Falling Rates of Bank Lending, Liquidity, and Government Revenues Point to 3Q GDP Lower than 6%, What Policy Tool Remains to Combat Hissing Bubbles?

The real danger comes from encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking, in effect standing by while bubbles and excesses threaten financial markets. Ironically, the “easy money,” striving for a “little inflation” as a means of forestalling deflation, could, in the end, be what brings it about—Paul Volcker, former US Federal Reserve Chairman

In this issue

Falling Rates of Bank Lending, Liquidity, and Government Revenues Point to 3Q GDP Lower than 6%, What Policy Tool Remains to Combat Hissing Bubbles?

-Falling Bank Lending Means Slowing Demand, CPI Should Fall Too

-Crowding Out Syndrome: September M3 Growth Plunges to Single Digit, Accelerating the Liquidity Drain!

-As Government and Banking System Compete for Savings, BSP Funds 48% of Record 9-Month Fiscal Deficit!

-Bank Lending, Liquidity, and Government Revenues Point to 3Q GDP Lower than 6%

Conclusion: What Policy Tools Does the NG have to Combat the Hissing Bubbles?

Falling Rates of Bank Lending, Liquidity and Government Revenues Point to 3Q GDP Lower than 6%, What Policy Tool Remains to Combat Hissing Bubbles?

The Philippine Statistics Authority is about to announce 3Q GDP on Thursday, November 8. The agency will also announce its CPI data on November 6.

Let us see the effects of the banking loans and domestic liquidity on it.

Falling Bank Lending Means Slowing Demand, CPI Should Fall Too

For September, banking loans and domestic liquidity were reported by the Bangko Sentral ng Pilipinas to have fallen steeply.

Figure 1

Production loans — “which comprised 88.7 percent of banks’ aggregate loan portfolio, net of RRP — increased at a slower pace at 17.2 percent in September from 19.1 percent in the previous month”  

On the production side, only seven of the 20 sectors registered an increase in growth rate, led by agriculture (+1.25% September, -25.24 August), hotel (+7.29%, 5.53%), real estate (+15.83%, +15.57%) and manufacturing (+20.62%, +19.94%). The reopening of Boracay must have contributed to the significant increase in hotel loans. 

The banking system’s loan exposure to the rest of the sectors, including construction (+36.4% September, +36.9% August), retail (22.51%, 24.45%), and financial intermediary loans (+31.42%, +37.21%), fell.

On the other hand, “loans for household consumption grew by 17.9 percent in September from 15.8 percent in the previous month.”

Auto loans (+21.11% in September from August +16.68%) spurred the jump in consumer loan growth in September’s 17.89% from August’s 15.8%.  However, this gain was hardly enough to offset the declines in production loans. Credit card loan growth at 21.89% was slightly off from 21.99% a month ago.

Ironically, the improvement in auto loans came amidst the continuing decline in auto sales (-9.7% in September). Question is: if car sales contracted and auto loans boomed, has credit money been diverted elsewhere? Where did it go?

And after shrinking in 2 straight months, the banking system’s payroll loans posted a marginal .62% increase.

In total, “outstanding loans of commercial banks, net of reverse repurchase (RRP) placements with the BSP, grew at a lower rate at 17.4 percent in September from 18.9 percent in August.” (see Figure 1 top and lowest window)

Including repos, “the growth in bank lending inclusive of RRPs decelerated to 16.3 percent in September from 18.4 percent in the previous month.”

September’s plunge in production loans and total loans growth rate has been reminiscent of 2014-2015.

From a high of 4.2% in July 2014, CPI dropped to two consecutive months of deflation -.4% in September 2015 and -.2% in October 2015. (see Figure 1 top window)

Changes in credit conditions provide a clue of the health of the economy in general and by sectors.

That said, not only has real economy has responded to price pressures, but the broad-based decline in production loans have been in reaction to the ongoing liquidity crunch in the banking system.

The BSP's 100 bps first three rate hikes plus the liquidity strains in the banking system may have contributed to the slowdown in bank lending. 

The effects from the 50 bps rate increase last September has yet to work its way to the loanable funds market.

If too much money chasing fewer goods defines inflation in the layman context, the material drop in banking loan growth heralds a lower CPI through the demand channel.

So while the CPI can be expected to drop significantly, its tradeoff would entail a considerable downturn in demand.  

Crowding Out Syndrome: September M3 Growth Plunges to Single Digit, Accelerating the Liquidity Drain!

Credit expansion from the banking system function as the principal source of the circulating liquidity in the economy.  Claims on banks and the financial industry accounted for about 83.7% of September’s M3

Money supply growth tumbled substantially, “domestic liquidity (M3) grew by 9.7 percent year-on-year to about ₱11.2 trillion in September 2018, slower than the 10.4-percent expansion in the previous month. On a month-on-month seasonally-adjustedbasis, M3 increased by 0.1 percent.” (see Figure 1 middle and lower window)

The money supply measure of M3 represents M2 plus peso deposit substitutes, such as promissory notes and commercial papers (i.e., securities other than shares included in broad money).

M1 or currency in circulation peso plus demand deposits registered the most significant decline to 11.34% in September from 11.48% a month ago.  

With currency in circulation down significantly, there has been considerably less cash to finance cash-based transactions in September.

And with less cash, credit cards have become the alternative source of financing consumer spending.

And with a downshift in banking loans to production sector, this means that demand in a large segment of the production sector has also dropped.

The weakness in loan issuance in the production sector in combination with the cash-based consumer industry reveals that the real economy has decelerated meaningfully last September!

But the distribution of liquidity hasn’t been even.

In as much as industries dependent on credit card financing remains vibrant, as credit card debt continues to sizzle, the vigorous growth in public debt underscores its state of liquidity. (see Figure 1 lowest window)

Total public debt jumped by 11.11% in September. (see figure 2; lower window)

Liquidity conditions indicate that while the private sector spending has been dramatically slowing; spending in the public sector remains exceptionally brisk!

Hence, the asymmetric distribution of liquidity exhibits the crowding out syndrome in motion (again)! The private sector’s use of resources and financing has been pushed away by the National Government (NG)! Or with the NG’s taking command of the use of resources and financing, there has been less available for the private sector.

Figure 2

That said, the banking system will likely show lower peso deposit growth and cash and due banks in the 3Q to reflect on the period’s loan portfolio and M3 performance. (see figure 2; upper window)

Truly stunning developments!

As Government and Banking System Compete for Savings, BSP Funds 48% of Record 9-Month Fiscal Deficit!

And here’s more.

The BSP continues to finance a significant share of public expenditures “net claims on the central government rose at a faster pace of 11.0 percent in September from 8.7 percent in August as a result of increased borrowings by the National Government.” Php 38.5 billion worth of public sector requirements had been funded by the BSP month on month. (see figure 2; lower window)

To finance the record-breaking deficit of Php 378.234 billion in the 9-months of the year, the National Government borrowed Php 146.514 billion from the domestic capital markets to account for a 38.7% share.

Meanwhile, the BSP monetized 48.52% of the NG’s record 9-month budget gap worth Php 183.551 billion. The balance of Php 48.17 billion may have been from the excess borrowing from last year.

Since in the 9-months of 2018, the banking system issued Php 694.32 billion, the Php 146.514 billion growth in domestic public debt essentially consumed 21.1% of the bank sourced domestic liquidity.  And this is why the BSP took the gist of the financing of the record fiscal deficit.

The BSP’s deficit monetization has acted as a counterbalance to the liquidity drain from segments of deficits financed through debt markets

Of course, the NG hasn’t been alone in seeking access to savings, competing with them is the cash-starved banking sector

Bank Lending, Liquidity, and Government Revenues Point to 3Q GDP Lower than 6%

If banking loans and liquidity conditions point to a material weakness last September, how much would a drag it would be to the 3Q statistical economy?

Figure 3

The banking system's lending growth rate has been dropping in the three months of the 3Q. 

And since bank credit expansion determines money supply conditions, and money supply conditions give a clue on the health of money supply in the economy, the slowdown in bank credit expansion should impact liquidity conditions, and subsequently, the statistical economy or the 3Q GDP.

The banking system’s production growth rate and M3’s contours have undulated harmoniously with the GDP since 2015 (figure 3, upper and middle windows)

When bank lending and M3 increased, so did the headline GDP.  When bank lending and M3 decreased, GDP turned lower. 

A slide by M3 to 11.76% in Q2 2018 resulted in a decline of real (headline) GDP to 6%.  

So will the end of the period M3 of 9.76% bring about a GDP lower than 6%?

And does the decline in both bank lending growth rate and M3 presage GDP lower than consensus estimates?

A third factor has been in play to reinforce this possibility: Government revenues.

The downdraft in bank loan conditions has reverberated with the National Government’s revenues which grew by only 1.13% in September.

And this may not be an anomaly. Sputtering NG revenues has occurred in 2 consecutive months.

If tax revenues echo economic activities, then the drop in revenue growth in September, mainly due to the BIR’s (-7.68%), may also indicate a GDP lower than consensus expectations.

Will the correlations of bank lending, M3 and NG revenues hold? Will 3Q GDP surprise lower?

Do understand that the GDP is an econometric constructed statistic which inputs are based mostly from surveys.

Given that the GDP plays a crucial role in politics and government financing, there may be incentives to overstate them. Besides, given that the Government is the author of the GDP, no audit is done to verify its validity.

The best way to cross check the GDP would be from actual outputs: energy consumption, bank lending, taxes, corporate revenues and earnings and etc…

Conclusion: What Policy Tools Does the NG have to Combat the Hissing Bubbles?

Nevertheless, bank loan portfolios, domestic liquidity, and NG revenues indicate a downshift in demand.

And demand from the government may not be enough to offset the decrease in the private sector.

While interventions in the supply side may likely reduce output (e.g. price controls, minimum wages), like government demand, it may not be ample enough to counteract the demand slowdown from the private sector.

That said, the softening of the CPI will express such downturn in demand. 

But, again, along with it comes the tradeoff: a significant slowdown in the real economy, earnings, government revenues, and more importantly, bank liquidity.

The peso should rally further (buy on dips the USD-Php).

In 2015, the BSP counteracted Tetangco’s concern of “disinflation” by instituting QE or the monetization of deficits. (net claims on central government)

That QE instrument remains in force and hovers at record levels.

Despite recent increases, policy interest rates are at still historically low levels and remain negative in real terms (inflation adjusted).

The NG has institutionalized fiscal stimulus as a growth model, which now runs at an unprecedented scale.

That being the case, the instituted policy measures (monetary and fiscal) are for emergency conditions and have remained so. With its excessive use, diminishing returns have come to haunt our policymakers. 

What policy tool do the government and the BSP have to counter the hissing of the twin bubbles?