Philippine bonds, Asia's best performing debt in 2005, may gain for a fifth year as investors speculate credit ratings will rise as the budget deficit shrinks.
The nation's dollar-denominated bonds returned 19.8 percent last year, more than twice as much as debt in Indonesia and Taiwan. Investors expect tax increases will help President Gloria Arroyo's government meet its goal of ending the deficit by 2008.
A higher credit rating would help lower funding costs because about 47 percent of the Philippines debt, or US$35 billion, is denominated in foreign currencies. Moody's Investors Service, Standard & Poor's and Fitch Ratings have a negative outlook on the bonds. Fitch plans to review its assessment in the first quarter.
Investors "are already anticipating improvements," said Edwin Chungunco, who is buying Philippine dollar bonds for the US$2 billion in Asian debt he helps manage in Singapore at Legg Mason Inc. "The market, as usual, is ahead of the rating agencies."
The Philippines' 8 7/8 percent dollar bond due in March 2015 yielded 7.23 percent as of 5 p.m. in Manila according to ING Bank NV, about 3 percentage points more than the 10-year U.S. Treasury note. The yield premium narrowed 1.71 percentage points last year, the most since 1999.
Philippines Treasurer Omar Cruz said last year's shortfall will be 165 billion pesos (US$3.1 billion), 15 billion less than the government's January 2005 estimate. It will fall to 125 billion pesos this year, he said in a Dec. 23 interview in Manila. The nation hasn't had a balanced budget since 1997.
"We have to show them, the investors, rating companies, creditors, our fiscal performance and there is a commitment to the program to reduce the deficit," Cruz said. "The market will reward us, regardless of our credit rating."
The Philippines sells a larger percentage of debt to international lenders than any other Asian nation. Foreign direct investment surged more than 30-fold in the first eight months of the year, Assistant Finance Secretary Gil Beltran said in a November 30 interview in Manila.
Last year's gain in Philippine dollar bonds followed returns of 13.8 percent in 2004, 15.5 percent in 2003, and 28.1 percent in 2002, according to an index compiled by HSBC Holdings Plc.
Indonesia's US$7.4 billion of dollar bonds handed investors 8.2 percent in 2005, the second-best in Asia. China was the worst performer among the region's debt markets, with a 1.8 percent return, HSBC data show.
Philippine bonds advanced 5.5 percent in the fourth quarter after the Supreme Court on October 18 approved Arroyo's tax increases to help reduce the government's shortfall. The nation posted a record deficit of 211 billion pesos in 2002.
"The present fiscal performance has been definitely good and expenditure control has been very good," James McCormack, Fitch's head of Asian sovereign ratings in Hong Kong, said in a December 20 interview.
While Fitch will review its BB rating, changing the outlook on the Philippines before the value-added tax increase is implemented on February 1 would be "premature," he said.
Moody's, Fitch and S&P cut their outlook for Philippine debt to negative from stable after the Supreme Court on July 1 blocked the government's revenue-raising plan, which imposes a 10 percent tax on previously exempt products and services including oil and power. The government's plan will raise the tax rate to 12 percent on February 1.
Arroyo has to boost revenue to reduce the deficit and increase capital spending to get a higher rating, Agost Benard, S&P's associate director for sovereign ratings, said in a November 29 interview from Singapore.
The Philippines' deficit is among the highest in the region, according to the International Monetary Fund. At about 3.4 percent of gross domestic product last year, it's below India and Malaysia. The shortfall in Indonesia is 0.9 percent of GDP. Thailand, Singapore and South Korea are expected to post surpluses.
S&P and Moody's rate Philippine bonds the lowest since they started evaluating the nation's debt in 1993. S&P's BB- ranking is three steps below investment grade. Moody's rates the bonds one level lower at B1. Fitch's ranking is the lowest since 1999.
Thomas Byrne, a senior credit officer at Moody's in New York, didn't return calls seeking comment.
Philippine bonds outperformed other debt rated BB- by S&P. The extra yield, or spread, Brazil's 10-year bonds offer above Treasuries narrowed 1 percentage point last year and Turkey's shrank 0.47 percentage point. Brazil's 10-year bond yields 6.89 percent and Turkey's 10-year security yields 6.45 percent, according to Bloomberg data.
Philippine bond spreads will narrow in the coming months as the country's finances improve, said Pamela Colocado, who helps manage about US$1.9 billion at Bank of the Philippine Islands, the nation's second-largest lender by assets.
"We are still bullish" on government bonds, Manila-based Colocado said. "We expect an improvement at least in the country's debt rating outlook once the value-added-tax is increased."