CHAPTER 7
MACROECONOMIC FRAMEWORK AND
DEVELOPMENT FINANCING
I. Assessment of Performance
A. Real Sector
In the previous planning period, the Philippine economy began to overcome basic economic weaknesses and staged a sustained recovery from the stagnation at the beginning of the decade. The recovery was private sector-led and was underpinned by a series of structural reforms to open up the economy. A macroeconomic stabilization program was also put in place to reduce the fiscal deficit. The gross national product (GNP) grew at an average rate of 4.9 percent in 1993-96 and peaked at 7.2 percent in 1996 (Table 7.1). This was within the output target range of 4.1-5.2 percent in the Medium-Term Philippine Development Plan (MTPDP), 1993-98.
The momentum for sustained growth was halted, however, by the financial crisis that hit Asia in July 1997, which was aggravated by adverse weather conditions. GNP growth in 1997 fell to 5.2 percent, much lower than the target of 7.0 _ 8.0 percent in the updated MTPDP, 1996-98. In 1998, GNP growth was recorded at 0.1 percent, representing the sharpest deceleration since 1990. The large depreciation of the peso vis-ā-vis the US dollar, the relatively high cost of credit, the lingering lack of confidence in the Asian region, exacerbated by the El Niņo phenomenon affected the whole economy, with agriculture recording the sharpest fall.
Growth prior to the crisis was investment- and export-led. Investments surged at an annual average of 8.2 percent during 1993-96, though short of the 10.2 percent low-end target. Investments grew in a climate of political and economic stability, helped by the liberalization and deregulation of critical sectors such as banking, power, telecommunications and transportation. In particular, construction rose by 9.5 percent in 1993-96. The tariff reductions implemented in connection with World Trade Organization (WTO) and the ASEAN Free Trade Area (AFTA) commitments, together with the Foreign Investments Act of 1991, as amended by Republic Act (RA) 8179, also contributed to higher investments. The implementation of build-operate-transfer (BOT) projects, largely involving power projects, also boosted private sector construction activities. Investment activities, however, took a downturn amid the Asian financial crisis. Investments shrank by 16.4 percent in 1998 and are not expected to recover fully until 2000.
Exports grew robustly at double-digit rates. In constant peso terms, exports rose by 13.4 percent over the period 1993-96, hitting the high end of the target range of 12.8-13.4 percent. This performance was fueled by the growth of electronics and semiconductors. In 1998, overall export growth was pulled down by the decline in services exports, offsetting the continued growth of merchandise exports.
The relatively strong performance of services and industry paved the way for the continued transformation of the production structure. From 22.8 percent in 1993, the share of agriculture to gross domestic product (GDP) dropped to 19.4 percent in 1998. The industry and services sectors' shares increased to 35.4 percent and 45.2 percent in 1998 from 34.3 percent and 43 percent in 1993, respectively.
Benefiting from deregulation, the services sector led the growth of domestic production. In 1998, the services sector continued to show resiliency in the midst of the crisis by being the only sector that grew during the year.
The industry sector also grew robustly in 1993-96 at 5.1 percent, which is within the low-end of the growth target. The growth was primarily driven by the construction and utilities subsectors. The utilities sector boomed in 1994-95 as investments in the power sector surged in response to the power crisis experienced in earlier years. Expansion of the construction sector peaked at 16.2 percent in 1997. In 1998, owing to the credit crunch and the general softening of demand, construction contracted significantly by 8.5 percent. The manufacturing sector also performed well prior to the Asian crisis, with growth peaking at 6.8 percent in 1995. In 1998, however, the sector was constrained by weak domestic demand and slow credit growth.
Meanwhile, agriculture remained vulnerable to adverse weather conditions, growing at 2.4 percent from 1993-96, approximating the low-end of the target. The drought in the early part of 1995 and the string of devastating typhoons toward the end of that year significantly affected rice and sugarcane production. The sector recovered in 1996-1997 but was again battered by the worst El Niņo to hit the country in 31 years, leading to the 6.6 percent contraction of the sector's gross value added (GVA) in 1998.
Notwithstanding policies to decentralize the locus of development, the National Capital Region (NCR) remained the largest economic base among the regions (Table 7.2). Nonetheless, most regions grew during 1993-1997, with the Cordillera Administrative Region (CAR) and Region I showing the strongest growth. Meanwhile, the Bicol and Visayas regions, including Central Visayas, continued to lag behind the other regions in Luzon. Mindanao, particularly the Central and Western regions, posted lackluster expansion rates.
B. Poverty Incidence and Income Distribution
Based on an annual nominal poverty threshold which was adjusted from P8,885 per capita in 1994 to P11,388 in 1997 (Table 7.3), poverty incidence declined to 32.1 percent in 1997 from 35.5 percent in 1994 and 39.9 percent in 1991. Due to population growth, however, the total number of poor families increased from 4.53 million in 1994 to 4.55 million in 1997.
The improvement in poverty incidence was more significant in the urban areas (from 24 % in 1994 to 18.5 % in 1997) than in the rural areas. Poverty incidence in the latter decreased from 47 percent in 1994 to only 44.4 percent in 1997. While income gains in the urban areas reduced the magnitude of poor families by about 600,000 families or about 32.6 percent from the 1991 level, the total number of poor families in the rural areas increased by 12.7 percent.
Bicol and the Autonomous Region of Muslim Mindanao (ARMM) registered the highest incidence, with more than half of the total number of families below the poverty line. Meanwhile, significant declines were seen in the CAR, Ilocos Region and Central Luzon.
In 1994-97, there was also an improvement in the average income of families. In real terms, the average family income in 1994 increased by 21 percent in 1997. The increase in the urban areas was higher at 28.9 percent compared with that for the rural areas at 11.5 percent. Across regions, average incomes also increased, although at varying degrees. The average family incomes in the NCR, Central Luzon and Southern Tagalog continued to be higher than the national average. Eastern Visayas had the lowest average family income.
In spite of the higher average family income across deciles, the income decile distribution showed decreasing income shares for families belonging to the first to ninth deciles. Only the income share of the richest (in the tenth decile) increased by 4.2 percentage points. As such, the 1997 income distribution resulted in a higher Gini coefficient of 0.496 compared with the 1994 ratio of 0.451. Consequently, the depth of poverty as measured by the poverty gap, or the income shortfall of all families as a proportion of the poverty line, rose from 12.6 percent in 1994 to 14 percent in 1997.
C. Employment
The average unemployment rate stood at 9.1 percent for 1993_ 97, approximating the 9 percent target under the Plan. However, the economic slowdown in 1998 led to a double-digit average unemployment rate of 10.1 percent.
In terms of jobs creation, the target in the previous Plan was to create more than one million jobs by 1998. This was achieved in 1996, two years before the target, when the economy generated 1.5 million jobs. However, the financial crisis clipped this growth in succeeding years, with the number of jobs created contracting to roughly one-third in 1997, and further in 1998 to less than one fifth (Table 7.4).
By region, the average jobless rates in the NCR (15.5 %) and Central Luzon (11.1 %) were higher than the average national unemployment rate for 1993-97 in view of their higher labor force participation. In 1998, the NCR unemployment rate reached 16 percent, traced mainly to the effects of the financial crisis. Central and Western Visayas and CARAGA also posted unemployment rates higher than 10 percent.
Following the transformation of the production sector, there was a shift in labor away from agriculture towards the services sector. In 1993, the share of the agriculture sector to total employment was 45.6 percent while that of services was 38.7 percent. By 1998, the share of agriculture went down to 39.2 percent while that of services increased to 44.4 percent. The share of manufacturing decreased slightly from 10.1 percent in 1993 to 9.7 percent in 1998.
Meanwhile, the number of underemployed persons, or those who wanted additional hours of work, grew at an average rate of 3 percent during 1993-98. The underemployment rate averaged around 21.3 percent in the same period. Of the underemployed, one-half worked for less than 40 hours a week. By geographic distribution, one-third of the underemployed worked in the rural areas. In 1998, underemployed persons totaled 6.1 million, of which 3.3 million were visibly underemployed or worked less than 40 hours a week.
Average output per worker or labor productivity generally increased over the previous planning period, except in 1996 and in 1998 when the agriculture sector was hit by the El Niņo. However, average labor productivity across all sectors fell below target. As the services sector absorbed excess agricultural labor, labor productivity in services declined, even before the crisis struck in 1997.
Among the regions, eight posted productivity improvements that were better than the national average, with the CAR recording the highest growth at 5.6 percent in 1993-1997. The NCR recorded the highest labor productivity in real terms at P76,527 or more than double the national average of P31,086 for the period. However, three regions recorded declining productivity performance, namely, Northern, Central and Western Mindanao. The ARMM and Bicol had the lowest labor productivity for the same period.
Estimates of Philippine TFP1 for 1993-96 show a negative trend. The poor performance of services contributed largely to the negative performance. A surprising result is the positive TFP for agriculture suggesting that the sector is moving towards more efficient production.
Economic growth in the last medium-term was supported by improved employer-employee relations. The improvement in relations can be attributed not only to the growing maturity of both the management and the labor sectors but also to the institutionalization of dialogue mechanisms such as the Tripartite Industrial Peace Council (TIPC). The number of strikes went down from 122 in 1993 involving 35,119 workers and 710,000 mandays lost, to only 92 strikes in 1998 involving about 33,000 workers and 557,000 mandays lost.
Overseas employment remained a viable option for workers. Total deployment of overseas Filipino workers (OFWs) increased at an annual average of 2 percent for 1993-98, reaching a record high of 755,684 in 1998. Since 1993, the Middle East was the major destination of OFWs, except in 1997 when the number of deployed OFWs was highest in Asia. In 1993-98, foreign exchange remittances of OFWs grew at an annual average of 16 percent. It may be noted that although deployment was highest in 1998, remittances fell by 14.2 percent from US$5.74 billion in 1997 to US$4.93 billion in 1998.
Total deployment was about 2.7 percent of total domestic employment in 1998. Moreover, total deployment was about 3.8 times bigger than the net increment in total employment, which was only 196,000 in 1998. Meanwhile, remittances from the OFWs accounted for 7.2 percent of GNP in 1998. This was about 16.7 percent of total export earnings for the same year. Gains from international labor migration in the form of technology and skills transfer are also noted.
D. Money, Interest Rates and Prices
Economic growth was accompanied by appropriate increases in money supply to accommodate domestic demand expansion. Domestic liquidity grew by around 25 percent in 1993-95, before decelerating to 16 and 21 percent in 1996 and 1997, respectively. The 1993-95 growth in domestic liquidity was consistent with the accelerating growth of the economy during the period. The deceleration in 1996-97 came about as the Bangko Sentral ng Pilipinas (BSP) adopted a cautious monetary policy stance to prevent further inflationary pressures arising from the rice crisis and to address the exchange rate instability arising from the regional financial turmoil which started in mid-1997. Meanwhile, from 43.7 percent in end-1995, private sector credit growth accelerated to 51.4 percent in end-1996, but decelerated to 28.7 percent in end-1997 on account of the regional crisis. Domestic banks availed of foreign borrowings to finance part of their credit expansion during the review period.
The money supply expansion in 1993-96, coupled with the relatively healthy fiscal balance, led to generally lower interest rates. The 91-day T-bill moved within the 11.3-13.6 percent band for the period (Table 7.5). Following the 1997-98 crisis, interest rates spiked starting July 1997 as the BSP raised its overnight borrowing and lending rates to 32 and 34 percent, respectively, to curb speculation in the foreign exchange market. Banks' reserve requirements were also raised from 15 percent on July 4, 1997 to 21 percent on August 28, 1997. As market conditions improved, the BSP reduced its key interest rates and implemented successive reductions in banks' reserve requirements. As a result, pressure on domestic interest rates eased. The 91-day Treasury bill rate averaged 13.4 percent in December 1998.
Inflation remained single-digit in 1993-98. The average inflation rate (1988 based) of 8.3 percent in 1993-96 was close to the target of 8.1 percent. In 1997, owing mainly to timely importation of food items, average inflation rate decelerated to 5.0 percent. In 1998, despite the peso depreciation, higher interest rate and increase in food prices due to the El Nino, average inflation rate was kept single-digit at 9.0 percent.
E. Financial Sector
The financial sector grew robustly over the plan period. From P1.4 trillion in 1993, total resources of the financial system grew by almost 150 percent as of September 1998, primarily due to the growth of commercial banks. The dramatic growth of commercial banks is attributed to the liberalization of the entry of foreign banks in 1994, the easing of rules on investment in banks, and reforms on bank branching in 1993. By 1998, commercial banks accounted for 74 percent of the total resources of the financial system. Thrift banks and rural banks accounted for 6 percent and 2 percent, respectively, while nonbank financial institutions (NBFIs) accounted for 18 percent.
The reforms also led to the significant growth in the number of the financial system's operating network. From 9,938 head offices and branches in 1993, the number of financial institutions almost doubled to 18,353 units in 1998. Over three-fifths of the increase was accounted for by nonbanks.
The financial reform process further deepened the financial market as evidenced by the increasing ratio of domestic liquidity (M3) to GNP from 32 percent in 1993 to 42 percent in 1997. With greater competition in the market, new financial instruments and services were introduced, leading to greater monetization of economic activities. Likewise contributing to the upward path was the resurgence of investor confidence in the market driven mainly by the continued improvement in market fundamentals and the establishment of a more liberalized and deregulated economy. Note, however, that the ratio slightly dipped to 41 percent in 1998 as the monetary authorities reined in the growth of liquidity to dampen inflationary pressures. Money demand softened as a result of slower GNP growth.
Financial indicators on the banking sector's nonperforming loans (NPLs), exposure to the real estate and capital adequacy have remained healthy despite the adverse effect of the financial crisis. The ratio of past due loans to total loans of the banking system or NPL steadily declined from 5.3 percent in 1993 to 3.5 percent in 1996. However, with the onslaught of the financial crisis in 1997, the ratio gradually increased to 11 percent in 1998. Compared with selected Asian countries, the country's ratio of past due obligations to total loans was far better than Indonesia's 50 percent, Thailand's 46 percent, Korea's 32 percent and Malaysia's 27 percent.2
Meanwhile, loan exposures of commercial banks to the property sector stood at 13.1 percent of their total loans3 as of December 1998, way below the 20 percent ceiling imposed by the BSP in June 1997. For prudential reasons, commercial banks with over 20 percent exposures have been required to submit a reduction program.
Finally, adequacy of capital to cover risk assets as measured by the net worth-to-risk-asset ratio of commercial banks reached 17.6 percent in October 1998, surpassing the 10 percent benchmark mandated by law.
F. External Balances and the Exchange Rate
The current account deficit remained manageable, averaging at 4.6 percent of GNP from 1994 to 1997, only 0.1 percentage point above the target for the period (Table 7.5). This was due to the rising income from trade in services which offset the trade deficit in goods. In 1998, however, there was a significantly smaller deficit in the trade in goods account due to continued exports growth and import compression arising from the economic slowdown. As a result, the current account was in surplus at US$1.3 billion in 1998, or 1.9 percent of GNP.
In the past, a large portion of the current account deficit was financed by medium- and long-term loans which expanded on average by 86.2 percent during 1993-97. Net investments, primarily in the form of portfolio investments by nonresidents, also increased substantially until the Asian crisis struck in 1997.
The reversal of global financial flows away from emerging market economies in Asia, including the Philippines, has led to a considerable reduction in financial flows in 1997-98. Medium- and long-term loans were about US$2.0 billion less in 1998 compared to 1997. However, as the financial and foreign exchange markets calmed in the last quarter of 1998, investments rebounded and reached US$1.7 billion by yearend. Net foreign direct investment expanded in 1998 by 43 percent, while net portfolio flows improved by 123 percent.
The turnaround in the current account offset the weak financial flows and enabled the economy to register a surplus of US$1.4 billion in its overall balance of payments position in 1998.
The deregulation of foreign transactions increased the size of the foreign exchange market. Average daily turnover in the foreign exchange market stood at $20.2 million and $173.9 million in 1993 and 1997, respectively. The surge in capital flows resulted in the appreciation of the peso from 1993-94. Towards the end of 1994 and the beginning of 1995, the peso fell vis-ā-vis the US dollar following the Mexican crisis. By May 1995 and until the July 1997 crisis, the nominal peso-dollar exchange rate remained generally stable. After the July 1997 depreciation, the government and the private sector adopted a series of measures to stabilize the exchange rate.
These measures included the Bankers Association of the Philippines' adoption of a foreign exchange volatility band, which was ultimately removed in early 1998. The BSP, on the other hand, redefined rules with respect to banks' foreign exchange positions, effected a series of changes in banks' reserve requirement and offered a Currency Risk Protection Program (CRPP) for borrowers with unhedged foreign exchange exposures. The depreciation of the US dollar in September 1998 and the reduction in short-term interest throughout the industrial countries in the last few months of 1998 eased the pressure on the financial markets in Asia. Consequently, the peso strengthened in the last quarter. From P43.78/US$ in September, the exchange rate beginning October gradually fell to P39.07/US$ by yearend.
G. Fiscal Balances
Although the National Government (NG) budget was in deficit at the beginning of the previous planning period, it was able to reverse this trend by: (a) enhancing revenues; (b) rationalizing government expenditures through the reduction of budgetary support to government-owned and -controlled corporations (GOCCs) and the phaseout of the Oil Price Stabilization Fund (OPSF); and (c) lengthening the maturity of debts through the flotation of long-term bonds (Tables 7.6 and 7.7). In 1998, a P50-billion deficit was posted on account primarily of the decline in the tax and revenue efforts.
In 1997, the Comprehensive Tax Reform Program (CTRP) was introduced to broaden the tax base and enhance the equity and efficiency of the tax system. The major measures included: (a) the introduction of the fringe benefits tax; (b) imposition of the 7.5 percent tax on interest from Foreign Currency Deposit Unit (FCDU) deposits; (c) the expansion of Value Added Tax (VAT) to include services; and (d) the conversion of ad valorem tax on excisable products into specific tax. Likewise, exemption levels from the income tax were increased while the income tax rates were reduced. The progressive decline in the importance of international trade taxes brought about by the Tariff Reform Program II, a landmark policy reform, has affected the Bureau of Customs (BOC) collections. Despite this, the BOC's performance remained on track, except during the crisis period.
Revenues rose from 17.4 percent of GNP in 1993 to 18.7 percent in 1997 (Table 7.7). However, the economic slowdown in 1998 significantly eroded revenues to 16.6 percent of GNP.
The Philippine privatization program has helped the economy by stimulating and attracting foreign and local investments. The program has broadened ownership base and generated revenues for the government. In 1993-98, total cumulative revenues generated from privatization and divestment of assets amounted to P121.2 billion, of which 64.5 percent was remitted to the National Treasury. Proceeds from privatization were used to finance government projects such as the Comprehensive Agrarian Reform Program (CARP) and infrastructure projects for countryside development.
On the expenditure side, prudence in spending was enhanced by the abolition and merger of government enterprises, leading to the gradual decline in national government disbursements as a percentage of GNP from 18.8 percent in 1993 to 18.3 percent in 1998. As a result of prudent debt management strategy, total interest payments also declined from about 27 percent of total disbursements in 1993 to 19 percent by 1998. Note that in 1998, the dip in expenditures is also traced to the mandatory 25 percent savings for all national government agencies.
The 13 monitored non-financial government corporations (MNFGCs) nearly balanced their budget in 1995 when only P1.3 billion deficit was incurred. However, increased expenditures in 1996 to 1998 brought back the MNFGCs financial position to double digit deficits (Table 7.8).
The sectoral allocation of the budget in 1993-98 reflected a slight shift in favor of social services. The share of economic services was reduced from 32.1 percent in 1993 to 28.3 percent in 1998, while that of social services increased from 31.8 percent to 40.8 percent (Table 7.9). Favored among the social services was education, culture and manpower development while the share of health, and housing and community amenities remained almost constant except for the jump in the share of housing and community amenities in 1995.