“..Built into the speculative episode is the euphoria, the mass escape from reality, that excludes any serious contemplation of the true nature of what is taking place. “Contributing to and supporting this euphoria are two further factors little noted in our time or in past times. The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes in only a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world. There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.” - John Kenneth Galbraith
In this issue
Deficit Spending Finance: The BSP Unleashes a Staggering Php 101 Billion QE in May!
-The Unsung Perils of the Growing Dependency of BSP’s Financing of Deficit Spending
-In the First Five Months, the BSP Has Financed the Duterte Regime’s Aggressive Deficit Spending!
-The National Government and the BSP Policy Path Dependency: More Inflation Coming!
-Tactical Macro-Prudential Goals: Manipulate Financial Markets and Statistics, and Increase Regulations in the Economy
Deficit Spending Finance: The BSP Unleashes a Staggering Php 101 Billion QE in May!
The Unsung Perils of the Growing Dependency of BSP’s Financing of Deficit Spending
Absolutely stunning!
Figure 1
From the Bangko Sentral ng Pilipinas: “Likewise, net claims on the central government rose by 17.3 percent in May from 13.1 percent (revised) in April as a result of increased borrowings by the National Government.”
An unconventional policy tool previously used for emergencies has now become conventional!
And people think that we are living in normal times!
And it has been a wonder why the USD peso rose by only 1.5% over the same period when the BSP has stepped up the tempo in using its highly inflationary "nuclear option" tool of financing the National Government’s deficit spending. (see figure 1)
The perils of such hazardous actions have been kept from the public by the officialdom or by establishment institutions.
In 2004, former Governor Rafael Buenaventura* assuaged the public on financing deficit spending with, “Let me also emphasize that the Philippines has enough institutional safeguards against excessive deficit financing and seigniorage that helpensure the BSP’s independence from fiscal sector constraints. The New Central Bank Act of 1993 (R.A. 7653) sets out clear limits on the size and the repayment period of the BSP’s financial assistance to the National Government.” (bold added)
*Governor Rafael Buenaventura, Some Thoughts on the Budget Deficit, speech at the Regular Membership Meeting Rotary Club of Makati Central, April 6, 2004, bsp.gov.ph
Two concerns raised from that statement: Institutional constraints on financing deficit spending and BSP independence
From the R.A. 7653: The New Central Bank Act
SECTION 89. Provisional Advances to the National Government. — The Bangko Sentral may make direct provisional advances with or without interest to the National Government to finance expenditures authorized in its annual appropriation: Provided, That said advances shall be repaid before the end of three (3) months extendible by another three (3) months as the Monetary Board may allow following the date the National Government received such provisional advances and shall not, in their aggregate, exceed twenty percent (20%) of the average annual income of the borrower for the last three (3) preceding fiscal years.
Does the BSP data suggest of a string of three-month rollovers? It seems more of a snowballing than a constraint on the financing of the NG.
The BSP’s net claim on National Government rose to a staggering Php 1.816 trillion in May, accounting for about 73.44% of 2017’s annual aggregate National Government revenue of Php 2.473 trillion.
The incumbent legal proscriptions on deficit financing seem as being ignored.
And former Governor Buenaventura was right. The more the involvement of the BSP in the financing of the deficit, the more the BSP has become subordinate to the National Government’s whims.
Extensive deficit financing means that whatever "independence" the BSP was supposed to have, had been severely compromised. This episode shows that the notion of central bank independence is mostly a myth.
And once again an excerpt from UP Professor and the BSP Sterling Chair Dr. Dante Canlas’ 2012 paper**: “Money shocks, however, often have fiscal origins. If the government has a persistent deficit in its budget that is accommodated by the monetary authority, money growth tends to become excessive. In this context, money shocks stem from fiscal shocks.”
**Dante B. Canlas, Business Fluctuations and Monetary Policy Rules in the Philippines: Lessons from the 19841985 ContractionApril 30, 2012, bsp.gov.ph
And in reaction to the paper of Dr Canlas, BSP Sterling and DLSU Professor Lawrence Dacuycuy wrote***: “The paper has also highlighted how monetary growth shocks can negatively affect the balance of payments which led to the abandonment of the fixed exchange rate policy. Surprisingly, the paper has shown that even with simple data on GDP and monetary growth rates and fixed exchange rates can clearly validate theoretical predictions. Now we know that monetary policies that support aggressive fiscal initiatives like deficit spending are not only unsustainable but dangerous.”
***Dr. Lawrence B. Dacuycuy, Discussion of Business fluctuations and monetary policy rules in the Philippines: with lessons from the 1984 – 1985 contraction May 2012
Those days establishment experts ranted freely about the hazards of the BSP’s direct or indirect financing of NG’s deficit spending because fiscal deficits were significantly smaller and more manageable, which didn’t require support from the central bank. (see above charts)
However, today, as the BSP ramps up its “not only unsustainable but dangerous” policies, establishment experts point to every other direction except monetary policies!
Such denials have been astounding!
In the First Five Months, the BSP Has Financed the Duterte Regime’s Aggressive Deficit Spending!
And it has been true that the BSP has fined tune its policies towards the accommodation of the National Government’s aggressive spending programs
Given its inflation targeting policy, I proposed a limited spectrum of actions for the BSP.
[See Why Interest Rates Will Rise: 1Q Fiscal Deficit Blowout Financed by BSP’s Debt Monetization (QE) and Spiking Public Debt!May 6, 2018]
1) If the NG uses the capital markets, rates will have to reflect the avalanche of supply. Moreover, NG spending will increase pressures on real economy prices.
2) If the NG will use the BSP option, the peso will fall steeply and inflation will rise, which again will ricochet or boomerang on bond yields.
3) If the government stops from its current undertaking, it will severely slow the GDP, prompt for a fall in tax revenues which should spike deficit as well. Credit risk will surface and subsequently impact the banking system. Markets will demand more collateral or increases in credit risk premium (higher yields!).
4) If the government should use or depend on external sources for its financing, they should see the same dilemma: rates have been rising too!
5) The last option would be for the NG and BSP to manipulate markets and statistics in the hope that the markets will conform and comply with their political targets.
Figure 2
First, some data.
The Bureau of Treasury reported the January to May fiscal deficit at Php 138.729 billion. (upper window)
2018’s deficits signify the second largest since 2010. In 2010, in response to the 2008’s Great Recession, NG revenues had been lackluster relative to public expenditure.
Today, aggressive public spending has eclipsed credit financed vibrant NG revenue growth.
This time is different. Free money rules!
Since 2015, the BSP has used its debt monetization program in support of its interest rate policies to meet its “inflation targets”. In reality, inflation targets function as invisible taxes.
As one would note, M3 growth has been in synchronized with tax revenue growth.
That is to say, the growth of tax revenues has been dependent mainly on credit growth.
Yet, the distortions from the imposition of the TRAIN law RA 10963 appear to be fading. That said, M3 should take the driver seat. (lower pane)
With M3 in seeming deceleration, May tax revenues (BIR + Bureau of Customs) growth has similarly declined to 13.07%.
Surprisingly, growth from BIR revenues has softened to 8.4%. If the 5.21% CPI (2006 base) is applied, real growth in BIR revenues has only been 3.19% in May!
Such data seemingly supports Mr. Duterte’s admission that the “economy is in the doldrums”. [see The Era of Easy Money is OVER! President Duterte Confirmed This With “The Economy Is In Doldrums” June 24, 2018]
And it is of no wonder why the administration has now been toying with the idea of legalizing jueteng!
Now for the incredible rationalization! From Inquirer (June 28, 2018) “Duterte says illegal drug trade may worsen if jueteng is stopped”: “President Rodrigo Duterte on Thursday said the illegal drug trade may take over if the illegal numbers game “jueteng” is stopped. “Jueteng is unlawful. It is not legal. It cannot be allowed,” Duterte told reporters in an ambush interview in Panglao, Bohol. He said he must be able to give alternative livelihood to those involved in jueteng or they may choose to join the illegal drugs trade.”
The suffocating grip on the economy will loosen when free money totally stops
In the context of deficit financing by debt, domestic borrowing in May has declined Php 74.5 billion month-on-month, which has slowed the rate of year on year gains to 6.94%. Foreign borrowing expanded Php 32.381 billion for the month for a year on year gain of 9.08%. Part of that gain emanated from the weaker peso. Total borrowing was down Php 42.136 billion in May (monthly basis) to lower annual growth rate to 7.68% (middle window)
On a year to date basis, to finance the NG’s fiscal deficit of Php 138.729 billion, the Bureau of Treasury (BoTr) raised a net Php 180.142 billion in foreign currency liabilities while the BSP lent to or absorbed Php 181.1 billion of NG’s securities. The BoTr reduced domestic debt by 16.9 billion while borrowing Php 197 billion in foreign currency.
To describe the picture a bit more fully, the BSP financed mainly the domestic requirements of the NG. Meanwhile, the BoTr’sraised external debt most likely to fund US dollar requirements of both the NG and the private sector (mostly banks). Perhaps, the spare US dollar borrowing could have also been used to support the peso.
In the meantime, the excess between the five-month fiscal deficit and the BSP’s debt monetization program must have been channeled to the domestic treasury market to manage yields. Precisely put, the spare money had been used to manipulate domestic treasury yield level and or the yield curve.
The National Government and the BSP Policy Path Dependency: More Inflation Coming!
The NG and the BSP’s path dependency have been made clear.
Because funding aggressive deficits by debt would siphon liquidity that would raise rates immediately, the NG has opted to use the BSP’s nuclear route (my second option).
The NG through the BSP has elected to gamble with the inflation genie.
The BSP hopes that either the supply side or output catches up with the magnified demand from the NG’s spending spree and also from credit financed the bubble economy, or that administrative tools, like wage and price controls, would weave its magic to temper excess inflation.
Figure 3
The CPI (+5.21 2006 base; 4.5% 2012 base) continues to climb even as bank credit growth rates to have been waning.
Total production and consumer loans have retreated to +19.26% in May from +19.58% in April
The declining rate of bank portfolio growth to consumers (+18.42% in May from +19.02% in April) appears to be accelerating. The sizzle in production loans seems to have reached a state of fatigue (+19.34% in May from +19.63% in April).
With slowing credit growth, the ebullience in M3 and the CP rates must have been from the BSP’s QE. Of course, the BSP’s QE could have also been designed to ease liquidity strains in the banking sector. The BSP’s QE has now supplemented the two reserve requirement cuts.
To be clear, financial liquidity hasn’t been evenly distributed. Rising rates signify ongoing liquidity strains even as banks have been throwing money around.
The NG, being the main beneficiary of public spending, has been the most liquid. It’s why prices have risen in areas where the government has spent most (e.g. construction material wholesale prices).
Despite the huge credit issuance, banks, on the other hand, have been gasping for liquidity.
Tactical Macro-Prudential Goals: Manipulate Financial Markets and Statistics, and Increase Regulations in the Economy
Manipulating markets and statistics may have been used by the BSP too (my option 5).
Whether the surge in external debt had been used for supplying the political economy with foreign exchange or for defending the peso, the Philippines has increased its “US dollar short” position. As the peso continues to enervate, those existing US dollar liabilities should swell. The pressure from the mismatches of foreign liabilities should exacerbate.
The BSP’s GIR position continues to emaciate and have been filled with artificial or borrowed reserves.
At the same time, manipulations on the financial markets (peso, stocks, and bonds) translate to more falsification of the pricing system which leads to intensifying accumulation of imbalances.
The BSP has achieved its negative real rates regime by suppressing rates. (figure 3, upper window)
Like stocks, the surge in yields in the morning will be tamed in the afternoon. And that has been the daily routine. For now, it works. That’s until street inflation explodes that will be manifested through the political realm.
Figure 4
In stocks, recoveries can only be engineered and barely a product of spontaneous market actions.
More than half of the week’s 1.8% gains have been owed to astounding serial pumpings. Of course, considering that market actions gravitate on 5 issues with a market cap of 45.23%, serial pumping has been reckoned by the BSP and the SEC as “normal” marketplace activities. A sense of “normal” which exists only in the Philippines.
Excess money from the BSP’s May QE may have found its way on the PSE. Will too much money be chasing too few assets?
As one can see, the NG and the BSP has been boxed into a corner.
And their recourse will be more combust more inflation.
Buy the USD Php!
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