Cablegate: U.S. Woes Unsettle Philippine Markets

DE RUEHML #2174/01 2620927
O 180927Z SEP 08





E.O. 12958: N/A
SUBJECT: U.S. Woes Unsettle Philippine Markets


1. (SBU) Summary: Uncertainties in the U.S. financial system drove
down the Philippine stock market by more than 11% on September 15-18
and the peso down to a sixteen-month low. The Philippine Central
Bank remains confident that local commercial banks' exposure to
Lehman Brothers will not pose systemic risk and state-run pension
funds announced they have no exposure. Although the stock market
and peso recovered somewhat on September 17 following news of the
AIG rescue package, resurgent fears of more troubles in the U.S.
financial more than wiped out those gains on September 18. AIG's
60-year old local subsidiary is the largest company in the
Philippine insurance industry. The mood of the Philippine financial
markets is anxiety but not panic. Record-high foreign exchange
reserves will give monetary authorities leeway to discourage
speculation and excessive foreign exchange volatility. The
Philippine government's economic team vowed to continue with reforms
to improve competitiveness and the economy's resilience to shocks,
including support for liberalizing constitutional limitations on
foreign investments should charter change initiatives prosper. End

Stock Market Tumbles, Peso Slips

2. (U) Resurgent uncertainties following recent news on Lehman,
Merrill Lynch, and AIG drove down the Philippine Stock Exchange
index (PSEi) by 4.1% on September 15 (Monday) and by another 4.5% on
September 16 (Tuesday).
The peso -- already affected by slower export growth and high fuel
and food prices -- also came under additional pressure. It closed
0.5% weaker to the US$ on September 15 and slipped by another 0.2%
on September 16, breaching the 47 pesos/$ mark and closing at a
16-month low.

3. (U) News of AIG's rescue package provided a modest, temporary
respite on September 17, but the stock market quickly reversed by
4.3% on September 18 -- taking its cue from the plunge on Wall
Street. As of noon on September 18, the peso was trading 0.4%
weaker from September 17's closing rate. The Central Bank has
reportedly intervened in the interbank foreign exchange market in
recent days to calm jitters and curb foreign exchange volatility,
preventing a more pronounced drop. At current levels, the PSEi and
the peso have weakened by 11.1% and 0.9%, respectively, over the
past four trading days; and by 35.0% and 14.5%, respectively, since
the beginning of the year.

Banking System Exposure to Lehman Instruments Manageable
--------------------------------------------- ----------

4. (SBU) A senior Central Bank official told econoffs that six
commercial banks reported a combined $375 million exposure to Lehman
Brothers (mainly investments in collateralized debt obligations and
credit link notes). That amount includes a $51 million loan
exposure by one of the banks to a Philippine-based Lehman subsidiary
operating as a special purpose asset vehicle. Analysts here
estimate that the banks would be able recover only 30% of the value
of their exposure to Lehman's investment products.

5. (U) The Central Bank official expects the banks' exposure to
Lehman to translate to thinner profit margins and to affect
capital-to-risk asset ratios. The Central Bank nevertheless expects
capital adequacy to remain above the 8% international benchmark and
above the 10% Central Bank-stipulated floor. The official stressed
that the exposed banks -- which rank among the largest in the
industry -- are well capitalized and are moving to increase
provisions for probable losses in line with prudential regulations.
The aggregate exposure to Lehman Brothers represents a modest
0.3%-0.4% of total commercial banking system assets. Although the
Central Bank stands ready to provide liquidity as needed, the
affected banks are currently not experiencing massive deposit
withdrawals nor do they expect to require emergency assistance.

6. (SBU) Although less a concern for now because of the reported
takeover by Bank of America, the Central Bank estimated commercial
banks' exposure to Merrill Lynch investments at about $460 million
(equivalent to roughly 0.5% of commercial banking system assets).
Central Bank officials also expressed confidence that as long as
fears do not lead to panic, this additional exposure will not pose a
systemic risk.

Impact of U.S. Woes on Insurance Sector on Watch
--------------------------------------------- ---

MANILA 00002174 002.2 OF 002

7. (U) In response to a recent disclosure by Toronto-based Sun Life
Financial Inc.'s $350 million exposure to Lehman bond securities
globally, local subsidiary Sun Life Philippines issued a statement
that the local unit has no exposure to Lehman's products and that
the bulk of its life, pre-need and mutual fund assets are invested
locally. Local company officials also stressed that the Sun Life
group overall remains financially sound and that the global exposure
to Lehman represents less than 0.4% of invested assets. Sun Life
Financial Philippines currently services more than a million clients
and is the second largest player in the Philippine insurance market
with about $1.4 billion in assets (equivalent to more than 18% of
the life insurance industry's total resources).

8. (U) Market observers and government regulators also are closely
watching developments on the AIG front, principally because the
company has a 60 year-old local subsidiary in the Philippines
(Philippine American Life or Philamlife) -- the largest, and
considered an institution, in the country with over 100 billion
pesos ($2.2 billion) in assets representing more than 30% of the
life insurance industry's resources. Philamlife officials have
stated that AIG's troubles will not affect local operations, which
are separate and adequately capitalized under Philippine laws. The
local unit's funds are also separately invested from the parent
company's and concentrated in marketable Philippine government
securities, corporate bonds, and blue chip equities.

State-Run Pension Funds Not Exposed

9. (U) Officials from the Government Service Insurance System
(GSIS) -- the pension fund for public sector employees -- have
stated that GSIS has no exposure to Lehman under its Global
Investment Program and that most of its overseas portfolio
investments are in the European market. According to officials from
the Social Security System -- the state-managed pension fund for
private sector employees - the System has no exposure to Lehman's
investment products or to any investments overseas.

Anxious Markets Looking to U.S.

10. (U) Overall, external shocks this year have resulted in net
outflows of portfolio capital but the balance of payments continues
to be in surplus ($2 billion currently), helped by strong
remittances from overseas Filipino workers -- which are up by more
than 18% thus far and expected to breach the $16 billion mark by
yearend (equivalent to about 11% of Philippine Gross Domestic

11. (U) Gross international reserves continue to be at comfortable
levels -- adequate for about six months worth of import requirements
and equivalent to nearly three times the country's short-term
foreign debt obligations -- providing Philippine monetary
authorities leeway to discourage speculation and inject liquidity as
needed. Although there may be some bargain-hunting, traders and
investment analysts expect portfolio investors and fund managers to
remain wary and to track policy pronouncements and developments in
the U.S. in coming days -- reflecting fears that more troubles may
yet appear.

GRP Economic Team Vows to Continue Reforms

12. (U) External shocks -- including turmoil in the U.S. financial
system -- have slowed economic growth and exports, pushed up
inflation and local and foreign borrowing costs, and slowed foreign
direct and portfolio capital flows. During the Philippine
government Investor Relations Office's bi-annual economic briefing
on September 17, President Arroyo and her economic team noted that
the Philippines, although not spared, has been holding up
respectably well due to reforms taken to strengthen the banking
system, restore fiscal stability, and slow rapid debt accumulation.
Economic managers vowed to continue with reforms to improve
longer-term competitiveness and the economy's resilience to external
and domestic shocks. They expressed support for
liberalizing/relaxing investment restrictions in the Constitution
should charter change initiatives prosper.


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