Governments love inflation. It is a hidden tax on everyone and a transfer of wealth from bank deposits and real wages to indebted governments that collect more receipts via higher indirect taxes and devalue their debts. That is why we cannot expect governments to take decisive action on inflation—Daniel Lacalle
In this issue
The BSP Panics: Imposes Biggest Rate Hike Ever in an Emergency Session! US Recessions Pull the Philippine GDP Lower
I. The BSP Panics: Imposes Biggest Rate Hike Ever in an Emergency Session! The BSP’s NO Exit Strategy
II. Nothing Is So Permanent as a Temporary Government Program and the Ratchet Effect in Motion!
III. Why the Philippine Economy Won’t Outgrow its Debt
IV. How Strong is the Political Economy to Confront Higher Rates from Stagflationary Forces?
V. US Recessions Pull the Philippine GDP Lower; the Philippines will NOT Escape a Global Recession
VI. Despite the Biggest Rate Hike Ever and Market Interventions, USD Peso Retests the 2005 High
The BSP Panics: Imposes Biggest Rate Hike Ever in an Emergency Session! US Recessions Pull the Philippine GDP Lower
In this outlook, we explain the following:
-8 signs which showed the BSP panicked into imposing the "biggest rate hike ever."
-One of the reasons is that monetary authorities view easy money as a permanent fixture. And authorities are implementing more and more interventions to sustain this regime. They keep digging the hole deeper.
-The idea that the economy is about to outgrow debt represents an unalloyed bunk.
-The economy reeling from recession, impeded by increasing interventions and lack of buffers, is more fragile than robust.
-The domestic economy will not decouple from the world economic developments.
-The first test of the BSP's "biggest rate hike ever," whose goal was to tame the USD peso, has yet to work.
I. The BSP Panics: Imposes Biggest Rate Hike Ever in an Emergency Session! The BSP’s NO Exit Strategy
Last week, the BSP implemented a stunner...
Businessworld, July 15: BSP Governor Felipe M. Medalla said the Monetary Board raised its key rate to 3.25%, effective immediately, which brought back the rate to the March 2020 level. This latest move is the BSP’s biggest rate hike ever. Rates on the overnight deposit and lending facilities were also hiked by 75 bps to 2.75% and 3.75%, respectively. “In raising the policy interest rate anew, the Monetary Board recognized that a significant further tightening of monetary policy was warranted by signs of sustained and broadening price pressures amid the ongoing normalization of monetary policy settings,” Mr. Medalla said in a Facebook Live on Thursday morning. The BSP’s surprise move came ahead of its regular policy meeting scheduled on Aug. 18, and follows two 25-bp rate hikes each in May and June. The Monetary Board has raised benchmark interest rates by a total of 125 bps so far this year. This was also the central bank’s first off-cycle move since April 16, 2020, when it cut rates by 50 bps to 2.75% to support the pandemic-hit economy.
Do you remember?
"Transitory" was the initial rationalization of mounting inflation.
For instance, the BSP predicted in late 2021 that there would not be second-round effects on inflation.
But the sustained upside momentum of their CPI prompted a continuing shift in their justification. Thus, "supply-driven" or "cost-push" and "imported" became the culprits.
Yet surprisingly, the newly appointed BSP chief defended their baby steps stance a day before the historic rate hike.
Businessworld, July 13: The Bangko Sentral ng Pilipinas (BSP) on Tuesday assured financial markets that appropriate policy action “will be taken when needed in a preemptive fashion,” as the Philippines continues to face external headwinds. BSP Governor Felipe M. Medalla said the markets should accept volatility and “live with it.” “People don’t want to hear that our tools are not very good in addressing supply shocks…They, or at least the noisier part of the gallery, also want us to raise interest rates much more in response to what was initially unanticipated US monetary policy hawkishness,” he said in his opening remarks during the 2022 BSP International Research Fair.
"Never Believe Anything Until It Is Officially Denied," validated anew! (Prudent Investor Newsletter, 2022)
Yet the quoted articles provide a poignant viewpoint of the politics operating behind the BSP.
1. Off-cycle represents euphemisms for the BSP’s emergency meetings.
2. The BSP admits that 'sustained and broadening' price pressures are neither transitory nor exclusively a supply-side dynamic.
Figure 1
3. By raising its cost, the BSP implicitly admits that monetary aspects or credit expansion are likewise the principal drivers of price pressures.
Kaboom!
Rate hikes have stalled bank credit growth in 2011 and 2014; it aggravated the downturn in 2018. (Figure 1, topmost window)
It will also raise the debt servicing cost for public debt.
For a credit-dependent economy, the rate hikes will most likely reduce GDP performance or lead to a recession.
4. Its newly appointed chief was annoyed by pressure groups from the 'noisier part of the gallery.' So while insisting on data-driven policies, some influential entities, and unlikely the referenced group, may have lobbied to alter the course of the BSP.
5. Even as a concession, why impose the "biggest rate hike ever" in an emergency session?
The historic rate hike is an admission that the CPI vastly understates the actual conditions; through direct and indirect price controls, biased samples, changing base rates, and other statistical artifices.
6. In the 2018 episode, the BSP increased its policy rates by 175 bps from 3% to 4.75% in 7 months. The BSP has raised 125 bps in the last three months and has proposed raising rates anew this August! And so, if the BSP does raise rates by 50 bps in August, it would have matched the 2018 rate increases but in just four months!
7. Yet, the spread of the 10-year treasury yield and the ON RRP of the BSP has surpassed the peak of 2018. How is the "biggest rate hike ever" a "preemptive fashion" policy when it is staggeringly "behind the curve?" (Figure 1, second to the highest pane)
Why the sudden rate hikes when numerous indicators in the treasury markets have consistently warned about mounting price pressures?
The treasury and currency markets have forced the BSP to play catch up.
8. Data is history or backward-looking. Monetary policies should be forward-looking. Or, when policies deal with the past than the future, it increases the risk of errors. This Wall Street adage applies: Past performance does not guarantee future outcomes.
More worryingly, this episode shows that impulses drive the decisions of the BSP, with power peddlers influencing their policies!
A panicked BSP means that the goal of its policy focus has been on the present predicament without dealing with its roots.
The gist is that the no exit strategy seemingly represents the BSP's overall strategy, so they have been winging it or making it up as they move along.
II. Nothing Is So Permanent as a Temporary Government Program and the Ratchet Effect in Motion!
Like its global peers, the BSP believes in free lunches. It sees easy money policies as the long-term path of development. It sees debt accumulation and the inflation tax as necessary components of growth.
Therefore, they spin away price pressures as an anomaly.
When has the BSP exited from its low-rates regime?
Since 2015, when has the BSP reversed its indirect QE channeled through the banking system? (Figure 1, second to the lowest window-left)
Businessworld, June 14: THE BANGKO Sentral ng Pilipinas (BSP) on Monday said it will reconfigure its government securities (GS) purchasing window into a regular liquidity facility under the interest rate corridor (IRC) framework. “Reconfiguring the GS window into a regular liquidity facility that can operate under normal and crisis conditions ensures consistency with overall monetary strategy,” BSP Governor Benjamin E. Diokno said at his weekly press briefing. “This is consistent with the BSP’s thrust to develop a broad range of instruments and new operating procedures to fight future crises.”
Stepping into the void of the growing slack in trading volume of the Philippine treasury market, the BSP initiated the issuance and trading of its securities. (Figure 1, second to the lowest window-right)
Authorities claim that the National Government has partially paid its Php 300 billion debt to the BSP. But this has not been supported by BSP data. Its survey reveals an explosion of 'Liabilities to the Central Government' bolstered by the unchanged Treasury holdings in the BSP's balance sheet. (Figure 1, lowest window)
This data shows that as of March 2022, there was barely any repayment and that the reduction in the BSP's net claims was entirely from its diminished 'new' financing. Neither has the June data of the central bank survey exhibited this.
If our take is correct, this facility only sanitizes the liquidity interventions through accounting mirage.
But both the great Milton Friedman and the great Robert Higgs were correct.
The late Nobel laureate Milton Friedman famously asserted that "nothing is so permanent as a temporary government program." (Friedman, 1984)
The Austrian economist Robert Higgs also introduced the "Ratchet Effect': Governments have used crises to expand their control permanently.
The crisis-driven surge of government growth may be analyzed usefully in terms of a multi-phase ratchet effect.
Opportunists, both inside and outside the formal state apparatus, play distinctive roles during each phase of this phenomenon. Indeed, their actions create the ratchet effect. These opportunists pursue their objectives by means of new government personnel, new government policies, new government agencies, new statutes, and new court decisions.
When the crisis ends, some emergency agencies remain in operation; some emergency laws remain in force; and some court decisions reached during the crisis stand as precedents for future decisions, including decisions to be handed down in normal times. Above all, the populace goes forward with altered political and ideological sensibilities. (Higgs, 2009)
The entrenchment of such conditions fundamentally deepens the distortions in the financial spectrum, which should have spillovers to the real economy.
III. Why the Philippine Economy Won’t Outgrow its Debt
Neither a recession nor stagflation is not about to happen to the Philippines.
So claims the consensus, ironically, who has not seen the coming of the pandemic recession and this inflation crisis.
But because they control the Overton window, with the help of social media, these experts help shape the uncritical mindset of the vulnerable public.
Fundamentally, when economic agents represented by experts have issues on conflict of interests, like deals with the government and businesses relying on the solicitation of savings from the public, predicting a recession will not help their company's interests.
But of course, none of these experts ever disclose this.
Yet, a few rarely discovered independent analysts support an objective perspective of risks.
South China Morning Post, July 09: A failure to tamp down inflation – particularly of fuel prices – could leave the country vulnerable to a possible recession, said Ron Acoba, founder and chief investment strategist at Trading Edge Training & Consultancy. While fuel prices are subject to external pressure, he said they accounted for up to 38 per cent of the uptick in headline inflation and may spill over into food prices. There’s a risk … we fall back into a recession once again, Ron Acoba, Trading Edge Training & Consultancy founder…Acoba said that if inflation is not addressed and prices remain high as the economy attempts to rebound from pandemic-era shutdowns, people would have no money to spend and “there’s a risk … we fall back into a recession once again.”
Of course, for the people who lost incomes and jobs during the pandemic and have not recovered them since, the erosion of purchasing power signifies a double whammy.
But even for people with jobs and income or the (SME) entrepreneurs, the shrinking peso translates to diminishing disposal income, which means lower spending on non-necessities and possibly even reduced access to necessities.
Businessworld, July 13: SOARING PRICES of food and fuel are now forcing many white-collar Filipino workers to cut back on nonessential spending, which some experts say may affect businesses focused on leisure and recreational services. Marhiel Sofia D. Garrote, a 24-year-old content editor for a lifestyle magazine, recently ended her subscriptions to some digital platforms and reduced purchases of milk tea and coffee drinks.
GMA News, July 6: Fast-food giants Jollibee Group and McDonald’s Philippines have confirmed that some of their stores had been experiencing chicken supply challenges.
The sustained diffusion of price pressures across the economic spectrum affects economic calculation and coordination and disrupts the division of labor, resulting in resource and financial maladjustments.
Yet, the pricing system attempts to clear misallocations by informing the public of the current conditions.
The transport crisis exhibits such dislocations (industry, workers, passengers, and consumption) from rising fuel prices, price controls, and the sector's increased politicization.
And curiously, are bailouts of afflicted sectors; a sign of growth or economic distress?
If bailouts are growth, then war is peace, freedom is slavery, and ignorance is strength, right?
Authorities also tell us that debt shouldn't be a problem because the economy can "easily outgrow it."
But debt didn't come about in a vacuum. It is a product of the easy money regime embraced by the BSP to support the incumbent political-economic framework!
It is misleading to explain the economy from the limited perspective of public debt for the same reasons.
Figure 2
The reference to the decrease in the share of public debt to GDP wasn't because of a faster denominator. Instead, the private sector took up the principal role of leveraging from 2007 onwards. (Figure 2, topmost pane)
And when the banking system hit the proverbial wall in 2019, authorities stepped up on the plate of deficit spending resulting in the shift back to public debt as the epicenter of leverage.
Today, both the public and banks have increased the intensity of leveraging.
System leverage, composed of the lending portfolio of Universal and Commercial banks and public debt, reached a record Php 22.2 trillion or 106% of the estimated 8% NGDP last May. (Figure 2, second highest pane)
In 2021, system leverage reached a record Php 21.5 trillion representing a milestone of 110% of the GDP.
One would argue that the share of system leverage should be more considering the likely embellishment of the GDP. Further, this data excludes other forms of leveraging, such as shadow banks.
That is to say, the prospects of deflation would send chills down the spine of our central bankers. And so, either one or both sectors has to expand credit to boost the growth of the money supply.
And are we supposed to believe economic conditions will be unscathed by higher debt loads and rising debt services?
The public seems oblivious to the past Financial Stability Report by the BSP.
When the second wave of the CPI boomed in 2017-18, here is the warning from the late BSP Governor Nestor Espenilla Jr.: While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner. (BSP, 2017)
That was in 2017-18.
In the second edition of the Financial Stability Report, the erstwhile Governor Benjamin Diokno pointed out how rising debt pulled down earnings of the PSE-listed firms: Higher interest rates from 2018 to mid-2019 suggest that debt servicing should be examined further. Based on the audited financial statements of the 148 Philippine Stock Exchange (PSE)-listed non-financial corporations (NFCs), the growth of interest expense (IE) has outpaced the rise of earnings before interest and taxes (EBIT). In addition to the rate of growth, the ratio of IE to EBIT shows a rise from 14.5 percent at the start of the first quarter of 2016 to 22.6 percent as of March 2019, with a high of 27.8 percent in December 2017. The same companies have also reported lower profitability with respect to return on assets. (BSP, 2019)
Both viewpoints came about when the BSP rates hit a high of 4.75% in November 2018. Of course, it is not just the rate level but the degree of leverage.
The point of the above is to show how excessive debt impedes growth and magnifies risk.
IV. How Strong is the Political Economy to Confront Higher Rates from Stagflationary Forces?
Are conditions today better than in late 2018 when the BSP raised rates to 4.75%?
Total Universal and Commercial bank loans have surged by 23.28% from November 2018, the peak of the BSP rate increase through May 2022.
Total public debt rocketed by 73.67% over the same period.
As a result, system leverage vaulted by 47.364%.
On the other hand, real GDP remains down by 6.36% from Php 4.932 trillion in Q4 2018 compared with Php 4.62 trillion in Q1 2022.
Scarred by the last recession, how strong is the political economy to confront higher rates from stagflationary forces? Are the institutions and the people buffered by sufficient savings?
But the theoretical GDP-based Gross Savings Rate is adrift at the lowest point ever. (Figure 2, second to the lowest window)
Meanwhile, the Php 2.3 trillion liquidity injections of the BSP have failed to boost the savings rate of the banking system. The growth rate of savings and deposit liabilities has declined over the years in conjunction with the BSP's official rates. (Figure 2, lowest pane)
Such deterioration indicates how the easy money regime has stripped mined savers to the point that banks are now dependent on issuing debt and central bank financing for their operations.
The good news is that rising rates may induce increases in deposits!
Figure 3
Not to mention that trading losses hit a milepost, a multi-year low in May, while banks continue to camouflage part of this through Held-to-Maturity (HTM) assets, which again, in nominal terms, continue to etch record after record highs! (Figure 3, topmost and second to the highest panes)
The banking system remains on the BSP's lifeline. The existing relief measures prevent the public from knowing the banking system's actual health conditions.
What is visible is that the cash reserves of the banking system are deteriorating fast. The opposite direction between Treasury yields and cash reserves rates showcases the crowding out effect of savings from public spending and financing. (Figure 3, second to the lowest window)
And these are the conditions that can withstand adverse forces?
Yet, these rate hikes should hurt demand for loans, diminish the deposit expense (subsidy), increase investment losses from treasury holdings, and amplify risks of distressed credit. (Figure 3, lowest window)
And rate hikes are about to diminish the inflation tax and raise the debt servicing costs of public liabilities.
These are the reasons why the BSP has adamantly resisted hiking rates.
V. US Recessions Pull the Philippine GDP Lower; the Philippines will NOT Escape a Global Recession
But then, there's more.
A stagflationary recession and a financial crisis should soon engulf the world.
Unlike in the past, the present recession-crisis scenario will emerge from multiple centers, with the transmission mechanism occurring from the periphery to the core.
As noted last week, the economic meltdown of Sri Lanka could be one of the dominoes of the looming contagion in progress. (Prudent Investor Newsletter, July 2022)
The recession could slam the advanced economies of the US, Europe, the UK, China, Japan, and others soon.
But because of the interconnectedness, the feedback loop means that this recession could ricochet to the rest of the world, reinforcing the downturn that triggers a financial crisis.
Figure 4
History shows that when the US suffers from a recession, it pulls the Philippine GDP lower, but not necessarily into a recession, as seen in the dot-com bust of 2001, the Great Financial Crisis of 2008, and the 2020 Covid recession. But again, except for 2020, the dot-com bust and the GFC were about a US-centered recession.
With increased fragility, it should be interesting to see how a credit-dependent political economy (comprising the real estate, trade, banking, construction, and public spending sectors) withstands internal (rising rates from malinvestments) and external challenges (global recession).
Good luck to the believers of decoupling.
VI. Despite the Biggest Rate Hike Ever and Market Interventions, USD Peso Retests the 2005 High
Figure 5
The meltdown of the peso must have prompted the BSP's historic action.
If tempering the growth of the USD peso was the objective, the initial impact of emergency rate hikes has yet to deliver. (Figure 5, topmost pane)
Not only rate hikes, but the USD-peso experienced the same end-session dump (like in the PSE) a day before the announcement.
As a side note, although down by 2.62%, the local version of the Plunge Protection Team (PPT) rescued the domestic equity benchmark (PSEi 30) from the abyss with an incredible three-day mark-the-close pump amounting to about 3% of the other week's close. The banks and Sy companies were beneficiaries of intensive rescue efforts. Yet, the more the distortions, the greater the risks.
Back to the USD-peso.
Trading at 56.30 to 56.40s throughout, the USD peso plummeted to close at 56.26 last Wednesday. That is to say, the BSP and banks could have sold the USD and bought the peso at the closing bell. (Figure 5, middle window)
The local currency dropped further to close at 56.16 when the BSP announced its emergency "off-cycle" hikes.
Unfortunately, both measures had interim effects as the USD peso returned to test the 2005 highs and closed the week higher by .8% to 56.36.
By the way, the peso-USD nestles at the lows of 2004. (Figure 5, lowest pane)
The continuing slide of the peso will likely induce the BSP to raise rates anew in August.
A cornered BSP now faces a Hobson’s choice of "damned if you do, damned if you don't!"
_____
Bibliography
Prudent Investor Newsletter, Never Believe Anything Until It Is Officially Denied: US Recession, the Stable Peso, and Stagflation, June 20, 2022
Milton Friedman, “Tyranny of the Status Quo,” (1984) p. 115
Higgs Robert (2009), The Political Economy of Crisis Opportunism, Mercatus.org
BSP (June 2018) 2017 FINANCIAL STABILITY REPORT (p.27), bsp.gov.ph
BSP (September 2019) 2018 H1–2019 H1 FINANCIAL STABILITY REPORT (p.13), bsp.gov.ph
Prudent Investor Newsletter, The President and the Markets "Disagree" on the CPI; Global Financial Crisis Icebreaker: The Collapse of Sri Lanka, July 11, 2022
Yours in liberty,
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