``It’s a good idea to operate your life on the assumption that unforeseen circumstances are lurking in the shadows, just around the next bend. Which is why it’s wise to handle your finances with the understanding that Fortune does not carry anyone on her shoulders indefinitely.”- Robert Ringer
One of the amazing observations derived from Asian Development’s Bank’s (ADB) recent development outlook can be found in the chart shown in Figure 1.
Figure 1: ADB: Treasury Bill Rates: Philippine rates LOWER than US Rates!
We have always argued that the strength of the Peso, so as with the advances of Philippine sovereign bonds, and the Phisix have been determined by foreign portfolio flows at the margin.
However, what seems SO incredible with the picture above is that Philippine short term rates have now been LOWER than that of its US counterpart, as if to suggest that US treasuries have now been seen as “riskier” assets than of Philippine sovereign issues.
Or has the world simply chosen to ignore the context of risks in its past signification? Or has the ocean of liquidity jaded the views of global investors? Or has several theories as “savings glut” (as proposed by Ben Bernanke of the US FED), “lack of investments” (Raghuram Rajan of IMF) or “Asset Shortage” or dearth of bond issuance arising from sustained reforms (Stephen Jen, Charles St-Arnaud of Morgan Stanley) been the underlying factors responsible for the present conditions? In short present conditions have been a worldwide phenomenon and are UNPRECEDENTED by sheer scale and magnitude.
This is what ADB has to say (emphasis mine), ``The banking system’s accumulation of net foreign assets fueled liquidity. Broad money (M3) growth has accelerated in the last few years, driven primarily by this accumulation (Figure 2). In 2006, net domestic credit also reversed from a decline in 2005 to contribute 7.8 percentage points to M3 growth, in large measure reflecting a recovery in credits to the private sector. A decline in the risk premium (based on improved fiscal performance), expectation of peso appreciation, accommodative monetary policy, and buoyant liquidity exerted downward pressure on interest rates. The nominal yield on 91-day treasury bills declined below comparable US treasuries in November (Figure 1) for the first time in 25 years.”
Evidently, Philippine asset classes have benefited from the present dynamics.
Figure 2: ADB: Philippine M3: Buoyant Liquidity Driven by Foreign Assets
Figure 2 simply confirms our long held view that the accumulation of net foreign assets has been important drivers of our asset classes and has contributed immensely to the torrential jump in domestic liquidity.
With even more compressed yields, you may continue to expect more of an impetus to the financial asset classes or to domestic investments. In fact, the FINANCIAL sector has registered the biggest jump in gains among the local industries, according to the IMF’s Selected Issues. Again this is in consonance with the evolving global trends, so much so that with the growing sophistication and the deepening of the financial markets brought about by accelerating trends of integration, such developments are most likely to continue.
In contrast to variable thesis posited presented above, global liquidity, in my view, is a result of massive inflationary activities undertaken by both the public and private domains in the financial world in support of the asset classes from which the present economic structures heavily depend upon.
Figure 3 ADB: Net Capital flows to Emerging Markets Nominal US dollar Exchange Rate Index
Figure 3 shows how strong international fund inflows have thus far boosted the equity markets of the Emerging Markets as well as of Asia Pacific’s. And we also see the same dynamics at work which has led to the firming trend of the Asian region’s currencies.
According to ADB’ Prospects for the world economy 2007 and 2008 (emphasis mine), ``Net private capital flows to emerging Asia amounted to $197.3 billion, only slightly down by 3.9% from the previous year, due to slightly smaller foreign direct investment flows. However, with its strong growth outlook, the region continues to be the primary recipient of private equity investment, attracting again more than 60% of net portfolio equity investment flows to emerging market economies in 2006. Relatively low interest rates and benign liquidity conditions in capital markets have kept private credit flows generally buoyant, benefiting emerging Asian borrowers. Credit spreads remained near record lows for emerging market issuers through most of 2006... Expectations for strong growth will continue to underpin the strength of Asian currencies in 2007, as will narrowing interest rate differentials, due to monetary tightening in some countries.”
Finally, when we talk of globalization, we talk of ever growing trends of greater interdependence in terms of trade and the financial markets. We also discussed in the past of the shared risks and benefits of such phenomenon. ADB affirms this view,
``With its share of exports (on a national accounts basis) close to 50% of GDP in 2006, and its dependence on capital inflows, the Philippines is closely tied to the global economy and to sentiments in international financial markets. This is offset somewhat by the seeming independence of remittances to global disturbances, likely reflecting their diversified origins. Low real interest rates and higher fiscal spending on priority projects should also support growth.
``The peso is likely to maintain its strength, supported by foreign exchange inflows from the balance-of-payments surplus. However, to preserve the price competitiveness of exports against the backdrop of slowing external demand and the appreciation of the peso (in real trade-weighted terms), the central bank may again accumulate foreign exchange reserves to stem the pace of currency appreciation. Measures to liberalize foreign exchange outflows to be effective from April 2007 may also relieve some upward pressure on the peso. They include doubling the amounts of foreign exchange that residents can buy to pay for overseas services and investment abroad....
``The main risk to the projections, apart from the extent of the slowdown in external markets, is the potential impact of the Congressional elections in May 2007. The elections need to be transparent and peaceful, and the fiscal and structural reforms kept on track. Steady progress on privatization will be an important signal to investors on the Government’s commitment.
While we share most of the assessment, the risk side is where we part. As we have previously argued, domestic politics appear to have been desensitized from the activities in the financial markets for as long as the IMPACT to the capital flows framework would be negligible. It is more likely that our financial markets be driven more by developments in the region or of the progress in the financial integration, as the recent “Shanghai Surprise-Yen Carry 2” shakeout last February or that of the May 2006 “Yen Carry” shakedown have shown.
Therefore, the object of our vigilance will continue to be directed at external factors more than that of domestic politics.
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