"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. ... This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard—Alan Greenspan
In this issue
October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?
-Record Fiscal Deficit Equals Greater Government Control of the Economy and Rising Risks of a Fiscal Crisis
-How Does One Analyze Financially the Transition to a Neo-Socialist State? Credit Allocation Determined by Politics
-The Carrying Costs of Spend, Spend and Spend Elixir: Accelerating Credit and Sovereign Risk and Peso Devaluation
-The Contortion of Keynesian Economics: Bulging Deficit-to-GDP Ratio in Good Times; With Emergency Policies in Place, What’s Left When The Tide Runs Out?
October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?
Record Fiscal Deficit Equals Greater Government Control of the Economy and Rising Risk of a Fiscal Crisis
Figure 1
With 10-months through 2018, the National Government’s (NG) fiscal deficit zoomed to Php 483.1 billion as public spending outpaced collections immensely. The 10-month deficit has raced 25% above last year’s annual rate with two months to go! (figure 1 upper window)
Though revenues recovered to jump by 20.33% year-on-year from September’s 1.13%, public expenditure growth sizzled at 35.16% in October from 26% a month ago. As such, October deficit more than doubled (174%) at Php 59.87 billion from 2017’s Php 21.8 billion.
The Bureau of Internal Revenue (BIR) collection growth bounced 15.61% in October from the -7.68% it registered in September. It was, however, revenues from the Bureau of Customs (+30.38%) and Non-Tax Revenues (+31.97%) that provided the main boost for the total revenue growth in October. BIR, BoC and Non-tax revenues had a revenue share of 66.78%, 22.67% and 9.93% of the total.
Following its peak in late 2017, tax revenue growth has been decelerating in line with the slowdown in the growth of total bank loans. The bounce in tax revenues in October appears to have echoed the rebound in the bank loans (+18.36%) in the same month from 17.42% in September and 18.83% in August.
Figure 2
In the 10 months, 2018’s total collection growth of 17.53% was the second highest since 2011’s 17.88%. However, despite a broader tax base and substantial increases in excise taxes, BIR collection growth of 11.6% trailed marginally 2016’s 11.69%, and lagged widely 2014’s 18.84%, 2013’s 20.36%, 2012’s 11.99% and 2011’s 14.29%.
Again, much of the growth in total revenues have been from collections by the BoC from the record imports that has brought about unprecedented trade deficits, and from non-tax revenues. And record imports have been much about public and private sector spending related to build, build and build. To this end, the government’s aggressive deficit spending produced a twin deficit: trade and fiscal deficit.
It is for this reason that TRAIN 2.0, from the perspective of the NG, must be onboarded.
NG collections would have to be kept at a targeted level to sustain the projected rate of fiscal deficit. Otherwise, a shortfall in total collections would unexpectedly widen the fiscal gap thereby requiring a disproportionate amount of funding.
And the risk of a fiscal crisis increases in the event of an unanticipated blowout in the spending-revenue gap. “Fiscal crisis” is a term coined by James O'Connor who denoted of a “structural gap” between public revenues and expenditures that leads to an economic, social and political crisis (encyclopedia.com).
Though studies like the IMF observed the emergence of such crises based on plummeting growth and unemployment and or a surge in inflation; from my perspective, the financing the gap should be more of a concern. Access to local savings through the banking system, domestic and international capital markets will play crucial roles in the bridge financing of the accretion of such deficits.
The 10-month data tells us that the escalation in public spending rather than a shortfall of revenues has engendered such a historic deficit.
As such, the aggressive pace of public spending has resulted in the government’s direct share of the estimated 10-month GDP to surge to 20.18%, the highest ever since 1986. Such figures exclude indirect expenditures or private sector spending on public projects (such as Public-Private Partnerships or PPPs).
Such frenzied rate of public spending ventilated through unmatched deficits reveals of the structural shift in the growth model of the Philippine political economy.
The Philippines has rapidly been moving away from a market economy and has transitioned to a socialist (state) economy, patterned after China. The neo-Maoist model.
And since government spending means competition for resources and funding, the bigger the share of the government, the lesser resources and funds are made available to the private sector. And with a lesser output from the diversion of funding and resource consumption to the government, street prices can be expected to rise, as it has.
How Does One Analyze Financially the Transition to a Neo-Socialist State? Credit Allocation Determined by Politics
How does one model or analyze such a transition? The shift towards political directed economic activities would render financial ratios, like PE, Price to Sales, ROIC and etc., obsolete!
For instance, instead of business viability, the principal determinant of credit quality would be about political connections.
Politically instituted monopolies would emerge as a result of business barriers and the political picking of winners and losers.
Legislative bills purportedly aimed to “open” the economic backdrop to a business-friendly environment would be all a sham for as long as the government continues to shanghai the economy’s resources and finances.
Moreover, sustained intrusion through various political channels such as regulations, mandates, licenses, prohibitions, taxation and more, cements the control of the economic sphere by politicians, bureaucrats and special interest groups.
It’s like the alleged deregulation of the Telecom industry in 1995 (RA 7925) which ended up with an oligopolistic structure, primarily because of operational interventions. Yes, on the surface, the government deregulated the industry, but the stranglehold of the industry increased resulting in the elimination of competitors by operational interventions.
And the same politically determined operational obstacles have been used to displace alleged competition to usher in the entry of China Telecoms as the third player last month. Fitch Solutions wrote: “The selection of China Telecom, which follows the almost immediate disqualification of the two other bidders, hints at the government’s bias towards Chinese involvement in the telecoms sector, and is a clear sign of Duterte’s warming posture towards China.” It was more than a bias, it was a setup. [See Has the Choice for the Third Telco Player Been Rigged? Will a National Social Credit System be the Next Telecom Agenda? (November 11, 2018)]
As the web of political control expands over the economic sphere, the distribution of economic opportunities would become more politicized at the expense of the marketplace.
Even the allocation of banking loans has become slanted towards industries favored or controlled by the NG.
Figure 3
Bank loans to the politically favored or controlled sectors grew robustly as these were the principal contributors to the improvement in bank lending in October, namely construction (39.08% in October, 37.04% in September), public administration and defense (28.19% and 27.52%), education (25.95% and 23.86%) and financial intermediation (32.01% and 31.01%). Only loan growth to the transport industry fell 17.73% and 22.03%.
Of course, there will always be a tradeoff. The opportunity costs of rewarding political sectors come at the expense of the consumers. Bank loan growth to the retail sector slipped to +19.91% in October from 22.71% in September and have now caught up with the sharp downturn in consumer loans +14.61% in October and 18.19% a month ago.
If the growth of cash in circulation (m1) collapsed in October (+8.92% from +11.4% a month ago) and where credit card spending slowed (+21.6% and +22.2%), how did consumers finance their spending? Salary loans continued to contract for four straight months!
The consumer economy paid the price of redistributing benefits to the political and politically affiliated sectors.
So what should happen to the frenetic race-to-build supply for the consumers?
The Carrying Costs of Spend, Spend and Spend Elixir: Accelerating Credit and Sovereign Risk and Peso Devaluation
However, there is no such thing as a free lunch.
The political spending elixirs that should serve as the nation's economic deliverance requires funding.
Thus, spend, spend and spend has been supported by a mixture of debt and the BSP’s monetization.
Figure 4
An update of the public debt data has yet to be published by the Bureau of Treasury.
Nevertheless, debt servicing of public debt swelled to Php 649.72 billion running at a rate to reach possibly the record high of Php 854.374 billion in 2006. The share of debt servicing to revenues jumped from a record low of 19.83% in the year 2017 to 27.55% in the 10-months of 2018.
With the burgeoning amount of debt supported by increasing interest rates, debt servicing can be expected to keep moving in pace with the record growth of deficits. One of the carrying cost to the economic deliverance from spend, spend and spend elixir would be the deepening leveraging of the taxpayer’s balance sheet and its attendant risks.
For as long as there will be access to credit or someone’s savings or income (via tax), the spending panacea can go on.
Naturally, the NG can’t use an all debt financing because it would siphon away liquidity in the private sector. If the private sector, the principal source of funding gets drained, from where will they get funding? That’s the reason why central banks exist.
To leave some crumbs to the private sector, the BSP assumes the other role of providing finance to the intensifying public sector spending.
From the BSP’s October domestic liquidity report: “Net claims on the central government grew by 11.3 percent in October, broadly steady from 11.4 percent (revised) in the previous month.”
The BSP allotted Php 17.09 billion in October for a 10-month aggregate of Php 207 billion or about 47.25% of the total deficit during the said period, the second largest amount of monetization by the BSP since 2015. The BSP launched its version of Quantitative Easing in 2015.
So the other carrying cost to the economic deliverance from spend, spend and spend elixir would be to inflate the system at which comes at the sacrifice of the peso, or the citizen’s purchasing power
The Contortion of Keynesian Economics: Bulging Deficit-to-GDP Ratio in Good Times; With Emergency Policies in Place, What’s Left When The Tide Runs Out?
The 10-month record deficit of Php 483.1 billion is just Php 40.5 billion shy from the NG's target of Php 523.6 billion
Christmas spending such as the published Php 25k bonus to government employees and other yearend earmarks can easily push such deficit beyond the official annual target.
Revenue conditions will play a critical role. If collections underperform in the face of programmed increases in expenditures, deficits will be pushed further away from the target. That said, how the NG finances this will be projected into the interest rates, the CPI, debt levels, the economy, and earnings.
So far, in the thrust to finance the record NG deficit and to clamp down on the CPI, the BSP has been tightening liquidity in the system directed at the private sector. The sharp fall of M3 and consumer credit demonstrates such transfer as shown above.
While tax collections have held ground in October, the effect of such tightening may lag.
In the last twenty years, deficit-to-NGDP ratios of over 3% occurred during downturns in revenues as an outcome of economic slowdown.
And public expenditures were ramped up in only times of economic stress, such as the Economic Resiliency Plan (ERP) in 2009, put in place as a stabilizing force against the Great Recession. Part of the ERP was the transitory Php 330 billion fiscal stimulus (4.1% of GDP)
A gradual withdrawal of fiscal stimulus segued as the economy gained momentum.
As I have been saying here, this time is different.
Fiscal stimulus used against adverse external influences has become the principal development model used to attain economic growth. The former, known as Keynesian economics, has been reinvented.
At the end of 2018, fiscal deficit should breach past 3% of GDP target even with the headline GDP hovering at 6% and above. (chart shows 1986-2017 only). Again, traditionally, 3% deficit to NGDP ratio coincided with falling real GDP. Not today.
The Philippine economy has been surviving on emergency measures via monetary stimulus (record QE, record low interest rates) and unprecedented fiscal stimulus.
Diminishing returns from these measures have become apparent even when no downturn or crisis has yet transpired. The peso has fallen, market rates, as well as, policy rates have increased and debt continues to mount.
While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise.
What policy tools would be left for our policymakers to use, should a genuine shock (whether of internal or external origin) occur?
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