CALMER WEEK ON POLITICAL FRONT PROVIDES RESPITE

UNCLAS SECTION 01 OF 03 MANILA 003370

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: CALMER WEEK ON POLITICAL FRONT PROVIDES RESPITE
FOR FINANCIAL MARKETS

REFS: A) Manila 3279, B) Manila 3326, C) Manila 2878,

D) Manila 2879, E) Manila 2881


1. (SBU) Summary: A relatively calmer week on the
political front and positive fiscal news gave currency,
stock, and bond markets some breathing space to partially
recoup lost gains. The peso traded above the 56 pesos/$1
level throughout the July 18-22 trading week, but ended
the week down slightly from the previous week's close.
In the equities market, the stock price index rose to a
four-week high and foreign buying more than offset net
foreign sales during the first half of July. After
rising over the past several weeks, the loan-benchmark 91-
day Treasury bill dipped to a 22-month low. However,
considering the Philippines' fractious political climate,
few discount the possibility of more surprises ahead.
Market players will closely watch President Arroyo's July
25 State of the Nation Address and Supreme Court action
on the suspended Expanded Value Added Tax law. End
Summary.

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91-Day Treasury Bill Rates Slide to 22-Month Low
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2. (U) Rates for 91- and 182-day papers declined during
the GRP's weekly Treasury bill auction on July 18. The
benchmark 91-day bills slid to an average rate of 5.452%,
down by 72.1 basis points week-on-week. The drop more
than made up for successive increases since mid-June 2005
and pulled down the average rate for the 91-day
instrument to its lowest level since late-September 2003.
Rates for 182-day bills also declined for the first time
since mid-June 2005, though by a more modest 10.9 basis
points to 7.431%. As of July 18, the average 182-day
Treasury bill rate was at a three-week low. The rate had
increased by 46.5 basis points from the end of May 2005
(before the audio tapes linking President Arroyo to
alleged election fraud surfaced),but was still down by
39.5 basis points from the end of December 2004.
Financial system liquidity, lessened political tension,
and encouraging first-semester fiscal results that showed
the National Government deficit (67.5 billion pesos) well
below its programmed 98.5-billion pesos ceiling and about
10% ahead of its financing program also helped ease rates
down.


3. (U) Risk premiums continued to rise, however, for the
longer-term 364-day bills because of hovering political
uncertainties. After rejecting all bids for the 364-day
paper in each of its weekly auctions since mid-June as
being "unreasonably high," the Government fully awarded
its scheduled 2 billion peso offering on July 18. The
364-day paper fetched an average rate of 8.482%, 63.1
basis points higher from when the Government last awarded
these papers on June 6. The July 18 average rate for the
364-day bills represented an 11-week high. It was 49.7
basis points higher than at the end of May 2005, but was
140.2 basis points lower than the 364-day rate during
2004's last Treasury bill auction. The average
differential between the 91-day and 364-day papers
widened to 303 basis points during the Government's July
18 auction, from the 206.5 and 209.4 basis point
differentials at the end of May 2005 and December 2004,
respectively.

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Peso Trades Above 56 pesos/$1 Throughout the Week
--------------


4. (U) Since July 14, the local currency has traded at
stronger than 56.00 pesos/$1 in the inter-bank market.
Inter-bank trades ranged from 55.25-55.98 pesos/$1 during
the July 18-22 trading week. The peso opened July 22,
the last day of the trading week, at 55.25 pesos/$1 --
the strongest intra-day rate posted since June 15 -- in
reaction to the slight appreciation of the Chinese yuan.
However, resurgent political jitters ahead of President
Arroyo's July 25 State of the Nation Address capped the
peso's recovery and the local currency ended the week at
55.89 pesos/$1, slightly weaker than the previous
Friday's 55.85 pesos/$1 close. At July 22's closing
rate, the peso was down 2.5% (1.37 peso) from the end of
May 2005; and was 0.7% (0.39 peso) stronger than at the
end of 2004.

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Investors Hunting Bargains; Foreigners Net Buyers
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5. (U) The Phisix inched up to its highest closing level
in nearly four weeks on July 21 (1,960.76) before
declining somewhat on profit taking before closing the
week at 1,954.40 on July 22. At that level, the Phisix
was up 1.3% from the end of May 2005 and up 7.2% from
yearend 2004. Foreign investors were net buyers of
Philippine stocks during four of the five trading days
this week. Net foreign purchases during the week
exceeded 1.7 billion pesos, more than offsetting net
foreign sales of 1.2 billion pesos during the first half
of July.

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Sovereign Bond Spreads
--------------


6. (U) As of July 21, sovereign bond spreads had
narrowed for medium-term Philippine bonds maturing in
2008 and 2010 but had widened somewhat for longer-term
foreign debt instruments. Spreads for Philippine bonds
maturing in 2008 and 2010 closed 156 and 320 basis
points, respectively, above comparable U.S. treasuries,
tightening from the previous week's close of 157 and 324
basis points. Spreads for the 2019 and 2025 papers
widened to 462 and 507 basis points, respectively, from
454 and 500 basis points the week before. As of July 21,
the respective spreads for the 2008, 2010, and 2019 bonds
were 47, 19, and 6 basis points narrower than at the end
of May 2005, and, for the 2025 bonds, 3 basis points
wider. Compared with end-December 2004, spreads for
these four bond maturities had tightened by 123, 80, 45,
and 13 basis points, respectively.

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Comment
--------------


7. (SBU) A sense of calm appears to have settled over
financial markets this week, but few local observers
discount the possibility of more political surprises in
the weeks ahead as the opposition works to impeach the
President and the Palace tries to establish an
independent "Truth Commission" (Ref B). Investors,
credit rating agencies, and other observers will also
closely watch President Arroyo's State of the Nation
Address on July 25 and the Supreme Court's decision on
the currently suspended implementation of the amended
Expanded Value Added Tax (EVAT) law. The EVAT
implementation will be an important test of the Arroyo
Administration's political will and its ability to
carryout economic reform and stabilize the deficit. As
Central Bank Governor Amando Tetangco underscored in
recent remarks to the business community, non-
implementation of this centerpiece tax measure would
deepen fiscal problems and significantly limit the
efficacy of monetary policy.


8. (SBU) Despite the media frenzy and oppositionists'
claims, and although the country continues to face many
important challenges (Refs C, D and E),the Philippines
does not appear to be on the brink of economic
dysfunction or financial insolvency. The main financial
and economic indicators have so far avoided immediate
danger. Managers at the Central Bank and the Finance
Department deserve at least some credit for maintaining
relative economic stability. For now, international
reserves appear adequate, the balance of payments is in
surplus (nearly $2 billion as of June),and bankers tell
us they see no sign of capital flight. The situation
nevertheless remains potentially volatile. Until the
EVAT and possible impeachment proceedings are settled,
many foreign and domestic investors will be in a wait-and-
see mode.

Mussomeli