COUNTRY REPORT

Philippines At a glance: 2001-02

OVERVIEW The resolution of the political crisis in January brought to power a new president, Gloria Macapagal Arroyo, backed by popular protest that enjoyed the co-operation of the leadership of the armed forces. Not everything is tied up, however, since the ousted president, Joseph Estrada, disputes Ms Arroyo’s legitimacy. The new regime should be more firmly bedded in after the May mid-term congressional elections, but the president will be under great political pressure to prove that she is “pro-poor” as well as an economic liberaliser. The Muslim and Communist insurgencies are likely to ease as peace negotiations, broken off under President Estrada, are resumed. Containing the fiscal deficit will be a priority in 2001, and reducing it the priority in 2002, which will reinforce the contractionary impact of much weaker external markets, keeping GDP growth below 3% in both years. Inflation will ease down from its 6-7% highs of early 2001 as the currency stabilises and domestic demand growth remains subdued. Merchandise trade will remain in surplus, but this will diminish as export growth weakens. Key changes from last month Political outlook • Political stability will not fully recover until the fate of former President Estrada is decided. The Supreme Court has, however, now ruled that he cannot make any further appeals contending that he is still president, although this may not be the end of the legal process. We expect the May congressional election to deliver a strong pro-administration majority in the lower house. Economic policy outlook • Despite short-term political constraints, the economic reform agenda will be resumed. The privatisation of the national power utility has been delayed, while objections are given more consideration. Economic forecast • The government’s efforts to rein in the budget deficit will constrain government consumption growth. Private consumption growth will also be muted, as agricultural activity is subdued and unemployment remains high.

April 2001

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Copyright © 2001 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the EIU does not accept responsibility for any loss arising from reliance on it.

ISSN 0269-428X

Symbols for tables “n/a” means not available; “–” means not applicable

Printed and distributed by Redhouse Press Ltd, Unit 151, Dartford Trade Park, Dartford, Kent DA1 1QB, UK Philippines 1

Contents

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2001-02 7 Political outlook 8 Economic policy outlook 10 Economic forecast

13 The political scene

17 Economic policy

22 The domestic economy 22 Economic trends 25 Agriculture 26 Manufacturing 27 Services

28 Foreign trade and payments

List of tables

10 International assumptions summary 11 Forecast summary 18 Budget results and forecasts 20 Public finance targets 22 Gross domestic product and gross national product 23 Gross domestic product by expenditure 23 Gross domestic product by origin 24 Consumer prices 25 Exchange rates 25 Rice output and area 26 GDP in major manufacturing industries 26 Manufacturing production 28 Foreign trade 29 Major imports 30 Balance of payments, January-November 2000

EIU Country Report April 2001 © The Economist Intelligence Unit Limited 2001 2 Philippines

List of figures

12 Gross domestic product 12 Philippine peso real exchange rates 22 GDP growth 24 Consumer price inflation, 2000 29 Trade balance

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Summary

April 2001

Outlook for 2001-02 The resolution of the political crisis in January brought to power a new president, Gloria Macapagal Arroyo, backed by popular protest that enjoyed the co-operation of the leadership of the armed forces. Not everything is tied up, however, since the ousted president, Joseph Estrada, disputes Ms Macapagal Arroyo’s legitimacy. The new regime should be more firmly bedded in after the May mid-term congressional elections, but the president will be under great political pressure to prove that she is “pro-poor” as well as an economic liberaliser. The Muslim and Communist insurgencies are likely to ease as peace negotiations are resumed. Containing the fiscal deficit in 2001and reducing it in 2002 will be priorities; this will reinforce the contractionary impact of much weaker external markets, keeping GDP growth below 3% in both years. Inflation will ease from its 6-7% highs of early 2001 as the currency stabilises and demand growth remains subdued.

The political scene A replay of People’s Power—civil protesters allied with the military—removed Joseph Estrada from the presidency on January 20th. He continues to dispute the legitimacy of President Macapagal Arroyo. The mid-term congressional elections will be a significant electoral test of the new administration. The government represents a return to the policies of the Ramos presidency. Peace talks are to resume with the Muslim and Communist rebel movements.

Economic policy The budget deficit hit P136bn (US$3.1bn) in 2000 and the new administration will be hard put to contain a further rise this year. Fiscal incentives have come under critical review, and counterpart funding for foreign-aided projects will be reduced. The terms of power sector reform—including the privatisation of the electricity utility—are still under discussion. The Philippines is set to enter a post-programme monitoring arrangement with the IMF. The secrecy accorded to bank deposits has been slightly diminished by a central bank decision.

The domestic economy GDP growth slackened in the fourth quarter of 2000, but was up over the full year to 3.9% as manufacturing growth gained momentum. Inflation hit a 21- month high in January. Interest rates have fallen to pre-crisis levels and the peso has stabilised. The government hopes to dispose of its equity in Philippine National Bank in a joint sale with the majority owner.

Foreign trade and The merchandise trade surplus reached a record US$6.7bn in 2000, but the rate payments of growth in electronics exports has fallen sharply. Lower workers’ remittances held down the growth in the current-account surplus last year. The capital account is in deep deficit; the balance of payments moved into the red in 2000.

Editors: Sophie Lewisohn (editor); Leo Abruzzese (consulting editor) Editorial closing date: April 10th 2001 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Political structure

Official name Republic of the Philippines

Form of government Under the 1987 constitution, the government is based on separation of powers between the executive presidency, bicameral legislature and independent judiciary

The executive The president is chief executive, head of state and commander-in-chief; serves no more than one six-year term; may approve bills passed by Congress or may exercise a veto, which can be overridden only by a two-thirds majority of Congress. Cabinet appointments are subject to approval by the Congressional Commission on Appointments

Legislature The Congress of the Philippines consisting of the Senate (24 members) and the House of Representatives (208 directly elected members and, since July 1998, up to 52 selected by party list); senators elected for six-year terms; representatives for three-year terms

Legal system Based on common law; 1987 constitution contains a Bill of Rights and prescribes a judiciary with the Supreme Court at apex

National elections May 11th 1998 (presidential, House of Representatives and half of the Senate); next election due May 2001 (mid-term congressional)

National government Gloria Macapagal Arroyo became president on January 20th 2001, replacing Joseph Estrada in the middle of his six-year term (he became president on June 30th 1998)

Main political organisations Lakas ng Edsa-National Union of Christian Democrats (Lakas-NUCD), the ruling party since January 2001, a role it had played under President Ramos (1992-98). The three components of Laban ng Masang Pilipino (Lamp), the pro-administration coalition under President Estrada, have separated: they are the Nationalist People’s Coalition (NPC), Partido ng Masang Pilipino (PMP) and Laban ng Demokratikong Pilipino (Laban); Communist Party of the Philippines (CPP); Moro National Liberation Front (MNLF); Moro Islamic Liberation Front (MILF)

President Gloria Macapagal Arroyo Vice-president Teofisto Guingona

Key ministers Agrarian reform Hernani Braganza Agriculture Leonardo Montemayor Budget Emilia Boncodin Defence Angelo Reyes Economic planning Dante Canlas Education & culture Raul Roco Energy Isidro Camacho Finance Alberto Romulo Foreign affairs Domingo Siazon Health Manuel Dayrit Interior Joey Lina Justice Hernando Perez Labour Patricia Santo Tomas Public works Simeon Datumanong Tourism Richard Gordon Trade & industry Manuel Roxas Transport & communications Pantaleon Alvarez

Executive secretary Renato de Villa

Central bank governor Rafael Buenaventura

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Economic structure

Annual indicators

1996 1997 1998 1999 2000 GDP at market prices (P bn) 2,171.9 2,421.4 2,674.1 2,996.4 3,322.6 Real GDP growth (%) 5.7 5.2 –0.6 3.3 3.9 Consumer price inflation (av; %) 9.0 5.7 9.7 6.7 4.3 Fiscal balance (% of GDP) 0.3 0.1 –1.9 –3.7 –4.1 Population (m; mid-year) 71.9 73.5 75.2 76.8 78.4a Exports of goods fob (US$ m) 20,543 25,228 29,496 34,210 38,078 Imports of goods fob (US$ m) 31,885 36,355 29,524 29,252 31,387 Current-account balance (US$ m) –3,953 –4,351 1,546 7,910 8,292a Reserves excl gold (US$ m) 10,030 7,266 9,226 13,230 13,054 Total external debt (US$ bn) 40.1 45.7 47.8 52.0 51.2a Debt-service ratio, paid (%) 13.4 9.2 11.9 14.3 15.4 a Exchange rate (av; P:US$) 26.22 29.47 40.89 39.09 44.19

April 10th 2001 P49.90:US$1

Origins of gross domestic product 2000 % of total Components of gross domestic product 2000 % of total Agriculture, forestry & fishing 16.5 Private consumption 70.3 Industry 30.8 Government consumption 12.7 Manufacturing 22.4 Fixed investment 17.8 Construction 4.9 Change in stocks –0.3 Utilities 2.9 Exports of goods & services 55.1 Services 52.6 Imports of goods & services –50.7 GDP at market prices 100.0 GDP at market prices incl statistical discrepancy 100.0

Principal exports 1999 US$ m Principal imports 1999 US$ m Electrical & electronic equipment 21,165 Semi-processed raw materials 11,080 Machinery & transport equipment 4,951 Telecoms equipment & electrical machinery 6,891 Garments 2,267 Parts for manufacture of electrical equipment 4,708 Coconut products 466 Semi-processed manufactures 2,504 Chemicals 294 Power generation equipment & specialised machines 2,396 Fish 287 Mineral fuels 1,998 Copper 278 Total incl others 30,726 Total incl others 35,032

Main destinations of exports 1999 % of total Main origins of imports 1999 % of total US 29.8 US 20.7 EU 19.3 Japan 20.0 Japan 13.3 EU 9.1 Netherlands 8.2 South Korea 8.9 Singapore 7.0 Singapore 5.7 UK 5.6 Taiwan 5.3 Hong Kong 5.0 a EIU estimate.

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Quarterly indicators

1999 2000 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Government finance (P m) Revenue 105,080 139,572 112,622 120,936 113,968 135,763 125,870 128,748 Expenditure 138,585 158,620 147,709 145,246 136,846 161,205 161,391 182,393 Balance –33,505 –19,048 –35,087 –24,310 –22,878 –25,442 –35,521 –53,645 Output GDP at constant 1985 prices (P m) 217,524 223,533 223,302 253,023 224,485 233,515 233,465 262,117 % change, year on year 0.7 3.6 3.8 4.9 3.2 4.5 4.6 3.6 Manufacturing index (1992=100) 139.5 139.5 149.5 142.8 150.6 152.1 173.2 175.9 % change, year on year –2.6 1.9 6.2 8.8 7.9 9.0 15.8 23.1 Employment and prices Employment ('000) 28,368 29,492 29,055 29,003 28,895 28,301 28,178 27,775 % change, year on year 2.5 5.9 4.3 2.6 1.9 –4.0 –3.0 –4.2 Unemployment rate (% of the labour force) 9.0 11.8 8.4 9.6 9.3 13.9 11.1 10.1 Consumer prices (1995=100) 134.0 134.1 135.5 136.8 138.0 139.3 141.6 144.8 % change, year on year 10.0 6.8 5.6 4.5 3.0 3.9 4.5 5.9 Wholesale prices (1985=100) 258.1 254.2 252.1 254.5 258.5 254.6 258.1 265.1 % change, year on year 13.5 6.7 4.4 –0.8 0.1 0.1 2.4 4.2 Financial indicators Exchange rate P:US$ (av) 38.70 37.99 39.24 40.43 40.65 41.88 44.99 49.25 P:US$ (end-period) 38.77 38.02 41.11 40.31 41.06 43.15 46.28 50.00 Interest rates (av; %) Deposit 11.2 7.1 7.2 7.2 7.1 6.6 7.5 12.1 Lending 13.8 12.1 10.3 10.9 10.3 10.0 10.9 12.0 M1 (end-period; P bn) 289.1 297.9 311.7 395.6 341.5 346.0 347.9 n/a % change, year on year 17.9 18.7 30.4 38.3 18.1 16.2 11.6 n/a M2 (end-period; P bn) 1,605 1,652 1,709 1,900 1,832 1,866 1,944 n/a % change, year on year 10.5 9.1 10.4 16.8 14.2 13.0 12.0 n/a PSE composite index (end-period; 1985=100) 2,028.2 2,487.0 2,096.2 2,143.0 1,681.7 1,534.0 1,434.0 1,495 % change, year on year –9.4 41.3 66.4 8.8 –17.1 –38.3 –31.6 –30.2 Foreign trade (P m) Exports fob 303,983 328,872 278,113 521,626 332,409 330,328 602,253 n/a Imports cif –301,600 –311,458 –330,674 –328,716 –340,388 –341,513 402,361 n/a Trade balance 2,383 17,414 –52,561 192,910 –7,979 –11,185 199,892 n/a Foreign payments (US$ m) Merchandise trade balance 748 382 1,907 1,921 787 1,608 2,039 n/a Services balance –932 –745 –561 –475 –472 –464 –384 n/a Income balance 1,614 1,580 1,124 853 1,098 810 844 n/a Current-account balance 1,545 1,333 2,601 2,431 1,521 2,052 2,591 n/a Reserves excl gold (end-period) 11,386 12,303 12,741 13,230 14,203 13,407 12,975 13,054 Sources: Bangko Sentral Ng Pilipinas, Selected Economic Indicators; IMF, International Financial Statistics; National Statistical Co-ordination Board, Economic Indicators.

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Outlook for 2001-02

Political outlook

Domestic politics What is being dubbed People’s Power II—a repeat of the overthrow of former president, Ferdinand Marcos, in February 1986—has brought a fundamental change in the political situation in the Philippines that did not look likely, in this form, at the beginning of 2001. Nevertheless, the nature and suddenness of the change in the presidency from the incumbent, Joseph Estrada, to his vice-president and constitutional successor, Gloria Macapagal Arroyo, are factors for short-term instability. She came to office after three days of mass street protests in Manila, during which demands that the president step down culminated in the resignation of most of the cabinet and the chief of staff, along with the heads of the armed forces and constabulary. While Mr Estrada, besieged in the presidential palace, agreed to leave the premises, he did not explicitly resign (he was deemed by the Supreme Court to have abandoned office) and he now claims that he is still the president and has merely taken temporary leave. That argument has been rejected by the Supreme Court, but Mr Estrada is appealing against the ruling.

Mr Estrada probably does not believe that he can resume office. But he wants to avoid prosecution on charges of plunder (which bears a capital sentence) and while he retains the title of president he cannot be prosecuted in the courts. This situation creates some uncertainty, which will not be resolved until Mr Estrada leaves the country, or formally renounces his claim to the presidency, or the mid-term congressional election delivers a strong pro- administration majority in the lower house and a raft of “pro-Gloria” senators in the upper house. (Half of the seats in the Senate are up for election in May.) A pro-administration majority is almost certain to be returned in the lower house; the Senate is far more problematic.

The EIU’s political forecast therefore remains one of some instability in the short term. However, this is unlikely to be prolonged, with a return to stability soundly based under Ms Macapagal Arroyo’s presidency. Moreover, since she is deemed to be serving out the remainder of the Estrada presidential term, she is eligible to stand for the presidency in her own right in mid-2004 (the constitution bars a second term). The prospect of a lengthy tenure is already prompting an accretion of congressional support for the new president, with a pro-administration majority in the House of Representatives in place even before the May vote. The traditional pattern is being followed: pro- administration holders of elective office usually remain in support of the administration through a change in the presidency, and their numbers tend to peak at the mid-term election (after which their attention turns to the likely presidential successor).

The new president, Ms Macapagal Arroyo, who was head of Lakas-NUCD, the pro-administration party under former president, Fidel Ramos, will work with tried and tested political players to push her legislative agenda through Congress. Prominent among these will be former President Ramos, assuming

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the role of elder statesman. The Ramos administration built up a strong record of legislative progress on economic reform, but Ms Macapagal Arroyo (who was involved in establishing that programme) will need a light touch on economic liberalisation, which is popularly perceived to cost local jobs. She will focus on policies enhancing social welfare, to counter the rhetoric of the “president for the poor” whom she has replaced. Ms Macapagal Arroyo has certainly brought to her presidential duties the diligence and intelligence that was so manifestly lacking in her predecessor.

The change of administration has important implications for the prospect of a peaceful settlement of the country’s insurgencies. Four weeks after taking office the president ordered a suspension of military operations against the Moro Islamic Liberation Front (MILF, the leading active Muslim rebel movement on the southern island of Mindanao). In late March secret talks in Kuala Lumpur between representatives of the Philippine government and the MILF led to an agreement to resume peace talks within three months. These had broken down in August 2000 after the previous Estrada administration had attacked and captured the MILF’s bases. At the same time, after the new government declared a ceasefire in two provinces where the New People’s Army, the military wing of the New Democratic Front (the umbrella organisation for the communist movement), was active, it was agreed that peace negotiations would resume in late April—the first such talks since 1999.

International relations The Philippines will remain committed to deepening its integration within the region, particularly on the trade front. A priority will also be to develop contacts with the EU and, in this respect, underline the country’s independence from its former colonial master, the US.

One source of contention in the Philippines’ relations with its neighbours remains the disputed sovereignty over the Spratly Islands, claimed in part or in whole by six countries in the region. China has sought to advance its claim by building structures on the islands, ostensibly as fishing outposts, and there have been a number of skirmishes between Chinese and Philippine fishing vessels in the waters around the islands since late 1999. The Philippine government will continue to protest formally at what it sees as incursions and will try to involve all claimants to the islands in a negotiated settlement.

Economic policy outlook

Policy trends With Congress in effect closed down since early February, when campaigning got underway for the May mid-term congressional election, no significant measures will be enacted before the 2001/02 session starts in June. The budget appropriations bill for 2001 has not been approved by the upper house, so the allocations for 2000 are being continued (with a special allowance agreed for election costs) and updating revisions will be legislated for in the second half of this year. The indications are that, despite the short-term political constraints—such as the need to win over those sections of the population who believed Mr Estrada’s claim to be the “president for the poor”—the economic reform agenda will be resumed. Ms Macapagal Arroyo’s early

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ministerial appointments have drawn heavily on technocrats who were active under Mr Ramos. However, the privatisation of the national power utility has not moved forward as rapidly under the new president as some had expected. She has not given priority to the Electricity Industry Reform Act, which sets out the terms for the privatisation as well as the regulatory structure for a liberalised power sector. The president wants more consideration to be seen to be given to objections, raised by the grass roots organisations who led the demand for Mr Estrada’s resignation, on the treatment of the utility’s debt and on cross-ownership.

Fiscal policy The first priority for the new administration is to arrest the fiscal deterioration that characterised the Estrada years. In 2000 the budget deficit reached P136bn (US$3.1bn at an exchange rate of P44.19:US$1), twice the original target and an increase on the already bloated P112bn recorded in 1999. The reason for the overshoot was that revenue was P61bn below target because of shortfalls in collection by the Bureau of Internal Revenue and, less significantly, disappointing results from asset disposals. Taking into account a legacy of P81bn in unpaid 2000 liabilities, the new administration has set a target deficit of P145bn for 2001. This is to be attained by a blend of improvements in tax collection (although new levies and structural reform must await the next Congress) and tight controls on spending. The government’s hopes for higher proceeds from privatisation (equity holdings in three companies and real estate in Manila are on the 2001 sales list) are realistic now that the climate for investment has been transformed by Mr Estrada’s departure from office. Lower interest rates will reduce the cost of government borrowing, providing some relief on the spending side. But keeping the deficit to the P145bn limit also assumes rather faster GDP growth in 2001 (the government projects 3.8-4.3%) than we forecast. So deficit reduction in 2001 will be modest.

Monetary policy The stabilisation of the peso at around the P50-52:US$1 level in the closing months of last year, allowed the Bangko Sentral ng Pilipinas (BSP, the central bank) to embark on a well signalled week-by-week reduction in overnight rates. The process was given a boost by Mr Estrada’s removal from office in January. That event immediately prompted a strengthening in the peso, which— together with the sharp rate cuts made by the US Federal Reserve—allowed more rounds of reductions in the BSP’s overnight rates, leaving them in late March 50 basis points below pre-crisis levels.

While still relatively high inflation rates will limit the extent of further monetary easing in the short term, the key short-term interest rate—on 91-day Treasury bills—has been falling at every auction this year, and was down to single digits by late March. Further falls are likely, given the reluctance of banks to lend to the private sector, even when they have considerable excess liquidity.

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Economic forecast

International assumptions summary (% unless otherwise indicated) 1999 2000 2001 2002 Real GDP growth World 3.5 4.8 3.0 3.9 OECD 3.0 4.0 1.8 2.6 US 4.2 5.0 1.3 2.8 Exchange rates (av) ¥:US$ 113.9 107.8 122.5 122.0 US$:€ 1.07 0.92 0.97 1.07 SDR:US$ 0.731 0.758 0.765 0.737 Financial indicators ¥ 2-month private bill rate 0.27 0.24 0.28 0.30 US$ 3-month commercial paper rate 5.18 6.32 4.89 5.39 Commodity prices Oil (Brent; US$/b) 17.9 28.4 23.9 23.0 Gold (US$/troy oz) 278.8 279.3 258.8 255.0 Food, feedstuffs & beverages (% change in US$ terms) –18.6 –6.1 8.0 14.8 Industrial raw materials (% change in US$ terms) –4.6 13.4 2.6 5.1

Note. Regional aggregate GDP growth rates weighted using purchasing power parity exchange rates.

International assumptions The slowdown in US GDP growth in 2001, to 1.3%, will represent a sharp reduction in external demand for Philippine exports, as the US is by far the country’s leading export market, accounting for 30% of sales in 1999. Oil prices, which surged to an average of US$28.4/barrel (dated Brent) in 2000— 58.9% up on the year earlier—will fall back in both 2001 and 2002, but only by a cumulative 19%. The Philippines relies on imported oil for around three- quarters of conventional energy use and will be adversely affected by the relatively high prices still prevailing.

Despite US interest rate cuts, the cost of the Philippine government’s foreign borrowing will nevertheless remain high in 2001 and 2002 while its budget is still in marked deficit, although the margins demanded on Philippine paper have narrowed following the change in the presidency. The yen will weaken against the dollar this year and remain weak in 2002. This has mildly unfavourable implications for the Philippines’ current account, since the bulk of inflows is dollar-denominated and a large proportion of outflows (trade-, investment- and debt-related) is in yen.

Economic growth We expect GDP growth to slacken in 2001, to 2.7%, with only a slight recovery in 2002. The pressures are both external and internal. World demand growth will register an unusually sharp deceleration this year, dampening Philippine export prospects. Meanwhile, growth in domestic consumption will be constrained by fiscal austerity (which will have to be maintained through 2002), and while the replacement of Mr Estrada by a president with strong economic reform credentials has altered the climate for investment, there will still be some initial investor wariness.

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Forecast summary (% unless otherwise indicated) 1999a 2000a 2001b 2002b Real GDP growth 3.3 3.9 2.7 2.9 Gross agricultural growth 6.0 3.4 2.0 1.6 Unemployment rate (av) 9.7 11.1 11.4 11.6 Consumer price inflation Average 6.7 4.3 6.1 5.6 Short-term interbank rate 11.8 10.9 10.5 10.5 Government balance (% of GDP) –3.7 –4.1 –3.9 –3.3 Exports of goods fob (US$ bn) 34.2 38.1 38.6 40.7 Imports of goods fob (US$ bn) 29.3 31.4 32.8 36.2 Current-account balance (US$ bn) 7.9 8.3 c 7.8 5.7 % of GDP 10.3 11.0 c 10.5 7.4 External debt (year-end; US$ bn) 52.0 51.2 c 52.9 55.6 Exchange rates P:US$ (av) 39.09 44.19 50.50 51.80 P:¥100 (av) 34.32 41.01 41.02 42.50 P:E (year-end) 40.50 46.94 52.50 58.91 P:SDR (year-end) 55.33 65.14 67.83 72.59

a Actual. b EIU forecasts. c EIU estimates.

We forecast a further 1% decline in fixed investment in 2001, since banks will only gradually shed their reluctance to lend to the private sector, while domestic demand growth will initially not be sufficiently strong to take up spare capacity and encourage new investment. Falling interest rates will therefore give only a delayed stimulus. Government consumption will rise only slightly, by 0.1% in 2001, as the larger than planned deficit last year and depressed revenue from lower than expected corporate profits this year put constraints on spending growth, despite the exigencies of the mid-year elections. Private consumption growth will remain at or below the rate of overall GDP growth in both 2001 and 2002, as agricultural growth is subdued and unemployment remains high. Overall domestic demand will remain flat in 2001. Exports, which account for over half of GDP in nominal terms, will provide a much weaker spur to growth in 2001-02. The foreign balance will change little in 2001-02. We have revised downwards our forecast for export growth, to average around 2% in 2001-02, as demand for electronic goods in particular—accounting for around 60% of total exports—falters. Imports will post marginal growth in 2001, after the slight pick up in 2000, but gather pace in 2002.

Inflation Consumer price inflation will ease down from the 6-7% rate of the first quarter of 2001, as oil prices fall and domestic demand growth remains subdued. We expect consumer price inflation to average 6.1% in 2001 and 5.6% in 2002.

Exchange rates When Ms Macapagal Arroyo was sworn into office as president on January 20th, the peso immediately surged to P44:US$1, from the previous end of the day close of P55.65:US$1. This recovery was excessive, and the peso has since stabilised at around P48-50:US$1. As the trade and current accounts

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are forecast to stay in surplus, and inflows from the Philippine community overseas are likely to pick up, the peso will resume the modest depreciation warranted by rather wider inflation differentials with the US and the need to remain competitive with the Thai baht. We forecast average annual exchange rates of P50.5:US$1 in 2001, and P51.8:US$1 in 2002.

External sector While we expect the current account to remain in surplus in 2001-02, that surplus will shrink, as export growth (in US dollar terms) is expected to fall below the already lower pace registered in 2000. This will be because of the sharp downturn in US GDP growth. Given relatively weak domestic demand and the less dynamic market for Philippine goods with a high import component, the rise in import spending will remain subdued. The trade balance will thus remain in comfortable surplus, but at falling levels, and the current-account surplus will fall to US$7.8bn in 2001 and US$5.7bn in 2002.

The combined services and income balance will remain in surplus in 2001-02, buoyed as always by remittances from overseas contract workers. With the political situation, and hence the peso, stabilising and removing the incentive to defer remittances, inflows of discretionary funds from Filipinos overseas— always more significant than remittances from overseas contract workers—will pick up. Meanwhile, the rise in income debits in 2002 stemming from the government’s still high foreign borrowing requirement will be contained by the narrowing in spreads on Philippine debt.

International reserves stood at US$13.1bn at the end of 2000. This represented a slight fall on mid-year levels, following BSP intervention to support the currency in September, but was a marked improvement on the October outturn of US$12.6bn, in part owing to government borrowing of US$200m in December. Reserves were, however, well below the year-end target of US$16.1bn agreed with the IMF. They have since eased down to stand below the October figure in January and February 2001, and we expect them to strengthen only marginally in 2001 and 2002, given our forecast for a slowdown in export growth. However, with import growth subdued throughout most of the period, reserves will continue to provide a comfortable level of import cover in 2001-02.

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The political scene

People’s Power ousts The political crisis which engulfed the Philippines last October, and which at President Estrada the beginning of this year threatened to rumble on for as long as another three years, was suddenly resolved on January 20th. President Joseph Estrada was replaced by his vice-president, Gloria Macapagal Arroyo.

The denouement was rapid. It began with a vote in the Senate, which had been conducting hearings since December 7th on four articles for the impeachment of President Estrada: bribery, graft and corruption, betrayal of public trust and culpable violation of the constitution (January 2001, pages 16-18). The prosecution panel from the House of Representatives had produced convincing evidence of the existence of secret multi-million peso accounts held by the president, which it claimed were the repository of illicitly acquired funds. An envelope that was thought to contain documents revealing more about these accounts was produced by the prosecution in the first week of January. It was widely assumed that this would seal the case against Mr Estrada. But pro- Estrada senators called a vote on January 16th to reject the admissibility of this evidence (on the grounds that the specific actions that it related to had not featured in the articles of impeachment). They won the vote by 11 to 10. The prosecution panel thereupon resigned, which meant that the impeachment trial was effectively at an end.

The opposition was not prepared to accept a de facto acquittal on these terms. Mass street demonstrations immediately began on the pattern of February 1986, when President Marcos was removed from power, and, as in 1986, civilians and the military came together. The heads of all the armed services and the head of the national police appeared on the podium at a rally at the Edsa shrine—the emblematic site of the 1986 People’s Power movement—and joined the call for the president to resign. The defence minister also announced his defection. This was followed by the resignation of most members of the cabinet. Besieged by the crowd at the presidential palace, Mr Estrada agreed to leave the premises, although he refused to resign. His successor under the constitution, Ms Macapagal Arroyo, was sworn in as president by the chief justice of the Supreme Court.

The displaced president Ms Macapagal Arroyo was thus brought to power by a civilian/military coup, sticks to his claim to office with the military high command turning against Mr Estrada because they feared a breakdown of order within the armed forces if they were required to put down a mass civilian protest movement. But the new administration claims that it has won power through due constitutional process. On January 20th, at Ms Macapagal Arroyo’s request and before Mr Estrada left the palace, an emergency session of the Supreme Court deliberated on the legality of her being sworn in as president. The 15 justices ruled unanimously that the vice-president had a constitutional mandate to assume the presidency: the reasoning was apparently (there has been some dispute since on this point) that, the armed forces having withdrawn their allegiance and in the absence of a cabinet, Mr Estrada was deemed no longer able to exercise the office, which had thus effectively been vacated. It is clear that the justices, like the military

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heads, had decided that if Mr Estrada stayed in office there was a real danger of civil unrest. It was after the Supreme Court ruling that the chief justice administered the oath of office.

Mr Estrada’s argument is that he only temporarily ceded office, owing to his desire to prevent unrest, and that Ms Macapagal Arroyo is thus only the acting president, who should step down when Mr Estrada feels ready to resume presidential duties. When Mr Estrada’s lawyers presented this argument to the Supreme Court it was rejected. On March 2nd another unanimous ruling upheld the legitimacy of the Macapagal Arroyo administration.

That decision is under appeal, but it is doubtful that Mr Estrada really believes that he can regain the presidency by court decree. But by claiming to be president, and thus to have executive immunity, and by maintaining his challenge through the courts, he hopes to escape arraignment on charges of plunder. That case is being put together by the ombudsman, Aniano Desierto, who has taken up the prosecution’s accusations in the impeachment hearings relating to the covert bank accounts. He has unearthed additional evidence on kickbacks allegedly received by the president on a number of major corporate purchases by the two government pension funds. But Mr Desierto has been prevented, by a ruling of the Supreme Court on March 20th, from filing the six cases he has prepared until Mr Estrada’s appeal against the March 2nd ruling has been heard.

The stakes are high for Mr Estrada; plunder is a non-bailable offence and carries the death penalty. But the stakes are also high for the new administration. It faces a dilemma. Opinion polls indicate that a majority would not approve of the death penalty being applied to the former president. The armed forces are reportedly opposed to pursuing the plunder case through the courts. But there is also pressure to bring the former president to book from the civil society groups who had a high profile role in the movement to force Mr Estrada to step down. They do not want a repetition of the Marcos precedent, where—more than a decade after Ferdinand Marcos was overthrown—the Philippine government has still to recover the assets acquired illicitly by the Marcos family.

The mid-term elections are The imminence of the mid-term congressional elections in May sharpens the unusually significant government’s dilemma. A nationally publicised trial of the president, who claims to stand up for the humble pinoy (common Filipino) against the rich and powerful—the political and business elite of which Ms Macapagal Arroyo is a scion—would consolidate the following that Mr Estrada still has among an apparently significant proportion of the population. He can still call on funds, his own or from those who have benefited from his rule, to fight an election that will inevitably be seen as the popular test of the legitimacy of the takeover in January. The administration is trying hard to counter any such interpretation, and President Macapagal Arroyo has not gone out to campaign in support of the senatorial and congressional candidates fielded by the Edsa II Coalition, the group of parties which backed her demand as vice-president that Mr Estrada resign. The coalition comprises the following parties: Lakas—NUCD (the pro-administration party under President Fidel

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Ramos, for which Ms Macapagal Arroyo stood as vice-presidential candidate in 1998); Reporma (the party which was formed to back the presidential candidacy of Renato de Villa, the defence secretary under President Ramos, in the same year); Probinsiya Muna Development Initiative (another party which appeared in the 1998 election); the Partido Demokratiko Sosyalista ng Pilipinas; and Aksyon Demokratiko.

Meanwhile Laban ng Masang Pilipino (Lamp), the pro-Estrada coalition of three parties, broke up within weeks of Mr Estrada’s fall. The major partner, the Nationalist People’s Coalition (NPC), formally broke away on February 1st and recognised the presidency of Ms Macapagal Arroyo. The other parties, the Partido ng Masang Pilipino (PMP, Mr Estrada’s own party) and the Laban ng Demokratikong Pilipino (Laban), have resumed their separate identities for the May ballot.

But even in this year’s unusual situation, the election result will follow the traditional path. In the House of Representatives, where all seats are up for election, candidates supporting the administration, whatever their exact party political label, will do well since they are close to the fount of power and hence in line for favours for years after the vote. A pro-Macapagal Arroyo majority will replace the pro-Estrada majority in the lower house; some congressmen will merely have switched their label. In the Senate, on the other hand, where the ballot is nationwide, name recognition and popular image are big determinants. Here it is possible that the 13 seats up for election (12 due plus one to replace a deceased senator) will go fairly evenly between the Edsa coalition parties, the pro-Estrada figures (including the former president’s wife) and independents. To some extent the senatorial contest will serve as a referendum on the January coup. A number of the candidates were major participants in the impeachment process: Manuel Villar (running as an independent) was the Speaker of the House who pushed through the vote on the articles of impeachment; Ernesto Herrera (running for Lakas—NUCD) played a major role on the prosecution panel: Franklin Drilon (running for a second term, as an independent) was the president of the Senate who resigned after the January 16th vote; Miriam Defensor Santiago, Juan Enrile and Gregorio Honasan all voted against opening the document that contained the further evidence against Mr Estrada: and Edgardo Angara and Ricardo Puno were among the few cabinet members who stayed with Mr Estrada to the end. Given that personal publicity and money play so large a part in determining the Senate result, this will be a restricted indicator of popular support for President Macapagal Arroyo.

The new government The cabinet appointments made by the new administration reveal two draws on the Ramos legacy fundamental characteristics of the Macapagal Arroyo presidency: it represents a return to the policy and personnel of the Ramos presidency, and it owes a debt of gratitude to the military. The two are not unconnected. The first appointments announced, within days of the takeover, included Renato de Villa (defence minister under President Ramos and previously armed forces chief of staff) to the important post of executive secretary, Alberto Romulo (deputy finance minister under President Ramos) as finance minister, and Dante Canlas as planning minister and concurrently the director-general of the

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National Economic and Development Agency (NEDA), where he had served as deputy director during the Ramos administration.

Some high-profile posts took longer to settle. It was not until February 6th that the vice-president was named. Teofisto Guingona was a fitting choice on several grounds. He has long experience in both government and Congress, as executive secretary (1993-95) and justice secretary (1995-98) under President Ramos, majority leader in the Senate in 1987-92 and minority leader since 1998. It was Senator Guingona’s privilege speech on October 6th 2000, exposing Mr Estrada’s alleged links to illegal gambling, which set off the process that ended with the president’s removal in January.

Angelo Reyes is named as Mr Guingona’s appointment was widely welcomed. The post of defence defence minister minister took even longer to fill, and proved controversial. Orlando Mercado had initially stayed on as a holdover from the Estrada cabinet. But he resigned the post a week later after the president appointed as national security adviser a retired general—Lisandro Abadia—against whom Mr Mercado’s department had filed a case relating to anomalies in the administration of the armed forces pension fund. An interim appointment was then made, of Eduardo Ermita, while General Abadia resigned to spare the president embarrassment; another former military officer (Roilo Gomez) took on the post of national security adviser. It was not until March 19th that the defence minister was finally named as Angelo Reyes, the armed forces chief of staff whose switch in support was critical on January 20th. He was scheduled to retire from military service after President Macapagal Arroyo rescinded the extension that President Estrada had granted. His move from chief of staff to defence minister follows the precedent set by Fidel Ramos (under President Aquino) and Mr de Villa (under President Ramos). President Estrada, by contrast, had a civilian as his defence secretary.

In the background, with no formal cabinet post (he is only roving ambassador and “personal and special representative” of the president) but with far greater influence than any minister, stands the former president, Fidel Ramos. Rumour has it that it was he that persuaded General Reyes to back Ms Macapagal Arroyo. In the days immediately before January 20th Mr Ramos had publicly speculated that the military might stand aloof from any crackdown on the civilian opposition—which immediately raised the spectre of a split within the military. His firm and open support for the new administration is a strongly stabilising factor politically, while his record of presiding over both economic liberalisation and sustained economic growth greatly enhances investor confidence, both domestic and foreign.

Peace talks are to resume One of the notable achievements of the Ramos presidency was the progress on with rebel movements the domestic insurgency front. The legalisation of the Communist Party of the Philippines in 1992, at the beginning of the Ramos term, further weakened the communist rebellion by offering the option of full involvement in mainstream politics, which some sections of the movement welcomed and others rejected. The 1996 peace settlement with the Moro National Liberation Front (MNLF, the larger of the two Muslim rebel movements in Mindanao), while imperfect, at least ensured a diminution of armed conflict in the south and offered the

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hope of a long-term resolution of the region’s problems. The Estrada administration, by contrast, saw a flare-up in communist activity in some regions and a collapse in peace talks, while last year, in what seems to have been an attempt to bolster his waning popularity, President Estrada embarked on an “all-out war” on the Moro Islamic Liberation Front (MILF, the second major rebel movement). Through this move he possibly lit the spark for an upsurge in operations by the extremist group, Abu Sayyaf, which earned the Philippines massively damaging publicity abroad and the group new recruits and funds.

Ms Macapagal Arroyo has conspicuously reverted to the Ramos policy on insurgency. On February 20th she ordered a suspension of military operations against the MILF, to allow for a resumption of peace talks (abandoned by the rebels in August last year) and the return to their homes in Central Mindanao of some 200,000 people displaced in last year’s fighting. A secret meeting in Kuala Lumpur in late March between representatives of the two sides led to an agreement to restart negotiations “within three months”. A venue for the talks has yet to be agreed, but it seems likely to be Malaysia, with the Malaysian prime minister, Mahathir Mohamad, acting as broker—thus meeting the MILF’s wish for such involvement by a country from the Organisation of the Islamic Conference. (The talks between the MNLF and Manila were similarly mediated by Indonesia.) A compromise was also apparently reached in Kuala Lumpur on the issue of the MILF bases captured in last year’s campaign, which Manila has made it clear it will retain; “joint development” of these bases is envisaged, respecting the strong Muslim presence there.

Likewise military operations against communist rebels in the provinces of Quezon and Laguna (south of Manila) were suspended. Supplemented by the release of a number of political prisoners, this set the scene for a resumption of talks with the National Democratic Front—Communist Party of the Philippines—New People’s Army (an array of communist groups). Talks are envisaged for April 27th and are expected to take place in Sweden.

In neither case will a final deal be easy to reach, but the clear commitment of the new president to a peaceful resolution means that the level of violence is set to diminish, with particularly marked positive effects on some of the poorest areas in the country in Mindanao.

Economic policy

The budget deficit hit The worst case scenario for the 2000 budget deficit—P139bn (US$3.15bn) was P136bn in 2000 cited by the finance minister in early January—did not in the event materialise, but this was only by dint of the last minute non-payment of some liabilities. The resulting budget deficit stood at P136.1bn, or more than double the original target deficit of P62.5bn, largely reflecting a P43bn shortfall in Bureau of Internal Revenue (BIR) receipts. Another, smaller shortfall was that registered by privatisation proceeds. Originally forecast at P22bn they had reached only around P3bn at year-end. Expenditure meanwhile was P12.3bn above the forecast figure. This is a modest overshoot given the pressure of much higher

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interest outgoings after the sharp fall in the peso’s value last October and the surge in domestic interest rates in the same month. But the expenditure overshoot would have been considerably higher than this had the government paid all its obligations due. The new administration soon uncovered a massive P70bn—later revised to P81bn—in unpaid liabilities. All administrations tend to go in for some degree of accounts manipulation to improve the full-year budget result. Any incoming administration is also likely to highlight the burden that it has inherited (Mr Estrada did the same in relation to his predecessor). But the sums in this case are large, and add significantly to the fiscal tightening required this year.

Budget results and forecasts (P bn) 1999 2000 2001 Actual Forecast Actual % changea Forecast % changea Expenditure 590.2 629.5 641.8 8.7 710.0 10.6 Revenue –478.5 –567.0 –505.7 5.7 –565.0 11.7 of which: Bureau of Internal Revenue 340.3 397.8 354.8 4.3 418.0 17.7 Bureau of Customs 84.4 91.9 93.5 10.8 122.9 31.4 Deficit 111.7 62.5 136.1 21.8 145.0 6.5 a Year on year. Source: Press reports.

No change is the best hope Against this background, the Macapagal Arroyo administration has set its for 2001 target for 2001 at holding the budget imbalance broadly steady in real terms, with an increase in nominal terms of 6.5% to P145bn. Even the last forecast of the outgoing administration—a deficit of P121bn—is now seen as unattainable. This is essentially because GDP growth will not meet the 4.5% envisaged in the original forecast. Current government expectations are of GDP growth in the 3.8-4.3% range, while the IMF sees growth at 3%, and the EIU’s forecast is even lower, at 2.7%. While more efficient tax collection would make a profound difference, the scope for improvement in the short term is limited. The obstacles are well entrenched and difficult to break down; bank secrecy is one notable example. Moreover, while there may be some obvious high-profile targets for closer examination by the tax authorities, these individuals and companies will certainly fight any claim by the government. The best than can be hoped for is that some reforms in detail (for example in the collection of documentary stamp tax) will have an impact. No new levies are scheduled for this year. Meanwhile, in an effort to hold down spending, all government agencies have been ordered to cut their budgets by 10%; this will involve a freeze on hiring and on salaries.

The one bright spot is that the cost of borrowing is likely to be below what seemed likely in late 2000. Whereas the original Estrada budget (which had forecast a deficit of P85bn in 2001) assumed an average 91-day Treasury bill rate of 9.5% this year, by December—as the political crisis deepened—that forecast had risen to above 12%. The rate had already fallen to just below the original 2001 target by late March, and all the pressure is on the downside, from trends in the US federal funds rate.

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The deficit is within target The budget outturn in the first quarter of the year was encouraging in that the so far deficit was some P3bn below forecast at P38.9bn; less encouraging is that, once more, deficit reduction targets are being met by reining in expenditure to make up for revenue shortfalls. A breakdown of the budget outturn for March was not available when we went to press, but for January and February both the BIR and the Bureau of Customs (BOC) failed to reach their collection targets, the latter marginally, so that total revenue for the first two months of the year was P6.18bn below schedule, at P80.15bn. Spending meanwhile was P8.11bn below target at P99.13bn.

Fiscal incentives come Right from the outset the new administration has signalled an attitude to fiscal under critical review incentives that is markedly different to that held by its predecessor. Last year a bill introduced by the government extended the income tax holiday from eight to 12 years and the application of the net operating loss carryover from three to five years. The Estrada administration also supported a Senate bill that proposed to lower the investment threshold for incentives from US$500m to only US$25m. These changes were estimated to represent a loss of P13.9bn a year in foregone revenue. They consequently ran counter to the tax enhancement that the IMF has long urged on the Philippine government as the appropriate path—rather than expenditure cuts—to achieve fiscal equilibrium. Faced with the possibility of a budget deficit in excess of P200bn this year (if the overdue liabilities brought forward from last year are paid off), the new administration immediately instituted a review of the incentives system. The rumour is that the tax holiday will revert to eight years, with some voices in the administration recommending a reduction to only four years.

Counterpart funding will The Philippines has a poor record in the rate of utilisation of foreign aid take a big hit funds for development projects and programmes. That record is set to worsen this year because the government’s ability to put up counterpart funds is constrained by the failure of Congress to pass the 2001 budget appropriation measure. So the re-enacted 2000 levels will apply, until the 2001 appropriations are approved by Congress—which will be June at the earliest. This raises the prospect of funding gaps of P12.1bn for projects aided by the Japanese Bank for International Co-operation, P7.6bn on World Bank projects, P6bn on Asian Development Bank projects, and another P12.8 bn on other allocations, representing a total shortfall of P38.5bn. This gap will not be fully made up when the 2001 appropriations bill is finally enacted since, as part of the restraint on budget spending, the Department of Finance proposes to ask for only an additional P8.9bn. To put the cuts on a rational basis the spending departments have been required to select priorities for counterpart funding this year.

New public finance targets The Estrada administration originally hoped to attain a zero budget balance in are set 2001; the target was moved to 2004 after the failure to hit deficit targets by a wide margin in 1999 and the prospect of a further deterioration in 2000. The new administration has now moved the target forward by another two years, to 2006. Meanwhile the consolidated public-sector deficit (which takes into account government-owned or controlled corporations and the central bank) is expected to hit zero in 2004, largely as the result of the sell-off of the power

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utility, the National Power Corporation (Napocor). This will both realise a capital sum (US$4bn is the forecast) and remove a major drain on public-sector finances. These are early projections, and attended by great uncertainty, notably on the proceeds of electricity privatisation, but they indicate a broad aim for public finances that will certainly be pursued.

Public finance targets (P bn) 2000 2001 2002 2003 2004 2005 2006a Fiscal deficit 136.1 145.0 116.7 85.4 46.8 25.7 0.0 Consolidated public-sector deficit 141.3 148.1 122.9 81.6 0.0 n/a n/a a Actual. Source: Press reports.

Issues remain to be settled The 2001 budget appropriations bill was one of the major pieces of legislation in power sector reform still to be finalised when President Estrada was replaced. Another one—for which there could be no interim solution—was the Electricity Industry Reform Act (EIRA). This is a multi-stranded measure covering the restructuring of the power industry, the privatisation of the state electricity utility, the Napocor, and the establishment of a regulatory structure for a liberalised sector. The bill had been approved in the lower house during the 1999/2000 session and was being considered by the Senate’s energy committee when the political crisis broke out last October. All movement was effectively halted as the impeachment hearings began in December. Given the new president’s liberalisation credentials, there was an expectation that she would give strong backing to EIRA, that the two houses of Congress would settle outstanding disagreements, and that the bill would be enacted in a special session immediately after the May polls.

These hopes received a setback when President Macapagal Arroyo did not single out the power bill as an immediate priority for her administration. This reticence was attributed to her desire to keep on board “civil society”— the numerous grass roots, non-party-political organisations who had spearheaded the movement to force Mr Estrada’s resignation. The groups were strongly opposed to some aspects of EIRA, in particular the proposal for a universal levy on consumers to help clear the public utility’s US$8.5bn debt and the clause permitting cross-ownership between power generators and power distributors. The former is seen as unfairly shifting the burden on to consumers and the latter as opening the way to monopoly. The Department of Finance has taken on board the latter objection in the amendments it has proposed to the joint congressional committee. The draft from the administration in mid-March limited a company in a related group to 30% of the installed generating capacity of a specific grid and 25% of national capacity. This is rather tighter than the 40% and 30% respective limits on cross-ownership proposed by Congress.

A new form of relationship Under whatever terminology applied, the Philippines has maintained a with the IMF is likely continuous relationship with the IMF for decades. This has served the country

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well at times of severe pressure—actual or feared—on external payments, while during more “normal” times the IMF seal of approval has been valuable in negotiating the terms of foreign loans and attracting investment. There was a small hiatus in the final months of the Estrada presidency, when the Philippines’ failure to meet an already substantially upwardly revised target for the fiscal deficit meant that the Fund did not approve the final drawdown on the funding facility agreed in March 1998.

Manila is not, apparently, aiming for a new funding facility, but a monitoring process is due to continue because the Philippines exceeded its IMF quota (SDR800m—equivalent to some US$1bn) last year, by around US$770m. It will now enter a post-programme monitoring arrangement, under which its monetary and fiscal targets will be reviewed twice a year. A Fund team visited Manila in late March to finalise the terms of the monitoring process.

Separately, the IMF in early April lowered its forecast for real GDP growth in 2001 to 3% from 3.3%, citing a sharper than expected reduction in external demand.

A small chink is seen in the The Estrada impeachment hearings revealed that money-laundering was going bank secrecy wall on at the highest levels, and that this was possible because of the Secrecy Law on Bank Deposits, which provides for almost absolute confidentiality for all types of bank deposits. Only in exceptional circumstances can information be elicited—through an order from the ombudsman. This measure has long been singled out by the IMF as working against efficient tax collection; the tax authorities have not been able to monitor payment of the gross receipts tax, the documentary stamp tax or the 20% tax on bank deposit income because banks would not allow them access to their records, under the provisions of this law. The bank secrecy law meant that the Philippines was named by the Group of Seven (G7) task force last July as “non-co-operative” in the fight against international money-laundering—one of only 15 countries, and the only Asian country, on the list.

The Philippine authorities made modest moves towards meeting the task force’s objections. The Bangko Sentral ng Pilipinas (BSP, the central bank) issued a circular in August last year requiring banks to report all outward and inward remittances of funds “without visible lawful purpose or underlying trade transactions”, “unusually large” transactions and “unusual transaction patterns”, and funds held as deposit substitutes if there were “reasonable grounds” to suspect they were the proceeds of criminal activities. A more effective step was the BSP’s requirement that banks keep records which identified the beneficial holders of numbered accounts (although this still apparently permitted the use of aliases by Mr Estrada).

Since the Estrada revelations the BSP has decided to enforce a previously voluntary waiver on deposit secrecy in the case of foreign-currency deposits held in the Philippines by foreigners. It is envisaged that the US Federal Reserve standard for identifying “suspicious transactions” will be adopted. A more far- reaching reform is proposed in the revised central bank law, which has yet to be approved by Congress. This would allow the Monetary Board to investigate accounts of P50m (US$1m) or above. Neither would be enough to secure the Philippines’ removal from the G7 black-list, and there remain numerous

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impediments, not limited to the bank secrecy law, to the transparency that is needed to improve tax compliance.

The domestic economy

Economic trends

Growth slackened in the According to preliminary national accounts data released at the end of January, final quarter of 2000 GDP growth reached 3.9% last year, close to the government’s low-end target of 4%. While better than some earlier expectations, the growth rate was well below the 4.7% recorded in the first nine months of the year. The deterioration was less marked in the GNP measure (the first nine months had registered a 4.5% rise in GNP) because of the upturn in net factor income inflows in the final months of the year. This easing in the rate of growth is not, however, to be explained by the rapid deterioration in the political environment in the final months of 2000. It reflects the peaking of year-on-year growth rates in the final quarter of 1999.

Gross domestic product and gross national product (% change, year on year) 1999 2000 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year GDP 4.9 3.3 3.2 4.5 4.6 3.6 3.9 Net factor income from abroad 10.5 10.1 5.9 3.6 6.3 20.2 9.0 GNP 5.1 3.7 3.4 4.6 5.7 4.4 4.5 Source: National Statistical Co-ordination Board (NSCB), National Accounts of the Philippines.

Most demand components The expenditure breakdown of GDP shows faster growth in nearly all sectors in strengthened last year the fourth quarter—which is surprising given the slackening in overall GDP growth year on year. The reason is a purely statistical one: the statistical discrepancy (not registered in the Gross domestic product by expenditure table) was a much smaller negative sum in the fourth quarter than in the third. The only deterioration was that registered in government consumption— which is a small expenditure component, accounting for only 6.9% of GDP in October–December last year. In this situation the full-year comparison is more illuminating. This shows two sources of growth last year: a recovery in private consumption, after two years of slowing growth, and a marked improvement in the net foreign balance, as exports resumed double-digit expansion and imports staged only a partial recovery (at constant prices they remained just below their pre-crisis 1997 level). The change in the net foreign deficit contributed 0.6 points to GDP in 2000—equivalent to the full improvement in GDP. Private consumption growth contributed 0.3%. The 2000 results were thus unusually dependent on one demand component—exports—at a time when the other traditional pillar of growth—investment—contracted, for the third year in succession.

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Gross domestic product by expenditure (% change, year on year) 1999 2000 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year Private consumption 2.9 2.6 3.2 3.2 3.7 3.9 3.5 Government consumption 6.5 5.3 –1.9 0.8 1.8 –0.1 0.2 Fixed capital investment –0.3 –2.0 –1.4 –2.8 –2.4 0.1 –1.6 Exports of goods & services 8.9 3.6 10.7 13.7 18.3 22.4 16.4 Imports of goods & services 6.6 –2.8 1.4 –3.8 –2.1 15.5 2.4 GDP 4.9 3.3 3.2 4.5 4.6 3.6 3.9 Source: NSCB, National Accounts of the Philippines.

Agricultural growth slows, It had always been expected that agricultural growth would ease back in 2000 but is still relatively strong after the unusually strong pace registered in 1999—which was a year of recovery after the steep fall in rice and maize output owing to the El Niño- related drought. However, the 3.4% rate achieved was marginally better than the sector’s long-term 3% expansion because the rice crop was up by 5.1%, a good performance that was largely down to favourable weather conditions, and coconuts (the major cash crop) rebounded from the lagged effect of the El Niño drought.

Industrial growth Industry registered stronger growth last year, buoyed by the performance of speeds up manufacturing. However, the construction sector, whose value added is about one-quarter of that of manufacturing, recorded a decline for the third year in succession. The decline steepened in 2000, as public construction, whose 15% expansion in 1999 had almost offset the continuing slump in private construction, contracted by 8.7%. Meanwhile private construction, which accounts for just over half of the sector’s GDP, remained in decline, but fell by a markedly slower rate (2.2%) than in 1999 (11.1%).

Gross domestic product by origin (% real change, year on year) 1999 2000 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year Agriculture, fisheries & forestry 6.6 6.0 0.1 4.8 5.3 3.8 3.4 Industry –3.8 0.9 4.4 3.5 3.9 2.8 3.6 of which: manufacturing 3.7 1.6 6.0 6.2 6.1 4.3 5.6 construction 1.6 –1.6 –4.8 –8.6 –5.4 –5.0 –6.0 Services 5.0 4.1 3.8 5.0 4.8 4.1 4.4 GDP 4.9 3.3 3.2 4.5 4.6 3.6 3.9 Source: NSCB, National Accounts of the Philippines.

Inflation continues at just The year-on-year rate of consumer price inflation reached a 21-month high of under 7% 6.9% in January. This had been widely expected and reflected a complex of factors: the lower year-earlier price base for the heavily-weighted food component; the steep fall in the peso’s value in October, which augmented the impact of high oil prices; and rather stronger private consumption growth in

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the second half of 2000. The small dip in the rate in February, to 6.7%, was entirely explained by the 0.9 percentage point fall in the food price inflation rate, which more than offset the further increase in energy prices. A further 0.3 percentage-point decline in food prices in March offset rises in fuel and housing prices, resulting in an overall inflation rate for the month of 6.7%

Consumer prices (% change, year on year) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Consumer price index 2000 2.6 3.0 3.3 3.7 4.1 3.9 4.3 4.6 4.6 4.9 6.0 6.6 2001 6.9 6.7 6.7 Food price index 2000 –1.0 –0.2 0.7 1.1 2.0 1.8 2.3 2.7 2.6 2.9 4.6 5.1 2001 5.2 4.3 4.0 Source: National Statistics Office.

Interest rates return to pre- The relaxation on interest rates and liquidity in November and December last crisis levels year, as the peso steadied after its October dive, was maintained after the political crisis was resolved in January. The central bank’s overnight rates were reduced in 50 point tranches, on January 29th, February 5th and February 12th, bringing them back to pre-crisis levels. Further cuts on March 8th and March 22nd left the overnight lending rate at 12.25%.

The more stable foreign-exchange market and declining central bank rates, particularly in the environment of falling US interest rates, prompted a slow but steady fall in the benchmark 91-day Treasury bill rate. From 12.88% on January 2nd it eased back at every weekly auction, reaching single digits in mid-March and 9.06% on March 26th—below the 9.3% rate just before the political crisis erupted in October. Concerns over higher inflation and the continuing depreciation of the peso prompted a rebound in the 91-day rate to 9.96% on April 10th.

The peso stabilises The replacement of the discredited Mr Estrada with a president able to claim constitutional legitimacy, as well as the support of the military high command, and traditionally identified with economic reform and pledged to

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transparency and honesty in government, had an immediate positive impact on the peso’s value. There was some correction after the initial rebound. From January 20th to mid-March, the rate hovered around P1 each side of the P48:US$1 mark. From late March to mid-April, however, it pushed up to and then past the P50:US$1 level owing to slower external demand and the continued weakness of the yen.

Exchange rates (period average) % change % change on P:US$ year on year preceding month 2000 Jun 42.649 –11.4 –2.0 Jul 44.336 –13.6 –3.8 Aug 44.898 –12.6 –1.3 Sep 45.737 –12.2 –1.8 Oct 48.106 –16.2 –5.0 Nov 49.754 –18.9 –3.4 Dec 49.896 –18.6 –0.3 2001 Jan 50.969 –20.7 –2.1 Feb 48.290 -15.8 5.6 Sources: IMF, International Financial Statistics; Bangko Sentral ng Pilipinas (BSP).

Agriculture

Outlook for rice is less One casualty of the government’s budgetary tightening this year is likely to be favourable this year the rice harvest. Under the Makamasa rice productivity programme, the Department of Agriculture distributes certified seeds, which can raise yields by as much as 40%. A plentiful supply last year, covering 500,000 ha, made a significant contribution to the 5.1% rise in the rice crop to a record 12.39m tonnes. The then agriculture secretary, Edgardo Angara, had set a target of 13.5m tonnes for 2001. The new incumbent appointed by President Macapagal Arroyo is aiming for 13m tonnes, but with a budget of P450m (US$9m), down from the P509m allocation in 2000. With weather currently forecast to be less favourable than a year ago, when the heavy rains that accompanied the La Niña climatic phenomenon extended the area planted to rice, the government target looks too high.

Rice output and area

1997 1998 1999 2000 Palay (paddy) rice output (m tonnes) 11.27 8.55 11.79 12.39 Area harvested (m ha) 3.84 3.17 4.00 4.04 Sources: NSCB; press reports.

EIU Country Report April 2001 © The Economist Intelligence Unit Limited 2001 26 Philippines

Manufacturing

Manufacturing recovery Although the year-on-year rise in manufacturing value added eased slightly strengthened during 2000 in the final quarter of last year, breaking a run of quarter-on-quarter increases in the rate of growth since early 1999, the pace for the full year represented a good recovery from the sluggish 1.6% in 1999. Whereas 14 out of the 20 sectors of manufacturing industry had registered a decline in 1999, last year the figure was down to six. Significantly it was two export-oriented sectors— electrical machinery and apparel—that did particularly well. Food manufacturing, the leading industry and one geared to domestic demand, while still expanding was much less buoyant than in the preceding year.

GDP in major manufacturing industries

% changea % of 1999 2000 manufacturingb Food manufactures 5.5 1.9 42.6 Electrical machinery 15.5 24.2 11.6 Products of petroleum & coal –0.9 7.4 8.1 Chemicals & chemical products –2.1 -2.5 7.1 Footwear & wearing apparel –14.9 14.1 5.4 Total manufacturing GDP (incl others) 1.6 5.6 100.0

a Year on year. b Percentage of manufacturing GDP in 2000 at current prices. Source: NSCB.

This picture is borne out by a different measure—the volume of production by 16 sectors of manufacturing, as registered in monthly surveys of 550 enterprises. This recorded a rise of 14% over the full year, compared with 3.5% in 1999. The improvement was not even through the year, however, as the table below indicates, and there was a sharp tailing off in December, which can be attributed to the effects of the political crisis which set in during October. Manufacturers’ production costs were sharply inflated by the plummeting in value of the peso in October and the raising of interest rates to brake that decline. The impact was even more marked in the first month of this year, when the volume index (on an incomplete coverage) fell by 2.4% compared with January 2000, with capacity utilisation down to 77.3%, against 80% in December and the lowest figure since December 1998. The resolution to the political crisis in January, with the return to pre-crisis interest rates by March and some stabilisation of the peso’s value, will have removed some pressure on the cost side in subsequent months, but the more difficult external market will have constrained manufacturing growth through the rest of the first quarter of 2001.

Manufacturing productiona (% change, year on year; volume) 2000 2001 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan 14.3 7.2 2.6 –4.0 12.3 14.3 21.3 8.8 15.5 21.0 40.4 8.6 –2.4 a Measured by monthly surveys of 550 enterprises; subject to continual revision. Sources: BSP, Selected Philippine Economic Indicators; press reports.

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Services

Another leading bank is Recent months have seen two major bank rescues—one publicised at the time, rescued the other only revealed in February 2001. The first was the P25bn (US$501m) credit extended to the Philippine National Bank (PNB) by the Bangko Sentral ng Pilipinas (BSP, the central bank) and the Philippine Deposit Insurance Corporation (PDIC) in early October (January 2001, page 28). The two credits (P15bn and P10bn, respectively) were subsequently rolled over for another 90 days (to end-March). The other support was even larger—P30bn in emergency liquidity assistance from the BSP in January to Equitable PCI Bank to accommodate a wave of deposit withdrawals.

The difficulties experienced by both of these major banks stemmed, to varying degrees, from their links with former President Estrada. The majority owner of PNB is a leading Estrada crony, Lucio Tan, while the impeachment hearings revealed the existence of secret accounts held by the president at Equitable, which is controlled by the family of another close friend, George Go. These revelations tarred Equitable, which is much sounder financially than the PNB, with a crony tag and alarmed depositors, including those who feared their own holdings might be made public. Hence the BSP rescue—the largest ever—to meet the run on deposits.

A proposal to clean up The whole banking sector in fact came under strain during the recent political portfolios is made crisis because of the impact of the sharp rise in interest rates in October on the level of non-performing loans (NPLs). At the end of September the commercial banks’ NPL ratio (NPLs as a proportion of the total loan portfolio) stood at a record 17.2%: by November it was 18.3%. As interest rates eased during December the ratio improved to 16.8% by year-end. While this remains low compared with other economies in the region, such as Indonesia and Thailand, the overall trend remained one of deterioration: a year earlier the figure was 13%, two years earlier 10.4%. Moreover this figure does not include foreclosed real estate holdings and restructured accounts. Industry observers estimate that these would bring the proportion of problematic assets to close to 30%.

In this situation the central bank has expressed its support for the setting up of an independent asset management entity which would aid in the disposal of the P172bn in NPLs reported by the commercial banks at end-2000. The agency would buy the loans at a discount, generating new lending resources for the banks and reducing their dependence on liquidity assistance from the BSP. The government has made it clear, however, that this independent body would have to be independently funded; it has no resources available to contribute.

The government hopes to One of the legacies of the Estrada presidency was the botched disposal of the disengage from PNB government’s equity in the PNB. As of mid-January Mr Tan, the close friend of Mr Estrada, held 70% of the equity. This would have risen to 86%, under the terms of the sale of the government’s residual stake in the PNB agreed last July, but Mr Tan failed to make the relevant payment on the due date last October (October 2000, page 16). The Estrada administration’s proposal for

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Mr Tan to complete the purchase, at a discount on the price agreed earlier, was not accepted.

The new administration now proposes to dispose of its 16% residual equity in a joint sale with Mr Tan, planned for April. A joint sale would undoubtedly attract a higher share price, since there would be little interest in a minority stake in a Tan-controlled entity. However earlier hopes of a P60 share price have taken a knock, as the latest audit (by PricewaterhouseCooper) has put the PNB’s book value at only P40 per share. Press reports speak of the bank’s loan portfolio as “worse than expected”: its NPL ratio at 39% is already more than double the industry average, and if holdings of foreclosed real estate are added in the measure reaches around 60%. The prospect remains that the disposal will not be realised until some progress is made in the rehabilitation of the bank, the programme for which includes a reduction in bad loans, the sale of foreclosed assets, a rationalisation of operations and a conversion of the P25bn funding from the BSP and PDIC.

Foreign trade and payments

Another surge in the As expected through much of the year, the surplus on merchandise trade rose merchandise trade surplus markedly in 2000, to US$6.7bn from US$5.0bn in 1999. This was the consequence of export growth which again exceeded the increase in import spending—exports rose by 11.3% to US$38.1bn compared with the 7.3% rise to US$31.4bn in imports. Over the two years since 1998 the differential is marked—a 29% rise in exports and a 6.3% rise in imports.

Foreign trade (US$ m fob unless otherwise indicated) 2000 2001 1 Qtr 2 Qtr 3 Qtr Nov Dec Jan Feb Exports 8,595 9,009 10,250 3,317 3,496 2,889 2,805 % changea 9.5 13.4 5.1 7.9 18.8 6.3 –3.3 Imports 7,890 7,460 8,291 3,075 2,237 2,472 n/a % changea 5.2 –6.7 6.0 30.8 –15.7 –6.8 n/a Balance 705 1,549 1,959 242 1,259 417 n/a a Year on year. Source: National Economic & Development Authority (NEDA).

Electronics exports are The pace of growth in exports has been flagging since the middle of last year, weakening even when the distortion represented by the one-off surge in sales in September and October 1999 is excluded. This is essentially the result of the sharp slowdown in the growth of sales of electronics, which accounted for 63% of total exports in 1999. In 1999 sales rose by 23.9%, to US$21.6bn; in 2000 they were up by only 4.4%, to US$22.5bn. By contrast non-electronics exports were up by 23% last year, with a number of major categories (machinery and transport equipment, garments and coconut products) registering growth at around this rate. This trend continued into the first two months of this year:

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electronics sales were up by only 1.7% in January, contributing only US$28m to the total US$182m rise in exports. In February total export value fell by 3.3% year on year and receipts from electronics exports declined by 7.5%.

Major imports (US$ m fob unless otherwise indicated) 1999 2000 % changea Telecommunications equipment & electronic manufactures 6,623 6,696 1.1 Materials for the manufacture of electronic equipment 4,703 4,159 –11.6 Crude petroleum 1,934 3,050 57.7 Power generating & specialised machinery 2,393 2,470 3.2 Total imports incl others 29,252 31,387 7.3

a 2000/1999. Source: NEDA.

The growth in the current– The sustained and higher surplus on merchandise trade meant that the current account surplus eases account remained in the black in 2000. At end-November it was US$7.6bn. However this was only 2% above the corresponding figure in 1999, whereas the merchandise trade surplus in November stood one-fifth above the year- earlier figure. The traditional surplus on income has fallen sharply, as inflows of earnings from employment overseas have declined. In January-November these were down by 15.6%, or by close to US$1bn—approximately equivalent to the improvement in the merchandise balance. The share of overseas workers’ remittances in total earnings on goods, services and income consequently narrowed from 15% to 12%.

Capital outflows push The deterioration in the capital account that was already evident in mid-2000 payments into the red deepened through subsequent months, so that whereas at end-June the balance on the capital and financial account was a deficit of US$1.5bn, by end-November the deficit had ballooned to US$4.9bn largely because of portfolio investment. From early 2000 foreign investors’ perceptions of the Philippines were deteriorating, killing any appetite for Philippine securities.

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Over the whole year inflows (on a different calculation from that used in the Balance of payments table in this section) fell by 76.7%, from US$12.3bn in 1999 to only US$2.9bn, with much of the latter representing bargain-hunting among the more resilient stocks. Outflows meanwhile declined by a similar degree, from US$11.8bn to US$3bn. This left a deficit of US$149m in contrast to a surplus in 1999 of US$473m.

Balance of payments, January-November 2000 (US$ m) 1999 2000 Exports fob 31,323 33,852 Imports fob 26,681 28,211 Trade balance 4,642 5,641 Services balance –2,475 –1,790 Income balance 4,833 3,374 of which: inflows of employment earnings 6,292 5,312 Net transfers 445 371 Current-account balance 7,445 7,596 Net direct investment 618 1,446 Net portfolio investment 4,386 37 Net other investments –5,697 –6,446 Net loans –13 31 Capital-account balance –706 –4,932 Net unclassified items –3,453 –3,582 Overall balance 3,286 –918 Source: BSP, Selected Philippine Economic Indicators.

International reserves ease A surge in the surplus on merchandise trade in December and a US$200m down once more bond placement by the government in the same month pushed up total reserves (on the central bank’s measure, which includes gold) from US$14.5bn in November to US$15bn at end-2000. This was the highest level since June. Reserves fell back in the following two months, to US$14.4bn in January and US$14.2bn in February, largely owing to the BSP’s payment of maturing obligations.

The central bank comes As the political crisis deepened in late 2000, greatly raising the cost of any back to the market foreign borrowing by official agencies, the BSP twice put off its planned borrowing of US$400m to meet its maturing obligations (January 2001, page 32). In the much calmer atmosphere of March 2001 the central bank returned to the capital market, and found its offer comfortably oversubscribed. This prompted it to step up its borrowing. On March 15th it signed a US$740m credit facility with 19 local and foreign banks. The reserves figures for March- April will reflect this new borrowing.

EIU Country Report April 2001 © The Economist Intelligence Unit Limited 2001