Philippines - Economic Recovery Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 10866 PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (LOAN 2787-PH) AND ECONOMIC RECOVERY TECHNICAL ASSISTANCE PROJECT (LOAN 2788-PH) JUNE 30, 1992 /ICROylCH/ CO Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit - Philippine Peso (P) 08/86 US$1 - P20.47 01/90 US$1 - P22.46 ABBREVIATIONS AND ACRONYMS APT Asset Privatization Trust CBP Central Bank of the Philippines COA Commission on Audit COP Committee on Privatization DBP Development Bank of the Philippines ERL Economic Recovery Loan ERP Economic Recovery Program EXIM Export-Import Bank of Japan GSIS Government Service Insurance System IFC International Finance Corporation IMF International Monetary Fund LC Loan Committee NEDA National Economic Development Authority OECF Overseas Economic Cooperation Fund of Japan OED Operations Evaluation Department O&M Operation and Maintenance PCR Project Completion Report PIDS Philippine Institute for Development Studies PNB Philippine National Bank PPAR Program Performance Audit Report QRs Quantitative Restrictions SAL Structural Adjustment Loan SSS Social Security System TAL Technical Assistance Loan VAT Value Added Tax FISCAL YEAR January 1 - December 31 FOR OFFICIAL USE ONLY THE WORLD BANK Washington. D.C. 20433 U.S.A. of Directar-Ceneral atMMln Evaluatko June 30, 1992 KEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Program Performance Audit Report on Philippines - Economic Recovery Program (Loan 2787-PH) and Economic Recovery Technical Assistance Project (Loan 2788-PH) Attached, for information, is a copy of a report entitled "Program Performance Audit Report on Philippines - Economic Recovery Program (Loan 2787-PH) and Economic Recovery Technical Assistance Project (Loan 2788-PH)," prepared by the Operations Evaluation Department. Yves Rovani by H. Eberhard K6pp Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. FOR OFFICIAL USE ONLY PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (LOAN 2787-PH) and ECONOMIC RECOVERY TECHNICAL ASSISTANCE PROJECT (LOAN 2788-PH) TABLE OF CONTENTS Page No. Preface . . . . . * * * . . * * * . - . * * * . . . . . . . . . . . . Basic Data Sheet . . * * * . * . . * . * . . . . . . . . . . . . . Evaluation Summary . . . * * . . . . . * . . . . . . . . . . . . . . ix PROGRAM PERFORMANCE AUDIT REPORT I. INTRODUCTION.......................... . II. BACKGROUND: THE ECONOMY PRIOR TO 1986......... ... . 1 III. THE ECONOMIC RECOVERY PROGRAM.......... ...... . 3 IV. THE BANK'S ECONOMIC RECOVERY LOAN...............5 V. IMPLEMENTATION OF THE ERL.............. .... . 9 VI. OUTCOME: THE ECONOMIC SITUATION AFTER LOAN CLOSING.... . . . 11 VII. SELECTED ISSUES............... .... . . . . . 13 A. Trade Regime.............. ... . . . . . 13 B. Macroeconomic Management........ ... . . . . . 15 C. Loan Design and Preparation....... .... . . . 19 D. Coordination of Cofinancing... .... . . . . . . . 21 E. Social Dimensions of the Adjustment. .... . . . . . . 21 F. Debt Restructuring and Burden Sharing. .... . . . . . 22 VIII. OVERALL EVALUATION............ ..... . . . . . 22 IX. LESSONS FOR THE FUTURE........ ..... . . . . . . . 23 TABLES 1. Key Macroeconomic Indicators . . . . . . . . . . . . . . . . . 12 2. Effective Protection by Major Groups . . . . . . . . . . . . . 15 3. Gross Domestic Investment . . . . . . . . . . . . . . . . . . 16 4. Structure of National Government Revenues . . . . . . . . . . 17 5. National Government Expenditures for Operations and Maintenance 17 6. Real Effective Exchange Rates . . . . . . . . . . . . . . . . 19 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Table of Contents (cont'd) Page No. ANNEXES I. Loan Agreement: Conditions for Tranche Release .... 25 II. Release of the Second Tranche - Memorandum to the Executive Directors............. .... . . . . 29 III. Release of the Third Tranche - Memorandum to the Executive Directors............. .... . . . . 36 IV. Key Macroeconomic Indicators, 1980-90...... ... . . . . 42 V. Philippines - Debt Outstanding and Disbursed.... . . . . . . 43 VI. Comments from The Central Bank oi Philippines. .... . . . . 44 VII. Projected and Actual Recovery Patterns. ........ . . . . 48 PROJECT COMPLETION REPORT PART I: Project Review from the Bank's Perspective 1. Project Identity............ ..... . . . . . . 51 2. Background................. ..... . . . . 51 3. The Program for Economic Recovery........ .... . . . 52 4. The Program of Action under the Economic Recovery Loan . . . . 53 5. Program of Action under the Economic Recovery Technical Assistance Project . . . . . . . . . . . . . . . . . . . . . 55 6. Role of the Bank in the Design of the Operation. ... . . . . 55 7. Accomplishments of the Adjustment Program. ... . . . . . . . 56 8. Monitoring of the Adjustment Program..... .... . . . . 66 9. Conclusions............... .... . . . . . . . 66 TABLES 1. Key Macroeconomic Indicators....... .... . . . . . . 58 2. Government Tax Revenues............. .... . . . 59 3. Elimination of Quantitative Restrictions on Imports . . . . . 61 4. Government O&M Expenditures and Public Investment. ... . . . 62 PART II: Prolect Review from the Borrower's Perspective 1. Introduction................ ..... . . . . 69 2. Tax Reforms.................. .... . . . . 69 Table of Contents (cont'd) Page No. 3. Trade Liberalization.......... ..... . . . . . . 72 4. Public Investments........... ..... . . . . . . 74 5. Government Financial Institutions...... ... . . . . . . 76 6. Overall Assessment........... ..... . . . . . . 81 TABLES 1. Economic Recovery Program Policy Matrix...... ... . . . 83 2. Status of the 1986 Tax Reform Package..... ... . . . . . 88 3. Revenue Impact of 1986 Tax Reform Package, 1986-1988 . . . . . 91 4. National Government Revenues, 1980-1990..... ... . . . . 94 5. Implementation of Phase I and Phase II of the Import Liberalization Program . . . . . . . . . . . . . . . . . 95 6. Import Values of Commodities Liberalized under Phase I and Phase II of the Import Liberalization Program, 1985-1990 . 97 7. Public Investments, 1980-1990.......... .... . . . 98 8. Real Levels of Expenditures of the National Government, Obligations Basis, 1980-1990 . . . . . . . . . . . . . . . . 99 9. Total Assets, Loans and Discounts and Net Profit of PNB, 1980-1988 . . . . . . . . . . . . . . . . . . . . . . . . 100 10. Key Financial Performance Indicators: PNB, 1986-1988 . . . . . 101 11. Total Assets, Loans and Discounts and Net Profit of DBP, 1980-1988. ..... . . . . . '..........................102 12. Key Financial Performance Indicators: DBP, 1986-1990 . . . . . 103 13. Selected Macroeconomic Indicators, 1985-1990. .... . . . .104 14. Selected National Income Accounts Data, 1986-1990 . . . . . 105 ANNEX I. Comments on the PCR from the Development Bank of Philippines 106 PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (Loan 2787-PH) and ECONOMIC RECOVERY TECHNICAL ASSISTANCE PROJECT (Loan 2788-PH) PREFACE 1. This is the Program Performance Audit Report (PPAR) on two loans to the Philippines: the Economic Recovery Program (Loan 2787-PH), for US$300 million and the Economic Recovery Technical Assistance Project (Loan 2788-PH) for US$10 million. Both loans were approved by the Board on March 17, 1987. The first loan war closed on December 31, 1989. On the Technical Assistance Loan, the Bank advanced US$1 million to a speclai account in December, 1987, but this advance was refunded by the Government in February, 1990. The loan was cancelled undisbursed. 2. The PPAR was prepared by the Operations Evaluation Department, and the attached Program Completion Report (PCR) was prepared by the Country Department I, East Asia and Pacific Region. Part II of the PCR incorporates the Government's assessment of the operations. 3. The PPAR is based on the PCR, the President's Report, the loan documents, economic and se7tor reports, loan and country files, and reports on tollow-on operations. OED staff interviewed present and former Bank staff and IMF staff who had been associated with these operations or with general country work. An OED mission visited che country Jn November, 1991. The mission interviewed present and former government officials, the new authorities of PNB, DBP and APT, the Philippine Institute for Development Studies, private bankers, businessmen and academic economists to secure their views on these particular operations and, more generally, on Bank assistance to the Philippines. The mission also visited the Manila offices of USAID, the Japan Overseas Economic Development Fund and the Asian Development Bank. Their kind cooperation and valuable assistance in the preparation of this report is gratefully acknowledged. 4. The PCR presents a good account and assessment of the background leading to these operations, of the preparation and implementation experience and of the outcome. Part II is particularly useful in reflecting the Government's insights and judgments regarding the loans. The PPAR presents an overall evaluation and draws some useful lessons for future adjustment and Technical Assistance operations. 5. The draft PPAR was sent to the Borrower for comments. The Central Bank of The Philippines responded and its comments are inccrporated throughout the PPAR and reproduced as Annex VI. On June 29, 1992 the Development Bank of - it - the Philippines (DBP) informed OED that it took exception to a statement in the PCR regarding tha privatization of rBP (cf. PCR, page 65, para. 7.27). The communication received from DBP is reproduced as PCR Annex I, page 106. - iii - PROJECT PERFORMANCE AUDIT REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (LOANS 2787-PH) BASIC DATA SHEET LOAN POSITION (Amounts in US$ Million) As of April 30, 1992 Loan Original Disbursed Cancelled Repaid outstanding 2787 300.0 300.0 0.0 0.0 300.0 CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENr FY 88 FY89 FY90 FY91 Appraisal Estimate (US$M) 100 200 300 300 (Revised) Actual (US$M) 200 200 200 300 Actual as % of Appraisal (%) 200% 100% 67% 100% Date of Final Disbursement: January 3, 1990 PROJECT DATES Original Actual Initiating Memorandum 07/86 07/86 Letter of Development Policy 11/86 01/02/87 Negotiations 12/86 01/87 Board Approval 10/86 03/17/87 Loan Agreement 10/86 03/30/87 Effectiveness N/A 06/04/87 Lean Closing N/A 12/31/89 Actual Completion N/A 01/03/90 - iv - STAFF INPUTS (staffweeks) Preappraisal Appraisal Negotiation Supervision Other Total 1987 3.2 65.7 18.3 7.7 3.6 98.5 1988 1.6 21.1 0.6 23.3 1989 12.8 12.8 1990 1,8 1.8 1.991 7.8 7.8 Total 4.8 65.7 18.3 51.2 4.2 144.2 MISSION DATA No. of No. of Staff Date of Month/Year Weeks Persor.s Weeks Report Appraisal 07-08/86 1.7 6 10.3 08/11/86 Supervision I 05-06/87 2.3 2 4.6 06/08/87 Supervision II 10-11/88 2.15 3 6.4 11/09/87 Supervision III 11/88 2.4 2 4.8 11/22/88 Completion 06/89 0.7 2 1.4 07/11/89 -v - OTHER PROJECT DATA Borrower/Executing Agency: Government of The Philippines Follow-on Project(s): Project: Economic Recovery Technical Assistance Project Loan No.: 2788-PH Amount: US$10.0 million Board Date: 03/17/87 Project: Program for Government Corporations Loan No.: 2956-PH Amount: US$200.0 Board Date: 06/15/88 Project: Financial Sector Adjustment Loan No.: 3049-PH Amount: US$300.0 Board Date: 05/04/89 Project: Debt Management Program Loan No.: 3149-PH Amount: US$200.0 Board Date: 12/21/89 - vi PROJECT PERFORMANCE AUDIT REPORT PHILIPPINES ECONOMIC RECOVERY TECHNICAL ASSISTANCE PROJECT (LOANS 2788-PH) BASIC DATA SHEET LOAN POSITION (Amounts in US$ Million) As of April 30. 1992 LoaD Original Disbursed Cancelle Reaid Outstanding 2788 10.0 0.0 10.0 0.0 0.0 CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS EY.A FY89 Y0 X2 EX21 Appraisal Estimate (US$M) 0.5 3.0 7.0 10.0 Actual (US$M) 0.0 0.0 0.0 0.0 Cancellations 0.0 5.0 10.0 10.0 PROJECT DATES Original Actual Initiating Memorandum 07/86 07/86 Letter of Development Policy 11/86 01/02/87 Negotiations 12/86 01/87 Board Approval 10/86 03/17/87 Loan Agreement 10/86 03/30/87 Effectiveness N/A 06/04/87 Loan Closing N/A 12/31/89 Actual Completion N/A 01/03/90 - vii - STAFF INPUTS (staffweeks) Preappraisal Appraisal Negotiation Supervision Other Total 1988 0.4 0.4 1989 7.8 7.8 Total 8.2 8.2 MISSION DATA No. of No. of Staff Date of Month/Year Weeks Persons Weeks Report Appraisal 07-08/86 1.7 6 10.3 08/11/86 Supervision I 05-06/87 2.3 2 4.6 06/08/87 Supervision II 10-11/88 2.15 3 6.4 11/09/87 Supervision III 11/88 2.4 2 4.8 11/22/88 Completion 06/89 0.7 2 1.4 07/11/89 OTHER PROJECT DATA Borrower/Executing Agency: Government of The Philippines Follow-on Project(s): Project: Economic Recovery Program Loan No.: 2787-PH Amount: US$300.0 million Board Date: 03/17/87 Project: Program for Government Corporations Loan No.: 2956-PH Amount: US$200.0 Board Date: 06/15/88 Project: Financial Sector Adjustment Loan No.: 3049-PH Amount: US$300.0 Board Date: 05/04/89 Project: Debt Management Program Loan No.: 3149-PH Amount: US$200.0 Board Date: 12/21/89 - ix - PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (Loan 2787-PH) and ECONOMIC RECOVERY TECHNICAL ASSISTANCE PROJECT (Loan 2788-PH) EVALUATION SUMMARY Introduction 1. When the Government of Corazon 2. The international community Aquino came to power in February 1986, welcomed the Aquino Administration and following a peaceful revolution, the prepared to give it strong support, economic situation of the Philippines including debt relief and new money. was precarious. Economic growth had The US Administration designated the been negative in the last two years, Philippines as one of the "Baker resulting in a cumulative loss of over Initiative" countries, which would 15 percent in output per capita. The translate into full bilateral and unemployment rate in Metro Manila had multilateral backing in exchange for more than doubled, to 25 percent. The adoption of an approved program of crisis had hit the poor particularly structural adjustment. A generalized hard, and three-fifths of the sense of urgency to help the fledgling population were below the poverty democracy was shared by all donors, line. The country's infrastructure including the Bretton Woods had been grossly neglected, and major Institutions. bottlenecks were emerging in power, transport and water. In spite of The Economic Recovery Proar previous Bank-supported attempts at import liberalization, the trade 3. With much help from the Fund and regime provided heavy protection to the Bank, the new Government drew up a domestic industry, at the expense of Medium-Term Development Plan, the agriculture and exports. A heavy Economic Recovery Program (ERP). The foreign debt burdened the public ERP's main objectives were: finances and the monetary authorities, who had been instructed to assume (i) poverty alleviation and social external debt obligations of both justice; public and private entities. Much of the financial sector, public and (ii) growth acceleration with private, was either bankrupt or in increased economic efficiency; distress. To deal with this daunting and, challenge, the Aquino Administration had to rely on a depleted civil (iii) reduction of the Governent's service, because a high rate of involvement in the economy, turnover among upper level government giving greater emphasis to officials had followed the transition private initiative. of power. 4. In support of the ERP the IMF (iii) Public Expenditures. Large extended an 18-month standby increases in public expenditures arrangement, complemented by a for investment and operations Compensatory Facility, for a total and maintenance (O&M) in the package of SDR 422 million. The social and economic sectors in standby program --approved in order to bring these priority September 1986-- provided for an expenditures back to levels that expansionary fiscal program, to be had been normal in the recent financed with increased foreign past. assistance. The consolidated public sector deficit was allowed to rise (iv) Reform of Government Financial from 6.1 percent of GNP in 1985 to 7.5 Institutions. Major percent of GDP in 1986 and to remain reorganization of the two above 5 percent of GDP in the next two largest government-owned banks, years. The program did not call for a the Philippirvs National Bank real devaluation, but included wide- (PNB) and the Development Bank ranging structural reforms, which had of the Philippines (DBP), which been designed in close consultation were technically bankrupt. with the Bank. Rationalization of the banking sector, reducing the The Bank's Economic Recovery Loan government's direct presence in (ERL) the financial system to encourage greater private 5. In parallel with the IMF, the ownership. Bank worked closely with the Government to draw up its own 6. There was a considerable overlap adjustment loan, the ERL, for US$300 between the ERL and parts of the million. The ERL contemplated standby agreement. This was a specific actions in four principal deliberate decision in order to ensure areas: the coordination of both programs. The Region proposed to disburse the (i) Reform of the Tax System. This ERL in three tranches, as a way of included rationalization of enhancing supervision and income taxes, streamlining of implementation. After loan approval, indirect taxes, including the Japan Overseas Economic substitution of a Value Added Cooperation Fund (OECF) contributed Tax (VAT) for a Sales Tax, and Yen 30 billion (equivalent to US$240 improvements in tax million) of cofinancing, and the Japan administration. Export-Import Bank (EXIM) cofinanced Yen 50 billion (equivalent to US$300 (ii) Trade Reform. Implementation of million). Disbursements under both import liberalization reforms cofinancing loans were expected to be that had been agreed upon under linked to the releases of the three previous SALs but either not tranches of the ERL, although the EXIM fully implemented or implemented loan disbursements would finance but reversed. Further investments under the government's elimination of quantitative public investment program (PIP). Such restrictions (QRs) and public arrangements involved the potential announcement of a calendar and risk of conflicts when the timing of schedule for tariff reform aimed bilateral disbursements, based on at reducing protection and public investment execution, did not making it less uneven, coincide with that of tranche - xi - releases, which are determined by the jalementation-of the ERL execution of prescribed conditionality. 10. Two factors that helped achieve a considerable degree of compliance 7. The government's Letter of with the conditionality were, first, Development Policy and the President's the fact that much of the required Report spelled out the conditionality actions was taken prior to release of linked to each tranche disbursement in the first tranche and, second, the considerable detail. The Loan recourse to three tranches rather than Agreement, on the other hand, was the more frequent two. rather vague and imprecise as regards the conditionality. 11. Compliance was excellent in the area of Government Financial 8. Recognizing the Administration's Institutions. There was a remarkable limited capacity to carry out the turnaround in the condition of DBP and proposed reforms, the Bank put PNB, and a new sunset institution, the together a US$10 million Technical Asset Privatization Trust (APT), was Assistance Loan (TAL) to complement created to dispose of the many non- the ERL. It was proposed to focus the performing assets that were TAL on the following areas: transferred from the books of those two banks to the Government. A (i) Institutional strengthening of process of divestiture was initiated. DBP and PNB. 12. Significant reforms were carried (ii) Disposition of non-performing out in taxation, the most significant assets to be transferred to the being the introduction, before Government by DBP and PNB. schedule, of a VAT in replacement of sales taxes. The structure of income (iii) Study of social security taxes was also improved. These institutions. measures, however, did not yield as much increase in revenues as had been (iv) Strengthening the Central Bank's expected, because of two main reasons. regulatory functions. First, severe problems in tax administration were not corrected and, (v) Supporting the Ministry of second, the shift from sales taxes to Finance to improve expenditure the more complex VAT resulted in loss control and accounting. of revenues because of the extremely short time that was allowed for the 9. It is not evident that the change. The share of import duties in Borrower participated much in the total tax revenues declined somewhat, decision to include the TAL in the ERL but continued to be high (around one- package, or in the choice of areas of fifth). focus. It is similarly not evident that the actual activities to be 13. The process of import carried out were well defined in liberalization was carried forward advance, in consultation with the under the ERL, and effective middle-level Borrower staff that would protection was generally lowered as a have been recipient of the technical result of the removal of QRs on a assistance. large number of items. But this - xii - process did not go as far as had been 16. Monitoring and supervision planned, owing to strong domestic missions were frequent and effective, opposition from business and Congress. and well coordinated with the IMF. The Government took several The Government participated fully with initiatives to reduce import duties, its own periodic reporting, and the but had to withdraw those initiatives Resident Mission provided valuable because of that strong resistance. support. Also, because import duties continued to represent a significant part of O total tax revenues, a further reduction would have created serious 17. The country's economic situation fiscal difficulties. improved markedly during the period of ERL implementation, 1987-89. 14. The dual objectives of raising Stimulated by capital inflows and the public investment expenditures to 5 - return of confidence, imports and 6 percent of GNP, and bringing O&M private investment revived and, with expenditures in the social and considerable excess capacity in the economic sectors to their real 1982 system, economic growth accelerated. levels were not attained, owing to a Tax revenues increased some, the tax combination of fiscal constraints on structure improved (although its spending and institutional weaknesses. administration remained weak) and the Management waived the first condition public sector deficit was reduced. when releasing the second and third The ERL contributed to this tranches of the loan, on the basis improvement in a number of ways. that there had been some significant First, by being part of a increase in public investment comprehensive package that included expenditures, that their composition the IMF standby arrangement, strong was appropriate, and that economic aid coordination and debt relief growth was accelerating as a result of activities in which the Bank played a expanding private investment. As key role. These efforts contributed regards O&M expenditures, at the time to relieve the foreign exchange of release of tranches 2 and 3, constraint and reinforced the return Management believed that the targets of private sector confidence. Second, were going to be met, although later the ERL helped by directly addressing revisions to the figures showed that some critical problem areas, such as expenditures had fallen short of the the distressed financial sector and conditionality. the need for public spending in maintaining the infrastructure. 15. Disbursements of the first two tranches of US$100 million each took 18. The growth momentum, however, place as originally planned, but the was not sustained. In 1990 GDP growth third tranche was delayed pending fell, domestic and external balances completion of some required actions. widened and inflation accelerated. This delay required extending the While uncontrollable events --terms of closing date by six months. The TAL trade losses, a major drought, an was cancelled at the government's earthquake, the Gulf war-- request. The authorities indicated precipitated the decline, it became that they could carry out the proposed clear as well that underlying activities either with their own weaknesses limiting the effectiveness resources or from grant sources. of macroeconomic policies had not been corrected. - xiii - 19. Monetary and exchange rate were not reached. This was due in policy were compromised owing to the part to financial constraints, and in precarious financial situation of the part to the design of the Central Bank. This, in turn, made conditionality. The public trade reform harder to pursue. The expenditure targets were set at the public sector deficit expanded, due to most aggregate level, expressed as growing subsidies on domestic energy percentages of GDP, without ndequate as adjustment to higher international attention to the reality underlying oil prices was delayed. Thus, efforts such numbers. The loan package did to increase public investment and O&M not specify what those numbers meant expenditures were continuously in terms of governmental jurisdictions thwarted, and severe infrastructure involved, kind of expenditures to be bottlenecks continued to hamper included, sectorial and geographic economic growth. This experience distribution, etc. The institutional served to expose areas where the ERL capacity to carry out those might have been more effective, expenditures (which represented a particularly trade regime and public large increase with respect to current expenditures. levels) were also not adequately considered, even though Bank Projects 20. The main elements of the staff were aware of the serious Government's Import Liberalization administrative constraints. Program were the removal of QRs and changes in the structure of tariffs, 22. Macroeconomic management issues to be pre-announced in order to give contributed to the problems clear signals for the private sector encountered, by not having tackled to invest in new export-oriented earlier the deteriorating financial activities. Considerable progress was position of the Centrl Bank of the accomplished une-er this program, and Philippines (CBP). By 1986 the CBP the average level of effective was already experiencing heavy losses protection for the economy as a whole (realized and not realized) because it was reduced from 49 percent in 1985 to had been instructed to take on 36 percent in 1988. This reduction, extraordinary obligations. These however, fell short of what had been included assuming the foreign currency expected, and the average figure does liabilities of certain public and not fully reveal the extent to which private enterprises, advancing the individual sectors remained highly payment of foreign interest on protected. Thus, "importables" for publicly guaranteed debt, and making all sectors continued to receive an forced loans to failing firms. To effective protection of 75 percent, absorb the excessive liquidity and certain industrial sub-groups resulting from these losses, the CBP received effective protection higher had to carry out open market than 100 percent. The Government operations which further increased its tried repeatedly to pass legislation losses. making further progress towards liberalization, but only in July 1991 23. Because of the CBP's financial it succeeded in passing a new tariff distress, monetary and exchange rate code. policy conflicted with the ERL's goals. The CBP's domestic borrowing 21. In the area of public operations contributed to raising expenditures, the desired targets for domestic interest rates and to investment in key priority areas and crowding out the private sector, thus p&M for social and economic sectors limiting the expansion of private - xiv - investment. Furthermore, CBP's and to prevent a worse deterioration external debt position made it of the physical infrastructure than extremely vulnerable to exchange-rate what has been observed. All these devaluations, leading it to conduct a are very positive results. very conservative exchange-rate management. Thus, the country's Lessons of Experience effective real exchange rate remained overvalued, at least with respect to 26. The experience gained during its main competitors for export design and implementation of the ERL, markets. This, in turn, made it was generally satisfactory. it harder to reduce further the levels of serves, nevertheless, to provide protection and to stimulate private lessons that can be useful in future investment in export-oriented adjustment operations. Most of these activities. lessons confirm findings of earlier OED evaluations of adjustment loans in OverallaEvaluation different regions. 24. The ERL provided a vehicle to 27. The practice of multiRle establish a fruitful dialogue of the tranchin can rovide an effective Bank with the new Administration, tool to ensure fuller comliance with This dialogue helped to create a the conditionality and obectives of consensus among the members of the adjustment operations. incoming Government on the desirability to continue and deepen Coordination with Other Donors the reforms that had been initiated under the deposed regime. Although 28. In most cases the success of an the specific results of this operation adjustment program is closely tied to may have been mixed, and the progress the macroeconomic framework. The link of the structural change since then takes place through the real exchange may have been uneven, the process of rate, the mix between fiscal and change was not interrupted, and monetary poicy, the choice between follow-on operations are still revenue enhancement and expenditure carrying it forward. Interviews in reduction to control a fiscal deficit, the field conducted by OED staff etc. While the IMF has primary confirmed that the Bank's intellectual responsibility for these areas, Bank leadership provided an important staff need to ensure that the influence during the transition structural adustment rogram that it period. Had this been the only suorts is fully consistent with the accomplishment of the ERL, it would macroeconomic framework. both in its have been sufficient to consider the design and in its implementation. It operation a success. may still be appropriate to repeat here one of the lessons derived from 25. But in addition to the above, the audit of the first two SALs to the the program financed by this loan Philippines: "When designing helped to drastically improve the structural adjustment programs it may condition of the two largest not be sufficient for the Bank to government-owned banks (BNP and DBP), leave matters of central economic and to begin a profound process of financial management to be covered by divestiture, to start the the IF in possible standby restructuring and rationalization of arrangements." the tax system, to make some further progress towards trade liberalization - xv - 29. Coordinaticn of cofinancing 31. Close cooReration of Projects or activities requires careful planning, Sector staff in the design an making sure that the donors understand suRervision of adjustment operations the need for the loan conditionality can be most valuable, even if the and fully share the conviction that primary responsibility rests with such conditionality is desirable. Programs or Country Operations. This Rules for disbursement under various is particularly important in areas tranching arrangements should be related to public investment and clearly spelled out in advance, and a maintenance of the physical financing program drawn out early on, infrastructure, including assessments to ensure both that the available of the institutional capabilities. financing is consistent with the reform program and that disbursement Borrower Ownership and Participation decisions of one donor do not undermine the reform program of 32. In designing Technical another donor. assistance projects it is Rarticularly ImRortant to ensure full involvement Internal Bank Organization and particiRation of the Borrower. not only at the highest levels, but also 30. The Bank must make every effort at the middle levels where the to ensure that the institutional technical assistance will be capacity to carry out the desired delivered. This includes precise program exists in the Government. formulation of work programs and terms This is particularly relevant when of reference. Budgetary provisions dealing with a young administration. and staffing arrangements for close In this connection, it can be risky to and intensive supervision of TALs need plan the elimination of a proven tax be made early on, before Board (even if it is sub-optimal) for a more presentation. Projects and sector efficient tax (such as the VAT) before staff should normally be closely adequate training and administrative involved in these activities. arrangements are fully in place for administration of the new tax. PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (LOAN 2787-PH) and ECONOMIC RECOVERY TECHNICAL ASSISTANCE PROJECT (LOAN 2788-PH) I. INTRODUCTION 1.1 This report evaluates the results of a loan in support of the Philippines Economic Recovery Program, for US$300 million, and of a complementary Technical Assistance loan for US$10 million, both approved by the Board on March 17, 1987. The evaluation places these loans in the context of two Structural Adjustment Loans (SALs) that preceded them, and of subsequent lending operations. II. BACKGROUND: THE ECONOMY PRIOR TO 1986 2.1 After a long period of prosperity and growth, the economy of the Philippines faced increasing difficulties during the latter part of the seventies. Between 1978 and 1981, the terms of trade fell by 30 percent. Public expenditures grew much faster than revenues. Large internal and external deficits were financed by heavy borrowing, mostly foreign. Inflation accelerated. These difficulties were caused in part by external events. However, because the country had relied on a strategy of import-substituting industrialization, the industrial sector stagnated when the domestic market became saturated towards the end of the decade. 2.2 To deal with the balance-of-payments crisis, the Government adopted a stabilization program for 1980/81, supported by a standby arrangement for SDR 410 million with the IMF. The program's objectives were to sustain economic growth, reduce the rate of inflation and strengthen the balance of payments. The Bank added its support with a first Structural Adjustment Loan (SAL), for US$200 million, approved in September, 1980. The SAL's objectives were to revitalize the manufacturing sector through a combination of import liberalization, support for manufactured exports, incentives for industrial restructuring and new investments, and a program of major industrial projects to accelerate industrial development. 2.3 The country met most of the standby program's criteria. However, after the program's end the economic situation deteriorated again in 1982. Expecting that a world economic recovery would boost exports and thus reduce the external deficit, the Government pursued expansionary fiscal policies. But the external environment deteriorated further, and the authorities had to resort to substantial external borrowing to cover the widening gap. A new one-year standby arrangement with the IMF for SDR 315 million was put into effect in February - 2 - 1983. It called for a gradual restoration of aggregate equilibrium through monetary and fiscal policies. 2.4 Bank staff, having found that program implementation under SAL I had been satisfactory, put together a second SAL. This loan, for US$302.3 million, was approved in April, 1983. The new loan continued to focus on industrial and trade policies, in a further attempt to correct the bias against export industries. It also contemplated improvements in energy policy, aimed at speeding up development of domestic energy resources and strengthening demand management. 2.5 Implementation of SALs I & II took place during a period of increasing economic and political turmoil. The Philippine economy was suffering severe difficulties owing to the world recession, low foreign demand for its traditional exports, high energy prices, sharply higher international interest rates and a domestic financial scandal. In August 1983, during the course of SAL II, Benigno (Ninoy) Aquino --the major opposition leader-- was assassinated. This event precipitated serious civil unrest in the country, accompanied by capital flight, reduced capital inflow, widespread business and bank failures and severe deterioration in the general economic situation. The country failed to meet the standby performance criteria. In October the authorities requested a standstill on external debt repayments. Although the country had reversed some of the trade liberalization provisions of the SALs, the Bank released the second tranche of SAL II in December 1983, in the expectation that the new restrictions would be lifted soon. 2.6 Short term crisis management, in the midst of a deep recession, dominated government economy policy for the next two years. Inflation accelerated, peaking at 66 percent during 1984. New import and exchange restrictions were imposed, further eroding some of the progress towards trade liberalization that had been made under the SALs. But during 1984 the authorities began to regain control over financial developments and to restore order in the external accounts. Fiscal and monetary policy became more restrictive and the exchange system was reformed, leading to a float that eliminated black market differentials. Then in December 1984 the IMF extended an 18-month standby arrangement for SDR 615 million. This program helped to restore some financial equilibrium and reduce payment arrears. The 1983-85 crisis had a heavy cost in terms of economic growth. Aggregate GNP dropped by more than 10 percent, resulting in a cumulative loss of over 15 percent in output per capita. The unemployment rate in metro Manila more than doubled, reaching 25 percent. 2.7 With the rise to power of the Government of Corazon Aquino in February 1986, following a peaceful revolution, the economic situation began to improve. The country was pacified, the external environment became more favorable, and the new Government signalled a strong commitment to broad and comprehensive reforms to reduce corruption and rationalize economic management. All this helped to restore private sector confidence. But the problems facing the Philippine economy seemed almost intractable: the country's infrastructure had been seriously neglected and major bottlenecks were emerging in power, water and transport. The poor had been hit hard by the crisis: three-fifths of the population were estimated to be below the poverty line. The trade regime -3- continued to be highly protective of domestic manufacturing and discriminatory against export-oriented activities and agriculture in general. A heavy foreign debt burden was particularly onerous on the public finances and on the monetary authorities, who had been instructed to assume foreign debt obligations of both public and private entities. Much of the financial sector was either bankrupt or in distress. The task of rebuilding the country, furthermore, was made particularly hard by the large turnover of key upper level officials throughout the Government. III. THE ECONOMIC RECOVERY PROGRAM 3.1 The international community welcomed the Aquino Administration and prepared to give it strong support. A Consultative Group meeting held in Tokyo recommended generous financial assistance, provided that the new Government adopted substantial policy reforms. The United States designated the Philippines as one of the countries to be included in the "Baker Initiative", which would translate into full bilateral and multilateral backing in exchange for adoption of an approved program of structural adjustment. A generalized sense of urgency to help the fledgling democracy was shared by all donors, including the Bretton Woods Institutions. 3.2 With help from the Bank and the Fund, the new Government started to draw up a medium-term development plan, the Economic Recovery Program (ERP). The ERP had the main objectives of: (i) providing greater attention to poverty alleviation and social justice; (ii) accelerating growth and stimulating increased economic efficiency; and, (iii) reducing the Government's involvement in the economy and giving greater emphasis to private initiative. 3.3 The ERP's objectives were consistent with the Bank's own view of the development priorities for the Philippines. Operationally, the ERP focused on a continuation of the major outstanding structural reforms that had been left untouched or uncompleted by the previous Administration. 3.4 The IMF immediately initiated Article IV consultations with the new authorities, and a mission visited Manila during March 10-15, followed by others in April, June and July/August, 1986. (The Bank's country economist participated in some of these missions.) Although performance under the ongoing standby arrangement was generally satisfactory, the new authorities chose to cancel it in advance of the third program review and to request a new 18-month standby arrangement for SDR 198 million. This was complemented by a SDR 224 million Compensatory Facility. Both were approved by the IMF in September 1986. Taking into account that considerable adjustment had already taken place under the previous program, the 1986-88 program did not aim at reducing external imbalances, but rather at a revival of growth, calling for increased support from external creditors. -4- 3.5 Consistent with the growth-oriented strategy, the Fund program raised the medium-term GNP growth target from a strong negative in 1984 and 1985 to 1.5 percent in 1986, and to 6 - 7 percent for 1987. The programmed external current- account balance was also raised, from equilibrium in 1985 and a 3 percent of GNP surplus in 1986 to deficits of 1.6 and 2 percent of GNP in 1987 and 1988 respectively. The consolidated public sector deficiti was allowed to rise from 6.1 percent of GNP in 1985 to 7.5 percent of GNP in 1986 and to remain at levels higher than 5 percent of GNP in the following two years. The Fund recognized the importance of an export-oriented foreign exchange policy for the success of the trade liberalization program, and pointed out that the substantial real appreciation of the peso in late 1984 and early 1985 had been prejudicial. Nevertheless, noting that a limited depreciation of the currency had recently taken place, the IMF program did not call for further action on this front, in the expectation that market forces would by themselves bring about the necessary corrections. The Fund paper stated that foreign exchange intervention by the monetary authorities would be limited to help avoiding a real appreciation. 3.6 Included in the IMF program were wide-ranging structural reform measures, many of which had been designed in close collaboration with the Bank. These included: (i) A tax reform package consisting of raticnalization of income taxes (globalization, reduction of high marginal rates), abolition of export duties, simplification of indirect taxes, introduction of a Value Added Tax (VAT), increases in the minimum import duties to a 10 percent minimum, and withdrawal of tax exemptions. (ii) Rationalization of public expenditures, setting minimum levels for investment and operation and maintenance outlays. (iii) Reform of 214 public nonfinancial corporations, including privatizations, consolidations, and improving managerial practices. (iv) Reform of government financial institutions, with emphasis on the Development Bank of the Philippines (DBP) and the Philippine National Bank (PNB). (v) Trade liberalization, to restore and carry forward the reforms that had been started under SALs I & II. 1 The IMF definition of Consolidated Public Sector was changed in 1986 to include, in addition to the National Government, 14 major and other smaller public corporations, local governments, the social security system, government financial institutions, and the Central Bank. The 1986 Standby Arrangement Staff Report explained that this expanded framework provided a broader measure of the size of the public sector deficit and its financing claims on domestic and foreign resources. Cf., International Monetary Fund, Philippines - Staff Report for the 1986 Article IV Consultation and Request for Stand-By Arrangement, EBS/86/222, dated September 22, 1986, particularly page 5. 1i Ibid., page 14. -5- (vi) Agricultural policies aimed at improving trading and marketing practices and investment policies in key subsectors, with emphasis on sugar, coconuts and foodgrains. IV. THE BANK'S ECONOMIC RECOVERY LOAN 4.1 rari-passu with the IMF preparation of its program the Bank started to prepare its own country assistant agenda and remained closely involved in the policy dialogue. An economic mission visited Manila in April, 1986 and its economic report provided a foundation for the Economic Recovery Loan (ERL)Q1. The report recommended the adoption of growth-oriented policies, to be financed through a much intensified effort at public resource mobilization (the report pointed out that the country's tax effort was exceptionally low) and by expanded external financing through concessionary loans and debt relief. The report identified as major obstacles for sustained growth the overvaluation of the exchange rate and the excessive protection to domestic manufacturing, which resulted in high negative effective protection for agricultural production and exports in general. It recommended to declare a strong government commitment to a policy of trade liberalization, with preannouncement of a calendar and schedule for elimination of import restrictions and tariff reductions. The report also urged a re-orientation of public expenditures towards maintenance and investment aimed at removing constraints to the expansion of agricultural and industrial production. It called for the rationalization of the financial sector, including limiting the role of the Central Bank to traditional monetary authority functions and redefining the role of government financial institutions. 4.2 In line with the agreed distribution of responsibilities with the IMF, overall macroeconomic and fiscal policy issues were handled by the IMF, as were questions of exchange management. In preparatory discussions between the two institutions, however, the Bank pressed for more decisive action towards an export-oriented exchange rate and for an expansionary financial programming that allowed for faster resumption of economic growth. As stated in the ERL's Initiating Memorandum "...the public sector will have to be a leading force in the recovery effort, given the uncertain political conditions and excess capacity factors that limit private investment."!/ The Bank also felt that the programmed need for external financing should be larger than what the Fund was planning. The Fund's projections were based on its assessment of likely availability of foreign financing, whereas the Bank felt that it was up to the Fund and the Bank to make a strong case for enlarged official aid. The Bank also questioned the validity of defining the public sector deficit as including the Central Bank losses, the recent change in the IMF definitions that resulted in 1t World Bank, The Philippines, A Framework for Economic Recovery (Report No. 6350-PH, dated November 5, 1986). 1i World Bank, Initiating Memorandum for the Philippines Economic Recovery Loan, dated July 9, 1986, para. 12. -6- a much larger deficit than under conventional definitions.Y The Bank argued that inclusion of the Central Bank large losses might lead to misleading international comparisons, since the losses had been caused in part by failures of the private sector to service its loans and not only by public sector spending decisions. In other countries, the Bank argued, such losses would show up under the private sector financing gap. 4.3 The Fund, in turn, objected to the Bank's attempts to incorporate an explicit real exchange-rate target into the ERL program, stating that a real depreciation of the peso would automatically take place if there were a substantial reduction in import protection and a continuation of flexible exchange-rate arrangements. Another aspect of the proposed ERL that met with Fund criticism was a Bank initiative to require overall minimum target Levels for government expenditures for public inve- 'ment and operation and maintenance (O&M) expenditures. The Fund feared that such requirements could introduce undue rigidities in public finances, and expressed preference for a more detailed listing of required expenditures, to be based on more careful technical reviews by the Bank of individual expenditure items, and to be reprogrammed yearly taking into account the evolution of the public sector deficit and its financing. The Fund also questioned the absence of conditionality regarding the sugar and coconut subsectors, two important areas of concern.- 4.4 Such differences between the two Bretton Woods institutions, while important, were on questions of specific details, but there was full agreement regarding the broad thrust of the strategy. Furthermore, there was an intensive dialogue between the two, which included production of joint papers and staff participation in each other's missions. The Bank's appraisal mission for the ERL coincided with the visit to Manila of the IMF mission to negotiate the standby. This collaboration made it possible for the differences that arose to be resolved constructively. 4.5 The Loan Committee (LC) discussed the proposed ERL at a meeting on July 21, 1986. Two IMF staff members participated in the discussion. At the Region's proposal, the LC decided that the operation would have three tranches rather than the usual two, in order to permit closer monitoring of the program's implementation. As regards exchange-rate policy, the LC accepted the Fund's view that it would be sufficient to use international reserve targets as a tool to monitor the adequacy of the exchange rate. With respect to trade liberalization, the LC recommended that measures that had been agreed under previous SALs should be fully carried out before Board presentation of the ERL. The LC also called for a reduction of maximum import duty tariffs to 30 percent as part of a longer term program. The possible role of IFC in the privatization of state enterprises was discussed as well, but without arriving at specific decisions. 11 Cf., memorandum from Attila Karaosmanoglu, AENVP, to Mr. Hubert Neiss, Acting Director, Asian Department, IMF; PHILIPPINES - Briefing Paper, dated July 3, 1986. I/ Cf., memorandum from Anoop Singh (IMF) to Mr. Hicks (Bank) Comments on the Initiating Memorandum for the Economic Restructuring Loan, dated July 1, 1986. -7- 4.6 Thanks to the intensive preparation that lasted almost one year, by the time the ERL was presented to the Board considerable progress had already been made towards implementAtion of the program. Within the Government, Bank staff had helped to bring about a substantial consensus regarding the thrust of the program. This in itself was a major achievement, since the Revolutionary Government had brought together individuals of different backgrounds and philosophies. Furthermore, many of the required actions had already been adopted by the Government.1 The policy content of the ERL was consistent with the economic report's diagnosis, and the proposed specific actions went a considerable distance towards implementing its recommendations. 4.7 The specific actions called for under the ERL's Action Program are described in the PCR (Section 1.4). The four main areas were: (i) Tax System Reform. Partial globalization of income taxes, increase of personal exemption, reduction of higher marginal rates. Rationalization of indirect taxes, elimination of export taxes, substitution of a value added tax for sales taxes. Improvements in tax administration. (ii) Trade Reform. Implementation of the reforms that had been called for under SALs I and II. These included removal of quantitative import restrictions on a large number of individual items and reductions in the import tariff levels. Many of these reforms had been totally of partially reversed in earlier years (paras. 2.5 and 2.6 suDR4). Additional elimination of import restrictions on 1,229 items representing about 17 percent of the value of imports and announcement (by December 1988) of a comprehensive program for further liberalization and tariff reform aimed at reducing effective protection and making it less uneven. (iii) Public Expenditures. Restoration of a level of public investment equivalent to 5 to 6 percent of GNP (about double the current levels at the time of loan approval). Maintenance of O&M expeaditures in the economic and social sectors at least at their 1982 level in real terms (equivalent to a 60 percent real increase over current levels). Measures to improve the programming and monitoring of public expenditures. (iv) Reform of Government Financial Institutions. The objectives were to reduce the Government's direct presence in the financial system, encourage private sector ownership and rationalize the organization of the sector. More specifically, the Action Program called for a major reorganization of the two largest government-owned banks, the DBP and PNB, which accounted for almost half of the banking system asseth. These two banks were technically bankrupt, with 80 percent of their portfolios being non-performing and representing a burden on the budget equivalent to 4 percent of GNP. 2' Cf., World Bank, President's Report for the ERL and the TAL, Report No. P- 4466-PH, dated February 23, 1987, pp.45-51. - 8 - 4.8 The considerable overlap of the Action Program under the ERL and that of the standby program supported by the IMF (cf., para. 3.4 suRra) was not coincidental. The two agencies had reached agreement on their assessments of development priorities, and had decided to coordinate closely their conditionalities. 4.9 Complemenfing the US$300 million of the ERL, the Bank helped secure large cofinancing loans from Japan. Subsequent to the ERL agreement, the Export- Import Bank of Japan contributed Yen 50 billion (equivalent to US$300 million) and OECF contributed Yen 30 billion (equivalent to US$240 million). 4.10 The description presented in the PCR of measures included in the Action Program represents the substance of the ERL conditionality. In the Loan Agreement, however, the conditions were described in a far less specific manner.- For example, the tax reform conditionality was only described as "Implementation of the 1986 tax reform program" without any further details or definitions. Further tax reforms were described as "studies for further improvements to the systems applicable to individual and corporate income taxes, property taxes and fiscal incentives" to be completed to the Bank's satisfaction. There were no quantitative or qualitative guidelines regarding the new import tariff to be announced prior to a tranche release. In a similar manner, public investment conditionality was only stated as "a public sector investment program with content and level satisfactory to the Bank" without mention of the 5 to 6 percent of GDP that the President's Report indicated, or to the sector composition of the expenditures. O&M expenditures in the economic and social sectors were not defined or quantified. Questions such as what government entities (i.e., national and/or local governments, public corporations, etc.) were included, or which expenditures should be counted as acceptable O&M were not addressed. With such vague legal wording, monitoring and enforcement of the conditionality was not an easy task. 4.11 Recognizing the limited capacity of the new Government to carry out the broad and ambitious program of economic reforms, the Bank complemented the ERL with a Technical Assistance Loan (TAL) that was included in the ERL package presented to the Board. The TAL program contemplated helping the Government implement reforms in the following areas: (i) Institutional strengthening of DBP and PNB. (ii) Disposition of non-performing assets to be transferred to the Government by DBP and PNB. (iii) Study of social security institutions. (iv) Strengthening the Central Bank's regulatory functions. V Cf., World Bank, Loan Agreement for the Economic Recovery Program, Loan No. 2787-PH, dated March 30, 1987. Schedule 4, describing the conditions for release of each of the three tranches is reproduced as Annex I to this PPAR. -9- (v) Supporting the Ministry of Finance to improve expenditure control and accounting. 4.12 Coordination of the technical assistance project was supposed to have been taken over by the Ministry of Finance. The total project cost was estimated at US$15 million equivalent, of which US$8 million would have been in foreign exchange costs. The proposed US$10 million loan would have thus financed 67 percent of total project costs.Y The project, however, was not implemented. The Bank advanced US$1 million to a Special Account in December 1987, but this advance was refunded by the Government in February 1990. The loan was eventually cancelled. V. IMPLEMENTATION OF THE ERL 5.1 In assessing compliance with the conditionality it may be useful to take as a starting point the substance of the understandings, as reflected in the Government's Letter of Development Policy'/ and in the President's Report, rather than the specific covenants in the Loan Agreement which were exceedingly vague. 5.2 The PCR presents a good description of the compliance with the loan conditionality and the process leading to release of the three tranches. In brief, formal compliance was most complete as regards the rationalization of government financial institutions, substantially complete in the area of tax reform, and partial in trade liberalization. There was no compliance in the area of public expenditures for investment and O&M. The technical assistance loan was cancelled at the request of the authorities, who preferred to carry out the activities with their own resources or to finance them from grants. 5.3 Much of the conditionality regarding the reform of government financial institutions was carried out prior to Board presentation of the loan. As explained in the PCR, the main achievements were: (i) Redefine Financial Sector Policy to open up the sector to competition from private banks, privatize six banks that had been acquired and, more generally, increase transparency and accountability. (ii) Restructure drastically DBP and PNB to bring them back to a healthy financial position, by means of profound rehabilitation programs, and transfer of their non-performing assets to a newly created Asset Privatization Trust (APT) for disposal. 9i Specific aspects of the TAL were described in Annex VII of the President's Report (Op. cit.). _t Republic of the Philippines, Ministry of Finance, Letter of Development Policy, dated January 2, 1987. Reproduced as Annex V in the President's Report (Op. cit.). - 10 - (iii) Begin a process of divestiture of banks that had been acquired by the State and of companies that had been taken over by the APT. 5.4 In the area of Tax Reform the principal innovation was the introduction of a Value Added Tax (VAT) to replace sales taxes. This was done ahead of schedule, with technical assistance from the IMF. Income taxes were largely globalized, personal exemptions were raised to exclude low-income households, tax brackets were simplified and the top marginal tax rates were significantly dropped. As noted in the PCR, timely implementation of these measures did not lead immediately to the expected results in terms of higher revenues owing to severe institutional weaknesses in tax administration and to the normal difficulties in introducing a value added tax. One consequence of the shortfall was that taxes on trade continued to represent an important source of revenues, making the process of tariff reduction more difficult. 5.5 Trade Reform measures focused initially on recovering the gains towards trade liberalization that had been initiated under SALs I and II. Additional progress was expected in the elimination of quantitative restrictions (QRs). As regards import duties, the Government promised to announce a comprehensive tariff reform program (with minimum tariffs of 10 percent and maximum of 50 percent) and a calendar for its implementation by December, 1988. Progress was on schedule during the first year of ERL implementation but some delays were encountered during the second year, owing to strong domestic opposition to further import liberalization. Selected tariff reduction measures were introduced in 1989, but were not approved. The comprehensive tariff reform program was not announced until July 1990, but congressional opposition blocked its implementation. In specific cases low duties (below the 10 percent flnor) were reinstated. The original objective of substantially lowering overall protection was not fully accomplished during the implementation of the ERL, as removal of QRs was compensated by introduction of higher tariffs. These higher tariffs took the form of surcharges on those specific items for which QRs were being removed. 5.6 The overall objective of raising the ratio of public investment to GNP to between 5 and 6 percent was not achieved. The PCR indicates that budgeted amounts were adequate to meet the targets, but that appropriations fell short owing to a combination of financial constraints and limited implementation capacity. Operation and maintenance for the social and economic sectors also fell short of the targets --i.e., to regain their 1982 levels in real terms-- as a consequence of administrative and financial constraints. These two conditions were later incorporated in the Debt Management Program loan (No. 3149-PH) and were reported by Management to have been met for the year 1991.L' 5.7 Disbursements of the first two tranches of US$100 million each took place in line with the original schedule. In releasing the second tranche, Management waived the minimum public investment requirement and the condition requiring completion of studies on further tariff reform. As regards O&M expenditures, Management explained that its projections for 1987 showed that the 11 World Bank, Philippines: Debt Management Program (Loan 3149-PH): Release of the Second Tranche - Waiver of Two Conditions, R92-50 dated March 26, 1992, para. 15. - 11 - condition would be substantially met.- Release of the third tranche was delayed owing to constraints in fulfillment of some conditions, notably those regarding public expenditures, trade liberalization and the privatization of six banks. At the Government's request, the Bank agreed to extend the loan closing date from June 30, 1989 to December 31, 1989. The third tranche was finally released just prior to the extended closing date. Management indicated that it had again waived the condition on minimum public investment levels, on the grounds that there had been substantial progress during 1989, and that the composition of the public investment program was satisfactory. As regards O&M expenditures, Management indicated that its projections for 1989 implied an expenditure level in excess of the agreed benchmark.131 5.8 Monitoring and Supervision were frequent and effective, assisted by the Resident Mission. Frequent visits to the country by Bank sector staff on project-related missions and by IMF consultation missions contributed to keep Headquarters staff up to date on implementation. Periodic reports prepared by the Borrower helped to keep a constructive dialogue open at all times during implementation. The process of tranche release, repeated three times, also provided opportunities for the Bank and Borrower to take stock of progress and to adopt mid course corrections when necessary. VI. OUTCOME: THE ECONOMIC SITUATION AFTER LOAN CLOSING 6.1 Macroeconomic indicators improved in 1987-89, the years of ERL implementation. Stimulated by the return of confidence, a marked improvement in the terms of trade and by foreign capital inflows at a time when the Philippine economy had considerable excess capacity, economic growth accelerated, private consumption expenditures per capita recovered, the overall investment ratio rose, and inflationary pressures abated. The economic expansion also benefitted the poor, and the proportion of the population below the poverty line dropped from three-fifths to one-half. Tax revenues also improved, albeit not by as much as had been planned, owing to severe administrative weaknesses. The structure of the tax system became sounder and more equitable, although it continued to rely excessively on trade tax revenues. The public sector deficit was reduced. The following table, partially based on macroeconomic indicators recently supplied by the Region,' shows that a strong resumption of official loan disbursements .1 World Bank, PHILIPPINES - Progress of the Economic Recovery Loan, Memorandum to the Executive Directors SecM88-320, dated March 23, 1988, Para. 14. L World Bank, PHILIPPINES --Release of the Third Tranche of the Economic Recovery Loan, Memorandum to the Executive Directors dated December 22, 1989, SecM89-1607, para. 13. The O&M projections, however, were not realized, and the tranche release condition was not met. Cf. Table 5. .U "Key Macroeconomic Indicators", reproduced as Annex IV. This table, based on a set of revised National Income Accounts released by the Philippine National Statistic Coordination Bureau in February 1992, has been provided by the Region - 12 - and direct foreign investment helped finance a fast expansion of imports, well in excess of export growth. This in turn made it possible for both investment and consumption to outpace output growth without generating excessive inflation. Table 1: MX MACROECONO*IC INDIAM 1985 1986 1987 1988 1989 1990 Growth Rates (M) P.a.: GDP -7.3 3.4 4.8 6.3 6.1 2.4 Private consumption -3.5 0.9 1.6 3.8 2.6 3.0 per capita Imports GNFS (US$) -14.2 10.2 28.6 19.6 15.2 10.0 Exports GNFS (US$) -16.6 17.1 6.5 14.7 10.7 1.3 Inflation (CPI) 23.1 0.8 3.8 8.8 10.6 12.7 Ratios and Indexes: Total Investment/DP 15.3 16.0 18.0 18.4 21.8 22.5 ratio -Of which: Private 11.6 13.1 14.9 15.2 17.7 17.2 Investment/GDP ratio Terms of trade/ 100.0 114.7 117.3 128.1 119.4 111.2 index (1985 - 100) Current account -0.3 3.2 -1.3 -1.0 -3.4 -6.1 balance/GDP Public Sector 5.9 5.0 2.8 3.1 4.5 5.5 Deficit/GDP ratio Tax Revenues/GDP 11.4 12.1 13.5 11.3 12.8 14.0 ratio US$ milliones Direct foreign 17 140 326 986 843 480 investment Official loan 716 912 998 938 1,324 1,760 disbursements Trade balance 482 202 1,017 1,085 2,598 4,020 Sources: Annex IV, PCR Part II, various Bank reports, World Debt Tables. 6.2 To what extent can this remarkable improvement be attributed to the ERL? In part the ERL contributed directly to the recovery by addressing real and supersedes Table 1 of Part I of the PCR. OED has not evaluated the new set of netional accounts data. - 13 - obstacles to growth, as indicated in the PCR. But more important, the ERL was part of a comprehensive package that included the Fund standby arrangemant, strong debt relief and aid coordination activities in which the Bank played a major role, as the PCR also recognizes. All these efforts resulted in a relaxation of the foreign exchange constraint and reinforced the return if confidence by the private sector. Real progress had been made towards improving the structure of the tax system and the financial health of government financial institutions. A process of privatization was well under way. 6.3 The observed improvements, however, were not sustained. By 1990 GDP growth had fallen drastically, inflation was accelerating, the public sector deficit was rising, growth of export earnings came to a temporary halt and the external account deficits widened to unsustainable levels. Uncontrollable events in 1989-90 precipitated the decline. The terms of trade worsened sharply, and a prolonged drought affected major crops and power supply. An earthquake and the Gulf War compounded the adversities. These challenges, however, revealed as well that many of the fundamental weaknesses of the economic system had not been corrected. 6.4 The stifling physical bottlenecks in power, transport and other utilities persisted, more acutely than before as a result of three years of economic growth that outpaced the expansion of infrastructure. Extreme poverty remained an intractable problem. The trade regime continued to provide negative protection to exports and agriculture. This discrimination was compounded by the maintenance of an overvalued exchange rate. The latter, in turn, could not be corrected by the monetary authorities because of the precarious situation of the Central Bank. Although the structure of foreign debt had improved, with a shift away from short term and conventional loans towards official and concessionary longer term, debt service remained a heavy burden, with interest payments absorbing close to 6 percent of GNP and a debt service burden equivalent to about one-third of export earnings. Domestic public debt, furthermore, had risen sharply from 19 percent of GDP in 1985 to almost 25 percent in 1989, becoming a source of financial distress. VII. SELECTED ISSUES A. Trade Regime 7.1 The main elements of the Government's Import Liberalization Program were the removal of quantitative import restrictions imposed by the Central Bank and the Board of Investment, together with changes in the structure of tariffs. Duties on some import items were raised to protect industries where QRs were removed, and on other import items duties were reduced in efforts to rationalize the tariff structure and reduce protection on intermediate goods. The system of investment and export incentives was also revised under the Omnibus Investment Code of 1987. 7.2 The combined effects on effective protection of the various measures adopted by the Aquino Administration have been assessed by the Philippine - 14 - Institute for Development Studies (PIDS). The estimates of effective protection of domestic value added (based on price comparisons with similar products in Hong Kong or Singapore) show that progress was made towards reducing effective protection between 1985 and the end of 1988.-L The overall rate of effective protection for all sectors dropped from 49.0 percent to 36.4 percent. But these very aggregated numbers obscure wide differences in effective protection across sectors, as well as within "importable' and "exportable" goods. As shown in Table 2, in all cases the former category enjoys high protection. In fact, the effective protection for exportables continues to be significantly negative in several of the categories analyzed here.L The effective protection of importables, on the other hand, is as high as 75 percent for all sectors combined, and reaches 80 percent for all manufacturing, 97 percent for Beverages and Tobacco and almost 300 percent for Machinery, including Electric and Transport Equipment. The extremely high rates for the latter categories are a consequence of the continuing import restrictions --including outright prohibitions-- for protective purposes. 7.3 These results were contrary to the spirit of the ERL in the area of trade reform. The Aquino Government had indeed been committed to further deepen the import liberalization process. Evidence of such commitment was given when the authorities proposed Executive Order 413 (EO 413) in July 1990. This legislation would have reduced the level and dispersion of nominal rates to a range of 3 - 30 percent. Its implementation would have reduced effective protection by one-third, thus making exports more profitable. But the Government was forced to withdraw the proposal in the light of intense domestic opposition, particularly in Congress. In July 1991, after extensive discussions with Congress and the private sector, a new tariff code was finally enacted (EO 470). The new EO is expected to accomplish substantially the same tariff reduction objectives as the original one, but with a gradual implementation, in steps over a five-year period. The Bank has continued to press for a more export-oriented trade policy, which is a pre-requisite for sustained economic growth. .L Philippine Institute for Development Studies, An Assessment of Trade and Industrial Policy, 1986-1988, by Erlinda M. Medalla, Working Paper Series No. 90-07, January 1990. L6 This situation is not believed to have changed much as of the closing of the ERL or even as of May, 1992, when the present audit report was written. -U "Negative effective protection" for exportables is equivalent to an export tax that results from the fact that the potential exporter is required to purchase inputs locally at prices that exceed international prices. An effective system of drawbacks and/or export subsidies could have wiped out this negative protection. "Exportables" have been defined as those products that are predominantly exported, and "importables" as products for which importing substantially exceeds exporting. - 15 - Table 2s EFFECTIVE PROTECTION BT MAJOR GROUPS 1985 1988 All Sectors 49.0 36.4 Exportables -7.9 -4.1 Importables 102.2 75.1 Agriculture, Fishing and Forestry 9.0 5.2 Exportables -8.5 -5.7 Importables 79.6 49.3 Mining -0.2 -2.0 Exportables -8.5 -9.0 Importables 24.2 18.6 All Manufacturing 73.3 55.5 Exportables -4.5 -1.3 Importables 107.3 80.2 Beverages and Tobacco 45.3 42.9 Exportables -9.2 -9.2 Importables 102.2 97.3 Paper, Rubber, Leather and Plastic 240.5 107.9 Exportables -7.0 -10.9 Importables 289.6 131.5 Non-Metallic Minerals 159.9 159.2 Exportables -8.0 -8.2 Importables 164.4 163.7 Machinery, Electric and Transport 239.6 169.5 Exportables 0 0 Importables 405.1 286.5 Source: Philippine Institute for Development Studies, An Assessment of Trade and Industrial Policy, 1986-1988, by Erlinda M. Medalla, Working Paper Series No. 90-07, January 1990, Table 9. B. Macroeconomic Management 7.4 The general thrust of macroeconomic management was not fully conducive to attaining some of the basic restructuring objectives of the ERP. These objectives included the deep opening up of the economy, the redirection of private investment towards export diversification and a rebuilding of the country's productive infrastructure to eliminate physical bottlenecks. To achieve these goals would have required maintenance of an aggressive exchange rate policy, availability of credit for private investment at a reasonable cost, a restructuring of taxes away from foreign trade and a strong expansion in selected public expenditures in O&M and investment. - 16 - 7.5 But, in the absence of a strong fiscal adjustment, demand management had to rely on a conservative monetary policy. This mix of fiscal and monetary policy, together with the effect of the external debt overhang, led to a crowding out of credit to the private sector. Real interest rates became high (exceeding at times 10 percent) and volatile, discouraging private investment. Although there was a recovery of credit to the private non-financial sector and of private investment in 1987-89, both did not recover their pro-crisis levels.-81 Investors had to finance increasingly out of equity, and debt-equity ratios for the largest companies declined from about 1.1 to 1 in 1985 to 0.45 to 1 in 1989. Table 3: GROSS DOMESTIC INVESTMENT (as percentage of GDP) National Government Total Total Private Government Corporations Public 1980 29.1 20.6 3.4 5.0 8.5 1981 27.5 16.5 4.5 6.4 10.9 1982 27.9 20.4 2.9 4.6 7.5 1983 29.6 23.5 2.8 3.3 6.1 1984 21.8 16.4 1.9 3.5 5.4 1985 15.3 11.6 1.5 2.2 3.7 1986 16.0 13.1 1.9 1.0 2.9 1987 18.0 14.9 1.9 1.1 3.0 1988 18.4 15.2 2.1 1.1 3.2 1989 21.8 17.7 2.5 1.6 4.1 1990 22.5 17.2 2.7 2.5 5.2 Sources: National Statistic Coordination Board, National Income Accounts, base year 1985, February 1992; R.G. Manasan, The Size. Financing and Impact of the Public Sector Deficit. 1985-84, PIDS, 1988; Government Corporate Monitoring and Coordinating Committee, various years; Department of Budget and Management, various years. 7.6 The failure to raise more significantly tax revenues from the VAT and from direct taxes had several negative consequences for the adjustment process. First, the share of import duties in total National Government revenues did drop, but not enough. As a consequence of the inability to raise revenues from other sources, the authorities found it difficult to further reduce taxes on imports. L World Bank, Philippines: Capital Markets Study, Report No. 10053-PH, dated February 24, 1992, Chapter II. - 17 - Table 4: STRUCTURE OF NATIONAL GOVERNMENT REVENUES (Percentages) 1980 1984 1986 1988 1990 Direct Taxes 24.7 28.1 31.5 32.6 33.4 Indirect Taxes 75.3 71.9 68.5 67.4 66.6 -of which: Import Duties (24.7) (27.0) (19.7) (19.4) (21.8) Source: World Bank, The Philippines: Country Economic Report, Report No. 10056-PH, dated February 20, 1992, page 26, 7.7 The shortfall in revenues also contributed (together with institutional weaknesses) to prevent the Government from reaching the planned levels of public investment and of O&M. Thus, the country's productive infrastructure continued to deteriorate. Table 5: NATIONAL GOVERNMENT EXPENDITURES FOR OPERATIONS AND MAINTENANCE (In constant billion pesos, 1982 prices) 1980 1982 1984 1986 1988 1990 10.8 12.4 6.2 7.7 9.3 10.1 Source: Data provided by the Philippine authorities. 7.8 The macroeconomic work connected with the ERP does not seem to have identified the deteriorating financial position of the Central Bank of the Philippines (CBP) as an issue to be addressed. This problem, however, turned out to have been one of the major impediments to the success of the program. As explained in the Capital Market Study,' in 1986 the CBP was asked to assume the foreign currency liabilities of certain public and private enterprises, including commercial banks. The CBP also advanced the payment of moratorium interest on maturing obligations of certain public corporations guaranteed by the ni Capital Market Study, Op.cit., Chapter IV. - 18 - National Government (NG), the peso equivalent of which had not been paid to the CBP. These liabilities led to large realized and unrealized losses. As a result, the CBP had to finance a substantial part of the fiscal deficit that should have been assumed by the NG. The CBP's losses arising from these and other related transactions --such as forced loans to failed or failing financial institutions, swap cover and open market operations aimed at absorbing domestic liquidity-- averaged 2.3 percent of GNP, almost as large as the overall deficit of the NG in 1986-89. 7.9 Because of its financial distress, the CBP's ability to conduct appropriate monetary and exchange rate policy was severely compromised. By financing its mounting losses through issuance of short-term bills and other instruments, it contributed to raising domestic interest rates and to crowding out the private sector. Furthermore, the CBP's net external debt position has made it extremely vulnerable to exchange-rate devaluations, because a devaluation causes a proportional increase in peso-denominated interest payments on its external debt and an almost proportional worsening of its net interest income position. This helps explain at least in part the very conservative exchange- rate management, which has resulted in an overvalued exchange rate, thus defeating the objectives of import liberalization and export diversification. 7.10 Attempts to assess the adequacy of the exchange rate do not yield unambiguous results. Exchange-rate policy in the Philippines has been a "managed float" consisting of maintaining a fixed nominal rate with the U.S. dollar for as long as feasible, to be followed by a major devaluation after a balance-of- payments crisis. However, to succeed in a policy of strong export diversification and growth, and to be able to effectively reduce protection from imports, the country needs to maintain a competitive edge with respect not only to its major trading partners (i.e., the United States, Japan, the United Kingdom and Germany) but, more important, to its potential competitors, notably Indonesia, Malaysia and Thailand. During the early part of the ERL implementation, the peso depreciated with respect to the major trading partners: there was a 26 percent real effective depreciation between 1985, when the peso was clearly overvalued, and 1988. But in the same period the peso appreciated by 15 percent with respect to the competiters. During the later part of the ERL, until mid-1989, the peso appreciated in real terms by about 7 percent against both sets of comparators, in spite of a nominal devaluation of 9 percent against the dollar. A 20 percent nominal devaluation against the dollar in the second half of 1989 helped to redress the overvaluation momentarily. But taking a longer view, the effective exchange with respect to the competitors in 1990 was almost twice its 1980 level. There is a broad consensus among analysts of the Philippine economy that a more aggressive and consistent export-oriented exchange-rate policy is needed to bring about a sustained economic transformation.L- -t Cf., World Bank, Capital Market Study (op. cit.) and Country Economic Report (op. cit.), PIDS, An Assessment of Trade and Industrial Policy, 1986-1988 (op. cit.) and PCR, Part II. The CBP has indicated partial agreement with this assertion, stating that, "while aggressive export-oriented exchange rate is necessary for a sustained economic transformation, this, however, should be categorically supported by appropriate policies in other areas of the economy" (cf. Annex VI). - 19 - Table 6: REAL EFFECTIVE EXCHANGE RATES (Index, 1980 - 100) 1980 1986 1987 1988 1989 1990 1991 Against Major Trading Partners 100 71 67 66 70 67 66 Against Major Competitors 100 99 114 117 124 121 122 N1U: An upward movement means appreciation. Source: Nathan Associates, Inc. and Louis Berger International, Inc., Evaluation of the Philippines Support for Development Program, (Submitted to USA:D/Manila) May 1991, as ammend by CBP (cf. Annex VI). C. Loan Design and Preparation 7.11 The Region devoted considerable efforts towards preparation of this important operation. These involved helping develop a consensus within the revolutionary government in support of continuing the liberalization process that had started under the previous government, coordinating with other donors to provide debt relief and secure additional aid, and design a package of reforms that was at the same time comprehensive, ambitious and feasible. Considerable attention was paid to the supporting economic and sector work, including the need for a public investment review and of complementary sector work.11 In the area of macroeconomic management the Bank collaborated intensively with the Fund, but ultimate responsibility rested with the latter. As regards public expenditures, on the other hand, the Bank was in charge. This is an area were the operation did not fully succeed, as evidenced not only by the failure to meet the quantitative expenditure targets and calendars, but more so by the observation that severe power shortages are asphyxiating the life of the country in the major industrial area of Luzon, and bottlenecks in transport and public utilities have worsened during the life of the loan. 7.12 One weakness of the loan design was that targets for public investment and for O&M expenditures were established at the most aggregate level, expressed as levels of expenditure as a share of GDP, without adequate attention to the reality underlying those numbers. The loan package did not define precisely what the targets meant in terms of the governmental jurisdictions involved, the kind of expenditures included, their sectorial composition and geographic distribution. Given that the Bank correctly identified the high priority of rebuilding the physical infrastructure, it would have been operationally more L C.f., Memorandum from Attila Sonmez, Philippines CESW--FY86-88, dated April 4, 1986. - 20 - productive to indicate physical targets, be it in terms of kilometers of roads to be repaired, additions to electrical generating capacity, etc. This should have been complemented with an analysis of the instf+.utional capacity of the various implementing agencies to carry out their mandate. 7.13 Bank projects staff were well aware of the precarious institutional situation in most of them, to the extent that as of the Autumn of 1986 only 13 percent of the Bank projects under implementation were problem free, and the average implementation delay from the original targets was 33 months." The inadequate implementation capacity of the new Government was noted by the appraisal mission, which noted:Ls "While the large increase in the 1986 investment budget is justified to restore the program to an adequate level, a continued rapid increase during 1987 by 38% appears excessive. In particular, the large increase in the budget for the Ministry of Public Works and Highways, and the Ministry of Transportation and Communications (MPWH/MOTC) of about 56% on top of the large increase in 1986 may substantially increase the risk that investments will be made in marginal projects and severely tax the implementation capacity of the ministry." 7.14 In spite of these warnings, in designing the loan conditionality the Bank adopted an optimistic position regarding the feasibility of the proposed investment levels:24 "The substantial increase in the investment program for the national government of about 37 percent represents largely carry-over activities from 1986. The investment program of P 9 billion for the MPWH/MOTC is expected to be well within their present implementation capacity as measured against an achieved investment program of 8.5 billion during the difficult period of 1986." 7.15 The institutional and design weaknesses that seem to have been overlooked during preparation became apparent in later stages of implementation. The inadequate definition of 0&M expenditures --what was included in them, which were the responsible entities-- complicated the supervision function. As regards public investment, the extent of the implementation constraints was identified at mid-course. These constraints included lack of in-house capability and L' World Bank, PHILIPPINES - 1986 Country Implementation Review of World Bank Financed Projects, Background Paper dated October 3, 1986, page 1, and Back-to- Office Report on Operational Discussions from John Cleaver, Deputy Chief, AEPA2 to Ralph Wadsworth, Chief, AEPA2, dated November 17, 1986. L' Back-to-Office Report of the Appraisal Mission, dated August 1, 1986, Annex IV. Lt World Bank, PHILIPPINES - Selected Issues in Public Resource Management, Report No. 6887-PH, dated April 15, 1988, para. 2.25. - 21 - manpower for project preparation, cumbersome and stringent practices for approval of projects, inadequate links between planning and budgeting, slow preparation of detailed engineering studies and bidding documents, slow selection of contractors, diffused responsibility of implementing agencies and inadequate supervision of civil works. 7.16 It is probable that closer involvement of Projects staff in the design of the public expenditure components of the ERL could have helped foresee some of these problems. In that case, it might have been possible as well to plan for more realistic planning and for assistance in executing the plans. The recently adopted practice of forming country teams in the Country Department -- incorporating sector and country Bank staff-- should go a long way towards insuring better integration of inputs in the future. A follow-on operation, the Debt Management Program (Loan No. 3149-PH, approved on December 21, 1989) picked up the same conditionality regarding public expenditures, but with greater attention to the institutional requirements. D. Coordination of Cofinancing 7.17 The Japanese Government participated in the international efforts to assist the Aquino Government with a larg aid program. During the last stages of ERL preparation, the Bank held intensive consultations with Japanese authorities. Between EXIM-Bank and OECF the Japanese aid program in 1987 was expected to be equivalent to US$1.15 billion, including US$540 million in direct cofinancing of the ERL. This important aid package facilitated the execution of the program, lending it credibility and liquidity. There were, however, some issues of coordination regarding the mechanisms for disbursements. Under Bank procedures, disbursements were made pari passu with tranche releases, to finance general imports based on a standard negative list, while the proposed EXIMBANK operation would finance selected government expenditures on projects chosen from the Philippine's Public Investment Program. The Bank accepted the different disbursement arrangements in a spirit of pragmatism. But such arrangements involve the potential risk of conflicts when the timing of the bilateral disbursements does not coincide with that of tranche releases, which are determined by the execution of prescribed conditionality. Large bilateral disbursements soon bafore or during a review process leading to a Bank tranche release might interfeie with the latter process. E. Social Dimensions of the Adjustment 7.18 At the beginning of the 1980's the Bank had addressed the need for decisive governmental action to improve social conditions. The dialogue, however, did not progress owing to lack of responsiveness on the Government's part. During discussions preceding preparation of ERL the new Government signalled to the Bank that its immediate attention had to focus on a resumption of economic growth. It felt that in the short run that would be the most effective way of alleviating the living conditions of the poor, through increases in employment and incomes growth. The Bank shared this view, and this was reflected in the President's Report (paras. 22-23). The Bank followed up on _t C.f., memorandum from Z. Drabek to G. Kaji dated December 21, 1988. - 22 - this issue by sending a lar e mission to the country in September, 1987. The mission produced a report,- the recommendations of which have started to be reflected in recent Bank work. F. Debt Restructuring and Burden Sharing 7.19 During the implementation period of the ERL there was a significant improvement in the structure of the external debt of the Philippines (cf., Annex V). While the total stock of outstanding debt increased from US$28.5 billion to US$30.5 billion in 1986 - 1990, short-term debt and long-term debt to private creditors were substantially reduced, as was the net use of IMF credit. Compensating for these reductions, the official debt to bilateral and multilateral creditors rose fast: bilateral debt more than doubled to reach almost US$8.9 billion in 1990, and debt to the World Bank rose from US$3.0 billion to US$3.9 billion. Debt to the IMF, on the other hand, dropped from US$1.3 billion to US$0.9 billion in the same period, and that to commercial banks dropped from US$11.0 billion to US$7.9 billion.L' (Commercial banks accepted substantial capital losses through discounted debt-equity conversions and buybacks.) The Bank helped the Government obtain the debt relief and restructuring that led to this improvement. VIII. OVERALL EVALUATION 8A1 The ERL provided a vehicle to establish a fruitful dialogue of the Bank with the new Administration. This dialogue helped to create a consensus among the members of the incoming Government on the desirability to continue and deepen the reforms that had been initiated under the deposed regime. Although the specific results of this operation may have been mixed, and the progress of the structural change since then may have been uneven, the process of change was not interrupted, and follow-on operations are still carrying it forward. Interviews in the field conducted by OED staff confirmed that the Bank's intellectual leadership provided an important influence during the transition period. Had this been the only accomplishment of the ERL, it would have been sufficient to consider the operation a success. 8.2 But in addition to the above, the program financed by this loan helped to drastically improve the condition of the two largest government-owned banks (BNP and DBP), to begin a profound process of divestiture, to start the restructuring and rationalization of the tax system, to make some further Z1 World Bank, The Philippines - The Challenge of Poverty, Report No. 7144-PH, dated October 17, 1988. 271 The CBP has provided OED with somewhat different figures for the debt outstanding balances just mentioned (cf. Annex VI, page 3, para. h). The preceding figures are based on the World Bank's official Debt Tables, and the relatively small differences may be explained by the timing of individual debt transactions. - 23 - progress towards trade liberalization and to prevent a worse deterioration of the physical infrastructure than what has been observed. All these are very positive results. IX. LESSONS FOR THE FUTURE 9.1 The experience gained during design and implementation of the ERL, was generally satisfactory. It serves, nevertheless, to provide lessons that can be useful in future adjustment operations. Most of these lessons confirm findings of earlier OED evaluations of adjustment loans in different regions. 9.2 The practice of multiple tranching can provide an effective tool to ensure fuller compliance with the conditionality and objectives of adjustment operations. Coordination with Other Donors 9.3 In most cases the success of an adjustment program is closely tied to the macroeconomic framework. The link takes place through the real exchange rate, the mix between fiscal and monetary policy, the choice between revenue enhancement and expenditure reduction to control a fiscal deficit, etc. While the IMF has primary responsibility for theso areas, Bank staff need to ensure that the structural adiustment program that it supports is fully consistent with the macroeconomic framework. both in its design and in its implementation, It may still be appropriate to repeat here one of the lessons derived from the audit of the first two SALs to the Philippines: "When designing structural adjustment programs it may not be sufficient for the Bank to leave matters of central economic and financial management to be covered by the IMF in possible standby arrangements." 9.4 Coordination of cofinancing activities requires careful planning, making sure that the donors understand the need for the loan conditionality and fully share the conviction that such conditionality is desirable. Rules for disbursement under various tranching arrangements should be clearly spelled out in advance, and a financing program drawn out early on, to ensure both that the available financing is consistent with the reform program and that disbursement decisions of one donor do not undermine the reform program of another donor. Internal Bank Organization 9.5 The Bank must make every effort to ensure that the institutional capacity to carry out the desired program exists in the Government. This is particularly relevant when dealing with a young administration. In this connection, it can be risky to plan the elimination of a proven tax (even if it L World Bank, Program Performance Audit Report - Philipoines First and Second Structural Adjustment Loans (Loans 1903-PH and 2266-PH), OED Report No. 5813, dated July 31, 1985, page v. - 24 - is sub-optimal) for a more efficient tax (such as the VAT) before adequate training and administrative arrangements are fully in place for administration of the new tax. 9.6 Close cooperation of Projects or Sector staff in the design and supervision of adjustment operations can be most valuable, even if the primary responsibility rests with Programs or Country Operations. This is particularly important in areas related to public investment and maintenance of the physical infrastructure, including assessments of the institutional capabilities. Borrower Owners*ip and Participation 9.7 In designing Technical Assistance projects it is particularly important to ensure full involvement and participation of the Borrower, not only at the hiphest levels, but also at the middle levels where the technical assistance will be delivered. This includes precise formulation of work programs and terms of reference. Budgetary provisions and staffing arrangements for close and intensive supervision of TALs need be made early on, before Board presentation. Projects and sector staff should normally be closely involved in these activities. -25- ANNEX I Page 1 of 4 LOAN NUMBER 2.lSl PH Loan Agreement (Economic Recovery Program) between REPUBLIC OF THE PHILIPFL:ES and INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Dated Mm o , 1987 - 26 - ANNEX I Page--of 7 SCMEULIC 4 Actions Referred to in Paragraph 3 of Schedule I to this Agreement Part A: Conditions for Release of First Tranche Action by the Borrower and other concerned entities towards the implementation of the following: 1. A plan, satisfactory to the Bank, for restructuring DBP and PNB into more economic and efficient entities including internal reorganization and the strengthening of internal controls, policies, procedures and systems, 2. A plan, satisfactory to the Bank, to reduce the operating costs of DBP and PNB including the rationalization of the numbers of their respective branches as well as their respVctive staff strength. 3. The transfer of title to, or assignment of rights in respect of, designated assets of DBP and PNB to the Borrower or the Asset Privatization Trust, and of designated liabilities of DBP and PNB to the Borrower or for its account; and the appropriate disposi- tion of non-performing assets of DBP and PNB including those transferred to the Borrower or the Asset Privatization Trust. 4. Management, in a manner satisfactory to the Bank, of deposits of the Borrower's funds in accordance with the Bor- rower's policies on government deposits (including funds of corporations owned directly or indirectly by the Borrower) in government depository banks and the maintenance by such banks of appropriate liquidity ratios against designated public sector liabilities at levels satisfactory to the Bank. 5. A public sector investment program with content and level satisfactory to the Bank. 6. Implementation of the 1986 tax reform program. 7. Maintenance of the Borrower's operations and maintenance expenditures in respect of economic and social sectors at a level at least equivalent, in real terms, to such expenditures in 1982. - 27 - ANNEX I Page 3 of 4 8. Liberalization of trade regulations, including, in parti- cular, quantitative Import restrictions in accordance witn ongoing programs for such liberalization. 9. A program of technical assistance including the Economic Recovery Technical Assistance Project. Part B: Conditions for Release of Second Tranche t. Issuance in respect of DBP and PKB, as audited by independent external auditors satisfactory to the Bank, of a balance sheet audit as of December 31, 1986 and a financial audit including income statement for the period July I - December 31, 1986. 2. Submission, no later than March 31, 1987, of detailed organizational, staffing and financial plans, policies and procedures of the Asset Privatization Trust. 3. Completion of a program of studies to develop proposals for the further reform of the tariff structure. 4. Completion of studies, and announcement of a progrea for, the further liberalization of quantitative Import restrictions. 5. Submission of a final branch reduction program for PUB by June 30, 1987. 6. Development and introduction of a system, satisfactory to the Bank, for monitoring and evaluation of the performance of DBP and PNB, including the establishment of appropriate performance targets. 7. Implementation of a system to monitor physical and financial accomplishments of the Borrover's public investment program. 8. Completion of studies, satisfactory to the Bank, for further Improvements to the systems applicable to individual and corporate income taxes, property taxes and fiscal incentives. 9. Attachment of DBP and PNB to the Ministry of Finance. - 28 - ANNEX I Page 4 of 4 Part C: Conditions for Release of Third Tranche 1. Issuance of financial audits of DBP, PNB and the Asset Privatization Trust for the fiscal year 1987, as carried out by independent external auditors satisfactory to the Bank. 2. Completion of all requ4eaments necessary for the divest- ment of the following banks: Associated Bank; Commercial Bank of Manila; Filipinas Bank; International Corporate Bank; Republic Planters Bank; and Union Bank. 3. Implementation of measures, satisfactory to the Bank, for further improvements to the systems applicable to individual and corporate income taxes, property taxes and fiscal incentives, based inter alia on recommendations formulated through studies undertaken under the Program. 4. Completion of studies undertaken under the Program regarding the following: Government Service Insurance System; Social Security System; Land Bank of the Philippines; and Philippine Export and Foreign Loan Guarantee Corporation. 5. Implementation of the system for monitoring and evaluation of DBP and PNIB referred to in paragraph 6 of Part B of this Schedule. 6. Introduction of a value added tax. 7. The public announcement of a program for the further reform of tariffs on Imports. 8. Implementation of a program for the further liberalization of quantitative import restrictions. - 29 - International Bank for Reconstruction and Development FOR OFFICIAL LSE ONLY ANNEX II Page 1 of 7 SecM88-320 FROM: Senior Vice President, Operations March 23, 1988 PHILIPPINES-- Progress of the Economic Recovery Loan* 1. As provided in Section 3.01 of the Loan Agreement for the Economic Recovery Loan to the Philippines (Loan No. 2787-PH), the Bank's staff have been monitoring progress during the past year on the economic recovery program supported by this loan. Supervision missions visited Manila in October, 1987 and February, 1988. This memorandum provides a brief update of the current economic situation, as well as a status report on the reform program and fulfillment of the agreed criteria for the release of the second tranche. I. RECENT ECONOMIC DEVELOPMENTS 2. Despite an unsettled political environment, the economy showed signs of a substantial economic recovery in 1987, in line with the targets in the program. Economic growth during 1987 is estimated to have been 5.1% (real GDP), with industrial growth of 8%. Major factors leading the recovery have been the increase in fixed investment (up 11% over last year), an increase in Government expenditures (up 8%), and increased exports of electronic items and garments (up by over 20%). Inflation has been kept under control despite the acceleration of growth; the increase in consumer prices for the year was only 3.7%. The national government budget deficit was only about 3.4% of GNP, below the expected level of 3.8%. This reflects both slightly better revenue performance and shortfalls in planned expenditures, particularly for investment. *Questions on this document may be referred to Mr. Hicks (ext. 72161) ox Mr. Jarvis (78035) Distribution: Executive Directors and Alternates President Senior Vice Presidents Senior Management Council Vice Presidents, IFC Directors and Department Heads, Bank and IFC This document has a restricted distribution and may be used by recipients oniy in the partormance of their oficial duties. Its contents may not otherwise be disclosed without World Bank authorization. -30- ANNEX II Page 2 of 7 3. On the balance of payments front, the overall currett account was in deficit this year by about $386 million (about 1.2% of GNP). While non- traditional manufactured export earnings have risen by over 30% from last year, this has been offset somewhat by lower earnings on primary product exports. As a result, total export earnings have increased by about 18% while imports have risen by about 28%. The import level is, however, only slightly higher than originally expected and in line with the higher growth of the economy. (See explanatory note below). 4. Gross reserves, which reached a peak of $2.5 billion at the end of 1986, declined to $1.8 billion by the end of the year. Since August, 1987, there has been increased pressure on the exchange rate which has required support by the Central Bank. While the rate has depreciated some- what since the end of 1986, it is currently somewhat below the parallel market which ranges from 21.5-22.0. (See explanatory note below). II. PROGRESS IN THE REFORM PROGRAM 5. The Economic Recovery Program concentrated on four areas of economic policy: government financial institutions, the restructuring of public expenditures, tax reform and trade reform. Government Financial Institutions 6. DBP and PNB. The reform program for the major government financial institutions (GFIs) has made major progress. The two main banks, DBP and PNB,1/ have been reorganized, major non-performing accounts have been removed from their books, and they are beginning to show signs of profit- able operations. The total staffs of the two institutions have been reduced from 9170 to 6706. Unprofitable foreign and domestic branches have either been closed or restructured to a more profitable basis. Audits by private auditing firms have been initiated for 1986. A major program of institutional strengthening has been undertaken by both organizations designed to improve procedures for loan evaluation and collection, as well as such internal functions as planning and budgeting, personnel management, legal and accounting services. Financial performance has been within the performance criteria agreed during negotiations in areas such as capital adequacy, liquidity, asset quality and earnings performance. As a result of the restructuring of these banks, their share in total banking system assets has declined from 39% at the end of 1985 to 12% by the end of 1987. 7. 6=. Non-performing accounts from the two major banks have been given over to the Asset Privatization Trust (APT) for disposal. For the year 1987, APT made sales amounting to P3.8 billion (69 accounts), substantially in excess of the expected target of P2.6 billion for the year. APT assets have attracted both foreign and domestic buyers, and have been strictly on a cash basis. For 1988, APT has an optimistic sales target of P8.7 billion. The future pace of sales may slow down, however, since many of the remaining accounts present difficult legal problems. 1/ Development Bank of Philippines and Philippine National Bank, respectively. Exolanatory Note: The Central Bank of the Philippines has provided OED with revised figures for these paragraphs. They are reproduced as Annex VI, page 4, paras. i and J. - 31 - ANNEX II Page 3 of 7 8. Monitoring and Attachment. The monitoring of the performance of the GFIs has been undertaken by the Inter-Government Financial Institutions Policy Coordinating Committee (IGFIPCC), a group of GFI heads chaired by the Secretary of Finance and including the Central Bank Governor. The Department of Finance serves as its secretariat. While it was originally agreed under the Loan Agreement that monitoring would be undertaken by the group that monitors public corporations, the setting up of a separate com- mittee is an acceptable alternative. The Committee has met quarterly, and monitors both the financial performance and institutional restructuring of DBP and PNB. In addition, it monitors the other GFIs, namely GSIS, SSS,2/ Philguarantee and Land Bank, although this was not required under the Loan Agreement. 9. It had been agreed that the attachment of PNB and DBP would be shifted from NEDA to the Department of Finance (DOF). In fact, the attachment of PNB and DBP was shifted to the Office of the President. While this arrangement is not necessarily the most appropriate arrangement, it achieves the overall goal of ensuring adequate oversight by some responsible unit of the Government. Since additional oversight responsibility is also being exercised by the DOF through the IGFIPCC, this arrangement is considered acceptable. 10. GFI Studies. Studies of four other GFIs have been initiated. These studies, which cover Philguarantee, Land Bank, and GSIS/SSS, will be completed prior to the release of the third tranche and will be partly financed by the Economic Recovery Technical Assistance Loan (Loan 2788-PH). 11. Government Acquired Banks. Of the six acquired banks, full or partial sales have been made in three cases. Sale of a majority interest in all six banks is a requirement for the third tranche release under the ERL; there is no target set for the second tranche. The Government has also sold a fourth bank, the PCI Bank, which was owned by DBP but was not included in the reform program. 12. Government Deposits. The Central Bank's policy on government deposits remains in force; depository banks are required to keep a 75% liquidity cover against public sector deposits, in the form of cash or government securities. The Government has liberalized the restriction placing all government deposits in government banks by permitting four private commercial banks also to act as public depositories. 13. Technical Assistance. At the time of appraisal, it was felt that the reform program for PNB and DBP would necessitate outside technical assistance. In addition, certain technical assistance needs in the Ministry of Finance and Central Bank were also identified. A $10 million technical assistance loan (Economic Recovery Technical Assistance Project Loan No. 2788-PH) was signed with the Government to help finance these needs, and to finance studies of four smaller GFIs, mentioned in para. 10, above. In fact, the reform programs for the two banks have been successfully carried out without outside technical help, largely by relying / Government Service Insurance System and Social Security System, respectively. - 32 - ANNEX II Page 4 of 7 on locally recruited new st.-ff, and by reorganization and better utilization of existing sta..f. The envisioned reform programs for the Ministry of Finance and Central Bank have not yet been started, as the Government is seeking to finance these needs with grant funds from bilateral donors. At the Government's request, million of Loan 2788-PH has been cancelled. Public Expendit~ures 14. Maintenance and operating expenditures (MOE) have been increased significantly this year. The projected level for 1987 is P 24.1 billion, which represents a real increase of 54% over 1986. Under the Economic Recovery Program, the Government is committed to raising the real level of MOE in the economic and social sectors to the real level of 1982. At present expenditures rates, the level would equal 97.4% of the target, which is acceptable. 15. While the composition of the public investment program is satisfactory, its level has not been increased as planned. Compared to the ERL target of 5% of GNP, expenditures during 1987 actually reached a level of only 3.3%, about a 9% real increase over the previous year. Part of this is explained by a lag between work accomplished and cash disbursement, changes in the administration of key agencies, and Commission on Audit (COA) requirements for the preauditing of expenditures. Steps have been taken to accelerate expenditures during the second half of the year. A Project Facilitation Committee at the undersecretary level has been established to improve project implementation and to accelerate the identification of new projects. The Undersecretary of the Department of Public Works and Highways has been designated as Presidential Adviser on Project Development and Implementation. As a result of these initiatives, the amount of preauditing by COA has been reduced, and additional resources made available to fund pre-investment activities. A recent report of the Project Facilitation Committee was received and reviewed by the Bank's staff, and it is our opinion that the necessary corrective steps have been taken which will raise the rate in 1988. Overall monitoring of the public investment program continues to rest with NEDA, which provides quarterly reports to the Cabinet, and to the Bank, on program implementation. Tax Reform 16. Progress in tax reform has been good. The value-added tax was introduced on January 1 of this year, ten months earlier than called for under the ERL program. The VAT could add as much as P1.5-3.0 billion to total tax revenue. The only part of the tax reform program that has not been carried out is the amalgamation of the special funds, including the gambling tax, into the general fund. Most tax exemptions for public corporations have been removed, although tax exemptions have been restored to the National Power Corporation (NPC) and the electric cooperatives in order to hold down the level of power rates. 17. The ERL program calls, as a condition of the second tranche, for the undertaking of five studies related to possible further tax reforms, with implementation of the recommendations as a condition for release of - 33 - ANNEX II Page 5 of 7 the third tranche. Studies have not been completed with respect to the inclusion of interest income in the globalized income tax, and the possibility of an inflation adjustment for depreciation. On the first item, a study of the globalization of interest income had already been undertaken in 1986. The Government feels that because of its weak enforcement position, it is not practical to undertake this step at this time. With regard to the inflation adjustment for depreciation, the Government argues that it is no longer necessary since accelerated depreciat--'on has just been introduced. In addition, the introduction of an inflation adjustment could erode tax revenues since it would permit depreciation greater than purchase prices. The Government has initiated several tax reforms, some of which had not been identified as part of the ERL program. Reforms undertaken so far include the imposition of ceilings on business deductions, a revised BOI investment incentive code, and improvements in tax administration and compliance. In our view, the overall thrust of the tax reform program is in compliance with the - expectations of the ERL program. Trade Reforms 18. The trade liberalization program is on schedule. The program calls for the removal of import controls on 299 import items between June 1987 and April 1988.1./ As required, the Government liberalized 72 restricted import items (mostly textile fibers) at the end of October and 63 items at the end of December, 1987. In fact, some items (mostly paper and paperboard products) were decontroled ahead of schedule. A program for the decontrol of another group of 673 items still controlled has been agreed, as reouired for the release of the second tranche. Of this group, a total of 104 items will be liberalized by the end of 1989; for an additional 455 items, the Government will announce plans for liberalization before the release of the third tranche. 19. Some upward tariff adjustments have been made on liberalized items, thus replacing quantitative controls with tariff protection. These increases are reasonable, and within the agreed ceiling for tariffs of 50%. In many cases, this proposed program would introduce temporary tariff increases including time-bound provisions for reductions back to existing levels. It also includes shifting some tariffs from an ad valorem to a specific basis, in an effort to discourage undervaluation of imports. 20. It was envisaged under the ERL that the Government would, by the time of the release of the second tranche, complete studies that could later lead to an overall reduction in tariff levels. While these studies have begun, they will not be completed until sometime next year. It is the Government's view that further tariff reductions at this time would under- mine the trade liberalization program, and lead to pressures to reimpose quantitative restrictions. It is the staff's view that a delay in the announcement of the new tariff program until sometime in 1988 is warranted provided the program for liberalization of quantitative restrictions remains on track, including progress on the remaining 673 items. 3./ It is estimated that these cover about 4% of total imports. - 34 - ANNEX II Page 6 of 7 III. PROGRESS AGAINST TRANCHE RELEASE CRITERIA 21. The following specific criteria for tranche release are listed in Schedule 4 of the Loan Agreement: (a) implementation of a plan for institutional strengthening and reorganization of PNB and DBP; (b) a program of cost reduction for PNZ and DBP, involving the rationalization of branches and staff reductions; (c) transfer of designated non-performing accounts and liabilities of PNB and DBP to the National Government; (d) due compliance with the Government's policy on public sector deposits and maintenance of appropriate liquidity ratios by government depository banks; (e) the maintenance of a public sector investment program with content and at levels satisfactory to the Bank; (f) the implementation of the Government's 1986 tax reform program; (g) raising Government maintenance and operations expenditures up to their 1982 real levels for the economic and social sectors; (h) carrying out the agreed program of trade liberalization; (i) implementation of the technical assistance program under the Economic Recovery Technical Assistance Project; (j) issuance of aucits of DBP and PNB for 1986 undertaken by independent external auditors; (k) submission of detailed organizational, staffing and financial plans for the Asset Privatization Trust; (1) completion of studies for the further reform of the tariff structure; (m) completion of studies and announcement of a program for a furthe- liberalization of quantitative import restrictions; (n) submission of a final branch reduction program for PNB by June 30, 1987; (o) introduction of a system for the monitoring and evaluation of PNB and DBP; - 35 - ANNEX II Page 7 of 7 (p) implementation of a system to monitor the public investment program; (q) completion of studies for the further improvement of the tax system; and (r) attachment of PNB and DBP to the Department of Finance. 22. The Government's actions, as described above, have substantially complied with these criteria, with the following exceptions: - the level of public investment was below the ERL target; - the audit of PNB for 1986 has been initiated, but not yet issued; - the tariff reform studies have been started, but not concluded; and - the technical assistance program under the Economic Recovery Technical Assistance Project has not been fully implemented. It should also be noted, however, that the Government has exceeded the limits set by the program in many important areas, specifically: - the staff reductions undertaken by PNB and DBP have exceeded initial targets; - private banks have been made eligible to receive government deposits; - the asset sales of the APT have exceeded our initial estimates; and - the trade liberalization program has been advanced over the agreed schedule. III. CONCLUSION 23. Overall progress on the program of reforms supported by this loan has been good. Minor shortfalls have been more than offset by better than expected compliance in other areas, and general adherence to the important aspects of the program. Criteria for disbursement of the second tranche were substantially met (except as noted in para. 22, above). The Government of the Philippines has therefore been advised of the availability of the second tranche of $100 million under this loan. Moeen A. Qureshi - 36 - Internationai 3ank for Reconstruction and Deveicoment 0R OFFICIAL LSE ONL' ANNEX III Page 1 of 6 SecM89- 1607 FROM: Senior Vice President, Operations December 22, 1989 PHILIPPINES--Release of the Third Tranche of the Economic Recovery Loan* 1. As provided in Section 3.01.of the Loan Agreement for the Economic Recovery Loan to the Philippines (Loan No. 2787 - PH), the Bank's staff have monitored progress on the economic recovery program supported by this loan. Supervision missions visited Manila in November 1988, June 1989 and July 1989. An IMF mission in October-November 1989 also reviewed and discussed with the Government the macroeconomic developments. This memorandum summarizes the progress achieved under the program during 1988-89 and towards the fulfillment of the criteria agreed for the release of the third tranche. I. Recent Economic Developments 2. The performance of the economy in 1988-89 has been satisfactory. Real GDP growth was 6.4 per cent in 1988, and is estimated at approximately 6 per cent in 1989. Total investment has increased slowly both in 1988 and 1989. reflecting the gradual absoiton of excess capacity, and it is expected to amount to approximately 20 per cent of GNP in 1989. Inflation was below 10 per cent in 1988, but rose in latter part of 1989. due to one-time events such as the minimum wage rise, and is expected to be approximately 13 per cent for the year as a whole. These events have negatively affected the public sector performance in 1989 and, in spite of a substantial rise in tax revenues, the consolidated public sector deficit is estimated to be at 4.4 per cent of GNP. The Government has initiated remedial action, including the announced petroleum price increase and legislative measures to raise tax revenues. Distribution Executive Directors and Alternates President *Questions on this Senior Vice Presidents document may be referred Senior Management Council to Ms. D. Gressani Vice Presidents, IFC (Extention 73539) Directors and Department Heads, Bank and IFC .,cum:nt :ut a '!nc:Jo J:rtriution anu rnj ne usea o% recipients only in ine performance A ::n: :. : Juties. its cuntnts may not otherwise be disclosed without World Bank authorization. - 37 - ANNEX III Page 2 of 6 3. Regar6ing the balance of payments, the current account was in deficit in 1988 and 1989. This reflected strong increases in capital goods imports that were required to sustain the recovery of investment. The performance of exports, though outpaced by the growth of imports, has been encouraging, with manufactured exports estimated to have grown 17 per cent in volume terms in 1989. Capital inflows, in particular direct foreign investment, have increased significantly in both yeais. The exchange rate has been kept in line with the parallel market rate. 4. The Government has recently reviewed with the IMF its medium-term macroeconomic program for 1990-92, which is supported by a three-year Extended Arrangement. The objective of the program remains the restoration of real growth at 6.5 per cent per year, single-digit inflation and the strengthening of the external payments position. The benchmarks agreed under the IMF Extended Arrangements include a ceiling on base money expansion and the public sector borrowing requirements, a floor on net international reserves, and targets for tax revenues Rnd public sector capital expenditure. 5. The Government presented its longer-term development strategy at the recent Consultative Group meeting in July 1989, where it received broad support. The Government has also made progress in defining and implementing its debt management strategy. An agreement with the Paris Club, involving rescheduling of principal and interest, was reached in May 1989, and an agreement, involving debt repricing, debt buy-backs and new lending, was reached with commercial creditors in October 1989. II. Program Implementation 6. The Economic Recovery Loan (ERL) for $300 million became effective in June 1987. The first tranche was released upon effectiveness; the second tranche was released in March 1988, as notified to the Board on March 23, 1988. The Economic Recovery Program supporting the loan concentrated on four areas of economic policy: government financial institutions, public expenditures, tax reform and trade reform. Government Financial Institutions 7. The reform program of the two major banks, Development Bank of the Philippines (DBP) and Philippine National Bank (PNB), has substantially been completed as agreed with the Bank. Institutional strengthening and improvement of internal procedures, branch restructuring and staff reduction, transfer of major non-performing accounts to the Asset Privatization Trust (APT) and the disposition of P 4.9 billion of such assets had been accomplished in 1987. In 1988-89, further progress has been made. Financial audits by external auditors were performed on DBP and PNB for 1987, and the Commission on Audit (COA) has completed auditing of DBP for 1988. Though not required under the agreed program, reform of PNB advanced further with the partial privatization of 30 per cent of PNB's total capital, accomplished in May 1989 with the successful public issue of shares. Disposition of the remaining non-performing accounts of PNB and DBP by APT has continued, and approximately P 1.3 billion have been disposed in 1988. APT has also been - 38 - ANNEX III Page 3 of 6 audited for 1987, though by COA rather than by an external auditor as required by the Loan Agreement. 8. The monitoring of DBP and PNB continues to be carried out by the Inter- Government Financial Institutions Policy Coordinating Committee (IGFIPCC), which was established under the program, and the two banks continue to be attached to the Office of the President. These arrangements are satisfactory to the Bank, in view of ensuring adequate supervision and responsibility by the Department of Finance, whose Secretary chairs IGFIPCC. 9. The divestment of six Government banks targeted for privatization under the Economic Recovery Loan has progressed substantially but has not been completed. Two banks (Commercial Bank of Manila and Filipinas Bank) have been fully transferred to the private sector: two banks (International Corporate Bank and Union Bank) have been partially transferred to the private sector, for 40 per cent of their equity. Further privatization of these banks and privatization of Associated Bank are delayed by litigation initiated by previous owners; the sixth bank. Republic Planters Bank, has not yet completed the rehabilitation process necessary prior to privatilzation. 10. The management of Government deposits continues to be in accordance with Central Bank regulations, including the maintenance f a 75 per cent liquidity ratio in cash and Government securities against public sector deposits, as agreed with the Bank. The Government has, however, restricted the function of Government depository bank to PNB in mid-1989, reversing the initial liberalization that in 1988 had allowed also four private banks to act as public depositories. 11. The four studies of Government financial institutions (Government Service Insurance System, Social Security System, Land Bank of the Philippines, Philippine Export and Foreign Loan Guarantee Corporation) to be carried out under the ERL have been completed, and their findings are being reviewed by our staff. 12' At time of appraisal it was felt that the Economic Recovery Program would require outside technical assistance, in particular with regard to the reform of Government financial institutions. The Economic Recovery Technical Assistance Project Loan (Loan No. 2788-PH) of $10 million was signed for this purpose. While the Government subsequently chose to resort to locally recruited staff and to use grant funds from bilateral donors for these purposes, the goals of the Technical Assistance Project were largely achieved, as evidenced by the successful reforms referred to above. At the Government request, approximately $9 million of the Technical Assistance loan has been cancelled. Public Expenditure 13. Operations and Maintenance expenditure of the national government in economic and social sectors was substantially increased in 1987, to reach approximately 88 per cent of the target agreed with the Bank (the 1982 level of Operations and Maintenance expenditures in real terms), and has been - 39 - ANNEX III Page 4 of 6 maintained at a satisfactory level in 1988. The projected figures for 1989 imply an expenditure level in excess of the agreed benchmark. 14. Regarding the performance of the public investment program, while the composition of the program remains satisfactory, its level has fallen short of the target of 5 per cent of GNP. The consolidated public sector investment expenditure is however estimated to have increased substantially in 1989, from 3.2 to 4 per cent of GNP. Tax Reform 15. The 1986 tax reform program had been largely implemented and the value added tax had been introduced prior to second tranche release, ahead of original plans. Further progress has been accomplished in 1989 with the broadening of the coverage of the value added tax to include sugar refining and trading. 16. The Government has made substantial progress in 1989 on the tax collection front. Improved tax administration contributed substantially to the large rise in tax receipts (estimated to have increased from 11 to 12.8 per cent of GNP in 1989), which resulted mostly from income tax, import tax and value added tax revenues. The Government also intends to accelerate computerization and personnel hiring and training for value added tax administration, which should further strengthen collection. 17. The studies of direct taxation and fiscal incentives carried out under the program did not recommend further reforms in these areas. Nevertheless, the Government introduced in 1989 regulations broadening the withholding tax system to include incomes from partnership shares and some professional fees under the IMF Extended Agreement. Further measures aiming in particular at tightening rules governing tax credit and tax deferral are to be introduced in 1990. Trade Reform 18. The original program of trade liberalization was successfully implemented and the liberalization of agreed items was completed by April 30, 1988. Further liberalization as agreed prior to second tranche release was undertaken in December 1988, .when restrictions .were lifted for 94 of the 104 items that had been originally agreed. The Government subsequently undertook reviews of the remaining items whose liberalization was to be evaluated under he program, with the goal of continuing to shift towards a system of tariff- ased protection. A program for further liberalization was agree' under the MF Extended Arrangements, aiming at eliminating most non-tariff restrictions y end-1994. As envisaged by this program, restrictions covering 90 items ere lifted in July and September 1989. The Government has also introduced egislation to rationalize import tariffs, and is preparing a bill that will educe some import tariffs on capital goods. II. Progress Against Tranche Release Criteria - 40 - ANNEX III Page 5 of 6 19. The following specific criteria for tranche release are listed in Schedule 4 of the Loan Agreement: a) implementation of a plan for institutional strengthening and rationalization of PNB and DBP; b) implementation of a program to reduce operating costs of PNB and DBP, involving rationalization of branch networks and staff reductions; c) transfer of designated assets and liabilities of PNB and DBP to the Government; d) due compliance with the Government policy on public sector deposits and maintenance of appropriate liquidity ratios by Government depository banks; e) implementation of a public sector investment program with content and level satisfactory to the Bank; f) implementation of the 1986 tax reform program; g) increase of the Government's Operations and Maintenance expenditures, in the economic and social sectors, to a level at least equivalent to the 1982 real level; h) implementation of the agreed program of trade liberalization; i) implementation of the program of technical assistance under the Economic Recovery Technical Assistance Project; j) introduction of a system for monitoring and evaluation of PNB and DBP; k) issuance of financial audits of DBP, PNB and APT for the fiscal year 1987, undertaken by external auditors; 1) divestment of six Government banks (Associated Bank, Commercial Bank of Manila, Filipinas Bank, International Corporate Bank, Republic Planters Bank, Union Bank); m) further improvements to individual and corporate income tax system, property taxes and fiscal incentives; n) completion of studies regarding: Philippine Export and Foreign Loan Guarantee Corporation, Government Service Insurance System and Social Security System, Land Bank of the Philippines; n) introduction of a value added tax; m) public announcement of a progrant for further reform of tariffs on imports; - 41 - ANNEX III Page 6 of 6 o) implementation of a program for further liberalization of quantitative import restrictions. 20. The Government actions, as described above, have substantially complied with these criteria, with the exceptions: - the level of public investment was below the agreed target; - the audit of APT for 1987 was conducted by COA rather than by an external auditor; - the Economic Recovery Technical Assistance Project has not been implemented. 21. It should be noted, however, that the Government has largely achieved the goals of the Economic Recovery Technical Assistance Project, and has proceeded further than agreed with the reform of PNB, with its partial privatization. IV. Conclusion 22. Overall progress on the program of reforms supported by this loan has been satisfactory. With the exceptions mentioned in paragraph 19, the Government has complied with the agreements, and criteria for disbursement of the third tranche have been substantially met. The Government of the Philippines has, therefore, been advised of the availability of the third tranche of $100 million under this loan. Hoeen A. Qureshi - 42 - ANNEX IV KEY MACROECONOMIC INDICATORS, 1980-90 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Real Growth Rates: Gross Domestic Product 5.1% 3.4% 3.6% 1.9% -7.3% *7.3% 3.4% 4.8% 6.3% 6.1% 2.4% Gross Domestic Income 4.6% 3.2% 2.8% 1.4% -8.7% -7.1% 4.2% 5.1% 7.2% 5.7% 3.9% Real per Capita Growth Rates: Gross Domestic Product 2.4% 0.9% 1.1% -0.6% -9.6% -9.5% 1.0% 2.3% 3.8% 3.6% 0.1 Total Consumption 1/ 1.7% -0.5% 1.4% -2.4% -3.4% -3.5% 0.6% 1.6% 4.0% 2.7% 3.4 Private Consumptioi 1.7% 0.1% 0.9% -1.9% -2.2% -3.5% 0.9% 1.6% 3.8% 2.6% 3.0. Debt and Debt Service: Total D0D/GDP 53.7% 58.7% 65.9% 73.6% 77.6% 88.2% 95.5% 89.4% 76.1% 66.8% 68. Debt Service/Exports 27.1% 34.3% 43.7% 37.2% 33.7% 32.2% 35.2% 38.9% 33.1% 26.1% 21. Debt Service/GDP 6.7% 8.3% 9.4% 9.1% 8.6% 8.3% 10.2% 10.7% 9.3% 7.6% 6. Interest/Exports 18.6% 25.4% 30.7% 25.0% 24.1% 22.2% 18.8% 19.7% 18.7% 17.3% 13. Interest/GDP 4.6% 6.1% 6.6% 6.1% 6.2% 5.8% 5.4% 5.4% 5.2% 5.0% 3.x. Ratios to GDP: Gross Investment 29.1% 27.5% 27.9% 29.6% 21.8% 15.3% 16.0% 18.0% 18.4% 21.8% 22.5 Domestic Savings 24.2% 24.1% 22.1% 23.1% 20.9% 17.4% 19.5% 18.4% 19.8% 20.1% 16.7 Current Account Balance -5.9% -5.8% -8.6% -8.3% -3.6% -0.3% 3.2% -1.3% -1.0% -3.4% -6.1 GOP Deflator (% growth rate) 14.3% 11.7% 8.7% 14.2% 53.3% 17.6% 3.0% 7.4% 10.2% 8.7% 13.4% Real Exchange Rate Index 112.9 113.3 117.6 97.2 92.8 100.0 79.9 75.1 73.9 77.9 75.1 Terms of Trade Index (*) 87.7 77.3 81.5 80.7 79.7 100.0 114.7 117.3 128.1 119.4 111.2 Exports CGNFS) Growth Rate 39.8% 6.4% -8.0% 4.5% 3.8% -16.6% 17.1% 6.5% 14.7% 10.7% 1. Exports (GNFS)/GDP 23.6% 23.8% 20.3% 21.6% 24.2% 24.0% 26.3% 26.6% 28.2% 28.5% 27. Imports (GNFS) Growth Rate 19.6% -0.8% 2.4% -3.1% -17.5% -14.2% 10.2% 28.6% 19.6% 15.2% 10. Imports (GNFS)/GDP 28.5% 27.2% 26.1% 28.1% 25.1% 21.9% 22.4% 26.1% 26.8% 30.3% 33.4 Memo: Current Account (US$ mt) -1904 -2061 -3200 -2750 -1116 -103 954 -444 -390 -1456 -2695 Exchange Rate CP/USS) 7.5 7.9 8.5 11.1 16.7 18.6 20.4 20.6 21.1 21.7 24.3 GDP (US$ mit) 32413 35600 37097 33161 31368 30549 29877 33320 38088 42595 44227 Population (mi) 48.32 49.54 50.78 52.06 53.35 54.67 56.00 57.36 58.72 60.10 61.48 .................................................-------------------------------********------------**-*---*- Sources: National Statistic Coordination Board, The National Income Accounts of the Philippines, base year 1985, February 1992. Central Bank of the Philippines, Selected Philippine Economic Indicators, 1990 and updates. World Bank, World Debt Tables, 1991-92. 1/ Excluding statistical discrepancy. C*) The Central Bank of the Philippines has indicated that this series has been revised. See Annex VI. Note: This Table is based on a revised set of National Income Accounts released by the Philippine National Statistic Cocrdination Bureau in February 1992. PBILIPPINES - DEBT OUTSTANDING AND DISBURSED (Year-end Stocks, US$ millions) 1970 1980 1983 1984 1985 1986 1987 1988 1989 1990 Long-Term Debt 1,544 8,817 13,692 14,010 16,620 21,872 24,747 24,015 23,339 25,113 Public sad publicly 625 6,363 10,567 11,299 14,020 19,578 23,231 23,023 22,597 24,108 guaranteed Official creditors 272 2,636 4,816 5,386 6,966 8,468 10,991 11,708 12,493 15,133 Multilateral 120 1,310 2,833 2,827 3,478 4,187 5,009 4,771 4,981 6,274 Concessional 75 279 560 638 682 733 778 824 875 1,282 IDA 0 34 61 71 84 92 99 102 102 101 Nonconcessional 46 1,031 2,273 2,189 2,797 3,455 4,230 3,948 4,106 4,992 IBRD 119 926 2,047 1,865 2,420 3,017 3,747 3,408 3,492 3,943 Bilateral 152 1,326 1,983 2,559 3,487 4,280 5,983 6,937 7,512 8,859 Concessional 68 894 1,303 1,374 1,900 2,551 3,810 4,580 4,776 5,818 Private creditors 353 3,727 5,751 5,913 7,055 11,110 12,240 11,314 10,104 8,974 Bonds 11 888 932 843 839 886 850 610 410 918 Comercial banks 267 2,256 3,959 4,021 4,852 8,744 9,689 9,007 8,428 6,917 Other private 75 583. 859 1,049 1,364 1,480 1,701 1,698 1,266 1,139 Private nanguaranteed 919 2,454 3,125 2,711 2,600 2,294 1,516 992 743 1,006 ewmo: total commercial 1,186 4,711 7,084 6,732 7,452 11,038 11,205 9,999 9,170 7,922 banks eo: not use of 1F 69 1,044 1,095 885 1,168 1,266 1,260 1,093 1,177 912 credit Nees short-term debt N/A 7,556 9,608 9,460 9,157 5,382 3,796 3,864 3,952 4,431 Sources World Bank, World Debt Tables 1991-92. M - 44 - ANNEX Vi Page 1 of 4 ..*jul, gEaI-:~ FRO~M ODG-RS 5å13e. v&q &våååýe A .001 49 (CCNTRAL $ANK OF TME P~LIPPINC-S) aøVNILN Pi.IPINAS rfMIMILC MCSS£WC TO: iax NwnmwrrS) : .202-•676-0560 rax Nunb:i,- 521-38-39 Artnticn : Mr. Mark Baird Sender oMr. Amando Tetaneo Drvistin Chief, Country Pollcy, Industry & yInance Operations Dept. ManagIng Director Cap.any i The World Bank ; seareb Sector o. of Pogøs d Cv four (4) M.avs : 1818 8. St., N. W. Date,•: 19 June 1992 Washingten, D.C. 20433 U.S.A. Dear Mr. Baird: & 4.... maLw , VUs urA. rrogram reriormance AuG:t Leport (rA) on the Philippine Ecouomc Recovery Program (EP) and Economic Recovery Techntcal åssltance Project (ERTAP) daced Ilay 29, 1992, ve generally concur with the overall evaluation of the report, except for the attached conuents/updates. Very truly yours, MANg . ITANGC,JR. ManagIng DIrector - 45 - ANNEX VI Page 2 of 4 ContLCorrions.L"AR Runami R cvwy Prugram. oan.=d EuanmilRecov.akTeicalAaainane Proj ec.t 1. With regards to the statement on p. 18, paragraph 7-10, last sentence, we would only partly agree with the observation that a more aggreasive and consistent export-oriented exchange rate policy is needed to bring about a sustained economic transformation. In the case of the Philippines. while the nominal exchange rate depreciated substantially for the past ten eW%^&W uw . WayLL waywelea i, Lnie poiicy lia not ensure sustained economic growth. Because of the transmission effect of exchange rate adjustments to price levels, and on to external competitiveness,. the. exchange rate in real terms appreciated due to higher inflation thus negating the impact of the initial exchange rate adjustment. The country'c external oompetitiveness was likewise dampened by unfavorable developments in other areas such as the country's low labor productivity, high domestic interest rate and poor capacity to export. Thus, while aggressive export-oriented exchange rate is necessary for a sustained economic transformation, this,'however, should be categorically supported by appropriate policies in other areas of the aeonomy. 2. To facilitate reference of the accompliehments of a MYaQiEU95Tflrminath it in itefntrd that the PPA? Should hITMo a oomparative summary of the planned and actual results of the program/project being evaluated, which could be in matrix form. This may be included as another annex or a combination of existing annexes in the report. 3. With regard' to the data/information used in the report, we have reflected corrections/update on the monetary section of the report for the Bank's future roference. a. page 7, paragraph 4.7, item (ii) on Trade Reform: Additional elimination of import restrictions on 1229 items (instead of 1232), representing about 17 percent (not. 14 as indicated) of the value of imports for 1988 and ... 1000 even. The 1229 items referred to above excludes the 3 items on augar under high tariff items, namely centrifugal, in buFly1986.r rAw. 'n"d fri w" on per agrCeemet wirp C in JuIv. 1986. - 46 - ANNEX VI Page 3 of 4 b. pago 12. Table 1: Key Manroeconomic Indicators. The line for official loan disburuensento should be revised to: 716 (1985), 912 (1986), 998 (1987), 938 (1988), 1324 c. page 13, 2nd paragraph, item 6.4. 11th line, "absorbing close to 6 percent... (instead of 5 peroent).... equivalent to about one third (instead of one fourth) of export earnings. d. page 17, second paragraph, item 7.8, line 6: insert "including commernial bank8" after "...Private enterprises". e. page 18., paragraph 7.10, 4th sentence: During... there wan a 20 (inotead of 25 percent) ... and 1988. f. page 18, paragraph 7.10. 6th sentence: During the peso ... by about 7 (instead of 8 percent) g. page 19, oorrectione to Table 6 on real effectivo exchange rates 1986 1987 1988 1989 1990 1991 Against Major Trafinu fnrtnrrm 71 T n TM 7T M Against Major Competitore 99 114 117 124 121 122 h. page 22, paragraph 7.19; While ... debt increased from Ui283 billion (instead of $28.5 billion) ... to US$2B:.5 billion (instead of $30.5 billion)... credit. Compensating... to reach almost US$8.5 billion (instead of .$8.9 billion) in 1990, and debt to the World Bank rose from US=.3 bi.Lnn (instead of US$3.0 billion) to UJS$.1 billLnm (instead of US$3.9 billion). Debt to the IMF dropped ... to US$1.0 billion (instead of $0.9 billion)... and that to commercial banks and other finnial institutions dropped from ZA$16.2 biIn (instead of USS11.0 billion) to US$1.& billion (instead of US$7.9 billion). - 47.- ANNEX VI Page 4 of 4 i. pago 30,. item 3: On the bala-n ... in deficit by about SAAA million (Irstead of $3O million) about 1A percent (instead of 1.2 percent) of GNP. Whil, non- traditional ... have rHen by &A percent (instead of 30 percent) ... this has been offset somewhat by ngative earts (rather than lower earnings) on primary products. As a result, total export earnings have increased by about L.Z percent (instead of 19 percent), while imports have risen by about iM.Ag (nntead of 28%). J. page 30, item 4: Gross reserves, ... declined to S"D billion (instead of $1.8 billion)... of the year... While the rate ... which ranges from P20,43-P22.91 (instead of 21.5-22.0). j. page 42, Annex IV: Terms of trade index: 1980 (from 87.7 to 83.8), 1981 (from 77.3 to 87.7); 1982(from 0201. I_ o .0), 1000 (%,w-D . o oQ .-t), Liba-(f&avus Tz.T WV 85.4); 1986 (from 114.7 to 107.9); 1987 (from 117.3 to 118.2); 1988 (from 128.1 to 131.2); 1989 (from 119.4 to 121.5); 1990 (from 111.2 to 109.5) Memo: Current account - 1990 (from -2688 to - 2895) Exchange rate - 1982 (from 8.6 to 8.5); 1985 from 18.7 to 18.6) PROJECTED AND ACTUAL RECOVERY PATTERNS 1986 1987 1988 1989 1990 Actual Projected Actual Projected Actual Projected Actual Projected Actual Annual Growth Rates (%) GDP Growth 3.4 5.0 4.8 4.5 6.3 4.9 6.1 5.3 2.4 Total Consumption 0.6 2.0 1.6 4.0 3.0 2.7 4.5 3.4 Exports GNFS 17.1 2.6 6.5 3.4 14.7 5.6 10.7 5.8 1.3 Imports GNFS 102 14.5 28.6 5.9 19.6 6.9 15.2 7.1 10.0 Terms of Trade Index (1985 100) 107.9 102.3 118.2 102.6 11.2 102.4 121.5 104.1 109.5 O Sources: Projected: ERL President's Report, Annex I, page 1. Actual: Annex IV. - 49 - PROJECT COMPLETION REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (LOANS 2787-PH 2788-PH) June 26, 1991 Country Operations Division Country Department II Asia Regional Office - 51 - PHILIPPINES ECONOMIC RECOVERY PROGRAM (LOANS 2787-PH & 2788-PH) PROJECT COMPLETION REPORT PART I: Project Review from the Bank's Perspective 1 Project Identity Project Name: Economic Recovery Program. Economic Recovery Loan and Economic Recovery Technical Assistance Project Loan Number: 2787-PH & 2788-PH RVP Unit: Asia Country: Philippines Loan Amount: USS310 million Board Approval: March 17, 1987 Signature: March 30, 1987 Effective Date: June 4, 1987 Closing Date: December 31, 1989 2 Background 2.1 While economic growth was rapid during the 1970s, distortions in the structure of incentives produced inefficient patterns of investment, slow growth in employment and low levels of domestic savings. The economy was heavily dependent on imports and foreign capital, and did not adjust well to the severe external shocks of the post-1979 period -- high oil prices, high interest rates, and declining export prices. While sohia adjustments undertaken during the early 1980s were effective, the economy experienced declining growth rates, a deteriorating balance of payments, and the accumulation of a large external debt. A domestic political crisis in 1983, combined with a worldwide debt crisis, led to a cessation of foreign credits and forced the Government to embark on a major stabilization effort. 2.2 To deal with the economic crisis, the Government undertook a stabilization program supported by the IMF Standby Arrangement of December 1984. Under the stabilization effort, fundamental economic reforms were introduced in order to restructure imbalances in the incentive regime and institutional framework. External debt service obligations to private banks and official I.biiateral creditors were rescheduled. The peso was allowed to float and exchange controls, introduced in *he 1983 crisis period, were eliminated. Monetary ?rowth was brought under control, and the budget deficit was reduced in size. Important structural reforms were initiated in the agricultural sector, designed to improve accountability auid marketing efficiency. Price controls on many basic commodities, including rice, were dropped. 2.3 While these stabilization efforts succeeded in bringing inflation under control, improving' the external payments situation and obtaining a sizeable reduction of foreign debt service, fundamental structural problems in trade, finance and other areas remained untouched. A deep recession occurred in 1984- - 52 - 85, leaving GNP per capita about 25 percent lower in 1986 than in 1980. At the same time, the level of public expenditure was reduced by slashing public investment, while current expenditures increased steadily and, among them, budgetary support of Government financial and non-financial corporations soared to almost 4 percent of GNP per year during 1984-86. 3 The Program for Economic Recovery 3.1 Since the change in Government in February 1986, a high priority has been placed on economic recovery. The overall approach of the Government, as contained in the Medium-Term Development Plan, emphasized three key principles: (a) greater attention to poverty alleviation and social justice; (b) acceleration of growth and increased economic efficiency; and (c) reduced Government involvement in the economy and an emphasis on private initiative. 3.2 The Government formulated a program for economic recovery whose main goals included: a. Macroeconomic Policy: reduction of fiscal imbalances by increasing revenue mobilization; continuation of tight monetary policy; maintenance of a competitive exchange rate; b. Financial Sector: financial and organizational restructuring of Government financial institutions (GFIs) and further reform of the sector, in order to provide adequate financial resources for the recovery; c. Public Sector: improvement of structure and enforcement of tax system; increase in investment and in operations and maintenance (O&M) expenditures; reform and privatization of Government corporations; d. Industrial Sector: extending the trade liberalization program and shifting incentives towards labor-intensive, export-oriented industries; e. Agricultural Sector: institutional changes directed to improving access to land, inputs, extension services and credit. 3.3 The Government program won the support of the IMF, which approved in October 1986 an 18-month Standby Arrangement; the main objectives of the program monitored under the IMF Standby included reducing the National Government deficit and monetary growth, increasing international reserves and maintaining a flexible exchange rate system. 3.4 Within the Government program, four areas were identified as high priority and were supported by the Economic Recovery Loan (ERL) and Economic Recovery Technical Assistance Project (ERTAP): a. reform of the tax system; b. continuation of trade liberalization program; c. restructuring of public investment program; d. reform..of Government financial institutions. The initial concept of the loans was originally discussed at the S.tbcommitte9 meeting of the Consultative Group for the Philippines in May 1986; the loans were appraised in July-August and negotiated in December 1986. - 53 - 4 The Program of Action under the Economic Recovery Loan 4.1 Reform of the Tax System. The overall tax effort in the Philippines had been consistently low, in comparison with other middle income countries, and the tax system had distortive effects on resource allocation and created inequities between taxpayers. The low elasticity of the tax system had required frequent adjustments in the tax rates in order to provide additional revenues, and institutional limitations led to heavy reliance on international trade taxes. 4.2 In order to improve the extremely weak performance of the tax system and increase its overall economic efficiency, the program included the following measures: a. Income Tax: partial globalization of income taxation; increase of personal exemption; decrease of marginal tax rate. b. Indirect Taxes: rationalization of excise taxation; abolition of all export taxes, with the exception of duty on logs; introduction of value added tax to replace sales taxes. c. Tax Administration: reassessment of property values; provision of tax amnesties; provision of incentives to increase collections. These measures were designed to raise tax revenues from 10 percent of GNP in 1986 to 11 percent in 1987 and 12 percent in 1988. In addition, studies on selected taxation issues -- capital gains tax, inflation adjustment of depreciation allowance, tax incentives, inclusion of interest in globalized income tax, property ta,.acLn -- were to be undertaken. 4.3 Trade Reform. A tariff reform and trade liberalization program had been initiated in 1980, supported by SAL I and SAL II. The program had initially been successful: between 1980 and 1982 the average tariff rate fell from 43 to 30 percent, and the total number of restricted imports declined by about 30 percent as almost 900 consumer goods were liberalized, A series of payments crises, however, derailed the trade reform program: an import tariff surcharge was introduced and administrative restrictions were expanded between 1983 and 1985, as the Government sought to reduce imports. As of end-1985, restrictions covered about 25 pevcent of total imports. 4.4 The trade reform program was thus aimed at achieving, in the first place, substantial liberalization of restricted imports and, secondly, reforming the tariff structure with the objectives of reducing level and dispersion in effective protection. The following measures were to be taken: a. elimination of administrative restrictions on 1232 items, or about 14 percent of imports; b. announcement of a program for further liberalization and tariff reform. 4.5 Public Expenditure. As a result of budget stringencies, public investment and O&M expenditures was drastically reduced during 1984-85. The restructuring of the public investment program was necessary both because of financin.i 'onstraints and excessive arowth in the early 1980s; the level of investment b. 1?85 was however insufficient to replace depreciated assets and adequately support private sector development in the medium term. The level of O&M expenditures had also declined to the point where it was insufficient to maintain existing investment in working conditions, in particular in irrigation. - 54 - 4.6 The action program called for the following measures: a. maintenance of a public investment rate of 5-6 percent of GNP in 1988-90; b. maintenance of O&M expenditures in the economic and social sectors at least at their 1982 real level; c. submission the Medium-Term Public Investment Program to the Bank for annual reviews, and notification to the Bank of any major changes in the program; d. implementation of an improved monitoring system for public investment projects; e. improvement of coordination between Planning Department and Office of Budget and Management to ensure adequate budget support through the implementation of investment projects. 4.7 Reform of Government Financial Institutions. The Bank's first major involvement with financial sector reform in the Philippines took place in 1979, when a joint Bank-Fund mission undertook a broad study of the financial system. The recommendations of the study included the liberalization of interest rates and the reduction of institutional fragmentation. The study led to a major reform of the financial sector in 1981-82, supported in part by the Bank's Industrial Finance Loan. The reform liberalized interest rates on loans to the industrial sector, deregulated interest rates on deposits, gave more flexibility to banks to undertake long-term lending, and limited the role of the Central Bank as "lender of last resort". On the institutional side, the legally mandated functional classification was significantly reduced, and universal banks were created, with authority to engage not only in traditional commercial banking but also in investment banking. 4.8 Further reform of the financial sector was a high priority for the Government: its underlying objectives included the reduction of the Government's direct presence in the financial system, the encouragement of private sector ownership of financial institutions, and the elimination of preferential treatment of Government financial institutions vis-a-vis private financial institutions. A most urgent pre-condition for the attainment of these objectives was, however, the re-organization of the two largest Government-owned banks, Philippine National Bank (PNB) and Development Bank of the Philippines (DBP). These two institutions, accounting for almost one-half of total banking assets, were technically bankrupt, with 80 percent of their combined portfolio being non- performing, and had become a heavy burden for public finances, requiring budgetary support amounting to almost 4 percent of GNP per year during 1984-86. The deterioration of these two banks was related to the overall economic crisis and was exacerbated further because of internal political problems and inadequate monitoring and accountability by the banks' management. %.9 The program for financial sector reform in general and Government financial institutions in particular, included the following actions: a. issuance by the Monetary Board of a Policy Statement on the Financial System, spelling out the principles for future reform; b. avoidance of establishment of new banks by the Government; c. achievement of financial viability by Government-owned banks, elimination of budgetary support or other special advantages, enhancement of performance monitoring and increased accountability by means of external audits; - 55 - d. restructuring of PNB and DBP; e. restructuring and divestment of six smaller banks that had been acquired by the Government following financial difficulties; f. separation of special credit programs directed by the Government from the banks' own resources; g. studies of four GFIs (Land Bank of the Philippines, Philippine Export and Loan Guarantee Corporation, Government Service Insurance System and Social Security System) with the objective of reviewing their role, long-term viability and needs for restructuring ard strengthening. 4.10 The program for restructuring DBP and PNB included the establishment of new charters, installation of new management and boards, transfer of liabilities and non-performing assets to the Government for disposition, implementation of programs to reduce staff and other costs, establishment of ceilings for Government deposits, improvements in monitoring their performance and coordinating their activities. 5 Program of Action under the Economic Recovery Technical Assistance Project 5.1 Given the level of complexity of several actions supported by the ERL, a sizeable technical assistance component was designed to complement the operation. The program included the provision of technical assistance in the following areas: a. institutional strengthening of DBP and PNB; b. disposition of non-performing accounts transferred by PNB and DSP to the Government; c. study of social insurance institutions; d. strengthening of regulatory functions of the Central Bank; e. support to the Ministry of Finance to improve expenditure control and accounting. 6 Role of the Bank in the Design of the Operation 6.1 The Bank had been extensively involved in the trade and financial sector in the Philippines: in the early 1980s two adjustment operations (SAL I and II) had supported reforms in the trade regime, industrial policy and energy policy; in the 1970s several lending operations through DBP were undertaken but were subsequently halted because of DRP's mounting financial problems; and in the early 1980s the Industrial Finance Loan and the Agricultural Credit Project supported important financial sector reforms, including the liberalization of interest rates and the gradual elimination of subsidized lending in the agricultural sector. 6.2 In addition to the lending operations, in 1986 a Bank economic report ("The Philippines: A Framework for Economic Recovery", Report 6350-PH, November 1986) had analyzed the causes of the crisis and the need for policy reform. The report had identified th4 public finance problem as the main constraint to economic recovery in the short run, and had recommended improving tax collections, cuttiny transfers to Government financial and non-financial corporations, and increasing the external financing of the public deficit as the macroeconomic management measures needed to prevent accelerating inflation and further crowding out of private investment. To restore long-run growth prospects, the report recommended further trade liberalization, restructuring of the Government financial - 56 - institutions, increased public sector revenue generation and collection, re- orientation of public expenditure priorities towards infrastructure investment and O&M expenditures, and an external debt management strategy focused on rescheduling. Analogous recommendations for structural reforms had already been formulated in a previous economic report ("The Philippines: An Agenda for Adjustment and Growth", Report 5258-PH, November 1984) but had not resulted in an adjustment operation because the economic crisis that had overtaken the Philippines had shifted the attention towards short-term stabilization issues. 6.3 In addition to these economic reports, a number of Bank studies had addressed specific issues. A joint Bank-Fund study in 1985 ("The Tax and Customs System of the Philippines", IMF FAD paper, June 1985) had identified a number of areas for reform, in order to increase elasticity, equity and efficiency of the tax system. A report on import restrictions ("Philippines Import Restrictions", March 1985, Report 5575-PH) reviewed issues in trade liberalization that were left unresolved after the SAL I and II and the potential for resource mis- allocation arising from these regulations. 6.4 The program supported by the ERL was to a large extent the result of on- going dialogue involving the Philippines authorities, the IMF and the Bank. The change of Government in 1986 had improved the dialogue as the new authorities were committed to reducing the role of the Government in the economy and encouraging private sector initiati-e. In the actual design of the ERL, there was continuous cooperation between the IMF and the Bank; in particular, during the ERL appraisal mission the IMF mission was negotiating the new standby Arrangement. The division of labor between IMF and Bank had the Fund concentrate on trade policy and indirect taxation issues, while the Bank took the lead role on the reform of the GFIs, the public expenditure program and direct taxation. The Government prepared proposals on each policy area covered by the loan; the proposals were then discussed and amended where necessary. Differences on the globalization of income taxation and the content of the investment program arose during appraisal but were subsequently resolved. 7 Accomplishments of the Adjustment Program 7.1 Macroeconomic Performance. If one is to judge the accomplishments of the ERL on the basis of macroeconomic performance in the years of the program, the ERL has done very well. Table 1 below presents the evolution of the main economic indicators during the period 1980-89. During 1987-89, a substantial recovery took place, and inflation was kept under control. On average, GDP, consumption and export growth exceeded the projected targets, while savings and investment did not recover as rapidly as anticipated. Imports also substantially exceeded the targets, and as a result the current account performance was worse than expected in 1989. Actions taken under the ERL clearly contributed to the resumption of economic growth by addressing crucial constraints to the recovery in all four areas covered by the program. Equally important were the restoration of domestic confidence and the infusion of official development assistance thal: were rekindled by he new Governmentls commitment to economic reform. These factors taken together were important in addressing the immediate problems and vekindling growth. 7.2 The Government was also successful in the management of external liabilities. The strategy concentrated on the achievement of comprehensive rescheduling agreements with bilateral and commercial creditors, as recommended - 57 - in the Bank economic reports. A commercial bank rescheduling agreement in 1987 deferred USS9 billion in principal repayments due over the 1987-92 period, and a Paris Club reacheduling agreement in 1989 deferred US$2 billion in principal repayments due in 1989-92. Agreement on a new financing package from commercial banks was reached in 1989; as a result, the Philippines obtained USSO.7 billion of new money, marginal repricing of existing debt, and retired USS1.3 billion at 50 percont discount in 1990 through a buyback operation. As a result of these restructuring operations and slower than anticipated disbursements by official lenders, external debt accumulation was less than projected and the debt to GDP ratio declined faster than projected. 7.3 While economic management and performance improved dramatically during the program period, substantial problems were however not solved. Large public sector deficits continued to arise from insufficient resource mobilization and large external debt; since they were not monetized but financed through issuance of short-term bonds, a rapid increase in the stock of domestic public debt ensued in 1988 and 1989, leading to a sharp increase in real interest rates. The real exchange rate was allowed to appreciate in 1987-89, increasing the pressure on domestic interest rates, damaging exports and encouraging imports. Public sector investment, though gradually increasing, was not sufficient to prevent bottlenecks in particular in energy and transport. Thus, both resource mobilization and public investment appear to have been correctly identified as crucial areas for improvement under the program supported by the ERL. Improvements in revenue mobilization, however, was not sufficient to offset the strain imposed on fiscal balances by the burden of external debt, and. the increase in level and quality of public investment not sufficient to sustain the growth of private sector activity. - 58 - Table 1: Key Macroeconomic Indicators 1960 1981 1982 1993 1984 1985 1996 1987 1988 1989 Real Growth Rates: Gross Domearic Product 5.3% 3.8% 2.9% 1.0% -6.1% -4.3% 1.4% 4.7% 6.3% 5.6% Gross Domestic Income 3.7% 3.2% 2.3% 1.8% -6.0% -4.61 2.1% 4.8% 9.5% 6.1% Real per Capita Growth Rates: Gross Domestic Product 2.5% 1.2% 0.3% -1.5% -8.4% -6.5% -0.9% 2.3% 3.8% 3.2% Total Consumption 1.6% 0.1% 8.6% 1.4% 3.8% -5.1% -1.0% 1.8% 4.1% 4.8% Private Consumption 1.7% 0.0% 9.5% 2.5% 5.2% -5.3% -0.8% 1.5% 4.0% 4.5% Debt and Debt Service: Total DOD/GDP 49.5% 54.1% 61.5% 70.5% 75.3% 81.4% 92.2% 87.5% 74.5% 65.1% Debt Service/Exports 13.9% 18.0% 23.5% 21.71 18.1% 19.8% 26.2% 30.8% 25.9% 21.6% Debt Service/GDP 6.2% 7.7% 8.8% 8.7% 8.3% 7.8% 9.9% 10.5% 9.9% 7.6% interest/Exports 18.6% 25.5% 30.7% 25.0% 24.L% 22.2 18.8% 20.2% 18.8% 17.6% Interest/DP 4.2% 5.7% 6.2% 5.9% 6.0% 5.3% 5.3% 5.4% 5.1% 4.9 Grose Invustment/GDP 31.4% 30.9% 29.0% 27.3% 16.5% 13.5% 12.1% 15.5% 17.1% 1R.6% Domestic Savinge/GDP 23.1% 22.9% 20.0% 18.6% 14.4% 14.3% 16.2% 14.4% 15.7% 16.0% Current Account Balance/GDP -5.4% -5.3 -8.0% -8.0% -4.0% -0.1% 3.1% -1.3 -1.0S -3.31 GDP Deflator (0 growth rate) 15.6% 11.1% 8.4% 11.6% 49.9% 18.4% 0.9% 7.9% 9.7% 10.6% Real E30hanae Rate (1989-100) 139 143 149 125 124 135 106 97 I5 100 TeLms of Trade Index (1989-100) 98 86 82 91 97 89 93 96 105 100 Export (GNPS) Volume Growth Rate 12.7% 1.1% -1.1% 9.0% 9.3% -7.4% 21.8% -1.31 15.9% 8.3% Exports (GNFS)/GDP 17.1% 16.7% 16.0% 17.3% 19.9% 19.3% 23.2% 21.8% 23.8% 24.4% Import (GNFS) Volume Growth Rate 3.2% -2.6% 3.2% 11.8% -16.5% -23.1% 12.9% 26.5% 33.4% 27.3% Imports (GNFS)/GDP 17.8% 16.7% 16.8% 18.6% 16.5% 13.3% 14.8% 17.8% ZZ.4% 27.0% 7.4 Implementation of the Program of Action Supported by the ERL. The program of action was implemented satisfactorily. The general objectives of the program, providing support for the Government's economic recovery efforts, were achieved, as discussed above. The sectoral objectives of the program in the area of taxation, trade policy, public expenditure and reform of financial institutions were all achieved, though progress fell short of expectations in tariff reform. In other areas, such as tax revenue mobilization and public investment, institutional weaknesses limited the achievements of the program, and are being addressed under subsequent operations. 7.5 Concerning compliance with legal agreements, some conditions were waived at time of tranche release. The disbursement of the second tranche required waiving the condition related to the level of public investment, which was below the target of 5 percent of GNP, and the condition concerning the implementation of the technical assistance component, in addition to two conditions that were in the process of being met (tariff reform studies and the 1986 audit of PNB). The disbursement of the third tranche required waiving again the condition concerning the level of public investment, which had substantially increased but not yet reached the target level, and the condition concerning the implementation of the technical assistance component; in addition, the condition requirina a independent external audit of APT for 1987 was waived on the ground that Commission on Audi (COA) had objected to a private audit but had performed the audit itself. 7.6 Reform of the Tax System. The core of the tax reform program supported by the ERL was implemented prior to Board presentation, with the exception of the introduction of value added tax, scheduled for October 1988. Concerning direct income taxation, the most important measures included the globalization on income - 59 - for the purpose of direct taxation with the exception of interest income (which remained subject to a 20 percent withholding tax), the increase in personal exemptions to exclude households below the poverty line from income tax, the simplification of tax brackets and reduction of the highest marginal tax rate from 60 to 35 percent. Concerning property taxation, real property taxes were collected on the basis of re-assessed property values. Concerning indirect taxes, several rationalization measures were taken and all export taxes were abolished, with the exception of the duty on logs, maintained for conservation purposes. 7.7 Subsequent actions included the introduction of the value added tax, the most important innovation undertaken under the ERL, introduced ahead of schedule on January 1, 1988. The VAT was introduced in a phased manner, with technical assistance from the IMF, and implemented satisfactorily. Five studies on taxation and fis7al incentives were completed in November 1988, fulfilling the program 6f action for tax reform under the ERL. The studies covered inflation adjustment of capital gains on real property, inflation adjustment of depreciation allowance, rationalization of incentives in the basic tax code, inclusion of interest income in globalized income tax, and property taxation. Further measures were not undertaken as the studies did not recommend additional reforms. 7.8 While implemented according to the program, tax reform was only partially successful in achieving its goals: while collections improved, in particular from direct taxes, revenues remained below potential. The indicative target for the tax-to-GNP ratio set under the ERL was met in 1987 but not in 1988, as the newly introduced VAT did not completely offset the losses from the elimination of the sales tax. The increase in tax effort continued in 1989, when it reached 12.8 percent of GNP, and, according to preliminary data, in 1990, when it reached 14 percent. While these results are very encouraging and indicate that the regulatory framework put in place under the program is adequate, institutional weaknesses in the tax collection agencies continue to limit the tax effort and are now being addressed as an institutional strengthening issue by a joint Bank- Fund effort. Table 2 below shows direct and indirect tax performance. Table 2: Government Tax Revenues a 1990 1981 1992 1983 1984 1985 1986 1997 198 1989 Tax "evenues, as share of G4P: Itdirect Taxes 10.0% 8.8% 8.8% 9.4% 8.5% 8.4% 8.8% 10.1% '.91 9.0% Direct Taxes 3.0% 2.8% 2.7% 2.5% 2.7% 3.0% 3.3% 3.3% 3.4% 3.9% Tc,tal Taxes 13.0% 11.6% 11.5% 11.9% 11.21 11.4% 12.11 13.51 11.3 1Z.Ri --- ---------------------------------------------------------------------------------------------------- 7.9 Trade Reform. As discussed above, the ERL followed two adjustment operations that had experienced difficulties in the area of trade liberalization. Thus, to avoid a'perceived risk of slippage, a large part of the program of action for trade-.reform under the ERL was implemented prior to Board presentation. By end-1986, the Government: a. announced a program to eliminate administrative restrictions on 1232 items, or about 14 percent of imports, and eliminated restrictions on 929 items; - 60 - b. eliminated the requirement of prior approval for capital goods imports; c. raised tariff rates on all goods with rates of 0 to 5 percent to a new minimum of 10 percent, in order to reduce tariff dispersion. 7.10 The following actions were required prior to the release of the second and third tranche: a. completion of a program of studies to develop proposals for further reform of the tariff structure; b. completion of studies, and announcement of a program for, further liberalization of quantitative import restrictions; c. public announcement of a program for further reform of tariffs on imports; d. implementation of a program for further liberalization of quantitative import restrictions. 7.11 In the first year of the proc , the action program was satisfactorily implemented. The program to liberc restricted import items which had been agreed and initiated ptior to Bo. ?ntation was implemented as envisaged, and for some items the schedule was elerated. During 1987, 171 items were liberalized, including raw materials such as textile fibers, paper and paperboard products. Quantitative control were replaced with tariff protection, thus entailing some upward tariff adjustments within the agreed ceiling of 50 percent. In many cases, the tariff increases were temporary and included time-bound provisions for reductions to pre-existing levels. In addition, the Government began the requested studies for further tariff reform that would lower protection levels and reduce overall tariff rates. 7.12 In February 1988 the Government announced a schedule for a second stage of liberalization, regarding the 673 remaining restricted items. It planned to free 104 items (List A) by the end of 1988 and to review 455 items (List B) for possible liberalization by end-1989. The remaining 114 items were to continue to be restricted indefinitely because of security and health reasons (List C). The Bank expressed disappointment with this proposal, and after discussions agreement was reached on the following: (a) the liberalization schedule for List A items (with 41 scheduled for June 1988, 43 for December 1988, and 20 for June 1989); (b) the announcement of the schedule for liberalization of List B items (to be implemented gradually, with one-third decided by December 1988, another third by June 1989, and the last third by December 1989; and (c) the reduction of the number of items in List C to 95 (with the transfer of yellow corn and meat items to List B). 7.13 At the time of the secord tranche release, in March 1988, the conditivin requiring completicn of the studies on further tariff reform was not met and thus waived on the ground that the studies were under way. It was the Government's view that further tariff reductions would undermine the trade liberalization program and lead to pressures to reimpose quantitative restrictions. The Bank felt that a delay in the announcement of the new tariff program until later in 1988 was warranted, provided the program for liberalization of quantitati*e restrictions remained on track and was expanded to cover a significant part .1f the remaining 673 items. 7.14 The liberalization of 1232 items initiated prior to Board presentation was completed according to the agreed schedule, with the last 129 items liberalized - 61 - in April 1988. Concerning the second stage of the liberalization program that had been agreed in March 1988, the June 1988 deadline for liberalization of 41 items in List A was not met. However, the program was put ahead of the agreed schedule in December 1988, when restrictions were lifted for 94 of the 104 List A items and the Bank waived the liberalization of the remaining 10 items on List A. The Government subsequently undertook reviews of the remaining items whose liberalization was to be evaluated, and a program for further liberalization was agreed under the 1989 IMF Extended Arrangement, aiming at eliminating most non- tariff restrictions by end-1994. As envisaged by the IMF-supported program, restrictions covering 93 items were lI"ted between January and October 1989. In December 1989 a further 39 items from List B were liberalized, thus leaving a total of 447 restricted items (of which, 331 items on Lists A and B were to be liberalized by end-1994 and 116 on List C were to remain regulated). Actual elimination of import restrictions is shown in Table 3. Table 3: Elimination of Quantitative Restrictions on Imports 1/ 1980 1981 1982 1993 1984 1985 1986 1987 1988 19A9 Imports Subject to QRS: Number at end-year 2901 2638 2051 2014 2041 1967 973 802 579 447 rercentage Change per annum -9% -22% -2% % 1% -4% -51% -18% 28% -231 1/ The change in the number of items subject to QRe reflects both additions to and deletion from the list of restricted items. 7.15 Progress on tariff reform did not materialize after 1987. During 1988, some restoration of tariffs lower than 10 percent on agricultural inputs occurred. A program of tariff adjustment was introduced, but further adjustments did not lower overall protection, as originally envisaged, but rather offset loss of protection resulting from removal of QRs. By December 1989, the Government had introduced legislation to rationalize import tariffs and was preparing a bill that would reduce some import tariffs on capital goods. A sweeping tariff reform was introduced by Executive Order in July 1990, but its implementation was blocked because of Congressional opposition. The Gulf crisis and ensuing fiscal difficulties led to the introduction of a 9 percent import surcharge in January 1991, scheduled to expire in June 1992. 7.16 Public Expenditure. The program of action regarding the public expenditure program was concentrated on improving the level and composition of public investment and O&M expenditures, as well as strengthening implementation and monitoring of public investment. The Medium-Term Public Investment Program for 1987-92 was agreed with the Bank prior to Board presentation. In 1988 a Bank economic report ("The Philippines: Selected Issues in Public Resource Management", Report 6887-PH) analyzed in detail sectoral composition and quality of projects in the program. The report concluded that the investment program was appropriate in size and content, but a small number of projects -- about 7 percent of the total program -- appeared inappropriate and their elimination was recommended. The, report also recommended increasing investment in the social sectors and improving cost-recovery and pricing policies. Subsequent updates of the public investment program, which is issued annually on a five-year r,:lli:1:f basis, have been regularly reviewecd by the Bank and have been found satisfactory to date. - 62 - 7.17 The program under the ERL required that the level of public investment be increased to 5 percent of GNP and that O&M expenditures be increased to the 1982 constant price level. Public investment and O&M expenditures were budgeted at adequate levels, but actual cash expenditures did not grow as rapidly as envisaged during the program period, both because of financing constraints and limited implementation capacity. In particular, the public investment target was not reached and the corresponding condition was waived both for the second and third tranche release. For this reason, and given that the need for adequate infrastructure and maintenance has not ceased to be critical, the two conditions concerning public investment and O&M expenditures were retained under the Debt Management Program (Loan 3149-PH) approved in December 1989; this program also included several measures aimed at improving project preparation and implementation procedures for the public investment program, which have been satisfactorily implemented to date. According to preliminary data, public investment reached its 5 percent target in 1990. Table 4 below shows public investment and O&M expenditures. Table 4: Government O&M Expenditures and Public Investment 1/ 1982 1983 1984 1985 1986 1987 1988 1989 Public Investment, 1 of GNP 8.7% 7.4% 4.5% 3.7% 3.0% 3.11 3.3% 4.01 O&M Expenditures, % of 1982 level 100% 89% 75% 63% 69% 82% 71% 96% 1/ Public Investment includes investment by the National Government and Public Corporations; O&M expenditures include only the economic and social sectors of the National Government. 7.18 The monitoring of public investment by the Philippine Government has improved substantially. In 1987 NEDA developed a monitoring system for its public investment program and initiated reporting on its status on a quarterly basis. The system continues to be implemented by NEDA's Project Monitoring Staff. 7.19 Reform of Government Financial Institutions. Substantial actions were implemented prior to Board presentation also concerning the reform of the financial sector and the restructuring of GFIs. These measures included: a. Financial Sector Policy: issuance by Monetary Board of an overall policy statement on the financial system, a resolution on external audit for GFIs, resolution on contingent liabilities, and a policy statement limiting public sector deposits at Government depository banks; b. DBP and PNB: approval of revised charters of DBP and PNB and issuance of policy statements by the Boards of these institutions; approval by these Boards of rehabilitation programs and transfer of non-performing assets; agreement with the Bank on cost reduction and branch-closing programs; agreement with the Bank on programs to strengthen internal goernance procedures and performance ionitorinl systems; - 63 - C. Institutional Strengthening: establishment of the Committee on Privatization, to supervise disposal of assets transferred from DBP and PNB, and the Asset Privatization Trust, to implement their disposal; appointment of trustees for APT; designation of the Inter- Government Financial Institutions Policy Coordinating Committee to monitor performance of PNB and DOP. 7.20 For second and third tranche release, the following measures were required: a. Financial Sector Policy: satisfactory management of public sector deposits in Government depository banks; issuance of financial audits for DBP and PNP by independent external auditors for fiscal years 1986 and 1987, and for APT fir fiscal year 1987; divestment of six Government acquired banks (Associated Bank, Commercial Bank of Manila, Filipinas Bank, International Corporate Bank, Republic Planters Bank, Union Bank); b. DBP and PNS: satisfactory implementation of cost reduction and branch closing progr -, internal reorganization and strengthening of internal procedures, performance monitoring system; transfer of title of assets to be disposed; C. Institutional Strengthening: establishment of satisfactory organizational, staffing and financial procedures for APT; satisfactory implementation of performance monitoring system for DBP and PNB, and their attachment to the Ministry of Finance; completion of studies on Government Service Insurance System, Social Security System, Land Bank of the Philippines, and Philippine Export and Foreign Loan Guarantee Corporation. 7.21 At the end of 1985, Government ownership of banking sector assets amounted to P158 billion, or about 40 percent of total banking sector assets, excluding the Central Bank. After the massive write-downs taken by DBP and PNB at the end of 1986, in compliance with the program of action supported by the ERL, the share of Government-owned banking sector assets declined to 21 percent of the total. The write-downs were implemented by transferring all non-performing loans of P10 million or more each from DSP and PNB to the APT for work-out and ultimately sale to the private sector; the corresponding liabilities were transferred to the Government. In the case of DSP, total assets were reduced from P74 billion to P10 billion; for PNB, the reduction in assets was from P70 billion to P26 billion. After these asset write-downs and the transfer of the corresponding liabilities, both institutions became comfortably capitalized. 7.22 In addition to restructuring the portfolio of PNO and DSP, their organizations were restructured to achieve cost-effective operations and specific targets were set to meet this objective. In the case of PNB, a staff reduction target from about 6,500 to 5,600 was set, to be achieved by the end of 1987. In fact, PNB did better: by November 1987, the staff had been reduced to 4,725. During 1988, when the volume of operations increased, total staff strength increased, but by1the end of 1988 the staff totalled some 5,300, still lower than the original target. Nine foreign branches were closed and the remaining seven were reorganized. Ten domestic regional offices were closed, and 65 domestic branches were reclassified and restricted to deposit takino without lendina authority. The internal organization structure was revised to reduce the number of departments from 31 to 22, with corresponding increase in the span of supervision. In addition, the operations management was streamlined with considerable strengthening of electronic data processing. In the case of DSP, -64- total staff was reduced from the pre-ERL level of 3500 to about 1900 by the end of 1989. Its internal organization structure has also been changed to enable it to respond to its role primarily as a wholesale bank, as was agreed subsequently. 7.23 The elimination of special privileges to GFIs was also satisfactorily implemented, and thire are now no special tax and credit privileges to either PNB or DSP. The only privilege temporarily allowed was the maintenance of Government deposits for P2 billion in interest-free accounts at DBP for a limited period of three years, in order to allow DBP to tide over its initial phase of restructuring. These deposits were eliminated by the end of 1989. 7.24 Lack of a proper system of governance was considered to be a principal cause for the poor performanice of PNB and DBP. Considerable weight was, therefore, given to imp oving the system of management, performance monitoring and auditing. Two main actions were agreed: shifting the location of the Government's ownership rights from NEDA to the Department of Finance, and requiring PNB's and DBP's accounts to be audited by independent external auditors. In addition, new managements were appointed and DBP's board of directors was also reconstituted. As regards the first, the attachment of PNB and DSP was not shifted to DOF; instead, both now report directly to the Office of the President. The performance of both institutions is also monitored by the Inter-Government Financial Institutions' Policy Coordinating Committee which is a group of GFI heads chaired by the Secretary of Finance and including the Governor of the Central Bank of the Philippines. This arrangement was deemed acceptable by the Bank. As regards the second, DBP and PNB both appointed private auditors immediately following the ERL, and independent audits were performed on DBP and PN8 accounts for fiscal year 1986. There was, however, strong resistance from COA; as a result, the accounts of DBP and PNB were since audited by COA. This was deemd acceptable by the Bank, on the ground that COA, while being a public institution, was an external auditor. Similarly, the audit for APT for fiscal 1987 was performed by COA. 7.25 The streamlining of the organization structures and operations, the cost reduction programs and the improvements in management and governance have enabled both PNB and DBP to emerge from their respective rehabilitation as profitable and financially sound institutions. For the year ended December 31, 1989, PNB earned a record profit of P2.1 billion. This implied a yield of almost 37 percent on year-end equity and amounted to a return on assets of 3.7 percent. Since 1986- 87, PNB's tetal deposits, loans and capital have all shown healthy increases. For DBP, too, the financial performance has been highly satisf,s.tory. For 1989, its income before tax amounted to P1.1 billion; net return or. assets, 9.5 percent; and return on average equity, 18.8 percent. It is conservatively capitalized, with debt/equity ratio of less than 1:1 and ample liquidity. 7.26 A major achievement has been the partial rrivatization of PNB. Although it was not a specific commitment under the ptogram, in 1989 the Government made a secondary pub'lic offering of 10.8 million sharea, or 30 percent of the total outstanding shares. Not only did it net P1.8 billion to the Government and fulfilled the obieptive of privatization envisaged under ERL, but it also had broader capital maxket development implications. It added P4.7 billion to the market capitalization of listed equities in just two months and, becAuse it was sold to widely dispersed individual investors, added some 25,000 additional stockholders. It demonstrated that properly structured equity deals involving Government-owned corporations could be successfully completed. PNO was the most actively traded stock on the manila Stock Exchange in 1990. - 65 - 7.27 As regards DOP, it was agreed that certain branches would be consoliaated and disposed of to private investors in a phased manner. Partly in the light of the PNB experience and partly as a result of a subsequent Bank study of the Philippine financial sector ("Philippines: Financial Sector Study", Report 7177- PH) -- which recommended a transformation of DBP intQ a primarily wholesale bank -- a new approach was envisaged, hiving off DSP's retail operations into a separate legal entity which would then be gradually sold to private investors through public offerings. But in April 1991 this approach was deciared incompatible with DBP's Charter by the Ministry of Justice. DBP is currently exploring alternative means of accomplishing privatization. The Bank continues to monitor DSP's privatization efforts in the context of three sitbsequent lending operations, the Financial Sector Adjustment Loan (Loan 3049-PH), the Industrial Investment Credit Project (Loan 3123-PH) and the Industrial Restructuring Project (Loan 3287-PH). In the context of the program originally envisaged under the ERL, the judc -sent must be that the privatization of DBP has been delayed. 7.28 As regards the privatization of the six banks that the Central Bank had taken over as a result of the exercise of regulatory powers in the period immediately preceding the ERL, the actual performance has been mixed. So far, three banks have been sold to private investors and all the three banks have substantial foreign investment. The Gqernment remains firmly committed to the sale to private investors of the remaining banks, but has been repeatedly frustrated in the actual sales because of the continuing litigation being conductet4 by the previous owners and managements. 7.29 Even after the rapid growth of PNB and the gain in its market share, and in spite of delays in privatizing DBP and the six Government-acquired banks, the Government's overall share in the banking sector assets continues to be under the indicative figure of 25 percent mentioned in the Development Policy Letter. Since then, particularly in 1989-90, both PNB and DBP have grown rapidly, PNB gaining momentum after its partial privatization and DSP after its emergence as the principal wholesale lender in the country. But the overall assets of the financial system have also grown substantially, and the increase in the market share of PNS and the specialized Government banks (as measured in terms of assets) has thus been small: at the end of 1990, PNB accounted for 15 percent and the other Government banks accounted for 8 percent ot total banking sector assets. In addition, now that PNB has been partially privatized and the Government banks do not enjoy tax and credit privileges, they face the same constraints and incentives as private banks. 7.30 Implementation of the Program of Action Supported by the ERTAP. The program of technical assistance was not implemented as envisaged, and the corresponding loan canceled in three stages, and closed in February 1990. The cancellation was caused in part by the Government's desire to use grant funds to inance technical assistance, and in part by legal and administrative constraints in the ,hiring of consultants (the latter issue has been addressed under the Debt Management Program). Technical assistance for the institutional strengthening of DBP and PNB and the disposal of the their non-performing assets was provided by local resourceir ani the corresponding objectives successfully achieved, as discussed above. 'TAe study of social security institutions was also carried out with local resources. The two remaining areas for which technical assistance was originally envisaged -- strengthening the regulatory functions of the Central Bank and expenditure and a,counting procedures of the Ministry of Finance -- were not addressed under the program. i' Tha DBP has taken exception to this statement, questioning the propriety of imposing such a conditionality. Cf. PCR Annex I, page 106. - 66 - 8 Monitoring of the Adjustment Program 8.1 Monitorability. In spite of the complexity of the program of action supported by the ERL/ERTAP, the policy matrix and the loan agreement spelled out very specific and time-bound actions that could be effectively monitored during the implementation of the program, with the only exception of trade reform. As discus3ed in the President's Report, a considerable public debate was taking place in the Philippines with regard to the merits of further trade liberalization, and concerns about short-term unemployment costs of trade liberalization were dominating the debate. The Government thus committed to announcing a trade reform program rather than to implementing an agreed set of measures. This arrangement effectively postponed negotiations on the specific content of the liberalization program and required extensive involvement by the Bank on this issue during the program period, as discussed above. 8.2 Suvervision. Four supervision missions visited Manila to taview the implementation of the ERL: in May-June 1987, October-November 1987, in November 1988 and in June 1989. The Government of the Philippines provided the Bank three very comprehei.sive status reports, in October 1987, February 1988 and December 1988. These documents witnessed to the Government own concern with monitorina the iinplementatior if the program and provided extremely helpful background for the supervision eftorts of the Bank. 8.3 Procurement. According to procedures in effect at the time of negotiations, a standard negative list was included in the Loan Agreement, and international competitive bidding required for contracts over USS5 million. Commodities commonly traded on international commodity markets were exempted from international competitive bidding, as provided by existing guidelines, and a list detailing these commodities was included in the minutes of negotiations. 9 Conclusions 9.1 Overall Assessment. The ERL accomplished its objective of supporting the Government's economic recovery efforts, and its implementation was accompanied by a marked resumption of growth, averaging about 6 percent per annum during 1987-89. Economic management and performance improved dramatically during the program period and progress was made towards addressing some of the fundamental problems of the economy. Substantial issues were however not solved, in particular concerning public resource mobilization and management. Policy reforms were introduced under the ERL as intended, with the exception of tariff reform; actions in all other areas were substantially undertaken as agreed, both in the letter and in the spirit of the program. The operation was designed to complement policy reforms with institutional improvements aimed at strengthening efficiency and accountability in two areas, the management of rovernment: financial institutions and of public expenditures. These institutional strengthening efforts were successful in restoring the financial health of the two largest banks, thus laying the groundwork for the following stage ;f financial sector reform. Concerning institutional building in the area )f publi.c expenditure management, coordination and monitoring improved substantially, but project preparation and implementation issues were not solved and were later addressed by the Debt Management Program. With hindsight, the very substanti7e progress made in establishing a more efficient tax system should have been complemented by institutional strengthening of the tax collection system. It has in fact become increasingly clear that institution building as well as - 67 - improvement in inter-agency coordination will be crucial to any further substantial -- and sustained -- improvement in the tax effort. 9.2 Tax Reform. Efficiency and equity of both direct and indirect taxation were substantially improved by the measures introduced under the ERL, in particular the globalization of income for direct tax purposes, the introduction of the VAT and the elimination of export taxes. These measures succeeded also in improving fiscal balances by increasing tax revenue mobilization, which has been -- and still is -- both below potential and below comparable countries. Further achievements in this area are limited by institutional weaknesses and will need to be addressed as institutional building issues. 9.3 Trade Reform. SAL I and II supported the Philippine Government in its first stages of trade reform. The reform of the tariff system and of the associated system of indirect taxes was a major accomplishment, while much less progress was made in the area of import Licensing and regulation. The ERL deepened trade reform by achieving a substantial reduction of quantitative restrictions. Contrary to expectations, further improvement of the tariff structure was not achieved, although no condition was technically violated during the program period. While there is room for further improvements, both in eliminating remaining administrative restrictions and simplifying and reducing tariff rates, the actions taken under the ERL have significantly improved the Philippine trade regime. 9.4 Public Expenditure. The accomplishments of the ERL in the area of public expenditure have been mixed. On the one hand, the composition of the public investment program has dramat;-%lly improved since 1986 and institutional mechanisms have been put in place for its periodical review by the Bank. In addition, internal monitoring procedures have been strengthened significantly. On the other hand, throughout the program period the level of public investment has never reached the target of 5 percent of GNP that had been set in the ERL. This resulted in part from the improvement in the composition of public investment, which had involved discarding inappropriate projects. Inadequate levels of public investment and insufficient maintenance have however contributed to power supply shortages and difficulties in transportation, which became particularly evident in 1990, as a result of external eventL -- such as a severg drought -- and increased economic activity. The ERL has however played a crucial role not only in preventing further erosion in these expenditures at a time of severe fiscal difficulties, but also in accomplishing their gradual increase to adequate levels. 9.5 Reform of Government Financial Institutions. Under the ERL, the Bank attempted to deal with the very serious financial and organizational problems of the two largest Government financial institutions, whose problems constituted A serious threat to the stability of the financial system as well as to public finances. The objectives of the reform program of the GFIs were by and large realized. The rehabilitation of PN9 and DBP has been satisfactorily completed: both institutions are now not only solvent but in healthy financial condition and the Government is obtainingj a satisfactory return on its investment. The rehabilitation of PNB was wore complete, as it was partially privatized, and its future d evelopment as a commercial bank is more predictabAe. Therefove, PUB'" suczessful rehabilitation can be expected to be sustained. DBP's financial rehabilitation is also complete and DBP is now profitable with a conservative capitalization. However, its long-term functional transformation is still in progress. DBP's privatization strategy is still being defined and its future - 68 - development path as a wholesale bank is more complex. The Bank's involvement with DBP continues to be intensive in the context of Financial Sector Adjustment Loan, the Industrial Investment Credit Project and the Industrial Restructuring Project. Finally, the successful experiences of the partial privatization of PNB and the disposal by the Asset Privatization Trust of the non-performing assets transferred from DBP and PNB have contributed to the design and implementation of the Government Corporations Reform Program (Loan 2956-PH), which focused on the restructuring and privatization of non-financial Government corporations. 9.6 Following the successful restructuring of the two large Philippine banks, the Bank's involvement with financial sector development took the form of a financial sector study, which led to a program of action involving the commercial banking sector and the supervisory functions of the central Bank, supported by the Financial Sector Adjustment Loan. The Bank is now in the process of undertaking a study of capital markets and related aspects. - 69- PROJECT COMPLETION REPORT PHILIPPINES ECONOMIC RECOVERY PROGRAM (LOANS 2787-PH AND 2788-PH) PART II: Project Review from the Borrower's Perspective 1 Introduction 1.1 Upon its assumption of office, the Aquino government formulated an economic recovery program based on the reinvigoration of private sector entrepreneurship and revitalization of public investments. Major reforms were to be undertaken in four key areas: (1) tax reforms; (2) trade liberalization; (3) public investments; and (4) government financial institutions. 1.2 The government sought the support of the Bank, the International Monetary Fund (IMF) and bilateral partners for this program. A new 18-month Standby Arrangement for 198 million SDRs (equivalent to $240 million) was approved by the IMF Board in October 1986. The $300 million Economic Recovery Loan (ERL) and accompanying $10 million Economic Recovery Technical Assistance Project (ERTAP) were approved by the Bank Board in March 1987. Cofinancing of Y50 billion (equivalent to $300 million) was also obtained from the Export-Import Bank of Japan and Y30 billion (equivalent to $240 million) from the overseas Economic Cooperation Fund of Japan. 1.3 Within the context of the new democratic regime, significant gains were achieved in the implementation of the contemplated structural reforms. This satisfactory performance led to the release of ERL tranche disbursements in September 1987, March 1988 and December 1989. Table 1 presents the details and timing of the policy actions supported by the ERL. This retrospective is an effort on the part of the government to review both the timeliness and substantiveness of these reforms and to assess their sectoral and macroeconomic impact, with a view to drawing lessons and -o identifying follow-up measures for future initiatives. 2 Tax Reforms 2.1 Goal6. Between 1980 and 1985, the tax-to-GNP ratio fell from 11,6 percent to 10.2 percent. The 1986 Tax Reform Package (TRP) was formulated to improve the revenue elasticity of the tax system, ensure that similarly situated individuals and entities bear the same tax burden, withdraw or modify taxes that impair incentives to production, exports and growth, and simplify the tax structure to improve tax administration and compliance. 2.2 Measures. The TRP -as comprised of 29 measures which included long-term structural reform initiatives as well as one-time revenue-raising measures. The structural reform measures were aimed primarily at improving equity and promoting growth and efficiency. These measures includeds (1) the change from schedular to global system of taxing compensation and business incumes of individuals; (2) imposition of a uniform schedule of rates, 0 to 35 percent, on compensation and - 70 - business incomes of individuals; (3) increase in personal and additional exemptions to relieve from income tares those at or below the poverty threshold; (4) introduction of separate computation for income tax purposes of married couples; (5) elimination of final withholding tax on inter-corporate dividends and phaseout of final tax on shareholders' dividends; (6) rationalization of private motor vehicle taxes; (7) reduction and simplification of sales taxes; (8) exemption of overseas contract workers from travel tax; (9) abolition of export taxes except on logs; and (10) withdrawal of tax and duty exemptions with certain exceptions. 2.3 Long-term measures to enhance the revenue productivity of the tax system included the following: (1) increase to 20 percent the final tax on all passive incomes; (2) imposition of uniform 35 percent tax rate on corporate incomes; (3) ceilings on certain allowable deductions from individual and corporate incomes; (4) introduction of the value-added-tax; (5) increase in taxes on beer, liquor and cigarettes and conversion of these taxes from specific to ad valorem rates; (6) increase in minimum import duty from zero to ten percent; (7) imposition of a standardized franchise tax and withdrawal of income tax exemption from franchise holders; (8) adjustment of the real property tax base from 1978 to 1984 values; (9) increase in taxes on gambling; and (10) increase in incentives for Bureau of Internal Revenue (BIR) personnel. 2.4 To offset the revenue losses arising from some of the structural reform measures and to raise revenues to finance the new government's expenditure program, the 1986 TRP included one-time measures such as: (1) amnesties on income and other internal revenue taxes; (2) amnesties on real property tax; (3) tax amnesty on repatriatioi of foreign assets; and (4) compromise settlements on delinquent accounts and disputed assessments with the BIR and Bureau of Customs (BOC). 2.5 Implementation. Using her decree-making powers as head of the then revolutionary government, President Aquino issued 17 Executive Orders to mandate the immediate implementation of 26 out of the 29 measures in the TRP (see Table 2). However, the implementation of the two measures prescr$.bing ceilings on allowable deductions from personal and corporate incomes were suspended indefinitely due to strong opposition from affected sectors and the preference to have these ceilings set by provision of law. Inter-agency discussions on the remaining three measures took longer than expected and were overtaken by the reopening of the Philippine Congress on July 27, 1987. Since then, the executive branch has been working with Congress to have these measures enacted into law. 2.6 The most radical measure included in the TRP was the introduction of the value-added-tax (VAT) to replace the turnover tax, sales taxes, privilege and other percentage taxes. Executive Order No. 273 issued on July 25, 1987 mandated the imposition of a uniform 10 percent VAT on the sale and importation of goods and services based on gross sales, effective on January 1, 1988. Lack of public information on the new tax and of trained personnel to implement it led to lower than expected collections in the first year of implementation. However, efforts to address these initial problems have made the VAT an increasingly important source of government revenues. - 71 - 2.7 Revenue Impact. The measures comprising the TRP have markedly different effects on tax revenues as can be seen from Table 3. Some - such as (1) the change from schedular to global income taxation; (2) increase in personal and additional exemptions; (3) separate taxation of incomes of married couples; and (4) abolition of export duties except on logs - have very large negative impacts, especially in the short term, while others are patently revenue generating measures. 2.8 on the whole, however, the TRP was expected to increase revenue collections and their responsiveness to economic activity. As indicated in Table 4, tax collections of the national government increased annually by an average of 23.7 percent during the 1987-1989 period compared to an average of 18.9 percent during the 1984-1986 period. Similarly, the tax- to-GNP ratio which averaged only 10.4 percent in 1984-1986 increased to 12.4 percent in 1987, fell temporarily to 11.1 percent in 1988, and increased again to 12.9 percent in 1989 for a three-year average of 12.1 percent. It increased further to 13.7 percent in 1990. 2.9 The share of direct taxes in total tax revenues increased from 30.3 percent in 1984-1986 to 30.6 percent in 1987-1989, indicating a slightly improvement in the progressivity of the tax system. However, the bulk of tax revenues still continue to come from indirect taxes. 2.10 The bouyancy of the tax system averaged 3.6 percent during 1987-1989, up from 1.7 percent in 1984-1986. This reflected an improvement in the responsiveness of tax revenues as a result of discretionary changes in income including improvements in tax administration. The buoyancy of direct taxes increased from an ave:age of 2.2 percent in 1984-1986 to 3.2 percent in 1987-1989 as a result of the tax measures designed to improve the equitableness and revenue productivity of the tax system such as the imposition of a uniform 35 percent tax rate on corporate income and withdrawal of income tax exemption of franchise holders. The buoyancy of indirect taxes also increased from 1.5 percent in 1984-1986 to 3.8 percent in 1987-1989 primarily as a result of the increase in taxes on consumer products like cigarettes and beer and the conversion of these taxes to ad valorem rates as well as the introduction of the VAT. 2.11 The over-all elasticity of the tax system improved from 1.30 for the 1984-1986 period to 1.76 for 1987-1989, signalling a marked improvement in tax compliance. 2.12 Future Actions. Although much has been accomplished through the 1986 TRP, a lot rattains to be done to make the tax system more equitable, revenue productive and conducive to economic growth. For example, the revenue potential of the VAT and excise taxes can be more fully realized by broadening their coverage to include businessee, persons and goods presently exempt from them or by increasing their rates to match those in comparable countries. The ceilings on certain allowable deductions, especially for personal incomes, should be imposed as soon as possible since self-employed individuals are already benefitting from the lowering of their tax rates without the accompanying limit on their deductions. Further improvements in the efficiency of :he major tax collection agencies and the plugging of loopholes should also be pui:sued through both administrative and legislative means. - 72 - 2.13 In all of these future initiatives, the lessons from the 1986 TRP should be kept in mind. No effort should be spared in informing the public especially the affected sectors about new tax laws and regulations so that public support and compliance can be secured as quickly and fully as possible. Likewise, all administrative arrangements must be put in place prior to the introduction of any major tax reform. 3 Trade Liberalization 3.1 Import Liberalization. The import liberalization program started in 1981 and had been supported by two Structural Adjustment Loans from the Bank. About a thousand items were liberalized between January 1981 and March 1986. However, the foreign exchange crisis that started in 1983 and lasted until 1985 forestalled further moves to eliminate import restrictions. 3.2 Phase I. Upon assumption of the Aquino administration in 1986, efforts to strengthen the industrial foundation of the economy through import liberalization were resumed with renewed vigor. A total of 929 items were liberalized during the five- month period between April 30 and September 30, 1986. Another 171 items were liberalized in 1987 and 129 items in April 1988 for a total of 1,229 items during Phase I of the import liberalization program supported by the ERL (see Table 5). A total of 1,232 items had initially been committed under the ERL but three sugar items were eventually waived in line with domestic sugar policy. 3.3 Phase II. In early 1988, after an intensive review and consultation process, the remaining 673 items still subject to import restrictions were classified into three lists: List A - 104 items for liberalization by end-June 1989; List B - 455 items for review and gradual liberalization; and List C - 114 items for continued regulation for reasons of health, safety and national security. 3.4 On December 22, 1988, Central Bank (CB) Circular No. 1192 liberalized 94 of the 104 items in List A. The ten remaining items were incorporated under List B which then consisted of 463 items while List C had 116 items. In the March 1989 Memorandum on Economic Policy (MEP) to the IMF, the Philippine government committed to take the following steps with respect to List B items and the ten remaining items under List A: (a) A minimum of 90 items were to be selected before June 30, 1989, for which restrictions would be removed and legislation submitted to Congress to introduce appropriate tariffs on these items by end-September 1989; (b) By December 31, 1989 and again by June 30, 1990, at least 45 additional items would be selected from List B, for which quantitative restrictions would be replaced by tariffs before the end of the IMF Standby Arrangement in mid-1992; (c) For all items not covered by the above steps, quantitative restrictions would be replaced by tariffs no later than end-1994 in general. In certain industries, a longer implementation period may be allowed for - 73 - rationalization, modernization, rehabilitation, and new investments. Such cases would be announced no later than June 30, 1990. 3.5 Implementation of the above liberalization program proceeded largely on schedule during the implementation period of the ERL. Restrictions on 90 List B items selected before June 30, 1989 were removed through CB Circular No. 1195 dated March 15, 1989 (3 items), CB Circular No. 1205 dated July 14, 1989 (60 items), CB Circular No. 1210 dated September 14, 1989 (12 items) and CB Circular No. 1212 dated October 6, 1989 (15 items). Target date of end-September 1989 was thus met for 75 of the 90 items with liberalization of last 15 items delayed by one week due to intensive consultations with industries concerned. In addition, one item under List A was also liberalized under CB Circular No. 1210. Appropriate tariff adjustments for items requiring such adjustments were made through the President's issuance of Executive Order No. 364 on July 21, 1989. 3.6 By December 31, 1989, an additional 45 items from List B were selected for liberalization by mid-1992. As of end-1989, restrictions on 41 of these 45 items had already been removed with the issuance of CB Circular No. 1212 (2 items) and CB Circular No. 1219 dated December 31, 1989 (39 items). The four remaining items were to be liberalized as soon as appropriate tariff adjustments were put in place. In addition, CB Circular No. 1231 dated February 27, 1990 liberalized 8 items which form part of the 45 items scheduled to be announced by end-June 1990. This brought the total number of List B items liberalized under Phase II to 139 as of end-June 1990. Together with the 95 List A items also liberalized under Phase II, a total of 234 items had been liberalized under Phase II as of end-June 1990. Together with the 1,229 items liberalized under Phase I, a total of 1,463 items were liberalized between April 1986 and June 1990. 3.7 Imnact on Import Growth. Phase I covering the period Apr 1 1986 to April 1988 resulted in the liberalization of a significant percentage of imports with the 1,229 liberalized items accounting for 13.6 percent of total imports in 1985. With the liberalized items growing faster at an annual averag rate of 29.4 percent during 1986-1989 than total imports which grew at an average rate of 20.3 percent, the share of the 1,229 liberalized items in total imports grew to 18.4 percent in 1989 (see Table 6). However, with their import value growing by only 0.4 percent to $1,919 million in 1990, the liberalized items accounted for only 15.7 percent of total imports in 1990. Of the 1,229 items, 789 items were raw materials, 436 items were consumer goods and only four were capital goods. Raw material imports accounted for an average of 94 percent of the import value of liberalized items during 1986-1990 with the balance accounted for by consumer goods. 3.8 Under Phase II which started in December 1988, the bulk of liberalized items were capital goods, accounting for 188 of the 234 items and 92 percent of the import value of liberalized items. From just a 4 percent share of total imports in 1988, imports of the 234 liberalized items grew by 42.7 percent to $471 million in 1989 and by 28.6 percent to $606 million in 1990 to account for 4.5 percent of total imports in 1989 and 5 percent in 1990. 3.9 From $837 million in 1985, the import value of the 1,463 items liberalized under Phase I and Phase II grew to $2,383 million in 1989 and $2,525 million in 1990. These liberalized items contributed 7.8 percentage points to the 27.7 - 74 - percent expansion of total imports in 1989 but only 1.4 percentage points to the 17.2 growth of imports in 1990. The share of liberalized items in total imports likewise dropped from 22.9 percent in 1989 to 20.7 percent in 1990. 3.10 The bulk of liberalized items consisted of iron and steel, synthetic resins and synthetic fibers and yarns and other raw materials needed by various industries. Raw materials accounted for about three fourths of the total import value of items liberalized under Phase I and Phase II while the share of capital goods ranged from 16 to 22 percent. In the case of liberalized consumer goods, imports accounted for less than 10 percent of liberalized import values and contributed less than one percent to overall import growth. It can therefore be said that the import liberalization program has contributed to the expansion of productive capacity and increased the competitiveness of Philippine exports by allowing the freer entry of producer goods essential for investment and export activities. 3.11 Tariff Reform. Complementing the import ..ralization program started in 1981 was the tariff reform program geared towards reducing or phasing out tariff protection which was deemed excessive or obsolete. It aimed to narrow the range of tariffs from zero to 100 percent to ten to 50 percent. As a result of the tariff reform program carried out from 1981 to 1985, the average nominal protection rate was reduced from 43 percent in 1981 to 28 percent in 1985. The range of effective protection rates for importable sectors was also reduced from 22 to 299 percent to a range of 18 to 144 percent. 3.12 Through Executive Order (E.O.) No. 49 dated October 15, 1986 and E.O. No. 70 dated November 25, 1986, remaining items subject to less than ten percent tariff were imposed a ten percent ad valorem tariff thereby making it the minimum tariff rate. Although no comprehensive tariff reform program was announced until July 1990, steps were taken to reduce the tariff rate on certain key items such as crude oil (E.O. No. 303 dated August 25,1987 and E.O. No. 306 dated October 20, 1987), cement (E.O. No. 353 dated March 27, 1989 and E.O. No. 387 dated December 6, 1989), and motor vehicle spare parts (E.O. No. 404 dated June 8, 1990). Tariff adjustments for items covered under the import liberalization program were also instituted through E.O. No. 364 dated July 21, 1989 and R.A. No. 6647 signed on January 29, 1988. 3.13 A major overhaul of the tariff structure was mandated by E.O. No. 413 dated July 19, 1990. It aimed to simplify and rationalize the tariff structure by reducing the number of tariff levels from seven to four and narrowing the tariff band from zero to 50 percent to three to 30 percent. This would have affected 65 percent of total tariff lines including those in agriculture, chemicals, textiles, paper, wood and leather products, metals and non-metals, and machinery and equipment. However, serious concerns raised by various sectors including Congress prompted the Aquino government to defer its implementation until further consultations could be held and appropriate modifications made. 4 Public Investments 4.1 Background. Due to revenue constraints and limited access to external financing, public investments fell from 7.7 percent of GNP in 1983 to 3.7 percent in 1985 and 3.0 percent in 1986. The energy, transportation and water supply - 75 - crises in the late 1980's had origins in these reductions. Thus, it was recognized that economic recovery cannot be sustained without substantial increases in public investments. 4.2 Medium Term Public Investment Program (MTPIP). The MTPIP for 1987-1992 envisioned a public sector investment rate of 5 to 6 percent of GNP annually. Financial constraints, institutional weaknesses and natural disasters combined to limit public investments to just 3.5 percent of GNP in 1987, 3.1 percent in 1988 and 4.1 percent in 1989 (see Table 7). It was only in 1990 that the 5.5 percent share fell within the target range. 4.3 The MTPIP is updated every year to reflect changes in sectoral priorities, developments in the macroeconomic environment and improvements in the absorptive capacity of the government to finance and implement projects. Shifts in emphasis from the industrial sector to agriculture and rural development including irrigation as well as to social sectors such as education and health have been observed. To accelerate project development and implementation under the MTPIP, various administrative improvemeits and institutional support measures were put in place. These measures have been geared more towards improvement of the managerial capabilities of implementing agencies and coordination among oversight agencies rather than the unnecessary relaxation of project selection criteria and project implementation controls. 4.4 Maintenance and Other Operating Expenses (M&OOE). In order to ensure the provision of support facilities and maintenance expenditures necessary to maximize benefits from existing facilities, the ERL called for M&OOE for the economic and social sectors to recover their 1982 real level of P12.4 billion. Table 8 shows that at no time during the loan period was this level achieved. However, it can be observed that M&OOE expenditures did grow rapidly over the period to reach the 1983 level of P10.5 billion. From P7.7 billion in 1986, it increased to P9.0 billion in 1987, P9.3 billion in 1988 and P10.7 billion in 1989. This was largely a result of increased funding for the repair and maintenance of infrastructure facilities. 4.5 In late 1990, a program of fiscal prudence was put in place. With the exception of outlays alloted for the maintenance of hospitals, roads, bridges, schools, and flood control facilities, maintenance and operating expenditures for 1990 remained close to 1989 real levels, growing only by a marginal 17 percent from 1989 nominal levels. 4.6 Monitoring System. Implementation of the MTPIP is monitored on a quarterly basis by the National Economic and Development Authority. With the establishment of a computerized data base system in 1987, the scope of quantitative monitoring has been expanded to include non- infrastructure components of the program. Likewise, the timeliness of reports on the financial status and physical accomplishments of individual projects has been improved. The Project Facilitation Committee was also organized in 1987 to monitor the implementation of foreign-assisted projects and help resolve bottlenecks at both policy and procedural levels. - 76 - 5 Government Financial Institutions 5.1 Background. By end-1985, the two major government financial institutions (GFIs), the Philippine National Bank (PNB) and Development Bank of the Philippines (DBP), accounted for around half of total assets held by the banking system. Moreover, about 70 percent of the combined loan portfolio of PNB and DBP were non-performing and causing huge losses equivalent to almost three percent of GNP. To restore the financial viability of these two GEIs and to reduce their presence in the banking sector, the government initiated general policy reforms in the sector and supported rehabilitation programs for both PNB and DBP. 5.2 General Policy Reforms. The Monetary Board of the Central Bank, through Resolution No. 1077 dated November 28, 1986, issued revised policies with respect to the role of the financial system in general and government financial institutions in particular in fostering sustainable economic growth. It declared that the government would take the necessary actions to ensure that GFIs would, in the future: (1) have limited market share relative to the entire banking system; (2) be financially viable and independent of government assistance; (3) be accorded equal treatment with private banks in terms of regulatory requirements; (4) borrow without national government guarantee except as may be required by official foreign sources in connection with debt restructuring; (5) not have unlimited access to public sector deposits, and be required to maintain liquidity balances against these deposits; and (6) not have to administer subsidized government credit programs from their own resources. 5.3 External Audits. Contingent Liabilities and Government Deposits. To enhance performance monitoring and increase accountability of GFIs by means of external audits, CB Circular No. 1124 dated December 5, 1986 requires each bank to submit to an annual financial audit to be conducted by an independent external auditor. CB Circular No. 1123 dated December 5, 1986 on the determination of the single borrower's loan limit under Section 23, R.A. 337 provides for the inclusion of the outstanding foreign and domestic standby and deferred letters of credit less marginal deposits and outstanding guarantees except those fully secured by cash, hold-out in deposits or government securities. CB circular No. 1121 dated November 14, 1986 limits government deposits at government depository banks to working balances. A 75 percent liquidity ratio in cash and government securities against government deposits is to be maintained. 5.4 Rehabilitation of PNB. To restore the financial viability of the PNB and its ability to contribute to economic recovery particularly in the countryside, the PNB underwent a two-year rehabilitation program that included policy redirection, transfer of non-performing assets to the national government and institutional strengthening. 5.5 Charter Revision. The Revised Charter of the PNB is embodied in E.O. No. 80 dated December 3, 1986. It was intended to serve as the basis for the operations of a reorganized and rehabilitated, smaller but stronger and more operationally viable bank. It tightened controls and safeguards to avoid a repetition of the past accumulation of mandated and non-performing accounts. More specifically, it provided that directors, officers and employees of PNB or any corporation or partnership wherein any PNB director, officer or employee and/or their relatives within the second degree of consanguinity or affinity is - 77 - an official or controlling shareholder are prohibited from borrowing from PNB, either directly or indirectly as representative or agent of others. The prohibition also applies to officers and personnel of agencies directly exercising regulatory authority over the FNB such as the Central Bank and Commission on Audit. In addition, the Revised Charter also states that the PNB shall "provide banking services for the development of agriculture and small and medium scale enterprises particularly in the countryside" but "within the context of a financially viable and stable banking institution". 5.6 Policy Statement. The PNB also adopted a policy statement to provide clear guidelines for the operation of the bank in accordance with the new emphasis on commercial viability and financial independence from the national government. The policies enunciated included the following: (1) interest rate policies shall ensure positive spreads and consistency with interest rates prevailing in the market; (2) loans are to be made on the basis of viability assessment; (3) uncovered foreign exchange risks are to be avoided and a favorable foreign exchange position maintained; (4) lending in support of government programs for social purposes is to be undertaken only if funds are specifically provided by the government and treated of f books; (5) private deposits are to be actively sought to reduce dependence on government deposits; and (6) public offering of shares is to be initiated by early 1989. 5.7 Transfer of Assets and Liabilities. To attain and maintain commercial viability and at the same time, support the economic priorities and programs of the government, it was agreed that the PNB must be allowed to start anew with a healthy balance sheet. Thus, an essential component of the rehabilitation plan was the transfer to the national government of P47 billion of non-performing assets (NPAs), P55 billion of liabilities including government deposits and foreign borrowings and P16.7 billion of contingent liabilities. The transfers reduced PNB's total assets from P76.1 billion in 1985 to P26.9 billion in 1986 and its capital accoints to the desired level of P2.5 billion. 5.8 Cost Reduction. Another important component of the rehabilitation plan was cost reduction through leaner staffing and streamlining of the branch network. By the end of the rehabilitation program in 1988, 2,002 personnel or 3.1 percent of the workforce had been separated from the bank. The resulting PNB personnel complement compared favorably to those in the private sector in relation to total assets, loans and deposits. Rationalization of the bank's domestic and overseas branch network also led to the abolition of ten regional offices and nine overseas offices and divestment of lending functions from 25 I-ranch offices. 5.9 Institutional Strengthening. To ensure PNB's overall operating efficiency, long-term viability and leading position in the commercial banking industry, major aspects of operational management and control were reviewed and reorganized. Credit control was strengthened by consolidation of head office lending functions into one department, establishment of credit committees at various levels and adoption of an early warning system for problem loans. Financial management was strengthened by regular monitoring of and adherence to financial performance standards, integration of the planning and budgeting systems and adoption of a performance recognition scheme based on unit profitability. Operations management was improved with the automation of data processing in all bank units including provincial branches and the reorganization - 78 - and realignment of functions and units. Staff performance was improvea with revision of the performance appraisal system and implementation of comprehensive training programs. 5.10 Financial Performance. The success of the PNB rehabilitation plan is attested to by the substantial improvement in the bank's financial performance. Total assets increased from P26.9 billion in 1986 to P38.8 billion in 1988 (see Table 9), way above the P32 billion projected under the rehabilitation plan. Net profits of P1.01 billion in 1987 and P1.85 billion in 1988 also excaeded projected levels of P30 million and P185 million, respectively. As a result of this unprecedented profit performance, the bank's capital accounts reached P5.01 billion in 1988, way above the projected level of P2.74 billion. In addition, PNB showed dramatic improvements with respect to certain financial indicators on capital adequacy, liquidity, funds sourcing, asset quality and earnings performance. Table 10 shows that PNB has stayed well within the target levels agreed with the World Bank under the ERL. 5.11 Savings Mobilization. The renewed strength and financial viability of the PNB enabled it to contribute to the developmental efforts of the national government particularly in domestic resource mobilization and expansion of credit services. PNB's total deporits more than doubled from P18.93 billion as of end-1987 to P45.4 billion as of end-1990, representing an average annual growth rate of 34.6 percent. The bigger part of this growth was accounted for by private deposits which grew threefold from P11.3 billion in 1987 to P29.5 billion in 1990. PNB's share in the total deposits of the commercial banking system steadily grew from 12 percent in 1987 to 15 percent in 1990. More significantly, deposits generated by the bank's countryside network grew at an annual average rate of 32 percent during the period, accounting for more than 50 percent of total private deposits and one-sixth of the total deposits generated in the countryside. 5.12 Lending Activities. PNB also contributed to economic recovery and growth by the provision of increased credit to productive sectors, especially those in the countryside. PNB's loan portfolio of P29.4 billion at end-1990 was almost three times the end-1987 level of P10.3 billion, representing an annual average growth rate of 42 percent. Its share in the total outstanding loans of the entire commercial banking system steadily increased from 9.5 percent in 1987 to 14.2 percent in 1990. The proportion of countryside loans in PNB's loan portfolio averaged 22 percent in 1987-1990, substantially higher than the 16 percent ratio prevailing in the rest of the commercial banking system. In addition, PNB provides financing under liberal terms to small and medium-scale enterprises and has specialized credit programs for those using indigenous inputs, those affected by the July 16, 1990 earthquake, small exporters and market vendors. 5.13 Public Stock Offerina. The bank undertook in mid-1989 a public offering of 30 percent of its outstanding shares of stock then held by the government. The offering resulted in 25,912 approved applications which made PNB the local bank with the widest ownership base. The share offering contributed significantly to the development of the country's equities market. In just two months after its listing in the stock exchanges, PNB shares added about P4.7 billion to total market capitalization. - 79 - 5.14 Rehabilitation of DBP. The Revised Charter of the CBP embodied in E.O. No. 81 dated December 3, 1986 leys the groundwork for the rehabilitation program for DBP. Like the PNB, the DBP was allowed to start operations under the Revised Charter on a viable basis through the transfer of non- performing assets and liabilities. To carry out its primary objective of providing medium and long-term financing to the private sector, the DBP was to evolve into primarily a wholesale bank, channeling funds to other financial institutions for on-lending to private business enterprises. Consistent with the emphasis on financial viability and independence, DBP's operations were to be guided by the following policy directions: (1) DBP shall submit to the test of financial viability to ensure sound capital structure, generation of sufficient earnings to cover costs and earn a profit margin, build-up of appropriate reserves, and protection of its equity base; (2) DBP shall compete in the market and operate on an equal footing with its private sector counterparts; (3) public sector lending shall be avoided; (4) interest rates shall be guided by full recovery of all costs and consistency with those prevailing in the market; (5) exposure to a single client shall be limited to 15 percent of DBP's unimpaired capital and surplus and total equity investment in any single company shall be limited to 15 percent of DBP's own total equity; and (6) DBP shall conduct lending activities in support of government programs only if funds are specifically provided, DBP is appropriately compensated, and such lending is treated off books. 5.15 Transfer of Assets and Liabilities. As with PNB, non- performing assets amounting to P61.4 B and liabilities amounting to P62.2 billion were transferred from DBP to the national government in 1986. Total assets of DBP were thus reduced from P72 billion in 1985 to P9.5 billion in 1986. Total assets of DBP were thus reduced from P72 billion in 1985 to P9.5 billion in 1986. 5.16 Cost Reduction. Bank costs have been substantially reduced through branch network reorganizatioin and staff retrenchment. The branch network reorganization involved the assignment of well-trained senior officers to oversee branch operations. A retirement program produced a leaner, more flexible organization that could respond more promptly to the financial needs of its clientele. 5.17 Institutional Strengthening. A key organizational reform was the limitation of the role of directors to policy-making, with the exception of the Chairman and the Vice-chairman who are the Chief Executive Officer and Chief Operating Officer of the bank, respectively. The job of managing units, departments, and banking groups has been entrusted to a corps of professional managers. The credit review process was also upgraded through the introduction of the Risk Asset Management Manual, a standard credit evaluation tool of private banks. An extensive staff training and value formation program was also institutionalized to make DBP personnel not only competent bankers but also effective agents of change and development. 5.18 Financial Performance. DBP's rehabilitation program succeeded in restoring its financial viability. Total assets increased from P9.5 billion in 1986 to P11.4 billion in 1988 (see Table 11). Net income improved dramatically from a net loss of P5.64 billion in 1985 and 1986 to a net profit of P1.65 billion in 1988. In addition, substantial improvements with respect to key financial performance indicators were achieved (see Table 12). - 80 - 5.19 Savings Mobilization. Both as a bank and as a development institution, the DBP has endeavored to promote the savings habit and generate deposits especially in the countryside. Between 1986 and 1990, DBP's deposits increased ten-fold from PO.5 billion to P5.1 billion. The bank has also participated in the development of the capital market by designing and marketing special bonds such as the Cebu Equity Bond Units (CEBUs) ana the Tulong sa Bayan Bonds intended to fund reconstruction efforts following the July 15, 1990 earthquake. 5.20 Lending Activities. While increasing its retail lending from P5.2 billion in 1986 to P7.8 billion in end-1990, the DRP also embarked on its wholesale lending operations primarily through the onlending of long-term funds sourced from international financial institutions such as the Bank. The $65 million Industrial Investment Credit Project funded by the Bank was the DBP's first wholesale facility. It was fully committed within three months from date of effectivity of the Bank loan. The administration of the APEX credit facility and the Industrial Guarantee Loan Fund (IGLF) were transferred from the Central Bank to the DBP in 1990. As of end-1990, 53 private financial institutions had been accredited to serve as retail outlets for DBP's wholesale funds. As a result, DBP has become a valuable source of medium to long term financing for agricultural and industrial enterprises. Through the bank's special development lending window, it also meets the special credit needs of farmers' cooperatives, irrigation service associations, jeepney drivers cooperatives and exporters associations. 5.21 Disposition of Non-Performing Assets (NPAs). The disposition of the NPAs transferred from PNB and DBP to the national government was made part of the government's privatization program. Proclamation No. 50 dated December 8, 1986 established the Committee on Privatization (COP) to oversee the program. The COP is composed of the Secretary of Finance (Chairman), Secretary of Budget and Management, Secretary of Justice, Secretary of Trade and Industry and the Director General of the National Economic and Development Authority. While the COP formulates policy guidelines and approves sales, actual marketing is done by designated diaposition entities such as the Asset Privatization Trust (APT). The APT was also established under Proclamation No. 50 to dispose of the NPAs transferred from PNB and DBP as well as certain government corporations earmarked for privatization. Of the 399 non-performing accounts lodged in the APT for disposition, 230 had been fully or partially sold as of end-December 1990. Included is Nonoc Mining and Industrial Corporation, APT's biggest account, which was sold for $325 million on October 12, 1990. 5.22 Divestment of Six Government Acquired Banks. Of the six banks that came under the control of the Central Bank, Commercial Bank of Manila and Pilipinas Bank had been fully sold as of end-December 1990 while Union Bank and International Corporate Bank had been partially sold. Republic Planters Bank is to be privatized by end-December 1991. Legal entanglements continue to stand in the way of privatization of Associated Bank. 5.23 Other GFIs. Studies on the social security institutions, Social Security System (SSS) and Government Service Insurance System (GSIS), and two other GFIs, Land Bank of the Philippines (LBP) and Philippine Export and Foreign Loan Guarantee Corporation (Philguarantee), were originally planned to be funded out of the $10 million ERTAP. However, in view of the objection raised by the - 81 - Commission on Audit to the loan funding for the studies, alternative ways of conducting the studies were adopted. The Department of Finance undertook the studies on the SSS and GSIS while the Central Bank did the study on the LBP. The Philguarantes study was contracted out by the Bank under separate grant funding. The report recommended the designation of Philguarantee as the national export credit agency and its institutional strengthening to enable it to carry out its new role. A corporate plan, pre-shipment export credit guarantee program and organizational development and manpower training program were also prepared for presentation to the Philguarantee Board. 6. Overall Assessment. 6.1 Macroeconomic Performance. During the implementation period of the ERL, the Philippine economy did recover and grow quite substantially. After two successive years of economic contraction, gross national product (GNP) in real terms grew by 4.2 percent in 1986, 5.1 percent in 1987, 7.2 percent in 1988 and 5.7 percent in 1989 (see Table 13). This growth was induced by strong recovery in investment activities together with sustained increase in consumption. Gross domestic capital formation increased by an average of 17.6 percent during the period 1987-1989. Total investments grew from P123.186 billion or 18.3 percent of nominal GNP in 1987 to P202.113 billion or 22.1 percent of GNP in 1989. The bulk of the investments were made by the private sector reflecting greater business confidence and high capacity utilization rates. After virtually stagnating in 1984-1986, personal consumption increased by an average of 5.06 percent in real terms in 1987- 1989 (See Table 14). 6.2 Average annual inflation rates were kept at single-digit levels between 1986 to 1988, although increasing from year to year. Owing mainly to pressures from the expansion in domestic demand induced by higher incomes and the shortages in agricultural products due to weather disturbances, the average annual inflation increased from 0.8 percent in 1986 to 3.8 percent in 1987 and further to 8.8 percent in 1988. 6.3 However, towards the end of the ERL period, in 1989 and 1990, macroeconomic imbalances began to emerge. The Philippine economy continued to grow in 1990 but at a decelerated pace of 4.2 percent. Inflation rose from 10.6 percent in 1989 to 12.7 percent in 1990. While significant structural reforms had been put in place, they were not able to completely offset the negative effects of an unsettled political situation, a series of natural calamities, including the July 16, 1990 earthquake, and the slowdown of the global economy compounded by the outbreak of the Gulf crisis. 6.4 Budget and BOP Effects of Loan Proceeds. The ERL disbursements considerably strengthened the non-monetary capital account of the balance of payments (BOP). Inflows from the World Bank and Japan Exim Bank cofinancing loans amounted to $249 million in 1987, $201 million in 1988, $147 million in 1989 and $3 million in 1990 and increased medium and long-term loan inflows by over $600 million in 1987-1990. With interest payments on the loans estimated at $116 million for the same period, net balance of payments impact of the loans amounted to $484 million during the period. - 82 - 6.5 Similarly, peso proceeds from the loans amounting to P12.75 billion during the period 1987-1990 helped reduce recourse to more expensive and shorter-term domestic borrowings. This resulted in savings in domestic interest payments which more than offset the interest payments on the foreign loans. Furthermore, the loans mitigated further increase in domestic interest rates that would have resulted from the higher levels of domestic borrowings required in the absence of such external funding support. 6.6 Macro Effects of Reform Measures. The reform measures supported by the ERL zontributed to the attainment of economic recovery in the period 1987-1989 both through their direct and indirect effects on real GNP growth. The tax reform package which included the abolition of export taxes removed disincentives to exports in particular and production in general and at the same time, laid the groundwork for increased tax collections. Higher tax revenues during the period 1987-1989 helped to keep the national government deficit within manageable levels and thereby create a low-interest rate, low-inflation rate macroeconomic environment conducive for local and foreign investments as well as personal consumption spending. As indicated above, the additional inflow of ERL-related external financing of the national government deficit further reinforced the decline in interest rates as represented by Treasury bill rates (see Table 13). 6.7 The revitalization of public investments spurred economic growth directly as well as through multiplier effects on private investments and consumer spending. Through their rehabilitation and renewed financial viability, the PNB and DBP were able to also contribute to economic recovery, eapecially in the countryside, through their intensified savings mobilization efforts and expanded lending activities to private agricultural and industrial enterprises. While the import liberalization program led to a temporary worsening of the current account of the BOP, it stimulated economic activity and paved the way for higher export growth by facUitating and lowering the cost of entry of imported raw materials and capital goods needed for the domestic production of locally consumed and exportable goods. 6.8 From the foregoing, it can be observed that the Aquino government was largely successful in implementing the economic recovery program that it drew up upon its assumption of office in 1986 and that these reform measures contributed to the economic recovery achieved in 1987-1989. Although another economic crisis loomed in 1990, the gains achieved under the 1987-1989 economic recovery program cannot be erased and may be counted upon to help the economy cope with internal macroeconomic imbalances, political uncertainties and natural disasters as well as an unfavorable external environment through a more efficient tax system, more competitive exports, revitalized public investments and more responsive government financial institutions. - 83 - TabeL1: ECONOMIC RECOVERY PROGRAM POLICY MATRIX Page 1 of 5 icy Reforma/Required Action First Tranche Second Tranche Third Tranche Fiscal Reforms 1. PubLic Expenditures a. Public Investment Agreement an Lovet and ConsuLtation an program Coutatfon on program Program composition for 1987- with Sank; Imptements- with Bank; Imptementation 1989 program. tion as agreed. as agreed. b. Operation and Agreement to maintain at ImpLementation. Implementation. maintenance Least 1982 real tevet. expenditures c. Monitoring system for Agreement to estabtish a ImpLementation. ImpL~tatIon. public investment. system to monitor physicaL and financial accompt ishments. 2. Tax Reforms Impementation. Implementation. a. Agreement on program Executive Orders issued of tax reform for for 26 mansures. 1986. b. Introduction of vaLue- Agreement to undertake Corpletion of Introduction of VAT. added tax. studies and/or use of preparation activities. technical. assistance. c. Further improvements Agree to undertake Completion of studies. Implementation based on to personal income studies on: studies. tax, corporation income tax, property - rationalization of tax and fiscal capitaL gains tax; incentives. - introduction of aifationt adjustment for depreciation; A rationaLioation of tax incentives; - possibl inctusion of interest income in grobatized Income tax; and - property taxation. Trade Reforms 1. Raise all tariffs at 0% Completed CEO No. 70.25 and 5% to at Least 1M. Noveober 1986) 2. Undertake further tariff Agree to develop program CompLeto studies. Hold hearings and ueoure reform to Lower protection of studies. new tariff sree program. levols end overaLl tariff ratsi. 3. Complete on-going trade Now schedule announaced Lfberelzod agreed Liberalize remaining Item liberalization program. for 299 Items (Ceontral Item by ApriL 30o 19f6. Bank Circutaor No. 112 and 1128 of January 9t 1987). - 84 - Table 1 (cont'd) Page 2 of 5 Policy ReforaVRequired Action First Tranche Second Tranche Third Trenche 4. Review of remaining Agree to review. Complete review; Start implementation. restricted item. announce scheIule. Government Financial Institutions 1. General Polieies a. Overall policy statement on Policy statement government role in approved by the Monetary financial system. Board (M Res. No. 1077, November 28, 1986), b. Monetary Board External audit for GFIs Resolution on external approved by the Monetary audit for GFIs. Board (CS Circular No. 1124, December 5, 1986). c. Nonetary Board Approved by the Monetary Resolution on Board (CS Circular No. Contingent LiabiLities 1123, December 5, 1986). 2. qehabi(Itation of DBP and PNB a. 08P f) Revised charter E No. 81 dated Deceaber 3, 1986 issued by the President revising charter of DSP. if) Policy Statement Policy statement approved by DSP Board and Monetary Board on December 23, 1986. Iif) External Audits Selection of external Preparation of 1986 Preparation of 1987 audit. auditors. audit. iv) Rehabilitation Rehabilitation Program program approved by MB and 08P Board on December 23, 1986. Transfer of non* Movement off books of Transfer/assignment of performing 08P. legal title for assets (Over P10 designated asets/ N) and desig* Liabilities. noted tiabit* itfes. - 85 - Table 1 (cont'd) Page 3 of 5 Policy Reform/Required Action First Trenche Second Tranche Third Tranche - Cost redluction Program agreed. Implemntation. Iptementation. program includ- Ing branch net- work reorgani za- tion and staff retrenchment. * Internal re- Agreement an Action plan organization and and on use of technical strengthening of assistance. Internal cont- rols, policies, procedures and system. * Performnce Agreement on indicators laptementation. Implementation. indicators and reporting to the World Bank on semi- annual basis. b. PN I) Revised charter EO No. So dated Dtcember 3, 1986 issued by the President revising charter of PN. if) Policy Statement Policy statement approved by PN6 Board and Monetary Board on Deceaber 23, 1986. III) External Audits Selection of external Preparation of 1986 Preparation of 1987 audit. auditors. audit. fv) Rehabilitation Rehabitftation Progrm program approved by M and PHI Board on December 23. 1986. - Transfer of non- Movement off books of Transfer"assigrsont of performing PNB. legal title for assets (Over P10 designated asets/ N) and desig- tiabilities. nated Liabtl- fties. Minin targets agreed. Sumission of final Implamentation. - Cost reduction branch reduction program includ- program by June 30, ing branch net- 1987. work reorganixa- tion and staff retrenchment. - 86 - Table 1 (cont'd) Page 4 of 5 Policy Reform/Required Action First Tranche Second Tranche Third Travhe Internal re* Agrement on Action plan tlemeantation. laitementation. organization and and use of technical strengthening of assistanwe. internal cont* rots, procedures and system. Performance Agreement on indicators Iplementation. Implementation. indicators and reporting to the World Bank on semi- anual basis. 3. Disposition of non- performing accounts (NPAs) a. Establishment of the cognittee on Privati- Proclamtion No. So lation (COP) and Asset issued by the President Privatization Trvst. on Deceaber 8, 1986 and Proclamation No. SA on Deceaber 15, 1986 establishing the COP and APT, respectively. b. Appointment of Trustees appointed. Trustes for APT. c. Specification of Agreemant in substance. Adopted by March 31, Iptementation. general APT operating 1987. guidelines, including disposition policies. Specification on interir liability and asset Managemnt arrangements. d. Classification and Approval of lists by Transfer/assigment of transfer of NPA to Goverment and movement Legal title of APT of the Government. off betance sheets of designated assets. PNB and 04P. e. Elaboration of Approval by March 31, laplemntation. detailed operating 1987. featurer of APT. * Organization and staffing * disposal program - brdget f. Disposition of assets Iplementation. Implementation. 4. Divestment of six Completed. Goverment-acquired banks - 87 - Table 1 (cont'd) Page 5 of 5 Poticy Reform/Requrd Action Firat Tranche Second Tranche Third Tranche 5. Adption of petcy Appoved by 4S (C aptementation. Limiting Givrnmnt Circutar No. 1121 of deposits at Lkvermnt Novler 14, 1986). dpository nks to working batcneca, and the establishment of lquidIty rq remmnts. 6. Studies of 018/33. LP Draft term of reference Agreemnt by Narch 31, C~plete studles. and PhiLguarantee. propeed and discussed. 1987 of finat TOR for studies; studies initiated. 7. Perform~nce mnitoring of Designötfon of QCNCC to Attach~ent of PN and laptmentation. 0aP and PHB. onitor PNB and DBP. DP transferred from NEDA to the Dept. of Finance; smi-vnut monitoring by GCNCC based on approved perforance fndicat-å. - 88 - Table 2 STATUS OF THE 1986 TAX RFORK PACKAGE Page 1 of 3 S-------------------------------------- -------------------------- Measures Executive Signing Date of Remarks Order No. Date Effectivity -------------------------- ----------------- ----------------- -------------------------- A. INCOME TA(ES Individual 1. Change from schedular to 37 July 31, 1986 January 1, 1986 global income tax 2. Uniform rate structure of -do- -do- -do- 0 - 35% on all income including business income 3. Prescribe celling on -do- -do- -do- Not implemented. allowable deductions 4. Raise personal exemptions -do- -do- -do- to avoid taxing incomes below the poverty line 5. Separate taxation of -do- -do- -do- incomes of married couples Corporate 6. Unifbrm tax rate of 351 -do- -do- July 1, 1986 7. Prescribe ceilings on -do- -do- -do- Not implemented. allowable deductions 8. Exeapt latercorporate -do- -do- August 1, 1986 dividends Individual/Corporate 9. Uniform final tax of 201 -do- -do- -do- on interest, dividends, royalties and otber passive income 8. MOTOR VIICLI TAI 10. Rationalize registration 43 August 22, 1988 January 1, 1987 fees Table 2 (cont'd) - 89 - Page 2 of 3 Heasiares Executive Signing Date of Remarks Order No. Date Effectivity C. INDIRECT TAXES Sales Txes 11. Reduce rates to three 36 July 30, 1986 August 1, 1984 levels 12. Remove unnecessary tax 36 -do- -do- exemptions 13. Disallow tax credits or 36. -do- -do- inputs if output is not taxed 14. Phase-out turnover tax and 273 July 25, 1987 January 1, 1988 replace with value-added tax Excise Taxes 5. Convert all taxes to ad 22 June 25, 1986 July 1, 1986 valores taxes and increase taxes on cigarettes and beer 16. Levy 5-20% excise duty on 36 July 30, 1986 August 1, 1988 motor vehicles as sales taxes are lowered D. REAL PROPERTY TAX 17. Adjust 1978-based taxable 73 November 25, 1986 November 25, 1986 Suspended by Hesorandu values to 1984 Order No. 77 until June 30, 1987 1. TRAVEL TAX 18. Exempt contract workers 25 July 1, 1986 July 1, 1986 1. IIO1RT DUTIES 19. Abolish all export duties 26 July 1, 1986 July 1, 1986 except on logs 0. CUSTMHS DUTIlS 20. Impose Maii 10 duty 70 November 25, 1988 November 25, 1986 oa iaports Table 2 (cont'd) - 90 - Page 3 of 3 easures huentive Signing Date of Remarks Order No. Date Iffectivity a. GENERAL AND ADMIISTATIVI Special funds 21. Rationalise tax treatment Not legislated. of all gambling activities 22. Bring casino, travel and Not legislated. other foods into the General Fand heaptions and Incentives 2?. Withdraw all tas and duty 93 December 17, 1986 March 10, 1987 incentives and replace with subsidies 24. Impose uniform franchise 72 November 25, 1986 November 25, 1988 tu and withdrav income tax exemptions Amnesties 25. Anesty on income and 41 August 22, 198$ August 22. 1986 other Internal revenue taxes Amending 10 41 54 November 4, 1988 November 4, 1986 Further Aneding 10 41 64 November 7, 1986 November 7, 1986 Further Amending 10 41 95 December 17, 1986 December 17, 1986 26. Amnesty on real property 42 August 22, 1986 August 22, 1988 tu Amending 10 42 104 December 24, 1986 January 1, 1987 27. Tax anesty on registra- Not legislated tion of foreign assets Administrative leasures 28. Compromise agreement on disputed assesents and delisquest accouts IS 44 September 4, 1988 September 4, 1988 B0C 38 Augst 6, 1988 August 6, 1986 29. Raise BI Incetives 45 September 4, 1986 September 4, 1986 Source: National Tax Rasereb Center - 91 - Table 3 RMS908 IMPACT 01 1986 TAI UFO PACIAGI, 1966 - 1988 (in million Pesos) Page 1 of 3 Measures Original Actual Revenues lstimates 1/ 1988 1987 1027 2/ T 0 TAL 8393 242 7292 11202 A. INCOME TAUS 230 125 -983 -1040 -1310 -382 -1735 -1976 Individual 1. Change from schedular to) global income t ) -540 0 -8 -703 2. Uniform rate structure of) 0 - 351 on all incoe) including business income) 3. Prescribe ceilings on 200 0 0 0 allowable deductions 4. Raise personal exemptions *410 -182 -491 -540 to avoid taxing Incomes below the poverty line 5. Separate taxation of -560 -200 8868 -733 incomes zf married couples Corporate 1140 111 576 636 6. Uniform tax rate of 35% 500 125 592 666 7. Prescribe ceilings on 670 0 0 0 allowable deductions 8. Iempt intercorporate -30 -14 -16 -30 dividends Individual/Corporate 400 396 236 300 9. Uniform 'final' tax of 400 396 238 300 201 on Interest, dividends, royalties and other passive income B. MOTOR VWICLI TAI 10. Rationalise registration 0 0 0 0 fees - 92 - Table 3 (cont'd) Page 2 of 3 Heasuree Original Actual Revenues Estinates 1/ 1986 1987 1988 2/ C. INDIRECT TABS 3290 1343 2789 3765 Sales Taxes 0 0 0 2500 11. Reduce rates to three 0 0 0 0 levels 12. Remove unnecessary tax 0 0 0 0 eeuptions 13. Disallow tax credits on 0 0 0 0 inputs if output is not taxed 14. Phase-out turnover tax and 0 0 0 2500 replace with value-added tax Excise Taxes 3290 1343 2789 1265 15. Convert all taxes to ad ) 2540 943 1783 542 valores taxes and lncrease ) 750 400 1006 723 tues on ciganttes and ) beer 16. Levy 5-201 excise duty on 0 0 0 0 motor vehicles as sales taxes are lowered D. REAL PROPERT TAI 3/ 3/ 17. Adjust 1978-based taxable 71 0 71 71 value to 1984 I. TlAVlL TAI 18. Exempt costract workers -100 -51 -100 -100 F. c1ORT N0TIES 19. Abolish all export daties except a los -1060 -319 0 0 a. cOSOII tiIs 20. Ime uialm 105 duty 150 0 252 150 oa Isports - 93 - Table 3 (cont'd) Page 3 of 3 measures Original Actual Revenues stimates 1/ 1986 1987 1988 2/ H. GENERAL AND ADMINISTRATIVE 5812 1364 5263 8356 Special Funds 0 0 0 0 21. Rationalize tax treatment 0 0 0 0 of all gambling activities 22. Bring casino, travel and 0 0 0 0 other funds into the General Fund Exemptions and Incentives 180 0 1029 4380 23. Vithdraw all tax and duty no estimate 0 924 4200 incentives and replace with subsidies 24. Imposes uniform francbise 180 0 105 180 tax and withdraw incose tax exemptions Amnesties 1262 1297 552 104 25. Amnesty on income and 1040 1010 356 0 other internal revenue taxes 26. Amnesty on real property 222 287 196 104 tax 27. Tax amnesty on registra- so estimate 0 0 0 tion of foreign assets Administrative Ieasures 4370 67 3682 3872 28. Compromise agreement on 1070 67 242 0 disputed assessments and delisquent accounts 29. Raise BI Incentives 3300 0 3440 3872 1/ atintes of full year revenue impact as of June 29, 1986. 2/ Revenues for 1988 are as submitted to Congress. 3/ In the absence of actual data, program levels were assumed to approximaste actual collections. Source: National Tax lesearch Center IATIGOAL GOVIMNEIT MIOUIS, 1980 - 1990 (øn million Pesos) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 TAK IEUIIUU 30,836 31,974 34,910 40.227 53,379 61.432 66,911 87,124 91,464 124,509 155,309 (g of 0P) 11.66 10.53 9.82 10.62 10.12 10.28 10.89 12.39 11.12 12.94 13.11 Direct Tales 7,619 9,050 9.593 10,073 14,984 19,332 21.065 23,562 29,857 40,032 51,873 (1 of CUP) 2.88 2.98 2.70 2.66 2.84 3.23 3.43 3.35 3.63 4.16 4.58 lacoe Tues 7,172 8,023 8,515 8,869 13,714 17,656 19,381 21,840 27,650 37,464 49,471 Other Direct Tles 447 1,027 1,078 1,204 1,270 1.676 1,704 1,722 2,207 2,568 2,402 ladirect Tales 23,217 22,924 25,317 30,154 38.395 42.100 45.846 63.562 61,607 84,477 103,436 (s of OP) 8.78 7.55 7.12 7.96 7.28 7.04 7.46 9.04 7.49 8.78 9.13 bxcise Tales 4.911 5,268 5,969 6,660 9,926 13,550 16,696 23,098 20,248 25,005 29,070 License aid Basinen Tues 7,672 7,586 7,967 8,308 9,247 9,936 12,376 18,681 17,829 24,612 31,847 loport Deties and Taes 7,601 7,432 8,647 12,219 14,419 13,694 13,191 18,130 17,762 28,306 33,899 Other ladireet Tales 3,033 2,638 2,734 2,967 4,803 4,920 3,583 3,653 5,768 6,554 8,620 tl-TUl OIUUS 4,198 4,510 4,426 6,108 6,856 7.771 13,706 17,291 22,541 29,948 29,098 (t of OP) 1.59 1.49 1.25 1.61 1.30 1.30 2.23 2.46 2.74 3.11 2.57 TOTAL IlINIIS 35,034 36,484 39,336 46,335 60,235 69,203 80,617 104,415 114,005 154,457 184,407 (I øf OP) 13.24 12.02 11.07 12.23 11.42 11.58 13.11 14.85 13.85 16.06 16.20 Ns lIeo: lumial GP 264,532 303,628 355,435 378,744 527,355 597,743 614,703 703,361 822.870 961,914 1,132,404 Source: National Tu lesearch Center - 95 - Table 5 IMPLERNTATION OF PHASE I AND PHASE II OF THE IMPORT LIBERALIZATION PROGRAM As of June 30, 1990 Page 1 of 2 Iapleaenting Effectivity Number Circular Date of Items PHASE I CB Circular 1100 Apr. 30, 1986 140 A/ -------- CB Circular 1105 Jun. 06, 1986 437 CB Circular 1109 Jul. 18, 1986 272 CB Circular 1117 Sep. 20, 1986 80 CB Circular 1128 Jan. 09, 1987 7 CB Circular 1149 Jul. 01, 1987 12 CB Circular 1150 Jul. 22, 1987 21 CB Circular 1161 Nov. 01, 1987 73 C8 Circular 1167 Dec. 24, 1987 58 B/ CB Circular 1174 Apr. 25, 1988 129 TOTAL LIBERALIZED, PHASE I 1,229 C/ PHASE 11 A. List A Itess CB Circular 1192 Dec. 22, 1988 94 D/ CB Circular 1210 Sep. 14, 1989 1 1/ 95 B. List 8 Ites CB Circular 1195 Mar. 15, 1989 3 1/ CB Circular 1205 Jul. 14, 1989 60 CB Circular 1210 Sep. 14, 1989 12 CB Circular 1212 Oct. 06, 1989 17 0/ CB Circular 1219 Dec. 31, 1989 39 CB Circular 1231 Feb. 27, 1990 8 1/ 139 SUB-TVAL LIBERALIZED 234 TO BE LIBERALIZED 323 C. List C Item ReConeded 116 for Contined leglation TOTAL, PHASE II 673 $P8 GWAD TOTAL (PHASE I AID PHASE II) 1,902 - 96 - NOTES ON TABLE 5: Page 2 of 2 A/ EXCLUDES THREE (3) ITEMS UNDER POLYESTER STAPLE FIBER AND FILAMENT YARN (266.52.01, 651.44.01 AND 651.45.01) WHICH WERE DELETED PURSUANT TO CB CIRCULAR NO. 110:3 DATED MAY 8. 1986. B/ EXCLUDES PAPERBOARD (641.22.01) SINCE IT WAS ALREADY COUNTED UNDER THE ACCELERATED SCHEDULE OF CIRCULAR 1150 DATED JULY 23, 1987. C/ EXCLUDES THE THREE (3) ITEMS ON SUGAR UNDER HIGH TARIFF ITEMS (061.11.00, 061.12.00 AND 061.19.00) WHICH WILL CONTINUE TO BE REGULATED PER AGREEMENT WITH THE IMF IN JULY 1986. D/ OUT OF A TOTAL OF 104 ITEMS SCHEDULED TO BE LIBERALIZED STARTING END-JUNE 1988 AND ENDING IN JUNE 1989, TWO (2) ITEMS FROM END-JUNE 1988 SCHEDULE -- EQUIPMENT FOR INDOOR GAMES (894.24.03 AND ELECTRICITY SUPPLY METERS 873.10.04 -- AND ONE (1) ITEM FROM END-DECEMBER 1988 SCHEDULE -- GAME COCKS (001.49.06) -- WERE NOT YET LIBERALIZED PENDING TARIFF RATE ADJUSTMENTS. OUT OF TWENTY (20) COMMODITIES UNDER BRAND NEW TRUCKS AND ENGINES SCHEDULED FOR LIBERALIZATION BY END-JUNE 1989, THIRTEEN (13) WERE LIBERALIZED AHEAD OF SCHEDULE WHILE SEVEN (7) WERE RETAINED SINCE THESE COMMODITIES MAY BE PRODUCED LOCALLY. THESE TEN (10) REMAINING ITEMS WERE INCLUDED IN THE FOUR HUNDRED SIXTY THREE (463) ITEMS UNDER LIST BE OF THE MEMORANDUM OF ECONOMIC POLICY DATED 6 MARCH 1989. E/ REFERS TO ELECTRICITY SUPPLY METERS (873.10.04) WHICH WAS ORIGINALLY INCLUDED IN THE LIST OF ONE HUNDRED FOUR (104) ITEMS UNDER LIST A. F/ REFERS TO THREE (3) CEMENT PRODUCTS WHICH WERE LIBERALIZED IN ADVANCE DUE TO THE PREVAILING ABNORMAL SUPPLY SITUATION. G/ INCLUDES THE ADVANCED LIBERALIZATION OF TWO (2) CEMENT PRODUCTS WHICH FORM PART OF THE FORTY-FIVE (45) ITEMS SCHEDULED FOR END-DECEMBER 1989. H/ UNDER THE REVISED CODE BASED ON THE HARMONIZED SYSTEM IMPLEMENTED IN 1990, FIFTEEN (15) COMMODITY LINES WERE LIBERALIZED CORRESPONDING TO TWELVE (12) LINES UNDER THE 1977 PSCC CODE. OF THE TWELVE (12) HOWEVER, ONLY TEN (10) LINES ARE INCLUDED IN LIST B. OF THESE TEN (10), TWO (2) ITEMS TO BE PART AND ACCESSORIES FOR TRACTORS (784.92.00) AND JEEP AXLES (784.97.00) TO BE LIBERALIZED UNDER CIRCULAR 1219, THUS THE COUNT WAS REDUCED TO EIGHT (8). - 97 - Table 6 IMPORT VALUSS Of CONNODITIES LIBRALIZED UNDES PASE I AND PHASE II OF TE IMPORT LIBIRALIZATION PROGRAM. 1985 - 1990 (FOB Value In Billion US$) No. of Itemas 1985 1986 1987 1988 1989 1990 1. LIBERALIZED COMMODITIES A. PHASE I (1986, 1987 & 1988) 1229 696 776 1142 1417 1912 1919 CAPITAL GOODS 4 -- -- -- -- -- -- RAW MA TRIALS 789 562 739 1.032 1,315 1,793 1,783 CONSUMR GOODS 438 134 37 50 102 119 136 B. PHASI 11 (1988, 1989 & 1990) 234 141 157 220 330 471 606 CAPITAL GOODS 188 139 152 206 315 445 549 RAN UTRIALS 17 -- 1 8 6 14 42 MINRALSUILS 2 -- -- 0 0 0 0 CONSUM GOODS 25 2 4 6 9 12 15 SPECIAL TRANSACTIONS 2 0 0 0 0 0 0 C. TOTAL, PHASE 1 & PHASI 11 1463 837 933 1382 174? 2383 2525 CAPITAL GOODS 192 139 152 206 315 445 549 RAW HATRIALS 806 562 740 1100 1321 1807 1825 MINMIAL FUILS 2 -- -- 0 0 0 0 CONSUMR GOODS 461 136 41 56 111 131 151 dICIAL TRAISACTIOIS 2 0 0 0 0 0 0 II. TOTAL IMPORTS 5111 5044 6737 8159 10419 12206 CAPITAL GOODS 769 839 1164 167 2424 3122 RAN MATRIAS 2338 2821 3628 4415 5388 5808 HINRML 1=S 1452 869 1249 1096 1397 1842 CONSUR GOODS 320 273 391 597 898 1061 SPECIAL TRAISCTIOIS 232 242 305 414 312 373 NO ITINS (AS PERCUTAGI 0 TOTA IMPORTS): PASE I/TOTAL IMPORTS 13.6 1 15.4 1 17.0 1 17.4 1 18.4 1 15.7 1 PAS1 II/0TJ INPOVS 2.8 1 3.11 3.31 4.0 1 4.5 1 5.0 1 TOTM PHASE I & II/TOTU IMPOffS 16.4 Z 18.51 20.2 1 21.4 1 22.9 1 20.7 1 Ste: -- with value less tha $1 Million Soaue: Central Bank of the Philippies - 98 - Table 7 PUBLIC INVESTMENTS, 1980-1990 (In Billion Pesos) 14 Monitored Local Total Percentage Year National Government Government Public of Nominal Government Corporations Units Sector GNP 1980 8.4 11.1 0.5 20.0 7.6 1981 12.7 13.9 0.6 27.2 9.0 1982 9.3 13.3 0.7 23.3 6.6 1983 10.4 18.1 0.8 29.3 7.7 1984 9.7 12.9 0.9 23.5 1.5 1985 8.8 12.4 0.8 22.0 3.7 1986 11.7 5.9 0.6 18.2 3.0 1987 14.7 8.3 1.5 24.5 3.5 1988 15.3 9.0 1.4 25.7 3.1 1989 20.9 14.9 1.8 37.6 4.1 1990 29.1 27.3 2.6 59.0 5.5 ----------------------------------------------------------------------------- Sources of Basic Data: National Economic and Development Authority Department of Budget and Management Table 8 REAL LIVELS OF KIPINDITURS Of TH NATIONAL GOVKNlNT, OBLIGATION BASIS, 1900 - 1990 (in Hillion Pesoe) ------------------------------------------------------------------------------------------------------- 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 ----------------------------------------------------------------------------------------------------- CURRENT OPERATING EIPMDITURIS 28,436 30,042 32,658 30,884 25,673 27,803 35,527 43,658 50,195 54,450 59,521 Personal Services 11,653 14,293 13,583 12,789 10,954 11,145 14,284 14,603 18,419 19,874 23,440 Haintenance and Other Operating Expensee 10,843 10,499 12,381 10,490 6,221 8,966 7,733 9,019 9,332 10,696 10,068 Allotment to Local Government Unite 1,715 1,890 2,291 2,326 1,670 1,780 1,693 1,776 1,843 1,275 1,046 Interest Payments 2,762 2,633 3,560 4,475 6,221 7,407 10,822 17,089 19,377 20,863 21,061 Petroleum Price Standby Fund 0 0 0 0 0 0 0 0 0 0 1,608 Subsidies 1,463 727 843 803 607 505 994 685 970 1,360 817 Tax Expenditures 0 0 0 40 0 0 0 486 253 382 0 CAPITAL OUTLAYS 15,010 20,571 14,934 13,861 9,953 7,966 11,036 9,382 7,705 10,457 15,285 Infrastructure 5,752 6,641 5,856 5,566 2,654 3,132 2,920 3,202 3,639 3,744 5,346 Corporate Equity 7,019 11,581 7,414 4,979 5,456 2,412 6,161 2,137 096 1,031 1,105 Other Capital Outlays 2,239 2,349 1,664 3,317 1,844 2,422 1,955 4,043 3,170 5,682 8,835 NIT LNDING 812 1,007 2,218 2,143 2,643 848 7,505 3,277 2,288 607 (159) DEBT AHORTIZATION 1,540 1,592 1,332 3,090 2,742 2,072 3,229 15,183 10,755 10,624 10,091 TOTAL 45,807 53,212 51,142 49,979 41,012 38,690 57,377 71,500 70,943 76,137 84,738 ---------------------------------------------------------------------- Source of Basic Data: Department of Budget and Management Table 9 TOTAL ASSITS, LOANS AND DISCOUNTS AID NIT PROFIT OF PIN, 1980 - 1908 (In Hillion Pesos) 1980 1981 1982 1983 1984 1985 1986 1987 1988 Total Assets 38,652.1 44,866.3 58,709.8 70,502.3 87,196.1 76,156.9 26,913.2 31,267.6 38,758.1 Loans and Discouats 24,419.7 27,410.3 32,894.4 44,502.3 47,893.5 35,319.1 8,668.2 12,406.4 15,124.7 larnings 3,319.3 5,655.6 6,586.4 7,738.3 9,170.8 5,176.1 3,941.2 3,390.1 4,998.3 xpenses 3,099.3 5,425.4 6,427.8 7,503.6 10,272.2 12,393.4 7,511.3 2,387.6 3,151.0 let Profit 211.0 230.1 158.6 234.7 (1,102.4) (7,217.3) (3,570.2) 1,010.5 1,847.3 (Lose) 0 Sources of Basic Data: PAB Annual Reports (various years) - 101 - Table 10 KEY FINANCIAL PERFORMANCE INDICATORS: PNB 1986 - 1988 -------------------------------------------------------------------------------------- Deviation 1986 1987 1988 NB vs 1988 Criterion (In % pts.) -------------------------------------------------------------------------------------- CAPITAL ADIQUACY Capital/total Assets (9.17%) 11.62% 13.20% 9.50% (Floor) 3.70% Debt/Equity 9.9% 7.6% 6.6% 10.00% (Ceiling) 3.41% Networth/Risk Assets 13.67% 25.93% 25.17% 10.00% (Floor) 15.17% Standby LCs/Networtb 30.97% 18.54% 15.03% 50.00% (Ceiling) 44.97% Total Contingent Liabilities/Net Worth 45.66% 37.65% 6.59% 75.00% (Ceiling) 68.41% LIQUIDITY Liquid Assets/Deposits 82.95% 85.91% 70.50% 50.00% (Floor) 20.501 Loans/Deposits 65.20% 81.78% 69.21% 85.00% (Ceiling) 15.79% FUNDING Gov't. Dep. & Borrowings/Total Liabilities 25.21% 26.74% 25.811 30.27% (Ceiling) CB Borrowings/Total Liabilities 0.05% 0.06% 0.01% 2.00% (Ceiling) 1.99% ASSET QUALITY Loan Loss Reserve/Total Loans 28.53% 24.26% 20.32% 21.50% (Floor) -1.18% Loan Loss Reserve/Pon-Performing Loans 44.05% 47.16% 57.891 57.88% (Floor) 8.89% EARNING PIRFORKANCE Return on Assets -7.02% 3.491 5.221 0.50% (Floor) 4.72% Return on Capital -212.00% 39.79% 80.57% 7.00% (Floor) 53.57% Operating fIpenses/Average Assets 4.41% 2.73% 2.901 3.10% (Nolling) 0.20% Personnel Costs/Average Assets 0.82% 1.161 1.151 1.33% (Ceiling) 0.18% Net Interest Income/Average Assets -3.00% 4.18% 4.491 3.001 (Floor) 1.49% -------------------------------------------------------------------------------------- Table 11 MOTAL ASSMTS, LOA0S AND DISCOUNTS AND Ii PROFIT 0F DBP 1980 - 1988 (le million Pesos) 198 1981 1982 1983 1984 1985 1986 1987 1988 Total Assets 27,086.2 34,706.8 43,988.5 54,934.0 66,800.2 72,043.0 9,503.6 10,531.6 11,432.5 Loam and Discouta 15,933.8 18,515.5 22,875.4 30,919.7 35,827.6 24,758.0 5,271.1 4,394.5 5,005.0 araings 2,673.7 3,419.7 4,369.6 5,369.8 2,648.0 3,140.2 2,138.5 1,777.2 2,569.3 hpenses 2,435.7 3,315.9 4,298.0 5,272.0 8,607.5 8,776.7 8,776.4 965.4 920.0 Het Profit 223.1 108.7 117.3 110.2 (6,640.9) (5,636.5) (5,638.2) 782.6 1,649.2 (Loms) Sourous of auic Data: DIP Anaual Reports (variois yearu) - 103 - Table 12 KEY FINANCIAL PERFORMANCE INDICATORS: DP 1986 - 1990 Indicators 1986 1987 1988 1989 1990 CAPITAL ADIQUACY Debt/1quity (incl. contingent liab.) 1/ 2.49 x 2.16 x 1.30 ' 0.85 1 1.48 x Net Worth/Risk Assetq 44% 71% 85.02% 87.731 60.431 Total Equity Inv./Net Worth 31% 13% 3.80% 2.79% 4.35% LIQUIDITY Liquid Asseta/Deposits 351% 619% 253.54% 156.551 103.85% FUNDING National Govt. Deposits/Total Liab. 60% 35% 50% 0% 0% ASSIT QUALITY Total Reserves/Total Portfolio 36% 461 35.261 27.08% 15.151 Reserves (PAs)/Portfolio (PAs) 2/ 3.4% 8.0% 11.371 2.31% 1.35% Reserves (NPA8-Old) Portfolio (NPAs-Old) 79% 100% 98.15% 104.11% 105.02% Coverage Ratios Debt Service Coverage Ratio 2.90 : 1 3.43 : 1 9.14 :1 1.29 : 1 Interest Coverage Ratio 4.74 : 1 8.98 : 1 5.98 : 1 3.12 : 1 EARNING PERFORMANCE Net Interest Margin/Total Assets 5.61% 7.47% 7.48% 10.061 9.431 Return on Assets 1.15% 7.07% 7.201 9.24% 6.17% Return on Net Worth 4.40% 22.34% 19.911 17.051 15.31% Operating hap. 3/ /Total Assets 2.40% 4.57% 4.88% 4.88 4.561 Personnel Cost/Total Assets 1.45% 2.431 2.45% 2.545 2.54% 1/ Icept those to be funded by National Government. 2/ For 1986, computed on new and existing performing accounts. For 1987 and 1988, computed on existing performing accounts as of June 30, 1986. For 1989 and 1990, computed on existing performing accounts as of eand-year. 3/ Includes only salaries, other administrative expenses and depreciation. * -104 - Table 13 SELECTED MACROECONONIC INDICATORS, 1985 - 1990 1985 1988 1987 1988 1989 1990 GNP Growth Rate (At constant -7.1 4.2 5.1 7.2 5.7 4.2 1985 prices) Inflation Rate 23.1 0.8 3.8 8.8 10.6 12.7 National Government Deficit (As I of GNP) 1.9 5.2 2.5 2.9 2.1 3.4 T-bill Rates (All maturities) 27.0 16.0 12.9 15.5 19.7 24.7 Imports ($M) 5,111 5,044 8,737 8,159 10,419 12,206 Exports ($N) 4,629 4,842 5,720 7,074 7,821 8,188 Trade Balance (SN) (482) (202) (1,017) (1,085) (2,598) (4,020) Current Account (0N) (103) 954 (444) (423) (1,456) (2,695) Non-Monetary Capital Accoant ($) 1,711 81 421 643 1,518 14,492 Balance of Payments ($N) 2301 1242 264 650 451 (185) Exchange Rate (Average) 18.6 20.4 20.6 21.1 21.7 24.3 (1nd-year) 19.0 20.5 20.8 21.3 22.4 28.0 ----------------------------------------------------------------------------------------------- Sources: National Economic and Development Authority Central Bank of the Philippines Department of Finance - 105 - Table 14 SELECED NATIONAL INOME ACCOUNTS DATA, 1986 - 1990 (Annual Percentage Change In Constant 1985 Prices) 1986 1987 1988 1989 1990 Gross National Product 4.2 5.1 7.2 5.7 4.2 Gross Domestic Product 3.4 4.8 .6.3 6.1 2.6 By Expenditure Share Personal Consumption 3.3 4.0 6.2 5.0 5.4 uovernment Consumption 0.3 4.9 9.1 5.6 9.3 Gross Domestic Capital Formation 8.2 17.6 11.6 23.6 5.6 Construction -7.9 5.5 7.3 17.7 0.6 Durable Equipment 13.7 6.1 23.7 32.5 15.3 Exports 17.1 6.5 14.7 10.7 1.3 Imports 10.2 28.6 19.6 15.2 11.0 By Industrial Origin Agriculture 3.7 3.7 3.2 3.0 1.3 Industry 2.3 5.4 7.6 8.2, 1.8 Mining and Quarrying 3.5 -8.8 4.2 -2.7 -2.6 Manufacturing 1.8 5.6 8.5 6.4 2.0 Construction -1.7 11.2 4.7 24.5 3.0 Elec., Gas and Water 13.2 4.2 6.9 2.7 0.1 Services 4.2 5.2 6.8 6.0 4.0 -------------------------------------------------------------------- Source: National Economic and Development Authority - 106 - PCR ANNEX I Development Bank of the Philippines URcE oF ml CHAM June 29, 1992 Mr. Mark Baird Division Chief World Bank 1818 H Street, N.W. Washington, D. C. 20433 U. S. A. Dear Mr. Baird: We refer to your letter of.29 May*1992 soliciting comments on the draft Program Performance Audit Report (PIAR) on the Economic Recovery program.. (Loan 2787-PH) and Economic Recovery Technical Assistance Project (Loan 2788-PR). We take exception to your statement on page 61 of the draft PPAR which states that "In the context of tre program originally envisaged under the ERL, the judgment must be that the privatiza- tion of DBP has been delayed". Considering that the various schemes of branch privatization for DBP have been pursued to the hilt and yet were met with varying constraints, the WB Mission in February 1992 stated that "the mission is now cohvinced that the successful transformation of DBP to a wholesale bank and the branch privatization can only be realistically achieved through legislative amendments to its charter ......". Mr. Vineet Nay- yar's letter of March 6, 1992 also mentioned that they "now believe that an amendment of DBP's Charter is the only realistic and viable option". With these developments, we do not agree that we could consider the program as delayed. In facz, since the objectives for which branch privatization, among others, vae attempted had already been achieved, (i.e., successful introduc- tion of wholesale banking, rehabilitation of DBP, etc.) there appears to be a need to take a second look at the propriety of imposing such a conditionality. Very truly yours, CBsZaTA V. FRNcISCO Senior Vice President T( 1 PC. 9=W& NWA" MTIcftMa PwCF,c= l= GLOW&UAOZMY Asia C&Wftpu CAML~ PHOMWAM %A Eanm u'~cs fft~pw~m~g g4g.Iq FAA ~ ~ aB7~