Philippines - Reform Program For Government Corporations

Document of The World Bank FOR OFFICIAL USE ONLY LA,AJ O259J4&A Report No. P-4469-PH REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$200 MILLION TO THE REPUBLIC OF THE PHILIPPINES FOR A REFORM PROGRAM FOR GOVERNMENT CORPORATIONS May 20, 1988 This document has a restricted distribution a2id may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authoriz2tion.  CURRENCY EOUIVALENTS (as of April 1, 19B8) Currency Unit - Peso (P) US$1.00 - P 20.80 P 100 - US$4.80 Government Fiscal Year January 1 - December 31 PRINCIPAL ABBREVIATIONS AND ACRONYMS USED ADB - Asian Development Bank AO - Administrative Order APT - Asset Privatization Trust CAG - Corporate Affairs Group CB - Central Bank of the Philippines COA - Commission on Audit coP - Committee on Privatization CORPLAN - Corporate Planning Model CSC - Civil Service Commission DBCC - Development Budget Coordination Committee DBM - Office of Budget and Management DBP - Development Bank of the Philippines DE - Disposition Entity (for privatization) DOF - Department of Finance EO - Executive Order ERL - Economic Recovery Loan GC - Government Corporation GCMCC - Government Corporate Monitoring and Coordinating Committee GDP - Cross Domestic Product GFI - Government Financial Institution GNP - Gross National Product ICC - Investment Coordination Committee IMF - International Monetary Fund MWSS - Metropolitan Waterworks and Sewerage System NDC - National Development Company NEDA - National Economic and Development Authority NFGC - Non-Financial Government Corporation NHA - National Housing Authority NIA - National Irrigation Administration NPA - Non-Performing Account NPC - National Power Corporation PCGR - Presidential Commission on Government Reorganization PES - Performance Evaluation System PNB - Philippine National Bank PNOC - Philippine National Oil Company PPA - Philippine Ports Authority  FOR OFFICIAL USE ON1LY THE PHILIPPINES REFORM PROGRAM FOR GOVERNMENT CORrORATIONS Loan and Prolect Summary Borrower: Republic of the Philippines Amount: US$200 million equivalent Terms: 20 years, including 5 years grace, at the standard variable interest rate. Program Descrigtion: The proposed reform program constitutes the foundation stage for phased structural adjustment of the public corporato sector in the Philippines. It focuses on the Non- Financial Government Corporations (NFGCs), while the rehabilitation of the Government Financial Institutions (CFIs) is being addressed through a parallel operation, namely the Economic Recovery Loan (ERL) approved by the Board on March 17, 1987. The proposed program, already ongoing, establishes a policy and institutional framework to reduce, limit and rationalize government activities using the corporate form, and institutes improvements in the efficiency and effectiveniess of retained NFGCs and GFIs (collectively referred to as Government Corporations or GCs) in order to gradually reduce the heavy burden they impose on the economy. Its key elements are: (a) establishment of a policy framework which enunciates ground rules for the establishment and operation of 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 monitoring 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 15 of the largest NFGCs. Benefits: In the short term, the project would lead to reduction of Government grants and contributions as a result of reduced Government involvement in the corporate sector. In the longer term, the policy and institutional changes affecting the operations of retained GCs, combined with the implementation of corporate planning and performance evaluation systems will result in improved investment allocation, greater efficiency and 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.  - ii - effectiveness of operation, enhancement of the level of services and improved cost recovery. Public share issues resulting from the privatization of some GCs will also contribute to the development of the domestic capital markets. Risks: The proposed reform program introduces significant changes in the composition, organization, coordination, financing and management of GCs. Such changes are likely to be met with resistance from groups and individuals benefiting from the .status quo. The privatization and reorganization of GCs would affect the labor force, thus initially creating adverse reactions. Such internal pressures could slow implementation and/or reduce the effectiveness of some parts of the program. To addro';s these problems, and mitigate their possible adverse impact, the Government is educating the public on the need for the reforms, is planning for a phased implementation, and has introduced other compensatory measures such as early retirement packages and special severance payments. Although the main legal framework for the sector is already in place, some legislative action is still required, the approval of which may delay setting in place the completed framework envisioned by the Government. The above mentioned risks are also mitigated by the country consensus on the need to reform the government corporate sector, and the fact that some of the most difficult steps (the approval of the main legal framework, the establishment and staffing of the required mechanisms, the required studies and rationalization, the decisions on the disposition of the government corporations, etc.) have been achieved before Board presentation. Estimated Disbursements: The proposed loan is expected to be disbursed over a period of two and a half years. Given the measures already taken by the Government, the first tranche of $75 million equivalent would be available for disbursement after loan effectiveness; the second tranche ($75 million equivalent) and third tranche ($50 million equi%-alent) would be released after the timely completion of agreed actions described in the Development Policy Letter and the Action Plan and set odt in the draft Loan Agreements. Disbursements against the program would be as follows: --- Bank Fiscal Years --- 1989 1990 1991 --- US$ million ----- Annual 75.0 75.0 50.0 Cumulative 75.0 150.0 200.0 Rate of Return: Not applicable. Appraisal Report: This is a combined President's and Staff Appraisal Report Map: IBRD 20181  -PHIL.IPPINES REFORM PROGRAM FOR GOVERNMENT CORPORATIONS Table of Contents PAge No- Loan and Proiect Summary . .................................. PART I - THE ECONOMY ....................................... Background ............................................ Stabilization and Adjustment, 1983-1986 .... ........... 3 Medium-Term Prospects ................................. 6 PART II - THE PUBLIC CORPORATE SECTOR ..................... 8 Evolution and Growth of the Sector .... ............ 8 Supervisory Institutions for Covernment Corporations ........................................ 9 Sectoral. Issues and Constrainits ....................... 10 Background of the Reform Program'for Government Corporations ........................................ 11 Actions Taken to Date ................................. 11 Rationale for Bank Involvement ........................ 13 PART III - THE PROPOSED OPERATION ......................... 14 Program Objectives and Components ..................... 14 Legal Framework and Policy Statement .................... 15 Institutional Framework ................................ 16 - Corporate Rationalization Program ..................... 16 Retained Corporations: Institution Building and Improvements ........................................ 23 Institutional Framework for Departmental and Interdepartmental Supervision ....................... 23 Measures to Improve Performance of the Retained GCs ... 25 Improvements in the Organization, Management and Financial Structure of GCs ........................ 26 Corporate Planning . ................................ 26 Performance Monitoring and Evaluation .... ......... 27 Incentive Mechanisms ........ ....................... 28 Accounting and Auditing Improvements .. ............ 28 Differential Treatment ............................ 29 Technical Assistance Program .......................... 30 This report is based on the findings of an appraisal mission which visited the Philippines during January 13 to 30, 1987. The Mission team consisted of Messrs. D. Ahmad, C. Fernandez, V. Busjeet, I. Knapp, D. Flannery, N. Gopal and H. Keefe, and a post-appraisal missior. in February 1988 consisting of C. Fernandez, M. Gopal and L. M. Hannah. Ms. Patricia Brereton participated in editing the report.  -ii - ' Pagre No. Loan Administration .31 Proposed Loan ....................... 31 Project Implementation. ..................... 31 Disbursements .31 Tranche Release Conditions .31 Procurement .33 Audits and Accounts .33 Social Impact, Benefits and Risks .34 PART IV - WORLD BANK OPERATIONS .35 PART V - RECOMMENDATION .38 ANNEXES Annex 1 - Economic Indicators ............................ 39 Annex 2 - Status of Bank Group Operations in the Philippines .42 Annex 3 - Supplementary Project Data Sheet .44 Annex 4 - Letter of Development Policy .... .............. 47 Annex 5 - Initial 15 Government Corporations for program Implementation ............ ................. 52 Annex 6 - Matrix of Policy and Institutional Changes 53 Annex 7 Action Plan .55 Annex 8 - Implementation Responsibilities ........... 58 Annex 9 - Disposition Reco mendations for GCs .59 Annex 10 - Philippine Equity Markets ..... ................ 68 Annex 11 - CORPLAN Model. Output Sample .69 Annex 12 - Technical Assistance Program .76 Annex 13 - Selected Documents in the Project File 80 MAP IBRD No. 20181  REPORT AND RECOMNENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A PROGRAM OF REFORM OF GOVERNMENT CORPORATIONS 1.01 I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for a total of US$200 million equivalent to support a Program of Reform of Government Corporations. The loan would be repaid over 20 years, including five years of grace, at the standard variable interest rate. PAR.T I - THE ECONOMY Background 1.02 In recent years, the Philippine economy has been buffeted by events, both domestic and external, which have led to an abrupt decline in economic growth and a severe reduction in living standards for the majority of the population. The restoration of growth and deve .opment and the need to reduce poverty are priorities which the Government is attempting to address, and for which it is seeking assistance from the Bank. 1.03 Recent Bank economic reports have detailed the causes of the crisis and the needs for policy reform (see aPhilippines: A Framework for Economic Recovery" (Report No. 6530-PH, November 5, 1986) and "Philippines: An Agenda for Adjustment and Growth (Report No. 5258- PH, November 30, 1984)). In brief, these reports indicate that while growth was rapid during the 1970s, the economy suffered from a number of distortions in agricultural pricing, exchange rates, credit allocation, and industrial protection which resulted in a pattern of growth that could not be sustained. Thus, by 1980, the gains available from new seed technologies and expanded irrigation in agriculture were exhausted, as was the scope for expanded industrial output based on import substitution. In addition, the external terms of trade began to deteriorate, both because of higher energy prices and lower prices for major Philippine exports. The growing world recession also limited the growth of manufactured exports, which in the previous decade had expanded at a rate of 25% per annum. Despite the worsening balance-of-payments situation, the exchange rate was allowed to appreciate (1979-83), further reducing the competitiveness of manufactured exports and limiting their growth. 1.04 In response to the worsening economic situation, the Government embarked on an expanded investment program in order both to reduce energy dependence and to provide a countercyclical stimulus. As a result, public investment rose from about 6% of GNP in 1979 to about 9% by 1982 (see Table 1.1); over half of this was undertaken by public corporations. The expanded investment program produced some major benefits, such as substantially increasing the. share of domestic energy in total supply (from 21% to 45%, 1979-85). In other areas, however, the program was not well conceived and produced projects which either had very low returns or extremely long gestation periods.  -2- In the private sector as well, many investments were overpriced, poorly designed, or resulted in excess capacity or firms that could not compete in world markets. The viability of even sound projects, furthermore, was undermined by the deterioration in domestic and external conditions, including such diverse factors as declining copper and sugar prices, a drop in tourism, and excess cupacity in the world shipping industry. Many of these private sector projects, however, were financed with 3oans and guarantees from Government Financial Institutions (GFls). Project failures led to growing losses for these institutions, which eventually had to be covered (1984-86) by subsidies from the national budget. TabLe 1.1: SELECIED MACROECOMIC INDICATORS, 1975-1987 1975-79 1980 1981 1982 1983 1984 1985 1986 1987 Growth Rates (X) Real GNP 6.4 5.0 2.3 1.9 1.2 -7.2 -4.2 1.5 5.1 AgricuLture 5.1 4.9 3.8 3.3 -2.0 2.0 3.5 3.7 0.7 Industry 8.3 4.7 4.5 2.0 0.8 -10.3 -10.2 -2.7 7.9 Inflation (average) 9.9 18.2 13.1 10.2 10.0 50.3 23.1 0.8 3.8 % of GNP TotaL: Investment 30.0 30.7 30.7 2B.8 27.1 17.4 14.4 13.4 15.6 saving 24.0 25.3 25.3 20.7 19.0 13.5 14.3 16.8 14.1 Gap 6.0 5.4 5.4 8.1 8.1 3.9 0.1 -3.4 1.5 Pubtic Sector tX of CUP) Investment 6.3La 7.9 8.7 7.2 7.3 4.5 3.5 3.2 3.3 CPublic Corp.) (3.3) (4.5) (4.2) (3.8) (4.8) C2.4) (1.9) (2.5) (1.7) saving 4.0 4.9 3.6 1.2 3.3 1.6 0.8 -0.6 -0.7 Gap 2.3fr 3.0 5.8 5.3 3.2 3.0 2.6 4.3 4.0 La 1977-1979. 1.05 While public investment expanded during the 1980s, the level of public savings declined. The public sector savings-investment gap widened from 3% to 6% of GNP during 1980-82 and was largely financed by foreign bank credits, which were then readily available. The low level of public savings was directly related to the growing deficits of the public corporations and an inefficient and inelastic tax system that did not respond to the growth in the tax base. Thus, the Government had to introduce new taxes and raise existing rates frequently in order to maintain existing revenue levels, and it increasingly turned to foreign and domestic borrowing to fill the financing gap. Likewise, public corporations often turned to foreign borrowing to finance their growing investment programs, with little direct control on borrowings being exercised by the national government. Paralleling the domestic deficit, the current account deficit of the balance of payments rose during the same period, from about 4% of GNP to 8%.  -3- 1.06 The increased use of external borrowings to cover the balance-of-payments gap resulted in a rise in the overall level of debt outstanding, from US$13 billion at the end of 1979 to US$24 billion as of the end of 1984, or roughly 70% of total GNP. The debt service ratio rose to a peak of 37% in 1982, and the balance-of- payments equilibrium continued to be maintained by increased reliance on short-term debt and roll-overs of existing debt maturities. By the end of 1983, about 40% of total debt outstanding was short-term, one of the highest proportions of short-term debt of any of the heavily indebted countries. The high debt burden and the heavy reliance on short-term debt made the country extremely vulnerable to external shocks. The combination of the growing debt problems in the developing world and the political uncertainty following the Aquino assassination resulted in a cessation of credit lines from commercial banks in 1983 and in the need to declare a debt moratorium and to seek debt relief. Stabilization and Adjustment. 1983-1986 1.07 Beginning in 1983, the Government embarked en a major stabi- lization effort, designed to reduce the deficit in the budget, lower the balance-of-payments gap, and obtain a restructuring of its external debt. In the initial stages, controls were reintroduced on foreign exchange transactions, imports were restricted, and tariffs increased. While these measures succeeded in reducing imports and stabilizing the balance of payments, they also helped accelerate inflationary pressures, which were being fueled by a rapid increase in the monetary base. Inflation reached a peak of 50% during 1984 but had been brought under control by 1985 as a result of tight monetary and fiscal policies. Total output, however, declined with GNP growth rates of -7% in 1984 and -4% in 1985. Public investment was reduced by over 50% (1983-85), and private investment fell by about 35% (see Table 1.1). 1.08 To deal with the ecoLnomic crisis, the Government adopted a stabilization program supported by an IMF Standby Agreement in December 1984, and extended by a further agreement in October 1986. External debt service obligations to private banks and official bilateral creditors were rescheduled in 1985 and 1987. The peso was allowed to float and exchange controls, introduced in the 1983 crisis period, have been eliminated. Important structural reforms were initiated in the sugar and coconut subsectors designed to improve accountability and marketing efficiency. Restrictive import controls on many basic commodities, including rice, have been eliminated. The Government carried out a comprehensive review of its investment program for the period 1986-89, and reduced the program to an essential minimum. As a result, public investment was reduced from 7.3% of GNP in 1983, to 4.5% in 1984 and an estimated 3.6% in 1985. 1.09 Overall, the objectives of the stabilization program have been met or surpassed. GNP growth became positive in 1986 and accelerated to a 5% rate in 1987. Inflation has remained modest; the consumer price index registered increases of only 0.8% in 1986 and  -4- 3.9% in 1987. The current account has swung from a 3.9% of GNP deficit in 1984 to a balanced position in 1985 and back to a small deficit in 1987. 1.10 Poverty and Unemlovuent. The decline in real incomes that accom?manied the stabilization program has exacerb&ted the problems of poverty and unemployment. Despite rapid economic growth in the past, the incidence of poverty has remained high, ner caisQa consumption .,as declined (see Table 1.2), income distribution has continued to be skewed, and regional disparities have remained pronounced. The national incidence of poverty in 1985 is estimated to be about 52% and is considerably higher in the least-developed regions. Declining sugar prices and production have had a particularly adverse effect in sugar-producing areas such as Negros, including high levels of unemployment and malnutrition. The slow growth of employment opportunities in manufacturing, rising man/land ratios in the rural areos, and relatively rapid population growth have all contributed to a declining trend for real wages. This trend has been further exacerbated during the stabilization period, when ner capita incomes declined by abouit 15% (1982-96). Unemployment increased during the same periods, and, despite the recent resumption in growth, is estimated to be about 10% in the country as a whole, with significantly higher rates in Metro-Manila. The population growth rate, which was until recently estimated to be about 2.5%, is likely to be much higher, pre.bablv on the order of 2.7-2.9%. As a result of these factors, the restoration of growth is an urgent priority, as is the necessity to place new emphasis on programs that provide basic services, particularly in the rural areas. Table 1.2: SOCIOECONOMIC INDICATORS 1980 1982 1984 1986 1987 cL CNP per capita La 100.0 100.2 89.9 84.7 86.9 Private consumption per capita La 100.0 101.6 100.5 95.4 96.0 Unemployment (% of labor force) Total 4.8 4.7 6.2 11.8 9.5 MetroManila 12.3 11.6 15.2 24.5 bk /a Index in constant prices, 1980 - 100. Lb As of July 1986. Xc Preliminary figures. The figure for unemployment refers to October 1987. 1.11 Public Finance. The most immediate problem facing the Government at present is the management of public expenditures. Because of the structure of the tax system, poor tax administration, and growth in public expenditures, the budget deficit tended to grow in the early 1980s. From a level of about 2.3% of GNP during the late 1970s, the overall public sector deficit increased to a peak of 5.8%  -5- in 1982. Since 1983, the Government has been faced with the need to reduce the budget deficit in order to maintain price stability, while the economic recession has both reduced the tax base and made it difficult to enact new tax measures, Moreover, expenditures have been squeezed by the need to provide growing subsidies to financial and non-financial government corporations. Recent reform of the GFIs,has reduced their burden on the budget somewhat. However, equity and net lending required by Non-Financial Government Corporations (NFGCs) was P 10.4 billion in 1987, or about 10% of total revenues. In contrast, the capital expenditures for 1987 in the national government budget total only P14 billion. Recent tax reforms and improved collection efforts have raised tax collection to 12% of CNP (compared to 10% in 1984), but revenue picture remains tight. Interest expense alone now takes 36% of total revenues, as a result of high external diebt payments and domestic debts absorbed from the GFIs. In 1987, significant progress was made in restoring investment and O&M expenditures to more appropriate levels; further progress is planned for 1988. Table 1.3: NATION& BUDGET SUMM (P billion) 1983 1984 1985 1986 1987 1988 (Budget) Revenues and grants 45.6 56.9 69.0 79.2 103.1 117.9 Tax revenue 39.8 50.1 61.3 65.5 85.8 93.0 % Taxes on GNP 10.4% 9.5% 10.3% 10.7% 12.5t 12.0% Expenditures 53.0 66.9 80.1 110.5 122.7 145.1 Current operations 33.2 41.5 53.6 65.7 97.2 118.0 Interest 5.0 10.4 14.7 21.6 36.8 46.2 '&M 11.9 12.4 13.2 15.0 21.6 22.9 Capital Outlays 11.7 11.1 10.5 17.3 14.1 18.6 Equity and net lending 8.1 14.3 16.0 27.5 11.4 8.5 GFIs 1.2 7.6 11.1 16.0 1.0 1.0 NFCCs 6.9 6.7 4.9 11.5 10.4 7.5 Deficit -7.4 -10.1 -11.1 -31.3 -19.6 -27.2 % of GNP 2.0% 1.9% 1.9% 5.1% 2.8% 3.5% 1.12 Major problems continue, however, because of the subsidies required to support the operations of NFGCs (see Table 1.4). The level of internal cash generation is only a fraction of overall public corporate investments. During the period 1984-86, transfers to the 15 largest corporations from the national budget were required to cover about one half of the cash deficit of these firms. The deficits of these corporations accounted for about 40% of the total sector deficit in 1986, and over 50% in 1985. Yet, because of the shortage of resources within the corporations, many important maintenance and investment expenditures had to be deferred or delayed, leading to a deterioration in the quality of many important government services,  *6- including power, irrigation and water supply. Thus, an efficient and financially viable public corporate sector is a critical element In the overall recovery of the economy. TableA 1.4: MAJOR N0N-FINANCTAL GOVERNMENT CORPORATTONS (t billion) 1983 1984 19B5 1986 1987 Capital Expenditures 18.1 12.9 12.5 7.1 6.8 Capital Transfers 0.0 0.0 0.0 1.2 -1.4 Internal Cash Generation 2.1 1.7 4.5 0.3 6.1 Financing Deficit (-)/Surplus 16.0 12.2 8.0 6.8 0.7 ZinanatixB National Government Eouity 3.9 2.2 2.5 2.0 4.1 External Loans (net of repayment) 11.3 5.8 -2.3 -5.3 0.3 Government Loans (net of repaym.) 1.4 3.2 1.5 6.9 4.5 Bank Loans (net of repayment) -1.6 -0.3 -0.3 0.9 0.3 Other Net Domestic Financing 1.1 0.2 6:7 2.2 -8.6 Medium-Term ProsRects 1.13 Since February 1986 there has been a change in government. and the new administration has plac'&d a high priority on economic recovery. The overall approach of the Government, as contained in the recently approved Medium-lerm Development Plan, emphasizes certain key economic principles. These include: (a) greater attention to poverty alleviation and social justice; (b) acceleration of growth and increased economic efficiency; and (c) reduced government involvement in the economy and an emphasis on private initiative. 1.14 The role of the Government is clearly seen as intervening in the economy only in those areas where the private sector cannot meet social needs, and where there is comparative advantage for public action. Heavy emphasis will be placed on programs to reduce poverty, raise employment, particularly in rural areas, and accelerate agricultural production and exports. The Government is committed to reducing special privileges, tax exemptions, and subsidies for special interest groups. 1.15 Several important policy measures have been undertaken to facilitate future sustained growth. A revised public investment program was approved by the Cabinet in November 1986. A major tax reform has been initiated which includes the introduction of a value- added tax. Continued progress has been made in liberalizing trade  -7- restrictions. A major rehabilitation program for GFIs has been adopted and progress is being achieved in privatizing acquired assets and government corporations. 1.16 The government program is supported by multilateral, other official and private creditors. An 18-month agreement with the IMF for the amount of SDR 442 million was approved in November 1986. Government also successfully concluded negotiations with the Paris Club to reschedule 100% of principal and 70% of interest falling due over an 18-month period commencing January 1987. Negotiations with private creditors for a multi-year rescheduling of payments falling due in 1987-92 was successfully concluded in 1987. This agreement will reschedule about US$9 billion of commercial debt with repayments over ten years, following a seven year g.ace period. The Government has also instituted a debt-equity swap program as another mechanism to reduce the overall debt burden. 1.17 The Bank is supporting the Government program through lending operations which have been oriented towards quick-disbursing loans with a focus on macroeconomic and sectoral policy reform. A US$300 million Economic Recovery Loan (ERL) was approved by the Bank's Board on March 17, 1987. The Bank is involved in aid coordination through its chairmanship of a Consultative Group, which met in January 1987 in Paris. Subcommittee meetings of this group have been held periodically to monitor new developments. In formulating its assistance, the Bank has cooperated closely with the IMF. The current Standby Agreement reinforces the structural reforms supported by the ERL. 1.18 In the long term, the solution to the economic crisis lies with a resumption of growth in output and exports. The challenge faced by the Government in the coming year will be to restore growth without a resumption of inflation while maintaining a viable balance of payments. Essential elements in the recovery program will be measures to accelerate exports, increase public and private savings, and use investment resources more efficiently than in the past. Attention will have to be directed at industrial restructuring, reform of the financial system, and institutional improvements in agricul- ture. A combination of government actions, a restoration of private sector confidence and increased external assistance should permit a resumption of growth closer to historical experience or at an average annual rate of about 4-5%, perhaps higher. Over the longer term, therefore, the country remains creditworthy for new Bank borrowing on conventional terms, despite current short-term difficulties.  -8- PART II - THE PUBLIC CORPORATE SECTOR Evolution and Growth of the Sector 2.01 The stated policy of governments in the Philippines, past and present, has always been one of strong commitment to a private sector economy. In principle, use of public enterprises Aj was restricted to basic public services, acting as pioneers or pace- setters for the national economy and laying the foundation for accelerated economic development. Despite such commitments, the 1970s witnessed a significant expansion of GCs: in 1951, there were only 13 GCs; by 1970, the number of parent corporations had increased to 46, with an additional 18 subsidiaries. Today, there are 15 GFIs and a total of 296 GCs, comprising 93 parent corporations and 203 subsidiaries in virtually every sphere of economic and social activity. At the end of 1985, the GCs had assets of about P 743 billion and employed about 156,000 people, with the 15 GFIs accounting for combined assets of P 422 billion and the 281 NFCCs for total assets of p 321 billion (Annex 9). 2.02 The GCs invested heavily during the rapid economic growth of the 1970s. During 1975-82, investments of the major NFGCs alone averaged 4.5-5% of GNP. This was more than half of total public sector investment and about 15% of total national investment. Although the GCs' projected investments in 1985-90 are expected to drop to around 2.5% of GNP, this would still amount to a significant 40% of total public sector investment and about 13% of total national investment. 2.03 The contribution of the GCs to the national budgetary and external debt burdens has become significant in recent years, due to inadequate internal resource mobilization resulting from poor financial performance. The rate of return on total funds employed in fl Public enterprises in the Philippines are commonly referred to as Government Corporations (GCs) or Government-Owned and Controlled Corporations (GOCCs). The tens GC is used for all corporate entities in which the Government either owns the majority of shares or has voting control. GCs may be either "parent corporations" created through a special law, i.e., an Act of Parliament or Presidential Decree, or "subsidiary corporations" created under the general corporations law, the Corporations Code. In subsidiary corporations, the majority of the capital stock is in the name of a government agency or institution. The GCs can be further divided into two groups: the GFIs and the NFGCs. In addition to the CCs, there are corporations which were originally privately owned but came under government control by defaulting on financial obligations owed to GFIs; these are called Non-Performing Accounts (NPAs).  -9- 1983, for instance, ranged from 6% for the financial corporations to -10% for the educational, social and cultural corporations. The overall budgetary burden of the public corporate sector (mostly due to government contributions to the sector) was between 1.5% and 3.6% of GDP during 1978-83, reaching even higher levels in 1981 and 1982. The public sector deficit, which was less than 5% of GDP until 1980, escalated to 7.5% in 1981 and 8.1% in 1982. The Philippine GCs have also resorted to heavy external borrowing. Between 1975 and 1984, the public sector external debt increased from about US$2 billion to over US$13 billion, with some 70% of this debt each year resulting directly or indirectly from the public corporate sector. During the last five years (1983-87), however, although government transfers still averaged about 1 5 billion, external borrowing by the NFGUs (which reached 110 billion in 1983) was almost eliminated, while their debt repayments amounted to W7.4 billion during 1985-87. Supervisory Institutions for Government Corporations 2.04 Responsibility for supervising the GCs is shared by various line departments and core agencies. Each parent GC is attached to a department or another government agency which is administratively responsible for the functioning of the corporation. Investment programs of the GCs (and those of other government agencies) are evaluated by two interagency committees: the Development Budget Coordination Committee (DBCC) chaired by the National Economic and Development Authority (NEDA) the and the Investment Coordination Committee (ICC) chaired by the Department of Finance (DOF). Both Committees include senior representatives of government planning, budgeting and financial agencies. The ICC is primarily concerned with coordinating investment policies for the GFIs, while the DBCC deals with the overall planning of government funds for all GGs, i.e., both GFIs and NFGCs. NEDA and the Department of Budget and Management (DBM) play a key role in approving the budget and investments of the GCs. 2.05 The Government provides budgetary support to GC investments in the form of equity contributions and current transfers. The DBH evaluates the corporations' proposals and presents recommendations for review by the Cabinet and approval by the Congress. 2.06 The GCs are allowed to borrow subject to some restrictions. For foreign loans, approval of the Central Bank (CB) and the Monetary Board is required. NEDA also has to certify the economic justification of projects; the Department of Justice must rule on their legality; and the DBE must certify that debt ceilings have not been reached. Domestic loans are not subject to formal government control unless a government guarantee is required, but the available funds are quite limited. 2.07 The debt financing and capital expenditure programs of the NFGCs are monitored by the Government Corporate Monitoring and Coordinating Committee (UCMCC) to ensure compliance with targets set under the IMF stabilization program (para. 1.08). The list of corporations to be monitored is approved by the President and  - 10 - presently includes 18 GCs. The 0CMCC was created in 1984 as a result of discussions between the Government, the IMF and the Bank regarding the country's financial problems. Under the proposed project, GCMCC's mandate and composition was broadened and strengthened to eaable it to assume responsibility for the monitoring, performance evaluation and control of the GCs (para. 3.27). Sectoral Issues and Constraints 2.08 The Philippine public corporate sector is characterized by an inordinately high number of GCs, lack of a clear rationale for Government involvement, and continuing financial losses. These problems result from: (a) an inadequate policy framework for the creation of corporations and the resultant proliferation of corporations. From 1970 to the present, the number of corporations increased from 46 to 296 due to the absence of a well-defined policy on the creation, operation, dissolution and divestiture of CCs. This was reinforced by the tendency of the sectoral departments and parent corporations to create subsidiaries, partly to avoid the control of government financial, budgetary, and auditing agencies. The result has been duplication of activities among GCs and the creation of GCs in areas where the private sector has a comparative advantage; (b) inadequate institutional arrangements for monitoring and control of the sector. Monitoring and control of GCs has thus far focused on adherence to procedures, rather than on operational and financial performance. The primary responsibility for monitoring and control has been with the sectoral departments to which the corporations were attached, but no guidelines existed on how to implement this supervision. Moreover, the appointment of some government Secretaries and Undersecretaries to as many as 12 CC Boards of Directors resulted in either excessive dependence on the Government or their inadequate supervision. In addition, since each core agency has narrow supervisory responsibilities -- NEDA for investment approval, DBM for budget, CB and the Department of Finance (DOF) for borrowing authority -- these controls were often exercised in an uncoordinated and unsystematic manner, resulting in inconsistent treatment of the GCs; and (c) poor operating and financial management and performance at the corporation level. Inadequate attention to financial returns, lack of coordination among the controlling agencies and lax financial discipline led to careless capital expenditures, large staff increases and excessive external financing by the GCs. Lack of accounting standards, unsatisfactory accounting practices and substantial differences in the quality of audits combined to disguise the true magnitude of the problems, which were further  - 11 - compounded by politically motivated management appointments. As a result, the GCs performed poorly and their huge financial deficits had to be borne by the Government. Background to the Reform Program for Government Cornorations 2.09 As the country's economic crisis worsened in the early 1980s, the rapid growth of the public corporate sector, its contribution to the public sector deficit, and its share in the external debt burden all became matters of serious concern to the Philippine Government and to institutions providing financial assistance to the Philippines. Consequently, in October 1984, the Government requested the Bank's assistance to help formulate and implement a program of public enterprise reforms. The Bank's ensuing dialogue with government authorities led to the development of a project to rationalize and improve the efficiency of the GCs by supporting a program of policy reforms and institution building. The GC reform package for GFIs, including the rehabilitation of the major GFIs and acquired banks, became an important element of the ERL (para. 1.17). There is understandably overlap and commonality in terms of legal framework and implementation arrangements between the ERL and the proposed operation, which were both prepared in close coordination. The overall focus of the proposed reform program includes the overall rationalization of the corporate sector and provision of an improved legal framework, the disposition of assets to be privatized, the implementation of other non-privatization dispositions, and the improvement of the retained corporations. 2.10 The change in government in February 1986 temporarily slowed project preparation, since the new Government needed time to analyze studies which had been prepared by the Presidential Commission on Government Reorganization (PCGR) and undertaken by a government team assisted by local consultants. Additional time was also required to solve difficult economic, political and military challenges presented to the new Government, obtain the approval of the new Constitution and elect and install a new Congress. Having accomplished these tasks, the Government went on to strongly endorse the proposed reform program, approve all necessary legal instruments for the program, create, fund and staff organizations to carry out the progrant, and approve the disposition of most of the GCs. Actions Taken to Date 2.11 Substantial progress has been achieved during the last two years in the detailed preparation of the Reform Program. Indeed, to accelerate the structural adjustment process involved in reforming the public corporate sector, the Government has formulated and approved the program's main policy framework, established the required basic mechanisms and begun implementation of the adjustment program. What remains is the continuation of these actions for the completion of the program. The policies and actions already adopted and implemented include:  - 12 - (a) approval by the President of the required legal instruments setting the policy and legal frameworks for the program (para. 3.03); (b) establishment of a Committee on Privatization (COP) and an Asset Privatization Trust (APT) (paras. 3.12-3.16) and approval of APT's operating guidelines, budget, and staffing; (c) approval of operating guidelines for GCMCC (para. 3.23); (d) approval of the Corporate Affairs Group (CAG) to act as the technical arm for GCMCC and establishment of its budget and staffing (para. 3.27); (e) formulation by DBN and review by COP/GCKCC of recommendations for the disposition and rationalization of GCs (paras. 3.08- 3.10); (f) establishment by COP of privatization guidelines and procedures to be followed by APT and the other disposition entities (para. 3.13); (g) preparation of privatization plans for GCs approved for privatization (para. 3.13); (h) preparation of draft corporate plans for five major GCs (para. 3.32); (i) implementation of Executive Order No. 518 requiring GCs to declare dividends equivalent to 5% of their net earnings; Cj) introduction of an interest rate of 5% p.a. for the GCs' outstanding debt and current treasury bill rates for new lending from the Government; (k) establishment of standard procedures, based on generally accepted accounting principles, for accounting and auditing of GCs (paras. 3.36-3.38); (1) establishment of fiscal autonomy for the Commission on Audit (COA), with COA financed by budgetary allocations and the GCs paying audit fees to the Government (para. 3.38); and (m) disposition of some initial NPAs and GCs, with the sale in 1987 of five GCs and about 21% of the number of NPAs and sales or partial sales reaching 6% of their book value (para. 3.19).  - 13 - 2.12 On the broader macroeconomic front, the Government has been successfully implementing a program approved by the IMF Executive Directors on October 24, 1986 which involves the limitation of the annual national budget deficit to 4.4% of GNP, a growth rate in the monetary base of no more than 11%, and minimum levels for international reserves. These are to be supplemented by economic policy measures undertaken in connection with the BRL. All these actions taken to date clearly indicate the strong commitment of the Government to implement important policy reforms. Rationale for Bank Involvement 2.13 The Bank, through its lending operations, has been providing support to almost all major GCs in the Philippines. Through its industrial development finance and agricultural credit operations, the Bank has sought to strengthen the Development Bank of the Philippines (DBP), the country's main development finance intermediary. Similarly, through energy, irrigation, urban development, water supply and sewerage, and ports projects, among others, the Bank has sought to address enterprise-specific issues affecting some of the major GCs. The results of these operations have, however, been mixed in terms of institution-building and policy reforms. Greater gains could have been realized if effective systems of coordination and performance monitoring had been in place lit the national level to complement the institution-building efforts being carried out at the enterprise level. The proposed project, in conjunction with the ERL (Report No. P-4466-PR, February 23, 1987), provides a unique opportunity to relieve these constraints by addressing the issues affecting the performance and efficiency of all public corporations. To this end, the Government has requested the Bank to act as a catalyst to help formulate, analyze and implement a program of reforms for the structural adjustment of the public corporate sector. The Bank has therefore helped to organize the activities of task forces which have been working for the last three years, producing detailed proposals for the Government's consideration. The reform program designed on the basis of these proposals is expected to improve the overall management of the sector and to strengthen the organization and policies of several of the Bank's major borrowers. This in turn should help reduce the burden that the corporate sector represents to the economy. It is expected that completion of all stages of the reform program will, in the future1 require additional, separate sectoral operations, some of which are currently being prepared.  - 14 - PART III - THE PROPOSED OPERATION Program Objectives and Components 3.01 The proposed Reform Program constitutes the foundation of a series of phased structural adjustments to the policies, organization, and direction of the Philippine public corporate sector. The Program, together with the sector's new legal framework already approved by the Government (para. 3.03), establishes an appropriate policy and institutional framework for the Government's future use of the corporate form. Pursuant to these policies, appropriate steps will be taken to reduce, limit and rationalize government corporate activities, initiate improvements in the efficiency, cost recovery and effectiveness of GCs, and gradually reduce the heavy burden that public corporations currently impose on the Philippine economy. The Reform Program, defined in the Government's Letter of Development Policy (Annex 4), has the following key elements: (i) Passage of legislation and issuance of a policy statement enunciating government policies for the establishment and operation of duz. (ii) Issuance of legal instruments improving the sector's institutional framework and defining the functions and responsibilities of the government agencies dealing with GCs, their boards of directors and chief executives. (iii) Rationalization of the existing corporate portfolio and appropriate disposition of all GCs through their privatization, consolidation, conversion to private nonprofit status, transfer to ministries or abolition. This process is expected to reduce the number of GCs from 296 to 37 and to eliminate most of the subsidies required for the sector. (iv) Institutional strengthening of the retained corporations through the establishment of an oversight mechanism, GCMCC, to establish long-term planning, monitor the corporate sector, and introduce measures to help improve GC performance. (V) Technical assistance to support the above efforts. 3.02 There is clear consensus in the Philippines on the need for these reforms, which have already begun to be initiated satisfactorily. Agreement has been reached with the Government on the measures needed and on their implementation in accordance with a proposed Policy Matrix (Annex 6) and Action Plan (Annex 7). A chart showing institutional responsibilities for program implementation is given in Annex 8. The proposed operation would broaden and expand the reorganization of GCs begun under the ERL, with both operations  - 15 - sharing common policy and institutional frameworks (para. 3.12). The proposed reform package is also consistent with and supports the IMF program to monitor the financial performance and expenditure programs of the major GCs. Program details are described below. I. Legal Framework and Policy Statement 3.03 The proposed Program is based on an improved legal frame- work for the sector which has been provided by a number of legtl. instruments approved by the President of the Philippines. These include Administrative Order (A.O.) 59 (February 16, 1988). "Rationalizing the Government Corporate Sector"; Executive Order (E.O.) 236 (July 22, 1987), "Strengthening the Government Corporate Monitoring and Coordinating Committee"; the GCMCC Guidelines (January 22, 1988); E.O. 127-A (July 22, 1987), "Creating the Corporate Affairs Group"; E.O. 164 (May 5, 1987), "Providing Additional Guidelines in the Processing and Approval of Contracts of the National Government"; and Proclamations 50 and 50A (December 8 and 16, 1986), "Proclaiming and Launching a Program for the Expeditious Disposition and Privatization of Certain Government Corporations and/or Assets Thereof, and Creating the Committee on Privatization and the Asset Privatization Fund." The policies promulgated in this legislation are also reflected in the Letter of Development Policy signed by the Government on April 27, 1988. Together, these documents satisfactorily define the basic policies, role and organization of the government corporate sector in the economy. The key policy changes introduced are summarized in the Policy Matrix (Annex 6). In particular, these policies direct that: (a) the private sector should have a primary role in undertaking economic activities; (b) the Government may intervene in the economy when the goods and services involved are vital to society and the private sector is unwilling or unable to provide adequate services, or when Government intervention is justified by the need to create a bias in favor of disadvantaged sectors of the society. In such -cases, GCs rather than line departments would be used when greater flexibility is desirable, or when the Government wishes to limit its direct equity exposure; (c) GCs should be financially independent, require minimal government support, and operate without any special privilege or assistance from the Government; (d) GCs not complying with the above criteria will be disposed of and the corporate sector rationalized by: (i) partial or total privatization; (ii) abolition; (iii) conversion into private nonprofit status; (iv) consolidation with another GC; or (v) regularization, i.e., abolition of the GC and transfer of its functions, personnel, assets and liabilities to a regular line agency of the Government; (e) GCs will have adequate flexibility and autonomy, but within a  - 16 - framework of government supervision, monitoring and evaluation; and (f) subsidies may be granted only to create a bias in favor of disadvantaged sectors of the society, or to protect the operational viability of GCs in case of disastrous events or when Government mandates the GCs to undertake activities which are not financially viable. II. Institutional Framework 3.04 To implement the above mentioned objectives and policies, the Government established special institutions as follows: (a) GCICC to monitor the application of government corporate policies, particularly to approve the creation and acquisition of new GCs and to carry out the improvement, monitoring and performance evaluation of retained GCs. A Corporate Affairs Group (CAG) was also established in DOF to serve as technical secretariat for GCMCC; (b) COP to oversee implementation of the divestment program and APT and other Disposition Entities (DE) to carry out the privatization; and gc) the Presidential Commission on Government Reorganization (PCGR) analyzed the corporate sector, prepared a legal framework for the sector and provided the President with recommendations for disposition of GCs. After completing its work, PCGR was dissolved and its role and functions transferred to DBM, which in coordination with the respective departments is responsible for the abolition, consolidation, conversion and regularization of GCs. 3.05 Legislation has also been introduced in the Congress to allow differential compensation for employees of GCs. More flexible personnel policies for GCs would be developed under the program (para. 3.39). III. Corporate Rationalization Program 3.06 Program Development and Scone. During the last three years, the Government, with the help of local consultants, has carried out detailed studies analyzing the organization, finances, markets and prospects of each GC. Following the policies enunciated above (para. 3.03), and in agreement with the Bank, rules and criteria were established to rationalize the existing portfolio of 296 GCs. Excluded from this Program were assets of corporations which have been sequestered by the Government, pursuant to investigations pertaining to the legality of actions by the previous Government relating to such corporations. These corporations are being handled separately by the Presidential Commission on Good Government, but would also be eventually be disposed of by APT, subject to the resolution of relevant legal issues.  -17- 3.07 The objectives of the corporate rationalization program are to: (a) increase the efficiency and productivity of the economy by allowing fair competition and withdrawing the Government fron activities which could be performed more efficiently by the private sector; (b) minimize the Government's role and involvement in GCs and reduce the present burden of its loans and contributions to GCs, which have been a major cause of the public sector deficit; and (c) concentrate efforts and resources in improving the efficiency of the GCs that will remain in the public sector. 3.08 Rationalization Recommendations. Based on the above-mentioned studies, DBK, in consultation with the departments concerned, has prepared recommendations for the rationalization of the corporate sector and the disposition of each GC. COP/CGKCC have already agreed on the disposition of much of the portfolio. The disposition of 230 GCs (78% in number and 95% in value of total GC assets) has already been approved by the President. Disposition recommendations for the other 66 GCs (representing about 22% in number and 5% in the value of total GCs assets in 1985) are being finalized. Final approval for these 66 GCs would be a condition for release of the second tranche of the proposed loan. 3.09 According to the approved disposition or to DBK's recoimnendations (detailed in Annex 9), only 37 (12.5%) of the existing 296 GCs are expected to remain in the public sector. On this basis, an estimated P 137 billion (in 1985 prices) of the GCs' gross assets would be removed from the public corporate sector, -reducing by about P 8 billion the annual budgetary allocations. This would also represent a gradual transfer to the private sector of about 55,000 employees. Excluding three special corporations (the Central Bank, the Development Bank of the Philippines and the Social Security System), the GCs to be retained (including consolidations) had assets in 1985 of P 228 billion, representing a reduction of 88% in number and 42% in value of the government corporate sector. Privatization of discrete parts of the GCs being retained is also being implemented. The drastic reduction in the absolute number of corporations and the changes in departmental attachments would result in no single department supervising more than six corporations, with the average number being four. 3.10 The rationalization program envisages the following changes (see Annex 9 for details) for the other 259 GCs not being retained: privatization of some 132 GCs (44.6% of total), most of them engaged in productive activities but having a net drain on economic resources; liquidation or abolition of about 67 GCs (22.6%) for which there would be little interest in the private sector; consolidation with their parent corporations or other corporations in the se  - 18 - subsector of 16 OCs (5.4%) to eliminate existing duplications of purpose or function; regularization (incorporation into relevant government departments) of 36 GCs (12.2%) which have functions not suitable to the corporate form; and conversion to nonprofit private entities of 8 GCs (2.7%). The value of assets, liabilities, equity and the number of employees, excluding the three special corporations mentioned in para. 3.09 are shown in Table 3.1. TABLE 3.1 SUMHARY DISPOSITION PLANS EXCLUDING SPECIAL FINANCIAL GCS 1] - (MILLION PESOS DECEMBER 31, 1985) 1 OF TOTAL X OF TOTAL EQUITY GROSS NET NO. CORPORATIONS/DISPOSITION GCS ASSETS ASSETS LIAeI- REVENUE INCOME OF C(umber) IN THIS LITIES EIPLO- GROUP YEES --...-...-..------------- ..-.-.--.-.---.--.....--..-..----------.........-.-..------__---..---_-----_- RETENTION AS GCS 34 11.6% 227528 57.2% 153173 74355 440B5 3422 49804 ABOLITION 67 22.9% 11185 2.8Z 6834 4351 751 -56 4802 CONVERSION 8 2.7X 42 0.0% 24 18 12 -5 695 CONSOLIDATION 16 5.5% 1105 0.3Z 396 707 157 14 2155 PRIVATIZATION 132 45.1% 126163 31.7% 110923 15240 55596 -7137 5153B REGULARIZATION 36 12.3X 31863 8.01 18373 13490 12531 -365 31891 TOTAL EXCLWING SPECIAL FINAN.GCS 293 100.0% 397886 100.01 289725 10161 113132 -4127 140885 11 The CentraL Bank, the Development Bank ard the Social Security System. 3.11 Institutional Arrangements for the Reform Program. DOF will undertake overall coordination of the proposed program. GCMCC will be responsible for measures to improve the corporate sector (para. 3.25). The rationalization program will be implemented by COP and DB3. COP, with the support of the concerned disposition entities (DEs), i.e., APT and a few major parent corporations (para. 3.13), will complete the privatization program, while DBM, with the support of relevant departments and parent corporations, will be responsible for all other disposition actions. 3.12 Disposition Entities for Privatization. Institutional arrangements for the divestiture program established jointly under the ERL and this program are in place. Divestiture of both GCs and NPAs would be carried out under the overall responsibility of COP, an interministerial body comprising the Secretaries of Finance (Chairman), Trade and Industry, Justice, Budget and Management and the Director-General of NEDA. COP analyzes and submits to the President for approval the recommendations for privatization (para. 3.08); approves the terms of individual disposition proposals prepared by DEs; and monitors and reviews the progress of the entire privatization  - 19 - program. COP also recommends for the President's approval candidates for the APT Board, including their Executive Trustees, and approves the DEs' guidelines and budgetary requirements. The APT program is managed by a Board of Executive Trustees comprising five full-time members drawn from senior executive levels of private industry. Operating guidelines approved for APT are satisfactory, as are its organization, staffing, budget and work program (details available in the Project File). Although APT's budget for 1988 is almost unchanged from 1987, when its staffing was still incomplete, this is not expected to be a constraint since APT's operational expenditures in 1987 were P 6 million and they can be recovered from sale proceeds, which already reached P 3,800 million in 1987. 3.13 Under COP's guidance, the actual sale of GCs would be carried out by the DEs. Although APT is the main DE for all government assets, in view of its widespread commitment to the disposal of more than 300 NPAs and a large number of sequestered assets, its role in privatization of GCs would be initially limited to the privatization of some 40 GCs (10 of which are already transferred to APT). The remaining privatization will be undertaken by the parent corporations (mainly the National Development Corporation, the Philippine National Oil Company, and the Department of Agriculture). The knowledge of the parent corporations about the GCs to be privatized is expected to accelerate and simplify the sales of the respective GCs. To ensure that adequate, comparable and transparent methods are followed by all DEs, on August 15, 1987 COP issued detailed guidelines for privatization. The guidelines set procedures for COP monitoring of all privatization actions, require the preparation of detailed privatization plans for each CC, and provide guidelines for valuation of assets, identification of potential investors, disposition methods, etc. Detailed privatization plans have been approved by COP for most GCs approved for privatization. These plans describe the proposed privatization, provide financial and operational highlights of the GCs, recommend the privatization system (sale of assets or shares), valuation method, the schedule and program of privatization activities and provide information on any special factors which may affect the privatization. The DEs are required to provide COP with periodic progress reports on the privatization program; COP in turn is required to submit periodic progress reports to the President and the Congress. If satisfactory progress is not achieved within a reasonable period of time, COP will assign the completion of privatization to APT. The price, buyer, terms of disposition, and any rehabilitation or restructuring of corporations are subject to the prior approval of COP, which is the final authority in such matters. 3.14 Each DE will carry out the following functions: (a) formulation of a detailed action plan with the intention of completing the sale of all entrusted assets not later than December 31, 1991; (b) execution and/or management of all activities related to the divestiture of specific OCs, such as enterprise analysis,  - 20 asset valuation, determination of appropriate sales procedures, identification of potential buyers, estimation of sales values, tntroduction of legal and institutional changes required for the transactions, calls for bids and, if needed, for negotiation of torms of sale (including financial packaging and work force rodep.oyment schemes); (c) oversight of the maintenance of the assets and the improvement of the corporations' operations until their disposition, including measures which may be required to improve their saleability. Rehabilitatiorn requiring capital expenditures will be undertaken only in exceptional cases to be approved by COP; and (d) hiring of external expertise and technical assistance to support the privatization program. 3.15 The DEs will have a lean staff, supported by ad hoc advisors and consultants in finance, law, operations, accounting, auditing and public relations/marketing to provide highly specialized support and to ensure that all transactions are designed and implemented in a consistent and coordinated manner. The APT's staff includes the five Trustees and 42 other personnel. Although APT was able to complete 46 bids and dispose of about 21% of NPAs in 1987 without any special technical assistance, the disposition of GCs will require consultant and logistical support. COP has preliminary approval of the United States Agency for International Development (USAID) for a US$5.0 million grant to assist in completing the privatization (see Annex 12). Privatization of individual GCs and NPAs would be executed in the context of the priorities of the overall privatization program and the particular constraints (mainly legal requirements) of each GC. Wherever possible, the Government would leave capital-intensive restructuring or rehabilitation efforts to the private sector. 3.16 Budgetary savings resulting from privatization would be generated only over the long term because (a) the most logical candidates for early transfer to the private sector would be the most viable corporations and thus the least costly to the Government, and (b) GCs which are heavily indebted or subsidized would need to be sold at a discount or have substantial debt written off before they can be sold. Although many GCs have negative equities, their sales are likely to result in a positive capital inflow for the Government, since the liabilities to be paid are mostly with other government entities. Total sales of assets by APT and the other DEs reached P 8.9 billion in 1987; higher levels are expected in 1988, which would result in considerable cash inflows that would help support the privatization program. Nevertheless, although the end results of privatization would be a reduction in budgetary allocations and cash raised by sales, budgetary support is needed initially to sustain disposition operations as well as to assume the liabilities of some GCs. Budgetary requirements would vary with the speed of disposition and depend on many externalities. Initial budgetary requirements for APT and other DE (assumed by the parent corporations) are  - 21 - satisfactory. Agreement was reached during negotiations that the Government would continue to provide adequate budgetary funds to support the privatization and rationalization program. 3.17 Privatization Strateev. The privatization strategy pursued will seek to achieve a reasonable sale price while taking into account the limited absorptive capacity of the domestic capital market and the need to minimize implementation constraints. Creative financing schemes are already being implemented by APT. The Government is consieering alternative privatization strategies to facilitate the completion of the program in less than five years. These include: (a) partial privatization, particularly for large companies; this includes the option of stock ownership plans for management and employees; (b) debt/equity swaps; (c) joint ventures with domestic or foreign partners' providing capital and/or technology; (d) privatization of the management and operation of GCs (management contracts); (e) investment funds f4 to serve as financial intermediaries and raise funds from individuals, corporations or pension funds. These funds could be registered at foreign stock exchanges or offered through private placements abroad and could help mobilize remittances from Philippine nationals living overseas. 3.18 It is difficult to forecast with precision the likely demand among investors for the purchase of GCs scheduled for privatization. However, improvements in the political and economic environment in the country and the increased trading volume in the Manila and Makati Stock Exchanges as evidenced by the higher turnover ratio and the quadrupling of the stock market index in 1986 (Annex 10) indicate increased investor confidence in Philippine equity markets and bode well for the privatization efforts. Bids for the assets already offered have been generally successful and prices reasonable. 3.19 Although the potential for successful privatization is good, the local market may not have adequate financing capacity to absorb quickly the volnuw of sales envisaged: the net book value of the 132 GCs targeted for privatization, P 15 billion, represents almost one third of total market capitalization of the 127 companies currently /4 In April 1987, IFC's Board of Directors approved a proposed investment in the First Philippine Capital Fund, a "closed-end" fund of a vinimum of US$125 million and a maximum of US$250 million. The Fund will be managed by a wholly-owned subsidiary of Shearson Lehman Hutton, Inc. It is structured as a limited partnership under the laws of the State of Delaware, and will be marketed on a private placement basis mainly in the United States, Japan, Europe and the Middle East.  - 22 - listed on the Manila and Makati Stock Exchanges. Consequently, sales to foreign investors are also contemplated. Considerable interest has been expressed in the privatization program, which has been confirmed by APT's sales, and indicates a reasonable demand for investment opportunities. Considerable progress has already been achieved in 1987, with the divestiture of some 56 NPAs (and partial sales of another 28 NPAs) and five GCs. This included several large divestitures like the Commercial Bank of Manila (C 511 million), the First Philippine Holding Corporation (0 416 million), the Cebu Plaza Hotel (P 328 million), etc. The experience acquired last year is expected to further improve future results. 3.20 Even after the satisfactory progress of privatization in 1987, it is impossible to forecast when the privatization of any group of assets will be completed, which depends not only on government efforts, but also on the private sector's willingness and capacity to purchase the assets. This is also tied to the general political and economic stability of the country and, for a given corporation, the judicial and in some cases the legislative approval of legal changes or pending issues required for divestiture. Under these conditions and given the short implementation period of this project, agreement was reached at negotiations that all steps necessary to get in vendible form and offer for sale 30 GCs, representing in 1985 at least 20% of the gross assets approved for privatization of GCs, would be completed before the release of the second tranche of the loar, and that release of the third tranche would require that a cumulative total of 60 CCs, representing in 1985 at least 50% of the 1985 gross assets approved for privatization of GCs, would be in vendible form and offered for sale. Puttiig the corporations into vendible form will be the critical activity since the offer for sale follows normal bidding procedures. Making them vendible requires the removal of legal impediments to the sale, the settlement of creditors' claims, perfection of the title to the assets, completion of an inventory and financial evaluation of the CC. After these steps are completed, the DE provides information about each GC in a catalogue distributed to potential buyers. 3.21 Other Disposition Actions. PCGR prepared most of the studies and recommendations for other disposition actions during preparation of the proposed project. DBM would now be responsible for implementing these and other disposition recommendations for consolidation, conversion to nonprofit organizations, regularization into line agencies or departments, and abolition. Finalization by DBM of an implementation plan agreed with the Bank for the consolidation, regularization (absorption as line agencies or departments), conversion, and abolition of about 100 GCs would be a condition for the release of the second tranche; the achievement of satisfactory progress toward amending the charters of such CCs would be conditions for the release of the second and third tranches of the proposed loan. The implementation of this plan (including satisfactory progress towards anendments of charters of such GCC) and the preparation of an action plan agreed with the Bank for the remaining consolidations, regularizations, conversions and abolitions would be a condition for release of the third tranche. Substantial work would be needed to prepare the legal instruments necessary to change the CC charters.  - 23 - For this purpose, DBM will work closely with the Securities and Exchange Commission and the relevant departments on charter modifications. DBM staff responsible for this part of the program would consist only of a core group of six professionals who would be supported, as needed, by consultants on an ad hoc, short-term basis. Technical assistance for nonprivatization dispositions, mainly to prepare legislation and evaluate the GCs (Annex 12), is expected to be .financed by the United Nations Development Programme (UNDP) (para. 3.41). IV. Retained Corporations: Institution Building and Improvements 3.22 The 37 corporations to be retained constitute a substantial part, 57%, of the assets of the government corporate sector, (excluding three special corporations para. 3.09). Moreover, tnese corporations provide many essential services to the population (power, water supply, irrigation, low-income housing, etc). Therefore, the Reform Program emphasizes measures designed to improve their performance and effectiveness, in particular: (a) an institutional framework for departmental and interdepartmental supervision, and (b) improvements in the performance of the corporations themselves. These components are explained below. Institutional Framework for Departmental and Interde artmental Supervision 3.23 A.O. 59 provides guidelines for the respective roles of the boards of the GCs, their chief executive officers, and the departments to which the corporations are attached. The underlying principle in these provisions is to provide operational autonomy to the Boards and managements of GCs while maintaining reasonable control over their performance and results. The A.O. defines the supervisory functions of the departments in regard to the corporations attached, gives operational autonomy to the GCs, describes the functions of the Secretary of a Department vis-a-vis the corporations attached, outlines the powers of governing boards and the chief executive, establishes mechanisms to approve loans, prescribes periodic reporting requirements and confirms the supervisory authority of parent corporations over subsi&Laries. Under the improved legal framework, the core agencies will retain most of their present functions, although their coordination would be improved through interdepartmental supervision carried out by GCMCC. Specifically, NEDA will continue to prioritize and evaluate investment projects; DBM will continue to approve the budget, equity contributions, and other funds allocated to individual corporations; and the Central Bank will continue to be responsible for determining the GCs' foreign exchange and credit budgets and for compiling banking system reports on domestic corporate borrowings. COA will audit CC accounts and the Civil Service Commission (CSC) will enforce government personnel regulations. Agreement was reached at negotiations that before the release of the second tranche of the proposed loan the Government will issue regulations to eliminate automatic government guarantees for loans contracted by GCs and to provide that when GCs are required by  - 24 - Government to undertake activities which are not financially viable, the Government will take adequate and timely steps to protect the financial viability of such GCs-, on the basis of arrangements between the Government and the GCs as part of interdepartmental monitoring and evaluation by the GCMCC. Satisfactory progress toward the amendments of charters of GCs to incorporate the above-mentioned principles regarding the Board of Directors, subsidies and automatic government guarantees (para. 7 of Letter of Development Policy) is a condition for the release of the second and third loan tranches. 3.24 The Government would also review the charters of GCs and thereafter take necessary action to ensure that: (a) where the Chairman of a GC is the representative of the Department to which that GC is attached, arrangements for interdepartmental monitoring and evaluation by the GCMCC are appropriately, adjusted as necessary to take into account this fact; and that the other responsibilities of such representative are consistent with the need that the representative devote adequate time and attention in the discharge of his/her responsibilities as Chairman; and (b) where exofficio members constitute the majority of the members of the Board of Directors of a GC, the selection of the Departments represented on the Board in each case adequately takes into account the relevance of the functions of such Departments to the activities of the GC. The completion of this review is a condition for the release of the second loan tranche, and satisfactory progress in implementing the recommendations of the review would be a condition for release of the third tranche. 3.25 GCMCC. E-O 236 and its regulating guidelines establish an interdepartmental supervision mechanism to oversee the entire government corporate sector and ensure uniformity in the supervisory roles of the various agencies. This mechanism consists of GCMOC, a Cabinet-level committee, which includes the Executive Secretary, the Secretaries of Finance, Transportation and Communications, Agriculture, Public Works and Highways, Environment and Natural Resources, and Trade and Industry, and the Director of NEDA. It is chaired on a rotating basis, as decided by GCMCC. CCICC's objectives are to enhance public accountability of GCs, promote the efficient allocation and use of resources, instill financial discipline and self-financing of GCs, and integrate corporate sector and government goals and policies. 3.26 GCKCC is responsible to establish performance targets and standards, monitor the implementation of audit recommendations, conduct periodic reviews, appraise performance, and monitor the operation of GCs against agreed targets. GCMCC will not get involved in the management of the corporations, but will focus its attention on performance and results. GCMCC will also develop and recommend to the President incentives and sanctions to improve the performance of GCs. GCMCC would have the support of a Technical Board which includes representatives of the member agencies of GCZCC, as well as representatives of DBM, the Central Bank and COA. The list of GCs to be under GCMCC supervision would be expanded gradually. For 1988 it includes 18 of the largest CCs, fifteen of which are the targets for the initial implementation of the program (Annex 5).  - 25 - 3.27 The Corporate Affairs Group (CAG) will be GCCCC's technical secretarint. CAG currently has a staff of 28 but would be expanded to 40 by June 30, 1989. To ensure that the full complement of CAG staff benefit from the training and technical assistance planned for this component (para. 3.41), the appointment of adequate staff for CAG would be a condition for the release of the second tranche of the proposed loan. GAG will carry out the following functions for CCMCC: (a) provide assistance to define policies and recommendations regarding the corporate sector; (b) develop, coordinate and evaluate the corporate planning of GCs; (c) develop criteria and procedures for monitoring and evaluation of GCs; (d) establish and monitor the implementation of a management information system to rationalize the information requirements of managers, departments, and GCMCC; and (e) periodically evaluate the performance of all GCs. Measures to Improve Performance of the Retained GCs 3.28 The GCs' lack of adequate financial responsibility and operational accountability contributed to the country's present economic crisis. An improved system of financial discipline and control for GCs is therefore essential and would be introduced under the program through: (a) improvements in the organization, management and financial structure of GCs; (b) introduction of corporate planning, performance monitoring and evaluation, and a related incentive system; (c) improvements in accounting and auditing; and (d) provision of differential treatment. 3.29 These measures, to be introduced gradually, are expected to increase the efficiency and effectiveness of GCs, strengthen their corporate planning capacity, improve management information systems, and provide greater flexibility for GC operations. During the first project year, the above improvements would be introduced on a pilot basis in the following five major GCs, with which the Bank has been associated for many years: the National Power Corporation (NBC); the Metropolitan Waterworks and Sewerage System (HWSS); the National Irrigation Authority (NIA); the Philippine Ports Authority (PPA); and the National Housing Administration (NHA). During the second project year, these measures would be introduced into another ten large GCs.  - 26 - 3.30 Improvements in the Organization. Management and Financial Structure of GCs; Under the new legal framework (para. 3.03), the organization, managerial and financial practices of GCs would be standardized, and the GCs' existing charters would be changed as needed to conform with Government's policies and the present legal framework (para. 3.23). The three main changes introduced relate to Boards of Directors, government guarantees, and special privileges of CCs. (a) Boards of Directors. The new legal framework defines the managerial responsibilities of CC boards of directors and sets standards of technical competence, experience and integrity for board members (para. 3.23). Appointment and removal procedures are also defined. The supervision of GCs would henceforth be a responsibility of the supervising secretaries, while the direction of the corporations is entrusted to the GCs' Boards of Directors and their management to their chief executives. The implementation of these policies would require changes in the charters of some GCs (paras 3.23 and 3.24). (b) Automatic Government Guarantees. Provisions in CC charters specifying automatic government liability for GC obligations have led to large indebtedness among the GCs and have provided no incentives to improve their efficiency and cost recovery. The Government's policy is that direct loan guarantees or other government financial exposure will be curtailed and will require specific justification and ad hoc approval by GCMCC and the President. Unless specific approval is given, the Government would no longer automatically guarantee the liabilities of any CC beyond the Government's equity participation in that GC. Such policies will be reflected in new government regulations and in changes made to the GC charters (paras. 3.23 and 3.24). (c) Elimination of SDecial Privileges and Benefits. Until recently, most CCs enjoyed special exemptions (from income and other taxes, fees, custom duties, etc.), particular privileges (monopolistic rights and automatic government guarantees for borrowings) and government financial assistance, either from budgetary allocations or the provision of earmarked revenues and taxes. Tax exemptions and privileges of GCs were withdrawn by E.O. 93 (December 17, 1986), and although its implementation has been uneven, equity contributions were reduced and internal contributions by the corporations were tripled between 1983 and 1987, from P 2.1 billion in 1983 to P 6.1 billion in 1987. Dividends paid to the Government by GCs increased from P 46 million to P 126 million between 1986 and 1987. GCMCC is now satisfactorily monitoring the implementation of these policies. 3.31 Corporate Planning. Long-term corporate planning is essential for GCs, which frequently undertake projects and loans, the  - 27 - full effects of which in terms of expenses, debt service, revenues and benefits are not fully felt until after the project is completed. Although a few CCs have some corporate plannking experience, most existing corporate plans do not promote thorough analysis of the impact on the corporation of long-term investments or loans, nor do they include an integrated financial model for analyzing the main factors affecting financial performance and providing a reasonable long-term financial forecast. A good start has been made through the review of investment programs by GCGCC as part of the IMF stabilization program. Under the proposed program, improved corporate planning would be introduced to 15 large NFGCs, including a system of management reports and performance indicators. This will require improvements in the capabilities of the GCs to prepare, and GCMCC and CAG to revise and evaluate, proposed corporate plans and subsequently to monitor performance. 3.32 The linchpin of the improved corporate planning system is the introduction, under the supervision of GCMCC, of a Corporate Planning Model (CORPLAN) using micro computers. The CORPLAN model includes a detailed analysis of demand, revenues, expenses, debt, and investments. The model can be tailored and applied flexibly to the specific circumstances of each corporation, but will provide standard tables for investments, debt service, income, flow of funds, balance sheets and financial plans. To facilitate managerial review of corporate plans, CORPLAN provides graphs for the relevant indicators of each corporation. Improvement of the corporate planning process has already been initiated with the preparation of draft corporate plans for the five pilot corporations (NPC, MUSS, NIA, PPA and NHA). A sample of CORPLAN's main tables is shown in Annex 11. Initial training in the design and use of the program, to be complemented by technical assistance, has already been given to staff of the 15 GCs. The approval of a corporate plan agreed with the Bank by the Board of Directors of five GCs is a condition for disbursement of the second tranche of the Bank loan. Similar corporate plans, as approved by the respective Boards of Directors of another ter. large GCs, will be a condition for disbursement of the third tranche. 3.33 Performance Monitoring and Evaluation. Government monitoring of public corporations is currently limited to sporadic interventions by the supervisory agencies, with the result that the GCs have largely functioned without supervision or controls. Under the reform program, a consistent and regular system will be introduced to monitor and evaluate the results and performance of GCs. At the start of each year, GCMGC and the secretaries of the departments to which the GCs are attached will agree with each CC on a set of targets for the year, which will then become the basis for the evaluation of performance and results. The financial viability of the targets would be verified by the corporate planning model, which would also routinely provide a selective list of monitoring indicators and target numerical values to allow assessment of the performance of each corporation. The number of targets (as opposed to indicators, which are monitored to identify potential problems) will be limited, so as to give clear signals to management. In the case of GCs that are expected to meet social goals, the monitoring and evaluation system  - 28 - will be designed so as to take into account the constraints on financial performance imposed by such public policy expectations. The monitoring system intends to measure performance in three main areas: (a) the achievement of corporate goals in terms of service objectives (population served, coverage and reliability of services); (b) the efficiency of corporate management and resource utilization (number of employees per unit of output, collection efficiency, etc.); and (c) the financial performance of the corporation (rates of return, internal cash generation, liquidity and operating ratios, etc.). 3.34 A Performance Evaluation System (PES) will be designed with a weighting system for the above-mentioned factors and a methodology for the evaluation and rating of GCs. The PES would be introduced gradually, starting with the five pilot GCs mentioned earlier (para. 3.29). Monitoring of GCs has already been started by CAG. The introduction of the PES for 15 large GCs would be a condition for release of the third tranche of the proposed loan. 3.35 Incentive Mechanisms. To be fully successful, the PES has to be linked to a system of incentives. Such systems, which may include substantial bonuses for staff showing outstanding performance, have proven successful in several countries, including Pakistan and Korea. The Government is now planning to develop and introduce a PES suitable to the Philippines. The design of an appropriate PES and incentive system for GCs, which is included in the technical assistance to GCMCC, is a condition for the release of the second Bank loan tranche. 3.36 Accounting and Auditing ImRrovements. Until recently, accounting for GCs was not standardized. The conventions, presentation and some accounting methods were decided by each corporation, making it difficult to compare results among GCs, and complicating the audit and financial analysis of CGs. This contributed to an uneven audit performance. Moreover, while parent corporations were audited by COA, most of the subsidiaries have until recently not been subjected to any audit, and the financial results of parent corporations were not consolidated with those of their subsidiaries. 3.37 In 1987, COA substantially improved government accounting standards by adopting the generally accepted accounting principles established by the Philippines Accounting Standards Council. These standards, as enforced by COA, will ensure the comparability and reliability of the GCs' financial statements. The GCs have independantly beer attempting to develop tneir own computerized accounting svstems, but - zis has led to a duplication of efforts, limited and incompatible systems, as well as inadequate financial statements. DBM with the support of COA would introduce computerized  - 29 - accounting systems for the major OCs using the tstandard chart of accounts as a base. Consultant assistance would be required to design such a system (para. 3.41). The finalization of an implementation plan, agreed with the Bank, to introduce computerized accounting for GCs would be a condition for release of the second tranche of the proposed loan. The introduction of computerized accounting in ten large GCs would be a condition for release of the third tranche. 3.38 COA is responsible to provide adequate audits of all GCs. Recently, it substantially improved its procedures for auditing GCs through, among other things, the issuance of a revised Audit Manual in 1987, the adoption of accounting standards (para. 3.37), the introduction of statistical sampling, and the establishment of Special Audit Tenms to participate in the annual audits. The proposed reform program is designed to further this process by upholding the financial independence of COA. Until 1986, COA staff operated within, and were paid by, GCs being audited. To guarantee financial independence for COA, E.O. 19 (June 19, 1986) entablished that starting in 1987 audit charges are paid to the Government by each GC, and that COA is financed by the central government budget. To monitor these improvements and as part of efforts to assess overall country progress in this area, the Bank is planning to carry out annually an implementation review of the audit results of all projects it assists in the Philippines. 3.39 Differential Treatment. To improve their performance, the retained GCs will need adequate autonomy in matters relating to personnel, compensation and procurement. This requires treatment of corporations different from government departments. A.O. 59 recommends that service-wide government agencies (i.e., NEDA, DBM, DOF, etc.) would provide differential treatment to GCs relative to government departments. To provide for improved salary levels for GCs, the Congress is already studying legislation prepared by DBM L5. The CSC has been providing some flexibility in the application of civil service regulations to GCs and has prepared draft legislation to establi.sh a corporate career executive service, which provides for adequate autonomy and standards of employment, incentives, and career development for employees of GCs on the basis of comparable industry practices. As a condition for the release of the second tranche of the proposed loan, satisfactory progress would be achieved towards establishing an appropriate corporate career executive service for Gcs. 3.40 Satisfactory differential treatment is also being provided for procurement by GCs. Until 1987, GCs could approve contracts worth a few thousand pesos, but E.O. 164 (May 5, 1987) increased the h5 While different pay scales (up to 2.5 times the government scale) exist for the corporate sector, the present differentials are considered inadequate for some technical jobs. A number of corporations overcome this difficulty by selectively hiring their staff on a contract basis. A special case is the Philippine National Oil Company where virtually all staff are seconded from subsidiaries.  - 30 - approval authority of CC boards of directors to P 50 million for bids and P 5 million for negotiated contracts, and allowed department Secretaries to delegate their approval powers (for contracts costing up to P 100 million) to the boards of their attached GCs. These limits are satisfactory for most GCs. E.O. 164 also provides that upon recommendation of NEDA, the President may revise the above- mentioned ceilings. V. Technical Assistance Program 3.41 Technical assistance (TA) is essential to support overall implementation of the Reform Program, strengthen its institutional framework and help to improve the performance of the retained corporations. NEDA is coordinating TA for the program, which will be financed through grants from the Asian Development Bank (ADB), USAID, UNDP and OECF. The ERL also includes some US$500,000 that can be used to finance any shortfall in the TA program. Agreement was reached at negotiations on the Terms of Reference, cost, financing and implementation schedule of the TA. Assurances were obtained during negotiations that the Government would timely implement and finance the required TA. The qualification and experience of the consultants will be agreed with the Bank. The appointment of consultants is a condition for release of the second Bank loan tranche, and release of the third tranche would be conditional on the achievement of satisfactory progress toward implemznting the TA. The TA for the program would include the following: (a) Privatization Program. The TA to be provided would assist COP and DE in defining and changing the legal status of GCs, besides providing assistance and financial support for the valuation, marketing, evaluation and negotiation of GC sales. Much of this assistance would be provided by investment banking and financial experts to formulate financial packages and contracts and provide assistance for the sale of assets; (b) ImRrovement of Retained CorDorations. This includes support to GCMCC and GAG in monitoring the performance of the retained corporations. Assistance would be required in such areas as: introduction of CORPLAN to 15 major GCs; design and introduction of an appropriate performance evaluation system; design of a related incentive system; and establishment of an integrated information and reporting system for the GCs and various government agencies. Training of CAG and concerned GC staff would be an integral part of this TA component; (c) Disposition other than Privatization. The TA would support DBK in implementing the program of consolidations, changes of attachments and abolition of GCs, as well as affecting necessary changes in the charters of GCs. A major component of such assistance will be the preparation of legislation to support the disposition actions and to support limited privatization of some assets of retained GCs; and  -31- - (d) Accounting ImRrovements. TA would support DBM in improving the accounting of GCs by establishing a comaputerized accounting system, based on the standard chart of accounts approved by COA. This would result iu timely and accurate accounting and provide compatible financial information for all CCs. Loan Administration 3.42 t_posed Loan. The proposed Bank loan of US$200 million equivalent would support the Government's Reform Program for GCs. The project closing date would be August 31, 1991. Negotiations for the proposed program were held in Washington between March 24 and 30, 1988, with the Government delegation led by Mr. Edgardo del Fonso, Undersecretary, DOF. 3.43 Project Implementation. Annex 8 presents a chart showing implementation responsibilities. DOF will be responsible for overall coordination of the Reform Program. It will also prepare progress reports on overall project implementation for review by Bank missions prior to release of each loan tranche. Responsibility for implementation of the various program components would be as follows. DBE will be responsible for implementation of the remaining disposition actions under the rationalization program, namely, abolitions, consolidations, conversions to nonprofit status and changes in CC charters. DBN (with support from COA) will also be responsible for improvements in accounting and auditing. The privatization program will be managed by COP and implemented by APT and other DEs. The program to improve the retained corporations will be implemented by GCMCC, with technical support from CAG. Finally, the TA program will be coordinated by NEDA. 3.44 Disbursements. The proceeds of the proposed Bank loan for the Reform Program would be disbursed against general imports based on a standard negative list which includes, inter alia, goods and services for military or paramilitary purposes or for luxury consumption. Both private- and public-sector imports would be eligible for financing. Statements of Expenditures would be used for contracts below US$2,000,000 equivalent. To expedite disbursements, a Special Account would be established in the Central Bank of the Philippines (CBP) with an initial deposit of US$12 million. The Bank would replenish this account on the basis of adequately supported withdrawal applications. Retroactive financing for up to $30 million would be used to reimburse eligible program expenditures incurred after July 31, 1987. The proposed loan is expected to be disbursed over a period of two and a half years. 3.45 Tranche Release Conditions. Considerable progress has already been achieved in project preparation, most notably, the establishment of an improved legal framework for the public corporate sector, the completion of all studies for the rationalization of the sector, the approval of the disposition recommendations for most GCs, the approval and establishment of adequate institutional mechanisms  - 32 - for the program (i.e., COP, APT, GCMCC, and CAG), including their staffing, budget, and operational guidelines, the approval of privatization plans, the initiation of corporate planning, the establishment of improved accounting and auditing standards and the satisfactory implementation of the privatization program in 1987. Based on these actions, the first loan tranche of US$75 million equivalent would be available for disbursement upon loan effectiveness. The second tranche (US$75 million equivalent) and third tranche (US$50 million equivalent) would be released after the timely completion of agreed actions described in the Development Policy Letter and the Action Plan and set out ir. the draft Loan Agreements. 3.46 SDecific conditions for the release of the second tranche of the loan include: (a) final approval of the disposition recommendations for all GCs (para. 3.08); (b) completion of all steps necessary to get in a vendible form and offer for sale 30 GCs targeted for privatZzation and representing in 1985 at least 20% of the gross value of the assets to be privatized of GCs (parn. 3.20); (c) finalization of an implementation plan for the relevant consolidation, regularization, conversion and abolition of about 100 GCs, and satisfactory progress toward amending the charters of these GCs (para. 3.21); (d) completion of a review of the charters of GCs, and the formulation of recommendations regarding membership of the boards of the retained corporations (para. 3.24); (e) finalization of an implementation plan to introduce computerization of accounting systems for GCs (para. 3.37); (f) approval of a corporate plan by the Board of Directors of five GCs (para. 3.32); (g) design of a performance evaluation and incentive system (para. 3.35); (h) appointment of adequate staff for GAG (para. 3.27); (i) satisfactory progress towards amendments of charters of GCs to incorporate the principles in para. 7 of the Letter of Development Policy (para. 3.23); (j) issuance of regulations on subsidies and loan guarantees for GCs (para. 3.23); (k) satisfactory progress towards establishing a corporate career executive service (para. 3.39); and  - 33 - (1) appointment of consultants with qualifications, experience and terms of reference agreed with the Bank for the TA (para. 3.41). 3.47 Specific conditions for the release of the third tranche include: (a) completion of all steps necessary to get in vendible form and offer for sale an additional 30 of the GCs targeted for privatization, with the cumulative total of 60 representing in 1985 at least 50% of the gross value of the assets to be privatized of GCs (para. 3.20); (b) finalization of an implementation plan for the relevant consolidation, regularization, conversion and abolition of the remaining GCs (para. 3.21); (c) implementation of relevant consolidation, regularization, conversion and abolition of CCs as per the agreed implementation plan, including satisfactory progress towards amendments of charters of such CCs (para. 3.21); (d) satisfactory progress in implementing recommendations from the review of memberships in Boards of Directors (para. 3.24); (e) Satisfactory progress towards amendments of charters of GCs to incorporate the principles in para. 7 of Letter of Development Policy (para. 3.23); gf) approval of a corporate plan by the Board of Directors of another ten GCs (para. 3.32); (g) introduction of a computerized accounting system for ten large GCs (para. 3.37); (h) introduction of a performance evaluation system for 15 large GCs (para. 3.34); and (i) satisfactory progress in the implementation of the TA (para. 3.41). 3.48 Procurement. Both private and public sector imports would be eligible for financing. Procurement will be through international competitive bidding (ICB) but with two exceptions: (a) procurement of commonly traded commodities can be undertaken through organized international commodity markets or other channels of competitive procurement acceptable to the Bank, in accordance with procedures acceptable to the Bank; and (b) contracts for goods estimated to cost less than US$5 million each may be awarded on the basis of normal procurement procedures of the purchasers of such goods acceptable to the Bank. 3.49 Audits and Accounts. The DOF will maintain financial records  - 34 - of all public sector imports under the program in accordance with sound accounting practices. Agreement was reached during negotiations that within six months after the end of each year DOF would furnish to the Bank an audit report detailing the imports financed under the loan, the Statements of Expenditures and the Special Account, as audited by independent auditors acceptable to the Bank. Social Impact. Benefits and Risks 3.50 The proposed program, in the short term, is likely to increase unemployment. While it is difficult at this stage to quantify the number of public sector jobs that may be lost, it is inevitable that a program that includes privatization, consolidations and abolition of enterprises will lead to layoffs. Recognizing this, especially in light of its successful experience with reform of the DBP and the Philippine National Bank (PNB), the Government is addressing the issue through the provision of special measures like high severance payments and early retirement plans, and, when applicable, with retraining programs to reduce the adverse financial impact on those affected. Because of these measures most of the privatization actions in 1987 have been implemented without significant problems or delays. These aspects are a main consideration irn the DE evaluation of the corporation and the negotiations with potential buyers of GCs to be privatized. These measures and the phased implementation of the reform program over the next five years will lessen the adverse impact of these required changes. It is also expected that private ownership of most of the industrial corporations will have a significant 4rpact in making these corporations more competitive and efficient, resulting in higher growth rates which would improve the economy and the employment at large. 3.51 The proposed Reform Program would benefit the Philippines by restructuring, strengthening and making its GCs more efficient. Its immediate benefits would appear in the budget, through the reduction of government grants and contributions resulting from the reduction in size and scope of government activity in the corporate sector, and the cash flows proceeding from the sales of assets of GCs. Longer-term benefits include better allocation and utilization of investment funds, and improved productivity and cost recovery. The establishment of corporate planning as well as a system for performance monitoring and accountability would foster an increase in efficiency and effectiveness of the GCs, improve the provision of public services, in particular to the low-income population, promote better evaluation of capital expenditures and improve macroeconomic planning. Moreover, in so far as the privatization program would lead to public share issues over the next five years, there will be an ir.*-rease in the supply of new equity securities which will contribute to the development of the domestic capital market. Given the size of the corporations, their importance in the economy, and their direct influence on the lives of the majority of the population, the improvements initiated through the Reform Program would contribute significantly to the economic growth and prosperity of the Philippines. 3.52 The proposed reform program introduces significant changes in  - 35 - the composition, organization, coordination, financing and management of GCs. Such changes are likely to be met with resistance from groups and individuals benefiting from the status quo. The privatization and reorganization of GCs would affect the labor force, thus initially creating adverse reactions. Such internal pressures could slow implementation and/or reduce the effectiveness of some parts of the program. Although the matn legal framework for the sector is already in place, some legislative action is still required, whose approval may delay setting in place the completed framework envisioned by the Government. To address these problems, and mitigate their possible adverse impact, the Government is educating the public on the need for the reforms, is planning for a phased implementation, and has introduced other compensatory measures such as early retirement packages and special severance payments. The above mentioned risks are also mitigated by the country consensus on the need to reform the government corporate sector, and the fact some of the most difficult steps (the approval of the main legal framework, the establishment and staffing of the required mechanisms, the required studies and rationalization, the decisions on the disposition of the government corporations, etc.) have been achieved before Board presentation. PART IV - WORLD BANt OPERATIONS 4.01 As of March 31, 1988, the Philippines had received 102 Bank loans (of which two were on Third Window terms) amounting to US$4,169 million and six IDA credits amounting to US$107 million. IFG gross investments as of January 31, 1988 totalled US$99.4 million and investments hold by IFC (outstanding) totalled US$66.4 million. The share of the Bank Group in total medium- and long-term debt disbursed and outstanding is currently about 13%, and its share in total debt service is about 18%. These ratios are expected to be about 15% and 12%, respectively, by 1990. Annex 2 contains a summary of IDA credits, Bank loans, and IFC investments as of March 31, 1988. 4.02 Bank Group lending to the Philippines expanded from an average of about US$90 million and four loans per year in FY71-75 to an average of about US$420 million and seven loans in FY80-84. However, the lending program decreased dramatically in FY85 and FY86 because of the limited scope for traditior.al project lending under the economic circusmstances then prevailing. Only two loans were made in FY86 for a total of US$151 million. Although the lending program was reduced in size during the stabilization period (1983-1986), the emphasis of the program ensured that greater weight was assigned to alleviate the adverse socioeconomic impact of the economic stabilization program. In FY87, the lending program consisted of three loans totaling US$342 million; the bulk of this was accounted for by the Economic Recovery Loan which provided quick-disbursing assistance in support of a program of structural reforms. These reforms focus on the public investment program, the financial institutions, the trade regime and the tax system. Other loans were to support an Economic Recovery Technical Assistance Project and a  - 36 - Provincial Ports Project. 4.03 The Bank has financed projects in virtually all sectors of the economy, with particular emphasis on agriculture which has accounted for almost one third of total Bank/IDA lending. Lending for industry, transportation, energy and social sactors followed in descending order. In agriculture, lending i-litially focused on expanding the irrigation system, credit programs, and other services to support rice production. The experience with irrigation has been positive with the establishment of a strong institution (the National Irrigation Administration) and increase in irrigated area, although cost recovery is still a problem. Efforts have also been made to diversify agricultural production through loans for tree crops, livestock, fisheries, and integrated rural development projects. In FY85, the Bank provided assistance under the Agricultural Sector/Inputs Project to support programs of policy and institutional reforms, and the Agricultural Credit Project to provide credit to agricultural producers and to help establish a framework for a financially sound rural credit system. 4.04 In the industrial and financial sectors, lending has supported policy reforms under the Government's structural adjustment program. Structural adjustment lending in 1980 and 1983 (US$502.3 million total), supported a series of reforms of the tariff structure, the system of industrial incentives, energy pricing and export promotion. An Industrial Finance Loan approved in FY81 supported improvements in financial sector policies, including liberalizing interest rates, reducing bank specialization and increasing the availability of longer-term funds. It also introduced a new institutional concept to broaden the reach of Bank lending by channeling loans through an "apex' unit in the Central Bank. In addition, the Bank has continued to provide financial support and technical assistance to small and medium industries. 4.05 In infrastructure, the Bank has supported a number of transportation projects (five highway projects, two rural roads projects, three ports projects and one shipping project). Tne Bank's role has been to assist the Government in the implementation of its program in the sector, with special emphasis on institutional issues and strengthening maintenance capabilities and rural development. The Second Rural Roads Improvement Project (FY86) was designed to alleviate poverty in rural areas by providing farmers easy access to markets and social infrastructure. To mitigate the social consequences of the stabilization program, Bank-supported projects in water, urban and regional development emphasized improvement of basic social services. Future objectives would be to continue to provide assistance to the sector institutions with which the Bank deals, assist them to formulate sector priorities and investment programs, and implement appropriate sector policies. 4.06 In the goverment corporate sector, Bank lending has supported measures to improve the operational and financial performance of public enterprises. The MWSS has received financing under the Metropolitan Manila Water Distribution Project to  - 37 - computerize its billing and collection operations to be able to handle rapidly increasing connections and reduce its arrears. The ongoing Communal Irrigation Development Project includes financing of a study to establish an integrated financial management and reporting system at the National Irrigation Administration to improve control over disbursements and collection operations. The Rural Electrification Project has financed the establishment of a planning unit at the National Electrification Administration to help rural cooperatives prepare short- and medium-term supply and demand estimates and orient their operations accordingly. For the NPC, the Seventh Power Project has financed a training center to upgrade the technical and managerial/supervisory capacities of its rapidly expanding staff. Under the Provincial Ports Project, agreement was reached with the Government to authorize the PPA to operate as an autonomous corporation with full control over its resources; this will enable the PPA to maintain and rehabilitate its infrastructure and equipment in a timely manner. In connection with the proposed Housing Sector Reform operation, the Government has enacted legislptLon to rationalize sector institutions and financing, including, jinter alia, divestiture of the subsidiaries of the Human Settlements Development Corporation, limiting the functions of the NHA to low-ccst shelter production, and establishing a housing council to coordinate sector activities. 4.07 The FY88-89 lending strategy for the Philippines emphasizes operations that would address essential macroeconomic and sectoral policy reforms, rehabilitation and maintenance of existing infrastructure, and priority activities that would minimize the need for budgetary support. The framework for macroeconomic reform has been provided under the ERL which is supporting Government efforts to develop and implement appropriate policies for tax reform, trade liberalization, and rationalization of government financial institutions, and to restructure the public investment program. At the sectoral level, in addition to this proposed loan for reform of GCs, a Housing Sector Reform operation is being processed as mentioned in the preceding paragraph. It would address institutional and financial policy reforms to reduce reliance of the sector on Government support. Other proposed operations include a loan for irrigation operations to help define a realistic program for rehabilitation and maintenance of the irrigation system; a project for further development of geothermal power generation; a loan in support of small and medium scale industry; and a project for the development of health care, with particular emphasis on high impact programs.  - 38 - PART V - RECOMNENDATION 5.01 I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Washington, D.C. May 20, 1988  -39- ANNEX I imPM CPLZA GM La USM 54 A. fta eg Game Dwatia he*&ctm 3. Osuah Satur C par ammm (fes amms price data) Clun amunts prcice date) INS5 .1973 1950 Lift iII Lilp L9ES-7i 1973-S0 t9ue-E ins5 tn4 :vo.. Damst. lra&mt o-p. 100.0 100.0 100.0 100.0 ioa.a 100.0 3.4 6.3 -0. 7 -46 1 "at Imilren Tamse GO4 3.3 9.7 8.1 6.0 6.7 I... . AartCULtUse 25.9 29.3 23.3 2.53 26.7 26.1 4.1 5.0, 1.7y 3.5 3.4 Zoaa:try 27.9 32.2 36.6 54.4 22.9 12.4 7.4 7.8 -;4.3 -10.2 -3.a Cof *1Sth Ibaudafauar ) t 19.5 25.2 24.4 25.4 24.7 24.7 3.5 5.7 -1.3 -7.7 a0B Serums" 44.3 37.5 40.1 39.7. 4,.4 '1.5 4.3 5.8 -G.m -4.7 2.6 Rasourcea LinLes 0.0 3.5 -3. 7 -0.1 2.0 6.1.. . .. .- KiqWar of G5.J 17.2 22.0 20.2a 2.3 20.6 24.7 1.3 6.2 2.9 -7.2 21. 6 Lorns of CCVS 17.2 38.5 26.0 21.9 17.0 18.5 3.1 5.5.5 5 -31 25.7 Total EqsSlatm. iaa.a wi. 101.7 100.1 r7.0 n.e s.t 6.5 -2.3 -3.16 L. Total CeautaM 35. 4 75.1 75.3 61.2 33.9 53.3 5.3 5.0 2.. - . 2' PrintCs Cm,VatLIoI 76.4 66. 67.2 7t.6 77.0 75.8 5.6 5.1 2.4 -6. 5 . Canceal 9.0 8.6 3.0 i.e l.a 7.7 3.4 4.2 -0.6 -1.2 '9 fCroea DuantIin. 20.3 20.2 30.7 17.0 14.0 13.2. 4.5 11.0 -17.2 -21. 5 -7 2 rlis lamsso 17.6 U3.S 25.7 19k5 14.3 2.2.9 3.5 12.6 -L2. -34.4 -1'.'.i Che. ia Stat .3.2 4.4 5.0 4L.3 -0.3 0.2 . Gosso Danste Sawla, 20.8 25.7 25.0 16.9 17.0 19.3 5.6 7.3 -10.5a -0.9I 21.3 Net Faetoer hoes -0.5 -0.1 -0.1L -2.4 -2.4 -2O 0 Net Cuans Tzinsfsrs .. 2.1 1.3 1.2 1.2 1.4 . Owes Retinal. Saving ~~~~. . 25.7 20.2a 15.7 15.7 13. 14.4 7.1 -18.4 4.1 38. Tma milline of LW'a 1965 1973 1930 1914 1= 1tuft (at teatsm 191 primal -- - - - - Gros Demsic ?rohwct 113 175 26 283 253 25 3.4 6.3 -0.7 -'.6 1.1 Cawlrty co Zmnor 23 45 54 SG 53 S3 4.2 4.4 3.4 -9.7 13.8 Tomn of Tutui AMuStn 2 Li a L -1 12 . a Dmanti Isco 114 1I" 265 20n 255 270 5.0 5.53 -.6' -5. 2 6 a NarLeat Pro6ast 112 174 265 255 245 249 .5. 6.2 -1.6 -4.2 1. Gigs. NatLwta Inoh 12 115 265 256 244 261 5.9 5.5 -1.5 -4.3 7 -(1930- ( U 100)------ ---- -------Tnflatt Rastes CI P.aj- ----- C. PrIce ISdlem Im 1902 195 194 1935 imp 1935-73 1973-S 1950-fl 1iss h"p Canmer Prices (ifS 64) 100.0 125.7 129.5 209.7 258.2 20. 3 5.4 11.3 21.1 23.1 3.3 miasMa&X PrLces (IFS 63) 100.0 126.6 1*6.6 245.8 290.5 291.7 L0.3 12.4 24.9 15. 2 0.; mnpLLeL Mr Datlator 100.0 120.1 134.3 201.7 225.1 242.6 3.8 11.7 2.9.3 15.2 1.7 nspLLeit tmpszdzeua OmfliLtar 100.0 121.9 134.6 201.1 240.0 235.9 8.4 12.4 19.3 1.9.3 -1.7 ). Otbor Indictors 1963-f3 1973-S 1930-85 ------------------- ;Crwch Rates (I P.&.): POpL. S2.9 2.8 2.5 Data an rim Ectnac Todicataor tables Labor Fores .. . . shmAd