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Key Economic Data 
  2003 2002 2001 Ranking(2003)
Millions of US $ 80,574 77,076 71,400 43
GNI per capita
 US $ 1,080 1,020 1,050 135
Ranking is given out of 208 nations - (data from the World Bank)

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Update No: 017 - (27/05/05)

The final version of the value-added tax (VAT bill) has emerged from the bicameral committee of Congress and was signed into law on 23 May. What started out as a simple measure designed to increase the VAT rate from 10 percent to 12 percent in order to provide additional revenue to government has become an omnibus tax bill that will change in a fundamental manner the tax structure of the Philippines insofar as it affects the corporate and professional sectors.

The bill does not, of itself, raise the VAT rate to the requisite 12 percent but it does give the president the authority to do so. Most of the press comment so far has focused on the fact that Congress appears to have ducked this unpopular measure (as far as its acceptance with the general public is concerned) and has transferred the odium from the increase onto Malacañang. But this may in fact be a clever strategy since by providing the president with a directive, it may make the increase immune to constitutional challenge (although this is not to say, that interest groups will not test this aspect.)

The new law is far from ideal and as some have pointed out, it will hurt compliant taxpayers while doing little to address the problems caused by those who do not comply. Yet, as commentators have also pointed out, "politics is the art of the possible" and that given all the circumstances, the bill may be (with one exception) as good as it gets.

The new tax bill is already being criticised within the business community by those who fear that the increase in the corporate tax rate may act as a disincentive to investment into the Philippines. However, the new law contains a sunset clause and by 2009, the corporate tax rate will actually reduce to 30 percent. The pain is relatively short term and, as other commentators have pointed out, may be part of the short-term pain necessary in the interest of achieving a consensus. Given that much of new investment will be covered by various tax incentives that would normally carry newly established businesses beyond the 2009 deadline, the new rules may actually assist investment insofar as the ground rules are now being clarified - assuming that the tax bill is signed into law and that the president exercises the powers that have now been granted to her.

On the positive side, the Department of Finance has estimated that on a full year basis, the incremental yield from the changed regime be in excess of 100 billion pesos and brings the primary surplus to the level needed for public debt to be sustainable and for more funding to be made available for service delivery. This was one of the main concerns of the UP-11 who have pointed out that the first 80 billion raised does no more than tread water as far as debt servicing goes and that additional revenue needs to be generated above and beyond this amount if government services in health, education and general poverty reduction are to be improved.

Therefore provided the government stays the course and provided that the courts do not introduce a wild card into the equation, the overall effect of the new law should be "investment positive". Much will depend however on allied measures such as the fiscal incentives bill to clarify the overall investment framework and the manner in which the new regulations will be administered. 

Not everyone is happy though. The Philippine Chamber of Commerce and Industry is lobbying to have the rate hike in corporate taxes repealed. However, the chances of that happening are slim.

The real "fly in the ointment" is actually a provision that introduces the concept of a minimum VAT in a manner that distorts the system away from a pure tax on consumption and towards a tax on business turnover. This is done by placing a cap on input VAT claims at only 70 percent of output VAT. What this means in practice is that businesses that have a profit margin of less than 30 percent may not be able to fully offset their VAT inputs from their VAT output. In other words, any company where the input VAT is more than 70 percent of the output VAT will not be allowed to deduct the "excess" input VAT from the output VAT. Although, a carry-over is allowed chances are such companies will not recover in full the differential, until such time as the business ceases to trade. As such it represents a minimum 3 percent VAT on each and every transaction. For companies operating on the basis of low margins-high turnover, the 3 percent cannot be absorbed and prices will have to increase to compensate. 

When first introduced into the floor of the Senate, the intent of the minimum VAT proposal was to address the under-reporting of output VAT and the over-reporting of input VAT by non-compliant taxpayers. The original suggestion was for a 90 percent cap, a level that would not impact too adversely on compliant taxpayers while compensating for the problem of the non-compliant one. At the 90 percent level, the measure can be defended as a rough proxy for the VAT. However at a level of 70 percent, many believe the level to be punitive.

Although the cap on VAT is not consistent with a "best practice" VAT system, the idea can be considered to have merit in a country such as the Philippines where evasion is widespread. The skill is to set the cap at a level so as not to encourage compliant taxpayers to opt out of the system. A level of between 90-95 percent is considered to be an appropriate range. A number of business organisations are seeking to have Congress, with presidential backing, sponsor a further bill tidying up the drafting of this particular section of the tax code through a legislative amendment that could be passed before the new VAT bill takes effect on July 1 2005. At this time it is not known how receptive the president would be to such a solution but if not rectified, it does threaten to undo much of the good work contained in the rest of the bill.

Not another Argentina 
The fact that the government finally pushed through the most important piece of legislation in its efforts to overcome the fiscal problems of the country has not prevented the usual detractors to once again sowing fear and doom. The latest such warning of dire consequences for the country came from a highly publicised report from an analyst at Moody's Investor Services which once again compared the Philippines with Argentina.
The Philippines is not Argentina of course and the structure of the debt is quite different in both countries: Filipino debt is mostly long-term whereas Argentina got into trouble because it had too much short-term debt to service. And as the Secretary for Trade and Industry was quick to point out, the Philippines is making headway in closing the fiscal gap, with the implementation of new revenue measures. A balanced budget is now seen as a possibility as early as 2008. The economy remains buoyant. The Philippines has registered improving economic growth conditions since 2001 while Argentina had a three-year economic recession before it defaulted on its obligations. Even in 2005, with both the IMF and the OECD (and others) ramping back their forecasts for the global economy this year, the Philippines is likely to still do pretty well, expanding at a 5 percent clip. The problem of course is in the quality of growth which continues to be consumption led on the back of increasing inwards remittances from overseas Filipino workers.

Remittances are up
According to the Bangko Sentral ng Pilipinas (Central Bank), the total of dollar remittances in the first quarter was up 17 percent from US$1.96 billion a year ago, exceeding the government growth forecast of 10 percent for the whole year. Remittances coursed through banks reached US$8.5 billion in 2004 and are expected to reach US$9.4 billion in 2005, based on the 10-percent growth target. If the first quarter growth becomes a trend throughout the year, there are reasons to believe that cash remittances through banks would breach easily the US$10-billion mark for the first time in 2005.

Tax collections start to rise
The government's monthly revenue collection reached a high of US$1.5 billion (PhP82.8 billion) in April, enabling the government to post a budget surplus for the first time in four years. With expenditures standing at only PhP79.5 billion in the same month, the government was able to realise a PhP3.3 billion budget surplus during April. However, April's surplus, while pleasing was not sufficient to make a dent just yet in the huge accumulated budget shortfall that occurred in the first quarter.

The accumulated budget deficit from January to April this year amounted to PhP60.1 billion (US$1.1 billion), although the figure was below the government-set deficit ceiling of PhP77.8 billion. Expenditures hit PhP315.5 billion on revenues of PhP255.4 billion in the four-month period.

In April, the Bureau of Internal Revenue (BIR) reported that tax collection was up 18.7 percent to PhP62.9 billion, signifying that its campaign against large tax evaders such as movie celebrities is paying off. At least 17 famous individuals face tax evasion charges. Meanwhile, the Bureau of Customs, which collects import duties and other charges, reported a 17.5 percent increase in monthly collection to PhP12.43 billion in April. The Bureau of Treasury's revenue stood at PhP4.74 billion.

For the whole of 2005, the BIR is seen collecting a total of PhP551.4 billion while the Bureau of Customs is expected to raise PhP146.7 billion. Both agencies are "under new management" and seeking to plug system leakages that have caused underperformance in recent years. Finally, new management appears to be having some effect although it is early days yet and there is no room for complacency.

Inflation remains a concern
Minimum Wages in Selected Asian Countries
Daily Rates in US Dollar Equivalents
Singapore 14.25-44.80
Korea 20.04
Malaysia 4.24-9.10
Philippines 5.54
Thailand 3.36-4.25
Indonesia 1.36
China 0.31-1.28
Vietnam 0.93
Source: National Wages and Productivity Commission

There are a few storm clouds on the horizon - principally concern over inflation and export growth, which has suffered a severe and early downturn from the high point of 2004. As elsewhere in Asia, exports are dependent (many would claim - "over-dependent") on a buoyant electronics sector and electronics shipments have declined rapidly as consumers in OCED countries rein in their spending on consumer items to pay for higher prices at the petrol pumps.

As the government attempts to improve its fiscal situation by raising tax rates and increasing electricity charges, the Philippine economy is entering a crucial stage. The combination of measures proposed by (or supported by) government could lead the inflation rate to double-digit levels in the coming months if not handled with care. This is the possible outcome if the additional tax measures are combined with a new round of transport fare increases and the proposed wage adjustments. Many think the result could be a 20-percent inflation rate and a discontented public demanding a change in government. While each hike will represent a one-time shock, in reality there are likely to be several such events, the combined effect of which will represent a significant increase both in consumer prices and in the cost of doing business. How much can the general public (not to mention the business community) take?

In the first four months of 2005 alone, the year-on-year inflation rate averaged 8.5 percent, the highest in Southeast Asia. So heavy was the burden of high prices on consumers that labour groups are now demanding an increase in the daily minimum wage by a range of PhP78 to PhP125 (US$1.4 to US$2.3). Business groups appear to be amenable for a maximum wage increase of PhP30 (55 cents). Even this amount equates to a 10 percent increase in the daily minimum wage (based on Metro Manila).

According to the National Statistical Coordination Board (NSCB), the same government agency that releases the GDP figures, a proposed PhP125 increase in the daily minimum wage would push up consumer prices by as much as 15.1 percent, on top of the "normal inflation". Even the more moderate PhP30-wage increase proposed by employers, the NSCB said this would result in a 3.6 percent increase in prices, on top of the normal inflation. The total cost of production in that case is seen climbing 3.7 percent and the total cost of personal consumption by 3.6 percent. The NSCB said any wage increases without commensurate productivity gains would also make the cost of labour in the Philippines more expensive than in many other Asian countries.

Economic Planning Secretary Romulo L. Neri, made the right call when he said that the daily minimum wage should be adjusted at reasonable levels that would keep the country's economic competitiveness. Neri warned that granting a minimum wage beyond the capacity of local companies would affect the country's competitiveness and hurt the export sector.

Exports continue to decline
In fact, the export sector is already hurting. The latest trade figures show that in March, Philippine exports fell for the second consecutive month, by 2.8 percent year-on-year as demand for electronic products showed signs of further weakening. Exports were down 0.6 percent in February.

The government has set a 10-percent export growth target in 2005. This is even higher than the actual 9.3 percent growth registered in 2004, but data show that Philippine exports managed only a 3.6-percent increase in the first quarter of the year. The government target continues to look overly optimistic. With global growth forecasts being continually revised downwards, it must surely be time for a reality check by those responsible for issuing the local forecasts.

Exchange rate concerns
Measured against its own yardsticks, the Philippines is now doing much better than in the recent past. Yet, when compared to other Southeast Asian countries, this country continues to bring up the rear. In essence costs, especially manufacturing costs, are rising but the productivity of the workforce is not increasing at the same rate. The peso continues to be one of the few Asian currencies (apart from those pegged to the US dollar) that has so far not seen any real appreciation. Indeed, it is still considered the one currency in Southeast Asia that is under significant downward pressure. 

It is the inward remittances - this year likely to top US$10 billion - that is the salvation here but the reality is that the peso is over-valued at the present time if the country is to restore its export competitiveness. A slow slide is more likely than a fast drop but if inflation spins higher then we could see some instability develop, the consequences of which are hard to discern. Remittances might slow appreciably if overseas workers feel that by holding off, they can get more pesos per dollar for their families at home and of course, what a significant fall in the value of the peso might do to the repayment schedule of government on its foreign borrowings would be of major concern. At this stage, there are no immediate signs of the currency being under significant pressure other than to note that there are some clouds building on the horizon that need to be watched.

Consumption remains the principle driver
Despite signs of an upturn in foreign direct investment, most of it is in the form of investment commitments rather than actual inwards remittance and for the time being, consumption expenditure, buoyed by the increasing level of inwards remittances will continue as the principle growth driver. With El Nino affecting agricultural output throughout much of Southeast Asia, including the Philippines, any further growth input from this sector of the economy is unlikely this year. 

Government economists say they are keeping the economic growth forecast of 5.3 to 6.3 percent in 2005, in spite of rising prices, impending wage adjustments and the proposed two-percentage point increase in the value added tax (VAT). Government forecasters are also expecting that at this level of growth, the poverty incidence in the country, which fell to 30.4 percent of the population in 2003 from 33 percent in 2000 (based on official figures) would decline further this year.

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