Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession!

 

The total wealth of a country is the total value of goods and services it produces. When real estate prices rise much faster than this value, there has effectively been a large wealth transfer from those who don't own real estate to those who do—Michael Pettis 

In this issue: 

Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession!

I. Q3 2024: Philippine Real Estate Sees First Deflationary Spiral Since the Pandemic Recession! 

II. A Brief Insight into the Differences Between Pandemic-Recession Real Estate Deflation and Today’s Economic Landscape 

III. Despite Declines in New Housing Loans, Total Real Estate Consumer and Supply-Side Loans Surge, Unaffected by High Cap Rates 

IV. Real Estate’s Falling GDP Contribution and Increased Bank Lending Share Point to Heightened Concentration Risks 

V. Q3 2024 Real Estate Deflation Means Lower Sectoral and National GDP; Slower Retail Sales Amidst Greater Supply Side Expansion Translates to More Vacancies 

VI. Real Estate Deflation Amidst Near Full-Employment? What Happens When Unemployment Soars? 

VII. Property Sector Woes: From Price Deflation to Income Losses and Increased Debt Loads 

VIII. Property Sector Woes: From Liquidity Strains to Soaring Bank NPLs? 

IX. Will the BSP Launch QE 2.0 Soon? 

X. Conclusion: Two Ways to Bankruptcy: Gradually, then Suddenly

Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession! 

Philippine real estate prices experienced their first deflationary spiral in Q3 2024 since the pandemic recession, highlighting worsening imbalances in the sector. We explore the potential economic implications and possible policy responses. 

I. Q3 2024: Philippine Real Estate Sees First Deflationary Spiral Since the Pandemic Recession!

The Philippine consumer economy is hurting—and hurting badly. 

This pain is being reflected across several fronts, including the country’s most popular investment: real estate. 

Businessworld, December 30: HOUSING PRICES nationwide declined in the third quarter, the first contraction in over three years, data from the Bangko Sentral ng Pilipinas (BSP) showed. The Residential Real Estate Price Index (RREPI) fell by 2.3% year on year in the July-to-September period. This was a reversal of the 2.7% growth in the second quarter and 12.9% expansion in the same period a year ago. This was also the first time the RREPI posted a decline since the 9.4% drop recorded in the second quarter of 2021. (bold added)

And more news excerpts (all bold mine)

GMANews.com December 12, 2024: The oversupply of condominium units has shot up to an equivalent of 34 months as of November amid the sudden increase in availability of units, according to data released by Leechiu Property Consultants (LPC)… There were 4,971 new units launched in October and November, versus the 4,375 units sold during the period. Year-to-date, condominium take up was recorded at 25,565 units, equivalent to 63% of that recorded in the comparable period of 2023 while project launches stood at 13,226 or half of the previous year. Golez earlier also noted that the oversupply was due to a mix of high interest rates and external concerns, as well as a shift in preference to single-detached homes and properties in nearby provinces. 

Inquirer.net November 16, 2024: Vacancies in Metro Manila’s prime and grade A office market hit a 20-year high as of the end of the third quarter this year, with rental rates declining for the fourth straight quarter. A report from global commercial real estate services firm Cushman and Wakefield puts the average office vacancy rate at 18.2 percent, the highest since the second quarter of 2004. “The Metro Manila office market is exhibiting a slower-than-expected recovery in Q3 2024,” Cushman & Wakefield director and head of tenant advisory group Tetet Castro said in a statement.

Businessworld, November 12, 2024: DEMAND for office space outside Metro Manila has been “less robust” as office occupiers now have smaller space requirements, real estate services firm JLL Philippines said. “After the pandemic, I think the demand has weakened in general because for the key cities outside Metro Manila like Cebu and Iloilo, we’re still seeing a bit of takeup, but for the other peripheral areas, it’s not as robust anymore,” JLL Philippines Head of Research and Strategic Consulting Jan-Loven C. de los Reyes said at a briefing last week…

Businessworld, October 30, 2024: THE OFFICE VACANCY rate in Metro Manila is projected to reach 20.5% by the end of the year, driven by the influx of new office space and the departure of Philippine offshore gaming operators (POGOs), according to property consultancy firm Colliers Philippines…As of the end of the third quarter, Colliers data showed that office space vacancy rose to 18.6% from 18.3% the previous quarter due to space resulting from POGO lease terminations and non-renewal of pre-pandemic leases.

My Initial Insights: 

1. Polls indicate that the challenges faced in Q3 are likely to extend throughout the rest of 2024 and beyond. 

2. Mounting mismatches between weakening demand and rising supply have led to either increasing vacancies or a glut. 

3. Even the most bullish industry advisors have been forced to admit or confront the harsh reality facing the sector. However, they often put on a cosmetic face or a polished façade, promoting hope of recovery with little explanation beyond reliance on GDP growth. 

4. While real estate prices may seem "sticky," they are actually sensitive to liquidity and interest rates. Consequently, price declines reflect intensifying liquidity strains. In other words, vacancies have drained liquidity from many leveraged landlords and real estate owners, forcing them to sell properties at lower prices. 

5. The inflationary boom has morphed into a deflationary bust, where fear has replaced greed. 

6. Mainstream thinking has consistently overlooked the root of the issue: trickle-down policies that foster a "build-and-they-will-come" ideology, relying on the assumption of perpetual credit-driven demand fueled by low inflation and interest rates-or an everlasting regime of easy money.

Although we have been addressing this topic for some time, I will be quoting extensively from my May 2023 article: (bold and italics original)

There has been little realization that the industry has invested primarily in the foundation of the so-called "integrated community structure," anchored on urbanization and its extension of "satellite communities." 

Espousing the contortion of Say's Law, "supply creates its own demand," through "build and they will come," the race to build became the industry’s bedrock. 

Yet, the dynamic preference of consumers became one of the challenges of this model. 

And so, influenced by digitalization and pandemic policies, the transformation to hybrid/remote work has rendered a massive "sunk cost" or capital decumulation—signified by oversupply.  

… 

The thing is, though office spaces are the concern here, all other segments of the property sector constitute part of such "integrated communities," which therefore extrapolates to interconnection.  

By extension, it also means that the paradigm of "integrated community" is codependent not only on the vibrancy of the office properties but also residential, shopping malls, hotels, logistics and commercial hubs, and other related structures.   

Indeed, the dilemma of the office segment, the weakest link of the commercial real estate sector (CRE), should spread to other areas. 

Aside from the misallocation of capital, financing these imbalances through debt signifies a double whammy or the acceleration of capital consumption. 

The point having been made, these clusters of entrepreneurial errors are products of the distortion of money via the BSP's easy money regime. 

II. A Brief Insight into the Differences Between Pandemic-Recession Real Estate Deflation and Today’s Economic Landscape

Here’s a deeper dive into this developing seismic event.

The first article noted: "This was also the first time the RREPI posted a decline since the 9.4% drop recorded in the second quarter of 2021."

Figure 1

The last time deflation plagued the BSP’s Real Estate Price Index was in Q3 2020 (-0.4%), Q1 2021 (-4.2%), and Q2 2021 (-9.4%).  (Figure 1, upper window)

However, the difference between then and now is that policymakers responded to the pandemic-induced economic shutdown that led to five consecutive quarters of GDP contraction—a full-blown recession with aggressive measures.

Authorities reacted to this unprecedented disruption with a record fiscal deficit. Simultaneously, the BSP flooded the banking system with a historic Php 2.3 trillion of liquidity, aggressively cut interest rates to historic lows (2% from November 2020 to April 2022), significantly reduced the banking system’s Reserve Requirement Ratio (RRR) from 14% to 12%, implemented unprecedented capital, operational, and regulatory relief measures and subsidies, and placed a cap on the US dollar-Philippine peso exchange rate. The Finance Chief even ordered the SSS and GSIS to buy stocks and support the PSEi 30. 

All these collective actions were taken to prevent credit deflation and support collateral values—which back bank-issued loans—by reflating the bank-dominated financial system.

Fast forward to today, there has been no recession yet. Despite elevated interest rates, bank credit flows have been oozing.

III. Despite Declines in New Housing Loans, Total Real Estate Consumer and Supply-Side Loans Surge, Unaffected by High Cap Rates

Still, the RREPI fell into deflationary territory, led by properties in Metro Manila, which posted a 14.6% contraction—the second-largest decline since the 18.3% shrinkage in Q2 2021. (Figure 1, lower chart)

Areas outside the National Capital Region (AONCR) have experienced a sharp slowdown but remain on a growth path. 

Importantly, AONCR was barely affected by deflation during the pandemic era. Given the recent dynamics, it might not be exempt this time.

Figure 2

The BSP tacitly attributed this turn of events to the shrinking demand for new housing loans. (Figure 2, topmost table)  

In Q3 2024, the number of residential real estate loans (RRELs) granted for all types of new housing units in the Philippines contracted by 15.7 percent y-o-y. Specifically, loans granted in the NCR and AONCR decreased by 20.3 percent and 13.0 percent, respectively. Notably, the double-digit y-o-y contraction in RRELs in the Philippines, NCR, and AONCR in Q3 2024 was significant, yet not as severe as the decline in housing loan availment observed during the pandemic, which began in Q2 2020. (BSP, 2025) [bold added] 

However, a mere lack of demand for new loans is insufficient to cause a contraction. 

Nevertheless, theoretically, since real estate prices are duration-sensitive and influenced by changes in long-term interest rates, these shifts also impact capitalization rates (cap rates), which in turn affect property values.

Rising interest rates typically lead to higher cap rates, as investors demand a higher return to compensate for the increased cost of borrowing and the higher risk associated with interest rate changes. 

Consequently, higher cap rates generally lead to lower property values, as expected returns must adjust to match the new rates. Therefore, the adverse impact of higher cap rates on property values translates to diminished demand from investors. 

Notwithstanding the contraction in new property consumer loans, aggregate real estate consumer loans hit a record high of Php 1.061 trillion in Q3, although its growth rate fell from 13.5% in Q2 2024 to 8.07%. (Figure 2, middle graph) 

On the supply side, real estate bank loans reached a record Php 2.686 trillion in Q3 2024, with quarterly YoY growth accelerating from 3.86% in Q2 2023 to 13.9% in Q3 2024. 

In aggregate, total bank loans (net of interbank lending) rose to a record Php 13.24 trillion, with quarterly YoY growth also accelerating over the past five quarters. 

Thus, higher cap rates were hardly a factor; instead, the vibrant growth in supply-side bank lending likely contributed to more "build-and-they-will-come" supply. 

IV. Real Estate’s Falling GDP Contribution and Increased Bank Lending Share Point to Heightened Concentration Risks 

Furthermore, reports like this can be misleading: "Banks’ real estate exposure ratio dropped to 19.55% at end-September from 19.92% at end-June and from 20.55% at the end of September 2023—the lowest real estate exposure ratio recorded in five years, or since the 19.5% level as of September 2019." 

This is because the data on Real Estate Loans (REL) as a share of the Total Loan Portfolio (TLP) can signify many things. In this instance, the decline in REL/TLP is not primarily due to banks lending less to the sector or becoming more judicious or cautious. Rather, banks have been lending more aggressively to other sectors, particularly consumer credit cards and salary loans. 

In the realm of consumer loans, the share of real estate loans fell from a record high of 45.06% in Q4 2021 to 36.4% in Q3 2024, despite record peso real estate consumer loans. The 8.6% gap was filled by credit cards, which increased their share from 22.3% in Q4 2021 to 29% in Q3 2024. (Figure 2, lowest diagram) 

Meanwhile, the share of salary loans jumped from 8.3% to 13.22% over the same time frame. 

In statistics, there are many ways to "skin a cat." 

Unless funds are designated through escrow accounts, banks have virtually no control over how loan proceeds are spent. Some of the credit card and salary loans—or even loans declared for production purposes—could have been diverted to real estate mortgage payments, property purchases, or even stock investments. 

The fact that real estate credit growth remains buoyant suggests that most of the borrowed money may have been used for refinancing, with modest amounts allocated to acquiring second-hand properties (for consumer loans) and for property development expansion (supply-side loans). 

This also tells us that while new buyers played a smaller role in borrowings, more experienced buyers and property developers significantly contributed to the sector’s bank borrowings. 

On this note, despite lackluster growth, the real estate sector’s relative strength—compared to the overall weaker performance of other sectors—prompted a surge in its share of GDP in Q3 2024. 

The value-added contribution of the sector, which posted a 5.4% real GDP growth, amounted to 5.9% of national GDP. 

In the meantime, the real estate sector’s share of Universal-Commercial bank portfolios amounted to 20.46% in Q3.

Figure 3

Thus, a sector contributing 5.9% of GDP holds a 20.5% share of UC bank portfolios—representing significant concentration risks. (Figure 3, topmost chart)

Notably, this is based on the official definition of the banks’ real estate portfolios, whose actual exposure may already be understated. 

V. Q3 2024 Real Estate Deflation Means Lower Sectoral and National GDP; Slower Retail Sales Amidst Greater Supply Side Expansion Translates to More Vacancies

Of course, we’d also argue that the price deflation in Q3’s RREPI, which indicates slower spending across the industry, means less than the advertised GDP. Again, the sector reported 8.8% nominal GDP and 5.4% real GDP. (Figure 3, middle image) 

A lower real estate GDP should shave off a few more percentage points from Q3’s GDP of 5.2%. 

But here’s another potential discrepancy: According to the BSP, buyers of new properties have been less influential in driving demand for real estate. 

In particular, condominium prices plummeted by 9.4% in Q3 2024—the third largest of the five quarterly contractions from 2020 to the present. 

However, as a proxy, the performance of the top five listed developers (SM Prime, Ayala Land, Megaworld, Robinsons Land, and Vista Land) tells a different story. Their Q3 2024 real estate sales surged by 19.76% YoY, suggesting no signs of retrenchment in new property sales. 

This raises a critical question: Were the BSP numbers inaccurate, or have property developers been overstating their real estate sales? (Figure 3 lowest graph) 

As a side note, the property sales of the top five developers are not limited to residential condos; however, the comparison provided is for estimation purposes only.

Figure 4

But there’s more. 

The slowing rental income growth of the top four developers (SM Prime, Megaworld, Robinsons Land, and Vista Land) appears to align with the moderating revenue growth of the top six non-construction retail chains (SM Retail, Puregold, Robinsons Retail, Metro Retail, SSI Group, and Philippine Seven).  (Figure 4, topmost diagram)

In Q3, rental income for developers increased by 7.12%, while retail chains saw 6% growth. Both figures peaked in 2022 (Q2 and Q3, respectively) and have been on a downtrend since. 

This slowdown also reflects the growing mismatch between sales growth rates and the expansion of selling areas for retail chains and shopping malls, which has resulted in increasing vacancies. 

VI. Real Estate Deflation Amidst Near Full-Employment? What Happens When Unemployment Soars?

Intriguingly, despite unprecedented consumer bank borrowing rates and levels, the data signals intensifying signs of strained consumers—despite the supposedly near-full employment rate. (Figure 4, middle window) 

This also suggests that either the government’s labor data has been significantly stretched, or that consumers are increasingly burdened by the sustained loss of purchasing power in their wages and incomes, or by escalating balance sheet leverage. 

Worst of all, it could be both. 

What happens when the employment rate falls? 

Even more important, what happens when consumer credit slows or even retreats?

VII. Property Sector Woes: From Price Deflation to Income Losses and Increased Debt Loads 

Of course, deflation in the industry translates to weakened demand.

While property firms may attempt to mask this through possible overstatements of sales, internal pressures—such as diminishing liquidity, rising debt burdens, and increasing servicing costs—are likely to result in the eventual emergence of losses. 

When deflation gripped the industry in 2020–2021, the top five developers recorded net income losses over four quarters.(Figure 4, lowest chart) 

Currently, while net incomes are at all-time highs, their growth rate has been eroding.

Figure 5

Furthermore, debt levels continue to climb to record highs, accompanied by rising interest rate expenses. On the other hand, cash reserves have recently dropped and stagnated. (Figure 5, topmost and middle graphs) 

Coming down the pike, the likelihood of income deficits combined with a drain in business liquidity may result in even greater reliance on debt financing to sustain operations—even as collateral values deteriorate. 

If these developments have already impacted the top five developers, what more for marginal industry players—the mom-and-pop operators? 

VIII. Property Sector Woes: From Liquidity Strains to Soaring Bank NPLs?

Considering that banks hold significant exposure to real estate, the next phase will likely result in a surge in non-performing loans (NPLs). 

When deflation engulfed the sector in 2020-2021, real estate consumer NPLs surged and continued to rise even when the RREPI index peaked at 14.1% in Q2 2023. (Figure 5, lowest chart) 

NPLs hit a record Php 21.7 billion in Q2 2024 but slightly declined to Php 21.28 billion in Q3 2024. 

Due to credit expansion outpacing NPL growth, these numbers have been obscured as a function of ratios. They will likely become more prominent once credit expansion materially slows. 

Or what is likely to follow, after mounting losses and the depletion of liquidity, is a rise in NPLs—starting with smaller players and gradually affecting larger industry participants, in a "periphery-to-core" dynamic. 

IX. Will the BSP Launch QE 2.0 Soon?

In addition to surging public debt, the RREPI Q3 2024 deflation provides context for the BSP’s recent actions, which mirror a shadow of the pandemic recession playbook. These include the reduction of the Reserve Requirement Ratio (RRR) from 9.5% to 7%, effective October 2024, and the ongoing easing cycle, marked by the second and third interest rate cuts in the ONRRP in Q4 2024.

Furthermore, it explains the record-high 11-month public expenditures, reflecting the "Marcos-nomics" fiscal stimulus aimed at offsetting the decline in private sector demand.

Figure 6 

These policies have combined to momentarily bolster liquidity, which had been eroding from 2021 to 2023, as reflected in the YoY changes in M1. (Figure 6, topmost visual) 

Lastly, the Php 2.3 trillion injections by the BSP were partly channeled through its net claims on the central government (NCoCG). 

Interestingly, despite the supposed economic normalization, the BSP’s NCoCG remains elevated, prompting the IMF to request that the BSP become more transparent about its "balance sheet strategy." 

For instance, notes Inquirer.net, "the IMF said the BSP may want to publish more information about the size of its portfolio of government securities (GS), which remains 'substantial' despite declining since the central bank’s large purchases of state bonds during the COVID-19 pandemic." 

The BSP’s NCoCG stood at Php 650 billion as of November 2024, which is vastly above its 2002-2019 monthly average of Php 32.7 billion. (Figure 6, middle chart)

The BSP also holds Php 1.178 trillion worth of domestic securities (as of September 2024), accounting for 14.6% of its total portfolio. (Figure 6, lowest graph) 

The essence here is that by partly maintaining its quantitative easing (QE), the BSP remains heavily involved in controlling liquidity conditions in the banking system, where the real estate industry represents a significant counterparty.

This signifies the 'ratchet effect theory' in action, where temporary solutions to address specific problems become a permanent part of the legal landscape. (Matulef, 2023)

The Php 64 trillion question is: should current developments in the real estate sector deteriorate, would the BSP launch QE 2.0?

X. Conclusion: Two Ways to Bankruptcy: Gradually, then Suddenly

All told, despite the profusion of liquidity and the embrace of easy money policies, deflation in the Philippine real estate industry has emerged and could worsen.

This highlights the widening mismatch between vigorous debt-financed supply-side growth and weakening consumer demand—primarily driven by the erosion of the peso's purchasing power and the extended balance sheet leverage resulting from trickle-down policies, including the crowding-out effect. 

Although the challenge for policymakers would be to allow market forces to take command—cleansing household, corporate, and government balance sheets while rebuilding savings through productive undertakings—this would translate to a vastly diminished GDP and, more importantly, reduced political boondoggles. As such, this route is unlikely to occur. 

Nonetheless, authorities are likely to "fight the last war" by pursuing path-dependent, free-money policies aimed at boosting aggregate demand and GDP, while ignoring all other factors. 

Lastly, because the consensus believes these trends represent a temporary phenomenon, isolated from the pandemic's events and previous easy money policies, the "build-and-they-will-come" mentality is likely to prevail, driving an even greater debt-financed "race-to-build supply"—thereby exacerbating existing imbalances. 

As American novelist Ernest Hemingway wrote in The Sun Also Rises:

"How did you go bankrupt? Two ways. Gradually, then suddenly."

___

References: 

Prudent Investor, Philippine Real Estate:Mainstream Expert Worried Over Increasing Demand-Supply Gap; Q1 2023 Data ofTop 5 Listed RE Firms and the Property Index, May 28, 2023  

Bangko Sentral ng Pilipinas, Residential Real Estate Prices Decline in Q3 2024, December 27, 2024, bsp.gov.ph  

Michael Matulef, Beyond Crisis: The Ratchet Effect and the Erosion of Liberty August 18, 2023, Mises.org  

Ernest Hemingway, The Sun also Rises Chapter 13, 1926 Project Gutenberg Canada

How the BSP's Soft Peg will Contribute to the Weakening of the US Dollar-Philippine Peso Exchange Rate

 

Balance of payments crises are created in (soft) pegged arrangement because the monetary authority simultaneously targets both the exchange rate and interest rate and fails on both counts—Steve Hanke 

In this issue

How the BSP's Soft Peg will Contribute to the Weakening of the US Dollar-Philippine Peso Exchange Rate

I. Closing 2024: Major Interventions Boost the Philippine Peso and PSEi 30

II. A Brief History of the USDPHP's Soft Peg

III. USDPHP Peg: Tactical Policy Measures: Magnifying Systemic Risks

IV. The Cost of Cheap Dollars: Financing Challenges and Soaring External Debt

V. USDPHP Peg: The Other Consequences

How the BSP's Soft Peg will Contribute to the Weakening of the US Dollar-Philippine Peso Exchange Rate 

The Philippine peso mounted a strong rally in the last week of 2024, a hallmark of the BSP's defense of the USDPHP soft-peg regime. Why such policies would boost it past 60! 

I Closing 2024: Major Interventions Boost the Philippine Peso and PSEi 30

In the last week of December, I proposed in a tweet that the BSP and their "national team" cohorts might engage in "painting the tape" to boost Philippine asset prices during the final two trading sessions of the year.  

The BSP and their Philippine "national team" have 2 days left in 2024 to steepen Treasury markets, limit $USDPHP gains, and boost #PSEi30 returns after Friday's massive 5 minute pre-closing pump (correction: should have been Monday instead of Friday)

Figure 1 

This post turned out to be prescient. The "national team" apparently didn’t allow any major corrections on the PSEi 30 following Monday’s powerful 5-minute pump, subsequently, following it up with another two-day massive pre-closing rescue pump. (Figure 1, topmost charts)

However, the USD Philippine peso exchange rate (USDPHP) market exhibited even more prominent interventions. Despite the USD surging against 19 out of 28 pairs, based on Exante Data, the Philippine peso stood out by defying this trend, delivering the most outstanding return on December 26th. It was a mixed showing for the other ASEAN currencies. (Figure 1, middle table)

On that day too, the USDPHP traded at its lowest level from the opening and throughout the session, with depressed volatility—a clear indication of an intraday price ceiling set by the market maker, or possibly the BSP. (Figure 1, lowest graph)

By the last trading day of the year, the USDPHP weakened further, resulting in an impressive 1.64% decline over three trading sessions!

Figure 2

Notably, the Philippine peso emerged as the best-performing Asian currency during the final trading week of the year. Still, the USDPHP delivered a 4.47% return compared to the PSEi 30’s 1.22%. (Figure 2)

Figure 3

Over the past 12 years, the USDPHP has outperformed the PSEi 30 in 9 of them. Given its current momentum, this trend is likely to persist into 2025. (Figure 3, upper chart)

It is crucial to understand that such price interventions are not innocuous; they have lasting effects on the market and the broader economy.

II. A Brief History of the USDPHP's Soft Peg

The BSP employed a ‘soft peg’ or limited the rise of the USDPHP back in 2004-2005 (56.4 in 2004 and 56 in 2005).  (Figure 3, lower image)

Because of the relatively clean balance sheet following the post-Asian Crisis reforms, the BSP seemed successful—the peso rallied strongly from 2005 to 2007.

Despite the interim spike in the USDPHP during the Great Financial Crisis (GFC), it fell back to the 2007 low levels in 2013. This episode marked both the culmination of the strength of the Philippine peso and its reversal: the 12-year uptrend for the USDPHP.

Figure 4

Thanks to the expanded deployment of new tools called Other Reserve Assets (ORA), the BSP managed to generate substantial gains for the Philippine peso from 2018 to 2021. (Figure 4, upper window)

ORA includes financial derivatives (forwards, futures, swaps, and options), repos, and other short-term FX loans and assets.

However, this did not last, as the BSP launched a multi-pronged bailout of the banking system in response to the pandemic recession. The bailout comprised Php 2.3 trillion in injections (Quantitative Easing via Net claims on Central Government), aggressive RRR cuts, historic interest rate reductions, and various capital and regulatory relief measures, including subsidies. (Figure 4, lower diagram)

The USDPHP soared by about 5.4% from its 2004-2005 cap to reach the 59 level, marking the second series of its soft peg.

The USDPHP hit the 59 level four times in October 2022.

This second phase of USDPHP soft peg signified a part of the pandemic bailout measures.

Fast forward today, as the BSP maintained its implicit support via relatively elevated net claims on central government (NCoCG), the USDPHP’s 2023 countertrend rally was short-lived and rebounded through June 2024.

Promises of easy money from both the US Fed and the BSP sent a risk-on signal for global assets, including those in the Philippines sent the USDPHP tumbling to its low in September 2024.

Unfortunately, renewed signs of ‘tightening’ sent it re-testing the 59 levels three times in November-December 2024.

In short, despite recent interventions to maintain the 59 level, the numerous attempts to breach it signal the growing mismatch between the BSP’s soft peg and market forces.

III. USDPHP Peg: Tactical Policy Measures: Magnifying Systemic Risks

Yet, the BSP’s upper band limit signifies a subsidy on the USD or a price distortion that undervalues the USD while simultaneously overvaluing the peso.

This policy impacts the economy in several significant ways.

Widening Trade Deficit: First, the cap widens the trade deficit by making imports appear cheaper and exports more expensive. An artificial ceiling exacerbates imbalances stemming from the historical credit-financed savings-investment gap.

Figure 5

It is no surprise that the trade deficit hit its all-time high in the second half of 2022 as the BSP cap went into effect.

Meanwhile, in October 2024, the trade deficit reached its third highest on record, following the USDPHP run-up through June 2024 with a quasi-upper band limit of 58.8-58.9. The USDPHP hit the 59 level twice in October. (Figure 5, upper chart)

Reduced Tourism Competitiveness: Second, an artificially strong peso (due to the cap) could make the Philippines a more expensive destination for tourists. This could reduce the country’s competitiveness in the tourism sector, ultimately impacting tourism revenue negatively.

Resource Misallocation: Third, prolonged price distortions lead to resource misallocations. In the short term, an overvalued currency might fuel consumption-driven growth due to cheaper imports. However, businesses may over-import because of the cheap USD, while exporters face challenges, with some potentially shutting down, resulting in job losses.

Over time, this could lead to overinvestment in import-related and dependent sectors while underinvestment could spur declining competitiveness in exports and tourism-related industries. These represent only the first-order effects.

The intertemporal ripple effects extend through supply and demand chains, compounding the long-term economic impact.

Inflation Risks: Fourth, the policy could exacerbate domestic inflation. While one goal of the cap is to suppress rising import costs, dwindling reserves make defending the cap increasingly difficult. Once reserves are depleted, the risk of abrupt devaluation grows, potentially defeating the policy’s original purpose.

Reduced Foreign Direct Investment (FDI): Fifth, pricier peso assets and heightened inflation risks translate to higher ‘hurdle rates’ for Foreign Direct Investments (FDI). This diminishes competitiveness and results in slow or stagnant FDI inflows, hindering long-term economic growth. Since peaking in December 2021, FDI flows have been stagnating and have shown formative signs of a downtrend since falling most last September 2024. (Figure 5, lower graph)

Increased Market Volatility: Sixth, the artificial ceiling could inadvertently magnify market volatility. Although designed to maintain stability, the widening misalignment between the USDPHP and economic fundamentals may prompt speculative pressures. If markets perceive the cap as unsustainable, the result could be a destabilizing devaluation. 

Capital Flight and Financial Instability: Finally, the growing perception of an imminent, sharp devaluation might spur capital flight from prolonged price controls, increasing the risks of financial instability. 

The Long-Term Costs of Short-Term Policies: Tactical policy measures, such as an artificial cap, magnify risks over time. These stop-gap measures are not "free lunches." Instead, they increase economic inefficiencies, contribute to stagnation, and amplify systemic risks. 

IV. The Cost of Cheap Dollars: Financing Challenges and Soaring External Debt 

On top of that, there is the critical issue of financing. 

>By keeping the dollar artificially cheap, authorities ENCOURAGE USD debt accumulation. This policy may amplify medium- to long-term vulnerabilities, particularly in the face of rising global interest rates or a stronger dollar. 

>Depleting Reserves and Surging External Debt: The artificial ceiling requires substantial central bank intervention through the use of foreign reserves. However, prolonged interventions deplete these reserves and may compel the government to borrow externally to replenish them, thereby increasing public debt. 

Unsurprisingly, external debt soared in Q3 2024. 

What’s more, since the National Government’s (NG) net foreign currency deposits with the BSP include proceeds from the NG's issuance of ROP Global Bonds, external debt inflates the BSP’s Gross International Reserves (GIR).

Figure 6 

Still, the level and growth of Q3 external debt continue to outpace the GIR. (Figure 6, topmost image) 

As a side note, GIR fell by USD 2.6 billion to USD 108.5 billion last November.

>Increasing Refinancing and Liquidity Strains:

As I recently noted, 

rising external debt compounds the government’s predicament, as the lack of revenues necessitates repeated cycles of increased borrowing to fund gaps in the BSP-Banking system’s maturity transformation, creating a "synthetic US dollar short." (Prudent Investor, November 2024)

Increasing requirements for refinancing have only magnified the US dollar shortage, amplifying a race to borrow that heightens the risk of abrupt exchange rate adjustments or repayment shocks.

Additionally, banks (+34.14% YoY) and non-financial institutions (+5.5%) have also been ramping up their external debt. However, government borrowings (+18.7%) continue to outpace those of the private sector (in mil USD). (Figure 6, middle diagram) 

>Growing Short-Term Debt Concerns: Worse yet, while the BSP describes the present growth pace of external debt as "sustainable," short-term external debt has hit a record, and its share of the total has also expanded in Q3. (Figure 6, lowest window) 

The rapid rise in short-term debt is a symptom of mounting US "dollar shorts" or developing liquidity strains, which are likely to be magnified by the BSP’s caps. 

>Rising Debt Crisis Risk: Although one implicit objective of maintaining a USDPHP cap is to artificially lower the cost of debt servicing, the removal of this cap or an eventual devaluation could cause the cost of servicing foreign-denominated debt to skyrocket in local currency terms, potentially triggering a debt crisis. 

Figure 7

Eleven-month debt servicing costs have already hit a record (compared with same period and against the annual), partly due to the increasing share of foreign-denominated debt. Imagine where these costs would land if the USDPHP exchange rate breaches the 60 level!

V. USDPHP Peg: The Other Consequences

And that’s not all. 

The artificial peg may lead to additional consequences:

>Moral Hazard: Economic actors might engage in risky financial behavior, such as excessive USD borrowing, expecting government intervention to shield them from losses by perpetually maintaining a cheap dollar policy.

>Policy Tradeoffs: The BSP’s prioritization of exchange rate stability could worsen imbalances brought about by past and present monetary policy stances.

>Black Market Emergence: As USD supply becomes restricted due to prolonged interventions, a parallel or black market for the dollar may emerge.

>Social Inequality: The benefits of an artificially cheap dollar often skew toward wealthier individuals, who gain access to inexpensive foreign goods and international investment opportunities. In contrast, low-income households may face rising prices for basic goods—especially domestically produced ones—because local producers struggle with higher input costs or reduced competitiveness. 

>Economic Inequality: Moreover, such policies disproportionately favor certain groups, such as importers or holders of foreign currency-denominated assets (and related industries), and USD borrowers, at the expense of others, including exporters, local producers and savers.

>Trade Relations and Currency Manipulation Risks: A significant trade deficit driven by an undervalued dollar could strain trade relationships, potentially inviting retaliatory measures from trading partners or complicating trade negotiations. 

In extreme cases, accusations of "currency manipulation" could lead to sanctions by organizations such as the WTO. These sanctions might allow affected countries to impose tariffs on imports from the Philippines. 

All these factors point to one conclusion: the USDPHP is likely headed past 60 soon.

____

References

Prudent Investor US Dollar-Philippine Peso Retests Its All-Time High of 59, the BSP’s "Maginot Line": It’s Not About the Strong Dollar November 25, 2024