Country Brief

Recent Economic Developments

Despite domestic political tensions and increased market volatility, the Philippine economy performed unusually well in 2007—ending the year with its highest growth in three decades, benign inflation, a strong balance of payment position and an improving public sector fiscal situation. Notwithstanding this performance, the economy continued to show persistent structural weaknesses—a low tax effort, high unemployment and underemployment, and rising poverty. These weaknesses, together with mounting global uncertainties and domestic political instability, raise concerns whether the economy’s high growth can be sustained over the medium-term.

GDP expanded by 7.3 percent in 2007 largely on account of strong domestic demand. Private consumption was again the main driver, supported in part by rising remittances (the appreciation of the peso notwithstanding). Stimulated by higher public investment, private investment picked up too but the growth came mostly from construction; durable equipment growth remained lackluster. Export growth declined sharply over the four quarters of 2007 reflecting slower demand from key trading partners (except China). The peso’s sharp appreciation was also a factor although high infrastructure cost remains a key bottleneck to improving competitiveness. Negative real import growth was a surprise given the strength of domestic demand and the appreciation of the peso. On the production side, the services sector was the star performer, growing by an impressive 8.7 percent. The banking sector recorded double-digit growth despite the sub-prime induced volatility in the second half.

Agriculture remained robust but manufacturing growth slowed further for the fourth straight year. The economy’s strong performance in the last four years has not translated into poverty reduction. Between 2003 and 2006, poverty incidence increased from 30.0 percent to 32.9 percent despite average GDP growth of 5.4 percent. The Gini coefficient remains high at 0.45. Both urban and rural poverty increased on average and only 4 of 17 regions recorded an improvement in the poverty headcount. Falling real incomes of families and compression of public spending contributed to the rise in poverty.

Inflation was benign in 2007, averaging 2.8 percent. Higher food and oil prices were muted by the strong peso which appreciated by nearly 20 percent in the last two years—the most among the currencies in the region. In early 2008, inflation breached the central bank’s 4-5 percent target as international food and oil prices surged. Alarmingly, rice prices grew by 7.7 percent in February. The government has begun to secure its rice requirements by asking Vietnam to guarantee the country 1.5 million tons of rice and by tapping the emergency regional rice reserve.

Tight monetary policy slowed money growth last year. In the last six months, the central bank reduced the overnight borrowing rate by 1 percentage point compared to 2.75 percentage points in the US. M3 growth fell from 22.3 percent in end-2006 to 10.4 percent in end-2007. The domestic financial system exhibited resilience in the face of international market turbulence. With the exception of a handful of banks, the banking system as a whole was mildly affected given their small holdings of sub-prime-linked securities (0.2% of total assets according to the BSP). There was more, albeit still quite small, collateral damage resulting from falling sovereign bond prices.

High remittance inflow ($14.4 billion) in 2007 far outweighed the slowdown in exports, turning a large trade deficit into a healthy current account surplus of 4.4 percent of GDP. At the same time, net capital inflow was positive, aided by stronger portfolio investment ($3.1 billion) and other investment ($1.6 billion) inflows. As a result, reserves climbed by 50 percent, and reached $36 billion by February 2008 (6.1 months of imports). The strong reserve position enabled the country to pre-pay close to $3 billion in foreign debts last year of which $1.1 billion came from the public sector. Total external debt in 2007 is estimated to fall to about 40 percent of GDP.

The consolidated public sector deficit improved to a surplus through September 2007. Proceeds from privatization of 1.4 percent of GDP helped compensate for lower tax revenues. Administrative inefficiencies such as the under-registration of taxpayers, the lack of risk-based audits, and weak anti-smuggling enforcement, and built-in policy weaknesses such as the nonindexation of excise tax rates, have continued to undermine revenue collection. Decade-low interest rates and spreads provided the government more flexibility in increasing capital and social spending. The primary surplus (almost 4 percent of GDP) helped trim government debt (55.8 percent of GDP in end-2007 from 63.8 percent in end-2006).

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In 2007, the World Bank Group, in agreement with the Philippine Government decided to extend to June 2009 its current Country Assistance Strategy (CAS) which was originally planned to end in June 2008. A CAS Progress Report prepared in June 2007 reaffirmed the relevance of the CAS theme of Supporting Islands of Good Governance (successful experiences of public service delivery and effective public institutions).

Thus, our extended Country Assistance Strategy will continue to support Islands of Good Governance in national government agencies, local governments, and dynamic sectors in the Philippines that demonstrate how improved accountability and service delivery can lead to better economic and social outcomes. Our strategy builds on the Government's 2004-2010 Medium-Term Philippines Development Plan and has two main goals: economic growth and social inclusion. It also identifies two important levers for pursuing these goals: achieving fiscal stability and improving governance.

In supporting the Philippines, we are applying key lessons from our past engagements and from what we heard through in-depth stakeholder consultations—the need for less complex and more achievable reforms and closer alignment between World Bank Group support and national budget priorities. This implies a shift away from financing discrete projects toward more programmatic engagement with selected key agencies and sectors. This occurs at three platforms of engagement—national, local, and the private sector.

At the national level, we work with agencies that demonstrate a strong commitment to reform. Helping to strengthen governance and provide financing within the existing budget requires working through and improving in-country systems and processes. Similarly, our strategy seeks to avoid overburdening programs with impractical objectives and excessive innovations. One implication is a move towards more sector-wide operations focused on core functions and services within the budget, away from specific investment projects that are not compatible with fiscal constraints.

At the local level, our strategy involves a greater integrated, cross-sectoral focus on the Local Government Unit (LGU) as the direct client in order to increase the likelihood of better outcomes across all services delivered by the LGU. We support well-performing LGUs whose good governance experiences can be sustained and replicated. Central to this effort is developing a performance framework and capacity building program for LGUs that is consistent across projects. Linking financing and capacity building to a clear performance framework in a practical way will also facilitate good governance at the local level.

At the private sector level, our strategy promotes private investment by helping to strengthen regulatory agencies, reduce the cost of doing business, improve financial intermediation, and finance investments for public-private projects as well as in sectors with high growth potential. This involves greater coordination and joint projects with the International Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency (MIGA) on issues related to the relationship between the public and private sectors.

Our strategy seeks to provide the most value through the appropriate level and blend of lending, advice, and knowledge sharing. The effectiveness of the programs we support will depend, to a large degree, on the extent of political momentum for reform and the pace of change. Thus, our assistance strategy is designed to respond specifically to reform efforts.

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Donor Coordination

The 2008 Philippines Development Forum (PDF) was held in Clark Field, Pampanga from March 26-27, 2008. The PDF evolved from the traditional Government-Donors Consultative Group (CG) process, which was expanded into a multi-stakeholder forum that facilitates substantive policy dialogue on the country’s development agenda among participants from national and local government units, civil society, academia, private sector, and the international development partners. This was the fourth annual PDF held since its transformation in 2005.

As in past PDFs, the Government of the Philippines, led by the Department of Finance, organized and chaired the 2008 PDF. Finance Secretary Margarito Teves served as the Chair of the meeting. The World Bank, represented by World Bank Country Director for the Philippines, Bert Hofman, served as co-chair for the meeting. Vice-President Noli de Castro delivered the opening statement for the Government, and President Gloria Macapagal-Arroyo delivered the keynote address. Government representatives at the meeting included Cabinet secretaries and other high-level officials from various Government agencies. Twenty-one delegations from multilateral and bilateral agencies/teams were represented. Over 300 participants attended.

Similar to previous PDFs, this particular meeting did not include a pledging session, and instead focused on substantive policy dialogue among the various stakeholders on key thematic areas, drawing on the ongoing discussions throughout the year which are facilitated by the various PDF working groups. The overall theme of the 2008 PDF was “Accelerating Inclusive Growth Deepening Fiscal Stability". The PDF focused on this theme, with three break-out discussions organized on three relevant sub-themes. A special presentation was also built into the agenda on the Government's procurement harmonization agenda, which covered plans for new implementing rules and regulations for the Government's procurement law to help improve efficiency and accountability in the use of public funds.

The PDF participants identified three critical development challenges facing the country at this time: (i) Sustaining growth and maintaining fiscal discipline; (ii) Supporting growth that benefits the poor; (iii) Strengthening governance and fighting corruption. Overall, there was a strong common message which emerged from the forum, which was the need for the country to sustain growth and fiscal consolidation, focus more on the poor, and improve governance.

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For more information, contact:

The World Bank Office in Manila
Leonora Gonzales, External Affairs Officer
Tel: (632) 917-3003
Fax: (632) 637-5870
Email: Lgonzales@worldbank.org

The External Affairs Office in Washington DC
Mohamad Al-Arief, Communications Officer
Tel: (202) 458-5964
Fax: (202) 477-0169
Email: Malarief@worldbank.org

Updated: April 2008