Philippine policymakers say they can breathe life into the country’s flagging deficit reduction programme despite two years in which previous progress has been reversed.

“We should be able to hit our deficit target this year to put our long-term budget goals back on track,” Margarito Teves, Secretary of Finance for the Philippines, told Emerging Markets.

Fiscal consolidation has been a vital mainstay of government policy in recent years in order to free up money that goes on interest payments for other vital work. In 2004 government debt was equivalent to 79% of GDP and interest payments on that debt were taking 37.3% of all revenues. The budget deficit has been similarly damaging, and its ratio to GDP stood at 5.4% in 2005. The government reduced it to 0.2% by 2007 and had planned to balance the budget in 2008.

“But the onset of the global economic crisis convinced us that it was far more important to invest in stimulating our economy and providing social services for our people,” Mr Teves said. In 2009 the deficit was back at 3.9% of GDP and in March 2010 stood at a total of Ps63.9 billion. The target is now to balance it by 2013.

For Mr Teves to be right, the government will have to improve its record on tax collection, a perennial problem in the Philippines. Mr Teves said Bureau of Customs collections grew 40.5% in the first quarter and the Bureau of Internal Revenues by 12.4%. But he added: “Our revenue collection was inevitably adversely affected by the slowdown in the global economy.” He called upon the incoming Congress to pass new tax measures, such as changes to excise rates on alcohol and tobacco and a review of VAT exemptions, after this month’s general election.

The election itself is being closely watched by investors but Mr Teves tried to distance economic performance from electoral uncertainty. “The Philippine economy has time and again proven that it is much more decoupled from political developments in our country than in the past,” he said. “Political noise will be inevitable as we move closer to the elections, but… we are positioned for higher levels of growth as the global economy continues to recover.”

Amando Tetangco, governor of Bangko Sentral ng Pilipinas, said he believed the Philippines should grow “closer to the higher end” of the government’s GDP growth rate target of 2.6-3.6% for 2010. “The Philippines is in a good position to reap the benefits of the global rebound,” he said, adding it “can profit from a pick-up in external demand and an acceleration of its remittance proceeds.” He emphasized strong domestic consumption, strong prospects in BPO and tourism, and a rebound in investments.

Analysts are less sure. Barclays Capital analyst Rahul Bajoria thinks the budget shortfall will get worse, not better, and will hit 4.2% in 2010. He also expressed concern about slow progress in privatization of state assets, with PNOC Exploration’s planned sale of a stake in Malampaya natural gas project, expected to raise Ps14 billion, pushed back to at least the third quarter. “This may put additional pressure on the fiscal balance in the short term,” he said, although he did not think the situation was bad enough to trigger rating movements in the near term.

December 2009

If you had to pick one local currency bond market in the region that really stepped during the global financial crisis, it would probably be the Philippines. It’s not that the volumes raised in it are particularly great: less than a quarter as much was raised here as in Malaysia, and less too than Singapore or Thailand. But it’s the magnitude of improvement on previous years, delivered in a hopeless international environment, that stands out.

“One of the markets in the region that has developed most in my opinion is the Philippines,” says Sean Henderson at HSBC. “Historically it’s been a quite predictable, smallish-size kind of market.” But a look at issuance volumes demonstrates how it has stepped up. In 2008, according to ThomsonReuters, P86 billion was raised in peso debt; by November 19, the 2009 figure already stood more than 50% higher at P133.58 billion with several weeks of the year still to go.

Jose Pacifico Marcelo, head of investment banking at First Metro Investment Corporation, says the peso debt market has been more active this year than in any of his previous 10 at the bank. “It’s surprising, as only a year ago investment banking worldwide was thought to be in its death throes,” he says. “The local economy and financial sector has proven to be in better shape than counterparts in developed countries. As a result, the peso debt market became the haven of local borrowers and issuers who, fearful of the negative impact of the global financial crisis, advanced their funding requirements.” His own data puts total volume for the first 10 months of 2009 at P472 billion including government debt – a figure that has trebled year-on-year.

This bounty of new funding was vitally important for companies and banks in the Philippines. “Corporates’ ability to fund themselves without having to go offshore was vital in the depths of the crisis,” says Henderson. “If any one of them had had to come to the offshore high yield markets, they would have had to pay up massively.”

“So it’s done a few things,” says Henderson. “It’s kept a lot of borrowers out of G3 markets through the worst of the volatility; question marks over foreign borrowings haven’t been there; and it’s kept cost of funds lower than they might otherwise have been.”

Arguably the most significant local currency deal anywhere in southeast Asia in 2009 took place here: the P38.8 deal for San Miguel Brewery (see box). But that wasn’t all that happened. “San Miguel was an enormous benchmark for what people could get done,” says Henderson. “But on top of that you saw Robinson Land with two P5 billion issues, JG Summit – as corporate deals these were significantly larger than anything we saw in 2007-2008.”

In fact, a look at the bigger peso deals of 2009 shows a diverse roster of issuers. In the midst of the crisis, in February, Globe Telecom raised P5 billion in a deal led by BPI Capital, BDO Capital and First Metro. Then came the San Miguel Brewery landmark in March, followed by Petron, which raised P10 billion in May; Land Bank of the Philippines, which raised just under P7 in June, and then SM Investments (P10 billion) and Robinsons Land (P5 billion) the same month. Robinsons was back with another deal of the same size in August, by which time Energy Development Corp had raised P7.2 billion; since then Aboitiz Power Corp and Megaworld have raised P5 billion apiece. In short, funds have been raised for banks – including lower tier two capital – real estate, consumer goods and energy.

They’re also, mainly, household names. The brand recognition point reflects a powerful retail bid, expressed through the private banks. In fact, the investor base is quite diversified in the Philippines: banks, trust companies, insurance companies and mutual funds are all powerful. It adds up to a very liquid market for the right names. “When you look at San Miguel in Philippine pesos, that’s a deal size in local markets that’s been unheard of before now for corporate issuers,” says Jan Wipplinger at Deutsche Bank. “It shows the depth of the bid of the local investor base for local names.”

Notably, there is a strong onshore dollar bid in the Philippines too. “You saw with the SM Investment dollar deal, the largest ever corporate dollar deal, that there’s an enormous dollar bid onshore as well as a developing peso market,” says Rod Sykes at HSBC. “If you look at any Philippine dollar deal, in almost all cases there is significant onshore participation.” Wipplinger agrees. “When the Philippines launches in US dollars there is always a strong domestic bid. For SMIC and the banks there is a very tight domestic bid through international dollar curves.”

Peng-Meng Ling at Standard Chartered highlights the appetite for lower-tier bank capital in the Philippines, noting that investors show more interest in subordinated debt or preference shares than in other markets. Lower tier two sub-debt issuers have included Metrobank and RCBC since the collapse of Lehman – among the first places anywhere to reopen sub-debt issuance, he points out.

Still, things are not perfect, and in particular secondary market liquidity is weak. “Overall liquidity in the primary market is high,” says Marcelo. “For the secondary market, the only liquid issues are those by the government. For private issues, investors are primarily buy-and-hold.” He says tenor is lengthening, with retail bond issues showing some demand as long as seven years, and project financing up to 12 years. “Sophistication is still limited, as investors stick to simple products and top-tier issuers,” he says. “New products like securitization and REITs are expected to be more active in the next two years.”

Marcelo says the pipeline looks less impressive than 2009 has turned out. “With the May 2010 presidential elections, issuers will try to complete transactions by the first quarter,” he says. “The second quarter will likely be slow, and then volume will pick up by the second half.” In aggregate, he expects much lower overall peso debt volumes than in 2009, but hope springs eternal: “If the election results are credible, 2011 may be as good as this year.”

BOX: Deal profile: San Miguel Brewery.

If the Philippine debt markets proved their worth in 2009, San Miguel Brewery’s P38.8 billion (US$800 million) raising in March was the deal that did most to create that impression. “San Miguel was the standout in redefining in people’s minds what was achievable,” says Sean Henderson at HSBC, which was a bookrunner on the deal alongside Development Bank of the Philippines.

This was a fourfold increase on the previous record biggest Philippine peso bond issue, achieved in the middle of a global financial crisis, for a first-time issuer. Originally, the issuer had looked at going to offshore markets, or an onshore/offshore combination, before the global markets locked up. Rather than downsize, the deal proved there was no need to go overseas.

The deal did underline the point that brand name is vital in Philippine debt as well as equity. The prompt for the issue was San Miguel Corp’s spin-off of its brewery business, the largest brewery in the Philippines – a 95% market share – and a world-recognised beer brand.

The deal came in three tranches, a three-year at 8.25%, five years at 8.875% and 10 years at 10.5%. All priced at the tight end of guidance. Appetite came from institutional banks, pension funds, insurers and retail, with a wide range of domestic underwriters brought in order to increase to the greatest possible degree the reach of the deal. BDO Capital, BPI Capital, China Bank, First Metro Investment Corp, ING, Land Bank of the Philippines, Philippine Commercial Capital, Rizal Commercial Banking Corp, and Standard Chartered Bank, all ended up with joint underwriting credit alongside the bookrunners.

Other corporate bonds are covered in the main texts, but government issuance has been notable too. Marcelo considers the most significant deal for 2009 to be tranche 11 of the Retail Treasury Bonds, which raised P114.4 billion in September: the biggest retail bond issue for the Philippines since the government first started offering the bonds in 2001. Marcelo also highlights a project finance deal, Cebu Energy Development Corp – the first of its kind to raise all its debt requirements from the peso debt market, raising P16 billion.

When the global credit markets dried up in G3 currencies, many argued there was an opportunity for Asian local currency bond markets to prove their worth as an alternative funding source. There’s really no question which deal gave the clearest illustration of the liquidity that could be accessed outside the mainstream markets: the Ps38.8 billion (US$800 million) bond in Philippine pesos for San Miguel Brewery in March.

Led by HSBC and the Development Bank of the Philippines, this was the largest local currency debt issue in Philippine pesos by a multiple of four – in the middle of a global financial crisis. And this for a first-time issuer too. There really was little to suggest that this deal could get away. “It was originally going to be done either in the offshore market, or as an onshore/offshore combination,” says Rod Sykes, managing director and head of debt capital markets Asia Pacific at HSBC. “What makes it all the more significant was that with this deal they basically removed the need to move offshore, and that set a new benchmark in terms of size and capacity for the domestic Philippine peso market.”

The issue came about because of San Miguel Corp’s spin-off of its San Miguel Breweries business. SMB is an iconic and powerful brand. “It’s obviously a hugely popular name, the largest in the Philippines, with a 95% market share, and the largest publicly listed food, beverage and packaging company in southeast Asia,” says Sean Henderson, head of debt syndicate Asia Pacific at HSBC. It needed funds to buy brewery and land assets from parent San Miguel Corp, which in turn was a condition set by the arrival of Kirin Brewery as a majority shareholder in SMB.

Despite the issuer’s great brand appeal in the Philippines, it is worth recalling just how bad things were at the time of this deal. “At the time this was done we were in a period of intense and extreme market volatility, and for many names the cross-border markets were not really open,” says Sykes. A handful of deals were getting done, notably a bond for the Indonesian sovereign a month earlier, but at a price – Indonesia paid 11.625% on the 10-year component of that dollar deal.

Working out how the size and price was a challenge since nobody had ever sought such a large deal in the peso market before. The leads went out with guidance of 250 to 325 basis points over government benchmarks, and the tight end of that guidance despite the size, pricing at governments plus 250. There were three tranches: a three-year at 8.25%, a five-year at 8.875% and a 10-year at 10.5%. A wide range of buyers bought in: institutional banks, pension funds, and insurers, bringing a broad order book of around Ps45.6 billion. It helped that the leads had invited in every major domestic institution in the country to joint underwrite – BDO Capital, BPI Capital, China Bank, First Metro Investment Corp, ING, Land Bank of the Philippines, Philippine Commercial Capital, Rizal Commercial Banking Corp, and Standard Chartered Bank.

Also working in San Miguel’s favour was the rarity value – the first issue as San Miguel Brewery – and the fact that a good and beverage company is viewed as recession resistant. But even so, this was a remarkable response. “It’s about the domestic market having stepped up to the plate, and over delivered in terms of expectations, the depth and liquidity it provided,” says Sykes.

Since then other Philippine names, such as SM Investments Corp, have shown comfort in raising debt in the Ps10 billion range. Total volumes in pesos are just short of Ps100 billion so far in 2009, compared to just under PS79 billion for the whole of 2008.

Elsewhere, San Miguel Corp was at the time of writing close to signing a US$600 million three-year bullet loan with a dozen arrangers to refinance debts; it’s a popular credit. But it’s the bond issue that will be remembered, and its impact on the local markets will be felt for some time to come.

VIETNAM

 There was a time when Vietnam was something of a darling of the global credit markets. No more: worries about the state of its economy have sent investors elsewhere.

In the debt markets, the starkest confirmation of this change in attitude came in June when the sovereign, the Socialist Republic of Vietnam, officially ended plans for a G3 currency issue this year. Last year Barclays Capital, Citi and Deutsche Bank were mandated on a US$750 million global bond, but it had been clear for months that the deal was not going to make it across the line. Vietnam’s finance ministry has indicated that the deal will come back at some stage. But both because of the state of the global credit markets, and Vietnam’s own problems, nobody is expecting that to be any time soon.

Corporate issuance has gone the same way. Rumoured deals from Vietnam National Textile and Garment (US$500 million, through Deutsche), Vinashin Petroleum Investment and Transport (US$200 million) and PetroVietnam have come to nothing.

It’s a far cry from 2005, when a $750 million 10-year bond flew out the door, with orders of more than $4.5 billion. That bond paid a yield of just 7.125% for a new emerging market issuer.

The biggest problem has been the headlong arrival of inflation into what had otherwise been a vibrant economy, which had grown at 8.48% in 2007. Inflation figures for April were 25.2%, a 10-year high. On the back of that data, the currency has been badly hit and spreads have widened dramatically. The trade deficit is growing (although it did narrow in May on the back of a tighter monetary stance) and there are problems in the property market. Some consider the situation to be so bad that a localised version of the Asian financial crisis, with currency devaluation and a painful period of write-offs and recovery, may be on the cards; a Morgan Stanley report outlined exactly this vision in May, causing some alarm among domestic banks and fund managers. Against all this the stock exchange halved in value in the first half of the year.

The domestic bond markets don’t look much better either. In April, the government failed in a fourth consecutive domestic bond auction, with the coupon said to be as much as 100 basis points below the level investors think is fair.

Domestically at least, there are still plenty of borrowers ready to launch when things improve.  Vietnam International Commercial Bank (VIB) got a Moody’s rating, from B1 to Ba2 depending on the structure and term of the issue, in July, having gained approval to sell D3trillion of bonds this year the previous month. Techcombank has also been given approval to sell D5 trillion of bonds this year. And Sacombank has also received approval for domestic borrowing.

And, despite Vietnam’s absence from the international debt markets, domestic deals have got away even in the current environment. Vinpearl Tourism and Trading sold D1 trillion of privately placed three year and five year bonds through Bank for Investment and Development of Vietnam in May; the same month, Vincom Joint Stock Co sold D2 trillion through Vietnam Bank for Agriculture and Rural Development (Agribank).

The big question now is what happens to Vietnam’s economy. While the Morgan Stanley crisis theory remains an outlier view, there is still widespread expectation of devaluation in the currency, although the improvement of the balance of payments position in May does suggest that Vietnam has a good chance of bringing inflation under control. The State Bank of Vietnam raised its base rate by 200 basis points on June 11.

A typical strategist view is to say that things can be fixed, but that investors should still be wary. “Although in our view the authorities are moving more forcefully against inflationary pressures, and we believe we have seen the worst in terms of the deterioration in the trade deficit and rising inflation, the country is not yet out of the woods,” said Nicholas Biddy at Barclays Capital in a June study of the country’s position. He expects at least another 200 basis points of hikes in coming months. “We currently recommend investors err on the side of caution in the case of Vietnamese financial assets.” The state of bank asset quality is a particular concern, which in turn is likely to have an impact on their funding programs and use of the local and international debt markets.

KEXIM

Kexim Bank has been a stunningly active borrower in the capital markets this year. It has been everywhere, from the major currencies to Asian and Latin American local capital markets.

“Kexim is one of the savviest borrowers in the region,” says Sean Henderson, head of debt syndicate Asia-Pacific at HSBC. “They’ve proven again this year they have significant flexibility to consider almost every global market – and that is a lot more complicated than it looks.

“It requires a degree of internal sophistication in understanding a number of different market practises across documentation and execution, as well as an ability to accurately time each currency as opportunities arise.”

Kexim’s most recent adventures have been global. In May it raised a Eu750 million SEC-registered five-year bond through Citi, Deutsche Bank, Depfa, RBS and HSBC – the first euro-denominated deal from Asia in a year. It is understood to be planning a dollar deal, with the five banks to handle it (Barclays Capital, Deutsche Bank, Depfa, Merrill Lynch and Morgan Stanley) already agreed although no firm mandate has been given. Market rumour is for a US$1 billion 10-year global.

It has also issued twice in the Swiss markets, most recently with a Sfr350 million two-tranche fixed and floating rate senior bond in April, led by ABN Amro. It had already issued a five-year in January and has voiced an intention to return regularly. Kexim said at the time that the deal achieved funding around 20bp inside what it would have managed in dollars. Elsewhere, a five-year Y1billion deal went through in February via HSBC, and a seven year HK$375 million trade through Citi the same month.

It has also been active in less obvious funding markets. In April it launched a S$50 million one-year deal through HSBC, increased to S$70 million on demand. In March, it went for the ringgit markets, raising M$1 billion in five and 10-year bonds, placing to 40 local accounts. This was the first issuance by a South Korean borrower in ringgit; RHB led the deal with CIMB and OCBC as joint lead arrangers and Merrill Lynch as global financial advisor. Kexim has a M$3 billion MTN funding programme in Malaysia, so is likely to be back in that market before long.

And it’s not just in Asia that Kexim has been busy. In January it launched a Ps1.2 billion five-year floating rate bond issue in Mexican pesos through Merrill Lynch. This followed a 10-year Ps750 million global last October, again led by Merrill, which was tapped for a further Ps800 million in April this year. Earlier, the bank had taken a foray into Brazilian reals with a series of MTN deals in August 2007. It has even been active in Turkish lira.

This diversity looks set to continue, with the bank approved the right to sell up to Bt3.5 billion of local currency debentures in Thailand in the second half of this year. Once again, it will be a trend-setter: the first Korean financial institution to borrow in the baht market. Also looking ahead, Kexim has filed updates for Y200 billion of issuance between the end of June 2008 and 2010.

“It’s difficult to overstate the value of diversification in the current market,” Henderson says. “Global liquidity is shrinking, and various currencies can open at different times; often a borrower’s ability to lower cost will depend on being able to access the most appropriate market at any one time.”

He adds: “It pays not to overload one particular funding source. If you are too reliant on one market, it increases the risk you’ll eventually get backed into a corner either on a challenging market environment or investor capacity issues, and this adds up to more expensive funding.”

It hasn’t all been plain sailing, though. In April it cancelled a three and five-year Samurai issue two days before it was due to price, after failing to reach the Y50 billion the bank was hoping to achieve. Leads on the planned trade were Daiwa SMBC, Nikko Citi and Nomura. On April 23 the bank put out a statement blaming unfavourable markets, meaning it could not achieve the size or the pricing it wanted, although it is understood that there was demand for at least Y22.5 billion. There has been some conjecture in the markets that part of the problem was the fact that Kookmin Bank had launched a bigger deal, worth Y24.4 billion, just a week earlier in its inaugural Samurai issue, and that Kexim couldn’t countenance a smaller deal than its Korean contemporary. It remains to be seen whether the late pulling of the deal damages Kexim’s ability to return to Japanese investors.

This remarkable activity is to help get through a US$ 5 billion funding requirement for this year, spurred by an announcement in January that Kexim plans to lend W40 trillion this year, the largest amount since the bank’s foundation. There’s more to do, but Kexim has already got much of the hard work behind it.

ANZ

ANZ has demonstrated its strength and sophistication as a borrower consistently through the credit crunch. It says something that, despite ambitious capital raising requirements, it has almost completed its 2008 funding program already without having to pay through the nose for any of it.

So far this year ANZ has raised the equivalent of around A$32 billion. It has been active in euros, dollars, yen, Australian and New Zealand dollars, Swiss francs and Singapore dollars; increasing the period under review to the last 12 months adds several sterling deals to the mix as well.

“Since the onset of the global credit crisis our approach to funding has been to maintain an evenly balanced strategy much as we would do within normal market conditions,” says Rick Moscati, group treasurer at ANZ. “We set a strategy at the commencement of the year, we articulate that strategy to the market, and try to stick to that strategy.” That means not surprising investors with unexpected volumes. “If we say we’re going to do $25 billion of term debt issuance we don’t then do $40 billion or $15 billion. Transparency is very important for investors.”

It seems to have worked. Moscati says that since the credit crisis began, “we have had the opportunity to issue in all major global debt markets. By and large it has continued to be an issue of price.”

Perhaps the most significant was a domestic deal in April. The bank initially raised A$1.35 billion in senior five year fixed and floating rate transferable deposits, in a self-led deal; a day later it increased it by another A$150 million. Pricing, at 128 basis points over the three month bank bill swaps rate for the floaters, and an 8.5% coupon yielding 8.615% with a 128bp spread over A$ mid swaps for the fixed, was not especially cheap but did demonstrate the viability of a market that had been largely inactive for months. A month later, ANZ tapped the bonds again, bringing the total outstanding on them to A$1.75 billion.

It was a very closely watched deal. “There had not been a lot of issuance at the longer end of the domestic curve prior to this transaction,” Moscati recalls. “I think that deal gave the market some confidence: it was at the upper end of our volume expectations and it confirmed the Australian market was working well for domestic issuers.”

Another striking transaction was ANZ’s samurai debut in March. This deal raised Y135.8 billion, or US$1.3 billion, in a three-tranche issue that represented the largest ever yen-denominated bond from Australia. Daiwa SMBC, Mizuho and Nikko Citi were joint leads. “That’s been an important new market for borrowers this year,” says Moscati. “It brings with it some increased diversification, which is always attractive for us.”

This deal was actually cheaper than the Aussie dollar bonds that followed it. A Y37.1 billion three-year fixed rate note had a 1.77% coupon, making 80 basis points over Libor; A five year fixed rate deal raised Y27 billion at 2.07%, or Libor plus 95; and a Y71.7 billion five-year floating rate note was priced at 95 basis points over three-month yen Libor. The five year pricing was equivalent to around BBSW plus 110 basis points, making it 18 basis points cheaper than the Australian trades of the same tenor.

Recent months have also brought benchmarks in euros and dollars. Barclays Bank and Credit Suisse led a Eu2 billion bond for ANZ in May, followed in July by a US$2 billion raising through JP Morgan, Citigroup and Goldman Sachs. “Part of our strategy  is based around executing at least one benchmark bond transaction annually in each of our core strategic markets,” Moscati says. “Traditionally these markets have included the Australian domestic, euro and to a lesser extent the US markets. We have already initiated a strategy to expand this to include all major currencies, including yen, sterling and a greater focus on distribution into Asia.”

ANZ is likely to be quieter in the second half of the year, having already done almost all it needs to for 2008. “We’ve largely completed our 2008 funding task,” says Moscati. “To the extent we issue any larger public deals for the remaining part of this year it will be mainly about pre-funding 2009 requirements, which we expect to be similar to what we’ve done in 2008.”

THE PHILIPPINES

Some decent-sized deals are getting away in the Philippine peso bond market. There’s not much going right in the country’s stock market or economy, but at least it’s clear the local debt markets are maturing.

For example, in May Banco de Oro Universal Bank raised P10 billion, the equivalent of US$235 million, in a bond through HSBC, ING and Standard Chartered. The deal, a public offering of lower tier 2 notes, was originally planned as a Ps5 billion offer but was doubled in size after applications reached five times the initial amount. It flew out the door so fast that the public offer on the bond was ended a week early.

The coupon attracted investors – at 8.5% on the unsecured subordinated notes, it was higher than some other lower tier notes sold this year – but it was not widely priced. Instead, it reflects the growing liquidity in the peso market.

Another example came with a lower tier 2 deal for Philippine National Bank, which raised P6 billion in June in a deal led by Deutsche Bank. This deal, a 10-year non-call five subordinated bond, had drawn Ps8 billion of demand by a week before the scheduled close so, just like BDO, closed a week early. Again, the notes were priced at 8.5%. And while BDO had priced at a zero spread over the benchmark, PNB actually came inside it, pricing at 40 basis points below the Philippine Dealing System Treasury rates.

Other deals, if not quite as tightly priced, have found an enthusiastic following. Rizal Commercial Banking Corp raised Ps7 billion in February, through HSBC and ING, even after lowering its price guidance on the 10 year non-call five issue.

Seeing this, other banks are likely to follow. Metropolitan Bank & Trust is expected to launch a Ps10 billion lower tier two issue in the fourth quarter of this year; it has previously raised Ps8.5 billion in a sub debt issue through ING and Standard Chartered last October. This next one, however, may be partly in US dollars. Additionally, Allied Banking Corp has approved from Bangko Sentral Ng Pilipinas, the Philippine central bank, to go ahead with a Ps5 billion lower tier two offering, with ING understood to be mandated.

An upper tier two deal is also believed to be in the works for Philippine Export-Import Credit Agency – the first major such deal in pesos by a Philippine financial institution. (An upper tier two deal did get away last October, for GM Bank, but at Ps75 million it was not considered particularly significant.) The issue, understood to be slated for the end of the third quarter, is expected to raise up to Ps3 billion.

Aside from the banks, some other groups have been active in the market. National Food Authority raised Ps8 billion in a corporate bond in February, with AB Capital & Investment, Philippine Commercial Capital, Deutsche Bank, United Coconut Planters Bank, Multinational Investment Bancorp and SB Capital Investment lead managing it. Ayala Corp raised Ps6 billion in November, and its affiliate Ayala Land has mandated BPI Capital, HSBC and Land Bank of the Philippines to lead and underwrite a Ps4 billion five year-bond, expected to be launched in August (and, unusually, to list them on the Philippines Dealing & Exchange, as Ayala Corp has also done).

And among foreign issuers, something of a landmark was launched by European Investment Bank, the supranational, in January. It raised a Ps2 billion five-year bond with settlement in US dollars. While not especially large, the deal – led by HSBC – was seen as heralding the start of a synthetic peso market, allowing offshore investors to get exposure to the peso. The issue was mainly taken up by Asian investors but European and American buyers participated too. EIB has previously used a similar model in Indonesian rupiah.

The activity reflects greater local liquidity, a more established benchmark along the curve which makes it easier for other issuers to price off, and also favourable interest rate policy. But it’s really one of the few areas of optimism in the Philippines today. HSBC noted in a recent bond market report: “The Philippines’ unpopular Arroyo administration and the central bank will face an extremely difficult time ahead trying to strike a balance between inflation containment and sustaining economic activity.” Noting high inflation, political uncertainty, poor tax collection and potential revenue shortfalls, HSBC says: “Clearly, the sovereign credit metrics will stay under pressure and investors will be disappointed that the government will have to tap the offshore market to finance its growing budget deficit.”

It was all going so well. In the last three years the Philippines has been the poster child of emerging markets fiscal policy, turning a crippling deficit into an almost balanced budget. But having done all the hard work, it may all be derailed, thanks to the twin threats of the soaring oil price and rising food prices.

It’s worth recalling just how bad things once were in the Philippines. In 2004, government debt was equivalent to 79% of GDP, and interest payments on that debt were eating 37.3% of all revenues. That meant more than a third of all incoming money, in a poor country battling a host of challenges from El Nino to the oil price, was going straight to banks, rather than to roads or education. Fixing the situation involved a lot of pain: broadening the tax base, completely reforming the tax collection mechanisms, pushing through privatisations that had been deadlocked for years, shifting funding policy from G3 currencies to the local debt markets, and dedicating money that could have been spent on social services on bringing down the debt load instead.

But by the end of 2007 it was done: a budget deficit of just P12.4 billion, or 0.2% of GDP. And then came the food price crisis, with rice prices hitting US$750 a tonne in April, more than double the rate a year earlier. “We don’t know what will happen in the months to come… it’s going to be stressful,” says Margarito Teves, finance secretary for the Philippines. “The issue of balancing the budget is not a sacrosanct goal at this point in time. Some of these things are really beyond our control.”

That’s a sad admission. But the problem the Philippines has is that it is self-sufficient in neither of the commodities whose price has so dramatically escalated. “We are not as fortunate as other countries who have oil, and we have challenges with food,” he says. “It’s a double whammy.” At just under 90% self-sufficiency in food, it’s better placed than some; but when the tradable stocks of rice disappeared from the market earlier this year, the Philippines was hard hit, unable to buy the supplies it needs for its people.

“We have not really pushed self-sufficiency [on food] as a policy because in the past the supply of rice internationally was available,” Teves says. The gradual removal of supply from the international markets, coupled with a failure to push through a planned irrigation program and increasing input costs such as fertiliser, has made self-sufficiency more of a priority. “We need to stress food security: 88 or 90% [self-sufficiency] is still a bit risky given the situation we are faced with today.” He says in three to five years the country aims to reach 95 to 100% sufficiency.

Like many countries in the region, the Philippines faces a challenging environment for monetary policy. Central banks like Bangko Sentral ng Pilipinas must decide which is the greater of two threats: flagging growth caused by a slowing US economy; or inflation. In fact, the Philippines is one of the only countries in the region to be loosening monetary policy at a time when others in the region are tightening it or trying to keep it in balance. Teves calls the situation “a dilemma, because we have a large number of people who are still below the poverty level, and inflation is a major factor in terms of their well-being and ability to cope. At the same time, we also need to make sure we retain a higher level of growth because we need to provide jobs for people.”

The only bright spot has been the increasing strength of the peso against the dollar, which has at least partially offset the impact of the oil price, but even so, at US$120 a barrel, “it’s going to hurt us,” Teves says.”I wish it would come down lower than it is right now, but we don’t have control over it.”

It’s certainly not just the Philippines that faces this dilemma. “Food price inflation across the region is likely to press higher, reflecting not only supply shocks but also strong demand growth,” notes HSBC economist Frederic Neumann in a recent note. “Policy makers will have to address the issue head-on, as neglect will lead to second-round effects and deepen inflation.” Neumann argues that Vietnam and Indonesia are furthest behind the curve in adapting monetary policy to deal with price inflation; “Vietnam has negative real policy rates in double digits.”

All sorts of wild and wonderful ideas are coming out of Asian central banks under this pressure: a proposal from Thailand suggests an OPEC-styled rice cartel, while India’s finance minister, P Chidambaram, recently mooted banning commodity futures.

From where Teves stands, there is little option for the Philippines but to keep doing what they already were, chiefly improving efforts on tax. Teves wants tax revenues to hit 15% of GDP this year, which looks achievable from 14% now; he expects privatisation to make less of a contribution this year, though. “I’d like Congress to help us in terms of rationalising our fiscal incentives,” he adds. “Right now there is a heavy emphasis on income tax holidays. We would like incentives to be more practical and really helpful to those who are starting business, and to work on some of the red tape.”

There’s another warning light too. The Philippines benefits enormously from the millions of its people who work overseas, even (in fact especially) those who work in low-paid domestic helper jobs in Hong Kong, Singapore and the Gulf. Their remittances to families back home have in the past been a vital capital inflow, and in previous years have gone so far as to counteract rises in the oil price. Now they, too, seem to be slowing, perhaps as a consequence of the flagging US economy, where many Filipinos are based. “I hope that is just an aberration,” says Teves. “They help us.”

Asian ministers and bank governors have described some of the toughest challenges they have ever faced as they try to balance two opposing forces: threats to growth from a slowing US economy and high food and oil prices on one side; inflation on the other.

Shamshad Akhtar, governor of the State Bank of Pakistan, described today’s environment for monetary policy as “almost the most challenging task I have ever taken in my career.”

And Margarito Teves, finance secretary of the Philippines, said the food price crisis could undo much of the hard work the country has done in almost balancing its budget.

Ms Akhtar said the challenge of “striking an adequate balance between growth and inflation risks… keep central banks worried – up the whole night sometimes”, in particular the rise in oil and food prices.

“It has to be recognised the current trend in global commodity prices is not one of distortion, or a cyclical spike,” she said. “The global commodity price upswing reflects growing population stress and is likely to stabilise to a new and higher level.” On food prices, she said she hoped financial support could help rejuvenate food production, but added: “I believe it’s already late and the damage will leave some scars.”

Mr Teves said the tension between growth and inflation was “a dilemma, because we have a large number of people who are still below the poverty level, and inflation is a major factor in terms of their well-being and ability to cope. At the same time, we also need to make sure we retain a higher level of growth because we need to provide jobs for people.”

The Philippines faces what Mr Teves called “a double whammy” in that the country is not self-sufficient in food or oil. “We have not really pushed self-sufficiency [on food] as a policy because in the past the supply of rice internationally was available,” he said. The gradual removal of supply from the international markets, coupled with a failure to push through a planned irrigation program and increasing input costs such as fertiliser, has made self-sufficiency more of a priority. “We need to stress food security: 88 or 90% [self-sufficiency] is still a bit risky given the situation we are faced with today.” He said in three to five years the country aims to reach 95 to 100% sufficiency.

In the meantime, though, the country’s fiscal position will be under threat. In one of the most successful fiscal consolidation programs anywhere, the Philippines had reduced the budget deficit from over 30% of GDP four years ago to 0.2%, or P12.4 billion, in 2007. “We don’t know what will happen in the months to come… it’s going to be stressful,” he said. “The issue of balancing the budget is not a sacrosanct goal at this point in time. Some of these things are really beyond our control.”

Ms Akhtar argued that challenges in Asian economies “dispel any notion of a decoupling with the US economy. The size and scale of interaction between Asia and American brings immeasurable benefits when the going is good, but will bring a measure of misery when economies are in trouble.” She called upon Asia central banks and governments to work more closely together to mitigate risks for the future.