MANILA, October 24, 2005
 (STAR) PHILEQUITY CORNER By Ignacio B. Gimenez - Despite all the political noise and the attacks against President Arroyo, the peso remains one of the strongest currencies in Asia and the world. The peso rallied strongly against the US dollar last week to close at 55.43 — making it the best performing currency in Asia year-to-date (with the exception of the renminbi whose peg to the dollar was removed last July). The major reasons for the peso strength are the following:

1) Supreme Court’s final decision to uphold the EVAT,

2) The strong capital accounts surplus,

3) The announcement by the Department of Finance of a balanced budget by 2008,

4) BSP increasing overnight rates, which is in tandem with the Fed rate increases.

Note that most major currencies like the euro and the yen are down more than 11 percent against the US dollar.

The rate hike last Thursday supported the strengthening of the peso and quelled threats of possible portfolio outflows due to the narrowing interest rate spread with US treasuries. This is also a preemptive move on the part of the BSP in response to higher global inflationary expectations (due to high oil prices) and price pressures that may arise from the implementation of EVAT.

Although the timing of the recent rate increase came as a surprise to most, we believe that it is appropriate given the US Fed’s stance of monetary tightening. Other countries such as Thailand, Indonesia, South Korea and Canada have made similar moves in a bid to keep inflation on target and their currencies stable.

Even European Central Bank (ECB) chief economist Otmar Issing recently commented that central banks have to be "extremely vigilant" against inflation sparked speculation. This is a clear signal that the ECB may soon raise its policy rates which have been kept steady at two percent for over two years now.

In our view, the objective of a tamer inflation and a more stable peso will more than compensate businesses for the effects of the modest increase in interest rates. Besides, the BSP has been very accommodative in their monetary policy. Real interest rates (interest rates adjusted for inflation) have been hovering in negative territory for more than a year now.

The strong balance of payments and capital accounts is another major reason for the peso appreciation. The countries balance of payments position amounted to $2.73 billion for the first nine months of 2005 compared to a deficit of $176 million a year earlier.

Remittances from our OFWs are up 28 percent to $7 billion in the period January to August. In August alone, remittances reached $954 million — the highest ever recorded for a single month.

Meanwhile, portfolio inflows in equities and bonds have supported the turnaround of the capital accounts. Net portfolio investments surged to $2.02 billion for January to September 2005 compared to $191.7 million last year. This is clearly a stamp of approval on the country’s fiscal reforms. Without the reforms, the exchange rate could have gone beyond P58/$1 by now solely on the strength of the US dollar against the global currency basket.

The strongest inflows came in during the first four months of the year with March posting the biggest with $562 million. However, the delay of the passage of the EVAT and afterwards the delay in its implementation have shrunk net portfolio investments in subsequent months. In June, only $31.6 million flowed in due to the TRO on VAT. We expect this to pick up again once the EVAT is implemented in November and reinvigorates the country’s fiscal reform program.

Talking about fiscal reforms, the Department of Finance is doing a good job in its bid to balance the budget by 2008. For the period of January to September 2005, the budget deficit amounted to P108.5 billion, down 24 percent year-on-year and well ahead target. Revenue collections improved by 14 percent while expenditures remained prudent with only a 6 percent for the same period.

Another important measure worth noting is the primary fiscal surplus (computed by removing interest payments from the fiscal balance). This measures the ability of the government to pay off the principal of its loans. The January to September primary surplus stood at P126.8 billion, up 122 percent year-on-year and well ahead of government’s target of P96.7 billion.

Note that the benefits from the EVAT have yet to kick in. Meanwhile, the increase in excise taxes (on cigarettes and liquor) which took effect in January 2005 has not yet been fully captured since most manufacturers have front-loaded their inventories during the prior year.

There is also overall improvement in the consolidated public sector deficit which declined by 55.8 percent to P41.6 billion in 1H05. This is attributed to the P1/kwh Napocor increase and the 121 percent increase in surplus of the state-owned pension funds. With the expected implementation of the EVAT in November, we expect this improving trend in the CPSD to continue in 2H05 and into 2006.

We would like to thank the Supreme Court for its enlightened decision in upholding the EVAT law. As we have always said, we are one with the investment community, the credit rating agencies and multilaterals such as the World Bank and IMF in supporting immediate and full implementation of EVAT.

Oil Prices Have Dropped

The price of oil dropped below $60/barrel level last week. The peso appreciated also last week. The drop in the price of oil and the improvement in the peso should mitigate any inflationary effects of the EVAT. These developments all the more reinforces the stand of Finance government that the EVAT should be implemented soon.

The government continues to get criticisms from different sectors. However, the peso remains strong, Philippine bonds are resilient and the capital accounts positive. Either the government is doing right or the fund managers are wrong. But fund managers are usually astute investors and have the talent of looking at the overall picture. Perhaps, the Filipino or the common "tao" and many in the media are looking at the trees and not the forest.

Many Filipinos tend to undermine themselves or sell their own country short. As it is, the investment community is looking positively at the Philippines, and they are encouraged by our economic numbers.

It is clear that we are on the path towards fiscal recovery. While a balanced budget is a long way to go, what’s important is that we have turned around and the trend towards improving our fiscal position continues. As for investors, they should be looking at investing in Philippine assets (the peso, ROPs, equities) now that we are on the path towards a balanced budget by 2008… not when everything is rosy by 2009. Despite all the negativism, we are bullish on Philippine assets in the long term.

Chief News Editor: Sol Jose Vanzi

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