Amando M Tetangco, Jr: Prospects and challenges in 2010 - the bond
market in the context of the Philippine economy?
Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines
(Bangko Sentral ng Pilipinas), at the Bloomberg Conference "Gearing for 2010. Ensuring
Profitability. Containing Risk", Makati, 4 November 2009.
* * *
A few days ago, I had the occasion to speak before an international body of Asian bankers.
There, I shared my views about the future of the regional banking market and specifically
raised product and policy issues that confront Asia today. These are the concerns that arise
if we are to move forward as a banking hub underpinned by the region's vast economic
potential.
I join you this afternoon to focus in particular on the Philippine situation. Instead of providing
you with the usual parameters that come with a macro prognosis, allow me instead to
discuss the bond market in the context of our broad macro-financial situation. This would be
our natural recourse given the inherent relationship between interest rates and fixed-income
valuation on one hand and between economic activity and capital-raising on the other.
When structure translates into operations
To talk about the Philippine bond market necessarily means talking about the Philippine
government securities (GS) market. In addition, it is probably not much of an exaggeration to
argue that the local bond market is inherently linked to fiscal policy. Over the last 5 decades,
the national government has found itself in a budget deficit position, with the exception of 5
fiscal years. The NG funds the deficit principally by the issuance of domestic GS. Of course,
as the country's macroeconomic fundamentals improved, the NG has also been able to tap
the international capital market for portion of the budgetary requirement.
Nevertheless, domestic funding remains the primary funding source to a ratio of more than
two-thirds of total borrowing mix. Relative to the size of the economy, outstanding GS
accounted for about one-third of nominal GDP as of end 2008.
This basic structure translates into a challenging operating framework. To be sure, the
national government has every interest to bring down its cost of borrowing. Yet in the same
token, it is also the most active borrower in the market.
One added feature that can readily be seen from the data of the BTr is that GS issues thru
ADAPS have been predominantly in the form of Treasury Bills, accounting for 58% on
average since 2000. This significant amount of short-term debt invariably puts pressure on
managing liquidity and fiscal authorities have to fund frequently maturing obligations.
The shorter-term debt profile also helps explain lower trading activity. As of June 2009,
calculations by the ADB show a turnover ratio of 0.37 which literally means a recorded trade
value of only 37 centavos per peso of outstanding government security.
At the other end of the tenor profile, many institutional participants choose to immunize their
long-term obligations with long-term assets. Even those who may not have such long-dated
obligations often prefer to hold Treasury Bonds to term because of the steady stream of
coupons over the long-term. The net effect of both of these is that our long-term treasury
issues tend to be rather illiquid. One can readily check that the long-end of the PDST-R2
series is often the "best bid" of benchmark bonds rather than actual done deals.
The irony then is that sheer volume has really not nurtured a liquid GS market. Asset price
liquidity can be problematic to establish for certain issues. For some tenor buckets and
specific issues, funding liquidity may also be a concern from time to time. The point has been
raised that the market dominance of GS may in fact be absorbing funding liquidity away from
other market instruments, curtailing the development of the latter product lines.
Market development and policy
Moving forward then, the clear mantra is to jump-start and nurture liquidity in GS. The recent
launch of the trading platforms for repos and Securities Lending Transactions (SLT)
separately should go a long way in institutionalizing organized secondary markets. The case
of the inter-professional repo platform, for example, gives us high hopes of what lies ahead.
From an outstanding amount of Php5.4 Billion as of year-end 2008, it is now at Php36.3
billion as of October this year.
What we would like to encourage is for trading activity and turnover to increase without
mandating holders of long-term issues to liquidate their positions. This is of course possible
only if the various tenors maintain sufficient depth while generating credible and transparent
market prices. In this way, we provide investors with the level of comfort that they can exit
their positions in an orderly manner without having to absorb significant distortions in
valuation.
This basic approach provides an essential ingredient, that of credible prices where trades
can and do occur. The BSP had previously issued in 2006 guidelines on what we deem to be
acceptable benchmark prices. What we would like to see is more depth and more activity
across the benchmark tenors precisely to assure investors that market prices reflect
consummation of demand and supply pressures. This is the only yield curve that would
eventually matter.
We understand that international accounting standards rely on "bid" rates to establish fixed
income benchmark rates. In a liquid market, there would be no debate that buy-side rates
would be sufficient since this would generally reflect the short-side that defines equilibrium.
However, if we are starting from a fragmented market where both funding and asset price
liquidity are not uniformly established, it is less clear that "done" rates are of less reference
value than "bid" rates.
The yield curve is essential for policy because it allows us to eventually price corporate
issues. Since GS would still enjoy the least of credit risk, the prices that come out of this
market reflect the market's premium for time. In other words, it is the pure premium for
waiting. With that on hand, corporate issues can be priced then for their tenor and credit
quality. The transparency of this dichotomy makes the market more efficient for investors
who can now choose the combination they are prepared to absorb as an investment risk.
To this end, the BSP is quite pleased to see the debt issues being listed at the fixed income
exchange. These are not only straight bonds but more recently includes two bank issues of
unsecured subordinated debt. As I have remarked at a previous occasion, the listing of these
corporate issues reflect the willingness of the issuer to be eventually judged by the market on
the market's terms. The fact that the last two listings are bank issues gives the BSP added
pleasure because this is aligned with our stated objective of broadening the ownership base
of banks while enhancing the capital market with newer instruments.
The bond market and the needs of the Philippine economy
Of course, a deep and liquid bond market that generates credible pricing has always been
the plan. The real question then is what else needs to be done to put the bond market within
the specific context of the Philippine economy.
I already mentioned the valuable contribution that the repo and SLT platforms can provide.
These are a good start because these platforms can unlock trapped liquidity in the long-term
issues for which we expect to improve on both liquidity and market turnover.
Beyond trading venues however, four initiatives come to mind.
First, it may be useful to revisit the issue of having 11 benchmark tenor buckets. It should be
evident by now that having so many benchmark tenors does not necessarily improve the
ability of the market to price off-the-run issues. Stated differently, the major economies
typically have 4-6 benchmark tenor buckets only and this has not weighed against liquidity
and the pricing of off-the-run issues. Recent initiatives to exchange short-for-long-term issues
help to consolidate depth but a significant potential remains untapped.
Second, the bond market can be a more active vehicle for raising long-term capital. The fact
that the GS market is as big as a third of GDP is itself not a binding constraint. Economies
such as Hong Kong, Korea, Malaysia and Singapore all have significant corporate bond
markets that complement their respective GS market. This would be a healthy next step for
the Philippines as it broadens the financing options for corporations while reducing the
gapping pressure on bank credits.
Third, we need to recognize that the Philippines is an archipelago. The implication is that the
market needs to bridge the gap in space to provide real-time opportunities. Two credits
cannot be priced differently if all that distinguishes them is location. Unless there is economic
value to location, any such difference is simply arbitrage. Worse, the same credit cannot be
priced differently as an investment opportunity in two different locations at the same time.
That is simply blatant inefficiency, if not market bias.
Fortunately, technology has moved forward to allow us to fill gaps in time and space. Some
time back, the BSP entered into a partnership with market stakeholders on the National
Settlement Highway. The NSH is the technological backbone that will allow the public to
efficiently clear and settle good funds across entities in different regions. More recently, the
FI-BIOS was launched to provide retail investors in different regions with the capability to
place investment orders on real time basis.
These are the type of technological innovations that help us address the unique situation of
the Philippines. I trust that we can maximize the use of such facilities and make further
innovations where needed.
Fourth and final initiative, the development of the bond market, whether GS alone or
inclusive of corporate issues, will not be self-sustaining unless there is a financially-aware
investing public. This is not a trivial task but the onus of providing the public with relevant
information must be shared by all stakeholders, both regulator and the regulated. The recent
passage of the PERA law together with its attendant IRR is a prime example of the type of
financial awareness campaign that must be pursued. PERA itself is encompassing given the
wide variety of products that may be offered. This can therefore be the linchpin for a
concerted campaign and eventually extended beyond PERA.
Final thoughts
Ladies and gentlemen, I have covered quite a bit of ground here this afternoon. Some may
choose to see this as an indication that there is much that is impaired with the Philippine
bond market, particularly that of the government securities. I beg to differ since I have seen
the strides that have been taken particularly in more recent times. Thus, I choose to see the
vast potential this market can offer to the Philippines as a necessary vehicle to promote
further economic development.
It would be a grave mistake however if we see the market simply as government securities.
While it is true that in the Philippines the GS market in inherently linked to our fiscal situation,
the broader development initiative cannot be held hostage by such limited concerns.
Fiscal consolidation is a continuing commitment and our collective efforts to address our
fiscal position may soon come to fruition. Between now and the point of a sustainable
national budget, the bond market needs to develop so that it moves beyond a largely
fiscalcentric tool to one that can provide opportunities for both business initiatives and the
investing public.
From the regulatory end, our commitment is to provide the enabling environment for the
broad fixed income market to thrive. That will include the prudential framework that is needed
for effective oversight and to protect the interests of the public. It will have to also include a
stable macroeconomic environment where expectations on market prices and economic
activity can be reasonably ascertained. This combination of a prudential framework and the
ability to mitigate volatilities is certainly at the heart of a thriving fixed income market.
I will submit to you this afternoon, ladies and gentlemen, that indeed we have such an
enabling macroeconomic environment before us. The outlook remains that of manageable
inflation expectations, "within-target" inflation rates for 2009 and 2010, continuing remittances
from overseas Filipinos, a surplus BOP position, market-driven peso value and interest rates
that are responsive to our market's needs. Already the current low interest rate environment
provides an interesting market backdrop for this point. Between a fixed coupon rate payable
over the long-term and bank credit that is re-priced annually, the current environment
appears to favour the former than the latter. Certainly, we have seen a number of debt issues
structured of late and I am told that a few more are in the realm of the possible.
Ladies and gentlemen, I have no doubt that the GS market can very well serve as the
catalyst for further reforms. The goal is to transform the market from a basic fiscal tool to a
broader venue that migrates savers into investors while raising capital for productive
initiatives. Instead of tapping foreign saving, entrepreneurs can very well raise funds locally
without the complications of cross-currency cross-border risks. Instead of crowding out
private saving, the GS market can act as the necessary base from which corporate credit can
be properly priced and sourced. Instead of seeing its limitations, I see what the Philippines
can do in this market and hold high hopes for its eventual success.
With that, ladies and gentlemen, I bid you all a pleasant afternoon.