U.S. Woes Unsettle Philippine Markets

UNCLAS SECTION 01 OF 02 MANILA 002174 STATE FOR EAP/MTS, EAP/EP/ EEB/IFD/OMA STATE PASS EXIM. OPIC, AND USTR STATE PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE TREASURY FOR OASIA SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN ECON RP SUBJECT: U.S. Woes Unsettle Philippine Markets SENSITIVE BUT UNCLASSIFIED: NOT FOR INTERNET DISTRIBUTION ¶1. (SBU) Summary: Uncertainties in the U.S. financial system drove down the Philippine stock market by more than 11% on September 15-18 and the peso down to a sixteen-month low. The Philippine Central Bank remains confident that local commercial banks' exposure to Lehman Brothers will not pose systemic risk and state-run pension funds announced they have no exposure. Although the stock market and peso recovered somewhat on September 17 following news of the AIG rescue package, resurgent fears of more troubles in the U.S. financial more than wiped out those gains on September 18. AIG's 60-year old local subsidiary is the largest company in the Philippine insurance industry. The mood of the Philippine financial markets is anxiety but not panic. Record-high foreign exchange reserves will give monetary authorities leeway to discourage speculation and excessive foreign exchange volatility. The Philippine government's economic team vowed to continue with reforms to improve competitiveness and the economy's resilience to shocks, including support for liberalizing constitutional limitations on foreign investments should charter change initiatives prosper. End Summary. Stock Market Tumbles, Peso Slips -------------- ¶2. (U) Resurgent uncertainties following recent news on Lehman, Merrill Lynch, and AIG drove down the Philippine Stock Exchange index (PSEi) by 4.1% on September 15 (Monday) and by another 4.5% on September 16 (Tuesday). The peso -- already affected by slower export growth and high fuel and food prices -- also came under additional pressure. It closed 0.5% weaker to the US$ on September 15 and slipped by another 0.2% on September 16, breaching the 47 pesos/$ mark and closing at a 16-month low. ¶3. (U) News of AIG's rescue package provided a modest, temporary respite on September 17, but the stock market quickly reversed by 4.3% on September 18 -- taking its cue from the plunge on Wall Street. As of noon on September 18, the peso was trading 0.4% weaker from September 17's closing rate. The Central Bank has reportedly intervened in the interbank foreign exchange market in recent days to calm jitters and curb foreign exchange volatility, preventing a more pronounced drop. At current levels, the PSEi and the peso have weakened by 11.1% and 0.9%, respectively, over the past four trading days; and by 35.0% and 14.5%, respectively, since the beginning of the year. Banking System Exposure to Lehman Instruments Manageable -------------- -------------- ¶4. (SBU) A senior Central Bank official told econoffs that six commercial banks reported a combined $375 million exposure to Lehman Brothers (mainly investments in collateralized debt obligations and credit link notes). That amount includes a $51 million loan exposure by one of the banks to a Philippine-based Lehman subsidiary operating as a special purpose asset vehicle. Analysts here estimate that the banks would be able recover only 30% of the value of their exposure to Lehman's investment products. ¶5. (U) The Central Bank official expects the banks' exposure to Lehman to translate to thinner profit margins and to affect capital-to-risk asset ratios. The Central Bank nevertheless expects capital adequacy to remain above the 8% international benchmark and above the 10% Central Bank-stipulated floor. The official stressed that the exposed banks -- which rank among the largest in the industry -- are well capitalized and are moving to increase provisions for probable losses in line with prudential regulations. The aggregate exposure to Lehman Brothers represents a modest 0.3%-0.4% of total commercial banking system assets. Although the Central Bank stands ready to provide liquidity as needed, the affected banks are currently not experiencing massive deposit withdrawals nor do they expect to require emergency assistance. ¶6. (SBU) Although less a concern for now because of the reported takeover by Bank of America, the Central Bank estimated commercial banks' exposure to Merrill Lynch investments at about $460 million (equivalent to roughly 0.5% of commercial banking system assets). Central Bank officials also expressed confidence that as long as fears do not lead to panic, this additional exposure will not pose a systemic risk. Impact of U.S. Woes on Insurance Sector on Watch -------------- --- MANILA 00002174 002.2 OF 002 ¶7. (U) In response to a recent disclosure by Toronto-based Sun Life Financial Inc.'s $350 million exposure to Lehman bond securities globally, local subsidiary Sun Life Philippines issued a statement that the local unit has no exposure to Lehman's products and that the bulk of its life, pre-need and mutual fund assets are invested locally. Local company officials also stressed that the Sun Life group overall remains financially sound and that the global exposure to Lehman represents less than 0.4% of invested assets. Sun Life Financial Philippines currently services more than a million clients and is the second largest player in the Philippine insurance market with about $1.4 billion in assets (equivalent to more than 18% of the life insurance industry's total resources). ¶8. (U) Market observers and government regulators also are closely watching developments on the AIG front, principally because the company has a 60 year-old local subsidiary in the Philippines (Philippine American Life or Philamlife) -- the largest, and considered an institution, in the country with over 100 billion pesos ($2.2 billion) in assets representing more than 30% of the life insurance industry's resources. Philamlife officials have stated that AIG's troubles will not affect local operations, which are separate and adequately capitalized under Philippine laws. The local unit's funds are also separately invested from the parent company's and concentrated in marketable Philippine government securities, corporate bonds, and blue chip equities. State-Run Pension Funds Not Exposed -------------- ¶9. (U) Officials from the Government Service Insurance System (GSIS) -- the pension fund for public sector employees -- have stated that GSIS has no exposure to Lehman under its Global Investment Program and that most of its overseas portfolio investments are in the European market. According to officials from the Social Security System -- the state-managed pension fund for private sector employees - the System has no exposure to Lehman's investment products or to any investments overseas. Anxious Markets Looking to U.S. -------------- ¶10. (U) Overall, external shocks this year have resulted in net outflows of portfolio capital but the balance of payments continues to be in surplus ($2 billion currently),helped by strong remittances from overseas Filipino workers -- which are up by more than 18% thus far and expected to breach the $16 billion mark by yearend (equivalent to about 11% of Philippine Gross Domestic Product). ¶11. (U) Gross international reserves continue to be at comfortable levels -- adequate for about six months worth of import requirements and equivalent to nearly three times the country's short-term foreign debt obligations -- providing Philippine monetary authorities leeway to discourage speculation and inject liquidity as needed. Although there may be some bargain-hunting, traders and investment analysts expect portfolio investors and fund managers to remain wary and to track policy pronouncements and developments in the U.S. in coming days -- reflecting fears that more troubles may yet appear. GRP Economic Team Vows to Continue Reforms -------------- ¶12. (U) External shocks -- including turmoil in the U.S. financial system -- have slowed economic growth and exports, pushed up inflation and local and foreign borrowing costs, and slowed foreign direct and portfolio capital flows. During the Philippine government Investor Relations Office's bi-annual economic briefing on September 17, President Arroyo and her economic team noted that the Philippines, although not spared, has been holding up respectably well due to reforms taken to strengthen the banking system, restore fiscal stability, and slow rapid debt accumulation. Economic managers vowed to continue with reforms to improve longer-term competitiveness and the economy's resilience to external and domestic shocks. They expressed support for liberalizing/relaxing investment restrictions in the Constitution should charter change initiatives prosper. Kenney