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Foreign funds return on resilient fundamentals

The first quarter of 2019 provided some positives for the Philippines. Inflation continued downwards, adding to the election-year stimulus. Foreign investors have also returned to the domestic stock market, reflected in year-to-date net foreign inflows of P40 billion ($768 million).

According to the latest First Metro Investment Corporation (First Metro) and the University of Asia and the Pacific’s Capital Market Research report – The Market Call –  foreign investors have once again returned to the Philippines, after their knee-jerk reaction to the MSCI rebalancing and  China A shares MSCI inclusion.

First Metro predicts that highly-anticipated rate cuts could add liquidity, improve sentiment and serve to further encourage investors back into the market.

Q. What factors drove investors out in February, after they returned in January?

Foreign outflows in February were mostly driven by the MSCI rebalancing (with effectivity on March 1) and the announcement of the increase in the weight of China A shares in the MSCI EM index which will displace emerging markets such as the Philippines in the index weights of the MSCI.   

Another factor is the downgrade of the Philippines growth outlook for 2019 due to the delay in the passage of the 2019 national budget. This offset positive developments arising from the country’s sustained inflation slowdown in February (3.8%), and optimism about a US-China trade deal.

Q. How will the Bangko Sentral ng Pilipinas (BSP) adding liquidity affect the second quarter bond market?

With inflation slowing to 3.3% in March and a first quarter inflationary average of 3.8% (within the BSP’s target range of 2-4%), a growth slowdown, and the delay in budget implementation, the market expects the BSP to resume its planned reduction in its reserve requirement ratio (RRR) this year.

In fact, BSP governor Benjamin Diokno mentioned that reserve cuts will be on the table for their May policy meeting. A 1% cut in the reserve ratio will free up P90 billion ($1.737 billion) of funds, which would help ease the temporary tightness in market liquidity, especially in light of the huge government borrowings and private sector demand for capital this year.

This additional liquidity will be positive for the bond market, as it expands the capacity of both corporates and banks to further invest in these instruments.

Q. If more corporate bonds are issued in the second half of 2019, what impact will this have on the bond market?

Corporates and banks are likely to continue to issue bonds in the second half of 2019. Banks have been tapping the capital markets recently in order to acquire longer term funding to support the new regulatory requirements such as the liquidity coverage ratio and net stable funding ratio, and also to support asset growth. 

As such, corporates and banks will compete for funding with the nation’s government. However, with the atmosphere being more positive this year, compared to 2018, there should be more investor appetite for debt securities, given the outlook for lower rates brought about by lower inflation expectations and possible rate cuts by the BSP.

Q. What caused the equities market slump and what factors could create a more positive market?

The index failed to hold above 8,000 due to the 2019 government budget impasse and the global slowdown, including Philippine growth. This was reflected in the recent cuts to global growth outlook by the IMF and ADB which downgraded the Philippines GDP to 6.5% from 6.6% for the former, and 6.4% from 6.7% from the latter.

First Metro believes the market will remain cautious and will be on a lookout for value stocks, especially now that the 2019 budget has been signed by President Rodrigo Duterte, and also on positive news about developments in the US-China trade dispute which President Donald Trump described as making good progress. The latter tended to underpin rallies in Asian emerging markets in past weeks.

The upside, however, would be in the BSP’s much-awaited RRR action that is predicted to be cut by 1%, to 17% overall. The BSP language surrounding that cut is likely to provide clues as to how many more cuts can be expected this year. 

A dovish tone will be positive for the market, as it signals more easing of liquidity. 

Much of this depends on an inflation downtrend in April, which should create scope for liquidity easing.

More liquidity will also benefit the property sector as interest rates decrease, given an increase in money supply. The ripple effect is likely to flow on to the major conglomerates since the main contributors to their earnings come from banks and property companies. This will, in turn, cause the market to rally as investors have long-awaited this RRR cut. Creating another possible catalyst is first quarter 2019 corporate earnings coming in better than 2018, preferably above 11%.

Still, the biggest potential jolt to the market in May could be the MSCI global index rebalancing that includes China mainland shares increasing to 10% of the index, up from 5%. This will cause displacements in the index weights of emerging markets, including the Philippines.

Q. How will the peso fare in the year ahead?

The key catalyst is the stable to weak dollar outlook going forward, which would tend to translate to peso strength. If the US Federal Reserve cuts rates, with odds of this potentially happening in the fourth quarter, it will be good for EM currencies including the peso. Secondly, the country’s GDP growth slowdown, as reflected in imports deceleration and the narrower trade gap, will ease the depreciation pressure on the peso.

Nonetheless, we expect the peso to remain stable but with temporary weakness amid the country’s huge trade imbalance, and as the BSP builds up its gross international reserves to counter possible external shocks.  

For more in-depth analysis by First Metro, please click here

 

 

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