Philippines - Country assistance strategy progress report

From: The President March 2, 1998 Philippines 21176 Country Assistance Strategy (CAS) Progress Report Executive Summary i. This Progress Report reviews the impact of the East Asian financial crisis on the Philippine economy and proposes some modifications in the 1996 CAS. A full CAS is scheduled for FY99 following elections in May 1998 and finalization of the 1998-2004 medium-term plan by the new government. ii. A decade long structural adjustment effort and a relatively shorter period of rapid credit growth and reliance on private capital inflows have moderated the impact of the East Asian financial crisis in the Philippines. The market has also up to now regarded Philippine problems to be of a different order of magnitude than those of Indonesia, South Korea and Thailand. iii. The near-term outlook is for a sharp reduction in the growth (to about 3 percent in 1998) and a slight increase (to 8 percent in 1998) in inflation. iv. There are significant risks which, if not managed properly, may lead to a deterioration of the situation. These risks emanate from: increasing corporate and banking stress; rise in inflation and unemployment; reduced foreign exchange reserves; continuation of the regional turmoil; and impending change of government administration. V. The authorities have requested quick disbursing assistance from the Bank, the IMF and the Asian Development Bank on an urgent basis since the next few months are most risky. At this time, the authorities are discussing a stand-by arrangement with the IMF. Recent and ongoing Bank missions will help prepare financial sector and public sector management reforrns and assess social impact of the crisis. (Up-to-date information will be provided at the Board meeting.) vi. The focus of Bank assistance in FY98-99 will be to help the authorities define and implement structural reforms to mitigate the economic and social consequences of the crisis while continuing support for long-terrn investments in people, rural development, infrastructure and environmental protection to enable a resumption of stronger growth. vii. The specific adjustments proposed in the FY98-99 program at this time are the following: - Adjustment lending and technical assistance for financial and public sector reforms, the former contingent on agreements with the IMF on a stand-by program and with the Bank on a comprehensive reform package and strong up front actions. - Rapid social impact assessment and interventions to protect vulnerable groups. - Monitoring of, and policy dialogue on, economic, financial, and poverty situation. - Lines of credit for businesses to adjust to the changed market environment. - Support for development efforts in Mindanao following the peace agreement. - Reassessment of the existing Bank portfolio in light of the financial crisis. - IFC is developing specific transactions in financial and corporate sectors. 4  -2 - A. Introduction 1. The last full CAS for the Philippines was discussed by the Board of Executive Directors in April 1996. This progress report provides an update on the implementation of the 1996 CAS and assesses effects of the East Asian financial crisis on the Philippine economy, the Bank's response so far, and the adjustments proposed to our assistance strategy in response to recent developments. The recent CEM' analyzes economic developments and policy issues through late 1997. We plan to present the next full CAS to the Board in Spring of 1999, as originally scheduled, following the May 1998 Presidential elections, and to take into account the new govermnment's Medium-Termn Investment Plan (1998-2004), expected to be finalized in late 1998. A participatory process is already underway, to prepare sectoral assistance strategy notes which will feed into the full CAS, which is also part of the program of self-evaluation pilots. The CAS adjustments being proposed in this progress report take into account those recommendations of the OED Country Assistance Review which are relevant to the current economic situation; the full CAS will comprehensively incorporate the CAR report findings and recommendations. B. Political Developments 2. Two important political developments since the last CAS deserve mention. First, presidential, congressional and local elections are scheduledfor May 1998. Although the three leading contenders have vowed to maintain the thrust of current economic policies, the outcome of the elections will be an important factor in full restoration of investor confidence. Another inplication of the elections is that the Congress is now in recess and is not expected to be available to pass new legislation until well after the new administration takes office in July 1998. However, the substantial legislation on economic and social topics, some of it enacted during the last few months, provides the current administration with ample basis to put in place further reformns before it leaves office at the end of June 1998. In addition, the authorities are willing to undertake the technical work necessary to draft new legislation in the coming months so that the next administration can focus on its passage later this year with the new Congress. 3. Second, a peace agreement between the government and the Moro National Liberation Front in Mindanao was concluded in September 1996, ending a more thzan 20-year old conflict. The govenmment has requested the Bank to play a leadership role in mobilizing donor support and to expedite Bank assistance for development of this poverty stricken region. The Bank has responded by mobilizing donor support at the 1996 and 1997 CG meetings, establishing a local aid coordination process for Mindanao and processing a social fund project. C. Economic Impact of the Regional Financial Crisis 4. Philippine economic growth has been impacted negatively by the regional financial crisis, but sofar less severely than several of its neighbors. Real GNP growth decelerated in 1997 to 5.8 percent from 6.9 percent in 1996. More rapid growth since 1994 has relied increasingly on rising private capital inflows. But there are significant differences compared to Indonesia, Thailand and South Korea, including: (a) a shorter period of large capital inflows and rapid credit growth; (b) a decade long structural adjustment effort with the support of the Bank ' Philippines: Managing Global Integration, Report No. 17024-PH, November 17, 1997.  - 3 - and the Fund; (c) a smaller real-estate bubble; (d) a banking system which has been restructured extensively in the last 10 years and is somewhat better supervised and capitalized; and (e) a relatively open society with an active legislature and judiciary. Acknowledging these differences, the market has thus far regarded the Philippines' problems as of a different order of magnitude than those of some of its neighbors. 5. Reflecting the overall loss of confidence in the regional markets, the net inflow of foreign capitalfrom all sources into the Philippines fellfrom about US$8 billion in 1996 to below USSSOO million in 1997. Net portfolio outflows, in particular, reached nearly US$5 billion in 1997, and since the second half of the year, access to private debt has fallen sharply and become more expensive. Rollover of short-term debt -- which is modest relative to neighboring countries -- has, however, not been a problem so far. Moreover, Philippine overseas workers expanded their remittances by 15 percent to about US$11.5 billion in 1997. 6. Faced with sustained speculative attacks and declining reserves (-US$3.4 billion for 1997 as a whole), the Philippines was among the first East Asian countries to follow Thailand's move to afloating exchange rate. From July 11, 1997 -- the date of this decision - to mid-February 1998, the peso lost 55 percent of its value against the US dollar, while equity prices have fallen by about 40 percent from their 1997 peak. 7. The combined effect of the depreciation and economic slowdown contributed to: (i) an improved trade performance in 1997, as exports grew by 23 percent while import growth slowed to 10 percent; (ii) a weakening of the fiscal situation, as revenue collection weakened and debt service increased sharply (1997 ended with a smaller than anticipated budget surplus); and (iii) a sharp reduction in availability of credit to the business sector. 8. An inflationary spiral was prevented in 1997: January 1998 inflation was 6.4 percent (from 5.1 percent at the end of 1996). This reflects the impact of a number of measures undertaken (i) to curtail demand, including a rise in reserve requirements, reductions in both current and capital spending plans in both 1997 and 1998; and (ii) to limit wage settlements, with minimum salary adjustments agreed in late 1997 limited to 7-8 percent. Increased competition and weakening demand have also held back price increases up to now. 9. Moderate inflation, however, was achieved at the cost of a sustained period of high interest rates (18-20 percent for the benchmark 91-day Treasury bill rate and 25-30 percent for prime lending rates), reflecting an increased risk premium on Peso assets, high deposit rates offered by banks experiencing liqaidity problems, and the growing preference of banks for liquidity. Such high rates in turn have begun to strain corporate finances, and the banking system's non-performing loans are expected to increase from their end-1997 level of about 5 percent. The persistence of interest rates at current levels, or further exchange rate depreciation, would increase the level of stress in the financial system. 10. Overall, the authorities' response to the regional crisis was swift and effective and follows a decade of structural reform that has improvedfiscalpolicy, reduced the external debt burden, liberalized trade and the capital account, and enhanced domestic competition. Nevertheless, the economy remains more susceptible to investor skittishness, which is also a function of developments elsewhere in the region. Quick agreement was reached with the IMF  to extend and augment the Extended Financing Facility (EFF) in July 1997; US$1.05 billion was made available from the IMF, of which some $700 million has been disbursed. An IMF mission is currently visiting Manila to discuss with the authorities the completion of the EFF and the possibility of entering into a new stand-by arrangement. Throughout this period, collaboration between the Bank and the IMF staff has been good. A joint Bank-Fund mission focusing on the banking system was completed in February 1998. D. Near-Term Outlook 11. A sharp reduction in growtlh (to about 3 percent in 1998) appears unavoidable under current conditions of tightening credit availability and its impact on private consumption and investment. The depth and duration of the slowdown will depend on the extent to which stress in the corporate and banking sectors increases and the speed which investor confidence returns. A recovery of output growth to 5 percent appears feasible by the year 2000, provided regional economic conditions stabilize and sound economic policies are maintained by the new government (see para. 33 on macroeconomic risks). 12. The macroeconomic framework for 1998-99, at the time of writing of this report, is under discussion between the authorities and the IMF and the Bank. In addition to fiscal and monetary targets for 1998, financial and public sector reforms are needed to mitigate the risks to the economy. The main macroeconomic objectives are to: (a) contain the slowdown of GNP growth to 3 percent in 1998 followed by 4 percent in 1999; (b) limit inflation to 8 percent in 1998, 6.5 percent in 1999, and 5 percent in subsequent years; and (c) increase reserve cover to 2.0 months of imports in 1998 and raise it to 2.1 in 1999.2 13. Against the background of declining capitalflows, foreign reserves have already fallen below prudent levels, and the authorities are now seeking to rebuild them over time to pre- crisis levels. The growth scenario presented above envisages that access to foreign finance from "regular" sources3 may recover somewhat to about US$5 billion in 1998, and US$6 billion in 1999. After an outflow of about US$3.5 billion in 1997, net foreign investment (direct and portfolio) would be close to zero in 1998, before recovering somewhat in 1999. But access to various formns of foreign borrowing (e.g., bonds, syndicated loans, project finance) would remain constrained relative to a peak of US$11 billion gross in 1996. The scenario also assumes uninterrupted rollover of short-term debt and continued growth of workers remittances. Major disruptions in short-term external financing would require significant adjustments to the economic and financing outlook, and additional policy adjustments. 14. Domestic adjustment is called for to bring domestic absorption in line withi these capital account developments. Some of this adjustment will be automatic, as investment plans are reassessed, in light of restricted access to foreign financing, and as private demand weakens. The ongoing cuts in public expenditure programs would further depress domestic absorption. In contrast, the growth in private consumption per capita would continue, albeit at a much slower rate. This domestic adjustment would curtail merchandise imports to a 4.5 percent growth rate 2 Final agreement on these targets and measures necessary to achieve them is part of the ongoing discussions with the IMF and the authorities on the standby. 3 Excluding fast disbursing flows from multilateral institutions.  -5 - (in dollar terms). But an expected slowdown in foreign markets may also cut the rate of merchandise export growth down to 16 percent in 1998 (in dollar terms). Under these conditions, the current account deficit would shrink to US$ 2.2 billion in 1999 from US$3.9 billion in 1996. 15. In view of capital account uncertainties and the need to maintain the momentum of refonn straddling two administrations, the authorities are seeking to mobilize extraordinary finance from the World Bank, the IMF, the Asian Development Bank and commercial and bilateral sources. 16. The adverse social impacts of thefinancial crisis were modest through 1997 given good growth and low inflation, but are likely to intensify in the near term and become more visible. The Govenmment conservatively estimates layoffs of 20,000 people in 1998. Unemployment is likely to rise, reversing recent declines, on account of layoffs in the corporate sector and slower job creation following the slowdown of growth. Prices are expected to rise in the coming months as inventories are depleted and the impact of higher import costs works through the economy. A wage-price spiral has been averted so far and wage increases have been moderate. The govenmuent's 1998 budget includes provisions for a doubling of the Poverty Alleviation Fund. But reductions in non-personnel expenditures of all departments which may affect provision of public services. Another concem is the negative impact of the repatriation of migrant workers from neighboring countries due to the crisis, as their remittances have benefited many poor households and could fall. A majority of Philippine overseas workers fortunately live outside of East Asia (e.g., Middle East, United States). The Bank has commissioned a social impact analysis (see para. 24) to help the government define mitigation measures. 17. To summarize, the near-term outlook remains for sharply slowing growth in 1998 with a modest increase in 1999 and beyond, albeit with signififcant risks which, if not managed properly, may lead to a deterioration of the situation. The focus of the Bank's adjustment lending and the IMF's stand-by arrangement would be to help the authorities contain the risks discussed below by pursuing a proactive program of reforms. The authorities are requesting such assistance on an urgent basis since tile next few months are most risky given the ongoing market turbulence and political transition. E. Progress with Respect to the 1996 CAS 18. Reflecting strong private capital inflows, the demand for the Bank's lending was lower than expected and the actual loan commitments from the Bank during FY96-98 are estimated at $874.4 million, below the approved base case lending amount of $1.5 billion. In line with the CAS, about one-third of the dollar value of lending and 7 out of the 10 projects were for interventions in poverty alleviation, rural development and environmental protection. Key activities in non-lending services were: 2 CEMs linked to the Consultative Group meetings in 1996 and 1997; a rural development strategy report; informal policy notes on banking, housing finance and contractual savings. 19. The last full CAS identified six criteria for success of the Bank's assistance program to the Philippines, in addition to good macroeconomic management. While it might be too early to evaluate progress in some of these areas, progress on most of them has been satisfactory.  Better portfolio quality: The share of problem projects in the portfolio of Bank loans to the Philippines has remained roughly unchanged (15 percent at mid-FY98) since the last full CAS, with 92 percent of projects rated satisfactory in terms of reaching their development objectives, and 85 percent in terns of implementation progress. These statistics, however, mask the facts that the old problem projects have been upgraded, the realism index has reached 100 percent and the quality at entry has improved markedly. Activities are underway to build better procurement, financial management and results monitoring and evaluation systems and capacity. * Improved access, financing terms, and quality of private investment in infrastructure: As a result of the Private Sector Infrastructure Initiative (PSII) of 1995, significant progress has been made during the last two years in facilitating transactions for solicited and unsolicited proposals under the BOT Law and in developing a framework to reduce government's contingent liabilities. * Agreement and implementation of reforms for the water resources sector: A Water Resources Development project underway includes regulatory reforms of the National Water Resources Board (NWRB) and preparation of a Master Plan for Water Resources Development and Management. The government has also recently prepared a draft Water Resource Authority (WRAP) bill, which is now before Congress. In addition to its pipeline of four projects, the Bank has been assisting government in the privatization of water utilities: IFC served as lead advisor on privatizing the Manila Water Utility (MWSS). * Increased investments in people and articulation of a rural development strategy to reduce poverty: Since the last CAS, the Bank has prepared with government a rural development strategy and is discussing increased assistance in this area. During FY96- 97, four projects (50 percent of new comnmitments) were approved for health, education and rural development. The three projects presented together with this Progress Report have poverty reduction as their main objective; they are the Early Childhood Development, Community Based Resource Management, and Social Fund projects. * Lower infant mortality and malnutrition among pre-schoolers: While malnutrition rates appear to be declining, no new data is available since the last CAS to look at detailed indicators. On the Bank side, the ECD project, prepared in close coordination with the ADB, aims at providing an integrated package of health, nutrition and pre-school services to poor pre-schoolers and includes surveys to provide more recent data. * Improved quality of elementary education of the poor: The new Elementary Education Project (FY97) focuses on better targeting of resources to the neediest provinces and schools and increasing the availability of basic inputs as intermediate indicators towards the medium-term objective of improving achievement and completion rates, as laid out in the last CAS. 20. One of the important lessons learned over recent years was the need to work more closely with LGUs, both in the human resources and infrastructure sectors, in view the  - 7 - government's decentralization policy. This has presented the Bank with an opportunity to develop a new framework for Local Government Unit (LGU) financing together with the government and other donors, but also with a major challenge, given the institutional capacity limits at local levels and the need for intensive supervision. It has also proven to be crucial in this regard to pursue the Bank's decentralization efforts. A strengthened field office now allows us to address issues in complex or problem projects faster and more forcefully. F. Bank Strategy 21. We have reassessed the 1996 CAS in the light of the recent developments and believe that the major policy challenges and the strategic thrusts of the Bank's assistance strategy remain valid. These are: (i) sustaining economic growth through sound macroeconomic policies; (ii) strengthening public sector management; (iii) strengthening infrastructure and facilitating private sector participation; (iv) alleviating poverty and upgrading basic social services; and (iv) supporting sustainable natural resource management. Within, this framework, we have made some and are proposing further adjustments to our FY98-99 program of lending and non-lending services in response to both the Asian financial crisis and the new opportunities in Mindanao. 22. During the period July 1997 to February 1998, the Bank's assistance to the authorities for responding to the crisis was in the form of non-lending services asfundingfrom IMF was sufficient and no funding from the Bank was requested. Our response included: (i) frequent visits by senior Bank officials to provide policy advice based on other country experiences; (ii) an expanded CEM which outlined recommendations for short-term economic management as well as a structural reform agenda; (iii) a CG meeting in December 1997 which helped donors and markets differentiate the Philippines from other crisis countries; and (iv) discussions with the authorities on options for expanded lending from the Bank in line with the alternative low case scenarios approved in the last CAS. (See para 107 of the last CAS.) 23. In response to a government request in January 1998, we propose to provide technical assistance and quick disbursing loans in CY98 to support structural reforms in the financial and public sectors. These would aim at helping the economy emerge stronger from the crisis and resume sustained rapid growth over the medium termn. . A technical assistance and training program to strengthen banking supervision and regulation is to be funded by a Japanese PHRD grant; and a technical assistance loan for the housing finance sector is already under preparation. A financial sector mission currently in the field is discussing with government and multilateral partners the priorities and coordination of further assistance for the financial sector. * Adjustmnent lending of about US$500 million in CY98 would be provided (i) to assist the authorities in developing and implementing a strong program of reform in response to the regional crisis, in order to restore investor confidence; reformns within the financial and public sector are expected to be essential to meet this objective4; (ii) to reduce the public Despite a number of past reforms in the banking system that have improved the banks' ability to cope with the crisis, additional measures may now be required to enhance mechanisms for early resolution and intervention, and strengthen supervisory and enforcement capacity and prudential regulations. Further reforms in public  - 8 - sector's large domestic financing requirement, thereby easing current pressures on interest rates; and (iii) to help rebuild foreign reserves in the current uncertain environment for private capital flows. 24. Undertaking an assessment of the social impact of the economic crisis aimed at identifying quick response interventions to protect vulnerable groups, including preservation or increase in public service delivery, and developing a program to address the longer-term impact of the crisis. A mission to carry out the first step in this work has just completed the field work. Increasing our policy dialogue with the authorities and intensifying our monitoring of the economic, financial and poverty situation in the country. This has become possible with our decentralization and strengthening of the field office. 25. Expanding our regular lending program in response to the government's request to include lines of credit for agriculture and industry for about US$150 million, in light of the constrained availability of term credit to the private sector. These operations would be contingent on strong progress in implementing financial sector reforns and are envisaged as a transitional measure, as the domestic medium- and long-term market develops, and as external confidence is restored. This would be in addition to operations already being processed to support public investment in the social sectors, infrastructure development, environmental protection, and rural development, and amounting to about US$0.5 billion in FY98-99. Many of these have a strong focus on poverty alleviation and promotion of geographic equity through diversification in rural economic activities, improved access and quality of basic education and health care, and particular development efforts in Mindanao which were not yet foreseen at the time of the last CAS. At least half of them also have an emphasis on environmental protection. 26. We are in the process of evaluating the impact of the crisis on the portfolio of ongoing projects with a view towards restructuring our portfolio where needed, covering inter alia potential increases in Bank disbursement percentage where sufficient counterpart funding cannot be provided. During a CPPR planned for later this fiscal year, we expect to agree with govemment on such changes. 27. OED. This assistance strategy already goes a long way in incorporating the recommendations of OED's CAR to be presented to CODE in March. In particular, the resumption of adjustment lending and the proposed lines of credit follow OED's recommendations closely. Moreover, targeting of the rural poor, as suggested by OED, has already become part of our strategy, with new and planned operations for Mindanao. The resident mission has also over the past year made considerable efforts to involve NGOs and the Philippine civil society to a larger extent in the Bank's work. Other recommendations will be taken into consideration as we prepare sector assistance strategy notes as a building block for next year's full CAS. expenditure management have also become more urgent, as well as in the power sector, given the fragility of its finances and significant share of the government's foreign debt.  - 9 - G. Lending Volumes, Triggers and Bank Exposure 28. The last CAS outlined a base case lending volume of an average $500 million p.a. Actual lending was less, due to lower governnent demand. It also provided for a low case scenario: in case of a deterioration of the economic situation primarily generated by external shocks and as long as an adequate policy response was forthcoming, Bank lending could increase temporarily to support the requirements of accelerated adjustment. It also stated that in such a situation, fast disbursing lending from the Bank may be necessary, contingent on an IMF program being in place. 29. This Progress Report sets out an assistance program in line witlh this alternative low case scenario. In this scenario, lending of about US$1,250 million is proposed for FY98-99 (including about US$500 mnillion in quick disbursing loans), compared with the approved base case of US$1 billion, before returning to about US$400 million in FY00. Lending beyond FY99 would be subject to discussion with the new administration in Fall of 1998 and reviewed in the next full CAS planned for Spring of 1999. The triggers for the increased FY98-99 lending level would be that government (i) agrees with the IMF on a new stand-by program; and (ii) agrees with the Bank on a comprehensive package of structural reforms within the financial and public sectors and carries out strong up front actions. The package would likely include measures to strengthen the prudential framework within the financial sector, and agreements with the Bank on the nature of fiscal adjustments in response to the crisis. 30. If these agreements cannot be reached, but the macro policy framework remains acceptable to us, we propose to proceed with all adjustments to our program described above, except for the adjustment lending. The lending volume for FY98-99 would then be at about US$750 million -- still below the base case levels approved in the last CAS. However, if the economic situation deteriorates further due to policy lapses and insufficient policy adjustment by the government, with no IMF framework in place, an alternative low case scenario was also provided for in the last CAS, whereby Bank lending would be limited to about US$200 million per year and focused primarily on human resource development, poverty alleviation, and basic infrastructure- 31. The attached tables are based on the scenario with adjustment lending, which we consider the most likely at this time. Even in this high lending scenario, the IBRD exposure indicators are within the guidelines (Annex B7). With this temporary increase, net disbursements by the Bank would tum positive during FY98/99 after which they would again become negative. H.. Use of New Bank Instruments 32. Within the proposed lending range, we are considering the use of two new Bank instruments which have become available since the last CAS. First, we are exploring the possibility for Learning and Innovation Loans (LIL), (i) in the transport sector to address traffic management problems in Metro Manila; and (ii) to support a partnership between the business community, government, and international institutions to promote out of school youth development. Other LILs might also be developed but they are expected to represent a small share of the total lending volume, with a maximum of I or 2 LILs per year. Second, we are considering Adaptable Program Loans (APL) for urban, water and sewerage, highway and rural  - lo0- infrastructure projects. We are also open to the use of guarantees, if requested, to help ease liquidity constraints. L Risks and Opportunities 33. Macroeconomic Risk: A prolonged financial crisis in East Asia andlor market perceptions of an adverse shift in economic policy by the incoming Philippine government may cause further loss of investor confidence. If the external financing environment were to deteriorate, growth prospects would weaken further with adverse consequences on unemployment and poverty. Interest rates would likely have to increase, further pressuring the corporate and banking sectors. While we recognize the limits to the Bank's capacity to contain crises of the magnitude currently experienced in East Asia, our expanded policy advice, increase in technical assistance, and planned US$500 million in adjustment lending together with a 2- year standby arrangement with the IMF in the amount of SDR 1,266.8 million (about US$1.7 billion) aim at mitigating this risk. 34. Political and Social Risks: (i) Adjustment lending in a period of political transition involves higher than usual risks of uncertain commitment from both the outgoing and incoming administrations. Tempering this risk is the opportunity to assist the authorities contain the crisis through provisions of timely assistance and the impressive record of the current administration in implementing reforms. Moreover, leading presidential candidates have publicly pledged to continue the further liberalization of the economy. Another indication of broad based support for the liberalization policies is the fact that during recent years, economic reforms were approved by a Senate controlled by the "opposition". Nevertheless, there remains a probability that the incoming administration may not fully commit itself to carry out the reform program. We and the IMF aim to contain the remaining risks through a number of safeguards including agreement on strong programs that bind the current and the new administration and provide framework for continuity of policies; willingness modify/suspend the programs if the conditions/commitment turns for the worse; and tranching of an adjustment operation if it is presented before the new administration has taken office. (ii) Peace in Mindanao may not be sustained. If this happens, we will scale back our planned activities in the affected areas. (iii) If vulnerable groups of society are not adequately protected from the effects of the economic crisis, social unrest could ensue with negative consequences for economic recovery and investor confidence. To address this risk, we plan to agree on social protection measures up front and monitor the developments regularly. Even with these safeguards and Bank programs in place, the remaining social and political risks are significant. 35. Risk of severe weather conditions: El Niho has manifested in the Philippines by severe drought in some areas which is affecting agricultural production leading to further reduction in growth and increased poverty, as well as deteriorating environmental conditions. The authorities have taken several measures to address the effects. We are monitoring the situation and preparing a rural development project in Mindanao to help with recovery. 36. Opportunities: On the positive side, the exchange rate depreciation may lead to a broadened development base making labor intensive industries more competitive internationally. It could also create the breathing space to press ahead with trade liberalization in new industries and services as discussed under WTO and APEC. Moreover, developments in Mindanao provide  - Il - new possibilities to create the basis for future growth and reduction of poverty in one of the poorest parts of the country. 37. Risks for Implementation of Bank Projects: In addition to the risks to rapid economic recovery described above, we see two specific risks for the implementation of the Bank's portfolio: (i) lack of counterpartfunds: as a result of the crisis, Bank investment projects may be affected more severely than in the past by lack of counterpart funds; the upcoming CPPR will focus on this issue and potential remedies; and (ii) risks related to decentralization: the government's decentralization of financial resources to Local Govermnent Units (LGUs) raises significant issues with regard to their often weak implementation capacity. Many of our planned projects focus on LGUs and have built-in programs to strengthen their capacity. Close work with local partners and fostering greater participation in project preparation will mitigate these risks, and the Bank's capacity in the resident mission has been strengthened in this regard. However, decentralized projects may also be affected by the crisis, since real revenues transferred to LGUs by the central govermnent may decline. J. IFC and MIGA 38. IFC's assistance to the Philippines has been focused on capital markets, privatization, infrastructure, and general manufacturing. In response to the crisis, IFC is in addition to close monitoring of its portfolio, actively developing specific transactions in the financial and corporate sectors, dovetailing the IBRD's and ADB's actions. In the financial sector, it expects to provide assistance both to banks and other financial intermediaries (including a venture capital fund, municipal bond guarantee vehicle, new credit rating agency, and a micro finance institution for Mindanao) and work with IBRD and ADB on technical assistance in the areas of securitization legislation and the development of a local currency bond market. In the corporate sector, IFC is considering equity investments and debt financing to address liquidity needs, help restructure companies, and to foster development in the Southem Philippines. 39. MIGA has to date issued two contracts of guarantees in the Philippines, which joined MIGA in 1994, for a maximum outstanding liability of US$60 million in the banking and power sectors. Over 20 preliminary applications for guarantees in the oil and gas, mining and power sectors are currently outstanding. MIGA has carried out promotional and marketing activities with banks and prospective clients in 1997. K Relationship with Government and Cooperation with External Partners 40. The Bank's relationship with the Philippines government remains close and constructive. Formal consultations take place through annual CPPRs and Programming missions, and through local consultations and aid coordination. The Bank decentralized the management authority for its Philippines program to the field in July 1997. This is expected to further strengthen our relationship with the Borrower and other stakeholders. 41. Work on closer partnerships with NGOs, the private sector and research/academic groups is being intensified. Noteworthy developments since the last CAS include an MOU between the Business Partnership Center of the Bank Group and the Philippines Chamber of Commerce calling for the Bank to provide information and training, a strong PIC and a multimedia  - 12- information kiosk in the field office, and quarterly newsletters on the Bank's activities, all possible with a strengthened field office. 42. The Bank's leadership on matters of aid coordination with ODA partners through the CG process is well established and the Philippines CG members expect to see a continuation of that role, in particular in the areas of macroeconomics, poverty alleviation and the development of Mindanao. In addition to a successful regular CG in December 1997, a "mini CG" was held for Mindanao in 1997. James D. Wolfensohn President by Sven Sandstrom Annexes Annex Al: Key Economic and Program Indicators: Change from Last CAS Annex A2: Philippines at a Glance Annex B2: Selected Indicators of Bank Portfolio Performance and Management Annex B3: Bank Group Program Summary FY98-00 Annex B6: Key Economic Indicators Annex B7: Key Exposure Indicators Annex B8: Status of Bank Group Operations and Statement of IFC's Committed and Disbursed Portfolio  Annex At Page loft Key Economic & Program Indicators - Change from Last CAS Forecast in Last CAS Actual Current CAS Forecast Economy (C') 1994 a 1995 b 1996 b 1997 b 1995 c 1996 c 1997 a 1998 b 1999 b 2000 b Growth rates (%) GDP 4.3 5.0 5.5 5.5 4.8 5.7 5.1 2.8 3.8 4.8 Exports (FOB)e 18.5 28.6 14.3 17.0 29.4 17.7 22.0 16.4 15.6 14.9 Imports (FOB)e 21.2 21.9 11.5 12.8 23.7 20.8 13.8 4.7 12.2 13.0 Inflation (%) (CPI) 9.1 9.0 12.3 6.7 8.1 8.4 5.1 7.8 6.5 6.0 National accounts (% GDP) Current account balance -3.2 -3.4 -4.0 -4.4 -4.3 -4.7 -4.5 -4.1 -3.2 -2.9 Gross investment 25.3 25.4 27.1 27.7 27.2 24.7 24.5 23.6 24.1 24.5 Public finance (% GDP) Fiscal balance -0.3 -0.1 0.0 0.0 0.6 0.3 -0.1 -0.4 0.4 0.5 International reserves 3.1 3.1 3.1 3.4 2.6 3.1 2.0 2.0 2.1 2.2 (as months of imports) Program (Bank's FY) FY96 a FY97 b FY98 b FY99 b FY96 c FY97 c FY98 a FY99 b FY00 b FYOI b Lending ($ million) 515 366 500 520 457.0 281.4 395.8 860.0 400.0 d 400.0 d Gross disbursements 307 340 380 428 376.9 313.2 432.0 635.0 505.0 400.0 ($ million) a. Estimated year b. Projected year c. Actual outcome d. Details to be discussed with new administration in July 1998 e. Dollar value   Annex A2 Page 1 of 2 Philippines at a glance 231 Lower- POVERTY and SOCIAL East middle- Philippines Asia income Development diamond' Poputaton mid-1996 (nwtions) 70.0 1.726 1.125 GNP per capita 199 (USS) 1.190 890 1,750 Life epaeancy GNP 1996 (bilons USS) 83.3 1,542 1,967 Avwage annual growth, i990-6 Populaton (%) 2.2 1.3 1.4 GNP/ Gross Labor force (%) 2.7 1.3 1.8 per // -I primary Most mcent estimte (laest year available since 1989) Capita N / enrollment Poverty: headcount index (% of populationJ 54 Urban population (% of total population) 54 31 56 Life expectancy at birth (years) 66 68 67 Infant mortality (per 1,000 live births) 39 40 41 Access to safe water Child malnutrition (% of children under 5) 30 Access to safe water (% of popultion) 84 77 lFircy (% of populafion ege 15+) 5 17 .. Grss pimary enrollment (% of school-age populaton) 111 117 104 hippnes Maw .. 120 105 - Lower-middl-income group Female .. 116 101 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1976 1986 1996 1996 , Economic ratios GDP (bllions USS) 15.0 30.7 74.2 83.8 Gross domestic investmenrtGDP 30.9 15.3 22.2 24.7 Openness of econorny Exports of goods and services/GDP 21.0 24.0 36.4 43.6 Gross domestic savinss/GDP 24.8 17.4 Gross national savings/GDP 26.6 15.9 17.8 20.0 Cuffent account balance/GDP -6.2 -0 1 -4.4 -4.7 . tnterest payments/GDP 0.8 3.1 2.6 Savings Investment Total debt/GDP 27.8 86.6 53.2 49.2 Toa debt servicelexports 14.4 31.6 16.5 14.7 Present value of debt/GDP .. Present value of deb/exports Indebtedness 197645 1986-96 1995 1996 1997-05 (avage annalgrowth) Philppines GOP 3.0 3.2 4.8 5.5 -.5 GNP per capita 0.3 1.5 2.5 4.4 35 - Lower-middlekrncome group Exports of goods and services 7.6 8.7 12.0 23.9 10.5 STRUCTURE of the ECONOMY 1975 19S5 1995 1996 (# of GOP) Growth rates of output and investment (1%) Agriculture 30.3 24.6 21.6 21.4 20 1 Industry 34.6 35.1 32.1 31.7 10 Manufacturing 25.7 25.2 23.0 22.6 Services 35.0 40.4 46.3 46.9 93 94 95 9e .10 9 2 9 Private consumption 64.5 75.0 74.2 73.9 -20 General government consumption 10.7 7.6 11.4 11.7 - GDI --*-GDP lmportsofgoodsandservices 27.1 21.9 44.2 53.9 197545 1986-96 1996 1996 (average aual growth) Growth rates of exports and imports (I% Agriclture 2.2 1.7 0.8 3.0 2S Industry 2.6 3.3 7.0 6.3 20 ) Manufacturin 1.8 3.2 6.8 5.6 Services 3.8 3.8 5.0 6.5 10 Prite consmption 3.3 4.1 8.5 5.3 s General government consumption 0.4 4.6 5.4 5.2 0 Gross domestic investment -0.4 6.9 3.0 15.6 -t 92 93 14 95 ff Imports of goods and services 3.9 12.3 16.0 21.1 Exports 0- knports Gross national product 2.7 3.8 5.0 6.9 Note: 1996 data are preliminary estimates. - The diamonds show four key indicators in the country (in bold) crompared with its income-group average. If data are missing, the diamond will be ircomplete.  Annex A2 Page 2 of 2 Philippines PRICES and GOVERNMENT FINANCE 1975 1985 1995 1996 Inflation (%) Oome6 pricz (% change) 20 Consumerprces 6.8 23.1 8.1 8.4 15. Imngicit GDP deflator 9.3 17.6 7.5 8.9 10s Gove,n m~n finaw c , Nec of GOP) %I 92 91 94 95 is Current revenue .. 12.1 18.5 19.5 Current tudget balance .. 2.4 2.5 3.1 - GDP def. -C--CPI Overall surplus/deficit .. .. -1.4 -0.4 TRADE 1975 1985 1996 1996 Export and import levels (mil. USS) (milbtons US$) Total exports (fob) .. 4,629 17,447 20.543 35.000 Coconut ad .. 347 826 571 300.0o O Sugar .. 185 74 139 25.000 7 n Manufactures .. 2,539 13,868 17.106 20.000 W ' Total inports (c) .. 5,111 26,391 31,885 ts,ooo 0wl r I Food .. 256 1,204 1.578 1 u.iI-IIr-U EiI Fuel and eneW 1,452 2.461 3,008 5 jJ3jJJjj3J,,jj,,3, Capi goods .. 769 8,029 10.472 o Exportpnceindex(1987=100) .. 81 124 124 so 81 22 92 94 95 96 Import price ndex (1967=100) .. 63 124 126 oExports knports Terms of trade (1987=100) .. 127 100 99 BALANCE of PAYMETS 1975 1985 1995 1996 ({rmilons USS) Current account balance to GOP ratio (%) ExportsofgoodsandserMnces 3,000 6,864 21,978 28.566 o..- Imports of goods and services 4,116 5,961 33,314 42,254 l 90 92 | 3 94 ff 9| Resource balance -1.116 903 -11,336 -13,688 L Net jncorm -126 -1,317 7.157 9.185 -2. Net current transfers 318 379 882 589 3 Current account blance, | - before official capital transfers -923 -35 -3,297 -3.914 - Financing items (net) 912 867 3,928 8,021 Changes in nt renserv 11 -832 -631 -4,107 . Aihmo:I_- Reserves iWduding gold (miF. USS) 1,458 1,098 7,762 11,745 Conversion rtae (b1akVS$) 7.2 18.6 25.7 26.2 EXTERNAL DEBT and RESOURCE FLOWS 1975 1985 1995 1996 (milfons USS) Composition of total debt, 1996 (mill. US$) Totaldebtoutstandingsnddisbursed 4,171 26,639 39,445 41,214 A ISRD 238 2,421 5,002 4.666 AG 4666 IDA 17 84 183 193 7969 193 Total debt seewv 457 2,534 5,337 5,778 405 IBRD 26 285 790 766 | 0 IDA 0 1 3 30 7 9 | Compoition or net esource flows 3079 Official grants 72 139 276 .. Official creditors 185 381 -648 ..20E Private credito 348 776 1,166 F | ' 12085 Foreign drect investment 98 12 1,478 1,600 12817 Poitfo equity 0 0 1,961 1,333 World Bank program Commitments 114 104 168 528 A - IBRD E - Blateral Disbursement 94 276 402 457 8 - IDA D - Other nmoilateral F - Privat | Principal repaymenb 12 110 415 426 C - IMF G -ShoItstm Netiows 82 166 -13 31 - , _ Interest paymients 14 176 378 343 Net transfers 68 -10 -391 -312 Development Ewonomics 2/23/98  Annex B2 Page 1 of 1 Philippines - Selected Indicators of Bank Portfolio Performance and Management Indicator FY1995 1996 1997 1998 t Portfolio Assessment Number of Projects under implementationa 29 30 28 269 Average implementation period (years)b 3.86 4.43 4.11 4.24 Percent of problem projectsa, c by number 13.79 3.33 10.71 15.38 by amount 13.19 3.73 16.25 15.08 Percent of projects at riska, d by number 29.63 3.33 16.00 17.39 by amount 30.49 3.73 28.00 16.20 Disbursement ratio (o/%)e 17.27 24.76 21.18 14.54 Portfolio Management CPPR during the year (yes/no) No Yes Yes Planned Supervision resources (total US$ thousands) 1,678.74 1,442.23 1,533.18 803.16 Average Supervision (US$/project) 57.89 48.07 54.76 32.13 Memorandum item Since FY80 Last five FYs Projects evaluated by OED by number 97 24 by amount (US$ millions) 5,014.4 1,778.5 Percent rated U or HU by number 25 4 by amount (US$ millions) 1,214.2 87.2 a. As shown in the Annual Report on Portfolio Performance (except for current FY) b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: investment projects only. f. As of mid-FY98. g. Excludes I MP and 2 GEF projects.   Annex B3 Page 1 of I Philippines - Bank Group Program Summary, FY 1998-2000 Proposed IBRD/IDA Base-Case Lending Program, FY 1998-2000' Strategic rewardsb Implementationb- FY Project US$(M) (HIMIL) risks (HIMIL) 1998 WATER DISTRICT DEV. 56.8 H H SZOPAD SOCIAL FUND 10.0 H M COMMUNITY BASED RES. MGMT. 50.0 H M EARLY CHILDHOOD DEV. 19.0 H M (S) ADJUSTMENT LENDING 250.0 H H LEARNING AND INNOVATION LOANS (LIL) c 10.0 H M Subtotal 395.8 1999 H'WAY MANAGEMENT II d 150.0 H M LGU FINANCE AND DEV d 100.0 H M LGU URB&WATER SANITA d 60.0 M M SOLID WASTE MNGMNT d 100.0 H H TEACHER DEVELOPMENT 50.0 M L ADJUSTMENT LENDING 250.0 H H (S) DEVELOPMENT FINANCE PROJECT e 150.0 H H Subtotal 860.0 2000 CALABARZON URB DEV&E 60.0 H H MANILA URB TRANSPORT 100.0 H M MINDANAO INT RUR INF d 50.0 H M Subtotalf 210.0 Total, FY 1998-2000 1,465.8 a. This table presents the proposed program for the next three fiscal years. b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate (M), or low (L). c. Currently under active consideration are LILs for (i) Metro Manila Transport and (ii) Youth Development. d. These operations are being considered for APLs; amounts may be reduced for the FY shown if we proceed with APLs. e. Lines of credit for agriculture and industry under consideration to help address the effects of the financial crisis on businesses. f. Pipeline projects will be discussed with the new administration in July 1998.   Annex B6 Page 1 of 3 Philippines - Key Economic Indicators Actual Estimate Projectedf Indicator 1992 1993 1994 1995 1996 1997 1998 1999 National accounts (as % GDP at current market prices) Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 21.8 21.6 22.0 21.6 21.4 20.9 20.4 20.0 Industry 32.8 32.7 32.5 32.1 31.7 31.9 32.2 32.4 Services 45.3 45.7 45.5 46.3 46.9 47.2 47.4 47.6 Total Consumption 85.1 86.2 85.1 85.4 84.4 84.1 85.2 83.8 Gross domestic fixed 20.9 23.8 23.6 22.2 23.2 24.5 23.6 24.1 investment' Government investment 4.9 5.8 4.9 4.8 4.7 5.0 4.6 5.4 Private investment 16.5 18.2 19.1 17.5 20.0 19.5 19.0 18.8 (includes increase in stocks) Exports (GNFSt 29.1 31.4 33.8 36.4 42.0 51.4 74.7 76.8 Imports (GNFS) 34.0 39.8 40.1 44.2 51.7 60.0 83.5 84.8 Gross domestic savings 14.9 13.8 14.9 14.6 15.6 15.9 14.8 16.2 Gross nationalsavings 19.7 18.4 19.5 17.8 20.0 20.0 19.5 21.0 Memorandum items Gross domestic product 52,977 54,368 64,085 74,136 83,788 82,779 63,224 68,670 (USS million at current prices) Gross national product per 800 830 910 1,020 1,160 1,230 1,100 1,020 capita (USS, Atlas method) Real annual growth rates (0/0, calculated from 1985 prices) Gross domestic product at 0.3% 2.1% 4.4% 4.8% 5.7% 5.1% 2.8% 3.8% market prices Real annual per capita growth rates (0%, calculated from 1985 prices) Gross domestic product at -1.8% 0.0% 2.2% 2.4% 3.5% 2.9% 0.7/o 1.8%/ market prices Total consumption -0.1% 1.3% 0.1% 5.8% 3.1% 2.6% 0.8% 1.8% Private consumption 0.2% 1.0% -0.3% 6.1% 3.1% 2.8% 0.9,% 2.00/ (Continued)  Annex B6 Page 2 of 3 Philippines - Key Economic Indicators (Continued) Actual Estimate Projected' Indicator 1992 1993 1994 1995 1996 1997 1998 1999 Balance of Payments (USSm) Exports (GNFS)b 13,303 14,368 17,436 21,978 28,566 36,147 40,766 45,855 Merchandise FOB 9,824 11,375 13,483 17,447 20,543 25,061 29,180 33,741 Imports (GNFS)b 16,827 20,687 25,987 33,314 42,254 49,654 52,823 58,220 Merchandise FOB 14,519 17,597 21,333 26,391 31,885 36,290 37,992 42,621 Resource balance (3,524) (6,319) (8,551) (11,336) (13,688) (13,507) (12,057) (12,365) Net current transfers 817 699 936 882 589 602 675 716 (including official current transfers) Current account balance (858) (3,016) (2,950) (3,297) (3,914) (3,742) (2,579) (2,187) (after official capital grants) Netprivate foreign direct 737 864 1,289 1,361 1,338 1,195 1,178 1,308 investment Long-term loans (net) 633 2,455 1,313 1,276 2,690 3,706 2,317 1,989 Official 2,020 1,521 569 (149) 132 Private (1,387) 934 744 1,425 2,558 Other capital (net, including 980 (469) 2,150 1,291 3,993 (4,533) (365) 244 errors and omissions) Change in rcscrves' (1,492) 166 (1,802) (631) (4,107) 3,374 (551) (1,354) Memorandum items Resource balance (% of -6.7% -11.6% -13.3% -15.3% -16.3% -16.3% -19.1% 1 8.00/o GDP at current market prices) Real annual growth rates (1985 prices) Merchandise exports .. 7.9% 15.2% 16.2% 9.3% (FOB) Merchandise imports .. 10.8% 14.9% 15.9% 16.6% (CIF) Public finance (as % of GDP at current sarket prices) Current revenues 18.0 17.7 19.9 18.9 18.7 18.8 19.0 19.3 Cufrent expenditres 15.9 15.4 15.8 14.5 15.0 15.0 15.2 15.3 (Continued)  Annex B6 Page3of3 Philippines - Key Economic Indicators (Continued) Actual Estimate Projected' Indicator 1,992 1.993 1,994 1,995 1,996 1,997 1,998 1,999 Current account surplus (+) 2.1 2.3 4.0 4.4 3.7 3.8 3.8 4.0 or deficit (-) Capital expenditure and net lending 3.2 3.8 3.1 3.8 3.4 3.9 3.4 3.6 Foreign financing 1.1 0.9 (0.7) (0.7) (0.3) (0.3) (0.6) (0.8) Monetary indicators M2/GDP (at currentmarket 28.5 32.6 35.9 39.9 40.1 prices) Growth of M2 (%/6) 11.0 24.6 26.5 25.3 15.8 Private sector credit growth / 8.2 0.3 1.4 1.4 1.3 total credit growth (%) Price indices (1985 =100) Merchandise export price 157.6 177.8 178.1 193.1 211.6 index Merchandise import price 149.9 172.5 173.9 185.5 196.9 index Merchandise terms of trade 105.1 103.1 102.4 104.1 107.4 index Realexchangerate 72.3 92.5 111.5 113.5 112.4 (US$/LCU)' Real interest rates 7.1% 4.8% 3.7% 3.7% 3.9