Philippines - Country Assistance Strategy

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 19137-PH MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ONA COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF THE PHILIPPINES April 12, 1999 Philippines Country Management Unit East Asia and Pacific Region 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 (As of April 9, 1999) Currency Unit = Peso $1.00 = 38.52 1.00 peso = $0.026 WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1 - December 31 IBRD IFC Vice President: Jean-Michel Severino, EAP Jemal-ud-din Kassum, CIOVP Country Director: Vinay K. Bhargava, EACPF Javed Hamid, CEADR Task Team Leader: Heidi Hennrich-Hanson, EACPQ Stoyan Tenev, CEADR  FOR OFFICIAL USE ONLY ACRONYMS AND ABBREVIATIONS ADB Asian Development Bank APEC Asia-Pacific Economic Conference APL Adaptable Program Loan ARCs agrarian reform communities ASEAN Association of South East Asian Nations ASEM Asia-Europe Meeting BOI Bureau of Investment BOO build-operate-own BOT build-operate-transfer BSP Bangko Sentral ng Pilipinas CALA Cavite-Laguna CAR Country Assistance Review CARP Comprehensive Agrarian Reform Program CAS Country Assistance Strategy CDF Comprehensive Development Framework CEM Country Economic Memorandum CG Consultative Group GIDA Canadian Agency for International Development CMU Country Management Unit COA Commission on Audit CPPR Country Portfolio Performance Review CPSD consolidated public sector deficit DA Department of Agriculture DAR Department of Agrarian Reform DBM Department of Budget and Management DBP Development Bank of the Philippines DENR Department of Environment and Natural Resources DOH Department of Health DOTC Department of Transportation & Communication DPWH Department of Public Works and Highways DSWD Department of Social Welfare and Development ECD Earlv Childhood Development ESW Economic Sector Work EU European Union FAP foreign-assisted project FDI foreign direct investment FIAS Foreign Investment Advisory Services FINCORP Financial and Corporate Sector Reform Loan FISFAP Financial Information System for Foreign Assisted Projects GDP gross domestic product GNP gross national product GOP Government of the Philippines GSIS government service insurance system GVA gross value-added HIGC home insurance and guaranty corporation HNP Health and Nutrition Program IBRD International Bank for Reconstruction and Development IDF Institutional Development Fund IFC International Finance Corporation IMF International Monetary Fund IPPs independent power producers 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.  ii IRA Internal Revenue Allotment JEXIM Japan Export-Import Bank JICA Japan International Cooperation Agency LGU local government unit LIL Learning and Innovation Loan LLDA Laguna Lake Development Authority LOGOFIND Local Government Finanice and Developmenit Project LRT Metro Manila Light Rail Transit system LGUUWS Local Government Ulit Urban Water Supply Program MIGA Multilateral Investment Guarantee Agency MTPDP Medium-Term Philippines Development Plan MTEP Mediulim-Term Expenditure Plan MWSS Metropolitan Waterworks and Sewerage System NAPC National Anti-Poverty Commission N DP National Development Plan NEDA National Economiic and Development Authority NFA National Food Authority NG National Governmenit NGO nonigoverinmental organization NHMFC National Home Mortgage Finance Corporation NPC National Power Corporation NPLs noniperformiing loans NRM natural resources managemenit NUPA National Urban Policy Agenda ODA official development assistance OECF Overseas Economic Cooperation Fund OED Operations Evaluation Department PAG-IBIG home development mutual fund PCCI Plhilippine Chamber of Commerce and Industry PECSP Private Enterprise Credit Support Project PHRD Policy and Human Resources Development Fund PNR Philippine National Railways PPI private participation in infrastructure PSRL Public Sector Reform Loan QR qualitative restriction RECs Rural Electric Cooperatives RMP Resident Mission Philippines S&T science and technology SEC Securities and Exchange Commission SEML Social Expenditure Management Loan SME small and medium enterprise SSS social security system SUCs state university and colleges SZOPAD Southiern Mindanao Zone for Peace and Economic Development TA techinical assistance TEEP Third Elementary Education Project TESDA Technical Education Skills Development Agency UHNP Urban Health & Nutrition Project UNDP United Nations Development Programme USAID United States Agency for International Development WBI World Bank Institute WHSMP Women's Health and Safe Motherhood Project  PHILIPPINES COUNTRY ASSISTANCE STRATEGY TABLE OF CONTENTS Page No. EXECUTIVE SUMMARY ....................................................................i I. DEVELOPMENT CHALLENGES AND SOCIAL AND POLITICAL CONTEXT .........1 A. DEVELOPMENT CHALLENGES .....................................................................1 B. SOCIAL AND POLITICAL CONTEXT ..................................................................... 2 II. ECONOMIC PERFORMANCE AND OUTLOOK ..............................................................3 A. RECENT ECONOMIC PERFORMANCE AND POLICY RESPONSES ........................3 B. ECONOMIC SCENARIOS AND THE EXTERNAL ENVIRONMENT ........... ...............5 C. DOWNSIDE RISKS .................................................................6 III. THE PHILIPPINE GOVERNMENT'S DEVELOPMENT AGENDA ...............................7 A. LONG-TERM VISION TO 2025 .................................................................7 B. MEDIUM-TERM PRIORITIES AND PROGRAMS .........................................................7 IV. BANK GROUP ASSISTANCE STRATEGY .................................................................... 11 A. FORMULATING THE COUNTRY ASSISTANCE STRATEGY .................................. 11 B. KEY STRATEGIC DIRECTIONS IN THE CAS ............................................................. 14 C. PROPOSED CAS SPECIFIC OBJECTIVES AND ACTIVITIES ................................. . 14 1. Address Crisis Effects and Promote Economic Recovery ............................................. 15 2. Enhance Human Development and Social Services for the Poor .................................. 17 3. Accelerate Environmentally Sustainable Rural Development ...................................... 18 4. Promote Sustainable Urban Development and Comnbat Urban Poverty ........................ 19 5. Develop Infrastructure, Particularly in the Provinces .................................................... 20 6. Enable Expansion of the Private Sector ................................................................ 21 7. Improve Governance and Transparency and Combat Corruption ................................. 22 V. BANK GROUP COUNTRY PROGRAM ................................................................... 23 A. VEHICLES FOR BANK GROUP ASSISTANCE ........................................................... 23 B. COUNTRY PROGRAM MONITORING ................................................................ 28 TEXT TABLE TABLE 1: PROGRAM TRIGGERS ................................................................ 25  TEXT FIGURES Page No. FIGURE 1: GROWTH, 1991-2002 ...................................................................1I FIGURE 2: POVERTY REDUCTION: RECENT TRENDS AND MEDIUM-TERM PLAN OBJECTIVES ...................................................................1 FIGURE 3: GDP CHANGE, SELECTED COUNTRIES .........................................................3 FIGURE 4: PHILIPPINE TRADE BALANCE, 1996-2002 .....................................................3 FIGURE 5: STOCKMARKET INDEX AND NOMINAL EXCHANGE RATE, JANUARY 1997-JANUARY 1999 ...................................................................4 FIGURE 6: INFLATION AND 91-DAY T-BILL RATES, JANUARY 1997- JANUARY 1999 ....................................................................4 FIGURE 7: NATIONAL GOVERNMENT BUDGET, 1996-2002 .........................................6 FIGURE 8: EXTERNAL DEBT AND INTERNATIONAL RESERVES, 1996-2002 ............6 TEXT BOXES BOX 1: PHILIPPINE GOVERNMENT'S MEDIUM-TERM DEVELOPMENT PRIORITIES AND TARGETS ...............................................................8 BOX 2: PROGRESS TOWARD FY96 CAS GOALS ............................................................ 12 BOX 3: OED COUNTRY ASSISTANCE REVIEW (1986-1997) ......................................... 13 BOX 4: PHILIPPINES: COUNTRY ASSISTANCE STRATEGY AT A GLANCE ............ 16 BOX 5: PARTNERSHIPS AND EXTERNAL, RELATIONS ................................................ 27 ANNEXES A2: PHILIPPINES AT A GLANCE B2: SELECTED INDICATORS OF BANK PORTFOLIO PERFORMANCE B33: BANK GROUP PROGRAM SUMMARY, FYOO-02 B4: SUMMARY OF NONLENDING SERVICES B5: POVERTY AND SOCIAL INDICATORS 136: KEY ECONOMIC INDICATORS B7: KEY EXPOSURE INDICATORS B8: STATEMENT OF BANK GROUP LOANS AND CREDITS B9: CAS PROGRAM (1999-2002) MATRIX B IO: CAS SUMMARY OF DEVELOPMENT PRIORITIES C: POVERTY UPDATE D: PORTFOLIO PERFORMANCE AND MANAGEMENT E: THE PARTICIPATORY APPROACH TO CAS FORMULATION F: CLIENT SURVEYS G: PRIVATE SECTOR STRATEGY H: CIVIL SOCIETY INPUTS IN CAS I: PROGRAMS OF OTHER DONORS J: TENTATIVE LIST OF COUNTRY PERFORMANCE INDICATORS & TARGETS K: PARTICIPATION AND DIALOGUE WITH NGOs MAP OF THE PHILIPPINES  Acknowledgements This Country Assistance Strategy was produced by a team led by Heidi Hennrich- Hanson, and including Bernard Funck, Sanjay Dhar, Rajashree Paralkar, Leonora Gonzales, Maribelle Zonaga and Stoyan Tenev as core team members. Valuable inputs were received from Vipul Prakash, IFC Resident Representative in Manila, and other members of the Bank-wide Philippines Country Team. Dharshani de Silva, Brenda Bermudez, Carolyn Singson and Cynthia Manalastas assisted with document processing.  PHILIPPINES Country Assistance Strategy Executive Summary i. Progress has been made since the last CAS (1996) in reducing poverty incidence and addressing the long-term development issues for the Philippines. The immediate challenge for the Government has changed from sustaining the growth and poverty reduction momentum of the 1 990s to restoring it following a 0.5 percent decline in GDP in 1998 due to bad weather and the crisis. ii. The economy is expected to bottom out in 1999 and resume growth. Initial growth is projected to come from a recovery in agriculture and continuation of growth in services and export sectors. Outlook is uncertain in the industrial sector. Average GDP growth during 2000- 2002 is projected to recover to between 4 and 5 percent which is required to keep poverty reduction on track. iii. So far the Philippines has earned admiration for its resiliency amidst adversity, particularly in the export, corporate and banking sectors,- although further stress cannot be ruled out. The authorities' macroeconomic policy responses are appropriately geared to support domestic demand, control inflation, stabilize the peso and strengthen the balance of payments. Structural reforms, supported by IBRD, ADB, IMF and the New Miyazawa Initiative loans are under implementation in banking, corporate, power and tax administration areas. Acceleration of these reforms as well as launching of new reforms is needed in fiscal consolidation, public sector management, trade and investment liberalization, governance, capital market development and contractual savings. Sustaining structural reforms is essential to prevent the economy from settling back into a slower growth path after a brief spurt in response to current fiscal stimulation. iv. External downside risks pertain to depressed capital flows, further slowdown in world trade and regional currency fluctuations. Internal risks to recovery pertain to persistence of: a more prolonged industrial recession; shaky investor confidence; and weaknesses in governance. v. The CAS supports the country's medium-term plan which is nearing finalization and calls for reducing poverty incidence from 32 percent in 1997 to 25-28 percent by 2004 through a program of policies and investments aimed, in particular, at rural development, human development, improving governance and infrastructure development. The Plan is being finalized in consultation with the civil society. The Plan's targets are ambitious and could come under pressure from resource and implementation capacity constraints. Helping address these constraints will be a key objective of the CAS.  - ii- vi. This CAS is a joint venture of IBRD-IFC. It is also a pilot within the World Bank for a "self-evaluation" CAS, in which government and the Bank agree on indicators for measuring success during the CAS implementation period. vii. This CAS was prepared in consultation with stakeholders in the national and local government, business leaders, nongovernmental organizations, representatives of peoples groups, trade unions, economists, and academicians. Other donors were also consulted in the process. The CAS incorporates the recommendations of the Country Assistance Review undertaken by the World Bank's Operations Evaluation Department in 1998, and two client surveys. viii. Drawing on these consultations, the CAS sets new directions towards longer-term poverty reduction, improving governance, structural reforms, a partnership approach, increased transparency, mainstreaming participation, and evaluation. The longer-term view is incorporated by aligning the CAS with the country's 1999-2004 medium-term plan objectives and selecting a few poverty reduction focused activities for support through adaptable program loans over a 10- 12 year period. Through these new directions, the CAS is taking an approach similar to the Comprehensive Deveiopment Framework approach. ix. Within the longer-term vision of the CAS, the government and the Bank have jointly identified about 15 lending operations and 8 to 10 major analytical and advisory services tasks for the three-year (FYOO-02) period. This program will be updated annually. The program activities have been carefully selected to allow the Bank to make a critical difference through a combination of applying knowledge and lending resources. The selected activities are described in the CAS and will support the govemment's programs for: addressing the effects of the crisis and promoting economic recovery; enhancing human development and social services for the poor; accelerating environmentally sustainable rural development; promoting sustainable urban development and combating urban poverty; developing infrastructure, particularly in the provinces; enabling the expansion of the private sector; and improving governance. x. The proposed IBRD base-case lending program for FYOO-02 will range from $1.0 billion to $1.5 billion similar to the levels approved for FY96-99 period. Agreement on and implementation of additional structural reforms would be supported by raising the amount to up to $2 billion. Under low-case scenario (triggered by substantial slippages in policy implementation, implementation performance and governance) the three-year lending would be reduced to about half of the base-case i.e. between $500 million and $750 million. IFC's base- case investment program in FYOO-02 is between $350 million and $500 million for IFC's own account in 15 to 20 projects. xi. Board members may wish to discuss the following issues/aspects: * Downside risks to the economic recovery (paras. 18-21 and 85-87); * Analytical and participatory process used for CAS formulation (paras. 38-40); * New strategic directions proposed in the CAS (paras. 41, 42 and 44); * Program to improve governance (paras. 34, 35, 67 and 70); and * Proposed Bank Group lending levels (paras. 73-77).  MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF THE PHILIPPINES I. DEVELOPMENT CHALLENGES AND SOCIAL AND POLITICAL CONTEXT A. Development Challenges 1. The Philippine economy's growth momentum of the 1990s (explored in the previous CAS) was dealt a severe blow by the crisis that hit the region in 1997." 2 Real GNP growth accelerated steadily from 1.6 percent in 1992 to a peak of 6.9 percent in 1996. In 1997, it slowed down to 5.9 percent before coming to a halt in 1998. The government now projects a steady recovery starting 1999 (Figure 1). Figure 1. Growth, 1991-2002 Figure 2. Poverty Reduction: Recent Trends (percent, yeeir to year, at constant 1985 prices) and Medium-Term Plan Objectives 8 0~55 5000 4 . No. of poor 2 c 45 <,/ . 4800 families (rhs) 2 0,45 0. 0.40 4600 -2 0,0--*Gini coefficient of -4 0.35 Low Case income -4 V4400 distribution (Ihs) -8 0,30 i ig as 4200 =m==overty 91 92 93 94 95 96 97 980 25 incidence (ohs) Actual 0I 20rqectea 0.2 4000 -GDP Farm n Nor-Farm 91 94 97 00 03 Projected 2. Reducing poverty remains a formidable challenge, in view of the slowdown of growth and the high (though reduced) population growth rate (down from 3.1 percent in the 1960s to 2.3 percent in the early 1990s). The proportion of households living in poverty fell from 40 percent in 1991 to 32 percent in 1997.3 However, the number of rural poor increased by 2.4 million between 1991 and 1997. During the same period, income inequality is estimated to have increased and rural-urban income differentials have widened (Figure 2 and Annex C). 3. Rural development has become a top national priority in view of rural poverty and concerns about food security. Growth in the agricultural sector declined from an annual 1 The Philippines: Country Assistance Strategy: Progress Report, Report No. R98-4 1, World Bank, March 3, 1998. 2 Philippines: The Challenge of Economic Recovery, Report No. 18895-PH, World Bank Poverty Reduction and Economic Management Sector Unit, East Asia and Pacific Regional Office, February 26, 1999. The government's poverty measures use a higher income cutoff level than do many other countries, which inflates the Philippines' poverty estimates somewhat in international comparisons.  - 2 - average of 4 percent in 1970-80 to about 2 percent in 1980-97 (Figure 1). Yet there is untapped potential for realizing higher and more sustained growth in agriculture.4 4. Human development will require renewed efforts to protect past gains and to generate competitive advantage in the future. The Philippines had achieved almost universal primary education enrollment by 1970, and today the female literacy rate is the second highest in the region (94 percent). However, about 30 percent of schoolchildren drop out before reaching sixth grade. Access and cohort-completion rates vary greatly between regions, and the quality of education is widely regarded as having declined. About 11.2 million out-of-school children and youth in the Philippines pose a significant social problem. Health indicators have improved (Annex B5), but little progress has been made in further reducing infant and maternal mortality, differences in health status among provinces and regions and between urban and rural groups, and communicable diseases. At current growth rates, the popiulation will double in the next 30 years, with enormous implications for social services. The social impact of the crisis on the Philippines is still unfolding, but its initial impact appears to have been less severe than in neighboring countries.6 5. Safeguarding the environment and providing basic services to a growing urban population remains a key challenge. Water and forest resource exploitation and conversion of forest lands to commercial uses continues at unsustainable pace and watershed management is poor. By 2020 about 6 out of 10 people will live in urban centers.7 Already, citydwellers account for nearly two thirds of GDP in manufacturing and services and this share is expected to go up. However, cities are becoming less livable and competitive in production, the environment is deteriorating and social disparities within cities are widening. Urban households' access to basic services such as clean and safe water supply and hygienic waste disposal is inadequate, and there is too little appropriate housing for poor and lower middle-class people. B. Social and Political Context 6. The Philipp-nes confronts these development challenges with a number of strengths. It has a relatively stable democracy, led by a new president elected in mid-1 998 for a six-year term. Its legislative and judicial branches of government are active, and decentralization has diffused political power. Civilians participate actively in political and economic affairs as members of the media, businesses, churches, academe or of the vibrant community of nongovermnental organizations (NGOs). The culture is open, with freedom of expression and broad social consensus on the desirability of an outward-oriented society. Despite the persistent potential for escalation of conflict in Southern Mindanao, peace and order hold sway. Over the past 10 years, pro-market policy reforms, substantial privatization, and an impressive record of private participation in infrastructure projects have helped build a vigorous private sector. The market recognizes the Philippines' decade-long structural adjustment effort as a favorable 4 Philippines: Promoting Equitable Rural Growth, Report No.17979-PH, Rural Development and Natural Resources Sector Unit, East Asia and Pacific Region, May 29,1998. "Out-of-school" designates young people who do not attend any formal or vocational school, are not employed, or are not tertiary level graduates. This group includes about 5.3 million in the 7 to 14 age group and 5.9 million in the 15 to 24 age group. 6Philippines: Social Expenditure Priorities, Report No. 18652-PH, World Bank Philippines Country Management Unit, East Asia and Pacific Region, November 13, 1998. 7Philippines: Restoring Stronger Growth with Greater Equity: What the Government Can Do and How the World Bank Can Help, World Bank, August 1998.  -3 - distinguishing factor in the economy's relatively better performance during the crisis, and investors recognize its skilled labor force as an asset. The Philippines is also set apart from some of its neighbors by a steady source of externalfinancial inflows from its overseas workers and its robust export performance. The Estrada administration has won respect for its promise to intensify pro-poor and pro-market policies and to combat graft and corruption. 7. The Philippines' performance has been constrained, however, by widely acknowledged weaknesses in implementation capacity and governance. Improvements are needed in capacity for: policy formulation and implementation; project management; procurement; controlling corruption; transparency and accountability; local governance, and congressional and judicial processes (see also paras. 34, 35, 67 and 70). Bank projects in the Philippines over the last dozen years and in the current portfolio have performed well relative to the Bank-wide and regional averages (Annex D).8 Nevertheless, many current projects suffer from poor project management and procurement bottlenecks. Other donor-financed projects also report recurrent implementation delays. II. ECONOMIC PERFORMANCE AND OUTLOOK A. Recent Economic Performance and Policy Responses 8. Although the Philippine economy was dealt a severe blow by the crisis, it has performed better than most market economies in East Asia (Figure 3). The banking and corporate sectors have resisted the type of systemic collapse witnessed elsewhere. Figure 3. GDP Change, Selected Countries Figure 4. Philippine Trade Balance, 1996-2002 (percent, year to year) (US$ billion and year-to-year percent change) 10 ___ 25___ __ -2 5 9 15 0 - d -6 -8 -5 -5 - *i -10 -15- -1 -15 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~--14 -15 ~~~~~~ ~~~~~~~~~-25 - - -- - --__ _ _ __ - -16 >(ee ~~~ -~~'~~r'~'~~' 96 97 98 99 00 01 02 U 1997 *1998 Balance (rhls) -Exports(lhs) lInVorts(lhs) 9. Several domestic factors account for the Philippines' greater resiliency: the private sector's shorter period of rapid credit expansion and debt accumulation, major banks' stronger capitalization, lower levels of corporate leverage, the private sector's greater experience with external shocks, and the government's appropriate macroeconomic policy responses. sPhilippines: Country Assistance Review, 2 vols., Report No. 17417, World Bank Operations Evaluation Department, March 2, 1998.  -4 - 10. Three external factors also helped: an outstanding export performance,9 improved terms of trade, and continued growth of remittances from overseas workers. As a result of a sustained double digit export performance (Figure 4), the Philippines has been one of the few crisis-beset countries to adjust externally through export expansion (in addition to import compression). 11. So far, the authorities have succeeded in stabilizing the economy. After 18 months of enormous volatility, financial markets have strengthened since September 1998, as equity prices nearly doubled from their six-year low in mid-September. The peso has strengthened (Figure 5), and real interest rates have declined to pre-crisis levels (Figure 6). The government has: adhered to a new standby arrangement with the International Monetary Fund (IMF), approved in March 1998; sought to protect social expenditures in the context of a declining budgetary envelope; influenced employers and workers to promote wage restraint in exchange for job security, thereby moderating increases in unemployment and inflation; and permitted massive rice imports to limit the impact of El Ninio on the most socially sensitive price. Figure 5. Stock Market Index and Nominal Figure 6. Inflation and 91-Day T-bill Rates, Exchange Rate, January 1997-January 1999 January 1997-January 1999 (year-to-year percent change) Jan Jan Jan 20% 97 Apr Jul Oct 98 Apr Jul Oct 99 18% 14% 25 -3500 16% L 12% 14%_ 10% 4 30 / >\ - 30010 12% 8% 2500 ~~10% 6 2500 ~8% 6'f 2000 4