2Q GDP: Broad Sector Downturn Driven by a Plunge in Capital Spending! Why Lower Inflation Extrapolated to a Fall in Consumer Spending?

The whole idea of GDP gives the impression that there is such a thing as the national output. In a market economy, however, wealth is produced by individuals and belongs to them independently—Frank Shostak

In this issue

2Q GDP: Broad Sector Downturn Driven by a Plunge in Capital Spending! Why Lower Inflation Extrapolated to a Fall in Consumer Spending?

-GDP’s Integrity at Stake

-The Big 2Q GDP Forecasting Miss: When Everyone Talks the Same, No One is Thinking!

-The GDP’s Inconvenient Truth: Philippine GDP Hasn’t Been About the Real Economy But About BSP Money Pumping!

-2Q GDP: Broad Sector Downturn Led by a Plunge in Capital Spending! Why has Consumer Spending Slowed?

-The Crowding out Effect on Construction Industry, Bank GDP Boosted by Treasury Boom, Manufacturing Recession?

-Despite BSP’s Policy Easing, Symptoms of Monetary Tightening Still Persists

2Q GDP: Broad Sector Downturn Driven by a Plunge in Capital Spending! Why Lower Inflation Extrapolated to a Fall in Consumer Spending?

GDP’s Integrity at Stake

Even some among the international mainstream economic profession has begun to question the integrity of GDP as an accurate measure of economic growth. Because of political reasons, India’s GDP, for instance, has allegedly been overestimated. Indian economist and former Chief Economic Adviser to the Government of India Arvind Subramanian recently asserted,

If statistics are sacred enough to require insulation from political pressures, they are perhaps also too important to be left to the statisticians alone. Nothing less than the future of the Indian economy and the lives of 1.4 billion citizens rides on getting numbers and measurement right. As we measure, so India will go

The Big 2Q GDP Forecasting Miss: When Everyone Talks the Same, No One is Thinking!

2Q GDP which registered at 5.5%, lower than the 1Q’s 5.6%, pulled the proverbial rug out from under the feet of the establishment economists.

An example of a bullish forecast on the 2Q GDP from Moody’s…

Inquirer, August 5, 2019: The research arm of debt watcher Moody’s was more optimistic about the Philippines’ second-quarter economic growth, which it projected at 6.2 percent year-on-year. “There’s some downside risk associated with this forecast, given the ongoing strength in imports against a backdrop of weak exports. The strength is forecast to be primarily coming from the consumption and investment segments of the economy, helping to offset weakness in the external sector,” Katrina Ell, assistant director and economist for Australia, New Zealand, Indonesia, Malaysia and the Philippines at Moody’s Analytics, told the Inquirer in an e-mail Monday

After the monumental miss, then comes the rationalization…

Philstar, August 9, 2019: The Philippine economy is set to recover from the “temporary” slowdown it experienced in the first half due to the delayed approval of the 2019 national budget, Moody’s Investors Service said Friday.

But, “temporary” eventually morphed into a downgrade…

Businessworld, August 9, 2019: Moody’s slashed its projection for Philippine GDP expansion further to 5.8% for this year, from the six percent it gave at the end of May in the face of delayed budget enactment and from the 6.2% in had penciled in February. The country grew by 6.2% last year against the government’s 6.5-6.9% target for 2018.

…which essentially reinforces the mainstream’s weakness of looking at economics in the lens of statistical aggregates than from human action.

Because of the wildly optimistic growth ‘downgrades’, not a single mainstream entity may get their annual forecasts right.

Inquirer, April 1, 2019: The World Bank has downgraded its growth forecast for the Philippines to 6.4 percent for 2019 as the government operated on a reenacted budget in the first quarter and amid a looming prolonged dry spell due to El Niño.

Inquirer, April 4, 2019: Amid slower global demand and the potential negative impact of the prolonged dry spell due to El Niño on the economy, the Asian Development Bank (ADB) has cut its 2019 growth forecast for the Philippines to 6.4 percent.

Inquirer, April 5, 2019: The United Nations Economic and Social Commission for Asia and the Pacific (Unescap) expects the Philippine economy to grow by 6.5 percent this year despite slowing growth across the region amid trade tensions between the United States and China.

Inquirer, April 9, 2019: The International Monetary Fund (IMF) has reduced its 2019 growth forecast for the Philippines to 6.5 percent in line with less rosy global economic prospects.

Inquirer, April 24, 2019: In its April 5 Capital Flows Report titled “The EM Positioning Overhang,” the IIF projected the Philippines’ gross domestic product (GDP) to grow 6.1 percent this year, a slower pace than the three-year low expansion of 6.2 percent last year. The IIF’s 2019 growth forecast for the Philippines was within the government’s downgraded 6-7 percent target range.

Then, more downside adjustments came…

Inquirer, July 18, 2019: The Asian Development Bank (ADB) has cut to 6.2 percent its 2019 growth forecast for the Philippines mainly due to government underspending at the start of the year that dragged first-quarter economic expansion to a four-year low. The Manila-based multilateral lender’s Asian Development Outlook Supplement report released Thursday showed a lower gross domestic product (GDP) growth projection for this year from 6.4 percent previously, even as it kept the 2020 forecast at a now faster 6.4 percent.

Inquirer, July 24, 2019: The regional macroeconomic surveillance organization Asean+3 Macroeconomic and Research Office (Amro) has slashed its 2019 and 2020 growth projections for the Philippines to 6.3 percent and 6.5 percent, respectively. This was contained in Amro’s Asean+3 Regional Economic Outlook July update which was released yesterday. In its previous report, Amro projected a 6.4-percent growth for the Philippines for 2019 and 6.6 percent for 2020. The slower growth forecasts were attributed by Amro to the “unexpected growth slowdown in the country’s first quarter growth due to the delay in the approval of the national budget.”

BusinessWorld: July 25, 2019: THE INTERNATIONAL MONETARY FUND (IMF) has further slashed its economic growth forecast for the Philippines this year and the next due to weaker-than-expected external demand and state spending last semester. In an e-mail on Wednesday, IMF Country Representative Yongzheng Yang said the IMF now sees the Philippine economy growing by six percent this year, slower than the 6.5% forecast published in its World Economic Outlook report in April as well as the 6.6% and 6.7% it had pencilled in October and September last year. The multilateral lender also cut its 2020 growth projection to 6.3% from the 6.6% estimated previously. The IMF’s latest projection compares to last year’s actual 6.2% and the government’s 6-7% target for this year.

Inquirer, May 31, 2019: British banking giant HSBC remains optimistic with the Philippines’ growth story, thanks to the simultaneous easing of the government’s monetary and fiscal policies. In a briefing, HSBC managing director and head of Asia investment strategy and advisory Cheuk Wan Fan said they were expecting the Philippines’ gross domestic product growth to stay firm at 6 percent in 2019 and 6.4 percent in 2020 with fiscal spending and imports accelerating following the midterm elections.

However, the National Government’s cheerleading was unperturbed by the wave of optimistic downgrades.

Inquirer, July 12, 2019: The Philippine economy can still grow by as much as 7 percent this year thanks to the ramping up of government spending in the second semester, according the country’s central bank chief. Speaking to investors and analysts during an online UBS forum, Bangko Sentral ng Pilipinas (BSP) Governor Benjamin Diokno said the lower inflation rate—brought under control earlier this year following a nine-year high spike in 2018—was also encouraging more Filipinos to help boost growth through increased household spending.  “Prospects for the Philippine economy continue to be favorable,” he said. “Despite the lower-than-expected growth in the first quarter of 2019, we remain optimistic about meeting the [gross domestic product] growth target of 6-7 percent for this year.” “We expect that the government’s commitment to accelerate public spending will take the driver’s seat on the supply side, while household spending, supported mainly by cooling inflation and remittance inflows, will spur growth on the demand side,” Diokno added.

Mainstream media luxuriated on the din of bullish forecasts by the NG and the consensus.

BusinessMirror (editorial) June 24,2019:  While an oversimplification, from a central banker’s point of view, the “Goldilocks” idea of inflation/economic growth is exactly the objective. In this age of manually controlled interest rates and money supply, this is the mix that the BSP is looking for. It is similar to the operation of an internal combustion engine. For the engine to function efficiently there must be a balance between the amount of air and the amount of fuel. Monetary policy is aiming for just enough inflation to create investment and spending today rather than waiting for tomorrow. Japan has lived through decades of flat economic growth because consumers in particular felt no urgency to buy today. If you know that the price of a refrigerator will be higher next year, then you might make a purchase now rather than later. However, we also need to look at the balance—the Goldilocks effect—in relation to other economies. Maybe it was “just right” for Goldilocks because she had low tolerance for hot and cold temperatures. How is the Philippine economy balanced?...

However, when the 2Q GDP was published, the vaunted “Goldilocks economy” transformed into a vicious blame game.

BusinessMirror, (editorial) August 9, 2019: The takeaway is this: Congress did not do its budget job on a timely basis. The BSP rate hikes were counterproductive to economic growth. Finally, “Growth is only likely to experience a moderate recovery over the second half of this year, and given today’s weak outturn we have lowered our 2019 forecast from 6.0 percent to 5.8 percent.” (italics added)

To reach an annual 6% would require a 6.4% GDP in the 2H.

With such numbers seemingly implausible, given the current rates, the NG downgraded their GDP projections.

Inquirer, August 10, 2019: The more than four-year low economic growth posted in the second quarter is expected to pull full-year expansion below the government’s 6 to 7 percent target range, with a number of institutions already cutting their 2019 forecasts. For the head of the Duterte administration’s economic team, the 5.5-percent gross domestic product (GDP) growth was inevitable due to government underspending on public goods and services of about P1 billion a day during the start of the year.  “Second-quarter growth was not an unexpected result given the apparent lingering impact on the government’s accelerated spending program of the four months-and-a-half delay in the passage of the 2019 budget in the House of Representatives. This delay was further exacerbated by the ban on infrastructure projects during the election campaign,” Finance Secretary Carlos G. Dominguez III said in a statement, adding that it did not help when the implementing guidelines of this year’s P3.7-trillion appropriations were released in late May.

“Second-quarter growth was not an unexpected result”, yet the NG didn’t revise their projections downwards.

And the next wave of bullish downgrades from the mainstream institutions can be expected in the coming weeks or months.

The GDP’s Inconvenient Truth: Philippine GDP Hasn’t Been About the Real Economy But About BSP Money Pumping!

I am no believer in the mainstream's GDP. To me, through the inaccurate presentations of statistical aggregates, the GDP has been designed to justify interventions from the NG, amplifying their contribution without considering its invisible costs and unintended consequences.

Or, GDP simplifies into an index a complex world, as explained by the US Government’s BEA, J. Steven Landefeld, and Robert P. Parker*:  (bold mine)

In particular, it is important to recognize that real GDP is an analytic concept. Despite the name, real GDP is not “real” in the sense that it can, even in principle, be observed or collected directly, in the same sense that current-dollar GDP can in principle be observed or collected as the sum of actual spending on final goods and services in the economy.Quantities of apples and oranges can in principle be collected, but they cannot be added to obtain the total quantity of “fruit” output in the economy. For this reason, real GDP must be computed by valuing the various components of GDP, using the prices of some period or periods. Real GDP is simply an index number—a computation, like the consumer price index or the price index for GDP, except that real GDP is an index number that measures quantities. Its computation cannot be determined by reference, or by analogy, to the methods used for the construction of current-dollar GDP.

*J. Steven Landefeld and Robert P. Parker Preview of the Comprehensive Revision of the National Income and Product Accounts: GDP’s New Featured Measures of Output and Prices, Bureau of Economic Analysis, July 1995

And simplification of the real world through indices paves the way for the slippery slope of government interventions.

Furthermore, in my view, GDP has been much lower than presented.

Since political institutions or agencies are responsible for the construction of the GDP, its output may reflect on political goals. Because the GDP is subject to no audit, there is no way to verify the survey data which comprises inputs to its econometric models.

The consensus swallows hook, line, and sinker the GDP as reflecting reality discounting the fact the statistics can be manipulated. Critical thinking is remarkably amiss when GDP comes into the conversation. 

But the thing is; since the economic and financial community worships the GDP, then we shall dwell with its context.

Figure 1

Last week, when I asked “How Will Tight Money Conditions Impact 2Q GDP?”, I presented the above chart less the 2Q GDP.

The 2Q data completes the picture. It shows how the oscillations of the headline GDP has been accordant with bank credit expansion, and subsequently, the money supply growth.

It gives further credence to the Austrian School of Economics, which sees the GDP as nothing more than a statistical construct predicated on the consequence of the changing rate of money pumping.

Wrote Dr. Frank Shostak**,  (bold mine)

All we can say is that this percentage has nothing to do with real economic growth and that it most likely mirrors the pace of monetary pumping. Since GDP is expressed in dollar terms, it is obvious that its fluctuations will be driven by the fluctuations in the amount of dollars pumped into the economy. From this, we can also infer that a strong real GDP growth rate most likely depicts a weakening in the process of real wealth formation.

Once it is realized that so called real economic growth, as depicted by real GDP, mirrors fluctuations in the money supply growth rate it becomes clear that an economic boom has nothing to do with real economic expansion.

**Dr. Frank Shostak, DOES THE GDP GROWTH HAVE ANYTHING TO DO WITH TRUE ECONOMIC GROWTH?, August 9, 2019 The Cobden Center

The slowdown attributed to as “temporary” represents no more than excuse rather than justified by the NG’s own data. The Philippine Statistics Authority’s complete menu of GDP data can be downloaded here.

Ever since the zenith of 3Q of 2017, bank credit growth, money supply growth, and headline GDP has turned south. (see figure 1, upper window) Said differently, the headline GDP has registered a declining rate in 6 out of 7 quarters. How can a trend, signified by a baseline, be considered as temporary?

And if distilled to measure the real output on a per capita basis (divided by the population), having peaked in 2013, the baseline trend for the GDP has been down and continues to trend south! On the other hand, real household consumption, having reached its apogee in the 2Q of 2016, has also looked south! (see figure 1, lower window)

The weaknesses of 1Q and 2Q 2019 GDPs only highlight the accelerating trend of declines, as the same charts depict!

2Q GDP: Broad Sector Downturn Led by a Plunge in Capital Spending! Why has Consumer Spending Slowed?

While the popular narrative attributes the 2Q GDP shortfall on public spending, from the Expenditure GDP perspective, all categories endured a marked slowdown! (figure 2, upper window)

More importantly, capital formation, principally from durable equipment (-13.5% from 1Q’s 6.1%), contracted big time (-8.5% from +8.0% in 1Q)!  

Figure 2

Specialized machineries and transport equipment GDP tanked by a stunning -12.5% and -25.8% from 1Q’s +.4 and +3.7%, respectively, while General Industry Machinery and Miscellaneous Equipment posted 0% and +3.0% increase in the 2Q from 1Q’s 12% and 14.9%, correspondingly. What's eye-popping has been the scale of deflation! (Figure 2, middle window)

In that context, the biggest contributor to 2Q GDP’s delinquency was a significant reduction in capital spending! Not only has the Philippines suffered from a water drought, the nation, according to the GDP, endured a capital spending drought, as well!

So while media has enthralled the public with a deluge of news about a torrent of investments, the NG’s capital formation’s data tell otherwise!

If capital spending has all but evaporated, where will future GDP derive its marginal growth that would counterbalance the current delinquencies?

True, government spending GDP slowed to 6.95% in the 2Q from 7.4% in the 1Q, but household spending fell by even more to 5.6% from 6.1% over the same period.  Household spending had a 66% share of real GDP in the 2Q, while public outlays constituted a 13% share.

So after capital spending, household spending had been the next most significant factor!

In contrast to popular wisdom that low inflation mechanically translated to higher consumer spending, 2Q GDP proved the opposite: plunging CPI signified a fall in consumer demand! (figure 2, lowest window)

If bank credit expansion had been the primary source of marginal demand of consumers, why shouldn’t the former’s fall not cause a slowdown in the spending activities by individuals? The record growth rate of credit card debt in the 2Q continues to finance consumption spending, based on BSP’s data.

And it gets better.

If the crowding out syndrome, where NG spending draws resources and funding away from the private sector, wouldn’t consumers be affected eventually? Especially from those in the private sector? (Figure 3, upper window)

Figure 3

In the industry origin, trade was among the few sectors that registered improved GDP in 2Q with an 8.5% increase from 7.3% in the 1Q. Electricity Gas and Water GDP jumped 7.5% in 2Q from 3.1% in the 1Q. Mining GDP spiked to 15.7% from 4.7%.Other services expanded 7.8% from 5.3%. And real estate GDP inched higher to 4% from 3.7% over the same period.

Nevertheless, it’s a wonder how the trade GDP was able to outperform when household spending slowed? (figure 3, middle window)

More so, if trade GDP boomed, why was rental GDP stagnating? Rental GDP advanced 2.5% in 2Q from 1.8% a quarter ago. From the pinnacle of Q1 2013, rental GDP has been in a downtrend. (figure 3, lower window)

With the cascading rental GDP indicative of mounting excess capacity, resource misallocations should balloon with billions of pesos still directed at them.

Also, was improved real estate GDP in the 2Q a function of a combination of demand from Chinese speculators catering to the POGO market and domestic punts? So while the GDP slowed, economic agents turned the real estate industry into a casino?

The Crowding out Effect on Construction Industry, Bank GDP Boosted by Treasury Boom, Manufacturing Recession?

Figure 4

While public construction GDP or “build, build and build” retreated 27.2% to weigh on the sector’s GDP contribution of -.6%, Private construction, jumped 23.1% over the same period.  With a 71% share of the sector’s GDP, private construction growth offset most of the public sector’s decline. (figure 4, upper window)

So the pullback on public works, or popularly known as build, build and build may have freed up resources to the private sector to boost the real estate GDP and those privately funded Public-Private Partnerships (PPP) projects.

Public spending may have slowed, but industries catering to public services continue to show modest strength.

The huge cash hoarding by the NG through the capital markets have fired an asset boom for banks. Financial GDP was up 9.2% modestly lower from 10.2% in the 1Q. That’s mainly from Banking GDP which zoomed 13% from 12.2% in the 2Q in the face of slowing GDPs of Non-Banks and Insurance 7.2% and 4.0% from 10.1% and 5.1% in the 1Q.

Meanwhile, Education GDP soared 12.6% from 4.9%. Public Administration slowed to 8% from 9.7%. Sewage GDP advanced slightly to 5.6% from 5.4% over the same period.

To put a cap on the GDP story, external trade softened substantially. Exports GDP slowed to 4.4% in the 2Q from 5.7% in 1Q, mainly on the slowdown of goods exports 4.6% from 6.3%. In the meantime, services exports improved to 3.8% from 3.6% over the same period. Import GDP, on the other hand, cratered to zero percent growth from 8.6% a quarter ago. The weakness in external trade resonated on manufacturing sector GDP, which registered a 4% growth in 2Q down from 4.9% in 1Q.

...

Figure 5

Interestingly, the PSA’s other metric on manufacturing, the Value of Production Index (Industrial Production), has registered the seventh month of contraction to highlight a manufacturing recession. (figure 5, lowest window)

With manufacturing down, which has been consistent with the decline in Exports and Imports, domestic demand, aside from external demand, must also be weak.

Despite BSP’s Policy Easing, Symptoms of Monetary Tightening Still Persists

As 2Q GDP disappointed, the Monetary board granted BSP Chief Diokno's wish.  The BSP cut policy rates for the second time this year last week, to join the central bank bandwagon of engaging in an interest rate-cutting spree.

Interestingly too, the rate cut comes in the face of plunging yields of the Philippine Treasury 10-year benchmark. The narrowing spreads of the BSP’s policy rates and the 10-year benchmark yield appears to coincide with the downshift in real GDP. (Figure 5, middle window)

As of Friday, the yield of the benchmark 10-year Philippine Treasury at 4.325% registered its narrowest gap with the BSP’s policy rate of 4.25% since 1Q 2016. Such thinning of spreads implies of financial tightening despite the easing policies embraced by the BSP.

Has the domestic Treasury boom been a manifestation of the global panic buying of government papers, or a flight to safety? Or could a less than optimistic economic outlook have been spurring a magnified demand for domestic treasuries from domestic savers? And hasn’t the paring of policy rates signified an admission that something has gone amiss in the economy?

With July CPI even lower at 2.4%, credit and money supply growth may have slowed by more or remained stagnant, which should imply a languid start for the 3Q.

The BSP’s earlier cuts in policy rates and Reserve Requirement Ratio (RRR) hasn’t boosted overall liquidity in the financial system. It shows that you can lead the horse to water, but you can’t make it drink.

Of course, despite the underperforming credit growth, which has been pulling lower the GDP, credit growth remains faster relative to the GDP. For instance, total bank credit growth clocked in at 10.28% in 2Q while nominal GDP was at 6.6%.

The BSP Chief desires to reignite credit expansion to spike the GDP, as well as, spruce up tax collection.  However, will faster-expanding credit in the face of slowing real economic growth not lead to more deterioration in credit quality that enhances credit risks? Will more central bank easing not strip away productive enterprises in favor of debt-dependent non-productive firms that may lead to the proliferation of zombie firms (which according to the BIS are firms that are unable to cover debt servicing costs from current profits over an extended period)? Will more easing not lead to more market concentration at the expense of smaller firms, thus amplifying the too big to fail syndrome or concentration risks?

The combined burden of bank credit (Php 8.16 trillion) and public debt (Php 7.87 trillion) which has reached an astronomic Php 16.07 trillion or a staggering 90.73% of the annualized 1H nominal 2019 GDP! (figure 5, lowest window)

The mounting debt onus alone will serve as an obstacle to real economic growth. And what of the ramifications from the escalating race-to-build supply?

So how can the baseline slowing GDP trend signify “temporary”?