PHILIPPINES

PHILIPPINES’ FISCAL SPACE AFTER RESPONDING TO

COVID-19 PANDEMIC 1

Fiscal space in the Philippines has narrowed in the wake of the COVID-19 pandemic. In 2020, the
supportive fiscal measures led to an increase in the general government debt-to-GDP ratio by 15 ppts
to about 52 percent in end-2020. With a sluggish recovery in revenue and the continued need for fiscal
support, the general government debt-to-GDP is expected to peak at about 62 percent in 2024, slightly
above the authorities’ indicative cap of 60 percent. As the fiscal space to respond to any future
economic downturns is now more limited, rebuilding fiscal space would be desirable in the medium
term. This goal could be achieved through higher revenue mobilization, better tax administration, and
stronger expenditure efficiency, anchored around a prudent medium-term fiscal framework. Measures
to boost real GDP growth would also help to improve the fiscal space.

A. Fiscal Response to the COVID-19 Shock and Its Impact

1. The fiscal deficit nearly doubled in 2020, in part due to the authorities’ fiscal response
to support recovery during the COVID-19 pandemic. Prudent fiscal management prior to the
pandemic provided the Philippines with substantial fiscal space to respond to the pandemic. The
fiscal support included two stimulus packages (Bayanihan Acts I and II) in 2020 and the CREATE tax
reform package, which included an accelerated reduction of corporate income tax rates.2 In total, the
direct budgetary support amounted to
4.4 percent of 2020 GDP. The government
also introduced below-the-line measures,
mainly for credit guarantees, that amounted
to about 0.6 percent of 2020 GDP. The
measures were well-targeted, focusing on
social spending for the most affected
sectors (text chart). The fiscal deficit
increased by about 4.2 ppts reaching
7.6 percent of GDP in 2020. The deep
contraction in output contributed to about
0.6 ppts to the increase in the deficit and to
lower revenues.

2. The higher fiscal deficit in 2020 led to a significant increase in the debt-to-GDP ratio,
narrowing the fiscal space. The general government gross public debt-to-GDP ratio is estimated to

1
Prepared by Sarwat Jahan. The analysis is based on data up to May 30, 2021.
2
CREATE refers to the Corporate Recovery and Tax Incentives for Enterprises Act. CREATE lowers corporate income tax
from the current 30 percent, the highest in the region, to 20 percent for micro, small, and medium enterprises with
net taxable income of PHP 5 million and below, and with total assets of not more than PHP 100 million excluding
land. For the rest, including foreign firms, the corporate income tax reduction is 25 percent.

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have increased by about 15 ppts in 2020, reaching about 52 percent by the end of the year.3 The
output contraction of about 9.6 percent in 2020 contributed about 4.2 ppts to the increase in the
debt-to-GDP ratio in 2020. The higher fiscal deficit led to higher general government gross
financing needs, which increased from 5.4 percent in 2019 to 10.1 percent of GDP in 2020. The
authorities had continued access to markets and were able to finance the deficit through higher
borrowing from both domestic and external sources (which led to cash buffers of about 4 percent of
GDP).

B. Post Pandemic Fiscal Space

3. The post-pandemic debt trajectory will continue to remain high, as fiscal policy will
continue to be expansionary in the near term to support recovery. The fiscal deficit is projected
to increase to about 9.6 percent of staff projected GDP in 2021, reflecting the sluggish recovery in
revenue (expected to grow by about 0.9 percent y/y in nominal terms in 2021) and a further
expenditure increase, to respond to the pandemic and push for infrastructure projects under the
Build Build Build program (leading to an increase in the infrastructure program from about
4.8 percent of GDP in 2020 to 5.3 percent of staff projected GDP in 2021).4 It is assumed that the
unwinding of the fiscal stimulus will start in 2022 when tax revenues recover, and support measures
elapse. The national government budget deficit is projected to reach 3.5 percent of GDP by 2026, as
the revenue-to-GDP ratio converges to historical values, while the expenditure-to-GDP ratio remains
slightly higher than the historical average due to the Mandanas ruling on revenue sharing with the
local government units (LGUs).5

3
The actual general government gross debt for 2020 is not yet available. However, the national government gross
debt increased from about 39.6 percent of GDP in 2019 to 54.6 percent of GDP in 2020 and further increased to
60.4 percent of GDP in 2021:Q1, with about 72 percent denominated in local currency.
4
The investment program includes national government expenditure on infrastructure investment, infrastructure
subsidy/equity to government owned and controlled corporations GOCCs, and transfers to local government units
(LGUs) intended for infrastructure spending.
5
The Mandanas Ruling, confirmed by the Supreme Court in 2019, stipulates that the revenue from all national taxes,
with a few exceptions, will be included in the base for determining the total allocation to the LGUs.

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4. Staff projects that the general gross government debt-to-GDP ratio will be
temporarily higher than the authorities indicative cap of 60 percent during 2023−25. With a
sluggish recovery in revenue and the continued need for fiscal support in 2021, temporarily higher
budget deficits will add to the debt ratios. Going forward, the relatively small revenue base will
continue to weigh on the fiscal space, although it will be partly mitigated by the growth recovery.
Under this baseline scenario, the general government gross debt-to-GDP ratio would peak at about
62 percent in 2024 and then gradually start to decline, although negative shocks could lead to
higher debt ratios. The fan chart shows the possible evolution of the debt-to-GDP ratio over the
medium term by simulating the impact of a large number of shocks (both the upside and downside
risks) to relevant macroeconomic variables such as real GDP growth, the effective real interest rate,
the real exchange rate, and the primary balance. The chart suggests that while debt may stay above
the baseline path under a downside scenario, it will remain bounded below 68 percent of GDP.

C. Rebuilding Fiscal Space

5. The authorities would benefit from a fiscal strategy that balances the need for
continued policy support in the short term with the rebuilding of fiscal space in the medium
term. In the near term, fiscal policy would need to remain flexible to support recovery, but it would
be prudent to build fiscal space in the medium term, to have the flexibility to respond to another
major downturn or a large shock (e.g., natural disasters that could lead to bigger damages with
climate change). Rebuilding of fiscal space would require a policy mix of revenue generation (¶6 and
¶7), expenditure efficiency (¶8), and boosting GDP growth. Policies to foster stronger growth,
including through structural reforms, will be critical in the strategy to increase fiscal space as
economic scarring due to COVID-19 will have a persistent impact.

6. Implementing the remaining tax reforms will be essential for sustaining higher
spending in support of longer-term growth while creating fiscal space. Fiscal space could be
rebuilt by strengthening revenue mobilization as Philippines’ revenue-to-GDP ratio is below the
average of ASEAN countries and ranks
below many EMs. The authorities
implemented the first package of their
Comprehensive Tax Reform Program
(CTRP) in 2018, which involved excise tax
increases for select products and a
broadening of the VAT tax base. The
envisaged increase in tax collection was to
be allocated to infrastructure projects
(70 percent) and social service programs
(30 percent). More recently, the authorities
implemented the second package of the
CTRP in March 2021 which accelerated the
reduction in corporate income tax
compared to the original plan in response to the pandemic through the CREATE Act. Remaining

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revenue-raising reform priorities includes broadening the tax base for property-related taxes; and
simplify taxes for financial services (table on tax measures).

Tax Reforms in the Philippines

7. Continued efforts to improve revenue administration would reinforce tax reforms.

Revenue administration can be strengthened by maintaining tax compliance of profitable firms, and
adopting new digital products and services will help boost revenue mobilization. Additionally,
building on the recent CREATE Act, revenue performance can be improved through streamlining and
reducing exemptions and loopholes. Under CREATE, the Fiscal Incentives Review Board (FIRB) will

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determine the target performance metrics that firms will need to meet to receive tax incentives; and
conduct regular monitoring and evaluation of investment and non-investment tax incentives, such
as cost-benefit analysis to determine their impact on the economy and whether agreed performance
targets are met. If properly implemented, FIRM can improve the oversight and design of current
extensive tax incentive regime, making the regime more accountable and effective in encouraging
business investment and job creation.

8. Exploring options to improve expenditure control and efficiency, including by better

targeting and improved delivery would complement revenue efforts. For example, compared to
the best-performing countries among emerging market economies, the Philippines has an efficiency
gap in translating public investment into infrastructure (IMF Country Report No. 19/137, Philippines:
Public Investment Management Assessment, 2019).6 In other words, although the perceived quality of
infrastructure seems good, the Philippines could generate more and better infrastructure services
with the same level of the public capital stock per capita if the efficiency gap were closed. Hence,
greater infrastructure could be generated with the same level of spending that could help mitigate
pressure on fiscal space.

9. To maintain fiscal discipline, the authorities may benefit from augmenting its
medium-term fiscal program (MTFP) with explicit fiscal anchors to ensure fiscal sustainability.
Currently, the Philippines has a three-year medium-term fiscal program (MTFP), which is set by the
Development Budget Coordination Committee (DBCC). The MTFP serves as the framework that
guides the macroeconomic and fiscal policies of the government. The national government’s fiscal
performance is consistently evaluated against the MTFP, and fiscal projections are updated in
mid-year to account for actual accomplishments, emerging challenges, and developments and
prospects in the macroeconomic and fiscal landscapes.7 Going forward, there could be benefits to
formulating medium-term fiscal plans with explicit anchors which would eliminate any concerns on
the authorities’ commitment to ensure fiscal sustainability, especially given the downside risks to the
near-term outlook and the heavy reliance on expenditure measures. The parameters could be set by:

• Medium-term fiscal strategy (MTFS). The authorities have an indicative debt-to-GDP ratio cap of
60 percent with an implicit deficit rate of around 3 percent. Under the baseline, the general
government debt-to-GDP ratio will exceed the indicative cap, and efforts to keep below the cap
in the near term will likely be counterproductive as the economy is recovering from a deep

6
The IMF has developed a methodology for estimating the efficiency of public investment, explained in the 2015
IMF paper, Making Public Investment More Efficient. Simply stated, a country’s performance is estimated based on an
index of the output of public investment compared to its per capita public capital, or input. A “frontier” that consists
of the countries achieving the highest output per unit of input is drawn. Using a consistent set of data, the
performance of a total of 128 countries is compared to the frontier.
7
The fiscal projections are regularly updated/revisited by the DBCC in order to adequately guide the country’s annual
budget preparation process through the issuance of the Budget Priorities Framework. This is supported by the
implementation of the Two-Tier Budgeting Approach through which the forward estimates or the future costs of
ongoing policies, and existing programs, activities, and projects (PAPs) for the next three years serve as the baseline
budget. This then feeds into the review and/or updating of the MTFP and is used to estimate the available fiscal
space to fund new or expanded PAPs.

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downturn. Instead, the cap could serve as a medium-term anchor with deficit targets as
intermediate objectives. A specific plan to meet the post-pandemic deficit ceiling by detailing
the underlying measures could help anchor expectations about the medium-term fiscal position
and reduce risks to policy credibility, especially if also backed by revenue measures. If the state
of the economy prevents meeting the target, risks to policy credibility could be reduced with a
well-articulated escape clause or regular progress reviews.

• Medium-term revenue strategy (MTRS). Taking advantage of the current reform momentum in
tax policy, the Philippines can adopt a MTRS which would be critical to lay out the plans for
financing a higher medium-term growth. The MTRS can draw out measure including to improve
tax administration and revenue collection, which could help finance the large infrastructure
expenditures as well as potential increase in the allocation to local government units.

• Medium-term debt management strategy (MTDS). Elevated public debt has heightened the need
to strengthen the capacity in debt management and to accelerate capital market development
to ensure stable domestic financing. While Philippines has prudently managed its debt thus far,
all debt-related analytical work currently focuses on Annual Borrowing Plans with no clear
analytical framework to guide the composition of the public debt portfolio. Adopting an MTDS
framework could strengthen debt management by not only providing clarity on the borrowing
objectives but also identify the risks of selected financing options.

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