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

Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth

 

The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance— Taylor Caldwell, (often misattributed to Marcus Tullius Cicero) 

In this issue

Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth  

I. The Radio Silence on Last Week’s Collapse of the Philippine Treasury Yield Curve

II. What a Bullish Flattener Implies

III. How Rate Cuts Could Affect the Health of the Philippine Banking System

IV. Mounting Economic Fragility: Higher May Unemployment Rate and the Rising Dependence on Government Jobs

V. Mounting Economic Fragility: Elevated Trade Deficit, Softened FDI Flows in April, and Stagnant Manufacturing Sales

VI. "Marcos-nomics stimulus:" The Turbocharging of Pre-Election Liquidity Growth  

Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth

The collapse in the yields of the Philippine Treasury Markets highlights the BSP's upcoming rate cuts, which, along with May's spending and liquidity growth spike, represents the "Marcos-nomics stimulus."

I. The Radio Silence on Last Week’s Collapse of the Philippine Treasury Yield Curve

Last week, significant developments in the Philippine treasury markets went largely unreported by the media and the echo chamber. Despite this, the implications of these changes are significant for the country's economy.

Figure 1

One. T-bill rates remained steady, while yields on Philippine notes and bonds plunged, deepening the "bullish flattening" process that we have been pointing out. (Figure 1, topmost window)

Two.  The entire Philippine treasury curve has traded below the Bangko Sentral ng Pilipinas' (BSP) overnight reverse repurchase rate (ON-RRP). (Figure 1, middle image) 

Figure 2

Three.  The steep drop in 10-year Philippine treasury notes last week was the most pronounced in the (ASEAN) region, even surpassing the recent declines seen in US Treasury counterparts. (Figure 1, lowest diagram, Figure 2, upper graph)

In essence, treasury traders have reinforced indications that the BSP is preparing to lower rates.

You heard this first here.

II. What a Bullish Flattener Implies

Yet, a bullish flattener can be seen as a sign of different things depending on the context.

In the BSP’s latest Financial Stability Report (FSR), a bullish flattening curve represents "Longer-term outlook is improving and investors price-in lower rates. This gives the central bank room to lower the policy rate" (BSP, 2023)

For Wellspring Financial Advisors, "We have historically seen bull flattening leading into a recession. This can often happen because of a flight to safety trade and/or a lowering of inflation expectations " (Bruss, 2023)

Last we noted that "T-bill rates have been coming off their recent highs, and the narrowing of the treasury curve or a "bullish flattening" has highlighted weaker inflation and slower GDP growth, supporting the BSP's desired rate cuts" (Prudent Investor, 2024)

The point is, while not a direct indicator of economic conditions or inflation, the treasury yield curve provides a crucial insight depending on prevailing economic and financial circumstances.

Nonetheless, the following factors may be relevant to the present conditions:

First, the fact that rates have been tumbling translates to the treasury markets expecting an easing of monetary policy. Rate cuts can only be justified by diminishing inflation rates.

Second, lower inflation expectations increase the demand for longer-term securities. (ceteris paribus)

Third, it could also signify slowing economic growth or increasing risk aversion (even flight to safety).

Fourth, it may imply accruing imbalances in the supply and demand for Philippine treasuries.

III. How Rate Cuts Could Affect the Health of the Philippine Banking System

How will this affect the banking system?

One. The illusion of debt-financed spending utopia.

While lower rates could boost the GDP in the immediate term through increased credit expansion, allowing for expanded financing of Keynesian desired spending, this is contingent upon the capacity of balance sheets to absorb higher leverage.

For instance, unlike in 2008-2017, the serial BSP rate cuts in pre-pandemic 2019 haven’t exactly bolstered bank lending, which in contrast, declined due to the scourge of hidden NPLs. (Figure 2, lower pane)

Only the BSP’s historic Php 2.3 trillion liquidity injections backed by the unprecedented relief measures reversed it in 2021.  

Powered mostly by consumer loans, universal commercial bank lending soared by 10.2% in May 2024—the strongest growth since March 2023.

Much of the current strength in bank lending is due to 'refinancing' or debt 'rollovers,' which is why the Consumer Price Index (CPI) remains subdued.

Ironically, the establishment brands this debt expansion as 'restrictive.' Incredible.

In the absence of this vigorous credit expansion, think of what would happen to inflation and GDP.

The thing is, spending will be determined by balance sheet conditions over time, rather than just rates alone.

Two. A temporary boost on investments.

With surging fixed-income prices, it may also boost the banking industry’s investment side of the balance sheets.

Figure 3

It may also temporarily lower the industry’s camouflaged mark-to-market losses in the context of held-to-maturity (HTM) assets. (Figure 3, topmost chart)

However, HTMs showed minimal improvement when 10-year yields plummeted in 2022-2023, confirming the trend observed from 2019 to 2022, where a crash in rates resulted in negligible progress for the bank’s HTM assets.

Three. An adverse impact on the bank’s interest margins.

Furthermore, the narrowing bond spreads should also lead to tighter interest margins for banks as the 2019-2020 experience showed, which means lesser incentive to lend. (Figure 3, middle graph)

Lastly, falling rates expose disguised credit risks.

During 2019-2020, the BSP rate cuts were in response to mounting pressures from credit delinquencies in the banking system. While the pandemic recession exacerbated the situation, BSP's comprehensive measures—combining rate cuts, liquidity injections, and various relief efforts—masked the true extent of NPLs. (Figure 3, lowest pane)

Despite some of these relief measures and subsidies in place, the recent resurgence of NPLs have been pressuring the BSP to consider such rate cuts.

Figure 4

In short, the BSP rate cuts would whet the speculative appetite of banks and financial institutions for "investments," while reducing their core "lending" operations (similar to the rate cuts of 2019-2020) (Figure 4, topmost image)

Most importantly, higher interest rates have exacerbated the servicing costs associated with record-high levels of public debt, indicating a potential reduction in GDP growth driven by lower public spending over time.

IV. Mounting Economic Fragility: Higher May Unemployment Rate and the Rising Dependence on Government Jobs

Despite its ever-shifting or ambivalent stance, the BSP has been advocating for lower rates. Several economic data released last week help explain this push.

Firstly, despite the recent record-high employment rates, labor markets continue to face challenges.

While the unemployment rate rose from 4% in April to 4.1% in May, this increase was primarily due to a rise in the labor force participation rate. The employed population actually increased by 510,000 month-over-month (MoM), but a larger increase in the labor force by 576,000 led to an uptick in the unemployment rate. (Figure 4, middle visual)

However, a broader analysis reveals emerging tensions in labor participation rates. 

It seems odd to see a job boost in the investment-starved agricultural sector reportedly suffering substantial losses from El Nino. Yet, the government bannered Php 9.6 billion in investment gains this month (mostly from the elites). 

Furthermore, the government was the largest contributor to job gains. Aside from construction jobs stemming partly from government infrastructure projects (including PPPs), the government and defense sectors saw significant gains in both May and March. (Figure 4, lowest chart) 

Even assuming its accuracy, this data provides clues as to why consumers have been struggling, contradicting the headline trend of "full employment." 

V. Mounting Economic Fragility: Elevated Trade Deficit, Softened FDI Flows in April, and Stagnant Manufacturing Sales 

Next, external trade retraced much of its April advances in May.

Figure 5

Import growth fell from a 13.01% increase in April to a negative 0.03% in May, primarily due to an 11.5% plunge in capital goods imports, while consumer goods imports only rose by a meager 0.42%. Capital and consumer goods accounted for 25.6% and 19.6% of the total share, respectively. (Figure 5, topmost pane)

Export growth also dived from a 27.9% growth spike in April to a 3.08% contraction in May. 

While Artificial Intelligence (AI) has boosted global semiconductor trade, with exports increasing by 19.3% year-over-year (YoY) and 4.1% month-over-month (MoM) in May, Philippine semiconductor exports saw an incredible collapse from a 30.7% YoY growth spike in April to a 13.3% contraction in the same month! Microchip exports accounted for 43.4% of the total share. (Figure 5, middle graph) 

Thirdly, despite periodic junkets by the leadership, which reportedly led to significant investment pledges from key geopolitical partners like the US and NATO, April's Foreign Direct Investments (FDI) fell by 36.9%, but overall YTD growth was up still 18.7%. Debt made up significant proportions of both April's and YTD FDIs: 73.2% and 63.5%, respectively. What happened to these investment promises? (Figure 5, lowest chart) 

Also, debt-driven FDI flows do not automatically translate into 'investments' and could serve other purposes. Some might declare it as such to the government to avail of incentives. 

Lastly, FDI flows exhibit a downtrend.

Figure 6

Finally, domestic manufacturing remains stagnant, with production values and volumes increasing by 2.2% and 3.2% respectively in May (YTD: -0.1% and +0.9%). However, these gains may be offset by declining sales values and volumes, which saw decreases of -1.5% and -0.3% in May (YTD: -1.4% and -0.3%). (Figure 6, topmost graph) 

Imports have partially filled the slack in domestic production, which is the essence of the trade deficit. 

Overall, weak imports and a manufacturing stupor manifest a fragile domestic demand. 

In a nutshell, despite optimistic projections by the echo chamber, even government data suggests a critical shortage of investments and an increasing dependence on debt supporting the real (not statistical) economy.  

Moreover, deepening dependence on the government to stimulate GDP growth, evidenced by near-record "twin deficits," could lead to heightened inflation, higher future taxes, and magnified reliance on external debt. (Figure 6, middle chart)

It is not helpful when the establishment confuses the GDP with the overall economy, for the simple reason that the GDP has been skewed to reflect the growth of the government and the elites—the "trickle-down syndrome." 

VI. "Marcos-nomics stimulus:" The Turbocharging of Pre-Election Liquidity Growth

Could the public spending spike observed in May 2024 signify a potential precursor to a "Marcos-nomics stimulus" program? 

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

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

So if we are not mistaken, "Marcosnomics" will be heavy on political expenditures but sold to the public as a "stimulus." (Prudent Investor, 2024)

May 2024 marked the fourth highest spending on record, which significantly boosted the BSP’s principal measure of liquidity, M3, to 6.5%, a six-month high.

Figure 7

A substantial portion of this liquidity growth stemmed from cash in circulation, which surged to its second-highest level on record, surpassing the zenith of December 2022. (Figure 7, topmost image) 

Traditionally, December has been the peak for M3 annually. However, this time could be different. If May’s spending trend continues, nominal cash levels may surpass the historic highs of December 2023 even before year-end! 

May’s cash growth rate of 6.1% YoY was the highest since December 2022’s 7.6%. 

For want of doubt, the administration has begun injecting large amounts of cash into the financial system. 

Together with the accelerating growth in the banking system’s loans, the BSP’s net claims on the central government (NCoCG) surged by 89.21% in May, while the bank's NCoCG slowed to 12.2%. (Figure 7, middle graph) 

This combined financing of government deficit spending and private sector borrowing or formal credit expanded by 9.44% to a record Php 27.02 trillion in May! 

And yet, all we can hear from the consensus is that this represents a “restrictive environment!” 

The thing is, if May’s deficit spending-driven liquidity growth will be sustained, it should put a floor on the present private sector-powered disinflationary impulses—with a time lag. 

The Philippine treasury markets have signaled that the BSP may be about to confirm the unannounced "Marcos-nomics stimulus" with upcoming rate cuts. 

However, such stimulus could also reinvigorate the third wave of the incumbent inflation cycle. (Figure 7, lowest chart) 

Stay tuned.

___ 

References

FINANCIAL STABILITY COORDINATION COUNCIL, 2023 FINANCIAL STABILITY REPORT December 2023, p.35 bsp.gov.ph

Kevin Bruss Steepening and Flattening of the Yield Curve, Wellspring Financial Advisors, August 10, 2023; wellspringadvisorsllc.com

Prudent Investor, June CPI’s Decline Reflects Demand-Side Slowdown: Will the BSP Join Global Peers in Easing Policies, and Will the Government Pursue 'Marcos-nomics Stimulus'? July 7, 2024

Prudent Investor, Could the Philippine Government Implement a 'Marcosnomics' Stimulus Blending BSP Rate Cuts and Accelerated Deficit Spending? Substack.com June 30, 2024

 

Adding to the SWS Mangahas’ Critique of Trickle-Down Economics: The Philippine Banking System’s Intrinsic Bias Against SMEs

  

The man in whose power it might be to find out the means of alleviating the sufferings of the poor would have done a far greater deed than the one who contents himself solely with knowing the exact numbers of poor and wealthy people in society—Vilfredo Pareto 

In this issue

Adding to the SWS Mangahas’ Critique of Trickle-Down Economics: The Philippine Banking System’s Intrinsic Bias Against SMEs

I. The Disconnect Between Economic Data and Public Sentiment: Adding to the SWS Mangahas’ Critique of Trickle-Down Economics

II. The Trickle-down Policy: The Philippine Banking System’s Intrinsic Bias Against SMEs

III. Banks' Preference for Government Securities Crowds Out the SMEs

IV. How Trickle-Down Policies Gutted the Magna Carta for MSMEs and Stunted Philippine Capital Market Growth

V. How Trickle-Down Policies Amplify Concentration and Contagion Risks

VI. Trickle-Down Policies: How HTMs Exacerbate Balance Sheet Mismatches

VII. Rising Non-Performing Loans: Moving from the Periphery to the Core?

VIII. More Crowding Out: Banks Magnify Borrowing from Savers Focusing on Short-Term Bills

IX. More Impact of the Trickle-Down Effect on Banks: Mark-to-Market Losses

Adding to the SWS Mangahas’ Critique of Trickle-Down Economics: The Philippine Banking System’s Intrinsic Bias Against SMEs

SWS’ Dr. Mahar Mangahas recently highlighted the failure of trickle-down economics by pointing to the disconnect between government data and public sentiment. Bank data on MSME lending reinforces his position. 

I. The Disconnect Between Economic Data and Public Sentiment: Adding to the SWS Mangahas’ Critique of Trickle-Down Economics

Figure 1 

I believe in rating economic progress by listening to what the people as a whole say about their own progress, rather than by listening to the international banks, big business, politicians, the diplomatic corps, and all others who point to how the aggregate value of production is growing. Counting the number of people who have gotten better off, and comparing it with the number who have gotten worse off, is the oldest survey question in the book. It has now been surveyed 152 times at the national level: annually in 1983-85, semi-annually in 1986-91, and then quarterly since 1992. The finding of more losers than gainers in 126 of those 152 surveys—despite persistent growth in real gross national product per person, coupled with stagnation of real wages—is the clearest proof of the failure of trickle-down economics in the last four decades. (Mangahas, 2024) [Figure 1, topmost quote]

While most don’t realize it, this quote offers a striking opposition or critique of the nation’s adaptive "trickle-down" political-economic framework. Given its dissenting nature, this theme should be unpopular among the establishment.

For starters, we are skeptical of surveys because they are susceptible to manipulation, social desirability bias, or social signaling, rather than reflecting genuine (demonstrated/revealed) preferences. Interestingly, surveys form the basis of much government data.

To illustrate why the CPI is considered the MOST politicized economic data, consider the following example—from the Philippine Statistics Authority (PSA) (bold mine).

CPI allows individuals, businesses, and policymakers to understand inflation trends, make economic decisions, and adjust financial plans accordingly. The CPI is also used to adjust other economic series for price changes. For example, CPI components are used as deflators for most personal consumption expenditures in the calculation of the gross domestic product.  Moreover, it serves as a basis to adjust the wages in labor management contracts, as well as pensions and retirement benefits. Increases in wages through collective bargaining agreements use the CPI as one of their bases. (PSA, FAQ)

In short, the CPI is the basis where economic policymakers…make economic decisions…and adjust financial plans…calculate the GDP…adjust wages in labor-management contracts…in CBA (or minimum wages) …and influence the calculation of pensions (mainly SSS and GSIS) and retirement benefits (also other welfare programs as Philhealth, Pagibigm, etc).

And so, the lowering of the CPI (e.g., by rebasing it from 2006 to 2012 to 2018) bloats the GDP, minimizes payouts for pensions and retirements, and distorts labor-management contracts. Most of all, it helps the government access cheaper savings from the public.

Yet, the (quality-of-life) survey referenced by the author reflects public sentiment rather than a discourse on economic theories or statistics.

The crux of the matter is that public sentiment contradicts the landscape authorities aim to achieve, which is far from its desired state. 

Ironically, this occurs despite the daily onslaught or barrage of news promoting rosy concepts like achieving "upper middle-class status," a "sound" banking system, "reasonable" inflation, a jump in FDIs, and more. 

It demonstrates the blatant disconnect of political economic metrics such as per capita GNP and GDP from grassroots perceptions. 

Simply put, GDP does not equate to the economy. A 

The disparity between the government figures and sentiment reflects the inequality of economic outcomes. 

Or, as much as the CPI does not represent the inflation of the average Juan or Maria, neither does the GDP. Yet, who benefits from it? Cui bono? 

Though we opine a different perspective from the author, the question is, why should government spending be considered a cornerstone of prosperity when it diverts and limits the private sector from fulfilling its primary role of satisfying consumer needs and wants? 

Does historical (public and private) leveraging and near-record deficit spending, which redistributes income and wealth opportunities to the government and the politically connected, contribute to the goal of achieving "upper middle-class status?"   

Based on 2023 (annualized) data, to what extent can the economy sustain this level of debt buildup under the savings-investment gap paradigm? Won't the sheer burden of debt, beyond interest rates, stifle the real economy?  What if interest rates rise along with the debt burden? Debt servicing-to-GDP and debt-to-GDP have been way above the 1997-98 Asian Financial Crisis levels. (Figure 1, middle charts and lowest graph)

Is this economic paradigm pursued because it is driven by the "trickle-down" ideology, which posits that (indiscriminate) spending drives the economy, or because it favors the centralization of the economy, benefiting a few? 

Yes, the article confirms my priors, but it also suggests that there are others who, in their own ways, share similar perspectives. 

On the other hand, although the author's motivations are unclear, it is uncertain whether they are driven by a political bias. 

Still, given the harsh realities of the prevailing censorship and disinformation in the incumbent political environment, it is unlikely that "analytical independence" could persist. 

II. The Trickle-down Policy: The Philippine Banking System’s Intrinsic Bias Against SMEs

The dispersion of bank credit expansion serves as a prime example of the inefficiencies inherent in the 'trickle-down' economics. 

The government's bank lending data provides valuable insights into the reasons behind its flaws.

Businessworld, June 14, 2024: PHILIPPINE BANKS failed to meet the mandated quota for small business loans in the first quarter, data from the Bangko Sentral ng Pilipinas (BSP) showed. Loans extended by the banking industry to micro-, small-, and medium-sized enterprises (MSMEs) amounted to P474.922 billion as of end-March. This made up only 4.41% of their total loan portfolio of P10.77 trillion, well-below the mandated 10% quota. Under Republic Act No. 6977 or the Magna Carta for MSMEs, banks are required to allocate 10% of their total loan portfolio for small businesses. Of this, 8% of loans should be allocated for micro and small enterprises, while 2% should go to medium-sized enterprises. However, banks have long opted to incur penalties for noncompliance instead of taking on the risks associated with lending to small businesses. (bold mine)

How can the government achieve its "upper middle-class status" goal when the backbone of the economy – small and medium-sized enterprises (SMEs) – has diminished access to lower-priced formal credit?

Figure 2 

SMEs dominate the economy. 

As noted by the DTI in 2022: "The 2022 List of Establishments (LE) of the Philippine Statistics Authority (PSA) recorded a total of 1,109,684 business enterprises operating in the country. Of these, 1,105,143 (99.59%) are MSMEs and 4,541 (0.41%) are large enterprises. Micro enterprises constitute 90.49% (1,004,195) of total establishments, followed by small enterprises at 8.69% (96,464) and medium enterprises at 0.40% (4,484)." (Figure 2, topmost pane) 

SMEs also have the largest share of employment. 

Again, the DTI stated: "MSMEs generated a total of 5,607,748 jobs or 65.10% of the country’s total employment. Micro enterprises produced the biggest share (32.69%), closely followed by small enterprises (25.35%), while medium enterprises lagged behind at 7.06%. Meanwhile, large enterprises generated a total of 3,006,821 jobs or 34.90% of the country’s overall employment." (Figure 2, middle image)  

The lack of access to formal credit leads to informal or shadow lenders, such as family, friends, local money lenders, NGOs, loan sharks, or '5-6' entities, filling the void. This inefficient means of financing results in higher costs for businesses, which in turn reduces the competitiveness of SMEs compared to large firms. 

The former president initially campaigned to ban '5-6' lending, which would have further stifled SMEs. Since the policy failed to gain traction, it can be inferred an undeclared policy failure.

The uneven effects of inflation via the Cantillon Effect—that the first recipient of the new supply of money has an arbitrage opportunity of being able to spend money before prices have increased—also pose an obstacle to MSMEs.(river.com). (Figure 2, lowest diagram)

In other words, the Bangko Sentral ng Pilipinas' (BSP) inflation targeting policy benefits large firms because they have access to new money from bank credit before prices increase, while SMEs are disadvantaged (as price takers): a reverse Robin Hood syndrome.

The lack of access to formal credit and the Cantillon Effect forge a 'protective moat' that favors large firms over SMEs.

This explains the innate inequality expressed by public sentiment.

It also weighs on the BSP’s other ambition to expand financial inclusion—a politically correct goal or a euphemism for the "war on cash."

Naturally, why would the SME universe enroll, when the formal financial system constrains their access to livelihood credit?

Figure 3

Yes, there may be improvements in many metrics of financial inclusion, but they remain distant from reaching upper middle-class levels. 

Participation rates in the banking system by the general populace remain dismal (BSP, Financial Inclusion) (Figure 3, topmost table) 

See the inequality at play? 

III. Banks' Preference for Government Securities Crowds Out the SMEs

Moreover, why would the formal financial system prefer to follow the BSP's policies rather than repricing credit higher to accommodate the higher risks associated with grassroots collections?

Repricing credit would likely raise the cost of financing government debt. Banks function as intermediaries in raising funds for the government, which represents the bulk of the bond markets. 

With a higher cost base, any institutional outlier would risk losing market share in the formal credit market. 

Intuitively, the formal financial system would rather pay the penalties associated with missing the 10% government quota than invest in a system that would reflect the higher cost of risks and transactions with SMEs. 

The spread between the average bank lending rate and the BSP's overnight repo rate (ON RRP) dropped to its lowest level in February 2023 and has barely bounced back from there. (Figure 3, middle chart) 

Therefore, there is hardly any motivation by the formal financial institutions to "go outside the box" or defy the convention. 

See how this perpetuates inequality? 

IV. How Trickle-Down Policies Gutted the Magna Carta for MSMEs and Stunted Philippine Capital Market Growth

Since banks have failed to adhere to the law and have resorted to a workaround, this translates to the fiasco of the Magna Carta legislation in its entirety. 

The restricted constellation of the formal credit system can also be found in the limited exposure to the insurance industry and capital markets. Insurance premiums signify a paltry 1.7% of the GDP. (Figure 3, lowest table) 

Figure 4 

It is barely understood that it is not the trading platform (G-stocks or other touted online alternatives) that constrains the PSE's volume, but rather the lack of savings or increases in disposable income. 

The PSE’s volume woes are equally reflected in the banking system’s cascading cash-to-deposit ratio, which eroded further last April to multi-year lows. (Figure 4, topmost chart) 

Why is this the case? 

Because the inflationary "trickle-down" policies pose a financial barrier to the general public, they also drain savings and redistribute resources to cronies and the government. 

Consequently, the paucity of penetration levels in formal institutions has also been reflected in the capital markets (fixed income and stocks). The lack of volume and breadth also characterizes the Philippine bond market, which is one of the most underdeveloped in Asia. (Figure 4, middle image) 

As previously discussed, the BSP seems misguided in thinking that the exclusion of the Philippines from the global market has been due to "foreigners don’t like us." 

Everything starts organically: rather, it’s the lack of local depth, which is a function of the failure of "trickle-down" policies. 

See how it magnifies the mechanisms of inequality? 

V. How Trickle-Down Policies Amplify Concentration and Contagion Risks

But there’s more. 

If banks have jettisoned the SMEs, then this means that they’ve been amassing intensive loan exposure on economic agents at the upper hierarchy.

As a result, this has led to an unprecedented buildup of concentration risks.  

While the mainstream views the record Total Financial Resource (TFR) and its growth positively, there is little understanding that this asset growth has primarily accrued in universal banks.

Despite April’s TFR slipping from historic March levels, it remains at an all-time high, even as the BSP’s official rates stay at a 17-year high. The rapid expansion of universal bank assets, which now constitute 78.2% of the TFR, has propelled the banking system’s aggregate share to 83.4%. Both their % shares declined in April from the unparalleled levels of March. (Figure 4, lowest graph) 

The banking system's exposure to heavily leveraged non-financial firms, such as San Miguel Corporation [PSE: SMC], is concerning. SMC's debt have reached a staggering record high of Php 1.44 trillion in Q1 2024, accounting for a significant 4.6% of the TFR in the same period.

The extent of this exposure raises questions about the potential risks to the financial system. Specifically, how much of the banking system's assets are tied up in SMC's debt? What happens within SMC will affect SMC alone? Really? 

VI. Trickle-Down Policies: How HTMs Exacerbate Balance Sheet Mismatches 

Figure 5

Banks have been funding the government through net claims on central government (NCoCG), much of which has been concentrated in Held-to-Maturity (HTM) assets. 

Once again, the BSP has acknowledged the liquidity-constraining effects of HTMs. 

The HTM component continues to be significant. Financial assets classified as HTM continued to increase in 2023. From 45.6 percent of financial assets at the beginning of 2021, its share is now nearly 58.8 percent as of November 2023 data. Taken at face value, this suggests that the banks remain defensive against potential MTM losses created by the higher market yields. Invariably, however, the threat of MTM losses can be mitigated by holding the tradable security to maturity. This though comes at the expense of liquidity. (bold original, italics mine) [BSP, FSR 2023] 

HTMs accounted for 55.56% of financial assets last April and 15.7% of the banking system’s total assets. (Figure 5, topmost chart)

Strikingly, the BSP highlighted further concerns in the 2023 Financial Stability Report (FSR), citing the US banking crisis as an example where HTMs created a false illusion of profits while significantly understating risks. 

A case to be highlighted is the phenomenon during the pandemic when the sizable allocation to HTM securities buoyed profits but had a significant impact on some banks’ liquidity during the reversal of interest rates, e.g., the case of SVB. While government securities (GS) are indeed High-Quality Liquid Assets, their liquidity can be further qualified depending on the RORO regime. A Risk-Off environment – when there are significant uncertainties and/or with sharp interest rate hikes – can freeze GS trading as banks would prefer safety. Yet, the difficulties may become too acute that they have to liquidate securities, even those classified as being held to their original maturity. There must be a way to assess the market value of the HTM assets during these periods. (italics mine) [BSP, 2023]

The extent of these maladjustments, partly revealed by balance sheet mismatches, determines the level of volatility.

Although the BSP aims to address this issue, they are hindered by the "knowledge problem," which is precisely why such imbalances exist in the first place—resulting from the policies they implement. 

Simply, if the BSP can do what it wishes to do, then markets won’t be required—a haughty pipe dream. 

VII. Rising Non-Performing Loans: Moving from the Periphery to the Core? 

Next, historic credit expansion suggests that credit delinquencies may arise due to excess exposure to unproductive debt. 

As previously noted, non-performing loans (NPLs) from credit cards and salary loans have not only increased but accelerated in Q1 2024. The relatively stable performance of motor vehicle and real estate loans has slowed down the overall growth of NPLs in consumer loans. 

The total banking sector's fixation with financing unproductive consumer spending opens a Pandora's Box of credit risks. The % shares of consumer loans and production loans are at historic opposite poles! (Figure 5, middle graph) 

Yet, problems are mounting at the periphery of the banking system. 

Net NPLs have increased significantly in government and commercial banks through April 2024. (Figure 5, lowest graph) 

One possible explanation is that government bank lending has been less prudent due to political objectives, which differs from those of the private sector. 

Notably, NPLs at commercial banks, the smallest segment, have also been increasing. Foreign banks have also seen a gradual increase in NPLs. However, there was a slight decrease in NPLs at foreign banks in April. 

A presumption here is that for these sectors to stay afloat against their largest competitors, the universal banks, commercial and foreign banks lent aggressively, and now the chicken has come home to roost. 

What happens when this reaches critical mass? 

Could this indicate signs of risks transitioning from the periphery to the core? 

VIII. More Crowding Out: Banks Magnify Borrowing from Savers Focusing on Short-Term Bills

As deposit growth has been insufficient to cover the liquidity shortfall from HTMs and NPLs, the Philippine banking system has increased its borrowings from local savers. 

Figure 6

Further signs of mounting liquidity deficiency include banks increasingly borrowing from the more expensive capital markets. (Figure 6, topmost chart) 

The focus of their financing has been on short-term securities, as evidenced by significant increases in bills payables. (Figure 6, second to the highest image)

So far, though aggregate bank borrowings have risen to near-record highs, the banking system's share of liabilities remains on the lower spectrum. 

However, increasing competition among banks, the government, and non-financial firms is likely to put upward pressure on interest rates. 

As the giants scramble for financing, this crowding out comes at the expense of SMEs. 

Do you see why the inequality persists?

IX. More Impact of the Trickle-Down Effect on Banks: Mark-to-Market Losses 

Finally, HTMs, NPLs, and the crowding out are not only the growing sources of the bank's liquidity deficits; mark-to-market losses will compound their problems as well. 

In addition to dwindling cash reserves, banks have relied on investments and the revival and acceleration of lending to bolster their assets. (Figure 6, second to the lowest chart) 

However, even when 10-year bond yields have been turned sideways, banks' mark-to-market losses have escalated. (Figure 6, lowest diagram) 

Therefore, mainstream banks are likely to conserve their resources at the expense of small and medium-sized enterprises (SMEs). 

There you have it: a litany of reasons why the Magna Carta for MSMEs failed and the reasons behind the divergence between public sentiment and mainstream statistics. 

In essence, when it comes to the interests of the Philippine version of Wall Street versus Main Street, policymakers tend to favor rescuing big money.

The infamous fugitive Willie Sutton famously explained why he robbed banks, "Because that's where the money is."

In the local context, "trickle-down" policies manifest the stark realities of political-economic inequalities, perpetuating income disparities and social exclusion. 

____

References: 

Mahar Mangahas, Independence from GNP Inquirer.net, June 16, 2024

Philippine Statistics Authority, Frequently Asked Questions, PSA.gov.ph

River Learn, Cantillon Effect, river.com

Bangko Sentral ng Pilipinas, Financial Inclusion in the Philippines Dashboard As of Third Quarter 2023, bsp.gov.ph

FINANCIAL STABILITY COORDINATION COUNCIL, 2023 FINANCIAL STABILITY REPORT, December 2023, (pp. 29 and 31), bsp.gov.ph