Some Questions About Philippines' Revival: William Pesek Jr.

Jan. 11 (Bloomberg) -- In a year of surprises in Asia few can compete with Philippine bonds, the region's best-performing debt market in 2005 thanks to an important display of fiscal responsibility by President Gloria Arroyo.

Dollar-denominated bonds in what's often called the ``sick man of Asia'' returned 19.8 percent last year, more than twice as much as debt in Indonesia and Taiwan. Philippine debt returned more than five times what the Standard & Poor's 500 Index did at a time when the U.S. is said to be booming.

Driving this bond rally are slowing inflation and tax increases implemented last year which are helping close a budget deficit that's among Asia's biggest.

All this is stellar news, increasing demand for the bonds of a nation that sells a larger percentage of debt internationally than any other Asian market. It's fueling expectations for higher credit ratings that may lower borrowing costs for the roughly 47 percent of Philippine debt, or $35 billion, denominated in foreign currencies.

The optimism can be seen in the nearly 6 percent rise in the Philippine peso versus the dollar in 2005 and 30-fold increase in foreign direct investment in the first eight months of last year.

Questions Remain

Question is: can the Philippines stay on the path toward economic stability? Yes, but only if officials in Manila take steps to keep it there. Trouble is: that's a big ``if.''

That Asia's 13th biggest economy is getting a second look from global investors hasn't escaped Arroyo. Last week, she expressed elation that the international press is highlighting how foreign capital is returning to an economy most avoided in recent years.

``With the rising investor confidence in the country, let us see to it that our economic reforms are sustained and translated into more jobs,'' Arroyo said last week, according to the Manila Standard. ``Let us refrain from the conflicts that will distract us from strengthening the economy.''

This comment nicely captures the tension that exists between what the Philippines needs, and what Arroyo's policy makers can deliver. A trained economist, the 58-year-old Arroyo gets it. And in a nation that often puts charisma before competence in choosing its leaders, she is an anomaly.

Arroyo's Challenge

As well intentioned as she was when she became president in January 2001, Arroyo came up against a formidable wall of resistance from lawmakers who favored the status quo. Endemic corruption stopped in their tracks efforts to collect more taxes from companies and well-off Filipinos.

Arroyo lost the moral high ground amid claims of vote rigging and allegations of her husband's and son's involvement in illegal gambling. That hobbled her ability to clean up the government and push through badly needed reforms. Massive protests calling for her ouster last year spooked markets. Luckily for Arroyo, the support of the military proved more important than public approval ratings.

What helped turn the tide, ironically, were credit-rating downgrades that sent Philippine bond yields soaring and the peso sharply lower.

Not So Crazy After All

At the time, analysts bullish on Philippine stocks -- like those at ING Bank urging investors to load up on Philippines bonds, and ones like Mark Matthews, a director at Merrill Lynch & Co. -- seemed out of their minds. But they were right. Downgrades by Moody's Investors Service and Standard & Poor's were a wake-up call to politicians to repair the economy.

Still, the most consistent quality of the Philippine economy is its ability to shock and disappoint markets. The reason is complacency. Philippine officials are very skilled at handling crises, and they've got loads of experience. They're not good at using windows of opportunity like the one that's open now to fix the economy.

Complacency takes many forms, and one involves the millions of Filipinos living overseas and sending money back home. Many developing nations rely on such remittances. For the Philippines, they're a much-needed source of foreign capital and support for consumers. One wonders if the process has already gone too far.

Just Be Careful

Policy makers like to say remittances are the secret weapon of their economy. In reality they're a weakness, and a growing one. The Philippines isn't creating enough jobs for its swelling population, driving one in 10 to seek work in places like Frankfurt, Hong Kong, Kuwait, Riyadh, Singapore, Tokyo and elsewhere. Polls show many more Filipinos would work overseas if immigration laws allowed.

Simply put, the government is failing its people, forcing them to leave. The flood of young, smart and hard-working citizens going abroad creates a brain drain with big economic implications. It also eases pressure on the government to create new jobs and raise living standards at home.

There's little doubt some good things are going on in the Philippines, and those brave enough to invest there last year were well compensated. There are some solid, well-run companies in the Philippines, where stocks rose nearly 15 percent in 2005. Yet the question, as always, is whether the good times will continue.

As long as Manila uses today's optimism to shore up its rickety economy, the future could be bright indeed. Its track record isn't great in that regard, so peso-denominated assets aren't for everyone. Yet, as last year demonstrated, it may be an even bigger mistake to ignore the Philippines in 2006.