Statement at the Conclusion of the 2014 Article IV Consultation Mission to the Philippines

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Press Release No. 14/133
March 26, 2014

The following statement was issued in Manila today at the conclusion of an International Monetary Fund (IMF) staff mission to the Philippines for the 2014 Article IV consultation:

The Philippines delivered another impressive macroeconomic performance in 2013. Growth accelerated to 7¼ percent on account of robust domestic demand including higher public spending and private investment, supported by accommodative monetary and financial conditions. Despite a series of natural calamities, growth was also sustained in line with resilient growth in Asia. Net foreign earnings through the current account increased further, helping to buoy investor sentiment and limit the risk of volatility from tapering by the U.S. Federal Reserve. Recognizing the progress made in strengthening external and fiscal positions, adopting sound policy frameworks, and raising growth while keeping inflation moderate, the three major rating agencies elevated the Philippines to investment grade during 2013.

Going forward, the economy is well positioned to absorb a gradual tightening of U.S. financial conditions and to implement timely, measured action on the domestic policy front. We forecast GDP growth to ease to a still-robust 6½ percent in 2014 and year-end inflation to moderate to 4 percent. With potential growth estimated at 6¼ percent, the positive output gap is expected to widen slightly in 2014 as the fiscal stimulus from reconstruction activities related to super typhoon Yolanda further supports growth. Higher imports to meet reconstruction needs are expected to narrow the current account surplus to 3¼ percent of GDP. Thereafter, and considering the reforms undertaken so far, GDP growth is projected to converge to 6 percent, with inflation remaining within the new lower 3±1 percent target band.

While this envisaged growth path is faster than what was achieved during previous decades, realizing the Philippines’ full potential for rapid, sustained and inclusive growth calls for further reducing bottlenecks to investment and formal sector employment that may be discouraging broader-based business activities.

A diversified production structure is, in turn, more conducive to delivering more durable, employment-intensive growth. This would help achieve significant progress in lowering unemployment and poverty rates, thereby reducing the number of people who may be vulnerable to natural disasters and other shocks. The challenge therefore is to continue implementing policies that deliver high quality, sustainable growth.

So far, policymakers have adeptly navigated the Philippine economy through the unprecedented easy policies adopted by advanced countries in the aftermath of the global financial crisis. Throughout, Philippines’ growth remained resilient, the external sector was strong, inflation was subdued, and the banking sector performed well, aided by prudent BSP oversight and regulatory standards.

With stronger global outlook, the need for accommodative monetary policies in the Philippines has waned. Already, ongoing tapering of quantitative easing by the Federal Reserve and expectations of future Fed actions are generating some autonomous tightening of domestic monetary and financial conditions. Supporting measures to gradually absorb liquidity would continue to align financial conditions with the targeted inflation trajectory and prevent the emergence of stretched valuations of real and financial assets. In the financial sector, where credit continues to expand in line with nominal GDP and sources of financing have become more diversified, the accelerated introduction of Basel III capital standards is welcome. Continued vigilance is needed to prevent any potential risk from developing. We support the BSP-proposed amendments to the BSP charter authorizing, among others, higher capitalization, exemption from income tax, the issuance of its own bills and enhancing its supervisory powers. The regulatory cooperation in the context of the new inter-agency Financial Stability Coordination Council is also important in this regard.

In the fiscal area, we support the government’s dual objectives of narrowing infrastructure gaps and mobilizing additional revenue. Increasing the national government deficit to 2 percent of GDP in 2014, together with continued modest revenue gains from stronger tax administration, would accommodate sizable reconstruction spending needs under “build back better” standards arising from the recent earthquake and typhoon. It would also imply a further modest decline in the public debt ratio. The reorientation of expenditure to more productive capital spending and social priorities (K-12 education program, universal healthcare, and expansion of the CCT program, partly financed with interest savings from prudent debt management) can be expected to increase the economy’s future productivity. Recent initiatives to improve fiscal transparency, including public websites to track expenditures of public calamity-related resources and to monitor foreign aid receipts, are commendable. Mobilizing the additional revenue needed to meet the authorities’ goal of achieving 5 percent of GDP infrastructure spending by 2016 while still remaining within the 2 percent of GDP deficit ceiling should rely primarily on tax base broadening, including the rationalization of income tax incentives. Additional tax revenue would be needed to offset any future reductions in statutory tax rates, and caution suggests that raising collections should precede the rate reductions.

On the structural policy front, further reforms are needed to create a more enabling business environment and to generate additional employment. Successfully executing PPPs and public capital spending projects would relieve infrastructure bottlenecks and help catalyze private investment. Identifying Public Private Pertnerships (PPPs) of national importance through amendments to the Build-Operate-Transfer law could mitigate regulatory uncertainty for investors, and further opening energy generation and distribution to competition would have downstream benefits for other sectors through lower input costs. Narrowing the negative list for foreign investment and scaling back generous perpetual income tax holidays that favor incumbents would support greater market contestability. Reducing internal transport costs including by opening domestic shipping to foreign competition under the Cabotage law amendment would support agri-business and lower food prices. Resolving uncertainties with land titles and use, expanding access to formal-sector credit by SMEs and micro-firms, reducing skill mismatches through better targeted education and apprenticeships would support job creation. Boosting resilience to natural disasters through “building back better” and low-cost insurance schemes would also promote poverty reduction. Improved prospects for local employment and lower incidence of poverty would reduce the appeal of working abroad, allowing more local talent to be deployed in the country.

We thank the Philippine authorities, officials in Cebu and Tacloban, and our private sector interlocutors for their generous hospitality and informative discussions.

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