Financeorpenanceforthepoor by socialwatchphilippines

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 III Editor

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: sowatphils@gmail.com 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 reflect 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

About the Authors 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 Office.

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, conflicts over natural resources, international labor migration, foreign investments, and contemporary politics. FfD: Finance or Penance for the Poor

iii

Table of Contents About the Authors

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Abbreviations and Acronyms

vii

Foreword Professor Leonor Magtolis Briones Renaud Meyer

iii

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

ix xi 1

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May pera na ba? Mobilizing Domestic Financial Resources for Development Leonor Magtolis Briones

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

................

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

Development Down the Drain: The Crisis of Official Development Assistance to the Philippines Eduardo C. Tadem Can Trade Finance Development? Jessica Reyes-Cantos

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Remittances for Development Financing Clarence G. Pascual

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

FfD: Finance or Penance for the Poor

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109

131

Abbreviations and Acronyms ADB – Asian Development Bank ABI – Alternative Budget Initiative AMORE – Alliance of Mindanao Off-Grid Renewable Energy AoA – Agreement on Agriculture ARISP – Agrarian Reform Infrastructure Support Project II ARMM – Autonomous Region of Muslim Mindanao ASEAN – Association of Southeast Asian Nations BCDA – Bases Conversion Development Authority BIR – Bureau of Internal Revenue BOC – Bureau of Customs BOI – Board of Investments BOT – Build-Operate-Transfer BPO – business process outsourcing BTr – Bureau of Treasury CAD – comparative-advantage defying CAF – comparative-advantage following CDC – Clark Development Corporation CIDP2 – Second Communal Irrigation Development Project CIDSE – Cooperation Internationale pour le Development et la Solidarite CNMEC – China National Machinery and Equipment Cooperation COA – Commission on Audit CSO – civil society organization CTC – community tax certificate CTS – Cargill Technical Services CTRP – Comprehensive Tax Reform Program DA – Department of Agriculture DAC – Development Assistance Committee DAR – Department of Agrarian Reform DBM – Department of Budget and Management FfD: Finance or Penance for the Poor

DBP – Development Bank of the Philippines DENR – Department of Environment and Natural Resources DOF – Department of Finance DOTC – Department of Transportation and Communication DPWH – Department of Public Works and Highways DSA – debt sustainability analysis DSSC – Development Support Services Center DTI – Department of Trade and Industry ECC/CNC -Environmental Compliance Certificate/Certificate of Non-Coverage EPRA – Economic Policy Research and Advocacy FAPs – foreign-assisted projects FDI – Foreign Direct Investments FfD – Financing for Development FMO – Fund Management Office FPE – Foundation for Philippine Environment FSSI – Foundation for Sustainable Society, Incorporated GAA – General Appropriations Act GATT – General Agreement on Tariffs and Trade GDP – gross domestic product GNI – gross national income GNP – gross national product GOCC – government-owned - or -controlledcorporation GOP – Government of the Philippines GPRA – Government Procurement Reform Act HD – human development HIPC – Heavily Indebted Poor Countries ICC – Investment Coordinating Committee

vii

ICT – Information Communication Technology IFC – International Finance Corporation IMF – International Monetary Fund IPAs – Investment Promotion Agencies IPP – Investment Priority Plan ITH – income tax holiday JBIC – 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 Philippines LGU – local government unit MDG – Millennium Development Goals MDRI – Multilateral Debt Relief Initiative MILF – Moro Islamic Liberation Front MNEs – multinational enterprises MOFA – Ministry of Foreign Affairs MOU – Memorandum of Understanding MTF-RDP – Mindanao Trust Fund – Reconstruction and Development Program NAMA – Non-Agricultural Market Access NBN - National Broadband Network NCR – National Capital Region NDF – Nordic Development Fund NEDA – National Economic and Development Authority NEP – National Expenditure Program NG – national government NGO – non government organization NLRC – North Luzon Railway Corporation NPC – National Power Corporation ODA – Official Development Assistance OECD – Organization for Economic Cooperation and Development OECF – Overseas Economic Cooperation Fund OFWs – overseas Filipino workers PCA - Philippine Construction Association PCGG – Presidential Commission on Good Government PCIJ – Philippine Center for Investigative Journalism

viii

PDF – Philippines Development Forum PERC – Political and Economic Risk Consultancy PEZA – Philippine Economic Zone Authority PhP – Philippine pesos PIDS – Philippine Institute of Development Studies PIOs – project implementation officers PRC – People’s Republic of China RA – Republic Act RATS – Run After The Smugglers RATE – Run After Tax Evaders REER – real effective exchange rate ROW – right-of-way SAPs – Structural Adjustment Programs SBMA – Subic Bay Metropolitan Authority SC – Supreme Court SCTEP – Subic-Clark-Tarlac Expressway Project SEC – Securities and Exchange Commission SEZ – special economic zone SRMP – Saug River Multi-Purpose Project TARGET MDGs – To Access, Revitalize and Gear Efforts Towards MDGs TEEP – Third Elementary Education Project TFCA – Tropical Forest Conservation Act TFP – total factor productivity TNC – transnational corporation TRIMs – Trade Related Investment Measures UN DESA – United Nations Department of Economics and Social Affairs UN IFAD – United Nations International Fund for Agricultural Development UNCTAD – United Nations Conference on Trade and Development UNDP – United Nations Development Programme UNFPA – United Nations Population Fund UP – University of the Philippines USAID – United States Agency for International Development VAT – value-added tax WB – World Bank WTO – World Trade Organization WWF – World Wildlife Fund

FfD: Finance or Penance for the Poor

Foreword S

ocial 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 final 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 financing 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 official 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 financing 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 financing the MDGs as well as the study of Dr. Joseph Lim on the possibilities of debt reduction for MDG financing; 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 financing for development as outlined in the Monterrey Consensus. The FfD themes are domestic resources, international resources/foreign direct investments, trade, official development assistance, debt and systemic issues. The preparation of each paper involved a series of workshops before and after the initial draft 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 financing development, including MDGs. They further reveal that bad governance and inappropriate economic policies have perpetuated a massive outflow of resources through debt payments, and corruption, for example, thus leaving few resources to finance 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 bookâ&#x20AC;&#x2122;s publication. It is important to take note that the papers here were finalized in early 2008 and thus have not taken into account the financial crisis gripping the world as well as the expected global economic slowdown. These recent trends will inevitably impact on the countryâ&#x20AC;&#x2122;s financial flows 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 financial 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 quantified 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 financial crisis only underscores the urgency and the need for national, regional and global action.

Professor Leonor Magtolis Briones Lead Convenor, Social Watch Philippines October 2008, Quezon City

FfD: Finance or Penance for the Poor

Foreword T

he unprecedented global financial challenges facing the world today call for a coherent and collective action 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 development require a long-term financing for development (FfD) strategy. The first 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 committed to six interrelated themes, namely, domestic resource mobilization, foreign direct investments and private capital flows, 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 implementation of the Monterrey Consensus will be held in Doha, Qatar to assess progress made, reaffirm goals and commitments, share best practices and lessons learned, and identify emerging issues and challenges as well as significant measures for further implementation. The Doha Conference will indeed be a significant milestone in the financing 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 Philippines, 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 financial 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 financing for development. I wish to congratulate the Social Watch Philippines and its partners for spearheading this process and for their excellent contribution to promote multistakeholder partnership under the FfD framework. The commitment expressed to ensure a broad-based process of financing 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 FfD: Finance or Penance for the Poor

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

This volume tackles the major themes that address FfD, specifically the generation or mobilization of financial resources to meet the MDGs. The major themes are: 1) domestic financial resources, mainly tax revenues; 2) investments (in this case, foreign direct investments); 3) international trade; 4) official 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 connection to this volume. First, notwithstanding the wide scope of FfD instruments, this volume does not tackle all possible sources of financing. 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 poverty 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 investors 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 institutions, 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 financing to achieve MDGs, this does not necessarily mean favoring an argument that financing 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. FfD: Finance or Penance for the Poor

Another conceptual problem pertains to the role of international trade. Indeed, trade generates finances 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 financing. An implication of such a narrow view is to return to purely mercantilist 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 significance at a particular stage of development. Some might ask why we attach significance 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 likewise concerns its effect on institutions. Richard Posner, 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 provocative and penetrating piece on aid as well as on trade, which is worth quoting (2005): “Trade and aid have become international buzzwords. 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 five 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 discussed in this volume, are not the determinants of long-term growth. Moreover, amidst the global growth slowdown arising from the financial 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 flight of capital away from emerging economies to reduce risk, the expanding fiscal deficit in the rich countries—all this resulting from the financial 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 ReyesCantos paper on trade adopts a broader framework that goes beyond financing 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 difficult for the Philippines to obtain not just because we are classified as a middle-income country but also because of the perception that debt sustainability is possible, as shown by the improvement in the figures for conventional debt indicators. The Clarence Pascual paper on OFW remittances departs from the convention that treats the inflow of remittance merely as a relaxation of the foreign exchange constraint. Pascual looks at the opportunity of using the resources from remittances to transform growth via investments and fiscal spending. This is an area where innovative policies can be tested. FfD: Finance or Penance for the Poor

To revisit Rodrik, his view ”that economic development 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 consideration the specific conditions and identifying the peculiar problems of a particular country are the first necessary steps to put in place the appropriate domestic reforms. In light of the search for domestic innovations, we need to reflect on how FfD can be used to meet the MDGs. To paraphrase Rodrik, development is ultimately not about financing 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 constraints. 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 diagnosis 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 necessarily 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 efficiently; hence liberalize capital flows. But a new thinking has emerged in the wake of the failure of the pro-liberalization Washington Consensus, which was everyone’s blueprint of what ought to be done. The new framework—doing diagnostics to identify the main binding constraints—does not repudiate the core economic principles that the Washington Consensus transformed into dogma. Said another way, the fundamental economic principles are high levels of abstraction. The challenge is how such abstractions are mapped onto conFfD: Finance or Penance for the Poor

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 Chinese innovations in the incentives and institutional arrangements concerning property rights and rule of law. The lesson that we can draw from the failed Washington Consensus is that a priori prescriptions—a comprehensive list at that—must be avoided. Similarly, 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 binding 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 thorough exercise that pinpoints the main binding constraints on growth and identifies 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 approach 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 significant distortion, but it does not necessarily have a high impact on social 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 appropriability, or the high cost of finance? 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 widespread corruption and macroeconomic mismanagement 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 financing, we need to see whether international or domestic finance is the culprit. It may be the case that financing is hampered by high intermediation costs or low savings/revenues. What I have enumerated is actually a sample of the proximate determinants of growth. This is nevertheless a good starting point to lead the inquiry into the specifics of the binding constraints. The point is diagnostics will lead us to specific 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 relieving 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 bottlenecks directly.” Thus, a universal prescription like the Washington Consensus becomes irrelevant in growth diagnostics. One will find varying binding constraints and concomitantly differing reforms for similarly situated countries. The approach of identifying the binding constraints 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 inefficiency of the financial system in allocating savings to domestic investments (Klaus Enders 2007).

In Brazil, a binding constraint then was the inadequacy of domestic savings resulting in high cost of financing 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, personified by Robert Mugabe.

How about the Philippines? A World Bank paper (Alessandro Bocchi 2007) identified three main binding constraints for the Philippines, namely: 1) the exchange rate, with the peso’s appreciation in 2007 (this changed course in 2008 amidst inflation and global uncertainties) 2) the fiscal imbalance, and 3) “elite capture.” The Asian Development Bank study (2007) identified several critical constraints on Philippine growth and poverty reduction, namely the fiscal situation, inadequate infrastructure, governance, expansion and diversification of industrial base, and equitable access to opportunities. The common thread in the ADB and World Bank studies is their concern about the fragile fiscal condition 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 investments, which are linked to other policy and institutional variables. The World Bank and ADB studies are fairly recent and thus remain instructive, as we cope with the domestic consequences of the crash of the world’s financial markets. Their studies are likewise highly relevant with respect to the Philippine FfD review. Among the FfD themes, the mobilization of domestic resources, specifically 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. FfD: Finance or Penance for the Poor

Furthermore, the FfD is emphatic about the role of governance and institutions in the developing countries. 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 organizations to blame the rich countries for the misery of the poor developing countries. How valid or appropriate this criticism is will depend precisely on one’s diagnostics—on a concrete analysis of concrete conditions.

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.

FfD: Finance or Penance for the Poor

MAY PERA NA BA? MOBILIZING DOMESTIC FINANCIAL RESOURCES FOR DEVELOPMENT

Leonor Magtolis Briones

Introduction This 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 preparatory 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 multila-teral institutions and the business sector. The civil society organizationsâ&#x20AC;&#x2122; proposals were then integrated into the Philippine position on FfD in Monterrey. 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 financial resources to finance 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 official 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 finance 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 finance the MDGs. In 2006, graduate students of the University of the Philippines National College of Public Administration 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 financing 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. FfD: Finance or Penance for the Poor

In 2007 also, Manasan came out with an updated study on financial requirements for MDGs. This time, she added calculations on poverty reduction. In spite of all the protestations of support for MDGs, financing 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

Table 1. Summary of Resource Gaps in Current Prices, 2007-2015 (in million pesos) (High cost assumption) Resources gaps â&#x20AC;&#x201C; MTPDP GDP growth rate Year

Education

Health

Water & Sanitation

Poverty Reduction

Total

Percent to 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

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

Source: Manasan, 2007

Campaigning for adequate financing: The Alternative Budget Initiative Civil society organizations led by SWP have been consistently advocating since 2001 that commitment to MDGs and other development goals has to be translated into provision of adequate financial resources. Upon the suggestion of then Congressman Allan Peter Cayetano, SWP organized the Alternative 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 8

the absorptive capacity of the departments had to be considered, as well as the preferred expenditures of the CSOs. As a result of ABIâ&#x20AC;&#x2122;S advocacy, the budgets for education and health were increased by PhP5.3 billion. 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 organizations. It was supported by the minority legislators, Liberal Party congressmen, as well as senators from both the majority and the minority. FfD: Finance or Penance for the Poor

At this writing, the General Appropriations Bill contains additions in social development expenditures amounting to PhP13 billion. The Bicameral Committee has not yet harmonized the Senate and House versions. In spite of the significant gains of the ABI, funding for the MDGs remains inadequate. Calculations on financial gaps for social development expenditures beyond the MDGs are not available. Seven years after commitments were fervently made during the Financing for Development Summit, financing remains an intractable problem.

Domestic Financial Resource Mobilization: The Philippine Situation The Monterrey Consensus places great importance on the mobilization of domestic financial resources for development, especially the MDGs. Despite improvements in domestic resource mobilization, these have not generated sufficient resources to match the massive requirements for development spending. The Consensus notes “estimates of dramatic shortfalls in resources require”(para. 2). The Philippines typifies 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 overemphasized” (para.6). Thus, greater reliance is on domestic financial resources than on external sources. It is expected that the share of revenues as a percentage of GDP should be significant. Jens Martens (2007) compares the share of revenues as a percentage of GDP in selected developing and industrialized countries in 2006. Nine developing countries indicate ranges of 8.8 percent to 18.0 percent share of revenues. Revenues generated in the Philippines constituted 14.8 percent 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 FfD: Finance or Penance for the Poor

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

Country

Share of revenues as a percentage of 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

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

from revenues. In France, revenues account for 43.3 percent of its GDP. Status of revenue collection in the Philippines At first glance, the revenue picture of the Philippines looks good. As shown in Table 3 above, tax revenues more than doubled from 1997 to 2006, from PhP412 billion to PhP 859.8 billion.

Table 3. Status of revenue collection NATIONAL GOVERNMENT REVENUE COLLECTIONS In million pesos 1997

TOTAL REVENUES Tax Revenues Bureau of Internal Revenue 1/ Bureau of Customs 1/ Other Offices Non-Tax Revenues

2002

2003

2004

2005

2006

471,843

462,515 478,512

1998

1999

514,762 567,481

2000

2001

578,406

639,737

706,718

816,159

979,638

412,165

416,585

431,686

460,034 493,608

507,637

550,468

604,963

705,615

859,857

314,697 94,800 2,668

337,175 76,005 3,405

341,319 86,497 3,870

360,802 388,679 95,006 99,981 4,226 4,948

402,742 99,322 5,573

427,350 117,201 5,917

470,329 127,269 7,366

542,697 154,566 6,352

652,734 198,161 8,962

59,678

45,930

46,816

54,728

73,873

70,769

89,269

101,754

110,544

119,781

BTr Income Others o.w. Fess and Charges Privatization CARP Foreign Grants ESF Proceeds Domestic Grants Sale of PNB Share

35,352 13,160 13,160 9,428

22,535 21,046 21,046 1,717 236 396

26,180 16,021 16,021 4,183 140 292

30,764 17,936 17,936 4,646 6 1,376

46,413 24,296 24,296 1,173

47,194 21,932 21,932 591

56,657 30,647 16,635 567

64,690 36,570 19,574 420

70,597 37,429 19,235 2,430

74,446 39,337 16,761 5,815

1,991

1,052

1,198

183

TOTAL EXPENDITURES 2/

470,279

648,974 714,504

789,147

839,605

893,775

OVERALL SURPLUS (DEFICIT) % of GDP

1,738

1,564 0.1%

512,497 590,160

962,937 1,044,429

(49,982) (111,658) (134,212) (147,023) (210,741) (199,868) (187,057) (146,778) -1.9% -3.8% -4.0% -4.0% -5.3% -4.6% -3.8% -2.7%

(64,731) -1.1%

Memorandum Items: 1/ Includes noncash collections 2/ Includes noncash subsidy Source: Department of Finance

On the other hand, non-tax revenues likewise doubled from PhP59.6 billion to PhP119.7 billion. The deficit is apparently going down. Nevertheless, it must be emphasized that the expenditures shown in the table include only debt service payments. 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 deficit may have been apparently reduced, but is this enough to fund development expenditures, particularly the MDGs? Actual vs. programmed collection It 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 significant shortfalls.

From January to September 2007 for example, shortfalls in tax collections reached PhP56.02 billion. 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 first 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 deficit was controlled by increases in the income of the Bureau of the Treasury (BTr), privatization and underspending of programmed expenditures. Revenue and tax effort The Department of Finance (DOF) has reported that since 1997 revenue and tax efforts have been steadily going down. In 1997, revenue effort stood FfD: Finance or Penance for the Poor

Table 4 NATIONAL GOVERNMENT REVENUE COLLECTIONS In million pesos Variance Jan-Sep 2006 Actual

REVENUES

Jan-Sep 2007 Program Actual

vs 2006 Actual

vs 2007 Program

Growth Rate In (%)

715,889

836,978

812,257

96,368

(24,721)

633,873

738,995

682,975

49,102

(56,020)

7.7%

48,755 145,818 7,300

566,902 164,988 7,105

521,920 152,957 8,098

41,165 7,139 798

(44,982) (12.031) 993

8.6% 4.9% 10.9%

Non-Tax Revenues

82,016

97,983

129,282

47,266

31,299

57.6%

BTr Income Fees & Charges Privatization Grants

50,752 30,084 1,090 90

43,656 29,034 25,293 0

57,201 29,560 42,393 128

6,449 (524) 41,303 38

13,545 526 17,100 128

12.7% -1.7% 3789.3% 42.2%

766,298

890,953

852,267

85,969

(38,686)

11.2%

254,450

246,595

222,689

(31,761)

(23,906)

-12.5%

(50,409)

(53,975)

(40,010)

10,399

13,965

-20.6%

Tax Revenues BIR BOC Other Offices

EXPENDITURES o.w. Interest Payments SURPLUS (DEFICIT)

13.5%

Source: Department of Finance

Table 5 NATIONAL GOVERNMENT REVENUE COLLECTIONS In million pesos Variance

REVENUES Tax Revenues BIR BOC Other Offices

Sep 2006 Actual

Sep 2007 Program Actual

vs 2006 Actual

vs 2007 Program

Growth Rate In (%)

73,648

80,623

80,890

7,242

267

9.8%

59,966

73,463

68,936

8,970

(4,527)

15.0%

42,766 16,501 699

53,495 19,042 926

48,929 19,062 945

6,163 2,561 246

(4,566) 20 19

14.4% 15,5% 35.2%

Non-Tax Revenues

13,682

7,160

11,954

(1,728)

4,794

-12.6%

BTr Income Fees & Charges Privatization Grants

4,293 9,152 1,090 14

4,058 3,102 25,293 0

8,601 3,134 42,393 3

4,308 (6,018) 41,303 (11)

4,543 32 17,100 3

100.3% -65.8% 3789.3% -78.6%

89,877

97,675

95,411

5,534

(2,264)

6.2%

33,042

29,125

30,174

(2,808)

1,049

-8.7%

(16,229)

(17,052)

(14,521)

1,708

2,531

-10.5%

EXPENDITURES o.w. Interest Payments SURPLUS (DEFICIT)

Source: Department of Finance

FfD: Finance or Penance for the Poor

Table 6. Revenue & Tax Effort Revenue Effort

Tax Effort Revenue and Tax Effort

BIR Tax Effort

BOC Tax Effort

1986 1987 1986 1988 1987 1989 1988 1990 1989 1990 1991 1991 1992 1992 1993 1993 1994 1994 1995 1996 1996 1997 1997 1998 1998 1999 1999 2000 2000 2001 2002 2001 2003 2002 2004 2003 2005 2004 2006 S12005 2007

Revenue Effort 13.0%

Tax Effort 10.8%

BIR Tax Effort 7.7%

BOC 2.9% Tax Effort

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%

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%

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%

2006 S1 2007

16.2% 16.3%

14.3% 13.8%

10.8% 10.7%

3.3% 2.9%

15.1% 13.0% 14.1% 15.1% 16.5% 14.1% 16.8% 15.5% 16.9% 17.7% 17.7% 18.0% 19.9% 17.7% 19.9% 19.0%

12.6% 11.3% 13.2% 14.1%

8.6% 8.0% 8.9% 9.7%

3.8% 3.1% 4.1% 4.3%

Source: Department of Finance

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

25.0% 20.0%

Revenue Effort Tax Effort

15.0%

BIR Tax Effort BOC Tax Effort

10.0% 5.0%

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

0.0%

Source: Department of Finance

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 Mobilization Regressive tax system The Philippine Constitution provides for a proFfD: Finance or Penance for the Poor

gressive system of taxation. This means that there should be higher dependency on direct taxes like income 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 inefficiency and leakages in the collection of direct taxes is appalling. Income taxes, for example, lend themselves to bargaining and negotiation 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 income levels of society. The problem of incentives The Philippines adopted the policy of attracting foreign investments much earlier than other developing 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 entry 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 benefits. Government policymakers tend to have conflicting views on the matter of incentives. The Department 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 incentives. This is not surprising given the active lobbying by the private sector. Furthermore, many lawmakers are linked to private business. FfD: Finance or Penance for the Poor

On the other hand, the DOF has been consistently calling for the rationalization of fiscal incentives. The department has been under tremendous pressure to increase levels of revenue collection. This is the preferred approach to deficit 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 Renato 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 direct 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 government provides are largely redundant. These are given to firms which would have invested anyway even without them. There are two major reasons. The first is that by international and even domestic standards, many firms were found to have high rates of return even before receiving incentives. The second is that large numbers of firms in the Philippines have low sensitivity to fiscal incentives. Reside estimated that the cost of redundant fiscal 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 impact 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. Studies by Rosario Manasan of the Philippine Institute of Development Studies showed that MDG-related services are clearly underfunded. Reside also emphasized that the poor and middle-class tax payers bear the brunt of the fiscal cost of incentives. A study by Roel Landingin of the Philippine Center for Investigative Journalism (PCIJ), Tax Incentives 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 profitable, 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 Lopezes, Ayalas, Gokongweis and Cojuangcos. Maynilad 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 Telecommunications Inc. and JG Summit Petrochemicals Inc. “ The study clearly showed that beneficiaries of tax incentives don’t need them at all. On the other hand shortfalls in revenues resulted in less spending for social 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 developing countries and their impact. However, they were

one in agreeing that incentives are not the most important criteria for attracting foreign investments. Even more important are: a level playing field, predictability in government regulations, good governance, adequate infrastructure and absence of graft and corruption. Panel members gave examples of countries which attract foreign direct investments without necessarily granting costly and redundant incentives. The panel also noted the effects of destructive competition 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 fiercely fight each other in attracting businesses to their respective 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 interest in the two bureaus, particularly in the appointment of officials. Usually, there is intense jockeying for plum positions in tax-rich regions with the protagonists going directly to the president for intervention. For decades, the impression was that the BIR was directly under the president. One Secretary of Finance only agreed to accept the position on condition 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 collection efforts. Through the years, there have been efforts to undertake a thorough-going reorganization of the two bureaus, particularly the BIR. Proposals have been made to convert the latter into an autonomous corporation, subject to stringent selection criteria on the FfD: Finance or Penance for the Poor

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 revenue collections will duly increase. Strangely, it has been observed that when reforms are introduced, collections 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 experiences: 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 sector program. Third, in an environment where timely, upward, adjustment in existing tax rates is difficult to legislate, ad valorem taxation should be preferred to specific 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 identified as one of the most corrupt in Asia.1 Surveys of international investors consider 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: 1

the Bureau of Internal Revenue and the Bureau of Customs. They are rightly or wrongly referred to as “flagships 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 government 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 financing for development. For example, the ill-gotten wealth of the late President Ferdinand E. Marcos which was spirited out of the country is calculated conservatively 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 focus of this campaign. The issue of corruption in the tax collection agencies is only part of the over-all climate of corruption in the governance system. Corruption is indeed chronic in the Philippines. 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 corruption. 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.

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 figures (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). 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).

FfD: Finance or Penance for the Poor

The World Bank believes that better governance, which includes reducing corruption, is a key to sustaining growth and improving lives. To quote the World Bank (2007): “Curbing corruption, reducing politically motivated public spending, and overcoming ‘regulatory capture’ will all be essential for translating recent economic gains and strong fiscal performance into sustained high growth. The effectiveness of institutions that manage public funds, those that regulate key sectors and oversee public-private partnerships 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 figures significantly in an explanation of the investment rate, which may partly explain the downturn in investment 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 investments.

Recommendations for FfD For governments Implement the constitutional mandate on a progressive system of taxation. The Philippines has had five Constitutions. Each Constitution has always advocated uniform and equitable systems of taxation. Article VI, Sec. 28 (1) clearly states that “The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation.” The Constitution mandates a progressive system of taxation. Nonetheless, indirect taxes which are regressive 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 exemplified 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 econ16

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—military spending, congressional pork barrel, subsidy to government corporations, etc. Historically, government spending for social development is much, much lower than needed financial resources . The increase in VAT rate has served to exacerbate the government’s extreme reliance on indirect sources for financing. 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 incomes pay higher taxes than those with lower incomes. 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 computation of income taxes. Even the innocuous community tax certificate (CTC) is also plagued with loopholes. Understatement 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 collect in taxes, we also lose significantly in incentives. In another study on tax incentives, Roel Landingin reported that it takes one Makati BIR district office one year to collect PhP13billion in taxes. However, it took another government office, the Board of Investments just 14 days to decide to grant the same amount in tax exemptions to two very profitable FfD: Finance or Penance for the Poor

companies, Globe Telecom, Inc. and Smart Communications, 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) convened 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 legislators. The alternative budget does not only propose increased levels of allocations for MDG-related expenditures. It also identifies possible sources of MDG funding by reallocating expenditures proposed by the executive that are vague, overlapping and unnecessary. It has also identified debt service payments for debts which can be subject to renegotiation and deferment. For the international community Many of the problems of individual countries in financing for development can be traced to the international financial system. No one developing country can solve them on its own. The following can be considered by the international financial 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 financing for development. Social Watch Philippines has consistently emphasized that the resolution of the global debt problem will free huge amounts of financial resources for development. It has also advocated debt relief not only for the least developed countries but also for middleincome developing countries that have been devastated by natural calamities like tsunamis, earthquakes FfD: Finance or Penance for the Poor

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 finance MDGs would be severely compromised by heavy debt burdens. The ABI proposed the recalculation of the interest 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 identified 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 impossible to penetrate. Funds deposited by high officials of developing countries find safe haven in banks which guarantee secrecy. These countries have acquired a reputation for accepting ill-gotten wealth with no questions asked. Censure or sanction misbehaving players in international finance. The competition among countries on incentives has become a race to the bottom. Developing countries fiercely compete with each other in giving the lowest possible tax rates and the highest levels of incentives. These practices can only harm host countries and benefit 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 financial shortfalls. It is time such practices were discussed on a regional 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 financial assets has largely been unsuccessful. In the case of the ill-gotten wealth of former President Ferdinand Marcos, part of the loot was recovered because documents were left behind when he and his family fled 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 greater 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 international 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. Varying 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 financing 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 organizations have come up with proposals for airline taxes which can be imposed on international travelers. Studies have shown that this is an international

tax with immense possibilities since millions of people travel around the world everyday.

Conclusion This paper has endeavored to show the importance of generating more financial 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 administration and tax policy. The matter of tax perks and incentives was treated extensively. At the same time, the paper has identified the heavy debt burden and high levels of corruption as among the constraints to adequate financing for development. Finally, the paper has addressed recommendations to the government and the international community. Nevertheless, some problems are linked to the international financial system. International action is needed to handle the problem of tax havens, countries which accept corrupt money deposited in their banks, and laws which protect the interest 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 Martens of the Global Policy Forum has proposed no less than 17 steps which can be undertaken towards global tax justice and eco-social fiscal reforms. Most of his proposals resonate in the Philippine situation. The point, however, is to act on them. Â&#x201E;

FfD: Finance or Penance for the Poor

References

Aldaba, Rafaelita (2006). FDI Investment Incentive System and FDI Inflows : 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.

FfD: Finance or Penance for the Poor

Foreign Direct Investments Policy:

A Closer Look at Assumptions in the Context of Philippine Constraints Mario Jose E. Sereno

I. Introduction Foreign Direct Investments (FDI) are viewed as a significant source of financing for development. While through the years the majority of FDI flowed to countries already considered developed, a substantial and growing FDI stocks have found their way to developing countries, which gear their economies and investment promotion activities towards attracting foreign investments. From a slow and steady growth through the 1980s and tremendous increases in the 1990s, FDI global inflows peaked at over US$1.4 trillion in 2000. Total FDI inflows 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. Figure 1. FDI inflows, global and by group of economies, 1980-2006 (Billions of dollars)

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

* Disclaimer: The views expressd in this paper are the views of the author and do not necessarily reflect the views or policies of his institutional affiliations.

FfD: Finance or Penance for the Poor

The Monterrey Consensus considers the mobilization 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 technology and generally uplift the standard of living of the host country. The conditions identified to attract and enhance FDIs are deemed to consist principally of a “transparent, stable and predictable investment climate, with proper contract enforcement and respect 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 currently undertaking a review of its own framework through the proposed Fiscal Incentives Rationalization bills. There is, however, a spirited debate on whether FDIs do indeed promote development. Difficulties in measuring the beneficial as well as the adverse effects of FDIs have resulted in confusing and sometimes contradictory research findings. 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 attracting FDIs actually benefits developing countries. In sorting through the myriad of research output and methodologies, the book Does Foreign Direct Investments 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 exportoriented vs import-substituting investments), and the economic configuration of the hosting country within which they operate.

Some of the book’s policy recommendations are noteworthy but need to be further dissected for applicability to a specific host country in their original or modified form. One advice generally states that “in countries with protected and distorted economies, FDI is harmful to economic welfare.” This may have been concluded by the book due to observations that FDIs geared towards serving the local market of some host country ultimately merely compete with local producers for domestic rents. The necessary progression of this simplistic statement is that openness in both trade and investment policies needs to be simultaneously pushed in order to maximize the benefits from investing foreign firms and avoid higher trade costs. Because the Philippines 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 inefficiencies that result from potentially higher trade costs are avoided. The applicability of the book’s conclusion therefore can be put to question in the case of the Philippines. However, other operational considerations for special economic zone (SEZ) locators and the impact of allowing export-oriented locators to sell in the domestic market may affect the assessment of the net benefits of the type of investment/trade regime adopted by the Philippines. Another policy recommendation of the book consists of prohibiting domestic content, joint venture or technology sharing requirements on foreign investments as these hinder intra-firm trade of multinational companies operating a global supply network. While this recommendation suits and is desirable for FDIs that are part of a global supply chain, a complete prohibition of such provisions to discrete enterprises may also limit the creation of linkages 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 requirFfD: Finance or Penance for the Poor

ing local content, technology transfer and other performance requirements. In a more recent development, 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 flexibility for developing countries to compel technology transfer, the utilization of domestic inputs and programming for backward linkages to the local economy in investment policy decisions. After citing new evidence and developments that undermined the theoretical arguments supporting the prohibition of investment measures 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 specific 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 differential 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 final 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 information to investors and education and training that benefits foreign and local firms alike.” This advice can be most relevant to Philippine policymakers at this time. While competition for FDI among developing 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 potential FDI should be carefully done to synchronize the development needs of the country with the resources allocated to attracting the desired FDI. FfD: Finance or Penance for the Poor

II. Philippine Investment Climate - Statutes In 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 globalizers” 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 during 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 sufficient for sustained GDP growth.” The findings of the report pointed to poor investment climate which limited capital formation, productivity improvements and the competitiveness of firms, as major reasons for the anemic growth of the Philippine 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 influences, namely macro fundamentals, infrastructure, 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 overview of the Philippine investment promotion regime through its statutory framework, a comparative performance with selected ASEAN countries in attracting 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 Philippines. Government consistently maintains a policy of welcoming foreign direct investments through several decades (Briones 2001). While limitations 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. 23

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 first BOT Law enacted to legitimize private sector involvement in government development undertakings, including the financing, 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 firms.

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 BuildOperate-Transfer Law (R.A. 7718 - 1994)

Encouraged an increase in private sector investment, local and foreign. Allowed variations of scheme, eases restrictions on government financing 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 inflation and interest rates, and arbitration for settlement of disputes. continuation, next page

The Foreign Investments Act of 1991 (Republic Act No. 7042 Section 3c) defines foreign investment “as equity investment made by a nonPhilippine 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.”

FfD: Finance or Penance for the Poor

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 financial institutions including their subsidiaries in preferred projects and/or projects allowed through either financial 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-five 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 conditionalities.” The liberalization of FDI was accelerated as part of the structural adjustment programs (SAPs) reforming the corporate and financial sectors.

III. Foreign Direct Investments (FDI) Statistics Philippine FDI inflows 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 inflows of US$9.325 billion for the seven-year period starting with US$1.3 billion in 2000, fluctuating 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 inflows however show similar erratic trends for the time period under review. Figure 2 shows this trend with the two agencies reporting identical figures 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 percent 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 inflows and stock with selected ASEAN countries indicates the relatively anemic 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 Inflows

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)

FfD: Finance or Penance for the Poor

Figure 2. Comparison of FDI Measurements

16,000

1,000

BSP Net FDI CBOP Concept)

500 2000

2001

2002

2003

2004

2005

2006

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

Per capita ($)

- 200

12,000

- 150

10,000 8,000

- 100

Per capita

6,000 4,000

Table 3. FDI Inward Stock - Philippines

Total (Million $)

14,000

Per capita in dollars

1,500

- 250

18,000

UNCTAD FDI Inflows

2,000

Total stock in miliion dollars

In Millions USD

2,500

Figure 3. Philippine FDI Stock

1990

2000

2006

3,268

12,810

17,120

161

191

- 50

2,000 0

Source: UNCTAD World Investment Reports, authorâ&#x20AC;&#x2122;s per capita computation

1990

2000

2006

-0

Source: UNCTAD World Investment Reports, authorâ&#x20AC;&#x2122;s per capita computation

Table 4. Economic Indicators (Selected ASEAN Countries) Land Area (sq. km.)

Population (millions in 2005)

Philippines

300,000

Thailand

513,254

Malaysia Indonesia Vietnam

GDP in 2005 (in billion US$)

Per Capita GDP (in US$)

84.2

97.7

1,160

64.8

176.6

2,725

330,257

26.1

130.7

5,008

1,890,000

220.0

280.3

1,274

330,363

83.1

52.8

635

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

compares economic indicators of the Philippines, Thailand, Malaysia, Indonesia and Vietnam. FDI inflow trends from 1992 to 2006 for the ASEAN countries being compared were significantly mixed as each economy displayed varying responses to and different behaviors resulting from the Asian financial contagion. As uncontrolled currency devaluations characterized each economy with the exception of Malaysia, total FDI to each country generally declined with Indonesia being the hardest hit. Indonesia witnessed significant consecutive FDI outflows from 1999 to 2001 following the social unrest and riots that accompanied the unprecedented devaluation of the rupiah. The effects on the Philippines and Vietnam were considered more benign. In terms

of average annual inflow for two periods, 19921997 and 1998-2006, the Philippines and Vietnam showed minimal, almost negligible, improvement although their 2006 figures were the highest for the period. Singapore remained a key recipient of FDI, almost equalling the combined flows of the other five countries in 2006. Malaysia regained its 19921997 annual average inflow of US$5.8 billion only in 2006, but averaged a significantly lower figure of US$3.5 billion for the 1998-2006 period. Despite being the catalyst of the Asian crisis in 1997 and having experienced the latest non-democratic change in government, Thailand showed robust inflows in 2004-06 and averaged annual inflows for 1998-2006 at more than twice its average for 1992-1997. Given the varied FfD: Finance or Penance for the Poor

Table 5. FDI Inflows by economy (millions of dollars) 1992-1997 ave.

1998

1999

2000

Philippines

1,343

2,212

1,725

Thailand

2,269

7,491

6,091

Malaysia

5,816

2,714

3,895

3,788

Indonesia

3,518

(241)

Singapore

8,295

7,690

Vietnam

1,586

1,700

1,484

2001

2002

2003

1,345

982

1,792

3,350

3,813

1,068

2004

2005

2006

1998-2006 ave.

319

688

1,854

2,345

1,474

1,802

5,862

8,957

9,751

5,354

554

3,203

2,474

4,624

3,965

6,060

3,475

(2,977)

145

(597)

1,896

8,337

5,556

634

17,217

15,038

5,730

11,409

19,828

15,004

1,289

1,300

1,200

1,450

1,610

2,021

14,688 2,315

1,597

Source: UNCTAD, World Investment Reports 2007, 2004

Figure 4. FDI Inflows by economy

Source: UNCTAD, World Investment Reports 2007, 2004

internal experiences of each country for the given period which consisted of both natural calamities as well as radical political changes, one would wonder how extensive the FDI flows 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, despite growing by 292 percent from 1990 to 2000 and then 34 percent from 2000 to 2006, registered the

Table 6. FDI Inward Stock (millions of dollars) Growth Rates 1990

2000

2006

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%

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, authorâ&#x20AC;&#x2122;s growth rates computation

FfD: Finance or Penance for the Poor

Figure 5. FDI Inward Stock 250,000

Percentage

200,000 1990

2000

2006

150,000 100,000 50,000 0

Philippines

Thailand

Malaysia

Indonesia

Singapore

Vietnam

Source: UNCTAD, World Investment Report 2007

Figure 6. FDI as percentage of GFCF 160 140

2004

2005

2006

Percentage

120 100 40 30 20 10 0

Philippines

Thailand

Malaysia

Indonesia

Singapore

Vietnam

Source: UNCTAD, World Investment Report 2007

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 flows 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 flows as a percentage of GFCF, the Philippines registered significant and consistent improvement in the last three years. Vietnam displayed a similar consistent growth trend while Thailand and Indonesia showed declines in 2006 in contrast with increases by Malaysia and Singapore, as the latter two experienced significant declines in 2005.

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

Source: UNCTAD, World Investment Report 2007

For FDI stock as a percentage of GDP, both Singapore and Thailand registered consistent growth from 1990 to 2006. The others showed declines in FfD: Finance or Penance for the Poor

Figure 7. FDI Stocks as percentage of GDP 160 140

1990

2000

2006

Percentage

120 100 80 60 40 20 0

Philippines

Thailand

Malaysia

Indonesia

Singapore

Vietnam

Source: UNCTAD, World Investment Report 2007

2006 as compared to 2000, with Malaysia and Indonesia registering significant declines. Statistics from the Board of Investments (BOI) provide details of approved investments and approved 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 firm expressions of interest to mobilize financial resources for domestic

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

Source: UNCTAD, World Investment Report 2007

Table 9. Summary of Approved Foreign Direct Investments vs FDI Inflows 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

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 Inflows (USD in millions)

1,345.00

982.00

1,792.00

319.00

688.00

1,854.00

2,345.00

9,325.00

74%

80%

201%

51%

22%

107%

73%

74%

Ave Forex*

% Inflows vs Approved

Source: Board of Investments and UNCTAD

FfD: Finance or Penance for the Poor

Figure 8. Actual FDI Inflows vs Approved FDI â&#x20AC;&#x201C; 2000 to 2006 3,500

Total Approved FDI (USD in millions)

3,000

UNCTAD FDI Inflows (USD in millions)

Percentage

2,500 2,000 1,500 1,000 500 0

2000

2001

2002

2003

2004

2005

2006

Source: Board of Investments and UNCTAD

development. In order to estimate the extent of the relationship of approved FDI to actual inflows, an iteration was made to convert the peso figures 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 flows do not correspond to approved volume of investments, the comparison of total flows for the seven years would indicate that roughly three-fourths or 74 percent of approved FDI resulted in actual inflows 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 percent of approved FDI locating in these two zones. However, no identification of which projects led to actual FDI inflows can be provided from the BOI data. It may do well, for current and future assessment of investment promotion strategies, for promotion agencies to compile statistics not only on approved registered projects and FDI but also on actual execution and FDI inflows 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

American

Dutch

British

Singaporean

Korean

German

Taiwanese

Others

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

55%

Electrical Machinery and Apparatus

Transport and car parts

Chemical and Chemical Products

Information Technology

Medical, Precision and Optical products

Rubber and Plastic

Garments and textile

Others

Source: Philippine Economic Zone Authority Website

FfD: Finance or Penance for the Poor

at the micro level, as they can also lead to programs that retain and sustain the established enterprise. 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 dutyand tax-free raw materials and goods will also be crucial to prevent diversions and leakages to the domestic market which injure domestic producers.

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 benefits expected of FDI are that they contribute to growth in the recipient countries. This growth is induced by adding to the existing capital 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 inflows 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 experienced by Malaysia and Indonesia for the same Figure 9. Philippine FDI Inflows (million $) 2,500 2,000 Million $

proved investments. Given that the seven-year total approved FDI in absolute pesos corresponding to these two agencies is much greater than the total corresponding approved investments, it would seem to require reconciliation of figures from the reporting agencies. For investments in the economic zones under the PEZA, significant and tremendous growth was registered since 1995, with total investments increasing 38-fold from PhP24.5 billion for the period 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-toyear. Investments for the period 1995-2004 were of Japanese origin (42 percent) with Filipino, American, Dutch and British investors rounding out the top five 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 machinery/apparatus sector with 11 percent while the transport and car parts sector contributed 7 percent of total approved locator investments. Export performance and employment generation registered substantial growth for PEZA firms. Economic zone employment grew from 229,650 in 1994 to 1,128,197 in 2005, a five-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 compilation 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 “approved investments.” The execution and actual inflow of capital funds, however, are not being reported on a per project or sectoral basis. The latter information is important if we are to realistically assess the effectiveness of our investment programs

1,500 1,000 500 0 2000 2001 2002 2003

2004 2005 2006

Source: UNCTAD World Investment Report 2007

20,000

15,000

10,000

5,000

1990

2000

2006

Percent of GDP

Stock in million $

Figure 10. Philippine FDI Inward Stock

FDI Inward Stock (million $) FDI Stock as % of GDP Source: UNCTAD World Investment Report 2007

Figure 11. Philippine FDI Inflows as % of GFCF

Percent

15 10 5 0

2004

2005

2006

Source: UNCTAD World Investment Report 2007

period. FDI stock as a percentage of GDP hovered at about 14.6 percent to 17 percent although FDI inflows as a percentage of Gross Fixed Capital Formation consistently grew in the last three years, registering 4.9 percent, 12.6 percent and 14.1 percent for 2004, 2005 and 2006, respectively.

A look at FDI inflow trends together with GDP growth experience indicates a weak relationship perhaps due to the anemic ability of the Philippines to attract more investments. Nominal and real GDP growth from 1999 to 2006 displayed positive although bouyant tendencies. The same holds for FDI inflows, although a correlation cannot be established apparently because FDI productive outputs may not be enough to be the main engine of GDP growth and influence GDP performance. Perhaps a longer time series analysis will reveal a more definitive relationship 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 inflows could reasonably display a conclusive correlation. Statistics have consistently shown a gradual but positive growth in total and manufacturing GDP so variances in the flows of FDI could not influence the aggregate GDP figures. A significant development in Philippine foreign investment experience is the tremendous growth in services investments particularly those related to the business process outsourcing (BPO) sector. This sector consists of ICT activities such as contact centers, software development, back office operations and medical/data transcription among others. Government has been particularly bullish in promoting investments in this sector especially with the compa-

Figure 12. Philippine GDP Growth Rates and FDI Inflows – 2,500 – 2,000 10

– 1,500 – 1,000

– 500 0

1999

2000

Real GDP Growth Rate (%)

2001

2002

2003

Nominal GDP Growth Rate (%)

2004

2005

2006

Inflow in million $

Percent growth

–0

BSP Net FDI (BOP Concept) ( in million US$)

Source: Bangko Sentral ng Pilipinas

FfD: Finance or Penance for the Poor

Figure 13. Philippine Total GDP, Manufacturing GDP and FDI Inflows – 2,500

1,500,000

– 1,500 – 1,000

500,000

– 500 0

1999

2000

2001

2002

2003

2004

2005

2006

Inflow in million $

In million pesos

– 2,000 1,000,000

–0

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$) Source: Bangko Sentral ng Pilipinas

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 subsector. Prospects of growth remain bright for the BPO sector with projections of employment increasing at an annual rate of 38 percent until 2010.

Although regarded as a solution to the Philippine unemployment problem and the jobless growth experience of the Philippine economy as a whole, the BPO sector by itself cannot and must not be the sole repository of development attention and strategy. Already, certain constraints have been identified unique to the sector and although manageable, challenges will have to be addressed in the areas of culture change and language 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-

Table 12 Type of service

No.of firms

Contact Center

Revenues

Employment

USD Million

% Share

Employees

% Share

114

1,792

75.10

112,000

68.61

Back Office

180

7.54

22,500

13.78

Medical Transcription

2.93

5,500

3.37

Legal Transcriptions

Other Data Transcription

0.25

450

0.28

1.63

3,000

1.84

Software Development

300

204

8.55

12,000

7.35

Animation

1.68

4,500

2.76

Engineering Design

2.01

2,800

1.72

Digital Content

0.29

500

0.31

Total

616

2,386

100.00

163,250

100.00

Source: Christina Morales presentation entitled Philippine Globalization in the New Millenium

FfD: Finance or Penance for the Poor

cated to attracting investments in this globally expanding 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, coherent and comprehensive development agenda. This brings us to the issue of where to direct efforts for attracting FDI. While most investments in the past flowed to the light manufacturing sector (electronics) located in special economic zones and in recent years to the BPO sector located in ICT special economic buildings, targeting of investments will have to involve a deeper assessment of needs and available competencies as well as aligning investment incentives systems with the desired development objectives. There is also the matter of addressing empirical evidence of perceived and actual constraints that impede the attractiveness and operational competitiveness 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 defines industrial policy as “the application of selective government interventions to favour certain sectors so that their expansion benefits 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 industrialization performance of the Asia-Pacific 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 undertaking the strategic integration, through various policies that can be categorized as industrial policy.” In the light of present multilateral trade and investment arrangements that consist of legally binding 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 member-states are free to set any level of duty rates below these ceilings. Bilateral and regional free trade agreements also normally offer flexibilities and exclusions which should allow for policy space within which industrial policy tools can be employed. As industrial policy inevitably involves the provision of rents, a crucial feature of this new form of

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

Source: Global Competitiveness Survey 2007

FfD: Finance or Penance for the Poor

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

Source: Asian Development Bank Investment Climate Survey 2003

industrial policy is its being used within a set time frame for development with roadmaps or development plans jointly crafted, monitored, managed and modified 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 Industry. This will involve the training and continuing education of technocrats who can shepherd sectoral development while deeply understanding the business dynamics of specific strategic sectors so that effective and calibrated policies can be well formulated and implemented. Private FDIs flow to destinations of willing national hosts according primarily to the return objectives of the investing enterprise. It becomes crucial therefore that the business model employed and the expected parameters for success triggering the investment decision be fully understood by the host gov2

ernment. While addressing the perceived contraints, impediments or the “bad image” of the country among foreign investors, must be a continuing activity 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 addressed 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 resources can be allocated to eliminate if not mitigate the adverse effects of the identified impediments. The Global Competitiveness Survey 2008-20092, for example, has identified the most problematic factors for doing business in the Philippines as corruption followed by inefficient government bureaucracy, inadequate supply of infrastructure, and policy instability. The ADB Investment Climate Survey of 2003, on the other hand, identifies the major or severe con-

This was released on October 8, 2008.

FfD: Finance or Penance for the Poor

straints that hinder the establishment of an attractive investment climate. Topping the survey results are macroeconomic instability, corruption, electricity and tax rates. The surveys above coincide with other survey results 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 investments as these same factors influence business decisions of local investors. In fact, in the light of the continued decline in total fixed 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 Investment: The Puzzle of the Philippines (2007), shows the erratic GDP growth from 1980 to 2006 and the fixed investment-to-GDP ratio relationship for the same period. The report highlights that although “…the Filipino economy is open to trade and capital inflows, and since 2002, growth has averaged 5.3 percent,… over the last 15 years, however, domestic investment has been stagnant in real terms and consistently declining as a share of GDP” (emphasis supplied). While the report identifies three main Figure 16

Source: National Statistical Coordination Board, 2007

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 expand fast and (3) the lack of any need for investments on the part of other private firms – more fundamental causes for such reasons could well be the identified factors that constrain business and dampen the investment climate. The role of “unbridled 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 sectoral levels, that is not hampered by issues assailing the leadership itself of being the very source or beneficiary of corruption. Suffice it to say that the image of corruption 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 publicity 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 augmented by stronger prosecutorial processes and more efficient judicial proceedings. On the technical and structural sides of the identified 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 multilateral financial institutions such as the IMF and the World Bank or by indigenous unilateral decision making, the adverse effects of blindly embracing unbridled 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 FfD: Finance or Penance for the Poor

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 market 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 Developing Asia and Lessons of Chinaâ&#x20AC;&#x2122;s Transition from a Planned Economy to a Market Economy. The choice or direction for choosing the appropriate development strategy, however, must meet the standards set by Article XII, section 1 of the Philippine 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 nation for the benefit 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 development and agrarian reform, through industries that make full and efficient use of human and natural resources, and which are competitive in both domestic and foreign markets. However, the State shall protect Filipino enterprises against unfair foreign competition and trade practices. Thus, while there may be pockets of successes as a result of the uncalibrated opening of the entire economic 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 sufficient. It may also be noted that the accelerated tariff liberalization of the Philippines during the 1990â&#x20AC;&#x2122;s could have resulted in the decision of potential investors to locate elsewhere in the region and merely supply, through importation, the countries with lower tariff rates. The study on fiscal incentives, identified the differFfD: Finance or Penance for the Poor

ent types of motivation for investors. Relative to the specific 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 processing 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 potential 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, fiscal incentives may not be the major consideration in investment decisions, although narrow and marginal differences among alternative locations may allow the incentives system to play a larger role. Discriminating from among different types of investments 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 Measures (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 promote development can be actualized. Furthermore, the rationalization of incentives can be structured in a way where the final pull-element for favorable investor decisions in desired investment activities can be made more effective and appropriate.

V. Conclusions and Policy Recommendations While “traditional” conventional wisdom, which is largely influenced in many areas by the Washington Consensus, appears to indicate that FDIs in whatever form and however configured (for “as long as investors do not pollute the environment and do not blatantly abuse workers”) are unequivocally beneficial for the host country, recent studies showing unclear or questionable linkages between FDI and development, should prompt policymakers to revisit and critically reflect on the current tools employed to attract 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 neighboring ASEAN economies, we must ultimately deliberate, not on fragmented pockets of concerns, but on the over-arching economic development agenda that precedes any successful sectoral development program. The ongoing steps to rationalize fiscal incentives through several proposed bills in Congress present a timely occasion to reflect not only on the investment incentives system but on the overall economic planning and management framework of the country. While there is need to configure the incentives regime to eliminate “redundant” or superfluous incentives, the potentially affected enterprises which mostly come from sectors that seek access to the domestic market should be supported by enhancing more appropriate non-fiscal incentives. Thus, while 3

income tax holidays (ITH) may be considered redundant for import-substituting projects, it could well be retained for enterprises that completely export 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 infrastructure support comparable to export-oriented investors and be entitled to other non-fiscal 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 fiscal and non-fiscal incentives for investments, classified by type of business model and motivation, could be more appropriately designed. Admittedly this will require a higher level of business 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 departments overseeing the development of industry and agriculture. The discussion on organizing “industry 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

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

The specific proposals contained in the communication are as follows: “11. Article 4 of the TRIMs Agreement should be amended in order to incorporate specific provisions that will provide developing countries with the necessary flexibility 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 following 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 deficits would cause or threaten to cause a major reduction in imports. (g) promote small and medium-sized enterprises as they contribute to employment generation.”

FfD: Finance or Penance for the Poor

supported by developing countries, especially the Philippines. For investments geared entirely for exports, the Philippines would do well to retain existing expectations of incentives as studies show little or negligible redundancy in fiscal incentives. Of particular concern, however, is the configuring 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 benefits investments made in these zones are expected to bring in the long run. The incentives offered geared to disperse establishments to the regions where development is lacking has proven unsuccessful precisely because these underdeveloped regions lack the minimum level of available infrastructure for investments to be attracted, much less to flourish. Thus, an attitude not entirely different from “missionary” work has to pervade 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-

FfD: Finance or Penance for the Poor

frastructure needs to be provided as non-fiscal incentives 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 consistently declining investment to GDP ratio, substantial and consistent OFW remittances that result in huge international reserves and high bank liquidity – should compel us to effectively identify more suitable 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 assessing 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 offered by FDI currently in place in the country. Furthermore, 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

Japan

20,382

23,021

17,054

8,841

26,596

27,539

20,066

143,499

21.8%

Top 10 1

USA

9,581

8,355

3,627

10,432

27,108

14,913

38,199

112,216

17.0%

Nauru

96,529

439

96,968

14.7%

Korea

823

2,771

1,345

712

3,260

10,828

54,327

74,067

11.2%

Netherlands

27,246

269

3,866

1,473

19,208

7,188

59,348

9.0%

Singapore

3,747

15,864

1,168

295

1,524

890

6,396

29,884

4.5%

240

611

12,198

2,554

1,654

1,394

1,953

20,602

3.1%

Taiwan PROC UK Cayman Islands Germany Manx Australia Br. Virgin Is.

172

146

893

311

127

195

17,935

19,778

3.0%

5,788

1,697

618

2,381

1,683

195

5,887

18,248

2.8%

9 10

13,817

384

14,201

2.2%

6,547

333

2,555

452

1,345

418

306

11,955

1.8%

7,634

1.2%

365

3,816

986

170

563

689

6,635

1.0%

220

208

658

5,450

6,606

1.0%

HongKong

3,086

279

134

256

1,431

553

5,830

0.9%

Switzerland

241

102

1,764

355

817

605

3,952

0.6%

Thailand

142

1,535

522

2,245

0.3%

France

725

330

1,106

2,238

0.3%

102

177

856

1,357

0.2%

Sweden

854

165

1,020

0.2%

Italy

126

0.0% 0.0%

Malaysia

Indonesia

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).

FfD: Finance or Penance for the Poor

Table 15. Total Approved Foreign Direct Investments by Industry (in Million Pesos) Industry Manufacturing Gas Services Mining Trade

2000

2001

2002

2003

2004

72,218

32,228

23,691

20,634

43,812

1,827

96,524

2005

2006

Total 7 yrs

% of Total

112,665

372,978

56.6%

Rank 1

98,441

15.0%

1,944

8,097

5,114

4,609

29,606

8,783

17,386

75,539

11.5%

2,715

11,589

856

230

7,313

724

23,462

3.6%

107

19,591

21,282

3.2%

439

19,960

3.0%

676

761

5,517

997

103

2,040

Communication

194

14,460

1,054

1,188

2,963

19,859

3.0%

Finance and Real Estate a/

4,165

564

901

291

203

7,627

13,758

2.1%

Construction

418

125

2,567

1,138

766

5,145

0.8%

Transportation

2,054

192

391

1,325

4,073

0.6%

Agriculture

110

291

2,381

2,914

0.4%

Electricity

Storage

216

205

347

172

1,025

0.2%

Water

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).

FfD: Finance or Penance for the Poor

Table 16. Summary of Approved Investments Total Approved Investments by Promotion Agency (in million Pesos) Agency BOI

2000

2001

43,611.50

PEZA

88,320.00

2002

2003

2004

2005

2006

28,352.10

28,340.70

135,722.80

38,741.10

31,346.10

50,561.10

62,761.20

83,761.10

Total 7-years

Rank

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

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

99,183.70

63,794.80

Total

% 51.24%

6.80% 3.90% 100.00%

Total Approved Investments by Industry (in million Pesos) Industry

2000

2001

2002

2003

2004

2005

2006

Total 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%

Manufacturing

85,280.40

48,301.80

56,992.50

29,809.50

54,330.40

42.86%

Electricity

6.39%

8.13%

6,567.90

2,171.40

1,016.10

632.4

8,564.30

21,659.40

45,402.60

Gas

4,639.90

104,501.10

268.6

Water

1,701.00

120.6

1,821.60

0.14%

7,509.90

2,746.70

412.8

3,441.60

1,139.90

83.3

3,857.50

19,191.70

1.43%

Construction Trade Transportation Storage

86,014.10

272.3

536.1

1,207.00

1,205.20

516.9

357

26,332.30

30,426.80

2.26%

2,310.20

636.3

5,543.80

514.5

466.9

22,172.20

3,530.50

35,174.40

2.61%

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%

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%

Services

6,609.40

26,624.60

16,613.30

9,792.90

14,224.00

15,343.90

29,105.30

8.79%

99,183.70

63,794.80

Total

100.00%

Projected Employment on Approved Investments by Promotion Agency Agency

2000

2001

2002

2003

2004

2005

2006

Total 7-years

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

Rank

FfD: Finance or Penance for the Poor

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

Initial Stock 2000

Annual Inflows 2001

2002

2003

2004

2005

2006

Total Inflows (20012006)

Computed Ending Stock 2006

Actual Reported Ending Stock 2006

(Apparent Divestments) /Unreported Inflows

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

1,200

1,450

1,610

2,021

2,315

9,896

30,492

33,451

2,959

1,300

FfD: Finance or Penance for the Poor

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.

FfD: Finance or Penance for the Poor

Possibilities of Debt Reduction for MDG Financing:

The Philippines and Indonesia Joseph Anthony Y. Lim

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 â&#x20AC;&#x153;in troubleâ&#x20AC;? 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 September 1998 due to the severe impact of the Asian crisis and the political, economic and financial turmoil that followed. The figures 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 fight 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. FfD: Finance or Penance for the Poor

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 countriesâ&#x20AC;&#x2122; national poverty rates are much higher than those of the more successful countries in the region (near 20 percent for Indonesia, 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 Samar provinces. - For both countries, the depressed areas are those prone to be conflict areas, or with indigenous peoples and minority groups, or those prone to natural disasters and are far-flung areas.

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 peopleâ&#x20AC;&#x2122;s empowerment. These include: - Quality, equitable, and sustained growth in incomes (an effective development strategy) - Increasing savings rate to strengthen domestic financing of physical, social and human capital formation (again an effective development strategy). - Increasing employment opportunities (a clear people-oriented development and employment 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 delivery (social and fiscal programs).

1.4 Financing gap estimates Manasan (2007) estimates that the financing gap for MDGs in the Philippines is about PhP777.8 billion (0.76 percent of GDP) for the period 2007-2015. The figures in dollars would have gone up significantly 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 financing gap for food, education, health and physical security amounted to around 2.5 percent of GDP in 2003. If this percentage 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 almost 100 percent of the central governmentâ&#x20AC;&#x2122;s external debt in 2005.

Even with respect to financing the MDG needs, debt reduction is just a supplementary policy. The main policies to bridge the financing gaps of the MDGs are: a) Fiscal Reforms: increase government financing of MDG needs. These include: - Progressive taxation; reduce under-reporting of sales and income and tighten rules on exemptions for corporate and non-fixed income earners. - Reduce the myriad of fiscal incentives and concentrate the incentives on a few key sectors with strong economic linkages, innovation and demonstrated contribution to the economy. - Reallocate government spending and reduce wastage to maximize impact on MDGs (includes reducing wastage & corruption).

FfD: Finance or Penance for the Poor

- 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 fiscal deficit targets to allow for higher government spending. A fiscal deficit of one percent to two percent of GDP will still be manageable. b) Resource mobilization and financing 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, especially grants, soft loans and debt reduction, making sure that the projects are determined by genuine Philippine interests and that no damaging conditionalities are imposed. - Improved social accountability and transparency for development and MDG projects, 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 reduction: - Prioritizing and planning for MDG projects and programs. - Laws and implementing guidelines that prioritize MDG spending in fiscal budget. - Strengthened and systematized reporting of MDG spending by the various line agencies to the budget office, and the consolidated budget for MDG spending by the budget department or ministry. d) Concrete recommendations to mobilize and safeguard MDG financing: - Have Social Accountability for the MDG projects and programs. FfD: Finance or Penance for the Poor

- Improve and provide financing of monitoring and evaluation processes. - Plan for and provide financing for improving local capacities to plan, implement, monitor and evaluate MDG projects. - Plan for and improve transparent processes in procurements, project planning, implementation 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 financing more demand-led. - Assure flexibility and appropriateness of donors’ conditionalities and requirements to local needs. - Agree to basic rules of procurement, accounting, disbursement of funds, auditing, monitoring and evaluation; issues on rightof-way, resettlement. - Develop local government capabilities. - Facilitate disbursements of funds from national 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 Indonesia) 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 Development (HD) Working Groups composed of government agencies, civil society representatives and UN agencies and co-chaired by BAPPENAS and the Coordinating 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 Empowerment Program (PNPM) and Conditional Cash Transfer 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 Benefit 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 developing countries would benefit from debt reduction towards financing of the Millennium Development Goals. 1. For very poor and low-income countries, a heavy debt burden, mostly from official debts to bilateral and multilateral creditors, reduces social financing for the majority of the poor population. Many of these countries have very little foreign exchange and/or fiscal 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 financing, 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 48

cover many countries in Sub-Saharan Africa and Central America. 2. During periods of financial crises, panic and deep recessions with investors and creditors withdrawing their funds and causing speculative attacks on the currency, many low-income and middle-income countries are unable to pay both commercial and official debts as international reserves dwindle and the domestic cost of the debt explodes due to currency depreciation. The Philippines and Latin America experienced this in the 1980s. Indonesia experienced this in the Asian crisis of 199799. Argentina and Turkey experienced this in the early 2000s. The heavy debt burden contributed to economic collapse and increased poverty and retarded human development. 3. For countries with high debt burden and significant current account and balance of payments deficits, 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 significant fiscal deficits, fiscal revenues are being channeled to debt and interest payments, which could have gone to MDG financing 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 Beneficial for MDG Financing of the Philippines and Indonesia 4.1 The fiscal and debt picture: Principal and interest payments are reducing funds for social and economic services in the Philippines The recent fiscal crisis of the Philippines increased public and government debt significantly. Debt servicing increased and encroached on vital spending on social and economic services â&#x20AC;&#x201C; public spending that FfD: Finance or Penance for the Poor

is essential for reaching the MDG targets. Almost all countries adversely affected by the 1997 Asian financial crisis were able to reduce their debt burden from the peak values reached in 1997 and 1998. Only the Philippines entered a fiscal crisis as fiscal positions deteriorated instead of improving, even as economic growth turned positive after the crisis. Figure 1 shows the Philippine national government deficit as percentage of GDP. There were three periods of extremely high fiscal deficits, the early

1980s, the second half of the 1980s, and especially the period 2002-2004. The first two preceded output recessions. The national government posted rare surpluses in 1994-97. High fiscal deficits in the Philippines 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).

Figure 1. National Government Deficit: % of GDP 2 1 0

Percent

-1 -2 -3 -4 -5

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

1971

1969

1967

1965

1963

1961

1959

1957

Sources: Department of Finance, Department of Budget and Management

Figure 2. Tax Effort, In % of GDP: Philippines 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00

FfD: Finance or Penance for the Poor

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

2.00

Large and rising fiscal deficits in 2002-2004 raised concerns from all corners. The most disturbing 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 Comprehensive Tax Reform Law of 1997 which failed to ensure lower exemptions to big corporations and high-income individuals, and deteriorating tax administration. Significant improvements in lowering the fiscal 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 budget 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 collection 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 government-owned shares of stocks in private corporations 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 first seven months of 2007. All these figures show a deterioration from the 1998 (Asian crisis) situation. This is in sharp contrast to Indonesia, which improved its debt burden significantly from its deep debt crisis lasting from 1998 to 2000. Its improvement was fast from 2001 onwards. In contrast, the Philippines â&#x20AC;&#x201C; which did not get deeply embroiled in the Asian crisis â&#x20AC;&#x201C; 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 Indonesiaâ&#x20AC;&#x2122;s public debt ser-

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

Source: Bangko Sentral ng Pilipinas

FfD: Finance or Penance for the Poor

Table 1. Public Debt Service and Public Debt Burden of the Philippines 1998

1999

2000

2001

2002

2003

2004

2005

2006

35.6

42.9

44.3

48.4

61.9

73.5

85.1

83.2

87.2

Jan-July* 2007

As % of Revenues NG Debt Service Payments 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 Govâ&#x20AC;&#x2122;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

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

Total Expenditure less Interest Payment

16.4

15.9

16.1

14.8

15.2

14.2

13.0

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

As % of GDP

*GDP was estimated as 7/6 times the GDP of the first semester of 2007 Source: 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

48.1

Total Central Govâ&#x20AC;&#x2122;t Debt (% of GDP)

98.8

83.2

70.7

64.6

61.9

52.7

Government Deficit (% 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

vice in 2004 was only less than 40 percent of government revenues, and its national government debt was less than 50 percent of GDP in 2005. Their situation even improved in more recent years. If the Philippines fiscal situation is not improved, the repercussions are: a. It will reduce funds that should go to infrastructure as well as economic, social and human development. Reduced funding prevents the government from pump-priming the system into higher growth and from undertaking poverty reduction. In particular, the infrastructure building program all over FfD: Finance or Penance for the Poor

the country promised by Gloria Arroyo in her State of the Nation address in 2006 will be jeopardized. b. The inability to solve the fiscal problem also reduces business confidence in the macro stability 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 human development.

4.2 High Cost of Debt Servicing Although there were improvements in the deficits from 2002 to 2006, the current situation is still significantly worse than in 1998 (the year of the Asian crisis). Furthermore, the fiscal position has not yet improved for the Filipino people. Table 1 shows the deficit being reduced, especially from 2004 to 2005, mainly through expenditure constriction. Total expenditure 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 economic 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, financing 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 PARTICULARS ECONOMIC SERVICES Agriculture, Agrarian Reform, and Natural Resources Trade and Industry Tourism Power and Energy Water Resource Development and Flood Control Communications, Roads, and Other Transportation Other Economic Services Subsidy to Local Government Units SOCIAL SERVICES Education, Culture, and Manpower Development Health Social Security and Labor Welfare Land Distribution (CARP) Housing and Community Development Other Social Services Subsidy to Local Government Units DEFENSE GENERAL PUBLIC SERVICES General Administration Public Order and Safety Other General Public Services Subsidy to Local Government Units TOTAL EXPENDITURES EXCL INTEREST PAYMENTS, NET LENDING NET LENDING INTEREST PAYMENTS TOTAL EXPENDITURES

1996 4.9 1.3

1997 5.4 1.7

1998 4.9 1.2

1999 4.7 1.1

2000 5.1 1.1

2001 4.3 1.1

2002 3.9 0.9

2003 4.0 0.9

2004 3.5 0.7

2005 2.9 0.6

0.2 0.0 0.1 0.1

0.2 0.0 0.1 0.3

0.1 0.0 0.1 0.1

0.1 0.0 0.1 0.2

0.1 0.0 0.0 0.1

0.1 0.0 0.0 0.2

0.1 0.0 0.0 0.1

2.0

2.2

1.8

2.3

1.7

1.4

1.6

1.4

1.0

0.2 0.9

0.1 1.0

0.2 1.1

0.1 1.2

0.1 1.1

0.1 1.2

0.0 1.1

0.1 1.0

5.7 3.4

6.5 3.9

6.6 4.0

6.5 3.7

6.4 3.5

5.9 3.2

5.5 3.0

5.2 2.7

4.7 2.5

0.5 0.5

0.6 0.8

0.5 0.9

0.5 0.8

0.4 0.8

0.4 1.0

0.4 0.9

0.3 0.9

0.3 0.7

0.0 0.2

0.0 0.1

0.1 0.1

0.1 0.3

0.1 0.1

0.1 0.0

0.0 0.1

0.2 0.0

0.1 0.0

0.0 1.0

0.0 1.1

0.0 1.2

0.0 1.3

0.0 1.2

0.0 1.3

0.0 1.2

0.0 1.1

0.1 1.0

1.4 3.6 1.5 1.3 0.2 0.7

1.2 3.8 1.5 1.4 0.1 0.8

1.1 3.6 1.2 1.4 0.0 0.9

1.1 3.7 1.2 1.4 0.1 1.0

1.0 3.3 1.1 1.2 0.1 0.9

1.0 3.4 1.1 1.3 0.1 1.0

1.0 3.3 1.0 1.2 0.1 0.9

0.9 2.9 0.9 1.1 0.0 0.8

0.8 2.6 0.8 1.0 0.1 0.8

15.6

17.0

16.4

15.8

16.3

14.5

14.3

13.8

12.4

11.1

0.1 3.5 19.2

0.1 3.2 20.3

0.0 3.7 20.2

0.1 3.6 19.5

0.1 4.3 20.7

0.1 4.8 19.5

0.1 4.8 19.1

0.1 5.3 19.2

0.1 5.4 18.0

0.1 5.8 17.1

Source: Department of Budget and Management

FfD: Finance or Penance for the Poor

ing the MDG targets is thus in grave jeopardy. 4.3 Large debt servicing vis-Ă -vis low government revenues But the biggest indicator that the fiscal 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 interest debt payments of the national government comprised 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 financed by new debts1 resulting in a continuing rise in public debt and a continuing expenditure constriction happening at the same time. The increase in total public sector deficits 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 increased, 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 lowincome transition economies in ASEAN (Laos and Cambodia), the Philippine national government is the most indebted in the region. 4.4 Indonesia to benefit from Debt to MDG conversions Although Indonesia has improved its debt burden compared to the Philippines, it also would benefit 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

0.28

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

4.11

3.57

6.77

4.88

8.84

5.51

4.43

Other economic services (less int) Interest Payments

1.86

2.67

5.11

4.43

4.47

3.34

3.07

2.98

Others

0.00

0.11

0.13

0.30

2.79

2.72

2.38

4.81

5.27

5.88

15.44

17.41

20.85

23.62

18.21

20.97

18.48

18.49

Regional Budget Expendnitures Total Budget Expenditures Source: ADB Key Indicators 1

It must be pointed out that standard accounting practice does not treat principal payments for debt as fiscal or government expenditures. Only interest payments for debt are considered as government expenditures. The financing of the fiscal deficit is defined as new (external and domestic) financing less principal payments (or amortization of debt payments). This accounting practice simply emphasizes the fact that new loans have to be incurred to finance maturing principal payments. Other new loans will also have to be incurred to finance the deficit itself.

FfD: Finance or Penance for the Poor

MDG financing. 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 payment of recapitalization bonds by the Indonesian government. Recapitalization bonds were bonds that the Indonesian government issued in 1999 to 2001 in order to finance the rehabilitation of failed banks. Thus, Indonesia faces heavy debt servicing not just from interest payments but payment of recapitalization bonds, which together added up to more than 5 percent of GDP in 2003 (Table 6). This would mean much less funds going to education, health, transportation, communications and public utilities. Figure 4 shows that the two of the three top budget items – “other economic services” and interest payments – 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 prioritized MDG financing needs. It is hoped that debt conversion is demand-led, i.e., based on the MDG financing 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 finance 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 financing

Figure 4. Indonesian Government Expenditures, % of GDP

Source: Table 4

FfD: Finance or Penance for the Poor

- debt reduction for MDG financing - debt conversions for MDG financing.

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-

Because of the Philippinesâ&#x20AC;&#x2122; and Indonesiaâ&#x20AC;&#x2122;s entry into grave debt and financial 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. Table 5. List of Paris Club Debt Treatments for Philippines 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

Source: Paris Club website

Table 6. List of Paris Club Debt Treatments for Indonesia: 1998 -2005 DATE OF THE TREATMENT

TYPE OF THE TREATMENT

STATUS OF THE TREATMENT

AMOUNT OF DEBT RE-SCHEDULED

May 10, 2005

Ad-Hoc

active

$2.704 billion

ODA debts rescheduled for 5 years with 2- year grace period at concessional rates Non-ODA debts rescheduled for 5 years with 2-year grace period at commercial rates

April 12, 2002

Houston

active

$5.473 billion

ODA debts rescheduled for 20 years with 10- year grace period at concessional rates Non-ODA debts rescheduled for 18 years with 5-year grace period at commercial rates

April 13, 2000

Houston

active

$5.445 billion

ODA debts rescheduled for 20 years with 10- year grace period at concessional rates Non-ODA debts rescheduled for 15 years with 3-year grace period at commercial rates

September 23, 1998

Ad-Hoc

active

$4.2 billion

ODA debts rescheduled for 20 years with 5- year grace period at concessional rates Non-ODA debts rescheduled for 11 years with 3-year grace period at commercial rates

Total

$17.822 billion

TERMS OF RESCHEDULING

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

FfD: Finance or Penance for the Poor

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 occurred 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 following: i) Debt-to-development or debt-to-nature swaps where a third party (international NGO, a UN agency) buys a sovereign debt and the Philippines 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 government putting up a peso counterpart (whether at a discount or not) for a priority MDG project. The Philippines has had beneficial debt conversion experiences, which include the following: a) The Foundation for the Philippine Environment (FPE): In 1991, the USAID signed a cooperative agreement 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 pesodenominated Central Bank bonds. This amount, together 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-government and peoples’ organizations for biodiversity conservation projects. Haribon is one of the beneficiaries. b) Debt-for-Mt. Pinatubo Victims: In 1991, the French Government agreed to write off 20 million French francs of Philippine Government debt so that the latter could put an equivalent amount to rehabilitate areas hard-hit by the eruption of Mt. Pinatubo. The major project undertaken was the construction of Camp O’ Donnel in Tarlac – which became the resettlement area for the Mt. Pinatubo 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 whereby 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 implement 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 peoples organizations and one credit union. d) RP-KFW Debt for Nature Swap: On 31 October 1996, the Kreditanstalt fur Wiederaufbau (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 forestry management project covering 10 barangays in FfD: Finance or Penance for the Poor

Quirino Province, adjacent to an on-going Germanfunded grant on Community Forestry. In January 2002, the Department of Environment and Natural Resources (DENR) completed the agreed undertakings in January 2002 and the KFW, after due evaluation, cancelled the debt. e) Tropical Forest Conservation Fund: In 2001 the Philippine and the U.S. governments signed a Debt Reduction Agreement and a Forest Conservation Agreement under the debt reduction/rescheduling scheme of the U.S. Tropical Forest 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 January 1998, would use the peso equivalents to endow the Tropical Forest Conservation (TFC) Fund. Payments to the fund would be done in 28 semi-annual payments starting 2003. The Philippines would continue to pay the principal in dollars based on the original amortization schedule while the US appropriated 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 conservation projects. Recent beneficial debt conversions given to Indonesia are: a) Between 2000 and 2003, the Indonesian government 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 teachersâ&#x20AC;&#x2122; capacities. b) In 2004, 23 million euros of Germanyâ&#x20AC;&#x2122;s loan to Indonesia (around 253 billion rupiahs, or around US$27.6 million) was converted to FfD: Finance or Penance for the Poor

build junior high schools in 54 regions in 14 provinces in Eastern Indonesia (again in negotiations with KfW). c) A debt conversion scheme involving 12.5 million euros (around 135 billion rupiahs and US$14 million and again with KfW representing Germany) was used for a debt-for-nature swap concentrating on natural resources conservation. 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 rupiah funds for the identified 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 cancelled 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 Indonesia. 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 being undertaken.

6. The Maneuvering Space for Debt Reduction for the Philippines and Indonesia 6.1 Difficulties of debt cancellation or discounting debt The first reason why it is difficult to do unilateral 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 Argentina and Nigeria required the payment of the

remaining debt (several billions of dollars) within a short period. The Philippines does not have fiscal 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 conversion 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 taxpayers. - 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 devoting 0.7% of their GNP for external development assistance.

6.2 The Paris Club’s New Evian Approach The Evian Approach of the Paris Club (2003) allows both countries to ask for a new debt restructuring which can include debt rescheduling, debt reduction 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 criteria: - the debt-to-GDP ratio is higher than 50 percent, - 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 official 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

Redefine 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 financing sustainable activities to attain the MDGs.

2. Paris Club Chair Xavier Musca

Paris Club instruments & Evian approach are sufficient 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 fiscal reforms and debt management more and is concerned with ’moral hazard’ from the Philippine side.

FfD: Finance or Penance for the Poor

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 financial 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. Canceling much of these debts is just an official writingoff of much of the defaulting debts. As mentioned earlier, the new debt sustainability analysis (DSA) developed by the IMF and World Bank adds a new framework to debt sustainability analysis for low-income and middle-income countries, and this includes the Philippines and Indonesia. The new framework does not help these countries get debt-to-MDG financing. 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 Indonesia and the Philippines and low-income countries that are not members of HIPC do not qualify for the significant 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, Indonesia, Pakistan, Bangladesh, Brazil, Nigeria, Mexico, 2 3

the Philippines, Vietnam, Turkey, Argentina) are all not part of HIPC, and most of these large nonHIPC 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 finished 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, totaling 152 developing countries. The UN Population 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 worldâ&#x20AC;&#x2122;s poor still reside outside these HIPC countries, 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 countriesâ&#x20AC;&#x2122; 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

UNFPA State of World Population 2005. Based on International Data Base Statistics for the 29 HIPC Countries Given Debt Relief (http://www.census.gov/cgi-bin/ipc/idbrank.pl).

FfD: Finance or Penance for the Poor

are poorer. But it is a well-known fact that sectors and areas in Indonesia, Brazil, the Philippines, Turkey 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 conversion 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 Secretary General and Philippine stakeholders, is a twopronged policy: 1) Offer attractive MDG projects and programs where bilateral debts or grants can be channeled 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 antipoverty plans to prioritize MDG projects that need financing. The government, in collaboration with line agencies and local governments, can identify priority programs and projects that have been victims

of tight budget or fiscal constriction. These priority 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 countriesâ&#x20AC;&#x2122; 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 Indonesia and their creditors/ donors should ensure transparency and accountability as well as efficient absorptive capacity of the programs â&#x20AC;&#x201C; to ensure the funds are appropriately and efficiently 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 conversions: Germany, Italy, Switzerland, US, Finland, Spain, France, Canada, United Kingdom, Denmark, Belgium, and the Netherlands. Non-Paris Club Countries: China, Taiwan, Singapore, 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 financing 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 converted without jeopardizing the countryâ&#x20AC;&#x2122;s credit worthiness and rating. A multilateral and coordinated debt reduction initiative for MDG financing can then be undertaken along the Norwegian recommendation. To operationalize the new debt sustainability concept, a country would need to satisfy the following FfD: Finance or Penance for the Poor

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 financing 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 exchange outflows 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 conditions 1 and 2a. The Philippines and Indonesia may not meet vital MDG targets and have significant MDG financing gaps. Also, despite the above, there is a constriction on social and economic services because of the general expenditure reduction and because 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 repayments). 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, Venezuela

Low-Income countries: Pakistan, Laos, Cambodia, Papua New Guinea Once a sufficient 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 “capacity to pay” concept usually involve economic reforms such as trade and market liberalization, privatization, deregulation, fiscal and financial 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 financing and towards efficient, transparent and accountable systems that will optimize the use of debt relief funds for MDG needs. As a Cooperation Internationale pour le Development et la Solidarite (CIDSE) report noted: “Debt sustainability assessments should be geared to ensure that debtor countries are able to fulfill the financing 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 international debt rules will include: Treatments of debts owed to Paris Club members should be allowed without any IMF debt sustainability assessment, without an IMF economic program and without being subjected to cut-off dates, but subject to the criteria of debt sustainability assessment based on MDG financing needs.

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

FfD: Finance or Penance for the Poor

Voluntary debt conversions should be allowed even more freely since they are voluntary. We want to endorse voluntary debt conversions to be a mainstream method of financing the MDGs, and for developed 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 development assistance equivalent to at least 0.7 percent of their GNP (and this includes funds from debt reduction), and in financing vital MDG projects and programs, including those of low- and middle-income countries outside the Heavily Indebted Poor Countries (HIPC). So far only five countries have complied with this commitment (Norway, Denmark, Luxembourg, The Netherlands, and Sweden). Two of the world’s and the Philippines’ top donors have very dismal records. Japan spent only 0.2 percent of its GNP for external development assistance 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 definition 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 redefine 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 finance and 100 percent debt cancellation, while for many heavily indebted nonHIPC and middle-income countries, it will require significantly 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 undertaken 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 MDGDebt paper was presented and the Philippine MDG-Debt paper was mentioned. * Some initiatives incorporating MDG financing needs into debt sustainability - Estimate MDG Financing Needs. - Compare this with government revenues. - Give debt relief to countries where government revenues cannot meet MDG financing needs. * Idea of ‘MDG Bonds’ – conversion of part of external debt to new bonds with debt service payments proportional to capability of government revenues minus MDG financing needs. UNDP and UN DESA are planning for a General Assembly meeting of developing countries to add to the already set agenda of discussing international 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 develop 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.

FfD: Finance or Penance for the Poor

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 definition of debt sustainability. Debtor countries should be at the forefront of such a campaign. 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 proposals 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 national income (GNI) to development assistance. Â&#x201E;

References 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.

FfD: Finance or Penance for the Poor

Development Down the Drain:

The Crisis of Official Development Assistance to the Philippines1 Eduardo C. Tadem

1. Introduction Foreign aid, or official development assistance (ODA), is said to play an important role in Philippine development. 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 official 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 misdirected 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. Definitions The Organization for Economic Cooperation and Development (OECD) defines ODA as “flows of official financing 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 official 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 financial 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

2 3

This is an abridged, revised, and updated version of a citizens’ audit report submitted to Social Watch Philippines and ODA Watch in March 2007. From the above definition, it is obvious that all forms of military assistance do not qualify as ODA. 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).

FfD: Finance or Penance for the Poor

would otherwise not attract private capital. The availability of grant assistance (which need not be repaid) also adds to ODA’s appeal. An important international body for the formulation 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-member Development Assistance Committee (DAC) is responsible for ODA monitoring and evaluation and is also engaged in “policy formulation, policy coordination and information systems for development.” 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 Cooperation Fund, Japan (OECF: established in 1961). Grants and technical assistance, on the other hand, are disbursed mainly by the Japan International Cooperation Agency (JICA) and, to a lesser extent by the Ministry of Foreign Affairs (MOFA). In October 2008, however, JICA has taken over JBIC’s loangranting 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 Authority (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 Committee (Infracom), has recommendatory functions over infrastructure project proposals.

3. ODA in the Philippines Since achieving political independence in 1946, the Philippines has been dependent on foreign assis66

tance to support its economic development agenda. In the 1950s and early 1960s, ODA was used for postwar rehabilitation, and was primarily in the form of grant assistance from the United States and Japanese reparations payments (UN International Labor Office 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 development assistance. Philippine government policy on development assistance is embodied in the Official 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 service 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 infrastructure, 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 “financing for private corporations with access to commercial credit. … The NEDA shall ensure that the ODA obtained shall be for previously identified national projects which are urgent and necessary.” Section 11c “In the hiring of consultants, contractors, architects, engineers, and other profesFfD: Finance or Penance for the Poor

sionals necessary for a project’s implementation, Filipinos shall be given preference.” Section 11d. “In the purchase of supplies and materials, preference shall be given to Filipino 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 specified 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 authoritarian regime and succeeding non-authoritarian administrations. Foreign assistance during the Marcos years (1965-1986) had acquired an odious reputation for corruption, bribery, human rights violations, environmental degradation, and various implementation flaws (Yokoyama 1990, Tsuda and Deocadiz 1986). The ascension of the Aquino government was accompanied by calls for the reexamination 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 measures have been put in place. To assess the progress of ODA, two time trends have been set: the first from 1986 to 2000 and the second from 2000 to 2006. This would indicate a line dividing the years before and after three defining 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 following: (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 disbursement and availment rates, (6) decrease in the ratio of ODA to external debt, (7) the untying of aid, (8) enhanced sensitivity to social and environmental issues, and (9) fixing various implementation problems. FfD: Finance or Penance for the Poor

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 percent 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 exclusively 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 bilateral assistance was in the form of loans, with only 21.10 percent in grants. Compared to the 19862000 shares of 78.43 percent and 21.57 percent respectively, bilateral assistance showed a deterioration in the loan-grant mix. Among the multilaterals, the World Bank is the largest provider at 50.66 percent but this was a decline 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 percent, 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 percent. 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

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

–

Subtotal

13,783.85

12,895.90

889.81

1. Japan

16,865.36

15,380.40

1,485.16

2. US

Bilateral 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

–

12. Korea

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.

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 figures for 2001-2006, however, confirm the Philippine trend of a continuing and rapid slowdown 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 average allotments was even more significant – 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, however, 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 FfD: Finance or Penance for the Poor

Table 2. Total ODA Committed to the Philippines, 1986-2000 (In US$million, By Source) Source

Total

Loans

Grants

1. IBRD/WB

6,162.70

6,131.60

31.10

2. ADB

Multilateral 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

–

Subtotal

11,894.47

11,248.85

645.82

Bilateral 1. Japan

12,649.36

2. US

1,443.32

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

–

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

extension of the North Luzon Expressway (Manila Bulletin 2007). Since the Philippines did not benefit from the global expansion of ODA previously recorded for the 2001-2005 period and OECD projects a prolonged 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 expects 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 Section 4.9 below). Given the need to improve its fiscal status, the government has decided to increase its dependence on ODA to fund its programs and projects (Dumlao 2006a). Finance Secretary Margarito Teves revealed FfD: Finance or Penance for the Poor

that of the programmed US$2.2 billion in fresh foreign borrowings earmarked for 2007, only US$600 million (28 percent) would be coursed from the commercial 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 assistance. 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 3. ODA Commitments to the Philippines, By Source, 2001-2006 (In US$million) Source

Total

Loans

% Loans

Grants

% Grants

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

Multilateral

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

362.940

100.00

–

00.00

Australia

167.680

–

00.00

167.68

100.00

Austria

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

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

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

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 mil4

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 Philippines.4

Previous lows were in 1962 (US$7.02 million) and in 1961 (US$8.54 million).

FfD: Finance or Penance for the Poor

Table 4. Japanese ODA to the Philippines, 2005-2007 Project

Date of exchange of notes

US$ million

July 8, 2005

3.97

Grant Aid Human Resource Development Scholarship Food Aid through WFP

March 17, 2006

Human Resource Development Scholarship

July 23, 2006

Food Aid through WFP

1.19 3.30

October 31, 2006

1.18

Human Resource Development Scholarship

July 2, 2007

3.92

Rural Electrification (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

Dec. 9, 2006

72.70

Loan Aid Pasig-Marikina River Channel Improvement Project (Phase II) TOTAL

101.50

Source: Japan Ministry of Foreign Affairs

This decline came about despite an announcement by the Japan International Cooperation Agency (JICA),5 in October 2004 that Japanese ODA for the Philippines would increase in 2005 (Cagahastian 2004). JICA officials had said that the cuts in Japan’s ODA to China would enable the increase in ODA commitments to the Philippines and Indonesia. Some increases could be expected in the coming years, particularly given Japan’s interest in projects related to peace building in Mindanao and other conflict-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 5 6

loans granted by JBIC. Out of twenty-five (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 Development Project (US$147 million). Only one major project was totally untied, the US$176 million New Communications, Navigation & Surveillance/Air Traffic Mgmt Systems Project. Of the ten partially untied projects, nine untied the main portion of the loan, but tied the consultancy 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 Japanese companies (as) feasibility studies are conducted by Japanese consultants (who) either specify the use of Japanese goods and equipment or recommend Japanese 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 construction firms have bewailed what they see as preferential treatment given to their foreign counterparts (or competitors). The Philippine Constructors Association (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-

JICA is the Japanese government agency that administers Japanese technical assistance and financial grants to developing countries. For these three projects, while the main portion is untied, no information was given on the nature of the consultancy services portion.

FfD: Finance or Penance for the Poor

Table 5. Untying Status of JBIC Loans, 2000-2004 Project Loan

Year

US$ million

Main Portion Status

Consultancy Portion Status

Kamanava Area Flood Control And Drainage System

2000

18.8

Tied

Mindanao Container Terminal Project

2000

79.0

Tied

LRT Line 1 Capacity Expansion

2000

197.0

Tied

New Iloilo Airport Development

2000

130.0

Tied

2nd Magsaysay Bridge and Butuan City Bypass Road Project

2000

31.4

Tied

Subic Bay Port Dev. Project

2000

145.6

Tied

Subic-Clark-Tarlac Expressway

2001

388.0

Tied

Northern Luzon Wind Project

2002

46.9

Tied

Urgent Bridges Construction for Rural Development

2002

147.0

Tied

Improvement of Marine Disaster Response & EnvironmentProtection

2002

74.8

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

176.4

Untied

59.8

Untied

No information

TOTAL (PARTIALLY TIED)

602.1

New Communications, Navigation & Surveillance Air Traffic Mgmt Systems Project

2002

Arterial Road Bypass Project (I) (Plaridel & Cabanatuan)

2004

TOTAL (TOTALLY UNTIED) Subic Bay Freeport Environmental Mgt Project (Phase I)

236.2 2003

8.40

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 firms.” 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 management positions which can easily be filled 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 exempted from VAT and income tax, and hence are able to present lower bids.” The PCA concludes that FfD: Finance or Penance for the Poor

Table 6. Summary of Untying Status of JBIC Loans to Philippines, 2000-2004 Status

No. of projects

% share

Loan Amount (US$million)

% Share

Totally tied

40.00

1,277.3

58.69

Partially untied

40.00

602.1

27.66

Totally untied

8.00

236.2

10.85

Incomplete info. Total

12.00

60.8

2.79

100.00

2,176.4

100.00

Source of basic data: Japan Bank for International Cooperation

the “uneven playing field for Filipino contractors has lessened initiatives to further develop the construction industry, in training their people, or upgrading their equipment” (Moreno 1995).

was governance and institutional development with an average share of 1.46 percent. Total allotments for the combined agriculture, land reform and industrial 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 development” there was a significant decrease in ODA commitments in the 2000-2006 period (7.85 percent) compared with the already minuscule 19872000 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 component 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

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, natural resources and agrarian reform had the second largest average share of 17.43 percent for 20002006. Industry and services was third with an average share of 8.14 percent, while social reform and community development was fourth with an average share of 7.85 percent. At the bottom of the list Table 7. Sectoral Shares of ODA Commitments, 2000-2006 Sector

Net 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%

21%

17%

18%

17.43%

Industry and Services

10%

11%

8.14%

Social Reform and Community Development

10%

13%

7.85%

Governance and Institutional Development

0.23%

1.46%

Source: NEDA Annual ODA Portfolio Reviews

Except in the case of “infrastructure support,” there is some difficulty in comparing the 2000-2006 data with the 1986-2000 figures 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.

FfD: Finance or Penance for the Poor

Table 8. Sectoral Allocation of ODA, 1987-2000 (In US$million) 1987-2000 Sector Infrastructure Support

Amount

Percent Share

13,931.46

50.06

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

Agri-Industrial Development

Disaster Mitigation

256.79

0.92

Others

1,950.40

7.01

TOTAL

27,827.56

100.00

Source for basic data: NEDA Public Investment Staff

year. The average share eventually doubled between 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 percent but this was a sharp decline from the previous share of 22 percent. The subsector of energy, power, and electrification was in third with 6.72 percent, a decline from 14.39 percent in 1994-2000. The subsector 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 9. Disaggregated Sectoral Allocation of ODA Commitments (As of December 2006 and 1994-2000) Sector/Sub-sector Agriculture, Agrarian Reform, and Natural Resources Agriculture and Agrarian Reform Environment and Natural Resources

As of December 2006

1994-2000

US$ m

% Share

US$ m

% Share

1,734.66

18.25

3,711.71

27.82

1,347.88

14.18

2,935.05

22.00

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 Electrification

638.71

6.72

1,919.81

14.39

Social Infrastructure

198.57

2.09

0.60

0.00

4,009.21

42.17

3,530.70

26.46

614.66

6.47

1,634.49

12.25

1,236.26

13.00

1,316.32

9.86

Transportation Water Resources Social Reform and Com. Dev. (Human Development) Education and Manpower Dev.

5.8

51.27

4.13

Health, Population, and Nutrition

359.15

551.68

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.

FfD: Finance or Penance for the Poor

tion and manpower development was fifth with 5.8 percent, a modest increase from its previous share of 4.13 percent. The subsector of environment and natural resources was sixth with 4.07 percent, a decline from 5.82 percent. Other human development-related subsectors fared badly – health, population and nutrition with a mere 3.8 percent, and social welfare and community development with only 2.1 percent.

distribution of ODA show that the most developed regions and provinces had the largest shares of ODA while less-developed regions with higher poverty levels 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, cornered 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-

3.4 Geographical Distribution of ODA Data from the NEDA Annual ODA Portfolio Reviews from 2000 to 2002 on the geographical

Table 10. Distribution of Total ODA Loan Commitments By Geographical Region, 2001 and 2002 2001

2002

Commitment ($ million)

% Share

LUZON

2,557.92

19.4

3,366

31.2

NCR

2,773.19

21.0

1,518

14.1

38.4

0.3

197.7

1.5

253

2.3

Island Group/Region

CAR Region I

Commitment ($ million)

% Share

Region III

1,043.3

7.9

790

7.3

Region V

65.3

0.5

0.7

Luzon-wide VISAYAS

967.0 1,284.32

7.3

505

4.7

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

370.5

2.8

226

2.1

MINDANAO

Visayas-wide

904.94

6.9

856

7.9

Region IX

25.1

0.2

Region X

119.0

0.9

109

1.0

Region XI

101.9

0.8

0.9

Region XII ARMM CARAGA

85.1

0.6

0.3

122.3

0.9

121

1.1

–

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

PROGRAM LOANS GRAND TOTAL

13,174.35

100.0

2,512

23.3

1,065

9.0

11,856

100.0

Source: NEDA Annual ODA Portfolio Review, 2001 and 2002

FfD: Finance or Penance for the Poor

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 percent (US$790 million) in 2002. The country’s poorest 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 region 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 developed 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 findings on the geographical distribution of ODA in the Philippines re-affirm 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 basis 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 filed 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 welfare 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 development 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 percent. 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

Source: Department of Finance

FfD: Finance or Penance for the Poor

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 dollar 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 disbursement 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 percent thereafter). Japanese bilateral loans have interest rates ranging from 0.75 percent to 2.2 percent. This is an improvement 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, Finland 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 commitment 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. 8

Table 12. Commitment Fees Paid on ODA Loans, 2001 to 2006

Year

Cumulative Commitment Fees (US$)

Yearly Commitment Fees (US$))

2001

21 million

9.5 million

2002

40 million

9.2 million

2003

45 million

9.5 million

2004

48.5 million

7.5 million

2005

50.9 million

6.4 million

2006

n.a.

5.7 million

Source: NEDA Annual ODA Portfolio Reviews

Government agencies and corporations that paid the most in commitment fees in 2006 were the Department of Finance (US$1.3 million), the Department 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 reflect the inefficiency and low capacity of government and government-affiliated implementing agencies. In recent years, conflicts 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 inflows, record remittances from Filipino overseas workers, tight spending policies and proceeds from sale of government properties, the government has adopted a policy of promptly paying its debts, including the prepayment of foreign loans. Thus the foreign debt declined 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 Pilipinas (BSP) scheduled the prepayment of US$805

JBIC loans do not charge commitment fees.

FfD: Finance or Penance for the Poor

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 payments 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 government 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 payments 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 capacity of the government with regard to contracted ODA funds. NEDA defines 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 performance of a project from start to finish” and that “backlogs compound commitment fees.”9 As of December 2006, NEDA reported a 71 percent availment rate representing cumulative disbursements of US$5.49 billion out of a target disbursement 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.

Table 13. Philippine ODA Loan Disbursements and Availments (1988-2005) Year

Disbursements (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%

Source: National Economic Development Authority

The “industry, trade and tourism” sector had the highest availment rate in 2006 with 94.35 percent (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 previous year’s leader, the “social reform and development” 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

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.”

FfD: Finance or Penance for the Poor

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-

ficient budget cover; and, project completion or loan closure, … difficulty 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

PNOC

N. Luzon Wind Power Proj.

49.636

DOTC

Improvement of the Marine Disaster Response and Environment Protection Sys.

79.288

DOTC

New Communications, Navigation, Surveillance Traffic Mgt. Systems

186.856

ASFPDFMO

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

1.403

38.597

3.51

Source: NEDA Annual ODA Portfolio Reviews

FfD: Finance or Penance for the Poor

tions, Navigation, Surveillance Traffic Management Systems, and the Improvement of the Marine Disaster 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 Development and the Arterial Road Bypass Project I (Plaridel and Cabanatuan). Despite the NEDA ODA Portfolio Review’s satisfaction with availment rates of 18 to 20 percent, then Socioeconomic Planning Secretary Romulo Neri admitted in February 2007 that “at the moment ODA utilization is very poor and the Department of Finance and the Department of Budget and Management are rationalizing the country’s development financing profile” (Manila Bulletin 2007b). 3.7 China’s ODA to the Philippines The beginning of the new century saw an acceleration in Philippines-China economic relations (Storey 2006). Two-way trade rose a phenomenal 433 percent between the years 2000 and 2005, from US$3.3 billion to US$17.6 billion. China become the Philippines’ 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 development 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 agreement 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 fiber 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 five 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 Gaylican 2007). Of the five approved loans, the most controversial is the North Rail project, which consists of a US$503 million concessional loan from the Export-Import Bank of China and a Philippine government’s counterpart of US$107 million. Signed on 26 February 2004, China’s largest ODA commitment 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 considering 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 official who said that “the resettlement expenses were deliberately hidden so these would not reflect on the overall, already bloated, project cost” (Pabico 2005). Furthermore, the interest rate of three percent per annum for 20 years (with a five-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)

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 relocation and resettlement of the project. 10

FfD: Finance or Penance for the Poor

of the China National Machinery and Equipment Corporation group (CNMEC) as the project’s primary contractor without the benefit of a competitive public bidding was also seen as violating Philippine laws.12 Given these onerous terms a study by the University of the Philippines Law Center “recommended the cancellation of the contract” and “if warranted, criminal, civil and/or administrative cases should be filed against the concerned public officials and private individuals.” Based on this UP Law Center report 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 Supreme Court. Undeterred by the controversy surrounding the Northrail Project, the Philippine and Chinese governments, went ahead to sign a new memorandum of understanding (MOU) in July 2006 on the rehabilitation 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 (Landingin 2007). Chinese banks, all of them state-owned, seem to be competing with each other to provide the Philippines with ODA loans. In February 2007, China Development Bank, reportedly China’s biggest bank, started talks with the Philippine government on providing 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 Philippines 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 donors 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 filling 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 approval 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 firm (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 pressing problems of classroom and textbook shortages. They also aired concerns that the project “aims to

The Office 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 influence peddling, the National Broadband Project project was cancelled by the government in September 2007. 12

FfD: Finance or Penance for the Poor

replace teachers with satellite-beamed lessons, and force the use of English instruction instead of encouraging the use of local languages.” Philippine peasant organizations and agrarian-support NGOs are not happy with China’s aggressive push into the Philippine economy. In a full-page advertisement 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-sufficiency 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. Acting 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 recent cancellation by the World Bank of a road project loan (see section on corruption above).

4. ODA Issues 4.1 The 2005 COA Report on ODA The report of the Commission on Audit (COA) on ODA for 2005 contains findings on 55 ongoing 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 government and glaring inefficiencies in project implementation. Total losses resulting from the above irregular15

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 office supplies, (4) misclassification 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 beneficiaries of project benefits, 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 familiar 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 cronies in the form of rebates (or commissions), in return 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 payment 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.

NEDA’s 15th ODA Portfolio Review (2006) was released in September 2007 and the Review’s updated ODA figures have been incorporated in this study, but not the implementation problems which appear to be mere repetitions of past concerns.

FfD: Finance or Penance for the Poor

Twenty-one years later, the situation remains basically unchanged. In a January 2007 survey of expatriate business persons in thirteen Asian countries and territories, the Philippines was considered “the most corrupt” (Bonabente 2007). The survey was conducted among 1,476 foreign business persons (100 of them based in the Philippines) by the Hongkongbased 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 environment is also seen as a breeding ground for corrupt practices. A paper prepared by the Economic Policy Research and Advocacy Group (EPRA) headed by former NEDA Director General Cielito Habito notes that the “lack of transparency and insufficient disclosure in infrastructure projects with private sector participation engender graft and corruption that work against the interests of the taxpaying public” (Lucas 2007). This lack of transparency and disclosure “increases fiscal 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-supported infrastructure development, “remains hounded by controversies related to vagueness over unsolicited 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 assistance from the US hinges on its ability to implement 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 Contractors (CCLC) claimed that its members had paid between PhP1 million and PhP5 million to an official 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 Narciso Abaya. The Chinese-funded US$330 million National Broadband Project (NBN) was scuttled due to disclosures of bribery attempts involving high government officials. In November 2007, the World Bank, in a highly unusual move, suspended the release of US$232 million 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 first phase (International Herald Tribune 2007, World Bank 2007). The investigation unit had uncovered anomalies involving the China State Construction Engineering, a company owned by the Chinese 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 construction companies in later bidding rounds” (International Herald Tribune 2007). The Bank’s 24-member governing board “refused to authorise the project,

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) Hongkong, 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. 16

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arguing that the corruption issues in the first 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 environment and cause involuntary dislocations of communities in the target area. For the latter, indigenous peoples are often the victims of human rights violations who not only lose their homes and farm-based sources of livelihood but also their ancestral lands. Social conflicts are the logical consequences of such ill-conceived development projects. In recent years, some of these socially and environmentally controversial 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 firm; (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-fired Thermal Power Plant; (9) various infrastructure projects in Manila financed by JBIC. In June 2006, local and international environmental 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 forcible 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 investigate 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 organizations in June 2006, environmental groups presented 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 Kalikasan-PNE claimed that since Mrs. Arroyo became President, 15 environmental activists have been murdered 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 difficulties in securing Environmental Compliance Certificates (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 unfortunately 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 implementing rules and regulations (in Section 6.2) state a preference for the hiring of Filipino experts in implementing projects even when the consulting or contracting firm is of foreign origin. The NEDA’s Rules and Regulations on the Procurement of Consulting Services for Government Projects, approved in September 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 FfD: Finance or Penance for the Poor

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 “superfluous” presence of highly paid foreign consultants in ODA projects in positions where Filipino expertise was not deficient (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 Results 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 find ways to cut costs for consulting services and to achieve design and cost efficiency in implementation.” The particular issue of consultancy costs, however, did not find a responsive chord among the donors, who ignored this specific 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 firms, President Arroyo issued Executive Order 278 “directing all government agencies to prioritize Filipino-owned construction and consultancy firms in the bidding for

government projects.” The Construction Industry Association of the Philippines and the Filipino Consulting Organizations lamented their “losing out to foreign companies in the competition for big government projects,” especially foreign-funded ones. In a November 2001 meeting of project implementation officers (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 implementing agencies to contract the services of foreign consultants “even in instances when the needed expertise 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 reform 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 significant 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 officials themselves) “officials 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 consultants 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

In 1989, the Senate Blue Ribbon Committee branded as “superfluous 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. 18

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projects often “do not reflect the true development needs of communities but the interests of foreign corporations” and in some cases, “could lead to economic 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 firm is an affiliate 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 subsidiary of Cargill, one of the world’s biggest agribusiness 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 privatization.” Cargill’s Philippine subsidiary, Cargill Philippines Inc., operates large-scale integrated animal feeds plantations in General Santos City in Central Mindanao. Perhaps due in part to the inability of host countries like the Philippines to effectively enforce policies and laws on the hiring of foreign consultants, the UNDP has established a Development Support Services Center (DSSC) for “the purpose of strengthening UNDP’s operational support for Nationally Executed (NEx) projects” by stressing “the importance of using national capacities to undertake programs and projects.” To achieve its objectives, the UNDPDSSC “regularly undertakes local and international contracting of consultants in various fields of expertise, as well as selection of suppliers of good/equipment, 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 availment rates, low disbursement levels, budgeting prob-

lems, right-of-way and land acquisition issues, and LGU participation, among others. Agencies reporting the above-named problems all cite the unavailability 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 country and the Philippine government, and (2) between national government agencies and local government units. In 2005, 11 government agencies had foreignassisted projects that were adversely affected by the unavailability of counterpart funds. At the local government level, some projects, e.g., the World Bankfunded Agrarian Reform Communities Development Project, follow the cost sharing policy of 50-50 between the national government (NG) and LGU that is burdensome to the latter, resulting in LGU withdrawals 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 managed 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 flexibility to permit Bank financing up to 100 percent of cost of individual projects and activities, where appropriate, within the context of an overall cost sharing framework.” The JBIC, on the other hand, “has offered to increase its disbursement ratio (financing ratio) to the highest possible limit based on actual requirements 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 administrative costs. Moreover, it does not address implementation concerns not related to local counterpart funding problems. With respect to procurement issues, the NEDA Review examined 21 civil works, 4 consulting services FfD: Finance or Penance for the Poor

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 Government Procurement Reform Act (GPRA).” There were procurement delays by four agencies “with amounts ranging from PhP106 million to PhP14 billion, resulting 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 Project implemented by the Supreme Court (5 months) and the North Luzon Wind Power Project (PNOCEDC) funded by GOJ-JBIC Special Yen Loan Package (SYLP) facility (over 12 months). The main reason 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 reaffirm viability of the project.” 4.6 VAT Reimbursements Under a government-to-government agreement, the Philippines exempts Japanese contractors, consultants, and suppliers of Japanese-funded ODA projects from the payment of Value Added Taxes (VAT). These are, however, advanced by consultants and contractors of GOJ-JBIC/JICA-assisted projects “subject to reimbursement by concerned government agencies.” The absence of appropriation 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 projects under the Japan General Grant-Aid program; b) delay in the commencement of the 27th Yen Loan Package negotiation; and c) decreased confidence in GOP’s capability to meet its obligations.” For four years from 2002-2005, the government was unable to pay fully VAT refunds because of its huge budget deficit (Manila Bulletin 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 projects 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 reflect the self-serving character of the latter. 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-

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.

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sues in the implementation of 30 of their ongoing ODA projects in 2005. Reasons cited were: “(a) delayed approval of the 2005 General Appropriations Act (GAA); (b) inadequate appropriations cover; c) delayed release of Special Allotment Release Order (SARO) and Notice of Cash Allocation (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 percent 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 deficit 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 laudable in principle, often results in problems in project implementation. NEDA reports that in 2005, “a total of 44 ODA projects with direct LGU participation 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 income class.” This problem arises during the “preparation 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 autonomous units for solid waste management in the LGUs) and preparation of engineering plans and Environ21

mental Compliance Certificate/Certificate of NonCoverage (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 Management Project. 4.9 Right-of-Way/Land Acquisition Issues ODA projects, especially major infrastructure-related ones, often require the takeover by government of privately owned lands after paying the proper compensation. Funds for landowner compensation, however, are often inadequate, due to budget constraints21 and in some cases, disagreements arise on compensation payments, with the landowners rejecting the government’s final proffered price. Other right-ofway issues involve the “resistance of project affected people/relocatees, presence of illegal settlers and claimants and deferment in the acquisition of housing 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, flood control works, airports, highways and expressways, water supply projects, irrigation schemes, and river rehabilitation plans. 4.10 Project Management Political instabilities, an insecure national leadership, and questions about the legitimacy of the government have characterized Philippine governance over the past few years. These have resulted in frequent “changes in heads of agencies/management” 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-

“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 filing the petition on eminent domain case” (NEDA 2005).

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ect II (ARISP), SBMA’s Subic Bay Freeport Development 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 procurement processes/decisions adopted by the previous administration.” For ARMM, the planned “transition in project management from the Fund Management Office (FMO) to the ARMM Regional Government, (then still pending with the Office 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 additional 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/supplemental 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 efficiency of ODA project implementation. FfD: Finance or Penance for the Poor

4.12 Loan Cancellations, Closed Loans, and Loan Extensions Twenty-three (23) loans totaling US$260 million 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 exchange rate movement; c) low demand for relending; d) reduction in scope of projects; and, e) budget 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 counterpart funding and loan repayment (Remo 2004). A previously approved major project that was canceled was the JBIC-funded Phase 5 of the Metro Manila Interchange Construction Project worth US$47 million which went into effect in September 2001 and was supposed to have been completed 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 “budgetary constraints and technical issues” for the incomplete 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 Cotabato 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-project 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 amounting 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 financial institutions, 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 five projects having to do with industrial support, domestic 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 financial crisis and fear of a possible downgrade of the country’s sovereign international rating, (b) selective lending by private financial institutions 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 universities 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 Simon 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 finance 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 financial crisis, (c) excess liquidity 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 filed in court by interested parties based on allegations of irregularities in project 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 studies 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 Government of Sarangani have yet to resolve the legal personality of the Environmental Conservation and Protection Center (ECPC). The most high profile 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 Section 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 appropriateness in addressing the more relevant concerns of the Filipino people. The possible candidates for best ODA practices include: • The Second Communal Irrigation Development 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 beneficiaries and stakeFfD: Finance or Penance for the Poor

holders in project implementation and maintenance; 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 efficient managers turned the project around. The results among the targetted areas were lower drop-out rates, narrower gaps in completion rates, higher academic performances, and improved national rankings (JBIC Study Team 2006).

5. Summing up the Philippine ODA Experience From 1947 to 1977, the US provided US$1.7 billion in economic assistance to the Philippines but a US government study concluded that “concrete development 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 rural 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 after 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 imports” thus resulting in unmanageable debt service and debt-to-GDP ratios. This is because many 22

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 institutions for foreign loans and guarantees.” The UP group further pointed out that “official assistance was tied to projects which were not necessarily 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, mismanaged, not viable to begin with, or made unviable by changes in the exchange rate and the international environment.” Twelve years later, Malaluan (1998) criticized the government’s public investment program’s excessive 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 contributions 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 issues 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 estimated income were most often not real-

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).

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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 liabilities of the different sectors for lack of definition of the components to be considered as public debt.” 4. “The DOF’s data on outstanding public debt does not include indebtedness of other government corporations” and “contingent liabilities on account of guarantees issued by the national government. Under these conditions, the government could not make an accurate assessment of its financial condition.” 5. “A number of projects funded from borrowings were approved without proper evaluation. … 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 quality of aid, then Budget Secretary Emilia Boncodin enumerated “painful blunders that have been committed in the name of development” and cited loans that “have ignored pressing needs and yielded counter-productive results” (Sison 2003). Boncodin questioned the “ownership” of development projects particularly “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 public 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 having their own agenda to push, effectively ‘driving’ the preparation and implementation of the projects/programs rather than the recipients” (Sison 2003).

6. List of Recommendations The policies and practices surrounding ODA in the Philippines are obviously in need of a thoroughgoing overhaul. Not all of the issues and concerns identified in this study are acknowledged by official government reports, particularly the annual NEDA portfolio reviews which deal mainly with implementation glitches. Notable 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 recommendations, 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 distribution of aid to poorer areas. 6.1.5 Address social and environmental concerns. 6.1.6 End all tied aid. 6.1.7 Delink aid from the war on terror, particularly 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. FfD: Finance or Penance for the Poor

6.2.3 Address the foreign consultants’ issue. 6.2.4 End human rights violations in aid projects. 6.2.5 Focus on long-term and alternative sources of development financing. 6.2.6 Strictly follow the legal requirements in negotiating loan agreements. 6.2.7 Adopt a policy of transparency and popular 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.

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This report by no means exhausts all the issues and concerns that have been raised about official development assistance in the Philippine case. Nevertheless, this partial assessment already forms a strong basis to criticize the quality, quantity, and effectiveness of foreign assistance at both the donors’ and the recipient Philippine government’s end. Given the evidence, and in a deeply significant sense, the term “development assistance” in the Philippines has become an oxymoron. Unfortunately for the poor and disadvantaged sectors of society, “foreign aid” does not just connote a figure of speech but a reality that unfolds on a daily basis, the presumed benefits of which they only have a phantom acquaintance.

References

Alburo, Florian, Romeo Bautista, Dante Canlas, Benjamin Diokno, Emmanuel de Dios, Raul V. Fabella, et al (1986). Economic Recovery and Long Run Growth: Agenda for Reforms, Volume I, Philippine Institute for Development Studies, 1 May. Monograph Alunan, Rafael M. III (2006). Philippine Infrastructure Challenges and Opportunities, Business World, 20 June. 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, 20 November. 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.

FfD: Finance or Penance for the Poor

International Herald Tribune (2007), World Bank graft report delays loan to the Philippines, 19 November. JBIC Study Team (2006). Transforming Basic Education: Lessons and Recommendations from the Third Elementary Education Project (Final Integrated Report Part 2), 18 October. Manuscript. Landingin, Roel (2007). More Chinese loans for RP rails, Newsbreak, 12 February. Lucas, Damian l. (2007). DOTC Hit for ‘Bias’ in $240-M Project, Philippine Daily Inquirer, 27 March. Luib, Romulo T. (2001). Tighter Rules Sought in ODA Projects’ Review, BusinessWorld, 6 November. Maitem, Jeoffrey (2007). US extends P32-M in aid to Bangsamoro agency, Philippine Daily Inquirer, 10 November. Malaluan, Nepomuceno A. (1998). Public Investments in the Quest for Poverty’s End. In Filomeno Sta Ana III (editor), The State and the Market: Essays on a Socially Oriented Philippine Economy (Quezon City: Action for Economic Reforms). Malaya (2006). Environmental Activists’ Slay Linked To ODA Review, 16 June. http://www.malaya.com.ph/jun16/ metro3.htm. Manila Bulletin (2006). JBIC’s P736-M VAT Claims To Be Paid, 29 September. ____________ (2007a). Gov’t Sees P48.5 B From Donors, 9 March. ____________ (2007b). Biggest China Bank Offers ODA to RP, 11 February. Moreno, Marga (1995). Uneven Playing Field stunts Growth of Local Contractors, BusinessWorld 24 November. Morrel, Jim (1987). Aid to the Philippines: Who Benefits? in Daniel B. Schirmer and Steven Rosskam Shalom (eds), The Philippines Reader: A History of Neocolonialism, Dictatorship and Resistance, (Quezon City: Ken Incorporated). No author (2004). The Good News: Filipino contractors to get priority in government projects, 22 February. http://www.gov.ph/news/default.asp?i=4522 Ogata, Sadako (2007). Japan’s Development Assistance and the New Challenge, speech delivered at Oxford University on 22 June, JICA News Release, 25 June. Olchondra, Riza T. (2007). Gov’t to seek ODAs for Railway plan in Mindanao, Philippine Daily Inquirer, 8 February. Orejas, Tonette (2006). BCDA Head Orders Probe of ‘Commission’, Philippine Daily Inquirer, 31 August. Pabico, Alecks P. (2005). Nightmare At North Rail: Cost Of Resettling 40,000 Families Deliberately Hidden, Philippine Center for Investigative Journalism, 2 October 2. www.pcij.org. Padilla, Arnold (2004). Mini-Marshall Plan for Mindanao: Will Foreign Aid Help End the Moro War, Reality Check, October. Philippine Daily Inquirer (2001). Debt squeeze a Ramos legacy, 16 July. ___________________ (2007a). Delays hound Subic-Clark road project , 2 February.

FfD: Finance or Penance for the Poor

___________________ (2007b). Government Urged to Strengthen Infrastructure Screening Process, 13 March. Remo, Michelle V. (2007a). Net Borrowings Drop by 54%, Philippines Daily Inquirer, 5 February. ______________ (2007b). Gov’t Seeks $300M in grants from US, Philippines Daily Inquirer, 4 January. ______________ (2006). RP requesting $535M in Japanese ODA this year, Philippines Daily Inquirer, 16 January. _______________ (2004). Gov’t moves to cancel P13B worth of ODA, Philippines Daily Inquirer, 10 November. Report on Discussions of the Consultative Group Meeting on the Philippines (2006). April. Philippines, Republic of the (2007). Philippines, Bureau of Treasury, National Government Debt to GDP Eased to 64% as of end 2006 from 72% as of end 2005, Press Release. 12 March. ______________________ (2006). National Economic Development Authority, Annual ODA Portfolio Reviews 1993 to 2006. ______________________ (2005). Commission on Audit, Official Development Assistance Audit Report for CY 2005. ______________________ (2004). Commission on Audit, Sectoral Performance Audit Report on Public Debt (CY 2004). ______________________ (1966). Republic Act 4860, Foreign Borrowings Act of 1966, 8 September. ______________________ (1996). Republic Act 8182, Official Development Assistance Act of 1996, 11 June. ______________________ (1996). Implementing Rules and Regulations for Republic Act 8182, 23 July. Rivera, Temario C. (2000). The Political Economy of Aid: Japanese ODA in the Philippines, 1971-1999, paper presented at a symposium on Japan-Philippines Relations hosted by the Japan-Philippines Research Forum, 13-14 May, Tokyo, Japan. Rufo, Aries and Gemma B. Bagayaua (2007). Gloria’s Mark, Newsbreak, 12 February. Schirmer, Daniel B. and Steven Rosskam Shalom, editors (1987). The Philippines Reader: A History of Neocolonialism, Dictatorship and Resistance, (Quezon City: Ken Incorporated). Serrano, Isagani, Ronald Paraguison, and Joseph Purugganan (1998). Primary Stakeholder Participation and the World Bank: The Case of the Second Communal Irrigation Development Project (CIDP 2), November. Sison, Marites (2003). Aid Recipients Asking Tough Questions, Inter-Press Service, 24 January. Storey, Ian (2006). China and the Philippines: Moving Beyond the South China Sea Dispute, China Brief (Volume 6 , Issue 17), 16 August. Tadem, Eduardo C. (1983). Japanese Presence in the Philippines: A Critical Assessment, Anuaryo: Journal of History and Political Science (Vol. 2 Nos. 1-2) May 1983-March 1984 and as Philippines in the Third World Papers No. 34.

FfD: Finance or Penance for the Poor

_______________ (1989). Japan, the US, and Official Development Assistance to the Philippines, Kasarinlan (Philippine Quarterly of Third World Studies), Vol. 5, No. 4, 1990 and in Japan Asia Quarterly Review (Vol 21 Nos 2-3) 1989 as Philippine Assistance Plan: A Mockery of Aid. _______________ (2003). Official Development Assistance to the Philippines: Can it be Reformed?, Public Policy Vol. VII, No. 1, January-June. Tsuda, Mamoru and Leo Deocadiz, editors (1986). RP-Japan Relations and ADB: In Search of a New Horizon (Manila: National Book Store). Tujan, Antonio Jr. (2005). Japan ODA to the Philippines, Reality of Aid Asia Pacific, Fifty Years of Japan ODA: A Critical Review for ODA Reform (Quezon City: Ibon Books). Ubac, Michael Lim and Jerry E. Esplanada (2007). $460-M Cyber Education deal not scrapped, Philippine Daily Inquirer, 4 October. Yokoyama, Masaki (1990). Marcos Yen for Corruption, Kasarinlan (Philippine Quarterly of Third World Studies), Vol. 5, No. 4. World Bank (2006). Phase 1 of Mindanao Trust Fund Launched, Press Release, 27 March 27. _________ (2007). Statement On The Second National Roads Improvement And Management Program (NRIMP2) in the Philippines, 19 November.

FfD: Finance or Penance for the Poor

Can Trade Finance Development? Jessica Reyes-Cantos

Trade, of course can finance 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 finance 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 finance 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 finance 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; • diversification of its export market; • and an increasing positive trade balance.

Getting the Picture After 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 fingers 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 manufacturing 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. FfD: Finance or Penance for the Poor

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

Imports

Balance 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

100

FfD: Finance or Penance for the Poor

Figure 2. Agriculture, Industry and Services Share to GDP

Source: National Statistical Coordination Board

The global labor market is likewise able to provide employment and gainful income for our people â&#x20AC;&#x201C; eight million of them. 4. The profile of our exports is limited. Electronics makes up more than 60 percent of export earnings, garments a far five percent, and so do agriculture-based products. The only commodity group that has inched up, in fact, doubled its export earnings share, are mineral products, from less that two percent in 2005 to five percent in 2007. That is most likely attributable to the activity of mining companies after the Supreme Courtâ&#x20AC;&#x2122;s reversal of its decision to declare the Mining Act unconstitutional. So un-diverse is our exports profile that the removal of the electronics sector practically reduces our export earnings to crumbs. 5. Despite all the years of being our export winners, 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 emFfD: Finance or Penance for the Poor

Figure 3. Employment by Sector (In thousands)

Source: National Statistical Coordination Board

ployment and add to our dollar earnings, they also add to our import bill. 6. Our manufacturing sector is a laggard compared to our Asian neighbors. 7. If it is any consolation, we have somewhat diversified our export market. Then US and Japan remain our major export markets but China, Singapore and other Asian countries,

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Table 2. Distribution of Philippine Exports by Commodity Group 2004 to 2007 (Jan-Dec) Commodity Total Agro-Based Products

2007 Jan-Nov p

2006 Jan-Nov

2006 Jan-Dec

2005 Jan-Dec p

2004 Jan-Dec r

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%

Fruits and Vegetables

1.48%

1.60%

1.51%

1.04%

0.97%

1.07%

1.20%

Fish, Fresh or Preserved Of Which: Shrimps & Prawns

0.58%

0.54%

0.58%

0.68%

Abaca Fibers

0.03%

0.30%

0.04%

Tobacco Unmanufactured

0.08%

0.07%

0.04%

Other Agro-Based Products

Natural Rubber

0.08%

0.10%

0.09%

Seaweeds, Dried

0.04%

0.05%

0.07%

0.09%

Others Forest Products

0.22%

0.17%

0.23%

0.26%

0.07%

0.05%

0.80%

0.09%

Mineral Products

4.93%

4.41%

1.95%

2.01%

Petroleum Products

2.05%

2.01%

1.42%

0.96%

Manufactures

85.70%

85.79%

89.60%

89.53%

Electronic Products

62.19%

62.72%

66.23%

67.35%

Other Electronics

2.25%

1.95%

0.48%

2.88%

Garments

4.63%

5.60%

5.58%

5.47%

Textile Yarns/Fabrics

0.41%

0.45%

0.59%

0.60%

Footwear

0.06%

0.05%

0.60%

0.09%

Travel Goods and Handbags

0.22%

0.06%

0.50%

0.10%

Wood Manufactures

1.56%

1.39%

0.33%

0.31%

Furniture & Fixtures

0.48%

0.59%

0.74%

Chemicals

1.98%

1.56%

1.33%

1.13%

Non-Metallic Mineral Manufactures

0.41%

0.38%

0.41%

0.42%

Machinery & Transport Equipment

3.71%

3.56%

4.45%

4.04%

Processed food and Beverages

1.45%

1.21%

1.26%

1.25%

Iron & Steel

0.50%

0.53%

0.23%

0.15%

Baby Carr., Toys, Games and sporting goods

0.31%

0.32%

Basketwork, Wickerwork & Other Plaiting Materials

0.11%

0.14%

0.17%

Misc.Manufactured Articles, n.e.s.

0.68%

0.63%

0.69%

0.59%

Others

4.75%

4.62%

4.29%

3.92%

Special Transactions

2.76%

3.48%

2.08%

2.70%

Re-export

1.27%

1.30%

1.80%

1.32%

Source: Foreign Trade Statistics Section, Industry and Trade Statistics Dept National Statistics Office

102

Notes: a - No export data p - Preliminary r - Revised Components may not add up to totals due to rounding

FfD: Finance or Penance for the Poor

Table 3. Developing Asia Manufacturinhg Output Shares by Decade ––1970s

1980s

1990s

2000 - 04

31.27 15.32

36.26 16.43

32.90h 16.58

34.50i 15.71

NIEs Hong Kong, China Korea Singapore Taipei, China

– 21.61 24.84a 32.43

21.18 27.51 26.09 34.95

9.43 27.14 26.11 27.11

4.32 27.82 27.39 22.80

ASEAN - 4 Indonesia Malaysia Philippines Thailand

10.42 16.82 25.75 18.98

15.35 20.42 25.03 23.32

23.72 27.05 23.29 29.55

29.04 31.21 22.94 34.00

Other Southeast Asia Cambodia Lao PDR Myanmar Viet Nam

– – 9.64 –

– 9.27d 9.07 19.69e

11.08 14.20 6.90 15.23

19.40 18.67 8.49m 19.94

Other South Asia Bangladesh Bhuta Maldives Nepal Pakistan Sri Lanka

– – – 4.11 15.89 19.02

13.76 5.29 – 5.24 15.98 15.39

14.87 10.39 – 8.77 16.44 15.68

15.73 7.79m – 8.85 15.99 15.90

PRC India

Source: “Benchmarking Developing Asia’s Manufacturing Sector,” Jesus Felipe and Gemma Estrada, ERD Working Paper No. 101, Asian Development Bank, September 2007

of late, have started to accommodate our products. This is more a result of increased intra-ASEAN trade.

The Other Side of the Picture The 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 FfD: Finance or Penance for the Poor

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 agricultural products still have the potential to make inroads in the export market. Table 4 lists the country’s top agriculture exports. But much still has to be done in terms of making 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 protect 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

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Table 4. Top 12 “Reliable” Agricultural Exports (in million US$) 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

83.68

86.60

91.02

91.81

92.69

88.96

83.24

82.41

Source: “Overview of Philippine Agriculture and Agricultural Trade”, Lecture given by Dr. Ramon Clarete, PGTEP, Makati Sports Club, 5 October 2006.

Organization (GATT-WTO), first by removing quantitative 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 fighting 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 Department rather than a policy crafted as a result of deliberations done by Congress. As if to rub salt in their wounds, government could have easily raised tariffs 1

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 Filipino workers (OFWs). On the other hand, whatever protection our domestic producers got from a tariff 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 imported inputs can come in duty-free, while justified by the jobs that they create domestically, likewise distorts whatever rationality still remains in our tariff structure. But apart from creating economic enclaves, the long term impact of these economic zones must be seriously looked at. There are clearly foregone revenues both of the local and national govern-

Editor’s note: In 2008, the peso reversed the trend of appreciation. Inflation and the global financial crisis led to the weakening of the peso.

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FfD: Finance or Penance for the Poor

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

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

Agriculture

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

Source: Tariff Commission

Philippine Tariff Profile (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%

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 Disintegration Over the long run, what is critical in achieving meaningful and sustainable economic development is the creFfD: Finance or Penance for the Poor

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 policy Civil society organizations have shouted themselves hoarse with repeated calls for a clear agroindustrial 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, Chi105

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 Office. The setting up of such an office 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 executed 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 Development Round of trade negotiations in the WTO2. Our agriculture negotiators united with other negotiators from developing countries with defensive interest in agriculture to form the so-called Group of 33 or G33 for short. The G33 (now actually numbering 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 influx. This mechanism may be in the form of increased tariffs, even beyond the WTO bound rates, that is, if the G33 remains firm and united in what they want. It is no easy task, though, considering that the whole concept of special products and special safeguard 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 homestretch approaches. But still, much of it depends on the political will of developing country governments and the clarity and consistency of their industrial plan.

Editor’s note: The Doha Development Round collapsed in July 2008, as no compromise on agriculture import rules materialized.

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References

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 Asiaâ&#x20AC;&#x2122;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 Pacific, Asia-Pacific Human Development Report 2006, Macmillan.

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Remittances for Development Financing Clarence G. Pascual

I. Introduction In the last two decades, remittances clearly emerged as a major driver of foreign exchange flows to the developing world. From US$25 billion in 1990, total remittance inflows 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 exponential 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 deficits to resilient surpluses (or less dramatically a reduction of the deficits) 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 inflows, the Philippines is a good example of the historic turnaround in a country’s external position as a result of strong and sustained remittance flows. 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 ballooned 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 deficit along with significant 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 reflected 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 halfcentury, the change from “structural” deficits to “structural” surpluses thanks to strong remittances obviously has profound implications on development strategies and policies (Griffith-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 industrialization (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 FfD: Finance or Penance for the Poor

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finance 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 budgets and low current account deficits. The economic literature reflects an abiding concern about the importance of the current account deficit in relation to crises that have recurred with increasing frequency in recent decades. The literature highlights the nature and composition of the current account deficit, that size as well as sustainability of financing the deficit matters, and that a sudden reversal from deficit to surplus in the context of a crisis hurts investment and growth (Edwards 2000). A related strand in the literature has examined episodes of capital bonanzas and how they are associated with economic crises—debt defaults, banking, inflation and currency crashes. In developing countries, surges in capital flows are associated with pro-cyclical fiscal policies and attempts to curb or avoid an exchange rate appreciation, both of which are likely to contribute to economic vulnerability (Reinhart and Reinhart 2008). A key assumption in the academic and policy discourse 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 excess supply of foreign exchange in receiving economies is rarely recognized. Rather the situation of excessive foreign exchange flows due to remittances is regarded as a temporary aberration, a disease-carrying gift (note the frequent references to the Dutch Disease), an economic 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 assumption of a shortage of foreign exchange or an external deficit financed by highly volatile capital

110

flows. 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 fiscal 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 finance critical public investment and social services. From this point of view, excessive reserve holdings carry significant opportunity costs, namely, foregone economic benefits from productive investment 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 exchange 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 specifically a migration-remittance issue. This is correct to the extent that current account surpluses and large-scale reserve accumulation in many developing countries can be traced to factors other than remittances, notably commodity booms (the oil and natural resource exporting countries), over-performing export sector (China), and capital bonanza (India). We argue that, at least in the case of the Philippines, the question over the use of foreign reserves is closely related to the issue of the impact of remittances on development. As Griffith-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, investing reserves coming from the capital account is merely investing borrowed money. For the Philippines, the underlying reason behind the current account surplus and rising reserve holdings is strong FfD: Finance or Penance for the Poor

remittance flows 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, particularly 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 Philippine economy with the end-goal of creating decent jobs for all, thus undermining the forces driving mass migration, is to do justice to the sacrifices and heroism of migrant Filipino workers. In sum, remittances provide the wherewithal to undertake sensible but difficult reforms (given resource constraints and ideological bias) to transform the Philippine economy and put growth on a more vigorous, sustained, and equitable path. This paper is divided into five sections, the first of which is this introduction. Section II paints in broad strokes recent trends in remittances in the Philippines. In sections III and IV, we briefly 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 fiscal policy, in particular. We also draw on the literature to examine issues pertaining to the use of remittances to finance development, particularly the high opportunity cost associated with holding excessive levels of foreign reserves. Section VI makes concluding remarks.

II. Recent trends in remittances Remittances have become a major source of external financing for developing countries. In 2007, remittances to all developing countries exceeded US$250 billion—which accounted for three-fourths of global remittance flows—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 official sources (Kapur 2004). Unlike in the past when strong capital flows 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 billion in 2007, behind only India, China and Mexico; it captured 5% of global remittance flows, representing 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%

8.0%

China

25,703

0.9%

7.6%

Mexico

25,052

3.0%

7.4%

Philippines

17,217

13.0%

5.1%

France

13,854

0.6%

4.1%

Poland

10,671

2.5%

3.2%

Spain

10,633

0.7%

3.2%

Romania

8,533

5.5%

2.5%

United Kingdom

8,124

0.3%

2.4%

Belgium

8,027

1.9%

2.4%

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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 million in 1977, remittances rose fourfold to US$1.5 billion 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 difficulties in the major desti-

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 five years. Again between 1996 and 2001, remittances fluctuated and were below the trend level in 2000 and 2001. This notwithstanding, the exponential growth in remittances is well on track. The unprecedented growth in remittances has been largely responsible for the current account surplus in recent years (Figure 2), a reversal of halfcentury of current account deficits. 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

Figure 2. Composition of Current account, in USD Million

Source: Diokno-Pascual (2008) â&#x20AC;&#x153;Remittances as Self-Insuranceâ&#x20AC;?

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FfD: Finance or Penance for the Poor

in the current account becomes even more significant in view of two things: one, a huge and growing trade deficit (external trade in goods), and significant 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 deficit. Regardless of the merits of official 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, remittances are clearly the most important source of foreign exchange flows for the Philippines on a net basis. Between 1999 and 2007, remittances exceeded all traditional sources of capital flows combined— portfolio capital, foreign direct investment, and debt. For example, remittances were four times net portfolio investment in 2005, five times net FDI flows in 2006, and 10 times net borrowings by the National Government. With the current global financial turmoil which has triggered capital flight from developing countries, the importance of remittances is likely to grow. Moreover, remittances averaged 28 percent of export revenues in the last five years. While it is difficult to determine with precision the import flows related to exports, it is well known that the country’s major export product—electronics—is highly dependent on imported inputs, generating insignificant foreign exchange earnings for the economy (UNCTAD 2005). Arguably, remittances are the biggest net foreign exchange earner for the Philippine economy, including exports of commodity and services. Finally, remittances have emerged as a stable source of foreign exchange flows. While there are occasional dips in total amounts (during the early 1980s and late 1990s), exponential growth of remittances over the long-term is clearly evident. The magFfD: Finance or Penance for the Poor

nitude and, more importantly, the stability of remittance 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 remittances. First, remittances are not return and interest maximize earnings. A positive implication is that remittances do not exhibit strong herd-like behavior unlike portfolio and debt flows. Second, remittances are not debt-creating transfers hence there are no counterflows at the level of the macroeconomy. These counterflows, as in the case of portfolio investment, FDI and debt, can be substantial, but also sudden and sharp, exacerbating the instability of traditional capital flows and causing great difficulties for economies being abandoned. Third, migration network theory and its variants imply that migration flows and the consequent remittance flows can take on a life of their own as previous migrants facilitate the recruitment of new ones. Migration flows 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 flows. To claim credit or pin the blame on government for the migration phenomenon is to give too much credit to policy. More importantly, however, the network theory of migration implies long-term stability of remittance flows. De Hass (2007) finds evidence that remittances begin to slow down around 15 years after the peak of migration. Sending countries do have ample opportunity to mobilize remittances to accelerate development. An upshot of the massive remittance flows 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 flows remained positive 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 financial accounts were also in the black by US$5.3 billion, despite a net outflow of US$1.6 billion in 2004. Thus, the Philippines joins other developing countries rapidly accumulating foreign exchange

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Table 2. Gross International Reserves of the Bangko Sentral ng Pilipinas (BSP) 1985 Period

GIR

Import Cover 1

1985

1,087

1986

Short-Term External Debt Cover (in percent) Original Maturity

Residual Maturity 2

0.8

2,506

1.8

1987

2,014

1.5

1988

2,111

1.6

1989

2,375

1.8

1990

2,048

1.5

1991

4,526

3.4

121

1992

5,338

3.4

122

1993

5,922

3.2

132

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

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

Number of months of average imports of goods and payment of services and income that can be financed by reserves. 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 months Source: BSP

1 2

reserves in the present decade on account of remittances. Foreign exchange flows of the magnitude induced by remittances are certain to have important consequences on receiving households, their communities, and the larger economy. Not surprisingly, a voluminous literature has emerged examining the economic consequences of remittances, a subject we turn to in the next section.

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III. Microeconomic consequences of remittances There is by now a voluminous literature on the economic consequences of migration and remittances. A number of studies provide a comprehensive and multi-disciplinary review of this literature (De Haas 2007 and Grabel 2009 are two examples). For brevity, the discussion in this section is confined to studies in the Philippine context. Following the review of FfD: Finance or Penance for the Poor

the local literature in Orbeta (2008), we focus on the research findings and largely ignore methodological issues.

Household expenditures Remittances raise household incomes so that we would expect remittance to increase household expenditures on normal goods. The impact of remittances, 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 receiving and not receiving remittances. They find higher consumption expenditure for remittance-receiving households, higher allocation for housing, education, health care and recreation services, as well as higher expenditure elasticities for housing, education, health care, durables, and transportation and communication. Tabuga (2007) produces the same results, using a slightly different methodology. In addition, to higher shares and elasticities on education, housing, and durable goods, he finds no effect on tobacco 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) finds that total household expenditures is not affected by changes in remittances. Part of the reason for this result 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 finds positive impact. Another reason for the difference in results is methodological. Of particular interest to economists are household expenditures on education. As discussed above, Tullao, Cortez and See (2007) as well as Tabuga (2007) find that remittances have a positive impact on education spending. Not only do remittance-receiving households have higher education expenditure shares, but they have higher expenditure elasFfD: Finance or Penance for the Poor

ticities. Likewise, Yang (2008) reports a positive impact of remittances on education investments. He also finds that remittances increase the likelihood of children staying in school and reduces hours worked for children 10-17. Interestingly, the former effect is significant only for girls, while the latter holds only for boys.

Labor force supply There 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 results are mixed. Tullao, Cortez and See (2007) find that labor force participation rates and employment rates are generally lower in households receiving remittances. Using a different data set and refining the methodology done in Tullao, Cortez and See (2007), The Ducanes and Abella study (2007) shows that there is no significant difference in labor force participation 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 migration 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 reducing their work hours, although the effect is rather small. Cabegin (2006) focuses on the labor supply responses of migrantsâ&#x20AC;&#x2122;s spouses. She finds that the responses differ between wives and husbands, the former reducing her labor supply and no significant impact on husbands. She also finds 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 latterâ&#x20AC;&#x2122;s likelihood of nonemployment. 115

The results of Yang (2008) show that remittances do not have a significant 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 investments One view holds that the magnitude of the development impact of remittances on the receiving countries was assumed to depend on how this money was spent. Presumably, investment spending has larger and longer-lasting impact on development than consumption 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 business (which invariably means more market reforms, macroeconomic stability, and sustained economic growth). Yang (2008) analyzes the impact of remittances on household investment income, overall entrepreneurial activity and specific investment types. The results are not very encouraging: He reports neither a clear impact on total entrepreneurial income nor on activity. He does find an impact on specific entrepreneurial activities, in particular, in transportation, communication, manufacturing, and other capital-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 spatial Where there is consensus on the impact of remittances is on alleviating poverty. Yang and Martinez (2005) found that remittances reduce poverty incidence but not poverty depth as measured by the poverty gap. It also appears that the general increase in economic activity has spillover effects in that they reduce overall poverty incidence. Other studies report similar positive effect. Ducanes and Abella (2007) for example show that migration has allowed poor families to raise their financial status, and that the poor 116

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 indicesâ&#x20AC;&#x201D;the incidence, depth and severity of poverty in the Philippinesâ&#x20AC;&#x201D;using data on household income and expenditures. Their findings suggest that remittance flows have a statistically significant impact on all three measures of poverty, but the magnitudes are fairly small. A 10 percent increase in per capita remittance 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 households 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 employing an applied general equilibrium framework. The results indicate that the main beneficiaries 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 beneficiary of remittances. Estudillo and Sawada (2006) use provincial panel data and household data from 1985 to 2000 to estimate the impact of, among other variables, nontransfer 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) finds that remittances have boosted per capita expenditure of the bottom 40 percent of households, indicating that remittances contribute significantly to poverty alleviation. This beneficial 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 consumption, education, and housing and their consequent multiplier effects. FfD: Finance or Penance for the Poor

IV. Macroeconomic effects of remittances The 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 aggregate economy are amplified because of the “multiplier 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 consumption 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. Despite the weak impact of remittances on household investment, studies show that that remittances raise total investment levels. A study of 11 Central and Eastern European countries found that remittances significantly contribute to the increase of the investment levels of the source economies. A similar study of 20 developing 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 financial sector to finance investment by the private or the public sectors. This is the same as saying that remittances promote financial 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 sufficiently 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 mechanisms through which remittances can affect longterm 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 inequality and, indeed, the results from empirical studies are mixed (Rapoport and Docquier 2005). The disFfD: Finance or Penance for the Poor

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 entrepreneurship appears more encouraging. Studies show that remittances raise the probability of children staying in school, that is, they reduce the risk of children dropping out of school. As expected, there is evidence that remittances generate additional consumption and investment 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 important ways. First, remittances are unrequited flows: they do not result in claims on assets, debt service obligations or other contractual obligations (Brown 2006, Kapur 2005). In contrast to purchases of financial or productive assets, which can be liquidated and repatriated, remittances cannot be withdrawn from a country ex post (Singer 2008). For this reason, remittances have become the most important source of net foreign exchange flows to developing countries. Second, remittances have emerged as the least unstable source of financial flows. They are affected by economic crises and recession, but they are more stable than private capital flows which exhibit strong herd like behavior, amplifying the boom-bust cycles in emerging markets. Flows of remittances tend to increase 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 financial crisis. Bond investors will withdraw their funds in the face of high inflation and fiscal difficulties. FDI will decline in reaction to a downturn in economic growth.

117

Large scale foreign exchange inflows as induced by remittances, however, can have negative consequences. A direct negative macroeconomic consequence of massive remittances is the appreciation of the local currency. Many authors have emphasized the negative consequences of an overvalued currency. Currency appreciation reduces the profitability of the export sector, industry in particular, and reduces its growth. A slowdown in the rate of growth of industry is associated 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 relative 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 externalities (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 governments 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. Exporting 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 export-led growth is considerably attenuated. For instance, countries can maintain larger fiscal deficits in the context of international migration and remittances. In the absence of remittances, high fiscal deficits would imply higher current account imbalances and hence greater reliance on foreign savings (assuming the deficit is not monetized—which is

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less likely given that central banks are relatively more independent today) resulting in higher capital account inflows. However, if remittances are high, current account deficits would be lower, thereby reducing the likelihood that high fiscal deficits will precipitate a balance-of-payments crisis—the most common trigger for economic reforms in LDCs. Thus countries high levels of remittances can sustain higher fiscal deficits—while at the same time keeping international financial 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 benefited from the diaspora, the remittance bonanza …has conveniently 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 indirect effects that are potentially as important as direct effects. These negative indirect effects stem from central bank intervention in the foreign exchange market to resist currency appreciation in the face of strong remittance flows 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 inflation. Second, reserve accumulation entails carrying costs for the central bank where local interest rates are above international levels. Third, the central bank faces potential valuation loss from currency appreciation. Fourth, reserve accumulation can lead to excess liquidity in the banking system which can feed a lending boom especially in the real estate and property sector. Increased bank lending could show up in higher equity prices, while expectations of a currency appreciation could attract short-term capital inflows. FfD: Finance or Penance for the Poor

Finally, central banks can resort to non-market instruments such as raising reserve requirements or direct credit control measures to drain excess liquidity released in the course of accumulating foreign exchange reserves. Reserve requirements are viewed as a tax on the banking system, which discourages financial intermediation while direct credit controls are seen to compromise the efficiency of resource allocation. These negative indirect effects of remittances have raised concerns among economists and policymakers. Mohanty and Turner (2006), however, find that many of these fears have not materialized, even as central banks have successfully avoided significant appreciation of their currencies in the face of large scale foreign exchange flows. Inflation 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 domestic 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 appreciation 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 central 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 inflows, of which remittances made up an important part, have been accommodated without apparent harm to receiving economies. Contrary evidence notwithstanding, Mohanty and Turner (2006) insist on their initial hypothesis: “That such accumulation has continued for several years apparently without major adverse efFfD: Finance or Penance for the Poor

fects on inflation has come as a surprise. Should, however, inflation 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 financial sector imbalances are gradually building up. Continued intervention also creates risks for efficient financial intermediation.”

V. Remittances and macroeconomic policy choices The literature on remittances discussed in the previous section illustrates some of the important consequences of remittances on households and economies, 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 important assumption that the economy faces a scarcity of foreign exchange. The strong inflow 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 context brought about by remittances—an excess supply of foreign exchange originating from a current account surplus—has important implications for macroeconomic economic policy choices. The change in economic policy, in turn, potentially magnifies the economic impact of remittances. Investment and growth The 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, (SI) is the savings-investment balance in the domestic sector. The relationship between the current account

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balance, on the one hand, and domestic savings and investments, on the other hand, shows the total resource 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 focused 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 account 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 solution was to encourage industrialization through import substitution policies. The oil crisis in the mid-1970s caused large swings in the current account balances of most countries, prompting economists to analyze the determinants of the current account. The view that emerged during this period emphasized the intertemporal dimension 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 phenomenon. The policy implication of this view is that to the extent that the current account deficit reflects new investment, there is no reason to be concerned about a huge current account deficit. The Lawson doctrine states that the current account is no cause for concern as long as fiscal accounts are in balance. In light of the debt crisis of 1982, economists adopted a more conservative view of current account deficits and argued that large deficits 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 financing the current deficit than on the size of the deficit. This was reinforced in the

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1990s as highly volatile portfolio investments became an important source of external financing. Frequent crises in the 1980s and 1990s also led to an interest in the cost of reversals in the current account. Current account reversals significantly impact on growth by reducing investment (Edwards 2000). Equally important, capital inflow bonanzas to finance current account deficits are associated with a higher likelihood of economic crises, including debt defaults, banking, inflation and currency crashes (Reinhart and Reinhart 2008). In sum, a country’s external position matters to investment and growth. High current account deficits and highly volatile external financing 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 flows over long periods is of critical importance as it reduces the vulnerability of the economy to “sudden stops” in capital flows reducing the likelihood of costly economic crises. While there is little debate about the contribution of remittances as a source of substantial and stable foreign exchange, the implications for investment 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 fiscal policies to encourage domestic investment have fallen out of favor in the context of recurring current account problems.

Fiscal policy and deficits The discussion above relates aggregate domestic investment to the current account balance. The right hand side of equation (1) can be expanded to distinguish between the private and public sector investment: (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 fisFfD: Finance or Penance for the Poor

cal policy, equation (2) can be rearranged, thus: (3)

(T-G) = (Sp-Ip) + (X-M)

Equation (3) says that the budget deficit is equal to the saving-investment deficit plus the current account deficit. This implies the crowding-out problem: holding the current account balance constant, an increase in the budget deficit will result in a reduction in private sector investment. Until the 1990s, economists 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 deficit and the current account deficit. The dominant view is that large budget deficits lead to the high current account deficits which can lead to instability and crisis. There is no one-to-one link between the budget deficit and current account deficit, but the implication of remittances to this analysis is that a smaller current account deficit or a higher current account surplus allows the economy to post higher budget deficits to stimulate investment and growth.

Financing the deficit The link between the budget deficit and the current account deficit can also be seen from the point of view of financing the budget deficit. The budget deficit can be financed in four ways: printing money, running down foreign exchange reserves, borrowing abroad, and borrowing domestically. Each form of financing has its drawbacks. Printing money is associated with inflation. Running down foreign exchange reserves is associated with the onset of exchange crises. Foreign borrowing is associated with an external debt crisis. Domestic borrowing is associated with high interest rates and unsustainable debt levels (Easterly and Fischer 1990). Each form of financing the budget deficit relates to the country’s external balance. The objection to using foreign exchange reserves to finance the deficit is that sooner or later the central bank’s reserve holdings are exhausted and the inevitable happens. But even before that point is reached, the private sector’s FfD: Finance or Penance for the Poor

expectation that the limit is about to be breached can provoke capital flight and a balance of payments crisis. 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 borrowing to finance the budget deficit are well-known as these have been amply illustrated by past debt crises. As foreign debt accumulates, the country finds it increasingly difficult to generate the foreign exchange needed to service the foreign debt. The situation is compounded by loss of confidence among creditors as debt levels begin to reach unsustainable levels. The link between the budget deficit and foreign borrowing is closer the smaller the domestic capital market is and the more limited domestic borrowing possibilities are. As for printing money to finance the deficit (monetizing the deficit) the objection is that the resulting inflation would lead to a depreciation of the currency and that the mere threat of a large depreciation and high inflation would lead to a massive capital flight (De Dios et al 2004). The latter requires capital controls to ensure that the situation does not get out of control. But the main objection to monetizing the deficit is that it leads to inflation. “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 deficits and inflation are in order because this is at the heart of much of the bias against deficit spending. Taking off from Milton Friedman’s famous dictum that inflation 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 deficit. Rapid money growth is conceivable without an underlying fis-

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cal imbalance, but it is unlikely. Thus rapid inflation is almost always a fiscal phenomenon.” First, developing countries have considerable room for monetizing the deficit while keeping inflation 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 inflation and that the maximum rate of seignorage is attained at inflation rates of between 30 percent and more than 100 percent. Second, such rates of inflation, 30 percent to 100 percent, seem alarming compared to currently low inflation rates, the latter a product of decades of single-minded focus on inflation fighting regardless of the adverse effects on output and employment. But the empirical evidence shows that only high inflation is costly. How high is high? Stiglitz (1998) summarizes the empirical evidence: “Bruno and Easterly (1996) found that when countries cross the threshold of 40 percent annual inflation, they fall into a high-inflation/lowgrowth trap. Below that level, however, there is little evidence that inflation is costly. Barro (1997) and Fischer (1993) also confirm that high inflation is, on average, deleterious for growth, but they too, fail to find any evidence that low levels of inflation are costly. Fischer finds the same results for the variability of inflation. Recent research by Akerlof, Dickens, and Perry (1996) suggests that low levels of inflation may even improve economic performance relative to what it would have been with zero inflation (emphasis in the original). “The evidence on the accelerationist hypothesis (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 inflation rate is related to past increases in inflation. Evidence on reversing inflation suggests that the Phillips curve may be concave and that the costs of reducing inflation may thus be smaller than the benefits incurred when inflation is rising” (Stiglitz 1998).

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Easing the financing constraints Remittances directly impact on some of these forms of financing. Concerns about the dangers posed by deficit spending from the point of view of financing the deficit assume an excess demand for foreign exchange. In the context of a current account surplus due to strong inflows of remittances, such fears are greatly exaggerated. Exhaustion of reserves can be avoided by calibrating their use taking into consideration normal requirements 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 financing must take into account the normal reserve requirements for trade and capital management purposes. 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 reserve 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 confidence rather than weakness and near-panic. Nonetheless, it may be prudent, though, to put in place some forms of capital control to reduce the risk of contagion or self-fulfilling prophesies to which financial markets are prone. While capital controls may discourage capital inflows, this should not be a cause for concern given strong remittance flows and the surplus in the current account. Using reserves to finance the deficit reduces the need for foreign borrowings, which translates to savings on interest payments. Equally important, remittances 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 borrowing by the government tends to push the private sector 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 FfD: Finance or Penance for the Poor

because of remittances makes the servicing of the existing foreign debt less costly in peso terms. Finally, remittances, by slowing down the rate of exchange depreciation, slow down inflation, offsetting the inflationary effects of deficit spending. In sum, the objection to budget deficits to stimulate growth and investment rests on the assumption 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 fiscal deficit that the economy can accommodate as well as forms of financing the deficit. Remittances allow a higher budget deficit without risking a foreign exchange crisis, regardless of the preferred means of financing the deficit. At the same time, remittances make some form of financing the deficit more attractive, in particular, the use of foreign exchange reserves accumulated from remittances.

Opportunity cost of reserves The discussion so far on the implications of remittances 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 financial 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 foreign exchanges reserves, the social costs of such reserves, their use for investment (in sovereign wealth funds) and development financing, the implications for monetary policy and exchange rate management, and so on. The issues raised in the literature are obviously 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 FfD: Finance or Penance for the Poor

difference between the economic returns on investments in physical and human capital in developing countries and return on reserves (in particular the portion held as interest bearing deposits or as shortterm 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 developing nations from a successful conclusion of the Doha round of trade negotiations. The high cost of holding reserves raises the question of why developing countries have been accumulating reserves at unprecedented and sub-optimal (excessive) levels. Reserves, of course, are needed to smooth out payment imbalances from current account 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 flows for two reasons: because trade imbalances are likely to be randomly distributed (the size of reserves should increase in proportion to the

123

square root of the increase in trade) and because innovations in the financial 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 inflows, the central bank intervenes in the foreign exchange market to prevent the appreciation of the local currency and maintain the competitiveness of exports. While plausible, Aizenman and Woo (2005) find that the mercantilist motive cannot quantitatively account for the recent build-up. Moreover, Griffith-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 significant. The growing literature on foreign reserves points to self-insurance against risks and uncertainties arising from financial 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 widely noted, for example, that the rapid accumulation of foreign exchange among developing countries accelerated after the series of financial crises following the Asian debacle in 1997. Financial globalization has increased the need for higher reserve holdings. The Guidotti-Greenspan 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, financial globalization imposes greater demands than implied by the Guidotti-Greenspan rule. The evidence shows that central banks have been accumulating reserves in relation to financial variables, notably M2, in re-

124

sponse to uncertainties arising from financial liberalization (Aizenman and Woo 2005; Obstfeld et al 2007). This is because with open capital account, the potential pressure on the exchange rate and the financial system comes not only from foreign investors but also from domestic financial and non-financial 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 percent 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 reserves 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 deficit even at its height in 2002. The annual cost of reserves is more than three to six times the annual cost of financing 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 consequences, if any, of tapping the reserves at a modest 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. FfD: Finance or Penance for the Poor

Table 3. Cost of excess reserves

GIR

3-mo import cover

1999

15,064

10,065

2000

15,063

2001

Excess GIR

Cost of excess GIR $million

Cost of excess GIR as % of GDP

% of GDP

10%

20%

GDP in $m

10%

20%

4,999

6.6%

500

1,000

75,632

0.7%

1.3%

12,985

2,078

2.7%

208

416

76,724

0.3%

0.5%

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%

6,633

6.9%

663

1,327

96,262

0.7%

1.4%

6,633

13,266

4.5%

8.9%

Annual ave

$ million

Cumulative 1999-2008

Ironically, while there has been little support for tapping foreign reserves for development financing, there is strong global support for increased foreign aid in order for developing countries, including the Philippines, to be able to achieve the MDG. Locally, 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 officials at all levels.) Foreign aid, foreign direct investment, and any capital flows have the same monetary implications as the use of reserve holdings of the central bank. Some quarters have put forward the idea of securitizing remittance flows for foreign borrowing (Ratha 2003), which has the benefit of lowering the spread on the governmentâ&#x20AC;&#x2122;s bond issuances. Besides the difficulty of securitizing these flows, this seemingly sophisticated proposal is a roundabout and costly way of using foreign reserves for development. Direct use of foreign reserves saves the economy interest payments on new foreign debt, besides professional fees alluded to above. Note, however, that the FfD: Finance or Penance for the Poor

use of reserves is not different from borrowing abroad in terms of monetary implications. A more rational approach would combine capital account management policies to reduce the risk of global financial flows, hence reduce the need for reserve holdings and to invest the excess reserves to augment the economyâ&#x20AC;&#x2122;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 inflows.

VI. Concluding remarks The implications of remittances on macroeconomic policy, specifically fiscal 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 financial 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. 125

In the early part of this decade, the size of the fiscal deficit and the public debt raised alarms once again as the fiscal deficit peaked at over four percent of GDP in 2002 and the public debt hit 130 percent of GDP. The government responded with a combination of spending cuts and new taxes to keep the deficit in check. A benign environment of low inflation, low interest rates, appreciating currency, and strong demand for government securities eased the situation. In the latest episode, remittances entered the discussion but in a tangential manner. It was widely acknowledged, 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 remittances. But it was believed that the situation was unsustainable. An influential 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 exchange than it spends (thanks especially to overseas 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 fiscal austerity (Lim

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2007). While the current fiscal policy acknowledges the contribution of remittances, it maintains the key assumption that the country faces an excess demand of foreign exchange, notwithstanding the rapid accumulation of foreign exchange reserves and, until the current global financial crisis, the strong pressure on the peso to appreciate. This raises the issue of whether fiscal 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 fiscal policy, in particular, so as to allow higher investment and economic growth. The need to change gears when it comes to fiscal policy gains urgency in light of the global crisis which triggered a drop in export demand and domestic consumption. The slowdown in investment activities of the private sector—foreign and local—places the burden of stimulating the economy on the public sector. Current proposals of deficit 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 remittances. Beyond paying lip service to the heroic contributions of overseas workers, economic policymakers need to figure 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.

FfD: Finance or Penance for the Poor

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Tan, Edita (2000). Overseas Filipinosâ&#x20AC;&#x2122; Remittance Behavior. UPSE Discussion Paper ___, University of the Philippines School of Economics, Quezon City. Tullao, T. and M. Cortez and E. See (2007). The Economic Impacts of International Migration: A Case Study on the Philippines. Paper presented at the International Conference and Panel Discussion on East Asian Labor Migration, NEDA Bldg, Makati City. Yang, Dean (2008). International Migration: Remittances, and Household Investment: Evidence from Philippine Migrantsâ&#x20AC;&#x2122; Exchange Rate Shocks. Economic Journal, 118 (528). Yap, Josef (2008). Managing Capital Flows: The Case of the Philippines. PIDS Discussion Paper 2008-04, Philippine Institute for Development Studies (PIDS), Makati City.

FfD: Finance or Penance for the Poor

129

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

Introduction This 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 thorough diagnosis to determine the countryâ&#x20AC;&#x2122;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 Monterrey Consensus, this essay sets its focus on the section titled: â&#x20AC;&#x153;Addressing systemic issues: enhancing the coherence and consistency of the international monetary, financial and trading systems in support of development.â&#x20AC;? FfD and MDG FfD 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, demagogues, 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 fight poverty and bring about prosperity, especially for the less-developed countries. A commonly repeated statement, a stylized fact, is that without augmented financing, the MDG cannot be met. In a manner, the FfD is the recycled version of the financing-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 financed through external sources like foreign debt, ODA, and FDI. What supposedly makes the FfD different from the old financing-gap approach is that it has the benefit 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, FfD: Finance or Penance for the Poor

131

achieving universal primary education, promoting gender equality, reducing child mortality, improving maternal health, combating HIV/AIDS, malaria and other diseases, ensuring environmental sustainability, and fostering global partnerships for development. Each goal has specific, time-bound targets. Obviously, all these goals are laudable. And they are plain and straightforward; in fact, they are mainly motherhood statements. The difficult part is how to achieve these goals. The FfD attempts to provide an answer. The assumption is that the fulfillment of the MDG requires tremendous resources. Hence, FfD becomes an overarching framework that weaves together major themes or what the official document calls “leading actions.” To wit: the mobilization of domestic financial resources (e.g, taxation), international trade, international private resources (e.g., FDI), international financial cooperation (mainly ODA), external debt, and systemic issues that will provide the coherence of the multilateral monetary, financial, and trading systems.

A Critique of the FfD Approach Just 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 Consensus. To illustrate, here is a tiring, verbose statement from the FfD document: “We stress the need for multilateral financial institutions, in providing policy advice and financial 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 poverty, 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 132

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 develop. 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 development 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-targeted and suited to concrete conditions, they can reinforce internal development reforms. The FfD and MDG are blueprints, but the problem with blueprints is that their models and details do not exactly correspond to the complexity of development 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 development? Domestic mobilization of resources is critical, but the FfD by itself does not offer explicit proposals on improving tax policy and administration in the Philippines. The best it can do is to reiterate the basic principles of domestic revenue generation and share best national practices that cannot be replicated easily in other country settings. FfD: Finance or Penance for the Poor

On international trade, we ask the question: Will liberalization under the World Trade Organization or under bilateral agreements result in longterm 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 emphasizes instead the critical role of domestic institutional 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 liberalization-growth relationship suffer from methodological problems such as the direction of causality, the identification 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 matter? The FfD urges the developed countries to meet the target of ODA to developing countries, equivalent 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 relationship, positive or negative, between aid and growth. What makes their study different from previous ones is that their paper takes into account different settings (time horizons, time periods, crosssection and panel data, types of aid). Further, their paper addresses the problem of endogeneity (that is, whether increasing aid leads to good economic performance 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 FfD: Finance or Penance for the Poor

is that the authors “no longer find that aid promotes growth in good policy environments.” What needs further study is the role of total factor productivity (TFP) in long-term growth. Easterly says the TFP’s conceptions have yet to be fully explained. 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 institutions, formal as well as informal, are country-specific. 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. Indeed, even for the short run, we must be conscious of working out the appropriate institutional arrangements 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 refine 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.

Diagnostics This brings us to the relevance of country growth diagnostics, as amplified by Hausmann, Rodrik, and Andres Velasco (2004), among others. The key in growth diagnostics is to identify the economy’s binding constraint(s). Figure 1 is an illustration of how growth diagnostics is done (from Hausmann, Rodrik and Velasco, 2004). How growth diagnostics can be applied to determine and resolve the Philippines’ main binding constraints is well beyond the scope of this paper. Fortunately, the ADB and the WB have applied growth diagnostics to the Philippine situation. 133

Figure 1. Growth Diagnostics (from Ricardo Haresmann et al., 2004)

Problem: Low levels of private investment and entrepreneurship

Low return to economic activity

Low social returns

High cost of finance

bad international finance

Low approriability

government failures

poor geography

low human capital

micro risks: property rights, corruption, taxes

macro risks: financial, monetary, fiscal instability

The ADB has embarked on a project titled “Strengthening Country Diagnosis and Analysis of Binding Development Constraints in Selected Development 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/country-studies.asp. Alessandro Bocchi, a WB economist, has also written a paper that deals with growth diagnostics and binding constraints (2007). Suffice it to say that the ADB and WB diagnosis papers on the Philippines have a lot of common points—on good governance and elite capture of the state, on corruption, on fiscal 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, international mechanisms such as the FfD become a secondary matter, unless it turns out that the main binding constraint on sustained growth in the Philippines

134

market failures

information externalities “self-discovery”

bad infrastructure

bad local finance

coordination externalities low domestic living

poor intermediation

pertains to global rules. Being secondary does not suggest that the FfD becomes irrelevant. For global rules and commitments can support or for that matter weaken domestic reform initiatives. That FfD as an international instrument is secondary is an affirmation that development is internally driven. External factors nevertheless can provide an enabling environment for national processes 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 concept 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 FfD: Finance or Penance for the Poor

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 integration.” 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 respect to the FfD’s systemic issues vis-à-vis Philippine concerns.

economic crisis. For its political survival, the beleaguered administration was compelled to undertake the painful measures to boost revenues. Despite the increase in revenues, the revenue collection agencies, especially the Bureau of Internal Revenue, are having difficulty meeting their targets. The implication is that tax administration remains a serious problem. Furthermore, much still has to be done in relation to tax reforms. The rationalization of fiscal incentives has always met stiff resistance. The infirmities 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 development (e.g., health and education) and infrastructure has fallen. To be sure, the compression of productive spending contributed to the narrowing of the fiscal deficit. This of course was a bad tradeoff, something that could have been avoided in the first place.

Domestic Resource Mobilization The mobilization of domestic financial resources is a primary concern. The Philippines has tentatively moved out of the danger zone in relation to its fiscal position. The national government budget deficit and the consolidated public sector deficit are now manageable. In 2004-05, a fiscal crisis was on the verge of breaking out. But a series of revenue measures, especially the increase in the rate of the value-added tax (VAT) from 10 percent to 12 percent, staved off the fiscal threat that could have turned into a full-blown

Public Investments The decline in spending for health, education, and infrastructure, among others, threatens longterm growth.

Figure 2. Decrease in spending for essential services: infrastructure, health and education (as a percentage of GDP)

3.0 2.5 2.0

Infrastructure

2.5

1.9

1.8

Basic Education

Health

1.8 1.6

1.6

1.5 1.5

1.5

1.5 1.3 2.5

1.0

1.2

0.7 O.5

0.5

O.4

0.5

O.3

O.2

0 1999

1999

Source: Department of Finance

FfD: Finance or Penance for the Poor

135

The spending gap in these productive sectors can be partially addressed through financing 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 redundant 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 financing from China, exemplifies the worst features associated with bad ODA projects. The NBN (already canceled in the wake of intense popular opposition) intended to provide another broadband backbone, to be operated by government, but this was unnecessary in the first place. The country has capable and sufficient backbones, thus making another backbone, using public money, redundant. An additional 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 officials. 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 complacent in light of the improvement of the fiscal position, is again resorting to foreign borrowing without clear development objectives. (Again, the NBN and Cyber-education projects attest to this.) Worse, additional borrowing, especially borrowing to finance economically and unsound projects, contributes to the strengthening and overvaluation of the Philippine peso.

Exchange Rate The continued appreciation of the peso is a serious 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 partially 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 substitutes). They now have to compete with cheaper imports, apart from the rampant smuggling of goods whose prices have further cheapened because of the strong peso.1 A specialized role for the IMF is to monitor the movement of the exchange rate, including a determination of whether the domestic currency is overvalued or undervalued. The task of exchange rate monitoring or surveillance has gained more significance in the wake of the Asian financial crisis in 1997. There is consensus among economists and other policymakers that overvalued currencies contributed to the 1997 financial crisis. The IMFâ&#x20AC;&#x2122;s own computation of the real effective exchange rate or REER (see Table 1) showed a slightly overvalued peso (as of March 2007).

Editorâ&#x20AC;&#x2122;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 financial 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.

136

FfD: Finance or Penance for the Poor

Table 1. Market rate, nominal effective exchange rate, and real effective exchange rate indices (2000-March 2007), from the IMF Units National Currency per US Dollar

None

Scale

Index Number

None

Index Number

None

Units National Currency per US Dollar

None

Index Number

None

Index Number

None

Units National Currency per US Dollar

Scale None

Index Number

None

Index Number

None

Units National Currency per US Dollar

None

Index Number

None

Index Number

None

Units National Currency per US Dollar

None

Index Number

None

Index Number

None

Units National Currency per US Dollar

None

Index Number

None

Index Number

None

Units National Currency per US Dollar

Scale None

Index Number

None

Index Number

None

Units National Currency per US Dollar

None

Index Number

None

Index Number

None

Scale

Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP Descriptor MARKET RATE NEER FROM INS REER BASED ON REL.CP

2000M1

2000M2

2000M3

2000M4

2000M5

2000M6

2000M7

2000M8

2000M9

2000M10

2000M11

2000M12

40.39

40.85

41.06

41.28

42.83

43.15

44.94

45.08

46.28

51.43

49.39

50.00

106.00

107.11

105.90

105.19

105.30

102.35

99.05

98.24

96.91

93.02

90.44

90.48

104.22

105.63

104.59

104.43

104.79

102.01

99.01

98.56

97.36

94.16

92.21

93.04

2001M1

2001M2

2001M3

2001M4

2001M5

2001M6

2001M7

2001M8

2001M9

2001M10

2001M11

2001M12

49.41

48.26

49.38

51.22

50.58

52.37

53.56

51.21

51.36

51.94

52.02

51.40

89.04

93.97

95.07

92.96

92.16

90.96

88.40

88.99

89.74

89.65

89.61

90.75

92.09

97.81

99.27

97.15

96.43

95.40

93.22

93.84

94.95

95.05

95.12

96.86

2002M1

2002M2

2002M3

2002M4

2002M5

2002M6

2002M7

2002M8

2002M9

2002M10

2002M11

2002M12

51.20

51.35

51.15

50.74

49.97

50.42

51.29

51.81

52.45

53.02

53.59

53.10

92.88

92.90

92.88

92.78

93.26

90.94

88.81

87.35

87.17

86.74

85.52

84.79

99.04

99.06

99.57

99.50

100.27

97.42

95.25

93.97

93.88

93.48

91.85

91.34

2003M1

2003M2

2003M3

2003M4

2003M5

2003M6

2003M7

2003M8

2003M9

2003M10

2003M11

2003M12

53.80

54.35

53.53

52.82

52.28

53.71

54.69

55.11

54.94

55.25

55.77

55.57

83.49

82.78

82.05

84.99

83.89

82.39

82.29

80.69

79.79

78.43

77.84

76.96

90.31

89.96

89.07

92.82

91.93

90.71

90.45

88.73

87.85

86.46

85.83

85.02

2004M1

2004M2

2004M3

2004M4

2004M5

2004M6

2004M7

2004M8

2004M9

2004M10

2004M11

2004M12

56.09

56.28

56.36

55.86

55.84

56.18

56.01

56.22

56.34

56.35

56.23

56.27

76.07

75.14

75.55

76.02

77.32

76.47

76.38

76.87

76.16

75.45

74.24

73.27

84.26

83.43

84.19

85.11

86.92

86.75

87.45

88.31

88.08

87.49

86.50

86.09

2005M1

2005M2

2005M3

2005M4

2005M5

2005M6

2005M7

2005M8

2005M9

2005M10

2005M11

2005M12

55.11

54.72

54.79

54.35

54.37

55.92

56.11

56.16

56.06

55.06

54.00

53.07

78.31

75.32

75.61

76.25

76.59

76.25

76.00

75.49

75.48

77.18

79.41

80.54

92.34

88.91

89.45

90.68

91.60

91.45

91.40

90.93

91.07

93.53

97.04

98.79

2006M1

2006M2

2006M3

2006M4

2006M5

2006M6

2006M7

2006M8

2006M9

2006M10

2006M11

2006M12

52.34

52.09

51.28

51.83

52.65

53.59

51.62

50.94

50.39

49.81

49.76

49.13

80.71

82.38

83.21

82.40

79.53

78.88

80.09

81.56

83.33

84.42

83.91

83.90

99.07

102.35

103.82

102.71

99.18

98.33

100.03

102.03

104.66

106.56

105.66

105.43

2007M1

2007M2

2007M3

49.03

48.29

48.26

85.66

86.51

85.63

107.56

108.43

107.21

continuation, next page

FfD: Finance or Penance for the Poor

137

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.

What is interesting regarding the exchange rate issue is not only the conclusion that an overvalued currency is bad for growth but more to the point, an undervalued currency translates into higher long-term growth. A recent empirical paper by Rodrik (2007) explains the significance of currency undervaluation to long-term growth.

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 ** Authorâ&#x20AC;&#x2122;s calculations using BSP data *** Only covers January to September 2007

138

FfD: Finance or Penance for the Poor

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 inflow 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 influence the country’s exchange-rate policy. Nevertheless, the BSP is in a position to temper the quick appreciation of the peso. To its credit, it has occasionally intervened in the foreign currency market to smoothen the fluctuations that point to further peso strengthening. Nevertheless, its present effort has so far been insufficient to curb the continued appreciation of the currency. There is in fact a policy bias for currency appreciation, given that the BSP rigorously, or even rigidly, pursues its mandate of targeting inflation. A policy of targeting inflation, however, should not undermine other development or economic objectives like increasing employment and sustaining productive growth. GMA, too, has expressed her support for a “strong peso.” Hence, we have a situation where both the Executive and the independent BSP are in full agreement 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.

Institutions In the section on systemic issues, the FfD document mentions this: “Good governance at all levels is also essential for sustained economic growth, poverty eradication and sustainable development worldwide.” 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.) FfD: Finance or Penance for the Poor

It is the building of good, strong, robust institutions 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 Philippines 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 political 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 attitudes and behavior of politicians, businessmen, and other agents to make everyone responsible and ruleabiding 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 positive contributions. In many instances, conditionalities tied to ODA or debt packages have not worked. But some conditionalities—those sensitive to social and economic standards and not violative of basic economic principles—are unavoidable, to promote transparency and accountability and to address moral hazard problems. In this light, the engagement of the European Union, the United States, and the UN agencies in tackling crucial development concerns such as corruption, regulatory capture, extra-judicial killings and other human-rights violations is most welcome. Tying aid to the promotion of human rights and the resolution of extra-judicial killings is not interference. Speaking out against high-level corruption and abuse of power is not interference. They are statements that affirm universal principles.

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To return to the growth diagnostics exercise, the identification of the main binding constraints is not confined to purely economic variables. The binding 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 undemocratic, 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) explicitly 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 beset the Philippine economy since time immemorial. Thus, rebuilding the country’s institutions is an absolutely necessary task.

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Concluding Remarks To conclude, this essay situates the FfD to finance the MDG within the context of the most relevant economic and development issues in the Philippines. The FfD’s “leading actions” need to be reviewed in light of new studies and findings regarding the contribution 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 nationally owned institutional and policy reform innovations.

FfD: Finance or Penance for the Poor

References

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.

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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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