Second of three parts
Last week, the Bureau of the Treasury conducted its first debt swap since 2011, exchanging P121.72 billion in shorter-term bonds for longer-term issues due in 2024, and accepting an additional P9.40 billion in new subscription offers for the 10-year bonds yielding 4.125 percent.
The success of the debt swap was greeted with understandable enthusiasm by officials at the Treasury and the Department of Finance. Besides lowering interest costs—the new bonds are priced below existing 10-year issues, whose yield stood at 4.365 percent at the end of the week, and the new bonds extend the average maturity of government bonds to 5.2 years, according to the Treasury.
It would be a fair assessment to say that the results of the “domestic liability management exercise,” as the Treasury officially referred to it, were an endorsement of the current state of the government’s debt management approach. Investors are evidently finding Philippine government securities a good buy; the P121 billion the Treasury accepted for exchange was only about half the total amount of existing bonds that were offered.
That success is even more impressive when one considers the scale of the job of “liability management.” While the numbers attached to the latest debt swap are significant, they pale in comparison to the size of the existing government securities market.
As of the end of June, the total amount of outstanding local currency government bonds was P3.82 trillion, accounting for a little more than 85 percent of the P4.5 trillion market, and that total does not include the approximately P500 billion in outstanding government Treasury bills and other securities.
What seems a bit unusual about the current state of the market for government securities is that in terms of volatility and interest rate spreads, two common indicators of the strength of bonds, a remarkable stability has been seen since the end of April.
Volatility is an indicator of risk due to fluctuations in bond yields; the higher the volatility, the less predictable day-to-day changes in yields are, and therefore, the riskier the investment.
Interest rate spreads are comparisons of the yields on long- and short-term bonds, for example, 10-year bonds versus 2-year bonds. Longer-term issues should naturally pay higher yields, and these are indicated by positive spreads; a negative spread indicates a higher yield on shorter issues, and is generally regarded as a sign of negative sentiment about the government’s longer term financial prospects. The smaller the spread, the closer yields of long- and short-term bonds are to each other; whether this is always a good sign or not is somewhat debatable, but one effect it does seem to have is to spread out investments more evenly between long- and short-term bonds, which could give the government a bit of flexibility in managing its debts.
What makes all this interesting is that beginning in April, the Philippines began what seems to be a trend of declining economic indicators.
April’s inflation rate was 4.1 percent, 0.2 percent higher than in March, and as of July it had reached 4.9 percent. The country’s first-quarter GDP growth rate registered an unexpectedly low 5.7 percent, and while most observers expect that to have improved a bit for the second quarter, several key forecasts for the economy’s expansion for the rest of the year and into next year were revised downward. A persistent issue with congestion in Manila’s main container ports—which is perhaps being blown out of proportion to some extent for political reasons—has, nevertheless, put businesses on edge, and while estimates of the problem’s actual economic cost vary widely, they are all in the tens of billions of pesos.
None of those things are ordinarily good signs for the bond market; reduced economic activity is eventually reflected in lower government revenue, which is a negative indicator for the country’s ability to meet its debt obligations. The consequential increase in risk is then reflected in higher bond yields.
Yet, that does not seem to be the case in the Philippine government securities market; according to data provided by Security Bank’s Market Edge report yesterday (August 26), yields continue to be remarkably stable. Only on shorter-term issues, 2-year bonds and 3-month, 6-month, and 1-year Treasury bills, have yields perceptibly increased from a month ago.
Eduardo Francisco, president of the Investment Banking Group at BDO Capital and Investment Corp., suggests that the government’s fiscal management fundamentals may be strong enough to render shorter term economic concerns irrelevant.
“Current yields are a reflection of the market,” he said. “They have gone down significantly the last few years. There is some expectation they will be up slightly because of higher inflation. But whatever clears today is reflective of the market.”
Francisco pointed to the result of the recent debt swap as an example. “Long term sovereign rates at 4.125 show how strong the Philippines already is,” he added.
Development challenges remain
Former National Treasurer Sergio G. Edeza agrees with the general perception that Philippine government debt issues are handled well, but suggested a number of things that should be done to improve the market, and sounded one note of mild caution.
“I think since 2010 the Treasury has done well in managing its debt financing. In particular they have managed their debt mix, as well as their maturity profile,” he said.
Edeza, who was appointed by President Gloria Macapagal-Arroyo in February 2001 and served as Treasurer until 2004, faced a rather more challenging financial situation than the current government: 10-year government bond yields hit an all-time high of 18.64 percent in January 2001 as the country struggled with high debts and a significant budget deficit.
One of the issues Edeza had to address, according to contemporary news reports, was a bit of a disagreement with the Bangko Sentral ng Pilipinas (BSP) over interest rates, a topic that has some relevance to the present given the possibility of further BSP tightening in response to increasing inflation.
Edeza explained, “It is understood that the BSP has to do its job and it really has to manage inflation.
Naturally, treasurers have to worry about the effects of BSP actions on interest rates.”
The biggest effect increasing interest rates have is on the discount rate of short-term Treasury bills, in that higher interest rates mean they must be sold at bigger discounts by the Treasury (which effectively turns into a higher interest rate at maturity), but monetary tightening also affects bond yields.
“To manage these kinds of situations a treasurer will have to be mindful of the signals from the BSP and make his decisions appropriately,” Edeza explained. “In a period of rising interest rates one will have to lock in by borrowing longer tenors but also consider that economic cycles come in certain time intervals. Therefore, one should not lock into fixed-rate borrowings for very long tenors.”
Whether or not the Treasury is following this advice remains to be seen. So far this year, bond offerings were made in the first and third quarters, with shorter-term 3-, 5-, and 7-year bonds being sold earlier in the year and 7-, 10-, and 20-year bonds being offered this quarter. The auction for 20-year bonds is scheduled for September 18, a week after the BSP’s Monetary Board meets to decide whether policy action in the form of interest rate changes or other steps is needed.
One point that Edeza stresses is the need for the bond market to expand its reach and become viable for more investors.
“I think market has evolved well in terms volume of issue and size of trades. But there are still major issues that need to be addressed by regulators,” he said.
One issue Edeza’s successor, Norma Lasala, had to contend with was a strong push by the BSP and Department of Finance to implement the electronic Fixed Income Exchange (FIE), something which Edeza opposed.
“On the Fixed Income Exchange I was opposed to it because it increased the cost of trading government securities,” he explained. “While transparency in the government market is a good objective, that should not come at a heavy cost to market players.”
Edeza’s other suggestions are also strongly pro-investor. One area of concern is increasing the participation of private (i.e., corporate) issuers in the local bond market. “This can be done by amending some SEC regulations,” he said. “There should be a fast-track mechanism for the SEC registration process for bond issuance for listed companies.”
“The requirement for a fully underwritten bond issuance is also counterproductive since it does not allow for a truly market-driven deal,” he adds. “Requiring a fully underwritten deal is not exactly favorable to the issuer. For one thing, since banks are the ones that underwrite, the private sector issuers are still affected by the single borrower’s limit,” meaning that the size of any individual bond issuance has an arbitrarily imposed ceiling, regardless of the creditworthiness of the issuer.
In addition to easing some SEC restrictions and pushing the development of the repo (repurchase) market, Edeza also recommended lowering some tax costs that serve as to discourage investment.
“The tax regime should also be amended to support local market development through the removal Of DST (documentary stamp tax) and lowering of withholding taxes,” he said. “This in effect reduces the cost of borrowing and will make the cost of doing business in the Philippines lower.”
WITH KRISTYN NIKA M. LAZO
On Friday: Part three of this special report on the Philippine bond market will unwrap the crystal ball and look at what may be expected—where bond rates and volumes are headed and what prospects lie ahead for expanding the market’s capabilities.