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Peso Yield Premium Lures Union in Upgrade Bet: Southeast Asia

Philippine's President Benigno Aquino
Benigno Aquino, president of the Philippines. Photographer: Julian Abram Wainwright/Bloomberg

Philippine peso bonds will beat the nation’s dollar debt in 2013 as investors lured by the chance of an investment-grade rating favor the higher-yielding notes, according to Union Investment Privatfonds and Jyske Bank A/S.

The 4.95 percent local-currency securities due January 2021 that were sold internationally yield 3.37 percent, compared with 2.3 percent for similar-maturity dollar debt, according to data compiled by Bloomberg. The peso is the best-performing Southeast Asian currency this year, with a 6.5 percent rally against the dollar, and will gain 3.7 percent in 2013, according to the median estimate of 22 analysts in a Bloomberg survey.

President Benigno Aquino signed a law to increase tobacco and liquor taxes on Dec. 20, prompting Standard & Poor’s to raise the country’s credit-rating outlook from stable to positive a few hours later. Aquino has cut the budget deficit, cracked down on tax evaders and made progress in tackling corruption since he took office in 2010, while the Philippine economy grew 7.1 percent in the third quarter, the fastest pace in Southeast Asia.

“A switch from U.S. dollar Philippine debt to peso government bonds makes sense since you have a better yield and a low-volatility currency makes this switch quite attractive,” Sergey Dergachev, senior portfolio manager in Frankfurt at Union Investment Privatfonds, which oversees $8.5 billion of emerging-market debt globally, said in an e-mail. “I foresee a chance of more than 50 percent since the country did a lot on the fiscal side,” he said, referring to the odds of a credit-rating upgrade next year.

Low Volatility

Philippine local-currency notes have returned 2.8 percent since the end of September, compared with 1.7 percent for dollar bonds, according to indexes tracked by HSBC Holdings Plc. That follows three quarters in which the global securities outperformed the peso-denominated ones.

One-month implied volatility for the peso, a measure of expected exchange-rate movements used to price options, has dropped 3.35 percentage points to 4.4 percent this year, according to data compiled by Bloomberg. That compares with 5.7 percent for the rupiah and 10 percent for India’s rupee.

The Philippines imposed limits on currency forward positions at banks yesterday to restrain the surge in the peso that threatens exports. The cap for non-deliverable currency forwards at local banks is 20 percent of capital, and 100 percent for foreign lenders, Bangko Sentral ng Pilipinas Governor Amando Tetangco said in a briefing in Manila yesterday. Banks have two months to comply with the new rules, he said.

Investment Grade

Moody’s Investors Service raised the Philippines’ debt rating to Ba1, one step below investment grade, on Oct. 29. S&P assigned the country its top junk rating in July, following a similar assessment by Fitch Ratings in June 2011. S&P cited improved governance and public finances when it changed its outlook on Dec. 20.

The nation is “only half a step” away from exiting junk status, Finance Secretary Cesar Purisima said Dec. 20. The sin tax may raise 184.3 billion pesos ($4.5 billion) over the next four years, he said in an e-mail on Dec. 11.

The budget deficit was 115.74 billion pesos in the January-through-October period, well under the full-year target of 279 billion pesos, or 2.6 percent of gross domestic product. The shortfall was 3.5 percent in 2010 and 2 percent in 2011. The Philippines recorded a balance-of-payments surplus of $2.2 billion in November, the most since July, official data show.

Sin Tax

“If revenue-enhancing measures such as the sin tax afford the authorities the fiscal space to improve the quantity and quality of public investment spending, and that leads to a higher sustainable GDP growth trajectory, it would be positive for the ratings,” Philip McNicholas, Fitch’s Hong Kong-based director of Asia Pacific Sovereigns, said in a Dec. 11 e-mail.

Barclays Plc, which recommends clients reduce holdings of Philippine dollar debt and buy more of the global peso notes, predicts Aquino’s reforms, the robust growth and its balance-of-payments surplus will see the nation win its first investment-grade rating in the second half of 2013.

The yield premium investors demand to hold Philippine dollar debt over Treasuries fell 114 basis points this year to 194 basis points, less than the 2.59 percentage points average for developing Asia, an HSBC index shows.

“Philippine dollar bonds trade at spreads much tighter than higher-rated emerging-market countries,” Avanti Save, a sovereign credit analyst in Singapore at Barclays, Britain’s second-biggest bank by assets, wrote in an e-mail on Dec. 18. “At current low yields, Philippine dollar bond returns are likely to be anemic in 2013.”

Monetary Policy

The central bank has cut the overnight borrowing rate by 100 basis points this year, banned foreign investors from its special-deposit accounts and ordered lenders to provide more funds to cover risks on non-deliverable currency forwards. Forwards are agreements in which assets are bought and sold at current prices for settlement at a later specified time and date. Non-deliverable forwards are settled in dollars rather than the underlying asset.

“Our in-house fund holds both dollar and peso global bonds and we like the long-term peso issues particularly,” Patrick Bengzon, a senior emerging-market bond trader at Silkeborg, Denmark-based Jyske Bank, the nation’s third-largest lender, said in a Dec. 12 interview. “There’s peso appreciation and lower yield prospects. But it’s also a question of how tolerant the central bank is for peso strength versus the other Asian currencies.”

Barclays predicts the peso will strengthen 4 percent to 39.5 over the next 12 months, Prakriti Sofat, its Singapore-based regional economist, said on Dec. 18.

‘Continued Jawboning’

“Over the medium term, we remain constructive on the peso,” she said. “In the near term, we believe the central bank’s continued jawboning and the risk of macro-prudential measures are likely to make market participants a bit cautious on the peso, particularly given the worsening global risk sentiment.”

The cost of protecting Philippine five-year debt against non-payment has dropped 94 basis points to 100 basis points this year, while that for Indonesia fell 83 basis points to 124, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

The Philippine economy will probably grow 6 percent to 7 percent next year and 6.5 to 7.5 percent in 2014, Economic Planning Secretary Arsenio Balisacan said on Dec. 18. The nation’s jobless rate dropped to 6.8 percent in October, the lowest in a year, official data showed on the same day. Inflation slowed to 2.8 percent in November, the slowest since June, official data show.

“There’s growing interest in investment in the Southeast Asian nations due to their economic outperformance, including the Philippines,” said Tsutomu Soma, manager of the investment trust and fixed-income business unit at Rakuten Securities Inc. in Tokyo, said in an interview on Dec. 12. “Some institutional investors can’t buy non-investment grade bonds. When the Philippines is upgraded, I am sure there will be quite strong demand.”

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