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Number

Journal Philippine 46, Volume ofXXV, No. 2, Development Second Semester

_

1998

U.S.

Investors' Response to Philippine Capital Market Liberalization: Evidence from the First Philippine Fund* Angelo

A.

Unite

and

Steve

Beveridge

INTRODUCTION

When

countries

restrict

are segmented markets and foreign investors. depends

on

the

type

international

investment,

what

of investment

activity

these

countries

restrict

whether the restrictions are binding. Specifically, this study how U.S. investors view Philippine barriers to international and

the

these

recent

steps

restrictions.

to provide

taken

by the

In particular,

(FPF), a closed-end

country

evidence

relaxation we

do

of these

data

are

effective

if announcements are related country

and

investigates investments in liberalizing

Philippine

at the New York Stock

is deemed

FPF closed-end

government on the First

international

the Philippine We test whether

restrictions

in the Philippines of the

traded

existing

Philippines

by examining

restrictions discounts

in the

Philippine

we use

fund

on whether

have effectively segmented international capital markets. investments

may result

where assets are valued differently by domestic The degree to which restrictions act as barriers

investment

Fund

Exchange, restrictions

capital market from the restrictions on international and

whether

important

the

announced

by U.S. investors.

of changes to changes

in the

This

investment

in the premiums

and

fund.

'This paper is based on a chapter of Dr. UIlite's Ph.D. in Finance dissertation at the University of Alberta, Canada. Thanks are due to the Canadian International Development Agency and the Association of Deans of Southeast Asian Graduate Schools of Management for funding. We are also grateful to Dr. Michael J. Sullivan, Associate Professor of Finance at the University of Nevada at Las Vegas, far his vel-y helpful comments and suggestions on the structure of this paper. Thanks are also accorded to Dr. Tereso S. Tullao, Jr., Professor of Economics at De La Salle University, for his suggestions. Finally, we would like to thank an anonymous referee for the thorough comments and recommendations to improve the original draft "'Senior Research Fellow, Angelo King Institute for Economics La Salle University and Professor of Finance, Department of Finance Faculty of Business, University of Alberta, respectively.

and Business Studies, De and Management Science,


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

and

"B" shares.

shares this

2 "A" shares

can be purchased ownership

preferences

are reserved

by both

restriction,

and

is the only country in "A" shares

fund

permitted

of domestic This

alternative

to direct

investment

funds

can

(NAVs).

fund's but

market.

Given

substitutes, end

country However,

that

barriers

on assets

country Eun

and

They show

the

imply

that

when

these

relative

covariance the while

limits

closed-end shares.

Thus,

restrictions

fund investing in that of such restrictions. 4

country

foreign

in the assets

foreign

are

have

similar

Hietala

(1989)

the expected

argue returns

on these

market

close

a closed-

should

Based

models,

segmentation.

Hietala

can

fraction

(1989)

assume

and

these

by both

are

models

the

The foreign

country's

unrestricted

shares.

the unrestricted

shares

analogous suggest

sell

depending

preferences.

themselves

the

nationals

with the premium

will increase above

be purchased

investor

funds

country's

of the

shares

shares

foreign

investors.

are binding,

country funds'

and

and

that

the

of returns

the country

some

overseas

to the restricted

matrix

quantitative

on

the

as its share

traded

cause

only the

shares

limits

Values

of assets as the form of international a foreign country has two classes

that

and

country

internationally,

countries.

(1986)

shares

nationals

unrestricted

binding

to differ across premiums

imposes

at a premium

shares,

risk

market.

market

assets

can

capital foreign Net Asset

underlying

(1986)

investment

(b) unrestricted

government

their

its underlying

Janakiramanan

country's

underlying

and

Janakiramanan

(a) restricted

buy

and

securities

only to

accessible

funds,

same

are integrated

limits on cross-ownership barrier. In their models,

of shares:

on the

and

fund

and

quantitative investment

foreign

shares

to international

of equal

nonzero

funds markets

their

closed-end

in the

of the underlying

country

Eun

to domestic

to invest

available

Philippine over

rights, the FPF

easily

dosed-end

than

the

government

FPF an

"B"

a Other

However,

otherwise

the

or discounts determined

if capital

fund's

risk.

can

that

then,

are

counterparts,

in contrast

NAV is not

by the prices

that makes

while

between

of shares.

in the restricted

domestic

at premiums

However,

country price

trade

local investors,

by the Philippine

feature

nationals,

no distinctions

companies

nationals. to their

are

and

of the two classes

Philippine

Similar

for Filipino

foreign

there

limitations

2S5

The assets

to the

restricted

can be considered that

imposition

the price-to-NAV

level prevailing

as

ratio

in the

of

of the

absence


2,56

JOURNAL OF PHILIPPINE DEVELOPMENT

An intuitive Suppose

that

directly

a particular

purchasing

by which

foreign

investor

investors

and

are

the fund

becomes

investor.

decreases

thus

and

before.

equities

discount

the

on the

In summary, funds

country

restrictions

premiums

or discounts.

ceteris

paribus,

increases fund

restrictions model

reduces

of these

international markets

share

should

Using

This

this

the

the

lesser

value shares

premium shift

demand

for the

NAV of the

country

or increasing

the price-to-NAV

to international us to test

the discount

if this

country's

measures This the have

in the country models

similar

be priced

like domestic

theoretical

framework,

fund's

suggest

on a closed-end

country

investment

of a liberalization the discount

when

of the

on, the fund. asset

pricing

of the barriers

international

of a closed-end risk.

that,

barriers

of the effectiveness

shares

in

of existing

an underlying

is because

if

changes

international

of, or increases

do not necessitate

ratios

investments

whether

of a tightening

or an announcement

should

securities

investors

premium

imply that

allows

of or reduces

require

local

of the host country's

the

the preceding

are fully integrated,

price

models

the premium

assets

increases

In particular,

investments.

its underlying

foreign

with changes

hypotheses

nor do they

that

are associated

effective,

of the

for the fund's

purchases

by barriers

in a country

are

in the

to diversification-minded

This increases

announcement

the premium

investing

restrictions

Tests

an

market

fund. _

are effective.

investment

to invest

is likely to have

of reducing

the preceding

can be affected

restrictions

equity

are likely to sell at a lesser

in turn

from

the only means

purchase

it is possible

effect

that

demand

fund to direct

which

This reinforces

these

time,

investors

over its NAV. s Therefore,

direct the

of liberalization.

equities,

value

the fund

shares

from the country

country's

Assume

have

and

easier,

foreign

is allowed

Consequently,

same

as a result

of country

relaxed

is as follows.

to this country's

sell at a premium

the fund's

At the

their capital

the

securities.

which

possibly

for the foreign

fund.

fund,

inferences

prohibits

can gain access

restrictions

underlying

host

legally

This fund will, most likely,

the

than

country

a closed-end

securities.

of the preceding

its local equity

a foreign

is through

when

explanation,

country

Consequently

to

capital fund the

and

fund's

funds. Bonser-Neal,

Brauer,

Neal and


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

Wheatley

(1990)

of changes funds'

examine

in investment

premiums

January they

discounts

1989 for five funds

(or increase weeks

sample

restrictions.

Overall, are

regulations funds an

that restrict announcement

significantly

associated

sensitive

ratio during

barriers

Although

not conclusive,

traded

while

between

of a country countries

fund's

which

average

restrictions

have

investing

restrictions restrictions,

funds

on

fund

country

funds which

like to emphasize how

regulator?"

been that

trade have

had

no

effective. country

fund.s

country

traded

restricted

funds

on average

markets

if the

some

in

high premiums.

have

relationship and

kinds

investment

the level

investing

have

m

traded

on

find in their

at an average discount, some very strict foreign ownership

premiums.

Moreover,

with

greater

or smaller

in countries

Philippines,

have

Kim and Lee (1995)

premiums

investing

not

doubt

since

of countries

higher

would

investments

on foreign

at average

changes

have

less they

to international

Bodurtha,

asset

in segmenting

closed-end

access

in the

price-net

relatively

find that

foreign

restrictions

the

have

is monotonic

in securities

including

is only

three

effective

had

However,

most country in countries

tend to have

We would study

in foreign

is some evidence

investing

Likewise,

traded

they find that some

the

announced

average,

access

restrict

premium

been

on

there

of barriers

impose

sample that, while funds that operate funds

funds

at discounts.

premiums

that government-imposed

restrictions

at discounts.

the severity

funds,

in country

in the

is because

et al. (1990)

which

on average

to

of investment

changes

decline

have

This

if the

Bonser-Neal

at premiums

1981

country

of or during

This suggests

with difficult

in markets

country

May

fund's

of changes

restrictions,

premiums

investing

in the

that

a 6.8 percent

on fund

For example,

indicate

markets.

in markets

from

of a liberalization

investments

investment

invest

decrease

in anticipation

the event period,

international

in closed-end data

investments. They find that across all country of a relaxation of investment restrictions is with

capital

announcements

in New York. For four

results

to international

impact

changes

to announcements

international

that

either

between

weekly

announcement

their

premiums

and

a significant

the

exists

using

trading

in discounts)

surrounding

a relation

restrictions

and

find in their

value

whether

25'7

foreign discounts.

with strict

exhibit

they

on

at the

outset

that

changes

in

Philippine

the

that

ownership However,

foreign

discounts

find

ownership average.

focus

of this

international


258

JOURNAL OF PHILIPPINE DEVELOPMENT

investment

restrictions

FPF closed-end

have

country

the FPF closed-end

affected

the premiums

fund. 7 This

country,

paper

fund trades

does

and

not seek

at a premium

are

Bodurtha

referred

Schneeweis as they DATA

and

Dinning

address

these

studies

of Chang,

The initial

and

comprises November

share

The Wall Street

price

gains

distributions,

were

obtained

and

NAV are Journal.

closed-end

country

of Friday's

close over

funds,

and

Senbet

NAVs of the

29,

1995. 8 Both

in U.S. dollars

announcement

& Poors

the

FPF's

NYSE

net

asset

=

premium

SP_

=

stock

NAy

=

net

(discount)

price asset

of the value

fund prices

and

Reports.

NAV is valued

in local

and

are

translated The fund's

constructed

of the

of the

fund

at end fund

and net asset

Figure plot

November after which its NAV.

1 plots

shows

that

the fund's during

24, 1989 to March the

fund

was

premium the

first

has

since

dates,

Like other currency

into

U.S.

weekly

as

dollars

{percentage)

as:

at the

end

of week

t

at end values

of week

over the initial four been

of week

t

t

are only approximately

months

the Philippine sample

after

23, 1990), the FPF was trading

and

collected

and capital

x 100

NA V_

fund

are

ex-dividend

Stock

country value

and

of dividends

synchronous because a difference of 17 hours exist between stock exchange close and New York's close. 9 The

1993)

and

on the amount

the

foreign

PD,

The reported

(1995),

prices

,PD, = L where

Errunza

closing

rate in effect at that time.

the

Kolodny

(1994), Johnson,

24, 1989 to December

reported

Standard

in the

the exchange

and

CHARACTERISTICS

weekly

Data

including

from

Eun

or discount and the fund offers.

and Wizman

Diwan,

AND SAMPLE

sample

from

premiums

(1993},

the period

fund

La Porta

why

nor does

issues.

DESCRIPTION

FPF covering

using

to the

et al. (1.995), Hardouvelis,

of the

to explain

or discount

it investigate the determinants of this fund's premium the extent of international diversification benefits that Readers

discounts

selling

period, l째

launch

{from

at a premium

at a discount

over


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

Figure

1. First Philippine November 24,

2,59

Fund Weekly Premium (Discount) 1989 to December 29, 1995

80.00 1

60,00

40.00

8 _ 20.oo

a_

0.00

-40.00 -_-----_

Week

The market the

FPF was

launched

booming

amid

was

ranks

of Asia's earlier,

Philippine

government

the

otherwise

available

premium

when

to overthrow Philippine Index response prices

stock by

to the

of Philippine

of the fund's

industrialized

countries.

is the

entry

only

to invest was

of the fund, the

to fall

the country

FPF

fund

26 coup

launched.

causing

percent

within

attempt

securities

the

and

one

had been inflated

into the market,

permitted

within

by the are

explains

the

several

adversely

Stock

with

by speculators

the FPF management

attempted the

Composite

trading the

weeks

affected

Exchange

after

as

that

of the military

This

combined

importantly,

This possibly

week

set to join

of companies

factions

Manila

Philippine

finally

fund

However,

government.

the

More

country

nationals.

when was

in "A" shares

right wing

Philippine market

1989

that

only to Philippine

the

of the launching

hopes

newly

discussed

in November

began.

perception

In that

in anticipation adopted

a policy

p


260

JOURNAL OF PHILIPPINE DEVELOPMENT

of proceeding in cash that

cautiously

(nonpeso

total

cash

to 24.5 percent

changes

in the

Therefore,

following

sample

the

offering

of the FPF.

marketing

Philippines.

four-month

efforts

or by the sentiment confounded

during

in the

Johnson

immediately

period

March

30,

traded

at a discount

speculation

sizable

variation

investors.

share

fund's

discusses

the procedure

explained investment

by announcements restrictions.

price

Moreover,

the

had

economic

biased

changes study

discount

over

whether

of changes

securities

in the premium coup

is avoided.

covers

the period

On average,

sample time. some

public

by initial

over the adjusted

29, 1995.

discount

initial

the

(and consequently

not

1989 attempted

over this

for testing

the

from

of Philippine

used for this 1995.13

to December

of 19 percent

in the

increasing

as of December

with

following

by local holders

the FPF's weekly

1990

at 0.3 percent

we exclude

is thus

by the effect of the December

2 shows

such

the first four months

et al. (1993),

Consequently, the adjusted sample March 30, 1990 to December 29, Figure

stood

U.S. than

premium/discount) of fund

bonds)

31, 1989, gradually

By doing so, the fund's

and

stocks

primarily

12

period

percentage

remained

then to 27.4 percent

in premium sentiment

fund

as U.S. Treasury

common

30, 1990, and

to do With investor

fund's

The

equivalents

in Philippine

by June

fundamentals

market.

of the fund as of December

31, 1990. j._Clearly,

the

and cash

investments

of total net assets

more

into the

sample

the FPF has

period,

suggesting

The following of this variation

in the Philippines'

a

section can be

international

METHODOLOGY Identification The

criteria

to international

of Events for selecting investment

Bonser-Neal

et al. (1990},

(a} changes

in restrictions

ability

of foreign

the ability controls

investors

of local investors affecting

direct

the in the

events

Philippines

we consider that

related

affect

to acquire

shares

to invest

outside and

in barriers

is as follows.

two types

directly

investment

to changes

of regulatory,

or signal of Philippine

the Philippines portfolio

Following

changes

changes: in the

companies

or

(e.g., capital

investment)

and

(b)


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

Figure

2.

First

Philippine

March

30,

Fund

1990

to

Weekly

261

Premium

December

29,

(Discount)

1995

0.00 -

-5,00 -10,00

E., 8

-15,00 -20,00

[V_

C3 -25,00

-30.00 •

-35.00

-40,00

Week

changes

in restrictions

currency

required

that

affect

to purchase

affecting nonresident An initial list of

18

local

accounts events

An

source,

event

found.

Likewise,

announcements than

six

weeks

a liberalization criteria.

then

they

is dropped

events

of each

list

are

collected if its

to obtain

(e.g.,

dropped

Five

from

events

The

capital

the

all

restrictions, is provided

TM

and Exchange events are not Street

date initial

not

if

multiple

list

within

happen

satisfy

Journal.

could

occur

of which

the

controls

accounts). International

Wall

restrictions

events,

investment

of these

from

announcement

in investment

other.

of international

A description

been

the

of changes

of investors assets

on Exchange Arrangements dates for the identified

have

from

ability

or foreign

and resident foreign exchange has been obtained from the

Monetary Fund's Annual Report Restrictions. if the announcement in this

the

the

in Appendix

be

less

to entail preceding A.


2,62

JOURNAL OF PHILIPPINE DEVELOPMENT

Tests

of the

Effects

of Changes

in International

Investment

Restrictions This

section

announcements Philippines discounts.

are

describes

the

procedure

of changes

in the

foreign

associated

with

changes

testing

in

whether

restrictions

the

FPF's

in the

premiums

or

15

If the existing

international

investment

changes are effective, an announcement restrictions should be associated with FPF.

for

investment

The

null

international

hypothesis

investment

FPF's discounts.

is that

prior to the regulatory

announcements

restrictions

The alternative

barriers

of a liberalization of investment an increase in the discount of the

in the

hypothesis

of liberalization

Philippines

do not

of

affect

is that announcements

the

increase

the discount of the fund. We only consider the impact of announcements related to a relaxation of investment restrictions since all of the events in the

sample

happen

We test

this

to involve

hypothesis

some

using

form

the

of liberalization.

regression

model:

ApD t = .13o + j_lnlt + .132D2,+ J33D3,+ ct Here

APD t is the

variable and and

one

week

the

variable

in Equation

potential

(1) due

reporting

of the

the event

itself.

fund's Table

to the price

noncontemporaneous

share

changes

significant change the

and

in the

fund's

fund's

NAV over

share the

window

effects and

as the

estimates

lagged

one

over

week.

predicts

same

in

lagged

reporting

the

the

of

the

manner,

fund's

statistically

at lag -1 indicates

week

In the

period

and statistically

between

in NAV. In particular,

price next

event trading,

positive

cross-correlations

of 0.14

dummy

of the coefficients

a possible

are some

coefficient

The

before

after the announcement

of nonsynchronous

NAV and

dummy

one week

0 otherwise.

is used

in the

that there

changes

cross-correlation

and

t. The

before the announcement

D2t = 1 if t is between

for bias

1 shows

significant price

in week

two and seven weeks

_6 A three-week the

discount

announcement

D3t = 1 if t is between to reduce

fund's

two and seven weeks

The dummy after

0 otherwise.

order

in the

Dlt= 1 if t is between

0 otherwise.

variable and

change

that

change the

a in

cross-


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

2.63

Table 1: Sample Cross-Correlations Between Fund Share Price Changes and Net Asset Value Changes of the FPF Closed-end Country Fund Computed Using Weekly Data from March 30, 1990 to December 29, 1995"

-6

-5 -4 -3 -2 -I 0.03 0,01 0.06 -0.02 0.14

0 0.54

0,o

i 0,23

2 0.04

3 0,2

4 5 -0.01 -0.08

[.(1,26) (0.55) (0.10) (1.05) (O.3O)(2.4S)* (11.07)* (4.0S)* (O.64) (3,4S)* (O.25) (1,42) (0.89) *Figures in parentheses are t-ratios The superscript a denotes significance

correlation

coefficient

over one week week. These

of 0.23

predicts

The restrictions weekly in the

change

in the

the fund's using

J33 measure

discount

_3 measures

and their statistical

things

from

zero

alternative

constant, under

the

hypothesis,

the coefficient null

this coefficient

FPF's

investment the

average

period

weekly

of change

surrounding

average

weekly

significance

the

change

in

are estimated are determined

standard errors and t-statistics heteroscedasticity.18 Holding all

b 2 should

hypothesis.

at

announcement

the average

the

next

trading

on the

These parameters

on Newey and West (1987) adjusted are robust to serial correlation and

other

effects

to the

three-week

after the announcement.

least squares

over the

b I measures

prior

NAV

to new information

the

b 2 measures the

price

in international

coefficient

discount

during

share

in the

lags or nonsynchronous

changes The

The coefficient

ordinary

based which

JSI, J_2, and

fund's

a change

NAVs to respond

The coefficient

discount

announcement.

and

that

in the fund's

with reporting

Philippines.

changes. fund's

i suggests

of announced

in the

regulatory

at lag

prices

parameters

changes

level.

the change

are consistent

which cause recorded different times. 17

discount

at the 0.01

On should

not be significantly the

other

hand,

be negative

and

different under

the

statistically

significant if the barriers to international investments that existed before the announced liberalizations have effectively restricted foreign access to the

Philippine

EMPIRICAL

Table of the

capital

market.

RESULTS

2 shows

coefficient

the results

f12 indicates

of estimating that,

on

average,

Equation an

(1). The estimate

announcement

of a


264

JOURNAL OF PHILIPPINE DEVELOPMENT

relaxation a

0.45

of investment percent

increase

estimate

of the

that

announcement

the

three

weeks

do

react

to the

Table

2 also

Table

do

not

the

in the fund's

ag2 is of the has

surrounding level.s

discounts

in

coefficient

conventional not

restrictions

no

the

effect

reports increase

discount. expected on

This

the

results during

the

null

discount

cannot

result

be

with

while

the

hypothesis during

rejected

the at

the

suggests

that

U.S.

investors

during

the

event

period.

of testing the

However,

fund's

liberalizations the

is associated

sign,

announcement

of significance. announced

Philippines

the

weeks

null before

hypotheses and

after

that the

2: Test of the Effect of Changes in Philippine International Investment Restrictions on the FPF Closed-end Country Fund Discount Using Weekly Data from March 30, 1990 to December 29, 1995 a ZIPD g Po+ P ,D ,,+ _ D_,,q-_D ,,+ g,

where .4PD is the change in the FPF's discount in week t DI_ = 1 if t is between two and seven weeks before the announcement of a loosening of the Philippines' investment restrictions and 0 otherwise D=_ = 1. if t is between one week before and one week after the announcement of a loosening of the Philippines' investment restrictions and 0 otherwise D_L =

1 if t is between two and seven weeks loosening of the Philippines' investment Parameter /_o

after the announcement of a restrictions and 0 otherwise.

Estimate -0.034 (-0.23)

/_,

0.188 (0.33)

__,

g

-0.449 (-0.83)

o.o5 (0.09)

R2

0.0015

Figures in parentheses are t-ratios for tests of the hypotheses _>0 against the alternative that _,<0, i=0, 1, 2, 3, based on OLS regression with standard errors computed using the Newey-West (1987) correction for heteroscedasticity and 3rd-order serial correlation.


UNITE AND BEVERIDGE: CAPITALMARKET LIBERALIZATION

announcement

period.

the

conventional

not

react

that

levels

prior

changes.

there

aggregate

the

is no delayed results

during

U.S. investors or major

the

conventional

U.S.

investors

do

the

hypothesis

is

levels

of significance,

to the announced

relaxation

wisdom.

these

regulatory

The following

prior

existing

restrictions

(Unite of equity

restrictions

were most

is evidenced monitor

by the

stock

purchase the

fact

purchases

for these

that

the

Moreover,

resulting

in order from

of the

Philippine perceived

investments. equity

stringent

their

The effectiveness Central

the

Bank

of the

are legally

Central

Bank

subsequent

companies

shares

into two

of this restriction

as they

to qualify

to 40

Ownership

since most

classify

ASEAN

limited

change.

In

ownership

among was

firms

generally

restrictions

investors

participation

by foreigners

be registered proceeds

areas

most

to

securities.

the foreign

prior to this policy

and "B" shares.

"B" shares.

acquisitions

the

often effective

restricted

"A" shares

foreign

seem

listed

to foreign

that

facts

the prior

liberalization 1991,

foreign

in most businesses

fall into these

categories:

were

In fact,

stylized

in Philippine

major

expressed

Philippines 1995).

that the announcement

perceive

investing

accepted

view the prior restrictions and

as impediments

investors

of the

countries percent

restrictions

foreign

evidence

in November

they view

to commonly

to believe

U.S. investors

to the

policy

or that

that

or both.

U.S. investors

to directly

example,

particular,

that

either

(i.e., not a significant

are counterintuitive

anecdotal

to

investment

suggests

as ineffective

we are less inclined

investment

then

This finding

as unimportant

only because

do not respond

in international

restrictions)

suggestions

deterrents

For foreign

changes

the possibility

as effective

period.

of existing

In particular,

favor more

U.S. investors

the prior restrictions

effect was insignificant as ineffective.

that

of relaxations

regulatory

However,

and

that

at

Likewise,

response

indicate

sample

perceive

the announced

that

at the

announcement

restrictions

the

period.

be rejected

1,) Overall,

the

indicating

announcement

be rejected

that

is that _61>0 cannot

of significance,

to the

J_a>O cannot

suggesting

The hypothesis

265

Philippines allowed

requires

for repatriation

can only to

that

such

of dividends

sale.

On the

other

hand,

unlike

firms,

banks

are heavily

e.g., Lamberte

and

Llanto

1995).

Before

the liberalization

regulated of the

(see

banking


266

JOURNAL OF PHILIPPINE DEVELOPMENT

sector,

entry

financial Bank

of foreign

bank

firms,

shares it would

not

violate under

and

Central

and

four to six months and

opportunity

effect it

that

could

announcements wishing

costs,

which

the

to directly

prior

for

using

such

been which

studies

found

because

they

industries industries

Llanto

participate

Philippine country

not

effect is observed

only if the restrictions

if U.S.

perceive

the

announced

funds

market.

the the

changes.

It is

to foreign

stock

that

a significant

liberalization

is as

to gauge

announcement

domestic

22

on analyzing

differentiate

are effective

costly

results

regulatory

insignificant

it is possible

are

their

U.S. foreign

stock

concentrated

did

and

regulations

for individual

of such

in the

1993). 2_ It seems nature

were more likely to be important

were not. 2_Therefore, investors

have

announcements

to be placed

counterintuitive

closed-end

liberalization

and

export-oriented

and

in the

waiting

registered

payments

allowed

bureaucratic

these

"while

of duly

of BOI-registered and

rules

it took

were settled

interest

impediments invest

then

studies market

to directly

(Lamberte

of

by the

In fact,

that

were

of stock

of their

1993). 20

approval

proceeds

Bank-certified

because

reason

when

have

shares

as effective

of the aggregate

possible

require

dividends,

of their

repatriation

to nine years.

dividend/splits

approval"

that,

wish

Previous

interest

equity

by foreigners

(Rodrigo

also stipulated

cash

in Central

Bank

of capital

percentage

regulations,

divestment

as

securities,

may be perceived

impact

well

of stock

associated

follows.

and

approval

as

A possible

restriction"

non-

"A" share

foreign

were purchased

exchange

1995). The rules

of stock

who

small

was given and transactions

to infer

investors

shares

traded the

the

before

reasonable

and

foreign

or repatriation,

Central

with

and

Central

laws under

with publicly do not follow

a sufficiently

floated

other

from three

only in government with prior

Act and

banks

by the

were staggered

proceeds

shares

Banking

of complying

of dividends

investment

divestment

regulated

banks

ownership

prior

Llanto

for reinvestment foreign

foreign

remittance

Bank

(Lamberte

"float

even if all those

Finally, capital

they

of domestic

highly

In contrast

traded

as a means

Instead,

so that

Bank.

all publicly

convention

restriction.

ownership

were

via the General

of the Central almost

- "B" share

and equity

by foreigners

of the Philippines

the supervision

and

banks

institutions

market

effects, between investors and

those

announcement

and at the same of the

time

restriction


UNITE AND BEVERIDGE:CAPITAL MARKET LIBERALIZATION

as important prior

a significant

international

been the

(i.e.,

effective FPF's

investment

but

the

discount resulted

when

to the

that

the

pre-announcement

were

three

were

equity

participation

limits

(events

dated

6/6/91

6/22/94),

relaxation

of foreign

10/92),

and

foreign

banks

to operate

Investment

involve

a major was

treated

equity

company,

than new

separately

investors,

regression

to the

(event

dated

seek

model

the

relaxation

liberalization

10/14/94).

and

covered

both

the

it applies over

of

by the

limits,

of control

8/

of entry

Although

participation

a degree

to the

1/3/92

is not

of

Act of 1991 related

dated

which

equity

portfolio

the

since

Investment

from the first one because

who

to individual

to a major

(events

Philippines

of foreign

insignificant

in the sample

(b) announcements

related

Act of 1991

This

We discount

the events

related

restrictions

in the

relaxation

to direct

The

exchange

on effects

to be insignificant.

via the Foreign

(c) announcements

Foreign category

and

being

fully anticipated

we classify

(a) announcements

foreign

have

by investors.

collectively.

found

may

insignificant

effect

were

the

announcements

unimportant

changes was

Philippines

out by the

considered

announced

Consequently,

of important

announcement

to test this hypothesis,

groups:

in the

washed deemed

overall

coefficient

In order

effect

were

all announcements

possibility

into

significant

which

relaxation).

restrictions

changes

of announcements possibly

or major

267

last more

the

local

investors.

is:

APD,._ ao + a2FIA 2 + a3FIA3t + a4FX1t + asFX2t + a6FX3, + aTBKlt + asBK2, + agBK3, + u t As in Equation t. The

(1), ADPD

F/Airs represent

liberalization

of the

other

banking.

than

announcement

change

are the

entry

of foreign

in the

the

dummy

variables

foreign

equity

participation

The

FXis

of a liberalization

BKts

i = 1, 2, and

is the

dummy banks.

variables

the

of foreign for the

The values

3, follow those

are

of model

that

fund's

for the limits dummy

discount announcement

areas

variables

announcement

(1). Longer

of a

in economic

exchange

these

in week

dummy windows

for

restrictions. of liberalization variables

take,

the The of for

for the pre- and


268

JOURNAL OF PHILIPPINE DEVELOPMENT

post-announcement results.

periods

The coefficients in the

fund's

areas

banks

a 7 measure

the

areas

banks

a 9 capture

the

on economic banks

estimate limits

relaxation

that

of foreign

discount On

other

corresponding

to

restrictions,

equity

suggesting

that

restrictions

has

surrounding

the

Philippines

has

the

the

three-week

equity

event

participation

associated

with

adjusted

announcement has

of a

no effect

the

estimate

of relaxation sign,

on the

announcement

fund's

discount

coefficient

of foreign

exchange

the estimate

contrary

is statistically

of the liberalization fund's

insignificant,

of foreign during

of the liberalization

on the

of the

it is statistically

as, is positive,

no effect

(2). The

The Newey-West

that

Meanwhile,

coefficient

Equation the

of a liberalization

on the

Philippines,

this estimated

and

level of significance.

expected

announcement

announcement

the limits

restrictions,

is on average

discount.

weeks

announcements

banks the

banking

although

to the announcement

However,

during of foreign

surrounding

corresponding

that

after

participation

exchange

and

a3, a6 and

discount

equity

three

the announcement.

in the

the limits

restrictions,

of estimating

hypothesis

1 percent

no effect

fund's

restrictions

hand,

as, is of the

exchange

participation

the

participation

The coefficients

that

in the fund's

at the

the

than

the "null

during

be rejected

results

a 2 indicates

increase

suggests

discount

respectively.

the

other

and

before

foreign

of a liberalization

areas

limits

restrictions,

equity

on foreign

banking,

restrictions,

coefficient

in economic

t-ratio

can

than

an announcement

a 1.53 percent

fund's

other

participation

fund's

foreign in the

the

al, a 4 and

respectively.

changes

change

The coefficients

on foreign

banking,

weekly

exchange

on the

similar

surrounding

equity

respectively. effect

average period

foreign

of changes

3 summarizes

of the

period,

banking,

restrictions,

entry

Table

in foreign

than

effects

areas

changes

changes

of regulatory

the

three-week

weekly

other

entry

announcement

a 8 measure

restrictions,

average

but they produced

the

than

of regulatory

on economic

foreign

other

entry

announcement

foreign

during

of regulatory

on economic foreign

a2, a s and

discount

announcement

were also considered

the

exchange three

weeks

of the coefficient of entry

of foreign

to what

is expected.

insignificant,

suggesting

of entry discount.

of foreign

banks

in


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

Table

3:

Tests of the by Category

Effect of Changes in Philippine of Regulatory Change on the

International FPF Closed-end

269

Investment Country

Restrictions Fund Discount

Using Weekly Data from March 30, 1990 to December 29, 1995 " Z_D,= or,,+ Ot,FIA.,+ Ot2FIA_,+ (Z_FIA_,+ (z4FX.,+ (zsFX_,+ _cFX_,+ OtTBKt,+ ot.BK2,+ ot_,BK_,+ u, whcre

APD F/At= FIAt,= FIAa,= FXI, = FX_ = FXar = BKt, = BK2_= BK3_=

is the change in the FPF's discount in week t 1 if t is between two and seven weeks before the announcement of a loosening of the foreign equity participation limits in economic areas other than banking and 0 otherwise i if t is between one week before and one week after the announcement of a loosening of the foreign equity participation limits in economic areas other than banking and 0 otherwise 1 ff t is between two and seven weeks after the announcement of a loosening of the foreign equity participation limits in economic areas other than banking and 0 otherwise; i ff t is between two and seven weeks before the announcement of a loosening of the foreign exchange restrictions and 0 otherwise 1 if t is between one week before and one week after the announcement of a loosening of the foreign exchange restrictions and 0 otherwise 1 ff t is between two and seven weeks after the announcement of a loosening of the foreign exchange restrictions and 0 otherwise i if t is between two and seven weeks before the announcement of liberalization of entry of foreign banks and 0 otherwise I if t is between one week before and one week after the announcement of liberalization of entry of foreign banks and 0 otherwise 1 ff t is between two and seven weeks after the announcement of liberalization of entry of foreign banks and 0 otherwise. Parameter Ct,_

Estimate -0.034 (-0.23)

o_

0.473 (0.44)

O_z

-1.529 (-2.88)*

ct_

0.055 (0.07)

Ct_

-0.325

(-o.48) 0t5

0.28 (0.36)

o_,

0.49 (0.69)

Ct7

0.646 (0.66)

_

0.254 (0.47)

ct_, R_

-0.842 (-0,75) 0.0103

" Figures in parentheses are t-ratios for tests of the hypotheses a_O against the alternative that a_ <0, i=0, 1,2..... 9, based on OLS regression with standard errors computed using the Newey-West (1987) correctioa for heteroscedasticity and 3rd-order serial correlation, The superscript _ denotes significance at the 0,01 level,


270

JOURNAL OF PHILIPPINE DEVELOPMENT

For each hypothesis before

group

that

the

the

event

a130 , a4a0

period

and

significance.

of announcements,

fund's

results

be

on each

of the three

anticipated

by U.S.

investors.

effects

for announcements

restrictions

and liberalization

after The

the event null

that

period

conventional response

other

banking

of the Foreign

areas

as the most its once

related

the

perceive

on

the

alternative

that

insignificant

the effects

relaxation

Prior

announced

and

to the immediate

for prior

approval

insignificant

in foreign

exchange

are not a consequence Likewise,

do not fall during

the weeks

that

there

tested. at the

is no

delayed

to 100

the

insignificant

foreign

exchange banks

suggest

why we are

foreign

that

of foreign Bank

all

ownership

is

and

exchange

may

investment

earlier

to believe

the

as ineffective. perceived

restriction

the

is as follows.

which

proceeds

of the Philippines,

investors The

are statistically

have

liberalization

relaxation

U.S.

inclined

of announcements

investors

exchange

virtually

of announcements

find the prior restrictions

U.S.

regulatory

government

unimportant. less

activity

investors.

restrictions

rationale

by the Central

foreign

to the

In fact, the

opened

effects

as relatively

foreign

these

by the Philippine

towards

changes

of the

view

as effective.

percent

step taken attitude

U.S. investors

repatriation

investors

related

of economic

Act of 1991 which

to up

that

areas

restrictions

of these groups

reason

announced

not been

by U.S. investors.

in most

U.S.

of foreign

the

because

A possible

that

of foreign

entry

provide

banks

indicating

the existing

hand,

announced

discussions

changes

the

effect for announcements

resolute

to the liberalization

of restrictions

that

of

investment

have

be rejected

unfriendly

other

levels

a3>0, a6>0 , or ag>0 cannot

activity

to reverse

conventional

are also

Investment

considered

that

of announcements

participation

and

of economic

On

group

suggests

passage

3. The hypotheses

of announcements.

equity

as important

weeks

indicate

FPF's discounts

the null the

in Philippine

anticipated

of a significant

changes

during

of announcements

also

of significance

of foreign

than

been

the

group

The finding relaxation

changes

of entry of foreign

that

levels to each

the

to regulatory

for each

hypotheses

that

They

having

the null hypotheses

at

groups

related

of the announcements

in Table

rejected

suggest

restrictions

of testing

do not increase

are also reported

a730 cannot

These

the results

discounts

allowed without

full need

full repatriation


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

and

remittance

though

privileges

on a staggered

In addition,

foreign

requirements

that

Euromoney reportorial

existing

cites 24

domestic

bank

direct

This

investment

potential

than

diversification

(1995) document First Philippine

that Fund

FPF who

have the

perceived announced

net

investors

between

1991

the

majority.

announcement up

of other

sectors

of banking of total assets also

assets

of the

in nonbank

portfolio

from the Foreign

of economic

of the percent

that total

investment inward

for the

It shows

especially

in the

year

the

However,

it constitutes

fund

compared

stocks

investments

in the banking portfolio

of the

been

growing

announcement

only under 80 percent

20 percent share

of net

1995. rates

of total

inward

An examination

of the

annual

sector

This is reflected

government/listed

of the Bangko

investments sectors.

do not prefer B lends some

30,

in approved

Department

constitute in

1995

to

These

growth

and

Philippines.

after

to the

as of June

activity.

the percentage have

in the

nonbanking

that

may

relative

investors Appendix

of banks

distribution

Exchange

U.S. investors importance

stocks

common

percentage

investments

total inward shows

1995,

liberalization.

net

in the

portfolio

inferences.

effect of banking individual investors

Alternatively,

to be of minor

FPF in common

and

seek in the of the

preceding

of the

who

as of December 1990, institutional ownership constitute only 12 percent of the total shares

opening

to the

assets

through et al.

inferences do not imply, however, that individual to hold portfolio investments in the banking sector. support

affects

Bodhurta

represent this

investors

mostly

funds.

fund. Therefore, the insignificant announcement liberalization possibly reflects the perceptions of the of the

portfolio enterprise

portfolio

via country

of an

incorporated

liberalization

individual

of foreign

stock

subsidiary

of the domestic

benefits

the remaining

voting

by individual

banking

who seek control

rather

global

viewed

example,

of entry

of the

Bank.

reporting

For

with

liberalization

a new banking

allowed

rigorous

change.

associated

of 60 percent been

already

by the Central

with

regulatory

the announced

is because

investors

to deal

the

or through

were

to approval

have

inefficiencies

may have

unimportant.

institutional

the

via a purchase

in the Philippines as

still despite

hand,

investments

and subject

remain

other

effected

basis investors

(1996) process.

On the banks

for foreign

271

Sentral

securities ng Pilipinas

only 11.61 percent compared

to 86.49


272

JOURNAL OF PHILIPPINE DEVELOPMENT

The events

in the sample

announcements limits and

related

(Foreign those

Investment

related

regression

were also classified

to the liberalization

Act of 1991 and banking

to a liberalization

model

simply

of foreign

for this

of foreign

alternative

into two groups:

equity

participation

liberalization

exchange

classification

combined)

restrictions.

of events

zlDPD t= Yo+ y1FIABKj_ + y2FIABK2t + y3FIABK3 t+

y4FXlt

The

is:

y_FX2t + y6FXjt +

+

17c /IDPD t represents

the change

represent

the

of foreign

equity

variables

for the

restrictions.

dummy

windows

for the The

of model

the

foreign

exchange

The results, model,

though

the coefficient of foreign the

discount

surrounding significant announcements in a different corresponding restrictions,

changes

the

0.10

related group. to the

level,

change

surrounding

limits

coefficients

h and

discount

before

participation

Y4 the

limits Y3 and

discount

equity

in the

participation

fund's

similar

after

participation

fund

to those

significance.

g0 the

limits

with

during

the

three

other

contrary

hand,

the

of relaxation increase week

in

period

weaker

than

when

Act of 1991 are classified estimate

of relaxation to what

of

effect is statistically

is relatively investment

second

The estimate

a 0.93%

This announcement which

of the

an announcement

is associated

announcement

Ys, is positive,

4, are

on average,

to the Foreign On the

used.

The coefficients

the

of statistical

country

the announcement.

weekly

longer

respectively.

in general FPF

average

equity

on foreign

in Table

that,

limits

of the

at

in

changes

were

fund's

on foreign

when

periods

The

the

dummy exchange

for i = 1, 2, and

found

equity

respectively.

in terms

g2 indicates

equity

on

take,

period

respectively.

effect

restrictions,

weaker

the

the

are

of foreign

were

in foreign

of changes

reported

results

three-week

changes

of regulatory

FXits

variables

ys measure the

restrictions,

effects

announcement and

/'2 and

weekly

exchange

represent

dummy

t. The FIAB_ts

of a liberalization

The

post-announcement

of regulatory

foreign

in general.

restrictions,

average

in week

announcement

(1). Similar

during

exchange

the

announcement and

and

discount

of a liberalization

these

of regulatory

foreign

measure

pre-

discount

announcement

limits

that

coefficients

fund's

for the

announcement

The values those

and

variables

participation

3, follow

the

in the fund's

of the

coefficient

of foreign

exchange

is expected.

However,

this


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

273

Table 4: Tests of the Effect of Changes in Philippine International Investment Restrictions by Category of Regulatory Change on the FPF Closed-end Country Fund Discount Using Weekly Data from March 30, 1990 to December 29, 1995" APD= _,+ y,FIABK,+ _FIABK2,+ y,FIABK_ + _FX,+ _FX_,+ _/_A_a+ /7, where APD, is the change in the FPF's discount m week t FIABK_, = 1 if t is between two and seven weeks before the announcement of a loosening of the foreign equity participation limits m economic areas including banking and 0 otherwise FIABK2= 1 if t is between one week before and one week after the announcement of a loosening of the foreign equity participation limits m economic areas including banking and 0 otherwise FIABK3= 1 if t is between two and seven weeks after the announcement of a loosening of the foreign equity participation limits in economic areas including and 0 otherwise; FXl, = 1 if t is between two and seven weeks before the announcement of a loosening of the foreign exchange restrictions and 0 otherwise FX2, = 1 ff t is between one week before and one week after the announcement of a loosening of the foreign exchange restrictions and 0 otherwise FX3, = 1 if t is between two and seven weeks after the announcement of a loosening of the foreign exchange restrictions and 0 otherwise Parameter

Estimate

7,

-0.034 (-0.23)

Y1

0,531 (-0.67)

Y2

-0.934 (-i.55)***

Ya

-0.244 (-0.36)

Y4

-0.325 (-0.48)

75

0.280 (0.36)

y_

0,490

Ra

(0.69) 0,0068

"Figures in parentheses are t-ratios for tests of the hypotheses 7_30 against the alternative that y_ <0, i=0, 1,2,...,6, based on OLS regression with standard errors computed using the Newey-West (1987) correction for heteroscedasticity and 3rd-order serial correlation. The superscript

*** denotes

significance

at the 0.10 level.


2,74

JOURNAL OF PHILIPPINE DEVELOPMENT

coefficient fund's

is statistically

discounts

for each at

rise during

group

the

conventional

indications

are

that

The finding in this category when

that

participation

equity

response

However,

the banking

to the Foreign

that

Investment

discount

is stronger

banking

is relaxed.

related

there

the

are no

changes

as

of significance

of

to the relaxation

suggests

foreign

that

investors

is included

of foreign

the existing

access

barriers

to the Philippine

effect is weakly

significant

in the announcements

Act of 199 1 implies

only when

that

76>0.

the announcement

liberalization

be rejected

regulatory levels

the

period

implies

Likewise,

conventional

is significant restrict

This

announced

announcements

effectively

market.

at the y3>0 and

limits

74>0, cannot

by investors.

to the

that

to the announcement

significance.

not anticipated

hypotheses

prior

i.e., ),1>0 and of

by the nonrejection

null

equity

the weeks

levels

of delayed

indicated

The test of the hypothesis

of announcements,

announcements

the

insignificant.

that

the foreign

the impact

equity

related

on the fund's

ownership

other

than

CONCLUSIONS

In

this

international of the

study, investment

First

the

international

fund's

should

hypothesis

that

reduce

the

and

on the

fund.

We test

whether

are associated

discounts.

If the

announced

of

discounts

restrictions

effective, premium

of liberalization

Philippines

country

in investment

results changes

announcements

with

barriers

to

liberalizations

or increase

suggest

that

in

FPF's

of changes

although a

there

significant

announcements results

closed-end

are

impact

the

discount

of of the

fund. The overall

effective,

the in the

premiums

investments

restrictions

However,

Fund

of changes

in

country

investigate

restrictions

Philippine

announcements changes

we

suggest

is evidence

discounts

are

supporting associated

the with

in international

investment

restrictions.

indications

the

barriers

relationship

are deemed that

are

the

there

important

announcements

that appears

existing to

by U.S. investors. of liberalization

hold

only

are when

Specifically, of investment

the


UNITE AND BEVERIDGE:CAPITAL MARKET LIBERALIZATION

restrictions

that

other

than

with

an

limit

banking

foreign

and

increase

financial

in

announcements

the

related

(in particular

the removal investments

foreign

to operate

portfolio the

investors

investors

to international in most

in the Philippines

of the study

investments

economic

liberalization

of this

The results

also indicate

been

effective

of this restrictions that

companies

market,

domestic

firms.

with the liberalization cost

of raising

critical

of funds faced

liberalization the

inflow

obvious

relationship movement financial consistency

funds

we have

shown

estimated of returns securities

between

establishes

of liberalization

that

of capital

discount

increases

a reduction

in the

market, is one Philippines.

liberalization

financial

programs

sector

The

indirect

has

effects.

have

The

at

various

impacts are

on quite

significant

measures

underlying impact.

effects

As

resources.

through

direct

on liberalization

of the

aimed

domestic

as well as indirect

country.

the

for the

projects

this indirect measures

through

like the

direct

news

To the extent

economy

potential

on a fund

ownership

projects

and mobilizing

the

the

equities.

FPF's

has

investment

in the

into

equity

implies

stock

investors.

One implication

the cost the

limits

announced

restriction

market. foreign

that

barriers

by U.S.

ownership

restrictions

created

that

important

increased

market

has

of

that

ownership

and

investment

has pursued

measures of foreign

but

new

to finance

barriers

investors

Philippine

equity

on Philippine

by a developing

of market

that

equity

Philippine

capital

of foreign

are no indications

effective

equity

the finding

the country

the domestic

removal

return

in the

problems

developing The

capital

restrictions

by individual

constant,

of ownership

Sourcing a consequence,

else

restrictions

Therefore,

exchange

the

to be viewed

by foreign

been

finance

ownership

hand,

seem

evidence

the Philippine

the required

other

of entry

There

the foreign

all

the

liberalization

is deemed

that

is that,

raised

Philippine

stock

have

in segmenting

evidence

provide

restriction

associated

announcements.

represented

activities

significantly

and

unimportant. these

of business

on the ability

dividends)

anticipate

The findings

On

in areas

of foreign

of restrictions and

are

discount.

relaxation

as relatively

fully

participation

institutions

fund's

to the

to repatriate banks

equity

2?5

and

the

peso-denominated The continuance

the potential

of making

and peso-


2"76

JOURNAL OF PHILIPPINE DEVELOPMENT

denominated

assets

attractiveness, assets, Thus,

attractive

in effect,

which,

in turn,

in the

creates

may raise funds

macroeconomic

measures

policies

of Philippine

as well as to continue

the

investment

market,

to pursue

market.

This

for peso-denominated

an impact

capital

policymakers

capital

demand

for various

make

firms viewed from the international on the part

international

additional

undertakings.

on financial

features

it is therefore

imperative

consistent

liberalization

of

macroeconomic

programs.

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P. "Asset

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Massachusetts:

NYSE Stock

Policy, Trends,

De La Salle University

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R. "A Model

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280

JOURNAL OF PHILIPPINE DEVELOPMENT

NOTES

1

2

Nondiversified means that the country fund is not limited by the U.S. Investment Company Act of 1940 in the proportion of its assets that it may invest in the securities of a single issuer (Standard & Poors 1989). This restriction on foreign equity participation was relaxed with the implementation of the Philippine Foreign Investments Act of 1991. This measure virtually opened all economic sectors to 100 percent foreign equity ownership, except in those areas specified in a transitory negative list. A key feature of the FIA is the negative list of sectors where foreign investment would be limited to a maximum of 40 percent, but free to invest in all other sectors without prior approval from authorities. On October 1991, a three-year transitional period went into effect during which foreign ownership was restricted to a maximum of 40 percent in sectors specified in the transitory negative list. The issuance of Executive Order No. 182 in June 1994 effectively deleted List C of the transitory negative list. Foreigners can now fully own businesses in areas such as insurance, travel agencies, wholesale trading, convention organizing, and manufacturing under foreign licenses.

3

It must be noted, however, that not all companies follow this "A" and "B" share convention. Exceptions include (a} companies that are not involved in restricted areas of business and do not own land and (b) companies that float a sufficiently small percentage of their shares so that even if all those floated shares were purchased by foreigners it would not violate foreign ownership restriction (Rodrigo 1993). As a result of the liberalization of foreign equity restrictions, firms that have recently listed their shares rarely resort to this share classification.

4

In addition, the international asset pricing models of Black (1974) and Stulz (1.981) provide implications on the relationship between barriers to international investments and country funds' price-to-NAV ratios. However, the models of Eun and Janakiramanan (1986) and Hietala (1989) seem to capture better the nature of investment restrictions in the Philippine equity market. Black (1974) and Stulz (1981) assume that international investment barriers take the form of a tax on holdings of foreign risky assets by domestic investors that make it costly to hold foreign securities relative to domestic securities. The restriction essentially places a limit on the amount of capital that domestic investors can export. Both models predict that the expected return on long positions on tbreign assets will exceed the expected return on a domestic asset of the identical risk by the rate at which such holdings are taxed thereby ensuring that after-tax expected returns on the two assets are the same. The closed-end country funds, whose underlying shares are foreign risky assets, are analogous to long positions on foreign risky assets indirectly taken by domestic investors while the country funds' shares themselves can be considered as domestic assets of about the same risk. Therefore, these models suggest that international investment restrictions that make it costly for a domestic investor to hold foreign assets relative to domestic assets will increase the required return on the country funds' underlying assets relative to the required return on the funds' shares themselves. Consequently, the imposition of effective or binding restrictions in a country will increase the price-to-NAY ratio investing in that country by an amount related to the tax exacted. Chang, Eun and Kolodny (1995), Johnson, Schneeweis and Dinning (1993), and Diwan, Errunza and Senbet (1993) provide evidence of international diversification benefits through investment in closed-end country funds, especially in funds devoted to emerging markets' securities.

s


UNITE

6

AND

BEVERIDGE:

CAPITAL

MARKET

LIBERALIZATION

2.81

Stylized facts seem to support this argument. For example, Mullin (1993) reports that during the mid-1980s, closed-end country funds were the primary, and in some cases, the only available, means through which foreign portfolio investors 'purchased' emerging market equities. 1990 at US$3.4 billion and then declined was

in contrast

direct reason

to the

observed

rapid

increase

equity portfolio inflows during for the dampened demand

acceleration liberalization

of direct reforms

The issuance of such funds peaked in to US$1.2 biIlion :in 1991. This decline in international

the same period. for closed-end

placements

He cites that country fund

equity portfolio inflows can be attributed instituted by several developing countries,

and

an apparent shares and

to capital which

market reduced

the impediments to direct equity purchases by foreigners. To support this argument, Mullin {1.993) provides an inventory of liberalization of restrictions on foreign access to the equity markets of developing countries including Argentina, Brazil, Chile, Mexico, Korea, Taiwan, Malaysia, Thailand, mid India which occurred during the period 1989 to 1992. 7

It should

be

Philippine have been

securities interesting

changes

in the

However, s 3

data

Although vember The

New

l0

The

FPF

are

listed

(Standard

Stock

hours

other

country

investment

country

was

1.989

York

funds

gaps

in the

on

Exchange

of the

plot

not

November

& Poors

devoted

to investing

stock

correspond

in the

readily

8, 1989,

Philippines

as

NYSE

from

0930

exchange

it began

trading

to

New York

time.

The

to 1200

local

time

1600

is from

time.

to the weeks

The

0930

market

of April

5, 1991,

in Philippine equities 30, 1991 and at 96.2

Stock

et al. (1994)

Reports,

examine

well.

available. only

on No-

is open

from

November

Monday 27,

respectively, when the fund did not report its NAV. The these missing values is discussed in Note 13.

& Poors

in

1990}.

operates

Philippine

Note, however, that investments net assets of the fund as of June Hardouvelis

funds

restrictions were

to 2300 of previous day New York Friday in both exchanges.

(Standard t2

there

and which are traded in the London stock exchange, it would to examine how European investors view the announced

international

and March 3,1995, dure for estimating tl

that

on these

the 15,

operating or 2000 through

noted

the

1991

and

extent

1992, proce-

represented 57.3 percent of percent as of June 30, 1995

1995).

to which

the

noise-trader

model

of

asset prices (De Long, Shleifer, Summers, and empirical regularities of the weekly price behavior on the New York and American stock exchanges ture of the noise trader model is the variation

Waldman 1990) can explain the of 35 country funds that traded between 1986 and 1993, A feain the demand of noise traders

arising from other things,

of fundamental value, Among counterparts, country funds are

shifts they

in sentiment or misperceptions find that, like their domestic

typically issued at a premium and that the premium declines by approximately 20 percent over the 24 weeks lbllowing the initial public offering. They argue that this is consistent with the predictions of the noise-trading model. One prediction of this model is that a new fund will be issued only when sentiment for the fund is high. The premium at the initial offering of a country fund is then explained ability of fund organizers to time the issuance of funds to coincide with fund investor sentiment {e,g., bullish investor sentiment for a country). other hand, the subsequent reversion in fund investor la

We estimate procedure

the

three

is based

deterioration sentiment.

missing on

observations

Beveridge's

(1992)

in the

premium

based extension

on

this of the

is explained adjusted linear

by the positive On. the by mean-

sample. least

The

squares


282

JOURNAL OF PHILIPPINE DEVELOPMENT

interporlator. An advantage of this technique over the earlier mation of missing values is that it can handle any pattern

procedures of estiof nonconsecutive

observations. First, the NAVs are adjusted to include dividends and capital distributed during the period. Per closed-end fund reporting conventions,

gains divi-

dends and capital gains axe deducted from reported NAV when the shares go exdividend and not on the dividend payment date. Secondly, autoregressive (AR) models were estimated for the NAV series immediately prior to the first missing observation. Similarly, AR models were estimated for the series of NAV immediately after the first missing observation up to the observation immediately before the second missing observation and for the series of NAV immediately after the second missing observation up to the observation immediately before the third missing observation. Using the Schwarz Information Criterion (SIC), an AR(1) was found to be the best model in each case. In each case, the estimate of the AR(1) coefficient is significant and very close to 1 and the residual autocorrelations of the estimated model are all statistically insignificant at the 0.01 level. These suggest that the NAV series follows a random walk. To confirm this, each series was first differenced. The autocorrelations of each of the first difference series are all statistically insignificant. Therefore, the best estimate (minimum mean squared error) of each of the three missing values is obtained by taking a simple average of the NAV observations, with dividends and capital gains payments included, immediately before and after the missing value and then deducting the dividends and capital gains payments. 14

Direct investments axe investments which give the investor some degree of control over the funds invested (e.g., acquisitions of 10-25% of voting shares of a cornparty) while portfolio investments are not afforded such control (e.g., purchases of bonds and equity ownership of less than 10-25% of voting shares) (International Monetary Fund 1977).

is

We will only refer to discount changes and not premium paper. The reason for this is that the FPF consistently its NAV during the period under study.

changes for the rest of the traded at a discount over

16

A similar model is employed by Bonser-Neal et al. (1990). Prior to estimating Equation (1), the fund's discount changes axe adjusted to remove any dividend/ capital gains payment announcement effect and ex-dividend/capital gains effect. The details of the adjustment procedure axe discussed in Appendix B of BonserNeat et al. (1990). Four discount changes are adjusted because they cover dividend announcement and ex-dividend periods. The adjusted discount change series has about the same mean though slightly higher standard deviation than the unadjusted discount change series. The mean of the adjusted discount change series is 0.030 compared to -0.033 for the unadjusted series. The standard deviation of the adjusted discount change series is 3.035 compared to 2.998 for the unadjusted series. We also estimate Equation (1) using the unadjusted discount changes but there is a very minor difference in the results compared to those reported in this paper.

17

Bonser-Neal

et al. (1990) and Bodurtha

et al, (1995) argue

that the positive

cross-


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

283

correlations in the price and NAV of country funds could be an artifact of nonsynchronous SP and NAV measurements due to the timing differences between the foreign country stock market and the NYSE. As mentioned earlier, there is a 17-hour difference between the Philippine Stock Exchange close and New York's close. This might introduce a bias in the results if the event window is confined to the announcement week. The potential for bias can be illustrated as follows. As discussed in the Theoretical Framework, ceterisparibus, the introduction of binding restrictions will increase a country fund's price-to-NAV ratio above the level prevailing in the absence of such restrictions by approximately the amount the investor is willing to pay to avoid the restrictions. For example, the Philippine government announces a relaxation of its foreign investment restrictions. Since the removal of investment barriers that reduces the cost for the U.S. investor of directly holding Philippine equities will reduce the required return on the fund's underlying assets relative to the required return on the fund's shares, the price and NAV of the FPF will rise in response to the announcement. If the prevailing restrictions prior to the announced liberalization are binding, the fund's priceNAV ratio will fall; i.e., the fund's premium decreases or the discount increases. However, if NAVs are reported with some lag, the fund's price will change before its NAV changes and the fund's premium will rise (discount will decrease) in the announcement week. The decrease in premium (or increase in discount} would only become evident the following week, when both the fund price and its NAV would have completely adjusted. i8

The sample autocorrelations of the first 6 lags of the changes in percentage discounts for the FPF are -0.19, -0.07, -0.12, -0.03, -0.03 and 0.01, respectively. The firstand third-order autocorrelation coefficients are found to be significant at the 0.05 level wl_ile coefficients at higher-order lags are all insignificant. These suggest that the residuals of regression model (1), as well as the other models considered in this study, are likely to be serially correlated. The pattern of the regression models' sample residual autocorrelations confirms our initial diagnostics. For Equation (1), the sample residual autoeorrelations for the first 6 lags -0.20, -0.05, -0.14, 0.00, -0.05, and 0.03. Only the first- and third-order autocorrelation coefficients are significant at the 0.05 level. The higher-order (beyond the sixth-order) autocorrelation coefficients are all statistically insignificant. The sample residual autocorrelations for the first 6 lags of Equations (2) and (3) and their significance are identical to those of Equation (1). Likewise, the higher-order sample autocoiTelation coefficients of Equations (2) and (3) are all statistically insignificant. It is also possible that, as a result of the various liberalization announcements, the fund's discount changes may not be homoscedastic. Consequently, we employ a heteroscedasticity and autocorrelation consistent estimate of the variancecovariance matrix of the OLS estimates based on the procedure proposed by Newey and West (1987).

i9

The results of using longer pre- and post-announcement w'.'ndows are not very much different from those reported here. In fact, among the 10 publicly traded banks in 1991, only one bank (Rizal Commercial Banking Corporation) has an "A" share - "B" share classification. The rest had unclassified shares,

2o


284

21

JOURNAL

Under

the new

approved in

rules

a bank

now

An

anonymous

referee

and monitoring such

as the

were

July

1997.

that

this

that

covers

that

that

surveyed

international

potential

1991;

Rodrigo

towards

example,

regulatory

country, funds.

This

our

an

the

ensures

restrictions

1996).

that

These (see e.g.,

For example,

from

markets

the

large

in general

government

rigorous

it would

among

abroad

Philippine

other

Philippines

restrictions.

maintained

that

period

and

impression

benefited

in think

sample

guides in the

emerging

While

and

we don't

published

has

regulatory

mentioned

and Euromoney

it has

directed

are

towards

in particular.

foreign

Bonser-Neal, changes

"Generally,

the

todian

bank

chase

foreign

proceeds,

of the

per

intensive. must The

certificate investor. ing the

Sentral

currency

a BSRD

part

bank.

Bangko

from

has

reporting

the government

and'

:is aware

be forewarned

a different

bank,

advice,

This

Frequently

the

payment,

as

bank

of inward

remittance

names

and

addresses

and

after-tax

the

dividend."

that

not

if the

inflow

dividends

not the

the

investor, of the 1996).

the

receive bank

the

investment currency

bm_k

to use

originally

BSRD

from

BSRD

of the

to

all or

and

currency

BSRD the

is

bank

time-consuming

be accompanied

dividend,

To pur-

custodian

remitting

the that

by a cus-

foreign

the

foreign

to provide

must

of the

ask

is issued securities. of the

If the

manually

is selling

amounts

(Euromoney

(BSRD)

must

announced

Fund.

for repatriation

investor

be able

from

of aggregate Taiwan

presented.

authorizes

it does

may

of cash

be

is inefficient,

bank

custodian

Remittances

the

effect of the

Document

bank

must

which

process

the case

government/listed

custodian

invoice

letter

delay

the

sales

BSRD.

find

in the

in approved

the gross-

declaring

(1990)

Registration

for investments

from

provid_

et al.

to be insignificant

a broker's

purchased

and

1996;

is being

during

of such

Philippines

Asia

However,

create

and

that

in the

and

commenced

that

environment and

restrictions

of the Philippine

all investment

seriousness

directed

prior

of the administrative

on the previously

investors

"The

the

crisis

investors

country

securities

1995).

supervisory

argument.

Hinkelman

recently

over

investment

financial

can Also,

to reverse."

For

tion

1993;

interest

controls

of where

the

deposit 1.996)_

agencies

in the

investment

of the

reports

that because

almost

stress

to foreign

south-east this

regulatory

foreign in

cater

of investment

welcomed

were

the

investors

(1996)

amounts

foreign

In fact,

emphatically

mostly

Euromoney and

analyze

foreign

George

among

to 1995.

Llanto

possible

Asian

the

Bank-approved

and

flaws

valid

investments

publications

the

on

Bank-

deposited

(Euromoney

in the regulatory These

is a very

view

1989

publications we have

this

earned

as ineffective

Bank.

during

prevailing

the year

it is also

inefficiencies

We feel that is the

that

Central

exposed

interest

(Lamberte

investors

in Central

may be temporarily

in Central

days

DEVELOPMENT

investments

registration

investment

by U.S.

government

any

further

to four

argued

viewed

weaknesses

to

24

in three

foreign

an investment

and

without

to foreign

be settled

been

covering from

repatriation,

related

can

mechanisms

23

to

be remitted

transactions

may have

regulations

any proceeds

prior

automatically

22

and

securities,

OF PHILIPPINE

pa-

for repatriathe

custodian

as it is awaiting sold

pesos

by a schedule securities

as well as a board

a

to the showinvolved,

resolution


UNITE AND BEVERIDGE:CAPITAL MARKET LIBERALIZATION

Appendix

A:

Chronological

Listing

in Philippine 10/14/94. was

liberalized

purchase

(Circular

of a new banking

of foreign No. 51).

of 60 percent

of Announcements

International

The entry

subsidiary

Such

equivalent

(converted

three

additional

P35 million must capital inflows. 6/22/94.

branches

assigned

President

to overseas

businesses.

liberalization

that

businesses ownership. travel

The executive

order

rate

of P26.979

dollar per

and converted branches. For equivalent

investment,

the Philippine is part

the

to the branch

of the

be remitted of three

Direct

opened

effect

or

or through

the U.S. dollar

(IMF 1995):

Fidel Ramos

takes

a

bank

capital

at the exchange

to be opened,

be remitted.

through

domestic

banking authority, subject Bank. For a foreign bank

US$1 - the rate prevailing on June 5, 1994) must into pesos, which will allow for the establishment each

Philippines

can be effected

in the Philippines

permanently

of P210 million

in the

of an existing

incorporated

established),

Restrictions

to operate

entry

stock

establishment of branches with full licensing requirements of the Central (new or already

of Changes

Investment

banks

of the voting

285

of

loosening,

economy

wider

of a foreign-investment

Oct. 24. Non-Filipinos

will be able

to own

in many sectors that now are restricted to 40 percent foreign Foreigners will be allowed to operate in areas such as insurance,

agencies,

wholesale

trading,

convention

organizing,

manufacturing

under foreign licenses, and cockfighting. The easing isn't expected to affect the economy much initially, but it underscores Mr. Ramos's determination to increase

competition

of hardship. 'adequate

in protected

The National capacity'

areas,

Economic

and

is not a sound

basis

despite

small

Development

capital

8/10/92.

foreign

The Philippines Businesses

deregulation

of trade

year,

will remove

earnings Philippine

to banks. residents

said that

investments

benefits high-cost Direct investment,

inflows.

restrictions.

said the measures,

claims

Authority

for excluding

in a particular sector. It said restricting competition producers at consumers' expense. (WSJ 6/23/94): loosening,

companies'

and

will scrap analysts

most remaining

welcomed

and foreign-investment the second

stage

requirements Under may

that

the package borrow

policies.

of an overhaul exporters expected

as much

foreign-exchange

the move but urged

further

President

Fidel Ramos

launched

late the last

sell their to take

foreign-exchange effect

as $1 million

from

this month, banks

for


2,86

JOURNAL OF PHILIPPINE DEVELOPMENT

investment

abroad

deposits.

Gold imports

gold exports required

central

won't

will be allowed.

15 types

including to banks

bank

require

approval

central

The first stage,

of enterprises,

ranging

and

may hold overseas

bank

authorization

widely

considered,

from airlines

which

encourage

said it removed Filipinos

92): Foreign

exchange

1/3/92.

Central

changes

entailed

liberalization

Bank

loosening,

of the

to investment

more earnings. capital

Philippines

the

broader

of repatriation

coverage

outflows.

issued

rules/regulations

of foreign

and remittance

of reportorial

No. 1318, foreign

investments,

privileges

requirements.

are defined

Act of 1991, which

the investor.

Full and immediate

of duly registered

considers

to include

the nationality

repatriation

investments,

as direct

as

Under

investments brought Foreign

or citizenship

of

privileges

for

and remittance

whether

and regardless of the made are now allowed

the

and the reduction

and documentary

investments

Investments

shares/securities investment were

and

(WSJ 8/11/

by a resident in foreign exchange or its equivalent in assets actually into the country, as contrasted to the definition under the

all types

and

all these earnings move encouraged

blocks

to repatriate

incomplete,

foreign exchange transactions, including investment With respect to foreign investments, the major policy

well as simplification CB Circular

abroad

accounts,

liberalizing nontrade related transactions.

psychological

and most

to oil companies

most foreign-exchange earners, to sell almost for resale to the central bank. The latest

businesses, could

without

equity

or in listed

type of industry or sector where to be directly serviced by AABs

[Authorized Agent Banks which include all categories of banks (except offshore banking units) duly licensed by the Central Bank] without prior CB approval. This is in contrast to previous guidelines where immediate repatriation was allowed only for registered investments certified

export-oriented

otherwise

staggered

years, depending investments were repatriation

industries

and

for investments

in CB-approved

in other

of investment

financed

under

Circular

No. 1111 dated

dated

October

20, 1982

and

through

August Circular

shall be governed

by said Circulars

(IMF 1.993, WSJ outflows.

1/7/92):

Foreign

securities,

industries

on the type of industry and made. However, under Section the

but

from three

is

to nine

sectoral priority where 40 of Circular No. ].3].8, debt-to-equity

26, 1986, Revised No. 1267 dated

or any subsequent exchange

full and in CB-

accounts,

Circular

program No. 1111

December

20, 1990,

alnendments

thereto.

loosening,

capital


UNITE AND BEVERIDGE: CAPITAL MARKET LIBERALIZATION

6/6/91. own

as

ited

to 40

aimed

as

percent.

Philippine 100

$100

and

medium

percent

million

holding

of gradually.

flows.

(note:

Appendix

jobs from

B:

common

Meanwhile,

the

in Philippine 6 / 7 / 91):

into

Direct

Manila Bank

lim-

is also

will seek

to borto small

will probably

shed

80

year

in-

in a single investment,

to

now

for relending

government

Airlines

foreigners

country,

law in November,

Separately,

Development

phase

this

loosening,

capital

updating)

Percentage Philippine

stocks

in the

to be signed

Asian

Distribution Fund â&#x20AC;˘

As of 6/30/1.991

In

a bill allowing

businesses

for Filipinos.

the

(WSJ

need

approved

of most

measure,

industries.

of its

Congress

percent

The

at generating

row

stead

The

much

287

As of 6/30/1992

of the

Net

As of 6/30/1993

Assets

of the

As of 6/30/1994

First

As of 6/30/1995

of firms in:

Banking

2.0

7.0

8.0

10.5

16.4.

Telecommunications

18.7

22.8

14.6

16.1

13.3

Food m_d Beverage

12.0

17.4

18.6

22.7

21.2

0.2

8.6

8.0

8.2

11..3

7.0

11.6

14.5

12.7

3.2

6.8

10.0

8.6

10.9

19.8

9.9

16.4

12.8

10.4

57.3

83.2

87.2

93.4

96.2

Conglomerates Electric Utilities

Nil

Real Estate Development Other Total Common

Stocks

Net assets are based on market value. Source: Standard & Poors NYSE Stock Reports

{1991-1.995)

in-


/pidsjpd98-2fund