Philippines - Reform Program for Government Corporations Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15614 PERFORMANCE AUDIT REPORT PHILIPPINES REFORM PROGRAM FOR GOVERNMENT CORPORATIONS (LOAN 2956-PH) MAY 13, 1996 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents (end of period) Currency Unit = Philippine Peso (PP) 1984 US$1.00 P 19.760 1990 US$1.00 P 28.000 1985 US$1.00 P 19.032 1991 US$1.00 P 26.650 1986 US$1.00 P 20.530 1992 US$1.00 P 25.096 1987 US$1.00 P 20.800 1993 US$1.00 P 27.699 1988 US$1.00 P 21.335 1994 US$1.00 P 24.418 1989 US$1.00 P 22.440 Abbreviations and Acronyms APT Asset Privatization Trust COA Commission on Audit COP Committee on Privatization CSC Civil Service Commission DBP Development Bank of the Philippines GC Government corporations GOCC Government-owned and/or controlled corporations IMF International Monetary Fund NFGC Nonfinancial government corporations OCPC Office of Compensation and Position Classification OED Operations Evaluation Department PAR Performance Audit Report PCGG Presidential Commission on Good Government PCR Project Completion Report PNB Philippine National Bank PNOC Philippine National Oil Co. PR President's Report Fiscal Year Government: January I - December 31 FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.S A. Office of the Director-General Operations Evaluation May 13, 1996 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on the Philippines Reform Program for Government Corporations (Loan 2956-PH) Attached is the Performance Audit Report (PAR) on the Philippines Reform Program for Government Corporations (Loan 2956-PH), prepared by the Operations Evaluation Department. This US$200 million adjustment loan was approved in June 1988 and closed in February 1992. This project, which focused on nonfinancial government institutions, had the main objective of supporting the Government's program by (i) establishing a policy and institutional framework to reduce the number and size of government corporations; and (ii) bringing about improvements in the efficiency and effectiveness of those government corporations to be retained in the public sector. Complementary structural reforms were supported by other interrelated Bank loans, notably the Economic Recovery Loan (FY87), the Financial Sector Loan (FY89) and the Debt Management Program Loan (FY90). The project opened the door to a general acceptance of the need for drastic reductions in the Government's involvement in productive activities, and it helped to pioneer a system of incentives, monitoring and evaluation for public corporations. Thus, the PAR agrees with the findings of the Project Completion Report (PCR) that the project helped the Government make substantial progress towards its objectives. Its outcome is rated as satisfactory, sustainability of the benefits as likely, and institutional development impact as substantial. Bank performance is rated as satisfactory. Although the Borrower complied with the formal conditionality of the loan with minor delays, implementation of the privatization process was held back by a combination of external developments (natural disasters, the Gulf War), political instability, and a multitude of complex institutional safeguards. The latter aimed at maximizing the price obtained by the Treasury from the sale of public assets, allay fears of patronage and unscrupulous practices, and provide transparency and accountability. A more streamlined approach would have led to a faster disposition of the public corporations, thus reducing the fiscal burden and permitting an earlier resumption of private investment and economic growth. However, given the uncertain political climate at the time of project design, and the need to secure wide acceptance and ownership of the privatization program, the PAR concludes that elaborate control mechanisms were justified. A key lesson derived from this operation is that the "optimal price" of a government corporation is not necessarily the one that maximizes the sales proceeds, but rather one that permits timely divestiture of unprofitable enterprises, while meeting the public's desire for transparency and accountability. The Asian Development Bank, a cofinancier of the project, endorses this conclusion. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY Contents Preface............................................................3 In Memoriam .......................................................5 Basic Data Sheet...........................................................7 Evaluation Summary ................................................ 1 1. Background ........................................ ......... 17 Growth of Public Enterprises ............................. ......... 17 Financial Losses..........................8...... ..............18 Heavy Economic Burden..........................8.... ...........18 Genesis of Bank Involvement. ............................ .......... 18 2. Loan Objectives ........................................ ......21 3. Project Design .......................................... .....23 Accountability at the Expense of Expediency .............................. 23 Guidelines for Valuation and Sale of Corporations .................. .....23 Conditionality Requiring Legislative Action .......................23 Tranching Arrangements ...................................24 Technical Assistance .....................................24 No Timetable to Sell Any Corporations ........................24 4. Implementation ..................................... .........25 5. Outcome ....................................................27 Post-privatization Performance of Firms That Were Sold............ ......28 6. Evaluation ..................................................29 7. Lessons of Experience...........................................31 Attachment: Letter from the Asian Development Bank...... ....................33 This report was prepared by Luis Landau (Task Manager) who audited the project in November 1994. Norma Namisato provided administrative support. The report was issued by the Country Policy, Industry and Finance Division (Manuel Pefialver, Chief) of the Operations Evaluation Department (Francisco Aguirre-Sacasa, Director) Thisdocument has a restricted distribution and may be used by recipients only in the performance of their oicial duties. Its contents may not otherwise be disclosed wiihout World Bank authorization.  3 Preface This is a Performance Audit Report (PAR) on The Philippines Reform Program for Government Corporations (Loan 2956-PH). The loan, in the amount of US$200 million, was approved by the Board in June 1988. The loan was fully disbursed and was closed in February 1992, six months behind schedule. This PAR is based on the PCR, the President's Report, loan documents, loan and country files, files of complementary loans, Bank economic and sector reports, IMF reports, and other relevant documents. OED staff held extensive discussions with Bank and IMF staff. An OED mission visited the country in November 1994 to interview government officials who were associated with this operation, staff of the Asian Development Bank, local representatives of the International Finance Corporation and other bilateral donors, private sector individuals and non- government academic economists. The kind cooperation and valuable assistance of the Bank's field office in Manila is gratefully acknowledged, as well as the willingness of all those interviewed to openly share their views and experiences. The PCR presents a good analysis of the program's design, implementation experience, and outcome as of the closing date. The coverage of this PAR complements and extends that of the PCR. It assesses the relevance of the loan's objectives, in the context of its genesis and special political circumstances. It evaluates the efficacy of the complex mechanisms established for disposing of state enterprises, including the pricing of the public assets, taking into account the need for public trust in the reform program. The PAR also explores issues of implementation, including the effectiveness of supervision and coordination with other donors, and attempts to evaluate the prospects of sustainability of the program, including necessary follow-up actions. The PAR agrees with the conclusion of the PCR that the outcome of the loan was on balance satisfactory. It finds that the elaborate controls and financial safeguards that were established under the program resulted in delays in the privatization process, at a considerable cost to the economy in terms of fiscal burden and foregone economic growth. However, these arrangements were probably necessary to widen. ownership of the reform program among the various governmental bodies. The fact that the needed broad ownership of the reforms was indeed achieved makes it likely that the benefits of the program will be sustained. The draft PAR was sent to the Borrower and cofinanciers for comments. The letter received from the Asian Development Bank is reproduced as Attachment to the PAR.  In Memoriam The Reform Program for Government Corporations, as well as much of the World Bank's efforts to assist the Government of the Philippines, owes much to the loving efforts of Mr. Claudio Fernandez. As task manager, Claudio represented the best qualities that Bank staff can offer. His strong personal commitment to the public sector improvement in the Philippines earned him the respect and appreciation of all his colleagues and government counterparts. With his constant presence, wit, initiative, and imagination he helped to overcome the many obstacles faced by this ambitious operation. Even when he was hospitalized in Washington as a result of an accident, he continued to meet with other staff and with government officials in order to continue negotiations on a follow-on project. In June 19, 1994, Claudio was killed in an automobile accident while on mission in the Philippines, the adopted country that he loved  7 Basic Data Sheet REFORM PROGRAM FOR GOVERNMENT CORPORATIONS (LOAN 2956-PH) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs n.a. n.a. Loan amount 200 200 100 Cofinancing n.a. 6(*) Cancellation - Date physical components completed n.a. n.a. Economic rate of return n.a. n.a. Institutional performance Satisfactory (*) Grants for TA. Cumulative Estimated and Actual Disbursements FY88 FY89 FY90 FY91 FY92 Appraisal estimate (US$M) 75.0 150.0 200.0 200.0 200.0 Actual (US$M) 75.0 75.0 150.0 150.0 200.0 Actual as % of appraisal 100 50 75 75 100 Date of final disbursement: February 24, 1992 Project Dates Original Revised Actual Identification Mission Dec. 1984 Dec. 1984 Preparation/Project Brief Mar. 1985 Nov. 1985 Jan. 1986 Pre-Appraisal Mission Mar. 1985 Sep. 1985 Appraisal Mission Feb. 1986 Jan. 1987 Pre-Negotiation Jan. 1988 Feb. 1988 Negotiation May 1986 Apr. 1987 Mar.1988 Board Presentation June 1986 Apr. 1987 June 1988 Signing June 1987 Sep. 1988 Effectiveness June 1986 Nov. 1988 Tranche Release #1 July 1986 Dec. 1988 Tranche Release #2 July 1987 Aug. 1989 July 1990 Tranche Release #3 July 1988 Feb. 1991 Feb. 1992 Closing date Aug. 1991 Feb. 1992 8 Staff Inputs (staff weeks) FY85 FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 Total Preparation 27 169 41 237 Appraisal 23 23 Negotiations 7 13 21 Lending 45 13 6 1 66 Operations Supervision 20 26 18 3 68 Completion 2 2 Administration 0.5 0.6 2 2.6 Total 72 182 77 15 20 26 19 5 2 418 Mission Data Date No. of Staff days Specializations (month/year) persons in field represented Through Appraisal 03/85 6 21 Dev. Fin, Fin. Pol., Macro. 07/85 7 21 Dev. Fin., Rural Fin., Fin. Econ., Ind. Fin., Comm. Banking 07/85 2 7 Proj. Mgmt. 09/85 6 18 Inst. Framework, Legal, Org. Plann., Audit & Acct., Perf. Eval. 12/85 2 5 Dev. Fin., Ind. Policy 12/85 1 2 Legal Aspects 01/86 4 4 Proj., Mgmt., Org. Plann., PSM, Fin. Disc./Ctrl. 04/86 4 10 Proj. Mgmt., Macroec. 05/86 1 9 Audit & Accounting 06/86 2 14 Civil Serv., Legal, Inst. Framework 07/86 4 14 Proj. Mgmt., Legal, Ind. Pol., Privatization 10/86 2 7 Proj. Mgmt., Legal 9 Date No. of Staff days Specializations (month/year) persons infield represented Appraisal through Board 01/87 7 21 Proj. Mgmt., Ministerial Approval Superv., Divestiture/Privat., Disposition Plans, Legal, Inst. Framework 08/87 1 10 Proj. Mgmt. 02/88 1 9 Proj. Mgmt. 08/88 1 4 Cofmancing Supervision 1 01/89 5 10 Disposition/Privat., Proj. Mgmt., Cofin., Legal Supervision 2 04/89 2 5 Proj. Mgmt. Supervision 3 07/89 1 6 Perf. Eval. System Supervision 4 07/89 1 n.a. Proj. Mgmt. Supervision 5 09/89 2 7 Legal Aspects Supervision 6 10/89 3 10 Proj. Mgmt., Privat., Perf. Eval. System Supervision 7 11/89 1 9 Proj. Mgmt. Supervision 8 03/90 2 7 Proj. Mgmt. Supervision 9 09/90 4 12 Proj. Mgmt., Legal, Perf. Eval. System Supervision 10 01/91 1 10 Proj. Mgmt. Supervision 11 03/91 1 10 Computerization of Accounting System Supervision 12 06/91 1 7 Proj. Mgmt. Supervision 13 11/91 1 7 Proj. Mgmt. Other Project Data Borrower/Executing Agency: Republic of The Philippines FOLLOW-ON OPERATIONS Operation Loan no. Amount Board date (US$ million) Economic Recovery Loan 2787-PH 300 03/17/87 Economic Recovery TA 2788-PH 10 03/17/87 Financial Sector Adjustment 3049-PH 300 05/04/89  11 Evaluation Summary Background 1. The number of government-owned and/or controlled corporations (GOCCs) expanded rapidly during the 1970s. Their original purpose was to improve the provision of infrastructure services. But during the Marcos regime (1967-86) it was alleged that use of the corporate form was chosen in some cases to escape the supervision and control of oversight agencies. 2. A growing number of corporations were placed outside the rules and regulations of the public sector concerning auditing, compensation and civil service. However, because these corporations were not subject to the market discipline of the private sector, a number of serious problems arose. The problems included duplication of functions amongst state-owned firms, interlocking directorates with conflicts of interest, monopolistic practices, hidden subsidies, displacement of private investment. As public accountability was relaxed, heavy financial losses emerged. State-owned banks were required to assume the liabilities and acquire the assets of large numbers of defaulting corporations. 3. The resulting drain on public resources was not matched by the contribution of these corporations to the national product. During 1975-84 the GOCC sector borrowed one-fifth of domestic loanable funds and absorbed almost half of external loans to the country, but its value added contributed only 1.8 percent of the country's gross national product. Bank Support 4. The Bank had supported attempts to reform government corporations through several project loans, but the results were disappointing, largely owing to the systemic problems. To address these broad problems, in 1984 the Bank started discussions on a reform program with the Government, but progress was delayed by the political process that led to the assumption of the Aquino administration in early 1986. 5. Project preparation continued under the new administration, but it took over two years more before the loan could be presented to the Board. The new Government was convinced of the need to privatize, reduce the size and rationalize the GOCC sector, but a number of obstacles had to be overcome. These included a complex institutional situation, opposition from vested interests, and also the leg*timate concerns of those who feared a give-away of public assets, and wanted to put in place a transparent and elaborate system of checks and balances for the disposition of the state-owned corporations. Project Design and Objectives 6. The loan in support of the Reform Program for Government Corporations (RPGC) was presented to the Board in M:y 1988 and approved in June 1988. It was an integral part of a broad program of structural reforms, which were supported by several interrelated Bank loans. These included the Economic Recovery Program loan (FY87), the Financial Sector loan (FY89), the Debt Management Program loan (FY90) and a loan/credit for environmental protection, aimed at strengthening the management of natural resources (FY91). Because the objectives of all these operations were intertwined, the RPGC loan did not articulate separately its own 12 objectives or objective criteria for evaluation. Instead, the President's Report (PR) listed "key elements" which consisted of major institutional arrangements aimed at creating the conditions for the sale or divestiture of state-owned corporations, and a framework for the improved functioning of the corporations that would remain in the public sector, with greater accountability and monitoring These were relevant and necessary reforms, critical to the economic progress of the country. 7. The project was designed as a series of related institutional reforms, supported by several technical assistance programs. The Bank helped the Government to coordinate grants from the Japan and US governments and from the Asian Development Bank to finance these technical assistance programs. The loan conditionality also called for steps to "prepare for sale" a minimum number of corporations, according to an agreed timetable. The Government was not required to actually sell a pre-determined number of corporations, because such a condition would have weakened the government's bargaining position vis-j-vis potential buyers. The operation was designed to be disbursed in three tranches, and some of the conditionality was duplicated in the interrelated operations mentioned above. These two characteristics turned out to be helpful in supporting the implementation of reforms, in cases where there was domestic resistance from vested interest groups. 8. In order to address fears of patronage and unscrupulous practices, the Government's program included complex arrangements aimed at providing transparency and accountability. Thus, six separate agencies were put in charge of implementing the program. Detailed guidelines were issued to govern the privatization process, including the valuation of assets, the identification of potential investors, and the financial terms of sales. All transactions were subject to further reviews and prior approvals by more than one supervisory agency. It was believed by Bank staff that these safeguards, aimed at maximizing the price obtained by the state from the disposition of its assets, were needed to ensure broad public ownership of the program. 9. In contrast with the detailed guidelines drawn out to govern the sales of public assets, the criteria for providing financial discipline and control of those corporations retained in the public sector were left to be defined at a later date. Arrangements for improvements in accounting and auditing, monitoring and evaluation mechanisms, and related incentive systems would be defined and introduced gradually, on a pilot basis, over a period of several years. Implementation 10. Project implementation was difficult and required intensive staff efforts. Adverse external developments (military coups, devastating typhoons and earthquakes, the Gulf War with the resulting rise in international interest rates and energy prices) combined with a strong domestic opposition by vested interests to delay implementation. Implementation delays were also caused by the multitude of institutional safeguards described above, which resulted in unclear lines of responsibility, conflicts of interest, and duplications of supervisory functions. But the strong Government's commitment and the dedication of Bank staff helped to overcome the obstacles, and the loan conditionality was fully met with a delay of only six months with respect to the original schedule. No serious problems of coordination with other donors were encountered. 13 Outcome 11. Although the formal conditionality was satisfied, serious problems remained as of loan closing. The number and value of corporations actually disposed of fell 40 percent short of the original expectations. The corporate sector continued to represent a significant drain on public finances. Organizational duplications and lack of clear functional lines of responsibility for the privatization of individual firms delayed excessively progress in the disposition of public assets. In the area of performance monitoring of the retained corporations, original progress appeared to be slowed down. There was still a need for clear guidelines for evaluating performance of GOCCs and of effective incentives systems, and for generally accepted accounting standards for the valuation of firms. 12. Concerns were also raised about the continuation of monopolistic practices among some of the privatized firms. The absence of anti-trust laws or of effective monopoly regulation prevented the benefits of privatization on improving resource allocation from being fully achieved. 13. The benefits of privatization had not reached broad numbers of people, with the exception of workers who were given the opportunity (and subsidized loans) to acquire stock in their companies. Instead, much of the buying activity had been confined to local business elites and to their foreign partners. 14. In spite of the limited results, this operation helped to open the door to a fundamental change in the country's attitudes towards public corporations. It brought about a general acceptance of the need for drastic reductions in the government's involvement in productive activities, and for the principles of strict monitoring and accountability. Furthermore, the delays caused by the elaborate system of controls, as well as the extensive consultations with the affected workers, may have helped to enhance this public acceptance. 15. This reform process was continued and deepened under the sponsorship of new Bank lending operations, notably the Economic Integration Loan (3539-PH, approved in FY93), and considerable progress is being reported under this recently closed operation. Post-privatization Results 16. Preliminary and fragmentary evidence suggests that in a majority of the firms privatized the change in ownership resulted in greater financial profitability. It is not clear, however, the extent to which these privatized firms continued to enjoy a degree of monopoly. Evaluation 17. Although a full evaluation of the Reform Program for Government Corporations should be carried out jointly with the other related adjustment loans, it is apparent that it succeeded in improving the business climate and conditions for private investment. It is growth in the latter that will permit the country to achieve a sustained rise in living standards and will generate the resources needed to build a strong infrastructure. 14 18. The outcome of the loan is rated by OED as satisfactory. Both the Bank's and the Government's roles were critical in bringing about the positive results achieved. The institutional development impact of the loan is rated as substantial. The prospects for sustainability of the benefits are rated as likely. These assessments are consistent with those presented in the PCR, including the Borrower's evaluation. Lessons of Experience 19. This operation serves to confirm a number of lessons recently compiled by OED and to derive some new ones. The following lessons are particularly relevant for the Philippines: * First, a strong political commitment is necessary for the success of any privatization program. Privatization in the Philippines had a strong support from President Aquino. * Second, while strong political commitment is a necessary condition for success, it is not a sufficient one. Equally important is the ability of the Government to implement the reforms. A more unified administrative structure for privatization could have been organized to give the program the focus and continuity that it deserves. The use of disposition entities led to incentive compatibility problems and, consequently, delayed the privatization effort. This suggests the importance of the design of the implementing machinery for privatization. In a number of cases, stronger institutional support was needed. * Third, the complicated financial safeguards concerning sales of public assets were justified because of the past history of patronage and the need to build trust and acceptability of the reform program. However, the emphasis on maximizing the sales price of those assets, and the resulting cumbersome system of controls, had a high cost in terms of time lost, foregone fiscal savings and delayed economic growth. To the extent permissible by political constraints, expediency in the privatization of public corporations is likely to bring higher economic returns for the country than attempts at maximizing or optimizing the sales price. * Fourth, policymakers should not underestimate the time, effort, and cost of privatization. The more massive the effort, as in the Philippines, the more time and resources are involved to push the program to its desired conclusion. Furthermore, in a democratic society, where transparency is a necessary aspect of governance, the cost could be even higher. * Fifth, policymakers should also recognize that there are exogenous factors that may have an impact on the success and pace of privatization. The series of coup attempts, a string of natural calamities (earthquake, volcano eruptions, and floods), the Gulf War, the economic recession in developed countries, and so on, had an impact on the investment climate, supply of investible funds, and willingness to take risk. * Sixth, the privatization program could draw a stronger support if it is presented as a component of a structural reform program. It is a means to an end, not an end in itself. It should be presented as a measure: (a) to reduce the Government's intervention in areas where there is no market failure thus making the economy more efficient and globally competitive; and (b) to reduce the public sector deficit by reducing the component of the budget in support of government corporations. 15 * Seventh, it was helpful to have three tranches and to duplicate some of the conditionality in other loans, to reinforce the domestic credibility of the reforms.  17 1. Background Growth of Public Enterprises 1.1 Before World War II, government intervention through the public enterprise form was limited to the financial and agricultural sectors. Government-owned and/or controlled corporations (GOCCs)I organized during the American colonial years were engaged in financing and public transportation. The initial group of GOCCs include the Philippine National Bank, PNB (1916), the National Development Company (1919), and the Manila Railroad Company. 1.2 After the war, as the Philippines reconstructed its economy, the growth of GOCCs accelerated. From 1945 to 1959, about 30 government corporations were organized. A number were in public utility and infrastructure like the Manila Railroad Company (MRC), the Metropolitan Water District (MWD), and the National Power Corporation (Napocor). Some were engaged in agricultural production and trading as, for example, the National Tobacco Corporation and the National Food Products Corporation. Many were in finance such as the Philippine National Bank, Development Bank of the Philippines, the Agricultural Credit and Cooperative Administration (ACCA), and the Government Service Insurance System (GSIS). During this period, regulatory GOCCs emerged such as the National Land Settlement Corporation and the Rural Progress Administration. 1.3 As the number of GOCCs expanded rapidly, there developed a disturbing overlap and duplication of activities among state-operated firms. Numerous attempts to reorganize and streamline public enterprise operations were made but failed. By 1967, the number of state- operated enterprises had grown to 44. 1.4 During the Marcos regime (1967-86), public enterprises grew fast in terms of number, size, and resources. The pervasive use of public enterprises had been justified as a strategy in accelerating the country's economic take off. But some analysts argued that the use of the corporate form was designed to escape the supervision and control of oversight agencies such as the Commission on Audit (COA), the Civil Service Commission (CSC), and the Office of Compensation and Position Classification (OCPC) of the Budget Commission. About half of the GOCCs escaped COA's review. According to COA's 1984 Annual Report, of the 303 GOCCs, 155 had refused to be audited by COA. Armed with a Department of Justice Opinion, corporations that refused COA review argued that the subsidiaries established under the General Corporations Law were not subject to COA audit. A government-owned and/or controlled corporation is defined as "a corporation which is created by special law organized under the Corporation Code in which the Government, directly or indirectly, has ownership of the majority of the capital or has a voting control on the corporation. Provided, that an acquired assets corporation as defined in the next paragraph shall not be considered as GOCC or government corporation." Acquired asset corporation is defined as a corporation (1) which is under private ownership, the voting or outstanding shares of which (i) were conveyed to the government or to a government agency, instrumentality or corporation in satisfaction of debts whether by foreclosure or otherwise, or (ii) were duly acquired by the government through final judgment in a sequestration proceeding, or (2) which is subsidiary of a government corporation organized exclusively to own and manage, or lease, or operate specific physical assets acquired by a government financial institution in satisfaction of debts incurred therewith, and in which case by law or by enunciated policy is required to be disposed of to private ownership within a specified period of time. 18 Financial Losses 1.5 Largely because state-operated enterprises have escaped the auditing, compensation, and civil service rules and regulations, a number of administrative and financial problems arose. First, this led to the duplication of functions of certain state firms. Second, interlocking directorates became commonplace as high government officials were appointed as directors in various government corporations. Third, heavy financial losses were incurred as public accountability was relaxed. Also during this period, state-owned banks acquired holdings in a large number of corporations through default. The Development Bank of the Philippines (DBP) and the Philippine National Bank (PNB) became saddled with nonperforming assets, particularly from 1981 to 1983, due mainly to investments by unethical businessmen and the banks' own faulty credit decisions, often dictated by politics. For example, investments that featured overpriced assets were common and created bloated liabilities and a subsequent loss of equity for these banks. The credit compression exposed financial weaknesses in undercapitalized firms. To prevent large scale failures, the Government set up a rehabilitation fund to help financially troubled companies, but this did not prevent many defaults and only increased the DBP's and PNB's nonperforming assets further. By 1986, there were an estimated 399 nonperforming assets on the books of state-owned banks, with an estimated book value of P 132 billion. This figure excludes smaller companies, those with book values of less than P 10 million, whose recoverable value has been estimated at P 24 billion. Thus, the DBP and PNB were in serious technical default when the new administration took power in 1986. Heavy Economic Burden 1.6 The growing need to subsidize government corporations led to the neglect of developmental expenditures, such as infrastructure investment, maintenance, and operation. In spite of this neglect of needed expenditures, the public sector deficit rose from an average of 2.3 percent of GNP during the late 1970s to over 8 percent in 1982. Growing deficits in turn led to the build up of an unsustainable external debt burden. Between 1975 and 1984 the public sector external debt increased from about US$2.3 billion to over US$13 billion, with about 70 percent of the increase resulting directly or indirectly from the public government sector. 1.7 At least as important as the fiscal burden on the Filipino economy was the pervasive effect of the government corporate sector on resource allocation, through distortions in relative prices, monopolistic practices and discouragement of private sector activity. Genesis of Bank Involvement 1.8 The Bank had long supported attempts at reform of individual government corporations through several project loans, but the results were disappointing. Recognizing how serious the problems of the sector had become, in 1984 the Bank started discussions with the Marcos Government to help formulate a reform program. But progress was delayed by the revolutionary process that led to the installation of the Aquino administration in early 1986. 1.9 The new Government was committed to the objectives of rationalizing the sector, and of reducing the number of state enterprises. But, in view of the recent history of corruption and nepotism, it also gave high priority to the need for transparency and accountability in public sector transactions. This meant that decisions to privatize or liquidate publicly owned 19 enterprises would have to be subject to an intensive and public review, to avoid the possibility or even the appearance of improprieties. 1.10 The process of loan preparation was therefore long. Bank staff found that its key interlocutors at the highest government levels had a strong ownership of the reform program. But they had to face political opposition in Parliament, the resistance of vested-interest groups, and the legitimate concerns of those who, fearing a give-away of public assets, wanted to put in place an elaborate system of checks and balances. Thus, it took more than two years following the installation of the Aquino administration to get the loan ready for Board presentation.  21 2. Loan Objectives 2.1 Working closely with the new Government to formulate an ambitious reform program, the Bank put together an integrated series of adjustment loans. First was the Economic Recovery Program Loan (US$300 million, approved in FY87) aimed primarily at improvements in trade policy, public investment management, tax policy, and the reform of public sector financial institutions.2 This was followed by the Reform Program for Government Corporations (RPGC) which focused on the nonfinancial government corporations (NFGCs). 2.2 The President's Report (PR) did not spell out specific objectives for this operation, because this loan was an integral part of the broader package of Bank adjustment loans. This loan was in support of an ongoing program to reduce, limit, and rationalize government activities using the corporate form. The PR listed the following as "key elements": (a) "establishment of a policy framework which enunciates ground rules for the establishment and operation of Government Corporations (GCs); (b) a rationalization program to correct anomalies in the existing public sector corporate portfolio and ensure an appropriate disposition of all GCs; this includes privatization, consolidation, conversion to private nonprofit status, transfer to departments or abolition of GCs; and (c) an institutional framework for improved operations and n onitoring of the corporations remaining in the public sector; this includes clarification of the roles of government entities dealing with GCs, improvement of their supervision and control, establishing of corporate planning and performance evaluation systems, and improving the accounting and auditing of GCs. Measures to improve the performance of the retained GCs will initially be implemented by 15 of the largest NFGCs."3 2 Other adjustment loans that followed closely were: * the Financial Sector Loan (US$300 million, approved in FY89), which focused on Central Bank reforms, regulation and control of private banks, improved legal systems, depositor protection and competition in the banking industry; * the Debt Management Program (US$200 million, approved in FY90), which supported the buyback of US$1.33 billion of external debt at a cost of US$665 million, and improvements in the country's debt management system; and * the loan/credit for Environmental and Natural Resources (US$158 million plus IDA credit of US$66 million equivalent, approved in FY90) to strengthen the management of natural resources and the protection of biological diversity. President's Report, Loan and Project Summary. 22 2.3 This statement of objectives lacked the precision of more recent Bank loans. The PR, furthermore, did not offer clear criteria by which to assess the achievement of those objectives, such as measurable reductions in the fiscal burden of GCs, or specific numbers of firms to be divested. But these limitations do not detract from the merits of the operation, for several reasons: first, this was the first privatization operation of large magnitude attempted by the Bank; second, it was difficult to isolate the loan's objectives because this was part of a large program of interrelated adjustment operations; and, third, the conditions for tranche release were left purposely open to interpretation in order to enable the Government and Bank to respond with flexibility to the evolving economic and political conditions in the country. 2.4 The major conclusion emerging from a review of the loan's objectives is that they addressed urgent reform needs of the country, and thus were clearly relevant to the Bank's and the Government's own strategy. 23 3. Project Design Accountability at the Expense of Expediency 3.1 Because the problems addressed by the loan were primarily institutional, it was necessary to contemplate fundamental changes in the legal processes affecting public sector management. Also, design of the project had to balance the need for quick divestiture of unproductive assets with the nation's desire for due process, transparency, and accountability. For these reasons, the design that emerged was rather complex and difficult to implement. 3.2 Six separate agencies were put in charge of implementing the program: the Department of Finance (DOF), the Department of Budget and Management (DBM), the Committee on Privatization (COP), the Government Corporations Monitoring Coordinating Commission (GCMCC), the Asset Privatization Trust (APT), and the Civil Service Commission (CSC). Each of these agencies had a specific separate mandate under the program. While the DOF was given the primary function of rationalizing and enhancing corporate efficiency and accountability, the direction and control of the various program components were left to the designated implementing agencies. The latter, thus, retained primary responsibility for the planning, organization, and execution of activities under each program component.4 Guidelines for Valuation and Sale of Corporations 3.3 To ensure that all disposition agencies followed adequate, comparable, and transparent methods, the COP issued detailed guidelines for privatization. These included methods to be followed for valuation of assets, identification of potential investors, etc. The price, buyer, terms of disposition and any rehabilitation or restructuring of corporations were subject to the prior approval of COP. An important objective of these arrangements was to maximize the price received by the Treasury from the sale of public assets. 3.4 The assets could be disposed through any of the following seven modalities: (1) bidding through APT dispositions; (2) direct debt buy out (DDBO) through APT dispositions consisting of the average of two appraisals of mortgage assets plus 10 percent (DDBO-AV); (3) DDBO through APT dispositions composed of transfer price plus interest from June 30, 1986 (DDBO- TP); (4) retrieval through APT dispositions; (5) other modes through APT dispositions; (6) sales through GFI dispositions; and (7) other modes, through non-APT, non-GFI dispositions. Conditionality Requiring Legislative Action 3.5 Loan conditionality included the passage of legislation for public sector reorganization and divestiture and the adoption of several major institutional reforms. They are well described in the PCR, and resulted in implementation delays. Because the operation was meant to sail uncharted waters, some of the specific actions required were left to be determined following the completion of studies, a decision that allowed the Bank to move forward rapidly in the early stages of implementation, while permitting flexibility for mid-course corrections. Project Completion Report, Project Review from Borrower's Perspective, para. 3.0. 24 Tranching Arrangements 3.6 To facilitate the needed flexibility, loan design contemplated the release of the funds in three tranches. This would allow Bank staff to tailor disbursements more closely to the progress in implementation, and also strengthen the domestic leverage of government officials to pursue needed but controversial reforms. Similar considerations led to the adoption of parallel conditionality in the related adjustment operations mentioned earlier. Technical Assistance 3.7 Provision of adequate technical assistance was essential, given the magnitude of the institutional changes contemplated. The Bank assisted the Government in coordinating grants for this purpose with the Asian Development Bank (ADB), the US Agency for International Development (USAID), the United Nations Development Program (UNDP), and the Government of Japan. However, in contrast with the explicit coordination arrangements that were contemplated with other donors, project design does not appear to have involved the International Finance Corporation (IFC), which presumably could have been associated in the privatization aspects of the operation. No Timetable to Sell Any Corporations 3.8 A significant aspect of the project design was the absence of deadlines on the Government to actually sell any individual corporation. The Government's formal commitment was to create the necessary conditions for the divestiture, up to the point of offering the firms for sale. This approach was meant to avoid weakening the bargaining position of the authorities in 5 negotiations with potential buyers. 3.9 In contrast with the detailed guidelines drawn out to govern the sales of public assets, the criteria for providing financial discipline and control of those corporations retained in the public sector were left to be defined at a later date. Arrangements for improvements in accounting and auditing, monitoring and evaluation mechanisms, and related incentive systems would be defined and introduced gradually, on a pilot basis, over a period of several years. Cf., World Bank Assistance to Privatization in Developing Countries, OED Report No. 13273, August 19, 1994, particularly para. 3.28. 25 4. Implementation 4.1 Details of project implementation and of the process of releasing the three tranches are well described in the PCR. To deal with the complexity of the program, Bank staff made an intensive supervision effort. Thirteen missions were sent from Headquarters, and staff from the resident office in Manila maintained a permanent presence to help solve day-to-day problems. The close involvement of the task manager, Mr. Claudio Fernandez, was an essential component of this process. 4.2 Many factors contributed to delay implementation of the reform process. First was the diffused organizational structure. Too many agencies were involved in the process: in addition to those listed earlier (cf., para. 3.2), there were other disposition entities. The major ones among the latter were the National Development Company, the Government Service Insurance System, and the Philippine National Oil Co. 4.3 Sales were generally made through public bidding in accordance with rules and regulations prescribed by COA. In case of failed bids, negotiated transactions were resorted to. In 1992, 27 assets were disposed primarily through negotiated sale as the stringent measures made it difficult for prospective buyers to comply with the APT terms during the bidding. As of September 30, 1993, 89 out of 247 fully disposed assets and 25 out of 62 partially disposed assets were subject to negotiated sale. The second major disposition mode was public bidding, accounting for 58 and 30, respectively. 4.4 A more unified organization structure may have made a difference. Frequent changes in the top posts of the Department of Finance may not have resulted in shifts in privatization priorities and policies but they slowed down any momentum. Frequent changes were not limited to the level of the Secretaries. Even at the Undersecretary and Director levels, there were frequent changes. Undersecretaries represent their respective departments (Finance, Budget and Management, Justice, Trade and Industry, and National Economic and Development Authority) in the COP Technical Committee. The appointment of these top-level officials in a concurrent capacity affected the pace of privatization, especially in the case of the Secretary and Undersecretary of the Department of Finance who serve as Chairman of COP and the COP Technical Committee, respectively. At a time when the Finance Department was heavily engaged in loan negotiations with IMF and other financing institutions, raising foreign assistance, restructuring foreign and domestic debt, and collecting taxes, the privatization program may have been better addressed had it been assigned to a full time privatization czar or board reporting directly to the President. 4.5 Second, a big part of the delays in the privatization process was due to legal problems. Privatization would have been easier had the 399 assets transferred from the PNB and DBP been fully-owned corporations. But since 300 of the 399 assets had been acquired as a result of default on loans to firms previously owned by private individuals, APT had to go through the process of foreclosure. As a result, APT had to tangle with numerous legal cases. Previous owners, creditors, and losing bidders stalled the privatization process through court injunctions. 4.6 Third, the investment climate worsened due to the successive coup attempts, the natural calamities that hit the country, and the Gulf War, along with high interest rates and oil prices. 26 The uncertainty led to a wait-and-see attitude which resulted in low interest in the sale of nonoperating assets. Public offerings of major government corporations like Philippine National Bank, National Steel Corporation, and Manila Hotel were deferred until market conditions improved. 4.7 Fourth, there was reluctance on the part of supervising Departments or parent government corporations to dispose of some GOCCs or their subsidiaries. The pace at which privatization proceeded was generally slower for firms to be disposed through disposition entities rather than through the APT. Allowing supervising Departments or parent corporations to sell subsidiary corporations led to the problem of incentive incompatibility. Some GOCCs were reported to have deliberately stalled the privatization process since it would mean a reduction of their sphere of influence. There appeared to be a bias to dispose of losing subsidiaries first before the profitable ones. For example, in the case of the Government Service Insurance System, Philippine Plaza Hotel has been privatized while Manila Hotel remains in public sector hands. In the case of Philippine National Oil Co., the losing Malangas Coal Corporation and PNOC Marine Corporation were the first to go while Petron, the country's biggest refinery and marketing corporation, was delayed. More recently, the change in the board of directors of disposition entities, resulting from the change in the country's leadership, from Aquino to Ramos, contributed also to the delay. New executive teams in profitable GOCCs, again announced deferrals of scheduled privatization, as in the case of the Philippine National Bank and Manila Hotel. 4.8 Fifth, the bidding procedures tended to delay the process. Government approval and bidding procedures needed to be followed. An interagency consensus was required to approve the list of assets for sale. Public bidding appeared to be a less preferred mode by a number of potential investors. On the other hand, transparent, public bidding was the preferred option by the COA. COA required at least two bidders for a bidding. Moreover, valuation of assets was a major cause of delay. Pricing involved an interagency decision and ratification by COA. However, since the valuation studies of most of remaining assets have been completed, the issue of valuation will be a less severe drag on the privatization process in the future. 4.9 Finally, part of the delay in the privatization process was the poor physical and financial state of the assets to be sold. Future investors were discouraged by the large debt overhang of some of the assets which could threaten their financial viability once turned over to the private sector. 4.10 In spite of the difficulties and delays encountered during project implementation, it was possible to implement all the conditionality of the loan and to fully disburse the three tranches with only minor delays. As indicated earlier, the process of approving release of the successive tranches provided valuable support to the implementing staff (in the Bank and in the Government) for carrying out the more controversial reforms. Coordination with other donors was good. Negotiated severance payments with displaced workers were helpful in overcoming industrial relations problems. 27 5. Outcome 5.1 In a formal sense, all the conditionality of the loan was carried out to the satisfaction of the Bank, as is well documented in the PCR. This is a significant accomplishment, taking into account the complexity and "demandingness" of the program, and the occurrence of severe external developments (natural disasters, the Gulf War, frequent military challenges to the Presidential rule) that conspired against the success of the reforms. 5.2 The technical assistance studies were completed and their recommendations were essentially implemented. The institutional and legal framework for divestiture and for rationalization of the GCs was well established. The loan's quantitative targets in terms of GCs offered for sale were surpassed. As of loan closing, a total of 336 enterprises (70 GCs and 266 transferred assets) were either liquidated or privatized. More important, the general objectives of the loan had become more generally accepted in the country. 5.3 But as of loan closing severe problems remained. The number of privatizations of the very large GCs ("large-ticket items") was small. The combined assets of GCs privatized represented only 60 percent of the total assets that had been scheduled for privatization. And the drain on the public finances of the GC sector, while reduced, remained heavy: in 1991 the net flow of funds from the national government to GCs (comprising subsidies, net lending and equity investments, net of tax payments, interest and dividends) was P 7.7 billion, a high number when compared to a total public sector deficit (excluding GCs) of P 18.8 billion. 5.4 Two related aspects of the privatization program have raised concern: the distribution of benefits of privatization and its impact on competition. Much of the buying activity has so far been confined to local business elites and their foreign partners, with limited participation from the broad business class due to resource considerations. Furthermore, privatization has mostly involved direct sales of assets to a single buyer rather than a sale of stocks to a large number of shareholders or employees. At the same time, privatization has not improved competition in key areas. Most of the units which have been privatized were already in competitive sectors, while most of the corporations that enjoy monopoly or oligopoly positions have either not been privatized or have been privatized without any change in the market structure. An example is the recent privatization of Philippine Airlines. There has been a change of ownership but, in essence, a protected public monopoly has been changed into a protected private monopoly. In this context, the benefits of privatization have been dampened by the absence of antitrust or competition laws in the Philippines and of effective regulatory authorities.6 5.5 An important component of the loan was the establishment of mechanisms for monitoring the performance of GCs. Following a good start, there was major back-tracking in this area in 1994, when the secretariat functions of the Monitoring Committee were taken away from the Department of Finance, and the Committee ceased to have periodic meetings. There are still weaknesses in the performance evaluation system, the mechanisms for "contracts" with the GCs and the incentives for good performance. The lack of clear responsibility, with different offices claiming jurisdiction, makes progress in this area difficult to attain. 6 World Bank Economic Memorandum on the Philippines, Report no. 11061, dated April 1, 1993. 28 5.6 Notwithstanding the serious limitations, this operation helped to bring about a fundamental change in the country's attitude towards public corporations. It brought about a general acceptance of the need for a drastic reduction of the public sector in productive enterprises, and for the principles of strict monitoring and accountability. The reform process initiated by the loan was continued and deepened under the Economic Integration Loan (Loan 3539-PH), and considerable more progress is being reported under this recently closed operation. Post-privatization Performance of Firms That Were Sold 5.7 Has there been an improvement in overall economic efficiency as a result of the transfer of ownership from the Government to the private sector? No comprehensive study has been done yet to allow a definite answer to this question. Yet, some fragmentary evidences based on case studies of privatized government corporations indicate that the change in ownership may have resulted in greater economic efficiency and financial profitability. 5.8 A case study of three privatized GOCCs concluded that there has been a dramatic turnaround in factor productivity after privatization. For the three firms, it was estimated that total productivity increased three-fold while capital productivity improved four-fold.7 In a case study of 20 nonperforming assets which were recently sold by APT, the evidence support the view that there has been an improvement in the financial performance of the selected GOCCs after privatization. Of the 13 corporations where financial data are available, eight firms managed to reverse their financial fortune from losses to profitability, three remained financially distressed, while two remained not operational at the time of the study. 7 See R. Gascon, Effects of Privatization in Selected GOCCs, 1991 (unpublished). Valdez, Development Impact of the Divestment to the Private Sector of the Asset Privatization Trust-Held Assets, 1992. 29 6. Evaluation 6.1 A full evaluation of the Reform Program for Government Corporations should be carried out jointly with the other adjustment loans to the Philippines that complemented it. In particular it should encompass the Economic Integration Loan, which followed in terms of further rationalization of the GC sector. 6.2 It is apparent already that this pioneering operation opened the door for a sustained series of institutional improvements that helped, inter alia, to make the business climate in the country friendlier for private investment. It is the growth of the latter, in turn, that will permit the Philippines to raise living standards and will generate the resources to continue building a strong infrastructure. 6.3 The Borrower's assessment, expressed in Part II of the PCR, is cautiously positive: "Notwithstanding the difficulties, the objectives of the program were largely achieved. While there is ample ground for skepticism and disappointment on the Program's pace and contributions, reforms undertaken during the last five years give a feeling of optimism that a lot more can be achieved especially considering that the various components of the program require an intricate plan of action that could easily be derailed along the way."9 6.4 The outcome of this loan is rated by OED as satisfactory. Both the Bank's and the Government's roles were critical in bringing about the positive results attained. The institutional development impact of the loan is rated as substantial. The prospects for sustainability are rated as likely. PCR, part II, Project Review from Borrower's Perspective.  31 7. Lessons of Experience 7.1 This operation serves to confirm a number of lessons recently compiled by OED and to derive some new ones.10 The following lessons are particularly relevant for the Philippines: * First, a strong political commitment is necessary for the success of any privatization program. Privatization in the Philippines had a strong support from President Aquino. * Second, while strong political commitment is a necessary condition for success, it is not a sufficient one. Equally important is the ability of the Government to implement the reforms. A more unified administrative structure for privatization could have been organized to give the program the focus and continuity that it deserves. The use of disposition entities led to incentive compatibility problems and, consequently, delayed the privatization effort. This suggests the importance of the design of the implementing machinery for privatization. In a number of cases, stronger institutional support was needed. * Third, the complicated financial safeguards concerning sales of public assets were justified because of the past history of patronage and the need to build trust and acceptability of the reform program. However, the emphasis on maximizing the sales price of those assets, and the resulting cumbersome system of controls, had a high cost in terms of time lost, foregone fiscal savings and delayed economic growth. To the extent permissible by political constraints, expediency in the privatization of public corporations is likely to bring higher economic returns for the country than attempts at maximizing or optimizing the sales price. * Fourth, policymakers should not underestimate the time, effort, and cost of privatization. The more massive the effort, as in the Philippines, the more time and resources are involved to push the program to its desired conclusion. Furthermore, in a democratic society, where transparency is a necessary aspect of governance, the cost could be even higher. * Fifth, policymakers should also recognize that there are exogenous factors that may have an impact on the success and pace of privatization. The series of coup attempts, a string of natural calamities (earthquake, volcano eruptions, and floods), the Gulf War, the economic recession in developed countries, and so on, had an impact on the investment climate, supply of investible funds, and willingness to take risk. * Sixth, the privatization program could draw a stronger support if it is presented as a component of a structural reform program. It is a means to an end, not an end in itself. It should be presented as a measure: (a) to reduce the Government's intervention in areas where there is no market failure thus making the economy more efficient and globally competitive; and (b) to reduce the public sector deficit by reducing the component of the budget in support of government corporations. * Seventh, it was helpful to have three tranches and to duplicate some of the conditionality in other loans, to reinforce the domestic credibility of the reforms. 10 OED Report No. 13273, World Bank Assistance to Privatization in Developing Countries, and OED Report No. 10870, World Bank Structural and Sectoral Adjustment Operations: The Second OED Review.  33 Attachment ASIAN DEVELOPMENT 1ANK Programs Depadment (East) Division III 5 March 1996 Mr- Manuel Perhialver Division Chief Country Policy, Industry, and Finance Operations Evaluation Department The World Bank 1818 H Street N.W. Washington, D.C. 20433 U. S. A. Dear Mr. Peialver: Subject: PHILIPPINES: Reform Program for Government Corporations (Loan 2966-PHI) - Performance Audit Report Thank you for a copy of the draft PAR on the captioned IBRO loan and the opportunity to comment. We feel that though the privatization process set up under the loan is not complete and that there is still much remaining to be done, the loan has contributed very substantially to the process. We also agree with the conclusions of the Report. We particularly support the conclusion that too much attention, often unnecessarily, is paid to the sale price, which can delay privatization and result in greater overall economic losses for the Government and the economy. The Bank is also engaged in assisting the Government in the privatization process and will continue to support this effort under its various projects and technical assistance operations. We look forward to continued cooperation with the World Bank in this effort. Sincerely, Werner M. Schelzig Programs Manager  s IMAGING Report No: 15614 Type: PPAR