P-Noy, peso power

THE SUCCESSFUL sale last week of the government’s $1 billion Peso Global Bonds was a vote of confidence for President Aquino’s administration, especially considering that it was undertaken less than three months after it assumed power, still a short time to evaluate a regime’s capabilities.

As the bonds were denominated in pesos, it is also an assessment by the global financial community—for the first time in our post-war history—on the steadiness, and even strengthening of the peso’s value. This is due both to overseas workers’ remittances and, as expounded here, to our nation’s decision to adhere to constitutional processes, despite the very serious challenges against these in the past several years.

The bond’s tax-free feature certainly helped: the exemption from the 20-percent withholding tax on interest income usually imposed on such financial instruments. “The Republic will make all payments of principal and interest in respect of the global bonds free and clear of, and without withholding or deducting, any present or future taxes of any nature imposed by or within the Republic, unless required by law,” according to its prospectus.

Even that categorical statement on the bond’s tax-free feature actually had not convinced fund managers enough. The worry was that some “troublemaker” will file a suit in court and get a ruling requiring payment of the tax. So at the last minute of the bonds’ sale, another assurance was put: “(In the event that the tax exemption is ruled illegal), the Republic will pay additional amounts so that the holders of the global bonds receive the amounts that would have been received by them had no withholding or deduction been required.” It is as if the finance secretary told the fund managers: “If a court rules that the tax should be paid, government itself will pay the tax.” That was the big sweetener for the issue.

“The bond’s tax advantage is a big issue,” according to a Bloomberg report. “Investors had been primarily lured by the asset’s tax-exempt feature and generally optimistic expectations for the Philippine peso,” according to the New York-based consultancy firm Global Source Partners.

However, the basic reason the bond issue was successful is the peso’s strength in the past three years and the calculation by the global financial community that it will continue appreciating.

While the bonds are denominated in pesos, these were bought and will be redeemed in US dollars. So if you bought $1 million of these bonds, you’ll be holding an IOU note for P44 million, computed at the exchange rate of $1:P44, set at the bonds’ launch last week, which is the peso’s current value.

If you get paid on this IOU two years from now, and the peso strengthens to a rate, say, of $1:P40, the dollars you will get for its face value will not be $1 million, but $1.1 million, or $100,000 more. Add the interest, which at 5 percent per year, for the two years which is $110,000—tax free—and you’d therefore be earning $210,000 on the $1 million you lent to the Philippine government. While the bond’s return on face value therefore is 5 percent, it will be 10.5 percent, a windfall rate for an essentially risk-less exposure. That is, if the peso strengthens to $1:$40.

Conversely, if the peso depreciates in the next two years, say to $1:P55 (the 2005 rate), you will be getting back only $800,000 for the $1 million worth of peso bonds. Add the interest earned of $80,000 (dollar value at $1:P55 rate of P4.4 million) in the two years, and you’ll get back only $880,000—or a $120,000-loss.

The fact that fund managers from all over the world rushed to buy the bonds is the global financial community’s calculation that the peso will strengthen. This was a preposterous idea several years ago. Given the peso’s weakening in the past five decades, from P2:$1 in 1960, it even seemed that it was some kind of law of gravity in economics that down was the only way for the peso to go. In 2002, a taipan, who should know what he’s saying and who’s not usually given to making exaggerated claims, even predicted that the rate would be P120 to the dollar by 2008.

Two factors explain the strengthening of the peso in the past several years. First: the huge remittances of Filipinos living and working overseas. These have climbed from $1 billion annually in the 1990s to $17.3 billion last year.

But huge remittances are a necessary but not sufficient cause for the strengthening of the peso. Even if remittances were increasing by over 20 percent annually from 1995 to 2004, the peso’s international value steadily fell from P39:$1 in 1999 to a low of P56:$1 in 2004. The rate though started to strengthen from P55:$1 in 2005, to P47 in 2009, to the current P44, even moving to the P43 level the other day.

The main reason for this: stability, both political and economic which interact. Workers’ remittances are just like any capital: they always find a way to avoid risk, and nest in safe havens.

The coup attempts and other forms of movements against President Macapagal-Arroyo since 2001 (especially the Oakwood and Manila Peninsula crises) and the scenario of an Erap restoration via Fernando Poe’s presidency created an image of the Philippines in turmoil, so much so that the peso’s value plunged to its lowest in the presidential election year of 2004. While political controversies continued from 2005 to 2009, the global financial markets seemed to view these as tabloid noises, and calculated that there would be a peaceful turnover of power in 2010—which happened. For nations, stability is often all that matters.

From the Philippine Daily Inquirer