Justifying more money printing because "there is no inflation" is like justifying going faster on a highway because we haven't crashed yet—Daniel Lacalle
In this issue
Philippine Elites Urge the BSP to Double Liquidity Injections as 3Q Corporate Debt Swells while Revenues and Income Plunge!
I. Billionaires Recommend the More than Doubling of BSP’s Liquidity Infusions!
II. BSP’s Php 1.9 Trillion Injections Equals Explosive Surge in Corporate Debt, as PSYEi 30 Revenues and Income Plummet in the 3Q!
III. Corporate Debt Growth Explodes; Maturities Shorten and The Debt Cockroach Problem Resurfaces: From Hanjin to PAL
IV. Corporate Debt Growth Explodes: FX Exposures Soar Amplifying Currency Risks!
V.The BSP’s Php 1.9 Trillion Injections Equates to a Php 3.1 Trillion Bailout of the PSYEi 30!
VI. Diminishing Returns from the BSP’s QE? Rising Rates Pushes Back Euphoric PSE
Philippine Elites Urge the BSP to Double Liquidity Injections as 3Q Corporate Debt Swells while Revenues and Income Plunge!
I. Billionaires Appeal for More than Doubling of BSP’s Liquidity Infusions!
Haven’t we been told that economic recovery is on the horizon, then why this?
From the ABS-CBN News (November 23):
Philippine billionaires on Monday said more government stimulus is needed to revive the pandemic-battered economy, which slipped deeper into recession following an 11.5 percent contraction in the third quarter. “Government will have to spend in stimulus of at least 20 percent of GDP. That is my opinion. Support MSMEs, provide liquidity. Whether the Central Bank has to follow the footprints of the Fed and ECB and start printing a bit... 20 to 25 percent of GDP is what is necessary for consumption-based economy," said ICTSI Chairman and President Enrique Razon at the Go Negosyo Angat Lahat 15th anniversary Conference….
Ayala Corporation CEO Jaime Augusto Zobel de Ayala meantime shared more spending is required from both public and private sectors. “Public and private sector have to work together. We are depleting our resources deliberately in order to survive this. They have been putting stimulus on the table but demand has to kick in. We all have to use our balance sheets to kick start the economy. There is no way around it," said Zobel de Ayala.
Why are the elites desperately invoking the National Government/Bangko Sentral ng Pilipinas to gamble with the economy by printing massive amounts of money?
Some Php 1.9 trillion, said the BSP, has been injected into the economy allegedly to fight the adverse effects of the pandemic. That’s about 10% of the GDP. Apparently, such a massive amount hasn’t been sufficient, so the desire to up the ante by asking for the next wave of Php 1.9 to Php 2.85 trillion from the BSP—(again) on top of the present Php 1.9 trillion infusions—to attain a 20% to 25% of the GDP target!
If the economy is on track to heal naturally, and soon, why even bother throwing a lifeline?
Let us examine the impact from the first Php 1.9 trillion, from a combination of BSP policies, such as cuts in ON RRP and Reserve Requirement Ratios, Quantitative Easing, and other capital and regulatory relief measures.
It is important to remember that since official rates are near their "Effective Lower Bound" (ELB), which means that these are, like RRR cuts, finite or limited, the BSP would need to step up on its asset purchases or quantitative easing or money printing, which should take on a larger share of their policies over time, in the pursuit of further easing financial conditions.
And true enough, most of the components of the PSEi 30 have been using or expanding their balance sheets, not necessarily to "kick start" the economy, but rather, to survive the recession.
II. BSP’s Php 1.9 Trillion Injections Equals Explosive Surge in Corporate Debt, as PSYEi 30 Revenues and Income Plummet in the 3Q!
Table 1
Php 436 billion!
That’s a milestone amount of MARGINAL borrowing underwritten by the non-financial composite members of the PSYEi 30 in the last 9-months! And that’s also 60.3% GREATER than last year’s previous record marginal ANNUAL borrowing of Php 271.5 billion and 10% MORE than the 9-month period of 2019.
Twenty-one or 80.8% of Non-Financial Companies (NFC) posted increases in debt over the same period. San Miguel (24.33%), JG Summit (14.9%), PLDT (10.19%), Globe (7.3%), and Ayala Corp (7.03%) constitute the largest share of borrowers in the same period.
This stunning debt surge came in the face of an income and revenue collapse during the last 9-months, as well as, in the 3Q, the latter supposedly signified the reopening phase of the economy.
Nota Bene: Some of PSYEi 30 stats are double-counted. That is because subsidiaries also publish the numbers incorporated and broadcasted by the holding/parent firms. Nonetheless, despite such idiosyncrasies, we shall use them the same way the mainstream does.
In the first nine months, the published net income of the PSYEi 30 (inclusive of banks) plunged 52.45% on the back of a 19.42% crash in total revenues. Non-financials endured contractions of 54.8% and 20.9%, respectively.
The Holding firms sector hemorrhaged most with a startling 63.22% dive in earnings mainly brought about by the 26.08% cascade in revenues. The property subsidiaries pulled down the income and revenue figures of their parents, stumbling by 53.65% and 26.1%, respectively.
Table 2
The loosening up of the economy was supposed to boost 3Q financials substantially. But like the (-11.5%) GDP, the results had been a letdown, writ large.
In the 3Q, the published net income of the PSYEi 30 (inclusive of banks) plunged 38.9% on the back of a 19.6% crash in total revenues. NFCs shed a hefty 39.72% and 20.51%, respectively.
Unlike the first 9-months, the property sector bled most in terms of income (-63.27%) and revenues (-41.13%). The parent firms came next, which bottom-line and top-line were down sharply by 40.83% and 24.71%, respectively.
Incidentally, while deficits dominated the earnings conditions in the 3Q, some companies, like PLDT, SMC, ICT, FGEN, and EMP, managed to post profits. However, the earnings growth from some of them like, San Miguel and First Gen, were largely from non-recurring events. SMC reported a Php 7.9 billion windfall from ‘Miscellaneous’ income while USD 5.76 million from insurance proceeds padded FGEN’s earnings.
The thing is, losses in the revenue and income could have been more extensive than the Financial Statement (FS) reports submitted by the listed firms.
Meanwhile, cash reserves of the member firms (inclusive of banks) jumped 16.7%, or by a marginal Php 215.8 billion in the 9-months of 2020.
That being the case, by racking up financial leverage on an unprecedented scale, these firms used the BSP’s liquidity subsidies; not only to cover the operational liquidity vacuum from the economic downturn and to refinancing existing liabilities but also to build-up cash positions. Or, elite firms used subsidized liquidity for defensive posturing.
From the GDP perspective, aggregate revenues of the composite members of the headline index account for 23.16% and 22.9% of the Nominal or current priced GDP (NGDP) in the 3Q and 9—months, respectively. Of the 133 firms I tabulated, inclusive of the PSEi 30 members, or for companies with at least Php 5 billion in assets or Php 1.5 billion in sales, aggregate revenues accounted for 39.9% and 36.1% of the Nominal or current priced GDP (NGDP) in the 3Q and 9—months, correspondingly.
That is to say, listed firms, most especially those in the headline index, control a significant share of the economy.
The disproportionate distribution of the economic pie tells us of the potential extent of influence the owners of these firms have on policy-making.
III. Corporate Debt Growth Explodes; Maturities Shorten and The Debt Cockroach Problem Resurfaces: From Hanjin to PAL
Yet there’s more.
Decreasing liquidity has been prompting elite borrowers to shorten credit tenor.
From the BSP-led Financial Stability Coordinating Council’s Financial Stability Report (p.19-20)
Corporate securities are being issued but at short tenors. The lower-for-even-longer interest rate regime may not have boosted the equities market much but it has made it attractive for PH corporates to issue fixed-rate securities. New issuances from March 17 to September 14 amounted to PHP 201.5 billion, which is equivalent to 13.6 percent of total outstanding listed corporate securities. These issuances, however, are observed to have shorter-term tenors, mostly between one to three years (Figure 2.5). This strongly suggests that the funds would be more for operations, shore up liquidity or refinancing, rather than for capital expenditures.
Corporates are pricing-in more risk moving forward. The heightened issuance of corporate securities also comes with an underlying pricing narrative. As illustrated in Figures 2.6a and 2.6b, the premium of corporate bond yields over the credit risk-free government bond rates have been rising, for a sample of similarly rated securities with two-year and five-year tenors. This is interesting considering that the policy rate has decreased, which then has brought down the yields of government securities (GS).
Got that?
The BSP’s liquidity boom spurred a shift of the maturity spectrum of corporate debt from long-term to short-term to reflect on operational and liquidity requirements rather than for CAPEX reasons.
In doing so, the Php 1.9 trillion liquidity bonanza has effectively been subsidizing big-time corporate borrowers at the expense of savers while simultaneously amplifying credit risks as signified by the growing divergence in the bond spread of corporations and the domestic treasuries.
Interestingly, the BSP seems perplexed and or surprised at the emerging deviation of the market’s behavior from its easing policies!
Importantly, the Php 1.9 trillion liquidity boom has barely contributed to the jump-starting of the economy.
And the FSR raises the alarm bells on corporate debt servicing… (p 10-11)
The amount of income affects corporate viability. What concerns financial authorities is that liquidity concerns can, under certain conditions, escalate into a solvency problem. This converts a one-off operating anomaly into a viability concern, from temporary to structural effects.
EBIT is again a useful metric but phrased as an interest coverage ratio (ICR).9 Figure 1.6 showed that the ICR fell sharply in 2020. A closer look at firm-level data implies that the deterioration in ICR was generally experienced across industries, as the Q2 ICR values for the 25th percentile, median and 75th percentile of the total sample stood lower relative to the immediately preceding periods. While this is a natural consequence from Figure 1.5, the concern is that half of the 174 firms covered have ICRs below unity in Q2. This is a red flag…
These points reiterate why the drop in earnings in 2020 is critical. Apart from the timing issue raised in the preceding section, there is a rather sharp drop in ICRs that should be monitored. While previously it was leverage which was seen as a potential systemic risk, the current situation is different. Today, debt servicing – and arguably for some, it may be corporate viability – may be the primary issue as a result of the income shock. This is despite lower interest rates which should translate into lower interest expenses once repricing sets in. However, the fixed schedule of obligations will now be matched against the variable timing and quantity of income.
A recent example of the above, partially realized.
From the Inquirer (November 27) “PAL, banks grapple with looming $5-B debt rehab–biggest in PH history”: The total liabilities of Philippine Airlines (PAL)—including its outstanding obligations to foreign aircraft suppliers—stand at almost $5 billion, making its proposed debt restructuring plan the largest in the country’s history. “This [amount] is due to new accounting rules on [aircraft] leases that were implemented in 2019,” a company insider told the Inquirer, even as he explained that the actual amount of loans excluding these assets was “much smaller than that.” According to company insiders, the flag carrier’s total liabilities are expected to fall to around $3 billion once its rehabilitation plan is approved by US courts, possibly as soon as next month. “PAL will likely seek US court protection once it has 67 percent of its creditors or lessors agreeing to its request for restructuring,” another industry source familiar with the airline’s situation said.
After Hanjin Heavy Industries and Construction Philippines’ over USD 400 million default in January 2019 [Inquirer, January 11, 2019, Local banks grapple with biggest default in PH corporate history], now comes the debt restructuring or the partial default of PAL.
From the biggest default to the biggest debt rehab: There is seldom just one cockroach in the kitchen, once warned Warren Buffett, the legendary investor. That’s because financial woes, such as accounting chicanery or debt defaults, are likely symptoms of underlying problems, where more incidences are likely to surface.
Once the BSP lifts its debt moratorium, the debt cockroach problem should get MORE interesting.
IV. Corporate Debt Growth Explodes: FX Exposures Soar Amplifying Currency Risks!
And even more…
Not only are corporations deepening their leverage with local exposure, but they have been taking on more foreign liabilities! (p 21-22)
Various data confirmed that there are Philippine corporations who have the credit standing to be able to borrow in foreign currency (FCY) terms in the offshore market.22 Indeed, this is what the data from the Bank for International Settlements (BIS) showed, where the debts of NFCs have increased significantly between March 2018 and March 2020 (Figure 2.9). COVID-19 presents a debt servicing concern to the extent that corporate incomes have weakened since the Q1 cut-off for the BIS data.
The incentive remains, however, for NFCs to borrow in the offshore market. Interest rates should be lower offshore and the Philippine peso has been generally appreciating against the US dollar. For NFCs that use the borrowed funds to generate FCY income in the same currency, there is obviously no additional exchange rate risk involved. Without granular data on who these borrowers are, this remains a blind spot for the Philippine authorities and should be managed as a risk.
This risk cannot be dismissed as a paper exercise. Based on third-party sources, NFCs will have significant FCY maturities in 2023 and 2024 (Figure 2.10). This will put the FCY obligations at roughly 20 percent to 25 percent of the country’s international reserves, which would seem to be a nontrivial amount if there is a bunching in the demand. More to the point, COVID-19 has instigated a flight to the USD as a safe haven currency. Within ASEAN, the capital outflow has been consistent for 2020 (Figures 2.11a and 2.11b) with the likely destination being US Money Market funds (Figure 2.12). These outflows are occurring despite sovereigns maintaining positive interest rate spreads over US instruments. This can only suggest that either there is a notional-though-positive spread below which funds will prefer USD instruments or that, based on the interest rate parity framework, the local currencies are seen as depreciating significantly in the near-term to more than make up for the positive interest rate spread.
From the above, if there is an incentive for the BSP to keep the peso strong, it is because of this: corporate borrowers pose as the primary channel for exchange rate risks, which may have spillover effects on the banking system and the National Government (NG).
Yet, such risk assessment assumes that the NG is "risk-free" or cannot be the source of volatility, should serve as another blind spot for the BSP!
And though there is "no additional exchange rate risk involved"; citing foreign currency revenues of some of local NFC firms leveraging extensively through offshore dollar markets, which share of exposure the BSP admits it sparsely knows, forex risks may fundamentally emerge from unproductive and excessive leveraging of the balance sheets even on exporters of goods and or services and or financials.
The essence of risk management is not solely from looking at its source of income but at the overall financial/economic or non-financial conditions that may affect the health of an entity's balance sheet.
And the fact that "corporate incomes have weakened" in the face of surging foreign borrowings is a testament to the unsustainability of the strong peso or the mounting case in favor of the peso shorts, which the BSP refers to as "the preference for the USD instruments" despite "positive spread over US instruments".
Finally, though the banking system reported a 2.13% YoY growth of the Total Loan Portfolio (TLP) last September, excluding Reverse Repos and Interbank Loans, the 9-month nominal TLP peso loans contracted by a staggering Php 236.1 billion.
Even when part of the borrowing of Php 436 billion by NFC’s of the headline index have been channeled through banks, aside from the mandated loans to the MSMEs, the net contraction of the bank loans has been indicative of the escalating debt delinquencies.
Figure 3
The popular call for MORE bailouts by expanding the BSP’s balance sheet only translates to further additions of unproductive and high-risk debt or the kicking of the proverbial can down the road with nastier consequences ahead.
Global central banks and authorities have embarked on the grandest monetary experiment ever. Global policy rates are at the lowest uncharted levels ever, backed by liquidity injections of global central banks that have spiked debt levels and sending leveraging ratios to the highest in history!
V.The BSP’s Php 1.9 Trillion Injections Equates to a Php 3.1 Trillion Bailout of the PSYEi 30!
What has the tsunami of liquidity injections by the global central banks, including the BSP, done?
In two words: Asset inflation. Liquidity operations have been inciting a speculative frenzy on asset markets around the globe, including the Philippine Stock Exchange.
As noted last week, for the BSP, risk aversion represents a key source of disruptions in credit flows, which it thinks can’t be resolved by markets alone. Again from the FSR:
This suggests that unless the risk aversion is addressed, any economic forecast of future growth that rests on the premise that risk aversion can selfcorrect is contentious, particularly if the transition period is protracted. ( p.18)
And such, to restore confidence or the Keynesian animal spirits, it announced the undertaking of several measures:
Philippine regulators also provided a springboard for risk assets to rebound. The Securities and Exchange Commission (SEC) adjusted its disclosure requirements to promote transparency and accountability. It also enabled the creation of corporate debt vehicles to support liquidity requirements. These, and the stable outlook in the country’s credit ratings, are seen to restore investing public confidence and ease business pessimism. (32)
Part of which is to use excess liquidity to fire up confidence level through implicitly powering up the asset markets:
Thus, the objective is to re-deploy the liquidity as part of a general strategy for the lending institutions to get more comfortable in taking more calibrated risks.
There is now a need to enhance risk pricing and valuation in the capital market. The viability of any investment outlet depends on risk pricing (at initial issue) and valuation (in the secondary market). This ensures that risktakers are appropriately rewarded. However, current conditions suggest an uncertainty premium (p.38)
And risk assets could be part of the BSP’s signaling channel (communication policy):
As difficult as these challenges may be, communication must play a role. It is essential to effective policy. To address risk aversion, the authorities need to establish and communicate the market landscape of the New Economy. This must be a strategic view with enough tactical details. This has not been done before. (p. 42)
In an amazing turnaround, the BSP ratiocinates or justifies nosebleed valuations from the equity boom:
As a proxy, consider the price-to-earnings (P/E) as a measure of how equities are priced relative to earnings. It is recognized that P/E valuation is typically used at the firm level and some fair amount of caution is necessary in trying to replicate it as a market valuation tool. Within this caveat though, it immediately stands out that in 2020 amid the COVID-19 crisis, the aggregated ratio was more volatile compared to previous years when it was merely moving within a band (Figure 2.4). A sharp increase in P/E was particularly noted in August. Looking closely, however, the marked rise in P/E came with a marginal increase in price P, and as implied, a steep drop in earnings E. Given this, it can be argued that the spike is not telling of a higher valuation in the equities market, but rather, an indicative pressure on earnings. The drop in implied earnings also times well with the August release of GDP figures as well as the quarterly reports for the bulk of listed firms in the same month, all of which have corroborated the narrative of depressed income streams due to the COVID-19 shock…
In the context of this discounted cash flow type of valuation which takes into account financial and macroeconomic data, including a prolonged lowinterest rate environment, a recovery of the equities market appears to hinge on better prospects for the economy as a whole. (p.19)
An inordinate bidding up of share prices relative to earnings in the face of stagnant or slower growth or a drop in earnings or even losses is called the price multiple expansion.
"Better prospects for the economy" is not a sufficient rationalization to overrule the pricing away of the equity markets from economic reality.
As proof, the PSYEi posted a closing high of 6,156.45 and closed at 5,884.18 in August. Again, that was August.
Last week’s climax was at 7,178.62 or 22% above the August close!
This comes in the wake of "the narrative of depressed income streams" or "pressure on earnings".
Neither the GDP nor earnings in the 3Q validated the scale of the rampant inflation of the equity markets last August. If prices in August did not warrant its levels, what justifies the present?
Likewise, their latest FSR, which they admit as laden with serious blind-spots and unknowns (red flags), barely supports the meme of "better prospects for the economy".
Figure 4
From the lows of the week ending March 27th to the week ending with a 9-month high last November 20th, the PSYE 30’s full market cap exploded by a staggering Php 3.1 trillion! (Figure 4, upmost pane)
That’s 63% more than the BSP’s 1.9 trillion liquidity injections. And again, the main recipient of the BSP’s liquidity bailout are the biggest market cap issues! (Figure 4, middle pane)
Gross inequality exists even in the distribution of the market caps! And so it is easy to game the index.
And the aggregate 9-month earnings plunged by 52.45%. Even if we apply a 20% premium to such published eps to attain the 2020 (annual) earnings (due to better prospects), the aggregate PERs still represents a moonshot!
The lowest window from Figure 4 (prices as of November 27) should give a clue on the scale of valuations predicated on the “depressed income streams” as participants panic bid on prices to reflect on “better prospects for the economy”!
How will re-inflating stock market bubbles revive the economy?
VI. Diminishing Returns from the BSP’s QE? Rising Rates Pushes Back Euphoric PSE
Figure 5
The 1-month BVAL T-bill rates jumped as the overvalued PSEi plunged 5.3% from euphoric levels last week. The headline index rocketed when the same rates plumbed to fresh lows in November as the BSP embarked on the expanded QE.
Coincidence?
Or has the BSP’s Php 540 billion liquidity operations reached diminishing returns for the PSE?
If treasury (fixed income) markets have reached their zenith, this leaves stocks as the main channel to bolster the animal spirits. But what if the current mania translates to a second major top? Will it exacerbate the loss of confidence emanating from the erosion of real savings that is being obscured by money printing?
And while formal system (banking and public) debt slowed to Php 18.1 trillion in September from August all-time high of Php 18.4 trillion. Systemic leverage should amount to a whopping 100% should the GDP contract by 8% in 2020! Yet to be accounted for are other forms of leveraging and informal credit.
Surely, rising rates will foment disorderly adjustments on a debt addicted economy. And as the major borrowers, the elites know it. So aside from appealing for low rates, they are proposing to supply mass vaccinations to the gullible public.
As the great Austrian economist, Ludwig von Mises presciently warned*
Because the effects which the inflationists seek by inflation are of a temporary nature only, there can never be enough inflation from the inflationist point of view. Once the quantity of money ceases to increase, the groups who were reaping gains during the inflation lose their privileged position. They may keep the gains they realized during the inflation but they cannot make any further gains. The gradual rise of the prices of goods which they previously were buying at comparatively low prices now impairs their position because as sellers they cannot expect prices to rise further. The clamor for inflation will therefore persist.
*Ludwig von Mises, 1. Inflation III. INFLATION AND CREDIT EXPANSION INTERVENTIONISM: AN ECONOMIC ANALYSIS p.36 fee.org
Has it not been a wonder why the spin for persistent interventions and bailouts for the BSP/NG to keep rates perpetually low?
