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Annual Report 2002

Overview

The economy performed better than expected in 2002, showing resilience in the face of generally weak global conditions and challenges in the domestic front. Demand was underpinned by robust private consumption demand, which was helped in part by declining inflation and interest rates as well as by inflows from the remittances of overseas Filipino workers (OFWs). Output, meanwhile, was driven by the steady performance of the services sector and the upturn in the industrial sector.

The strengthening of economic activity occurred against a backdrop of subdued price conditions as average CPI inflation settled at its lowest level since 1988 and fell below the government’s target of 4.5-5.5 percent. The benign inflation environment stemmed mainly from lower food inflation, fairly stable non-food prices and muted demand-side influences on consumer prices. The latter may be attributed to the limited pricing power on the part of producers amid evidence of spare manufacturing capacity, subdued credit demand, and soft labor market conditions. Such conditions imply that overall demand has sufficient room to strengthen without generating inflationary pressures.

The combination of a manageable inflation environment and weaker-than-expected global economic conditions provided scope for the monetary policy of the BSP to focus on providing the appropriate liquidity conditions needed to support a non-inflationary growth path. For this reason, the BSP policy interest rates were reduced by a cumulative 75 basis points during the first quarter of the year on the basis of a continued benign inflation outlook. The rates were left unchanged for the rest of the year as monetary policy settings were deemed to be adequately supportive of the domestic demand. In addition, monetary authorities recognized the inflationary risks stemming from the impact of possible increases in oil prices against the backdrop of a US-led offensive against Iraq and the challenges posed by the need to strengthen the National Government’s (NG’s) fiscal position.

The year 2002 also marked the first year of the formal implementation by the BSP of an inflation targeting framework for monetary policy. The framework consists of a set of institutional arrangements under which monetary policy decisions are made and carried out. It is expected to strengthen the BSP’s commitment to price stability and improve further the transparency and consistency of monetary policy and the accountability of the BSP in attaining its price stability goal.

The financial system remained resilient while the external position continued to be stable. These developments also contributed to improve the macroeconomic fundamentals. Total resources of the banking system continued to grow while asset quality, capitalization and loan loss provisions improved. Meanwhile the current account surplus benefited from the rebound in exports and the strong remittances from OFWs. As a result, the country’s balance of payments posted a healthy position. Reserves were maintained at comfortable levels in terms of import cover and as a ratio to short-term debt. As such, the peso stayed broadly stable. Meanwhile, the country’s external debt remained manageable.

Economic growth strengthens. The country’s real Gross National Product (GNP) and real Gross Domestic Product (GDP) grew by 5.2 percent and 4.6 percent, respectively in 2002, surpassing the government’s full-year growth target of 4.5-5.0 percent for real GNP and 4.0-4.5 percent for real GDP. It also exceeded the previous year’s real GNP and real GDP growth rates of 3.4 percent 3.2 percent, respectively. The expansion was driven mainly by the robust performance of the services sector and the upswing of the industry sector. On the demand side, growth was driven by buoyant consumer spending in communications and retail trade supported in part by the increased remittances from OFWs, as well as the downtrend in both the inflation and interest rates.

Inflation is lower than target. Inflation was consistently on track in 2002, with average inflation for the year decelerating to 3.1 percent, the lowest level recorded in 15 years. The average for 2002 was also lower than both the previous year’s comparable figure of 6.1 percent and the low-end of the government’s inflation target of 4.5-5.5 percent. The benign inflation outturn in 2002 was attributed to lower prices for major food items such as rice and corn, stable non-food inflation as well as to subdued demand-side influences on consumer prices.

National Government’s fiscal deficit is larger-than-program. The NG posted a budgetary deficit of P212.7 billion in 2002, about P65.7 billion or 44.7 percent higher than the P147.0 billion recorded in the previous year. This developed as the growth of expenditures at 9.6 percent in 2002 outpaced the growth of revenues at only 0.4 percent.

Monetary policy stance remains supportive of a non-inflationary growth path. The combination of a manageable inflation environment and weaker-than-expected global economic conditions gave scope for the monetary policy of the BSP to focus on providing the appropriate liquidity conditions needed to support a non-inflationary growth path. The BSP reduced its policy interest rates three times by a cumulative amount of 75 basis points, mainly during the first quarter of the year, bringing the overnight borrowing and lending rates to their lowest levels of 7.0 percent and 9.25 percent, respectively in more than 10 years. The BSP’s policy rates were kept on hold for the remainder of the year as monetary policy settings were deemed to be adequately supportive of the domestic demand and as monetary authorities recognized the inflationary risks stemming from factors such as the impact of possible increases in oil prices against the backdrop of a US-led offensive against Iraq and the challenges posed by the need to strengthen the NG’s fiscal position. These factors were deemed to have a crucial impact on the inflation outlook as well as on inflationary expectations.

BSP implements the inflation targeting framework in monetary policy. The formal shift to inflation targeting as framework for monetary policy took effect in January 2002. The said framework involves the announcement of the inflation target that the BSP is committed to attain over a two-year policy horizon. This is expected to improve further the transparency and consistency of monetary policy and the accountability of the BSP in attaining the price stability objective. This framework will also help guide expectations toward a non-inflationary economic growth path.

Interest rates remain low. The reduction in the BSP’s policy rates combined with ample liquidity of the banking system, has contributed to the downtrend in the benchmark 91-day Treasury bill (T-bill) rates. During the last auction of T-bills on 9 December 2002, the 91-day T-bill rate settled at 5.164 percent, indicating a decline of about 1,060 basis points relative to its average level in November 2000. Similarly, the low end of the range of banks’ lending rates dropped by more than 1,070 basis points during the same period to average at 8.122 percent in December 2002.

The banking system remains resilient. The BSP continued to implement policy reforms that were focused on the maintenance of the strength and stability of the banking system, improvement of banking services, enhancement of management capability and corporate governance within the banking system, as well as the promotion of the international campaign against money laundering. Total resources of the banking system continued to grow while asset quality, capitalization and loan loss provisions improved.

Moreover, the BSP has been supporting the disposition of banks’ non-performing assets through the creation of privately owned asset management companies (AMCs) or special purpose vehicles (SPVs). The BSP likewise continued to pursue reform initiatives that are focused on strengthening its supervisory capability and regulatory powers and promoting transparency and aligning standards with internationally accepted norms. As a result, the Philippine banking system remained resilient despite transitory shocks posed by the recent global developments in the financial market.

The balance of payments posts a surplus. The country’s balance of payments (BOP) during the first nine months of 2002 yielded a US$751 million surplus, a reversal of the US$1,308 million deficit posted in the same period last year. Underpinning this positive development was the consistently strong performance of the current account. Exports for the first nine months of the year reached US$25.4 billion or 9.3 percent higher than the level a year ago.

The country’s gross international reserves remain robust. The BSP’s gross international reserves (GIR) including the reserve position in the IMF, climbed to US$16.2 billion as of end-December 2002. The GIR was 3.0 percent or US$521 million higher compared to the end-December 2001 level of US$15.7 billion. The end-2002 level of reserves was equivalent to 4.8 months’ worth of imports of goods and payment of services and income. Using other reserve coverage measures, the level of reserves is 2.8 times the amount of the country’s short-term foreign liabilities based on original maturity and 1.3 times based on residual maturity. The net international reserves (NIR) level similarly increased to US$12.8 billion as of end-December 2002 from the previous end-year’s US$11.4 billion.

The exchange rate is generally stable. The peso was generally stable in 2002 even as the BSP continued to maintain a market-oriented foreign exchange rate policy. Although recently affected by geopolitical factors and fiscal concerns, the peso remained fundamentally supported by a healthy international reserves level and improving external balance. The peso-dollar rate averaged P51.60/US$1 in 2002, a 1.2 percent depreciation compared to the average rate of P50.99/US$1 in 2001. Exchange rate volatility, as measured by the standard deviation of the daily peso-dollar rate, declined to P1.13 in 2002 from P1.57 in 2001.

External debt remains manageable. The country’s total outstanding external debt stood at US$53.6 billion as of end-September 2002, an increase of US$1.3 billion from the 2001 level of US$52.4 billion. The country’s external debt remained manageable with US$47.7 billion or 89.0 percent of the total external debt representing medium- and long-term (MLT) liabilities and only 11.0 percent consisted of short-term debt. The average maturity of MLT debt was computed at 16.4 years, with the debt maturity averaging at 10.4 years for the private sector and 19.0 years for the public sector.