“Everything is fine until inflationary pressures or something else shocks up the interest rates. And the minute they go up, it becomes obvious that government debt service has gone high enough so they will have no recourse but to have the central bank finance still more. And when that happens the writing is on the wall, the currency collapses and the inflation becomes essentially uncontrollable. This is a highly non-linear process that cannot be captured by the econometric models that are in widespread use. They are essentially linear”—William R White, chairman of the Economic Development and Review Committee for the OECD
In this issue
Bullseye Again! BSP’s RRR Cuts Had Been Targeted to Shore Up the Banking Sectors’ Liquidity Woes as USD Peso Soars to a 12-Year High!
-Strains in the Banking System Intensifies
-BSP’s 1st Reserve Requirement Ratio Cut: Stimulative Until It Isn’t
-BSP’s 2nd RRR Cut: Neutral Only If We Want It
-BSP’s RRR Cuts: Hardly About More Bank Lending; The Transition to Phase 2 of the Inflation Process
-BSP’s RRR Cuts Had Been Targeted to Shore Up the Banking Sectors’ Liquidity
-National Government’s Aggressive Spending will Complicate the BSP’s Banking Rescue Operations
-RRR Cuts Sends USD Php to a 12-Year High, Bond Yields and the PSEi Lower
Bullseye Again: BSP’s RRR Cuts Had Been Targeted to Shore Up the Banking Sectors’ Liquidity Woes as USD Peso Soars to a 12-Year High!
The Philippine banking system is in a dire bind.
Strains in the Banking System Intensifies
Mounting fractures have been surfacing from various signposts: the sector’s balance sheet, the sector's fund-raising activities, market prices of stocks and ROP yields to the BSP’s policy responses.
Figure1
As previously explained*, the drain in the banking system’s most liquid assets, cash and due banks have been accelerating. Moreover, the marked shift in the composition of the sector’s asset investment allocation may have been contributing to this developing internal liquidity strains. The irony has been that liquidity pressures have been occurring at a near-record pace of bank lending, supposedly improved profitability (1Q 2018), and with it, the reported near record lows in Non-Performing Loans.
*See Philippine Banking System’s Underbelly Exposed: Cash Drains at Fastest Rate, Fixed Income Stampedes into HTM Accounts as Concentration Risk Mounts May 14, 2018
As banks have been placing most of their eggs into the lending portfolio, profits and low delinquencies should have provided the system with sufficient liquidity.
But the current conditions contradicts this sanguine outlook
Not only in the Philippine Treasury (ROP) markets, such strains have become evident even in the Philippine Stock Exchange.
Banks have been weighed most on the Phisix. Though the main equity barometer has declined by 10.64% in 2018, banks have lost 15.59% or 46.5% more. (Figure 1; middle right window).
The picture gets even more dismal. The banking index has tanked by 19.05% which has almost reached the bear market threshold level of 20% on a peak-to-trough basis. (Figure1; lower window) All data as of May 25.
And despite the sustained session end price fixing, banks shares continue to cascade
Who has been selling? Has it been the insiders? Could it be that banks have been offloading their shares in the market, through their related party transactions, to shore up their cash balances?
BSP’s 1st Reserve Requirement Ratio Cut: Stimulative Until It Isn’t
So the BSP comes to a subtle rescue.
For the second time this year, the Bangko Sentral ng Pilipinas (BSP) announced last week that it would slash the banking system’s reserve requirement ratio (RRR) by one (1) percentage point which takes effect on 1 June 2018.
The RRR cut marks a volte-face by the BSP
At the end of January, the BSP chief Nestor A. Espenilla, Jr. bluntly asserted that stimulus was not required. [Businessworld BSP: not time to cut reserve requirement January 31, 2018] (bold added)
“While the current manageable outlook for inflation allows scope for a reduction in RRR, domestic liquidity conditions are not unduly tight, as both M3 (domestic liquidity) and credit continue to expand at double-digit rates,” Mr. Espenilla said in an interview with GlobalSource Partners that was published on Jan. 28.
NO NEED FOR MORE STIMULUS
“Moreover, the overall pace of credit growth is also considered to be in line with the requirements of the economy, suggesting thatadditional stimulus to the real economy is not necessary at present.”
Fifteen days later, the BSP abruptly turned around to pare down RRR rates.
The BSP asserted that it would “gradually lessen its reliance on reserve requirements for managing liquidity” and “shift towards the use of market-based monetary instruments since the adoption of the interest rate corridor (IRC) framework”
The discourse on stimulus vanished from the official statement!
Aside from the shift in the tools for policy management, the BSP couched the “potential liquidity impact” of the RRR cut on its ability to mitigate these through “offsetting auction-based monetary operations”
In plain English, the RRR cuts have stimulative effects that can be counteracted by the BSP with its auction-based monetary operations (Term Deposit Facility)!
It is stimulative until it isn’t! Who says? Says I, the BSP.
BSP’s 2nd RRR Cut: Neutral Only If We Want It
Fast forward last week.
The BSP repeated that its mantra that RRR policy signified a shift in policy management.
However, the BSP added that such policy has not been “intended to signal any change in the prevailing monetary policy stance”. In layman’s terms, RRR policies are supposedly neutral.
But because the BSP didn’t define their pathway, they have obscured what “the prevailing monetary policy stance” is.
Because of market pressures, the BSP raised rates on May 10. On the other hand, as the BSP chief indicated in January, RRR cuts signified a stimulus.
Have the BSP been in a tightening or an easing mode? Or have they been confused on which direction to take?
With some Php 90 billion of funds freed, some observers see the BSP’s action as a substantial liquidity infusion that may ‘ease short-term rates’.
More pointedly, observers see the BSP’s move a credit easing operation. Or the BSP’s stretching for free money. Such perception goes against the projected official theme that BSP move is neutral.
Of course, technically, the RRR cut and an interest hike tackle on different operational aspects of the banking system.
While the latest RRR move aims to free funds held by banks, interest rate policies are designed to allocate credit through the pricing (interest rate) signal. Since rising interest rates translate to a higher cost of credit, demand for credit will be affected.
Having more funds for lending does not necessarily mean more lending.
The BSP’s take on RRR policies has been evolving. In January, RRRs were about the stimulus. In February, RRRs can be stimulative until the BSP decides against it. And last week, RRRs are neutral only if the BSP wants it.
Famed novelist George Orwell would call the BSP's communication a ‘doublespeak’
BSP’s RRR Cuts: Hardly About More Bank Lending; The Transition to Phase 2 of the Inflation Process
And is the BSP trying to push more money for credit allocation?
Figure 2
More credit allocation for more liquidity? Really?
Based on traditional measures of liquidity, such as changes in credit and money supply conditions, banks have been lending at near record pace (over 18% in the last 15 months). Money supply growth has likewise been picking up speed (+14.4% in March).
That is to say, general liquidity conditions have been on fire!
So how much more credit growth is the BSP expecting from the banks?
Concerns over “overheating” and of the BSP being “behind the curve” have emerged in some quarters. Will further credit and liquidity expansion not reinforce such escalating apprehensions?
And is the BSP expecting money supply growth to explode beyond present rates to levels seen in 2013-2014???? If that is the case, the present rate of price inflation could DOUBLE or more. The peso will suffer a meltdown!
Inflation comes in three phases, according to the Austrian School of Economics.
In the first stage, the government prints money but prices don’t rise as much as the money supply. The reason for the suppressed inflation is because money printing is perceived as a temporary episode. When people hoard money in anticipation of the lowering of prices, prices can even fall. In the second stage, when people begin to realize that the policy of inflation has become entrenched, demand for money falls as price inflation intensifies. At the final stage, prices go up faster than the money supply. A shortage of money develops and popular pressures emerge for the government to print more money to harmonize with rising prices. If the government accommodates such popular demand, real economy prices and the money supply skyrockets. The final phase is characterized as a crack-up boom or what is known as hyperinflation which entails the destruction of the currency or the death of money.
Applied to the domestic landscape, if you haven’t noticed, raging real economy prices have become increasingly political.
Rising prices have prompted the President Duterte to require the Department of Labor to convene wage boards. Such call to action signals the likely rise in minimum wages. And minimum wage hikes will likely be passed on to consumers or squeeze company earnings which should lead to reduced output, which again should lead to higher prices. Once imposed, the inflation cycle accelerates.
The Duterte administration looks likely to institute price controls and embark on a populist witch hunt against “profiteers”.
Rising prices have also impelled several senators to call for the suspension of RA 10963 or the TRAIN Law. A rollback, partial or whole, of the TRAIN law, will explode fiscal deficits to the moon! That’s because there will be no rollback on public expenditures!
With tax revenues down, the fiscal chasm from a scale back on TRAIN will have to be financed by a mountain of debt that leads to spiraling interest rates and or the BSP’s debt monetization which should fuel even more inflation. The proverbial chicken comes home to roost.
Real economy prices have been rising even BEFORE RA 10963! (see figure 2 lower window) TRAIN has signified an aggravating factor than inflation’s principal cause.
The BSP’s free money policies of Zero Bound Rates and Debt Monetization have been principally responsible for the current the predicament of the Philippine economy.
This free lunch policy is quite evident even in the BSP’s Balance sheets. (Figure 2 middle chart) Growth in the BSP’s international assets as a share of total assets has tumbled strikingly from late 2016. Intense money printing through the banking system has been replacing the slack in international assets growth. The peso reserve deposits as a share of total liabilities have more than DOUBLED since 2012. This shows WHY the peso has been monkey hammered. An avalanche of pesos has been created to finance every US dollar generated by the financial ecosystem.
So why won’t inflation be a problem?
The increased politicization of inflation suggests that the Philippine economy has moved from phase 1 to phase 2 of the inflation process.
And the above circumstances tell us why the BSP RRR stance has hardly been about credit allocation.
BSP’s RRR Cuts Had Been Targeted to Shore Up the Banking Sectors’ Liquidity
When the BSP made a U-turn on its RRR policy last February, I offered three reasons**.
**Bullseye! Panicked BSP Slashed Reserve Requirements in the face of Meltdown in Philippine Bonds! February 18, 2018
One, the RRR cuts would address the BSP's morbid fear of positive real rates as this means the elimination of invisible transfers to the government. Two, the RRR cut was meant to bolster or protect government revenues or taxes. Three, it was a measure to fight or cushion the bond meltdown.
It turns out that there is a fourth reason.
Strains on the banking system’s liquidity have emerged.
About Php 1.867 trillion of reserve deposits of other depository corporation as of December, has been held by the BSP suggesting that more than Php 36 billion will be released for banks to use from the twin RRR 1% cuts.
The banking system’s most liquid assets, cash and due banks, dropped by Php 43.52 billion last March and by Php 198.6 billion from the start of the year. It has been down by Php 294.4 billion from its recent peak in August 2017. The current growth rate of cash and due banks hasn’t recovered since peaking in 2013.
Ironically, the BSP’s first RRR cut took effect on March, yet the banking system’s cash and due banks position dived by 9% or by Php 43.52 billion!
Such exhibits liquidity drain from the banking system’s balance sheet despite the furious pace of credit issuance and an uptick in money supply growth.
Freeing funds as a patch to the banking system’s cash crunch has been the most likely implicit goal of the BSP’s RRR Policy.
However, treating symptoms isn’t the same as treating the disease. Band-aid remedies are likely to prove as short-term palliatives.
The crux of the matter is what has been the source of the liquidity strains of the banking system?
Have these been about the unreported surge in credit payment delinquencies? Have these been about massive losses in investments? Or has the toxic mix of both factors contributed to these?
In both aspects, the BSP will push for more easing.
The BSP hopes that its interest rate magic would effectively buy time for credit impaired institutions (customers of banks). These institutions would be like what the Bank for International Settlement calls as Zombie firms – companies totally reliant on low-interest rates to survive.
Unfortunately, implicit subsidies have real economy effects such as the “crowding out”. Transferring resources from productive to non-productive uses will only deplete capital which should undermine productive growth over time.
Moreover, since zombie firms require more borrowed funds to finance existing liabilities, systemic leverage will continue to expand as credit quality deteriorates.
Interestingly, if the BSP’s measures fail to resolve such issues, affected banks may be forced to call in their loans. The system’s credit expansion may slow, or even shrink, and this may lead to liquidations and reductions in deposits. And the BSP will likely bail out these banks with taxpayer funding. Woe to the peso!
And if this has been about losing investments, the BSP hopes that negative real rates will spur the same trick of bolstering the animal spirits that would prompt for a frantic chasing of yields.
Unfortunately, the maladjustments in the economy will get amplified from the distortion in the pricing mechanism that leads to a misdirection of resources.
Inflation is a symptom of such process.
And since these are unsustainable, it is only a matter of time when such malinvestments will surface.
For now, I don’t expect banks to use the BSP’s emergency facilities since this will unveil the rut within the system that may incite a panic.
So the BSP will likely use RRRs and its balance sheet (debt monetization) to work on fixes on the liquidity problems of the banking system. These would be channeled through serial injections and through manipulations of marketplace (ROP markets and the USD peso)
And unless pushed by the markets, the BSP’s interest rate policy will function as a public relations veneer. The timid tightening it embraced was meant to please the public pressure and the markets. At the same time, the BSP hopes that there will be a magical resolution to the accrued imbalances in the system
As I have been saying here, these are additional signs that BSP has lost control: The BSP continues to forcibly feed easy money to a system that has sought for increased disciplinary conditions through tighter money.
National Government’s Aggressive Spending will Complicate the BSP’s Banking Rescue Operations
The actions of the National Government will further complicate the BSP’s operations
Heightened competition for access to savings hasn’t been limited to the banking industry.
The National Government’s Cash Operations registered a surplus of Php 46.315 billion as revenues soared by a stunning 30.32% in April, which had been offset partly by the astonishing 42.69% boom in expenditures.
Figure 3
Who paid for all these taxes? The PSEi 30’s annual income growth of 4.21% in 2017 and 6.89% in the 1Q 2018 hardly support the revenue number.
Additionally, with the deepening crowding out dynamic brought about by increased government activities in the economy, it is unlikely that the ex-PSEi 30 listed firms and the unlisted firms contributed that much. Has the NG inflated the revenue numbers? (NG’s debt figures and the BSP’s net claim on central government should give us a clue, perhaps by next week)
Tax revenues (BIR and BoC) posted its best showing in the last 7 years (perhaps more) but generated only the lowest surplus because of the incredible spending boom. (upper window)
Just what happens if the tax revenue growth moderates? And what happens if there will be a rollback in RA 10963?
These astonishing numbers are worrisome. NG’s actions have been predicated on the linearity of such policy influenced dynamics!
The end of the calendar year for the filing of taxes is in April. Therefore, fiscal surpluses have been common for the month. Paradoxically, this year’s surplus has been the lowest in 5 years.
April’s surplus will momentarily ease the National Government’s demand for funding.
Again, the Bureau of Treasury has yet to post the NG’s April’s debt numbers.
April’s Php 46.3 billion fiscal surplus reduced the 4-month deficit to Php 105.86 billion which accounted for 2.71% of the 1Q nominal GDP of Php 3.9 trillion. (Figure 3 middle window)
Still, the deficit accrued from January to April 2018 was the third largest since 2008!
Over the decade, either lower revenue growth or higher expenditures have caused the swelling of deficit spending. It’s different this time. Both revenue and spending growth have surged simultaneously. That’s a milestone in recent history.
With annual deficit spending targeted at 3% of GDP (about Php 520 billion), much of the funding requirements of the National Government will come in the second semester.
Again, the banks will have to compete with the National Government for funding. And that would complicate the BSP’s rescue operations
RRR Cuts Sends USD Php to a 12-Year High, Bond Yields and the PSEi Lower
So how did the RRR cut affect the financial markets this week?
Figure 4
Yields of Philippine Treasuries (ROP) fell from the short-term to the 10-year spectrum. The 10-year bellwether rallied most; its yield fell by 63 basis points. Yields of the longer-maturity papers rose marginally. (Figure 4, upper right chart)
Over the past month or so, ROP yields soar in the morning and most often register substantial declines in the afternoon. These are likely outcome of the BSP’s operations to control the pace of changes in bond yields. (Figure 4, upper left chart)
Just look at how the 10-year yield had been chopped from 6.6554% to 6.1116% for a whopping 54.38 bps move! 86% of the Yield reduction came from Friday’s afternoon pump!
The bond yield control seems similar to the price-fixing activities in the Phisix.
Curiously, when the BSP first announced the RRR cuts in February, Phisix jumped 1.28% over the week. However, the enthusiasm then hasn’t been repeated with this week’s .32% decline.
Had it not been for the massive end session pumps which totaled 46.42 points or .6% of last week’s close, the decline should have been larger (figure 4 lower window)
Banks (-2.03%) and services (-1.44%) were responsible for the week’s decline. On the other hand, the property (+.45%), holding firms (+.2%) and the industrial (+.21%) sectors posted gains.
Recall that the BSP lowered the RRRs when the PSEi 30 was close to its peak in February; 3 months after, the Phisix has been substantially lower.
If the BSP’s RRR fix doesn’t improve the bank’s conditions, the industry’s share prices will be adversely affected. If banks have been liquidating their shares to raise funds, such dynamic can be expected to continue.
And if banks are the heart and lifeblood of the contemporary debt-financed Keynesian modeled economy and if credit issues beset them, just what would happen to industries heavily dependent bank leverage?
Finally, the USD Php jumped 1.01% during the week the BSP announced its first RRR change last February.
Figure 5
This week’s RRR cut resonated with the past. The BSP’s rescue operation helped power the USD peso (+.71%) to a fresh 12-year high
The BSP has been boxed to a corner with their choice having been limited to either to inflate or die (suffer from a recession).
One of these days the USD Php will experience significant upside spikes.
Buy the USD Php!
Funny but am I not supposed to be a stock market analyst? ;)
