Philippine government debt and the PSE

THE government held an auction for its seven-year Treasury bonds on Tuesday. This auction, which was of average size, raised P25 billion for the government’s coffers. Actually, this bond offering was not really new, since this was only a reissue, or “roll over”, of existing debt. Government borrowing is down by 40 percent for the first 10 months of 2014 over the figure posted in the same period last year.

The bonds are paying 3.5 percent, which is down 24.2 basis points from the 3.7543-percent average interest rate paid at the government’s previous debt auction. In comparison, the Untied States government is currently paying 2.02 percent for seven years.

Coincidentally, on the same day the auction was held, the Philippine Stock Exchange Composite index (PSEi) dropped 0.65 percent. But, in truth, it is not a coincidence.

Conventional wisdom says some money will always be placed in fixed-income debt, and other money will always go to equity investments, like the stock market. In practice, however, buying debt is, more or less, guaranteed, and equity investment is risky, although it is bought with the anticipation of a return greater than the investment.

Conventional wisdom also says we need to remember that the higher the risk the debt will not be paid off, the greater the interest rate that is paid on the debt. However, the fact that the government is paying a higher interest rate than the US is not based on the potential for default. The interest rate is higher because Philippine debt is denominated in pesos, while US debt is in dollars.

Because of the massive amount of cross-border shifting of money and assets, currency fluctuations are as equally important as the creditworthiness of the debt issuer. The fact that the Philippine government pays an interest rate higher than what the US government pays shows that there is more risk of a devaluation of the peso in relation to the dollar.

The ability of a government to pay its debt is only a consideration for nations like Venezuela and Argentina, which are so far down in the economic hole that a default is a real possibility. For nations like the US and Japan, which have the ability to print money, no matter how far down the debt hole they might be, they are safer investments. The reason they’re safer is that, in the land of the blind, the one-eyed man is king.

If Japan eventually pays its debt in greatly devalued yen, at least you can use than money to buy sushi and high-rise buildings in Tokyo.

So foreign money wants a higher interest rate on its peso lending, because it fears peso devaluation against the almighty dollar, and it prefers condominiums in San Francisco than in Manila.

But what’s important to consider is that most of that P25-billion debt was bought with local, not foreign, money. This brings us to Tuesday’s government-debt auction’s connection to the PSE.

The wisdom that says some
money should be placed in debt instruments and others in equities is as outdated as the idea that depositing your excess cash in a bank is safe.

Any financial expert who tells you to “save for a rainy day” is either working for the bank or selling umbrellas on the side. Your return must always equal the inflation rate, at least. Notice that the yield on treasury bonds and the interest rate are nearly equal to the current inflation rate. Furthermore, the market value of those bonds will rise if—and as—the inflation rate falls.

While the Philippine stock market has performed well in 2014, the question for investors choosing between the PSE and government bonds is this: Over the next 90 days, on a percentage basis, will the stock market go up as much as inflation goes down?

The inflation rate dropped to 3.7 percent in November from 4.3 percent in October. The PSEi did not increase between the end of September and the end of November.

All investments and comparisons are not created equal. But these days, you put your money where you think the greatest return will come, regardless of the type of investment vehicle used.