BY LAILANY P. GOMEZ REPORTER

The Development Bank of Singapore (DBS) said it expects no major upward pressure on yields from debt auctions next year despite the Philippines’ huge budget deficit. In its latest research note, Asia’s biggest lender said rate hikes in the first quarter continue to look unlikely as the Philippines’ gross domestic product (GDP) will likely expand at a pace of only 1.2 percent or so every quarter in 2010 and inflation is likely to average only four percent year-on-year.

“This is good news for the local currency bond market and, as we outlined in our 2010 first quarter quarterly report, we expect yields to stay low in January to March period,” DBS said.

The government had rejected bids at several recent auctions and prevented the 10-year benchmark yields from rising above the 8.27 percent weighted average fixed coupon on outstanding local currency government debt.

On October 20, the government rejected bids for the fresh 10-year bonds when market players asked for a premium that was unreasonably high.

Again, on November 17 the government rejected all bids for the seven-year T-bonds. Had the auction committee made a full award, the debt papers would have fetched an average rate of 7.376 percent, 1.126 basis points higher than its coupon rate of 6.250 percent. Bids ranged from a low of 7.25 percent to a high of 7.8 percent.

Had the auction committee made a full award, the 10-year debt paper would have fetched an average rate of 7.88 percent, 5 basis points higher than its coupon rate of 7.875 percent. Bids ranged from a low of 7.8 percent to a high of 7.998 percent.

“This suggests the government is comfortable with its funding prospects and there will continue to be heavy reliance on alternative funding sources, like foreign currency debt, to plug next year’s budget gap,” DBS said.

It added that if the strategy of keeping longer-term interest rates low succeeds, the 10-year yields will stay around 8 percent until the central bank hikes rates, which will probably not be before third quarter next year.

If it doesn’t succeed, 10-year yields will rise sharply even if yields on short-dated bond remain low, the Singaporean lender said.

“Yields would rise, simply because investors will ask for higher yields at auctions,” it added.

The Bangko Sentral ng Pilipinas (BSP) in August cut short a monetary easing cycle that began in December last year, with its overnight borrowing and lending rates dropping to record lows of 4 percent and 6 percent, respectively.

“We think the Philippines will probably be able to fund a substantial portion of next year’s deficit through foreign currency denominated bonds. Even if there would be no domestic net issuance at all, funding the entire P233-billion deficit next year through foreign currency debt would not push the level of outstanding foreign debt above that of domestic debt,” DBS said.

The Philippines raised $3.25 billion from $3 bond sales—$1.5 billion in January, $750 million in July, and $1 billion in October—this year, and is likely to raise funds overseas in early January next year, when a successor to President Gloria Arroyo will be elected.

“Selling foreign currency debt should not be a problem after this year’s dollar bond sales drew bids for more than four times the debt on offer. If the Philippines faces no problems in funding the deficit, the next key events for the local bond market are the May election and the onset of the rate hike cycle.
These, however, are still several months, not weeks, away,” DBS said.

Separately, the National Economic and Development Authority (NEDA) on Wednesday said the government should continue to incur a budget deficit until the post-typhoon rehabilitation is completed.

“Deficit spending has served us well in 2009, given the global economic crisis. Moreover, pump-priming the economy allowed us to escape recession,” Acting Socioeconomic Planning Secretary and NEDA Director General Augusto Santos said in a statement.

In 2010, the world economy will continue to post a fragile recovery, Santos said, adding that this requires the government to continue deficit spending.

He dismissed the Philippines’ deficit-to-GDP ratio of 0.9 percent last year as smaller than, among others, the 2.1 percent of Cambodia, 4.7 percent of Malaysia, 5.8 percent of Laos. “In other words, our deficit is not only manageable; it also reflects responsible deficit management,” the NEDA chief said.

In a post-disaster needs assessment exercise, the government and donors estimated the total damage and losses at P206 billion, or 2.7 percent of GDP.

Santos said the country’s recovery and rehabilitation work would cost approximately $4.42 billion from 2010 to 2012.
WITH REPORT FROM DARWIN G. AMOJELAR