Report No: 26946-PH PHILIPPINES DEVELOPMENT POLICY UPDATE October 16, 2003 Poverty Reduction and Economic Management Sector Unit East Asia and Pacific Regional Office CURRENCY EQUIVALENTS (As of 16 October 2003) Currency Unit = Peso $1.00 = PhP54.69 FISCAL YEAR January 1 ­ December 31 ACRONYMS AND ABBREVIATIONS AMLA Anti-Money Laundering Act IT Information Technology APJR Action Program for Judicial Reform LFPR Labor Force Participation Rate ARMM Autonomous Region for Muslim LGC Local Government Code Mindanao LGU Local Government Unit BIR Bureau of Internal Revenue LTS Large Taxpayer Service BOC Bureau of Customs MDGs Millennium Development Goals BOI Board of Investment MFN Most Favored Nation BSP Bangko Sentral ng Pilipinas NCR National Capital Region BTr Bureau of Treasury NG National Government CHED Commission on Higher Education NGAS New Government Accounting System CAR Capital Adequacy Ratio NGO Non-government organization COA Commission on Audit NPA Non-Performing Assets CPA Corrective Prompt Action NPC National Power Corporation CPS Consolidated Public Sector NPL Non-performing loan CPSD Consolidated Public Sector Deficit NSO National Statistics Office CSC Civil Service Commission PCA Prompt Corrective Action DBM Department of Budget and Management Presidential Commission Against Graft DepEd Department of Education PCAGC and Corruption DOF Department of Finance PDIC Philippine Deposit Insurance Corporation DST Documentary Stamp Tax Power Sector Assets and Liabilities ECs Electric Cooperatives PSALM Management Corporation EIU Economic Intelligence Unit PPI Private Participation in Infrastructure EPIRA Electric Power Industry Reform Act PPP Purchasing Price Parity ERC Energy Regulatory Commission PSE Philippine Stock Exchange FATF Financial Action Task Force Real and Other Properties Owned and FDI Foreign Direct Investment ROPOA Acquired IPO Initial Public Offering ROSC Report on Standards and Codes GDP Gross Domestic Product SEC Securities and Exchange Commission GENCO Generation Companies SPV Special Purpose Vehicle GNP Gross National Product SSS Social Security System GOCC Government-Owned and Controlled Technical Education and Skills Corporation TESDA Development Authority GSIS Government Service Insurance System TLP Total Loan Portfolio HIV/AIDS Human Immune Virus/Acquired Immuno TRANSO National Transmission Corporation Deficiency Syndrome UNDP United Nations Development Programme ICT Information, Communication and WESM Wholesale Electricity Spot Market Technology WTO World Trade Organization IPP Independent Power Producer Vice-President: Jemal ud-din Kassum, EAP Country Director: Robert Van Pulley, EACPF Sector Director Homi Kharas, EASPR Task Manager Lloyd McKay, EACPF Table of Contents Page Executive Summary..............................................................................................................i I. RECENT ECONOMIC AND SOCIAL DEVELOPMENTS........................................... 1 A. Economy Exhibits Resiliency to Shocks ................................................................ 1 B. Social Development Outcomes Have Been Mixed................................................ 6 II. IMPROVING PUBLIC SECTOR PERFORMANCE..................................................... 9 A. Fiscal Performance and Revenue Mobilization ..................................................... 9 B. GOCC Performance and Contingent Liabilities ................................................... 11 C. Closing the Governance Gap............................................................................... 13 III STRENGTHENING PRIVATE SECTOR PERFORMANCE....................................... 16 A. Infrastructure Development.................................................................................. 16 B. Banking and Capital Market Development .......................................................... 18 C. Competition and Security of Contract.................................................................. 21 Tables: 1. Selected Economic Indicators 2. Social Indicators 3. National Accounts 4. Inflation Rates 5. Monetary Survey 6. National Government Operations 7. Consolidated Public Sector Deficit 8. Balance of Payments 9. Labor and Employment Acknowledgement This report is prepared by a team led by Lloyd McKay which included Joven Balbosa, James Villafuerte, and Marjorie Espiritu. Other major contributors were Miguel Navarro-Martin, Gaurav Datt, Chorching Goh, Arvind Gupta, Teresa Ho, Selina Shum, Idah Pswarayi-Riddihough, Amitabha Mukherjee, Sameer Goyal and Sanjay Dhar. Bernard Funck and Brian Pinto served as peer reviewers. Draft for Review Executive Summary The Philippines has achieved reasonable employment creation and poverty reduction economic growth of about 4 percent per being sustained. Indeed, the rate of annum over the past two years, in spite of investment has been so low relative to adverse global developments (e.g. slow expansion of the labor force that the ratio of world economic growth, depressed demand capital per worker has fallen--in marked for electronics, the war in Iraq, and SARS), contrast to other rapidly developing countries sporadic conflict in Mindanao, political such as Thailand. And questions about the uncertainty and investor concerns regarding quality of education amplify the concerns with fiscal sustainability. Moreover, this growth stagnation of labor productivity. has been geographically widespread, with agriculture and service sector growth being In recent years it has been consumption particularly prominent. As a result, poverty rather than investment that has underpinned is being reduced, but the high population growth, and this cannot continue indefinitely. growth rate means that per capita GDP has This relatively strong growth of domestic only grown at about 2 percent per annum consumption, coupled with a slowdown in and poverty reduction has been modest. export growth in 2003 and a lack of capital inflows has increased pressure on external The economy has been particularly resilient balances and the Peso. In fact, the Peso has in view of concerns regarding fiscal depreciated by 4 percent against the management and the limited recovery in weakening US dollar over the past two years investment since the 1997 Asian financial while the Thai Baht, for example, has crisis. As acknowledged by government appreciated by 8 percent. However, and economic analysts alike, the expansion continued strong overseas worker of the National Government (NG) deficit to remittances (more than $8 bn per annum), 5.3 percent of GDP in 2002, and the five the prospects for a rise in export growth if the year decline in tax revenues to below 12 Philippines can effectively link with China's percent of GDP posed a major challenge. growth, and renewed investment as political Progress has been made in 2003 in turning uncertainties wane and there is sustained around both these trends through tight peace, could reverse this pressure and expenditure control in the first half of the contribute to higher growth. year and a concerted improvement in tax administration. But it will take several years Sustained geographically dispersed economic of good progress to recreate a reasonable growth and relatively stable prices (inflation of level of fiscal flexibility, bring the fiscal 3-4 percent per annum) have resulted in a deficit to GDP and the debt to GDP ratios decline in poverty. And there has been down, rebuild market confidence and thus reasonably good progress with most of the reduce bond spreads and real interest rates Millennium Development Goals (MDGs) since to previous levels, and increase resources 2000. The percentage of Filipinos living on for social expenditures and strategically less than $1 per day is projected to have important public investments. fallen from about 13.5 percent in 2000 to 11.2 percent in 2003, while the percentage living The persistent low levels of investment ­ on less than $2 per day is projected to have below 20 percent of GNP compared with fallen from about 47 percent to 44 percent. about 23 percent in the early to mid 1990s - Others MDGs for which there is a high raises concerns about future growth. probability of success are access to water, Without a rebuilding of investor confidence universal primary education, gender equality and parallel rise in investment, it is difficult in access to primary education, reducing child to envisage the hoped for rapid growth, mortality, and stopping the spread of i Draft for Review HIV/AIDS. The two where extra effort politicized regulatory environment. The appears to be needed for the goals to be prospective deficits of the largest reached are halving the proportion of government-managed pension fund (SSS) underweight children and reducing maternal also need to be addressed. Recent mortality by 75 percent. measures, such as a one percentage point increase in contributions, are helpful, Both the public and private sector will need but will need to be complemented by to contribute for the Philippines to more fully further actions to achieve financial achieve its development objectives. Three sustainability of the Social Security issues are central to improved public sector System. performance ­ fiscal management · Improve governance. Third, efforts to (especially revenue mobilization), off-budget losses and contingent liabilities (GOCCs improve public sector governance need to and pension funds), and governance: continue to improve the efficiency of resource use, help rebuild investor · Increase revenues while containing confidence, and enhance peace and expenditures. As the tax revenue to personal security. Recent finalization of GDP ratio had fallen from over 16 implementation arrangements for percent in 1997 to less than 12 percent procurement reforms will help, and in 2002, the welcome improvement in reforms under way for the judiciary are mid 2003 is just a beginning. Ongoing widely acknowledged. So too are the efforts to further improve tax planned civil service reforms, well administration must be continued and researched lifestyle checks of government need to be complemented by legislative officials and efforts to increase audit actions to sustain a recovery in the tax effectiveness. Overall, though, there is a to GDP ratio of 0.5-1 percentage point need for continued vigorous efforts to per annum for the next few years. As enhance public sector governance and planned this should include restoring the reduce corruption as part of the effort to real value of excise taxes and rebuild confidence, increase efficiency preventing them from again being and improve the rule of law. eroded by inflation. And tax-based investment incentives need to be limited Mindful of the Philippines' relatively poor to contain tax losses. Without a competitiveness coupled with the fact that recovery in revenues and the continued growth, employment creation and poverty containment of recurrent expenditures, reduction depend critically on private sector government would continue to lack the performance, this update has focused on necessary resources to improve human three key investment issues ­ infrastructure, resource investments, protect the poor, the financial sector, and competition. and address critical shortcomings in Improved private sector performance infrastructure. depends on success with actions in these · Reduce off-budget public sector areas to complement macroeconomic losses. The ballooning expansion of stability, efforts to enhance peace and NPC losses needs to cease and off- security, and reduced uncertainty: budget losses as a whole decline to · Improve infrastructure. The importance avoid offsetting the hard-won gains in of accelerating efforts to alleviate NG fiscal management. The objectives infrastructure bottlenecks and reduce the of the power sector reforms need to be cost of infrastructure services is widely realized through transparent acknowledged. This calls for further privatization, stronger governance in privatization of infrastructure, a stable and GOCCs awaiting privatization, and credible regulatory environment for private reinforcement of a credible, non- providers of infrastructure in transport, ii Draft for Review water, power and telecommunications, capital markets calls for further and an increase in maintenance and improvements in property, shareholder investment from private and public and creditor rights, insolvency laws and sources. corporate governance. · Strengthen the financial sector. · Strengthen competition. To increase Ongoing efforts to strengthen and investment the Philippines also needs to deepen the financial sector need to keep pace with other developing countries succeed to support improvements in in terms of the investment environment. productivity and the much needed To enhance productivity, markets need to recovery in investment. Efforts under be contestable. Investment needs to be way to reduce the burden of non- rising, but in response to market performing loans on banks need to incentives and opportunities. In this succeed to reduce risks, enable banks context, it is important that the temptation to expand lending, and reduce margins. to role back import tariff rates to And further banking sector reforms, previously higher levels be resisted as this including increased authority and legal would impede competition and implicitly protection for bank regulators, are still tax exports. Barriers to entry need to be needed to facilitate the rapid resolution reduced, and efforts under way to of distressed banks and bring the strengthen transparency, corporate Philippines in line with international and governance, contract security and regional best practices. Strengthening investor rights need to succeed. non-bank financial institutions and Summary of Key Priorities ­ The Ten Most Needed · Increase the tax to GDP ratio by at least 0.5 percentage points per year. Supportive measures should include continued vigilance on tax administration, appropriate legislation on excise taxes and tightening the investment incentive regime. · Reduce NPC and other GOCC losses to avoid them offsetting hard won improvements in NG fiscal management. · Articulate a vision for making the pension funds financially sustainable and progressively implement it. · Press ahead with plans for civil service reform, including rationalizing, de- politicizing, professionalizing, and moving to a meritocratic system. · Accelerate efforts, such as the power sector reforms, to alleviate infrastructure bottlenecks and reduce the cost of infrastructure services. · Facilitate a reduction of non-performing loans in the banking sector and associated corporate restructuring. · Further strengthen property, shareholder and creditor rights to help deepen capital markets. · Resist pressure to increase import protection, but instead, press on with efforts to increase productivity, market competition and competitive behavior. · Improve the quality of basic education, and ensure resources for priority health programs including reproductive health. · Enhance peace and personal security. iii Draft for Review I. RECENT ECONOMIC AND boost to services. Transferring public SOCIAL DEVELOPMENTS holidays to create additional long weekends has also encouraged the growth in local A. Economy Exhibits Resiliency to travel and domestic tourism (Figure 1.2) Shocks Figure 1.2: Services lead growth Output 8.0 % p.a. Over the past two years, the Philippines has 6.0 achieved reasonable though modest economic growth (4.4 and 3.9 percent per 4.0 annum for GDP in 2002 and the first half of 2.0 2003)1 with services sector and agriculture growth being particularly prominent. And this 0.0 has been achieved in spite of adverse global -2.0 and domestic developments, such as slow Q101 Q201 Q301 Q401 Q102 Q202 Q302 Q402 Q103 world economic growth, weak demand for GDP Industry Service Agriculture electronics, war in Iraq, SARS, renewed Source: NSCB conflict in Mindanao and political uncertainty. Indeed, since 2002 the Philippines performed at par with most Southeast Asian economies Solid growth in agriculture (3.3 percent in (Fig. 1.1). Moreover, this growth was 2002 and 2.4 percent in the first half of 2003) geographically dispersed with 12 out of 16 occurred without the benefit of ideal weather regions posting growth. On average, per given the prolonged spell of el nino. This capita GDP has grown at about 2 percent per performance appears to be attributable to a annum (Figure 1.1). number of factors - larger public outlays since 1997 for irrigation systems, post- Figure 1.1: Economic growth is reasonable harvest facilities, and agricultural extension services, the application of fertilizers, the use of hybrid crop varieties and the wider 6.0 % p.a. adoption of modern farming techniques. 5.0 Agricultural production also expanded in response to the upswing in the prices of key 4.0 agricultural commodities and credit provided 3.0 by banks and micro-credit facilities. 2.0 Manufacturing growth has been relatively 2001 2002 2003 2004 broad, with 13 out of 20 sectors enjoying an Philippines South East Asia increase. Growing sub-sectors include Indonesia Malaysia metals, machinery except electrical, products Source: WB Forecast of petroleum and coal, chemicals, paper and paper products, textile, footwear and food A large proportion of this growth has taken manufactures. These industries have grown place in the services sector (5.4 percent due to rising demand for industrial products. growth in 2002 and 5.3 percent in the first half of 2003) where telecommunications, Demand was underpinned by the sturdy transportation, and the trade sectors have growth of private consumption (4.1 percent in 2002 and 5 percent in the first half of 2003) grown strongly. In particular, the demand for which has been sustained by a healthy inflow wireless services, roll-on-roll-out transport of factor income from abroad, particularly schemes, and cargo handling, rose overseas worker remittances which have significantly, while recovery in the housing grown by 17 percent in the first half of this and real estate sectors provided an extra year2. Remittances have risen on account of the growing pool of nurses, caregivers and IT 1The corresponding rates of growth for GNP were 5 percent and 4.6 percent. 2Remittances reached $4.5 billion from January-July 2003. 1 Draft for Review professionals abroad. Stable food prices, periods where marked declines in capital have supported a bigger volume of stock per worker were observed. The first household spending for food, housing, and from 1983, to 1986 during the liquidity crisis utilities. A significant reduction in lightrail when the country defaulted on debt. The fares in Manila triggered substitution in second came after the Asian crisis when transport demand, with people shifting to there was a large capital outflow and investor lightrail. Moreover, with more open borders, confidence has been slow to recover. As a this strong consumer demand is reflected in result, the Philippines now has one of the strong import growth (Figure 1.3). lowest capital stock per worker among market economies in Southeast Asia3. In contrast, Thailand's capital stock per worker, Figure 1.3: Consumption underpins growth which was only half of the Philippines' in (percent per annum) 1970, exceeded that of the Philippines by 1990 (Figure 1.5) 9 Figure 1.4: Capital stock per worker falls 4 (in US dollars) -1 Q102 Q202 Q302 Q402 Q103 Q203 -6 4000 3900 -11 3800 3700 GDP Private Consumption 3600 Net Exports Domestic Demand 3500 3400 Source: Computed from NSCB Data. 3300 80 82 84 86 88 90 92 94 96 98 00 02 In mid-2003, however, the pace of growth Liquidity Power crisis Financial moderated, with GDP growing at 3.2 percent crisis crisis compared to 4.5 percent growth in the Source: Computed from NSCB second quarter 2003. This slowdown has emanated from the adverse effects of weak external demand on exports, drought on rice and corn production, and tighter government Figure 1.5: Philippine capital stock per spending. Export growth tumbled as import worker lags behind (in US dollars) demand from industrialized countries 30,000 6,000 contracted. Trade in Asia was also severely 25,000 5,000 affected by SARs. The tight fiscal budget 20,000 4,000 has reduced capital outlays for such activities 15,000 3,000 as water supply, irrigation and roads. And 10,000 2,000 fiscal austerity measures have also 5,000 1,000 weakened public spending on social 0 0 services. 70 72 74 76 78 80 82 84 86 88 90 Structural weaknesses have also contributed HKG (left) KOR (left) PHL (right) THA (right) to this slow-paced growth. In recent years, Source: Easterly and Ross Levine.Dataset. the consistent growth in output combined with the low rate of capital replacement has depleted the country's excess production capacity. The share of investment to GDP has fallen from a high of 25 percent in 1997 3The computation of capital stock for the Philippines to around 20-21 percent from 2000 to 2002. was based on the method described in Easterly, W. and Together with rapid population growth, this Ross Levine, "It's not factor accumulation: stylized facts has led to a fall in the capital stock per and growth models." The country comparison was based on the original dataset obtained from Easterly and worker being stagnant or falling over the past Levine. 20 years (Figure 1.4). There were two 2 Draft for Review At the same time, the unbalanced demand On the capital account, the small inflow of structure suggests that the present growth portfolio and equity investments, weak credit path may not be sustainable. At present, disbursement from official sources, and large approximately 80 percent of growth comes debt amortization suggest a larger than usual from private consumption. Investment and outflow of capital. Investment inflows have Government consumption make very modest remained low due to weak exports and an contributions to growth. As the trade balance uncertain political environment. From has moved for positive to negative, net January-June, FDI inflows had fallen by exports have made a negative contribution to around 90 percent from US$0.9 bn during a growth. The concentration of growth in comparable period last year to US$0.1 bn consumer demand and services has been this year. In the first six months of this year, associated with imports rising more rapidly a net capital outflow of $2.4 bn was recorded than exports. In the first five months of 2003, in contrast to a net inflow of $1.7 bn last year. imports of consumer goods rose by almost Net official flows have slowed due to rising 21 percent. To date, only the strong inflow of amortization payments and delays in utilizing remittances is offsetting the deterioration in project loans. For this year and next, it is the trade balance. If overseas worker expected that the country will make net remittances were to weaken, the current repayments of about $2 billion to official account balance and Peso would be further creditors. pressured. Figure 1.6: Trade balance weakens (in Trade & Balance of Payments percent [lhs], in USD mn [rhs]) During the last two years, the tentative global 50 400 recovery, coupled with cyclical volatility in 40 electronics has weakened exports. This was 200 30 further exacerbated by SARs which affected 20 0 demand from within East Asia. On a year-on- 10 -200 year basis, merchandise exports grew 1 0 -400 percent in the first seven months of 2003, -10 compared to the 14 percent growth in the -20 -600 second half of 2002. The drop in exports was Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul pronounced for electrical equipment, parts & telecommunications (-7.5%), travel goods 02 03 and handbags (-23.4%), and footwear (- Trade balance (rhs) Exports (lhs) 12.5%). Exports to major markets have also Imports (lhs) contracted ­ US (-16%), Taiwan (-16%), Source: NSO Singapore (-8%), Netherlands (-6%), and Korea (-2%). On the import side, increases in oil prices, higher demand for oil inventories, The combined effect of this is that the increased imports of capital goods, and the balance of payments have registered a net more expensive cost of transport and outflow of $0.6 bn for the first half of 2003, insurance contributed to a 16.6 percent compared with a net inflow of $1.7 bn last growth in imports4. These two factors, year. Sovereign and private bond issues together, resulted in a reversal in the balance offset this but at still relatively expensive of trade from a surplus of $0.8 bn in the first terms ­ of around 370 basis points for half of 2002 to a deficit of $1.5 bn in the first Eurospreads. Overall, the perceived risk to half of 2003. In spite of this, and due to the the country's external position is manifested offsetting inflow of remittance, a current in the bond spreads which have remained account surplus equivalent to 2.1 percent of one of the highest in the region (Figure 1.7). GNP was still recorded for the first half of this year (Figure 1.6). Immediately after the financial crisis in 1997, the maturity period for new debt was shortened to five years, resulting in repayments for this and loans incurred in the 4The import value of oil rose 42%, capital goods rose early 1990s, when the country borrowed 16.6%, and consumer goods rose 21.3%. 3 Draft for Review heavily to avert a power crisis, being heavily about personal security have undermined concentrated in 2003 and 2004. As a result, business confidence. Based on the August the ratio of debt service to exports has gone 2003 business confidence survey, 76% of up by more than a percentage point from respondents did not have expansion plans. 20.6 percent to 22 percent this year. In a similar vein, the leading economic indicators for the third quarter of 2003 have Figure 1.7: Eurospreads still high (in basis weakened with declining energy points) consumption, falling imports, softening producer prices, declining sales volume and a depreciating Peso. 600 500 400 Money, Prices and the Peso 300 200 During the last two years, monetary policy 100 has generally supported growth. Since 2001, - the central bank has cut policy interest rates Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep ten times, bringing the rates down by 225 2002 2003 basis points. A tiering deposit system was also introduced and effectively lowered the THA MYS INO PHL yields on deposits with the central bank5. Source: Haver Analytics The central bank has also reduced the reserve requirement by two percentage points. The result from this monetary Investment and Savings expansion was a fall in the average bank lending rate by 350 basis points, and private During the last three years, gross national sector credit growing again after contracting savings as a proportion of GDP has been in 2001. reported at 24-27 percent, largely on the back of strong inflow of remittances from Inflation for the first nine months of 2003 abroad (Table 1.1). In part, this pool of remained well below target and at par with savings was used to accumulate foreign last year's rate at around 3 percent. Due to assets. The public sector has also utilized ample liquidity and low inflation, and cuts in private savings to finance the budget deficit. the policy rate by the central bank, domestic interest rates have fallen substantially in nominal terms. The 91-day treasury bill rate Table 1.1: Investment stagnates fell from almost 10 percent in 2001 to around 5.4 percent in 2002 and lending rates dipped from 12.4 percent in 2001 to 8.9 in 2002. As % of GDP 1999 2000 2001 2002 Between February to May 2003, rates crept Gross domestic saving 14.3 17.3 18.1 19.5 up marginally but have trended down again Gross national since. It is notable, however, that the spread saving 21.7 24.2 25.4 26.8 between the deposit and the lending rate has Gross domestic widened and remains one of the highest in capital formation 18.8 21.2 20.6 19.3 the region (Figure 1.8) Fiscal Balance -3.8 -4.1 -4.0 -5.2 Source: Computed from NSCB Despite the availability of savings, however, domestic investments continue to suffer from the negative effect of a poor investment 5The tiering system was first introduced in August 2001 climate, and a contraction in public to encourage bank lending and to support the issuance of treasury bill rates. The tiered rates offer different investment. In addition, perceptions of fiscal yields to different volume of deposits, i.e., P5 billion and external vulnerability, regulatory and deposit gets 7 percent, P5-10 billion gets 4 percent, and political uncertainty, corruption, and concerns deposits greater than P10 billion received only 1 percent. This tiering was removed in mid 2003. 4 Draft for Review Figure 1.8 Inflation modest Table 1.2: Local currencies/USD 8 Depre- 15% 2001 2002 Sep ciation 03 from 2001 12% Average lending level 9% Phil. Peso 51.6 53.4 55.2 -6.5 Singapore $ 1.8 1.7 1.8 5.2 6% Thai Baht 44.2 43.1 40.5 9.3 Inflation rate Indo Rupiah 10,400 8,950 8,463 22.9 3% Source: Concensus Economics, Sept. 2003 0% Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Employment 02 03 The large number of unemployed and Source: BSP, NSO underemployed have historically reflected the absence of sustained, rapid economic growth In contrast to most regional currencies which amidst high population growth. In the last have appreciated vis-à-vis the US dollar, the four years, the labor force has grown by 3.4 Peso has depreciated in 2003 (Table 1.2). percent per annum, compared to the 3.1 This weakness can be traced to a number of percent growth per annum in jobs. Another factors including fiscal performance, weaker factor that explains the labor market than expected export growth, security imbalance is the significant recovery in the concerns, and political uncertainty. To arrest labor force participation rate (LFPR). LFPR the slide of the currency, the central bank rose from about 65 percent in 2000 to 67.4 has taken precautionary measures including, percent in July 2003. Mostly, these people the reduction of the maximum tenor of reentered the labor market based on the forward contracts, limitation on the foreign perceived improvement in employment exchange overbought positions of banks, and opportunities. The quality of employment is increasing the outstanding short position of also often low as the numbers of own- the central bank in the non-deliverable account workers and unpaid family labor forward contracts. accounts for more than half of those employed. Figure 1.9 Peso weakens again (Peso/USD[lhs], Index [rhs]) Weak labor market institutions also contribute to the unsatisfactory level of employment. These institutions are intended to promote job facilitation, training and 56 180 retraining, social dialogue, and social REER (rhs) security. However, except for promoting 55 175 social dialogue, their achievements have 54 170 been modest. For job facilitation, the absence of institutional information on job 53 165 vacancies has resulted in a small number of 52 workers being placed. Technical Education PhP/USD1 (lhs) 160 and Skills Development Authority (TESDA) 51 155 and Commission on Higher Education 50 150 (CHED) have had limited manpower compliment, management capability, and Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep financial resources for training and retraining 02 03 activities. In terms of social security, records Source: BSP on labor standards show that only a limited number of institutions are being inspected and only a small portion of those inspected 5 Draft for Review are complying. Thus, the only significant Table 1.4: Headcount index (%) and number success appears to be in promoting effective of the poor, 1997 - 2004 labor market conciliation which has contributed to a peaceful labor market as 1993-PPP- Number 1993-PPP- Number evidenced by the small incidences of labor Year US$1/day, living US$2/day, living below below disputes (28) with very limited man-days lost % below (mn) % below (Mn) (128). 1997 12.1 8.6 45.2 32.3 2000 13.5 10.3 47.1 35.9 Table 1.3: Labor force and employment 2001 12.2 9.5 45.8 35.6 2002 11.9 9.5 45.3 36.0 July July 02 03 2003 11.2 9.1 44.3 35.9 (000) Total 15 yrs old & over 50.5 50.7 Source: World Bank Labor Force 33.9 34.2 Employed 30.1 29.8 Note: Years 1997 and 2000 are based on actual data Unemployed 3.8 4.3 from Family Income and Expenditure Surveys, years Underemployed 5.1 6.2 2001-2004 are Bank Staff's projectors. (percent) LF Participation rate 67.1 67.4 Projections of poverty changes suggest that Employment rate 88.8 87.3 Unemployment rate 11.2 12.7 the incidence of poverty has again begun to Underemployment rate 17.1 20.8 fall since 2000. Growth of 4.0-4.5 percent Source: NSO per year and the geographically widespread nature of this growth leads to this projected fall in the incidence of Filipinos living on less B. Social Development Outcomes Have that $1 per day ($2 per day) from 13.5 (47.1) Been Mixed percent in 2000 to 11.2 (44.3) percent in 2003. Poverty Social Weather Station's recent self-rated Notwithstanding the achievement in poverty data supports this observation. After economic growth, the performance of the attaining a peak of 66 percent in mid-2002, it country in terms of social development has has fallen to 53 percent in mid-2003 (Fig. been mixed. In the 1990s poverty fell 1.10). significantly as the share of Filipinos living on less than $1 per day feel from 19.1 percent in Figure 1.10: Self-rated poverty falls 1994 to 12.1 in 1997 and as per capita GNP (in percent) grew 3 percent during the period 1995-1997. During this period the elasticity of poverty 68 reduction with respect to growth was high as 66 growth in services and construction facilitated 64 62 the transfer of labor to the more advance 60 sector. Thereafter, between 1997-2000, 58 poverty increased due to lower growth, 56 54 especially in labor absorbing activities such 52 as construction. 50 Mar Jul Sep Nov Mar May Sep Nov Mar Jun 01 02 03 Source: Social Weather Station On a regional basis, the disparity in income is still stark. Based on government data, the 10 poorest provinces are found in the ARMM, Cordillera, and Bicol regions. These areas are frequented by armed conflict, are 6 Draft for Review economically isolated, and are endowed with mortality; e) improve maternal health; and f) little infrastructure6. Among the four poorest combat HIV/AIDs, malaria and other provinces, poverty incidence ranges from 53- diseases. Based on the most recent review, 63 percent based on the government's six out of the eight basic targets under these income measure. In comparison, the least goals have a high probability of being poor provinces has poverty incidence ranging attained. These are: a) halving the proportion from 5-12 percent. Not surprisingly the of people below the poverty threshold; b) poorest regions also experience the worst halving the proportion of people without gap and severity of poverty. access to clean water; c) achieving universal primary education; d) attaining equal access Table 1.5: Poverty measures of the poorest for boys and girls in primary school; e) provinces, 2000. reducing child under-5 mortality by two- thirds; and f) stopping the spread of Poverty Gap Poverty HIV/AIDS, malaria and tuberculosis. Two Headcount (%) (%) Severity (%) targets - hunger (halving the proportion of underweight who are under five years old) Based on Expendi Income Expen Income Expen Income ture diture diture and maternal health (reducing maternal mortality by three-fourths) - are not likely to Provinces be met as the current rate of progress is very Masbate 70.8 62.8 24.2 22.6 10.4 10.6 low. Among outstanding issues which needs Romblon 74.3 55.2 23.6 18.5 9.8 8.2 to be addressed are: Tawi Tawi 75.3 56.5 25.7 15.4 11 5.6 · Eradicate Extreme Poverty and Hunger - Sulu 92 63.2 37.1 17.1 16.9 5.8 despite the significant reduction in Source: NSCB subsistence poverty there are still 2.5 million households who are food poor Occupational choice and education play an and the proportion of stunted children is important role in the determination of poverty. high. Six out of ten poor families are in agriculture. Equally notable, fifty percent of the poor have · Achieve Universal Primary Education - very little education. More importantly, the the gender neutral and almost universal consumption shortfall for the uneducated enrollment rates have masked the poor was twice that of the poor with primary problem in educational effectiveness or education and five times that of the poor with quality (see Table 1.6). high school education. Table 1.6 Quality of education is poor Millennium Development Goals Countries Average Scale Score Sustained economic growth, stable markets Taiwan 569 and strong commitment from the government Singapore 568 have generated substantive progress in Korea 549 Hongkong 530 attaining most of the Millennium Malaysia 492 Development Goals (MDGs)7. This section Thailand 482 reviews six out of the eight goals which are Indonesia 435 closest to human development, namely: a) Philippines 345 Intl. Ave. Score 488 eradicate extreme poverty and hunger; b) Source: TIMSS achieve universal primary education; c) promote gender equality; d) reduce child · Reduce Child Mortality - while average child health has improved, the disparity 6 of health status across income groups For instance, renewed conflict in Mindanao has displaced over 100,000 people. The per capita income and geographic locations has not of ARMM is 40 percent of that for Mindanao and only narrowed. 12.6 percent of that for National Capital Region. Six out of the ten poorest provinc es on the official list are in · Reduce Maternal Mortality - maternal Mindanao. mortality rates in the Philippines have 7 This section draws primarily from the UNDP Progress remained one of the highest in the Report of January 2003, Philippines Progress Report on the MDGs. region. Regional disparity is also high 7 Draft for Review with mortality rates in ARMM almost (in percent) three times that for the National Capital Region. The devolution of health care services continue to pose a threat to maternal health care. Proportion of families living in extreme poverty · Combat HIV/AIDS, Malaria, and 23 Tuberculosis - while HIV/AIDs is under control, Malaria and Tuberculosis 18 continue to be primary health concern especially for the high-risk groups, i.e., 13 indigenous people, upland subsistence farmers, forest workers, and migrant 8 agriculture workers in the remote areas. 1991 2000 2015 There is a need to increase capacity of local health programs to handle the % of families w/ access to safe water prevention and control of malaria and tuberculosis. 90 85 The government's commitment to the MDGs 80 and to programs that emphasized poverty 75 issues is commendable. These programs, together with growth, have improved human 70 development outcomes reduced poverty 65 substantially since the early 1990s. 1991 2000 2015 However, moving forward, income inequality remains acute, and disparity in health and Under-5 mortality rate education outcomes, and access to services 100 are wide between income groups and 80 provinces and need to be reduced. To do this, there are needs for further analytical 60 work, a review of existing policies, and 40 consultation in defining priority areas of 20 public action for equitable growth and focused poverty programs. Several 0 important areas include creating an 1990 1998 2015 investment climate with a stable macroeconomic environment conducive to growth; improving governance and reducing corruption; promoting and sustaining regional peace in areas of conflict; addressing issues in agriculture to improve rural livelihoods; improving human capital by ensuring the poor have access to quality education and health care; and improving access to basic infrastructure such as water, sanitation, transport, power and communications. Figure 1.11: MDG goals are attainable 8 Draft for Review II. IMPROVING PUBLIC SECTOR Figure 2.1: NG revenue outpace expenditure PERFORMANCE (% yoy, 3-month moving average) 25% The National Government (NG) achieved an 20% important turnaround in its fiscal performance 15% in the first eight months of 2003. Government 10% spending has, however, accelerated in the 5% 0% third quarter and will have to be checked if -5% the NG deficit target is to be met. Moreover, Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug this improving NG performance is being 02 03 undermined by rising deficits of government owned and controlled corporations (GOCCs), Revenue Expenditure emanating primarily from losses in the power Source: Bureau of Treasury sector. As a result, the consolidated public sector deficit (CPSD) is expected to continue improved collections. At the BIR, on-going to grow in 2003, adding to the debt stock, administrative reform efforts have had a and ultimately, threatening to crowd-out positive effect. Beginning early this year, the needed social expenditures to the poor. bureau has implemented a five-point strategy in boosting collection: A. Fiscal Performance and Revenue Mobilization 1. More effective compliance control systems. This includes electronic-based For the first eight months of 2003 the NG tax collection and monitoring systems, fiscal deficit amounted to P114 billion, P14 resolution of pending court cases, and billion below target. For the same period, review of tax exemption rulings, tax revenues reached P408 billion, P25 billion refunds, use of VAT input credits, income above target, or 12.4% higher than the same tax holidays, and net-operating-loss- period last year. Expenditures reached P522 carryover policies. billion, P11 billion or 2.2% above program, 2. Detection and reduction of revenue and 3% higher than last year's level (Figure leakages. The expansion and better 2.1). The turnaround in revenue utilization of existing third party performance is quite significant, particularly information databases of the BIR, and in the context of declining tax revenue8 for enhancement of existing detection five consecutive years. systems that cover stop filers tracking, delinquent accounts and case Underpinning this increase in revenue was a management systems. 13% increase for the Bureau of Internal Revenue (BIR) and a 14% increase for the 3. Intensified enforcement focusing on pro- active and computer assisted audits; and Bureau of Customs (BOC). Revenue special operations on professionals and collections at the BOC improved as measures were put in place to improve trade self-employed (e.g., doctors, lawyers, and other professionals). A very visible facilitation, track revenue collection from the component of this strategy is the "BIR on major ports, and promote transparency and accountability. The upsurge in oil imports in Wheels" program, where BIR staff wearing conspicuous red shirts visit malls the early part of the year and the weakness and market areas to check tax records of of the peso have also contributed to various establishments. 4. Organizational adjustments. Review of 8 the Large Taxpayer Service unit (LTS), Tax revenue has deteriorated by about 5 percentage and regional district office operations, points of GDP since 1997. A mix blend of three factors is found to be responsible for the decline in tax revenue collaboration with the Presidential since 1997: 1) the slowdown in the economy in the Commission Against Graft and aftermath of the East Asia crisis and the El Nino Corruption (PCAGC) on life-style check9, phenomenon; 2) policy changes affecting tax collection ­ or in the case of excise tax es the lack thereof; and 3) administrative efficiency. 9The DOF recently filed a case in court against 3 BIR and 1 BOC officials under the life-style check initiative. 9 Draft for Review and linking up with Commission on Audit Figure 2.2: Rising NG debt service burden (COA), Board of Investments (BOI) and (percent of total expenditures) other regulatory agencies on tax compliance. 50 45 Interest payments + Amortization 5. Campaign with the private sector for 40 good and honest governance program. In 35 this initiative, the bureau has link up with 30 25 various private sector associations and 20 academe to improve awareness and 15 provide information on the efforts of BIR 10 Interest payments to raise revenue. 5 0 96 97 98 99 00 01 02 As commendable as these efforts are, sustaining the increase in tax effort over the Source: Bureau of Treasury medium term--which is essential given the extent of revenue decline since 1997-- will The combined constraint of debt servicing require more than administrative efforts and low revenues is also illustrated by the alone. These administrative efforts must be fact that the Philippines has a relatively high continued and complemented by legislated share of interest payments to revenues (28 changes in tax policy to further increase the percent) when compared with other countries tax revenue to GDP ratio. Obvious priorities (Figure 2.3). High and rising interest include legislative measures to adjust excise payments are a direct result of the high and taxes for liquor, tobacco and petroleum rising debt stock. As of end 2002, NG debt products to reflect movements in their prices reached USD 53 billion (71 percent of GDP), over time10 and rationalization of tax up from USD 46 (64 percent of GDP) in incentives given to various industries. 2001. In addition, NG reported contingent liabilities of USD 12 billion (15 percent of Expenditure management also needs GDP). continuing attention. Since the Asian crisis, the debt service burden of the national Figure 2.3: High share of interest payments government has steadily increased as a in revenue (% of total revenues, 2000) share of total expenditures, from 27 percent in 1997 to 46 percent last year (Figure 2.2). 30 28 24 Interest payments alone take up a quarter of 25 22 total expenditures, up from 17 percent in 20 15 1997. From January to August 2003, NG 15 7 interest payments comprised 28% of 10 expenditures, twice the size of capital 5 0 outlays. Increasingly, the much needed expenditure for social services, infrastructure Brazil and maintenance takes a smaller share of Philippines Argentina Indonesia Thailand the budget pie, endangering growth and Source: World Development Indicators 2003 poverty reduction objectives. Education expenditures are being compressed while it Reducing the debt to GDP ratio and ensuring is readily acknowledged that more resources fiscal sustainability depends critically on the are needed to improve the quality of primary fiscal balance, the difference education. And additional resources are between economic growth and the interest needed for priority public health programs, rate, the magnitude of off-budget losses and including family planning. privatization receipts. With the consolidated public sector debt at 124 percent of GDP by the end of 2002 and economic growth roughly equal with the real interest rate, the consolidated public sector balance11 needs to 10Tax rates for these products have been fixed per liter volume since 2000 despite changes in their retail prices over time. Thus, government tax collection has been 11 The NG primary fiscal balance (NG deficit less eroded over time by inflation. interest payments) plus the off-budget net balance. 10 Draft for Review show a primary surplus to reduce the government, the Energy Regulatory consolidated public sector debt to GDP ratio Commission (ERC), and the Supreme Court (Figure 2.4) This again highlights the have triggered additional losses in the power importance of increasing revenues as quickly sector. NPC had also incurred liabilities as possible and avoiding further large off- amounting to $18.3 billion and this expose budget losses as discussed below. the corporation to a heavy debt service burden -- $1.5 billion annually. Combined, Figure 2.4: Rising public sector debt these factors contribute to a high gearing (percent of GDP) ratio that is above the prudent corporate threshold. Over time the high cost of 140 Total public sector debt borrowing by the National Power Corporation (NPC) has led to the national government 120 increasingly borrowed directly to finance 100 NG debt + contingent liab. NPC's cash deficits, thus replacing loan 80 guarantees and the associated contingent 60 liability, with direct government liabilities. More recently, increases in retail and 40 NG debt less contingent liab. wholesale power rates are expected to begin 20 to address this problem. 0 97 98 99 00 01 02 Table 2.1: Consolidated public sector Source: DOF balance (peso billion) 2003 2001 2002 B. GOCC Performance and Contingent estimate Liabilities Total Surplus (+) / -167 -231 -291 Deficit ( - )12 -147 -211 -202 While NG fiscal balance performance is National Govt. showing improvement in 2003, the same CB restructuring -26 -15 -20 cannot be said of the consolidated public Monitored GOCCs -23 -46 -97 sector deficit (CPSD), largely because of o.w. NPC -8 -22 -73 rapidly growing losses in the power sector NFA -2 -8 -13 (Figure 2.5 and Table 2.1)12. In fact, SSS/GSIS 11 26 11 combined GOCC losses are projected to rise 5 4 1 by more than PHP 50 billion, thus more than BSP 5 5 4 offsetting the hard-won gains in the NG GFIs deficit. LGUs 4 3 1 Source: DOF The National Power Corporation (NPC) losses alone are now expected to rise from Figure 2.5: NG & consolidated public sector PHP 22 billion in 2002 to PHP 73 billion in balance (percent of GDP) 2003. Most of the financial problems of NPC are attributable to inadequate tariff 0 adjustments, inadequate capitalization, and -1 98 99 00 01 02 03 the high costs imposed by independent prog power producer (IPP) contracts signed in the -2 early 1990s. This has resulted in large -3 losses for NPC notwithstanding electricity -4 National Government tariffs that are high by regional standards. In -5 addition, a number of rulings by the -6 -7 Consolidated Pub. Sector 12DOF defines financing deficit to include net current -8 expenditure, capital expenditures, and net cash generation. The definition does not include amortization Source: DOF which is a substantial amount of the borrowing requirement of GOCCs. 11 Draft for Review Actions to reform the power sector have - Realignment of the role and progressed in a number of directions: the organization of the National Electric Power Industry Reform Act (EPIRA) Electrification Administration (NEA) to was enacted in 2001, which has permitted minimize government financial and the unbundling of the generation and risk exposure. transmission segments of the National Power Corporation's (NPC) operations and opening Another component of the CPS that will have up power generation to competition; and a profound impact in the medium term is the transmission company (Transco) has been pension system. The slow pace of pension created, the operation of which the reforms continues to be of concern. In government has attempted to privatize particular, the financial condition of Social through a concession contract. However, Security System (SSS), the largest pension uncertainty over the regulatory environment fund serving private sector employees, in the Philippines, the protracted delays in remains problematic. The actuarial valuation Congress' approval of the Franchise Bill, the of the reserve fund of SSS shows that benefit weak global investor appetite for investment payments have exceeded contributions in in the Philippine power sector, and adverse 1993 to 1995 and in 1999 to 2002. The rulings on contractual disputes have slowed deficit has been paid out from the pension implementation of the intended power fund reserve thus continuing to reduce the privatization and restructuring program. life expectancy of the fund at an accelerated pace, with complete depletion by 2015 if no Short-term action that could pave the way for further actions are taken. In an effort to a meaningful power sector reform could contain the short-term financial problems include: faced by SSS, some adjustments have been · Timely implementation of ERC decisions made including a 1% increase in the on power tariffs based on the principle of employers' contribution. These actions have full cost recovery with a reasonable alleviated the deficit situation but only return on investment. This would help partially and temporarily. A carefully planned restore the financial viability of the sector and phased-in increase in contribution rates and attract additional private investments together with other parametric and structural needed for economic growth. changes is needed to ensure SSS's medium and long-term viability. · Expedite passage of the Franchise Bill and negotiate only with qualified The Government Service Insurance System companies. The Government may need (GSIS) is facing a different problem. Despite to provide risk mitigation measures (e.g. current allegations that its finances are guarantee for termination payment in the deteriorating due to unpaid Government event of failure of Congress to approve premiums13, the reality is that GSIS has had the transfer of franchise within a specific several years of ample liquidity. Contributions time period). still exceed pension payouts and will · Expedite implementation of Wholesale continue to do so if more Government Electricity Spot Market. employees opt to retire under rule RA 161614 instead of retiring with a GSIS pension. As · Reduce the fiscal burden for rural such, the pension fund continues to grow but electrification through: investment income remains constrained by - ERC approval for a universal charge the lack of local investment instruments and for missionary electrification, thereby the continued deterioration of the stock and reducing the deficit of Small Power Utilities Group (SPUG) of NPC - Leveraging 13 One of the reasons cited by GSIS on why it cannot public funds with fulfill its loan-granting activities. increased private sector participation 14 Under RA 1616, a government employee eligible for through privatization of SPUG assets; retirement benefits has the option to choose a lump-sum use of management contracts for retirement fund paid for by the National Government, distressed electric cooperatives; and rather than the usual GSIS pension. In which case the GSIS keeps the premiums paid and does not have to invitation for qualified third parties to reimburse the National Government. accelerate barangay electrification. 12 Draft for Review real estate markets. This shortage has meant sector balance. Steps to reverse this trend that returns on investment are below the include: levels needed for long-term sustainability. GSIS needs to find alternative investment 1. Continuing and sustaining the gains in options (locally and/or abroad) for its excess government revenue mobilization of liquidity, diversify its portfolio and obtain government and supporting the gains better returns. In addition, GSIS needs to with legislative measures, such as, improve the management of its loan portfolio adjustment of sin tax rates, and and its management information systems. rationalization of fiscal incentives; The Local Government Units (LGUs) are 2. Facilitating the mandate of the PSALM another component of the CPS which is (Power Sector Assets and Liabilities worth noting. The 1991 Local Government Management Corporation) in the Code (LGC) provided the policy framework privatization of NPC generation assets, for the increased role of LGUs in the real estate, and IPP contracts, among provision of quality public services to the others, to ease the burden on the public. While demand for effective and national government in absorbing the efficient delivery of social services has stranded costs of the NPC; increased over time, the LGUs have 3. Tightening control of debt management continued to predominantly rely on national by national government over government transfers (i.e., the Internal Revenue corporations and greater selectivity in Allotment) to meet their financing needs, and providing guarantees to them. This may have not succeeded in mobilizing revenue entail changes in the charter of the from measures within their purview15. GOCCs; Success with efforts to strengthen LGU's own revenues will be important to sustain, 4. Improving the monitoring of contingent and expand LGU programs without further liabilities of the national government and adding to the burden on national government risks assessment; finances. 5. Action to ensure the financial viability of the pension funds; and GOCCs, pension programs and LGU finances all need to be addressed as part of 6. Accelerating efforts to improve local a comprehensive program to strengthen government revenue mobilization. public finances and avoid growing off-budget needs off-setting improvements in national C. Closing the Governance Gap government finances. Without improvement in overall public sector finances, the The Philippines continued poor ranking on consolidated public sector financing needs international corruption ratings reinforces the are in danger of crowding out a recovery in general perception that institutional private investment and limiting the prospects weaknesses persist in such key areas as the for higher growth. judicial system, enforcement of the rule of law, expenditure management, public In summary, recent fiscal performance shows financial accountability and management, improvement in the national government's and the civil service. Since the present fiscal position reflecting commendable gains administration assumed office on a platform in tax administration and tighter spending in of anti-corruption and good governance the first eight months of 2003. However, the programs, progress has been uneven, recent collective performance of other public though much has been done to improve sector entities has offset these hard-won governance. Key measures and gains from the NG so there has been a achievements are outlined below. further deterioration in the overall public Judicial reform. Over the past four years, the judiciary has prepared a reform program 15This is discussed in-depth in an ongoing joint World to address shortcomings in access to justice, Bank-Asian Development Bank study (Philippines: Decentralization and Service Delivery, Report no. corruption, weak administrative structures 26104-PH). and operating systems, deficient court 13 Draft for Review technologies and physical facilities, accounting system (NGAS). The NGAS aims underdeveloped human resources, and to simplify government accounting, bring it limited public understanding, and has begun into closer conformity with international to implement it. This reform program, the accounting standards, and generate timely Supreme Court's Action Program for Judicial and accurate financial statements for better Reform (APJR), includes institutional reform monitoring. The NGAS has several features (e.g., procedural, administrative, and that make it a significant improvement, management), together with improvements to including a modified accrual accounting supporting technology, infrastructure and basis, improved accounting for assets, the human resources. adoption of a single fund concept and a simplified three-digit chart of accounts. A key Procurement reforms to improve public challenge now is the timely provision of expenditure management. From 2000 to technical advice and implementation 2002, outlays for procurement of goods, assistance to the many national and local works and services by national agencies, government agencies. LGUs and GOCCs averaged more than PhP115 billion annually. Although no reliable Internal audit. Internal auditing is not a well- estimates are available of losses due to developed function in government agencies, public sector procurement-related corruption, although internal audit units are authorized the perception of large leakages persists. An under the Internal Audit Code. With 11,000 October 2001 study by Procurement Watch auditors under COA, a careful study needs to Inc. indicated that the potential leakage be carried out before embarking on a through procurement corruption could have program to universally establish internal audit been about PhP 95 billion in 2001, an units. Such a study would review the transfer amount that the DBM noted could have of some of the routine audit functions from funded the DepEd twice over or build more COA to internal audit units and the than 500,000 houses. The experience of implications for COA staffing needs. textbook and drugs procurement under World Bank-financed projects indicates that the Lifestyle or asset consistency checks. As adoption of improved procurement processes part of efforts to promote integrity by and practices can reduce prices by about 40 strengthening the threat of detection and percent. retribution for misbehavior, the Department of Finance and the President's Office has The new Government Procurement Reform initiated asset consistency checks. Tax Act, signed into law in January 200316, is a collection officers have been an early focus key government achievement. This law of this effort and it has already lead to simplifies pre-qualification procedures, several prosecutions. When carefully encourages electronic procurement, reduces researched and well documented, such officials' discretion on bids and awards, independent asset checks can help enhance establish a Government Procurement Policy integrity. Board for oversight and regulation of government procurement, protects Civil service reforms. Given the pressing procurement officials from unjust legal suits fiscal constraints, it is clear that the size and arising from the performance of their duties, cost of the civil service requires review and and imposes criminal and civil liabilities for adjustment as a priority. The key civil service those found guilty of collusion. The constraints are long-standing and well-known implementing rules and regulations (IRR) for to policy makers: many civil servants are paid this Act was issued in September. relatively low salaries, shortcomings in personnel information and the control Strengthening accounting, reporting and system, large numbers of political financial controls. The Commission on appointees17, and institutional capacity. Audit (COA) has begun phased implementation of a new government 16Implementing rules and regulations were issued 17Appointments to about 11,000 positions are made in September, 2003. directly by the President. 14 Draft for Review Establishment control is relatively weak despite efforts in recent years to control recruitment and impose selective hiring freezes. At present, there is no reliable method to verify information on the number of filled and unfilled positions. The DBM, Civil Service Commission and the GSIS currently maintain their own personnel information databases, but these are not integrated with each other. The situation is exacerbated by the employment of a considerable number of non-permanent staff such as casuals and contractuals, particularly at the LGU level. Low salary levels for executives in the top pay grades and for some professionals in the middle grades have made it difficult to attract and retain key categories of personnel, such as lawyers, auditors, IT professionals and doctors. And allowances are often non- transparent and do not fulfill their objectives. Key steps in controlling the wage bill could consist of expediting the establishment of a workable personnel information system, and deciding on fiscally affordable compensation improvement and rightsizing options. Administrative streamlining and consolidation would need to accompany employment and compensation adjustments. Expediting national government initiatives to streamline the structure and functioning of the central executive would be appropriate. Starting and sustaining the transformation of the BIR would be widely seen as a litmus test of the government ability, willingness and resolve to implement core institutional reforms. The Civil Service Commission (CSC) has drafted a new Civil Service Code (now under legislative review) focusing on merit-based recruitment; competitive compensation within fiscal constraints and linking compensation to performance; protecting civil servants; and strengthening accountability and integrity mechanisms. Measures to strengthen the merit-based competencies of public servants could help in de-politicizing their ranks and ultimately contribute to a more effective delivery of public services. 15 Draft for Review III. STRENGTHENING PRIVATE subset of key, namely, infrastructure; banking SECTOR PERFORMANCE and capital market; and trade, competition, and security of contract. Strengthening private sector performance necessitates increased investment and A. Infrastructure Development productivity and hence an improvement in competitiveness and the investment Inadequate infrastructure has long been environment. This would complement rated as a key constraint to rapid economic concurrent actions to improve fiscal growth in the Philippines. Consistently, most management, strengthen public sector business surveys have found the country's governance, increase peace and security, infrastructure as grossly insufficient and of and reduce political and other uncertainties, generally poor quality. This observation was in achieving national development objectives. echoed in the recent World Economic Forum survey that ranked the country 68th, in terms Philippine competitiveness has not managed of infrastructure quality, out of 75 economies to keep pace with most other competing rated. In most of these surveys, infrastructure Asian economies (Table 3.1). As a result, it has been perceived by respondents as one is not ranked with Indonesia and Vietnam of the most important bottlenecks to the and is well behind Malaysia, Thailand, China conduct of their business. and India. This poor performance stems from the relatively low volume and productivity of Data on infrastructure support this investments18. And this low level of perception. Road networks, water and investment arises from perceptions of risk sanitation facilities, and power generation and deficiencies in the investment and and distribution are among the poorest in the operating environment for private sector region. Road access, and road quality are enterprises19. both sources of concern. In the water sector, access is relatively high and is cheap but the Table 3.1: Competitiveness rankings and disparity between urban and rural access to risk scores water remains wide. The water utilities are also poorly managed with high rates of EIU accounts receivable. In the power sector, Risk 1998 1999 2000 2001 2002 access to electricity is good but the cost of Score power is high. Yet, most of the power firms Singapore ... 10 12 9 9 9 are barely making profit and there are large Korea ... 28 28 27 26 23 system leakages through transmission and Malaysia 35 27 27 30 37 26 distribution losses. Service quality of these firms is also poor with high frequency of Thailand 42 37 39 40 38 35 power interruptions. And, a power shortage India ... 44 42 37 36 37 seems likely by 2007 unless there is new China 42 42 49 44 43 38 investment. The ICT infrastructure, however, remains at par or better than most East Asian Vietnam 49 43 50 53 62 60 economies as the volume of internet and Philippines 49 45 44 46 53 61 cellular subscribers are high. However, fixed Indonesia 62 51 53 47 55 64 lines density can still be improved. Source: IMD World Competitiveness Yearbook 2003 These deficiencies in infrastructure are In view of the importance of private sector primarily the result of two factors. First, there performance to employment creation, growth has been low and declining public sector and poverty reduction, this chapter looks at a spending on capital investments and maintenance. Between 1997 and 2001 public sector capital expenditures fell by over 1 18The country's investment to GDP ratio is lower than percent of GNP and at around 3 percent is other East Asian economies. the lowest in the region. The share of capital 19A recent survey of top 1000 firms by A.T. Keaney shows that the country is not among the top 20 outlay to total expenditure has gone down destinations of foreign investors. from 21 percent in 1997 to 16 percent in 16 Draft for Review 2002. Second despite expectation that advantage to charge higher fees for private investors would take on a larger role interconnection thereby squeezing out their to meet the growing need, private sector competitors. This practice has prohibited the investment in infrastructure has also fallen development of an open system and has during this period. Private sector investment created technological barriers between in infrastructure contracted from around $4 communication network. Second, the policy billion in 1993-1997 to about $1 billion in of providing cross-subsidies to the 1997-2001. This decline reflects a development of less lucrative areas have combination of large financial losses in the further segmented the market. This arises late 1990s and the negative corporate from the behavior of firms to charge higher environment arising from barriers to entry, interconnection fees to compensate for distorted regulations, unclear and changing network development. Third, the absence of policy on the respective roles of the public regulations on mergers and consolidation and the private sectors, and weak can open the market to abuse from vertical administrative capacity from the government. integration among the big networks. Effective implementation of regulations is needed to It is clear that investments in infrastructure contain this risks. contribute to increased growth and improved living standard. Inadequate infrastructure Power. Reform in the power sector aims to imposes high economic cost. In the long run, encourage private investments through the improvement in the budget balance is offset unbundling of generation, transmission, and by the deterioration in public infrastructure distribution facilities, and the privatization of which leads to higher costs of business, NPC. PSALM was created to take over the lower private sector investments, and lower liabilities of NPC while TRANSCO was growth. The social impact is even greater as organized to handle the transmission poor infrastructure contributes to persistent function. In the absence of private sector unemployment and deterioration in access to interest in the sector and an expected power key basic services such as water, sanitation, shortage by 2007, there is a need to review the public sector role and the regulatory and power. design. For one, the current rate on return cap is a big disincentive for investors. And Presently, a number of controversies have regulatory risk is perceived to be quite high. arisen in key infrastructure projects involving water, power, and transportation. These have Second, the sector is also bearing the cost of financially distressed power cooperatives arisen from: a) contract disputes; b) which imposes huge financial cost to unreasonable tariff rates and take or pay contracts; c) weak provisions for exchange restructuring. Providing guarantees to these cooperatives without reforming these rate risks; and d) political interference. These institutions would expand the contingent controversies have discouraged private sector participation in infrastructure. Together liability of the public sector without addressing the issue of governance. For with the poor current state of Philippine TRANSCO, the series of failed biddings infrastructure, they highlight the importance of a clear stable operating environment to suggests that there are regulatory issues that pose risks to investments and these need to generate the needed increase in investment be examined and contained. and the delivery of reliable and cost effective infrastructure services. Roads. At present, the poor quality of roads reflects the lack of management framework, Telecommunications. Despite good ICT infrastructure, the sector would benefit from insufficient budget, and weak role of local government units in road development. The an improved regulatory environment that weak management framework arises from enhances competition and prevents dominant large firms from behaving the unclear mandate given to various agencies assigned to oversee the road uncompetitively. At present, there are two development. Often implementation remains sector policies that warrant review. First, is the decentralized setting of interconnection fragmented as various agencies have overlapping functions and have little fee that gives the dominant carrier a natural coordination. The required budget for 17 Draft for Review maintenance and rehabilitation has been privatization that favors fair competition. This estimated at P10 billion a year. And despite requires regulation that ensures competitive the local government units' closeness to most behavior. It is important to focus on doing the of the service areas, LGUs have played a small things effectively and to move away limited role in local road programs. Much from mega-type projects that are often effort is needed to decentralize road associated with large monopolies or public management and to transfer the utilities. These monopolies are often responsibility of programs and projects inefficient and end up serving the middle implementation to LGUs. There are also a class rather than the poor. Second, there number of distortions that prohibit effective has to be a reasonable division of risk public-private sector partnership. These between the public and the private investors include: a) ambiguity of the PNCC franchise to enter the infrastructure sector. There are which discourage private investors; b) non-market risks which the public sector is inadequate information on viable roads better able to assume than the commercial projects; c) government's preference for market. Third, the poor are willing to pay and mega-type projects which reduces the are actually paying a high price for the number of participants; d) short maturity for absence of infrastructure. But at the same commercial loans which does not match the time targeted subsidies to enhance cash profile of road projects; e) large foreign connection and ensure access by the poor exchange risks which introduces large may need to be considered. Fourth, financial contingent liability on investors; and f) support for infrastructure needs to be made contracting uncertainties which make project more effective by focusing on outcomes and management difficult. linking the disbursement of funds to the actual deliveries of services. Lastly, The realities in the infrastructure sector are improving infrastructure within a constrained very challenging. First, the financing fiscal situation will be a challenge. The thrust requirement for infrastructure is huge. Based of reforms could be to: a) restructure on a recent estimate, the Philippines need municipal and development finance USD 200 million a year to provide for the institutions to become efficient vehicles for maintenance, operations, and development mobilizing and pooling both public and of roads. The stranded cost of power also private financing; b) introduce competition amounts to USD 8.3 billion. Second, the and transparency in the design and award of economic and social importance of concession contracts and use of government infrastructure as well as the consequence of guarantees; c) quickly settle high profile not having sufficient infrastructure is equally contractual disputes in the infrastructure enormous. Twenty-one percent of the urban sector; d) develop a strategy to deal with population and thirty-one percent of the rural legacy of PPI contracts that have become population lack access to clean water and highly politicized; e) immunize further the adequate sanitation, respectively. 5,000 regulators from political and legal barangays have no access to electricity. Only interference and f) systematically develop a half of the 4,200 tons of solid waste produced domestic bond and securitization market. daily are accommodated by existing facilities. Third, the public sector does not have the B. Banking and Capital Market resources nor the capability to undertake this Development growing need alone. Hence, private sector participation is indispensable, but recent A quick recovery of the financial system from experience with private sector partnership in high stress levels does not appear likely. The infrastructure has not been as satisfactory as ratio of non-performing loans to total loans of hoped. the financial system remains as one of the highest among the post-crisis countries Given this fact, the lessons from other (Figure 3.1)20. In this regard, the priority countries offer clear insights regarding the areas are enactment of the amendments to mixture of policies that are needed to achieve effective infrastructure development. First, empowering the market necessitates 20It is acknowledged that Indonesia sharply reduced changing the regulatory structure to promote NPLs by transferring them to the public sector. 18 Draft for Review the BSP and PDIC charter, and the fast sector, averaging more than 16%, partly transition to a consolidated risk based conceals continuing vulnerability in the supervision to provide them with increased banking system. There is also a tendency in authority and legal protection for bank the system to postpone prudent measures, regulations. Strengthening non-bank exercise regulatory forbearance, and find financial institution and capital markets calls temporary fixes to systemic weaknesses. for further improvement in property, This is evident from the use of liquidity shareholder and credit rights, insolvency support by the central bank instead of closing laws and complete governance. Pension troubled institutions; and relaxing rules on the reforms are also a high priority and are issuance of tier II capital rather than setting covered in chapter 2. deadline for owners to put in tier I capital. Despite substantial liquidity in the system, Figure 3.1 NPLs are still high (in percent) lending growth has been relatively slow due to the limited number of credible borrowers 60 with sound proposals and limited growth in 50 demand. Given these factors, there are few 40 options for the banks to improve their asset 30 20 quality and strengthen their capital position. 10 0 Table 3.2 Indicators of the health of the Dec Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep banking sector 98 99 00 01 02 03 2000 2001 2002 Indonesia Malaysia Korea Interest margins Thailand Philippines Korea 1.05 2.16 - Source: ARIC Database, ADB Indonesia 3.3 3 3.8 a/ Malaysia 3.95 3.46 3.2 a/ Philippines 3.7 3.5 3.4 Asset Quality & Capital Position Thailand 1.62 2.23 -- The asset quality and capital position of the Rate of return on assets commercial banking sector remains weak Korea -0.57 0.76 0.8 a/ with little change in the first half of 2003. At Indonesia 0.7 1.5 1.8 a/ the end of June 2003, the non-performing Malaysia -- 1.42 1.78 loans (NPLs) of commercial banks were 15.2 Philippines 0.4 0.5 0.8 Thailand -3.55 -0.19 -- percent of the total loan portfolio (TLP). If ROPOA (Real and Other Properties Owned Rate of return on and Acquired) are factored in, the ratio of the equity sum of NPLs and ROPOA to the sum of TLP Korea -10.8 16.3 -- Indonesia 20.1 21 16.8 b/ and ROPOA works out to 23.8 percent. Malaysia -- 16.89 20.94 Reserves for non-performing assets (NPAs) Philippines 3 3.4 6.1 cover less than a third of the NPAs in the Thailand -130.9 -3.68 -- system and even though NPA's are likely to Capital adequacy be discounted during NPA workouts and ratios transactions, these reserves are likely to be Korea 10.5 10.8 --- inadequate to cover the losses. Indonesia 12.7 20.5 23.2 a/ Furthermore, given weaknesses in the Malaysia 12.5 12.8 -- Philippines 15.6 15.3 c/ 15.6 c/ accounting and auditing standards and slow Thailand 13.4 12.9 transition towards international standards Source: Philippine Deposit Insurance Corporation (particularly in the banking sector where a/ As of August 2002. b/ As of July 2002. c/ Beginning coordination is required between the July 1, 2001, computation for capital adequacy ratio in the Philippines is in accordance with Circular 280 dated securities and exchange commission and the March 29, 2001 (Risk based Capital Adequacy Ratio). central bank), the financial position of the The latest CAR data is as of September 30; BSP does banks appears stronger than what it would not provide data on interest margin. This figure is from be if international accounting standards are the Philippine Deposit Insurance Corporation website. applied. Thus, the relatively high capital adequacy ratio for the commercial banking 19 Draft for Review Asset Recovery and Restructuring granting additional powers to supervisors may limit the effectiveness of initiatives in In terms of asset recovery, the passage of terms of prompt corrective action Hence, the Special Purpose Vehicle (SPV) law in alternative administrative measures may be December 2002 strengthened the framework needed to strengthen the framework for PCA. to deal with bad debts. However, no investment partnerships have yet been The Financial Action Task Force (FATF) completed. The major hurdles are the decided not to impose countermeasures on valuation and pricing principles, and the the Philippines as it accepted the March principles for booking the losses from these 2003 amendments to the Anti-Money transactions. In short, the gap between what Laundering (AMLA) Act. In late August 2003, the sellers want for their assets versus what the implementing rules and regulations of the the buyers want to pay for them is reportedly amended AMLA were also approved. The passage of the rules, among other things, wide. Part of the difficulty is that valuation empowers the AML Council to seek freeze and appraisal guidelines were not included in orders on accounts linked to any frozen the Implementing Rules and Regulations. accounts. However, the Philippines will Presently, consultations with the accounting remain on the FATF list of non-cooperating industry are still in progress to finalize these countries and territories until it has shown the valuation and appraisal rules. More so, there effective implementation of the amended is a need to clarify the treatment of loan AML law. Presently, the AML Council is losses as this will effect asset price and the preparing the AMLA implementation plan for conduct of the deals. Other concerns that discussion with the Asia Pacific Group, the are important and will likely affect NPA regional coordinator for the FATF. workouts in the future are: the absence of real servicing companies; propensity by Presently, changes to the rules governing the debtors to use temporary restraining orders Securities Regulation Code have been to block or delay workouts; restrictions on proposed by the Securities and Exchange foreign ownership of assets (particularly land, Commission. These changes plan to protect the primary collateral from most credits); and the investing public through stricter rules on lack of a unified registry for properties. the registration and issuance of share or securities, enhanced public disclosure and Regulation and Supervision improved credibility of financial statements, and greater transparency in stock market Though the Philippine authorities have been transactions. Among the salient features of making efforts to improve the regulatory and the proposal are: i) it broadens the disclosure supervisory framework, amendment to the requirement for material information that are charters of the BSP and the PDIC continue to relevant to the price and value of shares or face delays. The proposed amendments are securities; ii) it expands the scope of public expected to enhance compliance with offering to include random or indiscriminate existing regulations and strengthen the sale of securities; iii) companies that have framework for prompt corrective action (PCA) debt papers to be rated by accredited rating against distressed banks. They would also agencies; iv) stricter rules on sale of insulate the supervisors and senior proprietary and non-proprietary shares; v) management of BSP from fear of undue legal stricter rules on delivery of shares bought by prosecution21. However, opposition to clients; vi) additional requirement for the licensing of brokers and dealers; and vii) broader function for the stock exchange's 21In mid-August the Court of Appeals found the compliance and surveillance group. Governor of BSP and four other senior officials "administratively liable of gross neglect of duty" when the BSP ordered the closure of medium sized bank and its two subsidiaries in April 2000. The Court of Appeals decision ordering 1 year suspension of the BSP Governor and four other BSP officials not only has an immediate negative impact on the regulatory and supervisory functions but also damages the investor another part of the Court of Appeals to rule in favor of confidence in the economy as such. And the fact that the BSP officials does not yet alleviate this problem. 20 Draft for Review Capital Markets Table 3.3: Corporate governance indicators In the Philippines, equity and debt markets Rules & EnforcePolitical/ Institutio Country and non-bank financial institutions play a Regs. ment Regulat nal Score (1) minor role in mobilizing resources and ory Mechani sms managing risks. There are limited IPOs; Singapore 8.5 7.5 6 8 7.7 primary and secondary housing finance Hong Kong 8 6.5 6.5 7 7.3 systems are underdeveloped; specialized India 8 6 6 6.5 6.6 housing finance services are limited; Taiwan 7 5 5 6 5.8 government housing financial institutions are not viable; equipment leasing has not taken Korea 7 3.5 5 6.5 5.5 off; factoring and forfeiting arrangements that Malaysia 79 3.5 4 6.5 5.5 use non-land collateral to secure lending do Thailand 7.5 3 4 4.5 4.6 not exist; and securitization of cash flows to China 5 4 5 3 4.3 enable the recycling of resources and to Philippines 6.5 2 2 4 3.7 reduce the need to borrow is undeveloped. Indonesia 4.5 1.5 4 2.5 3.2 The absence of these institutions and practices heightens the vulnerability of the Source: CLSA private sector to shocks, tends to shorten 1)Higher score implies a better corporate governance investment horizons and inhibits long-term environment investments. In view of these gaps, the government could aim to strengthen C. Competition and Security of Contract domestic debt markets. Many measures have been proposed including the Banker's Competition Association blueprint for a fixed-income exchange to provide a platform for secondary Since the 1980s, a number of policy reforms trading of private and publicly issued debt were undertaken to promote greater securities. Efforts are also underway to competition. These were embodied in the rationalize the documentary stamp tax (DST); different programs including trade address the cascading impact of DST on liberalization, investment deregulation, financial transactions and correct the current foreign investment reforms and the pursuit of tax rate distortions between equity and debt a market based exchange rate. The trade instruments. SEC has also proposed draft liberalization program was implemented in legislation relating to non-bank financial four phases. First, from 1981 to 1985, the companies, futures trading and alternate import tariff was reduced from 100% to 50%. trading systems. These proposals could be Second, from 1986 to 1989 non-tariff import expedited to develop the regulatory capacity barriers to trade were largely eliminated. that could catalyze the development of the Third, from 1991 to 1995 tariff rates were equity and debt markets. Also crucial is the reduced further, though the maximum tariff credible enforcement of rules and regulations remained at 50 percent. This has resulted in as the country fares poorly in this area (Table the Philippines now having relatively low 3.3). import tariff on manufactured goods but higher rates on agricultural goods (Figure 3.2). In the early 90s, new investment deregulation and foreign investment laws provided an assortment of investment incentives and lifted certain constitutional restraints on investment. And export- processing zones were also created to provide efficient business infrastructure to foreign investments. 21 Draft for Review Figure 3.2: Average tariff, 2000 (in percent) petrochemicals, glass, and vegetables. The Philippines has also become more aggressive in implementing trade defense 30 measures and product regulations. At 25 20 present, for purposes of tax assessment, the 15 Bureau of Customs has frozen import tariff 10 rates at their 2000 level. Other measures that 5 0 are being used to limit the free entry of goods are: a) authority granted to the Secretary of Agriculture to restraint imports to protect the Indonesia Malaysia Thailand Malaysia Thailand domestic fishing industry; b) import Philippines Indonesia Philippines restrictions on rice, automobiles, satellite Agriculture Total phones, and coal; c) nationality requirements Source: TRAINS Database in the telecommunications, banking, advertising, public utilities, and shipping sectors; d) minimum capitalization, local As a result of these reforms, the economy sourcing, and divestment requirements for became more open and more competitive in export markets. Average effective protection retail trade; e) incentives and subsidies granted under the Investments Priorities rate fell from 38 percent in 1985 to 12.6 Plan; and f) administrative regulations in the percent in 2002. The share of exports to GDP also rose from 16 percent in 1980 to 44 BOC. percent in 2002. The composition of exports The worldwide evidence is overwhelming that shifted into new growth. Based on the ratio of domestic resource cost to the shadow the benefits from trade liberalization far exchange rate22, the share of highly efficient outweigh its cost. Reversing the tide of reform would forgo the benefits, create firms in production rose from 19 percent in 1983 to 42 percent in 1994. And total factor uncertainty, and lessen productivity and competitiveness. Most of the products productivity estimate have risen by 2.1 p.a. covered by the proposed tariff reversals are from 1990 to 1992. intermediate inputs. Hence, raising the tariff would make the impacted industries less It is notable, however, that the impact of this competitive, less able to take advantage of export growth was limited due to its high concentration in enclave activities, highly the opportunities presented by China's growth and to effectively integrate with import-intensive nature of exports and the regional production networks. weak linkages with the rest of the economy. Most of local suppliers appear not to have Since 1991, the value of exports have grown the capability to ensure product quality and by more than four-folds and reached $34 prompt service delivery. Poor infrastructure also serves as natural barriers to integration billion in 2002. From 1995 to 2002, exports grew by more than 10.6 percent p.a. and as administrative and transport costs are contributed more than 4 percent to GDP high. Moreover, the employment effect of such exports is largely confined to the export growth. This significant contribution from exports derives mainly from the enclave. transformation of exports from being primarily At this time, the government is reviewing agricultural and resource based to electrical and electronics including semiconductors WTO commitments and has proposed and ICT. During the last two years, the slowing down or reversing these commitments and returning many import Philippines sold over $47 billion worth of electronics accounting for 70% of total tariffs to their 1998 levels. Since, 2002 exports23. reversals have already happened in cement, 22 A DRC/SER ratio greater than one means an industry is an inefficient earner or saver of foreign exchange. It uses up more domestic resources in earning/saving a 23The biggest chunk of electronic exports went to the unit of foreign exchange compared to what a unit of US (19.5 %), Japan (13.9 %), Netherlands (11.5 %), foreign exchange is worth to the society. Taiwan (8.9 %), and Singapore (8.7 %). 22 Draft for Review The recent weakness in global demand and percent of gross fixed capital formation and the cyclical volatility in electronics pose a about 16.6 percent of GDP. Malaysia, in significant risk to export growth. As global contrast, maintains an FDI stock of $53 trade weakened in 2001, exports contracted billion that accounts for about 16.5 percent of for 14 consecutive months resulting to a their fixed investments and almost 60 percent double digit fall in exports for the year. of their GDP (Table 3.4). Exports recovered in the second half of 2002 due to further weakening of import demand Table 3.4: FDI stock 1990 ­ 2001 from the US and Europe, and the effect of SARs on Hong Kong, Singapore, and Taiwan 1990 1995 2000 2001 has resulted in export being stagnant in the final half of 2003. Philippines FDI Stock 3.3 6.1 12.4 14.2 Regional development provides hope for (US$ Bn) renewed export growth. First, the % of GDP 7.4 8.2 16.6 19.9 reorganization of the production chains have Malaysia contributed to the rapid ascent of Asian FDI Stock 10.3 28.7 52.7 53.3 countries in the global value chain. Second, (US$ Bn) China has become a major player in the % of GDP 23.4 32.3 28.8 58.4 global and regional trade and its import Thailand demand is rising rapidly. Historically the US FDI Stock 8.2 17.4 24.5 28.2 (20.5%) and Japan (15.4%) were the (US$ Bn) Philippines' major trading partner but recently % of GDP 9.6 10.4 20 22.3 the markets for Philippine exports have Source: World Investment Report 2002 become more diversified. The share of China in total exports has increased from 0.8% in In support of trade reform, the government 1990 to 2.5% in 2001 as Beijing has become has taken a number of other steps to further a dominant player in the electronics trade24. open up the market to competition. These included privatization of government As China is a global powerhouse, growing at corporations, deregulation of the shipping 8% and absorbing imports equivalent to $244 and airlines industries, demonopolization of billion a year, the potential benefit from RP- telecommunications, oil deregulation, easing China trade is large. Traditional exports such the entry of foreign banks, easing the equity as tropical fruits, minerals and manufacturing limits on foreign investments, and the could expand into China. And cross border liberalization of retail trade. However, despite investments are expected to further expand these efforts, market structure in the this trade25. Philippines has remained highly concentrated. Aldaba (2002)26 has noted that In the long run, export competitiveness 74 percent of manufacturing value added in depends on FDI. Mainly, FDI inflows can manufacturing was accounted for by the top enhance competitiveness by bringing new four firms in the sub-sectors. Saldana technology and developing management (2001)27 observed that the top shareholder in capability among local firms. It also gives industry on average controls about 41 access to the global production chain and the percent of the company's market value, while world product markets. As of 2001, the the top five shareholders control about 65 cumulative stock of inward investments stood percent. This domination became even more at around $14 billion and accounted for 9.2 concentrated as equity financing fell in the aftermath of the financial crisis. 24It has moved in rank from the 9th place to become the 4th exporter of computer components in 2001. The Barriers to entry persist in spite of trade and Philippine's top five exports to China are semi-conductor devices, copper cathodes, parts and accessories of investment liberalization, and deregulation. automatic data processing machines, fresh bananas, and fuel oils. 25To date among the major companies with foreign 26Aldaba R.M. 2002. "The State of Competition in the operations in China are San Miguel, the Tan Group of Philippines". PIDS. companies, Universal Robina Corporation, Solid Group 27Saldana C.G. 2001. "Corporate Governance and of companies among others. Finance in East Asia". ADB. 23 Draft for Review These barriers to entry have taken several There could be an institution to safeguard forms. First, the policy of picking winners or against uncompetitive behavior. champions has created a special class of entrepreneurs who are vested with fiscal Security of Contract incentives and trade privileges. Examples are the incentives given to synthetic fibers, steel Security of contracts and protection of mills, shipping, motorcycle, and cars. investors' rights are crucial for private sector Second, there are still sectors which are development. Without this the private sector protected by import tariffs and non-tariff will not participate in market activities even restrictions. These include rice, sugar, though the expected return may be large. petrochemicals, steel, cement, and glass. Uncertainties also affect the nature of The protection accorded to these industries investment as firms prefer contracting and is high given that their inputs have low tariffs. partnership arrangements that provide lower Third, there are behavioral impediments to exposure and cost of exit. In the Philippines, entry as reflected in the strategic behavior of the cost of dispute resolution is one of the firms to exert market power. Such behavior highest in the world28. As a consequence, the can be manifested through collusion among supply of foreign capital, the technology key players to set the price; exclusive transfer, and the integration into global dealership to limit product distribution of the production networks is low. Evidence of this product; predatory pricing; price can be found in the modern retail sector in discrimination to capture various segments of Philippines where foreign firms prefer the market; and producing excess capacity to franchise arrangements to arrangements that discourage entry. Collusion has been noted involve greater capital commitments. to exist in the sugar, flour milling, inter-island shipping, and the cement industries. Natural Interestingly, the protection accorded to and technological constraints have also creditors under the law as well as under served as barriers to entry. These are bankruptcy protection and workout especially true in infrastructure where there arrangements in the Philippines has also are high capital requirement, and large been among the weakest in the world. economies of scale, and sunk costs. Fourth, Secured creditors are not protected from stay continuing dominance of public sector of foreclosure and do not enjoy a priority in enterprises discourage competition. payment. Several steps have already been taken which could provide the bases for Further reforms are needed to achieve constructing a broader range of options for genuine competition that will improve affording relief to distressed companies and productivity. Completing the remaining their creditors. The draft Securitization bill agenda for trade liberalization, including could enable both banks and buyers of services and agriculture, to ensure that distressed assets to mobilize capital and markets become more open and contestable distribute risks more efficiently. This is would help. So would privatizing the evident from the experiences of Malaysia and remaining GOCCs where feasible. However, Korea. In India the enactment of the privatization should not only entail a transfer Securitization, Reconstruction of Financial of ownership but should come hand in hand Assets and Enforcement of Security Interest with reforms to ensure that any unwanted Act of 2002 is playing a vital role in advantages previously enjoyed by the firm accelerating NPL resolution along with should be removed to ensure competition. measures such as a pilot asset restructuring Third, where natural monopolies are more company, corporate debt recovery mechanism, debt recovery tribunals, and likely to occur, there is a need for an effective one-time settlement process. The Philippines regulatory framework to ensure competitive could also consider measures to establish a behavior. Finally, the government could unified property and collateral registries and consider a policy to promote competition. to ease foreign ownership restrictions of land This could begin with an information and in the context of NPL recovery. Both Thailand education program to disseminate and Malaysia eased restrictions on understanding on the benefits derived from competition and the costs from the lack of it. 28World Bank, Doing Business Database. 24 Draft for Review condominium ownership as a way of Philippine Deposit Insurance Company is accelerating NPL resolution and limited in terms of technical staff expertise, securitization. unclear definition of unlawful practices, weak penalties for non-disclosure and inadequate Table 3.5: Comparative cost of doing information and monitoring system, and the business presence of blind spots or gray areas for regulation. Regulation could be improved by Business Contract Insolvency Labor more effectively integrating the efforts Registration Enforceme (Years) Restructurin covering banking and non-bank financial (Days) nt (Days) g Flexibility Index1 institutions, with those covering other corporate entities. Unfavorable rulings on Philippines 59 164 5.7 39 commercial contracts have increased Indonesia 168 225 6 43 uncertainty. There are no quick institutional remedies for these problems but a number of Malaysia 31 270 2.2 15 steps can be taken to minimize the China 46 180 2.6 57 uncertainty arising from these concerns. Thailand 42 575 2.6 30 These include: a) improve the access to Singapore 8 50 0.7 1 information and increase penalty of non- Hong Kong 11 180 1 1 disclosure; b) strengthen the judiciary; and c) India 88 225 11.3 45 rationalize the functions of the different Source: World Bank, Doing Business Database regulatory agencies. Efforts are already underway in these areas and the government 1Lower value indicates higher flexibility. needs to continue and strengthen these reforms. There is also little protection given to small shareholders. Most of the listed corporations To enable private firms to compete effectively are family owned where effective ownership in a rapidly changing world environment calls and management control is captured by the for a strategy built around an open and stable top shareholders. Often, public disclosure of investment, trade and regulatory environment corporate records is incomplete and supported by a financial and physical inaccurate. As a result, there is information infrastructure and which leverages off high asymmetry and asset stripping is not an quality human capital. uncommon practice. More so, the capability of regulatory agencies such as the Securities and Exchange Commission and the 25 Draft for Review Table 1. Economic and Social Indicators, 1997-2003 1997 1998 1999 2000 2001 2002 Social Sector Population growth (Mn) 71.5 73.2 74.9 76.6 78.3 80.0 Poverty Incidence (1$ a day) 12.1 13.7 13.5 13.5 12.2 11.9 Per Capita GNP, Atlas Method - 1,080 1,040 1,030 1,030 1,020 Contribution to GDP Growth GDP 5.2 -0.6 3.4 4.4 3.0 4.4 Domestic Demand 7.1 -1.8 0.3 4.4 2.8 2.5 Private Consumption 3.8 2.6 0.2 2.8 2.8 3.2 Government Consumption 0.4 -0.2 0.5 0.5 -0.4 0.2 Gross Domestic Investment 2.9 -4.3 -0.4 1.2 0.4 -0.9 Net Foreign Balance 0.1 -1.6 3.0 5.3 -3.4 -0.8 Agriculture 0.7 -1.3 1.3 0.7 0.7 0.7 Industry 2.2 -0.8 0.3 1.7 0.3 1.3 Manufacturing 1.1 -0.3 0.4 1.4 0.7 0.9 Services 2.3 1.5 1.8 2.0 2.0 2.4 As % of GDP Gross National Savings 21.2 22.6 21.7 24.2 25.4 26.8 Gross Domestic Investment 24.8 20.3 18.8 21.2 20.6 19.3 Resource Gap -6.0 -3.6 2.9 3.0 4.7 7.5 Public Sector Budget Balance (% of GDP) Consolidated Public Sector -1.0 -3.0 -3.4 -4.6 -4.7 -5.8 National Government Balance 0.1 -1.9 -3.8 -4.1 -4.0 -5.2 Revenue 19.4 17.4 16.1 15.6 15.3 14.1 Expenditure 19.4 19.2 19.8 19.6 19.3 19.3 Monetary and Financial Sector Broad Money, Growth Rate 20.9 7.4 19.3 4.6 6.8 9.5 Private Sector Credit, Growth Rate - -47.6 -10.4 29.5 -18.5 -2.1 91-day Treasury bill rate 13.1 15.3 10.2 9.9 10.2 5.9 PSE composite index (end-period) 1,869 1,969 2,143 1,495 1,168 1,018 Prices Consumer Prices (change, average) 6 9.7 6.7 4.4 6.1 3.1 Exchange rate (peso/$, ave of period) 29.47 40.89 39.09 44.19 51.3 51.3 External Sector (US$ Billion) Current Account Balance 7.2 6.3 1.3 4.2 (as % of GDP) - - 9.5 8.4 1.8 5.4 Merchandise Exports 34.2 37.3 31.2 34.4 Growth rate - - 19.1 9.0 -16.2 10.1 Merchandise Imports 29.3 33.5 32.0 34.0 Growth rate - - 4.2 14.5 -4.5 6.2 External Debt (US$ Billion) 45.4 47.8 52.2 52.1 52.4 53.9 (% of GDP) 55.2 73.4 68.6 69.5 73.1 68.7 Debt Service Ratio 11.6 11.7 14.1 12.4 15.8 16.4 Gross International Reserves 8.8 10.8 15.1 15.0 15.7 16.2 (as % of imports) 2.0 3.1 4.5 4.2 4.6 4.7 26 Draft for Review Table 2. Social Indicators 1990 1995 2001 2002 GNI Per Capita 740 1,040 1,030 1,020 Life Expectancy 65.6 67.7 69.5 69.8 Poverty and Hunger Population below $1 a day 19.1 14.8 11.9 11.5 Population below minimum level of dietary energy consumption 26.0 ... 23.0 ... Education Net primary enrollment ratio 97.5 100.6 92.7 ... Secondary participation rate a 55.4 ... 73.4 ... Water & Sanitation b % with access to potable water 73.7 77.4 78.5 ... % with access to sanitary toilets 71.6 74.9 82.5 ... Gender Equality Ratio of young literate females to males 100.4 100.4 100.4 100.4 Child Health Under 5 mortality rate (per 1000) 66.0 51.0 38.0 35.3 Infant mortality rate (per 1000 live births) 45.0 36.0 29.0 29.0 Immunization, measles (% children under 12 months) 85.0 72.0 75.0 ... Maternal Health Maternal mortality ratio (per 1000 live births) ... 240.0 ... ... HIV/AIDS, malaria and other diseases Contraceptive prevalence rate (% 36.1 48.1 47.0 ... of women ages 15-49) Incidence of TB (per 100,000 ... ... 329.7 ... people) Source: Philippine Progress Report on the Millennium Development Goals 27 Draft for Review Table 3 : Gross National Product, Annual Percent Change (Constant 1985 Prices) 1997 1998 1999 2000 2001 2002 2003 Sem 1 Growth Rate (percent per annum) GDP 5.2 -0.6 3.4 4.4 3.0 4.4 3.9 GNP 5.3 0.4 3.7 4.8 3.5 4.5 4.8 By Industrial Origin Agri, Fishery, Forestry 3.1 -6.4 6.5 3.4 3.7 3.3 2.3 Industry 6.1 -2.1 0.9 4.9 0.9 3.7 2.8 Manufacturing 4.2 -1.1 1.6 5.6 2.9 3.5 4.6 Construction 16.2 -9.6 -1.6 1.4 5.0 -3.3 -8.2 Utilities 4.8 3.3 3.1 4.2 0.7 4.3 2.8 Service 5.4 3.5 4.0 4.4 4.3 5.4 5.3 Transp,Storage,Telecom 8.2 6.5 5.3 10.4 8.8 8.9 8.4 Trade 3.9 2.4 4.9 5.2 5.6 5.8 5.4 Finance 13.0 4.4 1.9 0.9 1.2 3.4 5.8 Real Estate 3.8 1.6 0.6 0.0 -0.5 1.7 3.5 By Expenditure Personal Comsumption Expenditure 5.0 3.4 2.6 3.5 3.6 4.1 5.0 Government Consumption Expenditure 4.6 -1.9 6.7 6.1 -5.3 2.4 -5.5 Capital Formation 11.7 -16.3 -2.0 5.5 2.1 -3.5 8.5 Fixed Capital 11.5 -11.2 -2.3 3.1 -3.7 2.4 0.5 Exports 17.2 -21.0 3.6 17.7 -3.4 3.6 2.6 Imports 13.5 -14.7 -2.8 4.0 3.5 4.7 14.4 Memorandum Items Gross International Reserves, Bn $ 7.2 9.2 13.2 13.1 15.7 16.2 16.1 Exchange Rate (P/$, end of period) 29.5 40.9 39.1 44.2 51.3 51.3 52.9 Tax Effort (% of GDP) 17.0 15.6 14.5 13.9 13.3 12.3 13.0 Deficit (% of GDP) 0.1 -1.9 -3.8 -4.1 -4.0 -5.2 -3.9 Non-Performing Loans (% of Total Loans) 4.7 10.4 12.3 15.1 17.3 15.0 15.2 Sources: National Statistical Coordination Board, Bangko Sentral ng Pilipinas National Statistical Office, and Department of Finance Websites 28 Draft for Review Table 4. Inflation Rates, 1997-2003 1999 2000 2001 2002 Mar 03 Jun 03 Aug 03 (in percent per annum) All Items 6.7 4.4 6.1 3.1 2.9 3.4 3.0 Food, Beverages & 5.2 2.0 4.1 2.0 1.8 2.7 1.5 Tobacco Clothing 6.3 2.6 3.7 2.6 2.0 2.3 2.4 Housing and Repairs 9.3 5.3 6.8 4.9 2.7 2.6 3.2 Fuel, Light and Water 7.0 10.2 12.1 4.8 5.2 7.8 9.5 Services 10.5 11.6 11.5 5.0 6.7 5.6 5.8 Others 5.3 1.3 5.2 1.9 1.6 1.8 1.9 Source: National Statistics Office Table 5. Monetary Survey, 1997-2003 1997 1998 1999 2000 2001 2002 Jun-03 (in billion pesos) Total Liquidity 1,608 1,679 1,938 2,079 2,165 2,351 2,363 Broad Money (M3) 1,066 1,145 1,365 1,427 1,525 1,670 1,647 Narrow Money 258 282 394 387 388 470 445 FCDU Deposits 433 478 522 586 586 628 652 Other Liabilities 108 57 51 66 54 53 63 Net Domestic Assets 1,685 1,539 1,609 1,737 1,760 1,809 1,772 Net Domestic Credit 1,923 1,870 1,923 2,088 2,106 2,208 2,191 Public Sector 468 460 529 581 645 727 727 Private Sector 1,455 1,411 1,394 1,507 1,462 1,480 1,464 Net Other Items -238 -332 -315 -351 -347 -398 -419 Net Foreign Assets -77 141 329 343 405 541 591 Central Bank 267 314 367 430 449 538 519 Deposit Money Banks -251 -80 -38 -87 -44 4 72 (in percent of GDP) Broad Money 42.2 40.8 43.5 40.8 38.9 38.9 40.4 Net Domestic Assets 66.6 54.9 51.3 49.7 44.9 42.2 43.5 Private Sector Credit 57.5 50.3 44.5 43.1 37.3 34.5 35.9 Net Foreign Assets -3.0 5.0 10.5 9.8 10.3 12.6 14.5 Source: Bangko Sentral ng Pilipinas 29 Draft for Review Table 6. National Government Operations 1997 1998 1999 2000 2001 2002 2003 Sem I (in billion pesos) Total Revenue 471.8 462.5 478.5 514.8 563.7 567.1 306.3 Tax Revenue 412.2 416.6 431.7 460.0 489.9 496.4 265.2 Bureau of Internal Revenue 314.7 337.2 341.3 360.8 388.7 394.5 209.2 Bureau of Customs 94.8 76.0 86.5 95.0 96.2 96.3 53.0 Nontax Revenue 57.9 45.5 46.5 53.4 71.9 69.7 40.2 Total Expenditure 470.3 512.5 590.2 649.0 710.8 777.9 385.9 Current Expenditure 419.4 467.9 524.2 585.4 648.9 - 333.4 Personnel Services 150.4 172.9 167.0 182.7 190.9 - 137.1 Maintenance and Operations 108.1 118.3 141.6 149.3 155.6 - 27.6 Allotment to LGUs 71.0 72.0 96.4 99.8 118.2 140.5 55.9 Interest Payments 78.0 99.8 106.3 140.9 174.8 185.9 111.1 Capital Outlay 47.9 43.5 61.2 60.4 57.4 - 49.8 Equity 1.6 0.8 1.5 0.5 0.5 1.5 0.2 Net Lending 1.4 0.3 3.2 2.6 3.9 2.6 2.8 Surplus/(Deficit) 1.6 -50.0 -111.7 -134.2 -147.0 -210.7 -79.6 Financing 27.1 88.9 181.7 203.8 175.2 264.2 83.5 Net Domestic Financig -20.3 76.6 98.9 119.5 152.3 155.0 37.6 Net External Financing -6.8 12.3 82.8 84.4 22.9 109.1 45.9 (as % of GDP) Total Revenue 19.4 17.4 16.1 15.6 15.3 14.1 15.0 Total Expenditure 19.4 19.2 19.8 19.6 19.3 19.3 18.9 Overall Surplus/Deficit 0.1 -1.9 -3.8 -4.1 -4.0 -5.2 -3.9 (in billion US$) Debt and Debt Service Total 33.8 38.3 44.0 43.3 46.4 53.0 54.8 Domestic Debt 18.8 21.8 24.3 21.4 24.3 27.7 28.5 Foreign Debt 15.0 16.5 19.8 22.0 22.1 25.3 26.3 Total Debt Services 3.1 4.2 5.1 4.6 5.3 6.7 3.7 Interest Payments 2.0 2.6 2.6 2.8 3.4 3.5 2.1 Principal Payments 1.2 1.7 2.5 1.7 1.9 3.2 1.6 (as % of GDP) Total 55.7 56.1 59.6 65.5 64.9 70.0 72.9 Domestic Debt 30.9 31.9 32.9 32.3 34.0 36.6 37.9 Foreign Debt 24.8 24.2 26.8 33.2 31.0 33.4 35.0 (as % of Exports of Goods and Services) Total Debt Services 5.0 5.9 6.5 6.5 7.0 8.3 9.2 Interest Payments 3.1 3.6 3.4 4.0 4.5 4.3 5.1 Principal Payments 1.9 2.3 3.2 2.5 2.5 4.0 4.1 Source: Bureau of Treasury 30 Draft for Review Table 7. Consolidated Public Sector Deficit 1998 1999 2000 2001 2002 (in billion pesos) TOTAL SURPLUS+/DEFICIT- -83.2 -100.5 -151.9 -167.1 -231.1 Percent of GDP -3.0% -3.4% -4.6% -4.7% -5.8% National Government -50.0 -111.7 -134.2 -147.0 -210.7 CB restructuring -26.4 -20.5 -19.1 -25.7 -15.1 Monitored GOCCs -38.0 -4.6 -19.2 -23.0 -46.1 o.w. NPC -16.2 -1.1 -3.4 -8.3 -21.7 NFA -11.9 -0.8 -1.9 -2.3 -8.1 SSS/GSIS 17.7 36.4 15.4 10.5 25.6 BSP 3.2 -3.9 0.2 5.0 4.2 GFIs 5.4 3.3 2.8 4.8 5.4 LGUs 2.0 3.2 3.8 4.2 3.4 Source: Department of Finance Table 8. Balance of Payment, 1997-2003 1999 2000 2001 2002 Jun-03 (in million US$) Exports of Goods & Services 39,014 41,267 34,391 37,439 18,045 Remittances 6,795 6,050 6,031 7,189 3,880 Imports of Goods & Services 36,767 39,883 37,184 38,295 20,181 Net Trade in Goods & Services 8,082 1,384 -2,793 -856 -2,136 Net Income Receipts 4,460 4,437 3,669 4,550 2,698 Net total current transfers 512 437 447 503 306 Current Account 7,219 6,258 1,323 4,197 868 4,197 Capital Account Balance -8 38 -12 -19 -11 Financial Account 8,628 1,660 2,192 2,938 -2,428 Net direct investment 1,754 1,453 1,142 1,026 10 Net portfolio investment 6,874 207 1,050 1,912 258 Others -10,953 -5,817 -3,260 -5,023 -2,696 Errors and ommissions -1,300 -2,651 -435 -1,433 955 Reserves, net change -3,586 513 192 660 616 Total External Debt 1 52,210 52,060 52,355 53,874 55,806 Medium and Long-Term 46,465 46,112 46,306 48,315 49,383 Short-Term 5,745 5,948 6,049 5,558 6,423 Trade 1,836 1,640 1,285 1,055 1,205 Non-Trade 3,909 4,308 4,765 4,503 5,218 Source: Bangko Sentral ng Pilipinas 31 Draft for Review Table 9: Labor and Employment Indicators (000) 1997 1998 1999 2000 2001 2002 Jul-03 Population 71,521 73,177 74,878 76,627 78,317 80,040 - Growth Rate 2.2 2.3 2.3 2.3 2.2 2.2 - Working Age Population 45,770 44,995 46,321 47,640 48,929 50,344 50,751 Growth Rate -1.7 2.9 2.8 2.7 2.9 -1.3 Total Labor Force 30,355 29,674 30,759 30,911 32,809 33,936 34,206 Growth Rate -2.2 3.7 0.5 6.1 3.4 0.1 Labor Force Participation Rate 66.3 65.9 66.4 64.9 67.1 67.4 67.4 Unemployed 2,640 3,043 3,017 3,459 3,653 3,874 4,348 Unemployment Rate 8.7 10.3 9.8 11.2 11.1 11.4 12.7 Underemployed 6,121 5,758 6,127 5,955 5,006 5,109 6,211 Underemployment Rate 22.1 21.6 22.1 21.7 17.2 17.0 20.8 Employment by Sector Agriculture 11,314 10,091 10,774 10,181 10,850 11,122 10,384 Industry 4,631 4,542 4,515 4,454 4,713 4,694 4,953 Manufacturing 2,732 2,715 2,759 2,745 2,906 2,869 3,026 Services 11,771 11,999 12,453 12,817 13,593 14,246 14,520 Total 27,716 26,632 27,742 27,452 29,156 30,062 29,858 Jobs Generated Agriculture -331 -1223 683 -593 669 272 -769 Industry 201 -89 -27 -61 259 -19 232 Manufacturing 23 -17 44 -14 161 -37 189 Services 659 228 454 364 776 653 123 Distribution by Class of Workers (percent of total) Wage and Salary Workers 48.6 49.9 49.6 50.7 49.5 48.7 53.9 Own-account Workers 37.4 37.0 36.8 37.1 37.5 37.9 35.6 Unpaid family Workers 14.1 13.1 13.6 12.2 13.0 13.3 10.5 Source: National Statistics Office 32 Draft for Review wb182527 M:\PREM\Development Update 2003\October\DevUpdate_Oct16_2003 - Joven.doc October 16, 2003 1:58 PM 33