PEZA Versus DoF’s TRAIN 2.0; BPO Investments Plunge 32% in 2017! Thanks to the TRAIN, the Auto Bubble Cracks!

“The first flaw is that they are incapable in thinking in second steps and unaware of the need for it –and about every peasant in Mongolia, every waiter in Madrid, and every car service operator in San Francisco knows that real life happens to have second, third, fourth, nth steps. The second flaw is that they are also incapable of distinguishing between multidimensional problems and their single dimensional representations –like multidimensional health and its stripped, cholesterol-reading reduced representation. They can’t get the idea that, empirically, complex systems do not have obvious one dimensional cause and effects mechanisms, and that under opacity, you do not mess with such a system. An extension of this defect: they compare the actions of the “dictator” to the prime minister of Norway or Sweden, not to those of the local alternative”—Nassim Taleb

PEZA Versus DoF’s TRAIN 2.0; BPO Investments Plunge 32% in 2017! Thanks to the TRAIN, the Auto Bubble Cracks!

PEZA versus Department of Finance: TRAIN 2.0 a Tax sword of Damocles! BPO Investments Plummet 32% in 2017!

The leadership’s desire to reconfigure the Philippines into his preferred or ideal state of affairs with rapacious spending has driven a wedge between his members of the cabinet.

Fearing the worsening of BPO investments, the PEZA chief Charito Plaza called on the Department of Finance to withhold from slapping the industry with more taxes. The PEZA chief called the TRAIN the tax 'sword of Damocles'!

From the Nikkei Asian Review: [Duterte spooks foreign investors with tax 'sword of Damocles', April 17, 2018] (bold mine) 

Currently, the authority grants export-oriented companies income tax holidays of up to eight years. After that, the companies' gross income is subject to a perpetual 5% tax.

The Department of Finance, however, wants the tax breaks to be based on performance -- meaning they might not be extended to all. The 5% tax, meanwhile, is to be replaced with a 15% levy on net taxable income. 

"TRAIN 2 has become a sword of Damocles hanging over the head of PEZA and the industries and investors," Plaza told reporters after her speech. "All industries have submitted their position papers and everybody is against it."

Investments in the BPO industry collapsed by a stunning 32% in 2017, but DoF’s Mr. Dominguez would have none of this.

But in 2017, BPO-related investments declined 32% to 4 billion pesos. This threatens ambitious goals for 2022 set by the Information Technology and Business Process Association of the Philippines: to grow the sector's revenue to $38.9 billion,and to increase the head count to 1.8 million from 1.15 million in 2016.

Some are already feeling the change in the industry environment. A human resources manager at a call center company said a major American client just completed its pullout this year. "Losing contracts is normal in the industry, but from an HR point of view, I've seen more staff being relegated to floating status," said the manager, who declined to be named out of concern for job security.

The Department of Finance insists the state is losing 300 billion pesos annually because of the fiscal incentives, and that the perks should be targeted at emerging sectors. "The world is changing and there are many new industries that are developing, such as robotics, data analytics [and] artificial intelligence," Finance Secretary Carlos Dominguez said last Friday. "These are the kinds of industries we want toattract, because AI is poised to take over some of the lower-end business process outsourcing businesses." 

The BPO industry has been slowing fast even without the TRAIN factor. Thus higher taxes would serve as the proverbial kicking the man when he is already down.

There you have it, more evidence that the Philippines will soon experience an economic shock.

The Auto Bubble Cracks! Duterte’s Various War on Commerce Will Hammer the Auto Industry to its Knees

A good template for the BPOs woes is the current performance of the auto sales

Motor vehicle sales plunged by 23% last March. On a month on month basis, CAMPI data on auto sales improved 7.8%, but that’s because of the three-day differentials between February and March.

Articles like this “Philippine auto sales remain optimistic in March 2018 with 28,216 units” puts a spin by cherry picking on the monthly sales statistics. On a daily average, auto sales shrank 2.64% month-on-month. There was no improvement.

It needs to be recalled here that the year-on-year rate of change in motor vehicle sales have been consistently headed south since it peaked in August of 2016.  True, auto sales in nominal units continued to head north, but the rate of improvement had been slowing materially. And that’s before the distortions brought about by TRAIN.

The trend channel of the rate of change of auto sales (in % yoy) reveals the unfolding trend. (upper window)

December 2017’s boom was in response to the “selling the price increase” where people rushed to buy autos ahead of the sharp increases in excise taxes from RA 10963 (TRAIN Law).

The March 2018 crash, which broke below the trend channel, highlights either a dramatic downside shift in the trend line or a bounce will occur to normalize present trends. Either way, the furtherance of a downtrend looks likely.

A curious statistic is from the BSP. While motor vehicle sales contracted by 3.2% in February, auto loans grew by 24.7%! Which of the numbers has gone astray, the BSP or CAMPI?

If not, where the heck did the credit money from the sector flow into? Have people been using the auto industry as a staging point for diversion of loans elsewhere?

On a quarterly basis, motor vehicle sales shriveled by a hefty 8.5% year-on-year!

1Q used to be the quarter which posted the strongest growth in auto sales. Sales exploded in 2015-2017 at a rate of over 21%.

In 2017, 1Q sales growth registered a hot 22.95% besting the previous two years. Suddenly, it crashed by 8.5%! From 22.95% to -8.5%! From Boom to Bust.

Following a five-month reprieve, auto manufacturers have upped their production by a modest 4.81% in February.  That’s if the data on auto production from the PSA is accurate.

Aside from near zero growth in September and October, transport production posted negative percentage changes from November 2017 to January 2018 

It appears that there had been significant drawdowns in inventory for them increase production, or that manufacturers have turned optimistic and have projected increases in future sales.

Well, I doubt that there would be any meaningful recovery for the following reasons

First, if the present surge in bond yields transform into borrowing costs, then that would be a double whammy for sales. Think of it, significantly higher auto prices faced with substantially higher financing costs. There will be less incentive to increase balance sheet gearing. Furthermore, the rise in financing cost will most likely put pressure on the balance sheets of entities exposed to high leverage that would diminish demand for either investments or consumption. The takeaway: slower sales.

Second, the ongoing war with the TNVS industry would hardly be helpful in driving up sales.

Third, higher real economy prices from the BSP and RA 10963 would translate to compressed profits for most businesses and reduced disposable income and purchasing power for consumers.

Rising oil and energy prices will likewise increase the cost of maintaining a vehicle and thus erode the incentive to have one.

Fourth, soaring fiscal deficits financed by higher taxes which diverts resources from the private sector to the government would likewise reduce the private sector’s capability to expand business and diminish household consumption.

Fifth, the auto industry does not exist in a vacuum. The industry consists of supply and demand chain as well as credit flows.

Both its upstream and downstream industries will be affected by the ripple effect from the current slowdown of the core auto industry. (chart from AT Kearney) [I previously showed this in Has Peak Auto Sales Arrived? Part 2; Downshift in Sales Growth Spillover to Auto Production! September 17, 2017]

For instance, a sustained stagnation in the core automotive industry should translate to slower sales in after-market services, in car parts, in insurance, in fuel sales and other industries in chain link.

A prolonged stagnation in production would likely slow volume and peso sales of input providers to the core industry.

The industries within the chain link have themselves demand for motor vehicles. Demand for the industry's products may also emanate from the industry stakeholders, such as officers, employees, or owners. Hence, a downturn in sales, output, and profits will negatively impact demand for motor vehicles from the industry itself.

The upstream and downstream industries have their own supply and demand chains. So a sustained stagnation in sales, output, and profits would diffuse into its ecosystems. For instance, once stagnation percolates into the downstream industries such as retail auto parts and services, such could reduce demand for retail commercial spaces

Sixth, the war on tourism, particularly on Boracay will most likely have a significant impact on the real economy.

The economy represents a latticework of complex intertwined chains of commercial activities. Following this logic, Boracay’s supply and demand chains will directly be pounded first. The epicenter of dislocations will be on Region 6 which is likely to spread nationwide over time.

The economic dislocations from the championing of environmental socialism won’t be like the deleterious effects of a massive typhoon which has a limited impact.  Even if Boracay closes for only four months, this should have devastating economic effects.  The construction activities used to preserve the environment at the expense of the tourist activities won’t be enough to offset the latter’s losses. 

Seventh, more and more political interventions will be taking place. And since redistribution from such intrusions represents a zero-sum game, there will be fewer investments, jobs, earnings, and consumption.

For instance, what gift would Mr. Duterte give to the leftist labor groups in Labor Day? Would Mr. Duterte grant them their desire to have Endoended by an Executive Order (EO)? Or would Mr. Duterte personally handle a crackdown or directly intervene to end 5-5-5 practices?

The labor undersecretary suddenly resigned from his post, after being accused of being pro-management, as well as preempting Mr. Duterte from firing him on the account of alleged graft.

Has this signaled the coming suppression of entrepreneurs and capitalists?

A rigid clampdown on labor contracting and subcontracting should have adverse medium to long-term effects on investments, on labor and the economy.

Mr. Duterte’s ‘class war’ won’t boost demand for the automotive industry.

Besides, Mr. Duterte’s war on the automotive sector, through higher excise taxes, should mean that the industry is highly vulnerable to an economic shock.

So the industry should serve as one of the leading indicators of economic fragility

Evidence of the economic susceptibility has been swiftly piling up!