................... 18
INFLATION AND MONETARY POLICY ............................................................................................................................................................................. 19
FISCAL POLICY ..................................................................................................................................................................................................................... 19
  SPECIAL FOCUS 1.......................................................................................................................................................... 21
   Raising Excise Taxes on Tobacco and Alcohol Products .................................................................................................................. 21
  SPECIAL FOCUS 2.......................................................................................................................................................... 31
   Philippine Exports: Where do they stand? ...........................................................................................................................................31
  DATA APPENDIX .......................................................................................................................................................... 38




                                                                                                         FIGURES
  FIGURE 1. PRIVATE CONSUMPTION AND INVENTORY INVESTMENT. ........................................................................................ 6
  FIGURE 2. PUBLIC CONSTRUCTION GROWTH HAS IMPROVED. .................................................................................................... 6
  FIGURE 3. SERVICES BUOYED GROWTH GIVEN INSIPID CONTRIBUTIONS FROM INDUSTRY AND AGRICULTURE. .......... 7
  FIGURE 4. POVERTY AND HUNGER ROSE IN SEPTEMBER. ............................................................................................................ 7
  FIGURE 5. REMITTANCE GROWTH HAS SLOWED AS DEPLOYMENT GROWTH MODERATES. ............................................... 9
  FIGURE 6. RESPECTABLE GROWTH IN NON-ELECTRONICS AND SERVICES EXPORTS............................................................. 9
  FIGURE 7. EXPORTS HAVE FALLEN TO LEVELS LAST SEEN IN 2008. ........................................................................................10
  FIGURE 8. RESERVES HAVE REMAINED HEALTHY AND CONTINUED TO GROW IN NOVEMBER.........................................10
  FIGURE 9. SOVEREIGN SPREADS REACTED TO THE EURO ZONE CRISIS..................................................................................12
  FIGURE 10. FIRMS HAVE INCREASED LEVERAGE GIVEN THE LOW INTEREST RATE ENVIRONMENT. ..............................12
  FIGURE 11. NET FOREIGN BUYING LIFTED THE PSEI ................................................................................................................13
  FIGURE 12. FOOD AND UTILITY INFLATION ..................................................................................................................................13
  FIGURE 13. TOBACCO RETAIL PRICES AND TAXATION ACROSS INCOME GROUPS ................................................................22
  FIGURE 14. TOTAL TAX BURDEN AS A SHARE OF RETAIL SALES PRICE FOR MOST SOLD BRAND ......................................22
  FIGURE 15. CROSS COUNTRY COMPARISONS: CIGARETTE PRICE PER PACK, AND TAX AS PERCENT OF THE PRICE ..... 22
  FIGURE 16. CROSS COUNTRY COMPARISONS: PRICE PER PACK OF CIGARETTES ..................................................................23
  FIGURE 17. CROSS COUNTRY COMPARISONS: MINUTES WORKED TO PURCHASE A PACK OF CIGARETTES .................... 23
  FIGURE 18. THE SHARE OF ALCOHOL SPENDING IN TOTAL HOUSEHOLD SPENDING FALLS AS INCOME RISES .............. 24
  FIGURE 19. ALCOHOL EXCISE COLLECTION ...................................................................................................................................24
  FIGURE 20. SHARE OF KEY EXPORTS................................................................................................................................................32
  FIGURE 21. TOP TEN EXPORTERS OF SEMICONDUCTORS ...........................................................................................................32
  FIGURE 22. EXPORT SOPHISTICATION ............................................................................................................................................34
  FIGURE 23. PHILIPPINE MERCHANDISE EXPORT HAS BEEN BUOYED BY NON-ELECTRONICS. ...........................................34
  FIGURE 24. DECLINING IMPORTS OF ELECTRONIC PARTS AND THE BOOK TO BILL RATIO ................................................37
                                                                        TABLES

TABLE 1. FOREIGN CLAIMS ON CRISIS-AFFECTED ECONOMIES ................................................................................... 11
TABLE 2. NATIONAL GOVERNMENT FISCAL GAP ....................................................................................................... 14
TABLE 3. SUMMARY OF MEASURES TO IMPROVE TRANSPARENCY AND ACCOUNTABILITY ......................................... 15
TABLE 4. RETAIL SALES PRICE, EXCISE BURDEN AND TOTAL TAX BURDEN IN SELECTED COUNTRIES ...................... 22
TABLE 5. EXCISE TAX RATES IN SELECTED ASEAN COUNTRIES .............................................................................. 24
TABLE 6. TOBACCO EXCISE REFORMS: SCENARIO AND PROJECTED REVENUE ............................................................ 27
TABLE 7. TOBACCO EXCISE LEVELS AND RSPS FOR A UNIFIED RATE BY 2014 (SCENARIO 9)...................................... 28
TABLE 8. ALCOHOL EXCISE RATES AND RSPS FOR SCENARIO 7 .................................................................................. 28
TABLE 9. ALCOHOL EXCISE REFORMS: SCENARIO AND PROJECTED REVENUE............................................................. 29
TABLE 10. TOP PHILIPPINE EXPORT DESTINATIONS (IN PERCENT OF TOTAL).......................................................... 32
TABLE 11. COMPARATIVE SURVIVAL PROPENSITY OF ASEAN COUNTRIES................................................................ 35
TABLE 12. ESTIMATED ELASTICITIES ......................................................................................................................... 36
TABLE 13. ESTIMATED COEFFICIENTS FOR THE INPUT MODELS ............................................................................... 36
TABLE 14. PHILIPPINES: SELECTED ECONOMIC INDICATORS, 2008-13 ...................................................................... 38
TABLE 15. PHILIPPINES: NATIONAL GOVERNMENT CASH ACCOUNTS (GFS BASIS), 2008-11 ................................... 39
                                         Executive Summary
After a strong rebound in 2010, Philippine economic growth slowed by more than half to 3.6 percent in
the first three quarters of 2011. Slower third quarter (Q3) growth of 3.2 percent was the result of significant
contractions in exports and public investment. The contraction in exports largely reflected weaker demand in
advanced economies while public investments continued to shrink in part because of measures to improve
accountability of public spending. On the production side, industrial and agricultural activities were sluggish,
leaving the services sector to buoy growth. To improve growth outcome in the remainder of the year, the
government announced a PHP 72 billion (about 0.7 percent of GDP) disbursement acceleration plan to ensure
that budgeted items are spent by year end.

The country’s external position remains at healthy levels, thanks to robust remittances and capital
inflows. Remittances continued to fuel private consumption, which grew by over 7 percent in Q3. Net foreign
portfolio investments from January to October increased to USD 3.4 billion, notwithstanding large capital
outflows in September due to heightened risk aversion. Sustained inflow of portfolio investments and
remittances has led to higher reserves accumulation. Meanwhile, external debt continued to decline towards 34
percent of GDP (World Bank definition).

Monetary policy remains accommodative, though higher liquidity, rising credit growth, and slower
economic growth are all posing challenges to the authorities. CPI inflation through November averaged 4.8
percent, within the central bank’s target range of 3 to 5 percent for the year. Following two consecutive hikes in
policy rates earlier in the year, the central bank left policy rates unchanged in the second half of the year and
instead raised the reserve requirement twice. Further liquidity management measures are expected in case of
stronger portfolio inflows and inflationary pressures.

The national government’s fiscal deficit markedly fell to 0.8 percent of GDP in the first ten months
largely on account of under-spending. But once institutional reforms to improve accountability are in place,
spending is expected to fully recover at cost-effective levels with more resolute impact on the country’s growth
and development. On the revenue side, tax revenues are projected at 12.4 percent of GDP on account of
improved tax administration. To raise more revenues, the executive has submitted a proposal to congress to
raise excise taxes of alcohol and tobacco products. To plug future leakages in tax revenues, the executive is
working with congress to pass the fiscal responsibility and fiscal incentives rationalization bills.

The Philippines is relatively well-positioned to weather shocks emanating from the current global
turmoil given its strong macroeconomic fundamentals, and regulatory reforms and prudential measures
instituted following past crises and slowdowns. Overseas Filipino workers’ large remittance inflows have
shown a counter-cyclical pattern and have insulated the country from external imbalances. The financial sector’s
conservative stance throughout the preceding decade has helped to ensure healthy balance sheets. The corporate
sector, for the same reason, also exhibited no systemic vulnerabilities.

Growth is projected to moderate to 3.7 percent in 2011 and 4.2 percent in 2012. The Philippines is
benefitting from relative political stability and an improved macroeconomic position. However, key downside
risks to growth remain such as increased uncertainties about global demand and a possible further slowdown in
investments and public spending, due to the government’s emphasis on the quality of budget execution.
Portfolio inflows are expected to remain strong, while FDI is projected at moderate levels. Consumption is
expected to drive overall growth given strong remittances. The current account is projected to remain in
healthy surplus, driven by sustained remittances despite a widening trade deficit as exports weaken.

Growth prospects in the medium to long-term can be sustained at above 5 percent provided that
reforms to address structural bottlenecks are implemented to raise overall competitiveness. These
include reforms to i) raise revenues efficiently and equitably, beginning with excise taxes and fiscal incentives
rationalization, ii) improve the quantity and quality of public spending, in particular infrastructure and human
capital investment, iii) enhance governance, and iv) reduce the cost of doing business. A stronger structural
underpinning would allow the country to deal with shocks more effectively, achieve more inclusive growth, and
reduce poverty at a faster rate.
                                             Recent Economic and Policy Developments
                                                                            Output and Demand


1.     After a strong rebound in 2010, Philippine economic growth slowed by more than
half to 3.6 percent in the first three quarters of 2011, bringing year to date growth below
the government’s revised target of 4.5 to 5.5 percent for 2011. 1 Third quarter (Q3) growth of
3.2 percent was driven by private consumption and inventory build-up, which grew by 7.1 and
147.7 percent respectively (Figure 1). The country’s slower expansion places it behind its
neighbors with Indonesia, Vietnam, and Singapore growing above 6 percent, Malaysia at 5.8
percent, and Thailand, which was devastated by massive flooding in recent months, at 3.5
percent.
2.      Slower third quarter growth was the result of further contractions in exports and
public investment. The contraction in exports at -14.8 percent largely reflected weaker
demand in advanced economies as their fiscal conditions deteriorated—this amid the recovery
of the Japanese supply chain following the March earthquake and tsunami. 2 On the domestic
side, public investments continued to shrink, albeit by a smaller 21 percent from almost 60
percent in the second quarter (Q2) (Figure 2). This improvement, together with sizable
investments in durable equipment in the telecoms and transport sectors, pushed up fixed
investment growth to positive territory after falling by almost 10 percent in Q2. To improve
growth outcome in the remainder of the year, the government announced a PHP 72 billion
(equivalent to 0.7 percent of GDP) disbursement acceleration plan to ensure that budgeted
items are spent by year end. 3
                        Figure 1. Private consumption and inventory                                  Figure 2. Public construction growth has improved
                            investment were robust amid signficant                                       though still in negative territory while private
                                   deterioration in net exports.                                          construction growth appears to be tapering.

                                   Contribution to YoY GDP growth
                        15                                                                                              Construction Sector
                                                                                                         16                                                 80
     percentage point




                        10                                                                                          Private (lhs)          Public (lhs)
                                                                                                                    Public growth          Private growth
                         5                                                                               12                                                 40
                                                                                        percent of GDP




                         0                                                                                                                                        percent
                                                                                                         8                                                  0
                         -5
                        -10
                                                                                                         4                                                  -40
                              Q1   Q2   Q3   Q4   Q1   Q2   Q3    Q4   Q1   Q2     Q3

                                    2009                 2010               2011                         0                                                  -80
                                                                                                              Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
                                   Discrepancy                   Net Exports
                                   Investment                    Govt Consumption
                                   Private Consumption           GDP growth                                      2009               2010          2011


    Source: National Statistical Coordination Board (NSCB)                              Source: NSCB


1 The economy grew by 4.6 percent in the first quarter. Second quarter growth was revised downward from 3.4 to
3.1 percent on account of slower investment growth, which was revised from 0.9 to -7.7 percent.
2 See Special Focus No. 2 on exports for more discussion on the state of Philippine exports.
3 This includes public works and agriculture infrastructure, housing, relocation and resettlement, funding support

to local government units, rehabilitation of railways, health care insurance, and human resource development
training. As of early November 2011, 60 percent of the PHP 72 billion has been released.

                                                                                                                                                                            6
3.      On the production side, industrial and agricultural activities were sluggish,
leaving the services sector to buoy growth. The industrial sector reflected the contraction in
exports and construction. Among the sectors, only manufacturing contributed to growth, albeit
modestly at 0.7 percentage points (ppts) but this was offset by weak construction, which
subtracted an equal amount to industrial growth. Agriculture growth slowed noticeably from
8.2 percent in Q2 to only 1.8 percent in Q3, as the country was buffeted by severe weather
disturbances. Aided by robust remittances, the services sector continued to be the main driver
of growth, contributing 3 ppts to GDP as real-estate, trade, and other services expanded
further (Figure 3).
            Figure 3. Services buoyed growth given insipid                                 Figure 4. Poverty and hunger rose in September as
               contributions from industry and agriculture.                                    typhoons damaged crops and livestock, raising
                                                                                                         prices and destroying jobs.
                               Supply Side: Contribution to Growth                                           Poverty and Hunger Incidences
                                                                                                     70                                                30
                     8                                                                                     Poverty (rhs)             Hunger: Overall
                                                                                                     65    Hunger: Moderate          Hunger: Severe    25
  percentage point




                     6
                     4                                                                               60                                                20

                                                                                           percent




                                                                                                                                                            percent
                     2                                                                               55                                                15
                     0                                                                               50                                                10
                     -2                                                                              45                                                5
                          Q1   Q2     Q3    Q4    Q1   Q2     Q3     Q4   Q1   Q2     Q3
                                                                                                     40                                                0

                                                                                                          May-05
                                                                                                          Dec-04

                                                                                                          Dec-05




                                                                                                          Dec-07

                                                                                                          Dec-08

                                                                                                          Oct-09
                                                                                                          Mar-10

                                                                                                          Mar-11
                                                                                                          Sep-10

                                                                                                          Sep-11
                                                                                                           Jun-03
                                                                                                          Nov-03
                                                                                                           Jun-04




                                                                                                           Jun-06
                                                                                                          Nov-06
                                                                                                           Jun-07

                                                                                                           Jun-08

                                                                                                           Jun-09
                                2009                    2010                   2011


                                    Agriculture    Industry        Services


Source: NSCB                                                                                  Source: Social Weather Station (SWS)


                                                                      Employment and Poverty

4.     The quality of employment is lackluster and is largely inelastic to economic
growth owing to structural issues in the labor market. In the most recent Labor Force
Survey (October round), the unemployment and underemployment rates improved to 6.4 and
19.1 percent, respectively, from 7.1 and 19.6 percent in the same period last year. However, the
quality of employment has not improved much as the stronger headline numbers were mainly
driven by non-wage earners and low productivity jobs. Structurally, the composition of
employment has barely changed even during high growth years. The share of wage and salary
earners (a proxy for formal sector employment) has remained at around 53 percent of total
employment while the shares of own account workers and unpaid family workers (proxies for
informal sector employment) have stayed around 35 and 12 percent respectively.
5.     Employment by sector likewise exhibits the same rigidity. In the last five years,
there have been no significant shifts in the employment shares of agriculture, industry, and
services (roughly stable at around 34, 15, and 51 percent respectively). Small fluctuations
between agriculture and services largely reflect movements between farm and off-farm
employment depending on the crop season. The services sector remains the main source of
employment, of which the informal sector accounts for a huge majority. In 2011, services


                                                                                                                                                                      7
provided about 70 percent of new jobs, equivalent to about two-thirds of the new entrants to
the labor force.
6.     Self-rated poverty and hunger incidences 4 have been on the rise, on the back of
lackluster employment generation and some increases in food prices. More than half of the
population, equivalent to 10.4 million households, considered themselves poor in Q3 (Figure
4). 5 Hunger incidence likewise increased from last year, with almost one-fourth of the
population experiencing hunger. Record high poverty and hunger incidences were most evident
in Luzon (outside the National Capital Region), which was hit hard by recent typhoons and
flooding. Rising food inflation, which reached a high of 6.2 percent, and higher
underemployment in previous quarters were identified as causes of rising hunger. 6



                                              External Accounts

7.      The country’s external accounts remain at healthy levels, thanks to robust
remittance and capital inflows. As of October 2011, remittances grew by 7 percent to USD
16.5 billion, equivalent to about 6.5 percent of GDP. Through October, remittances from
Europe, East Asia, and the Middle East excluding Saudi Arabia continued to grow at above 6
percent. In Saudi Arabia, the Nitaqat program, which limits the issuance of new work permits
to Filipinos, has significantly slowed down deployment and, consequently, remittance growth
to only 0.4 percent. Moreover, a new Philippine law that bars deployment of workers to
countries which failed to sign international conventions protecting the rights of migrant
workers may further pull down remittance growth once implemented. 7 Nonetheless, higher
deployment to East Asia should limit these negative impacts on remittances (Figure 5).
8.     Electronics exports performance failed to recover following the Japanese disaster
as demand from advanced economies weakened significantly in Q3. From a record high
growth of 50.3 percent in September 2010 (albeit coming from a low base in 2009), electronics
export growth gradually fell and entered negative territory in February this year, culminating
in a contraction of 36.5 percent in October. The slump in electronics exports was driven by
weak demand for semiconductors, which fell by 50 percent. 8 In contrast, non-electronics and
services exports continued to perform well, growing by 23.8 and 8 percent through October

4 These results were taken from the Social Weather Station survey conducted during September 4-7, 2011 using

face-to-face interviews of 1,200 heads of households in Metro Manila, the rest of Luzon, Visayas, and Mindanao.
The survey questions cover the household’s own experience of hunger, poverty, and food poverty.
5 Self-rated poverty incidence in September 2011 reached 52 percent, nine percentage points higher than the

trough in March 2010 (a record low since 1987).
6 According to a recent research, a one-time increase in food prices can result in an increase in hunger incidence

that will last for five quarters, while a one-time increase in underemployment can result in an increase in hunger
incidence for two quarters. Food inflation averaged 5.5 percent in the first three quarters while underemployment
rate increased to 19.1 percent in July 2011 (latest available data) from 17.9 percent last year. These developments
could explain the rise in hunger incidence, pointing to the limited buffer and usable assets of the poor to cope with
shocks (Mapa, D., F. Han, and K. Estrada. (2010) “Food Inflation, Underemployment and Hunger Incidence in the
Philippines: A Vector Autoregressive (VAR) Analysis.” Transactions of the National Academy of Science and
Technology (Philippines), 32(1)).
7 On the other hand, this could just be a temporary slowdown as the government has been approached by some

countries in the ban list with proposals on bilateral labor agreements regarding overseas Filipino workers’ (OFW)
welfare protection.
8 Source: Semiconductors and Electronics Industries in the Philippines, Inc. (SEIPI)


                                                                                                                   8
and September (most recent data available), respectively (Figure 6). In particular, services
exports, led by business process outsourcing, have proven to be counter-cyclical in the past
crisis.
9.     On the other hand, imports continued to grow, albeit at a slower rate, resulting in
a wider trade deficit (Figure 7). Merchandise imports grew by 11.7 percent in September (9.6
percent in Q3) thanks to a positive reversal in capital goods imports, which began to grow in
August following a seven-month contraction. The rebound in capital imports was driven by
high power and specialized machinery, and aircrafts, boats, and ships importation, all of which
suggest a near to medium-term expansion of investment and production capacity.
                    Figure 5. Remittance growth has slowed as                                         Figure 6. Respectable growth in non-electronics
                            deployment growth moderates.                                                  and services exports compensated for poor
                                                                                                                      electronics exports.
                        Land-based OFW deployment and                                                                    Exports Growth
               30                                                         1600
                                  remittance                                                     120

               25
                                                                                                     80
                                                                          1200
               20
                                                                                                     40
                                                                                           percent
                                                                                  levels
     percent




               15                                                          800
                                                                                                      0

               10
                                                                                                     -40
                                                                           400
                5
                                                                                                     -80
                                                                                                           Apr-07




                                                                                                           Apr-08




                                                                                                           Apr-09




                                                                                                           Apr-10




                                                                                                           Apr-11
                                                                                                           Jan-07




                                                                                                           Jan-08




                                                                                                           Jan-09




                                                                                                           Jan-10




                                                                                                           Jan-11
                                                                                                            Jul-07




                                                                                                            Jul-08




                                                                                                            Jul-09




                                                                                                            Jul-10




                                                                                                            Jul-11
                                                                                                           Oct-07




                                                                                                           Oct-08




                                                                                                           Oct-09




                                                                                                           Oct-10




                                                                                                           Oct-11
                0                                                          0
                      2005    2006   2007     2008   2009   2010    YTD
                                                                   3Q11
                                                                                                           Electronics     Non-electronics   Services exports
                    OFWs deployed ('000)               Remittances ('0000, USD)

                    Deployment growth (lhs)            Remittance growth (lhs)
       Source: Philippine Overseas Employment                                                Source: National Statistics Office (NSO)
       Agency (POEA)                                                                        Bangko Sentral ng Pilipinas (BSP)




10.     Despite greater volatility, the financial accounts expanded following recent
sovereign credit rating upgrades and risk aversion in advanced economies. Net foreign
portfolio investments (FPI) from January to October 2011 increased to USD 3.4 billion against
USD 2.5 billion last year and were invested mostly in stocks and government bonds. 9 The
Philippines saw rapid capital outflows in September as investor risk aversion escalated on the
back of deteriorating conditions in Europe, though this was quickly reversed in the following
months. Foreign direct investment (FDI) inflows of USD 671 million through September
remained weak as in previous years, owing to investor risk aversion and the country’s weak
investment climate.
11.    Sustained inflows of portfolio investments and remittances have enabled the
country to continue accumulating reserves. GIR reached USD 76.4 billion in November –
25 percent higher than the country’s outstanding external debt as of August, and can cover
11.2 months of imports or 645 percent of the country’s short-term external liability by residual
maturity. Similarly, liquid reserves as measured by the forward book of the central bank


9   Investments in equities and government securities registered 26 and more than 300 percent growth, respectively.

                                                                                                                                                                9
amounted to USD 7.7 billion in October (Figure 8). Meanwhile, total external debt continued
to decline to around 35 percent of GDP as of August (World Bank definition).

    Figure 7. Exports have fallen to levels last seen in                                           Figure 8. Reserves have remained healthy and
       2008. Imports continued to expand away from                                                          continued to grow in November.
                      the crisis trough.
                              Balance of Trade, 3 MMA1/                                                                   Gross International Reserves
                  6                                            0.5                          105                    Months of import (rhs)
                                                                                                   90              ST external debt cover (rhs) 1/                                                         12
                                                                                                                   NIR + Forward Books (lhs)
                                                               -                                   75              GIR (lhs)
                  4




                                                                                     billion USD
    billion USD




                                                                       billion USD
                                                                                                   60                                                                                                      8
                                                               (0.5)
                                                                                                   45
                  2                                                                                30                                                                                                      4
                                      Exports                  (1.0)
                                                                                                   15
                                      Imports
                                      Trade Balance (rhs)                                          -                                                                                                       0
                  0                                            (1.5)




                                                                                                        May-09




                                                                                                                                            May-10




                                                                                                                                                                                May-11
                                                                                                                 Aug-09



                                                                                                                                   Feb-10



                                                                                                                                                     Aug-10



                                                                                                                                                                       Feb-11



                                                                                                                                                                                         Aug-11
                                                                                                                          Nov-09




                                                                                                                                                              Nov-10




                                                                                                                                                                                                  Nov-11
                      Apr-08




                      Apr-09




                      Apr-10




                      Apr-11
                      Jan-08




                      Jan-09




                      Jan-10




                      Jan-11
                       Jul-08




                       Jul-09




                       Jul-10




                       Jul-11
                      Oct-08




                      Oct-09




                      Oct-10




                      Oct-11




                  Source: NSO                                                                   Source: BSP
                  1/Three month moving average                                                 1/ Short-term debt by residual maturity




                                                            Financial Markets

12.     Improved macroeconomic fundamentals, recognized by three credit rating
upgrades in the past year, have helped to strengthen the peso, raise the stock market
index, and lower sovereign borrowing spreads. Beginning late-2010, the Philippines’
sovereign credit rating was upgraded by Fitch Ratings to one notch below investment grade,
and by Moody’s and Standard & Poor’s to two notches below investment grade. 10 As a result,
sovereign spreads fell to an average of 200 basis points 11 from 300 basis points in 2009 and as
high as 600 basis points during the height of the 2003 fiscal crisis (Figure 9). This together
with strong market liquidity has enabled the government to reduce its borrowing cost as
reflected in recent Treasury bond auctions which saw long-term rates falling to around 5-6
percent and the completion of the government’s 2011 borrowing requirements below
programmed cost.
13.     The core financial system is sound and generally resilient to a wide range of risks.
Direct exposure of Philippine banks to PIIGS’s 12 sovereign debt is very small, although
indirect exposures through other European banks 13, which comprise almost 70 percent of total
Philippine claims (higher than exposures to US and Japanese banks combined), can have a

10 Fitch Ratings upgraded the country’s long-term foreign currency issuer default rating (IDR) from BB to BB+

(one notch below investment grade) and the country’s long-term local currency IDR and country ceiling to BBB-
from BB+. Moody’s upgraded the Philippines’ ratings to Ba2 from Ba3 (two notches below investment grade).
Standard & Poor’s upgraded its foreign currency denominated credit rating from BB- to BB, one notch higher
from its previous rating bringing it to two notches below investment grade.
11 Following global developments, spreads temporarily increased in September to around 300 basis points before

normalizing in October.
12 This refers to Portugal, Italy, Ireland, Greece, and Spain.
13 This includes United Kingdom (UK).


                                                                                                                                                                                                                10
significant impact on Philippine financial stability should the crisis escalate (Table 1). At any
rate, the Philippine banking system exhibits improving asset quality and healthier balance
sheets through the first three quarters of 2011. Non-performing loans, non-performing assets,
and distressed assets remain low. The non-performing loan coverage is currently above 100
percent while the past due and loan loss ratios (i.e., expense allowance for bad loans) are on a
decline and currently below 5 percent. Finally, the capital adequacy ratio of over 15 percent
remains well above regulatory requirements.
14.     With increasing liquidity, domestic interest rates have remained low. The 91-day
T-bill rate hovered at around one percent while lending rates have fallen to 5-7 percent. As a
result, bank lending (net of RRPs 14) and private credit continued to grow by above 15 percent
in September. The manufacturing, utilities, and real-estate sectors were the principal drivers of
credit growth (Figure 10). Household credit growth, including credit card loans, remained
below pre-crisis highs, growing by about 14 percent in Q3 from a high of 23 percent in 2008.
The central bank’s special deposit account (SDA) grew by 78 percent in the first nine months of
the year to PHP1.6 trillion given negative real interest rates of banks. An acceleration of the
public-private partnership (PPP) program as well as improvements in the investment climate
should help divert the large stock of SDA to useful investments.


                          Table 1. Foreign claims on crisis-affected economies
                           and total claims on the Philippines (USD billions)

                                                       All banks    European   Japanese   UK        USA
 Total exposure of foreign banks to crisis-affected economies
                               Foreign Claims               1,275      1,155         48    112         61
 Portugal, Italy, Greece (PIG)
                               % Exposure                     4.7        6.1        1.8    2.7        1.7
                               Foreign Claims               1,681      1,481         71    175        114
 Italy and Spain
                               % Exposure                     6.2        7.8        2.7    4.2        3.2
 Portugal, Italy, Ireland,     Foreign Claims               2,484      2,178         95    354        181
 Greece, Spain (PIIGS)         % Exposure                     9.1       11.5        3.6    8.5        5.2

 Total exposure of Philippine banks to foreign banks
                               Total Claims                   33          15          4         7          8
 Claims on the Philippines
                               % Exposure                    100          47         11        22         23
 Source: Bank of International Settlements (BIS)


15.    The stronger peso has helped to contain inflation, although the associated influx
of short-term capital has also raised policymakers’ concerns about inflationary risks and
sudden reversals. The exchange rate remains market-driven with interventions limited to
smoothing exchange rate volatility (e.g., the forward foreign exchange swap). While the peso
depreciated to PHP 43.2 against the USD in November from PHP 42.4 in August, it remains in
line with fundamentals and exporters still find the peso’s strength a hindrance to export
growth. In October, the BSP imposed a higher capital charge on banks’ holdings of non-




14   Reverse repurchase placements (RRP) with the BSP

                                                                                                          11
deliverable forwards (NDFs) to tame speculative foreign exchange transactions. 15 In
November, the Monetary Board further liberalized and simplified its foreign exchange
regulations to improve efficiency of foreign exchange transactions. 16
16.    The Philippine equity market, being a high beta 17 market, was not spared from
the volatility caused by the Euro Zone debt woes. The Philippine stock exchange index
(PSEi) fell 7.6 percent to around 4,100 in October from a high of 4,400 in July, driven to a large
extent by net foreign selling which amounted over USD 200 million in August and September.
After the initial shock, the index corrected, steadily returning to the 4,300 level in end-October
and is consistent with the trends in other Asian markets. Net foreign buying equivalent to
around USD 340 million buoyed the PSEi in the last two months, closing at nearly 4,300 in
end-November (Figure 11).
                     Figure 9. Sovereign spreads reacted to the Euro                                                                   Figure 10. Firms have increased leverage given the
                      Zone crisis but are generally stable and low. The                                                                            low interest rate environment.
                                exchange rate remains stable.
                              Sovereign Debt Spread and Foreign Exchange Rate                                                                                   Growth in Production Loans
                    600                                                                                                 52                                      (3 MMA1/ percent change)
                                                                                                                                       60

                                                                                                                        48
                    400                                                                                                                30
     basis points




                                                                                                                             percent



                                                                                                                        44
                                                                                                                                        0
                    200
                                                                                                                        40             -30                      May-10




                                                                                                                                                                                                                        May-11
                                            PHL EMBI (lhs)                PHP/USD
                                                                                                                                                       Mar-10




                                                                                                                                                                                                               Mar-11
                                                                                                                                              Jan-10




                                                                                                                                                                         Jul-10




                                                                                                                                                                                                    Jan-11




                                                                                                                                                                                                                                 Jul-11
                                                                                                                                                                                  Sep-10




                                                                                                                                                                                                                                          Sep-11
                                                                                                                                                                                           Nov-10
                      0                                                                                                 36
                                   Mar-09




                                                                 Mar-10




                                                                                             Mar-11
                                               Jul-09




                                                                           Jul-10




                                                                                                      Jul-11
                          Nov-08




                                                        Nov-09




                                                                                    Nov-10




                                                                                                               Nov-11




                                                                                                                                                       Manufacturing                                         Electricity, Gas & Water
                                                                                                                                                       Real Estate                                           Total Production loans

                     Source: BSP and World Bank                                                                                               Source: BSP
                                                                                                                                             1/ Three month moving average




                                                                                             Inflation and Monetary Policy

17.     CPI inflation reached 4.8 percent through November, near the high-end of the
central bank’s target range of 3 to 5 percent. October inflation rose to 5.2 percent on
account of higher food and utility prices given supply constraints before slowing to 4.8 percent
in November (Figure 12). Food inflation spiked once again in October to 5.7 percent after
decelerating from a high of 6.2 percent in May as a result of flooding in Northern Luzon. In
November, food inflation slowed to 4.8 percent, the lowest for the year. The Thai flood is
expected to have minimal impact on imported rice prices thanks to Thailand’s ample buffer
stock. In addition, India’s provisional lifting of its rice exports ban and expected increase in

15 Earlier this year, banks have agreed to voluntarily limit their NDF positions, thereby reducing NDF volumes by
20 percent. Following this move, the central bank in June required banks to report their NDF transactions daily
instead of weekly in order to closely monitor the NDF market and curtail exchange rate volatility.
16 The new regulations aim to facilitate i) corporate access to foreign exchange market through formal (from the

previous parallel/informal) markets, and ii) residents’ and non-residents’ transactions through the banking system
to improve data capture of such transactions.
17 This refers to markets that are highly correlated with the US stock market.


                                                                                                                                                                                                                                                   12
Vietnam rice exports next year should provide adequate supply. 18 Utility prices increased in
October by 6.5 percent following hikes in generation rates and power supply disruptions caused
by ongoing maintenance work and damaged power plants due to recent typhoons. Like food, it
also decelerated in November as supply began to normalize. Other measures of inflation such as
the producer, wholesale, and construction price indices show relatively low and stable prices.
Noteworthy is the price of cement, which has contracted by 6.3 percent from last year
following weak construction demand.

18.     Monetary policy remains accommodative though higher liquidity, rising credit
growth, and slower economic growth are all posing challenges to the authorities.
Following two consecutive policy rate hikes earlier in the year, the central bank left policy rates
unchanged between June and early December. Instead, it raised the reserve requirement twice
to 21 percent to better manage liquidity growth. In October, the BSP increased the market risk
weight of NDFs as a pre-emptive measure to curb speculation against the peso through the
NDF market. According to the BSP, further liquidity management measures may be used,
including curtailing banks’ NDF operations, in case of stronger portfolio inflows and
inflationary pressures.

             Figure 11. Net foreign buying lifted the PSEi                                                                                                                                Figure 12. Food and utility inflation
                        back to the 4,300 level.                                                                                                                                        were key drivers of CPI inflation in 2011.
                                                                                                                                                                                                         Contribution to YoY Inflation
                                       Stock Market Performance                                                                                                                  6            Others                                                  Transport
      4800                                                                                                                                          12
                                                                                                                                                                                              Fuel, Light and Water                                   Food and Beverage
                                           Net Foreign Buy (rhs)                                                          PSEi                      10                                        Inflation Rate
      4400                                                                                                                                          8
                                                                                                                                                                                 4
                                                                                                                                                    6
                                                                                                                                                         billion PHP


                                                                                                                                                                       percent




      4000                                                                                                                                          4
                                                                                                                                                    2
                                                                                                                                                                                 2
      3600                                                                                                                                          0
                                                                                                                                                    -2
      3200                                                                                                                                          -4
                                                                                                                                                                                 0
                        7/16/2011
                                    7/31/2011
                                                8/15/2011
                                                            8/30/2011
                                                                        9/14/2011
                                                                                    9/29/2011
                                                                                                10/14/2011
                                                                                                             10/29/2011
                                                                                                                          11/13/2011
                                                                                                                                       11/28/2011
             7/1/2011




                                                                                                                                                                                                                                                                               Aug-11
                                                                                                                                                                                                                                           Apr-11
                                                                                                                                                                                                                Jan-11

                                                                                                                                                                                                                         Feb-11




                                                                                                                                                                                                                                                                      Jul-11



                                                                                                                                                                                                                                                                                        Sep-11
                                                                                                                                                                                              Nov-10




                                                                                                                                                                                                                                                                                                          Nov-11
                                                                                                                                                                                                                                                             Jun-11
                                                                                                                                                                                                                                                    May-11
                                                                                                                                                                                                       Dec-10




                                                                                                                                                                                                                                  Mar-11
                                                                                                                                                                                     Oct-10




                                                                                                                                                                                                                                                                                                 Oct-11




             Source: CEIC                                                                                                                                                                 Source: BSP



                                                                                                                                                    Fiscal Policy

19.    National government spending remained weak in Q3 despite some efforts to
accelerate disbursement. Total spending declined by 5.3 percent through October, resulting
in a budget deficit of only 0.8 percent of GDP as opposed to above 3 percent of GDP in the
same period last year. Capital outlay was 30 percent below programmed levels and priority
PPP projects have stalled given government decision to review all projects for efficiency and
cost considerations. These numbers indicate a primary spending gap equivalent to 1.9 percent
of GDP as of Q3, of which 56 percent was contributed by lower capital spending (Table 2). As

18   Source: United Nations Food and Agriculture Organization (UNFAO)

                                                                                                                                                                                                                                                                                                                   13
discussed above, the new administration’s efforts to improve transparency and accountability in
public spending is largely responsible for the temporary setback (Table 3 summarizes the
measures and reasons for delay). But once institutional reforms are in place, spending is
expected to fully recover at cost-effective levels with more resolute impact on the country’s
growth and development.

                                Table 2. National Government Fiscal Gap
                                                                      2011
                                                   Q1          Q2         3Q         YTD Q3
                        1
                   GAP (PHP, billions)
                   Total Revenues                  3.8         -8.6      -18.9         -23.7
                   Total Expenditure              -82.0       -57.7      -65.4        -205.1
                    Interest Payment              -10.5        -9.5       -9.1         -29.2
                    Primary Spending              -71.5       -48.2      -56.3        -175.9
                    Capital Outlays               -25.0       -48.1      -29.0        -102.1

                   Net Gap                         85.8       49.1        46.5         181.4
                                             2
                   GAP (% of Annual GDP )
                   Total Revenues                  0.0        -0.1        -0.2         -0.2
                   Total Expenditure               -0.8       -0.6        -0.7         -2.1
                    Interest Payment               -0.1       -0.1        -0.1         -0.3
                    Primary Spending               -0.7       -0.5        -0.6         -1.8
                    Capital Outlays                -0.3       -0.5        -0.3         -1.0
                   Net Gap                         0.9         0.5         0.5          1.9
                   Source: Department of Finance, Bureau of Treasury, and Department of Budget
                   and Management, and WB staff calculations.
                   1/ Actual less planned.
                   2/ Base case forecast for 2011.



20.     On public financial management, the government remains committed to
improving the efficiency of public spending. Towards this end, the government is working
to institutionalize zero-based budgeting (ZBB) and program evaluation to ensure that budget
items reflect government priorities and are implemented in cost-effective manner. These
approaches have enabled the executive to rationalize, eliminate, or scale up programs in the
2011 and 2012 Budgets, based on efficiency and equity considerations. 19 In addition, the
passage of the GOCC (government-owned and controlled corporation) Governance Act will


19 Rationalized programs include the Food for School Program, which is being administered more efficiently by
the Department of Social Welfare and Development (DSWD) using its national targeting system, and the
agricultural input subsidies program, which was found to mainly benefit non-poor farmers. Several programs that
exhibited weak project implementation ratings or procurement bottlenecks, such as the textbook program, teacher
deployment and school building construction, and TESDA's training for work scholarship programs, saw their
funds held up in both 2010 and 2011. Special purpose funds, especially the highly discretionary ones, have been
trimmed down significantly. Support to government corporations that did not meet the ZBB criteria was also
reduced, though measures to stop the underlying losses, mostly but not solely linked to quasi-fiscal operations
have yet to be announced and implemented. Finally, budget for social services increased significantly. For instance,
the budget for the conditional cash transfer program increased by more than 50 percent from last year.

                                                                                                                 14
enable the government to have a better handle of GOCCs with the end goal of reducing public
sector deficits and debt, and associated fiscal risks.

21.     On the revenue side, improved tax administration has led to higher tax revenues
in 2011. Through October, tax revenues grew by 12.9 percent – ahead of nominal GDP
growth. Full year tax effort is likely to improve from 12.1 to about 12.4 percent of GDP solely
on the back of improved tax administration given the absence of tax policy and modest
economic growth. Key programs include the regular filling of tax evasion charges under the
Run After Tax Evaders (RATE) Program and Run After the Smugglers (RATS) Program. A
similar program for corrupt tax officials is also being implemented.


               Table 3. Summary of measures to improve transparency and accountability
                in infrastructure spending and other reasons for implementation delays
             1. Realignment of around 80 percent of line item projects in the General
             Appropriations Act 2011 to reflect the priority of the government and to
             correct past inefficiencies.

             2. Implementation of the “no approved program of work, no budget” policy.
             This is an institutional reform requiring the preparation and approval of
             detailed program and scope of work prior to the release of funds.

             3. Stricter adherence to the procurement law on competitive public bidding.

             4. Clustering of smaller projects (e.g., on the same road alignment) into one
             contract package for efficiency.

              5. Late release of special allotment release orders (SAROs) for lump sum
             funds, which fund a substantial amount of DPWH projects.
           Source: Department of Public Works and Highways (DPWH)


22.    To raise more revenues, the executive has submitted a bill to congress proposing
to raise excise taxes of tobacco and alcohol products. Through a gradual alignment of tax
rates with inflation and a gradual shift from the multi-tier system to a unified system, this
reform is estimated to generate 0.6 percent of GDP in the first year. 20 The bill proposes to
earmark a portion of the revenue intake to the government’s universal health care program. To
plug future leakages in tax revenues, the executive is working with congress to pass the fiscal
responsibility and fiscal incentive rationalization bills.

23.    With improved macroeconomic fundamentals, the national government’s debt
ratio continues to decline due to higher nominal GDP growth, appreciation of the peso,
and lower borrowing costs. The government has been taking advantage of these favorable
conditions to reduce the risk profile of its debt stock by lengthening its debt maturity and
stemming further appreciation of the peso by raising its 2012 domestic-to-foreign borrowing
mix to 75-25.

20   For more details, please see the Special Focus No. 1 on excise taxes.

                                                                                             15
                                       PROSPECTS
                                     Output and Demand

24.    The external environment has become much weaker in recent months. Among
high-income economies, Japan is falling into recession in 2011 due in large part to the effects of
the Earthquake and Tsunami. The US economy was sluggish in the first half but has been
picking up and is expected to expand by 1.7 percent for the year. Output in the Euro Zone
expanded by about the same rate in 2011, but has weakened sharply in the second half and the
region may well go into recession in early 2012. Barring a marked deterioration of the situation
in Europe, growth in the United States should remain relatively strong, but fiscal consolidation
is expected to keep growth rates through 2013 below 2.5 percent. Output in Japan should
continue to strengthen as the economy rebounds from Tohoku-related disruptions and
reconstruction efforts gain way. Growth in East Asia is projected to slow from 8.1 percent in
2011 to 7.7 percent next year. While a number of countries are expected to enact fiscal stimuli
to buoy growth, they are likely to be limited compared to 2009 given narrower fiscal space.

25.     Despite the weaker global environment, the Philippines is relatively well-
positioned to weather shocks emanating from the current global turmoil given its strong
macroeconomic fundamentals, and regulatory reforms and prudential measures that
were instituted following past crises and slowdowns. The Philippines is also benefitting
from relative political stability, though downside risks to growth remain significant such as
increased uncertainties about global demand and a possible further slowdown in investments
and public spending. Overseas Filipino workers’ large remittance inflows have shown a
counter-cyclical pattern and have insulated the country from recent external imbalances. The
financial sector’s conservative stance throughout the preceding decade has helped to ensure
healthy balance sheets while the corporate sector, for the same reason, also exhibits no systemic
vulnerabilities.
26.     Philippine economic growth is projected at 3.7 percent in 2011 though significant
downside risks could push growth further down. Our projection hinges on the successful
implementation of the government’s disbursement acceleration program and an acceleration in
private consumption and investment, which have begun to grow faster in the last quarter. In
addition, lower growth in Q4 2010 should provide the added base effect boost. Significant
downside risks largely stem from the weaker external environment and less than satisfactory
public spending.
27.     Growth next year is projected to improve to 4.2 percent in line with regional
forecasts. Higher 2012 growth hinges on improvement in exports, acceleration of PPP
projects and private sector investment, and a full recovery of public spending with possibly a
medium-size fiscal stimulus. Higher public spending is expected to be financed by higher tax
revenues stemming from improved tax administration and higher excise taxes. A quicker
resolution of the Euro Zone’s debt crisis would bode well for the Philippines in terms of higher
exports and FDI flows. If the fiscal turmoil in Europe deteriorates and results in another
recession, the Philippines could moderate its impact with appropriate fiscal and monetary
stimuli. Box 1 presents a possible low case scenario for the Philippines.
28.   Growth prospects in the medium to long-term can be sustained at above 5
percent provided that reforms to address structural bottlenecks are implemented to
                                                                                               16
raise overall competitiveness. These include reforms to i) raise revenues efficiently and
equitably, ii) improve the quantity and quality of public spending, in particular infrastructure
and human capital investment, iii) enhance governance, and iv) reduce the cost of doing
business. A stronger structural underpinning would allow the country to deal with shocks
more effectively, achieve more inclusive growth, and reduce poverty at a faster rate.

                                  Box 1. Low Case Scenario

Given significant downside risks, another world recession cannot be ruled out. Global
growth in 2012 could mimic the 2009 recession and recovery could be much slower with
possibly a mild recession in 2013 (i.e., growth of -1 percent in advanced countries and low
positives for emerging and developing countries) and modest growth in 2014.

For the Philippines, growth could fall to around one percent similar to 2009. Significant
contraction in private and external demand can be cushioned by a large enough fiscal stimulus
equivalent to around 1 to 1.5 percent of GDP (as was the case in 2009). The fiscal stimulus and
a possible postponement of tax policy reform given the uncertainties would lead to a higher
deficit above 3 percent of GDP in 2012 before gradually declining towards 2 percent of GDP
beginning 2013. While the temporary surge in deficit is broadly sustainable, efforts to raise
revenues, especially from excise taxes, are very much needed to ensure adequacy of future fiscal
space in the event that a prolonged global slowdown requires further expansionary policy.

As in 2008-09, the level and quality of employment would be adversely affected but
these might not be fully reflected in official statistics. Manufacturing jobs will likely take a
big hit but total employment rates may not change much given net job creation in the informal
sector. At the same time, the underemployment rate may not rise as workers take in more jobs
to maintain household income levels.




                                  Employment and Poverty

29.     The projected slowdown is expected to lead to some deterioration in the labor
market especially among wage and salary earners. The electronics and other export-
oriented manufacturing sectors are most vulnerable as the 2009 experience shows, while the
BPO sector is expected to remain strong and possibly expand as foreign firms cut cost and
reallocate to the Philippines. Deployment of OFWs may decelerate once the government
begins to implement a deployment ban to 41 countries which failed to sign international
conventions protecting the rights of migrant workers. Although the countries included in the
deployment ban employs only about 2 percent of total deployment (around 20,000 workers), its
effect on the domestic economy is not trivial. Un-deployed workers and their families may be
forced to find work in the informal sector (i.e., as self-employed or workers without pay), which
raises their vulnerability to shocks and thus may cut down on human capital investment given
lower incomes.




                                                                                              17
                                          External Accounts
30.    The current account is projected to remain in surplus thanks to robust
remittances despite a widening trade deficit as exports weaken. Remittances will continue
to support growth given its counter-cyclical nature. 21 Remittance growth in 2011 and 2012 is
projected at 6 and 3 percent, respectively, slightly lower than historical growth rates as
deployment of Filipino workers moderates given political developments in recipient countries
particularly in the Middle East, stricter compliance with the country’s Migrant Workers Act,
and the global slowdown.

31.      Given the country’s reliance on electronics, export growth faces substantial
downside risks from a significant decline in global demand as was the case in 2009.
Export growth for 2011 and 2012 is projected at no more than 1.0 and 2.5 percent,
respectively. 22 For electronics exports, the industry forecasts an 18 percent contraction this
year and possibly extending to 2012. 23 The expiration in December 2011 of the special eco-
zone generation charges extended to exporters will hit Philippine exports hard given the high
share of power to total domestic input cost (as high as 35 percent of domestic input for some
firms). 24 To mitigate the problem, firms are negotiating bilateral agreements with power
suppliers for preferential rates. Greater intra-regional trade, trade with other large and fast
growing countries, and product diversification can partly offset the falling electronics demand
from advanced countries (see Special Focus No. 2 on exports).
32.      The impact of capital outflows is likely to be more tempered. Historically low
levels of FDI suggest that even under the low case scenario, a very low level of FDI would
have a minimal impact on Philippine external accounts. FDI is projected to moderate as foreign
investors retain their “wait and see” stance and as structural impediments to growth, such as
infrastructure availability, remain. FPI may retreat in the short-term if risk aversion escalates,
and hence make a noticeable but temporary dent in the external account but as markets
normalize, we can expect renewed capital inflows to the Philippines because of growth rate,
interest rate, and risk differentials. The projected sizable surpluses in both the current and
capital accounts point to a further build-up of the country’s reserve position and a gradual
decline in external debt from 37.3 percent of GDP in 2009 to around 32 percent of GDP in
2013. 25




21 During the 2008-09 slowdown, remittances continued to grow, aided in part by strong deployment of Filipino
workers in 2008 (20.2 percent) and 2009 (7.7 percent). In 2011, growth in land and sea-based workers with
processed contracts slowed to 4.5 and 5.5 percent, respectively, through August, but still sizable to provide
support to the country’s medium-term remittance prospects. Though the Middle East continues to be the top
destination of OFWs (i.e., recipient of more than 60 percent of total deployment), there has been some noticeable
diversification within the region such as the shift from Saudi Arabia towards higher growth and politically stable
countries such as UAE and Qatar.
22 See the special focus section on exports for more information on how the growth rates were estimated.
23 Source: Semiconductors and Electronics Industries in the Philippines Inc. (SEIPI)
24 Eco-zone generation rates are about one peso less per kilowatt-hour compared to standard rates.
25 World Bank definition


                                                                                                               18
                              Inflation and Monetary Policy
33.     CPI inflation for 2011 is projected at 4.8 percent, near the high-end of the BSP’s 3
to 5 percent target range, before easing to 3.5 percent in 2012 in part due to easing
commodity prices as world output slows. Given receding inflationary risk, the central bank
is expected to maintain overnight borrowing and lending rates at 4.5 and 6.5 percent,
respectively, until at least the first quarter of 2012 (when full year 2011 GDP is released),
allowing the BSP enough time to re-assess the appropriateness of monetary policy. Upside risks
to inflation include domestic food supply shocks following severe weather disturbances, which
have become more common, and the possible escalation of the La Niña weather effect in 2012.
Large-scale capital inflows, which could fuel further growth in domestic liquidity, also pose risk
to inflation.
34.    A key policy challenge in the near-term is curbing possible domestic overheating
from rapid credit growth and excessive capital inflows while maintaining an
environment conducive to growth. This requires a careful balance as monetary easing, while
supportive of short-term growth, could fuel further credit expansion leading to a deterioration
of credit quality thereby adversely affecting medium-term growth prospects. Given these
considerations, monetary authorities would need to keep watchful eye and act promptly against
any signs of overheating to prevent a credit boom-induced crisis.
35.     A combination of monetary and exchange rate policies, and related regulatory
and macro-prudential measures are needed to reduce risks to financial stability that may
endanger macroeconomic stability. Options to moderate credit growth include i) ceiling on
the loan-to-deposit ratio, ii) lending limits to sectors exhibiting rapid credit growth, such as
real estate, iii) more stringent liquidity requirements and sound credit management policies, iv)
limits on foreign exchange exposures including reduction in short-term borrowing, and v)
allowing greater exchange rate flexibility. In addition, to moderate capital inflows, the
government could allow the exchange rate to appreciate in line with fundamental, and reduce
the share of foreign borrowings and tap instead the large domestic fund. The central bank has
stated its readiness to implement further macro-prudential measures to deal with the effects of
capital surges on domestic liquidity and asset price inflation.


                                        Fiscal Policy
36.    With less room for monetary easing, the government can support growth by
appropriate fiscal expansion given ample fiscal space. Raising adequate revenues is vital to
supporting a large enough stimulus program while keeping the deficit within sustainable
bounds. To have the biggest impact on growth, the stimulus program would need to be
directed towards public infrastructure and other programs that generate more employment.
These would complement the government’s PPP program and raise overall investment levels
over the medium-term.
37.    Higher tax revenues beginning 2012 hinges primarily on new tax policy measures
and an acceleration of tax administration reforms. Key policy measures for 2012 include
raising excise taxes of alcohol and tobacco, enactment of the fiscal responsibility and fiscal
incentives rationalization bills to plug future leakages in tax revenues, and possibly a
comprehensive tax reform program aimed at lowering rates, broadening the base, and
                                                                                               19
improving equity and efficiency of the tax system. Passing the fiscal incentives rationalization
bill is crucial especially given that it has stalled in congress for over a year. An acceleration of
tax administration reforms would also help secure the much needed revenues to increase public
spending. Taken together, tax effort could increase by up to 0.7 ppts of GDP in 2012 from 12.4
percent of GDP in 2011 if these reforms are enacted in full. The Special Focus on excise taxes
gives a detailed analysis of Philippine tobacco and alcohol excise taxes and provides options on
how to further raise excise revenues.
38.    Careful management of public finances and the government’s resolve to raise tax
revenues should enable the government to gradually reduce its deficit towards 2 percent
of GDP beginning 2013. Consequently, national government debt levels could decline
towards 40 percent of GDP by the end of the current administration. Barring any unexpected
shocks, both trajectories are indicative of a sustainable fiscal policy setting.




                                                                                                 20
                                       SPECIAL FOCUS 1
                    Raising Excise Taxes on Tobacco and Alcohol Products 26

The real revenue yield from excises on tobacco and alcohol has declined significantly since 1997. This
erosion mainly reflects i) low tax rates to begin with, ii) specific rates that have not been updated
regularly in line with inflation, and iii) the use of 1996 prices to determine the tax rate for old products.
As a result, from 1997 to 2009, excise collection as a share of GDP fell by about 0.6 percentage points
from an already low yield of 1.2 percent of GDP. Quite alarming, Philippine tobacco excise tax rates
and burden are among the lowest in South East Asia. A major downside of this policy stance is that the
country has become the largest consumer of cigarettes among ASEAN countries (and 15th worldwide),
where almost one fifth of Filipinos begin smoking before the age of 10 and prevalence is increasing.

Raising excise tax revenues requires i) shifting from multiple to uniform excise tax rates, ii) raising
excise tax rates closer to international benchmarks and indexing to nominal GDP growth thereafter, and
iii) improving tax administration to minimize leakages from smuggling and evasion. A first best reform
would yield as much as 1.3 percent of GDP in additional revenues over the next five years. This
incremental revenue would enable the government to increase its human and physical investment to
improve the country’s growth and development prospects.
While excise taxes are regressive in the short term and when taken in isolation from other policies, they
nevertheless are intended to address the large negative externalities arising from smoking and drinking
and to discourage their consumption. Over the medium-term, higher excise rates are expected to lead to
better progressivity as the price elasticity of demand of poor households is higher so that large price
increases would induce these households to disproportionately reduce their consumption compared to
wealthier households. Savings from reduced consumption of alcohol and tobacco can be channeled to food
and human capital investment, which would enhance their welfare. Finally, revenues from the reform can
be used to improve health services and social protection, which would further enhance progressivity.


Tobacco
39.     Tobacco excise collections in real terms have been declining despite intermittent
attempts to address the decline. Since 1997 tobacco, excise collections decreased by 0.3
percentage points of GDP to 0.4 percent of GDP. The very low revenue yield from tobacco
products is due to a number of reasons including: i) low excise tax rates (the average excise to
retail sales price (RSP) ratio is as low as 25 percent for low-tier brands), ii) specific tax rates
that are not indexed to inflation, and iii) the use of 1996 prices for older products and current
prices for newer products for placement in price tiers with varying excise tax rates. Moreover,
the four-tier classification system distorts production and promotes consumption of cigarettes
by low income earners. While there have been some changes in tobacco excises in recent years,
after January 2011, no further excise tax rate increases are provided in the law. Given this,
tobacco excise revenues are on a predictable downtrend.


26 This special focus is based on a forthcoming publication of the World Bank entitled “Philippines: A Tax System

for High and Inclusive Growth” by Eric Le Borgne, Karl Kendrick Chua, Jonathon Kirkby, Peter Mullins, and
Sheryll Namingit.

                                                                                                              21
40.    While tobacco taxes are regressive in the short-term and when taken in isolation
from other policies, they are nevertheless intended to discourage smoking and to
address the large negative externalities of smoking. Between 2003 and 2009 the tax had
become more regressive, possibly partly due to a decline in smoking by the higher income
earners. Despite this, there is widespread agreement that tobacco taxes need to be increased in
order to deal with the negative externalities of smoking.
 Figure 13. Tobacco retail prices and taxation across                    Table 4. Retail sales price, excise burden and total tax
                   income groups 1/                                                   burden in selected countries 1/




 Source: World Health Organization (2010)                               Source: Philip Morris International and Sunley (2009)
1/ Simple average price of the most sold brand, excise tax per         1/ X-rate = foreign exchange rate; LC/$ = local currency/US$; data
     pack, and total tax share by income group, 2008.                       as of July 31, 2009.



 Figure 14. Total tax burden as a share of retail sales                  Figure 15. Cross country comparisons: cigarette price
              price for most sold brand 1/                                      per pack, and tax as percent of the price 1/




 Source: Sunley (2009)                                                  Source: Barber et al. (2008)
1/ US Dollar price per pack of 20 cigarettes is in brackets; data as   1/ 2004 to 2005 data.
     of July 31, 2009




                                                                                                                                      22
Figure 16. Cross country comparisons: price per pack                  Figure 17. Cross country comparisons: number of
                    of cigarettes 1/                                   minutes worked to purchase a pack of cigarettes 1/




Source: Blecher and van Walbeek (2008)                             Source: Blecher and van Walbeek (2008)
1/ US dollars (2006). The figure does not include countries that   1/ Median of seven lowest-paid occupations, 2006. The greater the
have no observation for 2006. HI — high income, UMI — upper-       number of minutes worked, the less affordable the pack of cigarettes.
middle income, LMI — lower-middle income, LI — low income          b 2003 data; c 2000 data.


41.     This is evidenced by the range of bills in congress on this issue, and the desire to
use the revenue from a tax increase to fund improved public health services. It should
also be noted that the regressive nature of excises on tobacco is lessened and the excise can
even become progressive over the long term as the price-elasticity of consumption is
significantly higher for poor (and young) smokers. High excises therefore induce
proportionately more poor consumers to quit smoking than richer ones. Savings from reduced
consumption of tobacco can be channeled to food and human capital investment, which would
enhance their welfare. Finally, additional revenues from the reform can be used to improve
health services and social protection, which would further enhance progressivity.

42.    Philippine tobacco excises are low compared to international standards. Table 5,
Figure 14, and Figure 15 show that in a comparison of 15 countries, the Philippines’ rates
appear in the lower half when comparing taxes as a share of retail prices. The low tax on
tobacco is one of the reasons why prices for cigarettes are among the cheapest among low to
medium income countries (Figures 16 and Figure 17).


Alcohol


43.     The issues with alcohol excises are similar to tobacco. The decline in revenue from
0.5 percent of GDP in 1997 to 0.3 percent in 2010 is due to i) the low excise tax rates (the
average excise to RSP ratio is 24 percent), ii) non-indexation of the rates, and iii) use of old
prices to determine applicable excise tax rate. As with tobacco, the law does not include any
increases in alcohol excise tax rates after January 2011.

44.     Alcohol taxes are regressive with low-income earners spending a greater portion
of household income on alcohol than the well-off (Figure 18). Lower income households
spend most on cheap wine and spirits, which could be partly due to the low excises on wine and
locally made spirits compared to other products such as beer. Despite being regressive in the
sense that low-income earners spend a higher share of their total expenditure on alcohol, the

                                                                                                                                     23
concentration curve of alcohol excise collection (Figure 19) lies below the 45 degree line so that
richer households contribute to a larger share of excise collection than poorer ones (as they
consume higher priced alcohol which is excised at a higher rate). The concentration curve
barely changed between 2003 and 2009. The low excises on local spirits, compared to the
excise on imported spirits, are currently in dispute at the WTO. Despite the regressive nature
of the excise taxes, congress is clearly concerned about the impact of excessive alcohol
consumption on the population, with a range of ‘sin’ tax bills seeking to address these concerns.

45.     Philippines alcohol excises are low compared to the region. While comparisons of
excise data on alcohol products are subject to some caveats (e.g., excise/RSP for the Philippines
will be lower than comparable ad valorem rate), Philippines alcohol excises are still low
compared to other countries in the region (except for Cambodia).

  Figure 18. The share of alcohol spending in total                                                                              Figure 19. Alcohol excise collection
        household spending falls as income rises
                                             Spending on Alcohol, 2009                                                                 Concentration Curve: Alcohol Taxes




                                                                                                                        1
                              1.4
                                                               Wine
  % share of total spending




                              1.2

                                                                                                                        .8
                                                               Beer
                              1.0                              Other alcoholic bev.               Cumulative Share(p)
                                                                                                                        .6
                              0.8
                                                                                                                        .4




                              0.6
                                                                                                                        .2




                              0.4
                              0.2
                                                                                                                        0




                                                                                                                             0         .2         .4              .6          .8   1
                                                                                                                                                   Percentiles (p)
                              0.0                                                                                                                      45° line        2003


                                   51   62   7 3  8 4  9 10
                                                                                                                                                         2006          2009


                               Income Decile
  Source: World Bank staff calculations based on FIES 2009                                      Source: World Bank staff calculations based on FIES data




                                                   Table 5. Excise Tax Rates in Selected ASEAN Countries


                                                          Cambodia                    Lao   Thailand 1/                               Vietnam     Philippines

                                                                        (Ad valorem rates, in percent)                                          (Excise/RSP)
                                         Beer                      30               50             55                                      50            26.1
                                         Wine                      10               60             60                                      25             5.5
                                         Spirits                   10            60-70          25-50                                   25-50            35.8

                                         Source: Respective Ministries of Finance.
                                        1/ Thailand also has minimum specific rates, with the excise being the higher of the specific rate or ad
                                        valorem rate.




                                                                                                                                                                                   24
Recommendations
Overall

•   Continue levying specific—rather than ad valorem--excises for tobacco and alcohol.

Rationale
46.     Specific excises that are automatically and frequently (e.g., annually) indexed to
inflation (CPI or nominal GDP as the case may be) can mirror ad valorem excises in
terms of revenue. Ad valorem excises, however, are more complex to administer since the
value of the product has to be ascertained and is prone to transfer pricing abuse. This leaves
more opportunities to challenge BIR and BOC assessments as opposed to specific excises which
simply require counting physical quantities. In the case of the Philippines, the experience with
ad valorem excises prior to the 1997 switch to specific excises illustrate the administrative
challenges in monitoring ad valorem excises and the greater opportunity to undermine excise
collection through the setting up of affiliated companies or marketing agents that increase the
retail price compared to factory price (and the corresponding excises).


Tobacco

•   Shift to a uniform excise tax rate for all cigarette brands.

•   Raise excise tax rates to achieve an average excise to retail sales price (RSP) ratio of 50
    percent in 2012 (and 60 percent by 2016), and index excise rates to nominal GDP
    thereafter.

•   Ensure all tobacco taxes are subject to specific tax rates, including cigars.

•   Significantly improve administrative efforts to minimize leakages from smuggling due to
    the proposed higher tax regime.

Rationale
47.     The shift to a uniform excise tax rate for all brands will remove production
distortions, discourage consumption, and improve equity across brands. The current
multi-tier price classification system has no clear policy rationale and is unique internationally.
It therefore should be abolished.

48.     A significant increase in the excise rate will bring the excise rates closer to the
regional rates and at the same time significantly increase revenue. Given inelastic demand,
excise tax rates should be set as high as possible to raise adequate revenues, discourage
consumption, and correct externalities. A good target would be to set the excise/ RSP ratio to
at least 50 percent. A first best target would be to aim for 67 percent, but such a rate may have
too severe an impact on the formal market. The proposed increase would align the Philippines
tobacco excises with international standard.



                                                                                                25
49.     Indexing the excise tax rates to nominal GDP growth will keep the excise burden
from falling, avoid revenue erosion in the future, and provide funds to improve health
services. An alternative could be to index to CPI, but this is not considered adequate to
maintain the revenue yield as a share of GDP as the combined growth of tobacco demand and
CPI is lower than nominal GDP growth.

50.     Applying specific tax rates to cigars will simplify the administration of tobacco
taxes. In 2005, taxation of cigars reverted to ad valorem taxes. However, a standard method
for calculating excises for all tobacco taxes would be simpler, and is consistent with the
simplification objective of the overall tax reform package.

51.     Significantly higher taxes will likely encourage more smuggling and tax evasion,
hence administrative efforts should be enhanced to minimize leakages. The current efforts
to preventing smuggling will need to be substantially improved to avoid a significant erosion of
the tax base.
Revenue estimates
52.    The recommended reform should generate 0.98 percent of GDP in additional
tobacco excise and VAT revenues by 2016. Estimates of the preferred option together with
a number of alternative policy scenarios are set out in Table 8. The scenarios are described
below.

•    Scenario 1: no policy change. This results in a predictable decline of tobacco revenues from
     0.35 percent of GDP in 2010 to 0.25 percent of GDP in 2016.

•    Scenario 2: indexing to CPI. Even if this scenario is implemented at the beginning of 2012,
     it will still result in a gradual decline in revenues to 0.31 percent of GDP since the growth
     in nominal GDP is projected to be higher than the combined growth of CPI and demand.

•    Scenario 3: indexing to nominal GDP (nGDP). This indexation is necessary to stabilize
     tobacco revenues. Indexing to nGDP will increase revenues to 0.39 percent of GDP by
     2016. However, this figure is still quite low relative to 1997 revenues. Moreover, it is not
     enough to finance the government’s ambitious Universal Health Care (UHC) program. 27

•    Scenarios 4 to 6: Increasing excise tax rates of each brand to a target excise to RSP ratio
     (say 50 percent). Such an increase is desirable but will still yield lower revenues as
     consumers will simply substitute downwards. Moreover, retaining the four-tier
     classification system will continue to distort production, will not address negative
     externalities, and discourage consumption. Additional revenue yield ranges from only 0.38
     to 0.44 percent of GDP depending on the number of years of adjustment to reach the
     desired target level.




27 Aside from providing financing for programs such as the UHC, the cost of tobacco-related health care is
estimated by WHO at PHP 43 billion (0.5 percent of GDP). Given this, any reform should generate at least 0.5
percentage points of GDP in additional revenues to be useful.

                                                                                                         26
                           Table 6. Tobacco excise reforms: scenario and projected revenue 1/
                                                                                                                                             Change      VAT      Total
                                                                                           2010   2011   2012   2013   2014   2015   2016
                                                                                                                                             2009-16   impact with VAT

                                                                                                                       (In percent of GDP)
    Scenario 1    No policy change                                                         0.35   0.35   0.33   0.31    0.29 0.27 0.25         -0.05    -0.01     -0.06
    Scenario 2    Retain 4-tier system, indexed to CPI beginning 2012                      0.35   0.35   0.34   0.33    0.32 0.31 0.31          0.01     0.00      0.01
    Scenario 3    Retain 4-tier system, indexed to nGDP beginning 2012                     0.35   0.35   0.36   0.37    0.38 0.38 0.39          0.09     0.01      0.10
    Scenario 4    Retain 4-tier system, one time adjustment in excise tax rates in 2012    0.35   0.35   0.64   0.65    0.66 0.68 0.69          0.39     0.05      0.44
                  to reach 50% excise/RSP ratio and indexed to nGDP thereafter
    Scenario 5    Retain 4-tier system, staggered adjustment in excise tax rates in 2012   0.35   0.35   0.47   0.48   0.64   0.66   0.67       0.37     0.04     0.42
                  and 2014 to reach 50% excise/RSP ratio and indexed to nGDP
                  thereafter
    Scenario 6    Retain 4-tier system, staggered adjustment in excise tax rates in        0.35   0.35   0.42   0.43   0.52   0.53   0.64       0.34     0.04     0.38
                  2012, 2014, and 2016 to reach 50% excise/RSP ratio and indexed to
                  nGDP thereafter
    Scenario 7    Shift to 2-tier system, one time adjustment in excise tax rates using    0.35   0.35   0.51   0.52   0.53   0.54   0.55       0.26     0.03     0.29
                  high and premium rates to reach excise/RSP of 50%, and indexed to
                  nGDP thereafter
    Scenario 8    Shift to a 1-tier system using premium rate, one time adjustment in      0.35   0.35   0.73   0.75   0.77   0.79   0.82       0.52     0.06     0.58
                  excise tax rates to reach excise/RSP ratio of 50% in 2012, and
                  indexed to nGDP thereafter
    Scenario 9    Shift to a 1-tier system using premium rate, one time adjustment in      0.35   0.35   0.67   0.92   1.12   1.15   1.17       0.87     0.10     0.98
                  excise tax rates to reach excise/RSP ratio of 50% for premium tier
                  and 3-year adjustment elsewhere, and indexed to nGDP thereafter
    Scenario 10   DOF version                                                              0.35   0.35   0.53   0.73   0.90   0.86   0.83       0.53     0.06     0.59

      Source: World Bank staff simulations.
     1/ RSP stands for retail sales price.


•       Scenarios 7 and 8: Shifting to a dual or unified rate and indexing to nGDP are an
        improvement but are not enough unless excise taxes are increased.

•       Scenario 9: Shifting to a unified rate for all brands by 2014, imposing higher excise tax
        rates, and indexing to nGDP constitutes the preferred reform. This involves shifting to a
        unified rate using the premium rate as starting point and adjusting the rate to reach an
        average excise/RSP ratio of 50 percent in 2012 and moving towards 60 percent by 2016.
        To avoid sudden price jumps, the tax rates for lower tier brands can be adjusted over a
        period of three years. 28 Adopting a tax schedule following Table 9 and indexing to nGDP
        thereafter once the target is reached is projected to yield additional 0.98 percent of GDP in
        excise and VAT revenues by 2016. 29 The reform would also prevent the excise burden from
        falling over time.




28 The increase in prices is likely to be tempered by a reduction in the net retail price as manufacturers cut prices
to accommodate demand (at any rate, the profit margin is quite high for some brands). In fact, this practice
occurred in 2005 for low-tier brands when excise tax rates were almost doubled.
29 An even better reform is one that targets an excise tax to RSP ratio of at least 67 percent for all brands. This

would yield over 2 percent of GDP in additional excise and VAT revenues but would eliminate the low-tier formal
market and thus is not feasible.

                                                                                                                                                                    27
    Table 7. Tobacco excise levels and RSPs for a unified rate                              Table 8. Alcohol excise rates and RSPs for
                        by 2014 (scenario 9)                                                                  Scenario 7

                         2011        2012       2013          2014   2015    2016                                        2011   2012      2013       2014     2015    2016


     Excise                                 (In pesos per pack)                       Excise tax rate                                  (in peso per liter)
      Low priced          2.72   15.20          27.67      40.15     44.28   48.83     Beer                              10.4   25.5       28.1        31.0    34.2    37.7
      Medium priced       7.56   18.42          29.28      40.15     44.28   48.83     Wine                              22.0   50.5       55.7        61.4    67.8    74.7
      High priced        12.00   21.38          30.76      40.15     44.28   48.83     Spirits                           14.7   75.5       83.3        91.9   101.3   111.7
      Premium priced     28.30   33.00          36.40      40.15     44.28   48.83
                                                                                      Excise/RSP ratio of leading tier                   (in percent)
     Excise/RSP ratio                          (In percent)                            Beer                              26.1   34.8      35.6        36.4     37.3    38.1
      Low priced           25         60          69           74      74      75      Wine                               5.5   11.2      11.8        12.3     12.9    13.5
      Medium priced        37         55          63           67      67      68      Spirits                           14.0   42.4      43.5        44.6     45.7    46.8
      High priced          39         50          56           60      61      61
      Premium priced       34         35          36           36      37      37
      Average              34         50          56           59      60      60
                                                                                     Sources: WB staff calculations
     Source: WB staff calculations




Alcohol

Recommendations

•     Shift to a uniform excise tax rate per class of alcohol.

•     Raise excise tax rates to PHP 25.5, PHP 50.5, and PHP 75.5 per liter (proof liter for spirits)
      respectively for beer, wine, and spirits. Index excise tax rates to nominal GDP thereafter
      (excise rates on highly taxed spirits will be reduced to align with other spirits, but the
      current consumption of these products is very low).

•     Significantly improve administrative efforts to minimize leakages from smuggling due to
      the proposed higher tax regime.


Rationale

53.     The rationale for the recommendations is similar to that proposed for tobacco.
The shift to a uniform excise tax rate for all similar categories of alcohol products will remove
production distortions, discourage consumption, improve equity across brands, and simplify the
taxation of alcohol. The increase in the excise rates will align them closer to international
standards and increase revenue, with the indexing ensuring the revenue is not eroded in the
future.

54.      Setting a single rate for broad classes of alcohol should also address the issue in
the WTO dispute. Locally produced spirits will be taxed in the same manner as imported
spirits. There may be concerns that expensive spirits would be subject to the same excise as
cheaper locally produced spirits. While the excise rates are the same, the VAT imposed on the
products will ensure a higher absolute amount of tax is paid on the more expensive brands. In
any case, the current consumption of imported spirits is very low.



                                                                                                                                                                        28
Revenue estimates
55.    The recommended reform can generate 0.34 percent of GDP in additional alcohol
excise and VAT revenues (BIR collection only) by 2016. Estimates of the preferred option
together with a number of alternative policy scenarios are set out in Table 11. The scenarios
are:

•       Scenario 1: No policy change. This results in a predictable decline of alcohol revenues from
        0.27 percent of GDP in 2010 to 0.19 percent of GDP in 2016.

•       Scenario 2: Indexing to CPI beginning in 2012. This still results in a gradual decline in
        revenues (to 0.23 percent of GDP) since the growth in nominal GDP is projected to be
        higher than the combined growth of CPI and demand.

•       Scenario 3: Indexing to nominal GDP (nGDP). This is necessary to stabilize alcohol
        revenues. Indexing to nGDP will increase revenues to 0.30 percent of GDP by 2016.
        However, this figure is still quite low relative to 1997 revenues.

•       Scenarios 4 to 6: Increasing excise tax rates of each price tier to a target excise to RSP ratio
        (40, 10, and 50 percent for beer, wine, and spirits respectively). This is desirable but will
        still yield lower revenues as consumers will simply substitute downwards. Moreover,
        retaining the multi-tier classification system will continue to distort production, and will
        not address negative externalities and discourage consumption. Additional revenue yield
        averages about 0.30 percentage points of GDP depending on the number of years of
        adjustment.

                               Table 9. Alcohol excise reforms: scenario and projected revenue

                                                                                                                                                 Change      VAT Total with
    Total projected collection (BIR only)                                                    2010   2011   2012   2013   2014    2015    2016
                                                                                                                                                 2009-16   impact      VAT

                                                                                                                         (In percent of GDP)
    Scenario 1   No policy change                                                            0.27   0.27   0.25   0.24     0.22   0.21    0.19     -0.10    -0.01     -0.11
    Scenario 2   Excises indexed to CPI beginning 2012                                       0.27   0.27   0.26   0.26     0.25   0.24    0.23     -0.05    -0.01     -0.06
    Scenario 3   Excises indexed to nGDP beginning 2012                                      0.27   0.27   0.28   0.28     0.29   0.29    0.30      0.01     0.00      0.01
    Scenario 4   2012 adjustment in excise taxes to reach 40, 10, and 50 percent of          0.27   0.27   0.53   0.53     0.54   0.55    0.55      0.27     0.03      0.30
                 RSP for beer, wine, and spirits respectively and indexed to nGDP
                 thereafter
    Scenario 5   2012 and 2014 adjustments in excise taxes to reach 40, 10, and 50           0.27   0.27   0.40   0.40    0.55    0.56   0.56       0.28     0.03     0.31
                 percent of RSP for beer, wine, and spirits respectively and indexed to
                 nGDP thereafter
    Scenario 6   2012, 2014, and 2016 adjustments in excise taxes to reach 40, 10,           0.27   0.27   0.34   0.35    0.44    0.44   0.54       0.25     0.03     0.28
                 and 50 percent of RSP for beer, wine, and spirits respectively and
                 indexed to nGDP thereafter
    Scenario 7   Unified rate per class and 2012 adjustment to reach P25.5,                  0.27   0.27   0.54   0.55    0.56    0.57   0.58       0.29     0.04     0.33
                 P50.5,P75.5 per liter for beer, wine, spirits respectively and indexed to
                 nGDP thereafter
    Scenario 8   DOF version                                                                 0.27   0.27   0.46   0.52    0.64    0.62   0.59       0.30     0.04     0.34

    Source: World Bank staff simulations.




•       Scenario 7: Shifting to a unified rate per alcohol class, imposing higher excise tax rates, and
        indexing to nGDP thereafter. This is the preferred reform of the report. This involves
        shifting to a unified rate per alcohol class using the most popular price-tier as base. The

                                                                                                                                                                         29
    proposed excise tax rates are as follows: PHP 25.5, PHP 50.5, PHP 75.5 per liter (proof liter
    for spirits) respectively for beer, wine, and spirits in 2012 and indexing to nGDP
    thereafter. 30 Adopting a tax schedule following Table 10 and indexing to nGDP thereafter
    once the target is reached is projected to yield additional 0.33 percent of GDP in excise and
    VAT revenues by 2016. The reform would also prevent a decline in the excise burden over
    time.




                                              Selected References

Blecher, Evan and Corné van Walbeek. (2008) “An Analysis of Cigarette Affordability.”
       International Union Against Tuberculosis and Lung Disease, Paris.

Sunley, Emil M. (2009) “Taxation of Cigarettes in the Bloomberg Initiative Countries:
       Overview of Policy Issues and Proposals for Reform.” International Union Against
       Tuberculosis and Lung Disease, Paris.

World Health Organization. (2010) WHO Technical Manual on Tobacco Tax Administration,
      Geneva.




30 The increase is prices is likely to be tempered by a reduction in the net retail price as manufacturers cut prices to

accommodate the lower demand (this is likely as the profit margin is quite high for some brands).

                                                                                                                    30
                                        SPECIAL FOCUS 2
                             Philippine Exports: Where Do They Stand?

Despite being an open economy, the Philippines’ openness to trade is lower than its neighbors and its
exports have been growing slower than GDP. Export diversification has improved in terms of market
destination (e.g., more exports to China and other emerging markets and less to the US) but not in terms
of product line. The global market share of its main export, semiconductors, has continued to decline.
This is in part due to the adverse external environment, changing technology that the Philippines has yet
to fully adopt (e.g., new generation gadgets such as tablet computers and smart phones), and stagnant
physical capital per worker. In terms of exports survival, the Philippines scores the lowest among
comparable ASEAN countries. Thus, improving the country’s business environment, particularly in non-
PEZA areas, will be essential to boost physical investments, encourage innovations, and promote
investments in human capital so that the country can better internalize and harness advanced technologies
and business know-how embedded in foreign direct investments. In terms of services exports, a more
efficient regulatory system would improve the industry’s productivity, thus improving its competitiveness.


Trends
56.    The Philippines has a fairly open trade regime. Average effective tariff rate was 4.77
percent31 in 2010, close to China’s 4.29 percent. However, its economy is becoming less
dependent on trade compared to its neighbors. Trade as a share of GDP has gradually declined
from 105 percent in 2000 to about 70 percent in 2010, while Thailand maintains it at around
130 percent and Vietnam has grown rapidly from 112 to 153 percent. The country’s
merchandise exports-to-GDP ratio dropped from about 50 to 35 percent in the last decade.
Unlike its neighbors, growth in exports has been slower than GDP growth. Export growth is
recent years has been driven by PEZA 32 exports, which receive generous tax incentives.

57.     Philippine export markets are diversified. Between 1999 and 2009, Philippine export
markets expanded from less than 70 to well over 100 economies. Key trading partners include
countries in the European Union, United States, Japan, China, and countries in the rest of East
Asia (Table 12). Each region/country accounts for about a fifth of total merchandise exports.
Trade with other large and fast growing countries are insignificant. World Bank (2011) finds
that the Philippines is under-trading with countries such as Brazil, Russia, India, and South
Africa (the so called BRICS country excluding China).




31 This is defined as the average of effectively applied rates weighted by the product import shares to each partner

country.
32 Philippine Economic Zone Authority


                                                                                                                 31
                         Table 10. Top Philippine Export Destinations (in percent of total)
                                                        Total exports                                                                                     Electronics1
                                  2006    2007         2008     2009           2010             Average                2006               2007           2008     2009         2010          Average
European Union2                   18.5    17.0          17.4            20.7   14.4                  17.6               27.0              24.9           23.4           26.8   15.7            23.6
United States                     18.4    17.0          16.7            17.7   14.7                  16.9                4.7               3.4            3.4            2.9    4.0             3.7
Japan                             16.3    14.5          15.7            16.2   15.2                  15.6                7.0               5.3            6.2            8.3    5.1             6.4
China                              9.8    11.4          11.1             7.6   11.1                  10.2               14.1              16.2           19.5            8.2    7.4            13.1
East Asia3                        19.8     21.2         20.6            17.2   19.8                  19.7               23.7              23.9           25.4           12.8   11.0            19.3
Singapore                          7.4      6.2          5.3             6.4   14.2                  7.9                11.8              10.2           7.9            15.2   36.8            16.4
Source: World Integrated Trade Solution (WITS).
1/ WITS ISIC code 3210
2/ Defined as EU 27
3/ Low and middle income countries




58.     The shares of exports to emerging markets, notably China, have increased while
the shares to traditional export partners, such as the US, have declined. As shown in
Figure 20, the prominence of the US has dropped from about 40 percent in 1991 to only 15
percent in 2011. On the other hand, China gained from 1 to 15 percent in the last decade, while
the traditional markets of US, Japan, Singapore, and Europe remain important, Korea, Thailand
and Malaysia are now among the top ten export destinations.


                      Figure 20. Share of key exports                                       Figure 21. Top ten exporters of semiconductors

                 45
                                                  China, People's Republic
                                                                                            100                         Electronics Top 10 Market Shares
                 40                               of: Mainland                                                                                                                 France
                                                  United States
                 35                                                                                                                                                            Thailand
                                                                                                80
                 30                                                                                                                                                            Philippines
                                                  EUROPEAN UNION (EEC)
       percent




                 25                                                                                                                                                            Germany
                                                                                                60
                                                                                      percent




                 20
                                                                                                                                                                               Malaysia
                 15                                                                             40                                                                             United States
                 10
                                                                                                                                                                               Korea, Rep.
                 5                                                                              20
                                                                                                                                                                               Japan
                 0
                                                                                                 0                                                                             China
                      1990Q1
                      1990Q4
                      1991Q3
                      1992Q2
                      1993Q1
                      1993Q4
                      1994Q3
                      1995Q2
                      1996Q1
                      1996Q4
                      1997Q3
                      1998Q2
                      1999Q1
                      1999Q4
                      2000Q3
                      2001Q2
                      2002Q1
                      2002Q4
                      2003Q3
                      2004Q2
                      2005Q1
                      2005Q4
                      2006Q3
                      2007Q2
                      2008Q1
                      2008Q4
                      2009Q3
                      2010Q2
                      2011Q1




                                                                                                                                                                               Singapore
                                                                                                       2001

                                                                                                              2002

                                                                                                                     2003

                                                                                                                            2004

                                                                                                                                   2005

                                                                                                                                           2006

                                                                                                                                                  2007

                                                                                                                                                         2008

                                                                                                                                                                2009

                                                                                                                                                                       2010




       Source: International Monetary Fund (IMF)                                  Source: World Integrated Trade Solution (WITS)


59.    In contrast, product diversification continues to pose a challenge. While nearly all
sectors experienced healthy growth (with the exception of the textiles and clothing industry),
concentration on high-tech products, which accounts for some 60-70 percent of total exports
(before the current slowdown), persists. Electronics parts (45 percent of total), such as
microprocessors and mobile phone chips, and finished electronics goods (20 percent of total) are
the main product lines. 33 Although only a third of Philippine electronics exports are shipped to
the USA, Euro Zone, and Japan, it is estimated that a larger 50 percent is shipped to China and
other East Asian economies for assembly and eventual export to advanced economies.



33   In terms of ISIC classification, these fall under product codes 3210 and 3000 respectively.

                                                                                                                                                                                                 32
60.    The Philippines is the eight largest exporter of semiconductors with a market
share of about four percent, down from seven percent ten years ago (Figure 21). The
decline in Philippine market share reflects rapid growth of Korean, Singaporean, and Chinese
semiconductor exports and growing demand for new generation electronics such as tablet
computers and smart phones. This suggests a further deceleration of Philippine semiconductor
exports in the medium-term. To improve growth prospects, industries would have to align its
business to the new technology and demand or diversify into other products.

61.      Two characteristics of Philippines exports suggest potentials for growth. First,
the Philippines’ export basket is richer than its income. 34 In a sample of 100 developing
countries that the World Bank has classified as either low or middle income, Philippines lies
above the regression line implying that its export basket is “richer” than its income (Figure
22). 35 Countries above the line can expect to see growth from existing products because they
are deemed sophisticated. However, if sophistication is measured based on the final value of
assembled good, it is likely to exaggerate the ability of the country to produce complex, high-
value products. While the increasing focus of the Philippines on manufactured goods is a
desired outcome, it remains to be analyzed what value the country adds to these exports.

62.     Second, Philippine exports have medium human and physical capital content.
Revealed factor intensity 36 suggests that the Philippines’ export profile is dominated by
products with medium, not low, human and physical capital content. However, physical capital
content has been growing slower. Between 1997 and 2007, the median value of capital content
increased only minimally. Average human capital increased by about 10 percent but physical
capital per worker hardly changed, from USD 15,067 to USD 15,488 (measured at 2000 prices).



Recent developments
63.     After a strong recovery in 2010, electronics export performance collapsed anew,
reflecting the impact of three major shocks, notwithstanding domestic structural issues.
First, the earthquake and tsunami disasters in Japan resulted in shutdowns of firms and
disrupted the global supply chain. Second, lower growth in advanced economies, coupled with
concerns about another recession, slowed down global trade. Third, widespread flooding in
Thailand has led to another disruption in the manufacturing supply chain. This latest shock
could drag the country’s export performance further down.

64.    Non-electronics exports have buoyed overall exports growth. With lackluster
electronics export performance (i.e., year-to-date contraction of 20.1 percent), overall exports

34 This discussion is taken from World Bank (2011).
35 This is based on one of the measures of export sophistication (EXPY), which assesses the export baskets of
countries by the incomes of countries that produce similar products, weighted by the share of those exports in the
national total.
36 The indices are computed by weighting the factor endowments of all countries exporting a particular product.

Weights are derived from a modified version of the revealed comparative advantage (RCA). Goods that are
predominantly exported by countries rich in human capital are revealed to be intensive in human capital. See
Cadot et al. (2009). The database is available in http://r0.unctad.org/ditc/tab/index.shtm.

                                                                                                               33
growth has been buoyed by non-electronics exports, which grew by almost 30 percent in the
first three quarters of 2011 (Figure 23). This positive trend runs counter to the experience in
2008-09 in which non-electronic exports also collapsed. These dynamics have contributed to a
growing share of non-electronics exports to total exports. From around 30 percent in 2007, the
share of non-electronic exports to total exports had risen to 50 percent by October 2011.

65.     Services export, which is dominated by the BPO industry, continues to perform
well growing by 8.5 percent in the third quarter. The BPO industry currently employs
525,000 workers (around 8.4 percent of formal services sector employment 37) and accounts for
around 5 percent of gross value-added. The industry expects its manpower and revenues to
grow by 15-20 percent in the coming years given strong growth potential even in the face of
another global slowdown. As the experience of the last crisis showed, the industry is largely
“recession-resilient” given its large operations in a-cyclical sectors such as healthcare, legal, and
accounting services. It also remains an attractive option for foreign firms bent on reducing
operating cost. 38 On the other hand, the country’s other major services export, tourism, has yet
to reach its potential as its contribution to GDP remains sluggish at around 3 percent for the
past decade. 39

               Figure 22. Export sophistication                      Figure 23. Philippine merchandise export has been
                                                                                   buoyed by non-electronics.
                                                                                                          Merchandise exports performance
                                                                                    8                                                                                                               100
                                                                                                     Non-electronics exports (lhs)                         Electronics exports (lhs)
                                                                                    7                Electronics growth                                    Non-electronics growth                   80

                                                                                    6                Total exports                                                                                  60

                                                                                    5                                                                                                               40
                                                                      billion USD




                                                                                                                                                                                                          percent
                                                                                    4                                                                                                               20

                                                                                    3                                                                                                               0

                                                                                    2                                                                                                               -20

                                                                                    1                                                                                                               -40

                                                                                    0                                                                                                               -60
                                                                                        Jan-08




                                                                                                                   Jan-09




                                                                                                                                              Jan-10




                                                                                                                                                                         Jan-11
                                                                                                          Sep-08




                                                                                                                                     Sep-09




                                                                                                                                                                Sep-10




                                                                                                                                                                                           Sep-11
                                                                                                 May-08




                                                                                                                            May-09




                                                                                                                                                       May-10




                                                                                                                                                                                  May-11
   Source: World Bank                                                Source: NSO
   Note: Countries lying above the straight line are considered as
    those with richer export baskets.




37 This is proxied by total employment in the services sector excluding employment in wholesale and retail trade,

transport, private household and others.
38 During the 2008-09 global slowdown, the industry grew by a respectable 14 percent, though much lower than

its 40 percent growth prior to the slowdown.
39 Source: World Development Indicators (WDI)


                                                                                                                                                                                                                    34
Survival Propensity 40

66.     Philippine exports have a lower probability of surviving export spells compared
to Indonesia, Thailand, and Malaysia (World Bank 2011). The Kaplan-Meier (KM) survival
estimates 41 indicate that the probability of a Philippine export surviving beyond the first, sixth,
and twelfth years are consistently lower than corresponding rates for the other three countries,
albeit differences are not highly significant except when compared to Thailand where export
spells have the best record of survival among the ASEAN-4 (Table 13). 42 One caveat of this
analysis is that product death is not necessarily a poor export achievement if they occur more
frequently in product categories that are dynamic in nature, such as parts and components
manufacturing that are part of global production networks.


                     Table 11. Comparative survival propensity of ASEAN countries
                     Spell length (Year)                       KM Survival Estimate
                     Mean       Median       No. of spells     1st year 6th year                        12th year
Philippines          3.15       1            60,114            0.5442    0.2555                         0.2011
Indonesia            3.38       2            101,011           0.5611    0.2749                         0.2176
Malaysia             3.46       2            104,594           0.5710    0.2856                         0.2286
Thailand             3.70       2            116,712           0.5867    0.3193                         0.2629
Source: World Bank (2011)


67.     Diversification and nurturing trade relationships could increase the probability of
survival. The analysis suggests that the probability of an export spell surviving longer is
higher if it is exporting to i) non-ASEAN countries (excluding Brunei and Myanmar) compared
to ASEAN countries and ii) richer countries (with per capita income exceeding USD 50,000)
than to less rich countries. In addition, export spells that start big (with order values of at least
USD 100,000) have much higher rates of survival, reflecting established trade links between
importers and exporters. Surprisingly, the study finds that export survival does not depend on
broad product types. For instance, manufactured exports (i.e., SITC 5-8, except SITC 68) do
not fare better in terms of survival than non-manufactured exports. Another interesting
finding is that of the spells that survive five years or longer, the final year value was larger than
the initial year value for 60 percent of the spells. This corroborates the observation in the
literature that the first few years of a new trade relationship are crucial. If they can be nurtured
during the early period, exports generally increase in value.

    This section draws from World Bank (2011).

                                                                                                                  ̇
40



least to time t in discrete time is given by: S(t) = P (T ≥ t) t = 1, 2… The estimator at time t is defined as ����(����) =
41  The Kaplan-Meier estimator is a survivor function and is defined as the probability that an individual survives at

������������≤���� [�������� − �������� /�������� ].
42 During the 12-year period of coverage (1997 to 2009), each product is exported to a particular country mostly in

spurts. There are 38,147 country-product pairs with at least one year of exports valued at least USD 1000. For
many of the country pairs at the product level, trade takes place just once, or a single spurt of consecutive years.
Some die and are then revived. So, the total number of export spells is 60,114. About 8.3 percent of export spells
(that are not left-censored) last the full 12 years, but the median duration of spell is only 1 year. Philippines’
exports at the SITC 4-digit level to all (reporting) countries from 1997 to 2009 are analyzed for their propensity
to survive consecutive periods.

                                                                                                                   35
Prospects
68.     Given the Philippines’ high reliance on high-tech exports, its economy faces
material risks from a significant decline in world high-tech demand as was the case in
2009. To model this transmission, we apply three methods: i) an elasticity model which
regresses Philippine exports with partner country GDP growth and imports from the
Philippines and ii) two input models, one which regresses Philippine electronics exports with
the North American book to bill ratio, and a second which regresses Philippine electronic
exports with imports of electronic parts. The results of the models are shown in Tables 14 and
15 while Figure 24 shows historical trend of the key variables. All models are significant and
give a high degree of correlation.

69.      The results suggest a strong relationship between the various determinants of
export growth and Philippine export growth. For example, using the elasticity model, the
weighted average elasticity of Philippine electronics export growth to partner country import
of Philippine electronics of 0.76 suggests that a 10 percent decline in partner country’s import
of Philippine electronics leads to a 7.6 percent decline in Philippine electronics exports. The
book-to-bill regression with lag of three months suggests that a 10 percent decline in the book-
to-bill ratio leads to an export growth of -0.58 percent while the electronics import regression
with lag of one moth suggests that a 10 percent contraction in electronics import leads to a 3
percent contraction in electronics exports growth. 43 These elasticity and coefficient estimates,
together with assumptions for non-electronics and services exports, suggest that Philippine
merchandise export growth is likely to slow to around 1.0 and 2.5 percent respectively in 2011
and 2012 under the base case scenario.

                                                 Table 12. Estimated elasticities
                                 PHL electronics exports     PHL electronics exports        PHL non-electronics      PHL non-electronics exports
                                 growth to country GDP     growth to country electronics exports growth to country     growth to country non-
          Country                        growth                  imports growth                GDP growth            electronics imports growth
China                                     3.87                         0.73                         2.83                          0.82
EAP (developing countries)                5.74                         1.10                         4.56                          0.89
EU                                        4.27                         0.73                         5.09                          0.91
Japan                                     4.55                         0.87                         4.32                          0.80
USA                                       5.92                         1.00                         6.96                          1.00
Weighted                                  4.19                         0.76                         4.07                          0.77
*In bold if significant at 10%
Source: World Bank staff estimates




43 The North American book-to-bill ratio, which pertains to the ratio of global billings and bookings of North

American headquartered semiconductor equipment producers (all billings and bookings are in millions of dollars
and based on a three-month moving average), has been declining since May 2011, reaching a low of 0.75 in
September – painting a bleaker picture for semiconductors exports in the coming months. Moreover, imports of
electronic parts have not recovered, also suggesting weak demand in the months ahead.

                                                                                                                                              36
                                                                                       Figure 24. Declining imports of electronic
      Table 13. Estimated coefficients for the input models                            parts and the North American book to bill
                                                                                     ratio suggest further export contraction in the
                                                                                                     coming months
                                       Electronics Exports Growth                          Electronics Trade (3 mma) and Book-to-Bill
                                       Constant     Beta       R2                    4                                                                                                                1.6
       Book-to-bill lag 3                -86.8       95.8      0.6
       Book-to-bill lag 4                -83.8       93.4      0.6                   3                                                                                                                1.2




                                                                       billion USD
       Electronic imports growth lag 0    4.0         0.7      0.4
       Electronic imports growth lag 1    3.2         0.6      0.4                   2                                                                                                                0.8

                                                                                     1                                                                                                                0.4

                                                                                     0                                                                                                                0




                                                                                                            Sep-08




                                                                                                                                       Sep-09




                                                                                                                                                                  Sep-10




                                                                                                                                                                                             Sep-11
                                                                                                   May-08




                                                                                                                              May-09




                                                                                                                                                         May-10




                                                                                                                                                                                    May-11
                                                                                         Jan-08




                                                                                                                     Jan-09




                                                                                                                                                Jan-10




                                                                                                                                                                           Jan-11
                                                                                                  Electronics exports (lhs)                                Electronics imports (lhs)
                                                                                                  Book-to-Bill (rhs)
      Source: World Bank staff estimates                             Source: NSO and www.semi.org
      Note: Results presented here are significant at 5 percent.




Conclusion

70.     The key to ensuring continued growth of Philippine exports is its ability for
greater diversification. This includes i) shifting towards greater diversification of exports
portfolio with an increased share in non-electronics exports, ii) increasing trade with countries
with higher growth prospects such as the BRICS 44, and iii) moving towards a more balanced
trade across partners to mitigate systemic and temporary trade disruptions due to financial and
economic slowdowns, and supply chain disruptions such as those in Japan and Thailand. In
order to achieve these, improving the country’s business environment, in particular in non-
PEZA areas, is essential to boost investments in both physical and human capital and
encourage innovations to allow the country to move up the value-chain and expand product
diversity. In terms of services, an efficient regulatory system would improve the industry’s
productivity, thus improving its competitiveness.


                                                          Selected Reference

World Bank. (2011) “Basic Notes on Merchandise Trade in the Philippines.” A briefing paper.




44   Brazil, Russia, India, China, and South Africa

                                                                                                                                                                                                            37
                                                         Data Appendix
                      Table 14. Philippines: Selected Economic Indicators, 2008-13
                                                             2008        2009        2010         2011      2012       2013
                                                                    Actual         Prel. Act.            Projection

Growth, inflation and unemployment                                   (in percent of GDP, unless otherwise indicated)
  Gross domestic product (% change)                           4.2            1.1      7.6          3.7       4.2        5.0
  Inflation (period average)                                  9.3            3.2      3.8          4.8       3.5        4.0

Savings and investment
  Gross national savings                                     16.7        22.1        24.8         22.8      23.8       24.9
  Gross domestic investment                                  19.3        16.6        20.5         20.8      21.5       23.0
Public sector
  National government balance (GFS basis) 1/                 -1.5        -3.9        -3.6         -2.5       -3.3      -2.3
  National government balance (Govt Definition)              -0.9        -3.7        -3.5         -2.4       -3.2      -2.2
    Total revenue (Govt Definition)                          15.6        14.0        13.4         13.4      14.2       14.8
      Tax revenue                                            13.6        12.2        12.1         12.4      13.1       13.5
    Total spending (Govt Definition)                         16.5        17.7        16.9         15.8      17.4       17.0
  National government debt                                   54.7        54.8        52.4         50.2      49.0       48.0
Balance of payments
  Merchandise exports (% change)                             -2.5        -22.1       34.8          1.0       2.5       11.6
  Merchandise imports (% change)                              5.6        -24.0       31.5          7.3       6.0       12.0
  Remittances (% change of US$ remittance)                   13.7            5.6      8.2          6.0       3.0        5.0
  Current account balance                                     2.2            5.6      4.2          2.0       2.3        1.9
  FDI (billions of dollars)                                   1.3            1.6      1.2          1.0       1.0        2.5
  Portfolio Investment (billions of dollars)                 -3.6        -0.6         4.0          3.0       4.0        3.0
International reserves
                            2/
  Gross official reserves        (billions of dollars)       37.6        44.2        62.4         76.6      78.8       81.4
  Gross official reserves (months of imports)                 6.0            8.7      9.6         11.1      10.6        9.9
External debt
  Total 3/                                                   37.4        37.3        36.3         34.8      33.3       32.1

Source: Government of the Philippines for historical, World Bank for projections
1/ Excludes privatization receipts and includes CB-BOL restructuring revenues and expenditures (in accordance with GFSM)
2/ Includes gold
3/ Based on World Bank definition. The difference with central bank definition is that it includes the following: i) Gross--Due
     to Head Office/Branches Abroad of branches and offshore banking units of foreign banks operating in the Philippines,
     which are treated as quasi-equity in view of nil and/or token accounts of permanently assigned capital required of these
     banks, ii) Long-term loans of non-banks obtained without BSP approval which cannot be serviced using the foreign
     exchange resources of the Philippine banking, and iii) Long-term obligations under capital lease agreements.




                                                                                                                              38
          Table 15. Philippines: National Government Cash Accounts (GFS Basis), 2008-11
                                          2008                       2009                         2010                                  2011

                                             Year            Jan-Oct        Year          Jan-Oct        Year          Jan-Oct      Budget      WB proj.
                                                        (in percent of GDP, unless otherwise stated)
Revenue and grant                            15.2                  11.5         14.0            11.0        13.4            11.4        15.5         13.4
  Tax revenue                                13.6                  10.0         12.2             9.9        12.1            10.1        14.1         12.4
       Net income & profits                   6.2                    4.4         5.2             4.4         5.4               ..        6.0          5.5
       Excise tax                             0.8                    0.6         0.7             0.6         0.7               ..        0.6          0.6
       Sales taxes and Licenses               2.3                    2.2         2.7             2.0         2.4               ..        3.2          2.5
       Other                                  0.8                    0.6         0.6             0.6         0.7               ..        0.7          0.8
       Tariff (collection from the BOC)       3.4                    2.3         3.1             2.4         2.9             2.2         3.5          2.9
  Nontax revenue 1/                           1.6                    1.5         1.7             1.1         1.3             1.4         1.4          1.0
  Grant                                       0.0                    0.0         0.0             0.0         0.0             0.0         0.0          0.0

Total expenditure 2/                         16.7                 15.0          17.9           14.1             17.0        12.3        18.9          15.8
  Current Expenditures                       13.6                 11.9          14.3           11.3             13.8        10.3        15.2          13.3
    Personal services                         4.9                  4.1           5.2            4.1              5.2         4.0         6.0           5.4
    MOOE                                      1.8                  1.7           2.1            1.6              2.0         1.4         2.3           2.0
    Allotment to LGUs                         2.2                  2.1           2.5            2.0              2.4         2.0         2.5           2.4
    Subsidies                                 0.2                  0.2           0.2            0.2              0.2         0.2         0.1           0.2
    Tax expenditures                          0.8                  0.5           0.6            0.4              0.5         0.2         0.2           0.2
    Interest payment                          3.7                  3.3           3.7            3.0              3.4         2.5         4.0           3.2
  Capital Outlays                             2.9                  3.0           3.4            2.7              3.1         1.8         3.6           2.4
  Net lending                                 0.2                  0.1           0.2            0.1              0.1         0.2         0.2           0.1


Balance (GFS definition)                         -1.5              -3.5         -3.9            -3.1            -3.6        -0.8         -3.4         -2.5
Balance (Government definition)                  -0.9              -3.3         -3.7            -3.0            -3.5        -0.8         -3.2         -2.4
Primary Balance (GFS)                             2.2              -0.2         -0.3            -0.1            -0.2         1.6          0.7          0.8

Memorandum Items
 Privatization receipts (PHP billions)           31.3               1.1          1.4             0.6             0.9         0.7         6.0           6.0
 CB-BOL interest payments (% of GDP)              0.2               0.2          0.2             0.1             0.1         0.1         0.1           0.1
Source: Department of Finance, Bureau of Treasury, and Department of Budget and Management
1/ Excludes privatization receipts (these are treated as financing items, in accordance with GFSM)
2/ Data from the Department of Budget and Management; Allocation to Local Government Units excludes capital transfers to
    LGUs. Allocation to LGUs excludes their capital transfer (it is included in capital outlays).
3/ Nominal GDP is based on World Bank staff estimate.




                                                                                                                                                      39
        Selected Special Focus from Previous Quarterly Updates

September 2011 PQU: Solid Macroeconomic Fundamentals Cushion External Turmoil

External Spillovers to Philippine Growth. During 1997-2011, shocks from East Asian-3 economies,
China in particular have become more important for ASEAN-5 including the Philippines than those
from the United States and the Euro zone. Spillovers of East Asian economies’ shocks are channeled to
the Philippines through trade, while the United States and the Euro zone shocks are transmitted largely
through financial variables. The findings suggest that vigorous growth in the East Asian economies can
cushion declines in demand from the West.

The 2012 Proposed National Government Budget. The 2012 national budget is a results-focused
budget and calls for higher spending in general, particularly on social services. The budget will rest on
increased revenue collection efficiency by broadening the tax base and improving tax administration and
collection efforts. The Administration aims to lower government debt payment for 2012, which would
release additional resources available for priority spending. The budget continues to employ the zero-
based budget approach to rationalize expenditures and includes reforms to make further progress in
improving spending efficiency, transparency, and accountability. Some of the major reforms include (i)
fleshing out lump sum funds and (ii) tightening the use of savings, particularly from unfilled authorized
positions. The reform in the use of savings implies that the government agencies and institutions, in
particular those in the education sector, need to speed up on hiring. For poverty reduction and inclusive
growth, higher spending on priority areas (education and health in particular) is required – an increase
to 5-7 percent of GDP. To support this additional spending needed, the government needs to continue
to strive for heightened revenue mobilization.

June 2011 PQU: Generating More Inclusive Growth

Poverty and Inequality in the Philippines. The recently released 2009 poverty estimates and household
survey (FIES) provide a much needed update on poverty, inequality and income dynamics in the
Philippines. The FIES reveals that in contrast with previous trends, household per capita incomes grew
from 2006 to 2009 and that, remarkably, rural and poorer households strongly outperformed. However,
despite this increase and a resilient economy poverty incidence continued to increase through 2009
though, some improvements occurred in both the gap and severity of poverty. Therefore, poverty, and
especially poverty dynamics, in the Philippines remains worse than its neighbors. Spatially, poverty
remains highly concentrated in rural areas and in terms of sectors, households that rely on agricultural
income are significantly more likely to be poor than other households. From 2006 to 2009, poverty in
urban areas increased more rapidly, became more severe, and contributed more to the continuous
increase in poverty. Across regions, 10 of the 17 administrative regions experienced an increase in
poverty incidence.

The Services Sector in the Philippines. The services sector has the potential to play an important role in
promoting inclusive growth in the Philippines. The sector is already large and has been an important
driver of employment and GDP growth. However, this has not necessarily led to a rise in the average
quality of jobs or productivity gains. Unshackling the constraints on services as a source of inclusive
growth will require broad-based policy action: providing higher quality education for all to meet the
demand for skills as services move up the value chain; improving infrastructure and enabling policies to
facilitate agglomeration economies; removing investment climate distortions to allow services firms to
invest and innovate.

The 2011 National Accounts Revisions (1998-2010). The Philippines recently revised its national
accounts series for the period 1998 to 2010. The revisions involve shifting to a new base year (from


                                                                                                       40
1985 to 2000) and adopting most of the recommendation of the System of National Accounts (SNA)
1993 and some recommendations of SNA 2008. The new series shows roughly the same GDP growth
though sectoral growth varies. The revisions led to a significantly higher investment-to-GDP ratio and
to a higher level nominal GDP—of about 6 percent for 2010. Finally, the previously large statistical
discrepancies between the production and the expenditure accounts have largely been eliminated
through a methodological improvement that made use of the supply-and-use table.

January 2011 PQU: Robust Growth, Stubborn Poverty

Food Prices in the Philippines. In contrast to many countries in the region, food price inflation has been
muted so far in the Philippines and is expected to remain moderate in 2011 though risks are tilted
upwards. In the short-term, concerns about a return of a 2008-style food crisis in the Philippines seem
limited as rice price increases are projected to remain contained thanks to recent strong domestic palay
production, good planting intentions, record stock piles of rice, and domestic retail prices significantly
above international prices. Food prices are nonetheless expected to rise moderately, not least as the
base impact of the increase in some food prices (especially vegetables) following typhoons Ondoy and
Pepeng wears out.

Fiscal Risks in the Philippines. Fresh into office the Aquino government established a comprehensive
assessment of fiscal risks and published the outcome in a Fiscal Risk Statement (FRS) in November
2010. International experience reveals that disclosure of fiscal risks generates important benefits in
terms of lower and better managed fiscal risks, improved policies, and lower cost of financing.
Historically, fiscal risks have been prevalent in the Philippines and at times have generated large and
unexpected fiscal costs. Important weaknesses in the Philippines public financial management
framework have contributed to heightened fiscal risks. As the FRS reveals, while fiscal risks have abated
in important areas they still remain sizeable in 2010.

Export of Services: Lessons from the BPO and Tourism Sectors. Services exports are rising strongly in the
Philippines and provide an important source of diversification of the country’s exports. The rapidly
rising business process outsourcing (BPO) sector is building on the natural comparative advantages of
the Philippines, namely a cost-competitive platform built around an English-speaking, technology-savvy
young labor force, readily available telecommunication infrastructure, and a favorable economic zone
environment. Tourism could become an important source of diversification for the country but the
sector is constrained by a weal investment climate, periodic security concerns, weak transport and
tourism-related infrastructure, and regulations on air transport services.

September 2010 PQU: Stepping Up Reforms to Sustain Growth

The 2011 National Government budget: structural reforms and consolidation. The 2011 budget could be the
turning point the country public finances as it changes dynamics in two critical areas: (1) the (structural and
cyclical) fiscal policy stance, and (2) the efficiency, transparency and accountability of public finances. The budget
renews the fiscal consolidation effort—albeit modestly—and contains significant reforms measures aimed at
improving spending efficiency, transparency and accountability of the budget. For the 2011 budget to indeed turn
the country away from a weak fiscal position, inconsistent spending efficiency, and significant gaps in public
expenditure and financial accountability, efforts initiated in this budget will have to both be sustained over time
and expanded. Strengthening revenue mobilization—through a modern tax system with efficiency and equity at
its core—would enable to scale up spending needed to generate inclusive growth.

Employment, Poverty and distributional impacts of El Niño in the Philippines. The 2010 El Niño phenomenon
was less intense than the 1998 one. It is nonetheless estimated to lead to a large reduction in agricultural output
and to subtract 0.9 percentage points to 2010 real GDP growth. Using a micro-simulation model, we find that El
Niño will result in (1) a 0.9 percent reduction in total household income in 2010 mainly due to a combination of
lower employment levels and individual earnings; (2) moderate increases in poverty incidence and poverty gap

                                                                                                                  41
(0.4 and 0.2 percentage points increases, respectively); and (3) no significant impacts on the indices of overall
inequality—though income losses are larger at the bottom of the income distribution—and a similar impact for
urban and rural areas at the bottom half of the distribution.

The Philippines during the recent international financial shocks. Contrary to some expectations, the Philippine
economy has shown to be remarkably resilient to recent international financial shocks. Using equity price indices
and sovereign credit default swaps (CDS) spreads, we document the extent to which the country was affected in
absolute and relative terms by the global financial crisis and the more recent European sovereign turmoil.
Financial data reveal that: (1) during the last decade, the Philippines stock market exhibited strong co-integration
with the US market and, to a lower extent with China’s, (2) the historically high volatility of the Philippine equity
index decreased noticeably since the global financial crisis, (3) the sovereign credit quality of the Philippines is
emerging favorably from the global financial crisis, and (4) Philippines sovereign CDS have not been correlated
with CDSs of the fiscally weak European countries.

Constraints to growth: the agribusiness value chain in Mindanao. Understanding how the Philippines could
improve its competitiveness in agribusiness and agricultural commodities markets in which the country,
particularly the island of Mindanao, enjoys strong comparative advantages is critical to fighting poverty and
boosting rural incomes. A recent World Bank study of the performance of two key agricultural value chains in
Mindanao—yellow corn and export bananas—reveals that both corn and banana value chains offer significant
future growth potential; yet they are facing some critical issues in terms of their long-term viability and
sustainability. These include average farm-level productivity well behind international benchmarks, in large part
due to infrastructure and logistics deficiencies. As the specific channels by which these constraints curtail growth
prospects resonate with constraints that other regions and sectors also struggle with, this study is illustrative of
the developmental challenges facing the Philippines, especially as regards inclusive growth generation and the
fight against poverty.




                                                                                                                 42
       Selected recent World Bank publications on the Philippines
                 (for an exhaustive list, please go to: http://go.worldbank.org/BRHFJLLQD0)

No.     Document Name                                                                       Date         Document Type
      1 Making everyone count : Gender-sensitive Monitoring and Evaluation in a              11/1/2011   Working Paper
        Community-Driven Development Project - the case of the Philippines KALAHI-
        CIDSS
      2 Quarterly economic update : solid macroeconomic fundamentals cushion external         9/1/2011   Working Paper
        turmoil
      3 Ripe for a big bang ? assessing the political feasibility of legislative reforms in   9/1/2011   Policy Research Working
        the Philippines' local government code                                                           Paper
      4 The Economic Returns of Sanitation Interventions in the Philippines                   8/1/2011   UNDP-Water &
                                                                                                         Sanitation Program
      5 Philippines - Discussion notes : challenges and options for 2010 and beyond        6/9/2011      Other Financial
                                                                                                         Accountability Study
   6 Philippines - Public expenditure review : strengthening public finance for more         6/1/2011    Public Expenditure
     inclusive growth                                                                                    Review
   7 Philippines - Reproductive health at a glance                                           6/1/2011    Brief
   8 Philippines quarterly update : generating more inclusive growth                         6/1/2011    Working Paper
   9 The politics of power : the political economy of rent-seeking in electric utilities in  6/1/2011    Policy Research Working
     the Philippines                                                                                     Paper
  10 Overview of the Philippines' Conditional Cash Transfer Program : the Pantawid           5/1/2011    Brief
     Pamilyang Pilipino Program (Pantawid Pamilya)
  11 Philippines - Power distribution in Olongapo city                                       4/1/2011 Brief
  12 Building governance and anti-corruption in the Philippines' conditional cash            3/1/2011 Brief
     transfer program
  13 The Search for Durable Solutions : armed conflict and forced displacement in            3/1/2011 Working Paper
     Mindanao, Philippines
  14 The search for durable solutions : armed conflict and forced displacement in            3/1/2011 Working Paper
     Mindanao, Philippines
  15 Doing business in the Philippines 2011 : comparing business regulation in 25            1/1/2011 Working Paper
     cities and 183 economies
  16 Philippine health sector review : challenges and future directions                      1/1/2011 Working Paper
  17 Philippines - Fostering more inclusive growth : main report                             1/1/2011 Working Paper
  18 Philippines - Private provision, public purpose : a review of the government's          1/1/2011 Working Paper
     education service contracting program
  19 Philippines - Typhoons Ondoy and Pepeng : post-disaster needs assessment (Vol.          1/1/2011 Other Environmental
     1 of 3) : Executive summary                                                                      Study
  20 Philippines - Typhoons Ondoy and Pepeng : post-disaster needs assessment (Vol.          1/1/2011 Other Environmental
     2 of 3) : Main report                                                                            Study
  21 Philippines - Typhoons Ondoy and Pepeng : post-disaster needs assessment (Vol.          1/1/2011 Other Environmental
     3 of 3) : Sector reports                                                                         Study
  22 Philippines quarterly update : robust growth, stubborn poverty                          1/1/2011 Working Paper
  23 The Philippines - Sun Power expansion moves solar industry closer to grid               1/1/2011 Brief
     parity
  24 Trust funds country report FY09 - FY10 Philippines                                      1/1/2011 Annual Report
  25 Helping small water utilities become bankable                                          11/1/2010 Brief
  26 It is not too late : preparing for Asia's next big earthquake - with emphasis on the 10/20/2010 Working Paper
     Philippines, Indonesia, and China : policy note
  27 Status of Projects in Execution (SOPE) - FY10 : East Asia and Pacific region -         10/3/2010 Annual Report
     Philippines
  28 Skills for the labor market in the Philippines                                         10/1/2010 Publication
  29 Stepping up reforms to sustain growth                                                   9/1/2010 Working Paper
  30 Philippines - Study on agribusiness, infrastructure, and logistics for growth in        8/1/2010 Policy Note
     Mindanao : policy note


                                                                                                                             43
                COPIES OF THE PHILIPPINES QUARTERLY UPDATE:
Online copies of this publication can be downloaded in www.worldbank.org.ph

Printed copies are also available in the following Knowledge for Development Centers
   (KDCs):

   1. World Bank KDC
   Ground Floor The Taipan Place, Francisco Ortigas Jr. Road (former Emerald),
   Ortigas Business Center, Pasig City 1605

   2. Asian Institute of Management KDC
   Joseph R. McMicking Campus, 123 Paseo de Roxas, Makati City 1226

   3. Ateneo de Naga University KDC
   James O'Brien Library, Ateneo Avenue, Naga City 4400

   4. Central Philippine University KDC
   Ground Floor Henry Luce III Library, Lopez Jaena Street, Jaro, Iloilo City 5000

   5. House of Representatives KDC
   Congressional Planning and Budget Department, 2F R.V. Mitra Building,
   Batasang Pambansa Complex, Constitution Hills, 1126 Quezon City

   6. Notre Dame University KDC
   Notre Dame University Library, Notre Dame Avenue, Cotabato City 9600

   7. Palawan State University KDC
   Graduate School - Law Building, Manalo Campus, Valencia St., Puerto Princesa City 5300

   8. Saint Paul University Philippines KDC
   3rd floor, Learning Resource Center, Mabini St., Tuguegarao City 3500

   9. Silliman University KDC
   Silliman University Library, Dumaguete City 6200

   10. University of San Carlos KDC
   University Library, P. Del Rosario Street, Cebu City 6000

   11. University of Southeastern Philippines KDC
   Obrero, Davao City 8000




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