Support for economic recovery in the Philippines

28352 NUMBER 43 *Precis Operations Evaluation Department May 1993 Support for Economic Recovery in the Philippines When the Aquino administration sector was bankrupt or in distress. The taxes, replacing the sales tax with a came to power in 1986, output per capita departure of many senior officials and value added tax (VAT), and improv- had fallen by more than 15 percent in two upper and middle level technical staff ing tax administration. years. Three-fifths of the country's had depleted the civil service. 0 Trade: Implementing import population were below the poverty line, liberalization measures agreed upon and the unemployment rate in Metro The intemational community under earlier SALs; eliminating Manila was 25 percent. Infrastructure welcomed the new administration and quantitative restrictions QRs); had been severely neglected, and major prepared urgently to give it strong reforming the tariff structure. bottlenecks were emerging in power, support, including debt relief and new Reforms were to be preannounced, transport, and water supply. A structur- money. Being designated as one of the to give clear signals to potential al reform program begun by the Marcos Baker Initiative countries assured the private investors in export-oriented regime, with support from the Bank and Philippines full bilateral and multilater- activities. IMF, had barely begun to yield results. al backing, in exchange for the adoption o Public expenditures: Substantially of an approved program of structural increasing public outlays for invest- The Aquino coalition represented a adjustment. For its part the Bank ment-to 5-6 percent of GDP-and spectrum of views, some of them opposed chaired the Consultative Group on the bringing operation and maintenance to market-oriented reform. An OED Philippines, began an extensive (O&M) expenditures in priority audit* explores the role played by the program of economic and sector work, social and economic sectors back to Bank's Economic Recovery Loan and launched a comprehensive lending their real 1982 levels. (approved 1987) in establishing a program centered on the government's o Government financial institutions: dialogue with the new government and medium-term plan, the Economic Reorganizing the two largest govern reaching agreement among policy makers Recovery Program (ERP). ment-owned banks, the Philippines on the necessary course of reform. While National Bank (PNB) and the Develop- its accomplishments were mixed, the loan The ERP aimed at alleviating ment Bank of the Philippines (DBP), kept the country on the path of economic poverty, improving social justice, which were technically bankrupt and liberalization and paved the way for a accelerating growth with increased together accounted for nearly half the large-scale resumption of financial economic efficiency, and reducing the assets of the Philippine banking system. assistance from the Bank and other government's economic role in favor of Reducing the government's direct donors. the private sector. It was supported by presence in the financial system to the Bank's Economidc Recovery Loan encourage greater private ownership. Background (ERL) and contributions from other Despite previous attempts at donors. ' Audit Report, import liberalization, in 1986 Philippine Economic Recovery Loan Philippines: Economic Recmx7y industry remained highly protected, at Prognun and Technical Assistance the expense of agriculture and exports. The ERL ($300 million, approved Pro*t", Report No. 10866, June A bloated government corporate sector 1987, completed 1990) called for reforms 1992. OED reports are avilable to contributed heavily to the fiscal deficit in four areas: Bank Eecutie Dkctors and staff and external debt. The large foreign from fhe Internal Documents Unit debt burdened public finances and the Tax system: Rationalizing the central bank. Much of the financial tax system, streamlining indirect ialsices andtem - -_ -- -1 ment repeatedly tried to introduce Successful Bank Restructuring: DPB and PNB legislation making further progress toward liberalization, but only in July At the start of the ERP, the two The two banks now face the same 1991 did it succeed in passing a new largest government-owned banks, the constraints and incentives as private tariff code. (It is worth noting that Philippines National Bank (PNB) and banks. because import duties were still a the Development Bank of the Phihp- large share of tax revenues, earlier pines (DBP1, were technically bank- Both banks emerged profitable and success in lowering them could have rupt. Eighty percent of their portfolios financally sound. PNB by 1989 created serious fiscal difficulties.) were nonperforming, and imposed a earned a profit equivalent to a yield of Fiscal constraints on spending burden on the budget equivalent to 4 almost 37 percent on year-end equity; percent of GNP. since 1986-87, its total deposit, loans back the planned increases in public and capitalI have all shown healthy investment and O&M. The ERL supported a phased action increases. DPB, in 1989, earned a Compliance was excellent in the program for their restructuring, return on average equity of 18.8 area of government financial institutions. compliance with which was excellent: percent. PNB and DBP notably improved their * Actions taken before ERL was Partial primtization of PNB: A financial condition and began divest- approved: approval of revised charters, major achievement has been the ing nonperforming assets (see Box). rehabilitation programs, and arrange- partial privatization of PNB, beyond At the end of 1985, government had ments for transfer of nonperforming the commitments made under the owned 40 percent of total banking assets; agreement with the Bank on ERL. In 1989 the government made a sector assets, excluding those of the programs to strengthen internal secondary public offering of 30 central bank. Massive write-downs by governance and performance monitor- percent of PNBs outstanding shares. PNB and DBP at the end of 1986, in ing; establishment of a committee to As well as netting the government compliance with the action program supervise disposal of assets, and of an P1.8 billion, this had broader implica- supported by ERL, reduced this share Asset Privatization Trust AMT to tions for the capital market. It added to 21 percent. implement the disposal; and designa- P4.7 billion to the market capitaliza- tion of a government committee to tion of listed equities in just tVo Conditionality: The loan was monitor the banks' performance. months and, because it was sod t divided into three tranches, rather * Conditions for release of second widely dispersed individual investors, than the two more often used. and third tranche: satisfactory added some 25,000 stockholders. T implementation of cost reduction and showed that properly stThugh man o the ird aco branch dosing programs, internal equity deals involving government reorganization and strengthening of corporations could be successfully was released, tranching helped internal procedures, performance completed. PNB was the most program implementation by requiring monitoring systems, and transfer of actvely traded stock on the Manila Bank and borrower to assess system- titles of the assets being disposed of. exchange in 1990. atically the progress made with each loan condition and the possible need At the end of 1986, the two banks The overall assets of the financial, for corrective action. transferred all nonperforming loans system have grown substantially. At above PlO million ($0.5 million) toA17T end 1990, PNB accounted for 15 Monitoring and supervision for workout and ultimately sale to the percent, and other government banks missions were frequent and generally private sector; corresponding liabilities 8 percent, of Philippine banking sector effective. On public expenditures and were transferred to the government. assets. technical assistance, closer involve- c s ment of sector staff would have been useful. The government participated Implementation somewhat, but remained high at fully with periodic reporting, and the around 20 percent. resident mission provided valuable * Significant tax reforms were carried 9 Trade reforms were adopted, support. After completion, the out, including the conversion-3earer including the removal of QRs from government prepared a detailed than scheduled-fsom sales tax to a many products, which lowered completion report whch it used to value added tax and an improvement average effective protection from 49 derive lessons from experience. in the income tax structure. However, percent in 1985 to 36 percent in 1988. the refores did not yield the expected But because of strong opposition from Technical assistance loan: Bank staff revenue increases: tax administration business and Congress, import had proposed a complementary $10 remained weak, while the shift to VAT liberalization fell short of targets. million Technical Assistance Loan (a more complex tax than the sales tax Some sectors remained highiy (TAL). There were real needs for it replaced) was too hasty and resulted protected, and certain industrial institutional strengthening, and in a revenue loss. The share of import groups received effective protection of administrative limitations were part of duties in total tax revenues fell more than 100 percent. The govea- the reason why the public expenditure May 1993 by the strong international support The precarious financial condition of Subsequent Bank Assistance and by the reforms begun under the the central bank compromised the to the Philippines ERP-stimulated imports, exports, conduct of monetary and exchange-rate and some private investment. With policy, making trade reform more Hardly any Bank-financed considerable excess capacity in the difficult (see below). Adjustment to operations were approved in the system, exports surged and economic higher energy prices was delayed, and last years of the Marcos govern- growth picked up (see table). Tax growing energy subsidies, uncompensat- ment, but with the economic revenues increased somewhat, and ed by the low-yielding tax reform, added improvements that resulted from the public sector deficit was reduced. to the fiscal deficit and crowded out the Economic Reform Program, Using the official poverty line, poverty development-oriented public expendi- Bank lending, including support incidence of families and of individu- tures. infrastructure bottlenecks wors- for further adjustment, grew als declined by 3 percentage points ened, particularly in power, transport, substantially. In FYS'-92, 30 between 1985 and 1988. and other utilities, further discouraging operations were approved, private investment. totaling $3.6 billion, in nearly all The ERL contributed to these sectors. The Bank has had an active policy dialogue with the improvements by: Assessment government, backed by economic and sector work. package that included the WMW dialogue between the Bank and the new Today's lending program standby arrangement, strong aid administration that helped to forge emphasizes infrastructure, poverty coordination, and debt relief activities agreement within the administration on alleviation, and sustainable in which the Bank played a key role. the need to continue with economic environment issues. The infra- These efforts helped to relieve the liberalization. Though the achievements structure program emphasizes foreign exchange constraint and under the ERL itself were mixed, and power, transport, water supply reinforce the retur of private sector further progress on structural reform has and sewerage, and other initiatives confidence, been uneven, the process of change in the including Mount Pinatubo-related Directly addressing some critical Philippines has been sustained and rehabilitation. Lending in educa- tion and training and in health- especially targeting women and financial sector and the need for public loans from the Bank (see Box). children-will help alleviate spending to maintain infrastructure. poverty. Environmental issues are being addressed through assis- But, as events showed, the largest government-owned banks, to tance in agriculture, natural underlying macroeconomic weak- begin a far-reaching process of divesti- resource management, and nesses had not yet been corrected. In ture, to start the rationalization of the tax industrial pollution control. 1990, unable to withstand the effects of system, and to make progress toward ______ ___ ____- a major drought, an earthquake, the trade liberalization. The country's Gulf war, and termns-of-trade losses, physical infrastructure would probably growth declined, inflation accelerated, have deteriorated even further without and tax reform components of the ERL and the export drive slowed down, the ERL. did not succeed. But lack of borrower participation in the design and prepara- tion of the TAL conspired against its success. There is no evidence that the borrower participated much in the decision to include the TAL in the ERL package, or in choosing the areas of focus. The activities were not well defined in advance, and mid-level staff GDP -73 3.4 4.8 6.3 6.1 2.4 who would have received the assistance were not consulted. The government Private consumption 0.9 1.6 3.8 2.6 3.0 eventually requested cancellation of the per capita TAL, undisbursed. Imports GNFS (US$) -14.2 10.2 28.6 19.6 15.2 10.0 Outcome Exports GNFS (UJS$) -16.6 17.1 6.5 14.7 10.7 1.31 Economic performance improved markedly during the implementation of Inflation (CPI) 23.1 0.8 3.8 8.8 10.6 12.7 ERL (1987-89). Renewed capital inflows ESource Audit report, op.cit, page 12. considerabeD cpcit in the the OE pulcPet riciws rdcd an overvalued exchange rate, which Recommendations in turn hindered further reductions * Close coordination with IMF is jointly. Bank sectoral staff should m industrial protection. indispensable. This calls for participate Aid coordination rigorous efforts to ensure that structural adjustment programs to Close cooperation between sector Other donors, notably the IMF be supported by Bank lending are and country operations Bank staff in compatible with government the design and supervision of adjust- stabilization prmgrams. ment operations can be most valuable, to the ERP. The IMF extended an 18- regardless of which Bank unit has month standby and a Compensatory * Borrowers' institutional capacity primary responsibility. Facility arrangement, for a total of to carry out the program should be SDR 422 million. Bank staff relied on ascertained during preparation. Coordination of cofinancing the macroeconomic framework Arrangements for technical assis- requires careful planning. Conditions provided by the IMF, which contem- tance or institutional strengthening for tranche release should be clearly plated an expansionary fiscal policy should be made jointly, before Board spelled out in advance, and a financing to be financed with increased foreign presentation. program drawn up early on, to ensure aid. While this program included that the available financ'ing is consis- wide-ranging structural reforms * Technical assistance projects need lent with the retorm program and that which had been coordinated with the the borrower's full involvement and one donoes disbursement decisions do Bank, it did not address the worsen- participation not only at the highest not undermine the implementation of ing financial situation of the CBP, or levels but also at the middle levels reforms supported by another call for a real devaluation which where the TA will be delivered. Precisely formulated work pro- Multiple tranching can effectively grams, terms of reference, budgetary influence compliance with the orented private investment. provisions, and supervision conditons and objectives of adjust- arrangements should be worked out ment operations. between sectoras Econtiu andoeat countr operCion Banktsiaffti ed $240 million equivalent of cofi- Issues deteriorating position of the Central nancing, and the Japanese Eximbank Bank. Monetary and exchange rate $300 million equivalent. Disburse- Public expenditures policy, shaped by CBP's financial ments under the latter loan were distress, conflicted with the ERL's linked to progress in executing the Part of the reason why the targets goals. country's public investment pro- for public investment and for O&M gram, rather than to fulfillment of were not met was that they were too By 1986, CBP was experiencing tranche-release conditionality. This abstract. The loan conditions specified heavy losses because of the extraor- arrangement involved the potential the targets as percentages of GDP, and dinary obligations it had taken on risk of conflicts when the timing of not enough attention had been given earlier. (These had included bilateral disbursements did not to the realities of governmental assuming the foreign currency coincide with that of Bank tranche jurisdictions, the kinds of expenditures liabilities of certain public and releases. to geographic distribution. Also private enterprises, advancing the missing was an adequate assessment payment of foreign interest on Institutional capacity of the institutional capacity needed to publicly guaranteed debt, and meet the targets-even though they making forced loans to failing Especially when dealing with a represented a large increase over firms.) To absorb the excessive young administration, the Bank prevailing levels and Bank staff were liquidity caused by these losses- should make every effort to ensure aware of the counhys serious admin- which were not addressed by the that the institutional capacity exists to istrative constraints in general. ERL or by the IMF program--CBP carry out the program. For example, borrowed domestically, pushing up it can be risky to plan the elimination Macroeconomic management interest rates and crowding out of a proven-even if suboptimal- private investment. CBP's external tax before installing adequate Reforms were made more debt position made it vulnerable to training and institutional arrange- difficult by not tackling earlier the devaluations, leading it to maintain ments for administering the new tax. OED Pr&is is produced by the Operations Evaluation Department of the World Bank to help disseminate recent evaluation findings to development professionals within and outside the World Bank. The views here are those of the Operations Evaluation staff and should not be attributed to the World Bank or its affiliated organizations. Please address comments or enquiries to the managing editor, Rachel Weaving, E-1204, World Bank, telephone 473-1719. May 1993