Emerging market debt eyes Brazil's key testimony; Philippines' murky story

By Reshmi Basu and Paul A. Harris

New York, June 14 - Brazilian paper rallied Tuesday after Roberto Jefferson, a Labor Party deputy, testified that he had no proof to back up his charges of corruption against president Luiz Inacio Lula da Silva's administration.

Much of the focus on Tuesday centered on Jefferson's testimony before a congressional ethics committee, said sources. Last week, Jefferson incited a political scandal when he accused the government of paying "monthly allowances" to many lawmakers in return for support of government-backed legislation.

In recent interviews, Jefferson acknowledged that he had no proof to back up the charges. And that remained the case during Tuesday's testimony.

"I have no proof, I am only a witness," testified Jefferson.

Brazilian financial markets rallied on the news.

"The market was waiting to see if he had any proof, any tapes, anything to prove his allegations," said a buyside source.

"Apparently, he doesn't have anything, so the market took that as a positive and it's rallying," said the source.

Prior to his testimony, there was little movement in Brazilian debt. The Brazil C-bond was spotted unchanged at 101½ bid while the bond due 2040 inched up 0.10 to 117.65 bid.

After the conclusion of Jefferson's testimony, the C bond was up a quarter of a point to 101¾ bid while the 2040 bond gained 0.35 to 117.90 bid.

The buyside source added that there was not a lot of clarity as to whether Lula's chief of staff Jose Dirceu, who has been under increasing pressure from the scandal, will step down and return to the lower house of congress.

"All in all, I think investors might be looking at this as a slight positive because Lula has been trying for awhile now to restructure the cabinet and allow the other parties in the coalition to take some seats," said the source.

"And this will probably be a good time for him to do that, so I think if that happens, the market will react positively."

Nonetheless, sources said the political scandal is far from over.

"I don't think it has died down. Obviously, that he [Jefferson] does not have a case or anything to prove his corruption allegations is a positive, but I think there might be still some headlines coming up in the following weeks," warned the buyside source.

Philippines' confusion

The unfolding of the alleged corruption story in the Philippines has been a murky one, as investors have had a tough time reading the situation. Accusations have been flying around that president Gloria Arroyo fixed last year's close presidential election.

Furthermore, there are tapes which allegedly have wiretapped conversations between Arroyo and commissioner Virgilio Garcillano planning to carry out election fraud.

Additionally, members of the president's family have been accused of involvement in an illegal numbers game. Her eldest son has stepped down from the senate, which was viewed as a market positive, said the buyside source.

"The market has been behaving relatively well given all the stress associated with the corruption scandals, but the Philippines was already trading relatively wide to EM as a whole, so some of these problems were arguably already priced into spread levels," according to an emerging market analyst.

The country's paper saw higher bids Tuesday. During the session, the Philippine bond due 2023 gained a quarter of a point to 111¼ bid.

Nonetheless, the damage has been done as the headlines have diminished the ability of Arroyo to push through much needed legislation, said the analyst.

"The chances of an outright collapse of Arroyo's government appear low, but the main problem now is that Arroyo will be discredited by these accusations, which in turn will make it that much more difficult for her to continue to pursue the fiscal austerity program.

"She still needs to implement the bulk of the tax increases next year, which may be more difficult for her to do if her popularity ratings are in a nosedive," he added.

The buyside source also remarked that this corruption story has been hard to grasp, given that it can change dramatically from day to day.

The source, who holds a neutral position in the Philippines, made that decision based on the Philippines' fiscal performance, which has been better than expected.

"So we kind of suffered a little bit there," said the source.

"With all this political noise, we're comfortable being neutral. And if things change for the better, we might increase to overweight. But we've been neutral for a long time," replied the source.

EM down

Overall, emerging market debt drifted lower during the session. The JP Morgan EMBI+ Index fell 0.04% while its spread to Treasuries narrowed four basis points to 316 basis points.

The overall tone in the market is positive, noted the buyside source.

"We have a round of strengthening here. I don't think there is anything coming from within the asset class. We have to look outside for something that will push us wider here," remarked the source.

"Overall, investors still have some cash and are willing to put it to work here and there."

Meanwhile the source added that there must be some sort of market correction down the road, but it is hard to predict just when that will happen.

"It's just surprising, with GM and Ford and everything that's happened, we've held up surprisingly well. Right now, the high-yield market is doing fine. Credit is doing fine in general, so we're okay.

"It's hard to say what will be the next trigger for a widening."

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