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ECONOMY

Since the end of World War II, the Philippine economy has had a mixed history of growth and development. Over the years, the Philippines has gone from being one of the richest countries in Asia (following Japan) to being one of the poorest. Growthimmediately after the war was rapid, but slowed over time. Years of economicmismanagement and political instability under the Marcos regime eventually harmedeconomic growth and grossly adversely affected macroeconomic instability. A severerecession in 1984-85 saw the economy shrink by more than 10%, and perceptions of political instability during the Aquino administration further dampened economic activity.During his administration, President Ramos introduced a broad range of economicreforms and initiatives designed to spur business growth and foreign investment. As aresult, the Philippines saw a period of higher growth, but the Asian financial crisistriggered in 1997 slowed economic development in the Philippines once again.President Estrada managed to continue some of the reforms begun by the Ramosadministration. Important laws to strengthen regulation and supervision of the bankingsystem (General Banking Act) and securities markets (Securities Regulation Code), toliberalize foreign participation in the retail trade sector, and to promote and regulateelectronic commerce were enacted during his abbreviated term. Efforts to reform theconstitution to encourage foreign investment, particularly foreign ownership of land,were abandoned amidst nationalist opposition. Initial optimism about prospects for economic reform also had dimmed amid concerns of governmental corruption. Scandalsinvolving the Philippine Stock Exchange, and the President's close ties to certainbusinessmen, shook the confidence of investors and the business community andultimately led to successful efforts to impeach and remove President Estrada.Despite occasional challenges to her presidency and resistance to pro-liberalizationreforms by vested interests, President Arroyo has made considerable progress inrestoring macroeconomic stability with the help of a well-regarded economic team.Nonetheless, long-term economic growth remains threatened by widespread poverty,crumbling infrastructure and education systems, and trade and investment barriers.Important sectors of the Philippine economy include agriculture and industry, particularlyfood processing, textiles and garments, and electronics and automobile parts. Mostindustries are concentrated in the urban areas around metropolitan Manila. Mining alsohas great potential in the Philippines, which possesses significant reserves of chromite,nickel, and copper. Significant natural-gas finds off the islands of Palawan have addedto the country's substantial geothermal, hydro, and coal energy reserves.

Today's Economy

GDP grew by 7.3% in 2007, the fastest pace of growth in over three decades, andcapped nine consecutive quarters of growth at greater than 5%. Historically, thePhilippines has had difficulty sustaining growth at over 5%. GDP increased by 5.4% in2006, 4.9% in 2005, and 6.4% in 2004. Growth in 2007 was fueled by increasedgovernment and private construction expenditures; a robust informationcommunications technology industry; improved post-drought agricultural harvests; andstrong private consumption, spurred in part by $14.4 billion in remittances fromoverseas workers (equivalent to about 10% of GDP). GDP growth is expected to slow in2008, but still reach between 5% and 6%. Still, it will take a higher, sustained economicgrowth path to make more appreciable progress in poverty alleviation given the

Philippines' annual population growth rate of nearly 2%--one of the highest in Asia. Theratio of the population living below the national poverty line increased from 30% to 33%between 2003 and 2006, which translated to 3.8 million more poor Filipinos. Inequitableincome distribution also makes steady progress in poverty alleviation especiallychallenging.The services sector now accounts for about 55% of Philippine GDP and grew by 8.7%in 2007. Business process outsourcing (BPO) has been the fastest-growing segment of the Philippine economy, totaling an estimated 10% of the global outsourcing market andgenerating an estimated $5 billion in revenues during 2007 (equivalent to about 3.5% of Philippine GDP). BPO revenue grew 40% during 2006 and 2007, and is expected torepeat this growth over the next two years. The construction industry grew by almost20% in real terms during 2007, fueled by a 30% real increase in governmentconstruction expenditures and a 10% increase in private construction investment.Tourism and mining continued to emerge as key industries in 2007. Tourism enjoyed arecord year in 2007, with over 3 million arrivals from overseas spending more than $5billion and helping to fuel air transportation growth of 15%. Mining and quarrying grewby 25%.At $8.6 billion, the overall balance of payments ended 2007 with a record surplus which,among others, reflected higher overseas workers remittances, tourism receipts, BPO-related revenues, portfolio investments, and official development assistance funds.Merchandise exports, relying heavily on electronics shipments for about two-thirds of export revenues, slowed to 6% growth (from 15% growth in 2006). Although there hasbeen some improvement over the years, local value added of electronics exportsremains relatively low at about 30%. Net foreign direct investment (FDI) inflow rose froma low base to nearly $3 billion in 2006 and 2007--nearly double the 2005 level--but stilllags most regional neighbors. The U.S. remains the Philippines' largest trading partner with over $17 billion in two-way trade, and the largest investor with more than $6.5billion in total FDI.The Philippine stock market closed 2007 among the top performers in East Asia. ThePhilippine peso appreciated about 16% to the U.S. dollar between end-2006 and end-2007, making it East Asia's best performing currency. Gross international reservesclosed 2007 up nearly 47% year-on-year to a new record high of $33.7 billion, adequatefor nearly 6 months of goods and services imports and equivalent to 3 times foreigndebts maturing over the next 12 months.Efforts in recent years to reduce the public sector deficit and raise new taxes havehelped reduce high debt ratios, create additional fiscal space to increase spending onvital social services and infrastructure after years of tight budgets, and improveconfidence. December 2004 legislation provided for biennial adjustments to the excisetax rates for tobacco and liquor products until 2011, while a law signed in January 2005seeks to institute a performance-based rewards and penalty system in the government'srevenue collection agencies. Despite public resistance and initial legal challenges, thegovernment began implementing an expanded value-added tax (VAT) law in November 2005, which added an estimated 75 billion pesos ($1.5 billion) to national governmentrevenues during 2006 (equivalent to 1.2% of GDP).

From a record 5.3% of GDP in 2002, the national government has recorded decliningfiscal deficits for five consecutive years (to 0.1% of GDP in 2007) and targets balancingthe budget in 2008. For a second consecutive year, the national government's deficit-reduction program has helped yield modest surpluses for the consolidated public sector.Although more reforms and greater transparency are needed, tighter financial controlsover state-owned companies and initiatives to improve the longer-term viability of state-run pension funds also contributed to recent surpluses of the consolidated public sector (which, in addition to the national government, includes state-owned enterprises, state-run pension funds, local government units, and the Central Bank). Although still high,the debt of the consolidated public sector has declined to under 80% of GDP, from2003's peak 118%-of-GDP ratio. Major credit rating agencies raised their rating outlookfor Philippine sovereign debt from "negative" to "stable" in recognition of fiscal progress,helping to bring down domestic interest rates and tighten spreads on foreign bonds.Looking forward, further reforms are needed to ease fiscal pressures from large lossesbeing sustained by a number of government-owned firms and to control and managecontingent liabilities. Despite recent improvements, challenges still remain to ensuringthe long-term viability of state-run pension funds.The national government's tax-to-GDP ratio remains low relative to historicalperformance and vis-a-vis regional standards. It had slipped from a peak of 17% in1997 to 12.5% by 2004 before improving to 13.0% in 2005 and further improving to14.3% in 2006 (boosted mainly by collections from the expanded VAT law). However,the tax-to-GDP ratio declined to 14% in 2007. Heftier privatization receipts more thanmade up for the shortfall in targeted tax collections but are not a sustainable revenuesource.The Special Purpose Vehicle (SPV) Act of 2003, which provides time-bound fiscal andregulatory incentives to encourage the sale to private asset management companies,has helped to reduce banks' portfolios of non-performing assets. The ratio of non-performing assets to total commercial banking system assets--which peaked at 18.3%in October 2001--has reverted to single-digit levels since mid-2005 and had declined to5.2% of assets by end-2007. The share of non-performing loans to commercial bankingsystem loans had declined to 4.5% as of end-2007, from a March 2002 high of 17.6%.Reforms in recent years include the adoption of international accounting and financialreporting standards (starting 2006) and Basel II standards (effective July 2007).Nevertheless, circumstances surrounding bank closures continue to highlight remainingimpediments to more effective bank supervision and timely intervention--includingstringent bank secrecy laws, obstacles preventing bank regulators from examiningbanks at will, and inadequate legal protection for Central Bank officials and examiners.The Central Bank's adoption since January 2002 of an inflation-targeting framework hasenhanced transparency in the conduct of monetary policy. The inflation rate averaged6.2% in 2006, down from 7.6% in 2005, and was expected to fall further to 2.8% in2007, comfortably below the Central Bank's target of 4%-5%.The Arroyo administration enacted an anti-money laundering law in September 2001and followed through with amendments in March 2003 to address remaining legalconcerns posed by the Organization for Economic Cooperation and Development(OECD) Financial Action Task Force (FATF). The FATF removed the Philippines from its

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