3Q CPI Fall to 42-Month Low as Divergences in Component CPIs Widen; Flawed CPI—the Shakey’s Pizza Evidence

Outside show is a poor substitute for inner worth—Aesop

In this issue

3Q CPI Fall to 42-Month Low as Divergences in Component CPIs Widen; Flawed CPI—the Shakey’s Pizza Evidence

-Clashing CPI CORE CPI Outlook: CPI Signals Downside Pressure, CORE Indicates Bottom

-Food and Transport Deflation! Have Consumers Stopped Eating and Moving About?

-Rice Under the Shadow of The Law of Supply; Weak Food Demand and Not a Supply Glut

-Restaurant CPI’s Record Divergence with Food CPI

-Flawed CPI: The Shakey’s Pizza Evidence, T-Bills Defy the CPI

3Q CPI Fall to 42-Month Low as Divergences in Component CPIs Widen; Flawed CPI—the Shakey’s Pizza Evidence

With the government’s statistical inflation, the CPI, falling to .83%, a 42-month low, the administration held its victory lap to claim that “sound and working policies” had been responsible for it. Meanwhile, the Bangko Sentral ng Pilipinas forecasted that “inflation has likely bottomed out” in October, which the consensus agreed.

Clashing CPI CORE CPI Outlook: CPI Signals Downside Pressure, CORE Indicates Bottom

Because the CPI is a politically sensitive statistic, promoting the National Government’s agenda maybe an unstated objective behind its construction.

Such an agenda includes embellishing the National Accounts or GDP statistics intended to promote the political capital of the incumbent administration engineered to influence the market prices for the NG to obtain cheap financing from the public for its boondoggles.  

And because the CPI attempts to create one-size fits all or an aggregated number from a complex network of interdependent disparate individuals, operating on distinct and shifting perceptions, ever-dynamic preferences, and that drive their actions, it is nothing more than a meaningless statistic.

Primarily because of the deflation in rice prices, which in the statistical basket constitutes the largest component with a 9.57% share, the headline CPI has dropped to this level.

In response to the 2H 2018 rice crisis, true enough, the National Government overhauled barriers to rice imports by replacing quota with tariffs, which resulted in an avalanche of supply, and subsequently, the reported contraction in rice prices.

Figure 1

Yet the number is nothing more than statistical contraption barely representative of reality.

With its statistical construction disproportionately skewed towards food prices, the negative divergence between the headline and its CORE component has reached unprecedented levels, which occurred again in October. (figure 1)

Despite falling to 2.65% from 2.75% in September, the CORE CPI remains elevated adrift at 2018 levels and in the proximity of the 2014 pinnacle.

Though food prices, which drive the headline CPI, tend to run ahead of the CORE, especially during the upside, their gyrations tend to exhibit tight correlations. That is, the positive spread between the headline index and the CORE eventually narrows. And the scale is limited when it inverts.

Such interactions appear to have been disrupted by the sharp deflation in rice prices. Rice prices contracted by 9.7% in October.

As an aside, it’s a wonder how many people have experienced any such price decline [year to date -2.1% or month on month -.8%]?

Well, based on statistics, this time is different!

So while the general prices, as demonstrated by the headline CPI, have been suggested to have undergone substantial downside pressures, the CORE CPI asserts little of these.

But does it matter? For the consensus, it’s all about the headlines.

Predicting a “bottoming out” in the CPI, because of this gross distortion, is a piece of cake, ain’t it?

Food and Transport Deflation! Have Consumers Stopped Eating and Moving About?

Two of the CPI’s components dropped to the subzero zone.

 

Figure 2

Food prices contracted for the second straight month! It was -.86% in October from -.94% a month back. And accompanying food prices have been the deflation in transport CPI, which also registered -1.57 and -.93% over the same period. (figure 2, upper window)

And the deflation in food CPI has not been just about rice prices, but the downside pressures spread ironically even to meat prices!  As if the African Swine Flu did not even exist! Meat CPI was just 2.7% YoY or .4% MoM! Vegetable prices were in deflation too at -.8% YoY! (figure 2, BSP table)

And there had been little signs of substitution, where people shifted from pork, to avoid AFS, to other food items. Instead, because suppressed demand, says the Food and Beverage CPI, people practically went on a diet!

Incredible!

Figure 3

Heck, with the record borrowing spree, what had consumers been spending on??? Buying cars and luxury goods at the expense of food? Starve to elevate one's social status through positional goods?

But how about the poor? Have they been practicing abstinence? And has this been the reason why statistics say that “fewer families experience involuntary hunger”?

Rice Under the Shadow of The Law of Supply; Weak Food Demand and Not a Supply Glut

How about the supply side?  Has there been in a deluge in food supplies?

Have people in the cities been growing vertical farms?

However, the National Government’s PSA says domestic food production has barely grown. In the 3Q, the sector grew by just 2.87%.

The PSA’s GDP shows that as well. Nominal agricultural output was even negative (-3.6%) in the 3Q, however because of the magic PCE deflator, real output turned into positive (+3.1%) lead was turned into gold!  The alchemy of statistics! (figure 2, lower pane)

So reduced nominal revenues of farmers have transformed into growth according to statistics! Statisticians should tell farmers to eat and live by statistics!

Separately, domestic Palay production has contracted in the 3Q. Palay real GDP production decreased by 4.2%, while current priced GDP data showed an output slump of 29.4%!

And nor has slowing overall imports been about a shift towards a barrage of food imports. Nondurable consumer imports, which consisted of food and beverage, declined 4.8% in September. Food and live animal imports shrunk by 7.5% in part because rice imports contracted by 53%!

The thing is, the rice episode exhibits the law of supply in motion. The law of supply states that as the price of a good or service increases, the quantity supplied increases, and vice versa.

And in response to the rice crisis or the spike in rice prices, the administration opened the floodgates that ushered in an initial barrage of rice imports. The ensuing deflation in rice prices demonstrates the next stage of the law of supply: as the price of the good decreases, the quantity supplied decreases.

Hence, rice imports and production output has been down. Economics 101!

And although the NG’s statistics have been broadcasting deflation in prices, the contraction in imports and production output must have been accelerating the ongoing drawdown of rice oversupply.

The reported deflation in rice prices is, thus, about to end.

And overall, falling prices amidst stagnant agricultural or food production and imports point to a problem of demand.

Restaurant CPI’s Record Divergence with Food CPI

Another facetious aspect of the CPI is the incoherence of its components, the Food and Beverage CPI with the Restaurant CPI. While the Food CPI controls 38.34% of the basket, Restaurant and Miscellaneous services hold the third-largest share with 12.59%.

The restaurant CPI supposedly signifies the price rate of change in the consumer's spending on food outlets. Resto CPI was 2.88% in October, slightly lower than 2.97% in September. In contrast, deflation in food CPI occurred in the same period. (figure 4, upper pane)

Figure 4

Echoing the headline and the CORE CPI, the variance between food and resto CPI has dropped to the unseen levels. (figure 4, lower window)

But why the glaring dissonance in the spending pattern of consumers in the context of restaurant and non-restaurant food expenditures?

Are food prices in the resto industry price inelastic (or unaffected by changes in demand or supply)?

If the little scathed resto CPI translates to relatively more demand, wouldn’t this influence the market prices of food that should have been reflected on the consumers?

Or has the coordinative function of the pricing system between consumers and producers broken down?

And wouldn’t such glaring disparity be a boon to the profit margins of the food retailing industry?

Flawed CPI: The Shakey’s Pizza Evidence, T-Bills Defy the CPI

Figure 5

Shakey’s Pizza 3Q 17Q gives us a clue as to the relevance of the CPI. (Nota Bene: PIZZA is the first and the only food chain to report on the 3Q Financial Statement last week.)

Have PIZZA’s margins spiked because of this extraordinary CPI spread aberration?

In the 3Q, BSP’s CPI fell to 1.7% from 3% in the 2Q and 3.8% in Q1.

On the other hand, PIZZA’s gross profit margins increased modestly by 69 bps to 26.5% from 25.81% in 3Q of 2018.

However, as the CPI jumped from 2% to 6.2% in the 3Qs of 2016 to 2018, PIZZA’s 3Q profit margins tumbled from 33.22% to 25.81% over the same period.

That said, the recent crash in the CPI has hardly magnified PIZZA’s margins.

Since 3Q 2019 CPI at 1.7% has been below the 3Q 2016 CPI of 2%, PIZZA should have at least regained its 2016’s 33% profit margins.

Here’s the thing, while lower prices in the early quarters have helped improve marginally PIZZA’s margins, the firm acknowledged the challenge of rising costs in the 3Q.

From the PIZZA’s press release: “We are pleased with the results of our initiatives to trim down unnecessary expenses and run a leaner, tighter ship. Year-to-date, raw materials have also moved in our favour adding extra upside to our margins. Nonetheless, we are bracing ourselves for a more challenging year-end with some of our main input costs on an upward trend,” said President and CEO Vicente Gregorio.” (bold and underline mine)

Disinflation or no inflation in the 3Q? Only in statistics!!!

And has the lower CPI bolstered demand for Pizza’s products as indicated in the GDP?

From the same press release: “Same-store sales growth (SSSG), however, remained flat with PIZZA withholding from raising prices during the latest nine-month period.”

Hence, PIZZA’s sales growth came from “new store openings in second-tier cities - in line with the Company’s push to expand in under penetrated areas of the country.”

9-month systemwide sales and revenues grew 9% and 7.4%, the lowest in three years, yet was bumped up by 3Q sales, which jumped 13.6% from its latest acquisition, the Peri-Peri Charcoal Chicken chain. The company’s domestic outlets expanded 18.4% to 263 and added one abroad, as of the end of September.

Expanded demand from consumers? Only in statistics!!!

Though as a chained pizza full-service restaurant with a 64.2% share of the market, according to the Euromonitor, I understand that PIZZA may not represent the whole industry.

However…

Not only have the fundamental premise and logic behind the statistics been flawed, but these numbers have been detached from the real world as proven by micro-evidence.

Hence, sorry guys, that CPI thing has been misstated.

With T-bills holding steady in the face of a crashing Headline CPI, not even the treasury markets (BVAL rates) believe these numbers! (figure 5, lower window)

Attachments area

Headline CPI at 40-month Low Diverges with the CORE; Plummeting M2’s Savings Deposits Should Spur the BSP to Relaunch QE Soon

In any type of activity or business divorced from the direct filter of skin in the game, the great majority of people know the jargon, play the part, and are intimate with the cosmetic details, but are clueless about the subject—Nassim Nicholas Taleb

In this issue

Headline CPI at 40-month Low Diverges with the CORE; Plummeting M2’s Savings Deposits Should Spur the BSP to Relaunch QE Soon

-As Political Statistics, the CPI May Reflect on Political Agenda; Negative Variance Between Headline and CORE CPI Hits Record!

-The Logical Inconsistencies of the CPI Data

-Unrealistic CPI: Consumers on Credit-Financed Spending Spree as Supply Side Remains Lackluster

-Will Stumbling CPI Fuel a Boom in GDP and Stocks?

-Dialing Back on Rice Tariffication; DEFLATION of M2’s Savings Deposits Should Spur the BSP to Relaunch QE!

Headline CPI at 40-month Low Diverges with the CORE CPI; Plummeting M2’s Savings Deposits Should Spur the BSP to Relaunch QE Soon

As Political Statistics, the CPI May Reflect on Political Agenda; Negative Variance Between Headline and CORE CPI Hits Record!

With the roundtrip of the CPI to a 40-month low, political authorities have swiftly claimed credit for it.

Reported the Inquirer (October 4, 2019): One of the loudest cheers at the 0.9 inflation rate in September came from the Bangko Sentral ng Pilipinas (BSP) which had forecast an inflation range of 0.6 to 1.4 percent, nearly hitting the exact mark…In a statement, the BSP said the 0.9 inflation rate was “driven by continued decline in rice prices and electricity rates which offset higher prices of petroleum and selected food products.”

From another Inquirer article (October 4, 2019): Malacañang welcomed Friday the slowest inflation rate in over three years, which the Philippine Statistics Authority (PSA) pegged at 0.9 percent in September, saying that it shows the administration is “delivering results.”  “We are elated to hear the Philippine Statistics Authority report that inflation is at its slowest pace in over three years. Despite the criticisms this administration receives, economic indicators show that our government is delivering results,” Communications Secretary Martin Andanar said in a statement.”

The CPI, along with the National Accounts (GDP), represents government constructed statistics that have a significant impact on the financial and political front.  

The Philippine Statistics Authority on the Primer on the CPI: “The CPI is most widely used in the calculation of the inflation rate and purchasing power of the peso. It is a major statistical series used for economic analysis and as a monitoring indicator of government economic policy.” (bold added)

Because of the incentives to influence the political environment are inherent in a political organization, and because such statistics are not subject to audit, the CPI may be indirectly constructed to promote policy agendas than for objective reporting.

And since a critical source of government financing emanates from the capital market, which is sensitive to the perception of inflation, the central banks may use the CPI as a “signalling channel” tool designed to influence the marketplace.

This October 7th headline from the Inquirer, “T-bills sold out, but rates fall amid skimpy inflation”, provides a clue.

And for the first time since the Philippine Statistics Authority published CPI under 2012 price methodology, the September data reveals a milestone divergence between the CORE and Headline CPI! (figure 1, upper window)

That is, the free fall of the headline CPI in September was a product of the price deflation in two of its major components, namely Food and Alcoholic Beverage and the Transport CPI!

Figure 1

Comprising the component with the biggest 38.34% pie of the CPI basket, the Food and Non-alcoholic beverages (FNAB) CPI registered a -.94%, a deflation, in September from +.56% in August. (figure 1, middle pane)

Deflation in the Transport CPI, the fourth main constituent of the basket, widened to -.93% in September from -.14% a month ago.

Meanwhile, at 2.74%, the CORE CPI remains adrift, not so distant from its previous peaks of 2013 (3.27% in December 2013) and 2017 (2.89% in March 2017).

In perspective, while the CORE CPI was down by 46.3% from its zenith at 5.1% reached last November 2018, the headline CPI collapsed by 86.3% from its acme at 6.7% reached last September 2018. Put differently, the differentials between the headline and the CORE CPI rates, a negative, hit a landmark. (figure 1, lowest pane)

Such divergence, an anomaly, should put a doubt on the credibility of such data.

The Logical Inconsistencies of the CPI Data

And what an irony, as food prices nose-dived, the Restaurant and Miscellaneous Goods (RMG) CPI had barely been changed! The RMG CPI dropped only to 2.97% in September from 3.16% in August as FNAB plunged to -.94%, a deflationary zone. (figure 2, upmost pane)

Figure 2

The first implication: instead of consuming food at home, households had their meals at restaurants. It stands to reason that the plunging food CPI, in the face of seemingly inelastic Restaurant CPI, must translate to a spike in the restaurant’s profit margins!

Such a gigantic boost on the income statement of publicly listed restaurant chains had barely found support from 1H data. The asymmetry between Food and Restaurant CPI had been a dominant phenomenon this year.

The next inference: Even the expanded demand from the Restaurant industry failed to bolster the overall prices of food indicates! Such represents statistics operating in a void!

Consequently, the marginal decline in the Restaurant CPI, if anywhere accurate, should extrapolate to lower revenues from dampened demand!

Third, the September data exhibits that the emergence of the African Swine Fever (AFS) had a NEGLIGIBLE impact on the nation’s food supply!

While the data supported the official perspective, even authorities recognize that the slack in pig supply would entail a substitution of consumption to other food items. In other words, should the outbreak intensify, the AFS would REDUCE, not just the supply of pigs, but the OVERALL or TOTAL food supply, ceteris paribus!

So UNLESS the supply of the other food items materially improves to sufficiently meet the increased demand from substitution, the AFS would represent a temporary supply shock that would noticeably raise food prices (thereby bring about an increase in supplies)!

Public official maintains a benign outlook of the impact of the AFS on the national pig supply. However, other studies see the risk that the spreading of the AFS could knock off a considerable supply of pigs!

Fourth, in the world of statistics, it is a land of aplenty!!!

So aside from rice (-8.9%) and corn (-4.1%), vegetable prices (-4.7%) likewise suffered from a deflation. So scratch out a veggie diet in September!

And since meat (+2.4%) and fish (+1.2%) prices had tempered inflation in the same period, only fruit prices (+7.9%) saw a spike.

So have households been having a mostly fruit diet at the expense of meat and veggies? Or has the general public been fasting?  Or have Martians provided the Philippines with alternative meals?

Logical inconsistencies reveal the inaccuracies from egregious errors, or numerical gymnastics applied by statisticians to arrive at such incredible self-contradicting numbers.

Unrealistic CPI: Consumers on Credit-Financed Spending Spree as Supply Side Remains Lackluster

And it doesn’t stop here.

Developments in the demand and supply spectrum, predicated on credit and liquidity data, don’t seem to fit.

The BSP reported on the Banking System’s August Loan Portfolio: “Loans for production activities—which comprised 87.4 percent of banks’ aggregate loan portfolio, net of RRPs—expanded at a slower pace of 9.0 percent in August from 9.8 percent in the previous month. The growth in production loans was driven primarily by lending to the following sectors: real estate activities (17.7 percent); financial and insurance activities (16.3 percent); electricity, gas, steam and air conditioning supply (11.2 percent), construction (39.2 percent); and wholesale and retail trade, repair of motor vehicles and motorcycle (3.7 percent). Bank lending to other sectors also increased during the month, except those in professional, scientific and technical activities (-38.9 percent) and other community, social and personal activities (-35.9 percent). Meanwhile, loans for household consumption grew by 25.4 percent in August from 23.0 percent in July, due to faster growth in motor vehicle, credit card, and salary-based general purpose consumption loans during the month.

So while the bank loans to the production side of the economy continue to decelerate, consumer borrowing caught fire! (figure 2, middle pane)

Bank lending to the consumer hit an all-time high rate of 25.4%, backed by credit card growth, which zoomed to a historic 26.4% clip! Auto loans rocketed to 28.94% in August! Even payroll loan growth jumped 7.7% from 6.4% from a month ago. (figure 2, lowest pane)

Have consumers been imbibing more leverage to augment, possibly, burgeoning deficiencies in income growth?

Bank lending to the consumer’s auto loans flourished in August, yet vehicle sales growth shrunk by 2.4%. (figure 3, upmost window) Will sales exhibited by the excess credit financing in August appear in a ‘stronger than expected’ data in September?

The only segment that showed an increase in the CPI data — a huge one — was alcoholic beverage and tobacco [ABT] CPI, which vaulted to 14.3% in August from 10.07% in July, a 42.07% spike. The ABT spiral may be due to hoarding in anticipation of the likely imposition of a higher sin tax.

Outside vehicle sales and rice, what undergirded the consumer's booming use of credit card and the improvement in payroll loans? If not for spending, has these been about the settlement of existing loans? Why has the CPI not manifested these? Has the supply side of consumer goods grown at the pace of credit-fueled demand?

Figure 3

Neither domestic production nor imports support the view that the supply side matched consumer demand growth. The PSA’s August data on industrial production reported a 7.8% contraction, its 9th straight month, or a recession! Food manufacturing even crashed by -18% in August, worse than -11.4% in July. (figure 3, middle window)

Meanwhile, import growth shrunk 11.77% in August, according to the PSA, marking the fifth consecutive month of declines!  

Downside pressures have afflicted the supply side for months, in response to the softening of previous demand as a consequence of a liquidity crunch. Since the August CPI was 1.7%, September’s .9% could even mean lower numbers! (figure 3, lowest pane)

If the boom in consumer credit has been about spending, why should the CPI sink to such level when the supply has barely been growing?

The CPI is supposed to represent a process, a trend. Therefore, the time lag in the published data of the bank credit and supply side showcases the previous infirmities contributing to the September’s .92% CPI.

Will Stumbling CPI Fuel a Boom in GDP and Stocks?

Falling CPI, it has been popularly held, would automatically translate to boost in the consumer’s spending power that should distill into earnings and GDP.

While this notion embeds some grain of truth, the CPI should reflect on the balance of demand and supply. What has caused the plunge of the CPI? Has it been an avalanche of output? Or has relatively weaker spending, from the productive sector or the households or both, been its cause?

Figure 4

Instead, the current CPI downturn has been a product mostly of demand, as evidenced by the downtrend in the growth of credit in the production sector, which has diffused into money supply growth.

Falling CPI equals a boom in GDP? Even empirical evidence defies this notion! Tumbling CPI translates to a raging PhiSYx? Empirical evidence points to the other direction! (figure 4)

In contrast, in the past, it has been loose money conditions, which drove the CPI higher that has provided a boost not only to the Nominal GDP but also to the stock market with a time lag. When surging CPI reaches a threshold of pain, ventilated through political outcries, that’s when the CPI backfires on the GDP.

To be sure, it is true that real economy inflation has been decelerating, but the CPI has been overstating this.

Dialing Back on Rice Tariffication; DEFLATION of M2’s Savings Deposits Should Spur the BSP to Relaunch QE!

But the CPI should mount a comeback.

First of all, shifting political winds may alter the supply-side conditions.

The record divergence of the Headline and the CORE CPI alludes to the politicization of the rice supply in response to last year’s shortages. Or, the frantic political response has signified a critical source of the so-called deflation in the food CPI, and consequently, the headline CPI.

Cascading rice prices, which have affected farmer's income, nevertheless have prompted the National Government to reckon with a dial back on the shift to tariffs from quotas for rice imports. Rice inventories in September 2019 soared by 57.9% from a year ago, according to the PSA.

And the proposed adjustments on the Tariffication law would come in the form of significant hikes in tariffs and from the likely imposition of non-tariff barriers, through quality restrictions or ‘safeguard duties’.

Once this political change takes hold, then the manna from the deflation of rice prices should reverse.

Next would be the demand component from money supply growth.

From the BSP’s August report on Domestic Liquidity: “Preliminary data show that domestic liquidity (M3) grew by 6.2 percent year-on-year to about ₱11.9 trillion in August 2019, slightly slower than the 6.7-percent growth in July. On a month-on-month seasonally-adjusted basis, M3 increased by 0.3 percent. Demand for credit remained the principal driver of money supply growth. Domestic claims grew by 6.2 percent in August from 5.8 percent (revised) in the previous month. This was due mainly to the sustained growth in credit to the private sector. Loans for production activities continued to be driven by lending to key sectors such as real estate activities; financial and insurance activities; electricity, gas, steam and airconditioning supply; construction; and wholesale and retail trade, repair of motor vehicles and motorcycles. Loans for household consumption increased due to the growth in credit card loans, motor vehicle loans, and salary-based general purpose consumption loans during the month. Meanwhile, net claims on the central government grew by 2.1 percent following a 1.8-percent contraction in July, reflecting the increased borrowings by the National Government.” (bold added)

Because “demand for credit remained the principal driver of money supply growth”, the sinking growth rate of the banking system’s overall portfolio have not only reduced growth in the benchmark M3 money supply but also contributed to the CPI’s crash. 

The thing is, WHY has the money supply has been in a slump?

Figure 5

The BSP defines money supply M3 as composed of the following:

M1: currency outside depository corporations (in circulation) and Transferable Deposits included in broad money

M2: M1+ other deposits in broad money consisting of savings deposits and time deposits, lastly

M3: M2 + securities other than shares included in broad money (deposit substitutes)

The collapse of the savings deposits component of M2 has fundamentally fueled the plummeting M3 rate.

M2’s Savings Deposits shriveled (-) 2.2% in August, the second time after June’s -.6%, representing the biggest contraction of the year! The last time banks suffered from savings deposit deflation, as reflected in the money supply conditions, was over 10-years ago or in February 2009 in the aftermath of the Great Recession!

At any rate, savings deposits deflation signifies more symptoms of the banking system in distress.

But the growth rates of the other M3 components have been headed downhill too.

After its growth pinnacle in April 2016 at 20.2%, cash in circulation has been southbound. It registered a 12% clip in August, a 27-month low, was slightly down than 12.4% rate in July. Needless to say, the growth rate of cash last August has signified a 40.6% crash from its April 2016 apex.  

The growth rate of M2’s Time Deposits slipped to 11.7% in August from 13% a month ago, but has rallied from a 5.3% low in September 2018. Time Deposits growth has climaxed at 22.7% rate in September 2017.

In the meantime, the growth rate of M1’s Transferable Deposits growth almost doubled to 8% from 4.8% over the same period.  The spike of M1 had been accounted for by Transferable Deposits and not by cash in circulation.  According to the BSP’s Glossary: Transferable Deposits Included in Broad Money, Other Resident Sector refers to the “BSP's peso deposit holdings of its employees' provident and housing funds.” So funds from the BSP’s employees had been responsible for such an upside spiral.

And deposit substitutes have signified the only M3 component in a steady uptrend. Following a trough in December 2016, Deposit substitutes (Securities Other Than Shares Included in Broad Money) growth continued to climb higher and has presently been drifting at a 10-year high.

And since ‘Securities Other Than Shares’ represent all types of money market borrowings by banks like promissory notes, repurchase agreements, commercial papers/securities and certificates of assignment/participation with recourse, its surge highlights the financial system’ sharp increase in the use of leverage, including very short-term lending!

So not only have savings deposits flowed into the coffers of the National Government and the banking system, but it has funded many forms of leveraging too amplifying systemic fragility!

With the stumble of M3’s savings deposits into deflation territory, the BSP will likely supercharge its QE, if the RRR cuts would prove to be ineffectual.  Liquidity represents the primary risk, as admonished the BSP Governor Ben Diokno in their latest (2018) FSR, “If there are risk issues to raise, it will have to be the prospects of managing liquidity”.*

*Diokno’s 2018 FSR Report Warns on Bank’s Mounting Liquidity, Fund Mismatching, Settlement Fails and Concentration Risks; the BSP Chops RRR rates by 100 bps! October 6, 2019

And history should rhyme.  When the headline CPI dropped to deflation in September (-.4%) and October (-.2%) 2015, the BSP revved-up the direct funding (net claims) to the National Government that catapulted the CPI, the GDP and the USD-php.

While current conditions are different compared to 2015, the BSP would surely mount a rescue of the banking system.

As it stands, the steepening of the Philippine treasury curve, suggests a forthcoming revival of the moribund CPI, which most likely will usher the era of stagflation!

Summary and Conclusion

In summary…

As a politically sensitive statistic, the CPI may manifest on the administration’s political agenda than objective reporting.

Several inconsistencies have emerged in the CPI, mainly stemming from the unmatched divergence between the Headline and the CORE as exhibited by logical contradictions.

Besides, the banking system’s loan portfolio and liquidity conditions also reveal its economic flaws. For instance, while the consumer credit growth rate has stormed to unparalleled heights, production loans have fallen to multi-year lows. If consumer credit has been about augmenting spending, why would prices not reflect such a spike on the slack in production?

The mainstream tells the public that lower CPI equals a boost to consumer spending, thereby diffusing into the GDP. While such may hold some grain of truth, this depends on the cause. If a shortfall in demand has prompted for a lower CPI, rather than from a deluge of supply, such would hardly provide support to consumption. At present, constraints in financial liquidity have contributed to the deficiencies in demand.

But like in 2015, CPI’s decline is likely temporary. Politics will likely be its primary cause.

On the supply side, the slump in rice prices, which constituted the gist of the current downturn in the CPI, has also signified a political response to the last year’s crisis. Since there has been a political backlash on the Tariffication Law, authorities have considered taking measures of walking back some of its features. Such actions are likely to put a stall on the current inventory buildup of rice, thus reverse food deflation.

On the demand and monetary side, the contraction in savings deposits has incited the sustained plunge in the money supply conditions. In 2015, when money supply growth pulled the CPI to the deflationary zone, the BSP responded by launching the Philippine version of Quantitative Easing, or the direct financing of the NG through debt monetization. This time with savings deposit under pressure, to jumpstart liquidity and rescue the banking system, aside from RRR cuts, the BSP is likely to recharge QE. The reactivation of QE should re-ignite the CPI upwards.

The domestic treasury market has been signaling the reemergence of inflation through its steepening slope.