The USD-PHP Breaks 59: BSP’s Soft Peg Unravels, Exposing Economic Fragility

 

Devaluing is a de facto default and the manifestation of the insolvency of a nation—Daniel Lacalle 

In this Issue

The USD-PHP Breaks 59: BSP’s Soft Peg Unravels, Exposing Economic Fragility 

Part I: The USD-Philippine peso Breach at Php59

IA. The Soft Peg’s Strain Finally Shows

IB. "Market Forces" or Managed Retreat?

IC. Gold, GIR, and the Mirage of Strength

ID. Historical Context: Peso Spikes and Economic Stress

Part II: The Savings–Investment Gap (SIG) Illusion

IIA. Savings–Investment Gap—a Flawed Metric and Free Lunch Spending

IIB. Misclassified Investment, ICOR and the Productivity mirage

Part III: Soft Peg Unravels: Systemic Fragility Surfaces, Confidence Breakdown

IIIA. The Keynesian Hangover: How "Spending Drives Growth" Became National Pathology

IIIB. Credit-Fueled Consumption and Fiscal Excess: Twin Deficits

IIIC. CMEPA and the Deepening of Financial Repression: How the State Institutionalized Capital Flight

IIID. Corruption as Symptom, Not Cause: The Flood Control Scandal and Malinvestment Crisis

IIIE. The Soft Peg's Hidden Costs: FX Regime as Subsidy Machine and Flight Accelerant

IIIF. Gold Sales Redux: The 2020–2021 Playbook Returns

IIIG. GIR Theater: Borrowed Reserves and Accounting Opacity, Slowing NFA and Widening BOP Gap

IIIH. Soft Peg Lessons: Where From Here? Historical Patterns and the Road to 62—or 67?

IV. Conclusion: Why This Time May Be Worse, the BSP is Whistling Past the Graveyard 

The USD-PHP Breaks 59: BSP’s Soft Peg Unravels, Exposing Economic Fragility 

How the BSP’s widening savings–investment gap, soft peg, flood control response left the peso exposed—and what it reveals about the Philippine economy.

Part I: The USD-Philippine peso Breach at Php59 

IA. The Soft Peg’s Strain Finally Shows 

This is what we posted at X.com 

After three years, $USDPHP breaks the BSP’s 59 Maginot line. What cracked it?

• 👉 Record savings–investment gap (BSP easing, deficit spending, CMEPA)
• 👉 BSP soft peg (gold sales)
• 👉 Capital controls fueling flight
• 👉 Weak economy + high debt 

The soft peg’s strain finally shows. 

After three years of tacit defense, the BSP’s 59.00 line cracked on October 28. Yet it closed the week—and the month—at 58.85, just below what we’ve long called the BSP’s ‘Maginot line.’ 

IB. "Market Forces" or Managed Retreat? 

The BSP and media attributed the breach to “market forces.” But if the peso’s rate is truly market-determined, why issue a press release at all? To reassure the public? Why the need for reassurance? And if the breakout were merely “temporary,” why frame it at all—unless the goal is to condition perception before the markets interpret the breach as systemic or draw their own conclusions?

Figure 1

Another dead giveaway lies in the BSP’s phrasing: it “allows the exchange rate to be determined by market forces.” (Figure 1, upper image)

That single word—allows—is revealing. 

It presupposes BSP supremacy over the market, implying that exchange rate movements occur only at the central bank’s discretion. FX determination, in this framing, is not a spontaneous process but a managed performance. Market forces operate only within the parameters permitted by the BSP. “Allowing” or “disallowing” thus reflects not market discipline, but bureaucratic control masquerading as market freedom. 

Yet, the irony is striking: they cite “resilient remittance inflows” as a stabilizer—even as the peso weakens. If OFW remittances, BPO earnings, and tourism inflows are as strong as claimed, what explains the breakdown? 

Beneath the surface, the pressures are unmistakable: thinning FX buffers, rising debt service, and the mounting cost of defending a soft peg that was never officially admitted.

IC. Gold, GIR, and the Mirage of Strength

Then there’s the gold angle. 

In 2024, the BSP was the world’s largest central bank seller of gold—offloading reserves to raise usable dollars. (Figure 1, lower chart)

Figure 2

Now, higher gold prices inflate its GIRs on paper—an accounting comfort masking liquidity strain. It’s the same irony we saw in 2021–22, when the BSP sold gold amid a pandemic recession and the peso still plunged. (Figure 2, upper graph) 

Adding to the drama, the government announced a price freeze on basic goods just a day before the peso broke Php 59. Coincidence—or coordination to suppress the impact? 

And there was no “strong dollar” to blame. The breakout came as ASEAN peers—the Thai baht, Indonesian rupiah, Singapore dollar, and Malaysian ringgit—strengthened. This was a PHP-specific fracture, not a USD-driven move. (Figure 2, lower table) 

ID. Historical Context: Peso Spikes and Economic Stress

Figure 3

Historically, sharp spikes in USDPHP have coincided with economic strain:

• 1983 debt restructuring
• 1997 Asian Financial Crisis
• 2000 dotcom bubble bust
• 2008–2010 Global Financial Crisis
• 2020 pandemic recession (Figure 3, upper window)

The BSP even admitted “potential moderation in economic growth due in part to the infra spending controversy” for this historic event. That makes reassurance an even more potent motive. 

Remember: USDPHP made seven attempts to breach 59.00—four in October 2022 (3, 10, 13, 17), three from November 21 and 26 to December 19, 2024. That ceiling revealed the BSP’s implicit soft peg. The communique doesn’t explain why the eighth breach succeeded—except to say it was “market determined.” But that’s just another way of saying the market has abandoned the illusion of BSP control. (Figure 3, lower diagram)

As I’ve discussed in earlier Substack notes, this moment was years in the making: 

• The widening savings–investment gap
• CMEPA’s distortions
• Asset bubbles, the creeping financial repression and fiscal extraction that eroded domestic liquidity 

The peso’s breach of 59 isn’t just a technical move. It’s the culmination of structural stress that monetary theater can no longer hide. 

Part II: The Savings–Investment Gap (SIG) Illusion

IIA. Savings–Investment Gap—a Flawed Metric and Free Lunch Spending 

Spending drives the economy.  That ideology underpins Philippine economic policy—from the BSP’s inflation targeting and deficit spending to its regulatory, tax, and FX regimes—and it has culminated in a record savings–investment (SIG) gap. 

This is the Keynesian hangover institutionalized in Philippine policy—confusing short-term demand management with sustainable capital formation 

But this is not merely technocratic doctrine; the obsession with spending anchors the free-lunch politics of ochlocratic social democracy. 

Yet even the SIG is a flawed metric. 

As previously discussed, “savings” in national accounts is a residual GDP-derived figure riddled with distortions, not an empirical aggregation of household or corporate saving. It even counts government savings—retained surpluses and depreciation allowances—when, in truth, fiscal deficits represent outright dissaving. (see reference) 

Worse, the inclusion of non-cash items such as depreciation and retained earnings inflates measured savings, masking the erosion of actual household liquidity.

IIB. Misclassified Investment, ICOR and the Productivity mirage 

Even the “investment” side is overstated. Much of it is public consumption misclassified as capital formation. Because politics—not markets—dictate pricing and returns, the viability of monopolistic political projects cannot be credibly established. 

Consider infrastructure. Despite record outlays, the Incremental Capital-Output Ratio (ICOR) has worsened—proof that spending does not equal productivity.

Figure 4

According to BSP estimates, the Philippines’ ICOR has fallen from around 8.3 in the 1989-92 period to approximately 4.1 in 2017-19, contracted by 12.7% and recovered to around 3.0 by 2022 (see reference) (Figure 4, topmost visual) 

While the ICOR trend suggests some efficiency gains since the 1990s, it remains a blunt and often misleading proxy—distorted by GDP rebasing, project misclassification, and delayed returns. What it does reveal, however, is the widening gap between spending and sustainable productivity 

Listed PPP firms, meanwhile, sustain appearances through leverage, regulatory capture and forbearance, and mark-to-model accounting. The result is concealed fragility, reinforced by the hidden costs of various acts of malfeasance, conveniently euphemized as by the public as “corruption.” 

In the end, the SIG tells a simple truth: domestic savings are too scarce to fund both public and private investment. The gap is bridged by FX borrowing. 

But this is not a sign of strength—it’s a symptom of deepening structural dependence, masked by monetary theater and fiscal illusion, thus amplifying peso vulnerability. Every fiscal impulse now imports external leverage, entrenching the illusion of growth at the expense of stability. 

Part III: Soft Peg Unravels: Systemic Fragility Surfaces, Confidence Breakdown 

IIIA. The Keynesian Hangover: How "Spending Drives Growth" Became National Pathology 

Spending-as-growth isn’t just policy—it’s pathology.

While the BSP’s mandate is "to promote price stability conducive to balanced and sustainable growth," its inflation-targeting framework—tilted toward persistent monetary easing—has effectively become a GDP-boosting machine to finance free-lunch political projects. 

Banks have realigned their balance sheets accordingly. Consumer loans by universal and commercial banks rose from 8.2% of total lending in December 2018 to 13.5% in August 2025—a 64% surge—while the share of industry loans declined from 91.7% to 86.5% over the same period. (Figure 4, middle pane) 

Fueled by interest rate subsidies and real income erosion, households are leveraging aggressively to sustain consumption. Yet as GDP growth slows, the marginal productivity of credit collapses—meaning every new peso of debt generates less output and more fragility for both banks and borrowers. 

Production credit’s stagnation also forces greater import dependence to meet domestic demand.

IIIB. Credit-Fueled Consumption and Fiscal Excess: Twin Deficits 

Meanwhile, deficit spending—now nearing 2021 pandemic levels—artificially props up consumption at the expense of productivity gains. (See reference for last week’s Substack.) 

Together, credit-fueled consumption and fiscal excess have produced record "twin deficits." (Figure 4, lowest chart) 

The fiscal deficit widened from Php 319.5 billion in Q2 to Php 351.8 billion in Q3, while the trade deficit expanded from USD 12.0 billion to USD 12.76 billion—levels last seen in 2020. 

Historically, fiscal deficits lead trade gaps—it raises import demand. If the budget shortfall hits fresh records by year-end, the external imbalance will likely push the trade deficit back to its 2022 peak.

Figure 5

These deficits are not funded by real savings but by credit—domestic and external. The apparent slowdown in approved public foreign borrowings in Q3 likely masks rescheduling (with Q4 FX borrowings set to spike?), delayed recognition, shift to BSP-led financing (to reduce scrutiny) or accounting prestidigitation (Figure 5, topmost diagram) 

Public external debt accounted for roughly 60% of the record USD 148.87 billion in Q2. Even if Q3 slows, the trajectory remains upward. (Figure 5, middle graph) 

In short, widening twin deficits mean more—not less—debt. 

Slowing consumer sales growth, coupled with rising real estate vacancies, signals that private consumption is already being crowded out—a deepening symptom of structural strain in the economy.

IIIC. CMEPA and the Deepening of Financial Repression: How the State Institutionalized Capital Flight

Yet the newly enacted CMEPA (Capital Market Efficiency Promotion Act, R.A. 12214) deepens the financial repression: it taxes savings, institutionalizes these by redirecting or diverting household savings into state-controlled channels or equity speculation, and discriminates against private-sector financing. By weakening the deposit base, it also amplifies systemic fragility. The doubling of deposit insurance last March, following RRR cuts, appears preemptive—an implicit admission of the risk CMEPA introduces. 

Authorities embraced a false choice. Savers are not confined to pesos—they can shift to dollars or move capital abroad entirely. Capital flight is not theoretical; for the monied class, it can be a reflexive response. 

IIID. Corruption as Symptom, Not Cause: The Flood Control Scandal and Malinvestment Crisis 

The recent “flood control” corruption scandal has merely exposed the deeper rot. 

Consensus recently blames the peso’s fall and stock market weakness on “exposed corruption.” But this is post hoc reasoning: both the peso and PSEi 30 peaked in May 2025—months before the scandal broke. (Figure 5, lowest image)

Corruption, as argued last week, is not an aberration—it’s embedded or a natural expression of free-lunch social democracy 

It begins at the ballot box and metastasizes through centralization, cheap money, financial repression, the gaming of the system and rent-seeking. It explains the entrenchment of political dynasties and the extraction economy they operate on. 

What media and the pundits call “corruption” is merely the visible tip. The deeper pathology is malinvestment—surfacing across: 

• Bank liquidity strains
• Wile E. Coyote NPLs
• Record real estate vacancies
• Slowing consumer spending despite record debt
• Cracks in employment data
• Persistently elevated self-rated poverty ratings (50% + 12% borderline as of September).
• Stubborn price pressures and more… 

The BSP’s populist response to visible corruption? 

Capital controls, withdrawal caps, probes, and virtue signaling. These have worsened the erosion of confidence, potentially accelerating the flight to foreign currency—and escalating malinvestments in the process. (see reference) 

What emerges is not just structural decay, but a slow-motion confidence collapse. 

IIIE. The Soft Peg's Hidden Costs: FX Regime as Subsidy Machine and Flight Accelerant 

And there is more. The BSP also operates a de facto FX soft-peg regime. 

By keeping a lid on its tacit thrust to devalue, its implicit goal is not merely to project macro stability, but to subsidize the USD and manage the CPI within its target band. Unfortunately, this policy overvalues the peso, encouraging USD-denominated borrowing and external savings while providing the behavioral incentive for capital flight.

Figure 6

Including public borrowing, the weak peso has prompted intensified growth in the banking system’s FX deposits. In August 2025, FX deposits rose 11.96%—the second straight month above 10%—reaching 15.07% of total bank liabilities, the highest since November 2017. (Figure 6, topmost window) 

The BSP’s FX regime also includes its reserves management—Gross International Reserves (GIR).

IIIF. Gold Sales Redux: The 2020–2021 Playbook Returns 

As noted above, similar to 2020–2021, the BSP embarked on massive gold sales to defend the USDPHP soft peg. Yet the peso still soared 22.97% from 47.90 in May 2021 to 58.9 in September 2022. That pandemic-era devaluation coincided with a CPI spike—peaking at 8.7% in January 2023. The 2024 gold sales echo this pattern, offering a blueprint for where USDPHP could be heading. 

The BSP insists that benchmarks like the GIR assure the public of sufficient reserves. Yet it has never disclosed the composition in detail. Gold—which the BSP remains averse to—accounts for only ~15% of the GIR (September). A former BSP governor even advocates selling gold "to profit” from it." (2020 gold sales and devaluation occurred in his tenure) 

But since the BSP doesn’t operate for profit-and-loss, but for political objectives such as "price stability," this logic misrepresents intent.

IIIG. GIR Theater: Borrowed Reserves and Accounting Opacity, Slowing NFA and Widening BOP Gap 

A significant portion of GIR—around 5%—consists of repos, derivatives, and other short-term instruments classified as Other Reserve Assets (ORA), introduced during the 2018 peso appreciation. Not only that: national government borrowings deposited with the BSP are also counted as GIR. Hence, “borrowed reserves” make up a substantial share. (Figure 6, middle graph) 

If reserves are truly as strong as officially claimed, why the peso breakout—and the need for a press release? 

All this is reflected in the stagnating growth of BSP net foreign assets (NFA) since 2025, reinforcing a downtrend that began in 2013. While nominally at Php 6.355 trillion, NFA is down 2.1% from the record Php 6.398 trillion in November 2024. (Figure 6, lowest diagram)

Figure 7

This fragility is also evident in the balance of payments (BOP) gap. Though narrowing in recent months, it reached USD 5.315 billion year-to-date—its highest since the post-pandemic recession of 2022. That’s 67% of the November 2022 peak. (Figure 7, topmost graph) 

The apparent improvement merely reflects deferred pressure—delayed borrowings and import compression. 

Despite BSP claims, net outflows reflect more than trade gaps. They signal external debt servicing amid rising leverage, capital flight, and systemic strain.

IIIH. Soft Peg Lessons: Where From Here? Historical Patterns and the Road to 62—or 67? 

Last March, we wrote: 

The USDPHP exchange rate operates under a ‘soft peg’ regime, meaning the BSP will likely determine the next upper band or ceiling. In the previous adjustment, the ceiling rose from 56.48 in 2004 to 59 in 2022, representing a 4.5% increase. If history rhymes, the next likely cap could be in the 61–62 range. (see reference) 

At the time, our lens was historical—measuring breakout levels from 2004 to 2022 and projecting forward to 2025. 

But as noted above, USDPHP spikes rarely occur in a vacuum. They tend to coincide with economic stress. Using BSP’s end-of-quarter data, we find: (Figure 7, middle table) 

• 1983 debt restructuring: +121% over 12 quarters (Q1 1982–Q1 1985)
• 1997 Asian Financial Crisis: +66.15% over 6 quarters (Q1 1997–Q3 1998)
• 1999–2004 dotcom bust: +30.6% over 20 quarters (Q2 1999–Q1 2004)
• 2007–2009 Global Financial Crisis: +16.95% over 5 quarters (Q4 2007–Q1 2009)
• 2020–2022 pandemic recession: +22.64% over 7 quarters (Q4 2020–Q3 2022) 

While the USDPHP also rose from 2013–2018, this episode was largely driven by the Fed’s Taper Tantrum, China’s 2015 devaluation, and Trump-era fiscal stimulus—with no comparable economic event.

IV. Conclusion: Why This Time May Be Worse, the BSP is Whistling Past the Graveyard 

The current moment is different. 

Using the post-2022 low—Q2 2025 at 56.581—as a base, a 10% devaluation implies a target of 62.24. But with the late-cycle unraveling, a weakening domestic economy, and rising debt burdens, the odds tilt towards a deepening of stagflation—or worse. If the peso mirrors its pandemic-era response, a 20% devaluation to 67.90 is not far-fetched. 

Even the BSP now concedes "potential moderation in economic growth." 

Yet it continues to cite “resilient inflows” like tourism. The Department of Tourism data tells another story: as of September 2025, foreign arrivals were down 3.5% year-on-year—hardly a sign of strength. (Figure 7, lowest chart) 

Otto von Bismarck’s maxim applies: 

Never believe anything in politics until it has been officially denied. 

Hounded by diminishing returns and Goodhart’s Law—where every target becomes a distortion—the BSP clings to benchmarks that no longer signal strength. From the USDPHP to GIR composition, Net Foreign Assets, and FX deposit ratios, the metrics have become theater. The more they’re defended, the less they reflect reality.

In the face of unraveling malinvestments, deepening institutional opacity, and accelerating behavioral flight, the BSP is whistling past the graveyard. 

Caveat emptor. The illusion is priced in.  

____ 

References 

Bangko Sentral ng Pilipinas, Discussion Paper Series No. 2024-10: Estimating the Incremental Capital Output Ratio (ICOR) for the Philippines, Towards Greater Efficiency: Estimating the Philippines’ Total Factor Productivity Growth and its Determinants BSP Research Academy, June 2024. 

Prudent Investor Newsletters: 

When Free Lunch Politics Meets Fiscal Reality: Lessons from the DPWH Flood Control Scandal, Substack, September 07, 2025 

The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback, Substack, July 27, 2025 

The Seen, the Unseen, and the Taxed: CMEPA as Financial Repression by Design, Substack, July 27, 2025 

The Philippine Flood Control Scandal: Systemic Failure and Central Bank Complicity, Substack, October 05, 2025 

The Political Economy of Corruption: How Social Democracy Became the Engine of Decay, Substack, October 26, 2025 

BSP’s Gold Reserves Policy: A Precursor to a Higher USD-PHP Exchange Rate? Substack, March 03, 2025 

How the BSP's Soft Peg will Contribute to the Weakening of the US Dollar-Philippine Peso Exchange Rate, Substack, January 02, 2025 

June 2025 Deficit: A Countdown to Fiscal Shock, Substack, August 03, 2025

9-Month Balance of Payment Deficit Soars to Record! Incipient Signs of Capital Flight? As Expected, Peso Rallied; Price Controls Magnifies Inflation!

Economics does not say that isolated government interference with the prices of only one commodity or a few commodities is unfair, bad, or unfeasible. It says that such interference produces results contrary to its purpose, that it makes conditions worse, not better, from the point of view of the government and those backing its interference—Ludwig von Mises

In this issue

9-Month Balance of Payment Deficit Soars to Record! Incipient Signs of Capital Flight? As Expected, Peso Rallied; Price Controls Magnifies Inflation!

-Record 9-Month Balance of Payment Deficit: Incipient Signs of Capital Flight???

-How International Reserve Influences the BSP’s Domestic Policies

-USD Dollar Tightening Equals Domestic Peso Tightening?

-Conclusion: The Peso’s Rally is Temporary

-Lower CPI? Price Controls Would Destabilize the Supply Chain! Build, Build and Build Prices Show No Sign of Reprieve!

-IMF on the Remittance Trap: OFW Remittances Benefit the Government and Not the Economy!

9-Month Balance of Payment Deficit Soars to Record! Incipient Signs of Capital Flight? As Expected, Peso Rallied; Price Controls Magnifies Inflation!

Record 9-Month Balance of Payment Deficit: Incipient Signs of Capital Flight???

As expected, the peso staged a significant rally. [See The BSP in a Panic: Drastically Hikes Policy Rates and Slashes Deficit Financing To Curb Demand as M3 Growth Plunges! (October 1, 2018)]

The peso was this week’s best performer in Asia. The USD peso dropped .79% to 53.7.

But policies that paved the way for this week’s rally came at a significant price.

From the Inquirer: With the central bank forced to cushion the fall of the peso, the Philippines experienced a surge in dollar outflows last month that aggravated the already yawning trade gap caused by the country’s large imports and weak exports, authorities said on Friday. The Bangko Sentral ng Pilipinas (BSP) said that the overall balance of payments (BOP) position posted a deficit of $2.7 billion in September, marking a reversal of the $24-million surplus recorded in the same month last year. These outflows “stemmed mainly from foreign exchange operations of the BSP and payments made by the national government for its foreign exchange obligations,” the BSP said, the former referring to the monetary authority’s selling of dollars in the open market to meet the foreign currency demand from investors or end-users.”

Figure 1

The September BOP deficit was the second biggest monthly deficit since January 2014 and the largest year-to- date deficit since at least 1999. (figure 1, topmost pane)

The Bangko Sentral ng Pilipinas defined its Balance of Payment as “a summary of the economic transactions of a country with the rest of the world for a specific period.” Economic transactions of which are “grouped into three major categories: (1) current account, (2) capital account, and (3) financial account.”

The current account includes merchandise and services trade (e.g. BPOs), primary income which constitutes OFW, and profit remittances along with gifts, grants and donations.

The capital account captures the investment aspects consisting of capital transfers and acquisition and disposal of nonproduced, nonfinancial assets between residents and nonresidents, as well as grants and donations investment (i.e., machinery and equipment, buildings and structures).

Direct investments, portfolio investments and other investments comprise the Financial account.

From the current account perspective, the following may have influenced the spike in the September BOP deficit:  

The trade deficit, which was last at USD 3.514 billion in August, could have swelled materially in September. (I showed the chart last week) If it hasn’t then other factors may be at work

Surpluses from services exports provided little in alleviating the onus of burgeoning trade deficits. Put bluntly, BPOs haven’t been of help.  

The declining growth trend of OFW remittances has been VALIDATING what I have been predicting here for some time. OFW remittances contracted in August which reduced year to date growth to a paltry 2.4% for personal and 2.5% for cash. (figure 1, lower window).

OFW remittances may have contracted by more in September! The plunging peso has hardly encouraged increased remittances. The health of the global economy may be deteriorating. (see the IMF’s take on OFW remittances discussion below)

The current account has been on a steep downtrend, which was last updated in June, the September spike entails a sharper downside. (figure 1 middle window)

If so, growth in the efflux through “profit remittances” and “gifts, grants and donations”, may have been material. If this is accurate, then a likely principal contributor to the September’s current account deficit may have been CAPITAL FLIGHT!

The National Government, the BSP, and media have been crowing about FDIs. True or not, inflows from the Financial Account have been insufficient to offset the current account deficit. And what if Financial Account has also posted a deficit, where domestic residents invested overseas more than the opposite?! If so this should be another channel for CAPITAL FLIGHT!

What does a current account deficit, the biggest contributor to the BOP deficit mean?

From the BSP: “If the current account balance is in surplus, the country is a “net lender” to the rest of the world in the amount of the surplus or the excess in the current account transactions. Net lending occurs when the national saving is more than the country’s investment in real assets. If in deficit, the country is said to be a “user of funds” and thus, is considered asnet borrower from abroad in order to fill in the shortage. In this case, the country invested more than what its national saving can finance.”  (bold mine)

So to finance investments (mostly public through build, build and build), the public and the private sector went into a borrowing spree in foreign exchange (of course)!!!!

That said, the Philippines exposure to US dollar shorts continue to amass!

Incredibly, this entails that the free lunches have become even more deeply entrenched in the actions of the mainstream!

How International Reserve Influences the BSP’s Domestic Policies

The BSP notes that the BOP has been consistent with the GIR standings.

Figure 2

The BSP expended significant amounts of international reserves to fund domestic dollar requirements and to intervene in the currency markets to shore up the peso. $6.4 billion or 7.9% of USD reserves have drained off the BSP in 2018. (see figure 2, topmost pane)

(Think where the USD peso would have been without it!)

And it is more than the record 9-month BOP deficit and the sharp fall GIR.

The sharp drop in forex reserves has also affected BSP’s domestic policies.

International reserves constituted 87% of the BSP assets (August 2018) exhibiting the ‘dollarization’ of the peso. The world operates on a de facto dollar standard, with the offshore dollar as its principal source of funding.

It also reveals that conditions of international reserve holdings influence significantly how the BSP conducts its domestic policies.

Having peaked in September 2016, the growth rate of BSP assets has been in a declining trend. BSP assets were down by 1.41% last August. (figure 2, center pane)

And BSP’s Reserve Deposits of Other Depository Institutions (or the banking system) have resonated with the declining trend in international reserves. The growth rate of the banking system’s deposit reserves slowed to a paltry .02% last August. (see figure 2, lowest window)

Figure 3

To further reinforce the diminished access to offshore dollars, US Treasury data reveals that US bank lending of various dollar instruments to domestic counterparties have been in decline since peaking in 2013. This downdraft in credit intermediation by US banks has coincided with the fall of the peso. The peso firmed when US banks expanded exposure on its domestic counterparties from 2009 to 2013. [see figure 3, upper window]

Reduced ‘dollars’ means either diminished expansion or a contraction of the BSP’s balance sheet.

Theoretically, there are three options available for the BSP. It may increase its domestic (peso) assets at the cost of the peso. It may allow the monetary base to decline to reflect on the reduced dollar supply. Lastly, it may decrease bank reserves through the trimming of the reserve requirement ratio (RRR), thereby allowing banks to use them to inject liquidity into the financial system. 

The BSP has cut RRR twice this year. Since the February announcement of the first RRR cut, the BSP’s reserve deposits declined by Php 61.47 billion or by 3.3%

Aside from reduced dollar supply, those RRR cuts were designed to ease the rapid draining of banking system’s liquidity. The banking system’s most liquid assets cash and due banks fell by 11.67% (year-on-year), but improved 2.62% (month-on-month) or by Php 63.5 billion in August. [figure 3, lower window]

Aside from RRR cuts, the marginal improvement of liquidity may have emanated from the banking system’s massive financing programs. [See The Crowding-Out: Wave of Announcements for Another Round of Massive Bank Financing! The Minsky Cycle to the Minsky Moment September 23, 2018]

Along with the government’s increased Treasury issuance to finance record deficit, these have resulted to the continuing decline in the growth rates peso deposits (+10.12% in August, +10.37% July and +10.77% June) and foreign currency deposits (+4.78% in August, +8.43% July and +7.81% June)

USD Dollar Tightening Equals Domestic Peso Tightening?

And the reduced availability of offshore dollars has been mirrored by domestic liquidity.

 

Figure 4

Domestic Treasury yields continue to surge to underscore ongoing strains in local financial liquidity. IF the BSP-led Financial Stability Coordinating Council issued a warning in their Financial Stability Report on the escalating 3Rs based on lower rates to have “caused dislocations of crisis proportions have come as a surprise”, what more at the current pace of rate surges!

And there’s more.

The mid-curve has inverted with the 10-year benchmark to 2015 levels. Such inversion wouldn't be helpful to the banking system's margins.  

But it gets worst, surging Treasury yields means that the NG will have to pay more for its aggressive deficit financing. And this would compound on the cycle of higher deficits and rate increases.

What truly breathtaking developments!

Conclusion: The Peso’s Rally is Temporary

Back to the BSP.

For as long as the BSP aligns the conditions of its domestic assets with international reserves, liquidity in both USD and the peso will continue to tighten.

And the tightening of USD liquidity translates to an amplified US dollar ‘shorts’. US dollar shorts translate to an inadequate supply of offshore US dollars to satisfy the maturity transformation used by the financial system in carrying out commercial activities.  For instance, the cost of servicing of US dollar liabilities increases substantially.

If the BSP expands its domestic assets relative to its international reserve materially, the peso will drop.

Aside from massive interventions by the BSP in support of the peso, signs of capital flight may have worsened the BOP deficit in September

Importantly, in spite of the domestic tightening from market forces and belatedly from the BSP, the growing scarcity of cheap USD financing in the face of mounting external liabilities should translate to a weaker peso,

In both instances, the USD-Php’s fall or the peso’s rally should be temporary.

Buy the USD-Php!

Lower CPI? Price Controls Would Destabilize the Supply Chain! Build, Build and Build Prices Show No Sign of Reprieve!

If NG doesn’t cease from disrupting price discovery in the marketplace the publicized efforts to contain the CPI would have the opposite results.

The leadership tells the public that they would wonderfully allow “anyone can import rice”. However, demonstrated preferences reveal that such an assertion hasn’t been true.

In a bidding last week, only four companies, reported the Inquirer, “were able to qualify in the National Food Authority’s (NFA) bidding process yesterday for the purchase of 250,000 metric tons (MT) of rice as most companies were not able to meet the agency’s reference price”. 

Disputing claims that the leadership authorized “unimpeded importation”, the NFA enforced his authority over rice imports as revealed by last week's bidding.

Really? A neo-socialist government would embrace liberalization?

But the more significant aspect has been the imposition of direct and implied price controls.

After bread prices started to increase in early October, officials of the Department of Trade and Industry ‘met separately…with flour and bread associations”, where the latter “committed to hold on to prevailing prices”.  

The DTI has also been reported to impose controls on prices of Noche Buena goods. From Philstar: “The Department of Trade and Industry (DTI) has released the suggested retail price (SRP) for Noche Buena products to allow consumers to plan their purchases for the Christmas season... Castelo added that manufacturers need to submit data to DTI for price analysis and confirmation before any new adjustment on SRP may be made.”

Lower rice prices, it has been held, would be brought about by harvests and by rice imports.

But why the heck would they have to do this?

From the Inquirer: “Starting next Tuesday (Oct. 23), rice could only be labeled as local or imported regular-milled rice and well-milled rice, and special rice. “There will be no more use of Sinandomeng, fake Dinorados, no more Super Angelica, no more yummy rice. Everybody is selling fake Dinorado, people are claiming Sinandomeng, which we don’t have a rice variety of such kind,” the secretary said. Local regular-milled and well-milled rice will be sold at P39 and P44 a kilogram, respectively, while imported regular-milled and well-milled rice will be sold at P37 and P40 a kilo, respectively. Special or fancy rice variants such as Jasmine and Japanese, however, will not be regulated…This is not the first time that the agency resorted to imposing SRPs to regulate prices. Earlier this year, DA imposed a price point for regular-milled rice at P39 a kilo with the help of private traders. This was in response to the call of President Duterte to provide an affordable option for rice.”

So if earlier price controls didn’t work, doubling down would do the trick then?

And price controls will extend to other commodities: “Other commodities with imposed SRPs include chicken and sugar. A kilo of chicken will be sold based on its farm-gate price with an additional mark-up of P50, while a kilo of sugar will be sold at P55.Traders and retailers who will sell beyond the 10-percent margin allowed on the SRP face a jail term of five to 15 years and fines of up to P1 million, based on the Price Act of 1992.”

While a monetary induced demand shock can ripple through the supply chain and cause a second order supply shock, price interdictions will exacerbate supply chain disruptions even when demand goes down.  Differently put, price controls cause supply shocks that incite price dislocations.  

The President pretentiously calls for the axing of inflation inducing executives, but then aside from money printing and price controls, this week the Land Transportation Franchising and Regulatory Board (LTFRB) increased fare prices of jeepneys andbuses. Ironically, one LTFRB official said that fare increases would have inflationary effects.

As I predicted last June,

When the going gets tough, palpably, implicit price controls will morph into explicit policies.  

See Inflation Has Hardly Been About the TRAIN Law; The Credit and Liquidity Cure Can Be Worse Than The Tax Disease! June 4, 2018

Because the mainstream sees inflation as a statistical construct rather than real life developments, political measures have been directed to address such statistics.

Figure 5

What they sorely miss is how those money printing operations from the banking system and from the BSP to finance build, build and build have functioned as the epicenter of the inflation.

Despite the bank induced M3 decline, “build, build and build” construction material wholesale prices have even inched higher to8% in September from 7.9% in August. (figure 5, upper window).

The CPI has been highly correlated with build, build and build prices. (figure 5, middle window). Both sprinted up at the same time!

Money spent on grand infrastructure boondoggles, the first recipients of credit expansion, spread like wildfire in the economy. 

Plagued by lack of investments and by inherent obstacles as protectionism, the surge in demand from the “build, build and build” exposed the deficiency and upset the supply side response of the food industry.

Such should be an example of how demand shock had been transmitted into supply shock. 

In contrast, to build, build and build, the private sector, construction material retail prices remained steady at 2.0% in September.

Yet, what an amazing price gap: 8.0% wholesale prices vis-à-vis 2% retail prices!

It is like having a parallel world.

If the statistics are accurate then it shows that there is little sensitivity by the public sector on prices to bid away resources against the private sector. More than that, the vast differentials exhibit the pricing dysfunction in the construction industry which showcases seismic imbalances.

Free markets would have arbitraged away such enormous chasm.

Finally, the Philippine Statistics Authority published the Gross Revenue Index of Industries of the 2Q. To get the inflation-adjusted or real revenues and compensation numbers, I applied the 2012 CPI.

The statistics say that revenues and compensation in real terms have been declining sharply since 2016!

If one applies the 2006 CPI, compensation would have even contracted!

Whatever gains seen have from higher prices have been an illusion.

IMF on the Remittance Trap: OFW Remittances Benefit the Government and Not the Economy!

Let me now move back to remittances

As I have been saying here, remittance flows are hardly good signs of the economy.  The IMF concurs.

Here are their reasons. I have reservations to some of them, but given the time constraints, I’d leave this for future discussion. 

It does little help to the economy:  “here is increasing evidence of a remittance trap that causes economies to get stuck on a lower-growth, higher-emigration treadmill….Lebanon is not an isolated example. Of the 10 countries that receive the largest remittance inflows relative to their GDP—such as Honduras, Jamaica, the Kyrgyz Republic, Nepal, and Tonga—none has per capita GDP growth higher than its regional peers. 

It promotes higher price levels through the Dutch disease: “The flood of foreign exchange, along with higher prices, makes exports less competitive, with the result that their production declines. Some have referred to this syndrome as Dutch disease”

Dependency stifles entrepreneurial activities: “Part of the remittance trap thus appears to be the use of this source of income to prepare young people to emigrate rather than to invest in businesses at home. In other words, countries that receive remittances may come to rely on exporting labor, rather than commodities produced with this labor”

Dependency reduces the work force: “by increasing the so-called reservation wage—that is, the lowest wage at which a worker would be willing to accept a particular type of job. As remittances increase, workers drop out of the labor force, and the resulting increase in wages puts more upward pressure on prices, further reducing the competitiveness of exports.”

It contributes to the inflation of asset bubbles: “To make matters worse, remittances are often spent on real estate, causing home prices to rise and in some cases stoking property bubbles.” Hmm sounds familiar?

It diminishes the political involvement of the recipient families: “The reasoning is simple: families that receive remittances are better insulated from economic shocks and are less motivated to demand change from their governments;government in turn feels less obligated to be accountable to its citizens.”

It rewards poor governance: “To the extent that governments tax consumption—say through value-added taxes—remittances enlarge the tax base. This enables governments to continue spending on things that will win them popular support, which in turn helps politicians win reelection. Given these benefits, it is little wonder that many governments actively encourage their citizens to emigrate and send money home, even establishing official offices or agencies to promote emigration in some cases. Remittances make politicians’ job easier, by improving the economic conditions of individual families and making them less likely to complain to the government or scrutinize its activities. Official encouragement of migration and remittances then makes the remittance trap even more difficult to escape.” Amen to this!