PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY INVESTING IN THE FILIPINO APRIL 2019 PREFACE The Philippines Economic Update summarizes key economic and social developments, important policy changes, and the evolution of external conditions over the past six months. It also presents findings from recent World Bank studies, situating them in the context of the country’s long-term development trends and assessing their implications for the country’s medium-term economic outlook. The update covers issues ranging from macroeconomic management and financial-market dynamics to the complex challenges of poverty reduction and social development. It is intended to serve the needs of a wide audience, including policymakers, business leaders, private firms and investors, and analysts and professionals engaged in the social and economic development of the Philippines. The Philippines Economic Update is a biannual publication of the World Bank’s Macroeconomics, Trade, and Investment Global Practice (MTI), prepared in partnership with the Poverty & Equity, Finance, Competitiveness & Innovation, and Social Protection & Labor Global Practices (GPs). Ndiame Diop (Practice Manager for the MTI GP) and Souleymane Coulibaly (Lead Economist and Program Leader) guided the preparation of this edition. The team consisted of Rong Qian (Senior Economist), Kevin Chua (Economist), Kevin Cruz (Research Analyst), Karen Lazaro (Consultant), and Ray Gomez (Consultant) from the MTI GP, Isaku Endo (Senior Financial Sector Specialist) from the Finance, Competitiveness and Innovation GP, Gabriel Demombynes (Program Leader), Xubei Luo (Senior Economist) and Sharon Faye Alariao Piza (Economist) from the Poverty & Equity GP, and Pablo Acosta (Senior Economist) and Arianna Zapanta (Consultant) from the Social Protection GP. The report was edited by Oscar Parlback (Сonsultant), and the graphic designer was Christopher Carlos (Сonsultant). Peer reviewers were Ralph Van Doorn (Senior Economist), Habib Rab (Program Leader), and Hnin Hnin Pyne (Program Coordinator). Logistics and publication support were provided by Reinaluz Ona (Program Assistant) and Adrienne Mendoza (Consultant). The Manila External Communications Team, consisting of David Llorito (Communications Officer), Clarissa David (Senior Communication Officer), Stephanie Margallo (Team Assistant) prepared the media release, dissemination plan, and web-based multimedia presentation. The team would like to thank Mara Warwick (Country Director for Brunei, Malaysia, Philippines and Thailand) for her advice and support. The report benefited from the recommendations and feedback of various stakeholders in the World Bank as well as from the government, the business community, labor associations, academic institutions, and civil society. The team is very grateful for their contributions and perspectives. The findings, interpretations, and conclusions expressed in the Philippines Economic Update are those of the World Bank and do not necessarily reflect the views of the World Bank’s executive board or any national government. This report went to Press on April 1, 2019. If you wish to be included in the email distribution list for the Philippines Economic Update and related publications, please contact Reinaluz Ona (rona1@worldbank.org). For questions and comments regarding the content of this publication, please contact Ms. Rong Qian (rqian@worldbank.org). Questions from the media should be addressed to David Llorito (dllorito@worldbank.org). For more information about the World Bank and its activities in the Philippines, please visit www.worldbank.org/ph. 3 ABBREVIATIONS AND ACRONYMS ARMM Autonomous Region in Muslim Mindanao ASR Adult survival rate BIR Bureau of Internal Revenue BPO Business process outsourcing BSP Bangko Sentral ng Pilipinas DHS Demographic and health survey EAP East Asia and Pacific EGRA Early Grade Reading Assessment EMDES Emerging market and developing economies FDI Foreign direct investment GAB General Appropriations Bill HCI Human Capital Index HCP Human Capital Project HHIC-PHIL Hanjin Heavy Industries and Construction Philippines IT Information technology LET Licensure exam for teacher NCR National Capital Region PDP Philippine Development Plan PIDS Philippines Institute for Development Studies PISA Programme for International Student Assessment PMI Purchasing managers’ index PPAN Philippine Plan of Action for Nutrition PSA Philippines Statistics Authority RHU Rural health unit SHS Senior high school TIMSS Trends in International Mathematics and Science Study TRAIN Tax Reform for Acceleration and Inclusion 4 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO © 2019 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. 5 TABLE OF CONTENTS PREFACE 2 ABBREVIATIONS AND ACRONYMS 3 EXECUTIVE SUMMARY 8 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 11 Soft Economic Growth amid Rising External and Domestic Challenges 12 Exchange Rate Dynamics and the External Sector: Weak External Environment 18 Monetary Policy and Financial Markets: Tightening Policy to Curb Inflation 21 The Success of Fiscal Reforms 25 Inflation Affected Poor Households 28 02 OUTLOOK AND RISKS 33 Growth Outlook Remains Positive 34 Poverty Reduction and Shared Prosperity Progress 41 Some Risks and Policy Challenges Remain 42 03 THE PROMISE OF HUMAN CAPITAL 47 The Philippines Can Achieve its Full Potential by Boosting Human Capital 48 Nutrition Is the Weakest Link of Human Capital for the Philippines 51 Limited Quality of Education Generates a Learning Gap 54 Overall Health 57 Key Policy Levers for Human Capital 60 REFERENCES 62 6 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO LIST OF FIGURES Figure 1. Investment spending drove growth in 2018, Figure 24. Real GDP is expected to grow above 6.0 as net export performance weakened 12 percent in 2019-21 34 Figure 2. …while services remained the main engine Figure 25. Global growth is expected to slow in the of growth. 12 coming years… 40 Figure 3. Export of electronics equipment slowed Figure 26. …along with a slowdown in global trade. globally in 2018. 14 Figure 27. Actual and Projected Poverty Rates in the Philippines, 2006-2021 40 Figure 4. Global growth moderated in 2018 16 Figure 27. Real GDP is expected to grow above 6.0 Figure 5. …as global trade growth weakened and percent in 2019-21 41 global manufacturing growth slowed. 16 Figure 28. While the Philippines’ macroeconomic Figure 6. The Philippines recorded a larger current- fundamentals are strong, challenges remain. 42 account deficit in 2018. 18 Figure 29. Consumer and business confidence Figure 7. Both the real and nominal exchange rate worsened in 2018. 42 depreciated further in 2018… 20 Figure 30. The Human Capital Index shows the Figure 8. …as imports grew faster than exports. 20 impact of current investments in children on future productivity. 49 Figure 9. Inflation increased throughout most of 2018, before decreasing in the last two months. 21 Figure 31. Human Capital Index by Region, 2017. 49 Figure 10. Rising food prices contributed to more than Figure 32. Human Capital Index by Socioeconomic half of the total rise in inflation in 2018. 22 Status, 2017. 49 Figure 11. Rising Food, housing and utilities, and Figure 33. The Human Capital Index and transport prices were the main drivers of inflation Its Subcomponents 50 in 2018. 22 Figure 34. Between 1990 and 2016, the probability a Figure 12. Loan Portfolio of the Philippine Banking Filipino child survives to the age of five improved from Sector (December 2017 and 2018) 23 94 to 97 percent. 51 Figure 13. National Government Fiscal Balance, 2013-18 26 Figure 35. Rates of Return on Investments to Reduce Stunting by Country 52 Figure 14. The government finances its deficit mainly through domestic borrowing, but the share of foreign Figure 36. Stunting Trends in the Philippines and Peru 53 financing increased in 2018. 27 Figure 37. Limited Learning Creates a “Learning Gap” Figure 15. National Government Expenditures by between Expected Years of Schooling and Learning- Component (% of GDP). 27 Adjusted Years. 54 Figure 16. National Government Tax Collections by Figure 38. School Enrollment Rates by Age for the Type (% of GDP). 27 Poorest 20% and richest 20% 55 Figure 17. The Overall Debt-to-GDP ratio fell slightly Figure 39. Results from the TEACH Classroom in 2018. 27 Observation Study 56 Figure 18. Unemployment and Figure 40. Pass Rates of the Licensure Exam for Underemployment Rates. 28 Teachers by Region, 2016 57 Figure 19. Number of New Jobs by Sector 28 Figure 41. Health Insurance Coverage, 2017 58 Figure 20. Labor Force Participation Rate 29 Figure 42. Birth Trends in Facilities and Vaccination Rates 58 Figure 21. Average Daily Real Wage (Measured in Constant 2012 Php) 30 Figure 43. Reaching PDP targets by 2022 would lead to a significant improvement in productivity and Figure 22. Rising inflation especially affected economic growth. 60 poor households. 30 Figure 44. Human capital spending has increased Figure 23. The increase in food prices contributed to over time, outpacing GDP growth. 60 higher inflation faced by the poor. 31 7 LIST OF TABLES Table 1. Contribution to Growth, Expenditure Side (Percentage Points) 15 Table 2. Contribution to Growth, Supply Side (Percentage Points) 15 Table 3. Balance of Payments Position (2015 – 2018) 20 Table 4. Economic Indicators for Baseline Projections 35 Table 5. Status of 75 Flagship Infrastructure “Build, Build, Build” Projects (as of November 30, 2018) 37 Table 6. Real GDP Growth, 2016-21 40 LIST OF BOXES Box 1. Recent Global Developments 16 Box 2. Tracking the Basket Components of Inflation 22 Box 3. The Resilience of the Philippines’ Financial Sector 24 Box 4. The Impact of High Inflation 31 Box 5. Implementation of Flagship Infrastructure Projects under the “Build, Build, Build” Program 37 Box 6. The Global Economic Outlook 39 Box 7. The Delayed Passage of the 2019 National Government Budget 44 Box 8. Tools for Boosting Human Capital: The Pantawid Pamilya Pilipino Program 59 8 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO EXECUTIVE SUMMARY Philippine economic growth moderated in 2018, growth outpaced revenue growth, widening the fiscal as the country faced both external headwinds and deficit from 2.2 percent of GDP in 2017 to 3.2 percent of high domestic inflation. Weak global trade led to GDP in 2018—above the government’s deficit target of slower export growth while import growth remained 3.0 percent. Still, the government’s overall fiscal position robust, resulting in net export being a drag on growth. remains healthy as the national government debt, Meanwhile, private consumption growth decelerated mainly denominated in peso, declined to 41.9 percent of to its slowest pace since 2014, due to high domestic GDP in 2018 from 42.1 percent in 2017. inflation and weaker consumer sentiment. Inflation only retreated toward the end of the year, as global fuel On the external side, a weak and uncertain global prices declined, rice supply increased, and in response market environment contributed to an overall balance to Bangko Sentral ng Pilipinas monetary policy of payments deterioration and a depreciation of the tightening. The slowdown in private consumption and Philippine peso in 2018. Despite robust growth in the net export drag combined caused a moderation services exports, the current-account deficit widened in economic growth which slowed for the second from 0.7 percent of GDP in 2017 to 2.4 percent of GDP consecutive year, from 6.7 percent, year-on-year, in 2017 in 2018, due to a widening of the merchandise trade to 6.2 percent in 2018—below the government’s 6.5-7.0 deficit. Capital inflows, however, were notably higher target range. percent with the financial account reaching a surplus of 2.4 percent of GDP in 2018 from 0.9 percent of GDP in 2017. The overall economic growth slowdown occurred The Philippine peso depreciated in nominal terms by amid solid growth in private investment and 4.3 percent, year-on-year, in 2018, from a 5.8 percent public spending. Fixed capital formation accelerated depreciation in 2017. from 9.5 percent, year-on-year, in 2017 to 14.0 percent in 2018, fueled by: i) continued investment in durable While household income likely continued to increase equipment as firms sought to improve their productive in 2018, higher inflation may have slowed progress in capacity; ii) a strong rebound in private construction poverty reduction. Data from the most recent annual activities; and iii) an acceleration in public investment poverty indicators survey suggest that the poverty growth as the government ramped up infrastructure rate declined in 2017, as household per capita income spending. Public expenditure (in percent of GDP) increased at a faster rate than inflation, and the income reached its highest level since 1983, driven by a of the bottom 40 percent of the population grew at a significant increase in infrastructure spending and a rise faster rate than that of the average household. in personnel services expenditures mainly due to the In addition, the continuing transition of employment implementation of the third tranche of the adjustment to non-agricultural wage jobs suggests more to the salary standardization law and an increase in the sustainable sources of income for households. However, pay for the military and uniformed personnel. the impact of high inflation may have hampered poverty reduction efforts in 2018, as the poorest income The rapid increase in public spending mirrors good quintile experienced higher inflation than the performance in revenue collection, even if the latter average household. falls short of the ambitious target set by the Bureau of Internal Revenue (BIR) for 2018. Despite softer GDP The economic growth outlook remains positive. growth, the tax ratio reached its highest level in more The country’s economic growth is projected to reach than two decades. Nominal tax revenue growth stood 6.4 percent in 2019 and slightly edge up to 6.5 percent at 14 percent in 2018, leading to an overall government in 2020 and 2021, as inflation is expected to decline, revenue growth of 15.2 percent (up from 12.6 percent and spending due to the upcoming midterm elections in 2017). As a result, revenue-to-GDP increased to 16.4 is likely to boost private consumption growth. Public percent, up from 15.6 percent in 2017, providing space investment growth is expected to be tempered in the for greater public spending. Nevertheless, expenditure first half of 2019 due to delays in approving the public 9 budget, and is projected to recover in the second doing business, and reducing non-tariff barriers to half of 2019. Export growth will likely remain weak, as boost trade. For instance, passing the Public Sector global economic and trade growth are projected to Act Amendment bill will entice foreign investments decelerate in the near term, due to persisting trade and bring competition to the transportation and tensions. The further strengthening of the U.S. dollar, telecommunications sectors that are key backbone possible increases in U.S. interest rates, and geopolitical services whose efficiency directly affects uncertainties continue to be the main external overall productivity. downside risks to the economic outlook. Human capital formation remains a critical policy However, domestic downside risks are intensifying agenda for the Philippines given its critical role for long with the delay in the approval of the 2019 budget and term economic growth. While labor productivity growth looming drought. The continuing delay in the approval has been high since 2000, sustaining high productivity of the 2019 budget is a significant downside risk as growth requires continuous investment in human under a reenacted budget no new programs and capital in addition to ramping up physical investment. projects can be implemented, which will negatively The recently released World Bank Human Capital Index impact public investment, a key parameter of our is a helpful tool to deepen the understanding of human projection in 2019 and over the medium term. capital development, and helps the country identify Additional policy risks stem from uncertainty over area with most pressing needs for policy intervention. the remaining tax reform programs. Indeed, as the government ramps up spending to implement its Rapid technological advances are increasingly making inclusive growth agenda, complementary reforms to human capital—knowledge, skills, and good health— enhance revenue generation are needed to ensure essential to a country’s economic success. The overall fiscal sustainability. Finally, the impact of the El Niño HCI of 0.55 for the Philippines is above the average phenomenon on agriculture presents a risk to economic for lower middle-income countries but substantially growth as it might affect production and food inflation. below the average of countries in East Asia and Pacific. This means that children born in the country today are Key short-term priorities to sustain the Philippines’ rapid expected to achieve only 55.0 percent of their potential economic growth include prudently managing fiscal income when they reach adulthood, compared to and current account balances and adopting policies fully healthy children who receive a complete, high- to preserve consumer and business confidence. As the quality education. Effective implementation of the government continues to expand public investment to government’s human capital initiatives will make it address the country’s infrastructure gap, it is crucial to possible for the Philippines and all Filipinos to achieve raise additional revenue to preserve fiscal sustainability, their full potential. particularly as financing conditions may tighten globally. In addition, the trade deficit is estimated to The Philippines’ performance on the HCI points to three remain wide, as export growth will likely stay weak policy priorities to improve the country’s human capital. while import growth is expected to accelerate. Given The first is to improve the learning outcome of the that global financing conditions may tighten, the entire education system. This orientation can motivate government needs to closely monitor the performance the implementation of the country’s many education of remittances, service exports, and foreign direct initiatives, including the Philippine Professional investment to prevent an external funding gap. Standards for Teachers. The second priority is to tackle the high child stunting rate of 33 percent. The extreme In the long term, in addition to sustained efforts to level of stunting is a drag on the country’s economic build human capital, initiatives to address structural growth potential, and although the government has a constraints are needed to accelerate inclusive growth. Philippines’ Plan of Action for Nutrition, and awareness Improved market competition, accelerated investment, about the issue is rising, government-wide recognition and improved labor market conditions to boost both of how critical addressing this issue is to the country’s productivity and economic growth will be essential. future is missing. A third priority is leveraging expanded This calls for urgent actions on a couple of policy access to improve the quality of health care. The initiatives including revisiting foreign participation in implementation of the Universal Health Coverage Law the domestic market, implementing reforms to improve will provide this opportunity. 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS Economic growth moderated for the second consecutive year, from 6.7 percent, year-on-year, in 2017 to 6.2 percent in 2018—below the government’s 6.5-7.0 percent target range. The moderation in growth reflected both external headwinds and domestic challenges: export growth slowed due to weak global trade, and private consumption growth decelerated because of high domestic inflation. The growth slowdown was only partially offset by a strong rebound in investment spending, fueled by an acceleration in durable equipment investment growth and a dynamic construction sector. Inflation gradually retreated toward the end of 2018, as global fuel prices declined, rice supply increased, and in response to a cumulative 175 basis points increase in the Bangko Sentral ng Pilipinas policy rate to 4.75 percent in 2018. In line with other currencies in the region, the Philippine peso depreciated by 4.3 percent in 2018, owing to a fall in capital inflows and a larger current-account deficit. On the fiscal side, rapid expenditure growth outpaced strong revenue growth in 2018, resulting in a fiscal deficit of 3.2 percent—slightly above the government’s 3.0 percent budget deficit ceiling. Household income likely continued to increase during the year, especially for the bottom 40 percent of the population, although the impact of inflation may have slowed progress in poverty reduction. 12 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO SOFT ECONOMIC GROWTH AMID RISING EXTERNAL AND DOMESTIC CHALLENGES Philippine economic growth moderated to 6.2 percent, year-on-year, in 2018, driven by softer private consumption growth and weaker net export performance. While aggregate investment growth also accelerated—fueled by continued investment in durable equipment, an acceleration in public investment growth, and a strong rebound in private construction activities—it could only partially offset the deceleration in private consumption and net exports. Philippine economic growth moderated in 2018 driven by robust public investment activity, while the due to both external and domestic factors. The deceleration in export growth was driven by global Philippine economy expanded by 6.2 percent, year- growth moderation, weakening global trade, and on-year, in 2018—down from 6.7 percent in 2017 and a slowdown in manufacturing activities (Box 1). In the lowest level since 2015. This was also below the 2018, private consumption growth moderated to its government’s growth target range of 6.5-7.0 percent. slowest pace since 2014, tempered by high inflation The growth moderation in 2018 was partly driven and weaker consumer sentiment. Meanwhile, public by weak performance in the net exports sector, as consumption growth accelerated by double digits import growth outpaced export growth for the year. for the first time since 2012 due to the government’s The continued surge in import growth was primarily expansionary fiscal policy stance. Figure 1. Investment spending drove growth in 2018, Figure 2. ...while services remained the main engine of growth. as net export performance weakened... DEMAND SIDE: CONTRIBUTION TO GDP GROWTH SUPPLY SIDE: CONTRIBUTION TO GDP GROWTH 15 7 10 5 Percentage point Percentage point 5 0 3 -5 1 -10 -1 2014 2015 2016 2017 2018 2013 2014 2015 2016 2017 2018 Private consumption Government consumption Agriculture Other industries Investments Discrepancy Manufacturing GDP Growth Net exports GDP Growth Services Source: Philippine Statistics Authority (PSA) Note: Other industries are mining and quarrying, construction, and electricity, gas and water. Source: PSA PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 13 Investment growth was the principal driver of increasing by 12.8 percent, year-on-year, in 2018, up economic growth in 2018, bolstered by strong from 7.0 percent in 2017, as personnel services (i.e., public investment spending (Figure 1). Fixed salaries and wages) and maintenance and operating capital formation growth accelerated from 9.5 expenditures increased substantially. percent, year-on-year, in 2017 to 14.0 percent in 2018, as investments in durable equipment and The country’s net export performance weakened the construction sector increased significantly. as import growth, despite decelerating since 2016, Investment growth in durable equipment, which outperformed export growth in 2018. Philippine account for nearly 60.0 percent of fixed capital import growth slowed from 20.2 percent, year- formation, accelerated slightly from 10.7 percent, on-year, in 2016 to 18.1 percent and 14.5 percent in year-on-year, in 2017 to 13.4 percent in 2018.1 2017 and 2018, respectively. The continuous rise in Investments in the three broad durable equipment imports was largely driven by robust import growth categories2 all registered an acceleration in growth in capital investment goods and raw materials in 2018 compared to 2017, as relatively high capacity and intermediate goods—consistent with the utilization rates led firms to focus on improving their government’s focus on investment spending and productive capacity. In addition, investment growth the country’s participation in global value chains in construction expanded by 15.1 percent, year-on- (specifically electronics). Meanwhile, the Philippines’ year, in 2018—more than double the growth of export growth softened, expanding by 11.5 percent, 5.9 percent registered in 2017.3 Robust construction year-on-year, in 2018, down from 19.5 percent in growth was largely driven by an increase in public 2017, as both merchandise and services export investment spending and a strong recovery in growth decelerated. A moderation in the growth of private construction activities.4, 5, 6 electronics exports, which accounted for nearly 60.0 percent of goods exports in 2018, drove the overall Private consumption growth moderated for the fall in exports, decelerating from 25.3 percent, year- second consecutive year in 2018 amid high inflation. on-year, in 2017 to 15.4 percent in 2018. Electronics Private consumption growth decelerated from exports fell partly because of the completion of 5.9 percent, year-on-year, in 2017 to 5.6 percent in the technology inventory restocking cycle, which 2018—the lowest level since 2014. The moderation led to a slowdown in global electronics output and in private consumption growth was primarily the exports (Figure 3). Moreover, exports of other major result of rapidly rising inflation, which weakened commodity groups fell substantially in the same year, consumer sentiment,7 and slower growth of partly as a result of a moderation in global growth remittances from overseas Filipinos.8 Nevertheless, and softening in global trade, manufacturing, and consumption growth remained at a relatively healthy investment activities. Also, growth in services exports level, accounting for 68.5 percent of GDP in 2018, decelerated from 14.5 percent, year-on-year, in 2017 supported by a lower unemployment rate, continued to 7.9 percent in 2018, which contributed to weaker expansion in credit, and an increase in disposable overall export growth. In particular, the tourism income due to personal income tax cuts under the sector grew by a mere 2.9 percent, year-on-year, in Tax Reform for Acceleration and Inclusion (TRAIN), 2018, substantially lower than 35.5 percent in 2017, which benefitted over 60.0 percent of all wage as the sector’s performance was dampened by the earners. Meanwhile, public consumption closure of the island of Boracay for six months due to benefitted from an expansionary fiscal policy, the government’s rehabilitation efforts.9 1 Investments in durable equipment contributed 2.2 percentage points to overall GDP growth in 2018, compared to 1.7 percentage points in 2017. 2 The three durable equipment categories are i) specialized machinery for particular industries; ii) general industrial machinery and equipment; and iii) transport equipment. 3 The construction sector’s contribution to GDP increased by 1.5 percentage points in 2018, up from 0.6 percentage points in 2017. 4 Investments in private construction increased by 12.9 percent, year-on-year, in 2018, more than four times the 3.7 percent growth recorded in 2017. The sector contributed 0.9 percentage points to overall growth in 2018, up from 0.3 percentage points in 2017. 5 Investments in public construction expanded from 12.7 percent, year-on-year, in 2017 to 21.2 percent in 2018. The sector contributed 0.5 percentage points to overall growth in 2018, up from 0.3 percentage points in 2017. 6 Public investments expanded by 49.7 percent, year-on-year, in nominal terms in the first 11 months of 2018, substantially greater than the 15.3 percent growth registered in 2017. 7 As inflationary pressures continued to build up in 2018, consumer sentiments regarding the Philippine economy turned more pessimistic, with the consumer con- fidence index dropping to -22.5 percent in the fourth quarter of 2018. This was the lowest level of consumer confidence registered by the Bangko Sentral ng Pilipinas’ Consumer Expectations Survey since the third quarter of 2014 (-26.3 percent). 8 In 2018, remittances grew by 3.0 percent, year-on-year, in nominal terms, down from 5.3 percent in 2017. 9 Although tourist arrivals increased by 7.7 percent, year-on-year, to reach 7.1 million in 2018, this was well below the Philippine government’s 7.4 million target for the year. According to the Department of Tourism, Boracay island, which was closed for six months due to the government’s rehabilitation efforts, sees an estimated 80,000 tourists per month. 14 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Figure 3. Export of electronics equipment slowed globally in 2018. 60 58 PURCHASING MANAGERS’ INDEX (PMI) 56 54 52 Manufacture of Electronic Equipment: Output 50 Manufacture of Electronic Equipment: New Orders 48 Manufacture of Electronic Equipment (Global PMI) JAN 2016 MAR 2016 MAY 2016 JUL 2016 SEP 2016 NOV 2016 JAN 2017 MAR 2017 MAY 2017 JUL 2017 SEP 2017 NOV 2017 JAN 2018 MAR 2018 MAY 2018 JUL 2018 SEP 2018 NOV 2018 Note: A value of 50+ signifies an expansion. Source: Haver Analytics. The services sector continued to drive economic sector expanded by 4.9 percent, year-on-year, growth in 2018, while the agriculture sector in 2018—lower than the 8.4 percent recorded in continued to underperform (Figure 2). Services 2017 and the lowest level since 2011 (4.7 percent). expanded by 6.6 percent, year-on-year, in 2018, Weaker manufacturing growth was largely driven slightly down from 6.8 percent in 2017. Higher by a contraction in the production of chemical inflation and weaker consumer sentiment led to manufactures, which accounted for 10.9 percent of weaker growth in the wholesale and retail trade total goods exports in 2018. Chemical manufactures sector, from 7.3 percent, year-on-year, in 2017 to 5.9 contracted by 4.9 percent, year-on-year, in 2018, percent in 2018. Meanwhile, the country’s agriculture down from an expansion of 7.9 percent in 2017. The sector failed to sustain the progress achieved in 2017, sector’s weak performance was likely demand growing by a mere 0.8 percent, year-on-year, in 2018, driven, as exports of chemical products contracted down from 4.0 percent in 2017. Production dropped by 25.3 percent, year-on-year, in 2018—more than in both the crops10 (from growing by 6.7 percent, double the 12.7 percent contraction registered year-on-year, in 2017 to contracting by 1.0 percent in in 2017.13, 14 In addition, softer growth in food 2018) and fisheries11 (from contracting by 1.7 percent, manufactures (from 4.9 percent, year-on-year, in year-on-year, in 2017 to contracting by 1.1 percent 2017 to 4.1 percent in 2018), which accounted for in 2018) sectors. The agriculture sector’s continued nearly half of all manufacturing output, contributed poor performance was due to persistent challenges to a deceleration in manufacturing growth. The affecting the productivity of the sector, exacerbated slowdown in food manufacturing was also affected by its vulnerability to severe weather conditions.12 by tepid growth in agricultural output and lower Specifically, the production decline in the crops demand for food products due to high inflation in sector was the result of a combination of inadequate 2018. Yet, industry sector growth remained robust, irrigation services and severe weather conditions decelerating slightly from 7.2 percent, year-on-year, such as the occurrence of typhoons. in 2017 to 6.8 percent in 2018. Industry growth was driven by the construction sector, which grew by Manufacturing growth decelerated to its slowest 15.9 percent, year-on-year, in 2018—three times the pace in seven years in 2018, driving the slowdown 5.3 percent growth recorded in 2017. in overall industry growth. The manufacturing 10 The crops sector accounted for 55.1 percent of total agricultural output in 2018. 11 The fisheries sector accounted for 14.5 percent of total agricultural output in 2018. 12 PSA, 2018. Performance of Philippine Agriculture (Q1-Q4 2018). 13 Based on value (FOB US$). Source: PSA 14 The country’s chemical manufactures primarily cater to regional value chains in the Asia-Pacific region, with Japan as the country’s primary trading partner and China receiving an increasing share. By 2014, these two countries accounted for 58.0 percent of all chemical exports from the Philippines. Source: DTI. 2017. DTI Policy Briefs: The Philippines in Chemical Global Value Chain. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 15 Table 1. Contribution to Growth, Expenditure Side (Percentage Points) 2015 2016 2017 2018 Private Consumption 4.4 4.9 4.1 3.8 Government Consumption 0.8 0.9 0.7 1.4 Fixed Capital Formation 3.6 6.2 2.6 4.0 Construction 1.0 1.2 0.6 1.5 Durable Equipment 2.5 4.7 1.7 2.2 Exports 4.0 5.7 9.9 6.5 Merchandise Exports 2.5 4.1 8.4 5.6 Services Exports 1.5 1.5 1.6 0.9 Imports -7.1 -10.6 -10.7 -9.5 Merchandise Imports -5.4 -9.8 -9.4 -8.5 Services Imports -1.7 -0.8 -1.3 -1.0 Gross Domestic Product 6.1 6.9 6.7 6.2 Source: PSA Table 2. Contribution to Growth, Supply Side (Percentage Points) 2015 2016 2017 2018 Agriculture, Fishery, & Forestry 0.0 -0.1 0.3 0.1 Agriculture & Forestry 0.0 0.0 0.4 0.1 Fishery 0.0 -0.1 0.0 0.0 Industry 2.2 2.7 2.4 2.3 Mining & Quarrying 0.0 0.0 0.0 0.0 Manufacturing 1.3 1.6 1.9 1.1 Construction 0.7 0.7 0.3 1.0 Electricity, Gas, & Water 0.2 0.3 0.1 0.2 Services 3.9 4.3 3.9 3.8 Transport, Communication, & Storage 0.6 0.4 0.3 0.4 Trade 1.2 1.3 1.2 1.0 Finance 0.4 0.6 0.6 0.5 Real Estate, Renting and Business Activities 0.8 1.0 0.8 0.6 Government Services 0.1 0.3 0.3 0.6 Other Services 0.8 0.8 0.7 0.8 Gross Domestic Product 6.1 6.9 6.7 6.2 Source: PSA 16 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Box 1. Recent Global Developments Global growth is moderating as the recovery in trade and manufacturing activities loses steam (Figure 4). Global growth slowed to a near three-year low of 2.2 percent (q/q seasonally adjusted annual rate) in the third quarter of 2018, and survey data suggest that the subdued momentum persisted in the fourth quarter, with the global manufacturing purchasing managers’ index ending the year at a 27-month low (Figure 5). The weakness in global growth seems to have continued in 2019, with the global manufacturing PMI falling to 50.7 in January, its lowest in more than two years. Despite ongoing negotiations, trade tensions among major economies remain elevated. These tensions, combined with concerns about softening global growth prospects, have weighed on investor sentiment and contributed to a fall in global equity prices. Also, borrowing costs for EMDEs have increased, partly due to central banks in advanced economies continuing to withdraw policy accommodation in varying degrees. A strengthening U.S. dollar heightened financial market volatility, and rising risk premiums have intensified capital outflow and currency pressures in some large EMDEs, with some vulnerable countries experiencing substantial financial stress. Energy prices have fluctuated markedly, mainly due to supply factors, with sharp falls toward the end of 2018. Other commodity prices—particularly for metals—have also weakened, posing renewed headwinds for commodity exporters. Figure 4. Global growth moderated in 2018... Figure 5. ...as global trade growth weakened and global manufacturing growth slowed. 8 5.0 55 54 6 4.5 53 4 4.0 52 51 2 3.5 50 0 3.0 49 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 JUN 2017 SEP 2017 MAR 2018 JUN 2018 SEP 2018 NOV 2018 DEC 2017 World Advanced economies Industrial production EMDEs New export orders (RHS) Source: World Bank staff estimates Note: A value greater than 50 signifies an expansion in new export orders. Source: Haver Analytics. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 17 Growth has moderated in most advanced economies, with the notable exception of the United States, where fiscal stimulus is boosting economic activity. U.S. growth reached an estimated 2.9 percent, year-on-year, in 2018, up from 2.2 percent in 2017, mostly reflecting stronger-than-expected domestic demand following a procyclical fiscal policy and an accommodative monetary policy that bolstered economic activity. By contrast, economic activity in the euro area has been weaker than previously expected, as economic growth slowed from 2.4 percent, year-on-year, in 2017 to an estimated 1.9 percent in 2018. In particular, exports in the euro zone softened, reflecting an earlier appreciation of the euro and lower external demand. While economic growth in advanced economies slowed to an estimated 2.2 percent, year-on-year, in 2018, it was still above potential and in line with previous forecasts. Japanese economic growth decelerated from 1.9 percent, year-on-year, in 2017 to an estimated 0.8 percent in 2018, reflecting a contraction in growth in the first and third quarters due to bad weather and natural disasters. The economic recovery in EMDEs has stagnated. Economic growth in EMDEs decelerated slightly from 4.3 percent, year-on-year, in 2017 to an estimated 4.2 percent in 2018—0.3 percentage points lower than previously projected, as a number of countries with large current-account deficits experienced substantial financial market pressures and a slowdown in economic activity. Domestic demand across EMDEs has generally moderated, reflecting tighter domestic borrowing conditions, softer confidence, and policy tightening in some large economies to abate domestic price pressures and prevent capital outflows. A more challenging international environment was accompanied by renewed market attention to country-specific vulnerabilities and financial stress in some large economies with persistent macroeconomic fragilities, such as Argentina and Turkey. Economic growth moderated in about 40.0 percent of commodity importing EMDEs in 2018, with notable declines in countries facing currency and financial market pressures. Meanwhile, the recovery in many commodity exporting EMDEs stagnated in the same year, reflecting lower external demand, tighter borrowing conditions, volatile commodity prices, and various domestic headwinds. Following a strong momentum in 2017, growth in global goods trade slowed markedly in the first half of 2018 and has only partially recovered. After reaching a six-year high of 5.4 percent, year-on-year, in 2017, global trade growth slowed to an estimated 3.8 percent in 2018—the sharpest deceleration since 2012. The slowdown was more pronounced than previously expected, which was reflected in the fall in export orders and global manufacturing activity. In particular, global capital goods production, which is highly trade-intensive, has slowed in Europe and developing Asia—two tightly interconnected global manufacturing hubs.15 The softening of global goods trade came against the backdrop of ongoing trade tensions between the United States and China. New tariffs introduced since the beginning of last year have affected about 12.0 percent of U.S. total goods imports, 6.5 percent of China’s total goods imports, and about 2.5 percent of the global goods trade. The temporary pause in tariff hikes agreed by the United States and China during the G20 meeting in early December 2018 and the successful negotiations of the new United States-Mexico-Canada Agreement have somewhat tempered trade policy uncertainties. However, the possibility of escalating trade restrictions involving major economies remains elevated.16 15 Nearly one-third of European exports and more than half of German exports to developing Asia consist of machinery and vehicles, while capital goods and electronics account for one-third of exports from developing Asia to Europe. Source: Raschen and Rehbock (2016). 16 World Bank. 2019. Global Economic Prospects January 2019: Darkening Skies. 18 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO EXCHANGE RATE DYNAMICS AND THE EXTERNAL SECTOR: WEAK EXTERNAL ENVIRONMENT A weak and uncertain external environment and subpar performance in net exports contributed to an overall balance of payments deterioration and a depreciation of the Philippine peso in 2018. The current account deficit significantly widened 4.0 percent and reached US$23.8 billion in revenue in 2018, led by a large trade deficit (Figure 6). With as of June 2018, although it missed its revenue target imports growing faster than exports, the trade deficit under its five-year roadmap.18 Similarly, primary and ballooned from US$40.2 billion (12.8 percent of GDP) secondary income19 receipts from abroad continued in 2017 to US$49.0 billion (14.8 percent of GDP) in to grow but at a slower pace in 2018, mainly as a 2018.17 The widening trade deficit was not offset by result of a growth deceleration in remittances from services exports, which expanded by 20.7 percent, overseas Filipinos. Personal remittances grew by a year-on-year, in 2018, down from 23.4 percent in mere 3.0 percent and reached US$32.2 billion in 2018, 2017. Services exports grew on the back of sustained down from 5.3 percent in the same period in 2017. revenues from telecommunication, computer, and As a result, the current account deficit further technical services. The business process outsourcing widened from US$2.1 billion (0.7 percent of GDP) in (BPO) industry, in particular, expanded by about 2017 to US$7.9 billion (2.4 percent of GDP) in 2018. Figure 6. The Philippines recorded a larger current account deficit in 2018. 5 4 3 2 1 Percent of GDP 0 Current account -1 -2 Capital and Financial accounts -3 Net unclassified items -4 Overall BOP position -5 -6 2014 2015 2016 2017 2018 Source: Bangko Sentral ng Pilipinas (BSP). 17 The surge in import growth was partly a result of the significant increase in capital goods imports in 2018, driven in part by the acceleration of the Philippine govern- ment’s public investment program. 18 The Information Technology and Business Process Outsourcing Association of the Philippines remarked that it missed its revenue target under its five-year roadmap due to uncertainty amid plans to change the fiscal regime and the U.S. president’s vow to attract jobs back to the United States. The cited 4.0 percent expansion measured growth over the past 18 months, ending in June 2018. The IT-BPM roadmap projected revenue to grow at 9.2 percent annually starting in 2017 to reach US$38.9 billion by 2022. See https://www.bworldonline.com/bpo-sector-blames-policy-challenges-for-missed-targets/; and ITBPAP, “Accelerate PH Future Ready Roadmap 2022,” 2017, available online: http://itbpm-roadmap2022.ibpap.org. 19 The primary income account shows the flows of labor, financial assets, and land and natural resources between resident and nonresident institutional units. It records receipts earnings of resident overseas Filipino workers and the profit of Philippine investments abroad. The secondary income account shows current transfers between residents and nonresidents. Transfers may be made in cash or in kind. Remittances of non-resident overseas Filipinos are recorded under the secondary income account together with current transfers such as gifts, grants, and donations. Source: BSP Balance of Payments and International Investment Position, and IMF, Balance of Payments and International Investment Position Manual, Sixth ed. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 19 The country’s balance of payments remained in Weakness in the Philippine peso persisted deficit in 2018 despite increased capital inflows. throughout 2018 amid heightened external Capital inflows were notably higher with the financial uncertainty and weak net exports. The Philippine account reaching a surplus of US$7.9 billion (2.4 peso depreciated in nominal terms by 4.3 percent, percent of GDP) in 2018 from a US$2.9 billion (0.9 year-on-year, in 2018, from a 5.8 percent depreciation percent of GDP) surplus in 2017. The higher surplus in 2017 (Figure 7). It closed the year at Php/US$52.72, was led by the inflows of other investments20, and compared to Php/US$49.92 in 2017. In real terms, the the reduced outflows of portfolio investments. Other peso weakened by 2.7 percent in 2018, compared investments recorded net inflows of US$2.9 billion to a depreciation of 4.5 percent in 2017. The foreign (0.8 percent of GDP) in 2018, reversing the US$1.8 exchange market was generally volatile in 2018, billion (0.6 percent of GDP) outflows in 2017, while affected by market uncertainties due to the U.S.- portfolio investments recorded net outflows of 0.3 China trade dispute, contagion fear from the percent of GDP in 2018, down from 0.8 percent of crisis in Turkey and Argentina, and the ongoing GDP in 2017. Meanwhile, foreign direct investment normalization of the U.S. Federal Reserve’s monetary (FDI) contracted by 4.4 percent year-on-year to reach policy. Yet, domestic factors also played an important US$9.8 billion (3.0 percent of GDP) last year from role in the depreciation of the peso, given the 23.9 percent expansion in 2017. Out of US$9.8 billion strong demand for U.S. dollars to cover imports of in FDI, US$6.7 billion represented debt instruments, capital and intermediate goods. Import growth while nearly half of the US$2.3 billion that flowed accelerated from 10.2 percent, year-on-year, in 2017 to industries went to manufacturing.21 Despite the to 13.4 percent in 2018 (Figure 8). By contrast, exports improvements in the financial account, the balance contracted by 1.8 percent in 2018, a sharp reversal of payments deficit widened from US$0.8 billion (0.3 from the 9.5 percent expansion in 2017, percent of GDP) in 2017 to US$2.3 billion (0.7 percent impacted by weak external demand and of GDP) in 2018 (Table 3). competitiveness challenges. 20 Other investment accounts include loans (trade and non-trade), holdings of currency and deposits, and other investments. 21 Of the US$9.8 billion in FDI, US$6.7 billion represented debt instruments, mostly in the form of intercompany borrowing and lending, US$0.9 billion constituted retained earnings, and US$2.3 billion represented equity other than reinvestment of earnings, which mostly went to the manufacturing (47.7 percent), finance (14.6 percent), and real estate (13.1 percent) sectors. 20 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Figure 7. Both the real and nominal Figure 8. ...as imports grew faster than exports. exchange rate depreciated further in 2018... US FEDERAL RESERVE RATE HIKES 100 DEC 2018 OCT 2018 91 AUG 2018 Percent Index JUN 2018 82 APR 2018 FEB 2018 73 DEC 2017 JAN 2013 SEP 2013 MAY 2014 JAN 2015 SEP 2015 MAY 2016 JAN 2017 SEP 2017 MAY 2018 JAN 2019 -30.0 -20.0 -10.0 0.0 10.0 20.0 30.0 40.0 50.0 Nominal Exchange Rate (January 2013: indexed to 100) Exports Real Effective Exchange Rate Imports Source: BSP. Source: PSA. Table 3. Balance of Payments Position (2015 – 2018) In percentage of GDP 2014 2015 2016 2017 2018 Current account 3.8 2.5 -0.4 -0.7 -2.4 Goods -6.1 -8 -11.7 -12.8 -14.8 Exports 17.5 14.8 14 16.5 15.6 Imports 23.6 22.7 25.7 29.3 30.4 Services 1.6 1.9 2.3 2.8 3.2 Primary Income 0.3 0.6 0.8 1 1.2 Secondary Income 8 7.9 8.1 8.3 8.1 Capital and Financial accounts -3.3 -0.8 0 0.9 2.4 Capital account 0 0 0 0 0 Financial account 3.4 0.8 0.1 -0.9 -2.4 Direct investment 0.4 0 -1.9 -2.2 -1.8 Net acquisition of financial assets 2.4 1.9 0.8 1.1 1.2 Net incurrence of liabilities1/ 2 1.9 2.7 3.3 3 Portfolio investment 1 1.9 0.5 0.8 0.3 Financial derivatives 0 0 0 0 0 Other investments 2.1 -1.1 1.5 0.6 -0.8 Net unclassified items2/ -1.4 -0.8 0.1 -0.5 -0.7 Overall BOP position -1 0.9 -0.3 -0.3 -0.7 Memo: Basic Balance 3.4 2.5 1.5 1.5 -0.6 Gross international reserves (in billions USD) 79.5 80.7 80.7 81.6 79.2 Import coverage (in months) 9.9 9.9 8.8 7.7 7 1/Net incurrence of liabilities refers to net foreign direct investment to the Philippines. 2/The term “Net unclassified items” is a balancing figure. There are two methods of computing the BOP position: the first approach uses the change in net international reserves due to transactions, while the second approach computes the sum balances of the current account, capital account less financial account. The two measures do not necessarily tally. The BSP uses the first approach to determine the overall BOP position. Note: Following the BSP presentation, the BOP balance = Current Account Balance + Capital Account Balance - Financial Account Balance + Net Unclassified Items. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 21 MONETARY POLICY AND FINANCIAL MARKETS: TIGHTENING POLICY TO CURB INFLATION To manage rising inflation, the Bangko Sentral ng Pilipinas (BSP) tightened its monetary policy stance in 2018, resulting in higher interest rates that led to a moderation in the growth of credit and the money supply. Inflation rose steadily throughout most of 2018, prices, the increase in the excise tax on fuel, upward prompting the BSP to tighten its key policy rate. The adjustments in electricity rates, and a weaker peso. headline inflation rate rose from 2.9 percent, year- Excluding the volatile energy and food items, the on-year, in 2017 to 5.2 percent in 2018. It increased average core inflation rate reached 4.1 percent throughout most of 2018, peaking at 6.7 percent in 2018, up from 2.5 percent in 2017, suggesting in the third quarter, before gradually decreasing underlying price pressures in the economy, which in the last two months of the year. The main could be linked to the impact of fiscal expansion as drivers of inflation were rising food, energy, and well as the pass-through effect of a weaker peso. transport prices (Box 2). Food inflation increased Both the headline and core inflation rates breached primarily because of a tight domestic supply of key the upper end of the BSP’s inflation target range of commodities such as fish, rice, meat, and vegetables, 2.0-4.0 percent in 2018. As a result, the BSP raised its caused by the impact of typhoons and heavy rains key policy rates on a staggered basis by a cumulative as well as the mismanagement of rice imports. 175 basis points, from 3.00 percent in the beginning Moreover, the rise in energy and transport prices of 2018 to 4.75 percent in November (Figure 9). was due to a combination of rising global crude oil Figure 9. Inflation increased throughout most of 2018, before decreasing in the last two months. YEAR-ON-YEAR INFLATION RATE (PERCENT) 8.0 7.0 6.0 5.0 4.0 Percent 3.0 2.0 1.0 (2012=100) 0.0 -1.0 DEC 2014 FEB 2015 APR 2015 JUN 2015 AUG 2015 OCT 2015 FEB 2016 APR 2016 JUN 2016 DEC 2015 AUG 2016 OCT 2016 DEC 2016 FEB 2017 APR 2017 JUN 2017 AUG 2017 OCT 2017 DEC 2017 FEB 2018 APR 2018 JUN 2018 AUG 2018 OCT 2018 DEC 2018 Core Inflation Headline Inflation Key policy rate Sources: PSA and BSP. 22 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Box 2. Tracking the Basket Components of Inflation Rising food prices were the main drivers of inflation in the Philippines in 2018. They contributed more than half of the headline inflation in the same year (Figure 10). The steady rise in food prices in the first half of 2018, followed by their sudden rise in the third quarter and decline in the last two months of 2018, closely paralleled the movement of the overall inflation rate. Throughout most of the year, rising fish, rice, and meat prices, which constituted about three-fifths of the food consumption basket, were the main drivers of food inflation. Heavy rains and typhoons severely disrupted food production and interrupted transport to key commercial hubs. Mismanagement and untimely importation contributed also to a tight rice supply. Moreover, a small supply of fish has been attributed to delayed fish stocking due to typhoons, the fishing ban in the Visayas, and the suspension of commercial fishing in the Davao Gulf from June to August.22 In the last two months of 2018, headline inflation eased as food inflation declined because of an improvement in supply conditions, the ongoing rice harvest season, and the arrival of rice imports. The decline in housing and utilities and transport inflation toward the end of the year also helped to reduce price pressures. General housing, water, electricity, gas, and other fuel prices started to rise in the second quarter of 2018 (Figure 11). This was mainly attributed to upward adjustments in electricity rates due to higher power generation costs and an increase in water rates in the third quarter. Rising global oil prices as well as the implementation of the new excise tax on oil and fuel led to higher prices for domestic petroleum products, which exerted pressure on transport inflation. As a result of higher fuel prices, transport fares increased, such as for public utility jeepneys in July and for public utility buses in November, which contributed to higher transport inflation. As global oil prices started to decline in the last quarter of the year, energy prices started to ease, resulting in a series of rollbacks in household liquefied petroleum gas prices and a marked decline in gasoline and diesel prices. Year-end food and transport inflation rates were lower than their 2018 averages. The food and beverage inflation rate averaged 6.9 percent in 2018, reaching a peak of 9.7 percent in September. It fell to 6.7 percent at the end of December, signaling subsiding price pressures. Similarly, the transport inflation rate averaged 6.5 percent in the same year, reaching a high of 8.9 percent in October and November, before falling to 4.0 percent at the end of the year. Moreover, the average education inflation rate was lower in 2018 compared to 2017, which was mainly the result of the national government’s free tuition program for public tertiary education that became effective in 2018. Meanwhile, the inflation rates for the rest of the components of the consumption basket, including clothing and footwear, health, recreation and culture, and restaurants and miscellaneous goods and services, were markedly higher at the end of the year compared to their 2018 averages, suggesting continued underlying price pressure for these non-volatile items. Figure 10. Rising food prices contributed to more . Figure 11. Rising food, housing and utilities, and transport than half of the total rise in inflation in 2018. prices were the main drivers of inflation in 2018. 10 9% Restaurant and Miscellaneous 8 Goods and Services 51% in percentage Food and Non-Alcoholic 10% Beverages 6 Transport 4 5.2% 17% 2 Housing, Water, Electricity, Gas, and Other Fuels 0 JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 6% Headline inflation Housing, Water, Electricity, Gas, and Other Fuels Alcoholic Beverage and Tobacco Transport Food and Non-Alcoholic Beverages Source: PSA. Source: PSA. 22 For more information, see the BSP’s Inflation Report. There is a general sense of declining overall fish stock as seen in the continuous contraction in the fishing sector since 2014. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 23 Credit growth moderated in the second half of 2018, credit card and motorcycle loans increased by as the BSP adopted a tighter monetary policy stance. 20.0 percent and 23.0 percent, respectively. The Domestic liquidity (M3) growth moderated from credit-to-GDP ratio continued to rise at an average of 13.0 percent, year-on-year, in 2017 to 10.0 percent 68.0 percent in 2018, slightly higher than the in 2018. In December 2018, it grew by 9.2 percent, 64.5 percent registered in 2017. year-on-year, and totaled Php11.6 trillion pesos. Accordingly, the banking system’s loan-to-deposit The Philippines’ financial system remains stable ratio increased from 75.6 percent in December 2017 and resilient. The share of non-performing loans to 79.0 percent in December 2018. Credit to firms averaged 1.85 percent between November 2017 and grew by 15.0 percent, year-on-year, in December 2018, November 2018, ranging from 1.90 percent to 1.73 down from 17.2 percent in the same month of 2017, percent. Philippine banks are well capitalized, with while the growth in household loans decelerated a total capital adequacy ratio of 15.36 in November from 20.0 percent, year-on-year, in December 2017 to 2018—an improvement from 14.66 in December 8.5 percent in the same month of 2018. The sectoral 2017 and well above the 10.0 percent regulatory composition of firms’ loan portfolios remained minimum. The banking sector maintained high broadly unchanged in 2018 (Figure 12). In December profitability in 2018, with an average return on equity 2018, lending increased by 42.0 percent, year-on- of 9.8 percent and an average return on assets of year, in arts, entertainment, and recreation and by 1.2 percent. The share of interest income in total 34.0 percent in construction. Also, loans to finance operating income in the 4th quarter of 2018 was household consumption grew by 10.1 percent, year- 77.18 percent, compared to 75.73 percent in the same on-year, in the same month of 2018, among which quarter of 2017. Figure 12. Loan Portfolio of the Philippine Banking Sector (December 2018) 18% Wholesale and Retail Trade, Hospitality Industry 13% Manufacturing 19% Mining, Utilities, Transport and ICT 12% Household Consumption 19% Real Estate and Construction 9% Financial and Insurance Activities 3% Agriculture, Forestry and Fishing 7% Other Production Activities Source: BSP. 24 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Box 3. The Resilience of the Philippines’ Financial Sector The Philippines’ largest shipping firm filed for the largest corporate bankruptcy in the country’s history in 2019, defaulting on US$1.3 billion. On January 8, 2019, Hanjin Heavy Industries and Construction Philippines (HHIC- Phil) filed for bankruptcy in a regional trial court in Subic on a loan worth US$1.3 billion. The court placed HHIC- Phil under corporate rehabilitation under the Financial Rehabilitation and Insolvency Act (Republic Act 10142). Five local banks—the Land Bank of the Philippines (Landbank), Rizal Commercial Banking Corporation (RCBC), Metropolitan Bank & Trust Company (Metrobank), Bank of the Philippine Islands (BPI), and Banco de Oro Unibank (BDO)—that were exposed to HHIC-Phil had losses totaled US$412 million.23 As a result, the Philippine stock market dropped by 81.14 points (-1.0 percent) and closed at 7,904.49 on the day of the bankruptcy. The index swiftly recovered in the following days as the market remained confident in the country’s financial system. The Philippines’ financial system showed its resiliency due to strategic reforms implemented by the BSP. Over the past 20 years, the BSP has been implementing reforms that have resulted in higher capitalization ratios and stronger risk management systems to manage potential threats.24 As a result, the banking system’s capital adequacy ratio was 15.36 percent in December 2018, which was higher than the regulatory requirement of 10.0 percent. In addition, the banking system’s non-performing loans remained at a low 1.77 percent in December 2018. The BSP claims that the country’s banking system is well-positioned to manage the effect of HHIC-Phil’s default. According to its statement on the Hanjin bankruptcy, the BSP points to robust capitalization rates and sufficient liquidity buffers as evidence that the Philippine banking system can manage about US$400 million in loan exposure to HHIC-Phil. The loan exposure represents only 0.24 percent of total bank loans and 2.49 percent of foreign currency loans from foreign currency deposit units. Moreover, an assumed write-off of loan exposures to HHIC-Phil will have a minimal impact on the industry’s capital adequacy ratio, according to the results of the BSP’s stress-test exercise. 23 https://www.philstar.com/business/2019/01/16/1885352/hanjin-philippines-shipbuilding-bankruptcy. 24 In 2014, the BSP issued Guidelines on Sound Credit Risk Management Practices; Amendments to the Manual of Regulations for Bank and Non-Bank Financial Institutions (BSP Circular 855 of 2014). The circular intends to fundamentally strengthen credit risk management practices of financial institutions and provides minimum set of operating standards that are consistent with BSP regulations and the Basel Core Principles for effective bank supervision. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 25 THE SUCCESS OF FISCAL REFORMS Despite softer GDP growth, public revenue reached its highest level in over two decades in 2018 due to recent tax policy and administration reforms. Nevertheless, the fiscal deficit breached the government’s 3.0 percent of GDP target in 2018, as expenditure growth outpaced revenue growth. The fiscal deficit exceeded its programmed target in nominal terms in 2018, up from 12.8 percent in of 3.0 percent of GDP in 2018, as the government 2017, as the government focused on implementing increased public spending in line with its small-scale infrastructure projects.30 As a result, expansionary fiscal policy stance (Figure 13). In 2018, public infrastructure outlays, which accounted for the country’s public expenditure effort25 reached nearly one-fourth of total government spending in its highest level since 1983,26 as the government 2018, increased from 3.5 percent of GDP in 2017 to continued to implement an expansionary fiscal 4.6 percent of GDP in 2018. In addition, personnel policy for the third consecutive year. A significant services, which accounted for nearly one-third of increase in spending on infrastructure and personnel public spending in the same year, expanded by 22.1 services was the primary driver of the overall percent, year-on-year, in nominal terms in 2018 (up acceleration in public spending. Meanwhile, revenue from 14.3 percent in 2017) and reached 5.7 percent growth remained robust, as the tax ratio27 reached of GDP in 2018 (up from 5.2 percent of GDP in 2017). its highest level in more than two decades, partly The substantial increase in personnel services driven by tax policy and administration reforms expenditures was the result of the implementation introduced in the TRAIN law.28 However, expenditure of the third tranche of the adjustment to the growth outpaced revenue growth in 2018, widening salary standardization law, the increase in pay for the fiscal deficit from 2.2 percent of GDP in 2017 to military and uniformed personnel, and the faster 3.2 percent of GDP in 2018—above the government’s rate of filling vacant positions in various national deficit target of 3.0 percent of GDP. The government government agencies.31 continued to finance its deficit primarily through domestic borrowing (75.0 percent) in 2018 Moreover, despite softer GDP growth, public revenue (Figure 14).29 reached its highest level in over two decades in 2018 in part due to the implementation of various National government expenditure breached the tax reforms. In 2018, national government revenue programmed target and reached its highest level increased by 15.2 percent, year-on-year, in nominal in 2018 due to a continued surge in infrastructure terms, up from 12.6 percent in 2017, and reached spending. Public expenditure growth accelerated 16.4 percent of GDP, up from 15.6 percent of GDP from 10.8 percent, year-on-year, in nominal terms in 2017. The robust growth in public revenue was in 2017 (17.9 percent of GDP) to 20.7 percent in 2018 driven by an acceleration in tax and non-tax revenue (19.6 percent of GDP), fueled primarily by a rise in growth. Tax revenue growth accelerated from infrastructure and personnel services expenditures 13.6 percent, year-on-year, in nominal terms in 2017 to (Figure 15). Public infrastructure outlays ramped up 14.0 percent in 2018, benefitting from a combination substantially, growing by 41.3 percent, year-on-year, of strong economic growth32 and recent tax 25 Defined as the ratio between public expenditure and GDP. 26 Fiscal data published by the Philippine government are available beginning in 1983. 27 Defined as the ratio between tax revenue and GDP. 28 RA 10963 became effective on January 1, 2018. 29 The government increased its share of foreign financing from 19.0 percent of total financing in 2017 to 25.0 percent in 2018. 30 Infrastructure outlays were directed toward implementing various road infrastructure, flood control, and dike and river basin repair projects as well as repairing and rehabilitating school and medical (under the Department of Health’s Health Facilities Enhancement Program) facilities. In addition, other capital outlays were directed to the purchase of military equipment under the Armed Forces of the Philippines’ modernization program and the procurement of machinery, aircraft, and aircraft equipment under the Department of Transportation. 31 Source: http://www.dbm.gov.ph/wp-content/uploads/DBCC/2018/NG_Disbursements-November-2018_Full-Report_for-posting.pdf. 32 Nominal GDP expanded by 10.2 percent year-on-year in 2018, higher than the 9.2 percent in 2017. 26 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Figure 13. National Government Fiscal Balance, 2013-18 20.0 3.5 19.6 17.6 17.9 2.5 16.0 16.7 16.3 16.4 15.7 15.8 15.2 15.7 1.5 14.9 15.1 Fiscal balance (Percent of GDP) 0.5 12.0 Percent of GDP -0.6 -0.5 -0.9 -1.4 8.0 -1.5 -2.2 -2.4 -2.5 4.0 -3.2 -3.5 0.0 -4.5 2013 2014 2015 2016 2017 2018 Revenues Expenditure Fiscal Balance (RHS) Source: Bureau of the Treasury (BTr). policy and administration reforms. As a result, the Despite the wider fiscal deficit, the Philippine Philippines’ tax ratio increased from 14.2 percent government’s overall fiscal position remains healthy. of GDP in 2017 to 14.7 percent of GDP in 2018— The country’s debt management has resulted in the highest level since 1997 (15.3 percent of GDP). favorable debt metrics. The national government’s However, despite strong growth in tax collections, debt-to-GDP ratio fell from 42.1 percent of GDP the government failed to meet its revenue target in 2017 to 41.9 percent of GDP in 2018 (Figure 17). for the year, as the Bureau of Internal Revenue (BIR) The debt portfolio is predominantly composed of fell short of meeting its Php2.044 trillion collection long term borrowings at 80.7 percent and short- to target for 2018 by Php82 billion, or 0.5 percent of medium-term at 19.3 percent in 2018. Two-third of GDP. The BIR missed its collection target largely due the debt is peso-denominated and a third is foreign to a shortfall in income tax, value-added tax, and currency denominated. In an effort to reduce the excise tax collections.33 Meanwhile, non-tax revenue risk exposure to exchange rate volatilities, the increased by 27.8 percent year-on-year in 2018 (3.2 government pursued a debt mix of 65-35 in 2018, percent in 2017), reaching 1.7 percent of GDP in in favor of domestic borrowings. The average costs 2018 compared to 1.4 percent of GDP in 2017. The of borrowings, both external and domestic, have substantial increase in non-tax revenue was fueled generally been declining since 2014. In September by the significant increase in Bureau of Treasury 2018, the average interest rates of external income34 and the proceeds from the privatization of borrowings reached 4.3 percent, cheaper than the the Coco Levy fund.35 average interest rates for domestic borrowings at 5.3 percent.36 33 The BIR missed its collection targets for the income tax by 4.0 percent (Php42.5 billion, or 0.2 percent of GDP), value-added tax by 17.8 percent (Php77.6 billion, or 0.4 percent of GDP), and excise tax by 12.7 percent (Php42.2 billion, or 0.2 percent of GDP). The shortfall was partly offset by the Php80.2 billion (0.5 percent of GDP) in tax collections from other percentage taxes (the BIR defines other percentage taxes as taxes imposed on individuals or businesses who sell or lease goods, properties, or services and whose gross annual sales or receipts do not exceed Php1,919,500, and are not VAT registered) and other taxes in excess of the BIR’s programmed targets. 34 Total income generated by the BTr expanded by 14.0 percent year-on-year in 2018 as a result of higher dividends from national government’s shares of stocks, and the national government’s share from Philippine Amusement and Gaming Corp. (PAGCOR) income. 35 Proceeds from privatization reached Php15.7 billion in 2018, a more than 15-fold increase compared to the Php0.8 billion in privatization revenues in 2017. This was in large part due to the one-off transfer of the Php13.5 billion worth of bond proceeds from the Coconut Industry Investment Fund to the Special Account in the General Fund for the Coco Levies. 36 S&P Global Ratings raised the Philippines’ outlook to ‘positive’ in April 2018, while maintaining a BBB rating. While both Fitch Ratings and Moody’s Investor Service maintained a ‘stable’ outlook for the Philippines in 2018. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 27 Figure 14. The government finances its deficit mainly through domestic Figure 15. National Government Expenditures by Component (% of GDP). borrowing, but the share of foreign financing increased in 2018. 0.1 20 0.1 0.1 240 0.1 5.6 0.1 16 0.1 4.2 4.4 200 3.0 3.3 2.8 160 12 120 in Billion Pesos 80 14.3 8 13.1 13.4 13.3 13.4 40 12.8 - 4 (40) (80) 0 2013 2014 2015 2016 2017 2018 (120) Q1-Q3 JULY JAN JUL JAN JULY 2017 2018 Current operating procedures Capital outlays Net Foreign Financing Net lending Net Domestic Financing Sources: DBM, PSA Budget Surplus/Deficit Source: BTr. Figure 16. National Government Tax Collections by Type (% of GDP). Figure 17. The Overall Debt-to-GDP ratio fell slightly in 2018. 15 50 3.5 2.9 12 2.6 2.9 2.8 2.7 0.8 0.12 40 0.7 0.7 0.7 0.7 16.9 15.2 15.5 14.9 14.0 14.4 9 2.7 2.7 2.6 2.7 2.8 2.6 in percent of GDP 1.2 1.1 1.3 1.7 30 1.0 1.1 6 6.2 6.2 6.4 6.4 6.5 6.1 3 20 32.4 30.2 29.2 27.2 28.1 27.4 0 2013 2014 2015 2016 2017 2018 10 Q1-Q3 Net Income & Profits Excise Tax 0 Sales Taxes & Licenses Other Taxes 2013 2014 2015 2016 2017 2018 Customs Duties Domestic debt Sources: DBM, PSA External debt Sources: Source: BTr, PSA. 28 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO INFLATION AFFECTED POOR HOUSEHOLDS Labor demand remains strong, driven primarily However, net job creation was below the by public construction projects. The demand for government’s target partly due to persistent labor increased in the second half of 2018, and the job losses in the agriculture sector. Total net-job unemployment rate reached 5.1 percent in October creation reached 826,000 in 2018, below the annual 2018, equivalent to 2.2 million Filipinos, bringing the target of 900,000. The lower-than-expected job full-year average unemployment rate for 2018 to 5.3 creation was partly due to the 259,000 job losses percent—its lowest level in over a decade (Figure 18). recorded in the agriculture sector (job losses started Throughout 2018, labor demand was driven by the accelerating in the second quarter). The destructive services and industry sectors, which created 610,000 typhoons that hit the country in 2018 partly explain and 475,000 jobs, respectively. The biggest job- the loss in agricultural jobs, as they adversely generating sectors were construction, with 328,000 affected agricultural output.38 Nearly all of the additional jobs, public administration and defense, Philippines’ regions either improved or retained their with 152,000 additional jobs, and manufacturing, unemployment rates compared to 2017, except for with 144,000 additional jobs (Figure 19). The large Central Visayas, Bicol, and the Autonomous Region in contribution of the construction sector to total Muslim Mindanao (ARMM), all of which experienced employment generation mirrored its robust growth, a rise in unemployment. In October 2018, Ilocos fueled by the rapid expansion of public construction recorded the country’s highest unemployment activities, although the private sector still accounts rate of 6.7 percent, followed by major urbanized for a majority of investments in the Philippines.37 regions such as the National Capital Region (NCR) and central Luzon, both of which recorded an unemployment rate of 6.0 percent. Figure 18. Unemployment and Underemployment Rates Figure 19. Number of New Jobs by Sector (in ‘000) 25.0 Underemployment rate 328 20.0 15.0 152 144 110 Percent 93 93 10.0 defense; compulsory social Wholesale and retail trade; Construction Public administration and security Manufacturing Administrative and support service activities repair of motor vehicles and motorcycles Transportation and storage Unemployment rate 5.0 0.0 JAN OCT JUL APR JAN OCT JUL APR JAN OCT JUL APR JAN OCT JUL 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Labor Force Survey (2017 and 2018), PSA. Source: Labor Force Survey (various rounds), PSA. 37 Based on national income accounts, the construction sector grew by 15.9 percent, year-on-year, in 2018, up from 5.3 percent recorded in 2017. Moreover, the public construction sector grew by 21.2 percent, year-on-year, in 2018, while the private construction sector, which accounts for 73.0 percent of total investments, grew by 12.9 percent in the same year. 38 Based on the Philippine Atmospheric, Geophysical and Astronomical Services Administration (PAG-ASA) data, 21 tropical cyclones hit the Philippines in 2018, 8 of which were classified as typhoons. The damage from typhoon “Ompong,” which arrived in the Philippines in the second half of 2018, totaled an estimated Php26.7 billion worth of agricultural losses, according to the National Disaster Risk Reduction and Management Council. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 29 Underemployment improved in the second half The supply of labor continued to decline in the of 2018 but remains high in most regions. The Philippines in 2018. The labor force participation underemployment rate, or the proportion of rate, representing the workforce engaged in work employed persons who desired additional hours of or available for work, fell in the second half of work or additional jobs, averaged 15.3 percent in the 2018 and averaged a record-low of 61.0 percent in latter half of 2018—equivalent to 6.3 million Filipinos. 2018 (Figure 20). The labor force participation rate It fell to 13.3 percent in October 2018, the lowest declined despite the graduation of the first cohort level since 2008, with underemployment in the of senior high school (SHS) students in the second services sector falling from 47.9 percent in October quarter.39 The labor force participation rate for the 2017 to 43.2 percent in October 2018. The total share portion of the population aged 15-24 fell from 41.1 of self-employed and unpaid family workers also percent in October 2017 to 37.2 percent in the same declined, from 33.9 percent in October 2017 to 32.2 in month of 2018. The passage of the Universal Access October 2018, implying that the share of vulnerable to Quality Tertiary Education Act, which provided work fell at the end of 2018. Nevertheless, the full- free tuition in 112 state universities and colleges year underemployment rate marginally increased and 78 local universities and colleges starting in from 16.2 percent in 2017 to 16.4 percent in 2018, the 2018/19 academic year, may have incentivized mostly due to the high underemployment rates graduates to continue their studies.40 Evidence from recorded in the first three quarters (average of 17.4 the Philippines Institute for Development Studies percent in January-July 2018). In addition, only 6 out (PIDS) suggests that three out of four SHS students of 16 regions, outside the NCR, observed year-on- plan to proceed to higher education, including year improvements in underemployment in 2018, technical-vocational-livelihood education.41 More highlighting the need to expand access of quality women opting out of the workforce also contributed jobs nationwide. to the overall decline in the labor force participation rate. The participation rate among women declined from 47.8 percent in October 2017 to 46.4 percent in October 2018. Figure 20. Labor Force Participation Rate 67.0 66.0 65.0 64.0 Percent 63.0 62.0 61.0 60.0 JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Labor Force Survey (various rounds), PSA. 39 An estimated 1.2 million SHS students graduated in 2018, according to the Department of Education. 40 Republic Act 10931 also provides free tuition in state-run technical-vocational institutions, establishes tertiary education subsidies and student loan programs, and strengthens the unified student financial assistance system for tertiary education. 41 See Ortiz, M., Lagarto, M., Ortiz, D., Orbeta, A., & Potestad, M. (2018). “Senior High School and the Labor Market: Perspectives of Grade 12 Students and Human Resource Officers,” Discussion Papers DP 2018-49 (Revised), Philippine Institute for Development Studies. 30 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Real wage growth accelerated in 2018, boosting percent, year-on-year, in 2017—below the national household income. The real daily wage increased average—to 6.2 percent in 2018—above the national in the second half of 2018 after stagnating in the average. As a result, when the headline inflation rate second half of 2017. In July 2018, the daily wage peaked at 6.7 percent in September 2018, the poorest averaged Php385 (at 2012 prices), a 3.5 percent households effectively experienced an inflation rate increase from the same period in 2017 of Php372 of 8.4 percent (Figure 22). (Figure 21). This was likely an effect of the regional wage hikes enforced in 2018. Meanwhile, the While household incomes likely continued to grow movement of workers from agricultural employment in 2018, higher inflation may have slowed progress in to non-agricultural wage jobs has continued in poverty reduction. Data from the most recent annual recent years, changing the structure of household poverty indicators survey suggest that the poverty incomes. Based on the annual poverty indicators rate declined in 2017, as household per capita income survey, the share of wages in household income increased at a faster rate than inflation, and the has increased over time, accounting for about half income of the bottom 40 percent of the population of total household income in 2017 (from about 44.0 grew at a faster rate than the income of the average percent in 2007). This has been especially evident household. Furthermore, the continuing transition of among households in the bottom income quintile, employment to non-agricultural wage jobs suggests where the share of wages in total income increased more sustainable sources of income for households. from 32.0 percent in 2007 to 44.0 percent in 2017. It is likely that household incomes, especially for the bottom 40 percent, continued to increase in 2018. The increase in inflation in 2018 especially affected However, the impact of inflation may have hampered poor households. Consumer prices soared between poverty reduction efforts. The opinion survey from the first and third quarters of 2018, resulting in an the Social Weather Stations showed a much lower average inflation rate of 5.2 percent, year-on-year, percentage of Filipinos (37 percent) saying their lives in 2018, up from an average of 2.9 percent in 2017. improved in December 2018 compared to the same However, the average inflation rate for households period in 2017 (41 percent). in the poorest income quintile increased from 2.7 Figure 21. Average Daily Real Wage (Measured in Constant 2012 Php) Figure 22. Rising inflation especially affected poor households. 400 MONTHLY YOY INFLATION FROM 2017 TO 2018 OF POOREST AND RICHEST QUINTILE 380 9.0 360 6.0 340 3.0 320 - 300 JAN 2017 MAR 2017 MAY 2017 JUL 2017 SEP 2017 NOV 2017 JAN 2018 MAR 2018 MAY 2018 JUL 2018 SEP 2018 NOV 2018 JAN OCT JUL APR JAN OCT JUL APR JAN OCT JUL APR JAN OCT JUL 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Economy-wide Source: Staff estimates using Labor Force Survey (various rounds), PSA. Poorest (1st income quintle) Richest (5th income quintle) Poorest Average Year Average Source: PSA and WB Staff Calculations. PART 01 RECENT ECONOMIC AND POLICY DEVELOPMENTS 31 Box 4. The Impact of High Inflation High food prices contributed to the surge in inflation experienced by poor households in 2018 (Figure 23). An analysis of 2018 average inflation rates by per capita income quintile reveals that food inflation, which averaged 6.6 percent per month in 2018, up from 3.2 percent in 2017, constituted two-thirds of the average inflation rate of 6.2 percent that households in the poorest income quintile experienced in 2018. By contrast, less than one- third of the 4.7 percent effective average inflation rate faced by the richest income quintile was affected by food inflation in the same year. Rice, fish, and vegetables, which constitute a larger share of the consumption baskets of poorer than richer households, experienced a monthly average inflation rate of 5.7, 12.0 and 10.5 percent, respectively, in 2018, up from 0.96, 7.5, and 4.4 percent, respectively, in 2017. Together, their price increases constituted 47 percent of the effective inflation experienced by poor households in 2018. Figure 23. The increase in food prices contributed to higher inflation faced by the poor. CONTRIBUTION OF FOOD AND ENERGY INFLATION TO INFLATION BY PER CAPITA INCOME QUINTILE (AVERAGE) 7.0 6.2 5.9 5.6 6.0 5.2 5.2 28% 4.8 32% 5.0 35% 37% 11% 38% Percent 14% 40% 4.0 16% 20% 19% 2.0 29% 61% 55% 48% 1.0 44% 43% 31% - ALL 1ST 2ND 3RD 4TH 5TH Food Energy-related Other expenditure While higher food inflation severely affected poorer households, the direct impact of higher energy prices in 2018 especially affected richer households. An increase in the price of energy-related expenditure items, including electricity, liquefied petroleum gas, solid fuels, fuel and lubricants for operation of personal transport, and transport services (railway, road, sea, and air), contributed more to the effective inflation experienced by richer households. The direct impact of higher energy prices on poor households in 2018 was only minimal due to the low share of energy-related items in their total expenditure. The inflation experienced by richer households was largely driven by higher prices of energy-related commodity items. 02 OUTLOOK AND RISKS The Philippines’ growth outlook remains strong, with the economy projected to grow at 6.4 percent in 2019 and 6.5 percent in both 2020 and 2021. Private consumption growth is expected to accelerate in 2019 as inflation declines and election activities provide an added boost. Investment spending may initially be tempered, impacted by delays in approving the public budget and the pre-election spending ban on new public construction projects, but is expected to recover toward the second half of 2019. Export growth is likely to remain weak, as global growth and trade activities are projected to moderate in the medium term. The government is expected to continue its expansionary fiscal policy agenda, while the BSP may take a pause in its tightening stance as inflationary pressure diminishes. The positive growth outlook, together with the delivery of public transfer programs, will contribute to poverty reduction. Nonetheless, the economic outlook is subject to downside risks, including the further strengthening of the U.S. dollar, possible increases in U.S. interest rates, continuous trade tensions and geopolitical uncertainties, and the impact of the El Niño phenomenon on agriculture. Prudent management of fiscal and current-account balances and policies to preserve consumer and business confidence are key short-term priorities, while fostering inclusive growth remains an important long-term policy objective. 34 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO GROWTH OUTLOOK REMAINS POSITIVE Economic growth in the medium term will be anchored in robust domestic demand, an expected decline in inflation, and an added boost from election activities. Export growth prospects, however, remain bleak due to the weak external environment. Capital formation growth may be tempered, impacted by the delay in approving the government budget. The Philippine medium-term growth trajectory expected to decline in 2019 in line with projected remains strong, with growth expected to gradually lower global crude oil prices. The roll out of policy accelerate in 2019-21. The World Bank baseline measures such as the liberalization of the rice sector forecast projects real GDP growth at 6.4 percent in could also contribute to lower food prices. Capital 2019 and 6.5 percent in both 2020 and 2021 (Figure formation growth is expected to temper in the first 24). These estimates are lower than the projected half of 2019 due to delays in approving the public 6.5 percent growth in 2019 and 6.6 percent in budget and the implementation of a 45-day pre- 2020, reflected in the January edition of the Global election spending ban on new public construction Economic Prospects. The country’s growth outlook projects, and it is expected to recover towards the remains strong, and economic growth is expected to end of 2019. Net export growth will likely remain recover in 2019, driven by higher private consumption subdued, given the weak external environment and growth amid a projected decline in inflation and an an expected increase in imports. added boost from election42 activities. Inflation is Figure 24. Real GDP is expected to grow above 6.0 percent in 2019-21 8.0 Forecast 6.0 Percent 4.0 2.0 0.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 April 2019 projections January 2019 projections Actual growth Source: PSA, World Bank staff calculations. 42 The Philippine midterm elections will be held on May 13, 2019 covering municipal, city, provincial-level positions, as well as all seats in the House of Representatives, and 12 seats in the Senate of the Philippines. PART 02 OUTLOOK AND RISKS 35 The growth forecast assumes a pause in the BSP’s Household consumption growth is anticipated tightening monetary policy stance, mimicking the to rebound as inflation declines and pre-election US Fed and as domestic inflationary pressure is spending starts. The Philippine economy has expected to diminish in 2019. Inflation peaked in historically been consumption-driven, with the third quarter of 2018, before falling in the last households contributing more than two-thirds two months of the year. Inflation is expected to of aggregate expenditures. Annual private continue to decline, as global crude oil prices are consumption growth declined from 5.9 percent in projected to fall from an estimated US$68.3 per 2017 to 5.6 percent in 2018 due to high inflation, but barrel in 2018 to US$67.0 per barrel in 2019-20. The it is expected to recover to 6.0 percent in 2019-2020 decline in crude oil prices is likely to temper the due to declining inflation and an improving labor inflationary impact of the second round of the excise markett44 (Table 4). Moreover, remittance inflows tax on petroleum products, which officially took are expected to remain steady as new employment effect on January 1, 2019.43 Meanwhile, rice supply opportunities for Filipinos become available in management is expected to improve and lead to countries like Japan, Germany, and Poland, which lower rice prices upon the implementation of the is expected to contribute to an acceleration in liberalization of the rice sector , which will open the consumption growth.45 Finally, consumption will country to unrestricted rice importation subject be supported by pre-election activities and the to a minimum of 35 percent tariff. Additionally, an continued implementation of infrastructure projects, administrative order adopted in the third quarter of which will increase public spending and generate 2018 streamlined the importation of fish, vegetables, job opportunities. meat, and other food products to supplement the domestic food supply. Finally, inflation expectation will likely adjust to lower levels in relation to falling inflation, further supporting the declining price trend in 2019. Table 4. Economic Indicators for Baseline Projections 2016 2017 2018 2019f 2020f 2021f Real GDP growth, at constant market prices 6.9 6.7 6.2 6.4 6.5 6.5 Private Consumption 7.1 5.9 5.6 6.0 6.0 6.0 Government Consumption 9.0 7.0 12.8 10.8 10.0 9.7 Gross Fixed Capital Investment 26.1 9.5 14.0 11.4 16.5 17.0 Exports, Goods and Services 11.6 19.5 11.5 12.4 13.0 13.8 Imports, Goods and Services 20.2 18.1 14.5 14.0 16.4 17.0 Inflation (period average) 1.3 2.9 5.2 3.5 3.3 3.0 National government balance (% of GDP) -2.4 -2.2 -3.2 -2.8 -2.8 -2.8 Current account balance -0.4 -0.7 -2.4 -2.3 -2.5 -2.5 43 The TRAIN law imposed a Php2.50 per liter excise tax on diesel and increased the levy on gasoline to Php7.00 per liter on January 1, 2018. Fuel excise taxes increased by Php2.00 per liter in January 2019. 44 The unemployment rate continues to improve in the Philippines, falling to 5.3 percent in 2018—its lowest level in over a decade and well below the ten-year average of 6.9 percent. 45 The Philippines Overseas Employment Administration reported demand for Filipino health workers in Germany, Saudi Arabia, and the United Arab Emirates. Japan has announced that it will welcome over half a million foreign workers in 2019-25 to help fill its labor shortage in the nursing, shipbuilding, construction, and hospitality industries. 36 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO The growth forecast also assumes further ramping However, project delivery constraints will likely lower up of public spending. The Philippine government the country’s fiscal deficit targets. The government’s remains committed to accelerating investments current fiscal deficit target is 3.2 percent of GDP in both public infrastructure and human capital for 2019 and 3.0 percent of GDP for 2020-21. The development, reflected in its Php3.76 trillion budget World Bank projects a slightly lower deficit over for 2019. While public spending will be tempered the projection period, as a number of constraints, in the first half of 2019 impacted by the delay in stemming from longstanding implementation approving the budget, growth outlook assumes bottlenecks and capacity limitations, may hinder that public spending will accelerate in the second progress in program implementation by line half of 2019. This rests on the assumption that the agencies.47 A slightly narrower deficit for 2019 also 2019 budget will be approved before end of the 17th factors in the delay in approving the 2019 national Congress. Programmed disbursements are expected government budget, which is likely to delay new to increase by 13.7 percent, year-on-year, in nominal capital outlays in the first half of 2019 (Box 5). terms to Php3.83 trillion (19.7 percent of GDP) in Although public infrastructure spending continued 2019, driven by a significant rise in recurrent and to improve throughout 2018, infrastructure outlays infrastructure spending46 Recurrent spending will be were largely driven by small public works projects, as driven by a rise in personnel services expenditures, the implementation of the public “Build, Build, Build” as the government implements the fourth and last infrastructure program was slower than expected.48 tranche of the salary standardization law adjustment The timely implementation of the government’s and creates new public-sector jobs. Meanwhile, infrastructure investment program remains vital to public infrastructure spending is expected to accelerate investment growth in the Philippines. increase gradually to reach 6.4 percent of GDP in 2021, as the government continues its rollout of the “Build, Build, Build” program. 46 National government disbursements are expected to increase by 12.6 percent, year-on-year, in 2020 to Php4.314 trillion (20.1 percent of GDP) and by 11.3 percent to Php4.803 trillion (20.3 percent of GDP) in 2021. 47 The government needs to tackle issues related to weak program and project design, procurement difficulties, and limited absorptive capacity. 48 Infrastructure outlays are typically front-loaded during an election year to comply with election rules on disbursement of public funds and the implementation of public works projects. PART 02 OUTLOOK AND RISKS 37 Box 5. Implementation of Flagship Infrastructure Projects under the “Build, Build, Build” Program Implementation of the “Build, Build, Build” program has been slower than expected. While 46 projects started implementation activities between 2016 and 2018,49 only 11 have reached the construction phase,50 out of which only two projects, valued at Php1.2 billion, were completed in 201851 (Table 5). Under the government’s program, there are a total of 37 approved projects worth Php1.56 trillion, 29 projects under review worth Php0.60 trillion, and nine projects that do not require the NEDA Board’s approval worth Php11.4 billion, according to the latest status update released by NEDA in January 2019.52 Table 5. Implementation of Flagship Infrastructure Projects under the “Build, Build, Build” Program NEDA Board-Approved Under Review by NEDA Board Does Not Require Total Started Construction Phase as NEDA Board’s Approval of January 31, 2019 Target start of Number of Project cost Number of Project cost Number of Project cost Number of Project cost Number of Project cost implementation projects (Php billion) projects (Php billion) projects (Php billion) projects (Php billion) projects (Php billion) 2014 1 1.0 1 1.0 1 1 2016 1 5.4 1 5.4 1 5.4 2017 2 4.7 1 0.2 3 4.9 2 2.1 2018 11 969.4 10 230.7 4 9.0 25 1209.1 7 31.7 2019 13 554.3 10 232.1 23 786.3 - - 2020 4 10.5 5 55.5 1 1.2 10 67.2 - - 2021 6 20.0 1 10.5 7 30.5 - - TBD 3 71.6 2 TBD 5 71.6 - - Total 37 1564.4 29 600.4 9 11.4 75 2176.2 11 40.2 Source: NEDA. Close to a quarter (Php909.7 billion) of the 2019 public budget (Php3.757 trillion) is dedicated to flagship infrastructure projects.53 This represents 4.8 percent54 of nominal GDP and is projected to create 1.1 million jobs.55 About 60.0 percent of the budget for flagship projects is allocated to projects under the Department of Public Works and Highways for road construction, rehabilitation and improvement, flood and drainage systems management, asset preservation, and river ferry stations, along with big ticket projects in Luzon, Visayas, and Mindanao.56 Meanwhile, the Department of Transportation has been allotted 8.3 percent, or Php76.1 billion, for its railway, airport, and sea transportation projects. The remaining 2019 funds will benefit other projects focused on assistance to municipalities and state universities’ internet connection as well as the national broadband plan. However, the delayed passage of the 2019 national budget, along with the 45-day public spending ban prior to elections in May 2019, risks further delaying the implementation of infrastructure projects. Specifically, a lack of access to funding may aggravate delays due to existing implementation constraints, such as restrictive procurement laws, right-of-way issues, contractors’ lagging schedule, and late fund disbursements.57,58 To minimize the impact of limited government spending on first quarter economic growth, the government has requested the Commission on Elections to exempt vital infrastructure projects worth at least Php500 billion59 under the “Build, Build, Build” program from the election-related spending ban that will run from March 29th to May 12th.60, 61 49 Implementation includes budgeting, financing, Detailed Engineering Design, and procurement stages, aside from the construction phase. 50 The following 9 projects are still under construction as of January 31, 2019: Clark International Airport Expansion (Php9.36 billion), Clark Green City Commercial Center (Php0.85 billion), Clark Green City Government Center (Php1.78 billion), Clark Green City Mixed-Income Housing (Php3.33 billion), Bonifacio Global City to Ortigas Center Road Link (Php1.90 billion), Estrella-Pantaleon Bridge (Php1.37 billion), Chico River Pump Irrigation (Php4.34), Panguil Bay Bride (Php7.38 billion), and Binondo-Intramuros Bridge (Php4.61 billion). In addition to BBB projects, other big-ticket infrastructure projects such as the South Integrated Transport System (Taguig) (Php5.2 billion) and LRT Line 1 Cavite Extension and O&M (Php64.9 billion) have also begun pre-construction activities in 2018 and early 2019, respectively. 51 Pulangi 4 Selective Dredging Phase 3 Project in Region 10 (Northern Mindanao Region) worth PhpPhp0.24 billion (funded through GAA) and the project focused on improving the remaining sections along Pasig River from Delpan Bridge to Napindan Channel in the NCR worth Php1 billion (funded by a loan from Japan). 52 National Economic and Development Authority http://www.neda.gov.ph/infrastructure-flagship-projects/,, Public-Private Partnership (PPP) Center, Retrieved from https://ppp.gov.ph/project-database/ 53 The Php909.7 billion budget for the flagship infrastructure projects refer to both ongoing projects and projects that have yet to be implemented. 54 Given World Bank’s projected real GDP growth rate for 2019 at 6.3 percent and projected inflation in 2019 at 3.5 percent. 55 Musico, Jelly, “P909.7-B allotted for ‘Build, Build, Build’ program in 2019”, Retrieved from http://www.pna.gov.ph/articles/1042562 56 Cervantes, Filane Mikee, “Solon backs infra exemption from poll ban”, Retrieved from http://www.pna.gov.ph/articles/1060614 57 Torres, Sherrie Ann, “Foreign firms eyed amid ‘shortage’ of contractors for infra projects,” Retrieved from http://news.abs-cbn.com/business/07/19/18/foreign-firms-eyed-amid-shortage-of-contractors-for-infra-projects 58 Velasco, Ed, “NEDA: Build, Build, Build projects done by ‘22”, Retrieved from https://www.manilatimes.net/neda-build-build-build-projects-done-by-22/422368/ 59 Nicolas, Bernadette D., “Spending ban exemption to cover P500-billion projects”, Retrieved from http://governance.neda.gov.ph/spending-ban-exemption-to-cover-p500-billion-projects/ 60 Cervantes, Filane Mikee, “Solon backs infra exemption from poll ban”, Retrieved from http://www.pna.gov.ph/articles/1060614 61 Cu, Rea, “Comelec seen to grant exemption of vital infrastructure from spending ban,” Retrieved from https://businessmirror.com.ph/2019/01/30/comelec-seen-to-grant-exemption-of-vital-infrastructure-from-spending-ban/ 38 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO The global economic environment remains Growth in the services and industry sectors will challenging, limiting the Philippines’ export growth be supported by strong domestic demand, while prospects. Global growth is projected to moderate a weak recovery is anticipated for the agriculture from 3.0 percent, year-on-year, in 2018 to 2.9 percent sector. A growing middle class and a steady flow of and 2.8 percent in 2019 and 2020-21, respectively, remittances from overseas Filipinos are expected to amid elevated trade tensions, a slowdown in fuel the demand for real estate and financial services. international investments, and tightening financing Also, the upcoming general elections in May are conditions (Box 6). Close to 70.0 percent of advanced expected to provide an added boost to transport and economies are expected to register weaker growth communication and government services, helping in 2019 compared to 2018, while growth projections to accelerate growth in the services sector from 6.6 were downgraded in more than 40.0 percent of percent, year-on-year, in 2018 to 6.9 percent in 2019. EMDEs. The growth deceleration will soften the However, growth in the industry sector is expected demand for Philippines exports, as exports to high- to slightly decelerate from 6.8 percent, year-on-year, income economies account for roughly 70.0 percent in 2018 to 6.7 percent in 2019, as manufacturing of the country’s export market. The growth of the activities are expected to be impacted by the Philippines’ main goods exports—electronics and slowdown in global trade. While growth in the electronics components—have already started to agriculture sector is likely to recover partly due to the slow, growing by a mere 2.8 percent, year-on-year, in low base in 2018, it will be limited due to unresolved 2018, down from 24.2 percent in 2017.62 Meanwhile, productivity challenges and vulnerability to weather import growth is expected to outpace export growth disturbances, such as the potential impact of El Niño in 2019, driven by an increase in domestic economic in 2019.63 activities, anchored in the capital requirements of public infrastructure projects. As a result, net exports are likely to remain a drag on economic growth, while current-account pressures may continue. 62 In FOB Value in US Dollars. 63 https://pubfiles.pagasa.dost.gov.ph/climps/climateforum/climateoutlook.pdf PART 02 OUTLOOK AND RISKS 39 Box 6. The Global Economic Outlook Global growth is expected to gradually slow in the coming years, from an estimated 3.0 percent in 2018 to 2.9 percent and 2.8 percent in 2019 and 2020-21, respectively (Figure 25). Economic growth in advanced economies is expected to slow as monetary policy is normalized and capacity constraints become increasingly binding. Meanwhile, growth in EMDEs is likely to weaken, reflecting weaker-than-expected growth in commodity exporters along with growth deceleration in commodity importers. Growth also continues to be affected by trade tensions between the United States and China.64 While the temporary pause in tariff hikes agreed by the two countries in early December 2018 tempered trade policy uncertainties, the possibility of escalating trade restrictions remains elevated. This uncertainty is likely to weigh on firms’ investment and export decisions. Combined with an increasing prevalence of temporary trade barriers, such as anti-dumping and countervailing duties and safeguards, recent protectionist measures have disproportionately affected trade in parts and components, with negative repercussions for international value chains and trade growth (Figure 26). The growth deceleration may be more severe if downside risks to the global outlook materialize. These downside risks include an escalation of trade tensions, a sharper-than-expected tightening of global financing conditions, and heightened political uncertainty. For example, escalating trade tensions can cut about 5.0 percent of global trade flows if all tariffs under consideration were implemented. While a number of countries stand to benefit from trade diversion in the short run, trade protectionism would stifle investment and disrupt global value chains, contributing to higher prices and lower productivity. Further tightening of global financing conditions could exert further downward pressure on economic activities in EMDEs, including in countries with large current-account deficits financed by portfolio and bank investment flows. Debt levels have risen in some EMDEs over the last few years, including in many low-income countries, reducing the fiscal space to respond to shocks and heightening the exposure to shifts in market sentiment and rising borrowing costs. Given the substantial risks and weaker growth prospects, EMDEs are faced with the challenge of ensuring sustained improvements in living standards while promoting productivity growth. This will require investments in both human capital and skills development to raise productivity and take full advantage of technological change. In the current environment of limited fiscal resources, it is vital that the government ensures the effective allocation of public resources and increases the efficiency of the public sector. Moreover, many EMDEs could do more to liberalize their trade regimes and further integrate their economies into global value chains, which would foster job creation, export diversification, and a more efficient allocation of resources. Policies that address these areas would also address the challenges associated with informality, reinforcing the basis for future productivity growth. 64 The trade dispute led to the introduction of new tariffs that affected about 12.0 percent of U.S. goods, 6.5 percent of China’s goods imports, and 2.5 percent of global goods trade in 2018. 40 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Figure 25. Global growth is expected to slow in the coming years... Figure 26. ...along with a slowdown in global trade. 8 6 5 6 4 Percent Percent 4 3 2 2 1 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2016 2017 2018 2019 2020 2021 World Trade Advanced economies 2000-18 average EMDEs Source: GEP January 2019. Source: GEP January 2019. Table 6. Real GDP Growth, 2016-21 2016 2017 2018e 2019f 2020f 2021f World 2.4 3.1 3.0 2.9 2.8 2.8 Advanced economies 1.7 2.3 2.2 2.0 1.6 1.5 Emerging market and developing Economies 3.7 4.3 4.2 4.2 4.5 4.6 Developing East Asia & Pacific 6.3 6.6 6.3 6.0 6.0 5.8 Philippines 6.9 6.7 6.2 6.4 6.5 6.5 Note: Developing East Asia & Pacific includes Cambodia, China, Fiji, Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea, Philippines, Solomon Islands, Thailand, Timor-Leste, and Vietnam. Source: World Bank Global Economic Prospects, January 2019; World Bank Global Monthly, January 2019. PART 02 OUTLOOK AND RISKS 41 POVERTY REDUCTION AND SHARED PROSPERITY PROGRESS The positive growth outlook is expected to further contribute to poverty reduction efforts, supported by the improvement in non-agriculture wages and the delivery of public programs such as the Pantawid Pamilyang Pilipino Program. Filipino households are likely to continue reaping have received the cash grant to date. The program the gains from high economic growth. Non- will continue in 2019, with benefits increasing to agriculture wages are expected to continue to Php3,600. spur growth in household incomes, particularly for lower income groups. Cash transfers from the Poverty reduction is also expected to continue government, including from programs that were based on the current economic growth outlook. started in 2018, have been particularly helpful to An acceleration in economic growth will contribute mitigate the impact of high inflation. For example, to poverty reduction through job creation, higher the Unconditional Cash Transfer Program was rolled wages, and a continuation of social programs. out to the government’s Pantawid Pamilyang Medium-term poverty projections based on the Pilipino Program beneficiaries and senior citizens in middle-income poverty line of US$3.20/day show the 2018, with Php2,400 in annual benefits to mitigate poverty rate declining from 26.0 percent in 201565 to the impact of higher excise taxes. According to 20.7 percent in 2019, 19.6 percent in 2020, and 18.5 administrative data, about 7 million beneficiaries percent in 2021 (Figure 27). Figure 27. Actual and Projected Poverty Rates in the Philippines, 2006-2021. PERCENT 45 40 35 30 25 20 15 10 5 0 2006 2009 2012 2015 2018 2021 Source: PSA, World Bank staff calculations. 65 Actual estimates are slightly different from previous publications due to updates in the Consumer Price Index. 42 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO SOME RISKS AND POLICY CHALLENGES REMAIN The economic outlook is subject to downside external and domestic risks. Prudent management of fiscal and current-account balances and policies to preserve consumer and business confidence are key short-term priorities, while fostering inclusive growth remains an important long-term policy objective and challenge. Downside risks to the Philippines’ economic and the potential impact of El Niño phenomenon growth outlook have increased. Key external risks on agriculture production and food prices are emanate from heightened uncertainty generated additional domestic risks that might affect the by the U.S.-China trade dispute, the ongoing growth outlook. In the medium to long term, the policy normalization in advanced economies, and government’s expansionary fiscal policy could lead tightening global financial conditions. Domestic risks to fiscal sustainability challenges if not accompanied have increased with the delay in the approbation by revenue increases. Nonetheless, there are strong of the 2019 budget, negatively impacting the macroeconomic fundamentals in place to protect implementation of public infrastructure projects. the country against shocks such as large foreign Uncertainty over the passage of the remaining reserves, an accommodative monetary policy, and packages of the government’s tax reform program,66 the flexible exchange rate regime. (Figure 28).67 Figure 28. While the Philippines’ macroeconomic fundamentals Figure 29. Consumer and business confidence worsened in 2018. are strong, challenges remain. 90.0 120 80 80.0 78.4 60 100 40 70.0 Percent 63.0 20 60.0 80 54.2 0 Billions US$ 50.0 46.7 Percent 60 -20 40.0 -40 30.0 40 23.7 -60 20.0 17.4 17.6 17.0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 20 10.0 9.2 8.8 9.6 7.9 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 4.5 5.4 4.9 2.4 3.4 0.4 0.0 0 Overall Consumer Confidence Index (Current Quarter) Per capita Cash Inflation Debt Public International growth remittances rate (in percent of expenditure reserves (USD Overall Business Confidence Index (All Sectors) (in percent of GDP) (in percent of billion, RHS) GDP) GDP) Source: BSP. 1990 - 1999 2000 - 2009 2010 - 2018 Source: PSA, World Bank staff calculations. 66 A number of tax reform packages have passed in the House of Representatives but are still being deliberated in the Senate. Should Congress fail to pass the tax reform packages before the end of the 17th Congress of the Philippines, these will need to be refiled once the 18th Congress resumes in June 2019. 67 For example, the growth of cash remittances decelerated from an average of 9.2 percent in 2000-09 to 8.8 percent in 2010-18, and remittances grew by a mere 3.1 percent in the first 11 months of 2018. The import cover of international reserves has fallen from 8.8 months in December 2016 to 7.7 months and 7.0 months in December 2017 and December 2018, respectively. PART 02 OUTLOOK AND RISKS 43 External uncertainty remains high, posing a Domestic risks include further delay in the approval challenge to the Philippine economy. Heightened of the 2019 budget while the passage of additional global uncertainty is rooted in the potential comprehensive tax reforms is needed to ensure fiscal escalation of trade tensions between the U.S. and health. An important downward risk to baseline China and the ongoing policy normalization in growth outlook is the delay in the 2019 budget advanced economies, which can undermine investor approval process, and the reenactment of the 2018 confidence and trade activities in the region. In budget (Box 7). Under a reenacted budget, no the past, episodes of market uncertainty have led new programs and projects will receive funding, as to volatility in the country’s capital and foreign budget allocations are based on the appropriations exchange markets, induced by foreign capital made in the previous year’s budget. As a result, the outflows as investors looked for safer investment limited public spending may negatively impact the outlets. Sudden capital outflow puts pressure on Philippines’ growth prospects for 2019. Meanwhile, as the Philippine peso and may undermine consumer the government ramps up spending to implement and business confidence. Moreover, the policy its inclusive growth agenda, complementary reforms normalization by the U.S. Federal Reserve can lead to enhance revenue generation are needed to to tighter financing conditions, raising borrowing ensure fiscal sustainability. In particular, additional costs at a time when foreign funds are partly used to tax policy measures, which were expected to pass in finance the government’s infrastructure investment 2018, have yet to be adopted by the Congress of the program. The external environment is, therefore, not Philippines.69 These measures were included in the expected to be accommodative to domestic growth, national government’s medium-term fiscal program warranting prudent policy actions. and the budget preparation process for 2019. The passing of these revenue measures will help to The current-account deficit has to be carefully ensure that the government is able to limit deficit managed to prevent gaps in external funding. The increases while continuing its ambitious program current-account deficit is expected to further widen, to increase public spending in infrastructure and as goods export growth remains weak while import human capital. growth accelerates, driven by the government’s focus on increasing infrastructure investment spending. Prudent management of fiscal balance and Unlike in the past, services exports and inflow of improvement in public investment management remittances are unlikely to offset the trade deficit, as are needed as the government ramps up its public growth in remittances and the IT-BPO industry has investment program. As financing conditions started to soften after years of double-digit growth. continue to tighten globally, the government must In the context of possible further tightening of continue to exercise prudent fiscal management to global financing conditions, the government needs maintain long-term debt sustainability. In addition to manage the current-account deficit to prevent to raise new revenue to meet spending needs, the it from widening too much too fast. In a way to government may benefit from diversifying sources address the sagging export competitiveness, it can of project financing to include overseas development help exports industries connect to the global value assistance, general appropriations funding, and chain, improve domestic linkages not only between public-private partnerships. Beyond financing, public services and other sectors but also among industrial investment management needs to be improved subsectors, attract more investments, and support to help maximize the efficiency of infrastructure the IT-BPO industry move up the value chain.68 investment in the medium-term, particularly in Nevertheless, healthy foreign reserves, large inflows project appraisal, multi-year budgeting, portfolio of FDI, a flexible exchange rate regime, and low management and oversight, and procurement.70 public debt levels will help public authorities address emerging external funding challenges. 68 See Philippines Economic Update October 2016 for a box on Moving up the value chain: from BPO to KPO; and Philippines Economic Update April 2017 for a chapter on trade competitiveness and global value chains in the Philippines. 69 For example, tax reform Package 1B, which includes reforms to estate tax amnesty, a general tax amnesty, adjustments to the motor vehicle user tax, and a relaxation of bank secrecy and automatic exchange of information, was expected to generate Php37.2 billion (0.2 percent of GDP) in additional revenues in 2019 under the government’s 2019 medium-term fiscal program. Moreover, Package 2+, which includes an adjustment to excise taxes on alcohol and tobacco as well as mining revenue, is expected to generate an additional Php62.7 billion in 2020 (0.3 percent of GDP) and Php78.9 billion in 2021 (0.3 percent of GDP). 70 Source: International Monetary Fund. The Philippines: Public Investment Management Assessment. 2018. 44 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Box 7. The Delayed Passage of the 2019 National Government Budget For the first time since 2010, the government operated under a reenacted budget in the first quarter of 2019,71 as the Congress was unable to pass the proposed 2019 budget in 2018. The 2019 public budget was ratified by Congress on February 8, 2019 but is still pending approval, as an impasse between both houses of Congress has caused further uncertainty on the timing of the passage of the 2019 budget. The ratified budget would significantly increase allocations to a number of key agencies. In particular, the Department of Public Works and Highways would receive an additional Php32.9 billion, while the Department of Health would receive an additional Php21.5 billion. The ratified version of the budget also reverts the 2019 budget back to an obligation- based budget, as Congress rejected the implementation of a cash-based budgeting system. To soften the limitations created by the reenacted budget, the Department of Budget and Management issued guidelines (DBM Circular 2019-01) on the release of public funds. These stated that government agencies were authorized to obligate 2019 budget funds in the first quarter of 2019 but only up to 25.0 percent of their corresponding 2018 budget allocations. This applied to personnel services, maintenance and operating expenditures for regular programs, and existing capital outlays under a multi-year obligation authority. The implementation of the reenacted budget meant delays in the government’s disbursement program. Under a reenacted budget, no new programs and projects under the proposed budget will receive funding, as budget allocations will continue to be based on the appropriations made in the previous year’s enacted budget. For example, under the reenacted budget, no new capital outlays will be implemented in the first quarter of 2019, which is a crucial period during an election year when the government typically frontloads the implementation of infrastructure projects. According to the Department of Budget Management, the delayed passage of the 2019 national budget is estimated to lower programmed disbursements by Php43.7 billion in the first quarter of 2019. Sources: Department of Budget and Management; and Cepeda, M. 2019. “Bicam approves 2019 budget but rejects cash-based budget system.” Retrieved from https://www.rappler.com/nation/223033-bicam-approval-2019-budget-remove-cash-based-budgeting-system . Cepeda, M. 2019. “Bicam approves 2019 budget but rejects cash-based budget system.” Retrieved from https://www.rappler.com/nation/223033-bicam-approval-2019-budget-remove-cash-based-budgeting-system 71 Under the 1987 Constitution, if the Philippine government is unable to pass the General Appropriations Bill (GAB) by the end of the year, the government will operate under the previous year’s budget until the government passes the GAB. PART 02 OUTLOOK AND RISKS 45 Preserving business confidence not only requires El Niño in September to November 2019. Mitigation policy clarity and commitment but also consensus measures, such as targeted cash transfer to among government agencies on the nature farmers and ample and timely importation of rice, and timing of reforms. Business sentiment in vegetables, and other food products, would be key in the Philippines worsened in 2018, with the BSP’s preventing inflationary risk and welfare loss by business confidence index falling from 43.3 in the the farmers. fourth quarter of 2017 to 27.2 in the fourth quarter of 2018—its lowest level since the first quarter of 2010 The Hanjin corporate default—the largest in (Figure 29). Uncertainty in the external environment Philippine history—is unlikely to threaten the and persistent high inflation are reasons for a country’s financial stability. According to the BSP, the more pessimistic expectation. A lack of clarity country’s healthy capital buffers and the low share into the timeframe of the government’s planned of non-performing loans in the total loan portfolio policy reforms, including the remaining tax reform make the country’s banking system well-positioned packages, creates uncertainty among investors to withstand the corporate loan default of US$412.0 who may be temporarily withholding investments million from five local banks affected by the default until the scope of reforms becomes clear. Moreover, of HHIC-Phil. The loan exposure represents only 0.2 uncertainty is heightened by difficulties in reaching percent of total loans in the banking system and 2.5 a consensus between the executive and legislative percent of foreign currency loans in foreign currency branches as witnessed for instance, in the delayed deposit units. However, credit rating agencies, approval of the public budget, which casts doubt including Moody’s Investor and Fitch Ratings, warn over the timely delivery of public investment that the Hanjin default poses risks to local banks, as it projects. Therefore, while the government has will reduce profits and raise credit costs.73 established policy clarity and demonstrated a commitment to reforms, it needs to effectively The government is faced with the challenge of convene and build consensus among government effectively and sustainably implementing its agencies on the opportunity, nature, and timing inclusive growth agenda in the long term. This of reforms to lower governance risks and temper requires a commitment to structural reforms market uncertainties. that improve market competition, encourage investments, and improve labor market conditions. An intensified El Niño in 2019 may weaken Policies that support market competition and agriculture output and result in food supply investments are critical to boosting both productivity constraints if mitigating measures are not put in and economic growth as it has been identified as place. Past El Niño events in the Philippines have the key steps toward achieving inclusive growth.74 resulted in production losses in the agriculture- Key policy initiatives include revisiting foreign fisheries sector due to dry farmlands, stunted growth participation limits in the domestic market and of livestock, and lower fish catch. In 2015-16, an El implementing reforms to improve doing business in Niño episode resulted in about Php15.4 billion worth the country which will lead to higher competition, of damage and production losses (0.11 percent of improve consumer choices, improve quality of GDP) from lost crops such as corn, cassava, banana products and services, and lower prices. Labor and rubber.72 It directly affected 413,456 farming market initiatives include reducing labor market households which needed government support to rigidities, implementing training and job-search recommence farming activities for the next cropping programs, and measures to support workers affected season. Production loss might cause higher food by the sectoral shifts of employment, which will inflation as it was seen during the 1997-98 El Niño boost productivity growth while ensuring workers’ when food inflation reached 8.3 percent. According welfare. Moreover, to accelerate inclusive growth, to the Philippine Atmospheric, Geophysical, and sustained investments are needed in human capital Astronomical Services Administration (PAGASA), development, especially in health and education, some effects of a drought are already prevailing in and in sectors that create quality jobs. the country and warns a 65 percent chance of 72 El Niño in the Philippines, Food and Agriculture Organization of the United Nations, September 2015, Available online: www.fao.org/3/a-i4947e.pdf. 73 https://www.rappler.com/business/221037-moodys-hanjin-crisis-threatens-banks-credit-ratings; and https://www.philstar.com/business/2019/01/15/1885318/ fitch-unit-hanjin-bankruptcy-unlikely-threaten-philippines-financial-stability. 74 World Bank (2018) 03 THE PROMISE OF HUMAN CAPITAL Human capital is a critical driver of both economic growth and inclusion. The prospects for continuing economic growth in the Philippines will depend on expanding its high-skill services sector, which will require boosting human capital. The Human Capital Index (HCI) is a useful starting point for considering the country’s human capital challenges. The HCI score of 0.55 for the Philippines indicates that due to shortcomings in human capital, a Filipino child born today will on average achieve only 55 percent of his or her potential lifetime earnings. Access to education and health care has improved in recent years due to reforms and increased public spending, but the Philippines continues to spend less on human capital investments than many other countries in the region. Key policy priorities to improve the country’s human capital including making learning the central objective of the education system, leveraging expanded access to improve the quality of health care, and reducing the high level of child stunting. 48 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO THE PHILIPPINES CAN ACHIEVE ITS FULL POTENTIAL BY BOOSTING HUMAN CAPITAL Advances in human capital—knowledge, skills, This is especially important for realizing people’s and good health—have driven economic growth aspirations for a prosperous and predominantly and lifted millions of people out of poverty. The middle-class society by 2040. extraordinarily rapid ascent of the East Asian miracle economies was due in large part to their efforts to The Human Capital Index developed as part improve human capital. With rapid technological of the HCP constitutes a useful starting point change, the wealth of nations has become closely for understanding the challenges faced by the tied to their level of human capital development. Philippines in an increasingly technology-intensive Investments in human capital serve a dual purpose: global economy. It quantifies the level of human they accelerate future economic growth and capital that a child can expect to attain by age 18. increase opportunities for all Filipinos. The HCI consists of three components: The risk that the Philippines may be left behind 1. Survival: the proportion of children that survive by technological change is high. Technology has from birth to school age; made possible the tremendous expansion of the 2. Schooling: the number of “learning-adjusted” BPO sector in the Philippines, which has grown to years of schooling a child born today is expected constitute 7.8 percent of GDP in 2017. This success to complete; and has generated hundreds of thousands of new 3. Health: a combination of the child stunting rate jobs for those with basic skills. But many of those and the adult survival rate. same jobs could be eliminated in just a few years as call center operators are replaced by automated The index is designed to capture the impact of computer systems with voice simulation and human capital on future productivity, earnings, artificial intelligence. To maintain its success and economic growth. The HCI uses an underlying the BPO industry will have to upgrade into higher- theoretical framework that is based on the economic skilled services. Likewise, across manufacturing and returns from good health and schooling. Figure 30 agriculture, processes are becoming increasingly presents a conceptual version of the HCI. technology and skill-intensive. Investments in human capital can ensure that the Filipinos are ready for the economy of tomorrow. The different components of human capital development are closely interrelated. For example, a child’s survival is determined by a country’s general The World Bank launched the Human Capital Project health conditions. Also, a student’s nutrition is a key (HCP) in 2018 in an effort to accelerate investments driver of success in school, as malnourished children in human capital across the globe. The Philippine risk limited cognitive development, which can lead government was an “early adopter” of the Human to learning difficulties and early school dropout. Capital Project and is working with the World Bank to improve and implement the human capital initiatives of the Philippine Development Plan The overall HCI for the Philippines is above the (PDP). The PDP recognizes the challenge posed by average for lower middle-income countries but technological change and states the government substantially below the average of countries in East must undertake “investment in human capital so Asia and Pacific (EAP). Globally, the Philippines that Filipinos are equipped to learn and adapt to new ranked 84th out of 157 countries included in the HCI, technology and the changing profile of society.” with a score of 0.55. The HCI can be interpreted in two ways. One interpretation is that the country’s PART 03 THE PROMISE OF HUMAN CAPITAL 49 Figure 30. The Human Capital Index shows the impact of current investments in children on future productivity. X X = Survival School Health Productivity of future worker, relative to potential Source: World Bank future GDP will reach 55 percent of what it could Autonomous Region of Muslim Mindanao (BARMM) be, if the Philippines’ of human capital were at the has the lowest average score (Figure 31). As a result level of top performers like Singapore. An alternative of limited human capital opportunities, children interpretation is that an average Filipino child, in the in BARMM, Eastern Visayas, and Soccsksargen absence of renewed efforts on human capital, will will reach less than half of their potential future reach 55 percent of potential, in terms of productivity earnings when they reach adulthood. There is also and lifetime income. a marked difference in the HCI between rich and poor households (Figure 32). Children who grow up There are wide disparities in human capital in the in the wealthiest one-fifth of families accumulate Philippines. Region II (Cagayan Valley) has the 40 percent more human capital than those in the highest average HCI score, while Bangsamoro poorest one-fifth of households. Figure 31. Human Capital Index by Region, 2017. Figure 32. Human Capital Index by Socioeconomic Status, 2017. HCI 0.70 <0.50 0.50 - 0.54 0.60 0.54 - 0.58 0.58 - 0.62 0.50 >0.62 0.40 0.30 0.20 0.10 0.00 POOREST 2ND 3RD 4TH RICHEST QUINTILE QUINTILE QUINTILE Source: World Bank staff analysis. Source: World Bank staff analysis. 50 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Philippine women fare better than men in all aspects childhood—up to the age of five—the primary of the HCI. Girls are slightly more likely to survive to considerations are child survival and nutrition. In the age of five and are less likely to be stunted than later childhood, human capital is acquired through boys. They also stay in school longer and perform education. Finally, adults maintain their human better on standardized tests, on average. As in most capital through good health. The remainder of this countries, Philippine women are also more likely section examines human capital in the Philippines than men to survive to the age of 60. As a result, the in these three life phases in light of the HCI and its Philippines’ overall HCI for women is 0.58, compared subcomponents. Figure 33 shows a comparison of to 0.52 for men. the values of the HCI and its subcomponents for the Philippines to the averages of the East Asia and the Human capital can be accumulated in early Pacific region and to other countries by childhood, later childhood, and adulthood. In early income group. Figure 33. The Human Capital Index and Its Subcomponents HUMAN CAPITAL INDEX PROBABILITY OF SURVIVAL TO AGE 5 HIGH INCOME 0.74 HIGH INCOME 1.00 EAST ASIA AND THE PACIFIC 0.61 UPPER MIDDLE INCOME 0.98 UPPER MIDDLE INCOME 0.58 EAST ASIA AND THE PACIFIC 0.98 PHILIPPINES 0.55 PHILIPPINES 0.97 LOWER MIDDLE INCOME 0.48 LOWER MIDDLE INCOME 0.96 0.00 0.20 0.40 0.60 0.80 0.00 0.20 0.40 0.60 0.80 1.00 EXPECTED YEARS OF SCHOOLING HARMONIZED TEST SCORES HIGH INCOME 13.3 HIGH INCOME 506 PHILIPPINES 12.8 EAST ASIA AND THE PACIFIC 451 EAST ASIA AND THE PACIFIC 11.9 UPPER MIDDLE INCOME 428 UPPER MIDDLE INCOME 11.7 PHILIPPINES 409 LOWER MIDDLE INCOME 10.4 LOWER MIDDLE INCOME 391 0 5 10 15 0 100 200 300 400 500 600 ADULT SURVIVAL RATE FRACTION OF CHILDREN UNDER 5 NOT STUNTED HIGH INCOME 0.92 HIGH INCOME 0.94 EAST ASIA AND THE PACIFIC 0.87 UPPER MIDDLE INCOME 0.87 UPPER MIDDLE INCOME 0.86 EAST ASIA AND THE PACIFIC 0.78 LOWER MIDDLE INCOME 0.81 LOWER MIDDLE INCOME 0.73 PHILIPPINES 0.80 PHILIPPINES 0.67 0.70 0.75 0.80 0.85 0.90 0.95 0.0 0.2 0.4 0.6 0.8 1.0 Source: World Bank PART 03 THE PROMISE OF HUMAN CAPITAL 51 NUTRITION IS THE WEAKEST LINK OF HUMAN CAPITAL FOR THE PHILIPPINES The most critical period for human capital The levels of child malnutrition in the Philippines development encompasses the early years of life. are shockingly high.75 One in three children under During the first 1,000 days, between conception the age of five is stunted—the principal marker and a child’s second birthday, the foundation for of malnutrition—and stunting rates have been optimum health, growth, and neurodevelopment stagnant over a decade. Malnutrition is particularly is established. The HCI includes two separate severe among children in poor households. Half of components that capture a child’s experience during children in the poorest income quintile are stunted, this period: i) the child survival rate—the fraction of and one in five are severely stunted. These data children who survive to the age of five—and ii) the points demonstrate one facet of intergenerational fraction of children under the age of five who are poverty: children who grow up in poor households not stunted. are often inadequately nourished and more likely to suffer from limited cognitive and physical The Philippines performs well in terms of child development, increasing the likelihood that they will survival. Ninety-seven percent of Philippine children suffer from poverty in adulthood. live to see their fifth birthday. This rate is slightly above the average of lower middle-income countries The Philippines has long-standing efforts to address (95.0 percent) and has improved over time, from the country’s high malnutrition rates, however, the 94.3 percent in 1990 to 97.1 percent in 2016 (Figure rate of stunting remains high. For example, the 34). There are, however, disparities by wealth and National Nutrition Council, the principal agency geography. Children in the poorest 20 percent of responsible for nutrition planning and policy, was households are nearly four times more likely to die created in 1974. The Philippines Development Plan before the age of five than children in the wealthiest highlights nutrition as a priority, and the 2017- 20 percent of families. The child survival rate is 2022 Philippine Plan of Action for Nutrition (PPAN) the lowest in Bangsamoro Autonomous Region of recommends a multisectoral combination of both Muslim Mindanao (BARMM), where 5.5 percent of nutrition-specific and nutrition-sensitive initiatives. children die before reaching the age of five. However, the rate of stunting remains Figure 34. Between 1990 and 2016, the probability a Filipino child survives to the age of five improved from 94 to 97 percent. 98.4 East Asia & Pacific 97.1 Philippines 96.0 World 95.0 94.3 Lower middle income Fraction of 94.2 newborns surviving to age 5 (%) 90.7 87.8 1990 1995 2000 2005 2010 2016 Source: World Development Indicators 75 The term “malnutrition” refers to a deviation from optimal nutrition status and includes both overnutrition and undernutrition. Overnutrition represents an oversupply of nutrients relative to the body’s physiological needs. Undernutrition refers to a state of nutritional deficiency and presents the most serious risks to health and devel- opment when experienced by women during pre-pregnancy/pregnancy/lactation, and infant and young children. There are a variety of measure of undernutrition. The discussion here focuses on one measure: child stunting, defined as low height-for-age in children under five years of age. Stunting results from chronic undernutrition and indicates a failure of a child to attain the height expected among healthy children. 52 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Figure 35. Rates of Return on Investments to Reduce Stunting by Country India Indonesia Philippines 66 to 1 Vietnam Bangladesh Pakistan Tanzania Ethiopia Sudan Kenya Nepal Nigeria Uganda Madagascar 0 10 20 30 40 50 60 70 80 90 Source: Galasso and Wagstaff (2016). stubbornly high. The initiatives outlined in the A study tracking children born in Cebu has estimated PPAN are in line with the recommendations based the long-term impact of malnutrition in the on global evidence, but implementation—which Philippines. Children who were not stunted in their relies largely on effective action by health workers early years performed significantly better in school.77 and policymakers at the local level—is uneven. The They started school at a younger age, learned more potential rate of return on investments to boost during each year of schooling, were less likely to nutrition is extraordinarily high in the Philippines, repeat grades, and stayed in school longer.78 Children as the estimated benefit is Php66 for every Php1 who were better nourished also had a higher IQ invested—the third highest rate of return across all at the age of eight.79 These effects endured into countries surveyed (Figure 35). adulthood: those who were not stunted at a young age were more likely to hold formal sector wage Costs of Malnutrition jobs in their early 20s.80 One recent study, which attempted to aggregate the costs of undernutrition Evidence from countries around the world shows in the Philippines, estimated that undernutrition the high long-term costs of child malnutrition.76 costs the society 2.8 percent of GDP in terms of Childhood stunting is associated with adverse lower skills and productivity and 0.05-1.6 percent outcomes throughout life. Malnourishment and of GDP in additional healthcare costs.81 A separate the diseases that cause stunting impede the study, using a different methodology, estimated development of young brains, resulting in impaired the total economic burden of undernutrition in the cognitive and socioemotional skills, which can lead Philippines at US$4.5 billion per year—equivalent to to lower levels of schooling and less income when 1.5 percent of GDP.82 reaching adulthood. Additionally, children who are stunted are more likely to face health problems later in life, resulting in higher healthcare costs. 76 Galasso and Wagstaff (2016) provides one recent survey of this evidence. 77 Glewwe et al (2001) 78 Daniels and Adair (2004) and Daniels and Adair (2005) 79 Mendez et al (1999) 80 Carba et al (2009) 81 Save the Children (2016) 82 UNICEF (2017) PART 03 THE PROMISE OF HUMAN CAPITAL 53 Drivers of Malnutrition The view that stunting is principally due to genes is not supported by science. If genetic factors Malnutrition is driven by a complex mix of factors. were the main cause of stunting, rates of stunting A number of studies have examined the potential would be fairly constant over time. In reality, many drivers of the high levels of stunting in the countries—including China, Vietnam, Brazil, and Philippines.83 Factors includes lack of breastfeeding, Iran—have achieved rapid drops in stunting. One child nutrient deficiencies and low quality of diet, particular relevant point of comparison for the lack of access to clean water and sanitation, and high Philippines is Peru. Up until 2008, Peru had a level levels of adolescent pregnancy. of stunting similar to that of the Philippines (Figure 36). A common view in Peru at that time was that Poor health and nutrition of mothers before and stunting was largely driven by genetic factors. during pregnancy is a key cause of child stunting. In Unlike the Philippines, Peru experienced a large 2015, one in four pregnant women in the Philippines drop over the following years, cutting the stunting were categorized as “nutritionally-at-risk,” and a rate in half. Factors in Peru’s successful fight against substantial number of mothers were anemic or had stunting include economic growth paired with iodine deficiencies. International research shows that strong and sustained leadership, effective use of a child with low weight at birth (less than 2.5 kg) is at communications tools to change behaviors, and very high risk of being stunted, and 14.5 percent of multisectoral efforts including a conditional cash Filipino children had low birth weights.84 Low birth transfer program optimized for nutrition and a weight is principally a consequence of the mother’s targeted financing mechanism. Spending focused health and nutrition before and during pregnancy. on key interventions including vaccinations to reduce childhood infections, monitoring the growth of infants and young children, and promotion of feeding and hygiene practices at home.85 Figure 36. Stunting Trends in the Philippines and Peru 50% 40% 33.4 30% 20% 14 10% Philippines Peru 0% 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: World Development Indicators and Food and Nutrition Research Institute (2016). 83 Recent studies that discuss possible factors include Food and Nutrition Research Institute (2016) and Herrin (2016). Danaei et al (2016) estimates the importance of various drivers by comparing international evidence with national data. 84 Source: Demographic and Health Survey (DHS) 2017. This figure is among the 84 percent of births for which a weight is reported by the DHS. Weight is reported for only 70 percent of children in the poorest wealth quintile. The actual percentage of children with low birth weight is likely higher. 85 Marini and Rokx (2017) 54 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO LIMITED QUALITY OF EDUCATION GENERATES A LEARNING GAP The HCI highlights that learning is not the same as However, limited learning creates a gap between schooling. Traditionally, education outcomes have years of schooling and learning-adjusted years. been measured by how many years of schooling Adjusting for how much children learn, 12.8 years of a child receives. But it is clear that what matters is schooling in the Philippines is equivalent to just not only how long a child is in a classroom but how 8.4 years in the highest performing education much she learns while she is there. To reflect this systems, such as that of Singapore, resulting point, the HCI combines two measures. The first is in a “learning gap” of 4.4 years (Figure 37). The the number of years of schooling a child is expected Philippines’ learning gap is an indication that its to complete by her 18th birthday. The second education system is failing to provide full educational is a measure of learning based on international opportunities for its children. student achievement tests. These two measures are combined to calculate “learning-adjusted years of There are also large disparities in educational schooling.” The adjustment reflects how far short a opportunities between regions and socioeconomic country falls in terms of learning relative to the best groups in the Philippines. On average, a child born performing education systems. today in Cagayan Valley will complete nearly three additional learning-adjusted years of schooling than The Philippines compares quite favorably to regional a child born in the BARMM. peers in terms of the number of years of schooling a child today can be expected to complete. The The Philippines has implemented a series of reforms expected years of schooling for a Filipino was 12.8 that have increased access to education and reduced in 2017, significantly above the average of 11.9 years drop-out rates. First, it has implemented a K-12 Basic for EAP and 10.4 years for lower middle-income Education Program, made kindergarten universal countries. The high level of expected schooling in and mandatory, and added two additional years of the Philippines reflects major government efforts to senior high school to what was previously a 10-year increase access to education in recent years. education curriculum. The first cohort of senior high Figure 37. Limited Learning Creates a “Learning Gap” between Expected Years of Schooling and Learning-Adjusted Years. 14 12 Learning gap = 4.4 years 10 8 6 4 2 0 Expected Years of Schooling Learning-Adjusted Years of School Source: The Human Capital Project, World Bank, 2018. PART 03 THE PROMISE OF HUMAN CAPITAL 55 school students under the new program graduated senior high school in 2017-18— the first year in which in 2018. Second, the 2017 Universal Access to Quality the second year of senior high school existed. While Tertiary Education Act provides free tuition for all there has been no full evaluation of the impact of Filipino students enrolled in state or local universities the K-12 expansion, initial evidence suggests that it or colleges. The Free Tuition Law also establishes a raised the enrollment rates substantially, particularly tertiary education subsidy to further support poor for poorer students. students by subsidizing their schooling if they enroll in private higher education institutions. Finally, the Educational enrolment, completion, and attainment government expanded its conditional cash-transfer rates are low in conflict-affected areas. In 2014-15, program Pantawid Pamilyang Pilipino to cover the average achievement test score for grade six about 4.4 million identified households. The program students in BARMM was 60 percent, and it was helped raise enrollment rates to near universal 41 percent for fourth year high school students, levels for elementary-age children in beneficiary compared to the national averages of 69 percent households and led to an increase in high and 50 percent, respectively. Repeated cycles of school enrollment. armed violence have damaged many education and health facilities. The region also suffers from These efforts have greatly expanded enrollment low levels of public spending and poor service rates. Nearly all Filipino children up to the age of 17 in delivery, and regional authorities find it difficult the richest 20 percent of households were enrolled to attract qualified teachers since many areas are in school in 2017 (Figure 38). Even among students remote and insecure. A 2015 study found that school in the poorest income quintile, enrollment is close closures were prevalent in ARMM, and absence rates to universal for children up to age 12and exceeds 80 are high for both teachers (31 percent) and students percent for children up to age 16. A large number of (29 percent).86 children from the poorest households attended Figure 38. School Enrollment Rates by Age for the Poorest 20% and Richest 20% POOREST 20% RICHEST 20% AGE 20 19 18 17 16 Kindergarten Post-High School* 15 Elementary 14 Senior High School 13 Junior High School Junior High School 12 Senior High School 11 Elementary 10 Post-High School* Kindergarten 9 8 7 6 5 100% 80% 60% 40% 20% % % 20% 40% 60% 80% 100% PERCENTAGE OF CHILDREN ATTENDING SCHOOL Source: Staff estimates using 2017 APIS *includes technical-vocational education and training, college and post college 86 Making Education Spending Count for the Children of Autonomous Muslim Region of Mindanao: Public Expenditure and Institutional Review for ARMM Basic Education (2015). 56 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO The principal challenge for the Philippine education Teacher knowledge and skills are a core constraint system is to ensure that children learn. The Trends to improving learning outcomes. Unlike in many in International Mathematics and Science Study other countries, Philippine teachers have low (TIMSS) and the Programme for International absenteeism rates. However, they have on average Student Assessment (PISA) are two major insufficient knowledge of the subjects they teach international standardized tests. The Philippines last and are poorly prepared in terms of pedagogical participated in TIMSS in 2003 and joined PISA for the techniques. In tests administered to teachers in the first time in 2018. The 2003 TIMMS was administered subject areas they teach, a majority of teachers in separately for students in grade four and grade eight. both grade six and ten answered less than half of Among the 25 countries for which a fourth-grade the questions correctly, with the one exception of test was administered, the Philippines ranked 23rd sixth-grade teachers in English who demonstrated in both mathematics and science. Among the 45 relatively strong performance.88 A recent study of participating countries in the eighth-grade test, the teacher methods based on classroom observations Philippines ranked 42nd in mathematics and 41st in in Mindanao found that most teachers scored “high” science.87 Available data suggest that school quality or “medium high” in terms of creating a supportive remains a key concern for educational outcomes in classroom culture. However, a majority were the Philippines. While it is likely that school quality categorized as “low” or “medium low” in terms of has improved somewhat since the 2003 TIMSS was quality of instruction, and most rated in the bottom administered, results from national achievement category in fostering socioemotional skills tests suggest that quality improvements have (Figure 39).89 been modest. Despite increased demand for socioemotional skills The 2018 PISA offers a critical opportunity to identify in the job market, school curricula devote little areas where the education system is succeeding attention to developing these skills. Socioemotional and where more effort is needed to boost learning. skills are important for acquiring other technical and Results from the exam will be publicly available in cognitive skills, including an ability to focus on tasks, December 2019. The results will provide an updated articulate arguments, communicate effectively, learn assessment of the relative performance of the to listen, work with others, and mature emotionally. Philippine system to other countries. Additionally, Furthermore, these types of skills are often linked a detailed analysis of the rich PISA data can identify to an ability to observe professional etiquette in the key constraints to learning and help the workplace and follow work-specific rules and prioritize efforts. guidelines. Socioemotional skills are rewarded in the job market, especially for women and youth.90 Figure 39. Results from the TEACH Classroom Observation Study Low Medium Low Medium High High CLASSROOM CULTURE 28% 68% INSTRUCTION 27% 59% 13% SOCIOEMOTIONAL SKILLS 69% 27% 5% 0% 20% 40% 60% 80% 100% PROPORTION OF TEACHERS RATING IN EACH CATEGORY Source: World Bank (forthcoming) 87 Because of the lack of a more recent TIMSS or PISA score, the HCI for the Philippines made use of a separate exam, namely the 2013 Early Grade Reading Assessment (EGRA) administered to a nationally representative sample of children in Grade 3. The EGRA score was transformed into a “TIMSS-equivalent” value using a statistical technique that exploits the correlation between EGRA and TIMSS scores in countries where both tests were administered. Details can be found in Patrinos and Angrist (2018). 88 World Bank, 2016. 89 World Bank, 2019. 90 Acosta et al (2017) PART 03 THE PROMISE OF HUMAN CAPITAL 57 OUT-OF-POCKET HEALTH EXPENDITURE AND QUALITY OF CARE REMAIN CHALLENGES In addition to child survival and malnutrition rates, The country expanded its health insurance scheme— the HCI includes the adult survival rate (ASR) as a the Philippine Health Insurance Corporation proxy for overall health conditions. The Philippines’ (PhilHealth)—with higher taxes on cigarettes and ASR—the percentage of the population alive at the alcohol beginning in 2013. This reform increased age of 15 that survives to the age of 60—was 80 coverage and widened the benefits package to percent in 2017—below the average of 81 percent for include outpatient services. As a result, the portion lower middle-income countries and substantially of the population with some health insurance below the average of 87 percent for EAP countries. coverage rose dramatically, from 38 percent in 2008 The ASR in the Philippines is much higher for to 66 percent in 2017 (Figure 41). While PhilHealth women (87 percent) than men (74 percent). At is supposed to provide universal coverage for the current age-specific mortality rates, three in four poor, many poor households report not having Filipino men will survive from the age of 15 to the health insurance. The reasons for this include a age of 60. This relatively low survival rate likely lack of knowledge and exclusion errors and other reflects weak overall health services for much of inefficiencies in the rollout and implementation the population. of the program.91 The recently approved Universal Health Coverage Law represents a renewed effort Access to healthcare in the Philippines has improved by policymakers to expand equitable and affordable in recent years, particularly among poor households. access to healthcare. Figure 40. Four out of five Filipino 15-year-olds will survive to the age of 60 90 East Asia & Pacific 86 85 World Fraction of 15 year olds surviving 82 Lower middle income to 60 (%) 81 80 Philippines 77 75 1990 1995 2000 2005 2010 2016 Source: World Development Indicators 91 Brederkamp et al, 2016. 58 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO Figure 41. Health Insurance Coverage, 2017 Figure 42. Birth Trends in Facilities and Vaccination Rates 90.0 90% 80.0 1.3% 80% 70.0 77.7 5.4% 60.0 70% 69.9 18.5% 16.9% 50.0 60% 29.7% Percent 40.0 39.6% 50% 30.0 47.3% 45.2% 62.8% 77.9% 20.0 40% 30.9% 10.0 19.4% 30% 0.0 Overall Poorest 2nd income 3rd income 4th income Richest 20% Population income Quintile Quintile Quintile income 1990 1995 2000 2005 2010 2015 2020 Quintile Quintile PhilHealth Paying Other health insurance Percentage of children who received all 8 basic vaccinations Percentage of births delivered in a health facility PhilHealth Indigent Source: 2017 Demographic and Health Survey Source: Demographic and Health Survey data The impoverishing impact of out-of-pocket health rough proxy for the overall functioning of the health expenditures remains high, pushing vulnerable and system—fell in the same period. The portion of poor households deeper into poverty. The share young children who had received all eight basic of the population that fell into poverty because of vaccinations initially increased from 71.5 percent health spending has doubled over the past decade. in 1993 to 79.5 percent in 2008, before falling to Despite the national health insurance program, 69.9 percent in 2017. Alarmingly, only 9.0 percent households’ out-of-pocket health expenditures of children had received their basic vaccinations in totaled 54 percent of total health expenditures ARMM in 2017. While the country’s low vaccination in 2016. rate is a concern in itself, it also illustrates weaknesses in overall health service delivery. Philippine households also face a triple burden of disease. First, non-communicable diseases Rural health units (RHUs) in poor areas perform contribute increasingly to mortality and morbidity worse than their wealthier counterparts in terms in the Philippines, and the country’s health of service readiness. RHUs in the wealthiest 40 system needs to improve its ability to manage percent of municipalities have better quality chronic diseases. Second, communicable, infrastructure, more basic equipment, and higher maternal, neonatal, and nutritional diseases remain diagnostic capacity than units in municipalities in a challenge for the health system. Finally, increasing the poorest quintile. In particular, RHUs in BARMM levels of urbanization have forced the government lack key inputs to effectively deliver services, to focus on diseases associated with highly including essential medicines.92 Policymakers need urbanized communities. to improve access to health units and the quality of care, especially in poor rural areas. Concurrently, the Leveraging expanded access to improve the quality broader health sector requires reform to increase of service delivery is a core challenge. The number efficiency and sustainability of health financing, of Filipino children born in health facilities more and the integration of service delivery to provide than doubled in the last two decades, from 28.3 continuity of patient-centered care. Implementation percent in 1993 to 77.7 percent in 2017, mainly as a of the ambitious new Universal Health Coverage result of the massive expansion of health insurance Law provides an opportunity for the government to coverage (Figure 42). However, vaccination rates—a address these various challenges. 92 Morimoto, T. et al., Supply-Side Readiness of Primary Health Care in the Philippines, 2017 and Morimoto, T. et al. “Supply-Side Readiness of Primary Health Care in ARMM” (forthcoming) A forthcoming study conducted in ARMM in 2017 that compared the same indicators as the earlier national survey show that ARMM scored lowest among the regions in seven out of eight tracer conditions. PART 02 OUTLOOK AND RISKS 59 Box 8. Tools for Boosting Human Capital: The Pantawid Pamilyang Pilipino Program The national conditional cash-transfer program Pantawid Pamilyang Pilipino has played a key role in increasing human capital of children and reducing the extent and incidence of poverty in the Philippines. The cash- transfer program expanded rapidly in 2007–15, increasing its coverage from 6,000 households in 2007 to 4.4 million in 2015, and has become the primary government social assistance program for the poor. It extends cash grants to 77 percent of the country’s poor households and contributes both to reducing poverty and building human capital. Its budget accounted for 0.5 percent of GDP in 2018. The Pantawid Pamilyang Pilipino Program has raised school enrollment rates for older children, encouraged early childhood education, and increased the health-seeking behavior of beneficiaries. Studies show that gross enrollment rates for high school students from beneficiary households is 6 percent higher than those for students from non-beneficiary households, and the program has contributed to reducing severe stunting among beneficiary children by up to 10 percentage points. Beneficiaries of the cash-transfer program are selected using the National Household Targeting System for Poverty Reduction, or Listahanan, which uses a proxy means test methodology to estimate a household’s level of economic welfare based on socioeconomic and demographic indicators. Aside for the Pantawid Pamilyang Pilipino Program, Listahanan has been used extensively to identify poor and near-poor beneficiaries of PhilHealth and other social programs. The Department of Social Welfare and Development is scheduled to update its database in 2019, which will be important to ensure that Listahanan is able to effectively target households and contribute to an improvement in the delivery of social services and the efficient allocation of human capital investments. Source: Department of Social Welfare and Development and World Bank 2014. 60 PHILIPPINES ECONOMIC UPDATE SAFEGUARDING STABILITY, INVESTING IN THE FILIPINO KEY POLICY LEVERS FOR HUMAN CAPITAL There are a large number of initiatives in the A necessary but not sufficient condition for Philippines focused on boosting human capital improving human capital will be to sustain a development. Specific initiatives include the high level of investment in relevant initiatives. Philippines Plan of Action for Nutrition, the new Government human capital spending has increased Philippines Professional Standards for Teachers, the in recent years both as a percentage of total new Universal Health Coverage Law, and ongoing government expenditure (rising from 20.7 percent efforts to improve the Pantawid Pamilyang in 2009 to 29.8 percent in 2017) and as a percentage Pilipino Program. The principal challenge facing of GDP (increasing from 3.4 percent in 2009 to 6.3 policymakers is the effective implementation of percent in 2017) (Figure 44). This improvement these initiatives. If the country were to achieve all reflects the expansion of the Pantawid Pamilyang the human capital-related goals in the PDP, its HCI Pilipino Program, the growth of PhilHealth, and would increase to 0.75 by 2022, which would imply increases in education spending. Nonetheless, a 36 percent increase in the Philippines’ future human capital spending as a percentage of GDP productivity and GDP (Figure 43). remains low compared to most other countries in the region. Figure 43. Reaching PDP targets by 2022 would lead to a significant improvement in productivity and economic growth. HCI 0.75 0.80 0.55 0.60 0.48 0.40 0.20 0.00 2012 2017 2022 Source: World Bank staff analysis. Figure 44. Human capital spending has increased over time, outpacing GDP growth. 29.5% 29.8% As % of total government expenditure 23.1% 20.7% 20.2% 6.3% 5.3% 4.4% As % of GDP 3.4% 3.4% 2000 2005 2010 2015 2017 Note: Human capital expenditures are defined as the total spending across the following sectors: (1) Education, culture and manpower development, (2) Health and (3) Social security, welfare and employment. Source: DBM, PSA. PART 03 THE PROMISE OF HUMAN CAPITAL 61 The Philippines’ performance on the HCI points Information System is underutilized and could be a to three policy priorities to improve the country’s valuable tool for policymakers. Additionally, making human capital. The first is to make learning the timely data more widely accessible to outside central objective of the entire education system. researchers would catalyze work to inform policy. This orientation can motivate implementation of For example, microdata from the National Nutrition the country’s many education initiatives, including Survey could yield insights on how to address the the Philippine Professional Standards for Teachers. country’s nutritional challenges if were made more The second priority is to tackle malnutrition of readily available to a broader audience. The Open women and young children. The extreme level of Data Initiative of the Philippines Statistics Authority child stunting is a drag on the country’s economic has improved access to survey data, but publicly growth potential. Although the government available data from many agencies is outdated. has a Philippines Plan of Action for Nutrition, and awareness about the issue is rising, wide The Philippines economic future will be determined recognition of how critical addressing this issue is by the investments the country makes in its children. to the country’s future is missing. A third priority is Many Filipinos born in 2019 will witness the dawn of leveraging expanded access to improve the quality of the 22nd century, and live and work in a world very health care. Implementation of the Universal Health different from the Philippines of today. 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