Philippine Political Events & Economic Reforms: Land & Trade's Role, Study notes of Law

Download Philippine Political Events & Economic Reforms: Land & Trade's Role and more Study notes Law in PDF only on Docsity! This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: Developing Country Debt and Economic Performance, Volume 3: Country Studies - Indonesia, Korea, Philippines, Turkey Volume Author/Editor: Jeffrey D. Sachs and Susan M. Collins, editors Volume Publisher: University of Chicago Press Volume ISBN: 0-226-30455-8 Volume URL: http://www.nber.org/books/sach89-2 Conference Date: September 21-23, 1987 Publication Date: 1989 Chapter Title: The Aquino Government and Prospects for the Economy Chapter Author: Robert S. Dohner, Ponciano Intal, Jr. Chapter URL: http://www.nber.org/chapters/c9054 Chapter pages in book: (p. 558 - 593) 558 Robert S. Dohner and Ponciano Intal, Jr. the tradable goods sector. Despite the large devaluations, the real exchange rate at the end of 1985 was nearly unchanged from its level in the early 1980s. Beyond the income loss and unemployment, the severity of the credit squeeze traumatized the financial and industrial sectors, forcing many firms under and undermining the willingness of the banking system to take on lending risk, factors that would later delay the recovery of confidence and investment. The Aquino Government and Prospects for the Economy The “New Society” proclaimed by Marcos in the early 1970s failed to produce its promised improvements in the welfare of Filipinos, and, as martial law continued, opposition to the Marcos government grew. The oil shock and subsequent fall in commodity prices hurt incomes, particularly in the rural areas. Although measured economic growth was substantial, regional income disparities increased, and over the decade the proportion of the population living in poverty remained high.’ Continuing arrests and human rights violations by the military brought protests, particularly from the Catholic church. But the most crucial loss of regime support came in those groups that had provided the initial constituency for martial law. The patronage machinery on which the political foundations of martial law rested, especially the particularistic interventions and the generation and distribution of monopoly rents, tended over time to narrow the base of political support. By 1985 Marcos’ base was dangerously thin. The early support for the government within the rural sector faded as the momentum of land reform dissipated and as military abuses and corruption increased. Even though agricultural terms of trade were falling, the government increased its taxation of important crops through export and producer levies and through monopolization of trading and processing activities. The increasing incidence of rural poverty aided the insurgency, and the communist NPA took over effective administration, including taxation, in several areas. Although the military had been the main beneficiary of martial law, opposition within the armed forces developed over promotions and over the deployment of forces against the Moslem and communist insurgencies. Before 1972, the Philippine armed forces had been small, relatively professional, and reasonably effective. Martial law greatly zxpanded the size 561 PhilippinesiChapter 8 The breaking point came on February 22, when Marcos’ defense minister, Juan Ponce Enrile, along with General Fidel Ramos and a small number of troops, set up a command post at the Manila army base Camp Crame and declared their support for Corazon Aquino. The failure of Marcos and his chief of staff, General Ver, to quickly move against the rebels, the mobilization of huge numbers of civilians to surround and physically block loyalist troops from entering Camp Crame, and an eventual flood of defections from government forces left Marcos, by the time of his inauguration on February 25, a virtual prisoner in Malacanang p a l a ~ e . ~ He left the Philippines the next day on a U.S. Air Force jet for Guam and then to exile in Hawaii. On 26 February 1986, Corazon Aquino was suddenly president of the Philippines, in an unexpected and uneasy alliance with the military. The presidential election and its immediate aftermath had a significant impact on economic policy. The fiscal and monetary discipline that the Philippines had exercised under its standby arrangement with the IMF was abandoned to the cause of electoral survival. At the end of the third quarter in 1985, the Philippines was well within targets for the money supply, but between October and mid-February the money supply grew by over 50 percent, reaching a level of P. 44 billion, well above the March 1986 program target of P. 39 billion. The government deficit ballooned to P. 10 billion in the first quarter, ten times the deficit of the first quarter of 1985 and more than the program target for the entire year. After the election, the central bank sought to rein in the money supply to meet the IMF program requirements. The central bank’s efforts were complicated by the opposition-inspired boycott of government-associated financial institutions which severely affected several commercial banks, particularly the Philippine National Bank, and required a sharp increase in emergency assistance. But the central bank persisted in selling its own securities, and by the end of June the money supply had been reduced by 13 percent to P. 38.0 billion. The result was a further domestic financial shock-Treasury bill rates rose from 16 percent in January to 24 percent in February, at a time when inflation was decelerating. Real interest rates on commercial bank loans reached 30 percent in the same period. The stringent monetary actions prevented the injection of funds during the election campaign from translating into higher inflation or currency depreciation, but those gains had a high price. Real investment fell by an additional 15 percent in 1986, and the episode further unsettled an already skittish financial system. 8.1 Challenges Facing the New Government Despite the mood of national euphoria that accompanied Corazon Aquino’s assumption of the presidency, the problems that her government 562 Robert S. Dohner and Ponciano Intal, Jr. faced were extremely difficult ones, involving both political and economic reconstruction. The Marcos regime had corrupted and nearly destroyed key Philippine institutions. The military had become highly politicized, inti- mately involved in government, and accustomed to the patronage flows that martial law had created. Public esteem for the armed forces had almost disappeared. So had the effectiveness of the military as a force in countering the communist insurgency; in 1986 the NPA was far better organized and more capable of mounting operations than were the Armed Forces of the Philippines. However, despite its weakness in the field, the military remained a potent force in Manila politics, and its crucial role in precipitating the collapse of the Marcos government convinced many in the defense establishment that their position was coequal with that of the new president. The Philippine judiciary had also suffered under martial law. The ability of Marcos to dismiss judges at any level bent the judiciary into cooperation. Judicial decisions were increasingly based on influence or on wealth during the latter years of the regime. Other democratic institutions had been greatly weakened. The 1973 constitution had been molded to assure Marcos’ hold on government and had been repeatedly amended by him to suit immediate needs. The Batasang Pambansa, the legislature that Marcos created, had no substantive authority and was controlled by members of Marcos’ party, the Kilusang Bagong Lipunan (KBL). Political power and almost all decision making had been centralized in Manila under martial law; local governments had in some cases been superceded by the military, and the administrative ability of provincial and local governments weakened. Political issues and events dominated President Aquino’s first two years in power. The new government moved immediately to dismantle the political structures that Marcos left behind. Aquino dissolved the Marcos-controlled legislature. She dismissed thousands of local governors and mayors, replacing them with officers in charge, who would serve until elections could be held. The new government also moved quickly to recapture the assets that Marcos and his cronies had accumulated during the previous administration. Aquino’s first executive order established the Presidential Commission on Good Government (PCGG) to pursue legal action against Marcos and his associates outside the Philippines, and to identify and sequester their assets in the Philippines. Next was the need to provide a legal framework for the new government, and to begin to rebuild the institutions that had deteriorated or been destroyed by martial law. In March 1986 Aquino declared a “Freedom Constitution” that gave her the decree-making powers of her predecessor, although for a limited period, included a bill of rights, and called for a convention to draft a new constitution. The convention produced a draft constitution that was approved in a national referendum in February 1987. The constitution provided for a legislature similar to the U.S. Congress, and 563 PhilippineKhapter 8 congressional elections were held in May 1987. Local elections for mayors, governors, and other officials were held in January 1988, completing a process of four national referendums in just under two years. The other political challenge the Aquino government faced was assuring its own survival. Early coup attempts were mounted by Marcos loyalists. Later, more serious attempts were mounted by members of the armed forces, first in November 1986 and then in August 1987, in a coup that almost toppled the government. The military grievances against the government were several. The first concerned the national reconciliation policy that Aquino had adopted to deal with the Moslem and communist insurgents. The low pay and lack of support and equipment for military personnel also fueled discontent. Furthermore, military officers viewed themselves as political participants; some of the same individuals who had first deserted Marcos in February 1986 were the ones who led the coup attempt in August 1987. The partnership between the military and the Aquino government remains uneasy, and the military itself is highly factionalized. The Aquino government moved to satisfy some of the demands of the military after the August coup attempt, adopting a firmer stance toward the communist insurgency, increasing military pay, and removing from the cabinet members of whom the military had been especially critical. But Aquino was also forced to co-opt the military leadership, appointing and promoting on the basis of loyalty to the new government, and this has increased resentment in some quarters and set back the process of professionalizing the armed forces. While the NPA is a more serious threat to the security of the country, the military remains a more immediate threat to the elected government. The Aquino government also faced serious economic problems, as well as exaggerated expectations about what a new government could accomplish in the economic sphere. The recession of the previous three years had led to a sharp fall in per capita income, erasing the fruits of the previous eight years of growth. Open unemployment in Manila had doubled to 22 percent, while rates of underemployment were estimated at 40 percent. The import- substituting industrial sector had been decimated by the recession, with production cuts in some industries as high as 80 percent. Real investment dropped by over half between 1983 and 1986, but substantial excess capacity and continued financial and political uncertainty limited its recovery. The Philippines also faced the burden of the external debt inherited from the previous administration. At the end of 1985 total external debt of the Philippines was $26.3 billion. Although the total had only increased by 6 percent in the previous three years, the ratio of Philippine external debt to GNP had jumped from 63 to 82 percent, the result of declining economic activity and the real depreciation of the peso. Net external borrowing was almost zero for 1986, but the total external debt jumped again to $28.3 billion. This was the result of the appreciation of the yen against the dollar during the year and the fact that about 15 percent of Philippine external debt 566 Robert S. Dohner and Ponciano Intal, Jr. The final advantage that the new government had when it entered office was the general revulsion against the excesses and plunder of the Marcos government. Aquino had campaigned on a platform of reducing the role of government in business activities, doing away with particularistic grants of privilege, and returning acquired companies, as well as many govemment- established corporations, to the private sector. The widespread desire to purge the country of the institutions of the previous government, the desire for economic reform and recovery, and in addition, the disarray of the sectors that had depended on government protection or largess, created an opportunity for sweeping economic reforms. Although economic policy was overshadowed by political reconstruction and political crises, the govern- ment was able to push through fundamental policy changes that had long been advocated by external critics of the Marcos government. 8.2 Economic Policy The Aquino government faced three types of economic policy problems. The first was short-run economic policy to achieve recovery after almost three years of recession. The second was the establishment of broad outlines of economic policy for longer term growth, while the third was a renegotiation of the Philippine external debt with official and private creditors.’ 8.2.1 Recovery The Philippine stabilization episode was unusual in that domestic consumption expenditure did not drop, but instead continued to slowly rise as households drew down their savings. By 1986 there was little reserve left to consumption that could be drawn on to support recovery. Investment had been decimated during the recession and dropped further in 1986, a reflection of both the high degree of political and economic uncertainty and large excess capacity in most industries. The government immediately drew up a plan of increased public expenditure to boost the economy, primarily through a Community Employment and Development Program (CEDP) for labor-intensive projects in rural areas. The targets under the previous IMF program for the Philippines had been exceeded in the pre-election spree of the Marcos government, and the government was unable to draw on the second-to-last tranche of the standby agreement. Instead of a waiver, the government and the Fund negotiated a new standby program for the country. The atmosphere in the negotiations was far more cordial than that of the previous standby, and the resulting program was more liberal than its predecessor. The program allowed a 30 percent growth in base money from March 1986 to March 1987, the first increase in the government investment program since the crisis, and a rise in 567 PhilippineKhapter 8 the national government deficit from 1.9 percent of GNP in 1985 to 4.4 percent in 1986.8 The new program, submitted in September and approved in October, was for $262 million over eighteen months, with an additional $296 million available immediately under the Compensatory Finance Facility (IMF 1986~). Although real government expenditure did increase in 1986, organizing and implementing expenditure programs was difficult for the new government. The CEDP employment program was slow in getting started, and at the end of the year disbursements lagged well behind targets. Public sector investment also came in below targets due to a shortfall in expenditure by government corporations. 8.2.2 Policy Reforms The Aquino government had much greater success in implementing broad economic policy reforms. Although these took place under the shadow of political events, and not all reforms were achieved, by mid-1988 the policy environment in the Philippines had been fundamentally altered. Economic policy was more neutral in rewarding lines of economic activity, more transparent than it had been since the 1950s, and compared favorably with that of any other East Asian country. Understanding the success of the Aquino government in shifting economic policy requires some discussion of the ideological bases of the new administration. Although the opposition to the Marcos government in 1986 covered the entire ideological range, the 1986 presidential election was contested by only a limited segment of the opposition. The two groups that united to field Corazon Aquino and Salvador Laurel as candidates were from the center to center-right of the political spectrum, a group that has been characterized as “conservative reformists” (Lande 1986, 124). This group has provided the core of the new government, despite its appearance of being ideologically fractious. The conservative reformist nature of the cabinet was epitomized by President Aquino’s choices for the two key economics portfolios. The finance minister, Jaime Ongpin, was chairman of Benguet Mining Corpora- tion and had also headed the citizens’ election commission, NAMFREL, in the presidential election. The central bank governor, Jose Fernandez, was the sole holdover from the previous government and had been appointed by Marcos, under pressure, after the reserves overstatement discovery. As central bank governor, Fernandez had been responsible for much of the success, and the severity, of the stabilization program. Other cabinet ministers represented a wider range of opinions. Furthest to the left was Labor Minister August0 Sanchez, whose pronouncements about labor justice and workers rights quickly made him the Aquino government’s bCte noire among business groups, bankers, and U.S. officials.’ More centrist, but also outspoken, was Planning Minister Solita Monsod. Monsod was strongly critical of foreign commercial banks for many of the loans that 568 Robert S. Dohner and Ponciano Intal, Jr. had been extended to the Marcos government, and argued for a case by case review and “selective repudiation” when funds had been knowingly lent for corrupt or questionable projects. Within the cabinet, she has pushed for trade liberalization, land reform, and a more growth- and foreign-resource- oriented economic policy. The last key player on economic matters was Joker Arroyo, who held the powerful office of presidential executive secretary, or “little president” as it is known in the Philippines. Arroyo pushed for a more nationalist economic policy and resisted efforts to sell off state-owned or -acquired corporations, using his control over the flow of paper to the president to sidetrack measures he opposed. Arroyo was also a harsh critic of the military and a focal point for armed forces criticism of the government. He left the government after the coup attempt of August 1987, in an arrangement that also included the resignation of Finance Minister Ongpin. lo Although the Aquino government did not have the benefit of a transition period, it was able to draw on a group of University of the Philippines academics, who had been involved in critical analysis of the Philippine economy in the latter years of the Marcos regime.” This group quickly prepared a policy agenda for the new government that became known as the “yellow book” (Alburo et al. 1986). The economic policies proposed in the yellow book were essentially conservative, market-oriented policies, many of which had long been advocated by the multilateral institutions, the United States, and other outside observers of the Philippine economy.’* The authors of the yellow book argued for greatly reduced government intervention in the economy, an emphasis on alleviating poverty and achieving distributive justice through land reform, and a reorientation of development policy toward rural areas. To support the rural-based develop- ment strategy, the yellow book recommended an outward-oriented trade policy, the elimination of quantitative restrictions on imports, the elimination of taxes on traditional exports, and the avoidance of an overvalued exchange rate. The authors argued that debt servicing should be subordinated to the goals of economic recovery and achieving growth, but they favored seeking additional external resources to sustain growth rather than reducing debt servicing costs through unilateral action. l 3 Other recommendations included a shift in the basis of taxation toward direct taxes, the reduction of taxes on financial intermediation, and the privatization of much of the government corporate sector. The recommendations of the yellow book became the basis for economic policy under the Aquino government, although implementation of some proposals has proved difficult. l4 The Aquino government was able to move quickly to dismantle the particularistic and monopolistic interventions of the martial law government. In the coconut sector, it removed the export levy and the prohibitions on direct exports of copra and new investments in milling; as a result, the spread between world and farmgate copra prices narrowed sharply. In the 571 Philippines/Chapter 8 private commercial banks. The obligations of the two institutions would no longer carry government guarantees nor would the two have access to special credit or tax privileges. Public sector deposits would no longer be available on the scale or at the low cost they previously enjoyed and, just like private commercial banks, both would be subject to external audit. In addition, the government agreed that social projects with below market rates of return would be funded through explicit budgetary support, rather than at government behest through its financial institutions. The transfer of the assets of PNB and DBP to the national government and the government's assumption of the liabilities of the two institutions greatly reduced the share of the government in the domestic financial market.'' Under the restructuring program, the government pledged to operate PNB as an ordinary commercial bank, eventually offering shares for sale to the private sector as its profitability improved. The emphasis of DBP was to shift from large-scale, industrial sector loans to the provision of credit for agriculture, housing, and small and medium-sized firms. The rationalization programs were largely successful; by 1988 both institutions were profitable. The Philippine government also pledged to sell off the six commercial banks that it had acquired. Privatization One of President Aquino's campaign pledges was to return the corporations acquired by the government to the private sector and to sell off government corporations that duplicated private sector activities. The new government established an interagency Committee on Privatization headed by the finance minister and, as an implementing arm, the Asset Privatization Trust (APT) headed by David Sycip, a prominent local businessman. The APT was given a five-year timetable to dispose of the acquired assets; all sales were to be done in cash, with bids collected through auction. The privatization program in the Philippine has proceeded slowly and has revealed deep ideological splits within the government. There has been widespread dissatisfaction among investors over the pace of the program, and recurring disagreements within the government over the assets that have been included or left out of the sales list. There has also been no single agency responsible for carrying out privatization. The APT has been responsible for the sale of nonperforming assets transferred to it, and these have come almost entirely from the two major government financial institutions. In contrast, the reorganization and privatization of nonfinancial government corporations has been left to the corporations themselves, and many have been reluctant participants. At the end of 1987, the APT had accepted bids for over forty assets for a total of P. 3.3 billion ($160 million).20 In these sales, the APT has been able to realize about 20 percent of book value.2' But as yet none of the government corporations slated for privatization has been sold, and the status of many of the most attractive 572 Robert S. Dohner and Ponciano Intal, Jr. assets that the government holds is still uncertain. Despite Aquino’s reaffirmation of her government’s commitment to proceed with its privatization program, the program remains in doubt.” Trade and Industrial Policies The Marcos government had initiated a tariff reform and trade liberaliza- tion program in the early 1980s under a structural adjustment program with the World Bank. The tariff reductions were successfully completed by 1985, but little progress was made in reducing quantitative restrictions and licensing requirements. Both the tariff reform and trade liberalization programs were superceded by the balance of payments crisis in 1983, as tariff surcharges were applied and the central bank imposed foreign exchange allocation. Both the tariff surcharge and the central bank allocation of foreign exchange were removed under the IMF program in 1985. At the end of 1985, the Philippines adopted a second program of trade liberalization, covering 1,232 items subject to import licensing, but this program was interrupted by the presidential elections and by the change of government in early 1986. Trade liberalization was among the policy proposals contained in the yellow book and was a priority of both the IMF and the World Bank in negotiations with the Philippines in 1986. Within the cabinet, trade liberalization was pushed strongly by Planning Minister Monsod. However, trade liberalization quickly became the most controversial economic policy issue facing the Aquino government. Liberalization was strongly resisted by industrial groups, represented in the cabinet by the minister of trade and industry, Jose Concepcion, as well as by several leftist groups. The government decided to continue with the 1985 program of trade liberaliza- tion, replacing the import licensing requirements with tariffs of equal protective effect. By April 1988 all 1,232 items had been liberalized, and the government was committed to liberalizing an additional 104 items by mid- 1989. On the remaining items subject to licensing, the government decided to retain limits on 114 for health and security reasons, and deferred decision on the remaining 455 items subject to quantitative restraint. This last list contains many of the most sensitive products-finished consumer durables and industrial intermediates-and the IMF has continued to press for their liberalization. The Marcos government also revamped the industrial incentive system in 1983 as a part of the structural adjustment program. The revised investment incentives made the encouragement of exports a priority, deemphasized the measured capacity concept that had been used to define overcrowded industries, and simplified and reduced the number of incentives. Investment incentives were replaced with performance-based incentives covering profits, wages paid, and the extent of domestic procurement of inputs. As a result, the capital-cheapening effect of the incentive system was greatly r ed~ced . ’~ 573 PhilippineKhapter 8 The Aquino government, after much internal debate and delay, finally issued its own set of investment incentives in the Omnibus Investment Code of July 1987. Most of the incentives system remained unchanged from the 1983 revisions. The most significant modification was the replacement of performance-based incentives on net local content and net value added with income tax holidays. In addition, the government appears to have increased the scope for discretion in administering the incentives by reviving the notion of measured capacity and reinstituting an investment priorities plan. The nature of the incentive program is still under discussion with the World Bank, and a further study of the incentive system is one of the conditions of the Bank’s economic recovery loan to the Philippines. The policy reform momentum in the Philippines has, at least for the time being, waned, and policy debates over the next few years are likely to involve holding actions on reform measures that have already been taken. The Aquino government has moved much farther in some areas than in others. The fewest results have been achieved in the highly visible privatization program, which became for many investors a barometric indicator of the attitudes of the Aquino government. The Aquino government has had more success in policies establishing the economic framework, or environment, in the Philippines. And despite varying success, one should not understate the degree of reform that has been achieved. Government intervention in many domestic markets has been greatly reduced or eliminated, monopolies and exclusive privilege have been abolished, and publicly owned firms are now on a footing similar to that of private companies. A comprehensive tax reform has been undertaken in a very short period of time. And the trade and industrial incentive reforms to which the Marcos government had committed itself have been taken up and largely completed. In the 1980s the Philippines has gone from being the ASEAN country with the most stringent import protection to a country with restrictions comparable to other East Asian countries and low by interna- tional standards, as we point out in table 8. l . A recent World Bank mission concluded that “as a result of cumulative policy adjustments since 1980, the Philippine regulatory and incentive structure has fewer distortions than at any time since 1950, and is now comparably neutral with other East Asian countries’ ’. 24 Land Reform There is one further policy issue that is important both for the economic development of the Philippines and for its political stability, and that is the issue of land reform. Land reform has long been an issue in Philippine politics. In the period since independence there have been several efforts at reform, mostly confined to legislation and the creation of agencies responsible for land reform efforts. But land reform has largely been undertaken for political reasons, either to mobilize rural support or to diffuse 576 Robert S. Dohner and Ponciano Intal, Jr. on the terms of Philippine rescheduling and debt service, and the status of loans made by the banks to the previous government. Many of the loans made to the Marcos government had been to support public investment projects, or privately organized but government-favored projects, that were either of questionable viability or involved substantial misappropriation of funds. The suspicion of many in the new government was that the banks were cognizant of the uses to which the funds were being put and, therefore, bore some of the responsibility for questionable and now nonperforming loans made to the previous government. The calls for case-by-case evaluation of commercial bank loans, with repudiation in egregious cases, came almost immediately after the formation of the Aquino government and were most closely associated with the planning minister, Monsod. The finance minister, Ongpin, and the central bank governor, Fernandez, were opposed to any repudiation, and they won the argument within the government in 1986. President Aquino announced in mid-year that the Philippines would honor its foreign obligations, even in cases of questionable loans. But the bitterest bone of contention between the Philippines and its creditor banks concerned the terms of the second rescheduling. Philippine negotiators were strongly influenced by the outcome of the bank negotiations with Mexico in September 1986 that had provided $6 billion in new money, an interest spread over LIBOR of 2 percentage points, and a contingency fund of $500 million if Mexican growth fell short of targets. Reacting to the Mexican outcome, the Philippines came to the negotiations in October with the demand that the Philippines be granted an interest rate spread of over LIBOR. The Philippine negotiators had two arguments for the reduced spread. The first was that the terms of the initial rescheduling had been deliberately harsh in order to punish the Marcos administration. The Aquino government, they argued, was committed to the refoms that the external creditors had long stressed and deserved a better program. The second argument was that the Philippines had successfully followed its adjustment program, eliminating its current account deficit, inflation, and external arrears. The Philippines did not need and was not asking for additional new money and, the negotiators argued, the country deserved better terms than Latin American debtors, who had been less successful in adjusting. Most of the members of the bank advisory committee were willing to reduce the spreads of the original rescheduling agreement, but Citibank was initially adamant against any reduction in interest rates on rescheduled Philippine debt.26 The negotiations with the bank advisory committee broke down in November over this issue, but resumed in January when Citibank agreed to the negotiating position of the other advisory committee banks. The banks and the Philippine negotiators still remained divided over terms when the negotiations resumed. As a compromise measure, Ongpin proposed 577 PhilippinedChapter 8 that the banks receive a higher interest rate spread if they were willing to take the spread in the form of Philippine Investment Notes (PINs). These notes were dollar denominated and sold at discount, but their terms (six-year maturity, no interest payment) made their conversion into pesos for partici- pation in the Philippine debt equity conversion scheme particularly attractive. The initial proposal was rejected by the advisory committee, but a revised version, making the acceptance of PINs optional on the part of the banks and guaranteeing a return of 5 percent, was accepted and formed a part of the second Philippine rescheduling .27 The Philippine negotiators and the bank advisory committee reached agreement on a multiyear rescheduling on 27 March 1987 (table 8.2). The agreement restructured $3.6 billion in debt falling due between 1987 and 1992, as well as the $5.9 billion previously restructured in the 1985 agreement. The amortization period on restructured debt was lengthened to seventeen years, with seven and one-half years' grace. The trade facility, which previously had been extended to mid-1987, was further extended to June 1991. There was no additional new money in the 1987 agreement. The $925 million new money from the previous agreement was not rescheduled, but the facility was repriced along with the restructured amounts. In the agreement, the Philippine negotiators settled for an interest rate spread that was slightly higher than the Mexicans had received in their negotiations in 1986, as well as an arrangement that allowed commercial banks to book higher earnings through the acceptance of PINs in lieu of Table 8.2 Philippine Debt Restructuring Agreements Commercial Banks Second Round, July 1987 First Round, May 1985 Amount Maturity Interest Amount Maturity Interest ($ billion) (grace) Spread ($ billion) (grace) Spread Previously restructured 5.88 17(7.5yrs) Debt falling due 3.58 17(7.5yrs) 5.88 10(5yrs) 12 New money 1: Revolving trade credit 2.97 2.97 I! 71 8 Wyrs) 3 4 First restructuring 0.925 Second 0.00 Total 12.26 9.69 Official Creditors Amount Amount $ Billion % $ Billion % Period First round (20 December 1984) 0.725 100 0.258 60 Jan 85/June 86 Second round (22 January 1987) 0.704 100 0.289 70 Jan 87/June 88 Source: Central bank, Financial Plan Data Center. 'Repricing. 578 Robert S. Dohner and Ponciano Intal, Jr. cash. The interest rate spread on restructured debt, the trade facility, and the 1985 new money agreement was seven-eighths over LIBOR.28 The negotiators also agreed that if the Philippines were to later ask for new money, it would also seek to reschedule the 1985 new money facility, accepting a 1 percent spread. The agreement on the interest rate was, however, made retroactive to 1 January 1987. The 1987 agreement significantly extended the period for amortizing principal on Philippine external debt and reduced the interest spread by three-quarters of a point. As a result, the debt service ratio for the Philippines was reduced from 48 percent before rescheduling in 1987 to 34 percent after. However, the failure of the negotiators to achieve an interest rate spread as low or lower than that received by the Mexicans was a stumbling block to approval of the agreement in the Philippine cabinet. The terms became a major issue in the Philippines when, shortly after the agreement was concluded, Argentina reached an agreement with its commercial creditors for an interest rate spread of 2, the same as the Mexicans had received and The results of the Argentine negotiations were greeted in the Philippines with dismay. Finance Minister Ongpin declared his intention to reopen the negotiations with the banks over the issue of the interest rate spread, but was eventually dissuaded by bank promises to take more interest in the form of PINS. The issue of the interest rate spread and the treatment of the Philippines relative to other LDC creditors remained the source of much domestic opposition to the 1987 agreement and a focal point of domestic opposition to Ongpin and Fernandez. But the arguement over spreads was almost overshadowed by the reemergence of the Planters Products (PPl) issue. Barclays Bank, a major PPI creditor and a member of the bank advisory committee, refused to sign the rescheduling agreement worked out in April, and renewed the demand that the Philippine government assume the $57 million dollar external liability of the fertilizer company. The Philippine negotiators first tried to work out a compromise but in the end President Aquino agreed to assume PPI’s obligations to rescue the agreement and preserve its retroactivity to January 1. The PPI compromise and the whole debt rescheduling package became a major domestic political issue when, in an address to the newly assembled Philippine Congress in July, President Aquino charged that the banks had blackmailed the country into the agreement. In the months that followed, the external debt became the principal issue of the Philippine Senate. Bills were introduced to repudiate part of the debt and to limit debt service to a portion of foreign exchange receipts. Ongpin and Fernandez were called to testify before Congress to explain and justify the terms of the rescheduling agreement. below that of the Philippines. 581 PhilippinesKhapter 8 Philippines to 1983 income levels by 1992. Those outside the government, including the IMF, have adopted more modest, but still optimistic, projections of 6 percent real growth per year. Achieving even this rate of growth is by no means certain and will involve policy reform and perseverance, external cooperation, and some degree of luck. The most obvious difficulties that the Philippines will face are the burden of servicing its external debt and limitations on its ability to borrow to achieve higher growth. The recent official and commercial bank reschedul- ings resulted in a significant reduction of scheduled amortization payments on external debt, as shown in table 8.3. However, projected interest payments still amount to 6 percent of national income, and the Philippines faces the burden of meeting the remaining amortization payments over the next five years. The debt crisis affects the Philippines and other LDCs not just through the difficulty in shouldering the current debt burden; it also affects their ability to grow out from under that burden. The severely limited access to additional external finance is for most of these countries a constraint on the rate of investment and growth. Difficulties in financing an emerging current account deficit did not affect the Philippines immediately, primarily because of the unexpectedly large current account surplus in 1986. But the country has now reached a point where the external financing constraint is a real one, and additional external funds are necessary to sustain growth. The difficulty lies in the way in which the current account deficit was closed during the stabilization period. Table 8.3 Philippines Projected Debt Service, Government Projections (in billions of U.S. dollars) 1987 1988 1989 I990 1991 1992 Debt service before rescheduling Principal Interest Principal Interest Debt service after rescheduling of which: IMF Interest as % of GNP Debt service ratio" Before rescheduling After rescheduling GNP (billion S) Exports goods and services Memo Items: 4.40 5.44 4.59 5.22 5.43 5.17 2.27 3.13 2.27 2.80 2.85 2.49 2.13 2.31 2.32 2.41 2.58 2.68 2.94 3.03 3.01 3.43 3.70 3.66 0.98 0.88 0.82 1.13 1.25 1.07 0.31 0.16 0.18 0.33 0.31 0.15 1.96 2.15 2.18 2.30 2.45 2.58 6.0 6.0 5.5 5.2 5.0 4.7 49.4 56.9 44.7 46.5 44.4 38.1 33.0 31.7 29.3 30.6 30.3 26.9 32.79 36.05 39.94 44.38 49.21 54.41 8.90 9.55 10.27 11.22 12.23 13.57 Source: Central bank. Notes: Reschedulings include monetary and nonmonetary debt. Interest rescheduled by the Paris Club. "Ratio of interest and principal payments to exports of goods and services. 582 Robert S. Dohner and Ponciano Intal, Jr. Between 1983 and 1986, Philippine merchandise export earnings fell by 3 percent; thus, the entire closure of the current account deficit was due to a reduction in imports. After years of import substitution, Philippine imports are heavily concentrated in capital goods and imports of fuels and raw materials; only about 16 percent of the country’s imports are made up of consumer goods (table 8.4). The Philippines has been relatively successful in reducing its dependency on imported oil, substituting coal and other sources of domestic energy. But over a medium-tern planning range, the demand for oil remains quite price inelastic, and the oil import bill is largely determined by swings in the world price of oil. Two of the other categories are closely tied to domestic economic activity-capital goods imports to the level of domestic invest- ment and raw materials imports to industrial output. The behavior of each of these import components during the stabilization episode is shown in table 8.5. Capital goods imports as a percentage of GNP dropped rapidly, reflecting the sharp reduction in domestic fixed investment that took place during the period. Although the drop in the share of industrial output in GNP was not huge, those industries that depended on imported raw materials were particularly hard hit. Finally, slack domestic demand, plus the weakness in world oil prices, was responsible for the drop in oil imports. In contrast, consumer goods imports remained constant at about 5 percent of GNP, despite their being low priority imports. Table 8.4 Philippine Import Composition (percentage) 1970-75 1976-80 Capital goods 35.7 Mineral Fuels 13.1 Nonoil raw materials 36.4 Consumer goods 14.7 29.1 24.7 29.4 16.9 ~ Source NEDA, Philippine Staristical Yearbook, 1987 Table 8.5 Philippine Imports by End-Use Category (percentage of GNP) 1981 1982 1983 1984 1985 1986 1987 Capital goods Nonoil raw materials Mineral fuels Consumer goods Total Memo Items (% of GNP): Exports Fixed investment Industrial output 5.0 4.5 5.0 3.6 2.5 2.8 3.5 5 .O 5.3 5.7 4.6 4.0 5 .5 7.0 6.4 5.4 6.2 5.2 4.5 2.9 3.6 4.3 4.4 5.0 5.8 4.9 5.4 5.5 20.7 19.5 21.9 19.3 15.9 16.6 19.6 14.9 12.8 14.7 17.1 14.4 15.9 16.7 26.1 25.7 25.1 20.1 15.1 13.0 14.0 36.8 36.5 36.4 35.4 33.6 32.6 32.6 Source: NEDA, Philippine Staristical Yearbook. 1987. 583 PhilippinesXhapter 8 The fact that exports did not contribute to closing the current account deficit and that the reduction in imports took place in capital and intermediate goods explains why the current account balance has worsened sharply as the economy recovered. Even very large rates of growth of exports are unlikely to change this outcome. The reason for this is twofold. The categories of exports most likely to increase rapidly, elec- tronics and garment exports, have imported input contents of 65-80 percent, and thus their expansion will lead to a partially offsetting rise in imports. Other categories of exports that are candidates for expansion will require substantial new investments, raising, at least for a time, imports of capital goods. Nor is there likely to be much help from the service sector. The Philippines is unusual among the LDCs studied in this NBER research project in having substantial service export earnings. Despite net interest payments amounting to 6 percent of GNP, the country ran a small surplus on service account in 1985 and 1986.29 Net service receipts are expected to diminish and become negative by 1992 as the growth of the economy raises service payments and because the prospect of weak growth in Middle Eastern countries limits expected earnings from construction and Filipino labor overseas. As a result, medium-term projections for the Philippines all give current account deficits of 2-2.6 percent of GNP. Current account projections prepared by the Philippine government and the IMF are shown in table 8.6. The government projection assumes an economic growth rate of 6.5 percent per year between 1987 and 1992, and thus a more rapid rate of growth of imports and exports than does the IMF projection which assumes a domestic growth rate of 6 percent per year. Even with growth of export earnings of 13-14 percent per year, the current account deficit rises to 2.6 percent of GNP by the end of the forecast period. The current account is not the only source of a need for external finance. In addition, the Philippines will have to either make or reschedule amortization payments on its external debt falling due, plus achieve a balance of payments surplus sufficient to allow reserves to grow along with imports. In some cases, financial commitments have already been identified, either in the form of loans that are being drawn down in tranches, commitments for external aid, or rescheduling that has already been agreed upon. But even with these three, there remains required finance that has not as yet been identified. Projections of future financing requirements are less forecasts than they are planning exercises. One such projection for the Philippines is shown in table 8.7. For table 8.7 we use the current account projections of table 8.6, along with scheduled amortization payments on medium- and long-term external debt before agreed upon rescheduling. The overall balance of payments is assumed large enough to meet servicing requirements on 586 Robert S. Dohner and Ponciano Intal, Jr. Slumping international commodity prices and declining Philippine export volumes of these primary commodities were responsible for a 15 percent decline in the dollar value of merchandise exports from 1981 to 1986, despite a continued growth in nontraditional export volumes and earnings. The influence of primary commodities in total Philippine exports has been greatly reduced to a current share of about one-quarter, although they still account for a larger share of net export earnings due to their higher domestic content. For a variety of reasons, the prospects for sustained growth in Philippine primary export earnings are not good, although some near term growth can be expected as export taxes and the systems of monopoly regulation are removed. In the sugar industry, Philippine costs of production are estimated to be about 12 cents per pound, compared to a current world price of about 8 cents per pound. The Philippines benefitted up to 1984 from favorable long-term supply contracts it had negotiated when sugar prices were high. Since those contracts have expired, Philippine sugar exports have gone entirely to the United States under the U.S. sugar import quota, where sales prices have been about 18 cents per pound.31 Thus even a substantial recovery of world sugar prices would not significantly increase Philippine export earnings. The prospects for future sales to the United States are also bleak; the U.S. has reduced overall sugar import levels substantially since quotas were reintroduced in 1982 and announced substantial reductions for 1988. For the Philippines this meant a reduction in quota from 240,000 tons in 1987 to 148,000 in 1988. The U.S. drought in 1988 brought an increase in sugar imports late in the year, but the longer term outlook remains unchanged. In the past two decades the Philippines has increased its output of coconut products by extending the area of cultivation. Limits on cultivatable land have been reached, and increasing output now depends on increasing yields. Philippine coconut production has been hampered by low yields and aging trees, and total coconut production has fallen well below the peaks reached between 1978 and 1981. A program of replanting higher yield varieties would increase coconut output, but only after a gestation period of several years. In addition, since the Philippines accounts for about two-thirds of world exports of coconuts, and coconut products face competition from other vegetable oils, the prospects for increasing earnings through additional exports are quite low. Philippine mining exports have some prospect for growth if world copper prices remain high. Philippine production costs are slightly above world market averages, making the Philippines a marginal supplier although much of the country’s mining capacity closed during the financial crisis. Gold is a byproduct of copper mining in the Philippines, and higher world gold prices have already raised mining earnings. The prospects for expanding manufactured goods exports from the Philippines are brighter, although not assured. Philippine manufactured 587 Philippines/Chapter 8 goods exports are dominated by two industries, electronic components and garments, which together account for 72 percent of nontraditional exports and 53 percent of total exports. As a result of the protection given to Philippine domestic industry, both the electronics and the garment industries have developed as virtual enclaves, largely foreign owned, dependent upon imported inputs, and with few linkages to the Philippine economy other than the purchase of labor. Exports of electronics components declined with the slump in the world semiconductor market in 1985 and 1986, but increased strongly in 1987 and 1988. Philippine electronics exports are diversified, with the largest share going to other ASEAN countries, but future growth will depend on the growth of the world market and the continued maintenance of competitive real wages. Philippine garment exports go almost exclusively to the United States, and thus the prospects for growth depend considerably on the degree of protection provided to the American industry. Despite this fact, Philippine garment exports have the potential for substantial growth. The Philippines has not been as aggressive as other countries in increasing its bilateral quotas, although it did receive higher U.S. and European quotas in 1987. More importantly, the Philippines has not taken full advantage of the quotas that it has. Quota utilization by the Philippines was the lowest among ASEAN countries in the 1980s and fell below 50 percent in 1984 and 1985.32 Other factors work in favor of the Philippines in the longer term. The country has a small share of world exports of textiles and clothing, and both its product composition and export markets are highly concentrated, leaving open the possibility for diversification. Finally, after years of falling real wages, the Philippines now has a sizable cost advantage over other garment exporters in the region; only China has a productivity adjusted wage rate lower than that of the phi lip pine^.^^ The Philippines also has the opportunity to increase net export earnings from the garment industry, and perhaps also from the electronics industry, by developing backward linkages to the domestic economy as have other countries in the East Asian region. Successfully substituting domestic for foreign inputs will require that the Philippines carry through with its intention to reduce protection of the domestic industrial sector, and will also require that incentives for this type of indirect exporting match those for sourcing components externally. For example, subsectors of the domestic textile industry, in particular spinning, knitted fabric, denim, and sewing thread, appear to be competitive on world markets if the textile industry were to have access to inputs at world prices.34 Diversifying export industries may be the most successful strategy that the Philippines can pursue in increasing exports over the next five to ten years. The prospects for developing new industries are especially promising in the rural areas, in resource-based or labor-intensive industries. Already the Philippines has seen dramatic increases in exports of prawns to Japan and 588 Robert S. Dohner and Ponciano Intal, Jr. other East Asian markets, and, before the land reform controversy erupted in mid-1987, producers in sugar growing areas were making substantial investments in prawn beds. Other possibilities for export crop diversification include coffee, cacao, pineapple and other fruits and vegetables, black pepper, and ramie. To a greater extent than growth from existing industries, growth through export diversification will require a more aggressive and sustained array of policy incentives. Diversification of exports from the rural areas will require complementary inputs of capital and rural infrastructure, a settlement of the land tenure issue, and maintenance of security and order in several of the rural areas. Both agricultural and export diversification will also require a shift in the balance of production incentives to encourage export activities, including the maintenance of an appropriately valued exchange rate. 8.4.3 Financial Issues In addition to overcoming the external financing constraint, achieving sustained economic growth in the Philippines will require solving several outstanding domestic financial sector problems. Financial markets in the Philippines have been buffeted by a series of financial crises, starting in 1981 and extending through the stabilization episode. The burden of credit stringency fell largely on the private sector, and among firms that survived there has been a significant deterioration in financial ratios. By one estimate, nearly half of all firms are facing, or are likely to face, significant financial diff i~ul t ies .~~ These show up most often as problems in servicing existing loan obligations or difficulties in obtaining adequate working capital. Furthermore, until the financial ratios of these corporations improve, they are unlikely to be able to raise additional funds for investment or expansion as the Philippine economy recovers. Carrying out programs of financial restructuring and recapitalization for the affected firms will be necessary for them to participate in an expansion of the Philippine economy, and given the number of firms involved, these restructuring programs may be required before significant growth can take place. This presents a number of problems for the Philippines, since there has been little experience with financial restructurings of this kind, and since the available expertise is quite limited. The necessary expertise may be available through foreign technical assistance, but the restructurings may also require legal and procedural changes to write down the assets of current creditors and recapitalize the firms. The second and more general financial issue concerns the mobilization of domestic credit and the terms upon which it is made available to borrowers. The financial trauma of recent years in the Philippines has wiped out the progress that the Philippines made in financial deepening in the late 1970s and early 1980s. It has also erased what had been gradual progress toward extension of credit for longer terms; after several gyrations of interest rates, 591 PhilippinesXhapter 8 type that had long been argued for, and was not asking for new money, the banks gave the Philippine negotiators an extraordinarily difficult time. Their heavy-handed treatment of the Planters Product issue, holding the entire agreement hostage to the government's assumption of the firm's liabilities, their failure to come down further on the interest rate spread, and their subsequent delivery of the Philippine interest rate demand to the Argentines, led to the discrediting of Jaime Ongpin and Jose Fernandez, the introduction of a raft of bills in the Congress on debt limitation or repudiation, and the departure from the government of Ongpin, who had been their strongest ally. Much has been said about the difference in the interest rate spread between the Philippine and the Argentine rescheduling, amounting to only $5 million in annual interest payments for the Philippines. But the argument cuts both ways. The banks gained only $5 million, having squandered the precedent in the Argentine negotiation, and lost Jaime Ongpin. Corruption, or more generally, the generation and distribution of economic rents, has been an enduring feature of the Philippine economy. The Aquino government has not been immune to this charge. Two cabinet ministers were dismissed early in the administration after allegations that they were using their ministries for profit. Members of President Aquino's family, particu- larly her younger brother, have used their ties to her to increase their influence and wealth. There have been charges that the activities of the Presidential Commission on Good Government, set up to recover the assets of Marcos and his cronies, have diverted funds or transferred ownership to commission members or their relatives, and there have been numerous stories about low-level graft in the country even after the change in government. 37 Opposition politicians, particularly the former defense minister Enrile, have charged the government with developing a new set of cronies, as bad or worse than those of the Marcos government. Such charges vastly overstate the case. Corruption in the current government is nowhere near the organized and extensive draining of the economy during the Marcos administration. The issue for the Philippines is not so much whether there is corruption, but on what scale corruption takes place, and how much damage it does to the operation of the economy. The key for fostering economic growth is to limit the scope of possible corruption and the amount of activity that can profitably be expended in seeking kickbacks, privilege, or other economic rents. In the Philippine case this means decentralizing and localizing corruption, so that it is not run on an almost economy-wide basis as it was under M a r ~ o s . ~ ' It also means changing the nature of the rules and limiting the scope for discretion, so that entrepreneurial energy is channeled into production and not the competition for rents. This is the real importance of government reorganization and privatization in the Philippines. It is not so much an issue of whether the private sector is inherently better than the public sector, but more an issue of removing the 592 Robert S. Dohner and Ponciano Intal, Jr. operation of industry and economic outcomes from those who control policy. Other policy reforms, import liberalization and the reform of the incentive structure, are important here because they shift the ground rules under which firms operate more toward neutrality and universality, and so direct energy into activities that are truly profitable for the society. So far, most attention has been placed on the pace of liberalization and privatization. More important are the terms on which these take place and the ground rules that are established. Finally, to maintain the policy reforms that have been established and to achieve stability in economic policy, the solutions to the difficult economic problems that the country faces must, be seen to be in Philippine hands. Economic ideology in the Philippines places the United States and U.S. influenced institutions in an ambiguous role. On one hand, the United States is seen as the source of Philippine problems4olonial dominance, exploitation by foreigners-but the United States is also viewed as the ultimate savior and guarantor of the Philippine situation. There has been a strong sense of deus ex machina in Philippine thinking about policy, a feeling that the United States would intervene to save them, when in fact the United States has treated the Philippines carelessly for most of postwar history. The Philippine desire for an external solution to its current difficulties was seen in the expectation, immediately following the February revolution, that the Philippines would be the recipient of a flood of foreign aid and direct investment, as well as the tremendous interest in a “Marshall Plan” for the Philippines when such a proposal was introduced in the U.S. Congress at the end of 1987. While a program will definitely go forward in what has now been renamed the Multilateral Assistance Initiative, the amount of additional funds will be far less than the $10 billion originally suggested. It is also evident in the number of “solutions” to debt difficulties that have been proposed-the recovery of the Marcos fortune, the bargaining demand that the United States take over the Philippine debt in exchange for a new bases agreement, even the government-sponsored search for the “Yamashita treasure,” a vast fortune in gold rumored to have been buried by Japanese soldiers. But the economic problems of the Philippines go beyond debt and beyond its relations with the United States and the rest of the outside world. If the Philippines is to achieve rates of economic growth that would allow it to rejoin the income ranks of its neighbors, it will require fundamental reorientation of domestic economic policy toward a more pragmatic, instrumental, and growth-oriented stance. Much intellectual effort has been expended in the search for the policy recipe that was responsible for the rapid growth of Japan and other East Asian countries, as if simply repeating the steps would duplicate their outcomes. But the success of these countries came primarily from their almost single-minded devotion to growth based on exports, and because they turned the outside world to their advantage. 593 Philippines/Notes In contrast, much of Philippine policy, and certainly much of Philippine nationalism, has been defensive in character, designed to insulate and protect the economy from the outside world and the dangers perceived there. What the Philippines needs to develop is a more aggressive and self-confident nationalism, one that manipulates and takes advantage of the opportunities that the outside world offers-an “inward culture and an outward economy” rather than the reverse (Intal 1987). In fact, the situation in which the Philippines finds itself today is not so different from the situation characterizing many of the industrializing East Asian countries before their rapid growth took place, although none had the foreign indebtedness that the Philippines now shoulders. Japan, Hong Kong, and Singapore each had to deal with an unfavorable economic event that drastically limited their options and forced them to focus on export growth. For Taiwan and Korea it was the imminent reduction in U.S. aid which had supported domestic investment and large current account deficits that forced the shift in policies. This is not to say that adversity always leads to success, or that the problems that the Philippines now faces are no more difficult than those faced by the East Asian exporters. Nor will Philippine prospects be unaffected by events and policies in the outside world. External markets that stay open to LDC exports, rather than markets that close down at the first sign of exporting success, will have a tremendous influence over whether economic policy in those less developed countries encourages production at world prices for world markets. A commercial bank lending process that recognizes and rewards successful policy reform and economic growth, rather than a concerted lending process that provides the minimum in financing that a country can get by with, will also greatly influence the incentives for persevering in reform. But whether the Philippines will ultimately be successful will be primarily determined by the actions that the country takes and the commitment that it can forge to policies that achieve growth. Notes Chapter 1 insurgency which has troubled the Philippines for the past two decades. 1 . The tensions created by this migration are the primary force behind the Moslem 2. Golay (1961, 202), Table 39. 3 . On the problems of collection of Philippine taxes, see Golay (1961, 186-91). Tait, Gratz, and Eichengreen (1979) provide a comparison to other countries, and rank the Philippines near the bottom in tax effort.