financeorpenanceforthepoor

FINANCING for DEVELOPMENT

Finance or Penance for the Poor

Mobilizing Resources for the MDGs:The Five Year Review of Financing for Development

FILOMENO S. STA ANA IIIEditor

Financing For Development

FINANCE OR PENANCE FOR THE POOR

Mobilizing Resources for the MDGs:

The Five Year Review of Financing for Development

Copyright 2008

Social Watch Philippines

3rd Floor No, 40 Matulungin Street

Brgy. Central, Quezon City

Telephone Nos. +63 02 4265626 / 4265632

E-mail: [email protected]

Website: www.socialwatchphilippines.org

Supported by the United Nations Development Programme (UNDP) through a project

implemented by the National Economic and Development Authority (NEDA).

Views expressed by the authors of this volume do not necessarily refl ect the positions of the

UNDP and NEDA.

All rights reserved. No part of this book may be reprinted or reproduced without permission

in writing from the publisher.

ISBN: 978-971-92014-5-8

Published by: Action for Economic Reforms, Inc.

Philippine Rural Reconstruction Movement

Printed in the Philippines

First printing: June 2009

Editor: Filomeno S. Sta. Ana III

Project Coordinator: Janet R. Carandang

Book and Cover Design: Nanie S. Gonzales

iiiFfD: Finance or Penance for the Poor

LEONOR MAGTOLIS BRIONES is a Professor at the National College of Public Administration and Governance, University of the Philippines, Diliman. She is the lead convenor of Social Watch Philippines. She was the Republic of the Philippines’ National Treasurer from 1998 to 2001, and, in concurrent capacity, served as Presidential Adviser for Social Development.

JESSICA REYES-CANTOS is the Chief of Staff of Representative Lorenzo Tañada III of the 4th District of Quezon Province. She is the President of Action for Economic Reforms and a convenor of Social Watch Philippines. Her other NGO involvements include being convenor of Rice Watch and Action Network and the East Asia Rice Working Group and being member of the Fair Trade Alliance.

JOSEPH ANTHONY Y. LIM is a Professor at the Economics Department of the Ateneo de Manila University. He was a Professor at the School of Economics of the University of the Philippines, Diliman from 1978 to 2005; and was the Policy Adviser on Debt and External Finance for Developing Countries of the Bureau for Development Policy of the United Nations Development Programme (UNDP) in New York.

CLARENCE G. PASCUAL is the principal investigator of various projects including “Globalization, Adjustment and the Challenge of Inclusive Growth: Effects of Industry Churning on Workers Welfare” of the Angelo King Institute, De La Salle University, and International Development Research Centre; and “Impact Assessment of Local Interventions in the Informal Economy” of the International Labor Organization (ILO) Philippine Offi ce.

MARIO JOSE E. SERENO is the Chairman of the International Trade Policy Committee of the Federation of Philippine Industries; and the Committee on Tariffs of the Philippine Chamber of Commerce & Industry. He is the executive director of the Association of Petrochemical Manufacturers of The Philippines. He served in concurrent capacity as the President & General Manager of the Philippine Petrochemical Products, Inc. and Philippine Adhesives Inc. (1999-2002).

FILOMENO S. STA. ANA III is the coordinator of Action for Economic Reforms. He is a regular contributor to the BusinessWorld’s Yellow Pad column. He has been published in several volumes, including being co-author of Philippine Democracy Assessment: Economic and Social Rights (2007) and editor of The State and Market: Essays on a Socially Oriented Philippine Economy (1998).

EDUARDO C. TADEM is Professor of Asian Studies at the University of the Philippines, Diliman. He has a Ph.D. in Southeast Asian Studies from the National University of Singapore. He has researched and published extensively on agrarian reform and rural development, industry studies, regional development, rural unrest and social movements, the political economy of foreign aid, Philippine Japan relations, confl icts over natural resources, international labor migration, foreign investments, and contemporary politics.

About the Authors

vFfD: Finance or Penance for the Poor

Table of Contents

About the Authors ........................................................................................................................................................................................................................................................................ iii Abbreviations and Acronyms .......................................................................................................................................................................................................................vii

Foreword Professor Leonor Magtolis Briones ................................................................................................................................................................................. ix Renaud Meyer.............................................................................................................................................................................................................................................................................xi

Introduction: A Frame to Assess Financing for Development ...........................................................................1Filomeno S. Sta. Ana III

May pera na ba? Mobilizing DomesticFinancial Resources for Development......................................................................................................................................................................................7Leonor Magtolis Briones

Foreign Direct Invetsments Policy:A Closer Look at Assumptions in the Context of Philippine Constraints ................21Mario Jose E. Sereno

Possibilities of Debt Reduction for MDG Financing:Philippines and Indonesia ....................................................................................................................................................................................................................................45Joseph Anthony Y. Lim

Development Down the Drain:The Crisis of Offi cial Development Assistance to the Philippines ..................................................65Eduardo C. Tadem

Can Trade Finance Development? ................................................................................................................................................................................................99Jessica Reyes-Cantos

Remittances for Development Financing ..........................................................................................................................................................109Clarence G. Pascual

How Relevant is Financing for Development to Philippine Realities? ............................................................................................................................................................................................................................................131Filomeno S. Sta. Ana III

viiFfD: Finance or Penance for the Poor

Abbreviations and Acronyms

ADB – Asian Development BankABI – Alternative Budget InitiativeAMORE – Alliance of Mindanao Off-Grid

Renewable EnergyAoA – Agreement on AgricultureARISP – Agrarian Reform Infrastructure Support

Project II ARMM – Autonomous Region of Muslim MindanaoASEAN – Association of Southeast Asian NationsBCDA – Bases Conversion Development AuthorityBIR – Bureau of Internal RevenueBOC – Bureau of CustomsBOI – Board of InvestmentsBOT – Build-Operate-TransferBPO – business process outsourcingBTr – Bureau of TreasuryCAD – comparative-advantage defyingCAF – comparative-advantage followingCDC – Clark Development CorporationCIDP2 – Second Communal Irrigation

Development ProjectCIDSE – Cooperation Internationale pour le

Development et la SolidariteCNMEC – China National Machinery and

Equipment CooperationCOA – Commission on AuditCSO – civil society organizationCTC – community tax certifi cateCTS – Cargill Technical ServicesCTRP – Comprehensive Tax Reform ProgramDA – Department of AgricultureDAC – Development Assistance Committee DAR – Department of Agrarian ReformDBM – Department of Budget and Management

DBP – Development Bank of the PhilippinesDENR – Department of Environment and Natural

Resources DOF – Department of FinanceDOTC – Department of Transportation and

Communication DPWH – Department of Public Works and

HighwaysDSA – debt sustainability analysisDSSC – Development Support Services Center DTI – Department of Trade and IndustryECC/CNC -Environmental Compliance

Certifi cate/Certifi cate of Non-Coverage EPRA – Economic Policy Research and AdvocacyFAPs – foreign-assisted projectsFDI – Foreign Direct InvestmentsFfD – Financing for DevelopmentFMO – Fund Management Offi ce FPE – Foundation for Philippine Environment FSSI – Foundation for Sustainable Society,

Incorporated GAA – General Appropriations ActGATT – General Agreement on Tariffs and TradeGDP – gross domestic productGNI – gross national incomeGNP – gross national productGOCC – government-owned - or -controlled-

corporationGOP – Government of the PhilippinesGPRA – Government Procurement Reform Act HD – human developmentHIPC – Heavily Indebted Poor Countries ICC – Investment Coordinating Committee

viii FfD: Finance or Penance for the Poor

ICT – Information Communication TechnologyIFC – International Finance CorporationIMF – International Monetary FundIPAs – Investment Promotion AgenciesIPP – Investment Priority PlanITH – income tax holidayJBIC – Japan Bank for International Cooperation JCCIPI – Japan Chamber of Commerce and

Industry in the Philippines, Inc.JEXIM – Japan Export-Import Bank JICA – Japan International Cooperation Agency KFW – Kreditanstalt fur Wiederaufbau LBP – Landbank of the PhilippinesLGU – local government unitMDG – Millennium Development GoalsMDRI – Multilateral Debt Relief Initiative MILF – Moro Islamic Liberation FrontMNEs – multinational enterprisesMOFA – Ministry of Foreign Affairs MOU – Memorandum of UnderstandingMTF-RDP – Mindanao Trust Fund –

Reconstruction and Development ProgramNAMA – Non-Agricultural Market AccessNBN - National Broadband Network NCR – National Capital RegionNDF – Nordic Development FundNEDA – National Economic and Development

Authority NEP – National Expenditure Program NG – national government NGO – non government organizationNLRC – North Luzon Railway CorporationNPC – National Power CorporationODA – Offi cial Development AssistanceOECD – Organization for Economic Cooperation

and DevelopmentOECF – Overseas Economic Cooperation FundOFWs – overseas Filipino workersPCA - Philippine Construction AssociationPCGG – Presidential Commission on Good

GovernmentPCIJ – Philippine Center for Investigative

Journalism

PDF – Philippines Development ForumPERC – Political and Economic Risk ConsultancyPEZA – Philippine Economic Zone Authority PhP – Philippine pesosPIDS – Philippine Institute of Development StudiesPIOs – project implementation offi cers PRC – People’s Republic of ChinaRA – Republic ActRATS – Run After The SmugglersRATE – Run After Tax EvadersREER – real effective exchange rate ROW – right-of-waySAPs – Structural Adjustment ProgramsSBMA – Subic Bay Metropolitan AuthoritySC – Supreme CourtSCTEP – Subic-Clark-Tarlac Expressway ProjectSEC – Securities and Exchange CommissionSEZ – special economic zoneSRMP – Saug River Multi-Purpose ProjectTARGET MDGs – To Access, Revitalize and Gear

Efforts Towards MDGs TEEP – Third Elementary Education ProjectTFCA – Tropical Forest Conservation Act TFP – total factor productivity TNC – transnational corporation TRIMs – Trade Related Investment MeasuresUN DESA – United Nations Department of

Economics and Social AffairsUN IFAD – United Nations International Fund

for Agricultural Development UNCTAD – United Nations Conference on Trade

and DevelopmentUNDP – United Nations Development

ProgrammeUNFPA – United Nations Population FundUP – University of the PhilippinesUSAID – United States Agency for International

DevelopmentVAT – value-added taxWB – World BankWTO – World Trade OrganizationWWF – World Wildlife Fund

ixFfD: Finance or Penance for the Poor

Foreword

Social Watch Philippines is pleased and proud to publish this volume of papers that were presented during

its National Consultation in November 2007. It will be recalled that on 22 March 2002, state leaders

gathered in Mexico to adopt the fi nal outcome of the International Conference of Financing for Development

(FfD) which has since been known as the Monterrey Consensus. The Monterrey Consensus sought to respond

to “the challenges of fi nancing for development around the world, particularly in developing countries” as

it recognized the estimated “dramatic shortfalls in resources required to achieve the internationally agreed

development goals, including those contained in the United Nations Millennium Declaration.”

The Philippine is one of the signatories of the Monterrey Consensus. Social Watch Philippines (SWP) led

civil society participation in the multi-stakeholder crafting of offi cial policy positions on FfD conducted by

government in 2001. The partnership forged among government, civil society and the business sector during

this undertaking has since been recognized by many as a “best practice” in constructive engagement.

In 2007, a study by Rosario Manasan, titled “Financing the Millennium Development Goals: the

Philippines,” was published by the Philippine Institute for Development Studies (PIDS), a government

think-tank. The study estimated the available and required resources to achieve targets under the Millennium

Development Goals on a yearly basis until 2015 under different growth and cost assumptions. From years

2007 to 2010, the fi nancing gap was estimated to be within the range of PhP 350.623 billion (or 1.07 percent

of GDP) using high growth-low cost assumptions to PhP 447.842 billion (or 1.41 percent of GDP) using low

growth-high cost assumptions.

The studies for this paper aptly coincided with the initiative of SWP as it kicked off a civil society review of

FfD in the Philippines in the same year. SWP conducted the FfD review process, which had these objectives:

1. To catalyze the preparatory process for the review of the outcomes of the Monterrey Consensus from

the point of view of civil society;

2. To have the FfD policy review agenda built on the research and policy recommendations of the

NEDA-commissioned study on fi nancing the MDGs as well as the study of Dr. Joseph Lim on the

possibilities of debt reduction for MDG fi nancing;

3. To build a broad-based consensus among civil society organizations around FfD policy agenda towards

generating new and additional resources for the MDGs in the Philippines; and

4. To disseminate the civil society position papers on the six themes and to use these in the engagement

with national government, business sector and other stakeholders.

The FfD review as contained in this publication consists of seven papers corresponding to the different

areas of fi nancing for development as outlined in the Monterrey Consensus. The FfD themes are domestic

resources, international resources/foreign direct investments, trade, offi cial development assistance, debt and

systemic issues. The preparation of each paper involved a series of workshops before and after the initial draft

x FfD: Finance or Penance for the Poor

had been written. Such workshops were conducted to engage civil society participation in the discussion of

issues and recommendations towards the comprehensive review of FfD in the Philippines.

Overall, the papers reveal the challenges in mobilizing resources from domestic sources, foreign investments,

trade, ODA and debt towards fi nancing development, including MDGs. They further reveal that bad

governance and inappropriate economic policies have perpetuated a massive outfl ow of resources through debt

payments, and corruption, for example, thus leaving few resources to fi nance development. Recommendations

on how to address these challenges have been provided, and it is hoped that policymakers will be informed and

inspired to take the necessary reforms through this book’s publication.

It is important to take note that the papers here were fi nalized in early 2008 and thus have not taken

into account the fi nancial crisis gripping the world as well as the expected global economic slowdown. These

recent trends will inevitably impact on the country’s fi nancial fl ows and are expected to derail growth in the

real economy. The crisis will most likely put a strain on mobilizing domestic resources since the national

government will be hard-pressed to meet its revenue targets. Foreign investments may decline as fi nancial

markets in developed countries experience a meltdown. The slowdown among trading partners can dampen

export growth. These developments will highlight all the more the magnitude of foreign debt service, as

revenues and foreign exchange earnings dip. These are general observations on the likely impact of the global

crisis on FfD in the Philippines. The extent of the impact has yet to be fully determined and quantifi ed but,

it would be prudent for the reader to consider these emerging trends in the course of reading the analyses and

recommendations of this book.

At the time the papers were prepared, SWP was already stressing the urgency of FfD. The ongoing

fi nancial crisis only underscores the urgency and the need for national, regional and global action.

Professor Leonor Magtolis BrionesLead Convenor, Social Watch Philippines

October 2008, Quezon City

xiFfD: Finance or Penance for the Poor

Foreword

The unprecedented global fi nancial challenges facing the world today call for a coherent and collective ac-

tion to be on track in achieving genuine and people-centered development. World leaders have recognized

that addressing the challenges of poverty reduction, sustained and inclusive growth, and sustainable develop-

ment require a long-term fi nancing for development (FfD) strategy.

The fi rst International Conference on Financing for Development held in Monterrey, Mexico in March 2002

achieved a consensus (known as Monterrey Consensus) to develop strategic actions for mobilizing resources that can

be made available, especially to developing countries, to help them meet the internationally agreed goals set under

the Millennium Declaration---the Millennium Development Goals (MDGs). The Monterrey consensus com-

mitted to six interrelated themes, namely, domestic resource mobilization, foreign direct investments and private

capital fl ows, fair trade, international development cooperation, external debt, and systemic issues.

Six years after, a Follow-Up International Conference on Financing for Development to review the imple-

mentation of the Monterrey Consensus will be held in Doha, Qatar to assess progress made, reaffi rm goals and

commitments, share best practices and lessons learned, and identify emerging issues and challenges as well as

signifi cant measures for further implementation. The Doha Conference will indeed be a signifi cant milestone

in the fi nancing for developinent process as it emphasizes the need for concrete follow-up actions at all levels

involving different stakeholders for increased mobilization and effective use of resources.

Within the framework of this global initiative, UNDP Philippines supported a national review process of

the implementation of the Monterrey Consensus led by civil society. In partnership with Social Watch Philip-

pines, thematic policy papers covering the six interrelated FfD themes were developed as important policy

instruments of civil society organizations in their effort to engage national government and other stakeholders

to pursue their common goal of generating new and additional resources for the MDGs in the Philippines.

These policy papers build on two UNDP-assisted policy instruments, namely, “Financing the Millennium

Development Goals: The Philippines” that deals with resource gaps and fi nancial requirements to achieve the

MDGs and “Financing Options for the Millennium Development Goals that assesses the feasibility of the

Philippines’ Debt-for-MDGs proposal that aims at generating additional resources for the MDGs.

This body of work is an important contribution to the effort to bring the Philippine civil society agenda to

the mainstream of global discussions on fi nancing for development. I wish to congratulate the Social Watch

Philippines and its partners for spearheading this process and for their excellent contribution to promote multi-

stakeholder partnership under the FfD framework. The commitment expressed to ensure a broad-based process

of fi nancing for development is essential to address long-standing issues of poverty reduction, inclusive growth

and broad-based development in the Philippines.

Renaud Meyer

Resident Representative a. i.

United Nations Development Programme

1FfD: Finance or Penance for the Poor

This volume tackles the major themes that address FfD, specifi cally the generation or mobilization of fi nancial

resources to meet the MDGs. The major themes are: 1) domestic fi nancial resources, mainly tax revenues; 2) invest-

ments (in this case, foreign direct investments); 3) international trade; 4) offi cial development assistance (ODA); 5)

external debt reduction and debt sustainability; and 6) systemic issues.

The themes are broad enough to cover the main sources of FfD. These themes are plausible factors that can

explain growth and development in developing countries.

Nevertheless, we wish to surface some issues or questions that the discerning readers will likely raise in connec-

tion to this volume.

First, notwithstanding the wide scope of FfD instruments, this volume does not tackle all possible sources of

fi nancing. Notably absent is the role of domestic private investments, even though one chapter is devoted to foreign

direct investments.

The question of investments is arguably the key to development itself. Growth, creation of jobs and hence pov-

erty reduction can only happen when investments are healthy and vigorous. Said differently, sustained investments

make the challenge of development less complicated

It can likewise be argued that foreign investments follow the direction of domestic investments. Domestic in-

vestors have better information, are more familiar with the rules of the game, and are more sensitive to the local

norms and therefore can exercise better judgment than foreigners in making business decisions in the home country.

Foreign investors take the cue from them.

Investments are intertwined with many factors, especially those relating to the quality of governance and institu-

tions, macroeconomic policy and management, social norms, and internal peace. A key question is: What animates

the spirits of investors and entrepreneurs? We try to address this question, or at least attempt to provide a frame, in

this introductory chapter, as we emphasize the role of diagnostics in coming out with appropriate interventions.

Second, conceptual problems and questions of interpretation may arise in connecting the six themes enumerated

above to FfD and MDGs. For example, although this volume is essentially about fi nancing to achieve MDGs, this

does not necessarily mean favoring an argument that fi nancing is the principal obstacle to development, at least in

the Philippine context.

This again brings us back to the role of diagnostics to identify what the principal problems are.

INTRODUCTION:

Filomeno S. Sta Ana III

A Frame to Assess Financingfor Development

2 FfD: Finance or Penance for the Poor

Another conceptual problem pertains to the role

of international trade. Indeed, trade generates fi nanc-

es in terms of export earnings and tariffs. But it is, of

course, a narrow conception to look at trade simply

as a means to obtain more fi nancing. An implication

of such a narrow view is to return to purely mercantil-

ist objectives that Adam Smith and his cohorts railed

against. Said another way, trade is not just about the

foreign exchange gains from exports and tariffs from

imports. Neither is it just about consumer welfare

gains. International trade also has a crucial role in

the shaping of a development strategy for long-term

growth, alongside industrial-technological policies

and innovations.

Third, the themes discussed in this volume have

varying degrees of signifi cance at a particular stage of

development. Some might ask why we attach signifi -

cance to, say, ODA or foreign debt, when neither is a

decisive factor at present in igniting growth towards

meeting the MDGs.

William Easterly et al. (2003) raised doubts about

the effectiveness of foreign aid in promoting growth,

although their paper was not an argument against aid.

The skepticism of some economists regarding aid like-

wise concerns its effect on institutions. Richard Pos-

ner, to provide an extreme view, thinks that aid creates

or abets bad government. But his point is disputable,

given the experience of some countries that used aid to

supplement pro-growth, pro-poor policies.

On the other hand, Dani Rodrik wrote a provoca-

tive and penetrating piece on aid as well as on trade,

which is worth quoting (2005):

“Trade and aid have become international buzz-

words. More aid (including debt relief ) and greater

access to rich countries’ markets for poor countries’

products now appears to be at the top of the global

agenda. Indeed, the debate nowadays is not about

what to do, but how much to do, and how fast.

“Lost in all this are the clear lessons of the last fi ve

decades of economic development. Foremost among

these is that economic development is largely in the

hands of poor nations themselves. Countries that have

done well in the recent past have done so through their

own efforts. Aid and market access have rarely played

a critical role.”

To repeat, aid, debt relief, and trade, themes dis-

cussed in this volume, are not the determinants of

long-term growth.

Moreover, amidst the global growth slowdown

arising from the fi nancial crisis, developing countries

cannot expect trade, aid, and debt to serve as growth’s

main engine. The decline of commodity prices, the

weakening of exports, the fl ight of capital away from

emerging economies to reduce risk, the expanding

fi scal defi cit in the rich countries—all this resulting

from the fi nancial meltdown and global economic

slowdown—will exact a toll on developing countries,

especially those that depend on foreign trade, foreign

debt and aid, and foreign investments.

Without going into the details, the chapters on trade,

ODA, and debt offer critical views. The Jessica Reyes-

Cantos paper on trade adopts a broader framework that

goes beyond fi nancing development. Reyes-Cantos,

in fact, argues, that trade policy must be linked to an

agro-industrial development plan, a pitch for industrial

and technology policy. Similarly, the Mario Jose Sereno

chapter on investments recommends “identifying new

technologies for targeting of investments.”

The chapter on ODA written by Eduardo Tadem

makes a “strong indictment of the quality, quantity,

and effectiveness of foreign assistance.” The section

on external debt authored by Joseph Lim points out

the limitations of debt reduction for the Philippines.

Debt reduction has become all the more diffi cult for

the Philippines to obtain not just because we are clas-

sifi ed as a middle-income country but also because of

the perception that debt sustainability is possible, as

shown by the improvement in the fi gures for conven-

tional debt indicators.

The Clarence Pascual paper on OFW remittances

departs from the convention that treats the infl ow of

remittance merely as a relaxation of the foreign ex-

change constraint. Pascual looks at the opportunity

of using the resources from remittances to transform

growth via investments and fi scal spending. This is an

area where innovative policies can be tested.


To revisit Rodrik, his view ”that economic de-

velopment is largely in the hands of poor nations

themselves” can help us think about what domestic

innovations to develop. Rodrik advocates different

recipes for different countries. Thus, taking into con-

sideration the specifi c conditions and identifying the

peculiar problems of a particular country are the fi rst

necessary steps to put in place the appropriate do-

mestic reforms.

In light of the search for domestic innovations, we

need to refl ect on how FfD can be used to meet the

MDGs. To paraphrase Rodrik, development is ulti-

mately not about fi nancing and timetables; it is about

what should be done at a given time. It is not about

“how much…and how fast.”

We ultimately return to the relevance of doing

growth diagnostics and identifying main binding con-

straints. It is for this reason that we open and end this

volume with a discussion of growth diagnostics and

binding constraints.

The correct prescriptions are based on a diagno-

sis of what ails the economy. First off, we must state

that growth diagnostics recognizes that what works for

one country or for a set of countries will not necessar-

ily work for the Philippines. The binding constraints

and the enabling conditions differ from one country

to another.

Until now, some economists and policymakers

drive policy on the basis of their faith in principles.

Trade is welfare-enhancing; hence liberalize trade.

Capital is scarce and must be allocated effi ciently;

hence liberalize capital fl ows.

But a new thinking has emerged in the wake of

the failure of the pro-liberalization Washington Con-

sensus, which was everyone’s blueprint of what ought

to be done.

The new framework—doing diagnostics to iden-

tify the main binding constraints—does not repudi-

ate the core economic principles that the Washington

Consensus transformed into dogma.

Said another way, the fundamental economic

principles are high levels of abstraction. The chal-

lenge is how such abstractions are mapped onto con-

crete country conditions. Take for example the basic

principles of secure property rights and rule of law.

Communist China, the country that has registered

the highest growth rates sustained over a long period

of time, is hardly the model of secure formal property

rights and rule of law. So what explains its growth

despite the weakness of property rights and rule of

law?

One way to look at this puzzle is to examine Chi-

nese innovations in the incentives and institutional

arrangements concerning property rights and rule of

law.

The lesson that we can draw from the failed Wash-

ington Consensus is that a priori prescriptions—a

comprehensive list at that—must be avoided. Simi-

larly, immediately and simultaneously removing all

distortions in the economy or putting in place as many

reforms as possible is an impossible strategy. Some of

the reforms may not be sensitive to the main bind-

ing constraints. Worse, they can even complicate the

problems in the immediate term, thus damaging the

over-all reform process.

The growth diagnostics alternative entails a thor-

ough exercise that pinpoints the main binding con-

straints on growth and identifi es the priority policies

that address the said constraints. The subtext is that

the policy menu is thin.

Analyses and decisions are based on the evidence,

and the different decisions are weighed towards having

a priority.

The diagnostics-and-binding-constraints ap-

proach likewise cautions us not to equate the most

binding constraint with the one that has the biggest

economic distortion. For instance, a tariff on one

good with substitutes creates a signifi cant distortion,

but it does not necessarily have a high impact on so-

cial cost.

In doing growth diagnostics, we are guided by a

decision tree. As we descend from the treetop and

move from one branch to another, we ask the relevant

questions:

Why is growth low or sluggish? Why is there a low

level of investments and entrepreneurship? Does it


stem from low return to economic activity, poor ap-

propriability, or the high cost of fi nance?

If low return to economic activity is the plausible

reason, is it because of low social returns such as poor

education or deteriorating human capital? Or perhaps,

poor infrastructure?

Or is it a case of low appropriability? Which in turn

can be traced to either government failures like wide-

spread corruption and macroeconomic mismanage-

ment or market failures such as access to technology as

well as information and coordination problems.

If on the other hand, low investments originate

from high cost of fi nancing, we need to see whether

international or domestic fi nance is the culprit. It may

be the case that fi nancing is hampered by high inter-

mediation costs or low savings/revenues.

What I have enumerated is actually a sample of the

proximate determinants of growth. This is neverthe-

less a good starting point to lead the inquiry into the

specifi cs of the binding constraints.

The point is diagnostics will lead us to specifi c

variables that constrain growth. This in turn will help

us identify the priority or a narrow set of priorities that

will have the biggest and most direct impact on reliev-

ing the principal binding constraints on growth.

To quote Ricardo Hausmann et al (2005), “the

principle to follow is simple: go for the reforms that

alleviate the most binding constraints, and hence

produce the biggest bang for the reform buck. Rather

than utilize a spray-gun approach, in the hope that

we will somehow hit the target, focus on the bottle-

necks directly.”

Thus, a universal prescription like the Washington

Consensus becomes irrelevant in growth diagnostics.

One will fi nd varying binding constraints and concomi-

tantly differing reforms for similarly situated countries.

The approach of identifying the binding con-

straints has become a fad, and there’s a danger that it

can be applied mechanically. Nevertheless, we do not

lack good examples of how this is done.

In Egypt, a main binding constraint was the inef-

fi ciency of the fi nancial system in allocating savings to

domestic investments (Klaus Enders 2007).

In Brazil, a binding constraint then was the inad-

equacy of domestic savings resulting in high cost of

fi nancing for investments (Hausmann et al 2005).

In Mongolia, the binding constraints included

poor transportation, corruption, distortionary taxes,

and coordination failures (Elena Ianchovichina and

Sudarshan Gooptu 2007).

In Zimbabwe, the binding constraint is obviously

the problem of governance, personifi ed by Robert

Mugabe.

How about the Philippines?A World Bank paper (Alessandro Bocchi 2007)

identifi ed three main binding constraints for the Phil-

ippines, namely: 1) the exchange rate, with the peso’s

appreciation in 2007 (this changed course in 2008

amidst infl ation and global uncertainties) 2) the fi scal

imbalance, and 3) “elite capture.”

The Asian Development Bank study (2007) iden-

tifi ed several critical constraints on Philippine growth

and poverty reduction, namely the fi scal situation,

inadequate infrastructure, governance, expansion and

diversifi cation of industrial base, and equitable access

to opportunities.

The common thread in the ADB and World Bank

studies is their concern about the fragile fi scal condi-

tion and the weakness of governance, manifested in

massive, high-level corruption. And even if the ADB

and World Bank studies use different perspectives,

they are basically in agreement about the weak invest-

ments, which are linked to other policy and institu-

tional variables.

The World Bank and ADB studies are fairly recent

and thus remain instructive, as we cope with the do-

mestic consequences of the crash of the world’s fi nan-

cial markets.

Their studies are likewise highly relevant with re-

spect to the Philippine FfD review. Among the FfD

themes, the mobilization of domestic resources, specif-

ically the improvement of tax effort, appears to be the

most critical issue in relation to the country’s binding

constraints. The chapter written by Leonor Briones is

thus indispensable to this volume.


References

Asian Development Bank (2007). Philippines: Critical Development Constraints. Country Diagnostic Studies,

Economics and Research Department.

Bocchi, Alessandro Magnoli (2007). Rising growth, declining investment: The puzzle of the Philippines.

World Bank.

Easterly, William, Ross Levine, and David Roodman (2003). New Data, New Doubts: Revisiting “Aid,

Policies, and Growth.” Center for Global Development Working Paper No. 26.

Enders, Klaus (2007). Egypt—Searching for Binding Constraints on Growth. International Monetary

Fund (IMF) Working Paper No. 07/57.

Hausmann, Ricardo, Dani Rodrik, and Andres Velasco (2005). Growth Diagnostics.

Ianchovichina, Elena and Sudarshan Gooptu (2007). Growth Diagnostics for a Resource-Rich Transition

Economy: The Case of Mongolia. World Bank Policy Research Working Paper No. 4396.

Rodrik, Dani (2005). The Trade-and-Aid Myth. Project Syndicate copyright.

Furthermore, the FfD is emphatic about the role

of governance and institutions in the developing coun-

tries. Corruption, rent seeking, and elite capture of the

state apparatus are chronic problems in the Philippines

and other developing countries, stunting growth and

development.

We note a tendency among civil society organiza-

tions to blame the rich countries for the misery of

the poor developing countries. How valid or appro-

priate this criticism is will depend precisely on one’s

diagnostics—on a concrete analysis of concrete con-

ditions.


MAY PERA NA BA?MOBILIZING DOMESTIC FINANCIAL RESOURCES FOR DEVELOPMENT

IntroductionThis paper was presented during the National Consultation on Financing for Development on November 21,

2007 organized by Social Watch Philippines.

The 2007 National Consultation was a reprise of the activity SWP organized in 2001 as part of the prepara-

tory process for the FfD Summit in Monterrey, Mexico. The results of the national consultation process among

civil society organizations served as input for subsequent consultations with government, representatives of mul-

tila-teral institutions and the business sector.

The civil society organizations’ proposals were then integrated into the Philippine position on FfD in Mon-

terrey.

The 2007 consultations were considered for the 2008 review of Financing for Development.

May Pera Na Ba?In 2002, the Philippine delegation to the Monterrey Summit committed to generate additional fi nancial re-

sources to fi nance the MDGs as well as other social and economic development goals. The event was witnessed by

civil society organizations from the Philippines, who participated in the NGO parallel summit.

Social Watch Philippines was part of the offi cial delegation. As far as we know, the Philippines was the only

country in the global summit that had civil society representatives in its delegation.

Also in 2002, UNDP Philippines commissioned a study by Rosario Manasan of the PIDS on additional

resources required to fi nance four major goals: education, health, water and sanitation.

As early as 2002, therefore, the government already had data on the magnitude of additional resources needed

to fi nance the MDGs.

In 2006, graduate students of the University of the Philippines National College of Public Administra-

tion and Governance (UP-NCPAG) compared actual budget allocations for the MDG, with the resource

requirements in the Manasan studies, as well as calculations by the government departments themselves. The

studies revealed huge gaps in fi nancing requirements, particularly in education and health. The study, entitled

May Pera Pa Ba? was published with the assistance of U.P. NCPAG and the United Nations Development

Programme.

Leonor Magtolis Briones


In 2007 also, Manasan came out with an updated

study on fi nancial requirements for MDGs. This time,

she added calculations on poverty reduction.

In spite of all the protestations of support for

MDGs, fi nancing remains inadequate. Hence, the

question: May Pera Na Ba?

of the Executive with the financial requirements

for the MDGs. As expected, the financing gaps

were enormous.

The ABI proposed additional expenditures for

health, education, agriculture and the environment.

These were nowhere near the Manasan estimates but

Campaigning for adequate fi nancing: The Alternative Budget Initiative

Civil society organizations led by SWP have

been consistently advocating since 2001 that com-

mitment to MDGs and other development goals has

to be translated into provision of adequate fi nancial

resources.

Upon the suggestion of then Congressman Al-

lan Peter Cayetano, SWP organized the Alterna-

tive Budget Initiative (ABI) in 2006. Twenty-two

civil society organizations and ten congressmen

joined the ABI. They formed technical working

groups and compared the proposed 2007 budget

Table 1. Summary of Resource Gaps in Current Prices, 2007-2015 (in million pesos)(High cost assumption)

Source: Manasan, 2007

the absorptive capacity of the departments had to be

considered, as well as the preferred expenditures of the

CSOs.

As a result of ABI’S advocacy, the budgets for

education and health were increased by PhP5.3 bil-

lion. The proposed increase advocated by ABI was

PhP22 billion.

In 2007, the ABI network proposed an increase

in the 2008 budget by PhP20 billion. The number of

participating CSOs had by then swelled to 48 organi-

zations. It was supported by the minority legislators,

Liberal Party congressmen, as well as senators from

both the majority and the minority.

Year

Resources gaps – MTPDP GDP growth rate

Education HealthWater &

SanitationPoverty

Reduction TotalPercentto GDP

2007 31,966 7,903 367 54,359 94,595 1.39

2008 36,271 8,258 352 53,338 98,219 1.28

2009 44,185 8,631 325 51,265 104,406 1.21

2010 53,326 9,110 305 49,502 112,243 1.16

2011 52,547 9,350 255 39,510 101,663 0.94

2012 50,080 9,680 199 34,552 94,511 0.78

2013 38,658 9,979 129 28,395 77,161 0.56

2014 28,255 10,237 44 20,858 59,394 0.39

2015 13,574 10,455 (58) 11,833 35,804 0.21

2007-2010 165,748 33,902 1,350 208,463 409,463 1.25

2007-2015 348,863 83,602 1,918 343,611 777,995 0.76


At this writing, the General Appropriations Bill

contains additions in social development expendi-

tures amounting to PhP13 billion. The Bicameral

Committee has not yet harmonized the Senate and

House versions.

In spite of the signifi cant gains of the ABI, fund-

ing for the MDGs remains inadequate. Calculations

on fi nancial gaps for social development expenditures

beyond the MDGs are not available.

Seven years after commitments were fervently

made during the Financing for Development

Summit, fi nancing remains an intractable prob-

lem.

Domestic Financial Resource Mobilization: The Philippine Situation

The Monterrey Consensus places great importance

on the mobilization of domestic fi nancial resources

for development, especially the MDGs. Despite im-

provements in domestic resource mobilization, these

have not generated suffi cient resources to match the

massive requirements for development spending. The

Consensus notes “estimates of dramatic shortfalls in

resources require”(para. 2). The Philippines typifi es

this situation.

The Consensus likewise notes that “Each country

has primary responsibility for its own economic and

social development, and the role of national policies

and development strategies cannot be overempha-

sized” (para.6). Thus, greater reliance is on domestic

fi nancial resources than on external sources. It is ex-

pected that the share of revenues as a percentage of

GDP should be signifi cant.

Jens Martens (2007) compares the share of rev-

enues as a percentage of GDP in selected devel-

oping and industrialized countries in 2006. Nine

developing countries indicate ranges of 8.8 per-

cent to 18.0 percent share of revenues. Revenues

generated in the Philippines constituted 14.8 per-

cent of the GDP.

On the other hand, revenues constitute far larger

percentages of the GDPs of industrialized countries.

In Norway for example 49.3 percent of its GDP is

from revenues. In France, revenues account for 43.3

percent of its GDP.

Status of revenue collection in the PhilippinesAt fi rst glance, the revenue picture of the Philip-

pines looks good.

As shown in Table 3 above, tax revenues more

than doubled from 1997 to 2006, from PhP412 bil-

lion to PhP 859.8 billion.

Table 2. Central government revenues as a percentage of GDP in selected countries

Source: World Bank, 2006b, from Jen Martens “The Precarious State of Public Finance”, January 2007, Global Policy Forum Europe.

Country

Share of revenues as a percentageof GDP

Developing Countries

Bangladesh 10.0

China 8.8

Guatemala 10.6

India 12.6

Pakistan 13.8

Philippines 14.8

Peru 16.7

Senegal 18.0

Uganda 12.1

Industrialized Countries

Germany 28.6

France 43.3

Great Britain 36.6

Italy 37.7

Canada 19.9

Netherlands 41.1

Norway 49.3

Austria 38.2

Russia 27.3

Switzerland 19.4

USA 17.2


On the other hand, non-tax revenues likewise

doubled from PhP59.6 billion to PhP119.7 billion.

The defi cit is apparently going down. Neverthe-

less, it must be emphasized that the expenditures

shown in the table include only debt service pay-

ments. Principal payments on debt are not included.

Thus actual cash payments are much larger than the

expenditures since the former include payments for

principal.

At the end of the day, however, the question is:

Revenue may have increased and the defi cit may have

been apparently reduced, but is this enough to fund

development expenditures, particularly the MDGs?

Actual vs. programmed collectionIt has been shown earlier that revenues in the

Philippines constitute only a small part of the GDP,

compared to other developing countries as well as

the industrialized ones. An examination of the actual

revenue collection vs. programmed revenues shows

signifi cant shortfalls.

From January to September 2007 for example,

shortfalls in tax collections reached PhP56.02 bil-

lion. The Bureau of Internal Revenue (BIR) had an

accumulated shortfall of PhP44.982 billion while

the Bureau of Customs (BOC) had a shortfall of

PhP12.031 billion. Ironically, during a period when

the government was rejoicing in a hefty GDP growth

rate for the fi rst half of 2007, revenue shortfalls were

building up.

The shortfalls are even more evident in the

monthly collections. As can be seen in Table 5 BIR

had a shortfall of PhP4.566 billion for the month

of September alone. The defi cit was controlled by

increases in the income of the Bureau of the Trea-

sury (BTr), privatization and underspending of pro-

grammed expenditures.

Revenue and tax effortThe Department of Finance (DOF) has reported

that since 1997 revenue and tax efforts have been

steadily going down. In 1997, revenue effort stood

Table 3. Status of revenue collection

Source: Department of Finance

NATIONAL GOVERNMENT REVENUE COLLECTIONSIn million pesos

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

TOTAL REVENUES 471,843 462,515 478,512 514,762 567,481 578,406 639,737 706,718 816,159 979,638

Tax Revenues 412,165 416,585 431,686 460,034 493,608 507,637 550,468 604,963 705,615 859,857

Bureau of Internal Revenue 1/ 314,697 337,175 341,319 360,802 388,679 402,742 427,350 470,329 542,697 652,734 Bureau of Customs 1/ 94,800 76,005 86,497 95,006 99,981 99,322 117,201 127,269 154,566 198,161 Other Offi ces 2,668 3,405 3,870 4,226 4,948 5,573 5,917 7,366 6,352 8,962

Non-Tax Revenues 59,678 45,930 46,816 54,728 73,873 70,769 89,269 101,754 110,544 119,781

BTr Income 35,352 22,535 26,180 30,764 46,413 47,194 56,657 64,690 70,597 74,446 Others 13,160 21,046 16,021 17,936 24,296 21,932 30,647 36,570 37,429 39,337 o.w. Fess and Charges 13,160 21,046 16,021 17,936 24,296 21,932 16,635 19,574 19,235 16,761 Privatization 9,428 1,717 4,183 4,646 1,173 591 567 420 2,430 5,815 CARP 236 140 6 Foreign Grants 1,738 396 292 1,376 1,991 1,052 1,198 74 88 183 ESF Proceeds Domestic Grants Sale of PNB Share

TOTAL EXPENDITURES 2/ 470,279 512,497 590,160 648,974 714,504 789,147 839,605 893,775 962,937 1,044,429

OVERALL SURPLUS (DEFICIT) 1,564 (49,982) (111,658) (134,212) (147,023) (210,741) (199,868) (187,057) (146,778) (64,731)% of GDP 0.1% -1.9% -3.8% -4.0% -4.0% -5.3% -4.6% -3.8% -2.7% -1.1%

Memorandum Items:1/ Includes noncash collections2/ Includes noncash subsidy


Table 4


Table 5



Variance

Jan-Sep 2006 Jan-Sep 2007 vs 2006 vs 2007 Growth Rate Actual Program Actual Actual Program In (%)

REVENUES 715,889 836,978 812,257 96,368 (24,721) 13.5% Tax Revenues 633,873 738,995 682,975 49,102 (56,020) 7.7% BIR 48,755 566,902 521,920 41,165 (44,982) 8.6% BOC 145,818 164,988 152,957 7,139 (12.031) 4.9% Other Offi ces 7,300 7,105 8,098 798 993 10.9% Non-Tax Revenues 82,016 97,983 129,282 47,266 31,299 57.6% BTr Income 50,752 43,656 57,201 6,449 13,545 12.7% Fees & Charges 30,084 29,034 29,560 (524) 526 -1.7% Privatization 1,090 25,293 42,393 41,303 17,100 3789.3% Grants 90 0 128 38 128 42.2%

EXPENDITURES 766,298 890,953 852,267 85,969 (38,686) 11.2% o.w. Interest Payments 254,450 246,595 222,689 (31,761) (23,906) -12.5%

SURPLUS (DEFICIT) (50,409) (53,975) (40,010) 10,399 13,965 -20.6%


Variance

Sep 2006 Sep 2007 vs 2006 vs 2007 Growth Rate Actual Program Actual Actual Program In (%)

REVENUES 73,648 80,623 80,890 7,242 267 9.8% Tax Revenues 59,966 73,463 68,936 8,970 (4,527) 15.0% BIR 42,766 53,495 48,929 6,163 (4,566) 14.4% BOC 16,501 19,042 19,062 2,561 20 15,5% Other Offi ces 699 926 945 246 19 35.2% Non-Tax Revenues 13,682 7,160 11,954 (1,728) 4,794 -12.6% BTr Income 4,293 4,058 8,601 4,308 4,543 100.3% Fees & Charges 9,152 3,102 3,134 (6,018) 32 -65.8% Privatization 1,090 25,293 42,393 41,303 17,100 3789.3% Grants 14 0 3 (11) 3 -78.6%

EXPENDITURES 89,877 97,675 95,411 5,534 (2,264) 6.2% o.w. Interest Payments 33,042 29,125 30,174 (2,808) 1,049 -8.7%

SURPLUS (DEFICIT) (16,229) (17,052) (14,521) 1,708 2,531 -10.5%


at 19.4 percent. By 2006 it had gone down to 16.2

percent. For the same year, tax effort was at a high

of 17.0 percent. By 2006, it had gone down to 14.3

percent.

Obstacles to Increased Domestic Resource MobilizationRegressive tax system

The Philippine Constitution provides for a pro-

Table 6. Revenue & Tax Effort


Table 7. Revenue & Tax Effort (CY 1986-2006)


Revenue and Tax Effort

Revenue Effort Tax Effort BIR Tax Effort BOC Tax Effort

198619871988198919901991199219931994199519961997199819992000200120022003200420052006

S1 2007

13.0%15.1%14.1%15.5%16.9%17.7%19.9%

Revenue Effort Tax Effort BIR Tax Effort BOC Tax Effort

19861987198819891990

13.0%15.1%14.1%16.5%16.8%

10.8%12.6%11.3%13.2%14.1%

7.7%8.6%8.0%8.9%9.7%

2.9%3.8%3.1%4.1%4.3%

19911992199319941995

17.7%18.0%17.7%19.9%19.0%

14.6%15.4%15.6%16.0%16.3%

9.3%9.9%

11.1%9.9%

11.0%

5.2%5.4%5.6%4.8%5.1%

19961997199819992000

18.9%19.4%17.4%16.1%15.3%

16.9%17.0%15.6%14.5%13.7%

12.0%13.0%12.7%11.5%10.8%

4.8%3.9%2.9%2.9%2.8%

20012002200320042005

15.6%14.6%14.8%14.5%15.0%

13.6%12.8%12.8%12.4%13.0%

10.7%10.2%9.9%9.7%

10.0%

2.8%2.5%2.7%2.6%2.8%

2006S1 2007

16.2%16.3%

14.3%13.8%

10.8%10.7%

3.3%2.9%

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Revenue Effort

Tax Effort

BIR Tax Effort

BOC Tax Effort

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%


gressive system of taxation. This means that there

should be higher dependency on direct taxes like in-

come and property taxes, than on indirect taxes like

the value-added tax (VAT). The situation has been

exacerbated by the increase of VAT from 10 percent

to 12 percent.

Collections from direct taxes are not high enough.

The level of ineffi ciency and leakages in the collec-

tion of direct taxes is appalling. Income taxes, for

example, lend themselves to bargaining and negotia-

tion between the tax collector and the taxpayer.

The trend among many countries is to rely on

indirect taxes as major sources of revenue. These are

convenient and administratively easier to collect.

However, in countries like the Philippines which are

plagued with massive levels of inequality, indirect

taxes place the burden of taxation on the lower in-

come levels of society.

The problem of incentivesThe Philippines adopted the policy of attracting

foreign investments much earlier than other develop-

ing countries. As early as the 1960s, laws and policy

declarations encouraging direct investments were

already passed. Then followed a series of laws and

presidential decrees creating export processing zones,

which granted more incentives and facilitated the en-

try of more investments.

The major policy strategy adopted was to offer

tax holidays, tax incentives and other perks to lure

investors to the country. As expected, policymakers

went overboard in their enthusiasm and eagerness.

Foregone revenues far outweighed expected benefi ts.

Government policymakers tend to have con-

fl icting views on the matter of incentives. The De-

partment of Trade and Industry (DTI) and related

agencies tend to advocate incentives to strengthen

the competitive edge of the Philippines over other

countries.

Congress likewise has the propensity to offer in-

centives. This is not surprising given the active lob-

bying by the private sector. Furthermore, many law-

makers are linked to private business.

On the other hand, the DOF has been consistently

calling for the rationalization of fi scal incentives. The

department has been under tremendous pressure to in-

crease levels of revenue collection. This is the preferred

approach to defi cit reduction.

Whatever revenue increases attained by the DOF

are eaten up by foregone taxes and other income due

to the proliferation of incentive schemes.

Two Studies on Incentives

What is the impact of incentives on investments

in the Philippines? Two studies shed light on this

question. These are Investment Incentives and FDI:

The Philippine Experience by Rafaelita M. Aldaba

(2006) and Towards Rational Fiscal Incentives by Re-

nato E. Reside (2006).

The Aldaba study concluded that tax incentives

were not able to compensate for the relatively weak

fundamentals and poor investment climate. It also

cited an obvious effect, that tax incentives have a di-

rect negative effect on revenues, even as some address

the need to reduce economic distortions.

On the other hand, Reside concluded that a large

amount of incentives which the Philippine govern-

ment provides are largely redundant. These are given

to fi rms which would have invested anyway even

without them.

There are two major reasons. The fi rst is that by

international and even domestic standards, many

fi rms were found to have high rates of return even

before receiving incentives. The second is that large

numbers of fi rms in the Philippines have low sensi-

tivity to fi scal incentives.

Reside estimated that the cost of redundant fi scal

incentives in 2004 amounted to PhP43.2 billion for

Board of Investments (BOI) alone. This estimate did

not include other institutions like the Philippine Export

Processing Zone, Clark Development Corporation, and

Subic Bay Metropolitan Administration.

Tax incentives and the poor

A major issue involving tax incentives is its im-

pact on government services to the poor. Leading


economist Felipe Medalla pointed out that due to

the high cost of collecting taxes, a peso gained by big

investors from tax incentives could be equivalent to

as much as two pesos worth of foregone spending for

infrastructure and social services for the poor. Stud-

ies by Rosario Manasan of the Philippine Institute

of Development Studies showed that MDG-related

services are clearly underfunded. Reside also empha-

sized that the poor and middle-class tax payers bear

the brunt of the fi scal cost of incentives.

A study by Roel Landingin of the Philippine Cen-

ter for Investigative Journalism (PCIJ), Tax Incen-

tives for the Rich are Harming the Poor (August 14,

2006), dealt with the issue of incentives and the poor.

Landingin cited an earlier PCIJ study which revealed

that “companies availing themselves of incentives for

the biggest projects with the BOI are also among the

country’s largest and most profi table, and belong to

its wealthiest and powerful families.”

According to Landingin, “of the 10 companies

that registered the biggest projects, seven are owned,

controlled or run by some of the Philippines’ best

known family-based conglomerates such as the Lo-

pezes, Ayalas, Gokongweis and Cojuangcos. Mayni-

lad Water Services Inc., the joint venture set up by

the Lopezes with the French engineering group Suez,

topped the list. The Ayalas’ Manila Water Co., a joint

venture with the United Utilities of UK, was No. 3,

while the family’s telecommunications unit, Globe

Telecoms, was No. 8. The Gokongweis also had two

companies in the top 10 list: Digitel Telecommunica-

tions Inc. and JG Summit Petrochemicals Inc. “

The study clearly showed that benefi ciaries of tax

incentives don’t need them at all. On the other hand

shortfalls in revenues resulted in less spending for so-

cial development, particularly the MDGs.

The Global View on Incentives

In 2006, I was invited to be part of an experts’

panel at the World Economic Forum in Davos,

Switzerland. The speakers differed in their views

about the need for foreign investments in develop-

ing countries and their impact. However, they were

one in agreeing that incentives are not the most im-

portant criteria for attracting foreign investments.

Even more important are: a level playing fi eld, pre-

dictability in government regulations, good gover-

nance, adequate infrastructure and absence of graft

and corruption.

Panel members gave examples of countries which

attract foreign direct investments without necessar-

ily granting costly and redundant incentives. The

panel also noted the effects of destructive competi-

tion among developing countries to grant the most

attractive incentives and perks. It was also noted

that competition in tax incentives also takes place

among local government units as they fi ercely fi ght

each other in attracting businesses to their respec-

tive localities.

Problems in Tax and Non-Tax Administration

As in other countries, there are two major revenue

collection agencies of the government: the Bureau of

Internal Revenue or BIR, and the Bureau of Customs.

Non-tax revenue is collected by different agencies,

like fees and licenses and registration of vehicles.

The two agencies are part of the Department of

Finance. However, the Executive takes a direct inter-

est in the two bureaus, particularly in the appoint-

ment of offi cials. Usually, there is intense jockeying

for plum positions in tax-rich regions with the pro-

tagonists going directly to the president for interven-

tion. For decades, the impression was that the BIR

was directly under the president. One Secretary of

Finance only agreed to accept the position on con-

dition that the president should not interfere in the

appointment process and the management of the

Bureau.

Obviously, the choice of the heads of these two

agencies is critical to the effectiveness of revenue col-

lection efforts.

Through the years, there have been efforts to un-

dertake a thorough-going reorganization of the two

bureaus, particularly the BIR. Proposals have been

made to convert the latter into an autonomous cor-

poration, subject to stringent selection criteria on the


matter of personnel, operating on strictly business

procedures, and protected from political pressures.

Commissioners have come and gone with changes in

administrations but efforts at reorganization have not

gotten off the ground.

Tax reform programs have been initiated as well.

When reforms are introduced, it is expected that rev-

enue collections will duly increase. Strangely, it has

been observed that when reforms are introduced, col-

lections tend to fall below programmed levels.

The success of tax reform programs hinges largely

on how these are managed. Economist Benjamin

E. Diokno studied the implementation of two tax

reform programs: the 1986 Tax Reform Program

and the 1997 Comprehensive Tax Reform Program

(CTRP). Diokno elicited lessons from the two experi-

ences: First, these should be done at the start of a new

administration. Second, these should be presented as

a critical component of a comprehensive public sec-

tor program. Third, in an environment where timely,

upward, adjustment in existing tax rates is diffi cult to

legislate, ad valorem taxation should be preferred to

specifi c taxation. Fourth, successful reforms require

broad political support. Fifth, and most important,

the President must have the political will to do what

is best for the country (Diokno 2005).

Revenue administration and the cancer of bureaucratic and systemic political corruption

The Philippine public administration system has

been consistently identifi ed as one of the most cor-

rupt in Asia.1 Surveys of international investors con-

sider corruption as the most problematic factor for

doing business in the Philippines.2

Corruption is perceived to be rampant in the two

leading tax agencies of the Department of Finance:

the Bureau of Internal Revenue and the Bureau of

Customs. They are rightly or wrongly referred to as

“fl agships of corruption.” Corruption at the level of

the tax collectors results in legitimate tax revenue

being channeled to private hands. As a cynical joke

goes, “the tax collector gets the tax while the govern-

ment gets the commission.”

In countries like the Philippines where billions

of pesos have been lost to large-scale, comprehensive

and systemic corruption, the recovery of ill-gotten

wealth would contribute substantially to fi nancing

for development. For example, the ill-gotten wealth

of the late President Ferdinand E. Marcos which was

spirited out of the country is calculated conservative-

ly at US$5 billion. The entire amount has not been

fully recovered, even as the Presidential Commission

on Good Government (PCGG) was created precisely

to recover stolen wealth.

Corruption in revenue administration cannot be

separated from comprehensive corruption occurring

at the highest political levels. The government has

set up a PhP1 billion anti-corruption fund. Agencies

that are supposed to be corruption-prone are the fo-

cus of this campaign.

The issue of corruption in the tax collection agen-

cies is only part of the over-all climate of corruption

in the governance system.

Corruption is indeed chronic in the Philip-

pines. The World Bank and ADB, for example,

have expressed concern over corruption issues.

They have noted that the Philippines has a low

global ranking in relation to controlling corrup-

tion. Vietnam and Indonesia—countries in the

region perceived to be the most corrupt—are in

fact faring better with regard to recent efforts to

control corruption.

1 In the World Bank study An East Asian Renaissance: Ideas for Economic Growth by Indermit Gill and Homi Kharas (2007:p.319) the Philippines is ranked as “highly corrupt” in its corruption perception index. Numbers for 2005 are higher than those for 1995 and

2000. The Control of Corruption index for 1996-2004 also shows weaker control of corruption in 2006 compared to 2004. The above is corroborated by later fi gures (2007) cited by UNDPin Tackling corruption, changing lives (2008:p.189). The same trend is indicated. In 2007, Transparency International ranked the Philippines No. 131 where No. 1 is considered the cleanest. In 2008, the Philippines’ rank moved farther down to No.141. (Source: Transparency International Corruption Perception Index 2007 & 2008, http://www.transparency.org/policy_research/surveys_indices/cpi/2008).

2 The International Countries Risk Guide (ICRG) by Political Risk Services caters to the business sector . As cited by UNDP, levels of corruption as measured by ICRG worsened from 1996 – 2006. (Source: UNDP, Tackling corruption, changing lives, 2008).


The World Bank believes that better governance,

which includes reducing corruption, is a key to sus-

taining growth and improving lives. To quote the

World Bank (2007): “Curbing corruption, reducing

politically motivated public spending, and overcom-

ing ‘regulatory capture’ will all be essential for trans-

lating recent economic gains and strong fi scal perfor-

mance into sustained high growth. The effectiveness

of institutions that manage public funds, those that

regulate key sectors and oversee public-private part-

nerships in infrastructure will determine the future

direction of the Philippine economy.”

The ADB has a similar message. To quote ADB

(2007), “the perception of worsening corruption fi g-

ures signifi cantly in an explanation of the investment

rate, which may partly explain the downturn in in-

vestment in recent years.”

And so, corruption has a negative effect on the

domestic mobilization of resources not only in terms

of revenue effort but also in terms of attracting in-

vestments.

Recommendations for FfDFor governments

Implement the constitutional mandate

on a progressive system of taxation.

The Philippines has had fi ve Constitutions. Each

Constitution has always advocated uniform and eq-

uitable systems of taxation. Article VI, Sec. 28 (1)

clearly states that “The rule of taxation shall be uni-

form and equitable. The Congress shall evolve a pro-

gressive system of taxation.”

The Constitution mandates a progressive system

of taxation. Nonetheless, indirect taxes which are re-

gressive have always accounted for a greater part of

tax collections for decades. When tax reforms are

introduced there is a marked preference for indirect

taxes. This is exemplifi ed by the recent decision of the

government to increase the VAT rate from 10 percent

to 12 percent.

The argument that increased collections from

VAT will go to expenditures for the poor has been

put forward, not only by policymakers, but by econ-

omists as well. It must be emphasized, however, that

that VAT collections directly go to the General Fund

which covers all expenditures under the sun—mili-

tary spending, congressional pork barrel, subsidy

to government corporations, etc. Historically, gov-

ernment spending for social development is much,

much lower than needed fi nancial resources .

The increase in VAT rate has served to exacerbate

the government’s extreme reliance on indirect sources

for fi nancing. It has worsened the regressive nature of

the tax system. It is time that a serious effort be made

to correct this inequituous arrangement.

Strengthen collection of non-regressive

sources of revenue.

The income tax is recognized as a progressive

tax. It is assumed that those who have higher in-

comes pay higher taxes than those with lower in-

comes. However, it is widely known that most of

the loopholes in tax collection are in the income tax.

It is also taken for granted that much negotiation,

bargaining and bribery take place in the computa-

tion of income taxes.

Even the innocuous community tax certifi cate

(CTC) is also plagued with loopholes. Understate-

ment of income is more common than declaration of

true income in the case of the CTC. The same goes

for real property tax.

Calculations of tax revenue lost in income taxes run

to billions. Analysts have pointed out time and again

that it is not necessary to impose new taxes. What is

needed is to correctly implement present tax laws.

Reduce or eliminate redundant and

unnecessary tax incentives.

So many studies have shown that what we col-

lect in taxes, we also lose signifi cantly in incentives.

In another study on tax incentives, Roel Landingin

reported that it takes one Makati BIR district offi ce

one year to collect PhP13billion in taxes. However,

it took another government offi ce, the Board of In-

vestments just 14 days to decide to grant the same

amount in tax exemptions to two very profi table


companies, Globe Telecom, Inc. and Smart Commu-

nications, Inc.

For once, the economic managers should come to

an agreement on the matter of incentives. One hand

takes while the other gives away.

Support proposals for Alternative Budget

Initiative/Social Watch Philippines.

The Alternative Budget Initiative (ABI) con-

vened by Social Watch Philippines began in 2006. It

started with 22 CSOs and 10 legislators. At present,

it is composed of 48 CSOs and many more legisla-

tors. The alternative budget does not only propose

increased levels of allocations for MDG-related

expenditures. It also identifi es possible sources of

MDG funding by reallocating expenditures pro-

posed by the executive that are vague, overlapping

and unnecessary. It has also identifi ed debt service

payments for debts which can be subject to renego-

tiation and deferment.

For the international community

Many of the problems of individual countries in

fi nancing for development can be traced to the inter-

national fi nancial system. No one developing country

can solve them on its own. The following can be con-

sidered by the international fi nancial community:

Consider lasting solutions to the debt problem,

including those of middle-income countries.

The need for lasting solutions to the debt problem

is recognized as one of the Millennium Development

Goals. It is rightly included in the goal for building

partnership among countries. During the Monterrey

Summit, debt was also recognized as one of the major

problems in fi nancing for development.

Social Watch Philippines has consistently empha-

sized that the resolution of the global debt problem

will free huge amounts of fi nancial resources for de-

velopment. It has also advocated debt relief not only

for the least developed countries but also for middle-

income developing countries that have been devas-

tated by natural calamities like tsunamis, earthquakes

and typhoons. These would include countries like Sri

Lanka, Indonesia, Philippines, etc.

A paper prepared by Joseph Lim for the UNDP

proposes debt relief for middle-income countries

whose capacity to fi nance MDGs would be severely

compromised by heavy debt burdens.

The ABI proposed the recalculation of the inter-

est for debt service based on current exchange rates.

At the same time, it included debts which can be

deferred, renegotiated or even cancelled. These debts

were identifi ed by Freedom from Debt Coalition, a

member of the ABI.

Exert stronger international pressure

on tax havens and laundry republics.

There are countries which serve as tax havens. At

the same time, there are those whose banks serve as

depositories for money generated from corruption in

developing countries. The veil of secrecy is nearly im-

possible to penetrate. Funds deposited by high offi -

cials of developing countries fi nd safe haven in banks

which guarantee secrecy.

These countries have acquired a reputation for ac-

cepting ill-gotten wealth with no questions asked.

Censure or sanction misbehaving players

in international fi nance.

The competition among countries on incentives

has become a race to the bottom. Developing coun-

tries fi ercely compete with each other in giving the

lowest possible tax rates and the highest levels of in-

centives. These practices can only harm host coun-

tries and benefi t foreign investors who seek the best

bargains.

The net result is that host countries give away tax

revenues with one hand even as they borrow heavily

to cover fi nancial shortfalls.

It is time such practices were discussed on a re-

gional or on a global scale.

Support efforts to recover and repatriate stolen wealth.

During the 1970s and 1980s African and Asian

dictators were known to have opened accounts in


European countries and other well-known havens.

Recovery of these fi nancial assets has largely been

unsuccessful.

In the case of the ill-gotten wealth of former

President Ferdinand Marcos, part of the loot was re-

covered because documents were left behind when

he and his family fl ed in haste to Hawaii. In normal

circumstances, establishing a paper trail and piercing

the layers of veils protecting these deposits would

have been next to impossible.

A major roadblock is the fact that the laws of a

depository country are designed to protect its banks.

Going back to the Marcos ill-gotten wealth, although

part of it has been recovered, it is believed that a great-

er part of the US$5 billion believed stashed abroad is

safely out of the reach of the Philippine government.

A developing country cannot wage an extremely

complicated international legal battle without inter-

national support.

Encourage sharing and exchange of experience,

including technical assistance for alternative budget

initiatives or participatory budgeting.

Participatory budgeting is gaining ground in

a growing number of developing countries. Vary-

ing degrees of success have been reported in Africa,

Latin America and Asia. The Philippine experience

is very interesting since it involves support from the

legislators. These experiences deserve to be shared

with other developing countries that want to learn

lessons from those who have initiated participatory

budgeting.

Continue the study and development of international

taxes which can generate huge amounts of fi nancing

for development.

For nearly 30 years now, taxes on global commons

have been studied and discussed as a rich source of

funding for development. Recently, civil society or-

ganizations have come up with proposals for airline

taxes which can be imposed on international travel-

ers. Studies have shown that this is an international

tax with immense possibilities since millions of peo-

ple travel around the world everyday.

ConclusionThis paper has endeavored to show the impor-

tance of generating more fi nancial resources for

development. It has shown that in the case of the

Philippines, the Millennium Development Goals

remain severely underfunded. Underfunding for

other economic and social development goals is just

as severe.

The paper has pinpointed problems in tax admin-

istration and tax policy. The matter of tax perks and

incentives was treated extensively.

At the same time, the paper has identifi ed the

heavy debt burden and high levels of corruption as

among the constraints to adequate fi nancing for de-

velopment.

Finally, the paper has addressed recommenda-

tions to the government and the international com-

munity.

Nevertheless, some problems are linked to the

international fi nancial system. International ac-

tion is needed to handle the problem of tax havens,

countries which accept corrupt money deposited

in their banks, and laws which protect the inter-

est of tax havens and depositors of ill-gotten wealth

more than the interest of peoples of the developing

world.

As part of the international advocacy, global taxes

should be explored.

The problems discussed here are nothing new.

Some of the proposed solutions have been around

for 30 years. Studies conducted in other countries

have come to the same conclusions and proposed

similar recommendations. For example, Jens Mar-

tens of the Global Policy Forum has proposed no

less than 17 steps which can be undertaken towards

global tax justice and eco-social fi scal reforms. Most

of his proposals resonate in the Philippine situa-

tion.

The point, however, is to act on them.


Aldaba, Rafaelita (2006). FDI Investment Incentive System and FDI Infl ows : The Philippine Experience,

Discussion Paper Series No. 2006-20, Philippine Institute for Development Studies, November.

Asian Development Bank (2007). Philippines: Critical Development Constraints. Prepared by the Economics

and Research Department as part of its Country Diagnostics Studies.

Diokno, Benjamin (2005). Reforming the Philippine Tax System: Lessons from Two Tax, Discussion Paper

No. 0502, School of Economics, University of the Philippines, March.

Landingin, Roel (2006). Tax incentives for the rich are harming the poor, Manila Standard, 14 August.

Manasan, Rosario (2007). Financing the Millennium Development Goals: The Philippines.

A Philippine Institute of Development Studies (PIDS) paper funded by the United Nations Development

Programme.

______________ (2002). Explaining the Decline in Tax Effort, PIDS Policy Notes No. 2002-14, December.

Martens, Jens (2007). The Precarious State of Public Finance, Global Policy Forum Europe, January.

Reside, Renato, Jr. (2006). Towards Rational Fiscal Incentives: Good Investments or Wasted Gifts?, EPRA

Sector: Fiscal Report No.1, 7 June.

United Nations Development Programme (2004). Indonesia: Progress Report on the Millennium

Development Goals, February.

World Bank (2007). Higher Quality Public Spending, Credible Regulatory Institutions

Matter for Growth and Poverty Reduction. Series #: 07/15. http://www.worldbank.org.

ph/WBSITE/EXTERNAL/COUNTRIES/EASTASIAPACIFICEXT/PHILIPPINESEXTN/

0,,contentMDK:21216287~menuPK:332988~pagePK:1497618~piPK:217854~theSitePK:332982,00.

html.

References


I. IntroductionForeign Direct Investments (FDI) are viewed as a signifi cant source of fi nancing for development. While

through the years the majority of FDI fl owed to countries already considered developed, a substantial and

growing FDI stocks have found their way to developing countries, which gear their economies and invest-

ment promotion activities towards attracting foreign investments. From a slow and steady growth through

the 1980s and tremendous increases in the 1990s, FDI global infl ows peaked at over US$1.4 trillion in 2000.

Total FDI infl ows however declined to only about U$560 million in 2003, possibly as a result of the global

slowdown that followed the 9/11 tragedy in 2001, before recovering to reach its second highest level of over

US$1.3 trillion in 2006.

Foreign Direct Investments Policy:A Closer Look at Assumptions in theContext of Philippine Constraints

Source: World Investment Report 2007, UNCTAD and FDI/TNC database (www.unctad.org/fdi statistics).

Figure 1. FDI infl ows, global and by group of economies, 1980-2006 (Billions of dollars)

* Disclaimer: The views expressd in this paper are the views of the author and do not necessarily refl ect the views or policies of his institutional affi liations.

Mario Jose E. Sereno


The Monterrey Consensus considers the mobili-

zation of FDIs as vital to the development agenda of

reducing poverty and sustaining economic growth.

Traditionally, FDIs are viewed as effective means

to enhance economic activities in the host country,

provide jobs, upgrade skills and the level of technol-

ogy and generally uplift the standard of living of the

host country. The conditions identifi ed to attract

and enhance FDIs are deemed to consist principally

of a “transparent, stable and predictable investment

climate, with proper contract enforcement and re-

spect for property rights.” How various countries

position themselves through the employment of

varied tools of FDI attraction and maintenance

has been the subject of numerous economic studies

involving, among others, comparative investment

incentives regulation. The Philippines itself is cur-

rently undertaking a review of its own framework

through the proposed Fiscal Incentives Rationaliza-

tion bills.

There is, however, a spirited debate on whether

FDIs do indeed promote development. Diffi culties in

measuring the benefi cial as well as the adverse effects

of FDIs have resulted in confusing and sometimes

contradictory research fi ndings. While some studies

show a positive correlation between the volume of

FDIs and economic growth or between FDI spillover

effects and economic development, the existence of

studies pointing to contrary conclusions has made it

unclear whether devoting substantial resources to at-

tracting FDIs actually benefi ts developing countries.

In sorting through the myriad of research output and

methodologies, the book Does Foreign Direct Invest-

ments Promote Development? (Moran, Graham and

Blomström 2005) holds the position that “the search

for a ‘universal relationship’ between inward FDI

and host country economic performance” is futile.

That position does not negate, however, the need for

deeper research analyses characterized by identifying

the effects of different “types” of FDIs (as in export-

oriented vs import-substituting investments), and

the economic confi guration of the hosting country

within which they operate.

Some of the book’s policy recommendations are

noteworthy but need to be further dissected for ap-

plicability to a specifi c host country in their original

or modifi ed form. One advice generally states that

“in countries with protected and distorted econo-

mies, FDI is harmful to economic welfare.” This

may have been concluded by the book due to ob-

servations that FDIs geared towards serving the lo-

cal market of some host country ultimately merely

compete with local producers for domestic rents.

The necessary progression of this simplistic state-

ment is that openness in both trade and investment

policies needs to be simultaneously pushed in or-

der to maximize the benefi ts from investing foreign

fi rms and avoid higher trade costs. Because the Phil-

ippines has historically adopted an export-oriented

strategy in attracting FDIs and has consequently

established various export processing enclaves that

effectively are duty-free, the possible adverse effects

and operational ineffi ciencies that result from po-

tentially higher trade costs are avoided. The applica-

bility of the book’s conclusion therefore can be put

to question in the case of the Philippines. However,

other operational considerations for special eco-

nomic zone (SEZ) locators and the impact of allow-

ing export-oriented locators to sell in the domestic

market may affect the assessment of the net benefi ts

of the type of investment/trade regime adopted by

the Philippines.

Another policy recommendation of the book

consists of prohibiting domestic content, joint ven-

ture or technology sharing requirements on foreign

investments as these hinder intra-fi rm trade of mul-

tinational companies operating a global supply net-

work. While this recommendation suits and is desir-

able for FDIs that are part of a global supply chain,

a complete prohibition of such provisions to dis-

crete enterprises may also limit the creation of link-

ages to domestic suppliers and hinder technological

spillover effects on the host economy. Economic

history is full of examples that show how countries

succeeded in achieving a higher level of sustained

development by using investment measures requir-


ing local content, technology transfer and other per-

formance requirements. In a more recent develop-

ment, Brazil and India submitted communication

to the World Trade Organizations (WTO) calling

for a review, with the intention of amending, certain

provisions in the Trade Related Investment Measures

(TRIMs) Agreement to provide greater fl exibility for

developing countries to compel technology transfer,

the utilization of domestic inputs and programming

for backward linkages to the local economy in invest-

ment policy decisions. After citing new evidence and

developments that undermined the theoretical argu-

ments supporting the prohibition of investment mea-

sures in the areas of technology, competition policy,

regional development policy and the environment,

among others, Brazil and India argued that “…The

disciplines of the TRIMs Agreement disregard the

above structural inequalities among Members and,

apart from already concluded transitional periods,

incorporate no specifi c meaningful clauses for special

and differential treatment. The absence of effective

and operative clauses aiming at addressing the special

needs of developing countries has made the TRIMs

Agreement one example of reverse special and dif-

ferential treatment. While developed countries had

decades to choose when, how and in which economic

sectors to apply such measures, developing countries

had their right to choose simply revoked.”

A fi nal advice to developing countries is to “avoid

competing to give the best tax incentives to foreign

investors.” The authors believe that resources for

promoting investment are more effectively spent on

“improving local infrastructure, the supply of infor-

mation to investors and education and training that

benefi ts foreign and local fi rms alike.” This advice

can be most relevant to Philippine policymakers at

this time. While competition for FDI among devel-

oping countries has been characterized by some to be

a “race to the bottom,” a critical review taking into

account the types and business models of various po-

tential FDI should be carefully done to synchronize

the development needs of the country with the re-

sources allocated to attracting the desired FDI.

II. Philippine Investment Climate - StatutesIn the Asian Development Bank (ADB) report

entitled Improving the Investment Climate in the

Philippines (2005) it was observed that while the

Philippines was among the more “prominent glo-

balizers” during the 1990s, its economic growth

lagged considerably behind those of neighboring

economies particularly China (PRC), India and

Thailand. The accelerated pace and sequence of

liberalization steps the Philippines undertook dur-

ing this period may have something to do with this

comparatively dismal performance, which can lead

to the conclusion that “while openness to foreign

trade and investment is important, it is not suf-

fi cient for sustained GDP growth.” The fi ndings

of the report pointed to poor investment climate

which limited capital formation, productivity im-

provements and the competitiveness of fi rms, as

major reasons for the anemic growth of the Philip-

pine economy over the past two decades. A study

of the various factors that make up the investment

environment consisted mainly of three broad sets of

infl uences, namely macro fundamentals, infrastruc-

ture, and governance and institutions.

This paper does not attempt to present a detailed

analysis of what troubles Philippine attractiveness to

foreign investors. Rather, it hopes to present an over-

view of the Philippine investment promotion regime

through its statutory framework, a comparative per-

formance with selected ASEAN countries in attract-

ing FDI over the past seven years (2000-2006) and

a discussion of some issues on the impact of FDI on

economic development as experienced by the Philip-

pines.

Government consistently maintains a policy

of welcoming foreign direct investments through

several decades (Briones 2001). While limita-

tions exists on foreign ownership and control of

enterprises due primarily to constitutional and

statutory provisions, these limitations have been

relaxed, entirely removed or mitigated with the

passing of incentives legislation during the last

two decades.


Below is a summary table of investments and investment-related laws and their key provisions:

Table 1. Philippine Investment and Investment-related Laws

Law Main Provision(s) / Remarks

Proclamation No. 50 on Privatization – December 1986

Made government corporate sector open and available to foreign investors. (e.g. Petron Corp.).

Omnibus Investments Code of 1987 (Executive Order 226)

Integrated all prevailing laws on FDI. Consisted of new incentive package deemed competitive with those offered by other ASEAN countries. Guaranteed full repatriation of investments in the currency it was originally made. Successor to the Investments Act of 1967 which created the Board of Investments (BOI) to centralize the process of assigning industrial priorities and to administer the incentives available to local and foreign enterprises. Incentives, among others , included tax exemption and tax credit on imported capital equipment, supplies and raw materials.

Build-Operate-Transfer (BOT) Law (Republic Act 6957) 1990

The fi rst BOT Law enacted to legitimize private sector involvement in government development undertakings, including the fi nancing, construction, operation, and maintenance of infrastructure projects (e.g. LRT 3).

Foreign Investment Act of 19911 (Republic Act 7042 as amended by R.A. 8179 in 1996)

Governed the entry of foreign investments without incentives, decreasing the minimum paid-in equity from $500,000 to $200,000. Allowed foreign entities to invest as much as 100% in various areas except those included in the negative list. Furthermore, no restrictions were imposed on the extent of foreign ownership of export enterprises.

Bases Conversion and Development Act of 1992 (R.A. 7227)

Provided incentives to enterprises within the Subic Bay Freeport Zone, Clark Economic Zone and other economic zones created from former military reservations/installations. Created the Bases Conversion Development Authority (BCDA).

Special Economic Zone Act of 1995 (R.A. 7916)

Provided a framework for the granting of incentives to locators in special economic zones (SEZs) and the management of SEZs, industrial estates/parks, export processing zones, and other economic zones. Created the Philippine Economic Zone Authority (PEZA). Each economic zone is managed as a separate customs territory and provided with transportation, telecommunications, and other infrastructure to facilitate linkages among industries within and outside the economic zones.

Export Development Act of 1994 (R.A. 7844)

Provided incentives to exporting fi rms.

Investors Lease Act (R.A. 7652) Allowed qualifying foreign investors to lease private lands for an initial period of up to 50 years, renewable for up to 25 additional years.

R.A. 7721 – Act Liberalizing the Entry and Scope of Operations of Foreign Banks (1994)

Eased the Restrictions on the entry and operations of foreign banks.

Amendment of the Build-Operate-Transfer Law (R.A. 7718 - 1994)

Encouraged an increase in private sector investment, local and foreign. Allowed variations of scheme, eases restrictions on government fi nancing and the setting of tolls and charges, and increased the opportunity for wholly foreign-owned corporations to undertake a project. The government was expected to provide credit enhancements, income tax holidays, escalation formula in the event of erratic movements in infl ation and interest rates, and arbitration for settlement of disputes.

1 The Foreign Investments Act of 1991 (Republic Act No. 7042 Section 3c) defi nes foreign investment “as equity investment made by a non-Philippine national in the form of foreign exchange and/or other assets actually transferred to the Philippines and duly registered with the Central Bank which shall assess and appraise the value of such assets other than foreign exchange.”

continuation, next page


Law Main Provision(s) / Remarks

R.A. 7888 Amending Article 7 (13) of EO 226

Allowed the President to suspend the nationality requirements under the Omnibus Investments Code in cases of ASEAN projects, or investments by ASEAN nationals, regional ASEAN or multilateral fi nancial institutions including their subsidiaries in preferred projects and/or projects allowed through either fi nancial or technical assistance agreements entered into by the President. This can lead to multilateral institutions such as the International Finance Corp. (IFC) and the Asian Development Bank (ADB) to make investments surpassing statutory equity ownership limits.

The Electric Power Industry Reform Act (R.A. 9136 – 2001)

Mandated total privatization of the generation assets, real estate, other disposable assets as well as existing Investment Priority Plan (IPP) contracts of the National Power Corporation (NPC). Allowed foreign investors to acquire NPC-generation assets and IPC contracts and required at least seventy-fi ve percent (75%) of the such funds to be inwardly remitted and registered with the Bangko Sentral ng Pilipinas.

Securities Regulation Code (R.A. 8799 – 2000)

Reorganized the Securities and Exchange Commission (SEC) which enforces the provisions of the Foreign Investments Negative List.

General Banking Law of 2000 (R.A. 8791 - 2000)

Allowed foreign banks to acquire up to 100% of the voting stock of one local bank.

Retail Trade Liberalization Act (R.A. 8762 – 2000)

Repealed the Retail Trade Law and fully opened retail trade to qualifying foreign investments. Allowed foreign investors to acquire shares of stocks of local retailers.

In her presentation on Foreign Direct Investments,

Professor Briones states that “practically all laws of the

Philippines allowing FDI are part of IMF condition-

alities.” The liberalization of FDI was accelerated as

part of the structural adjustment programs (SAPs) re-

forming the corporate and fi nancial sectors.

III. Foreign Direct Investments (FDI) StatisticsPhilippine FDI infl ows for the last seven years from

2000 to 2006 showed erratic movements although

consistent growth was displayed from 2003 onwards.

UNCTAD’s World Investment Reports (2004 and

2007) showed total infl ows of US$9.325 billion for

the seven-year period starting with US$1.3 billion in

2000, fl uctuating then declining to US$319 million

in 2003 and then consistently increasing since then

up to the highest level of US$2.3 billion in 2006.

A different measure of net FDI used by the Banko

Sentral ng Pilipinas (BSP) shows a generally similar

trend although amounts were more disparate in the

initial two years but totalling almost a similar US$9

billion over the seven-year period.

The two different measures of FDI infl ows howev-

er show similar erratic trends for the time period under

review. Figure 2 shows this trend with the two agencies

reporting identical fi gures in 2004 and 2005.

Total FDI stock grew from just US$3.3 billion in

1990 to US$17.1 billion in 2006 although the 34 per-

cent growth rate from 2000 to 2006 was just a fraction

of the 292 percent growth rate experienced during the

previous decade. The stock per capita registered a less

impressive growth of 19 percent from 2000 to 2006

after growing by 216 percent from 1990 to 2000.

Comparing Philippine FDI infl ows and stock with

selected ASEAN countries indicates the relatively ane-

mic growth performance of the Philippines. Table 4

Table 2. Comparison of FDI Measurements - Philippines (2000-2006)

UNCTAD vs BSP BOP Concept (In million dollars)

2000 2001 2002 2003 2004 2005 2006 Total 7 yrs

UNCTAD FDI Infl ows 1,345 982 1,792 319 688 1,854 2,345 9,325

BSP Net FDI (BOP Concept) 2,240 195 1,542 491 688 1,854 2,086 9,096

Source: UNCTAD World Investment Reports, Bangko Sentral ng Pilipinas (BSP)


compares economic indicators of the Philippines, Thai-

land, Malaysia, Indonesia and Vietnam.

FDI infl ow trends from 1992 to 2006 for the

ASEAN countries being compared were signifi cantly

mixed as each economy displayed varying responses

to and different behaviors resulting from the Asian

fi nancial contagion. As uncontrolled currency deval-

uations characterized each economy with the excep-

tion of Malaysia, total FDI to each country generally

declined with Indonesia being the hardest hit. Indo-

nesia witnessed signifi cant consecutive FDI outfl ows

from 1999 to 2001 following the social unrest and

riots that accompanied the unprecedented devalu-

ation of the rupiah. The effects on the Philippines

and Vietnam were considered more benign. In terms

of average annual infl ow for two periods, 1992-

1997 and 1998-2006, the Philippines and Vietnam

showed minimal, almost negligible, improvement

although their 2006 fi gures were the highest for the

period. Singapore remained a key recipient of FDI,

almost equalling the combined fl ows of the other

fi ve countries in 2006. Malaysia regained its 1992-

1997 annual average infl ow of US$5.8 billion only

in 2006, but averaged a signifi cantly lower fi gure of

US$3.5 billion for the 1998-2006 period. Despite be-

ing the catalyst of the Asian crisis in 1997 and having

experienced the latest non-democratic change in gov-

ernment, Thailand showed robust infl ows in 2004-06

and averaged annual infl ows for 1998-2006 at more

than twice its average for 1992-1997. Given the varied

Table 3. FDI Inward Stock - Philippines

1990 2000 2006

Total (Million $) 3,268 12,810 17,120

Per capita ($) 51 161 191

Source: UNCTAD World Investment Reports, author’s per capita computation

Figure 2. Comparison of FDI Measurements

Source: UNCTAD World Investment Reports, Bangko Sentral ng Pilipinas (BSP)

2000 2001 2002 2003 2004 2005 2006

2,500

2,000

1,500

1,000

500

0

In M

illio

ns U

SD

UNCTAD FDI Infl ows

BSP Net FDICBOP Concept)

Source: UNCTAD World Investment Reports, author’s per capita computation

Figure 3. Philippine FDI Stock

- 250

Tota

l sto

ck in

mili

ion

dolla

rs

1990 2000 2006

- 200

- 150

- 100

- 50

- 0

Per c

apita

in d

olla

rs

18,000

16,000

14,000

12,000

10,000

8,000

6,000

4,000

2,000

0

Total (Million $)

Per capita

Table 4. Economic Indicators (Selected ASEAN Countries)

Land Area(sq. km.)

Population (millions in 2005)

GDP in 2005 (in billion US$)

Per Capita GDP (in US$)

Philippines 300,000 84.2 97.7 1,160

Thailand 513,254 64.8 176.6 2,725

Malaysia 330,257 26.1 130.7 5,008

Indonesia 1,890,000 220.0 280.3 1,274

Vietnam 330,363 83.1 52.8 635

Source: Philippine Daily Inquirer, July 25, 2007, pp. A12-13


internal experiences of each country for the given pe-

riod which consisted of both natural calamities as well

as radical political changes, one would wonder how

extensive the FDI fl ows were affected by these national

as well as regional events. In general, though, recovery

became apparent in 2003, with 2006 witnessing pe-

riod record highs for Singapore, Thailand, Malaysia,

the Philippines and Vietnam.

In terms of FDI stock, Singapore led the way

with US$210 billion in 2006. The Philippines, de-

spite growing by 292 percent from 1990 to 2000 and

then 34 percent from 2000 to 2006, registered the

Table 5. FDI Infl ows by economy (millions of dollars)

1992-1997 ave.

1998 1999 2000 2001 2002 2003 2004 2005 2006 1998-2006 ave.

Philippines 1,343 2,212 1,725 1,345 982 1,792 319 688 1,854 2,345 1,474

Thailand 2,269 7,491 6,091 3,350 3,813 1,068 1,802 5,862 8,957 9,751 5,354

Malaysia 5,816 2,714 3,895 3,788 554 3,203 2,474 4,624 3,965 6,060 3,475

Indonesia 3,518 (241) (2,977) 145 (597) 1,896 8,337 5,556 634

Singapore 8,295 7,690 17,217 15,038 5,730 11,409 19,828 15,004 14,688

Vietnam 1,586 1,700 1,484 1,289 1,300 1,200 1,450 1,610 2,021 2,315 1,597

Figure 4. FDI Infl ows by economy

Source: UNCTAD, World Investment Reports 2007, 2004

Source: UNCTAD, World Investment Reports 2007, 2004

Table 6. FDI Inward Stock (millions of dollars)

1990 2000 2006

Growth Rates

1990-2000 2000-2006

Philippines 3,268 12,810 17,120 292% 34%

Thailand 8,242 29,915 68,058 263% 128%

Malaysia 10,318 52,747 53,575 411% 2%

Indonesia 8,855 24,780 19,056 180% -23%

Singapore 30,468 112,633 210,089 270% 87%

Vietnam 1,650 20,596 33,451 1148% 62%Source: UNCTAD, World Investment Report 2007, author’s growth rates computation


least stock at only US$17 billion in 2006 compared

to US$19 billion and US$33 billion for Indonesia

and Vietnam, respectively.

Comparative tables and graphs of FDI fl ows as a

percentage of Gross Fixed Capital Formation (GFCF)

as well as FDI stock as percentage of Gross Domestic

Product (GDP) are shown below. In terms of FDI

fl ows as a percentage of GFCF, the Philippines reg-

istered signifi cant and consistent improvement in

the last three years. Vietnam displayed a similar con-

sistent growth trend while Thailand and Indonesia

showed declines in 2006 in contrast with increases by

Malaysia and Singapore, as the latter two experienced

signifi cant declines in 2005.

Figure 5. FDI Inward Stock

250,000

200,000

150,000

100,000

50,000

0Philippines Thailand Malaysia Indonesia Singapore Vietnam

1990 2000 2006

Source: UNCTAD, World Investment Report 2007

Figure 6. FDI as percentage of GFCF

160

140

120

100

40

30

20

10


2004 2005 2006


Perc

enta

gePe

rcen

tage

Table 7. FDI Inward Flows as Percentage of Gross Fixed Capital Formation by economy


2004 2005 2006

Philippines 4.9 12.6 14.1

Thailand 14.0 17.5 16.5

Malaysia 19.1 15.2 20.1

Indonesia 3.4 12.3 6.4

Singapore 77.05 57.6 79.5

Vietnam 10.6 11.5 12.5

For FDI stock as a percentage of GDP, both Sin-

gapore and Thailand registered consistent growth

from 1990 to 2006. The others showed declines in


2006 as compared to 2000, with Malaysia and Indo-

nesia registering signifi cant declines.

Statistics from the Board of Investments (BOI)

provide details of approved investments and ap-

proved FDI. While investment approvals do not by

themselves give a categorical indication of successful

investment promotion activities nor of recognized

competitiveness of the Philippines as an investment

destination, they do point to fi rm expressions of

interest to mobilize fi nancial resources for domestic

Table 9. Summary of Approved Foreign Direct Investments vs FDI Infl ows

Total Approved Foreign Direct Investments(in Million Pesos)

Agency 2000 2001 2002 2003 2004 2005 2006 Total

BOI 1,757.60 705.8 13,690.70 373.8 2,154.60 1,329.00 8,083.10 28,094.60

PEZA 1,998.00 287.7 746.7 365.3 2,314.80 838.7 68,901.70 75,452.90

SBMA 15,529.40 29,042.90 8,815.10 8,348.50 127,889.00 43,796.90 36,557.00 269,978.80

CDC 61,089.20 32,399.70 22,796.10 24,922.80 41,536.80 49,842.20 52,338.20 284,925.00

Total 80,374.20 62,436.10 46,048.70 34,010.30 173,895.20 95,806.80 165,880.00 658,451.30

Ave Forex* 44.19 50.99 51.60 54.20 56.04 55.09 51.31

Total Approved FDI (USD in millions)

1,818.68 1,224.41 892.35 627.46 3,103.06 1,739.24 3,232.63 12,637.83

UNCTAD FDI Infl ows (USD in millions)

1,345.00 982.00 1,792.00 319.00 688.00 1,854.00 2,345.00 9,325.00

% Infl ows vs Approved

74% 80% 201% 51% 22% 107% 73% 74%

Source: Board of Investments and UNCTAD

Figure 7. FDI Stocks as percentage of GDP

160

140

120

100

80

60

40

20


1990 2000 2006


Perc

enta

ge

Table 8. FDI Stocks as Percentage of GDP by economy


1990 2000 2006

Philippines 7.4 17.1 14.6

Thailand 9.7 24.4 33.0

Malaysia 23.4 58.4 36.0

Indonesia 7.0 15.0 5.2

Singapore 82.6 121.5 159.0

Vietnam 25.5 66.1 54.8


development. In order to estimate the extent of the

relationship of approved FDI to actual infl ows, an

iteration was made to convert the peso fi gures of

approved investments to dollars using the average

peso-dollar exchange for the year. Table 9 shows

that although on a year-to-year basis, actual fl ows

do not correspond to approved volume of invest-

ments, the comparison of total fl ows for the seven

years would indicate that roughly three-fourths or

74 percent of approved FDI resulted in actual in-

fl ows for the country. The table would also indicate

that SBMA and Clark Development Corporation

(CDC) cornered most of the approved FDI under

the seven-year period from 2000-2006 with 84 per-

cent of approved FDI locating in these two zones.

However, no identifi cation of which projects led to

actual FDI infl ows can be provided from the BOI

data. It may do well, for current and future assess-

ment of investment promotion strategies, for pro-

motion agencies to compile statistics not only on

approved registered projects and FDI but also on

actual execution and FDI infl ows of the registered

projects.

It is also interesting to note that while

Table 9 on approved FDI shows that the bulk of

approved FDI are under SBMA and CDC, Table

16 from the same sources showing total approved

investments (FDI and others) indicate that SBMA

and Clark only accounted for 10 percent of total ap-

Table 10. PEZA Approved Locator Investment by Nationality (1995-2004)

Japanese 42%

Filipino 16

American 14

Dutch 7

British 6

Singaporean 5

Korean 3

German 2

Taiwanese 1

Others 4

Source: Philippine Economic Zone Authority Website

Table 11. PEZA Approved Locator Investment by Industry (1995-2004)

Electronics and Semiconductors

55%

Electrical Machinery and Apparatus

11

Transport and car parts 7

Chemical and Chemical Products

4

Information Technology 4

Medical, Precision and Optical products

3

Rubber and Plastic 2

Garments and textile 2

Others 12

Source: Board of Investments and UNCTAD

Figure 8. Actual FDI Infl ows vs Approved FDI – 2000 to 2006

3,500

3,000

2,500

2,000

1,500

1,000

500

02000

UNCTAD FDI Infl ows (USD in millions)

Perc

enta

ge

2001 2002 2003 2004 2005 2006

Total Approved FDI (USD in millions)


proved investments. Given that the seven-year total

approved FDI in absolute pesos corresponding to

these two agencies is much greater than the total cor-

responding approved investments, it would seem to

require reconciliation of fi gures from the reporting

agencies.

For investments in the economic zones under

the PEZA, signifi cant and tremendous growth was

registered since 1995, with total investments in-

creasing 38-fold from PhP24.5 billion for the pe-

riod from 1984-1994 to PhP955.7 billion for the

period from 1995-2005. Recent locator investments

totaled PhP50 billion in 2005 and PhP67 billion

in 2006 representing a 33 percent increase year-to-

year. Investments for the period 1995-2004 were of

Japanese origin (42 percent) with Filipino, Ameri-

can, Dutch and British investors rounding out the

top fi ve nationalities. A majority of investments

were in the electronic and semiconductors industry

which garnered 55 percent of total approved locator,

investments. This was followed by the electrical ma-

chinery/apparatus sector with 11 percent while the

transport and car parts sector contributed 7 percent

of total approved locator investments.

Export performance and employment genera-

tion registered substantial growth for PEZA fi rms.

Economic zone employment grew from 229,650 in

1994 to 1,128,197 in 2005, a fi ve-fold increase over

the 10-year period. Exports grew almost twelve-fold

from US$2.7 billion in 1994 to US$32.03 billion in

2005. PEZA exporters contributed more than ¾ or

77 percent of total Philippine exports for 2005.

It should be noted that in this overview of the

investment landscape, certain gaps in the compila-

tion of data by government agencies, particularly

the Investment Promotion Agencies (IPAs) have

been identified. BOI and PEZA, for example,

meticulously and regularly report statistics on “ap-

proved investments.” The execution and actual

inflow of capital funds, however, are not being re-

ported on a per project or sectoral basis. The latter

information is important if we are to realistically

assess the effectiveness of our investment programs

at the micro level, as they can also lead to pro-

grams that retain and sustain the established enter-

prise. This can also be complemented with regular

updates and reporting of the actual employment

generated by the registered enterprises. The proper

monitoring and accounting of the flow of duty-

and tax-free raw materials and goods will also be

crucial to prevent diversions and leakages to the

domestic market which injure domestic produc-

ers.

IV. Impact of FDI – The Philippine Experience Have foreign direct investments promoted the

development of the Philippine economy? How can

we ensure that they do?

The traditional benefi ts expected of FDI are that

they contribute to growth in the recipient countries.

This growth is induced by adding to the existing capi-

tal stock in the host country, by stimulating technical

progress, and by upgrading technological capability

resulting in the enhancement and/or increase in the

creation of new jobs.

The Philippines registered bouyant FDI infl ows

from 2000 to 2006 although consistent growth was

registered during the last three years. FDI stock grew

consistently through the years although a simplistic

FDI retention analysis (Table 17) would indicate that

substantial divestments were also experienced during

the period although not as substantial as those ex-

perienced by Malaysia and Indonesia for the same

Figure 9. Philippine FDI Infl ows (million $)

Source: UNCTAD World Investment Report 2007

2,500

2,000

1,500

1,000

500

0

Mill

ion

$

2000 2001 2002 2003 2004 2005 2006


period. FDI stock as a percentage of GDP hovered

at about 14.6 percent to 17 percent although FDI

infl ows as a percentage of Gross Fixed Capital For-

mation consistently grew in the last three years, regis-

tering 4.9 percent, 12.6 percent and 14.1 percent for

2004, 2005 and 2006, respectively.

Figure 12. Philippine GDP Growth Rates and FDI Infl ows

2004 2006200520032002200120001999

– 2,500

– 2,000

– 1,500

– 1,000

– 500

– 0

Infl o

w in

mill

ion

$

15

10

5

0

Perc

ent g

row

th

Real GDP Growth Rate (%) Nominal GDP Growth Rate (%) BSP Net FDI (BOP Concept) ( in million US$)

Source: Bangko Sentral ng Pilipinas

Figure 10. Philippine FDI Inward Stock


20,000

15,000

10,000

5,000

0

Stoc

k in

mill

ion

$

1990

Perc

ent o

f GDP

20

15

10

5

02000 2006

FDI Inward Stock (million $)

FDI Stock as % of GDP

Figure 11. Philippine FDI Infl ows as % of GFCF


15

10

5

0

Perc

ent

2004 2005 2006

A look at FDI infl ow trends together with GDP

growth experience indicates a weak relationship per-

haps due to the anemic ability of the Philippines to

attract more investments. Nominal and real GDP

growth from 1999 to 2006 displayed positive al-

though bouyant tendencies. The same holds for FDI

infl ows, although a correlation cannot be established

apparently because FDI productive outputs may not

be enough to be the main engine of GDP growth and

infl uence GDP performance. Perhaps a longer time

series analysis will reveal a more defi nitive relation-

ship if such indeed existed.

The relationship of FDI to GDP levels likewise

could not be readily established. Even taking only the

manufacturing sector which reportedly received the

bulk of FDI infl ows could reasonably display a con-

clusive correlation. Statistics have consistently shown

a gradual but positive growth in total and manufac-

turing GDP so variances in the fl ows of FDI could

not infl uence the aggregate GDP fi gures.

A signifi cant development in Philippine foreign

investment experience is the tremendous growth in

services investments particularly those related to the

business process outsourcing (BPO) sector. This sec-

tor consists of ICT activities such as contact centers,

software development, back offi ce operations and

medical/data transcription among others. Govern-

ment has been particularly bullish in promoting in-

vestments in this sector especially with the compa-


Although regarded as a solution to the Philippine

unemployment problem and the jobless growth expe-

rience of the Philippine economy as a whole, the BPO

sector by itself cannot and must not be the sole reposi-

tory of development attention and strategy. Already,

certain constraints have been identifi ed unique to the

sector and although manageable, challenges will have

to be addressed in the areas of culture change and lan-

guage development, health and working conditions,

continuing education and training. This however

should not divert attention from other development

requirements in other areas. Even as resources are allo-

Figure 13. Philippine Total GDP, Manufacturing GDP and FDI Infl ows

2004 2006200520032002200120001999

– 2,500

– 2,000

– 1,500

– 1,000

– 500

– 0

Infl o

w in

mill

ion

$

1,500,000

1,000,000

500,000

0

In m

illio

n pe

sos

GDP at constant 1985 prices (in million pesos)Manufacturing GDP at constant 1985 prices (in million pesos)BSP Net FDI (BOP Concept) ( in million US$)


rably adequate telecommunications infrastructure of

the Philippines vis-a-vis competing Asian countries

like India and China.

The contribution of the BPO sector to total GDP

is no small feat. From just 0.075 percent of GDP

in 2000, it contributed 2.4 percent to total GDP in

2005 with total annual revenues of close to US$2.4

billion. At the end of 2005, it employed 163,000

workers, with 70 percent in the contact center sub-

sector. Prospects of growth remain bright for the

BPO sector with projections of employment increas-

ing at an annual rate of 38 percent until 2010.

Table 12

Type of service No.of fi rmsRevenues Employment

USD Million % Share Employees % Share

Contact Center 114 1,792 75.10 112,000 68.61

Back Offi ce 62 180 7.54 22,500 13.78

Medical Transcription 64 70 2.93 5,500 3.37

Legal Transcriptions 9 6 0.25 450 0.28

Other Data Transcription 39 1.63 3,000 1.84

Software Development 300 204 8.55 12,000 7.35

Animation 42 40 1.68 4,500 2.76

Engineering Design 14 48 2.01 2,800 1.72

Digital Content 11 7 0.29 500 0.31

Total 616 2,386 100.00 163,250 100.00Source: Christina Morales presentation entitled Philippine Globalization in the New Millenium


cated to attracting investments in this globally expand-

ing sector, the Philippines will have to also contend

with grave concerns in the manufacturing, mining and

agricultural sectors if it is to achieve a balanced, coher-

ent and comprehensive development agenda.

This brings us to the issue of where to direct ef-

forts for attracting FDI. While most investments in

the past fl owed to the light manufacturing sector

(electronics) located in special economic zones and

in recent years to the BPO sector located in ICT spe-

cial economic buildings, targeting of investments will

have to involve a deeper assessment of needs and avail-

able competencies as well as aligning investment in-

centives systems with the desired development objec-

tives. There is also the matter of addressing empirical

evidence of perceived and actual constraints that im-

pede the attractiveness and operational competitive-

ness of the country. In the area of choosing which

types of foreign multinational enterprises (MNEs)

to target for investment projects in the Philippines,

it becomes unavoidable to resort to what can be

termed as “calibrated industrial policy.” A UNDP

Discussion Paper entitled Who’s Afraid of Industrial

Policy by Emel Memi and Manuel F. Montes de-

fi nes industrial policy as “the application of selective

government interventions to favour certain sectors

so that their expansion benefi ts the productivity of

the economy as a whole.” After asserting that the

“only proven path out of underdevelopment…has

been through industrialization,” the authors point to

a lesson that can be drawn from a study of the in-

dustrialization performance of the Asia-Pacifi c region

of ‘successful’ globalizers which is: “…development

through strategic, as opposed to passive, integration

into the external economy is possible…” and that the

“…State played an indispensable role in undertak-

ing the strategic integration, through various policies

that can be categorized as industrial policy.”

In the light of present multilateral trade and in-

vestment arrangements that consist of legally bind-

ing disciplines, a calibrated industrial policy remains

a valuable tool for development. For industrial policy

to be calibrated, it will have to operate within the

parameters of international commitments, which

still has a lot of leeway in reality. Trade obligations in

the WTO, for example, principally operate through

committed tariff ceilings or bound rates and mem-

ber-states are free to set any level of duty rates below

these ceilings. Bilateral and regional free trade agree-

ments also normally offer fl exibilities and exclusions

which should allow for policy space within which

industrial policy tools can be employed.

As industrial policy inevitably involves the provi-

sion of rents, a crucial feature of this new form of

Source: Global Competitiveness Survey 2007

Figure 14. Most Problematic Factors for Doing Business in the Philippines


industrial policy is its being used within a set time

frame for development with roadmaps or develop-

ment plans jointly crafted, monitored, managed and

modifi ed by government and the private sector. For

it to be successful, therefore, a new set of bureaucracy

has to be created, consisting of “industry desks” and/

or sectoral units in the current government planning

agency as well as in the Department of Trade and In-

dustry. This will involve the training and continuing

education of technocrats who can shepherd sectoral

development while deeply understanding the busi-

ness dynamics of specifi c strategic sectors so that ef-

fective and calibrated policies can be well formulated

and implemented.

Private FDIs fl ow to destinations of willing na-

tional hosts according primarily to the return objec-

tives of the investing enterprise. It becomes crucial

therefore that the business model employed and the

expected parameters for success triggering the invest-

ment decision be fully understood by the host gov-

ernment. While addressing the perceived contraints,

impediments or the “bad image” of the country

among foreign investors, must be a continuing ac-

tivity of host countries. Responding to the interface

of foreign investment and management systems with

the local economy must likewise be of paramount

concern. This deeper understanding could be ad-

dressed by developing the necessary skills of those

assigned in the industry desks.

In the area of perceived constraints, the Philippines

has had numerous inputs to help direct where resourc-

es can be allocated to eliminate if not mitigate the ad-

verse effects of the identifi ed impediments. The Global

Competitiveness Survey 2008-20092, for example, has

identifi ed the most problematic factors for doing busi-

ness in the Philippines as corruption followed by inef-

fi cient government bureaucracy, inadequate supply of

infrastructure, and policy instability.

The ADB Investment Climate Survey of 2003,

on the other hand, identifi es the major or severe con-

Figure 15. Share of Firms Rating Constraints as Major or Severe

Source: Asian Development Bank Investment Climate Survey 2003

2 This was released on October 8, 2008.


straints that hinder the establishment of an attrac-

tive investment climate. Topping the survey results

are macroeconomic instability, corruption, electricity

and tax rates.

The surveys above coincide with other survey re-

sults that identify corruption and bad infrastructure

as major impediments to doing business and thus

to attracting investments. These results should also

be used in identifying impediments to domestic in-

vestments as these same factors infl uence business

decisions of local investors. In fact, in the light of

the continued decline in total fi xed investments as

a percentage of GDP, addressing these factors take

on more urgent attention. Figure 16, which appears

in the World Bank report authored by Alessandro

Bocchi entitled Rising Growth, Declining Invest-

ment: The Puzzle of the Philippines (2007), shows

the erratic GDP growth from 1980 to 2006 and the

fi xed investment-to-GDP ratio relationship for the

same period. The report highlights that although

“…the Filipino economy is open to trade and capi-

tal infl ows, and since 2002, growth has averaged 5.3

percent,… over the last 15 years, however, domes-

tic investment has been stagnant in real terms and

consistently declining as a share of GDP” (emphasis

supplied). While the report identifi es three main

reasons for what it calls an economic “puzzle” – (1)

government’s inability to generate ample funds, (2)

the capital-intensive private sector’s refusal to ex-

pand fast and (3) the lack of any need for invest-

ments on the part of other private fi rms – more

fundamental causes for such reasons could well be

the identifi ed factors that constrain business and

dampen the investment climate. The role of “un-

bridled globalization” could also be a main reason

for hindering industrial entrepreneurship.

Grappling with the issues of massive corruption

will require a leadership, both at the national and sec-

toral levels, that is not hampered by issues assailing the

leadership itself of being the very source or benefi ciary

of corruption. Suffi ce it to say that the image of corrup-

tion can only be addressed with genuine and successful

prosecution, conviction and punishment of high-level

and substantial numbers of perpetrators, both public

and private, and not merely through cosmetic or pub-

licity programs of running after violators. The existing

programs consisting of lifestyle checks, Run After The

Smugglers (RATS), Run After Tax Evaders (RATE)

and legislative oversight committees need to be aug-

mented by stronger prosecutorial processes and more

effi cient judicial proceedings.

On the technical and structural sides of the iden-

tifi ed impediments, a serious look into the prevailing

fundamental economic management philosophy must

be undertaken. Through the years, economic policy

has been largely driven by the country’s adoption of

the prescriptions collectively termed the Washington

Consensus. Whether such adoption came as a result

of structural adjustment programs imposed by mul-

tilateral fi nancial institutions such as the IMF and

the World Bank or by indigenous unilateral decision

making, the adverse effects of blindly embracing un-

bridled globalization continue to plague the country.

While certain proponents, both domestic and foreign,

continue to espouse a supposed “new paradigm” out

of underdevelopment by largely paying attention to

the services sector without industrialization, the fact

remains that economic history and the development

of the now First World countries show that the only

Figure 16

Source: National Statistical Coordination Board, 2007


proven path for development is industrialization. It

would be good to study the still ongoing transition

of China from a centrally planned economy to a mar-

ket economy and the strategic sequencing of reforms

needed to transition development models from

comparative-advantage defying (CAD) strategies to

comparative-advantage following (CAF) strategies as

expounded upon by Justin Yifu Lin in his papers on

Development Strategies for Inclusive Growth in De-

veloping Asia and Lessons of China’s Transition from

a Planned Economy to a Market Economy.

The choice or direction for choosing the appro-

priate development strategy, however, must meet the

standards set by Article XII, section 1 of the Philip-

pine Constitution which states:

Section 1. The goals of the national economy

are a more equitable distribution of opportunities,

income, and wealth; a sustained increase in the

amount of goods and services produced by the na-

tion for the benefi t of the people; and an expanding

productivity as the key to raising the quality of life

for all, especially the under-privileged.

The State shall promote industrialization and

full employment based on sound agricultural devel-

opment and agrarian reform, through industries that

make full and effi cient use of human and natural re-

sources, and which are competitive in both domestic

and foreign markets. However, the State shall protect

Filipino enterprises against unfair foreign competi-

tion and trade practices.

Thus, while there may be pockets of successes as

a result of the uncalibrated opening of the entire eco-

nomic landscape, genuine industrial deepening with

countryside development has eluded the Philippines.

From the perspective of attracting and mobilizing

foreign direct investments, it should be emphasized

that openness per se is not suffi cient. It may also be

noted that the accelerated tariff liberalization of the

Philippines during the 1990’s could have resulted in

the decision of potential investors to locate elsewhere

in the region and merely supply, through importa-

tion, the countries with lower tariff rates.

The study on fi scal incentives, identifi ed the differ-

ent types of motivation for investors. Relative to the

specifi c area of investment, investors look primarily at

opportunities to, among others, (1) seek and exploit

the purchasing power of a growing domestic market

(non-exporting, import-substituting activities), (2)

source indigenous raw materials for further process-

ing in the host country or in the home country or in

a third country (e.g. petroleum, minerals, wood), (3)

tap into available skills, traits or cheaper cost of labor

(product or service exports), and (4) avail themselves of

locational advantages relative to multinational and/or

multi-regional operations and corporate consolidation

strategies. Targeting the right set of FDI will therefore

require an understanding of the motivations of poten-

tial investors and their business models for positioning

a facility in the host country. This being the case, the

incentives system, by itself, cannot form the basis of

investment decisions. In fact, fi scal incentives may not

be the major consideration in investment decisions,

although narrow and marginal differences among al-

ternative locations may allow the incentives system to

play a larger role.

Discriminating from among different types of in-

vestments should therefore lead to a more rational

construction of the incentives framework as well as

the conditions that may be imposed (contractually

or by allowable regulation) for investments that can

assist in creating and maximizing the spillover effects

that the host country basically desires. This exercise

will inevitably result in the use of industrial policy

tools which, although already brought into various

disciplines under the Trade Related Investment Mea-

sures (TRIMS), Agreement on Agriculture (AoA)

and Non-Agricultural Market Access (NAMA)

Agreements of the WTO, nevertheless still become

relevant for certain types of investments that do not

affect international trade. Consequently, proper and

effective targeting of the types of FDI that can pro-

mote development can be actualized. Furthermore,

the rationalization of incentives can be structured in

a way where the fi nal pull-element for favorable in-

vestor decisions in desired investment activities can

be made more effective and appropriate.


V. Conclusions and Policy RecommendationsWhile “traditional” conventional wisdom, which is

largely infl uenced in many areas by the Washington

Consensus, appears to indicate that FDIs in whatever

form and however confi gured (for “as long as inves-

tors do not pollute the environment and do not bla-

tantly abuse workers”) are unequivocally benefi cial

for the host country, recent studies showing unclear

or questionable linkages between FDI and develop-

ment, should prompt policymakers to revisit and

critically refl ect on the current tools employed to at-

tract investments and to ultimately manage economic

development effectively. Against the backdrop of the

overall poor performance of the country in attracting

investments, especially when compared to neighbor-

ing ASEAN economies, we must ultimately deliber-

ate, not on fragmented pockets of concerns, but on the

over-arching economic development agenda that pre-

cedes any successful sectoral development program.

The ongoing steps to rationalize fi scal incentives

through several proposed bills in Congress present

a timely occasion to refl ect not only on the invest-

ment incentives system but on the overall economic

planning and management framework of the coun-

try. While there is need to confi gure the incentives

regime to eliminate “redundant” or superfl uous in-

centives, the potentially affected enterprises which

mostly come from sectors that seek access to the

domestic market should be supported by enhancing

more appropriate non-fi scal incentives. Thus, while

income tax holidays (ITH) may be considered re-

dundant for import-substituting projects, it could

well be retained for enterprises that completely ex-

port their output. However, investments that are

aimed at merely meeting domestic market demands

(i.e., import-substituting), while not being entitled

to ITH, should be provided improved infrastruc-

ture support comparable to export-oriented inves-

tors and be entitled to other non-fi scal inducements

to improve overall competitiveness. Thus, it may be

possible that instead of formulating an “omnibus”

package that grants incentives to all investments, a

menu of fi scal and non-fi scal incentives for invest-

ments, classifi ed by type of business model and

motivation, could be more appropriately designed.

Admittedly this will require a higher level of busi-

ness understanding and development orientation

from the investment promotion authorities. It will

also require the adoption of industrial policy tools

that should be made available to the line depart-

ments overseeing the development of industry and

agriculture. The discussion on organizing “in-

dustry desks” becomes relevant in this sense. It is

for this reason that the Philippines must preserve

whatever is left of its available policy space, which

is now threatened by the ongoing negotiations

at the WTO as well as by bilateral and regional

trade and investment agreement negotiations. The

communication by Brazil and India on modifying

provisions of the TRIMs3 in the WTO should be

3 Communication from Brazil and India (G/C/W/428: G/TRIMS/W/25: 9 October 2002) The Mandated Review of the TRIMs Agreement Para-graph 12(b) of the Doha Ministerial Declaration Implementation-related issues and concerns (tiret 40).

The specifi c proposals contained in the communication are as follows:

“11. Article 4 of the TRIMs Agreement should be amended in order to incorporate specifi c provisions that will provide developing countries with the necessary fl exibility to implement development policies. One possible solution is to extend the range of situations in which developing countries are allowed to deviate temporarily from the provisions of Article 2. Among the new provisions that should be included, the follow-ing should be considered.

“12. Developing countries should be allowed to use TRIMs in order to: (a) promote domestic manufacturing capabilities in high value-added sectors or technology-intensive sectors;

(b) stimulate the transfer or indigenous development of technology;(c) promote domestic competition and/or correct restrictive business practices; (d) promote purchases from disadvantaged regions in order to reduce regional disparities within their territories; (e) stimulate environment-friendly methods or products and contribute to sustainable development; (f) increase export capacity in cases where structural current account defi cits would cause or threaten to cause a major reduction in

imports. (g) promote small and medium-sized enterprises as they contribute to employment generation.”


supported by developing countries, especially the

Philippines.

For investments geared entirely for exports, the

Philippines would do well to retain existing expecta-

tions of incentives as studies show little or negligible

redundancy in fi scal incentives. Of particular con-

cern, however, is the confi guring of tax and duty-free

privileges of exporters as there is common knowledge

that this privilege is abused via technical smuggling,

to the detriment of domestic producers. This issue

may not only be an operational or law-enforcement

concern as special economic zone locators are allowed

by law to sell a proportion of output (30 percent to

50 percent) to the domestic market. This structural

feature could possibly negate whatever benefi ts in-

vestments made in these zones are expected to bring

in the long run.

The incentives offered geared to disperse estab-

lishments to the regions where development is lack-

ing has proven unsuccessful precisely because these

underdeveloped regions lack the minimum level

of available infrastructure for investments to be at-

tracted, much less to fl ourish. Thus, an attitude not

entirely different from “missionary” work has to per-

vade inducements to establish enterprises in these

areas which may only be achieved when a clustering

of related trailblazing enterprises can be formed. Of

course the attendant network of public physical in-

frastructure needs to be provided as non-fi scal incen-

tives for this purpose.

The incentives system, while an important tool

in attracting foreign investments, is just one of the

many components and structural reforms needed

in the mobilization of resources, both domestic

and foreign, for development. Other components

need to be addressed. The unique situation the

Philippines is in – rising growth, low and consis-

tently declining investment to GDP ratio, substan-

tial and consistent OFW remittances that result in

huge international reserves and high bank liquidity

– should compel us to effectively identify more suit-

able and perhaps more effective areas of mobilizing

resources to address poverty and sustain economic

development.

Finally, formulating and making available a real

and coherent national economic development plan,

making a dynamic baseline and benchmark for assess-

ing investment projects, re-focusing strategic coverage,

and evaluating overall economic performance, must

become a priority task of economic managers. Along

this line, scaling up the development ladder should be

the focus in order to harness the synergies already of-

fered by FDI currently in place in the country. Fur-

thermore, identifying new technologies for targeting

of investments can be the platform for bringing the

economy to a higher level of industrialization.


Table14. Total Approved Foreign Direct Investments by Country (in Million Pesos)

Country 2000 2001 2002 2003 2004 2005 2006 Total 7yrs % Top 10

Japan 20,382 23,021 17,054 8,841 26,596 27,539 20,066 143,499 21.8% 1

USA 9,581 8,355 3,627 10,432 27,108 14,913 38,199 112,216 17.0% 2

Nauru - - - - 96,529 - 439 96,968 14.7% 3

Korea 823 2,771 1,345 712 3,260 10,828 54,327 74,067 11.2% 4

Netherlands 27,246 99 269 3,866 1,473 19,208 7,188 59,348 9.0% 5

Singapore 3,747 15,864 1,168 295 1,524 890 6,396 29,884 4.5% 6

Taiwan 240 611 12,198 2,554 1,654 1,394 1,953 20,602 3.1% 7

PROC 172 146 893 311 127 195 17,935 19,778 3.0% 8

UK 5,788 1,697 618 2,381 1,683 195 5,887 18,248 2.8% 9

Cayman Islands - - - - - 13,817 384 14,201 2.2% 10

Germany 6,547 333 2,555 452 1,345 418 306 11,955 1.8%

Manx - - - - 7,634 - - 7,634 1.2%

Australia 365 3,816 46 986 170 563 689 6,635 1.0%

Br. Virgin Is. - 220 - 69 208 658 5,450 6,606 1.0%

HongKong 3,086 279 134 256 1,431 93 553 5,830 0.9%

Switzerland 241 102 1,764 68 355 817 605 3,952 0.6%

Thailand 17 142 - - 29 1,535 522 2,245 0.3%

France 0 11 725 20 330 46 1,106 2,238 0.3%

Malaysia 102 177 98 45 10 69 856 1,357 0.2%

Sweden - 854 - - - 0 165 1,020 0.2%

Italy 1 51 7 12 29 8 18 126 0.0%

Indonesia - - - - - - 11 11 0.0%

Others 2,035 3,886 3,549 2,712 2,400 2,623 2,826 20,031 3.0%

Total 80,374 62,436 46,049 34,010 173,895 95,807 165,880 658,451 100.0%

Sources of Basic Data: Board of Investments (BOI), Philippine Economic Zone Authority (PEZA), Subic Bay Metropolitan Authority (SBMA) and Clark Development Corporation (CDC).


Table 15. Total Approved Foreign Direct Investments by Industry (in Million Pesos)

Industry 2000 2001 2002 2003 2004 2005 2006 Total 7 yrs % of Total Rank

Manufacturing 72,218 32,228 23,691 20,634 43,812 112,665 372,978 56.6% 1

Gas - - - 1,827 96,524 90 - 98,441 15.0% 2

Services 1,944 8,097 5,114 4,609 29,606 8,783 17,386 75,539 11.5% 3

Mining 36 2,715 11,589 856 230 7,313 724 23,462 3.6% 4

Trade 59 36 676 761 53 107 19,591 21,282 3.2% 5

Electricity 5,517 - 997 103 2,040 439 19,960 3.0% 6

Communication 194 14,460 1,054 1,188 - - 2,963 19,859 3.0% 7

Finance and Real Estate a/

8 4,165 564 901 291 203 7,627 13,758 2.1% 8

Construction 97 418 125 2,567 1,138 34 766 5,145 0.8% 9

Transportation 80 3 2,054 192 27 391 1,325 4,073 0.6% 10

Agriculture 5 110 98 25 5 291 2,381 2,914 0.4%

Storage 216 205 72 347 172 1 13 1,025 0.2%

Water - - 15 - - - - 15 0.0%

Total 80,374 62,436 46,049 34,010 165,880 658,451 100.0%

a/ - Includes Economic Zone Development and Industrial Park

Notes: 1. Approved Investments refer to the project cost or committed investments by Filipino and foreign investors.2. Details may not add up to totals due to rounding.3. The services industry includes hotel/restaurant businesses, computer software development, health care program services, renting and leasing of water sport equipment, training services, protection/security training course, college education and other services.

Sources of Basic Data: Board of Investments (BOI), Philippine Economic Zone Authority (PEZA), Subic Bay Metropolitan Authority (SBMA)and Clark Development Corporation (CDC).


Table 16. Summary of Approved Investments

a/ - Includes Economic Zone Development and Industrial Park

Notes: 1. Approved Investments refer to the project cost or committed investments by Filipino and foreign investors.2. Details may not add up to totals due to rounding.3. The services industry includes hotel/restaurant businesses, computer software development, health care program services, renting and leasing of water sport equipment, training services, protection/security training course, college education and other services.

Sources of Basic Data: Board of Investments (BOI), Philippine Economic Zone Authority (PEZA), Subic Bay Metropolitan Authority (SBMA)and Clark Development Corporation (CDC).

Total Approved Investments by Promotion Agency (in million Pesos)

Agency 2000 2001 2002 2003 2004 2005 2006Total

7-years % Rank

BOI 43,611.50 28,352.10 28,340.70 135,722.80 51.24%

PEZA 88,320.00 38,741.10 31,346.10 50,561.10 62,761.20 83,761.10 38.06%

SBMA 4,663.80 1,836.80 4,542.20 2,359.30 3,727.80 1,484.40 72,933.30 91,547.60 6.80%

CDC 2,912.50 1,568.90 27,548.20 1,748.60 2,935.00 3,110.10 12,692.50 52,515.80 3.90%

Total 99,183.70 63,794.80 100.00%

Total Approved Investments by Industry (in million Pesos)

Industry 2000 2001 2002 2003 2004 2005 2006Total

7-years % Rank

Agriculture 143.3 2,398.80 1,215.80 2,855.70 212.2 770.5 4,734.10 12,330.40 0.92%

Mining 171.9 3,366.80 - 3,999.20 1,511.70 8,293.80 16,146.70 33,490.10 2.49% 8

Manufacturing 85,280.40 48,301.80 56,992.50 29,809.50 54,330.40 42.86% 1

Electricity 6,567.90 2,171.40 1,016.10 632.4 8,564.30 21,659.40 45,402.60 86,014.10 6.39% 6

Gas - - - 4,639.90 104,501.10 268.6 - 8.13% 5

Water - - 1,701.00 120.6 - - - 1,821.60 0.14%

Construction 7,509.90 2,746.70 412.8 3,441.60 1,139.90 83.3 3,857.50 19,191.70 1.43% 10

Trade 272.3 536.1 1,207.00 1,205.20 516.9 357 26,332.30 30,426.80 2.26% 9

Transportation 2,310.20 636.3 5,543.80 514.5 466.9 22,172.20 3,530.50 35,174.40 2.61% 7

Storage 703.8 1,039.00 183.6 539.1 388.4 26.2 35.3 2,915.40 0.22%

Communication 14,877.50 58,305.80 2,290.30 1,258.60 - 2,079.50 47,042.10 9.35% 3

Finance & Real Estate a/

83,438.90 47,635.00 12,007.40 4,985.50 7,091.00 10,019.50 28,833.40 14.42% 2

Services 6,609.40 26,624.60 16,613.30 9,792.90 14,224.00 15,343.90 29,105.30 8.79% 4

Total 99,183.70 63,794.80 100.00%

Projected Employment on Approved Investments by Promotion Agency

Agency 2000 2001 2002 2003 2004 2005 2006Total

7-years % Rank

BOI 21,665 33,410 30,130 21,374 33,804 46,349 49,266 235,998

PEZA 52,249 56,629 36,536 38,395 55,250 71,792 81,110 391,961

SBMA 2,271 2,585 2,868 3,217 3,044 6,116 16,808 36,909

CDC 9,683 2,819 40,895 3,292 10,926 7,786 8,994 84,395

Total 85,868 95,443 110,429 66,278 103,024 132,043 156,178 749,263


Table 17. Retention Analysis using FDI Infl ows and Stocks Selected Countries (millions of dollars)

Initial Stock 2000

Annual Infl ows

Total Infl ows (2001-2006)

Computed Ending Stock 2006

Actual Reported Ending Stock 2006

(Apparent Divestments) /Unreported

Infl ows2001 2002 2003 2004 2005 2006

Philippines 12,810 982 1,792 319 688 1,854 2,345 7,980 20,790 17,120 (3,670)

Thailand 29,915 3,813 1,068 1,802 5,862 8,957 9,751 31,253 61,168 68,058 6,890

Malaysia 52,747 554 3,203 2,474 4,624 3,965 6,060 20,880 73,627 53,575 (20,052)

Indonesia 24,780 145 (597) 1,896 8,337 5,556 12,360 37,140 19,056 (18,084)

Vietnam 20,596 1,300 1,200 1,450 1,610 2,021 2,315 9,896 30,492 33,451 2,959


References

Asian Development Bank (2005). Improving the Investment Climate in the Philippines.

Bocchi , Alessandro Magnoli (2008). Rising Growth, Declining Investment: The Puzzle of the Philippines,

World Bank Policy Research Working Paper 4472.

Briones, Leonor Magtolis (2001). Mobilization of International Resources: Focus on Foreign Direct

Investment (FDI).

Fair Trade Alliance (2006). Nationalist Development Agenda: A Road Map for Economic Revival, Growth and

Sustainability.

Lim, Joseph (2007). Trade and Investment Component: Abridged Version.

Lin Justin Yifu (2004a). Development Strategies for Inclusive Growth in Developing Asia.

____________ (2004b). Lesson’s of China’s Transition from a Planned Economy to a Market Economy

Moran, T.H., E.D. Graham and M. Blomström, editors (2005). Does foreign direct investment promote

development? Washington DC: Institute for International Economics/Center for Global Development

United Nations Conference on Trade and Development (2007). World Investment Report.

____________ (2004). World Investment Report.

World Trade Organization (2002). Communication from Brazil and India, The Mandated Review of the

TRIMs Agreement, Paragraph 12(b) of the Doha Ministerial Declaration Implementation-related issues

and concerns (tiret 40), 9 October.


Possibilities of Debt Reduction for MDG Financing:The Philippines and Indonesia

1. The Need for MDG Financing for the Philippines and Indonesia

1.1 A lot of work to do to attain MDGs in the Philippines

Although MDG on poverty reduction is still on track in the Philippines, the latest data (2003) show that close

to 25 million Filipinos, or more than 30 percent of the population, are considered poor. This is much more than

those of any of the ASEAN countries.

There are also MDG targets that are not on track (see Philippine MDG Report, UNDP [2005b]). These are:

- Reducing the number of malnourished and underweight children.

- Achieving the minimum dietary requirement for the population.

- Adequate family planning and population programs.

Furthermore, MDG targets “in trouble” or needing attention are:

- Elementary cohort survival rate (deteriorating).

- Immunized children (deteriorating).

- Maternal health (bad data and little sign of progress).

- Child mortality.

- Water and sanitation.

- Natural resource degradation, pollution.

1.2 A lot of work to do to attain MDGs in Indonesia

In Indonesia, the national poverty rate more than doubled from 17.7 percent in 1996 to 38.7 percent in Sep-

tember 1998 due to the severe impact of the Asian crisis and the political, economic and fi nancial turmoil that

followed. The fi gures for 2006 showed the rate to be back to the 1996 level (17 percent and up from the previous

level), affecting 39 million people. Thus Indonesia lost 10 years in the fi ght against poverty due to the Asian crisis.

MDG targets not on track or needing attention are:

- Improving child nutrition (reducing the number of malnourished children).

- Reducing child and infant mortality.

Joseph Anthony Y. Lim


- Maternal health (also patchy data, and no sign

of progress).

- Water and sanitation.

1.3 Regional disparities in Indonesia

and the Philippines

For both countries reducing the national poverty

rate (MDG Goal No. 1) is on track.

However, both countries’ national poverty rates

are much higher than those of the more successful

countries in the region (near 20 percent for Indone-

sia, more than 30 percent for the Philippines).

Furthermore, both have very depressed regions

where almost 50 percent or more of the population

are poor:

- Papua, Maluku, Gorontalo, East and West

Nusa Tenggara and Aceh for Indonesia.

- Autonomous Region of Muslim Mindanao

(ARMM), Cordillera, Caraga, Bicol, the Sa-

mar provinces.

- For both countries, the depressed areas are those

prone to be confl ict areas, or with indigenous

peoples and minority groups, or those prone to

natural disasters and are far-fl ung areas.

1.4 Financing gap estimates

Manasan (2007) estimates that the fi nancing gap

for MDGs in the Philippines is about PhP777.8 bil-

lion (0.76 percent of GDP) for the period 2007-2015.

The fi gures in dollars would have gone up signifi cantly

as the peso had appreciated since 2006. This is around

1/4 to 1/3 of the total external debt of the Philippines

(as of end 2005), around 40 percent to 50 percent of

the government external debt (as of end 2005).

The Indonesia Human Development Report

(2004) estimated that the fi nancing gap for food,

education, health and physical security amounted

to around 2.5 percent of GDP in 2003. If this per-

centage remains constant, the amount will be around

US$60 to US$70 billion for 2006-2015, which is

around 50 percent of external debt in 2005 and al-

most 100 percent of the central government’s exter-

nal debt in 2005.

2. Main Path to Achieving the MDGs It has to be emphasized that debt reduction should

not be the main policy to achieve the MDGs.

The main policies to achieve the MDGs would

of course be policies towards people’s empowerment.

These include:

- Quality, equitable, and sustained growth in

incomes (an effective development strategy)

- Increasing savings rate to strengthen domestic

fi nancing of physical, social and human capi-

tal formation (again an effective development

strategy).

- Increasing employment opportunities (a clear

people-oriented development and employ-

ment strategies).

- Reduction of the high dependency burden.

(family planning and population programs).

- More equitable sharing of wealth and income:

reforms in land, agrarian assets, housing and

access to resources and social services (equity

programs).

- Increased and improved social services deliv-

ery (social and fi scal programs).

Even with respect to fi nancing the MDG needs,

debt reduction is just a supplementary policy. The

main policies to bridge the fi nancing gaps of the

MDGs are:

a) Fiscal Reforms: increase government fi nanc-

ing of MDG needs. These include:

- Progressive taxation; reduce under-report-

ing of sales and income and tighten rules

on exemptions for corporate and non-fi xed

income earners.

- Reduce the myriad of fi scal incentives and

concentrate the incentives on a few key sec-

tors with strong economic linkages, innova-

tion and demonstrated contribution to the

economy.

- Reallocate government spending and reduce

wastage to maximize impact on MDGs (in-

cludes reducing wastage & corruption).


- Protect the MDG budget from any budget

cut.

- Ensure that the MDG budget is growing as

fast as the other budget items.

- Stick to current high-revenue targets but

relax on fi scal defi cit targets to allow for

higher government spending. A fi scal defi cit

of one percent to two percent of GDP will

still be manageable.

b) Resource mobilization and fi nancing of MDG

needs:

- Private-public sector partnerships with

business groups, international and domestic

NGOs, religious sectors, and civil society/

community/ people’s groups.

- External development assistance, espe-

cially grants, soft loans and debt reduc-

tion, making sure that the projects are de-

termined by genuine Philippine interests

and that no damaging conditionalities are

imposed.

- Improved social accountability and trans-

parency for development and MDG proj-

ects, and reduce corrupt and wasteful use of

funds in the public sector.

c) Putting in place effective MDG projects and

programs prior to funding and debt reduc-

tion:

- Prioritizing and planning for MDG projects

and programs.

- Laws and implementing guidelines that pri-

oritize MDG spending in fi scal budget.

- Strengthened and systematized reporting of

MDG spending by the various line agencies

to the budget offi ce, and the consolidated

budget for MDG spending by the budget

department or ministry.

d) Concrete recommendations to mobilize and

safeguard MDG fi nancing:

- Have Social Accountability for the MDG

projects and programs.

- Improve and provide fi nancing of monitor-

ing and evaluation processes.

- Plan for and provide fi nancing for improv-

ing local capacities to plan, implement,

monitor and evaluate MDG projects.

- Plan for and improve transparent processes

in procurements, project planning, imple-

mentation and bidding of projects.

e) Issues of absorptive capacity, transparency and

accountability of MDG projects:

- Match donor and government projects and

viewpoints.

- Correct MDG prioritizing will make the

MDG fi nancing more demand-led.

- Assure fl exibility and appropriateness of do-

nors’ conditionalities and requirements to

local needs.

- Agree to basic rules of procurement, ac-

counting, disbursement of funds, auditing,

monitoring and evaluation; issues on right-

of-way, resettlement.

- Develop local government capabilities.

- Facilitate disbursements of funds from na-

tional to local.

Indonesia already made plans to achieve the

above. The TARGET MDGs (To Assess Revitalize

and Gear Efforts Towards MDGs) Programme of the

BAPPENAS (Economic Planning Agency of Indo-

nesia) and UNDP aim to build national and local

capacities to accelerate progress towards achieving

the MDGs, especially in the depressed areas.

Indonesia has set up MDG/Human Develop-

ment (HD) Working Groups composed of govern-

ment agencies, civil society representatives and UN

agencies and co-chaired by BAPPENAS and the Co-

ordinating Ministry for People’s Welfare, which will

be responsible for providing the data and monitoring

processes to track the progress towards HD and the

different goals of the MDGs

The TARGET MDGs programme has plans to

set up an MDG Fund for depressed areas to mobilize


resources to assist districts that are lagging behind in

terms of reaching the MDGs. The main aims are:

a) to improve delivery of basic services and

strengthen institutions that provide them in

the poorest regions; and

b) to improve affordability of these services by

providing better economic opportunities in

the poor regions.

This complements the Community Empower-

ment Program (PNPM) and Conditional Cash Trans-

fer Program. The programme is expected to cover all

the sub-districts (5,263) in Indonesia by 2009, thus

requiring the Government to raise and allocate over

US$20 billion.

The MDG Fund and PNPM can incorporate

funds derived from debt reduction, together with

grant money, and other generated funds.

3. Why Developing Countries Would Benefi t From Debt Reduction for MDG Financing

Even if the main path towards achieving the

MDGs is to follow the right development strategy,

employment strategy, anti-poverty strategy and social

services delivery, there are various reasons why devel-

oping countries would benefi t from debt reduction

towards fi nancing of the Millennium Development

Goals.

1. For very poor and low-income countries,

a heavy debt burden, mostly from offi cial

debts to bilateral and multilateral creditors,

reduces social fi nancing for the majority of

the poor population. Many of these countries

have very little foreign exchange and/or fi scal

earning capacities. They therefore are unable

to pay their foreign debt and are in de facto

debt default. Because of the inability to pay

their debts, these countries are cut off from

international fi nancing, which they direly

need for their development and MDG needs.

The main motivation of the Heavily Indebted

Poor Countries (HIPC) Initiative and the

Multilateral Debt Relief Initiative (MDRI)

is to supposedly address this problem. They

cover many countries in Sub-Saharan Africa

and Central America.

2. During periods of fi nancial crises, panic and

deep recessions with investors and creditors

withdrawing their funds and causing specula-

tive attacks on the currency, many low-income

and middle-income countries are unable to

pay both commercial and offi cial debts as in-

ternational reserves dwindle and the domestic

cost of the debt explodes due to currency de-

preciation. The Philippines and Latin Amer-

ica experienced this in the 1980s. Indonesia

experienced this in the Asian crisis of 1997-

99. Argentina and Turkey experienced this in

the early 2000s. The heavy debt burden con-

tributed to economic collapse and increased

poverty and retarded human development.

3. For countries with high debt burden and

signifi cant current account and balance of

payments defi cits, precious foreign exchange

needed for development is going to pay for

principal and interest debt payments. This

leads to lower economic growth or recessions

and retardation of development and MDGs.

4. For countries incurring high debt burden and

signifi cant fi scal defi cits, fi scal revenues are be-

ing channeled to debt and interest payments,

which could have gone to MDG fi nancing

such as health, education, social services,

housing and infrastructure development of

depressed areas. This is the problem faced by

the Philippines and Indonesia.

4. Why Debt Reduction and Debt-to-MDG Conversions Would Be Benefi cial for MDG Financing of the Philippines and Indonesia4.1 The fi scal and debt picture: Principal and

interest payments are reducing funds for social

and economic services in the Philippines

The recent fi scal crisis of the Philippines increased

public and government debt signifi cantly. Debt ser-

vicing increased and encroached on vital spending on

social and economic services – public spending that


is essential for reaching the MDG targets. Almost all

countries adversely affected by the 1997 Asian fi nan-

cial crisis were able to reduce their debt burden from

the peak values reached in 1997 and 1998. Only the

Philippines entered a fi scal crisis as fi scal positions

deteriorated instead of improving, even as economic

growth turned positive after the crisis.

Figure 1 shows the Philippine national govern-

ment defi cit as percentage of GDP. There were three

periods of extremely high fi scal defi cits, the early

1980s, the second half of the 1980s, and especially

the period 2002-2004. The fi rst two preceded out-

put recessions. The national government posted rare

surpluses in 1994-97. High fi scal defi cits in the Phil-

ippines can be traced to three factors: low tax effort,

high public debt service, and losses of government

corporations. Value-added taxation was instituted

in the late 1980s. High growth in the 1994 to 1997

period helped raise the tax effort as it peaked at 17

percent in 1997 (Figure 2).

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

18.00

16.00

14.00

12.00

10.00

8.00

6.00

4.00

2.00

0

Figure 2. Tax Effort, In % of GDP: Philippines

Figure 1. National Government Defi cit: % of GDP

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2

1

0

-1

-2

-3

-4

-5

6

Perc

ent

Sources: Department of Finance, Department of Budget and Management


Large and rising fi scal defi cits in 2002-2004

raised concerns from all corners. The most disturb-

ing thing was the decline in the tax effort in the

post-Asian crisis years of 1999 to 2005 (Figure 2),

despite economic recovery and growth. The reasons

for this decline can be traced to reduced tariffs due

to import liberalization, the effects of the Compre-

hensive Tax Reform Law of 1997 which failed to

ensure lower exemptions to big corporations and

high-income individuals, and deteriorating tax ad-

ministration.

Significant improvements in lowering the fis-

cal deficits of the Philippines were achieved from

2003 to 2006, but at very high costs. For one,

lower deficits were achieved mainly through deep

cuts in social and economic services (see Figure 3)

as interest payments went up (making up around

30 percent of the total budget in 2006). Total bud-

get expenditure shrank to 12.2 percent of GDP

in 2005 and 2006 and improved only in the first

half of 2007. The expansion of the coverage of the

value-added tax and improved financial condition

of the state-owned National Power Corporation

(whose losses aggravated public deficits in 2002 to

2005) helped tax revenues in 2006. But tax col-

lection faltered again in 2007 as the fiscal target

was missed and as government again spent below

its spending targets in order to reduce the fiscal

deficit. Furthermore, to make up for the missed

tax revenue targets the government sold govern-

ment-owned shares of stocks in private corpora-

tions derived from the sequestration of the Marcos

assets. Even with these problems, the government

still aimed for a balanced budget (zero national

government deficit) by 2008, two years ahead of

the original target date.

With national government debt representing

64 percent of GDP in 2006, debt service (interest

and principal) payments have been taking up more

than 80 percent of government revenues (Table 1).

Interest payment was a high 5.5 percent of GDP

and 31.1 percent of the budget in 2006. This went

down to around one-quarter of the budget in the

fi rst seven months of 2007. All these fi gures show

a deterioration from the 1998 (Asian crisis) situa-

tion. This is in sharp contrast to Indonesia, which

improved its debt burden signifi cantly from its deep

debt crisis lasting from 1998 to 2000. Its improve-

ment was fast from 2001 onwards. In contrast, the

Philippines – which did not get deeply embroiled

in the Asian crisis – found its debt and debt service

burden seriously deteriorating from 2002 to 2003

and is now in worse shape than Indonesia.

Table 2 shows that Indonesia’s public debt ser-

Figure 3. Government Expenditures by Type of Services, % of GDP



vice in 2004 was only less than 40 percent of gov-

ernment revenues, and its national government debt

was less than 50 percent of GDP in 2005. Their situ-

ation even improved in more recent years.

If the Philippines fi scal situation is not improved,

the repercussions are:

a. It will reduce funds that should go to in-

frastructure as well as economic, social and

human development. Reduced funding pre-

vents the government from pump-priming

the system into higher growth and from un-

dertaking poverty reduction. In particular,

the infrastructure building program all over

the country promised by Gloria Arroyo in

her State of the Nation address in 2006 will

be jeopardized.

b. The inability to solve the fi scal problem also

reduces business confi dence in the macro sta-

bility of the country. This reduces investments

and economic activity.

c. The large debt service payments and public

debt burden involve risks of possible defaults

due to external or unanticipated shocks, and

may bring major economic downturns, which

will exacerbate poverty and retardation of hu-

man development.

Table 1. Public Debt Service and Public Debt Burden of the Philippines

1998 1999 2000 2001 2002 2003 2004 2005 2006 Jan-July* 2007

As % of Revenues

NG Debt Service Payments 35.6 42.9 44.3 48.4 61.9 73.5 85.1 83.2 87.2

Interest 21.6 22.2 27.4 30.8 32.1 35.4 36.9 36.7 31.7

Principal 14.0 20.7 16.9 17.6 29.8 38.1 48.2 46.5 55.6

As % of GDP

Total National Gov’t Debt 56.1 59.6 64.6 65.7 71.0 77.7 78.2 71.5 63.8

Domestic 31.9 32.9 31.8 34.4 37.1 39.5 41.1 39.8 35.7

Foreign 24.2 26.8 32.7 31.3 33.9 38.3 37.2 31.7 28.1

As % of GDP

Total Public Sector Debt 94.6 101.4 106.0 110.2 117.5 108.7 92.6 73.9

Domestic 35.2 32.8 32.5 32.7 34.4 35.5 35.1 32.1 28.7

Foreign 59.5 68.6 76.8 73.3 75.9 82.1 73.7 60.5 45.2

As % of GDP

Total Expenditure less Interest Payment

16.4 15.9 16.1 14.8 15.2 14.2 13.0 12.2 12.2 13.5

Interest Payment 3.7 3.6 4.2 4.8 4.7 5.2 5.4 5.5 5.1 4.4

Total Expenditure 20.2 19.5 20.3 19.6 19.9 19.5 18.3 17.7 17.3 17.9

Interest Payment As % of Budget 18.6 18.3 20.6 24.5 23.5 27.0 29.2 31.1 29.7 24.4

*GDP was estimated as 7/6 times the GDP of the fi rst semester of 2007Source: Bangko Sentral ng Pilipinas, Bureau of Treasury, Department of Budget Management

Table 2. Debt Burden of Indonesia

2000 2001 2002 2003 2004 2005

External Debt (% of GDP) 97.8 82.2 63.0 56.3 56.3 48.1

Total Central Gov’t Debt (% of GDP) 98.8 83.2 70.7 64.6 61.9 52.7

Government Defi cit (% of GDP) -1.2 -2.4 -1.3 -1.7 -1.3

Government Principal and Interest Debt Servicing (% of GDP) 32.7 34.3 36.2 31.8 39.9

Source: Bank Indonesia, Ministry of Finance of Government of Indonesia


4.2 High Cost of Debt Servicing

Although there were improvements in the defi cits

from 2002 to 2006, the current situation is still sig-

nifi cantly worse than in 1998 (the year of the Asian

crisis). Furthermore, the fi scal position has not yet

improved for the Filipino people. Table 1 shows the

defi cit being reduced, especially from 2004 to 2005,

mainly through expenditure constriction. Total ex-

penditure fell from around 19 percent of GDP from

1998 to 2003 to 17.3 percent in 2006.

But the situation is worse. Table 3 shows that eco-

nomic services fell from 5.1 percent of GDP in 2000

to 2.9 percent of GDP in 2005, with sharp drops

in public spending for communications, roads and

other transportation. Expenditures for social services

fell from 6.4 percent of GDP in 2000 to 4.7 percent

in 2005, with sharp falls in spending for education,

housing and health.

In short, fi nancing for social and economic services

has been suffering especially in the last few years. Attain-

Table 3. National Government Expenditures, Obligation Basis, By Sector, % of GDP

P A R T I C U L A R S 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 ECONOMIC SERVICES 4.9 5.4 4.9 4.7 5.1 4.3 3.9 4.0 3.5 2.9 Agriculture, Agrarian Reform, and Natural Resources

1.3 1.7 1.2 1.1 1.1 1.1 0.9 0.9 0.7 0.6

Trade and Industry 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Tourism 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Power and Energy 0.1 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 Water Resource Development and Flood Control

0.1 0.3 0.1 0.2 0.1 0.2 0.2 0.2 0.2 0.1

Communications, Roads, and Other Transportation

2.0 2.0 2.2 1.8 2.3 1.7 1.4 1.6 1.4 1.0

Other Economic Services 0.2 0.1 0.1 0.2 0.1 0.1 0.1 0.0 0.1 0.1 Subsidy to Local Government Units

0.9 1.0 1.0 1.1 1.2 1.1 1.2 1.1 1.0 1.0

SOCIAL SERVICES 5.7 6.5 6.6 6.5 6.4 5.9 5.9 5.5 5.2 4.7 Education, Culture, and Manpower Development

3.4 3.9 4.0 3.7 3.5 3.2 3.2 3.0 2.7 2.5

Health 0.5 0.6 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3 Social Security and Labor Welfare

0.5 0.8 0.9 0.8 0.8 1.0 0.9 0.9 0.9 0.7

Land Distribution (CARP) 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.0 0.2 0.1 Housing and Community Development

0.2 0.1 0.1 0.1 0.3 0.1 0.0 0.1 0.0 0.0

Other Social Services 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 Subsidy to Local Government Units

1.0 1.1 1.1 1.2 1.3 1.2 1.3 1.2 1.1 1.0

DEFENSE 1.4 1.2 1.2 1.1 1.1 1.0 1.0 1.0 0.9 0.8 GENERAL PUBLIC SERVICES 3.6 3.8 3.8 3.6 3.7 3.3 3.4 3.3 2.9 2.6 General Administration 1.5 1.5 1.5 1.2 1.2 1.1 1.1 1.0 0.9 0.8 Public Order and Safety 1.3 1.4 1.4 1.4 1.4 1.2 1.3 1.2 1.1 1.0 Other General Public Services 0.2 0.1 0.1 0.0 0.1 0.1 0.1 0.1 0.0 0.1 Subsidy to Local Government Units

0.7 0.8 0.8 0.9 1.0 0.9 1.0 0.9 0.8 0.8

TOTAL EXPENDITURES EXCL 15.6 17.0 16.4 15.8 16.3 14.5 14.3 13.8 12.4 11.1 INTEREST PAYMENTS, NET LENDING

NET LENDING 0.1 0.1 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 INTEREST PAYMENTS 3.5 3.2 3.7 3.6 4.3 4.8 4.8 5.3 5.4 5.8 TOTAL EXPENDITURES 19.2 20.3 20.2 19.5 20.7 19.5 19.1 19.2 18.0 17.1

Source: Department of Budget and Management


1 It must be pointed out that standard accounting practice does not treat principal payments for debt as fi scal or government expenditures. Only interest payments for debt are considered as government expenditures. The fi nancing of the fi scal defi cit is defi ned as new (external and domestic) fi nancing less principal payments (or amortization of debt payments). This accounting practice simply emphasizes the fact that new loans have to be incurred to fi nance maturing principal payments. Other new loans will also have to be incurred to fi nance the defi cit itself.

ing the MDG targets is thus in grave jeopardy.

4.3 Large debt servicing vis-à-vis low

government revenues

But the biggest indicator that the fi scal problem is

really severe is the national government debt service

payments as a proportion of national government

revenues, shown also in Table 1. Principal and inter-

est debt payments of the national government com-

prised 35.6 percent of national government revenues

in 1998. This increased tremendously to more than

80 percent of national government revenues in 2004

to 2006. This leaves very little of the revenues to fund

vital spending by government. The rest will have to

be fi nanced by new debts1 resulting in a continuing

rise in public debt and a continuing expenditure con-

striction happening at the same time.

The increase in total public sector defi cits has

increased the size and burden of public sector debt,

particularly for the national government. Table 1

gives us the levels of national government and public

sector debts as percentages to GDP. One can see that

the national government debt had continuously in-

creased, from 56.1 percent of GDP in 1998 to 78.2

percent of GDP in 2004. This improved to 63.8

percent of GDP in 2006, still higher than in 1998.

All traditional analyses consider the debt burden to

be more comfortable if national government debt is

below 50 percent. Outside the highly indebted low-

income transition economies in ASEAN (Laos and

Cambodia), the Philippine national government is

the most indebted in the region.

4.4 Indonesia to benefi t from Debt

to MDG conversions

Although Indonesia has improved its debt bur-

den compared to the Philippines, it also would ben-

efi t tremendously if debt payments are diverted to

Table 4. Indonesian Central Government Expenditures, By Function, as % of GDP

1996 1997 1998 1999 2000 2001 2002 2003

Total Central Government Expenditures 15.44 17.41 18.07 20.90 15.83 16.16 13.20 12.61

General public services r 1.17 1.02 0.78 0.83 0.55 0.52 0.55 0.70

Defence 1.64 1.31 1.16 0.91 0.82 0.97 1.04 1.34

Education 1.42 1.40 1.27 1.31 0.85 0.81 0.85 1.07

Health 0.44 0.47 0.57 0.57 0.28 0.21 0.21 0.37

Housing and community amenities s 3.65 3.46 3.02 3.54 3.01 0.37 0.49 0.17

Economic services 5.26 7.10 6.16 9.31 5.84 9.82 6.88 5.69

Agriculture 0.87 0.83 0.74 1.58 0.44 0.50 0.51 0.56

Industry 0.22 0.09 0.03 0.05 0.02 0.05 0.10 0.03

Electricity, gas, and water u 0.63 0.79 0.85 0.30 0.14 0.16 0.22 0.14

Transport and communications v 1.23 1.28 0.96 0.61 0.35 0.27 0.54 0.53

Other economic services (less int) 4.11 3.57 6.77 4.88 8.84 5.51 4.43

Interest Payments 1.86 2.67 5.11 4.43 4.47 3.34 3.07 2.98

Others 0.00 0.00 0.00 0.00 0.00 0.11 0.13 0.30

Regional Budget Expendnitures 2.79 2.72 2.38 4.81 5.27 5.88

Total Budget Expenditures 15.44 17.41 20.85 23.62 18.21 20.97 18.48 18.49

Source: ADB Key Indicators


MDG fi nancing. Table 4 shows Indonesian central

government expenditures as percentage of GDP.

What Table 2 hides is that Indonesia’s government

budget doesn’t just include debt interest payments

(as shown in Table 4) but “other economic services.”

Under “other economic services” is actually the pay-

ment of recapitalization bonds by the Indonesian

government. Recapitalization bonds were bonds

that the Indonesian government issued in 1999 to

2001 in order to fi nance the rehabilitation of failed

banks. Thus, Indonesia faces heavy debt servicing

not just from interest payments but payment of re-

capitalization bonds, which together added up to

more than 5 percent of GDP in 2003 (Table 6).

This would mean much less funds going to educa-

tion, health, transportation, communications and

public utilities.

Figure 4 shows that the two of the three top bud-

get items – “other economic services” and interest pay-

ments – are involved with debt service payments.

4.5 Advantage of debt reduction

If done properly debt conversion schemes will

free debt servicing and channel funds to already pri-

oritized MDG fi nancing needs.

It is hoped that debt conversion is demand-led,

i.e., based on the MDG fi nancing priorities. Some

ODAs and export credit loans are supply-led or tied

aid that imposes conditionalities and requirements

that may not match domestic conditions.

It is easier to break the debt trap by reducing the

debt burden rather than incurring more debt in order

to fi nance repayment of debts and interest. The latter

brings about a debt trap and vicious cycle.

5. Options for Debt Reduction and Past Experiences of Debt Treatments and Debt Conversions

5.1 The options for debt relief and debt

reduction are:

1. Outright cancellation of debts or asking large

discounts for debts: e.g. Argentina, Nigeria,

Iraq.

2. Asking for debt treatments which including:

- debt rescheduling for MDG fi nancing

Figure 4. Indonesian Government Expenditures, % of GDP

Source: Table 4


- debt reduction for MDG fi nancing

- debt conversions for MDG fi nancing.

Because of the Philippines’ and Indonesia’s entry

into grave debt and fi nancial crises in 1984-85 (for

the Philippines) and 1997-99 (for Indonesia), the

two countries were given debt treatments consisting

of debt rescheduling shown in Tables 5 and 6.

It should be noted that when both countries went

into debt crisis (in 1984-85 for the Philippines and

in 1997-99 for Indonesia), they were only given debt

rescheduling with grace periods. They had to make

additional interest payments for lengthening the

term of the loans. Indonesian CSOs say that this is

very different from the debt reduction Indonesia

got in 1970 (a politically motivated debt reduc-

Table 5. List of Paris Club Debt Treatments for Philippines

Table 6. List of Paris Club Debt Treatments for Indonesia: 1998 -2005

Source: Paris Club Website: http://www.clubdeparis.org

DATE OF THE TREATMENT

TYPE OF THE TREATMENT

STATUS OF THE TREATMENT

AMOUNT OF DEBT RE-SCHEDULED TERMS OF RESCHEDULING

May 10, 2005 Ad-Hoc

active $2.704 billion

ODA debts rescheduled for 5 years with 2- year grace period at conces-sional ratesNon-ODA debts rescheduled for 5 years with 2-year grace period at commercial rates

April 12, 2002

Houston

active

$5.473 billion


April 13, 2000 Houston

active

$5.445 billion


September 23, 1998

Ad-Hoc

active

$4.2 billion


Total $17.822 billion

Source: Paris Club website

Date of treatment Amount ($ m) Type Cutoff date Debt swaps Status

19-Jul-94 585 Houston 1-Apr-84 Yes Active

20-Jun-91 1,096 Houston 1-Apr-84 Yes Fully paid

26-May-89 1,859 Classic 1-Apr-84 - Fully paid

22-Jan-87 870 Classic 1-Apr-84 - Fully paid

20-Dec-84 1,000 Classic 1-Apr-84 - Fully paid

Total 5,350


tion given to the new Suharto government by the

Western countries) wherein no additional interest

payments were charged and the country got a debt

reduction amounting to around 50 percent of the

debt.

Since the debt treatments of the Philippines oc-

curred mostly in the 1980s, the only active debt

treatment left was the one derived in 1994. On the

other hand, Indonesia still has a lot of active debt

treatments amounting to several billions of dollars

since these were derived more recently.

5.2 Debt conversions for rescheduled debts

under an active debt treatment.

Debt conversion schemes can be among the fol-

lowing:

i) Debt-to-development or debt-to-nature swaps

where a third party (international NGO, a UN

agency) buys a sovereign debt and the Philip-

pines puts up a peso counterpart (whether at a

discount or not) for a priority MDG project;

and

ii) A conditional bilateral debt cancellation

wherein a sovereign creditor agrees to write

off sovereign debts in exchange for the gov-

ernment putting up a peso counterpart

(whether at a discount or not) for a priority

MDG project.

The Philippines has had benefi cial debt conver-

sion experiences, which include the following:

a) The Foundation for the Philippine Environ-

ment (FPE):

In 1991, the USAID signed a cooperative agree-

ment with the World Wildlife Fund (WWF), making

the latter the trustee of an environment endowment.

The WWF bought Philippine debt papers in the

international market and exchanged these for peso-

denominated Central Bank bonds. This amount, to-

gether with a donation from the Bank of Tokyo and

further grants from the USAID, all totaling US$21.2

million, was used to establish the Foundation for the

Philippine Environment in 1992. The FPE used the

endowment to give grants to Philippine non-gov-

ernment and peoples’ organizations for biodiversity

conservation projects. Haribon is one of the benefi -

ciaries.

b) Debt-for-Mt. Pinatubo Victims:

In 1991, the French Government agreed to write

off 20 million French francs of Philippine Govern-

ment debt so that the latter could put an equivalent

amount to rehabilitate areas hard-hit by the erup-

tion of Mt. Pinatubo. The major project undertaken

was the construction of Camp O’ Donnel in Tarlac

– which became the resettlement area for the Mt. Pi-

natubo victims.

c) The Foundation for a Sustainable Society,

Incorporated (FSSI):

The Swiss government established the Swiss Debt

Reduction Facility. Through this facility, the Swiss

and Philippine governments signed on 11 August

1995 an External Debt Reduction Agreement where-

by 42,436,551.80 Swiss francs worth of Philippine

bilateral debt to Switzerland was cancelled and a peso

fund equivalent to 50 percent of the face value of the

debt became the endowment of the FSSI to imple-

ment development projects. In 2004, FSSI approved

48 new projects comprising loan assistance (10);

development deposits (10); joint ventures (2) and

grant assistance (26). Project proponents included

24 NGOs; 10 cooperatives, three rural banks, three

cooperative banks, three private enterprises, two peo-

ples organizations and one credit union.

d) RP-KFW Debt for Nature Swap:

On 31 October 1996, the Kreditanstalt fur Wie-

deraufbau (KFW) and the Philippine government

signed an agreement whereby up to 6,531,776.70

Euros (12,775,044.82 deutschemarks) of Philippine

bilateral debt to KFW would be cancelled as soon

as the Philippines put up not later than 31 March

2002 an amount in pesos equivalent to 30 percent of

the to-be-cancelled debt for a community-based for-

estry management project covering 10 barangays in


Quirino Province, adjacent to an on-going German-

funded grant on Community Forestry. In January

2002, the Department of Environment and Natural

Resources (DENR) completed the agreed undertak-

ings in January 2002 and the KFW, after due evalua-

tion, cancelled the debt.

e) Tropical Forest Conservation Fund:

In 2001 the Philippine and the U.S. governments

signed a Debt Reduction Agreement and a For-

est Conservation Agreement under the debt reduc-

tion/rescheduling scheme of the U.S. Tropical For-

est Conservation Act (TFCA) of 1998. Under these

agreements, the Philippines, instead of paying the

accumulated interest totaling US$8,247,538.00 on

eight loans contracted from the US before 1 Janu-

ary 1998, would use the peso equivalents to endow

the Tropical Forest Conservation (TFC) Fund. Pay-

ments to the fund would be done in 28 semi-an-

nual payments starting 2003. The Philippines would

continue to pay the principal in dollars based on the

original amortization schedule while the US appro-

priated US$5.5 million for the interest payment. The

Fund, which amounted to PhP137,414,697.05 as of

1 December 2004, is to be used for forest conserva-

tion projects.

Recent benefi cial debt conversions given to Indo-

nesia are:

a) Between 2000 and 2003, the Indonesian gov-

ernment and Germany, through the German

bank, KfW (Kreditanstalt fur Wiederaufbau),

negotiated the debt conversion of 48 million

euros (equivalent to 505 billion rupiahs, or

US$57.6 million) of debts due to Germany

for the development of elementary education

learning research centers. This consisted of the

establishment of 511 science and technology

study centers to be built in 17 provinces for

the training and improvement of elementary

teachers’ capacities.

b) In 2004, 23 million euros of Germany’s loan

to Indonesia (around 253 billion rupiahs, or

around US$27.6 million) was converted to

build junior high schools in 54 regions in 14

provinces in Eastern Indonesia (again in nego-

tiations with KfW).

c) A debt conversion scheme involving 12.5 mil-

lion euros (around 135 billion rupiahs and

US$14 million and again with KfW represent-

ing Germany) was used for a debt-for-nature

swap concentrating on natural resources con-

servation.

d) A debt conversion scheme for education

amounting to 20 million euros was used to

build schools in Central Java.

In all these conversions, the agreement was that

the Indonesian government would provide the rupi-

ah funds for the identifi ed projects amounting to 50

percent of the debts to be cancelled. This effectively

gave a debt discount of 50 percent.

e) A possible debt-to-health swap of around 35

million euros of German loans will be can-

celled on condition that 50 percent of the face

value of the debt will be given by Indonesia

to a Global Fund approved project for HIV/

AIDS, tuberculosis or malaria.

f ) More debt conversions are planned for Indo-

nesia. Similar debt swaps are being negotiated

with the Italian government. Negotiations

with the United Kingdom, the United States

and Australia for debt conversions are also be-

ing undertaken.

6. The Maneuvering Space for Debt Reduction for the Philippines and Indonesia

6.1 Diffi culties of debt cancellation

or discounting debt

The fi rst reason why it is diffi cult to do unilat-

eral debt cancellation or ask for debt discounts is that

government economic managers themselves prefer to

focus on voluntary debt conversion of bilateral debts

or voluntary debt treatments of debts.

Second, even the massive debt relief won by Ar-

gentina and Nigeria required the payment of the


remaining debt (several billions of dollars) within a

short period. The Philippines does not have fi scal and

international reserves resources for this type of debt

conversion. There is also not much discount now for

Philippine and Indonesian debts, especially after the

credit upgrades.

Third, outright debt cancellation is only given to

HIPC and poor low-income countries. Multilateral

debts cannot be reduced.

However, bilateral debt conversions and debt

treatments are constrained by IMF and Paris Club

rules. The eligible debts for the Philippines are debts

incurred before the cut-off date of 1 April 1984. This

leaves very little debt eligible for debt reduction and

debt conversion.

For Indonesia, possibilities for large-scale debt con-

version funds are not big. All the projects mentioned

are small percentages of external debt. The German

government has told the government of Indonesia that

the latest debt conversion would be the last.

On the part of creditor countries, they are also

reluctant to convert the debt of middle-income

countries. They give the following reasons for this

reluctance:

- They claim to have obligations to their tax-

payers.

- There is a need to go through the legislative

and budget processes of the creditor country.

- They prefer to help only politically important

countries and allies.

- They forget about the commitment of devot-

ing 0.7% of their GNP for external develop-

ment assistance.

6.2 The Paris Club’s New Evian Approach

The Evian Approach of the Paris Club (2003) al-

lows both countries to ask for a new debt restructur-

ing which can include debt rescheduling, debt reduc-

tion and debt conversions with a new cut-off date.

But the two countries will most likely have to pass

the Houston terms.

The Houston terms define high indebtedness

as fulfilling at least two of the following three cri-

teria:

- the debt-to-GDP ratio is higher than 50 per-

cent,

- the debt-to-exports ratio is higher than 275

percent,

- the scheduled debt service over exports ratio is

higher than 30 percent, and

- the country has a stock of offi cial bilateral debt

that is at least 150 percent of private debt.

Both countries will not qualify under these

terms.

To ask for the Evian Approach, the Philippines

and Indonesia will have to ask for a debt sustain-

Table 7. Responses of Entities Consulted on Debt-to-MDG Approach

Entity Consulted Main Position Additional Remarks

1. UN Secretary General Kofi Annan

Redefi ne debt sustainability concept as the level of debt that allows developing countries to achieve the MDGs without an increase in their debt ratios to allow developing countries to achieve the MDGs without an increase in their debt ratios.

Broadening the scale and scope of debt swaps would help provide debt relief and release additional funds for fi nancing sustainable activities to attain the MDGs.

2. Paris Club Chair Xavier Musca

Paris Club instruments & Evian approach are suffi cient to address debt situation of non-HIPC countries, based on debt sustainability analysis by the IMF. Debt-to-equity swaps will occur naturally with private creditors seeking high rates of return.

3. Japan Does not want to undertake debt conversions for Philippines since it thinks Philippines needs fi scal reforms and debt management more and is concerned with ’moral hazard’ from the Philippine side.


ability assessment from the IMF, and come up with

an economic program approved by the IMF. This is

not acceptable to the economic managers of the two

countries since an IMF program is based on a debt

sustainability analysis of capacity to pay. This will

give the wrong signal that the two countries cannot

pay their debts and will rattle the fi nancial markets.

7. The Need to Go Beyond HIPC and MDRI Initiatives to Achieve the MDG for Low-Income and Middle-Income Countries

One major criticism is that the HIPC and MDRI

initiatives are easy measures for bilateral, multilateral

and commercial creditors since most of the heavily

indebted poor countries are de facto in default. Can-

celing much of these debts is just an offi cial writing-

off of much of the defaulting debts.

As mentioned earlier, the new debt sustainabil-

ity analysis (DSA) developed by the IMF and World

Bank adds a new framework to debt sustainability

analysis for low-income and middle-income coun-

tries, and this includes the Philippines and Indonesia.

The new framework does not help these countries get

debt-to-MDG fi nancing.

The weakest initiatives for debt relief are those

aimed at heavily indebted middle-income countries

such as the Philippines, Turkey and many Latin

American countries. Millions of poor people live in

these countries. Indonesia will join the ranks of these

countries in a year or two.

Furthermore, middle-income countries like In-

donesia and the Philippines and low-income coun-

tries that are not members of HIPC do not qualify

for the signifi cant debt reduction of HIPC and the

MDRI. The number of poor people in non-HIPC

countries (both low-income and middle-income

countries) far exceeds the number of poor people in

HIPC countries. This is due to the fact that the most

populous countries (China, India, Russia, Indone-

sia, Pakistan, Bangladesh, Brazil, Nigeria, Mexico,

the Philippines, Vietnam, Turkey, Argentina) are

all not part of HIPC, and most of these large non-

HIPC countries have between 20 percent and 40

percent of their population below the poverty line.

Furthermore, there are 40 HIPC countries but only

29 of them had either fi nished or are in the process

of undergoing a debt relief programme. The others

do not have any debt relief programme at all. The

World Bank in 2003 listed 54 low-income countries,

58 lower middle-income developing countries and

40 upper middle-income developing countries, to-

taling 152 developing countries. The UN Popula-

tion Fund (UNFPA) estimated that there are three

billion people living on less than US$2 a day in

20052. The World Bank estimated the poor people

in 2001 to be around 1.1 billion people (using the

US$1 a day poverty threshold.) The total population

of the HIPC countries with a debt relief programme

(29 countries) totaled 448,234,8003 in 2005. Thus

even if we assume 100 percent of the population of

these HIPC countries are poor (which obviously is

not realistic), it is safe to say that the majority of the

world’s poor still reside outside these HIPC coun-

tries, even if these HIPC countries are some of the

poorest in the world. It is therefore obvious that if

poverty reduction and achieving Goal One of the

MDG is a serious endeavor, debt relief cannot stop

merely at the doorsteps of the HIPC countries.

Given the dismal showing of developed countries’

commitment to the Millennium Declaration and the

Financing for Development to commit 0.7 percent

of their GNPs to external development assistance to

developing countries, there is much room to increase

assistance and debt relief to both low-income and

middle-income countries, including both HIPC and

non-HIPC countries.

Developed countries, in justifying their lack of

external development assistance, often claim that

HIPC and low-income countries should be given

priority over developing countries because they

2 UNFPA State of World Population 2005.3 Based on International Data Base Statistics for the 29 HIPC Countries Given Debt Relief (http://www.census.gov/cgi-bin/ipc/idbrank.pl).


are poorer. But it is a well-known fact that sectors

and areas in Indonesia, Brazil, the Philippines, Tur-

key and many other middle-income countries are

as poor as those in the poorest of countries. It is

a poor suggestion that developed countries play

Solomon and decide whether the poor in Zambia

or Nicaragua should have priority over the poor in

Papua, Aceh or the Indians in the Amazon regions

of Brazil. In order to settle this problem, it should

at least be a practice that additional ODA and debt

relief be given to middle-income countries and that

the funds be channeled to those sectors, regions and

provinces that are as poor as or poorer than those

in low-income countries. The German debt conver-

sion schemes that we discussed in a previous section

work precisely along this principle.

8. An Alternative Approach to Debt Reduction for Middle-Income Countries

8.1 Two-pronged strategy

The strategy recommended by this study, and

consistent with the suggestions of the UN Secre-

tary General and Philippine stakeholders, is a two-

pronged policy:

1) Offer attractive MDG projects and programs

where bilateral debts or grants can be chan-

neled to, within or outside the Paris Club

rules.

Rechanneling debt relief funds can be in the form

of:

* Debt conversions.

* Debt reduction.

* Debt Rescheduling.

* Grants.

Government and civil society should cooperate in

this regard. It is recommended that government and

CSOs use the current development plans and anti-

poverty plans to prioritize MDG projects that need

fi nancing. The government, in collaboration with

line agencies and local governments, can identify pri-

ority programs and projects that have been victims

of tight budget or fi scal constriction. These prior-

ity programs can be systematized and publicized to

creditor countries and international NGOs and UN

agencies as possible destinations of debt conversion

funds as well as ODA funds.

The developing countries’ government and civil

society should attract the bilateral creditors with

projects and programs that will advance the MDGs,

based on a system of prioritization of programs that

is consistent with the Medium-Term Philippine

Development Plan. Both the Philippines and In-

donesia and their creditors/ donors should ensure

transparency and accountability as well as effi cient

absorptive capacity of the programs – to ensure the

funds are appropriately and effi ciently channeled to

achieve the MDGs.

It is necessary to target the countries which are

most receptive to debt conversions, debt reduction

and grants. Among these countries are:

Paris Club countries more open to debt conver-

sions: Germany, Italy, Switzerland, US, Finland,

Spain, France, Canada, United Kingdom, Denmark,

Belgium, and the Netherlands.

Non-Paris Club Countries: China, Taiwan, Sin-

gapore, Korea, Hong Kong, India.

Muslim Countries: Malaysia, Brunei, Kuwait,

Libya, Saudi Arabia.

Countries averse to debt conversions (e.g. Japan,

Australia) should also be asked for grants.

2) Ask the UN system and UNDP to spearhead

an international campaign to change the

concept of debt sustainability of the Bretton

Woods Institutions from capacity to pay to

whether fi nancing the MDGs is being blocked

or hampered by debt servicing.

This would change the Paris Club rules and allow

a bigger chunk of bilateral debts to be reduced or con-

verted without jeopardizing the country’s credit wor-

thiness and rating. A multilateral and coordinated debt

reduction initiative for MDG fi nancing can then be

undertaken along the Norwegian recommendation.

To operationalize the new debt sustainability con-

cept, a country would need to satisfy the following


conditions for it to be considered as requiring debt

relief:

1. The country is lagging in meeting at least one of

the MDG targets and is facing MDG fi nanc-

ing gaps, and one or both of the following

conditions hold:

2a. There are clear indicators that public sector

debt service payments are encroaching on or

reducing the potential and actual budget for

social and economic services vital to meet the

MDG targets.

2b. There are clear indicators that foreign ex-

change outfl ows to pay debt service impede

the economic and social development of the

country and are retarding the progress to

achieve the MDG targets.

Both the Philippines and Indonesia satisfy condi-

tions 1 and 2a. The Philippines and Indonesia may

not meet vital MDG targets and have signifi cant

MDG fi nancing gaps. Also, despite the above, there

is a constriction on social and economic services be-

cause of the general expenditure reduction and be-

cause of the bigger budget share for debt servicing.

Furthermore, external development assistance

for the Philippines and Indonesia has been falling in

recent years (new debts are smaller than the repay-

ments).

Indonesia and the Philippines are representative

of many middle- and low-income countries outside

of the HIPC. Indonesia and the Philippines are good

examples for the need to change the concept of debt

sustainability. But more country case studies are

needed to show several countries outside HIPC are

suffering the same fate.

Examples of Non-HIPC countries with high debt

burden are:

Middle-Income countries: Argentina, Brazil,

Lebanon, Paraguay, Turkey, Ukraine, Uruguay, Ven-

ezuela

Low-Income countries: Pakistan, Laos, Cambo-

dia, Papua New Guinea

Once a suffi cient number of country studies are

available, the UNDP and the UN system can build a

strong case for an international lobby and campaign.

8.2 Changing the conditionalities in the

new debt sustainability scheme

The IMF and WB conditionalities using the “capac-

ity to pay” concept usually involve economic reforms

such as trade and market liberalization, privatization,

deregulation, fi scal and fi nancial sector reforms.

The main conditionalities employing the new

concept of debt sustainability will have to be towards

ensuring that debt relief funds go to MDG fi nancing

and towards effi cient, transparent and accountable

systems that will optimize the use of debt relief funds

for MDG needs.

As a Cooperation Internationale pour le Develop-

ment et la Solidarite (CIDSE) report noted:

“Debt sustainability assessments should be geared

to ensure that debtor countries are able to fulfi ll the

fi nancing requirements to meet human development

goals and the MDGs. The faithful implementation

of this principle requires that: a) it be equally applied

to all countries, without distinctions, including those

based on income, b) debt relief and cancellation be

actively promoted as a means to reduce the debts of

countries when they are above sustainable levels, c)

the methodology for performing Debt Sustainability

Assessments deliberately seeks to measure the cost of

achieving the MDGs and places it against the public

revenue available to meet them.[1]”

The minimum change targeted in the interna-

tional debt rules will include:

Treatments of debts owed to Paris Club members

should be allowed without any IMF debt sustainabil-

ity assessment, without an IMF economic program

and without being subjected to cut-off dates, but

subject to the criteria of debt sustainability assess-

ment based on MDG fi nancing needs.

[1] “The New World Bank/ IMF Debt Sustainability Framework: A Human Development Assessment,” CIDSE, April 2006.


Voluntary debt conversions should be allowed

even more freely since they are voluntary. We want

to endorse voluntary debt conversions to be a main-

stream method of fi nancing the MDGs, and for de-

veloped countries to comply with their Monterrey

commitment to give 0.7 percent of their GNP as

external development assistance.

The developed countries should strive to achieve

their commitment of providing external develop-

ment assistance equivalent to at least 0.7 percent of

their GNP (and this includes funds from debt reduc-

tion), and in fi nancing vital MDG projects and pro-

grams, including those of low- and middle-income

countries outside the Heavily Indebted Poor Coun-

tries (HIPC).

So far only fi ve countries have complied with

this commitment (Norway, Denmark, Luxembourg,

The Netherlands, and Sweden).

Two of the world’s and the Philippines’ top do-

nors have very dismal records. Japan spent only 0.2

percent of its GNP for external development assis-

tance in 2003, while the US spent only 0.15 percent

of its GNP for external development assistance for

the same year

Given the dismal showing of developed countries’

commitment to the Millennium Declaration and the

Financing for Development to allocate 0.7 percent

of their GNPs to external development assistance to

developing countries, there is much room to increase

assistance and debt relief to both low-income and

middle-income countries, including both HIPC and

non-HIPC countries.

The UN Secretary General has underlined the

need for a new defi nition of debt sustainability:

“[The] US$54 billion committed for debt relief

to 27 countries under HIPC still falls far short of

what is needed. [T]o move forward, we should rede-

fi ne debt sustainability as the level of debt that allows

a country to achieve the Millennium Development

Goals and reach 2015 without an increase in debt

ratios. For most HIPC countries, this will require ex-

clusively grant-based fi nance and 100 percent debt

cancellation, while for many heavily indebted non-

HIPC and middle-income countries, it will require

signifi cantly more debt reduction than has yet been

on offer[2].”

8.3 A UN Campaign and International

Campaign

The UNDP and United Nations Department of

Economics and Social Affairs (UN DESA) have un-

dertaken activities to promote a debt relief strategy

that incorporates meeting the MDG goals. Some of

these activities include:

* Conference held at UN New York on 30

October 2006 where the Indonesian MDG-

Debt paper was presented and the Philippine

MDG-Debt paper was mentioned.

* Some initiatives incorporating MDG fi nanc-

ing needs into debt sustainability

- Estimate MDG Financing Needs.

- Compare this with government revenues.

- Give debt relief to countries where govern-

ment revenues cannot meet MDG fi nanc-

ing needs.

* Idea of ‘MDG Bonds’ – conversion of part

of external debt to new bonds with debt ser-

vice payments proportional to capability of

government revenues minus MDG fi nancing

needs.

UNDP and UN DESA are planning for a Gen-

eral Assembly meeting of developing countries to

add to the already set agenda of discussing inter-

national bankruptcy and insolvency procedures. To

this agenda must be added a discussion on the new

concept of debt sustainability. As much support as

possible from developed and developing countries,

especially indebted countries, must be gotten for

this. Then the countries and the UN should de-

velop a proposal to the G8 on this change of debt

sustainability concept and propose a change in the

Paris Club Rules.

[2] From Report of the Secretary General of the United Nations, Ch. II, Freedom From Want, p. 18, March 2005.


8.4 Participation of Debtor Countries

and International CSOs

International CSOs will most likely support

and lobby for such a campaign for debt relief that

includes demands for changes in international rules

and a new defi nition of debt sustainability. Debtor

countries should be at the forefront of such a cam-

paign. Support from debtor countries is crucial. The

Indonesian and Philippine governments and their

civil society can support such a campaign, especially

now that both countries are (or will be) getting credit

upgrades. This is to delink the debt-to-MDG pro-

posals from the old concept which gives debt relief

only to those countries facing debt defaults. CSOs

of developed countries on the other hand should also

pressure their governments to live up to their FfD

commitment of giving 0.7 percent of their gross na-

tional income (GNI) to development assistance.

Eurodad (2005). Still Missing the Point: Unpacking the New World Bank/ IMF Debt Sustainability

Framework, 14 September.

Manasan, Rosario (2007). Financing the Millennium Development Goals: The Philippines,

Report Submitted to the National Economic and Development Authority (NEDA).

Social Watch (2006). Moving forward with the Millennium Development Goals. Philippines

United Nations (2005). Report of the Secretary General of the United Nations, Ch. II,

Freedom From Want, March.

United Nations Development Programme (2005a). 2005 Philippine Human Development Report.

Makati City: UNDP.

_______ (2005b). The Second Philippine Progress Report on the Millennium Development Goals.

Makati City: UNDP.

_______ (2004). Indonesia: Progress Report on the Millennium Development Goals (2004), Feb. 2004.

References


Development Down the Drain:The Crisis of Offi cial DevelopmentAssistance to the Philippines1

1. IntroductionForeign aid, or offi cial development assistance (ODA), is said to play an important role in Philippine devel-

opment. Yet for the past two decades and despite the overthrow of the scandal-plagued Marcos dictatorship, it

has been mired in problems and long-standing inadequacies that only serve to negate its intentions and avowed

objectives.

This report focuses on the track record of offi cial development assistance in the Philippines from the fall of

the Marcos regime in 1986 to the present. Revelations of ODA misuse including corrupt practices and misdi-

rected and ill-conceived projects had hounded Philippine foreign assistance in the two decades of the Marcos

regime (1965-1986). The downfall of one-man rule had thus raised expectations of long-overdue reforms in the

sourcing and utilization of foreign aid.

2. Defi nitions

The Organization for Economic Cooperation and Development (OECD) defi nes ODA as “fl ows of offi cial

fi nancing administered with the promotion of the economic development and welfare of developing countries as

the main objective.” To qualify as ODA, aid needs to contain three elements: (a) it is undertaken by the offi cial

sector, i.e., government bodies; (b) its main objective is the promotion of economic development and the welfare of

recipient countries; (c) the aid is granted at concessional fi nancial terms.2 The concessionality provision means that

loans should have a grant element of at least 25 percent.3 ODA consists of either bilateral contributions from donor

government agencies to developing countries or multilateral assistance from international or regional institutions.

ODA is an attractive source of development funds in that interest rates for loans are lower than commercial

rates, repayment periods are longer with extended grace periods, and funds are usually geared for projects that

1 This is an abridged, revised, and updated version of a citizens’ audit report submitted to Social Watch Philippines and ODA Watch in March 2007.

2 From the above defi nition, it is obvious that all forms of military assistance do not qualify as ODA. 3 The “grant element” is an index that indicates the “softness” of a loan. “When a loan is given on a purely commercial basis, the ‘grant

element’ is 0 percent, but when it is given in the form of a grant, its ‘grant element’ is 100 percent. The minimum ‘grant element’ required for ODA is 25 percent. For example, a loan with an annual interest rate of 5 percent and repayment period of 10 years including 5 years grace period has a ‘grant element’ of 25 percent” (APIC 1989).

Eduardo C. Tadem


would otherwise not attract private capital. The avail-

ability of grant assistance (which need not be repaid)

also adds to ODA’s appeal.

An important international body for the formu-

lation of policies on aid and the coordination and

monitoring of its implementation is the OECD, an

economic policy coordination club composed of

30 of the world’s richest economies. Its 22-mem-

ber Development Assistance Committee (DAC) is

responsible for ODA monitoring and evaluation

and is also engaged in “policy formulation, policy

coordination and information systems for develop-

ment.”

The primary outlet for Japanese loan assistance is

the Japan Bank for International Cooperation (JBIC)

which was established in October 1999 through the

merger of the Export-Import Bank of Japan (JEXIM:

established in 1950) and the Overseas Economic Co-

operation Fund, Japan (OECF: established in 1961).

Grants and technical assistance, on the other hand,

are disbursed mainly by the Japan International Co-

operation Agency (JICA) and, to a lesser extent by

the Ministry of Foreign Affairs (MOFA). In October

2008, however, JICA has taken over JBIC’s loan-

granting component and MOFA’s grants aid program

(Ogata 2007). This makes the new JICA the world’s

largest bilateral development agency with resources

amounting to US$8.8 billion.

In the Philippines, the government agency that

approves, monitors, and evaluates ODA projects is

the National Economic and Development Author-

ity (NEDA), a cabinet level inter-agency body whose

head carries the titles of NEDA Director General

and Secretary for Socioeconomic Planning. NEDA’s

Investment Coordinating Committee (ICC) is in

charge of evaluating and approving proposed aid

projects while another body, the Infrastructure Com-

mittee (Infracom), has recommendatory functions

over infrastructure project proposals.

3. ODA in the PhilippinesSince achieving political independence in 1946,

the Philippines has been dependent on foreign assis-

tance to support its economic development agenda.

In the 1950s and early 1960s, ODA was used for post-

war rehabilitation, and was primarily in the form of

grant assistance from the United States and Japanese

reparations payments (UN International Labor Of-

fi ce 1976). Foreign aid dramatically increased at the

beginning of the 1970s with the organization of the

Consultative Group on the Philippines in 1971. An

economically resurgent Japan also replaced the US as

the country’s primary contributor of bilateral devel-

opment assistance.

Philippine government policy on development

assistance is embodied in the Offi cial Development

Assistance Act of 1996 which contains the following

pertinent sections (Tadem 2003):

Section 2a. (… ODA is a loan or loan and grant

which) … “must be administered with the

objective of promoting sustainable social and

economic development and welfare of the

Philippines.”

Section 4. “The proceeds of ODA shall be used

to achieve equitable growth and development

in all provinces through priority projects for

the improvement of economic and social ser-

vice facilities taking into account such factors

as land area, population, scarcity of resources,

low literacy rate, infant mortality and poverty

incidence in the area: Provided that rural in-

frastructure, countryside development and

economic zones established under the PEZA

law shall be given preference in the utilization

of ODA funds.”

Section 4a and 4b. “ODA shall not be availed of

or utilized directly or indirectly for projects

mandated primarily by law to be served by

the private sector” and “fi nancing for private

corporations with access to commercial credit.

… The NEDA shall ensure that the ODA

obtained shall be for previously identifi ed

national projects which are urgent and neces-

sary.”

Section 11c “In the hiring of consultants, contrac-

tors, architects, engineers, and other profes-


sionals necessary for a project’s implementa-

tion, Filipinos shall be given preference.”

Section 11d. “In the purchase of supplies and

materials, preference shall be given to Fili-

pino suppliers and manufacturers, so long as

the same shall not adversely alter or affect the

project, and such supplies and materials are

to the standards specifi ed by the consultants,

contractors, … connected with the projects.”

3.1 The Twenty-Year Record, 1986 to 2006

The year 1986 is used here as a benchmark as it

marks a demarcation point between the Marcos au-

thoritarian regime and succeeding non-authoritar-

ian administrations. Foreign assistance during the

Marcos years (1965-1986) had acquired an odious

reputation for corruption, bribery, human rights

violations, environmental degradation, and vari-

ous implementation fl aws (Yokoyama 1990, Tsuda

and Deocadiz 1986). The ascension of the Aquino

government was accompanied by calls for the re-

examination of ODA and for reforms in aid policy

and implementation.

In this report, the twenty-year record of ODA

in the Philippines from 1986 to 2006 is examined

to determine whether the proper ODA reform mea-

sures have been put in place. To assess the progress of

ODA, two time trends have been set: the fi rst from

1986 to 2000 and the second from 2000 to 2006.

This would indicate a line dividing the years before

and after three defi ning events – the adoption of the

Millennium Development Goals, the September 11

attacks, and Japan’s new ODA Charter.

The positive indicators looked for are the follow-

ing: (1) increases in ODA commitments, (2) change in

the loan-grant mix in favor of the latter, (3) increases

in sectoral allocation to human development projects,

(4) change in geographical distribution in favor of less

developed regions, (5) improvement in the disburse-

ment and availment rates, (6) decrease in the ratio of

ODA to external debt, (7) the untying of aid, (8) en-

hanced sensitivity to social and environmental issues,

and (9) fi xing various implementation problems.

Total ODA committed to the Philippines over

the period from 1986 to 2006 amounted to US$37.9

billion. Of total ODA from 1986 to 2006, 84.22

percent was in the form of loans and only 15.78 per-

cent was in grant form. Compared to the 1986-2000

loan-grant distribution of 85.42 percent and 14.58

percent respectively, a minimal improvement was

registered. This could perhaps be accounted for by

the total absence of loan commitments from the US

for the 2001-2006 period as it concentrated exclu-

sively on giving out grants.

Of this amount, 63.65 percent was shared by

bilateral contributions. Compared to the data from

1986 to 2000, the contribution of multilateral

agencies fell by 3.65 percent in 2001-2006. Loans

constituted 93.55 percent of multilateral ODA and

only 6.45 percent was in the form of grants. This

is a minuscule improvement from the 1986-2000

shares of 94.57 percent in loans and 5.43 percent in

grants. On the other hand, 78.90 percent of bilat-

eral assistance was in the form of loans, with only

21.10 percent in grants. Compared to the 1986-

2000 shares of 78.43 percent and 21.57 percent

respectively, bilateral assistance showed a deteriora-

tion in the loan-grant mix.

Among the multilaterals, the World Bank is the

largest provider at 50.66 percent but this was a de-

cline from the 52 percent share for the 1986-2000

period. The ADB, on the other hand, increased its

share from 43 percent in the 1986-2000 period to

44.2 percent. Total WB and ADB exposure is 94.86

percent which is slightly less that the two institutions’

share of 95.25 percent in 1986-2000.

Among bilateral donors, and contrary to the

global trend, Japan continues to lead with 78.17 per-

cent, an increase over its 1986-2000 share of 75.6

percent of total bilateral ODA. As before, the US lags

as a poor second with 8.31 percent even as this was

an improvement over its 1986-2000 share of 7.5 per-

cent. Germany was third with a mere 3.99 percent

and the UK was fourth with 3.93 percent.

The 2001-2006 period was marked by the entry

of two new ODA players in the Philippines, both of


them from the Asian region, China and Korea. China

made an impressive debut by contributing US$467

million for only three projects, making it the seventh

largest bilateral donor. However, only 1.5 percent of

this amount was in the form of grants. Moreover,

85.65 percent (or US$400 million), was for one single

project, the controversial rehabilitation of the North

Luzon Railway system (see Section 4.9 below).

The fi gures for 2001-2006, however, confi rm

the Philippine trend of a continuing and rapid slow-

down in ODA commitments from the country’s

traditional donors. The 1986-2000 20-year annual

average was US$1,263.88 million while for the

six-year period from 2001-2006, ODA commit-

ments averaged only US$978.82 million, a 22.55

percent reduction. The decrease in Japan’s aver-

age allotments was even more signifi cant – from

US$562.18 million to US$351.33 million, a 37.51

percent decline.

At the Philippine Development Forum (PDF)

meetings from 8-9 March 2007 in Cebu City, how-

ever, the Department of Finance proposed a package

of 10 “high-impact” infrastructure projects worth

PhP83 billion (US$1.5 billion) to the country’s major

donors, including the World Bank, ADB, Japan, the

US, and other bilateral donor countries. The projects

include the PhP35.5 billion Light Rail Transit Line

6 and the PhP19.4 billion proposed 84.5-kilometer

Table 1. Total ODA Committed to the Philippines, 1986-2006 (In US$million, By Source)

Source Total Loans Grants

Multilateral

1. IBRD/WB 6,983.98 6,841.64 142.34

2. ADB 6,101.63 5,998.12 103.51

3. EU 344.90 – 344.90

4. UN System 322.74 25.54 299.06

5. Others 30.60 30.60 –

Subtotal 13,783.85 12,895.90 889.81

Bilateral

1. Japan 16,865.36 15,380.40 1,485.16

2. US 2,006.78 173.30 1,863.48

3. Germany 962.79 675.70 242.01

4. UK/GB 949.49 920.09 29.40

5. Australia 819.70 171.43 621.27

6. France 499.35 489.73 9.62

7. China 466.99 459.99 7.00

8. Canada 402.50 15.40 387.16

9. Spain 376.78 350.89 25.78

10. Italy 117.10 75.00 42.15

11. Brunei 100.00 100.00 –

12. Korea 57.30 57.30 –

13. Others 508.27 170.40 189.73

Subtotal 24,132.41 19,039.63 4,902.76

TOTAL 37,916.26 31,935.53 5,792.57

Source of basic data: NEDA Public Investment Staff

Note: Loans as of September 2006; grants as of June 2006.


extension of the North Luzon Expressway (Manila

Bulletin 2007).

Since the Philippines did not benefi t from the

global expansion of ODA previously recorded for

the 2001-2005 period and OECD projects a pro-

longed continuation of the decline registered in

2006, the country cannot expect any increased

ODA commitments from hereon, at least, not from

OECD DAC member countries. NEDA thus ex-

pects the bulk of the new ODA funds to come from

China or Chinese sources, thus marking a radical

shift in ODA sourcing for the Philippines (see Sec-

tion 4.9 below).

Given the need to improve its fi scal status, the

government has decided to increase its dependence

on ODA to fund its programs and projects (Dumlao

2006a). Finance Secretary Margarito Teves revealed

that of the programmed US$2.2 billion in fresh for-

eign borrowings earmarked for 2007, only US$600

million (28 percent) would be coursed from the com-

mercial sector while the remainder of US$1.6 billion

(72 percent) would be in cheaper ODA loans.

3.2 Japan’s ODA to the Philippines

For the twenty-year period from 1986 to 2006,

an overwhelmingly large 91.19 percent of Japanese

assistance was in the form of loans and only 8.81

percent was in the form of grants and technical as-

sistance. The reverse was true with the US, on the

other hand, with American assistance consisting of

92.86 percent in grants and only 7.14 percent in

loans. Japan had lagged behind the US in terms of

grant assistance with 30 percent of bilateral grants

compared to 38 percent for the US in the 1986-2000

Table 2. Total ODA Committed to the Philippines, 1986-2000 (In US$million, By Source)

Source Total Loans Grants

Multilateral

1. IBRD/WB 6,162.70 6,131.60 31.10

2. ADB 5,167.13 5,092.65 74.48

3. EU 310.20 – 310.20

4. UN System 230.04 – 230.04

5. Others 24.60 24.60 –

Subtotal 11,894.47 11,248.85 645.82

Bilateral

1. Japan 12,649.36 1,443.32

2. US 1,255.94 173.30 1,082.64

3. Germany 605.74 392.24 168.71

4. France 499.35 489.73 9.62

5. Australia 457.34 171.43 285.91

6. Canada 297.20 15.40 281.86

7. Spain 237.96 219.43 18.53

8. UK/GB 168.81 194.21 29.40

9. Italy 117.10 75.00 42.15

10. Brunei 100.00 100.00 –

11. Others 348.30 89.23 167.90

Subtotal 16,737.10 13,126.21 3,530.04

TOTAL 28,631.57 24,375.06 4,175.86

Source of basic data: NEDA Public Investment Staff


years. In the 2000-2006 period, this gap has widened

with the US taking a 55.7 percent share of bilateral

grants compared to Japan’s 2.98 percent. However, as

previously noted, there is no record of new U.S. loans

for the 2000-2006 period.

The period covering 2005-2007 saw a drastic

scaling down of Japanese ODA to the Philippines.

The total for the three years was only US$101.5 mil-

lion consisting of one loan project in 2006 worth

US$72.7 million and eight grant assistance projects

amounting to US$28.8 million. No new Japanese

loans were granted in 2005. The US$3.85 million

in Japanese ODA for 2005 was the lowest level ever

reported throughout all the years that Japan has

been providing development assistance to the Philip-

pines.4

Table 3. ODA Commitments to the Philippines, By Source, 2001-2006 (In US$million)

Source Total Loans % Loans Grants % Grants

Multilateral

ADB 934.500 905.47 96.89 29.03 3.11

World Bank 821.280 710.04 86.45 111.24 13.55

UN System 92.700 23.68 25.54 69.02 74.46

OPEC 7.000 7.00 100.00 – 00.00

Euro Comm 34.710 – 00.00 34.71 100.00

NORDIC 6.000 6.00 100.00 – 00.00

Subtotal 1,896.190 1,652.19 87.13 244.00 12.87

Bilateral

Japan 2,108.001 2,087.081 99.01 20.92 00.94

U.S. 390.420 – 00.00 390.42 100.00

Germany 178.379 141.729 79.45 36.65 20.55

China 466.985 459.985 98.50 7.00 1.50

Canada 52.650 – 00.00 52.65 100.00

UK 362.940 362.940 100.00 – 00.00

Australia 167.680 – 00.00 167.68 100.00

Austria 33.370 33.370 100.00 – 00.00

Spain 69.408 65.728 94.70 3.68 5.30

Belgium 26.920 17.320 64.54 9.60 35.66

Korea 57.300 57.300 100.00 – 00.00

Netherlands 25.930 20.15 77.70 5.78 22.30

New Zealand 5.140 – 00.00 5.14 100.00

Norway 0.340 – 00.00 0.34 100.00

Saudi Arabia 19.995 19.995 100.00 – 00.00

Sweden 11.310 10.000 88.42 1.31 11.58

Subtotal 3,976.758 3,275.598 82.37 701.16 17.63

TOTALS 5,872.948 4,927.788 83.91 945.16 16.09

Note: Loans as of September 2006; Grants as of June 2006

Source for basic data: National Economic Development Authority

4 Previous lows were in 1962 (US$7.02 million) and in 1961 (US$8.54 million).


loans granted by JBIC. Out of twenty-fi ve (25) JBIC

project loans from 2000 to 2004, ten (40 percent)

were totally tied, another ten were partially tied, and

only three (8 percent) were totally untied. Three

projects totaling US$60.8 million had incomplete

information.6 In terms of loan amounts, 59 percent

was totally tied, 28 percent was partially untied, and

only 2.8 percent was totally untied.

Three of the biggest projects were totally tied,

namely, the Subic Clark-Tarlac Expressway project

(US$388 million), the Light Rail Transit (Line 1)

Capacity Expansion Project (US$197 million), and

the Urgent Bridges Construction for Rural Devel-

opment Project (US$147 million). Only one major

project was totally untied, the US$176 million New

Communications, Navigation & Surveillance/Air

Traffi c Mgmt Systems Project.

Of the ten partially untied projects, nine untied

the main portion of the loan, but tied the consultan-

cy services component. Thus the issue of tied aid is

intimately linked to another ODA issue of concern –

that of foreign consultants (see 4.10.4 below). Given

the observation that “a large portion of the so called

untied loan funds still end up in the hands of Japa-

nese companies (as) feasibility studies are conducted

by Japanese consultants (who) either specify the use

of Japanese goods and equipment or recommend Jap-

anese industrial standards” (Tadem 1983/1984 and

Tadem 1990), the tying of consultancy services could

transform the project to a completely tied loan.

Since the advent of foreign assistance projects

in the Philippines in the 1950s Filipino construc-

tion fi rms have bewailed what they see as preferen-

tial treatment given to their foreign counterparts (or

competitors). The Philippine Constructors Associa-

tion (PCA) complains that while “foreign contractors

were allowed to bring equipment into the country

tax free, local contractors are slapped a 30-percent

duty” (Moreno 1995). The PCA also criticizes the

government for “failing to encourage foreign con-

Table 4. Japanese ODA to the Philippines, 2005-2007

ProjectDate of exchange

of notes US$ million

Grant Aid

Human Resource Development Scholarship

July 8, 2005 3.97

Food Aid through WFP March 17, 2006 1.19


July 23, 2006 3.30

Food Aid through WFP October 31, 2006 1.18


July 2, 2007 3.92

Rural Electrifi cation (N. Luzon)

Oct. 10, 2007 6.28

Improvement of Flood Forecasting & Warning System (Pampanga & Agno River Basins)

July 31, 2007 6.41

Grant Assistance for Farmers Mar. 19, 2007 2.55

Loan Aid

Pasig-Marikina River Channel Improvement Project (Phase II)

Dec. 9, 2006 72.70

TOTAL 101.50

Source: Japan Ministry of Foreign Affairs

5 JICA is the Japanese government agency that administers Japanese technical assistance and fi nancial grants to developing countries.6 For these three projects, while the main portion is untied, no information was given on the nature of the consultancy services portion.

This decline came about despite an announce-

ment by the Japan International Cooperation Agen-

cy (JICA),5 in October 2004 that Japanese ODA

for the Philippines would increase in 2005 (Caga-

hastian 2004). JICA offi cials had said that the cuts

in Japan’s ODA to China would enable the increase

in ODA commitments to the Philippines and In-

donesia.

Some increases could be expected in the coming

years, particularly given Japan’s interest in projects re-

lated to peace building in Mindanao and other con-

fl ict-torn areas.

3.2.1 Japan’s Tied Aid in the Philippines

Despite internationally concerted and organized

efforts to untie aid, the situation in the Philippines

appears to have taken a turn for the worse beginning

in the year 2000. This is particularly true of Japanese


Table 5. Untying Status of JBIC Loans, 2000-2004

Project Loan Year US$ millionMain Portion

StatusConsultancy

Portion Status

Kamanava Area Flood Control And Drainage System 2000 18.8 Tied Tied

Mindanao Container Terminal Project 2000 79.0 Tied Tied

LRT Line 1 Capacity Expansion 2000 197.0 Tied Tied

New Iloilo Airport Development 2000 130.0 Tied Tied

2nd Magsaysay Bridge and

Butuan City Bypass Road Project 2000 31.4 Tied Tied

Subic Bay Port Dev. Project 2000 145.6 Tied Tied

Subic-Clark-Tarlac Expressway 2001 388.0 Tied Tied

Northern Luzon Wind Project 2002 46.9 Tied Tied

Urgent Bridges Construction for Rural Development 2002 147.0 Tied Tied

Improvement of Marine Disaster Response & EnvironmentProtection

2002 74.8 Tied Tied

TOTAL (TOTALLY TIED) 1,277.3

Sustainable Environmental Management Proj (N. Palawan) 2001 18.8 Tied Untied

The Laoag River Flood Control & Sabo Project 2001 58.4 Untied Tied

Selected Airports(Trunkline) Development Project (Phase II) 2001 108.7 Untied Tied

Help For Catubig Agricultural Advancement Project 2001 48.2 Untied Tied

Mindanao Sustainable Settlement Area Development Project 2001 60.3 Untied Tied

Metro Manila Interchange Construction Project(Phase V) 2001 51.4 Untied Tied

Arterial Road Links Development Project(Phase V) 2001 76.8 Untied Tied

Rural Road Network Development Project(Phase Iii) 2001 57.4 Untied Tied

Bago River Irrigation System Rehabilitation & Improvement 2002 25.8 Untied Tied

Iloilo Flood Control Project (Ii) 2002 54.3 Untied Tied

TOTAL (PARTIALLY TIED) 602.1

New Communications, Navigation & SurveillanceAir Traffi c Mgmt Systems Project

2002 176.4 Untied Untied

Arterial Road Bypass Project (I) (Plaridel & Cabanatuan) 2004 59.8 Untied Untied

TOTAL (TOTALLY UNTIED) 236.2

Subic Bay Freeport Environmental Mgt Project (Phase I) 2003 8.40 Untied No information

ARMM Social Fund for Peace & Development Project 2003 20.9 Untied No information

Central Mindanao Road Project 2003 31.5 Untied No information

TOTAL (INCOMPLETE INFO) 60.8

Source of basic data: Japan Bank for International Cooperation

Note: NEDA data has the Subic-Clark-Tarlac Expressway project loan valued at US$355 million.

tractors to enter into joint ventures with local fi rms.”

Such partnerships would have facilitated technology

transfer, a goal that is inscribed in the Philippines’

ODA Law of 1996.

Furthermore, the foreign contracting companies

“bring in their own nationals to occupy top man-

agement positions which can easily be fi lled up by

Filipinos.” Aside from this, “foreign contractors are

also inclined to purchase materials abroad despite

available supply in the domestic market.” Finally,

the PCA complains that “since foreign contractors

are paid in foreign currency, they are in effect ex-

empted from VAT and income tax, and hence are

able to present lower bids.” The PCA concludes that


Table 6. Summary of Untying Status of JBIC Loans to Philippines, 2000-2004

Status No. of projects % shareLoan Amount (US$million) % Share

Totally tied 10 40.00 1,277.3 58.69

Partially untied 10 40.00 602.1 27.66

Totally untied 2 8.00 236.2 10.85

Incomplete info. 3 12.00 60.8 2.79

Total 25 100.00 2,176.4 100.00

Source of basic data: Japan Bank for International Cooperation

the “uneven playing fi eld for Filipino contractors has

lessened initiatives to further develop the construc-

tion industry, in training their people, or upgrading

their equipment” (Moreno 1995).

3.3 Sectoral Allocation of ODA

From 2000 to 2006, ODA commitments for

infrastructure averaged a share of 65.28 percent of

total ODA. This constituted a 15.2 percent increase

compared to infrastructure’s share of 50.1 percent

during the 1987 to 2000 period. Agriculture, natu-

ral resources and agrarian reform had the second

largest average share of 17.43 percent for 2000-

2006. Industry and services was third with an aver-

age share of 8.14 percent, while social reform and

community development was fourth with an aver-

age share of 7.85 percent. At the bottom of the list

was governance and institutional development with

an average share of 1.46 percent. Total allotments

for the combined agriculture, land reform and in-

dustrial development sectors showed an increase to

25.3 percent from the 1986-2000 share of 21.23

percent.7

What is clear, however, is that for “human devel-

opment” there was a significant decrease in ODA

commitments in the 2000-2006 period (7.85 per-

cent) compared with the already minuscule 1987-

2000 share of 10.95 percent. It also appears that

the increase in shares for infrastructure support,

and agricultural and industrial development came

at the expense of the human development compo-

nent of ODA. The lowest points were in the years

from 2000 to 2002, when “human development”

took in an average share of only five percent per

7 Except in the case of “infrastructure support,” there is some diffi culty in comparing the 2000-2006 data with the 1986-2000 fi gures because NEDA had renamed the categories in 2001. Previously, “agricultural and industrial development” were lumped together. “Social reform and community development” was previously known as “human development.” Previously separate categories such as “commodity aid,” “integrated area development”, and “disaster mitigation” have presumably been integrated into one of the new categories.

Table 7. Sectoral Shares of ODA Commitments, 2000-2006

SectorNet Commitment

2000 2001 2002 2003 2004 2005 2006 Average

Infrastructure Support 66% 69% 63% 69% 68% 65% 57% 65.28%

Agriculture, Natural Resources, and Agrarian Reform

16% 16% 21% 17% 17% 17% 18% 17.43%

Industry and Services 10% 9% 9% 5% 5% 8% 11% 8.14%

Social Reform and Community Development

5% 5% 5% 9% 8% 10% 13% 7.85%

Governance and Institutional Development

3% 1% 2% 0% 2% 2% 0.23% 1.46%

Source: NEDA Annual ODA Portfolio Reviews


year. The average share eventually doubled be-

tween 2003 and 2005.

In terms of subsectors, transportation continued

to have the biggest allocation of 42.17 percent as

of December 2006, a 59 percent increase from the

1994-2000 share of 26.46 percent. Agriculture and

agrarian reform was in second place with 14.18 per-

cent but this was a sharp decline from the previous

share of 22 percent. The subsector of energy, power,

and electrifi cation was in third with 6.72 percent, a

decline from 14.39 percent in 1994-2000. The sub-

sector of water resources was close behind with 6.47

percent even as its share declined from its previous

allotment of 12.25 percent. The subsector of educa-

Table 8. Sectoral Allocation of ODA, 1987-2000 (In US$million)

Source for basic data: NEDA Public Investment Staff

1987-2000

Sector Amount Percent Share

Infrastructure Support 13,931.46 50.06

Agri-Industrial Development 5,906.64 21.23

Human Development 3,047.05 10.95

Development Administration 1,058.21 3.80

Commodity Aid 702.08 2.52

Integrated Area Development 974.93 3.50

Disaster Mitigation 256.79 0.92

Others 1,950.40 7.01

TOTAL 27,827.56 100.00

Table 9. Disaggregated Sectoral Allocation of ODA Commitments (As of December 2006 and 1994-2000)

Sector/Sub-sectorAs of December 2006 1994-2000

US$ m % Share US$ m % Share

Agriculture, Agrarian Reform, and Natural Resources

1,734.66 18.25 3,711.71 27.82

Agriculture and Agrarian Reform 1,347.88 14.18 2,935.05 22.00

Environment and Natural Resources 386.78 4.07 776.66 5.82

Industry, Trade and Tourism 1,052.30 11.07 612.65 4.43

Infrastructure 5,461.15 57.45 8,017.34 60.00

Communications 29.8* 0.3 135.48 1.01

Energy, Power, and Electrifi cation 638.71 6.72 1,919.81 14.39

Social Infrastructure 198.57 2.09 0.60 0.00

Transportation 4,009.21 42.17 3,530.70 26.46

Water Resources 614.66 6.47 1,634.49 12.25

Social Reform and Com. Dev. (Human Development)

1,236.26 13.00 1,316.32 9.86

Education and Manpower Dev. 551.68 5.8 51.27 4.13

Health, Population, and Nutrition 359.15 3.8 283.75 2.12

Social Welfare and Com. Dev. 196.58 2.1 20.53 0.15

General Social 100.0 1.1 460.77 3.45

Shelter & Urban Development** 28.85 0.3 – –

Governance and Institutions Development (Political governance)

21.9 0.23 467.81 3.50

Others – – 528.89 3.95

TOTAL 10,194.1 100.0 13,341.04 100.00 Source of basic data: NEDA Annual ODA Portfolio Reviews*As of Dec. 2005. This category is missing in the 2006 Report.** This is a new category introduced in the 2006 Report.Note: “Others” include disaster mitigation and integrated area development.


tion and manpower development was fi fth with 5.8

percent, a modest increase from its previous share of

4.13 percent. The subsector of environment and nat-

ural resources was sixth with 4.07 percent, a decline

from 5.82 percent. Other human development-re-

lated subsectors fared badly – health, population and

nutrition with a mere 3.8 percent, and social welfare

and community development with only 2.1 percent.

3.4 Geographical Distribution of ODA

Data from the NEDA Annual ODA Portfolio

Reviews from 2000 to 2002 on the geographical

distribution of ODA show that the most developed

regions and provinces had the largest shares of ODA

while less-developed regions with higher poverty lev-

els got smaller allotments.

Luzon’s share of ODA increased from 17 percent

(US$2.2 billion) in 2001 to 19.4 percent (US$2.56

billion) to 31.2 percent (US$3.37 billion) in 2002.

Within Luzon, the National Capital Region (NCR),

which includes the Metropolitan Manila area, cor-

nered 20 percent (US$2.6 billion) of total ODA in

2000, 21 percent (US$2.8 billion) in 2001 and 14

percent (US$1.52 billion) in 2002. The Metro Ma-

Table 10. Distribution of Total ODA Loan Commitments By Geographical Region, 2001 and 2002

Source: NEDA Annual ODA Portfolio Review, 2001 and 2002

Island Group/Region

2001 2002

Commitment ($ million) % Share

Commitment($ million) % Share

LUZON 2,557.92 19.4 3,366 31.2

NCR 2,773.19 21.0 1,518 14.1

CAR 38.4 0.3 35 0.3

Region I 197.7 1.5 253 2.3

Region III 1,043.3 7.9 790 7.3

Region V 65.3 0.5 71 0.7

Luzon-wide 967.0 7.3 505 4.7

VISAYAS 1,284.32 9.7 1,037 9.6

Region VI 287.0 2.2 327 3.0

Region VII 507.0 3.8 385 3.6

Region VIII 119.9 0.9 100 0.9

Visayas-wide 370.5 2.8 226 2.1

MINDANAO 904.94 6.9 856 7.9

Region IX 25.1 0.2 18 0.2

Region X 119.0 0.9 109 1.0

Region XI 101.9 0.8 98 0.9

Region XII 85.1 0.6 35 0.3

ARMM 122.3 0.9 121 1.1

CARAGA – – 125 1.2

Mindanao-wide 307.3 2.3 351 3.3

MULTI-REGIONAL 2,694.28 20.5 3,020 28.0

NATIONWIDE 2,959.70 22.5 2,512 23.3

PROGRAM LOANS 1,065 9.0

GRAND TOTAL 13,174.35 100.0 11,856 100.0


nila area has the lowest incidence of poverty in the

country. Next to NCR, the second-highest level of

ODA funds went to Region III (Central Luzon) with

7.9 percent (US$1,043 billion) in 2001 and 7.3 per-

cent (US$790 million) in 2002. The country’s poor-

est region, Region V (Bicol), had a mere 0.5 percent

share in 2001 and 0.7 percent in 2002.

The three regions in the Visayas, on the other hand,

had only 9 percent (US$1.2 billion) in 2000, 9.7 percent

(US$1.3 billion) in 2001, and 9.6 percent (US$1.037

billion) in 2002. Furthermore, the most developed re-

gion in the Visayas, Region VII (Central Visayas), which

includes Metropolitan Cebu, got the bulk of ODA for

the Visayas island group at 39 percent.

Mindanao, with its six regions (including three of

the country’s poorest regions), lags behind even the

Visayas with only 7 percent of total ODA (US$945

million) in 2000, 7 percent (US$905 million) in

2001, and 7.9 percent (US$856 million) in 2002.

Inter-regional disparities were also noted as the de-

veloped region in Mindanao, Region X (Northern

Mindanao) and XI (Davao) got the bulk of ODA in

2001 (22 percent) and in 2002 (24 percent).

These recent fi ndings on the geographical dis-

tribution of ODA in the Philippines re-affi rm what

Rivera (2000) had observed for Japanese ODA in the

1990s where “the regional distribution of yen loans

shows a highly disproportionate allocation on the ba-

sis of major island groupings and regions on the basis

of poverty incidence. Data up to 1995 show that the

poorest island groupings and regions also received

the least loan assistance” from Japanese ODA.

It must be noted that the NEDA Annual ODA

Portfolio Reviews provide data on the geographical

distribution of ODA only for the years from 2000 to

2003. The 2003 data, however, are in peso amounts

and not disaggregated accordingly. Thereafter, NEDA

has ceased reporting on the regional distribution of

ODA. This was one of the reasons cited in Philippine

Senate Resolution No. 179 fi led by Senator Loren

Legarda in November 2007 for the Committee on

Economic Affairs to conduct an inquiry into, among

others, “the extent to which … ODA has promoted

sustainable and economic development and the wel-

fare of the Philippines” (Philippine Senate 2007).

The pattern, however, is clear and the situation

violates the provisions of the ODA Act of 1996

which, as cited earlier, mandates the use of ODA for

the equal development and growth of all provinces

and with attention to areas that are resource poor

and are characterized by low levels of human devel-

opment and high poverty incidence.

3.5 ODA as Share of External Debt

ODA’s share of the country’s external debt stood

at 40.8 percent as of June 2006. Though this was one

of lowest shares registered, the average share of ODA

over the eighteen-year period from 1988 to 2006 was

a high 45 percent. The highest level was in 1994 at

60 percent and the lowest was in 2005 with 39.9 per-

cent.

Table 11. ODA as Share of External Debt, 1988-2006 (In US$billion)

Year Amount % Share

1988 11.6 41.5

1989 12.3 44.5

1990 16.0 55.9

1991 16.1 53.6

1992 18.4 57.4

1993 16.6 46.6

1994 23.2 60.0

1995 20.4 51.8

1996 22.1 52.7

1997 21.9 48.3

1998 25.0 52.2

1999 26.7 51.1

2000 25.0 47.7

2001 24.1 46.4

2002 24.5 45.7

2003 25.9 45.2

2004 25.2 46.0

2005 21.6 39.9

2006 (June) 22.0 40.8



World Bank loans command an interest rate that

hovers around 6.94 percent, a “pool-based variable

rate” that is determined every six months. There

is also a one-percent “front-end fee.” Thus for the

US$410 million in new World Bank loans to the

country in 2006 alone, the Philippine government

was immediately saddled with a front-end fee of

US$4.1 million and annual interest payments of

US$28.45 million.

Additional WB charges include a 0.85 percent

commitment fee per year that is charged on the

undisbursed amount “from the date of which such

charges commences to accrue but excluding the

fourth anniversary of such date.” After the fourth

year, commitment fees are 0.75 percent.

ADB loans are pegged at 6.7 percent for dol-

lar loans, 5.5 percent for multi-currency loans. The

0.75 percent commitment fee is paid annually on

the undisbursed portion of the loan based on a dis-

bursement schedule (15 percent of Total Project

Commitment for the 1st year, 45 percent for the

2nd year, 85 percent for the 3rd year, and 100 per-

cent thereafter).

Japanese bilateral loans have interest rates ranging

from 0.75 percent to 2.2 percent. This is an improve-

ment from the 1990s when interest rates for Japanese

loans reached as high as 3.0 percent and the 1980s

where rates were pegged at 4 percent. Loans from

other countries range from a low of 0.75 percent for

Germany to a high of 4-5 percent for Austria. There

are no interest charges for loans from Belgium, Fin-

land and Norway.

In 2006 alone, the Philippine government paid

US$5.7 million in commitment fees, which was 11

percent less than the total paid in 2005 of US$6.4

million. As of December 2005, cumulative commit-

ment fees amounted to US$50.9 million. These fees

are paid mainly to the World Bank and the Asian

Development Bank.8 For 2005, total commitment

fees paid to the WB and ADB amounted to US$8.4

million.

Government agencies and corporations that paid

the most in commitment fees in 2006 were the De-

partment of Finance (US$1.3 million), the Depart-

ment of Agriculture (US$0.7 million), Land Bank of

the Philippines (US$0.4 million), and Development

Bank of the Philippines (US$0.2 million).

Commitment fees are a consequence of delays in

the implementation of ODA projects and refl ect the

ineffi ciency and low capacity of government and gov-

ernment-affi liated implementing agencies. In recent

years, confl icts between the Executive branch and

the Legislature (particularly the Senate) resulted in

the non-passage of the government budget bill. This

forced the government to re-cycle the previous year’s

budget. As a result, the appropriate counterpart funds

for ODA projects were jeopardized, forcing delays in

scheduled loan disbursements.

Buoyed by the appreciation of the peso relative

to the US dollar, strong capital infl ows, record remit-

tances from Filipino overseas workers, tight spend-

ing policies and proceeds from sale of government

properties, the government has adopted a policy of

promptly paying its debts, including the prepay-

ment of foreign loans. Thus the foreign debt de-

clined slightly to PhP1.69 billion in 2006 compared

to PhP1.72 billion in 2005, a 1.5 percent reduction

(BOT 2007). For 2007, the Bangko Sentral ng Pili-

pinas (BSP) scheduled the prepayment of US$805

8 JBIC loans do not charge commitment fees.


Year

Cumulative Commitment Fees (US$)

Yearly Commitment Fees (US$))

2001 21 million 9.5 million



2004 48.5 million 7.5 million

2005 50.9 million 6.4 million

2006 n.a. 5.7 million

Table 12. Commitment Fees Paid on ODA Loans,2001 to 2006


million in foreign loans that would still be due later in

the year up to 2008 (Dumlao 2007). Not all foreign

donors, however, allow for prepayment of loans.

The Bureau of Treasury reported in 2006 that a

large percentage of the government’s annual revenue

collection went to debt servicing with interest pay-

ments eating up a third of the national budget (Remo

2006). Also for 2006, commercial loans accounted for

77 percent of government debts. For 2007, the gov-

ernment intended to improve the mix somewhat to 55

percent commercial and 45 percent ODA. However,

“the bulk of borrowings by government was simply

used to pay existing obligations” (Remo 2007). For the

period January 2007 to July 2007, debt service pay-

ments totaled PhP409.37 billion, with 39 percent of

the amount consisting of interest payments alone.

3.6 ODA Loan Disbursements and Availments

Availment rates characterize the absorptive ca-

pacity of the government with regard to contracted

ODA funds. NEDA defi nes the availment rate as

“the cumulative actual disbursements as a percentage

of cumulative disbursement … reckoned from the

start of implementation of projects” up to the end

of a particular calendar year. The agency also notes

that the “availment rate captures the historical per-

formance of a project from start to fi nish” and that

“backlogs compound commitment fees.”9

As of December 2006, NEDA reported a 71 per-

cent availment rate representing cumulative disburse-

ments of US$5.49 billion out of a target disburse-

ment of US$7.74 billion. This was a 10.7 percent

improvement over the 2005 availment rate of 60.3

percent representing cumulative disbursements of

US$4.71 billion out of a target disbursement amount

of US$7.81 billion. The 2005 availment rate was, in

turn, better by 2.8 percent over the 2004 level of 57.5

percent which was US$4.3 billion disbursed out of a

target of US$7.6 billion.

The “industry, trade and tourism” sector had

the highest availment rate in 2006 with 94.35 per-

cent (US$480 million out of US$508 million) a big

jump from its 2005 availment rate of 69.1 percent

(US$348 million out of US$504 million). The pre-

vious year’s leader, the “social reform and develop-

ment” sector came in second, this time with 75.76

percent (US$482 million out of US$637 million)

an improvement over its 71.7 percent availment rate

in 2005 (US$442 million out of US$616 million).

Agriculture, agrarian reform, and natural resources

retained third position with 69.85 percent (US$981

million out of US$1,405 million) compared to the

2005 rate of 60.9 percent (US$891 million out of

9 Interestingly, the NEDA Annual ODA Portfolio Review states that “while preferred targets for availment and disbursement rates are set at 100 percent, a disbursement ratio in the range of 18-20 percent is acceptable” and that “a 5-10 percent disbursement ratio for a project at detailed engineering stage should be acceptable.”

Source: National Economic Development Authority

YearDisbursements (In US$Million)

Availment Rates (Percentage)

1988 852 79%

1989 978 82%

1990 1,386 84%

1991 1,033 77%

1992 1,660 79%

1993 1,747 81%

1994 1,195 78%

1995 1,299 76%

1996 1,368 79%

1997 1,300 74%

1998 1,136 66%

1999 840 62%

2000 995 63%

2001 1,048 62%

2002 1,035 59%

2003 1,405 61%

2004 1,095 58%

2005 1,205 60%

2006 1,937 71%

Table 13. Philippine ODA Loan Disbursementsand Availments (1988-2005)


US$1.5 billion). The sector with the highest share in

ODA allotments, infrastructure, was second to the

last in terms of availment rates with 61.52 percent

(US$2,615 million out of US$4,251 million) with

governance and institutional development bringing

up the rear with 31.94 percent (US$5.36 million out

of US$16.77 million).

NEDA notes that problems in meeting targeted

disbursement and availment levels were traced to

“delays encountered in procurement; low demand for

credit; unavailability of counterpart funds or insuf-

fi cient budget cover; and, project completion or loan

closure, … diffi culty in catching-up with the initial

cumulative delays incurred, and right of way issues.”

An additional problem of course is that for World

Bank and ADB projects, higher undrawn balances

result in higher commitment fees.

As of June 2006, a number of projects suffered

from extremely low availment rates. Those with zero

availment rates included the Subic Bay Freeport

Environmental Management Project II, Northern

Luzon Wind Power Project, the New Communica-

Table 14. ODA Projects with Lowest Availment Rates (As of June 30, 2006, In US$m)

Source/Project Net Commitment Disbursement Undrawn balance Utilization Rate, %

World Bank

DOH Second Women’s Health and Safe Motherhood Project

16.00 0.380 15.620 2.38

LBP Manila Third Sewerage Proj. 64.000 1.999 62.001 3.12

LLDA Laguna De Bay Inst’l. Strengthening and Community Dev’t. Proj.

5.00 0.200 4.800 4.00

DENR Land Administration and Management Proj. Phase II

18.995 0.894 18.101 4.71

Japan Bank for Int’l Coop (JBIC)

SBMA Subic Bay Freeport Environmental Mgt. Proj. II

8.398 0 8.398 0

PNOC N. Luzon Wind Power Proj. 49.636 0 49.636 0

DOTC Improvement of the Marine Disaster Response and Environment Protection Sys.

79.288 0 79.288 0

DOTC New Communications, Navigation, Surveillance Traffi c Mgt. Systems

186.856 0 186.856 0

ASFPD-FMO

ARMM Social Fund for Peace and Development

20.932 0.091 20.841 0.43

DPWH Arterial Road Bypass Project I (Plaridel and Cabanatuan)

52.737 0.259 52.478 0.49

DPWH Central Mindanao Road Proj. 31.500 1.085 30.415 3.44

DPWH Urgent Bridges Construction Project for Rural Dev.

156.678 6.692 149.986 4.27

Asian Development Bank (ADB)

DOH Health Sector Dev. Project 13.00 0.360 12.640 2.77

DBP Development of Poor Urban Community Sector Project

28.851 .893 27.958 3.1

TRANSCO Elec. Market and Transm. Development Project

40 1.403 38.597 3.51



tions, Navigation, Surveillance Traffi c Management

Systems, and the Improvement of the Marine Disas-

ter Response and Environment Protection System,

all funded by JBIC loans. Those with less than one

percent availment rates were two other JBIC-funded

projects - the ARMM Social Fund for Peace and De-

velopment and the Arterial Road Bypass Project I

(Plaridel and Cabanatuan).

Despite the NEDA ODA Portfolio Review’s sat-

isfaction with availment rates of 18 to 20 percent,

then Socioeconomic Planning Secretary Romulo

Neri admitted in February 2007 that “at the mo-

ment ODA utilization is very poor and the Depart-

ment of Finance and the Department of Budget

and Management are rationalizing the country’s

development fi nancing profi le” (Manila Bulletin

2007b).

3.7 China’s ODA to the Philippines

The beginning of the new century saw an accelera-

tion in Philippines-China economic relations (Storey

2006). Two-way trade rose a phenomenal 433 per-

cent between the years 2000 and 2005, from US$3.3

billion to US$17.6 billion. China become the Philip-

pines’ fourth largest trading partner in 2005, up from

12th place in 2001.10 The two governments have also

agreed on a bilateral annual trade target of US$30

billion by 2010. Consequently, investment and de-

velopment assistance followed.

During Chinese President Hu Jintao’s state visit

to the Philippines in April 2005, he agreed to invest

US$1.1 billion in the country, including US$950

million in a nickel mining plant.

A major China-Philippines agricultural agree-

ment was signed in January 2007 which could mean

the entry of PhP10 billion in Chinese investments

for bioethanol projects, and contracts for growing

corn, rice, sorghum, cassava, and tropical fruits and

coco fi ber production for export to China (Gaylican

2007). The 19 agreements stipulate that 1.24 million

hectares of farmland will be reserved for the China

agricultural deal.

In terms of development assistance, the Chinese

government provided loans to fi ve projects worth

a total of US$763 million. An additional US$541

million for two loan infrastructure projects are also

under consideration (Olchondora 2007 and Gayli-

can 2007). Of the fi ve approved loans, the most

controversial is the North Rail project, which con-

sists of a US$503 million concessional loan from the

Export-Import Bank of China and a Philippine gov-

ernment’s counterpart of US$107 million. Signed

on 26 February 2004, China’s largest ODA commit-

ment to the Philippines is for the rehabilitation and

upgrading of the North Luzon Railway project.

The ODA agreement, however, has been criticized

as being grossly disadvantageous to the Philippine

government (Rufo and Bagayaua 2007). The average

cost per kilometer would be almost US$16 million

(around P900 million) per kilometer, not consider-

ing the costs for clearing, relocation, and resettlement

of 200,000 informal dwellers occupying the railroad’s

right of way.11 The PCIJ says that “this would make

it the biggest — and costliest — resettlement project

ever undertaken by the Philippine government” and

quotes a former Philippine railway offi cial who said

that “the resettlement expenses were deliberately hid-

den so these would not refl ect on the overall, already

bloated, project cost” (Pabico 2005).

Furthermore, the interest rate of three percent per

annum for 20 years (with a fi ve-year grace period)

makes the loan more expensive to service than other

loan agreements with other donors. The designation

by the North Luzon Railways Corporation (NLRC)

10 For 2005 alone, two way trade between the two countries amounted to US$6.97 billion, or 8 percent of total external trade for the year. Interestingly, the Philippines enjoyed a healthy trade surplus of US$8.1 billion with China between 2000 and 2005.

11 For the relocation and resettlement of an initial 40,000 informal dwellers in the Bulacan segment alone of the North Rail project, the Housing and Urban Development Coordinating Council (HUDCC) estimates an additional cost of P6.6 billion (Pabico 2005). The National Housing Authority (NHA), on the other hand, the lead agency for implementing the resettlement program, has earmarked only P1.6 billion for reloca-tion and resettlement of the project.


of the China National Machinery and Equipment

Corporation group (CNMEC) as the project’s pri-

mary contractor without the benefi t of a competitive

public bidding was also seen as violating Philippine

laws.12

Given these onerous terms a study by the Uni-

versity of the Philippines Law Center “recommended

the cancellation of the contract” and “if warranted,

criminal, civil and/or administrative cases should be

fi led against the concerned public offi cials and pri-

vate individuals.” Based on this UP Law Center re-

port and other testimonies during public hearings,

the Philippine Senate concluded that the project was

full of irregularities and should be abandoned. As

of November 2007, the case was pending at the Su-

preme Court.

Undeterred by the controversy surrounding the

Northrail Project, the Philippine and Chinese gov-

ernments, went ahead to sign a new memorandum

of understanding (MOU) in July 2006 on the reha-

bilitation and upgrading of the southern portion of

Luzon’s railway system (Escandor 2006). This MOU

was converted into two loan agreements between the

two countries during the visit of Chinese Premier

Wen Jiabao in January 2007 which committed US$1

billion in long-term fresh credits that would enable

Chinese state-owned corporations to gain contracts

for the building and repair of existing Luzon rail links

without going through competitive bidding (Landin-

gin 2007).

Chinese banks, all of them state-owned, seem to

be competing with each other to provide the Phil-

ippines with ODA loans. In February 2007, China

Development Bank, reportedly China’s biggest bank,

started talks with the Philippine government on pro-

viding concessional loans especially for infrastructure

development (Manila Bulletin 2007b). This is in ad-

dition to the funds already committed through the

China Export-Import Bank.

All in all, China has pledged to provide the Phil-

ippines with US$2 billion in loans each year from

2007-2009. This commitment was made during a

lunch meeting of 100 aid donors in August 2006 in

Manila, an announcement that shocked Western do-

nors particularly since it made “the US$200 million

offered separately by the World Bank and the Asian

Development Bank look puny, and easily outstripped

a US$1 billion loan under negotiation with Japan”

(Perlez 2006).

China now appears to be fi lling the gap created by

falling OECD DAC development assistance to the

Philippines which observers say is caused in part by

the US government’s displeasure with Mrs. Arroyo’s

decision to withdraw Philippine troops from Iraq in

2004 (Perlez 2006). China has even managed to ease

out no less than the ADB in one project, Manila’s

new aqueduct, as it offered “cheaper rates, faster ap-

proval and fewer questions” (Naim 2007).13 The issue

of competitive pricing apparently does not apply in

the case of (the now mothballed) government plans

to build a national broadband network (NBN) where

a Chinese fi rm (ZTE), to be backed by a Chinese

ODA loan, appears to be favored by the Department

of Transportation and Communications (DOTC)

over a local company despite the latter’s supposedly

lower price offer (Lucas 2007).14

Another controversial Chinese loan project is the

US$465.5 million cyber-education project of the

Department of Education which aims to use satellite

technology to electronically link schools nationwide

(Ubac and Esplanada 2007). Critics have called the

project an unnecessary expense given the more press-

ing problems of classroom and textbook shortages.

They also aired concerns that the project “aims to

12 The Offi ce of the President claimed that a public bidding for the project was not required as this was an executive agreement between China and the Philippines.

13 Comparing China’s aid packages with other donors, Socioeconomic Planning Secretary Neri “noted the appealing absence of the expensive consultant fees common to Western projects” (Perlez 2006).

14 Due to sensational and embarassing exposés in Senate hearings of attempted bribery and various forms of infl uence peddling, the National Broadband Project project was cancelled by the government in September 2007.


replace teachers with satellite-beamed lessons, and

force the use of English instruction instead of en-

couraging the use of local languages.”

Philippine peasant organizations and agrarian-sup-

port NGOs are not happy with China’s aggressive push

into the Philippine economy. In a full-page advertise-

ment in the Philippine Daily Inquirer on 12 February

2007, the groups demanded that the 19 agricultural

agreements with China be canceled because they were

“tantamount to selling off (the) national patrimony”

and “violates the agrarian reform law and reverses

attempts at attaining food security through self-suf-

fi ciency in production.” The groups also questioned

where the 1.24 million hectares would be secured

given that “there are no longer any idle alienable and

disposable lands.”

As Japanese ODA to the Philippines continues its

decline, China is poised to take over as the country’s

primary foreign aid source (Amojelar 2007). For

2007 alone, Chinese loans in terms of pledged funds

and signed agreements reached US$2.21 billion. Act-

ing NEDA Director General Augusto Santos echoes

the line that Chinese loans are more concessional

and more affordable than either ADB or World Bank

loans. This appears to be a barbed reaction to the re-

cent cancellation by the World Bank of a road project

loan (see section on corruption above).

4. ODA Issues4.1 The 2005 COA Report on ODA

The report of the Commission on Audit (COA)

on ODA for 2005 contains fi ndings on 55 ongo-

ing foreign-funded projects that put the Philippine

government’s and the donor community’s handling

of foreign aid in a particularly bad light. The COA

audit team uncovered a number of anomalies and

irregularities related to ODA implementation and

management resulting in huge losses for the govern-

ment and glaring ineffi ciencies in project implemen-

tation. Total losses resulting from the above irregular-

ities amounted to PhP4.7 billion (US$85 million).

The irregularities consisted of (1) overpricing of

relocation sites, (2) unrecorded transactions, double

recording, understatement and overstatement of

various accounts, (3) improper or non-recording and

inventory of property, plant, equipment and offi ce

supplies, (4) misclassifi cation or non-reporting of

accounts, (5) non-compliance with prescribed laws,

rules, regulations, loan agreements and contracts,

(6) delays or non-completion of projects resulting in

slow availment of loan proceeds/low utilization rate

and contributing to additional commitment fees, (7)

the non-utilization of facilities, textbooks and other

items which deprived the benefi ciaries of project ben-

efi ts, and (8) the non-transfer to the government of

titles for forty-six (46) purchased lots.

The implementation of ODA projects in the

Philippines is constantly mired in problems that have

recurred over the years. Except for corruption, social

and environmental concerns, and the issue foreign

consultants, the other issues and problems presented

below are culled from NEDA’s 14th Annual ODA

Portfolio Review (2005) and they sound like a famil-

iar refrain.15 These are problematic areas in addition

to the issues discussed above.

4.2 Corruption and Lack of Transparency

The downfall of the Marcos regime in January

1986 revealed an elaborate web of corruption in the

disbursement of Japanese ODA funds that consisted

in the payment of large sums to Marcos and his cro-

nies in the form of rebates (or commissions), in re-

turn for facilitating loan projects (Tsuda and Deocadiz

1986 and Yokoyama 1990). Estimates of “embezzled”

loan proceeds reached as high as 30 percent of loan

amounts. Since Japanese companies regard the pay-

ment of commissions, or rebates, as “normal procedure

in ordinary commercial transactions” and are known

worldwide for such practices, it stands to reason that

such activities continue unabated till today.

15 NEDA’s 15th ODA Portfolio Review (2006) was released in September 2007 and the Review’s updated ODA fi gures have been incorporated in this study, but not the implementation problems which appear to be mere repetitions of past concerns.


Twenty-one years later, the situation remains basi-

cally unchanged. In a January 2007 survey of expatri-

ate business persons in thirteen Asian countries and

territories, the Philippines was considered “the most

corrupt” (Bonabente 2007). The survey was con-

ducted among 1,476 foreign business persons (100

of them based in the Philippines) by the Hongkong-

based Political and Economic Risk Consultancy

(PERC) group. The Philippine rating of 9.40 out of

a possible 10.00 enabled it to topple Indonesia (with

8.03 rating) as the region’s most corrupt area.16

The country’s policy and implementing environ-

ment is also seen as a breeding ground for corrupt

practices. A paper prepared by the Economic Poli-

cy Research and Advocacy Group (EPRA) headed

by former NEDA Director General Cielito Habito

notes that the “lack of transparency and insuffi cient

disclosure in infrastructure projects with private sec-

tor participation engender graft and corruption that

work against the interests of the taxpaying public”

(Lucas 2007). This lack of transparency and disclo-

sure “increases fi scal and transaction costs, … causes

distortions in how resources are allocated” and results

in overpriced infrastructure projects. As a solution,

EPRA called for the passage of a local version of the

US Freedom of Information Act.

A 2005 World Bank report on “Philippines –

Meeting the Infrastructure Challenge,” observed that

the Build-Operate-Transfer (BOT) law, which allows

for greater private sector participation in ODA-sup-

ported infrastructure development, “remains hound-

ed by controversies related to vagueness over unso-

licited bids where the scope of corruption becomes

considerable” (Alunan 2006). In the 2006 Philippines

Development Forum (PDF), the international donor

community “urged the government to plug expendi-

ture leakages caused by corruption”(Dumlao 2006).

In January 2007, Finance Secretary Margarito Teves

admitted that the country’s access to more grant as-

sistance from the US hinges on its ability to imple-

ment government reform, “especially in the area of

corruption control” (Remo 2007b). 17

One of the country’s largest ODA projects, the

Subic-Clark Tarlac Expressway (SCTEP), has been

hounded by allegations of corruption (Orejas 2006).

A group called the Concerned Central Luzon Con-

tractors (CCLC) claimed that its members had paid

between PhP1 million and PhP5 million to an offi -

cial of the Bases Conversion Development Authority

in exchange for non-existent subcontracts. Known

among contractors as “shortlist fee” the charges have

been ordered investigated by BCDA president Nar-

ciso Abaya. The Chinese-funded US$330 million

National Broadband Project (NBN) was scuttled due

to disclosures of bribery attempts involving high gov-

ernment offi cials.

In November 2007, the World Bank, in a highly

unusual move, suspended the release of US$232 mil-

lion in loans earmarked for the 2nd National Roads

Improvement and Management Program (NRIMP)

after the Bank’s Internal Investigation Unit reported

instances of corruption in the bidding process during

the project’s fi rst phase (International Herald Tribune

2007, World Bank 2007). The investigation unit had

uncovered anomalies involving the China State Con-

struction Engineering, a company owned by the Chi-

nese government “which won a $6.2 million contract

for road maintenance in the Philippines in 2002,”

and “had tried to rig bids with a cartel of construc-

tion companies in later bidding rounds” (Interna-

tional Herald Tribune 2007). The Bank’s 24-member

governing board “refused to authorise the project,

16 The PERC ratings for the thirteen countries and territories are: (1) Philippines, 9.40; (2-3) Indonesia and Thailand, 8.03; (4) Vietnam, 7.54; (5) India, 6.67; (6) South Korea, 6.3; (7) China, 6.29; (8) Malaysia, 6.25; (9) Taiwan, 6.23; (10) Macau, 5.11; (11) Japan, 2.10; (12) Hong-kong, 1.87; (13) Singapore, 1.20.

17 Transparency issues are not the monopoly of recipient countries like the Philippines. Concerned about the high rate of unsuccessful projects under the Asian Development Bank’s poverty eradication program, donor countries, meeting in Manila in June 2003, called for greater transparency and accountability in the operations of the ADB’s US$5.6 billion anti-poverty fund known as the Asian Development Fund, or ADF (Saulon 2003). In particular, the donors want the program’s key department supervising the ADF, the operations evaluation department (OED) to be made independent from the bank’s immediate control and supervision.


arguing that the corruption issues in the fi rst phase of

the project hadn’t been resolved and that World Bank

President Robert Zoellick hadn’t been apprised of the

loan request” (Davis and Simpson, 2007).

4.3 Social and environmental concerns

Large infrastructure and power projects, many of

which are ODA-funded, often endanger the envi-

ronment and cause involuntary dislocations of com-

munities in the target area. For the latter, indigenous

peoples are often the victims of human rights viola-

tions who not only lose their homes and farm-based

sources of livelihood but also their ancestral lands.

Social confl icts are the logical consequences of such

ill-conceived development projects. In recent years,

some of these socially and environmentally contro-

versial projects are:

(1) The JBIC-funded San Roque Multi-Purpose

Dam Project;

(2) The Agno River Integrated Irrigation Project;

(3) the JBIC-funded 400-hectare Leyte Industrial

Development Estate which housed a copper

smelter plant, a fertilizer plant, and a mining

fi rm;

(4) the Calabarzon Industrial Zone whose master

plan was funded by a JICA grant;

(5) the MWSS Umiray River Diversion Project

funded by ADB;

(6) the Pampanga Delta Development Project,

again funded by JBIC;

(7) the ADB-funded Umiray River diversion

Project;

(8) the Calaca Coal-fi red Thermal Power Plant;

(9) various infrastructure projects in Manila fi -

nanced by JBIC.

In June 2006, local and international environmen-

tal groups asked the Japanese government to review

two JBIC-funded projects, the US$58 million Bohol

Irrigation Project and the US$124 million Northern

Negros Geothermal Power Plant Project due to “to

human rights violations complaints involving forc-

ible displacement of locals” (Business World 2006a).

Japanese activists belonging to Friends of the Earth,

an international environmentalist group, asked JBIC

and the Japanese Ministry of Foreign Affairs “to in-

vestigate for themselves what is happening on the

ground. Human rights violations could actually be a

cause for them to withdraw their funding since it is

one of the principles of the ODA Charter.”

The killing of environmental activists has also

been linked to ODA projects. In a meeting between

the Japanese government and non-government orga-

nizations in June 2006, environmental groups pre-

sented the case of peasant leader Jose Doton who was

slain while campaigning against the San Roque Dam

Multi-Purpose Project and the Agno River Integrated

Irrigation Project at the boundary of Pangasinan and

Benguet provinces (Malaya 2006). The group Ka-

likasan-PNE claimed that since Mrs. Arroyo became

President, 15 environmental activists have been mur-

dered as part of a wave of extra-judicial killings that

had by then already totaled 700 victims.

Back in 1994, NEDA had acknowledged in its

Annual ODA Portfolio Review the problems of

“social unacceptability” of some ODA projects and

diffi culties in securing Environmental Compliance

Certifi cates (ECCs). Instead of addressing the issues,

however, the NEDA ECC Committee had tried to

water down environmental and social safeguards in

order to speed up the ICC certifying process (Tadem

2003). Since then, however, NEDA has unfortunate-

ly ceased to monitor environmental and social issues

with respect to ODA projects.

4.4 Foreign Consultants

The ODA Act of 1996 (in Section 11c) and its im-

plementing rules and regulations (in Section 6.2) state

a preference for the hiring of Filipino experts in imple-

menting projects even when the consulting or con-

tracting fi rm is of foreign origin. The NEDA’s Rules

and Regulations on the Procurement of Consulting

Services for Government Projects, approved in Sep-

tember 1998, echoes the above and adds that in cases

where the hiring of foreign consultants is unavoidable,

the “foreign consultants shall be required to associate

themselves with Filipino consultants.” The exercise of


this preferential option is rationalized in the interest of

effecting technology transfer. It also comes in the wake

of numerous complaints in previous years regarding

the “superfl uous” presence of highly paid foreign con-

sultants in ODA projects in positions where Filipino

expertise was not defi cient (Tadem 1990).18

An ADB technical report on one of its funded

projects gives an indication of the glaring inequities

in salary rates between foreign consultants and local

experts. In the ADB-funded Harmonization and Re-

sults Technical Assistance Project, the project budget

allots to foreign consultants honoraria amounting

to US$217,400 with international travel costs of

US$104,000 while Filipino consultants were to be

paid a total of US$5,580 (PhP279,000). Thus local

consultants would be getting a mere 2.6 percent of

the salaries of their foreign counterparts, excluding

the international travel privileges.

The Philippine government apparently is aware of

resentments that these inequities engender so that in

the Philippines Development Forum (PDF)19 in March

2006, NEDA Director General Romulo Neri called

on the donor community to “work to sustain ODA

portfolio improvements and enhance development

impact,” by, among others, “helping the government

fi nd ways to cut costs for consulting services and to

achieve design and cost effi ciency in implementation.”

The particular issue of consultancy costs, however, did

not fi nd a responsive chord among the donors, who

ignored this specifi c concern in their comments and

merely “welcomed the Government’s intention to look

into the provision of budget and funding for project

preparation up to loan effectiveness.”

In February 2004, following complaints from

local construction and consultancy fi rms, President

Arroyo issued Executive Order 278 “directing all gov-

ernment agencies to prioritize Filipino-owned con-

struction and consultancy fi rms in the bidding for

government projects.” The Construction Industry

Association of the Philippines and the Filipino Con-

sulting Organizations lamented their “losing out to

foreign companies in the competition for big govern-

ment projects,” especially foreign-funded ones.

In a November 2001 meeting of project imple-

mentation offi cers (PIOs) of foreign-funded projects

on measuring the performance of project consultants,

the PIOs decried “exclusive eligibility requirements”

provided for in loan contracts which require imple-

menting agencies to contract the services of foreign

consultants “even in instances when the needed ex-

pertise could be hired locally” (Luib 2001). This came

about in the light of observations on “the high costs

of acquiring consultancy services;” subsequently, the

PIOs “suggested that this be addressed during loan

negotiations between the Philippine government and

the lending agency.”

These concerns were raised on top of reports of

poor performances by consultants and the need to re-

form the hiring process and install a reporting system

that will sanction poorly performing consultants.

The presence of underperforming consultants may

be linked to the phenomenon of signifi cant delays in

the implementation of ODA projects and resulting

cost overruns “owing to penalties that lenders impose

on unused loan money.”

Surprisingly, despite the concerns expressed by

PIOs (who are high-ranking government offi cials

themselves) “offi cials of oversight agencies have yet

to issue statements on whether this particular issue

will be used to reform the process of hiring project

consultants.”

One consequence of the hiring of foreign con-

sultants in the design and implementation of ODA

projects is that, “in most cases, local communities

or their organizations are not consulted” (Padilla

2004). Thus, as designed and implemented, ODA

18 In 1989, the Senate Blue Ribbon Committee branded as “superfl uous and unnecessary “ the consultancy fees paid to foreign consultants of ODA projects for services well within the expertise of Filipinos. In the mid-1990s, concerns were raised about the abnormally large presence of Japanese consultants in JICA-funded grant assistance projects and that in one Japanese-funded coal power project, 82 percent of the environmental management costs went to Japanese consultancy fees.

19 The PDF was formerly called the Consultative Group Meeting on the Philippines.


projects often “do not refl ect the true development

needs of communities but the interests of foreign

corporations” and in some cases, “could lead to eco-

nomic and physical displacement of communities”

particularly indigenous peoples. One such project

is the PhP3.8 billion Japanese-funded Saug River

Multi-Purpose Project (SRMP) in Davao del Norte

in Southern Mindanao which will affect the ancestral

lands of 8,000 people belonging to four indigenous

ethnic groups.

In some cases, the foreign consulting fi rm is an

affi liate of a corporation that has business interests in

the project area (Padilla 2004). This is the case with

Cargill Technical Services (CTS) which is a subsid-

iary of Cargill, one of the world’s biggest agribusi-

ness transnational corporations. CTS undertakes

consultancy work for USAID’s Growth with Equity

in Mindanao (GEM) Project by providing “technical

assistance in agriculture management, agro-industrial

development, investment promotion, and privatiza-

tion.” Cargill’s Philippine subsidiary, Cargill Phil-

ippines Inc., operates large-scale integrated animal

feeds plantations in General Santos City in Central

Mindanao.

Perhaps due in part to the inability of host coun-

tries like the Philippines to effectively enforce poli-

cies and laws on the hiring of foreign consultants, the

UNDP has established a Development Support Ser-

vices Center (DSSC) for “the purpose of strengthen-

ing UNDP’s operational support for Nationally Ex-

ecuted (NEx) projects” by stressing “the importance

of using national capacities to undertake programs

and projects.” To achieve its objectives, the UNDP-

DSSC “regularly undertakes local and international

contracting of consultants in various fi elds of exper-

tise, as well as selection of suppliers of good/equip-

ment, among others.”

4.5 Lack of Counterpart Funding and

Procurement Delays

The issue of counterpart funding is related to

several problems discussed in this report – low avail-

ment rates, low disbursement levels, budgeting prob-

lems, right-of-way and land acquisition issues, and

LGU participation, among others. Agencies report-

ing the above-named problems all cite the unavail-

ability of counterpart funding as a major factor that

hinders the smooth and trouble-free implementation

of ODA projects under their jurisdiction.

The issue of counterpart funding takes place at

two levels: (1) between the donor agency or coun-

try and the Philippine government, and (2) between

national government agencies and local government

units. In 2005, 11 government agencies had foreign-

assisted projects that were adversely affected by the

unavailability of counterpart funds. At the local gov-

ernment level, some projects, e.g., the World Bank-

funded Agrarian Reform Communities Development

Project, follow the cost sharing policy of 50-50 be-

tween the national government (NG) and LGU that

is burdensome to the latter, resulting in LGU with-

drawals from the projects. But even in cases where

the NG-LGU sharing policy requires only as little as

10 percent LGU equity, e.g., DA and DPWH man-

aged projects, local counterpart funds were still hard

to come by (Galang 2002).

The counterpart funding shortfall has become

serious enough for the World Bank and JBIC to

take the unusual step of instituting policy changes

in project cost sharing ratios (NEDA 2006). The

WB’s new policy now “provides the fl exibility to

permit Bank fi nancing up to 100 percent of cost of

individual projects and activities, where appropriate,

within the context of an overall cost sharing frame-

work.” The JBIC, on the other hand, “has offered

to increase its disbursement ratio (fi nancing ratio)

to the highest possible limit based on actual require-

ments provided that it will be limited to existing

loan amounts.” Increasing donor share of project

costs, however, also entails a higher debt burden for

the Philippine government and increased adminis-

trative costs. Moreover, it does not address imple-

mentation concerns not related to local counterpart

funding problems.

With respect to procurement issues, the NEDA

Review examined 21 civil works, 4 consulting services


and 11 goods contract packages and noted “a wide

variance in procurement periods” ranging from 1.44

months to 35 months “versus the prescribed timeline

of 3.2 months per Republic Act 9184 or the Govern-

ment Procurement Reform Act (GPRA).” There were

procurement delays by four agencies “with amounts

ranging from PhP106 million to PhP14 billion, re-

sulting in the agencies’ inability to meet performance

targets.” These delays were attributed to “(a) high bid

prices; (b) failure in bidding/rebidding of contracts;

(c) lengthy review process; (d) changes in the agencies’

leadership; and (e) lack of familiarity with RA 9184

and/or funding institutions’ procurement guidelines.”

Other projects which encountered procurement

problems were the Judiciary Reform Support Proj-

ect implemented by the Supreme Court (5 months)

and the North Luzon Wind Power Project (PNOC-

EDC) funded by GOJ-JBIC Special Yen Loan Pack-

age (SYLP) facility (over 12 months). The main rea-

son cited for the delay of the latter project was the

tied loan character of the Special Yen Loan support

which required “at least 50 percent Japanese content

for goods and services and limited only to Japanese as

the primary contractor and supplier.” Bids submitted

were thus “more expensive than international prices

leading to total project costs which are substantially

higher than ICC-approved costs, thus requiring ICC

reevaluation to reaffi rm viability of the project.”

4.6 VAT Reimbursements

Under a government-to-government agreement,

the Philippines exempts Japanese contractors, con-

sultants, and suppliers of Japanese-funded ODA

projects from the payment of Value Added Taxes

(VAT). These are, however, advanced by consul-

tants and contractors of GOJ-JBIC/JICA-assisted

projects “subject to reimbursement by concerned

government agencies.” The absence of appropria-

tion cover, however, caused delays in the reimburse-

ment of such payments which, in 2005, amounted

to PhP1.185 billion for projects implemented by

eight agencies.20

According to the Japan Chamber of Commerce

and Industry in the Philippines, Inc. (JCCIPI), 23

Japanese companies had 205 pending applications

for VAT refunds as of February 2005. These delays

resulted in: “(a) suspension in the processing of proj-

ects under the Japan General Grant-Aid program; b)

delay in the commencement of the 27th Yen Loan

Package negotiation; and c) decreased confi dence in

GOP’s capability to meet its obligations.”

For four years from 2002-2005, the gov-

ernment was unable to pay fully VAT refunds

because of its huge budget deficit (Manila Bul-

letin 2006a). By September 2006, pending VAT

refunds still amounted to P736 million on yen

loans, an amount which the government said it

would repay completely at the end of the year.

Taking the side of its business community, the

Japanese government threatened to cut its ODA

to the Philippines for 2006 unless the tax refunds

were immediately remitted (Remo 2006).

The exemption from VAT levies of fees paid to

foreign consultants and contractors of ODA proj-

ects constitutes foregone income for the Philippine

government. The amounts involved are substantial

and for the foreign players, are added incentives (in

the form of additional incomes) for participating in

ODA projects. As these projects are likely to be “tied

loans” they refl ect the self-serving character of the lat-

ter. Considering that Filipinos are made to pay the

full cost of the VAT payments, the exemptions also

end up discriminating against local taxpayers with

meager incomes and salaries.

4.7 Budgeting Problems

Of the 20 implementing agencies dependent

on the government budget, six reported budget is-

20 These agencies were Department of Public Works and Highways (DPWH), Department of Transportation and Communication (DOTC), Manila International Airport Authority (MIAA), National Irrigation Authority (NIA), Philippine Ports Authority (PPA), National Power Corporation (NPC), Department of Education (DepEd) and Benguet Provincial Government.


sues in the implementation of 30 of their ongoing

ODA projects in 2005. Reasons cited were: “(a)

delayed approval of the 2005 General Appropria-

tions Act (GAA); (b) inadequate appropriations

cover; c) delayed release of Special Allotment

Release Order (SARO) and Notice of Cash Allo-

cation (NCA); and d) confusion among projects

using the Municipal Development Finance Office

(MDFO) as conduit.”

The 2005 GAA (RA 9336), allotted PhP37 billion

for foreign-assisted projects (FAPs), which was 12 per-

cent lower than the proposed FAPs budget of PhP41.4

billion but 5 percent higher than the recycled 2004

budget of PhP35.3 billion. The budget defi cit for

ODA projects from 2004 to 2005 led to extensions in

implementation schedules and closing dates of more

than 13 projects, thereby jacking up project costs.

The Department of Budget and Management

(DBM), however, reported total accounts payable of

the National Government at PhP80 billion in 2005,

a 38 percent decline from PhP130 billion in 2002.

4.8 Local Government Units

The involvement of local government units

(LGUs) as ODA implementing agencies, while laud-

able in principle, often results in problems in project

implementation. NEDA reports that in 2005, “a to-

tal of 44 ODA projects with direct LGU participa-

tion accounted for 18 percent of the portfolio.” A

major problem is the “lack of LGU equity.”

A second major problem is the “limited technical

capacity of LGUs, particularly those in the lower in-

come class.” This problem arises during the “prepara-

tion and submission of documents required during the

subproject appraisal stage, e.g., the conduct of surveys,

preparation of loan applications and documents to

comply with Bank requirements (i.e., cost recovery for

operations and maintenance and formation of autono-

mous units for solid waste management in the LGUs)

and preparation of engineering plans and Environ-

mental Compliance Certifi cate/Certifi cate of Non-

Coverage (ECC/CNC) from DENR and detailed

engineering design stage.” ODA projects affected were

DOF’s Local Government Finance and Development

Project and the Credit Line for Solid Waste Manage-

ment Project.

4.9 Right-of-Way/Land Acquisition Issues

ODA projects, especially major infrastructure-re-

lated ones, often require the takeover by government

of privately owned lands after paying the proper com-

pensation. Funds for landowner compensation, how-

ever, are often inadequate, due to budget constraints21

and in some cases, disagreements arise on compensa-

tion payments, with the landowners rejecting the

government’s fi nal proffered price. Other right-of-

way issues involve the “resistance of project affect-

ed people/relocatees, presence of illegal settlers and

claimants and deferment in the acquisition of hous-

ing units.”

NEDA listed eleven major infrastructure projects

and their respective implementing agencies as having

major right-of-way and land acquisition problems in

2005. These involved bridge projects, fl ood control

works, airports, highways and expressways, water

supply projects, irrigation schemes, and river reha-

bilitation plans.

4.10 Project Management

Political instabilities, an insecure national lead-

ership, and questions about the legitimacy of the

government have characterized Philippine gover-

nance over the past few years. These have resulted

in frequent “changes in heads of agencies/manage-

ment” which, in turn, “impact on implementation

of ODA projects.” The results are “delays in award

of contracts, because of repeated reviews of contracts

for due diligence, or in certain cases, even changes

in project design.” Among the projects affected were

DAR’s Agrarian Reform Infrastructure Support Proj-

21 “The law requires the implementing agency to deposit the payment of 100 percent of the Bureau of Internal Revenue (BIR) zonal value or proffered value of the property to be acquired with a government bank after fi ling the petition on eminent domain case” (NEDA 2005).


ect II (ARISP), SBMA’s Subic Bay Freeport Develop-

ment Project, and the ARMM Social Fund for Peace

and Development Project.

In the case of DAR, “a change in leadership required

evidence of authority for the new appointee” while for

SBMA, “new management had to review the procure-

ment processes/decisions adopted by the previous ad-

ministration.” For ARMM, the planned “transition

in project management from the Fund Management

Offi ce (FMO) to the ARMM Regional Government,

(then still pending with the Offi ce of the President)

created “uncertainties in project management.”

4.11 Project Cost Overruns

Increases in project costs are perennial problems

encountered in ODA projects. For 2005, an addi-

tional amount of PhP29 billion was added to the

project costs of 17 projects. In terms of funding

source, 15 projects (with additional outlays of PhP21

billion) were funded by JBIC while the World Bank

and China accounted for one project each.

The reasons given by implementing agencies

for the project overruns are: “a) additional civil

works (changes in scope/variation orders/supple-

mental agreements); b) increase in right-of-way/

land acquisition/ resettlement costs; c) increase

in unit cost of labor, materials and equipment;

d) high bids (bids above Approved Budget for the

Contract/Approved Agency Estimate); e) currency

exchange rate movement; and, f ) claims for price

escalation.” Most of these reasons, however, point

to faulty planning and lack of foresight not just on

the part of the implementation agencies but also of

the donor agencies or countries.

The PhP29 billion additional allocations for 17

projects in 2005 constituted a 163 percent rise in

increased project costs and a 212 percent rise in the

number of projects over the 2004 figure of PhP11

billion and eight projects. The obvious conclusion

here is that the deterioration in the cost situation

of a large number of projects between 2004 and

2005 clearly reflects a drastic decline in the effi-

ciency of ODA project implementation.

4.12 Loan Cancellations, Closed Loans,

and Loan Extensions

Twenty-three (23) loans totaling US$260 mil-

lion were cancelled in 2005. Both implementing

and funding agencies agreed on the cancellations

due to: “a) unutilized balance at the close of the

loan; b) excess financing as a result of foreign ex-

change rate movement; c) low demand for relend-

ing; d) reduction in scope of projects; and, e) bud-

get constraints.” In 2004, then NEDA Director

General Romulo Neri announced the cancellation

of PhP13 billion (US$260 million) of ODA loans

that were due to be implemented by the DOTC

because of insufficient budget cover for counter-

part funding and loan repayment (Remo 2004).

A previously approved major project that was can-

celed was the JBIC-funded Phase 5 of the Metro

Manila Interchange Construction Project worth

US$47 million which went into effect in Septem-

ber 2001 and was supposed to have been complet-

ed in September 2006 (de la Cruz 2006).

Of the 29 loans that were reported as closed

and/or fully availed in 2005, at least three had

incomplete project outputs. The implementing

agencies for these unfinished projects cited “bud-

getary constraints and technical issues” for the in-

complete project outputs. Fourteen loans worth

US$923 million were extended in 2005. These

constituted nine percent of the ODA portfolio.

No details on the reasons for the extension were

reported by NEDA.

A 23-kilometer road project in South Cota-

bato has been extended due to “peace and order

problems, logistical problems and bad weather”

(Business World 2006a). Originally scheduled for

completion in May 2006, the PhP73 million-proj-

ect was only 50 percent completed in June 2006.

The area has been the scene of “bloody killings

among warring local armed groups over the last

few years.”

Japanese loans suffer from the most number

of cancellations. In 2006, 14 JBIC loans amount-

ing to US$166 million were canceled (Amojelar


2007). These were due to “unutilized balances at

the close of the loan, excess financing as a result

of foreign-exchange rate movements, low demand

for relending, reduction in scope of projects, and

budget constraints.”

4.13 Low Demand for Credit

Two government-controlled fi nancial institu-

tions, the Development Bank of the Philippines

(DBP) and the Land Bank of the Philippines (LBP)

access ODA funds which are then relent to other

government agencies, including local government

units, or the private sector. In recent years, however,

the demand for credit from these two institutions

has been low, adversely affecting the ODA programs

under their supervision.

NEDA reports that “for projects implemented by

DBP, low demand was experienced in the fi ve proj-

ects having to do with industrial support, domes-

tic shipping, pollution control, water supply, and

technical education.” Reasons for the low demand

included: (a) wait-and-see attitude of investors in

light of the fi nancial crisis and fear of a possible

downgrade of the country’s sovereign international

rating, (b) selective lending by private fi nancial in-

stitutions to big projects, (c) increase in prices of

equipment, (d) non-prioritization of environmental

projects, (e) rejection of Design-Build-Lease scheme

by LGUs, and, (e) competition from state univer-

sities and other public institutions which offer

cheaper training courses. The 2005 performance of

DBP-managed ODA loans contrasted sharply with

the optimism expressed by then DBP President Si-

mon Paterno in 2004 regarding the bank’s relending

program in ODA funds (Dumlao 2004).

For LBP-implemented projects, NEDA reports

that low demand was in rural fi nance and local

water supply development. Reasons cited were: (a)

limited types of projects that can be funded and

non-viability of sub-projects, (b) weakness of both

large and medium scale businesses due to prolonged

effects of the Asian fi nancial crisis, (c) excess liquid-

ity in the banking system, and (d) competition from

DBP with its below-market lending rates.

4.14 Legal Cases

The NEDA Portfolio Review 2006 reported that

legal cases are sometimes fi led in court by interested

parties based on allegations of irregularities in proj-

ect implementation. In the DPWH-managed Agno

River Flood Control Project – Phase II, charges of

“irregularity and anomaly in the bidding and award

of the contract to the lowest bidder” went all the way

to the Supreme Court in 2002. Although the SC

dismissed the petition, in April 2005, the DPWH

successfully completed the bidding process only in

February 2006 because of the need for further stud-

ies on unit cost prices due to “the three and a half

year delay in contract award.”

There is a pending legal case in the Southern

Mindanao Integrated Coastal Zone Management

Project, where the DENR and the Provincial Gov-

ernment of Sarangani have yet to resolve the legal

personality of the Environmental Conservation and

Protection Center (ECPC). The most high profi le

legal case, however, is the Chinese-funded Northrail

Project where a petition for the cancellation of the

project is pending with the Supreme Court (see Sec-

tion 3.8).

4.15 Best Practices

The Philippine ODA picture, however, does not

look entirely bleak. There are some projects that

have been cited for their effectiveness and appropri-

ateness in addressing the more relevant concerns of

the Filipino people. The possible candidates for best

ODA practices include:

• The Second Communal Irrigation Develop-

ment Project (CIDP 2) - World Bank

• Alliance for Mindanao Off-Grid Renewable

Energy (AMORE) – USAID

• The Third Elementary Education Project

(TEEP) – JBIC

The characteristics that the CIDP2 and AMORE

projects have in common are (1) community-based;

(2) direct participation by benefi ciaries and stake-


holders in project implementation and mainte-

nance; and (3) relatively small-scale operations

and lower per-capita costs. The TEEP, on the other

hand, was initially problematic, but the takeover by

dedicated, non-bureaucratic and effi cient managers

turned the project around. The results among the

targetted areas were lower drop-out rates, narrower

gaps in completion rates, higher academic perfor-

mances, and improved national rankings (JBIC

Study Team 2006).

5. Summing up the Philippine ODA ExperienceFrom 1947 to 1977, the US provided US$1.7 bil-

lion in economic assistance to the Philippines but a

US government study concluded that “concrete devel-

opment advances are hard to identify” (Shirmer and

Shalom 1987). In 1979, an independent study of the

impact of US aid projects to the Philippines noted that

“only 22 percent of the aid is reaching the needy …

amounting to less than a penny per person per day”

(Morrel 1987). Only a few projects “have reached the

poor … such as irrigation works, rural roads, safe water

facilities, and rural health centers” while “the majority

of US aid (was) not even intended to help the poor.”

The latter consisted in “tobacco loans, insurance for a

Bank of America branch, military aid, expensive ru-

ral electricity services, and balance-of-payments loans

conditioned on the adoption of government policies

that reduce real wages for the poor.”

A 1986 report by a group of 16 economists from

the UP on the socio-economic reforms needed af-

ter the overthrow of the Marcos regime pointed to

“the foreign debt as one of the biggest obstacles to

economic recovery” (Alburo et al 1986).22 It was

not only the size of the debt that was worrisome

but that “most of the projects that were financed

by foreign loans were unproductive” in that they

were not used “to increase exports and reduce im-

ports” thus resulting in unmanageable debt service

and debt-to-GDP ratios. This is because many

foreign financed projects “were not well chosen or

were probably chosen precisely to finance capital

flight through the overpricing of projects.”

An additional burden was that “many private

sector projects relied on government financial in-

stitutions for foreign loans and guarantees.” The

UP group further pointed out that “official assis-

tance was tied to projects which were not necessar-

ily high in the country’s priorities or were tied to

sources of imports and equipment that were more

expensive than competitive suppliers.” On top of

this, “many of the projects were overpriced, mis-

managed, not viable to begin with, or made unvi-

able by changes in the exchange rate and the inter-

national environment.”

Twelve years later, Malaluan (1998) criticized

the government’s public investment program’s ex-

cessive obsession with growth to the detriment of a

redistributive agenda. His study contends that this

investment pattern is reflected in the track record

of foreign assistance that “imposes a resource bias

against redistributive policies” since aid criteria

“are based mainly on projected project contribu-

tions to capital formation and foreign exchange.”

Thus “foreign assistance focuses on the economic

sectors in fast-growing … and highly urbanized

areas” thereby exacerbating regional, geographical

and sectoral imbalances.

As the new millennium slowly unfolds, the is-

sues that have long characterized foreign assistance

to the Philippines continues to haunt both the

government and its creditors. The 2004 COA’s

Sectoral Performance Audit Report on Public

Debt shows how little has changed over the last

decades. The following are the highlights of the

COA audit:

1. “Existing laws, rules and regulations were

inadequate to ensure proper management

and monitoring of public debt. As the es-

timated income were most often not real-

22 At the time that Marcos was overthrown, the Philippines “was one of the most heavily indebted countries in the world: seventh in size of debt, sixth in debt to exports ratio, fourth in debt to gross domestic product, and ninth in debt service ratio” (Alburo et al. 1986).


ized, actual borrowings even exceeded the

amount programmed to be borrowed.”

2. “The loan proceeds did not significantly

contribute to our economic development

as these were expended for loan repayments

and not to projects.”

3. “There is inconsistent treatment of liabili-

ties of the different sectors for lack of defi-

nition of the components to be considered

as public debt.”

4. “The DOF’s data on outstanding public debt

does not include indebtedness of other gov-

ernment corporations” and “contingent li-

abilities on account of guarantees issued by

the national government. Under these condi-

tions, the government could not make an ac-

curate assessment of its fi nancial condition.”

5. “A number of projects funded from borrow-

ings were approved without proper evalu-

ation. … Risks in project implementation

were not addressed before the projects were

started, thus, wasting limited government

resources at the expense of the taxpayers and

depriving the public of the benefits to be

derived from the projects.”

In a 2003 international conference on the qual-

ity of aid, then Budget Secretary Emilia Boncodin

enumerated “painful blunders that have been com-

mitted in the name of development” and cited loans

that “have ignored pressing needs and yielded coun-

ter-productive results” (Sison 2003). Boncodin ques-

tioned the “ownership” of development projects par-

ticularly “when foreign consultants come in and ‘call

the shots,’ proposing solutions that are not adaptable

to local situations” In the case of new technologies

that are introduced, the result was only to “raise the

costs of public services.”

Echoing Boncodin’s complaint in the same

meeting, Jonathan Uy, director of the NEDA pub-

lic investment staff, said that, in some instances,

“there was disregard for existing structures and

local practices which should have been adapted

rather than supplanted.”

Uy further scored the “recipient’s weakness in

identifying its needs and donors and consultants hav-

ing their own agenda to push, effectively ‘driving’ the

preparation and implementation of the projects/pro-

grams rather than the recipients” (Sison 2003).

6. List of RecommendationsThe policies and practices surrounding ODA in the

Philippines are obviously in need of a thoroughgoing

overhaul. Not all of the issues and concerns identifi ed

in this study are acknowledged by offi cial government

reports, particularly the annual NEDA portfolio reviews

which deal mainly with implementation glitches. No-

table exceptions are the COA audits which, however,

are released to the public on an intermittent basis and

which, despite the seriousness of the problems that are

reported, appear to have been regularly ignored by the

agencies to which they are addressed. In the meantime,

this report makes the following urgent recommenda-

tions, for whatever they are worth:

6.1 Recommendations to donor governments

and multilateral institutions

6.1.1 Increase and improve the quality of aid

allotments.

6.1.2 Realign the loan-grant mix to favor the

latter.

6.1.3 Increase the share of projects on human

and social development.

6.1.4 Realign regional and provincial distribu-

tion of aid to poorer areas.

6.1.5 Address social and environmental con-

cerns.

6.1.6 End all tied aid.

6.1.7 Delink aid from the war on terror, par-

ticularly in Mindanao.

6.1.8 Closely monitor aid effectiveness.

6.2 Recommendations to the Philippine

government

6.2.1 Fix implementation problems.

6.2.2 Plug the hemorrhage of government

funds in repaying loans.


6.2.3 Address the foreign consultants’ issue.

6.2.4 End human rights violations in aid proj-

ects.

6.2.5 Focus on long-term and alternative

sources of development fi nancing.

6.2.6 Strictly follow the legal requirements in

negotiating loan agreements.

6.2.7 Adopt a policy of transparency and pop-

ular participation.

6.2.8 Draw up comprehensive and consistent

ODA performance standards.

6.2.9 Re-evaluate government policies and

thrusts on ODA.

6.2.10 Adopt a policy of preferential option for

untied aid.

This report by no means exhausts all the issues

and concerns that have been raised about offi cial

development assistance in the Philippine case. Nev-

ertheless, this partial assessment already forms a

strong basis to criticize the quality, quantity, and ef-

fectiveness of foreign assistance at both the donors’

and the recipient Philippine government’s end.

Given the evidence, and in a deeply signifi cant

sense, the term “development assistance” in the Phil-

ippines has become an oxymoron. Unfortunately for

the poor and disadvantaged sectors of society, “for-

eign aid” does not just connote a fi gure of speech but

a reality that unfolds on a daily basis, the presumed

benefi ts of which they only have a phantom acquain-

tance.


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Amojelar, Darwin G (2007). As Japan aid declines Chinese loans to RP rising, The Manila Times, 3 December.

Banal, Conrado R. III (2007). Soap or Pera”, Breaktime, Philippine Daily Inquirer, 27 February.

Bonabente, Cyril L. (2007). RP ‘Most Corrupt’ in Asia, Philippine Daily Inquirer, 14 March.

Business World (2006a), Glitches Stall Completion of ADB-funded Road Project, 9-10 June.

___________ (2006b). ODA Problem, 16-17 June.

Cagahastian, David (2004). More Japanese Financial Assistance For RP in 2005, Manila Bulletin Online,

21 October.

de la Cruz, Roderick T. (2006). Japan ODA loans to RP Slow Down, Manila Standard, 18-19 February.

Davis , Bob and Glenn R. Simpson (2007). World Bank struggling with corruption, Wall Street Journal,

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Dumlao, Doris C. (2006a). Donors tell RP: Curb corruption, spend more, Philippine Daily Inquirer, 1 April.

______________ (2006b). Gov’t Cuts Planned ’07 Bond Offer to $900M, Authorities to Tap Instead

Cheaper ODA Loans, Philippine Daily Inquirer, 13 November.

_____________ (2007a). BSP to Prepay More Loans, Philippine Daily Inquirer, 24 February.

_____________ (2007b). Gov’t Warned Against Wasting ODA Funds, Philippine Daily Inquirer,

15 February.

Escandor, Juan Jr. (2006). China to Fund Extension of South Luzon Railway, Philippine Daily Inquirer,

22 July.

Galang, Jose Jr. (2002). Aid Energy Languishing in Pipeline, Awaiting Release, The Manila Times, 17 February.

Gaylican, Christine A. (2007). $1-B China loan sought for Laiban dam project, Philippine Daily Inquirer,

20 February.

_________________ (2007a). P10-B Windfall Awaits Agriculture Sector at Asean Summit, Philippine Daily

Inquirer, 9 January.

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Can Trade FinanceDevelopment?

Trade, of course can fi nance development. And for relatively small economies that do not have oil or capital

goods, trade is essential just to keep their economies going. Keeping the economy going is one thing, using trade

to propel real development is another. It takes not just the desire to earn enough dollars to fi nance a country’s

import needs, the dollar earnings should be more, a lot more than your import needs so that residual funds can

be used to fi nance investments.

When the Philippines adopted the so-called “export-oriented strategy” during the 1970s until now, it was

under the long-held belief that being aggressive in the global market can generate positive trade balances. The

earnings from trade can therefore be used to fi nance industrialization and development.

A general picture of a “normal” development path under an export-oriented strategy has the following features:

• the decline in the share of agriculture in the total output of the economy and the consequential increase

of the share of the industrial sector;

• in the country’s total output an increase in high value-added exportables, i.e. a strong backward linkage of

the export sector with the rest of the local economy;

• the increase in employment share of the manufacturing sector;

• the increasing share of high value-added, greater economies of scale and high technology manufactures in

the total output of the manufacturing sector;

• diversifi cation of its export market;

• and an increasing positive trade balance.

Getting the PictureAfter three decades, and now going into our fourth decade of holding on to this strategy, we can picture our

economy from different angles.

1. You can count on your fi ngers the number of years where we experienced a positive trade balance.

2. The share of the agriculture’s output to GDP has declined, but rather than increase, the share of the manu-

facturing sector has stagnated. What has increased is the share of the service sector.

3. In terms of employment generation – there was virtual stagnation in the manufacturing sector. The service

sector is providing the jobs for the greater number of job seekers.

Jessica Reyes-Cantos


Figure 1. Demand Components, % of GDP

Table 1. 1992 to 2006 Trade Performance (F.O.B. value in million U.S. dollars)

Year Total Trade Exports ImportsBalance of Trade Favorable

(Unfavorable)

2006 99,183.79 47,410.11 51,773.68 (4,363.00)

2005 88,672.86 41,254.68 47,418.18 (6,163.50)

2004 83,719.73 39,680.52 44,039.21 (4,358.69)

2003 76,701.72 36,231.21 40,470.51 (4,239.30)

2002/r 74,444.67 35,208.16 39,236.51 (4,028.35)

2001/r 65,207.36 32,150.20 33,057.16 (906.96)

2000 72,569.12 38,078.25 34,490.87 3,587.38

1999 65,779.35 35,036.89 30,741.46 4,294.43

1998 59,156.64 29,496.75 29,659.89 (163.14)

1997 61,161.52 25,227.70 35,933.82 (10,706.12)

1996 52,969.48 20,542.55 32,426.93 (11,884.38)

1995 43,984.81 17,447.19 26,537.63 (9,090.44)

1994 34,815.46 13,482.90 21,332.57 (7,849.67)

1993 28,972.21 11,374.81 17,597.40 (6,222.59)

1992 24,343.24 9,824.31 14,518.93 (4,694.62)

Source: National Statistical Coordination Board


The global labor market is likewise able to pro-

vide employment and gainful income for our people

– eight million of them.

4. The profi le of our exports is limited. Electron-

ics makes up more than 60 percent of export

earnings, garments a far fi ve percent, and so do

agriculture-based products. The only commod-

ity group that has inched up, in fact, doubled

its export earnings share, are mineral products,

from less that two percent in 2005 to fi ve per-

cent in 2007. That is most likely attributable to

the activity of mining companies after the Su-

preme Court’s reversal of its decision to declare

the Mining Act unconstitutional. So un-diverse

is our exports profi le that the removal of the

electronics sector practically reduces our export

earnings to crumbs.

5. Despite all the years of being our export win-

ners, or so-called top dollar earners, garments

and electronics still have very low value-added

and weak backward linkage with the rest of

the economy. While indeed they create em-

Figure 2. Agriculture, Industry and Services Share to GDP


Figure 3. Employment by Sector (In thousands)


ployment and add to our dollar earnings, they

also add to our import bill.

6. Our manufacturing sector is a laggard com-

pared to our Asian neighbors.

7. If it is any consolation, we have somewhat

diversifi ed our export market. Then US and

Japan remain our major export markets but

China, Singapore and other Asian countries,


Commodity 2007

Jan-Nov p2006

Jan-Nov2006

Jan-Dec2005

Jan-Dec p2004

Jan-Dec r

Total Agro-Based Products 4.50% 4.26% 4.25% 4.86% 4.72%

Agro-Based Products 3.46% 3.29% 3.28% 3.79% 3.52%

Coconut Products 1.79% 1.59% 1.42% 1.99% 1.81%

Sugar and Products 0.19% 0.23% 0.22% 0.20% 0.20%

Fruits and Vegetables 1.48% 1.48% 1.48% 1.60% 1.51%

Other Agro-Based Products 1.04% 0.97% 0.97% 1.07% 1.20%

Fish, Fresh or Preserved Of Which: Shrimps & Prawns

0.58% 0.54% 0.54% 0.58% 0.68%

Abaca Fibers 0.03% 0.03% 0.03% 0.30% 0.04%

Tobacco Unmanufactured 0.08% 0.07% 0.07% 0.07% 0.04%

Natural Rubber 0.08% 0.10% 0.10% 0.09% 0.09%

Seaweeds, Dried 0.04% 0.05% 0.05% 0.07% 0.09%

Others 0.22% 0.17% 0.17% 0.23% 0.26%

Forest Products 0.07% 0.05% 0.05% 0.80% 0.09%

Mineral Products 4.93% 4.41% 4.41% 1.95% 2.01%

Petroleum Products 2.05% 2.01% 2.01% 1.42% 0.96%

Manufactures 85.70% 85.79% 85.79% 89.60% 89.53%

Electronic Products 62.19% 62.72% 62.72% 66.23% 67.35%

Other Electronics 2.25% 1.95% 1.95% 0.48% 2.88%

Garments 4.63% 5.60% 5.60% 5.58% 5.47%

Textile Yarns/Fabrics 0.41% 0.45% 0.45% 0.59% 0.60%

Footwear 0.06% 0.05% 0.05% 0.60% 0.09%

Travel Goods and Handbags 0.22% 0.06% 0.06% 0.50% 0.10%

Wood Manufactures 1.56% 1.39% 1.39% 0.33% 0.31%

Furniture & Fixtures 0.48% 0.59% 0.59% 0.74% 0.74%

Chemicals 1.98% 1.56% 1.56% 1.33% 1.13%

Non-Metallic Mineral Manufactures 0.41% 0.38% 0.38% 0.41% 0.42%

Machinery & Transport Equipment 3.71% 3.56% 3.56% 4.45% 4.04%

Processed food and Beverages 1.45% 1.21% 1.21% 1.26% 1.25%

Iron & Steel 0.50% 0.53% 0.53% 0.23% 0.15%

Baby Carr., Toys, Games and sporting goods

0.31% 0.32% 0.32% 0.32% 0.32%

Basketwork, Wickerwork & Other Plaiting Materials

0.11% 0.11% 0.11% 0.14% 0.17%

Misc.Manufactured Articles, n.e.s. 0.68% 0.68% 0.63% 0.69% 0.59%

Others 4.75% 4.62% 4.62% 4.29% 3.92%

Special Transactions 2.76% 3.48% 3.48% 2.08% 2.70%

Re-export 1.27% 1.30% 1.30% 1.80% 1.32%

Table 2. Distribution of Philippine Exports by Commodity Group 2004 to 2007 (Jan-Dec)

Source: Foreign Trade Statistics Section, Industry and Trade Statistics Dept National Statistics Offi ce

Notes: a - No export data p - Preliminary r - Revised Components may not add up to totals due to rounding


of late, have started to accommodate our

products. This is more a result of increased

intra-ASEAN trade.

The Other Side of the PictureThe export-oriented strategy was only good on

paper. Critical prerequisites to having products that

can effectively compete in the global market are sorely

missing, or even if there are strides, say, for instance,

in infrastructure development, they were never at par

with the kind of infrastructure development of our

Asian neighbors. Add to that high power and labor

costs and a deteriorating quality of education and

indeed, the export-oriented strategy, while sensible,

remains a pipe dream.

Thanks to the earnings of our OFWs we have

a safety valve from which we can somehow provide

funds for our insatiable demand for imports.

But there is still a lot of potential for increasing

our export earnings. In fact, recently, the growth in

exports has been faster than imports. But apart from

light manufactures, processed and unprocessed agri-

cultural products still have the potential to make in-

roads in the export market. Table 4 lists the country’s

top agriculture exports.

But much still has to be done in terms of mak-

ing our agriculture exports acceptable, especially in

foreign markets that use sanitary and phytosanitary

measures in supposedly raising the standards for their

own consumers’ safety but likewise use them to pro-

tect their own markets.

The agriculture sector was subsequently subjected

to liberalization as part of our commitment to the

General Agreement on Tariffs and Trade–World Trade

––1970s 1980s 1990s 2000 - 04

PRCIndia

31.2715.32

36.2616.43

32.90h

16.5834.50i

15.71

NIEsHong Kong, ChinaKoreaSingaporeTaipei, China

–21.6124.84a

32.43

21.1827.5126.0934.95

9.4327.1426.1127.11

4.3227.8227.3922.80

ASEAN - 4IndonesiaMalaysiaPhilippinesThailand

10.4216.8225.7518.98

15.3520.4225.0323.32

23.7227.0523.2929.55

29.0431.2122.9434.00

Other Southeast AsiaCambodiaLao PDRMyanmarViet Nam

––

9.64–

–9.27d

9.0719.69e

11.0814.206.9015.23

19.4018.678.49m

19.94

Other South AsiaBangladeshBhutaMaldivesNepalPakistanSri Lanka

–––

4.1115.8919.02

13.765.29

–5.2415.9815.39

14.8710.39

–8.7716.4415.68

15.737.79m

–8.8515.9915.90

Table 3. Developing Asia Manufacturinhg Output Shares by Decade

Source: “Benchmarking Developing Asia’s Manufacturing Sector,” Jesus Felipe and Gemma Estrada, ERD Working Paper No. 101, Asian Development Bank, September 2007


Organization (GATT-WTO), fi rst by removing quan-

titative restrictions in imports, except for rice, and

converting the quantitative restrictions into tariffs.

Since our accession to the WTO, we have never had

any positive agriculture trade balance. This further

puts into question our capacity to feed our people.

Given our uncompetitive infrastructure facilities

and power costs, plus an uncompetitive currency, the

use of tariffs has become the recourse of our domestic

producers in order to have a fi ghting chance against

the onslaught of cheap subsidized imports into our

domestic market.

Our nominal tariffs have progressively gone

down, except for a temporary halt in 2005.

To the lament of our domestic producers, though,

these reductions in tariff were not real commitments

to the WTO but more of a unilateral move by the

government through a series of Executive Orders.

They are merely initiatives of the Executive Depart-

ment rather than a policy crafted as a result of delib-

erations done by Congress. As if to rub salt in their

wounds, government could have easily raised tariffs

Table 4. Top 12 “Reliable” Agricultural Exports (in million US$)

Source: “Overview of Philippine Agriculture and Agricultural Trade”, Lecture given by Dr. Ramon Clarete, PGTEP, Makati Sports Club, 5 October 2006.

Commodity 1987 1990 1993 1995 1998 2000 2003 2006

Bananas 121.24 149.28 226.07 223.74 217.04 291.65 333.00 326.43

Cake of Coconuts 73.48 54.01 45.30 66.87 35.54 23.57 35.60 31.07

Coconuts, Dessicated 75.29 60.68 83.85 68.29 74.30 73.25 95.75 99.74

Fatty Acids Oils 12.99 12.59 10.54 17.82 30.51 10.97 29.92 28.67

Fruit Preoaredness 19.41 27.58 65.58 52.09 51.96 42.13 71.00 79.67

Mangoes 12.49 15.32 26.63 42.23 45.99 39.81 44.73 36.90

Oil of Coconuts 380.54 360.75 357.61 826.09 705.66 463.94 504.86 577.79

Pineapples 24.46 22.70 23.16 24.76 20.84 24.79 38.10 41.13

Pineapples, Canned 86.34 88.68 94.16 80.78 79.25 90.70 84.28 88.73

Rubber Natural Dry 7.54 11.71 11.83 27.77 14.25 14.29 32.78 34.49

Sugar (Centrifugal, Raw) 60.37 110.87 102.24 66.49 80.47 52.00 62.02 67.27

Tobacco Leaves 18.47 20.43 25.67 20.52 27.11 18.96 16.89 17.78

Top 20 exports 1,067 1,079 1,179 1,654 1,492 1,288 1,621 1,735

“Reliable 12” 893 935 1,073 1,518 1,383 1,146 1,349 1,430

Share 83.68 86.60 91.02 91.81 92.69 88.96 83.24 82.41

up to the bound rates from the miserably low tariffs

that were being applied without breaking any WTO

rules. But except for sugar, vegetables and cement,

other sectors never got any reprieve.

In 2007, the most immediate and serious threat

to our export sector as well as our domestic producers

is the continuous appreciation of the peso against the

dollar.1 Our exporters have been earning less pesos

for every dollar they earn, as do our overseas Filipi-

no workers (OFWs). On the other hand, whatever

protection our domestic producers got from a tar-

iff reduction halt in 2005 was actually wiped out by

the peso appreciation. Imports, when converted into

their peso value, actually come in cheaper.

The creation of more economic zones where im-

ported inputs can come in duty-free, while justifi ed

by the jobs that they create domestically, likewise

distorts whatever rationality still remains in our tar-

iff structure. But apart from creating economic en-

claves, the long term impact of these economic zones

must be seriously looked at. There are clearly fore-

gone revenues both of the local and national govern-

1 Editor’s note: In 2008, the peso reversed the trend of appreciation. Infl ation and the global fi nancial crisis led to the weakening of the peso.


Table 5. Weighted Average Tariff by Major Sectors, 1990-2005, selected years

Sector and Product Groups 1990 1995 2000 2004 2005

Sectoral Weighted Averages 27.86 21.91 17.38 10.76 14.41

Agriculture, Fishery and Forestry 23.63 22.00 16.55 14.52 14.39

Agriculture 26.42 25.60 22.13 20.08 19.77

Fishery 17.86 16.46 6.15 3.42 4.33

Forestry 189.31 10.64 3.18 2.87 1.54

Mining 1.67 1.43 -0.20 0.42 0.37

Manufacturing 31.02 23.09 18.73 9.94 15.24

Food Processing 40.40 32.31 35.13 21.50 31.62

Beverages and Tobacco 51.93 42.28 17.75 0.55 8.66

Textile, Garments and Footwear 25.35 13.33 5.16 2.55 3.39

Wood and Wood Products 33.81 16.38 12.03 2.81 7.00

Furniture and Fixtures 21.32 13.19 10.96 1.40 9.33

Paper, Rubber, leather and Plastic Products 32.37 20.66 13.06 3.94 7.02

Chemicals and Chemical Prodcuts 23.50 11.27 6.86 3.46 5.54

Non-metallic Mineral Products 10.59 11.91 4.90 3.07 3.13

Basic Metals and Metal Products 23.15 15.48 8.47 3.58 4.66

Machinery 24.22 11.32 7.92 2.21 4.68

Miscellaneous Manufactures 20.58 10.29 6.51 2.17 3.00

ation of strong backward and forward linkages among

and between sectors. I would argue that the trade policy

that government has implemented through the years has

not contributed to this kind of development.

That our domestic economy cannot provide

gainful employment for our people cannot be

simply explained away as a natural consequence

of globalization.

The need for an industrial policyCivil society organizations have shouted them-

selves hoarse with repeated calls for a clear agro-

industrial development plan that would guide the

formulation of trade and investments policy. But its

absence already puts our country in default when

we negotiate and engage in WTO processes as well

as in bilateral and regional trading agreements. The

impasse in the WTO talks is a fertile ground for the

proliferation of bilateral trade agreements. With so

many other countries negotiating with Japan, Chi-

Philippine Tariff Profi le (2006)

Binding coverage Agriculture – 98% NAMA – 61.8% (38.2% Unbound)

Average bound rates Agriculture – 34.7% NAMA – 23.4%

Average applied tariffs Agriculture – 8% NAMA – 4.3%

Source: Tariff Commission

ment, it is being used as a smuggling backdoor and it

discourages forward and backward integration. The

legislature’s attention must be called to this matter as

they plan to create more and more economic zones.

Putting a Stop to our Economic DisintegrationOver the long run, what is critical in achieving mean-

ingful and sustainable economic development is the cre-


na, Korea, EU for their own bilaterals, it could very

well result in a race to the bottom among developing

countries. But in this globalizing world, it is all the

more important to have a targeted industrial policy

and not just simply leave everything to the market

after “setting the right policy environment.”

In the meantime, one legislative measure worth

supporting is the creation of the Philippine Trade

Representative Offi ce. The setting up of such an

offi ce will hopefully facilitate the crafting of trade

negotiating strategies – setting the mandate from

Congress, setting the parameters, determining the

bottomline. Trade these days is like going to war. If

you do not have a battle plan which should be ex-

ecuted by a General (the Trade Representative), then

you lose. Telling your negotiators to simply “preserve

our policy space” is no battle plan at all.

Strengthening unities with other developing countries

The Philippines is actually a major player in the

shaping and perhaps un-shaping of the Doha Devel-

opment Round of trade negotiations in the WTO2.

Our agriculture negotiators united with other ne-

gotiators from developing countries with defensive

interest in agriculture to form the so-called Group

of 33 or G33 for short. The G33 (now actually num-

bering more than 40) was instrumental in securing

in the WTO text so-called “Special Products” that

are critical in a country’s food and livelihood security

and rural development. These special products will

be subject to no tariff cuts at best, or slower-than-the

usual cut with a new round of WTO negotiations, at

worst. Further, these countries may avail themselves

of a “Special Safeguard Mechanism” to protect their

agriculture products from import surges without

any need to go through the usual circuitous mode

of proving injury caused by the import infl ux. This

mechanism may be in the form of increased tariffs,

even beyond the WTO bound rates, that is, if the

G33 remains fi rm and united in what they want.

It is no easy task, though, considering that the

whole concept of special products and special safe-

guard mechanism goes against the very grain of the

WTO dictum of progressive liberalization. And the

developed countries like the US and the EU are using

every means to divide and conquer the G33.

The G33 was able to hang tough but pressures

continue to mount as WTO-member countries try

to reach a consensus to have a new WTO agreement.

Civil society groups can play a major role in helping

preserve the fragile unity of the G33 as the home-

stretch approaches. But still, much of it depends on

the political will of developing country governments

and the clarity and consistency of their industrial

plan.

2 Editor’s note: The Doha Development Round collapsed in July 2008, as no compromise on agriculture import rules materialized.


Fair Trade Alliance (2006). Nationalist Development Agenda:A Road Map for Economic Revival, Growth and

Sustainability, Quezon City.

Felipe, Jesus and Gemma Estrada (2007). Benchmarking Developing Asia’s Manufacturing Sector, ERD

Working Paper No. 101, Asian Development Bank, September.

Oxfam International (2002). Rigged Rules and Double Standards: Trade, Globalisation, and the Fight against

Poverty

Porter, Michael E. (1990). Competitive Advantage of Nations, The Free Press, A Division of Macmillan, Inc.,

New York.

United Nations Development Programme (2006). Trade on Human Terms: Transforming Trade for Human

Development in Asia and the Pacifi c, Asia-Pacifi c Human Development Report 2006, Macmillan.

References


Remittances forDevelopment Financing

I. IntroductionIn the last two decades, remittances clearly emerged as a major driver of foreign exchange fl ows to the devel-

oping world. From US$25 billion in 1990, total remittance infl ows to developing countries more than tripled to

US$85 billion in 2000, more than tripling again to US$250 billion before the end of this decade. This exponen-

tial rise in remittances was an important factor behind a dramatic turnaround in the external position of many

developing countries during this period: a shift from structural defi cits to resilient surpluses (or less dramatically

a reduction of the defi cits) in the current account, in turn, resulting in the large-scale accumulation of foreign

exchange reserves in the developing world.

Fourth largest in the world in terms of remittances infl ows, the Philippines is a good example of the historic

turnaround in a country’s external position as a result of strong and sustained remittance fl ows. From US$630

million in 1980, remittances grew close to US$1.5 billion in 1990, jumped to US$6.2 billion in 2000, and bal-

looned to US$17.2 billion in 2007. The impact of the rapid rise in remittances on the country’s external balance

became evident in the present decade. Since 2003, the current account has been posting surpluses year after year

despite a persistent and huge trade defi cit along with signifi cant foreign debt service payments. Over the same

period, the central bank was accumulating foreign exchange reserves at unprecedented levels.

This paper explores the implications of remittances on growth and investment policies, starting from the

obvious fact that remittances have improved the external position of the Philippine economy as refl ected in a

current account surplus and rising foreign exchange reserve holdings of the central bank. From a macroeconomic

perspective, remittances expand the total resources available for investment and growth. In particular, the rise

in remittances has eased the lack of foreign exchange that hitherto constrained long-term growth for decades.

Given the importance of the foreign exchange constraint to Philippine economic development in the last half-

century, the change from “structural” defi cits to “structural” surpluses thanks to strong remittances obviously has

profound implications on development strategies and policies (Griffi th-Jones and Ocampo 2008).

Resolving the foreign exchange constraint has been a major preoccupation of development strategies and

macroeconomic policies in the post Second World War era, with those of import substitution industrializa-

tion (ISI) and export oriented industrialization (EOI). ISI sought to remove the structural dependence of the

economy on imports, thus reducing the need for foreign exchange. EOI emphasized earning foreign exchange to

Clarence G. Pascual


fi nance the requirements of growth. The same can be

said of the Washington Consensus with its overriding

emphasis on macroeconomic stability: a key pillar of

conventional macroeconomic policy is balanced bud-

gets and low current account defi cits.

The economic literature refl ects an abiding con-

cern about the importance of the current account

defi cit in relation to crises that have recurred with

increasing frequency in recent decades. The literature

highlights the nature and composition of the cur-

rent account defi cit, that size as well as sustainability

of fi nancing the defi cit matters, and that a sudden

reversal from defi cit to surplus in the context of a

crisis hurts investment and growth (Edwards 2000).

A related strand in the literature has examined epi-

sodes of capital bonanzas and how they are associated

with economic crises—debt defaults, banking, infl a-

tion and currency crashes. In developing countries,

surges in capital fl ows are associated with pro-cyclical

fi scal policies and attempts to curb or avoid an ex-

change rate appreciation, both of which are likely to

contribute to economic vulnerability (Reinhart and

Reinhart 2008).

A key assumption in the academic and policy dis-

course is that developing countries face a scarcity of

foreign exchange. For the Philippines and some other

developing economies, remittances have rendered the

scarcity assumption increasingly unrealistic. While

the economic consequences of remittances are widely

studied, the idea that remittances have generated an ex-

cess supply of foreign exchange in receiving economies

is rarely recognized. Rather the situation of excessive

foreign exchange fl ows due to remittances is regarded

as a temporary aberration, a disease-carrying gift (note

the frequent references to the Dutch Disease), an eco-

nomic Trojan horse, if you will—a short-term relief

for foreign exchange starved economies which carries

considerable costs that policymakers must learn to deal

with (Mohanty and Turner 2004).

Remittances pose a challenge to development

strategies and economic policies built on the as-

sumption of a shortage of foreign exchange or an

external defi cit fi nanced by highly volatile capital

fl ows. Remittances in so far as they have lifted the

foreign exchange constraint have many profound

implications on development thinking and national

economic policy choices. This paper focuses on the

implications of remittances and a surplus of foreign

exchange to aggregate investment policies and fi scal

policy in particular.

In general, remittances are additional resources

that can be productively invested to accelerate growth

without risking a foreign exchange crisis as has been

the case in the past. In principle, foreign exchange

reserves in excess of the normal requirements can be

used to fi nance critical public investment and social

services. From this point of view, excessive reserve

holdings carry signifi cant opportunity costs, namely,

foregone economic benefi ts from productive invest-

ment of this money more so in the context of mass

poverty and mass unemployment.

The argument put forward in this paper revolves

around the mobilization of abundant foreign ex-

change resources that have been made available to the

Philippine economy. That is, it can be argued that the

issue is about a current account surplus and reserve

accumulation and not specifi cally a migration-remit-

tance issue. This is correct to the extent that current

account surpluses and large-scale reserve accumula-

tion in many developing countries can be traced to

factors other than remittances, notably commodity

booms (the oil and natural resource exporting coun-

tries), over-performing export sector (China), and

capital bonanza (India).

We argue that, at least in the case of the Philip-

pines, the question over the use of foreign reserves is

closely related to the issue of the impact of remittanc-

es on development. As Griffi th-Jones and Ocampo

(2008) show, an economic case can be made for using

foreign exchange reserves for long-term investment

when this is generated by a current account surplus

and that this is a “resilient surplus.” Otherwise, in-

vesting reserves coming from the capital account is

merely investing borrowed money. For the Philip-

pines, the underlying reason behind the current ac-

count surplus and rising reserve holdings is strong


remittance fl ows and that a key characteristic of

remittances is relative stability over reasonably long

time horizon.

Recognizing the role played by remittances in

transforming the economy’s external position, partic-

ularly in lifting the foreign exchange constraint that

has hitherto stunted long-term growth, highlights the

historic economic contribution of overseas Filipinos.

More important, mobilizing the resources generated

by remittances to transform and develop the Philip-

pine economy with the end-goal of creating decent

jobs for all, thus undermining the forces driving mass

migration, is to do justice to the sacrifi ces and hero-

ism of migrant Filipino workers. In sum, remittances

provide the wherewithal to undertake sensible but

diffi cult reforms (given resource constraints and ide-

ological bias) to transform the Philippine economy

and put growth on a more vigorous, sustained, and

equitable path.

This paper is divided into fi ve sections, the fi rst of

which is this introduction. Section II paints in broad

strokes recent trends in remittances in the Philip-

pines. In sections III and IV, we briefl y review the

relevant literature on the economic consequences of

remittances. In Section V, we explore some policy

implications of remittances, focusing on investment

and growth, in general and, and fi scal policy, in par-

ticular. We also draw on the literature to examine is-

sues pertaining to the use of remittances to fi nance

development, particularly the high opportunity cost

associated with holding excessive levels of foreign re-

serves. Section VI makes concluding remarks.

II. Recent trends in remittancesRemittances have become a major source of ex-

ternal fi nancing for developing countries. In 2007,

remittances to all developing countries exceeded

US$250 billion—which accounted for three-fourths

of global remittance fl ows—a tenfold increase in just

two decades. Remittances now exceed traditional

sources of foreign exchange: 10 times net transfers

from private sources and twice that from offi cial

sources (Kapur 2004).

Unlike in the past when strong capital fl ows to

emerging economies—portfolio investments, FDI—

evaded the country, this time the Philippines did not

miss the boat. When it comes to migrant remittances,

the Philippines is a major global player: fourth largest

recipient of remittances in absolute terms, $17 bil-

lion in 2007, behind only India, China and Mexico;

it captured 5% of global remittance fl ows, represent-

ing 13 percent of the country’s GDP.

Table 1. Top 10 recipients of workers’ remittances, compensation of employees, and migrant transfers, credit (US$ million)

2007

Remittances as a share of GDP, 2006

(%) Global rank

Remittances as a share of total, 2007

(%)

India 27,000 2.8% 1 8.0%

China 25,703 0.9% 2 7.6%

Mexico 25,052 3.0% 3 7.4%

Philippines 17,217 13.0% 4 5.1%

France 13,854 0.6% 5 4.1%

Poland 10,671 2.5% 6 3.2%

Spain 10,633 0.7% 7 3.2%

Romania 8,533 5.5% 8 2.5%

United Kingdom 8,124 0.3% 9 2.4%

Belgium 8,027 1.9% 10 2.4%


Figure 1. Remittances in USD Million, Philippines, 1977-2007

Source of basic data: World Bank

Remittances have been growing exponentially

since the 1970s (Figure 1). From below US$350 mil-

lion in 1977, remittances rose fourfold to US$1.5 bil-

lion in 1990, to over US$6 billion a decade later, and

to US$17 billion as of 2007. Certainly, there have

been occasional dips in total remittances, particularly

in periods of economic diffi culties in the major desti-

The unprecedented growth in remittances has

been largely responsible for the current account

surplus in recent years (Figure 2), a reversal of half-

century of current account defi cits. Since 2003, the

current account has been in surplus peaking to as

much as four percent of GDP, no trivial amount for

an economy growing at a moderate pace. The surplus

nation countries. Thus,

total remittances dipped

to $714 million in 1984

from US$1.1 billion in

the previous year and

remained below this

level in the next fi ve

years. Again between

1996 and 2001, remit-

tances fl uctuated and

were below the trend

level in 2000 and 2001.

This notwithstanding,

the exponential growth

in remittances is well on

track.

Source: Diokno-Pascual (2008) “Remittances as Self-Insurance”

Figure 2. Composition of Current account, in USD Million


in the current account becomes even more signifi cant

in view of two things: one, a huge and growing trade

defi cit (external trade in goods), and signifi cant debt

service payments. On the one hand, the former has

gone by largely uncommented, which speaks of the

growing importance of trade in services, remittances

and debt service payments. On the other hand, heavy

debt service payments relating to the public foreign

debt raised serious concerns in the recent years,

prompting the government to tighten on public

spending in an attempt to contain the budget defi cit.

Regardless of the merits of offi cial policy, the issue

has ceased to be a major concern, not least because

the current account has been in surplus so that there

is no danger of inability to service the debt.

As with many other developing countries, re-

mittances are clearly the most important source of

foreign exchange fl ows for the Philippines on a net

basis. Between 1999 and 2007, remittances exceeded

all traditional sources of capital fl ows combined—

portfolio capital, foreign direct investment, and debt.

For example, remittances were four times net portfo-

lio investment in 2005, fi ve times net FDI fl ows in

2006, and 10 times net borrowings by the National

Government. With the current global fi nancial tur-

moil which has triggered capital fl ight from develop-

ing countries, the importance of remittances is likely

to grow.

Moreover, remittances averaged 28 percent of ex-

port revenues in the last fi ve years. While it is diffi cult

to determine with precision the import fl ows related

to exports, it is well known that the country’s major

export product—electronics—is highly dependent

on imported inputs, generating insignifi cant for-

eign exchange earnings for the economy (UNCTAD

2005). Arguably, remittances are the biggest net for-

eign exchange earner for the Philippine economy, in-

cluding exports of commodity and services.

Finally, remittances have emerged as a stable

source of foreign exchange fl ows. While there are

occasional dips in total amounts (during the early

1980s and late 1990s), exponential growth of remit-

tances over the long-term is clearly evident. The mag-

nitude and, more importantly, the stability of remit-

tance earnings have crucial implications for economic

policy. We return to this point below. But there are

at least two reasons behind the relative stability of re-

mittances. First, remittances are not return and inter-

est maximize earnings. A positive implication is that

remittances do not exhibit strong herd-like behavior

unlike portfolio and debt fl ows.

Second, remittances are not debt-creating trans-

fers hence there are no counterfl ows at the level of

the macroeconomy. These counterfl ows, as in the

case of portfolio investment, FDI and debt, can be

substantial, but also sudden and sharp, exacerbating

the instability of traditional capital fl ows and causing

great diffi culties for economies being abandoned.

Third, migration network theory and its vari-

ants imply that migration fl ows and the consequent

remittance fl ows can take on a life of their own as

previous migrants facilitate the recruitment of new

ones. Migration fl ows once they reach a critical mass

can increase exponentially and be self-sustaining over

a long period. In reality, government has little to do

with subsequent trends except to facilitate migrant

and remittance fl ows. To claim credit or pin the

blame on government for the migration phenom-

enon is to give too much credit to policy. More im-

portantly, however, the network theory of migration

implies long-term stability of remittance fl ows. De

Hass (2007) fi nds evidence that remittances begin to

slow down around 15 years after the peak of migra-

tion. Sending countries do have ample opportunity

to mobilize remittances to accelerate development.

An upshot of the massive remittance fl ows and

the surplus in the current account is the rapid rise in

the central bank’s foreign exchange reserves (Table 2).

Part of the reason is that capital fl ows remained posi-

tive despite a current account surplus. For example,

between 2003 and 2007, while the current account

was in surplus by US$15.6 billion, the capital and

fi nancial accounts were also in the black by US$5.3

billion, despite a net outfl ow of US$1.6 billion in

2004. Thus, the Philippines joins other developing

countries rapidly accumulating foreign exchange


1985Period GIR

ImportCover 1

Short-Term External Debt Cover (in percent)

Original Maturity Residual Maturity 2

1985 1,087 0.8 35 25

1986 2,506 1.8 80 59

1987 2,014 1.5 64 47

1988 2,111 1.6 67 49

1989 2,375 1.8 76 56

1990 2,048 1.5 65 48

1991 4,526 3.4 121 85

1992 5,338 3.4 122 86

1993 5,922 3.2 132 83

1994 7,142 3.1 170 101

1995 7,786 2.6 192 113

1996 11,773 3.2 217 139

1997 8,799 2.0 139 96

1998 10,842 3.1 185 112

1999 15,064 4.5 304 188

2000 15,063 3.5 274 164

2001 15,692 4.0 262 144

2002 16,365 4.0 294 144

2003 17,063 4.0 276 141

2004 16,228 3.6 322 157

2005 18,494 3.8 289 132

2006 22,967 4.3 459 250

2007 33,751 5.7 476 261

2008 37,550 5.7 452 287

Table 2. Gross International Reserves of the Bangko Sentral ng Pilipinas (BSP)

1 Number of months of average imports of goods and payment of services and income that can be fi nanced by reserves. 2 Refers to adequacy of reserves to cover outstanding short-term debt based on original maturity plus principal payments on medium and long-term loans of the public and

private sectors falling due in the next 12 monthsSource: BSP

reserves in the present decade on account of remit-

tances.

Foreign exchange fl ows of the magnitude induced

by remittances are certain to have important conse-

quences on receiving households, their communities,

and the larger economy. Not surprisingly, a volumi-

nous literature has emerged examining the economic

consequences of remittances, a subject we turn to in

the next section.

III. Microeconomic consequences of remittances

There is by now a voluminous literature on the

economic consequences of migration and remittanc-

es. A number of studies provide a comprehensive and

multi-disciplinary review of this literature (De Haas

2007 and Grabel 2009 are two examples). For brev-

ity, the discussion in this section is confi ned to stud-

ies in the Philippine context. Following the review of


the local literature in Orbeta (2008), we focus on the

research fi ndings and largely ignore methodological

issues.

Household expendituresRemittances raise household incomes so that we

would expect remittance to increase household ex-

penditures on normal goods. The impact of remit-

tances, however, could vary across expenditure items

depending on the level of income of the household,

the so-called Engle effect. Local studies show mixed

results.

Tullao, Cortex and See (2007) compare levels

and expenditure patterns between households receiv-

ing and not receiving remittances. They fi nd higher

consumption expenditure for remittance-receiving

households, higher allocation for housing, educa-

tion, health care and recreation services, as well as

higher expenditure elasticities for housing, educa-

tion, health care, durables, and transportation and

communication. Tabuga (2007) produces the same

results, using a slightly different methodology. In ad-

dition, to higher shares and elasticities on education,

housing, and durable goods, he fi nds no effect on to-

bacco and alcohol expenditures and on food regularly

eaten outside. As expected, the impact of remittances

on food expenditure shares is negative.

In contrast to these two studies, Yang (2008) fi nds

that total household expenditures is not affected by

changes in remittances. Part of the reason for this re-

sult is that he does not include in the total household

expenditures spending on education, durable goods

or investments in household enterprises which he

considers investment and for which he fi nds positive

impact. Another reason for the difference in results is

methodological.

Of particular interest to economists are house-

hold expenditures on education. As discussed above,

Tullao, Cortez and See (2007) as well as Tabuga

(2007) fi nd that remittances have a positive impact

on education spending. Not only do remittance-re-

ceiving households have higher education expendi-

ture shares, but they have higher expenditure elas-

ticities. Likewise, Yang (2008) reports a positive

impact of remittances on education investments. He

also fi nds that remittances increase the likelihood of

children staying in school and reduces hours worked

for children 10-17. Interestingly, the former effect is

signifi cant only for girls, while the latter holds only

for boys.

Labor force supplyThere has been some interest on the impact of

migration on the labor supply of family members

left behind arising from casual observation that

migration is generating a culture of dependence

among remittance-receiving households. The re-

sults are mixed.

Tullao, Cortez and See (2007) fi nd that labor

force participation rates and employment rates are

generally lower in households receiving remittances.

Using a different data set and refi ning the method-

ology done in Tullao, Cortez and See (2007), The

Ducanes and Abella study (2007) shows that there

is no signifi cant difference in labor force participa-

tion rates of households with and without migrant

members. In fact, if one removes children of school

age, the labor force participation rate of those with

migrants is higher.

Other studies tend to support the view that mi-

gration reduces labor supply of those left behind. The

Rodriguez and Tiongson study (2001), using data

from households in Metro Manila in 1991, reports

that households with migrant workers tend to have

lower labor supply, with both men and women re-

ducing their work hours, although the effect is rather

small. Cabegin (2006) focuses on the labor supply

responses of migrants’s spouses. She fi nds that the

responses differ between wives and husbands, the

former reducing her labor supply and no signifi cant

impact on husbands. She also fi nds that the presence

of school age children (7-14) encourages the wives

to take on self-employment rather than a full-time

job, while an increase in the remittance of a wife to

the husband increases the latter’s likelihood of non-

employment.


The results of Yang (2008) show that remittanc-

es do not have a signifi cant impact on total hours

worked of household members, but they do raise the

likelihood of self-employment, which is in agreement

with Cabegin (2006).

Household investmentsOne view holds that the magnitude of the devel-

opment impact of remittances on the receiving coun-

tries was assumed to depend on how this money was

spent. Presumably, investment spending has larger

and longer-lasting impact on development than con-

sumption spending. This seems to be the basis for

governments and economists haranguing migrants

about investing their money in business activities,

and economists lecturing governments to focus

on providing an environment conducive for busi-

ness (which invariably means more market reforms,

macroeconomic stability, and sustained economic

growth).

Yang (2008) analyzes the impact of remittances

on household investment income, overall entrepre-

neurial activity and specifi c investment types. The

results are not very encouraging: He reports neither

a clear impact on total entrepreneurial income nor

on activity. He does fi nd an impact on specifi c entre-

preneurial activities, in particular, in transportation,

communication, manufacturing, and other capi-

tal-intensive activities. Impact of investment at the

macro level, however, could be completely different

from that at the micro or household level.

Poverty: household and spatialWhere there is consensus on the impact of remit-

tances is on alleviating poverty. Yang and Martinez

(2005) found that remittances reduce poverty inci-

dence but not poverty depth as measured by the pov-

erty gap. It also appears that the general increase in

economic activity has spillover effects in that they re-

duce overall poverty incidence. Other studies report

similar positive effect. Ducanes and Abella (2007) for

example show that migration has allowed poor fami-

lies to raise their fi nancial status, and that the poor

households who successfully crossed over the poverty

line were those with more education.

Capistrano and Sta. Maria (2007) also examine

the impact of remittances on three poverty indi-

ces—the incidence, depth and severity of poverty in

the Philippines—using data on household income

and expenditures. Their fi ndings suggest that remit-

tance fl ows have a statistically signifi cant impact on

all three measures of poverty, but the magnitudes are

fairly small. A 10 percent increase in per capita remit-

tance leads to a mere 0.4 percent reduction in the

proportion of families living below the poverty line.

An important issue that has not been examined is to

what extent migration has permanently lifted house-

holds out of poverty.

The above studies have the household as the unit

of observation. Others have examined remittances

and poverty reduction at more aggregative levels.

Goce-Dakila and Dakila (2006) analyze the impact

of remittances across regions and income levels em-

ploying an applied general equilibrium framework.

The results indicate that the main benefi ciaries of

remittances are the middle-income classes across all

regions, followed by low income households in all

regions, except the National Capital Region where

the high-income households are the second highest

benefi ciary of remittances.

Estudillo and Sawada (2006) use provincial panel

data and household data from 1985 to 2000 to es-

timate the impact of, among other variables, non-

transfer and transfer income on poverty. The study

shows that transfer income alleviates poverty at the

household level. Looking at the regional distribution

of remittances, Pernia (2006) fi nds that remittances

have boosted per capita expenditure of the bottom

40 percent of households, indicating that remittances

contribute signifi cantly to poverty alleviation. This

benefi cial effect rises monotonically up to the fourth

quintile then peters out for the richest 20 percent of

households. Furthermore, remittances spur regional

growth through increased spending for consump-

tion, education, and housing and their consequent

multiplier effects.


IV. Macroeconomic effects of remittancesThe impact of remittances at the macroeconomic

level may differ with their impact at the household

level as discussed above. For one, the effects at the ag-

gregate economy are amplifi ed because of the “mul-

tiplier effect.” To illustrate, in Mexico, a dollar of

remittances spent on consumption has a multiplier

effect of 2.7 for urban households and 3.2 for rural

households (Ratha, 2003). One dollar of remittance

translates to about three dollars of additional con-

sumption for the economy as a whole.

For another, some of the positive consequences of

remittances may only be realized at the aggregate level

of the economy rather than at the household level. De-

spite the weak impact of remittances on household in-

vestment, studies show that that remittances raise total

investment levels. A study of 11 Central and Eastern

European countries found that remittances signifi cant-

ly contribute to the increase of the investment levels of

the source economies. A similar study of 20 develop-

ing countries attained similar results (OECD 2000).

Households receiving remittances may not themselves

invest additional income into productive investments,

but remittances may raise household savings. Higher

national savings are then intermediated by the fi nan-

cial sector to fi nance investment by the private or the

public sectors. This is the same as saying that remit-

tances promote fi nancial deepening.

The impact of remittances on consumption

and investments or aggregate demand in general is

seen as having a short-term impact, which if strong

enough can likewise suffi ciently raise the medium

term growth prospects of the economy. In terms of

the impact of remittances on long-term growth, the

economic literature focuses on four possible mecha-

nisms through which remittances can affect long-

term growth, namely, a) inequality, b) human capital

formation, c) entrepreneurship, and d) productivity

and rural development.

Using the framework of endogenous growth,

remittances have an ambiguous impact on inequal-

ity and, indeed, the results from empirical studies

are mixed (Rapoport and Docquier 2005). The dis-

tributional impact depends on a number of factors

including the “selectivity” of migration, the periods

and sectors studied, as well as the direct and indirect

economic effects of remittances. The evidence on the

effects of remittances on education and entrepreneur-

ship appears more encouraging. Studies show that re-

mittances raise the probability of children staying in

school, that is, they reduce the risk of children drop-

ping out of school. As expected, there is evidence that

remittances generate additional consumption and in-

vestment spending and thus can boost growth.

Another area where remittances play an obvious and

important role is in supporting balance of payments of

receiving developing countries. Remittances provide

the hard currency needed for importing scarce inputs

that are not available domestically and also additional

savings for economic development. Remittances differ

from traditional sources of foreign exchange in impor-

tant ways. First, remittances are unrequited fl ows: they

do not result in claims on assets, debt service obliga-

tions or other contractual obligations (Brown 2006,

Kapur 2005). In contrast to purchases of fi nancial or

productive assets, which can be liquidated and repatri-

ated, remittances cannot be withdrawn from a coun-

try ex post (Singer 2008). For this reason, remittances

have become the most important source of net foreign

exchange fl ows to developing countries.

Second, remittances have emerged as the least

unstable source of fi nancial fl ows. They are affected

by economic crises and recession, but they are more

stable than private capital fl ows which exhibit strong

herd like behavior, amplifying the boom-bust cycles

in emerging markets. Flows of remittances tend to in-

crease during economic down turns as migrants send

more funds back home to cushion their families. In

contrast, bank lending, sovereign bond investment,

and FDI are highly procyclical in their reaction to

the state of the domestic economy. For example bank

lending will dry up if a country experiences a fi nan-

cial crisis. Bond investors will withdraw their funds

in the face of high infl ation and fi scal diffi culties.

FDI will decline in reaction to a downturn in eco-

nomic growth.


Large scale foreign exchange infl ows as induced by

remittances, however, can have negative consequenc-

es. A direct negative macroeconomic consequence of

massive remittances is the appreciation of the local

currency. Many authors have emphasized the nega-

tive consequences of an overvalued currency. Curren-

cy appreciation reduces the profi tability of the export

sector, industry in particular, and reduces its growth.

A slowdown in the rate of growth of industry is asso-

ciated with slower aggregate economic growth, which

indicates that exchange rate issues are more acute in

developing countries. The loss of competitiveness of

the export or tradable sectors and raising the rela-

tive price of the non-tradable sector, the so-called

Dutch disease, can have long-term consequences.

To the extent that production of tradable goods is

subject to learning, cost-discovery and other exter-

nalities (Krugman, Hausmann and Rodrik, 2003), a

short-term loss of export competitiveness can have

long-term consequences in that it can undermine a

country’s ability to upgrade its industrial structure.

Some authors extend the Dutch disease analogy

to the area of policy reform. Kapur (2004) argues

that remittances remove the incentive for govern-

ments to take up economic reforms. In the presence

of large remittances there is little incentive to pursue

economic reforms necessary to build a strong export

industry. It is appropriate to quote Kapur (2004)

more extensively:

“Exporting products requires painstaking effort to

build the institutions and infrastructure that helps

develop the necessary productive capacity. Export-

ing people, on the other hand, occurs in most cases

by default rather than by design. Nonetheless if the

latter also results in large foreign exchange receipts,

the pressure to undertake reforms needed for ex-

port-led growth is considerably attenuated. For in-

stance, countries can maintain larger fi scal defi cits

in the context of international migration and re-

mittances. In the absence of remittances, high fi scal

defi cits would imply higher current account imbal-

ances and hence greater reliance on foreign savings

(assuming the defi cit is not monetized—which is

less likely given that central banks are relatively

more independent today) resulting in higher capital

account infl ows. However, if remittances are high,

current account defi cits would be lower, thereby

reducing the likelihood that high fi scal defi cits will

precipitate a balance-of-payments crisis—the most

common trigger for economic reforms in LDCs.

Thus countries high levels of remittances can sus-

tain higher fi scal defi cits—while at the same time

keeping international fi nancial institutions like the

IMF and the World Bank at bay.”

A similar argument is offered by Pernia (2006) in

the case of the Philippines arguing that remittances

have a moral hazard effect:

“While the country has certainly benefi ted from

the diaspora, the remittance bonanza …has con-

veniently kept the government from pursuing real

policy reforms (including no population policy)

that would have improved the performance of

the domestic economy and reduced the need for

overseas employment.”

Large-scale remittances also trigger adverse indi-

rect effects that are potentially as important as direct

effects. These negative indirect effects stem from cen-

tral bank intervention in the foreign exchange market

to resist currency appreciation in the face of strong

remittance fl ows and in which the central bank ends

up accumulating foreign exchange reserves. First,

many central banks have used reserve accumulation

to expand the monetary base, inviting the threat of

infl ation. Second, reserve accumulation entails car-

rying costs for the central bank where local interest

rates are above international levels. Third, the central

bank faces potential valuation loss from currency ap-

preciation.

Fourth, reserve accumulation can lead to excess

liquidity in the banking system which can feed a

lending boom especially in the real estate and prop-

erty sector. Increased bank lending could show up in

higher equity prices, while expectations of a currency

appreciation could attract short-term capital infl ows.


Finally, central banks can resort to non-market in-

struments such as raising reserve requirements or

direct credit control measures to drain excess liquid-

ity released in the course of accumulating foreign

exchange reserves. Reserve requirements are viewed

as a tax on the banking system, which discourages

fi nancial intermediation while direct credit controls

are seen to compromise the effi ciency of resource al-

location.

These negative indirect effects of remittances

have raised concerns among economists and policy-

makers. Mohanty and Turner (2006), however, fi nd

that many of these fears have not materialized, even

as central banks have successfully avoided signifi cant

appreciation of their currencies in the face of large

scale foreign exchange fl ows. Infl ation remained low

even as central banks expanded the monetary base.

The carrying costs to central banks of large foreign

exchange reserves have been minimal because do-

mestic interest rates have been kept low. Valuation

losses from a currency appreciation appear to have

been moderate as appreciation has been modest. And

since countries were net foreign borrowers apprecia-

tion reduces debt payments.

Furthermore, in most cases, bank lending has

been weak compared to the period before the 1997

Asian crisis so that debt securities issued by the cen-

tral banks were short-term and held by banks with

liquid balance sheets. The strong demand for these

risk-free instruments by banks has kept interest rates

low, limiting the cost of sterilization to central banks.

Finally, the use of non-market instruments has been

limited so far owing to the deepening of domestic

bond markets in recent years, making sterilization

easier.

In sum, there is evidence that large-scale foreign

exchange infl ows, of which remittances made up an

important part, have been accommodated without

apparent harm to receiving economies. Contrary evi-

dence notwithstanding, Mohanty and Turner (2006)

insist on their initial hypothesis:

“That such accumulation has continued for sev-

eral years apparently without major adverse ef-

fects on infl ation has come as a surprise. Should,

however, infl ation risks rise, the underlying policy

dilemma posed by reserve accumulation might

become more evident. Intervention over many

years has had a major impact on balance sheets.

Aggregate credit has already begun to expand

rapidly in some countries, and fi nancial sector

imbalances are gradually building up. Continued

intervention also creates risks for effi cient fi nan-

cial intermediation.”

V. Remittances and macroeconomic policy choices

The literature on remittances discussed in the pre-

vious section illustrates some of the important con-

sequences of remittances on households and econo-

mies, and their implications on economic policy. Two

things should be noted about this literature. First of

all, the literature examines the impact of remittances

given existing policies. And second, the discussion on

the policy implications of remittances makes the im-

portant assumption that the economy faces a scarcity

of foreign exchange. The strong infl ow of remittances

is treated as a short-term, temporary phenomenon,

the consequences of which must be managed. As we

will argue in this section, recognizing the new con-

text brought about by remittances—an excess supply

of foreign exchange originating from a current ac-

count surplus—has important implications for mac-

roeconomic economic policy choices. The change in

economic policy, in turn, potentially magnifi es the

economic impact of remittances.

Investment and growthThe importance of the current account surplus

generated by remittances is clearly seen in the basic

macroeconomic identity of an open economy:

(1) (X-M) = (S-I)

Here (X-M) is the current account balance, (S-

I) is the savings-investment balance in the domestic

sector. The relationship between the current account


balance, on the one hand, and domestic savings and

investments, on the other hand, shows the total re-

source constraint for the economy. It underlies the

interest in the relationship between current account

and growth or crisis.

Edwards (2000) shows that economists’ views on

the current account have changed in important ways.

In the 1950s to the mid-1970s, policy debates fo-

cused on whether devaluations improve the country’s

external position, including its trade and current

account balances. The consensus was that although

the relevant elasticities were small, a devaluation of

the local currency improves the trade and current ac-

count balance.

Structuralists argued that in the developing world

trade and current account imbalances were structural

in nature and severely constrained ability of these

countries to grow. According to this view, the solu-

tion was to encourage industrialization through im-

port substitution policies.

The oil crisis in the mid-1970s caused large

swings in the current account balances of most coun-

tries, prompting economists to analyze the determi-

nants of the current account. The view that emerged

during this period emphasized the intertemporal di-

mension of the current account. Since the external

balance is equal to domestic savings and investments

(as in equation 1), and since the behavior of savings

and investments is based on intertemporal factors,

the current account is an intertemporal phenome-

non. The policy implication of this view is that to the

extent that the current account defi cit refl ects new

investment, there is no reason to be concerned about

a huge current account defi cit. The Lawson doctrine

states that the current account is no cause for concern

as long as fi scal accounts are in balance.

In light of the debt crisis of 1982, economists ad-

opted a more conservative view of current account def-

icits and argued that large defi cits were a sign of trouble

to come even if domestic investments were high and

rising. Economists began to place more emphasis on

the sustainability of fi nancing the current defi cit than

on the size of the defi cit. This was reinforced in the

1990s as highly volatile portfolio investments became

an important source of external fi nancing.

Frequent crises in the 1980s and 1990s also led

to an interest in the cost of reversals in the current

account. Current account reversals signifi cantly im-

pact on growth by reducing investment (Edwards

2000). Equally important, capital infl ow bonanzas to

fi nance current account defi cits are associated with a

higher likelihood of economic crises, including debt

defaults, banking, infl ation and currency crashes (Re-

inhart and Reinhart 2008).

In sum, a country’s external position matters to

investment and growth. High current account defi -

cits and highly volatile external fi nancing have posed

critical constraints to growth. Remittances allow the

receiving economy to achieve higher investment and

growth rates without generating external imbalances.

The stability of remittance fl ows over long periods is

of critical importance as it reduces the vulnerability

of the economy to “sudden stops” in capital fl ows re-

ducing the likelihood of costly economic crises.

While there is little debate about the contribu-

tion of remittances as a source of substantial and

stable foreign exchange, the implications for invest-

ment policies and growth strategies have been largely

unexplored. Remittances warrant more aggressive

macroeconomic policies that aim to raise the level of

domestic investment and growth. In recent decades,

monetary and fi scal policies to encourage domestic

investment have fallen out of favor in the context of

recurring current account problems.

Fiscal policy and defi citsThe discussion above relates aggregate domestic

investment to the current account balance. The right

hand side of equation (1) can be expanded to distin-

guish between the private and public sector invest-

ment:

(2) (X-M) = (Sp-Ip) + (T-G)

Where (Sp-Ip) and (T-G) are the balances of the

private and public sectors. To highlight the role of fi s-


cal policy, equation (2) can be rearranged, thus:

(3) (T-G) = (Sp-Ip) + (X-M)

Equation (3) says that the budget defi cit is equal

to the saving-investment defi cit plus the current ac-

count defi cit. This implies the crowding-out problem:

holding the current account balance constant, an in-

crease in the budget defi cit will result in a reduction

in private sector investment. Until the 1990s, econo-

mists worried about the possibility of the crowding

out of private sector investment. Since then there

has been growing emphasis on the link between the

budget defi cit and the current account defi cit. The

dominant view is that large budget defi cits lead to the

high current account defi cits which can lead to insta-

bility and crisis. There is no one-to-one link between

the budget defi cit and current account defi cit, but

the implication of remittances to this analysis is that

a smaller current account defi cit or a higher current

account surplus allows the economy to post higher

budget defi cits to stimulate investment and growth.

Financing the defi citThe link between the budget defi cit and the cur-

rent account defi cit can also be seen from the point

of view of fi nancing the budget defi cit. The budget

defi cit can be fi nanced in four ways: printing money,

running down foreign exchange reserves, borrowing

abroad, and borrowing domestically. Each form of fi -

nancing has its drawbacks. Printing money is associ-

ated with infl ation. Running down foreign exchange

reserves is associated with the onset of exchange

crises. Foreign borrowing is associated with an ex-

ternal debt crisis. Domestic borrowing is associated

with high interest rates and unsustainable debt levels

(Easterly and Fischer 1990).

Each form of fi nancing the budget defi cit relates

to the country’s external balance. The objection to

using foreign exchange reserves to fi nance the defi cit

is that sooner or later the central bank’s reserve hold-

ings are exhausted and the inevitable happens. But

even before that point is reached, the private sector’s

expectation that the limit is about to be breached can

provoke capital fl ight and a balance of payments cri-

sis. A highly open capital account hastens the whole

process as holders of the domestic currency add to

the pressure on the exchange rate.

The dangers of excessive reliance on external bor-

rowing to fi nance the budget defi cit are well-known

as these have been amply illustrated by past debt cri-

ses. As foreign debt accumulates, the country fi nds it

increasingly diffi cult to generate the foreign exchange

needed to service the foreign debt. The situation is

compounded by loss of confi dence among creditors

as debt levels begin to reach unsustainable levels. The

link between the budget defi cit and foreign borrow-

ing is closer the smaller the domestic capital market is

and the more limited domestic borrowing possibili-

ties are.

As for printing money to fi nance the defi cit (mon-

etizing the defi cit) the objection is that the resulting

infl ation would lead to a depreciation of the currency

and that the mere threat of a large depreciation and

high infl ation would lead to a massive capital fl ight

(De Dios et al 2004). The latter requires capital con-

trols to ensure that the situation does not get out of

control. But the main objection to monetizing the

defi cit is that it leads to infl ation. “The printing of

money at a rate that exceeds the demand for it “at the

current price level creates excess cash balances in the

hands of the public. The public’s attempts to reduce

excess cash holdings eventually drive up the overall

price level until equilibrium is restored” (Easterly and

Fischer 1990).

While this view holds sway in most policy circles,

a few remarks about budget defi cits and infl ation are

in order because this is at the heart of much of the

bias against defi cit spending. Taking off from Milton

Friedman’s famous dictum that infl ation is always

and everywhere a monetary phenomenon, Easterly

and Fischer (1990) state:

“…governments do not print money at a rapid

rate out of a clear blue sky. They generally print

money to cover their budget defi cit. Rapid money

growth is conceivable without an underlying fi s-


cal imbalance, but it is unlikely. Thus rapid infl a-

tion is almost always a fi scal phenomenon.”

First, developing countries have considerable

room for monetizing the defi cit while keeping infl a-

tion levels within reasonable bounds. As the same

authors explain that the historical record shows that

on average developing countries can achieve rates

of seignorage of about 2.5 percent of GNP without

stoking infl ation and that the maximum rate of sei-

gnorage is attained at infl ation rates of between 30

percent and more than 100 percent.

Second, such rates of infl ation, 30 percent to 100

percent, seem alarming compared to currently low

infl ation rates, the latter a product of decades of sin-

gle-minded focus on infl ation fi ghting regardless of

the adverse effects on output and employment. But

the empirical evidence shows that only high infl ation

is costly. How high is high? Stiglitz (1998) summa-

rizes the empirical evidence:

“Bruno and Easterly (1996) found that when

countries cross the threshold of 40 percent an-

nual infl ation, they fall into a high-infl ation/low-

growth trap. Below that level, however, there is

little evidence that infl ation is costly. Barro (1997)

and Fischer (1993) also confi rm that high infl ation

is, on average, deleterious for growth, but they too,

fail to fi nd any evidence that low levels of infl a-

tion are costly. Fischer fi nds the same results for the

variability of infl ation. Recent research by Akerlof,

Dickens, and Perry (1996) suggests that low levels

of infl ation may even improve economic perfor-

mance relative to what it would have been with

zero infl ation (emphasis in the original).

“The evidence on the accelerationist hypoth-

esis (also known as “letting the genie out of the

bottle,” the “slippery slope,” or the “precipice

theory”) is unambiguous: there is no indication

that the increase in the infl ation rate is related to

past increases in infl ation. Evidence on reversing

infl ation suggests that the Phillips curve may be

concave and that the costs of reducing infl ation

may thus be smaller than the benefi ts incurred

when infl ation is rising” (Stiglitz 1998).

Easing the fi nancing constraintsRemittances directly impact on some of these

forms of fi nancing. Concerns about the dangers

posed by defi cit spending from the point of view of

fi nancing the defi cit assume an excess demand for

foreign exchange. In the context of a current account

surplus due to strong infl ows of remittances, such

fears are greatly exaggerated.

Exhaustion of reserves can be avoided by calibrat-

ing their use taking into consideration normal re-

quirements for purposes of trade and debt servicing

and the trajectory of the balance of payments. The

share of reserves that can be used for development

fi nancing must take into account the normal reserve

requirements for trade and capital management pur-

poses.

Public expectations need not move against the

local currency if the public is made aware that the

decline in reserves (or keeping the central banks re-

serve holdings to reasonable levels) is a deliberate and

well-calibrated move undertaken by the authorities

to support productive investments, that is, it is born

of strength and confi dence rather than weakness and

near-panic. Nonetheless, it may be prudent, though,

to put in place some forms of capital control to re-

duce the risk of contagion or self-fulfi lling prophesies

to which fi nancial markets are prone. While capital

controls may discourage capital infl ows, this should

not be a cause for concern given strong remittance

fl ows and the surplus in the current account.

Using reserves to fi nance the defi cit reduces the

need for foreign borrowings, which translates to sav-

ings on interest payments. Equally important, remit-

tances increase domestic liquidity, which allows the

government to borrow domestically without raising

interest rates and without crowding out private sector

investment.

In the absence of remittances, domestic borrow-

ing by the government tends to push the private sec-

tor into borrowing more abroad as domestic credit

is soaked up by the public sector. Thus, remittances

reduce the need for additional foreign borrowings. At

the same time, the appreciation of the local currency


because of remittances makes the servicing of the ex-

isting foreign debt less costly in peso terms. Finally,

remittances, by slowing down the rate of exchange

depreciation, slow down infl ation, offsetting the in-

fl ationary effects of defi cit spending.

In sum, the objection to budget defi cits to stim-

ulate growth and investment rests on the assump-

tion that the economy faces a scarcity of foreign

exchange. To the extent that they ease the foreign

exchange constraint, remittances have implications

for the size of the fi scal defi cit that the economy

can accommodate as well as forms of fi nancing the

defi cit. Remittances allow a higher budget defi cit

without risking a foreign exchange crisis, regard-

less of the preferred means of fi nancing the defi cit.

At the same time, remittances make some form of

fi nancing the defi cit more attractive, in particular,

the use of foreign exchange reserves accumulated

from remittances.

Opportunity cost of reservesThe discussion so far on the implications of remit-

tances on macroeconomic policies involves the use of

the central bank’s excess foreign exchange reserves.

A striking development in recent decades especially

after the 1997 Asian fi nancial crisis is the large-scale

accumulation of foreign exchange reserves by central

banks in the developing world. The phenomenon has

spawned a growing literature dealing with a number

of issues including the motives for accumulating for-

eign exchanges reserves, the social costs of such re-

serves, their use for investment (in sovereign wealth

funds) and development fi nancing, the implications

for monetary policy and exchange rate management,

and so on. The issues raised in the literature are obvi-

ously relevant to our discussion.

A key issue with regard to the accumulation of

foreign reserves is the high social cost of holding large

reserves (Stiglitz 1998, Baker and Walentin 2001,

Hauner 2005, Olivier and Ranciere 2005, Rodrik

2007). There is more than one way of thinking about

the cost of reserves, but estimates invariably show large

magnitudes. Baker and Walentin (2001) consider the

difference between the economic returns on invest-

ments in physical and human capital in developing

countries and return on reserves (in particular the

portion held as interest bearing deposits or as short-

term government debt of the United States). Using

values of 10 percent and 20 percent representing

the economic returns on investments, they estimate

the opportunity cost of excess reserves at between

one percent and two percent of annual GDP in East

Asia for the 1960s to 1990s. The cumulative cost of

a decade of reserve holdings is a high 20 percent of

current (1999) GDP in East Asia.

Rodrik (2007) assigns a lower value of five

percent—the mid-point of the range of spreads

between private foreign borrowing costs and

yields on reserve assets—to the cost of reserves

and considers reserve holdings up to 2004. His

results show the cost of excess reserves is about

one percent of GDP, a large number, he notes, by

any standard. It is a multiple of the budgetary cost

of even the most aggressive anti-poverty program

implemented in developing countries, referring

to Mexico’s Progresa program which costs around

0.2 percent of GDP. It is roughly the same order

of magnitude as the projected gains for develop-

ing nations from a successful conclusion of the

Doha round of trade negotiations.

The high cost of holding reserves raises the ques-

tion of why developing countries have been accu-

mulating reserves at unprecedented and sub-optimal

(excessive) levels. Reserves, of course, are needed to

smooth out payment imbalances from current ac-

count transactions, for example if there are delays

in receiving payments for exports. The traditional

rule of thumb is that central banks should hold a

quantity of foreign exchange reserves equivalent to

three months of imports. Increased global trade in

recent decades would necessitate a rise in reserve

levels. But as Baker and Walentin (2001) point out,

reserves should increase less than proportionately to

the size of trade fl ows for two reasons: because trade

imbalances are likely to be randomly distributed (the

size of reserves should increase in proportion to the


square root of the increase in trade) and because in-

novations in the fi nancial sector would require less

reserves for the same amount of trade. In any case,

the high cost of large reserves, if indeed the latter

were purely trade-related, can easily nullify the gains

from increased trade.

Another trade-related reason for the accumulation

of foreign reserves is the so-called mercantilist motive.

In the face of strong foreign exchange infl ows, the

central bank intervenes in the foreign exchange mar-

ket to prevent the appreciation of the local currency

and maintain the competitiveness of exports. While

plausible, Aizenman and Woo (2005) fi nd that the

mercantilist motive cannot quantitatively account

for the recent build-up. Moreover, Griffi th-Jones and

Ocampo (2008) point out that some non-natural

resource exports are fairly resilient to exchange rate

appreciation. In this vein, it may be remarked that

while remittances are sensitive to a devaluation of the

local currency relative to the source country currency,

the absolute impact on remittances is unlikely to be

signifi cant.

The growing literature on foreign reserves points

to self-insurance against risks and uncertainties aris-

ing from fi nancial globalization, including banking

and currency crises, macroeconomic instability, and

the risk of running to the multilaterals for assistance

with the associated conditionality, loss of national

policy autonomy, and wrong policy advice. It is wide-

ly noted, for example, that the rapid accumulation of

foreign exchange among developing countries accel-

erated after the series of fi nancial crises following the

Asian debacle in 1997.

Financial globalization has increased the need

for higher reserve holdings. The Guidotti-Greens-

pan rule, which is also endorsed by the IMF, states

that countries should hold liquid reserves equal to

their foreign liabilities coming due within a year or

short-term debt (Rodrik 2006). In reality, fi nancial

globalization imposes greater demands than implied

by the Guidotti-Greenspan rule. The evidence shows

that central banks have been accumulating reserves

in relation to fi nancial variables, notably M2, in re-

sponse to uncertainties arising from fi nancial liber-

alization (Aizenman and Woo 2005; Obstfeld et al

2007). This is because with open capital account, the

potential pressure on the exchange rate and the fi -

nancial system comes not only from foreign investors

but also from domestic fi nancial and non-fi nancial

agents.

The point is that in the Philippine context

wherein reserve holdings come from remittances,

overseas Filipinos are paying for the high price of

financial globalization, the benefits of which in

the light of recent evidence have been increasingly

called into question (Prasad et. al 2003, Rodrik

2008). Our rough estimates of the cost of excess

BSP reserves are presented in the table below.

Taking into account the traditional three-month

import cover requirement for holding reserves,

excess reserves of the central bank rose more than

eightfold from a low of US$416 million in 2000

to US$3.5 billion in 2008, representing 2.7 per-

cent of GDP in 2000 and 11.9 percent of GDP

in 2008. Excess reserves averaged close to seven

percent of GDP for the period 1999-2008.

Using the 10 percent and 20 percent cost of re-

serves used by Baker and Walentin (2001), the cost

of excess BSP reserves averaged 0.7 percent to 1.4

percent of GDP in the last 10 years. The cumulative

cost of reserves during this period ranged from 4.5

percent to 8.9 percent of GDP.

These are obviously large numbers. The excess

reserves can easily cover the budget defi cit even at its

height in 2002. The annual cost of reserves is more

than three to six times the annual cost of fi nancing

key MDG goals related to poverty, education, health

and water and sanitation estimated at 0.2 percent of

GDP (Manasan 2006). Financing the MDG goals

from excess reserves would hardly make a dent on

the overall level of reserves. The inflationary con-

sequences, if any, of tapping the reserves at a mod-

est level (0.2% of GDP) are obviously outweighed

by the gains achieved by meeting just one of the

MDG targets, say, reducing the poverty incidence

by half.


GIR

3-moimport cover

Excess GIRCost of excess GIR

$million GDP in

$m

Cost of excess GIR as % of GDP

$ million % of GDP 10% 20% 10% 20%

1999 15,064 10,065 4,999 6.6% 500 1,000 75,632 0.7% 1.3%

2000 15,063 12,985 2,078 2.7% 208 416 76,724 0.3% 0.5%

2001 15,692 11,653 4,040 5.6% 404 808 72,667 0.6% 1.1%

2002 16,365 12,429 3,936 5.6% 394 787 69,750 0.6% 1.1%

2003 17,063 12,702 4,361 6.1% 436 872 72,000 0.6% 1.2%

2004 16,228 13,714 2,514 2.9% 251 503 85,684 0.3% 0.6%

2005 18,494 14,524 3,970 4.0% 397 794 99,200 0.4% 0.8%

2006 22,967 16,174 6,793 5.7% 679 1,359 118,822 0.6% 1.1%

2007 33,751 17,795 15,956 11.1% 1,596 3,191 143,205 1.1% 2.2%

2008 37,550 19,868 17,682 11.9% 1,768 3,536 148,933 1.2% 2.4%

Annual ave 6,633 6.9% 663 1,327 96,262 0.7% 1.4%

Cumulative 1999-2008

6,633 13,266 4.5% 8.9%

Table 3. Cost of excess reserves

Ironically, while there has been little support for

tapping foreign reserves for development fi nancing,

there is strong global support for increased foreign

aid in order for developing countries, including the

Philippines, to be able to achieve the MDG. Lo-

cally, there is much pining for higher foreign direct

investment to spur growth to the point that there is

willingness to tinker with the fundamental law of the

land to entice investors. (The objection among many

opponents of Charter change is primarily political:

term-extension of incumbent offi cials at all levels.)

Foreign aid, foreign direct investment, and any capi-

tal fl ows have the same monetary implications as the

use of reserve holdings of the central bank.

Some quarters have put forward the idea of se-

curitizing remittance fl ows for foreign borrowing

(Ratha 2003), which has the benefi t of lowering the

spread on the government’s bond issuances. Besides

the diffi culty of securitizing these fl ows, this seem-

ingly sophisticated proposal is a roundabout and

costly way of using foreign reserves for development.

Direct use of foreign reserves saves the economy in-

terest payments on new foreign debt, besides profes-

sional fees alluded to above. Note, however, that the

use of reserves is not different from borrowing abroad

in terms of monetary implications.

A more rational approach would combine capi-

tal account management policies to reduce the risk

of global fi nancial fl ows, hence reduce the need for

reserve holdings and to invest the excess reserves to

augment the economy’s physical and human capital

base. This strategy has better chance of undermining

migration in the long-term than relying on highly

volatile and in any case limited foreign capital in-

fl ows.

VI. Concluding remarksThe implications of remittances on macroeco-

nomic policy, specifi cally fi scal policy, as sketched

above have particular relevance to the Philippines.

Historically, the lack of foreign exchange has been a

binding constraint to adequate and sustained growth

as evident in recurring foreign exchange crises from

the 1950s up to the Asian fi nancial crisis in 1997.

Over the decades, the nature of the foreign exchange

problem evolved, but the underlying issue remained

a shortage of foreign exchange to sustain growth over

the long-term.


In the early part of this decade, the size of the

fi scal defi cit and the public debt raised alarms once

again as the fi scal defi cit peaked at over four percent

of GDP in 2002 and the public debt hit 130 percent

of GDP. The government responded with a combi-

nation of spending cuts and new taxes to keep the

defi cit in check. A benign environment of low in-

fl ation, low interest rates, appreciating currency, and

strong demand for government securities eased the

situation.

In the latest episode, remittances entered the dis-

cussion but in a tangential manner. It was widely ac-

knowledged, for example, that the country has been

able to avoid a debt crisis so far because of a surplus

in the current account on account of overseas remit-

tances. But it was believed that the situation was un-

sustainable. An infl uential paper by De Dios et al.

(2004), for example, argued that:

“At the moment, such scenarios (of a debt

crisis) are being fended off only by the fact that

the country continues to earn more foreign ex-

change than it spends (thanks especially to over-

seas workers remittances). But this could just as

easily change. Any large external shock, such as a

sustained increase in world oil prices, or a sharp

fall-off in workers remittances…would make the

country increasingly vulnerable.”

The government has successfully avoided a debt

crisis since then, but a clear victim of this balancing

act has been new capital and social spending which

bore the brunt of the policy of fi scal austerity (Lim

2007). While the current fi scal policy acknowledges

the contribution of remittances, it maintains the key

assumption that the country faces an excess demand

of foreign exchange, notwithstanding the rapid ac-

cumulation of foreign exchange reserves and, until

the current global fi nancial crisis, the strong pres-

sure on the peso to appreciate. This raises the issue

of whether fi scal austerity is warranted in view of

the surplus in the current account. As the discussion

in the previous section points out, the fundamental

change in the country’s external position brought

about by remittances calls for a re-examination of

macroeconomic policy, in general, and fi scal policy,

in particular, so as to allow higher investment and

economic growth.

The need to change gears when it comes to fi scal

policy gains urgency in light of the global crisis which

triggered a drop in export demand and domestic con-

sumption. The slowdown in investment activities of

the private sector—foreign and local—places the bur-

den of stimulating the economy on the public sector.

Current proposals of defi cit spending of around one

percent to two percent of GDP are clearly inadequate

and do not take into account the favorable current

account position as a result of continuing strong re-

mittances. Beyond paying lip service to the heroic

contributions of overseas workers, economic policy-

makers need to fi gure out how to take advantage of

the resources provided by overseas workers to raise

growth, create employment, and eventually remove

the rational for overseas migration.


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How Relevant is Financingfor Development toPhilippine Realities?

IntroductionThis paper reviews and rethinks FfD to support the MDG and situates the critique in the context of current

Philippine economic and development realities.

It argues that the relevance of the FfD instruments can be appreciated in conjunction with a frank and thor-

ough diagnosis to determine the country’s main binding constraints on growth and development.

Doing the diagnostics is not an objective of the paper, but several critical issues or problems are laid out. How

the FfD can address these issues is likewise a challenge.

Since the FfD is a big plan in itself and other papers elaborate on the other major themes of the Mon-

terrey Consensus, this essay sets its focus on the section titled: “Addressing systemic issues: enhancing

the coherence and consistency of the international monetary, financial and trading systems in support of

development.”

FfD and MDGFfD and MDG have become ubiquitous terms used by the development community. Democratically elected

leaders, dictators, WB and IMF technocrats, UN bureaucrats, journalists and commentators, neo-liberals, dema-

gogues, reformists, NGO workers, anti-globalization radicals, grassroots activists, and everyone else involved in

shaping the world, for better or for worse, are familiar with FfD and MDG.

FfD and MDG have become the buzzwords to fi ght poverty and bring about prosperity, especially for the

less-developed countries. A commonly repeated statement, a stylized fact, is that without augmented fi nancing,

the MDG cannot be met.

In a manner, the FfD is the recycled version of the fi nancing-gap approach (the Harrod-Domar model, being

the archetype) that gained currency in the immediate post-World War II period. That is, investments determine

growth, and since poor countries lack savings that can be translated into investments, the gap would be fi nanced

through external sources like foreign debt, ODA, and FDI. What supposedly makes the FfD different from the

old fi nancing-gap approach is that it has the benefi t of hindsight to avoid the mistakes and failures associated

with foreign debt, ODA, and FDI of previous periods.

The Millennium Development Goals consist of eight core goals, namely wiping out poverty and hunger,

Filomeno S. Sta. Ana III


segments of society.”

Whew! In short, it says that the IMF and WB

should not impose anti-poor conditionalities and

should allow space for home-grown reforms to de-

velop.

Nevertheless, the FfD can be criticized for being

like the IMF or WB. That is, the FfD lists many dos

and don’ts. The maze of ideas confounds.

William Easterly, a former senior adviser at the

World Bank and the arch-critic of Jeffrey Sachs, the

director of the UN Millennium Project, describes the

UN approach as a top-down approach. Mr. Easterly’s

derisively criticizes Mr. Sach’s push for a grand devel-

opment plan as expressed in the Millennium Project,

labeling it “utopianism.”

The UN plan, according to Mr. Easterly, is

no different from communism’s central planning.

And it is a new form of colonialism wherein global

powers ram their programs down the throat of the

developing world. (See Easterly’s The White Man’s

Burden, 2006.)

To be sure, Mr. Easterly’s criticism is hyperbolic.

The FfD and MDG are not coercive apparatuses.

And if FfD/MDG policy instruments are well-tar-

geted and suited to concrete conditions, they can

reinforce internal development reforms.

The FfD and MDG are blueprints, but the prob-

lem with blueprints is that their models and details

do not exactly correspond to the complexity of devel-

opment in a particular country.

Application of FfD’s Blueprint to Philippine Conditions

Let us return to the FfD’s “leading actions.”

Exactly how can they help Philippine develop-

ment?

Domestic mobilization of resources is critical, but

the FfD by itself does not offer explicit proposals on

improving tax policy and administration in the Phil-

ippines. The best it can do is to reiterate the basic

principles of domestic revenue generation and share

best national practices that cannot be replicated eas-

ily in other country settings.

achieving universal primary education, promoting

gender equality, reducing child mortality, improv-

ing maternal health, combating HIV/AIDS, ma-

laria and other diseases, ensuring environmental

sustainability, and fostering global partnerships for

development. Each goal has specifi c, time-bound

targets.

Obviously, all these goals are laudable. And they

are plain and straightforward; in fact, they are mainly

motherhood statements. The diffi cult part is how to

achieve these goals.

The FfD attempts to provide an answer. The as-

sumption is that the fulfi llment of the MDG requires

tremendous resources. Hence, FfD becomes an

overarching framework that weaves together major

themes or what the offi cial document calls “leading

actions.” To wit: the mobilization of domestic fi -

nancial resources (e.g, taxation), international trade,

international private resources (e.g., FDI), interna-

tional fi nancial cooperation (mainly ODA), external

debt, and systemic issues that will provide the coher-

ence of the multilateral monetary, fi nancial, and trad-

ing systems.

A Critique of the FfD ApproachJust like the discredited Washington Consensus,

however, the FfD is very comprehensive. It contains

so many ideas, principles, issues, and tasks, some of

which are subtle criticisms of the Washington Con-

sensus. To illustrate, here is a tiring, verbose state-

ment from the FfD document:

“We stress the need for multilateral fi nancial in-

stitutions, in providing policy advice and fi nancial

support, to work, on the basis of sound, nationally

owned paths of reform that take into account the

needs of the poor and efforts to reduce the pover-

ty, and to pay due regard to the special needs and

implementing capacities of developing countries

and countries with economies in transition, aiming

at economic growth and sustainable development.

The advice should take into account social costs of

adjustment programmes, which should be designed

to minimize the negative impact on the vulnerable


On international trade, we ask the question:

Will liberalization under the World Trade Organi-

zation or under bilateral agreements result in long-

term growth? Rigorous studies done by Ricardo

Haussman, Francisco Rodriguez, and Dani Rodrik,

among others, debunk the idea that trade openness,

in terms of import liberalization, is a predictor of

growth. Mr. Rodrik (2001), for instance, “questions

the centrality of trade and trade policy and em-

phasizes instead the critical role of domestic insti-

tutional innovations.” In the same vein, he “argues

that economic growth is rarely sparked by imported

blueprints and opening up the economy is hardly

ever critical at the outset.”

The regressions that yield a trade liberaliza-

tion-growth relationship suffer from methodologi-

cal problems such as the direction of causality, the

identifi cation of variables and the coverage of data.

(A good summary of the criticisms can be found

in Mr. Rodriguez’s short paper for the International

Poverty Centre’s Policy Research Brief, November

2007.)

On foreign aid, will an increase in ODA mat-

ter? The FfD urges the developed countries to meet

the target of ODA to developing countries, equiva-

lent to 0.7 percent of their gross national product

(GNP).

The conclusions drawn from the aid literature

are mixed. But a re-examination done by Raghuram

Rajan and Arvind Subramanian (July 2007) shows

that there is little robust evidence to establish a re-

lationship, positive or negative, between aid and

growth. What makes their study different from pre-

vious ones is that their paper takes into account dif-

ferent settings (time horizons, time periods, cross-

section and panel data, types of aid). Further, their

paper addresses the problem of endogeneity (that is,

whether increasing aid leads to good economic per-

formance or economic performance attracts aid).

Or is good policy a determinant of growth? There

is no supporting evidence, according to Easterly and

Ross Levine (2001) and Easterly, Levine and David

Roodman (2004). The conclusion in the latter work

is that the authors “no longer fi nd that aid promotes

growth in good policy environments.”

What needs further study is the role of total fac-

tor productivity (TFP) in long-term growth. Easterly

says the TFP’s conceptions have yet to be fully ex-

plained. Arguably, the most crucial feature of TFP

concerns institutions.

Where there is near-consensus among economists

is that institutions are a determinant of long-term

growth. But again, building and reforming institu-

tions, formal as well as informal, are country-specifi c.

The institutional development and innovation in

fast-growing developing countries China, Vietnam

or India cannot illuminate the reform path in the

Philippines.

It must be stressed though that the positive link

of institutions and growth is for the long term. In-

deed, even for the short run, we must be conscious

of working out the appropriate institutional ar-

rangements that will sustain growth in the long run.

But in the short run, too, policies that will likewise

result in reforming or strengthening institutions are

crucial.

Thus, we refi ne an earlier point (recall Easterly)

about policy not being a determinant of long-term

growth. Good policy has an impact on institutions

(take the case of tax policy or the exchange-rate policy)

and thus indirectly contributes to long-term growth.

DiagnosticsThis brings us to the relevance of country growth

diagnostics, as amplifi ed by Hausmann, Rodrik, and

Andres Velasco (2004), among others. The key in

growth diagnostics is to identify the economy’s bind-

ing constraint(s).

Figure 1 is an illustration of how growth diagnos-

tics is done (from Hausmann, Rodrik and Velasco,

2004).

How growth diagnostics can be applied to deter-

mine and resolve the Philippines’ main binding con-

straints is well beyond the scope of this paper. For-

tunately, the ADB and the WB have applied growth

diagnostics to the Philippine situation.


The ADB has embarked on a project titled

“Strengthening Country Diagnosis and Analysis of

Binding Development Constraints in Selected De-

velopment Member Countries.” The Philippines is a

participating country, and several documents for the

Philippines have been drafted. The URL link for the

ADB’s Philippine diagnosis papers is: http://www.

adb.org/Projects/Country-Diagnostic-Studies/coun-

try-studies.asp.

Alessandro Bocchi, a WB economist, has also

written a paper that deals with growth diagnostics

and binding constraints (2007). Suffi ce it to say that

the ADB and WB diagnosis papers on the Philip-

pines have a lot of common points—on good gov-

ernance and elite capture of the state, on corruption,

on fi scal policy, on the exchange rate, among other

things. This paper, however, is not the forum to delve

into their content.

In the context of country diagnostics, interna-

tional mechanisms such as the FfD become a second-

ary matter, unless it turns out that the main binding

constraint on sustained growth in the Philippines

Figure 1. Growth Diagnostics (from Ricardo Haresmann et al., 2004)

pertains to global rules.

Being secondary does not suggest that the FfD be-

comes irrelevant. For global rules and commitments

can support or for that matter weaken domestic re-

form initiatives. That FfD as an international instru-

ment is secondary is an affi rmation that development

is internally driven. External factors nevertheless can

provide an enabling environment for national pro-

cesses and innovations to prosper.

A useful framework to appreciate the relationship

or interaction of international institutions (in this

case, not only FfD and MDG but also the IMF, WB

and WTO) with national institutions is Rodrik’s con-

cept of “political trilemma of the world economy”

(2002). In brief, Rodrik argues that given current

conditions where global institutions are weak (or the

absence of “global federalism”), one can’t have deep

economic integration (globalization), the nation state

(sovereignty), and democratic or mass politics all at

the same time. To quote Rodrik:

“We can have at most two out of these three. If

we want to push global economic integration much

Problem: Low levels of private investment and entrepreneurship

Low return to economic activity High cost of fi nance

bad internationalfi nance

bad local fi nanceLow social returns Low approriability

government failures market failures

low domestic

living

poorintermediation

coordinationexternalities

informationexternalities

“self-discovery”macro risks:fi nancial,

monetary, fi scalinstability

micro risks:property rights,

corruption, taxeslow human

capital

poorgeography

badinfrastructure


further, we have to give up either the nation state or

mass politics. If we want to maintain and deepen

democracy, we have to choose between the nation

state and international economic integration. And if

we want to keep the nation state, we have to choose

between democracy and international economic in-

tegration.”

The framework offers perhaps in stark terms the

tradeoffs from globalization. Of course, the choices

are still to be made at the national level.

That said, we submit the critical points (in the

following sections) for debate and discussion with re-

spect to the FfD’s systemic issues vis-à-vis Philippine

concerns.

Domestic Resource MobilizationThe mobilization of domestic fi nancial resources

is a primary concern. The Philippines has tentatively

moved out of the danger zone in relation to its fi scal

position. The national government budget defi cit and

the consolidated public sector defi cit are now man-

ageable. In 2004-05, a fi scal crisis was on the verge of

breaking out. But a series of revenue measures, espe-

cially the increase in the rate of the value-added tax

(VAT) from 10 percent to 12 percent, staved off the

fi scal threat that could have turned into a full-blown

economic crisis. For its political survival, the belea-

guered administration was compelled to undertake

the painful measures to boost revenues.

Despite the increase in revenues, the revenue col-

lection agencies, especially the Bureau of Internal

Revenue, are having diffi culty meeting their targets.

The implication is that tax administration remains a

serious problem.

Furthermore, much still has to be done in re-

lation to tax reforms. The rationalization of fi scal

incentives has always met stiff resistance. The infi r-

mities or loopholes in the excise tax on sin products

and some exemptions on the VAT law have to be

tackled soon.

Ironically, despite increasing revenues, the spending

(say, as a percentage of GDP; see table 1) for human de-

velopment (e.g., health and education) and infrastruc-

ture has fallen. To be sure, the compression of produc-

tive spending contributed to the narrowing of the fi scal

defi cit. This of course was a bad tradeoff, something

that could have been avoided in the fi rst place.

Public InvestmentsThe decline in spending for health, education,

and infrastructure, among others, threatens long-

term growth.

Figure 2. Decrease in spending for essential services: infrastructure, health and education (as a percentage of GDP)

3.0

2.5

2.0

1.5

1.0

0.5

01999

Infrastructure Basic Education Health


1999 1999 1999 1999 1999 1999

2.5

1.8

O.5

1.9

1.6

O.4

1.5 1.5

O.4

1.81.6

O.40.5

1.5

O.3

0.7

1.3

O.3

2.51.2

O.2


The spending gap in these productive sectors can

be partially addressed through fi nancing from debt and

ODA as well as through private sector participation.

But there are major caveats to this.

At the micro level, big-ticket projects have been

accompanied by massive corruption and bribery and

accommodation of vested interests. The projects

themselves lack sound economic basis, being redun-

dant or offering little social returns. The North Rail,

the National Broadband Network (NBN), and the

Cyber-education projects are clear examples. (See the

2007 paper of Raul Fabella and Emmanuel de Dios

with regard to the economic arguments against the

NBN and Cyber-education projects.)

The NBN project, with loan fi nancing from

China, exemplifi es the worst features associated

with bad ODA projects. The NBN (already can-

celed in the wake of intense popular opposition)

intended to provide another broadband backbone,

to be operated by government, but this was unnec-

essary in the fi rst place. The country has capable

and suffi cient backbones, thus making another

backbone, using public money, redundant. An ad-

ditional backbone could also jack up the costs that

consumers eventually have to pay as economies of

scale are reduced.

In addition, based on testimonies and evidence

presented to the Senate, it was alleged that the project

was overpriced by about US$130 million and that

bribes were given to some public offi cials. The NBN

scandal reignited a political crisis.

The reminder to donors and creditors is to avoid

being made instruments of vested interests whose

main interest in ODA projects is to accumulate

wealth at the expense of public interest and resources.

Donors and creditors likewise have to be reminded

of the old saying that they should not throw good

money after bad.

At the macro level, encouraging further foreign

borrowing can lead to a moral hazard problem. The

Philippine government, already becoming compla-

cent in light of the improvement of the fi scal posi-

tion, is again resorting to foreign borrowing without

clear development objectives. (Again, the NBN and

Cyber-education projects attest to this.)

Worse, additional borrowing, especially borrow-

ing to fi nance economically and unsound projects,

contributes to the strengthening and overvaluation

of the Philippine peso.

Exchange RateThe continued appreciation of the peso is a se-

rious concern for the whole economy. The popular

perception is that exporters and the dependents of

overseas Filipino workers are the most hurt by the

appreciating peso. (The peso appreciation leads

to an overvaluation of the currency.) This is par-

tially true; the whole real sector of the economy

(the tradable sector, specifically) hurts from an

overvalued peso. An appreciating and overvalued

peso likewise has a negative impact on those who

produce for the domestic market (the import sub-

stitutes). They now have to compete with cheaper

imports, apart from the rampant smuggling of

goods whose prices have further cheapened be-

cause of the strong peso.1

A specialized role for the IMF is to monitor the

movement of the exchange rate, including a determi-

nation of whether the domestic currency is overval-

ued or undervalued. The task of exchange rate moni-

toring or surveillance has gained more signifi cance in

the wake of the Asian fi nancial crisis in 1997. There

is consensus among economists and other policy-

makers that overvalued currencies contributed to the

1997 fi nancial crisis.

The IMF’s own computation of the real effective

exchange rate or REER (see Table 1) showed a slight-

ly overvalued peso (as of March 2007).

1 Editor’s note: This paper was written in 2007, at a time that the peso rapidly appreciated. In 2008, however, the peso began to depreciate in the wake of soaring oil and food prices and the global fi nancial meltdown. Nevertheless, the exchange rate will remain a debatable issue because the BSP, its primary mandate being price stabilization, has a bias for a strong currency.


Table 1. Market rate, nominal effective exchange rate, and real effective exchange rate indices (2000-March 2007), from the IMF

Units Scale Descriptor 2000M1 2000M2 2000M3 2000M4 2000M5 2000M6 2000M7 2000M8 2000M9 2000M10 2000M11 2000M12 National Currency per US Dollar None

MARKET RATE 40.39 40.85 41.06 41.28 42.83 43.15 44.94 45.08 46.28 51.43 49.39 50.00

Index Number None NEER FROM INS 106.00 107.11 105.90 105.19 105.30 102.35 99.05 98.24 96.91 93.02 90.44 90.48

Index Number None

REER BASED ON REL.CP 104.22 105.63 104.59 104.43 104.79 102.01 99.01 98.56 97.36 94.16 92.21 93.04


MARKET RATE 49.41 48.26 49.38 51.22 50.58 52.37 53.56 51.21 51.36 51.94 52.02 51.40


Index Number None



MARKET RATE 51.20 51.35 51.15 50.74 49.97 50.42 51.29 51.81 52.45 53.02 53.59 53.10


Index Number None



MARKET RATE 53.80 54.35 53.53 52.82 52.28 53.71 54.69 55.11 54.94 55.25 55.77 55.57


Index Number None



MARKET RATE 56.09 56.28 56.36 55.86 55.84 56.18 56.01 56.22 56.34 56.35 56.23 56.27


Index Number None


continuation, next page


MARKET RATE 55.11 54.72 54.79 54.35 54.37 55.92 56.11 56.16 56.06 55.06 54.00 53.07


Index Number None



MARKET RATE 52.34 52.09 51.28 51.83 52.65 53.59 51.62 50.94 50.39 49.81 49.76 49.13


Index Number None


Units Scale Descriptor 2007M1 2007M2 2007M3 National Currency per US Dollar None

MARKET RATE 49.03 48.29 48.26

Index Number None NEER FROM INS 85.66 86.51 85.63

Index Number None

REER BASED ON REL.CP 107.56 108.43 107.21


We likewise used the Bangko Sentral ng Pilipinas

(BSP) data on the REER, but did a rebasing with

1986 as base year (Table 2). The REER with 1986

as base year showed an overvaluation of the currency

(January-September 2007) of 12.4 percent. Using

a more recent base year (2001, for example) would

yield a higher overvaluation.

Table 2. Nominal and Real Effective Exchange Rate Indices (base years: 1980 and 1986)

Dec 1980 = 100 Dec 1986 = 100

Nominal* Real* Nominal** Real**

1980 102.69 99.44

1981 101.17 106.8

1982 100.89 110.04

1983 78.52 86.36

1984 53.37 82.89

1985 48.17 89.28

1986 38.92 70.03 102.23 103.09

1987 35.6 64.32 93.51 94.69

1988 33.15 65.64 87.08 96.63

1989 32.81 70.11 86.17 103.2

1990 28.81 66.2 75.67 97.46

1991 25.08 65.95 65.89 97.08

1992 26.48 73.22 69.55 107.79

1993 24.96 72.7 65.56 107.02

1994 24.86 76.54 65.29 112.67

1995 24.7 79.19 64.88 116.58

1996 24.93 86.28 65.49 127.01

1997 23.5 85.53 61.72 122.96

1998 17.54 67.21 46.06 98.94

1999 18.25 76.68 47.93 112.88

2000 16.61 71.92 43.64 105.87

2001 14.72 67.37 38.66 99.17

2002 14.27 66.5 37.49 97.9

2003 12.44 59.94 32.69 88.24

2004 11.87 58.07 31.18 85.48

2005 11.64 61.98 30.58 91.24

2006 12.91 71.44 33.91 105.16

2007*** 13.73 76.35 36.06 112.4

Source: Basic Data from Bangko Sentral ng Pilipinas (BSP)* Averages of the monthly data from BSP** Author’s calculations using BSP data*** Only covers January to September 2007

What is interesting regarding the exchange rate is-

sue is not only the conclusion that an overvalued cur-

rency is bad for growth but more to the point, an un-

dervalued currency translates into higher long-term

growth. A recent empirical paper by Rodrik (2007)

explains the signifi cance of currency undervaluation

to long-term growth.


Here, the Philippines faces a far more complex

problem. OFW’s foreign exchange remittances have

fueled consumption-led growth. But at the same

time, the heavy infl ow of OFW foreign exchange

earnings contributes to currency appreciation. Part

of the challenge is how to tap remittance earnings for

productive investments.

Understandably, the IMF is in no position to

infl uence the country’s exchange-rate policy. Never-

theless, the BSP is in a position to temper the quick

appreciation of the peso. To its credit, it has occa-

sionally intervened in the foreign currency market to

smoothen the fl uctuations that point to further peso

strengthening.

Nevertheless, its present effort has so far been insuf-

fi cient to curb the continued appreciation of the cur-

rency. There is in fact a policy bias for currency appre-

ciation, given that the BSP rigorously, or even rigidly,

pursues its mandate of targeting infl ation. A policy of

targeting infl ation, however, should not undermine

other development or economic objectives like increas-

ing employment and sustaining productive growth.

GMA, too, has expressed her support for a “strong

peso.” Hence, we have a situation where both the Ex-

ecutive and the independent BSP are in full agree-

ment about the exchange-rate policy. Unfortunately,

it is not the appropriate policy that will be conducive

to employment generation, long-term investments

and sustained growth.

It will thus take a substantive change in policy

regime, if government would opt for a strategy of a

competitive or undervalued currency.

InstitutionsIn the section on systemic issues, the FfD docu-

ment mentions this: “Good governance at all levels

is also essential for sustained economic growth, pov-

erty eradication and sustainable development world-

wide.” Good governance is actually the product of

good institutions. (The relationship of institutions

and governance is explained in Emmanuel de Dios’s

draft paper (undated) for the Asian Development

Bank project on the Philippine country diagnosis.)

It is the building of good, strong, robust institu-

tions that is arguably the biggest challenge that the

Filipinos collectively face. (See, for example, Michael

Alba’s paper (undated) on the impact of institutions

on Philippine growth, titled: Why has the Philip-

pines Remained a Poor Country? Some Perspectives

from Growth Economics.)

The reforms that have an impact on institutions

are wide-ranging. To name some: electoral reforms

to ensure clean and credible elections, reduction

of discretionary power residing in the presidency,

strengthening of the party system and making politi-

cal parties accountable, reorientation of the Armed

Forces of the Philippines, and depoliticization of the

judiciary. On the economic front, we need to think

of incentives (or disincentives) that will shape the at-

titudes and behavior of politicians, businessmen, and

other agents to make everyone responsible and rule-

abiding citizens.

While the role of external parties, multilateral and

bilateral institutions, in institution building in one

country is a delicate task, as they have to steer clear

of accusations of meddling and interference, the fact

remains that their policy engagement can have posi-

tive contributions.

In many instances, conditionalities tied to ODA

or debt packages have not worked. But some con-

ditionalities—those sensitive to social and economic

standards and not violative of basic economic prin-

ciples—are unavoidable, to promote transparency

and accountability and to address moral hazard prob-

lems.

In this light, the engagement of the European

Union, the United States, and the UN agencies in

tackling crucial development concerns such as cor-

ruption, regulatory capture, extra-judicial killings

and other human-rights violations is most wel-

come.

Tying aid to the promotion of human rights and

the resolution of extra-judicial killings is not interfer-

ence. Speaking out against high-level corruption and

abuse of power is not interference. They are state-

ments that affi rm universal principles.


To return to the growth diagnostics exercise, the

identifi cation of the main binding constraints is not

confi ned to purely economic variables. The bind-

ing constraint can be political. To illustrate, it can

be argued, as others have argued, that the binding

constraint on Zimbabwe and its economy is the un-

democratic, repressive, and irresponsible leadership

of Robert Mugabe.

In the Philippines, it can likewise be argued

that a main binding constraint is political. The

Bocchi paper from the World Bank (2007) explic-

itly identifies “elite capture,” leading to expensive

inputs, as a serious constraint.

Corruption and the feeble enforcement of the

law—in other words, weak institutions—also be-

set the Philippine economy since time immemo-

rial. Thus, rebuilding the country’s institutions is

an absolutely necessary task.

Concluding RemarksTo conclude, this essay situates the FfD to fi nance

the MDG within the context of the most relevant eco-

nomic and development issues in the Philippines.

The FfD’s “leading actions” need to be reviewed

in light of new studies and fi ndings regarding the con-

tribution of aid, debt, trade and policies in general to

growth. In sum, there is a lack of substantial evidence

to show that they are determinants of growth.

Further, the relevance of FfD mechanisms in

relation to problem-solving at the national level is

conditioned upon making rigorous diagnostics that

attempt to identify the main binding constraints on

growth and development.

Within this context can the FfD’s mechanisms

and leading actions supplement or help enable na-

tionally owned institutional and policy reform inno-

vations.


Alba, Michael (undated). Why has the Philippines Remained a Poor Country? Some Perspectives from Growth

Economics. Preliminary Draft. Economics Department, De La Salle University.

Bocchi, Alessandro Magnoli (2007). Rising growth, declining investment: the puzzle of the Philippines,

Breaking the “Low-Capital-Stock” Equilibrium. World Bank

De Dios, Emmanuel (undated). Identifying Binding Constraints on Sustainable Growth, Governance,

Institutions, and Political Economy. A working paper for the Asian Development Bank project on

Strengthening Country Diagnosis and Analysis of Binding Development Constraints in Selected

Development Member Countries.

Easterly, William (2006). The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill

and So Little Good. New York: Penguin Press.

Easterly, William, Ross Levine and David Roodman (2004). New data, new doubts: A Comment on Burnside

and Dollar’s “Aid, Policies, and Growth.” American Economic Review, June 2004, 94 (3), 774-780.

Easterly, William and Ross Levine (2001). It’s not factor accumulation: stylized facts and growth models.

World Bank Economic Review, 15 (2).

Fabella, Raul and Emmanuel de Dios (2007). Lacking a backbone: The controversy over the “National

Broadband Network” and Cyber-education projects.

Hausmann, Ricardo, Dani Rodrik and Andres Velasco (2005). Growth Diagnostics. Revised version,

March 2006.

Hausmann, Ricardo and Dani Rodrik (2005). Self-Discovery in a Development Strategy for El Salvador,

Economia, 6(1): 43-87.

Rajan, Raghuram and Arvind Subramanian A. (2007). Aid and Growth: What Does the Cross-Country

Evidence Show? Forthcoming, Review of Economics and Statistics.

Rodriguez, Francisco (2007). Policymakers Beware: The Use and Misuse of Regressions in Explaining

Economic Growth. Policy Research Brief, International Policy Centre, November 2007, No. 5.

Rodriguez, Francisco and Dani Rodrik (2000). Trade Policy and Economic Growth: A Skeptic’s Guide to the

Cross-National Evidence. In Bernanke, Ben S. and Kenneth S. Rogoff, editors. NBER Macroeconomics

Annual 2000. Cambridge, MA: MIT Press.

References


Rodrik, Dani (2007). The Real Exchange Rate and Economic Growth: Theory and Evidence.

__________ (2002). Feasible Globalizations. Harvard University.

__________ (2001). The Global Governance of Trade As If Development Really Mattered. New York:

United Nations Development Programme.

United Nations Financing for Development Coordinating Secretariat, Department of Economic

and Social Affairs. (2002). Financing for Development: Building on Monterrey. New York: United Nations

Publication.

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