Philippines - Economic Integration Loan

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15209 IMPLEMENTATION COMPLETION REPORT REPUBLIC OF THE PHILIPPINES ECONOMIC INTEGRATION LOAN (LOAN No. 3539-PH) DECEMBER 29, 1995 Country Operations Division Country Department I East Asia & Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Peso (P) Average Januarv-June 1995 US$1 P25.5 Average 1994 US$1 P26.9 Average 1993 US$1 P27.1 Average 1992 US$1 P25.5 FI.SCAL YEAR OF BORROWER January I - December 31 ABBREI'IA TIOA VAND ACRONYYMS BOT Build-Operate-Transfer BSP Bangko Sentral ng Pilipinas (Central Bank of the Philippines) GATT General Agreement on Tariffs and Trade GOCCs Government Owned and Controlled Corporations ICR Implementation Completion Report JEXINMl Export-Import Bank of Japan OPSF Oil Price Stabilization Fund QRs Quantitative Restrictions on imports  FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT REPUBLIC OF THE PHILIPPINES ECONOMIC INTEGRA TION LOAN (LOAN NO. 3539-PH) Table of Contents Page PREFACE EVALUATION SUMMARY ...................................i PART I. IMPLEMENTATION ASSESSMENT A. Statement/Evaluation of Objectives ..................................... 1 B. Achievement of Objectives ....................................3 C. Major Factors Affecting the Project .....................................6 D. Project Sustainability ............................7 E. Bank Performance .........................7 F. Borrower Performance .........................8 G. Assessment of Outcome .........................8 H. Future Operations ..........................9 I. Key Lessons Learned .........................9 PART II. STATISTICAL ANNEXES Table 1: Summary of Assessments ............................... 11 Table 2: Related Bank Loans ............................... 12 Table 3: Project Timetable ............................... 12 Table 4: Loan Disbursements: Cumulative Estimated and Actual ............... .............. 12 Table 5: Key Inclicators for Project Implementation ................................................. 13 Table 6A: Project Costs ................................................. 15 Table 6B: Project Financing ................................................. 15 Table 7: Status of Legal Covenants ................................................. 15 Table 8: Bank Resources: Staff Inputs .................. ............................... 16 Table 9: Bank Resources: Missions ................................................. 16 APPENDICES A. Mission's Aide-Memoire ................................................. 17 B. Borrower Contribution to the ICR ............... .................................. 19 This document has a restricted distribution and may be used by recipients only in the performance of their offcial dudtes. Its contents may not otherwise be disclosed wiihout World Bank authorization.   IMPLEMENTATION COMPLETION REPORT REPUBLIC OF THE PHILIPPINES ECONOMIC iNTEGRA TION LOAN (LOANNO. 3539-PH) Preface This is the Implementation Completion Report (ICR) for the Economic Integration Loan in the Republic of the Philippines, for which Loan No. 3539-PH in the amount of US$200 million equivalent was approved on November 2, 1992 and became effective January 27, 1993. The loan was closed on March 31, 1995 compared with the original closing date of December 31, 1993. The first tranche, released February 9, 1993, was fully disbursed in March 1993; the second and final tranche was released March 29, 1995, and the loan was fully disbursed by June 7, 1995. Parallel financing in the amount of US$200 million was provided by the Export- Import Bank of Japan. The ICR was prepared by Ms. Erika Jorgensen, Economist, Country Operations Division, East Asia and Pacific Region, and was reviewed by Ms. Pamela Cox, Division Chief, Country Operations Division, Mr. Walter Schwermer, Project Advisor, and Mr. Callisto Madavo, Director, East Asia and Pacific Department 1. The borrower provided comments on a draft of this document, and they have been incorporated. Preparation of this IC(R was begun during the Bank's final supervision mission in February 1995 and continued during the completion mission in October 1995. It is based on material in the project file. The borrower contributed to preparation of the ICR by regularly providing the project progress/status reports, contributing its views during the missions, working on its own evaluation of the project's execution (which is not yet finalized), and commenting on the draft ICR.   ECONOMIC INTEGRATION LOAN (Loan No. 3539-PH) REPUBLIC OF THE PHILIPPINES Introduction 1. The Bank Group's support for the Economic Integration Loan complemented past Bank policy-based lending in the Philippines. The themes of tariff reform and import liberalization were included in earlier Bank programs (Structural Adjustment Loan II, Ln. 2266-PH in FY83 and the Economic Recovery Program, Ln. 2787-PH in FY87), and this loan completed this process. Similarly, while government financial institutions were restructured under the Economic Recovery Program, financial restructuring of the BSP was supported by conditionality added to the second tranche of the Financial Sector Adjustment Loan (Ln. :3049-PH) in FY89 and concurrently by this loan. The Reform of Government Corporations Program (Ln. 2956-PH) in FY88 supported the government privatization program, and conditionality on privatization was extended further in this loan. The Debt Management Program (Ln. 3149-PH) in FY90 supported a first phase debt and debt service reduction agreement with commercial banks, the first such operation supported by the World Bank. The second and final stage of the commercial bank debt reduction program was completed in December 1992, funded by the Government and augmented resources of the IMF, and was considered a key part of the Economic Integration Program although this loan was not a debt and debt service reduction operation. This operation extended and deepened the sequence of economic reforms, most significantly through the full liberalization of the foreign exchange market. Project Objectives 2. The loan, in the amount of US$200 million, was to be disbursed in two tranches (of US$120 million and US$80 million respectively), to finance general imports of goods to meet part of external financing requirements at a time when foreign resources had been drained by the needs of a second phase debt and debt service reduction operation and when an investment recovery was anticipated. Together with parallel financing by the Export-Import Bank of Japan, these sources were to help fill the unfinanced external gap in 1993 and help reduce the 1994 gap to a manageable size. The loan's objective was to support improved macroeconomic management through strengthening the improvement of Central Bank (Bangko Sentral ng Pilipinas, BSP) finances and setting appropriate energy pricing policies, and to improve the environment for private investment through implementation of the new Foreign Investment Code, trade and transport liberalization, and the liberalization of t.he foreign currency market.  Implementation Experience and Results 3. The loan has met and, in many cases, surpassed its original targets. All conditions of the first and second tranches have been substantially achieved. Macroeconomic stability has been maintained, and investor confidence has returned. Commercial bank debt and debt service has been reduced. The Central Bank has been successfully restructured, and the Oil Price Stabilization Fund, a key factor in a persistent fiscal deficit, has been brought into surplus, while inflation has also been brought under control. In addition, substantial progress has been made in promoting competitiveness. Foreign investment has increased considerably, and over one hundred government corporations have been privatized. Tariffs have been greatly reduced, and most quantitative restrictions (QRs) on imports eliminated. Moreover, impressive gains have been made in deregulating the transport sector and in foreign exchange liberalization. 4. Because many of the improvements have come about through legislative action and because the Government is firmly committed to reform, no problems are expected concerning project sustainability. In fact, the key factors supporting sustainability are the same ones which made it possible to achieve the initial project objectives: borrower commitment, institutional capabilities, built-in incentives, and economic growth. There were slight delays in the areas of privatization and in the implementation of the Energy Sector Plan. In addition, the removal of QRs on some agricultural products was a problematic area (due to the Department of Agriculture's openly protectionist stance), but a continuous dialogue with the Government was maintained; and, as a result, compromises were elicited. In addition, lengthy public hearings preceded the eventual Senate ratification of the Uruguay Final Round of the GATT. These developments resulted in the need for three closing date extensions (of six months, eight months, and one month). Aside from the closing date extensions, the agreed financing arrangements and implementation timetables were largely in line with estimates, and all programs remained on track. 5. The Bank's participation in helping to address issues of macroeconomic management, competitiveness, foreign investment, trade and transport liberalization, energy pricing policies, and the foreign currency market has had a catalytic impact and is favorably regarded by the officials of the implementing agencies. The Bank fostered ownership of the program, beginning with project identification, by recognizing the initiatives of the implementing agencies and by building support for the project through active participation by the relevant institutions. The Bank recognized the capacity of the Government and implementing agencies and their ability to manage the overall program within the parameters set in the Loan Agreement. 6. The performance of the Government and implementing agencies was highly satisfactory. All targets were met and, in many cases, exceeded. Implementation was largely on track and successful. Compliance was also highly satisfactory (although delayed in some instances); terms of loan covenants were met, and there were no problems with audits, procurement, or disbursements (except for delays in the audits of the first and second tranches).  -.1.- Summary of Findings, Future Operations, and Lessons Learned 7. Overall, then, the loan's outcome was highly successful. The loan achieved or exceeded all of its major objectives and has achieved, or is highly likely to achieve, substantial development results without major shortcomings. 8. As a result of the aforementioned developments and tighter overall macroeconomic management by the Government, macroeconomic outcomes have strengthened. The Government successfully completed its 1991-93 IMF Stand-By Program. The Government's stabilization policies since 1992 have established a track record of sound macroeconomic management which has weathered several shock waves generated by the Mexican peso. Inflation has been reduced, and the government deficit has shifted to a surplus as a result of tight cash management, lower domestic interest rates, and revenues from the privatization of government corporations. Displaying similar progress, the consolidated public sector deficit for 1994 fell below 1 percent of GDP, and retuming flight capital and other foreign exchange inflows have nurtured reserve levels. A particularly encouraging sign in this recovery has been the robust expansion of direct foreign investment, which has increased six fold between 1991 and 1994 by government estimates. 9. While the project was completed satisfactorily, there are lessons to be learned about the correct balance between encouraging the government to move more quickly on economic reforms than they otherwise would have and yet ensuring that the reform program is owned by the client, with the speed of implementation responsive to local political developments. In terms of project design, there was a trade off between designing narrow conditions of action which are intended to yield very specific results but leave little room for flexibility, and outlining broader conditions which would allow greater flexibility in adapting to unforeseen changes in the environment. Secondly, the loan was designed with a very short life in order to encourage the Government to accelerate action in certain areas. These two issues came to light most clearly with regard to the agreed conditions on trade liberalization, specifically, the removal of QRs from import items. Second tranche release was delayed while negotiations were conducted on how to secure progress on import liberalization; but because of the short time frame allowed, extensions of the closing date became necessary; and because of the specificity of the conditions, the Bank was unable to compromise despite our support overall of the speed and content of the Government's ongoing program of structural reforms. The Bank and Government maintained a continuous dialogue, and positive actions were eventually achieved. However, more flexibility in supervision would have allowed for a more sophisticated dialogue with the Government on policy issues, rather than inflexible enforcement of tranche conditions. 10. Future operations related to this loan are not planned. No further adjustment loans are foreseen for the Philippines, because balance of payments support is no longer needed. The country is one year into an Extended Fund Facility, considered an exit program, with the IMF.   IMPLEMENTATION COMPLETION REPORT REPUBLIC OF THE PHILIPPINES ECONOMIC INTEGRA TION LOAN (LOAN NO. 3539-PH) Part 1. Implementation Assessment A. Statement/Evaluation of Objectives 1. The Economic Integration Loan (Ln. 3539-PH) was approved in December 1992 in the amount of US$200 million, structured as two tranches of US$120 miNlion and US$80 million, respectively. The loan was financed in parallel in the amount of US$200 million by the Export- Import Bank of Japan (JEXIM). The loan's objective was to support improved macroeconomic management through strengthening of Central Bank (Bangko Sentral ng Pilipinas, BSP) finances and setting appropriate energy pricing policies, and to improve the environment for private investment through implementation of the new Foreign Investment Code, trade and transport liberalization, and the liberalization of the foreign currency market. By design, the program of action was heavily weighted towards the first tranche. A second tranche was added at the request of the Loan Committee to ensure follow through in the main policy areas. 2. Despite the structural reforms initiated in the 1980s and the progress in macroeconomic stabilization, the economy had been unable to attain an efficient sustainable growth path as of 1992. Three principal factors constrained progress. First, the government record on implementation was mixed. Its ability to sustain a stable macroeconomic environment was complicated by political pressures and by the presence of high external debt. Second, economic performance had been constrained by the high degree of uncertainty regarding the future course of policies. Third, trade and investment reforms were more tentative than necessary. As a result, the economy remained partially protected, unable to benefit fully from integration with the rest of the world. 3. The Government sought to address these constraints through the implementation of a strong macroeconomic and structural reform program, supported by a comprehensive reduction of commercial bank external debt and debt service. There were three broad components in the Economic Integration Program. The first component focused on institutional capabilities to provide improved tools for economic management, most importantly, to improve the condition of Central Bank finances. Second, remaining distortions in the real sector of the economy needed to be removed, including limits on foreign equity ownership, private participation in major infrastructure projects through Build-Operate-Transfer (BOT) and related schemes, and quantitative restrictions (QRs) on a modest number of key imports. The third component involved the liberalization of the foreign exchange market. 4. The Economic Integration Loan built on past policy reforms, which had begun in 1980, and was based on: actions already undertaken by the Government, including several key  -2- legislative initiatives, where the Bank had been actively encouraging the Government through its policy dialogue; the conclusion of the agreement between the Government and its commercial bank creditors, resolving medium- and long-term commercial bank debt; and additional actions by the Government to deepen the reform effort. 5. The first tranche supported foreign investment liberalization, tariff reform, and foreign exchange liberalization, and first steps to eliminate the Oil Price Stabilization Fund (OPSF) deficit and to deregulate the transport sector. A new law on foreign investment opened most sectors to foreign ownership. A new tariff code was adopted, lowering the average tariff rate from 20 percent in 1991 to below 13 percent in 1995, and reducing tariff dispersion. The foreign exchange system was deregulated, allowing full retention by exporters of foreign exchange receipts and free use of foreign exchange funds purchased in the market. As a result, the current account was fully liberalized, and only minor restrictions on the capital account still remain. 6. The second tranche supported import liberalization, privatization, and financial restructuring of the Central Bank, and further policy steps to eliminate OPSF deficits and to deregulate transport. All areas except one were more or less on track from the start. The problematic area was the removal of QRs on some agricultural products. A continuous dialogue with the Government was maintained, and some small compromises were elicited despite the Department of Agriculture's openly protectionist stance. Also, some slight delays arose in the areas of privatization and in the implementation of the Energy Sector Plan. As the original closing date of December 31, 1993 approached, only a year after Board approval, the Government requested and was a granted a first extension of the closing date of six months, a period short enough to keep up the pressure for action. By June 1994, the Department of Agriculture had adopted a new stance of ratifying the Uruguay Final Round of the GATT. Since the GATT agreement would require the Philippines to move far beyond the requirements of this loan on trade liberalization, the Bank accepted this change in stance as substantive progress towards the goal of removal of all remaining QRs. A second extension of eight months was granted, this time coordinated with the new I!MF Extended Fund Facility's schedule for structural measures. Then, when final required actions for second tranche release did not occur until mid-February 1995, an extension of one month, until March 31, 1995, was granted to allow time for reviewing compliance and preparing for tranche release. 7. This loan complemented past Bank policy-based lending in the Philippines. The themes of tariff reform and import liberalization were included in earlier Bank programs (Structural Adjustment Loan II, Ln. 2266-PH in FY83 and the Economic Recovery Program, Ln. 2787-PH in FY87), and this loan completed this process. Similarly, while government financial institutions were restructured under the Economic Recovery Program, financial restructuring of the BSP was supported by conditionality added to the second tranche of the Financial Sector Adjustment Loan (Ln. 3049-PH) in FY89 and concurrently by this loan. The Reform of Govemment Corporatiors Program (Ln. 2956-PH) in FY88 supported the government privatization program, and conditionality on privatization was extended further in this loan. The Debt Management Program (Ln. 3149-PH) in FY90 supported a first phase debt and debt service reduction agreement with commercial banks, the first such operation supported by the World Bank. The second and final stage of the commercial bank debt reduction program was completed in December 1992, funded by the Government and augmented resources of the IMF, and was considered a key part of the  -3- Economic Integration Program although this loan was not a debt and debt service reduction operation. This operation extended and deepened the sequence of economic reforms, most significantly through the full liberalization of the foreign exchange market. 8. The loan was also in line with the Bank's economic and sector work in the country. The Bank has continuously engaged in studies which contribute to the macroeconomic dialogue, the definition of development issues and the future lending strategy in key sectors. At the time of preparation, recently completed reports on natural resource management and the environment, energy, financial, and education sectors and the almost completed basic economic report, "An Opening for Sustained Growth," provided the analytical basis for the program. Related studies since include a Capital Market Study (1992); a brief Macroeconomic Update in 1994; and a Private Sector Assessment in 1994. 9. The Government program continues to receive financial support from the IMF in the form of an Extended Fund Facility agreed with the IMF in June 1994. There has been extensive cooperation between the Bank and the IMF in the development of this policy program, as there was for past programs. Various Fund agreements have supported policy reforms initiated by the Bank, including privatization and energy pricing. Likewise, the Bank and the Fund have in turn taken the lead in some policy areas, including tax reform and import liberalization. B. Achievement of Objectives 10. The loan has met, and in many cases surpassed, its original targets. All conditions of the first and second tranches have been substantially achieved. Macroeconomic stability has been maintained, and investor confidence has returned. Commercial bank debt and debt service has been reduced. The Central Bank has been successfully restructured, and the OPSF has been brought into surplus, while inflation has also been brought under control. In addition, substantial progress has been made in promoting competitiveness. Foreign investment has increased considerably, and over one hundred Government Owned and Controlled Corporations (GOCCs) have been privatized. Tariffs have been greatly reduced, and most QRs eliminated. Moreover, impressive gains have been made in deregulating the transport sector and in foreign exchange liberalization. In privatization, foreign investment liberalization, tariff reform, and the removal of QRs, targets have been exceeded. (i) Improved Macroeconomic Management. 11. The Government (with the support of the IMF) has maintained macroeconomic stability. Key measures improving the Government's ability to manage the economy have been the financial restructuring of the BSP and greater control over balances in the OPSF, as well as the reduction of external debt servicing. In the policy areas related to the macroeconomic framework ---foreign investment liberalization, foreign exchange deregulation, simplification of procedures for foreign investors, and tariff reform under Executive Order 470--performance has exceeded attainments laid out by the Economic Integration Program. In addition, the Philippine authorities and the IMF agreed to a three-year Extended Fund Facility in June 1994. The program is based on a comprehensive array of structural measures, which deepen the reforms supported by this loan. The program provides close monitoring of macroeconomic management; the fiscal deficit and inflation, in particular, have performed better than programmed since June 1994.  -4- 12. Central Bank Restructuring. A comprehensive solution to the Central Bank's financial condition was put into effect through its restructuring into a new financially sound and independent Bangko Sentral ng Pilipinas (BSP) and a totally separate entity, the Central Bank Board of Liquidators, whose losses are serviced directly by the National Government. The Central Bank has adopted policy resolutions enabling the Central Bank to achieve and maintain a positive level of net foreign assets. The BSP achieved a positive level of net foreign assets in 1993 and has maintained it since then; as of July 1995, its net foreign asset position was US$4.5 billion. In addition, the Central Monetary Authority Law provided for an initial paid-in capital of PIO billion for the BSP; and the National Government paid PIO billion to the BSP in July 1993. As a result of these measures, some of which were also supported by the Bank's Financial Sector Adjustment Loan (Ln. 3049-PH) , the BSP can function as an independent monetary authority. 13. Oil Price Stabilization Fund Deficit. As part of the Government's Energy Sector Plan, oil pricing has begun to be depoliticized through legislation, with the accumulated gains and losses of ef 2 the OPSF to be bounded to levels which will not have substantial macroeconomic effects. Preceding the passage of the required legislation, the Government brought the OPSF into surplus in 1991, a measure supported by the loan's first tranche. It has remained in surplus for the years since, except for 1993. 14. Reduction of Commercial Bank External Debt and Debt Service. Following the completion of a broad debt restructuring agreement with its creditor banks in 1992, the country regained international creditworthiness. The Brady-type agreement restructured US$4.5 billion of Philippine medium and long-term commercial bank debt. As a result, total debt service as a share of exports fell to 18 percent for 1994. Further, the commercial bank debt agreement, along with macroeconomic stability and rising foreign exchange reserves, improved creditworthiness sufficiently to allow the Government and some large Philippine companies to re-enter international capital markets in 1993. Lastly, the Government has now chosen to make its bilateral debt payments according to the original schedule, declining the Paris Club's 1994 offer of rescheduling; it is the first country to take such action. (ii) Promotion of Competitiveness. 15. Foreign Investment. A new Foreign Investment Act (Republic Act 7042 of 1991) allowed for higher proportions of foreign equity ownership in most companies and also expanded the sectors where foreign investment can freely flow. As part of this expansion, the Government set The Financial Sector Adjustment Loan, approved in May 1989 in the amount of US$300 million, aimed to strengthen the supervision and regulatory framework for conimercial banks, improve institutional arrangements of depositor protection, reduce intermediation costs in the banking system, and improve the institutional framework for mobilization and delivery of long term credit. In December 1992, an additional covenant was added for second tranche release, requiring the financial restructuring of the BSP. The tranche was released in December 1993. 2 During discussion of the draft version of this report, the Department of Finance brought to the Bank's attention that as part of its ongoing Energy Sector Plan, in September 1995, the Government lifted restrictions on the importation of petroleum products and on the setting up of gas stations; actions planned for 1996 include the adoption of an automatic oil pricing mechanism and the restructuring of oil taxes; and the abolition of the OPSF and the full deregulation of the oil industry is scheduled for early 1997.  -5- up a program to encourage private participation in major infrastructure projects through BOT and related schemes, which have been highly successful in the rapid expansion of power generation. At the same time, the Government took various steps to improve the business environment for foreign investors: actions were taken to streamline procedures for foreign investors with respect to visas and work permits. In addition, the Government has undertaken a bold move to liberalize further by allowing ten foreign banks to enter the domestic financial market, which had been protected from foreign investment since the 1940s. 16. I'rivatization. The Government has now moved well beyond the privatization targets set out in the Economic Integration Program. One hundred one government owned and controlled corporations (GOCCs), constituting over 75 percent of the 1985 asset value of the 122 GOCCs originally designated for privatization, have been offered for sale or actually sold; and additional GOCCs, not on the original list, have also been privatized. From 1991 through July 1995, P51.8 billion accrued to the National Government from privatization. These substantial contributions to the treasury have greatly assisted in reducing the fiscal deficit. 1 7 liade Liberalization. A new tariff code (Executive Order 470 of 1991), representing major adjustments in tariffs, was put in place to encourage export oriented growth by lowering trade protection and simplifying customs administration. Supported by the first tranche, Executive Order 470 reduced tariff dispersion and the number of tariff bands, and lowered overall protection in stages. The average import-weighted tariff, which was 43 percent in 1980, was reduced to below 13 percent by July 1995. The Government has not only kept to its schedule of tariff reductions, it has accelerated the lowering of rates for many items. In addition, a bill backed by the Department of Finance and the Bureau of Customs which shifts import valuation from the Philippines' Home Consumption Value method to a standard international method of fair market valuation was submitted to the House and Senate, where it is under consideration. Negotiations for the Asian Free Trade Area involve further duty reductions; and the Philippines has unilaterally declared a goal of a uniform five percent duty rate by the year 2004. The Senate also ratified the Uruguay Round Final Act of the GATT. Legislation to implement the Uruguay Round, removing QRs from all agricultural items except rice, was submitted to the Congress in the first half of 1995, and in November 1995, the Government informed the World Trade Organization that the invocation of Article XVIII:B of the GATT will cease within two years. The lifting of QRs on coal and petroleum products is scheduled to coordinate with the deregulation of the energy sector, which is underway and is to be completed by end 1997. 1 8 icransporl Deregulation. The Government has implemented substantial improvements in policies for the transport sector by promoting competition on major routes and liberalizing rate setting. In 1992 and 1993, the Government used administrative powers to remove barriers to entry and exit from the land transport industry and to liberalize market-based rate and fare setting, actions supported by the loan's first tranche. Administrative means were also used to deregulate The Department of Finance added that, apart from the important benefits in terms of revenue, the privatization program has proven to be a vital tool in revitalizing the Philippine economy. by expanding the scope of private economic activity, improving the investment climate, broadening the ownership base. developing capital markets, and gencrating employment.  -6- inter-island shipping, also supported under the first tranche. Significant improvements in the quality of service and in fleet modernization have already been observed in the maritime and land transport sectors. The administrative liberalization of the transport sector has been incorporated into a Transport Services Act, supported by the second tranche. (iii) Foreign Exchange Deregulation. 19. Until the notable liberalization of foreign exchange trading during 1991-92, supported by the loan's first tranche, largely unenforceable regulations had been restricting trade and use of foreign exchange. The foreign exchange liberalization program has been highly successful in achieving its objectives of providing a market-based exchange rate and integrating domestic and international capital markets. The current account has been fully liberalized, and only minor restrictions on the capital account remain. 20. Social Objectives. The agreed structural reforms have advanced the Government's broad efforts to achieve a more competitive economy which improves prospects for growth. Through higher overall growth rates of income and a more liberal policy environment that encourages competition and efficiency, this loan works to reinforce poverty alleviation and ameliorate regional income disparities. As the rate of economic growth has accelerated from 0 percent GDP expansion in 1991 to 4.3 percent in 1994 in a reformed economy, poverty has begun to shrink. The headcount of the poor has fallen from 39 percent of families living below the official poverty line in 1991 to 36 percent in 1994. 21. Private Sector Development Objectives. As previously noted, the loan substantially achieved its private sector development objectives. As part of the 1991 Foreign Investment Act, the Government set up a program to encourage private participation in major infrastructure projects through Build-Operate-Transfer (BOT) and related schemes, which have been uniquely successful in the rapid expansion of power generation and have placed the Philippines in the forefront of such efforts worldwide. Privatization has also been an area of resounding success for the Government, especially in the last few years as the program has gained momentum (See para. 17.). The Bank provided support, starting in 1988, through the Reform for Government Corporations Program (Ln. 2969-PH) and then through this loan. Moreover, macroeconomic stability has spurred renewed interest in the Philippines, increasing flows of foreign investment for private sector development initiatives across a variety of sub-sectors. C. Major Factors Affecting the Project 22. Since the loan successfully achieved all of its objectives, there were no major factors affecting the loan. As noted earlier, the removal of QRs on some agricultural products was a problematic area, but was subsequently resolved by the Government's (and especially the Department of Agriculture's) acceptance of the Uruguay Final Round. Delays also arose in privatization of GOCCs and in the implementation of the Energy Sector Plan. These developments resulted in the need for a closing date extension. In addition, lengthy public hearinigs preceded the eventual Senate ratification of the Uruguay Final Round. 23. The risks laid out in the President's Report have generally not been realized. The Government adhered to the reform program despite only a modest recovery of growth in 1993, and private sector confidence began to build. The establishment of a deregulated foreign  -7- exchange market was rapid, and the Central Bank has continued to intervene where necessary to avoid excessive volatility, particularly to counter the repeated shock waves in currency markets generated by the Mexico crisis of December 1994. However, as the President's Report warned, large capital inflows did push the exchange rate higher than desirable for robust export growth, as a result of high domestic real interest rates used to keep inflation under control. Continued fiscal strengthening is needed for medium term stability. D. Project Sustainability 24. No problems with project sustainability are expected. The Government's decisive actions in the areas of privatization, and foreign exchange, trade and foreign investment liberalization are now well established. There remains work to be done in the areas of transport deregulation and in energy pricing, but the Government is firmly committed to reform, and, therefore, no problems are anticipated. The economy has return to growth over the last two years, with GDP expanding by 4.3 percent in 1994 and a projected 4.9 percent in 1995. Export growth in dollar terms has tripled, from less than 9 percent in 1991 to over 26 percent in 1994; and foreign direct investment has increased six-fold between 1991 and 1994 according to government estimates. E. Bank Performance 25. Project identification was highly satisfactory, the loan complemented past Bank policy- based lending in the Philippines. The project was also in line with the Bank's country assistance strategy which focused on, among others, maintaining a prudent macroeconomic framework (including trade liberalization, foreign exchange deregulation, and promotion of foreign investment) and improving the business environment for private enterprise. In addition, it supplements Bank economic and sector work by supporting a number of specific macroeconomic and sectoral reforms recommended, e.g., continued trade liberalization and deregulation of the energy sector. Preparation of the project was highly satisfactory and was conducted in close collaboration with the Government and implementing agencies. ProjecL appraisal was also highly satisfactory. The policies were already well in train, and the Government's commitment to them was clear. The operation required monitoring of the consistency of the macroeconomic framework and the implementation of specific actions, which was well within the capacity of the Government and implementing agencies. The monitoring of macroeconomic performance, in particular, was carried out in close coordination with the IMF. 26. Suipervision performance was also highly satisfactory. During supervision, the project's performance and implementation progress were consistently rated satisfactory, and all the loan covenants were complied with (except the audit of the second tranche, due December 3 1, 1995, and not yet received). There were no significant implementation problems, although there were slight delays in the areas of privatization, implementation of the Energy Sector Plan and removal of quantitative restrictions from agricultural products. These delays resulted in two closing date extensions, however, the problems were identified, assessed, and corrected. The quality of supervision was professional, objective, and had the respect of the implementing agencies. It was based on a solid understanding of the borrower's institutional capabilities and the Bank's policies and procedures. In addition, there was a great deal of cooperation and communication between the Bank, IMIF, JEXIM, Department of Finance, and government line agencies.  -8 - F. Borrower Performance 27. The performance of the Government and implementing agencies was highly satisfactory. The adjustment program was coordinated by the International Finance Section of the Department of Finance. As noted earlier, all targets were met, and in many cases, exceeded. Implementation was largely on track and successful. Compliance was also highly satisfactory; terms of loan covenants were met, although later than anticipated in some instances. There was a slight delay in the audit of the first tranche, because some technical assistance was underway with the Philippine Government's Commission on Audit at the time, and the audit of the second tranche, not yet overdue, has not been received; but otherwise there were no problems wvith audits, procurement, 45 or disbursements. G. Assessment of Outcome 28. Overall, the loan's outcome was highly successful. The loan achieved or exceeded all of its major objectives and has achieved, or is highly likely to achieve, substantial development results, without major shortcomings. 29. As a result of the above developments and tighter overall macroeconomic management by the Government, macroeconomic outcomes have strengthened. The Government successfully completed its 1991-93 IMF Stand-By Program. While tight fiscal and monetary policies and severe power shortages slowed growth to about 0.5 percent per annum during 1991-1992, GDP growth recovered to 2.1 percent in 1993 and then accelerated to 4.3 percent in 1994, led by private investment and export growth of over 26 percent (in dollar terms). A particularly encouraging sign in this recovery has been the robust expansion of net foreign investment, from around US$750 million in 1992 to US$1.4 billion in 1994. The Government's stabilization policies since 1992 has established a growing track record of sound macroeconomic management. Inflation has been reduced from 19 percent in 1991, to 7 percent in 1994. The national government deficit has also been steadily reduced from 3.5 percent of GDP in 1990 to a surplus of 0.8 percent in 1994 (and the consolidated public sector deficit fell below I percent of GDP), as a result of tight cash management, lower domestic interest rates, and US$1 billion in revenue from the privatization of government corporations. Displaying similar improvement, the consolidated public sector deficit for 1994 fell below I percent of GDP, and returning flight capital and other foreign exchange inflows have nurtured reserve levels. 4 Thc audit report for the second tranche is due December 31, 1995. The Bank expects to receive it in Januarv 1996. 5 The Department of Finance suggested that the Bank reconsider its audit requirements for adjustment loans. Audit reports for loans disbursed against general imports, when the amount disbursed is relatively small compared with the flow of imports overall, do not improve implementation and constitute unnecessary bureaucratic procedures. from the perspective of the Government.  -9- H. Future Operations 30. Future operations related to this loan are not planned. No further adjustment loans are foreseen for the Philippines, because balance of payments support is no longer needed. The country is one year into an Extended Fund Facility, considered an exit program, with the lMF. I. Key Lessons Learned 31. While the project was completed satisfactorily, there are lessons to be learned about the correct balance between encour aging the government to move more quickly on economic reforms than they otherwise would have and yet ensuring that the reform program is owned by the client, with the speed of implementation responsive to local political developments. In terms of project design, there was a trade off between designing narrow conditions of action which are intended to yield very specific results but leave little room for flexibility, and outlining broader conditions which would allow greater flexibility in adapting to unforeseen changes in the environment. Secondly, the loan was designed with a very short life in order to encourage the Government to accelerate action in certain areas. These two issues came to light most clearly with regard to the agreed conditions on trade liberalization, specifically, the removal of QRs from import items. Second tranche release was delayed while negotiations were conducted on how to secure progress on import liberalization; but because of the short time frame allowed, extensions of the closing date became necessary; and because of the specificity of the conditions, the Bank was unable to compromise despite our support overall of the speed and content of the Government's ongoing program of structural reforms. The Bank and Government maintained a continuous dialogue, and positive actions were eventually achieved. However, more flexibility in supervision would have allowed for a more sophisticated dialogue with the Government on policy issues, 67 rather than inflexible enforcement of tranche conditions. 6 The Department of Finance noted that this program would have been more efficient if it had been a single tranche. The substantial actions of the program were all first tranche conditions, while second tranche conditions merely supported progress on reforms already made. The delays on a small number of the multiple and detailed second tranche conditions created the incorrect perception that the program was not going as well as planned, added the Department of Finance during discussions of the draft of this report. 7 The Department of Finance suggested that the Bank look into the creation of greater flexibility on disbursement. At the point when the Philippines had met all conditions necessary for release of the second tranche, the Government would have preferred more control over the timing of the capital inflows, given problems with a strengthening exchange rate and some uneasiness in the market in the wake of the Mexico crisis. However, the imminence of the closing date left the Government with no room to maneuver. Further, the Department of Finance suggested that the Bank reconsider its requirement that the commitment fee be charged in full in such a situation.  -10- IMPLEMENTATION COMPLETION REPORT REPUBLIC OF THE PHILIPPINES ECONOMIC INTEGRA TION LOAN (LOAN NO. 3539-PH) Part II. Statistical Annexes Table 1: Summary of Assessments Table 2: Related Bank Loans Table 3: Project Timetable Table 4: Loan Disbursements Table 5: Key Indicators for Project Implementation Table 6A: Project Costs Table 6B: Project Financing Table 7: Status of Legal Covenants Table 8: Bank Resources, Staff Inputs Table 9: Bank Resources: Missions  -11- Table 1: Summary of Assessments A. Achievement of Oblectives Substantial Partial Neghieible Not Applicable Macro policies Sector policies M Financial objectives cm 3 C