JULY 27-AUGUST 5 UPDATE: PHILIPPINE FINANCIAL

UNCLAS SECTION 01 OF 03 MANILA 003657

SIPDIS

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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: JULY 27-AUGUST 5 UPDATE: PHILIPPINE FINANCIAL
MARKETS HOLDING

REFS: A) Manila 3456, B) Manila 3391, C) Manila 3458,

D) Manila 3593, E) Manila 3421, F) Manila 3061

Sensitive but Unclassified - Not for internet - Protect
accordingly.


1. (SBU) Summary: President Arroyo and her new economic
team went on a media offensive shortly after the
President's July 25 State of the Nation Address (SONA) to
assure investors, creditors and other Philippine
observers that the Administration remains focused on
managing the economy and pursuing reforms despite current
political challenges (Ref A). While political
uncertainties continue as the opposition works to impeach
the President (Refs B and C) and new witnesses emerged to
discredit her (Ref D),markets continue to hold thus far.
The peso closed at 55.91 pesos/$1 on August 5, slightly
stronger than on July 26 (Ref E). The stock price index
inched upward and foreign investors continued to purchase
Philippine stocks. Rates for Treasury bills softened and
sovereign spreads for the GRP's medium- to long-term
foreign debts continued to hold. However, anxious
markets will be looking for signs that President Arroyo
remains focused on moving reforms and the economy
forward, such as the fate of the amended Expanded Value
Added Tax law currently pending with the Supreme Court.
End Summary.

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SHARE PRICES INCH UP; FOREIGNERS ARE NET BUYERS
-------------- --


2. (U) The Philippine Stock Price Index (Phisix) rose
over the past two weeks since President Arroyo's July 25
State of the Nation Address, buoyed in part by generally
positive second-quarter corporate earnings reports. The
Phisix broke the 2,000 mark to close the July 26-29
trading week at a six-week high, before profit taking
retracted some of the gains. The Phisix closed the
August 1-5 trading week at 1,975.60, up 0.8% from July

26. As of August 5, the Phisix was up 2.4% from the end
of May 2005 (before the audio tapes linking President
Arroyo to election fraud surfaced) and up 8.4% from year-
end 2004. Net foreign purchases of Philippine stocks,
which resumed during the July 18-22 trading week (Ref E),
generally continued since the SONA. Net foreign stock
purchases totaled 1.9 billion pesos from July 18-August
5, more than offsetting 1.2 billion pesos in net foreign
sales during the first half of July.


3. (U) GRP officials maintain that political
disturbances have thus far not seriously eroded net
foreign portfolio investments (which, in addition to
stocks, includes investments in securities, money market
instruments, and deposits.) June saw net foreign
portfolio inflows (estimated at over $300 million)
despite the brewing political crisis. The first week of
July saw net foreign portfolio withdrawals (about $59
million),followed by net foreign portfolio inflows
during the second week of that month. From January 1 to
July 15, net foreign portfolio investments were estimated
at about $1.9 billion, 12.4 times the level during 2004's
comparable period.

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T-BILL RATES SOFTEN
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4. (U) Rates for Treasury bills softened somewhat across
all maturities during the GRP's weekly dealers' auction
on August 1. The average rate for the 91-day bills
dropped by 4.3 basis points to 5.589%, the lowest
recorded since mid-October 2003. The average rate for
the 181-day bills declined by 0.4 basis points to 7.397%,
a four-week low. The average rate for the 364-day bills
dropped by 2 basis points to a three-week low of 8.397%.
Although the Government's 6-billion peso offering was
more than three times oversubscribed, securities traders
commented that hovering political uncertainties prevented
bids for the longer-term T-bill maturities from declining
more markedly. As of August 1, the average 91-day
Treasury bill rate was 33.1 basis points lower than at
the end of May 2005 and 220.1 basis points lower than at
the end of 2004. The average rate for the 182-day paper
was down 43.1 and 148.0 basis points from end-May 2005
and end-December 2004, respectively. As of August 1, the
average rate for the 364-day paper had increased by 41.2
basis points from the end of May 2005 but had declined by
148.7 basis points from the end of 2004.

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PESO TRADES SIDEWAYS; BSP MAINTAINS NEUTRAL POLICY STANCE
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5. (U) The local currency, which again weakened to the
56.00 pesos/$1 mark on July 26, traded in the 56.01-
56.24/$1 range from July 27 to August 3. Regional
currencies reverted to pre-yuan revaluation levels after
strengthening briefly. Usually stronger month-end
foreign exchange requirements and seasonally strong third-
quarter import demand also exerted pressure on the peso.
The peso weakened briefly to a four-week intra-day low of
56.24 pesos/$1 on August 1 on new allegations that
President Arroyo had personally witnessed payoffs to
election officials. The peso strengthened to a 55.86-
56.00/$1 trading band on August 4-5 on more modest
corporate demand and some weakening of the US$. The peso
closed August 5 at 55.91 pesos/$1, up from July 26's
closing rate of 56.00 pesos/$1. At August 5's closing
level, the Philippine currency was down 2.5% (1.39 pesos)
from the end of May 2005 and 0.7% (0.37 pesos) stronger
than at the end of 2004.


6. (U) The Philippine Monetary Board -- the highest
policy making body of the Bangko Sentral ng Pilipinas
(BSP, the central bank) -- decided to maintain key policy
rates at current levels (i.e., 7% for overnight borrowing
and 9.25% for overnight lending) during its rate-setting
meeting on July 28. The Monetary Board has raised BSP
policy rates only once (by a quarter of a percentage
point in April 2005) despite successive increases by the
U.S. Federal Reserve Board since mid-2004. Senior
Central Bank officials told econoffs that they have not
yet seen disturbing shifts from pesos to foreign assets
despite narrowing interest rate differentials but they
continue to monitor the potentially volatile political
situation closely.

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SOVEREIGN BOND SPREADS TIGHTEN
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7. (U) Sovereign bond spreads narrowed between July 25
and August 5 for the Government's medium- and long-term
foreign bonds. Spreads for Philippine bonds maturing in
2008, 2010, 2019, and 2025 (the most actively traded in
secondary markets) closed at 141, 286, 436, and 480 basis
points, respectively, above comparable U.S. Treasuries,
tightening from the July 25 closing spreads of 152, 316,
463, and 507 basis points. As of August 4, the
respective spreads for the 2008, 2010, 2019, and 2025
bonds were 62, 53, 32, and 24 basis points narrower than
at the end of May 2005. Compared with end-December 2004,
spreads for these four bond maturities had tightened by
138, 114, 71, and 40 basis points, respectively.

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Comment
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8. (SBU) Immediate economic prospects remain stable.
For now, businessmen and investors appear to be willing
to give President Arroyo and her economic team the
benefit of the doubt that reforms will continue.
However, with more surprises likely on the political
front as the political controversies drag in the weeks
and months ahead, the business and investor communities
will be increasingly anxious for concrete signs that
President Arroyo and her Cabinet have not lost their
focus on reforms and on the economy. Many continue to
cite the fate of the amended Expanded Value Added Tax
(EVAT) law as the major litmus test of whether the GRP
will be able to continue painful but necessary economic
reforms. The Supreme Court, which issued a Temporary
Restraining Order (TRO) on the implementation of the
amended EVAT law on July 1 (Ref F),is expected to issue
a decision before the end of August. Several senior GRP
officials told econoffs they are confident that the
Supreme Court will rule in the Government's favor and
allow the EVAT law to go through, but private sector
observers are less optimistic.

Johnson