Could the Philippine Government Implement a 'Marcosnomics' Stimulus Blending BSP Rate Cuts and Accelerated Deficit Spending?

 

Keynesianism is the destruction of the middle class. By printing money and bloating deficits and spending, the size of government in the economy rises faster than the private and productive sectors. The size of the government increases during recessions by increasing expenditure to combat them, and it also increases during economic downturns by hiking taxes and creating inflation, which is a hidden tax—Daniel Lacalle 

In this issue

Could the Philippine Government Implement a 'Marcosnomics' Stimulus Blending BSP Rate Cuts and Accelerated Deficit Spending?

I. Will the BSP Embark on the Path of Easing via Rate Cuts Starting in August? 

II. Will the BSP’s Rate Cuts Not Amplify the Balance Sheet Imbalances?  

III. Will a Slowdown in June CPI Reinforce the BSP’s 'Dovish' Position? 

IV. Public Spending Surges to Fourth-Highest Level on Record in May! 

V. Will the Government Introduce a Fiscal Stimulus Package Soon? 

VI. Aggressive Deficit Spending Expected to Increase Public Financing or Debt 

VII. "Marcosnomics" Stimulus: Expanded Spending on Pre-Election, Defense Related and Infrastructure? 

VIII. Five-Month Debt Servicing Costs Hits Record High! 

IX. "Marcosnomics" Stimulus: BSP Easing Plus Accelerated Deficit Spending; Burst of Deficit Spending to Cap Disinflation 

X. The Addiction to Government Interventions and Stimulus Magnify Systemic Risks 

Could the Philippine Government Implement a 'Marcosnomics' Stimulus Blending BSP Rate Cuts and Accelerated Deficit Spending?

With the BSP priming the public for a policy easing this August, and May public spending reaching a non-December all-time high, could this signify the implementation of a 'Marcosnomics' signature stimulus?

I. Will the BSP Embark on the Path of Easing via Rate Cuts Starting August?

Businessworld, June 28,2024: THE BANGKO SENTRAL ng Pilipinas (BSP) kept interest rates steady for a sixth straight meeting on Thursday but signaled that a rate cut at its next meeting in August is “somewhat more likely than before,” with up to 50 basis points (bps) in easing likely this year…Mr. Remolona said he expects inflation to further ease in the second semester with the implementation of lower tariffs on rice. 

If an increase in rice tariffs will lower the CPI, why would this require the BSP to cut rates?

Policy rates represent a tool for managing aggregate demand, largely ignoring the impact on balance sheets.

By signaling a cut, is the BSP admitting to a worsening slowdown in demand?

Don’t you see the contradiction? Why would the BSP use a demand management policy to address a supply-side concern? 

For the avoidance of doubt, the results of the BSP’s latest consumer survey corroborate their implicit worries (bold added): The consumer sentiment in the Philippines was more pessimistic for Q2 2024 as the overall confidence index (CI) became more negative at -20.5 percent from -10.9 percent in Q1 2024. The decline in the index is reflective of the increase in the percentage of pessimists, which outweighed the increase in the percentage of optimists. The weaker confidence among consumers was mainly due to their concerns over the: (a) faster increase in the prices of goods and higher household expenses, (b) lower income, (c) fewer available jobs, and (d) the effectiveness of government policies and programs on inflation management, traffic and public transportation, provision of financial assistance, and labor and employment.  For the next quarter (Q3 2024), the CI turned negative at -0.4 percent from 2.7 percent in Q1 2024. However, the consumer sentiment for the next 12 months (May 2024-April 2025) remained optimistic as the CI was little changed at 13.5 percent from 13.4 percent in Q1 2024. (BSP, June 2024) 

So, could this be the genuine reason for the entrenchment of the BSP’s 'dovish' stance? 

It does not stop there. 

It’s not just consumers; businesses have also shared this dour sentiment for 2024. 

This is according to another BSP survey. (bold mine): The business sentiment in the Philippines turned less upbeat in Q2 2024 as the overall confidence index (CI) declined to 32.1 percent from 33.1 percent in Q1 2024. This is reflective of the combined decrease in the percentage of optimists and the increase in the percentage of pessimists. The Q2 2024 business confidence turned less buoyant due mainly to the firms’ concerns over: (a) softer demand for goods and services such as personal care, health and other consumer products, construction supplies, city hotels and restaurants, and manpower services, (b) ongoing international conflicts that may push oil prices higher, (c) slowdown in business activity due to El Niño-induced extreme weather conditions, and (d) persistent inflationary pressures that may weigh down consumer spending. For Q3 2024, the country’s business confidence weakened as the overall CI also fell to 43.7 percent from 48.1 percent in the Q1 2024 survey result. For the next 12 months, business outlook was similarly less upbeat as the overall CI decreased to 56.5 percent from 60.8 percent in the Q1 2024 survey result (BSP, June 2024) 

Even before this survey, has the BSP been aware that the revenue growth of listed retail chains had been struggling for some time? 

Besides, why did the BSP not address the escalating tensions between the Philippine government and China over the disputed South China Sea claims? 

An outbreak of violence in the region would not only disrupt global supply chains but also raise the specter of a wider conflict—a "casus belli"—that could have severe socioeconomic and financial consequences for the Philippines. 

Does this represent another case of an analytical "blackout?" 

In a nutshell, is the BSP concerned about how the gloomy views of consumers and businesses may translate into weaker GDP growth? 

II. Will the BSP’s Rate Cuts Not Amplify the Balance Sheet Imbalances?

On the other hand, how would interest rate cuts boost demand, incomes and jobs if household and business balance sheets are already heavily leveraged?

Figure 1

Has the BSP not learned from the Bank of Japan's experience with negative nominal interest rates, where instead of stoking inflation, it exacerbated the curtailment of demand that led to its "lost decades?" (Figure 1, topmost graph)

Further, would the BSP's rate cuts not only magnify economic imbalances and stoke inflationary pressures but also widen inequality between those with access to formal credit and those reliant on shadow banking, such as small and medium enterprises (SMEs)?

Moreover, has the BSP also expressed concerns over the deteriorating conditions in the banking system, where higher interest rates have led to the erosion of accounting profits, potentially worsening financial liquidity conditions and exposing the solvency issues of bank borrowers and the industry? (Figure 1, middle and lower windows)

Will the BSP’s rate cuts not amplify the balance sheet imbalances?

III. Will a Slowdown in June CPI Reinforce the BSP’s 'Dovish' Position?

Along with the above, as previously noted, May's CPI could represent an interim peak. We arrived at this conclusion based on several factors:

Figure 2

1. Slowing month-over-month momentum in the CPI

2. A bullish flattening of the Philippine treasury yield curve, which narrowed further in June (Figure 2, topmost graph)

3. Instead of boosting demand, the elevated leverage in household balance sheets—as revealed by record consumer spending—has fueled an increase in consumer non-performing loans (NPL)

4. Deteriorating job market conditions

5. The recent bounce in imports may be driven by substitution effects due to production slack

6. The rising US dollar-Philippine peso exchange rate, which not only contributes to higher import and financing costs but also puts pressure on local industries to generate more foreign exchange revenues to fill the widening trade gap. (Prudent Investor, June 2024)

The BSP has published its projected CPI for June (3.4%-4.2%)—which seems tilted lower than May (3.7%-4.5%). The next step will be for the consensus "to pin the tail on the donkey" by selecting numbers within the BSP’s range.

If the CPI slows, would it validate our view that the economy has been slowing faster than expected? And would this justify the BSP’s proposed easing this August?

IV. Public Spending Surges to Fourth-Highest Level on Record in May!

We also noted peculiar signs of restraint in government spending in the first four months of 2024.

However, this trend may have reversed in May, as the enlarged deficit emanated from outsized government spending!

Inquirer.net, June 28, 2024: The government reverted to a fiscal deficit in May, after posting a P42.7-billion surplus in April, amid higher public spending fueled by accelerating inflation and a high-interest environment…Government spending in May amounted to P557 billion, accelerating by 22.24 percent mainly driven by allotments to government agencies’ projects and budgetary support to local government units and state-run corporations. For the first five months, disbursement reached P2.3 trillion, up by 17.65 percent…For this year, the government has set a budget deficit ceiling of P1.48 trillion, or equivalent to 5.6 percent of gross domestic product (GDP). It also aims to reduce the deficit-to-GDP ratio to 3.7 percent by 2028.

May's government spending represented the fourth largest on record, according to data from the Bureau of Treasury! (Figure 2, middle chart)

Ironically, this May spending surge was in line with the biggest spending streams that occurred in December over the last three years—when the government typically used the final month to meet or exceed (political) expenditure targets. Yet, it is not even the end of the second semester. (Figure 2, lowest image)

Or, public spending in May was the highest on record (excluding the December expenditures)!

Has the government's frontloading of expenditures last May broken the seasonal December spending cycle? 

That’s right.  The surge in May’s deficit spending may set the template for the coming months through the year-end—we can only expect December spending to surge even more (or hit a fresh milestone)! 

Because of the revenue or collection slowdown, the spending ballooned the fiscal deficit way above 2023’s level. 

V. Will the Government Introduce a Fiscal Stimulus Package Soon?

Figure 3

Remember that government revenues are dependent on economic, financial, and administrative performance, while spending is programmed as part of the Congress—approved budget. 

For instance, not only does public spending play a crucial role in shaping economic imbalances that can lead to inflation, but inflation also has a material influence on revenue collection. Revenues depend on the declared transacted price levels.  That is to say, a slowdown in private GDP growth would materially widen the fiscal deficit. (Figure 3, top and middle visuals) 

The government has already proposed a 10% increase in the 2025 budget to Php 6.35 trillion. 

A surge in public spending increases a segment of the private sector’s revenues from Public-Private Partnerships (PPP) and other direct and indirect linkages via the political bureaucracy—which will be used for "consumption." 

Therefore, as we observed in our early June post, 

Are they saying that the current weakness in consumer spending growth will reverse with more deficit spending or more implicit transfers favoring the government and its cronies? Or how will increasing this reverse the current trend?  (Prudent Investor, May 2024) 

Are authorities expecting an economic downturn? Are they preparing the public for the launch of a grand stimulus through measures via easing rates, liquidity injections, and deficit spending? 

As we concluded from the same note last May, 

Once again, when the economy slows substantially or recession risks mount, monetary authorities will likely resort to the 2020 pandemic playbook: substantially easing interest rates, infusing record amounts of liquidity, and deepening the imposition of relief measures. Alongside this, political authorities are likely to drive deficits to reach record levels. 

VI. Aggressive Deficit Spending Expected to Increase Public Financing or Debt 

The increase in the fiscal budget gap for May translates to an impending reversal in the four-month deceleration of public debt issuance. (Figure 3, lowest chart) 

Intriguingly, some quarters have praised this deceleration without fully comprehending the policy "path dependency" of the authorities. 

Subsequent to the April announcement of a Php 2.57 trillion target for 2024, which represents an 8.9% increase from last year's Php 2.07 trillion, the government has already declared that it proposes to raise Php 600 billion in Q3, following the projected Php 585 billion increase in Q2.

As of May, the Bureau of the Treasury (BoTr) has raised Php 1.038 trillion, which amounts to 40% of the projected Php 2.57 trillion financing.

The increase in the May’s fiscal budget gap translates to a coming reversal in the four-month deceleration in public debt issuance.  Intriguingly, some quarters have exalted this deceleration with hardly a comprehension of the policy path dependency of authorities. 

And subsequent to the April announcement of a Php 2.57 trillion target in 2024 or an 8.9% increase from last year’s Php 2.07 trillion, the government has already declared that it proposed to raise Php 630 billion in Q3 following the projected Php 585 billion domestic borrowings in Q2. 

Through May, the BoTr has raised Php 1.038 trillion or 40% of the projected Php 2.57 trillion financing. 

This path dependency on deficit spending would entail increases in systemic leveraging. 

VII. "Marcosnomics" Stimulus: Expanded Spending on Pre-Election, Defense Related and Infrastructure? 

How is the government deploying our anticipated 'stimulus'?

Figure 4

We anticipated a reversal from the recent slack in LGU allocations, primarily due to the upcoming 2025 Senate and local elections.

The 'proxy war' between the US-NATO alliance and the Russia-China-BRICs alliance is playing out in the domestic political sphere through an intensifying contest between the incumbent and former administrations, where LGUs will play a pivotal role in determining the winners.

The pro-China former President and his two children plan to run for Senate in 2025 against the pro-US incumbent.

Facilitated by the BSP's easing and the banking system's liquidity infusions, the incumbent administration is expected to disproportionately increase budgets for select and favored LGUs that will promote their domestic and geopolitical agendas.

Although LGU allocations increased by 8.54% in May, the 5-month growth surged by 10.6%, reaching a nominal spending of Php 420.3 billion, the second-highest on record. (Figure 4, upper graph)

Meanwhile, infrastructure, public defense-related projects, pre-election expenditures, and bureaucratic spending were likely funded by the national government, which saw a 22.3% spike in disbursements in May.

This contributed to a 14.8% surge in national government spending over the first 5 months, reaching an all-time high nominal level of Php 1.443 trillion! (Figure 4, lower image)

So if we are not mistaken, "Marcosnomics" will be heavy on political expenditures but sold to the public as a "stimulus."

VIII. Five-Month Debt Servicing Costs Hits Record High!

But there is more.

Figure 5

Notably, interest payments skyrocketed by 47.8% in May alone! (Figure 5, topmost graph)

Over the 5-month period, interest payments soared by 40% to a record high of Php 321.6 billion. As it is, the pie of interest payments rose to 14.24%—its highest level since 2009!

Consequently, 5-month debt servicing (including interest and amortization) surged by 48.5% to an unprecedented Php 1.217 trillion, accounting for 91.78% of the full-year debt servicing in 2023! (Figure 5, middle and lowest windows)

Specifically, amortizations are just 8.22% below the 2023 levels, while interest payments remain 48.8% short of last year’s level.

IX. "Marcosnomics" Stimulus: BSP Easing Plus Accelerated Deficit Spending; Burst of Deficit Spending to Cap Disinflation

Adding these together, the BSP’s incentive to ease or cut rates is largely political in nature.

Primarily, it aims to lower financing costs to support the administration’s pre-election geopolitical and GDP "stimulus," while mitigating the rising costs of public debt servicing. 

Additionally, it seeks to alleviate liquidity and solvency challenges affecting the banking industry and its clients. 

The banking system operates similarly to a cartel under the BSP's oversight.

Figure 6 

Faced with stepped-up deficit spending, the BSP could likely bankroll this by increasing its direct liquidity operations (net claims on the central government—NCoCG); a strategy previously employed in 2020. (Figure 6, topmost chart) 

In coordination with the BSP, banks are also expected to increase financing of public debt through purchases of government debt (NCoCG). (Figure 6, middle graph) 

The acceleration of the banking system’s historic NCoCG has mirrored the surge in the record-high in public debt. May’s data will be reported by BuTr in the first week of July.

Figure 7

Let's not forget that banks have also been significant borrowers of local savings to bridge gaps from deposit shortfalls, hidden non-performing loans (NPLs), substantial mark-to-market losses, and record Held-to-Maturity (HTM) assets reflected on their balance sheets.

The banking system's bonds and bills payable have been approaching the Q4 2019 zenith. (Figure 7, topmost image)

Essentially, the banking system is in tight competition with the government and non-financials for access to the public's savings. 

Not only does this put a floor on rates, but it also provides an incentive for the BSP to expand liquidity operations to keep the system afloat. Yet, this entrenches inflation, the interconnectedness of leverage, and the potential transmission of risks.

As such, while we expect the rebound in the CPI to have likely climaxed in May—largely due to growing slack in the private sector—a burst of deficit spending should put a floor under it. 

Along with this, the specter of stagflation rises.

X. The Addiction to Government Interventions and Stimulus Magnify Systemic Risks

It is no coincidence that the rise in the USD to Philippine peso exchange rate has closely correlated with public spending.

Put differently, monetary inflation in support of the “trickle-down” policies that lead to the “twin deficits” emasculates the purchasing power of the peso against the USD and gold. 

So there you have it.  The BSP’s ‘dovish’ stance is largely in consonance with the acceleration of the national government’s intensifying deficit spending. 

While intended as a GDP “stimulus,” these measures also serve other underlying political agendas—facilitating access to cheaper domestic savings for pre-election financing, geopolitical activities, other domestic political objectives, and cushioning banks from worsening balance sheet challenges. 

As the above shows, the Philippine government and the establishment have been so hooked on stimulus in the hope that it will deliver some form of utopia. 

Yet, the more the interventions, the deeper the imbalances, the greater the probability of risks. 

___

References: 

Daniel Lacalle, The U.S. fiscal nightmare. Yellen cannot expect a strong economy with higher spending and taxes, dlacalle.com May 26, 2024 

Bangko Sentral ng Pilipinas, Consumers are Pessimistic in Q2 and Q3 2024, But Optimistic for the Next 12 Months*, June 28, 2024, bsp.gov.ph 

Bangko Sentral ng Pilipinas, Businesses are Less Optimistic in Q2 2024, Q3 2024, and the Next 12 Months*, June 28, 2024, bsp.gov.ph  

Prudent Investor, Has the May 3.9% CPI Peaked? Are Filipinos Really Spending More On Non-Essentials? Credit Card and Salary Loan NPLs Surged in Q1 2024! June 10, 2024  

Prudent Investor, Philippine Q1 2024 5.7% GDP: Net Exports as Key Driver, The Road to Financialization and Escalating Consumer Weakness May 12, 2024

 

PSEi 30 Posted its Largest Weekly Plunge of 3.53% in 2024: Why the Incredible Silence on the Influence of the June 17th Ayungin Shoal Incident?

Journalists cannot serve two masters. To the extent that they take on the task of suppressing information or biting their tongue for the sake of some political agenda, they are betraying the trust of the public and corrupting their own profession—Thomas Sowell

PSEi 30 Posted its Largest Weekly Plunge of 3.53% in 2024: Why the Incredible Silence on the Influence of the June 17th Ayungin Shoal Incident?

Why has the June 17th Ayungin Shoal Incident been absent from all media narratives on the stock market? Is censorship making a comeback?

Here is a list of news articles carrying Friday’s selloff at the Philippine Stock Exchange:

Inquirer.net, June 22, 2024: A weaker peso and strong foreign selling pushed the local bourse over its steepest drop of the year so far on Friday, with the benchmark index touching the 6,100 level for the first time in seven months. The Philippine Stock Exchange Index (PSEi) entered an eight-session losing streak on the last trading day of the week, falling by 2.93 percent, or 186.08 points, to close at 6,158.48…Philstocks Financial Inc. research analyst Claire Alviar noted that the market’s negative performance was due to strong net foreign selling, recording a net outflow of P1.34 billion…The local bourse has been falling in recent weeks, mostly due to the Bangko Sentral ng Pilipinas hinting at fewer interest rate cuts this year, which would mirror the move of the US Federal Reserve.

Philstar.net, June 22, 204: The stock market plunged to its lowest level this year as the peso fell to nearly 20-month low against the dollar. The benchmark Philippine Stock Exchange index (PSEi) lost for the eighth consecutive session, plummeting by 2.93 percent or 186.08 points to end at 6,158.48. This was the PSEi’s lowest level in over seven months or since hitting 6,110.88 in Nov. 15, 2023.

Manila Times, June 22, 2024: THE peso and the stock market ended the week on a sour note with both hitting multi-month lows amid a continued lack of positive catalysts. Analysts said that both the currency and financial markets had taken their cues from each other and that sentiment also remained negative amid continued dollar strength and a tech sell-off on Wall Street.

PNA, June 21, 2024: The local stock market ended the last trading day of the week in the negative territory due to net foreign selling, while the peso closed almost flat. The Philippine Stock Exchange index (PSEi) dropped 186.08 points to 6,158.48, while the broader All Shares also fell 65.11 points to 3,375.20. "The local bourse dropped by 186.08 points (2.93%) to 6,158.48 due to strong net foreign selling, recording a net outflow of P1.34 billion. The market’s new level is its lowest this year and marks its 8th straight day of decline. Additionally, the weakness of the peso against the US dollar continued to weigh on sentiment," Philstock Financials, Inc. research associate Claire Alviar said.

The three wise monkeys: "see no evil, hear no evil, speak no evil"

Isn’t it surprising that there’s NO mention of the escalating West Philippine Sea conflict in media coverage of stocks and the peso? 

Does the rising risk of a full-blown conflict hold any implications for the local financial markets?

Could the chaos — including the death, injury, disability, and destruction of private and public property — even lead to a stock market rally?

It’s incredible to observe that after the media passionately highlighted the knife-toting, boat-ramming, and boat-boarding incident by the Chinese Coast Guard at Ayungin Shoal on June 17, Philippine authorities backpedaled from calling it an "armed attack" that could have triggered the Mutual Defense Treaty (MDT) with the US government, potentially escalating into World War 3.

And yet, the astonishing code of silence by the establishment on its economic and financial impact!

However, foreign investors seem to have taken a different page from local media.

Down by 3.53%, the PSEi 30 suffered its largest weekly decline in 2024, with 83% of this week's deficit attributed to Friday's 2.93% plunge.

Figure 1

This selloff was aggravated by a substantial 1.26% pre-closing dump. (figure 1, topmost pane) 

Friday's meltdown saw a significant outflow of foreign funds, with net selling reaching Php 1.34 billion that represented 48.83% of the week's total outflows. (Figure 1, middle graph)

Foreign money has been selling the PSE in the last 12 of the 13 weeks.

Figure 2

Yet this week's selloff affected most of the 10 largest heavyweights, with the top 5 market caps continuing to decline. (Figure 1, lowest graph) (Figure 2, upper window) 

Could this be the law of mean reversion in motion?

The selloff can hardly be attributed to global developments, as the PSEi 30 suffered the largest weekly deficit among Asian-Pacific stocks. (Figure 2, lower diagram)

Could the weak peso be the culprit?

As earlier noted, the peso's frailty is a long-term trend. Why should concerns over a USDPHP breakout suddenly become an immediate threat to foreign investors?

Moreover, why would foreign funds rush for the exit when the region was experiencing a "fear of missing out" (FOMO) mood?   Eleven of the 19 national indices closed higher, with an average return of 0.44%, while four national benchmarks hit fresh record highs.

In addition to imbalances from market concentration plaguing the PSEi 30, sluggish local volume exacerbated its downside volatility due to panic selling.

Figure 3

Despite a significant boost from cross trades by institutional brokers, the five-month trading volume hit a four-year low, further reinforcing its long-term downtrend. (Figure 3, upper graph)

Once again, dwindling trading volumes increase the risk of a market crash.

Though oversold from Friday’s plunge, which could see a bounce this week, the latest breakdown of the PSEi 30 makes it vulnerable to testing recent lows (5,960 October 27, 2023 and 5,740 September 30, 2022). (Figure 3, lowest chart)

Lastly, media narratives typically focus on either post hoc or availability bias when attributing recently concluded events, but why the blackout on the June 17th Ayungin Shoal incident?

Bottom line: Are authorities assuming that shielding the public from the escalating risk of war will somehow keep the economy and financial markets afloat?

Is censorship making a comeback?

Is the Philippine Peso Immune from the Rising Risk of a Sino-Philippine Military Conflict? Why the Silence over its Risks?

  

The risk of catastrophe will be very high. The nation could erupt into insurrection or civil violence, crack up geographically, or succumb to authoritarian rule. If there is a war, it is likely to be one of maximum risk and effort – in other words, a total war. Every Fourth Turning has registered an upward ratchet in the technology of destruction, and in mankind’s willingness to use it– Strauss & Howe: The Fourth Turning

In this issue

Is the Philippine Peso Immune from the Rising Risk of a Sino-Philippine Military Conflict? Why the Silence over its Risks?

I. Reverse Psychology? Philippine Peso as One of Asia’s Worst Performing Currencies?

II. Blissful Oblivion or Willful Negligence: Is the Philippine Peso Immune to the Growing Risk of a Military Conflict?

III. Asian Currencies in the Shadow of a Strong US Dollar

IV. The Gross International Reserves is no Talisman Against the Uptrend of the USDPHP

V. The BSP’s Increasing "Borrowed Reserves"

VI. The Trickle-Down Political Economy’s Dependence on "Twin Deficits" Depletes FX Buffers

VII. Thinning FX Buffers: Slowing Remittances and Tourism, Debt-dependent FDI, and Volatile Foreign Portfolio Flows

VIII. USDPHP is Driven by the Real Economy; Questioning a War-Hawkish Public and Financial Experts, "You Two Are Discussing the Same Country, Aren't You?"

Is the Philippine Peso Immune from the Rising Risk of a Sino-Philippine Military Conflict? Why the Silence over its Risks?

While the local media is abuzz with the worsening standoff in the territorial dispute between the Philippine government and China, and the Philippine Peso nearing record levels, financial experts are oddly silent about the economic risks involved.

I. Reverse Psychology? Philippine Peso as One of Asia’s Worst Performing Currencies?

Figure 1

Mainstream experts seem more confused than ever about the state of the US dollar-Philippine peso $USDPHP. 

As the $USDPHP approaches a milepost, they appear to be sugarcoating the fragility of the Philippine peso by attributing the peso’s weakness to the divergent policy conditions between the US Federal Reserve and the Bangko Sentral ng Pilipinas (BSP). (Figure 1, topmost image)

They are actually defending the Philippine peso when they allude to the strength of the US dollar, the elevated Gross International Reserves (GIR), and other possible BSP toolkits. 

Using what seems as reverse psychology, a foreign institution even projected that the peso would "become one of Asia’s worst-performing currencies," given the BSP’s ‘dovish’ stance. (Figure 1, middle visual)

Bizarrely, they placed a marker for this: the USDPHP would "hold at 58 per dollar, although it may weaken to as low as 58.60, which would be a few centavos away from the record-low 59 it hit in 2022." 

Amazing. 

The thing is, the news was hardly a projection; it was a description of present events. 

The USDPHP signified the fourth worst currency in Asia (year-to-date), after the Japanese yen $USDJPY, South Korean won $USDKRW, and Indonesian rupiah $USDINR—as of June 21st. (Figure 1, lowest chart) 

By placing a boundary for the "worst in Asia" assumption to hold, it translates to either a positional stasis or that most Asian currencies would do better because of the so-called ‘dovish’ stance of the BSP. 

Figure 2

Ironically, the nominal yield spread between the 10-year Philippine BVAL and US Treasury bonds has been rising in favor of the former.

Operating under the belief of arbitrage opportunities, the consensus thinks that relatively higher (nominal) rates for the Philippine Treasury should favor the peso.

But this dynamic has barely been the case, as a relatively lower Philippine yield has coincided with a strong peso and vice versa from 2019 to Q1 2022. Since then, USDPHP has climbed ahead despite the spread—or the correlation broke from Q2 2022 to the present. (Figure 2, topmost diagram) 

In brief, this loose correlation does not support the popular thesis.

II. Blissful Oblivion or Willful Negligence: Is the Philippine Peso Immune to the Growing Risk of a Military Conflict?

Here is what the Overton Window critically overlooks: the escalating standoff over the territorial dispute between the Philippines and the Chinese government.

Haven't you noticed? The Sino-Philippine West Philippine Sea showdown has been splashed all over mainstream media. Despite this, there is nearly ZERO attribution about it to the Philippine peso or the Philippine economy. This stark contrast underscores the disconnect between the intense diplomatic and military tensions and the lack of insights into its potential economic fallout.

That is to say, while the risks of the Philippines becoming the Ukraine of Asia grows with every confrontation, the consensus oxymoronically sees such risks as non-existent. 

Could they be talking about the Philippines? Why the complete absence of the mounting risks of war?

This seemingly incredible blindness represents either "blissful oblivion" or "willful negligence" over the possible cataclysmic risks from an outbreak of violence. 

As I recently posted on my X (formerly Twitter) account, at the onset of wars, the currencies of those involved—namely the Russian ruble $USDRUB, Ukraine’s hryvnia $USDUAH, and Israel’s new shekel $USDILS—materially fell against the US dollar. (Figure 2, lower image)

That's a blueprint for the Philippine economy that we should expect when water cannons and knives escalate into a shooting battle.

Aside from a possible plunge in the Philippine peso, depending on the scale of war, we can expect a double "deep" recession, a possible stock market crash (if it remains open), rolling brownouts—when power plants become military targets—which means disruptions in digital payments and bank ATM withdrawals, massive disruptions in the division of labor, and the BSP printing more money—which leads to stagflation!

While we earnestly pray that this does not happen, as there are other peaceful options like Vietnam’s "bamboo diplomacy," the Asian version of foreign policy neutrality, it is a risk that every Philippine resident confronts as contending parties to territorial claims remain intransigent and lean on belligerency.

Although we won’t expand further on the geopolitical dimension of the rising risks of a Sino-Philippine military conflict, it's crucial to note that the US dollar-Philippine peso exchange rate is not insulated from these rising tensions. 

My brief two cents on the Philippine government’s turnaround regarding the alleged "armed aggression" of China in an X thread. 

III. Asian Currencies in the Shadow of a Strong US Dollar 

Operating under the de facto US dollar standard, the US and its political, economic, and financial activities overseas have a distinctive impact on the world. 

In addition to the transition away from globalization and domestic politics, geopolitics is another key factor contributing to the recent increasing value of the USD. 

An abrupt rise in the US dollar is often a sign of emerging economic distress.

Figure 3 

Unlike its popular portrayal, the rising value of the USD is not an anomaly. 

Using the US dollar index $DXY as a benchmark, it has been in an uptrend since 2021, supported by a reverse head-and-shoulders pattern. More importantly, the longer-term trend shows a 9-year uptrend. (Figure 3, topmost and second to the highest graphs) 

The $DXY is composed of a weighted basket of developed economy currencies, including the European euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc. 

The uptrend in the USD is evident across several ASEAN currencies, including the Indonesian rupiah $USDIDR, the Philippine peso, the Malaysian ringgit $USDMYR, and the Vietnam dong $USDVND, though it's not shown in the chart. (Figure 3, second to the lowest chart) 

In the long term, however, the USD has underperformed against the Thai baht $USDTHB and Singapore dollar $USDSGD. (Figure 3, lowest window)

Using the mainstream's logic, the Bank of Indonesia (BI) unexpectedly raised rates in April in an attempt to "anchor the rupiah". Despite this move, the $USDIDR pair carved out a milestone high last week. Was the BI's decision still "dovish"? 

The essence lies in the fact that Asian currencies exhibit asymmetric performances that are underpinned by their idiosyncratic or unique domestic conditions. 

A sweeping generalization of a strong USD represents a fallacy of composition.

IV. The Gross International Reserves is no Talisman Against the Uptrend of the USDPHP

Figure 4

More intriguing is the widespread conviction that the country's foreign exchange reserves (GIR) serve as a talisman against the rising US dollar, which appears to be more of a manifestation of faith or defending piety than an analysis based on economic theory and data.

If this belief were valid, then $USDPHP pair would have underperformed. Alternatively, there wouldn’t have been an uptrend in $USDPHP if the GIR had functioned as advertised. (Figure 4, topmost image)

Instead, we see that the GIR fell upon its drawdown by the BSP to defend the peso when the $USDPHP carved a record in 2022.

Ironically, the BSP accelerated its accumulation of GIR in 2019-2020 just at the late stage of the peso's rally.

Since then, it has been a tango for the GIR and USDPHP as both proceeded higher.

Separately, as evident from the BSP's annual balance sheet, the strength of the $USDPHP has coincided with an increasing percentage share of BSP's local currency issuance against its total liabilities. (Figure 4, middle chart)

In short, the primary driver of the USD/PHP's uptrend has been the BSP's money printing operations, not the GIR.

V. The BSP’s Increasing "Borrowed Reserves"

Furthermore, what authorities say is often taken as "gospel truth," with few questioning the numbers behind them.

Let us turn to the GIR. 

The Philippine government borrowed USD 2 billion in early May.

The BSP described the increase in its GIR for the same month as follows: "The month-on-month increase in the GIR level reflected mainly the National Government’s (NG) net foreign currency deposits with the Bangko Sentral ng Pilipinas (BSP), which include proceeds from its issuance of ROP Global Bonds, and net income from the BSP’s investments abroad." (BSP, 2024) 

Subsequently, the BSP also disclosed that its Balance of Payments (BOP) showed a surplus during the same period: "The BOP surplus in May 2024 reflected inflows arising mainly from the National Government’s (NG) net foreign currency deposits with the Bangko Sentral ng Pilipinas (BSP), which include proceeds from its issuance of ROP Global Bonds, and net income from the BSP’s investments abroad." (BSP, 2024)

See that? The BSP admitted that "borrowed reserves" has constituted a part of its GIR and BOP. Hence, the USDPHP ignored them and proceeded higher. (Figure 4, lowest graph)

Figure 5

May’s US dollar borrowings will likely add to the USD 128.7 billion of external debt, which was up by 8.32% in Q1 2024. (Figure 5, topmost graph)

External debt has soared past the BSP’s GIR of USD 104.1 billion for the same period.

Yet, as acknowledged by the BSP, part of external debt has been incorporated into the GIR.

There’s more to consider.

As the Philippines’ April GIR showed, based on IMF’s International Reserves and Foreign Currency Liquidity (IRFCL), the BSP has been selling off its gold reserves and has boosted its use of Other Reserve Assets (ORA).  The BSP’s physical gold reserves last April signified a multi-year low! (Figure 5, middle pane)

Other Reserve Assets comprise financial derivatives, short-term currency loans, repos, and other liquid assets. (IMF, IRFCL)

During the international easy money era, ORA became a feature in the GIR build-up from 2018-2020 and the rally of the peso. (Figure 5, lowest chart)

However, rising costs compelled the BSP to reduce its use in 2022. Nonetheless, the BSP returned to it last April 2024.

The thing is, "borrowed reserves" represent "US dollar shorts," which is attendant with an increasing likelihood of maturity mismatches, especially during times of stress.

Furthermore, "borrowed reserves" will need payment or refinancing. The greater the borrowings, the higher interest payments, refinancing, and principal payments, even in the assumption of steady rates, which translates to increased pressure for organic sourcing of USD revenues.

Otherwise, the economy and government would be forced to continue borrowing externally to meet growing USD liquidity needs, while increasing domestic liquidity, which would amplify the pressure for the Philippine peso to depreciate further. 

VI. The Trickle-Down Political Economy’s Dependence on "Twin Deficits" Depletes FX Buffers 

Given the entrenched "trickle-down" political-economic architecture driving the borrowing-to-spend (to prosperity) paradigm, which has engendered a record savings-investment gap, it is difficult to envision a structural shift in the current dynamics—specifically, a transition away from debt dependence—without a disorderly adjustment. 

Underpinned by Keynesian ideology, the establishment has made little or no effort to promote this essential structural change.

Rather than acknowledging the accruing tradeoffs from transitioning to a centralized political economy anchored in fiscal spending (infrastructure and the war economy) and increasing bureaucratization, the consensus continues to promote the illusion of a consumer-driven economy. 

Figure 6

A strengthening economy would swell trade deficits, given the structural shortcomings in local production, while an acceleration of the fiscal deficit would magnify the credit-financed "twin deficits." 

As evidence, April’s trade deficit expanded as imports grew by 12.6%, driven by increases in capital imports (+10.5%) and consumer goods (+15.7%). (Figure 6, top, middle and lowest chart) 

Therefore, authorities would need to rely on remittances, tourism, service exports, FDIs, foreign portfolio flows, or borrowings to cover the FX deficits.

VII. Thinning FX Buffers: Slowing Remittances and Tourism, Debt-dependent FDI, and Volatile Foreign Portfolio Flows

Figure 7

Despite record-high nominal Overseas Filipino Workers (OFW) remittances last April, their growth rate has been slowing down primarily due to base effects.

Moreover, remittance flows are heavily influenced by global economic conditions, which may face hurdles from increasing barriers to social mobility. For instance, rising economic barriers and increased nationalism are expected to slow OFW flows.

On the other hand, vigorous tourism growth in 2023, fueled by strong domestic "revenge travel" and improved foreign arrivals, appears to have cooled down in 2024.

While FDI flows seem to be improving, the majority of these flows consist of debt. Reported FDI flows were up 23% last March and 42% in the first quarter, with debt accounting for 68% and 62% of the share, respectively.

Intercompany debt infusions do not guarantee genuine investments. Instead, they expand the USD shorts.

Additionally, taking sides in the geopolitical hegemonic contest could deter investors, making politics rather than markets the determinant of investment flows.

Meanwhile, volatile flows from foreign portfolio exposure cannot be relied upon to boost demand for the peso. This is primarily due to the structural inadequacy of the capital markets' depth (PSE and the fixed income market), which remain dominated by the elites.

Another fundamental reason is that portfolio flows are heavily dependent on global risk conditions.

Lastly, services exports appear to be the remaining hope to cushion the peso via USD revenues. So far, the industry is said to be on track to meet its growth targets this year.

However, any slowdown in this sector would exacerbate USD funding pressures.

VIII. USDPHP is Driven by the Real Economy; Questioning a War-Hawkish Public and Financial Experts, "You Two Are Discussing the Same Country, Aren't You?" 

It is clear that the USDPHP has not been primarily driven by BSP-FED policy divergence but by real economic factors, including the BSP’s domestic monetary operations. 

If the current arrangements have resulted in thin buffers, imagine what an outbreak of military conflict would do. 

The striking divergence between a war-hawkish leaning public and the absence of discussion about its risks in the domestic financial sphere reminds me of the glaring disparity in the fact-finding report by two of former US President John F. Kennedy's foreign policy advisors, Victor Krulak and Joseph Mendenhall, on Vietnam. President Kennedy reportedly asked both, "You two did visit the same country, didn't you?" 

Paraphrasing Kennedy and alluding to local media and domestic financial experts, "You two are discussing the same country, aren't you?"

_____

References: 

Bangko Sentral ng Pilipinas, End-May 2024 GIR Level Rises to US$104.48 Billion June 7, 2024, bsp.gov.ph 

Bangko Sentral ng Pilipinas, BOP Posts US$2.0 Billion Surplus in May 2024; End-May GIR Rises to US$105.0 Billion June 19, 2024 bsp.gov.ph

International Monetary Fund, INTERNATIONAL RESERVES AND FOREIGN CURRENCY LIQUIDITY GUIDELINES FOR A DATA TEMPLATE, p.25 imf.org