PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

 

History will not be kind to central bankers fixated on financial economy and who created serial speculative booms to sustain the illusion of prosperity. It will also be critical of governments unwilling to address weaknesses, who deflected shifting hard policymaking to independent, unelected and largely unaccountable central banks—Satyajit Das 

In this issue 

PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

I. PSEi 30 Craters on Signs of Re-Tightening Amid Rising Dollar and Higher UST Yields

II. Despite the Market Carnage: Financials Share of the PSEi 30 Zoom to All-time High!

III. Financialization: The Expanding Role of Banks in Achieving Political Goals

IV. "National Team?" In Q2, Other Financials Corporations Sold, the PSEi 30 Plunged

V. In Q3, Mismatch Between Financial Index-Bank Fundamentals Reached a Blow-off Phase!

VI. Worsening Bank Liquidity Conditions as Cash-to-Deposits Hit Milestone Low

VII. Liquidity and Collateral Crunch? Bank Borrowings, Focused on Bills, Zoomed to Record Highs in September, as Repos also Hit All-time Highs!

VIII. Despite Lower Rates Held to Maturity Assets Near All-time Highs, Record Bank QE

IX. A Snapshot of Q3 and 9-Month Performance of PSE Listed Banks

X. Highlights, Summary and Conclusion

PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

Even as the PSEi plummeted due to signs of global and local re-tightening, the Financials outperformed, widening the mismatch between share prices and fundamentals. Will a reckoning come soon?

I. PSEi 30 Craters on Signs of Re-Tightening Amid Rising Dollar and Higher UST Yields"

Figure 1

The Sage of Omaha, Warren Buffett, once said, "Only when the tide goes out do you discover who's been swimming naked."

Have the signs of tightening upended the dream of easy money’s "goldilocks" economy, or have they exposed those who have been "swimming naked?"

The surging US dollar index, coupled with rising 10-year Treasury yields—both largely attributed to Trump's policies— has sent global risk assets tumbling. Yet, these developments took shape two months before the US elections. (Figure 1, topmost graph)

This includes the Philippine PSEi 30, which plunged by 4.31%, marking its largest weekly decline in 2024 and the steepest drop since the week of September 30, 2022, when it fell by 8.3%.

As of Thursday, November 14, the headline index broke below the 6,600 level, closing at 6,557.09.

A notable oversold rebound in industrials, led by Meralco (up by 7.78%) and Monde (up by 7.52%), along with financials from BPI (up by 3.7%) and CBC (up by 4.58%), contributed to a low-volume rally of 1.82% on Friday.

Year-to-date, the PSEi 30 is struggling to maintain its narrowing return of 3.5%.

II. Despite the Market Carnage: Financials Share of the PSEi 30 Zoom to All-time High!

The Financial Index, down by only 1.86%, was the least affected in this week’s market carnage. BPI was the only member of the PSEi 30 component to withstand the foreign-driven selloff, while Jollibee ended the week unchanged. (Figure 1, middle pane)

Interestingly, this outperformance has propelled the aggregate free-float market capitalization weighting of the three major banks of the headline index to an all-time high. (Figure 1, lowest chart)

Figure 2

Furthermore, financials accounted for 41.7% of the mainboard's volume on Friday—the third-highest share since October. (Figure 2, topmost diagram)

Meanwhile, October’s cumulative 29.92% accounts for the sector’s highest share since July 2023, which also translates to a 2017 high.

In a related note, the Bangko Sentral ng Pilipinas (BSP) has suspended its free publication of non-BSP-generated data, including PSE data on monthly price-earnings ratios (PER), market capitalization by sector, index data, and volume distribution by sector. This suspension hampers our ability to track critical developments in market internals. (Yes, I wrote them)

The point being, the increasing share of mainboard volume by the financial sector has pillared the rising share of the sector’s market cap share of the PSEi 30.

However, this dynamic also implies growing concentration risk in the stock market.

III. Financialization: The Expanding Role of Banks in Achieving Political Goals

Businessworld, November 13: THE PHILIPPINE banking system’s net profit jumped by 6.4% at end-September as both net interest and non-interest income grew, data from the Bangko Sentral ng Pilipinas (BSP) showed. The combined net income of the banking industry rose to P290 billion in the first nine months of 2024 from P272.6 billion in the same period a year ago.

The PHP 290 billion profit and a 6.4% growth rate represent the Q3 figures year-over-year (YoY).

Continuing from last week’s discussion, the diverging dynamics in the Philippine Stock Exchange (PSE) have also been reflected in the GDP figures. 

Although the financial sector has been on an upward trajectory since the new millennium, its share of the real GDP has rapidly deepened during the BSP’s historic rescue of the sector. 

This was notably influenced by the BSP historic intervention to rescue the sector, which included an unprecedented PHP 2.3 trillion quantitative easing package, historic cuts in official and reserve ratios, as well as unparalleled subsidies and relief measures. 

In line with the rising share of money supply-to-GDP, the financial sector's share of GDP reached its third highest level at 10.8% in Q3. (Figure 2, middle image) 

It even hit an all-time high of 10.9% when considering the 9-month real GDP data. 

While this evolution may be labeled as "financialization," the essential message is clear: BSP policies have led to an economy increasingly immersed (or heavily reliant) in credit and liquidity, primarily channeled through an elite-owned and controlled banking system. 

This deepening dependence comes at the expense of the development of other competing financial conduits, such as capital markets. 

The underlying reason for this is political: the bank-led financial sector serves as the primary non-BSP financier of the government’s deficit spending. 

As a result, the government's calls for improvements in the capital markets appear to be mere lip service. 

However, judging by their "demonstrated preference" in policy choices, it appears that inflating bank shares may serve to camouflage the adverse consequences of this deepening and complex political-economic arrangement. 

IV. "National Team?" In Q2, Other Financials Corporations Sold, the PSEi 30 Plunged

The developments in Other Financial Corporations (OFCs) provide valuable insights. 

In Q2, OFCs eased their holdings of equities.  According to the BSP, "The other financial corporations’ claims on the other sectors dropped as their holdings of equity shares issued by other nonfinancial corporations fell." 

The Non-bank financial institutions and OFCs "includes the private and public insurance companies, other financial institutions that are either affiliates or subsidiaries of the banks that are supervised by the BSP (i.e., investment houses, financing companies, credit card companies, securities dealer/broker and trust institutions), pawnshops, government financial institutions and the rest of private other financial institutions (not regulated by the BSP) that are supervised by the Securities and Exchange Commission (SEC)" (Armas, 2014) 

In the same quarter, OFC claims on the private sector decreased by 0.5% quarter-over-quarter (QoQ), while the PSEi 30 index plunged by 7.1%. (Figure 2, lowest visual) 

My guess is that some of these OFCs are part of what could be considered the Philippine version of the "national team." 

V. In Q3, Mismatch Between Financial Index-Bank Fundamentals Reached a Blow-off Phase!

Nevertheless, the deviation between the fundamentals of banks and their share prices has reached "blow-off" proportions!

Figure 3 

In Q3, the banking system reported a modest growth of 6.4%, slightly higher than Q2’s 4.1%. However, the financial index skyrocketed by 19.4% quarter-over-quarter (QoQ). 

From another angle, 9-month profit growth was up by 5.07%, even as the financial index surged by a stunning 23.4% year-on-year in Q3.

Worst of all, profit trends and the financial index have moved in opposite directions. 

Since profit growth peaked in Q3 2022 and subsequently eased, shares of the seven-member bank stocks (excluding the eighth member: PSE) within the financial index have continued to accelerate. (Figure 3, topmost window) 

Meanwhile, given that universal and commercial banks account for 93.9% of total bank assets, their profit growth largely mirrors the entire banking system. In Q3, profit growth was 7.03%, and on a 9-month basis, it stood at 6%. 

These figures underscore the increasing monopolization of the financial industry by banks validated by the BSP’s Total Financial Resources (TFR) data. 

Total financial resources grew by 10.07% to a record PHP 33.08 trillion. 

The banking sector’s share surged to an all-time high of 83.3%, driven mainly by universal and commercial banks, whose contribution reached a record 78.1%. (Figure 3, middle image) 

So let us get this straight: banks have increased their share of trading activities in the PSE, as well as their slice of both the PSEi 30 and the GDP pie. They now command 83.3% of total financial resources and are continuing to rise. 

This dominance doesn’t even account for their substantial role in the local bond markets, where they act as issuers, intermediaries, and holders. 

Even without the BSP acknowledging this, what we are witnessing is the intensifying risks within the Philippine financial-economic system. 

VI. Worsening Bank Liquidity Conditions as Cash-to-Deposits Hit Milestone Low

Have you ever seen any experts or establishment analysts address the developing contradiction between the banks' reported profits and their liquidity conditions? 

Cash and due from banks, or bank cash reserves, plummeted by 13.6% in September 2024, following a brief 4% rebound in August. This decline brought cash reserves to their lowest level since 2019. (Figure 3, lowest graph) 

To address the emerging liquidity shortfall, the BSP previously reduced the bank reserve requirement ratio (RRR) from 19% to 14%, implemented in seven installments from March 2018 to December 2019. 

Cash reserves saw a temporary spike in 2020 when the BSP injected Php 2.3 trillion into the system, accompanied by an RRR cut from 14% to 12% in April 2020. 

However, facing diminishing returns, cash reserves resumed their downward trend. 

Once again, doing the same thing and expecting different results, the BSP reduced the RRR by a larger margin than in 2020, lowering it from 12% to 9.5% in June 2023. 

Despite these efforts, the challenges within the banking system's cash reserve position have persisted.

Figure 4

Moreover, while the growth in peso deposit rates increased from 6.9% in August to 7.07% in September—the slowest growth rate since July 2023—the BSP’s cash-to-deposit ratio plummeted to 12.44%, its lowest ratio since at least 2013! (Figure 4, topmost and second to the highest graphs) 

Yet, with the record bank credit expansion, why the sluggish growth in deposits? Where did the money flow into? 

Even with the recent decline in inflation rates, have a minority of "banked" households continue to draw from their savings? 

Furthermore, the banks' liquid asset-to-deposit ratio, which includes both cash reserves and financial assets, fell to 50.34%, reverting to levels seen during the BSP's rescue efforts in July 2020. 

Incredible. 

And this is just one facet of the mounting liquidity challenges that banks seem to be facing. 

VII. Liquidity and Collateral Crunch? Bank Borrowings, Focused on Bills, Zoomed to Record Highs in September, as Repos also Hit All-time Highs! 

More eye-catching data emerged last September. 

Bank borrowings—primarily in short-term bills—skyrocketed to an all-time high! Borrowings surged by 49.7%, reaching a record PHP 1.7 trillion, with their share of total liabilities climbing to 7.3%, the highest since 2021. (Figure 4, second to the lowest and lowest charts) 

The liquidity shortfall is most pronounced over the short-term, this is why bank’s bills payable zoomed to unscaled heights.

Figure 5

Not only that, bank short-term repo (repurchase agreements) or RRP (reverse repurchase) operations with the BSP and other banks have also launched into the stratosphere!

With record repo operations, the RRP’s 3.72% share of the bank’s total assets surged to the highest level since at least 2015! (Figure 5, upper image) 

Could this rampant use of repurchase agreements (repos) be underlying growing collateral issues in the financial system? As banks increasingly depend on repos for short-term liquidity, are we witnessing a decline in the quality of collateral or a shortage of high-quality assets available for these transactions? 

These developments likely explain the BSP's abrupt announcement of the latest series of RRR cuts, which took effect last October. 

However, such actions resemble a Hail Mary pass, with RRR ratios now headed toward zero. 

VIII. Despite Lower Rates Held to Maturity Assets Near All-time Highs, Record Bank QE

Another paradox: banks reported that credit delinquencies—across the board—marginally declined in September. (Figure 5, lower diagram) 

If this is true, then higher profits combined with lower non-performing loans (NPLs) should result in more, not less liquidity 

Figure 6

Additionally, the easing of interest rates, as indicated by declining treasury yields, should have reduced banks' held-to-maturity (HTM) assets. As noted repeatedly, HTM assets drain liquidity because they lock up funds. (Figure 6, topmost graph)

Yet, there hasn’t been significant improvement in this area. 

Moreover, since authorities aim to meet year-end spending targets, boost GDP, and finance the upcoming elections, it is expected that the government will ramp up its deficit spending in Q4. 

This increase in public spending will likely lead to a rise in banks' and the financial sector’s net claims on central government (NCoCG), which may translate to higher HTM assets. (Figure 6, middle chart) 

Furthermore, if the current trend of declining inflation reverses, or we experience a third wave of rising inflation, banks might resort to accounting maneuvers to shield themselves from potential mark-to-market losses by shifting these assets into HTMs. 

That is to say, increases in debt-financed government spending and rising inflation rates could therefore result in higher levels of HTM assets.

Above all, banks are not standalone institutions; they have deep exposure to counterparties. As noted last week, 

Led by banks, the financial sector is the most interconnected with the local economy.  Its health is contingent or dependent upon the activities of its non-

financial counterparties. 

Alternatively, the sector’s outgrowth relies on political subsidies and is subject to diminishing returns. 

Yet ultimately, this should reflect on its core operational fundamentals of lending and investing. (Prudent Investor, October 2024) 

The transformational shift in the banking system’s business model—from production and consumption—could be ominous. Part of this shift has been motivated by pandemic-era subsidies and relief measures, as well as a move away from unproductive industry loans. 

As a result, the consumer share of total bank loans (excluding real estate) reached an all-time high of 14.9% in September 2024, while the share of production loans declined to 82.7%. The remaining 2.4% comes from non-resident loans. (Figure 6, lowest image) 

Banks have embraced the government’s belief that spending drives the economy, neglecting the balance sheet health of individuals, as well as the potential misallocations as a result of artificially low rates. 

But what happens to the consumer economy once their balance sheets have been tapped out? 

This should not surprise to our readers, given that the "inverted belly" of the Treasury yield curve has already been signaling these concerns.

IX. A Snapshot of Q3 and 9-Month Performance of PSE Listed Banks

Finally, here is a snapshot of the micro aspects of the financials.

Table 7

The performance of PSE-listed banks indicates that while all-bank profits grew by 14% to Php 226 billion in the first nine months of 2024, bills payable jumped by 79%, or Php 579 billion, reaching Php 1.31 trillion. This increase in bills payable signifies more than double the net profits generated over the same period. The data excludes the small-scale Citystate Savings Bank [PSE: CSB]. [Table 7]

PSEi banks accounted for 84% of the nine-month increase in bills, relative to their 73% share of net income growth. Metrobank [PSE: MBT] represented the most aggressive borrower, with a 61% share. 

We have yet to reconcile the stark divergence between the reported BSP bank performance and the aggregate activities of listed firms. 

Nonetheless, through aggressive lending, banks boosted their top and bottom lines in Q3, positively impacting the nine-month performance. 

Fueled by a 29.7% growth in non-PSEi banks, the net income growth of all banks soared by 22%. 

X. Highlights, Summary and Conclusion 

In the end, we can summarize the banking sector as having the following attributes: (as of September or Q3) 

1. all-time highs in:

-Financial Index

-market cap share of the PSEi 30 (3 biggest banks)

-turnover of financial sector to mainboard volume (near)

-nominal or Philippine peso and % share of total financial resources

-nominal net claims on central government

-nominal Held-to-Maturity assets

-total bank lending in Philippine pesos

-percentage share of consumer bank lending

-nominal bank borrowing (mainly Bills)

-nominal repo operations

- nominal net financial assets

2. Historical lows in:

-cash-to-deposits

-production pie of total bank lending

-reserve requirement ratio

3. Declining trend in:

-cash reserves

-profit growth

-deposit growth

-liquid asset-to-deposit ratio

How is it that the supposedly "profitable" financial institutions, supported by the recent slowdown in non-performing loans, have been accompanied by sustained declines in deposit and savings rates, as well as a massive hemorrhage in liquidity that compelled them to rapidly access short-term financing via bills and repos?

Have profits been overstated? Have NPLs been understated?

To what extent have the BSP’s relief measures and subsidies caused distortions in banks’ reporting of their health conditions?

Why the flagrant disconnect between stock prices and the actual conditions of the banks?

Could the "national team" have been tasked with camouflaging recent developments through a panicked pumping of the sector’s shares?

Does the ongoing shortfall in liquidity portend higher rates ahead?

Given all these factors, what could possibly go wrong?

As we recently pointed out,

To be clear, we aren’t suggesting that CBC and other record-setting bank shares, such as BPI, are a simulacrum of Lehman; rather, we are pointing to the distortive behavior of speculative derbies that may hide impending problems in the sector. (Prudent Investor, October 2024)

____

References 

Satyajit Das, Central banks: The legacy of monetary mandarins, New Indian Express, November 15, 2024 

Jean Christine A. Armas, Other Financial Corporations Survey (OFCS): Framework, Policy Implications and Preliminary Groundwork, BSP-Economic Newsletter, July-August 2014, bsp.gov.ph 

Prudent Investor, Q3 2024 5.2% GDP: Consumers Struggle Amid Financial Loosening, PSEi 30 Deviates from the GDP’s Trajectory, November 10, 2024 

Prudent Investor, Important Insights from the Philippine PSEi 30’s Melt-Up! October 7, 2024

  

September 2024 Fiscal Deficit Highlights the "Marcos-nomics Stimulus"; How Deficit Spending Drives a WEAKER Philippine Peso

 

A failure to correct unsustainable fiscal trajectories poses major risks to growth, inflation and financial stability—Agustín Carstens, General Manager, Bank for International Settlements 

In this issue

September 2024 Fiscal Deficit Highlights the "Marcos-nomics Stimulus"; How Deficit Spending Drives a WEAKER Philippine Peso

I. September Deficit Highlights Three of the Five Phases of Marcos-nomics Stimulus

II. Untold Aspects of Fiscal Health: How the Shift in Monthly Revenue Reports Impact Quarterly Performance

III. Revealing Hidden Dynamics: How Quarterly Expenditures Shape Fiscal Outcomes

IV. September Debt-Servicing Costs Hits an All-Time High Relative to Historical Annualized Data!

V. How Deficit Spending Drives a WEAKER Philippine Peso; the USD-PHP V-Shape Recovery!

VI. All Time High in Interest Payment as Share of Expenditures Soar to 2009 High!

VII. Pre-Election Spending? All Time High in 9-Month Government Disbursements, Second Highest LGU spending

VIII. The Inflation Tax: BSP and Banking System’s QE

IX. Conclusion: Big Government Comes at The Expense of a Healthy Market Economy

September 2024 Fiscal Deficit Highlights the "Marcos-nomics Stimulus"; How Deficit Spending Drives a WEAKER Philippine Peso

There seems to be little recognition that September's deficit was a milestone of a kind; it actually highlights "Marcos-nomics" in action. With a quarter to go, debt servicing costs hit an all-time high as the USD-Peso mounts a ferocious recovery.

I. September Deficit Highlights Three of the Five Phases of Marcos-nomics Stimulus

Everyone has been conditioned to believe that current economic conditions are "normal."

To reinforce this notion, media narratives often highlight selective aspects of growth while ignoring other salient parts and related data.

That’s right: when the public’s dependence on "political interventions"—referred to as ‘stimulus’—becomes entrenched, this deepening addiction becomes the norm.

As the great Nobel Laureate Milton Friedman presciently stated, "Nothing is so permanent as a temporary government program."

But have you heard any expert mention this? You might read piecemeal allusions; for example, the BSP's rate-cutting cycle is expected to boost household spending and business activity.

Nonetheless, the public hardly understands the interconnectedness of what are sold as disparate policies.

As previously discussed, we identify the five phases of the "Marcos-nomics stimulus," subtly operating under the Pandemic Bailout Template (PBT).

The first phase involves record-setting public spending, contributing to a significant deficit.

The second phase highlights the BSP’s monetary policy, characterized by the latest round of interest rate cuts.

The third phase signifies the BSP and bank injections, partially fulfilled by the recent reduction in the banking system’s Reserve Requirement Ratio.

The fourth and fifth phases encompass various subsidies, such as the current credit card interest rate ceiling, along with pandemic relief measures.

The National Government and the BSP have yet to expand their coverage in this area, but it is expected to happen soon.

This step-by-step approach underlines the structure of the stimulus, which subtly mirrors the Pandemic Bailout Template.

September’s deficit highlights its first phase.

II. Untold Aspects of Fiscal Health: How the Shift in Monthly Revenue Reports Impact Quarterly Performance

Inquirer.net, October 25, 2024: The country’s budget deficit widened by 8.9 percent to P273.3 billion in September from P250.9 billion in the same month last year, as the increase in revenues was not enough to cover the hike in expenses, the Bureau of the Treasury reported on Thursday. Revenue collections increased by 17.32 percent to P299.7 billion last month, from P255.4 billion last year, while state expenditures also grew by 13.15 percent to P572.9 billion. But for the first nine months, the budget deficit narrowed by 1.35 percent to P970.2 billion from the P983.5-billion budget gap a year ago.

While the Bureau of the Treasury (BuTr) issues a monthly report, recent changes in tax revenue reporting and end-of-quarter budget compliance targets make quarterly reports far more significant.

In fact, monthly reports can be considered largely meaningless without considering the quarterly performance.

For instance, the latest BuTr report sheds light on the reasons behind recent revenue surges.

The increase in VAT collections in 2024 is partly due to the impact of the change in payment schedule introduced by the TRAIN law provision which allows the tax filers to shift from monthly to quarterly filing of VAT return [bold mine] (Bureau of Treasury, October 2024) 

Distortions brought about by changes in the BuTr’s reporting methods pose a crucial factor in analyzing the fiscal health of the Philippines. 

This brings us to September’s performance. 

Indeed, public revenue in September grew by 17.3%, but this increase is primarily due to base effects. 

Additionally, administrative policy changes and one-off charges contributed to the month’s revenue growth.         

This is attributed to higher personal income tax (PIT) particularly on withholding on wages due to the release of salary differentials of civilian government personnel pursuant to Executive Order No. 64, series of 20242 , which updated from the Salary Standardization Law (SSL) of 2019… 

Non-tax revenues surged to P46.2 billion in September, more than twice the level attained a year ago primarily due to the one-off windfall from the Public-Private Partnership (PPP) concession agreement…the higher outturn for the period was attributed to the P30.0 billion remittance from the Manila International Airport Authority (MIAA), representing the upfront payment for the MIAA-Ninoy Aquino International Airport (NAIA) PPP Project [bold added] (Bureau of Treasury, October 2024) 

Importantly, aside from the factors mentioned above, as noted by the BuTr, the shift in VAT payment timing played a crucial role in boosting 2024 revenues.

Figure 1

That is to say, since VAT payments are made at the end of each quarter but recorded in the first month of the following quarter, this quarterly revenue cycle inflates reported revenues for January, April, July and October, often resulting in a narrowed deficit or even a surplus for these months. (Figure 1, topmost chart) 

Therefore, we should anticipate either a surplus or a narrower deficit this October.

In any case, Q3 2024 revenues increased by 16.95%—the highest growth rate since Q3 2022, which was a record in nominal terms for Q3 historically. However, this was also the second-highest quarterly revenue in pesos after Q2 2024. (Figure 1, middle image)

What might collections look like if we consider only “core” operations? Would deficits be larger without these reporting distortions? Or could the government be “padding” its revenue reports? 

III. Revealing Hidden Dynamics: How Quarterly Expenditures Shape Fiscal Outcomes 

The mainstream media and their expert cohorts rarely mention the most critical segment: historic public (deficit) spending. 

Although public spending rose by only 13.2% in September due to a high base effect, it marked the largest non-December outlay on record. It was also the third-largest overall, trailing only the year-end budget expenditures of December 2023 and December 2022. (Figure 1, lowest graph) 

Notably, 2024 has already seen three months of spending exceeding Php 500 billion—even before the year-end budget allocations. This pattern isn’t an anomaly but rather a path-dependent trajectory of political decisions. 

Figure 2

In the context of quarterly performance, Q3 spending grew by 6.4% year-over-year, also constrained by high base effects. Still, this represents the third-highest quarterly outlay on record, following Q2 2024 and Q4 2023, and a milestone high when compared with previous Q3 performances. (Figure 2, topmost diagram)

Similarly, the monthly deficit resulting from September’s historic expenditure constituted the second largest non-December monthly deficit, following the pandemic recession in April 2020, which saw a deficit of Php 273.9 billion. This was the sixth largest deficit when including the year-end closing budget.

Furthermore, the pressure to meet quarterly compliance targets push the burden of expenditures to the closing month of each period; thus, the largest deficits occur at the end of each quarter (March, June, September, and December). (Figure 2, middle pane) 

Simply put, this new schedule has introduced significant distortions in the Bureau of Treasury’s (BuTr) fiscal balance reporting. 

Revenues at the start of each quarter are likely to close the gap with expenditures in October, potentially leading to a surplus or a narrowed deficit. In contrast, end-of-month spending for each quarter should boost expenditures and consequently increase deficits. 

However, for now, the alteration in BuTr reporting has artificially inflated the government’s fiscal health. 

Still, it goes without saying that the year-end expenditure target will likely push December 2024’s fiscal deficit to a fresh milestone! 

From a quarterly perspective, revenues remain above their polynomial trendline, while spending hovers slightly below it, reflecting revenue outperformance in comparison to trend-aligned spending. (Figure 2, lower graph) 

Meanwhile, the widening gap between the deficit and its trendline may signal increased volatility ahead. 

IV. September Debt-Servicing Costs Hits an All-Time High Relative to Historical Annualized Data!

Despite the potential embellishment of budget statistics through inflated revenues or understated deficits, it remains essential to recognize that this spending requires funding. 

Some mainstream experts have attributed the recent decline in Bureau of Treasury (BuTr) financing to prudent “rationalization” by budget overseers. 

However, we have consistently argued that this perspective is grotesquely misguided; it is the government’s default action to indulge in a spending binge. 

This behavior serves not only to advance its political agenda of centralizing the economy and promoting its interests in the upcoming elections but also because such fiscal transfers create a temporary illusion of economic boom. 

For a spending-based GDP, ramping up expenditures is necessary to increase tax revenue and, more importantly, to depress interest rates, which allows the government to access public savings cheaply to fund its expenditures. 

True, revenue expansion in August reduced that month’s deficit, which led to an improvement in the 9-month deficit, dropping from last year’s level. However, we suspect this improvement may be short-lived, as December 2024’s massive spending is likely to push the deficit above last year’s figures. 

Still, it is noteworthy that the 9-month deficit for 2024 remains the fourth largest since the pandemic bailout template (PBT) measures began in 2020. 

Any improvement in the deficit has been inconsequential, as the post-PBT deficits have remained in an “emergency” mode. 

It only takes a substantial downturn in GDP for this deficit to set a new high—which is likely what its polynomial trendline suggests.

Figure 3

Despite improvements in the 9-month deficit, financing reversed its downward trend, rising 12.6% year-over-year to Php 1.875 trillion. (Figure 3, topmost chart)

This trend reversal means not only an increase in the public debt stock—recently improved due to the peso’s substantial gains against the USD—but also higher costs of servicing public debt.

The BuTr will report on September’s public debt figures next week, but with the substantial V-shaped recovery of the USD, October is expected to yield interesting data.

Nevertheless, the 9-month cost of servicing public debt has reached an ALL-TIME HIGH relative to annual historical data, with a full quarter left to go! (Figure 3, middle graph)

Interestingly, amortizations have exceeded the annual 2023 data by 8.7%, while interest payments remain just 7.2% below this benchmark.

Signs of normal times?

V. How Deficit Spending Drives a WEAKER Philippine Peso; the USD-PHP V-Shape Recovery!

Although the 9-month growth rate for debt servicing slowed to 17.4% due to base effects, it set a record in peso terms.

More importantly, the share of external financing has been increasing, which not only indicates rising credit levels in the local currency but also amplifies external borrowing, effectively exacerbating "USD shorts" (implied short positions on the USD). (Figure 3, lowest window)

Borrowings ultimately need repayment. However, if organic USD revenue sources prove insufficient to meet debt obligations and refinance existing loans, the government will need to take on more debt to cover existing obligations—essentially, a recycling of debt, or what is known as Ponzi finance.

Figure 4 

Compounding these challenges, debt-financed government spending, a preference for easy-money conditions, and domestic banks’ bias toward consumer lending all contribute to a widening savings-investment gap, fueling the country’s "twin deficits." This combination of factors will likely increase reliance on external financing, leading to a structural depreciation of the peso. 

The crux of the matter is this: the widening fiscal deficit results in a weaker Philippine peso, raising external credit risks. (Figure 4, upper image) 

Oddly enough, some media outlets and pseudo-experts have recently attributed the recent V-shape recovery of the USDPHP exchange rate to a “Trump presidency!” 

Huh? Are they suggesting that a Harris administration would result in a strong peso? 

As I recently posted on x.com: During the Trump 1.0 presidency 1/20/17 (49.92) -1/20/21 (48.054), the USDPHP fell by 3.74%! How about Biden? So far, at 58.32, the USDPHP is up 21.4% (as of October 25, 2024)! 

Certainly, the recent strength of the dollar has played a role, contributing to a broad-based rebound of Asian currencies this week. While the USD Index (DXY) rose by 0.8%, the Philippine peso fell by 1.39%. 

In the context of the USD-Philippine USDPHP reclaiming its old trendline, this represents a "signal," while the peso’s recent bounce signifies "noise" or an anomaly. (Figure 4, lower chart) 

On the other hand, the DXY remains below its immediate broken trendline. 

So, is the USDPHP market suggesting a retest of 59 soon? 

This partially illustrates the "exorbitant privilege" of the US dollar standard, where global central banks rely on building up their USD reserves, to "back" or "anchor" their domestic monetary or currency operations that fund their economies and imports. 

In any case, over the long term, the relative performance of a currency against regional peers vis-à-vis the USD might signal developing vulnerabilities within that currency.

This inability to recognize causality represents the heuristic of attribution bias— giving credit to endogenous activities while attributing deficiencies to exogenous forces.

VI. All Time High in Interest Payment as Share of Expenditures Soar to 2009 High!

Circling back to debt servicing, it's important to note that amortizations are not included in the published budget. As the government defines it, this represents "a financing transaction rather than an expenditure" (Ombudsman, 2012). 

Consequently, this aspect has barely been addressed by the headlines or the experts.

Figure 5

Despite attempts to downplay discussions around interest payments, the nine-month interest payments have surged to an all-time high, with their share of disbursements climbing to 13.7%—the highest level since 2009! (Figure 5, topmost diagram)

The growing debt burden from deficit spending, amid elevated rates, translates into an even larger cost of servicing, impacting both the budget’s allocated expenditures and its mandatory cash flows.

How’s that for "prudential" debt management or "rationalizing" the budget?

VII. Pre-Election Spending? All Time High in 9-Month Government Disbursements, Second Highest LGU spending

Aside from interest payments, what might be the other major spending items? 

The nine-month central government’s disbursement growth surged by 11.64% to an all-time high of Php 2.78 trillion, which, according to the Bureau of the Treasury (BuTr), signifies "the implementation of capital outlay projects by the Department of Public Works and Highways and larger personnel services expenditures due to the implementation of the first tranche of salary adjustments." (Figure 5, middle window)

It is worth noting that, aside from aiming for GDP targets, this spending appears to be tactically timed for pre-election purposes.

Meanwhile, local government spending growth rebounded sharply from a 16.6% contraction in 2023 to 8.8% this year, reaching the second highest level in 2024. (Figure 5, lowest image)

A crucial segment of this substantial recovery may involve direct and indirect financing of local pre-election campaign activities.

The nine-month share of national disbursement was 65.24%, slightly higher than 2023’s 65.2%, while the share of local government unit (LGU) spending declined from 18.2% in 2023 to 17.72% in 2024.

In any event, given the embedded accelerated trajectory in deficit spending for socio-political (pre-elections, war economy, infrastructure-led GDP) and financing goals in the face of volatile economically sensitive revenues or collections, what could go wrong?

VIII. The Inflation Tax: BSP and Banking System’s QE

Direct taxation and debt have not only served as the primary sources of financing for the increasing scale of spending and deficits; the inflation tax has also taken on a more significant role in funding deficit spending.

It's important to remember that the Bangko Sentral ng Pilipinas (BSP) operates under an "inflation targeting" regime.

The unstated objective is not to "eliminate" inflation—since that is never the goal—but rather to contain the inflation "genie" within manageable limits.

The BSP aims to utilize the inflation tax alongside direct taxes and borrowing, while carefully controlling it to prevent social discord.

Consequently, attributing the current inflationary episode solely to supply-side factors has proven to be a convenient way to deflect blame from the BSP to the broader market economy, often framing it as “greedflation.”

Given this context, it’s hardly surprising that none of the establishment experts anticipated the surge in inflation, despite our repeated warnings about the inflation cycle.

Figure 6

When authorities began ramping up spending even before the pandemic in 2019, the BSP’s net claims on the central government (NCoCG)—essentially a local version of quantitative easing—started to escalate and has remained on an upward trajectory ever since. (Figure 6, topmost chart)

Even as mainstream narratives tout the aspiration of achieving "upper middle-income status," little has changed in the BSP’s NCoCG since their historic Php 2.3 trillion bailout of the banking system during 2020-2021.

The same holds true for the Philippine banking system’s NCoCG, which continues to be a vital source of financing for public debt. (Figure 6, middle window)

As of last August, the banking system’s holdings of government securities were just shy of the all-time high reached in July.

Although bank holdings of held-to-maturity (HTM) assets dipped in August, they remained tantalizingly close to the record high set in December 2023. Philippine NCoCG are entwined with HTMs. (Figure 6, lowest chart)

When have these been signs of "normal?"

IX. Conclusion: Big Government Comes at The Expense of a Healthy Market Economy

Figure 7

We shouldn’t overlook the fact that the accelerating surge in the nominal value of public debt has diverged from the rising trajectory of public spending, suggesting a potential understatement of the fiscal deficit. (Figure 7, topmost graph)

The establishment often emphasizes the importance of public spending, claiming it has a ‘multiplier effect.’ However, from the perspective of the banking system, the reality appears to be the opposite: instead of stimulating growth, increased public spending has led to a diminishment of savings, as evidenced by the declining growth of peso deposits. (Figure 7, middle chart)

The impact of diminishing savings is also evident in the capital markets, with trading volumes on the Philippine Stock Exchange (PSE) declining further due to the surge in pandemic-era deficits. Yes, PSEi 30 have risen on the backdrop of declining volumes. Amazing! (Figure 7, lowest diagram)

In short, the greater the centralization of the economy— through: (1) intensifying public spending, (2) increasing political control over the economy—such as Public-Private Partnerships (PPPs), which can be viewed as a neo-fascist or crony capitalist model, (3) the expansion of the bureaucratic state due to welfare and warfare sectors, and (4) the increasing reliance on the inflation tax, the lower the productivity.

Simply put, a big government comes at the expense of a healthy market economy.

Given these circumstances, could this scenario catalyze a third wave of inflation?

When has the Philippine economy truly returned to a pre-pandemic "normal?"

___

References:

Bureau of Treasury September 2024 Budget Deficit at P273.3 Billion Nine-Month Deficit Narrowed to P970.2 Billion, October 24, 2024 Treasury.gov.ph

Office of the Ombudsman, I. Basic Concepts in Budgeting, December 2012, www.ombudsman.gov.ph

 

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

 

The short end of the UST curve is highly influenced by the Federal Reserve’s monetary policies while the long end clarifies those policies through the prism of risk/return. A steep yield curve…is one that suggests a low rate, accommodative monetary policy that is likely to work over time. This accounts for the curve’s steepness. A flat and inverted curve is the opposite. Whatever monetary policy is being conducted, the long end is interpreting that policy as well as other conditions as being highly suspect—Jeffrey P Snider 

In this issue:

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion!

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion? 

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion! 

The Philippine yield curve inverts as the BSP significantly reduces the Bank RRR, while the US Fed embarks on a "Not in Crisis" 50-bps rate cut. 

The BSP has been telegraphing cuts to the banking system’s Reserve Requirement Ratio (RRR) since its last reduction in June 2023. 

For instance, Philstar.com, May 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking at a significant reduction in the level of deposits banks are required to keep with the central bank after it starts cutting interest rates this year, its top official said. BSP Governor Eli Remolona Jr. said the Monetary Board is planning to cut the reserve requirement ratio (RRR) of universal and commercial banks by 450 basis points to five percent from the existing 9.5 percent, the highest in the region. 

Four months later. 

GMANews.com, September 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking to cut the reserve requirement ratio, the amount of cash a bank must hold in its reserves against deposits, “substantially” this year and reduce it further in 2025. BSP Governor Eli Remolona Jr. said on Wednesday that the cut in the reserve requirement is being considered, with the timing being discussed. He earlier said this can be reduced to 5% from the present 9.5% for big banks. 

Two days after. 

ABSCBNNews.com, September 20, 2024: The Bangko Sentral ng Pilipinas is reducing the reserve requirement ratio (RRR) for universal and commercial banks by 250 basis points (bps).  This RRR reduction will also apply to non-bank financial institutions with quasi-banking functions, the BSP said… The reduction shall bring the RRRs of universal and commercial banks to 7 percent; digital banks to 4 percent; thrift banks to 1 percent; and rural and cooperative banks to zero percent, the central bank said. The new ratios take effect on October 25 and shall apply to the local currency deposits and deposit substitute liabilities of banks and NBQBs. (bold mine) 

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity 

Bank lending growth has been accelerating, while broad economic liquidity measures have been rising, so why would the BSP opt to inject more liquidity through Reserve Requirement Ratio (RRR) cuts? 

The following data set may provide some answers.

Figure 1

Although lending by Universal and Commercial Banks is at a record high in nominal peso terms, the growth rate remains far below pre-pandemic levels. (Figure 1, topmost image) 

The RRR cuts from 2018 to 2020 appeared to have worked, as the loans-to-deposit ratio rose to an all-time high in February 2020 but the pandemic-induced recession eroded these gains. (Figure 1, middle graph) 

It took a combination of historic BSP policies—record rate cuts, an unprecedented Php 2.3 trillion liquidity injection, and extraordinary relief measures—to reignite the loans-to-deposits ratio. Nonetheless, it still falls short of the 2020 highs. 

A likely, though unpublished, explanation is that bank liquidity continues to decline. 

As of July, the cash and due-to-bank deposits ratio was at its lowest level since at least 2013. The BSP policies of 2020 and subsequent RRR cuts bumped up this ratio from 2020-21, but it resumed its downtrend, which has recently worsened. (Figure 1, lowest chart)

Figure 2

After a brief recovery from the RRR cuts of 2018-2020—further aided by the BSP’s historic rescue measures in 2020—the liquid assets-to-deposits ratio has started to deteriorate again. (Figure 2, topmost pane) 

Additionally, Q2 2024 total bank profit growth has receded to its second-lowest level since Q2 2021. (Figure 2, middle diagram) 

From this perspective, liquidity boost from increased bank lending, RRR cuts, and reported profit growth has been inadequate to stem the cascading trend of cash and liquid assets. 

Furthermore, despite subsidies, relief measures, and a slowing CPI, Non-Performing Loans (NPLs) and distressed assets appear to have bottomed out in the current cycle. (Figure 3, lowest visual) 

Increasing NPLs in the face of a slowing CPI is indicative of demand. Refinancing has taken a greater role in the latest bank credit expansion. 

To wit, rising NPLs contribute significantly to the ongoing drain on the banking system’s liquidity. 

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

Figure 3

A primary source of the downtrend in the cash-to-deposits ratio has been the banking system's Held-to-Maturity (HTM) securities. (Figure 3 upper image)

Once again, the BSP has acknowledged this. 

Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtM losses. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity. [BSP, 2018] (bold mine) 

Even though rates have dropped, HTM (Held-to-Maturity) assets remain at record levels but appear to be plateauing. Falling rates in 2019-2020 barely made a dent in the elevated HTM levels at the time. 

Yet, a principal source of HTMs continues to be the bank's net claims on central government (NCoCG). (Figure 3, lower graph) 

That is, banks continue to finance a substantial portion of the government's deficit spending, which has represented an elementary and major contributor to the deterioration in bank liquidity. 

Why has the BSP been doing the same thing over and over again, expecting different results? Some call this "insanity." 

If the goal is to remove distortions—however ambiguously defined—why not eliminate the RRR entirely? 

It seems the BSP is merely buying time, hoping for a magical transformation of unproductive loans into productive lending. Besides, a complete phase-out of the RRR would leave the BSP with fewer "tools," or bluntly speaking, strip them of excuses. 

Thus, they’d rather have banks continue to accumulate unproductive loans in their portfolios and gradually subsidize them with relief from RRR cuts, rate cuts, various subsidies, and later direct injections—a palliative/band-aid treatment. 

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion! 

Figure 4

Rather than steepening, the Fed's "not in a crisis" panic 50-basis-point cut also helped push the Philippine Treasury yield curve from an "inverted belly" to a "full inversion" on September 20! (Figure 4, tweet)

Figure 5

While yields across the entire curve plunged over the week, T-bill yields declined by a lesser degree relative to medium- and long-term Treasuries. (Figure 5, topmost window)

As a result, yields on Philippine notes and bonds have now fallen below T-bills!

Although one day doesn’t make a trend, this current inversion is the culmination of a process that began with a steep slope, then an inverted belly, and now a full inversion since June 2024. (Figure 5, middle chart)

The spreads between the 10-year bonds and their short-term counterparts are at the lowest level since March 2019! (Figure 5, lowest graph) 

And an inverted curve could serve as a warning signal/alarm bell for the economy.

From Investopedia: 

>An inverted yield curve forms when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile.

>The inverted curve reflects bond investors’ expectations for a decline in longer-term interest rates, a view typically associated with recessions.

Further, it is a sign of tight liquidity: short-term borrowing costs rise or remain elevated, leading to higher yields on short-term debt instruments compared to long-term yields.

Moreover, expectations of slowing growth or economic recessions can also lead to decreased demand for riskier assets and increased demand for safer long-term bonds.

Again, the inverted curve must have resulted from the BSP’s announcement of a sharp reduction in the RRR in October, along with the Fed’s 50-basis point rate cuts.

Bottom line: cuts in the banks’ RRR were meant to address the banking system’s liquidity challenges as manifested in the Philippine treasury markets. The Fed’s 50-bps rate cut has exacerbated these distortions.

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion?

Figure 6

Finally, it is interesting to observe that following the PSEi 30's intraday push above 7,300 last Friday, September 20, foreigners sold off or "dumped" SMC’s shares by 5% during the pre-closing five-minute float, contributing to the sharp decline in SMC’s share price and diminishing gains for the PSEi 30. (Figure 6, tweet) 

While we can’t directly attribute this to the inversion of the Philippine term structure of interest rates (yield curve), SMC’s intensifying liquidity challenges—evidenced by deteriorating cash reserves relative to soaring short-term debt in Q2 2024—should eventually influence its slope. (Figure 6, lower chart) 

In sum, as a "too big to fail" institution, SMC’s difficulties will inevitably reflect on the government’s fiscal and monetary health as well as the banks and the economy. 

____

references

FINANCIAL STABILITY COORDINATION COUNCIL, 2017 FINANCIAL STABILITY REPORT, p. 24 June 2018, bsp.gov.ph