MARKETS CAUTIOUS AS TRADING WEEK OPENS

UNCLAS SECTION 01 OF 02 MANILA 003188

SIPDIS

SENSITIVE

STATE FOR EAP/PMBS, EAP/EP, EB/IFD, EB/TPP/BTA/ANA
STATE PASS USTR FOR BWEISEL AND DKATZ
STATE PASS USAID AND OPIC
TREASURY FOR OASIA FOR AJEWELL
USDOJ FOR MCRAWFORD
USDOC FOR 4430/ITA/MAC/DBISBEE

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV RP
SUBJECT: MARKETS CAUTIOUS AS TRADING WEEK OPENS

REFS: A) Manila 3167, B) Manila 3163, C) Manila 3156,

D) Manila 3154


1. (SBU) Summary: Markets opened the trading week on
July 11 shaky on resurgent fears of protracted political
controversies and escalating concern that the political
turmoil will distract and/or paralyze President Arroyo's
ability to move her Administration's reform agenda
forward. Recent reactions suggest that markets may be
increasingly open to a transition to a constitutional
successor, if only to put an end to the political
disorder and impasse. End Summary.

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July 4-8 Trading Week Closes on Hopeful Note. . .
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2. (U) July 8 was a particularly volatile day for the
foreign exchange market following the resignation of key
members of the Administration's economic team and calls
by a number of formerly staunch political and business
group supporters for President Arroyo to resign (Refs B
and D). The local currency traded at a high of
PhP56.05/$1 and low of PhP56.44/$1, almost hitting during
morning inter-bank trades the weakest historical rate of
PhP56.45/$1 posted in the run-up to the May 2004
elections. However, the peso recovered to PhP56.10/$1 by
day's end, up 0.3% from July 7 (although down 0.4% week-
on-week).


3. (U) The stock market also opened July 8 on a jittery
note after bargain-hunting on select blue chip stocks
pushed up the benchmark Philippine Stock Price Index
(Phisix) to a four-day high of 1,847.32 on July 7. The
Phisix slid to as low as 1,813.99 in the moments
following the press conference where Arroyo's former
economic team announced its resignation on July 8, but
eventually closed stronger at 1,876.28, up for a second
consecutive trading day (Ref C).


4. (U) Secondary market spreads on Government foreign
bonds maturing over the next five years -- which narrowed
on July 6 and 7 after rising markedly on July 4 and 5 --
threatened to widen on July 8. However, like the
currency and stock markets, bond spreads for Government
medium-term debt papers eventually narrowed as the day
progressed (by 9 basis-points for bonds maturing in 2008
and 8 basis-points for bonds maturing in 2010). Spreads
for the longer-term maturities continued to rise. As of
July 8, spreads for Government bonds maturing in 2019
(513 basis points) and in 2025 (560 basis points) had
risen by 29 and 44 basis points, respectively, from the
end of June.

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. . .But Market Sentiment Changes Gears After the Weekend
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5. (SBU) Market jitters resurfaced with the opening of
the July 11-15 trading week on resurgent fears of
protracted political controversies, despite the decision
by the Catholic Bishop's Conference not to call for the
President's resignation (Ref A). A number of local
traders told econffs that investors are growing
increasingly weary of the protracted political
uncertainties.


6. (U) Fitch Ratings announced on July 11 that it had
downgraded the outlook for the Philippines' long-term
foreign and domestic currency debts from "stable" to
"negative" because of the "heightened political
uncertainty" and pending legal hearings on the
implementation of the amended Expanded Value Added Tax
(EVAT) law (the centerpiece of the GRP's fiscal reform
program). Fitch expressed serious concern whether "the
weakened leadership will commit the necessary political
capital to resolving the EVAT issue soon." The agency
warned that protracted delays in resolving the EVAT
issue, a court decision that would prevent EVAT
implementation, or continued political disorder could
trigger a downgrade in the ratings themselves. Late in
the afternoon on July 11 Manila time, Standard & Poor's
announced it also revised its ratings outlook from
"stable" to "negative," citing the same concerns. (Note:
Before this latest action, Fitch -- which last lowered
scores for Philippine sovereign bonds in June 2003 -- had
upgraded its ratings outlook from "negative" to "stable"
shortly after President Arroyo signed the amended EVAT
law on May 24. Standard & Poor's last cut credit ratings
by a notch in January 2005. End Note.)


7. (U) The Peso opened July 11 at PhP56.25/$1 and traded
in the PhP56.18-56.30/$1 range. It closed the day at
PhP56.22/$1, 0.2% weaker than July 8's PhP56.10/$1 close.
The Phisix ended July 11 at 1,852.78, weaker by 0.3%. As
of 1:30 in the afternoon Manila time, secondary-market
spreads on Government bonds maturing in 2008 and 2010 had
widened by more than 30 and 15 basis points,
respectively, more than erasing the gains of the previous
two days.

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Comment
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8. (U) Fears are escalating that the political turmoil
will paralyze the Administration's ability to move
forward with necessary but painful economic reforms.
Despite the many economic challenges still facing the
Philippines, local and foreign fund managers had given
the President credit for having helped improve economic
fundamentals, especially praising efforts to address the
public sector's chronic deficits. The actions by the
Administration in the next few days and weeks (among
others, to fill key economic positions in the Cabinet and
address legal challenges to the amended EVAT law) will be
crucial to helping calm fears of the financial and
investor community.

Mussomeli