Philippines Quarterly Update--September 2010 Report No. [XXXXX]-PH 57423 PHILIPPINES QUARTERLY UPDATE STEPPING UP REFORMS TO SUSTAIN GROWTH September 2010 Poverty Reduction and Economic Management Unit East Asia and Pacific Region Document of the World Bank 1 Philippines Quarterly Update--September 2010 Preface The Philippines Quarterly Update provides an update on key economic developments and policies over the past three months. It also presents findings from recent World Bank work on the Philippines. It places them in a longer-term and global context, and assesses the implications of these developments and other changes in policy for the outlook for the Philippines. Its coverage ranges from the macro-economy to financial markets to indicators of human welfare and development. It is intended for a wide audience, including policy makers, business leaders, financial market participants, and the community of analysts and professionals engaged in the Philippines. The Philippines Quarterly Update is a product of the World Bank's Philippines Poverty Reduction and Economic Management (PREM) team. It was prepared by Eric Le Borgne (Senior Country Economist and task team leader), Sheryll Namingit, and Marianne Juco, under the general guidance of Ulrich Lächler (Lead Economist). Special contributors include Manohar Sharma (WB-EASPR) with Sergio Olivieri (WB-PRMPR) for the analysis of the poverty impact of El Niño, Fabrizio Bresciani (WB-EASPS) for the box on agriculture value chain in Mindanao, and Roy van der Weide (WB-DECPI) for the analysis of financial volatility indicators in the Philippines. Annalyn Sevilla contributed to the special focus on structural reforms introduced in the 2011 budget. Comments from the BSP, NEDA as well as World Bank staff are gratefully acknowledged. The findings, interpretations, and conclusions expressed in this Update are those of World Bank staff and do not necessarily reflect the views of the Executive Board of The World Bank or the governments they represent. For information about the World Bank and its activities in the Philippines, please visit www.worldbank.org/ph. To be included on an email distribution list for this Philippines Quarterly Update series and related publications, please contact Nenette Santero (nsantero@worldbank.org). For questions and comments on the content of this publication, please contact Eric Le Borgne (eleborgne@worldbank.org). Questions from the media can be addressed to David Llorito (dllorito@worldbank.org). 2 Philippines Quarterly Update--September 2010 TABLE OF CONTENTS PREFACE .......................................................................................................................................................................................................... 2 SUMMARY........................................................................................................................................................................................................ 4 RECENT ECONOMIC AND POLICY DEVELOPMENTS .................................................................................................................... 5 OUTPUT AND DEMAND ................................................................................................................................................................................................. 5 EMPLOYMENT AND POVERTY...................................................................................................................................................................................... 6 BALANCE OF PAYMENTS AND EXTERNAL DEBT..................................................................................................................................................... 7 FINANCIAL MARKETS ..................................................................................................................................................................................................... 9 MONETARY POLICY ......................................................................................................................................................................................................10 FISCAL POLICY ...............................................................................................................................................................................................................11 PROSPECTS ................................................................................................................................................................................................... 12 OUTPUT AND DEMAND ...............................................................................................................................................................................................12 EMPLOYMENT AND POVERTY....................................................................................................................................................................................12 BALANCE OF PAYMENTS AND EXTERNAL DEBT...................................................................................................................................................13 MONETARY POLICY ......................................................................................................................................................................................................14 FISCAL POLICY ...............................................................................................................................................................................................................15 SPECIAL FOCUS ........................................................................................................................................................................................... 15 1. THE 2011 NATIONAL GOVERNMENT BUDGET: STRUCTURAL REFORMS AND CONSOLIDATION ........................................................15 2. EMPLOYMENT, POVERTY AND DISTRIBUTIONAL IMPACTS OF EL NIÑO IN THE PHILIPPINES ...........................................................19 3. THE PHILIPPINES DURING THE RECENT INTERNATIONAL FINANCIAL SHOCKS .....................................................................................23 4. CONSTRAINTS TO GROWTH: THE AGRIBUSINESS VALUE CHAIN IN MINDANAO ....................................................................................26 DATA APPENDIX ........................................................................................................................................................................................ 29 SELECTED SPECIAL FOCUS FROM RECENT QUARTERLY UPDATES .................................................................................. 30 SELECTED RECENT WORLD BANK PUBLICATIONS ON THE PHILIPPINES ...................................................................... 31 BOX, FIGURES, AND TABLES BOX 1. SPECIAL PURPOSE FUNDS: A PRIMER AND PROPOSED CHANGES FOR 2011. ..........................................................................................17 FIGURE 1. A V-SHAPED RECOVERY THANKS TO MANUFACTURING .......................................................................................................................... 5 FIGURE 2. INVESTMENTS AND EXPORTS ARE ADDING TO GROWTH AGAIN ........................................................................................................... 5 FIGURE 3. AGRICULTURE STOPPED DESTROYING JOBS BUT EMPLOYMENT IN THE SERVICES SECTOR STALLED ........................................ 6 FIGURE 4. NON- AND UNDER-EMPLOYMENT REMAIN HIGH DESPITE DECREASES IN LABOR FORCE PARTICIPATION................................. 6 FIGURE 5. WIDENING GAP BETWEEN ACTUAL AND POTENTIAL LABOR FORCE .................................................................................................... 7 FIGURE 6. DESPITE A BOOMING ECONOMY, PROGRESS ON FIGHTING POVERTY AND HUNGER REMAIN CHALLENGING ........................... 7 FIGURE 7. THE BALANCE OF PAYMENTS REMAINS FIRMLY IN SURPLUS ................................................................................................................. 8 FIGURE 8. RESERVE ACCUMULATION GROWING BRISKLY AND REACHES RECORD HIGHS .................................................................................. 8 FIGURE 9. A LENGTHENING OF EXTERNAL MATURITIES IS CONTRIBUTING TO A STRONG ST EXTERNAL DEBT COVER .......................... 8 FIGURE 10. REMITTANCES ARE PICKING UP IN DOLLAR TERMS ................................................................................................................................ 8 FIGURE 11. THE PESO IS FIRMING UP AGAINST THE DOLLAR AND SPREADS ARE APPROACHING THEIR HISTORICAL LOWS .................... 9 FIGURE 12. EXPORTS ARE BACK TO THEIR PRE-CRISIS LEVEL AND THE BOOK-TO BILL RATIO BODES WELL GOING FORWARD .............. 9 FIGURE 13. THE PSEI REACHED A HISTORICAL HIGH AS FOREIGN INVESTORS PILED IN .................................................................................. 9 FIGURE 14. THE FLATTENING OF THE YIELD CURVE FROM THE DEEP END CONTINUES ................................................................................... 9 FIGURE 15. THE INFLATION RATE HAS BEEN REMARKABLY STABLE THROUGH 2010 ......................................................................................10 FIGURE 16. CURRENT AND EXPECTED INFLATION REMAIN WELL WITHIN THE BSP'S ANNOUNCED TARGET ...........................................10 FIGURE 17. CONSUMER AND BUSINESS SENTIMENT SURVEY ...................................................................................................................................12 FIGURE 18. AFTER FOUR YEARS OF DETERIORATION, THE STRUCTURAL DEFICIT IS ESTIMATED TO SHRINK IN 2011 ...........................16 FIGURE 19. THE IMPROVING STRUCTURAL FISCAL BALANCE RESULTS FROM BOTH THE REVENUE AND SPENDING SIDES ....................16 FIGURE 18. HIGHLY DISCRETIONARY SPECIAL PURPOSE FUNDS, 2003-11 .........................................................................................................17 FIGURE 19. TRACKING THE MONEY: KEY RE-ALLOCATION IN THE 2011 BUDGET ...........................................................................................19 FIGURE 22. EL NIÑO AND AGRICULTURE CONTRIBUTION TO GDP GROWTH AND EMPLOYMENT .............................................................20 FIGURE 23. AGRICULTURAL OUTPUT IN H1 2010 AND THE EL NIÑO PHENOMENON .......................................................................................21 FIGURE 24. ESTIMATED EMPLOYMENT AND INCOME IMPACT OF EL NIÑO ........................................................................................................21 FIGURE 25. GROWTH INCIDENCE CURVES (WITH VERSUS WITHOUT EL NIÑO, 2010) .....................................................................................22 FIGURE 26. GROWTH INCIDENCE CURVES (WITH VERSUS WITHOUT EL NIÑO, 2010) .....................................................................................23 FIGURE 27. EQUITY MARKET INDICES IN CHINA, THE PHILIPPINES, AND THE US ...........................................................................................24 FIGURE 28. TIME-VARYING VOLATILITY OF WEEKLY EQUITY MARKET RETURNS ............................................................................................24 FIGURE 29. TIME-VARYING CORRELATIONS BETWEEN WEEKLY PHILIPPINE EQUITY RETURNS AND OTHER MARKETS ........................25 FIGURE 30. DAILY SOVEREIGN CDS SPREADS ..............................................................................................................................................................25 FIGURE 31. CORRELATIONS BETWEEN RETURNS ON PHILIPPINE CDS AND THOSE ON CHINA, INDONESIA, GREECE, & PORTUGAL ..26 TABLE 1. INVESTOR CONFIDENCE ON THE PHILIPPINES HAS MARKEDLY RISEN IN THE SECOND QUARTER ...............................................12 TABLE 2. EL NIÑO'S IMPACT ON POVERTY AND INEQUALITY ..................................................................................................................................22 TABLE 3. PHILIPPINES: SELECTED ECONOMIC INDICATORS, 2008-12 ...................................................................................................................29 TABLE 4. PHILIPPINES: NATIONAL GOVERNMENT CASH ACCOUNTS (GFS BASIS), 2008-11 ...........................................................................29 3 Philippines Quarterly Update--September 2010 SUMMARY The economy recovered strongly from the global recession owing to a combination of transitory and permanent, as well as global and idiosyncratic factors. Similar to its regional peers, the recovery was partly driven by the rebound in global trade and domestic consumption linked to sharp increases in consumer confidence. In the Philippines, growth was also spurred by two domestic and temporary factors--continued fiscal policy easing and election-related spending--and a structural one, namely the acceleration in global outsourcing which benefited the country's Business Process Outsourcing sector and associated sectors such as construction. The global recession has revealed the extent to which the Philippines' macro-financial resiliency has improved thanks to a remarkably robust external position (Special Focus #3). At the onset of the global financial crisis, the Philippines was considered a high volatility country. Thanks to sound initial macro-fundamentals--especially the banking system, corporate sector, balance of payments, and fiscal and monetary policy space--coupled with large counter- cyclical remittance inflows, the country is now exhibiting notable decreases in volatility in financial indicators such as its stock market index and its sovereign credit spreads. As the country was rocked by diverse supply and demand shocks, the robustness of the balance of payments asserted itself as shown by a continued current account surplus and rapidly growing foreign exchange reserves that provide solid coverage of imports and short-term external liabilities. The economy is projected to grow by 6.2 percent in 2010 and by 5 percent in 2011, with large but broadly balanced risks. While inflation expectations are under control, the prospects of large short-term capital inflows partly linked to renewed quantitative easing by key G7 central banks are complicating monetary policy at a time when the economy no longer needs accommodative monetary policy. The focus of the incoming government on spending efficiency slowed down spending noticeably in Q3 thereby helping to keep the 2010 fiscal deficit within target. Despite the surging economy, tax buoyancy has been weak as revenue-eroding measures continue to be implemented. While the economy is creating wealth at a rapid pace, generating inclusive growth and reducing poverty remain major challenges. The labor market is recovering but structural weaknesses remain, including high levels of informality, while poverty and hunger incidence are not declining noticeably. Indeed, while in most countries rapid and sustained economic growth is associated with reduction in poverty incidence, this has not been the case in the Philippines in recent years. High and growing income inequality, an unequal sectoral and regional distribution of growth, and barriers to factor mobility across sectors and regions structurally explain this disappointing poverty-growth elasticity. External shocks such as the El Niño phenomenon have further hindered progress in tackling poverty (Special Focus #2). Tackling the above structural impediments would help ensure that the benefits from growth are widely shared. The first (proposed) budget of the Aquino government could be a turning point for the Philippines in the public finance area (Special Focus #1). The 2011 budget changes current dynamics in two critical areas: the (structural and cyclical) fiscal policy stance and the quality of public finances. This "reform budget" renews the fiscal consolidation effort--albeit modestly-- and contains significant reform measures aimed at improving spending efficiency, transparency and accountability of the budget. For the 2011 budget to indeed turn the country away from a weak fiscal position, inconsistent spending efficiency, and significant gaps in public expenditure and financial accountability, efforts initiated in this budget will have to both be sustained over time and expanded. Strengthening revenue mobilization--through a modern tax system with efficiency and equity at its core--would enable future budgets to scale up spending needed to generate inclusive growth. 4 Philippines Quarterly Update--September 2010 Recent Economic and Policy Developments Output and Demand 1. The Philippine economy grew vigorously in the first half of 2010 thanks to the rebound in global trade, increased investor and consumer confidence, and temporary domestic stimulus policies. Strong growth in the first quarter, which was further revised upwards by 0.5 percentage points to 7.8 percent, was sustained at 7.9 percent in the second quarter. Notwithstanding the negative impact of the El Niño phenomenon on agriculture, the country's performance is broadly comparable with overall growth in the East Asian region. The regional recovery continued to be driven by increased global trade and renewed investor and consumer confidence. Pro-cyclical fiscal policy and election-related spending also contributed to higher domestic growth; remittances continued to boost domestic private consumption. 2. Industrial production, and especially manufacturing and construction, fuelled the recovery (Figure 3). In the second quarter, manufacturing accounted for one third of overall second quarter GDP growth thanks to continued recovery of export; construction grew by 23 percent and ranked second to manufacturing in terms of its contribution to overall GDP growth. Notwithstanding the construction ban prior to the May general election, public construction grew by a robust 29 percent. Private construction also buoyed growth as it benefitted from the stellar growth and prospects of the Business Process Outsourcing (BPO) sector. The services sector's contribution to growth also improved, in part due to election-related spending in trade and private services. On the downside, agricultural production continued its decline as the El Niño phenomenon severely impacted field irrigation. Figure 1. A V-shaped recovery thanks to Figure 2. Investments and exports are adding to manufacturing growth again YoY GDP Growth (Supply side) Contribution to YoY GDP growth 24 20 percentage pt / percent Agriculture Industry 15 20 Services GDP Growth 10 16 Manufacturing 5 12 0 percent 8 5 4 10 0 15 4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 8 12 2006 2007 2008 2009 2010 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Discrepancy Net Exports 2006 2007 2008 2009 2010 Investment Govt Cons Private Consumption GDP growth Source: National Statistical Coordination Board (NSCB) Source: National Statistical Coordination Board(NCSB) 3. On the demand side, private consumption firmed up while exports and investment became net contributors to growth, partly due to a strong base effect. Exports of goods and services continued to hold up well thanks to the recovery of the global electronics market as well as the strength of the BPO. After seven consecutive 5 Philippines Quarterly Update--September 2010 quarters of negative contribution to growth, net exports' contribution turned positive in the second quarter. Similar to other countries in the region, domestic demand continued to support overall economic growth. However, in contrast to other countries in the region, investment in fixed capital has grown strongly. Investment in fixed capital grew 25.5 percent year on year driven by the growth in construction--to a large extent BPO- related--and durable equipment. Private consumption continued to accelerate with improving consumer confidence and stimulus coming from election-spending. Employment and Poverty 4. The labor market is slowly recovering from the worst of the global recession's impact. The unemployment rate fell to 6.9 percent in July compared to 7.6 percent a year before as the economy create 800,000 new jobs, mostly from the agriculture--400,000 new jobs but this reflects a strong based effect after four quarters of employment losses--and trade sectors, especially retail and wholesale trade (Figure 3). Underemployment also declined in July despite the termination of temporary jobs created as part of the election campaign. One important factor behind the firming up of the labor market is the notable decrease in the labor force participation rate (Figure 4). 5. Structural weaknesses of the labor market remain, including high informality. The share of formal employment--proxied as the share of workers receiving wages and salaries--decreased from 55.3 this July against 53.2 percent the previous July resulting in 1.1 million new self-employed and unpaid family workers. The share of full time employment also decreased (Figure 5). 6. Despite a booming economy, progress in fighting poverty and hunger remains erratic. Self-rated poverty rose in June while self-rated hunger incidence remained at record high levels, according to a Social Weather Station survey (Figure 6). The June results tend to indicate that the February dip in poverty likely reflected election-related spending geared towards low-skilled workers; the overall trend shows limited headway in tackling poverty and hunger. Simulation analysis also reveals that the El Niño phenomenon negatively impacted poverty (See Special Focus on page 19 for details). Figure 3. Agriculture stopped destroying jobs but Figure 4. Non- and under-employment remain employment in the services sector stalled high despite decreases in labor force participation LFPR, non and underemployment, Net Job Creation 64.6 3Q Moving Average 23.5 Service Agri 1.6 Manuf Nonmanuf Industry 64.4 21.5 Total 64.2 19.5 1.1 64.0 17.5 in percent 63.8 in percent 15.5 63.6 million 0.6 13.5 63.4 Labor Force Participation Rate (LHS) 11.5 63.2 0.1 Unemployment Rate (RHS) 63.0 9.5 Underemployment rate (RHS) 62.8 7.5 (0.4) 62.6 5.5 ... ... ... Apr Apr Apr Jan 08 Jan 09 Jan 10 Jul 07 Jul 08 Oct 07 Oct 08 Oct 09 Jul 09 Jul 10 Source: National Statistics Office (NSO). Source: National Statistics Office (NSO). 6 Philippines Quarterly Update--September 2010 Figure 5. Widening gap between actual and Figure 6. Despite a booming economy, progress on potential labor force fighting poverty and hunger remain challenging Labor Force Survey (July Sweeps) Poverty and Hunger Incidence 60 30 2,100 68.0 25 55 1,600 66.0 20 percent percent thousands percent 1,100 50 15 64.0 10 600 45 62.0 5 100 40 0 (400) 60.0 Oct06 Oct07 Oct08 Oct09 Feb07 Feb08 Feb09 Feb10 Jun06 Jun07 Jun08 Jun09 Jun10 2006 2007 2008 2009 2010 Change in potential labor force (pop 15 years and over) Change in actual labor force Selfrated Poverty (LHS) Hunger: Overall Job Creation Hunger: Moderate Hunger: Severe Share of full time jobs (RHS) Source: Source: National Statistics Office (NSO). Source: Social Weather Station (SWS). Balance of Payments and External Debt 7. The country is emerging from the global recession with a remarkably robust external position, in part due to resilient remittance inflows. The current account surplus increased to 5.6 percent GDP in the second quarter from 4.4 percent in the first quarter, thanks to strong remittance inflows, surging BPO sector earnings and lower income payments by residents to direct investors abroad (Figure 7).1 Gross international reserves reached a record high of USD49.6 billion in August, covering more than nine months of imports while the forward book of the BSP also reached a record high, at USD19.5 billion (Figure 8). 2 External debt remained broadly flat at 41 percent of GDP (USD53.9 billion) but the share of long-term debt increased noticeably during the crisis, rising to 90.4 percent at end-June 2010 (Figure 9). Combined with rapid economic growth and quantitative easing in many advanced economies, this led to an acceleration of the strengthening of the peso against the dollar (Figure 11) as well as on a trade-weighted basis. As detailed in our Special Focus on page 23, the global financial crisis and recession have revealed the extent to which the Philippines macro- financial resiliency has improved. 8. The trade deficit is narrowing as exports are growing briskly (Figure 12). The trade deficit stood at USD346 million in the second quarter. Imports grew by a robust 26 percent to USD14.6 billion, led by mineral fuels, capital goods and consumer good. The hike in global prices of petroleum crude contributed to the increase in mineral fuel imports, while the growth in capital and consumer goods was brought about by increased purchases of land transport equipment, passenger cars and motorbikes (some related to the need to replace vehicles destroyed during typhoons Ondoy and Pepeng in late 2009). Merchandise exports, predominantly driven by a 1 On the financial side, net portfolio investments contracted by 2.4 percent of GDP as concerns over the European debt crisis fueled the withdrawal of investment in the second quarter. Foreign direct investment was subdued as investors took a wait-and-see attitude during the election period. 2 Net international reserves, for the second quarter, covered 4.8 times the country's short-term external liabilities by residual maturity. 7 Philippines Quarterly Update--September 2010 resurgent electronics and semiconductor sector, surged by 34 percent to USD12.2 billion thanks to robust regional trade and a recovery in demand from the U.S. Figure 7. The balance of payments remains firmly in Figure 8. Reserve accumulation growing briskly surplus and reaches record highs Balance of Payments Foreign Currency Liquidity 6 70000 4 60000 NIR Forward Book 2 50000 mln US$ in mln US$ 0 40000 30000 2 Others 20000 Financial Account 4 Current Account 10000 6 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2006 2007 2008 2009 2010 2007 2008 2009 2010 Source: Bangko Sentral ng Pilipinas (BSP). Source: Bangko Sentral ng Pilipinas (BSP). Figure 9. A lengthening of external maturities is Figure 10. Remittances are picking up in dollar contributing to a strong ST external debt cover terms External Debt Remittance Growth, 3 mma 59 600 50 57 Nominal USD Nominal Php 500 40 55 Real Php 53 400 30 51 300 in percent 20 bln US$ 49 200 47 100 10 45 43 0 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 10 2006 2007 2008 2009 2010 20 Feb06 Apr06 Aug06 Feb07 Apr07 Aug07 Feb08 Apr08 Aug08 Feb09 Apr09 Aug09 Feb10 Apr10 Aug10 Jun06 Jun07 Jun08 Jun09 Jun10 Oct06 Oct07 Oct08 Oct09 Dec06 Dec07 Dec08 Dec09 LongTerm ShortTerm GIR, ST External Debt Cover (rhs) Source: Bangko Sentral ng Pilipinas (BSP). Source: Bangko Sentral ng Pilipinas (BSP). 9. Dollar remittance inflows are firming up again thanks to robust OFW deployment (Figure 10). Remittance inflows in nominal dollar terms have increased by 7.1 percent year-on-year in the year through July; this compares with growth of 3.8 percent in the same period in 2009. Strong deployments of OFWs during 2009 partly explain this growth.3 Remittance growth in real peso terms, however, paint a different picture: while the real peso value of remittances grew by a robust 12.4 percent in 2009 during the global recession--thereby acting as a strong counter-cyclical force for the economy--these flows have contracted by 1.6 percent through July due to the strengthening of the Peso and a moderate increase in inflation. The counter-cyclical pattern of remittances to the Philippines was also present during the 2007 economic boom. 3 See Box 2 of our June 2010 Philippines Quarterly Update for details on Philippines migration patterns during the global recession. 8 Philippines Quarterly Update--September 2010 Figure 11. The Peso is firming up against the dollar Figure 12. Exports are back to their pre-crisis level and spreads are approaching their historical lows and the book-to bill ratio bodes well going forward Sovereign Debt Spread and Foreign Exchange Rate Balance of Trade (3 mma) and BooktoBill 600 90 1.6 7000 Exports (lhs) Imports (lhs) 1.4 500 80 Trade Balance (lhs) BooktoBill (rhs) 1.2 400 70 5000 in bln US$ basis points 1 300 60 3000 0.8 200 50 0.6 1000 PHL EMBI (lhs) 100 40 0.4 Foreign Exchange Rate (PhP/USD) (rhs) REER Index (1980=100) (rhs) 30 1000 0.2 0 Jan07 Jan08 Jan09 Jan10 Jul07 Sep07 Nov07 Jul08 Sep08 Nov08 Jul09 Sep09 Nov09 Jul10 May07 May08 May09 May10 Mar07 Mar08 Mar09 Mar10 Oct08 Dec08 Oct09 Dec09 Aug08 Apr09 Aug09 Apr10 Aug10 Feb09 Feb10 Jun08 Jun09 Jun10 Source: Bangko Sentral ng Pilipinas (BSP) Source: Bangko Sentral ng Pilipinas (BSP) Financial Markets 10. Financial markets surged to record highs thanks to strong foreign investor interest in Asian emerging markets and improving domestic fundamentals. The Philippine stock exchange index hit a historical high of 4,000 in mid-September (Figure 13). This was fueled by strong investor confidence, including from foreign investors chasing economic growth differentials with developed economies.4 Other confidence factors include favorable growth prospects, stable interest rates, strong earnings, and a resolution of political uncertainty. Investors also showed strong appetite for fixed income (the first issue of USD1 billion-equivalent in global peso bond was 13 times oversubscribed). Sovereign spreads narrowed sharply.5 In the domestic market, the long end of the domestic yield curve tilted downwards (Figure 14). The government took advantage of these favorable conditions to reduce the risk profile of its debt stock by lengthening its debt maturity and improving its domestic-foreign composition. Figure 13. The PSEi reached a historical high as Figure 14. The flattening of the yield curve from foreign investors piled in the deep end continues Philippine Stock Exchange Yield Curve (Treasury Reference Rates) 4500 12.0 45000 Stocks: Net Foreign Buy (lhs) PSEi Composite Index (rhs) 4000 35000 10.0 3500 25000 3000 8.0 in mln US$ in percent 2500 points 15000 2000 6.0 5000 1500 5000 4.0 1000 Jul08 Feb09 15000 500 2.0 Aug09 Mar10 25000 0 Aug10 0.0 Jul08 Jul09 Jul10 May08 May09 May10 Nov07 Nov08 Nov09 Jan08 Sep08 Jan09 Sep09 Jan10 Sep10 Mar08 Mar09 Mar10 1M 3M 6M 1Y 2Y 3Y 4Y 5Y 7Y 10Y 20Y 25Y Source: CEIC. Source: Bangko Sentral ng Pilipinas (BSP) 4Cumulative net foreign buying for the year reached P29.5 billion through September, exceeding the P19 billion posted for the full year of 2009. 5 From 260 basis points in June due to concerns regarding sovereign credit in some European countries to 168 bps points in August, or within 30 bps of the countries record low of May 2007 (Figure 11). 9 Philippines Quarterly Update--September 2010 Monetary Policy 11. Current and expected headline inflation remains well within the BSP's target zone (Figure 16). The year-on-year headline inflation rate has remained broadly unchanged since December 2009 before dipping slightly to 3.5 percent in September as utility and food prices eased (Figure 15). Core inflation also moderated slightly, reaching 3.8 percent in September. Through 2010, inflation peaked at a low 4.4 percent in April due to pressures arising from electricity price increases linked to production stoppages in some power plants. Utility prices have moderated slightly since then due to lower generation costs and peso appreciation; transportation fares also declined alongside oil prices. As food prices are the largest contributor to the CPI basket, high global food commodity prices remain an upside risk to inflation. 12. Amidst a continuing accommodative monetary stance in the Philippines, strong capital inflows are further complicating monetary policy. With the BSP's key policy rates unchanged since December 2008, historically low real interest rates, and a rapidly closing output gap, monetary policy continues to remain accommodative in 2010.6 As a result, bank lending has been accelerating, growing at an annual rate of 9.8 percent in August; lending to both production activities and to households (especially car loans) expanded briskly. The rapid increase in foreign portfolio inflows that took place in September helped strengthen the peso, push the PSEi to record highs, and fixed income yields down towards historical lows. A stronger peso helps contain imported inflation but short term capital inflows, unless adequately managed, could generate risks for the economy, including asset price inflation or "sudden stops". Figure 15. The inflation rate has been remarkably Figure 16. Current and expected inflation remain stable through 2010 well within the BSP's announced target Contribution to YoY Inflation Rate Monetary Policy 14 7.0 Inflation Target Forecast 5.0 Band 10 percent 3.0 percentage pointts 6 1.0 1.0 2 3.0 Jan Jan May May Jun Jun Jul Jul Dec Mar Mar Feb Sep Feb Sep Nov 2010 2011 Oct Apr Apr Aug Aug 2 Fuel Others Food Inflation Rate Core Inflation 2009 2010 Full 6 Year Sep07 Nov07 Sep08 Nov08 Sep09 Nov09 Sep10 May08 May09 May10 Mar08 Mar09 Mar10 Jan08 Jan09 Jan10 Jul08 Jul09 Jul10 Core Inflation Headline Inflation RRP Discount Rate Real Interest Rate Source: Bangko Sentral ng Pilipinas (BSP). Source: Bangko Sentral ng Pilipinas (BSP). 6 Though, relative to some countries in the region, changes in monetary policies during the crisis were less drastic given the resiliency of the economy. In January 2010 the BSP withdrew some of the liquidity enhancing measures it introduced during the global recession--i.e., it increased and realigned the rediscounting facility rate to the overnight RRP rate--but these measures only constitute a small part of the monetary policy easing undertaken (for details on this, see paragraph 17 of our February 2010 Philippines Quarterly Update.) 10 Philippines Quarterly Update--September 2010 Fiscal Policy 13. The new Aquino government's focus on spending efficiency slowed down spending noticeably thereby returning the 2010 fiscal deficit within budget target (Table 4). During the first half of 2010, fiscal policy was strongly pro-cyclical. The primary fiscal deficit (i.e., excluding interest payments) grew by 0.5 percent of GDP. Over two thirds of this was driven by increases in primary spending--especially wages and capital spending--while one third came from weaknesses in both tax and non-tax revenue. As the Department of Budget and Management implemented a (prioritized) Zero-Based Budgeting approach to prepare the 2011 budget, the rationale and alignment of some ongoing 2010 spending items with the new government's priority came into light and led to a review of such spending items.7 As a result, primary spending during the two months of July and August 2010 against the same 2009 period, slowed down by 0.4 percent of GDP. While tax and non-tax efforts were unchanged from 2009, these still produced a notable turn in the projected 2010 deficit, which we now project to be in line with the revised budget target. 14. Despite the surging economy, tax buoyancy has been weak as revenue- eroding measures continue to be implemented (Table 4). In the year through August, the tax effort remained unchanged from the similar period in 2009 at 8.5 percent of annual GDP. After a substantial reduction in tax collection in 2009 stemming from large and permanent tax cuts, additional revenue-eroding measures are due to be implemented this year and the full year impact of some 2009 tax cuts carries into 2010. New tax measures to be implemented in 2010 include the Personal Equity and Retirement Account (PERA) law, the ASEAN Trade in Goods Agreement (ATIGA) and tourism incentives.8 The new administration's focus on improving tax compliance to raise revenue has led to a strong emphasis on improving BIR and BOC efficiency. Several noteworthy programs have also been reinvigorated, including the Run After Tax Evaders (RATE) program and improved cooperation and coordination with the Department of Justice are expected to improve compliance. International evidence shows that, with a few exceptions, revenue gains stemming from such administrative measures accrue slowly over time. 15. Appetite to finance the deficit remains strong so that financing terms are favorable, both domestically and externally. Ample domestic liquidity and strong appetite for Asian emerging market equity and fixed income assets have pushed yield close to historical lows. In September, the government was able to raise additional $1 billion worth of Peso-denominated (the first in Asia) global bonds following its successful issuance of global and Samurai bonds early this year. The National Government debt increased to 53.9 percent of (projected 2010) GDP in June. 7These included capital spending where disbursements were put on hold for some infrastructure projects pending a review of their supply contracts. 8 Significant uncertainty surrounds the revenue loss of implementing these measures for 2010 and the implementation parameters are still not decided. 11 Philippines Quarterly Update--September 2010 PROSPECTS Output and Demand 16. The strong rebound in the first half warrant a full year 2010 growth of not less than 6 percent, even with modest growth in the next two quarters. After a robust 7.9 percent in the first half of 2010, growth is expected to slow down as the recovery in trade is maturing and the stimuli from election related spending and pro- cyclical fiscal policy fade away. Real GDP is projected to expand by a robust 6.2 percent in 2010 and to grow broadly in line with potential GDP in 2011, with 5 percent growth in part due to a tightening of monetary and fiscal policy stances through a progressive unwinding of the stimulus measures introduced during the global recession (Table 3). 17. Consumption and investment are projected to continue buoying domestic demand. With notable improvements in both consumer and investor sentiments in the Philippines, robust deployment of overseas Filipino workers and remittance inflows, private consumption is projected to accelerate slightly (Figure 17 and Table 1). Sentiment is also improving thanks to the strong focus of the new administration on tackling corruption and improving the investment climate.9 Total investment is therefore projected to grow by double digit, paving the way for a recovery in the investment-to-GDP ratio that deteriorated to record lows during the global recession. While the Aquino administration is kick starting a new wave of Public-Private Partnerships (PPP) projects so as to fill some important gaps in public infrastructure, given the long preparation cycle inherent in such projects, only a few projects are projected to physically start until the latter part of 2011. The direct impact on growth of the PPP agenda would therefore mostly materialize from 2012 onwards. Figure 17. Consumer and business sentiment Table 1. Investor confidence on the Philippines has survey markedly risen in the second quarter Index of Confidence Outlook ING Investor Dashboard Sentiment Index 80 60 40 percent 20 0 20 40 60 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2007 2008 2009 2010 Business: Current Quarter Business: next Quarter Consumer: Current Quarter Consumer: Next Quarter Consumer: Next 12 Mos. Source: Bangko Sentral ng Pilipinas (BSP) Source: ING 18. Downside risks to growth for the remainder of 2010 include continued weather-related shocks, and a rapid appreciation of the peso. The agriculture sector, already impacted by weather-related damages and losses since the fourth quarter 9 Based on indicators like the ING Investor Dashboard Sentiment Index 12 Philippines Quarterly Update--September 2010 of 2009--i.e., typhoons Ondoy and Pepeng, and the El Niño phenomenon--remains vulnerable from the projected La Niña phenomenon although no heavy rains were so far seen up to September. A rapid appreciation of the peso due to robust short-term capital inflows would negatively impact the competitiveness of labor-intensive and low margins exporters, including in the furniture and agriculture sector (see Special Focus #4); it would also dampen the real peso value of remittances and therefore dampen consumption ahead of the important Christmas season. Employment and Poverty 19. While the economy is creating wealth at a rapid pace, generating inclusive growth and reducing poverty remain major challenges given the disappointing poverty-growth elasticity. While in most countries, rapid and sustained economic growth is associated with notable reduction in poverty incidence, this has not been the case in the Philippines from 2000 to 2006. A recent World Bank study10 found that high and growing income inequality, unequal sectoral and regional distribution of growth, and barriers to factor mobility across sectors and region--reflecting inadequate access to social services and social protection--structurally explain the poor progress on reducing poverty. In addition, the series of large external and domestic shocks--the global food crisis, Ondoy and Pepeng, and the El Niño phenomenon--have further negatively impacted progress in tackling poverty (see the Special Focus #2 on the poverty and distributional impact of El Niño for details). Tackling the above structural impediments would help ensure the benefits from growth are widely shared. Balance of Payments and External Debt 20. The balance of payments is projected to remain robust. The current account surplus is projected to reach 3.9 percent of GDP in 2010, with continued gains from increasing remittances and the sharp rebound in exports. The low import and export bases and rapid global trade recovery are resulting in solid double-digit growth in both exports and imports for 2010 but these are projected to gradually stabilize to 7 percent and 8.3 percent, respectively for 2011. The resulting trade deficit would remain broadly unchanged at around 5 percent of GDP in both 2010 and 2011. Remittance inflows are projected to grow by 8.0-9.5 percent in dollar terms for 2010-2011, in large part thanks to the projected strong deployment of Filipino workers abroad. With the resolution of political uncertainty and the positive confidence impact of the new administration, foreign direct investment is expected to steadily increase (Table 3). 21. Resiliency is expected to characterize the balance of payments in the near to medium-term, even in the face of external shocks. Balance of payments fundamentals are strong and risk exposure limited: short-term external debt is below 3 percent of GDP and imports or short-term debt reserve cover is strong. External debt (World Bank definition) is projected to decline to 38.5 percent of GDP in 2010 and to 37.7 percent of GDP in 2011. Remittances have proved to be a significant and effective buffer against domestic (e.g., natural disasters) or external (e.g., food and fuel crisis, 10 See World Bank (2010), Philippines: Towards Inclusive Growth, Manila and Washington DC. 13 Philippines Quarterly Update--September 2010 global recession) shocks and, with continued strong deployments, especially for sea- farers given the strong demand fundamentals, they are expected to continue doing so. Monetary Policy 22. The new round of quantitative easing from influential central banks complicates monetary policy making in the Philippines. Experience during the global recession showed that the monetary transmission mechanism of global imbalances to Asian countries was large. In particular, Choi and Lee (2010) find evidence of a significant pass-through of the global monetary gap to domestic monetary gap, which in turn affect output growth and inflation in emerging market countries in Asia.11 Based on this recent experience, the renewed round of quantitative easing from both the US Federal Reserve and the Bank of Japan is expected to transmit to countries such as the Philippines. As the country is rapidly closing its output gap and would therefore be looking to gradually unwind its expansionary monetary policy stance, large capital inflows and their impacts on the exchange rate and domestic asset prices would complicate monetary policy, not least because higher interest rates (or their expectation) could be counter-productive in that it could fuel further capital inflows. 23. The BSP has stated its readiness to implement prudential measures to deal with the effects of capital surges on domestic liquidity and asset price inflation. While the central bank considers the economy in a sweet spot given the high economic growth and low inflation, based on its past reaction function--as well as some of its statements--if necessary and warranted it will likely consider allowing the peso to appreciate to address the liquidity impact of disrupting short-term capital flows. 24. Inflation is projected to remain within the BSP target range but risks are on the upside. BSP surveys reveal that inflation expectations are well anchored.12 While global food supply of staple products such as maize and rice have been impacted by a series of diverse natural disasters in 2010 (from draughts to floods), the cuts in production come from historically high 2009 production levels. Stockpiles of rice are also significant in both large exporting and importing countries, including the Philippines. Price pressures on rice are, therefore, not expected in the short-term but upside risk clearly exist. Global food production is expected to recover in 2011, barring renewed large natural disasters. A repeat of the 2008 food (and especially rice) crisis in the Philippines is therefore not in our baseline projection. Average inflation is projected to reach 4.2 percent in 2010 and 4.5 percent in 2011. Risks to inflation are on the upside and linked to both stronger and weaker than expected global recovery; a stronger recovery could put pressure on global food and commodity prices; a weaker recovery due to under-performance from developed economies (e.g., low but positive growth in the US) could generate large capital inflows in the Philippines and feed asset price inflation, such as in the real estate sector, though the associated strengthening peso would also reduce imported inflation. 11Woon Gyu Choi and Il Houng Lee, 2010, "Monetary Transmission of Global Imbalances in Asian Countries", IMF Working Paper No. 10/214, Washington DC. 12 The mean inflation rate forecast from Consensus Economics, Inc is 4.2 percent for 2010 and 4.3 percent for 2011, well within the BSP's target band. 14 Philippines Quarterly Update--September 2010 Fiscal Policy 25. A structurally low tax effort and robust spending are projected to lead to a slight deterioration of the fiscal position for 2010 (Table 4). The new Aquino administration's focus on strengthening tax compliance has been backed by visible and important measures, such as the filing of a number of tax evasion cases. For 2010, due to these tax administration measures, the tax effort is projected to reach 13.0 percent of GDP, an improvement of 0.2 percentage points of GDP compared to 2009. Total spending is projected to remain broadly unchanged at 18.8 percent of GDP thanks to effort undertaken since July to review and rationalize spending. With strong growth, and an appreciating currency, National Government debt is projected to decline to 56.2 percent of GDP in 2010--the first time in three years that the NG debt would decrease. SPECIAL FOCUS 1. The Proposed 2011 National Government Budget: Structural Reforms and Consolidation 26. The first (proposed) budget of the Aquino government could be the turning point the country needs in the public finance area. The 2011 National Expenditure Program (NEP) submitted to congress in late August changes current dynamics in two critical areas: (1) the (structural and cyclical) fiscal policy stance, and (2) the efficiency, transparency and accountability of public finances. Titled as a "reform budget", it renews the fiscal consolidation effort--albeit modestly--and contains significant reforms measures aimed at improving spending efficiency, transparency and accountability of the budget. For the 2011 budget to indeed turn the country away from a weak fiscal position, inconsistent spending efficiency, and significant gaps in public expenditure and financial accountability, efforts initiated in this budget will have to both be sustained over time and expanded. Strengthening revenue mobilization-- through a modern tax system with efficiency and equity at its core--would enable future budgets to scale up spending needed to generate inclusive growth. 27. The 2011 NEP aims toward fiscal consolidation--albeit modestly-- following years of fiscal easing and deteriorating structural fiscal balances (Table 4 page 29 and Figure 18). While total revenue for 2011 is budgeted to remain flat compared to 2010 as a ratio of GDP, total spending is decreasing by 0.7 percentage points of GDP compared with the 2010 revised budget (GFS basis). The deficit therefore narrows to 3.5 percent of GDP. On a structural basis--i.e., after eliminating revenue and spending items that are linked to the economic cycle--the fiscal balance which had consistently deteriorated from 2006 to 2010, is projected to slightly improve thanks to both revenue improvement and spending contraction (Figure 19). The National Government debt would decrease to 55.3 percent in 2011. 15 Philippines Quarterly Update--September 2010 Figure 18. After four years of deterioration, the Figure 19. The improving structural fiscal balance structural deficit is estimated to shrink in 2011 results from both the revenue and spending sides Decomposition Analysis of the Fiscal Balance Components of the Structural Fiscal Balance 2.00 24.0 6.0 1.00 22.0 5.0 % of potential GDP % of potential GDP 0.00 % of potential GDP 20.0 4.0 1.00 18.0 3.0 2.00 16.0 2.0 3.00 14.0 1.0 4.00 12.0 0.0 5.00 Cyclical Deficit 10.0 1.0 Structural Deficit 6.00 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Revenues Expenses Deficit Source: Updated (with new data) WB staff calculation based on the second method presented in Fedelino et.al., 2009, "Computing Cyclically Adjusted Balances and Automatic Stabilizers", IMF, FAD Technical Notes and Manual, Washington DC. See February 2010 Philippines Quarterly Update for a more detailed discussion of structural and cyclical fiscal balances in the Philippines. 28. Revenue is budgeted to remain stable in 2011 as improved tax administration efficiency offsets declines in non-tax collection (measured on a GFS basis). Total revenue is budgeted to remain at 15.5 percent of GDP in 2011, the same ratio as the revised budget for 2010 (Table 4). The tax effort is budgeted to increase by 0.2 percentage points of GDP thanks to strengthened administration. No tax policy measures are budgeted for 2011 so that the tax base will actually be eroded by the implementation of tax-eroding measures previously approved by Congress such as the Personal Equity and Retirement Account (PERA) law and the Real Estate Investment Trust (REIT). Non-tax collection (excluding privatization) is budgeted to decline mostly due to lower interest rates. 29. Expenditure consolidation mostly stems from improved expenditure efficiency, itself the result of the zero-based budgeting (ZBB) approach. ZBB has enabled the Department of Budget and Management (DBM) to rationalize, put on hold, or scale up key programs based on efficiency and equity considerations. Rationalized programs include the Food for School Program--a more efficient version will be administered by the Department of Social Welfare and Development (DSWD) making use of its national targeting system--and the Input Subsidies program which was found to benefit rich instead of poor farmers. Programs whose release of funds has been held up for both 2010 and 2011 are those with weak project implementation ratings or with procurement bottlenecks. These include DepEd's Textbooks, Teacher Deployment and School Building Construction, and TESDA's Training for Work Scholarship programs. Special Purpose Funds, especially the highly discretionary ones, have been materially trimmed down (Box 1). Support to government corporations that did not meet the ZBB criteria was also reduced though measures to stop the underlying losses--mostly but not solely linked to quasi fiscal operations--have yet to be announced and implemented, such as for the NFA.13 13 It is important to note that, since most of the public support for the NFA's loss making operations is outside of the National Government's budget, moving the NFA's quasi fiscal operations (i.e., its rice subsidy program and price support to farmers) towards more efficient programs such as the CCT (which is fully on budget), would not necessarily generate fiscal savings--at least in the short-term--for the 16 Philippines Quarterly Update--September 2010 Box 1. Special Purpose Funds: A Primer and Proposed Changes for 2011. SPFs are lump sum budgetary allocations. Most of the funds allocated to SPFs are automatic payments for items such as debt service, transfers to Local Government Units (Internal Revenue Allotment) and pension benefits for retired public servants. Historically, SPFs also included funds over which the President's Office had a high level of discretion but limited public reporting and accountability obligations (flow-of-funds tracking and their auditing, for example, have proved challenging). As SPFs are lump sum, it is not possible to know what the discretionary funds will be specifically used for and, therefore, whether they will be aligned with overall budget priorities.1/ Through 2010, SPFs' scale has steadily grown, accounting for 57 percent of the total national budget in 2010. The increase in the highly discretionary SPFs is particularly striking, with almost 7 percent of the total national budget falling into this category in 2010--Figure 20.2/ The 2011 proposed budget significantly reduced both the number and overall scope of SPFs, especially the highly discretionary ones that tended to have inconsistent alignment with budget priorities and limited efficiency. The proposed budget cuts the number of SPFs from 21 to 13 and total SPF appropriations by P122 billion (about USD 2.6 billion).3/ P50 billion of the total SPFs cut arises from the termination of unprogrammed fund used to support calamity-related programs and projects. A large share of the reduction in total SPF appropriation was the result of the transfer of several SPFs to the regular budget of their implementing agencies in an effort to increase transparency and accountability. For example, AFP modernization fund and retirement benefits allocation have been shifted to the departments of National Defense and of Interior and Local Government (for police pension) while the subsidy for health insurance premium (PhilHealth) (P3.5 billion) have been transferred to the regular budget of Department of Health.4/ Figure 20. Highly Discretionary Special Purpose Funds, 2003-112/ Source: DBM's GAA, various years; * = re-enacted budget; ** = proposed budget. _____________ 1/ SPF funds, for example, can be used for capital projects that are not part of the Priority Investment Plan; this calls into question their desirability and effectiveness. 2/ Included in this category are: the Area Development Assistance Fund, Calamity Fund, Contingent Fund, National Unification Fund, E- Government Fund, Priority Development Assistance Fund, parts of the Unprogrammed Fund, Economic Stimulus Fund, and the non-IRA Allocation to LGUs. 3/ Highly discretionary SPFs such as the Kalayaan Barangay Program Fund (P1 billion), Kilos Asenso Support Fund (P1 billion), Financial Subsidy to LGUs (P5.7 billion), and General Fund Adjustments (P1 billion) were completely removed of the SPF list. These SPFs were replaced by the Performance-Based Challenge Fund for LGUs (P500 million) under the 2011 regular budget of the DILG. This fund is an incentive fund for LGUs in the form of counterpart funding to high-impact capital investment projects in the Annual Investment Program. It rationalizes intergovernmental transfers to LGUs, and encourages alignment of local development initiatives with national government development agenda and priorities. all SPFs of the National the 2010 budget. A particularly surprising increase is the additional P14 billion increase in the Priority 4/ Not budget were cut compared toGovernment, though it unequivocally generates savings for the non-financial public sector fiscal (PDAF), (which includes, the in the budget that funds the priority development programs and projects of Development Assistance Fund balance a lump-sum appropriationNG and GOCCs, among others). the government, as identified by the legislators. Its transparency and alignment to the budget is often questioned. The increase in the PDAF of both houses of Congress was due to a provision that the funds will be uniformly divided among its members, namely P200 million per senator and P70 million per congressional district and party representative. However, as a counterpart to the increase, the list of eligible spending categories has been tightened and limited to the new administration's priorities. 17 Philippines Quarterly Update--September 2010 30. Titled a "reform budget", the 2011 NEP includes significant reforms in the areas of spending efficiency, transparency and accountability. On the former, the budget submitted to Congress is based on a modified zero-based budgeting approach14 whereby all significant existing spending programs have been reviewed by the DBM and unless their rationale could be demonstrated--e.g., in terms of efficiency, alignment with government priorities, value for money, targeting--they were not renewed; symmetrically, well-performing programs in priority areas were expanded, most notably the conditional cash transfer (CCT/4Ps) program. Concrete and notable measures to increase transparency and accountability include (1) re-allocating highly discretionary funds from Special Purpose Funds (SPFs) to specific spending programs in line ministries or agencies; this results in spending being aligned with budget priorities, more transparent, and accountable (Box 1); and (2) requiring ministries and government agencies to publish on their respective websites the status of project implementation and fund utilization.15 31. The ZBB approach created sufficient fiscal space to permit scaling up priority social spending, using efficient and transparent programs. Budgetary support to government corporations which is dominated by some notoriously inefficient and non transparent programs, was transferred to the DSWD, which runs the Conditional Cash Transfer (CCT) program, among others. Similarly, the education budget was increased by P31 billion to build more classrooms and hire more teachers. Meanwhile, the budget of the Department of Public Works and Highways was reduced by P26 billion--some of which was reallocated to the PDAF. The budget of Department of Agriculture was reduced due to decreased funding for input subsidies while the budget of the Department of Agrarian Reform declined due to the transfer of the Tulay ng Pangulo ("Bridge of the President") program and its fund to the DPWH. Figure 21 tracks key program re-allocations between the 2010 and 2011 budgets. 32. Heightened revenue mobilization is necessary to sustain the spending needed in priority sectors to generate more inclusive growth. The 2011 budget introduces major reforms in public expenditure efficiency and accountability while creating fiscal space for priority spending. Nonetheless, with additional spending needs in priority sectors such as health and education estimated at about 5-7 percent of GDP,16 the fiscal space generated from efficiency improvements will have to be supplemented with more efficient revenue mobilization, including a more efficient and progressive tax structure. Inadequate and insufficient spending in priority sectors 14Application of an extensive ZBB approach was not possible due to time constraints, as the new administration, which assumed office on July 1, 2010, had less than two months to finalize the 2011 NEP. 15More specifically, each department, bureau, office or agency, especially the Constitutional Commissions, including branches of government enjoying fiscal autonomy, have been required to publish on their respective websites their approved budget, performance targets, annual procurement plan, program completion and evaluation and assessment reports. Detailed information such as project status and fund utilization reports of each implementing unit shall also be disclosed. Specific reports and documents particularly contracts awarded with the name of contractors/suppliers/consultants, targeted and actual beneficiaries, and program/project evaluation and/or assessments are also to be included in the on-line posting requirements. The heads of agencies will be responsible in ensuring compliance to this provision and non-compliance will be made the basis for DBM to discontinue the release of the fund. 16 World Bank, 2010, Philippines Public Expenditure Review, forthcoming. 18 Philippines Quarterly Update--September 2010 contributes to the challenge in generating inclusive growth. While more effective tax and customs administrations can undoubtedly boost tax compliance and the overall tax effort, a more modern tax structure should be designed so as to complement BIR and BOC reforms, reduce tax compliance costs--thereby improving the investment climate--improve the progressivity of the tax system (both vertical and horizontal), as well as the tax effort. (Our previous Philippines Quarterly Updates detail some the tax measures that would move the Philippines towards this objective.) Figure 21. Tracking the Money: Key Re-allocation in the 2011 NEP Top Departmental Budget Increases/Decreases 1/ Top Increase/Decreases in Special Purpose Funds* DND PDAF 129% DEPED DILG Calamity Fund 150% DSWD Int'l Commitments Fund 100% DOTC DOH Misc. Personnel Benefits Fund 3% Others 2/ AFP Modernization Program 100% Congress DFA Budgetary Support to Govt Corps. 66% NEDA Allocations to LGUs 59% DA DAR Retirement Benefits Fund 56% COMELEC Unprogrammed Fund 15% DPWH 75 60 45 30 15 0 15 30 30 20 10 0 10 20 30 40 50 billion, Php billion, Php Source: DBM; *From 2010 GAA**Other executive offices. 1/ Other automatic appropriations (excluding interest payments and Internal Revenue Allocation (IRA); 2/ Interest payments; 3/Budget of Departments. 2. Employment, Poverty and Distributional Impacts of El Niño in the Philippines: Results from a Micro-Simulation Exercise 33. The 2010 El Niño phenomenon was less intense than the 1998 one. It is nonetheless expected to lead to a large reduction in agricultural output and to subtract 0.9 percentage points to 2010 real GDP growth. Using a micro-simulation model, we find that El Niño will result in (1) a 0.9 percent reduction in total household income in 2010 mainly due to a combination of lower employment levels and individual earnings; (2) moderate increases in poverty incidence and poverty gap (0.4 and 0.2 percentage points increases, respectively); and (3) no significant impacts on the indices of overall inequality--though income losses are larger at the bottom of the income distribution--and a similar impact for urban and rural areas at the bottom half of the distribution. 34. The last time the Philippines was severly hit by El Niño was in 1998. Since then, agriculture's contribution to GDP growth been positive in the Philippines, expect for 2010 (Figure 22); although the Ondoy and Pepeng typhoons of September and October 2009 depressed agriculture's contribution to growth to zero fin that year.17 Similar to the 2010 El Niño that came on the back of the global recession, the 1998 episode came about immediately after the 1997 Asian financial crisis. 17 See our November 2009 Philippines Quarterly Update for details. 19 Philippines Quarterly Update--September 2010 35. El Niño reduced agricultural output significantly in the first half of 2010, complicating the country's recovery from the global recession. Drought and other abnormal conditions brought about by the El Niño phenomenon led to an overall decline in agricultural production by 2.6 percent in the first half of 2010 (Philippines Bureau of Agricultural Statistics). The crop sector was the hardest hit recording a decline of 6.7 percent and, within it, corn production declined the most (25 percent) followed by rice production (10.2 percent)--Figure 19. Losses were due both to reduced acreage and lower yields. Areas affected most severely were Western Visayas, Cagayan Valley and SOCSARGEN. As the agricultural sector accounts for about one-third of total employment and almost a fifth of GDP, effects of this contraction reverberated to other sectors of the economy. 36. El Niño is estimated to have reduced real GDP growth in 2010 by 0.9 percentage points of GDP, i.e., GDP would have grown by 7.1 percent instead of the 6.2 percent we are projecting. The loss in GDP growth is attributable to lost output in both the agriculture and manufacturing sectors. Figure 22. El Niño and Agriculture Contribution to GDP Growth and Employment 1.50 1.0 percentage point of GDP 1.00 0.5 In million of jobs 0.50 0.0 0.5 (0.50) Occurence of (1.00) strong El Niño 1.0 phenomenon (1.50) 1.5 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Agricultural Output: Contribution to GDP growth (lhs) Net Job Creation in Agriculture (rhs) Source: NSCB and NSO. 37. The El Niño phenomenon affected employment, poverty, and income distributional through both direct and indirect channels. While the most direct and obvious losses occur to land owners and tenant cultivators through reduced earnings due to lower production, it also affects farm laborers whose earnings are reduced due to lower wages, reduced time of employment, or a combination of both.18 Secondary impacts also take place via the multiplier effects of reduced spending by cultivators and laborers. They also take place through food price changes that affect both the food poverty line and the terms of trade between agriculture and other domestic sectors. 18 It is also worth noting that there is significant agricultural activities in peri-urban centers that are frequently classified as `urban' in surveys and other administrative classification systems. 20 Philippines Quarterly Update--September 2010 38. The following analysis builds on a micro-simulation model to estimate the macroeconomic impacts of El Niño on household income (the model was developed by Habid et al., 2010,19 as part of a World Bank project to assess the impact of the global recession in the Philippines). This model superimposes macroeconomic projections on behavioral models built on pre-crisis household data is used. The macroeconomic shocks are transmitted to households through changes in employment, labor earnings, and non-labor income (including remittances from migrants). Comparisons of with and without El Niño scenarios for 2010 are used to measure the impact of the crisis, comparisons are made between. Figure 23. Agricultural output in H1 2010 and the Figure 24. Estimated employment and income El Niño phenomenon impact of El Niño 1/ OVERALL EMPLOYMENT Agriculture Services Other Industries Manufacturing TOTAL INCOME NonLabor Income Labor Income 2.00 1.50 1.00 0.50 0.00 0.50 Source: Bureau of Agriculture Statistics (BAS) Source: World Bank staff estimates 1/ Percentage change between "without" and "with El Niño". 39. The labor market impact of El Niño can be decomposed into employment and earnings effects. Annual employment rates are expected to fall by about 0.6 percent in 2010 due to El Niño.20 The shock is spread out across the agriculture and services sectors but the effect is highest in the agricultural sector (Figure 24). Earnings per worker are predicted to be slightly lower in 2010 due to El Niño, with the largest declines occurring in agriculture (2 percent) and manufacturing (1 percent). The combination of lower employment levels and individual earnings translates into overall household labor income being 0.7 percent lower in 2010 as a result of El Niño (Figure 24). Non-labor income is lower by 0.2 percent with El Niño. 40. The impact of El Niño on the overall poverty rate and depth is projected to be small. Poverty headcount rate in 2010 is projected to be higher by 0.4 percentage points due to the El Niño effect (Table 2). The poverty gap, which measures the depth of poverty, is projected to increase by 0.2 percentage points. There are no significant impacts on the indices of overall inequality (e.g., Gini or Theil coefficients). 19 Habib, B., A. Narayan, S. Olivieri and C. Sanchez-Paramol, 2010, "Assessing ex ante the employment, poverty and distributional impact of the global crisis in Philippines: a microsimulation approach" World Bank Policy Research Working Paper No. 5286, Washington DC. 20Employment growth projections for 2010 with and without El Niño are computed using past trends in output and employment (2003-2008) and GDP projections. 21 Philippines Quarterly Update--September 2010 41. Income losses are largest at the Table 2. El Niño's impact on poverty and inequality bottom of the income distribution, while the losses across the rest of the Baseline 2010 Impact population are fairly evenly distributed 2006 Without With 1/ (Figure 25). For the country overall, the (in percent) Moderate poverty largest losses in per capita income (1 to 2 -Headcount rate 33.1 30.4 30.8 0.4 percent) occur for the bottom 20 percent of -Poverty gap 10.2 9.4 9.6 0.2 the income distribution (Figure 25a). Inequality per-capita income These losses are mainly due to labor -Gini 0.47 0.466 0.467 0.001 -Theil 0.43 0.42 0.423 0.003 income losses in agriculture and manufacturing sectors (Figure 25b). Source: Bank staff micro-simulations using macro projections. Figure 25. Growth Incidence Curves (with versus without El Niño, 2010) a) Per capita income b) Per capita income: economic sectors 3.00 3.00 2.50 2.50 2.00 2.00 1.50 1.50 1.00 1.00 0.50 % Change 0.50 % Change 0.00 0.00 -0.50 -0.50 -1.00 -1.00 -1.50 -1.50 -2.00 -2.00 -2.50 -2.50 -3.00 -3.00 0 10 20 30 40 50 60 70 80 90 100 Percentile 0 10 20 30 40 50 60 70 80 90 100 Percentile Agriculture Manufacturing Other Ind Services Source: World Bank staff simulations based on FIES (2006). Note: (1) GIC's have been smoothed to eliminate sharp kinks in the original curves; (2) Percentiles of income on the horizontal axis are for the relevant group (all country, agriculture, etc) 42. The projected impact of El Niño is similar for urban and rural areas at the bottom half of the distribution (Figure 26). This is in contrast to the effect of the global recession where the growth slowdown was higher among urban households than rural households for all parts of the urban and rural income distributions (Habib et al., 2010). Larger impacts (a loss of 1 percent of more in per capita income) among poor and vulnerable households in rural and urban areas are likely the result of weaker attachments to the labor markets and employment in informal/less productive jobs, including in agriculture wage labor market. There are differences in impact between rural and urban households for the upper half of the distribution. In rural areas the impact gets progressively smaller for higher parts of the distribution and is nearly zero for households around the 90th percentile but increases thereafter. This is probably because households beyond the 90th percentile are also likely to be large land owners who are disproportionately affected by reduced agricultural output. In urban areas, on the other hand, a loss of 1 percent or more in per capita income is projected for those between 70th and 90th percentile, possibly due to loss of manufacturing labor income. 22 Philippines Quarterly Update--September 2010 Figure 26. Growth Incidence Curves (with versus without El Niño, 2010) a) Per capita income: urban and rural b) Per capita income: regions 3.00 3.00 2.50 2.50 2.00 2.00 1.50 1.50 1.00 1.00 0.50 0.50 % Change % Change 0.00 0.00 -0.50 -0.50 -1.00 -1.00 -1.50 -1.50 -2.00 -2.00 -2.50 -2.50 -3.00 -3.00 0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80 90 100 Percentile Percentile Urban Rural NCR Central Luzon Calabarzon Others Source: World Bank staff simulations based on FIES (2006). Notes: (1) GIC's have been smoothed to eliminate sharp kinks in the original curves; (2) Percentiles of income on the horizontal axis are for the relevant group (eg. rural, urban etc); absolute levels of income for each percentile will therefore differ across these groups. Generally rural households are poorer: when percentiles are drawn at the national level, rural households account for almost 70 percent of the bottom half of the distribution. 3. The Philippines during the Recent International Financial Shocks 43. Contrary to some expectations, the Philippine economy has shown to be remarkably resilient to recent international financial shocks. Using equity price indices and sovereign credit default swaps (CDS) spreads, we document the extent to which the country was affected in absolute and relative terms by the global financial crisis and the more recent European sovereign turmoil. Financial data reveal that: (1) during the last decade, the Philippines stock market exhibited strong co-integration with the US market and, to a lower extent with China's, (2) the historically high volatility of the Philippine equity index decreased noticeably since the global financial crisis, (3) the sovereign credit quality of the Philippines is emerging favorably from the global financial crisis, and (4) Philippines sovereign CDS have not been correlated with CDSs of the fiscally weak European countries. 44. Since 2001, the Philippines stock market has been strongly co-integrated with the US market and, to a lower extent with China's (Figure 27).21 While from 1993 to 1996, Philippine equity prices outperformed those of China and the U.S, the 1997/98 Asian Financial crisis marked a dramatic turning point. A year into the 1997/98 crisis, equity markets in the Philippines (and the rest of Asia) lost more than four years worth of growth. Meanwhile equity markets in the U.S grew steadily up to the "dot-com bubble" burst of March 2000. Interestingly, since that time, the Philippine equity market has moved in tandem with the U.S. market. Both markets went into decline, and only started their recovery around 2003. In 2008, all markets were taken down by the global financial crisis. For the Philippines, the loss incurred is more modest as during the Asian crisis. 21 This does not mean that the Philippine stock market is necessarily strongly correlated with the US market (i.e., that it moves in synchrony on a daily basis); it means that the two markets cannot move away from each other for an extended period of time without eventually moving back towards each other (or to a mean distance of each other). 23 Philippines Quarterly Update--September 2010 Figure 27. Equity market indices in China, the Figure 28. Time-varying volatility of weekly equity Philippines, and the US 1/ market returns 2/ 900 0.1 800 0.09 0.08 700 0.07 600 0.06 500 0.05 400 0.04 0.03 300 0.02 200 0.01 100 0 Jul-93 Jul-95 Jul-97 Jul-99 Jul-01 Jul-03 Jul-05 Jul-07 Jul-09 0 93 95 97 99 01 03 05 07 09 Philippines China US Philippines China US Source: DataStream. 1/ Weekly equity prices; Normalized to 100 at start-date; 2/ Conditional variances are estimated on the basis of the GO-GARCH multivariate volatility model of Van der Weide (2002) "GO-GARCH: A multivariate generalized orthogonal GARCH model", Journal of Applied Econometrics, Vol. 17, pp.549-564. 45. While the Philippine equity index historically exhibited high volatility, this volatility decreased noticeably since the global financial crisis (Figure 28). Volatility in the Philippine equity market spiked during the 1997/98 Asian financial crisis, then in 2000/01 during the dot-com crisis, and recently in 2008 with the onset of the global financial crisis. The magnitude of the volatility spikes was highest during the Asian Financial crisis. During the global financial crisis, volatility in the Philippines rose sharply, but by a lower magnitude than both the US and China. As the distress levels from the immediate post Lehman Brothers failure normalized, the Philippines has tracked remarkably well the reduction in volatility experienced in the US market-- which until then was subject to lower levels of volatility; as a result, the gap in volatility levels between the US and the Philippines has narrowed down remarkably, in contrast to China's equity volatility.22 Volatility levels in the Philippines are now below even the lows reached prior to the Asian financial crisis. 46. Philippines' equity returns exhibit a strong correlation with Asian markets (Figure 29). Links are particularly strong with neighboring countries, such as Indonesia and Singapore. The relatively lower correlations with China may stem from the fact that China is more connected with global markets relative to other Asian economies. Note that the linkages with all four markets intensified during the global financial crisis, most likely due to a contagion effect. While the increase in correlations is sudden and large--it occurred around the collapse of Lehman Brothers in September 2008--it was relatively short-lived.23 22 It may arguably be attributed to the high volatility of industrial production in China--found to be the highest in the region; see Kim and Yang (2009), "International monetary transmission and exchange rate regimes: Floaters vs. non-floaters", ADBI Working Paper No. 181, Tokyo--which is found to be among the important determinants of equity price volatility (see Engle, Ghysels and Sohn (2008), "On the economic sources of stock market volatility", mimeo, New York University). 23Similar results are obtained by Kim and Kim (2010) while Chiang et al. (2007) find evidence of a contagion effect during the 1997/98 Asian financial crisis (see Kim and Kim, 2010, "Spillover effects of the U.S. financial crisis on financial markets in emerging Asian countries", mimeo; and Chiang, Jeon and Li, 24 Philippines Quarterly Update--September 2010 Figure 29. Time-varying correlations between Figure 30. Daily sovereign CDS spreads2/ weekly Philippine equity returns and other markets1/ 0.8 1400 0.7 1200 0.6 1000 0.5 800 0.4 600 400 0.3 200 0.2 0 0.1 Jan-06 Sep-06 Jan-07 Sep-07 Jan-08 Sep-08 Jan-09 Sep-09 Jan-10 May-06 May-07 May-08 May-09 May-10 0 93 95 97 99 01 03 05 07 09 Philippines China Indonesia China Indonesia Singapore US Malaysia Thailand Korea Greece Ireland Source: DataStream. 1/ Correlations have been estimated based on the GO-GARCH model from Van der Weide (2002). 2/ 5- year maturity. 47. The sovereign credit quality of the Philippines is emerging favorably from the global financial crisis (Figure 30).24 The onset of the global financial crisis led to a sudden and sharp increase in sovereign spreads in almost all countries, including the Philippines; in the region, spreads on Indonesia were particularly high. As the financial crisis turned into a global recession, the combination of large banking sector bail out costs, large fiscal stimuli, and of limited growth prospects in some European countries led to the possibility that sovereign default could occur in the region. This resulted in elevated levels of sovereign spread in some European Union countries. By contrast, a sharp rebound in economic activity, sound financial and balance of payment indicators led to a rapid decrease in Philippines sovereign spreads (spreads in Indonesia remained at elevated levels significantly longer than the Philippines). Markets are pricing these spreads at pre-crisis levels. 48. Since the global financial crisis, Philippines sovereign CDS have become more correlated with those of its neighbors; no such increase is observed vis-à-vis fiscally weak European countries (Figure 31). While the Philippines was already highly correlated with Indonesia prior to the crisis, correlations with other Asian markets are increasing and have become almost similar to the one observed for Indonesia.25 The linkage with Europe is noticeably weaker and stable in 2010. The high correlations between Asian markets may stem from the effect that emerging market 2007, "Dynamic correlation analysis of financial contagion: Evidence from Asian markets", Journal of International Money and Finance, Vol. 26, pp.1206-28). 24As measured by sovereign CDS spreads. An increase in sovereign risk yields lower bond prices (and thus a higher cost of acquiring capital) and reductions in the flow of foreign investments (Kraay, Loayza, Serven, and Ventura, 2004, "Country Portfolios," World Bank Policy Research Working Paper No. 3320). 25Correlations with Asian markets (not included in the graph because of readability but available upon request) such as Malaysia, Thailand and Singapore, are similar to those observed for China. 25 Philippines Quarterly Update--September 2010 investors may consider markets in the same region to be similar, especially in times of crisis.26 Figure 31. Correlations between returns on Philippine CDS and those on China, Indonesia, Greece, and Portugal 1/ 1.20 1.00 0.80 0.60 0.40 0.20 0.00 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 -0.20 -0.40 -0.60 China Indonesia Greece Portugal Data source: DataStream. 1/ Time-varying correlations on daily CDS returns computed using Van der Weide (2002). 4. Constraints to Growth: The Agribusiness Value Chain in Mindanao 49. Understanding how the Philippines could improve its competitiveness in agribusiness and agricultural commodities markets in which the country, particularly the island of Mindanao, enjoys strong comparative advantages is critical to fighting poverty and boosting rural incomes. A recent World Bank study of the performance of two key agricultural value chains in Mindanao--yellow corn and export bananas--reveals that both corn and banana value chains offer significant future growth potential; yet they are facing some critical issues in terms of their long-term viability and sustainability. These include average farm-level productivity well behind international benchmarks, in large part due to infrastructure and logistics deficiencies. As the specific channels by which these constraints curtail growth prospects resonate with constraints that other regions and sectors also struggle with, this study is illustrative of the developmental challenges facing the Philippines, especially as regards inclusive growth generation and the fight against poverty. 50. Mindanao is one of the main agricultural regions of the Philippines.27 Corn and banana production are economically important both for Mindanao but also for the wider country. In recent years, corn production has been steadily increasing pulled by the demand for feed for the livestock and aquaculture industries. Mindanao is also the 26 Several rational behaviors can explain such "herding" phenomenon. For example, Bekaert and Harvey (2003) and Gande and Parsley (2005) find that carrying out comprehensive country-specific studies can be too costly as information relevant for investors is generally harder to come by in developing countries (see Bekaert and Harvey, 2003, "Emerging markets finance", Journal of Empirical Finance, Vol. 10, pp.3-55; and Gande and Parsley, 2005, "News spillovers in the sovereign debt market", Journal of Financial Economics, Vol. 75, pp.691-734.) 27For details, see World Bank, 2010, "The Philippines: Agribusiness, Infrastructure and Logistics for Growth in Mindanao". 26 Philippines Quarterly Update--September 2010 country's main banana producing region, both for export and for the domestic market. Thanks to the industry's ability to position itself on the growing markets of East Asia, the Philippines have in recent years become the world's second top exporter of Cavendish bananas.28 These two crops are of paramount importance to agriculture's growth in Mindanao and hence to the reduction of poverty, which is predominantly concentrated in rural areas. 51. However, both corn and banana value chains are now facing some critical issues in terms of their long-term viability and sustainability. While in the case of corn these issues concern the sector's ability to realize its competitiveness potential, in the case of the (premium) Cavendish banana sector the challenge is to sustain the competitiveness attained during the past few decades. Three broad priority areas require attention: bridging the productivity and quality gap; investing in infrastructure for improved value chain performance; and improving linkages to markets. 52. On average, farm-level productivity for both corn and export bananas lag well behind international benchmarks. For sustained competitiveness, average yields in corn need to increase from 2.6 to a minimum of 5 MT per hectare. In the case of banana growers, increases in output prices have not been sufficient to compensate for the increase in the cost of production factors during the last decade. The average yield of about 3,200 to 3,500 boxes of Cavendish bananas per hectare lags behind the world standard of 4,500 to 5,000 boxes per hectare. The substantial yield gaps in both farming systems, suggest that a farm productivity enhancement and support program for corn and banana production should be at the top of the agenda, focusing primarily on technical assistance and on a more efficient use of inputs and land. As access to capital and credit continues to prove a limiting factor in improving on-farm production, innovations in agricultural value chain finance--such as tripartite financing--are also needed. 53. For corn, specific reforms needed to overcome bottlenecks to growth include the promotion of partnerships PPPs, enforcement of quality standards, better information, and completion trade liberalization. Critical reforms include: (1) development of public-private partnerships (PPPs) to overcome coordination failures along the corn value chain and encourage investment by the private sector in post- harvest facilities;29 (2) establishment and enforcement of quality standards commercially acceptable by the private sector; (3) wider dissemination of critical information on production costs among regional competitors; and (4) completion of the process of trade liberalization by reducing tariffs on imports from non-ASEAN countries. Eventually, farmers who cannot raise their productivity should be assisted in transitioning to other more remunerative crops like fruits and vegetables. 54. For the banana industry, pricing transparency, management of environmental issues, and strengthening of professional organization are needed. As the banana industry matures new challenges have emerged in terms of its social and 28 Cavendish banana is the export quality banana on demand internationally. 29Recent interventions by NABCOR in Mindanao through the establishment of post-harvest facilities are a move in the right direction but have so far failed to materialize substantial interest by the private sector. 27 Philippines Quarterly Update--September 2010 environmental sustainability. First, pricing mechanisms the lack of transparency and regulation in pricing poses a threat for the future economic and social viability of the value chain. The overall organizational arrangements and types of linkages between farmers and exporters dictate prices paid to small farmers. New forms of market linkages and increased competition have taken place in the industry ­ which has resulted in higher prices to growers ­ but the lack of regulation has also translated in "price wars" like in 2008 ­ which can be detrimental to quality and to the overall competitiveness of the industry. Thus, it is in the industry's best long-term interest to bring more transparency and provide more information on banana export prices. Second, serious environmental issues need to be addressed urgently and comprehensively. The recent ban imposed by Davao City on aerial spraying of banana plantations shows the acuteness of the environmental problems and the need for both the industry stakeholders and government to come together to address them. It also points to the broader issue of wide-spread encroachment of banana plantations--and agriculture, in general--in urban or semi-urban areas. This encroachment exacerbates the tensions between agricultural and non-agricultural activities. Strategies to raise the environmental awareness of the industry and improve its compliance with good agricultural practices need to be designed and implemented. Greater compliance with these standards is required and will contribute to improving the competitiveness of the Philippine bananas. Finally, the emergence of strong and responsible professional organizations can contribute to help tackle complex issues confronting the value chain such as environmental sustainability and spatial redistribution of production that require cooperation between farmers, private actors and government. 55. Investments in infrastructure are critical to improve the performance of the two value chains. Competitiveness of the two selected commodities on the world market is driven by cost. The study reveals that traditional broad infrastructure constraints (roads, irrigation infrastructure, land use, post-harvest facilities, and power supply) are becoming an ever more binding constraint. Particularly for bananas, which are a perishable product, logistics efficiency needs to be achieved to guarantee freshness, quality, and safety all the way to the final market. To support such wide-scale investment in basic rural market-oriented production infrastructure a farm-to-market road rehabilitation program should be designed and implemented as the precondition to improve market access for small farmers. Targeted investment in rural roads rehabilitation could play a vital role in improving access to markets for farmers and in unlocking new areas with productive potential. These investments should be accompanied by policy measures on contract procurement and funding for road maintenance that have been recommended already in previous studies. In addition to hard infrastructure, long-due legal reforms are more than ever a priority in reducing the impact of inter-island shipping costs on the cost structure of both value chains. The problems for corn are high costs, inefficiency, and poor service for inter-island logistics. These problems also affect the transport of bananas in the domestic market. As is well known, the major difficulty lies in the regulated nature of the port and shipping industry. While access to ports and modern facilities therein has improved during recent years, inter-island shipping is still constrained by the regulations that govern logistics operations. 28 Philippines Quarterly Update--September 2010 Data Appendix Table 3. Philippines: Selected Economic Indicators, 2008-12 2008 2009 2010 2011 2012 Actual Projection Growth, inflation and unemployment (in percent of GDP, unless otherwise indicated) Gross domestic product (% change) 3.7 1.1 6.2 5.0 5.1 Inflation (period average; in percent) 9.3 3.2 4.2 4.5 4.5 Savings and investment Gross national savings 17.5 20.0 19.6 19.5 19.8 Gross domestic investment 15.3 14.6 15.8 16.4 17.3 Public sector 1/ National government balance (GFS basis) -1.5 -4.1 -4.2 -3.6 -2.7 National government balance (Govt Definition) -0.9 -3.9 -4.0 -3.3 -2.5 Total revenue (Govt Definition) 16.2 14.6 14.7 14.8 15.6 Tax revenue (Govt Definition) 14.2 12.8 13.0 13.2 14.0 Total spending (Govt Definition) 17.2 18.5 18.6 18.1 18.1 National government debt 57.0 57.3 56.2 55.3 52.9 Consolidated non-financial public sector debt 61.0 61.0 59.9 59.2 56.2 Balance of payments Merchandise exports (% change) -2.5 -22.3 22.0 7.0 7.1 Merchandise imports (% change) 5.6 -24.1 19.0 8.3 8.3 Remittances (% change of US$ remittance) 13.7 5.6 8.0 8.5 9.0 Current account balance 2.2 5.3 3.9 3.1 2.6 FDI (billions of dollars) 1.3 1.6 2.0 3.0 3.5 Portfolio Investment (billions of dollars) -3.8 1.4 1.0 1.8 2.3 International reserves 2/ Gross official reserves (billions of dollars) 37.6 44.2 51.5 53.3 55.2 Gross official reserves (months of imports) 6.0 8.7 8.4 8.2 7.9 External debt 3/ Total 38.9 39.0 38.5 37.7 37.8 Source: GOP for historical, World Bank for projections. 1/ Excludes privatization receipts and includes CB-BOL restructuring revenues and expenditures (in accordance with GFSM); 2/ Includes gold; 3/ World Bank definition/ Table 4. Philippines: National Government Cash Accounts (GFS Basis), 2008-11 2008 2009 2010 2011 Rev. Jan-Jun Jan-Jul Jan-Aug Year Jan-Jun Jan-Jul Jan-Aug Rev. Bud. Budget4/ WB proj. Budget WB proj. (in percent of GDP, unless otherwise stated) Revenue and grant 15.8 7.1 8.4 9.6 14.6 7.0 8.2 9.4 14.6 15.5 14.6 15.5 14.7 Tax revenue 14.2 6.3 7.4 8.5 12.8 6.4 7.4 8.5 13.1 13.9 13.0 14.1 13.2 Net income & profits 6.5 2.8 3.3 3.8 5.7 2.8 3.2 ... 5.9 5.9 5.5 6.0 5.8 Excise tax 0.8 0.4 0.4 0.5 0.8 0.4 0.4 ... 0.7 0.7 0.7 0.6 0.8 Sales taxes and Licenses 2.4 1.4 1.6 1.8 2.7 1.3 1.5 ... 2.6 2.8 2.8 3.2 3.0 Other 0.9 0.4 0.4 0.5 0.7 0.4 0.4 ... 0.7 1.0 0.8 0.7 0.2 Tariff (collection from the BOC) 3.5 1.4 1.7 1.9 2.9 1.5 1.8 2.0 3.2 3.4 3.1 3.5 3.4 Nontax revenue 1/ 1.7 0.8 1.0 1.1 1.8 0.6 0.8 0.9 1.5 1.7 1.6 1.4 1.5 Grant 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total expenditure 2/ 17.3 9.2 11.0 12.5 18.7 9.4 11.0 12.3 18.4 19.7 18.8 19.0 18.3 Current Expenditures 14.1 7.3 8.8 10.0 15.1 7.3 8.7 9.8 15.4 15.7 15.1 15.3 14.6 Personal services 5.1 2.5 2.9 3.3 5.4 2.7 3.1 3.5 5.9 5.9 5.9 6.0 5.8 MOOE 1.9 1.0 1.2 1.4 2.3 1.1 1.3 1.4 2.0 2.3 2.3 2.3 2.3 Allotment to LGUs 2.3 1.3 1.6 1.8 2.6 1.3 1.5 1.7 2.5 2.6 2.6 2.5 2.5 Subsidies 0.2 0.1 0.1 0.2 0.2 0.1 0.1 0.1 0.2 0.2 0.2 0.1 0.2 Tax expenditures 0.8 0.4 0.5 0.5 0.7 0.3 0.3 0.3 0.4 0.5 0.5 0.2 0.2 Interest payment 3.9 2.0 2.5 2.8 3.8 1.8 2.3 2.6 4.2 4.1 3.7 4.1 3.7 Capital Outlays 3.0 1.8 2.1 2.4 3.6 2.0 2.3 2.4 2.9 3.8 3.7 3.6 3.6 Net lending 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.1 0.2 0.2 Balance (GFS definition) -1.5 -2.1 -2.6 -2.9 -4.1 -2.4 -2.8 -2.8 -3.8 -4.1 -4.2 -3.5 -3.6 Balance (Government definition) -0.9 -2.0 -2.4 -2.7 -3.9 -2.3 -2.7 -2.7 -3.5 -3.9 -4.0 -3.2 -3.3 Primary Balance (GFS) 2.3 -0.1 -0.1 -0.1 -0.3 -0.6 -0.5 -0.2 0.4 0.0 -0.6 0.7 0.1 Memorandum Items Privatization receipts (PHP billions) 31.3 0.5 0.7 0.8 1.4 0.1 1.1 0.4 12.5 2.0 2.0 6.0 6.0 CB-BOL interest payments (% of GDP) 0.2 0.1 0.1 0.1 0.2 0.1 0.0 0.1 0.2 0.2 0.2 0.2 0.2 Nominal GDP (PHP billions) 3/ 7,409 7,679 7,679 7,679 7,679 8,498 8,498 8,498 8,498 8,316 8,498 9,045 9,328 Source: Department of Finance, Bureau of Treasury, and Department of Budget and Management; 1/ Excludes privatization receipts (these are treated as financing items, in accordance with GFSM); 2/ Data from the Department of Budget and Management; Allocation to Local Government Units excludes capital transfers to LGUs; 3/ Nominal GDP for 2010 is World Bank estimate/forecast; 4/ As of July 2010. 29 Philippines Quarterly Update--September 2010 Selected Special Focus from Recent Quarterly Updates June 2010 PQU: The Recovery Continues Despite Global Financial Turbulence Economic development and peace: the case of Mindanao (Box 1) Philippines migration patterns during the global recession: resiliency through diversification and flexibility (Box 2). Despite the global recession, total deployments (both new hires and rehires) to all destinations actually posted stronger growth rates than in the pre-crisis period, with females, service workers, seafarers, and rehires less susceptible to negative shocks from the financial crisis. Due to financial constraints, the shipping industry shifted to more inexpensive Filipino labor, thus inducing large increases in the employment of Filipino seafarers. The European sovereign debt turmoil and the Philippines (Box 3) Bottlenecks to the Philippines competitiveness: (Box 4) The marked decline in competitiveness relative to key neighboring ASEAN countries is mostly driven by the opacity of government policy making, favoritism in decisions of government officials, a weak judicial system, high inflation in 2008, high agricultural policy costs, and a weaker relationship between wage and labor productivity. February 2010 PQU: Layout the Exit Strategies Cyclical and permanent changes in fiscal policy during the global recession: The large counter-cyclical fiscal policy engineered to fight the global recession helped buffer the economy but generated a large and mostly structural fiscal deficit, as permanent revenue-eroding and expenditure-increasing measures were introduced. To enable a measured unwinding of this fiscal expansion, laying out a specific and credible medium-term plan that takes into account the country's inclusive growth agenda is warranted. Petroleum Taxation in the Philippines (Box 1): Tax collection from petroleum excises is 1.8 percentage points of GDP lower than in 1997. Raising revenue through such excises would (1) generate minimal economic distortions (excises are "efficient" taxes); (2) predominantly impact the most well-off Filipinos (consumption is strongly "progressive" therefore guaranteeing vertical equity: the richer you are the more you pay); (3) reduce bad side effects of consuming petroleum products ("negative externalities") such as traffic congestion, accidents, but also pollution which creates health hazards and environmental damages--the Philippines under-taxes compared to the rest of the world a major source of global warming; and (4) be easy to administer provided effective border controls are in place. November 2009 PQU: Towards an Inclusive Recovery Comparing the NFA and the 4Ps/CCT as social safety net instruments (Box 3): As a subsidy program for the poor, the NFA rice subsidy program suffers from serious deficiencies, not least: (1) limited assistance reaching the poor as they get only get 16 percent of their rice consumption from the NFA; (2) high leakage to the non poor with about half of NFA rice by the non poor; (3) a very expensive program due to limited operational efficiency of NFA--in 2008, for every peso-equivalent given to the poor through the rice subsidy program, the Philippine taxpayers spent between 3 to 8.6 pesos. Reallocating NFA's fiscal support to the 4Ps/CCT would cover 100 percent of the poor against 25 percent with NFA, with each poor household receiving 7 times the benefits it receives with the NFA. Reallocating the NFA's fiscal support to the 4Ps/CCT would generate major social protection gains and notable fiscal savings. July 2009 PQU: Sailing Through Stormy Waters Consumption and remittances during the global recession (Box 2) Assessing and containing fiscal risks in the Philippines: a comprehensive assessment (Box 3) Risks to the Philippines banking sector during the global recession: an assessment (Box 5) 30 Philippines Quarterly Update--September 2010 Selected recent World Bank publications on the Philippines (for an exhaustive list, please go to: http://go.worldbank.org/BRHFJLLQD0) Publication Document Title Date Type Philippines Quarterly Update (PQU): The Recovery Continues Despite Global 2010/06/30 Economic Monitoring Report Financial Turbulance Behind the Veil of Conflict: Moving Towards Economic Integration for Sustained 2010/06/24 Special Report Development and Peace in Mindanao, Philippines Assessing Poverty and Distributional Impacts of the Global Crisis in the 2010/04/01 Policy Research Working Paper Philippines : a Microsimulation Approach The effects of school-based management in the Philippines : an initial assessment 2010/03/01 Policy Research Working Paper using administrative data Philippines Quarterly Update (PQU): Laying Out the Exit Strategies 2010/02/28 Economic Monitoring Report Philippines - Integrated Persistent Organic Pollutants Management Project: 2009/12/28 Board Report environmental and social assessment Philippines - Country environmental analysis 2009/12/01 Country Environmental Analysis Philippines Quarterly Update (PQU): Towards an Inclusive Recovery 2009/11/25 Economic Monitoring Report Philippines: Typhoons Ondoy and Pepeng: post-disaster needs assessment 2009/11/10 Special Report Disparities in labor market performance in the Philippines 2009/11/01 Policy Research Working Paper Education and wage differentials in the Philippines 2009/11/01 Policy Research Working Paper Philippines ­ Country environmental analysis 2009/10/29 Country Environmental Analysis Output-based aid in the Philippines: improved access to water services for poor 2009/07/01 Brief households in Metro Manila Philippines Quarterly Update (PQU): Sailing Through Stormy Waters 2009/07/01 Economic Monitoring Report The power of information: the impact of mobile phones on farmers' welfare in the 2009/07/01 Policy Research Working Paper Philippines Philippines - Transport for growth : an institutional assessment of transport 2009/02/24 Public Expenditure Review infrastructure Climate resilient cities : a primer on reducing vulnerabilities to disasters - Makati 2009/01/01 Working Paper city, Philippines Grand corruption in utilities 2008/12/01 Policy Research Working Paper Philippines - Country procurement assessment report 2008/10/03 Country Procurement Assessment Doing business 2009 : country profile for Philippines 2008/09/29 Working Paper A road to trust 2008/09/01 Policy Research Working Paper Managing migration : lessons from the Philippines 2008/08/11 Brief Do community-driven development projects enhance social capital? Evidence 2008/07/01 Policy Research Working Paper from the Philippines Doing business in the Philippines 2008 2008/06/03 Working Paper Engaging local private operators in water supply and sanitation services 2008/06/01 Brief So you want to quit smoking : have you tried a mobile phone ? 2008/06/01 Policy Research Working Paper Philippines-2008 Development Forum : summary report 2008/04/29 Board Report Rising growth, declining investment : the puzzle of the Philippines 2008/01/01 Policy Research Working Paper Who's at the wheel when communities drive development? The case of the 2007/09/01 Working Paper KALAHI CIDSS Yield impact of irrigation management transfer : story from the Philippines 2007/08/01 Policy Research Working Paper Economic results of CDD programs : evidence from Burkina Faso, Indonesia and 2007/06/01 Brief the Philippines Philippines : Agriculture Public Expenditure Review 2007/06/01 Working Paper Philippines - Invigorating growth, enhancing its impact 2007/05/18 Development Policy Review Inequality and relative wealth: do they matter for trust? Evidence from poor 2007/03/01 Working Paper communities Measuring the costs and benefits of community driven development : the 2007/01/01 Working Paper KALAHI-CIDSS project 31 Philippines Quarterly Update--September 2010 COPIES OF THE PHILIPPINES QUARTERLY UPDATE: Online copies of this publication can be downloaded in www.worldbank.org.ph Printed copies are also available in the following Knowledge for Development Centers (KDCs): 1. World Bank KDC Ground Floor The Taipan Place, Francisco Ortigas Jr. Road (former Emerald), Ortigas Business Center, Pasig City 1605 2. Asian Institute of Management KDC Joseph R. McMicking Campus, 123 Paseo de Roxas, Makati City 1226 3. Ateneo de Naga University KDC James O'Brien Library, Ateneo Avenue, Naga City 4400 4. Central Philippine University KDC Ground Floor Henry Luce III Library, Lopez Jaena Street, Jaro, Iloilo City 5000 5. House of Representatives KDC Congressional Planning and Budget Department, 2F R.V. Mitra Building, Batasang Pambansa Complex, Constitution Hills, 1126 Quezon City 6. Notre Dame University KDC Notre Dame University Library, Notre Dame Avenue, Cotabato City 9600 7. Palawan State University KDC Graduate School - Law Building, Manalo Campus, Valencia St., Puerto Princesa City 5300 8. Saint Paul University Philippines KDC 3rd floor, Learning Resource Center, Mabini St., Tuguegarao City 3500 9. Silliman University KDC Silliman University Library, Dumaguete City 6200 10. University of San Carlos KDC University Library, P. Del Rosario Street, Cebu City 6000 11. University of Southeastern Philippines KDC Obrero, Davao City 8000 32