Once the proportion of non-productive activities from overall activities starts to increase, this tends to put pressure on the profitability of companies. This in turn raises the likelihood of an increase in banks’ bad assets. Consequently, banks expansion of credit through the fractional reserve lending (i.e., the expansion of lending out of “thin air”) is likely to slow down, and this in turn is likely to weaken the growth rate of money supply—Frank Shostak
In this issue
The BSP, DoF and Philippine Stocks Declares Premature Victory on Inflation: Falling CPI Not Equal to Strong GDP
-Headline Inflation Plunged to 5.1% in December, Core Inflation Fell Less
-The BSP, DoF and Philippine Stocks Declares Premature Victory on Inflation, The Challenge Will Be its Consequences
-Falling CPI Not Equal to Strong GDP
-Because of the 2014-2015 Experience, The Domestic Financial System Remains Under Emergency Mode
-Buy the USD-Php: The BSP May Cut Reserve Requirement Ratio, Then Policy Rates; 2015 International Scenario Redux
The BSP, DoF and Philippine Stocks Declares Premature Victory on Inflation: Falling CPI Not Equal to Strong GDP
Headline Inflation Plunged to 5.1% in December, Core Inflation Fell Less
The Philippine Statistics Authority (PSA) reported the National Government’s (NG) measure of consumer price changes, the CPI, at 5.1% last December. December’s CPI plunged from November’s 6.0% and October’s 6.7% representing a two-month decline of 160 bps! Such scale of CPI decline signifies the largest since the PSA introduced the 2012 base reference to substitute for the previous base of 2006.
The substantial drop in the food and (non-alcohol) beverage headline CPI to 6.7% in December from 8.01% in November and 9.43% in October weighed most in the headline figures. Also, the Transport CPI which dived to 4% in December from 8.9% in November and 8.75% was the other significant factor behind December headline numbers.
Core inflation, which excludes food and energy prices, registered 4.73% in December, slightly down from 5.1% in November and 4.93% in October.
Interestingly, the PSA attributes core inflation’s demand aspect to money supply: “Core inflation is usually affected by the amount of money in the economy, relative to production, or by monetary policy.” (bold mine)
Figure 1
But the collapse in the money supply growth since the 1Q of 2018 hardly affected the core aspect of the PSA’s inflation in 2018. (see figure 1, upper window)
To the contrary, the food and energy segment became more sensitive to the constraint on the demand side from the reduction of money supply growth.
And the recent surge in domestic energy prices can hardly be blamed on international oil prices which barely recovered from its heights in 2014.
Because international prices of oil haven’t been the principal cause of the recent spike of the CPI, oil price’s recent crash would only signify an aggravating factor.
I previously discussed it here:
The recent upside price spiral in the CPI mostly represented magnified demand from the NG’s record deficit spending program, significantly financed by the BSP, that caused supply dislocations on areas suffering from underinvestments (agriculture).
Hence, food inflation represented the opportunity costs from the crowding out syndrome brought about by the NG’s massive public spending and domestic bubbles.
The BSP, DoF and Philippine Stocks Declares Premature Victory on Inflation, The Challenge Will Be its Consequences
The Bangko Sentral ng Pilipinas declared victory in containing the elevated CPI through a series of policy rate increases implemented from May to November amounting to 175 basis points.
The Inquirer reported (January 4): “The central bank on Friday declared victory in its fight against rising prices after the government announced that the consumer price index for December 2018 fell to 5.1 percent — lower than the expectations of even the most optimistic economists. In a press statement, the Bangko Sentral ng Pilipinas said the latest figure confirms its assessment that the inflation target for the next two years will be achieved. The within-target inflation outlook over the policy horizon largely reflects the estimated impact of the rice tariffication law, lower global oil prices, and latest monetary policy adjustments by the BSP,” the central bank said.”
But declaring victory over inflation is an exercise in futility.
For a system that has become dependent on monetary inflation, its fall comes with nasty consequences.
Remember, less liquidity or money in circulation means reduced demand, particularly for areas dependent on credit provided by the banking system.
I predicted the collapse in the CPI last November: [Falling Rates of Bank Lending, Liquidity, and Government Revenues Point to 3Q GDP Lower than 6%, What Policy Tool Remains to Combat Hissing Bubbles? November 4, 2018] (bold and italics original)
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.
The GDP will make a rousing come back in 2019, predicts the Department of Finance, because of the plunging CPI. From theInquirer (January 1, 2019): With inflation seen to ease and return within government target this year, economic growth is expected to “pick up steam” in 2019, according to the Department of Finance (DOF). In a statement, the DOF said it was attributing expectations of a “marked slowdown” in headline inflation this year to the “prompt and decisive” measures undertaken by the economic team last year after the rate of increase in prices of basic commodities hit over nine-year highs.
Defying the selloff in Wall Street and the region, the Philippine equity bellwether surged 3.95% in the first three days of 2019, predicated on such bunk. And it has not just been about the benchmark, a heavy tilt towards a recovery in consumer spending highlights the distribution of this week’s gains.
The property sector (+6.87%) significantly outperformed the composite index (+3.95%).
With the exclusion of the mines, the other mainstream sectors, namely, the holding firms (+3.61%), industrials (+2.73%), services (+2.82%) and financials (+1.9%) rose by less than the headline.
Listed retail firms were the biggest beneficiaries: Robinsons Retail (+10%), Puregold (+9.77%), SSI Group (+5.88%), PIZZA (+7.24%), MAXS (+5.65%) and Jollibee (+5.89%; hit a new record).
Falling CPI Not Equal to Strong GDP
Figure 2
With the exception of 2017, the annual CPI and the annual GDP had mostly positive correlations since 2013. That is, annual real GDP rose along with the annual CPI and vice versa!
The recent (2017 and 2018 9-month GDP) deviance in such correlations could mean the following: The tolerable CPI threshold level has been exceeded to have stalled the GDP, or the GDP may have weighed by other factors (such as the crowding out syndrome), or both forces have affected the 2017 and 9-month 2018 GDP.
History tells us that slowing CPI would translate to declines in the GDP!
Why the heck the nudge on the BSP by the mainstream experts for rate cuts in 1H if things are hunky dory? Because of chronic addiction to free lunches!
As an aside, ‘statistics’ is ‘statistics’: the government can manufacture any number it desires. And there is no audit for it.
And to re-emphasize: December 2018’s 5.1% is still way above the 4.18% (4.92% base 2006) high of August 2014. 2018’s 5.2% CPI represents a 10-year high. Yes, CPI did slow rapidly, but it remains high in recent context. As of December 2018, the average CPI rate of the 2012 base since 2013 was 2.7%. 5.1% represents almost double the 6-year average.
An excerpt from a politician showcases the gravity of the public’s misperceptions on inflation: From the Inquirer (January 6, 2019): “But an opposition lawmaker, Akbayan Rep. Tomasito Villarin, said while the easing of inflation was a good sign, it was no cause for celebration, as prices of goods were still high compared to previous year’s prices and annual inflation of only 2.7 percent in 2017.” (italics added)
CPI is about the rate of change of a basket of consumer prices. Because of the structural permanence money supply growth(Figure 2, lowest window), consumer prices will almost always rise (except for some circumstances as recessions). (Figure 2 middle window) The difference will be in the rate of increases.
And remember, the output of price index changes will be dissimilar from growth rates measured on rising price base levels. Hence, a 5% increase on a Php 10 product would translate to a 50 cents increase, whereas applied to a Php 15 product, the same rate translates to a 75 cents increase. Thus, because of the base effects, same rates of price changes would have different nominal price outcomes.
Not unless jobs and incomes grow sufficiently, lower CPI growth numbers don’t necessarily provide more purchasing power to the inflation-harried consumers.
Because of the 2014-2015 Experience, The Domestic Financial System Remains Under Emergency Mode
2014-2015 should serve as a useful precedent or template.
The CPI spiked to a high of 4.18% in August 2014 in response to the sweltering 10-month growth rate of over 30% of M3 in 2H 2013 to 1H 2014. Policy rates were raised in July and September 2014 by the BSP to contain the CPI.
Partly in response to the BSP policy, the CPI rate cascaded. Though its decline had been at a slower clip compared to the present. The CPI hit its trough when it posted two successive months of mild deflation in September (-.37%) and October (-19%) 2015.
Back then oil prices and China’s stock market also crashed, the prospect of deflation prompted several global central banks as Japan and the ECB to introduce or re-engage in negative interest rates.
Figure 3
The BSP implemented the local version of Quantitative Easing in 2H of 2015. (Figure 3 upper window)
Additionally, under the camouflage of instituting a corridor system, the BSP chopped policy rates by 1% in June 2016 to a historic low.
In short, in the emergence of deflationary impulses, the BSP placed the entire financial system under its version of the Intensive Care Unit (ICU).
Now those bubble policies that had been reinforced by the present government bubble, the deficit spending boom! And the ramification has been to accelerate the surfacing of the mounting maladjustments within the system.
Given the emergency measures still in place, what tools remain available for the BSP to operate on should economic and or financial stress escalate? Remember the 3Rs of the Financial Stability Coordinating Council?
Interestingly, the sharp drop of the CPI has led to positive real interest rates. For the second month, the yields of the one-year Philippine Treasury notes have exceeded the CPI.
Like in 2015, the invisible subsidy on the government liabilities through the interest rate channel has now evaporated!
Figure 4
Even more, notice the yield curve differentials between the 5.1% CPI last June and that of December. (figure 4, upper window)
While rates at the long-end have remained similar, yields of the T-bills to the mid-end have dramatically risen in just 6 months.Contra the actions of the stock market, the Philippine sovereign yield curve continue to signal tightening conditions in the financial system that would likely result in lower economic activities or a softer GDP. And concomitantly, nominal (NGDP) should fall along with gross revenues of firms.
Though banks would likely take the gambit of relying on volume for its credit portfolio in the face of declining interest margins, deterioration in credit quality will likely spur more liquidity issues in the industry which should feedback through elevated rates.
And despite the BSP managed treasury market, the domestic yield curve is at the risk of inversion!
Since higher rates have thus far affected less the banking system’s credit issuance operations, interest rate cuts could have a marginal impact on banking industry’s credit expansion.
Buy the USD-Php: The BSP May Cut Reserve Requirement Ratio, Then Policy Rates; 2015 International Scenario Redux
So the BSP could likely CUT reserve requirements first. The RRR cut will be designed to align the decline of growth in the international assets of the BSP and to help disencumber banks from liquidity pressures.
The BSP will report on November’s domestic liquidity and bank credit conditions next week.
Moreover, expectations of the BSP’s policy easing via interest rate cuts should likewise reflect on the USD peso exchange rate. The USD-peso will likely recoil upwards when either RRR or interest cuts become imminent. The recent crash of M3 growth rates has forewarned of a lower USD Php.
The public has been trained to see the USD peso as a function of USD stocks (Gross International Reserves) and flows (OFW and BPO remittances, trade and current account), but stocks and flows of the USD have mainly been a function of domestic money supply.
The public spending boom and the real estate, retail, and construction bubbles have blossomed through massive credit and money supply expansion that has enlarged demand on these sectors beyond the nation’s capacity to provide sufficient supply. Hence the massive trade deficits and current account deficits.
The inadequacy of domestic jobs and income as the ramification of the inflation of the peso has impelled a diaspora of domestic workers abroad thus OFW remittances.
Despite the positive spin, the real repercussions of the declining CPI have yet to emerge.
Interestingly, the 2015 episode of the oil price crash, the expanded volatility in the international financial markets (stocks and currencies) have resurfaced. The Japanese yen experienced a flash crash last week.
The difference is that this has been happening with global central banks in a tightening mode, vastly higher debt levels, a more leveraged system, significantly higher equity valuations, and a more fractious geopolitical setting.
For 2019, expect the unexpected.
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