Investor protection is weak in the Philippines, in part because secured creditors do not have priority in bankruptcy proceedings. The country scores four on a ten-point index for strength of legal rights in the Doing Business 2010 report. Shareholders’ rights, particularly those of minority shareholders, are not effectively protected and the enforcement of legal rights through judicial proceedings is problematic, as protracted court proceedings are a major deterrent to effective rehabilitation and insolvency proceedings. Trial court proceedings last up to four years; and up to 10 years if the judgment is appealed all the way to the Supreme Court.
The country’s collateral system is fragmented into different registries, which makes debtor searches difficult. The current system for registering land titles is inadequate: the data are not centrally filed and are not publicly available online. The absence of reliable cadastral surveys leaves large tracts of land without enforceable titles. Furthermore, in rural areas, uncertainties surrounding land ownership brought about by delays in the agrarian reform program and restrictions on the transfer of land discourage investments in agriculture, as this effectively strips farmers of their collateral, limiting their access to credit from formal financial intermediaries. At the same time, restrictions on the use of land have resulted in the premature conversion of agricultural lands, thus undercutting rural economic growth.4
The Foreign Investment Negative List is very narrow, which contributes to the high cost of doing business. This list comes with a 40 percent cap on foreign equity ownership in most sectors, and even lower caps on land ownership (foreigners are not allowed to own land) as well as in capital-intensive sectors, such as air transport. This ownership restriction also complicates asset restructuring.
The entry of new firms or expansion of existing businesses in the Philippines is also affected by the overall investment climate. In addition to the direct costs of opening or closing a business discussed above, decisions to enter a market are also determined by broader considerations of competitiveness, or productive potential. A well-known indicator of the quality of national business environments, the World Economic Forum's Global Competitiveness Index (GCI),5 consistently ranks the Philippines among the less competitive half of the countries surveyed. Moreover, its relative standing has been dropping since 2000, unlike the more favorable evolution of the regional comparator countries (Table 5).
Table 5: Global Competitiveness Rankings for selected East Asian Countries
2009
2005
2004
2000
Sample size
133
2005 sample
117
2004 sample
104
2000 sample
58
Philippines
87
82
77
73
76
52
46
Indonesia
54
49
74
70
69
49
47
Malaysia
24
24
24
23
31z
27
30
Thailand
36
34
36
34
34
28
40
Source: World Economic Forum, Global Competitiveness Report, various issues.
Looking behind the overall GCI rating, the Global Competitiveness Report points to two major shortcomings that undermine the competitiveness of the Philippine economy: weak governance and inadequate public infrastructure. These overall findings are broadly corroborated by the Enterprise Surveys associated with the Investment Climate Surveys carried out by the World Bank and Asian Development Bank, which had also identified the threat of macroeconomic instabilility as a major concern. Of these three shortcomings, the level of corruption is the topmost concern of managers in the Philippines (Figure 2). This finding applies regardless of business size and significantly raises the cost of doing business for private enterprises. Without delving into the details of each constraint,6 they are mentioned here to emphasize that any efforts to foster greater competition in the Philippines must also take into account these broader investment climate constraints if they are to succeed fully.
A more specific constraint on firm entry and expansion in the Philippines is the limited access to financing. While not among the top three concerns, this issue weighs heavily on micro, small and medium-sized enterprises (MSMEs), which comprise 99.6 percent of businesses in the Philippines.7 More SMEs can be created, or once created can have better expansion opportunities, if investment finance is readily available. The main factors that limit their access to financing are (i) a lack of institutions willing to finance SMEs, (ii) bureaucracy and red tape in processing applications, and (iii) lack of collateral. While there have been cases where directed lending has worked, these are very rare. Instead of encouraging private sector development, the mandatory allocation for SME lending mostly results in the re-labeling or re-categorizing of loan files by the banks in order to meet the target without having to venture into new markets or attract new clients – this appears to be a common practice among banks in the Philippines. Also, enforcement of mandatory lending targets relies upon self-reporting (from banks to the regulator), and on the regulator's capacity to supervise, which is usually overstretched. Furthermore, lending to microfinance institutions (MFIs) also counts towards meeting the mandatory minimum SME target; a common loophole that results in no additional SME lending.
Source: World Economic Forum, Global Competitiveness Report, 2009-2010, 2009 Executive Opinion Survey.
Access to credit in the Philippines is hampered by relatively high creditor risk. The four-country comparison in Table 6 indicates that SME access to loans is inversely related to the average time it takes to complete bankruptcy proceedings and to bankruptcy costs, and positively related to the expected creditor recovery rate on bad loans. That the share of SMEs with bank loans (at 17 percent) should be so low in the Philippines is therefore not surprising when one considers that the bankruptcy process is extremely slow (it takes around six years to complete a bankruptcy case), bankruptcy administration costs are high (38 percent of estate), and expected creditor recoveries are low (4.4 cents on the dollar). The procedural and administrative bottlenecks in the bankruptcy process are so inefficient that creditors hardly ever use it.8 These factors make the financing of SMEs a very risky proposition in the Philippines.
Table 6:
SME Access to Credit Is Inversely Related to Creditor Risk
Malaysia
China
Indonesia
Philippines
SMEs with loans (2007)
57%
52%
17%
17%
Years to complete bankruptcy case (2010)
2.3
1.7
5.5
5.7
Bankruptcy cost relative to estate (2010)
15%
22%
18%
38%
Expected creditor recovery on loans (2010)
38.6%
35.3%
13.7%
4.4%
Private bureau coverage of adult population (2010)
82%
0%
0%
6.1%
Public registry coverage of adult population (2010)
48.5%
62.1%
22%
0%
Source: Doing Business database.
The lack of accessible information on payment histories adds further to creditor risks. Table 6 also suggests that access to financing is positively associated with the operation of credit information bureaus. The ability of financial institutions to provide cost-effective services depends in large part on the availability of information necessary to assess the creditworthiness of their clients. The Doing Business 2010 report reveals that the scope, accessibility and quality of credit information through either public or private bureaus in the Philippines are very low. A strong credit information infrastructure would greatly contribute to increasing the Philippines’ rating in the Doing Business report and, even more importantly, facilitate a greater volume of financing. So far, there has not been much progress in finding ways to set up the public registry. This is all the more important in the context of the on-going global financial crisis, where trade is further hampered because of the lack of information on the creditworthiness of importers.
Weak competition framework
Though market concentration in many sectors of the Philippine economy has been high and increasing during the 1990s, greater openness to imports increased market contestability and limited the potential abuse of market power.9 Nevertheless, a few sectors continue to face substantial import restrictions and there is evidence of market collusion in some markets, either due to structural barriers or behavioral constraints. In most cases, the previously mentioned barriers to entry for SMEs also play a role. Table 7 lists a number of industries where the degree of market competition appears to be limited, either on account of collusive behavior or structural constraints to the entry of new firms.10
Table 7:
Selected Sectors with Barriers to Entry and Competition
Sector
Source of Barrier to Entry
Agriculture
-- Rice
-- Corn, Sugar
Import licenses or tariff quotas
Cartel behavior by dominant producers
Agribusiness
Restrictions on foreign land ownership; Restrictive land use policies
Downstream Oil
Cartel behavior by oligopolistic producers; Large capital requirement
The promotion of competition has been implicit in the major reforms implemented since the 1980s, even though the Philippines has no explicit competition framework. There are several pieces of sector or industry-specific competition laws, as well as regulatory arrangements in place to manage natural monopolies, but these are not adequate for dealing with the wide range of anti-competitive behaviors that have or could emerge in different sectors in a consistent manner. Also, the Philippines does not have a single central institution for enforcing competition legislation. The creation of such an institution could contribute to a more comprehensive and consistent competition policy, while the availability of a comprehensive competition framework would serve to prevent anti-competitive behavior, as well as to help guide policymakers in the definition and implementation of future measures designed to bring about a more competitive economy.
B. Where the Philippines Could Be: Policy Options
The promotion of greater competition has been an implicit intermediate objective of the Philippines development program since the 1980s. This effort appears to have lost some momentum in recent years and needs to be reinvigorated in the interests of achieving sustained growth that is broadly shared. To generate a more competitive environment, policymakers will need to go beyond the elimination of trade barriers and remove some of the remaining behind-the-border constraints to trade and firm entry. Two important categories of behind-the-border constraints identified earlier that need to be addressed in this context are the overly complex business requirements to open and close businesses, and the difficulties faced by small and medium-sized enterprises in accessing credit. Another important obstacle is the absence of a comprehensive competition framework to guide further reforms. Various concrete measures that would help to reduce these barriers are discussed next.
Table 8:
Summary of Policy Actions to Foster Greater Competition & Competitiveness
Action 3.3 Set up an independent advisory body to advance the economic reform agenda
Policy Area 1: Streamlining Business Regulations in a Rule-Based Environment Action 1.1 Simplify business regulations to reduce operational costs
The Philippines’ business regulatory system currently requires 15 procedures to start a business and eight procedures for registering property. The authorities might consider paring down these two sets of procedures to nine and six, respectively, which would put the Philippines on a par with regional comparator countries and reduce the cost of starting a business. Once businesses are registered, cumbersome licensing and inspections requirements (e.g., in securing construction permits) strain their operations. It would be advisable to revamp these licensing systems as well, using an approach that goes beyond the traditional ‘item-by-item’ reform and, instead, applies a comprehensive top-down methodology whereby all licenses not actively justified by the regulators are eliminated by default.
Set up a Small Business Tax Regime to help address the sometimes complex administrative burden faced by entrepreneurs when complying with tax regulations. The administrative complexity of complying with tax obligations is among the top complaints voiced by SMEs, and a frequent excuse for remaining in the informal business sector. By reducing compliance burdens through a simplified and integrated regime specifically targeting small businesses, another benefit would be to potentially widen the tax base in the Philippines, and increase (modestly) the government’s tax collections. More importantly, it could also help in reducing corruption in the tax system.
Facilitate a better understanding, especially among incipient firms, of the different registration, licensing and taxation processes through the presentation of flowcharts prominently displayed in public places. This can be done by creating a step-by-step guide with a list of required documents and flowcharts showing which offices to visit when and with what documents, and listing the addresses, working hours and contact number of each office. A first step in this direction was already taken with the Anti-Red Tape Act, which brought about the Citizen’s Charter flowcharts now displayed in various government offices. This can be further improved in terms of completeness, accuracy, and accessibility. Developing (or improving) an online system is another way to make information more widely accessible, saving time for both businesses and government officials. More importantly, by reducing the need for direct interactions with different officials, it removes the potential for under-the-table transactions.
