Philippines - First and Second Structural Adjustment Loan Projects

Document of The World Bank FOR OMCIAL USE ONLY Report No. 5813 THE WORLD BANK PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES FIRST AND SECOND STRUCTURAL ADJUSTMENT LOANS (LOANS 1903-PH and 2266-PH) July 31, 1985 Operations Evaluation Department This document has a restricted disbllem and maY be used i0Y recipkent OnlY in the performance Of ther aicia duties Its cm-ta- my et atherwise be discloed withou Worl Bank auOrwEatimB. FOR OFFICIAL USE ONLY ABBREVIATIONS ADB - Asian Development Bank BEU - Bureau oi Energy Utilization BIR - Bureau of Internal Revenue BOI - Board of Investments BSMI - Bureau of Small and Medium Scale Industries CITE)! - Center for International Trade Expositions and Missions, Inc. EPR - Effective Protection Rate EPZA - Export Processing Zone Authority IPP - Investment Priorities Plan L/C - Letter of Credit MAAB - Memorandum to Authorized Agent Banks Meralco - Manila Electric Company MIRDC - Metal Industry Research and Development Center MIS - Management Information System MOE - Ministry of Energy MTI - Ministry of Trade and Industry NCSO - National Census and Statistical Office NEC/UC - Nonessential or Unclassified Consumer Goods NEDA - National Economic and Development Authority NPC - National Power Corporation NTRC - National Tax Research Center OBM - Office of Budget and Management SMI - Small- and Medium-Scale Industry TRP - Tariff Reform Program fThis document has a resticned distm on and may be used by recpiWts onl in the peform nce of thei1rC f ites. Its contents may not ofthewie be disclsed withut World Bank aulthorizaton. PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES FIRST AND SECOND STRUCTURAL ADJUSTMENT LOANS (LOANS 1903-PH and 2266-PH) TABLE OF CONTENTS Page No. Preface ..... ....... ......................... ....1 Basic Data Sheets .................................................. ii Highlights ....................................................... iv PROGRAM PERFORMANCE AUDIT MEMORANDUM I. BACKGROUND ........ . .................................1 II. FIRST AND SECOND STRUCTURAL ADJUSTMENT OPERATIONS - OBJECTIVES AND DESIGN ........ ................ ........ 2 III. THE PROGRAMS AND THEIR IMPLEMENTATION .................... 4 A. Foreign Trade Policy ..................................... 4 (a) Import Policy ......................................... 4 (b) Export Incentives ................. ............... 6 (c) Exchange Rate Policy ................................ 7 B. Industrial Policy ......................................... 7 (a) Investment Incentives ............................... 7 (b) Restructuring Programs ...... ................. 8 (c) Major Industrial Projects ...................... 9 C. Energy Policy ............9........................ 9 D. Technical Assistance .. ................... ......... 11 E. Summary Assessment of Program Implementation ......... 11 F. IMF Operations . ............................. ...... 12 IV. IMPACT OF THE STRUCTURAL ADJUSTMENT PROGRAM .............. 13 V. ROLE OF THE BANK ................................ ...... 15 A. Disbursement and Procurement ...................... 15 B. Lending Program ............................. ...... 16 C. Economic and Sector Work ...................... 17 D. Organization and Design of the Structural Adjustment Operations .................... ....... 17 VI. CONCLUSIONS AND LESSONS .................................. 19 TABLE OF CONTENTS (continued) Page No. ANNEXES 1 - Letter, Philippine Industrial Development Policy, (August 12, 1980) ............... ...... ....... 22 2 - Review of the Philippines Structural Adjustment Loan, (February 24, 1981) ..................................... 57 3 - Release of Second Tranche of the Philippines Structural Adjustment Loan, (July 20, 1981) ......................... 59 4 - Letter, Structural Adjustment Program, (March 29, 1983) 61 5 - Release of the Second Tranche of the Structural Adjustment Loan to the Philippines, (December 12, 1983) ............. 90 Attachment - Comments from Borrower ..................... .......... 94 PROJECT COMPLETION REPORT SUMMARY AND CONCLUSIONS .......................................... 109 I. INTRODUCTION.............................................. 117 Emergence of Structural Problem .......................... 117 First Structural Adjustment Loan ......................... 120 Second Structural Adjustment Loan ........................ 121 II. IMPLEMENTATION OF THE STRUCTURAL ADJUSTMENT PROGRAM ..... 121 Trade Policy Reforms ..................................... 121 Industrial Incentives and Promotion Policy Reforms ....... 131 Energy Policy and Resource Management .................... 143 Other Aspects of the Program ............................. 148 Evaluation and Conclusions ............................... 151 ANNEX 1: Summary of Performance ... .............................. 155 PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES FIRST AND SECOND STRUCTURAL ADJUSTMENT LOANS (LOANS 1903-PH and 2266-PH) PREFACE This is a performance audit of the Bank's first and second structural adjustment loans (SALs) to the Philippines. The first SAL (Loan 1903-PH, US$200 million) was signed on September 25, 1980 and fully disbursed by September 1981 (except for a small technical assistance component). The second SAL (Loan 2226-PH, US$302.3 million) was signed on April 27, 1983 and fully disbursed on January 5, 1984. Release of the second tranche under SAL I was delayed by five months; no delay occurred in disbursing SAL II. The audit consists of a Program Performance Audit Memorandum (PPAM) prepared by the Operations Evaluation Department (OED) and a Program Completion Report (PCR) prepared by the East Asia and Pacific Regional Office. The PPAM is based on a review of the President's Reports, the Loan Agreements, the summaries of Board Discussions, the PCR, and related documents in the Bank's files. Bank staff associated with the SALs have been interviewed. An OED mission visited the Philippines in November 1984 to review the structural adjustment operations with Government officials. Their valuable assistance is gratefully acknowledged. The draft audit report was subsequently sent to the Borrower for comments. Comments have been received from the Inter-Agency Committee to Monitor and Coordinate the Structural Adjustment Program as well as from the Tariff Commission; they have been reflected in the report and are reproduced as attachme-ts to the PPAM. - ii - PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES FIRST STRUCTURAL ADJUSTMENT LOAN (LOAN 1903-PH) BASIC DATA SHEET (Amounts US$ million) Original Disbursed Cancelled Repaid Outstanding Loan No.: 1903-PH 200.0 199.4 0 0 .6 Original Loan Dates Actual or Re-estimated Initiating Memorandum 08/07/79 /a 06/17/80 Letter of Development Policies - 08/12/80 Negotiations 06/80-07/80 07/03/80 Board Approval 08/80 09/16/80 Loan Agreement - 09/25/80 Effectiveness - 11/14/80 Loan Closing 06/30/85 06/30/85 Actual Completion/Import Component 12/81 09/81 Actual Completion/Tech. Assistance Component 12/84 12/84 CUMULATIVE LOAN DISBURSEMENT FY81 FY82 FY83 FY84 (i) Planned 195.0 196.0 198.0 200.0 (ii) Actual 100.2 196.3 197.7 199.4 /b (iii) (ii) as % of (i) 51.4 100.2 99.8 99.7 MISSION/STAFF INPUT DATA Month/ No. of No. of Staff Date of Year Weeks Persons Weeks /c Report Preparation 11-12/79 4 3 29.8 /d 02/25/80 Appraisal 03-04/80 4 6 54.1 04/15/80 Supervision 01/81 3 4 60.1 03/25/81 Completion 03/84 3 3 20.5 07/ /84 FOLLOW-ON SAL OPERATIONS Second Structural Adjustment Loan (Loan No. 2266-PH) approved on April 26, 1983 in the Amount of US$302.3. /a At this stage the proposed loan was called a Program Loan for Industrial Restructuring. /b The balance of US$373,000 for technical assistance has not yet been disbursed. /c Includes total staffweeks devoted to SAL based on the Time Recording System. /d Underestimates the actual staff input since the preparation of SAL benefited from previous economic and sector work. PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES SECOND STRUCTURAL ADJUSTMENT LOAN (LOAN 2266-PH) BASIC DATA SHEET (Amounts US$ million) Original Disbursed Cancelled Repaid Outstanding Loan No.: 2266-PH 302.3 302.3 0 0 0 Original Loan Dates Actual or Re-estimated Initiating Memorandum 04/09/82 Letter of Developtment Policies - 03/29/83 Negotiations 09/82-10/82 01/28/83 Board Approval 11/82 04/26/83 Loan Agreement - 04/27/83 Effectiveness - 04/28/83 Loan Closing 12/31/84 12/31/84 Actual Completion 05/84 01/05/84 CUMULATIVE LOAN DISBURSEMENT FY83 FY84 (i) Planned 0 302.3 (ii) Actual 74.8 302.3 (iii) (ii) as % of (i) .. 100.0 MISSION/STAFF INPUT DATA Month/ No. of No. of Staff Date of Year Weeks Persons Weeks /b Report Preparation /b /b /b 197.7 /b Appraisal 04-05/82 4 4 129.6 06/04/82 Supervision 10/83 3 6 59.1 11/30/83 Completion 03/81 3 3 20.5 07/-/84 FOLLOW-ON SAL OPERATIONS Third Structural Adjustment Loan of $200.0 million is planned for FY86. /a Includes total staff-weeks devoted to SAL based on the Time Recording System. lb Preparation was undertaken by the following missions: (a) Identification Mission: June-July 1981, 4 weeks, 3 persons, report of August 21, 1981. (b) Preparation/Preappraisal Mivaion: November-December 1981, 4 weeks, 3 persons, report of January 5, 1982. (c) Industrial and Energy Component Preappraisal Missions: February-March 1482, 3 weeks, 4 persons, report of April 8, 1982. - iv - PROGRAM PERFORMANCE AUDIT REPORT PHILIPPINES FIRST AND SECOND STRUCTURAL ADJUSTMENT LOANS (LOANS 1903-PH and 2266-PH) HIGHLIGHTS After a long period of prosperity and growth, the economy of the Philippines faced increasing difficulties during the second half of the 1970s. Between 1978 and 1981, the country's terms of trade fell by some 30 percent. Public expenditure grew rapidly but revenue increased slowly. Large deficits, internal and external, were financed by local and foreign borrowing. The annual rate of inflation rose and with greater external borrowing the debt service ratio increased to more than 20 percent at the beginning of the 1980s. The difficulties were not entirely due to external factors. From the 1950s manufacturing industry had been encouraged by protectionist measures progressively to replace imported products, especially consumer goods, in the domestic market. In time, production approached domestic demand, and there was less scope for further industrial expansion (PPAM, paras. 1-4; PCR, paras. 1.02-1.08). In 1979, industrial policies were reviewed by Bank staff working jointly with Philippines officials. With exports of primary products slowing, rapid growth of manufactured exports was essential. To this end changes were needed in the incentives system. Relatively small investment in labor intensive export industries was expected to have a major effect on employment. The Government was also concerned to fill gaps in the industrial structure, where the initial investment would be large, by promoting such projects in the public sector. Following this review the Government formulated an action program to improve the performance of the industrial sector which became the basis of the first two structural adjustment loans (SALs) to the Philippines. The principal elements of the program were to encourage manufactured exports through a variety of administrative and financial incentives; to improve resource allocation through tariff reform and import liberalization; to facilitate private industrial investment and increase industrial efficiency through restructuring programs; and to reassess the economic viability of public investment in major industrial projects. Under SAL II the program was broadened to improve the efficiency in energy consumption, and to speed up the development of domestic energy resources (PPAM, paras. 7-11; PCR, paras. 1.09-1.20). The structurat adjustment program was complemented by stand-by agreements with the IMF which focussed on correcting external and domestic financial imbalances (MA, paras. 56-57; PCR, para. 2.100). The Borrower carried out most of the program agreed under the two SALS, but not always in the stated time. By the second half of 1983 the country was faced with a major foreign exchange crisis. Emergency measures to stabilize the economy took precedence over structural adjustment reforms. Measures to liberalize imports were replaced for a year by quantitative - v - controls and imports were subject to temporary additional duties. The preoccupation with crisis management also delayed some of the industrial reforms. In the light of the major difficulties facing development in the Philippines, the program itself has been seen to be insufficient. The Government's present approach to stabilization and economic recovery, with support from the IMF stand-by arrangement, suggests that more adequate structural adjustment measures may come to be adopted (PPAM, paras. 13 ff; PCR, paras. 2.104-2.113) During the period 1980-84 the impact of the structural adjustment program on the economy did not reach the expectations expressed by Bank staff when the first loan was presented to the Board. This was primarily due to the economic crisis, but also because improvements in efficiency from structural reforms cannot be expected in the short run. Moreover, by focusing on one or two key sectors the program did not address some key areas of macroeconomic management. These were to be covered by IMF stand-by agreements,1I/ but for a substantial part of the four years no stand-by was in operation (LPAM, paras. 59-66). Four years of structural adjustment lending leads to lessons which may be relevant for future SALs in the Philippines or elsewhere: (a) The program should be the country's own to which the Government is firmly committed with the Bank providing support if it addresses key structural issues and appears to be clearly feasible; (b) 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 stand-by arrangements; (c) Benefits in the form of improvements in the economy and its management may be realized only over a term of years and as time goes on further structural changes may be required. Both the Bank and the Borrower would wish to build on these achievements and should be concerned that they be maintained; and (d) Structural adjustment lending calls, therefore; for a close working relationship between the Borrower and the Bank. Whether further lending of this kind is contemplated or not, SALs should include arrangements for the Borrower and the Bank to continue to review progress regularly after the program has been completed. 1/ The Region's view is that only the exchange rate issue was left exclusively to the IMF. - 1 - PROGRWM PERFORMANCE AUDIT MEMORANDUM PHILIPPINES FIRST AND SECOND STRUCTURAL ADJUSTMENT LOANS (LOANS 1903-PH and 2266-PH) I. BACKGROUND 1. Over the twenty years from 1960 to 1980, output of goods and services in the Philippines expanded rapidly. GDP at constant prices rose on average by more than 5 percent per annum, agriculture expanding by more than 4 percent, and manufacturing by nearly 7 percent. Exports more than doubled in volume. At the beginning of the period, exports consisted almost entirely of primary products; by 1980 a third of exports in value were manufactured goods. 2. The growth of output was sufficient to provide a substantial increase in average income per capita, even though the population was growing rapidly. GNP per capita increased at an annual rate of 2.8 percent, but the distribution of income was highly skewed, those in the top income groups having a high proportion of total household income. 3. Developments in the 1970's were generally less favorable than in the previous ten years. The quadrupling of the price of oil, the country's largest import, at the end of 1973 was a major shock to the balance of pay- ments, but was eased by favorable prices for Philippines primary exports. The second increase in 1979 was followed by a slowing down in activity in industrial countries and consequently lower prices of Philippines exports, especially of primary commodities. Between 1978 and 1981, the country's terms of trade fell by some 30 percent. During the second half of the the 1970's the role of the public sector in the economy, which had been small, was expanding rapidly to provide for basic infrastructure and improve social services. At the end of the decade expenditure continued to grow rapidly but revenue increased slowly. Large deficits were financed by local and foreign borrowing. The annual rate of inflation rose after 1978, and with greater external borrowing the debt service ratio rose to more than 20 percent at the beginning of the 1980's. 4. The Philippines' difficulties, which were to become greater as the external deficit deepened, were not entirely due to external factors. From the 1950s manufacturing industry had been encouraged by protectionist measures progressively to replace imported products, especially consumer goods, in the d-mestic market. In time, production approached domestic demand, and measures were taken to encourage exports of manufactures. The Board of Investments (B01) was set up to speed up industrialization, admin- istering special incentives for approved purposes and a separate export processing zone was established. For most of the 1970s industrial employment and exports grew rapidly. - 2 - 5. The Development Plan, 1978-82, set out four principal objectives: (a) to speed up the rate of growth; (b) to provide productive employment for the rapidly growing labor force; (c) to meet the basic needs of the people; and (d) to reduce social, regional and economic disparities. 6. The industrial strategy called for further processing of domestic raw materials, accelerated employment generation by small and medium scale industries and selected large scale projects. The projected balance of payments current account deficit was to be kept to a manageable size by vari- ous measures, which included aggressive export expansion and domestic energy developments. 7. In 1979, industrial policies were reviewed by a Bank mission work- ing jointly with Philippines officials. With exports of primary products slowing, rapid growth of manufactured exports was essential. To this end changes were needed in the incentives system. Relatively small investment in labor intensive export industries would have a major effect on employment. The Government was also concerned to remove major gaps in the industrial structure, where the initial investment would be large, by promoting such projects in the public sector. 8. In the light of the objectives of the development plan, and the review of industrial policies, the Goverment formulated a program of measures to improve the performance of the indu--trial sector. This was set out in the letter of August 12, 1980 from the Minister of Financel/-hereafter called the Structural Adjustment Program (SAP). But by then the economic situation had deteriorated, especially due to the 1979 increase in the price of oil. The SAP was therefore influenced by conditions less favorable than foreseen when the Plan was prepared and industrial policy reviewed (PCR, paras. 1.02- 1.08). II. FIRST AND SECOND STRUCTURAL ADJUSTMENT OPERATIONS OBJECTIVES AND DESIGN 9. To support the SAP the Bank provided a loan (1903 PH) of US$200 million equivalent (SAL I) in September 1980. The principal elements in the SAP were: 1/ Annex 1. - 3 - (a) Import Policy. To allocate scarce resources to industries where the Philippines was competitive, imports would be liberalized and the tariff structure revised in a series of steps phased over a number of years. To cushion the effect on revenue and the balance of payments, excise and sales taxes would, if necessary, be increased. (b) To Encourage Manufactured Exports, administrative procedure would be streamlined and export industries given all reasonable forms of support. (c) Investment Incentives and Administration. The administration of incentives for industrial investment would be simplified and criteria for the provision of incentives changed to give greater emphasis to labor intensive industry. Restructuring programs would be prepared to make existing industries more efficient. (d) A program of Major Industrial Projects to accelerate industrial development would be phased over five years because of the coun- try's limited resources, each project being undertaken only after economic and financial viability had been established. 10. In 1982, Bank staff found that despite the international recession and the ensuing domestic economic difficulties, implementation of the program had been good and a second operation was prepared. The program was supported by a loan (2266-PH) of US$302.25 million equivalent (SAL II), which was signed in April 1983. 11. In his letter of March 29, 1983, "Structural Adjustment Program of the Philippines",2/ the Minister of Finance had reviewed progress with the SAP and had outlined measures to be taken under the second SAL. The SAP was still focused on industrial and trade policies. The industrial incentive system was to be further strengthened by removing the capital cheapening effects of the old system and the bias against export industries, making incentives neutral with respect to factor choice. In addition, improvements in energy policy were to be made to speed up development of domestic energy resources and strengthen energy demand management. The SAP included specific steps to raise power prices and to make adjustments for increases in fuel costs (PCR, paras. 1.09-1.19). 12. In 1980 when SAL I was approved an IMF standby arrangement was in operation. The IMF program focused on adjustments to monetary, fiscal, external debt and balance o' payments policies. The Fund and Bank programs thus complemented each otuer with the Fund program covering areas of macroeconomic policy. 2/ Annex 4. -4- III. THE PROGRAMS AND THEIR IMPLEMENTATION A. Foreign Trade Policy (a) Import Policy 13. In 1980 the Government introduced a phased plan to liberalize imports and to change the structure of the customs tariff. Internal taxes were to be adjusted and other action taken to offset any adverse short term effect the program might have on revenue and the balance of payments. 14. Liberalization of Imports. Import control through licensing, applied sometimes to all imports for balance of payments purposes and more often to specific goods to protect local production, has been a long standing feature of economic management in the Philippines. The SAP, started in 1980, envisaged removing import licensing over the following three ye.-s from about 1,000 items classified as "non-essential" and "unclassified" consumer goods. These items were liberalized in the first quarter of the years 1981, 1982 and 1983 in the numbers specified in the Program, with the exception that 48 items instead of 87 were liberalized in March 1983 in response to representa- tions from local industries which would have been affected. 15. For liberalized items, however, commercial banks were required to report to the Central Bank all letters of credit opened and obtain prior clearance from the Central Bank to issue release certificates of the goods imported and some of the items which were liberalized were controlled once again. 16. During 1984 and 1985, the second phase of the SAP included removal of import licensing from the remaining 237 non-essential and unclassified items of consumer goods not covered by the 1980 program. Import licensing was, however, to be retained for 145 items, primarily to safeguard national security, public health and safety. In addition, the SAP included a plan for the liberalization of "regulated" items which was subsequently issued (under Monetary Board Resolution 702) as a condition for the release of the second tranche of SAL I. 17. In the event, before the first 16 items were due to be liberalized at the beginning of 1984, the foreign exchange position became so weak that control was extended to all imports. From October 17, 1983, all imports were made subject to approval by the Central Bank and a moratorium imposed on repayment of principal on most of the external debt. 18. On October 15, 1984, at the time of negotiations with the IMF of a series of reconstruction measures to be supported by a standby agreement, exchange control was in general removed from imports and importers could seek foreign exchange directly from commercial banks. For items liberalized in the first phase of the SAP once again no import license was required. 19. Many imports, however, are still regulated by individual government agencies. Imports such as vehicle assembly parts, continue to be confined to registered participants in special government programs and are subject to authorization by the Board of Investments (BOI). 20. In addition there is a list of "banned imports" and a "prohibited list". Import requires Central Bank approval which, for "banned imports", may be granted for inputs for export oriented firms registered with the government agency for the particular industry (such as the BOI and the Export Processing Zone Authority). 21. The Minister of Finance had stated (letter of August 12, 1980, para. 12) that the phased plan for liberalizing imports would also include "regulated" items. In a plan that was issued in 1981, twelve groups of regulated items out of 36 were given specific liberalization dates covering the period to 1985. No action, however, was taken before the foreign exchange crisis. The Government has recently announced its intention to liberalize "import licensing requirements when economic conditions permit" and four regulated items have now been liberalized.3/ 22. Tariff Reform. Since independence, and especially during the twenty years from 1960, manufacturing industry had been developed protected not only by import control but also by high customs tariffs. A duty of 100 percent applied to more than 200 tariff items out of a total of 1,300. To "allocate scarce resources more rationally to industries where the Philippines is competitive", the Government in 1980 embarked on a five year program of tariff reform as part of the structural adjustment policy which stressed the developmdnt of exports, efficiency and competitiveness. 23. The average tariff was to be reduced from 43 percent to 28 percent, the maximum rate was to be 50 percent and the minimum 10 percent. The tariff structure provided for rates up to 20 percent for raw materials, 20-30 per- cent for intermediate goods, 20-30 percent for capital equipment and producer goods, and 40-50 percent for consumer goods. 24. The program for 1981 and 1982, set out in the Letter of Development Policy for SAL I, for the reduction of peak tariff rates was carried out, but an additional duty of 3 percent ad valorem was applied to all imports from December 1982 as a temporary revenue measure under the IMF agreement. 25. The SAP for SAL II mentioned that a minimum rate of 10 percent "basically as a reference measure" had been established as a guideline for revising minimum rates. Existing tariffs below 10 percent would be reviewed after the tariff reform program had been completed in 1985. The reduction of maximum tariff rates continued in 1983 and at the beginning of 1984 only 133 3/ The Borrower states that the implementation of the trade liberalization of "non essential" "unclassified" items has been reduced and that a new timetable for liberalizaing 17 regulated commodity groups has recently been approved. - 6 - tariff lines remained with rates exceeding 50 percent, the maximum rate being 60 percent. 26. The general additional duty had, however, been raised from 3 per- cent to 5 percent in 1983 and to 8 percent and 10 percent in March and June 1984 as part of the measures taken during the balance of payments crisis. From October 15, 1984 the additional duty was reduced to 5 percent for petroleum products and beginning January 1, 1985 for all other products; and the Government stated it intended to remove al additional duty as soon as the budgetary situation permitted. 27. At the beginning of 1985 therefore, the five year tariff reform program for the years 1981-85 had been completed. Although since the beginning of 1981, rates on a few goods have been raised for protective purposes, effective protection rates have on average been lowered and the nominal tariff range has been narrowed (PCR, paras. 2.01 ff). 28. Sales Taxes. Not only has local production been protected by custom tariffs and import controls, but the sales tax also taxed imports "at rates higher than those imposed on similar goods of domestic or gin." In the SAP for SAL II in March 19b3 the Minister of Finance stated that a uniform markup had been adopted in the imposition of the advance sales tax--paid on imports when cleared by customs rather than when sold. This was an interim measure, prior to phasing out the advance sales tax, instituting a second stage value added tax and unifying tax rates by January 1, 1985. Differen- tial specific tax rates would also be removed by the same date. 29. Specific tax rates have been aligned. Abolition of the advance sales tax is now intended during 1985. In the meantime the situation remains that Imported goods are taxed at the uniform rate of 25 percent on a valua- tion consisting of the customs value plus the customs duty. Domestically produced goods are valued at the gross selling price; and are taxed at rates varying from 5 percent to 50 percent. Agricultural products are taxed on sale at different rates, imported at 10 percent and domestic at 1 percent respectively (PCR, paras. 2.23-2.27). (b) Export Incentives 30. As part of the program for SAL I, exports were to be supported by simplifying administrative procedures for conducting foreign trade. Standard costings/allowances for tax credit/duty drawback on imported inputs of export industries were to be introduced to carry out more easily the policy of duty- free import by export industries. Some improvement was made but simplified procedure for processing drawback claims was still being considered in 1984.4/ 4/ The Borrower states that since then procedures for processing duty drawback claims have been simplified. - 7 - 31. Production solely for export has been encouraged by establishing export processing zones. The number of such zones has been increased from 3 to 5. Various arrangements have been made for promoting exports including trade missions and fairs, and export guarantee arrangements have been made for small and medium scale industries (PCR, paras. 2.18-2.22). (c) Exchange Rate Policy 32. The 1980 letter stated that a flexible exchange rate policy would be followed allowing the rate to reflect basic economic forces. Official intervention would be limited to preventing disorderly fluctuations. In 1983 the intention to maintain a flexible exchange rate policy was reiterated. From the end of 1978 to the end of 1982 the exchange rate depreciated from P 7.4 to P 9.2 per US$. Over that period external reserves fell and consumer prices rose more rapidly than the exchange rate declined. When the full force of the balance of payments crisis was felt in the second half of 1983, overall exchange control and an external debt payments moratorium were imposed. As preparations were made to open up external transactions to market forces, the dollar rate moved down to nearly P 20 toward the end of 1984. In October of that year commercial banks were allowed to retain and issue foreign exchange they received. A system of floating exchange rates has been operating since December 1984. B. Industrial Policy 33. Soon after independence, import controls and protective tariffs were introduced to encourage industries serving the home market to develop. Manufacturing industries, especially those producing consumer goods, expanded rapidly. By the 1960's, however, production came to be limited by the size of the domestic market and output expanded at 5 percent per annum as compared with 12 percent in the 1950's. 34. In 1967, at a time of balance of payments crisis, it was decided that changes in policy were required to speed up the expansion of output and employment and to avoid recurrence of severe balance of payments difficul- ties. Industry needed to become more efficient and output more directed to exports (PCR, paras. 2.29 ff). (a) Investment Incentives 35. To this end a government agency, the Board of Investments (BOI) was set up with the task of "accelerating the economic development of the country by restructuring its industrial pattern". It administers legislation provid- ing tax incentives for industrial and agricultural investment, to develop exports and for foreign investors. The BOI also regulates many industrial imports and grants foreign firms registered for incentives the right to employ foreign nationals. The tax incentives consist of deductions from Jirect tax obligations, exemption or reduction of duty on imported capital equipment and, for export products, a special tax credit for taxes paid on materials used in their manufacture. Some enterprises are given long holidays from direct taxation, others may be given tariff protection. - 8 - 36. The package of incentives for registered firms depends on the BOI's assessment of the benefits to be derived from the particular kind of produc- tion involved. To this end the BOI draws up annual priority lists of the projects it will encourage the private sector to undertake, classifying them as pioneer or non-pioneer. Pioneer projects, to manufacture products not previously produced in the Philippines or using new processes, are given more incentives than non-pioneer. 37. The BOI has thus, for nearly twenty years, been influencing the direction of industrial investment and the profits of individual firms. Despice the intervention of the BOI and the growth of labor intensive non-traditional exports, the performance of manufacturing as a whole in the 1970s was not regarded as adequate. The sector accounted for a quarter of GDP but output expanded on average by 6.5 percent and employment as a propor- tion of total employment at 10-12 percent had remained almost unchanged for nearly twenty years, and was concentrated in the Manila area. Imports by manufacturers still greatly exceeded exports. 38. To encourage industries in which the Philippines had a comparative advantage, to increase employment more rapidly and to develop industry out- side metro Manila, the SAP for SAL I stated that priority would be given to labor intensive industry and additional incentives provided for industries setting up in specific "less developed" areas. 39. To promote competition, the number of "overcrowded industries" in which investment was discouraged was reduced from 38 to 9, and determining priority by reference to the "measured capacity" of the industry was discon- tinued for the food processing industry. To help existing industries to become more efficient, restructuring programs would be prepared, industry by industry, starting with the cement and textile industries. Finally, steps were to be taken to make BOI itself more efficient and to reduce the time it took to respond to applications. None of this was given a fixed time limit. 40. The program for SAL II was similar, but government intervention would turn from regulation to removing impediments to export production, employment generation, and regional dispersion of industries. In 1983 a new Investment Incentives Policy Act was implemented. The BOI introduced simpler application forms and adopted new guidelines for determining investment priority, including the economic rate of return. (b) Restructuring Programs 41. P.aparation of restructuring programs designed to help individual industries to become more efficient has become an important activity of the BOI. Firms in such industries may be given fiscal incentives and financial assistance, training for key staff and technical help. Programs have been prepared for the cement and textile industries, food processing and electron- ics. These programs represent a major effort to rehabilitate industry and can be costly. Technical assistance alone for the textile industry work drew more than $1 million from SAL I. - 9 - 42. Apart from incentives enjoyed by firms registered with the BOI, other private firms and government corporations received import duty and income tax concessions. These incentives, as intended in the SAP for SAL II, were reviewed and then in 1984 withdrawn both to raise revenue and to ratio- nalize the incentives system. In removing them, however, the possibility of restoring them in certain circumstances was envisaged. (c) Major Industrial Projects 43. The development of manufacturing had, over the years, been by privately-owned firms guided or regulated by government tax concessions, pro- tective tariffs and import controls, and assisted by financial institutions some of which came to be government owned. In 1979, however, as part of its efforts to speed up industrial development, 11 large projects, with long con- struction periods, considered unlikely to be undertaken by the private sector, were initiated by the government. The capital cost of the projects was great, some of them costing $1 billion or more, and in the SAP for SAL I it was stated that, in view of the demands on the Philippines limited resources, they would be phased over five years and wherever possible financ- ed from abroad. They would go ahead only after they bad been found viable. 44. Progress made with the projects is as follows: Copper Smelter - In operation Diesel Engine Plant - Privately owned enterprise in operation producing small diesel engines Phosphate Fertilizer Plant - Going into operation Coconut Chemicals Plant - Proceeding as partly private project Integrated Steel Mill - Held up by shortage of funds Heavy Engineering Works - Held by shortage of funds Other Projects - Aluminum smelter, pulp and paper mill, large diesel engine plant, petrochemical complex and also gas project have been deferred or abandoned. The last project, the conversion of privately-owned cement works from oil to coal, has been proceeding with some financial assistance from the Govern- ment. Reflecting the state of progress with projects which have been under- taken, budgetary appropriations for government participation in the major projects have fallen from P 391 million in 1984 to P 130 million in the 1985 budget. C. Energy Policy 45. Energy policy was not mentioned in SAL I but figures prominently in the measures undertaken for SAL II. The SAP states that the country needed - 10 - to reduce its dependence on imported oil, which provided about three-quarters of commercial energy requirements in 1981. 46. Before the quadrupling of crude oil prices at the beginning of 1974, oil imports amounted to 12 percent of imports in value. In 1979 they amounted to 22 percent and in 1980, after the second major increase in OPEC prices, to 29 percent of imports in value. In the meantime, restrained by measures to raise prices and to encourage the use of local sources of energy, imports of petroleum and petroleum production in volume had risen slowly from 75 million barrels in 1973 to 85 million barrels in 1980 and has since fallen. 47. At the beginning of 1983 policies for the development of the energy sector in the 1980s were outlined. These consisted of a program to speed up substitution of power generation using oil by coal, geothermal and hydro- power, adjusting power prices to provide a "reasonable level of self financ- ing" by the National Power Corporation (NPC) and reducing "subsidies among electricity consumers" in Metro Manila. Specifically the SAP for SAL II provided for: (a) Phasing out of budgetary subsidies for the NPC by 1986. In 1983 budgetary payments amounted to P 1.1 billion, in 1984 P 0.7 billion and the 1985 budget provided for P 0.4 billion. (b) NPC to cover its costs by raising charges over and above increases to cover higher fuel costs. From July 1982 wholesale power rates would be raised by P 0.0075 per kwh each quarter for seven succes- sive quarters. This was done, the last increase in this program being made in January 1984. Rates were also raised in both 1983 and 1984 to reflect increases in fuel oil, diesel oil, and coal prices and other peso costs increased by peso devaluation. All told over the whole period, NPC's charges have risen faster than internal inflation. (c) Introduction of restructured tariffs for Metro Manila retroactive to 1981, raising charges to all but the smallest domestic consumers and small commercial consumers relative to larger consumers. Action was held up by the Supreme Court until March 1984. Rates were increased n December 1984 and the restructured tariffs are now expected to be introduced during 1985. (d) Price changes to pass on to consumers increases in the peso cost of petroleum products and to reduce major differentials among them. Starting with July 1983, prices were increased 5 times up to the end of October 1984, raising the price of regular gasoline by about 70 percent. 48. After the increase in oil prices due to the floating of the peso in October 1984 has been reflected in power prices, the next factor affecting power prices may be the effect of the long delayed nuclear power plant coming into production. The decision to construct this 600 MW plant was taken - 11 - following the quadrupling of oil prices in 1974 to reduce the dependence of the country's power supplies on imported oil. The plant has proved to be extremely costly (about $3,000 per KW installed), but with interest capitalized during construction the Philippines has yet to carry the burden of servicing the external loans raised for the project (PCR, paras. 2.73 ff). D. Technical Assistance 49. $5 million from SAL I was provided for technical assistance, principally to finance consultants atd training programs. By May 15, 1984 $4.4 million had been disbursed as follows: $ thousands Tariff Reform Program 621 Petroleum Product Pricing 273 National Census and Statistics Office 27 National Tax Research Center 114 Export Development 642 Ministry of Trade and Industry 2,769 4,446 50. Half of the amount provided to the BOI was spent on studies of four industries--the food processing, metal working, textile and semi- conductor industries. One million U.S. dollars of this was spent on foreign and local consultants and the remainder mostly on staff training abroad (PCR, paras. 2.89-2.93). E. Summary Assessment of Program Implementation 51. The Borrower carried out most of the program in the two SAPs, but not all of it, where a time was specified, in the stated time. When progress was reviewed in terms of Schedule 1, para. 3(c) of the Loan Agreement for SAL I, it was found to be less than expected. There had been delays both in tariff reform and in removing import restrictions on specific items.5/ Release of the second tranche of the loan was accordingly delayed about five months to June 1981. 52. Emergency measures to meet the foreign exchange crisis effectively held up for a year from October 1983 the process of import liberalization. A smaller number of items than programmed had also been liberalized in the first quarter of 1983 to maintain protection, and the program to reduce tariffs was affected by the imposition of the emergency surcharge. The Bank 5/ The Borrower points out that "there has been no delay in the tariff reform program since from 1981 to the beginning of 1985 it proceeded as scheduled. The last and final phase of the tariff reform is now in place. However, because of the need for additional revenue, the Government had imposed a temporary across-the-board additional duty in October 1983. This additional duty have affected to some small degree programmed decline of the absolute tariff levels but have not reversed the scheduled program." - 12 - regarded the emergency measures as essential to stabilizing the economy and released the second tranche of SAL II. Although control over all imports by the Central Bank was removed in October 1984, this action was not accompanied by further liberalization measures. The Government has recently stated that it remains committed to the liberalization program. With many imports regulated" for one reason or another and little action taken to liberalize them, the list of items to be liberalized was of limited significance. Apart from the surcharges from December 1982, tariff reform has proceeded systemat- ically and is more or less on schedule. 53. At the time of Audit, at the end of 1984, most of the program for energy had been carried out, but the realignment of indirect taxes and the measures to encourage exports had not yet been comtleted. Exchange rate policy was merely expressed in broad terms in the SAP._/ 54. The other important area in the structural adjustment program covers industrial policy. The program for investment incentives, improvement in the administration and rehabilitation of specific industries was partly carried out. Elsewhere in the program, the $5 million for technical assis- tance has been committed but not yet fully disbursed. The funds have gone mostly to the BO. 55. To coordinate implementation of the program and to monitor its effects, the Government, at the beginning of 1983, set up a standing commit- tee of all the ministries and agencies involved. The committee is chaired by the National Economic Development Authority which provides the secretariat. Information which the Committee provided for the Audit indicated that it had closely monitored progress. F. IMF Operations 56. In February 1980, the Executive Board of the IMF approved a standby arrangement for the Philippines for a period of two years. It provided for a total amount of SDR 410 million, of which SDR 77 million was from ordinary resources and SDR 333 million was from the Supplementary Financing Facility. The entire amount was drawn. The standby arrangement was formulated in the wake of the second round of oil price increases, to correct a pronounced rise in inflation and contain the current account deficit, while maintaining the rate of real growth. To these ends, the authorities agreed to pursue tight monetary and fiscal policies and reforms in the financial and external sectors, as well as adjustments in administered prices, particularly for energy products. Several of the original targets of the program were modified during the course of the standby, partly on account of exogenous developments. Although certain program targets were not attained, fiscal and monetary policies were within the program parameters. The overall balance of payments deficit was, however, higher than envisaged at the time of the mid-term review. There was also some slippage in budgetary performance. 6/ The region notes that exchange rate issues were not addressed directly since this topic fell under the jurisdiction of the IMF. - 13 - 57. The economic situation deteriorated substantially in 1982, a year in which there was no program with the Fund. The Philippines authorities continued expansionary financial policies in the expectation that a world recovery would boost export earnings and limit the current account deficit. However, the international recession deepened, export growth slackened, and international interest rates remained high. In February 1983, the IMF concluded a further standby arrangement with the Philippines for SDR 315 million. The principal performance objectives of the program were to limit the overall balance of payments deficit to US$600 million in 1983, without a further expansion of short-term external debt. It was to be achieved through restrained domestic financial policies; curtailment of the public enterprise investment program; and the adoption of a flexible exchange rate policy. The Philippines did not however meet the quantitative performance targets set for the program. Hence, only two purchases totalling SDR 100 million were made. 58. For a substantial part of the four years from SAL I becoming effective until the Audit of SAL I and SAL II at the end of 1984, therefore, no stand-by arrangement was operative. The IMF and the Bank are working closely together in assisting the borrower to stabilize the economy and to provide a firm base for further development (PCR, para. 2.100). Experience during the last four years, however, shows that in considering conditions for structural adjustment lending, it is not enough for the Bank to leave matters of central economic and financial management to be covered by the IMF in possible stand-by arrangements (see para. 77 below).7/ IV. IMPACT OF THE STRUCTURAL ADJUSTMENT PROGRAM 59. When the SAL I program was submitted to the Board, the structural adjustment strategy was expected by the Bank staff to have a positive impact on growth, especially on manufacturing, on the balance of payments, and on external debt service in the 1980s. Three years later, in the light of the difficulties then known to be facing the country, lower growth rates were projected for SAL II. Nevertheless, the balance cf payments deficit was expected to decline rapidly, and external debt service payments, though larger than previously foreseen, were expected to remain manageable. Projec- tions made by the staff for some key indicators follow: 7/ The only macroeconomic aspect left for the IHF to cover was the exchange rate policy. Public resource management and resource mobilization were issues not addressed under the SAL because the government was not willing to go into them at the time. - 14 - Growth Percent at Constant Prices Actual SAL I SAL II Actual 1976-80 1980-85 1981-85 1980-83 Annual Average GDP (Market Prices) 5.9 6.4 3.4 2.6 Manufacturing 6.5 8.0 4.2 2.6 Exports 10.0 10.7 5.2 0.5 (goods) Imports 8.0 6.6 2.1 0.2 (goods) End of Period Balance of Payments Deficit 6.8 4.4 4.0 8.0 (percentage of GDP) MLT Debt Service Ratio (percent) 16.6 21.2 25.6 36.5 /a /a Reference is to 1982. Moratorium imposed from October 1983. Source: President's Reports SAL I and SAL II 60. Projections are also given in both reports for the economy without structural adjustment. In these conditions, growth generally would be restricted by balance of payments and creditworthiness constraints and by lower growth of manufacturing, because it would be producing at high cost for the limited domestic market. Export growth would be lower but propensity to import industrial imports and energy would be greater. "The debt service ratio would rise to over 30 percent and limit further borrowing" (SAL II, President's Report, para. 119). 61. Unfortunately the political and economic situation in 1983-84 has been one in which growth has been restricted by -balance of payments and creditworthiness constraints" foreseen without structural adjustment. As the table shows growth has been below expectations and even in 1982, the current balance of payments deficit was larger and the debt service ratio had risen to 37%. Apart from energy-where SAL II provided for price changes to continue to reflect fully changes in the peso cost of imported oil, and where other steps, including the nuclear plant, have been taken since 1974 to reduce dependence on imported oil-it is hard to see sufficient linkage between the measures in SAL I and SAL II and the projections (PCR, paras. 2.107-2.113). 62. This partly is a matter of timing. The SAL II report recognized that in the short term restrictive demand management would be needed to reduce the balance of payments deficit, and that improvements in efficiency from structural reforms so far made would take several years. It also refers to the difficulties in estimating their effect on the economy. Neither the size nor the timing of the long term benefits--and of the transitional disturbance-could be predicted with certainty, but they were estimated to be considerable. 63. Some of the measures are not defined precisely, thus complicating the task of assessing the potential benefit. Others represent merely a start with reforms and much will depend on future action to apply them generally. - 15 - The program to liberalize import control, for example, left a sulstantial share of imports untouched.8/ Were it to be adopted as a general -iolicy and applied expeditiously to imports, which are regulated, restricted or controlled in various ways, so that customs tariffs alone influenced impzrts, the effect should be considerable. In such circumstances, much woil. depend on the extent to which duties actually applied varied from the published tariff (for example in the form of concessions administered by the BOI). 64. Even if the action to be taken in every element of the structural adjustment program had been both clear and precise the actual behavior of the major economic indicators, taking external influences as given, could not have been fully attributed to the program. Many important factors which would affect economic performance are not to be found in the SAP. Key central instruments of economic policy were not included or were assumed to be covered by IMF stand-by agreements. These covered only a minor part of the first four years of the program (see para. 58 above). 65. In fact the period so far has been taken up by the approaching external liquidity crisis and attempts to stave it off, followed by the debt service moratorium, tight control Gver foreign exchange transactions, prepa- ration of stabilization measures and now by the present stage of establishing a sound basis for recovery and renewed expansion. For the next few years the measures outlined in the SAP are likely to be less important in determining economic performance than central resource management. V. ROLE OF THE BANK 66. The Bank supported the structural adjustment process not only by the two loans which being fast disbursing provided foreign exchange quickly when it was extremely short, but also by other program and project lending. It supplied technical assistance, especially for the BOI under SAL I and Bank staff often provided assistance while working closely with the Borrower. A. Disbursement and Procurement 67. The two loans were disbursed quickly with the exception of the $5 million technical assistance element in the first loan. Release of the second tranche under SAL I was delayed five months,9/ but $195 million equivalent to finance industrial imports was fully disburued by September 1981, less than one year after the loan became effective. The second loan of $302.3 million equivalent (4 percent of 1983 imports) was fully disbursed by January 1984, less than eight months after it became effective. The review made in terms of the loan agreement found progress in carrying out the SAL II 8/ The region notes that the import liberalization program left less than 10% of imports restrictions untouched. 9/ Annexes 2 and 3. - 16 - The second loan was completed in May 1984 in accordance with the originallO/ schedule. No procurement difficulties were encountered with the import component of either loan (PCR, paras. 2.94-2.97). B. Lending Program 68. On March 31, 1984, fifty-three Bank/IDA Loans/Credits to the Philippines totalling some $2,700 million were being disbursed, the undis- bursed balance was some $1,200 million. Only three of the projects (for rural infrastructure, city water supply and population) were financed by IDA credits which amounted to $90 million. From 1980-84, structural adjustment lending became the focus of the Bank's operations, but the flow of funds from project lending was larger. Disbursement has, however, been proceeding more slowly than envisaged when the loans were approved. Eleven of the twenty- three projects completed in 1980-84 were closed two years or more beyond the original closing date. Nevertheless total disbursements amounted to $1,615 million during the four fiscal years 1980-84 (including $497 million in imports financed by SAL I and SAL II). 69. Project lending at present covezs all of the major sectors. It is heavily concentrated in agriculture, fishing and rural development (21 opera- tions), but also includes industry, energy, transport, education, urban development, water sup?ly, sanitation and population. Therefore, it goes to the sectors addressed by the structural adjustment program and beyond. Project and structural adjustment lending should thus be mutually reinforc- ing, project lending concerning itself with financing needed for specific investment in the sectors and structural adjustment with central economic policy, sector policies and institutional development. 70. This would seem to have been the case in energy, since 1983 in terms of SAL II, but more so in industry. Indeed SAL I was originally planned as an industrial sector loan, but the measures affecting external trade and government revenue went beyond the industrial sector. SAL I was followed by two large loans to the industrial sector, the Industrial Finance (APEX) loan of $150 million in 1981 and the Textile Sector Restructuring Loan of $157.4 million in 1982. Disbursements if those loans has been less than expected. One of the financial institutions involved, the Development Bank of the Philippines, ran into major difficulties and, with another state bank, the Philippines National Bank, is now the subject of rehabilitation mea- sures. The textile industry was one of the first industries to be examined by the BOI as part of its restructuring program. Firms about to undertake measures needed for efficient development are helped by public sector finance as well as technical assistance. The number of investment proposals from individual firms has been much smaller than expected due to the weak state of the textile market. 71. The SAP did not include measures in the agriculture sector. The President's Report for SAL II, however, pointed to three major issues-the need to raise agricultural exports, the fact that economic policies had 10/ Annex 5. - 17 - reduced agricultural income, and the unsatisfactory institutional framework for formulating and executing agricultural policy. A review of the institu- tional framework was included in a list of studies being considered by the Government. Policies in these three areas have appeared in other SAPs, but for the Philippines in 1984 the Bank (instead of a SAL), made a program loan of $150 million to provide foreign exchange to import agricultural inputs, the Borrower undertaking a program to promote agricultural development. It was intended in part "to help to mitigate" the critical financial situation confronting the Philippine economy (President's Report P-3850-PH, para. 630), and was part of the Bank's Special Action Program. C. Economic and Sector Work 72. During the years 1978-83, major studies of the industrial, finan- cial, and energy sectors provided an analytical basis for the two structural adjustment operations and for other lending to these sectors. Since the first SAL was made, progress with the SAP has been reviewed in terms of the loan conditions and detailed studies have been made of individual industries for the industrial restructuring program. More recently studies of external debt and public expenditure have been related more to recovery from the present economic crisis that to the SAP. A study of agricultural pricing was reflected in the policy changes associated with the agricultural inputs loan. Country economic memoranda were produced in 1982 and 1984. 73. The program of economic and sector work for the present fiscal year includes studies to obtain a closer understanding of elements in the SAP (trade liberalization), continued review of progress with the SAP, and studies of public investment. In addition, Bank staff will be cooperating with IMF staff in reviawing progress in the light of the new (December 1984) stand-by arrangement. D. Organization and Design of the Structural Adjustment Operations 74. The program of Bank staff working on the Philippines is decided in Washington, and the staff are based there. Work on SAL I and II has been regarded as part of the normal tasks of the Program Division. There is no resident mission, and during the last six years there have been many visits to the Philippines from the initial preparation for SAL I (as a program loan for industrial restructuring) early in 1979 to the present time when only the technical assistance element has not been completed. 75. During the two years 1983/84, staff changes brought almost a completely new team to work on the Philippines (other than the Projects Department). While some staff provided continuity to work on SALS, other staff with little direct experience of the Philippines replaced those who had worked with the Borrower for several years. Thus, there was a learning period for the new staff-but the changes also provided the opportunity to take stock of the Bank's program and, as it happened, at a time of major - 18 - economic difficulties and political uncertainty.11/ As noted above the staff looked closely at some aspects of the SAP, but also at central economic issues and the help the Bank might provide in promoting recovery. 76. Leaving the present economic situation on one side for the moment and confining attention to staff work on structural adjustment operations, there is the question of what the role of the staif should be. To begin with, the Bank needs to be clear on what the Government intends to do, what its structural adjustment strategy consist of and how much importance it attaches to each element in the program. The staff can then judge to what extent, in the light of limiting factors such as administrative capacity and the economic climate, the program may be suitable and likely to be achieved. 77. While the direction of government policies may meet the Bank's criteria for structural adjustment lending, the measures to carry them out may be inadequate. Tariff reform and import liberal.ization were major areas where the Government intended to take action to promote industrial development. The program of import liberalization, year by year, where it was specific, even if carried out fully and sustained, would have left restrictions applying to a substantial share of total imports in value.12/ Similarly, the SAL II President's Report found the "incentive system a major cause of inefficient use of capital, low labor absorption and regional concentration of manufacturing" and the BOI exercising -excessive control over private investment decisions by effectively regulating entry into industry" (President's Report P-3389-PH, para. 36). Changes in the incentives system in the program for SAL II still left the BOI with a major role in investment decisions. 78. Even if the measures intended for each element in the SAP had been sufficient, there would remain the question of whether the program covered key factors that would determine structural change and development in the Philippines. That the first four years of the SAP and the deepest economic crises since independence coincided suggests that it did not. The tendency has been to attribute the crisis to external factors--the recession of 1981/82 following the second major increase in oil prices. The effect of the major deterioration in the terms of trade was severe, as it was in other oil importing primary commodity exporting countries. It has been recognized, however, that in the Philippines there are major weaknesses in public sector resotrce management and public financial institutions. The Bank has recently stated that the Government will need -to address structural issues in public finance" (World Bank News, January 24, 1985). 79. Structural change can be expected to take time to achieve and inclusion of measures to improve fiscal management, for example, in SAL I in 1980, could not have been expected in itself to have avoided the crisis. It 11/ The region notes that this reorientation would have been undertaken regardless of the changes in staffing. 12/ The region notes that the program, if implemented, would have left only 4% of 1975 imports restricted. - 19 - would, however, have given the Bank staff greater knowledge of the Cituation and the way in which it was developing. The seriousness of the situation was not realized at the time when SAL II was made. 80. Bank staff were closely involved in designing the SAP, but Bank economic work on resource mobilization and utilization at the time seems to have been more limited. The President's Report for SAL I noted that greater output depended on greater efficiency of investment because there was little scope for raising investment by restraining consumption, and reliance on foreign savings needed to be reduced. It further stated that a successful structural adjustment effort would depend primarily on, inter alia, "finan- cial sector reform" and "continued disciplined demand management" (President's Report P2872-PH, paras. 36 and 37). Nevertheless, the staff seems to have depended mostly on the IMF standby arrangement then in opera- tion to follow up on these issues. VI. CONCLUSIONS AND LESSONS 81. In the four years since the loan for the First Structural Adjust- ment Operation was signed the Borrower has been carrying out the Structural Adjustment Program (SAP) set out in the two letters from the Minister of Finance, the first written at that time and the sec-3nd in 1983 to support SAL II. To begin with, action took longer than expected and consequently release of the second tranche of SAL I was delayed. Release of the second tranche of SAL II was not delayed. All told, foreign exchange amounting to nearly $500 million was made available quickly during a period of increasing foreign exchange difficulty (PCR, paras. 2.104 ff). 82. Overall progress with the SAP has been substantial but uneven. Major achievements have been firstly, steady progress with the program of customs tariff reform; secondly, a series of increases in energy prices in terms of continuing policy to pass costs of imported petroLum products fully to consumers and since 1983 to make electricity production financially viable and no longer dependent on government subventions. 83. To a lesser degree improvements have been made in the provision and administration of incentives for industry. Discrimination against imports in the sales tax has been partly reduced. The large program of major industrial projects on which the Government embarked at the end of the 1970s, has also been pruned and slowed down, albeit in circumstances of financial strin- gency. 84. Progress with import liberalization (excluding "regulated" items) was on schedule at the end of 1982. Then in 1983, first of all fewer items were liberalized then programmed and then, in October, full control of imports was imposed along with the moratorium on external debt obligations and other measures to meet the foreign exchange crisis. In October 1984, the emergency measures to limit imports were removed, but a major part of the import trade is still restricted v. regulated in one way or another. - 20 - 85. With such measures still being applied, much of the import trade and protection of domestic prodructs will continue to be determined by regula- tion rather than by customs tariffs alone. Tariff reform will be of limited significance (except for revenue) until imports are free from restrictions. 86. The foreign exchange crisis was to a great extent a consequence of external factors--the second increase in oil prices in 1979, and the decline in prices of primary commodities and other exports in the recession of 1981/82. The major fall in the terms of trade inevitably confronted central economic management in the Philippines with major difficulties and conditions that were hardly propitious for structural adjustment of the economy. In the event from the time SAL II was made, until the end of 1984, the attention of the Government focused more on the short term situation than on structural adjustment. (It so happened that price policies in the energy sector of the SAP were essential for short term reasons as well.) 87. The crisis revealed weaknesses in some financial institutions and in central economic and financial management. The Bank staff now recognizes that the structural adjustment program needs to be extended to other sectors, including public finance. 88. The SAP was intended to turn the Philippines away from the long standing policy of encouraging industrial growth by protection towards more efficient, labor intensive development. In the 1970s, industry had been further encouraged by a pattern of incentives, including export incentives administered by a new regulatory agency. Structural adjustment was in some respects a reaction to excessive regulation. 89. Nevertheless the Government's intention was not to dispense with industrial regulation. The aim was more to change the direction of indus- trial investment and to make both enterprises and the incentive administering agency, the BOI, more efficient. It is not clear that the Philippines system of encouraging one form cf production and discouraging another, is conducive to the long term gre-ith of the economy. The need for industrial incentives and regulation of the kind applied at present deserves to be further examined. 90. Before SAL II was presented to the Board, the Government set up an interdepartmental committee to monitor the progress of the SAP. Monitoring and coordination of SAP work in the Bank has been regarded as a function of the program division. As it happened, the economic crisis in the second half of 1983 highlighted some of the macro-economic issues which, led the staff to study more closely progress with the program and the need to widen it. 91. Four years of experience with structural adjustment lending in the Philippines leads to conclusions which may also help when further lending of this kind is being considered: (a) A SAP should address the principal impediments to development. It should be expressed clearly and precisely. - 21 - (b) It should consist of measures designed to bring about substantial improvement in a number of key areas. Improvements in some areas (for example central economic and financial management) may be a prerequisite for sustained progress elsewhere. (c) The SAP should be the country's own program with the Bank deciding to lend if it considered the program adequate both in content and timing. The conditions for such loan operations should refer to policies to which the Government is firmly committed and should be specific. (d) It should be clear that such a program was likely to be feasible, taking into account the climate for major change, policies and attitudes in areas outside the program, the state of the economy and its short term prospects. (e) Benefits in the form of improvements in the economy and its manage- ment may be realized only over a term of years and as time goes on further structural changes may be sought. The Borrower will wish to build on these achievements and the Bank will be concerned that they be maintained. Then given sustained creditworthiness, loan support for further suitable programs may be envisaged. (f) Structural adjustment lending calls, therefore, for a close working relationship between the Borrower and the Bank. Whether further lending of this kind is contemplated or not, SALs should include arrangements for the Borrower and the Bank to continue to review progress regularly after the program has been completed. 92. The two SALs provided urgently needed foreign exchange for imports and counterpart funds for development. Much of the adjustment program has been implemented, measures that have not been carried out fully or sustained have, for the most part, been overridden by action to meet the economic crisis. In the light of the major difficulties facing development in the Philippines, the program itself has been seen to be insufficient. The Government's present approach to stabilization and economic recovery, with support from the IMF stand-by arrangement, suggests that more adequate structural adjustment measures may come to be adopted. - 22 - Republic of the Philippines MINISTRY OF FINANCE ANNEX I Office of the Minister Page I Manila 12 August 1980 Mr. Robert S. McNamara President The World Bank 1818 H. St., N.W. Washington, DC 20433 USA Dear Mr. McNamara: Re: Philippine Industrial Development Policy Introduction 1. One of the principal objectives of the Five-Year Philippine Development Plan, 1978-82, is to improve the performance of the industrial sector. In the last year we have made considerable progress in formulating and adopting the policy measures needed to achieve this objective. This letter is to request a structural adjustment loan to support our industrial development program. To this end, I should like to recapitulate briefly the reform completed to date and outline the actions that the Government plans to take in the coming years. Objectives of Industrial Policy 2. Philippine industrial policy aims at accelerating the growth of industrial output and employment, maintaining the rapid expansion of non-traditional exports, and stimulating greater development of industry outside the Metropolitan Manila area. To promote industrial development along these lines, over the next several years the Government intends to take action in the follow- ing five major areas: (a) export incentives and promotion measures; (b) tariff reform and liberalization of commodity import procedures; (c) investment incentives and their administration; (d) industrial restructuring; and (e) major industrial projects. The Government's objectives and policies for industrial development are stated in an Industrial Policy Statement dated THay 1980 (Attachment I). "Isang Bansa, Isang DIwa" - 23 - ANNEX 1 Page 2 Status of Policy Measures 3. In December 1979, the Government obtained a two-year stand- by from the DIF for SDR 410 million. This standby is to support the macroeconomic policies in the context of which the industrial development program will be undertaken. 4. In the past, protective trade policies, among others, have been reponsible for industry's suboptiial performance. The initial phase of the Government's policy program has, therefore, concentra- ted on reorienting trade policies toward greater openness and on lowering protection. This is being done both by reducing and evening out the tariff rate structure and by promoting exports. Measures recently adopted in these and other policy areas are enumerated in Part A of Attachment 2. 5. Obviously, not all the elements of a revised industrial policy can be implemented simultaneously. Improved administration of investment incentives, restructuring individual subsectors, and initition of the major industrial projects are necessarily medium- and long-tesn propositions. While significant improvements have been made recently in these areas, there remain many tasks that need further thought and action. Those on which we will be start- ing work shortly are enumerated in Part B of Attachment 2. Export Incentives and Promotion Measures 6. Philippine export policy is to support direct and indirect export producers/traders through streamlining administrative procedures related to international trade and other appropriate measures. Export industries will also be provided with all reasonable forms of support through financial and other active promotional measures. 7. In the last year, we have virtually completed all improve- ments needed in export incentives and promotional measures by: (a) strengthening and broadening of fiscal incentives for export production and trading; (b) simplifying import and export proce- dures; (c) liberalizing bonded manufacturing warehouse arrangements; (d) improving and broadening the availability of export financing facilities; and (e) strengthening the institutions that promote exports and international trade. 8. The Government intends to introduce standard costings/ allowances for the tax credit/duty drawback on imported inputs of export industries in order to streamline further the current arrange- ments for duty-free importation by export industries. We also will be undertaking studies on how best to improve the working capital financing for exporters and how to encourage commercial banks to take greater initiative than hitherto in providing expQrt financing. - 24 - ANNEX I Page 3 Tariff Reform, Liberalization of Commodity Import Procedures, and Complementary Measures 9. In order to allocate scarce resources more rationally to industries where the Philippines is competitive, the Government is revising the tariff structure and liberalizing commodity import procedures. Any adverse near term effects which these reforms may have on revenue collections and the balance of payments will be offset through additional internal revenue measures, among others. 10. Tariffs across and within sectors, particularly on raw materials and intermediate inputs vis-a-vis finished products, are being evened out and the nominal levels reduced, resulting in substantial reduction in the average effective protection rate. 11. We plan to realign the tariff rates for 14 major industries over a five-year period beginning January 1, 1981. In addition, the current peak tariff rates for other industries will be reduced from 70% and 100% to 50% in two stages on January 1, 1981 and January 1, 1982. In general, the maximum tariff would be 50% and the minimum tariff will continue to be 10%. Thus, the average nominal tariff rate would be reduced from 44% to 30%. The effective rate of protection for the four industry sectors (Phase 2) would be reduced from 158% under the present rates to 30% under the proposed rate, and for the ten industry sectors (Phase 3) from the average effective rate of protection of 53% under the present rates to 18% under the proposed rates. We will commence the review of the next phase of tariff reform shortly. For this purpose, public hearings have been started in late July and reports thereon are expected to be completed before the end of the year. 12. The Government has, in addition, established a phased plan for the liberalization of commodity imports. The liberalization plan covers both nonessential and unclassified consumer goods and other items which are "regulated." In order to insure that the liberalization plan is carried out expeditiously, complementary measures will be adopted when needed to offset any adverse effects liberalization may have. 13. To cushion the revenue and balance of payments impact and curb luxury consumption, sales and excise taxes on particularly conspicuous luxuries may be increased on a selective basis. Further realignment of indirect tax rates will be subsequently considered if it appears necessary to deal with the effects of tariff reform and liberalization of commodity import procedures. - 25 - ANNEX I Page 4 Exchange Rate Policy 14. As noted in our letter to the IF last December in connec- tion with the current standby arrangement: "We intend to follow a flexible exchange eate policy that will allow the exchange rate of the peso to reflect basic market forces, taking into consideration our desire of keeping the current account deficit at a sustainable level in the medium term as well as other policy objectives, and official intervention in the exchange varket will be limited to preventing disorderly fluctuaticns." Our exchange rate policy will also be consistent r.th the objectives and policies outlined in this letter. Investment Incentives and Administration 15. A number of steps are being taken in order to encourage more effectively investment in industries in which the Philippines has a comparative advantage, to rorrect distortions in the prices of labor and capital, to accelerate employment generation, and to stimulate further the growth of industry outside of Metro Manila. First, Investment priority plans will give greater emphasis to labor-intensive industry. Second, steps are being taken to simplify and streamline procedures for the administration of incentives. 16. We have already made significant progress towards the above objectives. Procedures for the administration of incentives have been streamlined by reducing the paper work required for registra- tion and shortening the processing time for evaluation of projects. The use of "measured capacity" for priority determination has been eliminated in the food processing industries in order to encourage greater competition and efficiency in that sector. Revised guide- lines have been adopted to reduce the number of industries on the "overcrowded industries" list. As a result, 29 out of 38 industries have been removed from the list. To encourage the location of industry in identified "less developed" areas of the country, a law has been enacted to provide additional incentives for such investments. 17. To deal with remaining tasks in this area, we are currently reviewing the staffing and organization of the Ministry of Industry/ Board of Investment (MOI/BOI). We will be reviewing guidelines for using economic analysis in determining of priorities and the evaluation of projects. We intend (a) to consider a labor-oriented - 26 - ANNEX I Page 5 package of incentives as an added alternative to the present package of incentives; (b) to review the usefulness of the concept of "measured capacity" in priority determination; (c) to consider additional steps to further shorten processing time for BOI registration and project evaluation; and (d) to consider additional measures to encourage industry to locate outside the greater Manila area. Restructuring Programs 18. Subsectoral restructuring programs will be implemented concomitantly with trade liberalization and improved investment promotion procedures. Some of these are intended to help existing industries produce at lower costs, improve efficiency, and other- wise increase their competitiveness so that they can adjust to the policy changes. Other programs would encourage the growth of neglected industries that have a potential comparative advantage. Restructuring programs are intended to provide a positive, construc- tive alternative to highly protective tariffs and trade restrItions. The Government is now working out the details of programs to restruc- ture the cement and textile industries. In the next few noths, the schedule, work program, and guidelines for formulating the other restructuring programs planned will be finalized. A national industrial estate program to support the regionalization of industry will also be considered. Development of Smalland Medium-Scale Industries 19. The recent transfer of the National Cottage Industry Deve- lopment Authority (1ACIDA) to the Miistry of Industry has put under one aegis the development programs for cottage, small-, medium-, and large-scale industries. This change should facilitate policy administration and assistance to the lower spectrum of small-scale industries, which has until now fallen under a different administrative framework. We are integrating NACIDA and 11inistry of Industry programs for development of small- and medium-scale industries. Major Industrial Projects 20. A program of 11 major industrial projects was announced by President Marcos in September 1979 as an additional instrument for accelerating industrial development. The Government, through the National Development Company and other agencies, is taking an active role in initiating these projects because they are typically large, have relatively long gestation periods, and are hence con- sidered risky by private entrepreneurs. - 27 - ANNEX I Page 6 21. In view of the multiple demands on the country's limited capital resources, initiation of the projects would be phased over a five-year period. The Government is carefully analyzing the balance of payments effects of the projects and will, to the extent possible, utilize foreign capital and export credits to finance the projects. 22. The Government intends to continue its prudent and flexible approach towards the implementation of the major projects, estab- lishing them only after rigorous economic and financial analysis have demonstrated their viability. Financial Reforms 23. Reforms in the financial sector will play an important complementary role in improving the performance of the industrial sector. Seven banking laws were revised in March 1980 to make possible the development of multipurpose banking. These reforms are intended to eliminate artificial legal barriers to competition, increase the flexibility and responsiveness of the financial system, improve the efficiency of financial intermediation for export-oriented and labor-intensive industrial development, help lengthen the maturity of lending, and increase the flow of financial savings. Progress is being made in the preparation of the proposed World Bank financial sector loan which would support these insti- tutional and policy initiatives. Conclusion 24. In view of the initiatives being taken to further develop the industrial sector, we would appreciate your favorable conside- ration of the Government's request for a structural adjustment loan of $200 million. We appreciate the continuing exchange of ideas with the Bank and look forward to the opportunity to discuss from time to time the progress in the implementation of the further industrial development measures planned. Sincerely yours, CESAR E.A. VIRATA Minister of Finance - 28 - Attachment 1 Pagel1 STATEMENT OF INDUSTRIAL POLICY FOR THE 1990s BACKGROUND The Philippines is one of the richest countries in Southeast Asia in terms of natural resources, ranking second only to Indonesia because of the latter's oil reserves. Moreover, the country's highly literate and English speaking population constitutes another ast important resource particularly for the development of industry. However, notwithstanding its many natural endow- ments, the Philippines has lagged behind its neighbors in *economic.growth. In terms of industrialization, a recent World Bank report indicates that one of the principal features of the Philippine economic development is a 6slower than desired industrial growth". The Philippines after the Second World War, started out with an industrialization policy that emphasized the establishment of industries producing import substitute products. This policy was backed up with the corresponding support of high tariff rates and other protective measures that discouraged imports rather than promot6 efficient and world competitive prices. After almost 30 years there- fore, the shift.in policy from import substitution to export and world competitive orientation for industries is expected to be a difficult but imperative move for the country. OBJECTIVES The Ten-Year Development Plan 1978-1987 sets the basic framework for the direction of developmental efforts during the 1980's. While sustained support to the developmentoof the agricultural bas* Is the key focus of the Plan, it recog- nizes that more intensified efforts for greater indpatriali- sation are essential. This is mandated by the need to provide income earning opportunities not only for those that are at present underemployed and unemployed, but also for the large and progressively increasing numbers entering the labor force - 29 - ANNEX I Attachment 1 Page 2 annually estimated between 600,000 to 700,000. Moreover, the need to generate foreign exchange to support the over- all development programs and the growing import bill provides an equally important reason for greater industria- lization efforts. In this light, industry will play an increasingly Important role in the overall economic development in the 1980's, such role reaching equal importance with the role of agri- culture by the end of the ten-year planning period. This task will not be an easy one and will require the concerted efforts of government and the private sector as well as the willingness of both sides to accept responsibilities and make short term sacrifices for long term Industrial developmPant. The thrust of the industrialization program shall be towards the creation, in a relatively short period of time. of a dynamic industrial structure based on camparative advantage, which is efficient and competitive by global standards. While emphasis -will continue to be placed on the development of small and medim scale S.ndustries especially in rural areas, particular attention will be paid to ensuring that industries, based on the country's compa- rative advantages of a relatively inexpensive, efficient and sizeable work force and a substantial raw material base, operate at scales which are efficient by international standards making them competitive in the world market. This will require both the encouragement of the establishment of new enterprises in identified priority areas and the ratio- nalization and modernization of existing industries serving the local and/or foreign markets. The government also intends that the accelerated industrial growth in the 1980's will not add to the congestion of the Metro Manila area but rather be d -spersed all over the archi- pelago to distribute more evenly the benefits of industria- lization among the population. -.30- ANNEX X .Page 3 POLICY PRAMEWORK The prime mover in the industrialization effort in the Philippines in the 1980's will continue to be the private sector. The Government will became directly involved in the establishment of industrial enterprises only in areas which are strategically Important and vital to the national interest and those projects which the private sector will not otherwise undertake without the initiation and vigorous support of the Government. Whenever possible, Government involvement in such industrial enterprises will be. In joint ventures with the private sector and only for a period required to achieve the projects' viability. Foreign Invest- ments, side-by-side with domestic investments,: will play an Important role in this industrialization effot in providing the much needed market access, technology and entreprenanzal knowhow. While the Government recognizes that this will necessitate allowing wholly owned foreign enterprises in same areas for a considerable period of time, the main focus will be in encouraging joint ventures between foreign investors with domestic entrepreneurs. The Government' s main role in the industrialization in the 1980's will be to provide the infrastructure and policy en- vironment which will allow the market mechanism to operate effectively. The Government will ensure that private sec- tor business decision making is not stiffled by too many cumbersome rules and regulations. The Goverament's role will be to adequately perceive the market mechanism and to fomulate policies and programs which will encourage private sector investment and activities in the appropriate areas/directions. To provide this policy environment, Government will adopt a more active posture and redirect its involvement away from the regulatory taerdS a more promotional and directional focus. Henceforth, while exports will be encouraged through the granting of special incentives, guidelines and programs - for the rationalization, modernization and development of industries will be differentiated between domestic and export oriented operations, as in the past, and adopt world compe- titiveness as the common yardstick for all industries and projects. This will be achieved by a set of policies which will Z -- Allow international market forces to play a greater role in the allocation of resources. -31- AN= 1. Attachment 1 Page 4 -- Assist all industries to move towards the adoption of technologies and scales of operation. which are efficient by inter- national standards and appropriate to the country's comparative advantages. -- Encourage increased investment into priority areas in a fashion consistent with overall national development objectives. -- Reduce institutional and procedural barriers (and red tape) which hinder the efficient working of the market mechanism and private enterprise. THE INDUSTRIAL POLICY FOR THE 1980'S The Idustrial Policy for the 1980's will be marked by th& following principal factors: -- A focused and organized exoort promotion program; -- The rationalization/restructuring of 14 key industry sectors; -- The accelerated implementation of major industrial projects; -- The accelerated dispersal of industrizs; -- Increased emphasis in the promotion of small and medium scale industries; -- The continued encouragement of foreign investments in selected areas; -- The closer coooeration and regular dialogue between the government and private sectors in the planning and implementation of industry policies and program. -32- ANNEX I. Attachment 1 Page 5 A FOCUSED AND ORGANIZED EXPORT PROMOTION EFFORT The Government, in the 1980's, will undertake a more selective approach in export development both in the choice of non-traditional export products to be promoted and the markets where these products will be promoted. The choice of products will focus on Philippine industries enjoying distinct, permanent and substantial comparative advantages such as cheaper labor rates and indigenous raw material costs over other international competitors. The products expected to lead prominently in the export development program are !lectronics, garments, furniture and wood products, shoes and leathercraft. Other promising non-traditional exports which have been exhibiting increasing export sales recently,include processed fruits, vegetable and seafood products. An organized marketing approach to cover the whole world will be put into full operation jointly by the Government and the private sector within the first half of the 1980's. Pursuant to this goal, 12 Filipino conglomerates have been selected to organize international trading networks and are expected to establish a network of 150 offices around the world by 1984 and consequently Philippine market presence in 42 of the world's major trading centers by end of 1980. The Government has also started actively dialoguing with 150 of the largest manufacturing companies each having a substantial domestic market base to motivate them to focus more attention on exports. In three years, it is estimated that the program will earn for the country between US $300-$500 million in additional exports without any significant additional investments in manufacturing facilities. In the latter part.of 1979, the Government started the implementation of a number of administrative reforms on export procedures as part of the long term objective of Government to extend the free trade export reforms to all direct export producers and traders and, where possible, also to indirect export pLoducers. These reforms include the following: - 33 - ANNEX I Attachment 1 Page 6 -- Simplification and shortening of the procedure for avallment of export incen- tives through the Board of Investments. -- Reduction- of the marginal deposit requirements of imported inputs of export industries from 501 to 25. In certain circumstances, marginal deposits may be waived. -- Liberalization of guidelines and pro- cedures for the establishment and operation of bonded manufacturing warehouses. .- In addition, the Government continued planning for the establishment of 12 new export processing zones throughout the country and started the undertaking of a study for possible Implementation of standard costings for duty drawback and tax credits on imported inputs into exports. This study is expected to be completed by end of June with the assistance of an International .Monetary Fund (MP) Technical Consultant who will work in the' country starting early May. One other area of major concern of the Government at present, in its drive to promote and support exports, is the need for special financing facilities for non-traditional export industries.. At the same time, Goverment is also concerned about enlisting the more active support of financing institutions for the export drive. Pursuant to these concerns, inter-agency discussions and consultations have been initiated to formulate measures and proposals on the establishment of special financing facilities for exports and the role financing institutions will play in the Government' s drive to promote exports. Specifically, the proposals center on shifting export financing away from the letter of credit to a more historical performance orientation as well as away from a short term to a more medium and even long term orientation. 34 ANNEX Y* Attachment 1 Page 7 RATIONALIZATION/RESTRUCTffRING OF 14 XEY INDUSTRY SECTORS Philippine industry is not benefited by overprotectionism. Removing excessive protection, while painful, is the only- alternative to promoting a truly efficient and competitive industry sector. For the 1980's, 14 industry sectors have been lined up for rationalization, modernization and/or rehabilitation. These industries are as follows: -- Basic and Intermediate Capital Goods Manufacturing Industries oo Iron asd Steel oo Cement oo Pulp and Paper oo Wood and Wood Products oo Heavy Engineering Machineries oo Ceramics/Glass -- Transport and Appliance Goods Manufacturing Industries - oo Automotive oo Motorcycles oo Electrical/Electronics oo Domestic Appliances -- Consumer Goods Manufacturing Industries oo Food Processing oo Textile and Garments oo Leather and Leather Products oo Furniture Industry - 35 - ANNEX 1 Attachment 1 Page 8 The cement industry has been successfully launched as the first of these sectoral rationalization/restructuring programs and over the next 5 year period, other sectoral rationalization and restructuring programs will be formulated and implemented. Sectoral rationalization and restructuring programs, in order to be effective will be presented to the private sector as a package consisting of policy changes and reforms$ such as rationalization of tariff and liberali- zation of import licensing, that will spurn industry to improve its competitiveness and cost efficiency, and assit- tance programs, such as access to financing for rehabilita- tion/modernization and technical assistance, to help indus- try adjust to the policy changes and reforms during the transition period. Preparation of sectoral development programs for textile and garments, food, pulp and paper, iron and steel, leather and leather products and furniture manufacturing industries and the mechanical engineering sector have already been started and are expected to be completed and ready within the year. Formulation of other sectoral programs for two sectors, wood and wood products and glass and ceramics, is being planned-and will be started within the year. Pour other sectors have on-going rationalization programs under the supervision of the Board of Investments. These rationaliza- tion programs will be reviewed. Already, as a start on the industry restructuring program, the Government reviewed and subsequently limited considerab- ly the scope of its Overcrowded Industry Policy. The Over- crowded Industry Policy was adopted in the early 1970's to conserve limited government financing and foreign exchange resources by discouraging investments in industries where established capacities are grossly in excess of local demand. Through the years however, the policy has taken an industry protective nature as it limited competition which in turn prevented improvements on product cost and quality in indus- tries classified as overcrowded. The recent move of the Government reduced the number of industries in the over- crowded list from 30 to 9. The status of industries remaining in the List are at present being evaluated under the revised guidelines for retention or immediate delisting. -36- ANNE I Attachment 1 Page 9 Tariff Rationalization A key instrument in the industrial restructuring program is the rationalization of tariffs aimed at narrowing down. the range of nominal tariff rates between 10% to 50% and at establishing, in the long run, a more reasonable range of effective tariff protection levels between 10% to 80%. This will involve the reduction of high tariff rates as well as the raising of some low ones particularly for products of the mechanical engineering industry sector. As a first step in this direction, the Government will reduce peak tariff rates, or rates in excess of 50%, to 50% in two steps over a maximum period of 2 years starting 1981. This has been called the Phase I of the Tariff Reform Program and the staging of the reduction over a maximum period of 2 years is designed to give the private sector ample time for adjustment. Henceforth, the Govern- akent- will also adopt, as a matter of policy, 50% as the highest tariff level for any product. As a second step, rationalization of tariffs for products involved in the selected industries will be undertaken on a sectoral basis to go hand in hand with the industry assistance and support measures that will be an integral part of the development programs for these industries. The phased adjustments on a sectoral basis have been desig- nated Phase II (for the.food, textile and garments, pulp and paper and leather and leather goods manufacturing sectors) and Phase III (for the remaining 10 sectors) and will be staged over a four to five-year period starting 1981. The third step (Phase IV) will be the rationalization of tariffs not covered in the peak rates reduction and the sectoral tariff reform (Phases II and III). The Tariff Commission will soon start conducting public hearings to solicit the opinions and positions of the different sectors on the rationalization of this last batch of tariffs and it is expected that specific proposals on the extent and staging of the reductions and increases will be submitted for con- sideration by the NEDA within the year. - 37 - ANNEX I Attachment 1 Page 10 Lfberaliaation of ~port Licensing xn conmonance with the tariff refrm, the governeunt will undertake a ~hased and gradual liberalisation of all exiEting import 11osfing requlrements la order that the tull *ffect of the tariff refoz: program in fostering co~mpetitiveneas, e ficincy and a mne d~namic grovth an Industrial output, eploymnt and eporta will aot be frs- treted. ardever, it is recognised that the liberaltsation of import lioasing may adversely affet the halance of payaat position of the country if mot proprly planned and impIemea- ted. As uch, selectivity must be exercised in the coioe of prodcts for Vhch import licensing hou~d be 1~1at~ly lberalied giving priority to producer good over consumer. goods and high tarlft goods over lov tarIff good. The liberalisata sakl cover bot only produts ln the UC and NEC .--ty Classif4.cations of the Central Bank but alse, in the long rn, products imports of Vhich are be~ng regulated or monitored by the Central ank ln aope- zation urth oher govmrnment agencies. .iberalization vill be started earler than or zimultanmous with the start af the tarff reform in cass of products vhose tariffs are to be reduced and simultanmous with or later than the start of the tariff reform in cases of prod~cts ~hs tn.riffs ar to be raised. RealignmMt of the Structure of indirect Taxes ghe tariff ieform and import licensing lberalization programs, *hle necesary to the over-all indusry restrc- turing exercise, may reduce government revenues while inreasing foreign exchange expend!ture. To offset thes, anticipated efiects, .j.w goverunent is considering the realigament of the sti=cure of indirect taxes to offset possible revanne losses ard to discourage consuption of luxury ite:~. This realignent vill hovever besbjctad-to extenivw studies and will bo Ixplemented once d fnal tarif .evels are reached in the reform program. - 38 - Attachmet 1 Page 11 The realigaent will also make sure that no further discriminatory treatment will be imposed between Imported and domestically produced goods. Industry Support and Assistance Measures To enable industry to withstand the initial adverse Impact of the restructuring programs particularly the effects of the tariff reforms and the liberalization of import licensing, and to eventually achieve Improved. efficiency and cost competitiveness, Government will PrOVI industry assistance and support measures an a sectoral b"ess the major components of which ill be access to flancing and fiscal Incentives. Investment Premotion Policy In the drawing up of the annual Investment Priorities Plan, following the pattern of sectoral restructurag, the Board of Invest:aents will shift fran its jxesent shoppLag list . approach to a more sectr*ral, approach. In addition, the damestic resozarce cost of every projct/area will be taken Into account to make jure that investaents are encouraged in areas that will really contran-ts to the countrygs development objectives of increased employment generation of foreign exchange earnings, and Industry dispersale among others. The more thorough econciae analysis will be applied both to the industry subsectors an well as specific major projects for inclusion in the Investment Prtorities Plan. The review of the fiscal incentives package being granted to the 3oard of Investments 'registered projects will continue for the purpose of identifying means of making It mre - attractive to investors without unnecessarily increpsIng the burden to the goverment. At the same time, Covernment will consider the desirability of introducing an site:aative incentives package that will be more meaningful to investors in labor intensive projects. - 39 ANNE 1. Attachment 1 Page 12 The Government is not only concerned about using better methods of identifying investment priority areas and more meaningful incentives packages, it will also continuously look into simplifying and shortening the procedure for Board of Investments registration and availment of incentives. Moreover, in view of the recog-- nition of the important role of financing in industry development and investment promotion, conscious effort is being and will be exerted to better define areas of coordination between the Board of Investments/inistry of Industry and the government financing institutions such as the Development Bank of the Philippines. THE MAJOR INDUSTRIAL PROJECTS The Philippine Government has identified 11 major national projects-which it intends to establish in the 1980's to constitute an important component in its industrialization program. These 11 major national projects are the copper smelter, phosphatic fertilizer plan, aluminum smelter, heavy engineering industries, integrated steel mill, petro- chemical complex, diesel engine manufacturing program, cement industry rationalization program, alcogas project and the integrated pulp and paper mill. Initial analysis of these projects indicate that they are economically viable. The study on the foreign exchange requirements and implications of the projects indicate that most of them could generate enough foreigr exchange to offset their foreign exchange costs. Moreover, while the projects are admitted- ly capital intensive, downstream labor industries with promising export potentials are envisioned to be established once the projects are operational. Still, the Government is exercising extreme prudence in planning their establish- ment and ensuring their viability and has always emphasized that it will only undertake any project when, at the time all factors have been considered and requirements have been negoctated, such project is proven convincingly viable. The Government realizes that the postponements in the. establishment of these projects have inflated the investment requirements considerably. It also realizes the need for prioritization of these projects as the investment requirements are substantial. -40- ANNEX I Attachment 1 Page 13 In view of this, work is now being focused at the following: -- Identifying the best foreign partners to invite into the project taking into consideration what the partners have to offer in terms of equity, technology, raw materials supply, market support, etc. -- Securing the best possible financing and credit terms for the projects to keep the public budget fran being unduly burdened. THE ACCELERATED DISPERSAL OF INDUSTRIES The concentration of industries in a few urban centers, particularly the Metro Manila Area, is undesirable not only from the environmental but also the social and economic points of view. As such, industrialization in the 1980's will aim both at increasing industrial output and distributing more equitably throughout the population the benefits of increased industrial activity. The Government recognizes that industry projects locating outside urban centers, unless such location.is dictated by specific natural and other resource availability, incur cost penalties or disadvantages primarily due to additional transport.communication and management costs. The continued priority rankings of the Government's infrastructure and communication development programs is expected to reduce thesecost disadvantages in the 1980's. In an attempt to further diminish these cost disadvantages, the Government will implement the following strategies for industry dispersal: -- Distribution and location of major national projects in various sites all over the country. Because of the magnitudes of these major national projects, they justify Government investment in infra- structure development linking their sites to urban and market centers. Consequently, they will serve as industrial nuclei around which smaller manufacturing and service projects may be established. - Al - ANNE r Attachment 1 Page 14 -- Establishment of industrial estates* export processing zones or smaller industrial villages throughout the major islands. The National Industrial Estate Program has at least 12.sites already identified for development. The establishment of the first 4 industrial estates under Phase I of the program is expected to commence very soon. -- Granting of incentives to firms locating in identified priority areas. Recently, the Batasang Pambansa passed the Batas Pambansa Bilang 44 granting additional incentives to Board of Investments' registered projects if they locate in less .developed areas identified by the Ministry of Industry, Ministry of Human Settlements and the National Economc and Development Authority. INCREASED EMPRASIS IN THE PROMOTION OF SMALL AND MEDIUM SCALE INDUSTRIES The Government's emphasis in the promction of small and medium scale industries will continue in the 1980's as these sectors contribute significantly to increased employment generation and industry dispersal and may also do the same to exports. The major problems of small and mediun. scale enterprises may be classified into three categories, namely, technical, financial and organizational. In response to these probleK- areas, Government promises to undertake the followings -- Increased technical assistance in the establishment (i.e., conduct of feasibility studies) and operation (i.e., extension of of technical training and cor.sultancy services) of small and medini scale industries. -42- ANNEX I Attachment 1 Page 15 -- Increased access to financing. The Government is studying various schemes and incentives to encourage comercial banks to participate with financing of small and medium industry projects. Recently, an agreement was reached by commercial banks and government and semi-government banks to set up venture capital corporations to finance mall and medium scale enterprises, particularly those in rural areas and utilizing indigenous raw materials. -- Organization of cooperatives and/or other groupings for the acquisition of common facilities and for pool purchasing of raw material requirements as well as pool marketing of finished products. -- Promotion of subcontracting to link small and medium firmas with large industries and vice-versa for better operating and production efficiendes. THE CONTINUED ENCOURAGEMENT OF FOREIGN INVESTMENTS IN SELECTED AREAS The accelerated industrialization program of the Government in the 1980's will require tremendous equity and financing funds. To lessen the burden of raising these .investment requirements, the government will continue to encourage and welcome inflow of foreign investments into selected areas and under certain conditions. Foreign investments will be particularly welcomed in the field of plantation agriculture, which could utilize large tracts of land which are at present idle and unproductive. Anticipating a positive reaction of foreign investArls to the Government' s open invitation, the National Development. Corporation was recently revitalized to facilitate co- venturing. At the same time, nDves have been made to relax -43- ANNEX I Attachment 1 Page 16 the citizenship requirement for investments. Specifically, the recently passed Batas Pambansa Bilang 44 provides exemption from the citizenship requirement of investments in identified less developed areas. Aside from foreign investors, the Government has also been encouraging the Philippine banking.sector to take a deeper involvement in industry. Pursuant to this end, the Batas Pambansa recently passed Batas Pambansa Bilang 61 to 67 amending the General Banking Act, Savings and Loan Association Act, Private Development Banks' Act, the creation of the Development Bank of the Philippines., Rural Banks' Act, the Investment Bouses Law, and the Central Bank Act, respectively, to achieve the following major objectivest -- Increased long-term financing, through the elimination of legislated restrictions on long-term lending, by banks and the modification of monetary policies to minimize .the bias against long-term lending. -- Increased competition and efficiency of banking institutions through minimizing the enforced distinctions of functions between different types of banks, such as allowing investment banking and ownership of equities. Specifically, the amendments which usher Universal-Banking into the country are as follows: -- Batas Pambansa Bilang 61 amending the General Banking Act of 1948 grants commercial banks expanded authority to grant long-term loans and to function as investment houses, invest equity in non-allied undertakings, in non- bank financial intermediaries and in thrift banks. The law also provides that commercial banks may, upon prescription of the Monetary Board, carry lower capital to risk assets ratio than the 10 percent otherwise prescribed (but not lower than 5 percent) in order to make them competitive with investment houses and to enable them to lend more than 10 times their combined capital accounts. Other reforms introduced under the same law include: broader own- ership in rural and thrift banks to include -44 - ANNEX I Attachment 1 Page 17 holding companies specifically formed to invest equity in these banks; allowing rural banks to set up nationwide branches; permitting savings and mort- gage banks to undertake full domestic commercial banking, exclusive of foreign operations and investment house functions; and liberalizing . credit teras from savings and mortgage banks. -- Batas Pambansa Bilang 62 amending the Savings and Loan Association Act allows savings and loan associations to extend the maturity period for short-term loans to 5 years (from the previous 3), and for mediud-and long-term loans to finance home building and agricultural projects to 30 years (from the previous 20) . To enable these institutions to raise fundk for long-ters lending, the Monetary Board may now raise their borrowing ceilings up to 30 percent of total assets, from the prescribed 20%. -- Batas Pambansa Bilang 63 amending the Private Development Banks * Act provides that private development banks may now operate as savings and mortgage banks and perform commercial banking activities. To strengthen their capital structure, these banks may also convert preferred shares to common shares when sold to private individuals. -- Batas Pambansa Bilang 64 amending the Charter of the Development Bank of the Philippines states that private development banks may - still purchase capital shares of a private development bank in an amount equal to the difference between the required paid up capital of the private stockholders. The Development Bank of the Philippines however, may retire such preferred shares if and when the Monetary Board deems that the private development bank has accumulated enough capital strength to permit the retirement of such shares. - 45 - ANNEX I Attachment 1 Page 18 -- BatAs Pambansa Bilang 65 amending the Rural Banks' Act changed the provision that previously restricted rural banks to lend only to small farmers owning no more than 50 hectares of cultivated land, merchants, and cooperatives. Rural banks may now give credit to the people of rural communities in general. To strengthen their capital structure, rural banks may seek counterpart capital of more than 71 million upon prescriptin of the Monetary Board to promote and expand rural economic development. Adding flexibility to rural bank services is the extension of the expanded banking authority to operate as savings and mortgage banks and as a commercial banks. -- Batas Pambansa Bilang 66 amending the Investment Houses Act gave investment :houses added powers to engage in foreign exchange operations directly related to encouraging companies to go public and to promoting enterprises, and to act as trustees of trust funds or trust properties. With the approval of, the Monetary Board, investment houses may now be converted into commercial banks under an expa4ded commercial, banking authority. -- Batas Pambansa Bilang 67 amending the Central Bank Act states that the Central Bank Monetary Board has now the power to impose administrative sanctions on erring non-bank financial intermediaries performing quasi-banking functions and which are now given access to Central Bank credit facilities. - 46- ANNEX I Attachment 1 Page 19 THE CLOSER COOPERATION AND REGULAR DIALOGUE BETWEEN THE GOVERWMENT AND THE PRIVATE SECTOR IN THE PLANNING AND IMPLEMENTATION OF INDUSTRY POLICIES AND PROGRAM The Government is taking a big step with the industry restructuring program. It cannot make this step alone for in the Philippines, easily 80% of total indus- trial investments are still by the private sector an. Government has no intention of changing that figure. The program must therefore be managed in active consul- tation with the private sector whose interests must be considered in any reform which Government institutes. The Government has made a wone voice for industry" proposal and the Philippine Chamber of Commerce and Industry.has taken up the challenge of being that voice. The President himself regularly meets with various representatives of foreign business chambers to explain new policies and hear out problems as well as suggestions and ideas of these groups. This practice will continue with greater emphasis in the 1980's. The preparation of sectoral rationalization or development programs will be an activity which will provide oppor- tunities for active consultations and dialogues. Other programs which will be undertaken and which*will require active participation of.tbe private sector include export promotion, standardization and testing of product quality, industry dispersal, planning and design of industrial estates, and many others. CONCLUSION It is difficult to predict what the 1980's will bring; all over the world, uncertainty prevails. This global uncertainty which tempts other leaders to opt for a status quo is the very driving force that made the Philippine Government undertake this ambitious industrial restructuring program. The Government believes that the solution to our growing problems, particularly, unemployment and the negative balance of payments, cannot be solved by a status quo but - 47 - ANEX I. Attachment 1 Page 20 rather by a decisive move that outlines clearly the Government's desire to set up a growing industrial base competitive with any other in the world. The Government realizes that this step is an irreversible one. Once taken, it offers no second chance for turning back. With this knowledge, the Goverrment is fully committed in seeing the program through. With the help and full cooperation of the private sector, the Government is confident that the industry restructuring program has every chance for success. -4s - ANNEX I Attachment 2 Page 1 INDUSTRIAL DEVELOPMENT PROGRAM A. POLICY MEASURES COMPLETED OR IN THE PROCESS OF IMPLEMENTATION I. General Industrial Policy Statement dated May 1980. (See Attachment 1) II. Export Promotion A. Incentives and Procedures 1. Streamlining of import and export procedures (Letter of Instruction No. 942, drted October 16, 1979). 2. Extension of BOI fiscal incentives for exports to all direct and indirect export producers and traders on a substantially expanded basis, both in scope and avail- ability (Presidential Decree No. 1646, dated October 1979). 3. Further rationalization of the administrative arrangements for the export trade (Letter of Instruction No. 1040, dated June 26, 1980). - 49 - ANNEK I. Attachment 2 Page 2 B. Financial Measures 1. Improvement of rediscounting facilities for nontraditional exports by the Central Bank (C.B. Circular Nos. 647, 658, 668, 671 and 672, dated January 22, March 5, March 20, and April 6, 1979, respectively). 2. Reduction of marginal deposit requirements for imported inputs into export industries from 50% to 252 (effective since January 1980 through C.B. letters to the Philippine Bankers Association). 3. Transformation of Philippine Foreign Loan Guarantee Corporation into the Philippine Export and Loan Guarantee Corporation for purposes of guaranteeing loans granted by Philippine or foreign financial institutions to qualified exporters and contractors (Revised Rules and Regulations dated February 21, 1980 to Implement Presidential Decree No. 1080, dated January 31, 1977). Transfer to it of the functions of the Philippine Export Credit Insurance and Guarantee Scheme for the purpose of eventually providing export credit insurance (Executive Order No. 574 of December 1979). - 50 - ANNEX I Attachment 2 Page 3 -C. Export Promotional Measures 1. Liberalization of requirements for bonded manufacturing warehouses (Executive Order No. 565, dated October 1979), creation of the Bonded Export Marketing Board, and stream- lining of BOI procedures (September 1979). 2. Approval for Export Trading Companies to set up overseas trade offices, to operate bonded manufacturing warehouses, and to utilize preferential export credit financing facilities. (Republic Act No. 6135 as amended by Presi- dential Decree No. 1646 dated October 1979). 3. Reorganization of the Export Processing Zone Authority to play a more dynamic role in industrial estate and export processing zone planning, development, and manage- ment. Initiation of planning and implementation of twelve such zones (Executive Order No. 567, dated November 1979 and Letter of Instruction No. 1033, dated June 1980). '. Reorganization of Ministry of Trade and creation of the Philippine Export Advisory Board (Executive Orders No. 573 and No. 574, dated December 1979). ANNEX I Attachment 2 Page 4 III. Tariff Reform and Complementary Measures 1. Reductions in tariffs on some 40 items of the fo6d processing Sneustry to stabilize domestic prices and assist export- oriented food processing industry (Presidential Decree No. 1628, dated July 11, 1979). 2. Accession to full membership of GATT effective January 1, 1980 (Executive Order No. 578, dated February 1980). 3. Revision of Tariff Code to provide greater flexibility in the setting of tariff rates (Presidential Decree No. 1690, dated A.pzil 1980). 4. keduction of the peak tariff rates from 70% and 100% to 50% in two stages on January 1, 1981 and January 1, 1982. Realignment of tariff rates for 14 major industries over a period of five years, beginning January 1, 1981 (Executive Order No. 609, dated August 1, 1980). 5. Approval of the plan for liberalizing commodity importation procedures for items in the Central Bank NEC and UC Commodity Classifications. (Monetary Board Resolution 1495 , dated August 15 , 1980). - 52 - ANNE 1. AttacmeMnt-7 Page 5 IV. Investment Incentives and Administration 1. Streamlining of procedures for the administration of investment incentives, reduction in number of documents/papers required for registration, and shortening of project evaluation period from 90 to 60 days (September 1979). 2. Formulation of proposals for making greater use of economic analysis in industrial priority determination and project evaluation based on subsector development programs (March 1980). 3. Issuance of guidelines for eliminating industries from the "overcrowded industries" list, reducing the number of over- crowded industries from 29 to 9 (January 1980). 4. Elimination of "measured capacity" criterion for food processing industries (October 31, 1979). 5. Provision of additional incentives to BOI-registered projects locating in identified less developed regions (Batas Pambansa Bilang 44, May 1980). 6. Review of staffing requirements and completion of reorganization of MOI/BOI (in the process of implementation). - 53 - ANNEX I Attachment 2 'Page 6 V. Industrial Restructuring 1. Transfer of NACIDA to Ministry of Industry (March 1980). 2. Announcement of the sectoral program for the restructuring of the cement industry (April 1980). 3. Preparation of a sector program for the restructuring of the textile industry (in progress and expected to be completed by June 1981). 4. Preparation of a plan for providing infrastructure to support regionalization of industry through the National Industrial Estate/Export Processing Zone Development Program (in progress). VI. Major Industrial Projects 1. Policy on major industrial projects announced by President Ferdinand E. Marcos (September 1979). Implementation of these projects, according to Industry Minister Roberto V. Ongpin, will be subject to rigorous economic analysis and proof of economic and financial viability. 2. Revitalization of the National Development Company to act as equity arm of the Government to initiate priority industrial projects (Presidential Decree No. 1648, dated October 25, 1979). -54 - ANNEX I Attachment 2 Page 7 B. POLICY MEASURES TO BE TAKEN I. Export Incentives 1. Completion of arrangements for utilizing standard costing for duty drawbacks and indirect tax refunds for exporters (as soon as possible after review of the IMF report now being drafted). 2. Study of (a) increasing the availability of working capital funds to exporters over and above those currently available through the export trading corporationsand Central Bank redis- counting facilities; and (b) of providing even greater incentives and promoting greater initiative by the commercial banks in extending facilities for export financing. (Inter- agency discussions have been initiated to formulate the terms of reference for such a study). II. Tariff Reform and Complementary Measures 1. Review of the next phase of tariff reform to rationalize the remaining tariff lines within the 10-50% range. (Public hearings started in July 1980 and review expected to be completed by end of 1980). 2. Preparation of a plan for the liberalization of import procedures for non-essential and unclassified consumer items and "regulated " commodity groups not covered 'n the initial liberalization plan. (Interagency discussior ' start in August and plan expected to be completed by e- . of 1980). 3. Increase in specific tax rates on alcoholic beverages and certain luxury type cigarettes and introduction of various other tax measures expected to generate peso 1.0 billion in additional revenues (Tax Program in support of the 1981 Budget: Cabinet Bills No. 36,37,38 & 39) - 55 - ANNEX I Attachment 2 Page 8 III. Investment Incentives and Administration 1. Studies of (a) the feasibility of introducing a labor-oriented package of incentives as an added alternative to the present package of incentives; (b) the usefulness of the concept of "measured capacity" in investment priority determination; (c) additional steps to further shorten processing time for BOI registration and project evaluation; and (d) additional measures to encourage industry to locate outside the greater Manila area. (Studies are includea in the technical assistance component of the loan and are expected to be started in 1980). 2. Review of present guidelines on the use of economic analysis in priority determination and in project evaluation. (Review is included in the technical assistance component of the loan and is expected to be started in 1980). 3. Study on improving the project data system for monitoring the status and performance of BOI-registered projects. (Study is included in technical assistance component of the loan and is expected to be started in 1980). - 56 - ANNEX I. Attachment 2 Page 9 IV. Industrial Restructuring 1. Preparation of a schedule, work program, and guidelines for formulating detailed industrial restructuring programs. (Included in the technical assistance component of the loan and expected to be started in 1980). 2. Preparation of an integrated program for small- and medium- scale industrial enterprises. (Included in the technical assistance component of the loan and expected to be started in 1980). International Bank for Reconstruction and Development FOR OFncuL USE OLY Page 1 of 2 - 57 - SecM61-121 IRoK: vice President and Secretary Februa%y 24, 1981 PRILIPPINES - STUCTURAL ADJUSTIENT LOAN Attached for information is a note regarding the consultations under the Philippines Structural Adjustment Loan relating to the general progress of the PhilIppine industrial development progrm and the status with respect to the release of the second (and final) traehe of the Loan. Questions on this document say be referred to R. Poortman (extension 72138). Distribution: Executive Directors and Alternates President Senior Vice Presidents President' s Council Vice Presidents, IPC Directors and Departument Beads, lank and IFC This document has a restricted distribution and naty be used by recipients only in the perfornmce of their alicial duties. Its contents may not otherwise be disclosed withot World Back authorization. FOR OFFICIAL USE ONLY . *IAN * To TIE EXECUMVE DIRECTORS AI -58 - Page 2 of-2 SUJECT: loview-of the PWI9AW 4117913110 Adivetment loan As provided to Section 3.05(b) of the Loan Agreement for the Structural Adjustment Loan to th# Pfilipplaes, discussions were held with the Goverment during January 7-29. 1981, on progress achieved in carrying out the industrial development program assisted by the loan. The review focussed on: (1) general progress on the Implementation of policy measures and studies as set forth In the Government's Letter on Industrial Development Policy; and (ii) the status with respect to the specific measures related to the release of the second tranche of the loan. General Progress of Industrial Development Program Considerable progress has been achieved In Iaplementing the Government's Industrial development program as outlined in the Statement of Industrial Policy for the 1980s. In the area of export promotion, arrangements for the introduction of standard costing for duty drawbacks and Indirect tax refunds for exporters are being finalized; and a plan for the establishment of an Export Credit Corporation is currently under considers- tion. The first stajge of the Government's five year program of tariff refoarm and liberalization of Import licensing became effective on January 1, 1981. and compleantary indirect tax measures were introduced as part or the tax program in support of the 1981 Budget. Studies are currently underway to review and Improve the Government's present industrial incentives and promotion system. Specific reconmendations will be formulated to revise the incentives, Improve the allocative mechanism, sauplify administrative procedures and encourage a greater dispersal of Industrial activity. Subsector development programs are under preparation to assist domestic industries to adjust to the tariff reform and trade liberalization measures. Approximately half of the $5 million technical asistance component of the loan has already been committed to help formulate and implement the various industrial policy measures. Status of Release of second Tranche the availability of the second (and final) tranche of $95 million is contingent on satisfactory progress by the Government in realigning tariffs and liberalizing Import licensing, i.e., the finalization of the last phase of the current round of tariff reform and the preparation of a plan for the liberalization of the importation of a final group of 39 restricted items. Considerable progress has been made in these two areas and the Government expects to have both measures finalized and adopted by April 1. 1981. Consequently, it was agreed with the Government to postpone the target date for the release of the second tranche by two months from January 31, 1981, as specified in Loan Agreement. to April 1, 1981. However, the second tranche could become available as soon as the two actions are completed. We will advise the Executive Directors when the actions are completed and the second tranche is released. Ernest Sterm Senior Vice President Operations Tis decomsA has a suiced distrbufon sad amy be used by edpientu only i the performance of ftek official duties. hs conicas may ao otherwise be disclosed without World Bank authorization. ANE III International Bank for Reconstruction and Developmentpise 1 of 2 FOR OFFAL USZ O.LY - 59 - Secm8-641 FPON: Vice President and Secretary July 20, 1981 PEILIPPINES - STRUCTURAL ADJUSTHENT LAN Attached for information is a note regarding the release of the second and final tranche of the Philippines Structural Adjustment Loan. Questions on this subject may be referred to Mr. Poortman (extension 72138). Distribution: E:mcutive Directors and Alternates P*1res*dent Senior Vice Presidents President's Council Vice Presidents, IFC Directors and Department Reads, Bank and IMC This document has a restrited distibution sad may be used by recipients only in the performance of their official duties. Its conteats may not otherwise be disclse without World Bank authorization. ioa OTCIAL UsE ONLY -60- Page 2 of 2 l~ TO W IUTIE DIMCOS UIJECT: Ealossa of Second Tramch of the Phiipins Stretaral AdJustment Loan as sat out la Schodule 1, para 1 () of the Loa Agreet for the Strutural djustmænt Lon to th hilippine, the avast1alMty of the ~cond (and final) tra~che of $95 million is coutingent on satisfactory progre*s b., h GCvermat in r<aliging tariffø and libral z-ing i~rt licnsing, i..... the fiqm~tIn of th last pbase of e curret rod of tariff refom and tha preparation of a plan for the lbarali~ation of the ~mp,ctati~ of a final group of restricted it=. Soch masurs hav n m boen finalised and- adoptad. Consequently, the Govern t of the Mhilippines ha bon advisad.of the availability of tha final trane of $95 mUiliom. Eruet Ster= Senior Vice Pres~dnt - Oparation o0 This h a~ ha a ra~i;led enirad and y be usd by rei. anty in m percrm= of eir ecial dud. la manm•m -y wom aer wisbe n~inu. wise WrM b.mk wom • - 61 - ANNEX 1V Page 1 Mepobe of Os P~m@pne MINISTRY OF FINANCE 29 March 1983 Mr. Alden W. Clausen President The World Bank 1818 H. Street, N.w. Washington, D.C. 20433, U.S.A. Dear Mr. Clausen: Re: STRUCTURAL ADTUSTMENT PROGRAM OF THE PHILIPPINES 1. The Philippines, towards the attainment of a progressive and balanced economy, has periodically reviewed its development programs and policies since the coun xy regained its independence. In 1980, the government launched a comprhensive program of structural reforms to address the fundamental need for improving the allocation and efficiency of investment and increasing the mobilization of domestic resources in an effort to reducing the reliance of the economy an foreign borrowings and accelerating the achievement of the country's economic development objectives. The initial phase of the structural adjustment program vas supported by the World Bank through a first Structural Adjustment Loan in 1980 and an Industrial Finano Loan (APE) in 1981. The Philippine Government has also adopted a stabilization program for calendar years 1980-81 which was supported by an IMF stand- by arrangement focusing an short-tera demand management policies. A new stand-by arranmnt for 1983 was agreed with the INF on 25 February 1983. 2. However, in 3pite of the determined adoption and implement- ation of the reform program, the Philippine economy was not spared the effects of the deterioration of the world economic conditions. The country experienced a significant drop in its term of trade between 1979 and 1982 resulting from increases in the price of oil, the lowering of export prices and the reduction in export volume as trading partners imposed restrictive trade measures. 3. This letter is to request for a second Structural Adjustment Loan to support the second phase of our adjustment effort. To this end, I would like to recapitulate briefly the structural reforms completed to date and outline what the Government intends to undertake in the future. "leang Bee. wIeg Dwer - 62 - ANNEX IV Page 2 Focus of the Structural Adjustment Program 4. Structural reforms need to be implemented in phases and over a period of time to cushion their impact on existing businesses and the private sector and to allow for an orderly transition process. Moreover, it is imperative that structural reforms encompass all sectors requiring adjustment, considering the interdependence of all sectors in contributing to the long- term economic development of the country and in defining its rate of growth. Cognizant of these principles, the Philippine Government continues to address an agenda of multi-sectoral policy reforms, which needs to be implemented as part of the overall structural adjustment program. Concentrating on a few areas at a time, the government is optimistic and confidpnt that the reforms already implemented and those still to be adopted will produce a complementary and synergistic effect towards an accelerated achievement of the country's three main economic objectives, i.e., generation of employment opportunities, increased capability in earning its foreign exchange requirements and the more equitable distribution of the benefits of economic development amon,) its people. This must be matched, however, with structural reforms of industrialized countries, specifically the active trading partners of the Philippines. 5. The initial focus of the government's structural adjustment program has been on trade, industrial and financial policies and involves primarily the shift from an import substitution orient- ation for industrial promotion to a policy of encouragina invest- ments in areas with comparative advantage. The shift is expected to improve efficiency in industrial investments and promote the establishment of a world competitive industrial base which, in time, will reduce the dependence of the economy on external borrowings. Thus,a major industrial and trade policy reform was initiated in 1980, and financial sector reforms were introduced shortly thereafter. 6. Implementation of a second phase of industrial and trade policy reforms has begun during the last few months. This phase includes major revisions in the country's industrial incentives and investment promotion policies and measures to extend the on- going trade liberalization program. The coverage of the structural adjustment program has also been expanded with the adoption of initial reforms in the area of energy policy and public resource management intended, not only to reduce the country's dependence on imported oil and improve the efficiency of energy use, but also to increase public revenues and strengthen the efficiency of public investment. The specific measures adopted in these policy areas are enumerated in Attachment I. - 63 - ANNEX IV Page 3 7. In the future, the adjustment program will address structural problems in other areas of the economy. First, government will resolve remaining issues in the energy sector. Sceond, further improvements in the area of public resource management will be undertaken to strengthen investment programming and budgeting procedures, as well as to improve the revenue performance of both the government and public corporations. Third, agricultural development policies and programs will be reviewed for the purpose of improving the sector's contribution to the economic development of the country. Substantial preparatory work needs to be done in all these areas before a comprehensive program can be formulated. A list of studies which government shall conduct to formulate future policy action is given in Attachment II. Status of the First Phase of the Structural Adjustment Program 8. In 1980, the government formulated and adopted a comprehensive statement of industrial policy for the 1980s. The policy aims at accelerating growth of the output of the manufacturing sector and generation of employment opportunities, sustaining the high growth performance of manufactured exports and improving the efficiency of investments. 9. Building on export promotion measures introduced in the 1970s, the government introduced a program designed to further reduce the import-substitution and capital-intensive biases of existing industrial (except when the technology requires capital intensiveness) and trade policies. The first stage of this program covers the: (a) reduction of the overall level of protection and evening out of the spread in tariff rates within and between sectors; (b) liberalization of import licensing procedures; and (c) improve- ments in the export regime. 10. The government, in an effort to allowing export procedures to operate under conditions approximating a free-trade environment to enhance their performance, introduced various export incentives promotion measures in early 1980. In August of that year, the government legislated a major tariff adjustment program which will cut peak nomnal tariff rates to a maximum of 50% over a 5-year period (1981-85) and reduce the level of effective protection for manufacturing sector from 44% to 29%. Complementing the tariff realignment, import licensing procedures for about 1000 items has been programmed for liberalization over a period of three years (1981-83). The trade liberalization program is proceeding on schedule with the first three stages implemented in 1981, 1982 and 1983. - 64 - ANNEX IV Page 4 11. The government implemented far-reaching institutional and policy changes in the financial sector in 1981 to complement the industrial and trade policy reforms. Changes aimed at increasing domestic savings and availability of long-term finance as well as reducing fragmentation and inefficiency of financial institutions were introduced. Towards these objectives, the government has adopted legislation for multipurpose-banking, decontrolled interest rates and introduced additional incentives for term-lending through revisions in fiscal and rediscount policies. In addition, a lender-of-last-resort facility was established by the Central Bank. Second Phase of the Structural Adjustment Program 12. The main focus of the current phase of the government's structural adjustment program, as in the first phase, remains industrial and trade policies. In addition, important improvements in energy policy have been and are being introduced. Industrial Incentives and Investment Promotion Policy 13. The government recently revised its industrial incentives and investment promotion policies to complement the onqoinq trade liberalization program under the guiding principles of comparative advantage and industrial efficiency. The revised policy allows for market forces to play a greater role in guiding industrial investment and redirects government intervention away from regulation towards the identification and treatment of distortions in market indicators which inhibit export production, employment generation and regional dispersal of industries. 14. A major amendment of the Investments Code has been approved by the Cabinet and is expected to receive final approval by the National Assembly in April 1983. The law replaces the large number of existing fiscal incentives with a small number of new incentives specifically aimed at compensating investors more directly and fully for market distortions. Moreover, the new set of incentives are related to industrial performance rather than investment per se thereby providing a higher level of accountability and cost- effectiveness in terms of revenue foregone and making the new system "neutral" with respect to factor choice. - 65 - ANNEX IV Page 5 15. Long-run comparative advantage has been established as the guiding principle to be used in the selection of activities eligible to recieve industrial incentives. The government has also decided to limit the use of concept of "measured capacity" (i.e., filling the gap between domestic demand and existing capacity) only to the determination of the extent to which government shall grant incentives (i.e., fiscal incentives and access to government financing and guarantees) in priority areas. The 1982 Investment Priorities Plan of the BOI reflects this decision. Moreover, no regulations will be imposed on investment in new or additional capacities for any sector except for those designated as capital intensive and those covered by government rationalization programs. As corollary to this, the government has adopted a plan to liberalize import licensing procedures for machinery equipment and spare parts except those to be used in the above mentioned cases/areas. 16. The Board of Investments on 11 January 1983 improved the administration of incentives system by streamlining the procedures for the availment of incentives and reducing the project evaluation period. Greater automaticity has been introduced particularly for the availment of export incentives. This simplification of administrative arrangements is also expected to have beneficial impact on small and regionally dispersed firms which, until recently,have not availed of incentives granted by the Board of Investments because of registration requirements which such firms could not easily comply with. 17. To implement the new system for the determination of eligibility for incentives, the BOI is reorienting its staff on the greater use of economic analysis in industrial project evaluation. 18. The BOI and the Ministry of Trade and Industry have also introduced the concept of sector development programs for policy design at the industry level. ithin the framework of the overall industrial policy, sector programs will outline a strategy for the development of particular industries over the medium-term and identify institutional constraints and policy concerns which require remedial and supporting actions. Sector development programs, to the extent feasible, will increasingly become an important basis for determining the need and justification for the granting of fiscal incentives to identified activities. In addition, sector develoment programs will provide a rational basis for determining and coordinating government policies at the sector level and constitute an important part of the indicative planning by which the Government shall provide - 6b - ANNEX IV Page 6 information to guide the private sector in making industrial investment decisions. Sector prograns for the cement and textile industries are being implemented. Moreover, sector programs for the metal working and food processing industries are presently being formulated. The preparation of sector programs for two other industries will be initiated within the next six months. 19. As indicated above, the new incentives systems, in combination with the ongoing trade liberalization program, constitutes a major departure from existing policies and has important ramifications for the role and organization of the BOI and the MTI. A thorough review has thus been made of the organizational structure of these two agencies to implement the new incentives system and more generally to strengthen their capability to assume their expanded roles in the field of indicative planning and policy formulation. Specific to the conduct of sectoral studies and the preparation of the sector development programs, special institutional arrangements have been made between these two organizations. A management informa- tion system has also been set up to monitor the administration and impact of the new incentives system. The government has also initiated a major program for strengthening of the National Census and Statistics Office and for the improvement in the gathering, processing and dissemination of industrial statistics. 20. The National Tax Research Center, on instructions of the Fiscal Incentives Review Board, is presently undertaking an evaluation of fiscal incentives granted by agencies other than the BOI with a view of making them consistent with the new Investments Code. Trade Policy t 21. The government has recently effected three important follow-up trade policy reforms to those initiated in 1980: (a) adjustment of low tariff rates; (b) further liberalization of import licensing procedures; and (c) realignment of the indirect tax system. - 67 - ANNEX IV Page 7 22. To complement the movement towards greater uniformity in the structure of protection resultina from the reduction of peak tariffs under the ongoing tariff reform program, the government is reviewing the low nominal tariff rates on a number of items. A minimum nominal tariff rate of 10%, basically as a revenue measure, has been established as a policy quideline for future tariff realignment. In this connection, a review of tariff rates below 10% has been initiated by the Tariff Commission in preparation for appropriate adjustments in the Tariff Code to be made after the completion of the current round of tariff reform in 1985. 23. In April, 1983 the Monetary Board will adopt a formal plan for the phased liberdlization of import licensing procedures for NEC/UC items not covered by the liberalization plan of August 1980. The plan provides for the lifting of import licensing procedures for 36 and 201 items in 1984 and 1985, respectively. The government, however, intends to maintain import licensing procedures for 145 items primarily for reasons of safeguarding national security, public health and safety. 24. The existing sales tax system has features that taxes imports of certain products at rates higher than those imposed on similar goods of domestic origin. As part of the over-all rationalization of the structure of protection, the protective element in the indirect tax system is being gradually eliminated. The government has adopted a uniform mark-up in the imposition of the advance sales tax as an interim measure to the phasing out of the advance sales tax, the institution of a second stage value added tax and the unification of tax rates by 1 January 1985. Similarly, differential specific tax rates will be equalized by 1 January 1985. A bill (Parliamentary Bill No. 3232) was filed with the National Assembly on 15 March 1983 for the revision of Section 290-B of the National Internal Revenue Code to authorize the President to modify taxes in accordance with regional (e.g., ASEAN) and international (e.g., GATT) commitments of the Philippines on trade matters. The phased elimination of the advance sales tax will provide affected industries with the necessary adjustment period and is expected to generate an additional 1300 million in 1985, the year when the tax realignment program will be in full implementation. - 68 - ANNEX IV Page 8 Energy Policy and Public Resource Management 25. The energy sector plays a criticol role in the structural adjustment effort of the Philippines. The country needs to reduce the dependence of its commercial energy supply on imported oil which provided about 73% of commercial energy requirements in 1981. In addition, the energy sector is important in the context of public resource management considering that the energy investment program constitutes about one-third of public fixed investments. Furthermore, energy taxes and pr:.ces are important sources of public revenue. 26. Since the 1973-74 oil price increase success has been achieved in the development of alternative domestic energy resources. Efforts have also been directed towards improving the efficiency of energy use and restraining energy demand through increases in petroleum prices and, to a lesser extent, electricity tariffs. However, the 1979 oil price increase, together with the recent resource constraints in Government revenues, has under- scored the need to intensify the structural adjustment f' fort in the energy sector. 27. In conjunction with its Six-Year Energy Development Program (1982-87) the Government has adopted a comprehensive Energy Policy Statement in January 1983, outlining the objectives and policies for the development of the energy sector in the 1980s (Attachment III). Broadly, energy policy aims at accelerating the development of various domestic energy resources and strengthening energy demand management. Towards the attainment of these objectives the government intends to under- take the following: (a) implementation of the Energy Development Program (1982-87); (b) adjustment in energy pricing and taxation; (c) introduction of other energy conservation measures; (d) promotion of the conversion from oil to other sources of energy, particularly coal; (e) development of nonconventional energy resources and evaluation of noncommercial energy needs; and (f) improvement of the institutional framework for energy planning and the implementation of the energy program. 28. Initially, attention has been focussed on the formulation of an energy investment plan and an appropriate financing program. In addition, adjustmentshave been made in various energy prices and other incentives, mainly fiscal, to promote energy conservation and conversion to non-oil fuels by industrial users. In the other areas, preparation is underway to formulate future policy action. - 69 - ANNEX IV Page 9 29. The 1982-87 Energy Development Program envisages investments amounting to W67 billion in terms of 1982 prices. The size and phasing of this program was designed taking into consideration the growth targets of the economy as well as the medium-term resource constraints of the public sector and the country's balance of payments. Over half of the total investments will be for the power development program of the National Power Corporation (NPC). The program concentrates on the accelerated substitution of oil-based power by domestic geothermal energy, coal and hydropower. The program was prepared on a least-cost basis and is, therefore, justified on economic grounds. 30. Energy pricing is an important instrument for improving energy demand management as well as in generating additional resources for the energy investment program. To ensure a reasonable level of self-financing for NPC and to reduce the need for government budgetary support for the Corporation, seven automatic quarterly increases in power tariffs of ]?0.0075 per kwh will be implemented over an 18 month-period commencing July 1982. The increases will be over and above adjustments for any increases in fuel prices. More recently, government approved an additional 10% increase in the average power tariffs to take effect on 12 February 1983. 31. The Cabinet has adopted a financing plan for the 1982-87 power investment program providing for the progressive phasing- out of government equity contributions to the NPC since the corporation would have sufficient asset base to generate cash to service its debtsand expand the system. The ulan provides for budgetary support targets going down from r2.5 billion in 1982 (actual Y2.3 billion) to Y2.3 billion in 1983, fl.7 billion in 1984 to 11.2 billion in 1985 to nil in 1986. The phase-out in government equity contribution will be achieved through further improvements in the efficiency of NPC's operations and/or further tariff increases and, if necessary, a re-phasing of the power investment program. In setting the power rates to meet the targets, consideration will be given to maintaining the competitiveness of Philippine industry provided the rates are consistent with the economic efficiency criteria. 32. A restructuring of the retail power tariffs in the Metro Manila Area to reduce subsidies among electricity consumers and to further encourage energy conservation was initiated in December 1982. Furthermore, government intends to undertake a study of the structure of wholesale and retail power tariffs, within the context of the region, with a view to identifying - 70- ANNEX IV Page 10 necessary reforms for the future. The National Economic and Develpment Authority will coordinate the study which is expected to be initiated in April 1983. 33. At p-asent, a two-phase study is being undertaken on relative prices of various petroleum products and LPG to identify adjustment measures to correct the present imbalances in supply and demand. The first phase of the study has been completed. In line with the study's recommendations, and in conjunction with the need to pass on to consumeis the newly imposed 3% import surcharge and the recent depreciation of the peso, the Government plans to adjust domestic prices of petroleum products and simultaneously reduce major differentials among them. Action will be taken as soon as the presently volatile international oil situation has settled down. The second phase of the study will address longer-term petroleum price issues covering price/tax differentials and the appropriate refinery mix for the Philippines in the context of projected international oil prices, output trends and trade in refined products. This study is scheduled to be completed in August 1983. 34. Whereas energy pricing policy has been, and will continue to be the major instrument for encouraging energy conservation and conversion to non-oil sources of energy, the government is considering the need to promote conservation- related investments and the utilization of non-conventional sources of energy through the granting of fiscal incentives. For this purpose, a special provision has been inserted in the revised Investments Code to encourage investment in energy saving equipment. Moreover, the BOI will continue to grant incentives to conversion investments. Future Structural Adjustment Measures 35. As outlined above, the Government is committed to complete the structural reform currently under implementation and extend the adjustment program to other sectors of the economy. For this purpose, it intends to undertake a number of studies and projects to identify and prepare future policy actions. For a number of these studies and projects, detailed terms of reference have already been formulated or are in the process of being prepared as indicated in Part A of Attachment II. Part B of Attachment II lists studies and projects which have been identified but for which terms of reference still need to be prepared. Additional areas for study will continue to be identified as the structural adjustment program proceeds. -71 - ANNEX IV Page 11 36. Some of the studies which the government intends to under- take in the areas of industrial and energy policy have been mentioned earlier. In addition, energy studies will be undertaken to review the viability of rural electrification program and its components, to evaluate standing policies for financing coopera- tives and other aspects of pertaining to the organization and operation of cooperatives, to review the development of non- conventional energy resources and to study the potential for further energy conservation in various sectors of the economy. 37. The further improvement of the management of public resources will also be pursued. Government also intends to review the fiscal incentives granted to agricultural investment and prepare a study for the implementation of a second stage sales tax in connection with the phase-out of the present advance sales tax. 38. During 1983, the government has programmed the initiation of studies in four major areas related to public finance: (a) public expenditures and their financing, including government corporations; (b) the Philippine tax system together with the current tax administration and revenue planning system; (c) the role and operations of government financial institutions; and (d) the financial planning system for the public sector covering the government corporations as well as the national government proper. Studies on the agricultural sector will also be under- taken for the purpose of preparing a comprehensive policy reform program for the sector. Monitoring of Structural Adjustment Program 39. The government has formed an inter-agency committee to .coordinate the implementation of the structural adjustment program and monitor its effects. This committee which is composed of the National Economic and Development Authority, Ministry of Trade and Industry, Ministry of Finance, Ministry of Energy, Central Bank of the Philippines, Bureau of Internal Revenue, Tariff Commission, Board of Investments, National Census and Statistics Office and National Tax Research Center will (a) evaluate the progress and impact of the ongoing reforms in the areas of industry, trade, finance and energy; and (b) formulate recommendations for future adjustment measures in these and other sectors of the economy. The committee will also liaise with the World Bank for the purpose of arranging and negotipating future structural adjustment loans. - 72 - ANNEX IV Page 12 Short-Term Measures 40. Measures aimed at short-term stabilization of the economy and containment of fiscal and international imbalances have been discussed with the IMF, resulting in a standby arrangement of 315 SDR million over a year starting February 1983. These measures include the imposition of a temporary 3% ad valorem surcharge on all imports for revenue purposes. Under its agreement with the IMF, the Government intends to maintain a flexible exchange rate policy consistent with the objectives and policies of the structural adjustment program, in general, and the trade liberalization program, in particular. Conclusion 41. In view of the progress that the Government continues to make in the formulation and implementation of its medium-term adjustment program, we would appreciate your favorable consideration of the Government's request for a second structural adjustment loan of US$302.3 million. Sincerely, CESAR E.A. VIRATA Minister of Finance Attachments: I. Second Phase of Structural Adjustment Program: Policy Measures Completed or in the Process of Implementation II. Preparation of Future Policy Reform III. Energy Policy Statement 73 - ANE IV ATTACHMENT I Page 1 SECOND PHASE OF STRUCTURAL ADJUSTMENT PROGRAM Policy Measures Completed or in the Process of Imolementation Industrial Incentives and Promotion Policy 1. Revision of the Omnibus Investments Code establishing a new industrial incentives system designed to eliminate capital- intensive bias, promote labor-intensive and excort-oriented industries, and encourage regional dispersal of manufacturinq industry. (Batas Pambansa Blq., April 1983). 2. Adoption of new guidelines for investment priority determination, i.e., new procedures for selection of activities eligible to receive incentives and new guidelines for the preparation of the annual Investment Priorities Plan (BOI Board Resolution No. 37 dated 11 January 1983). 3. Adoption of improved procedures for the administration of the industrial incentives system, both in terms of registration with the BOI and the availment of the incentives (BOI Board Resolution No. 37 dated 11 January 1983). 4. Amendment of MAAB No. 34 limiting its application, effective 1 January 1984, to projects availing of government incen- tives, financing and guaranties in sectors designated as under government rationalization programs or capital intensive (Monetary Board Resolution No. 482 dated 18 March 1983). 5. Introduction of the concept of sector develoPment programs for industrial strategy formulation at the sectoral level and adoption of a schedule and work program for the preparation of such sector development programs for 19 of the country's major industries (BOI Board Resolution No. 37 dated 11 January 1983). 6. Adoption of revised BOI/Ministry of Trade and Industry organization plan, including staffing and training programs, required to administer the new industrial incentives and promotion system and to prepare sector development programs (801 Board Resolution/MTI Circular dated 11 January 1983). - 74 - ANNEX IV ATTACHMENT I Page 2 7. Establishment of a management information system for the Board of Investment/Ministry of Trade and Industry for the purpose of, among others, monitoring the administration and impact of the new industrial incentives system. 8. Implementation of a program to improve industrial statistics in the Philippines and to strengthen the National Census and Statistics Office (Executive Committee Decision, dated July 6, 1982). Trade Policy 9. Adoption of a plan for liberalizing importation licensing procedures for 237 items not covered the Monetary Board Resolution No. 1495 of August 1980 (Monetary Board Resolution. April 1983). 10. Adoption of a uniform mark-up in the imposition of the advance sales tax (Executive Order No. 883 dated 16 March 1983). 11. Unification of the specific tax rates on domestic cinemat:>graphic films, regardless of width (Executive Order No. 884 dated 16 March 1983). 12. Filing of a bill in the National Assembly for the revision of Section 290-B of the National Internal Revenue Code to authorize the President to modify taxes in accordance with the country's regional (e.g., ASEAN) and international (e.g., GATT) committments on trade matters (Parliamentary Bill No. 3232 dated 15 March 1983). Energy Policy and Public Resource Management 13. Adoption of Energy Policy Statement (Executive Comittee Decision in January 1983). 14. Adoption of the Six-Year Energy Development Program (1982-87) (April 1982). 15. Adoption of 1980-90 power expansion program incorporating a financing plan that specifies the gradual phase-out of government equity investment in the National Power Corporation over the period 1982-86 (Presidential Approval dated 22 June 1982). - 75 - ANNEX IV ATTACHMENT I Page 3 16. Implementation by the National Power Corporation of seven quarterly FO.0075 per kwh increases in wholesale power tariffs starting 26 July 1982 (Presidential Approval dated 22 June 1982). 17. implementation by the National Power Corporation of an additional 10% increase in the average power tariffs effective 12 February 1983 (Presidential Approval dated 24 January 1983). 18. implementation by the Manila Electric Company of a program for the restructuring of retail power tariffs for Metro Manila retroactive to 4 December 1981 (Board of Energy Decision, dated 23 December 1982). -76- ANNUIV ATTACHMENT II Page 1 PREPARATION OF FUTURE POLICY REFORM A. Studies and Projects for Which Detailed Terms of Reference Have Been Prepared Industrial Incentives and Promotion Policy 1. Rationalization of fiscal incentives administered by agencies other than the BOI with a view to making them consistent with the new investment incentives system (to be undertaken by National Tax Research Center). 2. Formulation of sector development programs for the metal working and food processing industries (to be undertaken by Ministry of Trade and Industry/Board of Investments). Energy Policy 3. Study on the efficiency and equity aspects of wholesale and retail power tariffs of both public and private utility agencies (to be undertaken by an Inter-Agency Committee chaired by NEDA). 4. Study of the structure of the prices of petroleum products and LPG and domestic refinery configuration (to be undertaken by the Bureau of Energy Utilization of the Ministry of Energy). Other Policy Areas 5. Review of fiscal and non-fiscal incentives granted to agricultural investments, including a study of market distortions/ imperfections affecting the allocation of resources in the agriculture sector (to be undertaken by the Philippine Institute of Development Studies in cooperation with the Board of Investments and other relevant agencies). 6. Study on the introduction of a second stage value added tax to be levied equally on imported items and domestically produced substitutes to replace the present sales tax (to be undertaken by the Bureau of Internal Revenue). - 77 - ANNEX IV ATTACHMENT II Page 2 B. Studies and Projects Tentatively Identified Energy Policy 7. Studies of development and application of nonconventional energy resources (alcogas, coco-diesel, geothermal, biomas, etc.) with a focus on their commercial and economic viability. 8. Study of energy conservation potentials in the industrial, commercial and transport sectors, including appropriate policy measures to achieve these potentials. 9. Review of the viability of the rural electrification program and its power generation components. 10. Evaluation of standing policies for financing cooperatives including subsidy features and grace periods. 11. Review and evaluation of the procedures followed for organizing cooperatives and the selection of Board members, as they may affect operational efficiency. 12. Study of alternative rural electrification options and applicability in the Philippine setting or selected settings. 13. Analysis of existing pricing structures employed by different cooperative utilities in different regional grids. Public Resource Management 14. Study of public expenditures and their firancing. 15. Over-all review of the Philippine tax system for the purpose of formulating tax reforms to raise the elasticity of the revenue system anti to improve tax administration. 16. Study of government financial institutions and preferential credit allocation policies. 17. Review of the government's financial planning/work program- ming/budgeting system. Agricultural Policy 18. Review of institutional framework for agricultural policy formulation and implementation. - 78 - ANNEX IV ATTACHMENT III Page 1 POLICY STATEMENT FOR THE PHILIPPINE ENERGY SECTOR I. BACKGROUND Even before the oil crisis of 1973, the government had taken steps to reduce reliance on imported oil. Shortly after the Commonwealth was established in 1935, a law was enacted creating the National Power Corooration to develop hydro-power resources. After the Second World War, the government initiated exploration of geothermal areas, requested the IAEC to prepare a feasibility study for a nuclear power plant, and introduced legislation to revise the Petroleum Act in order to encourage oil exploration in the Philippines. Prior to October 1973, however, government efforts to diversify energy sources were stymied by the comoaratively low price of imported oil. In fact, it was difficult for the Philippines to secure official development assistance for hydro- power projects. Consequently, when tie first oil crisis occured, the Philippines was still about 90% dependent on imported oil for her commercial energy requirements. The oil import bill amounted to US$231 million in 1973, representing 13% of total imports and 11% of export revenues. In 1974, the oil import bill tripled to a level of US$681 million. The sharp increase in oil prices, moreover, was accompanied by uncertainties about the continuity and adequacy of imported oil supply. The Government took several important steps to meet the crisis. A machinery for developing indigenous energy was set into motion. The Philippine National Oil Company was created in 1973 to ensure reliable oil supplies initially and, subsequently, expanded to develop oil and nonoil resources domestically. Local experts from various energy disciplines were employed to assess the extent of domestic energy potential. Legislationwas passed to enable serious prospectors to develop indigenous resources as service contractors to government. In 1976, the first comprehensive 10-year energy plan was comoleted which has under- gone several updates since. In 1977, the Ministry of Energy was created, to which the PNOC and the National Power Corporation (NPC) were attached for program and policy coordination. At the same time, energy conservation was given a high priority and both price and nonprice measures were adopted. All oil price increases were passed on to consumers and, in addition, - 79 - ANNEX IV ATTACHMENT III Page 2 taxes on petroleum products were increased. Consequently, the average retail price of oil products in 1981 was 13 times that in 1973. In addition, education programs and energy monitoring systems were established. The result had been that dependence on imported oil for our commercial energy requirements had dropped from the 1973 level of around 90% 1/ to 73% in 1981. The contribution of oil- based power plants to total electricity generated had also been reduced from 83% in 1973 to 66% in 1981. Investments in energy resource development were increased from Y39.9 million in 1973 to Y2.7 billion in 1981. The conservation efforts yielded a 27% structural efficiency imrrovement (in the GNP/energy ratio) between 1973 and 1981. The value- added per oil barrel equivalent of input increased from 1?827 to Y1,051 (in 1972 prices). An average growth rate of 2.8% in enerzy consumption supported a real growth rate of 6% in gross national product from 1973 to 1981. II. PRESENT STATUS AND OBJECTIVES FOR THE 1980s A. Situation in 1981 The second oil shock of 1979, however, threatened the gains of previous years. Therefore, the Philippine Government continues to consider imported oil as an expensive and uncertain fuel for meeting the growing energy demands of industry, commerce, transport and households. Although the share of imported oil in commercial energy consumption had been reduced to 73% in 1981, the sharp oil price increases during 1979-1980 escalated the oil import bill to $2.5 billion in 1981, accounting for 30% of total imports, 39% of export revenue and 133% of trade deficit.2/ B. Objectives for the Eighties For the eighties, the Government is resolved to continue reducing dependence on imported oil and provide relief to the balance of payments. The primary objective of structural adjustment is the reduction of the oil import bill to restructure balance of payments. Continued development of domestic energy resources aims at meeting up to 49% of commercial energy require- ments from indigenous fuels by 1987. 1/ Figures include estimates of industrial use of bagasse and other agricultural by-product fuels (6.3 million barrels of fuel oil equivalent in 1973 and 10.5 million in 1981). 2/ SOURCE: CENTRAL BANK - 80 - ANNEX IV ATTACHMENT III Page 3 To achieve this, the energy program, firstly, targets the growth of comnercial energy demand to remain within the GDP growth rate per year. Secondly, the program projects an acceleration in the development of indigenous energy resources. Government is committed to mobilizing domestic capital resources to finance this effort. The price and tax adjustments required for this purpose will also be designed to improve efficiency of resource allocation in the economy. III. PROGRAMS AND POLICIES TO ACHIEVE THE OBJECTIVES A. The National Energy Development Program, 1982-87 In line with the energy objectives set for the 1980s, the Government has prepared, among other things, the National Energy Development Program, 1982-87. The target of increasing the share of domestic energy supply is supported by sectoral energy programs, the total investment of which will amount to V56.3 billion in 1982 constant prices. Of this amount, IF17.0 billion will be invested on upstream energy resources development, 034.9 billion on power and 1?4.4 billion on downstream projects. Adding F10.7 billion for the programs of the National Electri- fication Administration, the total energy investment will amount to Y67 billion. (Table 1) The major thrust of the energy resource development pro- gram targets an increase in geothermal field steam supply capabi- lity 3/ from 1,701 megawatts in 1982 to 3,076 megawatts in 1987; 18 million metric tons of domestic coal production during the period; and limited diversification to alcogas and cocodiesel. Power investment will expand power generating capacity from 4,884 megawatts in 1982 to 8,199 megawatts by 1987. The share of oil/diesel thermal plants in the total power generating capacity is expected to be reduced from 58% in 1982 to 31% in 1987. The power investment program is based on the least cost principle and any further change in the program will adhere to this principle. 3/ This refers to the total steam supply capability targeted to be proven for various steamfields for the year. Installed geothermal power plant capacity however, is expected to increase from 559 megawatts in 1982 to a minimum 1,554 megawatts in 1987. - 81 - ANNEX IV ATTACHMENT III Page 4 Selective investments in decentralized, mini-hydro and dendro-thermal systems will also be made, especially in grid- inaccessible rural settlements. Downstream development program will build and improve energy logistics systems such as distri- bution and marketing facilities for coal and oil products. With a view to adjusting the energy program in the light of the availability of resources and capacity for implementation, regular performance review as provided by the regular updating of the energy program will continue to be undertaken at least on an annual basis. This exercise includes matching interim accomplishments with targets, and reformulating, if necessary, targets and policy measures in the light of implementing experience. To ensure that investments are economic, the decision on the types, sizes and schedules of energy infrastructure will continue to be made on the basis of providing reliable energy including power supply at the least cost to the economy. Technical planning will continue to be done on as long a time horizon as is considered realistic and practicable. B. Financing Plan for the program The investment reauired for the Ministry of Energy program would reach 3156.3 billion. About 63% of the total will be on foreign exchange which will be met from external borrowings (official development assistance, supplier's credit and commer- cial loans) and direct foreign investments. The peso requirements for energy exploration and the major part of the peso requirements for nonpower energy development will continue to be funded locally mainly from internal cash generation and energy development funds. The peso funding for the power investment program will increasingly come from internal cash generation, gradually replacing government equity contributions according to the targets presented in Table 2. Towards this end, the government has approved seven (7) automatic quarterly increases of three-fourths centavo (.0V.0075) per KWH over an eighteen (18) month period starting July 26, 1982. The increases will be over and above adjustments for any increases in fuel prices. More recently, the government aoproved an addition- al 10% increase in average power tariffs. C. Cooperative Partnership between Government and Private Sector Government will rely on the private sector as a source of high technology for offshore petroleum exploration and development and will encourage both public and private sectors - 82 - ANNEX IV ATTACHMENT III Page 5 separately and in Joint ventures to explore and develop onshore energy resources. Thus, the private sector will have a prominent role in high technology upstream activities. The power generation and transmission subsector will continue to be handled by the public sector. Government also intends to provide a major part of the coal delivery system because of the heavy infrastructure commitments. It will conti- nue to participate in oil downstream activities (refining and marketing). Electricity-distribution systems will remain the domain of private firms and cooperatives. D. Energy Pricing Policies For the eighties, the Government will continue to follow the policy of industry cost-recovery in the pricing of primary or processed energy fuels to ensure continuity of supply and to discourage wasteful utilization of fuel resources. 1. Power Rate Policy The level and structure of NPC's wholesale power rates will be adjusted during 1982-86 to achieve the multiple objec- tives of controlling the demand for power, improving equity among power consumers encouraging dispersal of economic activity, and inreasing internal cash generation. Specifically, the power rates will be adjusted to gradually reduce budgetary contributiosm to NPC's investments with the objective of eliminating the latter by 1986. These revenue-generatinq efforts will be accompanied by efficiency improvements to effect cost savings in NPC's operations. In addition, a study of the structure of power tariffs will be undertaken to identify appropriate reforms, if warranted. For electricity retailing, the regulatory boards will continue to implement a rate policy of cost-recovery plus reaso- nable returns for electric distribution util.ties. The electri- city rates in Metro Manila area have been restructured effective December 1982, resulting in the reduction of cross-subsidies. 2. Petroleum Products Pricing Policy The government intends to continue its pricing policy on petroleum products which would be passing on to the consumer all increases in price arising from price actions of the oil producing countries. To encourage energy conservation, existing taxes on - 83 - ANNEX IV ATTACHMENT III Page 6 petroleum products will be maintained and increased if necessary or justified. The relative product prices, both at the refinery and retail levels, are being reviewed to identify and correct undully large differences which could exacerbate emerging produc- tion and demand imbalances notably with respect to gasoline and diesel. Adjustments, if necessary, would be made on the special fund and the tax components which vary widely at present among products including those that are close substitutes. In this regard, the government is undertaking a study that will propose alternative price and tax structures for each fuel products, including an implementation schedule that would spread over time the impact on wages and prices to acceptable levels. To supplement the effort, the following nonprice actions are proposed to be taKen: (a) Fuel oil imports, which presently consitute 13% of total petroleum imports, will be phased out. The crude oil import mix will also be changed, to the extent feasible, to one which yields less fuel oil and more diesel. (b) Arrangementsare being made, possibly with Singapore and/or Indonesia, !or reprocessing of the heavier components in order to obtain the desired quantities of diesel and other middle distillates. (c) Experiments in, and economic analysis of, blending of petroleum-based fuels with domestic biomass fuels, such as alcohol and coconut oil, will be continued. 3. Geothermal Pricing Policy The geothermal pricing policy currently established by the government targets an 18% rate of return on investments in geothermal steam development for commercial power generation. Furthermore, PNOC is committed to finance a study of alternative pricing options for geothermal steam and the prio- ritization of geothermal sites. - 84 - ANNEX IV ATTACHMENT III Page 7 4. Coal Pricing Policy In general, coal prices will be left to market determi- nation. However, in the cement industry case, where government has mandated coal conversions, the government, through the National Coal Authority (CA), guarantees a price ceiling for participants equivalent to 65% of domestic fuel-oil prices. For other users, the ceiling is the price of imported coal or 65% of domestic fuel-oil prices, whichever is higher. For domestic suppliers, the NCA also guarantees a floor purchase price equivalent to the transfer price of Semirara coal in its long- term supply contract with NPC which features a base market price escalated over time by a cost-inflation index in order to sustain production levels. E. Conservation/Conversion Policies Complementing the indigenous supply effort, it is the policy to continue to promote investments in conversion and conservation through appropriate incentives. While price will continue to be the main instrument for conservation, it is planned that the BOI incentives will be extended to those who propose to manufacture energy-saving devices that are more economically-produced locally. Government-mandated conversion programs for which special laws have legislated incentives, will continue to receive them under the provisions of those laws. Specific equipment-replace- ment projects, directly linked to energy saving, which are presently, eligible for BOI incentives, will continue to be given incentives under any 'incentive reform'package that the government may subsequently adopt. F. Development of Nonconventional Energy Resources Several activities have been started in the area of non- conventional fuels and applications. For instance, to accelerate geothermal energy utilization nonpower uses of qeothermal steam will be promoted based on the economics of alternative uses which the Ministry proposes to study. The use of low-enthalpy geother- mal fluids can be explored for producing biomass fuels such as alcohol. Experimentations will be continued to debug or improve the production technology of alcogas and coconut-diesel to reduce their production costs and encourage their use. - 85 - ANNEX IV ATTACHMENT III Page 8 The future direction of nonconventional energy R&D will emphasize commercialization of "excess agricultural waste" for rural and urban fuel use (e.g., rice hulls, biogas, coco-shells, lumber wastes, etc.). This means continuing R&D to bring produc- tion costs down or improve design efficiencies. But only the more economically-viable noncon technologies will be promoted and necessary studies will be undertaken for that purpose. The private sector will also be tapped to undertake R&D to promote commercialization of proven technologies. G. Non-commercial Energy The Government recognizes the relative importance of the non-commercial energy sector and regards it as an area that merits continuing attention. In this regard, it will continue to under- take follow-up surveys to the 1977 and 1979 nationwide surveys in order to obtain a better assessment of the sector's importance as an energy source for different rural and urban household applications. Government will undertake studies and steps to improve the efficiency in the use of non-commercial energy resources. H. Rural Electrification and Power Program The National Elecrtrification Administration (NEA) is presently implementing two programs: The Rural Electrification Progran for electric power distribution and transmission and the Rural Power Program for electric power generation. The Rural Electrification Program has a target of provi- ding more than five million homes with electric service by 1987. The electric service distribution system is built and managed by electric cooperatives. The sources or power for these coopera- tives are the power grids of the National Power Corporation (NPC) and the mini-hydro and dendro-thermal plants which are being installed under the Rural Power Program. The Rural Power Program was developed to provide elec- tricity from domestic, renewable resources and to provide adequate power at the least cost per kwh. It is further intended to encourage the development of local manufacturing industries, reforestation, rural employment and income, new farm units, and ecological balance. By 1987, it is estimated that power plants with a total capacity of about 500 MW will have been installed. - 86 - ANNEX IV ATTACHMENT III Page 9 Scheduling and specific project-components of both pro- grams are mainly determined by the relevant factors of demand, technical and economic feasibility, and availability of funds. The total investment requirement for both Programs (1982-1987) is estimated to be 10.7 billion (in 1982 prices), half of which will be required in foreign exchange. This foreign exchange zequirement will be met by external loans while the peso requirement will be met by Philippine Government equity contribu- tions. All investments are and will be made by and on behalf of the cooperatives. The funds received by NEA are relent to the cooperatives with a maximum thirty-year amortization period. The cooperatives' tariffs are in turn so designed as to cover the repayment of all loans and to provide a 2% to 3% margin on gross revenue. The repayment of loans from the cooperatives is used by NEA as its source of investments funds. Equity contribution from the Philippine Government is, therefore, the cash requirement of NEA net of cash inflow from loan repayments and other revenue sources. The present policy of NEA is to have a cash balance of not more than equivalent of three months' expenditure. I. Institutional Strenthening The Government has continued to take steps to strengthen the planning and implementing capability of the Energy Ministry and attached government corporations. The first stage of coor- dination planning has been taken with regular consultations done through technical counterpart committees between NPC and NEA in the presence of NEDA planning representatives. Highly competent technocrats have been recruited to staff critical management positions in the Ministry as well as the attached corporations. Innovative managerial concepts continue to be introduced. The practice or rotating managers for purposes of professional exposure and cultivating a more generalist perspec- tive is an existing practice. The corporate planning and executive units of the PNOC and NPC have been expanded and strengthened. Technical and super- visory training programs for line personnel are vigorously implemented. - 87 - ANNEC IV ATTACIMENT III Page 10 At the Ministry, responsibilities have been streamlined. The most recent step has been the creation of the Ministry's Policy and Program Coordinating Committee to ensure that the development of sector specific operational policies are compa- tible with those of other units within the Ministry. This Committee includes representatives of NPC, PNOC, Bureau of Energy Development, and Bureau of Energy Utilization and is chaired by the Senior Deputy Minister. In addition, the planning and coordinating capability of the Ministry of Energy will be strengthened, in areas of interface especially between geothermal,coal and power sectors. Coordination with other realted Ministries (e.g., Industry, Transportation, Highways) with an impact ca the energy program will also be improved especially in relation to locating energy intensive industries close to appropriate sources. Training programs will continue to be conducted to supply the sector with sufficiently trained manpower to meet the expanding challenges of an increasingly complex program. '.4 'UGIIIIG•01 &old cnui;unawe C'L9 olle 1'99 VU6 ol1e S' * 00 V'IL VOLt 9'14 CIOe ANMe t*St 9,10fa 3104% 91'Lt'4 0°Et'st991109'91 wtse>'( 16'118'1 t6'L65't 1t'191't 95'1SL'9 tolo10't 1SIS1L'G 95,900,C LLIL'6' 9t's10'Þ 00'199'95.S110'1p 'ivuu siv&0sL,L61 LLst o6a9LvAludo6 e6 t 6 (9esia4 1961 'emed ue111IN ul) LO-9061 'A~nu,ZM Wv~os ADMØ ZU 40 A~wm Aoffla JO AUSININ E1 "IM ANNEX IV Attachment III Saq Page 12 TABLE 2 SCHEDULE OF MAXIMUM GOVERNMENT EQUITY CONTRIBUTIONS TO NPC (Amounts in IF Billion) Maximnu Government YEAR Equity Infusions 1982 2.3Af 1983 2.3 1984 1.7 1985 1.2 1986 0.0 1987 0.0 A 7.5 - Actual. Th LargetL fo-92ws725blin International Bank for Reconstruction and Development FOR OFFICIAL LSE ONLY AMNEK V Page 1 of 4 90 -- SecM3-11541 FX0K: Senior Vice President, Operations* December 23, 1983 PHILIPPINES: Release of the Second Tranche of the Structural Adjustment Loan The following change is made to the Memorandum to the Board (SecM83-1154) of December 12, 1983. paragraph 6. sentence 2. to read: "A new standby arrangement is being negotiated between the Government and the International Monetary Fund, but has not yet been concluded." Distribution: Executive Directors and Alternates President Senior Vice Presidents Senior Management Council Vice Presidents, IC Directors and Department Beads, Bank and IFC This document ha% a restricted Jistnbution anu md, be used by recipients ertly in the performance of their official duties. Its content, mj% not otherwise be disclosed without World Bank authorization. International Bank for Reconstruction and Development FOR OFFICIAL USE ONLY ANNE V -91 - Page 2 of 4 SecM83-1154 FROM: Senior Vice President, Operations December 12, 1983 RELEASE OF THE SECOND TRANCEE OF TOE STRUCTURAL ADJUSTMENT LOAN TO THE PRILIPPINES* 1. As provided in Section 3.03 of the Loan Agreement for the Structural Adjustment Loan (SAL) II to the Philippines, discussions were held with the Government during October 10-26, 1983, to review the Implementation of the structural adjustment program supported by the loan. The review covered both the general progress of the program and the implementation of the specific measures related to the release of the second tranche of the loan. General Progress of Structural Adjustment 2. The Government has continued to make good progress in implementing the program of trade liberalization initiated in 1980. The tariff reform program, covering a five year program of phased tariff adjustments, continues to be implemented on schedule, despite a difficult balance of payments situation. The average nominal tariff rate has been reduced from 43% to 30% during 1980-83 and is scheduled to go down to 24% by 1985. Similarly, the three initial phases of the import liberalization program eliminated impor%. controls on 70% of items during 1981-83. Another 237 items will be liberalized in the next two years. Realignment of excise and sales, taxes to phase-out their protective effect has been signed into law. The realignment of excise taxes has become effective immediately and that of the sales tax will become effective on January 1. 1985. E Questions on this document may be referred to Mr. Khan (ext. 72137) Distribution: Executive Directors and Alternates President Senior Vice Presidents Senior Management Council Vice Presidents. IFC Directors and Department Heads, Bank and IFC Tht5 document has . retriated diainhuton anu m.a be used by recipients onl in the performance of their official duties Its content% ms not oher%iNe be disclosed without World Bank authorization. - 92 - ANNEX V Page 3 of 4 However, because of the acute balance of payments situation, the Government was forced to introduce temporary controls on foreign exchange allocations during the third quarter of 1983. In addition, a 5% surcharge on imports has been imposed in order to help reduce the budgetary deficit. The Government has agreed, however, that these are temporary measures designed to cope with the current crisis and will be removed as the balance of payments situation improves and new revenue devices are developed. . 3. The Government has also made good progress in other areas. For exports, a commission has been instrumental in simplifying procedures for accreditation and commodity clearance and is currently reviewing the existing bonded manufacturing warehouse facilities and duty drawback provisions. A new Investment Incentives Policy Act aimed at improving the efficiency of industrial investment and simplifying the administration of industrial incentives was enacted in April 1983. Rules and Regulations implementing the Act have since been formulated and the relevant staff is being trained and expanded. A series of sectoral development programs have been begun which will assist in investment priority determination, tariff reform, and incentives system design. 4. In the energy sector, the Government's program focuses on the development of domestic energy resources to reduce dependence on imported oil, the generation of funds for energy investment, appropriate energy pricing and energy conservation. Under this program, the share of imported oil in commercial energy consumption has dropped by about 82 during the last year. However, thz energy investment program is being reordered to take into account the current resources constraint which will affect the pace of oil import substitution. Power tariff increases are being implemented on schedule; the cumulative increase since July 1982 is about 21%. Recently, domestic prices of petroleum products have been increased toreflect the recent devaluations of the peso and increased duties and taxes. In the process, the differential among various petroleum product prices has also been narrowed. The Release of the Second Tranche 5. As agreed at the time of loan negotiations, the release of the second tranche of the loan was to be related to both general progress in structural adjustment and the completion of certain specific measures. The latter include adoption of legislation for the realignment of indirect taxes, preparation of sectoral development plans, the simplification of investment incentives procedures, adjustment of petroleum product prices, and im- plementation of the planned power tariff increases. 6. All of these conditions have been substantially met, as noted above. A new Standby Arrangement, covering part of 1983 and the whole of 1984, has recently been negotiated between the Fund's management and the Government. A special advisory committee of the commercial banks has also developed a financial package to support the country's stabilization measures. The Government has given the Bank written assurances that the import restrictions and foreign exchange controls imposed as part of its stabilization effort are purely temporary and will be removed as soon as the 93 - ANNEX V Page 4 of 4 balance of payments situation improves. The timing of the phase-out of these restrictions will be discussed as part of the mid-term review of the new Standby Arrangement. The Government has also given its commitment to remove the import duty surcharge by the end of 1984. Overall, the Government remains committed to, and has continued to implement, the program of structural adjustment despite a very adverse economic and financial situation. Consequently, we are proceeding with the release of the_final tranche of S100 million of this loan. Ernest Stern Senior Vice President, Operations By Warren C. Baum -94 - ATTACHMENT REPUBLIC OF THE PHILIPPINES Page 1 of 12 NATIONAL ECONOMIC AND DEVELOPMENT AUTHORITY .4 NEDA sa Pasig, Amber Avenue Pasig, Metro Manila Cable Address: NEDAPHIL P.O. Box 419, Greenhills COMMENTS FROM BORROWERTIs63.03 o0 Tels. 673-50-3t to 50 INTER-AGENCY C(mlWlTIEE TO NDNITOR AND )0RDINATE THE SIRUCTURAL ADJUMSTENT PROGRAM 7 June 1985 Director Yukinori W.itanabe Operations Evaluation Department The World Bank 1818 H Street, N.W. Washington D.C. U.S.A. Dear Mr. Watanabe: This has reference to your request for comments on the first draft of the Program Performance Audit Report on the Philippines' First and Second Structural Adjustment Loans. In this connection, we would like to inform you that we are in agreement with the Report 's general observations. Indeed, the implementation of measures committed under the structural adjust - ment program has largely been effected, albeit sometimes behind schedule. We likewise agree that in retrospect, the potential positive impact of the program is weakened by the non-inclusion of inportant/significant measures such as fiscal management which has greatly affected the performance of the Philippine economy. Thus, for future structural adjustment programs, we see the need for the country to formulate its own program consisting of precisely-expressed measures and covering key areas such as financial management, improvements which are prerequisites for sustained progress in the economy as a whole. The above points notwithstanding, we see the need to clarify and suggest revisions on specific points mentioned in the draft report. Attached is a tabulation of these specific comments. This includes the comments of various agencies such as the Ministry of Trade and Industry, Board of Investments, Central Bank, National Census and Statistics Office, National Tax Research Center, Tariff Commission, .../2 . ATTACHMENT Page 2 of 12. - 95 - Ministry of Energy, and NEDA which have been consolidated by our Staff as secretariat of the Inter-Agency Comittee to Monitor and Coordinate the Structural Adjustment Program. We hope that you will find these useful. Warm regards. Very truly yours, RAWON B. CARDENAS (Ciainan) Deputy Director-General ATTACHMENT -96 - Page 3 of 12 (DilElMS ON THE DRAFT PROGRAM PERFORMANCE AUDIT REPORT Page/Paragraph No. Comments 7/18 The date mentioned in the paragraph should be 15 October 1984 rather than 12 October 1984. While CB Circular 1029 (Consolidated Rules and Regulations to Govern Import Transactions) was approved by the Monetary Board on the latter date, it became effec- tive only on 15 October 1984. As such, sourcing of foreign exchange to finance imports of freely importable commodities/ liberalized items from the commercial banks without being coursed through the Central Bank took effect on that date. 7/19 Only imports of vehicle-assembly parts are confined to registered participants in special government programs. Raw materials, machinery and components may be imported by any firm. 7/20 It is informed that importation of banned consumer items by tourist duty-free shops and tourist-oriented establishments duly registered with the Philippine Tourism Authority may likewise be allowed upon prior approval by the Central Bank. This regula- tion is contained in Section 106 of CB Circular No. 1029. 8/22 Only four regulated items and not six as stated in the draft report had been libera- lized since the approval of the liberali- zation plan in 1980, i.e., solid caustic soda, cellophane, integrated data processing equipment and non-agricultural plantmachinery, equipment and spare parts. 8/24 The average tariff rate was to be reduced from 43% to 28% and not from 44% as mentioned. 9/26 Existing tariffs below 10% would be reviewed after the tariff reform program had been completed in 1985. Whether or not the tariff will be raised will depend on the findings of the review. ATTACHMENT Page 4 of 12 - 97 - Page/Paragraph No. Comments It is clarified that the reduction of maximum tariff rates continued in 1983 and that at the begiming of 1984, 133 tariff lines remained with rates exceeding 50%, the maximum rate being 60%. 9/27 The additional duty was reduced to 5% beginning 15 October 1984 for petroleum products and beginning 1 January 1985 for all others. 9/28 The first sentence should read "At the beginning of 1985 therefore, the five year tariff reform program for the years 1981-85 had been completed." 10/31 Export procedures have been simplified with the abolition of unnecessary export clearances and requirements by virtue of EO 1016 dated March 1985. Clearances are considered necessary only when required by the buyer- country or importing country, by treaties or international agreements, and when public interest requires government to ban or monitor export shipments. Procedures for processing duty drawback claims have been simplified. The Inter-Agency Committee on Standard Rates of Special Tax Credit/Drawback for Exporters has drawn up a list on which standard rates will be applied. The standard rates will be used to claim tax credit filed by BOI registered firms under the Onnibus Investments Code as well as claims for drawbacks filed by other exporters under Sec. 106 of the Tariff and Customs Code. Its use will ensure exportersof immediate refund of taxes and duties paid on imported inputs, reduction in processing time, and removal of unnecessary documentary requirements. In line with this, a Tax Rebate Center for Exporters was set up in May 1985 within the BOI with representatives from the BIR and the Bureau of Customs depu- tized to sign certificates of tax credit or drawback. ATTACHMENT -98- Page 5 of 12 Page/Paragraph No. Comments 11/33 The exchange rate cited in the para. at Y7.40 per US dollar at end 1978 and Y8.90 at end 1982 does not jibe with Central Bank figures. The end-of-period rates for these two years per CB data should be ?7.375 and F9.171, respectively. Further, it is clarified that the country's exchange rate system does not operate under a managed float but rather a free-float. With the abolition of the guiding rate as well as the use of the wider band (refers to the range within which the exchange rate for each individual foreign exchange transact- ion can deviate above or below the guiding rate for the trading day) effective December 13, 1984, the country's exchange rate system ceased to be classified as operating under a managed float. Presently, it operates under a free float or independent float wherein the buying and selling rates are determined competitively in the foreign exchange market (on and offthe trading floor). Therefore banks can buy and sell foreign exchange among themselves without having to bid in the trading floor of the Bankers Association of the Philippines. This conforms with the IMF classification which identified countries operating under a flexible float as those whose exchange rates are allowed to move continuously over time; if the authorities intervene at all they do so only to stabilize, but not to neutralize the speed of exchange rate move- ment. Alternatively, under a managed float, the exchange rate may be set for a short interval, usually one day to one week, and the authorities stand ready to buy and sell foreign exchange at flat specified rate. 12/36 It is clarified that the BOI jurisdication is limited to firms both Filipino and foreign, which are registered with the BOI for incentives. Other finns do not have to secure BOI clearance in order to employ foreign nationals. ATTACHMENT Page 6 of 12 - 99 - Page/Paragraph No. Coments 14/43 The following paragraph should be added: "To make sure that the restoration of with- drawn tax and duty exemption privileges is in consonance with declared policy guide- lines, reference to sectoral studies, whether on a firm or industry basis, is necessary. This is to be provided by the continuing review by the NTRC of incentives systems outside of those implemented by BO1." 16/47 Official statistics show that the share of oil imports to total imports has been as follows: Value of Oil t Share to IMports ($M) Imports Total Year Crude Refined Total ($M) Imports 1973 166 21 187 1,597 12 1979 1,115 256 1,371 6,142 22 1980 1, 857 369 2,226 7,727 29 It is suggested that the third sentence be revised as follows: Meanwhile, restrained by increasing prices and revenues...., imports of petroleum plus petroleum produc- tion which had risen slowly from 75 million barrels in 1973 to 85 million barrels in 1980 began to decline; this has dropped from 74 million barrels in 1981 to 58 million barrels in 1984. 16/48 With reference to budgetary payments, the 1984 figure should be P702 million instead of P0.9 billion. Further, it is informed that out of the 9702 million. 9593 million was received by NPC in 1984. (However, only P514 million was recorded in NPC's 1984 audited statements.) The unreleased portion of 9109 million as of year-end 1984 was received by NPC during -he first quarter of 1985. 17/49 The third sentence is best stated as follows: The government's concern for maximum safety has pushed the per KW cost to about $3,000 with capitalized interest during construc- tion. ATTACHMENT Page 7 of 12 - 100 - Page/Paragraph No. Coments 18/50 With regard to the agencies which received technical assistance from SAL, all references to the "Board of Investments" should be revised to 'Ministry of Trade and Industry/ Board of Investments." 18/52 There has been no delay in the implementa- tion of the tariff reform program since from 1981 to the beginning of 1985, it proceeded as scheduled. The last and final phase of the tariff reform is now in place. While the across-the-board additional duty imposed in October 1983 could have affectee to some small degree the programed decline of the absolute tariff level, it did not reverse the scheduled program. 19/53 As an update, it is informed that in April 32/84 1985, the Central Bank's Monetary Board issued Resolution Nos. 413 and 414 which implemented the resumption of the trade liberalization program. The Central Bank will issue a Circular liberalizing the 46 NEC/UC items originally scheduled for libera"ization on 1 January 1984 under the SAL program. The Monetary Board also approved the new timetable for liberaliza- tion of 17 regulated conmodity groups, 3 of which will be liberalized after the approval of the debt relief and the associa- ted trade facility from foreign commercial banks. The remaining 14 regulated commodity groups and another 202. NEC/UC items will be liberalized on 31 December 1985. 22/60 Regarding the debt service ratio presented in the Table, we lack information ort the basis for such computation. The following data on average ratios uses the RA 6142 concept and the IBRD/IMF method (actual and projected debt service burden/ratios include debt servicing on SAL I and II loans): ATTACHMENT Page 8 of 12 - 101 - Page/Paragraph No. Coments Average Debt Service Ratios (%) For Periods Indicated Per RA 6142 Per IMF/IBRD a/Med Year Concept Metod 1977S/- 1980 17.2 18.0 1980 - 1985 18.9 25.2 1981 - 1985 19.0 36.2 1980 - 1983 18.3 28.4 23/62 The third sentence should be revised as follows: Apart from energy --- where SAL II provided for the continuation of the long-standing policy of price adjustments to reflect fully changes in the peso cost of imported oil,.. a/ Computed as the ratio of debt service burden on all fixed term credits including IF obligations (but excluding prepayments and interim financing) to foreign exchange receipts of the inediately preceding year. b/Computed as the ratio of debt service burden on medium and long term credits including IMF obligations (net of pre- payments) and interest on short term non- bank and banking system liabilities (gross) to current year's receipts from export of goods and services. c/Start of calendar year being used as basis of computing ratios; previous year's ratios were on a fiscal year basis. ATTACHMENT Page 9 of12 - 102 - Page/Paragraph No. Comments 24/64 On the observation that some of the measures 29/77 adopted were not clearly defined making the program's potential benefits difficult to determine, it would have been better had the measures being referred to been identified. Contrary to the statement that regulated items were "left untouched", 4 items were already liberalized since 1980. The report tends to downplay the role of the trade liberalization program in effecting structural change. However, it is emphasized that this progran represents a major reversal of the protective import policy of past decades. While the liberalized items may account for a small portion of total imports thus rendering the program of "limited importance", their liberalization could already affect the investment decisions of domestic industry in major ways. This is because import controls an items needed by domestic industry represent costs which in some cases may be even more burdenscme than tariff payments. In the same way, the expanded availability of importable items which could compete with or complement domestic production would influence business decisions. On. the role of BOI, it is observed that while it continues to exercise a major role in investment decisions through .its incentive system, it can no longer be termed as "excessive". The BOI and MrI are now closely coordinating with the private sector in the determination of investment priori- ties, among others. This ensures a consul- tative mechanism through which such "excessive control" is minimized. The resulting freer environment would, in an indirect manner, enhance the management of industrial policy and subsequently the efficiency of investment decisions. ATTACHMENT Page 10 of 12 -103 - Page/Paragraph No. Conments 27/72 It is true that the Structural Adjustment Program "did not include measures in the agricultural sector". However, it should ae pointed out that SALs I and II were really directed at instituting measures relating to the trade, industry, and energy sectors. The reforms in the agriculture sector are proposed to be supported by SAL III. In fact, initial reforms in the agriculture sector have already been done under the Agriculture Inputs Loans with the World Bank as well as the $100-M Agricultural Credit Project Loan. 29/77 The first sentence is best stated as follows: While the direction of the government poli- cies may meet the Bank's criteria...., the measures may be inadequate. 31/82 The second sentence is best stated as follows: .....secondly, the continuation in 1983 of the government's policy to reflect inter- national price movements in energy prices to pass costs of imported petroleum products fully to customers and since 1983 to make electricity..... 32/86 It is suggested that the third sentence be deleted since it is not necessary to incor - porate it in the paragraph. 33/88 The report refers to large projects under- taken by the public sector which could have led to structural adjustment efforts. It seems that the projects referred to are the 11 major industrial projects. If so, this statement in para. 88 would not be accurate. It is recalled that it is one of the five major areas in the country's industrial policy which was presented to the WB for support under SAL I. Thus, it is part of the structural adjustment program, and not one of the causes for seeking structural adjustment. - 1.04 - ATTACHMENT COMMENTS FROM BORROWER Page 11 of 12 REPUBLIC OF THE PHILIPINE NATIONAL ECONOMIC AND DEVELOPMET AUTHORITY TARIFF COMMSON *UEZON CITY May 24, 1985 Mr. Yukinori Watanabe Director Operations Evaluation Department The World Bank 1818 H Street, N.W. Washington, D.C. 20433 U. S. A. Deai Sir: This has reference to your letter, dated 19 April 1985, requesting comments on the Program Performance Audit Report - Philippines First and Second Structural Adjustment Loans (Loans 1903 - PH and 2266 - PH). In this connection, hereinbelow is the Tariff Commission proposed corrections to and comments on the abovementioned report. I. para 24. First line, change "44" to "43". 2. para 26. Second sentence, change "raised" to "reviewed". 3. same para. Third sentence, delete "-84" and change the word "end" to "beginning"; change also "35" to "133". 4. para 27. Second sentence, change the phrase "the beginning of 1984" to "October 15, 1984". Insert after "5 percent" the following phrase "for petroleum products and beginning January 1, 1985 for all other products". In the same sentence, delete ", and" after "5 percent". 5. para 28. First sentence, delete the phrases "most of" and "except that some industries still had rates of 60 percent against competing imports". 6. para 52. Comments: There had been no delay in the tariff reform program since from 1981 to the beginning of 1985 it proceeded as scheduled. The last ATTACIMENT . - 105 - Page 12 of 12 and final phase of the tariff reform is now in place. However, because of the need for additional revenue, the Government had imposed a temporary across-the-board addi- tional duty in October 1983. This additional duty have affected to some small degree programmed decline of the absolute tariff level but have not reversed the scheduled program. Very truly yours, CORA B. MARCOS Commissioner -/06 - S/YV9Ce i4r  - 107 - PHILIPPINES STRUCTURAL ADJUSTMENT LOANS I AND II (IBRD LOANS 1903-PH AND 2266-PH) Program Completion Report July 30, 1984 Country Programs Department East Asia and Pacific Regional Office J - 109 - PHILIPPINES STRUCTURAL ADJUSTMENT LOANS I AND II Program COMPLETION REPORT SUMMARY AND CONCLUSIONS Emergence of Structural Problems The performance of the Philippine economy improved considerably during the 1970s. The growth rate of GNP increased from 5Z in the 1960s to almost 7% at the end of 1970s. The agricultural sector expanded rapidly and thu need for rice imports was eliminated in the second half of the decade. Manufactured exports, such as garments, electronics, handicrafts, and footwear, expanded dramatically in response to various export promotion mea- sures. These exports accounted for more than a third of the country's total merchandise exports at the end of the decade. There were, however, several disappointing features of this other- wise good performance. GDP growth was achieved at a high investment cost - the incremental capital/output ratio (ICOR) was about 35% higher than those of comparable Asian countries. Although inherently capital-intensive infrastruc- ture investments partly explain the high ICOR, inefficiency of industrial investment was the more important cause. Inappropriate trade, industrial, financial, and exchange rate policies provided high protection for domestic manufacturers and led to investment in activities in which the Philippines did not have a clear comparative advantage. Consequently, the domestic manufacturing industry remained inefficient and grew only at about the rate of the CNP. External borrowing and imports, including inputs for manufactured exports, expanded rapidly while traditional exports and domestic resource mobilization lagged. This resulted in a chronic shortage of foreign exchange and increasing external debt. These fundamental weaknesses in the structure of the economy kept the growth rate below its potential. Furthermore, the relatively high capital intensity of the economy and uneven pattern of growth hindered employment generation and poverty alleviation. To deal with these problems, the Government made initial attempts at structural change in the economy during the 1970s. It initiated a program to encourage and diversify nontraditional manufactured exports. An energy con- servation and resource development program was adopted to reduce oil imports. However, the structural problems of the Philippine economy were greatly exacerbated by the 1979 oil price increase, the ensuing international recession, and a fall in commodity prices. A continuing expansion of public sector investment in energy, industry, and infrastructure further increased the need for foreign borrowing. Increased debt service caused by rising interest rates and increased borrowings began to put additional strain on the balance of payments. The growth rate of GNP began to decline, and public finances and the financial sector further weakened. - 110 - The Structural Adjustment Program and Its Implementation The developments of 1979-80 accentuated the existing structural pro- blems and highlighted the need for reform. The Government, with assistance from the Bank, therefore, prepared a structural adjustment program for the 1980s. The program, as in other countries, was conceived as a series of measures to be implemented over time. The areas identified to be covered by this process included restructuring of the industrial sector, energy conserva- tion and development of domestic energy supply, financial sector reforms, appropriate interest rate po'icies, and disciplined demand management. Structural Adjustment Loans (SALs) I and II covered the first two phases of the program. SAL I (approved in September 1980 with an amount of $200 million) supputed the first phase focusing on reforms in trade and industrial policy.- SAL II (approved in April 1983 with an amount of $302.3 million) supported the second phase of the adjustment program. This phase continued the trade policy reforms, extended the industrial sector reforms, and initiated reforms in energy policies. The following paragraphs summarize the program and performance in various sectors under the two SALs (see Annex I for a summary rating of the performance). Trade Policy Reforms. A major effort under both SAL I and SAL II was made to achieve a more open, less restrictive, and less protective trading regime, with the objective of improving the efficiency of domestic industries, promoting exports and increasing employment. It consisted of a tariff reform program, removal of quantitative restrictions on imports, strengthening export promotion measures, and realignment of indirect taxes. The tariff reform program was designed to reduce the nominal maximum tariff rates from 70-100% to 50% and to Lower the average nominal rate from 43% to 28% by 1985. In addition, it aimed at reducing the degree of tariff escalation, which resulted from lower tariffs on raw material imports and much higher tariffs on finished products. It was also designed to raise tariffs for certain products which previously had low rates of protection such as machinery and other capital equipment. Overall, the tariff reform program has proceeded as scheduled, despite a difficult balance of payments situation. The average tariff rate had been reduced to 29Z in 1983. The last stage of the tariff reform is scheduled to be implemented on January 1, 1985. However, because of the need for increased revenues, the Government has imposed, starting in December 1982, a temporary additional import duty on goods. The duty is currently assessed at 10%. At the time of the mid-term review in October 1983, the Government had agreed that the additional duty would be removed at the end of 1984. However, the Government now feels that the duty can be removed only if a manageable balance of payments position is achieved by then. Otherwise it will be removed in 1985. 1/ Financial sector reforms were closely linked to industrial sector reforms and were supported by an Industrial Finance (Apex) Loan which was approved in May 1981. - 111 - The Government's import liberalization program envisaged (a) removal of import restrictions from most of the consumer goods items classified as non-essential or unclassified (NEC/UC) and (b) reduction of import licensing requirements for a large number of producer and consumer goods. Of the 1,304 NEC/UC items, 960 were to be liberalized under a three year plan. The bulk (873) of these items were liberalized on schedule in 1981 and 1982. The scheduled liberalization of the remaining 87 items was scaled back to 48 in 1983 in response to business concerns expressed during public hearings. The enactment of the 1984 portion of the import liberalization plan (covering 36 items) and reduction in import Licensing requirements for industrial machinery have been deferred pending improvement in the balance of payments situation. Despite this, the share of original NEC/UC items in total imports has risen from 2.9% in 1980 to about 4% in 1983. This shows that the liberalization program is working, but it has not had a significant adverse impact on the balance of payments. As the balance of payments situation worsened during 1983, a number of new restrictions have been temporarily imposed, or existing restrictions tightened. It is estimated that at present about 50% of non-oil imports come * under some form of restriction requiring "prior approval" of the Central Bank or various Government agencies. Nevertheless, the Government remains committed to the import Liberalization program and plans to remove these restrictions, including the newly imposed foreign exchange controls, once the balance of payments situation eases (discussed below). As a complement of the tariff reform, the Government had prepared a program of realignment of indirect taxes. The realignment aims at reducing the explicit or implicit protective effects of indirect taxes by removing advance payment of taxes on imports, unifying certain tax rates on imported and domestic goods, and simplifying relevant tax procedures. Part of the program has already been implemented and the rest is planned to be implemented by January 1, 1985, in accordance with the SAL II agreement. Although imple- mentation of these measures will improve resource allocation, the Government will have to improve tax collection and probably increase tax rates to avoid any revenue loss on this account. Improvement in export incentives and promotion formed a substantial component of SAL I, most of which had been accomplished prior to the formal SAL agreement. They included: strengthening and broadening of fiscal incen- tives for export production and trading; simplifying import and export proce- dures; liberalizing bonded manufacturing warehouse arrangements for exports; improving export financing facilities; and strengthening institutions that promote exports and international trade. The export promotion measures had also incLuded the introduction of standard costings and allowances for the duty drawback system and undertaking of studies on how to improvq export financing and export promotion. Only limited progress has been made in these areas. The Government has taken a number of steps to simplify the system of duty drawbacks but the standard duty drawback procedures have not been implemented. According to the Government, the private sector has not found the latter to be attractive. Similarly, the Government has undertaken only partial studies of certain aspects of export - 112 - financing. It has, however, implemented several improvements in the export financing facilities and instituted other reforms to improve exporter benefits. Industrial Policy Reforms. To supplement the trade policy reform program, the Government introduced a reform program of its industrial develop- ment policies. The program consisted of a reform of the industrial incentives system, introduction of a concept of sector development programs for policy design at the industry level, and strengthening of institutions. A new industrial incentives system was adopted in April 1983. Its main thrust was to reduce the capital-cheapening bias of the existing fiscal incentives and to relate the latter to the output performance of the firms. Furthermore, it introduced a new rationale for investment priority determination based on the country's comparative advantage and simplified substantially the procedures for the registration of investment projects and availment of incentives. A sector program approach to industrial planning was approved by the Board of Investments (BOI) in January 1983. The Government designated 19 key industrial sectors for which sectoral programs would be prepared. The pace of sectoral development programs has been much slower than had been planned. This was partly because the programs have turned out to be more complex than anticipated and partly because the institutional capacity of BOI was inade- quate for this ambitious task. At present, two sectoral programs, cement industry and textile industry modernization programs, are under implementation although the textile program is behind schedule mainly due to the continuing domestic recession. Programs for food processing industry and electronics industry have been almost completed; and a study on metal working industry is in advanced stage of preparation. In the light of the experience gained in sector programming, the Government is prioritizing the original list of sectors, making the programs more operational, and increasing the private sector participation in the preparation ot thq programs. In addition, export development plans for six priority products - have been separately formulated. To improve the institutional capacity in implementing the new industrial promotion policies, the Government has implemented a reorganization of the Ministry of Trade and Industry (MTI)/BOI and improved substantially the staffing and training programs of the concerned agencies. It is also implementing a Management Information System for MTI/BOI for the purpose of, among others, monitoring the administration and impact of the new incentives system. As part of its industrialization program, the Government had pro- posed to establish 11 major industrial projects. The Government has generally taken a prudent and flexible approach towards implementing these projects. Two projects (the copper smelter and the low horsepower diesel engine plant) have been completed and four projects (the phosphatic fertilizer plant, the 2/ Garments, furniture, electronics, gifts and housewear, leather and leather goods, and fresh and processed foods. - 113 - coconut chemical plant, a part of the heavy engineering industry project, and modernization of the cement industry) are under implementation. The Govtrn- ment has decided to delay the integrated steel mill project (although an exis- ting steel rolling mill is being expanded) and to postpone indefinitely dhe four remaining projects (alcogas, aluminium smelter, integrated pulp and paper mill, and petrochemical complex). While the implementation of the industrial policy reform program has been generally good, progress in some areas has been limited. These include the improvement of industrial statistics and strengthening of NCSO, the review of investment incentives administered by agencies other than BOI, and import liberalization, although the lack of progress in the last area is understand- able in view of the serious balance of payments difficulities. Energy Policy and Resource Management. The energy reform program was designed to reduce import dependence, diversify energy supply sources, increase energy conservation, rationalize energy investment, and generate additional funds for financing energy investment. Good progress has been made towards these goals: the share of domestic energy supply in total has increased from about 28% to 35% during 1981-83, energy efficiency has increased on account of conservation measures adopted, the investment program has been adjusted, and resource mobilization has improved. To encourage energy conservation and improve resource mobilization, the Government has continued to adjust energy prices. In the power subsector, which in the past had been excessively dependent on Government equity contri- butions for "ts investment program, the Government has significantly increased wholesale power tariffs and introduced automatic adjustments to reflect for- eign exchange rate changes and fuel cost increases. As a result, between June 1982 and January 1984, the nominal tariffs have increased by 82% and real tariffs by 40%. The National Power Corporation's need for Government equity contributions has been reduced (which are even lower than the agreed target figures) and will be eliminated by 1986. The Government has restructured retail electricity rates in the Metro Manila area. However, a study to sug- gest future reform of the country-wide structure of power tariffs has been substantially delayed due to lack of adequate financing. The Government had initiated a two-phase study of the price struc- ture of petroleum products and LPG for formulating a long-term pricing and refining policy. The first phase of the study was completed in 1982 and the second phase is now being finalized. In the meantime, reflecting the changes in international oil prices and the country's economic situation, the Government has increased the average domestic price of petroleum products by about 38% between June 1983 and June 1984. Simultaneously, as envisaged under SAL II, it has reduced the price differentials among various petroleum products. Evaluation of the Program As summarized above, the structural adjustment measures, with some exceptions, are being implemented on schedule. Overall, the program had several strong points. It was based on a number of economic and sector - 114 - reports - which had identified structural reforms in trade, industry, and energy sectors to be necessary for medium-term improvement in the balance of payments, growth, and employment. The program was specific and monitorable in terms of policy inputs. The concerned agencies had adequate institutional capacity to initiate the program which was further augmented during the imple- mentation of the program. Despite some setbacks, the program has largely ful- filled its purpose and bhould yield substantial benefits in the medium-term. However, it will take some time before the full impact of the program can be measured. The program also appears to have suffered from a few weaknesses. First, it was too detailed in several areas, making supervision time-consuming and tending to detract from the broader concerns. Second, at the Government's request, financing of a technical assistance component was not included in SAL II. The Government instead agreed to finance various studies and activi- ties from its own sources but has failed to do so. Lastly, in hindsight, and considering the recent economic developments, the program appears to have been somewhat narrowly based. The economic events have turned out to be more adverse during the last three years than had been foreseen when the program was prepared. The international recession has been too prolonged which, together with some appreciation in the real effective exchange rate, affected the country's exports adversely. At the same time, the country's terms of trade worsened seriously. Expecting a quick recovery, the country followed a countercyclical policy which compounded the impact of continuing expansion in public sector investment despite lagging resource mobilization. The growing current account (and budgetary) deficits were financed by external borrowing at increasingly hard terms which increased the country's vulnerability. Simultaneously, the viability of the financial sector was threatened by internal problems and continuing recession. Capital flight due to political uncertainty, and reduction in foreign credit availability, brought the crisis to a head in late 1983. Consequently, the Government adopted severe stabilization measures and started negotiating for debt rescheduling. A balance of payments crisis in the midst of a structural adjustment program necessarily raises questions about its appropriateness. Was the program properly designed to address the problems facing the economy? Did the program contribute (through trade liberalization) to the crisis? Would the program help the economy to recover from the crisis? 3/ Sharing in Development, ILO, Geneva, 1974. The Philippines: Priorities and Prospects for Development, World Bank, 1976. Industrial Development Strategy Policy in the Philippines, World Bank,1979. The Philippines: Aspects of Poverty, World Bank, 1980. The Philippines: Selected Issues for 1983-87 Plan Period, World Bank, 1982. The Philippines: Aspects of the Financial Sector, 1979. Philippines: Energy Sector Survey, World Bank, 1982. - 115 - On the first question, it needs to be said that the program was designed to reform trade, industrial, and energy policies identified by several studies (as noted earlier) as fundamental for improvement in medium- term economic performance. Although problems in other areas (for example, in public finances and external debt) existed, they did not appear to be equally serious then and have reached crisis proportions only recently. Partly due to this and partly due to the Government's lack of receptivity, these areas did not have sufficient 4conomic and sector work to provide a basis for inclusion in the SAL package- Nevertheless, it seems in hindsight that more broadly based SALs would have strengthened the program and, at least, softened the crisis. Although a broad macroeconomic structural adjustment program did not exist, this did not mean that the Government could not have adopted adequate measures to prevent the crisis. In fact, some of the problems (public sector deficits, current account deficits, and foreign borrowing) were the subject of short-term stabilization programs, agreed to by the Government and the IMF, which were, in principle, a more suitable vehicle for addressing these questions. On the second issue, trade liberalization or other programs do not appear to have contributed significantly towards increasing imports. Other aspects of the program, for example, energy pricing and resource development and export promotion, have probably had important positive impact on the balance of payments. Likewise, there seems to have been little revenue loss from the SAL measures, although the impact is hard to measure and may have been offset by other, positive, effects. Regarding the third issue, recovery from the present crisis depends primarily on successful short-term adjustment measures and debt rescheduling. While some parts of the program have suffered on account of stabilization needs, the program on the whole will provide the basis for resuming the growth momentum through improved resource allocation. It should especially help the economy increase its foreign exchange earning/saving capacity. Having lowered the level of protection in the industrial sector, it will also have reduced the implicit discrimination against agriculture. The next SAL could, therefore, build upon the previous accomplishments in the areas of trade, industry, and energy, and extend the coverage to public resource management, external debt, and agriculture that have emerged as critical areas for the future. In the meantime, however, the Government has the difficult task of adopting stabilization measures without seriously damaging the structural adjustment program and the medium-term growth prospects. Lessons for the Future. The experience with two SALs suggests some lessons which can be usefully applied to future lending of this type in the 4/ The Bank has since then reviewed public expenditures and external debt, and issues in these areas are now being addressed by the Government. - 116 - Philippines. First, as in the past, the SAL policy package needs to be based on a strong program of economic and sector work which has identified issues and policy instruments, and about which there is broad agreement between the Bank and the Government. Second, while pollcy packages should be specific and monitorable, care should be exercised to avoid making them excessively detailed, particularly in areas which are not central to the policy objec- tives. Third, if studies and institution-building are a part of the policy package, there should be an adequate mechanism for funding the required tech- nical assistance for their implementation. Finally, it should be recognized that attempts to deal with medium- and long-term structural issues can be disturbed by the emergence of a short-term financial crisis. Therefore, timely adoption of adequate stabilization measures is a necessary condition for successful implementation of a structural adjustment program. At the same time, the program should be sufficiently robust and flexible to accommodate temporary and short-run disturbances in the economy. - 117 - PHILIPPINES STRUCTURAL ADJUSTMENT LOANS I AND II Program Completion Report I. INTRODUCTION 1.01 The first and second Structural Adjustment Loans (SAL I and SAL II) to the Philippines of US$200.0 million (Loan No. 1903-PH of September 25, 1980) and US$302.3 million (Loan No. 2266-PH of April 28, 1983), respectively, supported the Government's program of structural reforms initiated in 1980. The structural reform program was designed to address the fundamental and longstanding problem of ineffective resource utilization and its impact on the balance of payments, which had deteriorated severely after the 1979 oil price increase and the ensuing international recession. A project completion mission for both SAL I and SAL II visited the Philippines in March 1984. Its findings are presented in this report. Emergence of Structural Problems 1.02 During the 1970s, the Philippine economy grew much more rapidly than in the past. The growth rate of GNP increased from 5% in the 1960s to almost 7% at the end of the 1970s. The agricultural sector expanded rapidly and the need for rice imports was eliminated in the second half of the decade. Manu- factured exports, such as garments, electronics, handicrafts, and footwear; grew dramatically in response to various export promotion measures. These exports, although relatively import-intensive, accounted for more than a third of the country's total merchandise exports at the end of the 4.-ade. 1.03 There were, however, several disappointing features of the country's economic performance resulting from structural deficiencies. First, the domestic manufacturing industry suffered from severe inefficiencies and grew only at about the same rate as GNP. Second, the expansion of the economy's output in the 1970s was low relative to the high level of investment which had risen from 16% to 25% of GNP over the decade. Also, the incremental capital/ output ratio in the Philippines was about 35% higher than that in the other countries of the region with comparable patterns of investment. This was primarily due to differences in the efficiency of private investment, especially in the manufacturing sector. It was also partly due to large public sector infrastructure investments with relatively long gestation periods undertaken during the 1970s. Third, as domestic resource mobilization leveled off during the second half of the decade, heavy foreign borrowing was needed to help finance the increase in investment. As a result, the external medium- and long-term debt of the Philippines increased almost six-fold during the decade, reaching US$8.9 billion in 1980. 1.04 Furthermore, the economic growth did not contribute significantly to alleviating the severe employment and poverty problems of the country. High - 118 - population growth kept the annual increase of GNP per capita at 3.6% in the 1970s which was the lowest growth rate among the major countries in the region. Real wages decreased substantially both in agriculture and industry, incidence of poverty remained high at about 40% of the population, and income distribution continued to be skewed. 1.05 The low efficiency and misallocation of investment as well as a heavy reliance on foreign savings were reflected in the balance of payments and caused a chronic shortage of foreign exchange during most of the 1970s. The continued large share of export earnings from a few primary products (coconuts, sugar, copper, timber) kept the Philippines highly vulnerable to international commodity price fluctuations. The protected industrial sector remained a net burden on the balance of payments, since the import substi- tution strategy simply shifted dependence on imports from consumer goods to capital and intermediate goods while inefficiency weakened export competitive- ness. Also, the country remained heavily dependent on imported oil for its energy supply, and the rising oil prices aggravated the trade imbalance. 1.06 The Government made initial attempts at structural change in the economy during the 1970s. Most successful was the program to diversify exports as a result of which non-traditional manufactured exports increased from US$50 million in 1970 to US$1.5 billion in 1979. However, because these exports were still heavily dependent on imported inputs, their net positive effect on the balance of payments was limited. The country also managed to constrain its energy imports through conservation and diversification of domestic energy sources. These measures helped to reduce the current account deficit temporariLy, but had only limited impact on the underlying structural problems of the economy, which had led to the low efficiency and suboptimal allocation of investment, particularly in the private sector. High protection and import restrictions provided by the trade regime were the main cause of this inefficiency because foreign competition was eliminated or severely reduced. The uneven structt-re of protection also led to allocation of invest- ment into activities in which the country did not have a comparative advant- age. Financial pol:-ies provided for below free-market interest rates and thus encouraged an excessive and wasteful use of capital. The industrial incentives and promotion system further cheapened the price of capital and reinforced the distortions in relative factor prices. 1.07 The structural problems of the Philippine economy were greatly exacerbated by the 1979 oil price increase and the ensuing international recession. Given its production structure, the Philippines was severely affected by the fall in commodity prices. At the same time, the Government mounted an expansion of the public sector investment program in energy, industry and infrastructure, which further increased the need for foreign borrowing. The increased debt service caused by rising interest rates and increased borrowings began to put an additional strain on the balance of payments. The rate of inflation, which had averaged about 7% during 1976-78, accelerated to 19% in 1979. The growth rate of GNP began to decline, which, together with the weakening of public finance and the financial sector put significant constraints on the development effort, further aggravating serious poverty problems. - 119 - 1.08 These structural problems had been identified by both the Government and the Bank in the 1970s and had received some attention in the 1978-82 Development Plan. However, the genesis of the current structural adjustment program can be traced to an economic/industrial sector mission of the Bank in early 1979, and to a subsequent financial sector mission which was a joint effort of the Bank and the IMF. After discussions of the reports of these missions with the Government, there was a broad agreement that a successful structural adjustment effort during the 1980s would depend primarily upon a) restructuring of the industrial sector; b) energy conservation and development of domestic energy supplies; c) financial sector reform; d) appropriate factor pricing policies; and e) continued disciplined demand management. In October 1979, the Government formed an interagency committee chaired by the Minister of Industry to coordinate its industrial development program. 1.09 Government's Program of Structural Adjustment. The Government's program of structural reform was started in 1980. As a first step, the Government adopted a short-term financial adjustment program, which was supported by a two-year IMF standby arrangement of SDR 410 million, for the period 1980-81. The objectives of the program were: a) to sustain the real rate of economic growth; b) to reduce the rate of inflation; and c) to restore approximate equilibrium in the balance of payments by 1982. The program included quantitative limits on net domestic assets of the banking system and on new approvals of foreign borrowings of 1-12 years' maturity, and it was expected to help maintain access to private capital markets during the initial years of the adjustment process when the balance of payments situation was expected to be most difficult. 1.10 The Government also initiated a major medium-term adjustment program which focused initially on a reform of the past trade, industrial, and finan- cial policies which, while aiming at import substitution, had led to the low efficiency and suboptimal allocation of investment in the private sector as explained in para. 1.06. The reform program aimed primarily at improving resource use in the industry and establishing manufacturing industry as a leading growth sector. In addition, reforms in these areas were expected to have a directly beneficial effect on the balance of payments by encouraging nontraditional manufactured exports, reducing reliance on imports of capital goods and intermediate inputs for manufacturing, and limiting dependence on external borrowings. 1.11 The first phase of the trade and industrial policy reforms was sup- ported under the Bank's first structural adjustment Loan (SAL I). The finan- cial sector reforms were supported by the Bank's Industrial Finance (APEX) Loan of $150 million (Loan No. 1984-PH, May 1981). SAL I also provided technical assistance to help the Government prepare future policy reform measures. 1.12 The second phase of the structural adjustment program was supported under SAL II. It continued the ongoing trade policy reforms, extended the reform program in the industrial sector, and initiated reforms in the energy sector and in public resource management. The Government also formulated a new short-term adjustment program to reverse the further deterioration of the balance of payments in 1982 through tight monetary and fiscal policies and - 120 - continued use of a flexible, market oriented exchange rate policy. The program, which was supported by an IMF Standby Agreement of SDR 315 million for 1983, included ceilings on net domestic assets of the banking system, net domestic credit to the public sector, new Central Bank approvals for foreign borrowings, and an understanding on the level of short-term external debt. In addition, the Government made arrangements to draw SDR 189 million from the IMF's Compensatory Financing Facility on account of an export shortfall for the twelve month period ending September 1982. First Structural Adjustment Loan (SAL I) 1.13 The first structural adjustment loan to the Philippines was preappraised in November/December 1979, appraised in March/April 1980 and negotiated in July 1980. It was approved by the Executive Directors on September 16, 1980, and became effective on September 25, 1980 (Loan No. 1903- PH). 1.14 The loan, $200.0 mitlion equivalent, was to support the initial phase of the Government's trade and industrial policy reform program, which was outlined in the Government's Statement of Industrial Policy for the 1980s. The program called for staged reforms over a 5-year period in the following five major areas: (a) export incentives and promotion measures; (b) tariff reform, trade liberalization, and complementary measures; (c) investment incentives and their administration; (d) industrial restructur- ing; and (e) major industrial projects. The program was summarized in the Government's Letter on Industrial Development Policy (LIDP) dated August 12, 1980, to the Bank, which also conveyed the Government's official request for the structural adjustment loan. 1.15 SAL I focused on major trade policy reforms. The objectives were to increase efficiency and international competitiveness of Philippine industry and to reduce allocative distortions by lowering the overall level of protec- tion and by evening out the spread in tariff rates within and between sec- tors. Liberalization of import licensing was planned to be undertaken simul- taneously since continued import restrictions would defeat the impact of the tariff reform. Complementing the tariff reform, the Government also intended to improve the export regime through introduction of various export promotion measures. 1.16 During this phase of the structural reform program, the Government also planned to start the implementation of industrial restructuring and rehabilitation programs to help existing industries to adjust to the changes in the trade and industrial policies. In addition, a program of eleven major industrial projects was initiated to deepen the country's industrial structure in the production of capital and intermediate goods. Furthermore, substantial work was planned to be done on the investment incentives system reform and on the industrial restructuring with an understanding that the reforms in these areas would be supported under the second structural adjustment loan. 1.17 The proceeds of the loan were to help finance industrial imports and technical assistance during the start of the structural adjustment process. The import component ($195 million), which was disbursed in two tranches, was - 121 - fully disbursed in September 1981. The technical assistance component ($5 million), all of which was made available at the time of loan effective- ness, had an undisbursed balance of $660,000 as of May 7, 1984. Second Structural Adjustment Loan (SAL II) 1.18 The second structural adjustment loan was appraised in April/May 1982, postappraised in October/November 1982 and negotiated in January 1983. It was approved by the Executive Directors on April 26, 1983, and became effective April 28, 1983 (Loan No. 2266-PH). 1.19 The loan, $302.3 million equivalent, was to support the second phase of the Government's medium-term structural adjustment program which extended the reform program in the industrial sector, continued the ongoing trade policy reforms, and initiated reforms in the energy sector and in public resource management. The second phase of the program was summarized in the Government's Letter of Development Policy (LDP) dated March 29, 1983. It included: (a) fundamental reform of the industrial incentives and promotion system; (b) adjustment of low tariff rates, further elimination of import restrictions, and the related realignment of indirect taxes; and (c) an energy policy reform program. It also initiated studies in energy sector, public finrnce and agriculture, which would provide the basis for the formulation of future structural adjustment measures. 1.20 The proceeds of the loan were to finance essential imports in 1983. The loan, which was disbursed in two tranches, was fully disbursed on January 5, 1984. II. IMPLEMENTATION OF THE STRUCTURAL ADJUSTMENT PROGRAM Trade Policy Reforms Trade Liberalization 2.01 A major effort under both SAL I and SAL II was made to achieve a more open, less restrictive, and less protective trading environment, which would serve both to limit the protection toward inefficient and often capital intensive domestic industries, promote exports and increase employment. These initiatives consisted of a major tariff reform program (TRP), the removal of quantitative restrictions on imports, and positive efforts to encourage exports. Tariff Reform Program 2.02 Under SAL I, the Government adopted a five year program of phased tariff reductions. The objective of the tariff reform program (TRP) was to reduce maximum tariffs from 100% to 50%, and to lower the average tariff from 43% to 28% by 1985. In addition, it aimed at reducing the degree of tariff escalation, which resulted from lower tariffs on raw material inputs and much higher tariffs on finished products. It was also designed to raise tariffs - 122 - for certain products which previously had low rates of protection, such as machinery and other capital equipment. 2.03 The TRP planned the reduction of maximum rates for 14 major industries to be implemented over a period of five years, 1981-85. For all other industries, the maximum rates were to be reduced to 50% by 1982. The phasing of the tariff reform for the 14 important industries was designed to give these industries sufficient time to adjust to the new trade environ- ment. In addition, the Government planned to develop subsector development programs for each of these important industries. These programs were an attempt to encourage increased efficiency and modernization of existing plants, and to identify areas where industry had a comparative advantage under the new tariff regime. 2.04 In terms of effective protection, the objective was to bring effec- tive protection rates (EPRs) to a general range of 10-80%, compared to the pre-TRP situation where EPRs were negative for certain export commodities and ranged upwards to over 200% for some consumer goods. The overall average effective protection rate would be lowered under the program from 52% (1980) to 28% by 1985, with protection for domestic, non-exporting manufacturing industries dropping from 89% to 45%. Such an improvement would bring the level of effective protection down close to that of the countries which had experienced rapid industrial and export growth, such as Korea and Taiwan. To be completely effective, however, the lower tariff protection had to be com- plemented by a program of reduction in quantitative import controls (see paras. 2.10-2.17). Table 1: EFFECTIVE RATES OF PROTECTION (EPR) (%) Pre-TRP Post-TRP/a (1980) (1985) Agriculture and primary 5 3 Manufacturing 66 36 Non-exportables 89 45 Import competing 49 35 Import noncompeting 185 67 Exportables 17 12 Overall average 52 28 /a The Government has not yet calculated the EPRs for any intervening year. 2.05 The initial tariff reform act was adopted as Executive Order No. 609 in August, 1980, and covered about 75% of the line items in the tariff code. The remaining items, which were closely identified with certain critical industries, were realigned in January, 1981 and August, 1981, after a series .f discussions with private sector groups. The original tariff proposal was modified by Executive Order No. 632A of November, 1980, after the implementa- - 123 - tion of the first tranche of SAL-I. This Executive Order amended some 82 tariff headings out of a total of 542 tariff headings covered by E.O. No. 609. About half of these tariff adjustments involved only a delayed staging of the tariff reform without changing the final rate provided in the original order. However, for about 42 headings, the final rate was either increased (in the case of consumer goods) or reduced (in the case of inter- mediate and a capital goods). No rates were raised above the ceiling of 50%, but some rates were reduced below the previously established minimum rate of 5%. The effect of these changes probably has been to increase the rate of effective protection for a few industries beyond that envisa,ed in the original reform proposal. However, the overall effect of these changes was minor, and did not constitute a major deviation from the general principles and spirit of the tariff reform program. The final revised tariff schedule was published as the Tariff and Customs Code of 1982. 2.06 Subsequent to the publication of the revised code, some further minor revisions have been adopted. Under an Executive Order which took effect in October, 1982 the rate of duty on mineral wool was increased from 20% to 40%, and that on glass wool, and on yarns, slivers and rovings from 30% to 40%. These modifications had been recommended by the Board of Investments (BOI) as post-operative tariff protection under the Omnibus Investments Code. Protection for these industries is presently being reviewed by the Tariff Commission. Executive orders in January, 1982 and December, 1983 modi- fied the rates of duties on various man-made fibers, increasing polyester fibers from 20% to 30% (in 1985 and thereafter), and making minor modifica- tions for the tariffs on acrylic, other synthetic fibers and acetate which lowered the rates from 20% to 10% only in the years 1983-85. In return for greater tariff protection, the Governr2nt has indicated that it would reduce the quantitative restrictions on imports of synthetic fibers. These subse- quent changes are considered to represent minor adjustments, not contravening the general tariff liberalization. 2.07 While the general objective of the TRP was to move all tariffs to within a range of 10% to 50%, the TRP left 33 items with rates of duty below 10%, seven of which required prior authorization by specific government agencies. These are largely certain food items and iron and steel products. The Government has indicated that they will review these tariffs on an industry/sector basis after the current round of tariff reform has been completed, i.e. after January 1, 1985. 2.08 Overall compliance with the tariff reform program has been good despite a serious worsening of the economic and financial situation over the period. In 1983, the Government was faced with a mounting balance of payments deficit, a growing debt service burden, and reduced access to private capital borrowings. In late 1983 it was forced to undertake a number of steps to correct the balance of payments which had seriously deteriorated through a combination of political uncertainties and resulting capital flight. These steps include a substantial devaluation of the peso, the suspension of debt payments, reductions in the national government budget deficit, and new controls over the allocation of foreign exchange. Furthermore, a 3% additional import duty levied (primarily to increase Government revenues) in - 124 - December 1982 was increased to 5% in 1983.1/ At the time of the mid-term review of SAL II, the Government agreed that the additional duty will be removed by the end of 1984. While the imposition of this duty reverses, temporarily, a certain degree of the decline in absolute tariff levels, it does not contravene the spirit of the tariff reforms in that it applies equally to all commodities, and slightly raises effective protection levels for all industries. 2.09 It is still too early to judge the impact of the tariff reform program on the structure of industrial sector investment and output. In terms of reallocation of resources, most of the impact would be felt on consumer goods industries, whose effective protection rates would drop from 102% to 42% while those for intermediate goods would drop slightly from 35% to 33%. Average effective rates for inputs into construction and cap ial goods would remain substantially unchanged, at 31% and 25% respectively.- While it is difficult to separate the impact of domestic recession and recent policy measures from that of the TRP, preliminary evidence suggests that, during the implementation of the TRP, there has not been a significant drop in tariff revenues, or a surge in imports. While tariffs were being lowered overall from 43% to 29% (see Table 2), total imports between 1980 and 1983 have actually declined by 3.5%, no doubt largely due to the impact of the reces- sion. Tariff revenue has increased by 58% in peso terms. This was largely due to the devaluation of the peso, for tariff revenue in dollar terms increased by 6%. However, tariff revenues had declined slightly during 1980-81 before the imposition of the additional duty in December 1982. An examination of goods whose tariff rates declined under the TRP indicates that, between 1980 and 1982, their share in total imports increased from 15% to 21%. Import Licensing and Regulation 2.10 In addition to protective tariffs, direct control over imports, including in some cases outright prohibition, also provided a significant amount of industrial protection. In general, these controls were of two types; first, there was a general prohibition on the importation of a large number of consumer goods, termed nonessential or uoclassified consumer goods (NEC/UC). Secondly, a large number of producer and consumer goods required prior clearance by various government agencies before importation could be permitted. In some cases, these regulations were in place to protect public health, safety or for national defense reasons, or to control misclassifica- tion or undervaluation of imports through appropriate monitoring. But in many cases, they were designed to protect domestic industries. 2.11 Of the 1,304 items classified as NECIUC, 960 were to be liberalized under a three year plan adopted under Monetary Board Resolution No. 1495, dated August 15, 1980. The consumer goods covered under this plan included 1/ Raised to 8% in March 1984, and 10% in June 1984. 2/ These rates were calculated by the Tariff Commission recording to the end-use as of September 1981. - 125 - Table 2: IMPACT OF TARIFF REFORM PROGRAM Ratio of Import Duties Average tariff Imports Import Duties to Imports rate (%) /a (mn $) (bn P) (mn $)/b (%) 1980 43 7,727 7.3 972 12.6 1981 34 7,946 7.2 911 11.5 1982 30 7,667 8.3 972 12.7 1983 29 7,469 11.5 1,034 13.8 1980-83 (change) -3.5% 58% 6.4% 9.5% /a Excludes additional import duty imposed in 1982-83. 7- Import duties converted to US dollars at current exchange rates. Source: Tariff Commission and Ministry of Finance. food, chemical, cosmetic, pharmaceutical, wood, leather, rubber and plastic products of various kinds, textiles and garments, furniture and travel goods, footwear and headgear, and electrical and electronic appliances. The bulk of these items were liberalized on schedule, including 263 in 1981 and 610 in 1982. The scheduled liberalization of 87 items in 1983 was scaled back to 48, in response to hearings conducted by the Ministry of Trade and Industry on the impact of the liberalization on various industries. In April 1983, the Government adopted a plan for the liberalization of 237 of the 382 remaining NEC/UC items; leaving 145 items still to be controlled for reasons of national defense, health and safety. Because of balance of payments difficulties, however, the Government has not enacted the 1984 portion (covering 36 items) in the program. The continued regulation and control over certain types of NEC/UC items (see below) has also reduced somewhat the impact of import liberalization. Despite this, the share of originally controlled NEC/UC items in total imports increased from 2.9% in 1980 to 4% by 1983. Thus, this part of the program has not had a particularly adverse impact on the balance of payments. The increase in the share of imports, however, indicates that the first round effect of import liberalization is in the expected direction. Ultimately, the impact of this liberalization will have to be judged in terms of increased efficiency of domestic industry. 2.12 A plan for the liberalization of regulated items was issued under Monetary Board Resolution No. 702, April 24, 1981. This plan identified 36 broad categories of commodities which were regulated in five categories: items regulated for the purpose of safeguarding public health and safety; items regulated for national security; items being monitored without setting limits on level of importation; items being regulated for the protection of local industries (16 items); and items regulated for other reasons. It should be noted that these items cover broad categories, such as iron and steel products, synthetic yarns and fibers, tires, cement and fabrics and textiles, which would occupy many tariff lines, and probably cover as many individual items as the NEC/UC list. - 126 - 2.13 For those items dealing with health, safety and national security, the plan for liberalization provided only a general commitment that: The government shall examine alternative mechanisms for regulating imports of these items for the purpose of identifying and adopting such schemes that will minimize the use of foreign exchange controls for the regulation of imports. The target date for adoption of alternative mechanisms, if any, will be January 1, 1983. Specific dates were given, however, for the liberalization of 12 items. Caustic soda, basic iron and steel products, tires (except used tires), and gasoline and kerosene engines were to be liberalized on or before January 1, 1982; fabrics and textiles, vinyl-asbestos tiles and sheets, and hydrogen peroxide on or before January 1, 1984; and newsprint, portland cement, sheet glass on or before January 1, 1985. The lifting of the restriction on the importation of canned mackerel and sardines is to be part of a package review of measures affecting the fishing and canned fish industries. The Covernment was to review the usefulness of restrictions on importation of nonagricultural machinery, equipment and spare parts, textile machinery and equipment, trucks, passenger cars, electronic goods and diesel truck engines although again, no specific deadline was indicated. 2.14 P e continued licensing of imports of industrial machinery (MAAB 34, June 1976)- was specifically raised during the negotiations for SAL II, since this device served as a mechanism for the licensing of industrial invest- ment. At that time the Government agreed to amend MAAB 34 so that it would cover only projects availing of government incentives, financing or guaran- tees, sectors that were highly capital intensive, and sectors covered by government rationalization programs. The Government was to have produced a listing of these designated sectors, which were to have been relatively few in number. 2.15 Despite these agreements, none of these restrictions, including those covering industrial investment, have been rescinded. Monetary Board Resolution No. 482 (March 18, 1983) confirmed the agreements reached under the SAL II negotiations, concerning investment goods but the listing of sectors was not produced, and the resolution has not yet been enforced. As the balance of payments situation worsened during 1982 and 1983, a number of new restrictions have been imposed, or existing restrictions tightened. In some cases, the new regulations return to licensing NEC/UC items which had been previously deregulated (such as electrical appliances and electronic pro- ducts). Government officials indicate, however, that they remain comitteed to the liberalization program, and these temporary restrictions will be removed once balance of payments situation eases. 2.16 A recent tabulation indicates that the number of items licensed or regulated now totals 42, but the numbers of items on the list does not give an 3/ Memorandum to Authorized Agent Banks No. 34, dated June 1, 1976, from the Monetary Board of the Central Bank. - 127 - adequate indication of the scope of the import licensing regime, since these are much broader categories than the customs line numbers used to designate the liberalization of the NEC/UC items. The imposition of restrictions, by reducing imports of licensed goods, also acts to limit the apparent coverage of import licensing in total imports. Nevertheless, it is roughly estimated that two-thirds of total imports, or about one-half of non-oil imports, are covered by some form of regulation. Commodities regulated for apparently pro- tective reasons constitute about 19% of non-oil imports; the balance of the regulated items are investment goods covered under MAAB 34. Goods regulated for health, safety and national defense reasons amount to less than 1% of non- oil imports; petroleum and petroleum products cover about 29% of total imports. 2.17 In addition to specific commodity restrictions, the Government has introduced in 1983, as a short-term measure, foreign exchange controls recuiring that all foreign exchange receipts earned by commercial banks through export transactions be turned over to the Central Bank. Under the guidance of a Joint Committee of the Central Bank and Banker's Association of the Philippines, the foreign exchange from this central pool is first alloca- ted to high priority uses: oil imports; foodgrains, debt payments on official loans, etc. Remaining funds, if any, are allocated to the commercial banks, with a high priority given to the import needs of export industries, followed by vital domestic industries. Because of foreign exchange shortages, however, little foreign exchange has been allocated to vital domestic industries through the official channel, and even export industries are not fully supplied. Thus, some import restrictions, such as those for NEC/UC items, are currently redundant since there is no foreign exchange available for these kinds of imports. Importers can, and do, import essential producers goods through the use of prepaid L/Cs, where foreign exchange is obtained on the unofficial market. For these goods, which usually constitute about 40% of total imports, the prevailing import restrictions would be effective. Export Development 2.18 A substantial component of SAL I included the improvement in export incentives and promotion. Most of the activities in this area, had been implemented in 1979 and early 1980, even before the final SAL agreement. They included: strengthening and broadening of fiscal incentives for export production and trading; simplifying import and export procedures; liberalizing bonded manufacturing warehouse arrangements for exports; improving export financing facilities; and strengthening insticutions that promote exports and international trade. 2.19 Under the Letter of Industrial Developm*nt Policy for SAL-I, the Government agreed to take two further steps to improve the export regime. These included: - the introduction of standard costings and allowances for the tax credit/duty drawback on imported inputs of export industries; and the undertaking of studies on how best to improve the working capital financing for exporters and how to encourage commercial banks to take greater initiative in providing medium-term expor financing. - 128 - In addition, SAL I provided technical assistance funds to support improvements in export promotion and for the establishment of an international trade center. 2.20 Since the SAL I agreement, the Government has undertaken a number of additional steps to simplify and improve the system of duty drawbacks, based largely on a 1980 IMF report. These include an expansion of drawback cover- age, the discontinuance by BOI of the Certificate of Non-availability of Local Raw Materials, the introduction of periodic or accumulated drawback claims, and the creation of an inter-agency working group to handle issues concerning drawback procedures. Improvements were also made, on the basis of the IMF report, in the areas concerning the temporary importation free of duty (consignment imports), manufacturer's duty-free bonded warehouse, import valuation, and the administration of the Bureau of Customs. A recent study by consultants - identified further improvements that can be made in each of these areas, and it is likely they will form part of the policy package to be associated with a forthcoming Export Development Project. 2.21 The specific agreement to introduce standard costings and allowance for the duty drawback system has not, in general, been implemented. The study by consultants notes that the private sector is not entirely convinced that standard duty drawback procedures are an advantage. Limited experience by BOI confirms this; standard rates have been developed for six firms, but only three have elected to use them. Many firms seem to believe that the standard duty drawback rates could potentially reduce the amount of tax reimbursement they would receive, compared to the existing system in which reimbursements are related to actual taxes paid. Nevertheless, BOI intends to undertake further work to develop a system of standard industry drawback rates, but the use of these rates will be optional for the exporter. 2.22 While the Government did undertake some partial studies of certain aspects of export financing requirements, the general study called for in SAL-I was, in fact, not undertaken. In January, 1981, the Government adopted legislation creating an Export Credit Corporation. This new corporation was envisioned to become the central institution responsible for the provision of medium and long-term export financing (particularly for the capital goods/metal working industries), and export insurance and guarantee facilities. Because of budget limitations, and the lack of a clear demonstra- tion of need, this new corporation has not yet come into existence as an operating institution. In the meantime, the need for medium-term finance for manufacturers, including exporters, has been met through the Apex unit in the Central Bank, which was created in 1981 with World Bank and other financing. This unit provides medium- and long-term capital funds to designated partici- pants, largely commercial banks, to meet the term finance needs of customers in the industrial sector, both exporters and non-exporters. At the same time the Government has made a number of improvements in its short-term export 4/ SGV, Inc., Final Report on the Evaluation of the System of Export Reliefs and Customs Evaluation (Manila, February, 1984). - 129 - financing facilities (Export Packing Credits), including reduced spreads to commercial banks and therefore lower interest rates to exporters, and increases in the amount of the loan that could be discounted for non-tradi- tional exporters from 80% to 90%. Realignment of Indirect Taxes 2.23 The indirect tax system 5 in the Philippines has effectively served as one of the instruments for protection of domestic industries. Under the so-called advance sales tax and the excise tax, many "semi-essential" and "non-essential" imports were taxed at significantly higher effective rates than close substitutes of domestic origin. These higher effective rates resulted from two factors. First, a variable mark-up of 20%, 50% or 100%, depending upon the category of imports, was used to calculate the tax base for the advance sales tax. Second, higher nominal rates were Levied on imports than on corresponding goods produced domestically; this applied to the advance sales tax as well as the excise taxes. The markups and the higher nominal rates provided a strong incentive for import-substitution and thus became important elements of the country's protection system. Estimates show that, on average, one-third of the effective protection accorded to the manufactur- ing sector in 1980 was due to the protective effect of the indirect taxes. For particular industries, especially those producing luxury consumer goods, this protective effect was estimated to be considerably higher. 2.24 The markups and differential rates were also important from the point of view of revenue generation. In 1982, about half of the sales tax revenue was collected from the advance sales tax. Similarly, half of excise tax revenue comes from the higher rates levied on imported products. Adminis- tration of these two taxes, however, was cumbersome because of a multitude of tax rates, largely related to five groupings of commodities by "essentiality". 2.25 Program for Realignment of Indirect Taxes. The objective of Lhe proposed reform was to remove the differential tax treatment o. imported and domestically produced goods, and, simultaneously, to simplify the tax adminis- tration. Moreover, greater progressivity was to be introduced to discourage non-essential consumption and restrain the expansion of luxury imports that could result from lowering tariffs and relaxing import restrict;ons. The reform had three components: (a) removal of the advance sales tix; (b) restructuring of excise taxes; and (c) introduction of a second-stage sales tax. A phased schedule was provided for the implementation of the reforms to allow a transition period for industry and consumers. To expedite the initia- tion of tax realignment, a Presidential Decree was issued on October 5, 1983, 5/ Before the initiation of the current reform in 1980, the indirect tax system included a sales tax and a number of excise taxes. The sales tax consisted of (a) a domestic sales tax which was levied on domestic production at the factory; and (b) an advance sales tax which was levied on imported goods at the port. The excise taxes were levied on imported and domestically produced goods at the port and the factory, respectively. - 130 - expanding the scope of the president's authority to make adjustments in internal revenue taxes pursuant to international commitments in respect to trade, tariff, and other similar arrangements. Accordingly, the full realign- ment of indirect taxes may be expedited through the issuance of Executive Orders (EOs) or Presidential Decrees. The following shows the extent of implementation of the realignment scheme and other reforms that have still to be made to achieve complete realignment of indirect taxes: - EO 883 effective on March 16, 1983 provided for adoption of 25% uniform mark-up for advance sales tax purposes. A draft EO has been prepared to take effect January 1, 1985, to fully eliminate the advance sales tax and to initiate other vital measures to restructure the sales tax system, i.e., revising the sales tax on cars by adopting engine displacement as basis for taxation. - EO 924, effective November 16, 1983, revised the specific tax on cigars and cigarettes by unifying taxes on imported cigarettes and locally manufactured articles falling under the highest bracket, among others. A draft EO introducing a hybrid of specific tax and ad valorem tax on cigars and cigarettes has been prepared to take effect January 1, 1985. Its finalization needs clearance from higher authorities. - FO 923, effective December 1, 1983, introduced the following changes: (a) reduction of the tax differentials on imported and domestically produced distilled spirits, wines, and fermented liquors; and (b) unification of tax rates on imported and domestically produced fermented liquor. - EO 947, effective June 1, 1984, provided for the complete unification of tax rates on impcrted and locally produced distilled spirits and wines and increased further the unified rate on fermented liquors. Thus, except for the tax on cinematographic film, this achieved full realignment of specific taxes. - On the restructuring of sales tax, following changes are proposed: reclassification of articles subject to sales tax; adontion of value-added tax on second sale of non-essentials including shift to cost reduction methods of computing the tax; and abolition of the advance sales tax. A draft EO integrating these changes has been prepared and will take effect December 31, 1984. However, in view of the present economic conditions, the impact of reforms on businesses and consumers, and large revenue loss that will result from abolisning advance sales tax, the Government plans to move cautiously towards implementing these measures. 2.26 As the above actions show, a substantial part of the tax reform has been implemented and the rest is proposed to be implemented by January 1, 1985. However, the action has been delayed in one respect, viz., some of the orders have been drafted and cleared by the Cabinet/President but not yet signed as originally agreed. In this regard, the Government says that it remains committed to the timely implementation of the actions on January 1, - 131 - 1985, but argues that signing of the relevant orders a year in advance of implementation is inadvisable under the present circumstances. 2.27 The realignment of indirect taxes is an important element in narrow- ing down the range of effective protection. As with other trade liberaliza- tion steps, this step will help improve resource allocation and remove the excessive incentives for import substitution. These steps would also affect revenues. The Bureau of Internal Revenues has not yet been able to estimate the net revenue effect of all the measures. Its preliminary assessment, how- ever, shows that unification of tax rates on wines, spirits, etc., and the merger of semi-essential goods into one category for the tax on original sale will have a marginally positive effect but the substitution of the advance sales tax by a tax at the point of sale would result in a loss of over P1.5 biLlion (due to the probable leakages between the import and sale). The Government would need to make up for this loss by some other tax measures. Conclusion 2.28 The SAL program in the Philippines has supported significant trade liberalization in the past few years. The impact of this Liberalization, however, is still difficult to measure, both because of the short time span since its adoption, and because of the worsened economic conditions in the country and the world during the same period. The reform of the tariff system, and of the associated system of indirect taxes, has been a major accomplishment. Much less progress has been made in the area of import licensing and regulation, however, which potentially limits the real effect of the tariff reform. While much attention was being paid to the number of items liberalized in the NEC/UC category, the latter covered relatively small por- tion of total trade, perhaps partly because of the effectiveness of the prohi- bition. The list of restricted items, vhile smaller in number, covered a much larger portion of trade but received 1':j attention by the Government, par- ticularly in 1982 when program fell behind schedule. On the other hand, in light of the deterioration in the balance of payments, it is not surprising that the Government would attempt to reintroduce quantitative restrictions as a temporary measure to control imports. In fact, considering the economic environment, compliance with the agreed program has been good. The Government has indicated that it remains committed to the program of import liberaliza- tion, and that these temporary restrictions on imports will be lifted as soon as possible. The speed by which these restrictions are, in fact, removed will be the true measure of the liberalization effort. While in the long run this liberalization effort should have a positive effect on industrial efficiency, it is still too early to judge the exact nature of these improvements. Industrial Incentives and Promotion Policy Reforms 2.29 To supplement the trade policy reform program and to reduce remain- ing distortions and to correct market failures, the government subsequently introduced a major reform program of .ts industrial incentives policies. The key elements of the program consisted of a reform of the industrial incentives system, introduction of a concept of sector development programs for policy - 132 - design at the industry level, and strengthening of institutions. The industrial reform program was initiated under SAL I and expanded under SAL II. 2.30 Industrial Investment Incentives System Reform. The pre-SAL indus- trial incentives system was based primarily on the Investment Incentives Act of 1967 to promote growth of manufacturing industry and the Export Incentives Act of 1970 to promote manufactured exports and to reduce the bias created by the earlier act towards import substitution and capital-intensive processing of primary products in general. The Investment Incentives Act also created the Board of Investments (BOI) to determine preferred areas of investment and to administer the incentives system. BOI estimates that in the 1970s about one-third of industrial investments received support from OI. 2.31 Overall, however, the incentives system did not provide an appropriate impetus to expansion and improved performance of the industrial sector. Although manufactured exports increased significantly during the 1970s as a result of export incentives (which partially compensated for the anti-export bias of the protection system), backward linkages were not estab- Lished, the performance of domestic industry remained inadequate, and the overall sector employment and output growth improved only marginally. The failure of the incentives system could be traced to major shortcomings in its conception and implementation. First, the incentives were designed mainly for encouraging investments and not for improving resource allocation. In fact, substantial reliance was placed on tax and duty exemptions on capital equip- ment, accelerated depreciation and reinvestment allowances, which reinforced the bias towards capital-intensity created by the low cost of capital and the low import duty on capital goods. Second, the eligibility for incentives was related primarily to the "capacity available for expansion," i.e., filling the gap between the projected (domestic) market demand and existing capacity, rather than to the country's comparative advantage. Third, the administrative prccess of obtaining incentives was complicated and required a considerable volume of information to be submitted to BOI for registration and for avail- ment of incentives. Finally, it was felt that BOI exercised excessive control over the private investment decisions not only in the preferred areas of investment but also in the non-preferred areas (i.e., investments not receiving fiscal incentives) through the administration of licenses for the importation of industrial machinery and equipment. 2.32 As a part of SAL II, a comprehensive reform program was prepared with the active invol 9ment of the Bank's staff. This program was approved by BOI in December 1982. The thrust of the program was to extend the guiding principle of comparative advantage and industrial efficiency already embodied in the trade liberalization program to the areas of fiscal incentives, deter- mination of eligibility for incentives, and sector programming. 2.33 The program became effective with the enactment of the Investment Incentives Policy Act of 1983 (B.P. 391) on April 28, 1983. The Rules and 61 Position Paper No. 1 - New Incentives System of the Board of Investments, December 16, 1982. - 133 - Regulations for the implementation of the new incentives system were approved on July 5, 1983. 2.34 The new Act continued to provide higher incentives for infant industries and for industries locating in disadvantaged regions. It also continued to provide the same incentives for service exporters, export traders, and agricultural producers as before. However, a new set of fiscal incentives was introduced for domestic and export producers and for producers participating in industry rationalization or energy saving programs. In addition, a new rationale for investment priority determination and stream- lined administrative procedures for registration and availment of incentives were introduced. The changes in these areas were substantial and provided major improvements to the earlier incentives system. 2.35 First, nine of the 15 existing fiscal incentives available for domestic and export producers were discontinued, among them many of the incen- tives that had capital cheapening bias (such as accelerated depreciation, tax allowances for reinvestments, and deduction of preoperating expenses). Among the six remaining incentives, two are still related to capital investments (exemption from taxes and duties on imported capital equipment and correspond- ing tax credit on domestic capital equipment), but their scope was substan- tially reduced. Four incentives were carried over essentially unchanged.z Second, two new, performance oriented incentives were introduced (tax credit on net value earned and tax credit on net local content of export products). 2.36 The introduction of the two new major incentives, together with the discontinuation of many of the incentives related to capital investments, considerably improved the neutrality, efficiency, and accountability of the incentives system. The new system is more neutral with respect to choices of production factors because the value of the incentives is determined primarily based on performance rather than on the value of investment. Under this sys- tem, firms that perform better than others, i.e. make higher contribution to the gross domestic product, will also receive higher incentives which will lead to a more desirable allocation of incentive resources than before. The new system will also facilitate better monitoring of revenue forgone and other impacts because the information regarding performance required for the avail- ment of incentives includes the information relevant for monitoring. 7/ These provided exemption from export taxes and fees, tax credit for taxes and duties paid on raw materials and supplies for export production, net operating loss carryover, and tax credit for withholding tax on interest on foreign loans. - 134 - 2.37 Investment Priority Determination. Whilg,the general objectives and structure of the Investment Priorities Plan (IPP) - were maintained, a significant change was implemented by the new Act in the use of specific evaluation criteria. Most notably, the "economic soundness of a project" as shown by its real economic rate of return was established as the primary criteria for its inclusion in the IPP. For generic categories, where it is not possible to determine an econRic rate of return, indicators of comparative advantage (DRC, EPR) - and cost-effectiveness of achieving social objectives were introduced. The use and scope of the measured capacity concept, i.e. the production capacity to meet unfilled domestic demand, as a primary criterion was consequently reduced. 2.38 The administrative procedures were improved by clarifying the organizational responsibilities and by making the IPP review a year-round activity to distribute the load over the whole year and facilitate faster revisions of the IPP. The new guidelines and procedures for the investment priority determination were approved by BOI on August 8, 1983 and applied in the preparation of the 1984 IPP. The 1984 IPP consists of 358 investment areas of which 34 are new inclusions. Among the new inclusions are six areas identified for listing in the IPP by the food processing sector study (see para. 2.50 below). Sixteen areas were identified mainly through evaluation of new applications, and 11 areas were automatically included because firms in these areas were exporting more than 50% of their production in 1983. Fifteen areas in the 1983 IPP were deleted, eight due to filled-up measured capacity, four due to uncertain demand, and the rest due to an unsatisfactory economic return. The deletions were done after a full review of .5 of the specific investment areas (out of a total of 2691 in the 1983 IPP. 2.39 Registration and Availment of Incentives. Considerable progress has been made in streamlining the administrative procedures for registration, and availment of incentives. New application forms for registration, which signi- ficantly reduced information requirements, were adopted by BOI on October 26, 1983. In addition, a simplified registration process has been adopted fo- small-scale projects costing less than P 4 million) and for projects involving limited or special incentives, which has reduced the evaluation period from 60 to 20 days. The registration process is expected to improve further after modifications in the IPP review reduce the need for additional evaluation at the time of registration, and after the administration and evaluation of applications has been computerized. 2.40 New application forms and procedural guidelines for the availment of incentives were approved by BOI on July 19, 1983. The forms and procedures are much simpler than before: the number of incentives is smaller and the 8/ Investments Priority Plan is an overall plan prepared by BOI and approved by the President which includes the specific activities and generic categories of economic activity .herein investments are to be encouraged. 9/ Domestic resource cost, effective protection rate. - 135 - availment of new incentives requires an enterprise to simply submit evidence of performance to BOI. In addition, the regional offices of the Bureau of Small and Medium Industries (BSMI) are available to assist firms in the admin- istrative procedures, which should also improve the utilization of the new investment incentives system by small and regionally dispersed firms. 2.41 Reduction of the Regulatory Role of BOI. The new incentives system, in combination with the ongoing trade and financial reforms, is expected over the longer term to significantly reduce the policy-induced market distortions and thus obviate the need for BOI to control the expansion of industrial capa- city. In addition, in conjunction with the incentives reform program and as a part of specific measures supported under SAL II, the Government planned to decontrol import restrictions on industrial machinery and equipment, with some exceptions, and allow free entry and competition in the manufacturing indus- try. As discussed in paras. 2.14-2.16, the Monetary Board of Central Bank decided on March 18, 1983, to limit, by the end of 1983, the import licensing requ Wments of industrial machinery and equipment (as applied under MAAB No. 34) - to projects availing of the Government's incentives, financing and guarantees. Import Licensing would also be maintained for projects in sectors that are highly capital intensive, and in sectors covered by the Government's rationalization programs. A plan for the amendment of MAAB No. 34 has been prepared. Its implem.etation, however, has been delayed due to the current economic crisis. 2.42 Rationalization of the Incentives Administered by Agencies Other than BOI. The new Investment Incentives Policy Act did not cover a number of investment incentives granted under other laws and administered by other agen- cies than BO. These incentives included, among others, iacentives f r expor- ters operating in export processing zones and for cottage industries -L The Government proposed to review these incentives with a view to making them con- sistent with those administered by BOI. The review, supported under SAL II, is being undertaken by the National Tax Research Center (NTRC). 2.43 According to the original plan discussed during the preparation of SAL II, the review was expected to be completed in three phases by late 1983 or early 1984. However, the progress of the review has been slower than expected. NTRC has completed the background reports of the first batch of studies which cover the fiscal and related non-fiscal incentives affecting the following six sectors: tourism, overseas contracting, cottage industries, location incentives by Phividec, minerals, and shipping. This batch has also been cleared by the Interagency Committee on Taxation. However, some work still needs to be done to prepare the final report of the first batch of sectors for presentation to the Fiscal Incentives Review Board, which is expected around mid-1984. The background papers of the incentives affecting 10/ Memorandum to Authorized Agent Banks No. 34, dated June 1, 1976, from Monetary Board of the Central Bank. 11/ Administered by the Export Processing Zone Authority and the National Cottage Industry Development Authority, respectively. - 136 - the second batch of sectors 12/ are now expected tc be completed by mid- 1984. A list of third batch sectors planned to be studied in 1985 is being formulated. 2.44 According to NTRC, the progress of the studies has been slow due to the lack of funding to hire local consultants and, in some cases, inadequate cooperation from other agencies in providing certain data and technical assistance. Furthermore, also due to the lack of funds, NTRC has not been able to acquire a microcomputer to speed up the indexation of the incentives !,!gislations and other time-consuming tasks of the review process. An early completion of the studies is clearly desirable to help make various investment incentive systems consistent with each other. Any contemplated actions could then be included in the possible next SAL. Sector Development Programs 2.45 As an integral part of the reform program of industrial incentives and promotion supported under SAL I and SAL II, the Government planned to prepare sectoral development programs to convert broad industrial development objectives into a consistent set of policies and actions at the sectoral level. 2.46 The sector program approach to industrial planning was outlined in the Government's position paper of June 21, 1982, which was based on the work done under SAL I technical assistance component. In this paper, the Govern- ment designated 19 key industrial sectors for which the sectora programs would be prepared over a three year period. Out of these, two sectoral devel- opment programs (cement industry and textile industry) are under implementa- tion; two programs (food processing industry and electronics industry) are being initiated; and a study on metalworking industry is in an advanced stage of preparation. 2.47 The Government has also prepared separate export development plans for six priority export products: garments, furniture, electronics, gifts and housewear, leather and leather goods, and fresh and processed foods. These plans are currently being implemented. 2.48 The Cement Industry Modernization Program was announced in April 1980. The first part of the program, conversion from oil to coal, has been completed. The emphasis of the second part of the program, the expansion of production capacity, however, has been changed from building new capacity to improving productivity of existing plants. For this purpose, the Philippines Cement Industry Authority (PCIA) is now finalizing a proposal for "The Increased Productivity Program of the Cement Industry." The main thrust of the program is to increase productivity and to maximize the net Local content of production by increasing the utilization of domestic (low quality) coal 12/ Location (through EPZA), the domestic air transport, agricuLture (coconut), energy (petroleum exploration and trade), and financial services. - 137 - through improved technology and by using domestically produced machinery. In this respect, the cement industry modernization is closely linked to the progress of the heavy engineering industry program. 2.49 A Modernization Program for The Textile Industry (which suffered from low efficiency and was significantly affected by the trade liberalization program) was initiated in 1981. As of the end of 1983, 35 firms had joined the program. Ten projects had been approved and eleven were under evaluation for becoming eligible for investment incenpives. While there has been some progress towards policy reform and institutional development, modernization of the sector has seriously lagged behind because project proponents are reluc- tant to proceed with the proposed investments due to the current economic crisis. (The Bank also provided assistance to the Program through Loan No. 2127-PH.) 2.50 The Food Processing Sector Study was completed in October 1983. The study, which focused on processed fruits, vegetables, and fish and other sea products, aimed at identifying investment opportunities and addressing sector specific issues such as tariffs, raw material supply, marketing, quality control, financing, research, reFulatory aspects and infrastructure. BOI is now formulating the sector program based on the recommendations of the study. As a first step, six new investment areas have been included in the 1984 Investments Priority Plan. MTI and BOI have also sponsored a symposium on investment opportunities for food exports which was attended by private food companies, financial institutions, and Government agencies. 2.51 The Electronics Industry Strategy Study was prepared by an American consulting company in April 1982 and presented in the final form to BOI in October 1983. Based on the consultant's presentation, a sector development program is being initiated. The thrust of the program is to create a suitable investment climate to gradually move from assembly operations of electronic components to designing and marketing of more sophisticated systems over the five year period of 1984 to 1988. A training program has already been started and promotional efforts have been launched to attract foreign investments in this sector. 2.52 The Metalworking Industry Study has progressed slowly. The first phase of the study, numerical estimation of a computerized model for a systematic determination of comparative advantage within the sector, has now been practically completed. The initial model solution has identified 53 investment areas with potentially significant comparative advantage. These areas are being studied in more detail. However, the policy studies planned to be undertaken simultaneously with the modeling exercise in areas that would affect the development of metal working industries (such as studies of specific tariffs and investment incentives, subcontracting, procurement, technology transfer, sales financing and credit, and import controls of used machinery) have not been completed. The modeling exercise appears to have taken too much time partly due to lack of adequate support and management. KTI is now of the view that preparation of practical recommendations of the exercise need to be accelerated. It has, therefore, decided that the program preparation would be continued by the Metal Industry Research and Development Center (MI."r), which is an attached agency of MTI for direct technical - 138 - assistance to the Metal Working Industry. It appears that MIRDC, which has been involved in the study from an early stage, has better capabilities for developing a policy and support program than the MTI/BOI staff now that the estimation of potential comparative advantage has been completed. 2.53 The studies on the leather and footwear industry and the furniture industry are scheduled to be started next under the supervision of the new fulltime consultant hired by MTI to, among other things, supervise the preparation of the sector programs. 2.54 Task Forces on Six Priority Export Products Groups. MTI is focusing its export promotion efforts on six priority products which have been identi- fied as having substantial comparative advantage. These include garments, furniture, electronics, gifts and housewear, leather and leather goods, and fresh and processed foods. Strategy groups were established for each of these product groups in March 1982. The strategy groups, which consist of represen- tatives of both the private sector and concerned government agencies, were set up initially to provide a forum for interaction between the Government and private industry. Their tasks were, however, expanded to include determina- tion of export tirgets and formulation of strategies for export development. Since their creation the stategy groups have met fairly regularly every second or third month. 2.55 The strategy group for garments has prepared a Garment Export Development Plan. The plan includes export targets for 1983-1987 and pro- posals on key issues in production, institutional support and marketing, including reviews of product specialization, imported raw materials require- ments, quota negotiation strategies, functions of government agencies involved in garment exports, fiscal incentives and disincentives for exports, develop- ment of export promotion schemes, improvement of quality and productivity, and arrangements for financial support. Some actions to implement the plan have already been taken and the progress of the program has been relatively good. 2.56 The strategy group for footwear and leathergoods has also prepared five-year export targets and action plans for key issues in production, mar- keting and financing, which it is currently implementing. Among the actions completed are preparation of a concept paper on centralized bonded warehousing system, establishment of the Footwear and Leathergoods Demonstration Training Center (FLDTC), creation of the Center for International Trade Expositions and Missions, Inc. (CITEM), and establishment of the Footwear and Leather Industries Foundation, Inc. (FILIFI). FILIFI is currently preparing programs on (a) raw materials, components, and supplies sourcing and development; (b) mechanization of production; and (c) manpower training and development. 2.57 The other strategy groups (furniture, fresh and processed foods, electronics, and gifts and houseware) have similarly prepared export targets for 1983-87 and submitted proposals7action plans for key issues of the sectors which they are currently implementing. 2.58 Development of Small- and Medium-Scale Industry. The development strategy for the small- and medium-scale industry (SMI) was outlined in the Government's SMI Development Policy Statement for the 1980's issued in early - 139 - 1982. The thrust of the SMI strategy was to, within the framework of the general industrial policy reform, increase the regional dispersion of SMI and promote SMI exports through strengthening of SMI development planning institu- tions, improving SMI access to financial resources, strengthening training of SMI staff and improving marketing and technical assistance to SMI. The implementation of the program has been supported by a separate Bank loan of $132.0 million (Third Small and Medium Industries Development Project; Loan No. 2169-PH, dated June 30, 1982). However, due to adverse economic condi- tions, the progress of the program has been slower than anticipated at the time of loan appraisal. Strengthening of the Institutions 2.59 To support the implementation of the government's new industrial promotion policies, several measures were agreed upon under SAL II on the strengthening of the institutions. These measures included reorganization of KTI/BOI, training of the MTI/BOI staff, establishment of a management informa- tion system at MTI/BOI, and improvement of industrial statistics through strengthening of the National Census and Statistical Office (NCSO). 2.60 Reorganization and Training of KTI/BOI. Under SAL I, the Government planned to review the staffing requirements and to complete the reorganization of KTI/BOI to support the effective implementation of investment incentives and promotion policy reforms. A review of the staffing requirements was com- pleted in June 1982. The study included an MTI/BOI reorganization plan and a proposal for training programs for the MTI/BOI staff. The adoption of the revised organization plan, including staffing and training programs was supported by SAL II. The following major elements were included in the plan: (a) Retention of BOI's industry-oriented type of organization but expanding gradually the staff of the Industry Departments to include industrial economists to undertake the economic analysis of project applications for registration and industry specialists to support the development of sector programs. (b) Creation of a full time core study team for sector studies. For each sector program exercise, the core team was to be supplemented by specialists from within KTI/BOI on a fulltime basis. In addition, an outside consultant was to be appointed to each sector study to provide technical expertise and to administer the particular study with the core team group leader. (c) Strengthening of BOI's capabilities in industrial planning and policy formulation. (d) Training of MTI/BOI staff in industral planning and policy formula- tion (including investments priority determination), project evaluR. tion, and the administration and monitoring of industrial programs and projects. - 140 - Except for the organizational arrangements for the preparation of sectoral studies, the progress of implementing these measures has been relatively good. BOI's industry groups have been strengthened by industrial economists and industrial specialists; BOI's Department of Economic Research and Statistics (DERS) has been made responsible for planning and policy formula- tion (including investment priorities determination) with technical support of BOI's Industry Groups; and extensive training programs have been implemented partly supported by Bank's Economic Development Institute. 2.61 ALl of the operating staff have undergone in-house training in investment pri;rity determination, project evaluation, and project supervision and monitoring. Selected BOI staff have likewise undergone industry familiar- ization programs through short-term corporate attachments, organized plant visits, and in-house workshops. Specialized training has also been extended to selected personnel in computer operations and management information systums. 2.62 As part of the program for staff recruitment and training, BOI has developed a "Young Managers Program" designed to attract and retain well qualified university graduates. An initial intake of 18 graduates by BOI was completed in May 1982. Currently, 26 graduates are participating in the pro- gram, half of whom have been sent abroad for graduate training in economics, business administration, engineering, and computer science. The program is financed from SAL I technical assistance component. However, no new partici- pants have been admitted this year because SAL I funds have already been fully committed and no budgetary allocations have been made. 2.63 The organizational arrangements proposed for sector programming have faced difficulties. The original idea of having a full time core study team within MTI/BOI, which would be supplemented by full time specialists and outside consultants for each sector program exercise, has not been implemen- ted. MTI/BOI staff gave four major reasons for this. First, it was hard to agree on the leadership, organizational position and authority of the study team. Second, it was difficult to find qualified staff to join the team because of BOI's inability to provide attractive compensation and because the organizational status of the team was not clearly defined. Third, the key MTI/BOI staff were so occupied with the preparation of the incentives system and other reforms that efficient functioning of the study team was not possible. Fourth, partly for the preceding reasons, MTI/BOI management was not wholly convinced of the desirability of a "centralized" approach towards sector programming. Therefore, the first sectoral studies have been prepared more or less on an "ad-hoc" basis with little coordination or systematic exchange of experience between the study teams. 2.64 For the remaining sectoral. studies, the Government is planning to continue the "decentralized" approach. The work will be carried out by task forces, drawn from BOI's regular staff, for each of the 19 key industrial sectors. These task forces will be assisted by a new full time consultant. Furthermore, increased emphasis will be given to the strategy groups of the six export product groups discussed in paras. 2.54-2.56. - 141 - 2.65 Strengthening of the National Census and Statistical OFffice (NSCO). The Government has prepared a four-year program to strengthen NCSO and statistical work of other government agencies with a view to producing timely and improved statistics, especially industrial and household income statistics. The Executive Committee, through its Chairman, endorsed the program on July 2, 1982, and agreed to designate NCSO as a "key agency" (which would enable NCSO to offer salary scales that are competitive with its parent body, Nat'onal Economic Development Authority) and allowed it to hire the needed consultants. Pursuant to the above decisions, NCSO retained local consultants who have, in October 1983, finalized a detailed work program. The program was estimated to cost $2.68 million in foreign exchange for the whole period and an estimated P 30 million annually. A request for the release of funds to operationalize the recommendations of the consultants was submitted to the Office of Budget and Management (OBM) on February 7, 1984. However, since a number of technical details have required further consultation between OBM and NCSO, no decision on the funding arrangements has been made. A major problem is the upgrading of the salary scales of NCSO's technical staff, which (although favorably endorsed by the Executive Committee in July 1982) is now considered to require an Executive Order from the President. No action to obtain the President's approval has yet been taken. However, it was indicated that NCSO is now preparing a limited proposal for funding other parts of the program (training, acquisition of vehicles, computers and other equipment and technical assistance). Meanwhile, NCSO is trying to implement the program within its regular budget. Three project teams have been organized to effect better planning of data processing activities and greater coordination within the organization. A project team for Establishment Surveys and Census, which was organized in July 11, 1983, is now in the field with the target of final- izing the 1983 survey by June 1984. Two other teams, a project team for Administrative Services and a team for Household Surveys, have been organized recently. NCSO, however, feels that unless additional funds are made avail- able, the completion of the surveys would be severely delayed. NCSO is also preparing a study to implement a stronger legal framework to ensure effective compliance by non-responding establishments. 2.66 The lack of financing for the NCSO program was discussed with the government at various levels during the SAL II mid-term review mission in October 1983. It was agreed that (a) a separate account of $6.0 million would be established in the Treasury to finance this program (and other studies) and (b) the Ministry of Budget would be requested to make an adequate provision for the program. The separate account of $6.0 million has been established subsequently, but the necessary authorization to withdraw the funds had not been issued by OBM until March 1984. 2.67 Management Information System. As a part of the SAL II program, the Government intended to establish a Management Information system (MIS) for MTI/BOI for the purpose of, among others, monitoring the administration and impact of the new investment incentives system. The progress in this area has been relatively good. An MIS group was established within MTI in February 1983 to develop ministrywide MIS at MTI and to coordinate the development of individual subsystems at departmental level. The working group finalized the computerization plan for MTI and its attached agencies in December 1983. This plan was a3proved by the National Computer Center (NCC) on January 11, 1984. - 142 - The total cost of the proposed hardware, software and services is estimated at P 22-27 million but the financing has not yet been assured. Training programs for different staff levels have been prepared and introductory computer courses have been started. 2.68 The overall MIS would consist of 11 subsystems in MTI and 7 sub- systems in the attached agencies. However, since individual bureaus and agencies are responsible for implementing their own MISs, the completion of the overall system is dependent on the progress of these subsystems. Currently, the Bureau of Small and Medium Industries (BSMI) has proceeded fastest. Two out of the three microcomputers proposed for the BSMI head office have already been installed and an extensive training program has been started for 20 of its staff. The Garment and Textile Export Board (GTEB), the Technology Transfer Board (TTB), and BOI are also setting up their systems. 2.69 Under a new budgetary arrangement, the agencies may use any savings out of their budgetary appropriations for operating expenditures (excluding salaries and wages) for acquiring computer equipment during the fiscal year in which the savings are realized (provided that the value of the computer equip- ment does not exceed P 2.0 million). BOI and TTB have acquired fourteen and three microcomputers, respectively, using their 1983 savings. Furthermore, the two agencies have jointly hired the services of a consulting firm to develop their systems. The whole system is expected to be installed by August 1984. Major Industrial Projects 2.70 In September 1979, the Governmen 3 ad announced a program of establishing 11 major industrial projects - to accelerate and deepen industrial development. In October 1979, the National Development Company was reorganized and revitalized to act as the corporate arm of the Government in initiating these industrial projects. However, since these projects are typi- cally large and have long gestation periods, the initiation of the projects was to be phased over a five year time period. Furthermore, as stated in the Government's Letter of Industrial Development Policy for SAL I, the Government planned to establish them onl5 after economic and financial analysis had demonstrated their viability. 2.71 The Government has generally taken a flexible approach towards implementing these projects, although some concern remains whether suffi- ciently rigorous appraisal has been done to determine their economic and technical feasibility. The copper smelter project has been completed and has been in operation since May 1983. The low horsepower diesel engine plant which is a part of diesel engine manufacturing program has also started 13/ The copper smelter, phosphatic fertilizer plant, aluminum smelter, heavy engineering industries, integrated steel mill, petrochemical complex, diesel engine manufacturing program (low and high horsepower engines), cement industry rationalization program, coconut industry rationaliza- tion, alcogas project and the integrated pulp and paper mill. - 143 - production. Five projects are currently under construction, some of them on a reduced scale. Three of these, the phosphatic fertilizer plant, the coconut chemical plant, and part of the heavy engineering project are scheduled to be completed by 1984/85. The coal conversion and plant modernization program of the cement industy is also in progress. The Government has delayed the integrated steel mill project. An expansion of an existing steel rolling mill has been undertaken,however, with the view that it will eventually become part of the integrated steel mill complex. The four remaining projects and the high horsepower diesel engine plant whose economic viability is still to be established have been deferred for the time being. 2.72 In retrospect, since the major industrial projects will have a significant effect on industrial development, the balance of payments, and the budget, it might have been desirable for the Bank to be more actively involved in the review of these projects. Although the Government was generally com- mitted to conducting a full technical and economic appraisal of the projects, no specific provision was made in the SALs to involve the Bank in the appraisal process. The Bank, however, has reviewed the steel mill project at the Government's request. Energy Policy and Resource Management 2.73 To reduce the country's high dependence on imported oil (in 1981, imported oil constituted 72% of commercial energy consumptions and 31% of mer- chandise imports), the Government, in 1982, drew u?41n energy reform program aimed at further structural changes in the sector.- The main objectives of the program were development of domestic resources and diversification towards non-oil sources of energy, increased energy conservation, rationalization of the energy investment plan, and generation of additional funds for financing energy investment. The measures and policies aimed at achieving these objectives were set forth in the Government's comprehensive energy policy statement (SAL II President's Report, Annex IV, Attachment III). These measures and policies, given their wide scope and numerous elements, could only be implemented as a phased program. Hence, the Government's initial policy reforms focused on the key issues of domestic energy development, energy pricing and resource mobilization, and energy conservation. The paragraphs which follow discuss the specific measures that had been proposed in these areas and the progress that has been achieved up to now. 2.74 Energy Investment Plan and its Financing. The main instrument for structural reform in the energy sector was the energy investment plan for 1982-87 amounting to P 67 billion in 1982 prices. The major thrusts of the 14/ For most of the 1970s, the Government had been emphasizing domestic energy resource development and, as a result, had been able to reduce the dependence on imported oil for commercial energy from 87% in 1973 to 79% in 1980. Since 1982, the Government has started including bagasse and agricultural waste in the commercial energy sources. However, reliable data on these sources are not available for the early 1970s. Thus, precise shares of various forms of energy cannot be given for 1973. - 144 - plan were to increase the use of geothermal steam, coal, and hydro resources for power generation; to expand domes,ic coal production; to promote oil and gas exploration and development; and to provide the necesbary infrastructure for all these activities. The target was to increase the share of domestic energy supply (including bagasse and other agriculturti,wastes) in total com- mercial energy from about 28% in 1981 to 49% by 1987- Energy imports as a percentage of merchandise imports were to fall from over 31% in 1981 to less than 25% at the end of the six-year period. If implemented successfuly, the plan would provide significant relief to the balance of payments by the mid- 1980s. 2.75 The power subsector had the largest share (52%) in the planned expenditures. Since this subsector, specifically, National Power Cor,oration (NPC), had been in the past excessively dependent on government equity contri- butions for its investment program, the structural reform had stressed resource mobilization from within this subsector. Thus, the peso requirements of the power subsector were to be financed increasingly from internal cash generation (see paras. 2.77-2.78 below). In 1982, the Government approved a financing plan for NPC which provided for eliminating government equity contributions by 1986 and fixed the annual equity targets of P 2.5 billion in 1982, P 2.3 billion in 1983, P 1.7 billion in 1984, and P 1.2 billion in 1985. Since equity contributions had in the past amounted to about one-fifth of the government budgetary deficit, their phasing out would provide substantial relief to the public resource position. 2.76 In the meantime, however, the country's resource constraint became more severe than anticipated. NPC, therefore, had to further adjust its investment and financing program. It has pruned its investments for 1982-87 by about 10%. It expects to increase (through power tariff increases discus- sed below) its internal cash generation, net of debt service, from negligible to about 30% of capital expenditures during 1984-87. Consequently, it expects to reduce the need for equity tributions to P 0.7 billion and P 0.4 billion in 1984 and 1985 respectively According to preliminary (unaudited) results, NPC has also been able to achieve an 8.2% rate of return in 1983 compared to 6% or lower in the earlier years. Thus, the major objectives of the structural reform in the energy sector, i.e., rationalization of the power investment program and increased resource mobilization from within the sector, have been successfully achieved. 2.77 Power Tariffs. To improve its internal cash generation, NPC increased its wholesale power tariffs which had remained significantly below the marginal cost of supplying power. Starting in July 1982, NPC began increasing the tariffs in quarterly installments of 0.75 centavos per kWh. 15/ The share of domestic energy supply is now estimated to reach 57% by 1987. 16/ The equity contributions for 1982 and 1983 were P 2.13 billion and P 1.6 billion, respectively, against the planned contribution of P 2.5 billion and P 2.3 billion. - 145 - The quarterly tariff increases have been implemented on schedule, with the seventh and last round implemented in January 1984. In addition, NPC had raised power tariffs by another 10% in February 1983. Thus, the cumulative increase in the base rate since July 1982 has been about 23%. 2.78 In addition to the increase in the base rate, NPC introduced a number of other measures to cover increased operating and debt servicing costs. A foreign exchange adjustment clause was implemented in September 1983 to enable NPC to adjust tariffs to compensate for changes in the peso cost of its foreign currency payments due to the depreciation of the peso. Automatic adjustments to cover price increases for geothermal steam and coal have also been introduced. The net result of these and base rate increases has been that the national average tariff rate has increased from 43.76 centavos per kWh in June 1982 to 79.43 centavos per kWh by January 1984. This represents a tariff increase of 82% in nominal terms and 40% in real terms. NPC projects a rate of return of 10% by 1987, with internal cash generation significantly higher than debt service charges, and equity contributions not required after 1985. 2.79 The Government's program of power tariff adjustment had also included restructuring of retail electricity rates in the Metro Manila area (which has a major share in the country's electricity consumption) to reduce cross subsidies and some geographical inequities. Under the new structure that was implemented in 1982/83, significant increases have been made in electricity rates for household consumers using between 50 kWh and 200 kWh per month and for commercial consumers. The tariffs for consumers using less than 200 kWh had not been increased for several years and were extremely low. The new tariff rates will help increase the efficiency of power pricing, conserve energy, and improve the financial position of the Manila Electric Company (Meralco). In November 1982, the President also approved a Program to extend Meralco's services upto 60 km radius of Manila. Meralco is in the process of implementing this program and substantial areas falling under other utilities and cooperatives are to be acquired during 1984. This will have the effect of applying uniform rates to the existing and acquired areas. To rationalize the overall structure of power tariffs, the Government has initiated a comprehen- sive study of the structure of both wholesale and retail power tariffs of public and private utility agencies with a view to eliminating remaining distortions (see para. 2.88 below). 2.80 Petroleum Product Pricing. Throughout the 1970's, the Government had followed the policy of passing through to the consumer all petroleum price increases and had imposed taxes and levies amounting to about 24% of the retail price on the average. This policy was largely effective in meeting the twin objectives of energy conservation and revenue generation. However, the price structure of petroleum products and LPG had become somewhat distorted. Considerable differentials had arisen in the retail prices of petroleum pro- ducts, especially those of gasoline and diesel, due mainly to different tax rates. The price of diesel was about 15% below that of gasoline in 1973 but the difference increased to 40% in 1981. This had induced substitution of gasoline by diesel and encouraged diesel consumption. Because of limited flexibility in refining coefficients, this entailed import of diesel fuel and export of gasoline. A similar price differential also encouraged increased - 146 - consumption of LPG, a close substitute of gasoline and diesel. Although the economic costs of these supply and demand imbalances were relatively small in the early 1980s, they could reach unacceptable levels in the future. In addition, the price differentials were inducing inefficient substitution and uneconomic investment by industries and consumers. 2.81 To correct the above imbalances and set a long-term price and refining iolicy, the Government initiated a two-phase petroleum pricing study. ihe first phase was completed in 1982 and suggested short-term price measures. The second phase is being finalized now (see para. 2.87 below) and will provide the basis for a long-term strategy. 2.82 In the meantime, reflecting changes in oil prices and the country's economic situation, the Covernment has increased the domestic prices of petroleum products by about 38% on the average between June 1983 and June 1984. Simultaneously, it has reduced the price differentials among various products (see Table 3), which was one of the policy objectives under SAL I'. For example, the ratio between diesel and pr Tmum gasoline prices has increased from 58% in 1981 to 74.3% in 1984.- Further actions in this regard will be taken in the light of the recommendations of the Phase II study, the international oil situation, and Government's revenue and energy conservation objectives. 2.83 Energy Conservation and Conversion. Although improved energy pric- ing was to provide the main incentive for increasing efficiency of energy consumption and for conversion to non-oil sources of energy, the Government has adopted a number of programs to reinforce the price effect. The Bureau of Energy Utilization (BEU) of the Minist.f of Energy (MOE) manages and monitors these programs. BEU regularly monitors energy consumption of 300 companies using one million or more liters of fuel oil equivalent energy per annum. These companies are required to submit quarterly reports on improvements in energy eff ency. An energy audit project covering 89 plants has been completed which identifies energy conservation potential of these plants. BEU itself has completed audits of another 219 establishments. BEU has conducted 37 energy management training courses and held a number of seminars, briefings, and19rkships. It has also started an Energy Management and Consultancy Service - and a Technology Transfer for Energy Management 171 The growth rate of consumption of diesel oil dropped from 4.3% in 1982 to 1.6% in 1983 compared to over 4% for premium gasoline in both the years. The slower growth of diesel consumption may be due partly to the price increa.e and partly to the continued slow economic activity. 18/ This project was carried out by Arthur D. Little, Inc. of USA and Brokenhill Proprietery Co., of Australia and was financed by ADB. 19/ Supported by UNDP and UNIDO. - 147 - Table 3: PRICES OF SELECTED WHOLESALE PETROLEUM PRODUCTS AND LPG (P per Liter) Product 3/23/79 3/22/81 7/1/83 11/3/83 6/1/84 Gasoline (Premium) 2.137 5.069 5.288 6.258 8.058 Gasoline (Regular) 1.976 4.876 5.095 6.065 7.815 Diesel 1.331 2.938 3.257 4.22 5.987 (Diesel/Premium Gasoline Price Ratio) (62.3%) (58%) (61.6%) (67.5%) (74.3%) LPG 1.298 2.692 3.011 3.98 5.471 Kerosene 1.296 2.962 3.281 4.25 6.011 Fuel Oil .933 2.085 2.404 3.4 4.645 Source: Ministry of Energy. Project.20/ BEU publishes booklets on specific topics geared to user needs and a Quarterly Review covering energy utilization, regulation, conservation, and statistics. BEU has established a test boiler for determining relative efficiency (and economic feasibility) of various fuels and a calorimeter for measuring efficiency of electric appliances. Incentives for manufacture of, and investment in, energy saving equipment continue to be provided by BOI. 2.84 The cement industry's program of conversion from oil to coal has been completed; as of February 1984, all cement plants except two had conver- ted to coal. Although the conversion program has proceeded well, the develop- ment of small scale domestic coal is lagging behind and the quality of domes- tic coal suffers from inconsistency. The Government is currently examining the issue. Nevertheless, the objective of energy diversification away from oil has been met and imported coal (primarily from Australia) remains cheaper than the imported oil. 2.85 It is difficult to separate the impact of economic changes, price changes, and direct conFirvation measures on energy consumption. However, the country's efforts towards energy conservation appear to have been general 1 successful. Energy consumption per unit of output has declined -rom 1.6 in 1974 to .984 in 1983. Dependence on imported oil has dropped from 72% in 1981 to 65% in 1983. In response to the direct measures and incentives for energy conservation, BEU estimated that during 1979-82, energy savings equal to P 488 million were made with an investment of P 349 million. 20/ Supported by USAID. 21/ BOE per P 1,000 of GNP. - 148 - 2.86 Energy Policy Studies. Two major energy studies were to be under- taken under SAL II to form a basis for future structural reform in the energy sector. These are the Petroleum Products Pricing Study and the Power Tariff Study. While the progress of the former study has been good, the latter study has been substantially delayed. 2.87 The Petroleum Products Pricing Study is being coordinated by BEU. Phase I of the Study (determination of short-term price adjustments) was completed in August 1982 and necessary actions have since then been taken as discussed above. Phase II (longer term petroleum pricing issues covering price/tax differentials and the appropriate refinery mix for the Philippines) is almost complete. The draft final report has been reviewed by the Bank and will shortly be discussed by the Government with the consultants. The final report is expected around mid-1984. 2.88 The Power Tariff Study is being coordinated by the National Economic and Development Authority (NEDA). Its objectives is to provide recommenda- tions for restructuring wholesale and retail tariffs to eliminate existing inefficiencies and inequities. This study has had a checkered history. The study was expected to commence in April 1983 but was delayed due to the lack of funds, both foreign and local. Initial work on data collection and review of the power tariff structure has been completed by the NEDA staff and a Project Manager has been appointed. Recently, the Government has signed a memorandum of understanding with the ADB for a technical assistance grant which will cover foreign exchange and some local currency expenditures of the study. The study is now expected to start in August 1984. Other Aspects of the Program Technical Assistance Component 2.89 A separate technical assistance component of $5.0 million was included in SAL I to be used over a four-year period for consultants' services, training and fellowships in four major areas. Among other activities, it was intended to finance assistance to strengthen MTI/BOI's planning and analytical capabilities with respect to project evaluation, access to information on technological alternatives, overall administration and organization, review of fiscal incentives system, and sector restructuring programs. It also provided assistance for training the Tariff Commission staff, establishment of an international trade center, and for strengthening training, product development and related activities in export promotion. Furthermore, consultants were also to be employed to help with the technical assistance program's management and administration. 2.90 The implementation of the SAL I technical assistance program has been good. A full-time team of consultants was hired in January 1981 and a work program for the implementation of the measures listed above was prepared. As of March 15, 1981, nearly half of the $5.0 million component was already committed. 2.91 Subsequently, during the mid-term review of SAL I in March/April 1981, two additional areas were agreed to be studied under the technical - 149 - assistance component. These areas were (a) realignment of the indirect tax system and (b) improvement of industrial statistics. 2.92 The Government's report on the use of the SAL I technical assistance component shows that, as of March 14, 1984, all of the $5.0 million have been committed and most of the funds (87%) withdrawn. MTI/BOI has received $3.2 million for consultants, training of staff, and preparation of sector development programs; the Tariff Commission has received $0.7 million for the strengthening of its staff; and $0.7 million has been allocated for export promotion through NDC and CITEM. In addition, the SAL I technical assistance funds have been used for the Ministry of Energy ($0.3 million), NTRC ($0.1 million), and NCSO ($27,000) to initiate some of the studies agreed upon under SAL II. 2.93 SAL II had no separate technical assistance component similar to that of SAL I. At the time of the appraisal of the loan, the Government indicated its preference for funding various studies and other activities from its own resources. This was to enable the Government to quickly draw down the loan in its entirety and to avoid paying commitment charges on the technical assistance funds which, 1r-pically, are disbursed over several years. Simul- taneously, the Government committed to providing the necessary funds for the studies/activ:ties mentioned in Attachments I and II of the Government's Letter of Development Policy, covering both local and foreign costs. The Government has, however, failed to make adequate provision for these funds, and many of the activities (namely, strengthening of NCSO, review of non-BOI incentives, preparation of sector development programs, and completion of number of studies) have been considerably delayed. Loan Disbursement and Procurement 2.94 The disbursement procedures of SAL I were designed to ensure rapid drawdown of loan proceeds. The import component of SAL I was intended to finance the foreign exchange cost of eligible imports defined to include non- consumer items in categories 2, 5, 6, 7, 8 and 9 of the SITC (with certain exceptions). The Central Bank was made responsible for maintaining and administering the Project Account. Procurement was to follow normal commer- cial practices. However, imports of goods in excess of $5.0 million per contract were to be subject to procedures ensuring international competitive bidding. These contracts were to be reported to the Bank before requesting a withdrawal of proceeds of the loan to ensure that such contracts have been let according to the guidelines. There were no such cases and no procurement problems arose under SAL I. 2.95 The disbursement of the import component of SAL I was quick. The first tranche of $100.0 million, which was made available at the time of loan effectiveness (November 14, 1980), was fully disbursed in June 1981. The release of the second tranche of $95.0 million was delayed from the original target date of January 31, 1981 to June 20, 1981, because of some delays in the completion of specific measures in realigning tariffs and liberalizing import licensing, which were the conditions for the release of the second (and final) tranche of the loan. The import component was fully disbursed in September 1981. - 150 - 2.96 The same arrangements that were made for the administration of the import component of SAL I were continued for SAL II. The loan was to finance the foreign exchange cost of eligible imports and it was subject to the same conditions for procurement as SAL I. There were no procurement problems with SAL II either. 2.97 The disbursement of SAL II was also rapid. The first teanche of $202.3 million, which was made available at the time of loan effectiveness (April 28, 1983), was fully disbursed in December 1983. The second tranche of $100.0 million was released on December 12, 1983, on the basis of satisfactory progress reported by the mid-term review mission. The loan was fully disbursed on January 5, 1984. 2.98 Use of Counterpart Funds. It was agreed under SAL I that the Government would use the pesos generated by the sale to importers of the foreign exchange proceeds from the loan to finance industrial development expenditures, broadly defined to include manufacturing, agro-industry, mining, construction and utilities. It was furthermore agreed that quarterly reports would be submitted to the Bank. However, the quarterly reporting was dis- pensed with after it became evident that the Government was acting according to the agreement and that the reports would provide little additional informa- tion for the monitoring of the SAL I program. The SAL II agreement did not include any specific conditions for the use of the counterpart funds. 2.99 Supervision of the Loans. The loans were supervised mainly through mid-term reviews and preparation missions for SAL II. An examination of the mid-term reports and other back-to-office reports shows that the supervision was comprehensive, pointed up the delays and problems in the program, and facilitated the implementation of the program. As the program's coverage expands, separate supervision missions would probably become necessary both to monitor the program's progress and to advise the Government on how to deal with the possible problems. Coordination with the IMF 2.100 Both SAL I and SAL II were carefully coordinated with the IMF, particularly in the areas of fiscal, monetary, and exchange rate policy. The IMF mission which negotiated the 1980-81 standby arrangement was in the field at the same time as the SAL I preappraisal mission. An IMF staff member participated in the SAL II appraisal mission. The SAL II post-appraisal mission overlapped with the IMF mission which discussed the standby for 1983; a Bank staff member also participated in the Latter mission. Draft documents and views were exchanged at various stages in the processing of the SALs and the standby discussiong. Institutional Capacity of the Government 2.101 At the time of the preparation of the structural adjustment program it appeared that the key government agencies had adequate capacity for initiating the program. However, this capacity needed to be strengthened in several areas and a provision for this purpose was made in the SAL I technical assistance component. This effort focused mainly on the strengthening of the - 151 - Tariff Commission and MTI/BOI (paras. 2.60-2.62) which were the key agencies for trade and industrial policy reforms. Funds were also provided for sup- porting the National Tax Research Center (NTRC) and some other studies. This helped improve the Government's analytical and technical capacity to design and implement the program in most of the areas. In addition, it appears that the Government was able to mobilize sufficient political support for trade liberalization, industrial incentives reform, and adjustment of energy prices, which might have been considered controversial or politically difficult parts of the program. 2.102 As agreed under SAL II, the Government has set up an inter- agency coordinating committee chaired by NEDA. This committee is responsible for the coordination of both implementation of the ongoing SALs and prepara- tion for the future ones. The committee meets regularly and has been very helpful in preparing both the SAL II mid-term review report and this report. Preparation of Future Policy Reforms 2.103 For the future, the Government intends to complete the structural reforms currently under implementation and extend the adjustment program to other sectors of the economy. In particular, remaining issues in energy policy as well as further improvements in public resource managemeut will be addressed. In addition, agricultural policy will be reviewed and an appropriate reform program formulated. To help towards this end, several studies were tentatively identified under SAL II in the areas of public resource management, energy, and agriculture. While the Government has made good progress in reviewing the issues in most of the areas, in some cases with outside assistance, some of the studies have been hampered by the lack of funds. The Government will need to make more concerted efforts to complete the studies and identify areas for future reform. Evaluation and Conclusions 2.104 The structural adjustment program agreed under SAL I and II has been substantially implemented (see Annex I for the summary of the perfor- mance). The average tariff and effective protection rates have been lowered, some import restrictions have been removed, indirect taxes are being realigned, industrial incentives have been reformed, and conservation, diver- sification and resource mobilization in the energy sector are generally proceeding on schedule. These reforms, however, have had to be implemented under very adverse, and unanticipated, external circumstances. Consequently, as discussed above, progress in the area of trade liberalization and tariff reduction has sufferea. It is hoped that the balance of the program will be implemented once the present economic situation improves. - 152 - 2.105 Overall, the program had several strong points. It was2 sed on a number of economic and sector reports prepared in the late 1970s.- These reports had provided the necessary analysis and established a meaningful dialogue with the government. This facilitated the preparation of an agreed policy package focused on trade and industry (to which energy policies were added later on) which suffered from longstanding structural problems and where reform could have long term impact on the balance of payments, growth, and employment. The program was specific and monitorable in terms of policy inputs, with an emphasis on completing the actions before the loan effective- ness. The concerned ministries had adequate institutional capacity and improved it further to prepare and implement the program. Despite some set- backs, the program has largely fulfilled the original expectations. The Government officials are of the view that the program effectively addressed the identified problems and should yield substantial benefits. It will, however, take some time before the full impact of the program can be measured: the program is still being implemented and the current economic crisis makes it difficult to observe the impact. 2.106 While largely well-designed and successful, the program also appears to have suffered from a few weaknesses. First, it was too detailed in several areas which made supervision time-consuming and tended to detract from the broader concerns. Second, while SAL I had a technical assistance component which proved extremely useful in the preparation of SAL II, this component was dropped from SAL II. The Government instead agreed to finance various studies and activities from its own sources. Although done at the request of the Government, the Bank was willing to accept the arrangement to facilitate disbursement and early closing of the loan. The Government has largely failed to provide the requisite funds for the proposed activities, which was only partly due to the current financial squeeze but mainly due to the lack of effort by, and coordination among, the concerned agencies. Lastly, in hindsight and considering the recent economic developments, the program appears to have been somewhat narrowly based. 2.107 The economic events have turned out to be more adverse during the last three years than had been foreseen when the progam was prepared. The international rece on has been too prolonged which affected the country's exports adversely.- At the same time, the country's terms of trade worsened by about on-third during 1980-83. Expecting a quick recove y, the country followed a countercyclical policy which compounded the im' of continuing 22/ Sharing in Development, ILO, Geneva, 1974. The Philippines: Priorities and Prospects for Development, World Bank, 1976. Industrial Development Strategy Policy in the Philippines, World Bank, 1979. The Philippines: Aspects of the Financial Sector, 1979. The Philippines: Aspects of Poverty, World Bank, 1980. The Philippines: Selected Issues for 1983-87 Plan Period, World Bank, 1982. Philippines: Energy Sector Survey, World Bank, 1982. 23/ The real effective exchange rate is estimated to have appreciated by about 5% during 1980-82 which must have also affected exports. - 153 - expansion in public sector investment despite lagging resource mobilization. The growing current account (and budgetary) deficits were financed by external borrowing. The increased borrowing, a Large part of it being short-term and at high and variable interest rates, substantially increased the debt service payments. Simultaneously, the viability of the financial sector was threatened by internal problems and continuing recession. Thus, the Government was under pressure to prevent large scale business failures by infusing fresh money. Capital flight due to political uncertainty, and reduction in foreign credit availability, brought the crisis to a head in late 1983. Consequently, the Government suspended debt repayments, devalued the peso substantially, reimposed foreign exchange controls, reduced public investment program, imposed additional import duty, and started negotiating debt rescheduling. 2.108 A balance of payments crisis in the midst of a structural adjustment program necessarily raises questions about the appropriateness of the program. Was the program properly designed to address the problems facing the economy? Did the program contribute (through trade liberalization) to the crisis? Would the program help the economy to recover from the crisis? 2.109 On the first question, it needs to be said that the program was designed to reform trade, industrial, and energy po'icies identified by several studies (as noted earlier) as fundamental for improvement in economic efficiency, equity and the balance of payments. Although problems in other areas (for example, in public finances and external debt) existed, they did not appear o be equally serious then and have reached crisis proportions only recently.- 2.110 The areas included in the program had been well studied (besides others, through Bank's industrial and energy studies) and a good dialogue had been established with the government. The other areas did not have a sufficient back up economic and sector work partly due to the lack of recognition of the severity of the problems and partly due to the lack of Government's receptivity. Since SALs by their nature must be well-prepared on the basis of shared views, between the Bank and the Government, about the problems and their solutions, this precluded inclusion of other areas in the program on short notice. Nevertheless, it needs to be recognized in hindsight that more broadly based SALs would have strengthened the program and, at least, softened the crisis. 2.111 Although a broad macroeconomic structural adjustment program did not exist, this did not mean that the Government could not have adopted measures to prevent the crisis. In fact, some of the problems (public sector deficits, current account deficits, and foreign borrowing) were the subject of short-term stabilization programs agreed to by the Government and the IMF, which were in principle a more suitable vehicle for addressing these questions. 24/ These areas have subsequently been studied by the Bank and issues are now being addressed by the Government. - 154 - 2.112 On the second issue, trade liberalization or other programs do not appear to have contributed significantly towards increasing imports. Other aspects of the program, for example, energy pricing and resource development and export promotion have probably had important positive impact on the balance of payments. Likewise, there seems to have been little revenue loss from the SAL measures, although the impact is hard to measure and may have been offset by other, positive, effects. 2.113 Regarding the third issue, recovery from the present crisis depends primarily on successful short-term adjustment measures and debt rescheduling. While some parts of the program have suffered on account of stabilization needs, the program on the whole will provide the basis for resuming the growth momentum through improved resource allocation. It should especially help the economy increase its foreign exchange earning/saving capacity. Having lowered the level of protection in the industrial sector, it will also have reduced the implicit discrimination against agriculture. The next SAL could, therefore, build upon the previous accomplishments in the areas of trade, industry, and energy, and extend the coverage to public resource management, external debt, and agriculture that have emerged as critical areas for the future. In the meantime, however, the government has the difficult task of adopting stabilization measures without seriously damaging the structural adjustment program and the medium-term growth prospects. 2.114 Lessons for the Future. The experience with two SALs suggests some lessons which can be usefully applied to future lending of this type in the Philippines. First, as in the past, the SAL policy package needs to be based on a strong program of economic and sector work which has identified issues and policy instruments, and about which there is broad agreement bet- ween the Bank and the Government. Second, while policy packages should be specific and monitorable, care should be exercised to avoid making them excessively detailed, particularly in areas which are not central to the policy objectives. Third, if studies and institution-building are part of the policy package, there should be an adequate mechanism for funding the required technical assistance for their implementation. Finally, it should be recog- nized that attempts to deal with medium-and long-term structural issues can be disturbed by the emergence of a short-term financial crisis. Therefore, timely adoption of adequate stabilization measures is a necessary condition for successful implementation of a structural adjustment program. At the same time, the program should be sufficiently robust and flexible to accommodate temporary and short-term disturbances in the economy. ANNE I - 155 - aeg I Summary of Performance Performance Evlaluation /a Actions supported under SeL I and SAL II 1 2 3 6 5 INDUSTRIAL POLICY REFORMS Reform of the Industrial Incentives System Rationalization of Incentives structure x Improvement of procedures for registration, availment of incentives, and investment priority determination x Elimination of provisions restricting the entry into an industry Studies of non-BOI fiscal incentives /b x Sector Development Planning Preparation of a concept paper and a work program Preparation of sector programs X Strengthening of Institutions Reorganization of HTI/BOI, implementation of staffing and training programs, and establishment of a management information system Implementation of a program to improve industrial statistics and strengthen NCSO/b x TRADE POLICY REFORMS Tariff Reform Program Implementation of a staged tariff reform program (1981-85) to reduce peak tariffs to 502 /c x Import Liberalization Implementation of a 1981-83 plan to eliminate import licensing requirements for consumer good. /d X Liberalization of the remaining NEC/UC item and producer and investment goods X Improvement of Export Promotion Regime x Realignment of Indirect Taxes Legislation to eliminate the protective effect of indirect tax system X Study of second-stage sales tax/b x ENGER! POLICY AND PUBLIC RESOURCE MANAGEMENT Domestic Energy Develooment Adoption of energy investment and financing plan X Energy Pricing and Conservation Increase in electricity tariffs to improve self- financing of NPC and restructuring of retail electricity rates in Metro-Manila X Adjustment of petroleum product prices x Energy conservation and conversion measures X Study of power tariffs X Study of petroleum product prices x Preparation of Other Studies X /a Ratings from poor to excellent. 7-b Progress inadequate due to lack of funds. W A temporary additional import duty of 10% is currently being levied. 7d- Scheduled liberalization in 1983 has been scaled back.