Document of

The World Bank

FOR OFFICIAL USE ONLY

LAl - 3 702-Repoit No. P-5967-PH

MEMORANDUM AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ON TWO

PROPOSED LOANS

IN AN AMOUNT EQUIVALENT TO US$211 MILLION

TO THE

NATIONAL POWER CORPORATION AND

THE PHILIPPINE NATIONAL OIL COMPANY

WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES

FOR THE

LEYTE-CEBU GEOTHERMAL PROJECT

JANUARY 6, 1994

FA-t

This document has a restricted distribution and '

their official duties. Its contents may not othel

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CURRENCY EQUIVALENTS(as of May 31, 1993)

Currency Unit Pesos (P)p 1 = US$0.038US$1 F26.0

WEIGHTS AND MEASURES

GWh = Gigawatt hour (1,000,000 kwh)kWh - Kilowatt-hour (860 kilo-calories)TWh = Tera watt hour (109 watt-hours)

ABBREVIATIONS AND ACRONYMS

BOT Build-Operate-TransferBTO Build-Transfer-OperateDOE Department of EnergyERB Energy Regulatory BoardESP Energy Sector PlanESMAP Energy Sector Management Assistance ProgramNPC National Power CorporationOPSF Oil Price Stabilization FundPNOC Philippine National OiJ CompanyRECs Rural Electrification CooperativesROL Rehabilitate-Operate-Lease

FISCAL YEARJanuary 1 to December 31

FOR OFMICIAL USE ONLY

PHILIPPINES

LEYTE-CEBU GEOTHERMAL PROJECT

Loan and Project Summary

Borrowers: National Power Corporation (NPC) and Philippine NationalOil Company (PNOC).

Guarantor: Republic of the Ihilippines.

Amounts: US$211 million equivalent, of which US$147 million to NPCand US$64 million to PNOC.

Terms: 20 years, including five years of grace, at the Bank'sstandard variable interest rate

Financing Plan:Local Foreign Total--- US$ million -

World Bank - NPC 0.0 147.0 147.0World Bank - PNOC 0.0 64.0 64.0BOT for Power Generation 21.0 153.7 174.7National Power Corporacion 29.5 16.5 46.0Philippine National Oil Company 17.2 10.0 27.2

TOTAL 67.7 391.2 458.9

Economic Rate of Return: 16%

PovertyCategory: Not applicable

Staff Appraisal Report: Report No. 11449-PH

Map: IBRD No. 24925

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

MEMORANDUM AND) RECOMMENDATION OF THE PRESIDENTOF THE IBRD TO THE EXECUTIVE DIRECTORS

ON TWO PROPOSED LOANSTO THE NATIONAL POWER CORPORATION ANDTHE PHILIPPINE NATIONAL OIL COMPANY

WITH THE GUARANTEE OF THE REPUBLIC OF PHILIPPINESFOR A LEYTE-CEBU GEOTHERMAL PROJECT

1. I submit for your approval the following memorandum andrecommendation on two proposed loans to the National Power Cotperation (NPC)and the Philippine National Oil Company (PNOC) with the guarantee of theRepublic of the Philippines for the equivalent of US$211 million (US$147million to NPC and US$64 million to PNOC' to help finance a Leyte-CebuGeothermal Project. The loans would be at the Bank's standard variable interestrate, with a maturity of 20 years, including five years of grace. TheGovernment of the Philippines would charge a guarantee fee of 1% per annum onthe outstanding amount of the Bank loan.

I. COUNTRY POLICIES AND BANK GROUP ASSISTANCE STRATEGY

A. Recen;. Economic and Social Performance

2. Background. The Philippines was an early adjustor, with one of thefirst Structural Adjustment Loans from the Bank in 1980. Since then, andparticularly since 1986, the authorities have made concerted efforts to correcta wide array of structural problems, comparable in scope to reforms undertakenin successful adjustment countries such as Mexico and Indonesia. Reforms inagricultural pricing and marketing, the financial sector, trade policy, the taxsystem, investment incentives, and energy pricing have been undertaken, alongwith privatization and procedures to set priorities for public investments.Sugar and coconut monopolies have been disbanded, interest rates are determinedby market forces, the bias towards capital intensity in investment incentiveshas been effectively removed, a value added tax and improved income taxmeasures have substantially reduced tax distortions, trade reform has beenpursued, and the Board of Investments has streamlined procedures and is in theprocess of taking on a more promotional role.

3. Desp4.te these structural reforms, the goal of sustained growth haseluded the Philippines; growth has often been interrupted by periods ofstagnation. The Philippine economy, for example, enjoyed relatively highgrowth of above 5 percent a year during 1986-89, recovering from thedevastating crisis of 1984-85 (when real GNP fell by 15 percent), only to beinterrupted by a period of stagnation (1990-92) when income grew by an averageof 0.7 percent a year, much below the population growth rate. In fact, realGDP per capita in 1992 was lower than that in 1976. This performance stands insharp contrast to that of neighboring East Asian countries where so-called"economic miracles" have spread from the original "tigers" to Malaysia,Thailand and Indonesia.

4. The Philippines already enjoys a high adult literacy rate, and thelevel of human capital does not appear to lag behind its neighbors. Whatdistinguishes the Philippines most clearly from the successful neighbors, then,is its low fixed capital formation. Its ratio to GDP in the Philippinesaveraged 22 percent in the 1980s, while most competitor countries in the regioninvested 30 percent or higher. While the domestic political turmoil of the1980s and persistent law and order problems acted as an additional damper on

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investment, the low private investor response to the reformed incentivestructure in the Philippines can be traced to the negative investor perceptionregarding sustainability of reform efforts arid, more recently, poor conditionsof infrastructural services. Although the accumulated impact of reforms takenso far has been significant, slow and piecemeal impl.-mentation, at timesaggravated by interventions by the judiciary, has created a persistentperception among potential investors that reforms in the Philippines might nothave been owned by the Government and thus could not be effectively implementedand might even be reversed. Also, frequent macroeconomic problems have led toa squeeze on maintenance and new investment spending on infrastructure reducingthe quality of service. In particular, in the power sector, not only existingstocks were poorly maintained but also no new investment was completed duringthe second half of the 1980s largely because of institutional weakness andcumbersome government procedures in planning and selecting projects.

5. Recent Economic Developments. The Government has been making effortsto improve policy implementation and remove infrastrmcture bottlenecks.Regarding macroeconomic management, the Government successfully completed theFund's stand-by arrangement in March 1993 although they have met with somedifficulties since then (para 8). Under the program, the consolidated publicsector deficit was reduced to manageable levels in 1992 (2.4% of GNP),inflation was reduced to single digit, the current account was reduced to under2% of GNP and gross reserves rose to over 3 months of imports. In addition,the Government liberalized foreign exchange markets for both current andcapital transactions. Together with the earlier liberalization of interestrates, this has reduced th- scope for discretionary Government actions; marketdetermined exchange and interest rates now provide a litmus test for judgingthe adequacy of macroeconomic policies. Other reforms to improve anddepoliticize macroeconomic management include removal of two previouslysignificant sources of public sector deficit: the financial restructuring ofthe Central Bank and the implementation of automatic linkage between domesticand international energy prices. Reform of the Central Bank has alsostrengthened the independence of monetary management.

6. Similarly, progress has been made in three other areas. First thecompletion of a Brady-type debt agreement in December 1992 has done much toensure a viable balance of payments consistent with sustained medium-termgrowth, both by reducing external interest and principal obligations and byrestoring access of the Government to international capital markets. The "debtoverhang", one of the country risk elements in lending to the Philippines inthe past, has been reduced, allowing private domestic corporations andmuwltinationals easier access to international financing for Philippine-basedprojects and providing the conditions for greater private sector participationin medium-term growth. Second, reforms have been undertaken to encouragegreater domestic and foreign competition and regain external competitiveness;measured in terms of unit labor cost or real effective exchange rates, thePhilippine competitiveness vis-a-vis East Asian neighbors has eroded sinceearly 1980s. In particular, with the liberalization of foreign investment in1991 and continued trade liberalization efforts, external competition facingthe traditional oligopolists has increased substantially. At the same time,there are already indications that small and medium enterprises have expandedtheir share of value added and employment in manufacturing. There are otherencouraging signs as well: the real return on assets and sales of theindustrial sector has increased; corporate debt/equity ratios have fallen; andthe real wage in manufacturing has fallen in the last few years. Third,

efforts are being made to increase the level and efficiency of publicinvestment in infrastructure although limited fiscal revenues often constrainthem. For example, power interruptions have decreased substantially and shouldbe eliminated in the first half of 1994 as new public and private BOT plantscome on stream.

7. However even with these recent efforts to improve the policyenvironment and infrastructure, output has continued to stagnate. CNP growthfor 1992 was only 1.0 percent. Weakness in global trade, and, in 1992, theappreciated exchange rate that resulted from sterilizing large inflows ofremittances have reduced export growth. Positive growth was attributable toincreased remittances from abroad, attracted by high Philippine real interestrates. In 1993, continued remittance flows and the recovery of agriculturehelped boost GNP growth to 1.8 pe-cent durinig the first half of the year. Withthe near-resolution of the power crisis, a depreciated exchange rate (thenominal exchange rate depreciated from P23/US$ in August 1992 to P29/US$ inOctober 1993), and emerging improvement in private sector confidence, furtherrecovery of economic growth is projectad; overall growth for the year may reach2.5 percent.

8. This emerging recovery in 1993 has already started to put pressureson macroeconomic management. Inflation edged up in the last quarter to above 8percent from about 7 percent earlier in the year, reflecting demand pressuresand adjustments in the exchange rate and some food prices. Throughout 1993,the authorities attempted to enhance fiscal revenues through improving taxadministration and introducing new taxes (e.g., energy tax, cigarette tax,documentary stamp tax) to finance the needed increase in infrastructure andother spending. But, difficulties in implementation of many of the new revenuemeasures caused revenue shortfalls, and contributed an increase in thepreliminary estimate of the consolidated public sector deficit, which could beas high as 4.5 percent of GNP. While exports have grown at 12 percent (nominaldollar), imports also increased at 18 percent and the current account deficitis projected to exceed 5 percent of GNP. A significant portion of this isfinanced by Eurobonds issuanca, other portfolio investments by foreigners and adrawdown of reserves. Given that there are continued strong pressures fromlabor unions for substantial wage increases, maintenance of sound macroeconomicmanagement has become an increasing challenge for the Government.

9. In short, while recent efforts in both policy implementation andother areas necessary for business confidence and investment are noteworthy,the results remain modest and tentative. These efforts need to be intensifiedwithin a medium term framework set out in Section C below.

B. The External Environment

10. The Philippines' exports have grown from 21 percent of GDP average in1979-81 to 26 percent in 1989-91, and manufactured goods now account for closeto 80 percent of the dollar value of commodity exports. The country's majortrading partners remain the United States (35 percent of Philippine exports)and Japan (20 percent). The recent slowdown in OECD growth dampen theprospects for robust growth over the next few years; however, the recent GATTagreement under the Uruguay Round is likely to improve the prospects for thePhilippines' exports over the medium to long term.

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ll. The prospects for a significant part of Philippine exports are alsodirectly affected by trading partner policies. Three important foreignexchange sources--garments, sugar, and worker remittances--are subject tobilateral negotiations. In garments, there is considerable uncertainty as tothe level and scope of future agreements. While quota arrangements will bereplaced by the recent GATT agreement after a transition period, unfavorablearrangements, in the meantime, would adversely affect garment export growth,particularly for the mass market garment products where Philippine weaknessesin technological and marketin% efforts are evident. The Philippine sugar quotain the US also faces bleak prospects. It was sharply reduced in 1991/92,because of high domestic stocks and the need to accommodate higher quotas forother countries. And while the quota increased somewhat to 157,422 metric tonsfor 1992/93, the 1993/94 global quota is expected to decline again. Last, thePhilippines needs to be assured of stable arrangements in the volume andtreatment of workers abroad, especially in the Middle East and Japan.

12. The largest single class of imports in the Philippines is oil, ($2billion, about 12 percent of total in 1993) and the balance of payments remainsvulnerable to oil price increases. Each dollar per barrel increase in theprice of oil represents a US$79 million (0.2 percent of GDP) increase in thetrade deficit. The country imports almost all its crude oil, which accountsfor 75 percent of total energy consumption. The strategy for the country,endorsed by the Bank, is to reduce oil dependency to 70 percent by the end ofthe decade through greater exploitation of geothermal, local coal, andhydroelectric resources, but the target for dependency may be lowered furtherin light of recently discovered off-shore oil and gas fields which should begincommercial production in about five years.

13. One significant development in the Philippines has been the hand-overof U.S. military bases at Clark and Subic in 1992 and reduction in the EconomicSupport Fund from the US and other military base-related spending. While suchdislocations have had substantial short-term local effects, they also providenew opportunities for private sector development. The facilities at Subic arein excellent condition, and there is considerable foreign investor interest inthe site. The development of Subic as a freeport is well underway.

14. As in other countries, it is difficult to deliver an unambiguousverdict on the effects of the external environment on the prospects for thePhilippine economy. The uncertainties inherent in the situation point to theneed to monitor the situation closely and to integrate the Philippine economywith global trade and capital flows to allow it to respond flexibly to avolatile external environment. The recent GATT agreement is expected to reducethese uncertainties, increase trade and thus benefit developing countries ingeneral. While its specific impact on the Philippines is being analyzed, theGATT agreement, along with parallel efforts to enhance intra ASEAN trade,would support the Philippines' goal of promoting export-led growth. Meanwhile,domestic economic policies--such as price reform, better investmentallocations, privatization, the establishment of a realistic exchange rate, andfinancial sector reform--as well as efficient project implementation aretogether likely to contribute more to the success of the economy thanfluctuations in the external environment.

C. The Philippines' Developmant Obiectives and Policies

15. The Government has prepared a Medium Term Development Plan (MTDP),1993-98, and an accompanving Public Investment Plan (PIP), which reflect thecountry's aspirations to achieve sustainpd economic growth and povertyreduction. The MTDP has two broad goals: (i) to strive for internationalcompetitiveness of the Philippine economy; and (ii) to "empower people" throughbroad-based job creation and income growth ce sustain the development process.In particular, the country wants to regain the competitiveness, vis-a-vis itsAsian neighbors, that has been eroded during the 1980s. To achieve thesegoals, the COP's agenda consists of the following five core objectives: (i)maintaining a prudent macroeconomic framework through, in particular, sounadfiscal management; (ii) improving the quality of infrastructure services; (iii)improving the business environment for both domestic and foreign investorsthrough appropriate competition policy and further deregulation; (iv)alleviating poverty; and (v) protecting the environment.

16. The Bank agrees that attention to these areas is critical to helpingthe country regain its competitiveness, especially vis-a-vis its neighbors.The actual success in these areas will depend on two key questions: on thePhilippines' capacity to implement the necessary projects especially ininfrastructure in a timely manner, so as to enhance its standing in theperceptions of investors; and on its ability to overcome the fragmented and attimes piecemeal approach to policy-making and implementation.

17. The authorities realize that sound macroeconomic management isessential for private investment and improved external competitiveness. Themost critical area of macroeconomic management has become fiscal management, inparticular, management of the national budget. In this connection, there is anemphasis on increased tax revenues through: improving administration of andexpanding coverage of VAT; and improving tax administration through, forexample, computerization of the Bureau of Internal Revenue and Bureau ofCustoms. The national government tax/CDP ratio has risen from 10.7 percent in1986 to 14-15 percent in the 1990s. These tax efforts have brought thePhilippines closer to the regional average: its tax/GDP ratio is about those ofSingapore, Korea, and Indonesia, but lags behind Malaysia and Thailand, whocollect about 16 percent of GDP as taxes. In view of the relatively weakfiscal outcome of 1993, the Government needs to continue to make vigorous taxefforts to contain the deficit to a level consistent with lowering interestrates and inflation, while at the same time increasing public investment,dismantling distortionary taxes (such as taxes on financial intermediation),and continuing with trade liberalization. In addition, continued discipline insetting public sector wages and minimum wages is critical. The Government isalso improving expenditure monitoring to identify and adequately fund priorityactivities.

18. The country's deteriorated infrastructure is a serious deterrent toprivate investment. In particular, electricity shortages r3ached a crisissituation in 1992-93 with brown-outs of 6-12 hours a day disrupting productiveactivity across all sectors. While brown-outs have been reduced to 2-3 hours aday, it remains critical that shortages be eliminated by enhancing the supplycapacity in an orderly manner. The GOP's has adapted an Energy Sector Planwhich outlines policy, pricing and institutional reforms along with aninvestment and financing program for the sector. It also emphasis demandmanagement. It is estimated that to mcct elect-ricity demand over the next four

years, the Philippines will need about 3,500 megawatts of additional capacity,which together with required transmission investment is estimated to cost about$7.5 billion, about 60 percent of which is supposed to be met by BOTarrangements with the private sector. Otber parts of infrastructure are alsoin a serious condition (water, roads, urban transport and sanitation), andsignificaitt increases in public and private investments in these sectors arerequired and anticipated. Put together, these needs will place a heavy burdenon public finance and require that the GOP address institutional constraints toimprove efficiency.

19. The third aspect to which the authorities are giving emphasis isimprovement in the private business environment through increased scope forforeign and domestic competition. The GOP has largely discarded past effortsbased on discretionazy fiscal incenUives and subsidized credit. Current policyis to implement measures to quicken the supply response to changes in marketconditions by: liberalizing entry to and exit from markets and improving theregulatory framework, especially in transport, banking and telecommunications;promoting export development; adopting improved energy pricing policies;following through with trade liberalization; and reducing the power of largemonopolies and oligopolies. The GOP is also encouraging private sectoractivity through privatization, even in areas that have traditionally beendominated by the public sector such as infrastructure and social services.Progress has been made on most of these areas of competition policy, but theGOP needs to convince investors, who have shown renewed but cautious interest,that it has the vision and determination for vigorous implementation.

20. Another important Government goal is to reduce ipoverty incidence fromthe current 40 percent (according to official criteria)V" to 30 percent by1998. The poor are overwhelmingly in the rural areas, and families with manyyoung children are particuiarly at risk. While recognizing that economicgrowth is the most effective means for poverty alleviation, the GOP has adopteda three-pronged strategy for poverty alleviation: human resource development;service delivery improvement through decentralization; and targeting ofassistance to the most vulnerable. First, education remains the Government'spriority long-term means for reducing poverty. The public education systemsuffers from low quality and the Government intends to give priority to qualityimprovement at all levels to increase retention rates and to supply the skillsneeded in the labor market. Second, the Government recognizes the need toimprove the access of the poor to social services by restructuring theinstitutional set-up of service provision and reallocating funds to priorityactivities. Decentralization is one mechanism being advanced to better matchpublic services with local needs. Third, the GOP is making efforts to targetdirect assistance to the most vulnerable segments of the society, such aspreschoolers younger than five years old and pregnant and lactating mothers.Programs such as women's health and family planning, nutrition, and control ofenvironmental degradation are oriented towards those at risk. These programswould also contribute to further deceleration of population growth, a criticalfactor for accelerating sustainable income growth.

1/ The Philippine poverty threshold is defined at the consumption levelthat is higher than, say, in Thailand or Malaysia. If the Thai definitionis used, the poverty incidence in the Philippines is now at about a third.

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21. The need for active preservation of the Philippines, richbiodiversity and fragile environment has been a major concern of the Governmentin the past few years and has strong and broad based support among thecountry's very large NGO community and the population generally. Th3 GOP hasbroadened its attention from natural resource management and establishment andprotection of a national park system to issues of industrial pollution andcontrol of toxic waste management. In 1989, the Cab'-net approved "ThePhilippine rrogram for Sustainable Development" (PPSD). Based on the PPSD, theGovernment is moving ahead with: (i) strengthening the preservation of naturalresources and biodiversity, especially forests and national parks throughlegislating the Integrated Protected Area System; (ii) controlling industrialair pollution; (iii) reducing urban degradation through better systems of humanand industrial waste management, including the eradication of toxic wastes; and(iv) strengthening the protection of coastal waters and fisheries. TheGovernment has also banned logging of old-growth virgin forests andstrengthened enforcement.

D. Medium-Term Prospects

22. The Bank's overall assessment is that there is now a window ofopportunity for the Philippines to achieve sustained growth (see ThePhilipgines: An ORening for Sustained Growth, Report No. 11061-PH, 1993). Keystructural reforms a;^e in place--liberalized interest and exchange rates,reduced effective protection rates, an openness to foreign trade andinvestment, and tax and incentive systems that are in line with other EastAsian countries. if the authorities move decisively to sustain theseimprovements and deepen structural reforms and if they successfully concludecurrent discussions for a new economic program with the IMF, then key elementswill be in place and medium-term growth of around 5 percent should be feasibleand sustainable (Table 1).

Table 1: Major Macroeconomic Indicators

1993 1994 1995 1996

GDP Growth 2.0% 3.5% 4.2% 5.0%

Fiscal Revenues/GDP 17.3% 18.7% 19.1% 18.9%Fiscal Expenditures/GDP 19.8% 20./% 21.1% 20.5%Budget Deficit/GDP 2.5% 2.0% 2.0% 1.6%

Inv/GDP 23.0% 24.4% 25.1% 26.6%

Current Account Deficit/GDP 4.8% 3.9% 3.3% 3.4%

23. This base-case growth would be supported by increased investments andlabor-intensive manufacturing exports. For agricuiture, modest growth of 2-3percent a year is projected based on the assumption that non-traditionalagricultural exports--e.g., aquaculture, cut-flowers--will respond to theimproved incentive structure. This has important implications for povertyalleviation and broad-based growth. Investments would increase from 22 percentof GDP to about 26 percent in 1996. Initially, investments in improvement ofinfrastructure services would be required by both private and public sectors to

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enhance returns to other directly productive private investments. Foreigndirect investments are expected to play an active role. As the nationalsavings is expected to be around 23 percent of GDP, a current account deficitof about 3 percent of GNP is projected. This means, with a conservativeassumptions on the foreign portfolio investments, that external borrowing needswould amount to $1.3 billion a year. From the past and expected aidcommitments, $800 million of net aid flows a year would be forthcoming. If thecountry utilizes prudently the recently regained access to international-apital markets, the remaining gap is expected to be manageable.

24. This base-case scenario rests upon a number of external and policyassumptions: (a) reasonably stable external environment free of significantprice, exchange rate or other external shocks such as growing protectionism ininternatiortal trade; and (b) the authorities, consistent implementation ofpolicy refcrms, including following through with and fine-tuning ongoingreforms; and (c) strengthening managerial and technical capacity of the publicsector for policy and project implementation. If the Government could notmaintain the reform momentum and sound macroeconomic management, requiredinvestments (both public and private) would not be forthcoming and the economywould continue to suffer from high fiscal and balance-of-payments gaps. Exportand investment growth would be substantially lower and the growth would bebarely above the rate of population expansion. Reduction in poverty incidencein this low case scenario would be minimal. On the other hand, under certaincircumstances a higher growth rate than that in the base-case would be possibleif the Government accelerated implementation of its reform program andinfrastructure projects, and if a rapidly rising private sector response wasevidenced.

E. Creditworthiness and Exoosure

25. Overall creditworthiness in the Philippines has steadily improved inrecent years as a result of debt and debt service reduction, limited newborrowing, and some growth. After the last Brady-type debt restructuring in1992, the debt service ratio (excluding resources devoted to buybacks andcollateral purchases) fell to 18 percent from 31 percent in 1988; and externaldebt to GNP was reduced to 61 percent. This has also enabled the country toregain some access to voluntary international capital markets. However, thecountry needs to avoid an imprudent rush to international markets by privateand public sector entities that could endanger these recent improvements incountry risk. Successive efforts to reschedule and restructure debts, however,drove the Philippines to the threshold of some IBRD exposure guidelines. Inparticular, the share of preferred creditor debt service is likely to be highuntil the rescheduling hump is over. This is in part because preferredcreditors have opted to assist the Philippines through greater disbursements(increasing the numerator) and others have opted to assist the country throughrescheduling (decreasing the denominator).

26. Over the next few years, creditworthiness is expected to continue toimprove. The debt service ratio is expected to be around 18-19 percent for thenext two-three years reflecting the need to finance high infrastructureinvestment, but is projected to fall to 16 percenc in the medium-term. InNovember 1993, the price of the Philippines' new money bonds on the secondarymarket was 88 cents on the dollar, up from 50 cents in 1991 and well above theinvestment threshold of 70 cents. The overall inflexibility of Philippine debtwill likely continue to rise, not because of an increase in the country's

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indebtedness, but rather because of the reduced share of debt service due bythe Philippines to, in particular, commercial banks resulting from the lastBrady deal.

F. Main Objectives of the Bank's Assistance Program

27. The starting point of our assistance strategy is that the immediateissues facing the Philippines have shifted between the 1980's and the 1990's.Macroeconomic stabilization compounded by the debt overhang was a major concernin the 1980's; today the debt overhang has been dealt with and significantprogress has been achieved on the stabilization front although this willrequire continuing attention. Major structural reforms have been undertakenand the economy today is free of serious distortions and has been opened up andintegrated with the global economy through substantial trade and foreigninvestment liberalization. Basic political stability including improved lawand order have been restored. What appears to be missing is the businessconfidence necessary for a competitive private sector to lead the economy intoa higheL growth path. This is in part the result of past institutionalweaknesses in implementing policy/projects consistently and effectively and thedeterioration in the quality and reliability of required infrastructureservices. The Bank's primary objective for the period ahead therefore is toassist the Philippines regain a sustainable high growth path led by theexpansion of an internationally competitive private sector. To achieve thisthe Bank will focus on macroeconomic management and improved policyimplementation, provision of infrastructure through improved projectimplementation, and general improvement in the private business climate. Withimproved business confidence and more robust growth, the Government's capacityto address poverty alleviation and environmental protection would be enhancedand the Bank's proposed assistance in these key areas would be more effective.

28. It is important to emphasize, however, that the recent gains instabilization do not lessen the importance of macroeconomic management; soundmacroeconomic management is a neither easy nor automatic outcome as seen in therecent history of the Philippines. Yet, it is a prerequisite of our strategy.Together with the IMF, therefore, our dialogue will continue to be driven byconcerns on the maintenance of sound macroeconomic management, in particular inthe fiscal areas.

29. Economic and Sector Work (ESW) and Aid Coordination. The Bank'sstrategy is to assist by providing a mix of financing with significantinstitutional support, especially in key infrastructure and social sectors.While it may be clear that total spending in these sectors must be increased,before this can be done efficiently, public/private roles need to be defined,spending priorities sharpened, and the implementation capacity of the publicsector improved. The planned public expenditure review (PER) beginning in FY94would assist the Government in these areas and help them better manage thelimited fiscal resources. Specifically, the PER would discuss: sectorspending priorities given the overall resource constraint; public/privatesector interface; civil service structure and emoluments; devolution of fiscalauthorities to the local governments; and liability management.

30. Sector dialogue must be based on adequate ESW, followed up by lendingoperations to provide the leverage to ensure that the recommended policychanges are implemented. We currently have an excellent dialogue with GOPofficials, which has been instrumental in shaping this strategy, and much of

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the ESW underpinning this approach is now in place. During FY93, we completedwork on Decentralization, a Basic Economic Report, and assessments ofInfrastructure, Health, and Industrial Pollution. ESW in power, education,private sector assessment and agriculture is ongoing.

31. In this strategy, aid coordination plays an important role. In someareas, such as Family Planning, where the GOP is interested in grant funding,our ESW has put us in an important role of coordinating concessional aidresources. Similarly, in the energy area, where several large donors areactive, it has been important to ensure that there is an agreement among donorsand the Government on the underlying policy thrusts developed in our ESW andthe Energy Sector Plan. Since the size of our lending program will not allowus to have a meaningful, comprehensive presence in all sectors, aidcoordination will become one of the prime mechanisms for translating Bankpolicy recommendations into GOP actions, even where we do not have asignificant lending presence. The coordination of donor views on sectoral andmacroeconomic issues is undertaken in a formal way through Consultative Groupmeetings which the Bank chairs and in an ongoing and less formal way throughlocal aid group meetings led by the Bank's field office in Manila.

32. Lendire Instruments. Macroeconomic developments di -ussed above alsoindicate that the role of adiustment lending should be much reduced in ourlendirg strategy. The case for adjustment lending, which fundamentally restson the need to provide exceptional support for the balance of payments, hasbecome weaker beca:se present levels of reserves are healthy, becausemechanisms have been adopted to ensure market solutions to balance of paymentscrises (i.e., exchange rate adjustments), and because most of the key reformswith significant implications for the balance of payments have been undertaken.Our strategy accordingly does not envisage any adjustment loans in the nearfuture. However, the strategy may need to be revisited should conditionschange, particularly if adverse global conditions temporarily threatened toderail the recovery and the transition to a high-growth path. The Bank'slending program, therefore, focusses on investment lending.

33. Lending Levels and Trigger Points. Given Bank exposure concernsbalanced by the outlook of cautious optimism, proposed base case lending wouldbe about $500 million a year with an emphasis on energy and otherinfrastructure (see Annex A for relative sector shares). The annual averagelending may be increased to $700 million in the high case and to less than $300million in the low case.

34. The high case scenario would be reached if the Government: (i)considerably accelerates and deepens structural reforms so that there arerising levels of private sector confidence and investment; (ii) maintains soundeconomic management through increased revenue e-forts to finance prioritypublic investments, especially in infrastructure; and (iii) undertakes newinitiatives in areas such as family planning and environmental protection.Under this scenario creditworthiness can be expected to improve considerably.On the other hand, the low case would be reached if the macroeconomy unravels,political instability sets in and the Government reverses structural reforms.In this case creditworthiness would substantially deteriorate and the Bank'slending would comprise selective basic infrastructure projects and projectsthat benefit specified target groups.

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Lending by Sector

35. The chief focus of Bank lending will be infrastructure. In numericalterms, infrastructure lending will be dominated by power, where significantgeneration, transmission and efficiency programs have been identified. The keyconstraint in expanding power rapidly is the absorptive capacity of the majoragencies. The adoption of the National Energy Sector Plan is an importantdevelopment in addressing this institutional weakness. The plan containsdetails to strengthen planning in the sector, define privatization targets,increase private sector participation, depoliticize energy pricing and improvedemand management, and identify key projects and financing requirements. TheBank has several loans planned for the sector which will depend on satisfactoryimplementation of the Energy Plan. Through sector work, the Bank is alsoassisting the Government to define the pricing, regulatory and institutionalarrangements needed to improve the interface between the private and publicsectors.

36. In transport, the Bank's strategy is to build on the progress madeunder the Highway Management Project (FY92) and to formulate a road networkmanagement program and increase expenditure for road maintenance to 1980 levelsin real terms. The Bank is preparing a Maritime Sector project to improveservice levels, correct price distortions and increase competition on inter-island shipping and improve efficiency at ports. To enhance competitiveness ofagriculture, the Bank is also preparing a project on rural infrastructure. Inother areas of infrastructure such as sewerage, sanitation, and solid wastemanagement, the Bank will focus on improving institutional effectiveness byincreasing resource mobilization, reducing the unit cost of investments andservices to help cost recovery and meet affordability constraints of lowerincome groups, and assuring maintenance of existing systems. The Bank is alsosupporting application of more stringent criteria in restructuring nationalirrigation investment programs to emphasize low-cost communal and run-of-the-river systems, while transferring management responsibilities and O&M costs touser groups.

37. In the agricultural sector, production and marketing are mainlyprivate sector activities. Thus, lending for the agricultural sector would belargely directed at support for the private sector, concentrating ondevelopment of necessary public infrastructure, improved means of delivery ofcredit to small scale farmers and rural enterprises, and upgraded supportservices including research and extension. Beneficiary participation throughuser groups and NGO collaboration will be key features of the approach. Policydialogue will continue to press for continued and consistent liberalization oftrade for agricultural products involving reduced use of protection andsubsidies. No less important will be the need to reduce uncertaintiesassociated with agrarian reform in order to facilitate increased investment inagriculture.

38. Attention to the social sectors will remain important as a means ofimproving skills as well as tackling poverty (see para. 39 below). Ineducation and training the Bank has lent significant amounts to the educationsector in the past but now a change in approach is warranted away from physicalconstruction towards emphasis on improved quality and greater economies. Onthe education sector's role in supporting growth, emphasis will be on improvingthe adaptability of the labor force through provision of a broad foundationemphasizing mathematics, science and technology. At the higher education

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level, there is a need to correct the present qualitative and quantitativemismatch as seen in the oversupply of poorly equipped graduates. In health theBank is emphasizing and developing a series of projects to provide basicservices to low income groups identified as most at-risk from specific healthhazards: urban slum dwellers; women of reproductive age; and children underfive years of age. Reduction of the high fertility levels that currently erodethe benefits of economic growth will also be high on the agenda. In botheducation and health, collaboration with NGOs will receive special attention.

39. Cutting across the sectoral priorities outlined above are a number ofthematic areas that the Bank strategy is addressing including poverty, gender,and environment. On goverty, Bank assistance consists of a series of projectsin health that provide basic services to slum dwellers, reproductive women andpreschoolers. A possible Child Development Project, which could catalyze largescale donor support, could include reallocating funds from inefficient foodsubsidies to a targeted child nutrition program. Most of the agricultural andnatural resource management lending will continue to include povertyeradication as a major objective, based on the recognition that overall ruraldevelopment is the best way to end poverty. In Second Agricultural SupportServices, a shift of extension responsibility to the private sector and/or massmedia would be encouraged for the better-off areas (mainly irrigated paddy riceareas), freeing public resources for application to poverty areas.

40. The Bank's focus on maternal health arose from findings of a 1989Bank assessment of women in development in the Philippines. Despite reasonablygood access to education and employment opportunities, the assessmentidentified maternal health and family planning services as key areas in need ofimprovement. High maternal mortality and morbidity levels are partly due tothe fact that health care for women has long taken second place tointerventions targeted at infants and children. Under the GOP's new healthpolicy, family planning is to become a core intervention because of itspotential in improving women's health; reducing child mortality; and reducingthe high fertility levels that currently erode the benefits of economic growth.

41. Through a sector adjustment operation (FY92) the Bank focussed uponnatural resource management. and environmental degradation in the uplands whichhas a poverty orientation. As a follow-up to this successful effort, aninvestment project is under prepazation. Initiatives to be supported includepromotion of community-based sustainable management of natural resources andbiodiversity, and strengthening the national agencies in conductingenvironmental impact assessments. Lending in this area will continue to takeinto account the close link between appropriate resource management at thegrass roots and poverty alleviation.

42. A recent Bank study, Towards Improved Environmental Policies andManagement (Report No.11852-PH), focussed upon industrial, energy, andtransport-induced pollution in the Philippines. On this basis, projects toreduce industrial pollution and improve solid waste management are plannedwhich would address the inadequacy of collective treatment facilities forindustrial waste, support the financing and purchase of pollution controlequipment by manufacturing firms, and provide technical assistance to lineagencies for implementing more efficiently pollution control standards andregulations.

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43. Portfolio Mana&ement. As of November 30, 1993, the Bank had 32 loansunder implementation withi an undisbursed amount of around $1.7 billion. Theportfolio continues to be rated moderate with a slight improvement over thelast year--projects with major problems declined from 5 perccnt to 3 percent,and projects with no or minor problems increased their share from 29 percent to31 percent. All projects with major problems are being addressedsatisfactorily.

44. Selected performance indicators over the last four years are shownbelow:

Table 2: Selected Indicators of Portfolio Performance and Management

Indicator FY91 FY92 FY93 FY94(Current)

Portfolia PerformanceNumber of projects under implementation 35 36 38 34Average implementation period (years) 6.5 - 6.3 6.2 6.1Average ratings

Development objectives 1.4 1.3 1.3 1.2Overall status 1.7 1.6 1.8 1.7

Cancelled during FY ($ milion) 8 4 6 n.a.Disbursement ratio (%) a/ 22.2 20.7 26.1 26.2Disbursement lag (%) 24.4 2.3 21.8 n.a.Memorandum item: % completed projects

rated unsatisfactory b/ 26.0

Po(folio ManagementSupervision resources (total staff weeks) 487.8 518.4 545.0 519.0Average supervision (staff weeks/project) 11.9 12.6 11.4 11.9Supervision resources by location (in %)

Percent headquarters 100.0 100.0 98.7 98.1Percent resident mission 0.0 0.0 1.3 1.9

Supervision resources by rating category(staffweeks/project)Projects rated I or 2 12.0 12.6 10.3 12.6Projects rated 3 or 4 8.5 - 15.8 12.0

Memorandum item: date of last CPPR: November 1993

a/ Investment projects only.b/ Cumulative from the OED database.

45. Past efforts in implementation are being intensified. For example,the Bank's Portfolio Review and Restructuring Report (January 1993) concludedthat the GOP budgetary process (particularly budgeting and cash releases) washaving a major adverse impact on Bank-assisted projects and on those of otherdonors. The report stressed the need to separate allocations for donor-assisted capital projects from those for operating expenses and for locally-financed capital projects to avoid shortfalls in planned financing flows. TheGOP has agreed to ensure that project implementing agencies do not shift fundsamong the various projects handled by their departments.

46. The necessary restructuring/modifications to projects were found tobe minor in the Portfolio Review, and one loan (the Housing Sector Loan) hasbeen canceled. The Bank's analysis of its portfolio has been shared with majordonors (such as JEXIM, OECF, USAID). The Government has also completed areview of all externally-funded projects. The portfolio review will continueto be repeated annually to ensure that limited resources are used in accordance

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with the agreed priority. The 1994 review is now in progress. In general,project implementation efforts at the local level will be strengthened, withthe Bank field office employing both headquarters and local staff to supportimplementation of projects.

47. IFC/MIGA Activities. IFC's strategy for the Philippines focuses onaddressing the most pressing needs of the country's economic development, whichat the present moment are reflected in power shortages and other infrastructureconstraints. In FY93, IFC approved five projects totalling over $1 billion(IFC's own investments were about $120 million), of which two were in the powersector. In capital markets, IFC's activities have focused on institutionbuilding in the financial sector and support of the industrial sector throughventure capital funds. The country's business activities in the near futurewill likely be buoyed by the improved political stability and the Government'scontinued efforts with respect to structural reforms and privatization. Inthis respect, the Corporation's joint effort with the Bank on assessingPhilippines' private sector development, a draft report of which is at anadvanced stage, would make a timely contribution. Regarding MICA, the Congresshas ratified the Convention in November 1993, making the country eligible forthe offering of MIGA services to investors, and exploratory discussions areexpected soon.

48. Co2oeration with Other Multilateral and Bilateral Institutions.There is substantial agreement between IMF and the Bank on issues and thepriorities for economic reform in the Philippines. Staff frequentlyparticipate in each other's missions. The IMF is currently discussing a newprogram with the Government, with the objective of raising the economy onto asustainable, higher growth path while maintaining a stable macroeconomicenvironment. Broad agreement has been reached with the authorities on keyissues and objectives. The discussions have been protracted partly because ofthe shortfall in fiscal revenues the Government experienced in 1993 whichreduced resources for financing infrastructure investment for future growth.In the interim between programs, the Government has resumed all payments on itsParis Club debt (amounting to about $400 million per quarter). We alsomaintain a continuing dialogue with the staff of Asian Development Bank.Collaboration with bilateral donors is strong and has been carried out throughcofinancing, the Consultative Group meeting (CG) and other informalcoordinating mechanisms. In the areas of human resources and the environment,we are working closely with the NGO community to solicit opinions and encourageparticipation from the grassroots level.

G. Key Policy Issues for Board Consideration

49. In summary, key development issues in the Philippines have evolvedfrom a phase of stabilization and structural policy reform to a phase ofinvestment/policy implementation and encouragement of the private sector. TheBank's country assistance strategy has also evolved in response. The CASagenda can be summarized as follows:

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SUMMARY OF CAS AREAS OF FOCUS AND OBJECTIVES

Area of Focus Principal Objectives Select Bank Instruments

A. Maintaining Sound MacroeconomicManagement

(i) Fiscal revenue enhancement * improve fiscal perfornance * econonic work

*raise public sector savings for investment * projects that strengthen revenuein infrastructure collection (Tax computerization)

v facilitate private investment (domestic * collaboration with Govt./IMF on aand foreign) growth oriented medium-term

economic program

(ii) Expenditure management * protect essential capital investments * public expenditure reviewthrough identification and implementa-tion of a CORE Investment Program * other analytical work or lending inespecially in infrastructure areas such as civil service, domestic

-- debt managemento address inflexibility of budget due to high

ratio of wages and interest payments

B. Strengthening Infrastructure e expand/maintain infrastructure (power, e lending especially in power, transporttransport, water, sanitation) and water, paying attention to centers

outside Manila while upgrading3 create well serviced centers outside infrastructure in Manila

metro Manila (Subic, Cebu) that canattract FDI * sector review reports focusing on im-

proved public sector management and* provide rural infrastructure to promote incentives for private sector provision

agriculture and other non-farm economic of infrastructureactivities

* rural infrastructure projects includingcommunity based irrigation

C. Improving Private Business e strengthen competition policy and * sector work on private investment inEnvirornent regulatory system to promote private other sectors such as agriculture

investment* greater use of BOT/BOO, ECO, etc.

* attract foreign investment through a more in conjunction with Bank financedopen foreign investment and trading system projects

* encourage a larger role for private * strengthened Bank/IFC collaborationprovision of public services e.g., PSA

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Area of Focus Prncipal Objectives Select Bank Instuments

D. Reducng Poverty * achieve broad-based reduction in poverty * Bank ESW and lending in the socialincidence and reduction of dispatities sectors: women's health and familybetween urban/rural areas and between planning; child development andincome groups nutrition; and education quality

improvement

agriculture and rural developmentthrough targeted rural and co-operative credit, commnunity basedwater development, targeted ruralinfrastructure

* assist the government to improveservice delivery throughdecentralization by carrying outanalytical work and pilot operations

E. Sustaining Development e consolidate and extend recent progress on e follow-up to the successfullythe green aspects of environment implemented Environmental SECAL;

extend grass roots based resource- make a determined start on the grey/brown management pioneered in the Central

aspects of environment which tend to be Visayas Regional Projectsneglected

* build on recently completed ESW on* strengthen institutional capacity and industrial pollution, solid waste,

processes in the Department of Environment urban transport etc.and Natural Resources (DENR)

a technical assistance to DENR

F. Strengthening Policy/Project * assist key line agencies and selected * ESW in public sector managementInplementation Government corporations in achieving broad issues including civil service

based improvements in implementation reform

* improve aid utilization * technical assistance components inprojects

* support for information technology

joint annual reviews of portfolio

50. There are three key criteria for judging progress and success.First, a key determinant of success will be the Government's ability to manageits fiscal affairs in a manner in which revenues continue to rise andinvestment levels are lifted within a sustainable budget deficit. Second willbe the degree to which infrastructure bottlenecks are effectively addressedthrough effective project implementation and relevant sector reforms in power,transport, water supply and sanitation. Third will be the extent to which theeconomy will remain open and competitive globally; for example no reversals intrade and foreign investment liberalization. The above, together withcontinued political stability should lead to increased foreign direct

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investment and more robust growth, making it possible fur the Philippines totackle poverty and environmental protection. Lack of progress in these areaswill imply that the economy would continue to "muddle through" with consequentadjustment in the Bank's strategy to manage the resulting risks.

51. Risk Management. We see two main risks. The first is that policyand project implementation remains weak despite recent efforts by theGovernment, thus weakening the attractiveness of the Philippines in the eyes ofinvestors. Delays in the completion of infrastructure projects would be doublyharmful, because they would prevent the existing productive base fromperforming to its capacity. The second risk is that resource mobilization doesnot pick up. By not making adequate domestic finance available, this wouldinhibit the use of aid resources and lead to low investment and keep theinfrastructure weak.

52. The riskiness of the Bank's portfolio in the Philippines ismanageable. If growth and foreign investment do not materialize (or ifpolitical stability deteriorates), clear triggers would reduce Bank lendingsubstantially and limit it to selected areas of basic infrastructure andtargeted poverty alleviation. The Bank would manage its risks by intensifyingportfolio supervision and increasing donor liaison on portfolio issues.

II. THE PROJECT

53. Sector Background. Power demand growth in the Philippines has beenuneven, and that is not surprising given variations in GDP growth. In the lasttwo years, it was severely restricted due to supply constraints; still, powersales increased 6.2% p.a. between 1986-92. Once adequate power supply isrestored early in 1994, sales are expected to rise by an average of 9% p.a.until the year 2000. In absolute terms, the annual per capita consumption forpower is very low (371 kWh)--equal to just a couple of weeks of per capita usein developed countries. Even after the effects of ongoing or proposed energyconservation programs are considered and conservative estimates of GDP growthare applied, peak demand is expected to double by the year 2000 to 8,260 MW.This will require substantial investments, sound financial policies to mobilizerequired resources, and increased private sector participation.

54. The Government's present strategy of steadily increasing the privatesector role in power generation and operational management is appropriate andshould be supported. The private sector has emerged as a principal player inthe energy sector: exploration for hydrocarbons is exclusively with the privatesector; oil refining and distribution are carried out by two private companies(CALTEX and Pilipinas Shell Petroleum Corporation) in addition to Petron (theoil subsidiary of state-owned PNOC). However, the Government has decided thatPetron will be privatized by 1994 and the process is now underway. In thepower sector, practically i11 distribution is with the private sector, whichincludes the following: (a) MERALCO (Manila Electricity Company), a privateutility in Metro Manila that distributes about 60% of the total electricity inthe country; (b) 12 private utilities that retail electricity in differentcities; and (c) about 120 member-owned rural electrification cooperatives(RECs), which distribute power and manage retail sales in rural areas. Thereare, however, two state owned corporations in the sector: (i) the NationalPower Corporation (NPC), which sells power in bulk to power utilities and isresponsible for power generation and transmission, and (ii) the National

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Electrification Admlinistration (NEA), responsible for financing and providingrelated technical support to the RECs. As agreed under the Energy Sector Plan(ESP), the Government is studying options for NPC's privatization, which islikely to require se-reral years, given constitutional, regulatory, commercialand financial constraints and the need to analyze options broadly identified byan USAID-funded study. It is in this context that the Bank is currentlyconducting an overall review of the sector structure. This will be completedby early 1994 and would serve as an input to detailed studies that wouldfollow.

55. NPC's Board of Directors already decided that all new generationplants (except multipurpose hydro) will be bid out as private BOT projects. Infact, over the last few years, Philippines has entered into large number ofcontracts with the private sector to construct, finance and operate powerplants, as Build-Operate-Transfer (BOT), Build-Transfer-Operate (BTO) andRehabilitate-Operate-Lease (ROL) schemes. About 20 of these projects are underimplementation and a significant number under bid or negotiations. Total powergeneration contracted with the private sector amounts to more than 60% of thepresent reliable capacity, of which more than 1,000 MW will be operating by theend of 1993. In the interim, ways and means are needed to support such vastprivate sector program, reduce the uncertainties and risks investors are likelyto face, and establish improved planning systems for an optimal integration ofprivate and public efforts in the power sector.

56. The Power Crisis and the Proiect. Over the period 1991-93, thePhilippines experienced ani acute power shortage; this posed a grave threat toits economic recovery, because it translated into prolonged outages thathampered industrial and commercial activities. As a result, unemploymentincreased and economic losses may have reached almost one billion dollars peryear. Conventional power supply projects (coal, geothermal and hydro) requireconstruction times of three to six years. and cannot provide relief in theshort term. Thus, the Government launched a "fast-track' generation expansionprogram based on combustion turbine or diesel-engine driven systems which werecontracted as BOT/BTO projects with the private sector. WhLile these plants areoperationally more expensive than base load plants, they were the only powersources that could be commissioned within one or two years. These plantsplayed a critical role in meeting the Philippines power deficiencies and in thefuture will provide peaking system requirements. They are, however, not costeffective means to meet the base load power needs, and the proposed project byusing geothermal energy in Leyte provides a more cost effective option as abase load plant for Cebu and the Visayas region (and in a near future forLuzon). In addition, it is environmentally preferable to other thermaloptions.

57. It is also important to continue ongoi-ng efforts to improve energyefficiency and demand side management. These efforts have already succeeded inimplementing efficient lighting, rating of electrical appliances, energyaudits, applying strict conservation measures at public offices and, given thehigh price of electricity (more than twice the average in Washington D.C.) inpromoting other energy conservation measures. Power demand charges to reducepeak load will be introduced by the project and further actions for discussionwith Government are being studied by the Bank's Energy Sector ManagementAssistance Program (ESNAP).

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58. Institutional Issues. While a severe three-year drought, whichseriously curtailed hydro capacity, was in large part responsible for the powershortages, poor institutional performance also contributed to the crisis:Environmental approvals for new power projects were substantially delayed andfinancial and institutional weaknesses in NPC prevented it from making theneeded investments. Moreover, NPC's finances deteriorated severely in 1991when costs rose sharply due to a large currency devaluation and higher oilprices (resulting from the Gulf War). A Supreme Court decision to stay a paripassu increase in tariffs added to NPC's financial difficulties and requiredthen a Government contribution of about US$135 million to NPC. In 1991-92 theCorporation's cash situation was also impaired because of the payment of oiltaxes which were not included in its tariffs (pending an appeal to the SupremeCourt). The final Court decision (May 1993) reconfirmed that NPC is exemptfrom such taxes and will allow to recover about US$360 million in overdue taxrefunds. NPC's equity was also increased by the Congress in 1993, mainly by aP3 billion equity infusion from the surplus in the Oil Price Stabilization Fund(OPSF). NPC also agreed to a reform program; its implementation has sinceresulted in considerable institutional and operational improvements that havestreamlined its structure, reduced the number of vice-presidencies from 26 tonine between 1991-93, and eliminated more than 2,000 staff. NPC is alsoestablishing targets for improving project implementation, internal audits andcontrol, and rationalizing and decentralizing functions (including a plan forestablishing separate units for Luzon, Visayas and Mindanao). Under the"Electric Power Crisis Act of 1993," the President has been given specialpowers to solve the power crisis; these include facilitating tariff increases,speeding-up project approvals and increasing technical salaries in the sector.A comprehensive management audit ("Efficiency and Operational ImprovementStudy") was completed in October 1993 and its recommendations would beimplemented under the project (para. 67).

59. The Energy Sector Plan (ESP). Sector reform is the highest priorityof the new administration. As a result of its dialogue with the Bank, inJanuary 1993, the Government prepared and approved the ESP, which charts acourse of action to improve the operations of the energy sector as a whole.The ESP sets out measures and implementation schedules in all areas of concern,particularly for sector coordination, regulatory development, private sectorparticipation, power and oil pricing, environmental management, energyconservation, operational efficiency and project implementation. TheGovernment, NPC and the Bank will discuss annually the implementation progressenvisioned. Some of the plan's key measures have already been introduced, suchas establishing the Department of Energy (DOE) and initiating actions toimprove NPC's finances: For example, tariffs were increased that tripled NPC'srate of return between 1991-92, from 2% to 7%. In fact, although NPC'ssituation in the last two years was unusually difficult due to the drought andpower outages, its net income surged from a deficit of US$135 million in 1991to a surplus of US$184 million in 1992. In addition, NPC critical powerinvestments doubled in 1993 and it will achieve the covenanted 8% rate ofreturn on revalued assets. Under the project, other tariff improvementsinclude the recent approval by the Energy Regulatory Board (ERB) of anadjustment scheme that will compensate for variations in the costs of fuel andpurchased energy and make future tariff adjustments largely automatic. Thesemeasures would ensure an adequate financial performance in future years.

60. Lessons Learned from Previous Bank Operations. From 1957-75, theBank financed three hydro projects, two thermal plants, one transmission

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project and a rural electrification scheme. Three loans were also approved forcoal, oil and geothermal exploration. Project Performance Audit Reports(PPARs) were prepared for two projects with NPC (the fourth and seventhprojects, PPAR No. 0980 and PPAR No. 8574). The major problems identified inthe PPARs were implementation delays and cost overruns due to project designchanges, cumbersome contract award procedures, and weak project management.Because of a disagreement on policies, the Bank discontinued lending until1988 when it approved a geothermal generation project, Bacon Manito Geothermal(Loan 2969-PH). This followed improvements in the sector policy environment.In 1988-89, two other projects were approved for the Manila Power DistributionSystem (Loan 3083-PH) and for the Energy Sector (Loans 3163-PH, 3164-PH and3165-PH). These projects financed sector investments and supported improvedsectoral policies regarding investment strategy, financing and coordination.They are generally being implemented satisfactorily, but NPC had problemsachieving the covenanted rate of return in 1991 and in the Bacon Manitoproject, although the power generation started satisfactorily in October 1993,the completion of other transmission lines required the extension for one yearof the closing date. We have endeavored to resolve these problems byestablishing an improved regulatory framework, by implementing automatic tariffincreases and by NPC placing the responsibility for each project under aproject director. Satisfactory progress is being made on these issues.

61. Rationale for Bank Involvement. Developing adequate infrastructure,particularly power supply, is among the highest priorities in the Bank'scountry assistance strategy; the lack of it is the most constraining factor inthe country's economic development. The proposed project would help alleviatethe power crisis, expand base load power capacity (financed by the privatesector) and assist the NPC to expand and reinforce the required transmissionsystem. Already, the Government has implemented far-reaching reforms in thepower sector, as it has adopted policies and strategies and made institutionalimprovements which conform with Bank policy. Bank intervention in the sectorhas been critical in helping define the improved policies and actions in theEnergy Sector Action Plan, establishing the DOE, strengthening NPC's finances,improving its efficiency, promoting private sector generation of power andpreparing the sector for a robust implementation of its power program. Bycompleting the sector study "Toward Improved Environmental Policies andManagement" the Bank has also supported a balance between the country's energydevelopment and sound environmental practices.

62. The Government's energy strategy closely follows recommendations inthe Bank's policy paper for the power sector. First, NPC is transferringalmost all its responsibility for incremental power generation to the privatesector (requiring investments of about US$1.2 billion per year for powergeneration). Second, the basis for future tariff adjustments has beenestablished, which will ensure NPC's long-term financial viability, includingthe indexing of its tariffs with fuel costs and purchased energy. Third, atransparent regulatory framework that covers the entire energy sector andprovides adequate protection for producers, distributors and consumers %Tascreated under an independent, quasi-judicial regulator (ERB). Fourth, NPC issubstantially improving its corporate policies and commercializing itsoperations, such as entering into management contracts with the private sector.Finally, the Energy Sector Action Plan provides for measures that, along withdemand charges, will further improve demand-side management and energyconservation. As a result of these actions, the sector can now grow vigorously

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and attract resources from the private sector, the Bank Group and otherbilateral and multilateral agencies.

63. Project Objectives. The objectives of the proposed project are to:(i) meet the rapidly increasing demand for power in Cebu and the Visayas regionusing indigenous and environmentally superior geothermal energy; (ii)strengthen the institutional, planning and financial systems of NPC and PNOC;(iii) promote private sector participation in power generation; (iv) improvethe performance of the energy sector through better policies and implementingmechanisms and (v) ensure the financial viability of NPC and PNOC to undertakea long-overdue investment program.

64. Proiect Description. The project includes the following components:PNOC would (a) develop a 185 MW geothermal energy field which would alsoinclude steam collection and power subtransmission systems; (b) enter into aBOT contract with private sector companies to construct and operate a 185 MWgeothermal power plant; and (c) carry out technical assistance for projectimplementation. For its part, NPC would (a) construct an overhead transmissionline in Leyte (about 77 km at 230 kV) and another in Cebu (about 93 km at 230kV, and about 110 km at 138 kV); (b) install a submarine cable (about 32 km)linking the Leyte-Cebu lines; (c) upgrade its existing 138 kV and 69 kV powertransmission facilities in Cebu; (d) carry out technical assistanceconsultancies for the design and preparation of tender documents for two hydro-electric projects (totalling about 400 MW); and (e) carry out institutionalsupport consultancies to implement the project, its power development programand the recommendations of the Efficiency and Operational Improvement Study.The project would also finance US$5 million to cover the impact of the Yenrevaluation under the Bank's special commitment for irrevocable letters ofcredit extended under the Energy Sector Project (Loan 3163-PH).

65. Project Implementation. NPC will implement the transmissioncomponent and PNOC will undertake the geothermal development component. BOTcontracts have been signed between PNOC and Ormat (for Upper Mahiao, 118.5 MW)and Magma (for Malitbog, 66.5 MW) and a BOO (build-own-operate) contract hasalso been signed between NPC and PNOC to supply electricity. The project costis estimated at US$434.8 million equivalent, with a foreign exchange componentof US$367 million equivalent (84% of total). The total financing required,including interest during construction, is US$458.9 million, of which the Bankwould finance US$211 million equivalent (57% of the foreign exchange cost and49% of the total project cost, excluding interest during construction).Retroactive financing of up to US$18 million would be provided for projectexpenditures incurred after April 1, 1993. A breakdown of costs and thefinancing plan are shown in Schedule A. Amounts and methods of procurement anddisbursements, and the disbursement schedule are shown in Schedule B. Atimetable of key processing events and the status of Bank Group operations inthe Philippines are given in Schedules C and D, respectively. A map is alsoattached. The Staff Appraisal Report, No. 11449-PH dated January 6, 1994, isbeing distributed separately.

66. Project Sustainability. In developing and implementing the ESP, theGovernment has provided a sound environment in which the sector can grow andstrengthen its organization, planning and finances. NPC has already takenimportant steps that will require greater responsibility and accountabilityfrom regional managers; in turn, these actions will improve projectimplementation and plant maintenance. NPC's revised tariff structure will

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provide it with enough resources to cover its operation and debt service andhelp finance the huge investments needed in the power sector. PNOC's operationand maintenance of renewable geothermal resources (under previous projects) issatisfactory and is expected to continue as such. The joint action envisionedbetween PNOC and private contractors will ensure that the power supply will bereliable.

67. Agreed Actions. Considerable progress has been achieved in thesector through the implementation of the ESP and reforms actions by NPC. Inaddition, the following actions have already been completed: (i) tariffs wereraised to achieve a rate of return of 8% in 1993 and 1994; (ii) an automaticfuel and purchase cost-adjustment system for NPC's tariffs has been approved(indexing about 82% of NPC costs); (iii) energy conversion contracts betweenPNOC and the BOT contractors have been signed; (iv) a power supply BOO contractbetween PNOC and NPC has been signed, and (v) NPC and PNOC have appointedproject directors. The effectiveness of the BOT contracts is a condition ofdisbursements for goods under the PNOC loan. Agreement was reached atnegotiations on the following: (a) the Government will certify by June 30, 1994as an Administrative Bill the anti-pilferage legislation; (b) the Government,NPC and the Bank will exchange views on implementing the ESP; (c) NPC will: (i)annually review with the Bank the power development plan and would review byApril 30, 1994 and implement thereafter the recommendations of the Efficiencyand Operational Improvement Study; (ii) achieve an after-tax rate of return onits net revalued fixed assets in operation not lower than 8% and a debt serviceratio higher than 1.3; (iii) introduce demand charges (as a condition fordisbursements of goods); (iv) implement in a timely fashion an Action Plan thatincludes project and institutional improvements; (v) conduct a satisfactoryvaluation of its fixed assets and update them annually and (vi) complete byJune 30, 1994 a study on the economic contracting and dispatch of private powergenerating plants; (d) PNOC Energy Development Corporation (PNOC-EDC) willmaintain: (i) a debt-equity ratio that does not exceed 70:30; (ii) a currentratio not lower than 1.0 and (iii) a debt service ratio not lower than 1.25.

68. Environmental Aspects. After the agreed mitigation measures areimplemented the project will only have minor environmental impact; it willhowever yield considerable benefits in reducing local pollution and globalwarming. This is because the CO2, SO4 and particulate emissions from the projectwill be small, only a minor fraction of what would otherwise be emitted byalternative coal or oil plants. Environmental impacts include minordeforestation at the site of the geothermal plants and near the transmissionlines (an Environmental Summary for Leyte Geothermal was circulated to theBoard on June 30, 1992 and an update--to expand the capacity from 350 Kw to 700MW--was circulated on June 22, 1993). The geothermal component is expected todisplace some 127 families (mainly as a result of H2S odors), which PNOC wouldresettle within a short distance from their existing residences. Theresettlement plan prepared by PNOC is satisfactory and is expected to increasethe income and living standards of the families affected. Transmission lineswill be routed along existing roadways and have been designed to avoid anyenvironmentally sensitive areas and minimize the impact of the right-of-way onhouses or crops. Nevertheless, some relocation (within a few meters) andcompensation will be needed for about 250 families. NPC's compensation andrelocation plan was reviewed by the Bank and the principles for a fairreimbursement have been agreed upon. Adequate mechanisms are also in place toensure the smooth implementation of these plans.

- 23 -

69. Project Benefits. The project would establish a reliable,environmentally superior power supply for the Visayas isiands (para. 12), whichinclude Cebu, the region with the fastest economic growth in the Philippines.It would lay the foundation for ultimately connecting the total country throughthe Leyte system, which would dispatch power in an optimal manner and reducethe reserve capacity required in the individual systems. Also, the projectwould establish a sound basis for sector development by restructuring andstrengthening it, improving NPC's corporate efficiency, policies and financesand increasing the participation of the private sector in power generation. Inaddition, it would reduce power shortages in the Visayas region, providing basegeothermal energy and decreasing or eliminating economic losses resulting fromoutages in Cebu. The project economic rate of return is 16%, which issatisfactory.

70. Risks. NPC's tardy procurement procedures have often resulted inimplementation delays; however, NPC has reorganized its procurement system andall key bids are underway. Further, in order to minimize such delays, NPC andPNOC have appointed high-level project directors (supported by staff andconsultants) to coordinate all project activities. Another risk is that thefinancing of the BOT could be delayed; however, the BOT contracts have alreadybeen signed and their cost is relatively small in relation with other BOTprcjects in the Philippines. Moreover, these contracts will be guaranteed bylarge performance bonds as a condition of disbursements for the PNOC loan. Athird risk is that the geothermal capacity will be lower than estimated, butthe Leyte-Cebu project will only use about one third of the capacity certifiedby independent consultants. Finally, there is a risk that tariffs will not beincreased, but this risk is reduzed because of recent decisions taken by theEnergy Regulatory Board that approve principles for NPC tariffs and because ofthe automatic tariff adjustments to be implemented. The new Government hastargeted the energy problem as a top priority and has successfully restoredNPC's financial viability.

71. Recommendation. I am satisfied that the proposed loans would complywith the Articles of Agreement of the Bank and recommend that the ExecutiveDirectors approve them.

Lewis T. PrestonPresident

AttachmentsWashington, D.C.January 6, 1994

- 24 -

Schedule A

PHILIPPINES

LEYTE-CEBU GEOTHERMAL PROJECT

Estimated Costs and Financing Plan(US$ million)

Estimated Cost Local Foreign Total---- (US$ million)---

Geothermal development 15.8 58.9 74.7Power station (BOT) 19.2 138.6 157.8Leyte-Cebu transmission 26.4 124.2 150.6Contracts Energy Sector Loan 3163-PH 4.9 4.9

Base Cost (June 1993) 61.4 326.6 3880.

Physical contingencies 3.8 20.9 24.6Price contingencies 2.4 19.7 22.2

Total Proiect Cost 67.6 367.2 434.8

Interest during construction 0.1 24.0 24.1

Total Financing Reguired 67.7 391.2 458.9

Financing Plan:

World Bank - PNOC - 64.0 64.0World Bank - NPC - 147.0 147.0BOT Contractor 21.0 153.7 174.7PNOC Internal Cash Generation 17.2 10.0 27.2NPC Internal Cash Generation 29.5 16.5 46.0

TOTAL Ll 67.7 391.2 458.9

/1 Totals may not add, due to rounding.

- 25 -

Schedule BPage 1 of 2

PHILjIPPINES

LEYTE-CEBU GEOTHERMAL PROJECT

Summary of Proposed Procurement Arrangements (US$ Milion equivalent)

Procuremt Method ICE LID LCD Other IBF Total

1A.WQRXS (PHOC) 31.0 5.0 3.3 39.3(24.8) (0.0) (2.0) (0.0) (0.0) (26.8)

Civil, Structural 27.1 5.0 3.3 35.4(22.3) (0.0) (2.0) (0.0) (0.0) (24.3)

Insulation, Tech. Services 4.0 4.0(2.4) (0.0) (0.0) (0.0) (0.0) (2.4)

lB.GOODS (PNOC) 21.7 16.5 38.2(18.9) (15.0) (0.0) (0.0) (0.0) (34.0)

Drilling MateriaLs 2.1 3.5 5.6(2.6) (3.0) (0.0) (0.0) (0.0) (5.6)

Steam Gathering 13.4 13.0 26.4(10.8) (12.0) (0.0) (0.0) (0.0) (22.8)

Power Tranam. & Switch. 6.2 6.2(5.5) (0.0) (0.0) (0.0) (0.0) (5.5)

1C.CONSULTANCIES & OTHER 4.7 1.5 6.2(0.0) CO.0) (0.0) (3.3) (0.0) (3.3)

Technical Assist. (PNOC) 4.7 4.7(0.0) (0.0) (0.0) (3.3) (0.0) (3.3)

Compensation & Administration 1.5 1.5(0.0) (0.0) (0.0) (0.0) (0.0) (0.0)

TOTAL PNOC 52.7 16.5 5.0 4.7 4.8 83.7(43.7) (15.0) (2.0) (3.3) (0.0) (64.0)

2. BOT POWER STATION 174.7 174.7(0.0) (0.0) (0.0) (0.0) (0.0) (0.0)

3A.CIVIL WORKS (NPC)Rehab. 138 and 69 kV lines 5.0 5.0

(0.0) (0.0) (2.0) (0.0) (0.0) (2.0)

3B.GOODS & INSTALLATION (NPC) 153.7 153.7(131.3) (0.0) (0.0) (0.0) (0.0) (131.3)

Transm. & Substations 148.7 148.7(126.3) (0.0) (0.0) (0.0) (0.0) (126.3)

Comnit.Sector Loan-3163-PH 5.0 5.0(5.0) (0.0) (0.0) (0.0) (0.0) (5.0)

3C.CONSULTANCIES & OTHER 13.7 4.1 17.8(0.0) (0.0) (0.0) (13.7) (0.0) (13.7)

Technical Assist. (NPC) 13.7 13.7(0.0) (0.0) (0.0) (13.7) (0.0) (13.7)

Compensation & Admin. 4.1 4.1(0.0) (0.0) (0.0) (0.0) (0.0) (0.0)

TOTAL NPC 153.7 5.0 13.7 4.1 176.4(131.3) (0.0) (2.0) (13.7) (0.0) (147.0)

TOTAL PROJECT 206.4 16.5 10.0 18.4 183.5 434.8(175.0) (15.0) (4.0) (17.0) (0.0) (211.0)

Note: Figures in parenthesis are the respective amounts financed by the Bank loan.ICB: Inernational competitive bidding.LIB: Limited international bidding.Other: Other includes consultancies.NBF: Not Bank financed include taxes, admninistration and compensation expenditures and the BOT contract for the power

generation plant.

- 26 -Shedule B

Page 2 of 2

Disbursements

Category Amount % of Expenditures to be FinancedUS$ Million

Philippine National O1 Company:

Works 28.0 100% of foreign expenditures.

Goods 32.7 100% of foreign expenditures, 100% of local expen-ditures (ex-factory cost) and 70% of localexpenditures for other items procured locally.

Consultant's Services 3.3 100%

Subtotal PNOC 64.0

National Power Corporation:

Works 2.0 60%

Equipment, material and related 126.2 100% of foreign expenditures. 100% of local expen-installation ditures (ex-factory cost) and 70% of local

expenditures for other items procured locally.

Equipment related to Energy Sector 5.0 100% of foreign expenditures.Project Loan 3163-PH

Consultant services 13.8 100%

Subtotal NPC 147.0

Total 211.0 _

Estimated Disbursements:

Bank Fiscal Year FY94 FY95 FY96 FY97 FY98------- (US$ million) --------

Annual 15.3 43.6 80.6 56.5 15.0Cumulative 1 31;R Q 139.5 196.0 211.0

- 27 -

Schedule C

PHILIPPINES

LEYTE-CEBU GEOTHERMAL PROJECT

Timetable of Key Project Processing Events

(a) Time taken to prepare the project: 2 years

(b) Prepared by: PNOC and NPC

(c) First Bank mission: January 1992

(d) Completion of the appraisal: April 23, 1993

(e) Negotiations: August 9-13, 1993

(f) Planned date of effectiveness: March 31, 1994

(g) List of relevant PCRs and PPARs: Fourth Power Project (PPAR P-0980);Fifth Power Project (PCR P-4388);Six Power Project (PCR P-4847)Rural Electrification Project (PPARP-5732);Coal Exploration Project (PCR P-6960)Seven Power Project (PPAR No. P-8574)

This report is based on the findings of an appraisal mission consisting ofClaudio Fernandez (Principal Financial Analyst), John Irving (Senior PowerEngineer), Moiffak Hassan (Petroleum Specialist Engineer), Enrique Crousillat(Energy Specialist) and P. T. Venugopal (Financial Consultant) who visited thePhilippines in April 1993. The report was edited by Mrs. Barbara Koeppel. Peerreviewers were Messrs. Rafael Moscote, Albert B. Gulstone and Jamil Sopher. Theproject was cleared by Mr. Callisto E. Madavo, Director EAI, and Mr. VineetNayyar, Chief, EA1IE.

- 28 - Schedule DPage 1 of 2

STATUS OF BANK GROUP OPERATIONS IN PHILIPPINES

A. STATEMENT OF BANK LOANS AND IDA CREDITS /a(As of September 30, 1993)

Amount (USS million)Loan or ihess cancellations)Credit Fiscal Undis-Number Year Borrower Purpose IBRD IDA bursed

One hundred and forty-five loans and seven credits heve been fully disbursed 4,423.66 171.18

Of which SALs, SECALs and Program Loans

1903 1981 Republic of the Philippines SAL 199.962266 1983 Republic of the Philippines SAL )) 302.252469 1985 Republic of the Philippines Agriculture Sector Inputs 150.002787 1987 Republic of the Philippines Economic Recovery Program 300.002956 1988 Republic of the Philippines Program for Govt. Reform 200.002277 1991 Republic of the Philippines Environment & Natural Res. Mgt. 66.00

1.152.21 66.00

2418 1984 Republic of the Philippines Highways V 95.00 16.062435 1984 Republic of the Philippines Municipal Development 40.00 7.172676 1986 Republic of the Philippines Manila Water Distribution 38.00 4.102716 1986 Republic of the Philippines Rural Roads Improvement il 82.00 30.352823 1987 Republic of the Philippines Provincial Ports 32.00 3.482969 1988 Philippines National Oil Co. Bacon-Manito Geothermal Power 41.00 .242969-1 1988 Republic of the Philippines Bacon-Manito Geothermal Power 59.00 23.553049' 1989 Republic of the Philippines Financial Sector 300,00 150.003084 1989 Dev. Bank of the Philippines Manila Power Distribution 65.50 35.013099 1989 Republic of the Philippines Health Development 70.10 35.333124 1990 Metro. Waterworks & Sew. Angat Water Supply 40.00 4.423146 1990 Republic of the Philippines Municipal Development II 40.00 22.563163 1990 Philippines National Power Corp. Energy Sector Loan 200.00 18.083164 1990 Philippines National Oil Co. Energy Sector Loan 150.00 92.803165 1990 Republic of the Philippines Energy Sector Loan 40.00 17.323204 1990 Republic of the Philippines Coconut Farms Development 121.80 97.663242 1990 Republic of the Philippines WS/SewerlSanitation I 85.00 69.923244 1991 Republic of the Philippines Second Elementary Education 200.00 128.723261 1991 Republic of the Philippines Communal Irrigation II 46.20 40.563263 1991 Republic of the Philippines Earthquake Reconstruction 125.00 43.313287 1991 Republic of the Philippines Industrial Restructuring 175.00 21.963356 1991 Republic of the Philippines Rural Finance 150.00 27.903360" 1991 Republic of the Philippines Env. & Natural Res. Mgt. 158.00 53.723430 1992 Republic of the Philippines Highway Management 150.00 149.453435 1992 Republic of the Philippines Engineering & Science Educ. 85.00 82.503439 1992 National Electrif. Adm. Rural Electrification 91.30 85.893455 1992 Republic of the Philippines Municipal Development II[ 68.00 68.002392 1992 Republic of the Philippines Second Vocational Training 36.00 37.182506 1993 Republic of the Philippines Urban Health & Nutrition 70.00 71.383523 1993 Dev. Bank of the Philippines Telephone System Expansion 134.00 134.003539" 1993 Republic of the Philippines Economic Integration 200.00 80.003603 1993 Republic of the Philippines Tax Computerization 63.00 63.003607 1993 Republic of the Philippines Irrigation Operation Support II 51.30 51.303626 1993 Philippines National Power Corp. Power Transmission & Rehab. 110.00 110,00

Total 7,729.86 277.18 1768.17of which has been repaid 2778 7.30Total now held by Bank and IDA 5,553.08 269.88

Amount sold 31.35Of which repaid 31.35

Total Undisbursed 108-57 1.,876.74

L The status of the projects listed in Part A is described in a separate report on all IBROIIOA-financed projects in execution, which is updatedtwice yearly and circulated to the Executive Directors on April 30 and October 31. Amounts are presented net of cancellations.

* Indicates SALISECAL Loan and Credits.

- 29 - Schedule DPage 2 of 3

B. STATEMENT OF IFC INVESTMENTS(As of September 30, 1993)

Total Undisbursedheld including

Original Commitments by IFC participants'Fiscal Loan Equity Total (at cost) portionYear Obligor Type of Business -.---....------ USS million ----------------

1963/73 Private Dev. Corp. of the Phi. Development Finance 15.0 4.4 19.41967189 Manila Electric Co. Utilities 33.2 4.0 37.2 28.31970/86/ Philippine Long Distance Tel. Co. Utilities 127.7 0.8 128.5 74.4 19.788/90

1970/72 Mariwasa Manufacturing Co. Construction Materials 0.8 0.4 1 .21970 Paper Industries Corp. Pulp & Paper - 2.2 2.21971/77 Philippine Petroleum ChemicalslPetrochem. 6.2 2.1 8.31972 Marinduque Mining & Ind. Corp. Mining 15.0 - 15.01973 Victorias Chemical Corp. Chemical 1.9 0.3 2.21974 Filipinas Synthetic Fiber Corp. Textiles & Fibers 1.5 - 1.51974/79 Maria Cristina Chemical Ind. Electro-chemicals 1.6 0.6 2.2 0.41974 RFM Corporation Food & Food Processing 1.2 - 1.2 -

1975 Phil. Polyamide Ind. Corp. Textiles & Fibers 7.0 7.01976 Philagro Edible Oils, Inc. Coconut Oil & Copra 2.7 0.2 2.91977 Sarmiento Ind. Plywood 3.5 - 3.5 -

1977 Acoje Mining Co. Inc. Mining 3.2 0.5 3.7 1.31978 Cebu Shipyard & Engineering Works Ship-repairing 2.1 - 2.11979/90 General Milling Corporation Food & Food Processing 4.0 1.7 5.7 1.71980 Ventures in Industry & Business Venture Capital - 0.2 0.2 -

Enterprise, Inc. (VIBES)1980/83/85 All Asia Capital & Leasing Equipment Leasing 11.1 0.8 11.9 1.31980 Consolidated Ind. Gas, Inc. a/ Industrial Gases 4.5 - 4.5 -

1981 Philippines Associated Smelting Copper Smelting - 5.0 5.0 .5and Refining Corp. (PASAR)

1981 Davao Union Cement Corporation Cement 16.0 .8 16.8 1.41981 Loans to Small & Medium Scale Capital Markets 18.0 1.1 19.1 -

Ent. (SMSE) aI/1983 NDC-Guthrie Plantations, Inc. Agribusiness 11.0 - 11.0 4.61985 Philippine Overseas Contractors Construction 38.0 - 38.0 - -

1986/91 Purefoods Food Processing - 4.2 4.2 4.51988 BPI Agribank Financial Institution 1.0 1.0 1.01988 Philfund Debt Conversion Fund - 4.2 4.21989 Kewalram Phil. Inc. b/ Textiles & Fibers 3.0 - 3.01989 AG & P Construction 10.0 - 10.01989 Hambrecht & Quist Capital Fund - 2.2 2.2 2.31990 Hopewell Energy Power 10.0 1.1 11.1 7.61990 Manila Fund Money & Capital Markets - 7.0 7.0 -

1990 First Phil. Fund Money & Capital Markets - 29.7 29.71990 Avantex Mill Corp. Textiles 11.3 2.3 13.6 12.51990 Makati Shangri-La Tourism 59.0 - 59.0 29.5 7.71991 Best Chemicals Chemicals 6.5 2.3 8.8 7.8 -

1991 Automated Microelectronics Electronics 9.0 2.8 11.8 11.3 9.01991 PCI Bank b/ Financial Institution 20.0 - 20.01991 Mactan Shangri-La Tourism 24.0 - 24.0 12.0 5.21992 Bacnotan Cement Corp. Cement 18.0 5.3 23.3 26.7 21.11992 Pilipinas Shell Petrochemicals 120.0 15.0 135.0 50.0 135.01993 Hopewell Power Power 100.0 10.0 110.0 70.0 70.01993 Northern Mindanao Power 38.5 9.5 48.0 17.0 13.4

Subtotal 754.3 121.9 876.2 366.1 281.1

- 30 - Schedule DPage 3 of 3

Total Undisbursedheld including

Oriainal Commitments by IFC participants'Fiscal Loan Equity Total (at cost) portionYear Obligor Type of Business ------------- US$ million .-------------

Approved but not yet signed

1991 Philnico Nickel Mining 90.0 15.0 105.0 60.0 105.01992 Universal Robina Food Processing 16.7 16.7 16.7 16.71992 Filsyn 11 Textiles & Fibers 40.0 5.0 45.0 25.0 45.01993 H & QPV-2 Capital Fund 2.5 2.5 2.5 2.51994 Walden Management Capital Markets .1 .1 .1 .11994 Walden Ventures Capital Markets - 3.8 3.8 3.8 3.8

Total Gross Commitments 884.3 164.9 09 4.1 454.1

a/ Subsequently cancelled.g/ Guarantees.

.. Less than USS0.5 million.

- 31 -

Annex APage 1 of 2

Philippines-- Bank Group Fact Sheet, FY91-97IBRD Lending Program, FY91-97

Past Current Planned alCategory FY91 FY92 FY93 FY94 FY95 FY96 FY97

Commitments (US$m) 935.2 430.3 628.3 448.0 460.0 480.0 640.0

Sector (%M b/

Agriculture/irrigation 7.0 8.0 47.0 10.0 22.0Industry and finance 35.0Power/Energy 21.0 18.0 91.0 21.0 39.0Public sector management 10.0Infrastructure &urban dev. 51.0 32.0 9.0 48.0 29.0 23.0Human resources 21.0 28.0 5.0 19.0 16.0Environment 37.0 21.0Mining & other extractiveMultisector 32.0

TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Lending instrument (%)

Adjustment loans cl 13.0 32.0Specific investment loansand others 87.0 100.0 68.0 100.0 100.0 100.0 100.0

TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Disbursements (US$m) 358.9 537.6 672.8 543.8 444.4 488.3 487.2

Adjustment loans cl 75.0 185.0 208.3 98.3Specific investment loansand others 283.9 352.6 464.5 445.5 444.4 488.3 487.2

Interest (US$m) 315.2 307.8 327.1 350.0 358.9 359.2 358.7

a/ Use ranges to reflect most likely scenario presented in the CSP.b/ For future lending, round to nearest 0 to 5%.c/ Program and Structural Adjustment Loans, Sector Adjustment Loans, and Debt Adjustment Loans.

- 32 -

Annex APage 2 of 2

Philippines-- IFC and MIGA Program, FY91 -FY94

Past Current

Category FY91 FY92 FY93 FY94

IFC Approvals (US Sm) 103.1 92.4 118.5 57.0

Sector (%)

Agri-business 3.0

Cap.Markets 20.0 2.0 6.7

Chem-Fertilizer 64.0 21.0

Infrastructure 76.0 93.3Manufacturing 32.0 43.0 1.0Oil- mining 48.0

TOTAL 100.0 100.0 100.0 100.0

Investment Instrument (%)

Loans 61 57 76 44

Equity 20 10 16 56

Quasi-equity a/ 33 8Other 19

TOTAL 100 100 100 100

MIGA Guarantees (US$rm) 0 0 0 0

MIGA Commitments (US$rm) 0 0 0 0

a. Includes quasi-equity types of both loan and equity instruments.

- 33 -Annex B

Phllppiaor Priority Poverty ICMM Page 1 of 2

m~~~~~~~~~~~~~~~o

UwI pv as.. _ u1 A 6334,., _1bmimm_m %dpap. - .. 62 12

LIs._apWvy Iamia .. 3.072HZ_&dsu S W%*p - *- 24 10

ONPpwcnn US 180 340 730 650 1.610 3,o

SNORtT TERM INCOME JNDICATORSUu,2libmwsm bmAw.| .. -. *.. ..3.1iva _ ' - -.

Umu1mofva* .. _. .... _.

Cmm,,im 1987-100 t 21 165..._1._d _ - ..57_

Lh_ * . .. _

aw .. ..-

sLOWA NDICTORSPubbsimwem k~~uee~a1we %efODp -

Pz~y %§61app . 113 107 110 12 100tMale * 115 .. 109 133 306F_ 111 - 110 124 98

h viiy *A" ." Wit 72 n, 41 42 40 33uZsmmtnnIy -_ d1 52 53 40

w. -3 88 70DFT * .. 78 90 74

_MWm(ium -S) -. -. 19 .. - _

TddaI- stXs 56 59 65 6S 67 69F _l s rio 1.06 1.05 .06 0S0 10S t.l

To1bUlty apw 6.S 5.5 3.6 2.6 3.5 26mUmwmanayrn I04.00Ol*sbidtm _ - 74 114 - _

Popatou gnwt re rffmn morlta me Puima" earounim

6+ 250 120.

3 2;+ _ I 100 , 60. .+ 4,; 2

4 gIS0

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062MindEs Mad7os e muid6o wal70; as mm iddOs mJ670s an

264

- 34 -

Anmex BPld_ R_Acd E_0d@Mu Page 2 of 2

mm Fa! ap- NW

UnS*$ IsM - AdA biW -

HUMAN RSOURCESPo_eh m ak- Ih91) 32AO 43.103 62m 1. 23 7733 623?AVdq%m yMt_032 0Qsa 0.753 0.5 0.71 03AUdbm %.(9096 31* 35A 43U 52A 539 729Papen uihowdu a% 3.1 2.6 22 1. 1.7 1.1Utb * 4.0 4.0 3.2 3.1 2.0

LA fom f(544) tni_ 12 16 23 914 302Z. 243AUIIW %dIhkmauw 52 53 -

1namy 16 16Fmka * 34 33 31 41 3i 30

Udun __ I 08 - - - -Rarm - 96

NATURAl RES90URAm q. km 300 300 340 166 2310 3944Damty km 107. 144.0 nu 990 31.0 1Ar7Umjw d %,i1;1. I" 27.3 30 53.2 41. 43CAin3S AIAM.1iM6 =a1 0%8 0.1 0.2 0.0 O0 0.1A im4rm bandWinian 9.4 17 16.2 7. 12. 8Fmmandv.odlad dha.be.km 170 133 106 423 530 7,705Defsmmm( t) , 43 *1.6 -19 . _ -

INCOMZHosabodkm(Sbmeawp2o%fbwad_ %dof 54 56 48 _Seibo=409h%M t * 12 14 1iSbus of b b 20% ft a ' 4 5 6

EXPEND1URE .F - %/f:Dp 37.3 3899__

SS*D ' _ t~~~~~~~ ~ ~~ ~ ~ ~ ~~~~~~~~~4.1 16 &Z Mew.fi. uuk. e ' 15c 15. .. _ _

C1a t b 10 124 24 M16 44,418 35*76Foodaid ab * 89 59 391 4,047 365F qmd3 cwm 1971-100 SO 99 82 131 101 108FatfllaOaMMiM kw 164 31. 65"0 5* 94.2 120STh=Of lhmbmGDP 25.) 303 219- 1.94_9

iEfg %OD? _ 6.1 1 4.Awuug dmW sa pffbmoM 6 6 _ Uihm * 7 6 4 _ _

Fmi:d_ ff,aP 3.5 2.-Fad 03 pon t %afDp - 1.6 4.0 -

EPV omtmvum p kg of ad ie*v. 158 257 213 570 I"249 170i

Ra .. _. _ .. _ _

T m _ t- zbef% DP - 15 3.0F= _ :,t_outw= eqw - 4.1 0.6 _ _ _T wed h km . 137.44 .. 8 _INVESrTMET IN IUM CAPITAL

A to b.ihcmt %*fP* -- .. .. _ _PapAssiompw* bvia pam _ 9,100 111 1.02_POqA& ipewt 1,139 2.691 _ 1.330Poa1ad= pubermb bed 600 780 553 509 _Aamo wafaw %fpc - 50.0 21.0 71.2 _ _Utbam .. 9 2Rnd 72.0 60.7

Oral stavydynt aW36ay(tv) %5 -_ 25 40 _

Seomey %p 41 54 73 50 56Faul * 40 _ 73 43

Ptapt14mdmnn1o:rini7 ~ pp 31 29 33 23 25Pup01.ehwr uy 33 -- 16 -PUPi1edUrng ads4 %of.da I. 78 1S s_Rqb _ Gm pnaay %oftal .. 2 2 6UtaicY %cfpOp. (Svl15) _ . 1o 24 _ _

Foods %Tflam(lpIs+) - - 11 34 -

Naw _wcima p*Am pq 27 16 38 46 SQW Wail. Baok bWwnmol Eam.m Deulm ApiI1

265

- 35 -

Annex CI of 2

Phflippines: Key Economic hndifators

Actual Prelim.

1988 '989 1990 1991 1992 1993 1994 1995 1998

Natnal Accot % 0GP at an. mp)

Gross Domestic Product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0Agriculture 22.9 22.7 22.1 21.1 21.7 22.5 22.4 22.2 21.8Industry 35.5 35.4 34.9 34.3 33.3 34.9 3S.6 36.6 37.4Services 41.6 41.9 43.0 44.6 45.0 42.5 42.0 41.2 40.8

Consumoton 78.6 79.4 81.9 84.1 85.8 84.1 82.0 80.6 79.1Gross Investment 18.4 21.8 24.9 20.9 22.6 23.0 24.4 25.1 26.6Priate investment 16.1 18.0 19.6 15.1 17.8 18.4 19.5 20.3 22.4Government investment 2.3 3.9 5.3 5.8 4.8 4.6 4.8 4.8 4.2

Expor GNFS 11 28.2 28.5 28.0 30.1 29.0 30.1 31.6 33.2 34.6imports GNFS 1/ 26.8 30.3 33.5 31.6 33.7 37.2 37.9 38.9 40.3Gross National Savings 19.7 19.8 20.0 21.4 21.0 18.2 20.1 21.6 23.0Gross Domesuc Savings 19.8 20.1 19.3 19.5 18.0 1 5.9 18.0 19.4 20.9

morandum hteGross Domestic Product 38043 42562 44003 45162 52462 53082 57185 60327 63854

(mill. US$ at curt. prices)Gross Domestic Product 648 708 716 718 816 810 855 885 921per capita (US$]

Pub.e Finnce 1% of GOP at cuem mrket pnces)Cutrent Revenues 141 16.5 16.9 17.8 18.2 17.3 18.7 19.1 18.9Currant expendtures 14.0 15.4 16.6 15.7 16.1 16.5 16.8 18.7 16.5Surtlus I+) or deficit 1-) 2.9 -2.1 -3.5 .2.1 -1.2 -2.5 -2.0 -2.0 -1.6Caottal exoenditure 3 0 3.2 3.7 4.2 3.3 3.3 3.9 4.4 4.0Foreign financing 0 5 0.9 0.4 0.6 1.1 2.7 1.7 1.2 0.9

Real annual growth rates 4%)Grossdomesticproduct 6.3 6.1 2.6 *0.8 0.0 2.0 3.5 4.2 5.0Gross domestc income 9.0 3.7 1.2 1.2 0.2 1.7 5.8 5.S 5.5

Red annual per capit growth aS 1%)Gross Domestc Product 3.8 3.6 0.3 *3.0 *2.2 0.0 1.5 2.2 3.2Total Consumptnon 4 0 2.7 3.3 *0.2 0.3 1.4 1.8 1.7 2.2Private Consumption 3.8 2.6 3.0 0.0 1.0 1.7 1.2 1.3 2.0

Metay IndiceStorM2IG0P 28.7 37.3 45.7 53.6 60.7 67.7 77.8 87.9 99.5Growth of M2 4% 24.6 30.1 22.5 17.3 13.2 11.6 14.8 13.0 13.2

- 36 -

Aun C

z of 2

Phdilppinae: Key Ecomic Indicatots

Actual PreUlm. Procta1988 1989 1990 1991 1992 1993 1994 1995 t996

BalanCO of Paym8m IUSS IliOng)

Ex%OrtS GNFS) 1/ 9487 10674 11108 12087 14244 15895 18049 20058 22072Merchbadise fo.b. 7074 7821 8186 8839 9824 10998 12604 14178 15728tmpor (GNFSl 11 9440 11845 13832 13699 16699 19146 21696 23448 25714Merchartdisetfo.b. 8159 10419 12206 12052 14520 17196 18943 20505 22549Resource Baiance 47 *1171 -2726 .1612 *2455 -3851 -3647 *3389 *3642Net Cufrent Transfers 775 1045 793 883 888 774 901 927 955Current Account Balance *390 .1458 *2695 .103S -994 -2584 *2204 -1974 -2207Prvawt Direct Investment 936 563 530 544 228 586 666 818 912MIT Loans Inetl 187 296 1024 590 2444 1876 1563 989 877OtherCapiu Iincludingerrers& om sonvl *59 899 1099 1655 11 .110 1100 1002 1273Change in Net ReSes2t *674 *300 45.1 -1755.2 -1689 229 -1124 *835 -855

Meneoundumft emExootts 1% of GOP) 24.9 25.1 25.2 26.8 27.2 29.9 31.6 33.2 34.6Imoos 1% of GOP) 24.8 27.8 31A 30.3 31.8 37.2 37.9 38.9 40.3Reswurce Balance I% of GD 0.1 *2.8 -6.2 -3.6 4.7 -7.3 *6.4 -5.8 -5.7

RW Annua Growt Rae 11985 pdtes)Merchandise Expors 14.7 10.7 1.3 6.8 1.2 8.8 9.6 10.0 10.5Merchandtse Impots 19.6 1S.2 10.0 *2.0 13.2 14.2 12.3 8.5 8.4

Price Indihe I1985 - 100)ExDort Price Index 1 16 1.22 1.36 1.59 1.64 1.70 1.87 2.08 2.31lmortl Price Index 1 01 1.15 1.33 1.49 1.51 1.59 1.66 1.80 1.99Terms ot Trade Index 1 14 1.06 1.02 1.07 1.08 1.07 1.13 1.1S 1.17Real Exchange Rats 69.8 74.9 72.9 72.0 79.9 80.0 82.4 84.9 87.4ConsumerPric Indexl%growth ratel 8.7 12.2 14.2 18.7 8.9 8.0 7.0 7.0 7.0Real interest Rates 5.5 5.7 2.4 6.5 6.5 6.5 6.5 6.5GOP Deflator 1% growth te 10.2 8.7 12.R 17.0 7.8 6.7 10.9 8.4 7.8

11 ONFS - goods snd nontactor services.2/ Includes use of IMf resources.

- 37 -

Annex D1 of 1

Philippines: Key Exposure Indicators

Actual Projected1988 1989 1990 1991 1992 1993 1994 1995

Tctal debt outstanding and disbursed 29,023 28,506 30,425 32,224 32,498 34,851 37,592 39,312

(TDO) (USSm) a/

Net Disbursements WUSWml a/ -90 871 1,114 1,203 2,037 2.316 1,804 959

Total debt service (TOS) (US4m) al 3,403 3,258 3.589 3,395 4,888 3,302 3.983 4,265

Debt and debt service Indicators 1%)

TDO/XGS b/ 262.6 223.3 228.9 217.9 184.3 183.1 176.9 167.4

TDO/GDP 77.0 67.8 68.7 70.4 60.6 65.7 65.7 65.2

TDS)XOS 30.8 25.5 27.0 23.0 27.7 d/ 17.4 18.7 18.2

Concessional/TDO 18.5 19.4 23.2 25.3 27.8 29.3 29.0 29.4

IBRD exposure indicators 1%)

IBRD DSIPPG DS 22.2 23.9 20.6 22.6 14.5 21.9 20.2 20.5

Preferred creditor/PPG DS 38.9 40.2 31.6 35.4 38.4 39.7

IBRD DS/XGS 5.2 4.2 4.5 4.2 3.6 3.5 3.3 3.2

IBRD portfolio share 4.0 4.1 4.1 4.1 4.8 5.0 4.9 4.8

IFC (US $m)

Loans 78.9 101.0 127.2 192.5 186.2 326.7 385.4 393.8

Equity and quasi-equity c/ 13.5 16.0 12.5 21.4 20.4 42.5 44.7 42.5

MIGA

MIGA guarantees (US$m) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

a. Includes public and publicly guaranteed debt, private nonguaranteed debt, use of IMF credits, and

short-term capital.

b. XGS = exports of goods and services.

c. Includes quasi-equity types of both loan and equity instruments.

d. Includes resources devoted to Brady-deal payments. Excluding these, the ratio would be 18%.

- 38-

The Status of Sak Operatons In PhIlippioas Annex EStatement of IBRD Loans and IDA Credits 1 of 1(as of November 30, 1993)

Undisb.

reltive to Last ARPPAmount In US8 million appraisal supervision ratng blLoan or Fiscal (less cancellations) projection Development OveralCredit No. Year Borrower Purpose ISRO IDA Undisb. lUS9m) a/ Objectivms objectives

145 Loans and 7 Credits closed 4,423.66 171.18

C2392 1992 Philippines 2nd Voc. Training 36.00 36.31 1 2L2418 1964 Philipphes Highways V 95.00 16.06 16.06 1 2L2435 1993 Philippines Municipal Dev. 40.00 4.09 4.09 1 2C2506 1984 Philippines Urb. Health & Nut. 70.00 69.94 R RL2676 1986 Philippines Manila Water Dist. 38.00 3.90 3.90 1 1L271 6 1986 Philippines Rural Roads Imp.l1 82.00 24.15 24.15 2 2U2823 1987 Philippines Provincial Ports 32.00 3.48 3.48 2 2L2969 1988 Nat. Oil Co. Bacon Manito Geoth. 41.00 0.24 10.52 1 212969-1 1988 Philippines Bacon Manito Geoth. 59.00 20.27 1 21.3049 1989 Philippines Financial Sector 300.00 150.00 150.00 2 2L.3084 1989 Dev. Bank Phi. Manila Power Dist. 65.50 35.01 12.29) 1 113099 1989 Philippines Health D0ev. 70.10 32.51 1.01 1 2L3124 1990 Metro. WW&S Angat Water Supply 40.00 3.86 (8.14) 1 1L3146 1990 Philippines Municipal Dev. It 40.00 20.78 (2.62) 2 2L3163 1990 Nat. Power Corp. Energy Sector 200.00 17.34 1 2L3164 1990 Nat. Oil Co. Energy Sector 150.00 88.24 32.41 1 2L3165 1990 Philippines Energy Sector 40.00 16.83 1 2L3204 1990 Philippines Coconut Farms Dev. 121.80 96.48 17.78 1 3L3242 1990 Philippines WS/Sewer/Sani.ll 58.00 42.65 35.75 1 2L3244 1991 Philippines 2nd Elem. Ed. 200.00 127.13 120.43 1 1L3261 1991 Philippines Communal Irrg. If 46.20 40.53 18.13 1 2L3263 1991 Philippines Earthquake Reconst. 125.00 38.34 -18.66) 1 2L3287 1991 Philippines Industrial Restruc. 175.00 17.43 (57.57) 1 2L3356 1991 Philippines Rural Finance 150.00 26.78 (60.22) 2 2L3360 1991 Philippines Env.&Nat. Res. Mtgt. 158.00 53.59 1 1L3430 1992 Philippines Highway Mgt. 150.00 149.40 6.90 1 2L3435 1992 Philippines Eng. & Science 61.00 57.99 7.99 1 2L3439 1992 Nat. Elec. Adm. Rural Electr. 91.30 85.89 (2.41) 1 2L3455 1992 Philippines Municipal Dev. III 68.00 68.00 5.90 2 2L3523 1993 Philippines Telephone System 134.00 134.00 7.30 1 1L3539 1993 Philippines Economic Integ. 200.00 80.00 26.70 1 2L3603 1993 Philippines Tax Computer. 63.00 63.00 0.00 1 1L3607 1993 Philippines Irrig. Oper. Sup.ll 51.30 51.29 0.49 1 1L3626 1993 Nat. Power Corp. Power Trznsm&Rehab. 110.00 110.00 0.00 1 1Total

7,678.86 277.18 1,785.51Of which has been repaid 2,220.31 7.34Total now held by IBRD and IDA 5,458.55 269.84Amount sold 31.35Of which repaid 31.35

Total undisbursed 1,679.26 106.25 1,785.51

a. Posiftive number equals lower actual disbursement than appraisal estimate.b. Rating of 1-4; see 00 13.05, Annex D2.

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