Domestic Incentives

Although the Philippines boasts one of Asia's oldest capital markets, it still remains heavily dependent on foreign portfolio investors, a reality confirmed by last year's market activity. The Philippine Stock Exchange Index (PSEi), alongside many of the world's equity markets, lost nearly 50% last year, mostly due to foreign sell off. However, despite the challenges endured by the PSEi in 2008, the Philippines defied most analysts by posting an annual GDP growth of 4.6%.

According to a recent market study conducted by First Metro Investment Corporation (FMIC) and the University of Asia and the Pacific (UAP), the PSEi began to fall as early as October 2007, following the downward trend of the Dow Jones Industrial Average (DJI). A closer examination of the two bourses revealed that from the period of October 11, 2007 to March 26, 2009 the DJI fell 44%, while the PSEi fell a comparable 46%.

Even though the bulk of the Filipino economy is domestically oriented and rather isolated from the fallout of the global financial turmoil, last year's large-scale exodus by foreign investors was more than enough to cause a sharp drop in the PSEi.

According to Francisco Sebastian, the chairman and CEO of First Metro Investment Corporation, "Foreign portfolio investors have been huge net sellers, accounting for the sharp decline in prices we saw throughout 2008. This illustrated the dependence of the local market on foreign investors and the lack of local liquidity. Foreign selling also affected the Philippine peso, which weakened as foreign funds flowed out of the country."

He later added that, "The withdrawal of foreign positions also exposed the weaknesses of the local market in terms of size, liquidity, breadth and depth. Liquidation of foreign holdings precipitated sharp falls in prices, and subsequently a drying up in trading volumes."

Indeed, a widening and deepening of the market has been sorely needed for years – not only to hedge against foreign investors but also against company and industry specific declines.

As the first quarter of 2009 comes to a close it is not surprising to see limited activity on the PSEi given the protracted bear market has seriously damaged many an investor's appetite. The PSEi will likely post first-quarter growth of somewhere in the range of 5%, which could possibly represent the bottoming out of the bourse after an 18-month slide.

Most of the first-quarter activity on the PSEi has been dominated by the Philippine Long Distance Telephone Company's acquisition of Meralco. The $627m acquisition of a 30% share in the country's largest electricity distributor by its largest telecoms company has created a few waves in the market, however, the move has not stimulated further noteworthy market movement as yet.

According to Francis Lim, the president of the PSE, "What worries investors is our dependence on the US market. They feel anything that happens there will be felt here as well. There is some validity to this. While the Asian markets have certainly become less reliant on the US in the past several years it is still unreasonable to believe that a decoupling is going to happen overnight."

Last year's passing of the Personal Equity Retirement Account (PERA) legislation is intended to stimulate domestic investment. The legislation, which was passed on August 22, 2008, should have a significant impact on capital markets in the future as it offers a range of tax incentives and investment products. PERA is intended to generate massive amounts of liquidity and an influx of domestic investors by attracting employers, employees and perhaps most importantly overseas Filipino workers (OFWs) to the market.

Inflows of foreign capital from OFWs will certainly continue to play an integral role in 2009. Coupled with the depreciation of the peso, it is now estimated that OFW remittances have a multiplier effect of 2.5 on the Filipino economy, according to FMIC-UAP analysis. Last year remittances totalled $16.4bn or 10% of GDP, which equated to flat growth on a previously record-high year in 2007. During the first quarter of 2009 remittances have remained stable, posting flat growth, though many analysts believe this will be hard to maintain throughout the remainder of the year.

However, foreign capital inflows from exports have experienced a difficult quarter as the sector has posted an approximately 40% decrease for three months running. The sharp drop off, which resulted from huge reductions in global demand for the country's electronics and semiconductors, is not expected to recover until at least 2010, when some industry insiders are predicting single-digit growth.

The inflationary effect that was so devastating during the middle of 2008 has been offset by the drop in crude oil prices, further aiding local markets. This decrease in inflation, which the Bangko Sentral ng Pilipinas anticipates to fall to 5.9-6.8% this March, from last year's high of 9.4% in August, has enabled the central bank to cut its benchmark interbank lending rate three times over the past three months from 6% in December to 4.75% today.

Meanwhile, the country's sovereign bond market appears to be on an upswing as risk-averse investors continue to shift to safer investment products. Given the difficult year the PSEi endured in 2008 it is not surprising to find the Philippine government receiving fully tendered offers at recent treasury-bill auctions. The national government was even forced to reject all tenors during its February 9th treasury-bill auction, and two of three tenors on February 23, as it proceeds cautiously in order to control its increasing budget deficit resulting from stimulus spending.

Indeed, the consensus among industry insiders does centre on the fact that in the short term the PSEi will follow the lead set by Wall Street. The real question concerning how the government will handle the future medium- and long-term development of the country's capital markets is likely to remain subject to much discussion, at least until some form of global economic recovery takes place.