Why the Constrained Spending in August's ‘Build, Build, and Build’? NG’s Borrowing and Cash Stockpile Hits New Record High!

Rome fell because the dictators ruined the Roman economy and the institutions that had made it prosperous. Rome was falling apart before the barbarian invasions. How did the Caesars do that? They were profligate spenders. As emperors with absolute power usually do, they thought big: infrastructure (roads, temples, palaces), a huge bureaucracy, and, as the key to maintaining their power they had a very large, loyal, and well paid army. As a consequence, massive government spending far outstripped revenue. They had what today we call a deficit problem—Jeffrey Harding

In this issue

Why the Constrained Spending in August's ‘Build, Build, and Build’? NG’s Borrowing and Cash Stockpile Hits New Record High!

-What Happened to Build, Build, and Build Last August?

-Public Work Spending Remained Subdued in August, NG Spent More on Subsidies

-August Revenues Improve on BIR Collections, BoC and Non-Tax Revenues Stagnate

-Unsustainable Impact from the Crowding Out Syndrome: NG’s Record Financing and Historic Cash Hoard! 

-Conclusion

Why the Constrained Spending in August's ‘Build, Build, and Build’? NG’s Borrowing and Cash Stockpile Hits New Record High!

What Happened to Build, Build, and Build Last August?

I asked this question last July, whatever happened to “build, build, and build”?

What Happened to July’s “Build, Build and Build”? NG’s Record Debt Issuance and Cash Hoard as Interest Rate Subsidies September 1, 2019

Or what happened to the commitments by the National Government (NG) to engage in massive and aggressive infrastructure spending?

Are these not supposed to function as a bulwark from the influences against adverse external forces?

Here’s a sample of the administration’s vow to use fiscal stimulus as ‘automatic stabilizer from external influences’. From the Inquirer (September 24): The Philippines can weather any disruptions that a potential global economic slowdown or a financial crisis may bring, thanks to the country’s strong fundamentals and a vigilant monetary regulator, the head of the central bank said. Speaking before Euromoney’s Philippine Investment Forum on Tuesday, Sept. 24, Bangko Sentral ng Pilipinas (BSP) Gov. Benjamin Diokno also noted that the Duterte administration’s commitment to its P9-trillion infrastructure buildup program will help fuel “high, sustainable and more inclusive economic growth.”

It’s been a quarter past the signing of the 2019 national budget by the political leadership. Nonetheless, based on the Bureau of Treasury’s data, the ambitious infrastructure projects have been nowhere to be found. Why?

Figure 1

True, in August, public outlays expanded 8.78% to Php 282.233 billion from Php 259.46 billion a year ago; however, NG revenues increased 8.9% to Php 279.75 billion from Php 256.9 billion, resulting in a deficit of ONLY Php 2.488 billion for the month. (figure 1, table)

But the spending growth in August barely compensated for the earlier miss.

In the eight months of the year, public spending grew by a measly .94% to Php 2.212 trillion from Php 2.191 trillion a year ago, in the face of total collections, which expanded by 9.54% to Php 2.091 trillion from Php 1.909 trillion over the same period. As a consequence, the aggregate deficit for the period reached Php 120.43 billion down 57.29% from Php 281.987 billion a year ago. (figure 1, table)

The NG has set a deficit-to-GDP ratio of 3.2% or Php 631.5 billion for 2019. The eight-month deficit represents ONLY 19.07% of this year’s target.

With a lot of catching up to do in the last 4-months of the year, will the NG fulfill its promise by accelerating the rate of public spending?

Thus far, the tight correlation between public expenditures and money supply growth extrapolates to financial liquidity conditions functioning as the fundamental driver of such political action. (figure 1, lowest pane)

Will this week’s RRR and policy interest rate cuts by the BSP alleviate such present financial tightness that would fire up political spending?

Public Work Spending Remained Subdued in August, NG Spent More on Subsidies

August expenditures grew alright.

Figure 2

But the allocation of expenditures doesn’t seem to be entirely focused on public works.

While the allotment to the Local Government Units (LGU) spiked 16.83% to Php 53.67 billion in August from Php 45.94 billion a year ago, the biggest % gainers were to subsidies (531.5%) and tax expenditures [exemptions, deductions, credit, reduced rates, and etc. …]  (82.35%), aside from equity (1,333%).  (figure 2, upper window)

As an aside, the NG allotted Php 27.7 billion or 87.07% share of the Php 31.81 billion spent on overall subsidies in August to the corruption scandal stained Philippine Health Insurance Corporation (PHIC). Also, August tax expenditure came mostly from the National Food Authority’s account with the Bureau of Customs.

Disbursements, which are the primary source of funding for public works, even contracted 2.93% to Php 169.72 billion from Php 174.8 billion. Allotments to disbursements, LGUs and subsidies represent the largest three segments of overall public outlays accounting for 60.13%, 19.02%, and 11.22% share, respectively.  (figure 2, middle window)

While the data reveals that public work spending on a national level remained subdued last August, perhaps infrastructure spending may have picked up on the local level or through the LGUs.

However, when viewed from a different dimension, the NG’s construction wholesale prices jumped 3.5% in August year-on-year from 3% a month ago.(figure 2, lower window) Since the construction wholesale price index attempts to measure the cost of construction of government projects, the August price hike points to improvements in public works. That’s if changes in the index align with reality.

So has the likely enhancement of construction material wholesale prices been a ramification of the bottoming signs of NG/BSP’s M2 (money supply growth)?

In the eight months of August, NG disbursements fell -.24% to Php 1.428 trillion from Php 1.431 trillion while allotments to LGU eked out a .91% increase to Php 398.5 billion from Php 394.95 billion. Lethargic public spending that has resulted in the underperformance of the 8-month deficit can hardly be blamed on the entirety to the delayed passage of the budget due to Congressional tiff.

So despite constant utterances of hitting an ambitious 3.2% deficit-to-GDP principally through aggressive public works, the Bureau of Treasury’s cash operations data reveals the current demonstrated preference, viz. the NG’s seeming embrace of parsimony, for undeclared reasons.

Importantly, how will such meager growth in public spending impact the 3Q GDP?

August Revenues Improve on BIR Collections, BoC and Non-Tax Revenues Stagnate

And despite 2018’s tax overhaul through TRAIN and 2019’s fuel tax hike, the NG’s revenue growth has been wobbling. Total Revenues expanded 8.9% YoY in August to Php 279.75 billion from Php 256.9 billion a year ago.  Total Revenues expanded 9.25% in July 2019, and 11.49% in August 2018. (figure 3, upper window)

Figure 3

BIR’s August 2019’s 11.09% growth to Php 205.6 billion from Php 185.1 billion was instrumental in covering for the lackluster collections of Bureau of Customs, which expanded 3.04% to Php 53.6 billion from Php 52.012, and non-tax revenues which climbed 3.98% to Php 17.954 billion from Php 17.3 billion over the same period.

As a likely consequence of the law of diminishing returns, total revenue collections have been trending downhill, mainly from the slowing monthly growth rates of the BIR and BoC. (figure 3, middle window)

The revenue story of August resonated with its 8-month performance. 

Tax Revenues, which grew 9.8% to Php 1.88 trillion from Php 1.712 trillion a year ago, had been boosted by the BIR. BIR collections jumped 10.56% to Php 1.452 trillion from 1.314 trillion. Bureau of collections contributed with a 7.22% growth rate to Php 411.25 billion from Php 383.544 billion. Non-tax revenues generated a 7.36% growth rate to Php 211.61 billion from Php 197.11 billion over the same period. (figure 3, lower window)

The recently imposed excise taxes plus the tax amnesty has recently upheld revenue collections growth conditions in spite of the sharp slowdown in the banking system’s lending conditions, as well as the money supply growth. (figure 4, upper window)

And it’s why the administration has been pushing hard to implement the Corporate Income Tax and Incentive Rationalization Act (Citira), formerly TRAIN 2.0 or Trabaho Bill, a bait and switch tax regime consisting of the incremental reduction in corporate taxes in exchange for expanding the tax base. A genuine tax reform program can't happen unless the NG reduces or minimizes its spending. All deficits will have to be funded.

The political leadership has even been pursuing a gross taxation system in the name of curbing corruption!

Nonetheless, economic (TRAIN, record deficits, record debt, enhanced regulatory mandates and etc. …), financial, and monetary conditions (record QE, cuts in RRR and ON RRP and etc. …) have barely been operating free of interventions since the incumbent political leadership has assumed office in 2016. Thus, such myriad political measures have only led to massive distortions in the economy.

Unsustainable Impact from the Crowding Out Syndrome: NG’s Record Financing and Historic Cash Hoard!  

Figure 4

And the manifestations of imbalances from the compounding of political interventions have been surfacing in the different dimensions.

In the context of the budget, while resisting the acceleration of public spending to meet its target, the NG has, thus far, been intensifying the scale of its borrowing from savers through the capital markets.

With the 8-month deficit at only Php 120.4 billion, the NG’s financing has zoomed by a staggering 45.6% to an unparalleled Php 803 billion from Php 551 billion in 2018. And because of the sudden penny-pinching in expenditures, the massive borrowing has ballooned the NG’s cash hoard to a historic Php 430.74 billion, 79x higher than last year’s Php 5.045 billion! (figure 4, middle and lower window)

Not content with the unrivaled rate of cash stash, the Bureau of Treasury said it would raise another Php 220 billion in Q4 reportedly to “have sufficient buffers to accommodate strong spending for the rest of the year.”

Why borrow at such scale if the public spending remains restrained? The National Government raised Php 783 billion to finance last year’s Php 558.3 billion deficit, which exceeded the 3% deficit to GDP ratio of Php 523.7 billion.

What has the national government been preparing for other than a spending surge in the last 4-months of 2019? Has the cash stash been about an undeclared contingent allocation? Is the NG expecting tax revenues to stumble, thereby, limiting outlays? Or, have these been about a potential bailout?

Figure 5

All actions have consequences.

The record cash hoard has provided an aura of a surfeit to liquidity, which has driven down treasury yields, thereby, providing interest subsidy to the NG (and the banking system) through lower debt payments. As I have said elsewhere, the steep plunge in CPI plus a frenzied bid on global treasury have also contributed to the boost in domestic treasuries. The treasury boom has likewise provided the banking system a reprieve by boosting accounting profits.

But tumbling bank liquid assets have signified one of the many opportunity costs of the government’s aggressive financing. The steep decline in the banking system’s cash and due banks have coincided with the NG’s amplified financing requirements since late 2017.

The correlation showcases the crowding-out effect of the NG’s spending in tight competition with banks for access to funding from the public’s savings.

Naturally, there are second-order effects from the possible ramp-up in NG spending and or from continuing liquidity drain on the banking system. That said, the current Treasury boom and or current subsidies to the NG and the banking is unsustainable.

Even the BSP-led FSCC’s latest Financial Stability Report (2018) admitted to mounting liquidity ‘concerns’ and to increasing pressures from funding mismatches. (to be discussed next)

Here’s a teaser: (bold added)

If there are risk issues to raise, it will have to be the prospects of managing liquidity. Aside from simply having more loans versus deposits, using liquid assets as a source for funding more earning assets needs our attention. However, the bigger issue will be that continuing on the path of being a bank-based financial market means that the provision of credit will require taking on mismatches in tenor and in liquidity. As more credit is dispensed, such mismatches will only increase.

Conclusion

While public spending remained restrained in August leading to a narrow deficit-to-GDP ratio for the last 8-months, the NG embarked on another month of record borrowing that has led to an unmatched cash hoard.

Whatever happened to the administration’s pet project, the ballyhooed “Build, Build, and Build”? With public spending barely improving, how will such provide a significant boost to 3Q GDP?  Will further borrowing by the National Government in competition with the banking system amplify the crowding-out effect partly manifested by the liquidity drain in the financial system?

Moreover, why has the NG been stockpiling cash? Is the NG expecting revenues to slump, thus putting a kibosh on spending?

Or has such liquidity amassment been about contingency planning, such as a forthcoming bailout? 

Lastly, how resilient has the Philippine economy and the financial system been in the face of imbalances nurtured from repeated political interventions?

Attachments area

The US Federal Reserve Has Lost Control: As Repo Rates Skyrocket, Rumblings in US Money Markets Reverberate Across the World!

NEGATIVE Repo Rates can happen when there is a shortage of cash or particular collateral security, like negative-yielding bonds, are put up to borrow against. Therefore, trying to borrow against a negative-yielding bond can present a crisis. The standard Repo contracts, such as the Global Master Repurchase Agreement (GMRA), have been drafted under the implicit assumption that general collateral (GC) Repo Rates would only ever be positive—Martin Armstrong

The US Federal Reserve Has Lost Control: As Repo Rates Skyrocket, Rumblings in US Money Markets Reverberate Across the World!

From Yahoo/AFP: (September 20) The New York Federal Reserve Bank said Friday it will inject billions into the US financial plumbing on a daily basis for the next three weeks in an effort to prevent a spike in short-term interest rates. The Fed will offer up to $75 billion a day in repurchase agreements -- exchanging secure assets for cash for very short periods -- through October 10, it said in a statement. In addition, it will offer three 14-day "repo" operations of at least $30 billion each. Banks have struggled in recent days to find the cash needed to meet reserve requirements which has pushed up short-term borrowing rates, prompting the New York Fed to pump billions into US money markets with repo operations over the past four days. However, in a sign a cash crunch could be easing, demand for liquidity on Friday did not significantly exceed the amount offered, as it had on two prior days. After October 10, the New York Fed will "conduct operations as necessary to help maintain the federal funds rate in the target range, the amounts and timing of which have not yet been determined." [bold mine]

The US Federal Reserve has been forced to respond to magnified signs of instability in the money markets as evidenced by rocketing of Repo Rates that has caused considerable dislocations on the Fed’s floor monetary system.

Operating under an ample reserves framework, by establishing a “floor” or a limit at which bank lending of reserves with other counterparties, the rate of interest rate on excess reserve (IOER) supposedly influences the Fed Fund rates as “No bank would lend reserves to another bank at a rate less than the rate it could receive by simply keeping cash parked at the Fed”. (Ng and Wessel, May Brookings 2019)

And because of repurchase agreements involve the participation of nonbanks, the overnight-reverse-repurchase agreement rate (ON RRP), one of the three rates in the Fed’s monetary stance supposedly sets a floor on market repo rates. (Money and Banking June 2019)

By the way, repos or repurchase agreement (repo), as defined by the Investopedia represents “a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day. For the party selling the security and agreeing to repurchase it in the future, it is a repo; for the party on the other end of the transaction, buying the security and agreeing to sell in the future, it is a reverse repurchase agreement.”

But theory and reality has gone asunder.

As free banking wizard George Selgin presciently observed, “If market rates don't keep step with the IOER rate, monetary policy isn't working properly. And if they don't budge when the IOER rate changes, monetary policy isn't working at all…”

Figure 1

The gap between the Effective Fed Fund (EFF) rates and IOER widened to 2009 levels. Negative spreads between the EFF and IOER emerged as far back in late March of this year. ON RRP rocketed past 2008 and 2001 recession levels last week. ON RRP has been ascendant since 2016! (see figure 1)

The consensus have dismissed and rationalized these to the “$35 billion money market outflows to fund September 15th quarterly corporate tax payments; settlements for outsized Treasury auctions; and the approaching end to the quarter (where money center banks generally reduce balance sheet leverage for financial reporting and regulatory purposes)”, however as some astute pundits have been pointing out, the scramble for short term liquidity didn’t happen overnight; it had been building through time intensifying as it ages.

Should such money market turmoil be ignored in the face of today’s uncharted environment where USD-CNY has broken the 7-threshold, sovereign bonds with negative yields which recently hit a $17 trillion as bond yields etched record low around the world, inverted yield curves gripped advanced economies, systemic leverage running at uncharted levels, global central bank in a rush to slash rates*, US financial assets at a historic 5.6x GDP, and others…?

Figure 2

*As a side note, rate cuts were announced by the US Federal Reserve (2nd for the year), Bank Indonesia (3rd time), Peoples’ Bank of China (2nd cut on loan rate), and Hong Kong Monetary Authority (2nd) this week. In contrast to the general trend, Norway’s Norges Bank increased its policy rate for the fourth time in 2019. (figure 2)

Should these just be considered coincidences? It can’t be. The perspicacious Doug Noland of the Credit Bubble Bulletin explicates: (bold added)

It is surely No Coincidence that this week’s “repo” ructions followed last week’s spike in yields and resulting deleveraging. Is it a Coincidence that the marketplace experienced a powerful “rotation” that saw the favorite stocks and sectors dramatically underperform the least favored? Is it a Coincidence that hedge fund long/short strategies have been clobbered, in what evolved into a powerful short squeeze and dislocation? Surely, it’s No Coincidence the so-called “quant quake” foresaw this week’s quake in the repo market.

Let’s expand this inquiry. Is it a Coincidence that this week’s money market upheaval followed by a few months dislocation in the Chinese money market? And is it mere Coincidence that U.S. money market instability erupted on the heels of the ECB’s decision to restart QE?

There are No Coincidences. Chinese money market issues and currency weakness were fundamental to the global yield collapse. Trade war escalation risked pushing China’s vulnerable Credit system and economy over the edge. Global central bankers responded to sinking bond yields with dovish talk and monetary stimulus, feeding the unfolding bond market dislocation. Collapsing market yields and dovish central banks stoked melt-up dynamics in stocks and sectors seen benefiting from a lower rate environment. Growth stocks were caught up in speculative melt-up dynamics, while short positions in underperforming financials and small caps were popular hedging targets. Both momentum longs and shorts became Crowded Trades

The world doesn’t operate in a vacuum. And actions have intertemporal consequences.

Figure 3

And why have primary dealers been hoarding USTs and why the accelerated stashing of these in 2019? (figure 3)

The brilliant exponent of the Eurodollar, Mr. Jeffrey P. Snider from Alhambra Partners explains: (bold mine)

How do we know which is which? Very, very easy. Every single price and yield up and down the curve says there is and has been overwhelming demand in the financial public for UST’s. So much so, people and financial entities are willing to pay premiums on them, to gain less in yield for UST’s than they would through other financial alternatives (such as the Fed’s reverse repo; why are T-bills yielding less than the RRP if there isn’t excessive demand for T-bills?)

If you are in the camp of dealers stuck with UST’s, then special factors. If you instead look at actual price evidence and apply basic common sense, dealers purposefully hoarding UST’s, unwilling to part with them apparently at any price, then you appreciate the significance of building systemic pressures which is instead more and more exposed by what are normal calendar bottlenecks no one would ever otherwise notice. The problem is therefore so much bigger than the fiscal US government deficit. Systemic monetary problem.

At the same time, DTCC’s agency fails have been climbing since June 2019. (figure 3 middle window) Collateral settlement fails, according to the DTCC, could be anchored from miscommunication, constrained technology, insufficient collateral, and counterparty insolvency.

When aggregate “fails” on a particular security balloon, it is likely a symptom of the scaling of bottlenecks and shortages of collateral settlements. And when reinforced by counterparty problems, the issue becomes systemic.

And now we proceed to the relationship between repo rates and swaps.

From Bloomberg Yahoo (September 20): Meanwhile, the costs of borrowing dollars in funding markets is still elevated. In currency swap markets, handing over yen in return for dollars for one week -- a time period which covers the crucial month end -- now costs you the equivalent of 2.4% on an annualized basis. It was just 0.2% a week ago. The same is true in cross-currency basis -- where banks and financial institutions can swap floating-rate payments in different currencies -- with the premium for the Australian dollar over its U.S. counterpart collapsing by the most in eight years during Asian trading hours on Friday. Finally, the spread between U.S. Treasuries and interest rate swaps reached a record low Wednesday. That’s an indication that traders are getting anxious about the rate at which they can finance bonds, and are starting to use swaps instead. [bold mine]

In other words, the US dollar scarcity has been spreading across the US financial markets, and subsequently, around the world.

Back to Mr. Snider: And so, ultimately, if dealers aren’t willing to sell UST’s, and that’s what all the evidence says, why would they be hoarding them like this? Not because they fear a breakdown in fed funds, the Fed being backward about everything, but because they recognize the non-trivial risks of a breakdown in repo – which is merely confirmed by the increasingly abnormal behavior in fed funds as in other more relevant and important markets like swaps.

The mainstream has advocated several fixes to the current bout of money market tremblor led by the re-imposition of LSAP or Quantitative Easing (QE) and or the Standing Repo Facility (SRF) among others.

Good luck with that.