Yet no effusions of authors however brilliant and sophisticated can alter the perennial economic laws. They are and work and take care of themselves. Notwithstanding all the passionate fulminations of the spokesmen of governments, the inevitable consequences of inflationism and expansionism as depicted by the "orthodox" economists are coming to pass. And then, very late indeed, even simple people will discover that Keynes did not teach us how to perform the "miracle ... of turning a stone into bread," but the not at all miraculous procedure of eating the seed corn—Ludwig von Mises
In this Issue
The BSP Unveils Stealth QE 2.0 (Variant)!
I. BSP Unveils Stealth QE 2.0 (Variant), Currency Issuance Jump to All-Time Highs!
II. Stealth QE 2.0: The Addiction to Inflationism
III. Symptoms of Liquidity Strains Abound the Banking System
IV. Why the Liquidity Drain in the Banking Industry?
V. Likely BSP Objective: Keep the Liquidity Loose!
The BSP Unveils Stealth QE 2.0 (Variant)!
The Philippine central bank, the BSP, reduced its liabilities to the central government, which sent its net claims soaring to a record. This blog explains the whys of liquidity injections.
I. BSP Unveils Stealth QE 2.0 (Variant), Currency Issuance Jump to All-Time Highs!
Since market liquidity is the cornerstone of a functioning financial market, it is “too important to fail” in this regard. The upshot of this is that the unconventional can quickly become the norm. While there were concerns over “monetizing the debt” when the authorities acted early on, this crisis quickly took a “whatever it takes” mantra, at least until we find a way out (BSP-FSCC, 2022)
The BSP's net claims on central gov't spiked by an unprecedented 48.3% YoY and 236.7% MoM or by a whopping Php 757.7 billion and Php 348 billion, respectively, last December. (Figure 1, upper window)
Figure 1
Although gross claims on the central gov't were little change from last year and a month ago, the BSP chopped its liabilities by a stunning 52.7% YoY and 35.9% MoM, which resulted in a spike in its net claims to a record Php 1.069 trillion! (Figure 1, lower window)
In 2021, when the authorities claimed it injected a historic Php 2.2 trillion in liquidity, it used direct monetization of public debt (claims on central gov't) for this operation.
As it is, net claims on central gov't bulged by Php 833.5 billion from March 2020 to February 2021. In perspective, December 2022's Php 752 billion increase represented a startling 90% of the expansion of the net claims in the 2020-21 episode in a SINGLE month!
This time while the BSP has engaged in a series of "aggressive" rate hikes, it is reversing the tightening process implicitly by scaling down or liquidating its liabilities, including probably FX deposits of the Philippine Treasury. (BSP, 2021)
As proof of monetary loosening, currency issuance in pesos spiked by Php 198.9 billion YoY or Php 161.6 billion MoM to a record Php 3.78 trillion! But because of the high base effects, the data constrains the gains in %: 7.4% (YoY) and 9.3% (MoM).
In turn, the torrent of liquidity flooded into Philippine financial assets, which propelled prices of the listed firms at the PSE (mostly PSEi banks) and domestic treasuries higher!
And as part of exercising "control" of the currency (indirectly inflation), the USD peso, the Philippine gov't raised USD 3 billion from domestic and overseas savers last week! While the flows should temporarily suppress the USD from an increase, such additional external borrowing represents "USD shorts," which require repayment in the future and render the peso more vulnerable to the sharp oscillations of the USD and global FX markets.
II. Stealth QE 2.0: The Addiction to Inflationism
These cumulative actions exhibit the dire predicament of the BSP. It is trapped. The system cannot absorb a 'full' tightening, so it engages in self-contradicting or divergent policies.
Let us count the ways.
One. The implementation of relief measures reduced the transparency of the banking system, disguising the actual risks of the banking system. But disguising risks doesn't eliminate them.
Two. By imposing a cap on credit cards, it shields consumers from rising rates. It has been partly responsible for the structural shift in the composition of the lending distribution of the banking system. It has also contributed immensely to recent street price pressures.
Three. Authorities continue to expand the usage of leveraging, through external borrowings and other reserve assets (ORA), to manage the USD peso or the domestic FX market.
Four. Through the latest expansion of the net claims or quantitative easing in a different form, designed to partially offset the headline "tightening," it has once again used liquidity injections to rescue banks and the financial markets or listed firms of the elites.
These infusions skew the distribution of social-economic benefits in favor of the politically privileged few. Like in 2020-21, it sows the seeds for the next round of street price pressures.
Fifth and last. Alongside and in collaboration with the BSP, banks have been entwined in the same liquidity operations. (Figure 2, upper window)
There appears to be little understanding that entrenching rescues increases systemic fragility. It also amplifies dependency and incentivizes unscrupulous behavior within its constituency—the moral hazard.
As noted last October,
By extension, the industry's mounting losses on multiple fronts, official and undisclosed NPLs, realized and floating investment losses, which contribute to the drain in cash and liquidity, herald even MORE interventions to rescue or bail out the system.
And to this end, the more interventions, the weaker the banking system; the greater the odds of a financial crisis.
In turn, these interventions foster more resource, financial and monetary imbalances that should escalate pressures on street inflation. (Prudent Investor, 2022)
Yet, the objectives of such cumulative measures of controlling statistics and market prices are for short-term goals or headline consumption (the appeal to the unwitting public).
The point is; the addiction to a regime of inflationism (easy money) has become so entrenched that the system cannot afford a withdrawal or wean from it.
Oddly, compared to 2020-2021, the BSP liquidity injections came amidst tempered inflation in a recessionary environment. This time the mutant form of liquidity injections occurs amidst a spiking CPI as the statistical economy, the credit-financed GDP booms! (Figure 2, lower window)
So how will these not contribute to further inflation over time? Why should these not amplify the cycle of the age of inflation?
III. Symptoms of Liquidity Strains Abound the Banking System
So why did the BSP likely choose this path?
Cash reserves of the banking system plummeted 19.6% last November, down to Php 2.738 trillion, close to the pre-pandemic level. Cash reserves have been rapidly depleting since the 4Q of 2021. (Figure 3, topmost pane)
Ironically, the near complete erosion of excess cash comes in the face of the reported 2022 earnings boom on the heels of the BSP's Php 2 trillion cash infusions in 2020!
Even from the BSP's liquidity metrics, November's plunge reinforces the downtrend in the cash-to-deposit ratio, which reached a multi-year low. (Figure 3, second to the highest pane)
And because cash reserves account for 12.3% of the aggregate banking assets last November, another multi-year low, it continues to weigh on the growth rate of total banking assets, up 8.93%.
Despite the mainstream's florid reports of the industry, there appears to be a black hole vacuuming financial resources in the banking system's balance sheets.
And it is not just the issue of cash; deposit liabilities have been on a downtrend too.
Despite the 16.32% surge in FX deposits from the recent spike in the USD-Php, total deposits grew by 7.4%, backed by a 5.82% rise in the peso deposits. Peso and total deposits have been adrift at multi-year low growth levels, reinforcing their long-term downtrends. (Figure 3, second to the lowest window)
As it is, banks have been dependent on the capital markets for financing their operations, which theoretically should come at a higher cost.
By plugging the gap, the BSP's injections in 2020 reduced the industry's reliance on the capital markets.
Nonetheless, banks have been tapping capital markets anew. But rising rates may have increased funding strains. (Figure 3, lowest window)
IV. Why the Liquidity Drain in the Banking Industry?
What drives the deteriorating state of bank liquidity?
Banks generate earnings primarily from interest rate spreads from their lending. The second crucial source of income emanates from investments.
Aside from the backdrop of "improved" credit expansion, the industry's Non-Performing Loans (NPLs) have been melting.
Figure 4
Strangely, although NPLs have declined, which likely has been spurred by the various relief measures of the BSP, the industry's allotment to bad loan provisions appears to diverge from the loan delinquency data. These aberrations suggest a substantial understatement of NPLs. (Figure 4, topmost pane)
Furthermore, in the 2018 episode, rising rates due to the elevation of inflation pushed NPLs higher. By contrast, today, in defiance of economic gravity, bank lending continues to increase in the face of higher rates.
With the CPI and policy rate above their respective 2018 levels, why wouldn't the same dynamics hold? Has the current portfolio of outstanding loans been healthier? Has the BSP succeeded in upending the law of demand? Or have the BSP's rescue measures muddied or obscured actual conditions?
Secondly, with the recessionary environment pulling down bank lending rates, banks amplified their exposures on "investments." As such, the financial assets rocketed to record highs. In November, financial assets (gross) reported their third-highest level at Php 6.14 trillion, following an all-time high in September 2022. (Figure 4, second to the highest window)
But higher rates have also translated to record market losses, which should siphon the bank's capacity to expand liquidity through converting profits to lending. Accumulated losses reached its second-highest deficit of Php 131.7 billion last November.
And that's not all.
Rising rates have translated to a surge in Held-to-Maturity (HTMs) assets, which likewise siphons liquidity from the industry. (Figure 4, second to the lowest pane)
But as a critical absorber of public debt since 2015, the industry's net claims on central government resonated with the uptrend of the HTMs.
So, the unseen costs of monetizing public debt to subsidize deficit spending and bailing out banks transformed into a liquidity vortex.
V. Likely BSP Objective: Keep the Liquidity Loose!
The BSP's move reflects its paramount priority of maintaining liquidity to keep its debt-based spending model afloat.
Figure 5
It may be anticipating the lagged effects of rising rates on bank lending, which should have a spillover effect on the GDP and financial assets. (Figure 5, topmost pane)
It probably sees a tightening transforming into funding strains. The flattening yield curve expresses this dilemma. The spread between the 10-year BVAL benchmark and the policy rate has narrowed substantially. (Figure 5, middle chart)
With rates affecting one business window of operations, this leaves the "investment" option as the critical alternative source of the banking industry's income and cash flows. (Figure 5, lowest chart)
But the elevated inflation rates also strip out their option to grant subsidies to the banks through deposit expenses via interest rate cuts.
It will also deprive authorities of wanton boondoggles through record deficits.
As they see it, significant liquidity infusions could boost asset prices and help lower rates benefiting political authorities and the banking industry.
So even if a slowdown has yet to emerge, liquidity injections function as a contingent or cushion against a drain.
The thing is, they may be discounting or ignoring its feedback loops on inflation, which is likely to impact both lending operations and restrain financial speculation.
Further, by inflating asset bubbles that magnify entrenched economic and financial imbalances, such policies signify a gamble with the economy.
___
References
FINANCIAL STABILITY COORDINATION COUNCIL, FINANCIAL STABILITY REPORT, 2nd SEMESTER 2021, FINANCIAL STABILITY REPORT, p.5, bsp.gov.ph
Bangko Sentral ng Pilipinas Depository Corporations Survey, p.2 October 2021 bsp.gov.ph
Prudent Investor, Is the Banking System Prepared for an Era of Stagflation and Higher Rates? October 16, 2022, substack, blogger.
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