Philippines - Second Industrial Investment Credit Project

CIRCULATING COPY RLE CJP7 TO BE RETURNED TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No.P-1726-PH REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A SECOND INDUSTRIAL INVESTMENT CREDIT PROJECT THROUGH THE DEVELOPMENT BANK OF THE PHILIPPINES December 3, 1975 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS US$1 = P 7.5 P 1 US$0.1333 P I million m US$133,000 P 1 billion US$133 million FISCAL YEAR July 1 - June 30  REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A SECOND INDUSTRIAL INVESTMENT CREDIT PROJECT THROUGH THE DEVELOPMENT BANK OF THE PHILIPPINES I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for an equivalent of US$75 million. The loan would have a term of 18 years including 4 years of grace and an interest rate of 8.5 percent per annum. The proceeds of the loan would be relent to the Development Bank of the Philippines (DBP) on the same terms as those of the Bank loan for onlending to specific productive enterprises. PART I - THE ECONOMY 2. The most recent Economic Report - "Current Economic Position and Prospects of the Philippines" (No. 568-PH of November 7, 1974) was circulated to the Executive Directors on November 11, 1974. A basic economic mission visited the Philippines in April/May 1975 and is now preparing its report. The discussion below includes the findings of the mission. Annex I of this report contains country data. Recent Developments 3. During the 1960's the economy grew in real terms at the rate of 5-6 percent per annum. However, the rate of growth was less than the level that might have been achieved if the considerable natural and human resources of the Philippines had been exploited more effectively. Moreover, the bene- fits of growth were not distributed widely and unemployment rose. Low levels of taxation resulted in inadequate public investment in necessary infrastruc- ture and social services. Relatively weak export performance, combined with a failure to reduce the import dependence of domestic industry, resulted in a steady deterioration in the balance of payments position. 4. During 1970-72, the authorities adopted policies of monetary and fiscal restraint in order to lay a firm basis for future growth. With assistance from the Consultative Group, they succeeded in improving substan- tially the maturity structure of the external public debt. Real GNP during that period increased at about 5 percent a year. In 1972, following severe floods, the President began a series of social and economic reforms in the country including an agrarian reform program, tax reforms, and an administra- tive reorganization. These programs are beginning to show results. 5. In 1973, there was a sharp increase in the level of economic acti- vity in the Philippines. This upsurge was led by the international commodity boom, which resulted in higher export incomes in the Philippines, a strong recovery in agricultural and industrial production for the domestic market and an expansion in public and private investment. The growth in real GNP doubled to 10 percent.  - 2 - 6. Like most countries, the Philippines was profoundly affected by the tumultuous events in the world economy that began with the jump in the prices for food and petroleum in late 1973. With international trade the equivalent of almost half of its GNP, the Philippines proved quite vulnerable to the impact of world inflation, the increase in oil prices and the prolonged recession in the industrialized countries. This sequence of events has temporarily frustrated the Government's attempt to accelerate the rate of development, and in 1974 GNP increased by only about 6 percent in real terms. While adverse effects of the recession were cushioned somewhat in 1974 by a modest improvement in the external terms of trade, the Philippines has been even more seriously affected in 1975 by the continued rise in import prices and reduced demand for Philippine exports. The real growth of GNP in 1975 is not expected to exceed the level of the previous year. Improvement in the growth performance in 1976 can be expected only if recovery takes place in the economies of the Philippines' main trading partners. 7. Agricultural production has grown at an average rate of 3.2 percent per year during the 1970s, a period which has been affected by unusually adverse weather conditions. Rice production increased by 25 percent in 1973-74, but due to serious damage by typhoons, it grew by only 1 percent in 1974-75, and the Government had to import 200,000 tons in the first half of 1975 to ensure adequate stocks. However, initial indications are that the outlook for rice production in 1975-76 is bright. The Government is giving the highest priority to increasing agricultural production and has initiated a number of programs designed to expand the use of fertilizer, irrigation and supervised credit. It has also intensified efforts to expand social services needed in rural areas, including rural electrification, health and family planning services as well as small-scale road and irrigation projects. 8. Although progress has been slower than initially planned, the Government has moved ahead with its agrarian reform program for the nation's one million tenant farmers who grow rice and corn. By mid-1975, land trans- fer certificates had been issued to nearly 200,000 tenants and progress had been made on land valuations and the transfer of titles. The Government has raised the cash portion of the compensation package to landlords to reduce their resistance to land reform, but strong administrative efforts will be necessary to ensure continued progress in the implementation of the Program. 9. Industrial production, which grew by 12 percent in 1973 was adversely affected in 1974 by the world-wide economic slowdown and grew by only 3.6 percent in 1975. This sector, which is discussed more fully in Part III of this report, has good growth prospects. 10. The Government has made significant progress in increasing public investment. The ratio of public investment to GNP is currently about 3 percent compared with 1. tpercent in FY72. The Government has also implemented a series of long needed tax reforms and improvements in tax administration. These reforms aided by the increased economic activity, the boom in export incomes, and domestic inflation, resulted in a 36 percent increase in national government tax revenues in FY73, and an estimated 47 percent in  FY74. As a result, the ratio of national government tax revenues to GNP has increased from an average of 9 percent in recent years to an estimated 12.3 percent in FY74. However, because of lower growth of foreign trade and domestic incomes the ratio fell to about 11.5 percent in FY75. 11. In the latter part of 1973, inflation emerged as a major problem in the Philippines and in 1974 consumer prices rose by almost 40 percent. The rise was caused by the large increase in liquidity that came with the export boom in 1973-74, and by a number of cost-push factors, including the higher rate of world inflation. To deal with this problem, the Government adopted contractionary monetary and fiscal policies, and attempted to reduce the impact of inflation on consumers by subsidizing such essential goods as wheat, imported rice, and cooking oil. As a consequence of the Government's measures, the annual rate of inflation decreased to less than 20 percent at the end of 1974 and less than 10 percent as of mid-1975. 12. The rapid inflation in 1974 exacerbated the decline in real wages which had begun in 1970. Overall, there was a decline of about 20 percent in real wages during 1974. In order to offset the deterioration of real wages in urban areas, the Government increased the salaries of Government employees and directed private firms to grant emergency cost of living ad- justments to employees earning less than P 600 per month. Nevertheless real urban wage incomes declined and reduced the demand for manufactured products, which contributed to the poor performance of the manufacturing sector in 1974. The depression in the urban areas was partly offset by the improvement in rural incomes that stemmed from continued high prices for agricultural commodities. 13. On the external side, the Philippine balance of payments benefitted considerably from the international commodity price boom during 1973. High prices for the country's chief exports, including coconut products, sugar, copper and wood products resulted in a 70 percent boost in export earnings and a balance of payments surplus of about $670 million. Since mid-1974 the external trade position has deteriorated due to the sharp increase in the price of oil and other imports and less favorable prices for Philippine exports. In 1974, imports nearly doubled while exports rose by only about 50 percent and as a result the balance of payments surplus fell to about $100 million. However, international reserves at the end of 1974 remained comfortably high amounting to about $1.2 billion, equivalent to roughly four months imports. 14. Due to the prevailing recession in the economies of the Philippines' main trading partners, there will probably be a 20 percent deterioration in the terms of trade during 1975 resulting in a decrease in export earnings of about 10 percent. As the import volume is estimated to rise only marginally, partly as a result of the domestic recession, the value of imports will probably rise by not more than 15 percent. The net result of these projected trends is probably that the Philippines may have an overall balance of payments deficit of about $350 million in 1975 and $220 million in 1976. These deficits can be managed without serious pressure on reserves through  - 4 - utilization of the IMF oil facility (and possibly in 1976 of the extended facility of the IMF) and by short-term foreign borrowing by the Central Bank. 15. The overall level of debt of the Philippines is expected to remain within reasonable limits, as the ratio of debt service payments to exports would average about 16 percent during the rest of this decade. At present, the Bank/IDA share in total debt outstanding is about 8 percent and its share in debt-service is about 5 percent. These shares are expected to increase slowly in the years ahead. 16. Foreign assistance is expected to continue to be of major import- ance in helping to finance the larger investment expenditures which will be necessary for the country's development. In order to ensure that disbursement of external assistance reaches levels commensurate with the level of develop- ment expenditures which will be required during the latter part of the decade, total commitments will need to be maintained in real terms at least at the level of about $500 million which was achieved in 1974. The Consultative Group for the Philippines at its meeting in Paris on October 1, 1975, agreed that it would be reasonable for the Philippine Government to seek aid commit- ments of about $600 million during 1976. Growth Prospects 17. Despite the slowdown in the growth of the economy which is primarily a result of worldwide economic conditions, the Government remains committed to regaining the growth momentum which began in 1973 to provide for a continued increase in incomes and employment. High priority must be accorded to expanding employment opportunities - in the short-term as well as the long-term - because unemployment and underemployment are still high and the labor force continues to grow at 3 percent a year. 18. Priority must also be given to expanding food production for the domestic market, to expanding industrial export production and to accelerating development of local energy resources. The difficulties experienced during the last two years in importing sufficient quantities of food at reasonable prices, especially cereals, have increased the Government's resolve to achieve self-sufficiency in rice and corn as soon as possible. The Govern- ment rightly recognizes that the increased cost of petroleum and other imports cannot be financed indefinitely by borrowing abroad and it is actively encouraging both local and foreign investors to expand the product- ive capacity of export industries and to undertake major new import-replacing investments. Because it will take time for these investments to have an impact on the balance of payments, the Government is seeking increased support from the international financial community to help carry out its development program and to ease the adjustment to higher petroleum and other import prices. Because of the substantial easing of the external debt burden which has taken place in the last several years, the Philippines now has the capacity to borrow externally larger amounts of capital in support of its development program. 19. Given the likely availability of resources and the expected growth in various sectors, it is reasonable for the Government to plan for a longer  - 5 - term growth in GNP of about 7 percent a year in real terms. To achieve this objective increased investments will be needed in a wide range of industries. Public investments also need to be increased. A new public infrastructure program is being prepared, and the Government is putting emphasis on developing nuclear and indigenous power sources and on irrigation, feeder roads and other projects to support increased food production. The Government has made considerable progress in recent years in building up the capacity of public sector agencies to prepare and execute projects. However, there will be a need for continued efforts to strengthen this aspect of administration. The ratio of public investment to GNP will need to rise from the present level of 3 percent to about 5 percent by 1980. To support the level of investment, the Government will need to intensify its tax efforts so that the ratio of national taxes rises from its present level of 11-12 percent to 14 percent by 1980. PART II - BANK GROUP OPERATIONS IN THE PHILIPPINES 20. The Philippines has received 31 Bank loans and three IDA credits totalling $722.2 million, net of cancellations. About 40% of the Bank/IDA lending, $293 million, has been for infrastructure projects in power, trans- portation, and water supply whilst $38 million has been for population and education. Of the remainder about $216 million has been for agriculture and about $175 million for industry in four loans for the Private Development Corporation of the Philippines, one loan for the Development Bank of the Philippines and one for small and medium industries. There has been a marked improvement in the way Bank financed projects in the Philippines have been executed in the last three years compared with experience in the 1960s when shortages of peso counterpart funds combined with poor administration to cause serious problems. All these projects are now going reasonably well. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of October 31, 1975 and notes on the execution of on-going projects. 21. The Bank's lending program has been designed to continue to support the increased Philippine development effort with its particular emphasis on agriculture and infrastructure. Shortages of domestic revenues led to low investment for these purposes in the past. The last three years have seen major changes which have helped to overcome these constraints and both the ambitious Philippine development program and the Bank's lending program have been designed to make good past neglect and to meet future needs. Commit- ments in FY74 amounted to $165.1 million, and in FY75 $208 million compared to an average of about $30 million a year in the preceding five years. 22. One loan of $42 million for the Magat Irrigation project has already been approved by the Executive Directors in FY76. In addition to the proposed project, other projects which may be ready for Board consideration in FY76 include livestock, fisheries, grain storage, education, urban development and irrigation.  - 6 - 23. IFC has made commitments in the Philippines totalling $76.2 million for investments in 13 companies in the fields of development banking, power, telecommunications, ceramic tiles, paper, petroleum products, nickel mining and refining, chemicals and synthetic fibers. Of these investments, as of October 31, 1975, $18.2 million have been sold, $0.4 million cancelled and $3.4 million repaid, leaving a net portfolio of $54.2 million. On the same date $2.1 million was undisbursed. Preliminary proposals have been received for an aluminum smelter and other projects in the pulp and paper, dinnerware, metal alloys and shipbuilding fields. PART III - THE INDUSTRIAL SECTOR AND INDUSTRIAL FINANCE The Industrial Sector 24. Industry (defined as manufacturing, mining and construction) is the third largest sector in the Philippine economy (after agriculture and services). In 1974, it accounted for almost 30 percent of net domestic product, absorbing over one-third of total fixed investment and providing employment for 15 percent of the total labor force. Manufacturing is by far the largest component of the industrial sector, and in 1974 accounted for 20 percent of net domestic product and for 10 percent of the labor force. Manufacturing enterprises are predominantly privately owned, and generally concentrated in large scale, vertically integrated, capital intensive units. Food and beverages are the largest manufacturing group, followed by chemicals and petrochemicals, and textiles. Geographically, over 65 percent of manufacturing enterprises are concentrated in the Greater Manila and southern Luzon area, although industrialization has been increasing in northern Mindanao and the Western Visayas. 25. Historically, Philippine industrial production was geared pri- marily to meeting the needs of the domestic market and there has been a heavy reliance on protection policies applied through the tariff system and some degree of import control. In the late 1960s, the Government became aware of the problem implicit in this approach and through the Investments Incentives Act of 1967 and the Export Incentives Act of 1970 has sought to diversify the traditional industrial base and to expand exports and industrial employment. Both Acts are administered by the Board of Investments (BOI) in the Department of Industry (DOI). Under these Acts incentives are provided to enterprises which are undertaking productive investments in those industries which are set out in BOI's annually revised investment and export promotion plans. However, there is growing doubt as to whether these policies have been fully successful in overcoming the effects of the earlier protectionist policies, and the National Economic and Development Authority (NEDA) and DOI are currently studying this matter. For the future the Government's industrial stategy is designed: to expand investments in a few large-scale projects such as wood processing, fertilizer, and copper smelters which will contribute to a major expansion of exports or a reduction in imports; to encourage projects to strengthen and diversify non-traditional exports and allow for greater integration in existing industries; and to emphasize the promotion of small and medium industries  - 7 - to boost employment generation, encourage regional dispersal of industry and bring production closer to raw materials and markets. 26. The growth rate of the industrial sector fell to 3.5 percent in 1974 compared to 12 percent during the previous year. This decline is primarily a result of depressed demand for Philippine exports on the part of the country's main trading partners and the concomitant slowdown in the rate of economic growth in the Philippines. Nonetheless, the longer-term prospects for industrial growth are very favorable, because of the existence of the natural and human resource endowments of the Philippines and a very active private sector. In recognition of these prospects, applications for planned investments in 1974 were more than twice the level of the previous year. 27. The Four Year Development Plan for FY75-78 estimates that total industrial investment in the period will be about $3.3 billion. The estimates for the period 1976-80 are about $7.4 billion, or about triple the level of investment in the period 1972-75. Investment in manufacturing is expected to account for about 90 percent of this. These levels of investment will require a large and sustained increase in domestic resource mobilization, as well as a steady inflow of foreign capital on reasonable terms. Industrial Finance 28. The Philippines has a well-developed financial system, but there are insufficient long-term funds available to finance industrial investment. DBP and the Private Development Corporation of the Philippines (PDCP) are the main sources of such finance, and they provide about 95 percent of the long-term finance available to the private sector in the Philippines. Working capital needs are financed mainly by commercial banks, which in 1974 provided $3.6 billion in domestic credit, 30 percent of which went to the manufacturing sector. The remaining gaps in financing are covered by internally generated funds and by equity financing through the capital market. The two long-term financing institutions, DBP and PDCP, accounted for less than 8.5 percent of the Philippines total net financial assets which stood at $12.6 billion at the end of 1974. This low proportion reflects the predominance in the Philippines of institutions and markets dealing in short-term funds. In order to help strengthen the financial sector, the Government has requested the assistance of the Bank, IFC and the IMF to undertake a series of studies of the capital market and the commercial banking system. The proposed loan is expected to help increase the availability of long-term capital in the Philippines by providing financial and institutional support to DBP in its efforts to expand its long term lending to high priority industrial projects. 29. The proceeds of the first loan through DBP (Loan No. 998-PH) have been used to finance a wide variety of sub-projects in textiles, chemicals, energy, edible oil processing, wood processing, milling, mining, machine tool manufacturing and other manufacturing. These sub-projects have estimated economic rates of return ranging from 11% to 80%. The internal financial rates of return for these sub-projects varied from 14% to 50%. DBP expects to approve projects utilizing the entire $48 million available under the first loan by the end of November.  - 8 - PART IV - THE PROJECT 30. The proposed loan is the eighth in a series of Bank Group loans for financing industrial investment in the Philippines. The most recent of these was a $30.0 million Bank loan for the development of small and medium industry which was approved in May 1975 (Loan 1120-PH). The proposed project was appraised in May 1975 and negotiations were held in October 1975. The leader of the Philippine negotiating team was J.V. de O'Campo, Acting Chairman, DBP. The Appraisal Report (No 872a-PH) on the project is being distributed separately to the Executive Directors. Annex III provides a loan and project summary. 31. The proposed loan of $75 million would help finance the foreign exchange costs of capital goods imports for medium and relatively large industrial sub-projects. Eligible enterprises would include those engaged in manufacturing, agro-industries, mining, ocean shipping and tourism. The proceeds of the loan would be directed mainly towards investments which would: further diversify the non-traditional export base; encourage greater domestic value-added through domestic processing of traditional exports; and encourage intermediate and capital goods production. 32. In addition to increasing the availability of medium and long- term resources for medium and large scale enterprises in the Philippines, the proposed loan would continue the process, begun under the first in- dustrial investment credit loan, of assisting DBP to make institutional improvements. These would include improvements in the caliber of DBP's industrial projects department staff, and its project appraisal and follow-up procedures; a strengthening of DBP's long-term resource base; and an improve- ment in DBP's financial performance. The project would also provide for material improvements in the quality of DBP's audits which are carried out by the Commission on Audit (COA) and the Central Bank (CB). 33. At the request of the Government, the proposed loan would, as in the case of previous loans for DBP, be made to the Government which would relend the proceeds of the Bank loan to DBP on the same terms as those of the Bank loan. Within DBP the proposed loan would be handled by Industrial Projects Department I (IPD I) as was the case with the first loan. Both the Bank loan and the subsidiary loan from the Government to DBP would be for 18 years including a grace period of 4 years at an interest rate of 8.5 per- cent per annum. In accordance with Philippine law, the relending rate charged by DBP to sub-borrowers would be 12 percent per annum for loans secured by land and 14 percent for loans which are not so secured (See Section 4.08 of the Loan Agreement). Sub-loans would be committed over the next two years and disbursed over four years. They would be for a maximum term of 15 years, including an appropriate grace period. Sub-borrowers would assume the foreign exchange risk on the currencies of the countries from which goods and services are procured. The Government would bear any residual exchange risk between the currency of procurement and the currency of obligation, for which Govern- ment would charge DBP a fee of 0.75 percent per year on amounts outstanding  on the Bank loan (see Schedule 3 of Loan Agreement). A ceiling of $5 million would be set for any sub-loan made by DBP for an individual investment project under the proposed loan (See Section 3.04 of the Loan Agreement). As under the first industrial loan to DBP, sub-loans of less than $1 million would be made without the Bank's prior approval. The aggregate limit of such sub-loans would be $30 million (see Section 2.02(b) of the Loan Agreement). Based on experience with the average size of industrial sub-loans under the first loan, it is estimated that with this free limit, about 70 percent by number or 85 percent of the amount of DBP's sub-loans would require the prior approval of the Bank staff. This would enable Bank staff to closely monitor the progress of the project. 34. DBP, established in 1958 as a wholly Government-owned development Bank, operates in all the important sectors of the economy. The bulk of DBP financing, including guarantees and equity investments, has gone to industry which accounts for about $2 billion or 70 percent of total com- mitments. The balance of about $800 million is accounted for by agriculture, real estate and other sectors, including lending to municipalities and private development banks. DBP's financing in the past two years accounted for about 13 percent of total fixed investment in the Philippines, and its industrial financing for 26 percent of total investment in the industrial sector. In addition to its financing, DBP has also helped to promote investment in low-cost housing and has assisted in the establishment of provincial private development banks and the Greater Manila Terminal Food Market. Because of the size of its financing and the wide variety of its activities, DBP has played and is expected to continue to play a central role in the economic development of the Philippines. 35. DBP's present management has continued its efforts to strengthen the institution and to raise the standards of its operations. While there has been some necessary movement of experienced staff, particularly from IPD I, to bolster weaker departments, the overall quality of DBP's management has generally improved. DBP has expanded its professional staff by 30 per- cent since December 1973, and reduced its services staff by 1.5 percent over the same period. IPD I had a total staff of 62 as of April 30, 1975. Since then it has employed 21 additional staff and expects to complete recruitment by the end of 1975 to fill the authorized positions still vacant. IPD I is recruiting mainly recent graduates, and DBP is developing suitable training programs both internally and with the Development Academy of the Philippines (DAP) to enable new staff to become fully operational as soon as possible. In the past year, DBP staff have also made training visits to other DFCs to study their operating systems and adapt them for DBP's use. During negotiations, improved procedures for loan appraisal and supervision were informally agreed upon and the impact of these on IPD I's operations will be closely monitored by the Bank. 36. DBP's lending operations have increased particularly rapidly in the last year and reached an unprecedented level of $324 million in FY75, compared to $39 million in FY74 and $31 million in FY73. In addition to a major and unusual increase in hotel lending operations, DBP's lending increased  - 10 - in other sectors, especially industry. This increase offset a deliberate reduction in DBP's guarantee operations which declined from $373 million in FY74 to $123 million in FY75. Equity investments, mainly in government enterprises, were approved for amounts totalling $28 million in FY75, a much higher level than in the previous two years. 37. DBP's financial position is reasonably sound. As of June 30, 1975, DBP's total assets stood at $1.0 billion and its contingent liabilities (outstanding guarantees) totalled $467 million. Its liquidity position is secure (current ratio 1.3 as is its present long-term capital structure (long-term debt-equity ratio 3.8:1). In order to increase DBP's long-term domestic resources, Government is paying in an additional $100 million (P 750 million) in the next two years to increase DBP's equity. In addition, the Government will convert P 400 million in short-term Treasury deposits in DBP into a loan with a five year maturity (see Section 4.11(c) of the Loan Agree- ment). The Government has also agreed to make by 1980 satisfactory arrangements to support DBP's large hotel financing program (see Section 4.11(a) of the Loan Agreement). To ensure the continued strength of DBP's capital structure, DBP has agreed for the first time to limit total borrowings and outstanding contingent liabilities to no more than 10 times its equity base (see Section 4.05 of the Loan Agreement). This limit is considered satisfactory. DBP has also agreed to set up a special foreign exchange loss reserve account, and to adopt a reserves policy statement satisfactory to the Bank (see Sections 3.01(b) and 4.07 of the Loan Agreement). DBP's net income for FY75 was $10 million, a decline on an annual basis of 21 percent. This is in contrast to the rising trend of FY73 and FY74. The decline in income reflected mainly a decline in collections, as a result of the effects of the economic downturn in FY75 on many of DBP's clients, and rapidly rising expenses. DBP has agreed to take the actions outlined in para. 38 in order to improve its financial performance (see Sections 4.08, 4.09 and 4.10 of the Loan Agreement). 38. DBP's arrears situation, which has improved substantially over the past year, continues to need substantial improvement. As of June 30, 1975, total arrears on the total loan portfolio including interest, amounted to nearly $75 million or 15.5 percent of the portfolio, compared to 23.5 percent a year ago; and the number of accounts in arrears amounted to 60 percent of the total, compared to 57 percent a year earlier. Defaults on guarantees have required DBP to advance an average of about $53 million annually over the past four years. These advances, which are immediately due and payable, amounted to $73 million equivalent as of Mtarch 31, 1975, or 15.6 percent of the outstanding guarantee portfolio. To reduce arrearages on its loan and guarantee accounts, DBP launched a major collection effort, beginning in January 1974, but this was retarded by the economic downturn in FY75. To alleviate the arrears problem, DBP has agreed to: reschedule all accounts in need of such action by March 31, 1976; further improve its system of recording and reporting arrears; establish prompt reminder procedures for overdue accounts and increase its penalty charges (see Sections 4.08, 4.09 and 4.10 of the Loan Agreement). 39. DBP's accounts are audited by Government auditors, whose reports, although thorough in many respects, do not cover certain essential aspects of DBP's financial condition, namely, the quality of the portfolio and the  - 11 - adequacy of provisions made for doubtful accounts. Both DBP and the Govern- ment concur with the views of the Bank staff on the need for improving the coverage of the audit. Agreement was reached during negotiations on the form, coverage and timetable for submission of the improved audits. It was also agreed that in the event audit reports for FY76 and beyond were found to be unsatisfactory, the government would take all such steps, including the appointment of outside independent auditors, as necessary to enable the Bank to make firm judgements about DBP's financial condition (See Section 4.03 of the Loan Agreement). 40. DBP expects to commit loans and guarantees totalling $580 million during the two-year period from July 1, 1975. Projected commitment levels have risen considerably compared to forecasts of 18 months ago, mainly because capital goods prices have increased at a much more rapid rate than anticipated. The proposed loan of $75 million would cover just over 50 percent of DBP's total direct foreign exchange commitment requirements over the next two-year period. DBP would finance the balance through a proposed loan of $25 million from the Asian Development Bank (ADB), and also hopes to obtain additional commercial borrowings. DBP's local currency requirements are expected to be provided by the Government and to some extent through DBP's internal cash generation and resource mobilization efforts. With the institutional improvements described in this report, DBP can be expected to carry out the projected level of operations effectively and to continue to improve steadily its financial position and performance. PART V - LEGAL INSTRUMENTS AND AUTHORITY 41. The draft Loan Agreement between the Republic of the Philippines and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank and the text of a draft resolution approving the proposed loan are being distributed separa- tely to the Executive Directors. The loan would not become effective until a Subsidiary Loan Agreement was concluded between the Government and DBP. 42. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 43. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments December 3, 1975   Page 1 of 3 pages WUNTy DATA1 - PffLUPPINEC AME POPULAIONuh DLCm 300,10 haD RMoiT na (mid-1972) . e sSfcbeln SOCIAL INDICATORS ~~~~asE2sneoR lannd Cuatie GO PER CAPITA US5 (ATLA BASIS) /2 160/ 220/ 220/A 370 /b 310 lb DRICGRAPHIC UM-97tfh rate (per thousaned) .h5/A 1,3/ 36 d2~ 26 Crude death rate (per thsauand) ..12T7 10 /2 13 8 Infant mortality rate (per thueand live birthe) . 0 60-90 11,5o Life expectancy at birth (years) 51 If 56 59 55 65 Gross reproduction rate2 ..3.3 3.2 2.6 4dg 2.5 Population growth rate /2 3.0 3.0(1 3.1 lb 2 5 h 2.2 /h Population growth rate - urban, 2/1.1JL 5Z2 h.5,1 6/ Age structure, (Percent) 0-11. 16 1,/b15 42 40o/b J.5-61, 51 517 52 545 65 and er3 37 3 3 Age dependency ratio A1 1.7 0.97 0.9 0.6 0 Econn,ec dependency rat_io A, 1.7 1.5 1.1 1.1 1.1 Urban population an permest of total 30 /2 32