Historic Moment Unfolding in the Philippine Financial System; More Free Lunch Policies

Since the BSP released its June data on domestic liquidity and the banking system’s lending condition, then this would just be an extension of the previous discussion.  [See 2Q and 1H Fiscal Deficit Surges to 2010 Levels! The Risks and Possible Consequences of the Current Fiscal Trend July 30, 2017]

BREAKTHROUGH HISTORY IS IN THE MAKING!

We are on a cusp of history.  The unfolding of an unparalleled process in the Philippine financial system has been happening real time!

The Philippine political economy now faces a TWIN Deficit!

MILESTONE fiscal deficit has now been accompanied by nearly a RECORD trade deficit. The latter represents an offshoot of the former. But since both require financing, the government has dealt these through UNPRECEDENTED monetary policies! 

To bridge the ballooning financing gaps, the BSP has resorted to HISTORIC low-interest rates and the awesome MONUMENTAL program of National Government (NG) debt monetization!

And both these factors have now spurred credit expansion beyond the banking system to include the government. Borrowing for both sectors, namely the banking system and the government which again based on nominal terms are at UNPARALLELED levels!

Yes, BREAKTHROUGH HISTORY is happening, right here, right now!

The BSP absorbed some Php 66.9 billion in NG debt last June. The BSP’s actions practically erased the 5 month slack. Year to date, the BSP acquired some Php 9.8 billion of NG claims. These numbers, which are published by the BSP, is accessible to the public (you and everyone else):  June data here and complete data from BSP’s financial system’s accounts.

Because the BSP’s depository survey data have hardly been discussed in the public, this would seem esoteric. But such activities signify a critical segment of the BSP’s activities.

Current process seems to be the following: NG issues debt to the public (mostly banks and financial institutions) to finance growing fiscal deficit, but such activities drain on the system’s liquidity. At the same time, the BSP buys some of the previously issued papers from the public which offsets the previous liquidity depletion.

At the end of the day, the BSP maneuvered to maintain the incumbent easy money policy IN SPITE of the ongoing crowding out process.

Again, despite the establishment’s overwhelming rhetoric that the Philippines is in good shape, still why the accelerated use of these emergency measures?

Why has the BSP been playing with an inflationary fire?

M3 growth, which spiked to 13.2% in June from 11.3% in May seem as a jump-start response to the BSP’s debt buying in the same month. And perhaps, part of the BSP’s implicit funding of the government may have arrested the recent fall in real economy prices. July’s CPI rose to 2.8% from June’s 2.7%. I am merely using government’s statistics for interpretation and not assuming its accuracy.

The BSP’s reacceleration of the domestic version of Quantitative Easing (QE) appears to have juiced up industry loans which at +17.88% in June was marginally higher from 17.57% in May.

However, growth in consumer loans lurched lower to register 22.54% in June compared to 23.56% in May.

While credit card loans have been in a turbocharged mode (June +16.97% versus May’s +15.63%), car loans dropped (+28.52% in June as against in 30.37% in May). The slowdown in car loans has resonated with car sales over the same period.

Meanwhile, payroll loan growth crashed to 24.51% in June from 40.3% in May. After a reaching a zenith at 63.06%, payroll loan growth continues to fall. So June’s downturn was hardly an anomaly.

Has the lower income spectrum been tapped out? Have financial inclusion or the migration from the informal economy to the formal economy reached a tipping point? Or could part of the payroll loan market have been diverted to the use of credit card? Or has the previous payroll borrowers opted to withhold spending thereby increase savings rate? Savings rate have been reported at all-time highs. Or could it have been a combination of the above?

For credit card, double digit growth rates begun in October. With higher consumer prices, the huge increase in credit card usage could mean that spending at present income levels may have reached its climax for them to resort to credit to augment spending.

Nevertheless, the ramifications of government’s actions have been incrementally percolating into the real economy.

These are truly interesting times!

The Economic Aftermath of Free Tuition Fees

And here’s more.

In defiance of his economic ministers, Philippine President Duterte signed a bill which puts into law the granting of tuition-free education in all state universities and colleges (SUCs).

Since I said that I would refrain from talking politics*, I can only make a prediction: this will blow a gargantuan hole in the government’s budget.

The article notes of budget estimates at Php 20 billion to Php 43 billion to Php 100 billion. I’d say that these numbers will be surmounted over time.

Reason? Basic Economics!

AT ZERO PRICE, DEMAND WILL OVERWHELM SUPPLY SUCH THAT SHORTAGES WILL OCCUR!

From the Revision Guru: (see chart in the lower pane above)

Zero pricing is an extreme form of maximum pricing; the maximum price is zero!  This means that goods and services are provided free of charge. This shows that, at a price of zero, there will be a shortage (excess demand) equal to QD QS.  This shortage will remain unless the price is raised to the equilibrium of Pe.

*I wrote about these before: I Am Not Alone: Economic Cabinet Members REJECT the Free Tuition Program! February 12,2007 and Wow, BSP Chief Sees The Rise of Populist Politics/Retreat from Multilateralism as Scary Developments, Scary Stuff for 2017! December 18, 2016

Let me just give a hint that the impact from free tuition will diffuse not only into fiscal balances but likewise to sociology to the government’s bureaucratic structures to other forms of social welfare.

And pray that free education won’t transform into an education crisis ala Venezuela.

Since one thing leads to another, expect more free lunch policies to be advanced.

Yet free lunch policies only assure the strangulation of the economy!

Finally, the Philippine peso posted its biggest (+.81%) rally since the week of April 14 (+1.3%). The USD peso closed at 50.16 from the other week’s 50.57.

However, such rally would not assume away the deleterious effects of the BSP’s inflationary policies as well as the expanding the free lunch populist politics.

To my mind, the peso merely responded to the US dollar’s general weakness. In short, a countercyclical rally. The peso has already been weak even as the US dollar has fumbled globally.

What happens more once the USD regains part of its legs even for just a bounce?

Use the current US dollar weakness to take a long USD-Php.

More Media Spin on the Philippine Statistical Bubble Economy

Perhaps in an attempt to recoup lost glory from recent political setbacks from the Pork barrel scam and Typhoon Yolanda debacle, the Philippine government’s PR campaign machinery may be working overtime.

Here is an example of a media spin romanticizing the supposed accomplishments from this government, from Bloomberg

Aquino has achieved this transformation by pruning a record $7 billion budget deficit in 2010 to $2.3 billion in the first nine months of 2013, declaring war on rampant corruption, announcing plans to more than double state spending on public works to $19 billion -- or about 5 percent of GDP -- by 2016, and exploiting Filipinos’ English-language skills to promote industries as diverse as casinos and call centers.

Reference points always matter in framing explanations.

The incumbent Philippine President assumed office in June of 2010, which means this administration has been half responsible for the spike in the government budget- GDP ratio during the same year (red arrow). 

So the article implies, first balloon the deficit, then reduce them and then call them “transformation”. Duh.

Second government spending is part of the calculation of GDP so we have a circular logic at work. A boost in government spending bloats GDP (or the denominator) which diminishes the impact of the budget (numerator) thus a lower budget-gdp ratio. 

Based on the above reasoning all this government has to do is keep throwing money at the Philippine economy for the “transformation” to continue.

And throwing money comes with no cost, no risks of higher future taxes, no risks of increase in debt, and no risks of inflation. There exists an endless pool of money to tap. Free lunch lives!

A far better measure would be to look at the Philippine government budget in nominal peso currency terms

Here is the so-called “transformation” of the administration (data based from National Statistical Coordination Board).

We have nominal deficits above pre-2010 levels as of 2012. This has emerged as the rate of government spending far outpaces tax revenue collection. And to consider, we are supposedly in boom days.

Look at the first chart. Government spending has constantly been rising since 1996 whereas tax revenues has been volatile. So what happens when the statistical economy slows? 

Here is a guess: the so-called “transformation” would mean an explosion of budget deficit. Remember the uptrend in government spending has been constant and even accelerating, whereas tax revenues have been gyrating.

So the current administration needs to keep pumping the debt driven statistical bubble in order to look good.

As a reminder, the above data are from the government which hardly anyone tries to vet.

And of course those deficits has been revealed in the country’s rapidly expanding debt levels based in nominal peso terms. Since 2010 total (foreign and local) debt has grown by over 15%. Data above are from NSCB and the Bureau of Treasury

So while the debt to gdp ratio may seem as moderate, largely due to the puffed up denominator from credit bubble in the property and allied industries and from government spending, seen in the context of debt in nominal terms (not as a ratio) debt levels have been expanding rapidly.

The government has been shifting the debt profile from external to internally generated debt.

So what happens if the statistical economy slows? Here is another guess, as budget deficit explodes so will the debt levels.

As for call centers, here is what the British Philippine Outsourcing says “BPO has been one of the fastest growing sectors in the Philippines in the past 7 years”

2013 minus 2010 equals 3 years. The administration is 3 years old, BPO’s have rapidly been advancing for the last 7 years. Thus attributing the triumph of BPOs to the administration's “exploiting Filipinos’ English-language skills to promote industries as diverse as casinos and call centers” represents a rather hyperbolic claim.

As for casinos while I see the industry as a necessary part of leisure, for many patrons, casino can be a vice. As for how vices can signify a boon to long term productivity to an economy signifies another bizarre allegation.

Besides the domestic casino industry appear to be part of the bubble propagation.

Oh by the way, “transformation” seems as another (this time is different) byword, catchphrase or slogan that gives me goose bumps.

English novelist and author Eric Arthur Blair popularly known for his pen name George Orwell warned us on the perversion of thoughts in “Politics and the English Language”

But if thought corrupts language, language can also corrupt thought.

Indian Government Agencies Squabble over Inflation

I have been saying here that QE has not been a practice limited to developed economies, but has become a global central bank operating standard.

In India, in what seems as pot calling the kettle black, two government agencies wrangle over who is responsible for causing of “inflation”.

From Bloomberg, (bold mine)

The biggest critic of India’s $100 billion budget deficit is also one of the largest purchasers of the debt that finances it: the central bank.

The Reserve Bank of India faults government expenditure for stoking inflation even as its sovereign-bond holdings have risen to $91 billion from negligible amounts in 2008. While it has a mandate for price stability -- like counterparts in the U.S., Europe and Japan -- the RBI has another charge its peers lack: ensuring the government achieves its borrowing program.

The RBI’s ability to damp the cost of living may be further curtailed by record government borrowing and spending next fiscal year, stoking demand and prices in an economy facing supply constraints. The inflation threat adds pressure on India to join nations from the U.S. to Brazil in separating debt management from inflation control. A bill to do so has been sent for cabinet approval, two Finance Ministry officials said…

The bank holds about 27 percent of the sovereign bonds issued since 2008, when its holdings stood at $2.5 billion, according to calculations by Bloomberg News based on RBI data.

The late great dean of the Austrian school Murray Rothbard lucidly explains the disparity between budget deficits/deficit spending and inflation: (bold mine)

Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling Treasury bonds to the public, then the deficits are not inflationary. No new money is created; people and institutions simply draw down their bank deposits to pay for the bonds, and the Treasury spends that money. Money has simply been transferred from the public to the Treasury, and then the money is spent on other members of the public.

On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money, in the form of bank deposits, is then spent by the Treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of one-tenth that amount. Thus, if banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately $10 billion of old Treasury bonds. This purchase increases bank reserves by $10 billion, allowing the banks to pyramid the creation of new bank deposits or money by ten times that amount. In short, the government and the banking system it controls in effect "print" new money to pay for the federal deficit.

Thus, deficits are inflationary to the extent that they are financed by the banking system; they are not inflationary to the extent they are underwritten by the public.

The RBI can always opt NOT to finance the government deficits via QE or debt monetization. But such would undermine the reason for their existence.

At the end of the day, all such manipulations and political accommodations through central banking inflationism will have nasty consequences.