It is the conclusion of the Executive Board of the International Monetary Fund (IMF).

Directors concurred that the fiscal stimulus in 2009 proved to be an effective response to the weak economic environment. Given the limited fiscal space, they supported a measured fiscal withdrawal in 2010. Public debt remains relatively high, and tax collections have weakened beyond cyclical factors. Directors welcomed the authorities' commitment to fiscal deficit reduction starting this year. They stressed that this will require new revenue measures as well as expenditure restraint focused on non-priority current spending.

To further strengthen public finances, bolster market confidence, and create fiscal space for pro-poor spending and growth-enhancing public investment, Directors encouraged the authorities to introduce a credible medium-term consolidation plan, building on revenue raising measures. They supported the authorities' request for technical assistance in this area. The introduction of a formalized fiscal framework would further underscore the commitment to fiscal prudence.

Directors welcomed the BSP's proactive easing steps in response to the crisis. In view of the still negative output gap and the planned tightening of fiscal policy, they concurred that monetary policy should remain accommodative until a sustained economic recovery is assured, while ensuring that inflation expectations remain well-anchored. Directors noted the staff's assessment that the exchange rate appears aligned with fundamentals. They recommended that foreign exchange interventions remain limited to smoothing operations, while allowing the exchange rate to adjust to market pressures.

Directors commended the authorities' good progress in implementing the recommendations of the 2002 Financial Sector Assessment Program (FSAP), noting that the financial sector weathered the crisis well, with banks remaining well capitalized and nonperforming loan (NPL) ratios low. While the moderate economic growth expected over the near term could dampen the banks' earnings and potentially lead to a deterioration in asset quality, stress tests conducted in the context of the FSAP update suggest that banks are quite resilient to adverse shocks. At the same time, concentration risks are more elevated due to the exposure to large conglomerates.

Directors supported additional steps to further strengthen financial sector supervision and the regulatory framework, including through early adoption of the proposed amendments to the New Central Banking Act. The latter would also provide supervisory staff with adequate protection from litigation. Directors suggested that capital requirements could be more risk-based, and welcomed the authorities' planned introduction in 2011 of the internal capital adequacy assessment process as an important first step. Directors also recommended further steps to strengthen the prompt corrective action and resolution frameworks.

To sustain the recovery and raise growth, Directors encouraged the authorities to make further efforts to strengthen governance and the business environment and improve basic infrastructure. This will be important to raise domestic demand, including through increased investment, and allow businesses to tap into new export markets.

Background

Following the adverse impact from the global economic and financial crisis, there are signs of a nascent recovery. The Philippine economy avoided a technical recession as second and third quarter GDP in 2009 rebounded by 1.7 percent and 1.0 percent (quarter-on-quarter), respectively, following the 2.1 percent contraction during the first quarter. Inflation has trended down during the year, reaching 3¼ percent during January-November, in the middle of the Bangko Sentral ng Pilipinas (BSP's) target range. Following the post-Lehman financial market stress in late 2008, market conditions are normalizing and equity prices have returned to pre-crisis levels. The current account has held up well, with the decline in exports cushioned by waning imports of commodities and resilient remittances. With the return of risk appetite, the exchange rate has appreciated and capital inflows have resumed, although so far primarily into the corporate and government bond market.

Growth is expected at ¾ percent in 2009 and to recover to around 3¼ percent in 2010. The recovery will likely be led by private consumption as confidence strengthens and remittances pick up further. Investments and exports are also expected to benefit from the global recovery. Risks to the near-term outlook are broadly balanced and sensitive to the global growth outturn. On the domestic side, the output losses from the devastation caused by the two recent typhoons could turn out to be larger than currently estimated, and fiscal slippage could raise investor concerns. On the upside, the post-typhoon rebuilding efforts could spur higher investment.

The financial sector has weathered the global financial crisis relatively well and generally remains sound. Bank earnings have improved during the first half of 2009 as global economic and financial conditions have stabilized. The capital adequacy ratio remains high at around 15 percent and nonperforming loans are also generally low (around 4 percent of loans), although they are relatively high for thrift and rural banks. Bank exposures are often concentrated on few large corporate borrowers due to the prevalence of big conglomerates. However, they are reportedly well monitored and financially sound.

Fiscal policy was loosened in response to the crisis, but poor revenue performance will likely lead to a breach of the widened deficit target in 2009. The deficit is now estimated at 4½ percent, overshooting the budget target of 3¾ percent of GDP (IMF definition). This deficit implies a positive fiscal impulse of around 2¼ percent of GDP and an estimated growth impact of around 1 percentage point.

The BSP took proactive steps to lessen the adverse impact of the global financial crisis. Policy rates have been cut by 200 basis points since end-2008, which had a significant impact on lending rates. Moreover, the reserve requirement rate on bank deposits and deposit substitutes was lowered by 2 percentage points (to 19 percent for universal/ commercial banks) in late 2008 and the rediscount window was tripled to pesos 60 billion.