Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟

 

An ever-weaker private sector, weak real wages, declining productivity growth, and the currency’s diminishing purchasing power all indicate the unsustainability of debt levels. It becomes increasingly difficult for families and small businesses to make ends meet and pay for essential goods and services, while those who already have access to debt and the public sector smile in contentment. Why? Because the accumulation of public debt is printing money artificially—Daniel Lacalle 

Nota Bene: Unless some interesting developments turn up, this blog may be the last for 2024. 

In this issue 

Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟

I. MSMEs: The Key to Inclusive Growth

II. The Politicization of MSME Lending

III. Bank's MSME Loans: Low Compliance Rate as a Symptom of the BSP’s Prioritization of Banking Interests

IV. Suppressed MSME Lending and Thriving Shadow Banks: It’s Not About Risk Aversion, but Politics

V. Deepening Thrust Towards Banking Monopolization: Rising Risks to Financial System Stability  

VI. How PSEi 30's Debt Dynamics Affect MSME Struggles

VII. The Impact of Bank Borrowings and Government Debt Financing on MSMEs’ Challenges 

VIII. How Trickle-Down Economics and the Crowding Out Effect Stifle MSME Growth 

IX. Conclusion: The Magna Carta for MSMEs Represents a "Symbolic Law," Possible Solutions to Promote Inclusive MSME Growth 

Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟ 

Despite government mandates, bank lending to MSMEs reached its third-lowest rate in Q3 2024, reflecting the priorities of both the government and the BSP. This highlights why the Magna Carta is a symbolic law.

I. MSMEs: The Key to Inclusive Growth 

Inquirer.net December 10, 2024 (bold added): Local banks ramped up their lending to micro, small and medium enterprises (MSMEs) in the third quarter, but it remained below the prescribed credit allocation for the industry deemed as the backbone of the Philippine economy. Latest data from the Bangko Sentral ng Pilipinas (BSP) showed total loans of the Philippine banking sector to MSMEs amounted to P500.81 billion in the three months through September, up by 3 percent on a quarter-on-quarter basis. But that amount of loans only accounted for 4.6 percent of the industry’s P11-trillion lending portfolio as of end-September, well below the prescribed credit quota of 10 percent for MSMEs. Under the law, banks must set aside 10 percent of their total loan book as credit that can be extended to MSMEs. Of this mandated ratio, banks must allocate 8 percent of their lending portfolio for micro and small businesses, while 2 percent must be extended to medium-sized enterprises. But many banks have not been compliant and just opted to pay the penalties instead of assuming the risks that typically come with lending to MSMEs. 

Bank lending to the MSME sector, in my view, is one of the most critical indicators of economic development. After all, as quoted by the media, it is "deemed as the backbone of the Philippine economy." 

Why is it considered the backbone?

Figure 1

According to the Department of Trade and Industry (DTI), citing data from the Philippine Statistics Authority, in 2023, there were "1,246,373 business enterprises operating in the country. Of these, 1,241,733 (99.63%) are MSMEs and 4,640 (0.37%) are large enterprises. Micro enterprises constitute 90.43% (1,127,058) of total establishments, followed by small enterprises at 8.82% (109,912) and medium enterprises at 0.38% (4,763)." (Figure 1 upper chart) 

In terms of employment, the DTI noted that "MSMEs generated a total of 6,351,466 jobs or 66.97% of the country’s total employment. Micro enterprises produced the biggest share (33.95%), closely followed by small enterprises (26.26%), while medium enterprises lagged behind at 6.77%. Meanwhile, large enterprises generated a total of 3,132,499 jobs or 33.03% of the country’s overall employment." (Figure 1, lower graph) 

Long story short, MSMEs represent the "inclusive" dimension of economic progress or the grassroots economy—accounting for 99% of the nation’s entrepreneurs, and providing the vast majority of jobs. 

The prospective flourishing of MSMEs signifies that the genuine pathway toward an "upper middle-income" status is not solely through statistical benchmarks, such as the KPI-driven categorization of Gross National Income (GNI), but through grassroots-level economic empowerment. 

Except for a few occasions where certain MSMEs are featured for their products or services, or when bureaucrats use them to build political capital to enhance the administration’s image, mainstream media provides little coverage of their importance.

Why?

Media coverage, instead, tends to focus disproportionately on the elite.

Perhaps this is due to survivorship bias, where importance is equated with scale, or mostly due to principal-agent dynamics. That is, media organizations may prioritize advancing the interests of elite firms to secure advertising revenues, and or, maintain reporting privileges granted by the government or politically connected private institutions. 

II. The Politicization of MSME Lending 

Yet, bank lending to the sector remains subject to political directives—politicized through regulation. 

Even so, banks have essentially defied a public mandate, opting to pay a paltry penalty: "The Bangko Sentral ng Pilipinas shall impose administrative sanctions and other penalties on lending institutions for non-compliance with provisions of this Act, including a fine of not less than five hundred thousand pesos (P500,000.00)." (RA 9501, 2010)

Figure 2 

With total bank lending amounting to Php 10.99 trillion (net of exclusions) at the end of Q3, the compliance rate—or the share of bank lending to MSMEs—fell to 4.557%, effectively the third lowest on record after Q1’s 4.4%. (Figure 2, upper window) 

That’s primarily due to growth differentials in pesos and percentages. For instance, in Q3, the Total Loan Portfolio (net of exclusions) expanded by 9.4% YoY, compared to the MSME loan growth of 6.5%—a deeply entrenched trend.(Figure 2, lower image) 

Interestingly, "The Magna Carta for Micro, Small and Medium Enterprises (MSMEs)" was enacted in 1991 (RA 6977), amended in 1997 (RA 8289), and again in 2008 (RA 9501). The crux is that, as the statute ages, industry compliance has diminished 

Most notably, banks operate under cartel-like conditions. They are supervised by comprehensive regulations, with the BSP influencing interest rates through various channels—including policy rates, reserve requirement ratios (RRR), open market operations, inflation targeting, discount window lending, interest rate caps, and signaling channels or forward guidance. 

In a nutshell, despite stringent regulations, the cartelized industry is able to elude the goal of promoting MSMEs. 

III. Bank's MSME Loans: Low Compliance Rate as a Symptom of the BSP’s Prioritization of Banking Interests 

Yet, the record-low compliance rate with the Magna Carta for MSMEs points to several underlying factors: 

First, banks appear to exploit regulatory technicalities or loopholes to circumvent compliance—such as opting to pay negligible penalties—which highlights potential conflicts of interest. 

Though not a fan of arbitrary regulations, such lapses arguably demonstrate the essence of regulatory capture, as defined by Investopedia.com, "process by which regulatory agencies may come to be dominated by the industries or interests they are charged with regulating" 

A compelling indication of this is the revolving-door relationship between banks and the BSP, with recent appointments of top banking executives to the BSP’s monetary board. 

Revolving door politics, according to Investopedia.com, involves the "movement of high-level employees from public-sector jobs to private-sector jobs and vice versa" 

The gist: The persistently low compliance rate suggests that the BSP has prioritized safeguarding the banking sector's interests over promoting the political-economic objectives of the Magna Carta legislation for MSMEs.

IV. Suppressed MSME Lending and Thriving Shadow Banks: It’s Not About Risk Aversion, but Politics

Two, with its reduced lending to MSMEs, banks purportedly refrain from taking risk. 

But that’s hardly the truth.

Even with little direct access to formal or bank credit, MSME’s are still borrowers, but they source it from the informal sector. 

Due to the difficulty of accessing bank loans, MSMEs in the Philippines are borrowing from informal sources such as the so-called 5-6 money lending scheme. According to an estimate, 5-6 money lending is now a Php 30 billion industry in the Philippines. These lenders charge at least 20% monthly interest rate, well above the 2.5% rate of the government’s MSME credit program. The same study by Flaminiano and Francisco (2019) showed that 47% of small and medium sized enterprises in their sample obtained loans from informal sources. 

...

An estimate by the International finance Corporation (2017) showed that MSMEs in the Philippines are facing a financing gap of USD 221.8 billion. This figure is equivalent to 76% of the country’s GDP, the largest gap among the 128 countries surveyed in the IFC report. (Nomura, 2020)

The informal lenders don’t print money, that’s the role of the banks, and the BSP.

Simply, the Nomura study didn’t say where creditors of the informal market obtained their resources: Our supposition: aside from personal savings, 5-6 operators and their ilk may be engaged in credit arbitrage or borrow (low interest) from the banking system, and lend (high interest) to the MSMEs—virtually a bank business model—except that they don’t take in deposits.

The fact that despite the intensive policy challenges, a thriving MSME translates a resilient informal credit arbitrage market—yes, these are part of the shadow banking system.

As an aside, uncollateralized 5-6 lending is indeed a very risky business: collections from borrowers through staggered payments occur daily, accompanied by high default rates, which explains the elevated interest rates.

Figure 3

That is to say, the shadow banks or black markets in credit, fill the vacuum or the humungous financing gap posed by the inadequacy of the formal financial sector. (Figure 3, upper diagram)

The financing gap may be smaller today—partly due to digitalization of transactional platforms—but it still remains significant. 

This also indicates that published leverage understates the actual leverage in both the financial system and the economy. 

Intriguingly, unlike the pre-2019 era, there has been barely any media coverage of the shadow banking system—as if it no longer exists.

As a caveat, shadow banking "involves financial activities, mainly lending, undertaken by non-banks and entities not regulated by the BSP," which implies that even formal institutions may be engaged in "unregulated activities." 

Remember when the former President expressed his desire to crack down on 5-6 lending, vowing to "kill the loan sharks," in 2019? 

If such a crackdown had succeeded, it could have collapsed the economy. So, it’s no surprise that the attempt to crush the informal economy eventually faded into oblivion. 

The fact that informal credit survived and has grown despite the unfavorable political circumstances indicates that the suppressed lending to MSMEs has barely been about the trade-off between risk and reward. 

It wasn’t risk that has stymied bank lending to MSMEs, but politics (for example, the artificial suppression of interest rates to reflect risk profiles). 

More below. 

Has the media and its experts informed you about this?

Still, this highlights the chronic distributional flaws of GDP: it doesn’t reflect the average experience but is instead skewed toward those who benefit from the skewed political policies. 

In any case, mainstream media and its experts tend to focus on benchmarks like GDP rather than reporting on the deeper structural dynamics of the economy.

V. Deepening Thrust Towards Banking Monopolization: Rising Risks to Financial System Stability

Three, if banks have lent less to MSMEs, then who constituted the core of borrowers?

Naturally, these were the firms of elites (including bank borrowings), the consumers from the "banked" middle and upper classes, and the government.

Total Financial Resources (TFR) reached an all-time high of Php 32.8 trillion as of October, accounting for about 147% and 123% of the estimated real and headline GDP for 2024, respectively. (Figure 3, lower pane)

TFR represents gross assets based on the Financial Reporting Package (FRP) of banking and non-bank financial institutions, which includes their loan portfolios.

The banking system’s share of TFR stood at 83.2% last October, marking the second-highest level, slightly below September’s record of 83.3%. Meanwhile, Universal-Commercial banks accounted for 77.8% of the banking system’s share in October, marginally down from their record 78% in September.

These figures reveal that the banking system has been outpacing the asset growth of the non-banking sector, thereby increasing its share and deepening its concentration.

Simultaneously, Universal-Commercial banks have been driving the banking system’s growing dominance in TFR. 

The significance of this lies in the current supply-side dynamic, which points towards a trajectory of virtual monopolization within the financial system. As a result, this trend also magnifies concentration risk. 

VI. How PSEi 30's Debt Dynamics Affect MSME Struggles

From the demand side, the 9-month debt of the non-financial components of the PSEi 30 reached Php 5.52 trillion, the second-highest level, trailing only the all-time high in 2022. However, its share of TFR and nominal GDP has declined from 17.7% and 30.8% in 2023 to 16.7% and 29.3% in 2024.

Figure 4

Over the past two years, the PSEi 30's share of debt relative to TFR and nominal GDP has steadily decreased. (Figure 4, upper chart) 

It is worth noting that the 9-month PSEi 30 revenues-to-nominal GDP ratio remained nearly unchanged from 2023 at 27.9%, representing the second-highest level since at least 2020. (Figure 4, lower image) 

Thus, the activities of PSEi 30 composite members alone account for a substantial share of economic and financial activity, a figure that would be further amplified by the broader universe of listed stocks on the PSE. 

Nevertheless, their declining share, alongside rising TFR, indicates an increase in credit absorption by ex-PSEi and unlisted firms. 

VII. The Impact of Bank Borrowings and Government Debt Financing on MSMEs’ Challenges

Figure 5

On the other hand, bank borrowings declined from a record high of Php 1.7 trillion (49.7% YoY) in September to Php 1.6 trillion (41.34% YoY) in October. Due to liquidity concerns, most of these borrowings have been concentrated in T-bills. (Figure 5, topmost visual) 

As it happens, Philippine lenders, as borrowers, also compete with their clients for the public’s savings. 

Meanwhile, the banking system’s net claims on the central government (NCoCG) expanded by 8.3% to Php 5.13 trillion as of October. 

The BSP defines Net Claims on Central Government as including "domestic securities issued by and loans and advances extended to the CG, net of liabilities to the CG such as deposits." 

In October, the banks' NCoCG accounted for approximately 23% of nominal GDP (NGDP), 18% of headline GDP, and 15.6% of the period’s TFR. 

Furthermore, bank consumer lending, including real estate loans, reached a record high of Php 2.92 trillion in Q3, supported by an unprecedented 22% share of the sector’s record loan portfolio, which totaled Php 13.24 trillion. (Figure 4, middle graph) 

Concomitantly, the banking system’s Held-to-Maturity (HTM) assets stood at nearly Php 3.99 trillion in October, just shy of the all-time high of Php 4.02 trillion recorded in December 2023. Notably, NCoCG accounted for 128.6% of HTM assets. HTM assets also represented 15.1% of the banking system’s total asset base of Php 26.41 trillion. (Figure 4, bottom chart) 

This means the bank’s portfolio has been brimming with loans to the government, which have been concealed through their HTM holdings.

Figure 6

Alongside non-performing loans (NPLs), these factors have contributed to the draining of the industry’s liquidity.  Despite the June 2023 RRR cuts and the 2024 easing cycle (interest rate cuts), the BSP's measures of liquidity—cash-to-deposits and liquid assets-to-deposits—remain on a downward trend. (Figure 6, upper window)

VIII. How Trickle-Down Economics and the Crowding Out Effect Stifle MSME Growth 

It is not just the banking system; the government has also been absorbing financial resources from non-banking institutions (Other Financial Corporations), which amounted to Php 2.34 trillion in Q2 (+11.1% YoY)—the second highest on record. (Figure 6, lower graph)

These figures reveal a fundamental political dimension behind the lagging bank lending performance to MSMEs: the "trickle-down" theory of economic development and the "crowding-out" syndrome affecting credit distribution. 

The banking industry not only lends heavily to the government—reducing credit availability for MSMEs—but also allocates massive amounts of financial resources to institutions closely tied to the government. 

This is evident by capital market borrowings by the banking system, as well as bank lending and capital market financing and bank borrowings by PSE firms. 

A clear example is San Miguel Corporation's staggering Q3 2024 debt of Php 1.477 trillion, where it is reasonable to assume that local banks hold a significant portion of the credit exposure. 

The repercussions, as noted, are significant: 

Its opportunity costs translate into either productive lending to the broader economy or financing competitiveness among SMEs (Prudent Investor, December 2024)

Finally, in addition to the above, MSMEs face further challenges from the "inflation tax," an increasing number of administrative regulations (such as minimum wage policies that disproportionately disadvantage MSMEs while favoring elites), and burdensome (direct) taxes.

IX. Conclusion: The Magna Carta for MSMEs Represents a "Symbolic Law," Possible Solutions to Promote Inclusive MSME Growth 

Ultimately, the ideology-driven "trickle-down" theory has underpinned the political-economic framework, where government spending, in tandem with elite interests, anchors economic development. 

Within this context, the Magna Carta for MSMEs stands as a "Symbolic Law" or "Unenforced Law"—where legislation "exists primarily for symbolic purposes, with little to no intention of actual enforcement." 

Politically, a likely short-term populist response would be to demand substantial increases in penalty rates for non-compliance (to punitive levels, perhaps tied to a fraction of total bank assets). However, this approach would likely trigger numerous unintended consequences, including heightened corruption, reduced transparency, higher lending rates, and more. 

Moreover, with the top hierarchy of the BSP populated by banking officials, this scenario is unlikely to materialize. There will be no demand for such measures because only a few are aware of the underlying issues. 

While the solution to this problem is undoubtedly complex, we suggest the following:

1 Reduce government spending: Roll back government expenditures to pre-pandemic levels and ensure minimal growth in spending.

2 Let markets set interest rates: Allow interest rates to reflect actual risks rather than artificially suppressing them.

3 Address the debt overhang through market mechanisms: Let markets resolve the current debt burden instead of propping it up with unsustainable liquidity injections and credit expansions by both the banking system and the BSP.

4 Liberalize the economy: Enable greater economic and market liberalization to reflect true economic conditions.

5 Adopt a combination of the above approaches.

The mainstream approach to resolving the current economic dilemma, however, remains rooted in a consequentialist political scheme—where "the end justifies the means."

This mindset often prioritizes benchmarks and virtue signaling in the supposed pursuit of MSME welfare. For example, the establishment of a credit risk database for MSMEs is presently touted as a solution.

While such measures may yield marginal gains, they are unlikely to address the root issues for the reasons outlined above.

_____

References 

Republic Act 5901: Guide to the Magna Carta for Micro, Small and Medium Enterprises (RA 6977, as amended by RA 8289, and further amended by RA 9501), p.17 SME Finance Forum 

Margarito Teves and Griselda Santos, MSME Financing in the Philippines: Status, Challenges and Opportunities, 2020 p.16 Nomura Foundation 

Prudent Investor, Is San Miguel’s Ever-Growing Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE? December 02, 2024

 

 

Is San Miguel’s Ever-Growing Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE?

 

Every Ponzi is sold as a non-zero sum store of value. Every Ponzi investor believes the investment is a non-zero sum store of value—Nassim Nicolas Taleb

Is San Miguel’s Ever-Growing Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE? 

San Miguel’s Q3 and nine-month sales performance validated the signs of a weakening economy. However, while the company reduced its debt from Php 1.484 trillion to Php 1.477 trillion, its practices exhibit symptoms of Minsky’s Ponzi finance.

I. San Miguel’s Slowing Sales Resonated with the Economy 

San Miguel’s 9-month sales performance demonstrates the weakening of the Philippine economy which was not limited to consumers.  

Given the current loose economic conditions, supported by the first BSP rate cut and the "Marcos-nomics" stimulus, it is surprising to see a contraction in cement and real estate revenues, as well as a downturn in infrastructure sales growth. For a company that has shifted its business model to rely heavily on political projects or enterprises, this downturn should be a cause for concern. 

Additionally, the consumer spending slowdown was pronounced in the context of declining food and packaging sales—which eked out marginal growth. 

SMC reported a Q3 revenue increase of only 3.9%—which would be flat once adjusted for inflation! 

Q3 sales pulled down the 9-month revenue growth, which clocked in at 11.2%.

In any case, despite a slight drop in margins, SMC reported income growth of 18.9%, amounting to Php 37.1 billion.

Despite this income growth, SMC’s outstanding debt fell only by Php 7.43 billion to Php 1.477 trillion from its 1H historic high of Php 1.485 trillion. 

II. San Miguel’s Incredible Short-term Debt Recycling, Deeper Signs of Ponzi Financing? 

However, this situation appears to be a result of smoke and mirrors, as the heavily leveraged holding firm raised approximately Php 71.4 billion through various preferred share issuances by its subsidiaries to bridge its financing gap. 

The issuance of preferred shares has potential impacts on common shareholders. Preferred shares typically have priority over common shares in receiving dividends and claims to assets. As a result, common shareholders may see reduced dividends, as preferred shareholders must be paid first. In the event of liquidation, preferred shareholders also have a higher claim on assets. 

A closer look at their cash flow statement reveals a striking example of debt recycling, reminiscent of Hyman Minsky’s "Ponzi finance." 

SMC borrowed an additional Php 110 billion in short-term debt, bringing the total to Php 933.794 billion, to pay off a rising Php 898.657 billion in loans. 

Professor Minsky described this as "Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts" (Hyman Minsky, 1992) 

Incredible! 

SMC’s Q3 interest payments rose by 10% to Php 25.05 billion, marking its second-highest level.

Although SMC reported a 6% increase in cash, amounting to Php 15.9 billion and totaling Php 281.2 billion, this figure remains significantly lower than its short-term liabilities of Php 383 billion, which raises the firm’s liquidity risks. 

III. Is SMC’s Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE? 

To put this in perspective, SMC’s 9-month 2024 Php 1.477 trillion debt is equivalent to 6.6% of the estimated 2024 GDP and 4.5% of total financial resources (Q3). 

It is a telltale sign of the expanding concentration risk in the economy, or the 'too big to fail' phenomenon. What could go wrong? 

Its opportunity costs translate into either productive lending to the broader economy or financing competitiveness among SMEs. 

This also means that even at zero interest rates, the mounting scale of Ponzi finance or debt recycling is virtually unsustainable. 

It would likewise be a blatant mistake to assume that "what happens in SMC stays in SMC." 

As a counterparty to lenders, a liquidity crunch or potential insolvency won’t just affect the health of the banking system, the fixed-income market, or, indirectly, the Treasury markets—it could have broader economic and political repercussions. 

A liquidity squeeze could affect both direct and indirect industry and consumer linkages to SMC’s businesses.

Moreover, a political decision to bail out SMC would likely fuel inflation, which would come at the expense of the Philippine peso.

Sadly, could SMC represent the proverbial "Damocles' Sword" hanging over the Philippine economy, the financial system, and the Philippine Stock Exchange?

Interestingly, SMC share prices appear to have recently behaved like a pegged currency, with entity/ies defending the lower band (price floor) during the 5-minute pre-close period for several days, maintaining the Php 88 level (as of November 29) Previously, the lower band was at around Php 88.7.

___

reference  

Hyman P. Minsky The Financial Instability Hypothesis The Jerome Levy Economics Institute of Bard College May 1992

 

Debt-Financed Stimulus Forever? The Philippine Government’s Relentless Pursuit of "Upper Middle-Income" Status

 

Deficits are always a spending problem, because receipts are, by nature, cyclical and volatile, while spending becomes untouchable and increased every year—Daniel Lacalle

In this issue

Debt-Financed Stimulus Forever? The Philippine Government’s Relentless Pursuit of "Upper Middle-Income" Status

I. Changes in Tax Collection Schedules Distort Philippine Treasury Data and Highlight Fiscal Cycles; Spending’s Legal Constraints

II. Stimulus Forever? The Quest for "Upper Middle-Income" Status and Credit "A" Rating, Rising Risks of a Fiscal Blowout

III. 10-Month Public Revenue Growth Deviates from PSEi 30’s Activities

IV. Q3 2024: 2nd Highest Revenue to NGDP, Headline GDP Weakens—The Crowding Out Effect?

V. Record 10-Month Expenditure: The Push for "Big Government"

VI. 10-Month Debt Servicing Costs Zoom to All-Time Highs!

VII. Rising Foreign Denominated Debt Payments!

VIII. Despite Slower Increases in Public Debt, Little Sign of the Government Weaning Off Stimulus

IX. Q3 2024: Public Debt to GDP rises to 61.3%

X. Conclusion: The Relentless Pursuit Of "Upper Middle Income" Status Resembles a Futile Obsession 

Debt-Financed Stimulus Forever? The Philippine Government’s Relentless Pursuit of "Upper Middle-Income" Status 

Improvements in the 10-month fiscal balance have fueled the Philippine government’s unrealistic fixation on achieving 'Upper Middle Income' status—here's why. 

I. Changes in Tax Collection Schedules Distort Philippine Treasury Data and Highlight Fiscal Cycles; Spending’s Legal Constraints 

Inquirer.net, November 28: A double-digit revenue growth helped swing the government’s budget position back to a surplus in October, keeping the 10-month fiscal deficit below the 2024 ceiling set by the Marcos administration. The government ran a budget surplus of P6.3 billion in October, a reversal from the P34.4- billion deficit recorded a year ago, figures from the latest cash operations report of the Bureau of the Treasury (BTr) showed. 

Most media outlets barely mention that recent changes in tax collection schedules have distorted the Bureau of the Treasury’s reporting data. 

As noted in September, these adjustments significantly impact the perception of fiscal performance. 

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. 

Therefore, we should anticipate either a surplus or a narrower deficit this October. (Prudent Investor, October 2024)

Figure 1 

For instance, October’s surplus of Php 6.34 billion underscores how the quarterly revenue cycle boosts collections at the start of every quarter, often leading to either a surplus or a narrowed deficit. Surpluses were observed in January, April, and October this year. (Figure 1, topmost chart) 

However, as the government pushes to meet its year-end 'budget execution' targets in December, a significant spike in the year-end deficit could emerge from the remaining spending balance. 

Based on the budget allocation for 2024 amounting to Php 5.768 trillion, the unspent difference from the ten-month spending of Php 4.73 trillion is Php 1.038 trillion. 

Notably, in contrast to previous years, 2024 has already experienced three months of public spending exceeding Php 500 billion, with December still underway. (Figure 1, middle image) 

On the other hand, this could indicate a potential frontloading of funds to meet year-end targets. 

While spending excesses are constrained by law, the government has consistently exceeded enacted budget allocations since 2019. (Figure 1, lowest diagram) 

Consequently, this trend, shaped by political path dependency, suggests that the remaining Php 1.038 trillion could likely be surpassed. 

According to the Department of Budget and Management (DBM), budget adjustments are permissible under specific conditions: (DBM, 2012) 

1.    Enactment of new laws,

2.    Adjustments to macroeconomic parameters, and

3.    Changes in resource availability. 

These provisions may provide political rationales to justify increases in the allocated budget.

Figure 2

Expenditures, while down from last month, remain within their growth trajectory, while revenues have so far outperformed expectations. (Figure 2, topmost graph)

Despite October’s 22.6% revenue growth contributing to a lower ten-month deficit—down from Php 1.018 trillion in 2023 to Php 963.9 billion—it remains the fourth largest on record.

II. Stimulus Forever? The Quest for "Upper Middle-Income" Status and Credit "A" Rating, Rising Risks of a Fiscal Blowout

What is seldom mentioned by mainstream media is that such deficits serve as "fiscal or automatic stabilizers," ostensibly for contingent or emergency (recession) purposes.

While authorities repeatedly propagate their intent to elevate the economy to "upper middle-income" status and attain a credit "A" rating soon, they fail to disclose that current political-economic conditions are still functioning under or reflect continued reliance on a "stimulus" framework.

In fact, as we keep pointing out, the Bangko Sentral ng Pilipinas (BSP)’s reserve requirement ratio (RRR) and interest rate cuts represent monetary measures, while authorities have ramped up fiscal measures or "Marcos-nomics stimulus" for their political agenda—namely, pre-election spending and a subtle shift toward a war economy, alongside centralization through increased public spending and an enlarged bureaucracy or "Big Government."

Finally, while expenditures adhere to programmed allocations and revenues fluctuate based on economic and financial conditions as well as administrative efforts, they remain inherently volatile.

Any steep economic slowdown or recession would likely compel the government to increase spending, potentially driving the deficit to record levels or beyond.

Unless deliberate efforts are made to curb spending growth, the government’s ongoing centralization of the economy will continue to escalate the risk of a fiscal blowout.

Despite the mainstream's Pollyannaish narrative, the current trajectory presents significant challenges to long-term fiscal stability.

III. 10-Month Public Revenue Growth Deviates from PSEi 30’s Activities

Let us now examine the details.

In October, public revenue surged by 22.6%, driven primarily by a 16.94% growth in tax revenues, with the Bureau of Internal Revenue (BIR) contributing 16.19% and the Bureau of Customs (BOC) 11.5%. Meanwhile, non-tax revenues soared by 87.7%, largely due to revenues from other offices, including "privatization proceeds, fees and charges, and grants."

These activities boosted the 10-month revenue growth from 9.4% in 2023 to 16.8% this year, largely driven by a broad-based increase, largely powered by non-tax revenues.

It is worth noting that, despite reaching a record high in pesos, the BIR’s net income and profit growth significantly softened to 8.3%, the lowest since 2021, remaining consistent with the 9-month growth rate.  This segment accounted for 50% of the BIR’s total intake. (Figure 2, middle pane)

In contrast, sales taxes jumped by 30.6% over the first 10 months, marking the highest growth rate since at least 2017, and represents 30% of the BIR’s total revenues. Sales taxes vaulted by 31.6% in the first 9 months. (Figure 2, lowest chart)

The reason for focusing on the 9-month performance is to compare its growth rate with that of the PSEi 30, allowing for a closer understanding or providing a closer approximation of the BIR's topline performance.

Figure 3

Unfortunately, when using same-year data, the PSEi 30 reported a 9-month revenue growth of 8.1%, the slowest since 2021. This pattern is echoed in its net income growth of 6.8%, which is also the most sluggish rate since 2021. (Figure 3 upper window) 

To put this in perspective, as previously discussed, the 9-month aggregate revenues of the PSEi 30 represent approximately 27.9% of the nominal gross domestic product (NGDP) for the same period. 

IV. Q3 2024: 2nd Highest Revenue to NGDP, Headline GDP Weakens—The Crowding Out Effect? 

In its September disclosure, the Bureau of the Treasury cited changes in the VAT schedule as a key factor boosting tax collections: " 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" (Bureau of Treasury, October 2024) [bold added] 

Once again, the adjustment in VAT schedules played a pivotal role in increasing revenues, helping to reduce the deficit and debt—a topic we discussed in September 2024 (Prudent Investor, September 2024). 

Or, whether by design or as an unintended consequence, a critical factor in the slower deficit has been a shift in government tax collection and accounting procedures. 

But what will happen if, under the same economic conditions or with only slight improvements, the effects of such transient changes wear off? Will the deficit soar again? 

Moreover, it is important to note that all this is occurring while bank credit expansion and public debt are at record highs. 

What will happen to credit and liquidity-fueled demand once household and corporate balance sheets become saturated with leverage? 

It’s also noteworthy that, even as the share of revenue to nominal GDP (NGDP) reached its highest level in Q2 and Q3 of 2024, real GDP continues its downward trend—a dynamic that has persisted since 2016 and reemerged in 2021. (Figure 3, below graph) 

Are these not symptoms of the "crowding-out effect," where the increasing share of government interventions, measured by expenditures, debt, and deficits, translates into diminished savings and capital available for private sector investments? 

V. Record 10-Month Expenditure: The Push for "Big Government" 

But what about expenditures? 

Local Government Unit (LGU) spending surged by 11.97%, and national disbursement growth reached 14.3%, powering an overall increase in October expenditures of 11.1%. Interest payments, on the other hand, fell by 6.1%. The former and the latter two accounted for shares of 18.1%, 66.64%, and 11.9% of the total, respectively.

For the first 10 months of the year, expenditures grew by 11.5%, reaching a record-high Php 4.73 trillion, driven by LGU spending, National disbursements, and interest payments, which posted growth rates of 9.1%, 11.9%, and 23.03%, respectively.

As noted above, these record expenditures are primarily focused on promoting political agendas: pre-elections, a subtle shift towards a war economy, and an emphasis on centralization through infrastructure, welfare, and bureaucratic outlays.

Figure 4

One notable item has played a considerable role: 10-month interest payments not only outperformed other components in terms of growth but also reached a record high in peso terms. (Figure 4, topmost graph) 

Additionally, their share of total expenditures rose to levels last seen in 2009. 

That said, the ratio of expenditures to NGDP remains at 23.98% in Q2 and Q3 and has stayed within the range of 22% to 26%—except for two occasions—since Q2 2020. (Figure 4, middle chart) 

Over the past 18 quarters, this ratio has averaged 23.4%. 

As mentioned above, despite all the hype about achieving "upper middle income" status and attaining a "Class A" credit rating, the Philippines continues to operate under a fiscal stimulus framework, which has only intensified with recent policies which I dubbed as "Marcos-nomics stimulus."

In the timeless words of the distinguished economist Milton Friedman, "Nothing is so permanent as a temporary government program."

Current conditions also validate the "Big Government" theory articulated by the economist Robert Higgs, particularly regarding what he termed "The Ratchet Effect." This concept refers to the "tendency of governments to respond to crises by implementing new policies, regulations, and laws that significantly enhance their powers. These measures are typically presented as temporary solutions to address specific problems. However, in history, these measures often outlast their intended purpose and become a permanent part of the legal landscape." (Matulef, 2023)

The push towards "Big Government" is evident, with approximately a quarter of the statistical economy deriving from direct government expenditures.

This figure does not include the indirect contributions from private sector participation in government activities, such as public-private partnerships (PPPs), suppliers, outsourcing and etc. 

As a caveat, the revenue and expenditure-to-NGDP ratio is derived from public revenue and spending data and nominal GDP—an aggregate measure where government spending is calculated differently—potentially leading to skewed interpretations of its relative size. 

In any case, as the government grows, so too does its demand for resources and finances—all at the expense of the private sector, particularly micro, small, and medium enterprises (MSMEs), as well as the purchasing power of the average Filipinos, represented here as Pedros and Marias. 

While government fiscal health may provide some insights into its size, there are numerous hidden or immeasurable costs associated with its expansion: compliance costs, public sector inefficiencies, regulatory and administrative burdens, policy uncertainty, moral hazard, opportunity costs, reduced incentives for innovation, deadweight losses, productivity costs, economic distortions, social and psychological costs, and more.

VI. 10-Month Debt Servicing Costs Zoom to All-Time Highs!

Rising interest payments represent some of the symptoms of "Big Government."

What’s remarkable is that, in just the first 10 months of 2024, the cost of servicing debt (amortization plus interest) soared to an all-time high of Php 1.86 trillion—16% higher than the previous annual record of Php 1.603 trillion set in 2023. And there are still two months to go! (Figure 4, lowest visual)

Amortization and interest payments exceeded their 2023 annual figures by 25.3% and 1.65%, respectively. 

Notably, amortization payments surged by a staggering 760% in October alone, reaching Php 161.5 billion.

As a result, amortization and interest payments have already surpassed their full-year 2023 totals. However, because the government categorizes amortizations (or principal payments) as financing rather than expenditures, they are not included in the budget.

VII. Rising Foreign Denominated Debt Payments!

There's more to consider.

Figure 5

Payments (amortization + interest) on foreign-denominated debt in the first 10 months of 2024 increased by 52%, reaching a record high. This brought their share of total payments to 21.9%, the highest since 2021. (Figure 5, topmost chart)

Unsurprisingly, the government borrowed USD 2.5 billion in the end of August, likely to refinance existing obligations. Adding to this, authorities reportedly secured another $500 million loan from the Asian Development Bank last week in the name of "climate financing."

Nonetheless, these serve as circumstantial evidence of increased borrowing to fund gaps, reflecting the "synthetic dollar short" position discussed last week.

VIII. Despite Slower Increases in Public Debt, Little Sign of the Government Weaning Off Stimulus

Here’s where mainstream narratives often place emphasis: a slower deficit translates into slower growth in public debt. (Figure 5, middle graph)

In other words, a decrease in financing requirements or a reduction in the rate of increase in public debt decreases the debt/GDP ratio.

Authorities are scheduled to announce public debt data next week.

The apparent gaslighting of fiscal health suggests that authorities are employing tactical measures to improve macroeconomic indicators temporarily. These efforts seem aimed at buying time, likely in the hope that the economy will gain sufficient traction to mask structural weaknesses.

Still, while public debt continues to rise—albeit at a slower pace—bank financing of public debt through net claims on the central government (NCoCG), which began in 2015, appears to have temporarily plateaued. At the same time, the BSP's direct financing of the national government seems to have stalled. (Figure 5, lowest image)

However, none of these emergency measures have reverted to pre-pandemic levels.

The government shows no indication of weaning itself off the stimulus teats.

IX. Q3 2024: Public Debt to GDP rises to 61.3%

Unfortunately, the record savings-investment gap underscores a troubling reality: the GDP is increasingly propped up by debt.

While mainstream narratives highlight the prospect of a lower public debt-to-GDP ratio, they often fail to mention that public debt does not exist in isolation.

In the aftermath of the Asian Financial Crisis, the Philippine economy underwent a cleansing of its balance sheet, which had been marred by years of malinvestment. When the Great Financial Crisis struck in 2007-2008, the Philippine economy rebounded, aided by the national government’s automatic stabilizers and the BSP's easing measures.

However, during that period, the BSP mirrored the Federal Reserve's policy playbook, prompting the private sector to absorb much of the increased borrowing. This reduced the economy’s reliance on deficit-financed government spending and shifted the debt burden from the public to the private sector, enabling a decline in the public debt-to-GDP ratio.

Today, however, this is no longer the case.

Figure 6

Following the pandemic-induced recession, where bank credit expansion slowed, the government stepped in to take the reins, driving public debt-to-GDP to surge. As of Q3, it remained at 61.3%—the second highest level since 2021’s peak of 62.6% and the highest since 2004. 

Currently, despite high-interest rate levels, both public borrowing and universal commercial bank lending have been in full swing—resulting in a systemic leverage ratio (public debt plus universal commercial bank credit) reaching 108.5% of nominal GDP in 2023. 

This means that the government, large corporations, and many households with access to the banking system are increasingly buried in debt.  

In any case, debt is perceived by consensus as a "free lunch," so you hardly ever hear them talk about it. 

X. Conclusion: The Relentless Pursuit Of "Upper Middle Income" Status Resembles a Futile Obsession 

In conclusion, while current fiscal metrics may appear to show surface-level improvements, the government remains addicted to various free-lunch policies characterized by easy money stimulus. 

The government and elites will likely continue to push for a credit-driven savings-investment gap to propel GDP growth, leading to further increases in debt levels and necessitating constant liquidity infusions that heighten inflation risks. 

The establishment tend to overlook the crowding-out effects stemming from government spending (and centralization of the economy), which contribute to embedding of the "twin deficits" that require more foreign financing—ultimately resulting in a structurally weaker economy. 

The relentless pursuit of "upper middle income" status resembles a futile obsession—a "wet dream" driven more by the establishment’s obsession with benchmarks manifesting social signaling than substantive progress. 

For distributional reasons (among many others), the GDP growth narrative does not reflect the true state of the economy. 

Persistent self-rated poverty and hunger, widening inequality, elevated vacancies in the real estate sector, low savings rates, and stagnating productivity are clear indicators that GDP number benefits a select few at the expense of many. This, despite debt levels soaring to historic highs with no signs of slowing. 

Even the Philippine Statistics Authority’s (PSA) per capita consumer and headline GDP trendlines contradict the notion of an imminent economic or credit rating upgrade. 

While having the U.S. as a geopolitical ally could offer some support in the pursuit of cheaper credit through a potential credit upgrade, it is important to acknowledge that actions have consequences—meaning the era of political 'free lunches' are numbered. 

And do authorities genuinely believe they can attain an economic upgrade through mere technical adjustments of tax schedules and dubious accounting practices, akin to the "afternoon delight" and 5-minute "pre-closing pumps" at the PSEi 30? 

Yet because the political elites benefit from it, trends in motion tend to stay in motion, until… 

___

References 

Prudent Investor, September 2024 Fiscal Deficit Highlights the "Marcos-nomics Stimulus"; How Deficit Spending Drives a WEAKER Philippine Peso October 28, 2024 

Department of Budget and Management, THE BUDGETING PROCESS, March 2012, dbm.gov.ph

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

Prudent Investor, Philippine Government’s July Deficit "Narrowed" from Changes in VAT Reporting Schedule, Raised USD 2.5 Billion Plus $500 Million Climate Financing, September 1, 2024

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