Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 59170-PH

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT

FOR A PROPOSED

FIRST DEVELOPMENT POLICY LOAN TO FOSTER MORE INCLUSIVE GROWTH

IN THE AMOUNT OF US$250 MILLION

TO THE REPUBLIC OF PHILIPPINES

APRIL 20, 2011

Poverty Reduction and Economic Management Unit East Asia and Pacific Region

This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Bank’s Policy on Access to Information.

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GOVERNMENT FISCAL YEAR January 1 to December 31

CURRENCY EQUIVALENTS (Exchange Rate Effective as of April 20, 2011)

US$1 = 43.28 PHP (Philippine Peso) PHP1 = US$0.0231

Weights and Measures

Metric System

ACRONYMS AND ABBREVIATIONS AusAID Australian Agency for International Development JPHRDTF Japan Policy & Human Res. Dev. Trust Fund ASEAN Association of Southeast Asian Nations LDP Letter of Development Policy ACLC Automatic Conversion into Local Currency LGUs Local Government units BESRA Basic Education Reform Agenda LTS Large Taxpayer Services BIR Bureau of Internal Revenue MDGs Millennium Development Goals BPLS Business Permit and Licensing System MTEF Medium Term Expenditure Framework BPO Business Process Outsourcing NAT National Achievement Tests BOC Bureau of Customs NEDA National Economic and Development Authority BOSS Business One-Stop Shop NERBAC National Econ. Research & Business Action Ctre BSP Bangko Sentral ng Pilipinas (Central Bank) NFA National Food Authority CAS Country Assistance Strategy NG National Government CCT Conditional Cash Transfer NGICS National Guidelines on Internal Control Standards CFAA Country Financial Accountability Assessment NHIP National Health Insurance Program COA Commission on Audit NSW National Single Window DBCC Development Budget and Coordination Committee OPIF Organizational Performance Infor. Framework DBM Department of Budget and Management 4Ps Pantawid Pamilyang Pilipino Program (CCT) DepED Department of Education PBR Philippine Business Registry DILG Department of the Interior and Local Government PDAF Priority Development Assistance Fund DPL Development Policy Loan PDF Philippines Development Forum DRMO Debt and Risk Management Office PDP Philippine Development Plan DOJ Department of Justice PER Public Expenditure Review DSWD Department of Social Welfare and Development PEZA Philippine Export Zone Authority DOF Department of Finance PFM Public Financial Management DOH Department of Health PGIAM Philippines Government Internal Audit Manual DTI Department of Trade and Industry PhilHealth Philippine Health Insurance Corporation EAP East Asia and the Pacific PPPs Public-Private Partnerships EIA Environmental Impact Assessment PSALM Public Sector Asset Liability Mgmt company E2M Electronic-to Mobile Customs RATE Run After Tax Evaders ESC Education Service Contracting RATS Run After the Smuggles FIR Fiscal Incentives Rationalization RIPS Revenue Integrity Protection Service FRS Fiscal Risk Statement ROSC Report on the Observance of Standards and Codes GASTPE Govt. Assistance Students/Teachers in Priv. Education SDR Special Drawing Rights GDP Gross Domestic Product SPFs Special Purpose Funds GIFMIS Govt. Integrated Financial Mgmt. Information System SEC Securities and Exchange Commission GOCCs Government Owned and Controlled Corporations SPF State and Peace-Building Fund HIPC Heavily Indebted Poor Countries SBM School Based Management IAC Inter-Agency Committee (for COA, DBM, DOF) TTRI Trade Tariff Restrictiveness Index IAS Internal Audit Service TCCs Tax Credit Certificates IBRD International Bank for Reconstruction & Development UNDP United Nations Development Program

IFC International Finance Corporation ZBB Zero –Based Budgeting IMF International Monetary Fund

Vice President:Country Director:

Sector Director:Task Team Leader:

James W. Adams Bert Hofman Vikram Nehru Ulrich Lächler

Republic of the Philippines

First Development Policy Loan to Foster More Inclusive Growth

TABLE OF CONTENTS LOAN AND PROGRAM SUMMARY I.  INTRODUCTION ............................................................................................................................ 1 II.  COUNTRY CONTEXT ................................................................................................................... 5 

A.  Recent Economic Developments in the Philippines .................................................................. 5 B.  Macroeconomic Outlook and Debt Sustainability ..................................................................... 8 

III.  THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES ....................... 13 A.  Maintaining a stable macroeconomic environment ................................................................... 14 B.  Improving Competitiveness and Increasing Infrastructure Investment ..................................... 23 C.  Improving Governance .............................................................................................................. 29 D.  Developing the Human Capital of the Poor ............................................................................... 33 E.  Implementing Effective Social Safety Nets ............................................................................... 38 F.  Summary Staff Assessment of the Government Program ......................................................... 40 

IV.  BANK SUPPORT TO THE GOVERNMENT’S PROGRAM ..................................................... 43 A.  Link to CAS............................................................................................................................... 43 B.  Collaboration with the IMF and Other Development Partners .................................................. 43 C.  Relationship to Other Bank Operations ..................................................................................... 44 D.  Lessons Learned from Previous DPLs ...................................................................................... 45 E.  Analytical Underpinnings .......................................................................................................... 46 

V.  THE PROPOSED OPERATION .................................................................................................... 49 A.  Operation Description ............................................................................................................... 49 B.  Policy Areas .............................................................................................................................. 49 

VI.  OPERATION IMPLEMENTATION ............................................................................................. 55 A.  Poverty and Social Impacts ....................................................................................................... 55 B.  Environmental Aspects .............................................................................................................. 55 C.  Implementation, Monitoring and Evaluation ............................................................................. 56 D.  Fiduciary Aspects ...................................................................................................................... 56 E.  Disbursement and Auditing ....................................................................................................... 56 F.  Risks and Risk Mitigation ......................................................................................................... 57 

ANNEXES: Annex 1: LETTER OF DEVELOPMENT POLICY .......................................................... 59 Annex 2: DPL Policy Matrix .................................................................................................... 67 Annex 3: FUND RELATIONS NOTE .................................................................................... 74 Annex 4: PHILIPPINES-AT-A-GLANCE ............................................................................. 78  MAP ………………………………………………………………………………………………….. FIGURES: Figure 1. Philippines: National Government Debt Sustainability Analysis 1/ .......................... 11 

TABLES: Table 1. Philippines: Selected Economic Indicators, 2003-2013 .............................................. 9  BOXES: Box 1: Poverty in the Philippines ............................................................................................... 7 Box 2: Relationship of DPL to other Bank Operations ............................................................ 44 Box 3: Proposed Prior Actions for DPL1 and Proposed Triggers for DPL2 ........................... 50 Box 4: Expected Program Outcomes and Indicators ................................................................ 52 Box 5: Application of Good Practice Principles for Conditionality ........................................ 53  This Loan was prepared by an IBRD team led by Ulrich Lächler (Lead Economist, EASPR) and consisting of Gerlin May Y Catangui (CEAPH), Soonhwa Yi (CFPIR), Michaela Weber (AFTPE), Thao Le Nguyen (CTRFC), Maribelle S. Zonaga, Josefina U. Esguerra, Annalyn Sevilla (EACPF), Lada Strelkova (EACPQ), Lynnette Dela Cruz Perez, Suhas D. Parandekar (EASHE), Eduardo P Banzon, Sarbani Chakraborty (EASHH), Alan Townsend, Aldo Baietti (EASIN), Eric Le Borgne, Karl Kendrick Tiu Chua, Sheryll P. Namingit, Rosa Alonso I Terme (EASPR), Victor Dato (EASPS), and Minneh M. Kane (LEGES). Peer reviewers are Jan Walliser (AFTP3) and Marijn Verhoeven (PRMPS). Able logistical support was provided by Mildred Gonsalvez and Nenette V. Santero (EASPR).

LOAN AND PROGRAM SUMMARY Republic of the Philippines

First Development Policy Loan to Foster More Inclusive Growth

Borrower

Republic of the Philippines

Implementing Agency

The Department of Finance is the main liaison with the World Bank on budget support operations, but policy dialogue, monitoring and evaluation of the program supported by this DPL is shared with DBM, DOH, DepEd, DTI, DILG and NEDA.

Financing Data

Single-currency, LIBOR-based, variable spread loan on level repayment terms, for a total maturity of 25.5 years, including a grace period of 10 years; US$250 million.

Operation Type

A single-tranche operation to be fully disbursed upon effectiveness; it is the first of a programmatic series of three DPLs.

Main Policy Areas

Fiscal and Public Financial Management Investment Climate Education and Health Service Delivery

Key Outcome Indicators

Higher tax revenues, lower public debt ratios and higher sovereign credit ratings, lower costs of opening a business, increased total investment spending as a share of GDP, enhanced transparency in public financial management through a unified Chart of Accounts and timely publication of budget execution data, higher school enrolment and better quality education through lower student-teacher and student-classroom ratios, and increased health service coverage for the poor.

Program Development Objective(s) and Contribution to CAS

The overall goal of this series of DPLs is to help the Philippines achieve sustained inclusive growth through (i) better fiscal management, an improved investment climate and better governance for faster growth, and (ii) investments in human capital to enable the poor to take better advantage of emerging growth opportunities.

Risks and Risk Mitigation

The main risks are fiscal (an inability to increase public revenues due to political or institutional constraints), external (downturns in the global economy, lower capital and remittance inflows and sharply higher oil prices) and catastrophic (particularly a vulnerability to typhoons). These risks are being mitigated in this operation by focusing on efforts to improve tax policy and administration, strengthen PFM and fiscal risk management, and through parallel efforts to strengthen disaster risk management.

Operation ID P118931

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IBRD PROGRAM DOCUMENT FOR A PROPOSED FIRST DEVELOPMENT POLICY LOAN

TO FOSTER MORE INCLUSIVE GROWTH IN THE REPUBLIC OF THE PHILIPPINES

I. INTRODUCTION

1. This program document describes a single-tranche development policy loan (DPL) to the Republic of the Philippines for US$250 million. It is being proposed as the first of a programmatic series of three DPLs to support the Philippines’ efforts to foster more inclusive growth by consolidating fiscal discipline, improving competitiveness, strengthening governance and promoting human capital accumulation. The need for more inclusive growth was made evident over the last decade, when the Philippines experienced a resurgence of economic growth that did not, however, translate into greater progress in poverty reduction. Recent analytical work suggests that an important obstacle to poverty reduction in these circumstances has been the country’s high degrees of inequality in the distribution of income and in the access to public social services. At the same time, shortcomings in the provision of public infrastructure and social services undermine the sustainability of growth and the Government’s ability to reduce inequality. 2. Specific measures being supported by this operation involve actions to (i) strengthen public revenue mobilization and fiscal risk management, (ii) improve the investment climate by reducing the costs of doing business and raising public investment through better PPP arrangements, (iii) promote better public financial management, budget transparency and accountability, and (iv) strengthen the access to and quality of basic education and health services. These actions represent a sub-set of a broader government reform agenda described in the 2011-2016 Philippine Development Plan (PDP). The choice of actions to be supported was determined by several criteria that included staff assessments of the relative importance of the measures proposed for achieving the development objectives and of the Government’s capacity for timely implementation, as well as the availability of Bank expertise and engagement in particular areas. Several policy areas (e.g., social protection, energy) are not supported under this operation even though they satisfy the selection criteria because they already are being adequately supported through other Bank instruments or other development partners. 3. Most of the issues being addressed in the proposed series of DPLs are not new and the previous government’s actions to address them had been supported through an earlier programmatic series of DPLs that was approved in December 2006. That series focused on the Government’s efforts to reduce the public sector deficit and debt, strengthen the investment climate and improve service delivery through increased and more effective government spending. While significant advances were made in some areas (notably the restoration of macroeconomic stability and a lowering of the public debt), progress in the implementation of actions agreed under the program was slower than anticipated.1 As a

1 See World Bank (2009), Implementation Completion and Results Report (Report No.: ICR00001112), Sept, 30.

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result, no follow-up DPL was approved within 24 months of the first DPL and the series lapsed in December 2008. 4. The lessons derived from this earlier DPL experience have been incorporated into the design of this operation. Key problems that contributed to unsuccessful performance of the earlier operation were insufficient country ownership of the reform program, inadequate coordination with other development partners in the context of a joint policy matrix and insufficient analytical underpinnings of certain measures. The Aquino Administration campaigned on a strong platform of reforms emphasizing improvements in governance and social services for the poor, and this commitment to reforms is evident in the 2011 Budget that was presented to Congress in August 2010. Most of the actions supported by this DPL were announced in the President’s message presenting the 2011 Budget to Congress. The Aquino Administration also appears to enjoy a stronger political mandate than the previous government, which should give it greater maneuverability in the implementation of reforms. While this operation is being prepared in close coordination with other development partners (particularly AusAID and IMF), it avoids the need to manage a joint policy matrix, which posed a challenge in the previous series of DPLs. Finally, a good number of studies and analyses were concluded since 2007 – notably a Public Expenditure and Financial Accountability Report, a report on Fostering More Inclusive Growth in the Philippines, several Public Expenditure Reviews and Philippine Development Reports and the Philippines Discussion Notes: Challenges and Options for 2010 and Beyond – that provide solid analytical underpinnings for the proposed operation. 5. Although these changes in design and domestic circumstances improve the prospects for a successful operation, many risks remain. The most important risk is that public revenues may fail to increase by a significant amount, either because of political and institutional capacity constraints that prevent adequate tax reforms or because the new measures prove inadequate. This would undermine macroeconomic stability and limit the fiscal space to levels that preclude any possibility of expanding public spending in priority areas by enough to address the shortcomings in public infrastructure and social services that are needed to achieve more inclusive growth. Other important sources of risk include the country’s external vulnerability and exposure to natural disasters (particularly the Philippines’ vulnerability to typhoons). This operation seeks to mitigate political risks by focusing on measures that do not require legislative action, as well as by avoiding politically sensitive areas (such as NFA and CCT reform) that are best supported by other means. The risks posed by external vulnerabilities and limited institutional capacities are being addressed through the actions intended to strengthen fiscal risk management and improve public financial management. In parallel, the Government has been strengthening its capacity to deal with natural disasters, including disaster response strengthening measures introduced in the aftermath of Typhoons Ondoy and Pepeng in September/October 2009. Furthermore, the World Bank is preparing a Catastrophe DPL-DDO at the Government’s request to address disaster risk management issues. 6. The DPL series is an important component of the Bank lending program contemplated in the CAS under four of its five strategic objectives. These four are the objectives of maintaining a stable macro economy, improving the investment climate, improving public

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service delivery (in health and education), as well as the cross-cutting objective of improving governance. These strategic objectives are also consistent with the Government’s new PDP. 7. Over the last year, the Philippines has enjoyed easy access to domestic and external financing on favorable terms (para. 17). The increase in foreign capital inflows has been putting upward pressure on the Peso, prompting the Government to rely increasingly on the domestic debt market to meet its financing needs. However, the Government continues to view foreign financing from the World Bank, ADB and other official lenders as an important component of its financing strategy to avoid a crowding out of the private sector in the debt market and to keep its sources of funding diversified for better risk management.2 Also, the authorities hope to continue benefiting from the knowledge transfer associated with financing from the development financing institutions in order to raise the development impact of planned public investments. To mitigate possible pressures on the exchange rate, this operation could be converted into Pesos at disbursement through an Automatic Conversion into Local Currency (ACLC) or any time thereafter (ad-hoc currency conversion) through a swap market transaction.3   

2 See interview with DOF Secretary Cesar Purisima in GobalSource Monthly Report (7 January 2011). 3 Swap market transaction into Philippine Pesos vary in terms of maturity and pricing. If the loan repayment exceeds the maturity available in the swap market at the time of the transaction the Bank can offer a partial maturity conversion with the option for the client to roll it over at maturity

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II. COUNTRY CONTEXT

8. The Philippines is an archipelago of 7,107 islands located in Southeast Asia and divided into three island groups (Luzon, Visayas and Mindanao). It has a projected population of about 94 million inhabitants4 in 2010, with a per-capita Gross National Income (Atlas method) of US$1,790 in 2009. The Philippines has strong potential for development in terms of abundant natural resources, a talented, English-speaking workforce, a dynamic private sector and an active civil society. However, overall development outcomes have fallen short of potential, as economic growth and job generation have tended to be more modest than in neighboring countries, leading many Filipinos to seek better opportunities abroad: an estimated 10 percent of the population resides abroad and is responsible for generating annual remittances equivalent to over 10 percent of the country’s GDP. Since 2001, economic growth has picked up, but this has not translated into poverty reduction. Instead, official poverty estimates indicate that the overall incidence of poverty increased between 2003 and 2006, and then remained unchanged through 2009, which suggests that the growth that has taken place has not been sufficiently inclusive. 9. Recent Political Developments. The Philippines held its first nationwide automated elections on May 10, 2010, with President Benigno S. Aquino III winning by a comfortable margin as candidate for the Liberal party on a platform focusing on anti-corruption and poverty reduction The new Administration faces significant opportunities as well as considerable challenges: an opportunity for new policy directions and new coalitions to push the development agenda forward with renewed vigor, but a need to overcome the inertial forces that slow down decisions and program implementation during transitions. Though his Administration came under fire a few months after assuming office (on matters related to social protection strategy, reproductive health, and the management of a hostage situation in Manila), President Aquino continues to maintain a high trust rating in recent surveys. His popularity carries across all geographic areas and socio-economic groupings, but is particularly high among the poorer segments of society. Meanwhile, the leadership of the Lower House of Congress is predominantly from the Liberal party, which should facilitate implementation of the reform agenda. The President also can expect considerable support in the Senate, even though it exhibits greater party fragmentation and Senators traditionally have tended to be more independent in casting their votes on specific issues. These developments suggest that the Philippine Executive may count on more legislative support for its reform initiatives during its tenure than was available to the previous administration.

A. RECENT ECONOMIC DEVELOPMENTS IN THE PHILIPPINES

10. After a sharp slow-down in 2009, the Philippine economy expanded vigorously in 2010, with an estimated growth rate of 7.3 percent that represents the highest annual rate in more than 30 years and puts the economy back on its pre-crisis growth trend.5 This rapid recovery is largely attributable to the rebound in global trade and increased investor and consumer confidence, which has been driving a similar growth resurgence in other East Asian countries. In addition, the economic expansion in the Philippines is reflecting temporary

4 Based on population estimates of the National Statistical Coordination Board. 5 Real GDP growth averaged 5.7 percent during 2003-07.

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domestic stimulus policies that were held over from 2009 and election-related spending in early 2010. 11. The main sector responsible for rebounding growth in 2010 has been industrial production, especially manufacturing and construction. In services, trade, finance, private services and, to a lesser extent, the real estate sub-sectors were the top contributors to growth. Only agriculture has been lagging behind, in part on account of the negative influence of ‘el Niño’. On the demand side, private consumption remains strong as remittance inflows remain steady, while exports and investment have revived in 2010 to yield a positive impact on growth. Merchandise exports rebounded 30 percent in 2010, thanks largely to the recovery of the global electronics market. 12. The headline inflation rate has been stable since 2009, with small variations reflecting developments in fuel, food and utility prices, and well within the Central Bank’s target zone. Monetary policy remains broadly accommodative: although the BSP withdrew some of the liquidity-enhancing measures introduced in the immediate aftermath of the global financial crisis, it has kept its key policy rates unchanged since August 2009. This policy has permitted bank lending to increase modestly (to an annual growth rate of almost 10 percent, or slightly below nominal GDP growth) and help close the output gap. Increases in foreign portfolio inflows in 2010 have helped strengthen the Peso, push up the stock market index and reduce interest rates. The stronger Peso has helped to contain inflation, but the associated short term capital inflows also have raised policymakers’ concerns about the rising risk of economic and financial disruptions in the event of sudden reversals. The central bank intervened successfully in late 2010, using its forward foreign exchange swap portfolio, to stem the rapid appreciation of the Peso. 13. The labor market has been recovering from the global recession, but very slowly. The unemployment rate fell from 7.6 percent in mid-2009 to 7.1 percent in October 2010, while underemployment afflicts 19.4 percent of the labor force. Both indicators are very high by regional standards. 14. The impact of the economic recovery on poverty reduction also has been weak. Successive Family Income and Expenditure Surveys indicate that the poverty incidence indicators have hardly budged since 2003: the poverty incidence among families increased from 20 percent in 2003 to 21.1 percent in 2006 and then declined slightly to 20.9 percent in 2009. In terms of incidence among population, poverty kept increasing from 24.9 percent in 2003 to 26.4 percent in 2006 and to 26.5 percent in 2009.6 This inelastic poverty response is corroborated by recent Social Weather Station surveys, which indicate that self-rated poverty only declined slightly in 2010, while self-rated hunger incidence remains at record high levels. (See Box 1 on Poverty in the Philippines.)

6 The figures on extreme poverty (i.e., subsistence incidence) exhibit a similar pattern: in terms of family (population) incidence, extreme poverty first rises from 8.2% (11.1%) in 2003 to 8.7% (11.7%) in 2006, and then declines slightly to 7.9% (10.8%) in 2009. (These figures are based on the newly defined national poverty lines posted by the National Statistical Coordination Board on 8 February 2011.)

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Box 1: Poverty in the Philippines

Low economic growth has been a long-standing problem in the Philippines, and largely accounts for the slow progress made in poverty reduction during the 1980s and 1990s, compared to the faster growing East Asian neighbors; see Box figure. So, when economic growth finally accelerated after 2001, expectations were raised that poverty would henceforth fall at a faster pace. These hopes were dashed by the 2006 household survey, which indicated that the improved economic performance had not translated into faster poverty reduction. Rather than declining, poverty ratios increased between 2003 and 2006, and remained broadly unchanged through 2009. Various factors explain the rise in poverty: one is the limited dynamism of economic growth, coupled with high degrees of inequality. Contrary to the evolution of GDP, real household incomes have been declining since 2000, which accounts for much of the higher poverty. In addition, considerable circumstantial evidence indicates that there also has been deterioration in the distribution of income. As noted in the 2010 World Bank report on “Fostering More Inclusive Growth” in the Philippines, various factors contributed to the worsening distribution: (i) an uneven sectoral and regional distribution of growth – where the most labor intensive sector (agriculture) and poorest regions have been exhibiting the least dynamic growth and the fastest growing sectors (manufacturing) have remained extremely capital-intensive, (ii) intense demographic pressures from rapid population growth, (iii) declines in the relative price of labor and (iv) an unequal distribution of human capital and in access to social services. These factors largely follow from the poverty profile of the Philippine poor, who tend to be concentrated in rural areas and engaged in agriculture, and to have significantly less access to basic services, lower education levels and larger families than the non-poor. To render growth more inclusive, the 2010 World Bank report recommends a two-pronged strategy aimed at (i) accelerating growth in a sustained manner to create better job opportunities, and (ii) raising the ability of poor households to take better advantage of those improved opportunities. To implement the first program, the report recommends (i) raising the tax ratio to anchor macroeconomic stability, (ii) removing infrastructure bottlenecks, (iii) improving governance, and (iv) creating a better private investment climate by reducing ‘behind the border constraints’ that inhibit business development. In regard to the second prong, as greater opportunities for job creation are being generated, the report stresses the importance of enabling workers to move to the sectors and regions where the best opportunities emerge, as well as of assisting households to participate in markets through greater investment in their human capital. This last aspect require greater investment in health and education (where the Philippines ranks far below other East Asian countries) and strengthening its systems of social protection to improve the lot of the extreme poor and prevent the near poor from falling into poverty whenever adverse economic shocks take place.

Evolution of Poverty in the Philippines and Other East Asian Countries

Source: World Bank, Development Data Platform.

15. The current account of the balance of payments yielded solid surpluses of 5.5 percent of GDP in 2009 and 5.2 percent in 2010. This robust performance reflects the strong

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contraction of imports in 2009, followed by a more modest recovery in 2010, and strong growth of goods and services exports, combined with steady remittance inflows. As a result, gross international reserves reached a record high of US$62.5 billion in December 2010, equivalent to more than 10 months’ worth of imports and to almost six times the country’s short-term external liabilities by residual maturity. Similarly, liquid reserves (as measured by the forward book of the BSP) exceeded US$17 billion in December 2010. Meanwhile, the external debt remained broadly stable at around 38 percent of GDP; see Table 1. 16. The fiscal deficit had widened significantly in 2009, as the Government implemented an expansionary fiscal policy in response to the global financial crisis. With the extension of the Economic Resiliency Plan into 2010, fiscal policy became strongly pro-cyclical and the fiscal deficit remained large at 3.7 percent of GDP (GFS definition). The increase in the fiscal deficit of the National Government by 2.2 percent of GDP between 2008 and 2010 reflects both a decline in tax revenues and increased expenditures in almost equal measure. Despite a surging economy in 2010, the tax effort remained largely unchanged from the previous year, as many of the cuts introduced in 2009 were permanent in nature and additional revenue-eroding measures were applied in 2010. Even so, the National Government debt ratio declined slightly in 2010, due to the rapid economic growth and depreciation of the Peso value of foreign debt obligations. 17. To satisfy its higher borrowing requirement, the government has benefited from easy access to domestic and external financing on favorable terms. The Philippines’ financial markets surged to record highs thanks to improving domestic fundamentals, as well as strong foreign investor interest in Asian emerging markets in general. As noted by a joint IMF-World Bank mission that visited the Philippines in late 2009, the core Philippine financial system is sound and generally resilient to a wide range of risks. Other confidence-building factors have been the improving growth prospects, stable interest rates, strong corporate earnings, and the resolution of political uncertainty. Investors have shown a strong appetite for fixed income assets and sovereign spreads have narrowed sharply.7 The Government has been taking advantage of these favorable conditions to reduce the risk profile of its debt stock by lengthening its debt maturity and raising its domestic-to-foreign debt ratio.

B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

18. Growth is projected to remain strong over the medium term, though slightly lower than in 2010, as monetary and fiscal policies are tightened to gradually wind down the stimulus package introduced earlier. Also, the rebound of exports is expected to taper off toward more modest growth rates. Domestic consumption is projected to remain firm, buoyed by the steady inflow of remittances, while total investment increases in response to rising investor confidence. In addition to benefitting from the overall surge of foreign interest in Asian emerging markets, investor confidence in the Philippines also is expected to improve with the new administration’s strong focus on tackling corruption and reducing the costs of doing business. Even though fiscal space for additional investment spending by the public sector remains limited in the short run, the Aquino government is intent on kick-starting a new wave of public-private partnership projects to fill important gaps in infrastructure. To

7 From 261 basis points in June 2010 due to concerns regarding sovereign credit in some European countries to 155 bps points in mid-November, or within 17 bps of the country’s record low of May 2007.

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the extent that these gaps are filled, the cost of infrastructure services should gradually decline, leading to further improvements in investor confidence. Meanwhile, the balance of payments remains robust, even though the current account is projected to yield smaller surpluses in future years.

Table 1. Philippines: Selected Economic Indicators, 2003-2013 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Prel. Act.

Growth, inflation and unemployment Gross domestic product (% change) 4.9 6.4 5.0 5.3 7.1 3.7 1.1 7.3 5.0 5.4 5.5Inflation (period average) 3.5 6.0 7.6 6.2 2.8 9.3 3.2 3.8 4.8 4.5 4.5

Savings and investment Gross national savings 17.2 18.6 16.6 19.1 20.3 17.5 20.0 20.9 20.8 20.7 20.1Gross domestic investment 16.8 16.7 14.6 14.5 15.4 15.3 14.6 15.6 16.6 17.5 18.4

Public sector

National government balance (GFS basis) 1/-4.9 -4.1 -3.0 -1.4 -1.7 -1.5 -4.1 -3.7 -3.5 -2.9 -2.2

National government balance (Govt def) -4.6 -3.8 -2.7 -1.1 -0.2 -0.9 -3.9 -3.6 -3.3 -2.8 -2.1 Total revenue (Govt def) 14.8 14.5 15.0 16.2 17.1 16.2 14.6 14.4 14.6 15.3 16.0 Tax revenue 12.8 12.4 13.0 14.3 14.0 14.2 12.8 12.8 13.2 13.8 14.5 Total spending (Govt def) 19.5 18.3 17.7 17.3 17.3 17.2 18.5 18.0 18.0 18.1 18.1National government debt 77.7 78.2 71.4 63.9 55.8 57.0 57.3 56.1 53.7 51.6 48.5

Consolidated non-financial public sector debt 100.8 95.0 85.9 73.9 61.1 60.7 60.7 58.4 57.3 56.6 53.7Balance of payments

Merchandise exports (% change) 2.7 9.8 3.8 15.6 6.4 -2.5 -22.3 33.6 7.4 7.8 9.0Merchandise imports (% change) 3.1 8.0 8.0 10.9 8.7 5.6 -24.1 28.0 9.6 9.8 9.8Remittances (% change of US$ remittance) 10.1 12.8 25.0 19.4 13.2 13.7 5.6 8.2 8.5 9.0 9.0Current account balance 0.4 1.9 2.0 4.5 4.9 2.2 5.5 5.2 4.2 3.2 1.7FDI (billions of dollars) 0.2 0.1 1.7 2.8 -0.6 1.3 1.6 0.9 2.0 3.0 4.0Portfolio investment (billions of dollars) 0.6 -1.7 3.5 3.0 4.6 -3.6 0.3 0.3 3.0 3.5 3.5

International reserves

Gross official reserves 2/ (billions of dollars) 17.1 16.2 18.5 23.0 33.8 37.6 44.2 62.4 72.1 83.1 89.7Gross official reserves (months of imports) 4.0 3.6 3.8 4.2 5.8 6.0 8.7 9.6 10.2 10.7 10.2

Real Effective Exchange Rate 3/59.9 57.5 62.0 70 76.2 80.2 77.3 83.9 … … …

% change -9.9 -4.1 7.9 12.9 8.9 5.2 -3.6 8.5 … … …External debt

Total 4/ 78.6 70.1 62.4 51.3 45.8 38.9 39.0 38.1 34.9 34.4 33.3

Source: Government of the Philippines, World Bank1/ Excludes privatization receipts (treated as financing items, in accordance with GFSM) and includes CB-BOL restructuring revenues and expenditures2/ Includes gold3/ Against major trading partners (US, Japan, European Monetary Union, United Kingdom); data for 2010 is as of September; 4/ World Bank definition; The difference with central bank data is that this includes the following:

a. 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 amounts of permanently assigned capital required of these banksb. Long-term loans of non-banks obtained without BSP approval which cannot be serviced using foreign exchange of the Philippine banking system c. Long-term obligations under capital lease agreements

------------------------ Actual ------------------ ------ Projection ------

(in percent of GDP, unless otherwise indicated)

19. As the gap between actual and potential output is closed, the monetary authorities will be looking to gradually unwind their previous expansionary monetary policy stance. The new round of quantitative easing from certain central banks abroad may complicate these efforts, as foreign investors are eager to take advantage of yield differentials and buy up new bonds issued by the central bank (BSP). The BSP has stated its readiness to implement further prudential measures to deal with the effects of capital surges on domestic liquidity and asset price inflation.

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20. On the fiscal front, the Aquino administration will be looking toward a gradual fiscal consolidation through higher tax revenues and improvements in the efficiency of public spending. Initial revenue measures have focused on improving tax compliance, such as the filing of a number of tax evasion cases, but these have only had a marginal impact in 2010. Revenues are projected to increase gradually after 2011, as further improvements in tax administration are implemented and other sources of leakages are plugged and tax policy measures are introduced. Meanwhile, total government spending contracted to 18 percent of GDP in 2010, thanks to initial efforts undertaken since July 2010 to review and rationalize spending by applying a zero-based budgeting (ZBB) approach. This approach also has enabled the Department of Budget and Management (DBM) to rationalize, put on hold, or scale up key programs in its draft 2011 Budget, based on efficiency and equity considerations.8 Looking ahead, DBM plans to strengthen its program evaluation capacity to make such spending reviews a regular feature of public sector expenditure programming.  21. Debt Sustainability. The balance of payments projections shown in Table 1 show a strengthening reserve position and a gradually declining external debt; from 39 percent of GDP in 2009 to 33.3 percent in 2013. Similarly, the projected trajectory of the National Government debt exhibits an even more pronounced downward trend, with the debt ratio falling from 57.3 percent of GDP in 2009 to 48.5 percent in 2013. Barring any unexpected shocks, both trajectories are indicative of a sustainable macroeconomic policy setting. This is confirmed by Figure 1, which shows a gradually declining public debt ratio in the base case projection, as well as broad resiliency to a variety of standard shocks. 22. Aside from the historical volatility exhibited by several key economic variables, the main source of fiscal risks in the Philippines is the still high level of the fiscal debt, coupled with weaknesses in the public debt management framework that prevents quick responses. Another key source of fiscal risks stems from contingent liabilities, which have been and remain large, mainly on account of the GOCCs, increased reliance on PPPs, the financial sector and threat of natural disasters. In the power sector, in particular, the Government has amassed sizeable liabilities, which projected forward will run into numerous billions of dollars over the decade or so. The Government’s Power Sector Asset-Liability Management company has been able to re-finance its debt, in part by availing itself of sovereign guarantees, but as the country approaches its foreign borrowing limit, this cannot continue indefinitely as it is likely to affect the Government’s overall credit rating. Even without considering borrowing limits, financing outcomes have not been efficient, and financing costs have been rising.

8 Rationalized programs include the Food for School Program – to be 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 benefit rich farmers. Several programs that exhibited weak project implementation ratings or procurement bottlenecks will have their funds held up in both 2010 and 2011, including DepEd's Textbooks, Teacher Deployment and School Building Construction, and TESDA's Training for Work Scholarship programs. Special Purpose Funds, especially the highly discretionary ones, have been trimmed down significantly. 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-fiscal operations – have yet to be announced and implemented.

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Figure 1. Philippines: National Government Debt Sustainability Analysis 1/

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Baseline 46

30

40

50

60

70

80

2004 2006 2008 2010 2012 2014

Combined shock 2/

combined shock

Source: World Bank staff calculations 1/ The shaded areas represent actual data. 2/ The ‘combined shock’ consists of permanent 1/2 standard deviation adverse shocks applied to the real interest rate, growth rate, and primary balance.

23. Key Challenges. The preceding account draws attention to the following macroeconomic challenges facing the Philippine authorities in the medium term:

Bringing down poverty is the overriding challenge: while growth is necessary, it has clearly not been enough to reduce poverty in the Philippines. In addition to implementing growth-enhancing measures, it will also be important to develop the human capital of the poor, enabling them to take better advantage of growth opportunities, while strengthening social protection mechanisms to prevent them from backsliding further into poverty as a result of adverse shocks.

Raising the tax effort: the Philippines exhibits important public expenditure gaps vis-à-vis other neighboring countries, notably in health and education, which partly explain why the Philippines has made relatively modest progress in poverty reduction since the 1980s.9 While improvements in the efficiency of public expenditures can help reduce the public spending gap, it will not be enough. Total public spending levels also will have to increase. Such an increase can only be sustained if the Government is able to reverse the erosion of tax revenues that has taken place over the last decade.

Raising and sustaining a higher-than-historical investment-to-GDP ratio: while there is a significant increase in investments this year, the challenge is sustaining a higher investment-to-GDP ratio to ensure that growth will continue in the medium/long-term.

Improving the capacity to manage fiscal risk: although the projected evolution of the fiscal deficit points in a stable direction, the weak GOCC oversight capacity of the National Government and greater prospective emphasis on PPP arrangements represent significant contingent risks that could undermine the Government’s fiscal consolidation efforts and ability to ensure a stable macroeconomic environment. In the

9 See World Bank, “Public Spending: Stepping up public spending for faster growth and poverty reduction”, Philippines Discussion Note No. 4, Report No. 55655, July 2010.

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power sector, the challenge for the Government will be to maintain the amount of debt at a level consistent with the projected revenue available for debt service.

24. Staff Assessment. Based on the preceding considerations, the Bank task team believes that the macroeconomic framework currently in place in the Philippines is adequate for this operation. Even though the high public debt ratio continues to pose a threat to macroeconomic stability, the gradual pace of fiscal deficit and debt reduction represents a compromise between several trade-offs. In particular, the slower pace of deficit reduction contemplated in the Government’s program helps facilitate the budgetary shift toward greater social sector spending begun with the 2011 budget, instead of forcing the Government to embark on a more austere spending program that could result in spending cuts in some priority sectors. Furthermore, even though a tighter fiscal stance would help to relieve some of the pressure that is currently appreciating the Peso and impairing competitiveness, there is also the danger that such a policy adjustment would reduce growth in the short term by reducing aggregate demand.

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III. THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES

25. At the center of the Aquino government’s development policies is a social contract with the Filipino people that envisions “a country with an organized and widely shared, rapidly expanding economy through a government dedicated to honing and mobilizing people’s skills and energies as well as the responsible harnessing of natural resources.”10 This vision of inclusive growth and poverty reduction is expected to result from a more transparent and accountable government, an uplifting and empowering of the poor and vulnerable, and faster economic growth. To render such development sustainable, the social contract also highlights the need for peace, justice, security, and preserving the integrity of natural resources.

26. The 2010-2016 Philippine Development Plan (PDP) seeks to substantiate the vision of inclusive growth and poverty reduction that underlies the social contract through concrete actions that focus on three strategic objectives: (i) attaining a sustained and high rate of economic growth that provides productive employment opportunities and reduces poverty, (ii) ensuring greater equity of access to development opportunities for all Filipinos, and (iii) implementing effective social safety nets to protect and enable those who do not have the capability to participate in the economic growth process. An overarching challenge in the pursuit of development in the Philippines is to improve governance, which has been recognized as an important constraint on sustained growth and poverty reduction.

27. To achieve the first objective of high sustained growth, the PDP focuses on maintaining a stable macroeconomic environment, improving competitiveness and increasing infrastructure investment, and improving governance, while strengthening institutions to promote competition. In order to maintain a stable macro environment, the PDP stresses the need for fiscal consolidation, low and stable inflation, a reduction in external vulnerabilities, and a strengthening of the financial system. The PDP emphasizes the development of strategic public-private partnerships (PPPs) and improvements in the investment climate for the private sector to develop public infrastructure. To improve governance, the PDP seeks to promote sound and consistent public policies, while enforcing the rule of law. It places great importance on improving the efficiency, transparency and accountability of public finances, while also raising the efficiency of public investment programming processes. It also aims to ensure equal justice for the rich and poor through reforms of the judiciary and criminal justice system, as well as to revive peace efforts in Mindanao.

28. To achieve the second objective of ensuring greater equity of access to development opportunities, the PDP focuses both on developing the human capital of the poor in order to enable them to take better advantage of emerging income-earning opportunities, and on reducing barriers to access to land, credit, technology and infrastructure services. Human capital development will be promoted through increased public investment in more and better education services, as well as on improving public health, nutrition and other basic social services.

10 Source: PDP 2010-2016, Stakeholder Consultation on the UNDP Country Programme Document, November 18, 2010

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29. Finally, to achieve the third objective of putting in place effective social safety nets, the PDP focuses on expanding the coverage of social protection mechanisms that have proven effective and responsive, such as the conditional cash transfer program (4Ps), expanding the public health insurance program for the poor, and an improved targeting of public expenditures. Looking toward the longer term, it also emphasizes the need to strengthen disaster risk and climate change management.

30. The PDP Consultations Process. The 2011-2016 PDP was developed under the leadership of the National Economic and Development Authority (NEDA), which organized several planning committees to facilitate the drafting and consultation of the document. The PDP Steering Committee was chaired by Secretary Paderanga of NEDA and included the DOF Secretary to represent the Cabinet cluster on economy, the DSWD Secretary to represent the cluster on social protection and poverty reduction, and the DILG Secretary to represent the cluster on security and governance. There were five planning committees assigned to draft the Plan chapters. National and regional consultations were conducted in December 2010/January 2011. Discussions on the Plan with development partners and other stakeholders were held on February 26, 2011, during the 2011 Philippines Development Forum. The final PDP is expected to be released in June 2011.

31. The remainder of this section focuses on four broad strategic areas of the Government’s program that are being supported by this DPL. Three of these areas, comprising the maintenance of a stable macroeconomic environment, improving competitiveness and increasing public investment, and improving governance, pursue the first objective of achieving high sustained growth. The fourth strategic area – developing the human capital of the poor – pursues the second objective of ensuring greater equity of access to development opportunities. The end of this section also provides a brief update of government efforts to implement effective social safety nets, even though it is not an area explicitly supported by this operation.

A. MAINTAINING A STABLE MACROECONOMIC ENVIRONMENT

32. An important challenge facing Philippine policymakers on the macroeconomic front is the need to gradually wind down the stimulus package implemented in 2009 and 2010 in response to the global financial crisis, without unduly restraining economic growth. With the Philippine economy’s strong growth performance in 2010, the small output gap that had opened up during the global recession is rapidly closing. The expansionary monetary and fiscal policies that were introduced during the crisis therefore need to be unwound, both to avoid overheating the economy and creating inflationary pressures, but also to create policy space for responding effectively to future shocks. To achieve this objective, the Government is taking measures to strengthen overall fiscal management, public revenue mobilization and fiscal risk management.

33. Strengthening Overall Fiscal Management. The main threats to macroeconomic instability in the Philippines over the last decade have emanated from the fiscal side, particularly a weak revenue mobilizing capacity. The PDP proposes to achieve fiscal stability and consolidation, predominantly through a marked increase in revenues, rather than through

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expenditure compression.11 The fiscal consolidation goals are modest, as the National Government (NG) overall fiscal deficit is only projected to decline by about 2 percentage points of GDP over the six year period of this administration.12 This is enough to reduce the NG debt-to-GDP ratio by 7 percentage points of GDP to 48.8 percent of GDP by 2013, thanks to the fairly strong projected GDP growth. Although no overall expenditure compression is being planned, the Government is also intent on cutting waste and inefficient spending to help create fiscal space for priority programs that aim to fulfill the Aquino administration’s Social Contract with the Filipino people.

34. To underpin these fiscal consolidation efforts, the Executive has drafted two bills on fiscal responsibility that seek to instill fiscal discipline in the public sector by establishing principles of responsible financial management and promoting full transparency and accountability in government revenue, expenditure and borrowing programs. One version of the bill, “the short version,” establishes deficit-neutral rules when enacting new spending or tax measures. It was filed in both houses of Congress in September 2010 and is currently on second reading in the Senate.13 Key provisions of this bill are (i) the introduction of countervailing measures that offset any mandatory spending or tax legislation that increase the deficit or reduce revenues, (ii) the control of fiscal incentives by requiring all such bills to be accompanied by a certification from the Department of Finance that the incentive bill complies with the annual fiscal targets, (iii) the review of all existing fiscal incentives laws within two years after the fiscal responsibility law comes into effect, and (iv) requiring all future bills with budgetary implication to identify supporting revenue measures.

35. The other, more comprehensive, version of the bill14 includes the same deficit-neutral rules and calls for: (i) reaching a medium-term fiscal accord between the Executive and Legislature on fiscal targets to be accomplished over a period of three years, (ii) agreement on an annual budget strategy between the Executive and Legislature on macroeconomic policies and fiscal targets to be achieved in the fiscal year, (iii) establishment of a debt cap at 40 percent of GDP for the national government and 60 percent of GDP for the non-financial public sector by 2016, and (iv) the capping of personnel expenditures at 45 percent of net current revenues starting 2014. The Department of Finance is currently focusing on passage of the short version, which stands a higher likelihood of being enacted more quickly into law than the longer version.

36. Maintaining stable prices remains the primary monetary policy objective of the Bangko Sentral ng Pilipinas (BSP). Inflation targets — set at 3 to 5 percent for 2011 through 2016 — have been effective in anchoring inflation expectations in the past. The year-to-date inflation rate of 4.1 percent falls well within the central bank’s 2010 target, as are inflation expectations for 2011. With inflation expectations in check, the BSP, which cut its policy

11 Revenue (expenditure) is projected to rise from 14.6 (18.5) percent of GDP in 2009 to 19.6 (21.6) percent of GDP in 2016. 12 The deficit reduction is targeted to be achieved by 2013. From 2013 to 2016, a constant 2 percent of GDP deficit in the NG overall fiscal balance is targeted. 13 The Senate bill was filed by Senator Drilon while the House bill was filed by Representative Abaya. Both bills were drafted by DOF. 14 This bill (filed by Senator Recto) is currently being revised following a recent discussion between DOF and DBM and will be re-filed in Congress soon after.

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rates by 200 basis points during the global financial crisis, has not yet tightened rates; policy rates are at their historical lows, while real rates are close to zero or slightly negative.

37. Subject to its inflation targeting regime, the BSP also aims to minimize exchange rate volatility while maintaining a floating exchange rate. To ensure orderly conditions and curb excessive volatility, the BSP sporadically intervenes in the foreign exchange market. With the recent rapid appreciation of the Peso, the BSP has responded by introducing measures to facilitate capital outflows to reduce excessive short-term volatility of the exchange rate (e.g., by increasing the limit on dollar purchases from $30,000 to $60,000).

38. Strengthening Public Revenue Mobilization. Revenue mobilization has been the weakest link in previous fiscal consolidation efforts. After peaking at 17 percent of GDP in 1997, total tax revenues declined steadily in the aftermath of the East Asian Financial Crisis, falling below 13 percent in 2002 and 2003. With an overall fiscal deficit of 5.6 percent of GDP and a public sector debt-to-GDP ratio that reached 100 percent, the Philippines was at the brink of a fiscal crisis. The Government averted the crisis through a set of fiscal measures in 2005 that broadened the base of the VAT, increased the VAT rate from 10 to 12 percent, and increased the corporate income tax (CIT) rate from 32 to 35 percent. Excise taxes on alcohol and tobacco were also increased but their rates were not high enough to offset inflation. An Attrition Act was also enacted to reward and punish revenue officials for meeting or failing to meet collection targets. These reforms succeeded in partially reversing the erosion of tax collections since 1997, but their impact was short-lived as the total tax intake began to decline again after 2006 due to both policy and administrative weaknesses. Economic factors also contributed to the decline, especially the downturn in 2009, though their effect on tax revenues was fairly small. In 2009, the tax effort fell to where it had been in 2003.

39. On the policy side, major revenue eroding measures include the lack of indexation of excise taxes since 2005, the removal of the 70 percent input VAT ceiling in 2007, the fall in the CIT rate from 35 to 30 percent in 2009, the increase in the exemption thresholds for the personal income tax in 2009, and several tax incentives that were enacted through the years, the latest of which include the exemption of senior citizens from the VAT. Together, these account for more than 1 percent of GDP. On the administrative side, reforms initiated in 2006 failed to take off as the revenue agencies focused their attention to meeting short-term collection targets at the expense of enhancing long-term reform efforts.15 Moreover, strong revenue collection in 2006 had adversely affected audit effort in the revenue agencies.16

40. The Aquino administration has reinvigorated efforts to strengthen revenue mobilization, initially focusing its reform efforts on tax administration measures aimed at

15 The annual turnover of BIR commissioners between 2007 and 2010 for failing to meet the collection target is a case in point. 16 A DOF assessment suggests that the contribution of administrative effort was negative in 2006 as the revenue agencies relied mostly on windfall VAT revenues to boost collection. The BIR’s administrative efforts improved marginally in 2007 and 2008, when it raised audit revenues from PHP2.2 billion to about PHP5.5 billion. In 2009, audit collection improved to PHP17 billion as the BIR intensified its audit program further. As a result, audit revenues increased from 0.3 percent of total BIR revenues in 2006 to 0.8 percent in 2007 and 2008, and further to 2.4 percent in 2009. Clearly, the bulk of BIR’s collection comes from voluntary declarations. During the mid-90s, when tax effort was highest, audit revenues accounted for about 2 percent of total BIR collections.

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boosting compliance as well as some tax policy measures. The rationale for this approach is to first exhaust all administrative options in raising tax revenues before increasing tax rates.17 This is grounded in the finding that leakages in the income tax and VAT systems amount to about 4 percentage points of GDP.18 The incremental gains in tax collection achieved between 2007 and 2009 suggest that more focused attention on tax administration, in particular audit and enforcement activities, can raise revenues significantly. To complement tax administration efforts, the Executive is pursuing the enactment of a fiscal responsibility bill (paras. 33-34) and a fiscal incentives rationalization bill (discussed below) to plug future leakages in tax revenues. Moreover, it has begun to raise non-tax revenues by reducing government subsidies and increasing user fees. These include raising the fares of the Light Rail Transit (LRT), Metro Rail Transit (MRT), and toll fees in some expressways. The Government also has indicated that it will consider tax policy reforms in the event that the tax administration reforms do not yield the desired effects by end-2011.

41. Key administrative measures being pursued by the new administration include (i) increasing tax collection from large taxpayers, (ii) improving performance management in the BIR, (iii) setting the groundwork for improving the VAT refund mechanism, (iv) reinvigorating the Run After Tax Evaders (RATE), Run After The Smugglers (RATS), and Revenue Integrity Protection Service (RIPS)19 programs, and (v) various improvements in customs administration. Each is discussed below.

42. To secure revenues from the country’s largest taxpayers, the Government has amended the revenue regulations governing the selection of large taxpayers by expanding the selection criteria with the goal of increasing the revenue share of the LTS from 54 percent in 2010 to 85 percent of total BIR collection over the medium-term. The new revenue regulation became effective on January 1, 2011. Apart from the standard tax and turnover threshold criteria, additional criteria for becoming classified as a large taxpayer include (i) being a publicly-listed firm, (ii) affiliation to a conglomerate or multi-national company, (iii) engagement in the banking, insurance, telecoms, utilities, petroleum, tobacco, or alcohol sectors with a market capitalization of at least PHP100 million, and (iv) having a market capitalization of at least PHP300 million independent of the sector of engagement. These additional criteria were added in response to reported large-scale tax evasion and inter-conglomerate transfer pricing practices that reduce tax liabilities by firms with these characteristics. As of January 1, 2011, about 747 more large taxpayers have been enlisted, bringing the revenue share of the LTS to an estimated 62 percent in 2011. The BIR aims to reach at least 70 percent by 2013.

43. Alongside the expansion of the LTS, the BIR is also seeking to improve the capacity of the LTS. The Government has begun to restructure the Large Taxpayer Service (LTS) under the approved LTS rationalization plan (as mandated by Executive Order No. 366). Recruitment of qualified auditors to staff the office according to the LTS rationalization plan is currently in progress. This is to be followed by capacity-building programs and the reestablishment of the LTS performance management system that had been suspended since

17 As expressed by DOF Secretary Purisima in an interview published in GlobalSource Monthly Report (7 January 2011), visible efforts to improve tax administration and to reduce wasteful public expenditures are needed first in order to “gain the moral ascendancy to ask for tax increases.” 18 See World Bank, Public Expenditure Review 2010, for details on the tax gap. 19 The RIPS program refers to an anti-corruption program for revenue agencies.

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2006. By 2013, BIR expects to have completed a business process reengineering plan for the LTS, to enable it to further improve its capacity to cater to more large taxpayers as envisioned by the amended revenue regulation.

44. The commencement by the Government of restructuring the LTS under the approved LTS rationalization plan, approval of its Revenue Regulation No 17-2010 (dated November 16, 2010), which broadens the selection criteria for large taxpayers and addition of about 747 taxpayers to the LTS as of January 1, 2011 are a Prior Action for this DPL. This action was completed in January 2011.

45. The BIR has begun to formalize a set of agency-level key performance indicators (KPIs) to improve performance management and accountability in the bureau. In 2009, BIR developed an agency scorecard using key performance indicators and collected baseline data for a number of indicators. A similar exercise is underway to collect data for 2010. In February 2011, BIR held a high-level strategic planning workshop in which a set of KPIs that conform to good international standards of tax administration were identified. BIR intends to adopt these KPIs formally by early 2012, together with a strategic plan for 2011-2016. By then it also plans to have collected the baseline data for 2011, while 2012 outcomes data becomes available by early 2013. Successful implementation of this program is expected to increase transparency and accountability in the bureau and reduce alleged widespread corruption. (The adoption of these KPIs and strategic plan, and collection of 2011 baseline data, is a trigger for DPL2.)

46. The Government has begun to address long standing problems regarding input VAT refunds. Currently, most companies with input VAT claims are given tax credit certificates (TCCs) that can in principle be used to offset future tax liabilities. In practice, however, revenue agencies, particularly BIR, do not always honor TCCs, especially when revenue collection is running behind target. In addition, Congress does not always approve the full budget for refunds, thus preventing BIR from paying out all valid refunds. The use of TCCs also has serious negative effects on the investment climate by restricting the cash management of exporters, creating disincentives to expand business, and promoting inefficient resource allocation as exporters substitute away from taxable inputs. Furthermore, firms are dissuaded from applying for VAT input refunds through disincentives (e.g., firms applying for VAT refunds are automatically subject to a tax audit), with the result that VAT refund claims are unusually low in the Philippines.

47. In March 2011, the Development Budget and Coordination Committee (DBCC) approved in principle a plan to shift from the TCC system to a cash refund system. A number of key steps have been identified to prepare for the shift to the new system and ensure its fiscal sustainability. These include (i) the review and validation of the BIR’s VAT registration system20 in accordance with Sec. 236-G of the National Internal Revenue Code, (ii) the development of a risk-based audit system that has the benefit of reducing the time of processing refund claims, (iii) the creation of individual accounts for exporters, and electronic linkages and data sharing between BIR and BOC, to enhance audit of input VAT refund claims, (iv) drafting of a bill for the creation of special accounts and earmarking VAT

20 According to the DOF, a recent IMF technical assistance mission found that BIR would not be ready to shift to a cash refund system unless the VAT registration system has been reviewed and validated.

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payments of exporters on their importation and local purchases of goods and services to the special accounts, and (v) issuance of a BIR regulation requiring exporters to submit monthly summaries of purchases to serve as the basis for computing the amount of input VAT to be deposited in a special account.

48. The BIR is implementing its ongoing compliance programs with more vigor. In July 2010, new management teams in BIR and BOC reinvigorated the RATE and RATS programs by filing high profile tax evasion cases against fraudulent taxpayers on a weekly basis. Between July 2010 and February 2011, a total of 30 RATE cases and 26 RATS cases have been filed, including multi-billion Peso cases against two large taxpayers. The conviction rate also improved from two convictions prior to the new management to 12 convictions as of February 2011.21 Although both BIR and BOC have not yet met their respective collection targets to date, it is expected that they will do so by April 2011, when most tax returns are filed.22 Similar progress has been made on the RIPS Program. The new administration filed four new RIPS cases between July 2010 and February 2011, and a total of 76 cases are pending before the Ombudsman. In addition to 13 staff members dismissed due to graft related charges in 2009, six more were dismissed in 2010. DOF intends to continue filing one case per month, although there still have been no criminal convictions to date.

49. The main tax policy measure currently under consideration is the re-filing of the Fiscal Incentives Rationalization (FIR) Bill. Over the last decade, several bills have been filed in Congress but none has come close to ratification. One reason for this had been disagreement between the Department of Finance and the Department of Trade and Industry on salient provisions of the bill. Under the new Administration, a breakthrough was achieved when both departments agreed on key provisions of the bill. These provisions include: (i) limiting the number of incentive-granting institutions and streamlining the institutional structure in investment tax incentive policy formulation, promotion and administration, (ii) imposing sunset provisions on all incentives, (iii) domestic capture of tax payments that otherwise would have gone to other countries under various tax treaties, (iv) limiting the granting of incentives to firms under the Philippine Export Zone Authority (PEZA), (v) introducing caps on income tax holidays and tax deduction allowances, (vi) limiting income tax holidays to at most three industries and only to exports, and (vii) granting the BOC authority to inspect goods that enter and exit export processing zones. Following the agreement on these provisions, the Executive submitted the new version of the FIR bill as House Bill No. 4152 in February 2011, and the President has identified it as a priority bill in the Legislative Executive Development Advisory Council (LEDAC) meetings in early 2011. With the passage of this bill, the Government expects to generate PHP10 billion over the medium-term and, more importantly, to plug future leakages in the tax system, which according to some reports23 are costing the Government about 1 percent of GDP annually. To provide the analytical underpinnings for the bill, DOF has commenced work on measuring the tax expenditures arising from various tax incentives. The Government intends to publish a

21 A new memorandum of agreement between BIR and the Department of Justice (DOJ) has served to improve coordination between the two agencies to increase the conviction rate. 22 The vigorous implementation of the RATE Program had resulted in a 74 percent increase in personal income tax revenues from self-employed and professionals in 2005. 23 See, for instance, Reside, R. (2006), “Towards Rational Fiscal Incentives”, Economic Policy Reform Agenda Project report.

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report on the size of fiscal incentives alongside the budget document submitted to Congress by 2013.

50. The Government’s submission of a revised Fiscal Incentives Rationalization Bill to Congress and identification as a priority bill is a Prior Action for this DPL. This action was completed in February 2011 with the filing of HB 4152 by Representatives Belmonte and Gonzalez.

51. Should tax revenues from administrative efforts and the two proposed bills prove insufficient in raising tax revenues to the desired level, the Executive would consider further tax reforms to “improve the revenue take of the tax system while promoting equity and level playing field among all stakeholders.”(See Chapter 1 of PDP). Key policy measures under consideration by DOF include raising excise tax rates and bases24 on alcohol, tobacco, and petroleum25 and indexing them to inflation, reversing several revenue-eroding measures such as VAT exemption to power transmission and senior citizens, as well as raising the VAT rate and a further broadening of the VAT base, possibly coupled with some reduction in the personal income tax rate to partially offset the increase in the tax burden.26 Related reforms in the granting of budgetary support to Government-Owned and Controlled Corporations (GOCCs), especially the National Food Authority, are also being considered to reduce the fiscal burden of subsidizing inefficient or ineffective operations of GOCCs.

52. With these reforms, the Government hopes to increase the amount of revenues generated through the LTS from 54 percent of total BIR collections in 2010 to at least 70 percent in 2013, and to raise total tax revenues in line with its PDP, from 12.8 percent of GDP in 2010 to a target level of 14.4 percent by 2013.

53. Strengthening Fiscal Risk Management. To improve the management of fiscal risks, the Government is actively pursuing a major program of institutional capacity building. An important first step for optimal management of fiscal risks is to have a timely and accurate risk assessment. This has already been achieved with the preparation of a Fiscal Risks Statement (FRS) and its publication in November 2010. The FRS contains quantitative and qualitative evaluations of fiscal risks for each of the major risk categories, as appropriate. It also includes the authorities’ ongoing efforts and plans to mitigate specific and overall risks. With the existence of the FRS – which the authorities plan to update at least annually within the context of the National Government budget submission to Congress – relative or absolute weaknesses in risk management can be better identified and prioritized. To that end, key government initiatives to structurally improve institutional capacity in managing and ultimately reducing fiscal risks focus on the public debt, PPPs, and GOCCs.

54. The publication by DBCC of a Fiscal Risks Statement as a reference for the 2011 Budget is a Prior Action for this DPL. This action was completed in November 2010.

24 The adjustment of excise tax bases is particularly relevant due to the use of fixed (1996) prices for alcohol and tobacco products that had been in production at the time of passage of the law. 25 The rates have not been adjusted since 1996. 26 See GlobalSource interview with Sec. Purisima and presentation of Undersecretary Gil Beltran in the January 31, 2011 DPL workshop.

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55. In regard to the public debt, the Government plans to set up a Debt and Risk Management Office (DRMO) within the Department of Finance to function as a middle office enabling a more pro-active liability management, first of the National Government, and eventually of the entire non-financial public sector. It is also planning to articulate and publish a debt management strategy,27 together with key debt metrics and analyses, including a periodically updated debt sustainability analysis.

56. A strong institutional framework for project selection, approvals and contract negotiations is needed to comprehend the fiscal risks involved in PPPs.28 To date, no government unit is responsible for generating comprehensive and timely information on PPP projects. While the DOF’s review process is meant to include stress testing project parameters to determine the range of outcomes and government exposures, this is done in isolation at the individual project level without reference to the wider risk profile of public sector debt and other contingent liabilities. Moreover, because of limited manpower and technological resources, there is no system for bringing together information on PPP projects to enable adequate monitoring of risk parameters and their likely impact on the budget. Accordingly, reform efforts by DOF, DBM and NEDA aim to improve the monitoring of contingent liabilities and establish a system that will systematically estimate the extent and cost of risk exposure from PPP projects. The ICC is planning to approve and publicly disclose a PPP risk allocation matrix in order to provide clarity as to the distribution and scope of risks the National Government is exposed to. It also intends to apply a policy of publicly disclosing all signed PPP contracts.

57. The reform agenda focusing on fiscal consolidation, improved expenditure efficiency, governance and service delivery extends to the broader public sector, with particular attention being given to Government Owned and Controlled Corporations (GOCCs). There are estimated to be around 767 GOCCs in the Philippines. They were created either by special laws, the corporation code or by judicial decisions, and their mandate involves social-oriented responsibilities, the provision of basic services, such as transport, water, power, housing and a stable food supply, or promotional activities, such as development financing. Although DOF is in charge of overseeing the financial performance of all GOCCs, only 14 corporations are closely monitored.29 These 14 GOCCs stand out on account of heavy dependence on the 27 It is expected that, in line with international best practices, this strategy would set out the goals and objectives that debt managers have to accomplish and would be accountable for. 28 While the legal and regulatory framework for PPPs are considered to be broadly adequate, the capacity to implement PPPs and evaluate them under that framework are not. The build-operate-transfer (BOT) law of 1993 requires national level BOT projects to be approved by the interagency Investment Coordination Committee (ICC). The ICC reviews projects in terms of their fiscal, monetary, and balance of payments implications. ICC clearance is a precondition for projects to secure government guarantees. However, the implementing agencies responsible for identifying and selecting BOT projects for ICC approval have limited technical, legal and financial capabilities to negotiate and write BOT/PPP contracts that minimize fiscal cost and risks. Additional due diligence by oversight agencies (NEDA, DOF, DBM), while often resulting in long negotiation periods, therefore helps to limit fiscal risks. Nonetheless, in some cases, despite concerns of the ICC technical team about a project’s financial feasibility, these were set aside in light of a project’s social desirability. These latter decisions have tended to increase fiscal risks as the Government assumes long-term risks to make projects financially attractive for the private sector. 29 These 14 GOCCs are the Home Guaranty Corporation, Light Rail Transit Authority, Local Water Utilities Administration, Manila Waterworks and Sewerage System, National Development Corporation, National Electrification Administration, National Food Authority, National Housing Authority, National Irrigation Authority, National Power Corporation, Power Sector Assets and Liabilities Management Corporation, National

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National Government for financial support, either directly though equity, subsidies or debt service advances, or indirectly through National Government guarantee of their debt obligations. They account for roughly 46 percent of the total non-financial public sector liabilities, or about 17.7 percent of GDP.

58. Instead of generating operating surpluses, the GOCCs have been incurring significant financial losses. This is partly attributable to a poor governance environment, leading to the failure to adjust tariffs, unnecessarily large capital requirements, and operational and management inefficiencies. But it is also partly due to the mandates under which many of the GOCCs were created, which directs them to pursue objectives whose public welfare rationale is unclear or no longer coincides with government priorities. Budget transfers from the National Government to cover the losses of the GOCCs have tended to increase over the past 10 years, both as a share of total government spending and as a share of GDP, reaching almost 1.3 percent of GDP in 2008. Furthermore, these budgetary transfers only represent a small part of the total public support they receive, which includes periodic recapitalizations and the financing of current deficits by issuing debts that are assumed by the National Government. The GOCCs also generally operate in a much more favorable regulatory and policy environment than private sector companies (e.g., most have tax exemptions and easy access to credit), which has a fiscal cost that usually does not appear in the government budget.

59. To improve GOCC performance and reduce the fiscal risks and burden they pose, the Government is introducing a more pro-active management and strengthened oversight of GOCCs, with special attention on the companies that pose the largest source of fiscal risk, namely the NFA and PSALM.30 To facilitate more comprehensive monitoring, the DOF is developing a new publicly accessible web-based financial monitoring framework for GOCCs that is to be fully implemented by March 2012. This framework will give the DOF more up-to-date, detailed and comparable information on the financial performance of the individual GOCCs, permitting better oversight and quicker remedial actions when performance deteriorates. In addition, the government plans to (i) introduce performance standards and compensation caps for all presidential appointees to GOCC governing boards, (ii) issue an executive order to direct the rationalization of the compensation and position classification system in the GOCCs and GFIs, (iii) initiate institutional and financial reforms geared towards raising operational and financial efficiency, (iv) engage in a more proactive management of contingent liabilities, and (v) adjust user charges and tariffs to appropriate levels. Eventually, the newly created DRMO is expected to manage the GOCCs’ debt with the aim of reducing overall risks and costs. A Senate Bill (No. 2640) has been filed in Congress to promote financial viability and fiscal discipline in GOCCs, in part through temporary delegation of reform powers from Congress to the Executive. Reforming the GOCCs, either to align their mandates with government priorities or to restructure them is very difficult if attempted on a case-by-case basis, as most of these firms were created under

Transmission Corporation, Philippine Economic Zone Authority, Philippine National Oil Corporation, Philippine National Railway and Philippine Ports Authority. 30 One historically large and remaining source of GOCC-related fiscal risk is the power sector. The Power Sector Asset-Liability Management company, PSALM, has the highest share of foreign-denominated loans. The company has been able to re-finance its debt, in part by availing itself through sovereign guarantees, but these are ultimately limited by law. PSALM financial standing is also contingent on the longstanding regulatory approval of universal charges for stranded debt and contract costs.

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separate congressional bills. Giving the Executive temporary powers to reform the GOCCs within certain parameters, therefore, would help significantly to speed up such reforms.

60. The filing in Congress of Senate Bill No. 2640, whose objectives are, among other things, to promote financial viability and fiscal discipline in GOCCs, in part through temporary delegation of reform powers from Congress to the Executive, is a Prior Action for this DPL. This action was completed on January 18, 2011. (DOF’s implementation of the web-based financial monitoring framework for GOCCs is a Trigger for DPL2.)

61. This set of reform measures is expected to improve the management of fiscal risks and, ultimately their cost and occurrence. The increase in fiscal discipline and improved monitoring and control of GOCCs will also help reduce the Philippines’ overall public debt level, contributing to a lower level of fiscal risk and lower cost of financing. This is expected to be reflected in an improvement in sovereign credit ratings by at least one of the rating agencies: Standard & Poor, Moody’s or Fitch.

B. IMPROVING COMPETITIVENESS AND INCREASING INFRASTRUCTURE INVESTMENT

62. Recent diagnostic studies have identified a weak investment climate, reflected in low investment spending, as one of the main constraints to growth in the Philippines. Total investment spending in the Philippines accounted for 14.7 percent of GDP in 2008, contrasting with the 25 percent average spending observed in the East Asia and Pacific (EAP) region. The Philippines Development Plan recognizes this shortcoming and lays out strategies to improve the investment climate by (i) reducing the cost of doing business, (ii) instituting policy and regulatory reforms,31 (iii) improving infrastructure development – including efficient transport systems and logistics – and (iv) promoting public-private partnerships in sectors or areas with strong linkages in domestic and global production chains.

63. Improving the Investment Climate. The regulatory framework poses a critical obstacle to a better investment climate in the Philippines, which ranks 148th out of 183 countries in the Doing Business 2011 report. Although the Philippines has made much progress in eliminating trade barriers and improving trade logistics since the 1980s, it has been less successful in reducing ‘behind-the-border-constraints’ and exhibits notable shortcomings in terms of the costs of doing business, which are much higher in the Philippines than in the rest of the East Asia and Pacific region. Doing Business 2011 points out big challenges associated with starting a business and dealing with construction permits (rank 156th). The main constraints in these regards refer to cumbersome procedures and lagging automation and computerization.32 Doing Business 2011 reports that the Philippines requires 15 procedures to start a new business and 26 to deal with construction permits, compared with 7.8 and 18.7 procedures, respectively, on average in the EAP region. These cumbersome procedures translate into high costs. For example, the average cost of starting a business is calculated at 30 percent of income per capita, which is far higher than in neighboring countries (5.6 percent in Thailand, 17.5 percent in Malaysia and 22.3 percent in

31 To rationalize regulatory reforms, the Asian Development Bank plans to support the Philippine Government in institutionalizing the regulatory impact analysis. 32 Global Information Technology 2009-2010 reports the low usage of information and communication technologies by the Philippine government (rank 111th out of 133 economies).

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Indonesia). Similarly, the cost of dealing with construction permits in the Philippines is more than seven times the average income per capita; six times higher than in Indonesia. The Enabling Trade Index 2010,33 in contrast, indicates that the Philippines has maintained an open trade regime with an average tariff rate of 3.8 percent, resulting in a Trade Tariff Restrictiveness Index (TTRI) that ranks the Philippines 21st out of 125 economies (World Bank, 2010b).34 However, its overall trade environment is less favorable (92nd) than suggested by the open market access,35 due, among others, to a weak border administration and poor regulatory environment. A better regulatory framework for doing business and trade procedures that approach international good practice could potentially lower the cost of doing business and encourage more Filipinos to open businesses,36 or informal firms to formalize their businesses, boosting firm productivity, investment, competition and, hence, competitiveness.37 64. The Government has undertaken several reforms to streamline procedures and computerize and automate registration systems, especially in areas associated with starting a business, including obtaining business permits. In the Philippines, starting a business in any city or municipality requires the business operator to register its business name, obtain relevant clearances from National Government agencies and then to apply to the local government unit for a business permit. With respect to business name registration, the Department of Trade and Industry (DTI) implemented a new web-based Enhanced Business Name Registration (BNR) system, including a mobile phone cast transfer system, which is designed to make business name registration faster and easier for sole proprietorships.38 As such, it should have a significant poverty impact, given that the vast majority of micro, small and medium-sized enterprises are sole proprietorships. (Pre- and post-reform motion studies indicate that the time required for business name registration has been reduced to 15 minutes under the new system.) System implementation was completed toward end-2010.39 To cut the cost of business name registration further, a four-tiered registration scheme and a fee depending on the territorial coverage of the business name have been implemented.40

33 The Enabling Trade Index “measures the extent to which individual economies have developed institutions, policies, and services facilitating the free flow of goods over borders and to destination.” (World Bank, 2010). 34 The MFN-applied tariff rate is 6.3 percent, with a maximum rate of 65, which is also much lower than the EAP averages (10.2 percent and 389.9 percent, respectively). 35 The only country that falls behind the Philippines in the East Asia Pacific (EAP) region is Mongolia (116th) (World Bank, 2010b, ibid.). 36 See, Bruhn (2008), “License to Sell: The Effect of Business Registration Reform on Entrepreneurial Activity in Mexico,” Policy Research Working Paper 4538, World Bank. 37 Loayza, Oviedo and Servén (2005) and Chari (2007) find that entry deregulations and lower start-up costs encourage firm productivity and better macroeconomic performance. 38 Corporations and partnerships register business names with the Securities & Exchange Commission (SEC). 39 The respective Department Administrative Order No. 10-08 2010 took effect as of October 7, 2010. The new system enables the registration of a business name, either online or in a DTI office, within 15 minutes. It simplifies the application form from 8 to 1 page and reduces information fields from 36 to 16. Shortly before the reform in October 2010, average processing time had already been reduced to 60 minutes. A random post-reform study in different LGUs in October 18-19, 2010, shows an average processing time of about 15 minutes, with a minimum of 1 minute and the maximum of 27 minutes. (An extreme outlier of 5 hours 56 minutes was found for Compostela Valley in Davao City, Mindanao, owing to inadequate internet connectivity.) The 15-minute average business name processing time was confirmed through a random visit and time studies in a DTI satellite office by a World Bank team on March 11, 2011. 40 The four-tiered registration fee system is based on the territorial jurisdiction: registration at the barangay level – PHP200, city/municipality – PHP500, and national – PHP1000. In other words, a firm with nationwide

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65. DTI’s adoption of a new web-based Enhanced Business Name Registration system that has reduced the average time required for a business name registration to 15 minutes is a Prior Action for this DPL. This action was completed in October 2010. 66. The DTI also has initiated the Philippine Business Registry (PBR) project in order to facilitate business registration-related transactions among a set of National Government agencies41 and local government units. The project’s objectives are to establish a fully-secured national business registry database, to harmonize business registration and to facilitate transactions among agencies and the business sector through a single on-line registration system.42 The Government is planning to upload the PBR on-line and link it to the BPLS of three LGUs (Caloocan, Quezon City and Mandaluyong) by mid-2011.43 Test runs with the National Government agencies have been successful. Going forward, the government is expecting to link the system with the Securities and Exchange Commission (SEC), which in turn needs to revamp its system to be linked to the PBR, to allow corporations and partnerships to register on-line. (The uploading of a functioning PBR on-line, linked with the BPLS of 3 LGUs is a Trigger for DPL2.) 67. At the LGU level, the Business Permit and License System (BPLS) reform – led by the Department of Interior and Local Government (DILG) and DTI - seeks to encourage all LGUs to adopt a single unified form in processing new applications for business permits and renewals, to implement a five-step application procedure to follow the prescribed number of signatories and to reduce processing times – to 10 days for the release of new permits and to 5 days for renewals.44 It also encourages automation of the process. To accomplish the reforms, the government is arranging training workshops and coaching sessions for a prioritized group of LGUs. In a second phase, the LGUs will be encouraged to link the LGU business permit system with the PBR single on-line registration system. This link will permit the one-time, on-line application for all the registrations and the issuance of business permits.45 The two lead agencies, assisted by the Local Government Academy, are responsible for monitoring and evaluating the implementation of the BPLS-related reforms in priority LGUs and plan to implement an LGU business permit simplification monitoring and evaluation tool.46 IFC, which is supporting the BPLS reform, piloted the BPLS reform programs in four cities in Metro Manila – Mandaluyong, Quezon City, Manila and Marikina – and assisted the cities to open Business One-Stop Shops (BOSSs) in their respective city halls. Doing Business 2011 finds that the one-stop shops contribute to reducing the time to obtain permits. Full

branches can register only one time for PHP1000. Previously, the fee was fixed at PHP300 per application and therefore a firm with 10 nationwide branches would need to register 10 times, incurring the total registration cost of PHP3000. 41 These national government agencies comprise the Bureau of Internal Revenue (BIR), the Social Security System (SSS), the Philippines Health Insurance Company (PhilHealth), and Pag-IBIG (the Home Development Mutual Fund). 42 DTI, 2010, “PBR Briefer”. 43 www.business.gov.ph. 44 For details, see DILG and DTI, Joint Memorandum Circular No. 01, Series of 2010, 06 August 2010. 45 Some cities (e.g,Quezon City and Mandaluyong in Metro Manila) have linked their BPLS to the PBR but it is yet to be fully operationalized. The DTI also has been working on linking Caloocan’s BPLS to the PBR. 46 Priority LGUs are defined as those having good potential in generating investments in the four priority sectors of government, namely business process outsourcing, tourism, mining and agribusiness.

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implementation of the streamlining BPLS project by all LGUs would allow businesses to complete the corresponding transactions on-line and thereby reduce their registration costs. 68. With the full implementation of the PBR, and aided by the development of the BPLS, the Government expects to reduce the average number of days required to start a business by 10 days, based on the Doing Business methodology for business entry.47 69. As a further element in reducing the cost of doing business and creating regulatory certainty for investors, the Government plans to improve clarity in interpreting the National Building Code and the new Fire Code. Currently, the procedures to obtain a building permit and the cost for a fire safety inspection certificate vary across LGUs. The sub-national Doing Business in the Philippines 2011 finds that the lack of clarity in applying the two codes encourages LGUs to exercise discretion, which results in large variations in time, cost, and number of procedures associated with obtaining a construction permit. Recognizing these shortcomings, the DTI and DILG are planning to develop a standard interpretation of Fire and Building codes, and are planning to implement it in at least three LGUs as pilot cases. 70. Similarly, the Government is emphasizing the alignment of LGUs’ ordinances with national laws, especially in the area of investment promotion. The Local Government Code of 1991 allows LGUs to approve ordinances (or resolutions) that are aimed at increasing efficiency or achieving effective decentralization. These ordinances, however, may not necessarily be in line with national laws. Investors, especially foreign ones, often complain about regulatory uncertainty within LGUs, some of which have had to be decided on by the Supreme Court. Mining is a good example:48 despite liberalization of the sector, some large mining investments have encountered setbacks with LGU ordinances that, for example, do not permit certain types of mining exploration.49 In an effort to align LGUs’ ordinances with national laws, while respecting LGU autonomy, the Government has created a task force to review existing local government ordinances that hinder business operating conditions. The Task Force will concentrate on the agri-business, business process outsourcing, mining and tourism sectors. Based on the outcome of the review, the task force plans to prepare recommendations to harmonize local ordinances with national laws, and implement these recommendations on a pilot basis in selected LGUs. 71. Finally, in the area of trade facilitation, the Government has been seeking to promote trade in a secure manner and conforming to international best practices and standards through the use of electronic transactions, compliance audits and better risk management.50 In this 47 The Global Doing Business 2011 indicator, which reported that it takes 38 days to start a business, is based on firms in Manila that are registered with the Securities and Exchange Commission. Before end-2011, a separate baseline will be created for sole proprietorships, using the same Doing Business methodology for business entry. 48 The Philippine Mines and Geosciences Bureau estimates the country’s untapped mining resources to be worth more than US$840 billion, or fifth in the world in terms of mineral potential. To realize the full economic potential of the resources, the government has allowed an exception to the 40 percent foreign-ownership restriction - allowing 100 percent foreign-ownership in large scale mining. Such liberalization on this exceptional basis seems to have been sufficient to attract foreign mining firms to enter the market. 49 For instance, the previous provincial government in South Cotabato in Mindanao (the richest mineralized region of the country) approved an ordinance that bans an open pit mining project, which has been derailing a US$5.9 billion Tampakan copper-gold exploration project. 50 BOC’s Five-Year Strategic Plan 2008-2012.

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context, the Bureau of Customs (BOC) has initiated the Electronic-to-Mobile Customs (E2M) Project to systematize customs procedures. Under the E2M, the Government has developed the Enhanced Selectivity System with funding from the European Union.51 The core of the project is the development of a risk management system that determines risk by comparing and evaluating data against predetermined standards and other criteria to facilitate the release of goods. Under the umbrella of the E2M, the Government is planning to implement nation-wide the Imports and Assessment System (IAS),52 the Payment Application System, and the Client Profiles Registration System with the objective of improving the effectiveness and efficiency of customs administration. In addition, the Government has put the National Single Window (NSW) in operation on a pilot basis, connecting with 30 government agencies, which allows trade transactions to be performed via internet and mobile phone.53 The NSW will be linked to the E2M. With the full implementation, the Government aims to phase out all cargo paper permits and clearances by first quarter of 2011.54 These measures are geared towards the full implementation of the National and ASEAN Single Window initiatives.55 72. Addressing Infrastructure Bottlenecks. The Philippines Government has taken significant strides in augmenting the infrastructure stock in the country. However, the overall quality of infrastructure service delivery remains a concern and has emerged as a key impediment to the country’s economic competitiveness.56 The 2010/2011 Global Competitiveness Index of the World Economic Forum ranks the Philippines 85th out of 139. Business leaders rank “the inadequate supply of infrastructure” as the third most problematic factor for competitiveness in the Philippines. By comparison, no respondents pointed to poor infrastructure as a source of major problems in Malaysia and Thailand. Assessments of the transport infrastructure network are particularly poor. While road density is comparable to that in other countries in the region, road quality compares less well, resulting in higher land transport costs and accident rates. Ports and airports are generally plentiful, but their capacity is under pressure in some places, also resulting in congestion and high costs. In various ports and airports, a key issue is sustaining viable operations under conditions of limited demand.

73. Since the 1997 Asian Financial Crisis, infrastructure investment has dropped from a peak of 8.5 percent of GDP in 1998 to only 2.8 percent of GDP in 2002. This indicator has improved in 2008, but the average rate still falls short of the 5 percent of GDP level achieved in faster growing neighboring countries over the past decade and recommended by various studies as a target for the Philippines.57 Stepping up infrastructure spending to achieve the 5 percent target is undermined by an inadequate public funding capacity, due to weak tax

51 Under the Trade Related Technical Assistance II and developed by UNCTAD. 52 Selected ports have implemented the system- for example Bataan Seaport in March 2009, the port of Manila and Batangas Seaport – and all ports are expected to be operating with this system by mid-2010. 53 The World Bank has reviewed the initial stage of the NSW and recommended strategies going forward. (See World Bank Team Report, “Philippines National Single Window”, November 2009. Contact: Hamid Alavi). 54 http://daweb.da.gov.ph/News_events/2010/nov/nsw_rel1.pdf. 55 Bureau of Customs, 2009, “Transformation of the Risk Management Group into the Risk Management Office Pursuant to E.O. No. 836 (S. of 2009) and CAO No. 6-2009,” Customs Memorandum Order No. 51-2009, December 9. http://www.customs.gov.ph/dynamic/CMO_51_2009.pdf. 56 World Bank. 2005. Philippines: Meeting Infrastructure Challenges. 57 Llanto, Gilberto M. 2008. A Review of Build-Operate-Transfer for Infrastructure Development: Some Lessons for Policy Reform. Philippine Institute for Development Studies Discussion Paper No. 2008-25.

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revenue collections, a high share of non-discretionary spending and a relatively high public debt level.

74. To address this challenge, the Government is seeking to re-energize public-private partnerships (PPPs). Though partly motivated by a desire to avoid fiscal pressures through cost-sharing with the private sector in financing, building and operating public infrastructure facilities, PPPs are also being pursued to improve overall performance in the delivery of public infrastructure services. In the new program publicly announced by the President and his Cabinet at the Infrastructure Philippines 2010 Conference on November 17-19, 2010, the new PPP agenda calls for (i) the reorganization and strengthening of a PPP unit to manage the overall process, (ii) the development of a Peso-denominated fund for financing the Government’s contribution to project development costs of PPPs, (iii) the strengthening and capacity-building activities of NEDA and other oversight agencies, and (iv) the identification of 10 priority projects which would be fast–tracked for bidding by private operators. By early 2012, the Government plans to have issued a call for bids for at least 10 priority projects. With the implementation of this agenda, the Government expects total investment spending to increase above the 15.3 percent of GDP achieved in 2010. (The Government’s call for bids on at least 10 priority projects to be financed under PPP arrangements is a Trigger for DPL2.)

75. The main outcome envisioned with the development in the Government’s capacity and experience in carrying out infrastructure projects under PPP arrangements and the general improvement in the investment climate propitiated, among other, by the reduction in costs of doing business, is an increase in total fixed investment levels as a share of GDP, above the 15.7 percent reached in 2010.

76. Power Sector Reform. Reliable availability of energy at reasonable prices is crucial for achieving a better investment climate in the Philippines. With the enactment of the Electric Power Industry Restructuring Act in 2001, the Philippines embarked on a process of reform intended to modernize the power sector and place it on a sound financial footing, with the private sector taking the lead in sector development. Considerable progress has been made since the reform began to be implemented in the mid-2000s. The Philippines now has one of the most advanced market and regulatory frameworks in East Asia, and while there have been issues related to implementation of power sector reform, that framework is generally functioning well. Most of the previously government-owned generation capacity (except for hydro-power plants) has been privatized as planned, and the Wholesale Electricity Spot Market, which commenced in 2006 in Luzon, has since then been extended to Visayas and is operating well. Also, the Electricity Regulatory Commission (ERC) is recognized as one of the most capable institutions of its kind in the region.

77. Alongside these developments, investment has been attracted into generation, transmission and distribution, so that dependable capacity is now estimated at 13,500 megawatts, with over 1,200 MW of new capacity under construction and another 2,000 MW or so in active development. Given this investment, there appears to be no immediate threat of a return to severe power shortages in Luzon and Visayas. (Mindanao, on the other hand, continues to be vulnerable to power shortages because of its dependence on hydroelectricity; however, the situation there is currently stable as well.) Although electricity prices continue to be extremely high in the Philippines, this is largely due to the archipelagic nature of the country (which makes service provision very costly), as well as to the high cost of developing

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the most prevalent domestic power sources (geothermal, natural gas and hydro-resources). A third factor contributing to high electricity costs has been the inadequately planned rush to procure new generation capacity in previous years, resulting in expensive projects reflected in high tariffs.

78. Almost all of the new capacity under construction or development is to be fueled by imported coal. As 68 percent of electricity is currently generated from indigenous resources (including wind, hydro, geothermal, coal, and natural gas), the dependence on coal-fired power for new generation will make the Philippines less self-sufficient over time. Financing all of this capacity might also be difficult on account of (i) the high cost of coal-fired power generation technology and (ii) the financial weakness of most of the 119 rural electricity cooperatives, which renders them unattractive as counterparties for new power purchase agreements. That raises the risk that some portion of the capacity under development may not reach the market in a timely fashion, which could lead eventually to renewed power shortages. Bolstering the financial strength of the Electric Cooperatives is therefore a key challenge.

79. The Government is in the process of reviewing its energy policy with a view to strengthening it further. Policy is geared towards achieving competitive energy pricing while ensuring stable, efficient, and reliable provision of power. To do this, a multi-pronged strategy is being contemplated with the following elements:

Implementation of the next steps contemplated under the Electric Power Industry Restructuring Act, especially with regard to introducing Open Access in the Luzon and Visayas market,

Greater energy diversification by implementing the Renewable Energy Act of 2008 and increasing market access to natural gas (which has the added benefit of moving the country to a lower carbon emission path),

Governance reforms in the Electric Cooperative sector, with incentives to improve all aspects of their operation,

More effectively targeted electrification programs, with the goal of making 4-million connections through 2017, so as to achieve 90 percent household electrification, and

An effective communication and provision of information to all stakeholders, with a focus on both reform and energy conservation aspects.58

C. IMPROVING GOVERNANCE

80. The Aquino Administration has made governance and anti-corruption a centerpiece of its agenda. Important steps are underway to improve public financial management and budget transparency and enhance the quality of public spending, exemplifying the Government’s efforts to bring about a more professional and accountable administration. These efforts face major challenges: the previous medium-term PDP (2004-2010) had candidly acknowledged

58 In addition, the Government also faces the challenge of dealing with the sizeable liabilities amassed under the government-owned Power Sector Asset and Liability Management company in the aftermath of the power sector restructuring reform. Projected forward, these liabilities will run in to several billion dollars over the next decade. So far, the Government has not succeeded in filing of universal charges for stranded debt and cost, as had been contemplated under the reform, resulting in the accumulation of further debts. This cannot continue indefinitely, but does not pose an immediate financial threat to government finances

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the extent of corruption, the low capacity and integrity of some government institutions and the pernicious influence of elite capture and patronage politics in the Philippines. There are also some bright spots, often achieved in concert with the country’s strong civil society (such as the advances made in public procurement reform), that give room for optimism. 81. Promoting Better Public Financial Management, Budget Transparency and Accountability. Since the mid-2000s, reform efforts in this area focused on enhancing the policy base and performance orientation of budgeting through the elaboration of a Medium Term Expenditure Framework (MTEF) and an output and outcome-oriented Organizational Performance Indicators Framework (OPIF). On budget execution, however, budget reporting, cash programming, accounting and auditing were done separately by different agencies using different classification formats. This undermined transparency and meant that the financial control function of the National Government was not functioning as effectively as it should. Recent PFM diagnostic studies cited the lack of reliable financial information on budget execution and cash positions, the delayed passage of the budget law, and unclear rules about realignment of funds as among the major issues. Lump-sum appropriations such as Special Purpose Funds, which had been increasing considerably every year, were seen to be the most vulnerable to misallocation and misuse. Efforts to improve budget execution had concentrated on developing (i) the electronic systems of expenditure accounting and reporting, (ii) Guidelines on Internal Control Systems (NGICS) and (iii) an Internal Audit Manual (PGIAM) for piloting in selected line departments, with the aim of strengthening internal audit functions at the agency level. However, progress in the implementation of the PFM agenda, especially in the areas of transparency and accountability, had been slow and uncoordinated. The new administration is providing them with much-needed momentum. 82. Since it took office in July 2010, the Aquino Administration has reaffirmed its commitment to improve public expenditure policy and management. The public expenditure reforms undertaken so far and contemplated in the future aim to increase the efficiency, effectiveness, transparency and accountability of government expenditures by focusing on strengthening: (i) the budget preparation process, (ii) budget execution data production and publication, (iii) the transparency and accountability of local government expenditures, and (v) the program evaluation function and overall performance-orientation of the budget.

83. Public sector financial management processes and information system. The Government is embarking on a major program to replace its fragmented financial management information system with an integrated system that can produce reliable and timely financial information to facilitate better planning and effective utilization of funds. An important output of this activity is the Government Financial Management Information System (GIFMIS) which requires the concerted efforts of the Commission on Audit, the Department of Budget and Management and the Department of Finance/Bureau of Treasury. These three agencies signed a Memorandum of Agreement in January 2010 and established an Inter-Agency Committee to oversee and develop the integration and harmonization of the Government’s financial management information systems. This system will cover all the financial transactions of government, from budget planning and appropriation, to execution, to reporting and accounting and to external scrutiny and audit. In January 2011, the Government also produced a Public Financial Management (PFM) Reforms Roadmap laying out the phased implementation of its PFM reforms. By March 2012, the Inter-Agency Committee is expected to have approved an action plan to implement the PFM Reforms

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Roadmap, including the adoption of a unified Chart of Accounts for accounting, budgetary and treasury transactions. By March 2013, the Government plans to have adopted a unified Chart of Accounts and to have progressed in the implementation of the GIFMIS, with the approval of detailed designs and procurement plans for the appropriate IT solution for an integrated financial information management system and a central database for all PFM operations. These measures should greatly contribute to enhanced transparency in public sector budgeting. (The Inter-Agency Committee’s approval of an action plan to implement the PFM Reforms Roadmap, including the unified Chart of Accounts, is a Trigger for DPL2.)

84. Strengthening budget preparation. In the past 11 years, budgets have consistently not been approved in a timely manner. This has triggered the automatic re-enactment of the previous year’s budget, leading to delays in the implementation of new programs and contributing to low budget execution rates. To prevent these delays, the Government has announced an earlier start of the budget preparation cycle aiming to present the budget to Congress in July and secure Congressional approval by end-November. The Government has also commenced annual consultations with civil society organizations in six departments and three GOCCs during budget preparation. These consultations are taking place early in the budget cycle and entail dialogue on the effectiveness and efficiency of public expenditure programs. They are being carried out in Manila as well as the regional level, and the Government expects them to help inform and complement its own program review process. In addition, as of the 2012 budget cycle, all departments and agencies will be required to fully disaggregate their budgets while disallowing lump sum funds, which will greatly increase the transparency of government budgets.

85. The Government also plans to strengthen the strategic allocation of its budgets by ensuring their consistency with the PDP and the sectoral MTEFs. To that effect, it intends to link the sector outcomes identified in the sector matrices of the PDP and the MTEFs to the

annual budget, building on the output and outcome-oriented Organizational Performance Indicator Framework (OPIF). This process should also benefit from ongoing work to refine the medium-term expenditure framework for the Department of Public Works and Highways and the Department of Health.

86. Production and publication of data on budget execution, key outputs and outcomes. The Government is instituting reforms in the area of public disclosure of government expenditures, including Special Purpose Funds (SPFs) and Congressional allocations, in order to enhance transparency and accountability of government expenditures. To this effect, all Congressional Allocations have been consolidated under one Special Purpose Fund – the Priority Development Assistance Fund (PDAF) and the Government has elaborated a closed menu of strategic projects in line with Government priorities to enhance the efficiency and effectiveness of PDAF expenditures. However, these projects will still not undergo the same level of scrutiny as under the regular planning and budgeting system. Strengthened transparency provisions have been included in the 2011 budget mandating the publication of implementation status and fund utilization of all departments and agencies on their official websites, while DBM is mandated to post on its website all releases and realignments under PDAF. By April 2012, the DBM website will provide the public with web-based access to current information on actual budget releases (Special Allotment Release Order, or SARO) for PDAF, DepEd’s School Building Program and IRA through the Electronic Transparency and Accountability Initiative Lump-sum System – Phase 1 (e-TAILS-1).

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87. The inclusion of strengthened transparency and accountability provisions in the 2011 General Appropriations (Act No. 10147), adopted by Congress, mandating that the implementation status and fund utilization of major programs and projects be posted by departments and agencies on their official websites and that DBM post on its website all releases and realignments under PDAF are a Prior Action for this DPL. This action was completed with the signing of the 2011 Budget by President Aquino in December 2011.

88. By end-March 2011, DBM plans to issue a circular requiring all central government agencies to report obligated expenditures of the 2011 budget no later than 10 days after the end of each quarter. In 2012, DBM plans to publish within 2 months after the end of each quarter the obligated expenditure data for the 2011 budget received from line agencies, as well as gaps from agencies that did not submit their obligated expenditures. (The publication by DBM of obligated expenditure data for the 2011 budget, including the gaps from line agencies that do not submit their obligated expenditure data, within two months of the end of each quarter is a Trigger for DPL2.) Starting in 2013, DBM aims to submit to the President by end-March the full-year 2012 budget execution report in a format broadly consistent with the IMF’s 1986 Government Financial Statistics classification for the National Government. Henceforth, it plans to submit such budget execution reports semi-annually. This would fill a critical gap in budget execution reporting in the Philippines and bring it closer to international good practice standards.

89. Improving local government transparency and accountability. The Government is implementing a number of reforms to improve the quantity, quality and timeliness of data produced by local governments expenditures and, eventually, key outputs and outcomes. In 2011, it hopes to align the classification for reporting LGU expenditures with that of the central government. In addition, the residual category “other expenditures,” which had grown significantly over the past few years, is to be eliminated and all expenditures are to be classified in their appropriate categories. The Department of Finance is also launching a program to provide grants to LGUs that perform well in complying with existing reporting requirements.

90. Strengthening the program evaluation function and the overall performance-orientation of the budget. The new Administration emphasizes transparency, integrity, and efficiency in the use of public funds and effectiveness in service delivery. To do so, it aims to strengthen strategic resource allocation to benefit the poor and vulnerable by re-allocating resources to sectors that directly contribute to the welfare of the poor, such as basic education, health and social protection. Moreover, by tightening links between budget allocations and PDP results matrices, the performance orientation of the budget should be significantly enhanced.

91. The Government aims to strengthen its program evaluation function and carry out periodic evaluations of major programs to enhance the effectiveness and efficiency of public expenditures by avoiding automatic program carryover and budget “incrementalism.” In this spirit, a zero-based budgeting approach was adopted to review major programs in the 2011 budget preparation process. As part of this exercise, 11 programs worth PHP82.9 billion (17 percent of 2010 discretionary budget) were evaluated. The programs selected for evaluation were identified by the Commission on Audit and other analysts as suffering from political interference, poor targeting and other significant program design weaknesses, and/or overall

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weak implementation and development impact. As a result of this exercise, a number of programs were terminated, while others were re-designed, and some agencies and GOCCs that had already accomplished the mandates for which they had been created were de-activated.

92. The Government intends to continue the process of program evaluation and to strengthen the overall program evaluation function at the Department of Budget and Management. In the preparation of the 2012 budget, 12 additional programs are being evaluated. By March 2013, DBM aims to have set up a program evaluation system and developed in-house capacity to carry out ZBB program evaluations on an annual basis. The findings of the ZBB program evaluations are to be used to strengthen the evidence base for government budgets and an overall better use of government resources through improved program design.

D. DEVELOPING THE HUMAN CAPITAL OF THE POOR

93. Reallocating Budgets to Prioritized Social Sectors. President Aquino presented the 2011 Budget to the Congress of the Philippines as a tool for social reform, giving special attention to the poor and vulnerable and making the social services sectors its top spending priority.59 In the 2011 budget, the social services sectors are allocated 34.1 percent of the total budget, up from the 32 percent share in 2010. The social sectors that have benefitted most from these budgetary increases are the Departments of Social Welfare and Development (123 percent increase), Education (18.5 percent) and Health (14 percent); in comparison, the overall budget increased by 6.7 percent in nominal terms. While the total amounts to be spent on health and education in the Philippines in 2011 still remain significantly below international benchmark levels,60 the shift in expenditures represents an encouraging development.

94. Expanding Coverage and Quality of Basic Education Services. The quality of basic education services remains one of the pressing development challenges in the Philippines. Low school quality disproportionately affects the poor and holds back the competitive development of the Philippines economy. The problem of quality is inextricably linked up with the problem of access. In the past decade, as the school age-population has increased by over 2 percent per year, the school enrollment has increased by only 1 percent per year – the school system has not been able to keep pace with the growing population – as schools and classrooms become more over-crowded, the quality of teaching suffers and some children prefer to drop out – Philippines suffers from some of the highest dropout rates among the countries in the region. The National Achievement Tests (NAT) shows a passing rate of 69 percent at elementary and 46 percent at secondary levels (2009-10) – a poor performance corroborated by the low ranking of Philippines in international comparisons (e.g., TIMSS 2003).

59 The President’s Budget Message: http://www.dbm.gov.ph/index.php?pid=9&xid=31&id=1308 60 Based on a projected GDP in 2011 of PhP 9,328 billion, the 2011 budget represents approximately 2.1 percent of GDP in education and under 1 percent of GDP in health (National Government and LGUs). In comparison, public spending in other middle income countries in the East Asia region averaged 4 percent of GDP on education in 2002-07, and 2 percent of GDP on health in 2006.

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95. The Department of Education is implementing a number of policy and resource allocation measures to address the interlinked problems of coverage and poor access outlined above. Within the framework of the Basic Education Reform Agenda (BESRA), these measures cover the following areas: increased resource allocation, efficiency improvements, public-private partnership arrangements, and curricular reform.

96. Increased resource allocation. The budget allocation (GAA) for DepEd in 2001 increased by 18.5 percent from the 2010 GAA, and the Government is committed to maintain actual spending by DepEd in 2011 to be the same or greater than the actual spending in 2010. (Ensuring that actual inflation-adjusted spending by DepEd in 2011 is the same or greater than actual spending in 2010 is a Trigger for DPL2.) Furthermore, DepEd is committed to maintain actual spending levels in future years to be at least as high in real terms as the 2011 target. As indicated earlier, the Philippines vastly under-spends in public education compared to other countries, which partly explains its comparatively poor growth and poverty-reduction performance. The Government’s commitment to not allow public spending on education to fall back to previous levels, therefore, represents an important step toward reducing the spending and performance gap vis-à-vis comparator countries. This increased budgetary allocation will enable DepEd to construct around 10,000 new classrooms and hire an additional 10,000 teachers over the period 2011-2015, which will help to relieve the overcrowding situation in schools and contribute toward an improvement of school quality.

97. Efficiency improvement. To improve the execution record on school construction and teacher deployment as well as other education programs, DepEd has updated its Medium Term Expenditure Framework (MTEF) to reflect the resource requirements for its policies, programs and strategies, including the K to 12 program. The Government expects DBCC to approve the basic education MTEF, subject to changes and refinements, by end of 2011, so that it can be integrated into the National Expenditure Program (NEP) by 2013. DepEd is also in the process of revising its rationalization plan and planning to substantially modernize and integrate its information systems.

98. The updating of DepEd’s medium term expenditure framework (MTEF) to reflect the resources required to implement its policies, programs and strategies, including the K to 12 program, is a Prior Action for this DPL. This action was completed in mid-March 2011.

99. Public-Private Partnerships. Even the most favorable scenarios regarding an improved functioning of administrative systems still leave a significant shortfall of school classrooms and teachers below what is needed to achieve DepEd’s education targets. As a result, the Administration is also seeking to deepen the implementation of a successful and innovative program to combine public financing with private provision – the Government Assistance to Students and Teachers in Private Education (GASTPE) program, and particularly the modality of Education Service Contracting (ESC). Accordingly, the GASTPE allocation that funds the ESC program of DepEd increased by 48 percent in 2011 compared to 2010. Looking toward the next school cycle, the Government is planning to increase the per-student subsidy provided to participants in the ESC program to enable greater student participation in the program from low income households. This increase will be based on a program review by DBM and DepEd. Also, a targeting study of the ESC is planned to be carried out later to evaluate the impact of per-student subsidies on student participation from lower income households.

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100. The increase of the GASTPE budget allocation that funds the Education Service Contracting (ESC) Program of DepEd, by 48 percent in 2011 compared to 2010, is a Prior Action for this DPL. This action was completed in December 2010, with the approval of the 2011 Budget. (The increase in the per-student subsidy provided to ESC participants in the ESC program to enable greater participation by students from low income households, based on a program review conducted by DBM and DepEd, is a Trigger for DPL2.)

101. Curricular reform. A vital part of the reform agenda to improve schooling quality is to enhance the basic education cycle to include one year of kindergarten and to extend the system from 10 to 12 grades – the so called K to 12 program. This should enable students to devote more time to individual study items, and will align the Philippine curriculum with international standards. To achieve this objective, the Government has launched the K to 12 program by establishing a steering committee and technical working groups, and has prepared a K to 12 Workplan to implement the program. Furthermore, the President is expected to include the K to 12 program among the priority bills to be presented to Congress in the context of the 2012 budget cycle, while the new curriculum for the K to 12 schooling cycle is being completed.

102. The five measures mentioned above are part of the program to be supported by the proposed DPL – each of them have clear performance markers and have a very strong results orientation. These measures represent an important subset of an ongoing series of reform measures being implemented in the Philippines under the Basic Education Sector Reform Agenda (BESRA).61 Two key outcomes expected over the medium-term from these reforms are the reductions in the student-to-teacher ratio and in the student-to-classroom ratio at the top 25 percentile point of their respective distributions. This outcome is considered particularly relevant for lower income households, whose children tend to be over-represented in the schools with the highest student-teacher and student-classroom ratios. Another key expected outcome is the increase in net enrolment ratios at the elementary and secondary levels.

103. Expanding Coverage and Quality of Health Services. The Government has announced its desire to expand universal health care for the Filipino population. While the country had made much progress in improving health outcomes, there are large disparities across income quintiles and provinces. Also, other countries of similar income levels have been able to sustain greater improvements in these outcomes over time. Moreover, all citizens are vulnerable to large out-of-pocket payments that affect their decision of when and where to seek care. The poor face the greatest vulnerabilities.

61 The BESRA has multiple forms of program and financial support from the Government’s own sources as well as from development partners including AusAID and the World Bank, all organized around the following five “key reform thrusts” (i) continuous school improvement facilitated by active involvement of local stakeholders through school-based management; (ii) improved teacher standards and teacher deployment; (iii) learning outcomes enhanced by national curriculum strategies, multi-sector coordination, and quality assurance; (iv) improved impact on outcomes resulting from complementary early childhood education, alternative learning systems and increased private sector participation in education; and (v) a change in DepEd’s organizational culture, rationalization of the DepEd structure, strengthening of financial and information systems, technological capabilities and accountability environment to respond to the requirements of these reforms.

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104. The objective of the Government’s health policy actions is to achieve universal health care through increased effective coverage (enrollment, utilization and financial protection) for poor Filipino families under the National Health Insurance Program. These actions are expected to help correct the following problems in the health sector: (i) disparities in health outcomes between poor and non-poor households, (ii) the high levels of out-of-pocket payments at point of service, which increases the vulnerability of poor households to impoverishment, and (iii) disparities in the utilization of health services. The latest available data for the Philippines shows that households in the lowest income quintiles have three to four times worse health indicators (e.g., maternal and child mortality) than the richest quintiles. Almost 55 percent of health spending is out-of-pocket and poor households pay a larger percentage of non-food expenditure on health. Finally, utilization of key health services such as facility-based deliveries and deliveries by skilled birth attendants is almost three times higher among the richest quintiles as compared with the poorest. In this context of disparities and limited financial protection, the Government of the Philippines has identified achieving universal health care as a priority policy direction over the medium-term. The key steps in implementing this policy priority are described next.

105. Expanding the enrollment of poor households and the near-poor households into the National Health Insurance Program (NHIP). In 2010, there was a significant shift in the National Government’s (NG) policy towards co-financing health insurance for poor Filipino families. 62 Previously, NG counterpart financing was provided for LGU-identified indigent households. From 2011 onwards, only those families identified through the National Household Targeting System – Proxy Means Test (NHTS-PMT) will be co-financed by the NG. There are an estimated 3.3 million families identified through the NHTS who are currently not enrolled in the NHIP. The first challenge for the GOP is enrolling this group. The second challenge is sustaining the enrollment of currently enrolled members in the Sponsored Program who are not on the NHTS list (4.9 million members). In sum, an estimated 8.2 million households/members will have to be enrolled in the NHIP. To address these concerns, the Government is adopting a three-pronged strategy: (i) amending the National Health Insurance Law to allow the National Government to pay in full for households identified through the NHTS, (ii) until the Insurance Law is amended, identifying an appropriate cost-sharing mechanism between the National Government, local governments and PhilHealth to pay for NHTS-targeted members, and (iii) implementing a partial subsidy scheme for near-poor households.63 This will help guarantee rapid expansion of health insurance coverage among the poorest households, while sustaining and eventually expanding coverage among near-poor households. 106. The first steps toward implementing this strategy have been taken: PhilHealth has adopted a Board Resolution64 and is preparing corporate circulars for the implementation of

62 According the National Health Insurance Law (Republic Act # 7875), Section 29 (Payment for Indigent Contributions): Contributions for indigent members shall be partially subsidized by the local government unit (LGU) where the member resides. The Corporation (PhilHealth) shall provide counterpart financing equal to the LGU’s subsidy for indigents. In the case of fourth, fifth and sixth class LGUs, the National Government (NG) shall provide up to 90% of the subsidy not exceeding 5 years. The share of the LGUs shall be increased until such time as its share becomes equal to the National Government. 63 Scheme 1: NG-LGU-Member, Scheme 2: LG-Member 64 PhilHealth Board Resolution No. 1479, of March 3, 2011, includes: (i) a shared payments scheme between national government, LGUs and individuals, (ii) automatic availment, (iii) outpatient package and other benefits

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the partial subsidy program for the Near-Poor, defined as those persons whose consumption levels are above the national poverty line, but below the 40th percentile of the distribution of Philippine population. Also, PhilHealth adopted Board Resolution No. 1478 and Joint Implementation guidelines have been drafted by DBM, DOH and PhilHealth for enrolling poor households identified under the National Household Targeting System (NHTS) in 2011. The authorities plan to have enrolled all households receiving Conditional Cash Transfers (CCT) in the NHIP, and to have implemented the partial subsidy program in at least 20 provinces by early 2012. By 2013, all households identified as poor by the NHTS are planned to be enrolled in NHIP, with the partial subsidy program implemented in at least 60 provinces. 107. PhilHealth’s adoption of Board Resolution No. 1479 for the implementation of the partial insurance premium subsidy program for the Near-Poor is a Prior Action for this DPL. This action was completed in March 2011. (The enrollment of all households receiving CCT in NHIP and the implementation of the partial subsidy scheme in at least 20 provinces is a Trigger for DPL2.) 108. Increasing the utilization of health insurance benefits among the enrolled. A study by DOH and PhilHealth65 indicates that enrolling more poor households into the NHIP is necessary, but insufficient, for addressing health protection adequately. This is because even when enrolled, members are not always aware of their benefits, do not have access to accredited PhilHealth facilities, and are often deterred from using services due to the high costs involved (PhilHealth only pays a portion of the hospital bills and there are long delays in claiming the payments from PhilHealth). Therefore, in addition to enrolling more poor Filipinos, a key element of the Government’s strategy for universal health care is the implementation of programs to increase members’ awareness of benefits, an increase in accredited PhilHealth facilities, improved PhilHealth benefits for financial protection and a streamlined benefits management system. The programs involve (i) a strengthened outpatient benefits package for the Sponsored Program and Partial Subsidy Program that links members with identified primary care providers and enhances the accountability of LGUs through performance-based contracts, (ii) negotiated contracts (initially with public hospitals and eventually with all PhilHealth accredited hospitals) for zero-balanced billing (Sponsored Program and Partial Subsidy Program enrollees choosing these hospitals will not have to pay out-of-pocket for hospital stays), (iii) streamlined benefits and claims management, and (iv) rapid accreditation of facilities in areas where NHIP coverage is expanding and there is a deficit in PhilHealth accredited facilities 109. To implement this strategy, the DOH plans to have implemented the following actions by March 2012: (i) enrolment of sponsored program members with a primary care provider, (ii) implementation of performance-based capitation grants with all LGUs, and (iii) implementation of zero balanced billing contracts with at least 50 percent of PhilHealth accredited hospitals. Other actions contemplated by early 2012 include the accreditation of all BeMONCs on the DOH list and the updating of the MTEF. In the medium term,

available through the Sponsored Program. The Resolution is time-bound and states that it will remain under implementation until such time as the NHTS targeting system is further developed to target near poor households. 65 Department of Health. 2010. Benefit Delivery Review. Department of Health, Manila, the Philippines

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continued implementation of the Executive Order calls for (i) sharing the PhilHealth report on data analysis from capitation contracts with all LGUs and DOH, and (ii) implementation of zero-balanced billing contracts with all PhilHealth-accredited hospitals. 110. Improving the accountability and sustainability of NHIP: In the Philippines, as in many other middle-income countries which have a mixed financing system (partial social health insurance, partial general budget resources), there is often duplication in the types of benefits financed through both sources. This is not only an inefficient use of limited health sector resources, but also creates perverse incentives – if people know that they can get a service for free, they are less likely to enroll in a health insurance program. The duplication of benefits is also confusing for citizens and can reduce transparency and accountability on the part of LGUs and health facilities. Therefore, to ensure the sustainability of the NHIP and to optimize the use of public funds going directly to health facilities, it is important to clarify the benefits packages for the NHIP (what is covered and not covered) and harmonize with the public health benefits package. 111. Implementation of these policy actions is expected to lead to the following medium-term outcomes:

Increased utilization of health services among poor and near-poor households, from less than 1 outpatient visit per capita to at least 1.5 visits per capita, and

Improved financial protection for the poor, as measured by reduced out-of-pocket payments for health care among insured poor households.

E. IMPLEMENTING EFFECTIVE SOCIAL SAFETY NETS

112. This sub-section provides a brief update of reforms to strengthen social safety nets in the Philippines. These reforms are being supported through various other Bank instruments, but not this DPL. Nevertheless, they are mentioned here for information purposes in light of the importance of social protection in promoting inclusive growth.

113. Expanding the Coverage of the Conditional Cash Transfer Program. While the Philippines has had numerous social protection programs in place, their effectiveness had been compromised by targeting, financing, and management problems. Recognizing the need to improve the impact, efficiency, and efficacy of social protection programs, the previous government launched a conditional cash transfer (CCT) program in January 2008, following the successful implementation of the program in other developing countries and the encouraging results from a pilot-test conducted in the Philippines in 2007. The CCT program, named the Pantawid Pamilyang Pilipino Program (4Ps), was developed under the guidance of the Department of Social Welfare and Development (DSWD), which had been assigned coordination responsibilities for the development of a national social protection framework. The CCT program began with an initial target of 20,000 household beneficiaries that was quickly expanded to 320,000 household beneficiaries in the 2009 GAA appropriation. In 2009, as the global financial crisis deepened, the Government decided to increase the number of beneficiaries to 1 million households, covering around 21 percent of the country’s poor population. By August 2009, about 700,000 households were receiving income support in the form of a conditional cash transfer.

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114. The CCT program has emerged as a promising backbone of a modern and more consolidated social protection system for the Philippines, integrating control and accountability measures. The Aquino Government is now planning to expand the coverage of the CCT to 2.3 million households in 2011. To achieve this target, the FY2011 budget increases DSWD’s resources by 123 percent compared to the 2010 GAA, while reducing resources for other, less effective social protection programs.  The abolition (or down-sizing) of ineffective social programs such as the Food-for-School Program, holds promise for rationalizing public expenditure priorities. There is also a strong push for the “Convergence Agenda” as a means towards better coordination of the splintered social protection and service delivery mechanisms for focused and targeted public provision of services and assistance. The planned massive expansion of the CCT program has the potential to make significant reduction in poverty as well as welfare improvements. However, it also poses large risks to ensuring project quality.

115. Improving Public Expenditure Targeting. To improve the targeting of poor households, DSWD adopted the National Household Targeting System for Poverty Reduction (NHTS-PR) in September 2008. This is a Proxy Means Test (PMT)-based targeting mechanism that includes a standardized database of poor households.66 By November 2008, the Government had established a standardized database containing over 200,000 poor households covering 83 municipalities and included adequate funding for expanding the database to the 20 poorest provinces in the 2009 budget. Meanwhile, DSWD has been using the NHTS-PR to select the beneficiaries of its CCT program. Subsequently, the Government decided to roll out the NHTS-PR nation-wide; by December 2009, DSWD had surveyed 5.9 million households. By mid-2010, the implementation of the National Household Targeting System (NHTS) had enumerated 9 million households, of which 4.2 million households have been identified as poor through the Proxy Means Test. Executive Order No. 867, issued in March 2010, provides for the adoption of the NHTS-PR (Poverty Reduction) as the mechanism for selecting beneficiaries of social protection programs nationwide. Earlier (in December 2009), DSWD and the Philippine Health Insurance Corporation (PhilHealth) had signed a memorandum of agreement to use the NHTS-PR for the selection of the beneficiaries of its Indigent Program, reflecting the Government’s commitment to improve targeting of its key social protection and transfer programs to the poor. At the same time, the National Statistical Coordination Board (NSCB) issued a resolution supporting the use of the NHTS-PR as a tool to identify beneficiaries of social protection programs.67 Since then, more agencies have become interested in using the system to target their services (e.g., the Departments of Health, Agriculture, and Labor and Employment). The increased interest in the use of NHTS data for poverty targeting by various agencies will require continued attention on ensuring their integrity and timely availability. Poverty reduction efforts are expected to benefit from the mainstreaming of the NHTS as the targeting mechanism for social programs.

66 The Department Order No. 1 Series of 2008 was issued by DSWD Secretary on 30 September 2008, which adopted the NHTS-PR for DSWD social protection programs and services. 67 NSCB resolution No. 18. Series of 2009.

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F. SUMMARY STAFF ASSESSMENT OF THE GOVERNMENT PROGRAM

116. The Government’s program to promote more inclusive growth and poverty reduction draws on many elements from the earlier PDP, but stands out with a new sense of urgency in moving forward with the implementation of reforms. Many of the reforms envisioned in the program are already off to a good start and promise to yield important benefits if carried out as envisioned. Others will require further preparation. In several instances, the results expected from the reforms that are contemplated so far appear to be very optimistic, so that an additional reform effort will need to be considered, possibly requiring further technical assistance. Below are the summary findings by policy area.

117. Public Revenue Mobilization. The specific measures proposed to raise public revenues focus almost exclusively on tax administrative reforms that, by themselves, are unlikely to yield the projected increases in revenues. This has been recognized by the authorities, who have left open the option of eventual tax policy reforms in the event that the administrative measures prove insufficient for achieving the targeted revenue increases.68 The specific policies that may eventually be needed to raise the tax ratio toward the PDP target have yet to be identified. The Bank and the IMF are preparing to provide technical assistance in this area at the Government’s request.

118. Fiscal Risk Management. The Government is well advanced in the development of a financial monitoring framework for GOCCs and has already taken several measures, such as issuing an executive order directing the rationalization of the compensation and position classification systems of the GOCCs and GFIs. Legislative initiatives to strengthen DOF’s oversight of these enterprises are also well underway, although the timing of congressional approval of any new legislation remains uncertain. These measures, together with a continuation of the sound macroeconomic management exhibited so far, should keep the program on track to achieve the expected outcomes envisioned in this area. Additional reform efforts will be needed beyond what has been identified so far, however, to carry out a restructuring of the major GOCCs, particularly NFA, once the legislative and monitoring frameworks are in place, and to deal with the large PSALM debt.

119. Improving the Investment Climate. While the Government has made a good start in streamlining procedures to reduce the costs of doing business, additional measures will be needed to fully implement the Philippine Business Registry (PBR) and ensure that the medium-term target of reducing the number of days to start a new business by 10 days can be met. Full implementation of the PBR requires both upgrading the information technology to link up different processes and institutions, as well as institutional reforms to streamline registration requirements and procedures among and within different government agencies. It will also require the automation and revamping of the SEC’s registration systems to allow larger corporations to benefit from this reform. While there has been much progress in upgrading the information technology platform of the PBR system, different government agencies still need to commit to necessary legal and institutional reforms. The IFC has been providing technical assistance in this area through the WBG Investment Climate Advisory

68 As DOF Secretary Purisima noted in an interview with GlobalSource (7 January 2011), the Administration plans to review the need for tax reforms after its first 18 months in office (i.e., by end - 2011).

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Services, and is prepared to engage further in promoting the necessary institutional reforms, depending on the Government’s needs.

120. The progress made in reducing the costs of doing business at the local level through the streamlined BPLS system has been promising. However, there is a risk of reform reversal as some LGUs see their revenues decline with the elimination of informal payment practices. To mitigate that risk the central government authorities could consider instituting better monitoring mechanisms and publishing the results, as well as providing LGUs with incentives (possibly through the Performance Challenge Fund) to encourage them to sustain the reform. The World Bank Group is also prepared to join other development partners in providing technical assistance in this area.

121. Addressing Infrastructure Bottlenecks. The PPP program is an important component of the Government’s strategy to build up the stock of quality infrastructure and close the public infrastructure gap. The PPP program appears very ambitious, both in terms of meeting the DPL2 trigger (which calls for 10 priority projects to be brought to the bidding stage within the next year) and the overall volume of public infrastructure investment to be achieved. A review of the Government’s priority projects identified at the time of Appraisal indicates that there are six projects (all in the transport sector) with a medium to high likelihood of being ready for bids by the end of 2011, so that issuing the call for bids on 10 PPP projects by March 2012 remains a ‘stretch target.’ Just bidding out successfully two or three priority PPP projects with quality transactions in a transparent manner within that time horizon would already represent a major step forward, given the current status of implementation capacity in this area and the country’s experience with PPPs. However, the Bank applauds the Government’s strong commitment to this reform and stands ready to assist, along with other development partners, particularly ADB, which is leading assistance efforts on the overall framework and design of financing and technical assistance for the PPP Center, while the World Bank Group is focusing on getting individual projects bid-ready. 69

122. Even in the countries that have been most successful in developing PPP projects, such projects only account for up to about 15 percent of total public infrastructure investment. While the contemplated improvements in the institutional framework to facilitate PPP projects can help to improve the quality of certain public investments, it appears unlikely that the currently large public infrastructure bottlenecks can be significantly reduced without stepping up public investment spending as well. The capacity to do so, however, will mostly depend on the progress made in raising public revenues to generate the requisite fiscal space.

123. Improving PFM, Budget Transparency and Accountability. The progress made over the last year in developing a plan to improve PFM and in introducing greater budget transparency has been modest compared to some of the advances made outside the Southeast

69 A major challenge in many PPP programs is developing a robust pipeline of properly prepared PPP projects that can be competitively bid out. In the Philippines, the history of unsolicited BOT proposals and joint venture undertakings magnifies this challenge. The new administration’s aims to tender 10 priority PPP projects by 2011 will require intensive and coordinated efforts from implementing and oversight agencies at various stages from project preparation, transaction advisory, and internal government review to procurement and project implementation. The priority projects involve different types of PPP arrangements, ranging from operation and maintenance or management contracts for existing infrastructure facilities, to construction of new facilities or expansion activities. hence the complexity of project preparation and need for support will vary across projects.

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Asia region. However, they are potentially very important when evaluated within the context of the region and considering previous shortcomings exhibited by public financial management in the Philippines. The measures taken so far are only a beginning, however, and full implementation of the PFM Reform Roadmap will require a long term commitment by this Administration and most likely by the next one as well. The Government can draw on ample technical assistance opportunities in this area, both from the World Bank and other development partners.

124. Strengthening the Basic Education Sector. The prior actions carried out in this area exhibit a strong commitment on the part of Government to improve the coverage and quality of education in the Philippines. Accordingly, the risk that the Authorities will not be able to complete the program as envisioned is considered low to moderate. This assessment is based on the Government’s expressed commitment to increase public spending in the social sectors, including in basic education, the seriousness with which DepEd management has been seeking to improve implementation of the ESC program with the formulation of guidelines and policies utilizing the findings of an analytical study prepared by the Bank, the fully supportive attitude of other agencies within government (particularly DBM and NEDA) toward greater resource reallocations toward basic education, and the extensive support provided by many development partners, the private sector and civil society organizations. The Bank is also supporting this reform process with financial assistance through the National Program Support operation and technical assistance in the areas of expenditure planning, enhanced efficiency of budget execution, and program monitoring and evaluation.

125. Strengthening the Health Sector. The health policy reform actions and outcomes contemplated in the Government’s program are ambitious. They will require strong and sustained program implementation efforts and oversight by key national agencies (especially DOF), as well as the sector agencies. Key risks include inadequate public financing for the subsidized programs (Sponsored Program and partial insurance premium subsidy scheme), delays in identifying the appropriate technical approaches for implementation, and a failure by PhilHealth to follow through on identified actions in a timely manner. These risks can be mitigated through a continued strong engagement by the Secretary of Health on the PhilHealth Board and active involvement of the recently formed Technical Working Group on Universal Health Care over the course of the reform program. A recently approved Institutional Development Fund for PhilHealth will strengthen its Board and support its monitoring capacity around key indicators. A new Bank project in support of Universal Health Care, contemplated in the CAS, will also help to support implementation of milestones and triggers contained in the DPL policy matrix. Also, the Bank team will stay closely engaged on just-in-time policy support through its lending operations (this DPL series and health projects) and AAA services.

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IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM

A. LINK TO CAS

126. The proposed DPL is consistent with the Bank Group’s Philippines’ Country Assistance Strategy (CAS), which covers the period July 1, 2009 to June 30, 2012 and contemplates a lending program on the order of US$700 million to US$ 1 billion per year. A CAS Progress Report to be submitted in May 2011 validates the continued relevance of the CAS and extends its coverage period to June 2013, with possible higher lending for the next two years. The CAS is anchored in the Philippine Development Plan and carries the theme of Making Growth Work for the Poor. Its overall goal is to achieve inclusive growth through five Strategic Objectives: (i) Stable Macro Economy, (ii) Improved Investment Climate, (iii) Better Public Service Delivery, (iv) Reduced Vulnerabilities, and (v) Good Governance, which is also a cross-cutting theme. The CAS explicitly contemplates the use of development policy operations in support of disaster risk management and in the context of a strong reform program in government financial management. The specific sectors focused on in this DPL would be most directly relevant for maintaining macroeconomic stability, improving the investment climate, improving the delivery of public services and promoting good governance, especially through improvements in public financial management.

B. COLLABORATION WITH THE IMF AND OTHER DEVELOPMENT PARTNERS

127. The Bank and Fund’s country teams collaborate regularly in the review of macroeconomic developments and have been meeting for annual consultations under the Bank-Fund Joint Management Action Plan. Collaboration with the Fund has been particularly intensive in the area of tax policy and administration, as well as in the financial sector area, where both teams participated in the preparation of a Financial Sector Assessment Program Update in 2009.

128. Strategic partnerships, supported by large bilateral and multi-donor trust funds administered by the World Bank, form a significant part of the country program. Such partnerships facilitate and help enrich the policy dialogue at the country level with other development partners. For instance, large trust funds in the health and education sectors are supported by the European Union and AusAID respectively, and help ensure coordinated support to policy actions in these sectors. Learning from the previous experience on the earlier DPL, coordination with the Asian Development Bank (ADB) on the DPL has been ensured, given the ADB’s plans for sector-focused program loans, which are similar to DPLs but focused on specific sectors. For instance, the ADB has a planned US$300 million investment climate program for FY11/12, which would have links to the Improved Investment Climate area envisioned under the DPL, as well as a large TA program to support the Government’s PPP agenda, which would link to the DPLs’ reform area of Addressing Infrastructure Bottlenecks. Discussions with ADB have been held by the DPL team as well as sector teams to ensure that each organization’s support complements each other to reinforce the country’s overall program in the areas covered by the individual operations, and at the least, does not undermine the efforts of the other. Likewise, JICA is another agency where close collaboration is being maintained, given its possible interest in supporting broad reform areas which may link to those proposed under the DPL. Coordination with these organizations have been ensured through bilateral meetings with these institutions during

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DPL missions, as well as through wider consultation meetings with the full group of development partners.

129. At the broader level, the Philippines Development Forum (PDF) is the primary mechanism of the Government for facilitating substantive policy dialogue among various development partners and other stakeholders on the country’s development agenda. The PDF is chaired by the Philippine Government, represented by the Department of Finance, and the World Bank serves as the co-chair. The PDF has eight active working groups which facilitate the policy dialogue throughout the year related to the working groups’ specific themes. Partnerships with the Government, other development partners, and other stakeholders on the policy reform agenda are facilitated through the PDF process. The Government convened the main PDF event on February 26, 2011. The policy discussions at the working group level leading up to that event have been helpful for the sectors to validate the policy actions in the DPL matrix that the Government has put together.

C. RELATIONSHIP TO OTHER BANK OPERATIONS

130. The policy areas focused on in the proposed DPL are also being supported by several other Bank lending, trust fund and AAA operations. The most important ones are identified in Box 2. To ensure close collaboration in the preparation of the DPL, the task managers of these other operations are also participating members of the DPL task team. Three areas (Tax Administration Reforms, Basic Education Reform and Health Reform) are supported through Bank lending activity in the form of National Program Support, while support in the remaining DPL policy areas is mostly provided through trust funds and AAA activities.

Box 2: Relationship of DPL to other Bank Operations DPL Policy Area Other Relevant Bank Operations

Strengthening public revenue mobilization

LEN: National Program Support for Tax Administration Reforms AAA: Public Revenue and Expenditure Review (2011)

Strengthening fiscal risk management

AusAID TF: Strengthening Public Financial Management

Improving the investment climate by reducing the cost of doing business

IFC: Doing Business (annual reviews)

Addressing infrastructure bottlenecks

AAA: Public Private Partnership Support PHRD: Public Private Participation in Transport Infrastructure IFC/CIDA/AusAid TF: Private Enterprise Partnership – Philippines.

Improving public financial management, budget transparency and accountability

AAA: PFM Reform Support 2 IDF: Policy-Based Budgeting Medium Term Framework PH-PTF: Agency PFM Benchmarking Assessments

Strengthening the basic education sector

LEN: National Program Support for Basic Education AusAID TF: Support to PHL Basic Education Reforms

Strengthening the health sector LEN: National Program Support for Health IDF: Results-based M&ER toward Equity & Effectiveness of Health Reforms

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D. LESSONS LEARNED FROM PREVIOUS DPLS

131. The experience obtained from the earlier DPL series approved for the Philippines in December 2006, and which lapsed at the end of 2008, has offered several important lessons: Country ownership is essential for a successful operation. After having advanced

quickly with the implementation of reforms in 2004-06, the Government appeared to have felt less urgency in pushing the reform process forward, causing it to stall. To avoid a similar outcome, the preparation of this DPL operation has sought to build country-ownership, particularly within the public sector, by ensuring that all of the measures supported by the DPL originate from the Government’s program and by convening a workshop wherein government staff has taken the lead in presenting and explaining their program. Further steps planned include the convening of workshops with civil society to disseminate information on the expected benefits of the DPL-supported measures and thereby strengthen the constituency in favor of the reforms.

Good coordination and open communication among the development partners is critically important. The fragmentation of a common position among the Philippines’ development partner institutions in mid-2008 sent mixed messages about the best way forward in the implementation of development policies. The use of a common policy matrix is a useful instrument for policy coordination, but can become overly constraining if managed too rigidly. The DPL team has sought to keep key development partners informed throughout the preparation of this operation, but without seeking to forge a time-consuming consensus on a joint policy matrix.

Good analytical underpinnings are essential for designing a viable program. When

adequate underpinnings are lacking for certain measures at the time of appraisal, it is advisable to defer those measures until they have been better analyzed. The present operation has been designed with the benefit of a significant number of pertinent background studies and diagnostics that have been carried out since 2007 (para. 132).

Narrow the scope of the program. The previous DPL series reflected a generalized

tendency in the Bank to combine macroeconomic, sector-specific and social objectives into one DPL series. This series would have been more manageable – in both the preparation and implementation stages – with a narrower scope. The present operation has sought to limit its focus on a smaller number of sectors and sub-sectors, involving fewer triggers.

Periodic interim reviews to re-assess the adequacy of targets can help maintain

continuity in the policy dialogue and periodicity in resource flows. Some program targets turn out to have been overly ambitious, leading to long delays in achieving compliance and threatening to disrupt the policy dialogue. To avoid such delays (and associated interruption of the predictability of resource flows), it is advisable to review the targets periodically with all development partners and to revise them if necessary, especially if related circumstances have changed. In developing the present operation, an effort was made to focus less on quantitative triggers and more on well-defined outcomes, to permit greater flexibility in the adoption of appropriate measures to achieve the desired

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outcomes under potentially evolving circumstances. Also, an effort will be made by the task team to maintain closer continuity in the policy dialogue with the authorities to flag potential problems at an early stage and agree on remedial actions.

E. ANALYTICAL UNDERPINNINGS

132. Several previous and ongoing studies underscore the importance of the reform measures being supported by this DPL to the development of the Philippines. Recently completed World Bank studies of direct relevance to the topics addressed in this DPL include: “Philippines Discussion Notes: Challenges and Options for 2010 and Beyond” (Report No.

55655-PH, July 2010), “Philippines: Fostering More Inclusive Growth” (Report No. 49482-PH, May 17, 2010), “Philippines: Public Expenditure and Financial Accountability” (Report No. 54584-PH,

May 2010), “Philippines: Public Expenditure Review – Strengthening Public Finance for More

Inclusive Growth” (June 2010), “Philippines: Basic Education Public Expenditure Review” (July 20, 2010), “Philippines: Transport for Growth – An Institutional Assessment of Transport

Infrastructure” (Report No. 47281-PH, February 24, 2009), and “Philippines: Agriculture Public Expenditure Review” (Report No. 40493-PH, June 2007). Ongoing work includes a follow-up Public Revenue and Expenditure Report (to be

completed in 2011), sector expenditure reports for Education, Health and Social protection and a poverty and social impact assessment to evaluate the effects of reforms in GOCCs associated with food security.

133. Two Philippines Discussion Notes (on Growth and on Poverty), together with the report on ‘Fostering More Inclusive Growth’, drew attention to the lack of inclusiveness in the growth experienced by the Philippines since the late 1990s, pointing to the need to render growth more sustainable by removing key growth constraints in the areas of public infrastructure, governance and fiscal stability, and to render growth more inclusive by ensuring greater access to infrastructure and social services by the poor, and by strengthening social safety nets. These insights served to develop the strategic focus of the DPL. 134. The Discussion Note on Public Spending, complemented by the 2010 Public Expenditure Review, drew attention to the large gap separating public spending on infrastructure, education and health in the Philippines and in other countries in the region, which coincides with equally pronounced performance gaps in growth and social indicators. These studies helped to inform the DPL-supported reforms involving budgetary reallocations in priority areas and stressed the need to mobilize public revenues in order to achieve the inclusive growth objectives envisioned in the Government’s program. Specific reforms supported in the areas of revenue mobilization are discussed and analyzed in the Discussion Note on Tax Policy and Administration, background analyses and supervision reports carried out under the ongoing Bank’s National Program Support for Tax Administration Reform (technical assistance) project and the ongoing Public Revenue and Expenditure Report. The DPL-supported reforms in the areas of fiscal risk management were informed by a Discussion Note on Fiscal Risk Management and by several reports and background studies covering some of the major GOCCs, including the 2007 Agriculture Public Expenditure Review.

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135. The Discussion Note on Competitiveness drew attention to the high ‘behind-the-border constraints’ in the Philippines, compared to the fairly liberalized trade environment, and thus helped to focus the DPL on reducing the domestic costs of doing business. Also, sector-specific work by the IFC in connection with the preparation of Doing Business indicators was important in informing the policy dialogue in this area. Various AAA activities carried out in different infrastructure sectors, including the 2009 Public Expenditure Review on the Transport Sector, have helped to inform the actions supported in the PER to strengthen the institutional framework for PPPs. 136. The recently finalized Public Expenditure and Financial Accountability report was especially important in contributing to the policy dialogue on improving public financial management and transparency. Two Discussion Notes, on Governance and on Public Financial Management, also informed the preparation of the DPL in this area, drawing particular attention to issues in budget execution and the problems of transparency caused by the absence of a unified Chart of Accounts. The analytical underpinnings of the policy reforms in the areas of health and education were primarily drawn from past and ongoing analyses carried out in connection with National Program Support operations in health and education, as well as previous and ongoing Public Expenditure Reviews on both sectors.

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V. THE PROPOSED OPERATION

A. OPERATION DESCRIPTION

137. The proposed DPL to foster more inclusive growth is the first in a programmatic series of three annual single-tranche operations. The proposed amount for this DPL is US$250 and the borrower is the Republic of the Philippines. (Subsequent DPLs in this series are expected to be for a similar amount.) During DPL appraisal, the task team discussed the possibilities and desirability of converting the loan to Philippine Pesos at the time of disbursement through an Automatic Conversion into Local Currency (ACLC) or anytime thereafter (ad-hoc currency conversion)70 through a swap market transaction. The development objective of this series of DPLs is to help the Philippines achieve sustained inclusive growth through (i) better fiscal management, an improved investment climate and better governance for faster growth, and (ii) investments in human capital to enable the poor to take better advantage of emerging growth opportunities.

B. POLICY AREAS

138. The choice of policy areas supported by this operation is motivated by the objective to bring about faster poverty reduction through more inclusive growth. Slow economic growth had been a long-standing problem in the Philippines, and when it did finally accelerate after 2001, the improved growth performance did not translate into greater progress in poverty reduction, suggesting that growth has not been sufficiently inclusive. Because dynamic growth is essential for poverty reduction, key constraints on growth need to be eliminated. In this regard, earlier diagnostic work has identified the need to (i) raise the tax ratio to anchor macroeconomic stability, (ii) remove infrastructure bottlenecks, (iii) improve governance, and (iv) create a better investment climate by reducing ‘behind the border constraints’ that inhibit business development. The Philippine experience over the last decade showed that generating faster economic growth is not enough, however. As greater opportunities for job creation are being generated, it is also important to ensure that growth is broad-based by enabling workers to move to the sectors and regions where the best opportunities emerge, as well as by assisting households to participate in markets through greater investment in their human capital. 139. The proposed operation supports selective and critical actions in four major areas of the Government’s reform program, described in the PDP, that are linked to the poverty reducing strategy described in the preceding paragraph. These areas refer to (i) the strengthening of public revenue mobilization and fiscal risk management, (ii) reductions in the costs of doing business and raising infrastructure investment efforts, (iii) improvements in public financial management, budget transparency and accountability, and (iv) reforms to improve the access to and quality of health and education services. These actions, which are summarized in Box 3, are assessed in analytical work by the Bank or other development partners, including ongoing analytical work such as the Public Revenue & Expenditure Review and Poverty and Social Impact Assessment of GOCC Reforms.

70 These options are currently embedded in the IFL with fixed spread only. For variable spread they will have to convert the loan to fixed spread first or sign a Master Derivative Agreement with the Bank.

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Box 3: Proposed Prior Actions for DPL1 and Proposed Triggers for DPL2 Policy Area Prior Actions for DPL1 Triggers for DPL2

Strengthening public revenue mobilization

The Government has commenced restructuring the Large Taxpayer Service (LTS) under the approved LTS rationalization plan, has approved its Revenue Regulation

No 17-2010 ( dated November 16, 2010), which broadens the selection criteria for large taxpayers, and has added about 747 taxpayers to the LTS as of Jan 1, 2011

The Government has submitted a revised Fiscal Incentives Rationalization Bill to Congress and identified it as a priority bill.

BIR has adopted a strategic plan for 2011-2016 and an agency-level set of key performance indicators (KPIs) that conform to good international standards in tax administration, and has collected baseline data for the year 2011.

Strengthening fiscal risk management

The DBCC has published a Fiscal Risks Statement as a reference for the 2011 Budget.

Senate Bill No. 2640, whose objectives are, among other things, to promote financial viability and fiscal discipline in GOCCs, in part through temporary delegation of reform powers from Congress to the Executive, has been filed in Congress.

DOF has implemented the web-based financial monitoring framework for GOCCs

Improving the investment climate by reducing the cost of doing business

The new web-based Enhanced BNR System adopted by DTI has reduced the average time required for a business name registration to 15 minutes.

The Philippine Business Registry (PBR) has been uploaded on-line and is functioning; PBR is linked with the business permit and licensing system (BPLS) of 3 LGUs.

Addressing infrastructure bottlenecks

.

The Government has issued calls for bids on at least 10 of its priority projects to be financed under PPP arrangements.

Improving public financial management, budget transparency and accountability

To strengthen transparency and accountability, the 2011 General Appropriations (Act No. 10147), adopted by Congress, has mandated that the implementation status and fund utilization of major programs and projects be posted by departments and agencies on their official websites and that DBM post on its website all releases and realignments under PDAF.

An action plan to implement the PFM Reform Roadmap has been approved by the IAC, including the adoption of a unified Chart of Accounts for accounting, budgetary and treasury transactions.

DBM has published the obligated expenditure data for the 2011 Budget received from line agencies, as well as gaps from agencies that did not submit their obligated expenditures, within two months after the end of each quarter.

Strengthening the basic education sector

The medium term expenditure framework of DepEd has been updated to reflect the resources required to implement its policies, programs and strategies, including the K to 12 program.

The GASTPE budget allocation that funds the Education Service Contracting (ESC) program of DepEd has been increased by 48 percent in 2011compared to 2010.

Actual spending (adjusted for inflation) by the Department of Education in 2011 is the same or greater than actual spending in 2010

The per-student subsidy provided to participants in the ESC program has been increased to enable greater participation in the program by students from low income households, based on a program review by DBM and DepEd.

Strengthening the health sector

PhilHealth has adopted Board Resolution No. 1479 for the implementation of the partial insurance premium subsidy program for the Near-Poor.

All households receiving CCT have been enrolled in NHIP and the partial subsidy scheme is being implemented in at least 20 provinces.

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140. The choice of actions supported by this DPL was also determined by staff assessments of the relative importance of the measures proposed for achieving the development objectives and of the Government’s capacity for timely implementation, as well as the availability of Bank expertise and engagement in particular areas. Several government program areas are not supported under this operation even though they satisfy these selection criteria. This includes the far reaching reforms being implemented to expand the conditional cash transfer (4Ps) program, which promise to yield significant poverty reduction benefits, but are not included here for reasons of program selectivity as they already are being adequately supported through other Bank instruments, namely the Supplementary Food Crisis Response DPO and the Social Welfare and Development Reform – National Household Targeting System project.  

141. The expected outcomes of the program of actions supported by this operation, and their link to the Strategic Objectives and Outcomes associated with the World Bank’s CAS Results are described in Box 4.

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Box 4: Expected Program Outcomes and Indicators DPL Policy Area Expected Outcomes by End-2013 Link to CAS Results

Strengthening public revenue mobilization

Total tax revenues increase from 12.8% of GDP in 2010 in line with the Government’s Philippine Development Program target (14.4% in 2013).

The amount of revenues generated by the LTS increases from 54% of total BIR collection in 2010 to at least 70% in 2013.

SO1, Outcome 1, Indicator 1: Tax/GDP increases to 13.9% of GDP by 2012

Strengthening fiscal risk management

Total NFPS debt as a % of GDP has declined below 60.7% (2009 baseline).

Fiscal risk is reduced, as reflected by improvement in the ratings of sovereign credit by any of S&P, Moody’s or Fitch.

SO1, Outcome 1, Indicator 2: NFPS debt/GDP declines to 57.7% by 2012.

SO1, Outcome 3: Improved management of key fiscal and financial sector risks

Improving the investment climate by reducing the cost of doing business

The average number of days required to start a business has been reduced by 10 days, based on the Doing Business methodology for business entry

SO2.1, Outcome 2, Indicator 5: Business process is simplified and business regulations are consistently applied.

Addressing infrastructure bottlenecks

Total fixed investment increases above 15.7% of GDP (2010 baseline).

SO2.1, Outcome 1: Increased and improved delivery of infrastructure

SO2.1, Outcome 2: Enhanced regulatory policy frameworks and institutional capacity for investment, service delivery and trade.

Improving public financial management, budget transparency and accountability

Enhanced transparency through the existence of a unified Chart of Accounts and the timely publication of budget execution data.

SO5.2, Outcome 2: Improved management and greater transparency in public finances. Indicator 3: PEFA scores for (i) budget predictability/ control & (ii) accounting/ reporting improve.

Strengthening the basic education sector

Reductions of the (i) Students-to-Teacher ratio and the (ii) Students-to-Classroom ratio at the top 25th percentile point of their respective distributions. (Baselines 2010/2011: 40.37 and 43.8 for public elementary schools, and 42.03 and 59.98 for public secondary schools.)

Net enrolment ratios increase. (Baselines 2009/10: 88.1% for elementary and 59.6% secondary. Targets 2013/14: 94% for elementary and 76% for secondary.

SO3.1, Outcome 1: Improved access to quality basic education services.

SO3.1, Outcome 1, Indicator 1&3 Net primary and secondary enrolment ratios increase to 90% and 70% by 2011.

Strengthening the health sector

Increased utilization of health services among poor and near-poor households from 1.0 outpatient visits per capita to at least 1.5 visits per capita

Improved financial protection for the poor, as measured by reduced out-of-pocket payments for health care among insured poor households.

SO3.1, Outcome 2: Improved access to health services.

SO3.1, Outcome 2, Indicator 3: Enrolment coverage of the NHIP for total population and indigent population increases to 85% and 100% by 2012.

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Box 5: Application of Good Practice Principles for Conditionality The design of this Development Policy Loan has drawn extensively on the lessons learned by the World Bank on application of conditionality. This Box describes the key good practice principles and how they have been applied to this DPL. Principle 1: Reinforce ownership. The DPL supports policy and institutional reforms in line with the Government’s priorities as expressed in the draft PDP. The reform program supported by this DPL was developed by the Government and many of its elements have already been under implementation for a number of years, and in part supported by the Bank through other investment lending and TA operations. To reinforce country and government ownership, a DPL workshop was organized in January 2011, providing an opportunity for government staff to present their program in a semi-public forum. Follow up workshops are envisaged with civil society and other stakeholders to address potential concerns and consolidate support for the program. Principle 2: Agree up front with government and partners on a coordinated accountability framework. The policy matrix for this DPL, which represents the framework agreed with the authorities and is based on the Government’s current PDP, provides the accountability framework for the operation. The DPL program has been discussed with Japan and is broadly consistent with IMF’s policy advice and the ADB’s programmatic series of Development Policy Support Program loans that concluded in 2010. Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances. The DOF has expressed interest in the proposed DPL program to help satisfy its financing needs, complementing the budget support and investment lending portfolio of other development partners and the Bank, as well as from the non-official domestic and international capital markets. The programmatic series approach, as well as the tentative timing of each operation, was requested by the authorities. The selected policy areas covered by the DPL program are derived from the draft PDP. Accordingly, the specific actions and intended outcomes also enjoy technical and political support in their respective sectors. The relevance and soundness of those actions have been assessed on the basis of previous and ongoing Bank analytical work and follow-up activities. Principle 4: Choose only actions critical for achieving results as conditions for disbursement. The actions supported by this operation are based on joint analytical work and technical discussions with the authorities, and focus on issues central for achieving the Government’s development objective of achieving inclusive growth. Principle 5: Conduct transparent reviews conducive to predictable and performance-based financial support. The programmatic series approach and the tentative timing of each individual operation respond to the Philippine government’s stated financial needs. The DOF will exercise leadership in coordinating the monitoring and evaluation arrangements, together with DBM and NEDA. Accordingly, the Bank‘s supervision effort will be documented through annual reviews in the context of preparing follow-up operations in the DPL, which will take into account progress made towards the selected outcomes and indicators in the policy matrix. Individual elements of the program (e.g., education and health sector reforms) will be reviewed more frequently in the context of parallel investment lending operations.

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VI. OPERATION IMPLEMENTATION

A. POVERTY AND SOCIAL IMPACTS

142. This operation is motivated by the objective to bring about faster poverty reduction through more inclusive growth. The strategy for achieving this outcome consists of three pillars – generating faster sustained growth, raising the human capital of the poor to take advantage of better growth opportunities and implementing effective social safety nets to protect those that are unable to participate in the growth process. The actions supported by this DPL are concentrated in the first two pillars and, therefore, are expected to deliver a poverty-reducing impact over the medium term. The actions contemplated under the first pillar of the PDP (strengthening public revenue mobilization and fiscal risk management, improved investment climate and improved public financial management) are designed to promote faster sustained growth, with indirect effects on poverty and social benefits. The measures aimed at increasing public revenues aim to provide more fiscal space that can be used to provide more and better growth-inducing public infrastructure and poverty-reducing social services in a sustainable manner. Similarly, measures aiming to improve the investment climate are designed to support a virtuous cycle of growth, employment generation and productivity gains that should benefit all workers and consumers, including the poor. Improvements in public financial management should improve the capacity of the Government to provide public services that benefit the poor, while greater budget transparency should permit a better targeting of social programs to the poor. 143. The policy actions related to strengthening the basic education and health sectors have the potential to deliver a significant poverty-reducing impact in the medium to long term. By providing greater access to and better quality of social services, the human capital of the poor will be increased, enabling them to take better advantage of the growth and income expanding opportunities being promoted through the actions contemplated under the first pillar of this operation.

B. ENVIRONMENTAL ASPECTS

144. The specific actions supported by this DPL are not expected to have significant effects on the environment, forests or other natural resources. It is worth noting, however, that the Government has in place reasonable environmental safeguard systems. The country has extensive laws on environmental management, one of which is the Philippine Environmental Impact Assessment (EIA) Act which requires the conduct of Environmental Assessment and securing an Environmental Compliance Certificate for new projects. The Bank has recently conducted a country safeguards systems review which indicates that country’s policies on Environmental Assessment (EA) and Indigenous Peoples (IP) are comprehensive and reasonable compared to internationally-accepted standards, including the Bank’s operational policies on safeguards.

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C. IMPLEMENTATION, MONITORING AND EVALUATION

145. The Department of Finance is the main liaison with the World Bank on budget support operations, including this one, but policy dialogue, monitoring and evaluation of the program supported by this DPL are shared with the Department of Budget and Management, the Departments of Health and of Education and the National Economic and Development Authority. The Government has designated an Under-Secretary from each of these agencies to serve on a DPL coordination committee as the Bank’s counterparts in the policy dialogue.

D. FIDUCIARY ASPECTS

146. In general, the public financial management and public procurement systems are adequate for this operation. The Bank prepared a PEFA assessment (para. 132) to document the current state of public financial management in the country and the actions being undertaken by the past and current Administrations to further increase public financial management and transparency. The PEFA assessment, completed in 2010, indicates that the Philippines’ PFM system is reasonably capable of maintaining overall fiscal balance, but that there is still scope for strengthening various dimensions of PFM, particularly in the areas of budget credibility and accounting/reporting, which limit its ability to support an efficient execution of priority programs. Progress has been made in implementing the PFM reform agenda, and the Philippines achieved an overall score of 55 out of 100 in the Open Budget Initiative 2010; up from a score of 48 in 2008 and significantly higher than the average score (33) for the countries surveyed from the Southeast Asia region. The current Administration has indicated its willingness to pursue further PFM reforms, some of which would be supported by this operation. In regard to financial sector risk, the 2010 Article IV Consultations mission of the IMF found that the financial sector withstood the recent global financial crisis well and that developments in recent quarters continue to support the January 2010 Financial System Stability Assessment that it remains sound.71

E. DISBURSEMENT AND AUDITING

147. The proceeds from the loan will be deposited into a deposit account in US dollars at the Central Bank (Bangko Sentral ng Pilipinas) that forms part of the Philippines’ official foreign exchange reserves. Prior to disbursement, the Government of the Philippines would provide to the Bank a copy of written instructions issued to the Bangko Sentral ng Pilipinas for conversion of the foreign exchange amount of the loan into local currency and that an equivalent amount be credited to an account of the Government available to finance budgeted expenditures. After disbursement of the loan, the Government would ensure that the equivalent Peso amount of this loan amount is promptly accounted for (in Philippine Pesos) in the Borrower’s budget system in the General Fund, and thereby be available to finance budget expenditures. The Borrower would provide to the Bank a written confirmation within 30 days of disbursement of the loan that this accounting has been completed, with supporting details. 148. Disbursement of the loan will not be linked to any specific purchases and no procurement requirements have to be satisfied. The proceeds of the operation would not be 71 The IMF team found that banks’ non-performing loan ratios have stayed low and capital adequacy ratios high, and welcomed the authorities’ careful monitoring of two sources of vulnerability, namely interest rate and concentration risk. Though asset bubbles have not been a concern so far, asset price movements warrant careful attention in an environment of rising external inflows.

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used to finance expenditures excluded under the Loan Agreement. If, after being deposited in a government account, the proceeds of the loan are used for ineligible purposes as defined in the Loan Agreement, the Bank will require the Borrower to refund the amount directly to the Bank. The Bank will retain the right to seek an independent audit of the Deposit Account by an auditor acceptable to the Bank, to seek reassurance on the accuracy of the information relating to transactions from this account that was provided by the Borrower, and that funds in this account were not used to finance expenditures excluded under the Loan Agreement.

F. RISKS AND RISK MITIGATION

149. Important sources of risk include a fragile political system (inability to forge a congressional majorities on important reform legislation), exposure to natural disasters (particularly the Philippines’ vulnerability to typhoons, which could disrupt economic activity and redirect public spending away from investment in development to emergency responses), and limited institutional capacity (which have hampered previous efforts to improve tax collections and public financial management).  

150. Fiscal Risks. One clear risk for this operation is that public revenues do not increase as planned, either because of political and institutional capacity constraints that prevent adequate tax reforms or because the new measures prove inadequate. This would undermine macroeconomic stability, and public perceptions thereof, and limit the fiscal space to levels that preclude any possibility of expanding public spending in priority areas. Without a significant increase in tax revenues, the Government will be forced to take austerity measures to maintain macroeconomic balance and will not be able to carry out the contemplated expansion in public infrastructure and in social services that are critical for bringing about more inclusive and sustained economic growth. Also, external investors (and credit rating agencies) would take a less optimistic look at Philippine development prospects and accordingly rein in their activities. Other fiscal risks are related to the still high level of public debt and the contingent liabilities arising from the GOCCs. These various fiscal risks are being addressed directly through the actions supported by this DPL that are intended to strengthen public revenue mobilization, fiscal risk management and public financial management.  

151. External Risks. The Philippines also exhibits external vulnerabilities associated with the possible closure of export markets in the event of a renewed downturn in the global economy, sudden stops in capital inflows in the context of a fluid global economy, declines in remittance inflows and sharply higher oil and food prices. The risks associated with the first two of these potential developments appear to be limited at this moment. The Philippine economy has proven quite resilient to the closure of export markets during the global downturn in 2008-09. A downturn of similar magnitude is not considered likely over the medium term, although this risk has risen significantly due to possible disruptions of manufacturing supply chains, particularly in the electronics industry, in the aftermath of the earthquake and tsunami that struck Japan on March 11, 2011. Capital inflows to the Philippines have been fairly modest compared to those experienced by other countries in the region, thereby limiting the danger of a sudden stop. Moreover, the authorities’ recent debt management efforts to lengthen maturities of the public debt and reduce its external share also have contributed to limiting the vulnerability to sudden stops.  

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152. The risks associated with the second set of potential external developments appear to be more significant. International food and oil prices have already increased significantly in recent months, and could rise further in response to continuing political turmoil in the Middle East and developments following the earthquake and tsunami in Japan. Reconstruction efforts in Japan are likely to increase the demand for certain commodities as well as for energy, particularly if the nuclear generation facilities damaged by the catastrophe remain disabled for an extended period. The risk posed for the Philippines by higher international food prices is tempered by the considerable level of protection afforded to rice,72 which represents the main food staple, and by currently ample rice reserves. To mitigate the impact of higher fuel prices, President Aquino created an Inter-Agency Contingency Committee in early March 2011 to address the recent oil price increases and ensure steady supplies of fuel.  

153. Disaster Risk. The Philippines’ exposure to natural disasters is rated among the highest in the world. The Government has been strengthening its capacity to deal with natural disasters, including disaster response strengthening measures introduced in the aftermath of Typhoons Ondoy and Pepeng, which devastated large parts of the Philippines in September/October 2009. Furthermore, the World Bank is preparing a Catastrophe Development Policy Loan with Deferred Draw-down Option at the Government’s request to address disaster risk management issues. 

154. Finally, there is also a reputational risk to contend with, given the unsuccessful outcome of the previous DPL series. This operation has sought to minimize the political risk of this operation by focusing on actions that do not require legislative actions, as well as by seeking to avoid the most politically sensitive areas (such as NFA or CCT reform) that are best supported through other means. More importantly, this operation has sought to address this risk by incorporating the lessons from previous DPLs, as described in paragraph 131 and Box 5. 

72 While it has kept domestic rice prices high by international standards, the high level of protection for the rice sector in the Philippines also has tended to insulate the domestic rice price from external prices.

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Annex 1: LETTER OF DEVELOPMENT POLICY

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61

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63

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65

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Annex 2: DPL Policy Matrix

Policy Areas Measures Taken by March 2011

(DPL1)

Measures Taken by March 2012

(DPL2)

Measures Taken by March 2013

(DPL3)

Expected Outcomes by End-2013

A. Maintaining a stable macroeconomic environment Strengthening public revenue mobilization

The Government has commenced restructuring the Large Taxpayer Service (LTS) under the approved LTS rationalization plani has approved its Revenue Regulation

No 17-2010 ( dated November 16, 2010), which broadens the selection criteria for large taxpayers, and has added about 747 taxpayers to the LTS as of Jan 1, 2011.ii

DBCC has approved, in principle, a plan to shift from the tax credit certificate system to a cash refund system to improve the VAT refund mechanism.iii The Government has submitted a revised Fiscal Incentives Rationalization Bill iv to Congress and has identified it as a priority bill.v

The staffing of LTS with auditors meeting the qualification standards has been completed according to the LTS rationalization plan. BIR has adopted a strategic plan for 2011-2016 and an agency-level set of key performance indicators (KPIs) that conform to good international standards of tax administration, and has collected baseline data for the year 2011. The VAT registry (as referred to in 236G of the National Internal Revenue Code of 1997) has been reviewed and validated.

BIR has completed a business process reengineering plan for the LTS. The Government undertakes further tax reforms, as needed and in line with the PDP, to improve the revenue take of the tax system while promoting equity and level playing field among all stakeholders. BIR publishes the 2011 baseline data for KPIs, and the KPI outcomes for 2012 onwards. BIR has put in place a risk-based audit system. The Government publishes a report on the size of tax expenditures from fiscal incentives as part of its budget submission to Congress.

Total tax revenues increase from 12.8% of GDP (2010 baseline) in line with the Government’s medium-term Philippine Development Plan (PDP) target (14.4% by 2013). The amount of revenues generated by the LTS increases from 54% of total BIR collection in 2010 to at least 70% in 2013.vi

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Policy Areas Measures Taken by

March 2011 (DPL1)

Measures Taken by March 2012

(DPL2)

Measures Taken by March 2013

(DPL3)

Expected Outcomes by End-2013

Strengthening fiscal risk management

The DBCC has published a Fiscal Risks Statement as a reference for the 2011 Budget.

DOF has designed a new web-based financial monitoring framework for GOCCs. Senate Bill No. 2640, whose objectives are, among other things, to promote financial viability and fiscal discipline in Government Owned and Controlled Corporations, in part through temporary delegation of reform powers from Congress to the Executive, has been filed in Congress.

An updated Fiscal Risks Statement has been published and made available jointly with the 2012 Budget. DOF has implemented the web-based financial monitoring framework for GOCCs

Fiscal Risks Statements are published regularly and made available with the government budget GOCCs financial operations are regularly updated on the publically available DOF web-based reporting system.

The Government has begun to reform at least 3 major GOCCs.

The Non-Financial Public Sector debt, as a % of GDP, has declined below 60.7% (2009 baseline). Fiscal risk is reduced, as reflected by improvement in the ratings of sovereign credit by any of S&P, Moody’s or Fitch.vii

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Policy Areas Measures Taken by March 2011

(DPL1)

Measures Taken by March 2012

(DPL2)

Measures Taken by March 2013

(DPL3)

Expected Outcomes by End-2013

B. Improving Competitiveness and Increasing Infrastructure Investment Improving the investment climate by reducing the cost of doing business

The new web-based Enhanced Business Name Registration System adopted by DTI has reduced the average time required for a business name registration to 15 minutes. 43 LGUs with good potential for generating investments are using streamlined procedures for new business permits and renewal applications under the BPLS Streamlining Program.

The Philippine Business Registry (PBR) has been uploaded on-line and is functioning; PBR is linked with the BPLS of 3 LGUs. viii An additional 50 priority LGUs are using streamlined procedures.

The DTI has linked the PBR with the business permit & licensing system (BPLS) of LGUs. Additional LGUs are using streamlined procedures.

The average number of days required to start a business has been reduced by 10 days, based on the Doing Business methodology for business entry.ix

Addressing infrastructure bottlenecks

PPP Center was restructured and attached to NEDA (EO No. 8), and a permanent Executive Director has been appointed. To promote the development of new PPP projects, the 2011 Budget (GAA) includes P12.5 billion for the PPP Strategic Support Fund, and EO 8 allocates P300 million for the Project Development and Monitoring Fund.

The Government has issued calls for bids on at least 10 of its priority projects to be financed under PPP arrangements.

Calls for bids issued for additional PPP priority projects

Total fixed investment increases above 15.7% of GDP (2010 baseline).

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Policy Areas Measures Taken by March 2011

(DPL1)

Measures Taken by March 2012

(DPL2)

Measures Taken by March 2013

(DPL3)

Expected Outcomes by End-2013

C. Improving Governance Improving public financial management, budget transparency and accountability

The MOA between COA, DBM, and DOF/BTr to create an Inter-Agency Committee (IAC) and cooperate in developing the Government Integrated Financial Mgmt. Information System (GIFMIS) has been reconfirmedx

and the PFM Reforms Roadmap has been approved by DBM, DOF, and COA.xi To strengthen transparency and accountability, the 2011 General Appropriations (Act No. 10147), adopted by Congress has mandated that the implementation status and fund utilization of major programs and projects be posted by departments and agencies on their official web-sites and that DBM post on its website all releases and realignments under Priority Development Assistance Fund (PDAF).xii DBM issues circular requiring all central Government agencies to report obligated expenditures of the 2011 Budget no later than 10 days after the end of each quarter.

An action plan to implement the PFM Reform Roadmap has been approved by the IAC, including the adoption of a unified Chart of Accounts for accounting, budgetary and treasury transactions. The DBM has issued instructions detailing the format and timing of website posts mandated by the 2011 Budget and posts on its website the allotment/SARO releases of SPFs covered by the Electronic Transparency and Accountability Initiative Lump-sum System – Phase 1 (e-TAILS-1) for PDAF (Congressional Allocation), DepEd School Building Program and IRA. DBM has published the obligated expenditure dataxiii for the 2011 Budget received from line agencies, as well as gaps from agencies that did not submit their obligated expenditure data, within two months of the end of each

The Government has adopted a unified Chart of Accounts for accounting, budgetary and treasury transactions. DBM submits to the president the full year 2012 budget execution report, and henceforth submits it semi-annually in a manner broadly consistent with the IMF’s 1986 Government Financial Statistics classification for the national government.

Enhanced transparency through the existence of a unified Chart of Accounts and the timely publication of budget execution data.

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Policy Areas Measures Taken by March 2011

(DPL1)

Measures Taken by March 2012

(DPL2)

Measures Taken by March 2013

(DPL3)

Expected Outcomes by End-2013

quarter. D. Developing the Human Capital of the Poor Strengthening the basic education sector

The Department of Education budget allocation (GAA) for 2011 increased by 18.5% from the 2010 GAA. The medium term expenditure framework of DepEd has been updated to reflect the resources required to implement its policies, programs and strategies, including the K to 12 program.xiv The GASTPE budget allocation that funds the Education Service Contracting (ESC) program of DepEd has been increased by 48% in 2011 compared to 2010.xv

Actual spending (adjusted for inflation by the Department of Education in 2011 is the same or greater than actual spending in 2010.xvi The Development Budget Coordination Committee approves the basic education MTEF, subject to refinements/changes. The per-student subsidy provided to participants in the ESC program has been increased to enable greater participation in the program by students from low income households, based on a program review conducted by DBM and DepEd.

Actual spending (adjusted for inflation) by the Department of Education in 2012 is the same or greater than actual spending in 2011. The MTEF is integrated into the National Expenditure Program (NEP) for 2013. A study of the ESC is carried out to evaluate the impact of per-student subsidies on student participation from lower income households.

Reductions of the (i) Students-to Teacher ratio and the (ii) Students-to-Classroom ratio at the top 25th percentile point of their respective distributions. Baselines (2010/11):40.37 and 43.80 respectively for public elementary schools, and 42.03 and 59.98 for public secondary schools. Net enrolment ratios increase. Baselines (2009/10): 88.1% (elementary) and 59.6% (secondary). Targets (2013/14): 94% (elementary) and 76% (secondary)

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Policy Areas Measures Taken by March 2011

(DPL1)

Measures Taken by March 2012

(DPL2)

Measures Taken by March 2013

(DPL3)

Expected Outcomes by End-2013

Strengthening the health sector

PhilHealth has adopted Board Resolution No. 1479xvii for the implementation of the partial insurance premium subsidy program for the Near-Poor.xviii PhilHealth adopted Board Resolution No. 1478 and joint implementation guidelines have been drafted by DBM, DOH and PhilHealth for enrolling poor households identified under the National Household Targeting System (NHTS) in 2011. xix

All households receiving CCT have been enrolled in NHIP and the partial subsidy scheme is being implemented in at least 20 provinces The following actions have been implemented: (i) Sponsored program members enrolled with a primary care provider, (ii) performance-based capitation grants implemented with all LGUs, (iii) zero balanced billing contracts implemented with at least 50 percent of PhilHealth accredited hospitals

All households identified as poor by NHTS are enrolled in NHIP and the partial subsidy program is being implemented in at least 60 provinces Continued implementation of circulars, specifically: (i) PhilHealth report on data analysis from capitation contracts shared with all LGUs and DOH, (ii) zero-balanced billing contracts implemented with all PhilHealth accredited hospitals

Increased utilization of health services among poor and near-poor households from less than 1 outpatient visit per capita to at least 1.5 per capita. Improved financial protection for the poor, as measured by reduced out-of-pocket payments for health care among insured poor households.xx

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Evidence Documenting Actions Taken:

i See approved LTS rationalization plan per EO 366.

ii See certification letter from the BIR, dated March 3, 2011.

iii See approved minutes of the DBCC meeting (forthcoming).

iv See House Bill No. 4152 filed by Reps. Belmonte and Gonzales in February 2011.

v The President identified this as a priority in the LEDAC meeting in early 2011.

vi In early 2011, this share is estimated at 62%.

vii The baseline ratings for sovereign bonds of the Republic of the Philippines, as of February 2011, are BB by Standard and Poor and by Fitch, and Ba3 by Moody’s.

viii The three LGUs refer to the cities of Caloocan, Quezon and Mandaluyong.

ix The Global Doing Business indicator, which currently reports that it takes 38 days to start a business, is based on firms in Manila that are registered with the Securities and Exchange Commission. Before

end-2011, a separate baseline will be created for sole proprietorships, using the same Doing Business methodology for business entry.

x See Document certifying the reconfirmation of the MOA between COA, DBM and BTr.

xi See copy of the PFM Reforms Roadmap

xii DBM will issue Circular specifically detailing the format, level of disaggregation and timing of the posting of reports as mandated under the transparency and accountability provisions. In regard to the

submission of financial reports and narrative accomplishments, Section 96 of GAA 2011 calls for a deadline of 30 days after each quarter.

xiii Obligated expenditures are defined as liabilities legally incurred and committed to be paid for by the government either immediately or in the future.

xiv The Enhanced K to 12 Basic Education Program of the Department of Education aims to universalize Kindergarten and add two more years to the basic education cycle by FY 2016-2017.

xv The Education Service Contracting (ESC) program under the Government Assistance to Students and Teachers in Private Education (GASTPE) wherein the government contracts with private schools

to enroll students in areas where there is a shortage of places in public high schools

xvi To adjust for inflation, education spending in nominal Pesos will be deflated by the Philippine Consumer Price Index for program monitoring purposes.

xvii This Resolution (No. 1479) includes: (i) a shared payment scheme between national government, LGUs and individuals, (ii) automatic availment, (iii) outpatient package and other benefits available

through the Sponsored Program.

xviii The Poor means those persons whose consumption is below the national poverty line established by the Borrower; and the Near-Poor means those persons whose consumption is above the national poverty

line but below the 40th percentile of the Philippine population.

xix This Resolution and guidelines clarify how financing for NHTS-PMT-targeted poor will be implemented in 2011 in a manner consistent with the National Health Insurance Law.

xx This indicator is tracked in the Family Income and Expenditure Surveys and the national health accounts.

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Annex 3: FUND RELATIONS NOTE IMF Executive Board Concludes 2010 Article IV Consultation with the Philippines Public Information Notice (PIN) No. 11/28 March 1, 2011

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2010 Article IV Consultation with the Philippines is also available.

On February 18, 2011 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with the Philippines.1

Background After slowing during the global financial crisis, economic growth recovered strongly during2010. The recovery has been helped by supportive macroeconomic policies as well as strongprivate demand. The smooth transition to a new Administration in July 2010 and thegovernment’s focus on improving governance have strengthened investor confidence. Theexternal surplus continued to grow in 2010, underpinned by both the current and financialaccount. Financial conditions remain accommodative, partly reflecting external inflows,although asset bubbles have not been a concern so far. Notwithstanding the strongrecovery, fiscal revenue fell short of budget targets in January–September. The near-term outlook is generally positive. Growth reached 7.3 percent in 2010 and is projected to moderate in 2011 to a still robust 5 percent. Inflation has been moderate andinflation expectations well anchored, although pressures may start to build during thecoming quarters as demand closes in on the economy’s supply potential. The balance ofpayments is projected to remain in surplus as remittances and export diversification supportthe current account balance and the Philippines continues to attract capital inflows, whichmay be largely structural in nature. Risks to the outlook are broadly balanced. The positive economic sentiment in the country may boost private investment more than expected. However, renewed shocks to globalgrowth and financial markets would affect Philippine exports and remittances. Monetary policy responded well to the crisis and has helped foster the recovery. A 200-basis-point cut in policy rates during December 2008–July 2009, and additional crisis-related liquidity support measures, helped to cushion the economy against the downturn.With the recovery underway, the Bangko Sentral ng Pilipinas (BSP) appropriately started to unwind its liquidity support measures since early 2010. In July, it extended through 2014the 3-5 percent inflation target for 2011. The authorities have relied on the traditional toolkit for managing external inflows in recent years. They have sought to strike a balance between the various elements in the toolkit.The authorities further liberalized controls on capital outflows in October, have had in place

75

for some years macro-prudential measures that have worked well, tried to repay external debt ahead of schedule, and have avoided capital controls. The exchange rate hasappreciated, although by somewhat less than in neighboring economies, and reserves haverisen to high levels. Fiscal consolidation is needed in order to create more fiscal space for the budget to be ableto respond effectively to future shocks. Consolidation would improve medium-term growth prospects by lowering sovereign risk and enhancing investment and it would reduce theshare of debt service in government expenditure. It would also help in managing themacroeconomic impact of external inflows. Against this background, the authorities intendto reduce the national government deficit to 2 percent of GDP from 2013. The mainelements of the authorities’ fiscal strategy are a greater tax effort, a reorientation ofexpenditure towards social sectors and infrastructure, and a debt management strategythat reduces the reliance on external debt and lengthens the maturity structure. The Philippine financial sector withstood the crisis well, and has been sound and stable inrecent quarters. The sector was relatively unaffected by the global market turbulence lastyear. Executive Board Assessment Executive Directors commended the authorities for skillful macroeconomic management, leading to a robust economic recovery and improved consumer and investor confidence. Theeconomic outlook is generally favorable, with sustained growth and a strong externalposition. A key policy challenge is to preserve macroeconomic stability while enhancing medium-term growth. Meeting this challenge will require a careful exit from stimuluspolicies in a complicated external environment, and further reforms to promote investment. Directors noted that monetary policy had succeeded in keeping inflation low while fosteringthe recovery, and welcomed the gradual unwinding of liquidity support. Given a potentialbuildup of price pressures in the near term, they encouraged the authorities to stand readyto tighten the monetary stance to head off inflation risks. Directors underscored the need for an appropriate mix of policy tools to manage capitalinflows, while facilitating productive use of these inflows. They supported the central bank’spolicy of allowing the exchange rate to adjust to market pressures and limiting interventionto smoothing operations. With the exchange rate broadly in line with fundamentals andreserves comfortable, greater exchange rate flexibility could be considered in response toadditional inflows. Directors took note of the authorities’ intention to further liberalizeforeign exchange regulations and avoid capital controls. Directors welcomed the planned gradual withdrawal of fiscal stimulus and the focus onmedium-term consolidation, which would create space for priority investment. Noting the relatively high public debt, they encouraged the authorities to consider accelerating thepace of debt reduction. Directors noted that achieving the deficit targets and increasingsocial and infrastructure spending will require substantial revenue efforts, includingbroadening the tax base and strengthening tax administration. They recommended earlyactions to reform excise taxes, rationalize fiscal incentives, and address gaps in the valueadded tax, complemented by reforms to strengthen the budgetary framework and control ofthe civil service wage bill. Directors noted that the financial sector withstood the crisis well, with high banks’ capitaladequacy ratios and improving profitability. Going forward, they emphasized the need to monitor key sources of vulnerability closely, particularly concentration and interest raterisks. While asset prices have not been a concern so far, they warrant attention in anenvironment of rising capital inflows. Directors looked forward to an early approval of the amendments to the central bank law, increasing legal powers and protection for thesupervisory authorities, and further progress in strengthening the AML/CFT (anti-money laundering and combating the financing of terrorism) framework.

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Directors stressed that promoting private investment and addressing impediments to jobcreation and productivity are crucial for raising potential growth. They agreed that thepublic-private partnership program can play an important part in this regard, and encouraged careful evaluation of projects that takes appropriate account of fiscal risks.Directors also welcomed the preparation of the Medium-Term Philippine Development Plan, and ongoing efforts to improve the business climate and infrastructure, and to deepen capital markets.

Philippines: Selected Economic Indicators, 2007–11 Proj.

2007 2008 2009 2010 2011 1/

Growth and prices (percent change)

Real GDP 7.1 3.7 1.1 7.0 5.0

CPI (annual average) 2.8 9.3 3.2 3.8 3.9

Public finances (percent of GDP)

National government balance (authorities' definition)

-0.2 -0.9 -3.9 -3.8 -3.2

National government balance (IMF definition) 2/ -1.7 -1.5 -4.0 -3.8 -3.3

Total revenue and grants 15.8 15.8 14.6 14.5 15.5

Total expenditure 17.4 17.3 18.6 18.4 18.9

Non-financial public sector balance 3/ 0.2 -0.3 -3.4 -2.6 …

Non-financial public sector debt 61.0 60.7 60.7 58.0 …

Monetary sector (percent change, end of period)

Broad money (M3) 10.6 15.6 8.3 7.7 4/ …

Interest rate (91-day treasury bill, end of period, in percent) 5/

4.2 5.8 4.3 1.8 6/ …

Credit to the private sector 8.5 16.8 8.1 10.1 4/ …

External sector

Current account (percent of GDP) 4.9 2.2 5.5 5.4 4.3

Reserves, adjusted (US$ billions) 7/ 33.8 35.9 44.2 62.9 78.4

Reserves/short-term liabilities, adjusted 8/ 240.5 284.4 389.1 498.6 595.4

Pesos per U.S. dollar 46.1 44.5 47.6 45.2 9/ ...

Sources: Philippine authorities; IMF staff projections. 1/ Public finance projections reflect the 2011 budget. 2/ Excludes privatization receipts and includes deficit from restructuring of the central bank (Central Bank Board of Liquidators). 3/ Includes the national government, Central Bank-Board of Liquidators, 14 monitored government-owned enterprises, social security institutions, and local governments. 4/ October 2010 (year-on-year). 5/Secondary market rate. 6/ November 2010. 7/Adjusted for gold and securities pledged as collateral against short-term liabilities. 8/Short-term liabilities include medium- and long-term debt due in the following year. 9/ Average for January to November 2010.

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1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

IMF EXTERNAL RELATIONS DEPARTMENT Public Affairs

Media Relations Phone: 202-623-7300 Phone

: 202-623-7100

Fax: 202-623-6278 Fax: 202-623-6772

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Annex 4: PHILIPPINES-AT-A-GLANCE

Philippines at a glance 2/21/11

East Lo wer-P OVER T Y and SOC IA L A sia & middle-

P hilippines P acif ic inco me2009Population, mid-year (millions) 92.0 1,944 3,811GNI per capita (Atlas method, US$) a/ 1,790 3,143 2,298GNI (Atlas method, US$ billions) 164.7 6,110 8,758

A verage annual gro wth, 2003-09

Population (%) 1.8 0.8 1.2Labor force (%) b/ 2.2 1.0 1.5

M o st recent est imate ( latest year available, 2003-09)

Poverty (% of population below national poverty line) c/ 27 .. ..Urban population (% of to tal population) 66 45 41Life expectancy at birth (years) 72 72 68Infant mortality (per 1,000 live births) 26 21 43Child malnutrition (% of children under 5) 26 12 25Access to an improved water source (% of population) 91 88 87Literacy (% of population age 15+) 94 93 80Gross primary enro llment (% of school-age population) 110 111 107 M ale 111 111 109 Female 109 112 105

KEY EC ON OM IC R A T IOS and LON G-T ER M T R EN D S

1989 1999 2008 2009

GDP (US$ billions) 42.6 76.2 166.6 161.2

Gross capital formation/GDP 21.6 18.8 15.3 14.6Exports o f goods and services/GDP 28.1 51.5 36.9 31.7Gross domestic savings/GDP 19.4 18.9 13.9 15.5Gross national savings/GDP 17.9 25.1 23.1 25.5

Current account balance/GDP -3.4 -3.8 2.2 5.5Interest payments/GDP 5.1 3.2 2.4 2.2Total debt/GDP 67.3 76.6 38.9 39.0Total debt service/exports 25.4 14.1 15.5 14.4Present value of debt/GDP .. .. .. 34.0Present value of debt/exports .. .. .. 79.8

1989-99 1999-09 2008 2009 2009-13(average annual growth)GDP 3.0 4.9 3.7 1.1 4.2GDP per capita 0.8 2.9 1.9 -0.7 2.7Exports o f goods and services 7.9 5.5 -1.9 -13.4 8.9

ST R UC T UR E o f the EC ON OM Y

1989 1999 2008 2009(% of GDP)Agriculture 22.7 17.1 14.9 14.8Industry 34.9 30.6 31.7 30.2 M anufacturing 24.9 21.6 22.3 20.4Services 42.4 52.2 53.4 55.0

Household final consumption expenditure 71.0 68.0 76.7 73.9General gov't final consumption expenditure 9.5 13.1 9.4 10.5Imports o f goods and services 30.3 51.3 38.4 30.8

1989-99 1999-09 2008 2009(average annual growth)Agriculture 1.5 3.7 3.1 0.0Industry 3.0 4.0 4.9 -0.9 M anufacturing 2.7 3.9 4.2 -4.4Services 3.8 6.0 3.2 2.8

Household final consumption expenditure 3.8 4.5 6.4 9.3General gov't final consumption expenditure 3.5 2.7 0.4 10.9Gross capital formation 3.7 1.8 2.3 -5.7Imports o f goods and services 8.8 3.3 0.8 -1.9

-10

-5

0

5

10

15

04 05 06 07 08 09

GCF GDP

Growth of capital and GDP (%)

-15-10-505

101520

04 05 06 07 08 09

Exports Imports

Growth of exports and imports (%)

Philippines

Lower-middle-income group

Development diamond*

Life expectancy

Access to improved water source

GNIpercapita

Grossprimary

enrollment

Philippines

Lower-middle-income group

Economic ratios*

Trade

Indebtedness

Capital formation

Domesticsavings

79

ANNEX 4: PHILIPPINES-AT-A-GLANCE continued

Philippines

P R IC ES and GOVER N M EN T F IN A N C E1989 1999 2008 2009

D o mest ic prices(% change)Consumer prices 12.2 5.9 9.3 3.2Implicit GDP deflator 9.0 8.0 7.4 2.6

Go vernment f inance d/(% of GDP, includes current grants)Current revenue 16.0 15.9 15.8 14.6Current budget balance 0.6 0.1 1.9 -0.3Overall surplus/deficit -2.1 -3.8 -0.9 -3.9

T R A D E1989 1999 2008 2009

(US$ millions)Total exports (fob) 7,821 34,243 48,253 37,610 Electronics/Telecom 1,751 25,965 29,927 23,590 Garments 1,575 2,267 1,952 1,536 M anufactures 5,192 31,741 40,999 33,525Total imports (cif) 10,419 40,220 61,138 46,473 Food 492 1,435 4,062 2,936 Fuel and energy 1,397 2,432 12,394 7,334 Capital goods 2,424 6,805 9,310 7,637

Export price index (2000=100) .. .. .. ..Import price index (2000=100) .. .. .. ..Terms of trade (2000=100) .. .. .. ..

B A LA N C E o f P A YM EN T S1989 1999 2008 2009

(US$ millions)Exports o f goods and services 11,046 37,711 57,970 47,858Imports o f goods and services 11,845 45,308 69,695 55,171Resource balance -799 -7,597 -11,725 -7,313

Net income -1,487 -1,062 105 28Net current transfers 830 5,784 15,247 16,073

Current account balance -1,456 -2,875 3,627 8,788

Financing items (net) 1,907 6,466 -3,538 -2,367Changes in net reserves -451 -3,591 -89 -6,421

M emo :Reserves including go ld (US$ millions) 2,324 15,147 37,551 44,243Conversion rate (DEC, local/US$) 21.7 39.1 44.5 47.6

EXT ER N A L D EB T and R ESOUR C E F LOWS1989 1999 2008 2009

(US$ millions)Total debt outstanding and disbursed 28,653 58,321 64,875 62,911 IBRD 3,492 4,040 2,533 2,488 IDA 102 206 187 181

Total debt service 3,244 6,439 12,199 9,881 IBRD 536 641 614 505 IDA 2 4 9 8

Composition o f net resource flows Official grants 380 176 271 .. Official creditors 874 -87 -868 625 Private creditors -275 4,372 -2,177 2,744 Foreign direct investment (net inflows) 563 1,247 1,544 1,948 Portfo lio equity (net inflows) 0 489 -1,289 -1,096

World Bank program Commitments .. 208 445 120 Disbursements 465 163 192 361 Principal repayments 269 387 478 401 Net flows 196 -224 -287 -40 Interest payments 269 258 144 113 Net transfers -73 -482 -431 -153

0

2

4

6

8

10

04 05 06 07 08 09

GDP deflator CPI

Inflation (%)

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

03 04 05 06 07 08 09

Exports Imports

Export and import levels (US$ mill.)

0

1

2

3

4

5

6

03 04 05 06 07 08 09

Current account balance to GDP (%)

A: 2,533B: 187D: 4,694

E: 14,196

F: 36,264

G: 7,001

A - IBRDB - IDA C - IMF

D - Other multilateralE - BilateralF - PrivateG - Short-term

Composition of 2008 debt (US$ mill.)

Iligan

PasigQuezon

GeneralSantos

Lucena

ViracBatangas

BoacMamburao

Romblon

Santa Cruz

Antipolo

BalerPalayan

TarlacIba

MalolosBalanga

Trece Martires

Laoag City

ViganBangued

Tabuk

Ilagan

Cabarroguis

BontocLagawe

BayombongLa Trinidad

Lingayen

Kabugao

Basco

Puerto Princesa

Pili

Sorsogon

Daet

MasbateCatarman

BoronganCatbalogan

Naval

Maasin

Bacolod

Dumaguete Siquijor

Tagbilaran

Mambajao

Surigao

San Jose

Tandag

Tubod

Prosperidad

TagumNabunturan

MatiKidapawan

DigosIsulan

Marawi

Malaybalay

OroquietaDipolog

Ipil

IsabelaCity

Jolo

KaliboRoxas City

San Jose deBuenavista

Jordan

Alabel

PanglimaSugala

Zamboanga Shariff Aguak(Maganoy)

San Fernando

Tuguegarao

BaguioSan Fernando

Legaspi

Tacloban

Cebu

Butuan

DavaoCotabato

Cagayande Oro

Iloilo

Pagadian

Koronadal

Calapan

Calamba

MANILA

1

2

4

6

7

11

14

17

18

19

20

2122

16

23

2425

27

31

39

42 46

47

49

54

75

59

62

65

66

71

73

74

76

81

80

77

78

63

3

5 9

10

8

12

13

15

28

29

30

26

32

33

34

35 36

37

38

40

41

43

44 45

48

50

51

52

53

55

56

58

61

64

68

69

70

60

67

72

57

ZAMBOANGA CITY

ICAR II

III

IV-A

V

IV-B VI VII

VIII

IX X

XIII

XI

XII

ARMM

NCR

MALAYSIA

Celebes Sea

Moro

Sulu Sea

Leyte Gulf

Visayan

Sea

Mindoro Strait

SibuyanSea

Phi l ippine

Sea

Babuyan Channel

Luzon Strai t

Gulf

DavaoGulf

MindanaoSea

BatanIslands

BabuyanIslands

PolilloIslands

LubangIslands

Catanduanes

TicaoSibuyanTablas

Busuanga

SemiraraIslands

CuyoIslands

Culion

Linapacah

Dumaran

Bugsuk

Balabac

Cagayan Sulu

Tawi-Tawi

Sulu

Basilan

Mindanao

CamiguinSiquijor

Negros

Panay

Bohol

Cebu Leyte

SamarMasbate

Marinduque

BuriasMindoro

Palawan

Luzon

Dinagat

Siargao

Sarangani

20ºN

10ºN

5ºN125ºE

120ºE

125ºE

IlocosIlocos NorteIlocos SurLa UnionPangasinan

Cordillera Admin. Reg.AbraApayaoBenguetIfugaoKalingaMountain Province

Cagayan ValleyBatanesCagayanIsabelaNueva VizcayaQuirino

Central LuzonAuroraBataanBulacanNueva EcijaPampangaTarlacZambales

National Capital Reg.

CALABARZONBatangasCaviteLagunaQuezonRizal

MIMAROPAMarinduqueMindoro OccidentalMindoro OrientalPalawan*Romblon

BicolAlbayCamarines NorteCamarines SurCatanduanesMasbateSorsogon

Western VisayasAklanAntiqueCapizGuimarasIloiloNegros Occidental

Central VisayasBoholCebuNegros OrientalSiquijor

Eastern VisayasBiliranEastern SamarLeyteNorthern SamarSamarSouthern Leyte

Zamboanga PeninsulaZamboanga del NorteZamboanga del SurZamboanga SibugayZamboanga City

I1234

CAR56789

10

II1112131415

III16171819202122

NCR

IV-A2324252627

IV-B2829303132

V333435363738

VI394041424344

VII45464748

VIII495051525354

IX555657---

Northern MindanaoBukidnonCamiguinLanao del NorteMisamis OccidentalMisamis Oriental

Davao Reg.Compostela ValleyDavao del NorteDavao del SurDavao Oriental

SOCCSKSARGENNorth CotabatoSaranganiSouth CotabatoSultan Kudarat

CaragaAgusan del NorteAgusan del SurDinagat IslandsSurigao del NorteSurigao del Sur

Autonomous Reg. inMuslim MindanaoBasilanLanao del SurMaguindanao**SuluTawi-Tawi

X5859606162

XI63646566

XII67686970

XIII7172737475

ARMM

7677787980

**Shariff Aguak (Maganoy) andSultan Kudarat serve as co-capitalsof the province.

*Executive Order 429, May 23, 2005,provides for the transfer of Palawanprovince (#31) from Region IV toRegion VI; Administrative Order 129holds EO429 in abeyance until animplementation plan is approvedby the President.

PHILIPPINES

0 50 100

0 50 100 Miles

150 Kilometers

IBRD 33466R4

MAY 2009

PHIL IPPINESSELECTED CITIES

PROVINCE CAPITALS

REGION CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

PROVINCE BOUNDARIES

REGION BOUNDARIES

INTERNATIONAL BOUNDARIES

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, o r any endo r s emen t o r a c c e p t a n c e o f s u c h boundaries.