Economic growth picked up somewhat to 3.9 percent in 2000, and inflation fell. However, the fiscal deficit came to more than twice the 2000 budget target because of poor revenue collection. The looming slowdown in the US economy and slower global demand for electronics exports are risk factors for growth in 2001.
Recent Trends and Prospects
Despite political and economic uncertainties, real GDP grew by 3.9 percent in 2000 after 3.3 percent in 1999, resulting in real per capita GDP growth of 1.8 percent, up from 1.1 percent in 1999. The services sector, in which growth strengthened slightly to 4.4 percent in 2000 from 4.1 percent in 1999, was responsible for more than half the economic improvement. Transport, communications, and storage, and wholesale and retail trade were the strong leaders in this sector. The communications subsector surged by 18.8 percent due to a sharp climb in the number of cellular phone subscribers. Agriculture, accounting for almost 20 percent of GDP, slowed to 3.4 percent growth in 2000 from 6.0 percent in the previous year when a bumper rice crop was harvested.
Relatively slow growth in the industry sector has been symptomatic of economic performance in recent years. Unlike some of its neighbors, the Philippines has lagged behind in shifting its output and employment structure away from agriculture to industry and to services. Industry’s share in GDP contracted from more than 40 percent two decades ago to nearly 35 percent in 2000. Nevertheless, industry showed a moderate upswing in 2000 as growth in value added quickened from 0.9 percent in 1999 to 3.6 percent. Manufacturing, which dominates the sector at over 70 percent of industrial value added, was at the forefront of the expansion, spurred by a strong performance in electronics arising from buoyant US demand for semiconductors and other high-technology products. Construction, however, continued to perform poorly, recording a larger contraction in 2000 than in 1999. Overcapacity, and an overhang of nonperforming loans that inhibited growth in bank financing for new construction projects, were the main factors.
Net exports continued to support the recovery, as export growth exceeded import growth. The value of semiconductor exports, the top export earner, grew strongly by 20.7 percent after a small increase of 1.9 percent in 1999. Other major exports showing strong gains in export earnings included electrical machinery (7.4 percent), garments (10.2 percent), and crude coconut oil (126.6 percent). Benefiting from enhanced purchasing power from such sources as increased net factor income from abroad, private consumption grew by 3.5 percent. Investment growth was sluggish, at 0.8 percent, but a turnaround from the previous year’s 1.7 percent contraction. Although fixed capital formation fell by 1.6 percent, pulled down by a 5.4 percent drop in construction, this was offset by a smaller adjustment for changes in inventories, which declined more slowly in 2000 than in 1999. Efforts to improve the investment climate were made harder by the Government’s need to raise interest rates in response to exchange rate volatility.
Despite the improvement in economic growth, the labor force participation rate fell between October 1999 and October 2000, from 65.7 percent to 64.3 percent as the number of people aged 15 years and above not in the labor force increased by over 1 million. The unemployment rate rose from 9.6 percent to 10.1 percent over the same period. Thus, the number of unemployed people reached about 3.1 million in October 2000.
Inflation continued to subside, averaging 4.4 percent for 2000, the lowest level in a decade. This was better than the 5–6 percent target set by the monetary authorities, and was achieved in spite of international oil price increases and the weakening of the peso. The lower inflation rate reflected slower money supply growth as well as weaker food prices stemming from slightly higher agricultural production and large stockpiles of grain from the previous season.
Lower than expected inflation allowed the monetary authorities to reduce interest rates in early 2000. But monetary policy was tightened in May and again in September in response to the peso’s depreciation (about 5 percent on average against the dollar in 2000), rising US interest rates, and emerging inflationary pressures. The benchmark 91-day treasury bill rate trended upward in the latter part of the year and then reversed itself in December 2000, reflecting the drop in policy interest rates for the month as the exchange rate stabilized. Overall, interest rates were lower in 2000 than in 1999 in nominal terms but were higher in real (inflation-adjusted) terms. For example, the average lending rate for all maturities fell from 11.8 percent in 1999 to 10.9 percent in 2000, while rising in real terms from 5.1 percent to 6.5 percent. Tightening monetary policy was reflected in the reduced rate of money supply (M2) growth, which fell from 19.3 percent in 1999 to 5.2 percent in 2000.
Fiscal performance, particularly revenue mobilization, continues to fall significantly short of expectations. The national fiscal deficit increased from P112 billion or 3.7 percent of GDP in 1999 to P136 billion or 4.1 percent in 2000, substantially higher than the government target of P63 billion or 1.9 percent of GDP. Revenues, at P506 billion, reached only 89 percent of the 2000 budget target because of shortfalls in tax collection and privatization revenues. Despite the shortfalls, expenditures, at P642 billion, slightly exceeded the 2000 budget target as deteriorating economic conditions made the Government reluctant to cut spending. As a consequence, national government debt worsened from 59.3 percent of GDP in 1999 to 61.3 percent as of September 2000.
With merchandise exports growing faster than merchandise imports (in dollar terms), the merchandise trade surplus rose by more than half from $4.3 billion in 1999 to an estimated $6.7 billion in 2000, while the current account surplus increased by only about 19 percent over the same period from $7.2 billion to an estimated $8.6 billion because of smaller levels of net income and current transfers. The capital account deficit was substantially larger in 2000, despite an increase in foreign direct investment, due to much larger outflows of portfolio and other short-term investments. This led to an overall balance-of-payments deficit, and a slight decline in net international reserves from $11.8 billion in December 1999 to $11.3 billion in December 2000, a level equivalent to about four months of imports of goods and services.
In spite of serious political problems in 2000, such as ethnic conflict in the south, and charges of large-scale corruption against the President and his subsequent impeachment trial, the economy nearly achieved the Government’s 4 percent growth target in 2000. The improved performance of both economic growth and job creation in services, and the sustained expansion in agriculture, where most of the poor are employed, bode well for poverty reduction, although the continued decline of the construction sector, an important source of employment for the urban poor, is of concern. Real economic growth is forecast to slow to about 3 percent in 2001 before recovering to over 4 percent in 2002, in line with the expected improvement in global economic conditions. Inflation is expected to rise to about 7 percent in 2001 due to the lagged effect of fuel price rises and pre-election spending prior to the May elections. On the external front, a slower US economy and weaker world demand for electronics point to a deceleration of Philippine export growth. (A large part of exports is composed of electronic goods—see Figure 2.10.)
In January 2001, the country resolved its political uncertainties. The early economic manifestations of this resolution were rising stock prices, a stabilizing exchange rate, and a restoration of investor confidence. The improved political climate should contribute significantly to carrying out the pending economic reforms. After the May elections, the Government needs to devote its energies to improve economic governance. A favorable environment needs to be developed to attract foreign direct investment, which is now crucial in a context of anticipated slower export growth and the Government’s ballooning fiscal deficit. Provided that the Government can revitalize the governance reforms and maintain political stability, the exchange rate, stock prices, inflation, and growth rates should all improve. Continued reform of the financial system is expected in 2001, specifically the drafting of the Implementing Rules and Regulations for the General Banking Law of 2000.
In 2002, any cyclical recovery in global electronics depends on a worldwide recovery of the information and communications technology sector, which will affect the economy’s export projections. By this time, it is expected that reform programs such as the Omnibus Power Bill, long delayed by the country’s political problems in 2000 and the intervening elections, will be in place. If the anticipated reduction of the Government’s fiscal deficit in 2001 is realized, then this enhances growth prospects for 2002, a prerequisite for which, however, is continuing political stability.
Issues in Economic Management
The priority for the Government is to turn its attention to the economic reform agenda so as to restore investor confidence. In terms of promulgating new economic legislation, following the establishment of an Economic Coordinating Council in January 2000, the Government saw some success. Laws enacted in 2000 included the Retail Trade Liberalization Act (liberalizing foreign ownership of retail firms), the General Banking Law of 2000, the Electronic Commerce Act (establishing regulations for and promoting e-commerce), and the Securities Regulation Code (enhancing capital market competitiveness). These laws are intended to create a business environment conducive to domestic and foreign investment, and should help improve investor confidence. However, the political and economic uncertainties that characterized much of 2000 detracted the Government’s attention from economic reforms, including implementation of the above laws. The efficacy of these new laws hinges on the Government’s success in tackling various investor concerns, including the large fiscal deficit, weak public sector governance, and ineffective implementation of laws. In terms of the fiscal deficit, the emphasis should be on revenue mobilization by streamlining the tax code to reduce the number of exemptions and by strengthening enforcement of tax laws.
Policy and Development Issues
The General Banking Law of 2000 was passed as part of a new banking framework in response to the Asian financial crisis and the changing global economic environment. The new law overhauls the regulatory and supervisory responsibilities of the central bank, Bangko Sentral ng Pilipinas. It updates the classification system of banks to include universal, cooperative, and Islamic banks. It also sets limits on the regulatory scope of the central bank over nonbank financial institutions.
The new law is also designed to restructure the banking system. On bank ownership, it liberalizes the entry of foreign banks to foster competition. The law raises the maximum foreign ownership level of banks to 40 percent of voting stock. Also, under certain conditions, the central bank can allow a foreign bank to own 100 percent of a domestic bank. The central bank will, however, ensure that banks majority-owned by locals hold 70 percent of total resources in the banking system.
The passing of the General Banking Law is expected to strengthen the domestic banking industry and make it better able to withstand internal and external shocks. However, the financial sector still faces several issues. One is the weak credit culture, as the country has one of the lowest degrees of financial intermediation in Asia. The inadequacy of credit to vital sectors of the economy and the inefficiency with which it is provided still need to be tackled. Among other things, this includes reducing or eliminating financial intermediation taxes to lower costs. It also includes promoting competition and encouraging greater foreign entry (addressed by the new law) as well as strengthening public listing requirements to improve corporate governance in the banking industry.
Enhancing the role of capital markets is a long-term policy issue. While private sector borrowing comprises mainly short-term bank credit, the development of long-term bond markets would help stimulate complementary financing through the capital markets. This would contribute to lowering banks’ nonperforming loan levels. Parallel reforms in the corporate sector are also important for the health of the banking system, including improvement of corporate governance, reinforcement of regulatory and supervisory arrangements, and expansion of the investor base. Such reforms may include upgrading standards of corporate disclosure and transparency, and adopting formal rules for rehabilitating companies.