The Philippine Stock Exchange (PSE) has started the year on the defensive. The market's main index, the PSEi, has fallen by more 25% from its October 2007 high of 3,873. The exchange has also seen a sharp upswing in net foreign selling, a sharp drop-off in daily market turnover, and a host of IPO cancelations. Equally troubling is the fact that the market has been unable to gain any momentum of its own, living day to day on the ups and downs of the international markets.
However, these somber facts should be put into perspective. Francis Lim, president and CEO of the PSE, told OBG, "We should remember that this is not a Philippine phenomenon. What we are seeing here is happening in nearly all of the Asian markets."
Lim's point is borne out by facts. Asian exchanges have suffered significantly over the past 12 months as markets have absorbed the subprime crisis, the credit crisis, and the growing likelihood of a U.S. slowdown.
Shanghai's SSE has fallen nearly 47% from its October 2007 high. Hong Kong Hang Seng fell 21% in the same period. Exchanges in Seoul, Jakarta, and Kuala Lumpur have all suffered losses of 15% or more since late 2007 or early 2008. Other indexes such as Japan's Nikkei and Taiwan's TSEC have managed to recover much of what they lost in early 2008 but are still suffering from high volatility.
Still, the PSE experience is somewhat unique, and Lim will be the first to admit it.
"Over the past several months I have been trying to compare the PSE with the Hong Kong Stock Exchange (HKEX). If you take a look at HKEX you will see that it is suffering from some of the same problems as we are, but not all. Most notably, its daily turnover has not suffered nearly as significantly as ours has," he told OBG.
This is an important distinction. Daily turnover makes or breaks markets, particularly small ones like the PSE. In a low-turnover market, investors may worry that they will not be able to turn their investments into cash when they need them. This in turn makes such investments more risky and less valuable.
This lack of liquidity along with a general feeling of risk aversion are the main explanations for the sharp increase in net foreign selling which has occurred over the past six months. The PSE has seen about P16.7bn ($384m) worth of net foreign selling since the beginning of 2008, in contrast to the P15.6bn ($371m) in net foreign buying registered in the same period last year.
Liquidity also affects other market indicators. Companies looking to list keep a firm eye on a market's liquidity to ensure that there will be ample interest in their offering. This, in part, explains why Cebu Pacific, San Miguel, and other prominent IPO's have been postponed or canceled for 2008. Pepsi-Cola Products Philippines is the only local company to brave the volatile market this year. However, despite its international name and lack of competition in the IPO market, it was forced to slash its initial share offer price.
Lim understands that solving the problem of liquidity is fundamental to the success of the PSE. He argues that that there are two main differences with the PSE and Hong Kong exchange: retail investors and a thriving derivatives market.
The first, domestic retail investors, allows the Hong Kong exchange to rely less on international markets, thus giving them a buffer against external shocks. The second, a thriving derivates market, provides retail and international investors a hedging mechanism. Without these instruments, investors have little choice but to pull out.
In both regards, Lim is optimistic for the future. The PSE has begun developing a derivatives market, but he noted that, "these things take time, the Hong Kong and the South Korea derivatives market took around eight years to develop. On this schedule we still have several years until we will have a well functioning derivatives market."
As far as the development of a retail market is concerned, the PSE may get some help from the government. The Personal Equity and Retirement Account bill, which has been passed by the senate and is currently making its way though the house, has the potential to reshape the retail landscape for the Philippine capital markets sector. The bill, which is fashioned after the US 401k law, aims to give investors incentives to put their savings into the capital markets.
Under the house version of the bill, individuals will receive a 5% deduction on their taxes for the first P100,000 ($2300) they put into the capital markets. For families, the cap is set at P200,000 ($4600). All the income from these investments will be tax exempt and employers will be able to deduct any contributions they make to the account of the employee.
There is also a special component designed specifically for Overseas Filipino Workers (OFWs). For these individuals, the cap will be doubled. In 2007 workers abroad sent back $14bn in remittances to the Philippine economy, but studies show they are sending back only 30% of their disposable income. Lim is hoping that these incentives will convince them to remit more.
If these reforms are successful, the PSE could emerge as a new and significantly more powerful exchange. Retail investors and hedging mechanisms will provide an important buffer against future external shocks.
As Lim told OBG, "a decoupling between the US and Asian economies will not happen overnight. Nor will a decoupling of the stock markets." A decoupling is certainly out of the question, but building levels to block floodwater would do much to ensure that Asian markets can weather the next economic storm that comes their way.
