The Crowding-Out Effect: Why the BSP’s Thrust to Attain Negative Real Rates Been Elusive? Bond Yields Surge, Flattening Dynamic Heralds Tightening!

In this issue

The Crowding-Out Effect: Why the BSP’s Thrust to Attain Negative Real Rates Been Elusive? Bond Yields Surge, Flattening Dynamic Heralds Tightening!

-The BSP’s Inflation Targeting: The Invisible Subsidies from Negative Real Rates  

-The BSP’s Paradigm: The Mouth-Watering Negative Real Rates of 2012-2014

-Why Has Broad Negative Real Rates Have Become Elusive? Will September’s Splendid Tax Revenue Growth Be Sustained?

-What Will Drive 3Q GDP, CPI or M3?

-Crowding-Out? Bond Yields Have Been Surging, Yield Curve Points to a Financial Tightening!

The Crowding-Out Effect: Why the BSP’s Thrust to Attain Negative Real Rates Been Elusive? Bond Yields Surge, Flattening Dynamic Heralds Tightening!

The Bangko Sentral ng Pilipinas published the banking system’s loan portfolio and domestic liquidity conditions for September at the close of October.

These figures have been wonderfully useful in the appraisal or evaluation of the current political-economic conditions particularly when incorporated with other relevant government statistics.

Such statistics include the Bureau of Treasury (BoTr) report on the National Government’s (NG) cash operation or the fiscal condition, which provides an overview of government’s immediate and past financial positions through collection versus spending, the financing of spending deficits through changes in the NG’s debt profile, the impact of banking system’s credit expansion and these public sector activities through BSP’sCPI and other real economy price data from the Philippine Statistics Authority (PSA).

The BSP’s Inflation Targeting: The Invisible Subsidies from Negative Real Rates  

Of course, market prices of select securities also provide insights when compared to these.

 

Unknown to the public, the BSP’s easy money policies, which was embraced and implemented since 2009 involved “inflation targeting”*, or in particular, had been designed to generate negative real rates by the driving down market rates below price inflation through zero bound rates.Negative rates provided invisible transfers to the government through two main channels: it lowered the government’s interest rate payments when compared to the free market, and by stimulating the expansion of the economy’s credit absorption, it expanded tax revenues.

A third channel for such subsidy transmission is the “Cantillon Effect” or the uneven proportion of spending distribution which favors the government and bank borrowers.  The recipients of newly issued money from the banking system and from the government are able to purchase goods and services at relatively lower prices compared to those at the farther chain from the source of money. Hence, consumers at the furthermost chain of the spending process transfer their purchasing power to the consumers closest to the source of money (banking system and the government).

*The BSP has a manual of inflation targeting which it implemented on January 24, 2000 (The BSP and Price Stability, June 2017). Of course, none of the above is discussed in it.

The negative real rate dynamic has been illustrated above.

The BSP’s Paradigm: The Mouth-Watering Negative Real Rates of 2012-2014

Here is the back story.

Because of easy money policies, the banking system’s growth rate in commercial and industrial loans sizzled to record highs in 2011 at over 22% for a few months. The consequence of such credit boom had been to elevate real economy prices. And yet, the perceived economic BOOM, which was highlighted by credit upgrades in 2012 and 2013, incited a panic bid on Philippine debt securities. As such, real interest rates turned deeply negative (the difference between BSP’s CPI and 1-year treasury bills).

So even when the banking system’s credit growth rate and CPI significantly decelerated from 2011 to mid-2013, because of the great demand for Philippine debt, the negative rates remained.

However, the slowdown in credit growth likewise began to affect real economy prices. Thus, the BSP responded by aggressively cutting interest rates several times from 4.5% to 3.5% in 2011-2012

The decline in credit growth reversed course and reaccelerated upwards. The startling 10 successive months of 30% money supply growth rates signified a product of the revival in credit expansion.

Again, this incited price pressures on the real economy. But this time part of the increase in price pressures became a political issue. The BSP reacted thru a series of partial tightening in 2014: it raised reserve requirements (2x), policy rates (2x) and SDA rates (3x).

In 2015, prices, earnings, and the GDP slowed. Shopping mall vacancies emerged for the first time. Negative real rates morphed into positive rates. (upper window) The BSP chief hinted about deflation risks.

And by the end of 2015, the strained BSP turbocharged the economy with measures it had only used during an economic/financial shock. It monetized the NG’s debt.

And to ensure its optimum effect, the BSP chopped interest rates to the lowest level ever in June 2016.  Such action was rationalized or justified upon the “interest rate corridor”.

Why Has Broad Negative Real Rates Have Become Elusive? Will September’s Splendid Tax Revenue Growth Be Sustained?

Fast forward the present.

Today, we are witnessing the consequences of the instituted emergency measures (BSP’s lowest interest rates PLUS debt monetization backed by the NG’s fiscal ‘infrastructure’ stimulus) conducted in response to the previous measures, which it had been compelled to abridge.

The exemplary tax revenue performance from 2012-2014 has represented the consequence from the BSP’s implicit 2009-2014 subsidies or transfers (below window).

The latest ICU stimulus has only succeeded to keep those revenues afloat but below the 2012-2014 growth rates.

A critical part of that reason has been the inability by the BSP to generate deep negative real rates.

The growth rate of tax revenues did spike in September (24.1%).

However, from where did such boost emanated? Was it from an economic rebound, or from more efficient collections or from a one-time tax windfall from penalties/settlements?

Mighty Tobacco was reported to have settled with the administration in June. Updated reports indicate that the unfortunate politically harassed firm has fully paid its obligations as of the first week of October (most likely paid in September).

With the current pace of public spending, it would be unlikely that the government would generate sustainable increases in tax & non-tax revenues. That would be because the government will be “crowding out” the private sector in both resources and finances. Yes, bond yields have risen across the board (see below). So the next option for the administration would be to impose more seizures of properties from the private sector, which eventually would entail nationalizations.

Hasn’t it been obvious WHY the Department of Finance has been desperate to pass its TRAIN (Tax reform for acceleration and inclusion act)?

Nevertheless, why the BSP’s painstaking ordeal in attaining negative real rates?

The answer: Divergence versus convergence. In 2012-2014, yields of 1-year bills and the CPI diverged to produce the broad negative real rates. The bond market perceived inflation risks as a fleeting episode. Or the inflation risks had been discounted. In the current milieu, yields and the CPI rates have moved in tandem or have converged. Reality has been seeping in.

So the instituted emergency measures haven’t been delivering the desired subsidies for the government.

Moreover, there has been little accommodation for error from the incumbent policies.

And hasn’t been evident too why the BSP stubbornly has resisted tightening?

And of course, it was a THANK GOD for the revenue spike in September otherwise, the government’s deficit would have run wild.

 

Most of the deficit financing for September has been channeled through domestic debt which was up 7.27% for the month. The NG must have paid down foreign debt for it to grow by only 3.36% even when the USD was up 7.17% over the same period. The underperformance of foreign debt aggravated the deceleration of domestic debt, thus total debt growth diminished to 5.87%.

Meanwhile, the BSP’s direct subsidies to the NG grew by 9.9% yoy.

The 9-month NG fiscal deficit of Php 213 billion had mostly been financed by domestic borrowing, which over the same period recorded Php 254 billion.

On the other hand, the BSP’s monetization of NG’s debt has totaled Php 36.31 billion. When the BSP’s ICU turned negative in April and May, money supply accompanied this downturn. Seeing this, the BSP immediately turned the corner and began to finance the NG anew but at a more moderate pace compared to last year.

Since the government’s debt issuance tends to drain liquidity from the system, the BSP has used debt monetization and incredibly low-interest rates as countermeasures.

The prevailing expectations have been that the banking system’s credit expansion will be more than sufficient to counteract the reductions in liquidity from government borrowing

So far that has held. The banking system (production and consumer loans) has issued Php 668 billion in loans during the last 9 months.

What Will Drive 3Q GDP, CPI or M3?

The government produces incredibly contradictory statistics.

First, growth in production loans has exploded. It registered 20.68% last September to hit a 2012 high.  Credit expansion had been widespread to include possibly parts of the public sector (community and social services up 175%, administrative and support services 80.25%).

As a side note. Surprise! Loans to the mining sector have been ramping up since March (+53.62% in September). That would be even prior to the Commission on Appointment’s rejection of DENR’s honcho Gina Lopez last May. Have miners gotten the foreknowledge of what has transpired? Have revenues been pressed such that the administration has sidelined its politically correct stance on the environment? Interesting, no?

Next, growth in consumer loans has strikingly ebbed. As I previously mentioned, auto and payroll loans registered substantial growth drawdowns in September as credit card growth soared. Nonetheless, loan growth declines of the former two had been more powerful than the additions from the latter. Have declining loans been a factor of rising income? Or has the rising leverage been the case for those with access to formal credit?

Curiously, while M3 marginally slowed (14.5% in September, 15.4% in August), the rate of growth of consumer prices substantially increased (3.45% in September, 3.12% in August) even as general retail prices (3.2% in September, 3.28% in August) have reportedly gone in the opposite direction. Or, consumers told the government that they bought at higher prices while retailers said that they sold at lower prices. Huh?

So what will drive the 3Q GDP? The government will be reporting 3Q GDP on November 16. The present wild pumps and dumps at the PSE appear to be heralding the speculative and insider trades.

The growth in nominal numbers would be significant, M3 points to this. However, will it be large enough to grow sufficient distance from the consumer price deflator? If so, GDP will improve. If not, we will likely see growth rates of the 2Q and 1H levels with + or – 10 basis points.

Crowding-Out? Bond Yields Have Been Surging, Yield Curve Points to a Financial Tightening!

Finally, embedded in popular psyche is the bizarre notion that free lunches tend to last forever

As far back in 2014, I have been saying that the culmination of such free lunch will appear first in the bond markets.

The bond markets have presaged a tightening anew!

Such developments have emerged in the face of a very accommodative BSP. Current market signals run in contrast to the flattening dynamic in 2014 to 2015. The BSP’s actual tightening then led to the flattening curve dynamic.

And such flattening comes in the face of a broad base yield increases. Or yields have risen across the board.

Yet, the 10-year yield appears to have been ‘managed’ by some unidentified entities who have been attempting to suppress it at the close of almost every trading session. In doing so, flattening dynamic has emerged.

In fact, the yield curve’s belly (5-10 year) has regressed to repeated inversions until last week’s emancipation of the 10-year yield which spiked! The narrowing of spreads have become evident even the standard yield curve (2-10 year)

To reemphasize, the significant narrowing of the yield curve has taken place even as monetary policies have remained loose.

The domestic bond market appears to be pressuring the BSP to tighten!

These are likely manifestations of the “crowding out effects” in a relatively closed and less liquid financial sector.

Fascinatingly, just what will happen to the credit-dependent industries if the BSP obliges?