In its latest assessment on the Philippine economy, the IMF noted that despite higher oil prices and intense regional competition, the balance of payments remained strong.

The IMF has commended the Philippine government for steadying the economic ship after the political turbulence in mid-2005 and for regaining momentum on their reform agenda—as evidenced by the sharp reduction in power sector losses and the full implementation of the landmark VAT reform law.

The IMF also welcomed the large reduction in the public sector fiscal deficit in 2005. These policies have helped to turn around investor sentiment, boost market confidence, and strengthen the peso.

Notwithstanding these notable achievements, the Philippines faces two key challenges going forward—namely, to strengthen its defenses against the remaining significant shortterm vulnerabilities, and to move the economy to a higher and more sustained economic growth path.

The assessment noted that with its still high debt levels, the Philippines remains vulnerable to a sudden turn in the current benign external financing environment.

In addition, further spikes in oil prices or an outbreak of avian flu pose additional near-term risks. Thus, the IMF has urged the authorities to sustain the reform momentum by completing the remaining agenda for fiscal and other structural reforms and thereby enhance the economy’s ability to absorb such shocks.

The IMF has underscored the importance of further enhancing the investment climate to set the stage for higher economic growth and substantial reduction in poverty.

It expressed concern about the recent weakening in export performance, and stressed that a stable macroeconomic environment, increased infrastructure investment, a stronger financial system, and improved governance, including in the area of property rights, will be key to increasing the rate of investment and enhancing competitiveness over the medium term.

By contrast, the IMF did not consider the recent appreciation of the exchange rate as a threat to the economy’s competitiveness.

It also welcomed the priority the authorities attach to raising public awareness of the benefits of reform, pointing in this context to the recent positive experience that has highlighted how improved market confidence can reduce the costs of tough but necessary policy measures.

The IMF has noted the sharp reduction in the nonfinancial public sector deficit that is underway.

It underlined the importance of the steps being taken to strengthen tax administration to ensure that the recent VAT reform package translates effectively into commensurately higher VAT revenue.

Balancing the budget over the medium term will require additional measures. The Philippine government has been urged to consider and pursue additional tax policy measures, such as a sufficiently ambitious rationalization of tax incentives, to broaden the tax net and improve efficiency and equity.

The IMF has agreed that rebalancing the composition of public expenditure, with reduced current outlays providing space for capital and social spending, should form an integral part of the fiscal consolidation.

The planned use of part of VAT reform proceeds for the financing of priority infrastructure projects and social programs was also welcomed.