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Chapter 1
Ensuring Sustained Growth with Equity and Macroeconomic Stability
Generating new jobs is key to winning the war against poverty. To enhance the capacity of the domestic economy to create jobs, competitive enterprises will be encouraged to flourish. Ensuring the stability of the macroeconomic environment is a must. A major challenge is ensuring that full-employment policies do not trigger inflation. A deficit reduction program will be pursued. Stable and low rates of inflation will be ensured through the shift of monetary policy to inflation targeting. A healthy external balance will be underpinned by a flexible exchange rate system. In addition, the national government (NG) will implement an expenditure program that preserves a bias for education, health, agriculture and other services for the poor. Regulatory agencies will be strengthened to provide the institutional framework for preventing and resolving corporate failures, and to reduce the vulnerability of the banking and corporate sectors to sudden shifts in internationally mobile capital. The capital market will be further developed to raise national savings including those required for the growth of small and medium enterprises (SMEs). This will be facilitated by regulatory reforms in the banking sector and equities market.
POLICY FRAMEWORK
A stable economic environment is essential to sustaining job and income generation. Macroeconomic stability is also important to battling poverty because in periods of economic downturn such as the 1997 Asian financial crisis, it is the poor who are hurt the most. Not only do they lack the assets – land, money and technical know-how – to cushion the fall in incomes arising from unemployment and inflation, they also cut down on expenditures such as education, which are essential for their long-term empowerment and their exit from poverty.
The pursuit of sustained and equitable growth requires consistent fiscal, monetary, external and financial sector policies. To achieve macroeconomic stability, the NG in coordination with monetary authorities shall pursue the following objectives: 1) fiscal discipline; 2) price stability; 3) sound external balance; 4) development of the banking and capital markets; and 5) sound corporate governance.
Large fiscal deficits are inconsistent with macroeconomic stability because they result in higher domestic interest rates (if the deficit is financed by domestic borrowings) and inflationary pressures (if financed by borrowings from the monetary authorities). The fiscal position of the NG has deteriorated since 1997. To avoid a potential debt problem, the NG will pursue a fiscal deficit reduction program towards a balanced budget by 2006. Revenue collection efficiency will be improved to finance the government’s development projects, especially those intended to support the poor. Expenditure programs will be prudent, and place priority on expenditures that contribute the most to the anti poverty agenda.
Inflation reduces purchasing power. It also lessens the competitiveness of Philippine products in the global market by increasing cost of production and creates pressures for a weakening of the peso if the real effective exchange rate is to remain stable. Inflation also increases nominal interest rates, which dampen investment including those of the farmers’ and small enterprises that borrow to meet their working capital requirements. Thus, monetary policy will be anchored on achieving price stability.
Integration with the world capital markets results in greater economic efficiency because it enables domestic firms to have access to a wide variety of credit instruments. At the same time, however, an open capital market increases the vulnerability of the economy to sudden shifts in capital flows and foreign exchange rate volatility. Cognizant of the perils and benefits of integrated capital markets, the government and the Bangko Sentral ng Pilipinas (BSP) remain committed to the full and free convertibility of foreign currencies while pursuing measures to reduce exchange rate volatility and curb speculation. Fiscal and monetary policies, which simultaneously affect prices, interest rate and foreign exchange rate movements, shall be coordinated.
The banking system will be strengthened to make it an efficient and dynamic financial intermediary between savers and borrowers. Policies to make it more responsive to the needs of the SMEs and borrowers will be pursued. Since a sound banking system cannot exist when the corporate sector and corporate governance are weak, regulations that enhance corporate governance will be pursued to complement the banking sector reforms. Simultaneously, the government shall promote the growth of the capital market, which includes the development of new debt and equity instruments. The latter shall provide alternative sources of long-term capital to complement the short- and medium-term loans that are granted by the banking system.
ASSESSMENT AND CHALLENGES
The Philippine economy has shown resiliency in the past two years as it recovered from the 1997 financial crisis and the 1998 El Niño drought. Buoyed by robust demand in the United States (US) and major trading partners, as well as stronger domestic demand, gross domestic product (GDP) grew by 3.4 percent in 1999 and 4.0 percent in 2000. Prices were also stabilized, with the inflation rate moderating to 6.7 percent in 1999 and further to 4.4 percent in 2000. The current account surplus rose to historical levels reaching 9.5 percent of gross national product (GNP) in 1999, and 11.8 percent in 2000. This was due to gross investment, which remained low at 17.8 percent of GNP in 1999 and 16.9 percent in 2000. The rosy current account surplus pushed gross national savings to 27.3 percent of GNP in 1999, and further to 28.7 percent in 2000 (Table 1.1).
Gross international reserves (GIR) was also boosted by the upturn in the current account. In 1999 and 2000, GIR was kept at around $15 billion, equivalent to 4.4 and 4.5 months worth of imports, respectively. Total external debt service remained at 12.3 percent of total exports of goods and services.
There are, however, areas which have remained weak, foremost of which are the fiscal sector, and the banking and corporate sectors. The NG’s fiscal deficit deteriorated to P111.7 billion in 1999 and further to P134.2 billion. Meanwhile, the nonperforming loans (NPLs) of the banking sector continued to inch up. In addition, the range of financial instruments for long-term financing of the corporate sector remained thin. This dragged the recovery of the corporate sector that is largely dependent of the banking sector.
Weakened Fiscal Position
The larger-than-targeted deficits of the NG were the results of weaker-than-expected revenue collections. Total revenues amounted to 15.2 percent of GNP in 1999 and went down to 14.7 percent in 2000. In both years, revenue collections were below the programmed collections because of lower tax efforts (Table 1.2). Administrative measures were implemented at the Bureau of Internal Revenue (BIR) such as the establishment of Large Taxpayers Unit and the Excise Tax Unit but these were not enough to offset the overall decline of the tax effort to 13.7 percent in 1999 and further to 13.2 percent in 2000. Meanwhile, structural weaknesses such as the nonindexation of excise taxes to inflation dragged the ability of the tax system to yield revenues as the economy grew. The continued slowdown of some sectors such as banking and construction also weakened the tax collections in 2000.
Meanwhile, total disbursements were kept within the programmed levels, or 18.7 percent of GNP in 1999, and 18.6 percent in 2000.
Borrowing from the domestic market to finance the NG deficit declined from 54.4 percent in 1999 and 49.0 percent in 2000. Thus, the weighted average of the 91-day Treasury bill (T-bill) rates remained at 10.2 percent in 1999 and 9.9 percent in 2000. The large fiscal deficits have led to a substantial increase in the NG debt to P2.2 trillion in 2000 (65.3% of GDP). A continued deterioration of the fiscal deficit is expected to put upward pressure on interest rates, which may dampen a private sector-led recovery.
Continued Rise of Nonperforming Loans and Inadequate Regulatory Framework
The ability of the private corporate sector to clean up their debts with the banking sector was challenged anew with the spike in interest rates and the depreciation of the peso in the second half of 2000. As of December 2000, the level of NPLs stood at P245.8 billion, or 15.1 percent of total outstanding loans of commercial banks (KBs). Taking into account the real and other properties owned and acquired (ROPOA) of KBs, total nonperforming assets of KBs rose to P374.0 billion in the same period, or 12.4 percent of total assets.
Dragged by the rising NPL ratio due to private corporate debt, most of domestic credit in the past two years went to the public sector. Domestic credit rose by 13.1 percent in 2000, largely due to the 31.9 percent increase in public sector borrowings. Credit to the private sector increased by only 8.1 percent.
A number of reforms and legislation were passed in 2000 to strengthen the banking system against systemic risks. These include Republic Act (RA) 8791 or the General Banking Law (GBL) of 2000, which aligns domestic banking standards with international best practices and improves regulatory oversight. The GBL also allows foreign banks to acquire up to 100 percent of a domestic bank within seven years of the effectivity of the law. Various regulations were also passed by the BSP to improve asset quality and risk management which include: (a) the adoption of risk-based capital adequacy standards aligned with international norms; (b) the strengthening of transparency with respect to NPLs, classified loans, and other risk assets, and loans to directors, officers, stockholders and related interests (DOSRI); (c) the requirement for banks wanting to provide electronic banking services to set up the necessary risk management practices; and (d) the shift of focus of supervision from a purely compliance-based and checklist-driven assessment to a forward-looking and risk-based framework. The BSP also began to supervise banks on a consolidated basis to include their foreign currency exposures. In the absence of legislation on antimoney laundering, the BSP issued circulars requiring banks to take reasonable steps to determine the true identities of their clients and report suspicious transactions.
Notwithstanding these reforms, there are still weaknesses in the banking system that need to be addressed. These are: (a) the inability of the monetary authorities to examine bank deposits due to laws that enshrine deposit secrecy, which, in turn, creates an avenue for money laundering; (b) incomplete oversight of the monetary authorities on banking operations such as trust operations; and (c) weak enforcement capability of regulatory authorities to take immediate and time-bound actions to prevent the dissipation of bank assets.
Underdeveloped Capital Market
The low savings rate of the Philippines is also a reflection of weaknesses in the nonbank sectors of the capital market. The country continues to have one of the lowest savings rate in Association of Southeast Asian Nations (ASEAN). If the Philippines is to post faster growth in investments without running into debt and balance of payments (BOP) problem over the long term, domestic savings must increase to finance growth.
The passage of the Securities Regulation Code (SRC) or RA No. 8799 in July 2000 is expected to strengthen the regulatory framework over the securities market. However, while this reduces the instances of market abuses, the government will support amendments to the SRC that will relax overlay restrictive provisions and promotes desirable market activity.
Major provisions of the SRC, which are expected to enhance corporate governance, include the demutualization (public listing) of the Philippine Stock Exchsange (PSE); the protection of minority shareholders; and the election of at least two independent directors to the board of the public corporation.
However, there remain issues to be addressed. The capital market continues to be characterized by a weak market of private bonds for long-term financing of the corporate sector. Taxes on secondary instruments such as the documentary stamp tax (DST) have also discouraged the development of the capital market. These constraints need to be addressed for the capital market to develop.
Challenges of Globalization
The growing integration of the Philippines in world trade, especially the new economy and global capital markets poses both benefits and perils. On the one hand, the global economy offers a bigger market for Philippine products. The Philippines has increasingly gained competitiveness in exports of electronics and semiconductors. In 2000, electronics and semiconductor exports accounted for 60 percent of total merchandise exports from only 34.3 percent in 1997. A sharper decline and a longer recovery of the global computer and telecommunications market pose risks to growth in 2001-2002. The integration of the Philippines in world capital markets also creates greater volatility in the foreign exchange market even as the Philippines benefits from equity foreign capital flows. Large and sudden shifts in capital flows, whether caused by changes in the underlying macroeconomic fundamentals, speculation or contagion require the pursuit of fiscal, financial, monetary and exchange rate policies that will increase the resiliency of the economy against volatile capital flows.
TARGETS AND STRATEGIES
Growth and Inflation Targets
Over the medium term, the government expects growth to accelerate through improvements in productivity, employment of greater manpower and physical capital. GDP will grow at the average rate of 5.1 to 5.6 over the period 2001-2006 (Table 1.3). Improvements in productivity, access to lower-priced products in the global market and the shift to inflation targeting will bring down inflation to 4.5 to 5.5 percent by 2006. Immediate policies will be implemented to put the economy back on a sustained growth path, foremost of which is the fiscal deficit reduction program. Measures that will address the recovery of the corporate and banking sectors and the strengthening of capital market reforms are indicated.
Growth targets
GDP growth is expected to accelerate from 3.3 percent in 2001 to 6.3 to 6.9 percent in 2006. This path hinges on the recovery and robust expansion in investments and exports as the economy benefits not only from greater renewed investor confidence and sustained macroeconomic stability but also from measures to improve overall governance and the competitiveness of the agriculture, industrial and service sectors. Investment demand will accelerate in 2002 with a 4.5 to 5.0 percent growth from the projected growth of 1.5 percent in 2001. Investments in durable equipment will be boosted by the continued strong growth in the telecommunications and the information and communications technology (ICT) industry, modernization of the agriculture sector and purchases of equipment in the power sector. New production capacity, especially in export-oriented areas, and the more favorable world economic growth prospects will bolster export growth to 9.5 to 10.0 percent by 2006.
A modest economic growth is, however, expected in 2001 because of weak exports growth caused by the downturn of the world economy. Consequently, exports (in 1985 peso prices) are projected to contract in 2001.
The recovery in incomes, particularly in rural incomes arising from the development of the rural economy are projected to bolster the growth of private consumption from 3.4 percent in 2001 to 4.2 to 4.7 percent in 2006. Government consumption, however, will remain modest due to the government’s fiscal deficit reduction program.
The recovery of the global market, and the implementation of productivity enhancing reforms such as the Electricity Industry Reform Act will propel industrial growth from 2.3 percent in 2001 to 7.1 to 7.6 percent by 2006. Reforms in the housing finance system will also lead to the recovery of the construction industry beginning in 2002. Construction will also be boosted by the build-up in power plant capacity. Meanwhile, the services sector will track the growth of industry with growth accelerating from 4.0 percent in 2001 to 6.6 to 7.1 percent by 2006. Expansion will be strong in all subsectors except in government services. Government policies to support the growth of ICT (see chapter on ICT) and tourism (see chapter on Tourism) will lead to its double-digit growth rates. The banking industry is expected to rebound as stable interest and foreign exchange rates lead to greater bank lending.
Meanwhile, the implementation of the Agriculture and Fisheries Modernization Act (AFMA) will push agricultural growth from 3.1 percent in 2001 to 3.9 to 4.9 percent in 2006 (see chapter on Agriculture).
Gross national savings (as a percent of GNP) will average around 20 percent in the medium term (Table 1.4). Public savings will increase to 4.1 percent of GNP in 2006 from -1.3 percent in 2001 as the consolidated public sector financial position (CPSFP) moves towards a surplus by 2006 (see section on Fiscal Sustainability).
Price stability
Inflation is targeted to decline from 6.0 to 7.0 percent in 2001 to 4.5 to 5.5 percent in 2006 (Table 1.3). The conduct of monetary policy will continue to be prudent. Adequate liquidity to support the targeted growth and inflation rates over the medium term will be provided. In 2001, the BSP will shift to inflation targeting so it will have greater accountability and flexibility in meeting inflation targets consistent with the government’s growth targets.
Improvements in the productivity of food production support the objective of price stability. Moreover, there will be timely importation of key agricultural commodities when domestic production falls short of domestic demand. At the same time, the reduction in tariff rates to 0 to 5 percent in 2004, which is consistent with the government’s international commitments, is expected to bring down inflationary pressures.
Strategies
Fiscal discipline and sustainability
The government shall engage in a deficit reduction strategy over the medium term to keep the debt burden to a manageable level. The consolidated public sector position will improve from a deficit of 4.3 percent of GNP in 2001 to a surplus of 0.4 percent by 2006 (Table 1.5). To achieve this target, the NG, which is the largest contributor to the total public sector position, will progressively reduce its deficit from P145 billion in 200l to achieve a balanced budget by 2006 (Table 1.6 ). The reduction in the deficit will be achieved through tax reforms and expenditure management. The government will ensure that the deficit is financed wisely.
With the decline in the NG’s borrowing requirements, the NG’s debt will also decline from 60.9 percent of GNP in 2001 to 44.4 percent in 2006 (Figure 1.1). Accordingly, interest rates are expected to fall gradually from 11 to 12 percent in 2001 to 9.5 to 10.5 percent in 2006.
Tax reforms
Strengthening tax collection efficiency is a must in reducing the fiscal deficit and in implementing the government’s development projects. Total revenue is programmed to increase from 14.6 percent of GNP in 2001 to 16.6 percent in 2006 supported by an improvement in the tax effort to 15.6 percent of GNP in 2006 from 13.0 percent in 2001. Collections of the BIR is targeted to improve from 10.1 percent of GNP in 2001 to 12.4 percent by 2006, while that of the Bureau of Customs (BOC) will grow modestly from 2.7 percent in 2001 to 3.0 percent in 2006 in the light of the tariff reduction program. Nontax revenues will progressively decrease. Revenue from privatization will fall to about 0.02 percent of GNP throughout the medium term.
The improvement in tax collection efficiency will entail: (a) short-term measures that generally involve improvements in tax administration; (b) medium-term measures that will involve a restructuring of the tax system and better organizational structures; and (c) the rationalization of fiscal incentives.
The BIR will continue implementing administrative measures such as: (a) strengthening of tax audit capabilities; (b) full computerization of its procedures; (c) full implementation of the Large Taxpayers Program; and (d) enhancement of the use of third party information.
In line with the recommendations of the Tax Study Group organized under the Development Budget Coordinating Committee (DBCC), administrative measures to improve collection from income taxes, value-added tax (VAT) and excise taxes were also identified as follows:
Income taxes. The implementing rules and regulations (IRR) governing the limits on certain deductible expense for tax purposes and the implementation of the accelerated depreciation and net operating loss carry-over (NOLCO) under the Comprehensive Tax Reform Program (CTRP) will be issued immediately. A more aggressive audit program for the payment of minimum corporate income tax (MCIT) will also be put in place. The capacity of the tax system to effectively cover hard-to-tax groups will be strengthened through audit of high profile hard-to-tax individuals beginning with the preparation of a list of these individuals. BIR will intensify the collection of delinquent accounts and the recovery of contested assets. Strict monitoring of compliance with the country’s withholding tax regulations by local government units (LGUs) and the national agencies shall be implemented;
Value-added tax. VAT administration has been seriously hampered by spurious claims for VAT credits. To address this, the BIR will conduct a profiling and benchmarking of the input structure by industry or sector. A closer tracking of the carry-over of excess input tax credits in succeeding years will also be undertaken to minimize fraudulent tax credit applications. In this regard, the tax form will be revised to differentiate credits for intermediate inputs from tax credits for capital equipment;
Excise taxes. The IRR governing the 12-percent adjustment of the per unit rates on alcoholic and tobacco products will be reviewed to ensure that all product classifications are covered by the adjustment. Additional measures shall include the use of fused-on stamps for cigarettes and alcoholic products and the conduct of random and surprise audits at the place of production. To capture the increase in price of tobacco and alcohol products in the collection of excise taxes, a price survey of tobacco and alcoholic products will be conducted immediately to permit the reclassification of said products based on their current prices;
Documentary stamp tax. Electronic metering in major offices of banks will be installed to plug leakages in the collection of the DST;
Border Taxes. The BOC will put in place measures to minimize revenue losses arising from the shift to transactions value. The BOC will also closely monitor trading warehouses and importers that are availing of duty exemptions under the AFMA. Close linkages among the revenue collecting agencies and periodic exchange of information among them will ensure that fraudulent practices will be minimized. An interagency team headed by the BOC and the Department of Justice (DOJ) has been formed to increase efficiency in arresting smugglers; and
Restructuring the tax system. Over the medium term, reforms will be undertaken to make the tax system simple and easy to administer, buoyant, equitable and less prone to corruption and tax evasion.
In the area of income taxation, the shift to gross income taxation is being considered as part of the administration’s long-term measures to raise revenues. The income tax will be reviewed for possible gains through modifications in the list of allowable deductions and rates. The income tax for corporations will be restructured to align the tax treatment of corporations and self-employed individuals, and rationalize the list of allowable business deductions, which have become regular sources of abuse.
Other reforms that the government will study include the rationalization of the taxation of financial intermediation, instruments and institutions (see section on Banking System); and the expansion of excise taxes on automobiles including all motor vehicles.
The organizational structure and processes of the revenue-collecting agencies will be studied, including the feasibility of creating an autonomous revenue agency wherein the Department of Finance (DOF) retains ultimate responsibility for the government’s fiscal and tax policies. The organization, processes and systems of BIR will be reviewed to identify areas where significant tax evasion, leakages and corruption exist. Organizational reforms in the BIR will include enhancing the professional skills of its manpower through the strict observance of performance-based merit systems, and continuing provision of training for upgrading skills and knowledge.
Rationalizing fiscal incentives
The government remains committed to support the development of globally competitive industries and to promote the country as an attractive investment destination. However, it needs to rationalize the grant of incentives to protect the revenue base. The fiscal incentives system will be simplified to further enhance the effectiveness of incentives as a tool for industry development without jeopardizing potential revenue sources.
The Investment Priorities Plan (IPP) will be highly focused and limited to a few industries. The process of selecting those to be included in the list will involve distinguishing between activities that need to be provided incentives and those that would be better supported by improving access to infrastructure or credit.
The definition of gross income and the allowable deductions in the computation of the 5-percent gross income tax enjoyed by enterprises operating in economic and free trade zones will be rationalized and defined clearly. Likewise, the tariff and related matters (TRM) process will address the concern of certain sectors related to the cost of capital equipment that are not locally produced and for which the tariff may be reduced to zero.
The medium-term thrust is to move towards the uniform application of incentives and rationalize the operations or mandate of agencies currently granting incentives. This would obviate the need for the government to choose favored sectors and enable the concerned agencies to focus on investment promotion. This move is also consistent with the World Trade Organization (WTO) Agreement on Subsidies and Countervailing Measures, which prohibits certain types of subsidies.
Expenditure management
Disbursements are programmed to fall to 16.6 percent of GNP by 2006 from 18.4 percent in 2001. This will be achieved through: (a) immediate implementation of austerity measures; (b) institutional reforms in key aspects of public financial management such as budgeting, budget execution, procurement, accounting, and management of contingent liabilities; and (c) reforms related to public administration such as reengineering the bureaucracy, human resource development, compensation, performance accountability and transparency (see chapter on Governance).
An austerity program is being implemented in 2001 under Administrative Order (AO) No. 5 where savings target of 10 percent of nonpersonal services expenditures is imposed on all public sector entities. To preserve the priorities of the Plan, the targets savings for social services, tourism and agrarian reform is limited to 5 percent. In addition, AO 5 mandates the conduct of Sector Efficiency and Effectiveness Reviews (SEERs) by the National Economic and Development Authority (NEDA) and Department of Budget and Management (DBM) in coordination with agencies and departments. The conduct of SEER enables the identification of low priority activities of agencies which could be deferred, discontinued or scaled down. The government will also strengthen the shift towards performance-based budgeting through the continued implementation of the Medium-Term Expenditure Framework (MTEF).
Expenditures that will directly benefit the poor will continue to be protected. Government spending on social services will get a bigger share in the budget throughout the medium term (Table 1.7).
Other public sector reforms
The contribution of government corporations to the public sector borrowing requirement shall be reduced. The review and approval process for NG guarantees for government-owned and -controlled corporations (GOCCs) shall also be tightened. Reforms will be introduced to improve the pricing mechanisms of the GOCCs, especially those in water and electrification. Likewise, government financial institutions (GFIs) shall pursue programs to enhance their profitability such as the development of new products and services; disposition of nonperforming assets; and further strengthening of their lending policies. The government shall work towards the privatization of the National Power Corporation (Napocor), Philippine National Oil Company-Energy Development Corporation (PNOC-EDC) and Philippine National Construction Corporation (PNCC). The restructuring of some GOCCs like the National Food Authority (NFA) will also be pursued. Private sector participation shall be sought in the rail transportation sector (see chapter on Infrastructure) while privatization in the water sector shall also be further pursued. Financing policies in the water and in rural electrification will be reformed to improve the performance of the consolidated public sector.
The government shall follow an optimal borrowing strategy which balances the cost of borrowing with the objective of lengthening the debt maturity structure to avoid refinancing problems. Over the medium term, the government will source its financing requirements from a balance of domestic and foreign sources with a growing share of funding from official development assistance (ODA). The government will increase the utilization rate of ODA by strengthening its monitoring and evaluation system and by setting up a performance rating scheme. The Investment Coordination Committee (ICC) will take a more proactive role by constituting a project action group that will interface with each agency’s project implementation officers for the timely implementation of the agencies’ projects.
New and creative debt and equity instruments will be issued to reduce the cost of borrowing and avail of the best terms for government. Hedging instruments will be tapped to minimize foreign exchange rate risks.
Sound external balance
The BOP is seen to improve from a deficit in 2001 to a surplus beginning 2002 as the economic conditions of our major trading partners improve, reaching around $2 billion by 2006. The current account is projected to remain in surplus, albeit moving towards a negative balance in terms of GNP to 0.9 percent in 2006. The expected recovery of the world economy in 2002 and the subsequent projected stronger inflow of direct investments in export sectors, particularly in ICT-related industries, are seen to boost exports over the medium term. However, the expected growth of imports arising from greater economic activity and falling tariff rates will lead to a smaller current account surplus.
An increase in capital and financial inflows of both direct and portfolio investments will support the improvement in the BOP. Capital inflows are expected to rise with greater macroeconomic stability and better system of governance in the corporate and capital markets.
The level of gross international reserves (GIR) will reflect the improvement in the external payments position. GIR will gradually rise to reach $20.4 billion by 2006. The 4.1 months import cover is expected to be maintained over the medium term (Table 1.8).
Given the rise in exports, the debt service ratio (in percent of exports of goods and receipts from services) is projected to decline from 17.4 percent in 2001 to 14.1 percent in 2006.
Cognizant of the benefits brought of being integrated with world capital markets such as access to cheaper and appropriate sources of financing, the government adheres to a freely convertible peso and market exchange rates. However, to ensure macroeconomic stability, policies that strengthen the country’s external accounts position and reduce its vulnerability to sudden reversals of capital flows will be adopted. The exchange rate will continue to be market determined and foreign exchange intervention will be limited to cases where there is a need to smoothen sharp fluctuations in the exchange rate. Moreover, considering that some capital flows can be destabilizing, prudential regulations will be strengthened to curb speculative activity. The BSP will continuously review its foreign exchange regulations to closely monitor foreign exchange transactions without limiting transfers and payments of legitimate foreign exchange transactions. It will also accumulate adequate international reserves that will provide a prudent amount of buffer against shocks in capital flows in addition to meeting external obligations, especially short-term obligations.
Development of the banking and capital market
Banking system
The government will improve the environment for raising domestic savings by continuing to strengthen the financial sector, which includes the banking sector and the capital (equity and bond) market. Strengthening the banking system will require addressing the problem of rising NPLs in the short run. At the same time, prudential regulatory powers of the BSP will be strengthened while policies to enhance financial intermediation will likewise be addressed.
Addressing the NPL problem of banks. The government will address the NPL problem by supporting the creation of private asset management companies (AMCs). In view of the government’s fiscal constraints, the government will not infuse financial equity into AMCs. The BSP is supportive of the creation of private sector-led AMCs. A number of banks have already shown interest in setting up such AMCs. In this regard, the role of government would be in creating an environment that facilitates effective resolution of impaired assets by the banks themselves, including improved asset valuation rules and procedures, and bringing the prudential and regulatory environment in line with best international practice to encourage, among other things, private capital injections.
Addressing money laundering and preventing system-wide risks. The supervisory authority of the BSP has been hampered by the bank deposits secrecy law. Moreover, the law creates incentives for money laundering and impedes the speedy resolution of bank failures, as it prevents the Philippine Deposit Insurance Corporation (PDIC) from gathering information on individual depositors prior to the closure of the bank. To address this weakness, the BSP will work to restore its power to inquire into bank deposits above a certain amount as an exception to the bank deposits secrecy law, when probable cause of use of banking system to commit violation of banking laws and regulations has been established. The government shall also seek the passage of an antimoney laundering bill.
The regulatory powers of the BSP shall also be strengthened through the amendment of the New Central Bank Act. The amendatory provisions include: a) expanding the supervisory and enforcement powers of the BSP to the trust entity affiliates of banks allowing the BSP to conduct examinations at least once in every calendar year; b) providing stricter criteria for placing banks under liquidation and receivership; and c) increasing the penalties for bank violations.
The BSP will continue its efforts to shift to consolidated bank supervision and risk-based examination. To improve the settlements and payments infrastructure, the BSP is developing a real time gross settlements system covering the equities, fixed income, money and foreign exchange markets.
The authorities will continue to accelerate the rehabilitation of certain KBs to restore their viability and profitability at the soonest possible time.
The government will also seek the passage of the PDIC Act to strengthen the supervisory authority of PDIC over insolvent banks. To reduce excessive risk-taking of banks and mitigate the effects of moral hazard that arise from deposit protection, the PDIC shall move towards a risk-based assessment system over the medium term. PDIC currently provides a deposit insurance cover of P100,000 for each depositor and charges banks a flat rate of one-fifth of one percent (1/5 of 1%) of total deposits. Under a risk-based assessment system, insurance assessment shall be based on differentiated rates proportionate to the degree of risk that an insured bank takes.
Improving financial intermediation. Over the medium term, the BSP will work towards the reduction of the reserve requirements to bring down the cost of financial intermediation. The reduction in reserve requirement, however, will be carefully weighed against the broad policy objective of maintaining price stability.
Support shall be given to microfinance institutions to improve the mobilization of savings from small savers and the access of small-scale borrowers to credit. This will require a regulatory framework for microfinance institutions and capability-building of these credit intermediaries. Prudential measures shall also be undertaken so that the stability of the financial system will not be undermined. To ensure the sustainability of microfinance institutions and reduce risks, the government will adopt a risk-based supervision approach and will continue to support a market-orientated interest rate policy. To improve access of farmers to credit, the government will support policies making farmlands under the agrarian reform law acceptable as collateral.
Capital market development
The development of the capital market is critical to raising domestic savings. The government will work with the private sector on long-identified capital market reforms. The capital market shall be deepened through: (a) the elimination of taxes that serve as disincentives to the development of the capital market; (b) the use of new and creative debt and equity instruments; and (c) expansion of institutional players.
Financial taxation. The gross receipts tax (GRT) imposed on banks and other credit institutions, the VAT on preneed companies and other contractual savings institutions, and the premium tax on life insurance companies will be replaced by Financial Institutions Tax (FIT). The latter will closely approximate the VAT on financial transactions.
The DST will also be rationalized. The DST is paid as many times as the instrument is transferred or resold. Such imposition creates a cascading effect that distorts pricing and makes financial intermediation costly, thus prohibiting secondary trading and making the market uncompetitive. Eliminating the DST on secondary trading encourages the development of a secondary market and eventually increases tax revenues as more capital market instruments are issued and transactions flourish.
Use of new and creative debt and equity instruments. New instruments that offer buyers better reward for their investments while providing both the government and the private sectors with lower-cost financing shall be introduced. Along this line, asset-backed securities shall be promoted. A secondary housing mortgage market shall also be developed to enable the
government to meet its housing targets. To achieve this, the government will push for the passage of the Securitization Act, which will define the framework for the issuance, and trading of asset-backed securities.
The SEC shall issue revised rules on securitization to recognize the creation of special-purpose vehicle (SPV) for securitization. The Insurance Commission (IC) shall expand the coverage of admitted assets to include asset-backed securities. To promote liquidity and sound management of SPVs and institutions involved in the trading of asset-backed securities, the listing of asset-backed securities with the PSE shall be encouraged.
The government will work for the creation of a provident fund for overseas Filipinos and seek the passage of the Personal Equity and Retirement Account (PERA) Act to deepen savings mobilization.
Expansion of institutional players. New market players will be encouraged to participate in the capital market. Under the proposed Revised Investment Company Act (RICA), nationality requirements of mutual funds will be relaxed to encourage entry of new players. Investment companies will also be allowed to sell or purchase securities outside of the Philippines while foreign investment companies will also be allowed to sell or purchase securities in the Philippines.
Reforms will be introduced to make the different pension fund systems more efficient and financially sound in providing social insurance and protection. The recommendations of the Presidential Retirement Income Commission (PRIC) created through Executive Order (EO) No. 91 dated April 6,1999 will be taken into account in instituting changes in the mandatory pension institutions (e.g., GSIS, SSS, AFP-RSBS and HMDF). The recommended actions include a study on the merits of adopting a four-pillar pension system, which will encourage the entry of new players. The first pillar is envisioned to be a tax-financed social assistance program that would provide basic protection to the aged who could not afford in their working years a contributory program. The second pillar will consist of the existing defined benefit programs of the SSS and GSIS. The third pillar is a mandatory defined contribution program that would supplement the benefits provided by the second pillar. The target income replacement rate provided by the sum of the second and third pillars is one that will allow for further growth and development of the fourth (voluntary) pillar which currently includes the preneed and insurance companies, trusts, mutual funds and other financial institutions that offer both defined benefit and defined contribution plans.
The proposed reforms by the PRIC include the introduction of a mandatory defined- contribution program and measures to improve investment management through the use of reputable and professional external fund managers. The possible unification of the public pension institutions will also be studied. Part of the PRIC’s task is to define policy measures that would rationalize the cost of the mandatory programs of the SSS and GSIS such that the social protection provided by these institutions would be the same for workers in the private and public sectors.
Corporate recovery and governance
To strengthen corporate governance, the PSE has been demutualized or reorganized as a stock corporation last August 8, 2001. The demutualization subjects the PSE to greater market discipline and strengthens the investing public’s external control over the stock exchange.
The government will also work with the private sector and the Capital Market Development Council (CMDC) to institutionalize a corporate governance reform program and conduct a public information campaign to increase awareness on corporate governance principles.
The government will seek the improvement of the corporate debt resolution framework by supporting the amendment of the 1909 Insolvency Law or the passage of the Corporate Recovery Act. The Corporate Recovery Act puts in place procedures for liquidation that balance the rights of creditors and debtors as it allows both parties to initiate liquidation proceedings.
