Economy

ECONOMY Since the end of World War II, the Philippine economy has had a mixed history of growth and development. Over the years, the Philippines has gone from being one of the richest countries in Asia (following Japan) to being one of the poorest. Growth immediately after the war was rapid, but slowed over time. Years of economic mismanagement and political instability under the Marcos regime eventually harmed economic growth and grossly adversely affected macroeconomic instability. A severe recession in 1984-85 saw the economy shrink by more than 10%, and perceptions of political instability during the Aquino administration further dampened economic activity. During his administration, President Ramos introduced a broad range of economic reforms and initiatives designed to spur business growth and foreign investment. As a result, the Philippines saw a period of higher growth, but the Asian financial crisis triggered in 1997 slowed economic development in the Philippines once again. President Estrada managed to continue some of the reforms begun by the Ramos administration. Important laws to strengthen regulation and supervision of the banking system (General Banking Act) and securities markets (Securities Regulation Code), to liberalize foreign participation in the retail trade sector, and to promote and regulate electronic commerce were enacted during his abbreviated term. Efforts to reform the constitution to encourage foreign investment, particularly foreign ownership of land, were abandoned amidst nationalist opposition. Initial optimism about prospects for economic reform also had dimmed amid concerns of governmental corruption. Scandals involving the Philippine Stock Exchange, and the President's close ties to certain businessmen, shook the confidence of investors and the business community and ultimately led to successful efforts to impeach and remove President Estrada. Despite occasional challenges to her presidency and resistance to pro-liberalization reforms by vested interests, President Arroyo has made considerable progress in restoring macroeconomic stability with the help of a well-regarded economic team. Nonetheless, long-term economic growth remains threatened by widespread poverty, crumbling infrastructure and education systems, and trade and investment barriers. Important sectors of the Philippine economy include agriculture and industry, particularly food processing, textiles and garments, and electronics and automobile parts. Most industries are concentrated in the urban areas around metropolitan Manila. Mining also has great potential in the Philippines, which possesses significant reserves of chromite, nickel, and copper. Significant natural-gas finds off the islands of Palawan have added to the country's substantial geothermal, hydro, and coal energy reserves. Today's Economy GDP grew by 7.3% in 2007, the fastest pace of growth in over three decades, and capped nine consecutive quarters of growth at greater than 5%. Historically, the Philippines has had difficulty sustaining growth at over 5%. GDP increased by 5.4% in 2006, 4.9% in 2005, and 6.4% in 2004. Growth in 2007 was fueled by increased government and private construction expenditures; a robust information communications technology industry; improved post-drought agricultural harvests; and strong private consumption, spurred in part by $14.4 billion in remittances from overseas workers (equivalent to about 10% of GDP). GDP growth is expected to slow in 2008, but still reach between 5% and 6%. Still, it will take a higher, sustained economic growth path to make more appreciable progress in poverty alleviation given the

Philippines' annual population growth rate of nearly 2%--one of the highest in Asia. The ratio of the population living below the national poverty line increased from 30% to 33% between 2003 and 2006, which translated to 3.8 million more poor Filipinos. Inequitable income distribution also makes steady progress in poverty alleviation especially challenging. The services sector now accounts for about 55% of Philippine GDP and grew by 8.7% in 2007. Business process outsourcing (BPO) has been the fastest-growing segment of the Philippine economy, totaling an estimated 10% of the global outsourcing market and generating an estimated $5 billion in revenues during 2007 (equivalent to about 3.5% of Philippine GDP). BPO revenue grew 40% during 2006 and 2007, and is expected to repeat this growth over the next two years. The construction industry grew by almost 20% in real terms during 2007, fueled by a 30% real increase in government construction expenditures and a 10% increase in private construction investment. Tourism and mining continued to emerge as key industries in 2007. Tourism enjoyed a record year in 2007, with over 3 million arrivals from overseas spending more than $5 billion and helping to fuel air transportation growth of 15%. Mining and quarrying grew by 25%. At $8.6 billion, the overall balance of payments ended 2007 with a record surplus which, among others, reflected higher overseas workers remittances, tourism receipts, BPOrelated revenues, portfolio investments, and official development assistance funds. Merchandise exports, relying heavily on electronics shipments for about two-thirds of export revenues, slowed to 6% growth (from 15% growth in 2006). Although there has been some improvement over the years, local value added of electronics exports remains relatively low at about 30%. Net foreign direct investment (FDI) inflow rose from a low base to nearly $3 billion in 2006 and 2007--nearly double the 2005 level--but still lags most regional neighbors. The U.S. remains the Philippines' largest trading partner with over $17 billion in two-way trade, and the largest investor with more than $6.5 billion in total FDI. The Philippine stock market closed 2007 among the top performers in East Asia. The Philippine peso appreciated about 16% to the U.S. dollar between end-2006 and end2007, making it East Asia's best performing currency. Gross international reserves closed 2007 up nearly 47% year-on-year to a new record high of $33.7 billion, adequate for nearly 6 months of goods and services imports and equivalent to 3 times foreign debts maturing over the next 12 months. Efforts in recent years to reduce the public sector deficit and raise new taxes have helped reduce high debt ratios, create additional fiscal space to increase spending on vital social services and infrastructure after years of tight budgets, and improve confidence. December 2004 legislation provided for biennial adjustments to the excise tax rates for tobacco and liquor products until 2011, while a law signed in January 2005 seeks to institute a performance-based rewards and penalty system in the government's revenue collection agencies. Despite public resistance and initial legal challenges, the government began implementing an expanded value-added tax (VAT) law in November 2005, which added an estimated 75 billion pesos ($1.5 billion) to national government revenues during 2006 (equivalent to 1.2% of GDP).

From a record 5.3% of GDP in 2002, the national government has recorded declining fiscal deficits for five consecutive years (to 0.1% of GDP in 2007) and targets balancing the budget in 2008. For a second consecutive year, the national government's deficitreduction program has helped yield modest surpluses for the consolidated public sector. Although more reforms and greater transparency are needed, tighter financial controls over state-owned companies and initiatives to improve the longer-term viability of staterun pension funds also contributed to recent surpluses of the consolidated public sector (which, in addition to the national government, includes state-owned enterprises, staterun pension funds, local government units, and the Central Bank). Although still high, the debt of the consolidated public sector has declined to under 80% of GDP, from 2003's peak 118%-of-GDP ratio. Major credit rating agencies raised their rating outlook for Philippine sovereign debt from "negative" to "stable" in recognition of fiscal progress, helping to bring down domestic interest rates and tighten spreads on foreign bonds. Looking forward, further reforms are needed to ease fiscal pressures from large losses being sustained by a number of government-owned firms and to control and manage contingent liabilities. Despite recent improvements, challenges still remain to ensuring the long-term viability of state-run pension funds. The national government's tax-to-GDP ratio remains low relative to historical performance and vis-a-vis regional standards. It had slipped from a peak of 17% in 1997 to 12.5% by 2004 before improving to 13.0% in 2005 and further improving to 14.3% in 2006 (boosted mainly by collections from the expanded VAT law). However, the tax-to-GDP ratio declined to 14% in 2007. Heftier privatization receipts more than made up for the shortfall in targeted tax collections but are not a sustainable revenue source. The Special Purpose Vehicle (SPV) Act of 2003, which provides time-bound fiscal and regulatory incentives to encourage the sale to private asset management companies, has helped to reduce banks' portfolios of non-performing assets. The ratio of nonperforming assets to total commercial banking system assets--which peaked at 18.3% in October 2001--has reverted to single-digit levels since mid-2005 and had declined to 5.2% of assets by end-2007. The share of non-performing loans to commercial banking system loans had declined to 4.5% as of end-2007, from a March 2002 high of 17.6%. Reforms in recent years include the adoption of international accounting and financial reporting standards (starting 2006) and Basel II standards (effective July 2007). Nevertheless, circumstances surrounding bank closures continue to highlight remaining impediments to more effective bank supervision and timely intervention--including stringent bank secrecy laws, obstacles preventing bank regulators from examining banks at will, and inadequate legal protection for Central Bank officials and examiners. The Central Bank's adoption since January 2002 of an inflation-targeting framework has enhanced transparency in the conduct of monetary policy. The inflation rate averaged 6.2% in 2006, down from 7.6% in 2005, and was expected to fall further to 2.8% in 2007, comfortably below the Central Bank's target of 4%-5%. The Arroyo administration enacted an anti-money laundering law in September 2001 and followed through with amendments in March 2003 to address remaining legal concerns posed by the Organization for Economic Cooperation and Development (OECD) Financial Action Task Force (FATF). The FATF removed the Philippines from its

list of Non-Cooperating Countries and Territories in February 2005, noting the significant progress made to remedy concerns and deficiencies identified by the FATF to improve implementation. The Egmont Group, the international network of financial intelligence units, admitted the Philippines to its membership in June 2005. Although encountering implementation hitches, the Arroyo administration also enacted legislation in 2001 to rationalize the electric power sector and privatize the government's debt-saddled National Power Corporation (NPC). This effort achieved significant progress in 2007 with the privatization of the state-owned transmission company (Transco) for $3.95 billion after four previous failed attempts. The government has achieved some success in establishing an independent regulatory system for electricity pricing that will benefit NPC finances. In addition to the Special Purpose Vehicle law, President Arroyo also signed into law in 2003 a priority initiative to reform the government procurement system (the Government Procurement Reform Act). During the first quarter of 2004, she signed into law legislation to rationalize and plug leakages in the Philippines' convoluted documentary stamp tax system and encourage secondary trading of financial instruments, as well as legislation (the Securitization Act) towards establishing the necessary infrastructure and market environment for a wide range of asset-backed securities. She also signed legislation to institutionalize Alternative Dispute Resolution for civil cases to help address the problem of overburdened court dockets. The U.S. Trade Representative removed the Philippines from its Special 301 Priority Watchlist in 2006, reflecting improvement in its enforcement of intellectual property rights (IPR) protection. However, sustained effort and continuing progress on key IPR issues will be essential to maintain this status. Despite a number of policy reforms and much improved general macroeconomic outlook, the Philippines continues to face important challenges and must sustain the reform momentum to catch up with its regional neighbors and to translate the current cautious optimism into the long-term confidence required to spur investments, achieve higher growth, generate employment, and alleviate poverty for a rapidly expanding population. Absent new revenue measures, sustained fiscal stability will require more aggressive tax collection efficiency to address the severe under-spending in infrastructure and social services in recent years of tight budgets. Continuing efforts to fast-track power sector privatization remain critical to the long-term stability of public sector finances, ensuring reliable electricity supply, and to bringing down the high cost of power. Potential foreign investors, as well as tourists, continue to be concerned about law and order, inadequate infrastructure, policy and regulatory instability, and governance issues. While trade liberalization presents significant opportunities, intensifying global competition and the emergence of low-wage export economies also pose challenges. Competition from other Southeast Asian countries and from China for investment underlines the need for sustained progress on structural reforms to remove bottlenecks to growth, to lower costs of doing business, and to promote good public and private sector governance. The government has been working to reinvigorate its anti-corruption drive, and the Office of the Ombudsman has reported improved conviction rates. Nevertheless, the Philippines will need to do more to improve international perception of

its anti-corruption campaign--an effort that will require strong political will and significantly greater financial and human resources. Agriculture and Forestry Arable farmland comprises more than 40% of the total land area. Although the Philippines is rich in agricultural potential, inadequate infrastructure, lack of financing, and government policies have limited productivity gains. Philippine farms produce food crops for domestic consumption and cash crops for export. The agricultural sector employs more than one-third of the work force but provides less than one-fifth of GDP. Decades of uncontrolled logging and slash-and-burn agriculture in marginal upland areas have stripped forests, with critical implications for the ecological balance. The government has instituted conservation programs, but deforestation remains a severe problem. With its 7,107 islands, the Philippines has a very diverse range of fishing areas. Notwithstanding good prospects for the agriculture subsector, the marine fishing industry continues to face a bleak future due to destructive fishing methods, a lack of funds, and inadequate government support. Agriculture generally suffers from low productivity, low economies of scale, and inadequate infrastructure support. Agricultural output fell in 1997 and 1998 due to an El Niño-related drought but increased by 6.0% in 1999 (over 1998's low base). Growth reverted to more normal rates in 2000 (4.0%) and 2001 (3.7%). Agricultural output (affected by another, albeit milder, dry spell) expanded by 3.9% year-on-year in 2002 and 3.2% in 2003. Agricultural output increased by 5.1% in real terms during 2004 but stagnated to 2.24% in 2005 due to drought and intermittent weather disturbances. Despite the adverse effects of successive and very strong typhoons in the last four months of 2006, the overall annual farm output expanded by 3.8% and accelerated further to 5.1% growth during 2007. Industry Industrial production is centered on processing and assembly operations of the following: food, beverages, tobacco, rubber products, textiles, clothing and footwear, pharmaceuticals, paints, plywood and veneer, paper and paper products, small appliances, and electronics. Heavier industries are dominated by the production of cement, glass, industrial chemicals, fertilizers, iron and steel, and refined petroleum products. The industrial sector is concentrated in the urban areas, especially in the metropolitan Manila region and has only weak linkages to the rural economy. Inadequate infrastructure, transportation and communication have so far inhibited faster industrial growth, although significant strides have been made in addressing the last of these elements. Mining The Philippines is one of the world’s most highly mineralized countries, with untapped mineral wealth estimated at more than $840 billion. Philippine copper, gold and chromite deposits are among the largest in the world. Other important minerals include nickel, silver, coal, gypsum, and sulfur. The Philippines also has significant deposits of clay, limestone, marble, silica, and phosphate. The discovery of natural gas reserves off Palawan Island has been brought on-line to generate electricity.

Despite its rich mineral deposits, the Philippine mining industry is just a fraction of what it was in the 1970s and 1980s when the country ranked among the ten leading gold and copper producers worldwide. Low metal prices, high production costs, and lack of investment in infrastructure have contributed to the industry’s overall decline. A December 2004 Supreme Court decision upheld the constitutionality of the 1995 Mining Act, thereby allowing up to 100% foreign-owned companies to invest in large-scale exploration, development, and utilization of minerals, oil and gas. GDP (2007): $144.1 billion. Annual GDP growth rate (2007): 7.3% at constant prices. GDP per capita (2007): $1,624. Natural resources: Copper, nickel, iron, cobalt, silver, gold. Agriculture: Products--rice, coconut products, sugar, corn, pork, bananas, pineapple products, aquaculture, mangoes, eggs. Industry: Types--textiles and garments, pharmaceuticals, chemicals, wood products, food processing, electronics assembly, petroleum refining, fishing. Trade (2007): Exports--$50.3 billion. Imports--$55.3 billion.