Has The Underperformance of Philippine Markets Been Due To Policy Credibility?

``In our opinion, global economic conditions are fraught with potential difficulties but Asia’s economic position puts the region in a strong position relative to the developed world. Budgetary and fiscal surpluses mean that countries have the scope to provide domestic stimulus. The banking sectors have ample liquidity and low non-performing loans; real estate prices are not in a bubble phase; corporate debt levels are low and after years of low investment there is not much excess capacity.” Edmund Harriss-Guinness Atkinson Funds, Asia Brief June 2008

So what else is new? The Philippine financial markets continue to get whacked. Again everything is being blamed on either high oil prices or “inflation” as if this whole episode is a restricted to a Philippine only affair.

Figure 1 from Dankse Bank shows the monthly returns of the Peso (left) and the Phisix (right)

Figure 1 from Denmark’s Danske Bank shows the Philippine Peso have been the worst hit among emerging market currencies (see red circle left), while the Philippine stock market benchmark has been the fifth worst performer among emerging markets (red circle right).

The Danske research team suggests that this has been all about central bank credibility. They for instance noted that Indonesia has far outperformed emerging market rubric in both currency (even gained last month) and stock market terms (the least losses) because investors perceived government actions as fitting to the present conditions.

From Danske (highlight mine) ``government has cut subsidies to avoid serious worsening of the fiscal situation and the central bank has moved fast to maintain its credibility. Indonesia has been rewarded by becoming the best currency in Asia, while India and the Philippines have been punished for dragging their feet on both fiscal and monetary policy.”

Indeed, pertinent to interest rates, Indonesia has ‘aggressively’ raised its benchmark rate for the third successive month (Bloomberg) compared to the Philippines which has reluctantly lifted only once (last June) for the first time in 3 years (Philippine Inquirer).

But for Indonesia to get “rewarded” for cutting subsidies where the Philippines has none is to assume the analogy of rewarding Indonesia for the transition from worst to bad when we are punished for maintaining the bad level. I don’t think this is the correct angle look at figure 2.

Figure 2 PIMCO: Real Policy Rates Are Negative in Emerging Markets

If negative real policy rates extrapolate as the fuel to the inflation fire, then certainly Singapore’s Central Bank should be interpreted as a paradigm or representative of the “bad policymaking” for having the steepest negative rate environment and should have been correspondingly meted with a market “penalty”. Likewise, Thailand, whose monetary regime has been similar to the Philippines, should also feel the heat. But where?

So if the conduct of policy doesn’t reflect the issue of real rates, then it can’t be about subsidies too. Look at figure 3 from the IMF.

Figure 3: IMF study: Change in Fuel Price Subsidies as a percent of GDP: 2006 to 2008

In IMF’s recent study “Food and Fuel Prices—Recent Developments, Macroeconomic Impact, and Policy Responses” it notes, ``Thirty-eight countries increased or decreased fuel price subsidies between 2006 and 2008. The increases (in 29 countries) range from near zero to 4.0 percent of GDP, with a median increase of 0.7 percent. The biggest increases have occurred in countries with large pre-existing subsidies. The decreases (in 9 countries) range from 0.2 to 5.3 percent of GDP, with a median of 0.6 percent, with the largest decreases in countries that were restructuring their subsidy programs.”

If the market’s “reward or punishment” system stems from policies of either subsidy reduction or subsidy gains, then those bars on the left (reduction) should see their currencies and stock markets outperform relative to those on the right (increases). Unfortunately the markets apparently don’t reflect on this line of thought.

Now of course currencies are valued based on relative terms. Or if we apply policy as a measure in valuing national assets classes then we have to parse on the obverse side-particularly policies governing the US dollar.

With 36 states in the US facing a decline (recession) as of May see figure 4, government’s fiscal positions risk getting slammed from declining revenues or tax collection in the face of rising government expenditures.

Figure 4: Nelson A. Rockefeller Institute of Government: 36 States on Decline

This from the Nelson A. Rockefeller Institute, ``The national economic slowdown—or recession —is depressing state tax revenue and restraining local government tax revenue. To date, the tax revenue weakness has been mild compared with past recessions. However, the seeds of greater fiscal stress are already sown: economic weakness is spreading rapidly and tax revenue from the “continuing” base should be very weak in the April-June quarter, although perhaps partially masked by payments with 2007 tax returns. After June, tax revenue is likely to be extremely weak as most states begin their fiscal years — and such weakness may linger as the year progresses. Many states finalized their 2008-09 budgets during the April-June quarter, when conditions may have misled forecasters into revenue projections that were too rosy. Governors in some states may, then, face difficulty implementing their new budgets —raising the prospect of midyear cuts and other actions to eliminate emerging gaps.” (emphasis mine)

What this suggests is that fiscal conditions in the US are likely to worsen. It would have to address this by painstakingly cutting expenses or inflating its way to cover such budget gaps or increase borrowing by issuing more debt instruments from foreigners or raise taxes. Whatever route taken is unlikely to be “positive” based on relative fiscal positions when compared to the Philippines.

All this go to show that while policymaking direction could be a factor influencing the market’s action, it certainly doesn’t show up in straightforward linkage.

However, we do share the frustrations over the Bangko Sentral ng Pilipinas’ dilly-dallying. In addition, we get even more concerned when we hear of our officials proposing to borrow money-$900 million from World Bank and ADB (Bloomberg)-in order to intervene in the currency markets to shore up the Philippine peso. This is like throwing money to a sinkhole, whose unnecessary losses will be charged to the taxpayers.

It would be a better option for the BSP to raise interest rates and reduce the negative real rates environment if they aim to defend the Peso and contain the consumer goods and services inflation pressures. But if the BSP is concerned about the impact to economic growth from higher interest rates, the market is doing it anyway for them through higher yields in domestic treasuries and from rising consumer prices. By closing the real rates gap at least they can’t be held solely responsible for “bad” policymaking. Besides, we read this labeling of bad policymaking as “reverse psychology”, maybe foreigners could be hoping for higher rates from the Peso to allow for them opportunities from a wider yield arbitrage.