PHILIPPINES QUARTERLY UPDATE Sustaining Growth in Uncertain Times December 2011 65750 PHILIPPINES QUARTERLY UPDATE Sustaining Growth in Uncertain Times December 2011 World Bank Office Manila www.worldbank.org.ph Sustaining Growth in Uncertain Times Preface The Philippines Quarterly Update provides an update on key economic and social developments, and policies over the past three months. It also presents �ndings from recent World Bank studies on the Philippines. It places them in a longer-term and global context, and assesses the implications of these developments and policies on the outlook for the Philippines. Its coverage ranges from the macro-economy and �nancial markets to indicators of human welfare and development. It is intended for a wide audience, including policymakers, business leaders, �nancial market participants, and the community of analysts and professionals engaged in the Philippines. The Philippines Quarterly Update is a report of the World Bank’s Philippine Poverty Reduction and Economic Management (PREM) team. It was prepared by Karl Kendrick Chua (Country Economist and Task Team Leader), Marianne Juco (Research Analyst), Nenette Santero (Program Assistant) and Soonhwa Yi (Economist), under the general guidance of Rogier Van Den Brink (Lead Economist). The �ndings, interpretations, and conclusions expressed in this Update are those of World Bank staff and do not necessarily reflect the views of its management, Executive Board, or the governments they represent. For information about the World Bank and its activities in the Philippines, please visit www.worldbank.org.ph. To be included in the email distribution list of the Philippines Quarterly Update and related publications, please contact Nenette Santero (nsantero@worldbank.org). For questions and comments on the content of this publication, please contact Karl Kendrick Chua (kchua@worldbank.org). Questions from the media can be addressed to David Llorito (dllorito@worldbank.org). Cover photo credits: 1) Nikki Sandino Victoriano “Doctor to the barrio�, 2) Eric Le Borgne “Construction�, 3) Soonhwa Yi “Rice Fields�, and 4) Jurgen Dezso “Parol�. i PHILIPPINES QUARTERLY UPDATE - December 2011 Table of Contents Preface i Executive Summary iv Recent Economic and Policy Developments 1 Output and Demand 1 Employment and Poverty 2 External Accounts 3 Financial Markets 5 Inflation and Monetary Policy 7 Fiscal Policy 8 Prospects 11 Output and Demand 11 Employment and Poverty 12 External Accounts 12 Inflation and Monetary Policy 13 Fiscal Policy 14 Special Focus 1 15 Raising Excise Taxes on Tobacco and Alcohol Products 15 Special Focus 2 24 Philippine Exports: Where Do They Stand? 24 Data Appendix 30 Selected Special Focus from Previous Quarterly Updates 32 Selected Recent World Bank Publications on the Philippines 35 List of Figures Figure 1. Private Consumption and Inventory Investment 1 Figure 2. Public Construction Growth has Improved 1 Figure 3. Services Buoyed Growth Given Insipid Contributions from Industry and Agriculture 2 Figure 4. Poverty and Hunger Rose in September 2 Figure 5. Remittance Growth has Slowed as Deployment Growth Moderates 4 Figure 6. Respectable Growth in Non-electronics and Services Exports 4 Figure 7. Exports have Fallen to Levels Last Seen in 2008 5 Figure 8. Reserves have Remained Healthy and Continued to Grow in November 5 Figure 9. Sovereign Spreads Reacted to the Euro Zone Crisis 7 Figure 10. Firms have Increased Leverage Given the Low Interest Rate Environment 7 Figure 11. Net Foreign Buying Lifted the PSEi 8 Figure 12. Food and Utility Inflation 8 Figure 13. Tobacco Retail Prices and Taxation Across Income Groups 16 Figure 14. Total Tax Burden as a Share of Retail Sales Price for Most Sold Brand 16 Figure 15. Cross Country Comparisons: Cigarette Price per Pack, and Tax as Percent of the Price 16 Figure 16. Cross Country Comparisons: Price per Pack of Cigarettes 17 Figure 17. Cross Country Comparisons: Minutes Worked to Purchase a Pack of Cigarettes 17 Figure 18. The Share of Alcohol Spending in Total Household Spending Falls as Income Rises 18 Figure 19. Alcohol Excise Collection 18 Figure 20. Share of Key Exports 25 Figure 21. Top Ten Exporters of Semiconductors 25 Figure 22. Export Sophistication 27 Figure 23. Philippine Merchandise Export has been Buoyed by Non-electronics 27 Figure 24. Declining Imports of Electronic Parts and the Book-to-Bill Ratio 29 ii Sustaining Growth in Uncertain Times List of Tables Table 1. Foreign Claims on Crisis-Affected Economies 6 Table 2. National Government Fiscal Gap 9 Table 3. Summary of Measures to Improve Transparency and Accountability 10 Table 4. Retail Sales Price, Excise Burden and Total Tax Burden in Selected Countries 16 Table 5. Excise Tax Rates in Selected ASEAN Countries 18 Table 6. Tobacco Excise Reforms: Scenario and Projected Revenue 20 Table 7. Tobacco Excise Levels and RSPs for a Uni�ed Rate by 2014 (Scenario 9) 21 Table 8. Alcohol Excise Rates and RSPs Scenario 7 21 Table 9. Alcohol Excise Reforms: Scenario and Projected Revenue 22 Table 10. Top Philippine Export Destinations (in Percent of Total) 25 Table 11. Comparative Survival Propensity of ASEAN Countries 28 Table 12. Estimated Elasticities 29 Table 13. Estimated Coefficients for the Input Models 29 Table 14. Philippines: Selected Economic Indicators, 2008-13 30 Table 15. Philippines: National Government Cash Accounts (GFS Basis), 2008-11 31 iii PHILIPPINES QUARTERLY UPDATE - December 2011 Executive Summary After a strong rebound in 2010, Philippine economic growth slowed by more than half to 3.6 percent in the �rst three quarters of 2011. Slower third quarter (Q3) growth of 3.2 percent was the result of signi�cant contractions in exports and public investment. The contraction in exports largely reflected weaker demand in advanced economies while public investments continued to shrink in part because of measures to improve accountability of public spending. On the production side, industrial and agricultural activities were sluggish, leaving the services sector to buoy growth. To improve growth outcome in the remainder of the year, the government announced a PHP 72 billion (about 0.7 percent of GDP) disbursement acceleration plan to ensure that budgeted items are spent by year end. The country’s external position remains at healthy levels, thanks to robust remittances and capital inflows. Remittances continued to fuel private consumption, which grew by over 7 percent in Q3. Net foreign portfolio investments from January to October increased to USD 3.4 billion, notwithstanding large capital outflows in September due to heightened risk aversion. Sustained inflow of portfolio investments and remittances has led to higher reserves accumulation. Meanwhile, external debt continued to decline towards 34 percent of GDP (World Bank de�nition). Monetary policy remains accommodative, though higher liquidity, rising credit growth, and slower economic growth are all posing challenges to the authorities. CPI inflation through November averaged 4.8 percent, within the central bank’s target range of 3 to 5 percent for the year. Following two consecutive hikes in policy rates earlier in the year, the central bank left policy rates unchanged in the second half of the year and instead raised the reserve requirement twice. Further liquidity management measures are expected in case of stronger portfolio inflows and inflationary pressures. The national government’s �scal de�cit markedly fell to 0.8 percent of GDP in the �rst ten months largely on account of under-spending. But once institutional reforms to improve accountability are in place, spending is expected to fully recover at cost-effective levels with more resolute impact on the country’s growth and development. On the revenue side, tax revenues are projected at 12.4 percent of GDP on account of improved tax administration. To raise more revenues, the executive has submitted a proposal to congress to raise excise taxes of alcohol and tobacco products. To plug future leakages in tax revenues, the executive is working with congress to pass the �scal responsibility and �scal incentives rationalization bills. The Philippines is relatively well-positioned to weather shocks emanating from the current global turmoil given its strong macroeconomic fundamentals, and regulatory reforms and prudential measures instituted following past crises and slowdowns. Overseas Filipino workers’ large remittance inflows have shown a counter-cyclical pattern and have insulated the country from external imbalances. The �nancial sector’s conservative stance throughout the preceding decade has helped to ensure healthy balance sheets. The corporate sector, for the same reason, also exhibited no systemic vulnerabilities. Growth is projected to moderate to 3.7 percent in 2011 and 4.2 percent in 2012. The Philippines is bene�tting from relative political stability and an improved macroeconomic position. However, key downside risks to growth remain such as increased uncertainties about global demand and a possible further slowdown in investments and public spending, due to the government’s emphasis on the quality of budget execution. Portfolio inflows are expected to remain strong, while FDI is projected at moderate levels. Consumption is expected to drive overall growth given strong remittances. The current account is projected to remain in healthy surplus, driven by sustained remittances despite a widening trade de�cit as exports weaken. Growth prospects in the medium to long-term can be sustained at above 5 percent provided that reforms to address structural bottlenecks are implemented to raise overall competitiveness. These include reforms to i) raise revenues efficiently and equitably, beginning with excise taxes and �scal incentives rationalization, ii) improve the quantity and quality of public spending, in particular infrastructure and human capital investment, iii) enhance governance, and iv) reduce the cost of doing business. A stronger structural underpinning would allow the country to deal with shocks more effectively, achieve more inclusive growth, and reduce poverty at a faster rate. iv Sustaining Growth in Uncertain Times Recent Economic and Policy Developments Output and Demand 1. After a strong rebound in 2010, Philippine economic growth slowed by more than half to 3.6 percent in the �rst three quarters of 2011, bringing year to date growth below the government’s revised target of 4.5 to 5.5 percent for 2011. 1 Third quarter (Q3) growth of 3.2 percent was driven by private consumption and inventory build-up, which grew by 7.1 and 147.7 percent respectively (Figure 1). The country’s slower expansion places it behind its neighbors with Indonesia, Vietnam, and Singapore growing above 6 percent, Malaysia at 5.8 percent, and Thailand, which was devastated by massive flooding in recent months, at 3.5 percent. 2. Slower third quarter growth was the result of further contractions in exports and public investment. The contraction in exports at -14.8 percent largely reflected weaker demand in advanced economies as their �scal conditions deteriorated—this amid the recovery of the Japanese supply chain following the March earthquake and tsunami. 2 On the domestic side, public investments continued to shrink, albeit by a smaller 21 percent from almost 60 percent in the second quarter (Q2) (Figure 2). This improvement, together with sizable investments in durable equipment in the telecoms and transport sectors, pushed up �xed investment growth to positive territory after falling by almost 10 percent in Q2. To improve growth outcome in the remainder of the year, the government announced a PHP 72 billion (equivalent to 0.7 percent of GDP) disbursement acceleration plan to ensure that budgeted items are spent by year end.3 Figure 1. Private consumption and inventory investment Figure 2. Public construction growth has improved though were robust amid sign�cant deterioration in still in negative territory while private construction net exports. growth appears to be tapering. Contribution to YoY GDP growth Construction Sector 15 16 80 Private (lhs) Public (lhs) percentage point 10 Public growth Private growth 12 40 5 percent of GDP percent 0 8 0 -5 -10 4 -40 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 0 -80 2009 2010 2011 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Discrepancy Net Exports Investment Govt Consumption 2009 2010 2011 Private Consumption GDP growth Source: National Statistical Coordination Board (NSCB) Source: NSCB 1 The economy grew by 4.6 percent in the �rst quarter. Second quarter growth was revised downward from 3.4 to 3.1 percent on account of slower investment growth, which was revised from 0.9 to -7.7 percent. 2 See Special Focus No. 2 on exports for more discussion on the state of Philippine exports. 3 This includes public works and agriculture infrastructure, housing, relocation and resettlement, funding support to local government units, rehabilitation of railways, health care insurance, and human resource development training. As of early November 2011, 60 percent of the PHP 72 billion has been released. 1 PHILIPPINES QUARTERLY UPDATE - December 2011 3. On the production side, industrial and agricultural activities were sluggish, leaving the services sector to buoy growth. The industrial sector reflected the contraction in exports and construction. Among the sectors, only manufacturing contributed to growth, albeit modestly at 0.7 percentage points (ppts) but this was offset by weak construction, which subtracted an equal amount to industrial growth. Agriculture growth slowed noticeably from 8.2 percent in Q2 to only 1.8 percent in Q3, as the country was buffeted by severe weather disturbances. Aided by robust remittances, the services sector continued to be the main driver of growth, contributing 3 ppts to GDP as real-estate, trade, and other services expanded further (Figure 3). Figure 3. Services buoyed growth given insipid Figure 4. Poverty and hunger rose in September as typhoons damaged crops and livestock, raising contributions from industry and agriculture. prices and destroying jobs. Supply Side: Contribution to Growth Poverty and Hunger Incidences 70 30 8 Poverty (rhs) Hunger: Overall 65 Hunger: Moderate Hunger: Severe 25 percentage point 6 4 60 20 percent percent 2 55 15 0 50 10 -2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 45 5 40 0 2009 2010 2011 May-05 Dec-04 Dec-05 Dec-07 Dec-08 Oct-09 Mar-10 Mar-11 Jun-03 Nov-03 Nov-06 Jun-04 Jun-06 Jun-07 Jun-08 Jun-09 Sep-10 Sep-11 Agriculture Industry Services Source: NSCB Source: Social Weather Station (SWS) Employment and Poverty 4. The quality of employment is lackluster and is largely inelastic to economic growth owing to structural issues in the labor market. In the most recent Labor Force Survey (October round), the unemployment and underemployment rates improved to 6.4 and 19.1 percent, respectively, from 7.1 and 19.6 percent in the same period last year. However, the quality of employment has not improved much as the stronger headline numbers were mainly driven by non-wage earners and low productivity jobs. Structurally, the composition of employment has barely changed even during high growth years. The share of wage and salary earners (a proxy for formal sector employment) has remained at around 53 percent of total employment while the shares of own account workers and unpaid family workers (proxies for informal sector employment) have stayed around 35 and 12 percent respectively. 5. Employment by sector likewise exhibits the same rigidity. In the last �ve years, there have been no signi�cant shifts in the employment shares of agriculture, industry, and services (roughly stable at around 34, 15, and 51 percent respectively). Small fluctuations between agriculture and services largely reflect movements between farm and off-farm employment depending on the crop season. The services sector remains the main source of employment, of which the informal sector accounts for a huge majority. In 2011, services provided about 70 percent of new jobs, equivalent to about two-thirds of the new entrants to the labor force. 2 Sustaining Growth in Uncertain Times 6. Self-rated poverty and hunger incidences4 have been on the rise, on the back of lackluster employment generation and some increases in food prices. More than half of the population, equivalent to 10.4 million households, considered themselves poor in Q3 (Figure 4).5 Hunger incidence likewise increased from last year, with almost one-fourth of the population experiencing hunger. Record high poverty and hunger incidences were most evident in Luzon (outside the National Capital Region), which was hit hard by recent typhoons and flooding. Rising food inflation, which reached a high of 6.2 percent, and higher underemployment in previous quarters were identi�ed as causes of rising hunger.6 External Accounts 7. The country’s external accounts remain at healthy levels, thanks to robust remittance and capital inflows. As of October 2011, remittances grew by 7 percent to USD 16.5 billion, equivalent to about 6.5 percent of GDP. Through October, remittances from Europe, East Asia, and the Middle East excluding Saudi Arabia continued to grow at above 6 percent. In Saudi Arabia, the Nitaqat program, which limits the issuance of new work permits to Filipinos, has signi�cantly slowed down deployment and, consequently, remittance growth to only 0.4 percent. Moreover, a new Philippine law that bars deployment of workers to countries which failed to sign international conventions protecting the rights of migrant workers may further pull down remittance growth once implemented.7 Nonetheless, higher deployment to East Asia should limit these negative impacts on remittances (Figure 5). 8. Electronics exports performance failed to recover following the Japanese disaster as demand from advanced economies weakened signi�cantly in Q3. From a record high growth of 50.3 percent in September 2010 (albeit coming from a low base in 2009), electronics export growth gradually fell and entered negative territory in February this year, culminating in a contraction of 36.5 percent in October. The slump in electronics exports was driven by weak demand for semiconductors, which fell by 50 percent.8 In contrast, non-electronics and services exports continued to perform well, growing by 23.8 and 8 percent through October and September (most recent data available), respectively (Figure 6). In particular, services exports, led by business process outsourcing, have proven to be counter-cyclical in the past crisis. 9. On the other hand, imports continued to grow, albeit at a slower rate, resulting in a wider trade de�cit (Figure 7). Merchandise imports grew by 11.7 percent in September (9.6 percent in Q3) thanks to a positive reversal in capital goods imports, which began to grow in August following a seven-month contraction. The rebound in capital imports was driven by high power and specialized machinery, and aircrafts, boats, and ships importation, all of which suggest a near to medium-term expansion of investment and production capacity. 4 These results were taken from the Social Weather Station survey conducted during September 4-7, 2011 using face-to-face interviews of 1,200 heads of households in Metro Manila, the rest of Luzon, Visayas, and Mindanao. The survey questions cover the household’s own experience of hunger, poverty, and food poverty. 5 Self-rated poverty incidence in September 2011 reached 52 percent, nine percentage points higher than the through in March 2010 (a record low since 1987). 6 According to a recent research, a one-time increase in food prices can result in an increase in hunger incidence that will last for �ve quarters, while a one-time increase in underemployment can result in an increase in hunger incidence for two quarters. Food inflation averaged 5.5 percent in the �rst three quarters while underemployment rate increased to 19.1 percent in July 2011 (latest available data) from 17.9 percent last year. These developments could explain the rise in hunger incidence, pointing to the limited buffer and usable assets of the poor to cope with shocks (Mapa, D., F. Han, and K. Estrada. (2010) “Food Inflation, Underemployment and Hunger Incidence in the Philippines: A Vector Autoregressive (VAR) Analysis.� Transactions of the National Academy of Science and Technology (Philippines), 32(1)). 7 On the other hand, this could just be a temporary slowdown as the government has been approached by some countries in the ban list with proposals on bilateral labor agreements regarding overseas Filipino workers’ (OFW) welfare protection. 8 Source: Semiconductor and Electronics Industries in the Philippines, Inc. (SEIPI) 3 PHILIPPINES QUARTERLY UPDATE - December 2011 Figure 5. Remittance growth has slowed as deployment Figure 6. Respectable growth in non-electronics and services exports compensated for poor growth moderates. electronics exports. Land-based OFW deployment and remittance Exports Growth 30 1600 120 25 80 1200 20 40 percent levels percent 15 800 0 10 400 -40 5 -80 0 0 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 2005 2006 2007 2008 2009 2010 YTD 3Q11 OFWs deployed ('000) Remittances ('0000, USD) Electronics Non-electronics Services exports Deployment growth (lhs) Remittance growth (lhs) Sources: National Statistics Office (NSO) Source: Philippine Overseas Employment Agency (POEA) Bangko Sentral ng Pilipinas (BSP) 10. Despite greater volatility, the �nancial accounts expanded following recent sovereign credit rating upgrades and risk aversion in advanced economies. Net foreign portfolio investments (FPI) from January to October 2011 increased to USD 3.4 billion against USD 2.5 billion last year and were invested mostly in stocks and government bonds.9 The Philippines saw rapid capital outflows in September as investor risk aversion escalated on the back of deteriorating conditions in Europe, though this was quickly reversed in the following months. Foreign direct investment (FDI) inflows of USD 671 million through September remained weak as in previous years, owing to investor risk aversion and the country’s weak investment climate. 11. Sustained inflows of portfolio investments and remittances have enabled the country to continue accumulating reserves. GIR reached USD 76.4 billion in November – 25 percent higher than the country’s outstanding external debt as of August, and can cover 11.2 months of imports or 645 percent of the country’s short-term external liability by residual maturity. Similarly, liquid reserves as measured by the forward book of the central bank amounted to USD 7.7 billion in October (Figure 8). Meanwhile, total external debt continued to decline to around 35 percent of GDP as of August (World Bank de�nition). 9 Investments in equities and government securities registered 26 and more than 300 percent growth, respectively. 4 Sustaining Growth in Uncertain Times Figure 7. Exports have fallen to levels last seen in 2008. Figure 8. Reserves have remained healthy and Imports continued to expand away from the continued to grow in November. crisis trough. Balance of Trade, 3 MMA 1/ Gross International Reserves 6 0.5 105 Months of import (rhs) 90 ST external debt cover (rhs) 1/ 12 NIR + Forward Books (lhs) - 75 GIR (lhs) 4 billion USD billion USD billion USD 60 8 (0.5) 45 2 30 4 Exports (1.0) 15 Imports Trade Balance (rhs) - 0 0 (1.5) May-11 May-09 May-10 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Nov-10 Nov-11 Nov-09 Jan-08 Apr-08 Jan-09 Apr-09 Jan-10 Apr-10 Jan-11 Apr-11 Jul-08 Jul-09 Jul-10 Jul-11 Oct-08 Oct-09 Oct-10 Oct-11 Source: NSO Sources: BSP 1/Three month moving average 1/ Short-term debt by residual maturity Financial Markets 12. Improved macroeconomic fundamentals, recognized by three credit rating upgrades in the past year, have helped to strengthen the peso, raise the stock market index, and lower sovereign borrowing spreads. Beginning late-2010, the Philippines’ sovereign credit rating was upgraded by Fitch Ratings to one notch below investment grade, and by Moody’s and Standard & Poor’s to two notches below investment grade.10 As a result, sovereign spreads fell to an average of 200 basis points from 300 basis points in 2009 and as high as 600 basis points11 during the height of the 2003 �scal crisis (Figure 9). This together with strong market liquidity has enabled the government to reduce its borrowing cost as reflected in recent Treasury bond auctions which saw long-term rates falling to around 5-6 percent and the completion of the government’s 2011 borrowing requirements below programmed cost. 13. The core �nancial system is sound and generally resilient to a wide range of risks. Direct exposure of Philippine banks to PIIGS’s12 sovereign debt is very small, although indirect exposures through other European banks13, which comprise almost 70 percent of claims on the Philippines (higher than exposures to US and Japanese banks combined), can have a signi�cant impact on Philippine �nancial stability should the crisis escalate (Table 1). At any rate, the Philippine banking system exhibits improving asset quality and healthier balance sheets through the �rst three quarters of 2011. Non-performing loans, non-performing assets, and distressed assets remain low. The non-performing loan coverage is currently above 100 percent while the past due and loan loss ratios (i.e., expense allowance for bad loans) are on a decline and currently below 5 percent. Finally, the capital adequacy ratio of over 15 percent remains well above regulatory requirements. 10 Fitch Ratings upgraded the country’s long-term foreign currency issuer default rating (IDR) from BB to BB+ (one notch below investment grade) and the country’s long-term local currency IDR and country ceiling to BBB- from BB+. Moody’s upgraded the Philippines’ ratings to Ba2 from Ba3 (two notches below investment grade). Standard & Poor’s upgraded its foreign currency denominated credit rating from BB- to BB, one notch higher from its previous rating bringing it to two notches below investment grade. 11 Following global developments, spreads temporarily increased in September to around 300 basis points before normalizing in October. 12 This refers to Portugal, Italy, Ireland, Greece, and Spain. 13 This includes United Kingdom (UK). 5 PHILIPPINES QUARTERLY UPDATE - December 2011 14. With increasing liquidity, domestic interest rates have remained low. The 91-day T-bill rate hovered at around one percent while lending rates have fallen to 5-7 percent. As a result, bank lending (net of RRPs14) and private credit continued to grow by above 15 percent in September. The manufacturing, utilities, and real-estate sectors were the principal drivers of credit growth (Figure 10). Household credit growth, including credit card loans, remained below pre-crisis highs, growing by about 14 percent in Q3 from a high of 23 percent in 2008. The central bank’s special deposit account (SDA) grew by 78 percent in the �rst nine months of the year to PHP1.6 trillion given negative real interest rates of banks. An acceleration of the public-private partnership (PPP) program as well as improvements in the investment climate should help divert the large stock of SDA to useful investments. Table 1. Foreign claims on crisis-affected economies and total claims on the Philippines (USD billions) All banks European Japanese UK USA Total exposure of foreign banks to crisis-affected economies Foreign Claims 1,275 1,155 48 112 61 Portugal, Italy, Greece (PIG) % Exposure 4.7 6.1 1.8 2.7 1.7 Foreign Claims 1,681 1,481 71 175 114 Italy and Spain % Exposure 6.2 7.8 2.7 4.2 3.2 Portugal, Italy, Ireland, Foreign Claims 2,484 2,178 95 354 181 Greece, Spain (PIIGS) % Exposure 9.1 11.5 3.6 8.5 5.2 Total exposure of foreign banks to Philippine banks Total Claims 33 15 4 7 8 Claims on the Philippines % Exposure 100 47 11 22 23 Source: Bank of International Settlements (BIS) 15. The stronger peso has helped to contain inflation, although the associated influx of short-term capital has also raised policymakers’ concerns about inflationary risks and sudden reversals. The exchange rate remains market-driven with interventions limited to smoothing exchange rate volatility (e.g., the forward foreign exchange swap). While the peso depreciated to PHP 43.2 against the USD in November from PHP 42.4 in August, it remains in line with fundamentals and exporters still �nd the peso’s strength a hindrance to export growth. In October, the BSP imposed a higher capital charge on banks’ holdings of non-deliverable forwards (NDFs) to tame speculative foreign exchange transactions.15 In November, the Monetary Board further liberalized and simpli�ed its foreign exchange regulations to improve efficiency of foreign exchange transactions.16 14 Reverse repurchase placements (RRP) with the BSP 15 Earlier this year, banks have agreed to voluntarily limit their NDF positions, thereby reducing NDF volumes by 20 percent. Following this move, the central bank in June required banks to report their NDF transactions daily instead of weekly in order to closely monitor the NDF market and curtail exchange rate volatility. 16 The new regulations aim to facilitate i) corporate access to foreign exchange market through formal (from the previous parallel/informal) markets, and ii) residents’ and non-residents’ transactions through the banking system to improve data capture of such transactions. 6 Sustaining Growth in Uncertain Times 16. The Philippine equity market, being a high beta17 market, was not spared from the volatility caused by the Euro Zone debt woes. The Philippine stock exchange index (PSEi) fell 7.6 percent to around 4,100 in October from a high of 4,400 in July, driven to a large extent by net foreign selling which amounted over USD 200 million in August and September. After the initial shock, the index corrected, steadily returning to the 4,300 level in end-October and is consistent with the trends in other Asian markets. Net foreign buying equivalent to around USD 340 million buoyed the PSEi in the last two months, closing at nearly 4,300 in end-November (Figure 11). Figure 9. Sovereign spreads reacted to the Euro Zone Figure 10. Firms have increased leverage given the crisis but are generally stable and low. low interest rate environment. The exchange rate remains stable. Sovereign Debt Spread and Foreign Exchange Rate Growth in Production Loans 600 52 60 (3 MMA1/ percent change) 48 30 400 percent basis points 44 0 200 40 -30 May-10 May-11 Mar-10 Mar-11 Jan-10 Jul-10 Jan-11 Jul-11 Sep-10 Nov-10 Sep-11 PHL EMBI (lhs) PHP/USD 0 36 Manufacturing Electricity, Gas & Water Mar-09 Mar-10 Mar-11 Jul-09 Jul-10 Jul-11 Nov-10 Nov-11 Nov-08 Nov-09 Real Estate Total Production loans Sources: BSP Source: BSP and World Bank 1/ Three month moving average Inflation and Monetary Policy 17. CPI inflation reached 4.8 percent through November, near the high-end of the central bank’s target range of 3 to 5 percent. October inflation rose to 5.2 percent on account of higher food and utility prices given supply constraints before slowing to 4.8 percent in November (Figure 12). Food inflation spiked once again in October to 5.7 percent after decelerating from a high of 6.2 percent in May as a result of flooding in Northern Luzon. In November, food inflation slowed to 4.8 percent, the lowest for the year. The Thai flood is expected to have minimal impact on imported rice prices thanks to Thailand’s ample buffer stock. In addition, India’s provisional lifting of its rice exports ban and expected increase in Vietnam rice exports next year should provide adequate supply.18 Utility prices increased in October by 6.5 percent following hikes in generation rates and power supply disruptions caused by ongoing maintenance work and damaged power plants due to recent typhoons. Like food, it also decelerated in November as supply began to normalize. Other measures of inflation such as the producer, wholesale, and construction price indices show relatively low and stable prices. Noteworthy is the price of cement, which has contracted by 6.3 percent from last year following weak construction demand. 17 This refers to markets that are highly correlated with the US stock market. 18 Source: United Nations Food and Agriculture Organization (UNFAO) 7 PHILIPPINES QUARTERLY UPDATE - December 2011 18. Monetary policy remains accommodative though higher liquidity, rising credit growth, and slower economic growth are all posing challenges to the authorities. Following two consecutive policy rate hikes earlier in the year, the central bank left policy rates unchanged between June and early December. Instead, it raised the reserve requirement twice to 21 percent to better manage liquidity growth. In October, the BSP increased the market risk weight of NDFs as a pre-emptive measure to curb speculation against the peso through the NDF market. According to the BSP, further liquidity management measures may be used, including curtailing banks’ NDF operations, in case of stronger portfolio inflows and inflationary pressures. Figure 11. Net foreign buying lifted the PSEi Figure 12. Food and utility inflation were key back to the 4,300 level. drivers of CPI inflation in 2011. Stock Market Performance Contribution to YoY Inflation 4800 12 6 Others Transport Net Foreign Buy (rhs) PSEi 10 Fuel, Light and Water Food and Beverage 4400 8 Inflation Rate 6 billion PHP 4 4000 4 percent 2 3600 0 2 -2 3200 -4 7/16/2011 7/31/2011 8/15/2011 8/30/2011 9/14/2011 9/29/2011 10/14/2011 10/29/2011 11/13/2011 11/28/2011 7/1/2011 0 Aug-11 Apr-11 Jan-11 Feb-11 Sep-11 Jul-11 Nov-11 Nov-10 Jun-11 May-11 Dec-10 Mar-11 Oct-11 Oct-10 Source: CEIC Source: BSP 19. Fiscal Policy 19. National government spending remained weak in Q3 despite some efforts to accelerate disbursement. Total spending declined by 5.3 percent through October, resulting in a budget de�cit of only 0.8 percent of GDP as opposed to above 3 percent of GDP in the same period last year. Capital outlay was 30 percent below programmed levels and priority PPP projects have stalled given government decision to review all projects for efficiency and cost considerations. These numbers indicate a primary spending gap equivalent to 1.9 percent of GDP as of Q3, of which 56 percent was contributed by lower capital spending (Table 2). As discussed above, the new administration’s efforts to improve transparency and accountability in public spending is largely responsible for the temporary setback (Table 3 summarizes the measures and reasons for delay). But once institutional reforms are in place, spending is expected to fully recover at cost-effective levels with more resolute impact on the country’s growth and development. 8 Sustaining Growth in Uncertain Times Table 2. National Government Fiscal Gap Source: Department of Finance, Bureau of Treasury, and Department of Budget and Management, and WB staff calculations. 1/ Actual less planned. 2/ Base case forecast for 2011. 20. On public �nancial management, the government remains committed to improving the efficiency of public spending. Towards this end, the government is working to institutionalize zero-based budgeting (ZBB) and program evaluation to ensure that budget items reflect government priorities and are implemented in cost-effective manner. These approaches have enabled the executive to rationalize, eliminate, or scale up programs in the 2011 and 2012 Budgets, based on efficiency and equity considerations.19 In addition, the passage of the GOCC (government-owned and controlled corporation) Governance Act will enable the government to have a better handle of GOCCs with the end goal of reducing public sector de�cits and debt, and associated �scal risks. 21. On the revenue side, improved tax administration has led to higher tax revenues in 2011. Through October, tax revenues grew by 12.9 percent – ahead of nominal GDP growth. Full year tax effort is likely to improve from 12.1 to about 12.4 percent of GDP solely on the back of improved tax administration given the absence of tax policy and modest economic growth. Key programs include the regular �lling of tax evasion charges under the Run After Tax Evaders (RATE) Program and Run After the Smugglers (RATS) Program. A similar program for corrupt tax officials is also being implemented. 19 Rationalized programs include the Food for School Program, which is being administered more efficiently by the Department of Social Welfare and Development (DSWD) using its national targeting system, and the agricultural input subsidies program, which was found to mainly bene�t non-poor farmers. Several programs that exhibited weak project implementation ratings or procurement bottlenecks, such as the textbook program, teacher deployment and school building construction, and TESDA's training for work scholarship programs, saw their funds held up in both 2010 and 2011. Special purpose funds, especially the highly discretionary ones, have been trimmed down signi�cantly. Support to government corporations that did not meet the ZBB criteria was also reduced, though measures to stop the underlying losses, mostly but not solely linked to quasi-�scal operations have yet to be announced and implemented. Finally, budget for social services increased signi�cantly. For instance, the budget for the conditional cash transfer program increased by more than 50 percent from last year. 9 PHILIPPINES QUARTERLY UPDATE - December 2011 Table 3. Summary of measures to improve transparency and accountability in infrastructure spending and other reasons for implementation delays 1. Realignment of around 80 percent of line item projects in the General Appropriations Act 2011 to reflect the priority of the government and to correct past inefficiencies. 2. Implementation of the “no approved program of work, no budget� policy. This is an institutional reform requiring the preparation and approval of detailed program and scope of work prior to the release of funds. 3. Stricter adherence to the procurement law on competitive public bidding. 4. Clustering of smaller projects (e.g., on the same road alignment) into one contract package for efficiency 5. Late release of special allotment release orders (SAROs) for lump sum funds, which fund a substantial amount of DPWH projects. Source: Department of Public Works and Highways (DPWH) 22. To raise more revenues, the executive has submitted a bill to congress proposing to raise excise taxes of tobacco and alcohol products. Through a gradual alignment of tax rates with inflation and a gradual shift from the multi-tier system to a uni�ed system, this reform is estimated to generate 0.6 percent of GDP in the �rst year.20 The bill proposes to earmark a portion of the revenue intake to the government’s universal health care program. To plug future leakages in tax revenues, the executive is working with congress to pass the �scal responsibility and �scal incentive rationalization bills. 23. With improved macroeconomic fundamentals, the national government’s debt ratio continues to decline due to higher nominal GDP growth, appreciation of the peso, and lower borrowing costs. The government has been taking advantage of these favorable conditions to reduce the risk pro�le of its debt stock by lengthening its debt maturity and stemming further appreciation of the peso by raising its 2012 domestic-to-foreign borrowing mix to 75-25. 20 For more details, please see the Special Focus No. 1 on excise taxes. 10 Sustaining Growth in Uncertain Times Prospects Output and Demand 24. The external environment has become much weaker in recent months. Among high-income economies, Japan is falling into recession in 2011 due in large part to the effects of the Earthquake and Tsunami. The US economy was sluggish in the �rst half but has been picking up and is expected to expand by 1.7 percent for the year. Output in the Euro Zone expanded by about the same rate in 2011, but has weakened sharply in the second half and the region may well go into recession in early 2012. Barring a marked deterioration of the situation in Europe, growth in the United States should remain relatively strong, but �scal consolidation is expected to keep growth rates through 2013 below 2.5 percent. Output in Japan should continue to strengthen as the economy rebounds from Tohoku-related disruptions and reconstruction efforts gain way. Growth in East Asia is projected to slow from 8.1 percent in 2011 to 7.7 percent next year. While a number of countries are expected to enact �scal stimuli to buoy growth, they are likely to be limited compared to 2009 given narrower �scal space. 25. Despite the weaker global environment, the Philippines is relatively well-positioned to weather shocks emanating from the current global turmoil given its strong macroeconomic fundamentals, and regulatory reforms and prudential measures that were instituted following past crises and slowdowns. The Philippines is also bene�tting from relative political stability, though downside risks to growth remain signi�cant such as increased uncertainties about global demand and a possible further slowdown in investments and public spending. Overseas Filipino workers’ large remittance inflows have shown a counter-cyclical pattern and have insulated the country from recent external imbalances. The �nancial sector’s conservative stance throughout the preceding decade has helped to ensure healthy balance sheets while the corporate sector, for the same reason, also exhibits no systemic vulnerabilities. 26. Philippine economic growth is projected at 3.7 percent in 2011 though signi�cant downside risks could push growth further down. Our projection hinges on the successful implementation of the government’s disbursement acceleration program and an acceleration in private consumption and investment, which have begun to grow faster in the last quarter. In addition, lower growth in Q4 2010 should provide the added base effect boost. Signi�cant downside risks largely stem from the weaker external environment and less than satisfactory public spending. 27. Growth next year is projected to improve to 4.2 percent in line with regional forecasts. Higher 2012 growth hinges on improvement in exports, acceleration of PPP projects and private sector investment, and a full recovery of public spending with possibly a medium-size �scal stimulus. Higher public spending is expected to be �nanced by higher tax revenues stemming from improved tax administration and higher excise taxes. A quicker resolution of the Euro Zone’s debt crisis would bode well for the Philippines in terms of higher exports and FDI flows. If the �scal turmoil in Europe deteriorates and results in another recession, the Philippines could moderate its impact with appropriate �scal and monetary stimuli. Box 1 presents a possible low case scenario for the Philippines. 28. Growth prospects in the medium to long-term can be sustained at above 5 percent provided that reforms to address structural bottlenecks are implemented to raise overall competitiveness. These include reforms to i) raise revenues efficiently and equitably, ii) improve the quantity and quality of public spending, in particular infrastructure and human capital investment, iii) enhance governance, and iv) reduce the cost of doing business. A stronger structural underpinning would allow the country to deal with shocks more effectively, achieve more inclusive growth, and reduce poverty at a faster rate. 11 PHILIPPINES QUARTERLY UPDATE - December 2011 Box 1. Low Case Scenario Given signi�cant downside risks, another world recession cannot be ruled out. Global growth in 2012 could mimic the 2009 recession and recovery could be much slower with possibly a mild recession in 2013 (i.e., growth of -1 percent in advanced countries and low positives for emerging and developing countries) and modest growth in 2014. For the Philippines, growth could fall to around one percent similar to 2009. Signi�cant contraction in private and external demand can be cushioned by a large enough �scal stimulus equivalent to around 1 to 1.5 percent of GDP (as was the case in 2009). The �scal stimulus and a possible postponement of tax policy reform given the uncertainties would lead to a higher de�cit above 3 percent of GDP in 2012 before gradually declining towards 2 percent of GDP beginning 2013. While the temporary surge in de�cit is broadly sustainable, efforts to raise revenues, especially from excise taxes, are very much needed to ensure adequacy of future �scal space in the event that a prolonged global slowdown requires further expansionary policy. As in 2008-09, the level and quality of employment would be adversely affected but these might not be fully reflected in official statistics. Manufacturing jobs will likely take a big hit but total employment rates may not change much given net job creation in the informal sector. At the same time, the underemployment rate may not rise as workers take in more jobs to maintain household income levels. Employment and Poverty 29. The projected slowdown is expected to lead to some deterioration in the labor market especially among wage and salary earners. The electronics and other export-oriented manufacturing sectors are most vulnerable as the 2009 experience shows, while the BPO sector is expected to remain strong and possibly expand as foreign �rms cut cost and reallocate to the Philippines. Deployment of OFWs may decelerate once the government begins to implement a deployment ban to 41 countries which failed to sign international conventions protecting the rights of migrant workers. Although the countries included in the deployment ban employs only about 2 percent of total deployment (around 20,000 workers), its effect on the domestic economy is not trivial. Un-deployed workers and their families may be forced to �nd work in the informal sector (i.e., as self-employed or workers without pay), which raises their vulnerability to shocks and thus may cut down on human capital investment given lower incomes. External Accounts 30. The current account is projected to remain in surplus thanks to robust remittances despite a widening trade de�cit as exports weaken. Remittances will continue to support growth given its counter-cyclical nature.21 Remittance growth in 2011 and 2012 is projected at 6 and 3 percent, respectively, slightly lower than historical growth rates as deployment of Filipino workers moderates given political developments in recipient countries particularly in the Middle East, stricter compliance with the country’s Migrant Workers Act, and the global slowdown. 21 During the 2008-09 slowdown, remittances continued to grow, aided in part by strong deployment of Filipino workers in 2008 (20.2 percent) and 2009 (7.7 percent). In 2011, growth in land and sea-based workers with processed contracts slowed to 4.5 and 5.5 percent, respectively, through August, but still sizable to provide support to the country’s medium-term remittance prospects. Though the Middle East continues to be the top destination of OFWs (i.e., recipient of more than 60 percent of total deployment), there has been some noticeable diversi�cation within the region such as the shift from Saudi Arabia towards higher growth and politically stable countries such as UAE and Qatar. 12 Sustaining Growth in Uncertain Times 31. Given the country’s reliance on electronics, export growth faces substantial downside risks from a signi�cant decline in global demand as was the case in 2009. Export growth for 2011 and 2012 is projected at no more than 1.0 and 2.5 percent, respectively.22 For electronics exports, the industry forecasts an 18 percent contraction this year and possibly extending to 2012.23 The expiration in December 2011 of the special eco-zone generation charges extended to exporters will hit Philippine exports hard given the high share of power to total domestic input cost (as high as 35 percent of domestic input for some �rms).24 To mitigate the problem, �rms are negotiating bilateral agreements with power suppliers for preferential rates. Greater intra-regional trade, trade with other large and fast growing countries, and product diversi�cation can partly offset the falling electronics demand from advanced countries (see Special Focus No. 2 on exports). 32. The impact of capital outflows is likely to be more tempered. Historically low levels of FDI suggest that even under the low case scenario, a very low level of FDI would have a minimal impact on Philippine external accounts. FDI is projected to moderate as foreign investors retain their “wait and see� stance and as structural impediments to growth, such as infrastructure availability, remain. FPI may retreat in the short-term if risk aversion escalates, and hence make a noticeable but temporary dent in the external account but as markets normalize, we can expect renewed capital inflows to the Philippines because of growth rate, interest rate, and risk differentials. The projected sizable surpluses in both the current and capital accounts point to a further build-up of the country’s reserve position and a gradual decline in external debt from 37.3 percent of GDP in 2009 to around 32 percent of GDP in 2013.25 Inflation and Monetary Policy 33. CPI inflation for 2011 is projected at 4.8 percent, near the high-end of the BSP’s 3 to 5 percent target range, before easing to 3.5 percent in 2012 in part due to easing commodity prices as world output slows. Given receding inflationary risk, the central bank is expected to maintain overnight borrowing and lending rates at 4.5 and 6.5 percent, respectively, until at least the �rst quarter of 2012 (when full year 2011 GDP is released), allowing the BSP enough time to re-assess the appropriateness of monetary policy. Upside risks to inflation include domestic food supply shocks following severe weather disturbances, which have become more common, and the possible escalation of the La Niña weather effect in 2012. Large-scale capital inflows, which could fuel further growth in domestic liquidity, also pose risk to inflation. 34. A key policy challenge in the near-term is curbing possible domestic overheating from rapid credit growth and excessive capital inflows while maintaining an environment conducive to growth. This requires a careful balance as monetary easing, while supportive of short-term growth, could fuel further credit expansion leading to a deterioration of credit quality thereby adversely affecting medium-term growth prospects. Given these considerations, monetary authorities would need to keep watchful eye and act promptly against any signs of overheating to prevent a credit boom-induced crisis. 22 See the special focus section on exports for more information on how the growth rates were estimated. 23 Source: Semiconductor and Electronics Industries in the Philippines Inc. (SEIPI) 24 Eco-zone generation rates are about one peso less per kilowatt-hour compared to standard rates. 25 World Bank de�nition 13 PHILIPPINES QUARTERLY UPDATE - December 2011 35. A combination of monetary and exchange rate policies, and related regulatory and macro-prudential measures are needed to reduce risks to �nancial stability that may endanger macroeconomic stability. Options to moderate credit growth include i) ceiling on the loan-to-deposit ratio, ii) lending limits to sectors exhibiting rapid credit growth, such as real estate, iii) more stringent liquidity requirements and sound credit management policies, iv) limits on foreign exchange exposures including reduction in short-term borrowing, and v) allowing greater exchange rate flexibility. In addition, to moderate capital inflows, the government could allow the exchange rate to appreciate in line with fundamental, and reduce the share of foreign borrowings and tap instead the large domestic fund. The central bank has stated its readiness to implement further macro-prudential measures to deal with the effects of capital surges on domestic liquidity and asset price inflation. Fiscal Policy 36. With less room for monetary easing, the government can support growth by appropriate �scal expansion given ample �scal space. Raising adequate revenues is vital to supporting a large enough stimulus program while keeping the de�cit within sustainable bounds. To have the biggest impact on growth, the stimulus program would need to be directed towards public infrastructure and other programs that generate more employment. These would complement the government’s PPP program and raise overall investment levels over the medium-term. 37. Higher tax revenues beginning 2012 hinges primarily on new tax policy measures and an acceleration of tax administration reforms. Key policy measures for 2012 include raising excise taxes of alcohol and tobacco, enactment of the �scal responsibility and �scal incentives rationalization bills to plug future leakages in tax revenues, and possibly a comprehensive tax reform program aimed at lowering rates, broadening the base, and improving equity and efficiency of the tax system. Passing the �scal incentives rationalization bill is crucial especially given that it has stalled in congress for over a year. An acceleration of tax administration reforms would also help secure the much needed revenues to increase public spending. Taken together, tax effort could increase by up to 0.7 ppts of GDP in 2012 from 12.4 percent of GDP in 2011 if these reforms are enacted in full. The Special Focus on excise taxes gives a detailed analysis of Philippine tobacco and alcohol excise taxes and provides options on how to further raise excise revenues. 38. Careful management of public �nances and the government’s resolve to raise tax revenues should enable the government to gradually reduce its de�cit towards 2 percent of GDP beginning 2013. Consequently, national government debt levels could decline towards 40 percent of GDP by the end of the current administration. Barring any unexpected shocks, both trajectories are indicative of a sustainable �scal policy setting. 14 Sustaining Growth in Uncertain Times SPECIAL FOCUS 1 Raising Excise Taxes on Tobacco and Alcohol Products 26 The real revenue yield from excises on tobacco and alcohol has declined signi�cantly since 1997. This erosion mainly reflects i) low tax rates to begin with, ii) speci�c rates that have not been updated regularly in line with inflation, and iii) the use of 1996 prices to determine the tax rate for old products. As a result, from 1997 to 2009, excise collection as a share of GDP fell by about 0.6 percentage points from an already low yield of 1.2 percent of GDP. Quite alarming, Philippine tobacco excise tax rates and burden are among the lowest in South East Asia. A major downside of this policy stance is that the country has become the largest consumer of cigarettes among ASEAN countries (and 15th worldwide), where almost one �fth of Filipinos begin smoking before the age of 10 and prevalence is increasing. Raising excise tax revenues requires i) shifting from multiple to uniform excise tax rates, ii) raising excise tax rates closer to international benchmarks and indexing to nominal GDP growth thereafter, and iii) improving tax administration to minimize leakages from smuggling and evasion. A �rst best reform would yield as much as 1.3 percent of GDP in additional revenues over the next �ve years. This incremental revenue would enable the government to increase its human and physical investment to improve the country’s growth and development prospects. While excise taxes are regressive in the short term and when taken in isolation from other policies, they nevertheless are intended to address the large negative externalities arising from smoking and drinking and to discourage their consumption. Over the medium-term, higher excise rates are expected to lead to better progressivity as the price elasticity of demand of poor households is higher so that large price increases would induce these households to disproportionately reduce their consumption compared to wealthier households. Savings from reduced consumption of alcohol and tobacco can be channeled to food and human capital investment, which would enhance their welfare. Finally, revenues from the reform can be used to improve health services and social protection, which would further enhance progressivity. Tobacco 39. Tobacco excise collections in real terms have been declining despite intermittent attempts to address the decline. Since 1997 tobacco, excise collections decreased by 0.3 percentage points of GDP to 0.4 percent of GDP. The very low revenue yield from tobacco products is due to a number of reasons including: i) low excise tax rates (the average excise to retail sales price (RSP) ratio is as low as 25 percent for low-tier brands), ii) speci�c tax rates that are not indexed to inflation, and iii) the use of 1996 prices for older products and current prices for newer products for placement in price tiers with varying excise tax rates. Moreover, the four-tier classi�cation system distorts production and promotes consumption of cigarettes by low income earners. While there have been some changes in tobacco excises in recent years, after January 2011, no further excise tax rate increases are provided in the law. Given this, tobacco excise revenues are on a predictable downtrend. 26 This special focus is based on a forthcoming publication of the World Bank entitled “Philippines: A Tax System for High and Inclusive Growth� by Eric Le Borgne, Karl Kendrick Chua, Jonathon Kirkby, Peter Mullins, and Sheryll Namingit. 15 PHILIPPINES QUARTERLY UPDATE - December 2011 40. While tobacco taxes are regressive in the short-term and when taken in isolation from other policies, they are nevertheless intended to discourage smoking and to address the large negative externalities of smoking. Between 2003 and 2009 the tax had become more regressive, possibly partly due to a decline in smoking by the higher income earners. Despite this, there is widespread agreement that tobacco taxes need to be increased in order to deal with the negative externalities of smoking. Figure 13. Tobacco retail prices and taxation across Table 4. Retail sales price, excise burden and total income groups 1/ tax burden in selected countries 1/ Source: World Health Organization (2010) Source: Philip Morris International and Sunley (2009) 1/ Simple average price of the most sold brand, excise tax per pack, 1/ X-rate = foreign exchange rate; LC/$ = local currency/US$; data and total tax share by income group, 2008. as of July 31, 2009 Figure 14. Total tax burden as a share of retail sales Figure 15. Cross country comparisons: cigarette price price for most sold brand 1/ per pack, and tax as percent of the price 1/ Source: Sunley (2009) 1/ US Dollar price per pack of 20 cigarettes is in brackets; data Source: Barber et al. (2008) as of July 31, 2009 1/ 2004 to 2005 data. 16 Sustaining Growth in Uncertain Times Figure 16. Cross country comparisons: Figure 17. Cross country comparisons: number of minutes worked to purchase a pack of price per pack of cigarettes 1/ cigarettes 1/ Source: Blecher and van Walbeek (2008) Source: Blecher and van Walbeek (2008) 1/ US dollars (2006). The �gure does not include countries that have no 1/ Median of seven lowest-paid occupations, 2006. The greater the observation for 2006. HI — high income, UMI — upper-middle income, number of minutes worked, the less affordable the pack of cigarettes. LMI — lower-middle income, LI — low income b 2003 data; c 2000 data. 41. This is evidenced by the range of bills in congress on this issue, and the desire to use the revenue from a tax increase to fund improved public health services. It should also be noted that the regressive nature of excises on tobacco is lessened and the excise can even become progressive over the long term as the price-elasticity of consumption is signi�cantly higher for poor (and young) smokers. High excises therefore induce proportionately more poor consumers to quit smoking than richer ones. Savings from reduced consumption of tobacco can be channeled to food and human capital investment, which would enhance their welfare. Finally, additional revenues from the reform can be used to improve health services and social protection, which would further enhance progressivity. 42. Philippine tobacco excises are low compared to international standards. Table 4, Figure 14, and Figure 15 show that in a comparison of 15 countries, the Philippines’ rates appear in the lower half when comparing taxes as a share of retail prices. The low tax on tobacco is one of the reasons why prices for cigarettes are among the cheapest among low to medium income countries (Figure 16 and Figure 17). Alcohol 43. The issues with alcohol excises are similar to tobacco. The decline in revenue from 0.5 percent of GDP in 1997 to 0.3 percent in 2010 is due to i) the low excise tax rates (the average excise to RSP ratio is 24 percent), ii) non-indexation of the rates, and iii) use of old prices to determine applicable excise tax rate. As with tobacco, the law does not include any increases in alcohol excise tax rates after January 2011. 44. Alcohol taxes are regressive with low-income earners spending a greater portion of household income on alcohol than the well-off (Figure 18). Lower income households spend most on cheap wine and spirits, which could be partly due to the low excises on wine and locally made spirits compared to other products such as beer. Despite being regressive in the sense that low-income earners spend a higher share of their total expenditure on alcohol, the concentration curve of alcohol excise collection (Figure 19) lies below the 45 degree line so that richer households contribute to a larger share of excise collection than poorer ones (as they consume higher priced alcohol which is excised at a higher rate). The concentration curve barely changed between 2003 and 2009. The low excises on local spirits, compared to the excise on imported spirits, are currently in dispute at the WTO. Despite the regressive nature of the excise taxes, congress is clearly concerned about the impact of excessive alcohol consumption on the population, with a range of ‘sin’ tax bills seeking to address these concerns. 17 PHILIPPINES QUARTERLY UPDATE - December 2011 45. Philippines alcohol excises are low compared to the region. While comparisons of excise data on alcohol products are subject to some caveats (e.g., excise/RSP for the Philippines will be lower than comparable ad valorem rate), Philippines alcohol excises are still low compared to other countries in the region (except for Cambodia). Figure 18. The share of alcohol spending in total household spending falls as income rises Figure 19. Alcohol excise collection Spending on Alcohol, 2009 Concentration Curve: Alcohol Taxes 1 1.4 Wine % share of total spending 1.2 .8 Beer Cumulative Share(p) 1.0 Other alcoholic bev. .6 0.8 .4 0.6 0.4 .2 0.2 0 0 .2 .4 .6 .8 1 0.0 Percentiles (p) 1 2 3 4 5 6 7 8 9 10 45° line 2003 2006 Income Decile 2009 Source: World Bank staff calculations based on FIES 2009 Source: World Bank staff calculations based on FIES data Table 5. Excise Tax Rates in Selected ASEAN Countries Source: Respective Ministries of Finance. 1/ Thailand also has minimum speci�c rates, with the excise being the higher of the speci�c rate or ad valorem rate. Recommendations Overall • Continue levying speci�c—rather than ad valorem--excises for tobacco and alcohol. Rationale 46. Speci�c excises that are automatically and frequently (e.g., annually) indexed to inflation (CPI or nominal GDP as the case may be) can mirror ad valorem excises in terms of revenue. Ad valorem excises, however, are more complex to administer since the value of the product has to be ascertained and is prone to transfer pricing abuse. 18 Sustaining Growth in Uncertain Times This leaves more opportunities to challenge BIR and BOC assessments as opposed to speci�c excises which simply require counting physical quantities. In the case of the Philippines, the experience with ad valorem excises prior to the 1997 switch to speci�c excises illustrate the administrative challenges in monitoring ad valorem excises and the greater opportunity to undermine excise collection through the setting up of affiliated companies or marketing agents that increase the retail price compared to factory price (and the corresponding excises). Tobacco • Shift to a uniform excise tax rate for all cigarette brands. • Raise excise tax rates to achieve an average excise to retail sales price (RSP) ratio of 50 percent in 2012 (and 60 percent by 2016), and index excise rates to nominal GDP thereafter. • Ensure all tobacco taxes are subject to speci�c tax rates, including cigars. • Signi�cantly improve administrative efforts to minimize leakages from smuggling due to the proposed higher tax regime. Rationale 47. The shift to a uniform excise tax rate for all brands will remove production distortions, discourage consumption, and improve equity across brands. The current multi-tier price classi�cation system has no clear policy rationale and is unique internationally. It therefore should be abolished. 48. A signi�cant increase in the excise rate will bring the excise rates closer to the regional rates and at the same time signi�cantly increase revenue. Given inelastic demand, excise tax rates should be set as high as possible to raise adequate revenues, discourage consumption, and correct externalities. A good target would be to set the excise/ RSP ratio to at least 50 percent. A �rst best target would be to aim for 67 percent, but such a rate may have too severe an impact on the formal market. The proposed increase would align the Philippines tobacco excises with international standard. 49. Indexing the excise tax rates to nominal GDP growth will keep the excise burden from falling, avoid revenue erosion in the future, and provide funds to improve health services. An alternative could be to index to CPI, but this is not considered adequate to maintain the revenue yield as a share of GDP as the combined growth of tobacco demand and CPI is lower than nominal GDP growth. 50. Applying speci�c tax rates to cigars will simplify the administration of tobacco taxes. In 2005, taxation of cigars reverted to ad valorem taxes. However, a standard method for calculating excises for all tobacco taxes would be simpler, and is consistent with the simpli�cation objective of the overall tax reform package. 51. Signi�cantly higher taxes will likely encourage more smuggling and tax evasion, hence administrative efforts should be enhanced to minimize leakages. The current efforts to preventing smuggling will need to be substantially improved to avoid a signi�cant erosion of the tax base. 19 PHILIPPINES QUARTERLY UPDATE - December 2011 Revenue estimates 52. The recommended reform should generate 0.98 percent of GDP in additional tobacco excise and VAT revenues by 2016. Estimates of the preferred option together with a number of alternative policy scenarios are set out in Table 6. The scenarios are described below. • Scenario 1: no policy change. This results in a predictable decline of tobacco revenues from 0.35 percent of GDP in 2010 to 0.25 percent of GDP in 2016. • Scenario 2: indexing to CPI. Even if this scenario is implemented at the beginning of 2012, it will still result in a gradual decline in revenues to 0.31 percent of GDP since the growth in nominal GDP is projected to be higher than the combined growth of CPI and demand. • Scenario 3: indexing to nominal GDP (nGDP). This indexation is necessary to stabilize tobacco revenues. Indexing to nGDP will increase revenues to 0.39 percent of GDP by 2016. However, this �gure is still quite low relative to 1997 revenues. Moreover, it is not enough to �nance the government’s ambitious Universal Health Care (UHC) program.27 • Scenarios 4 to 6: Increasing excise tax rates of each brand to a target excise to RSP ratio (say 50 percent). Such an increase is desirable but will still yield lower revenues as consumers will simply substitute downwards. Moreover, retaining the four-tier classi�cation system will continue to distort production, will not address negative externalities, and discourage consumption. Additional revenue yield ranges from only 0.38 to 0.44 percent of GDP depending on the number of years of adjustment to reach the desired target level. Table 6. Tobacco excise reforms: scenario and projected revenue 1/ Source: World Bank staff simulations. 1/ RSP stands for retail sales price. 27 Aside from providing �nancing for programs such as the UHC, the cost of tobacco-related health care is estimated by WHO at PHP 43 billion (0.5 percent of GDP). Given this, any reform should generate at least 0.5 percentage points of GDP in additional revenues to be useful. 20 Sustaining Growth in Uncertain Times • Scenarios 7 and 8: Shifting to a dual or uni�ed rate and indexing to nGDP are an improvement but are not enough unless excise taxes are increased. • Scenario 9: Shifting to a uni�ed rate for all brands by 2014, imposing higher excise tax rates, and indexing to nGDP constitutes the preferred reform. This involves shifting to a uni�ed rate using the premium rate as starting point and adjusting the rate to reach an average excise/RSP ratio of 50 percent in 2012 and moving towards 60 percent by 2016. To avoid sudden price jumps, the tax rates for lower tier brands can be adjusted over a period of three years.28 Adopting a tax schedule following Table 7 and indexing to nGDP thereafter once the target is reached is projected to yield additional 0.98 percent of GDP in excise and VAT revenues by 2016.29 The reform would also prevent the excise burden from falling over time. Table 7. Tobacco excise levels and RSPs for a uni�ed rate by 2014 (Scenario 9) Table 8. Alcohol excise rates and RSPs (Scenario 7) Source: WB staff calculations Source: WB staff calculations Alcohol • Shift to a uniform excise tax rate per class of alcohol. • Raise excise tax rates to PHP 25.5, PHP 50.5, and PHP 75.5 per liter (proof liter for spirits) respectively for beer, wine, and spirits. Index excise tax rates to nominal GDP thereafter (excise rates on highly taxed spirits will be reduced to align with other spirits, but the current consumption of these products is very low). • Signi�cantly improve administrative efforts to minimize leakages from smuggling due to the proposed higher tax regime. Rationale 53. The rationale for the recommendations is similar to that proposed for tobacco. The shift to a uniform excise tax rate for all similar categories of alcohol products will remove production distortions, discourage consumption, improve equity across brands, and simplify the taxation of alcohol. The increase in the excise rates will align them closer to international standards and increase revenue, with the indexing ensuring the revenue is not eroded in the future. 28 The increase in prices is likely to be tempered by a reduction in the net retail price as manufacturers cut prices to accommodate demand (at any rate, the pro�t margin is quite high for some brands). In fact, this practice occurred in 2005 for low-tier brands when excise tax rates were almost doubled. 29 An even better reform is one that targets an excise tax to RSP ratio of at least 67 percent for all brands. This would yield over 2 percent of GDP in additional excise and VAT revenues but would eliminate the low-tier formal market and thus is not feasible. 21 PHILIPPINES QUARTERLY UPDATE - December 2011 54. Setting a single rate for broad classes of alcohol should also address the issue in the WTO dispute. Locally produced spirits will be taxed in the same manner as imported spirits. There may be concerns that expensive spirits would be subject to the same excise as cheaper locally produced spirits. While the excise rates are the same, the VAT imposed on the products will ensure a higher absolute amount of tax is paid on the more expensive brands. In any case, the current consumption of imported spirits is very low. Revenue estimates 55. The recommended reform can generate 0.34 percent of GDP in additional alcohol excise and VAT revenues (BIR collection only) by 2016. Estimates of the preferred option together with a number of alternative policy scenarios are set out in Table 9. The scenarios are: • Scenario 1: No policy change. This results in a predictable decline of alcohol revenues from 0.27 percent of GDP in 2010 to 0.19 percent of GDP in 2016. • Scenario 2: Indexing to CPI beginning in 2012. This still results in a gradual decline in revenues (to 0.23 percent of GDP) since the growth in nominal GDP is projected to be higher than the combined growth of CPI and demand. • Scenario 3: Indexing to nominal GDP (nGDP). This is necessary to stabilize alcohol revenues. Indexing to nGDP will increase revenues to 0.30 percent of GDP by 2016. However, this �gure is still quite low relative to 1997 revenues. • Scenarios 4 to 6: Increasing excise tax rates of each price tier to a target excise to RSP ratio (40, 10, and 50 percent for beer, wine, and spirits respectively). This is desirable but will still yield lower revenues as consumers will simplysubstitute downwards. Moreover, retaining the multi-tier classi�cation system will continue to distort production, and will not address negative externalities and discourage consumption. Additional revenue yield averages about 0.30 percentage points of GDP depending on the number of years of adjustment. Table 9. Alcohol excise reforms: scenario and projected revenue Source: World Bank staff simulations. 22 Sustaining Growth in Uncertain Times • Scenario 7: Shifting to a uni�ed rate per alcohol class, imposing higher excise tax rates, and indexing to nGDP thereafter. This is the preferred reform of the report. This involves shifting to a uni�ed rate per alcohol class using the most popular price-tier as base. The proposed excise tax rates are as follows: PHP 25.5, PHP 50.5, PHP 75.5 per liter (proof liter for spirits) respectively for beer, wine, and spirits in 2012 and indexing to nGDP thereafter.30 Adopting a tax schedule following Table 8 and indexing to nGDP thereafter once the target is reached is projected to yield additional 0.33 percent of GDP in excise and VAT revenues by 2016. The reform would also prevent a decline in the excise burden over time. Selected References Blecher, Evan and Corné van Walbeek. (2008) “An Analysis of Cigarette Affordability.� International Union Against Tuberculosis and Lung Disease. Paris. Sunley, Emil M. (2009) “Taxation of Cigarettes in the Bloomberg Initiative Countries: Overview of Policy Issues and Proposals for Reform.� International Union Against Tuberculosis and Lung Disease. Paris. World Health Organization. (2010) “WHO Technical Manual on Tobacco Tax Administration.� Geneva. 30 The increase is prices is likely to be tempered by a reduction in the net retail price as manufacturers cut prices to accommodate the lower demand (this is likely as the pro�t margin is quite high for some brands). 23 PHILIPPINES QUARTERLY UPDATE - December 2011 SPECIAL FOCUS 2 Philippine Exports: Where Do They Stand? Despite being an open economy, the Philippines’ openness to trade is lower than its neighbors and its exports have been growing slower than GDP. Export diversi�cation has improved in terms of market destination (e.g., more exports to China and other emerging markets and less to the US) but not in terms of product line. The global market share of its main export, semiconductors, has continued to decline. This is in part due to the adverse external environment, changing technology that the Philippines has yet to fully adopt (e.g., new generation gadgets such as tablet computers and smart phones), and stagnant physical capital per worker. In terms of exports survival, the Philippines scores the lowest among comparable ASEAN countries. Thus, improving the country’s business environment, particularly in non-PEZA areas, will be essential to boost physical investments, encourage innovations, and promote investments in human capital so that the country can better internalize and harness advanced technologies and business know-how embedded in foreign direct investments. In terms of services exports, a more efficient regulatory system would improve the industry’s productivity, thus improving its competitiveness. Trends 56. The Philippines has a fairly open trade regime. Average effective tariff rate was 4.77 percent31 in 2010, close to China’s 4.29 percent. However, its economy is becoming less dependent on trade compared to its neighbors. Trade as a share of GDP has gradually declined from 105 percent in 2000 to about 70 percent in 2010, while Thailand maintains it at around 130 percent and Vietnam has grown rapidly from 112 to 153 percent. The country’s merchandise exports-to-GDP ratio dropped from about 50 to 35 percent in the last decade. Unlike its neighbors, growth in exports has been slower than GDP growth. Export growth is recent years has been driven by PEZA32 exports, which receive generous tax incentives. 57. Philippine export markets are diversi�ed. Between 1999 and 2009, Philippine export markets expanded from less than 70 to well over 100 economies. Key trading partners include countries in the European Union, United States, Japan, China, and countries in the rest of East Asia (Table 10). Each region/country accounts for about a �fth of total merchandise exports. Trade with other large and fast growing countries are insigni�cant. World Bank (2011) �nds that the Philippines is under-trading with countries such as Brazil, Russia, India, and South Africa (the so called BRICS country excluding China). 31 This is de�ned as the average of effectively applied rates weighted by the product import shares to each partner country. 32 Philippine Economic Zone Authority 24 Sustaining Growth in Uncertain Times Table 10. Top Philippine Export Destinations (in percent of total) Source: World Integrated Trade Solution (WITS) 1/ WITS ISIC code 3210 2/ De�ned as EU 27 3/ Low and middle income countries 58. The shares of exports to emerging markets, notably China, have increased while the shares to traditional export partners, such as the US, have declined. As shown in Figure 20, the prominence of the US has dropped from about 40 percent in 1991 to only 15 percent in 2011. On the other hand, China gained from 1 to 15 percent in the last decade, while the traditional markets of US, Japan, Singapore, and Europe remain important, Korea, Thailand and Malaysia are now among the top ten export destinations. Figure 20. Share of key exports Figure 21. Top ten exporters of semiconductors Electronics Top 10 Market Shares Source: International Monetary Fund (IMF) Source: World Integrated Trade Solution (WITS) 59. In contrast, product diversi�cation continues to pose a challenge. While nearly all sectors experienced healthy growth (with the exception of the textiles and clothing industry), concentration on high-tech products, which accounts for some 60-70 percent of total exports (before the current slowdown), persists. Electronics parts (45 percent of total), such as microprocessors and mobile phone chips, and �nished electronics goods (20 percent of total) are the main product lines.33 Although only a third of Philippine electronics exports are shipped to the USA, Euro Zone, and Japan, it is estimated that a larger 50 percent is shipped to China and other East Asian economies for assembly and eventual export to advanced economies. 33 In terms of ISIC classi�cation, these fall under product codes 3210 and 3000 respectively. 25 PHILIPPINES QUARTERLY UPDATE - December 2011 60. The Philippines is the eight largest exporter of semiconductors with a market share of about four percent, down from seven percent ten years ago (Figure 21). The decline in Philippine market share reflects rapid growth of Korean, Singaporean, and Chinese semiconductor exports and growing demand for new generation electronics such as tablet computers and smart phones. This suggests a further deceleration of Philippine semiconductor exports in the medium-term. To improve growth prospects, industries would have to align its business to the new technology and demand or diversify into other products. 61. Two characteristics of Philippines exports suggest potentials for growth. First, the Philippines’ export basket is richer than its income.34 In a sample of 100 developing countries that the World Bank has classi�ed as either low or middle income, Philippines lies above the regression line implying that its export basket is “richer� than its income (Figure 22).35 Countries above the line can expect to see growth from existing products because they are deemed sophisticated. However, if sophistication is measured based on the �nal value of assembled good, it is likely to exaggerate the ability of the country to produce complex, high-value products. While the increasing focus of the Philippines on manufactured goods is a desired outcome, it remains to be analyzed what value the country adds to these exports. 62. Second, Philippine exports have medium human and physical capital content. Revealed factor intensity36 suggests that the Philippines’ export pro�le is dominated by products with medium, not low, human and physical capital content. However, physical capital content has been growing slower. Between 1997 and 2007, the median value of capital content increased only minimally. Average human capital increased by about 10 percent but physical capital per worker hardly changed, from USD 15,067 to USD 15,488 (measured at 2000 prices). Recent developments 63. After a strong recovery in 2010, electronics export performance collapsed anew, reflecting the impact of three major shocks, notwithstanding domestic structural issues. First, the earthquake and tsunami disasters in Japan resulted in shutdowns of �rms and disrupted the global supply chain. Second, lower growth in advanced economies, coupled with concerns about another recession, slowed down global trade. Third, widespread flooding in Thailand has led to another disruption in the manufacturing supply chain. This latest shock could drag the country’s export performance further down. 64. Non-electronics exports have buoyed overall exports growth. With lackluster electronics export performance (i.e., year-to-date contraction of 20.1 percent), overall exports growth has been buoyed by non-electronics exports, which grew by almost 30 percent in the �rst three quarters of 2011 (Figure 23). This positive trend runs counter to the experience in 2008-09 in which non-electronic exports also collapsed. These dynamics have contributed to a growing share of non-electronics exports to total exports. From around 30 percent in 2007, the share of non-electronic exports to total exports had risen to 50 percent by October 2011. 34 This discussion is taken from World Bank (2011). 35 This is based on one of the measures of export sophistication (EXPY), which assesses the export baskets of countries by the incomes of countries that produce similar products, weighted by the share of those exports in the national total. 36 The indices are computed by weighting the factor endowments of all countries exporting a particular product. Weights are derived from a modi�ed version of the revealed comparative advantage (RCA). Goods that are predominantly exported by countries rich in human capital are revealed to be intensive in human capital. See Cadot et al. (2009). The database is available in http://r0.unctad.org/ditc/tab/index.shtm. 26 Sustaining Growth in Uncertain Times 65. Services export, which is dominated by the BPO industry, continues to perform well growing by 8.5 percent in the third quarter. The BPO industry currently employs 525,000 workers (around 8.4 percent of formal services sector employment37) and accounts for around 5 percent of gross value-added. The industry expects its manpower and revenues to grow by 15-20 percent in the coming years given strong growth potential even in the face of another global slowdown. As the experience of the last crisis showed, the industry is largely “recession-resilient� given its large operations in a-cyclical sectors such as healthcare, legal, and accounting services. It also remains an attractive option for foreign �rms bent on reducing operating cost.38 On the other hand, the country’s other major services export, tourism, has yet to reach its potential as its contribution to GDP remains sluggish at around 3 percent for the past decade.39 Figure 23. Philippine merchandise export has been Figure 22. Export sophistication buoyed by non-electronics. Export Sophistication in developing Countries Merchandise exports performance Source: World Bank Note: Countries lying above the straight line are considered as those with richer export baskets. Source: NSO Survival Propensity 40 66. Philippine exports have a lower probability of surviving export spells compared to Indonesia, Thailand, and Malaysia (World Bank 2011). The Kaplan-Meier (KM) survival estimates41 indicate that the probability of a Philippine export surviving beyond the �rst, sixth, and twelfth years are consistently lower than corresponding rates for the other three countries, albeit differences are not highly signi�cant except when compared to Thailand where export spells have the best record of survival among the ASEAN-4 (Table 11).42 One caveat of this analysis is that product death is not necessarily a poor export achievement if they occur more frequently in product categories that are dynamic in nature, such as parts and components manufacturing that are part of global production networks. 37 This is proxied by total employment in the services sector excluding employment in wholesale and retail trade, transport, private household and others. 38 During the 2008-09 global slowdown, the industry grew by a respectable 14 percent, though much lower than its 40 percent growth prior to the slowdown. 39 Source: World Development Indicators (WDI) 40 This section draws from World Bank (2011). 41 The Kaplan-Meier estimator is a survivor function and is de�ned as the probability that an individual survives at least to time t in discrete time is given by: S(t) = P (T ≥ t) t = 1, 2… The estimator at time t is de�ned as S(t) = πti≤t[ni - di /ni]. 42 During the 12-year period of coverage (1997 to 2009), each product is exported to a particular country mostly in spurts. There are 38,147 country-product pairs with at least one year of exports valued at least USD 1000. For many of the country pairs at the product level, trade takes place just once, or a single spurt of consecutive years. Some die and are then revived. So, the total number of export spells is 60,114. About 8.3 percent of export spells (that are not left-censored) last the full 12 years, but the median duration of spell is only 1 year. Philippines’ exports at the SITC 4-digit level to all (reporting) countries from 1997 to 2009 are analyzed for their propensity to survive consecutive periods. 27 PHILIPPINES QUARTERLY UPDATE - December 2011 Table 11. Comparative survival propensity of ASEAN countries Source: World Bank (2011) 67. Diversi�cation and nurturing trade relationships could increase the probability of survival. The analysis suggests that the probability of an export spell surviving longer is higher if it is exporting to i) non-ASEAN countries (excluding Brunei and Myanmar) compared to ASEAN countries and ii) richer countries (with per capita income exceeding USD 50,000) than to less rich countries. In addition, export spells that start big (with order values of at least USD 100,000) have much higher rates of survival, reflecting established trade links between importers and exporters. Surprisingly, the study �nds that export survival does not depend on broad product types. For instance, manufactured exports (i.e., SITC 5-8, except SITC 68) do not fare better in terms of survival than non-manufactured exports. Another interesting �nding is that of the spells that survive �ve years or longer, the �nal year value was larger than the initial year value for 60 percent of the spells. This corroborates the observation in the literature that the �rst few years of a new trade relationship are crucial. If they can be nurtured during the early period, exports generally increase in value. Prospects 68. Given the Philippines’ high reliance on high-tech exports, its economy faces material risks from a signi�cant decline in world high-tech demand as was the case in 2009. To model this transmission, we apply three methods: i) an elasticity model which regresses Philippine exports with partner country GDP growth and imports from the Philippines and ii) two input models, one which regresses Philippine electronics exports with the North American book to bill ratio, and a second which regresses Philippine electronic exports with imports of electronic parts. The results of the models are shown in Tables 12 and 13 while Figure 24 shows historical trend of the key variables. All models are signi�cant and give a high degree of correlation. 69. The results suggest a strong relationship between the various determinants of export growth and Philippine export growth. For example, using the elasticity model, the weighted average elasticity of Philippine electronics export growth to partner country import of Philippine electronics of 0.76 suggests that a 10 percent decline in partner country’s import of Philippine electronics leads to a 7.6 percent decline in Philippine electronics exports. The book-to-bill regression with lag of three months suggests that a 10 percent decline in the book-to-bill ratio leads to an export growth of -0.58 percent while the electronics import regression with lag of one moth suggests that a 10 percent contraction in electronics import leads to a 3 percent contraction in electronics exports growth.43 These elasticity and coefficient estimates, together with assumptions for non-electronics and services exports, suggest that Philippine merchandise export growth is likely to slow to around 1.0 and 2.5 percent respectively in 2011 and 2012 under the base case scenario. 43 The North American book-to-bill ratio, which pertains to the ratio of global billings and bookings of North American headquartered semiconductor equipment producers (all billings and bookings are in millions of dollars and based on a three-month moving average), has been declining since May 2011, reaching a low of 0.75 in September – painting a bleaker picture for semiconductor exports in the coming months. Moreover, imports of electronic parts have not recovered, also suggesting weak demand in the months ahead. 28 Sustaining Growth in Uncertain Times Table 12. Estimated elasticities Source: World Bank staff estimates Figure 24. Declining imports of electronic parts and the Table 13. Estimated coefficients for the input models North American book to bill ratio suggest further export contraction in the coming months. Electronics Trade (3 mma) and Book-to-Bill Source: World Bank staff estimates Source: NSO and www.semi.org Note: Results presented here are signi�cant at 5 percent. Conclusion 70. The key to ensuring continued growth of Philippine exports is its ability for greater diversi�cation. This includes i) shifting towards greater diversi�cation of exports portfolio with an increased share in non-electronics exports, ii) increasing trade with countries with higher growth prospects such as the BRICS44, and iii) moving towards a more balanced trade across partners to mitigate systemic and temporary trade disruptions due to �nancial and economic slowdowns, and supply chain disruptions such as those in Japan and Thailand. In order to achieve these, improving the country’s business environment, in particular in non-PEZA areas, is essential to boost investments in both physical and human capital and encourage innovations to allow the country to move up the value-chain and expand product diversity. In terms of services, an efficient regulatory system would improve the industry’s productivity, thus improving its competitiveness. Selected Reference World Bank. (2011) “Basic Notes on Merchandise Trade in the Philippines.� A brie�ng paper. 44 Brazil, Russia, India, China, and South Africa 29 PHILIPPINES QUARTERLY UPDATE - December 2011 Data Appendix Table 14. Philippines: Selected Economic Indicators, 2008-13 Source: Government of the Philippines for historical, World Bank for projections 1/ Excludes privatization receipts and includes CB-BOL restructuring revenues and expenditures (in accordance with GFSM) 2/ Includes gold 3/ Based on World Bank de�nition. The difference with central bank de�nition is that it includes the following: i) Gross--Due to Head Office/Branches Abroad of branches and offshore banking units of foreign banks operating in the Philippines, which are treated as quasi-equity in view of nil and/or token accounts of permanently assigned capital required of these banks, ii) Long-term loans of non-banks obtained without BSP approval which cannot be serviced using the foreign exchange resources of the Philippine banking, and iii) Long-term obligations under capital lease agreements. 30 Sustaining Growth in Uncertain Times Table 15. Philippines: National Government Cash Accounts (GFS Basis), 2008-11 Source: Department of Finance, Bureau of Treasury, and Department of Budget and Management 1/ Excludes privatization receipts (these are treated as �nancing items, in accordance with GFSM) 2/ Data from the Department of Budget and Management; Allocation to Local Government Units excludes capital transfers to LGUs. Allocation to LGUs excludes their capital transfer (it is included in capital outlays). 3/ Nominal GDP is based on World Bank staff estimate. 31 PHILIPPINES QUARTERLY UPDATE - December 2011 Selected Special Focus from Previous Quarterly Updates September 2011 PQU: Solid Macroeconomic Fundamentals Cushion External Turmoil External Spillovers to Philippine Growth. During 1997-2011, shocks from East Asian-3 economies, China in particu- lar have become more important for ASEAN-5 including the Philippines than those from the United States and the Euro zone. Spillovers of East Asian economies’ shocks are channeled to the Philippines through trade, while the United States and the Euro zone shocks are transmitted largely through �nancial variables. The �ndings suggest that vigorous growth in the East Asian economies can cushion declines in demand from the West. The 2012 Proposed National Government Budget. The 2012 national budget is a results-focused budget and calls for higher spending in general, particularly on social services. The budget will rest on increased revenue collection efficiency by broadening the tax base and improving tax administration and collection efforts. The Administration aims to lower government debt payment for 2012, which would release additional resources available for priority spending. The budget continues to employ the zero-based budget approach to rationalize expenditures and includes reforms to make further progress in improving spending efficiency, transparency, and accountability. Some of the major reforms include (i) fleshing out lump sum funds and (ii) tightening the use of savings, particularly from un�lled authorized positions. The reform in the use of savings implies that the government agencies and institutions, in particular those in the education sector, need to speed up on hiring. For poverty reduction and inclusive growth, higher spending on priority areas (education and health in particular) is required – an increase to 5-7 percent of GDP. To support this additional spending needed, the government needs to continue to strive for heightened revenue mobilization. June 2011 PQU: Generating More Inclusive Growth Poverty and Inequality in the Philippines. The recently released 2009 poverty estimates and household survey (FIES) provide a much needed update on poverty, inequality and income dynamics in the Philippines. The FIES reveals that in contrast with previous trends, household per capita incomes grew from 2006 to 2009 and that, remarkably, rural and poorer households strongly outperformed. However, despite this increase and a resilient economy poverty incidence continued to increase through 2009 though, some improvements occurred in both the gap and severity of poverty. Therefore, poverty, and especially poverty dynamics, in the Philippines remains worse than its neighbors. Spatially, poverty remains highly concentrated in rural areas and in terms of sectors, households that rely on agricultural income are signi�cantly more likely to be poor than other households. From 2006 to 2009, poverty in urban areas increased more rapidly, became more severe, and contributed more to the continuous increase in poverty. Across regions, 10 of the 17 administrative regions experienced an increase in poverty incidence. The Services Sector in the Philippines. The services sector has the potential to play an important role in promoting inclusive growth in the Philippines. The sector is already large and has been an important driver of employment and GDP growth. However, this has not necessarily led to a rise in the average quality of jobs or productivity gains. Unshackling the constraints on services as a source of inclusive growth will require broad-based policy action: providing higher quality education for all to meet the demand for skills as services move up the value chain; improv- ing infrastructure and enabling policies to facilitate agglomeration economies; removing investment climate distor- tions to allow services �rms to invest and innovate. 32 Sustaining Growth in Uncertain Times The 2011 National Accounts Revisions (1998-2010). The Philippines recently revised its national accounts series for the period 1998 to 2010. The revisions involve shifting to a new base year (from 1985 to 2000) and adopting most of the recommendation of the System of National Accounts (SNA) 1993 and some recommendations of SNA 2008. The new series shows roughly the same GDP growth though sectoral growth varies. The revisions led to a signi�- cantly higher investment-to-GDP ratio and to a higher level nominal GDP—of about 6 percent for 2010. Finally, the previously large statistical discrepancies between the production and the expenditure accounts have largely been eliminated through a methodological improvement that made use of the supply-and-use table. January 2011 PQU: Robust Growth, Stubborn Poverty Food Prices in the Philippines. In contrast to many countries in the region, food price inflation has been muted so far in the Philippines and is expected to remain moderate in 2011 though risks are tilted upwards. In the short-term, concerns about a return of a 2008-style food crisis in the Philippines seem limited as rice price increases are projected to remain contained thanks to recent strong domestic palay production, good planting intentions, record stock piles of rice, and domestic retail prices signi�cantly above international prices. Food prices are nonetheless expected to rise moderately, not least as the base impact of the increase in some food prices (especially vegetables) following typhoons Ondoy and Pepeng wears out. Fiscal Risks in the Philippines. Fresh into office the Aquino government established a comprehensive assessment of �scal risks and published the outcome in a Fiscal Risk Statement (FRS) in November 2010. International experience reveals that disclosure of �scal risks generates important bene�ts in terms of lower and better managed �scal risks, improved policies, and lower cost of �nancing. Historically, �scal risks have been prevalent in the Philippines and at times have generated large and unexpected �scal costs. Important weaknesses in the Philippines public �nancial management framework have contributed to heightened �scal risks. As the FRS reveals, while �scal risks have abated in important areas they still remain sizeable in 2010. Export of Services: Lessons from the BPO and Tourism Sectors. Services exports are rising strongly in the Philip- pines and provide an important source of diversi�cation of the country’s exports. The rapidly rising business process outsourcing (BPO) sector is building on the natural comparative advantages of the Philippines, namely a cost- competitive platform built around an English-speaking, technology-savvy young labor force, readily available telecommunication infrastructure, and a favorable economic zone environment. Tourism could become an impor- tant source of diversi�cation for the country but the sector is constrained by a weal investment climate, periodic security concerns, weak transport and tourism-related infrastructure, and regulations on air transport services. September 2010 PQU: Stepping Up Reforms to Sustain Growth The 2011 National Government budget: structural reforms and consolidation. The 2011 budget could be the turning point the country public �nances as it changes dynamics in two critical areas: (1) the (structural and cyclical) �scal policy stance, and (2) the efficiency, transparency and accountability of public �nances. The budget renews the �scal consolidation effort—albeit modestly—and contains signi�cant reforms measures aimed at improving spend- ing efficiency, transparency and accountability of the budget. For the 2011 budget to indeed turn the country away from a weak �scal position, inconsistent spending efficiency, and signi�cant gaps in public expenditure and �nancial accountability, efforts initiated in this budget will have to both be sustained over time and expanded. Strengthening revenue mobilization—through a modern tax system with efficiency and equity at its core—would enable to scale up spending needed to generate inclusive growth. 33 PHILIPPINES QUARTERLY UPDATE - December 2011 Employment, Poverty and distributional impacts of El Niño in the Philippines. The 2010 El Niño phenomenon was less intense than the 1998 one. It is nonetheless estimated to lead to a large reduction in agricultural output and to subtract 0.9 percentage points to 2010 real GDP growth. Using a micro-simulation model, we �nd that El Niño will result in (1) a 0.9 percent reduction in total household income in 2010 mainly due to a combination of lower employ- ment levels and individual earnings; (2) moderate increases in poverty incidence and poverty gap (0.4 and 0.2 percentage points increases, respectively); and (3) no signi�cant impacts on the indices of overall inequality- though income losses are larger at the bottom of the income distribution—and a similar impact for urban and rural areas at the bottom half of the distribution. The Philippines during the recent international �nancial shocks. Contrary to some expectations, the Philippine economy has shown to be remarkably resilient to recent international �nancial shocks. Using equity price indices and sovereign credit default swaps (CDS) spreads, we document the extent to which the country was affected in absolute and relative terms by the global �nancial crisis and the more recent European sovereign turmoil. Financial data reveal that: (1) during the last decade, the Philippines stock market exhibited strong co-integration with the US market and, to a lower extent with China’s, (2) the historically high volatility of the Philippine equity index decreased noticeably since the global �nancial crisis, (3) the sovereign credit quality of the Philippines is emerging favorably from the global �nancial crisis, and (4) Philippines sovereign CDS have not been correlated with CDSs of the �scally weak European countries. Constraints to growth: the agribusiness value chain in Mindanao. Understanding how the Philippines could improve its competitiveness in agribusiness and agricultural commodities markets in which the country, particularly the island of Mindanao, enjoys strong comparative advantages is critical to �ghting poverty and boosting rural incomes. A recent World Bank study of the performance of two key agricultural value chains in Mindanao—yellow corn and export bananas—reveals that both corn and banana value chains offer signi�cant future growth potential; yet they are facing some critical issues in terms of their long-term viability and sustainability. These include average farm-level productivity well behind international benchmarks, in large part due to infrastructure and logistics de�ciencies. As the speci�c channels by which these constraints curtail growth prospects resonate with constraints that other regions and sectors also struggle with, this study is illustrative of the developmental challenges facing the Philippines, especially as regards inclusive growth generation and the �ght against poverty. 34 Sustaining Growth in Uncertain Times Selected Recent World Bank Publications on the Philippines (for an exhaustive list, please go to: http://go.worldbank.org/BRHFJLLQD0) No. Title Publication Document Type Date 35 PHILIPPINES QUARTERLY UPDATE - December 2011 Copies of the Philippines Quarterly Update: Online copies of this publication can be downloaded in www.worldbank.org.ph Printed copies are also available in the following Knowledge for Development Centers (KDCs): 1. World Bank KDC Ground Floor The Taipan Place, Francisco Ortigas Jr. Road (former Emerald), Ortigas Business Center, Pasig City 1605 2. Asian Institute of Management KDC Joseph R. McMicking Campus, 123 Paseo de Roxas, Makati City 1226 3. Ateneo de Naga University KDC James O'Brien Library, Ateneo Avenue, Naga City 4400 4. Central Philippine University KDC Ground Floor Henry Luce III Library, Lopez Jaena Street, Jaro, Iloilo City 5000 5. House of Representatives KDC Congressional Planning and Budget Department, 2F R.V. Mitra Building, Batasang Pambansa Complex, Constitution Hills, 1126 Quezon City 6. Notre Dame University KDC Notre Dame University Library, Notre Dame Avenue, Cotabato City 9600 7. Palawan State University KDC Graduate School - Law Building, Manalo Campus, Valencia St., Puerto Princesa City 5300 8. Saint Paul University Philippines KDC 3rd floor, Learning Resource Center, Mabini St., Tuguegarao City 3500 9. Silliman University KDC Silliman University Library, Dumaguete City 6200 10. University of San Carlos KDC University Library, P. Del Rosario Street, Cebu City 6000 11. University of Southeastern Philippines KDC Obrero, Davao City 8000 36