report on economic and financial developments · slower growth in prices. ... rates, and softening...

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2001 2nd Quarter Report

1

A. OVERVIEW

Despite the slowdown in the economies of the country’s major trading partners, the Philippines’ gross domestic product (GDP) grew by 3.3 percent in the second quarter, within the Government’s revised target for the year and higher than the 2.8-3.0 percent forecast for the period under review. On the supply side, growth was underpinned by the gains registered across major sectors. On the demand side, growth was driven mainly by the increase in personal consumption expenditures and investments, which offset the slack in external demand. Inflation during the period remained moderate, contributing to the downtrend in domestic interest rates. In the external sector, the balance of payments registered a deficit due to the weakening of the current account as well as the financial and capital accounts. Gross international reserves stood at US$14.556 billion, more than adequate to cover 4.3 months worth of imports of goods and payments of services and income. The banking system meanwhile, continued to post an increase in its resources and remained adequately capitalized, notwithstanding the challenges posed by the economic environment. ��Better-than-expected economic performance. The Philippine

economy’s performance defied the market’s consensus of a lower growth in the second quarter, as it grew by 3.3 percent during the second quarter, slightly higher than the previous quarter’s growth of 3.2 percent. On the supply side, growth was traced to the upturn in industry (3.6 percent), services (3.4 percent) and agriculture (2.5 percent). On the demand side, the economic expansion was driven by the growth in personal consumption (3.2 percent) and investments (3.4 percent).

��Slower growth in prices. The inflation rate in the second quarter of

2001 moved along its projected path for the year. Headline inflation was recorded at 6.7 percent, lower than the 6.8 percent posted in the previous quarter on account of lower prices for food as well as fuel, light and water items.

��Lower interest rates. The continued easing of monetary policy

during the second quarter on account of the benign inflationary


2

outlook translated to further easing of interest rates. Mild inflation, moderately growing demand, generally stable foreign exchange rates, and softening of foreign interest rates led to the easing of monetary policy and subsequently the downtrend in interest rates.

��Faster growth in domestic liquidity. Domestic liquidity rose by

13.0 percent to P1.5 trillion as of end-June 2001, faster than the 11.5 percent recorded for the same period last year. The continued growth of liquidity during the quarter reflects the accommodative stance of monetary policy, prompted by expectations of easing inflationary pressures and efforts to complement the economy’s output growth objectives. The increase in domestic liquidity was accompanied by the continued growth in credits to the private and public sectors, which grew by 3.0 percent and 12.1 percent, respectively.

��Wider National Government (NG) deficit. The shortfall in revenues

relative to the first quarter coupled with the increase in expenditures resulted in a higher NG deficit. The cash operations of the NG registered a P39.9 billion deficit in the second quarter of 2001, P2.0 billion higher than the previous quarter’s deficit. Compared to the program, this quarter’s actual deficit exceeded the programmed level by P7.8 billion as actual revenues fell below the target while actual expenditures exceeded the target.

��Smaller balance of payments deficit. The country's balance of

payments shortfall contracted substantially to US$94 million. This was an improvement from the US$777 million deficit during the same period last year and the US$512 million deficit in the previous quarter.

��Lower international reserves. The Bangko Sentral ng Pilipinas’

(BSP) gross international reserves (GIR) dropped slightly to US$14.556 billion as of end-June 2001 from US$14.671 billion at end-March 2001. While lower than the previous quarter's level, the GIR was more than sufficient to cover 4.3 months worth of imports of goods and payments of services and income and more than twice the level of the country's short-term debt as of end-March 2001.


3

��Weaker peso. The peso weakened by 3.0 percent from the previous

quarter to average P50.74/US$1.00 in the second quarter due to the depreciation of emerging market currencies, the slowdown in the US economy, the financial crisis in Argentina, weak Philippine exports and the hostilities in Southern Mindanao.

��Sustained resiliency of the banking system. The banking

system’s aggregate resources expanded by 2.4 percent to P3,414 billion from the level recorded in the previous quarter in the face of challenges brought about by the macroeconomic environment. The system’s generally liquid position, strong capital base and manageable asset quality were among the key factors that underpinned its resiliency.

B. REAL SECTOR ��Production Aggregate Output

Despite the economic slowdown in the country’s major trading partners, the Philippine economy grew at a pace well within the government’s revised target, beating the market’s consensus of a lower growth in the second quarter of 2001. The resiliency of the economy was evidenced by the sustained growth across all major sectors on the supply side and the strength of personal consumption and investment spending on the demand side.

Gross Domestic Product

(GDP) grew by 3.3 percent during the second quarter of this year, slightly higher than the GDP

Real Gross National ProductAnnual Growth Rates in Percent

0

1

2

3

4

5

6

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

1999 2000 2001


4

growth performance of 3.2 percent in the previous quarter (Table 1). Likewise, Gross National Product (GNP) posted a higher growth rate of 3.5 percent compared with the previous quarter’s 3.3 percent as net factor income from abroad (NFIA), which inched up by 6.8 percent during the second quarter, provided added stimulus to GNP. The GDP and GNP growth rates were well within the government target range for the quarter of 3.2-3.7 percent and 3.4-4.0 percent, respectively. Overall economic performance during the quarter, however, indicated some slowing down when compared to the same period last year.

On the supply side, the sectors performed favorably when

compared to the first quarter performance as well as the performance of the second quarter in the previous year. Behind the 3.3 percent expansion in the GDP were the contribution of the following sectors: services, 1.54 percentage points; industry, 1.13 percentage points; and the agriculture, fishery and forestry sectors, 0.63 percentage point.

The services sector

contributed significantly to domestic output during the quarter even as its growth decelerated to 3.4 percent from 4.2 percent in the previous quarter and 4.9 percent from the same period last year. In particular, the transportation, communication and storage, trade, and private services sub-sectors were the main drivers of activity in the services sector, expanding by 7.1 percent, 4.5 percent and 3.4 percent, respectively.

The industry sector also performed moderately well during the

quarter under review at 3.6 percent, much higher than the 1.6 percent growth recorded in the previous quarter, and the 3.5 percent growth in 2000. This was mainly on account of the turnaround in construction as well as in the mining and quarrying sub-sectors. Manufacturing and electricity, gas and water, sustained their growth, albeit with some deceleration, at 2.6 percent and 3.5 percent, respectively.

Real GNP, By Industry ClassificationAnnual Growth Rates in Percent

-4

-2

0

2

4

6

8

10

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Agriculture, Fishery and ForestryIndustryServices

1999 2000 2001


5

The expansion in agriculture, fishery and forestry output during the second quarter slowed down to 2.5 percent from 3.5 percent in the previous quarter, and 4.5 percent in the comparable quarter in 2000. The growth of farm output decelerated following a contraction in the output of corn and coconut (including copra) alongside a slowdown in the production of major agricultural crops such as sugarcane, banana, and other crops, among others.

Aggregate Demand

On the demand side, the economic expansion was driven mainly by

personal consumption expenditures and investments (gross capital formation), which offset the slack in external demand indicated by lower export growth.

Personal consumption

expenditures (PCE) registered a slightly lower growth of 3.2 percent from 3.5 percent in the previous quarter but showed a steady growth compared to the same quarter in 2000. Public consumption, however, contracted by 2.4 percent from a 3.0 percent growth in the previous quarter due to the substantial cut in government expenditures.

Capital formation grew by 3.4 percent during the second quarter

as spending on construction and breeding stock and orchard development expanded by 5.9 percent and 4.3 percent, respectively, from negative 2.6 percent and 4.0 percent in the previous quarter. This development was attributed to the rebound in public construction as a result of continuing projects under the Build-Operate-Transfer (BOT) scheme. Meanwhile, spending on durable equipment contracted by negative 0.1 percent due largely to the steep decline in spending on transport equipment.

Real GNP, By Expenditure ShareAnnual Growth Rates in Percent

-8

-6

-4

-2

0

2

4

6

8

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Personal ConsumptionGovernment ConsumptionInvestments

1999 2000 2001


6

Exports contracted significantly by 4.1 percent during the quarter

under review following increases of 5.4 percent and 16.0 percent during the previous quarter and the same quarter last year, respectively. Semiconductors and finished electrical machinery, which together accounted for almost a third of total exports, declined significantly by 31.1 percent and 18.4 percent, respectively. Similarly, imports of goods and services continued to decelerate, posting a 2.3 percent increase during the second quarter compared to 4.3 percent in the previous quarter.

��Stock Market Developments

The average quarterly Philippine Stock Exchange Composite Index (PHISIX) fell to 1397.1 points, 11.7 percent lower than the previous quarter’s average. On an annual basis, the PHISIX plunged by 9.1

percent compared to the index in the same period in 2000 (Table 2).

The bearish sentiment in the stock market could be traced to domestic concerns including the widening public sector budget deficit, the downgrade in the growth projections by the government due to the contraction in exports, the

hostage crisis in Mindanao, and external factors particularly concerns about global economic slowdown, which has affected the economic activity of the various emerging markets.

The value of transactions traded in the second quarter declined by

25.0 percent to P40.7 billion from the first quarter level of P54.3 billion. The decline arose mainly from the substantial drop in the value of shares traded in the commercial and industrial (P4.9 billion) and property (P8.4 billion) sectors. Compared with the second quarter figures in 2000, the value of transactions traded contracted by a larger 48.9 percent.

The Philippine Composite Index (PHISIX)In Index Points, Average

0

500

1000

1500

2000

2500

3000

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

1999 2000 2001


7

The volume of transactions in the second quarter contracted by 47.1 percent to 32.8 billion shares from 62.0 billion shares in the previous quarter. The volume of trading in all the sectors declined, with volume turnover contracting sharply in the commercial/industrial (14.7 billion), mining (8.4 billion) and oil (3.9 billion) sectors. On an annual basis, this quarter’s total volume turnover was lower by 77.0 percent than the levels recorded in the same quarter in 2000. Despite the bearish mood in the market, market capitalization, defined as the closing price of stocks multiplied by the number of outstanding shares, as of end-June 2001 increased by 9.6 percent to P2.45 trillion from P2.23 trillion at the end of the previous quarter. Similarly, stock market capitalization in US dollar terms rose by 3.3 percent during the comparable period despite the weaker peso, while the average daily turnover nearly doubled to P802.9 million as of end-June from about P404.6 million as of end-March. Following the 6.3 percent increase in the U.S. Dow Jones Industrial Average, the average stock indices as of the end of the quarter rose across the Asian region compared to the previous quarter. The Hang Seng Index of Hong Kong, the Jakarta Stock Exchange (JSX) of Indonesia, the Strait Times Index of Singapore and the Stock Exchange of Thailand (SET), rose by 2.2 percent, 3.6 percent, 3.1 percent and 9.4 percent, respectively, compared to their levels in March 2001. The 0.2 percent fall in the Nikkei Index of Japan was accompanied by a decline in the PHISIX and the Kuala Lumpur Stock Exchange (KLSE) Index of Malaysia of 2.5 percent and 8.4 percent, respectively. ��Labor, Employment and Wages

Based on the Philippine labor force survey results for the month of April 2001, the employment rate increased by 0.6 percentage point to 86.7 percent from 86.1 percent in the same quarter last year (Table 3). This developed following a 3.8 percent

Em ploym ent IndicatorsIn Percent

0102030405060708090

100

Q 1 Q 2 Q3 Q4 Q 1 Q 2 Q 3 Q4 Q1 Q2

Em ploym entUnem ploym ent

1999 2000 2001


8

rise in the number of employed workers from the previous quarter to reach 29.2 million in the second quarter. Employment across all major sectors increased on a year-on-year basis. Employment in the agriculture, fishery and forestry sectors increased by 10.9 percent. In the industry sector, employment increased by 5.4 percent, particularly in the construction (7.8 percent) and manufacturing (5.6 percent) sub-sectors. Employment in the services sector also rose by 5.0 percent, particularly due to the increased employment in the wholesale and retail sub-sector (17.0 percent).

Compared to the January level of 88.6 percent, the employment

rate in April was 1.9 percentage points lower. However, this may be partly a result of the seasonal increase in the total labor force population in April as students and new graduates joined the workforce.

C. MONETARY SECTOR ��Reserve Money

Despite two successive cuts by the BSP of its RRP rate in the second quarter of 2001, the level of reserve money (RM) declined slightly

as of end-June 2001 to P282.0 billion from the end-March 2001 level of P284.4 billion (Table 4). The P2.4 billion drop in the RM level during the quarter reflected the P38.6 billion contraction in net domestic assets (NDA) of the BSP, which more than offset the P36.2 billion expansion in net foreign assets.

The decline in NDA can be traced mainly to the contractionary

impact of the buildup in banks’ deposits under their Special Deposit

Reserve MoneyIn Billion Pesos

0

50

100

150

200

250

300

350

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q21999 2000 2001


9

Accounts (SDAs) with the BSP, the decline in liquidity advances as banks paid off part of their outstanding liquidity loans with the BSP, and the outright sale of the BSP of its Treasury bill holdings. The increase in NFA, meanwhile, was traced to the buildup in gross international reserves coupled with the decline in BSP’s medium- and long-term liabilities.

On an annual basis, however, the level of RM expanded by 10.6

percent due to the improvement in both the NFA and NDA. The expansion in NFA was due mainly to an increase in gross international reserves. The expansion in NDA, meanwhile, was on account of the unwinding of RRP transactions, banks’ withdrawal from their SDAs with the BSP, and higher liquidity advances granted to banks. ��Domestic Liquidity

As of end-June 2001, domestic liquidity or M3 stood at P1.5

trillion, indicating an increase of 2.8 percent from the previous quarter. On an annual basis, M3 grew at a faster pace of 13.0 percent as compared to the 11.5 percent growth registered in the comparable period last year (Table 5).

By composition, peso

demand, savings and time deposits, which comprised about 88.5 percent of total domestic liquidity, rose by P42.3 billion or 3.3 percent during the second quarter relative to the previous quarter. Currency in circulation, which accounted for the remaining component of M3, decreased slightly by P2.4 billion or by 1.4 percent. Meanwhile, M4, which is defined as domestic liquidity (M3) plus foreign currency deposits (FCDs) of non-bank residents, reached P2.1 trillion as of end-June. On an annual basis, M4 registered an expansion of 13.6 percent in June 2001, from 11.5 percent in the comparable period a year ago. Likewise, M4 grew by 3.8 percent,

Domestic Liquidity (M3)

0

200

400

600

800

1000

1200

1400

1600

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q20

5

10

15

20

25

1999 2000 2001

In Billion Pesos In Percent per Annum


10

quarter-on-quarter, reflecting the 6.5 percent rise in foreign currency deposits (FCDs).

The continued growth in domestic liquidity was due in part to the

expansion in reserve money, which grew by 10.6 percent year-on-year in June. The liquidity growth also reflects the accommodative stance of monetary policy, as shown by the successive reductions in key BSP policy interest rates. This accommodative stance was prompted by expectations of a benign inflationary environment and efforts of the monetary authorities to provide broad support to the economy’s output growth objectives. The observed stronger expansion in M3 will help ensure an appropriate level of liquidity to allow domestic demand to strengthen and enable the economy to achieve non-inflationary output growth.

Meanwhile, the financial deepening ratio (defined as M3 over GNP),

which indicates the level of domestic mobilization of financial resources in the economy, increased slightly to 40.4 percent in the second quarter of 2001 from 40.3 percent in the previous quarter.

��Net Domestic Assets

The net domestic assets (NDA) of the monetary system as of end-June 2001 reached P1.8 trillion, representing a slight increase of 1.2 percent from the previous quarter’s level1. On an annual basis the growth in NDA moderated to 9.1 percent in end-June from the 10.4 percent in the comparable period of the previous year.

Compared to the levels in the previous quarter, net domestic

credits (NDC), a major component of NDA, grew slightly by 1.2 percent as of end-June 2001.1 The year-on-year growth of NDC slowed down to 5.6 percent, from the 10.4 percent growth registered in the comparable period of 2000. Credits to the public sector rose by 12.1 percent over the level a year ago to P643.7 billion. Meanwhile, private sector credits grew

1 Net Domestic Credits is the difference between Net Domestic Assets and Net Other Items. As of end-June 2001, Net Other Items, which is the difference between other assets and other capital and liabilities accounts, reached a higher negative level of P344.9 billion from P340.9 billion in end-March 2001. This implied an increase in the levels of capital (such as net income and revaluation gains) and other liabilities accounts over the level of other assets.


11

by about 3.0 percent year-on-year as of end-June 2001. The slowdown in domestic economic activity during the second quarter relative to the second quarter in 2000, which was due in part to the slack in external demand, limited private sector credit growth.

Commercial banks (KBs), which comprise the bulk of deposit

money banks (DMBs), remained the major source of credit. As of end-June 2001, loans outstanding of KBs continued to post positive growth at 4.0 percent, a slight deceleration from the 4.7 percent annual growth registered as of end-June of the previous year. Compared to the previous quarter, loans of KBs rose slightly by 1.1 percent. On an annual basis, bank lending registered increases in the following sectors: community, social and personal services, which grew by 17.7 percent; wholesale and retail trade, 17.1 percent; electricity, gas and water, 10.6 percent; manufacturing, 3.1 percent; and agriculture, fisheries and forestry, 0.6 percent.

As a percentage of GDP, domestic credits declined slightly to 61.0

percent as of end-June 2001 from 61.7 percent as of end-March 2001. The ratio of domestic credits to the country’s GDP also remained modest compared with those of other Asian countries, such as Taiwan (159.2 percent), Malaysia, (109.7 percent), and Korea (92.8 percent), but comparable to that of Indonesia (65.0 percent).

��Prices

Inflation in the second quarter of 2001 continued to move along its expected path for the year and remained within the government’s

inflation target range of 6.0–7.0 percent. The headline inflation rate for the second quarter of 2001 was recorded at 6.7 percent (Table 6). Although higher than the 3.9 percent recorded in the same quarter of the previous year, the second quarter inflation rate was slightly lower than the 6.8

Inflation RateIn Percent Per Annum

0

2

4

6

8

10

12

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

PhilippinesNCRAreas Outside the NCR

1999 2000 2001


12

percent posted in the previous quarter. The mild deceleration of inflation in the second quarter was traced

mainly to positive supply-side factors, notably lower prices for food as well as fuel, light and water (FLW) items. The inflation rate for food, beverage, and tobacco (FBT) fell slightly to 4.3 percent compared with 4.5 percent in the previous quarter as prices of major food items such as rice continued to soften. Similarly, the inflation rate for non-food items declined to 9.3 percent from 9.4 percent. This was due to the lower inflation rates of FLW (13.1 percent from 13.5 percent), services (13.6 percent from 13.8 percent), and miscellaneous items (6.4 percent from 7.1 percent).

In terms of geographical area, the average inflation rate within the

Metro Manila area rose slightly to 7.8 percent from the previous quarter’s rate of 7.7 percent. This was mainly on account of higher inflation rates for clothing, housing and repairs, and services, which more than offset the decline in inflation rates for FBT, FLW and miscellaneous items. The inflation rate in Metro Manila was also higher compared to the rate in the areas outside Metro Manila (AOMM), which decelerated to 6.2 percent from 6.4 percent in the previous quarter. The slowdown was ascribed to lower inflation rates for FBT, FLW, services, and miscellaneous items. ��Domestic Interest Rates

Domestic interest rates sustained a downtrend during the second quarter of 2001, as the monetary authorities continued to ease policy rates to spur economic activity through increased lending. Moderate inflation, weak domestic demand, broad stability in the foreign exchange market and the downward adjustments in interest rates in major and emerging financial markets, made possible the easing of monetary policy and subsequently, the continued softening of domestic interest rates.

Reflective of this policy thrust, the BSP reduced its key borrowing

(RRP) and lending (RP) rates twice during the quarter in review for a total of 100 basis points each to 9.00 percent and 11.25 percent, respectively. The policy move was intended to create a more conducive environment for increased lending and investment activities.


13

Reflecting the downtrend in BSP policy rates, market interest rates softened during the quarter in review. Interest rates on short-term government securities dropped across all tenors to 10.3700 percent during the second quarter from an average of 11.7970 percent a quarter ago. The benchmark 91-day T-bill rate registered the biggest decline of 169.4 basis points to 9.360 percent. This was followed by a similar decline in the 182-day and 364-day issues, which dropped by 139.3 basis points and 128.6 basis points to reach 10.4030 percent and 11.174 percent, respectively (Table 7).

As a result, the average

bank lending rates also dropped steadily from a range of 15.4608-17.2121 percent in the previous quarter to 13.2701-14.8906 percent during the second quarter of 2001. Meanwhile, the yields on savings deposits declined by 251.5 basis points to average 6.9460 percent. The interest rates on traditional time deposits (all maturities) and short-term promissory issues (MRRs) of banks similarly curbed downward to average 9.349 percent and 9.625 percent, respectively.

As both the domestic and foreign interest rates declined, the

interest rate differential narrowed generally during the review period. The effective differential, which is computed as the difference between the 91-day Treasury bill rate2 and the 90-day London Interbank Borrowing Rate (LIBOR), narrowed down to 3.289 percent from the previous quarter’s 3.493 percent. Inflation-adjusted interest rates on bank instruments and government securities also declined but remained positive during the quarter.

2 Net of Tax

Selected Domestic Interest RatesIn Percent per Annum

8

9

10

11

12

13

14

15

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

IBCLBank LendingReverse RP Term91-day T-Bill

1999 2000 2001


14

��Financial System Performance of the Banking System

During the second quarter of 2001, the banking system remained healthy and resilient despite the challenging macroeconomic environment. The generally liquid position and the strong capital buffer were among the system’s key strengths, enabling banks to perform their role in terms of financial intermediation and risk management.

Notwithstanding some episodes of transitory shocks in the

economy, the banking system managed to remain strong during the second quarter. The system’s aggregate resources expanded by 2.4 percent to reach P3,414 billion from the previous quarter, fueled by increased deposit mobilization and the continued improvement in banks’ capital base (Table 8). By category, commercial banks comprised the bulk of the system’s resources, with a 90.7 percent share, followed by thrift banks with 7.3 percent and rural banks, 2.0 percent.

Notwithstanding the ongoing consolidation in the banking system,

the number of operating banking units (head offices and branches) increased. From a total of 7,546 head offices and branches in March 2001, the number of banking institutions rose by 9 units to 7555 units. Of the total operating network as of end-June 2001, 938 were head offices consisting of 44 commercial banks, 109 thrift banks and 785 rural banks. Meanwhile, the number of operating branches expanded to 6,617 units from 6,603 units due to the reopening of branches of merged banks.

The system’s capitalization remained more than adequate relative

to international norms and the statutory floor. As of end-June 2001, the average capital adequacy ratio (CAR) of the commercial banking system reached 16.38 percent, well above the BSP statutory floor of 10 percent and the Bank for International Settlement (BIS) standard of 8 percent. In part, the high CAR reflected the banks’ continued capital build-up initiatives to strengthen their capability to deal with shocks. This developed in spite of the continued suspension in banks’ required


15

compliance with the second phase of the 1999 capitalization requirement.3

Meanwhile, banks’ asset quality—while showing signs of

weakening—has been maintained. Preliminary data as of June 2001 show banks’ non-performing loan (NPL) ratio rising moderately to 16.67 percent from an average of 16.29 percent at end-March. The slightly weaker asset quality of banks could have resulted from the continued depreciation of the peso and the slowdown in some business activities. Commercial banks’ NPL ratio weakened slightly to 16.96 percent in June from 16.60 percent last March. Compared with those observed in other countries in the region, however, the NPL ratio of Philippine commercial banks remained substantially lower than those of Indonesia (18.5 percent, April 2001), but higher than those of Thailand (12.57 percent, June 2001), Malaysia (10.2 percent, June 2001) and Korea (4.1 percent, June 2001). It should be noted that the NPL ratios of Thailand, Malaysia and Korea were significantly improved by the transfer of problem loans from banks’ balance sheets to asset management companies (AMCs).4 Meanwhile, in the case of the Philippines, no government funds have been used to improve banks’ balance sheets. Nonetheless, an improvement in domestic banks’ NPL ratio may be expected with the proposed establishment of private-owned asset management companies and on account of the continued decline in interest rates and stability in the exchange rate.

Banks’ loan loss provisioning—which serves as buffer against

potential losses arising from bad loans of banks—increased during the quarter. As of end-June 2001, banks’ provision for loan losses covered about 7.4 percent of total loans and 44.6 percent of banks’ aggregate NPLs from 6.9 percent and 42.5 percent coverage, respectively, in the previous quarter.

3 BSP Circular No. 257, dated 15 August 2000, set aside the target level of capitalization prescribed for banks as of end-2000 in order to prepare banks for the adoption of the international capital adequacy standards, including those of the Bank for International Settlements (BIS). 4 If the transferred NPLs are to be included in the computation, the NPL ratios would have been higher at 55.2 percent for Indonesia, 25.1 percent for Thailand, 19.2 percent for Korea, and 16.6 percent for Malaysia (Asia Recovery Information Center (ARIC), ADB).


16

Notwithstanding the slowdown in economic activity, commercial banks’ lending activity continued to expand. As of end-June 2001, outstanding loans of commercial banks recorded a year-on-year growth of 4.0 percent to reach P1.43 trillion. Quarter-on-quarter, bank lending expanded at a slower pace of 1.1 percent from P1.41 trillion in March. More than half (53.7 percent) of the outstanding loans of commercial banks were channeled to the manufacturing, financial, real estate and business services sectors.

Banking Reforms

Regulatory changes were implemented during the quarter to further enhance corporate governance, intensify the government’s fight against money laundering activities, and improve supervisory oversight. Among the major reforms issued were:

1) Requiring banks and non-bank financial institutions under the

supervision and regulation of the BSP to: (i) phase out anonymous accounts and numbered accounts; and, (ii) submit to the BSP a certification that they have monitored compliance with existing anti-money laundering regulations. (BSP Circular No. 279 dated 2 April 2001)

2) Amending provisions of Circular No. 229 dated 13 March 2000 on the

conditions for granting authority to banks to convert to a lower category. Among the conditions include requiring SEC approval of the bank’s amended articles of incorporation before the bank can start operation in the lower category it is converting to. (BSP Circular No. 281 dated 3 April 2001)

3) Allowing microfinance loans extended by rural banks and cooperative

banks to be eligible for rediscounting with the BSP, in accordance with provisions of the Republic Act No. 8791 otherwise known as the General Banking Law 2001. The circular sets the following implementing guidelines: (i) the maximum principal amount of microfinancing loan shall not exceed P150,000; (ii) interest rates shall be reasonable but not lower than the prevailing market rates; (iii) microfinancing loans, which are small unsecured loans, shall be exempted from rules and regulations by the Monetary Board governing unsecured loans subject to certain conditions; and


17

(iv) microfinancing loans shall be considered compliance with required loans to small and medium enterprises. (BSP Circular No. 272 dated 30 January 2001)

4) Setting guidelines to ensure the uniform implementation of the 6

percent to 25 percent allowance for probable losses (prescribed under Circular No. 247 dated 2 June 2000) on loan accounts classified as “substandard-secured”. (BSP Circular Letter dated 30 April 2001)

5) Amending the Manual of Regulations for banks and non-bank

financial institutions to include additional sections on the powers, authority and general responsibilities of the Board of Directors and the specific duties of a bank director. (BSP Circular No. 283 dated 17 May 2001)

6) Issuing implementing guidelines to be observed in the reporting of FX

Form 1A by thrift banks with FX transactions. (BSP Circular No. 284 dated 4 June 2001)

7) Amending Circular No. 147 dated 24 October 1997 (which governs the

mandatory credit allocation to small and medium enterprises) to revise the definition of medium enterprises (as those having total assets more than P15 million but not more than P100 million) and to tighten requirements that will permit loans to export and import traders to be considered as compliance with the mandatory allocation. (BSP Circular No. 285 dated 6 June 2001).

��Assessment of the Monetary Program

Following the expiration of the Standby Arrangement (SBA) at end-2000, the Philippines entered into a Post-Program Monitoring (PPM) arrangement with the IMF.

Under this arrangement program assessments are based on a review of policies rather than the attainment of specific quantitative targets or conditionalities. However, targets on key macroeconomic and financial aggregates were set internally by the Philippine authorities including policy commitments to ensure sustainable economic growth and adopt a forward-looking approach to policy formulation. These


18

economic and financial targets are not binding with the IMF as there is no financing involved. The IMF monitors these macroeconomic and monetary targets through close policy dialogue and periodic assessments of recent developments and reforms implemented to achieve economic recovery.

The first PPM mission was conducted on 28 March-10 April 2001. During said mission, the IMF noted the new government’s challenging economic situation, particularly the sizable budget deficit, decline in government revenues in recent years, remaining weaknesses in the banking sector and the decline in exports due to the slowdown in global demand.

However, the IMF commended the government’s economic strategy, which focused on fiscal discipline, good governance, market-oriented reform and poverty reduction. Concrete actions taken in these areas include the authorities’ efforts in strengthening tax administration; strengthening the banking system’s asset quality; its participation in the Financial Sector Assessment Program and progress made in the structural reform agenda, particularly the recent passage of the power sector reform legislation.

D. FISCAL SECTOR ��National Government Cash Operations

The cash operations of the

National Government (NG) registered a P39.9 billion deficit in the second quarter of 2001, higher by P2.0 billion than the previous quarter’s deficit of P37.9 billion (Table 9). This developed as the increase in expenditures outpaced the rise in revenues. Compared to the same period last year, this quarter’s deficit

Cash Operations of the National GovernmentIn Billion Pesos

-100

-50

0

50

100

150

200

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Revenues Expenditures Surplus

1999 2000 2001


19

was higher by P14.5 billion. Total revenue aggregated to P145.5 billion, P24.3 billion higher than the first quarter collections. Tax revenues posted a P25.5 billion improvement as tax collections by the Bureau of Internal Revenue (BIR) and the Bureau of Customs (BOC) improved by P20.9 billion and P4.7 billion, respectively. Non-tax revenues, on the other hand, dropped by P0.9 billion on account of the decline in fees and other charges by P2.5 billion. The lower collection of fees and other charges more than negated the P1.5 billion increment in non-tax revenues of the Bureau of the Treasury (BTr) derived largely from dividends on shares of stocks and interest on deposits. Meanwhile, expenditures totaled P185.4 billion, exceeding the previous quarter’s level by P26.3 billion. The increase was due mainly to higher allotments to local government units (LGUs), subsidies to government corporations and miscellaneous disbursements. However, this quarter’s actual deficit exceeded the programmed level by P7.8 billion as actual revenues fell short of the target by P5.1 billion and as actual expenditures exceeded the target by P2.7 billion. Despite the recorded improvement in the tax collections of the BIR and BOC during the period, these collections were not sufficient for both agencies to meet their targets. As a result, the shortfalls in the tax collections of the BIR and BOC of P6.6 billion and P1.0 billion, respectively, vis-a-vis their targets, were reflected in lower-than-expected government revenues during the quarter. During the period, the NG financed its cash operations deficit through borrowings from domestic (P26.2 billion) and external (P5.4 billion) sources, as well as by drawdowns from its deposit balances with banks (P22.0 billion).


20

E. EXTERNAL SECTOR ��Balance of Payments

The country’s external payments position for the second quarter of 2001 yielded a lower deficit of US$94 million compared with the year-ago deficit of US$777 million and the US$512 million deficit in the previous quarter (Table 10). The current account posted a deficit of US$217 million, in contrast to the surplus recorded a year ago, while the capital and financial account registered a higher net outflow of US$1.040 billion compared to the year-ago level.

Current Account

For the second quarter of 2001, the current account yielded a deficit of US$217 million, in contrast to the surplus of US$2.104 billion during the same period in 2000. This developed following the weakening of all major components of the current account. Merchandise Trade. The trade-in-goods account posted a deficit of US$503 million during the review quarter from the US$1.607 billion surplus recorded during the comparable period in 2000. This developed as merchandise exports contracted while imports increased. Merchandise exports dropped by 18.5 percent to US$7.168 billion during the reference quarter from US$8.794 billion a year ago. This was mainly on account of the 28.5 percent contraction in electronics exports, following the slowdown in both the U.S. and Japanese economies, the country’s major markets. Garments exports likewise declined by 2.3 percent. On the other hand, exports of machinery and transport equipment rose by 11.8 percent. Meanwhile, merchandise imports rose by 6.7 percent during the review quarter to US$7.671 billion from the

Balance of PaymentsIn Million US Dollars

-1000

-500

0

500

1000

1500

2000

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

1999 2000 2001


21

year-ago level of US$7.187 billion. With the exception of mineral fuels and lubricants, all major commodity groups registered increases. The rise in imports, particularly of capital goods and raw materials and intermediate goods, bodes well for the recovery of the economy as it indicates a pick-up in industrial activity. Services. The net outflow in the services account during the second quarter rose to US$502 million from US$464 million during the same period in 2000. This developed as construction and computer and information services recorded higher net outflows, while travel-related services posted lower net inflows. Income. The income account posted a surplus of US$683 million, lower by 20.0 percent than the year-ago level of US$854 million. The decline was due mainly to lower inflows of remittances from overseas Filipino workers (OFW), which constituted the bulk of income, and the increase in net interest payments on direct and other investments. Current Transfers. Net current transfers account recorded a surplus of US$105 million, slightly lower than the year-ago level of US$107 million. Transfers receipts were largely in the form of gifts, grants and donations from individual and non-governmental institutions. Capital and Financial Account

The capital and financial account yielded a net outflow of US$1.040 billion in the second quarter of 2001. This was lower than the previous year’s net outflow of US$1.616 billion, following the higher net inflow of direct investments and the reversal into a net inflow of the balance in the portfolio investments account, even as the other investment account posted a higher net outflow.

Capital Account. During the review quarter, the capital account posted a surplus of US$1 million compared to the year-ago surplus of US$11 million. This was primarily on account of the drop in general government transfers and transfers from immigrants.

Direct Investments. Direct investments posted a higher net

inflow of US$492 million from the US$458 million recorded a year ago. Direct investments were channeled mainly to the telecommunication,


22

manufacturing, banking and finance, real estate and transportation sectors. Portfolio Investments. The portfolio investments account recorded a net inflow of US$302 million during the review quarter from a net outflow of US$607 million in the same period a year ago. Contributing largely to this development was the higher net placements by non-residents in the local stock market amounting to US$257 million coupled with the lower net repayment of maturing bonds and notes to non-residents amounting to US$26 million. The favorable performance of equity securities was a reversal of the year-ago net outflow of US$100 million. Other Investments. The other investment account registered a higher net outflow of US$1.835 billion from the US$1.478 billion recorded during the comparable quarter in 2000, due mainly to lower net trade credits.

��International Reserves

The BSP’s gross international reserves (GIR), including the reserve position in the IMF, stood at US$14.556 billion as of end-June 2001. This was US$115 million lower than the end-March 2001 level of US$14.671 billion (Table 11). Despite the slight contraction, this quarter’s level of reserves remained adequate to cover 4.3 months’ worth of imports of goods and payment of services and income.

Reserves were also more than twice the level of the country’s short-term foreign exchange liabilities as of end-March 2001 based on original

Gross International ReservesIn Billion US Dollars

0

2

4

6

8

10

12

14

16

18

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q21999 2000 2001


23

maturity.5 Based on residual maturity,6 reserves were also able to cover 141.2 percent of short-term external debt.

The slight drop in international reserves during the second quarter

of 2001 may be traced primarily to the settlement of the BSP’s maturing external obligations (U$612 million); foreign exchange sales to the National Government (NG) to service its debt payments (US$688 million); and net withdrawals by government-owned and -controlled corporations from their foreign currency deposits with the BSP (US$94 million). The impact of these disbursements, however, was tempered by the following foreign exchange inflows: (1) proceeds from the issuance of the BSP’s floating rate notes (US$200 million); (2) proceeds from the flotation of RP’s floating rate notes (US$199 million); and (3) investment income (US$187 million).

Classified by component, the bulk of reserves (82.5 percent) were

in the form of foreign investments, while 13.6 percent were in gold, 3.1 percent in foreign exchange, and 0.8 percent in combined Special Drawing Rights and reserve position in the Fund.

The decline in the BSP’s GIR offset the drop in its foreign exchange

liabilities during the quarter in review. Hence, net international reserves contracted by 0.02 percent to US$10.786 billion from the end-March 2001 level of US$10.788 billion. ��Exchange Rate Trends in the Peso-Dollar Rate

The peso depreciated by

almost 3.0 percent from the previous quarter to average P50.74/US$1.00 during the second quarter of 2001 (Table 12).7 The peso was on a

5 Refers to principal payments on public and private sector loans with maturities of up to one year. 6 Refers to outstanding short-term debt based on original maturity plus principal payments on medium- and long-term loans (i.e., loans with maturities of more than one year) of the public and private sectors falling due in the next twelve months. 7 Dollar rates or reciprocal of the peso-dollar rates were used to compute for the quarterly percent changes.

Peso-US Dollar RateMonthly Average

0

10

20

30

40

50

60

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J

1999 2000 2001


24

generally depreciating trend during the review quarter. In early April, the peso breached the P50.00/US$1 level as it averaged P50.18/US$1 during the month. The weakening of the peso continued in May and June as it averaged P50.54/US$1 and P51.49/US$1, respectively. However, the pressure on the peso intensified towards the latter part of June as the peso breached a new psychological level of P52/US$.

Behind the depreciation of the peso, which started in mid-March,

was the generally bearish market sentiment brought about by a host of domestic and external factors. On the external front was the overall weakening sentiment on emerging market currencies due to the economic slowdown in the US, stalling of Japan’s economic recovery and the financial crisis in Argentina. On the domestic front, factors include the downgrade of growth projections due to weak exports and the slowdown in industry; the unresolved hostilities in Northern Mindanao; and the perceived overall peace and order problems as well as fiscal concerns.

Despite the peso depreciation, the second quarter of the year was

marked by lower exchange rate variability. Volatility, as measured by the standard deviation of the daily peso-dollar exchange rate, declined to P0.73 during the second quarter, from P1.67 a quarter ago. Another indicator of volatility, the average trading range, also showed lower volatility as it decreased to P0.26 during the second quarter compared with the previous quarter’s P0.53. 8

The peso’s movement mirrored the trend in other regional

currencies. As of end-June 2001, the peso-dollar rate depreciated by 4.5 percent relative to the level at the beginning of the year (2 January 2001). The following Asian currencies likewise depreciated against the US dollar during the period: the Indonesian rupiah (by 16.4 percent); the Japanese yen (by 8.3 percent); the Singapore dollar (by 4.9 percent); the Thai baht (by 4.2 percent); the New Taiwan dollar (by 3.9 percent); and the South Korean won (by 3.0 percent).

8 The average trading range is computed as the daily difference between the highest and lowest peso-dollar exchange rates of done transactions at the Philippine Dealing System (PDS).


25

Nominal and Real Effective Exchange Rates

The value of the peso in terms of the nominal effective exchange rate (NEER) index vis-à-vis its major trading partners declined during the second quarter of 2001.9 The average NEER of the peso depreciated slightly in nominal terms by 1.4 percent to 13.37 index points from 13.56 index points in the first quarter of the year. In contrast, compared with the broad and narrow baskets of currencies of competitor countries,10 the peso appreciated in nominal terms during the same period, by 3.2 percent and 6.9 percent, respectively. This was due to the more significant depreciation, relative to the peso, of most currencies in the basket against the US dollar during the period.

The nominal depreciation of the peso against the US dollar in the second quarter translated into a real depreciation and resulted in a gain in external price competitiveness. The real effective exchange rate

(REER) index against the currencies of the country’s major trading partners indicated a slight real depreciation of 1.0 percent to 62.55 index points compared to the quarter-ago average of 63.18 index points.11 This developed as the peso’s nominal depreciation more than offset the widening of inflation differential between the Philippines and the major

industrialized countries in the basket. On the other hand, relative to the currency baskets of broad and narrow competitor countries, the peso’s competitiveness declined as the REER indices against these baskets of 9 The NEER indices represent the weighted average exchange rate of the peso vis-à-vis a basket of foreign currencies such as the US dollar, the Japanese yen, the Deutsche mark and the British pound, the currencies of the country’s major trading partners. 10 The broad basket is composed of the currencies of Singapore, South Korea, Taiwan, Malaysia, Thailand, Indonesia and Hong Kong, while the narrow basket is composed of the currencies of Indonesia, Malaysia and Thailand. 11 The REER indices were derived from the NEER indices adjusted for inflation differentials vis-à-vis trading partners or competing partners.

Real Effective Exchange RateIndices of the Peso

0

50

100

150

200

250

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Narrow (Competing Countries)Broad (Competing Countries)Major Trading Partners

1999 2000 2001


26

currencies appreciated by 3.2 percent and 7.0 percent, respectively. The loss in external competitiveness developed as the nominal appreciation of the peso was accompanied by a slight widening of the inflation differential between the Philippines and the countries in the broad and narrow baskets (Table 12c).

��External Debt

The country’s outstanding external debt declined to US$49.95 billion as of end-March 2001 from the end-2000 level of US$52.06 billion (Table 13). Accounting for the US$2.11 billion quarter-on-quarter decrease in the debt stock were gains realized from foreign exchange revaluation, the decrease in foreign liabilities reported by commercial banks and net repayments of the public (non-banks) and private sectors.

Adjustments to reflect foreign exchange revaluation reduced total

external debt by US$1.38 billion. About 74 percent of the revaluation adjustments resulted from the continued weakening of the Japanese yen vis-à-vis the US dollar, with the Japanese currency exchanging for Y123.69 per US dollar as of end-March 2001 from only Y114.46 per US dollar as of end-2000. Yen-denominated liabilities comprised 26 percent of the total foreign obligations.

Foreign liabilities reported by commercial banks decreased during

the quarter, leading to a further reduction of the outstanding level of external debt by US$849 million. The decline in banks’ liabilities was due largely to payments of maturing short-term non-trade liabilities of private banks.

Philippine External DebtAs of End March 2001

Medium and Long-Term

US$44.73B89.55%

Short-termUS$5.219B

10.45%

TOTAL: US$49.949 Billion


27

During the quarter in review, total loan repayments were higher than availments, resulting in an additional US$47 million decrease in the debt stock. Higher repayments were recorded by the public (non-banks) and private sectors. While these repayments included the redemption of the US$400 million Eurobonds issued by the Bangko Sentral ng Pilipinas (BSP) in February 1999, a large chunk of the transactions consisted of short-term trade credits of private corporations. Meanwhile, major loan inflows that formed part of the country’s external liabilities during the period were the BSP’s syndicated loan of US$177 million12 and PNOC’s US$130 million loan from a syndicate of financial institutions. New loan inflows were mainly used to finance the requirements of the communication and transportation sectors as well as other infrastructure, and for power and energy development.

Mitigating the impact of these reductions in the debt stock were

the adjustments made to reflect the results of audit findings and late reporting of prior periods’ transactions and the decline in residents’ holdings of foreign currency-denominated Philippine debt papers issued offshore. These increased total external debt by US$137 million and US$29 million, respectively.

The maturity profile of the country’s external debt continued to

reflect prudence in external debt management. The share of external debt with maturities of more than one year went up to 89.6 percent of total debt as of the end of the first quarter of 2001 from 88.6 percent as of end-2000.13 The balance of 10.4 percent was accounted for by short-term liabilities. Average maturity of medium- and long-term (MLT) debt was 16.5 years. The average maturity of both the public and private sectors’ MLT debt remained unchanged at 19.4 years and 9.7 years, respectively. About 44 percent of the country’s foreign obligations had variable rates and 53 percent carried fixed rates.

By borrower type, the public sector accounted for 66.0 percent of

total debt as of end-March 2001, down from 66.1 percent as of end-2000. The decline was due mainly to revaluation gains on third currency-

12 Part of the US$740 million syndicated loan of the BSP, of which US$177 million was funded by foreign banks. 13 Of the US$44.73 billion medium- and long-term debt, 85.7 percent were long-term, with an average maturity of more than five years.


28

denominated debt and adjustments done on prior periods’ transactions. Compared to the previous quarter, the share of private sector debt increased slightly to 34.0 percent from 33.9 percent. In absolute level, however, private sector obligations dropped to US$16.97 billion from US$17.65 billion owing to the decrease in the liabilities of commercial banks and the gains from foreign exchange revaluation.

Classified by creditor type, official creditors (multilateral and

bilateral institutions) extended 48.0 percent of total credits. Foreign holders of bonds, notes and certificates of deposits accounted for 26.7 percent of the total external debt. Banks and other financial institutions comprised 21.9 percent of foreign obligations.

In terms of currency composition, the debt was largely

denominated in US dollars (56.0 percent) and Japanese yen (26.0 percent). Multi-currency loans from the World Bank and the Asian Development Bank comprised 9.8 percent of total external debt.

A preliminary estimate of the ratio of debt service to exports of

goods and receipts from services and income showed an improvement during the second quarter of 2001. Compared to the first quarter of the year, the ratio declined to 15.3 percent from 15.8 percent, in view of lower principal and interest payments on loans and bonds issued during the quarter in review (Table 14). ��Foreign Interest Rates

Key foreign interest rates trended downward in major financial markets during the second quarter of 2001 (Table 15). This developed following fears of continued deceleration in economic growth and weakening of economic indicators in most major and emerging economies.

In the US, the Federal Open Market Committee (FOMC), in its effort to boost US economic activity and improve market sentiment, lowered its target for the federal funds rate three times during the second quarter by a total of 125 basis points to average 3.75 percent. It likewise reduced the discount rate by a total of 125 basis points during the review


29

quarter to 3.25 percent.14 Consequently, US interest rates declined, with the weighted average federal funds rate falling by 129.53 basis points to 4.3521 percent and the weighted average US prime rate decreasing by 131.62 basis points to average 7.3437 percent.15

In other major financial markets, similar rate cuts were also made.

In the Eurozone, the Governing Council of the European Central Bank (ECB) lowered all its key interest rates by 25 basis points with the minimum bid rate on the main refinancing operations16 averaging 4.5 percent and interest rates on the marginal lending facility17 and deposit facility18 at 5.5 percent and 3.5 percent, respectively. Similarly, the Monetary Policy Committee of the Bank of England cut its repo rate twice during the quarter by 50 basis points to average 5.25 percent. Consequently, the 90-day London Interbank Offered Rate (LIBOR) fell by 115.12 basis points to 4.1990 percent during the quarter in review.19

Meanwhile in Asia, the 90-day Singapore Interbank Offered Rate (SIBOR) similarly came down by 117.06 basis points to 4.1989 percent, in line with the spate of interest rate cuts by the US Federal Reserve.20 In Japan, the Bank of Japan (BoJ), after lifting its zero interest rate policy in August 2000, undertook successive monetary easing measures during the previous quarter. This policy action was characterized by the change in BoJ’s main operating target of monetary policy operations, from the uncollateralized overnight call rate to the outstanding balance of current accounts held at the BoJ. The easing of monetary conditions illustrated

14 The Federal funds rate refers to the interest rate banks charge each other for overnight loans. The discount rate is the interest rate charged by the Federal Reserve banks on their loans to banks. 15 The prime rate is the interest rate banks charge their most creditworthy customers. 16 Main refinancing operations are regular liquidity-providing reverse transactions with a weekly frequency and a maturity of two weeks. It is the Eurosystem’s most important open market operation, playing a key role in steering short-term interest rates, managing the liquidity situation in the market and signaling the stance of monetary policy. The minimum bid rate refers to the minimum interest rates at which counterparties may place their bids. 17 The marginal lending facility is a standing overnight facility administered by National Central Banks (NCBs) and used by counterparties to obtain liquidity from the NCBs against eligible assets. The interest rates on the marginal lending facility normally provide a ceiling for the overnight market interest rates. 18 The deposit facility is another standing facility used by counterparties to make overnight deposits with the NCBs. The interest rate on the deposit facility normally provides a floor for the overnight market interest rate. 19 The LIBOR is the rate at which banks in London offer Eurodollars in the placement market. 20 The SIBOR is the rate at which banks in Singapore offer Eurodollars in the placement market.


30

BoJ’s firm determination to prevent prices from declining continuously and to provide a boost to economic activity. ��Other Major External Sector Developments

The US economy continued to show signs of weakening as it posted a marginal growth of only 0.2 percent for the second quarter from 1.3 percent during the previous quarter. Growth was constrained by the significant drop in capital spending during the period, brought about by weak domestic demand, and the continued slump in business activity. The slowdown in growth encouraged authorities to undertake monetary easing to spark domestic demand in the US with the successive reduction (by 125 basis points) in the target for the federal funds rate during the period. Meanwhile, in Japan, investor and business confidence continued to slide.

The Euro area posted a growth rate of 1.7 percent in the second quarter, lower than the 2.4 percent growth during the preceding quarter, but still relatively stronger than the US growth. Macroeconomic Performance Year-on-year growth (in percent) GDP INFLATION COUNTRY 1Q01 2Q01 1Q01 2Q01 Hong Kong 2.3 0.5 -1.9α/ -1.3 Indonesia 4.0 3.5 9.4 11.2 Japan 0.1 -0.8 -0.1 -0.5 Korea 3.7 2.7 4.3 5.3 Malaysia 3.1 0.5 1.5 1.6 Singapore 4.7 -0.9 1.7 1.7 Thailand 1.8 1.9 1.4 2.6 Source: China Economic Indicators Center (CEIC), Telerate, International Financial Statistics (IFS), Hong Kong Monetary Authority, Bank of Korea, Bank Indonesia, Japan Statistics Bureau and Statistical Center, Bank Negara Malaysia, Bank of Thailand, Ministry of Trade and Industry , Singapore, Indonesian Bureau of Statistics α/ Based on the HK Composite CPI, which reflects the aggregate expenditure patterns of all households in the relatively low, medium, and high expenditure ranges.


31

Dragged down by the global economic slowdown, growth in regional Asian economies recorded sharp declines relative to the first quarter growth. In particular, GDP growth decelerated in Indonesia (3.5 percent), Korea (2.7 percent), Malaysia (0.5), and Hong Kong SAR (0.5 percent). Meanwhile, the Singapore economy entered into a technical recession during the period with the contraction in growth of -0.9 percent. The contraction in growth was accompanied by higher inflation in Indonesia (11.2 percent), Korea (5.3 percent), Thailand (2.6 percent), and Malaysia (1.6 percent). Japan and Hong Kong continued to experience negative inflation rates of 0.5 percent, and 1.3 percent, respectively. Meanwhile in Singapore, consumer prices were unchanged relative to the first quarter average of 1.7 percent.

The recovery of Asian regional economies continued to lag during

the second quarter due, in part, to weaker exports, declining investment inflows, the slow pace of corporate restructuring, and political uncertainty. Against these downside risks, prospects in regional Asian markets will depend upon the rate by which individual economies can stimulate domestic demand and attract investment inflows through a genuine commitment to financial and corporate restructuring and the peaceful resolution of political difficulties and uncertainties that beset some of the countries in the region.

In Indonesia, political uncertainty brought about by the Parliament’s second censure of former President Abddurahman Wahid has caused some pressure on the rupiah, prompting credit rating agency, Standard & Poor’s (S&P) to downgrade the country’s long-term foreign currency rating to CCC+21 from B-22, with a negative outlook. Meanwhile in Thailand, investors’ concerns about the policy environment under the new government were weighed down by the graft trial of Prime Minister Thaksin Shinawatra.

21 A rating of “CCC” reflects current vulnerability to nonpayment wherein the obligation/obligor is dependent upon favorable business, financial and economic conditions for the obligor to meet its financial commitment on the obligation. 22 A rating of “B” reflects greater vulnerability to nonpayment relative to obligations rated “BB”, but the obligor currently has the capacity to meet its financial commitment on the obligation. A plus (+) or minus (-) sign shows relative standing within the major categories.


32

In other Asian countries, corporate restructuring continued to be a

major concern. In Malaysia, difficulties arising from recent mergers in the banking system, rising defaults involving large corporations, and the government’s move to help restructure state-owned Johor Corporation Bhd.’s bad loans through the Corporate Debt Restructuring Committee (CDRC) have put pressure on the level of non-performing loans and has raised fears that off-budget bailouts may add to fiscal pressure. Meanwhile, in South Korea, corporate restructuring remains a formidable challenge. The labor unrest experienced by the two major airlines, Korean Air and Asiana Airlines in June, claimed that corporate restructuring has led to unnecessary layoffs while difficulties encountered in restructuring Hyundai and Daewoo underscored the need for a stronger commitment to market-based reforms. F. FINANCIAL CONDITION OF THE BSP ��Balance Sheet Based on preliminary data, assets of the BSP expanded to P1.1 trillion in the second quarter of 2001. At the same time, its liabilities reached P982.7 billion, resulting in a P145.2 billion net worth, which was P12.9 billion higher than that of the previous quarter and P51.9 billion higher than that recorded during the same period last year.

At P1,127.9 billion, the BSP’s total assets as of end-June 2001 was 1.4 percent higher than the end-March 2001 level and 8.0 percent higher than the same period last year. This was due mainly to the growth in the level of international reserves maintained by the BSP during both periods. International

BSP Balance SheetIn Billion Pesos

0

200

400

600

800

1000

1200

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Assets Liabilities Net Worth

1999 2000 2001


33

reserves, which accounted for about 67.1 percent of total assets, increased by P98.2 billion over last year’s level, due primarily to the depreciation of the Philippine peso vis-à-vis the US dollar from P43.154/US$1 at the end of June 2000 to P52.366/US$1 at the end of June 2001. However, in dollar terms, international reserves contracted by US$807 million. Likewise, other assets and loans and advances increased by P16.9 billion and P15.0 billion, respectively, over their year-ago levels. This was due to the liquidity loans extended by the BSP to banks at the height of the country’s political crisis in the beginning of 2001. On the other hand, the growth in other assets was on account of higher receivable from the National Government;23 higher acquired assets; and higher deferred charges/credits on gold.

The expansion in these asset accounts was offset in part by the contractionary impact of the P50.0 billion decline in the BSP holdings of domestic securities over the year-ago level, on account of the 4 percent increase in the liquidity reserve requirements of banks imposed in October last year. Total liabilities increased by P31.2 billion or 3.3 percent over the level during the same period last year. The growth in foreign loans payable (58.8 percent) and revaluation of international reserves (36.7 percent), outpaced the decline in other liabilities including BSP debt instruments (35.7 percent), and foreign bonds payable (27.4 percent). Likewise, deposit liabilities of the BSP contracted due largely to the decline in special deposit accounts (68.3 percent), other foreign currency deposits (41.7 percent), and deposits of the Treasurer of the Philippines (11.5 percent). Currency issue, which expanded by 12.0 percent over last year to reach P198.4 billion, reflected the public’s preference for currency because of the political uncertainty and the election season factor during the period under review. The BSP’s net worth grew by P51.9 billion during the second quarter of 2001 vis-à-vis the same period last year. The increase was in

23 The share of the National Government in the valuation loss arising from the annual adjustment in the valuation of the IMF local currency holdings.


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the form of P48.9 billion reserves for fluctuations in foreign exchange and the P2.5 billion net income from regular operations. ��Income Statement Preliminary data indicated that the BSP financial operations during the second quarter of 2001 resulted in a net income of P4.6 billion, an improvement from the P0.8 billion loss recorded in the previous quarter and from the P1.4 billion net income posted during the same period last year. Revenues, including net gains from foreign exchange fluctuations, reached P18.6 billion. This amount was P3.2 billion higher than the P15.4 billion registered during the first quarter and about P1.0 billion higher than last year’s level. Most income accounts registered modest increases over the previous quarter, because of lower interest rates prevailing during the second quarter. In particular, interest income and miscellaneous income rose by P0.9 billion and P0.6 billion, respectively. However, compared to the previous year’s level, revenues (net of gains on foreign exchange fluctuations) increased marginally by P50 million. Expenditures during the period under review at P13.9 billion were lower by around P2.3 billion as compared to both the P16.2 billion posted in the previous quarter and the P16.3 billion recorded last year. On an annual basis, other expenses dropped by P1.7 billion on account of the significant decreases in fidelity and property insurance and bad debt expenses. Similarly, interest expense declined by P0.6 billion over last year’s level, due primarily to lower interest payments paid by the BSP on its debt instruments and on special deposit accounts. The contraction in the volume of BSP reverse RP transactions and banks’ special deposit accounts with the BSP accounted for the decline in interest expense during the period under review. On the other hand, interest payments paid by the BSP on National Government deposits with the BSP was higher by P1.02 billion than that over a year ago. Meanwhile, cost of minting increased by P0.07 billion during the second quarter of 2001.

BSP Income PositionIn Billion Pesos

-10

-5

0

5

10

15

20

25

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Revenues Expenditures Net Income/Loss(-)

1999 2000 2001


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The BSP paid some P1.0 billion in taxes and licenses to the National Government during the quarter. G. CONCLUSION: Challenges and Future Policy

Directions

The economy continued to post credible growth in the second

quarter of 2001, driven mainly by personal consumption expenditures and investments. At the same time, inflation remains on track to achieving the annual target range of 6.0-7.0 percent. The overall external balance also improved as the balance of payments deficit narrowed during this quarter. Moreover, the financial system remained generally sound and stable.

Amidst the positive economic developments, there are signs of

potential domestic vulnerabilities that could undermine macroeconomic performance and slow the growth momentum. These challenges include: the large fiscal deficit; the possible reemergence of inflationary pressures; the slow recovery of bank lending; weakening in bank asset quality; and sluggish export performance.

Several developments abroad likewise create a challenging external environment for continued recovery. There is a growing consensus of lower global economic growth prospects this year with the downturn in the US economy, the stalled recovery in Japan, and a slowdown of growth in Europe. In fact, several economies in the Asian region already experienced a contraction in their economies due, in part, to the slowdown in the major economies of the world and the downswing in the information technology sector. Capital flows may also continue to induce volatility not only in major financial centers but also in financial markets in emerging economies. Moreover, uncertainty in world oil market conditions brings to the fore the prospect of an increase in domestic fuel prices.

The economic authorities recognize the challenges posed by these developments. They likewise recognize the need to formulate appropriate policy responses not only to react to these challenges but also to identify potential sources of economic vulnerabilities for more proactive policies.


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In particular, economic policy will continue to be geared towards the maintenance of macroeconomic stability and the strengthening of the economy’s resiliency against shocks.

Monetary policy will remain focused on price stability. The easing

of the monetary policy stance starting December of last year, continued up to the first five months of this year. The BSP reduced its policy rates by a cumulative of 600 basis points from 4 December until 18 May of this year. Since then, the BSP has held back from reducing its policy rates due to some upside risks of inflation arising from the pass-through effects of a more depreciated peso and the build-up of excess liquidity. Monetary authorities will continue to monitor closely economic and financial developments and be vigilant for potential inflationary pressures.

To enhance the capability of the BSP to achieve its mandate of

price stability, it is continuing its preparations for the formal shift to an inflation-targeting framework by the latter part of this year. This more forward-looking policy framework is expected to strengthen accountability, facilitate transparency and, consequently, improve credibility in the conduct of monetary policy

The BSP will continue to maintain a market-determined exchange

rate policy with some scope for BSP action to dampen excessive fluctuations. This policy is supported by a strict foreign exchange monitoring system accompanied by the imposition of penalties on institutions or individuals who violate foreign exchange regulations.

In the banking system, the BSP will continue its efforts to

strengthen the sector. Currently, the BSP is proceeding with the formulation of implementing rules and regulations of the General Banking Law of 2000. These policy changes include those pertaining to the “fit and proper” rule for bank officers and directors, banking days and hours, limits on certain investments by banks, limits on bank exposure to DOSRI loans, and unsafe and unsound business practices.

The BSP will likewise continue its pursuit of the proposed

amendments to the BSP charter to enhance the BSP’s supervisory powers, improve prudential standards, and promote greater banking competition. Key reforms include the grant of authority to the BSP to


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conduct more frequent banking examinations, restoration of the BSP’s tax-exempt status with respect to open market operations, and the enhancement of the scope and strength of administrative sanctions. These proposed changes are expected to lead to a “safer financial architecture” inasmuch as they help fortify the banking system against various potential shocks.

Since July 2000, the BSP has been instituting a wide-range of

measures to help combat money laundering activities. This was partly in response to the Financial Action Task Force (FATF)24 report identifying the Philippines, together with 14 other nations, as being non-cooperative in the international fight against money laundering. More importantly, these measures were instituted as the Government recognizes the corrosive effect of money laundering on financial systems. When credit and financial institutions are used to launder proceeds from criminal activities, the soundness and stability of the institution concerned and integrity of the financial system as a whole could be seriously undermined. Unchecked, money laundering activities bare the potential effect of losing the trust and confidence of domestic and foreign investors in the financial system.

Aside from the measures already in place, the BSP, together with

the Department of Justice and the Department of Finance, is supporting the passage in Congress of a comprehensive law on anti-money laundering. The bill includes among others, provisions that will: a) criminalize money laundering; b) define the unlawful activities constituting money laundering; c) oblige the submission of suspicious transactions reports; d) grant immunity to reporting institutions and officers; and e) provide for forfeiture of laundered money. It will also include a proposal for the creation of a multi-sectoral body that will have the authority to investigate money laundering cases while at the same time ensuring depositors’ confidence in the banking system.

Despite our progress in pushing the economy further along the

path to long-term sustainable growth, much still needs to be done. Uncertainties stemming mainly from the global economic downturn could affect the performance of the external sector. As a result, the country

24 The FATF is a 29 member international group created at the 1989 G-7 Economic Summit that works to combat money laundering.


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has to rely on domestic demand to provide the impetus for economic growth. This can be achieved by keeping up consumer confidence. At the same time, the government, for its part, recognizes that sustained economic expansion requires the implementation of a credible and consistent policy framework, as a complement to structural reforms aimed at fostering a vibrant economy. The key challenge is to accelerate the pace of the reforms to boost domestic and external confidence and to enable a recovery in investments on a durable basis.

report on economic and financial developments · slower growth in prices. ... rates, and softening...

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