Phisix: Plagued By Domestic Politics

``The interventionist doctrinaires and their followers explain all these undesired consequences [of government intervention] as the unavoidable features of capitalism. As they see it, it is precisely these disasters that clearly demonstrate the necessity of intensifying interventionism. The failures of the interventionist policies do not in the least impair the popularity of the implied doctrine. They are so interpreted as to strengthen, not to lessen, the prestige of these teachings. As a vicious economic theory cannot be simply refuted by historical experience, the interventionist propagandists have been able to go on in spite of all the havoc they have spread."-Ludwig von Mises, Human Action

One of the risks we mentioned in today’s marketplace, aside from external recessionary environment, is domestic political risk.

Considering that foreign money has not been much of a driver of late, the Phisix has been subjected to mainly domestic sentiment, which has gyrated from the flux of events dominated by politics as the inopportune MERALCO affair.

Political Grandstanding Amidst Global Inflation

While external markets have mainly recovered from the other week’s selloff (see figure 4), the Phisix closed .77% lower over the week weighed by the seeming “tightening of the noose” by government officials on the marketplace as seen in the sordid Meralco imbroglio aside from the “free texting” and Banking industry’s forex deals.

Figure 4: stockcharts.com: Phisix versus the World

As we have repeatedly noted, the rising prices of consumer goods and services have spurred officials to do “something” in the face of public pressure if not as a deflection from controversial issues surrounding the administration. Essentially officials have vented the blame on public utilities for such dilemma.

Our public officials have not been forthright though; in an interview over an international business network we even hear the chief of our central bank claim that “inflation pressures” arose from “supply shocks”. This isn’t exactly the picture.

Like the rice crisis, these supposed “shocks” have been exacerbated by knee jerk political reactions (e.g. restriction of exports by surplus food producers or panic buying from the Philippines abroad) than the genuine causality. To date, since the rice crisis emerged, there has been no indication of a rice crisis for the commercial rice, but in the past-on NFA or government subsidized rice level. What was featured as a nationwide crisis in media was certainly true for some areas but not all.

Figure 5 ino.com: July Rough Rice

Of course, since many governments have now regained their composures and tempered their trading curbs aside from supply side responses to high prices in terms of more harvests (Bloomberg), rice prices have moderated (see figure 5)—for now.

With a sharp correction in major commodity prices this week, it is likely that goods and services inflation will probably have a “reprieve” in the coming weeks or months. But it is highly unlikely that these inflationary trends will meaningfully subside given the penchant for governments to “socialize” under the present landscape.

However, the fact is every part of the world today has been experiencing “goods and services” inflation, even among developed countries suffering from a credit squeeze due to the recent housing industry bubble bust. This means that goods and services inflation has basically been IMPORTED and not simply due to a domestic/global “supply” shock. Rising demand from emerging markets as China and India represents similarly a “demand” shock.

What policymakers have eluded to say is that monetary (monetary pegs, negative interest rates, bridge liquidity provisions for the credit affected financial sectors in the developed worlds, currency debasement or “competitive devaluation” programs in emerging markets) and fiscal policies (subsidies, high taxes and tariffs, trading curbs, non-transparency, nationalization, et. al.) have severely distorted the functions of price discovery, price transparency, pricing efficiency as allocators of resources in the marketplace, pushed a tsunami of money into the financial system, which has been finding a refuge at hard assets, where others superficially interpret as “market fundamentalism”, a.k.a. speculation.

Yet because most people don’t understand what is truly going on, for simplification purposes, somebody or some entity would have to take the blame.

This means that the first line of assault would be on the public utility providers, where “profits” are scrutinized and condemned as “unjust” and contributing to “inequality” and “poverty” thus requiring redistribution. Bolivia is an example of this recent movement, as it recently nationalized energy and telecom companies. Could we be smelling the same pattern here?

The popular notion is, if you squeeze public utility operators of profits or “nationalize” them, prices of basic services will go down. Baloney. Yes, this will happen over the short period of time. You can party for as long as the booze will last, but not when it gets depleted.

The basics is that the government can only afford to “subsidize” for as long as the revenues it gets is enough to compensate for this, which is the same as saying picking from taxpaying (productive) Pedro and doling out to non-taxpaying (non-productive) Juan. The problem is that the source of looting is limited while the demand for financing is unlimited.

The key question now is “Can a country’s productive sector permanently sustain a non productive sector?” The obvious answer is no. Eventually the country which undertakes heavy socialization or welfare programs will pay for the political mountebank when it enters into a financial crisis or sees its standard of living decline.

That’s why politics is always about short term convenience at the expense of the long term pain. The fundamental problem is that the public is easily directed away from the true causes.

A Snippet on Meralco’s Controversies

Energy issues have been taking the brunt with monopoly distributor Meralco down 3.91% over the week (down 25% from the week ending May 2^nd), aside from First Philippine Holdings (14% w-o-w) and Petron (10.53%-it’s a wonder if foreign investors are now anticipating a political spillover to this issue).

Fortunately enough, the strong performances in Friday ended the week positive for telecom issues and banking issues (led by Banco De Oro up 7.45% and Union Bank up 11.11%-could some prospective deals be brewing between them?).

As for Meralco we have not scrutinized on the nitty-gritty of the ongoing controversy but have construed the recent developments as possibly emanating from the following motivations:

One, a political retribution or a ruse to engage a vocal supporter of a well entrenched political adversary or

Two, an attempt to sidetrack the controversies surrounding the recent government scandals by redirecting the public attention to “goods and services” inflation by effectively focusing on utility providers as culprits, or

Three, a possible economic opportunity for certain interests group to wrest the management in order to benefit from the ongoing changes under the Electric Power Industry Reform Act (EPIRA) in the power sector. As a distribution monopoly, grabbing hold of this strategic network by any of the power producers ensures of a captive market.

Lastly, a combination of any of the three.

What are the major points of contention we can observe of in the corporate dispute:

-Take or Pay provision, a derivative of the 1993 Electric Power Crisis Act of the Ramos Regime which is the source of the wrangling over the charging of system losses.

-Royalty taxes and VAT charges

-alleged conflict of interest from cross ownership

So essentially you have a technical LEGAL spat over a government monopoly franchise operating under an intensely regulated industry.

Since the Lopezes have not been cordial or in good graces with the administration, the present environment of rising good and services inflation makes them susceptible targets for politicking.

But of course, other tangential concerns have brought upon by left leaning groups as;

-Subsidies
-market abuses from operators
-regulatory capture or regulators overwhelmed by those regulated
-corruption
-high rates required to sell Napocor assets
-“high prices breed inefficiency”

…our unsolicited comments;

-subsidies-see above
-market abuses (because of the monopoly), corruption and regulatory capture (the latter two are intertwined-regulators get controlled because they can be bought) are principally offshoots to overregulation. They represent the symptoms and not the cause.
-high prices in itself do not “breed” inefficiency but reflects on demand and supply even if they have been contorted with misaligned or skewed policies (e.g. high taxes) or lousy management. Simply said, high prices are the result of accrued inefficiencies. High prices DO NOT create, breed or foster inefficiencies; policies do. You put the horse before cart, and not the other way around.
-high rates needed to sell NPC assets accounts for a slippery slope argument. Investors invest because of the attractiveness of returns relative to risks not because of high prices. High prices do not guarantee returns. It’s the net margins or the ROI that counts!

Yes while a new management maybe able to trim down rates to achieve so called “efficiency” (which is highly doubtful), the fact that our problems is basically one of “imported inflation” ensures that over the long term energy prices will continue to rise unless:

One- demand destruction overtakes the global economy via ‘stagflation’ or

Two- alternative energy or unconventional energy sources will be able to generate sufficient economies of scale to overhaul the energy dynamics of the global transport and energy consumption infrastructure.

Three-policies will be undertaken to remove excess liquidity in the global financial system (meaning a policy induced recession)

Next, for the local energy sector, I’d like to give the EPIRA a chance to be fully implemented compared to a centralized energy policy since 1972 (Presidential Decree 40 - “Establishing Basic Policies For The Electric Power Industry”), where Napocor’s unwieldy P 600 billion debt should be enough lesson for us.

Risks of Owning Public Utilities

Figure 6: PSE: Industrials Taking the Heat

Of course, the major risk of owning “sensitive” public utilities today is that political powers will probably use them as scapegoats to pass populist policies which should be detrimental to the industry or to the society. The least is to harass them for publicity purposes as we might be probably witnessing today.

Figure 6 shows how the PSE Industrials have been buffeted by political volatility (aside from the recent bearmarket pressures) and is seen in a continued downdraft, where Meralco (26% of the Index) and other energy and public utilities are benchmarked. Overall the Industrials have been a sizeable drag to the “recovering” Phisix.

Besides, the risks of nationalization or instituting price caps or government takeover are enough reasons to dissuade foreign investors from owning these issues, even if it were just mere rhetoric. The problem is that it could be seen as an attempted assault on private ownership rights which tarnishes our credibility and takes sometime to restore.

Of course we don’t discount that there is a possibility that all these could also signify tactical moves of a facelift poop and scoop operation where investors flee from anxiety while giving entry opportunities for those fostering such scenario.

But on the contrary, we also understand that a declining Phisix isn’t a good reflection for the administration (especially if world markets begin to markedly advance) which habitually likes to take credit or bask in the glory of its past successes.

This means that if the Phisix will lag the world because of continued politicking, the meddling into these industries might suddenly or surprisingly fade! But this is being hopeful.

Important Disclosure:

This is not to say that you should own or not own public utilities shares. Instead, this is to evaluate on the risks of owning public utility shares given today’s “inflation” driven politicized environment. It represents risks or opportunities to gain from such risks. This is a market critically dependent on the path of government action.

Besides, not all of the public utilities share the same or equal measure of risks.

Writer owns shares of First Gen (FGEN).