The Philippines: Asia’s newest darling

When a sleeping tiger wakes

The Asia Pacific Economic Cooperation (APEC) summit in Manila last November was a crowning point in president Fidel Ramos’s four-year term. Summit participants included president Bill Clinton as well as leaders from the other 17 APEC member states. And in waiting were countless businessmen hoping to break into the latest Asian country seeking to achieve tiger economy status.

“The APEC summit marked the Philippines’ debut alongside the most successful economies in the region,” says Jojo Gonzales, director and chief strategist at Jardine Fleming Exchange Capital Securities. “Four or five years ago, nobody could have dreamed we would host such a conference. This was a stamp of approval.”

Four years into his presidency, Ramos has plenty to be proud about. GNP growth, 0.5% in 1991, surged to 5.5% in 1995 and estimates for 1996 suggest it topped 7% at a time when growth was tailing off in Malaysia and Thailand. International reserves are also increasing: they reached $11.6 billion last September compared with $4.2 billion in June 1993.

“There is no question that this economy has turned around and is joining the other countries in east Asia in terms of growth,” says Bernado Villegas, chairman of the Philipppines’ Centre for Research and Communication. The impetus for economic turnaround has come from an unprecedented combination of widespread liberalization and growing political stability. Perhaps the single most important measure was the landmark build-operate-transfer (BOT) law introduced early in 1993 to tackle crippling infrastructure problems. Insufficient electricity capacity, for example, had meant Manila endured eight-hour power cuts. The new legislation provided a framework to encourage the private sector to participate in large-scale projects the state could not afford to implement.

The impact has been overwhelming. In little more than three years, 18 private power projects worth $3.4 billion have been successfully completed. Sponsors have included Hong Kong’s Hopewell Holdings, Enron Power of the US, Asea Brown Boveri of Switzerland and Japan’s Kawasaki. After dealing with the power shortage, the government applied the same formula to transport systems and other areas in desperate need of funds.

Economic sectors that had long been the domain of friends of former president Ferdinand Marcos were opened to competition while Ramos has also speeded up the privatization process that had been initiated by Corazon Aquino, Marcos’s successor.

These moves have led to a rapid increase in investor confidence. Gross foreign investments rose to $7.8 billion in the first eight months of 1996 compared with $3.6 billion in 1993. Net foreign investments increased from $812 million to $1.4 billion over the same period.

Investment in electronics has attracted a high proportion of this investment. Intel, the world’s largest producer of computer chips, has invested $350 million over the past three years. Acer and Texas Instruments are also using the Philippines as a production base.

The outlook for this year is even brighter in the wake of the successful APEC meeting. According to a survey by the American Chamber of Commerce, US companies plan to invest an estimated $12 billion over the next five years in 18 major projects.

Among the planned investments is the $4.5-billion Camago-Malampaya gas field project to be undertaken by Occidental Petroleum and the National Power Corporation. Hydroelectricity to irrigation giant Cal Energy has also proposed a $1.3-billion project to start this year. Other major projects in the offing include a $500-million co-generation facility to be built by US companies Mission Energy and Caltex and a $400-million vehicle-manufacturing plant for General Motors.

This picture could hardly be more different to the situation in the late 1980s and early 1990s, when the Philippines lurched from one crisis to the next. Under Marcos, heavy-handed regulation and corruption hampered the economy, sending it into a downward spiral. The downturn was exacerbated by chronic deficits, mounting external debt and declining exports. Aquino swept into office in 1986 in a peaceful revolution. Although she laid many of the foundations for growth, the country’s uncanny ability to shoot itself in the foot continued to deter the world’s investors.

Those dark days now seem gone for good. The bold reforms of the Ramos administration look set to bring to a close the boom-bust cycles that have long been a feature of the economy.

“The potential was always here in the Philippines, but it needed Ramos to take the lid off,” says Keith Craig, managing director at WI Carr Securities. “We finally have stability. We have a properly elected president. Everything stems from that.”

The country has also benefited from the experience and international stature of a number of key officials. The appointment of Roberto de Ocampo as finance secretary had a major impact on sentiment. So too did the decision to appoint Gabriel Singson as the new governor of the Philippines’ central bank, the Bangko Sentral ng Pilipinas.

“We have had the good fortune of having two very competent officials in the monetary and fiscal areas and they have done extremely well,” says Octavio Espiritu, president and chief executive officer of Far East Bank & Trust. “What president Ramos has done is to inject political stability and pick good economic managers.”

One of the first initiatives of the Ramos administration was to begin liberalizing the peso, which now floats in an informal band. This was followed in 1993 by the lifting of almost all restrictions on foreign-exchange transactions and the abolition of the requirement that foreign direct investments have the approval of the central bank.

Other far-reaching measures have included the deregulation of banking, oil refining, shipping, air transport and telecommunications. Before 1993, Philippine Long Distance Telephone had a virtual monopoly on telephone lines. More than 10 telecommunication companies have sprung up since then, including both cellular and conventional providers. The once heavily protected monopoly enjoyed by Philippine Airlines has also been broken with the launch of Air Philippines, Cebu Pacific and, most recently, Asian Spirit.

“Deregulation has been crucial to putting the economy back on its feet,” says Jose Mario Cuyegkeng, research director at ING Baring Securities in Manila. “The basic infrastructure is now there to support more sustainable economic development.”

Not everything has gone smoothly. Privatization, for example, has slowed. Proceeds from state sell-offs declined from Ps5.2 billion ($196.4 million) in 1994 to Ps3.5 billion in 1995. And between January and October 1996, privatization raised only Ps1.35 billion ­ well below the government’s target. This was partly because of delays in sales of land at Fort Bonifacio, partly because of the postponement of further sales of shares in Philippine National Bank and Manila Electric Company, the largest electricity distributor.

Tax legislation has also been delayed. Under its comprehensive tax reform programme, the government had planned to revise both income and corporate tax, simplify fiscal incentives and close tax loopholes. But the bill has been held back by strong opposition.

There was, however, some consolation last November when the government overcame opposition to an excise tax on cigarettes, beer and spirits. The new tax is expected to generate Ps6.5 billion to Ps7 billion this year ­ enough to turn a budget deficit into a surplus and pave the way for other new taxes early this year. “The government walked away with more than it hoped for,” says one analyst. “Nobody believed that it could push the legislation through.”

The banking sector has also been liberalized. Since 1993, when the central bank was restructured and renamed, it has established itself as one of the most credible in the region. Under the respected hand of Singson, a career central banker, it has abolished many of the foreign exchange controls that suffocated the economy as well as virtually eliminating the hefty depreciation against the US dollar that afflicted the peso.

Since the beginning of 1995, the peso has remained in a tight band against the US dollar. Despite the informal peg, the government has been able to carry out monetary policy effectively. “The consistent vigilance exhibited by the [central bank] in fulfilling its mandate of fostering price and foreign exchange stability through monetary policy, has proven crucial in neutralizing intermittent cost-push inflation,” says a report by the World Bank.

It’s a sentiment widely shared in Manila. “The central bank has done an excellent job in the past few years,” says Gonzales. “They have been quiet as regulators, but they have kept a very close eye on banking and speculation on the currency and are very much on the ball.”

But there are still major challenges. Inflation, although down from the 18.8% it reached in 1991, still hovers at around 8.5% because of expanded value-added tax and oil and transport price increases. Real interest rates, based on the 91-day treasury bill, are declining but still among the highest nominal rates in Asia.

There are also concerns about the rising foreign trade deficit and dependence on potentially volatile capital inflows. In the first 10 months of 1996 the trade deficit rose over 40% to $10.2 billion from $7.1 billion on the back of a surge of imports. According to the National Statistics Office, imports reached $26.9 billion compared with $21.5 billion over the corresponding period in 1995, while exports rose from $14.4 billion to $16.8 billion over the same period. The bulk of imports were, however, raw materials and intermediate goods, including electronics and components, and industrial machinery and equipment. “Growth is sustainable,” says Villegas. “This is not a consumer-led boom. It is from exports and investments and the continuation of these two trends is guaranteed.”

Nevertheless, the possibility of a sudden outflow of capital choking recovery is likely to remain uppermost in investors’ minds. These concerns were voiced at a recent creditors’ meeting which called on the Philippines to strengthen its resilience to external shocks. Although donor countries at the 20th consultative group meeting in Tokyo pledged a $2.9-billion package to help fund the government’s economic programmes, they also urged it to foster domestic savings, which at 18.1% of GDP still remain among the lowest in the region.

The meeting also urged the government to improve tax collection. At present it is estimated that only 15.8% of the population pay income tax compared with 25% in Thailand. But if the comprehensive tax reform package is implemented, this could rapidly change.

Even more critical is rural development and land reform. According to the World Bank, 36% of the population is still living in poverty, despite the recent gains. The need to improve infrastructure also poses a daunting challenge. At present roads outside the capital are in poor repair, and everything from new bridges to airports and water supplies is needed.

The situation is little better in the capital itself. The government estimates that traffic moves at a paltry average of 26km an hour in Metro Manila, a figure expected to fall to 16kmh by 2000 if no improvements are made. Observers hold out hope that the Metro Manila Skyway road project as well as the Mass Rail Transit III will improve the situation. The skyway project, which is being undertaken by Citra Metro Manila Tollways, was launched in April of last year, after numerous delays. Other flagship transport projects, including Mactan International Airport, the Davao-Bukidnon Road and the Zamboanga City-Pagadian Road are also under construction.

Despite the challenges, most brokers remain optimistic. The Philippines has an abundance of English-speaking workers. Land is still cheaper than in many other countries in south-east Asia. Moreover, the country is growing from a very low base. To match Thailand’s per capita GDP, WI Carr estimates that the economy would have to grow in double figures for more than a decade. “You could be looking at a 10-year growth cycle,” says Carr’s Craig. “The controls are now there to manage the growth.”

Increased repatriation of funds from overseas contract workers, especially from the US, Hong Kong and the Middle East, could also have a major impact. Remittances last year reached $5 billion, a figure expected to rise as confidence in the economy grows. This could cushion any slowdown of capital inflows from overseas donors, which currently provide an estimated 40% of public-sector financing requirements.

Other indicators are also positive. According to ING Barings, inflation is likely to remain at around 8.5% in 1997, while the rate on the benchmark 91-day T-bill declined from 13% last June to 11.5% in September and looks set to continue its downward trend.

The rapid decline in the external debt burden has boosted confidence. The ratio of external debt service payments to export earnings has fallen from a high of 35.8% in the 1980s to an estimated 14% at the end of 1995.

The country’s position further improved after a recent restructuring of the country’s debt. In the third quarter of 1996, the government exchanged $678 million of Brady bonds, collateralized by US treasuries, for a new and uncollateralized $690-million 20-year fixed-rate government bond. The move not only retired bonds that carried the taint of debt rescheduling, but also created a benchmark long bond and removed the expense of the US treasury bond collateral.

An expected raising of the country’s credit rating to investment grade should also boost confidence. In 1995, Standard & Poor’s upgraded the Philippines from BB­ to BB. Moody’s Investors Service upgraded it from Ba3 to Ba2. This was followed in early 1996 by the Japan Credit Rating Agency’s upgrade to an investment grade rating of BBB­. There is talk that Standard & Poor’s and Moody’s could follow suit, enabling more Filipino companies to tap the Eurobond market. “It would be extremely positive in terms of increasing both direct investment and equity investment,” says Cuyegkeng.

The succession to Ramos in 1998 is a point of concern to investors. The constitution does not allow for a second term and analysts doubt that Ramos will attempt to change it since this would be too reminiscent of Marcos, who ruled the Philippines as if it were his personal fiefdom. Investors want reassurance that the new president will be pro-market and pro-foreign investment.

Possible candidates include Joseph Estrado, a former film actor and the current vice president. He has a strong popular following, but is not widely known abroad. Richard Gordon, chairman of the Subic Bay Metropolitan Authority, is also tipped to stand and is respected for his vision.

Whatever the outcome, analysts doubt that there will be a major reversal and reject fears that political instability will re-emerge. “Would a change of leadership lead to a change of direction? I doubt it,” says Cuyegkeng. “There may be a change of focus or a greater emphasis on social development, but a new president will not reverse the existing reforms.”

It’s a sentiment shared by other brokers. “This is not the Philippines of the late 1980s and early 1990s,” says Gonzales at Jardine Fleming Exchange Capital Securities. “This is not the Philippines of the boom-bust era. What you are seeing here is different.”

Settling down to business

After years of stagnation, the Philippine stock market is once again attracting foreign investors. Now the regulatory authorities are setting their sights on establishing a reputation as a leading Asian exchange. By Ben Davies

When Vitaliano Nañagas took over as president of the Philippine Stock Exchange (PSE) last October, he could hardly have hoped for better starting conditions. The regulatory problems caused by the creation of the PSE in March 1994 from two rival exchanges had been resolved and the equity market was enjoying some of its highest volumes in years. The Philippine Composite Stock Index rose more than 25% in the first nine months of 1996 and the Philippines is now being touted by analysts as one of the region’s rising stars.

“Our volumes and capital are up. Our membership is up. The number of listed companies is up. Our contribution to the economy has increased. Those facts speak for themselves,” says Nañagas.

This is a far cry from the situation five years ago when poor earnings and fears of a coup eroded investor confidence. The rival Manila Stock Exchange and the Makati Stock Exchange staunchly refused to countenance proposals for their merger, making share-trading confusing and inefficient. When markets around the region soared, the Philippines languished. The two exchanges’ combined monthly volumes averaged just Ps3 billion ($115 million) in 1991, compared with Ps55 billion on the PSE in 1996.

To make matters worse, high-profile battles between former commissioner of the Securities & Exchange Commission Rosario Lopez and the largest brokers bogged down reform. Lopez gracefully retired in August 1995, to be replaced by Perfecto Yasay, who has spent much of his career at the SEC. But it is the advent of the PSE that may have finally put the casino image of the Philippines to rest.

Situated in Exchange Square on the corner of busy Ayala Avenue and Paseo de Rojas, the new PSE has 177 operational members, a computerized trading system and electronic surveillance. Its credibility has strengthened over the past 18 months. “The byword now is quality,” says Nañagas. “We want to be the capital highway of the Philippines, providing expansion and opportunity.”

Apart from the merger, there have been several other reforms. PSE by-laws were changed last October to allow two additional non-broker members to be appointed to the board. And in December the PSE was granted self-regulatory organization (SRO) status by president Fidel Ramos, a step that signals its growing maturity and credibility and should go some way towards placing it on a par with those in neighbouring countries such as Indonesia, Singapore and Thailand.

The PSE will now be able to supervise and police its own members and conduct its own investigations into alleged wrongdoings, a role previously undertaken by the SEC. “I welcome our new SRO status,” says Nañagas. “It has confirmed that we are moving in the right direction.”

Following the granting of a conditional licence for the Philippine Clearing and Central Depository System, the PSE expects half of all issues to be scripless by June, with the rest to be added by the end of this year. “Over the past two years there have been major successes,” says Jose Mario Cuyegkeng, research director at ING Baring Securities in Manila. “We now have professional management operating the stock exchange. The PSE has done a lot of work in trying to correct abuses. There is a good working relationship between the SEC and the PSE.”

This partly explains why foreign brokers have been so eager to set up in the Philippines in recent years. In the late 1980s, James Capel, Sun Hung Kai and Asia Equity were the only major foreign brokers active in the market. They were joined in the early 1990s by Peregrine and Baring Securities and since then BZW, WI Carr and other players have arrived, lifting the number of foreign broker members and joint ventures to more than 35.

Ten of these now rank among the most active members on the PSE with total foreign turnover put as high as half of daily trading volumes. A seat on the stock exchange cost Ps5,000 in the 1960s. Now it averages around Ps90 million, making membership among the most expensive in the region.

The staggering increase in active members has been matched by the increase in market capitalization which rose from $15.6 billion to $56.8 billion between December 1992 and December 1994. It had topped $75 billion by the end of 1996. Meanwhile, the number of listed companies has also increased from 169 in 1992 to 219 in December 1996, as a spate of state-owned and family-owned companies came to the market.

Some IPOs have been very successful. C&P Homes, the Philippines’ biggest low-cost housing developer, launched a Ps7.1-billion offering in July 1995. The offering, which was lead managed by ING Barings and PCI Capital, was the largest issue in the Philippines in 1995 and was oversubscribed 14 times. When trading began the issue price of Ps12.70 rose to Ps17, although it has since fallen back to Ps14.

Other favourably received issues over the past 18 months include a Ps3.4-billion initial public offering (IPO) for construction company DMCI Holdings and a Ps5.4-billion IPO for property developer Empire East Land Holdings.

Big US houses such as Merrill Lynch, Goldman Sachs, Salomon Brothers and Morgan Stanley are swooping on a market they consider offers some of the brightest prospects in Asia. Merrill was recently appointed as an adviser to state-run National Power Corp for its upcoming privatization. Salomon Brothers and Goldman Sachs are also becoming increasingly active in convertible bond issuance. “This place is like a pot of honey and the queen bees are circling,” says a banker. “Everyone is looking to get in on the act.”

Not all IPOs have been successful, however. In August, Central Azucarera Don Pedro, a big integrated sugar refiner, came to the market with a Ps1-billion issue. But the shares fell from the IPO price of Ps5.85 to Ps3.6. Three months later, the Ps3.8-billion IPO by Digital Telecommunications flopped, with the shares falling from an issue price of Ps3 to a low of Ps2. “There was general scepticism on the forecasts provided by the company,” claims one observer. “They were too aggressive.”

Despite the poor reception of these IPOs, which was partly a result of tougher market conditions, the consensus is that demand for new issues will remain strong so long as pricing is fair.

One factor that should continue to underpin the growth of the Philippine market is that it is rising at a time when many others in the region look to have peaked. Thailand’s SET Index has fallen 40% since reaching a peak in January 1994 because of political worries and fears about a rising deficit and falling profits. Indonesia is also well below its all-time high.

New issues could also offer opportunities. The biggest companies slated to come to market include Equitable Bank and Smart Communications, a fast-growing telecoms company. The list of potential issuers could be further increased by an amendment to PSE rules that would allow approved infrastructure companies to list their shares without the present requirement for three years of audited accounts.

Privatization may add even greater depth to the market. National Power Corporation and Metropolitan Waterworks & Sewerage System are both expected to have their shares listed in the next 12-18 months. Philippine Associated Smelting Corp, Philippine National Oil Corporation and Nonoc Nickel could be partly floated at a later date.

“The new privatization of water utilities could be as dramatic as it was with power,” says Bernado Villegas, chairman of the Centre for Research and Communication. “You only need to see what has happened in Britain to see the impact it could have on the capital market.”

Amidst the optimism, there are plenty of worries. Some observers claim that brokers still have too much influence over the PSE. Others believe that the largest stocks have reached full valuations and that the market could be vulnerable to external shocks, especially from any major correction on Wall Street.

There are also fears that the property sector, which has been partly responsible for the dizzy rise of the index over the past 18 months, could be in for tougher times. According to a recent report by All Asia Securities, oversupply is expected to hit the high-rise development sector by 1998, leading to a dampening of investor confidence.

On other fronts the PSE expects brighter times. Nañagas, who spent more than 14 years at Citibank, is also expected to push for the introduction of equity futures and options. “The old president was perceived as a regulator who straightened out the first wave of changes that followed the merger,” says Jojo Gonzales, director and strategist at Jardine Fleming Exchange Capital. “The new president is perceived as a banker who may be able to move the exchange into new instruments and greater self-regulation.”

Foreign brokers remain bullish. Since early last July, when the market corrected by 370 points, the Philippine Composite Stock Index consolidated in the last quarter of 1996 at a level around 3,000 to 3,100. Now, on the back of strong corporate profits and an improving macroeconomic picture, many analysts believe it could be poised for further gains. Fund managers, who historically have underweighted the Philippines, have been swarming to Manila in recent months. What’s more, many of the same fund managers have been lowering their exposure to other markets in the region. “If the number of clients in town is an indication then big demand will continue,” says ING Barings’ Cuyegkeng.

Getting to grips with bonds

The Development Bank of the Philippines’ $175-million Eurobond issue in July 1993 was a milestone for a country that had long been absent from the international bond markets. Three years on, Filipino issuers have raised a further $4.4 billion in 40 separate Eurobond deals and the expansion seems set to continue.

“Over the next few years I expect to see a lot more interest from issuers and investors,” says Villamor Vital, vice-president and chief economist at All Asia Capital and Trust Corporation. “Foreign institutions are now familiar with names like San Miguel and Ayala Corp. They are also prepared to take Philippine debt at lower yields than corporate debt from Mexico and other emerging markets.”

Big US investment banks such as Salomon Brothers, Merrill Lynch, Lehman Brothers and Morgan Stanley are actively promoting the merits of Eurobond issues to the leading corporates in the Philippines. But they need little persuading. Many of them, including Philippine Long Distance Telephone Company (PLDT) and Ayala Corp, successfully tapped the market last year.

State-run National Power Corp (NPC) has shown the way forward. It successfully launched a $142-million dragon bond in 1995 and followed that last December with a two-tranche $360-million yankee. The latter issue, which was lead-managed by Salomon Brothers, was the largest and, with a 20-year tranche, the longest-dated offering from the Philippines.

Demand was so strong that NPC was able to raise funds well below the spread initially indicated by underwriters, while increasing the size of the deal from the original target of $200 million.

“This was uncharted territory for the Philippines,” says Vital. “It has helped create a benchmark which will improve access to the US market for other issuers as well as diversifying the investor base.”

But many of the international deals have not been straights. In June 1995, Jardine Fleming led a $100-million five-year Euroconvertible for Ayala International Finance ­ the first deal of its kind for a Filipino company. The bonds are convertible into Ayala Corporation B shares. There has been a spate of similar issues for corporates including Bacnotan Cement, Filinvest Corp, JG Summit, Metro Bank, Metro Pacific as well as PLDT.

Last June ING Barings and Deutsche Morgan Grenfell lead-managed one of the biggest offerings, a $200-million convertible issue for Pilipino Telephone Corporation, the country’s leading cellular telecommunications company. The issue, which carried a conversion premium of 15% with a yield to put of 75 basis points over treasuries, was widely regarded as the most aggressive offering to date. Even so, it was oversubscribed and widely distributed.

“Philippine companies are becoming more sophisticated about raising funds,” says Ricardo Tan, assistant vice-president at PLDT, which is one of the most frequent bond issuers. “There are now floating-rate notes and convertibles, and the appetite for long-dated issues is increasing.”

When PLDT tapped the bond market for the first time with a $250-million issue in 1994, almost all the bonds were placed with US institutions. But its latest deal, a $300-million offering comprising two tranches maturing in seven years and 10 years, also attracted significant demand from institutions in Europe and Asia reflecting the rising confidence that the Philippines will be given a credit-rating upgrade.

Analysts hope that the country’s fledgling domestic bond market will also take off. The Philippines already has a credit rating agency of its own, called Credit Information Bureau, which may link up with an international agency. Until recently, the local bond market was largely limited to short-term commercial paper with maturities of less than one year. But issuance of long-term debt with maturities of three to five years is also increasing. By the end of June 1996, outstandings of long-term paper had risen to Ps44.9 billion ($1.7 billion) compared with just Ps12.3 billion in the commercial paper market.

Under an ambitious plan drawn up by a committee of the Capital Market Development Council, an industry body, the foundations are being laid for a fully-fledged secondary bond market. This market, scheduled to open in October, would boost liquidity and open up a new source of long-term funding for corporates. “It could offer a lot of potential,” says Roman Azanza, director of Crosby Capital Markets and chairman of the Capital Market Development Council. “Philippine issuers now have only two real choices: equity or short-term paper.”

When it does take off, the market could have major repercussions for the entire economy. Lower intermediation costs could increase profitability for issuers. By offering an alternative to bank borrowings, bonds could also lead to a further reduction in the cost of loans. Most important of all, a viable domestic bond market could provide the long-term funds necessary to finance a new generation of infrastructure projects.