Deficits, whichever way you look at them, cause grave economic problems. If they are financed by the banking system, they are inflationary. But even if they are financed by the public, they will still cause severe crowding-out effects, diverting much-needed savings from productive private investment to wasteful government projects. And, furthermore, the greater the deficits the greater the permanent income tax burden on the American people to pay for the mounting interest payments, a problem aggravated by the high interest rates brought about by inflationary deficits—Murray N Rothbard
In this issue
2Q and 1H Fiscal Deficit Surges to 2010 Levels! The Risks and Possible Consequences of the Current Fiscal Trend
-2Q and 1H Fiscal Deficit Balloons to 2010 Levels! Government Stimulus ALL IN!
Increasing Fragility in Government’s Revenues
-Investment Tip: Expenditure Blitz on LGUs, GOCC Subsidies and Others Expected to Continue
-Philippine Economy Now Running on the Twin Engines of Credit
-Ramifications from the Bureau of Treasury’s Fiscal Conditions
-The Risks from DoF’s Tax Reform’s Likely Operational Lapses
2Q and 1H Fiscal Deficit Surges to 2010 Levels! The Risks and Possible Consequences of the Current Fiscal Trend
The National Government’s Bureau of Treasury (BoTr) published June’s fiscal and debt position last week. Should anyone wish to verify or reconstruct these, excel files are downloadable from the BoTr’s website.
What I have been writing about has only been reinforced and affirmed from current developments
2Q and 1H Fiscal Deficit Balloons to 2010 Levels! Government Stimulus ALL IN!
Though I won’t be elaborating on the political aspects, I have been pounding the table that the direction of the present political policies will lead to gigantic fiscal deficits. Unlike the mainstream experts who can’t seem to see its ramifications, through the crowding out phenomenon, burgeoning deficits will have a humongous impact on the interest rates, the real economy, corporate earnings and the financial markets.
The BoTr’s data revealed that June’s fiscal deficit soared to Php 90.873 billion, the second largest since December 2012. The largest monthly deficit recorded since 2008 was last December at Php 118.23 billion.
June’s deficit emerged from a combination of the worst factors, a plunge in revenues in the face of an accelerated expansion in government spending.
For the month, the national government’s (NG) tax and non-tax revenues registered a scanty 2.43% growth! That would be lower than the rate of the government’s General Retail Price Index (GRPI) which in May was at 3.1% and likewise down compared to June’s CPI at 2.8%! 2Q CPI, according to the BSP, was at 3.1%! In real terms, the NG’s gross revenues had actually been DOWN or NEGATIVE!
On the other hand, the government expenditures ballooned by a considerable 22.62%, the fastest since November 2016 at 33.21%.
To interpret June’s numbers in isolation would hardly be insightful. The comparable performance of the 2Q and the 1H of the fiscal balance or the government’s income statement may offer a broader and more penetrating perspective.
Amazingly, the present level of deficits has ballooned to the post Great Recession levels as shown above.
Recall that the NG used deficit spending, which had been partly monetized by the BSP, as part of the emergency “automatic” stabilization measures designed to prevent the Philippine GDP from falling into a recession. Policy rates were likewise aggressively chopped by the BSP from 7.5% in 2007 to 4% in 2010.
And because of the post-Asian crisis cleansing, the relatively leverage-free balance sheets of the private and public sector responded wonderfully to such stimulus. The systematic increase in leverage initially brought about higher Nominal GDP (aggregate demand), boosted corporate profits, bolstered tax revenues, increased jobs and wages, and most importantly, inflated the financial markets - real estate prices, stock market prices, sovereign and corporate bonds and the peso boomed!
Today, even WITHOUT a visible presence of an “emergency”, the NG and the BSP has practically doubled down in the utilization of the same tools for assumingly the same purposes!
The question is WHY?
Increasing Fragility in Government’s Revenues
The BoTr’s own financial statement provides the clues.
The simple answer is that government revenues have been trending DOWN!
I am aware that as part of a tax settlement, tobacco firm Mighty Corporation pledged to pay Php 25 billion“the biggest tax settlement” to the government. This amount would originate from the Php 45 billion sales of Mighty Corporation assets and distribution network to Japan Tobacco International Philippines. Media reported Mighty’s Php 3.44 billion initial payment. The balance of this payment would likely be on an installment. Although the settlement would augment the government’s PRESENT revenues, such would likely encourage the government to INCREASE spending by the same amount or more. If so, then Mighty’s contribution would be neutralized.
The NG’s revenue statement is divided into tax revenues and non-tax revenues. Collections from the Bureau of Internal Revenue (BIR) and Bureau of Customs (BoC) comprise the tax revenue segment while income from the BoTr, fees and charges, privatization, grants and others constitute the non-tax share of revenues.
Tax revenues account for the largest share - about 90% - while the non-tax revenues take up the rest.
In June, BIR collections rose by a meager 5.83%! The slowdown actually represented a string of underperformance or below 10% growth, particularly, 4.7% in May and 5.64% in April.
Meanwhile, collections from the Bureau of Customs has been volatile; June +.42%, May +23.45% and April -4.8%
On the other hand, the non-tax segment gyrated wildly, June -21.04%, May+85.9% and April -54.16%. The non-tax portion either serves to compliment or diminish collection growth rate of the main category.
Nevertheless, on a quarterly basis, tax (BIR + BoC) revenue was up by a paltry 5.63%. With the BSP’s CPI at 3.1%, inflation has basically gnawed on the government’s top line! There have hardly been any signs of G-R-O-W-T-H!
This stark collection underperformance by the NG essentially has resonated with the deceleration of domestic liquidity. Such liquidity downshift has, in turn, been manifested through the dramatic tumbling of growth rates in 2Q car sales in 2017. 2Q 2017 sales clocked in at only 12.2% as against 32.69% in 2016 and 19.66% in 2015. [See Has Peak Auto Sales Arrived? July 16, 2017]
Moreover, the plunge in revenue and income growth by cement producers Holcim and Cemex in the 2Q underscores not only has signified a likely ongoing slack in the construction sector but also the sector’s contribution to decreasing tax collections! [see Construction Boom? HLCM’s 2Q and 1H Sales and EPS Growth Crashed! Frenzied Bids on Property Issues Sends the Phisix to 8,037 July 26, 2017, Construction Boom? Cemex 2Q and 1H Earnings Collapses!!!! July 28,2017]
Even from the 1H basis, the growth rates of the NG’s major sources of revenues have been southbound since 2012! 1H collection growth rates have declined to 2015 levels.
The downturn in growth rates can be seen even from the government’s tax and non-tax NOMINAL collections. (lower window) After the 2015 zenith, revenues from the annual tax deadline in 2016 have barely topped the previous year’s high. Even worse, nominal collections for the same period even fell in 2017 compared to the previous two years!
Think of it, the popular GDP of 6-7% which typically has been represented by NGDP at 7.5%-9% which arethen deflated by inflation (PCE) has a collection ratio of anywhere 60% to 75% based on the present revenue numbers!
Either the survey constructed GDP numbers of the Philippine Statistics Authority have been bloated or that there has been too much leakage in the tax enforcement system. While there will always be seepages in tax administration, considering that the government’s revenue numbers have signified a trend, administrative inefficiencies can hardly function as the main cause for such dynamic.
Investment Tip: Expenditure Blitz on LGUs, GOCC Subsidies and Others Expected to Continue
While growth rates and nominal government revenues appear to be stalling, this has hardly been the case for expenditures.
For two months this quarter, expenditures growth rates have spiked - 22.62% in June and 20.36% in May – perhaps partly to cover the -4.36% shortfall in April.
Spending is easiest when the money spent is not yours.
Ever since the NG deployed the fiscal side of the stimulus in 2010 to put a firewall against a spillover effect from the Great Recession, the growth rate of NG’s expenditures continues to scale upwards (left upper window).
Such ascending trend has been similarly visible in the nominal peso expenditures (upper right window). The NG government spending binge has spanned two administrations.
The above gives us an investment tip.
The best bet would be on record deficits from the solid uptrend in government spending!
From an annual basis, June’s biggest growth contributor has been the allotment to local government units (LGUs) which jumped 49.25%!
Allotment to the LGUs essentially represents “the mandated share in the revenue collections”, notes the Department of Budget and Management (DBM)*, “arising 1) the automatically appropriated formula based share of all LGUs from national internal revenue collections pursuant to the Local Government Code (R.A. 7160); and 2) the special shares of selected LGUs from proceeds from national wealth, and other revenues pursuant to specific laws (e.g., share of tobacco producing provinces from taxes on Virginia and Burley tobacco).”
Perhaps part of this may be about “infrastructure”, although the share of LGUs to expenditures accounts for only 20.33%.
The second largest growth contributor to NG expenditures has been the subsidies to Government Owned and Controlled Corporations (GOCC). The subsidy, as defined by the DBM, represents the “amounts used to cover operational expenses not supported by corporate revenues or to cover corporate deficits and losses.”
NG subsidies to the GOCC spiked 101.28% to Php 32.31 billion in June. For the month, the bulk of transfersfrom the National Government were to National Housing Authority (Php 12 billion), Philippine Health Insurance (Php 9.261 billion), National Irrigation Authority (Php 5.72 billion), and Manila International Authority (Php 3.6 billion). Subsidies take up 11.93% share of June’s expenditure.
Finally, the other segment which accounted for 59.3% share of expenditures registered an 8.75% growth. Though I haven’t found the exact categories of this group, based on the BoTr’s Manual of Operations, these may be about the Modified Disbursement Scheme (MDS) transactions and Miscellaneous disbursements.
*Glossary, Department of Budget and Management p 701 (LGUs) p 715 (subsidy)
Given the Marawi siege, I would suspect that part of this spending spree involves increased subsidies to the military institution. The NG declared an all out war against the NPA. If this expanded theater of war becomes a reality, then military expenditures can be expected to rise further.
Essentially, spending for the major components of the NG, specifically, the welfare state, warfare state, the bureaucratic state and public works via infrastructure can be expected to escalate
Philippine Economy Now Running on the Twin Engines of Credit
From the perspective of the increasing vulnerability of the fiscal position of the NG, it would be easy to perceive WHY the recourse to emergency measures have been undertaken similar to that of the Great Recession.
Of course, the magnitude of deficits, the scale of the BSP’s acquisition of NG claims and policy interest ratesrepresents the major variance in policy implementation then and today. The current episode reveals that such measures have synchronically been at UNPRECEDENTED levels
Wouldn’t a supposed boom in the face of emergency measures signify a supreme enigma??? Or why would a government employ emergency financial-economic stabilization measures when a boom is supposed to be in place???
Now, since fiscal deficit means spending greater than the collections, then the government has to resort to other means of filling in the financing gap.
In 2016, the government relied on the BSP’s HISTORIC (Php 341.55 billion) debt monetization. This undisclosed stimulus has been implicitly targeted at reviving credit expansion which had emitted signs of fatigue in 2015.
Because of real economy price surges in 2014, which signified a natural response to the 2013-2014 money supply explosion (10 months of 30%+++ growth), the BSP was compelled to tighten monetary policy through increases in reserve requirements and policy rates (SDA and official rates). The effect of which has been to reduce credit growth and subsequently, crash money supply growth. The spillover effects of these actions caused a sharp downturn in real economy prices which seem to have scared the wits out of the BSP.
Hence last year’s undisclosed stimulus which incidentally had the same outcome from the previous easing cycle: real economy prices soared.
From then, the NG took on the mantle from the BSP.
In June 2017, part of the Php 90.873 billion fiscal deficit was funded out of the NG debt. The BoTr’s total debt rose to Php 72 billion (month on month) mostly from domestic debt which increased Php 49.06 billion. Though foreign debt expanded to Php 23 billion or 10.4% (month on month), most of such gains were due to the currency effect. BoTr data showed that based on FX used by them, the USD php rose 8.6%.
Signs of life for the NG’s Debt became evident in the second quarter. That’s because year-on year growth picked up steam in three straight months, specifically, April +8.27% May +7.81% and in June +7.89%. Again this had mainly been a surge in domestic debt April +10.37% May +8.96% and in June +9.35% (see upper left window)
With nearly the doubling of growth rates from 1Q 2017’s 4.36% to the 2Q’s 7.99% the quarterly gains have been most pronounced (upper right window)
Nominal debt has soared to Php 6.4 trillion as of June. That’s 44% 2016’s Php 14.6 trillion NGDP and 41% 2017’s optimistic estimates of NGDP growth at 8% at Php 15.64 trillion.
Now credit engines are running hot for both the government and the private sector.
At the present rate, both engines will outpace the GDP.
The ramifications will be more than about statistics.
Ramifications from the Bureau of Treasury’s Fiscal Conditions
To reiterate, such massive fiscal deficits will spur a substantial “crowding out effect” on the real economy and on the financial markets.
With the government competing with the private sector for access to savings, this should translate to diminished peso based liquidity that would drive interest rates higher. Government borrowing will sop up liquidity which the BSP will try to offset by keeping rates at current levels
And such deficits will crowd out the private sector, thereby bestowing to the government a bigger share of the economic pie. Another adverse effect would be to exacerbate a deluge of government induced imports that would lead to TWIN deficits (trade and fiscal deficits).
As previously noted, this would put pressure on the US dollar domestic liquidity, which should likewise weigh on the government’s US dollar reserves.
And to counter reduced US dollar liquidity, the government will be impelled to increase US dollar loans. Such enlarged exposure to foreign denominated debt would thereby increase the country’s currency risk (US dollar short) profile
By Monday, the BSP will disclose the banking system’s credit portfolio, as well as domestic liquidity conditions. My guess is that debt monetization by the BSP could be part of the financing of June’s deficit. If so, the peso would remain under strain.
The BSP now hopes that the government’s issuance of debt, which will drain liquidity, will be offset by more borrowing by the private sector. Such hope is premised on a world of abundance and not a world of scarcity.
Domestic sovereign yield spreads continue to significantly flatten. The market appears to have taken the initiative to embark on a tightening process in spite of the BSP’s actions.
Will the weak NG revenue growth for the 2Q entail a lower headline GDP?
Two factors from the revenue-NGDP chart. One, there has been a congruence in the undulation of the NGDP and government revenues trend lines. This suggests that lower revenues come with a decline in GDP
Second, over the past two years, the gap between NG revenue and NGDP has been widening. This reveals a paradox: a trend in that shows strained government revenues as statistical GDP boom continues
The Risks from DoF’s Tax Reform’s Likely Operational Lapses
Finally, the DOF’s Tax Reform for Acceleration and Inclusion Act (TRAIN) awaits the approval of the Senate.
First of all, to be clear, I am all in favor of tax cuts.
But as I have written here, tax cuts and massive deficit spending are INCOMPATIBLE. Tax cuts work when the government LIMITS spending. That’s not what has been happening.
The fact that revenues are variable, volatile and dependent on economic and financial conditions, while increases in political spending have almost been fixed guarantees that the income-spending gap will flow vastly in favor of spending or a fiscal deficit.
Those charts above tell you of such asymmetric relationship.
The crowding out effect also assures that instead of tax cuts, tax increases are the future. There are more to this, but I am running out of time.
Yet the phasing in of the execution of the TRAIN measure should be more of the immediate concern. I previously discussed this in Confirmed: May 2017 Fiscal Deficit was Monetized by the BSP; Softening Tax Revenues and The Phisix Casino July 5, 2017
Reducing taxes would be easy. But the raising of taxes would be complex and difficult. Such challenge applies to the lifting of the many VAT exemptions. The transition will be very critical. For instance, just how will the DoF implement sales taxes or VAT on professionals or on free-lance workers? What will be its success rate?
Even if the focus of cuts will be on the 80% of low-income earners which I guess delivers 20% of individual taxes, based on the BIR’s 2015 numbers, 20% still amounts to Php 60 billion. [Tax Data: 92% of Taxpayers Earn 33K and Below! Tax Reform Equals Tax Increase! June 11, 2017] Individual taxes account for 21.45% of the BIR’s tax collection.
So if the DoF fails to generate sufficient revenues out of operational or execution lapses, then this could blow wide open the present deficits which will be exacerbated by tax cuts. The DoF’s miscalculation may trigger an economic Black Swan which might force the government to drastically raise taxes—mostly through VAT.
There are now two things to worry about: the first is the economic and financial bubble, now add to this the TWIN deficits.
