October 2017 Preserving Consistency and Policy Commitment PRESERVING CONSISTENCY AND POLICY COMMITMENT October 2017 TABLE OF CONTENTS PREFACE .................................................................................................................................................. i EXECUTIVE SUMMARY........................................................................................................................... ii References ............................................................................................................................................ 57 ANNEX...................................................................................................................................................... 59 I. Recent Economic and Policy Developments ..................................................................................... 1 1.1 Growth: Consistent Performance................................................................................................ 2 1.2 The Exchange Rate and the External Sector: Weakening Balance of Payments ......................... 8 1.3 Financial Markets and Monetary Policy: Inflation Peaked and Remains Sticky........................... 14 1.4 Fiscal Policy: Staying on an Expansionary Path............................................................................ 17 1.5 Employment and Poverty: Progress but with New Challenges ................................................... 22 II. Outlook and Risks............................................................................................................................... 27 2.1 Growth Outlook .......................................................................................................................... 28 2.2 Poverty and Shared Prosperity.................................................................................................... 34 2.3 Risks and Policy Challenges ......................................................................................................... 35 III. Unlocking Mindanao’s Potential ....................................................................................................... 39 3.1 Introduction ................................................................................................................................ 40 3.2 The Development Challenge in Mindanao.................................................................................. 41 Slow Economic Growth ............................................................................................................ 41 The Labor Force: Opportunity and Challenge........................................................................... 42 High Incidence of Poverty ........................................................................................................ 43 Mindanao’s Agriculture............................................................................................................ 44 Improving Logistics and Transport Connectivity....................................................................... 45 Improving Power and ICT Infrastructure .................................................................................. 46 Supporting Private Investment: Skills Development, Easing of the Regulatory Burden, Better Access to Finance, and Improving Land Management............................................................. 48 3.3 Economic Policies to Reduce Conflict.......................................................................................... 50 3.4 A Regional Development Strategy for Mindanao........................................................................ 52 LIST OF FIGURES Figure 1: The Philippine economy continues to perform well compared to its regional peers… ........... 2 Figure 2: ...which has been sustained over the past five years ............................................................... 2 Figure 3: Economic growth moderated in the first half of 2017 ............................................................. 4 Figure 4: The services sector remained the principal growth engine .................................................... 4 Figure 5: The Philippine economy benefits from strong consumer and business sentiments ............... 5 Figure 6: Recent weakening in business confidence translated in weaker manufacturing growth ........ 6 Figure 7: Annual real growth of the mining and quarrying sector ......................................................... 7 Figure 8: Net foreign direct investment in the mining and quarrying sector.......................................... 8 Figure 9: Loans outstanding in the mining and quarrying sector............................................................ 8 Figure 10: The real effective exchange rate continued to weaken in the first half of 2017 ..................... 9 Figure 11: Regional currencies in nominal terms have generally depreciated since 2013........................ 10 Figure 12: Change in the real effective exchange rate from January 2017 to June 2017 (percent) ......... 10 Figure 13: Exports growth rebounded while import growth remained strong......................................... 10 Figure 14: The trade balance has been in deficit for the past five years .................................................. 11 Figure 15: Capital goods covered roughly a third of the total import bill in H1 2016 and H1 2017......... 11 Figure 16: The Philippines benefitted from robust remittances in the first half of 2017 ......................... 13 Figure 17: …reflecting the distribution of around 9.2 million Filipinos abroad........................................ 13 Figure 18: Inflation remained elevated at around 3 percent ................................................................... 15 Figure 19: The commercial loan portfolio is dominated by the real estate, utilities, transport and ICT sectors ............................................................................................................................... 15 Figure 20: The credit-to-GDP remains low in the Philippines where the non-performing loans ratio is among the lowest in the region .............................................................................................. 15 Figure 21: Rice inflation influences the level of food inflation ................................................................. 16 Figure 22: The government’s budget deficit reached 2.1 percent of GDP on the back of expansionary fiscal policy …........................................................................................................................... 18 Figure 23: ...as no new tax policy measures were introduced ................................................................. 18 Figure 24: The top recipients of the national budget (2017 & proposed 2018) ...................................... 21 Figure 25: Underemployment reached a 10-year low in April 2017 ........................................................ 22 Figure 26: The labor force participation rate declined in early 2017 ....................................................... 23 Figure 27: Changes in real daily wages from 2007-2017.......................................................................... 24 Figure 28: Distribution of type of worker................................................................................................. 24 Figure 29: Wage earners in private establishments by sector.................................................................. 25 Figure 30: Household income sources of all households ......................................................................... 25 Figure 31: Household income sources of the bottom 40 percent............................................................ 25 Figure 32: The growth trajectory is positive but lower than expected .................................................... 28 Figure 33: Global growth is expected to strengthen in 2017-2019.......................................................... 29 Figure 34: Global trade is expected to rebound in 2017.......................................................................... 29 Figure 35: Actual and projected poverty rates using the US$3.20-a-day poverty line............................. 34 Figure 36: Macroeconomic fundamentals remain intact ......................................................................... 35 Figure 37: Average annual GDP growth in Mindanao, the rest of the Philippines, and neighboring countries, 1975–2014, percent............................................................................................... 41 Figure 38: Poverty and vulnerability, farmers and fisherfolk in Mindanao, 2012, percent ...................... 43 Figure 39: Average savings of farmers and fisherfolk households by economic decile, Luzon and Mindanao, 2012 ...................................................................................................................... 43 Figure 40: Regional production as share of total agricultural production in the Philippines, 2014, percent ................................................................................................................................... 44 Figure 41: Crops produced in Mindanao as a share of total production, 2014, percent ........................ 44 Figure 42: Farm-to-market logistics issues in Mindanao.......................................................................... 45 Figure 43: Mindanao’s power issues ........................................................................................................ 47 Figure 44: Mindanao’s internet policy and investment deficits................................................................ 47 Figure 45: How to unlock Mindanao’s agriculture potential .................................................................... 55 LIST OF TABLES Table 1: Balance of payments, H1 2015 – H1 2017............................................................................... 14 Table 2: Actual and programmed expenditure of the Philippine government (H1 2015 – H1 2017).... 22 Table 3: Philippine government fiscal position (H1 2016 – H1 2017) ................................................... 22 Table 4: Real GDP growth rates, recent and projected ......................................................................... 30 Table 5: Economic indicators for baseline projection ........................................................................... 32 Table 6: Growth decomposition, 1978 to 2014 .................................................................................... 42 Table 7: Effects of poor connectivity on farmers, agribusiness, and consumers .................................. 54 LIST OF BOXES Box 1: The global economic recovery solidified in the first half of 2017............................................ 3 Box 2: Confidence in the Philippine economy .................................................................................... 5 Box 3: Regulation and investments in the mining industry................................................................. 7 Box 4: Opportunities and challenges of a weaker currency................................................................ 9 Box 5: The trade balance in the Philippines........................................................................................ 11 Box 6: Recent trends in remittances ................................................................................................... 12 Box 7: Rice policies and food inflation ................................................................................................ 16 Box 8: The proposed 2018 national budget........................................................................................ 21 Box 9: Increasing wage employment and household wage incomes.................................................. 24 Box 10: The global economic outlook................................................................................................... 29 Box 11: The Marawi city crisis .............................................................................................................. 37 Box 12: The market potential of agriculture in Mindanao ................................................................... 53 PREFACE T he Philippines Economic Update (PEU) summarizes key economic and social developments, important policy changes, and the evolution of external conditions over the past six months. It also presents recent World Bank findings, situating them in the context of the country’s long-term development trends and assessing their implications for the country’s medium-term economic outlook. The PEU covers issues ranging from macroeconomic management and financial-market dynamics to the complex challenges of poverty reduction and social development. It is intended to serve the needs of a wide audience, including policymakers, business leaders, private firms and investors, and analysts and professionals engaged in the social and economic development of the Philippines. The PEU is a biannual publication of the World Bank’s Macroeconomics and Fiscal Management Global Practice (MFM), prepared in partnership with the Poverty & Equity, Finance & Markets, and Social Protection & Labor Global Practices (GPs). Birgit Hansl (Lead Economist and Program Leader) and Ndiame Diop (Practice Manager for the MFM GP) guided the preparation of this edition. The team consisted of Kevin Chua (Economist) and Kevin Cruz (Research Analyst) from the MFM GP, Pablo Ariel Acosta (Senior Economist) from the Social Protection & Labor GP, Griselda Santos (Senior Financial Sector Specialist) from the Finance & Markets GP, Gabriel Demombynes (Program Leader), Xubei Luo (Senior Economist), and Sharon Faye Alariao Piza (Economist) from the Poverty & Equity GP. The report was edited by Oscar Parlback (Сonsultant), and the graphic designer was Robert Waiharo (Сonsultant). Peer reviewers were Jasmin Chakeri (Program Leader, LCC1C) and Yutaka Yoshino (Program Leader, AFCE1). Logistics and publication support were provided by Maria Consuelo Sy (Program Assistant). The Manila External Communications Team, consisting of David Llorito (Communications Officer) and Justine Letargo (Online Communications Officer), prepared the media release, dissemination plan, and web-based multimedia presentation. The team would like to thank Mara Warwick (Country Director for the Philippines) for her advice and support. The report benefited from the recommendations and feedback of various stakeholders in the World Bank as well as from the government, the business community, labor associations, academic institutions, and civil society. The team is very grateful for their contributions and perspectives. The findings, interpretations, and conclusions expressed in the PEU are those of the World Bank and do not necessarily reflect the views of the World Bank’s executive board or any national government. This report went to press on October 3, 2017. If you wish to be included in the email distribution list for the PEU and related publications, please contact Maria Consuelo Sy (msy@worldbank.org). For questions and comments regarding the content of this publication, please contact Birgit Hansl (bhansl@worldbank.org). Questions from the media should be addressed to David Llorito (dllorito@worldbank.org). For more information about the World Bank and its activities in the Philippines, please visit www.worldbank.org/ph. i PhilippineS ECONOMIC UPDATE • October 2017 EXECUTIVE SUMMARY T he Philippine economy continues to perform well relative to its regional peers. The Philippines grew faster in the first half of 2017 capacity. Higher inflation started to not only dampen consumer and business sentiments, but likely contributed to consumption and investment than Indonesia, Thailand, Malaysia, and Vietnam growth moderating. but slower than China. Following strong growth in the immediate two quarters after the new Although external demand picked up, output administration assumed office in July 2016, the growth is slowing and sentiments are weakening. economy had a slower start in the first half of A favorable external environment helped to 2017. The country’s economic growth rate fell increase exports from 10.4 percent, year-on-year, gradually from 7.0 and 6.8 percent in the first and in the first half of 2016 to 20.0 percent, year- second half of 2016, respectively, to 6.4 percent on-year, in the first half of 2017, which was the in the first half of 2017. Private consumption fastest half-year growth since the second half of resumed its position as the main engine of 2010. However, manufacturing activity slowed in economic growth in the first half of 2017, and the first half of 2017, and manufacturing output a rebound in exports contributed to growth. contracted in July for the first time since June Despite an improving external environment and 2015. At the same time, business confidence continued accommodative monetary and fiscal declined to its lowest level in three years. policies, both government and capital formation Consumer sentiments, which reached record growth slowed in the first half of 2017, partly highs in the first half of 2017, have also recently due to a slowdown in public spending and moderated. Rising concerns among businesses investments that were initiated during the 2016 and consumers go beyond a weaker peso and election period. higher inflation. They extend to the conflict in Mindanao, limited income increases, and the fact Fiscal and monetary policies remain supportive that unemployment increased from a historic low of growth. In the first half of 2017, the government of 4.7 percent in 2016 to 5.6 percent in July 2017. continued to pursue an expansionary fiscal policy which led to significantly higher expenditures The Philippines’ medium-term growth trajectory while the government missed its revenue target. remains positive. The economy is projected As a result, the fiscal deficit widened from 1.7 to expand at a slower rate in 2017 compared percent of GDP in the first half of 2016 to 2.1 to 2016, and the growth rate will likely end up percent of GDP in the first half of 2017. Higher at the lower end of the government’s target of expenditures are in line with the government’s 6.5-7.5 percent of GDP. The World Bank projects push to advance the country’s investment agenda the Philippine growth rate at 6.6 percent of GDP and are planned to be financed through a gradual in 2017 and 6.7 percent of GDP in 2018 and expansion of the revenue base, which is at the 2019. Exports are expected to increase to the heart of the priority tax reform. Meanwhile, the country’s main trading partner, while imports central bank has maintained its key policy rate are estimated to remain elevated due to high at 3.0 percent since June of last year. Inflation demand for intermediate and capital goods. climbed to an average of 3.1 percent in the first Steady consumption growth is projected to half of 2017 and was in part driven by higher continue to provide the main base for growth, food prices, which disproportionally affect sustained by an increase in remittances, an poor households. Inflationary pressures also expansion of credit, and improved income levels. continue due to the pass-through effect of the Higher capital outlays and construction activities depreciating Philippine peso and rising demand- are expected to boost investment growth as the side pressures, as the economy is operating near government speeds up the implementation of its PhilippineS ECONOMIC UPDATE • October 2017 ii Executive Summary infrastructure program. Slower economic growth preserve consumer and business confidence. may reduce the pace of poverty reduction, but For the Filipino consumer, it will be important the poverty rate is expected to fall as the economy that inflation remains at moderate levels. This continues its structural transformation. will warrant careful inflation management by the central bank authorities to anchor expectations. Risks to the outlook are increasing. The ongoing As long as it is consistent with medium-term fiscal U.S. Federal Reserve rate hikes could lead to a sustainability, an expansionary fiscal policy could further depreciation of the peso and continued support short-term growth. The successful and capital outflows from the Philippines. Moreover, timely implementation of the government’s fiscal rising protectionism in some advanced economies program, including its ambitious infrastructure increases the risk of lower levels of remittances plan and efforts to generate more revenue, and foreign trade. The government made would signal a strong commitment to the significant progress in building a pipeline for the government’s policy priorities. Key issues, such planned infrastructure program, however, slow as mining regulations and regional development implementation of the infrastructure investment in Mindanao, will require policy certainty to plan could pose a risk to growth. There is a preserve both external and domestic confidence need to improve the management of public in the Philippine economy. finances and preserve fiscal sustainability when government infrastructure spending increases, Implementing structural policies that support including improving revenue administration and investment and trade will be critical to boost collection. Despite these risks, the administration productivity and long-term growth. These is in a strong position, as macroeconomic policies would require the government’s fundamentals remain intact. However, both the commitment to reforms that promote fiscal and monetary space to address risks can competition in key sectors, secure property quickly diminish and limit the government’s rights, lessen regulatory complexities, and ability to mitigate those risks. improve doing business in the country. Longer- term policy priorities also include training Policymakers need to confront downside risks and job search programs and other measures while fostering long-term growth. The short-term to support workers most affected by sectoral risks to the country’s outlook include increased shifts in employment and share the dividends trade protectionism, the possibility of financial of growth and gains from globalization more market disruptions, and elevated economic policy widely. Sustained investment in human capital uncertainty. In the longer term, weaker growth development and in sectors that create quality potential remains the main risk. Consistency employment are also needed to safeguard the in the government’s policies to achieve stable country’s progress on delivering inclusiveness. inflation, fiscal stability, and security will help iii PhilippineS ECONOMIC UPDATE • October 2017 Part I: Recent Economic and Policy Developments The Philippine economy continues to perform well relative to its regional peers. Following strong growth in the immediate two quarters after the new administration took over in July 2016, the economy had a slower start in the first half of 2017. Capital formation growth eased to 9.7 percent, year-on-year, in the first half of 2017, compared to its rally of 30.9 percent, year-on-year, in the first half of 2016 when rapid economic expansion was spurred by a stimulus from election-related spending and investment. Positive consumer sentiment, coupled with robust remittance growth, boosted domestic consumption. A favorable external environment pushed export growth from 10.4 percent, year-on-year, in the first half of 2016 to 20.0 percent, year-on-year, in the first half of 2017. The services sector remained the principal engine of growth, and the agriculture sector recovered strongly as farm output benefitted from favorable weather conditions. Fiscal and monetary policies remained supportive of growth. The government executed its programmed budget in the first half of 2017 despite lower revenues, and the central bank kept its policy rate steady despite climbing inflation. The Philippine peso continued to weaken in the first half of 2017, impacted by the Federal Reserve’s rate hikes. The balance of payments turned into deficit in the first half of 2017, driven by higher capital outflows. Sustained economic growth increases the likelihood that poverty reduction has continued. Philippines ECONOMIC UPDATE • October 2017 1 I. Recent Economic and Policy Developments 1.1 Growth: Consistent Performance The Philippine economy had slow start in the first half of 2017. Consumer demand remained consistently robust while capital formation growth decelerated, and net exports rebounded alongside improving external demand. 1. The Philippines remained a consistent consumption and investment growth slowed in growth performer in the East Asia region, the first half of 2017 compared to the second half although growth moderated in the first half of of 2016 despite an improvement in the external 2017 (Figure 1 and Figure 2). The Philippines grew environment and continued accommodative in the first half of 2017 faster than Indonesia, monetary and fiscal policies. Thailand, Malaysia, and Vietnam but slower than China. Following strong growth in the immediate 2. Firming global economic activity improved months after the new administration assumed the country’s net exports performance.1 The office in July 2016, the economy had a slow start economic recovery in both advanced economies in the first half of 2017. The GDP growth rate fell as well as in emerging markets and developing from 7.0 and 6.8 percent, year-on-year, in the economies2 led to a strong boost in the demand first and second half of 2016, respectively, to 6.4 for the Philippines’ main export commodities percent, year-on-year, in the first half of 2017. (Box 1). Exports increased from 10.4 percent, Both the growth in government consumption year-on-year, in the first half of 2016 to 20.0 and capital formation weakened significantly percent, year-on-year, in the first half of 2017, on an annual basis, partly due to the slowdown which was the fastest half-year growth since the in the large election-related spending and second half of 2010. Electronics components, investments initiated in the first half of 2016. especially semiconductors, which comprise half Private consumption resumed its position as the of the country’s total exports of goods, expanded main engine of economic growth, and a rebound significantly.3 Meanwhile, import growth in exports contributed to growth. However, moderated from 23.2 percent, year-on-year, Figure 1: The Philippine economy continues to Figure 2: ...which has been sustained over the past perform well compared to its regional peers… five years 8.0 9.0 6.9 8.0 7.0 6.4 6.0 7.0 5.1 6.0 Percent 5.0 4.4 5.0 Percent 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 - China Philippines Emerging Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Developing East Asia Market and (1.0) 2013 2014 2015 2016 2017 excluding China Developing Economies Average (Developing EA ex. China) Indonesia Malaysia H1 2015 H1 2016 H1 2017 Philippines Thailand Vietnam China Source: World Bank staff calculations Source: World Bank staff calculations Note: Countries in Developing East Asia excluding China are the Note: Countries in Developing East Asia excluding China are the Philippines, Indonesia, Malaysia, Thailand and Vietnam. Philippines, Indonesia, Malaysia, Thailand and Vietnam. 1 The discussion of net exports in this section assesses values at constant 2000 prices. This differs from the discussion in the balance of payments section, where net exports are assessed based on values at current prices. 2 Emerging market and developing economies (EMDEs) includes all those that are not classified as advanced economies. Please refer to World Bank (2017b) for a list of all advanced economies. 3 Exports of electronics components increased by 25.7 percent, year-on-year, in the first half of 2017, up from 8.7 percent in the previous year. This was fueled by the growth of semiconductor exports, which expanded by 24.2 percent, year-on-year, over the same period. 2 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments in the first half of 2016 to 18.6 percent, year-on- components and semiconductors which grew by year, in the first half of 2017. A 25.8 percent year- 36.2 percent, drove the growth in imports in the on-year increase in the imports of intermediary first half of 2017. electronic goods, particularly electronics Box 1 The global economic recovery solidified in the first half of 2017 Global activity is firming broadly as international trade is picking up. Global economic growth firmed in the first six months of 2017 and contributed to an improvement in confidence worldwide, and industrial activities recovered, as global trade picked up after two years of slow growth. Output gaps are narrowing and inflation rates are converging with central bank targets, as the modest recovery in major advanced economies continues. The demand for imports has also strengthened, further contributing to the recovery in global trade. Meanwhile, obstacles to growth among commodity exporters in emerging-market and developing economies are gradually diminishing, while activity in commodity importers remains generally robust. Given the improved confidence and less policy tightening in some commodity-exporting countries, domestic demand is leading the global economic upturn. Advanced economies experienced solid economic performance in the beginning of 2017, with investments and exports regaining momentum after subdued growth in 2016. Private consumption decelerated somewhat in early 2017 despite improvements in labor markets. In the United States, a deceleration in consumer spending temporarily held back market activity, but it was partly offset by an increase in private investment. In the Euro Area, manufacturing activity and the exports of goods have been lifted by strengthening global trade and investment at a time when the unemployment rate fell to 9.5 percent in the first quarter of 2017, about 2.5 percentage points below its peak in 2013. Economic growth also accelerated in Japan, supported by an increase in exports, investments, and capital spending. As international conditions improved, growth in emerging markets and developing economies accelerated in 2017 after reaching a post-crisis low of 3.5 percent in 2016. Following years of near stagnating growth, a gradual recovery in commodity-exporting countries is supported by firming commodity prices, recovering industrial activity, stabilizing investments, and improving confidence. This recovery is broad-based, impacting nearly 70 percent of commodity exporters in 2017. For commodity importers, economic growth continues to be robust, supported by accommodative policies aimed at increasing domestic demand and a recovery in global trade which is bolstering export growth. Returns on assets in emerging markets and developing economies posted solid gains throughout the first half of 2017 but started to fall in July. Global financing conditions continue to be primarily driven by shifting expectations about monetary policy in the United States and the Euro Area. U.S. long-term yields decreased throughout much of the second quarter of 2017, reflecting disappointing inflation outcomes and diminished expectations of substantial fiscal stimulus. However, yields shifted upward in June 2017, reflecting the renewed pace of monetary policy normalization. As a result, capital flows and bond funds in emerging markets and developing economies registered net outflows in July – the first time in 2017. Moreover, currencies have suffered from tightening, especially for higher-risk and commodity exporters. Source: World Bank (2017b), (2017d) and (2017e) Philippines ECONOMIC UPDATE • October 2017 3 I. Recent Economic and Policy Developments 3. Private consumption remained the durable equipment moderated to 13.2 percent, main engine of economic growth, although it year-on-year, in the first half of 2017, compared weakened in the first half of 2017. Household to 41.3 percent, year-on-year, in the first half of consumption growth decreased from 7.3 2016. Moreover, the construction sector grew percent, year-on-year, in the first half of 2016 to by 8.8 percent, year-on-year, in the first sixth 5.8 percent in the first half of 2017. However, it months of 2017, considerably slower than the remained in line with the average annual growth 16.7 percent, year-on-year, recorded in the first of 5.7 percent during 2010-2016. Consumption half of 2016. Similarly, public construction grew growth was supported by an accommodative by only 9.0 percent, year-on-year, in the first monetary policy stance which kept the key policy half of 2017, down from 34.9 percent during the rates low. The low interest rate environment same period in the previous year. This marked led to a sustained increase in consumer loans, slowdown in investment growth was in part due which together with remittances from overseas to the high base in the first half of 2016 when large Filipinos expanded by 5.5 percent, year-on-year, election-related spending significantly boosted in the first six months of 2017, further boosting capital spending.4 Furthermore, the slowdown household purchasing power. Moreover, the in capital formation was a result of the slow overall consumer confidence index of Filipinos start in the implementation of the government’s registered record-high levels during the first half of infrastructure program in the first half of 2017. 2017 and only weakened recently (Box 2). However, inflation levels increased from an average of 1.3 5. On the production side, the services sector percent in the first half of 2016 to 3.1 percent in remains the principal contributor to economic the first six months of 2017. growth in the Philippines, although growth in both the services and industry sectors slowed 4. Growth in capital formation dropped significantly in the first half of 2017 (Figure 4). The sharply in the first half of 2017 following services sector, which constitutes 60 percent of unusually strong investment growth during the the country’s output, contributed 3.7 percentage election year. Fixed capital formation growth points to overall growth in the first six months of decelerated from 29.3 percent, year-on-year, in 2017. The sector grew by 6.4 percent, year-on-year, the first half of 2016 to 12.1 percent in the first in the first half of 2017, compared to 7.9 percent, half of 2017 (Figure 3). Investment growth in year-on-year, during the first half of 2016. Figure 3: Economic growth moderated in the first half Figure 4: The services sector remained the principal of 2017 growth engine Demand side: Contribution to GDP growth Supply side: Contribution to GDP growth 25 10 20 8 15 Percentage point 6 Percentage point 10 5 4 0 2 -5 0 -10 -15 -2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2014 2015 2016 2017 2014 2015 2016 2017 Private consumption Govt consumption Investments GDP growth Agriculture Manufacturing Other industries Discrepancy Exports Imports Services GDP growth Source: PSA Source: PSA Note: Other industries are mining and quarrying, construction, and electricity, gas and water. 4 Pre-election investment frontloading played a key role in the strong expansion of capital formation in the first half of 2016. The stimulus from election-related spending led to an acceleration in the growth of fixed capital formation from 13.5 percent, year-on-year, in the first half of 2015 to 29.3 percent in the same period in 2016. 4 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments Box 2 Confidence in the Philippine economy Even though the confidence of the Philippine business community improved as the economy grew over recent years, consumer optimism has been lagging. The government’s commitment to macroeconomic stability and good governance helped accelerate economic growth and earned the country international recognition.5 For the private sector, this prolonged period of improved macroeconomic management has translated into a persistent trend of positive business sentiments6 since 2007.7 However, there has been a long-term negative trend in the Bangko Sentral ng Pilipinas’ overall consumer confidence index since the consumer expectations survey launched in 2007. The fact that past high economic growth rates did not quickly translate into more inclusive growth might have contributed to a delay in improving consumer confidence.8 Consumer confidence surveys registered a positive value for the first time in the third quarter of 2016 but has since weakened. Even though consumer sentiments reached record highs in the first half of 2017, they have recently moderated but remain above 2016 levels.9 The gradual improvement in consumer sentiments was based on perceived positive prospects for the economy, improvements in household incomes due to a healthy job market, and government social protection programs (Figure 5).10 In particular, perceived improvements in peace and order fueled higher consumer confidence among Filipinos.11,12 However, recent data from the third quarter 2017 Consumer Expectations Survey show that consumer confidence is demonstrating signs of renewed weakness, similar to that of recent business confidence indicators. The overall Figure 5: The Philippine economy benefits from strong consumer and business sentiments 80 60 40 20 Percent 0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 -20 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 -40 -60 Overall Consumer Confidence Index (Current quarter) Overall Business Confidence Index (All sectors) Source: Bangko Sentral ng Pilipinas 5 The country is now rated at investment grade by the three major credit rating agencies, Standard & Poor’s Global Ratings, Moody’s Investors Service, and Fitch Ratings. 6 Business confidence is measured through the Bangko Sentral ng Pilipinas’ overall business confidence index. The index is calculated as the percentage of firms that answered in the affirmative minus the percentage of firms that answered in the negative in a given indicator. A positive confidence index indicates a favorable view. For more information, see: http://www.bsp.gov.ph/publications/regular_business.asp. 7 The only significant dip in business confidence occurred during the 2007-2008 global financial crisis. 8 Consumer confidence is measured through the Bangko Sentral ng Pilipinas’ overall consumer confidence index. This index is computed as the percentage of households that answered in the affirmative less the percentage of households that answered in the negative in a given indicator. A positive confidence index indicates a favorable view. For more information, see: http://www.bsp.gov.ph/publications/regular_consumer.asp. 9 By the second quarter of 2017, the overall consumer confidence index reached 13.1, a record high for the Philippines, and was the fourth consecutive quarter wherein the overall consumer outlook was positive. 10 Record high levels of consumer confidence were also observed in the three component indicators of consumer confidence in the second quarter of 2017: i) confidence in the country’s economic condition, ii) confidence in the family’s financial situation, and iii) confidence in family income. 11 The survey covering the second quarter of 2017 was conducted from April 1 to 12, 2017, which was before the Marawi events and the declaration of Martial Law in Mindanao. However, the recent conflict in Marawi City was among the factors cited in both the consumer and business expectations surveys as among the reasons for the weakening in overall confidence. 12 These were consistently the main reasons for overall positive consumer sentiment based on the Consumer Expectations Survey from the third quarter of 2016 to the second quarter of 2017. Philippines ECONOMIC UPDATE • October 2017 5 I. Recent Economic and Policy Developments consumer confidence index fell slightly from 13.1 percent in the second quarter of 2017 to 10.2 percent in the third quarter of 2017 due to concerns over higher inflation and unemployment and limited increases in income. Concerns over the conflict in Mindanao have likely also dampened overall consumer sentiment. There has been a recent weakening of business confidence (Figure 6). Based on the third quarter 2017 results of the business expectations survey, overall business confidence declined from 37.9 percent in the third quarter to 43.0 percent in Figure 6: Recent weakening in business confidence the second quarter, the lowest level in three translated in weaker manufacturing growth years.13 The weak peso, higher inflation, and 60 the ongoing conflict in Mindanao contributed to diminished business confidence. The Nikkei Manufacturing Purchasing Manager’s Index 55 PMI index (PMI)14, which appears to be a reasonable predictor of the Philippines’ main output 50 indicators, remained in expansion territory in the first eight months of 2017. However, it has weakened since May 2017 in line with 45 the worsening of business sentiment since Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 the beginning of the third quarter of 2017.15,16 Nikkei Manufacturing Purchasing Manager's Index Manufacturing output also weakened in the Manufacturing Volume of Production growth (RHS) first half of 2017 and contracted in July. Source: Markit Economics, PSA 6. Growth in wholesale and retail trade and performance in the first half of 2017 compared real estate remained the principal growth drivers the same period in 2016, including the mining in the services sector. The expansion in the sector, which contracted by 1.2 percent, year-on- industry sector also moderated in the first half of year, during the first half of 2017, a reversal from 2017 to 6.8 percent, year-on-year, compared to the 2.7 percent growth registered during the first 8.4 percent, year-on-year, in the first half of 2016, six months of 2016 (Box 3). as growth in the construction sector slowed due to a combination of base effects from the previous 7. The country’s agricultural sector expanded year and the slow start to the government’s during the first half of 2017. The sector grew public infrastructure program in the first quarter at an annual rate of 5.6 percent, reversing a of 2017. The manufacturing subsector continued contraction of 3.2 percent recorded during the to drive growth in industry, with annual growth same period in the previous year. A low base year remaining at over 7 percent in the first half of and more favorable conditions for farm output, 2017.17 However, overall manufacturing output as the effects of the El Niño phenomenon weakened and contracted in July. Meanwhile, the largely dissipated, contributed to the recovery three other industry subsectors all posted weaker in agriculture. 13 See: http://www.bsp.gov.ph/downloads/Publications/2017/BES_2qtr2017.pdf 14 Nikkei launched the Philippines’ Purchasing Manager’s Index data on September 1, 2016. Data was collected at the beginning of January 2016. 15 A reading of above 50 for the Nikkei Manufacturing PMI indicates economic expansion, while a reading below 50 points to a contraction. 16 Likewise, the Philippine Institute of Supply Managers, which releases its own PMI data for a broader set of sectors, including manufacturing, services, and wholesale and retailed trade, mirrors the overall trend seen in the Nikkei Manufacturing PMI, suggesting an expansion of output from firms in these sectors. Data from the PISM PMI was accessed through the central bank’s selected economic and financial indicators: http://www.bsp.gov.ph/ statistics/keystat/sefi.pdf. 17 Mines and Geoscience Bureau website; Ocampo and Arguelles (2017). 6 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments Box 3 Regulation and investments in the mining industry The Philippines is the fifth most mineral-rich country in the world for gold, nickel, copper, and chromite. It has an estimated US$840.0 billion worth of untapped mineral resources, and about 9 million hectares of land have a high mineral potential. The metal and non-metal deposits in the Philippines are estimated at 21.5 billion and 19.3 billion metric tons, respectively.18 In recent years, changes in government regulations and policy uncertainties have limited foreign investment in the mining industry. Despite the 1995 Philippine Mining Act, which opened up the country’s mining sector to 100 percent foreign ownership, foreign direct investment in the mining industry remain subdued (Figure 8). As a result, growth in the sector has been uneven with occasional periods of contraction (Figure 7). Government efforts to improve the mining industry face the difficult task of attracting new investments while protecting the environment and communities. In 2012, Executive Order no. 79 was enacted to reform the Mining Act by establishing mineral reservations19, expanding areas closed to mining operations, creating a Mining Industry Coordinating Council to help enforce mining laws, and imposing a moratorium on new mineral permits until legislation can be enacted to rationalize existing revenue sharing schemes. However, legislation has yet to be introduced in Congress, and the moratorium is still in place five years later. Figure 7: Annual real growth of the mining and quarrying sector 70.0 60.0 50.0 40.0 Percentage 30.0 20.0 10.0 0.0 -10.0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: PSA Mining is increasingly financed by domestic sources. Domestic corporate lending in the industry increased steadily since June 2014, and it surpasses foreign direct investment by a wide margin (Figure 9). Outstanding domestic credit grew on average 31.3 percent annually between June 2010 and June 2017. Based on data from five major mining companies, capital expenditures and debt refinancing constitute the bulk of outstanding credit for major industry players in the long term, while short-term debt for working capital requirements makes up a smaller portion.20 There is uncertainty in the policy environment surrounding the mining industry. In the first half of 2017, the former environment secretary ordered the closure of 23 of the Philippines’ 41 mines, the cancellation of 75 mining contracts in watershed areas, and banned prospective open-pit mines. In addition, the 2012 moratorium on new mining permits under the Executive 18 Mineral reservations are identified by the government as potential and future mining areas with known strategic mineral reserves and resources for the development of strategic industries. Please see Executive Order No 79 for a full description. 19 Growth in the construction sector dropped from 13.8 percent, year-on-year, in the first half of 2016 to 7.4 percent in the first half of 2017. Its contribution to growth in the industry sector declined from 29 to 20 percent during the same period. Philippines ECONOMIC UPDATE • October 2017 7 I. Recent Economic and Policy Developments Figure 8: Net foreign direct investment in the mining Figure 9: Loans outstanding in the mining and and quarrying sector quarrying sector 100 1,000 90 900 80 800 70 700 Millions US$ 60 600 Millions US$ 50 500 40 400 30 300 20 200 10 100 0 Jan-May Jan-May Jan-May Jan-May Jan-May Jan-May Jan-May Jan-May - June June June June June June June June 2010 2011 2012 2013 2014 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 Source: BSP Source: BSP Order no. 79 has yet to be lifted, and mining firms that were suspended still await the review of their appeals. This uncertainty is a challenge for investors who seek policy consistency and make business decisions based on an analysis of risks and potential returns. There are discussions in Congress about new legislation dealing with responsible mining practices, mining taxation, and revenue-sharing schemes. The push towards responsible mining should address concerns over the environmental and social impacts of mining. The most cited negative environmental impacts involve land and water contamination, such as the 1996 contamination of the Boac river from a tailing dam failure, and destruction of forest, farmlands, corals reefs, and deep rifts due to mining pollution. Social impact concerns include the relinquishment of ancestral domains of indigenous people and reports of intimidation. 1.2 The Exchange Rate and The External Sector: Weakening Balance of Payments While the Philippines’ current account deficit remained stable, the peso was impacted by the Federal Reserve’s rate hikes and continued to weaken, and the country’s balance of payments turned into deficit because of increasing capital outflows. 8. The Philippine peso further depreciated depreciation of the peso’s nominal exchange rate in the first half of 2017. In nominal terms, the in the first half of 2017. It depreciated 0.9 percent, peso depreciated by 6.5 percent, year-on-year, month-on-month, in February and 1.2 percent, from an average of Php46.88 per USD in the first month-on-month, in June. In both instances, the half of 2016 to an average of Php49.93 per USD expectations of and actual U.S. Federal Reserve in the first half of 2017 (Figure 10). Moreover, rate hikes led to capital outflows from the the real effective exchange rate depreciated from Philippines.21 In addition, strong imports raised 3.2 percent, year-on-year, in the first half of 2016 the demand for the U.S. dollar and weakened to 3.7 percent, year-on-year, in the first half of the peso. In July, the central bank reportedly 2017. The real depreciation of the peso has been intervened to temper excessive volatility in larger compared to other regional currencies the foreign-exchange market. As a result, gross (Box 4). There were two episodes of a marked international reserves slipped from US$85.5 20 Credit information came from disclosed figures in the companies’ annual reports. The select companies include Nickel Asia Corporation, Atlas Consolidated Mining and Development Corporation, Semirara Mining and Power Corporation, Philex Mining Corporation, and Lepanto Consolidated Mining Company. 8 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments Figure 10: The real effective exchange rate continued billion in July 2016 to US$81.3 and US$80.8 to weaken in the first half of 2017 billion in June and July 2017, respectively. At its 100 current level, the reserves cover 8.6 months’ 98 Brexit US Federal 96 US Federal Reserve Reserve Rate Hikes worth of goods imports, payments of services, 94 Rate Hike and primary income. It is also equivalent to 5.5 92 90 times the country’s short-term external debt 88 based on original maturity and 3.7 times based 86 84 on residual maturity. 82 80 78 9. The current account deficit slightly 76 moderated in the first half of 2017. It registered a US$233.6 million (0.2 percent of GDP) deficit in Nominal Exchange Rate (January 2013: indexed to 100) Real Effective Exchange Rate the first half of 2017, slightly lower than the 0.3 percent of GDP deficit recorded in the first half of Source: BSP Note: Decrease denotes depreciation 2016 (US$423.9 million). The current account was Box 4 Opportunities and challenges of a weaker currency In line with other regional currencies, the Philippine peso has steadily weakened since January 2013. The Philippine peso slid in nominal terms from Php40.00 per USD in 2013 to Php50.58 per USD in July 2017. Its performance in the past four years is comparable with other regional currencies and performed slightly better than the Malaysian ringgit and Indonesian rupiah (Figure 11). However, the peso was the weakest performer in the region during the first six months of 2017, and it dropped to a fresh 11-year low in August at a time when other regional currencies had gained strength. The depreciation of the country’s real effective exchange rate creates a relative price advantage that the Philippines can explore. The real effective peso exchange rate depreciated at a moderate pace of 3.1 percent, year-on-year, in first half of 2017, which made it the worst regional performer with the exception of China’s yuan (Figure 12). The depreciation of the peso has made it relatively cheaper to produce and export Philippine goods, improving the country’s export competitiveness in the region. This could help explain the country’s strong export performance over the past six months, as firms with established export products and sufficient production capacity to increase output in the short term were in a position to immediately take advantage of the price advantage. However, initial investments might be required for companies to take advantage of opportunities in more competitive markets. Global developments, such as the ongoing U.S. policy rate normalization and Brexit, have contributed to the depreciation of the peso. The anticipation of U.S. Federal Reserve rate increases and uncertainty surrounding Brexit caused capital outflows from emerging markets in the Asia-Pacific region, as investors moved funds to safer markets and U.S. assets regained attractiveness. In the Philippines, the stock exchange endured stock sell-offs in the last quarter of 2016 (US$357.0 million in September and US$383.0 million in November 2016) and in February 2017 that brought volatility in the foreign-exchange market and the continued deterioration of the peso. Since then, stocks in the Philippines have rebounded in line with top performing major stock indices in the region, and the country’s stock market reached a record-high of 8,321 in September 2017. However, the peso exchange rate has remained at relative low levels, with the market expecting further depreciation. 21 As of August 2017, the U.S. Federal Reserve has raised the interest rate twice for the year: on March 16 and June 15. Philippines ECONOMIC UPDATE • October 2017 9 I. Recent Economic and Policy Developments Figure 11: Regional currencies in nominal terms have Figure 12: Change in the real effective exchange rate generally depreciated since 2013 from January 2017 to June 2017 (percent) 105 2 100 95 1 90 85 0 80 75 -1 70 65 -2 60 -3 2013-01 2013-03 2013-05 2013-07 2013-09 2013-11 2014-01 2014-03 2014-05 2014-07 2014-09 2014-11 2015-01 2015-03 2015-05 2015-07 2015-09 2015-11 2016-01 2016-03 2016-05 2016-07 2016-09 2016-11 2017-01 2017-03 -4 China Indonesia Malaysia Change in REER Philippines Thailand Vietnam China CNY Philippines PHP Thailand THB Indonesia IDR Malaysia MYR Source: EAP Update October 2017 Source: WB staff calculation Note: Decrease denotes depreciation. Preserving confidence in the economy will be important, as widening current- and fiscal-account deficits and the continuing depreciation of the peso weigh heavily on investor sentiments. There are concerns over the anticipated current account deficit in 2017, the first in 14 years, and the ambitious public infrastructure investment plan that is expected to lead to a budget deficit of 3.0 percent of GDP over the next five years. There is a risk of overheating the economy if investments in new production capacity do not keep pace with demand, which could result in a higher inflation rate and a further weakening of the peso. Although the public infrastructure investment plan is consistent with the country’s development needs and will require greater capital formation and capital imports for some time, it will also need to be carefully managed to mitigate risks. stable in the first year of the new administration.22 percent annually and reached US$15.4 billion in The trade balance continued to widen from 11.8 the first half of 2017, compared to 4.4 percent, percent of GDP (US$18.2 billion) in the first half year-on-year, in the first half of 2016 (Box 6). of 2016 to 12.9 percent of GDP (US$19.4 billion) in the first half of 2017. However, the growth of Figure 13: Exports growth rebounded while import the trade deficit slowed, from 82.1 percent, year- growth remained strong on-year, in the first half of 2016 to 11.9 percent, Jun -17 year-on-year, in the first half of 2017 (Box 5). May-17 Exports grew at an annual rate of 14.6 percent, Apr-17 Mar-17 year-on-year, in the first half of 2017, compared Feb -17 Jan -17 to a 6.3 percent year-on-year contraction in Dec -16 the first half of 2016. Import growth continued Nov-16 Oct -16 to grow but at a slower rate of 10.1 percent in Sep -16 the first six months of 2017, compared to 21.8 Aug-16 Jul -16 percent in the first half of 2016 (Figure 13).23 Jun -16 Services exports weakened in the first half of -50 -40 -30 -20 -10 0 10 20 30 40 50 Percent 2017, including export revenues from business Exports Imports process outsourcing (BPO) services. The growth Source: PSA in personal remittances remained robust at 5.5 22 The current account deficit stood at US$530.0 million (0.3 percent of GDP) in the second half of 2016. 23 The discussion of net exports in this section assesses values at current prices. This differs from the discussion of net exports in the growth section, where net exports assess values at constant 2000 prices. 10 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments Box 5 The trade balance in the Philippines The Philippines’ trade balance has been in deficit for the past five years (Figure 14). Between 2011 and 2016, goods exports grew at an annual rate of 2.6 percent while merchandise imports grew at the faster annual rate of 5.7 percent. On average, the trade deficit was around 7.9 percent of GDP in 2011-2016 but rose to 8.7 percent of GDP in the first half of 2017. Exports rebounded in early 2017 after two consecutive years of weak growth. Goods exports expanded by 14.6 percent, year-on-year, in the first six months of 2017, compared to a 6.3 percent, year-on-year, contraction in the same period in 2016. Leading the rebound was the exports of electronic products, including semiconductors and electronic data processing machines, which accounted for more than two-fifths of the growth, followed by the exports of forest, mineral, and petroleum products which constituted about a quarter of the growth. The exports of agriculture-based products and other manufactured goods also increased compared to last year’s contractions, in part due to the general improvement in the external environment. Yet given the slower growth of exports compared to imports, the continued adoption of policies to further improve the country’s export competitiveness remains important. Even though the recent rise in imports exacerbated the trade deficit, a sizable share of the imports was capital goods. Capital goods, which used to constitute about a quarter of the total import bill during 2011-2015, have made up about a third of total imports since 2016 (Figure 15). Imports of capital goods grew at an average annual rate of 12.4 percent in 2011-2016. In the first half of 2017, they grew by 5.5 percent, year-on-year, driven by the imports of power generating and specialized machines, telecommunication equipment, and office and electronic data processing machines. Since capital goods are necessary inputs to build production capacity, their import growth is a welcome development to secure the country’s potential and future growth. The imports of raw materials and intermediate goods have increased as they are key inputs in the production of Philippine exports. In 2011-2016, the imports of raw materials and intermediate goods grew at an annual rate of 4.6 percent. Moreover, they grew from 8.8 percent, year-on- year, in the first half of 2016 to 9.9 percent, year-on-year, in the first half of 2017. Materials for the manufacturing of electronic equipment constitute a key share among intermediate goods (23.1 percent) and are important for the country’s main exports of semiconductors and electronic products. Figure 14: The trade balance has been in deficit Figure 15: Capital goods covered roughly a third of for the past five years the total import bill in H1 2016 and H1 2017 40.0 35.00 35.0 30.00 FOB value in billions US$ 30.0 25.0 25.00 Percentage of GDP 20.0 20.00 15.0 10.0 15.00 5.0 10.00 - (5.0) 5.00 (10.0) - (15.0) H1 2011 H1 2012 H1 2013 H1 2014 H1 2015 H1 2016 H1 2017 2011 2012 2013 2014 2015 2016 H1 2017 Manufactured goods: electronic products Manufactured goods: other manufactures Exports/GDP Imports/GDP Trade Balance/GDP - based products Agro Forest, mineral and petroleum products Source: PSA Source: PSA Philippines ECONOMIC UPDATE • October 2017 11 I. Recent Economic and Policy Developments Consumer goods imports rose alongside increasing domestic incomes. As income levels rise in line with rising GDP levels, the propensity to consume imported goods is likely to continue to be strong. In 2011-2016, the imports of consumer goods grew at an annual rate of 15.5 percent, and they grew by 6.5 percent, year-on-year, in the first six months of 2017, largely as a result of an increase in imports of both non-durable goods, such as food items, and durable goods, such as passenger cars and home appliances. In the first half of 2017, 16.8 percent of total imports were consumer goods while about 38.6 percent were raw materials and intermediate goods. Box 6 Recent trends in remittances Remittances to the Philippines continued to increase in the first six months of 2017, helped by the improving global economy and the continued strong deployment of overseas Filipinos. Personal remittances sent by overseas Filipinos expanded 5.5 percent, year-on-year, and reached US$15.4 billion (10.2 percent of GDP) in the first half of 2017, outpacing the 4.4 percent, year-on- year, expansion registered during the same period in the previous year (Figure 16). Meanwhile, cash remittances increased by 4.7 percent, year-on-year, over the same period to reach US$13.8 billion (9.2 percent of GDP), which is in line with the central bank’s projection of US$28.0 billion for 2017. Preliminary data from the Philippine Overseas Employment Administration reveal that a total of 1.1 million Filipinos were deployed overseas, on track to surpass the 2.1 million overseas Filipinos recorded in 2016. The source of remittances in the first half of 2017 broadly reflected the Filipino diaspora. Cash remittances from North and South America accounted for the largest share of remittance inflows (Figure 17), comprising 36.6 percent of total remittances, 90 percent of which were from the United States. The Middle East remained the second largest source of remittances, with a 28.3 percent share in the first half of 2017, followed by Asia (18.3 percent) and Europe (13.8 percent). These trends mirrored the distribution of around 9.2 million overseas Filipinos in 2016, with the United States accounting for the largest share of Filipino migrants at 39.5 percent (land-based), followed by the Middle East (24.8 percent), Asia and the Pacific (21.6 percent), and Europe (7.2 percent).24 Figure 16: The Philippines benefitted from robust Figure 17: …reflecting the distribution of around 9.2 remittances in the first half of 2017... million Filipinos abroad 9,000 Africa, 0% 8,000 Asia, 18% 7,000 6,000 US$ millions Middle East, 29% 5,000 4,000 3,000 2,000 1,000 - Europe, USA, Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 14% 33% 2012 2013 2014 2015 2016 2017 Oceania, 3% Other Americas, Personal remittances Cash remittances 3% Source: BSP Source: BSP 24 Source: Department of Foreign Affairs. 12 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments 10. Increasing capital outflows led to the outflow of US$0.5 billion in other investments.25 balance of payment swinging into deficit. The Foreign direct investments, which represent capital and financial accounts deteriorated in long-term investments, also moderated from the first year of the new administration, from registering US$4.2 billion in net inflows during the registering net inflows of US$1.5 billion (1.0 first half of 2016 to a net inflow of US$3.6 billion percent of GDP) in the first half of 2016 to posting in the first six months of 2017. The deterioration net outflows of US$1.1 billion (0.7 percent of in the capital and financial accounts overrode GDP) and US$81.9 million (0.1 percent of GDP) in the modest improvement in the current account. the second half of 2016 and the first half of 2017, As a result, the country’s balance of payments respectively. This can be partially explained by remained in deficit for the entire first year of the ongoing U.S. Federal Reserve rate tightening the new administration, registering a deficit of cycle and recovery in advanced economies which US$705.7 million (0.5 percent of GDP) in the first made foreign assets more attractive, leading to half of 2017. This was a reversal of the US$633.7 foreign equity outflows from the Philippines and million (0.4 percent of GDP) surplus registered in a weakening of the country-specific investment the first half of 2016 but an improvement from sentiment. In the first half of 2017, there was the US$1.1 billion (0.7 percent of GDP) deficit in a net outflow of US$3.0 billion in portfolio the second half of 2016 (Table 1). investments, which was exacerbated by a net Table 1: Balance of payments, H1 2015 – H1 2017 H1 2015 H2 2015 H1 2016 H2 2016 H1 2017 In millions US$ / In percentage of GDP Current account 4,866 3.4 2,400 1.6 (424) (0.3) (530) (0.3) (234) (0.2) Goods (9,528) (6.7) (13,781) (9.2) (17,349) (11.8) (18,199) (11.5) (19,420) (12.9) Services 2,076 1.5 3,379 2.3 3,465 2.4 3,579 2.3 4,640 3.1 Primary Income 851 0.6 1,006 0.7 1,337 0.9 1,239 0.8 1,700 1.1 Secondary Income 11,466 8.0 11,797 7.9 12,124 8.3 12,852 8.1 12,847 8.5 Capital and Financial accounts (1,841) (1.3) (375) (0.3) 1,511 1.0 (1,104) (0.7) (82) (0.1) Capital account 39 0.0 45 0.0 50 0.0 52 0.0 53 0.0 Financial account 1,880 1.3 420 0.3 (1,461) (1.0) 1,156 0.7 135 0.1 Direct investment 119 0.1 (219) (0.1) (3,518) (2.4) (2,302) (1.5) (3,194) (2.1) Net acquisition of 2,102 1.5 3,437 2.3 666 0.5 1,447 0.9 404 0.3 financial assets Net incurrence of 1,983 1.4 3,656 2.4 4,184 2.9 3,749 2.4 3,598 2.4 liabilities1/ Portfolio investment 3,110 2.2 2,361 1.6 2,326 1.6 (901) (0.6) 3,031 2.0 Financial derivatives (30) (0.0) 35 0.0 57 0.0 (89) (0.1) (170) (0.1) Other investments (1,319) (0.9) (1,757) (1.2) (325) (0.2) 4,448 2.8 468 0.3 Net unclassified items /2 (1,340) (0.9) (1,093) (0.7) (454) (0.3) 581 0.4 (390) (0.3) Overall BOP position 1,684 1.2 933 0.6 634 0.4 (1,054) (0.7) (706) (0.5) Memo: Basic Balance 4,746 3.3 2,619 1.8 3,094 2.1 1,772 1.1 2,960 2.0 1 / Net incurrence of liabilities refers to net foreign direct investment to the Philippines. 2 / The term “Net unclassified items” is a balancing figure. There are two methods of computing the BOP position: the first approach uses the change in net international reserves due to transactions, while the second approach computes the sum balances of the current account, capital account less financial account. The two measures do not necessarily tally. The BSP uses the first approach to determine the overall BOP position. 25 Other investment accounts consisted of domestic deposits in foreign banks and non-residents net loans from local banks. Philippines ECONOMIC UPDATE • October 2017 13 I. Recent Economic and Policy Developments 1.3 Financial Markets and Monetary Policy: Inflation Peaked and Remains Sticky Inflation peaked in April and remained at elevated levels. Monetary policy has remained accommodative to growth and domestic credit continues to expand. Finally, the financial system remains stable and well capitalized. 11. The inflation rate climbed to 3.4 percent in 13. The Philippine financial market remained the first half of 2017 and has continued to hover characterized by ample domestic liquidity and around 3 percent since. The average headline strong credit growth. In the first seven months of inflation rate stood at 3.1 percent in the first 2017, domestic liquidity growth remained robust eight months of 2017, up from an average of 1.5 at 12.3 percent, year-on-year (the same growth percent in the same period last year. It has been rate as in the first seven months of 2016), and steadily increasing since 2016, from a low of 0.9 averaged Php9.6 trillion. Credit growth, i.e. loans percent, year-on-year, in February 2016 to a peak of commercial banks, net of reverse repurchase of 3.4 percent, year-on-year, in April of this year. placements, grew from 17.7 percent, year-on- However, it remained within the central bank’s year, in the first seven months of 2016 to 19.7 target range of 2-4 percent and decelerated in percent, year-on-year, in the first seven months June 2017 to 2.8 percent before picking up again of 2017. Loans to firms, net of reverse repurchase in August to 3.1 percent (Figure 18). placements, dominate the banks’ loan portfolio and constitute 88.7 percent of the aggregate 12. The price of food has been the main driver loan portfolio. They grew from an average of 16.7 of the country’s high inflation rate, as higher percent, year-on-year, in the first seven months prices for staple food items caused about half of of 2016 to an average of 18.1 percent, year-on- the initial average increase in the inflation rate. year, in the first seven months of 2017. The credit Rice prices also increased towards the second expansion to businesses was primarily driven by quarter of 2017 in line with the end of the main lending to the real estate, electricity and gas, harvest season coupled with lower production wholesale and retail trade, and manufacturing in certain provinces because of pest infestation sectors (Figure 19). Loans to households grew and floods (Box 7). At an annual increase of 4.3 from 17.4 percent, year-on-year, in the first seven percent, food prices reached a new high in April months of 2016 to 23.6 percent, year-on-year, 2017. They declined between May and July only in the first seven months of 2017, with motor to climb back up to 3.7 percent in August due vehicle and salary loans constituting the bulk of to the adverse effects of the recent typhoons. new loans. Compared to neighboring countries, Throughout the first eight months of 2017, energy the Philippines’ domestic credit-to-GDP ratio is prices remained higher than in 2016, reflecting low at 44.7 percent in 2016 (Figure 20).26 higher local electricity costs and elevated global crude oil prices. The core inflation rate 14. The country’s banking sector was accelerated to an average of 2.8 percent in the stable and profitable in the first half of 2017. first eight months of 2017, up from 1.7 percent The financial system remained stable with in the same period last year. This was partly the nonperforming loans maintained at 2.0 percent result of the pass-through effect of the two peso of the total loan portfolio by end-July 2017, down depreciation episodes. It peaked in April at 3.0 from 2.2 percent at end-July 2016 (Figure 21). percent, eased back to 2.6 percent in June, before Banks maintained a strong capital adequacy climbing back up to 3.0 percent in August. The ratio of 15.3 percent on average as of March central bank authorities have maintained the key 2017, well above the 10.0 percent regulatory policy rate at 3.0 percent since June 2016, as the minimum.27 The banking system’s profitability inflation rate remained within the target range. also remained stable with an average net interest 26 The credit-to-GDP ratio was 124.1 percent in Malaysia, 156.0 percent in China, and 147.4 percent in Thailand in 2016. Source: World Development Indicators. 27 As of March 2017, Universal and Commercial Bank capital adequacy ratio was 15.0 percent while thrift banks were at 16.9 percent. Both are way above the minimum ratio of capital-to-risk weight assets of 8.0 percent under Basel II and 10.5 percent under Basel III. 14 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments margin of 3.3 percent and net interest income governor became effective after the term of the at 73.8 percent of total income throughout the previous governor ran out. The newly appointed first half of 2017. The return on assets averaged central bank governor promised a commitment to 1.2 percent and the return on equity 9.9 percent policy continuity and reaffirmed financial system over the first six months of 2017. Starting on stability and financial inclusion as top priorities July 1st, the appointment of a new central bank for the central bank. Figure 18: Inflation remained elevated at around Figure 19: The commercial loan portfolio is dominated 3 percent by the real estate, utilities, transport and ICT sectors 9.0 Agriculture, forestry Household and fishing, 8.0 consumption, 3% 8% 7.0 Other production 6.0 activities and loans Real estate and to residents, construction, Percent, YoY 5.0 12% 20% 4.0 Wholesale, 3.0 retail trade, Financial and hospitality 2.0 industry, insurance activities, 15% 8% 1.0 0.0 Manufacturing, Aug-13 Oct-13 Dec-13 Apr-14 Aug-14 Oct-14 Dec-14 Apr-15 Aug-15 Oct-15 Dec-15 Apr-16 Aug-16 Oct-16 Dec-16 Apr-17 Aug-17 Jun -14 Jun -15 Jun -16 Jun -17 Feb-14 Feb-15 Feb-16 Feb-17 Utilities, transport 13% and ICT, 20% Core Inflation Headline Inflation Mining and quarrying, Food & Non-alcoholic beverage Key policy rate 1% Source: BSP Source: BSP Figure 20: The credit-to-GDP remains low in the Philippines where the non-performing loans ratio is among the lowest in the region 4.5 Domestic credit to private sector by banks 180.00 160.00 4.0 Non-performing loans ratio 140.00 3.5 120.00 3.0 (% of GDP) 100.00 2.5 80.00 2.0 60.00 1.5 40.00 1.0 20.00 0.5 0.00 0.0 2011 2012 2013 2014 2015 2016 China (LHS) Thailand (LHS) Malaysia (LHS) Philippines (LHS) Philippines (RHS) Indonesia (LHS) China (RHS) Thailand (RHS) Malaysia (RHS) Indonesia (RHS) Source: World Development Indicators and http://www.theglobaleconomy.com/compare-countries/ (Compilation of data from the World Bank, the United Nations, the International Monetary Fund, the U.S. Energy Information Administration, UNESCO, the World Economic Forum, etc.) 28 The newly-appointed central bank governor took office in July. Having worked for the central bank for more than three decades, the governor is an advocate for structural reforms in the financial market, including tighter capital buffers, sound risk management, and the easing of foreign- exchange rules. Philippines ECONOMIC UPDATE • October 2017 15 I. Recent Economic and Policy Developments Box 7 Rice policies and food inflation In the Philippines, fluctuations in the price of rice have a significant influence on food inflation (Figure 21). Rice is a staple food among Filipinos and covers about a quarter of the food in the Consumer Price Index (CPI) basket or 8.9 Figure 21: Rice inflation influences the level of food percent of the total CPI basket. As a result of inflation the global rice crisis in 2008, Philippine rice 16.0 prices rose by 35-40 percent in 2008-2009, and 14.0 food inflation peaked at 17.3 percent in July 12.0 2008. Following the domestic rice shortage in 10.0 8.0 2013, the price of rice rose by 15-20 percent 6.0 in 2013-2014, and food inflation peaked at 4.0 8.3 percent in August 2014. Historically, the 2.0 negative impact of food inflation weighs 0.0 -2.0 more heavily on the poor. Poor households -4.0 spend about 70 percent of their income on Aug -12 Oct -12 Dec -12 Apr -13 Aug -13 Oct -13 Dec -13 Apr -14 Aug -14 Oct -14 Dec -14 Apr -15 Aug -15 Oct -15 Dec -15 Apr -16 Aug -16 Oct -16 Dec -16 Apr -17 Jun -13 Jun -14 Jun -15 Jun -16 Jun -17 Feb -13 Feb -14 Feb -15 Feb -16 Feb -17 food, with 23 percent on rice, while families Headline Inflation Food & Non- alcoholic beverage inflation in the middle and upper classes spend only Rice CPI inflation 30 percent of their income on food.29 Source: PSA Timely rice imports and responsive rice stock management are critical to smoothing rice prices. Rice imports are largely controlled by the National Food Authority (NFA) which is mandated to maintain a 30-day stock during lean season and a 15-day stock at any given time.30 However, restrictions on rice imports in recent years left the rice supply inadequate at times, and the mistiming of imports has caused a number of price hikes. For instance, domestic rice prices increased in 2014 because of importation lags, even as world rice prices fell.31 There have been improvements in rice stock management since 2015, in part through higher and timelier imports. Total imports reached 1.5 million tons in 2015 which supplemented local supply and managed to keep the rice price inflation at a low single digit. The NFA’s level of rice stocks has raised concerns over potential shortages and price hikes during the lean July-September season. The NFA is currently expediting its stock replenishment. In May, it shifted its import scheme from government-to-government procurement to government- to-private procurement32, allowing private foreign firms to participate in the bidding process, a move seen as more competitive and transparent. The bids for 250,000 metric tons of rice were awarded in July and will be delivered on a staggered basis from August to September. Meanwhile, the government has also approved private sector imports of 805,200 metric tons of rice in an auction that is expected to take place during the last quarter of 2017. The Philippine government recently extended the quantitative restriction (QR) for rice imports for three more years until June 30, 2020. QRs on rice imports violate the agreement with the World Trade Organization that the government signed on January 1, 1995. However, as a transition rule, the World Trade Organization allowed the Philippines to impose a 10-year rice import QR system in 1995, which was extended four times in 2004, 2012, 2014, and 2017. The new administration’s economic team actively promotes the lifting of rice import restrictions 29 Lozada (2015). 30 Private sector traders could apply for import permits and allowed to import rice, but they would be constrained by a collective limit of 805,000 metric tons per year and levied with 35 percent tariff rates. 31 World Bank (2015b). 32 This new scheme still allows foreign public sector entities to participate in the bidding process. 16 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments to attract more private sector participation. The Department of Agriculture, however, supports an extended grace period before the restrictions are removed to give farmers more time to adjust. The Philippines plans to offer trade concessions for several products for three more years in exchange for an extension of the QRs on rice imports.33 Meanwhile, a bill has been filed in the Senate for the tariffication34 of rice imports and the creation of a competitive enhancement fund that will benefit rice farmers. In the long term, effective rice import and stock management needs to be complemented with improvements in agricultural productivity and logistics. Liberalizing rice imports and improving rice stock management are not the only tools for managing domestic rice prices. Only 6 to 7 percent of total global rice production is traded internationally.35 As a result, the Philippines is likely to remain vulnerable to covariate shocks in regional exporting countries, such as Vietnam and Thailand. In the Philippines, the rice supply chain has high milling, drying, storage, and transportation costs, reflecting insufficient investments in roads and postharvest facilities as well as policy distortions. Increasing productivity and rice yields, including lowering the cost of transportation, would contribute to an improvement in the management of the country’s rice prices. Key to improving agricultural productivity is addressing the binding constraints to Mindanao’s agricultural sector, which contributes the largest share to the country’s agricultural output. For a more detailed discussion, please refer to Part III: Unlocking Mindanao’s Potential. 1.4 Fiscal Policy: Staying on an Expansionary Path In the first half of 2017, the government’s pursuit of an expansionary fiscal policy led to significantly higher levels of public expenditures while revenues fell short of their targets. As a result, the fiscal deficit increased to 2.1 percent of GDP. 15. A second consecutive year of expansionary 92.9 percent of total financing, expanded to fiscal policy led to a further increase in the fiscal Php365.7 billion, more than triple the amount deficit in the first half of 2017 (Figure 22 and of domestic financing registered in the first half Figure 23). The fiscal deficit increased in nominal of 2016. Moreover, net external financing nearly terms by 28.4 percent, year-on-year, in the first quadrupled from Php7.2 billion in the first half of six months of 2017, widening the fiscal gap from 2016 to Php28.2 billion in the first half of 2017. 1.7 percent of GDP in the first half of 2016 to 2.1 This was a sharp reversal from the contraction percent of GDP in the first half of 2017. However, of Php31.3 billion in foreign financing during the fiscal deficit in 2017 was smaller than the the second half of 2016. Despite an increase in deficit of 3.1 percent of GDP recorded in the borrowing, the overall debt-to-GDP ratio did not second half of 2016 when expenditures grew worsen. It registered 42.5 percent of GDP in the while revenues fell primarily due to seasonal first half of 2017, slightly down from 42.9 percent factors. In order to finance the deficit, the in the same period a year ago, as nominal GDP government continued to rely on mainly domestic growth outpaced the growth in the government sources of financing. In the first half of the year, debt stock. net domestic financing, which accounted for 33 The list of products for trade concessions has not yet been determined. 34 Tariffication refers to the replacement of non-tariff barriers to trade, such as import quotas, with their estimated tariff equivalent. 35 World Bank (2017a). Philippines ECONOMIC UPDATE • October 2017 17 I. Recent Economic and Policy Developments Figure 22: The government’s budget deficit reached 2.1 Figure 23: ...as no new tax policy measures were percent of GDP on the back of expansionary fiscal policy… introduced 120 20.0 3.5 100 18.0 2.5 Fiscal balance (Percent of GDP) 80 16.0 60 14.0 1.5 Percent of GDP 40 12.0 0.5 Billion Pesos 20 10.0 - -0.5 July Jan July 8.0 (20) Jan Jul Jan 6.0 -1.5 (40) (60) 4.0 -2.5 (80) 2.0 (100) 0.0 -3.5 12 13 14 15 16 H1 H2 H1 (120) 2015 2016 2017 20 20 20 20 20 16 16 17 20 20 20 Net Foreign Financing Net Domestic Financing Budget Surplus/Deficit Revenues Expenditure Fiscal Balance (RHS) Source: Bureau of the Treasury (BTr) Source: Bureau of the Treasury (BTr) 16. After a slow start to the year, the 2016 to 13.1 percent, year-on-year, in the first government has made significant progress half of 2017, propelled by an increase in salaries in executing its programmed budget in of government employees and uniformed recent months (Table 2). Actual government personnel as well as hiring in key agencies, expenditures amounted to 99.6 percent of such as the Department of Education and the programmed spending in the first half of 2017. Department of Health.38 This constituted a significant increase compared to previous years when the government failed to 17. Despite the government’s infrastructure execute its budget in a timely manner, leading push, growth in capital outlays moderated to significant underspending. Government in the first half of 2017. It slowed from 47.2 expenditures increased by 9.0 percent, year-on- percent, year-on-year, in the first half of 2016 to year, in nominal terms in the first half of 2017 to 31.8 percent, year-on-year, in the second half of reach 17.7 percent of GDP, which was the same 2016 and 12.3 percent, year-on-year, in the first level registered in the first half of 2016.36 This half of 2017. A similar moderation can be seen was slightly higher compared to the second half in infrastructure and other capital outlays, which of 2016 when expenditures reached 17.5 percent grew by 8.8 percent, year-on-year, in the first of GDP. Major expenditure items in both capital half of 2017 compared to 52.4 and 35.5 percent, outlays and recurrent expenditures, such as year-on-year, in the first and second half of personal services and subsidies to government 2016, respectively. Meanwhile, growth of capital corporations,37 drove the increase in government transfers to local government units accelerated spending in the first half of 2017. Spending on from 15.6 percent, year-on-year, in the first half personal services grew nearly three times, from of 2016 to 37.1 percent, year-on-year, in the first 4.4 percent, year-on-year, in the first half of six months of 2017.39 36 The national government recorded total spending of 17.5 percent of GDP in the second half of 2016. 37 Subsidies to government corporations, although relatively small compared to other expenditure items, increased by nearly 60 percent to fund the various programs of the NFA, the National Irrigation Administration, the Philippine Health Insurance Corporation, and the National Housing Authority. 38 The increase in salaries of government employees was a part of the second tranche under the implementation of the adjustment of the compensation structure of government personnel under Executive Order No. 201 s. 2016. Meanwhile, the adjustment of combat pay and incentives for uniformed and military personnel is pursuant to Executive Order No. 3 s. 2016. 39 The expansion in infrastructure and capital outlays was used to fund road construction, repair, and rehabilitation, and flood control projects under the Department of Public Works and Highways, as well as the purchase of big-ticket expenditure items under the modernization program of the Philippine military. Allotments and capital transfer to local government units were used to repair, rehabilitate, and improve local roads under the conditional matching grant of the Local Government Support Fund. Source: http://www.dbm.gov.ph/wp-content/uploads/DBCC/2017/Highlights%20of%20 NG%20Disbursements_as%20of%20June%202017_for%20posting.pdf 18 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments Table 2: Actual and programmed expenditure of the Philippine government (H1 2015 – H1 2017) Level Growth H1 2015 H1 2016 H1 2017 H1 2016 H1 2017 Program Actual Program Actual Program Actual Program Actual Program Actual Current operating 997 869 1,049 923 1,013 1,001 5.2 6.1 -3.4 8.6 expenditures Personnel Services 384 325 396 339 402 383 3.2 4.4 1.4 13.1 Maintenance and other 210 179 237 217 216 208 12.9 20.8 -8.8 -3.9 operating expenditures Subsidy 65 44 39 37 27 58 -40.2 -16.8 -30.8 59.3 Allotment to Local 156 156 171 171 196 196 9.8 9.9 14.7 14.2 Government Units Interest Payments 172 156 194 154 164 159 13.3 -1.5 -15.9 3.1 Tax Expenditures 11 9 12 5 9 5 1.8 -41.8 -21.7 -11.3 Capital Outlays 246 200 329 295 311 331 33.4 47.2 -5.3 12.3 Infrastructure & other 189 150 261 229 237 249 38.3 52.4 -9.3 8.8 capital outlay Equity 2 0 10 9 2 3 431.6 2,733.3 -77.2 -62.4 Capital transfer to local 56 50 58 57 72 78 3.2 15.6 25.2 37.1 government units Net Lending 9 3 9 4 13 -1 -1.1 57.7 45.3 -131.7 Total 1,252 1,072 1,386 1,221 1,337 1,331 10.7 13.9 -3.5 9.0 18. Even though the government missed its were enacted and the country’s main revenue- revenue target, public revenue grew at a healthy generating agencies failed to meet their collection rate in the first half of 2017. Revenue growth targets. The Bureau of Internal Revenue, which accelerated in nominal terms under the new is responsible for around 80 percent of tax administration, from 1.4 percent, year-on-year, revenue, fell short of the government’s target by in the first half of 2016 to 7.0 and 6.8 percent, 4.0 percent, and the Bureau of Customs, which is year-on-year, in the second half of 2016 and the responsible for around 20 percent of tax revenue, first six months of 2017, respectively (Table 3). missed its target by 3.0 percent. As a result, the However, revenue declined from 16.0 percent of country managed to collect 14.2 percent of GDP GDP in the first half of 2016 to 15.6 percent of in the first six months of 2017, compared to 14.3 GDP in the first half of 2017, as non-tax revenue percent of GDP in the first half of 2016. declined for the second consecutive year and GDP grew faster than revenues. In the first half of 19. On May 31, 2017, the first package of the 2017, non-tax revenue declined in nominal terms government’s tax reform program successfully by 9.0 percent to 1.4 percent of GDP, down from passed in the House of Representatives on its 1.7 percent of GDP in the first six months of 2016, third and final reading. The current version of as total income from the Bureau of Treasury fell the bill estimates the revenue intake at Php119.4 by 17.2 percent, year-on-year. Moreover, tax billion (0.7 percent of GDP), compared Php157.2 revenue grew at a slower pace in nominal terms, billion (0.9 percent of GDP) in an earlier version from 10.1 percent, year-on-year, in the first of the bill. On September 21, 2017, the Senate half of 2016 to 8.8 percent, year-on-year, in the of the Philippines filed its own version, SB No. first six months of 2017, as no new tax policies 1592. Deliberations on SB 1592 are ongoing as of 40 The BTr cites the decline of PHP9.2 billion in dividend collections from government-owned and controlled corporations in the first half of 2017 and reduced income generated from national government deposits as reasons for the decline in its income. Source: http://www.treasury.gov.ph/wp- content/uploads/2017/07/COR-Press-Release-June-2017-final_ed.pdf 41 Source: http://www.philstar.com/business/2017/09/24/1741939/anti-corruption-tax-reform-measures-top-ledac-talks 42 Source: https://www.rappler.com/business/182876-tax-reform-bill-philippines-explainer-graphs Philippines ECONOMIC UPDATE • October 2017 19 I. Recent Economic and Policy Developments Table 3: Philippine government fiscal position (H1 2016 – H1 2017) In billions PHP Growth (percent) Percent to GDP H1 2016 H2 2016 H1 2017 H1 2016 H2 2016 H1 2017 H1 2016 H2 2016 H1 2017 Revenues 1,101 1,095 1,176 1.4 7.0 6.8 16.0 14.4 15.6 Tax Revenue 983 997 1,069 10.1 8.1 8.8 14.3 13.1 14.2 Non-tax Revenue 118 98 107 -38.8 -3.2 -9.0 1.7 1.3 1.4 Expenditures 1,221 1,328 1,331 13.9 14.6 9.0 17.7 17.5 17.7 Current operating 923 1,006 1,001 6.1 9.9 8.6 13.4 13.3 13.3 expenditures Personal Services 339 384 383 4.4 13.1 13.1 4.9 5.1 5.1 Maintenance and other 217 223 208 20.8 -0.7 -3.9 3.1 2.9 2.8 operating expenditures Subsidy 37 67 58 -16.8 95.9 59.3 0.5 0.9 0.8 Allotment to Local 171 172 196 9.9 10.0 14.2 2.5 2.3 2.6 Government Units Interest Payments 154 151 159 -1.5 -1.6 3.1 2.2 2.0 2.1 Tax Expenditures 5 10 5 -41.8 19.5 -11.3 0.1 0.1 0.1 Capital Outlays 295 311 331 47.2 31.8 12.3 4.3 4.1 4.4 Infrastructure & other 229 264 249 52.4 35.5 8.8 3.3 3.5 3.3 capital outlay Equity 9 3 3 2,733.3 700.0 -62.4 0.1 0.0 0.0 Capital transfer to local 57 44 78 15.6 7.9 37.1 0.8 0.6 1.0 government units Net Lending 4 17 -1 57.7 144.3 -131.7 0.1 0.2 0.0 Budget surplus/deficit -120 -233 -154 -975.3 72.1 28.4 -1.7 -3.1 -2.1 the first week of October. Preliminary estimates broadly in line with the 2017 budget. The by the Department of Finance reveal that SB 1592 president submitted the proposed 2018 national would lower the revenue of an additional Php59.9 budget after the president’s second State of the billion (around 0.3 percent of GDP), as the Senate Nation Address on July 24, 2017. The budget version lowered the threshold for personal is equivalent to 21.6 percent of GDP and is income tax exemption, reduced the value added 12.4 percent larger than the 2017 budget of tax exemptions by 36 lines compared to 70 in the Php3.35 trillion. It focuses on the government’s DOF version of the bill, and restructured excise priorities of increasing investment in human taxes on fuel, automobiles, and sugar-sweetened capital and infrastructure (Box 8). The House beverages. The Senate is proposing to pass Senate of Representatives passed the proposed Bill 1592 on its third and final reading before budget, House Bill No. 6215 or the General the regular session ends in October. Differences Appropriations Bill, on its third and final between the versions in the Senate and the reading on September 26, 2017. The General House of Representatives will then be settled in Appropriations Bill was then forwarded to a bicameral conference, which the government the Senate of the Philippines, where parallel hopes will conclude in November. deliberations are ongoing for its own version of the budget. Once the Senate of the Philippines 20. The government has submitted its passes its own version, differences between the proposed 2018 national budget of Php3.77 lower house and upper house version will be trillion to Congress, with expenditure priorities settled through a bicameral conference. 20 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments Box 8 The proposed 2018 national budget The 2018 national budget builds on the new administration’s development agenda as embodied in the 0-10 Point Socioeconomic Agenda, the Philippine Development Plan 2017-2022, and the AmBisyon Natin 2040. The proposed 2018 national budget of PhP3.77 trillion represents a 12.4 percent increase over the previous year’s PhP3.35 trillion budget and aims to reduce poverty and boost shared prosperity. Funding to social services, which would receive the largest share of the budget, is set to increase by 7.3 percent, year-on-year, to Php1.45 trillion, as the government continues to prioritize the development of the country’s human resources through increased investments in education, health, and service delivery. Meanwhile, the proposed budget for the economic services sector is planned to expand by 25.0 percent to reach PhP1.2 trillion, anchored on the country’s continued push for strategic infrastructure development. The proposed 2018 national budget prioritizes investment in both human and physical capital, maintaining the government’s key policy priorities from the previous year’s national budget (Figure 24). With a proposed allocation of Php691.1 billion, funding to the education sector would increase by 6.4 percent compared to Figure 24: The top recipients of the national budget 2017, which would ensure that the sector (2017 & proposed 2018) remains the largest component of the national budget (18.3 percent of the total budget). 25.0 Meanwhile, the government is planning to raise 20.0 19.4 Percent to total budget 18.3 the budget for infrastructure by 27.8 percent, 17.1 year-on-year, from Php858.1 billion (5.3 15.0 14.0 percent of GDP) to PhP1.1 trillion (6.3 percent 10.0 of GDP), with a focus on improving logistics 4.5 4.6 4.4 4.4 4.1 3.8 3.8 3.7 5.0 connectivity by upgrading the country’s road, 1.7 2.0 1.4 1.4 1.0 0.9 0.8 0.7 air, and sea transport networks. The significant 0.0 rise in the proposed infrastructure budget is on ks an al th se re n re M rc & tio rn oc or fa tu M al n ou nt ce es ati fe He ta el ve & L ul AR W es e a part of the government’s Build, Build, Build uc De l R nm lW or ric ic Ed Go ior sp Ag bl ra ro cia an Pu r tu nvi te So Tr program, where the government plans to In Na E invest approximately Php8.1 trillion in strategic 2017 2018 infrastructure development from 2017 to 2022. Source: Department of Budget and Management Despite the expansionary nature of the new budget, the government remains committed to maintaining fiscal discipline. The recent transformation from a fiscal program under constant threat to one that is resilient underpins the country’s robust economic growth performance. Cognizant of the importance of prudent fiscal policy, the government has maintained a deficit target for the next five years but raised it from 2.7 percent of GDP in 2017 to 3.0 percent of GDP in 2018. Central to the government’s efforts to maintain fiscal discipline is its objective to improve the country’s tax policy and tax administration.44 The government expects the implementation of the first package of tax reforms to begin in 2018, which is expected to boost tax revenue by Php133.8 billion in its first year of implementation, increasing the government’s projected revenue effort from an estimated 15.2 percent of GDP in 2017 to 16.3 percent of GDP in 2018. Source: Department of Budget and Management 43 The education sector includes the Department of Education, the Commission on Higher Education, and state universities and colleges. 44 A more detailed discussion on the government’s proposed tax reform program was discussed in the April 2017 and October 2016 editions of the Philippines Economic Update. Philippines ECONOMIC UPDATE • October 2017 21 I. Recent Economic and Policy Developments 1.5 Employment and Poverty: Progress but with New Challenges Unemployment levels increased in the first half of 2017, as many temporary jobs created during last year’s election-related stimulus disappeared. Longer-term growth in wage jobs, particularly for households in the bottom 40 percent, and the shift of employment out of agriculture continue to drive the observed decline in poverty. 21. The country’s employment rate is close to 2016 to 15.3 percent in July 2017, but it has been historic low levels, although it decreased slightly gradually declining in the past decade. However, in the first half of 2017. The employment rate the underemployment rate45 retreated from 17.3 stood at 94.4 percent in July 2017, compared percent in 2016 to a 10-year low of 16.1 percent in to 94.6 percent in July 2016. The employment early 2017, before settling at 16.3 percent in July. rate peaked at 95.3 percent at end-2016 after a Since the underemployed are more likely to work rapid but temporary creation of jobs occurred in the informal sector, the underemployment rate during the election year. The unemployment is an indicator that there is still a large prevalence rate of 5.6 percent in July 2017 is an indication of informal jobs in the Philippines. that the economy is close to full employment. While this is slightly higher than the historic low 22. In the first half of 2017, the labor unemployment rate of 4.7 percent reached in participation rate dropped and the number of 2016, it remains 1.3 percentage points below new jobs created was lower compared to 2016. the average in 2007-2017 (Figure 25). Changes in The labor force participation rate continued unemployment were similar across regions. The its downward trend and decreased from 63.3 unemployment rate in Metro Manila increased percent in 2016 to 60.6 percent in July 2017 from 6.4 percent in 2016 to 7.9 percent in July (Figure 26), the lowest rate observed in the 2017, marking an increase for the first time since past decade. The decline was slightly larger for 2013. Even though other regions also experienced women, falling from 49.0 percent in 2016 to 45.6 an increase in the unemployment rate, there percent in July 2017, and women constitute 69.1 was still a declining trend over the past decade. percent of the non-working labor force. The drop Unemployment remains higher among men than in the labor force participation rate reflects in women at 5.7 and 5.4 percent, respectively. Youth part a slower pace in net job creation compared unemployment increased from 13.5 percent in to a year ago. There were 1.9 million net jobs Figure 25: Underemployment reached a 10-year low in April 2017 25.0 20.0 Underemployment rate 15.0 10.0 Unemployment rate 5.0 0.0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Labor Force Survey, PSA 45 The underemployed is defined by the Philippine Statistics Authority as employed persons who express the desire to have additional hours of work in their present job or an additional job, or have a new job with longer working hours. 22 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments Figure 26: The labor force participation rate declined in early 2017 67.0 66.0 65.0 64.0 63.0 62.0 61.0 60.0 59.0 58.0 57.0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Labor Force Survey, PSA created in the first half of 2016, compared to students were admitted to grade 11 in June 2016, a net loss of 0.6 million jobs in the first half of of which 1.45 million had finished grade 10.48 2017. The agriculture46 and services47 sectors lost Prior to the implementation of the senior high 0.5 and 0.3 million jobs, respectively. In contrast, school program, a proportion of these students the industry sector generated 0.2 million jobs would have joined the labor market. There were in the first half of 2017, 185,000 of which came also about 54,000 returning students who took from the construction industry. Manufacturing advantage of the additional two years of free and construction have been driving employment basic education.49 growth in the industry, and the latter grew at an annual rate of 11.1 percent over the past decade. 24. Household incomes in the Philippines have increased over time as more people have 23. Philippines’ youth accounted for most of transitioned into wage employment (Box 9). the drop in the country’s labor force participation However, adjusting for inflation, wages have rate. The labor force participation rate among 15 been largely flat over time, translating into to 24 year olds dropped from 42.1 percent in 2016 only modest gains for those already in wage to 38.8 percent in July 2017. This is equivalent to employment. Median wages grew by an annual a 0.7 million decline in the labor force. This may rate of only 1.1 percent between 2007 and be attributed to the implementation of the K-12 2017, before picking up slightly to 1.6 percent program which commenced during the 2016- in the first quarter of 2017. Until recently, 2017 school year. Based on enrollment records public sector wages grew more rapidly than by the Department of Education, 1.5 million their private sector counterparts (Figure 27).50 46 Employment in agriculture has been steadily declining. Its share in total employment fell to 25.2 percent in July 2017, a drop of 9.3 percentage points from a decade ago. 47 The recent push for the Security of Tenure Bill (one of the priority bills endorsed by the Legislative-Executive Development Advisory Council) may have started to affect the hiring decisions of firms particularly in the services sector. 48 This is equivalent to a high school graduate in the old curriculum. The Department of Education reported a 98 percent progression rate from grade 10 to grade 11. 49 The boost in senior high school enrollment may have resulted from the senior high school voucher program, where almost half (about 0.7 million people) of grade 11 student beneficiaries enjoyed free tuitions in private high schools. This was an interim solution to the shortage of public schools. 50 Two laws on the public sector salary standardization were implemented in the last 10 years. The first was Joint Resolution No. 4 by the Fourteenth Congress that authorized former President Gloria Macapagal-Arroyo to modify the compensation package for government, military, and uniformed personnel. The revised compensation took effect a year after it was signed in July 2008 for employees in national government offices and after eighteen months for employees in local government. The salary increase was implemented in equal tranches over four years. Another round of salary standardization through Executive Order No. 201 took effect in July 2016. This legislation ensured comparability of wages in government particularly management level positions with prevailing rates in the private sector. This new adjustment in wages will take effect in stages through 2019. Another important wage legislation is the Domestic Workers Act or Kasambahay Law, which regulates wages given to household employees and enforces the provision of social and other benefits. Wages of those working in private households have grown on average by 4.2 percent annually since the law was passed in January 2013. Philippines ECONOMIC UPDATE • October 2017 23 I. Recent Economic and Policy Developments Figure 27: Changes in real daily wages from 2007-2017 500 450 462 399 400 Pesos (in 2006 prices) 350 300 250 224 201 200 223 202 159 150 147 100 50 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Overall Private Establishment Public Family worker in Family Business Source: Labor Force Survey, PSA Between 2007 and 2017, median wages in the 25. Higher wage income, particularly public sector grew by 1.6 percent, year-on-year, for households in the bottom 40 percent, and there were significant increases in public constituted the main driver of recent poverty sector wages between 2010 and 2015. However, alleviation. The national poverty rate dropped wages in the public sector declined by 3 percent, from 25.2 percent in 2012 to 21.6 percent in year-on-year, in the first half of 2017. Private 2015. Transfers from the government’s social sector wages were mostly flat between 2007 programs, which increased from 0.1 percent in and 2014, before starting to move upwards in 2006 to 3.8 percent in 2015, have contributed to the beginning of 2015. In the first half of 2017, the faster pace of poverty reduction recent years. wages in the private sector increased by 4.0 percent, year-on-year. Box 9 Increasing wage employment and household wage incomes Wage employment is becoming more common in the Philippines, accounting for more than half of the country’s total workforce. In the first half of 2017, 57.1 percent of both public and private sector workers held wage jobs, up from 56.7 percent in the first half of 2016 (Figure 28). Public sector jobs constituted only 7.8 percent of wage jobs, and this share remained roughly constant in the past decade. As a result, Figure 28: Distribution of type of worker the growing share of wage jobs is due to 60 employment growth in the private sector. While the number of wage jobs has increased in the 50 agricultural and services sectors, the industrial 40 sector has seen the most rapid growth in wage Percent employment. Industrial wage jobs grew by 63 30 percent between 2007 and 2017, from the 4.1 20 million wage jobs in 2007 to 6.7 million jobs in April 2017. There has also been a decline in the 10 share of unpaid family workers to 6.7 percent 0 of the total employed in April 2017. Moreover, 2007 Wage (private and public) 2010 Self-employed 2017 the share of workers who are self-employed Unpaid family worker Employer in own business Wage (private HH and family worker) declined from 30.5 percent in April 2007 to 27.2 percent in April 2017. Source: Labor Force Survey April rounds, PSA 24 Philippines ECONOMIC UPDATE • October 2017 I. Recent Economic and Policy Developments The share of wages in household income Figure 29: Wage earners in private establishments increased from 44.8 percent in 2006 to 47.4 by sector percent in 2015 (Figure 29).51 The share of 10 non-agricultural wages constituted the biggest 9 change and increased from 41.9 percent in 8 2006 to 44.4 percent in 2015. The shift to 7 non-agricultural wage income was particularly 6 noticeable among households in the bottom Millions 5 40 percent of the population. 27.5 percent of 4 the income in these households came from 3 non-agricultural wages in 2015, up from 21.3 2 percent in 2006 (Figure 30). This shift away 1 from agricultural income has made domestic 0 2007 2010 2017 remittances more important for households Agriculture Industry Services in the bottom 40 percent, which constituted 8.5 percent of their income in 2015, up from Source: Labor Force Survey April rounds, PSA 6.7 percent in 2006 (Figure 31).52 Figure 30: Household income sources of Figure 31: Household income sources of all households the bottom 40 percent Non-ag wage Non-ag wage Others Others Non-ag enterprise Non-ag enterprise Foreign remittances Foreign remittances Ag enterprise Ag enterprise Domestic remittances Domestic remittances Ag wage Ag wage Gov't. transfers Gov't. transfers 0 5 10 15 20 25 30 35 40 45 50 0 5 10 15 20 25 30 35 40 45 50 Percent Percent 2015 2006 2015 2006 Source: 2006 and 2015 Family Income and Expenditure Survey Source: 2006 and 2015 Family Income and Expenditure Survey Note: Others include rental value of owner-occupied dwelling, Note: Others include rental value of owner-occupied dwelling, pensions, other agriculture related sources pensions, other agriculture related sources 51 2015 Family Income and Expenditure Survey. 52 The share of income coming from agriculture enterprises for the bottom 40 percent fell sharply, from 25 percent in 2006 to 15.2 percent in 2015. Philippines ECONOMIC UPDATE • October 2017 25 Part II: Outlook and Risks The Philippine economy is projected to expand by 6.6 percent, year-on-year, in 2017, before growing by 6.7 percent, year-on-year, in 2018 and 2019. Investment growth has been moderating partly because of a slower than envisioned implementation of the government’s infrastructure program, softening the growth prospects for 2017. However, the medium-term growth outlook remains positive, as stronger expected growth in the Philippines’ main trading partners would lead to higher external demand. Imports are expected to remain elevated due to a high demand of intermediate and capital goods. As the public infrastructure program gains traction, capital outlays and construction activities are expected to rise. Consumption growth is expected to remain firm, contingent on sustained remittances and expanding credit to households. The local elections in 2019 will likely boost domestic activities as early as the second half of 2018. The rate of Filipinos living on less than US$3.20-a-day is projected to decline to 22.9 percent in 2018. The pace of poverty reduction may drop slightly in the face of lower overall economic growth, but the poverty rate is expected to continue to fall as the economy continues its structural transformation. Short-term risks to the country outlook include increased trade protectionism, the possibility of financial market disruptions, and elevated economic policy uncertainty. Weaker potential growth remains the main long-term risk to the Philippines. An expansionary fiscal policy could help support growth in the short term as long as it is consistent with medium-term fiscal sustainability. Philippines ECONOMIC UPDATE • October 2017 27 II. Outlook and Risks 2.1 Growth Outlook The economy is projected to grow at a slower pace in 2017 compared to 2016. Fiscal and monetary policies are likely to remain accommodative to growing the economy, and recovering exports and strong consumption growth are expected to boost economic growth. Higher investment growth could push the country’s growth rate towards the upper end of the government’s target of 6.5 to 7.5 percent of GDP, but this is contingent on whether or not the public infrastructure program gains full traction. 26. The Philippines’ medium-term growth are expected to boost investment growth as the trajectory remains positive, but the growth rate government speeds up the implementation of for 2017 is likely to end up at the lower end of its infrastructure program. The local elections the government’s target of 6.5-7.5 percent of in 2019 will likely lead to increased domestic GDP. The economy is projected to expand by 6.6 activities as early as the second half of 2018. percent, year-on-year, in 2017 and 6.7 percent, year-on-year, in 2018 and 2019 (Figure 32). This 27. The growth in global trade is expected to projection reflects a downward revision from the rebound from a post crisis low of 2.5 percent in 2017 and 2018 forecasts of 6.8 and 6.9 percent, 2016 to 4.0 percent in 2017 despite rising trade respectively, in the July 2017 edition of the policy uncertainty (Box 10). The recovery in Philippines Monthly Economic Development. global trade, which began in the second half of However, the growth outlook remains positive 2016, has been supported by stronger industrial and exports are projected to grow at a robust activity. Since the slowdown in the growth of rate as stronger growth is expected in the global investments was an important factor Philippines’ main trading partners. Imports are behind the deceleration of global goods trade, expected to remain elevated due to high demand the increase in international investment flows for intermediate and capital goods. Moreover, may improve global trade in 2017.53 Chinese a steady consumption growth is projected to exports have benefited from the recovery, provide the main base for economic growth, resulting in increased demand for intermediate sustained by an increase in remittances, an products across regional and global value chains, expansion of credit, and improved income levels. including the Philippines. Moreover, the trade Higher capital outlays and construction activities in services, both globally and in the Philippines, demonstrated resilience throughout 2016, Figure 32: The growth trajectory is positive but lower supported by robust global consumer spending, than expected particularly in major advanced economies. The 9 Forecast ongoing recovery in the goods trade may also 8 7.6 6.9 6.8 6.96.8 boost services exports, which could benefit the 7 6.6 6.7 7.1 Philippines as they are less volatile and pro- 6.1 6.1 6.6 6.76.7 6 cyclical than goods exports.54 5.2 Percent 5 4.2 4 3.7 28. An improvement in the external 3 environment is expected to benefit the 2 Philippine economy. This constitutes one driving 1 1.1 assumption behind the World Bank’s projection. 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Global economic activity is projected to accelerate New forecast Old forecast (July 2017) Actual growth in 2017 and 2018 and firm in the medium term. Source: PSA, World Bank staff estimates The Philippines’ main trading partners among advanced economies demonstrated solid 53 Freund 2016; Boz et al. 2015; Bussiere et al. 2013; World Bank 2015a. 54 Borchert and Mattoo 2009; Ariu 2016; World Bank 2016b. 28 Philippines ECONOMIC UPDATE • October 2017 II. Outlook and Risks economic performance in the beginning of 2017, broadly stable in the Euro Area. Economic resulting in increased demand for Philippine forecasts for several major economies have also exports. Economic growth is expected to pick been upgraded.55 up in the United States and Japan and remain Box 10 The global economic outlook Despite substantial policy uncertainty, global growth is projected to accelerate in 2017-2019. The rate of global economic growth is projected to increase from a post-crisis low of 2.4 percent, year-on-year, in 2016 to 2.7 and 2.9 percent, year-on-year, in 2017 and 2018-19, respectively (Table 4). The short-term outlook for advanced economies has generally improved due to firming business and investment activities despite elevated policy uncertainty in the United States and the Euro Area. In 2017, advanced economies are projected to grow by 1.9 percent, year-on- year, before moderating to 1.8 and 1.7 percent, year-on-year, in 2018 and 2019, respectively. In emerging-market and developing economies, annual growth is predicted to reach an average of 4.1 percent in 2017 and 4.6 percent in 2018-19 (Figure 33). Obstacles to growth for commodity exporters have diminished while activity in commodity importers continue to be robust. Global trade growth is expected to recover at a robust pace in 2017. It is expected to rebound from 2.5 percent, year-on-year, in 2016 to 4.0 percent, year-on-year, in 2017, its fastest pace since 2010 (Figure 34). This growth is aligned with the global recovery in manufacturing activity and coincided with the bottoming out of global investments. It is supported by stronger import demand from major advanced economies, increased trade flows to and from China, and a diminished drag from weak import demand from commodity-exporting emerging-market and developing economies. Policy-induced infrastructure spending, specifically in China, will continue to support demand for industrial commodities, benefiting countries that export raw materials. The services trade will remain resilient and play a stabilizing role since it is less volatile and pro-cyclical than the goods trade. Nevertheless, trade growth will continue to be held back by structural impediments, such as maturing global value chains and a slower pace of trade liberalization. Figure 33: Global growth is expected to strengthen Figure 34: Global trade is expected to rebound in 2017-2019 in 2017 5 15 32 12 30 4 9 6 28 3 Percent Percent 3 Percent 26 0 2 -3 24 -6 1 22 -9 0 -12 20 2012 2013 2014 2015 2016 2017 2018 2019 2000 2002 2004 2006 2008 2010 2012 2014 20162017 World Advanced economies EMDEs Growth Share of GDP (RHS) Source: GEP June 2017 Source: GEP June 2017 55 Collectively, advanced economies in the Euro Area are expected to grow by 1.7 percent in 2017, while Japan is projected to grow by 1.5 percent in 2017, 0.2 and 0.6 percentage points higher than their respective forecasts from the January round of the 2017 Global Economic Prospects. Philippines ECONOMIC UPDATE • October 2017 29 II. Outlook and Risks There are downside risks to the global economic outlook. Risks such as trade protectionism and potential financial market disruptions dominate the outlook despite the possibility of more expansionary fiscal policies in advanced economies. A number of factors weigh on the long-term growth prospects of emerging-market and developing economies, including structural headwinds to global trade, worsening demographics, slowing productivity growth, and governance and institutional challenges. Moreover, even if the expected modest rebound in investment across emerging-market and developing economies materializes, slowing capital accumulation in recent years may already have reduced potential growth. Over the long term, structural policies that support investment and trade are critical to boost productivity and potential growth. Emerging-market and developing economies will need to continue to pursue structural reforms to improve their long-term growth prospects, diversify their economies, and develop domestic as well as foreign markets. These include policies to improve the business climate, support investment in human and physical capital, and enhance regional and global trade integration. Central banks in advanced economies will gradually normalize monetary policy as inflation increases and economic slack diminishes. While the U.S. tightening cycle is well ahead of other major advanced economies, it is proceeding at a substantially slower pace than in the past. Table 4: Real GDP growth rates, recent and projected 2014 2015 2016e 2017p 2018p 2019p World 2.8 2.7 2.4 2.7 2.9 2.9 Advanced economies 1.9 2.1 1.7 1.9 1.8 1.7 Emerging market and developing economies 4.3 3.6 3.5 4.1 4.5 4.7 Developing East Asia & Pacific 4.3 3.6 3.5 4.1 4.5 4.7 Philippines 6.1 6.1 6.9 6.6 6.7 6.7 Source: World Bank (2017b) Note: Developing East Asia & Pacific includes Cambodia, China, Fiji, Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea, Philippines, Solomon Islands, Thailand, Timor-Leste, and Vietnam. 29. The fiscal policy assumption of the estimated 6.3 percent of GDP in 2018. Moreover, World Bank’s projection is a continued infrastructure spending for the next four years is expansionary path. However, purposeful budget set to increase by an average of 14.8 percent, year- execution will require addressing important on-year, to reach Php1.9 trillion or an estimated implementation limitations. The delivery of large 7.4 percent of GDP in 2022. The government will new infrastructure projects had been slow in the need to ensure prudent spending, efficiency, and recent past. The government plans to primarily careful debt management if it is to deliver on its finance the development and implementation ambitious infrastructure targets. of infrastructure initiatives while contracting out operations and maintenance activities to 30. The implementation of the government’s the private sector. The implementation of the investment program is expected to be slower public infrastructure plan is expected to intensify than outlined in the medium-term budget over the next five years. To accomplish this, proposal. In the first half of 2017, the government the government has proposed to increase the was able to execute its programmed budget, national budget in 2018 by 12.4 percent, year-on- focusing on road repairs, irrigation projects, year, to Php3.8 trillion, up from Php3.4 trillion in school construction, and military equipment. 2017 (Box 8). The proposed infrastructure budget However, there was a slower than envisioned is programmed to increase by 27.9 percent, start in the implementation of large-scale year-on-year, to reach Php1.1 trillion or an public infrastructure projects, which are key to 30 Philippines ECONOMIC UPDATE • October 2017 II. Outlook and Risks the government’s Build, Build, Build agenda. barrel in 2016 to US$52.0 and US$54.0 per barrel As a result, the projected spending increase in 2017 and 2018, respectively.58 There may be in the World Bank forecast is lower than in the a need to manage inflation expectations, as medium-term budget proposal, and the fiscal the public investment push is expected to spur deficit is estimated at 2.4 and 2.5 percent of domestic demand, leading to higher inflation in GDP in 2017 and 2018, respectively. Faster the second half of 2018 and into 2019. However, economic growth is projected to bring down the central bank is expected to maintain its the debt-to-GDP ratio from 41.8 percent in current policy stance as the projected inflation 2017 to 41.2 percent in 2018.56 Going forward, rates remain within its target range. long-standing implementation constraints are likely to impact the administration’s investment 32. The Philippines’ medium-term growth plans.57 The government needs to improve outlook is anticipated to be boosted by stronger project planning and the implementation cycle growth in external demand. The growth in to resolve bottlenecks in the project approval net exports is expected to recover in 2017, but process and ensure that large expenditure import growth is projected to outpace export increases translate into productive investments. growth as an increase in infrastructure spending Furthermore, a successful and timely passage of would raise the demand for intermediate and the administration’s tax policy reform packages capital goods. Global trade growth is expected and the budget management reforms will be to rebound to 4.0 percent, year-on-year, in 2017, needed to guarantee sustainable financing of its fastest pace since 2010. An improvement in planned infrastructure investments. the external environment is expected to benefit Philippine exports, supported by stronger import 31. Monetary policy is expected to remain demand from its major trading partners, such accommodative, with the central bank’s as China, the United States, Japan, and the target average annual inflation rate remaining European Union. BPO services are expected between 2 and 4 percent in the medium term. to drive services exports. Meanwhile, import The inflation rate is projected to rise from an growth is likely to strengthen as rising domestic average of 1.8 percent in 2016 to 3.0 percent in incomes would lead to greater demand for 2017, before slowing to 2.6 percent in 2018 and imported consumer goods. The government’s settling at 2.8 percent in 2019. These projections infrastructure investment push is also projected are in line with those of the central bank which to lead to greater demand for capital goods. estimate the inflation rate to settle near the midpoint of the its target range of 3.0 percent 33. The current account is expected to remain +/- 1.0 percentage point in 2017 to 2019. After in deficit over medium term, partly owing to a the headline inflation rate reached an average of larger trade deficit. The current account deficit 3.1 percent in the first eight months of 2017, high is projected to grow from 0.2 percent of GDP base effects are expected to temper inflation in in 2017 to 0.3 and 0.5 percent of GDP in 2018 the remaining four months of 2017. High base and 2019, respectively. This is consistent with effects are also likely to spill over into 2018 and an expected increase in investments alongside moderate inflation rates despite an anticipated the government’s infrastructure investment rise in energy prices. The benchmark crude oil push. The share of capital goods increased from price is projected to recover from US$42.8 per about a quarter of total imports before 2016 56 The government’s planned budget deficits are 3.0 percent in 2017-2020. The debt-to-GDP forecast is 40.6 percent for 2017, 40.5 percent for 2018, and 39.8 percent for 2019. 57 Procurement issues and implementation bottlenecks, which delay and complicate the administration’s delivery of its public investment program, include bidding failures, legal challenges brought by losing parties, difficulties in securing permits, clearances and right-of-way issues, and contractors’ non-compliance or submission delays of documentary requirements. See Fiscal Risks Statement 2017 (DBM). 58 Meanwhile, international price for key food item particularly rice is expected to drop from US$396/mt in 2016 to US$385/mt in 2017 then rise to US$389/mt in 2018. Price for wheat is also expected to drop from US$167/mt to US$150/mt in 2017 and US$156/mt in 2018. World Bank commodities prices forecast, April 2017. Philippines ECONOMIC UPDATE • October 2017 31 II. Outlook and Risks to a third in 2016. This is expected to rise even average of 5.9 percent annually between 2011 further in the coming years as the government’s and 2015 to 6.0 percent in 2017, before rising to infrastructure investment plans gain traction. An 6.1 and 6.3 percent in 2018 and 2019, respectively increase in capital accumulation is expected to (Table 5). This follows a 7.0 percent, year-on- enhance the economy’s production capacity and year, growth rate in 2016, which was spurred by lay the foundation for future economic growth. election year stimulus spending. The Philippine economy has historically been consumption- 34. The Philippines’ medium-term growth driven, with household consumption representing outlook depends on the country’s level of roughly two-third of total expenditures, and investment growth. While the growth of private consumption is expected to remain the main investments is projected to remain robust, the base of growth in the medium term. The prospect growth level will depend on the public investment of strong consumption growth in the medium program gaining traction and the government’s term is supported by a number of factors. First, ability to remove bottlenecks in the infrastructure income levels in the Philippines are gradually project planning and implementation increasing as more people move into wage jobs process. However, the implementation of the and employment conditions improve. Second, government’s infrastructure program was slower the number of middle-income households, which than expected during the first half of 2017, have a higher propensity to consume, is gradually contributing to moderate fixed capital-formation growing because of sustained economic growth growth and a softening of growth prospects for and changing demographics. Finally, the flow the year. The World Bank’s projection assumes a of remittances appears to be resilient and is more gradual acceleration in the implementation expected to remain around current levels in the of the public investment plan, which is expected coming years. to lead to 12.2 percent, year-on-year, growth of fixed capital formation in 2017. Gross fixed capital 36. The services sector is projected to sustain formation is projected to grow from 12.2 percent, its recent expansion and remain the main year-on-year, in 2017 to 14.7 and 16.1 percent, driver of output growth. The sector is projected year-on-year, in 2018 and 2019, respectively. to grow at 6.8 percent, year-on-year, in 2017 and 7.0 percent, year-on-year, in 2018-2019. 35. Following exceptional growth in 2016, An expanding economy, coupled with a rising private consumption growth is expected to middle-income class and strong remittance moderate around its five-year average in the receipts from overseas Filipinos, is expected to next couple of years. Household consumption drive strong demand for real estate properties is expected to grow only moderately from an and financial services. The finance and insurance Table 5: Economic indicators for baseline projection 2014 2015 2016e 2017p 2018p 2019p Real GDP growth, at constant market prices 6.1 6.1 6.9 6.6 6.7 6.7 Private consumption 5.6 6.3 7.0 6.0 6.1 6.3 Government consumption 3.3 7.6 8.4 3.8 6.0 8.7 Gross fixed capital investment 7.2 16.9 25.2 12.2 14.7 16.1 Exports, goods and services 12.6 8.5 10.7 17.1 12.2 12.4 Imports, goods and services 9.9 14.6 18.5 17.0 14.3 15.5 Inflation (period average) 4.1 1.4 2.0 3.0 2.6 2.8 National government balance (% of GDP) -0.6 -0.9 -2.4 -2.4 -2.5 -2.8 National government debt (% of GDP) 45.4 44.8 42.6 41.8 41.2 40.8 Current account balance 3.8 2.5 0.2 -0.2 -0.3 -0.5 Source: PSA, BSP, BTr, World Bank Staff estimates 32 Philippines ECONOMIC UPDATE • October 2017 II. Outlook and Risks subsector has also been the favorite destination cements, improving the finance for micro, small of foreign direct investments, receiving 57.2 and medium-sized enterprises, and enhancing percent of net foreign direct investments in the market competition, would encourage higher first half of 2017, which is expected to boost investment levels and create more productive services-sector growth in the medium term. capacity and jobs. Meanwhile, credit growth has been generous in the real estate and construction (20.1 percent 38. Growth in the agriculture sector is of total domestic loans in the first seven months projected to recover somewhat in in the of 2017) and the wholesale and retail trade medium term, but the sector remains subsectors (15.2 percent), which is expected to vulnerable to weather-related events. The continue. The information technology (IT) and sector is set to rebound with an expected 4.2 BPO industries continue to enjoy strong growth percent annual growth rate in 2017, primarily prospects with revenues expected to increase due to an improvement in weather conditions60 from US$22.9 billion in 2016 to US$38.9 billion and a low base in 2016. Agricultural growth in in 2022, overtaking remittances as a major succeeding years is expected to moderate, as source of dollar receipts.59 the Philippines has yet to address longstanding structural weaknesses in the agricultural sector, 37. Manufacturing activities are projected to particularly in Mindanao. remain robust in the short term, but investment is needed in the medium term to expand 39. Decades of underinvestment and a long production capacity. The Volume of Production history of policy distortions have depressed Index for manufacturing has sustained its growth in agricultural productivity.61 These growth since mid-2015 while the PMI remained structural weaknesses are most apparent in expansion territory in the first eight months in Mindanao, the agricultural basket of the of 2017 but has weakened since May (Box 2). country, which produces more than a third Factory activities can likely be sustained in the of the Philippines’ total agricultural output. short run, although capacity utilization inched Despite possessing a comparative advantage up to 83.8 percent in July 2017, slightly up in agriculture,62 the Philippines has so far been from 83.5 percent a year ago. Even though unable to unlock the sector’s full potential, as low investment in durable equipment to support agricultural productivity among smallholders manufacturing is increasing, only a third of reflects a number of well-known policy, these investments have been for general and investment, and institutional deficits, which specialized machineries, leaving room for more tend to be magnified in Mindanao. As a result, investment. Efforts to create a more business- implementing a successful regional development friendly environment, such as implementing strategy for Mindanao is key to unlocking the business-friendly reforms, revisiting the potential of the country’s agricultural sector and negative investment list, reducing tariffs on key ensuring its transition into a sector marked by manufacturing inputs such as chemicals and high productivity and low vulnerability.63 59 IT and Business Process Association of the Philippines (2016). 60 Weather conditions in 2017 will generally be milder compared with conditions during the past two years. The state weather bureau reported that there was a bleak chance for the occurrence of rain-driving La Niña in 2017, while the El Niño phenomenon has already dissipated in mid-2016 after impacting the country from late 2015 to early-2016. The country will still be visited by seasonal typhoons that may impact farm outputs. 61 Examples include protectionist policies, such as the rice self-sufficiency policy, large subsidies for inputs, and distortions in institutions that prevent broad and secure access to land by small landholders. 62 Mindanao is blessed with good agro-climatic conditions, as most of its provinces lie below the typhoon belt and has rich natural resources, such as i) fertile soil and wide range of elevation suitable for a variety of crops, ii) large deposits of minerals such as gold, copper, and nickel, iii) extensive forests, albeit of secondary growth, and iv) vast marine wealth. 63 For a more detailed discussion on the development challenges faced in Mindanao and how to unlock its potential, please refer to Part III: Unlocking Mindanao’s Potential, which draws from the World Bank (2017c) Philippines Mindanao Jobs Report: A Strategy for Mindanao Regional Development. Philippines ECONOMIC UPDATE • October 2017 33 II. Outlook and Risks 2.2 Poverty and Shared Prosperity Poverty reduction will likely continue as the country’s growth outlook remains positive and inclusive growth policies are pursued. 40. Sustained economic growth increases the total employment decreased from about 37.0 likelihood that poverty reduction has continued percent in 2006 to 25.2 percent in July 2017, while since 2015. The World Bank tracks poverty rates the share of the services sector rose from about in the Philippines using an international poverty 49.0 to 55.4 percent during the same period. The line which is equivalent to US$3.20-a-day in gradual transition of workers from agriculture purchasing power parity terms.64 Using this to more productive sectors is expected to measure, the poverty rate for the Philippines is contribute to poverty reduction, as even lower- projected to have dropped from 27.0 percent in end industry and services jobs pay more than 2015 to 24.2 percent in 2017, implying that around agriculture jobs.66 Nevertheless, there is a need 1.0 million Filipinos exited poverty each year since to improve the productivity of the agricultural 2015. The projection is based on the Philippines’ sector which is only one sixth of the productivity growth forecast under the assumption that the of the industry sector. Agriculture is central for responsiveness of the poverty rate to economic the country to achieve inclusive growth, as the growth follows the observed historical average.65 sector employs a disproportionate share of the As economic growth remains robust in the short poor, and its output has a significant influence on term, the poverty rate is projected to decline food prices which heavily impacts the poor. further to 22.9 percent in 2018 (Figure 35). 42. Government investment policies and a Figure 35: Actual and projected poverty rates using public commitment to the inclusive growth the US$3.20-a-day poverty line agenda are expected to have a decisive impact on 45.0 poverty. The Philippine conditional cash transfer Forecast 40.0 38.4 program (Pantawid Pamilyang Pilipino), which 35.0 34.3 33.6 reaches one-fifth of the population, increases 30.0 27.0 the income necessary for beneficiaries to afford 25.6 basic needs and helped reduce the income Percent 25.0 24.2 22.9 21.7 20.0 gap of beneficiaries by up to 6.0 percentage 15.0 points in 2015.67 Improving the conditional cash 10.0 transfer program and other social assistance 5.0 programs would shore-up consumption among 0.0 2006 2009 2012 2015 2016 2017 2018 2019 poor households and promote greater human US$3.20 Poverty Incidence US$3.20 World Bank Poverty forecast capital accumulation to improve long-term economic prospects. Aside from social sector Source: PSA, World Bank staff estimates spending, the government is pursuing a large infrastructure agenda, which is expected to 41. Progress in the economy’s structural boost poverty reduction in the medium term transformation is expected to contribute to by generating employment opportunities in the poverty alleviation. The share of agriculture in construction sector. 64 This is the median of the national poverty lines among lower middle-income countries which is slightly higher than the Philippines’ national poverty line. 65 Specifically, it is assumed that the elasticity of GDP per capita with poverty reduction is equal to the average value observed over the period 2006-15. 66 Philippines Poverty Assessment, forthcoming. 67 Based on an assessment made on 2015 Family Income and Expenditure Survey data. More information in the Philippines Poverty Assessment, forthcoming. 34 Philippines ECONOMIC UPDATE • October 2017 II. Outlook and Risks 2.3 Risks and Policy Challenges Both external and domestic risks to the country outlook remain substantial and are increasing. Policymakers face the challenge of confronting downside risks while fostering long-term growth. 43. External risks remain prominent while normalization of policy rates in advanced domestic challenges are growing. The ongoing economies constitutes the most significant U.S. Federal Reserve rate hikes could result in external risk to the Philippines. A further increase new episodes of peso depreciation and capital in U.S. yields, driven by a sudden reassessment outflows from the Philippines, increasing of U.S. monetary policy expectations, could lead volatility in the foreign exchange market. Rising to renewed tightening of financing conditions. protectionism in some advanced economies also The higher interest rate environment risks raising constitutes a risk that could impact the country the country’s borrowing costs at a time when the through lower levels of remittances and trade. government is also considering sourcing foreign Domestic challenges include a slower than funds to finance its infrastructure program. envisioned implementation of the government’s Both expectations of and actual Federal Reserve infrastructure investment plan. As infrastructure interest rate hikes may lead to higher portfolio spending increases, there is also a growing need outflows from emerging markets, including to more prudently manage public finances and the Philippines, as U.S. assets become more preserve fiscal sustainability, including improving attractive. This will insert more volatility in the the revenue administration and collection. foreign exchange market and could lead to a Despite these risks, the administration is coming further depreciation of the peso. In July, the from a position of strength as macroeconomic central bank reportedly smoothened the volatile fundamentals remain intact. However, both the exchange rate market by using foreign-exchange fiscal and monetary space to address external reserves. A depreciating peso has the unwanted and domestic risks can quickly diminish and limit effect of an inflationary pass-through, as some the government’s policy options to mitigate those major commodities, such as rice, wheat, animal risks (Figure 36). feeds, and fertilizers, are partially imported. Figure 36: Macroeconomic fundamentals remain intact 45. Potential protectionism in some advanced Selected macroeconomics indicators economies raises concerns over a retreat from 70 120 an open world economy, which could impact the 60 100 Philippines through lower trade and remittances. 50 80 Protectionist sentiments in the United States Billions US$ 40 and elsewhere have not yet translated into Percent 60 30 actual policies that directly impact the Philippine 40 20 economy. However, American protectionist 10 20 measures can likely lead to lower levels of trade 0 0 and remittances, especially since the United International Per capita Cash reserves growth remittance Inflation rate Debt Public (percent expenditure States is the primary source of remittance (US$ billion, (percent of GDP) (percent of RHA) of GDP) GDP) inflows to the Philippines, accounting for 1990-99 2000-09 2010-17H1 more than a third of cash remittances (Box 6). Source: BSP, PSA, World Bank staff estimates Meanwhile, a slowdown in global trade may directly or indirectly affect the Philippines’ 44. Expectations of international interest export of commodities, such as electronics rate tightening may lead to an acceleration of and semiconductors, because of the country’s capital outflows and renewed volatility in the linkages with the global value chain. foreign exchange market. A faster-than-expected Philippines ECONOMIC UPDATE • October 2017 35 II. Outlook and Risks 46. Passing reforms related to public financial country’s solid macroeconomic fundamentals. management and the budget process are The first package of the government’s tax reform crucial to ensure the timely and successful program was successfully passed in the House of implementation of the infrastructure agenda. Representatives on its third and final reading on As the medium-term growth prospect hinges on May 31, 2017. The Senate of the Philippines is the infrastructure investment program, failure to currently conducting its own set of deliberations address implementation and delivery bottlenecks on its own version of the bill, which is expected to may result in lower infrastructure spending.68 If last until October 2017. Should the first package constraints are successfully removed, growth of tax reforms pass before the end of the regular could be potentially pushed towards the session of congress in 2017, implementation of upper end of the government target of 6.5-7.5 the new tax policy is scheduled to start in 2018. percent. Progress is being made to fully use The Department of Finance estimates an increase the programmed budget, but the government in revenue by Php119.4 billion (0.7 percent of needs to ensure that recent achievements GDP) in its first year of implementation, while are sustained. House Bill 5590 or the Budget preliminary estimates on the Senate version of Reform Bill, which the administration hopes the bill are estimated at least Php59.9 billion (0.3 will pass before year end, aims to strengthen percent of GDP), a downward revision from an government accountability for the use of public earlier version of the bill which had estimated funds through greater transparency and more additional revenues of Php157.2 billion (0.9 efficient public financial management. The bill percent of GDP). is expected to increase actual spending through new schemes that include a shift from obligation- 48. Commitment to the government’s policy to cash-based budgeting, shortening the validity goals of achieving stable inflation, fiscal stability, of appropriations from two years to one, the and security and rule of law will help preserve introduction of an extended payment period, consumer and business confidence. Maintaining and the establishment of a unified accounts code positive consumer and business sentiments structure. There are also plans to create an Office will support growth in both consumption and of Comptroller General, with internal auditing private investment, which are expected to be the duties, under the Office of the President to speed primary growth drivers of the Philippine economy up assessments and compliance.69 in the medium term. For Filipino consumers, it will be important that inflation remains at 47. The successful passage of the moderate levels. This will warrant careful inflation government’s tax reform package will help to management by the central bank authorities ensure the sustainability of the government’s to anchor expectations. There are a number of fiscal balance. An expansionary fiscal policy in the emerging key risks to inflation in the near term, medium term, including growing public sector stemming from exchange-rate volatility, the price wages, will continue to put pressure on public effects of the government’s tax reform policy, finances and overall fiscal health if the level of and demand-side pressures from an increase government revenues remains unchanged. The in infrastructure spending. The successful and timely passage of the government’s tax reform timely implementation of the government’s fiscal package is necessary to ensure the sustainability program, including its ambitious infrastructure of the government’s fiscal accounts in the plan and efforts to generate more revenue medium term, which is a key component of the (including the passage of the first package of 68 In previous years, ambitious increases in the government’s budget resulted in underspending, as fundamental issues in budget execution were not addressed. Structural weaknesses within key departments and agencies, such as poor planning, weak program and project design, and procurement difficulties, prevented the government from fully executing its programmed budget. From 2011 to 2015, actual disbursements by the national government fell short by around 10 percent per year despite the ample fiscal space afforded to the national government (Monsod, 2016). 69 See House Bill no. 5590, An Act to Reform the Budget Process by Enforcing Greater Accountability in Public Financial Management (PFM), Promoting Fiscal Sustainability, Strengthening Congress’ Power of the Purse, Instituting an Integrated PFM System, and Increasing Budget Transparency and Participation, and for Other Purposes. 36 Philippines ECONOMIC UPDATE • October 2017 II. Outlook and Risks the tax reform program), would signal a strong potential risks should also be a policy priority. commitment to the government’s policy priorities. Continued macroeconomic improvements in the Key issues facing the country, such as mining Philippines provide a window of opportunity to regulations (Box 3), the government’s response to address underlying vulnerabilities and long-term the ongoing conflict in Marawi City (Box 11), and structural issues. Over the longer term, structural regional development in Mindanao, will require policies that support investment and trade are policy certainty to preserve both external and critical to boost productivity and economic growth. domestic confidence in the Philippine economy. This will require the government’s commitment to reforms that promote competition in key 49. Policymakers face the challenge of sectors, secure property rights, lessen regulatory confronting downside risks while fostering long- complexities, and improve doing business in the term growth. The short-term risks to the country country. Other long-term policy priorities include outlook include increased trade protectionism, training and job-search programs and other the possibility of financial market disruptions, measures to support workers most affected and elevated economic policy uncertainty. In the by sectoral shifts in employment and share the longer term, weaker potential growth remains dividends of growth and gains from globalization the main risk. An expansionary fiscal policy more widely. Sustained investment in human could support short-term growth as long as it is capital development and in sectors that create consistent with medium-term fiscal sustainability. quality employment are needed to safeguard the Securing monetary and fiscal space to deal with country’s progress on delivering inclusiveness. Box 11 The Marawi city crisis Marawi City, a relatively small city in the Autonomous Region in Muslim Mindanao (ARMM), is an important economic and cultural hub in the region. Although Mindanao is an important part of the Philippine economy, Marawi City and the province of Lanao del Sur make up a relatively small share of Mindanao’s formal economy. The ARMM region, which Lanao del Sur is a part of, constitutes only 0.7 percent of the Philippines’ GDP and 4.8 percent of Mindanao’s GDP. Meanwhile, Marawi City is the least economically vibrant city in Mindanao.70 It ranks last in terms of taxes on business income among the 33 cities in Mindanao, as taxes on business revenue amounted to only Php0.5 million or 0.01 percent of business tax revenue among cities in Mindanao. Given the limited scope of Marawi City’s economy, it has a small direct impact on the Philippines’ formal economy. However, the city still plays an important role in the region as the economic hub of Lanao del Sur and as a cultural hub in Mindanao. It is strategically located in the region due to its proximity to Lake Lanao, as a center of trade and commercial activities to nearby towns and municipalities, and hosts the Agus 1 and Agus 2 hydro-power plants. Marawi City and Lanao del Sur are also important gateways to the provinces and cities of the Northern Mindanao region, providing an important link to the transport and flow of goods throughout Mindanao. Although the direct impact of this conflict on the country’s formal economy may be limited, the social development impact on the citizens of Marawi and nearby areas is more severe. Mindanao has some of the highest poverty rates in the entire Philippines, especially in conflict- affected areas, and the province of Lanao del Sur had the highest poverty incidence among provinces in the Philippines at 71.9 percent in 2015. Marawi City itself had a poverty incidence of around 60 percent in 2012. The ongoing conflict has resulted in the displacement of nearly 400,000 citizens from Marawi71 and caused significant damage to local infrastructure, agricultural 70 Measured by using total business tax revenue in 2016 as proxy for city income. Source: Bureau of Local Government Finance. 71 Source: http://www.gmanetwork.com/news/news/nation/616565/marawi-fighting-displaces-nearly-400-000/story/ Philippines ECONOMIC UPDATE • October 2017 37 II. Outlook and Risks resources, and other sources of livelihood for its citizens and nearby towns. In the short term, the continued timely response by the government is needed to ensure that those displaced receive appropriate humanitarian assistance, as internally displaced persons are vulnerable to various health risks. Over the medium term, careful coordination among various government agencies is required to ensure the rehabilitation of Marawi City is successful once the conflict is resolved. In addition, the Marawi conflict brings uncertainty to the completion of the peace process that is expected to end the almost five-decade violent conflict which large parts of Mindanao has suffered. The region’s history of widespread conflict has led to weak economic growth, low job creation, anemic poverty reduction, and a massive displacement of the population. But the Marawi City crisis has different characteristics than the previous conflict. First, it points to a convergence of different terrorist groups. Second, the scale of the disruption is different, with armed terrorist forces occupying an entire city which led to a complete evacuation. Finally, it has potential spillover effects into neighboring areas and brings uncertainty to the completion of the Mindanao peace process, which is likely to adversely affect national consumer and business sentiments. 38 Philippines ECONOMIC UPDATE • October 2017 Part III: UNLOCKING MINDANAO’S POTENTIAL 72 Economic progress in the Philippines will depend on the success of economic development in Mindanao, as it is hard to see how the country can achieve sustained and inclusive growth without progress in this region. Like the rest of the Philippines, the central policy challenge for Mindanao is how to accelerate inclusive growth— the type that creates more and better jobs and reduces poverty. But this is more difficult in Mindanao than in Luzon or the Visayas because of longstanding armed conflict in the region. Although progress has been made in making growth more inclusive, Mindanao still trails the rest of the Philippines in terms of shared prosperity. This is compounded by the weakness of the Mindanao economy, resulting from decades of not only armed conflict but also a narrow growth strategy. This special focus note, which is based on the main findings of the World Bank’s Philippines Mindanao Jobs Report, proposes a comprehensive strategy for unlocking Mindanao’s potential, including interventions in the region that will support sustainable peace and development and job creation. The strategy is built on three main components that aim to (1) raise agricultural productivity and improve farm-to-market connectivity; (2) boost human development; and (3) address drivers of conflict and fragility and strengthen institutions in ARMM and conflict-affected areas. This special focus note was prepared by Birgit Hansl. The analysis is based on a World Bank Report (2017): Mindanao Jobs Report - A Strategy 72 of Mindanao Regional Development with contributions from a large team of World Bank staff based in various GPs and experts from the Philippines, in particular Mindanao. Philippines ECONOMIC UPDATE • October 2017 39 III. Unlocking Mindanao’s Potential 3.1 Introduction 50. Boosting economic development in The report is also unique in that it deals with all of Mindanao is essential for the economic progress Mindanao and looked for ways to grow the entire of the entire Philippines. 37 percent of the regional economy, as most previous research has country’s poor population lives in Mindanao, focused on only conflict-affected areas or specific although the region only represents about 25 economic sectors. Conflict and non-conflict areas percent of the country’s population. As a result, in Mindanao are closely interconnected through reducing poverty in Mindanao will be key to economic trade routes. Because non-conflict reducing it nationally. Moreover, increasing areas and cities serve as consolidation stations agricultural production in Mindanao could for produce from conflict areas, developments reduce food and input prices nationally, improve in the latter have profound implications for the public welfare, and heighten the competitiveness rest of Mindanao and vice versa. Mindanao’s jobs of the Philippines’ agricultural sector since the challenge can only be effectively addressed if the region is considered the country’s agricultural development strategy seamlessly connects conflict food basket (Box 12). Achieving successful and lagging regions to growth poles so that all of economic development in Mindanao will be a Mindanao can benefit. Addressing constraints in major test of the country’s ability to achieve its any area will therefore improve economic activity long-term vision of rapid, sustained, and more and job creation throughout Mindanao. inclusive growth. 53. Jobs and economic opportunities are 51. Resolving the conflicts in Mindanao rests central to stabilize the region and achieve on addressing the root causes of conflict and peace. Conflict affects nearly 60 percent of all providing jobs and economic opportunities as Mindanao’s local government units. Breaking alternatives to violence. There are both economic the cycle of insecurity and reducing the risk of its and political drivers of the conflicts, and attaining recurrence will require a virtuous spiral of restoring a just and lasting peace will require political confidence in collective action and transforming solutions to address the causes of conflict, such institutions so they can provide sustainable as injustice, weak governance, land conflicts, and security, justice, and jobs.74 Jobs offer a stake in discrimination. The peace agreements that have society to groups that might otherwise receive been signed in the past have not been enough more respect and recognition from engaging in to put all of Mindanao on a path to inclusive armed violence rather than lawful activities. growth. Peace can only be secured by addressing the sources of conflict and creating jobs and 54. The World Bank is proposing a strategy economic opportunities. Fostering economic for regional development with concrete policy development is necessary to stabilize the region, recommendations. The three main components as jobs can provide opportunities to those who aim to (1) raise agricultural productivity and have not previously experienced the benefits of improve farm-to-market connectivity; (2) boost economic growth. human development; and (3) address drivers of conflict and fragility and strengthen institutions 52. This special focus note is based on the in ARMM and conflict-affected areas. The World World Bank’s Philippines Mindanao Jobs Report73 Bank engagement in Mindanao will be based which followed an inclusive approach of engaging on this strategy. Policy recommendations are with a broad-based group of stakeholders. The made in four separate categories: (i) increasing goal of the report was to generate ownership agricultural productivity by improving extension among Mindanawons through consultations that and irrigation services along with price reforms were guided by mostly local technical experts. to realize Mindanao’s agriculture potential; 73 World Bank (2017c). See: http://documents.worldbank.org/curated/en/395661498616337079/Philippines-Mindanao-jobs-report-a-strategy-for- Mindanao-regional-development 74 World Bank 2011. 40 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential (ii) building up logistics and transport connectivity by fostering competition; and (iv) supporting by improving road networks and the efficiency private investment by addressing the growing of shipping services to reduce trade costs; (iii) skills gap and the high regulatory burden for improving the supply of reliable power and the businesses and improving financial inclusion speed, affordability, and quality of information and land governance. and communications technology (ICT) services 3.2 The Development Challenge in Mindanao 55. Achieving rapid and sustainable growth Mindanao was as rich as Thailand and richer than in Mindanao constitutes a difficult challenge. both Indonesia and Vietnam until 1980. In 2014, In the region, productivity in agriculture is low per capita GDP in Mindanao was 30 percent of except for a few export crops, manufacturing is Thailand’s, 50 percent of Indonesia’s, and 87 constrained by weak infrastructure, and a low- percent of Vietnam’s. Moreover, the ability of productive and low-skilled services sector has economic growth to generate employment has become the catch basin for excess agriculture declined steadily in the region. Between 1975 workers who cannot find jobs in the cities. and 1996, employment only grew between 1.04 Lack of competition in key sectors, insecure and 1.72 percent for every 1 percent Mindanao’s property rights, complex regulations, severe economy grew. The elasticity in the region also underinvestment in infrastructure, education, fell to 0.43 between 1997 and 2008 and to and health, and weak institutions have led to 0.31 between 2009 and 2014, suggesting that an anomalous growth pattern for Mindanao, higher growth in recent years did not create a resulting in low-quality jobs for the majority of its commensurate number of jobs. population and substantial emigration of many of its talented people. Decades-long conflict has Figure 37: Average annual GDP growth in Mindanao, caused untold human suffering and severely the rest of the Philippines, and neighboring countries, 1975–2014, percent constrained economic growth in conflict-affected areas (about 60 percent of Mindanao’s cities and 7.0 municipalities are directly affected by conflict) 6.0 while reducing confidence and discouraging 5.0 investment throughout Mindanao. 4.0 Percent Slow Economic Growth 3.0 2.0 56. Mindanao has fallen behind the rest of the Philippines. Even though its per capita income 1.0 was once similar to Luzon’s and triple that of the 0 Visayas, Mindanao’s growth rate is now far below s o ia sia am nd s on R ne ya na NC es la ay z tn pi sa da Lu n ai al do ilip e Vi Th in Vi M those of these two island groups. The region’s In M Ph GDP increased by 3.4 percent annually between Source: World Bank, World Development Indicators database 1975 and 2014, compared to 4.1 percent in Luzon, translating into a 30 percent higher growth 57. Slow growth in Mindanao since the late rate for Luzon (Figure 37). By 2014, Mindanao’s 1970s reflects limited technological progress. per capita GDP was only about half that of From 1978 to 2014,76 the contribution of physical Luzon’s. Compared to neighboring countries with and human capital to Mindanao’s growth was a similar comparative advantage in agriculture, comparable to that of Luzon, but growth in output 75 This is the earliest available year with regional GDP data. 76 1977 is the earliest year all data were available. Two years are needed to measure initial capital formation, and 2014 data are the most recent available. Philippines ECONOMIC UPDATE • October 2017 41 III. Unlocking Mindanao’s Potential per worker was minimal and the contribution of (about 460,000) or underemployed (1.9 total factor productivity77 was negative (Table 6). million).79 Moreover, Mindanao’s relatively young Conflict is probably the cause for Mindanao’s population means that an expected 392,000 negative total factor productivity contribution, workers will enter the labor force each year which tends to undermine institutions, the rule between 2016 and 2022, totaling 5.2 million by of law, and incentives to innovate and grow. The 2022. For the region to benefit from the availability number of conflict-related deaths and incidences of its young workers, which is an enormous of negative total factor productivity from 1986 to potential resource that can boost growth, it will 2004 are positively correlated.78 require productive jobs that pay decent wages. Also, enabling workers to transition from the 58. However, Mindanao’s economic informal sector, which currently represents 70 performance has recently started to improve. percent of employment in Mindanao, to formal From 2010 to 2014, the region’s annual growth sector jobs could improve their welfare and rate averaged 6.1 percent of GDP, on a par with increase productivity. Luzon and the Visayas. Key cities in Mindanao, like Davao and Cagayan de Oro, are the region’s 60. The sources of Mindanao’s economic new engines of growth. Similar to the rest of the growth have not generated enough high-quality country, Mindanao’s growth trajectory reflects jobs. Unlike in Luzon and the Visayas,80 which have the increase in investments over the past six more diversified, innovative, and labor-intensive years. It also reflects public policies, such as the economic structures (e.g., higher-value exports, partial liberalization of the cabotage regime, and such as electronics and furniture) and fast-growing resources, such as a tripling of the infrastructure formal services (e.g., IT-BPO), Mindanao’s growth budget, devoted to growing Mindanao’s economy was driven by plantation crops (e.g., rubber, and improving investor confidence. abaca, banana, and pineapple) and forestry, mining, and heavy manufacturing (e.g., steel) The Labor Force: Opportunity and supported by an import substitution program.81 Challenge These capital-intensive sectors required little local processing, resulting in little local 59. There is a considerable and rising demand reinvestment of profits and low local multiplier for quality jobs that can raise real income and effects. Furthermore, infrastructure funds have lift people out of poverty. In 2014, some 2.4 not focused on building the intra-Mindanao million Mindanawons were either unemployed logistics network, which has discouraged intra- Table 6: Growth decomposition, 1978 to 2014 Growth input Contribution to growth per worker Physical capital Human capital TFP Philippines 0.90 0.14 0.29 0.46 Luzon 0.84 0.11 0.29 0.45 Visayas 1.76 0.67 0.34 0.74 Mindanao 0.08 0.13 0.26 -0.31 Sources: PSA, Bureau of Labor and Employment Statistics (BLES), and World Bank staff calculations. Notes: Cumulative growth from 1978-2014 is calculated similar to the method utilized by Bosworth-Collins (2003). 77 Total factor productivity is the residual of growth after accounting for the contributions of capital and labor, adjusted for educational attainment. On average, statistical errors should equal zero so that the negative residual likely reflects a lack of technological and institutional change. 78 Sufficient data are available only for these years. 79 About one in five Mindanao workers would like to work more, but many jobs are only temporary or part-time. 80 The rapid growth in the Visayas is also explained by large investments in the Leyte province under Ferdinand Marcos, whose wife, Imelda, comes from there. 81 Between the 1950s and 1980s, an import substitution policy was implemented to support local manufacturing. In Mindanao, Iligan City was a center of heavy manufacturing (e.g., steel production). 42 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential regional trade. Instead, funds have been used to back into poverty. As a result, a total of 3.7 connect the region’s plantations to its cities and million farmers and fisherfolk lived in or near ultimately to Manila and Cebu. While Mindanao’s poverty, leaving only 0.7 million (16 percent) growth sectors did contribute to high GDP famers and fisherfolk with regular marketable per capita between the 1960s and the 1980s, surplus to generate savings for the next planting they did little to create jobs or reduce poverty. season (Figure 38 and Figure 39). In part, the This growth pattern concentrated power and high poverty rate reflects unequal economic and wealth, which entrenched deep inequalities and political power. When one person or firm controls ultimately contributed to the region’s conflicts, as the land, labor, credit, and product markets, or few benefits reached the Muslim population and any combination thereof,83 that person can drive indigenous peoples. farmers to subsistence by exploiting interlocking markets or even blocking access to markets.84 High Incidence of Poverty Consultations and research undertaken for this study suggest that these practices thrive in 61. The poverty rate is higher in Mindanao Mindanao and lock some farmers and fisherfolk than in Luzon and the Visayas. According to the into a vicious spiral of poverty and indebtedness. 2015 Family Income and Expenditure Survey, 36 percent of the population of Mindanao lived 62. Poverty is highest in conflict-affected below the poverty line, compared to 13.1 percent in Luzon and 28 percent in the Visayas. Poverty areas. At 59 percent, ARMM has the is particularly high in rural Mindanao. In 2012, highest poverty incidence among cities and there were 1.2 million food-poor farmers and municipalities in Mindanao, which was 18 fisherfolk (27 percent of the total) and 1.1 million percentage points higher compared to the (25 percent) living between the food and poverty region as a whole in 2012.85 Municipal poverty thresholds. Another 1.4 million (31 percent) lived incidence deteriorated in ARMM between 2003 close to the absolute poverty line (20 percent and 2012 and is correlated with the incidence of above), making them highly vulnerable to fall rido, inter-clan feuds. Figure 38: Poverty and vulnerability, farmers and Figure 39: Average savings of farmers and fisherfolk fisherfolk in Mindanao, 2012, percent households by economic decile, Luzon and Mindanao, 2012 Income level of farmers and fishers 180 0.7M (16%) 16% 160 Rest of Marketable farmers surplus 140 0.5M (17%) 1.2M (25%) Rest of farmers 120 PHP (Thousands) Rest of farmers 1.4M (31%) Near poor 100 0.9M (34%) Near poor 80 2.0M (42%) Near poor 84% 60 Subsistence 1.1M (25%) or near 40 0.7M (26%) Poor subsistence Poor 20 1.0M (21%) Poor 0 0.6M (23%) 1.2M (27%) 0.6M (12%) Food poor Food poor -20 1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th Food poor Per capita income decile Luzon Visayas Mindanao Luzon Mindanao Source: FIES-LFS 2012 Source: FIES-LFS 2012 82 Based on the 2012 FIES. In 2012, the average annual per capita food poverty line in Mindanao was Php13,453 and the poverty line was Php19,291, both slightly higher (1.4 percent) than that of Luzon despite Mindanao being less developed. People falling below the provincial per capita food thresholds are considered food-poor, while those with per capita income equal to or above the provincial per capita food thresholds but below the provincial per capita poverty thresholds are considered poor. Those with per capita income equal to or above the per capita poverty thresholds but below the 50th population percentile (agricultural workers tend to have lower income) are considered near-poor. 83 For instance, in a Mindanao town, the datu (local chieftain) can control local politics, own the only rural bank, and have a monopoly of security services and wide influence over labor and land allocation. 84 For more discussion, see Binswanger, Deininger, and Feder (1993). 85 Small area estimates of poverty were used to determine municipal and city level poverty incidence in the Philippines. The latest available data from the Philippines Statistics Authority was in 2012. Philippines ECONOMIC UPDATE • October 2017 43 III. Unlocking Mindanao’s Potential 63. Poverty among workers is higher in coconuts (38 percent of world export volume Mindanao than elsewhere in the country. Thirty in 2014), bananas (33 percent in 2014), and four percent of workers in the region live below pineapples (28 percent in 2014).86 the poverty line, compared to 12 percent in Luzon in 2012. The incidence of in-work poverty 65. Since most workers in Mindanao rely is highest among less educated and less skilled directly on agriculture, transforming the sector workers, especially for those who hold temporary could be significant for generating jobs. In 2012, or involuntary part-time jobs. The self-employed the agriculture and agricultural produce value are more likely to be poor than wage earners, chain accounted for 60 percent of Mindanao’s and self-employment often reflects a lack of value added and 57 percent of its employment.87 opportunity rather than an entrepreneurial drive. Underemployment, not temporary 66. Mindanao’s agriculture sector is unemployment, is the main reason for in-work dominated by smallholder farming. About 60 poverty. The key to reducing in-work poverty percent of farms in Mindanao cover less than 2 in Mindanao is to provide better education hectares (smallholders) and another 33 percent and skills training and increase productive job are 2 to 5 hectares (mid-size farmers). Mindanao opportunities by making the investment climate also has a large proportion of landless agricultural more attractive. workers—estimated at over a million or about a third of all farm workers. Mindanao’s Agriculture 67. Despite the promise of agriculture, many 64. Mindanao is the agriculture center Mindanawons end up in low-paying services of the Philippines, producing diverse crops jobs in urban areas. Limited job creation in and livestock, including many high-value commodities. It contributes 40 percent of the agriculture has had economy-wide implications. country’s agricultural products (Figure 40), Because of slow agricultural growth, millions of with significant shares of rubber, cacao, coffee, workers have joined the informal services sector coconut (small farms), bananas and oil palm where jobs are of low-pay, low-skill, and of low- (mid-sized farms), and pineapple (large farms) productivity. Services generates 44 percent of (Figure 41). The top three Philippine exports are Mindanao’s economic output, but half of these Figure 40: Regional production as share of total Figure 41: Crops produced in Mindanao as a share of agricultural production in the Philippines, 2014, percent total production, 2014, percent 100 100 90 89 89 83 Visayas 80 77 28% 62 60 56 Luzon Percent 50 32% 42 40 Mindanao 23 20 20 40% 0 er o e m na e t re rn s y try nu rie la pl ffe ca al bb ltu Co na ul Pa ap co Ca he lP Co Po Ru cu Ba ne Co Oi Fis ua Pi Aq Source: PSA Source: PSA Note: Data for fisheries uses 2012 as base and the growth rate of the AFF sector to project 2014 shore of production. 86 Export volume estimates are based on the WITS database. 87 Of which 30 percent came from the farm (crops/livestock), fishery, and forestry sectors (primary sector) and the balance (30 percent) from various industrial and services sectors that add value to farm produce. 44 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential jobs are informal, such as in petty retail trade, Improving Logistics and Transport public transportation, and personal services. Connectivity Also, many workers who escaped unproductive agricultural jobs in depressed rural and conflict- 69. Lowering logistics costs would significantly affected areas are struggling to find better-paying benefit Mindanao’s agriculture value chains.88 jobs in urban areas. An efficient logistics system is essential if Mindanao’s potential of becoming a global 68. Poor public policies, investment deficits, supplier of basic and value-added produce is to and institutional shortcomings constitute current be realized. Ensuring a seamless logistics network constraints to realizing the transformative from farm to markets will entail (1) connecting potential of the agricultural sector. Some of the farms to towns by investing in village roads; (2) drivers and causes of the poor performance in the connecting towns to ports by investing in major sector are insecure and disputed property rights, roads; (3) promoting competition in the domestic ineffective farmer organizations, fragmented shipping industry; (4) liberalizing cabotage; (5) agricultural research and tenuous research- modernizing the major ports; and (6) streamlining extension linkages, limited access to and low export and import procedures. Because the quality of agricultural services, and continued logistics chain is only as good as its weakest link, weaknesses in the devolution of services to local partial reforms will not lead to lower prices and government units. There are also problematic better service. For instance, reforming domestic gaps in rural infrastructure, especially farm-to- shipping and cabotage without modernizing ports market roads and irrigation systems, and access to and improving roads will not lower shipping cost; capital is a continuing problem. Finally, there is an shipping lines will not upgrade to larger ships to extensive unfinished agenda of complementary increase scale if the movement of cargo will still reforms, primarily relating to agricultural price be delayed on the road and at the port. and trade-policy distortions. Figure 42: Farm-to-market logistics issues in Mindanao Underlying Issues 1. Congestion in roads, and in ports, leading to inefficiencies and high cost of logistics. 2. Leads to higher prices for the products of Mindanao, making the uncompetitive. 3. Acts as a drag on firm entry and expansion and lowering productivity. Road Network Ports Domestic Shipping 1. National road network needs upgrading 1. Congestion in port roads. 1. Lack of scale/consolidation raises shipping cost. to accommodate bigger traffic and 2. Ports are spread too thinly across 2. Limited of competition in inter-island shipping allows more container trucks. Mindanao. monopolistic practices to continue. 2. Significant gaps in the local road 3. Shallow bay prevents entry of larger 3. Repair and dry-docking are required to be done in the network; bias towards large fruits and and more efficient ships. Philippines (with a few exception) even if cheaper more productive areas instead of small options are 4. Inadequate port facilities limits farms, low quality of roads handling of modern container traffic. 4. Prohibitive taxes on importation discourage investment in 3. Insufficient road network connecting new and more efficient ships. 5. Conflict of interest in the Philippines leading to ports, resulting in congestion Ports Authority, which is both an 5. Domestic vessels are restricted from combining around ports (e.g. Cagayan de Oro) operator and regulator. international and domestic routes to reduce cost. Cabotage 1. Partial cabotage liberalization allows only for co-loading of export and import cargo in several ports. 2. This is not a full cabotage liberation, as foreign firms are still not allowed to participate in inter-island shipping. Village road Town road City road Port road Farm Town City Port Port Refrigerator 88 The Philippines Mindanao Jobs Report discusses the domestic and foreign markets for Mindanao’s agricultural products. In particular, unlocking the agricultural sector in Mindanao and addressing logistics and connectivity issues will strengthen the contribution of Mindanao’s agricultural output to the nation’s food security, particularly increasing rice and maize supply to the other island regions. In addition, there opportunity to expand the production of exportable agriculture products: aquatic, coffee, and coconut products. Here the challenge will be mainly to more closely link farmers with enterprises. Philippines ECONOMIC UPDATE • October 2017 45 III. Unlocking Mindanao’s Potential 70. Improving transport connectivity from Improving Power and ICT Infrastructure farm to market would have numerous positive effects on economic development. Without a 71. Daily power outages, together with well-developed transportation network, farmers logistics problems and armed conflict, are a must deal with higher input costs and lower prices huge cost to businesses and cited as a top for their produce. Because there are few marketing binding constraint for investing in Mindanao. options, farmers’ lack of bargaining power further Scheduled power outages due to insufficient reduces prices. Poor-quality roads may also limit generation averaged three hours a day in access to extension services and lower the quality major cities in 2015. Occasional unscheduled of produce that reach their destinations because shutdowns and maintenance of power plants can of the multiple transport modes needed to reach add up to four hours,91 and transmission repairs markets, from animal-drawn carts to trucks. As due to bombings can take weeks.92 Besides a result, poor transportation options reduce the disrupting work, power outages and fluctuations opportunities for farmers to diversify into higher- can damage machinery and equipment. The value perishable crops and invest in productivity total cost for three months of power outages or quality-enhancing improvements. Also, a large during the peak of the 2013 Mindanao power portion of produce is wasted because it is not crisis amounted to an estimated Php600 million possible or economically feasible to transport for businesses in Zamboanga City,93 and the cost it without access to quality roads.89 Improved was estimated at Php42 billion (0.3 percent of connectivity would also benefit rural societies Philippine GDP) for power outages in Davao City by facilitating the access to social services and in 2015.94 encouraging higher school attendance. In the Philippines, road investment complemented by 72. Efficient and affordable Internet service investments in education has had a significant has the potential to transform Mindanao in the same way it transformed Manila. Davao direct and indirect impact on the welfare of the has emerged as Mindanao’s IT-BPO hub95 and poor.90 Agro-enterprises in areas with limited Cagayan de Oro has been identified as a potential connectivity have higher costs for collecting destination. In 2015, there were 104 firms produce, higher physical and product quality involved with IT-BPO in Davao and Cagayan de losses, and greater difficulties in achieving the Oro, employing a total of 35,389 workers. Other scale required for the efficient use of processing major cities, such as General Santos and Iligan, facilities. Consumers relying on these producers are marketing themselves to attract technology are confronted by higher food prices, reduced firms. Yet Internet speeds in Mindanao are scope for dietary diversity and good nutrition, much lower than in the rest of the country and and increased exposure to food safety risks. significantly lower than in Metro Manila.96 In cities throughout Mindanao, average Internet speeds range from 141 kbps in Marawi97 to 2.4 mbps 89 For example, coconut water is dumped to lighten the coconuts carried by horses or people in Mindanao. In Sulu, because of poor roads and the high cost of shipping, many fruits are left to rot on farms despite high urban demand (e.g., mangosteens). 90 For an extensive discussion, see Balisacan and Pernia 2002. 91 For example, in early 2016, a seven-day corrective maintenance of a unit of the Therma South coal-fired plant in Davao City led to daily brownouts lasting three to four hours (Lacorte 2016). 92 For example, the November 2015 bombing of transmission lines in Marawi City shut out power from the Agus-1 and Agus-2 hydroelectric power plants for more than two weeks (Manar 2015). 93 This is double the amount of business taxes paid by Zamboanga businesses in 2014. A major hospital spends an additional Php600,000 a month on generators (http://www.zamboangachamber.com/home/articles/172--the-cost-and-effect-of-the-power-crisis-on-businesses-and-residents-of- zamboanga-city). 94 The Chamber of Commerce estimates the hourly cost of power outages at Php80 million, as reported in the Inquirer article by de Quiros (2016). The cost for 2015 assumes two hours of power outages a day x 260 work days x Php80 million = Php41.6 billion. 95 The 2015 Tholons top 100 outsourcing destinations in the world ranked Davao 69th among 100 cities. Davao is also in the 10 “next wave” cities for the IT-BPO industry. This recognition has already helped it attract a number of large IT-BPO firms. 96 In the absence of official data, a third-party website (www.testmy.net) was used to record Internet speeds. Individual speed-test results from each city are averaged. This method depends on the plan of each user who conducted the speed test. The plans are assumed to be fairly similar. 97 Residents of Marawi have to go some 38 km to Iligan to send large files. 46 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential Figure 43: Mindanao’s power issues Impact 1. Unreliable power supply, leading to daily power outages. 2. Businesses incur huge costs due to loss of power during business hours. 3. Acts as a drag on firm entry and expansion and lowering productivity. Generation Transmission Distribution 1. Reliance on hydro making alternatives uncompetitive. 1. Conflict issues (bombings of towers). 1. Weak management of cooperatives, resulting 2. Underinvestment and low maintenance of hydro assets 2. Property rights issues (i.e, rental in high system loss, low collection ef (Lowering dependable capacity over the years). payments, vegetation and structure and mounting debts. ficiency, 3. Climate change vulnerabilities during drought. under transmission lines, making them 2. Politicization of board to fulfill campaign vulnerable). promise. 4. Higher economic growth, resulting in higher demand and competing water use in agriculture and urban 3. Stand-alone transmission area not 3. Low consumer ability to pay leading coops to areas. connected to Luzon and Visayas grid. cut power. 5. Reliance on more expensive coal when natural gas is A viable alternative. 6. Tedious process to secure the permits, which take years. Generation Transmission Distribution Figure 44: Mindanao’s internet policy and investment deficits Underlying Issues 1. Analog legal framework despite an increasingly digital world. 2. The current legal framework is designed for a centralized, monolithic, obsolete long distance telephone system. The internet is naturally decentralized and does not fit in this system. Barriers to entry Anti-competitive practices Weak regulation 1. The 1987 constitution and the 1936 Public 1. Connecting to telco network entails 1. There is no explicit competition policy Service Act limit to foreign ownership of telcos. access charges, which are deregulated set for telcos. 2. Telcos need franchise from congress on top of and bilaterally negotiated between telcos 2. Decisions on mergers and acquisitions license to operate from telco regulator. and ISPs; wholesale and retail pricing are are not transparent, and not in line with also regulated. the anti-trust mandate. 3. By law broadband and non-voice services treated as a value added service that can be 2. Contracts between the duoply and ISPs 3. Spectrum allocation is not competitive, procured only from telcos. are governed by non-disclosure. transparent, and efficient. 4. By law, ISPs are required to use the backhaul of 3. Neutral local IP peering is not optimized 4. Consumer protection is minimal. telcos. as the dominant player does not use it. 5. These factors led to the duopoly structure and 4. There is no specific policy on local loop highly vertically integrated industry. unbundling. Underinvestment 1. There is lack of incentive to invest in farther areas given high capital outlay and preference to improve corporate earnings. 2. High cost of local government units and private property owners. 3. There is lack of coordination with public works to share network and civil works. 4. Lack of landing stations in Mindanao. 5. Conflict in Mindanao. Submarine Landing Middle Last cable Station Mile Mile Philippines ECONOMIC UPDATE • October 2017 47 III. Unlocking Mindanao’s Potential in Cagayan de Oro, compared to 3.6 mbps in Mindanao transform into manufacturing and Makati.98 It appears that Davao users have to pay high-skill services economies, skills will become about 1.5 times more to get the same speed as in even more important. The major causes of Makati, and Marawi users have to pay 26 times these skills shortages are too little investment in more. A dedicated line can cost up to Php20,000 basic education, inadequate training programs, per month for each additional 1 mbps of speed, and the migration of skilled workers. compared to Php700 for a residential line with no speed guarantee. 74. As in the Philippines in general, cities in Mindanao tend to perform worse on Doing Supporting Private Investment: Skills Business indicators than other East Asian Development, Easing of the Regulatory cities. For instance, the two best performers in Burden, Better Access to Finance, and Mindanao, General Santos and Davao, ranked Improving Land Management 124th and 125th, respectively, among 151 73. Despite heavy demand, skills shortages economies (Quezon City was 128th) for starting are slowing the expansion of the IT-BPO a business (Singapore was 1st, Thailand 59th, industry. The Davao ICT council estimated and Malaysia 71st). A number of reasons explain about 5,000 job vacancies in 2015, but the the high cost of starting and maintaining a industry could not fill them even though 20,000 business. First, many government agencies students graduate from college99 in Davao City at both the national and the local levels are and surrounding provinces every year.100 Most involved in starting a business, and several applicants in Davao are rejected for lack of private sector providers (e.g., bookstores, both soft101 and technical skills.102 This results in banks, etc.) are also involved, but there is lack a supply gap of 70 percent in Davao’s ICT sector of coordination. Second, one-stop shops and and 40 percent in Davao’s BPO industry.103 This process automation are limited, especially is less of a problem In Cagayan de Oro because in Mindanao where Internet service is slow. its industry is much smaller. A shortage of Third, several steps, such as securing an import engineers is also affecting manufacturing, permit and getting Securities and Exchange construction, and utility firms in Mindanao.104 Commission (SEC) approval, take several days The construction sector is hard-pressed to find because processing is done in Manila or in a civil, electrical, design, planning, and contract regional center (e.g., SEC registration of Iligan engineers. Moreover, the manufacturing sector firms is done in Cagayan de Oro, which is 90 is seeking mechanical, chemical, and industrial km away). Finally, most agencies have yet to engineers. Business chambers confirm a lack of shift from annual renewals of licenses to less engineers in Mindanao, as the few engineering frequent renewals, such as every three years graduates tend to leave Mindanao for jobs for low-risk businesses. in Manila or overseas. As leading cities in 98 Source: www.testmy.net. 2012 is the latest data. 99 Since 2010, the average number of graduates in the Davao Region (Region XI) is around 20,000 (CHED Higher Education Facts and Figures: http:// www.ched.gov.ph/central/page/ched-statistics). 100 High attrition rates are also a problem. A study by IBPAP and TeamAsia (2014) estimates the attrition rate of IT-BPO firms at 15 percent. In addition, about 18 percent of employees leave the industry as a whole each year (IBPAP). 101 Soft skills include critical thinking, communication, and teamwork. Results of the Global Competitiveness Assessment Tool, an industry-benchmarked assessment system used by BPO companies, show that the average scores of most schools are below the industry benchmark range. In particular, schools score below the range in learning ability, English language proficiency, perceptual speed and accuracy, and behavioral skills. On basic skills, 60 percent of test takers score below the 30th percentile. On behavioral skills, 70 percent of test takers score that low. 102 For more information, see DOST-ICTO and IBPAP (2014). 103 Estimates from Carillo (2013). 104 For more information, see the Department of Labor and Employment (DoLE), 2010. 48 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential 75. Mindanao’s economy constitutes 15 increase lending in the conflict-affected areas percent of the national GDP but receives of Mindanao. only 3 percent of total credit granted in the country. Eighty seven percent of credit granted 78. Financial inclusion and better access to by banks in the Philippines is concentrated in financial services constitute one element of the national capital region. Mindanao’s low the broader development effort envisaged to share of credit compared to its contribution to lift economic performance in the ARMM. The GDP is similar to the situation in the Visayas and National Strategy for Financial Inclusion, which Luzon. Bank credit tends to be concentrated in was adopted in 2015, creates a framework for metropolitan areas which are also centers of efforts to boost financial inclusion throughout economic activity. This pattern is repeated in the Philippines. A range of policy and regulatory Mindanao, where Davao receives 27 percent actions, financial education, and consumer of all credit in the region, and Davao, Cagayan protection programs and advocacy initiatives de Oro, and General Santos together represent can improve prospects for financial inclusion up to 52 percent of all credit in Mindanao. in ARMM. However, there is also a need for However, statistics on credit reported by interventions specifically tailored to the region banks may not fully reflect its geographical considering its specific challenges. destination because many banks process loans, especially for large commercial borrowers, in 79. Inadequate land-use planning and their regional or main offices. zoning is impairing the quality of life in Mindanao’s fast-growing cities. The region’s 76. Residents in Mindanao are on average city centers are becoming congested and less likely to use financial services by banks polluted, and informal settlement enclaves are and instead rely more on microfinance multiplying. Public administration is finding organizations and cooperatives. Forty three it hard to cope with the growing demand for percent of Fillipinos report having used a services, and infrastructure investments and bank in Mindanao, including ATMs, compared regulation of land use for housing, commerce, to 57 percent in Luzon and 35 percent in the and industry is becoming more challenging Visayas. In Mindanao, 36 percent of residents to coordinate. While several of Mindanao’s use microfinance organizations and 21 percent cities are beginning to proactively update use cooperatives.105 However, 34 percent of their comprehensive land use plans, recent residents report using informal credit and 28 accelerated growth will require more regular percent have some savings, which suggests a updates than the five years mandated by the possible demand for formal financial services. Local Government Code. 77. Agricultural businesses throughout 80. The registry of land transactions does the country have similar financing problems, not reflect reality. An estimated 10 to 20 but instability in Mindanao is an additional percent of transactions are not registered deterrent. There is high risk involved in mainly because of the high costs (formal and providing finance to businesses in smallholder informal) of transferring106 and registering a agriculture, especially when land rights are property. In 2011, the time and cost involved not secure. While changes in national policies in registering a property in Mindanao’s cities could increase lending to the agricultural sector were the highest in the Philippines. Moreover, nationally, several specific policies could help access to reliable and current information 105 BSP National Financial Inclusion Baseline Survey, 2015. This was estimated by local registrars and accessors. The cost is driven by a number of taxes and fees: capital gains, transfer, and documentary stamp 106 taxes, and registration and survey fees. Often, the magnitude of back taxes deters people from registering. Philippines ECONOMIC UPDATE • October 2017 49 III. Unlocking Mindanao’s Potential from the registry is costly. The Land Titling records that reduce incentives to develop Computerization Project has ironically made land, hold back formalization, prevent small accessing land records very expensive even for and medium-sized enterprises from accessing government offices fulfilling their mandates, formal credit, slow infrastructure projects with and it has contributed to delays in registering right-of-way issues, and complicate community new titles and transactions. The result is mortgage programs for buying land. missing, outdated, inaccurate, and costly land 3.3 Economic Policies to Reduce Conflict 81. Though the long-standing armed Almost 60 percent of Mindanao’s 455 cities conflicts affecting parts of Mindanao can only and municipalities and 13.6 million people (62 be resolved by political solutions, economic percent of the population) are directly affected policies can help reduce conflict. Dealing by conflict.108 In conflict areas, farmers often with historical injustices and recognizing produce at subsistence levels and businesses cultural minorities is essential for peace and remain small to escape being noticed.109 About reconciliation. However, the government’s 63 percent of the people in areas affected peace and development roadmap sets out by conflict live below the poverty line,111 and ways to also overcome the drivers of conflict. ARMM has the highest poverty incidence This section offers a series of recommendations among Mindanao’s regions. The provinces that to tackle these drivers as a complement to a became part of the ARMM decades ago were political solution. once the richest region of Mindanao but are now the poorest. 82. Violent conflict in Mindanao is complex and affects large areas. The state is engaged 83. Land disputes result in conflict.112 Two in peace processes with two groups: Moros factors explain the prominence of land disputes fighting for self-determination and communists among Moros and indigenous people: (i) the fighting for ideology and against poverty and legacy of resettlement and land programs from inequality.107 Violence can occur between the 1900s to the 1980s113 and (ii) magnified political dynasties, communities (e.g., Moros effects of overlapping legal frameworks for land. versus indigenous peoples, Christians, or The first largely affects the Moro people and the other Moros), and clans, and with criminal, second the indigenous people. Dispossession terrorist, kidnap-for-ransom, and other armed of the original inhabitants of Mindanao came groups. Of Mindanao’s six regions, conflict is in four waves: (1) from the end of Spanish most prevalent in the ARMM, the Zamboanga rule in 1898 to the end of the Philippine Peninsula Region, and the Caraga Region. Commonwealth in 1946; (2) the early years of 107 Some groups, however, are little more than extortionists fronting as a communist insurgency. 108 Sources include the Bangsamoro Conflict Monitoring System (BCMS), supplemented by field consultations and research. 109 Fear of kidnapping or extortion keeps businesses small and capital mobile. Most produce is sent to processing centers outside of ARMM to places like Davao, Cebu, and Zamboanga. In 2015, there were only 13 large companies registered in mainland ARMM; they were engaged in agricultural planting and processing, or biomass energy production (data provided by the ARMM Regional Board of Investments; a large establishment is defined as one that employs at least 200 persons). 110 World Bank staff estimates based on the BCMS, census of population and housing, and small area estimates of poverty. 111 Growth in the Caraga and Davao regions has been higher than in the ARMM due to less intense conflict, a more predictable conflict environment, and a mining boom. 112 This section draws largely from the World Bank and International Organization for Migration (2017). It also draws from LGI (2016). Floradema Eleazar is the main author under the guidance of Thea Hilhorst. 113 Unlike the Spanish and American colonization of the Philippines, the “colonization” of Mindanao by Manila was fairly recent, and there are people still alive who speak of how their land was taken from them. 50 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential the third republic from 1946 to the late 1960s; there were almost a million internally displaced (3) the martial law years from the 1970s to the persons in Mindanao according to the United mid-1980s; and (4) the comprehensive agrarian Nations High Commissioner for Refugees. Some years from the late 1980s to the present. Each 41 percent of the population in mainland ARMM was characterized by a policy instrument and adjacent provinces have been displaced at driven by the political and economic agenda least once, with many suffering far more often. of the central government. The magnified Millions have migrated from Basulta and central effects of overlapping legal frameworks grew Mindanao to safer areas in the Philippines and from Mindanao’s unique socio-geology that neighboring Sabah in Malaysia. The Malaysian creates multiple rights over the same plot of government estimates that there were 470,000 land. The Philippines has eight separate land Filipinos in Sabah in 2015. However, unofficial laws, with significant overlap and no clear sources put this number at about a million, of rules of precedence, that are the responsibility which 25 percent were considered “stateless”, of five offices in four agencies, often without i.e., they did not have birth certificates or coordination.114 The situation is exacerbated passports to prove their nationality, which by unique socio-geological features that reduces their access to jobs and services and disproportionately impact indigenous people. increases their vulnerability to exploitation. 84. Land dispossession and conflict are 86. Violent conflict has had a major impact aggravated by policies and developments on growth and poverty levels throughout that have disregarded traditional institutions Mindanao. Concerns over security have based on communal ownership of land. depressed tourism and boosted the emigration Among them are (1) poor land administration of skilled workers. The reputational damage and management that results in the approval caused by insecurity has even reduced of conflicting and multiple rights over the same investment in areas relatively unaffected by plots (all with legal anchors, although not violence. These areas also bear the fiscal burden all are necessarily seen as fair); (2) cadastral of coping with displaced persons. On the other surveys that cause conflict; (3) land dispute hand, more peaceful areas have benefited from systems favoring “confrontational” judicial opportunities to process agricultural produce mechanisms that ignore customary approaches from conflict-affected areas, where processing such as mediation by leaders; (4) excessive facilities are rare. Many skilled workers from accumulation of land by the new political elite conflict-affected areas have also migrated to and commercial interests in mining and logging; other regions of Mindanao. and (5) displacement of people due to violent conflict and environmental factors. There is 87. Economic policy can support the a strong case to be made to complement, or resolution of conflicts. The issues at the root even trump, conventional solutions to land of the conflicts, in particular a deep sense problems by solutions that address the core of injustice as a result of greatly unequal reason for grievances and are sympathetic to political and economic power and longstanding local customs. grievances over land dispossession, can only be resolved by a political settlement. It is 85. Mass displacements have exacerbated clear, however, that poverty and economic the welfare impact of conflict. In August 2014, hopelessness in conflict-affected areas help These are the Public Land Act of 1936 (Commonwealth Act 141), Forestry Code of 1975 (Presidential Decree 705), Comprehensive Agrarian Reform 114 Law of 1988 (Republic Act 6657), People’s Small-Scale Mining Act of 1991 (RA 7076), Local Government Code of 1991 (RA 7160), National Integrated Protected Areas System Act of 1992 (RA 7586), Mining Act of 1995 (RA 7942), and Indigenous Peoples’ Rights Act of 1997 (RA 8371). They are implemented by the Land Management Bureau and Forest Management Bureau in the DENR, Land Registration Authority in the Department of Justice (DOJ), the Department of Agrarian Reform (DAR), and the National Commission on Indigenous Peoples (NCIP). Philippines ECONOMIC UPDATE • October 2017 51 III. Unlocking Mindanao’s Potential perpetuate conflict, as individuals without alternative income sources and improving land or work opportunities are driven to join the delivery of basic services, particularly in armed groups to survive or seek social status. areas that have been neglected. Although such Discontent arising from social injustice and policies cannot resolve conflicts on their own, discrimination in the distribution of economic they can facilitate peace by creating economic opportunities and development resources can opportunities and demonstrating government also fuel violence. Thus, this report focuses effectiveness in improving welfare. on two major supports for peace: providing 3.4 A Regional Development Strategy for Mindanao 88. Reducing poverty and delivering on Mindanao accounts for 40 percent of the the new Philippine Government Strategic country’s total agricultural output and 60 Framework for Mindanao Peace and percent of all agricultural exports. However, Development will demand a new form of only 16 percent of Mindanao farmers produce engagement in Mindanao. The strategic a marketable surplus, and more than half framework recognizes that there are “two of farm households are poor. Also, rural Mindanaos”: one that can be characterized as underemployment is high, and many farmers relatively stable and prosperous and another are neither organized nor linked to value one that is suffering pervasive poverty, violent chains. With a few exceptions (e.g., bananas) conflict, and poor governance. To address the sector’s once vibrant growth has stalled. the goal of a peaceful, cohesive, secure, and inclusively developed Mindanao, the framework 91. There is domestic and foreign market calls for five linked strategic outcomes: resilient potential for Mindanao’s agricultural products communities built; effective governance (Box 12). First, there is scope to supply more promoted; inclusive economic growth and jobs rice and maize to the other islands of the ensured; security environment stabilized; and Philippines as food or feed ingredients. Although the consensus for peace strengthened. Mindanao accounts for a high proportion of national food production, it is only tenuously 89. The World Bank has created a strategy linked to the national market, limiting its for regional development in Mindanao. contribution to national food security. This is a This builds on a dialogue with the Philippine missed opportunity for both Mindanao and the government and local stakeholders. The three country. There is also an emerging opportunity main components are: (1) raise agricultural to cater to growing urban demand within productivity and improve farm-to-market Mindanao for higher-value perishable meat connectivity; (2) boost human development; and vegetables. Realizing the domestic market and (3) address drivers of conflict and fragility potential will depend on addressing limited while building up institutions in ARMM and connectivity to give farmers better access to other conflict-affected areas. markets both within Mindanao and beyond. Finally, there is an opportunity to expand the 90. Mindanao’s comparative advantage lies production of exportable agriculture products: in agriculture, yet its full potential is not being aquatic, coffee, and coconut products. This realized mainly because productivity remains involves linking farmers more closely with low. Agriculture and related services and enterprises, as it is primarily agribusinesses industries account for 60 percent of Mindanao’s that have the opportunity to differentiate or GDP and 57 percent of its employment. diversify product lines. 52 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential 92. Limited connectivity constitutes a major adequate farm to market roads, there is a need constraint for growing the agricultural sector. to prioritize modernization efforts to relieve Farmers are disconnected or misconnected with congestion on roads accessing ports for more technical service providers, agro-enterprises, connectivity beyond Mindanao. Moreover, markets, and consumers, a problem that has Mindanao ports lack economies of scale: there multiple consequences (Table 7). Many roads are some 690 ports in the region, yet the top are in bad condition or congested, resulting four ports handle only 17 percent of domestic in rejected agricultural produce, especially cargo and 12 percent of foreign. Many ports are perishable commodities like bananas and owned by private companies and are closed to other fruits and vegetables. Beyond the lack of smaller farmers. Box 12 The market potential of agriculture in Mindanao Mindanao is considered the agricultural basket of the Philippines, producing a diverse set of crops and serving both local and international markets. Of the three island regions, it accounts for the largest share of agricultural production and contributes significantly to national food security. For example, it produces about 50 percent of national corn production. Also, it produces most of the country’s high-value crops: about 80 percent of bananas and coffee and over 60 percent of coconuts. In addition, Mindanao contributes a significant share of the country’s key commodity contributions to total world export volume. Its bananas, pineapples, and coconuts comprise about a third of world export volumes.115 However, Mindanao’s agricultural sector has not realized its potential. A number of Mindanao’s agricultural products could extend their shares in both domestic and international markets. An analysis of about two dozen value chains in Mindanao reveals that some products, such as coffee, aquatic products, seaweed, and coconut, appear to have considerable market potential, either for more effectively serving nearby urban centers or for expanding in markets abroad. Ramping up coffee production in Mindanao could also address the demand for domestic consumption of currently imported coffee products. In recent years, domestic coffee consumption rose significantly to about 130,000 metric tons of coffee in 2015—more than double the consumption in 2007. Until the 1990s, the Philippines was a major exporter of coffee beans, but domestic production steadily fell following a sharp decline in prices. Today, green coffee is among the country’s top 10 agricultural imports. For Mindanao, where about two-thirds of national coffee production takes place, there is a potential to expand to coffee processing, such as the production of instant coffee, given that 95 percent of all domestically consumed instant coffee is imported. Aquatic products like milkfish, tilapia, and seaweed could serve wider domestic and international markets. According to the Food and Agriculture Organization, the Philippines ranks among the top 20 global producers of fish, crustaceans, and mollusks, accounting for about 1 percent of total global production; Mindanao contributes already nearly half of total domestic production. Domestically, milkfish and tilapia are central items in the Filipino diet, yet Mindanao’s contribution to milkfish and tilapia production is about 15 and 7 percent, respectively. Export volume estimates were generated using the World Integrated Trade Solution (WITS) database. 115 Philippines ECONOMIC UPDATE • October 2017 53 III. Unlocking Mindanao’s Potential In terms of the aquatic export markets, seaweed has the most market potential for Mindanao. The Philippines ranked 3rd globally in production of aquatic plants, with 5.7 percent of total world production in 2014. Mindanao accounts for more than half of total Filipino production and most of it takes place in the ARMM. Moreover, seaweed, as an aquatic export, is second only to tuna in terms of value, accounting for US$202 million—about 20 percent of total export earnings for fisheries in 2015. There is heavy demand from international markets for seaweed, from which carrageenan is extracted for use as an additive, binder, and emulsifier in the food, pharmaceutical, beverage, and cosmetic industries. The coconut industry represents a growth opportunity for Mindanao and a chance for its poorest farmers to establish linkages with enterprises. The Philippines is the second largest producer of coconuts in the world. In 2015, coconuts accounted for about 40 percent of total export earnings and over 60 percent of those coconuts came from Mindanao. In recent years, international demand has outstripped supply because of the proliferation of coconut byproducts, such as virgin coconut oil, coco sugar, and copra. As a result, there is an opportunity to expand Mindanao’s coconut-related agribusiness for both domestic and export markets. Table 7: Effects of poor connectivity on farmers, agribusiness, and consumers Farmers Agribusiness Consumers Reduced terms of trade (higher Higher aggregate cost for Higher food prices for both input costs and lower produce produce staples and non-staples foods prices) Reduced marketing options and Higher physical and product Reduced scope for dietary less bargaining power quality losses diversity and improved nutrition Reduced incentives to invest in Difficulties in realizing scale Increased exposure to food higher on-farm productivity benefits and utilizing processing safety risks capacity Minimal scope to diversify into Inability to service national higher-value perishable products markets Dulled incentives for producing Reduced export competitiveness higher-quality products and and profitability frequent rejections 93. Customs procedures are a major 94. Protracted land disputes and conflict bottleneck to trade facilitation, especially for have deterred investments in agriculture, agricultural products. On the Doing Business slowing job creation and poverty reduction. indicator for Trading Across Borders, the Favorable climatic conditions, the presence of Philippines ranked 95th in 2016116, one rank Lake Lanao and the Liguasan Marsh, and the lower than in 2015. The World Bank Logistics impact of climate change elsewhere in the Performance Index ranks the country at 71st, country have encouraged large firms based down from 85th in 2014, with a ranking of 78th in Davao and Cagayan de Oro to extend their for Customs and Border Management, 31 points operations to Lanao del Sur and Maguindanao lower than in 2014. through contract-growing agreements with smallholders. However, a large majority of World Bank, 2016a. 116 54 Philippines ECONOMIC UPDATE • October 2017 III. Unlocking Mindanao’s Potential prospective investors are deterred by unclear 97. Resolving conflict in Mindanao rests and overlapping property rights, and even on addressing the causes of conflict and current investors are deterred from expanding providing jobs and economic opportunities their operations. Land disputes can easily as alternatives to violence. The proposed turn into violent confrontation and inter-elite framework builds on the 2011 World Bank World clashes, which can destroy inventory, delivery, Development Report on conflict, security, and and production schedules. In some cases, development. Breaking the cycle of insecurity the potential for profit from large pineapple and reducing the risk of its recurrence require and banana farms has led elites to dispossess restoration of confidence in collective action smallholders as they consolidate lands for and transforming institutions to provide a contract growing. sustained level of security, justice, and jobs. “Restoring confidence” requires deliberate 95. The proposed strategy is designed to efforts by both state and private actors from support Mindanao’s comparative advantage the national to the community level in order and strengthen its linkages with the entire to launch the initial stages of confidence- region. It identifies three priorities to unlock building and institutional transformation and agriculture potential and streamline farm-to- secure early gains. “Transforming institutions” market connectivity: 1) raise farm productivity, requires giving early priority to actions to 2) develop the transport network, and 3) build reform the institutions responsible for citizen up ports and improve customs (Figure 45). security, justice, and jobs. 96. Connectivity bottlenecks are 98. Creating jobs is central to stabilize and compounded by skills deficits. Over 80 percent normalize conflict areas. First, jobs address of Mindanao’s farmers and fishermen are poor one of the root causes of conflict, which is a lack or near-poor, lacking scale and skills to compete. of employment opportunities that drives many, People with more education in Mindanao, particularly combatants and out-of-school youth, especially in ARMM, see few prospects for to desperation. Without prospects for earning a wage gains. To maximize human development decent income, the unemployed (especially the and productivity in Mindanao, weaknesses young) become pessimistic about the future. need to be addressed in both basic education Second, when employment opportunities are and skills & employment development. The available, recruitment by rebel or criminal approach needs to especially target the youth elements promising better income becomes less in conflict-affected areas. attractive. Third, jobs give individuals a sense Figure 45: How to unlock Mindanao’s agriculture potential Raise farm Support logistics productivity services Develop key ports through development, and modernize agro-spatial improve roads from customs approaches and agricultural to product alliances markets and ports Philippines ECONOMIC UPDATE • October 2017 55 III. Unlocking Mindanao’s Potential of being part of the society as they share in a specialized suite of programs is needed in its benefits. Finally, if individuals feel that they fragile environments that combines elements belong to the society, they will have a greater of security, justice, institution building, and stake in its preservation and have more to economic transformation. In addition to lose, especially their jobs and goals of a better making agriculture more productive, improving future, if conflict breaks out. farm-to-market connectivity, and promoting human development, it will be necessary to 99. However, job creation will not be build up institutions in the ARMM and other enough. Where the cause of conflict is not conflict-affected areas and address the less economic, such as the struggle for identity or obvious drivers of conflict and fragility. One self-rule, economic measures alone will not be aspect is to support resilient communities and enough to resolve the conflict. In Mindanao, responsive local governments. Another is to peace and development will hinge on a promote citizen security through supporting political solution that can successfully address normalization processes and promote justice the causes of violence—injustice, inadequate by addressing land conflicts. governance, land dispossession, discrimination, and sociocultural marginalization. Inclusive 101. The proposed strategy could have job creation can support peace by providing wide-ranging benefits to the Philippines. equitable access to economic opportunity for These range from nationwide improvements all, even those in remote, conflict-affected due to customs reform and the ability of communities. subsistence farmers and day laborers in poor areas to access farm-to-market roads to youth 100. Supporting the transformation of enrolling in job-training programs. It will also institutions will not be simple and cannot be transcend the divide between non-conflict done quickly. There will be no single “make and conflict-affected areas in Mindanao and or break” moment; it will take a series of support interventions to promote peace and self-reinforcing actions to restore confidence socioeconomic development as well as longer- and gradually build effective institutions. term economic development opportunities Violence prevention and recovery is only that would help reduce the risk of conflict in possible if it is recognized that security, justice, the future. The proposed strategy will guide and economic stresses are linked. As a result, the World Bank’s engagement in Mindanao. 56 Philippines ECONOMIC UPDATE • October 2017 References • Ariu, A. (2016). Crisis-proof Services: Why Trade in Services did not suffer during the 2008-2009 Collapse. Journal of International Economics 98: 138-149. • Balisacan, A., and E. Pernia. (2002). The Rural Road to Poverty Reduction: Some Lessons from the Philippine Experience. 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Washington D.C., World Bank Group. • __________. (2015a). Global Economic Prospects, January 2015: Having Fiscal Space and using it. Washington D.C., World Bank. • __________. (2015b). Philippine Economic Update, October 2015: Making Growth work better for Small Businesses. Washington D.C., World Bank Group. • __________. (2016a). Doing Business Report. Washington, DC. World Bank Group. http://www.doingbusiness. org/reports/global-reports/doing-business-2016. • __________. (2016b). Global Economic Prospects, June 2016: Divergences and Risks. Washington D.C., World Bank Group. • __________. (2017a). East Asia Pacific Economic Update, April 2017: Sustaining Resilience. Washington D.C., World Bank Group. • __________. (2017b). Global Economic Prospects, June 2017: A Fragile Recovery. Washington D.C., World Bank Group. • __________. (2017c). Philippines Mindanao Jobs Report: A Strategy for Mindanao Regional Development, Washington D.C., World Bank Group. • __________. (2017d). 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Washington D.C., World Bank Group. 58 Philippines ECONOMIC UPDATE • October 2017 ANNEX Table A.1: Key economic indicators (2015 to 2019) 2015 2016 2017 2018 2019 Actual Projected Growth and inflation (in percent of GDP, unless otherwise indicated) Gross domestic product (percent change) 6.1 6.9 6.6 6.7 6.7 Inflation (period average) 1.4 1.8 3.0 2.6 2.8 Savings and investment Gross national savings 24.9 24.8 25.6 26.9 30.6 Gross domestic investment 22.0 24.6 25.8 27.2 31.1 Public sector National government balance (GFS basis)1/ -1.0 -2.5 -2.5 -2.6 -2.9 National government balance (gov't definition) -0.9 -2.4 -2.4 -2.5 -2.8 Total revenue (government definition) 15.8 15.2 15.8 16.3 16.8 Total spending (government definition) 16.7 17.6 18.2 18.8 19.6 National government debt 44.8 42.0 41.8 41.2 40.8 Balance of payments Merchandise exports (percent change) -13.3 0.6 12.5 9.8 9.9 Merchandise imports (percent change) -1.0 16.6 17.3 17.8 18.4 Remittances (percent change of US$ remittance) 4.6 4.9 5.3 5.5 5.5 Current account balance 2.9 0.2 -0.2 -0.3 -0.5 Foreign direct investment (billions of dollars) 5.7 7.9 7.5 7.7 8.1 Portfolio Investment (billions of dollars) -0.6 0.4 0.5 0.7 0.8 International reserves Gross official reserves2/ (billions of dollars) 80.7 81.1 80.5 80.7 81.2 Gross official reserves (months of imports) / 3 10.1 9.2 8.6 8.6 9.0 External debt4/ 26.5 24.6 24.1 23.7 23.4 Sources: Government of the Philippines for historical and World Bank for projections 1 / Excludes privatization receipts and includes CB-BOL restructuring revenues and expenditures (in accordance with GFSM). 2 / Includes gold. 3 / Defined as the total of goods and services imports. 4 / Central Bank definition. Philippines ECONOMIC UPDATE • October 2017 59 Table A.2: National government cash accounts (GDS basis) (2016-2018) 2015 2017 2018 Actual Estimate Budget (in percent of GDP, unless otherwise indicated) Revenue and grant 15.2 15.8 16.3 Tax revenue 13.7 13.8 15.3 Net income and profits 6.4 6.4 6.4 Excise tax 1.1 1.3 1.4 Sales taxes and licenses 2.3 2.4 2.5 Others 1.1 1.1 0.9 Collection from customs 2.7 2.8 3.6 Nontax revenue / 1 1.5 1.9 1.0 Grant 0.0 0.0 0.0 Total expenditure 17.6 18.2 19.3 Current expenditures 13.2 13.3 13.4 Personnel services 5.2 5.2 5.13/ MOOE 2.9 3.1 3.2 Allotment to LGUs / 2 2.4 2.4 2.4 Subsidies 0.5 0.5 0.7 Tax expenditures 0.0 0.0 0.0 Interest payment 2.1 2.3 2.0 Capital outlays 4.4 4.8 5.8 Net lending 0.1 0.1 0.1 Balance (GFS definition) -2.5 -2.5 -2.6 Balance (GOP definition) -2.4 -2.4 -2.5 Primary Balance (GFS) -0.3 -0.1 -0.5 Memorandum items Privatization receipts (PHP billions) 0.7 2.0 2.0 Nominal GDP (PHP trillion) 14.5 15.9 17.5 Sources: Department of Finance, Bureau of Treasury, and Department of Budget and Management, and World Bank staff calculations 1 / Excludes privatization receipts (these are treated as financing items in accordance with GFSM). 2 / Allocation to local government units (LGUs) excludes capital transfers, which are included in capital outlays. 3 / Based on national government cash budget. On an obligation basis, personnel services make up 6.2 percent of GDP. 60 Philippines ECONOMIC UPDATE • October 2017 The World Bank PHILIPPINES 26th Floor, One Global Place, 5th Avenue Corner 25th Street, BGC Taguig, 1634 Metro Manila