Ready for an upgrade

Asian Development Bank Special Report 2018
8 min read
Steve Garton

Regulators are hoping that a package of reforms – supported by a US$300m ADB facility – will stimulate the Philippines’ capital markets and provide better access to long-term funding for local companies and infrastructure developers.

The Philippines has established itself in recent years as a favourite among global emerging-market investors. Its sovereign bonds are so popular in the US dollar market that its latest 10-year issue priced in January at 3.0%, a mere 37.8bp premium over US Treasuries.

Strong economic growth and a prudent fiscal policy have lifted the country to a solid investment-grade rating from all three major credit agencies. Fitch raised its sovereign rating to BBB in December, falling in line with Moody’s (Baa2) and S&P (BBB).

The ADB projects an acceleration in GDP growth to 6.8% in 2018 and 6.9% in 2019, up from last year’s 6.7%. The fiscal deficit shrank to 2.2% in 2017 from 2.4% a year earlier.

The local capital markets, however, do not look so advanced. Investment and capital formation is weak, the corporate bond market is shallow, and liquidity on the stock exchange is poor. The market capitalisation of the entire stock market is barely half that of Indonesia, and far less than Thailand, Malaysia or Singapore.

Outstanding local currency bonds – largely government debt – represent only 34.2% of the country’s GDP. Corporate bonds account for around 17% of all issuance, with 87% of that coming from the top 30 companies, according to ADB data. And weak money markets mean Philippines banks – and the national treasury – hold massive amounts of reserves that could be put to better use elsewhere: the government’s bond sinking fund sucks up 8% of GDP.

The current administration is taking steps to address those failings, in part to finance its increase in infrastructure spending under President Duterte’s ‘Build, Build, Build’ initiative.

The central bank, securities regulator, finance ministry and national treasury signed off on a sweeping package of reforms in August 2017 to revamp the domestic bond market. The measures are the latest under a policy-based programme agreed with the ADB in 2013, and came with a US$300m loan to support the second phase of the project.

The reforms include a plan to consolidate sales of government bonds into six liquid tenors, to lower issuance costs and produce a more efficient yield curve. Primary dealers will also be required to make markets in an effort to boost two-way trading volumes, and the repo market is to be overhauled. The central bank, in particular, has welcomed the creation of an organised interdealer repo market, which aims to boost liquidity by allowing securities lending and two-way trading of government securities, in line with global standards.

Officials hope the package will enhance liquidity in the government bond market and make the whole system more efficient. By reducing the vast pools of money currently held in reserve, the reforms aim to free up capital for real investment. In time, the improvements should filter down to the corporate bond market, supporting long-term financings and freeing up banks to lend to infrastructure.


There are other hurdles to stimulating the capital markets. Eduardo Francisco, president of BDO Capital, argues that corporate banks are the biggest obstacle.

“The Philippines bond market is small, but it’s not underdeveloped. We have all the products,” he said. “It’s the banks that are holding it back. It’s a by-product of the liquidity in the banking system.”

Local companies have little trouble accessing bank credit, and long maturities are available for the top names at low cost. That gives borrowers little incentive to make the extra effort to engage the capital markets.

The banks are lending more, too. A spate of big rights issues from the country’s top banks points to rising credit growth, the result of booming confidence in the corporate sector. Bank credit to businesses increased 18.1% in January 2018, according to ADB data.

Capital markets bankers, however, see reasons to be optimistic.

Alongside the government bond reforms, market participants hope that broader changes to the tax system will make the capital markets more competitive. President Duterte signed the first stage of the Tax Reform for Acceleration and Inclusion (Train) law in December and is working hard to push the next package through the Senate. There is some talk that withholding tax on securities will be clarified in the second bill, alongside measures to encourage savings and investment.

Things may also be looking up for the local stock market, which is already set for a record year for equity issuance in 2018.

At least eight deals are in the works for a total of over US$4bn, comprising IPOs, follow-ons and rights issues from both the corporate and financial sectors. San Miguel’s restructuring, injecting its beer and beverage assets into the former Pure Foods, is set to trigger a US$2bn–$3bn deal that would be comfortably the country’s biggest share sale on record.

That would be a big turnaround from 2017, when equity issuance totalled less than US$1.5bn, the lowest in South-East Asia’s major stock markets, and only three IPOs crossed the US$100m mark.

The stock exchange is also acquiring Philippine Dealing System Holdings, which runs the country’s main fixed-income exchange, in a move designed to improve transparency and liquidity by reducing “double collateralisation” among the brokers.

There is also talk of the first infrastructure listing, which would allow project sponsors to raise capital at an earlier stage, although the introduction of real estate investment trusts remains complicated by strict free-float requirements and tax rules.

It is no coincidence that the reforms have accelerated under Duterte. The controversial Davao strongman has made infrastructure spending a central focus of his presidency, and has both the support and the determination to push through reforms to make it happen.

“It’s all about creating an enabling environment for long-term infrastructure finance,” said one official involved in some of the reforms. “The government has money, but not that much. They need a good domestic market.”

Many of the measures were conceived in the previous administration, but it is the current one that will take the credit for their implementation.

“People have been trying to change the tax system for decades, but [Finance Secretary Carlos] Dominguez gets a lot of credit for getting it done,” said the head of one local bank.

Dominguez has been clear about the importance of developing the domestic capital market.

“The development of the domestic capital market will provide complementary local currency resources for our infrastructure programme and reduce our vulnerability to vicissitudes in the external environment,” he said in August.

The official involved in the reforms puts it more bluntly.

“The Philippines has an investment-grade rating but a basic bond market … It’s time for an upgrade.”

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Reform measures
Reform measures
The Philippines central bank, finance ministry, securities regulator and national treasury announced a package of reforms on August 25 2017 “to spur the further development of the domestic debt market to enhance the country’s economic growth and financial sector development”.
The reforms include:
-1a permanent increase in the volume of treasury bills,
-2the consolidation of government bonds into 6 liquid tenors : 2Y, 3Y, 5Y, 7Y, 10Y, and 20Y
-3the adoption of common semi-annual coupon payment dates,
-4the designation of market makers with concomitant obligations and privileges,
-5the introduction of a GMRA-based repo market,
-6the consideration of an SRO for a possible organized OTC market, and
-7regulatory reforms to support the adoption of a market based and IOSCO-compliant market pricing benchmarks.
Source: Bangko Sentral ng Pilipinas
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