document of the world bank commission on audit lgfpms ... cpar country procurement assessment report...

Document of The World Bank

Report No: ICR00001112

IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-74240)

ON A

LOAN

IN THE AMOUNT OF US$250 MILLION

TO THE

REPUBLIC OF THE PHILIPPINES

FOR A

FIRST DEVELOPMENT POLICY LOAN

September 30, 2009

Poverty Reduction and Economic Management Sector Unit East Asia and Pacific Region

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

REPUBLIC OF THE PHILIPPINES FISCAL YEAR

January 1 – December 31

CURRENCY EQUIVALENTS

(Exchange Rate Effective September 30, 2009)

Currency Unit = Philippine Peso (PHP) P1.00 = US$ 0.021 US$ 1.00 = P47.03

Vice President: James W. Adams

Country Director: Bert Hofman

Sector Director: Vikram Nehru

Task Team Leader: Ulrich Lächler

ICR Team Leader Ulrich Lächler

ACRONYMS AND ABBREVIATIONS

AAA Analytical and Advisory Activities HRMIS Human Resource Management Information

System ABC Approved Budget Ceiling IBRD International Bank for Reconstruction and

Development ADB Asian Development Bank ICB International Competitive Bidding BIR Bureau of Internal Revenue IDRs Integrity Development Reviews BOC Bureau of Customs IMCs Investment Management Contracts BOT Build-Operate-Transfer IMF International Monetary Fund BSP Bangko Sentral ng Filipinas IPP Independent Power Producers CAS Country Assistance Strategy IRA International Revenue Allotment CBMS Community-Based Monitoring System JBIC Japan Bank for International Cooperation CMIS Case Management and Information System LGU Local Government Unit COA Commission on Audit LGFPMS Local Government Financial Performance

Monitoring System CPAR Country Procurement Assessment Report LGPMS Local Government Performance Monitoring

System CPI Consumer Price Index MDGs Millennium Development Goals CPSD Consolidated Public Sector Deficit MIGA Multilateral Investment Guarantee Agency CSC Civil Service Commission MTEF Medium-Term Expenditure Framework CSOs Civil Society Organizations MTPDP Medium-Term Philippine Development

Plan DA Department of Agriculture NEA National Electrification Authority DAR Department of Agrarian Reform NEDA National Economic and Development

Authority DBCC Development Budget Coordinating Committee NFPS Non-Financial Public Sector DBM Department of Budget and Management NG National Government DENR Department of Environment and Nat. Resources NGOs Non-Government Organizations NPSTAR Nat. Prog. Supp. for Tax Admin. Reform DepEd Department of Education NPC National Power Corporation DOF Department of Finance NRIMP2 National Road Improvement and

Management Program Phase 2 DOH Department of Health OMB Ombudsman DOTC Department of Transportation and

Communications OPIF Organizational Performance Indicator

Framework DPL Development Policy Lending PDF Philippine Development Forum DSWD Department of Social Welfare and Development PEFA Public Expenditure Financial Assessment DSCR Debt Service Coverage Ratio PER Public Expenditure Review EAP East Asia and the Pacific PFM Public Financial Management EPIRA Electric Power Industry Reform Act PhilGEPS Philippine Government Electronic

Procurement System ERC Energy Regulatory Commission PPI Private Participation in Infrastructure FDI Foreign Direct Investment PPP Public Private Partnership FE Forward Estimates PSALM Power Sector Assets and Liabilities

Management Corporation FIES Family Income and Expenditure Survey PREM Poverty Reduction and Economic

Management GDP Gross Domestic Product RA Republic Act GEPS Government e-Procurement System RATE Run-After-Tax-Evaders Program GFIs Government Financial Institutions RATS Run-After-The-Smugglers Program GFMIS Government Financial Management

Information System RDO Revenue District Office

GNI Gross National Income RIPS Revenue Integrity Protection Service GNP Gross National Product SPV Special Purpose Vehicle GOCCs Government Owned and Controlled

Corporations UC Universal charges (in Power sector)

GOP Government of the Philippines VAT Value-Added Tax

GPPB Government Procurement Policy Board WESM Wholesale Electricity Spot Market

REPUBLIC OF THE PHILIPPINES

DEVELOPMENT POLICY LOAN

CONTENTS

Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring

1. Program Context, Development Objectives and Design ............................................ 1 2. Key Factors Affecting Implementation and Outcomes .............................................. 9 3. Assessment of Outcomes .......................................................................................... 22 4. Assessment of Risk to Development Outcome ......................................................... 27 5. Assessment of Bank and Borrower Performance ..................................................... 28 6. Lessons Learned........................................................................................................ 30 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners ........... 31 Annex 1 Bank Lending and Implementation Support/Supervision Processes .............. 31 Annex 3. Stakeholder Workshop Report and Results ................................................... 32 Annex 4. Summary of Borrower's ICR and/or Comments on Draft ICR ..................... 33 Annex 5. Comments of Cofinanciers and Other Partners/Stakeholders ....................... 33 Annex 6. List of Supporting Documents ...................................................................... 36

MAP

i

A. Basic Information

Country: Philippines Program Name: Development Policy Loan

Program ID: P100706 L/C/TF Number(s): IBRD-74240

ICR Date: 11/20/2009 ICR Type: Core ICR

Lending Instrument: DPL Borrower: THE REPUBLIC OF THE PHILIPPINES

Original Total Commitment:

USD 250.0M Disbursed Amount: USD 250.0M

Revised Amount: USD 250.0M

Implementing Agencies: Department of Finance

Cofinanciers and Other External Partners: B. Key Dates

Process Date Process Original Date Revised / Actual

Date(s)

Concept Review: 09/07/2006 Effectiveness: 02/06/2007

Appraisal: 11/06/2006 Restructuring(s):

Approval: 12/21/2006 Mid-term Review:

Closing: 03/31/2007 03/31/2007 C. Ratings Summary C.1 Performance Rating by ICR

Outcomes: Moderately Unsatisfactory

Risk to Development Outcome: High

Bank Performance: Moderately Satisfactory

Borrower Performance: Moderately Unsatisfactory

C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings

Quality at Entry: Moderately Satisfactory Government: Not Applicable

Quality of Supervision: Satisfactory Implementing Agency/Agencies:

Not Applicable

Overall Bank Performance:

Moderately SatisfactoryOverall Borrower Performance:

Moderately Unsatisfactory

C.3 Quality at Entry and Implementation Performance Indicators

Implementation Performance

Indicators QAG Assessments

(if any) Rating:

Potential Problem No Quality at Entry None

ii

Program at any time (Yes/No):

(QEA):

Problem Program at any time (Yes/No):

No Quality of Supervision (QSA):

None

DO rating before Closing/Inactive status:

D. Sector and Theme Codes

Original Actual

Sector Code (as % of total Bank financing)

Central government administration 70 70

Power 30 30

Theme Code (as % of total Bank financing)

Debt management and fiscal sustainability 33 17

Public expenditure, financial management and procurement

17 33

Regulation and competition policy 17 17

Tax policy and administration 33 33 E. Bank Staff

Positions At ICR At Approval

Vice President: James W. Adams Jeffrey S. Gutman

Country Director: Bert Hofman Joachim von Amsberg

Sector Manager: Vikram Nehru Homi Kharas

Program Team Leader: Ulrich Lachler Vera Songwe

ICR Team Leader: Ulrich Lachler

ICR Primary Author: Ulrich Lachler F. Results Framework Analysis

Program Development Objectives (from Project Appraisal Document) The proposed First Development Policy Loan would be the first in what is expected to be a series of single-tranche DPLs. The first operation (DPL1) supports the Government?s significant achievements in reducing public sector deficits and debt through tax reform and power tariff adjustments, and seeks to bolster this performance by: strengthening tax administration; improving budget execution and fiduciary performance; and strengthening the finances of the power sector.

iii

In addition, DPL1 lays the groundwork for deeper reforms in the areas of fiscal consolidation, governance and the fiduciary environment, the investment climate and social policy, with the objective of supporting specific reforms in these areas in the context of subsequent DPLs. Revised Program Development Objectives (if any, as approved by original approving authority) (a) PDO Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 : NFPS debt reduced Value (quantitative or Qualitative)

95% 65% by 2009 62%

Date achieved 12/31/2005 03/31/2009 12/31/2008 Comments (incl. % achievement)

Target exceeded (110%)

Indicator 2 : Public sector balances compatible with further reduction of the debt burden Value (quantitative or Qualitative)

-4.8% of GDP > -1.0% of GDP -0.5% of GDP


Target exceeded (113%)

Indicator 3 : Tax/GDP increased Value (quantitative or Qualitative)

13% 15.9% 14.0%


Not achieved (34% of target increase)

Indicator 4 : Integrated and comprehensive registration system with up-to-date and complete taxpayer information in place

Value (quantitative or Qualitative)

Date achieved Comments (incl. %

Qualitative target partially achieved (about 50%; see Annex 8 of ICR)

iv

achievement) Indicator 5 : Debt Service coverage ratio improved for consolidated NPC/PSALM Value (quantitative or Qualitative)

0.69 1.00 <0.84 (projected)


Unlikely to have been achieved. The projected value for 3/31/2009 is based on the PSALM financial recovery action plan of 2006. Updated figures are not available.

Indicator 6 : Number of departments wih a medium term policy and expenditure framework with realistic fiscal scenarios increased.


2 >2 3


Partially achieved; a greater degree of advance had been expected.

Indicator 7 : Detailed budget execution data and including IRA for DOH, DepEd, DPWH, and DA disclosed increases for total budget (net of interest payments and net lending)


22% 54% NA


Partially achieved (as evidenced by progress made in complying with DPL2 trigger), but progress slowed in 2008. Updated information not available to assess % achievement of outcome indicator

Indicator 8 : Number of national government departments with 100% of public procurement transations of their central offices posted on PhilGEPS website.


0 23 12 GPPB member departments posted transations.


Partially achieved (52%)

Indicator 9 : Public investment/GDP increased Value (quantitative or Qualitative)

2.4% 3.5% 2.6% (estimated)


Not achieved. Only minor progress was made, possibly linked to inability to raise tax revenue ratio.

Indicator 10 : Private investment/GDP increased Value (quantitative or

12.8% 14.0% 12.7%

v

Qualitative) Date achieved 12/31/2005 03/31/2009 12/31/2008 Comments (incl. % achievement)

Not achieved. No progress in raising private investment ratio, possibly reflecting continuing weaknesses in the investment climate.

Indicator 11 : Reduction in number of projects being delayed and reduction in period of delayValue (quantitative or Qualitative)

Date achieved Comments (incl. % achievement)

Indicator is too vaguely defined in program document; no information is available to assess this indicator.

Indicator 12 : Road maintenance by contract and long-term performance-based maintenance contracts institutionalized


50% 100% About 50%


Target not achieved. This target was expected to be reached by way of implementing the NRIMP2 project, which has been delayed.

Indicator 13 : The 10 high priority projects identified by NEDA commenced. Value (quantitative or Qualitative)

0 10 NA

Date achieved 11/30/2006 03/31/2009 03/31/2009

Comments (incl. % achievement)

Not rated. After presenting a Comp. Integ. Infrastr. Program with 10 priority investment projects as basis for 2008 budget, the Government subsequently presented multiple lists of high priority projects that prevent an assessment of this indicat

Indicator 14 : Sustainable, stable power market that can provide abase for market-driven investment in new generation



Not achieved. Metting this target requires open access in the sector, which can only start when 70% of generating assets are privatized; see next PDO indicator.

Indicator 15 : Significant part of generating assets and Transco privatized


43% of generating assets and Transco have been privatized

Date achieved 03/31/2009 Comments (incl. %

Partially achieved. (Since the baseline value and target were not indicated in the program document, it is not possible to assess % achievement.)

vi

achievement)

(b) Intermediate Outcome Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised

Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 : No intermediate outcomes were defined for any of the indicators Value (quantitative or Qualitative)


G. Ratings of Program Performance in ISRs

No. Date ISR Archived

DO IP Actual

Disbursements (USD millions)

H. Restructuring (if any) Not Applicable

1

1. Program Context, Development Objectives and Design 1. Approved on December 21, 2006, the First Development Policy Loan (DPL1) was envisaged as the first in a series of single tranche DPLs in support of the government’s efforts to reduce the public sector deficit and debt, strengthen the investment climate, and improve service delivery through increased and more effective government spending. Assuming adequate reform progress, subsequent loans were envisaged to follow an annual schedule. Progress in the implementation of the actions agreed for triggering the next DPL in the series was slower than anticipated, however, with the result that no follow-up DPL was approved within 24 months of the first DPL. This meant that the series lapsed in December 2008, according to Bank guidelines, prompting Bank management to call for the preparation of this Implementation Completion Report.

1.1 Context at Appraisal 2. In 2003, the Philippines was on the verge of a fiscal collapse. Fiscal balances had deteriorated significantly in the wake of the Asian crisis, such that by 2003, tax revenues had fallen by 4½ percentage points of GDP from their 1997 peak, the public sector deficit exceeded 5 percent of GDP, and public debt had been rising at an unsustainable pace, reaching over 100 percent of GDP.1 3. In August 2004, shortly after assuming office for the second time, President Macapagal-Arroyo urged Congress to enact a series of tax measures in response to the fiscal crisis. The most important of these measures was the reform of the value-added tax (VAT), which involved broadening the tax base by limiting exemptions and raising the rate. Full implementation of the Value-Added Tax (VAT) reform was completed in two stages by February 2006. In parallel, as these tax measures were being debated in Congress, the regulated power generation tariffs of the state-owned power company (NPC) were substantially increased in December 2004 and early 2005, while public expenditures were tightly restrained. 2

1 Between 1997 and 2002, the National Government account moved from approximate balance to a deficit of 5.3 percent of GDP, due to a plunge in tax revenues from 17 percent of GDP to 12.5 percent, and a growing interest burden that reflected both increasing debt and higher risk premia. The fall in tax revenue, which continued through 2004, was the result of weak corporate and banking profitability in the aftermath of the crisis, some built-in weaknesses in tax policy, reductions in import tariffs, as well as deterioration in administrative performance of the major revenue collection agencies. The deficits of Government Owned and Controlled Corporations (GOCCs) also widened significantly, rising from near balance in 1999 to 1.8 percent of GDP in 2004, driven largely by the escalating deficits of the National Power Corporation (NPC). By 2003, non-financial public sector debt exceeded GDP and global borrowing spreads had risen above 500 basis points. The fiscal deterioration was paralleled by governance concerns that in turn contributed to considerable political instability through much of the present decade.

2 The tax measures introduced by the government included (i) an increase in the excise tax on cigarettes, tobacco, and alcohol, (ii) a comprehensive tax reform package that included broadening VAT coverage by removing exemptions for petroleum products, power, and medical and legal services, (iii) authority

2

4. These fiscal actions turned out to be successful in averting a crisis: the consolidated public sector deficit (CPSD) was reduced by 3 percent of GDP in 2005, the debt/GDP ratio was placed on a declining trajectory, and tax revenues rose to 13 percent of GDP in 2005 and 14.2 percent in 2006. Meanwhile, the economy continued to grow at a rate of 5 to 6 percent per annum, exports and FDI increased sharply in 2006, and inflation was kept under control, while financial markets strengthened and borrowing spreads fell; see Table 1.

Table 1: Philippines – Key Macroeconomic Indicators and Projections (As percentage of GDP, unless indicated otherwise)

for the president to increase the VAT rate from 10 percent to 12 percent upon satisfaction of certain criteria, (iv) an increase in the corporate income tax from 32 percent to 35 percent (reverting to 30 percent in 2009), and (v) lateral attrition for revenue agencies (to improve incentives for tax administrators). In parallel, power generation tariffs were raised by about 30 percent in late 2004/early 2005, and import duties on oil products were raised from 3 to 5 percent (subsequently reversed to mitigate the impact of the VAT reform on fuel prices). In addition, the Department of Finance (DOF) intensified programs to identify and prosecute tax evaders and smugglers and a revenue integrity protection service that charged corrupt collectors in the revenue agencies was promulgated. A 30 percent average increase in excise taxes was enacted in December 2004, and, after considerable debate and delay, the crucial VAT reform was enacted in two steps (November 2005 for the removal of exemptions and February 2006 for the increase in rates). Total public expenditures declined during this period from 19.1 percent of GDP in 2003 to 17.3 percent in 2007, with much of this decline taking place on account of a declining public interest bill.

2002 2003 2004 2005 2006 2007 2008 2009 ------------------------Actual--------------------- Est.2/ Proj.2/ Output and Prices GDP growth (% Δ) 4.4 4.9 6.2 5.0 5.4 7.2 4.6 1.9 CPI Inflation (ave, % Δ) 3.0 3.5 6.0 7.6 6.2 2.8 9.3 4.5 Savings and Investment Gross Domestic Investment 17.7 16.8 16.8 14.6 14.5 15.3 15.3 14.9 Gross National Savings 17.2 17.2 18.7 16.6 19.0 19.7 17.7 16.9 Balance of Payments Current Account Balance -0.5 0.4 1.9 2.0 4.5 4.4 2.4 2.0 Public Sector Finances Consolidated Pub. Sec. Balance -5.6 -5.2 -4.8 -1.8 0.2 0.3 -0.4 -3.0 National Government balance -5.3 -4.6 -3.8 -2.7 -1.1 -0.2 -0.9 -3.2

Total Revenues 14.6 14.8 14.5 15.0 16.2 17.1 16.2 15.9 o/w Tax revenues 12.8 12.8 12.4 13.0 14.3 14.0 14.1 13.9 Total Expenditures 19.9 19.5 18.3 17.7 17.3 17.3 17.1 19.1

Debt Non-Financial Public Sector Debt 93.8 100.8 95.0 85.9 73.9 61.1 61.5 64.1 External Debt 1/ 61.8 68.3 62.7 52.3 45.3 45.7 34.9 -- Sources: Government of the Philippines and World Bank staff calculations. Note: 1/ Based on Outstanding Debt-Consolidated Nonfinancial Public Sector Table complied by DOF-FPPO Note: 2/ as of March 2009

3

5. The substantial fiscal adjustment that took place in 2004-05 made possible the resumption of Bank policy-based lending to the Philippines. The Bank’s Country Assistance Strategy (dated April 2005) in effect at the time of loan appraisal had identified weak fiscal performance as the single most important short-term obstacle to more rapid development in the Philippines and, thus, linked the resumption of policy-based lending directly and foremost to fiscal reforms. In particular, entry into the CAS high case, which included DPLs, was to be triggered by a Consolidated Public Sector Deficit (CPSD) reduction of at least 2 percent of GDP relative to the 2004 level, with a significant portion of the adjustment originating from increases in the ratio of tax revenue to GDP. As described earlier, these criteria were amply achieved by 2005, clearing the way for this operation to move forward. The DPL1 was the Bank’s first policy-based budget-support operation in the Philippines since the 1998 Banking System Reform Loan. 6. Engagement of Other Development Partners. Along with the introduction of urgent fiscal measures upon taking office in mid-2004, the Arroyo Administration also announced the Government’s Medium Term Philippine Development Plan (MTPDP), which sets out the country’s development priorities, policy agenda, programs and projects for 2004-2010, and served as the basis for policy discussions between the Government and international development partners. In 2005, the Government and its international development partners decided to convert the annual Consultative Group meetings into the Philippines Development Forum (PDF), permitting additional stakeholders, such as civil society, the private sector and the academic community, to participate in the policy discussions to strengthen implementation of the MTPDP. In March 2006, the Government and the World Bank agreed to use the PDF agenda for implementing the MTPDP as the basis for designing the Bank’s Development Policy Loan series. The Asian Development Bank (ADB) and the Japan Bank for International Cooperation (JBIC) participated in the discussions with the Bank and Philippine authorities on the policy reforms to be supported by the DPL, and proceeded with parallel policy-based operations using closely aligned policy matrixes.3 1.2 Original Program and Project Development Objectives (PDO) and Key Indicators (as approved) 7. The DPL series program had the objective of supporting government efforts to extend its track record of fiscal adjustment and reduce public debt to 60 percent by 2010, which would assuage investor concerns about instability. Strengthening tax administration and power sector finances were considered essential for achieving this objective. The Government’s commitment to a multi-year fiscal consolidation program with the Bank and other international development partners was meant to boost the program’s credibility among private investors and creditors. The DPL series also sought to support complementary measures needed to secure the fiscal consolidation effort. This includes the Government’s efforts to deliver services more effectively, in particular,

3 The Board of Directors of the Asian Development Bank approved a first Development Policy Support Program loan based on this program in early 2007.

4

through deepening implementation of procurement and financial management reforms thereby enhancing predictability in budget formulation, and transparency in its execution. 8. Finally, the DPL series was designed to support the Government’s efforts to increase public investment in infrastructure and social services financed from the proceeds of improved tax policy and administration, and to encourage greater private investment through an enhanced policy framework for public-private partnerships and the streamlining of procedures. The resulting higher investment and growth would bolster tax revenue and, in turn, help to achieve the Government’s fiscal consolidation objectives. 9. In the context of this series, the first operation (DPL1) supported the Government’s significant achievements in reducing public sector deficits and debt through tax reform and power tariff adjustments, and sought to bolster this performance by: strengthening tax administration; improving budget execution and fiduciary performance; and strengthening the finances of the power sector. In addition, DPL1 laid the groundwork for deeper reforms in the areas of fiscal consolidation, governance and the fiduciary environment, the investment climate and social policy, with the objective of supporting specific reforms in these areas in the context of subsequent DPLs.

1.3 Revised PDO and Key Indicators, and Reasons/Justification

No changes were made

1.4 Original Policy Areas Supported by the Program (as approved) 10. The Government’s reform agenda is based on the Medium Term Philippine Development Program (MTPDP), whose overarching objective is to reduce poverty and create jobs through faster, private sector-led growth and more effective public service delivery. The Government’s Letter of Development Policy and Policy Matrix described this reform agenda in the areas supported by the World Bank, ADB and JBIC in the context of the DPL series, and reflected discussions between government officials and staff from the World Bank, ADB and JBIC. These core areas were focused on in the Philippines Development Forum (para. 6) and comprise (i) macroeconomic and fiscal stability, (ii) governance and anti-corruption, (iii) investment climate and infrastructure and (iv) social inclusion. The remainder of this section describes the context in which the prior actions and proposed triggers for DPL1 and DPL2 were framed. A. Macroeconomic and Fiscal Stability 11. Fiscal Consolidation. A central objective of the DPL series was to reduce the public debt burden to 65 percent of GDP by 2009 (and to 60 percent by the end of the decade) in order to reduce the interest burden, allow for increased primary spending in priority areas, and assuage investor concerns about fiscal sustainability. Reaching this objective would represent a major turnaround from the early years of this decade when public debt was rising rapidly, exceeding GDP by 2003, and generating intensifying concern about fiscal sustainability. Accordingly, two prior actions selected for DPL1 were the reduction of the Combined Public Sector Deficit (CPSD) from 4.8 percent of

5

GDP in 2004 to 1.8 percent in 2005, and the reduction of the National Government deficit/GDP ratio from 3.8 percent in 2004, to 2.7 percent in 2005. As a trigger for DPL2, it was agreed to maintain the CPSD/GDP ratio at about 2 percent of GDP in 2006 and on track to reach 1.4 percent in 2007. For 2007, the primary means of reducing the CPSD was expected to be a further strengthening of the tax effort, which, coupled with a lower interest/GDP ratio, would permit the National Government deficit to decline even as primary spending increased. 12. Tax Effort. The tax policy reforms implemented in 2005 and 2006, coupled with a sustained effort to improve tax administration, were considered critical to the success of the fiscal and macroeconomic reform agenda. Accordingly, the prior actions for DPL1 were selected to be, (i) the broadening of VAT coverage in November 2005, by removing exemptions on petroleum products, electric power and legal and medical services, (ii) the increase in the VAT rate from 10 percent to 12 percent, effective as of February 2006, (iii) the establishment of a high level tax reform administration group in 2006 to oversee administration and the reform agenda, and convening of task forces to discuss reform strategy and priorities, that resulted in a work plan which coordinates all BIR and stakeholder efforts, and (iv) the significant response in terms of tax collection through September 2006—up 24 percent from 2005, following a 0.3 percent of GDP increase in 2005. The first two reform items above represent the core of the landmark VAT legislation. The third recognizes the efforts that were being made to strengthen tax administration in BIR. Item (iv) of the preceding prior actions recognizes the first significant improvement in tax effort since the Asian crisis, which raised hopes for a sustained recovery in tax revenue and a corresponding improvement of fiscal prospects. 13. Deepening the tax effort also represented a high priority – arguably the highest – for DPL2. Accordingly, a key trigger for DPL2 called for an increase in the tax effort by 0.5 percent of GDP in 2007, mainly through improved tax administration, further positive repercussions from the VAT reform, and improved excise tax performance. On the tax administration front, a further trigger for DPL2 was that the clean up and expansion of the large corporations and businesses in the BIR registration database be underway to improve the equity of the system and increase revenues. 14. GOCC Finances. Even as the national government deficit was being reduced, it was recognized that budget pressures originating from the Government Owned and Controlled Corporations (GOCCs) could arise, inter alia, on account of difficulties in keeping the NPC-regulated power tariffs from eroding in real terms after their substantial adjustment in 2004-05, and from efforts to increase public investment in infrastructure. Hence, in the context of fiscal consolidation, attention focused increasingly on strengthening the financial performance of GOCCs, in particular the Power Sector Assets and Liabilities Management Corporation (PSALM), the holding company of NPC and Transco, and by far the single largest GOCC in the country.4,5

4 The high cost structure of Philippine electricity provision had led to a perennial trade-off between fiscal and competitiveness concerns. In spite of charging among the highest power tariffs in East Asia, the power sector has traditionally generated significant deficits.

6

15. Consolidated PSALM finances. In late 2004 and 2005, NPC’s effective average generation tariff was increased by about 30 percent, contributing to a reduction of NPC’s deficit by 1.1 percent of GDP. This adjustment was recognized as a prior action for DPL1. In addition, P200 billion of NPC’s debt was assumed by the national government at end-2004. As a result, consolidated PSALM’s deficit was reduced sharply to 0.2 percent of GDP in 2005 and the overall GOCC deficit fell to 0.4 percent of GDP (from 1.8 percent in 2004). However, NPC remained insolvent with a negative net worth and a significant debt overhang. PSALM’s projection at the time was to reach break-even (debt service coverage ratio, DSCR, to reach one) by 2009. This would require timely and adequate remedial actions, without which the recent financial turnaround of Consolidated PSALM may not be sustained, undermining the objective of balancing the CPSD. 16. The authorities developed a detailed action plan to restore and sustain the financial viability of Consolidated PSALM that included, (i) continued improvements in operational efficiency and in prioritization of pre-privatization capital expenditures by NPC and Transco, (ii) publication of draft guidelines by ERC, for public consultation, for the filing of Universal Charges (UC) for stranded IPP contract cost and stranded debt, respectively; and implementation of the above UC by PSALM, (iii) appointment of the IPP Administrators (IPPAs),6 (iv) mitigation of perceived risks by investors to achieve successful privatization and use of the resulting privatization proceeds to reduce borrowings, (v) liability management, including refinancing debt on more favorable terms and hedge currency and fuel price exposure as appropriate, (vi) government reimbursement to NPC/PSALM for non-power cost of multipurpose projects, and (vii) government commitment to undertaking appropriate budgetary assistance, as necessary, to help Consolidated PSALM achieve an annual DSCR of at least one time by the end of 2009. Of these measures, the publication by ERC — for public consultation — of guidelines for setting universal charges for stranded costs and stranded debt respectively was taken as a prior action for DPL1, while the filing of universal charges for stranded debt and cost by PSALM were agreed as triggers for DPL2. B. Governance and Anti-corruption 17. Public Expenditure Management and Transparency. The DPL series sought to support the development of better mechanisms for expenditure prioritization, transparency and better predictability in the budget process with the aim of facilitating execution by line departments as well as the external monitoring by civil society groups. One important mechanism in this context is the generation of realistic and reliable

5 To the extent the government was able to strengthen the reform agenda in other GOCCs or other institutions that would contribute to bolstering public finances, these would be incorporated into the DPL series.

6This is an important step, as it strengthens the Wholesale Electricity Spot Market (WESM) by increasing the trading expertise available, and reduces the market and financial risks for NPC and PSALM from trading. Performance-based contracting of PSALM IPPs and NPC power generation to private expert traders would provide a legitimate proof that market revenues have been maximized, thus facilitating the approval and implementation of the UC.

7

forward revenue forecasts and more accurate aggregate resource constraint estimates. To implement this mechanism, the Government agreed to underpin its 2008 budget proposal by a medium term expenditure framework (MTEF), drawing from a refined budget strategy paper and forward estimates of budgetary costs of the existing programs and projects developed with the Departments. The budget strategy paper, in turn, would be underpinned by an analysis of critical expenditure management issues in priority sectors. The presentation of such a budget was taken as a trigger for DPL2. The submission to DBM of budget proposals based on a new improved budget format by four large government departments (DOH, DepEd, DPWH and DA) was an additional DPL2 trigger designed to promote better public expenditure management. This was intended to facilitate preparation of sector strategies and make the presentation of the budget document more aligned with core functions and the Major Final Outputs, which had been defined separately for each department as part of the Organizational Performance Indicator Framework (OPIF) initiative. 18. Two triggers on budget transparency were intended as a means of introducing a practice of public reporting of selected aspects of budget execution. In the long run, a comprehensive financial management information system would be necessary for the government to be able to report on its budget and financial management systematically and comprehensively. The triggers refer to posting on the DBM web site of two sets of information related to budget execution: detailed data on allotment and cash releases to central offices of DOH, DepEd, DPWH and DA; and details on payments to contractors to the central office and four pilot regions of the same four departments. 19. Procurement reform. To increase the transparency of public spending and control corruption, the Government also sought to improve the dissemination of public information on public procurement procedures and outcomes. Reflecting that objective, the number of bid opportunities and awards posted on the Philippine Government Electronic Procurement System (PhilGEPS) increased from 3,128 in 2004 to 8,919 in 2005 to 8,987 in 2006 (through Sept). At the same time, the award amounts posted increased from P4.45b (2004) to P15.0b (2005) to P21.2b (2006; through September). These increases in postings were selected as prior actions for DPL1. Furthermore, the posting of all publicly bid opportunities and bid awards of central offices of GPPB member departments plus DA (altogether 12 departments) on PhilGEPS, in compliance with Republic Act (RA) 9184, was identified as a trigger for DPL2. C. Investment Climate and Infrastructure 20. All surveys of private firms, investors and financiers have identified three main constraints to private investment: macro-fiscal instability, inadequate infrastructure, and corruption and regulatory uncertainty. As discussed in preceding sections, considerable progress has been made in reducing fiscal vulnerability. An emerging focus was thus on generating and allocating additional revenue towards investment in infrastructure and reducing regulatory uncertainty. Given the backlog of public infrastructure investment, private participation in infrastructure would be necessary and this will require a credible framework for such participation. Properly structuring such participation would help to

8

demonstrate to private investors the soundness of the investment climate across sectors. Hence the focus in this series was on enhancing the investment climate through several areas, as discussed below. 21. Promoting increased private sector participation in infrastructure (PPI) projects. The DPL aimed to support government efforts to enhance PPI projects by reducing risks and uncertainty and through the use of carefully chosen pilot transactions. The Government sought to complete the task of revising the BOT law so that policies relating to the award of concessions, issuance of public guarantees and provision of public subsidies became more transparent and led to improved confidence among private operators and financiers with regard to government commitments. This would be demonstrated in practice with the design and implementation of pilot public-private infrastructure projects. A few successful transactions were expected to send a positive signal to the private infrastructure community and substantially increase the interest of private investors, and enable NEDA to realize its target of attracting at least 22 percent of the total infrastructure financing from the private sector. The programming, planning and supervision of these activities could be overseen by a unit in one of the oversight agencies, which could develop the policy and program for PPP projects and could become the incubator for a pipeline of projects. The trigger agreed for DPL2 in this area was that the list of priority investment projects submitted by NEDA’s Infrastructure Committee to DBM would occur in time for inclusion in the 2008 budget. 22. Power sector reform. The Electric Power Industry Reform Act (EPIRA), enacted in 2003, provided a sound framework for the power sector structure, privatization, market arrangements and administration of stranded costs and stranded debt, but its implementation required coordinated actions with a carefully planned timetable. While implementation lagged behind the schedule envisaged under EPIRA, a significant milestone was reached in June 2006 with commencement of the commercial operation of the Wholesale Electricity Spot Market (WESM), and adoption of a range of important associated risk mitigation measures. This measure was followed by substantial NPC-regulated tariff increases that were implemented carefully to minimize adverse effects on the poor through the use of subsidized “lifeline rates”. These steps demonstrated the commitment to reform, and needed to be bolstered by implementing the pending measures under the government’s remaining reform agenda, particularly (i) strengthening and sustaining the power sector’s financial viability, (ii) mitigating market risks and ensuring a smooth transition to competitive energy markets, (iii) enhancing efficiency and private sector investment in the sector, and (iv) ensuring security of supply. 23. The commencement of commercial operations of the Wholesale Electricity Spot Market (WESM) in Luzon in June 2006 was selected as a prior action for DPL1. This market opening was preceded by a series of measures and transitional arrangements to mitigate market risks and to ensure that WESM—a critical part of the overall reform package—has a smooth start-up. Together with past regulatory measures to phase-out cross-subsidies in distribution and transmission tariffs and increases to regulated NPC power rates over the last 2 years, the commencement of WESM and associated measures showed a reactivated and more realistic move towards the implementation of the EPIRA.

9

These were important steps toward creating a sustainable market capable of attracting private investment and improved financial health of the sector. 24. The next critical step in this reform process was the privatization of NPC’s power generation assets and appointment of IPP administrators by PSALM to manage the trading of energy generated by NPC-IPPs. The early months of WESM’s operation, however, were characterized by a significant variability of spot prices, creating concern about possible market manipulation and highlighting the reputational risks for PSALM and the government, while PSALM continues to be the dominant market participant through the trading of power bought under the IPP contracts. Ensuring that there is a measured, considered response that maintains investor confidence is a technically complex task, requiring assistance to advise the government on the implementation of timely and appropriate responses. In particular, international experience suggests that fine tuning of market rules and pricing methodologies will be necessary, but the important price signals provided by a competitive market should not be lost or suppressed. Therefore, the trigger agreed for DPL2 in this context was that PSALM and NPC would engage an expert to advise on trading strategies and the strategy for appointing the IPP administrators, including risk sharing and performance incentives. D. Social Inclusion 25. The social sector reforms supported by the DPL series in 2006–2007 were to focus on continued improvement in the management of public expenditure, public procurement and transparency. These were seen as important foundations for ensuring that the planned increase in expenditure in the social sectors is focused on results, and that the impact of existing expenditure is increased. Accordingly, the governance component of the DPL included actions and triggers for the Departments of Education and Health, including preparing the ground for increased availability of resources as a result of fiscal consolidation. Future DPLs were envisaged to encompass more specific sectoral dimensions of the Government’s program for improving the quality of and access to essential social services, and for developing a social protection framework to enhance and complement the impact of economic growth on poverty reduction. 1.5 Revised Policy Areas (if applicable) No changes were made 1.6 Other significant changes No other changes were made 2. Key Factors Affecting Implementation and Outcomes 2.1 Program Performance 26. Table 2 below summarizes the prior actions that were selected for approval of DPL1, while Table 3 summarizes the triggers that had been agreed for proceeding with DPL2. The right hand columns in both tables summarize the status of implementation of

10

the government’s program as tracked by these actions. By design, the prior actions taken for approval of DPL1 were taken before this operation was sent to the Board in November 2006, so the first phase of the program was fully implemented.

Table 2: Prior Actions Taken under the First Phase of the Program Prior Action Status

1. The Borrower has reduced its consolidated public sector deficit from 4.8 percent of gross domestic product (GDP) in 2004 to 1.8 percent of GDP in 2005

Achieved

2. The Borrower has reduced the ratio of the national government deficit to GDP from 3.8 percent in 2004 to 2.7 percent in 2005 and reduced the level of national government deficit to 50.4 billion Pesos as of September 2006.

Achieved

3. The Borrower has broadened the VAT coverage by removing exemptions for petroleum products, electric power, and legal and medical services.

Achieved

4. The Borrower has increased the VAT rate from 10 percent to 12 percent. Achieved 5. The Borrower has increased its tax revenue by 0.3 percent of GDP in 2005 and further increased its tax revenue by 24 percent during the first nine months of 2006.

Achieved

6. The Borrower has established a high-level tax reform administration group in the BIR to implement its tax administration and reform agenda.

Achieved

7. The Borrower has increased NPC’s effective average generation tariff contributing to a reduction in NPC’s deficit by 1.1 percent of GDP in 2005.

Achieved

8. The Borrower, through ERC, has published, for public consultation, guidelines for universal charge for stranded costs and stranded debt.

Achieved

9. The Borrower has increased the number of notices with contract awards posted on the Philippines government electronic procurement system (PhilGEPS) from 3128 in 2004 to 8987 in the first nine months in 2006; and increased the amount of contract awards posted on PhilGEPS from 4.45 billion Pesos in 2005 to 21.2 billion Pesos in the first nine months in 2006

Achieved

10. The Borrower has commenced the commercial operation of the Wholesale Electricity Spot Market (WESM) in Luzon

Achieved

27. After the initial series of measures that served as prior actions for DPL1, the implementation of the program supported by the DPL series began to slow down. Most importantly, the tax collection effort and tax administration did not improve as envisaged in 2007. In mid-2008, a Bank team assessed the status of compliance with the triggers agreed for DPL2 and found that of the four triggers related to fiscal stability, two were fully achieved, while the tax effort trigger (for 2007) had not been achieved. The power sector trigger in this area also was not achieved, but was considered to have been ‘complemented’ by equivalent measures. Of the five governance-related triggers, the procurement trigger and one of the triggers referring to public expenditure management were achieved. The other trigger pertaining to public expenditure management and two triggers referring to public expenditure transparency were partially achieved. Finally, the two investment climate triggers were achieved. 28. The World Bank informed the authorities of this assessment in a letter dated July 18, 2008, and invited them to discuss the options and implications of these findings.7 The

7 Letter from Bert Hofman (Country Director Philippines) to Ms. Lea de Leon (Dept of Finance), dated July 18, 2008. While this letter focused on shortcomings in the tax effort, the Bank also suggested that better compliance with the triggers related to governance and transparency in public expenditure management and procurement was needed in response to emerging results from an INT investigation.

11

subsequent exchange of views did not lead to an agreed program, with the result that no follow-up development policy loan was prepared within 24 months of the time that the first DPL had been approved. According to Bank guidelines, this meant that the DPL series lapsed, calling for the preparation of this Implementation Completion Report.

Table 3. Progress Achieved in Implementing Second Phase of the Program

Triggers for DPL2 Status of Implementation

(as of March 2009)

Maintenance of an adequate macro/fiscal framework Adequate framework has been maintained

Fiscal Policy CPSD/GDP maintained at about 2% in 2006 and 1.4% in

2007 Tax revenue to increase by 0.5% of GDP in 2007, over

2006. [Baseline: tax ratio = 14.3% in 2006] Clean up and expansion of the large corporations and other

business in the BIR registration database underway

Achieved and exceeded. Small surpluses

achieved in 2006 and 2007. Not achieved. Tax effort remained

unchanged at 14% in 2007 and 2008. Partially achieved (50%). Progress has

been slow since early 2008.

Power Sector Universal charges for stranded debt and cost filed by

PSALM

Not achieved.* Progress made in privatizing

public assets helped improve PSALM finances, but not enough to restore solvency.

Governance

Public expenditure management: 2008 budget proposal underpinned by an MTEF based on

refined budget strategy paper and forward estimates developed with departments

DOH, DepEd, DPWH and DA submitted 2008 budget proposals to DBM based on a new budget structure.

Achieved Partially achieved (25% -- only DOH

complied out of 4 agencies)

Public expenditure transparency: Detailed data on allotment and quarterly cash releases by

agency for central offices of DOH, DPWH, DepEd and DA disclosed ex post on DBM website on a quarterly basis

Details on payments to contractors for central offices and 4 pilot regions of DOH, DPWH, DepED and DA disclosed ex post on DBM website on a quarterly basis

Partially achieved (progress stalled in 2008) Partially achieved (progress stalled in 2008)

Procurement reform: All publicly bid opportunities and bid awards of GPPB

member departments (altogether 12 departments) posted on PhilGEPS in compliance with RA 9184

Achieved. 12 out of the 12 targeted GPPB

agencies posted bid opportunities and awards

Investment Climate List of priority investment projects submitted by NEDA

Infrastructure Committee to DBM in time for inclusion in the 2008 budget

PSALM and NPC engaged advisor to advise on trading strategies and the appointment of the IPP administrators, including risk sharing and performance incentives

Achieved Achieved

*Note: In July 2008, this trigger was assessed as having been “complemented by equivalent measures”, but further analysis revealed that the privatizations that took place were not sufficient to restore solvency.

12

29. A subsequent review carried out in March 2009 in connection with this ICR revealed that the progress made since the mid-2008 review has been modest: as summarized in Table 3, five out of the 11 triggers agreed for DPL2 were fully achieved, four were partially achieved, and two were not achieved. The progress made in the individual program areas supported by the DPL is described next. 30. Trigger 1, in reference to reducing the Fiscal Deficit (Achieved). The consolidated public sector balance turned into a small surplus in 2006 that was maintained in 2007. It is estimated that the CPS balance remained in surplus in 2008, at 0.4 percent of GDP, as large surpluses from the social security institutions and local government units compensated for the increase in the national government deficit. (The national government balance fell from a deficit of -0.2 percent of GDP in 2007 to an estimated -0.9 percent in 2008.) 31. Trigger 2, in reference to raising the Tax Effort (Not achieved). The tax to GDP ratio had increased to 14.3 percent in 2006, so this trigger called for a target tax ratio of at least 14.8 percent in 2007. Meanwhile, the Government had set a target for itself of 15.3 percent of GDP. Actual tax revenues in 2007, however, fell back to 14 percent of GDP. Analyses carried out in 2008 by the Department of Finance (DOF) and the Bank suggested that most of the shortfall in total 2007 tax revenues (relative to the trigger) could not be explained by an adverse macroeconomic performance or policy changes conducive to lower revenues, and therefore that it was likely due to less-than-anticipated progress in tax administration. In fact, the analysis gave indications that tax administration effort was less in 2007 than in 2006. 32. The tax effort remained unchanged in 2008, at 14 percent of GDP. Preliminary tax collection data from the Treasury reveals that the tax revenues collected by the Bureau of Internal Revenues (BIR) grew by only 9.1 percent (or below nominal GDP growth of 12.8 percent) while collections by the Bureau of Customs (BOC) increased by 24.3 percent. The large collection by BOC is traced primarily to higher commodity prices (especially oil) and the weaker peso. Improvements in customs administration, on the other hand, are perceived to have made only a small contribution. In the BIR, a combination of macroeconomic impact, policy changes, and weaker tax administration explains the lower than targeted collections. This overall outcome for the year came as a disappointment, given that tax revenues had improved significantly in the first five months of the year. In the first half of 2008, proceeds from the tax amnesty law (at about P5 billion or 0.07 percent of GDP), higher prices and perceived stronger tax administration helped to raise internal tax revenues by 16.4 percent, compared to 6.6 percent over the same period in 2007. In the second half, the implementation of RA 9504, which exempts minimum wage earners from the income tax, raises the exemption thresholds of individuals and allows individuals to claim a standard deduction of 40 percent, brought down collection by about P7-14 billion, or 0.1 to 0.2 percent of GDP (according to the government’s projection). However, the weaker economy and poor tax

13

administration probably explain more of the decline in tax collection growth (which only averaged about 6 percent in the second half).8 The tax revenue intake continued to fall through the first Quarter of 2009, reflecting a deepening impact of the global economic crisis. Meanwhile, the progress made in tax administration reform (supported by the NPSTAR project) has been slow, with minimal accomplishment since early 2008.9 33. A number of reform measures initiated late in 2007 appeared to be gaining ground in early 2008, and may account for the improved revenue performance in the first quarter of that year. At the same time, however, a key concern emerged with regard to BIR’s de-listing of some 500 large taxpayers from the coverage of the Large Taxpayer Service, which was likely to undermine the impact of the other reform efforts to strengthen tax administration and revenue collection, such as the Run-After-The-Smugglers (RATS) program. As these fears materialized toward the end of the year, BIR reversed its position and the de-listed taxpayers have been reintegrated into the Large Taxpayer Service as of January 2009. 34. Several reform measures in the areas of registration, audit, and collection that were identified in 2007 also appeared to be showing progress during the first half of 2008. These measures include on-going data matching (with Customs, between BIR and SEC and of taxes by withholding agents and by income tax recipients under the tax reconciliation system (TRS)); new regulations to tighten controls over tax exemption removals; intensifying audit of taxpayers through the establishment of industry benchmarks and taxpayers profile as the basis for audit, initiating pre-audits of 2007 returns (normally audits are done towards the end of the year), rolling out the integrated computerized system (ITS) to 30 district offices as of April 2008, and rolling out the performance management system and accomplishment reporting system for 2008. The latter includes indicators beyond the collection goal—such as the audit effort ratio, the quality of audits, and the increase in the tax base and the clean-up of the database. 35. Reforms in the Bureau of Customs had made some progress in 2007 and 2008, following heightened media attention to smuggling. To address smuggling, which appears to have worsened in the last five years, the president created a high level task force to address smuggling and collusion of customs personnel in technical smuggling (i.e. mis-declaration of goods). A number of customs agents were charged with corruption under the Revenue Integrity Protection Service (RIPS) Program of the government. The e-customs project, which aims to computerize customs procedures and reduce physical contact between importers and customs agents, is underway. However,

8 Full year tax collection data for 2008 by type of tax is not yet available, but reports citing the DOF has VAT collection contracting by about 6 percent to P140.32 billion (1.9% of GDP) and income tax collection increasing by 1 percent to P482.24 billion (6.4% of GDP). BIR failed to meet its VAT collection of P204.88 billion for 2008 by P65 billion or 0.9 percent of GDP. The lower VAT collection could be traced to a weaker economy or deterioration in VAT administration, but with domestic consumption still relatively strong in Q3 and Q4 of 2008, the VAT base did not seem to be affected much. A weakening of tax administration, therefore, appears to have been more important.

9 See Annex 7, for a more detailed summary of the progress made in the implementation of tax management reforms.

14

Phase 3 of the program, which involves setting up the systems for electronic submission of manifests, electronic payments to banks, and electronic release of cargo, among others, appears to be significantly delayed. 36. To sum up, the targeted increase in the tax ratio could not be achieved in 2008, in spite of some encouraging developments at the beginning of the year. Looking forward, the tax ratio is expected to fall in 2009. (The Bank projects a ratio of 13.3 percent in the absence of remedial actions.) This decline in tax effort is attributable to three factors: (i) tax policy measures with a negative revenue yield,10 (ii) a cyclical economic slowdown, and (iii) weak tax administration, which together with a weakening economy led to a fall in tax compliance. 37. Trigger 3, in reference to cleaning up the BIR registration database (Partially achieved). Progress was made in building and cleaning up the taxpayer registry, but slowly. Out of more than 9,000 potentially unregistered corporations and 125,000 potentially inactive taxpayers that were identified in a data matching exercise in 2007, less than 50 percent were physically validated, and only 10 percent were identified for inclusion into the tax registry. The actual inputting of these taxpayers into the system, however, has not commenced. In 2008, a further 98,000 taxpayers were found to be registered with local government units but not with the BIR. These taxpayers are currently being validated by the district offices. Actual inputting of these taxpayers into the registration system is progressing very slowly. 38. The poor performance of the registration reform is primarily traced to poor management support and the overall focus of the BIR in meeting their monthly collection targets. The Attrition Act which rewards and punishes tax officials for meeting or failing to meet their respective collection targets appears to have provided a disincentive to pursue the registration and backlog clean-up. (For a detailed assessment of the progress in registration and backlog management of BIR, see Annex 8.) 39. Trigger 4, in reference to filing of Universal Charges for stranded debt and cost by PSALM (Not achieved). In 2007, after ERC had approved rules for stranded UCs filing in February and PSALM informed their intention to file and start collecting UCs, no filing was made by the latest deadline that year (June 15, 2007, including a three month extension requested by PSALM and granted by ERC). An earlier assessment carried out in mid-2008 suggested that the trigger could be considered partially achieved in view of successful privatizations in 2007 and upfront payment of privatization proceeds that led to improvements in the consolidated NPC/PSALM financial situation, and taking into account that PSALM was planning to file for stranded contract costs and

10 These include (i) the erosion of excise taxes, which are not indexed to inflation, (ii) a scheduled reduction in the income tax rate, as part of the 2004-06 VAT reform, and (iii) an increase in tax exemptions introduced in mid-2008 in response to the global financial and economic crisis.

15

stranded debts UC by July 2008. However, as of March 200911 there had still been no filing for stranded contract costs and stranded debt. UCs and preliminary financial projections prepared by PSALM in 2006 showed that projected privatization proceeds would not be sufficient to restore solvency.12 Information and preliminary estimations collected during Bank assessment missions on the impact of the financial crisis on the power sector (missions took place in December 2008 and January 2009) indicated that, notwithstanding the successful privatizations, debt overhang continues to be high, with the financial situation of NPC/PSALM depending critically on short to medium term refinancing. Moreover, estimation of 2008 operation results lead to significant stranded contract costs.13 During the financial impact assessment missions, PSALM informed plans to file for stranded costs by March 2009. PSALM has modified its strategy and again requested an extension from ERC until July 2009 justified on similar grounds as in previous years (audited reports will only be available by June). The extension was granted, but unless the 2008 stranded contract costs are actually filed within the deadline for 2009, their recovery through stranded costs UCs will not be possible. 40. Triggers 5 (Achieved) and Trigger 6 (Partially achieved), in reference to Public Expenditure Management Reform. The DBM continued its MTEF reform in the 2008 and 2009 budget preparation process. With technical assistance from the Bank, the DBM prepared the PBS for the third year in a row, detailing key policy issues in the priority sectors of education, health, public works and highways, agriculture and the environment, and proposing preliminary recommendations at a DBCC workshop. With AusAID technical assistance, DBM staff went through training to enhance their capacity to prepare forward estimates, and used these to calculate “allocable” fiscal resources to be distributed among priority sectors on the basis of the PBS recommendations. These accomplishments constitute full achievement of the Trigger 5. 41. The progress made in using the existing performance framework as a basis of agency budget structures has been more limited. The Organizational Performance Indicator Framework (OPIF) for each department identifies a set of Major Final Outputs (MFOs) and assigns corresponding budgetary costs to each MFO. But the actual budget estimates submitted to Congress (National Expenditure Program) as a basis for the General Appropriations Act follow the traditional Program, Activity and Project (PAP) structure that is different from the MFO structure. In the 2008 and 2009 budget proposals, DOH was the only department that adjusted its PAP structure more closely in line with its

11 Under the Implementing Rules and Regulations (IRR) of EPIRA, PSALM should file on or before March 15 of each year with the ERC for approval of Universal Charges for the following years.

12 Moreover, PSALM also projected reaching a break-even condition (DSCR to reach one time) by 2009 based on optimistic assumptions of privatization proceeds (up-front payments for privatization of major power plants during 2006-2007 and for the Transco concession by early 2008) plus collection of both UC for stranded contract cost and stranded debt (totaling P54 billion and P47 billion in 2009 and 2010, respectively).

13Preliminary estimations of PSALM refinancing needs total US$ 5.3 billion. These include repayment of outstanding NPC debt of US$ 4.1 billion through 2011 along with US$ 400 million of transmission costs, and US$ 800 million in stranded costs.

16

OPIF. None of the other priority departments revised their budget structures in a similar manner. Thus, Trigger 6 has only been partially achieved. 42. Triggers 7 and 8 in reference to Public Expenditure Transparency Reform (Partially achieved). In regard to Trigger 7, a breakdown of obligations and disbursements was provided for selected program/project for 2007 for DOH, DepEd, DA and DPWH. In regard to Trigger 8, data on contractor payments has been posted for DA, DepEd and DOH. For DPWH, the DBM web site has inserted a link to the DPWH web page on accounts payable to contractors. The data was posted on the DBM website only in early 2008, as opposed to the initial expectation of quarterly posting throughout 2007, partly because the amount of effort required to complete this task was underestimated. Due to deficiencies in the information systems, DBM had to scan data contained in paper copies submitted by the three agencies and upload them onto its website. As such, the data is not downloadable into a spreadsheet by external users. The fact that the posting relied on scanning data sent from the DA, DepEd and DOH to DBM in paper format, as opposed to electronic files, makes it difficult to ensure the sustainability of the effort.14 DBM has discontinued this effort since early 2008, when the ADB completed its appraisal of the 2nd Development Policy Support Program. Overall, therefore, these two triggers have only been partially achieved. 43. Trigger 9, in reference to Procurement Reform (Achieved). Posting of bid opportunities and awards on PhilGEPs is intended as a measure to improve transparency of government procurement. This is a requirement specified in the Government Procurement Reform Act. It captures just one of many dimensions of the procurement reform action plan agreed upon between the government and the development partners supporting the reform agenda as recorded in the current CPAR. The trigger has been achieved, albeit with some delay, as all 12 GPPB member agencies have posted bid opportunities and awards in the Philippine Government Electronic Procurement System (PhilGEPS). It is now apparent that the GPPB member agencies are complying with the requirements of the Government Procurement Reform Act. In meeting and assessing this trigger, however, some difficulties emerged that could have been anticipated better: (a) there is a timing difference between the posting of bid opportunities and award, sometimes as long as six months such that for a given assessment period, there is no one-to-one correspondence; (b) a technical challenge for the government to meet this trigger condition was to ascertain the universe of bid opportunities for each of the 12 departments that are members of the Government Procurement Policy Board (GPPB). Although required by law to link budget and procurement, the Annual Procurement Plan process has not been implemented properly in agencies. There is therefore no master file

14The scanned data posted are incomplete in terms of the time coverage (i.e., some months are missing) and the amounts posted cover only a small fraction of Maintenance and Other Operating Expenses (MOOE) and Cash Operations (CO) budget of the respective departments’ central office. The data for DPWH are itemized by each contractor and specify the amount due (but not actually paid). Unfortunately, the time coverage is limited to December 2007 and June 2008. It is also difficult to ascertain, from the way the data are posted, as to whether full data are made available from this database.

17

of all procurement transactions against which the number of postings can be compared. As a practical solution, the Technical Support Office (TSO) of the GPPB asked each department to submit a certified list of all its bid opportunities for 2007. However the data posted only captures procurement transactions by the departments’ main offices. 44. Triggers 10 and 11 in reference to Improving the Investment Climate (Achieved). As found in the mid-2008 review of the status of DPL implementation,15 both triggers were achieved: In regard to the first, the Comprehensive Integrated Infrastructure Program (CIIP) was prepared and was taken as a basis for the 2008 budget, becoming a more important planning and budgeting instrument for multi-year capital expenditures budgeting than before. Trigger 11 called for PSALM and NPC to engage advisors to advise on trading strategies and on the appointment of IPP administrators, including risk-sharing and performance incentives. (This action had the broad objective of improving the investment climate in the power sector and facilitating the transition to a competitive power market.) The Department of Energy (DOE) managed to contract the expert consultants in question through a PHRD grant to support the implementation of power sector reform and privatization (Grant for the Preparation of Private Sector Development Support Guarantee for Power Reform Project, TF055609).

2.2 Major Factors Affecting Implementation: 45. Various factors contributed to the slowdown in program implementation after the approval of DPL1, eventually causing the DPL series to lapse. 46. Declining country ownership. The program supported by the DPL series enjoyed limited country ownership.16 There was a strong consensus in 2004 and 2005 on the need to act quickly and decisively to raise tax revenues and reduce the fiscal deficit in order to avoid a fiscal crisis. The preparation and negotiation of DPL1, however, occurred toward the end of the fiscal consolidation process. By the time that the loan was appraised in November 2006, the threat of a fiscal crisis had subsided, reducing the sense of urgency that had driven the reform process earlier.

47. Political volatility. In July 2005, after the main fiscal reforms had been introduced, the eruption of a public scandal prompted the resignation of many Cabinet members and high level staff, including many of the more technocratic policymakers. After 2005, impeachment and coup attempts continued to surface periodically, contributing to political volatility and detracting attention away from the reform agenda. 48. High staff turnover. Staff turnover has been a problem. The high-level resignations mentioned above meant that many of the original architects of the government’s reform program were no longer in office by the time that DPL1 was

15 See Annex on “Status of DPL 2 Triggers” to letter from Bert Hofman (Country Director Philippines) to Ms. Lea de Leon (Dept of Finance), dated July 18, 2008.

16 In some instances, line agencies (e.g., BIR) did not appear to fully share the views and positions on the program expressed by the oversight agencies (e.g., DOF).

18

approved. This contributed to a loss of vision with respect to the future of the reform program and weakened the institutional capacity of key agencies. In particular, the BIR suffered a high turnover of Commissioners, which led to a lack of continuity in the reform effort. Other related factors contributing to the slow progress in BIR’s implementation of the tax reform program were the lack of adequate BIR management focus, inadequate staffing, inadequate performance incentives and deficiencies in the legal framework; see Annexes 7 and 8. 49. Weaknesses in program design. The core design of the DPL operation in general appears to have been sound. The sequencing of reforms, which began by focusing first on restoring fiscal soundness in DPL1, then shifting attention toward the strengthening of governance and public financial management in DPL2, and finally addressing shortcomings in the investment climate and in social sector service delivery, was appropriate in light of the government’s limited institutional capacity. By spreading out the reform effort over time, the risk of over-burdening institutional capacities to manage different reforms simultaneously was reduced. Even so, several of the reforms supported by the DPL series were too ambitious. In particular, the timing of reform actions envisaged in EPIRA to restore financial solvency to the power sector do not appear to have been achievable, thereby contributing to the government’s inability to meet Trigger 4; para. 36. Also, the measures to improve public expenditure transparency (Triggers 7 and 8) presupposed a better access to information, and the capacity to organize it in a meaningful manner, by the central Departments. In this last regard, it may have been more appropriate to wait for further advances in the development of better financial information management system before emphasizing the public dissemination of information. Other actions, such as the clean-up of the BIR registration database (Trigger 3) were eminently doable from a capacity viewpoint, so that the partial progress achieved in meeting the program target was attributable more to a lack of attention than to insufficient capacity. 50. Several prior actions and program triggers exhibited minor deficiencies. In particular, the set of prior actions in Table 2 could have been simplified, considering that the consolidated public sector deficit, the national government deficit and the NPC’s deficit are not independent of each other. Treating each as a prior action appears repetitive in the absence of a clear justification. Also, it would have been more appropriate to treat the VAT reform as one prior action, rather than considering the broadening of the VAT base and the raising of VAT rates as separate prior actions. A question arising in regard to the design of triggers for this operation is whether it was appropriate to maintain numerical targets for tax collections as triggers or to relegate them to the role of outcome indicators. The danger in opting for the former is that meeting the trigger depends on many factors outside of the government’s control and therefore may not adequately measure government efforts and commitment. In the final analysis, however, the failure to meet this quantitative trigger was not the main undoing of the program. Instead, it was the failure to come up with alternative remedial actions. 51. Although the choice of outcome indicators generally appears adequate in terms of quality and availability of information, there are some important exceptions. One is the

19

choice of separate outcome indicators for the public investment-to-GDP ratio and the private investment ratio. It turns out that the public investment figures in the National Income Accounts only refer to investment in construction, while any remaining public investments are lumped together with private investment. Separating these spending aggregates, therefore, does not make much sense. Also, several indicators are difficult to monitor for lack of systematic data that is available on a periodic basis. This is the case for the outcome indicator referring to the “number of projects being delayed and period of delay”, as well as the outcome indicator referring to “priority investment projects identified by NEDA”. Finally, a number of outcome indicators are not accompanied by baseline figures that can serve as reference points, reducing their value as measures of progress.

52. Gaps in the analytical underpinnings. A considerable amount of prior work had gone into analyzing the tax system and identifying its key weaknesses,17 and in analyzing the financial situation of the key GOCCs, particularly in the power sector. This includes a well-developed poverty and distributional impact assessment of the tax reforms supported under the DPL. However, the prior analysis available in the areas of public expenditure management and public financial management was more limited. A PER was concluded in 2003, but it covered a lot of ground and did not provide enough detail on the key PFM issues to serve as an adequate basis for the DPL. More detailed analysis followed later with the Public Expenditure and Financial Accountability (PEFA) diagnosis that was concluded in August 2008, but this came too late to influence the design of the DPL operation. 53. The links of the DPL to other lending or technical assistance operations were well developed for some program components, but less so for others. In the area of tax reform, several ongoing technical assistance projects, including from World Bank, IMF, SIDA and MCC, were available to assist the authorities in achieving improvements in tax administration and reaching the tax collection targets included in the DPL triggers. (As described in Annex 7, however, implementation of the Bank’s NPSTAR project has been weak, mirroring similar weaknesses in achieving compliance with the DPL2 targets.) Ongoing technical assistance provided through the Australian Agency for International Development and a PHRD grant managed by the Bank also were available to help with the implementation of some measures in the areas of public expenditure management, particularly the introduction of medium-term expenditure frameworks. In contrast, the amount of support to accompany the implementation of reforms in the areas of public expenditure transparency and financial management was much more limited and mainly confined to a few technical assistance grants. A government financial management information system strengthening project had been planned, but it has yet to enter the preparation stage. 54. Uneven development partner coordination. A commendable feature of donor cooperation when the program was being designed was the principle to adhere to a

17 This included a joint World Bank-IMF (Fiscal Affairs Dept.) report on “Critical Priorities in Tax and Customs Administration Reform” prepared in December 2005.

20

common policy matrix to which all partners could agree. Instead of having each development partner establish separate benchmarks and triggers for assessing program implementation, agreement on a common policy matrix was expected to provide a more consistent signal to the authorities in regard to the reform priorities being supported. Problems arose, however, when some development partners took a narrower interpretation of commonality (calling for common triggers as well as common milestones), which others regarded as an unnecessary straightjacket. This principle was eventually relaxed, as the ADB excluded from its series of DPSP loans the prior actions pertaining to the power sector that were contained in the policy matrix used by the World Bank.18 55. The management of a joint policy matrix, however, continued to present challenges in subsequent phases of the program. The Government did not exert a strong hand in donor coordination and the two largest providers of budget support – Asian Development Bank and the World Bank – eventually differed in their assessments of program implementation in mid-2008. Following its July 2008 assessment of the extent to which the triggers for DPL2 have been activated, the World Bank informed the government that some key triggers (on tax effort and governance) still remained pending and invited the government to discuss available options. The ADB, on the other hand, decided to remove the trigger pertaining to tax effort,19 and proceeded to prepare a second DPSP loan, which was approved in September 2008. The decisions by the World Bank and ADB to proceed in separate directions would have benefited from further consultations. By going separate ways, they undermined consensus on the importance of continued program implementation. 56. Finally, it may be pertinent to mention that the external environment was generally favorable during the first year following the approval of DPL1 and, thus, not a major factor contributing to the slowdown of the program. The key macroeconomic indicators turned out to be better than projected at the time of loan appraisal; Table 4. In particular, real GDP growth turned out significantly higher in 2007 than predicted (7.2 percent versus 5.7 percent), while the fiscal and external balances adjusted much faster

18 The ADB was also preparing a separate fast-disbursing operation for the power sector at this time, and therefore did not consider it appropriate to introduce such conditionality in its DPSP1 loan.

19 In regard to compliance with the tax effort trigger, the ADB’s program document for the DPSP 2 loan, makes the same observations as the World Bank’s mid-2008 program assessment, noting that while tax revenues fell short of budget targets in 2007, remedial actions taken by the authorities were leading to a recovery of tax revenues in the second semester of 2007 and during the first half of 2008, partially bringing the Government’s medium-term tax targets back on track. So, the ADB’s decision to move forward with the DPSP 2 loan is evidently not based on a different reading of this evidence. Instead, the ADB’s decision appears to have been motivated by a revised view on the adequacy of numerical targets for assessing implementation of tax policy. (The program document indicates that such numerical targets are more appropriately monitored as an outcome indicator, rather than as a policy trigger.) In any case, the justification given in the program document for removing the numerical tax revenue trigger is a Government request to eliminate the numerical trigger on tax revenues and to shift the focus on remedial actions to enhance tax collections. Also, ADB staff may have taken a more favorable interpretation than IBRD staff of the degree of compliance with some triggers (e.g., in transparency).

21

than originally projected, and so did not constitute an impediment to program implementation. The macroeconomic environment worsened significantly in 2008, first on account of the rising international food prices and then due to the global financial crisis. This manifested itself in higher inflation rates and lower growth in the second half of 2008. By that time, the program had already gone off track in terms of meeting the 2007 fiscal and public expenditure targets. However, it may have contributed to the government’s incapacity to follow through with the promising trends in tax collections observed in the first half of 2008.

Table 4

Key Macroeconomic Indicators – Projected and Actual; 2005-2009 (percentages of GDP, unless indicated otherwise)

2005 2006 2007 2008 2009Macroeconomic Projections (as projected in 2006)

Real GDP growth (% per annum) 5.0 5.5 5.7 5.9 6.2 CPI Inflation rate (average, % per annum) 7.6 6.7 5.0 4.2 3.5 Gross Domestic Investment 15.1 15.2 15.8 16.6 17.5 Consolidated Public Sector Balance -1.8 -1.8 -1.4 -0.9 -0.5 Non-financial public sector debt 87 80 74 69 65 Current Account Balance 2.4 2.4 1.8 1.4 1.0

Macroeconomic Outcomes (actual and estimated as of March 2009) Real GDP growth (% per annum) 5.0 5.4 7.2 4.6 1.9 CPI Inflation rate (average, % per annum) 7.6 6.2 2.8 9.3 5.5 Gross Domestic Investment 14.6 14.5 15.3 15.3 14.9 Consolidated Public Sector Balance 1/ -1.8 -0.2 -0.3 -0.4 -3.2 Non-financial public sector debt 86 74 64 62 62 Current Account Balance 2.0 4.5 4.4 1.6 2.2 Source: DPL1 Program Document (November 16, 2006) , Country Assistance Strategy (March 19, 2009), and DOF. Notes: 1/ CPS balance for 2009 is estimated as of June 2009.

2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization: 57. During the preparation of the DPL series, a set of 24 outcome indicators were identified. These were selected in agreement with Government counterparts and other development partners for the four programmatic areas covered by the program, and linked to areas of engagement originally contemplated for the complete series of DPLs. Considering that the series did not extend beyond the first DPL, the prior actions contained in DPL1 and the triggers discussed in connection with DPL2 are linked to a sub-set of 15 outcomes contained in the first three thematic areas (Macroeconomic and Fiscal Stability, Governance and Anti-Corruption, and Investment Climate and Infrastructure), as shown in Table 5. 58. The monitoring and evaluation of progress under the program primarily took place through DPL2 preparation missions, which reviewed the progress in compliance with the DPL2 triggers, through supervision activities carried out under related projects (notably the Tax Administration Reform project and an IDF grant to strengthen public expenditure and financial management) and through certain AAA activities (notably the Philippine Development Report), which provide inputs for the annual Philippine Development Forum that serves as a consultative group for discussing progress in

22

program implementation by the government and the development partner agencies.20 While this approach is appropriate from an operational viewpoint, it renders difficult the tracking of resources devoted to program supervision, since they are recorded under different tasks.

2.4 Expected Next Phase/Follow-up Operation (if any): 59. There are no follow-up operations contemplated under the present DPL series, given that it has lapsed after 24 months transpired since the approval of DPL1. (Another DPL was prepared in response to the food crisis under the Food Crisis Emergency Facility in September 2008, but this was a stand-alone operation separate from the just-lapsed DPL series.) The 2009 CAS contemplates the possibility of continuing with a new series of development policy loans, starting with a $250 million new DPL for CY2009, with a possible option of an additional US$250 million as a deferred drawdown option, supporting similar objectives of strengthening fiscal revenues and transparency as before, complemented by measures to improve the Philippines’ preparedness for the impact of the ongoing global crisis. Beyond this commitment to use DPLs to mitigate the impact of the global economic crisis, the Bank is also planning to use Catastrophe Development Policy Loans with deferred draw-down option (CAT-DDOs) in support of the government disaster risk management and in the context of a strong reform program in government financial management.

3. Assessment of Outcomes

3.1 Relevance of Objectives, Design and Implementation 60. The objectives pursued by the DPL series were fully consistent with the Bank’s 2005 Country Assistance Strategy, and continue to be relevant under the new 2009 CAS. The earlier CAS had focused on helping the government improve public institutions and services to help the country achieve higher and sustained growth, coupled with greater social inclusion. The modest growth achieved by the Philippines relative to its East Asian neighbors over the past 25 years was regarded as the main culprit responsible for the sluggish progress made in poverty reduction. Meanwhile, the CAS also identified weak fiscal performance as the single most important short-term obstacle to more rapid development of the Philippines. In that context, the strong focus on fiscal adjustments at the outset of the program makes sense. 61. Even though the fiscal policy adjustments achieved in 2004-05 averted a fiscal crisis and represented a major step forward in achieving these objectives, the additional

20 Since all the prior actions of single-tranche DPLs are met prior to Board presentation, there is nothing more to supervise under that project once the project funds are disbursed and the project is closed. Instead, the main program supervision at that stage takes place in the context of identification/preparation of the next project in the series.

23

measures contemplated in the DPL series continued to be highly relevant. In particular, the public debt ratio (86 percent at the end of 2005) was still very high, contributing to the country’s macroeconomic vulnerability, and thus requiring a sustained fiscal consolidation. On the other hand, the total investment ratio in the Philippines was and continues to be low, and appears incapable of sustaining the more rapid growth envisioned in the MTPDP. Furthermore, government spending on infrastructure and human development was extremely low by international standards, and leakages from public spending undermined the intended impact of such spending. This suggests that the policy focus adopted for the DPL series (measures to strengthen macro and fiscal stability, improve the investment climate and improve public expenditure management and transparency) was justified in terms of the country’s development needs.

3.2 Achievement of Program Development Objectives 62. In discussing the achievement of program development objectives, it is useful to separate the first three programmatic areas, on which most of the policy dialogue took place to date, from the last programmatic area, which was meant to be covered by future DPLs that never materialized.21 63. Macroeconomic and Fiscal Stability. The first programmatic area included 5 outcome indicators of which two were fully achieved, two were not achieved and one was partially achieved. The first two outcomes refer to the reduction in the public debt to GDP ratio and the maintenance of public sector fiscal balances compatible with a further declining public debt ratio. Achieving both outcomes attests to the government’s sound macroeconomic management, although the gradual increase in both the debt and the public deficit in 2008 raise questions about the sustainability of these gains in a less favorable external environment. Where government efforts have met with much less success is in regard to raising its tax revenue to GDP ratio and in restoring financial solvency to the power sector. The remaining outcome indicator, referring to updating of taxpayer information system, also was only partially achieved. As indicated earlier, this mainly appears to reflect flagging efforts on the part of the tax authorities. The outcomes in this area are rated moderately unsatisfactory, mainly on account of the failure to achieve the tax collection target, which had been the main focus of attention in the development of the DPL series, together with the absence of alternative remedial actions. 64. Governance and Anti-Corruption. All of the governance outcome indicators in Table 5 have been partially met. The lackluster performance in this programmatic area also is rated as moderately unsatisfactory.

21 The DPL policy matrix lists 24 outcomes, of which 15 are associated with programmatic actions related to the prior actions for DPL1 or with triggers identified for DPL2, while the remaining 9 outcomes are associated with program benchmarks that were not being monitored under these operations. In assessing program outcomes, this ICR only takes into account the 15 outcomes listed in Table 5 that are associated with the programmatic actions covered by DPL1 and DPL2.

24

65. The Government has registered tangible incremental progress in making annual budgeting more policy-based within a medium-term framework. In particular, the PBS has proven useful in steering the bureaucracy’s recommendations to the cabinet (through DBCC) on key budgetary priorities. But the effort has yet to reach a point of institutionalization. For the past two years, there have been some delays in key milestone decisions/events (e.g. determination of the priority topics to be reviewed in the PBS and thus in the preparation/finalization of the PBS within the budget preparation calendar) and ad hoc changes in key dimensions of budget making (e.g. the criteria for determining agency budget ceilings in the National Budget Call).

Table 5: Achievement of Outcome Indicator Targets Expected Results (by 2009) Actual Outcomes (as of March 2009)

I. Macroeconomic and Fiscal Stability NFPS debt reduced to about 65% of GDP from 96% in

2005 Public sector balances compatible with further

reduction of the debt burden Tax/GDP ratio increased to 15.9% Integrated and comprehensive registration system with

up-to-date and complete taxpayer information in place Debt service coverage ratio of at least one achieved for

consolidated NPC/PSALM

Fully achieved. NFPS debt reduced to 62% of

GDP in 2008 Fully achieved. CPSD remained low enough to

allow further reductions in public debt ratio Not achieved. Tax/GDP ratio remained around

14% in 2007 and 2008 Partially achieved (50%). Unlikely to be Achieved.

II. Governance and Anti-Corruption No. of departments with a medium term policy and

expenditure framework with realistic fiscal scenarios increased from baseline of 2 in 2006.

Detailed budget execution data and including IRA for

DOH, DepEd, DPWH, and DA disclosed for about 54% of total budget (net of interest payments and net lending) – up from 22% in 2005.

100% of public procurement transactions of central

offices of 23 national government departments posted on PhilGEPS website.

Partially achieved. A 3rd department (DSWD)

prepared an MTEF with Bank support. Partially achieved. (% achievement could not be

calculated for lack of information.) Partially achieved. (52%; 12 GPPB member

agencies posted bid opportunities and awards)

25

Table 5 cont’d.

Expected Results (by 2009) Actual Outcomes (as of March 2009) III. Investment Climate and Infrastructure

Public Investment/GDP increased from 2.3% in 2005

to 3.5% in 2009 Private Investment/GDP increased from 12.8% in 2005

to at least 15% in 2009 Reduction in number of projects being delayed and

reduction in period of delay 100% of road maintenance by contract and long-term

performance-based maintenance contracts institutionalized

10 priority investment projects identified by NEDA

have commenced Sustainable, stable power market that can provide a

base for market-driven investment in new generation Significant part of generating assets and Transco

privatized

Not Achieved. Public investment/GDP was at

2.1% in 2006, 2.7% in 2007, and projected to be at 2.6% in 2008 and 2.7% in 2009.

Not Achieved. Private Investment/GDP was at 12.4% in 2006, 12.5% in 2007, and projected to be at 12.7% in 2008 and 12.2% in 2009.

No baseline is provided Not Achieved. (It was included as part of

NRIMP2, which has been delayed.) Not rated, since government has presented

multiple lists of priority investment projects. Not Achieved. Can only be achieved when there is

open access, which can only start when 70% of generating assets are privatized.

Partially Achieved. 43% of the generating assets, and Transco, have been privatized.

66. In regard to budget transparency, the PEFA assessment and other diagnostic work the Bank and other development partners such as the IMF have conducted since the DPL1 was approved, suggest that there is much scope to improve budget management and execution, as well as budget transparency and reporting in the Philippines’ public financial management system. The Government has articulated transparency measures related to procurement through the PhilGEPs, but has yet to articulate a concrete plan to enhance budget transparency overall through greater disclosure of budgetary information. 67. Investment Climate and Infrastructure. Except for some progress made in advancing the privatization of public assets in the power sector, none of the outcomes targeted in this area was achieved. 22 Overall, the progress made in improving the investment climate and achieving a higher investment level (be it public or private) has been limited.

68. Social Inclusion. This fourth programmatic area in the policy matrix was not associated with any DPL1 and DPL2 actions, and was to be dealt with in future DPLs

22 One outcome in the policy matrix under this programmatic heading refers to a reduction in the average number of days needed to start a business, as reported in the Doing Business indicators. This outcome has been achieved, but it pertains to a program milestone that was not targeted under DPL1 or DPL2.

26

that never materialized. Surprisingly, it is the programmatic area showing the greatest proportion of outcome achievement.23 Since it was not linked to the actions supported by DPL1 and DPL2, however, the success in achieving these outcomes cannot be attributed to the DPL series.

3.4 Justification of Overall Outcome Rating Rating: Moderately Unsatisfactory 69. This rating is mainly motivated by the observation that, except for macroeconomic management (which has been satisfactory, though sustainability over time is not yet firmly entrenched), most of the outcome indicators in the area of fiscal management and in governance were not fully achieved. This overall rating is also warranted by the limited progress in program implementation, which prevented the Bank from pursuing the series after DPL1, thereby limiting its ability to influence further outcomes.

3.5 Overarching Themes, Other Outcomes and Impacts (a) Poverty Impacts, Gender Aspects, and Social Development 70. A worrisome development is the increase in poverty since 2003. Official household survey figures show that the incidence of poverty fell from 33 percent in 2000 to 30 percent in 2003, but then increased again to 32.9 percent in 2006. The data generating this result (Family Income and Expenditure Survey, FIES) diverges from the National Income Accounts, which indicate high growth during this period. The increase in poverty incidence indicated by the FIES, however, is consistent with other indicators

23The three outcomes included in the DPL series under the programmatic area of “Social Inclusion” are listed in the Table below, together with the progress made toward reaching those outcomes as of March 2009.

IV. Social Inclusion Increased coverage and use of the CBMS by 50% of the

LGUs from 4000 barangays in 2006 Increased elementary cohort survival rate to 71% (from

64”% in 2003/04) and high school cohort survival to 69% (from 63% in 2003/04)

Increased coverage rate of fully immunized children to

at least 87% (from 76% in 2005), tuberculosis case detection rate increased to at least 78% (from 71% in 2004) and cure rate increased to at least 85% (from 81% in 2004)

Substantially Achieved. 53 provinces (27 of which

province-wide), 554 municipalities and 43 cities covering 14,284 out of about 42,000 barangays (34%) use CBMS.

Achieved CSR: 2006 2007 1. Elem 73.43 75.26 2. Secondary 77.23 79.91 Achieved. For 2007, the following figures have been

reported: 1. Immunized coverage rate = 91% 2. Tuberculosis case detection = 75% 3. Tuberculosis cure rate = 85%

27

of poverty, such as the Social Weather Station reports, which have shown an increasing trend in the proportion of households experiencing hunger. Meanwhile, the progress in achieving the MDGs has slowed down since 2003, and in some cases (e.g., primary school enrollment) shows a recent deterioration. (b) Institutional Change/Strengthening Covered elsewhere in document (c) Other Unintended Outcomes and Impacts (positive or negative, if any) None

3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops Beneficiary surveys and stakeholder workshops were not conducted. 4. Assessment of Risk to Development Outcome Rating: High 71. The main development outcome achieved under this operation has been the restoration of macroeconomic balance and reduction of the public debt ratio. This outcome is now at risk with the onset of a much less favorable external environment triggered by the global financial and economic crisis. 72. Three other outcomes refer to the (i) modest improvements in the tax collection effort, (ii) modest improvements in public expenditure management and transparency, and (iii) opening up of the power sector to greater private participation and more efficient intervention of market forces. The risk of reversing the initial gains achieved in tax collections is also high, partly due to recent global developments, which also have contributed to a significant slowdown of economic activity in the Philippines. Partly as a result of this deceleration, as well as of tax cuts and base erosion measures, the tax ratio is projected to decline in 2009 toward its 2005 pre-fiscal consolidation level (13 percent of GDP). Also, the failure to index excise taxes to inflation means that tax collections are threatened by further erosion over time. The gains achieved in public expenditure management and transparency (including the introduction of MTEFs, adoption of new budgeting techniques and public dissemination of public expenditure information) are also subject to a high risk of reversal because they have not yet been institutionalized. Unless the current and future governments continue to persist in this effort, the modest gains achieved so far could be lost. The one area that offers a more optimistic outlook is the power sector, where the advances made in privatization and in the creation of a wholesale market appear to be subject to a more modest risk of being reversed.

28

5. Assessment of Bank and Borrower Performance

5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry Rating: Moderately Satisfactory 73. The joint policy matrix that was developed for this operation provided an acceptable basis for maintaining a policy dialogue. However, there were some gaps in the analytical underpinnings of measures supported by the DPL series that raised the likelihood of subsequent program failure. Although broad consensus was believed to have been achieved on the triggers, both with government and with other international development partners, the poor program implementation once the first DPL was approved indicates weak country ownership. A deeper consultation process may have been required to ensure more buy-in from the government. Some triggers appear in retrospect to have been too ambitious or premature (e.g., restoring solvency to PSALM finances), or not well sequenced (e.g., disclosure of public expenditure transparency prior to the strengthening of financial management information systems), and initial expectations that all development partners would adhere to the same set of triggers may have been too optimistic. 74. The proposed rating is one step lower than the overall judgment by the Quality at Entry Assessment (QEA8), of April 26, 2007. The QEA8 rated the operation highly on strategic relevance and approach based, among other, on strong borrower ownership, which subsequently proved deficient and which accounts for the lower rating offered in this ICR. On the other hand, the QEA8 coincides with this ICR’s assessment of the accountability framework for governance, which was found to be deficient with insufficient capacity building measures to mitigate this weakness.24 (b) Quality of Supervision Rating: Satisfactory 75. Even though progress in program implementation was slow, the assessment letter sent to Government in July 2008 indicated that all but one of the 11 triggers for DPL2 were considered to have been either achieved or partially achieved. Admittedly, these triggers were to have been achieved by end-2007 and the one trigger that was clearly not achieved (on tax effort) had been the object of greatest attention. Furthermore, the Bank

24Two other areas of coincidence between the QEA8 and this ICR can be highlighted: first, the QEA8 notes that there is potential confusion about the degree of flexibility associated with triggers for future DPLs and indicates that there may be advantages to keeping the DPLs on an annual cycle while modulating loan amounts in response to changes in the pace of reform implementation. (This point is also made in the discussion in paragraphs 75 of this ICR.) Secondly, the QEA8 assessment raises questions on whether it would have been advisable, as a means to improve partnerships, to place all triggers and milestones associated with the power sector within the ADB operation. (A similar question is raised in paragraph 54 of this ICR.)

29

also became increasingly concerned about the partial compliance with the triggers on public expenditure transparency and procurement in the wake of emerging results from the NRIMP INT investigation in 2008. Given the degree of progress made in complying with the DPL2 triggers, however, it would appear to have been possible to restructure the operation (or reduce the loan size) in an acceptable manner without jeopardizing the key development objectives. The Bank sought to engage the Government in a policy dialogue in early to mid-2008, precisely to consider remedial actions to bring the operation back on track, but no agreement was achieved. Stronger donor coordination during this period could have helped to consolidate the donor position and messages to the government. (c) Justification of Rating for Overall Bank Performance Rating: Moderately Satisfactory

5.2 Borrower Performance (a) Government Performance Rating: Not applicable (b) Implementing Agency or Agencies Performance Rating: Not applicable (c) Justification of Rating for Overall Borrower Performance Rating: Moderately Unsatisfactory 76. After having advanced quickly with the implementation of reforms during 2004-06, the Government appeared to have felt less urgency in pushing the reform process forward once macroeconomic equilibrium was on the way to being restored. To their credit, the authorities continued to maintain macroeconomic discipline, but many reforms contemplated in the DPL series were allowed to languish. Limited institutional and/or coordination capacity in the core Departments (e.g, DOF’s capacity to influence BIR) may have contributed to the sluggish reform effort. The Government authorities, however, did not articulate clear program priorities in response to the Bank communications inviting the authorities to propose alternative or remedial measures for bringing the DPL-supported program back on track. While various government entities exhibited weaknesses in program implementation, the most important shortcomings appeared in the Bureau of Internal Revenue (BIR), which had a key role to play in reforming tax administration and strengthening the government’s tax efforts.

30

6. Lessons Learned 77. The experience obtained from the First Development Policy Loan for the Philippines points toward the following lessons: Good coordination and open communication among the development partners is

critically important. The fragmentation of a common position among the Philippines’ development partner institutions in mid-2008 sent mixed messages about the best way forward in the implementation of development policies. The use of a common policy matrix is a useful instrument for policy coordination, but can become overly constraining if managed too rigidly.

Good analytical underpinnings are essential for designing a viable program.

When adequate underpinnings are lacking for certain measures at the time of appraisal, it is advisable to defer those measures until they have been better analyzed.

To be effective, reform processes need to be properly sequenced. The emphasis

on the public dissemination of information relating to public sector expenditures before an adequate management information system is in place, meant that the quality of the information that was disseminated remained poor, undermining its usefulness.

Narrow the scope of the program. The DPL series reflected a generalized tendency

in the Bank to combine macroeconomic, sectoral and social objectives into one DPL series. The series would have been more manageable – in both the preparation and implementation stages – with a narrower scope.

Periodic interim reviews to re-assess the adequacy of targets can help maintain

continuity in the policy dialogue and periodicity in resource flows. Some program targets turn out to have been overly ambitious, leading to long delays in achieving compliance and threatening to disrupt the policy dialogue. To avoid such delays (and associated interruption of the predictability of resource flows), it is advisable to review the targets periodically with all development partners and to revise them if necessary, especially if related circumstances have changed.

31

7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners (a) Borrower/Implementing agencies (b) Cofinanciers (c) Other partners and stakeholders (e.g. NGOs/private sector/civil society)

Annex 1 Bank Lending and Implementation Support/Supervision Processes

(a) Task Team members

Names Title Unit Responsibility/

Specialty Lending

Supervision Karl Kendrick Tiu Chua Country Economist EASPR Sanjay K. Dhar Economic Adviser AFTPM Joseph G. Reyes Financial Management Specialist EAPCO (b) Staff Time and Cost

Stage Staff Time and Cost (Bank Budget Only)

No. of staff weeks USD Thousands (including travel and consultant costs)

Lending FY07 49 287.57 FY08 1.67

Total: 49 289.24 Supervision/ICR

FY07 0.00 FY08 2.45

Total: 2.45

32

Annex 2. Beneficiary Survey Results (if any)

Not applicable

Annex 3. Stakeholder Workshop Report and Results (if any) Not applicable

33

Annex 4. Summary of Borrower's ICR and/or Comments on Draft ICR On the OVERALL RATING: MODERATELY UNSATISFACTORY This rating should be taken with the context of the Bank’s Performance. As enunciated in the section on Assessment of Bank Performance (p. 28), there were already gaps at the onset which “raised the likelihood of subsequent program failure.” Among those cited were “need for deeper consultation process to ensure buy-in from the government” and implicitly the quality of the triggers mutually adopted (e.g., not well sequenced re: disclosure of public expenditure transparency prior to the strengthening of financial management information systems). With the WB’s expertise/experience, the probability/feasibility of achieving such targets could have been better assessed and duly downscaled/reconfigured to consider track records and worst case scenarios, among others. The issue of the development of a joint policy matrix must also be raised given that ADB and WB have at some point differed in their assessment of the progress of program implementation. A critical gap which the report cited and which must be taken into account is the mutual adoption of triggers based on a favorable external environment which has since deteriorated into a much less favorable position to the government. On GOVERNANCE AND ANTI-CORRUPTION: MODERATELY UNSATISFACTORY The government has exhibited ability to comply with the initial triggers. However, as pointed out in the report, the feasibility/non-feasibility of meeting these triggers, especially those on public disclosure of public disbursement information, is challenged by the absence of a financial information management system. It is worth noting that this may not have been pointed out at the outset, or during the formulation of the program which could have avoided the posting of a “partially achieved” outcome. The government’s desire for increased transparency was indicated early on. In fact, alternative information on major project releases were posted in lieu of the original data which were not available for posting. The issue of institutionalization of the reforms towards making annual budgeting more policy based was raised, citing delays in milestone decision/events and ad hoc changes in key dimensions of budget making. In particular, the delayed determination of priority topics to be reviewed in the PBS was linked to the delays in preparation/finalization of the PBS within the budget preparation calendar. Similarly, the set of criteria for determining agency budget ceilings in the National Budget Call was cited as among the instances of ad hoc changes in budget making. While the DBM as Secretariat of the DBCC sets the process for identifying such priorities early on, several considerations contributed to the delayed identification of the same. These include delayed responses from ETB/DBCC members concerned. Another key consideration was the evolving macroeconomic outlook given the global uncertainties that happened in 2008 (and even in 2009) which naturally affected the timely configuration of the fiscal position for

34

purposes of determining the aggregate budget ceiling and consequently the department ceilings in the budget call. These experiences highlighted the need for government to base/propose commitments only where initial steps/actions have been made. On the matter of restructuring of agency budgets, the following must be taken into consideration: a) availability of approved agency’s rationalization plan which provides the connection/link between the organizational set-up of the agency and its budget; and b) the OPIF concept was too new for most agencies to grasp and sell to Congress. Again, this was a case of enthusiasm over institutional feasibility. On the OVERALL BORROWER PERFORMANCE Government’s “fervor” in pushing for reforms upon the restoration of macroeconomic equilibrium has not waned. In view of the continuing global financial and economic crisis, the implementation of these reforms has just become more challenging. What were being cited as weaknesses in program implementation merely reflected the government’s immediate priorities of ensuring social upliftment and economic resiliency amidst a “crisis” situation. As admitted in the report, revenue collections have been downscaled not only due to program backlogs but also because of the erosion of the tax base as a result of the external environment’s linkage with the Philippine economy. This consequently called for a realigning of the now lower level of resources to where there will be more immediate social/economic benefits. On INVESTMENT CLIMATE AND INFRASTRUCTURE The report noted that the projected improvement in the public investment-to-GDP ratio from 2.3% in 2005 to 3.5% in 2009, as well as the full institutionalization of road maintenance contract and long-term performance-based maintenance contracts by 2009, were not achieved. In addition, the report pointed out that there was no baseline provided for purposes of assessment relative to the reduction in number of projects being delayed as well as the reduction in period of delay. While these targets were not met, significant progress was achieved both in terms of budgets for infrastructure (vis-à-vis actual absorptive capacity) and in identifying measures to improve capacity. These outcomes should have been duly qualified so as not to reflect government’s lack of commitment to reforms. The prevailing constraints on government funds on account of the global crisis must be taken into account in viewing the percentage shares allotted for public investment. On the ASSESSMENT OF RISK TO DEVELOPMENT OUTCOMES: HIGH The report cited the high risk to the main development outcome (the restoration of macroeconomic balance and the reduction of the public debt ratio) on account of the less

35

favorable external environment, noting the possible deceleration of the tax effort to 13%. However, the same report also pointed out that despite the modest improvement in public expenditure management and transparency, there remains the risk of sustaining the gains, given the non-institutionalization of the reforms. On PEFA ASSESSMENT/WB DIAGNOSTICS The ICR notes that there is much scope to improve budget management and execution, as well as budget transparency and reporting .. Government articulated measures related to procurement but .. no concrete plan to enhance transparency through greater disclosure of budgetary information. The Government has been unwavering in its commitment to enhance transparency in budget operations.

Annex 5. Comments of Cofinanciers and Other Partners/Stakeholders Not applicable.

36

Annex 6. List of Supporting Documents IBRD Documents Country Assistance Strategy for the Republic of the Philippines (April 2, 2009) DPL2 Triggers Meeting: Questions for discussion/decision (July 22, 2008) Letter from Bert Hofman (Director) to Under-Secretary Lea de Leon on the ‘Status of

DPL2 Triggers’ (July 18, 2008) Eighth Quality at Entry Assessment (QEA8) for DPL1 (April 26, 2007) International Management Consultants, Ltd., “Philippines: Public Financial

Management Performance Report” (March 2007) Loan Agreement for DPL1 (January 23, 2007) IBRD, Program Document for the DPL1 (November 16, 2006) IBRD, Agreed Minutes of Negotiation for DPL1 (November 16, 2006) Appraisal Completion Note: Philippines, First Development Policy Loan (November

8, 2006) Minutes of the Meeting between the GOP Team and Development Partners

(September 11, 2006) Minutes of the ROC Meeting: Philippines DPL1 Concept Note Review (September 8,

2006) Minutes of the DPL Meeting (August 23, 2006) Minutes of the DPL Focus Group Meeting (August 17, 2006) Minutes of the Meeting on DPL Brainstorming (July 7, 2006) Country Assistance Strategy for the Republic of the Philippines (April 19, 2005) ADB Documents Asian Development Bank, “Report and Recommendations of the President to the

Board of Directors: Proposed Loan and Technical Assistance Grant, Republic of the Philippines: Development Policy Support Program, Subprogram 2” (September 2008)

37

Annex 7: Tax reform management update Background Activities under this component are crucial for the overall successful implementation of the reform program. The main task of the tax reform administration group (TRAG) is to facilitate the implementation of the reform program by providing overall guidance, timely advice, support, and monitoring of work plans, ensuring quality of terms of reference and in particular securing management support and oversight of the reform. Under the agreed setup with the Bank, the TRAG is headed by an official of the Bureau of Internal Revenue with the rank of a deputy commissioner. The TRAG is advised and overseen by a Project Steering Committee composed of all Deputy Commissioners and chaired by the Commissioner. In addition, a third body called the Coordinating Committee composed of all deputy commissioners was revived last year upon agreement with the Bank to ensure that reform activities are well coordinated even before reaching the level of the commissioner. Recent developments Recent events have begun to seriously affect the effectiveness of TRAG. In September 2008, the deputy commissioner for tax reform who has been with the project since inception was replaced by another person who had little knowledge and experience in the reform program. In March 2009 (during the middle of the supervision mission), the new deputy commissioner for TRAG took an indefinite leave of absence and was not replaced until recently (as per communication form DOF). Without a viable successor, project implementation had been stalling, especially since documents and correspondences such as procurement plan and request for no objection could not be signed. Moreover, the Department of Finance has recently approved the BIR’s rationalization plan which abolishes TRAG and instead creates a project management division headed by a division chief (which is three levels below the deputy commissioner) under the newly created strategic management services headed by an assistant commissioner who will directly report to the commissioner. In anticipation of the plan’s approval by the Department of Budget and Management, DOF and BIR issued revenue administrative order (RAO) 7-2009 last February 9, 2009 which prescribed the organization and function of the newly created strategic management service which contains the project management division. The supervision team indicated to the BIR that this move may have violated one of the loan covenants which states that BIR’s TRAG must maintain an organizational and management structure, staffing and resources which shall be adequate to enable TRAG to effectively implement the project. The mission also noted that the coordinating committee revived last year does not seem to function well. It was reported that the committee hardly met during the course of the year and during the supervision mission, access to the deputy commissioners and the commissioner was limited.

38

The large change management component, which was originally envisioned to begin immediately after loan effectiveness, has not commenced after almost two years despite having an approved terms of reference since a year ago. The slow progress was primarily traced to the lack of focus, understanding, and interest by TRAG and BIR management on change management. Moreover, issues raised by staff in two change management workshops conducted last year, such as frustration over the lack of staff, the need for additional resources and a better flow of information between the task forces and management regarding the reform programs, their need for clearer directions and better guidance from the BIR management, and concerns about staff movements and leadership transitions remain largely unaddressed. Reasons for slow progress The mission identified a number of issues which need to be addressed to ensure timely implementation of the reform program. These include: Lack of management focus on the reform: Managers across BIR continue to focus on revenue collections and achieving quick wins to meet their assigned collection goals. In recent months, the pressure to collect has increased due to the full implementation of the Attrition Act which removes officials who fail to meet their collection targets by more than 7.5 percent. In late 2008, the government released a list of “attritable” BIR officials who failed to meet their respective collection targets in 2007. As a consequence of this lack of attention to medium and long-term reform, implementation of the reform has continued to suffer. In addition, the lack of attention of and coordination among the deputy commissioners and bureaucratic delays such as a recent order in October 2008 requiring all members of the management committee and not just the concerned deputy commissioner to approve all project terms of references and procurement plans have also served to significantly slowdown project implementation. The tax reform office has little power and is inadequately staffed. Since the head of TRAG sits only in an acting capacity and has never had a full office, staffing with plantilla positions, and adequate budget, the clout of TRAG in coordinating and implementing the tax reform program is effectively diminished. TRAG staff complain about their inability to enforce project operating procedures and ensure timely and quality submissions by task forces. The Deputy Commissioner for TRAG is constrained by the lack of sufficient and adequately skilled staff. Unlike the original project vision, TRAG still has no permanent structure and staff has no permanent plantilla positions. Currently, TRAG has only five technical staff from eight a year ago. TRAG indicated that it would need at least five more technical staff to be more effective and efficient. Last year’s recommendation to appoint a deputy for TRAG with the rank of a director to assist in the day to day management of the reform has not been carried out. Frequent changes and movements in BIR management and personnel: In October 2008, the BIR commissioner who was in office for a little over a year resigned and was replaced by a new commissioner who took office in November 2008. At about the same

39

time, the head of TRAG was also replaced. Both the new commissioner and the new deputy commissioner for tax reform have had to spend time familiarizing themselves with the project which inadvertently caused some delay. Moreover, frequent changes in BIR managers across services and divisions have also affected project implementation. In 2008, several task force directors and heads were replaced (in some cases more than once) and a recently approved revenue travel assignment order has significantly shaken up the BIR organization, affecting again several directors and heads of task forces. These changes in task force heads and composition have stalled several projects and have also led to additional reviews and revision of activities that had been approved already under the previous heads. Multiple task forces with no clear reporting channels have made reform implementation more complicated. To launch the reform program 26 task forces were created and this was increased to 30 task forces before being reduced to seven critical task forces following the recommendation of last year’s supervision mission. Over time the management of the task forces has proven to be challenging especially with changing leaderships, the lack of manpower and skills, and poor supervision by management. Staff have been assigned to the task forces with little regard to qualifications and skills. The staff under the task forces continue to report to their functional managers, who, as mentioned above, are focused on collections and other inherent functions rather than the reform. Lack of incentives. TRAG and task force members have little incentives to perform under the reform program. Achieving collection targets has continued to be the sole performance measure in the BIR and despite the issuance last year of a revenue memorandum order (RMO) which puts in place a set of performance indicators to measure reform performance. The BIR has begun to implement the RMO but results have yet to come out and non-performing staff identified and appropriately sanctioned. Moreover several staff, especially those who have worked under the World Bank-funded Tax Computerization Project (TCP) in the 1990s, continue to compare and complain about the lack of compensation for doing the reform, which they claim is additional work on top of their regular work (the TCP had provided for full time staff secondment to the project and given honoraria on top of their regular pay). Policies on this have since then changed. Other task forces claim that they do not have enough staff to do both regular and reform work. It was noted in the supervision mission that some divisions have lost 50 percent of their staff based on plantilla position. These divisions claim that had they have more staff, they would have been able to give more attention to the reform. As a result, staff members that are assigned to one of several task forces do not work on a full time basis and often neglect their responsibilities in order to do their regular work and meet collection targets.

40

Recommendations DOF and BIR management need to fully assume more ownership of the reform program, and increase coordination of all reform activities. To improve ownership and coordination, and mainstream the reform activities within the regular functions of the BIR, it is suggested that all task forces be abolished and reform activities be institutionalized within the appropriate division or service in BIR. It is suggested that the assistant division chief, assistant revenue district officer or the HREA take full responsibility of the reform activity assigned to the office while the division chief, revenue district officer or the assistant commissioner continue to focus on re regular work of the office. Given the new leadership in the BIR, possibly and new emerging priorities of the new commissioner such as focusing attention more on the large taxpayers services, it is recommended that the BIR management prepare an overall strategy to guide tax reform. Outputs of the recent strategic planning workshop held by BIR in December 2008 could serve as a starting point. To ensure better monitoring and evaluation of project performance and improve accountability of staff involved in the reform, it is suggested that TRAG establishes performance standards for the various reform processes (i.e., TOR writing, procurement, etc.). Moreover the existing revenue memorandum order detailing the implementation of additional performance indicators that aims to measure reform performance be fully implemented to include individual staff evaluation and disposition. Over the medium-term, the Attrition Act needs to be amended to include non-collection-related performance indicators. The TRAG should be adequately staffed. The existing TRAG staff has done a commendable job stewarding the project thus far. However to accelerate Project implementation and ensure that the Project delivers on the expected results within a reasonable time frame, the office will need to be strengthened with more and better qualified staff who can effectively support the deputy commissioner. At least 10 full time technical staff are required, with at least one director level under the head of TRAG fully dedicated to the reform. To improve and professionalize project management, and to provide TRAG advice on proper project management, it is recommended that the BIR hire a full time professional project manager to support TRAG.

41

Annex 8: Update on Registration and Backlog Management of Tax Administration Background The registration and backlog management component is the backbone of the tax administration project given its importance in ensuring quality data for downstream processes such as arrears management, audit, and enforcement. As before, the mission focused extensively on the registration and backlog management component, recognizing the importance of this component for the rest of the tax administration. But significant delays and little progress to date in this component have casted doubt on the sustainability of the project. Recent developments One of the main tasks under this component is the matching of BIR data with other third party sources. In 2007, BIR matched its own data with data from the Securities and Exchange Commission and some 9,429 corporations were found to be unregistered with the BIR. Furthermore, the BIR also identified about 125,000 inactive taxpayers or taxpayers who have not filed returns or have not paid taxes for three consecutive years. Given the lack of manpower in the revenue district offices to physically validate the status of these unregistered and inactive taxpayers (presumably because efforts were put solely to meeting revenue targets), BIR outsourced the activity to a third party, an NGO called the Fellowship of Christians in Government (FOCIG). The contract was awarded in January 2008 and the activity was expected to have been completed by March 2008 but delays and problems encountered by FOCIG pushed the deadline to the second half of 2008. Progress of the FOCIG outsourcing activity proved to be minimal. In its progress report, FOCIG claimed that it validated about 50 percent or 68,000 out of 135,000 taxpayers and found out that only about 10 percent or 6,956 taxpayers were inactive or unregistered. BIR’s review of the progress report, however, reveals that FOCIG validated only 47 percent of taxpayers. Moreover, BIR found several inconsistencies in the FOCIG report and the registration task force and several RDOs doubt the accuracy of the report. In August 2008, BIR terminated the contract with FOCIG after FOCIG was not able to carry out the remaining terms of reference. As to validating the remaining taxpayers and revalidating some of the doubtful results, the task force said that its inclination was to ask the RDO to reverify most of these taxpayers. As of the mission date, the task force could not ascertain if the 6,956 unregistered or inactive taxpayers have been put into the tax system given poor reporting from RDOs and weak monitoring by the task force.

The BIR continues to reduce its backlog of registration, collection, and transaction returns with the help of the MCC funds. In 2008, 31 newly computerized RDOs were selected for the implementation of the backlog encoding, joining the original 4 RDOs which were selected in 2007 for the pilot run. As of Dec 2008, progress in backlog encoding reached 72 percent for registration backlogs, 95 percent for collection backlogs,

42

and 100 percent for transaction returns backlog. With the completion of the MCC project, the task force indicated that it would turn to the World Bank for support in encoding backlogs of the remaining computerized RDOs. A feasibility study on whether to hire a firm or individual encoders for the remaining RDOs would be conducted by the task force before plans are finalized for the remaining RDOs. Despite progress in this activity, the number of backlog registrations and transaction returns in the RDOs continue to be questionable. RDOs have remained reluctant to report the correct number of backlogs for fear of penalties. The BIR continues to work on matching its data with data from local government units as part of the registration cleanup. Progress slowed in mid-2008 when the license of the matching software expired. BIR has since then been able to renew the license and data matching is again moving. As of February 2009, the BIR has matched its data with data from 22 LGUs and the results reveal that about 98,000 taxpayers were registered with the LGU but not with BIR. These taxpayers were sent to the respective RDOs for physical validation. Preliminary and incomplete results reveal that about 22,000 taxpayers (about 20 percent of the total unmatched taxpayers) were found to be existing and active but not registered with the BIR. The second phase of the data matching, which is to compare reported gross sales/income is in progress. As of February 2009, BIR collected P250,000 for payment of registration fees and penalties. It has still to determine how much to collect from underdeclared gross sales/income. Revised policy and procedures for regulation have been put in place. In mid-2008, BIR issued revenue regulation (RR) 11-2008 which consolidates the various registration policies and procedures into one statute. However, the task force indicated that the new consolidated RR contains several provisions which have apparently increased the burden of compliance for some taxpayers. The task force is correcting this via an amendment to the RR and issuance of the corresponding RMOs. The task force indicated that the draft RR will soon be ready and could be issued by April. The next steps would be to hire a manual writer to convert the RR and corresponding RMOs into a user friendly registration manual to provide guidance to staff on assisting taxpayers in their registration efforts. There is a winning bidder for the registration manual but commencement would depend on when the revised RR can be issued. Reasons for slow progress During the supervision mission, the task force and the mission team assessed in detail the reasons for the poor performance of FOCIG to help improve succeeding outsourcing activities. Several reasons were cited such as

The contract did not mandate FOCIG to do a work plan and did not provide an initial down payment to serve as starting capital. The contract price might have been too low to attract qualified and bidders with the appropriate experience. Bidders with the right qualification such as credit investigators did not participate in the biding.

Taxpayers did not recognize the authority and mandate of FOCIG despite an official letter from the RDO. Some FOCIG agents were inexperienced with the

43

work and did not come as professional to the taxpayer (i.e., no uniform, wearing sandals, no ID,). Proper training of agents was also lacking.

Access of FOCIG agents to several buildings and subdivisions were restricted by building or subdivision security.

The initial time frame for the activity (2 months) appears to be too short and FOCIG admitted that they underestimated the complexity of the project.

Being the first contract to be awarded under the project, a lot of lessons could be learned from the experience before BIR embark on its next outsourcing activity (especially when results from the LGU data matching are ready to be validated).

The Attrition Act appears to have provided a disincentive to pursue the registration and backlog cleanup. The Attrition Act has effectively provided a disincentive for pursuing the clean-up and expansion of the taxpayer database since the Act has a provision stating that goal allocation should be distributed relative to the tax base of a region or district. Moreover, obsession with monthly collection targets has relegated most reform activities, especially registration, to the sideline since these activities do no yield immediate revenues. The lack of an effective KPI on registration clean-up has also slowed reform progress especially in the field. Lack of effective RDO monitoring is also seen a reason for the delay. Management of the registration activity is often lacking. For the most part of the registration reform, no assistant commissioner of the taxpayer assistance services which has jurisdiction over the registration process has effectively taken the lead and responsibility for the reform program. The task force heads which has the rank of a division chief or assistant division chief has normally taken the lead on this component without active guidance from a director or assistant commissioner.

Follow up of registration activity by RDOs has been weak. While some of the upstream registration activity has been outsourced, the downstream work of registering new taxpayers and taking action on validated non-BIR registered taxpayers must be undertaken by BIR staff in the Operations Group or RDOs. Without close direction and monitoring by senior management, it is expected that RDOs will continue to focus on collections. The lack of an updated and overarching law between the BIR and government agencies prevents the sharing of information for taxpayer verification. With the support of the Secretary of Finance and the issuance of EO 646, the BIR can now share data with local government units. However, other agencies such as the SSS, LTO, LTFRB, LRA, and DTI have yet to fully institutionalize data sharing with BIR. Only BOC and SEC have regular and institutionalized data linkages with BIR. However the BIR and the BOC do not yet have automatic data sharing as import declarations are still being manually picked up in CD format. To ensure continuous cross checking and third party data verification, the BIR needs to institutionalize this practice, including assigning staff permanently to these functions.

44

Recommendations Given existing policy (the Attrition Act) and focus on meeting short-term collection targets that provide systematic disincentive to the registration reform program, it is recommended that the whole registration clean-up component be shelved until such policies and environment conducive to the reform are available. Resources allocated to the registration could be used for other priorities such as strengthening the large taxpayers services in the BIR. The work on backlog management and encoding should continue. The Bank stands ready to provide funds for outsourcing of the encoding work (with due attention to improving the TOR and contract following lessons learned from the FOCIG experience). As the FOCIG contract will be not rebidded, it is suggested that the RDO pick up the work of FOCIG and validate the results again with due consideration to efficiency. To this end, the Commissioner should issue an RMO with guidelines to all RDOs on procedures to be followed and timelines allocated for RDOs to update their registration database. A monitoring system should be put in place to supervise RDO follow-through based on revalidation of the FOCIG data. On improving the scope of third party information sharing, BIR and DOF need to identify all relevant agencies with whom data sharing is critical and begin the drafting or submitting of EO proposals to the President. At the very least, the existing EO on data sharing, EO NO. 53 (1993), needs to be updated and broadened;