What flutters like a BB+, buzzes like a BB+, and stings like a BB+, yet trades like a B? The ROP papers, otherwise known as the sovereign bonds of the Republic of the Philippines.
ôWhy do bonds that we think are of high BB credit quality trade in the high four hundred basis point range, a level more suitable to bonds rated low BB or high single-B?ö asks Stephen Taran, the New York-based global head of sovereign credit research at Salomon Smith Barney.
That ROP 10-year papers are trading at spreads of treasuries plus 525 basis points and this is the anomaly in question.
On the other hand, a voice from Singapore does not find this extraordinary at all.
ôIn an Asian context, we agree that RoP spreads are wider than they should be based purely on fundamentals,ö says Martin Hohensee, the Singapore-based regional head of fixed income strategy at Deutsche Bank. ôHowever, dedicated emerging market investors are a traditionally important sponsor of RoP bonds. Within a broader emerging markets context, the Philippines is more or less in line with other emerging market credits.ö
ôThis situation is unjustified,ö says Joey Cuyegkeng, economist at ING Barings in Manila.ááôThe fundamentals of the Philippine economy remain steady with international reserves higher than last year.öá
Reviewing the countryÆs economic fundamentals may explain this anomaly.
The Philippines is currently rated BB+ by Standard and PoorÆs and Ba1 by MoodyÆs. The country has strong external accounts that is expected to be in the surplus for the third consecutive year. With a current account balance of 6% of GDP, among the PhilippinesÆ comparable emerging markets peers like Colombia, Mexico, South Africa, and Thailand, only the latter is expected to have a stronger current account performance.
The countryÆs has been exporting its way out of the crisis and its 11.7% export growth currently compares well with Mexico and among its Asian peers only Thailand performs slightly better, but then the kingdom carries a Baa3/BBB- rating classified as investment grade.
The PhilippinesÆ strong current account and export growth performance is supported by a strong external liquidity position which at 2.4 times [reserves to short term debt] is more than double its emerging market peers, again except Thailand. Its short term debt fell to $5.9 billion at the end of 1999.
Among the most watched economic parameter is the countryÆs gross international reserves that soared to an all time high of $15.4 billion in May which the government hopes to raise to $17.1 billion by year-end.
External debt performance while not particularly superlative at 109.3% of exports per TaranÆs 2000 year-end estimates, still sits comfortably well among its peers. The countryÆs debt service ratio estimated at 15.7 likewise falls within its peersÆ range.
Among the most notable fiscal changes in the Philippines are the enactment in rapid succession of several laws including the General Banking Act of 2000 allowing more foreign participation in the banking system, the Retail Trade Liberalization Act opening the retail sector to foreigners, and the Securities Regulation Code giving more teeth to the securities commission in enforcing insider trading violations.
Given the litany of fiscal developments, macroeconomic fundamentals, and monetary performance, the ROP papers are buzzing like a BB+ credit, yet why do they trade at single B levels?á
ôThe answer to the Philippine spread riddle is unequivocally not attributable to the state of the Philippine sovereign risk indicators,ö emphasized Taran of Salomon Smith Barney. ôThe Philippines compares favourably with comparatively rated sovereigns on virtually all of those indicators.ö
Arthur Woo, economist at HSBC in Singapore paints a downhill slope for the countryÆs export performance in May that may account for the continued pricing anomaly: ôThe Philippines exports are now growing more slowly than other Asian competitors for the first time since 1995. Electronic exports have slowed against a backdrop of robust global demand in the sector.ö
ING Barings is more optimistic of the economy. ôContinuation of modest growth in 1999 is likely,ö says Cuyegkeng, ôwhile economic reforms have been put in place in the past six months. Exports seem to be headed for a recovery sustaining a trade and current account surplus in 2000.öá
Deutsche Bank offers a slightly different view. Martin Hohensee at Deutsche Bank says: ôIn the same way that fundamentals fail to explain why Thailand trades through fundamentals, they also fail to explain the Philippines spreads at the moment. To our knowledge, nobody is recommending that anybody sell Thailand.ö
So why is the Philippines not trading through its fundamentals?á
ôThe collapse of the spread is largely sentiment driven, a situation similar to the peso weakness,ö says Joey Cuyegkeng of ING Barings Manila.á
From his vantage in New York, Taran offers a clue that seeks to evaporate the mists around the trading anomaly: ôThe answer to the Philippine spread mystery is the æmoÆ of Philippine sovereign credits. æMoÆ as in momentum.ö
He continues: ôThe underperformance of the Philippine sovereign bonds so far this year suggests that a significant number of investors think that the æmoÆ in the Philippine sovereign credit trends is in the wrong direction. We disagree. Right now, we think that the momentum seems to be strong enough and in the right direction, to ensure that the Philippines retains its Ba1/BB+ rating.ö
So there you have it.
On the other hand, Deutsche BankÆs Hohensee says: ôFor us, it's most relevant to focus on the potential supply of RoP paper, which is a direct function of the near-term deterioration of the Philippines fiscal accounts. The misalignment between pricing and fundamentals is likely to remain, as long as this issue hangs over the market.ö
And donÆt forget that Christmas is coming to town bringing sleigh-loads of consumer goods to brighten up the worldÆs longest Christmas season and dent the balance of trade.
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