ASIA CREDIT-Indonesian spreads narrow gap over Philippines

HONG KONG, Aug 20 - Indonesia's offshore bonds, once viewed as much riskier than bonds from similar-rated Philippines, are closing in on the gap as Jakarta delivers strong growth and fiscal numbers while Manila disappoints with a much slower pace of expansion and a wider budget deficit.

But despite the Philippines's poor economic performance, analyst do not expect its spreads, a measure of risk, to widen much as domestic banks, which are major investors, are likely to hold on because of capital adequacy incentives.

Both countries are rated BB-minus by Standard & Poor's, but the market has differentiated between their risk profiles.

Last October, Indonesia's 5-year credit default swaps (CDS) <IDGV5YUSAC=MG> were nearly 500 basis points (bps) higher than the Philippines' <PHGV5YUSAC=MG>.

But since then the gap has closed to about 20 bps after Indonesia, southeast Asia's largest economy, beat the street with a 4 percent second quarter economic growth, the best in the region, and after its political landscape began stabilising.

Such economic improvement is unlikely a flash in the pan as consumer confidence is near a five year peak.

Philippines on the other hand, has already raised its budget deficit ceiling three times this year and is expected to exceed even that as a significant pick up in revenue or major spending cuts are a remote possibility.

"The overall economic picture looks much better in Indonesia than in the Philippines" said Jens Lauschke, Singapore-based strategist at DBS Bank.

"This year's budget shortfall will likely turn out worse than the official projection. Next year is unlikely to see much improvement," he said.

On Wednesday, Manila reported that its budget deficit in the first seven months of 2009 reached three-fourths of its 2009 goal, fuelling market concerns it will exceed the annual limit.

And on Thursday, the government's planning agency said the economy's second quarter performance ranged between an annual 0.1 percent contraction and 0.9 percent growth, significantly more cautious than with market expectations of a 1 percent growth.

GROWING DEBT

Markets are already unsettled by Manila's decision to raise its offshore borrowing target by a third to $2 billion, some of which may even be pre-funded in 2009.

Fitch Ratings estimates state borrowings to GDP would rise to 58.4 percent this year from 55.8 percent in 2007. It will only marginally decline to 58 percent in 2010.

In contrast, Indonesia's public debt to GDP has shown remarkable improvement and is seen falling to just above 30 percent next year from around 35 percent in 2007.

More importantly, President Yudhoyono has already indicated the borrowing needs for funding next year's deficit will be met at home.

"The reduction in public debt, external debt and corporate balance-sheet should continue to fuel the virtuous cycle of capital cost reduction as macro risk premium declines," said Morgan Stanley in a report this month.

Ernesto Bettoni, Fortis Investment Management's London-based fund manager said: "We have kept Indonesia as one of our main overweights in external debt all through 2009. We expect Indonesian external bonds to outperform Philippine bonds."

The political landscape also shows a similar trend.

Indonesia is seen ushering in faster reforms that could lure foreign investment, create jobs and make high growth sustainable after President Susilo Bambang Yudhoyono's election win.

Meanwhile, there is great uncertainty regarding government policies in Philippines as the country heads into national and local elections in May 2010.

"It does appear that Indonesian politics are more stable than that of the Philippines having recently come off a relatively undisputed and seamless election and in recognition of the Philippines' very poor history of conducting credible elections," said Pete Troilo, of risk consultancy Pacific Strategies & Assessments.

And yet Indonesian spreads may not fall below Philippine spreads, both because of technical and fundamental reasons.

Philippine dollar bonds have a solid support base from domestic investors -- local banks, flush with dollar remittances from overseas workers, bought 40 percent of the last offering. Philippine banks need to maintain lower capital against these assets, so they are more attractive to hold.

"In case of external finances Philippines looks better, in case of public finances Indonesia looks better. For us the two balance out," said James McCormack, Asia sovereign ratings head at Fitch Ratings which has a BB rating for both countries.