Yahoo News: Philippine USD Bonds Improve, Some Still Worry

Philippine Bonds of late have manifested signs of dramatic improvements until the recent scandals. This yahoo report shows of how investors reacted to the latest political imbroglio and their corresponding outlook. Quoting the entire yahoo article…

Philippine USD Bonds Improve, Some Still Worry

By Oliver Biggadike
Of DOW JONES NEWSWIRES

SINGAPORE (Dow Jones)--Political uncertainty in the Philippines in recent days has stemmed a strong run in the country's dollar-denominated debt, but some analysts say the securities will resume their strengthening trend once the instability passes.

They say that the government's progress on fiscal reform is helping narrow the spread between yields on U.S. Treasurys and dollar debt issued by the Philippine government.

The Philippines, which is one of the most prolific Asian issuers of U.S. dollar bonds, passed tax laws on May 24 that cut from July most exemptions to the country's value-added tax and raise the tax rate in January 2006 to 12% from 10%.

That, together with improving sentiment for Asian high-yield issues, helped narrow the spread on the Philippines sovereign component of JPMorgan's Asia Credit Index to 388 basis points over U.S. Treasurys on June 6, its tightest since March, from its recent widest level on May 18 of 424 basis points.

"The worst seems to be over," said Lloyd Ong, credit analyst at BNP Paribas in Hong Kong. "The last few months (of underperformance) was due to the drawn out debate about the VAT bill."

Two days after the tax laws were passed, Fitch Ratings lifted its outlook for the Philippines to stable from negative. Fitch rates the Philippines at BB, one notch higher than Standard & Poor's BB- and two notches higher than Moody's B1.

But since June 6, the JACI Philippines spread has ballooned out to 423 basis points as of Thursday, following allegations that President Gloria Macapagal Arroyo rigged her 2004 election win and that her family received kickbacks related to an illegal numbers game.

Between Monday and Thursday, when the Philippine peso bucked the trend in other Asian currencies and weakened against the U.S. dollar, the JACI Philippines spread widened 33 basis points compared with a 14 basis point widening for the overall Asia Sovereign component of the index.

Arroyo has strongly denied the charges and has asked the Philippine justice department to investigate her family's role in the kickbacks.

Political analysts say that the president will probably survive the controversy and traders say that the spread widening is likely temporary.

"The only real downside is if the opposition is successful in convincing the people," said a Singapore-based trader. If the spread widens further, "it's probably a buying opportunity," he said.

On a more fundamental level, Martin Hohensee, head of Asian fixed income and credit research for Deutsche Bank, said Asian credits - including the Philippines - are improving their credit metrics.

"We're very encouraged by the low central bank rates (in the Philippines)," he said, noting that it improves the government's finances by keeping inflation at a high 8.5%.

"The fastest way for the Philippines to get out of its debt problem is real currency appreciation," he said, which is what happens when the exchange rate remains steady amid rising prices.

Some Say Govt Needs To Do More On Fiscal Reform

But some long-term investors aren't as positive, not because of the fuss swirling around Arroyo, but due to concerns of whether the Philippines has really turned the corner in long-term fiscal reform.

"The Philippines is the only large country in Asia where one has seen no structural improvement," said Nicolas Schlotthauer, who helps manage $2.5 billion in emerging market bonds at Deutsche Asset Management in Germany.

"The Philippines pay a higher interest-rate premium, but we see an extreme downside" due to the government deficits, he said. Of the money that Schlotthauer helps manage, around $200 million is in Asian U.S. dollar bonds.

Philippine bonds pay roughly 125 basis points more than Indonesia, another high-yield Asian issuer, Schlotthauer noted. "That's also required, given the risk," he added.

The Philippine government has said that this year it will use the additional VAT revenue, which it has estimated at PHP31 billion, to cut the deficit. In 2006, 70% of an estimated PHP105 billion in VAT revenue is earmarked for deficit reduction and Arroyo's goal is to balance the government budget by 2010.

"It's good that (the VAT hike) happened at all...but over the long-term, it's just not enough," Schlotthauer said. "Next to the low tax rate, (the losses at) the national power company is the central problem."

Ratings agencies have also cited losses at the state-owned utility National Power Corp. as an area of concern. Moody's Investor Service said in a June report that "the elimination of operating losses and restructuring of National Power Corporation...would also be positive factors" which could change the rating.

Others aren't as pessimistic and say that the long tenor of Philippine bonds gives the country time to fix its fiscal problems before the bonds mature.

Of the $15.3 billion Philippine U.S. dollar bonds on the JACI index, $12.7 billion have maturities longer than five years. Most recently, the Philippines in May sold $250 million of 10-year bonds and $500 million of 25-year bonds.

"Every time they do another $1.5 billion to $2.0 billion deal...it gives them more time to fix their deficit situation," said BNP Paribas' Ong.