The National Government Goes on a Borrowing Spree as the BSP Re-engages Quantitative Easing; Why?

“Jesus—the revolutionary, the political dissident, and the nonviolent activist—lived and died in a police state. Any reflection on Jesus’ life and death within a police state must take into account several factors: Jesus spoke out strongly against such things as empires, controlling people, state violence and power politics. Jesus challenged the political and religious belief systems of his day. And worldly powers feared Jesus, not because he challenged them for control of thrones or government but because he undercut their claims of supremacy, and he dared to speak truth to power in a time when doing so could—and often did—cost a person his life.”—John W. Whitehead

In this issue

The National Government Goes on a Borrowing Spree as the BSP Re-engages Quantitative Easing; Why?

-From Goodhart’s to Muller’s Law

-With 2017’s Deficit Below Target, What Happened to the Excess Funding?

-Despite January Surplus, National Government Went On a USD Borrowing Spree!

-BSP Balance Sheet: Replacing Dwindling International Reserves with Bank Credit Expansion

-BSP’s Debt Monetization Concealed National Government’s Domestic Debt Raising in February

-Should the BSP Push Forward with the Press, The Risk of a Peso Free Fall Amplifies

The National Government Goes on a Borrowing Spree as the BSP Re-engages Quantitative Easing; Why?

From Goodhart’s to Muller’s Law

Goodhart’s law states that “When a measure becomes a target, it ceases to be a good measure.” The general idea, as formulated by economist Charles Goodhart, is that when individuals try to anticipate the effects of a given policy, their cumulative actions tend to alter the outcome thereby diminishing the policy’s efficacy.

In his book “The Tyranny of Metrics”, former econometrician Jerry Muller improved on this insight by introducing “anything that can be measured and rewarded will be gamed”.

Instead of spontaneous actions directed at anticipating the effects of a specific policy, some actors work to manipulate policy metrics to their advantage, thus skewing outcomes.     

To broaden this perspective; a socio-economic system becomes more prone or vulnerable to manipulation when it becomes heavily dependent on political interventions by bestowing favors to one interest group over the rest. 

Let us see how this applies to the Philippines

With 2017’s Deficit Below Target, What Happened to the Excess Funding?

The Philippine National Government’s (NG) fiscal deficit for 2017 was at Php 350.64 billion or 2.2% of the Nominal GDP (NGDP). This number was slightly lower than 2016’s Php 353.4 billion and sharply down from the projected Php 482.1 billion or about 3% of the NGDP.

The lower than expected deficit mainly came about supposedly from the avalanche of revenues across the board in December, which pulled 4Q topline performance significantly higher.

Such 4Q (mainly from December) outperformance had been INCONSISTENT when seen from four angles*: real GDP dropped to 6.6% in the 4Q from the 7% in the 3Q, Government spending has been instrumental in shaping GDP throughout 2017 and growth in bank credit growth had likewise moderated quarter on quarter (4Q’s 18.85% from 3Q’s 19.86%)

*See The March to a Neo-Socialist Society; 2017’s Fiscal Deficit Down by 27% from Target March 19, 2018

Finally and most importantly, the NG’s domestic debt ballooned by a staggering Php 233.06 billion which accounted for 41% of 2017’s Php 562 billion increase of government arrears!

In total: 2017’s fiscal deficit of Php 350.64 billion was financed by net debt (which expanded by Php 562 billion) and by BSP’s debt monetization (which grew by Php 31.941 billion). Whatever happened to the excess funding raised by the government? Where have the surpluses been channeled to?

As I previously noted, “was the NG unprepared for the avalanche of revenues for them to borrow massively? If true, given the humungous two-month debt surplus of about Php 156 billion, the NG should refrain from tapping the debt market for at least a quarter. But the NG raised Php 74 billion mostly in foreign loans last January! However, if revenues were inflated, then the annual budget deficit had been understated. Because the Philippines can’t show signs of weakness, boosting the top-line which undervalues the budget deficit may have been designed to prevent the peso from a freefall.”

Despite January Surplus, National Government Went On a USD Borrowing Spree!

January’s fiscal conditions 2018 had been a shade of December 2017’s performance. Revenues vastly outperformed expenditures to register a minor surplus.

In details, because revenues surged 19.26% — which  emanated from all categories: BIR +19.5%, BOC +13.6% and non-tax revenues +35.08% — to outpace spending growth 15.45%, fiscal balance tallied a Php 10.191 billion surplus!

By this account, the government should start pruning its surpluses.

 

Yet, the total NG debt expanded materially by 9.9% or Php 73.7 billion in January.  Domestic debt shrank by Php 10.5 billion. Much of the Treasury’s foreign debt growth of Php 84.136 billion accounted for the NG’s issuance $2 billion in US dollar bonds last January. And a parcel of such foreign loans had been channeled to the BSP’s GIR.

The Philippine government even raised 1.46 billion renminbi or Php 12 billion in “Panda Bonds” from China’s Bond Markets last March.

The Bureau of Treasury (BoTr) updated its February debt conditions last week.

What’s striking has been the sustained surge in NG’s debt.

2018’s January-February debt issuance of Php 168.23 billion was the largest since 2013 (upper pane). Foreign debt which grew by Php 179.63 billion comprised all of the net gains in government debt. Domestic debt registered a reduction of Php 11.396 billion mainly from the downsizing of January’s Php 10.5 billion debt.

Considering that the USD-Peso rose 4.22% over this period, based on the BoTR data, about half foreign debt growth came from the weak peso or from the currency effect.

Including December 2017, total public debt swelled by a monumental Php 383.3 billion broken into Php 221.7 billion in peso debt and Php 161.63 in foreign denominated liabilities. (mid window)

To put a long story short; had there been a robust influx of revenues, such immense degree of fundraising from the domestic debt markets shouldn’t be happening. That would be unless these excess funds have been maintained as reserves for contingency purposes. 

But I highly doubt that this has been the motive. (see below)

The other factor is that the NG’s top-line has been vastly inflated.

BSP Balance Sheet: Replacing Dwindling International Reserves with Bank Credit Expansion

 

Yet, it would not be surprising to see the NG and the BSP resort to increased acquisition of foreign denominated loans.

While some of these were designed to service the domestic economy, the requirements of the government have signified the other important factor.     

The growth rate of international reserves, which constitute about 87% of the BSP’s assets (as of November 2017), has been rapidly dwindling. (highest pane in the chart above)

In fact, changes in international reserves from September to November has either stagnated or even contracted (September -1.49%, October +.7% and November -.24%). Thus, the BSP’s balance sheet appears to have peaked.

And to embellish its GIRs, the BSP’s US dollar reserves have been partly inflated by borrowing, partly from derivatives. For instance, the sustained massive pileup in forex holdings has mitigated the drop in February’s GIRs.(mid upper window)

Even more interesting, the waning growth in international reserves has been partially substituted by the sustained increases in reserve deposits of other depository corporations, which accounted for about 38% of the BSP’s liabilities in November 2017.

And such increase is being supported by a persistent upsurge in currency issuance, which has grown by double digits since the 1st quarter of 2013, and which has attained a 28.62% share of the BSP’s liabilities over the same period.

Such asymmetric growth rates reveal why the peso has been falling. It exhibits the creation of more pesos in the face of lessening or diminishing stocks of US dollar reserves!

Since more pesos are required to pay for existing US dollar liabilities, the acquisition of more US dollar-denominated liabilities to spruce up ‘statistics’ would only translate to a vicious feedback loop that would aggravate the sinking of the peso.

The unbalanced growth in its balance sheet also explains the BSP’s morbid fear of raising policy rates: With foundering international reserves, the BSP has increasingly become dependent on domestic credit creation to manage its balance sheet.

And stripped of the façade of an inflationary growth, the current cascading US dollar reserves of the BSP would imply the surfacing of credit risks.  Hence, the BSP would rather sacrifice the peso than risks the implosion of the burgeoning credit bubble.

BSP’s Debt Monetization Concealed National Government’s Domestic Debt Raising in February

This leads us to the third most unrecognized source of government financing: debt monetization.

 

Following a humongous surge in December’s domestic debt, the Bureau of Treasury reported a paltry Php 11.4 billion reduction for the first two months.

But the interesting part has been the bait and switch conducted by the government.

The BSP injected Php 43.14 billion into the financial system last February by acquiring NG’s debts. Yes, it lifted its nominal holdings of NG’s liabilities to breakout from the 2017 consolidation to a record high! (see lower window)

The BSP’s February operation was the second highest since July 2017. (upper pane from the chart above)

For the first two months, the BSP added a net Php 40.04 billion to its holdings. Obviously, the USD php tracked such developments. The USD Php rose by 4.35% over the same period.

So while major central banks have been pulling back or even reversing the use of their balance sheets to manipulate policy rates, here, in the Philippines, the BSP has been accelerating its emergency operations!

To repeat, this government (NG and the BSP) has only entrenched its “All or Nothing” policy!

And as it turns out, there has been NO reduction of NG’s debt. Holdings of NG liabilities merely shifted from the private sector and non-BSP government agencies to the BSP. 

The difference in the operation between the BSP (+Php 40.04 billion) and the NG (-Php 11.396 billion) meant that the latter’s liabilities expanded by Php 28.645 billion.

So much for the alleged surge in taxes.

 

Though the rate of growth from the BSP’s net claims of NG has been tapering, that’s because nominal levels have been at record highs. (upper window)

As stated above, the BSP’s February operations bumped its NG debt holdings to a fresh record

From the BSP: “net claims on the central government remained generally steady at 3.7 percent from 3.6 percent (revised), in part due to continued borrowings by the National Government.”

See? No debt reductions! 

Why should the BSP conduct liquidity injection operations when credit expansion has been raging? Why inundate the system with liquidity?

Have there been dislocations in the system caused by marginal credit impairments to require the flooding of money into the system? 

Should the BSP Push Forward with the Press, The Risk of a Peso Free Fall Amplifies

For February, production and household loans have been up by a staggering 18.57% and 19.95% respectively. Total bank credit expanded by a gargantuan 18.68%.

Although this fiery growth rate has moderated from the more torrid record 19-21% pace, it appears that the BSP has sought for more for it to have kicked off the Philippine version of QE.

Beyond the government statistics, the most likely answers have been that the banking system’s credit growth has hardly achieved the targeted inflation levels required to boost taxes and implicit subsidies to the government.

To put bluntly, despite the amplification of emergency policies, deep real negative rates have been elusive or had been hard to come by.

It took a non-monetary political factor, the DoF’s TRAIN or RA 10963, to spur a spike in the CPI.

My guess is that growing balance sheet problems of leveraged institutions have signified a key factor behind the inability of bank credit expansion to deliver the BSP’s ‘real’ inflation targets.

Yet, the Philippine Treasury markets have tracked such developments, hence, the significant rise in ROP yields across the curve.

The upside spike in yields incorporates expectations of higher inflation and more debt supply, as well as, possibly a deterioration in credit quality of the domestic credit markets.

My conjecture resonates with what happened in 2015; the BSP’s current operations have involved the managing or manipulation of the ROP yield levels and curve.

Nonetheless, if the BSP should revitalize and accelerate the use of this emergency tool to attain its policy targets, then money supply growth should soar further.

The outgrowth in money supply should be reflected in real economy prices, and subsequently, in ROP yields. Because the BSP should likely attempt at containing the bond yields and curve through the printing press, a feedback loop would ensue.

The distortive effects of accelerated money printing operations would be on prices of the real economy.  And the subsequent higher prices in the real economy would require the BSP’s accommodation through a greater growth of money supply.

This feedback loop has already been in motion. The transition process will likely test the BSP’s resolve.

Should the BSP fall for the temptation to use its printing presses to the hilt, domestic currency risks would magnify.

External influences such as a tightening of liquidity would likely escalate the current domestic conditions.

The takeaway: the all or nothing policies embraced by the Philippine government (most especially by the BSP) have been heightening the risk of a peso freefall or meltdown.

And manipulating markets or statistics intended to erect a Potemkin Village will only exacerbate imbalances thereby reinforcing a disorderly market clearing outcome.

As a final note, total government debt has reached Php 6.822 trillion as of February while the Banking system’s total loans (production and household) have reached Php 6.969 trillion. The combined loans have reached a record Php 13.79 trillion or 87.3% of the Php 15.798 trillion 2017 Nominal GDP!

People have come to believe that free lunches are entitlements without consequences!

I should be adding the graphs of Phisix tail spikes of last week, but I ran out of spaces.