Philippine Economic Update, August 2014 edition

Investing in the Future: Sharing Growth and Opportunities for All

Highlights:

Economic and policy developments

• After recording strong growth in the last 2 years, Philippine economic growth decelerated to 5.7 % in the first quarter of 2014 (Q1 2014). On the supply side, the services sector continued to be the main driver of growth, contributing 3.8 percentage points to overall growth, while agriculture remained weak. On the demand side, growth continued to be led by private construction, and to some extent, durable equipment, and infrastructure spending. Moreover, the recovery of net exports after 5 quarters of contraction contributed to growth. Their contribution, however, was muted by weak government consumption and the decline in private construction.

• After many years of slow poverty reduction, poverty incidence among the population declined by 3 percentage points between 2012 and 2013 to 24.9 %, lifting 2.5 million Filipinos out of poverty. For the first time in the country’s history, the government released comparable poverty estimates for 2 consecutive years instead of the usual three-year gap. Stronger job creation in the first half of 2014 (H1 2014) suggests that faster poverty reduction is expected to continue.

• The government has shifted efforts from relief to reconstruction in areas affected by Typhoon Yolanda. It has secured enough room for spending (PHP 162 billion or around 1.4 % of GDP) in the 2013 and 2014 budgets combined to support the reconstruction phase for Yolanda, the Bohol Earthquake, and other smaller disasters. Through May 2014, the Department of Budget and Management (DBM) has released PHP 32 billion, with physical works to ramp up spending in the second half of 2014.

Prospects and Risks

• Given the slow start in Q1 2014, weaker government spending in Q2 2014, and monetary policy tightening, baseline growth projections are being revised downwards from 6.6 to 6.4 % for 2014 and from 6.9 to 6.7 % for 2015. Strong domestic demand would continue to drive overall growth. Private consumption is expected to contribute more than half of GDP growth, supported by strong inflow of remittances. Ongoing and recently awarded public-private partnership projects equivalent to around 1.5 % of GDP are also new sources of growth. Finally, an acceleration of reconstruction spending can support growth at above 6 %.

• A number of external and domestic factors could pose risks to growth. External risks could come from disorderly policy normalization in high-income countries, a disorderly adjustment in China’s property market, political tensions in the Middle East and Eastern Europe, and territorial disputes in the region. On the domestic side, the main sources of risk are slow reconstruction spending and domestic reform lags, in particular reforms to raise tax revenues needed to raise infrastructure and social services spending.

Medium term reform agenda

• In the medium-term, growth can be sustained and made more inclusive by pursuing structural reforms and investing more in human and physical capital. Key structural reforms include protecting property rights, promoting more competition, and simplifying regulations. These are discussed in the recently launched Philippine Development Report “Creating More and Better Jobs.”

• The government’s planned doubling of infrastructure spending to 5 % of GDP, as well as significant increases in health and education spending, requires new sources of revenues. This can be achieved through a package of tax policy and administrative reforms. There is scope to increase tax revenues by broadening the base to making the tax system simpler, more efficient, and more equitable, while simultaneously lowering certain tax rates to increase the political feasibility of such a package.

• The Aquino Administration has successfully raised tax effort by 1.2 percentage points of GDP in the last 3 years through the sin tax reform, improved tax administration, and higher growth. Accelerating the current reform momentum would help the country yield additional tax revenues to create the fiscal space needed to enhance growth in the coming years.

• These reforms can help the country become more competitive, and in the process create more and better jobs, and accelerate poverty reduction. With further economic reforms, especially in areas which will have more impact on the lives of the poor, the government can help put the country on an irreversible path of inclusive growth and meet the jobs challenge.