April 2018 INVESTING IN THE FUTURE Macroeconomics, Trade and Investment Global Practice East Asia and Pacific Region INVESTING IN THE FUTURE April 2018 TABLE OF CONTENTS PREFACE.................................................................................................................................................... i ABBREVIATIONS AND ACRONYMS ........................................................................................................ ii EXECUTIVE SUMMARY............................................................................................................................ iii References............................................................................................................................................. 45 ANNEX....................................................................................................................................................... 46 I. Recent Economic and Policy Developments ....................................................................................... 1 1.1 Growth: Benefitting from the Global Recovery ................................................................................. 2 1.2 The Exchange Rate and the External Sector: Impacts from an Improving External Environment ... 6 1.3 Financial Markets and Monetary Policy: Keeping the Policy Rate Steady despite Rising Inflation .. 9 1.4 Fiscal Policy: Preparing for the Public Investment Increase .............................................................. 11 1.5 Employment and Poverty: A Tight Labor Market with Limited Real Wage Growth ......................... 15 II. Outlook and Risks................................................................................................................................ 19 2.1 Growth Outlook ................................................................................................................................ 20 2.2 Poverty and Shared Prosperity Outlook ........................................................................................... 26 2.3 Risks and Policy Challenges............................................................................................................... 27 III. The Missing Links to Higher Shared Prosperity in the Philippines.................................................. 31 3.1 Introduction........................................................................................................................................ 32 3.2 Drivers of Poverty Reduction ............................................................................................................. 34 3.3 The Remaining Challenge: Low-quality Jobs and Slow Real Wage Growth ...................................... 35 3.4 The Importance of Education in Labor Market Participation and Wage Growth ............................. 39 3.5 Conclusion .......................................................................................................................................... 44 LIST OF FIGURES Figure 1: Strong exports contributed to growth among regional peers in 2017 …........................................ 2 Figure 2: … and helped sustain growth in the Philippines ............................................................................. 2 Figure 3: In the Philippines, exports drove growth while investment significantly slowed …....................... 3 Figure 4: … while manufacturing expanded and agriculture recovered........................................................ 3 Figure 5: Average capacity utilization in the manufacturing sector has reached historic highs in early 2018........................................................................................................................................ 4 Figure 6: In 2017, the Peso has depreciated in both nominal and real terms…............................................ 6 Figure 7: … making it one of the worst performing regional currencies ....................................................... 6 Figure 8: Recovery in the external environment supported the growth in exports in 2017 ........................ 9 Figure 9: … yet continued higher import growth led to a widening current account deficit ........................ 9 Figure 10: Exports of electronics (index, 2010 = 100)...................................................................................... 8 Figure 11: Inflation rose sharply and surpassed in March 2018 the ceiling of the Central Bank’s target range ............................................................................................................................................... 10 Figure 12: Credit has sustained its double-digit growth rates ......................................................................... 10 Figure 13: National government fiscal balance, 2013-17................................................................................. 11 Figure 14: Fiscal balance, percent of GDP, 2000-17......................................................................................... 12 Figure 15: Public expenditures as a share of nominal GDP, 2013-17............................................................... 12 Figure 16: Public expenditures by economic classification (Actual disbursements), percent of total expenditures, 2013-17..................................................................................................................... 13 Figure 17: Public expenditures by functional classification (Obligation basis), percent of total expenditures, 2013-17.................................................................................................................... 13 Figure 18: Government revenue efforts, 2000-16 .......................................................................................... 14 Figure 19: Tax revenue efforts, 2000-16.......................................................................................................... 14 Figure 20: The government financed its deficit through domestic borrowing .............................................. 14 Figure 21: The overall debt-to-GDP ratio remained unchanged from 2016 to 2017...................................... 14 Figure 22: The unemployment rate remained around 5 percent .................................................................. 16 Figure 23: … while the labor force participation rate remained below the 10-year average......................... 16 Figure 24: Changes in real daily wages, 2007-17............................................................................................ 16 Figure 25: The Philippine economy is projected to grow at 6.7 percent in 2018 and 2019........................... 20 Figure 26: Global economic growth, 2000-2020............................................................................................. 21 Figure 27: Output gaps, 2000-2018................................................................................................................. 21 Figure 28: The largest share of domestic bank credit is channeled to real estate and construction............. 26 Figure 29: The manufacturing and finance sectors are among the favorite destinations of foreign direct investment ........................................................................................................................... 26 Figure 30: Sustained economic growth makes it likely that poverty reduction will continue........................ 27 Figure 31: Selected macroeconomic indicators .............................................................................................. 28 Figure 32: National poverty rates and number of poor.................................................................................. 32 Figure 33: Poverty trends based on national and international poverty lines ............................................... 32 Figure 34: Prosperity Improvement in the Philippines compared to the East Asia pacific region................. 33 Figure 35: Contribution of income sources to poverty reduction, 2006–2015.............................................. 34 Figure 36: Millions of workers transitioned out of agriculture....................................................................... 35 Figure 37: Greater earnings in services and manufacturing than in agriculture............................................ 35 Figure 38: Poverty rate by employment sector of household heads ............................................................. 36 Figure 39: Poverty rate by employment status of household heads.............................................................. 36 Figure 40: Working-age population, labor force, and employment growth................................................... 37 Figure 41: GDP, employment, and real wage growth ..................................................................................... 37 Figure 42: Share of employment of the poor by sector.................................................................................. 37 Figure 43: Share of employment of an average Filipino by sector ................................................................. 37 Figure 44: Intersectoral labor allocation in select East Asian countries ......................................................... 38 Figure 45: Countries changes in the composition of employment status over time ..................................... 39 Figure 46: Rate of return for another year of education ................................................................................ 40 Figure 47: Rate of return for education by education level............................................................................ 40 Figure 48: Marginal effect on the probability of wage employment with an additional year of schooling by gender and location................................................................................................................... 41 Figure 49: Marginal effect on the probability of wage employment with an additional year of schooling by education level........................................................................................................................... 41 Figure 50: Youth (20–29 years old) education levels across income groups .................................................. 42 Figure 51: Educational attainment rate among 22–24 year-olds by income quintiles, 2006-15 ................... 42 Figure 52: Educational attainment rate among 22–24 year-olds by gender, 2006-15 ................................... 42 Figure 53: Reasons for not attending elementary school among 6- to 11-year-olds in the poorest quintile, 2014.................................................................................................................................. 43 Figure 54: Reasons for not attending high school among 12- to 15-year-olds in the poorest quintile, 2014.43 LIST OF BOXES Box 1: The global economy is experiencing a broad-based and maturing cyclical recovery ................... 5 Box 2: Electronics export growth in the East Asia Pacific region ............................................................. 8 Box 3: Recent public expenditure profile of the Philippines..................................................................... 12 Box 4: Public revenue in the East Asia Pacific region................................................................................ 14 Box 5: Building human capital through the K-12 basic education program ............................................ 17 Box 6: The global economic outlook......................................................................................................... 20 Box 7: Initiatives to modernize the budgeting process............................................................................. 24 Box 8: The next steps for the Government’s tax reform program............................................................ 29 LIST OF TABLES Table 1: Balance of payments, 2014-17....................................................................................................... 7 Table 2: Real GDP growth rates, 2015-2020................................................................................................ 22 Table 3: Economic indicators for the baseline projection ........................................................................... 25 Table 4: Poverty rate in selected East Asian countries ................................................................................ 33 Table 5: Employment and earnings status, percent.................................................................................... 39 Table 6: Employment, unemployment, and daily earnings by educational attainment, percent .............. 40 PREFACE The Philippines Economic Update summarizes key economic and social developments, important policy changes, and the evolution of external conditions over the past six months. It also presents findings from recent World Bank analysis, situating them in the context of the country’s long-term development trends and assessing their implications for the country’s medium-term economic outlook. The update covers issues ranging from macroeconomic management and financial- market dynamics to the complex challenges of poverty reduction and social development. It is intended to serve the needs of a wide audience, including policymakers, business leaders, private firms and investors, and analysts and professionals engaged in the social and economic development of the Philippines. The Philippines Economic Update is a biannual publication of the World Bank’s Macroeconomics, Trade, and Investment Global Practice (MTI), prepared in partnership with the Poverty & Equity, Finance, Competitiveness & Innovation, and Social Protection & Labor Global Practices (GPs). Birgit Hansl (Lead Economist and Program Leader) and Ndiame Diop (Practice Manager for the MTI GP) guided the preparation of this edition. The team consisted of Kevin Chua (Economist), Kevin Cruz (Research Analyst) and Rong Qian (Senior Economist) from the MTI GP, Isaku Endo (Senior Financial Sector Specialist) from the Finance, Competitiveness and Innovation GP, Gabriel Demombynes (Program Leader), Xubei Luo (Senior Economist) and Sharon Faye Alariao Piza (Economist) from the Poverty & Equity GP. Thilakaratna Ranaweera (Consultant) provided technical support on the growth projection. The report was edited by Oscar Parlback (Сonsultant), and the graphic designer was Robert Waiharo (Сonsultant). Peer reviewers were Jasmin Chakeri (Program Leader, LCC1C) and Yutaka Yoshino (Lead Economist and Program Leader, AFCE1). Logistics and publication support were provided by Maria Consuelo Sy (Program Assistant). The Manila External Communications Team, consisting of David Llorito (Communications Officer) prepared the media release, dissemination plan, and web-based multimedia presentation. The team would like to thank Mara Warwick (Country Director for Brunei, Malaysia, Philippines and Thailand) for her advice and support. The report benefited from the recommendations and feedback of various stakeholders in the World Bank as well as from the government, the business community, labor associations, academic institutions, and civil society. The team is very grateful for their contributions and perspectives. The findings, interpretations, and conclusions expressed in the Philippines Economic Update are those of the World Bank and do not necessarily reflect the views of the World Bank’s executive board or any national government. This report went to press on April 13, 2018. If you wish to be included in the email distribution list for the Philippines Economic Update and related publications, please contact Maria Consuelo Sy (msy@worldbank.org). For questions and comments regarding the content of this publication, please contact Birgit Hansl (bhansl@worldbank.org). Questions from the media should be addressed to David Llorito (dllorito@worldbank.org). For more information about the World Bank and its activities in the Philippines, please visit www. worldbank.org/ph. Philippines ECONOMIC UPDATE • April 2018 i ABBREVIATIONS AND ACRONYMS 2TBA Two-tier Budgeting Approach BOP Balance of Payments BPO Business Process Outsourcing BSP Bangko Sentral ng Pilipinas CALABARZON Cavite, Laguna, Batangas, Rizal, and Quezon CPI Consumer Price Index EMDEs Emerging Market and Developing Economies FDI Foreign Direct Investment GOCC Government-owned and Controlled Corporation IT Information Technology PREXC Program Expenditure Classification TFP Total Factor Productivity TRAIN Tax Reform for Acceleration and Inclusion TVET Technical and Vocational Education and Training UACS Unified Accounts Code Structure VA Value Added ii Philippines ECONOMIC UPDATE • April 2018 EXECUTIVE SUMMARY In 2017, the Philippines was among the top The country’s medium-term growth outlook three growth performers in the East Asia region. remains positive. The Philippine economy is Only Vietnam and China performed better. projected to continue on its expansionary path The Philippines growth performance slightly and grow at an annual rate of 6.7 percent in both weakened in 2017 to 6.7 percent year-on-year 2018 and 2019. In 2020, growth is expected to from 6.9 percent in 2016. Growth was anchored level at 6.6 percent. The economy is currently in strong exports, while investment growth growing at its potential, making productive significantly slowed and consumption growth investment in physical and human capital moderated. The Philippines’ annual exports rose essential for the economy to continue to grow sharply in 2017 and became the main engine of along its current growth trajectory. Investment economic growth, while imports continued to growth hinges on the government’s ability to grow by double-digits. Investment growth slowed effectively and timely implement its ambitious in 2017, following two consecutive years of rapid public investment program. expansion, and climbing inflation slowed real wage growth and contributed to a moderation in Domestic risks are becoming more prominent. private consumption growth. Inflationary pressure is expected to intensify in 2018 due to both domestic and external Monetary and fiscal policy remained factors. The Philippine economy is also at risk of accommodative. Both fiscal expenditure and overheating. The implementation of the public revenue increased in 2017 compared to 2016. infrastructure program is vital to the country’s The fiscal deficit narrowed, as the government growth outlook, as private investment is narrowly missed its expenditure target, despite expected to weaken. Prudent fiscal management improved budget execution. Infrastructure and the implementation of the government’s tax expenditures exceeded their programmed target, reform agenda could help secure the country’s and focused on repair and rehabilitation projects, fiscal sustainability. External risks remain while most of the planned flagship investment present, especially a faster-than-expected policy program has not started construction yet. normalization in advanced economies that Revenue collection in the Philippines is still could trigger financial volatility and increase among the lowest in the region, but as a key capital outflows from the Philippines. Renewed revenue mobilization policy, the Philippines protectionist sentiments in several advanced successfully passed its first package of tax economies will also elevate policy uncertainty, reforms in December 2017, which is estimated which may disrupt trade and investments. to generate an additional Php82.3 billion in public revenue in 2018. Rising inflation started High-quality jobs and faster growth of real wages to put a strain on the Bangko Sentral ng Pilipinas’ are essential to achieve shared prosperity and (BSP) accommodative monetary policy in 2017, inclusive growth. In recent years, the Philippine and the inflation rate exceeded the ceiling of the economy has made great strides in delivering inflation target range in early 2018. Nonetheless, inclusive growth, evidenced by the declining the BSP’s monetary board kept the policy rate poverty rates and a falling Gini coefficient. fixed at 3.0 percent. Unemployment has reached historic low rates, Philippines ECONOMIC UPDATE • April 2018 iii Executive Summary but underemployment remains high, near its More can be done to create high-quality jobs in 18-20 percent decade-long average. More the Philippines. Delivering inclusive economic importantly, unlike its high-performing East Asian growth through better-paying jobs remains neighbors with booming manufacturing sectors the country’s most pressing challenge. The that provide large numbers of labor-intensive government needs to affirm its commitment to jobs, a majority of Filipino workers that transition structural reforms that promote competition, out of agriculture generally end up in low-end secure property rights, lessen regulatory service jobs. Thus, while employment increased complexities, and improve the country’s between 2006 and 2015, mean wages remained investment climate. Investing in the future stagnant, with only a four percent increase in real means prioritizing investment in both physical terms over the same period. High-quality jobs infrastructure and human capital, such as in and faster growth of real wages are the missing education, skills, and health, as this will create links to higher shared prosperity. better employment opportunities, especially among the poor. iv Philippines ECONOMIC UPDATE • April 2018 Part I: Recent Economic and Policy Developments The Philippines’ growth performance slightly weakened in 2017 to 6.7 percent year-on-year from 6.9 percent year-on-year in 2016. The country’s main growth driver was stronger external demand due to the ongoing global recovery. Philippine exports expanded by 19.2 percent year-on-year in 2017—the highest rate since 2010—and nearly doubled its 10.7 percent year-on-year growth in 2016. Consumption growth remained strong, close to its seven-year average, but moderated because of higher inflation in 2017. Investment growth slowed significantly in 2017, with fixed capital formation growing at 10.3 percent year-on-year in 2017 compared to 25.2 percent year-on-year in 2016. Monetary policy remained accommodative, as the key policy rate has been maintained at 3.0 percent since June 2016, while the reserve requirement ratio was lowered by one percentage point in March 2018. Fiscal policy remained consistent with the government’s policy to increase human capital and infrastructure investments. However, a faster-than-expected normalization of global policy rates and concerns over a growing current-account deficit in the Philippines diminished investors’ appetite for Philippine assets, leading to capital outflows and a continued weakness in the exchange rate. Nevertheless, sustained economic growth in recent years made it likely that poverty continued to decline, but recent inflation trends might adversely impact the poor. Philippines Philippines ECONOMIC ECONOMIC UPDATE UPDATE • October 2017 • April 2018 1 I. Recent Economic and Policy Developments 1.1 Growth: Benefitting from the Global Recovery In 2017, the Philippines was among the top three growth performers in the region, with an annual GDP growth rate of 6.7 percent. The country’s economic growth was anchored in strong exports, while investment growth significantly slowed and consumption growth moderated. 1. The ongoing global economic recovery 2. The Philippines’ annual exports rose has raised the demand for Philippine exports, sharply in 2017 and became the main engine which constituted the country’s main driver of of economic growth, while imports continued economic growth in 2017. A maturing, broad- to grow by double-digits. The export growth rate based cyclical recovery in advanced economies nearly doubled from 10.7 percent year-on-year in and a long-awaited rebound in global investment, 2016 to 19.2 percent year-on-year in 2017 — the trade, and manufacturing (Box 1) resulted in highest level since 2010 when exports rose by 21.0 favorable external demand conditions that led percent year-on-year (Figure 3).1 The country’s to more vibrant export activities in the region. As strong export performance was fueled by a with regional peers such as China, Vietnam, and rebound in the exports of electronics components Malaysia (Figure 1), the Philippines experienced — its main export commodities, which grew by a surge in exports, which partly compensated for 27.5 percent year-on-year, more than three times the significant fall in domestic demand, especially the growth rate in 2016.2 In particular, the growth for investment. As a result, its annual GDP growth in the exports of semiconductor components rate fell slightly from 6.9 percent in 2016 to 6.7 accelerated from 25.8 percent year-on-year in percent in 2017. Despite a continued inflow 2016 to 41.8 percent year-on-year in 2017. The of remittances, private consumption growth export of electronics components also drove the moderated as inflation continued to climb, import of intermediary electronics goods, which limiting real wage growth. Compared to 2016, grew from 34.0 percent year-on-year in 2016 to the Philippines fell by two ranks in the regional 35.2 percent year-on-year in 2017. Overall, the growth table in 2017, with China and Vietnam annual import growth rate of 17.6 percent in 2017 taking over the top ranks (Figure 2). remained close to the 2016 level of 18.5 percent. Figure 1: Strong exports contributed to growth among Figure 2: … and helped sustain growth in the regional peers in 2017 … Philippines 30.0 9.0 8.0 20.0 7.0 10.0 6.0 5.0 Percent Percent 0.0 4.0 -10.0 3.0 2.0 -20.0 1.0 2015 2016 2017 2015 2016 2017 2015 2016 2017 2015 2016 2017 2015 2016 2017 - -30.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Malaysia Indonesia China Philippines Vietnam (1.0) Private Consumption Government Consumption 2013 2014 2015 2016 2017 Gross Fixed Capital Formation Change in Stocks Average (Developing EA ex. China) Indonesia Exports Imports Malaysia Philippines Statistical Discrepancy GDP growth Thailand Vietnam Source: World Bank staff calculations, Haver Analytics, 2015-2017 data. Source: World Bank staff calculations. Note: Countries in developing East Asia, excluding China, are the Philippines, Indonesia, Malaysia, Thailand, and Vietnam. 1 The discussion of net exports in this section assesses values at constant 2000 prices. This differs from the discussion in the balance of payments section, where net exports are assessed based on values at current prices. 2 The growth of agricultural exports, driven by the exports of coconut and sugar products, rose from 1.8 percent year-on-year in 2016 to 9.3 percent year-on-year in 2017, as the agriculture sector recovered in 2016. 2 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments Figure 3: In the Philippines, exports drove growth Figure 4: … while manufacturing expanded and while investment significantly slowed … agriculture recovered 20 8 15 6 10 Percentage point Percentage point 4 5 0 2 -5 0 -10 -15 2013 2014 2015 2016 2017 -2 2013 2014 2015 2016 2017 Private Consumption Govt Consumption GDP growth Investments Discrepancy Agriculture Other industry Manufacturing Exports Imports Services GDP growth Source: PSA. Source: PSA. Note: Other industries are mining and quarrying, construction, electricity, gas, and water. 3. Consumption growth, the country’s investment growth in durable equipment and second engine of economic growth, moderated construction declined sharply. Investment in in 2017. The annual consumption growth durable equipment expanded by 12.2 percent rate decelerated from 7.1 percent in 2016 to year-on-year in 2017, significantly less than 6.0 percent in 2017 — close to its seven-year the 34.5 percent year-on-year in 2016, while average of 5.8 percent. It was supported by a construction investment growth slowed from 15.1 sustained credit expansion, which benefitted percent year-on-year in 2016 to 5.7 percent year- from a continued accommodative monetary on-year in 2017. The annual public construction policy stance by the Bangko Sentral ng Pilipinas growth rate fell from 28.0 percent in 2016 to 13.5 (BSP).3 Private consumption was also supported percent in 2017, which was likely partly the result by a robust growth in remittances from overseas of a base effect from the increase in public capital Filipinos from 4.9 percent year-on-year in 2016 spending during the pre-election period in 2016. to 5.3 percent year-on-year in 2017, totaling Moreover, private construction, which account US$31.3 billion, or 10.3 percent of GDP in for nearly three-fourths of all investments in 2017. However, a rising inflation rate gradually the construction sector, expanded at a much weakened consumer sentiment, and a slightly slower pace in 2017 (3.3 percent year-on-year) higher unemployment rate likely contributed to compared to 2016 (11.5 percent year-on-year). a slowdown in private consumption growth in 2017. The annual public consumption growth 5. The manufacturing sector grew for a rate also fell from 8.4 percent in 2016 to 7.3 second consecutive year, surpassing the growth percent in 2017.4 performance of the services sector. While growth in the industry sector was robust, it moderated 4. Investment growth moderated in 2017, from 8.4 percent year-on-year in 2016 to 7.2 following two consecutive years of rapid percent year-on-year in 2017 (Figure 4). The expansion. Fixed capital formation decelerated manufacturing sector, specifically communication from growing by 25.2 percent year-on-year in equipment production, food manufacturing, and 2016 to 10.3 percent year-on-year in 2017, as chemical production, continued to fuel output 3 The BSP kept the policy rate unchanged at 3.0 percent in 2017, which maintained low interest rates and contributed to a double-digit expansion in consumer loans in 2017. 4 Domestic spending in 2016 was supported by election-related government spending. Philippines ECONOMIC UPDATE • April 2018 3 I. Recent Economic and Policy Developments growth and grew from 7.0 percent year-on-year remains vulnerable to weather-related shocks in 2016 to 8.6 percent year-on-year in 2017.5 that continue to cause volatility and reduce farm While manufacturing output growth (i.e. the output. For example, damages from typhoon volume of production index) was negative in the Urduja, which struck the country in December latter half of 2017, it expanded rapidly in January 2017, reached an estimated Php1.0 billion, and February of 2018 (Figure 5). Together with affecting the livelihood of 38,466 farmers and increasing capacity utilization levels, this raises damaging 23,829 metric tons of farm output.9 A the risk of overheating in the economy (see positive development in the agriculture sector Part II. Outlook and Risks).6 The services sector is the continued diversification of farm produce constituted another strong growth performer in into high value export crops such as coconut, 2017 and expanded by 6.7 percent year-on-year coffee, and cacao, which is reflected in growing in 2017, down from 7.4 percent year-on-year in agricultural exports. 2016. In the services sector, financial services Figure 5: Average capacity utilization in the exhibited the strongest growth and expanded manufacturing sector has reached historic highs in early 2018 slightly from 7.6 percent year-on-year in 2016 to 30 84.4 7.7 percent year-on-year in 2017.7 25 84.2 Capacity utilization (in percentage) 20 6. Following a contraction in 2016, the 84 15 agriculture sector recovered in 2017 due to In Percentage 83.8 10 favorable weather conditions. The country’s 83.6 5 agriculture sector grew by 3.9 percent year- 83.4 0 on-year in 2017, reversing a contraction of 1.3 -5 83.2 percent year-on-year in 2016. The recovery was -10 83 May-17 Mar-17 Nov-17 Sep-17 Jan-17 Jan-18 primarily the result of a low base in 2016 and Jul-17 more favorable weather conditions for farm VoPI VaPI Average capacity utilization rate output.8 Despite the sector’s recent recovery, it Source: PSA. 5 However, the mining, construction, and utilities sectors registered lower growth in 2017. 6 Manufacturing output growth in early 2018 was mainly driven by the production of food, petroleum product, and electrical machinery, the last of which, could lead to the expansion of productive capacity. 7 Similarly, wholesale and retail trade, government services subsectors, and real estate all supported the growth in services, with each expanding by more than 7 percent year-on-year in 2017. Wholesale and retail trade grew from 7.2 percent year-on-year in 2016 to 7.1 percent year-on-year in 2017; government services grew from 7.2 percent year-on-year in 2016 to 7.6 percent year-on-year in 2017; and the real estate sector grew at an annual rate of 7.5 percent in 2017, down from 8.9 percent in 2016. 8 The fisheries subsector contracted in 2017 because of supply disruptions, attributed to the limited fishing operations in Zamboanga peninsula in the third quarter, a fishing ban in the Visayas sea that allowed for fish spawning in November and December, and weather disturbances from May to September. The livestock subsector grew at a weaker rate of 1.1 percent year-on-year in 2017, down from 4.6 percent year-on-year in 2016. 9 Geronimo, J. (2017). 4 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments Box 1 The global economy is experiencing a broad-based and maturing cyclical recovery The recovery in the global economy went hand in hand with a rebound in investment, manufacturing, and trade. This economic recovery came against the backdrop of benign global financing conditions, generally accommodative public policies, rising confidence, and firming commodity prices. The global GDP growth rate increased from 2.4 percent in 2016 to 3.1 percent in 2017, above the June forecast of 2.7 percent. The economic upturn is broad-based, with growth increasing in more than half of the world’s economies. In particular, the rebound in global investment growth—which accounted for three quarters of the acceleration in global GDP growth from 2016 to 2017—was supported by favorable financing costs, rising profits, and improved business sentiment across both advanced and emerging market and developing economies. This synchronous, investment-led recovery provided a substantial boost to global exports and imports. In 2017, the GDP growth rate in advanced economies rebounded to an estimated average of 2.2 percent year-on-year, driven by a pickup in capital spending, a turnaround in inventories, and strengthening external demand. The pickup in investment reflected increased capacity utilization, favorable financing conditions, and rising profits and business sentiment. Confidence was supported by the fact that policy uncertainty, albeit still elevated, diminished during the year. While growth accelerated in all major economies, the improvement was markedly stronger than expected in the Euro Area. The average GDP growth rate among emerging market and developing economies accelerated to an estimated 4.4 percent year-on-year in 2017, reflecting firming activity in commodity exporters and continued solid growth in commodity importers. Most emerging market and developing regions benefited from a recovery in exports, as commodity exporters benefited from key economies—such as Brazil and the Russian Federation—emerging from a recession, a rise in commodity prices, improved confidence, diminishing drag from earlier policy tightening measures, and a bottoming out of investment growth after a prolonged period of slow growth. Nonetheless, growth among commodity exporters, estimated at an average of 1.8 percent year- on-year in 2017, was still subdued and insufficient to improve average per capita income, which continued to stagnate after two consecutive years of contraction. Global goods trade volumes have gathered significant momentum since mid-2016, following two years of pronounced weakness. A cyclical rebound in investment contributed to a strong growth in the trade of machinery, electronics, and semiconductors. Global trade growth is estimated to have reached a stronger-than-expected 4.5 percent year-on-year in 2017, as import demand recovered in both advanced economies and emerging market and developing economies. The recovery in global trade has been closely linked to the cyclical upturn in global manufacturing, which in turn was encouraged by an increase in capital spending. Source: World Bank (2018a), World Bank (2018c), and World Bank (2018d). Philippines ECONOMIC UPDATE • April 2018 5 I. Recent Economic and Policy Developments 1.2 The Exchange Rate and the External Sector: Impacts from an Improving External Environment A favorable external environment supported export growth but also prompted interest rate hikes in advanced economies in 2017. A faster-than-expected global policy rate normalization and concerns over a growing current-account deficit in the Philippines diminished investors’ appetite for Philippine assets, leading to capital outflows and continued weakness in the exchange rate. 7. The peso experienced heightened an average of 4.1 percent year-on-year in 2017, volatility in 2017, weakening for most of the more than the average 3.6 percent year-on-year year, except in the second quarter and the depreciation in 2016.10 This made the peso, along end of the year when remittances increased. with the Indonesian rupiah, the weakest currency Robust import demand for raw materials among regional peers (Figure 7), although it may and intermediate goods contributed to a rise have supported the price-competitiveness of in demand for US dollars. Increasing capital Philippine exports. outflows weakened the exchange rate as a faster- than-expected global policy rate normalization 8. The current account ran a higher deficit in and concerns over a growing current account 2017 than in 2016, as stronger services exports deficit in the Philippines diminished investors’ and remittance receipts could not offset a appetite for Philippine assets. As a result, the widening trade deficit (Table 1). The current Philippine peso depreciated in nominal terms account deficit deteriorated from US$1.2 billion by 6.1 percent year-on-year, from an average of (0.4 percent of GDP) in 2016 to US$2.5 billion Php/US$ 47.51 in 2016 to an average of Php/US$ (0.8 percent of GDP) in 2017, as the merchandise 50.40 in 2017 (Figure 6). In February 2018, the trade deficit widened from 11.7 percent of GDP in peso reached its weakest point in twelve years, 2016 to 13.1 percent in 2017 (Figure 8).11 In 2017, breaching the Php/US$ 52.00 level, after having annual import growth of 14.2 percent outstripped ended 2017 just below the Php/US$ 50.00 mark. healthy export growth of 12.8 percent. However, The real effective exchange rate depreciated by the growth of imports was higher in 2016 (17.7 Figure 6: In 2017, the Peso has depreciated in both Figure 7: … making it one of the worst performing nominal and real terms… regional currencies 100 Brexit 6 98 US Federal US Federal 96 Reserve Rate Reserve Rate Hikes Hikes 4 94 92 90 2 Index 88 Percent 86 0 84 82 80 -2 78 76 -4 Mar-13 Jun-13 Dec-13 Mar-14 Jun-14 Dec-14 Mar-15 Jun-15 Dec-15 Mar-16 Jun-16 Dec-16 Mar-17 Jun-17 Dec-17 Mar-18 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 -6 Change in REER, Dec 2016 -Dec 2017 Nominal Exchange Rate (January 2013: indexed to 100) Real Effective Exchange Rate Philippines PHP Indonesia IDR China CNY Thailand THB Malaysia MYR Source: BSP. Source: World Bank staff calculations. Note: Decrease denotes depreciation. 10 In real terms, the peso depreciated from 4.1 year-on-year in March 2017 to 6.3 percent year-on-year in March 2018, weakening the real effective exchange rate to Php/US$ 81.34. 11 The discussion of net exports in this section assesses values at current prices. This differs from the discussion of net exports in the growth section, where net exports assess values at constant 2000 prices. 6 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments percent year-on-year),12 while export growth outsourcing (IT-BPO) industries.14 The flow of rebounded from a contraction of 1.1 percent personal remittances from overseas Filipinos in 2016.13 The weakening trade balance was totaled US31.3 billion in 2017 and grew from 4.9 also not offset by stronger net services exports, percent year-on-year in 2016 to 5.3 percent year- which grew at 34.8 percent year-on-year in 2017, on-year in 2017, despite political uncertainties in supported by strong receipts from the tourism the Middle East15 — the country’s second largest and information technology-business process source of remittances after the United States. Table 1: Balance of payments, 2014-17 In millions US$ / in percentage of GDP 2014 2015 2016 2017 Current account 10,756 3.8 7,266 2.5 (1,199) (0.4) (2,518) (0.8) Goods (17,330) (6.1) (23,309) (8.0) (35,549) (11.7) (41,191) (13.1) Services 4,576 1.6 5,455 1.9 7,043 2.3 9,496 3.0 Primary Income 727 0.3 1,857 0.6 2,579 0.8 3,094 1.0 Secondary Income 22,782 8.0 23,263 7.9 24,728 8.1 26,083 8.3 Capital and Financial accounts (9,523) (3.3) (2,216) (0.8) (113) (0.0) 2,265 0.7 Capital account 108 0.0 84 0.0 62 0.0 57 0.0 Financial account 9,631 3.4 2,301 0.8 175 0.1 (2,208) (0.7) Direct investment 1,014 0.4 (100) (0.0) (5,883) (1.9) (8,110) (2.6) Net acquisition of financial 6,754 2.4 5,540 1.9 2,397 0.8 1,939 0.6 assets Net incurrence of liabilities1/ 5,740 2.0 5,639 1.9 8,280 2.7 10,049 3.2 Portfolio investment 2,708 1.0 5,471 1.9 1,480 0.5 3,889 1.2 Financial derivatives 4 0.0 6 0.0 (32) (0.0) (51) (0.0) Other investments 5,905 2.1 (3,076) (1.1) 4,610 1.5 2,064 0.7 Net unclassified items2/ (4,091) (1.4) (2,433) (0.8) 892 0.3 (610) (0.2) Overall BOP position (2,858) (1.0) 2,616 0.9 (420) (0.1) (863) (0.3) Memo: Basic Balance 9,742 3.4 7,365 2.5 4,684 1.5 5,593 1.8 1 / Net incurrence of liabilities refers to net foreign direct investment to the Philippines. 2 / The term “Net unclassified items” is a balancing figure. There are two methods of computing the BOP position: the first approach uses the change in net international reserves due to transactions, while the second approach computes the sum balances of the current account, capital account less financial account. The two measures do not necessarily tally. The BSP uses the first approach to determine the overall BOP position. Note: Following the BSP presentation, the BOP balance = Current Account Balance + Capital Account Balance - Financial Account Balance + Net Unclassified Items. 12 The import of raw materials and intermediate goods grew from an annual rate of 5.2 percent in 2016 to 11.3 percent in 2017, as intermediate inputs are re-processed and exported abroad. Nonetheless, softer domestic demand significantly moderated the growth of imported capital goods from an annual rate of 46.6 percent in 2016 to 4.2 percent in 2017, and consumer goods from 30.1 percent in 2016 to 8.4 percent in 2017. The country’s international reserves declined, and import coverage shrank from an average of 9.7 months in 2016 to 8.4 months in 2017. In 2017, ASEAN, China, Japan, South Korea, and the United States were the Philippines’ major import partners, while ASEAN, Japan, the United States, Hong Kong, and China were the country’s major export partners. 13 The recovering external demand from advanced economies raised the country’s electronic exports, which accounted for more than half of the export bill and contributed to about two-thirds of export growth (Box 2). 14 Data from the Department of Tourism showed that total visitors to the country increased by almost 11.0 percent to 6.6 million in 2017, which exceeded the administration’s 6.5 million target under its National Tourism Development Plan for 2016-2022. In 2017, earnings from BPO services amounted to US$22.1 billion, they grew by 9.6 percent year-on-year. 15 These political uncertainties arose from the continuing conflict in Syria and the diplomatic crisis between Qatar and its neighboring Arab states that started in June 2017. In February 2018, the Philippines issued a ban on deploying overseas Filipino workers in Kuwait, following a series of deaths and injury reports of Filipino workers in the Gulf state. However, the two countries are finalizing a bilateral agreement meant to lift the current ban. Philippines ECONOMIC UPDATE • April 2018 7 I. Recent Economic and Policy Developments Figure 8: Recovery in the external environment Figure 9: … yet continued higher import growth led to supported the growth in exports in 2017 ... a widening current account deficit Dec 5.0 Nov 4.0 Oct 3.0 Sep 2.0 Percent of GDP Aug 1.0 Jul Jun - May (1.0) Apr (2.0) Mar (3.0) Feb (4.0) Jan (5.0) Dec (6.0) -50 -40 -30 -20 -10 0 10 20 30 40 50 2013 2014 2015 2016 2017 Percent Current account Capital and Financial accounts Exports Imports Net unclassified items Overall BOP position Source: PSA. Source: PSA. 9. Spurred by net portfolio and other percent year-on-year and totaled US$10.0 billion investment outflows, the annual balance of in 2017. This was the highest level of net FDI ever payments (BOP) deficit more than doubled recorded in the Philippines, which was driven in 2017 (Figure 9). The country’s overall BOP by strong investments in domestic equity and deficit widened from US$0.4 billion (0.1 percent debt instruments. Compared with neighboring of GDP) in 2016 to US$0.9 billion (0.3 percent countries in 2017, the Philippines’ net FDI as of GDP) in 2017. While portfolio and other a share of GDP (3.2 percent) surpassed that of investment net capital outflows amounted to Malaysia (2.9 percent), Indonesia (2.2 percent), US$3.9 billion and US$2.0 billion, respectively, and Thailand (1.8 percent). foreign direct investment (FDI) increased by 21.4 Box 2 Electronics export growth in the East Asia Pacific region An investment-led global recovery has provided a substantial boost to global and regional manufacturing and trade. In 2017, global trade growth benefitted from an acceleration of the global GDP growth rate to around 3.0 percent year-on-year, reflecting investment-led growth in advanced economies and a cyclical recovery in commodity-exporting emerging market and developing economies. As a result, global trade growth is estimated to have reached a stronger- than-expected 4.5 percent year-on-year in 2017, following two years of slow growth. In the East Asia Pacific region, this was driven by a combination of a rise in commodity prices and the bottoming out of the global technology inventory cycle. The global technological cycle increased exports of machinery, electronics, and integrated circuits. The rise in industrial production and the re-stocking of technology inventory (including mobile phones) were among the most significant determinants of export growth in 2017.16 China (including Hong Kong), Malaysia, and the Philippines were among the top ten exporters of integrated circuits (with 38.0, 6.4, and 3.4 percent of total exports in 2016, respectively) and semiconductor devices (with 41.0, 8.5, 2.5 percent of total exports in 2016, respectively) in 2016. While their share in global markets is relatively low, exports of broadcasting equipment, 16 Meanwhile, the inventory of technology goods in major export destinations accumulated during the recession years and finally reached its trough during the second half of 2015 and the first half of 2016. This start of the technology re-stocking cycle, partly fueled by the pickup in business investment in advanced economies and the anticipated launch of new mobile devices in the second half of 2017, helped boost Asia’s technology exports, including semiconductors and other mobile equipment components. Source: IMF (2017). 8 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments computers, and other final electronic Figure 10: Exports of electronics (index, 2010 = 100) products represent more than 10 percent of total exports in Vietnam, Thailand, the 350 Philippines, and Malaysia. These countries 300 benefitted disproportionately from the recovery in the global trade cycle due to their 250 competitiveness and established capacity. 200 150 As a result, electronics exports accelerated rapidly in the East Asia Pacific region in 2017, 100 following a muted performance in 2016. 50 The Philippines’ electronics export revenue 0 growth accelerated from 1.0 percent in 2016 2010 2011 2012 2013 2014 2015 2016 2017 to 20.5 percent in 2017 due to a rise in the China Vietnam Thailand Malaysia Philippines international demand for integrated circuits, Source: World Bank; IMF WEO, and World Bank staff estimates. computers, and other electronics, which represent more than half of the country’s merchandise export basket. Similarly, other countries in the EAP region recorded double-digit growth in electronics export revenue in 2017, such as Vietnam (19.5 percent), Thailand (18.4 percent), Malaysia (14.5 percent), and China (10.8 percent) (Figure 10). Source: International Monetary Fund (2017), World Bank (2018d). 1.3 Financial Markets and Monetary Policy: Keeping the Policy Rate Steady despite Rising Inflation In 2017, rising inflation started to put a strain on the BSP’s accommodative monetary policy, and the inflation rate surpassed in early 2018 the 4 percent ceiling of the inflation target range. Credit continued its rapid expansion in 2017 but eased in the fourth quarter. 10. Pressure from the rising inflation rate local electricity prices. Excluding the volatile food increased in 2017 while the key policy rate and energy items, core inflation also rose sharply, remained unchanged. Despite a newly rebased partly due to the pass-through effect of a weaker consumer price index (CPI) series,17 the headline peso. It could also indicate increasing demand inflation rate climbed from an average of 1.3 side pressure due to the economy operating at percent in 2016 to 2.9 percent in 2017, before its potential, which could be an early sign of the reaching 4.3 percent in March 2018, which was economy overheating. Despite rising domestic beyond the ceiling of the BSP’s inflation target inflationary pressure and the three upward range (Figure 11). Food inflation drove almost adjustments of the U.S. Federal Funds rate in half of the CPI inflation increase in 2017 because 2017, the BSP monetary board kept the policy of higher prices of fish, meat, and fruit products. rate fixed at 3.0 percent throughout the year, Energy prices rose in tandem with the global while it lowered the reserve requirement ratio by increase in crude oil prices and adjustments in one percentage point as of March 2, 2018.18 17 In March 2018, the Philippine Statistics Authority rebased the CPI series from 2006 as the base year to the new base year of 2012, changed the weights of the market basket with expenditure data from the 2012 Family Income and Expenditure Survey, and adopted the chain method in the 2012-based CPI series. 18 The BSP maintains that the 1 percentage-point reduction in the reserve requirement ratio was an operational adjustment to support its shift toward a more market-based implementation of monetary policy. The monetary board reaffirmed the BSP’s commitment to gradually reduce its reliance on reserve requirements for managing liquidity in the financial system, and observed that the BSP has ample scope to mitigate the potential liquidity impact of a phased reduction in the reserve requirement via offsetting auction-based monetary operations. Philippines ECONOMIC UPDATE • April 2018 9 I. Recent Economic and Policy Developments Figure 11: Inflation rose sharply and surpassed in March Figure 12: Credit has sustained its double-digit growth 2018 the ceiling of the Central Bank’s target range rates 6.0 30.0 5.0 25.0 4.0 20.0 In percent, YoY 3.0 Percent 15.0 2.0 10.0 1.0 0.0 5.0 (2012=100) -1.0 0.0 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 -2.0 For Production For household Consumption Metro Manila Outside Metro Manila Key policy rate Total loan portfolio (Net of BSP RRP agreements) Source: PSA, BSP. Source: BSP. 11. Credit growth remained strong in 2017. annual increase in credit for salary-based loans Total credit growth accelerated from an annual and 16.5 percent (24.9 percent) for credit card average of 14.3 percent in 2016 to 17.8 percent debt.19 The credit-to-GDP ratio continued to in 2017, mirrored largely by a domestic liquidity steadily rise from an average of 61.0 percent in (M3) increase from an average of 12.5 percent 2016 to an average of 64.6 percent in 2017. year-on-year in 2016 to an average of 13.2 percent year-on-year in 2017. Moreover, credit 12. The Philippines’ financial system to firms grew from 13.5 percent year-on-year in remains stable and resilient. The share of non- 2016 to 17.4 percent year-on-year in 2017, while performing loans declined from an average of the growth in household loans was sustained at 2.2 percent of total loans in 2016 to 1.9 percent an annual rate of 20.3 percent in 2017, which in 2017. Philippine banks are well capitalized, was slightly lower than the 20.5 percent increase with a total capital adequacy ratio at 15.3 in in 2016 (Figure 12). The sectoral composition September 2017, well above the 10 percent of firms’ loan portfolios has remained broadly regulatory minimum. In addition, banks’ return unchanged, as credit growth continued to favor on equity slightly decreased from an average of the real estate and wholesale and retail trade 10.0 percent in 2016 to 9.9 percent in 2017. Also, sectors. Among consumption loans, the largest the share of interest income to total operating credit increase in 2017 was for motor vehicle income increased from an average of 73.1 loans, which grew at an annual rate of 24.6 percent in 2016 to 74.7 percent in 2017, while percent (51.0 percent of total consumption net interest margins remained unchanged at an loans), followed by a 19.1 percent (20.5 percent) average of 3.3 percent. 19 Banking industry data reveal that some firms may have started to overleverage in the current environment of fast credit growth and low interest rates. The IMF article IV notes that non-financial corporate leverage has risen but is still moderate compared to peers. 10 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments 1.4 Fiscal Policy: Preparing for the Public Investment Increase The fiscal deficit narrowed in 2017, as the government missed its expenditure target, despite improved budget execution, and exceeded its revenue target. 13. The government continued to improve not yet started construction on its large planned budget execution in 2017. Public expenditure flagship infrastructure projects. increased from 17.6 percent of GDP in 2016 to 17.9 percent in 2017 (Figure 13). Nevertheless, 14. Although total public revenue increased the government’s budget execution fell from 15.2 percent of GDP in 2016 to 15.7 percent short of programmed public spending by in 2017, revenue collection in the Philippines is 2.9 percent in 2017, which was only a slight among the lowest in the region (Box 4). The level improvement from the 3.6 percent in 2016.20 of revenue generated in 2017 was slightly lower Underspending was primarily the result of than in 2015 (15.8 percent of GDP), and it only lower-than-expected recurrent spending on exceeded the government’s programmed target personnel expenditures and maintenance and by 1.9 percent. Tax revenue, which reached 14.2 other operating expenditures.21 Meanwhile, percent of GDP in 2017, is the biggest source of infrastructure expenditures exceeded their public revenue in the Philippines. Although the programmed target and increased slightly from Bureau of Internal Revenue and the Bureau of 3.4 percent of GDP in 2016 to 3.6 percent in Customs improved their revenue collection, they 2017. Infrastructure outlays were directed missed their programmed revenue targets by 0.6 towards the implementation of various road percent and 0.3 percent, respectively. infrastructure, flood control, and dike and river basin repair projects as well as the repair 15. The fiscal deficit slightly narrowed from and rehabilitation of school facilities and the 2.4 percent of GDP in 2016 to 2.2 percent in purchase of military equipment under the 2017, which was lower than the planned deficit of 3.0 percent of GDP. The deficit was largely Armed Forces of the Philippines’ modernization financed with domestic resources, with net program (Box 3). However, the government has domestic financing accounting for roughly 96.4 Figure 13: National government fiscal balance, 2013-17 percent of total financing in 2017 (Figure 20). Total net domestic financing more than doubled 20 17.6 17.9 from Php355.0 in 2016 to Php731.4 billion in 16.8 16.3 16.7 15 14.5 14.9 15.1 15.7 15.8 15.2 15.7 2017. The government also attracted Php27.6 billion in financing from external sources in 2017, Percent of GDP 10 a reversal from the negative Php24.1 billion in net foreign financing registered in 2016. As a result, 5 total public financing nearly doubled and reached Php758.9 in 2017. Despite the significant increase 0 -0.6 -0.9 in government financing, the overall debt-to-GDP -1.4 -2.3 -2.4 -2.2 ratio remained constant at 42.1 percent in 2017 -5 2012 2013 2014 2015 2016 2017 for the second consecutive year, as nominal GDP Revenues Expenditure Fiscal balance growth kept pace with the growth in the national Source: Bureau of the Treasury. government debt stock (Figure 21). 20 The government attributes improved budget execution to reforms to shorten the approval process of plans and programs and stricter implementation of project planning, monitoring, and scheduling. Source: https://www.dbm.gov.ph/wp-content/uploads/DBCC/2017/Highlights-of- NG-Disbursements_as-of-December-2017_for-posting.pdf. 21 In 2017, spending on personnel services was 8.4 percent below the programmed budget, while maintenance and other operating expenses was 1.9 percent below their programmed budgets. Philippines ECONOMIC UPDATE • April 2018 11 I. Recent Economic and Policy Developments Box 3 Recent public expenditure profile of the Philippines Public expenditure has consistently surpassed public revenue in the Philippines. The fiscal balance has been in deficit since 2000, reaching a high of 5.0 percent of nominal GDP in 2002 and a low of 0.2 percent of GDP in 2007 (Figure 14). Public expenditure averaged 16.8 percent between 2013 and 2017, which was similar to the average in the preceding five years but lower compared to the regional peer average of 23.9 percent in the same period (Figure 15). Among its peers, China’s public expenditure as a share of GDP was the largest at 37.5 percent, followed by Vietnam (29.6 percent) and Malaysia (22 percent). Nonetheless, public spending in the Philippines is programmed to substantially rise as the administration rolls out its flagship infrastructure and social investment programs. In 2018, budget disbursement is expected to increase to Php3.3 trillion, a 17.3 percent increase from the Php2.8 trillion actual disbursement in 2017. Figure 14: Fiscal balance, percent of GDP, Figure 15: Public expenditures as a share of nominal 2000-17 GDP, 2013-17 20.0 40.0 37.5 18.0 16.0 35.0 14.0 29.6 12.0 30.0 Percent of GDP Percent of GDP 10.0 25.0 Peer average: 23.9 21.7 22.0 8.0 6.0 20.0 4.0 15.9 16.8 2.0 15.0 0.0 -2.0 10.0 -4.0 -6.0 5.0 -8.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0.0 Total Revenues Total Expenditures Budget Balance Indonesia Philippines Thailand Malaysia Vietnam China Source: DBM. Source: World Bank staff calculations. Public spending on productive expenditure items has increased over the past five years. The central government and local government units received about two-thirds and one fifth of the total public budget, respectively, and the rest was shared between government-owned and controlled corporations (GOCCs) and creditors. Personnel services (including payments for salaries, wages, and other compensation) and maintenance and other operating expenses (including expenses for operations of government agencies) have dominated the Philippines’ public expenditures and remained roughly constant as a share of total expenditures between 2013 and 2017 (Figure 16). However, the share of interest payments declined significantly from 17.2 percent of total public spending in 2013 to 11.9 percent in 2017, freeing up funds that were increasingly directed to finance expenditures for infrastructure and other capital outlays.22 Public spending on infrastructure and other capital outlays and subsidies rose from an annual rate of 14.0 percent and 3.4 percent, respectively, in 2013 to 20.1 percent and 4.6 percent, respectively, in 2017. Since 2013, most public spending has been directed to education, health, and infrastructure in order to increase human and physical capital investment. The bulk of programmed social spending has historically been in the areas of education, culture, and manpower development, which constituted 21.2 percent of total public expenditures, or 4.5 percent of GDP in 2017 (Figure 17). In recent years, more budget resources have been allotted to social 22 The share of interest payments to total expenditures declined in recent years despite the depreciation of the Philippine peso, partly as a result of the government increasingly relying on domestic financing, and partly due to nominal GDP growth outpacing the expansion of interest payments. 12 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments protection, specifically for housing and social security, welfare, and employment, increasing from 0.6 percent of GDP in 2010 to 1.9 percent in 2017. In 2017, most public spending in the economic services sector23 was directed to communications and road and transportation, accounting for 3.0 percent of GDP, or nearly half of total spending in the sector. Debt services, particularly interest payments, dropped significantly as the government benefitted from a low interest rate environment and strategic debt restructuring. Figure 16: Public expenditures by economic Figure 17: Public expenditures by functional classification (Actual disbursements), percent of classification (Obligation basis), percent of total total expenditures, 2013-17 expenditures, 2013-17 100 100 90 90 In percentage of total expenditures Percent of total expenditures 80 80 70 70 60 50 60 40 50 30 40 20 30 10 20 0 2013 2014 2015 2016 2017 10 Infrastructure and other capital outlays Interest Payments 0 Personnel Services 2013 2014 2015 2016 2017 Allotments to Local Government Units Subsidies Economic Services Social Services General Public Services Other Expenses Debt Service Defense Net Lending Source: DBM, World Bank staff calculations. Source: DBM, World Bank staff calculations. Note: Other expenses are tax expenditure funds, corporate equity and capital transfers to local government units. Source: International Monetary Fund (2017), World Bank (2018d). 16. In December 2017, the Philippines tax base by limiting exemptions; adjusted excise successfully passed its first package of tax taxes on tobacco; automobiles, oil, and mineral reforms, effective since January 1, 2018. The products; and introduced an excise tax on sugar- president signed Republic Act 10963, also sweetened beverages and cosmetic procedures. known as the Tax Reform for Acceleration and The law is estimated to bring in an additional Inclusion (TRAIN), into law on December 19, Php82.3 billion in public revenue during its first 2017. TRAIN, also referred to as package 1A of year of implementation in 2018. Additional the government’s comprehensive tax reform revenue from the law will be used to help finance program, introduced reforms that reduced the government’s infrastructure program and personal income tax rates, adjusted the estate provide additional resources for social services. and donor’s tax, broadened the value-added 23 Spending on economic services includes expenditures in the following categories: i) communications, roads, and transportation facilities; ii) agriculture, agrarian reform, and natural resources; iii) water resources development and flood control; iv) trade and industry; v) power and energy; and vi) tourism. 24 The national government fell short of the Php482.1 billion programmed deficit by 27.3 percent. Philippines ECONOMIC UPDATE • April 2018 13 I. Recent Economic and Policy Developments Box 4 Public revenue in the East Asia Pacific region The Philippines’ public revenue and spending are low compared to peers (Figure 18). The country generated an average of 15.0 percent of GDP in revenue each year between 2006 and 2016, the lowest level among its peers in the region. This was significantly lower than Vietnam (25.0 percent of GDP), China (20.5 percent), and Malaysia (20.1 percent), resulting in relatively low levels of public expenditures in the Philippines over the past decade. The country’s low level of public revenue is primarily the result of its low tax effort compared to peers (Figure 19).25 Between 2006 and 2016, the Philippines’ tax effort averaged 13.2 percent of GDP each year, the second lowest among peers in the region despite relatively high tax rates, suggesting low collection efficiency and a limited introduction of revenue-enhancing reforms in the country.26 Adjustments to the corporate income tax in 2009 resulted in a lower tax effort, which caused a fall in tax revenue to 12.1 percent of GDP in 2010. In recent years, tax policy and tax administration reforms led to an increase in tax revenue to 14.2 percent of GDP in 2017, and revenue is expected to increase further as the government recently passed its first set of tax reforms in 2017. Figure 18: Government revenue efforts, 2000-16 Figure 19: Tax revenue efforts, 2000-16 30 25 25 20 20 Percent to GDP Percent to GDP 15 15 10 10 5 5 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Philippines Malaysia Thailand Indonesia Vietnam China Philippines Malaysia Thailand Indonesia Vietnam China Source: Haver Analytics, Bureau of Treasury. Source: Haver Analytics, Bureau of Treasury. Figure 20: The government financed its deficit through Figure 21: The overall debt-to-GDP ratio remained domestic borrowing unchanged from 2016 to 2017 260 60.0 240 220 200 50.0 180 160 18.6 140 40.0 22.2 21.4 16.9 In percent of GDP In Billion Pesos 120 15.2 15.5 100 14.9 14.0 80 30.0 60 40 20 20.0 - 32.8 32.4 (20) Jan Jul Jan July Jan July 30.2 29.6 30.2 29.2 27.2 28.1 (40) 10.0 (60) (80) (100) 0.0 (120) 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 Net Foreign Financing Net Domestic Financing Budget Surplus/Deficit Domestic debt External debt Source: Bureau of Treasury. Source: Bureau of Treasury, PSA. 25 Tax effort is defined as total tax collections as a percentage of GDP. 26 For example, the Philippines has the second highest value added tax rate and highest corporate income tax rate compared to regional peers. 14 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments 1.5 Employment and Poverty: A Tight Labor Market with Limited Real Wage Growth The labor market remains tight with the unemployment rate at around 5 percent, but the quality of employment remains a concern. 17. Labor demand remained strong 200,000 and 100,000 jobs added in construction throughout 2017, and the unemployment rate and manufacturing, respectively, in 2017.30 In only increased slightly from an average of 5.5 January 2018, net job creation in all the three percent in 2016 to an average of 5.7 percent main sectors increased, generating about 2.4 in 2017 (Figure 22). The unemployment rate million new jobs, with an almost equal share increased to a two-year high of 6.6 percent in from all three sectors.31 January 2017, likely influenced by the unwinding of temporary election-related jobs created in 19. Underemployment, which gives some 2016. The unemployment rate fell to 5 percent indication of the quality of jobs, improved in in October 2017, before increasing slightly to 2017, but sharply deteriorated in early 2018. 5.3 percent in January 2018, driven by higher The underemployment rate declined from an employment in the country’s three main average of 18.4 percent in 2016 to 16.1 percent economic sectors: agriculture, industry, and in 2017. This was accompanied by an increase services.27 Throughout 2017, labor demand was in the number of wage and salaried workers in mainly driven by manufacturing and construction the private and public sectors. By the end of activities. The Philippines’ low unemployment 2017, there were about 600,000 more wage and rate points to a continued tight labor market and salaried workers compared to the end of 2016. an economy close to full employment. However, the underemployment rate climbed to 18.0 percent in January 2018, with much of 18. Employment trends varied across regions the increase coming from the agriculture sector and sectors during 2017. Unemployment rates (from 32.8 percent in January 2017 to 36.2 declined in the growth centers of Cavite, Laguna, percent in January 2018). Underemployment did Batangas, Rizal, and Quezon (CALABARZON) and decrease in the industry (from 20.3 percent to Central Visayas,28 while they increased in Metro 19.2 percent) and services (from 46.9 percent Manila and regions predominantly dependent to 44.6 percent) sectors in the same period. on agriculture. As a result, there were job losses The pervasiveness of underemployment despite in the primary sector, mainly in agriculture.29 strong economic growth highlights the lack of Most new jobs were created in the secondary quality jobs in the Philippines. sector, primarily in the industry sector, with 27 This represents the highest first quarter growth in all of the previous January rounds of the Labor Force Survey since 2009. 28 CALABARZON is a growth center and hosts 35 of the 74 manufacturing economic zones in the country. See http://www.peza.gov.ph/index.php/ economic-zones/list-of-economic-zones. 29 The primary sector includes activities related to agriculture, hunting, and forestry. 30 The secondary sector includes activities related to manufacturing, processing, metal working, automobile production, textile production, etc. 31 The Labor Force Survey reports that 400,000 jobs were created in January 2018, and the manufacturing sector continued to grow with nearly 300,000 jobs created. Philippines ECONOMIC UPDATE • April 2018 15 I. Recent Economic and Policy Developments Figure 22: The unemployment rate remained around Figure 23: … while the labor force participation rate 5 percent ... remained below the 10-year average 25.0 67.0 66.0 20.0 65.0 64.0 15.0 63.0 Percent Percent 62.0 10.0 61.0 60.0 5.0 59.0 58.0 0.0 57.0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Unemployment Rate Underemployment Rate Source: Labor Force Survey (various rounds), PSA. Source: Labor Force Survey (various rounds), PSA. 20. On the labor supply side, the labor force consistently below the average in the past decade participation rate fell below its 10-year average (Figure 24). Private sector workers, which form bulk in 2017 (Figure 23). It dropped sharply to 60.7 of wage earners in the country, saw their wages percent in January 2017,32 before increasing to contract by 0.1 percent year-on-year in 2017 from 62.1 percent and 62.2 percent in October 2017 a 5.4 percent year-on-year expansion in 2016. and January 2018, respectively.33 The average labor force participation rate fell from 63.5 Figure 24: Changes in real daily wages, 2007-17 percent in 2016 to 61.2 percent in 2017, below 600 the 10-year average of 63.7 percent. Participation in the labor force is expected to increase in 2018, 500 as a portion of the first batch of senior high school Php (in 2006 prices) 400 graduates under the K-12 program joins the labor force (Box 5). 300 200 21. Real wages grew slower in 2017 compared 100 to their strong expansion in 2016.34 Between 2007 and 2017, the average overall real wage in 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 the Philippines rose slowly at an annual rate of Overall Private Household Private Establishment 0.8 percent, reaching an average of Php262.00. Source: Labor Force Survey (various rounds), PSA. However, the annual overall real wage grew faster in 2016 at 4.3 percent, but slower in 2017 22. The Philippines’ robust economic growth at 0.2 percent. The mean daily wage in the public and labor market characteristics make it likely sector is about 70.0 percent larger than the that poverty will continue to decline, although average overall wage, while the wages of family rising inflation may adversely impact the poor.35 workers and private household workers remained Based on the lower middle-income class poverty 32 Filipino youth accounted for most of the drop in the country’s labor force participation rate, which may be attributed to the implementation of the K-12 program that commenced during the 2016-2017 school year. Based on enrollment records by the Department of Education, 1.5 million students were admitted to grade 11 in June 2016, of which 1.45 million had finished grade 10. This is equivalent to a high school graduate in the old curriculum. Prior to the implementation of the senior high school program, a proportion of these students would have joined the labor market. See World Bank (2017b). 33 The National Economic and Development Authority attributes the rise in labor force participation to an increase in the female labor force participation rate from 45.2 percent in January 2017 to 47.5 percent in January 2018. This reflects the sharp decline in the number of economically inactive married women and women who opt out of the labor force due to household duties. 34 The available data for real wages in the Philippines come from the various rounds of the Labor Force Survey, covering 2007 to October 2017. 35 The quarterly self-rated poverty estimates of the Social Weather Station also show a declining trend in recent years. 16 Philippines ECONOMIC UPDATE • April 2018 I. Recent Economic and Policy Developments line (US$3.20/day in 2011 PPP) used by the and government conditional cash transfers, are World Bank, the country’s poverty rate fell from likely to continue to push the poverty rate down. an estimated 27.0 percent in 2015 to 24.3 percent However, the recent increase in inflation might in 2017. The factors that have been driving have a negative impact on poverty alleviation, poverty reduction in the recent past, including as inflation has increased largely due to higher the movement of employment out of agriculture, prices for food and non-alcoholic beverages – on the recent increase in real wages among private which poor households spend a significant share sector workers, and the increase in remittances of their income. Box 5 Building human capital through the K-12 basic education program The Philippines has made important strides toward improving its human capital in recent years. The 2013 Basic Education Act extended the basic education cycle from 10 to 13 years, adding universal kindergarten and 2 years of senior high school. The first cohort of grade 12 students graduated in March 2018. The education budget also grew markedly, from 2.9 percent of GDP in 2013 to 3.8 percent of GDP in 2016. This increased spending has funded the extension of the education cycle as well as school construction and teacher hiring that have improved school conditions at all grade levels. The country embarked on an ambitious reform agenda to align its education system with most other systems around the world and raise national competitiveness. The government views a K-12 system as vital for ensuring that all Filipinos are equipped with the basic skills required to play full and productive roles in the society. This is one of many investments in human capital that will be vital to meeting the country’s aspirations for sustained and inclusive growth. Research featured in the World Bank’s 2018 World Development Report shows, however, that simply increasing the number of years of schooling does not in itself boost a country’s economic fortunes. More schooling only improves a country’s economy if it results in greater learning. Despite a high level of commitment by teachers, the Philippines’ learning outcomes are the weakest among major countries in the East Asia Pacific region. The difference in test scores between the Philippines and high-performing countries like Vietnam is substantial and equivalent to three years’ worth of learning. An important caveat to this picture is that the Philippines test score data date from 2003, the last year the country participated in an international educational assessment. The country is participating in the 2018 Program for International Student Assessment, which will allow for an updated analysis of the performance of the education system relative to other countries. Quality teachers constitute the principal factor for improved learning outcomes. However, studies have found that teachers in the Philippines do not have the knowledge, support, or materials they need to teach effectively. One critical need is to improve the professional development opportunities for teachers, which will raise the quality of teaching and improve student learning. Important steps will include implementing the recently developed Philippines Professional Standards for Teachers and moving from a mass-training model to one based on a personalized, coaching approach. The K-12 expansion is the most visible of a series of efforts being made to modernize basic education in the Philippines. If effectively used, the country’s new investments to improve human capital will pay off in greater opportunity for the Filipino people. Over time, increasing the years of schooling, if its results in higher levels of learning, will improve the quality and ultimately productivity of the labor force. Philippines ECONOMIC UPDATE • April 2018 17 Part II: Outlook and Risks The medium-term economic growth outlook for the Philippines remains positive. The economy is expected to continue on its expansionary path, and grow at an annual rate of 6.7 percent in 2018 and 2019. The economy is currently growing at its potential, making productive investment in physical and human capital essential for a continuation of the current growth trajectory. The country is expected to benefit from the global recovery in 2018; however, export growth is expected to level off compared to its strong expansion in 2017, while imports are projected to remain elevated due to high demand for intermediate and capital goods. Domestic risks are more prominent while the key external risk is increasing policy uncertainty in global markets. In line with the Philippines’ growth outlook, poverty levels are expected to continue to fall. However, the missing link to higher shared prosperity is twofold: high-quality jobs and faster growth of real wages. More can be done to create high-quality jobs and accelerate the growth of real wages. Investing in the future means prioritizing investment in both physical infrastructure and human capital, such as in education, skills and health, will create better employment opportunities, especially for the poor. Philippines Philippines ECONOMIC ECONOMIC UPDATE UPDATE • October 2017 • April 2018 19 II. Outlook and Risks 2.1 Growth Outlook The Philippine economy is projected to grow at an annual rate of 6.7 percent in 2018 and 2019. 23. The economic outlook for the Philippines economy is overheating include the rise of core remains positive. The economy is expected inflation, the high capacity utilization rate in the to continue on its expansionary path, and the manufacturing sector, and the tight labor market World Bank projects the country’s GDP to grow (See Sections 1.1 and 1.3). at an annual rate of 6.7 percent in both 2018 Figure 25: The Philippine economy is projected to grow and 2019, before settling at 6.6 percent in 2020 at 6.7 percent in 2018 and 2019 (Figure 25). These projections remain largely 9.0 Forecast unchanged from the growth projections made 8.0 7.6 7.1 6.6 by the World Bank in October36 and December37 7.0 6.7 6.9 6.7 6.7 6.7 6.0 6.1 6.1 2017. The country’s external environment 6.5 Percent 5.0 remains accommodative to growth (Box 6). 4.2 4.0 3.7 However, the Philippine economy is currently 3.0 growing at its potential and productive physical 2.0 and human capital investments are necessary 1.0 1.1 for the economy to continue along its current 0.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 growth trajectory. The risk of overheating the April 2018 projections December 2017 projections Actual growth economy is increasing. Potential signs that the Source: PSA, World Bank staff estimates. Box 6 The global economic outlook A continuing cyclical recovery will sustain global growth over the next couple of years. Global growth is projected to rise from an estimated annual rate of 3.0 percent in 2017 to 3.2 percent in 2018, as investments, manufacturing activities, and commodity prices continue to recover globally (Figure 26). Global growth is forecasted to settle at an average of annual 3.0 percent in 2019-20. Growth in emerging markets and developing economies is expected to accelerate and reach 4.6 year-on-year in 2018 and an average of 4.7 percent year-on-year in 2019-20. This mainly reflects a further pickup of growth in commodity exporters, as the price of oil and other commodities are expected to firm and the effects of the earlier collapse in commodity prices dissipate (Table 2). Moreover, the cyclical recovery in many regional economies, including in the East Asia Pacific region, is close to running its course. In general, the regional economies are operating around their potential levels, with closing output gaps and tightening labor markets (Figure 27). The growth momentum in global trade is expected to continue in 2018 but faces risks stemming from renewed protectionist sentiment and policy uncertainty in global markets. Global trade growth is set to moderate from an estimated annual rate of 4.5 percent in 2017 to an average rate of 4.0 percent in 2018-19, in line with the projected deceleration of capital spending in advanced economies and China. Trade is expected to be constrained by structural forces, including the slower pace of global value chain integration and trade liberalization. Global trade, however, is further threatened by the more protectionist stance of some large economies. The United States 36 World Bank, Philippines Economic Update: Preserving Consistency and Policy Commitment, October 2017. 37 World Bank, Philippines Monthly Economic Development, December 2017. 20 Philippines ECONOMIC UPDATE • April 2018 II. Outlook and Risks recently imposed tariffs on solar panels, washing machines, steel, and aluminum. Moreover, trade war rhetoric has amplified between the United States and China. The rising tension creates policy uncertainty that may pose a risk to global trade growth. Global financing conditions are likely to tighten in 2018, as monetary policies gradually normalize in major advanced economies. In the United States, inflation expectations and prospects of a faster normalization of monetary policy have increased. Global interest rates are expected to continue to rise, as inflation gradually picks up and monetary policies normalize across advanced economies. Also, a continued drawdown of net asset purchases by major central banks will contribute to upward pressure on long-term yields. In advanced economies, a rise in inflation remains incipient despite ongoing tightening in labor markets. Although growth might accelerate in the near term, the global economic outlook is still subject to substantial downside risks. In the short term, these risks include the possibility of financial stress, increased protectionism, and rising geopolitical tensions. There are also challenges associated with subdued productivity and potential growth. As the global economy is on track to operate at or near full capacity in 2018 for the first year since the 2007-08 financial crisis, supply- side constraints will likely become more binding and global inflation is expected to gradually increase. As a result, global economic activity is expected to decelerate in the medium term. With less economic slack, policymakers need to look beyond monetary and fiscal policies to stimulate economic growth. Policymakers in both advanced economies and emerging market and developing economies need to pursue structural measures to boost potential long-term growth. With unemployment rates returning to pre-crisis levels and recoveries firming in advanced economies, productivity- enhancing reforms have become increasingly urgent as the pressures on underlying growth from aging populations intensify. Among emerging market and developing economies, output gaps are near zero in commodity importers but remain negative in commodity exporters, suggesting a continuing need to nurture the cyclical recovery in the latter even when fiscal space remains constrained. Figure 26: Global economic growth, 2000-2020 Figure 27: Output gaps, 2000-2018 8 4 Percent of potential GDP 6 2 Percent 0 4 -2 2 -4 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Advanced economies EMDE commodity exporters World Advanced economies EMDEs EMDE commodity importers Source: World Bank (2018c). Source: World Bank (2018c). Philippines ECONOMIC UPDATE • April 2018 21 II. Outlook and Risks Table 2: Real GDP growth rates, 2015-2020 2015 2016 2017e 2018f 2019f 2020f World 2.8 2.4 3.1 3.2 3.1 2.9 Advanced economies 2.2 1.6 2.2 2.3 2.0 1.7 Emerging market and developing Economies 3.6 3.7 4.4 4.6 4.7 4.7 Developing East Asia & Pacific 6.5 6.3 6.6 6.2 6.1 6.0 Philippines 6.1 6.9 6.7 6.7 6.7 6.6 Note: Developing East Asia & Pacific includes Cambodia, China, Fiji, Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea, Philippines, Solomon Islands, Thailand, Timor-Leste, and Vietnam. Source: World Bank (2018b), World Bank (2018c), World Bank (2018d). 24. The World Bank forecast assumes in implementing public investment projects. To higher government spending in 2018-20. The finance the budget deficits, the administration current administration is expected to increase plans to pursue an 80:20 financing mix in favor infrastructure and human capital investments of domestic sources. to continue the momentum set in 2017. Public spending is expected to increase from 10.8 25. Monetary policy is expected to gradually percent year-on-year in 2017 to 17.3 year-on-year tighten in the near future as the BSP adjusts percent in 2018, including a 27.1 percent year- to the changing global financial conditions on-year increase on capital outlays (to Php1.0 and the closing domestic output gap. Global trillion) and a 5.5 percent year-on-year increase interest rates are expected to continue to rise, as on social sectors (to Php1.4 trillion) in 2018. The global inflation picks up and monetary policies government plans to increase the level of public normalize across advanced economies.38 In expenditures from 17.7 percent of GDP (Php2.8 2017, the BSP did not make a policy adjustment trillion) in 2017 to 19.0 percent of GDP (Php3.3 despite three increases in the federal funds rate trillion) in 2018, including a 0.9 percentage point by the United States’ Federal Reserve, increasing increase in infrastructure investment from 5.4 the likelihood that the BSP will raise its key policy percent of GDP (Php0.9 trillion) in 2017 to 6.3 rate in 2018. Moreover, the Philippines may be percent of GDP (Php1.1 trillion) in 2018) and a 0.4 faced with a higher risk of inflation in the short percentage point decrease in social investment term, as the economy continues to operate near (from 8.6 percent of GDP (Php1.4 trillion) in its potential, the output gap is closing, and fiscal 2017 to 8.2 percent of GDP (Php1.4 trillion) in spending remains high. Nevertheless, average 2018). Infrastructure spending is programmed inflation is projected at 3.3 percent in 2018 to further rise in succeeding years to reach an and 3.0 percent in 2019 – within the BSP’s 2-4 estimated 6.8 percent of GDP (Php1.3 trillion) in percent target range. 2019 and 6.9 percent of GDP (Php1.5 trillion) in 2020. The government’s targeted annual fiscal 26. Sustained global growth will support the deficit is set at 3.0 percent of GDP in 2018-20, demand for Philippine exports in 2018. Global although the World Bank projects narrower growth is expected to peak at 3.2 percent in budget deficits over the same period (but 2018, before slowing down in succeeding years wider than in 2017). These projections consider as economic growth in advanced economies longstanding implementation bottlenecks and is projected to moderate and the slowdown capacity constraints that may hinder progress in China proceeds. Together with the effect of 38 World Bank (2018c). 22 Philippines ECONOMIC UPDATE • April 2018 II. Outlook and Risks a depreciating peso, this is expected to lead The prospect of rising domestic interest rates to sustained foreign demand for Philippine may also discourage private-sector borrowings products throughout 2018. However, export and lead to lower private-sector investment growth will likely moderate from its expansion of growth. 19.2 percent in 2017 to a projected 15.1 percent in 2018, partly due to the base effect of an 28. Consumption growth is expected exceptionally strong year in 2017. Import growth around its seven-year average in 2018, before is projected to outpace exports growth in both accelerating in 2019 because of election-related 2018 and 2019, as the demand for intermediate spending (Table 3). Private consumption is goods increases.39 The demand for capital goods expected to grow at 5.8 percent year-on-year is also expected to intensify, as the government in 2018, the same growth rate as in 2017 (and gradually rolls out its infrastructure investment similar to the past seven-year average), before projects. These negative net export trends will accelerating to 6.2 percent year-on-year in likely lead to a higher demand for US dollars, 2019, spurred by election-related expenditures. which is expected to further widen the current- Pre-election activities will likely increase public account deficit and continue to weaken the peso. consumption as early as 2018, with the most As a result, the current account is projected to visible impact being the additional salaries and reach deficits of 1.2 percent of GDP in 2018 and wages for election workers. Public consumption 1.4 percent of GDP in 2019. is projected to grow from 7.3 percent year- on-year in 2017 to 8.9 percent year-on-year in 27. Driven by public investment, annual 2018. Moreover, the value of remittances is investment growth is expected to slightly likely to increase in 2018 due to a weakening rise in 2018 and 2019. Gross fixed capital peso, strengthening the purchasing power of investment is projected to grow from 10.3 the families of overseas workers. However, other percent year-on-year in 2017 to 11.8 percent factors might weaken consumption growth in year-on-year and 11.9 percent year-on-year 2018. For example, continued high inflation in 2018 and 2019, respectively. Investment could subdue consumer confidence and weaken growth will largely depend on public spending consumption activities. The BSP’s latest consumer and the timely implementation of the expectation survey revealed a less upbeat government’s infrastructure and human capital consumer outlook in the first and second quarter investment programs.40 The administration is of 2018 and in the next 12 months compared to pursuing a budget reform bill to modernize 2017. The impact of the first tax reform package the budgeting process, accelerate program is likely to be neutral on consumption growth. delivery, and strengthen government focus On one hand, higher fuel excise taxes and taxes and accountability (Box 7). Private investment on sugar-sweetened beverages might increase growth may potentially soften in the coming inflation temporarily and dampen consumption, years, considering the decrease in the number of but on the other hand, lower income tax rates approved building permits and the lower volume increase workers’ take-home pay, which may of approved foreign investments by investment increase consumer spending. promotion agencies in 2017 compared to 2016. 39 Raw materials and intermediate goods imports accounted for roughly two-fifths of the total import bill in 2017, slightly higher than capital goods imports (32.3 percent). Imported materials make up the bulk of electronic goods that the country exports, with only about 25-30 percent as local value added. See Saulon (2017). For a short discussion on the composition of imports and exports in the Philippines, see World Bank (2017b), Box 5. 40 Very few projects have started this year while several are in the preparation stage. Projects currently under implementation are the Philippine National Railways (PNR) North 2 project and sports facilities in New Clark City for the 2019 Southeast Asian games. Approved projects that are still in pre-construction phase include the mega-Manila subway project, Philippine National Railway South Commuter line, Malolos-Clark Railway, and the Metro Manila Flood Control project. Philippines ECONOMIC UPDATE • April 2018 23 II. Outlook and Risks Box 7 Initiatives to modernize the budgeting process On January 3, 2018, the Department of Budget and Management issued the National Budget Call for fiscal year 2019 under the National Budget Memorandum no. 129. The budget memorandum provides general and specific guidance to national government agencies and government owned and controlled corporations (GOCCs) on the preparation of budget proposals for 2019. Agency proposals are mandated to be consistent with the administration’s priority policies embodied in the 0+10-Point Socio Economic Agenda, the Philippine Development Plan, the 2017-2022 Public Investment Program, and the 2019-2021 Three-Year Rolling Infrastructure Program. The budget call followed the macroeconomic assumptions adopted by the Development Budget Coordination Committee in December 2017, including a deficit ceiling pegged at 3.0 percent of GDP for 2019. The budget call incorporates the proposed shift from a multi-year obligation-based budget to an annual cash-based appropriation system. Under the budget call, the 2019 budget will be an annual cash-based outlay where budgetary performance will be evaluated based on payments of goods and services actually delivered within the fiscal year, with an extended payment period of three months. These are important reforms from past practices, which based payments on obligations and allowed appropriations for up to two years. To ensure a smooth transition to annual cash-based appropriations, infrastructure projects will be allowed a two-year transitory period. In addition, for the initial year of implementation in fiscal year 2019, cash-based appropriations for infrastructure projects shall be available for release, contractual commitment, and disbursement until December 31, 2020. Previous budgetary practices led to low budget utilization rates among government agencies. As the budget planning horizon effectively shortens to a year under the new system, the government expects to accelerate program delivery and on- schedule operations, improve government capacity, and strengthen accountability. Moreover, the government plans to continue to adopt budget administration reforms to improve transparency and reliability in the budget process. These reforms include the use of a two-tier budgeting approach (2TBA);41 a unified accounts code structure (UACS);42 and a program-based budgeting structure through the program expenditure classification (PREXC) approach.43 There are also reforms aimed at disaggregating lump-sum amounts within agency- specific budgets and institutionalizing a monitoring and evaluation system. Likewise, regional and local government agendas and budgets will be streamlined to ensure consistency with national government priorities. To institutionalize reform initiatives, the administration is pursuing a budget reform bill that has been approved by the House of Representatives. House Bill 5590, or the Budget Reform Act of 2017, and Senate Bill 1450, or the Budget Reform Act have been separately filed in both chambers of Congress. The acts aim to institutionalize the planned reforms of the budget process, including the shift to an annual, cash-based budget. The comprehensive release of funds to line agencies with the passage of the General Appropriations Act is sought after, including the authorization to conduct early procurement activities short of award to speed up project implementation for line agencies. On March 10, 2018, the House of Representatives approved the budget reform bill, which had been certified as urgent by the president. In the Senate, the sponsorship speech for the bill was made on March 21, and the bill is expected to be approved in May when senators return from recess. The government hopes that the bicameral committee will approve the Budget Reform Act shortly thereafter so it can be enacted into law in June 2018. Source: The Department of Budget and Management, National Budget Memorandum no. 129. DBM (2016). Guide to the Two-Tier Budget Approach, Manila. 41 The Two-Tier Budget Approach is a system where agency proposals for ongoing and existing programs and projects will be evaluated separately from new ones. Budgetary requirements for ongoing and existing programs are deliberated under Tier 1 and new spending proposals under Tier 2. 42 The Unified Accounts Code Structure (UACS) is a government-wide harmonized classification system for financial transactions, which is used by the Commission on Audit, Bureau of the Treasury, Department of Finance, and DBM. 43 The PREXC classifies all activities and projects and their performance indicators, under the appropriate program or major strategy being pursued by the agency to deliver a core objective or outcome. 24 Philippines ECONOMIC UPDATE • April 2018 II. Outlook and Risks Table 3: Economic indicators for the baseline projection 2015 2016 2017 2018f 2019f 2020f Real GDP growth, at constant market prices 6.1 6.9 6.7 6.7 6.7 6.6 Private Consumption 6.3 7.0 5.8 5.8 6.2 6.1 Government Consumption 7.6 8.4 7.3 8.9 7.1 6.6 Gross Fixed Capital Investment 16.9 25.2 10.3 11.8 11.9 12.6 Exports, Goods and Services 8.5 10.7 19.2 15.1 15.0 15.0 Imports, Goods and Services 14.6 18.5 17.6 15.8 15.8 16.0 Inflation (period average) 0.7 1.3 2.9 3.3 3.0 3.0 National government balance (% of GDP) -0.9 -2.4 -2.2 -2.5 -2.6 -2.8 National government debt (% of GDP) 44.7 42.1 42.1 41.8 41.6 41.4 General government debt (% of GDP) 36.2 34.6 34.6 34.4 34.3 34.3 Current account balance 2.5 -0.4 -0.8 -1.2 -1.4 -1.6 Source: PSA, BTr, BSP, World Bank staff calculations. 29. The service sector is expected to remain near full capacity. Meanwhile, the demand for the main driver of economic growth. The sector manufactured goods is expected to be strong, is projected to grow from 6.7 percent year-on- given the projected high external and domestic year in 2017 to 6.8 percent year-on-year in 2018- demand, which could lead to higher prices if 19. During the past five years, it consistently capacity constraints are not addressed. contributed roughly three-fifths of the country’s overall economic growth in 2018 and 2019. 31. Agriculture growth is expected to Among the service sub-sectors, the IT-BPO moderate in 2018-19 compared to its strong industry is expected to grow at an average annual expansion in 2017, and the government rate of 5.6 percent between 2016 and 2022, with needs to address structural weaknesses and revenues projected to reach US$38.9 billion in policy distortions facing the sector. While the 2022.44 This average growth, however, is slower agriculture sector grew at a robust annual rate compared to the industry’s double-digit growth of 3.9 percent in 2017, growth is expected to in the past decade, signaling the need to increase moderate in succeeding years to 3.7 percent the share of higher value-added services. and 3.0 percent in 2018 and 2019, respectively. Remaining constraints to growth in the sector 30. Manufacturing activities are projected include large input subsidies, insecure property to remain robust. The manufacturing sector rights for small landholders, and protectionist continues to be the preferred destination of policies such as the rice self-sufficiency policy both FDI and domestic credit. About a third of that reduces the incentives for the production foreign equity, other than retained earnings, of fruits and vegetables. These constraints and 14.1 percent of domestic commercial loans have made the sector unattractive to investors, were channeled to the sector in 2017 (Figure resulting in low credit and direct investment 28 and Figure 29). However, average capacity levels, a vicious cycle of low productivity, and utilization remains high, reaching a two-decade heightened vulnerability to weather-related high of 84.1 percent in January 2018, with more shocks. Developing the agriculture sector is key than half of the 20 major industries operating at for the Philippines to deliver inclusive growth, 44 ITBPAP (2017). Philippines ECONOMIC UPDATE • April 2018 25 II. Outlook and Risks as the sector employs a disproportionate share An encouraging prospect in the agriculture of the labor force. 45 Also, food production has sector is the ongoing shift to higher value crops a significant influence on domestic inflation. with export potential. Figure 29: The manufacturing and finance sectors Figure 28: The largest share of domestic bank credit is are among the favorite destinations of foreign direct channeled to real estate and construction investment 50.0 50.0 Percent of Equity other than Retained Earnings Percent of Total Business Loans 40.0 40.0 30.0 30.0 20.0 20.0 10.0 10.0 0.0 0.0 -10.0 Agriculture, Finance Utilities Manufacturing Wholesale Real Estate Wholesale Agriculture, Arts, Finance Real Manufacturing Utilities Forestry and and Retail and and Retail Forestry Entertainment and Estate and and Fishing Insurance trade Construction trade and Fishing and Recreation Insurance Construction 2015 2016 2017 2015 2016 2017 Note: Utilities include Electricity, Gas, Steam, Air-conditioning supply, Source: BSP. and water supply. Source: BSP. 2.2 Poverty and Shared Prosperity Outlook In line with the Philippines’ growth outlook, poverty levels are expected to continue to fall. While an increase in inflation might slow poverty alleviation, a rebound in agricultural sector growth could accelerate progress in poverty reduction. 32. Sustained economic growth is likely to inflow of remittances, and the government’s continue to contribute to poverty reduction. conditional cash-transfer program. Under the assumption that the responsiveness of the poverty rate to economic growth follows 33. However, rising inflation may negatively historical trends, the poverty rate, based on the impact the welfare of the poor. The poor are lower middle-income poverty line of US$3.20/ especially vulnerable to the recent increase in day, is projected to decline from 27.0 percent in inflation since it was largely due to higher prices 2015 to 22.9 percent and 21.7 percent in 2018 of food and non-alcoholic beverages, on which and 2019, respectively, as economic growth poor households spend a significant share of their remains robust (Figure 30). These projections income. Moreover, the tax reform package risks would imply a continuing trend of one million intensifying the hikes in food and energy prices. To Filipinos being lifted out of poverty each year. offset the impact of price increases from the tax Factors that have been driving poverty reduction reform package, the administration has allocated in the Philippines include the movement of Php25.7 billion, or Php200 per month to each of employment out of agriculture, a sustained the poorest 10 million households in 2018. 45 The agriculture sector contributed an average of 11.1 percent of GDP between 2007 and 2016, but employed an average of 32.1 percent of the labor force during the same period. 26 Philippines ECONOMIC UPDATE • April 2018 II. Outlook and Risks 34. Improving agriculture productivity is key Figure 30: Sustained economic growth makes it likely that poverty reduction will continue for the Philippines to achieve inclusive growth. Since most poor households live in rural areas 45.0 Forecast where agriculture is the main source of livelihood, 40.0 38.4 34.2 a rebound in the agricultural sector is expected 35.0 33.6 to disproportionately benefit the poor. Among 30.0 27.0 25.5 poor households, salaries and wages account for 25.0 24.2 22.9 Percent 21.7 20.6 over 40 percent of total income, and enterprise 20.0 income accounts for nearly 30 percent. Also, 15.0 over a third of their salaries and wages come 10.0 from agricultural activities, and about two-thirds 5.0 of enterprises that poor households rely on are 0.0 related to agriculture. Therefore, improving 2006 2009 2012 2015 2016 2017 2018 2019 2020 Lower middle-income poverty rate agricultural productivity is a means to raise wages Source: PSA, World Bank staff estimates. and salaries for the poor and help accelerate poverty reduction. 2.3 Risks and Policy Challenges There are several domestic risks facing the Philippines, including higher inflation, an overheating of the economy, and high fiscal deficits. External risks consist of greater policy uncertainty related to growing trade protectionism and increasingly inward-looking sentiments in several advanced and emerging economies, and potential market volatility from faster-than-expected U.S. Federal Reserve rate normalization. 35. Increasing policy uncertainty in global 36. Renewed protectionist sentiments in markets is the key external risk facing the advanced economies may disrupt exports Philippine economy. In 2017, the United States’ and economic growth. Fear of a looming trade Federal Reserve raised its federal funds rate war between large economies also raises three times, which led to episodes of adverse policy uncertainty. The United States recently capital outflows from the Philippines, as United announced heavy trade tariffs of 25.0 percent States assets became more attractive compared on steel and 10.0 percent on aluminum imports. to domestic assets. A faster-than-expected The European Union is targeting American normalization of the policy rate, driven by the agricultural products, such as peanut butter reassessment of United States monetary policy and orange juice, in retaliation if the tariffs are expectations, could result in renewed tightening implemented. Trade war rhetoric between the of financing conditions and heightened United States and China has also intensified. financial market volatility. The pace of policy While the United States tariffs are expected to normalization did not abate in the beginning only have a limited impact on Philippine exports, of 2018 and the Federal Reserve raised its rate they could potentially signal further restrictions in March in response to a continuation of the in the future. Since the Philippines is connected strong economic recovery and the stronger- to the global production chain, especially through than-expected employment and wage data in its intermediate electronics exports, an adverse the United States.46 trade policy against neighboring countries could eventually have an impact on the Philippines. 46 World Bank (2018d). Philippines ECONOMIC UPDATE • April 2018 27 II. Outlook and Risks 37. Inflationary risks are rising due to external Figure 31: Selected macroeconomic indicators and domestic factors. An improving external 90.0 120.0 environment is coinciding with a rise in global 80.0 78.4 100.0 commodity prices. The global price of crude oil is 70.0 63.0 projected to rise from US$52.80/barrel in 2017 60.0 54.2 80.0 Billions US$ 47.3 to US$58.00/barrel in 2018, which is expected Percent 50.0 60.0 40.0 to increase local energy prices. Exacerbating the 30.0 40.0 effects of rising global oil prices, the Philippine 20.0 17.6 17.4 16.7 23.7 peso is expected to further depreciate in 2018, 10.0 9.2 8.8 9.6 4.93.1 7.9 20.0 2.4 4.5 5.4 which will pass-through domestic prices. The 0.0 0.4 0.0 Per capita Cash Inflation Debt Public International recently passed first tax reform package could growth remittances (in percent rate (in percent of GDP) expenditure reserves (USD (in percent of billion, RHS) of GDP) GDP) also increase domestic prices. First, lower income 1990- 99 2000- 09 2010- 2017 taxes will increase workers’ take-home pay, which Source: PSA, World Bank staff estimates. may build-up demand-side pressures, especially in an environment of limited spare production 39. While the timely implementation of capacity. Second, higher excise taxes on fuel raise the public investment program is critical to transportation and energy prices. Finally, the the country’s growth outlook, fiscal risks are next round of rice imports unnecessarily risks increasing as spending continues to expand contributing to food inflation.47 Even though at an unprecedented rate. The government’s the government extended the quantitative infrastructure budget is set to increase from restriction for rice imports for three years until 13.4 percent year-on-year in nominal terms June 2020, it may need to reconsider its policy in 2017 to 24.5 percent year-on-year (to reach and open up the market to more private-sector Php1.1 trillion, or 6.2 percent of GDP) in 2018. participation. This represents a significant effort by the government to increase capital expenditures, 38. The Philippine economy is also at risk of and it aims to soon break ground on 34 out of overheating. The economy is currently growing 75 flagship projects under the public Build, at its potential rate, and the average capacity Build, Build infrastructure agenda.48 Although utilization in the manufacturing industry remains the government approved the first tax reform high, with all major industries operating at near package in late December 2017 that is projected full capacity. Moreover, unemployment reached to increase revenue by Php82.3 billion in 2018, record lows in recent years, signaling less spare the planned second tax reform package is labor capacity, although underemployment expected to be revenue neutral (Box 8). Given remains high. Therefore, investment in both plans for continued public expenditure increases capital assets and human capital is urgently over the next years, the risk to fiscal sustainability needed to increase the economy’s productive is heightened. Furthermore, weaknesses in capacity. In an environment of increasing fiscal budget execution due to limited absorptive spending and continued high credit growth, the capacity in government agencies could delay the risk of the economy overheating is increasing. implementation of public investment projects.49 47 Rice imports are largely controlled by the National Food Authority, which is mandated to maintain a 30-day stock during lean season and a 15-day stock at any given time. However, restrictions on rice imports in recent years left the rice supply inadequate at times, and the mistiming of imports has a caused a number of price hikes. For instance, domestic rice prices increased in 2014 because of importation lags, even as world prices fell. As a result, the current NFA rice stocks are reaching critical levels and are estimated to be depleted by April 2018. The next round of rice imports is set to arrive before the end of the second quarter. This mistiming of imports may yet again lead to higher rice prices and consequently higher food inflation. 48 De Vera, B. (2018). 49 The Department of Budget and Management cites the following factors that contribute to a limited absorptive capacity of public agencies: i) poor agency planning and project design; ii) difficulties in the procurement process; and iii) bottlenecks in project implementation such as right-of-way issues, lack of support and coordination among local government units, and claims and billing preferences of contractors and suppliers. Source: 2018 Fiscal Risks Statement, Department of Budget and Management. 28 Philippines ECONOMIC UPDATE • April 2018 II. Outlook and Risks 40. Prudent fiscal management and the strides in delivering inclusive growth, evidenced continuing implementation of the government’s by declining poverty levels and a falling Gini ongoing tax reform agenda are critical to coefficient. Underemployment, however, help secure the country’s fiscal sustainability. remains near its 18-20 percent decade-long Package 1A of the government’s tax reform average despite unemployment rates at historic agenda fell short of the initially targeted low levels. Therefore, delivering inclusive Php133.8 billion additional revenue and the economic growth remains the country’s most government hopes to pass Package 1B in 2018, pressing challenge, and more can be done to which is estimated to provide an additional create high-quality jobs and support poverty Php38.9 billion in tax revenue in 2018,50 reduction. The missing links to higher shared although the level of additional revenue remains prosperity in the Philippines are high-quality uncertain. Moreover, given tightening financing jobs and faster real wage growth (see Chapter 3: conditions globally, authorities must continue to Special Focus Note). The government needs to exercise fiscal discipline in order to maintain the affirm its commitment to structural reforms that country’s debt sustainability (Figure 31). promote competition, secure property rights, lessen regulatory complexities, and improve 41. Finally, slow progress in the medium term the country’s investment climate. Investing to implement structural policy reforms that in the future means prioritizing both physical would increase investment and create quality infrastructure and human capital investments employment could prevent the Philippines such as in education, skills, and health, as this from achieving more inclusive growth. In will create better employment opportunities, recent years, the economy has made great especially among the poor. Box 8 The next steps for the Government’s tax reform program In 2018, the government hopes to pass a number of tax reform packages to make the Philippine tax system more efficient, equitable, and competitive, starting with Package 2 of the comprehensive tax reform program. Package 2 of the reform program, which was submitted to Congress on January 16, 2018, aims to gradually lower the corporate income tax rate from the current 30 percent to 25 percent by 2022. The adjustment of the corporate income tax rate will be offset by the modernization of various investment tax incentives offered by the government, which will be designed to make incentives more performance-based, targeted, time-bound, and transparent. Moreover, package 2 aims to broaden the tax base through the repeal of 123 special laws on investment tax incentives and consolidating these into a single omnibus incentives law. Package 2 will also repeal various exemptions provided through the national internal revenue code, although the Department of Finance has proposed to include value-added tax exemptions for the coal industry and casinos, which were previously removed in the final version of the TRAIN law. The government aims to ratify package 2 in December 2018. In addition, supplemental packages to packages 1 and 2 are currently being prepared by the Department of Finance. Congress is targeting the passage of supplemental tax package 1B in 2018, which is expected to include a real estate tax amnesty, a general tax amnesty, amendments to the bank-secrecy law, and adjustments to the Motor Vehicle Users Charge. The Department of Finance estimates that Package 1B will generate Php38.9 billion in additional revenue in 2018. Moreover, the Department of Finance is currently in the process of preparing package 2 plus, which consists of an adjustment in tobacco and alcohol excise taxes and taxes on mining activities. Finally, package 3, which focuses on property taxation, and package 4, which focuses on passive income and financial taxes, are targeted to be submitted to Congress in July 2018. Source: Department of Finance. 50 Package 1B includes reforms to estate tax amnesty, a general tax amnesty, adjustments to the motor vehicle user tax, and a relaxation of bank secrecy and automatic exchange of information. Philippines ECONOMIC UPDATE • April 2018 29 Part III: An increase in wage income through the movement of employment out of agriculture, government transfers, and remittances from domestic and foreign sources helped to reduce the Philippines’ national poverty rate by an average of 0.5 percentage points between 2006 and 2015. However, 21.6 percent of the population still lived in poverty in 2015, and the pace of poverty reduction has been slow in the Philippines compared to other East Asian countries. Since less than 10 percent of the population has a per capita income above the global middle-income line, the country is still a long way from achieving its goal of becoming a middle-class society. The key challenge facing the government are not unemployment, but rather the poor quality of jobs in the labor market, as a large share of employment opportunities in the Philippines consist of low-paid jobs. Unlike its high-performing East Asian neighbors with booming manufacturing sectors that provide large numbers of labor-intensive jobs, a majority of Filipino workers that transition out of agriculture generally end up in low-end service jobs. Moreover, poverty alleviation efforts in the country were hampered by the mere four percent increase in real wages between 2006 and 2015. High-quality jobs and faster real wage growth are the missing links to higher shared prosperity in the Philippines. Philippines Philippines ECONOMIC ECONOMIC UPDATE UPDATE • October 2017 • April 2018 31 III. The Missing Links to Higher Shared Prosperity in the Philippines 3.1 Introduction 42. The Government of the Philippines has coefficient of 45, income inequality is higher in formulated strategic plans with a clear focus the Philippines than in most developing countries on reducing poverty and improving living in East Asia. Also, the country’s poverty rate, standards. To achieve the vision of the Ambisyon measured against the international poverty line 2040 and the Philippines Development Plan of US$1.90 per day, declined by an average of 0.9 2017-2020 to reduce poverty to 13-15 percent percentage points per year between 2006 and by 2022, authorities need to evaluate best 2015, far slower than in China (2.4 percentage practices and identify the key elements that points), Indonesia (2.2 percentage points), affect the inclusiveness of growth. This focus and Vietnam (2.1 percentage points) (Table 4). note aims to study the impact of growth on the Measured against the lower middle-class poverty living conditions of Filipinos and provide policy line of US$3.20 per day, the Philippines poverty suggestions that address the main constraints rate declined by an average of 1.3 percentage to strengthen inclusive growth and accelerate points per year in the same period, slower than poverty reduction. the average 3–5 percentage points for the group of select East Asian countries. 43. Economic growth helped to reduce national poverty in the Philippines over the past 45. The Philippines stands out among many decade. Between 2006 and 2015, the country’s East Asian countries for its lack of progress in average annual GDP grew by 5.4 percent and eliminating poverty and promoting economic by 3.8 percent in per capita terms. This robust security and its middle class (Figure 34). growth rate helped to push the national poverty The country’s persistent high level of income rate from 26.6 percent in 2006 to 21.6 percent in inequality has limited the responsiveness of 2015, declining by an average of 0.6 percentage poverty reduction to economic growth. Even points per year (Figure 32 and Figure 33). at the middle of the spectrum of the country’s income distribution the Philippines’ performance 44. Yet, poverty remains high and the pace lagged. Many East Asian countries have fared of poverty reduction has been slow compared better such as China and Vietnam, which have to other East Asian countries. With a Gini made significant progress in reducing economic Figure 32: National poverty rates and number of poor Figure 33: Poverty trends based on national and international poverty lines 25 30 45 40 25 20 35 20 30 Million Inidividuals 15 25 Percent Percent 15 20 10 10 15 5 10 5 5 0 0 0 2006 2009 2012 2015 2006 2009 2012 2015 Number of Poor Poverty Rate National International Lower -middle -income -class Source: World Bank staff estimates using various rounds of the Family Source: World Bank staff estimates using various rounds of the Family Income and Expenditure Survey. Income and Expenditure Survey. 32 Philippines ECONOMIC UPDATE • April 2018 III. The Missing Links to Higher Shared Prosperity in the Philippines Table 4: Poverty rate in selected East Asian countries US$1.90/day US$3.20/day (international poverty line) (lower middle income class poverty line) Decline per Decline per Country 2006a 2015a 2006a 2015a year year Thailand 0.7 0.0 0.1 6.2 1.1 0.7 China 18.8 1.9 2.4 43.5 20.2 3.3 Vietnam 19.5 2.8 2.1 51.3 11.6 5.0 Indonesia 27.5 7.5 2.2 65.6 34.0 3.5 Philippines 14.5 6.6 0.9 38.4 27.0 1.3 Source: World Bank staff estimates. a. Data for Thailand are for 2006 and 2013; 2005 and 2012 for China; and 2006 and 2014 for Vietnam. The Philippines uses income as the welfare measures, other countries use consumption. Figure 34: Prosperity Improvement in the Philippines compared to the East Asia pacific region A. Population distribution by economic class in the B. Population distribution by economic class in East Philippines, 2002-2015 Asia and Pacific, 2002-2015 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Note: Percent of total population. Note: Percent of total population. Source: World Bank staff calculations. Source: World Bank staff calculations. vulnerability. The share of the economically manufacturing sectors that provide large secure in the Philippines increased from 37 numbers of labor-intensive jobs, the majority of percent in 2002 to only 44 percent in 2015, workers in the Philippines that transition out of compared to one-fifth to two-thirds in the agriculture generally end up in low-end service region. Moreover, the share of the population jobs. The anemic 4 percent growth in real wages with per capita income above the global middle- between 2006 and 2015 brought limited gains income line of US$15 per day was only 9.2 for workers following the economy’s structural percent in 2015, lower than in Malaysia (65.7 transformation and limited the impact of percent), Thailand (35.4 percent), and China economic growth on poverty alleviation.51 (19.4 percent). As a result, the Philippines is still a long way from achieving its goal of becoming a 47. The inclusiveness of growth needs to middle-class society. increase if it is to substantially reduce poverty and create a growing middle class. Government 46. Unlike in high-performing East Asian policies can help establish mutually reinforcing countries with booming economies and positive cycles that will accelerate more inclusive 51 Due to the data limitation, the analysis of real wages covers the workers who reported positive wages only. The earning of those self-employed and who work without pay are not included in the statistics. The results related to wages need to be interpreted with caution. The information collected from the Labor Force Survey is from a sole informant for each household. The respondent is either the household head, the spouse of the household head, or in their absence, any responsible adult member of the household. Second-hand accounts of sensitive information such as wage and salary may be either underestimated or overestimated. Philippines ECONOMIC UPDATE • April 2018 33 III. The Missing Links to Higher Shared Prosperity in the Philippines growth and create a growing middle class well- policy recommendations. Section 2 of this integrated with other groups. Creating more focus note examines achievements in poverty well-paying jobs will require interventions across reduction; section 3 discusses the missing links multiple sectors that address both supply- and to real wage growth; and section 4 highlights demand-side constraints. the importance of education in increasing wages and participation in the labor market. Finally, 48. A better understanding of the factors section 5 provides policy recommendations for that drive poverty alleviation and the missing to accelerate poverty reduction and increase the links between economic growth and poverty inclusiveness of growth. reduction is needed for creating meaningful 3.2 Drivers of Poverty Reduction 49. In the past, the most important drivers continue to work in agriculture, data from the of poverty reduction in the Philippines were Labor Force Survey indicate that the share of increases in wage income due to a transition the population in primary production agriculture of workers out of agriculture. Other key factors (excluding agribusiness) declined by nearly 1 were government transfers and remittances percentage point each year from 2006 to 2015 from domestic and foreign sources (Figure 35). (Figure 36). Workers that transitioned to non- Wages and salaries, entrepreneurial income, agricultural jobs increased their living standards, and transfers accounted for four-fifths of total as even lower-end industry and service jobs paid household income. more than agriculture jobs (Figure 37). 50. The increase in wage income and 51. Transfers from government social movement of workers out of agriculture programs contributed about 25 percent of the contributed about two-thirds of the decline in reduction in poverty. Pantawid Pamilya, the poverty between 2006 and 2015. Higher non- national conditional cash-transfer program, agricultural wages were the main contributor, expanded rapidly over the past years and is accounting for over 50 percent of the reduction in now the primary government social assistance poverty. While most of the poor in the Philippines program for the poor. It extends cash grants to Figure 35: Contribution of income sources to poverty reduction, 2006–2015 2 Change in Poverty Incidence 0 -2 -4 -6 Non-agriculture Government Domestic Agriculture Non-agriculture Foreign Others Agriculture -8 wage transfers remittance wage enterprise remittance enterprise International poverty Lower-middle-income-class poverty Source: World Bank staff estimates using various estimates using various rounds of the Family Income and Expenditure Survey. International poverty is defined as household income per capita below US$1.90 a day (2011 PPP), and lower-middle-income-class poverty is defined as household income per capita below US$3.20 a day. 34 Philippines ECONOMIC UPDATE • April 2018 III. The Missing Links to Higher Shared Prosperity in the Philippines Figure 36: Millions of workers transitioned out of Figure 37: Greater earnings in services and agriculture manufacturing than in agriculture 25,000 Monthly wage, 2015 2015 20,000 2012 15,000 2009 10,000 2006 5,000 0 10 20 30 40 50 60 70 80 90 100 Percent 0 Agriculture Transportation, storage & comminication Laborers & Farmers, Service Trades & Plant & Clerks Technicians Special Professionals Gov’t. Manufacturing Public administration & defense unskilled forestry workers & related machine and occupations officials Other industry Accomodation, food & recreation services workers workers shop and workers operators associate corporate Trade Other services & fishermen market and proffesionals execs, sale assemblers managers Finance, real estate, renting & business activities Source: Labor Force Survey 2006 and 2015. Source: Labor Force Survey 2006 and 2015. 77 percent of the country’s poor households Domestic remittances were more prevalent and helps to reduce poverty and build human among the poor, while foreign remittances were capital. World Bank estimates indicate that more common among the non-poor. the program has reduced the national poverty rate by up to 1.5 percentage points. Pantawid 53. Entrepreneurial income had a 15 Pamilya also improved school enrollment of percent negative effect on poverty reduction. older children, encouraged early childhood Entrepreneurial activities vary in the Philippines, education, and increased health-seeking which may be reflected in their aggregate behavior among beneficiaries. negative effect on poverty. Poor rural households typically engage in agriculture-related activities, 52. Remittances from domestic and foreign while the urban poor often engage in lower-end sources contributed about 12 percent and services, and the non-poor more commonly 6 percent, respectively, of the decline in participate in businesses. Nevertheless, poverty. Two-thirds of all Filipinos, or 15 entrepreneurial income from agriculture- million households receive domestic or foreign related activities offers an opportunity to reduce remittances. While foreign remittances are much rural poverty if efforts are made to address higher in value, both types of transfers reduced productivity constraints, access to finance, the poverty rate by up to 4 percentage points. extension services, and climate change. 3.3 The Remaining Challenge: Low-quality Jobs and Slow Real Wage Growth 54. The Philippines’ slow pace of poverty growth in real wage incomes. The Philippine reduction compared to other countries in the labor market suffers from a lack of quality jobs, region is due to various factors, including less which means that most of the poor are working pro-poor economic growth, high inequality poor, as low-paying jobs or underemployment of income and wealth, the high frequency of prevent them from graduating out of poverty. disasters and the presence of conflict. While For example, some households earn as little the role of wage income in poverty reduction as 50–100 pesos (US$1–2) a day, and many is similar to many other developing countries, urban poor are trapped in low-wage and low- the Philippines has experienced much slower productivity jobs in the informal service sector. Philippines ECONOMIC UPDATE • April 2018 35 III. The Missing Links to Higher Shared Prosperity in the Philippines Therefore, the government needs to make 56. Labor market development in the past growth more inclusive to make it possible for decade was characterized by high growth in Filipinos to achieve higher and more stable the number of jobs. Strong economic growth income through productive employment. contributed to the steady decline in the unemployment rate from 8.0 percent in 2006 to 55. Poor-quality jobs (or “in-work poverty”), 6.9 percent in 2015. With consistent net positive rather than unemployment, constitute the job creation, employment growth was at par key challenge for government to reduce with the working-age population growth (both poverty.52 Poverty is closely associated with the at about 20 percent over the period) and even employment sector and the activity status of the slightly faster than the growth of the labor force household head, not whether the household (about 16 percent), resulting in a decline in the head is employed (Figure 38 and Figure 39). The unemployment ratio (Figure 40). poverty rate for households with a household head that is employed is close to the national 57. However, a large share of the jobs average of 21.6 percent (based on the national created were low-wage jobs. Moreover, the poverty line). Households headed by individuals rapid expansion of employment might have also that work in agriculture or are self-employed exerted negative pressure on wages. Although have the highest rate of poverty, highlighting employment increased by 20 percent between the importance of job quality and that a job is 2006 and 2015 when the country’s GDP increased not a ticket out of poverty. As a result, many by about 60 percent, real wages remained poor families are headed by the working poor stagnant, with only a four percent increase in and agricultural workers. Households headed real terms over the period (Figure 41).53 While by those not employed, a large share of which attractive in the short run, the low growth of real are migrants, or family business owners, had the wages is likely to have a negative effect on the lowest poverty rate. competitiveness of the country’s economy in the Figure 38: Poverty rate by employment Figure 39: Poverty rate by employment status of sector of household heads household heads 42% 30% 21% Overall Poverty Rate Overall Poverty 19% Rate 12% 13% 12% Not Employed Employee Self-Employed With Family Business Agriculture Industry Services Source: World Bank staff estimates based on the national poverty line Source: World Bank staff estimates based on the national poverty line using Family Income and Expenditure Survey, 2015. using Family Income and Expenditure Survey, 2015. 52 World Bank (2016). 53 The information collected from the Labor Force Survey is from a sole informant of each household. The respondent is either the household head or the spouse or, in their absence, any responsible adult member of the household. Second-hand accounts of sensitive information such as wage and salary may be underestimated (or overestimated). Due to the data limitation, the analysis of real wage covers the workers who reported positive wage only. The earning of those self-employed and work without paid are not included in the statistics. The results related to wage need to be interpreted with caution. 36 Philippines ECONOMIC UPDATE • April 2018 III. The Missing Links to Higher Shared Prosperity in the Philippines Figure 40: Working-age population, labor force, and Figure 41: GDP, employment, and real wage growth employment growth 130 200 120 150 110 100 100 50 90 0 2006 2009 2012 2015 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Labor force Working age population Employment GDP (2006=100) Employment Real wages (2006=100) Source: World Bank staff estimates using various rounds of the Labor Source: World Bank staff estimates using various rounds of the Labor Force Survey. Force Survey. long run, as the most educated Filipinos leave in the services sector. The share of agriculture in the country for better job opportunities. There total employment fell from about 36 percent in are currently 6 million Filipino migrants working 2006 to 28 percent in 2015, while the share of abroad, which might be an indication that this the services sector rose from about 49 percent human capital flight is already happening. to 55 percent over the same period. Meanwhile, the share of the labor force working in industry 58. In recent decades, the structural change increased from 15 percent in 2006 to just 17 that started in the 1970s continued as millions percent in 2015. Between 2006 and 2015, of jobs shifted from primary production the share of the poor employed in agriculture agriculture to the services sector (Figure 42 declined from 67 percent to 58 percent, the and Figure 43). Unlike in many neighboring East share of the poor working in industry increased Asian countries where surplus agricultural labor from 10 percent to just 13 percent, and the share moved to the labor-intensive manufacturing of the poor with services jobs increased from 23 sector, the majority of workers in the Philippines to 29 percent. who transited out of agriculture were employed Figure 42: Share of employment of the poor by sector Figure 43: Share of employment of an average Filipino by sector 2015 58% 13% 29% 2015 28% 17% 56% 2012 62% 11% 27% 2012 31% 15% 54% 2009 64% 11% 26% 2009 33% 15% 52% 2006 67% 10% 23% 2006 35% 15% 50% 0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80 90 100 % of employment in each sector each year % of employment in each sector each year Agriculture Industry/manufacture Service Agriculture Industry/manufacture Service Source: World Bank staff estimates using Labor Force Survey, various Source: World Bank staff estimates using Labor Force Survey, various rounds. rounds. Philippines ECONOMIC UPDATE • April 2018 37 III. The Missing Links to Higher Shared Prosperity in the Philippines 59. A large share of the unskilled labor that booming manufacturing sectors created large transitioned to non-agriculture employment numbers of labor-intensive jobs, absorbing the ended up in low-wage and low-skilled jobs in surplus labor from agriculture. It is an ongoing the informal services sector. According to the debate whether manufacturing can still deliver World Bank’s Philippines Development Report,54 the same productivity gains and well-paid more than three-quarters of the services sector employment opportunities for the unskilled is composed of low-paid and low-skilled jobs workers as in the past. in areas such as petty retail trade and public transportation. The low productivity of the 61. As a result, the country’s labor market services sector did not provide the basis for large has been characterized by a low unemployment wage increases, limiting the scope of poverty rate, a high underemployment rate, and a reduction and shared prosperity. The minimal limited increase in real wages (Table 5). The raise in wages over the last decade suggests that average employment and earning status of labor gains from the structural shift of workers to Philippine households has changed little over non-agricultural sectors have been limited. With the past decade. On average, the ratio of the a low rate of investment (20 percent of GDP), working-age population to total population the Philippines’ consumption-driven pattern was about 66 percent over the past decade. of growth may further restrict the potential of Labor force participation declined slightly from structural transformation in the labor market 63 percent in 2009 to 61 percent in 2015. and improvement in labor productivity. Moreover, the ratio of employment to working- age population was around 58 percent and has 60. The Philippines has transitioned from changed little over time. The unemployment rate an agricultural economy to a (low-end) fell from nearly 8 percent in 2006 to 6 percent in services economy without developing a 2015, but this masks the challenges associated manufacturing sector. The country’s labor with low-quality jobs. Despite the decline in productivity growth comes mainly from within- unemployment, underemployment—those who sector productivity growth (Figure 44). This is work but are willing and available to work “more contrary to the development patterns of many adequately”— has remained persistently high, in neighboring countries in East Asia, where the range of 20-22 percent, since 2006.55 Figure 44: Intersectoral labor allocation in select East Asian countries 10 8 6 4 2 0 -2 -4 -6 1990-96 1996-99 1999-2007 2007-10 1990-96 1996-99 1999-2007 2007-12 1990-96 1996-99 1999-2007 2007-11 1990-96 1996-99 1999-2007 2007-12 1990-96 1996-99 1999-2007 2007-11 China Indonesia Malaysia Philippines Thailand Static reallocation Dynamic reallocation Within-sector growth Source: World Bank (2017a), page 66. World Bank staff estimates based on data from the Groningen Growth and Development Centre 10-Sector Database; www.rug.nl/ggdc/productivity/10-sector. 54 World Bank (2013). 55 Underemployment is defined by the International Labor Organization as, “those who worked or had a job during the reference week but were willing and available to work “more adequately.” 38 Philippines ECONOMIC UPDATE • April 2018 III. The Missing Links to Higher Shared Prosperity in the Philippines Table 5: Employment and earnings status, percent Employment Working-age Labor force to working- Underem- population Unemploy- Daily wage Year participation age ployment (>=15)/total ment rate (2006 pesos) rate population rate population ratio 2006 65 63 58 8 22 259 2009 67 63 58 7 20 263 2012 67 62 58 7 21 263 2015 67 61 58 6 20 269 Growth, 2006–15 1 -2 -1 -2 -2 4 62. Between 2006 and 2015, real wages grew limited labor gains from the recent structural by only 1.5 percent for private establishment transformation of the labor market. workers, while they grew by 11 percent and 9 percent for public employees and private Figure 45: Countries changes in the composition of employment status over time household workers, respectively. Over the same period, private establishment jobs in total 100 11.6 10.7 9.6 7.8 90 4.2 3.6 3.4 employment increased, while wage employment 80 4.7 26.1 in private households, self-employment, and 70 30.6 29.5 27.2 60 unpaid work declined (Figure 45). In sum, growth 8.6 Percent 8.1 50 7.7 8.2 in real wages was minimal while there was a 40 shift in the labor market to employment with 30 39.4 41.2 45.7 48.1 20 higher earning potential. The increase in real 10 wages among workers in the public sector was 0 5.5 5.9 5.5 5.6 2006 2009 2012 2015 related to legislative changes to public-sector Private Household Private Establishment Gov't/Gov't Corporation Self Employed wages,56 whereas the small increase in real Employer With Pay (Family Owned Business) Without Pay (Family Owned Business) wages for private-sector workers, who constitute Source: LFS, various rounds. the largest share of employed workers, suggest 3.4 The Importance of Education in Labor Market Participation and Wage Growth 63. Labor market status is closely associated (Table 6). The share of college-educated with a worker’s level of education. While individuals who are underemployed is only half unemployment is lower for individuals with the of those with lower educational attainment, and least education (since the poor cannot afford to their daily wage is nearly 250 percent of those be idle and not working), workers with higher with a high school education, over three times of educational attainment have significantly higher those with an elementary school education, and wages than those with little or no education over four times of those with no schooling. 56 Two laws involving the standardization of public-sector salaries were implemented in the last 10 years. The first was Joint Resolution No. 4 by the Fourteenth Congress that authorized President Gloria Macapagal-Arroyo to modify the compensation package for government, military, and uniformed personnel. The revised compensation took effect 1 year after it was signed in July 2008 for employees in national government offices and after 18 months for employees in local governments. The salary increase was implemented in equal tranches over four years. Another round of salary standardization through Executive Order No. 201 took effect in July 2016. This legislation ensured comparability of public-sector wages, particularly management-level positions, with prevailing rates in the private sector. This new adjustment in wages will take effect in stages through 2019. Another important piece of wage legislation is the Domestic Workers Act or Kasambahay Law, which regulates wages given to household employees and enforces the provision of social and other benefits. Wages of workers in private households have grown by an average of 4.2 percent annually since the law was passed in January 2013. Philippines ECONOMIC UPDATE • April 2018 39 III. The Missing Links to Higher Shared Prosperity in the Philippines Table 6: Employment, unemployment, and daily earnings by educational attainment, percent Employment- Underemployment Unemployment Daily wage Education level to-working-age rate rate (2006 pesos) population ratio No schooling 52 22 3 115 Some elementary 68 27 3 141 Elementary graduate 66 24 4 158 Some high school 46 24 7 166 High school graduate 60 20 9 206 Some college 47 17 10 280 College graduate 67 11 8 506 64. Labor markets in the Philippines offer are a modest 6 percent per year, completing significant returns to education. Educational high school opens up the possibility of attending attainment, particularly secondary school college or completing technical and vocational completion, plays an important role not only in an education and training (TVET), which have much individual’s ability to become employed (particularly higher returns (Figure 46). On average, each in wage employment in private establishments, the year of college boosts wages by 19 percent, government, or government corporations) but also and returns to TVET are 11 percent per year of affects his or her wage earnings.57 schooling. For example, the rate of return for one additional year of college education is about 65. Having another year or level of education 19 percent, while it is 6 percent for completing is strongly associated with better wage a high school education. Education benefits employment in private establishments, the particularly women who are disadvantaged in government, and public corporations. However, the labor market. The gap in the rate of return returns vary by level of education. While the on education between rural and urban areas is wage returns for an additional year of high school not as large as that between genders (Figure 47). Figure 46: Rate of return for another year of Figure 47: Rate of return for education by education education level 16% College 19% 12% 11% 10% Technical and 11% 9% Vocational High School 6% Elementary 2% All Male Female Urban Rural Source: World Bank staff estimation using the Labor Force Survey, 2015. Source: World Bank staff estimation using the Labor Force Survey, 2015. 57 This section empirically discusses estimated returns to education using the Mincer (1974) method for education level, gender, rural/urban areas, and island groups, and the role of educational attainment for those who worked for private establishments, government or government corporations, were employers in own family-operated farms or businesses, or worked for pay in own family-operated farms or businesses in the Philippines. The majority of those who worked for private households worked without pay in own family-operated farms or businesses or were self-employed. Those without paid employees do not report wage earnings in the Labor Force Survey, So the discussion here includes only wage earners in the private establishments and government or government corporations. 40 Philippines ECONOMIC UPDATE • April 2018 III. The Missing Links to Higher Shared Prosperity in the Philippines 66. Educational attainment is also positively 67. The labor force has become more associated with wage employment in private educated, and the younger generation is more establishments, the government, and educated than the older. The share of the labor government corporations. The probability of 58 force with complete tertiary education has wage employment increases by 2.4 percentage gradually increased from 14 percent in 2006 points with another year of schooling (Figure to 17 percent in 2015. In 2015, 24 percent of 48). Again, this benefits women more than men, the 25–34 age group had completed tertiary and rural areas more than urban areas (Figure education, which was double that of the 55–64 49). More significantly, completion of tertiary age group. Only 2 percent of the labor force education is particularly important for wage in poor households had completed tertiary employment, as it increases the probability education in 2015, compared to 20 percent in of employment by 4.0 percentage points. The non-poor households, and the youth in poor highest marginal increase in the probability of household was much less educated that their wage employment is observed in rural areas. wealthier counterparts. In 2015, 60 percent This may be related to a scarcity of workers with of the youth (20–29 years old) in the bottom a college education and greater competition income quintile did not have a full secondary for wage jobs in rural areas compared to education, compared to only 5 percent of the urban areas. The effect of tertiary education youth in the richest income quintile (Figure is not significantly different in terms of wage 50). Similarly, only 2 percent of the youth from employment for women and men. However, the poorest quintile and 7 percent from the high school completion exhibits a big difference second-poorest quintile had completed tertiary between men and women, as it is particularly education in 2015, compared to nearly 60 important for women to at least complete high percent from the richest quintile. Workers with school if they intend to apply for wage jobs. less than secondary education earn significantly Differences in school attainment and learning less and are more likely to fall into poverty. The between children from poor and wealthier large gaps in educational attainment of the youth families result in differences in their earning from the poor and non-poor households might power as adults, perpetuating inequality perpetuate the gaps in their earning ability and across generations. income status. Figure 48: Marginal effect on the probability of wage Figure 49: Marginal effect on the probability of wage employment with an additional year of schooling by employment with an additional year of schooling by gender and location education level 3.4% College 2.6% 2.4% Technical and 2.0% Vocational 1.7% High School Elementary All Male Female Urban Rural Rural Urban Female Male All Source: World Bank staff estimation using the Labor Force Survey, 2015. Source: World Bank staff estimation using the Labor Force Survey, 2015. 58 The estimated returns to education omits individuals who are not wage earners in private establishments, government, or government corporations. Philippines ECONOMIC UPDATE • April 2018 41 III. The Missing Links to Higher Shared Prosperity in the Philippines Figure 50: Youth (20–29 years old) education levels across income groups 100 2 6 7 15 13 29 80 30 19 59 60 37 25 Percent 19 39 40 16 19 33 20 20 11 13 25 16 7 8 12 3 6 2 2 0 2 1 0 02 10 1st quintile 2nd quintitle 3rd quintile 4th quintile 5th quintile No grade completed Elementary undergradu Elementary graduate High school undergrad High school graduate College undergraduate College graduate Source: World Bank staff estimation using the Labor Force Survey, 2015. 68. Despite the overall progress in improving school, the increasing teen pregnancy rate, and access to basic education, the high dropout rate the financial constraints or opportunity costs of in secondary education, particularly among the staying in school. poor, remains a challenge. In 2015, 82 percent of young adults from the richest quintile had 69. Dropout rates are highest among children attained at least elementary education, compared from households in the bottom income quintile. to 67 percent from the poorest quintile. The About half of all boys and a third of all girls in the gaps in secondary education were much wider, poorest quintile who dropped out of school cite as 81 percent of young adults from the richest a “lack of personal interest in education” as the quintile had attained secondary education in primary reason for exiting school (Figure 53 and 2015, compared to 41 percent from the poorest Figure 54). This could reflect a perception among quintile (Figure 51). Moreover, female students both students and parents that there is a low completed their elementary and high school level of learning in the country’s schools, which studies more often than their male counterparts may be related to high opportunity costs and (Figure 52). The high dropout rate in secondary uncertainty of economic returns to education schools, particularly for poor households, might (or insufficient information about such returns), be related to the perceived lack of learning in particularly among boys. Many children from Figure 51: Educational attainment rate among 22–24 Figure 52: Educational attainment rate among 22–24 year-olds by income quintiles, 2006-15 year-olds by gender, 2006-15 100 100 80 80 60 60 Percent Percent 40 40 20 20 0 0 2006 2015 2006 2015 2006 2015 2006 2015 Primary Secondary Primary Secondary Bottom quintile Richest quintile Male Female Source: Merged Family Income and Expenditure Survey-Labor Force Source: Merged Family Income and Expenditure Survey-Labor Force Survey, various years. Survey, various years. 42 Philippines ECONOMIC UPDATE • April 2018 III. The Missing Links to Higher Shared Prosperity in the Philippines Figure 53: Reasons for not attending elementary school Figure 54: Reasons for not attending high school among among 6- to 11-year-olds in the poorest quintile, 2014 12- to 15-year-olds in the poorest quintile, 2014 High cost of education Lack of personal interest /Financial concerns Lack of personal interest Illness/disability Marriage/Family matters High cost of education /Financial concerns Illness/disability Too young to go to school Accessibility of school Accessibility of school Employment/looking for work 0 10 20 30 40 50 0 10 20 30 40 50 60 Percent Percent Girls Boys Girls Boys Source: APIS 2014. Source: APIS 2014. poor households need to contribute to the program since 2010 to help malnourished immediate welfare needs of their families, which children keep their focus in the classroom, and it often prevents them from staying in school. reached about 1.9 million student beneficiaries in the 2016–17 school year. However, a recent 70. Poor health and financial constraints are independent impact evaluation revealed mixed often major reasons for students dropping out results about the program’s effectiveness and of school. The poor health of many elementary sustainability.59 Moreover, financial concerns school children is a major concern and one of the and the cost of education are also significant main reasons for students dropping out of basic issues for households in the bottom income education. About 20 percent of boys and girls quintile, particularly for attending high school. who are not attending elementary school cited About half of the girls who were not attending health or disability conditions as the main reasons high school pointed to financial concerns as the for dropping out of school. The Department of most significant reason for not attending school, Education has carried out a school-based feeding compared to about a third of male dropouts. 3.5 Conclusion 71. The Philippines need to make economic sectors that address both supply- and demand- growth more inclusive, particularly through the side constraints for creating more well-paying creation of more well-paying jobs, to reduce jobs in the labor market. poverty and create a growing middle class. A vicious cycle of unequal investment in human 72. Access to more well-paying jobs, capital and a lack of quality job opportunities has particularly semi-skilled jobs that are suited for trapped generations of households in poverty. To workers with less than a high school education, break this cycle, the government needs to adopt will help to reduce poverty and address mutually reinforcing policies that will create a inequality through higher wage incomes. growing middle class that is well-integrated with This will require the government to improve other income groups. This should include the the business environment to attract more implementation of interventions across multiple investment, upgrade value chains to support 59 Tabunda, et.al. (2016). Philippines ECONOMIC UPDATE • April 2018 43 III. The Missing Links to Higher Shared Prosperity in the Philippines strong and sustainable growth, and strengthen goods and services. The Philippines could backward and forward linkages to take advantage leverage its strong performance in BPO to expand of skilled labor and create jobs for the unskilled. other service-based sectors and create more productive employment opportunities, including 73. The country’s investment-to-GDP ratio is jobs with skill requirements compatible with low compared to its high-performing East Asian workers from poor households. neighbors. To attract more private investment, authorities need to improve the business 75. The government needs to improve human environment, particularly through addressing capital, especially for poor households, to institutional constraints, strengthening ensure that Filipinos acquire the skills needed competition in key sectors, securing property in the 21st century economy. It is especially rights, providing risk-management solutions, important to invest in children starting in the and simplifying business regulations. first 1,000 days and target support to poor households and vulnerable groups to help 74. The Philippines has transitioned from an them mitigate shocks and improve their human agricultural economy to a (low-end) service capital. Key education and skills challenges economy without developing a manufacturing facing the Philippines include ensuring that sector. Therefore, the country needs to find students that are in school learn relevant skills, its specific niches in the services sector and in reducing the high dropout rates for the poor, and regional and global value chains to capitalize developing socioemotional skills. Specifically, on its growing service offering and increase public authorities need to boost learning in basic the productivity gains from the labor market’s education, increase enrollment and completion structural transformation. Specifically, authorities rates in secondary education among the poor, need to address both forward and backward and develop socioemotional skills in addition to linkages between the service, manufacturing, traditional technical and cognitive skills. and agriculture sectors to upgrade domestic 44 Philippines ECONOMIC UPDATE • April 2018 References • Department of Budget and Management. (2018). National Budget Memorandum no. 129. Available Online: https://www.dbm.gov.ph/index.php/209-latest-issuances/national-budget- memorandum/2018/406-national-budget-memorandum-no-129. March 23, 2018. • ___________. (2016). Guide to the Two Tier Budget Approach: 2TBA, A tool for agencies. Available Online: https://www.dbm.gov.ph/index.php/budget-documents/2017/guide-to-the-two-tier- budget-approach-2tba. March 23, 2018. • De Vera, B. (2018). Neda: Groundbreaking of 34 ‘flagship’ infra projects set for 2018. Philippine Daily Inquirer. Available Online: http://business.inquirer.net/244373/neda-groundbreaking-34-flagship- infra-projects-set-2018. January 18. • Geronimo, J. (2017). Agriculture damage from Urduja reaches P1 billion. Rappler, Available Online: https://www.rappler.com/business/192090-agriculture-damage-urduja-december-22. December 23. • International Monetary Fund. (2017). Regional Economic Outlook Update: Making the most of the Upswing. Washington D.C., International Monetary Fund. • IT and Business Process Association of the Philippines. (2017). Accelerate PH: Future Ready Roadmap 2022, The Philippine IT-BPM Sector. Available Online: http://itbpm-roadmap2022.ibpap.org/. March 18, 2018. • Mincer, J. (1974). Schooling, Experience and Earnings. New York: Columbia University Press. • Philippine Economic Zone Authority. (2018). Operating Economic Zone Map. Available Online: http:// www.peza.gov.ph/index.php/economic-zones/list-of-economic-zones. March 18, 2018. • Saulon, V. (2017). Electronics Group wants more Local Content in Export Goods. Business World. Available Online: http://www.bworldonline.com/content.php?section=Corporate&title=electronics- group-wants-more-local-content-in-export-goods&id=147341. April 10, 2018. • Tabunda, A., Albert, J. and I. Angeles-Agdeppa. (2016). Results of an Impact Evaluation Study on DepED’s School-Based Feeding Program. Philippines Institute for Development Studies. • World Bank. (2013). Philippine Development Report: Creating More and Better Jobs. Washington, DC: World Bank. • __________. (2016). Republic of the Philippines Labor Market Review: Employment and Productivity. Washington, DC: World Bank. • __________. (2017a). East Asia Pacific Economic Update: Sustaining Resilience. Washington D.C., World Bank. • __________. (2017b). Philippines Economic Update: Preserving Consistency and Policy Commitment. Washington D.C., World Bank. • __________. (2018a). Global Monthly newsletter, January 2018. Washington D.C., World Bank. • __________. (2018b). Global Monthly newsletter, March 2018. Washington D.C., World Bank. • __________. (2018c). Global Economic Prospects, January 2018: Broad-Based Upturn, but for How Long? Washington D.C., World Bank. • __________. (2018d). East Asia Pacific Economic Update: Enhancing Potential. Washington D.C., World Bank. Philippines ECONOMIC UPDATE • April 2018 45 ANNEX Table A.1. Key economic indicators (2016 to 2020) 2016 2017 2018 2019 2020 Actual Projected Growth and inflation (in percent of GDP, unless otherwise indicated) Gross domestic product (percent change) 6.9 6.7 6.7 6.7 6.6 Gross domestic product (percent change) 1.3 2.9 3.3 3.0 3.0 Inflation (period average) Savings and investment Gross domestic savings 15.3 15.4 15.6 15.7 15.9 Gross domestic investment 24.6 25.2 25.5 26.0 26.5 Public sector National government balance (GFS basis)1/ -2.5 -2.3 -2.6 -2.7 -2.9 National government balance (gov't definition) -2.4 -2.2 -2.5 -2.6 -2.8 Total revenue (government definition) 15.2 15.7 16.3 16.8 17.0 Tax revenue 13.7 14.2 14.8 15.2 15.4 Total spending (government definition) 17.6 17.9 18.8 19.6 20.0 National government debt 42.1 42.1 41.4 40.8 40.3 Balance of payments Merchandise exports (percent change) -1.1 12.8 9.8 9.9 10.0 Merchandise imports (percent change) 17.7 14.2 17.8 18.4 19.0 Remittances (percent change of US$ remittance) 4.9 5.3 5.5 5.5 5.5 Current account balance -0.4 -0.8 -1.2 -1.4 -1.6 Foreign direct investment (billions of dollars) 8.3 10.0 8.0 8.5 9.0 Portfolio Investment (billions of dollars) 0.4 -0.2 -0.4 -0.5 -0.6 International reserves Gross official reserves2/ (billions of dollars) 83.5 81.3 81.0 80.5 80.0 Gross official reserves (months of imports) 3/ 9.7 8.4 8.2 8.0 7.8 External debt4/ 24.5 23.3 23.0 22.8 22.6 Sources: Government of the Philippines for historical and World Bank for projections. 1/ Excludes privatization receipts and includes CB-BOL restructuring revenues and expenditures (in accordance with GFSM) 2/ Includes gold 3/ Defined as the total of goods and services imports 4/ Central Bank definition 46 Philippines ECONOMIC UPDATE • April 2018 Table A.2. National government cash accounts (GFS basis) (2016-2018) 2016 2017 2018 Actual Actual Budget (in percent of GDP, unless otherwise indicated) Revenue and grant 15.2 15.7 16.3 Tax revenue 13.7 14.2 15.3 Net income and profits 6.4 6.5 6.4 Excise tax 1.1 1.3 1.4 Sales taxes and licenses 2.3 2.3 2.5 Others 1.1 1.2 1.4 Collection from Customs 2.7 2.9 3.6 Nontax revenue1/ 1.5 1.9 1.0 Grant 0.0 0.0 0.0 Total expenditure 17.6 17.9 19.3 Current expenditures 13.2 13.4 13.4 Personnel services 5.2 5.1 5.13/ MOOE 2.9 2.9 3.2 Allotment to LGUs2/ 2.4 2.5 2.4 Subsidies 0.5 0.8 0.7 Tax expenditures 0.0 0.1 0.0 Interest payment 2.1 2.0 2.0 Capital outlays 4.4 4.8 5.8 Net lending 0.1 0.1 0.1 Balance (GFS definition) -2.5 -2.3 -3.1 Balance (GOP definition) -2.4 -2.2 -3.0 Primary Balance (GFS) -0.3 -0.2 -1.0 Memorandum items Privatization receipts (PHP billions) 0.7 2.0 2.0 Nominal GDP (PHP trillion) 14.5 15.8 17.5 Sources: Department of Finance, Bureau of Treasury, and Department of Budget and Management, and World Bank staff calculations 1/ Excludes privatization receipts (these are treated as financing items in accordance with GFSM). 2/ Allocation to local government units (LGUs) excludes capital transfers, which are included in capital outlays. 3/ Based on national government cash budget. On an obligation basis, personnel services make up 6.2 percent of GDP. Philippines ECONOMIC UPDATE • April 2018 47 The World Bank PHILIPPINES 26th Floor, One Global Place, 5th Avenue Corner 25th Street, BGC Taguig, 1634 Metro Manila Macroeconomics, Trade and Investment Global Practice East Asia and Pacific Region