"The reason social science calls itself a "science" is because of statistics. And their statistics are practically BS everywhere. I mean, really, everywhere." - Nassim Nicholas Taleb
In this issue:
Banking and Economic Fragility Before COVID-19, BSP’s Response: Php 400 Billion QE, and FIST! Copper Prices Breakout of 10-year Resistance!
I. Economic Recovery? The Past is the Roadmap to the Future
II. Structural Economic Weakness Before COVID-19
III. Banking Sector Fragility Before COVID-19: Rising NPLs and a Sharp Slowdown in Bank Credit Expansion
IV. BSP’s Bailouts: Massive Liquidity Injections from Cuts in Reserve Requirements and Quantitative Easing! QE Reaches Php 400 Billion!
V. Banks Raise Borrowing From Bonds, To Join Ranks of Property Sellers? Has the Real Estate Bubble Been Popped?
VI. How will the BSP Manage the Asset-Collateral Reflexive Cycle?
VII. The BSP Acknowledges Some of the Critical Shortcomings of MacroPrudential Policies!
VIII. Copper Prices Breakout of 10-year Resistance!
Banking and Economic Fragility Before COVID-19, BSP’s Response: Php 400 Billion QE, and FIST! Copper Prices Breakout of 10-year Resistance!
I. Economic Recovery? The Past is the Roadmap to the Future
Because we are coming to the rescue, the economy will recover soon!
From the Inquirer (September 11): The government’s “fiscally responsible” stimulus packages to address the health and socioeconomic crises inflicted by the COVID-19 pandemic will narrow economic contraction this year and create thousands of jobs, according to the country’s chief economist…Chua, who heads the state planning agency National Economic and Development Authority (Neda), later explained to the Inquirer that without the Bayanihan 1 and 2 packages, “the GDP contraction can be worse” in 2020.The economic team had projected GDP to shrink by 4.5-6.6 percent this year following an economic recession in the first half when output fell by an average of 9 percent.
From the CNN (September 11): President Rodrigo Duterte has signed into law the Bayanihan to Recover as One Act, which provides for a ₱165.5 billion fund for pandemic response and recovery. "We consider the Bayanihan II crucial in our efforts to gradually re-open the economy, support businesses and revitalize growth as we make our country resilient to COVID-19," said Roque in a statement. The stimulus plan consists of ₱140 billion worth of regular appropriations and an additional standby fund of ₱25.5 billion.
It’s best to understand the economic and financial conditions prior to the advent of COVID-19 and subsequent political response to it before we take their word as face value.
Study the past, counseled the Chinese Philosopher Confucius, if you would define the future.
The National Government recently released several critical information that provides clues of the conditions of the economy.
II. Structural Economic Weakness Before COVID-19
Figure 1
Though the national government allowed the loosening up of the economy, the slump in industrial production diminished moderately to -14.8% in July, compared to -16% in June and -27.3% in May.
And while the COVID-19 and the lockdowns contributed significantly to the recent meltdown, Industrial production has been in a contraction in 19 of the last 20 months. That said, though the GDP data hasn’t shown, the manufacturing sector has been flailing.
And its doldrums had also been manifested through exports, which plunged by 9.6% last July, an improved state though, compared to the -12.5% collapse in June and -26.9% in May.
Imports, on the other hand, dived by 24.4% in July, which was slightly worse compared to -23.1% in June but better than the -40.6% collapse in May.
The nation’s merchandise trade, the total of imports and exports, was plummeted 18.65% last July, was almost little change from June’s plunge of 18.73% but was least worse than the -35.3% last May. Stagnation has engulfed the nation’s merchandise trade in the 12 of the last 15 months through July.
Though exports outperformed imports, the nation’s merchandise trade registered a bigger USD 1.87 deficit last July, which should continue to pressure the nation’s USD supply.
Nonetheless, while losses haven’t been as deep in the 2Q, the performance of both industrial production and merchandise trade in the first month of the 3rd quarter suggests that the GDP will remain in a deep recession, which should be punctuated by a 2-week MECQ last August.
Here’s the thing. Manufacturing and imports represent supply-side conditions of the economy that provides a gauge to the conditions of domestic demand. But the NG’s data have pointed to lingering weakness antecedent to COVID-19, which has been consistent with slowing household consumption, increasingly being supported by credit, instead of productivity or income increases.
So except for providing bridge financing through increasing leverage of the private sector’s balance sheets, exactly how will the stimulus rectify the afflictions of the supply side in the face of dramatic alterations of the political-economic milieu from both COVID-19 and the quarantine regime?
Another interesting data recently presented by the PSA is domestic trade. The data is supposed to measure the "outflow value of commodities that goes out from a specified region/province to another region/province". And instead of surveys, according to the PSA, "the source documents for the coastwise trade statistics are the coasting manifests and coastwise passenger manifests from major ports and other active seaports listed by the Philippine Ports Authority all over the country. Air waybills, on the other hand, is the source document for air trade statistics issued by Philippine Airlines to every consignee".
The data’s weakness is that it lacks the coverage of rail transport, fishing and other marine products landed from the sea, cargoes carried by air carriers, lapses on manifest reports of ports, and airway bills. But this unappreciated data serves a relevant proxy to actual trade conditions within the country.
While it dived 69% in the 2Q YoY mainly due to the Community Quarantine regime, domestic trade has been surprisingly weak since the 4Q 2019. Domestic trade posted a 27.82% drop in 4Q 2019.
And since peaking in 3Q of 2016, the growth of domestic trade has been drudgingly southbound. That is, trade flows from the NCR to the different regions, and vice versa, as well as, intra-region trade has been slowing.
Ernest Hemingway once noted how bankruptcies occur, "gradually, then suddenly".
So the stagnation in intra-region or domestic trade has been reinforced and resonant with the stupor of the supply-side conditions preceding COVID-19 and the community quarantine regime. Gradually. The Community Quarantine regime exposed its inherent frailty. Suddenly.
The point is, while the consensus portrays the current recession as having been caused by a (COVID-19) shock, and thus the policy response of implementing stimulus to perceived affected areas, a critical mistake has been to overlook or dismiss the increasingly fragile economic condition preceding the pandemic.
That said, COVID-19 has indeed signified a shock, it has barely been the cause but a catalyst to an economy, vulnerable from the deepening entrenchment of severe maladjustments.
From a GDP perspective, the primary contributor to the pre-COVID economy has been public spending, which had been supported by rampant speculations in the real estate sector fueled by credit expansion.
III. Banking Sector Fragility Before COVID-19: Rising NPLs and a Sharp Slowdown in Bank Credit Expansion
Figure 2
Not just the economy, but the financial conditions supporting the economy has been corroborative of such elemental infirmities.
Declared Net NPLs of the Philippine banking system surged to multi-year highs last July. Even before COVID, NPLs climbed to recent highs in 2019. Net NPLs reversed course following its bottom in the 3Q of 2016. (Figure 2)
Yet, these are the declared the NPLs, which are analogous to the tip of an iceberg. Given the current conditions, the actions of the BSP provide an insight into the actual state of the escalating credit portfolio impairments of the banking system.
So what has the BSP done?
First a backstory.
Despite the cuts in Reserve Requirement ratio (200 bps) and policy rates (175 bps), the growth of the banking system’s lending portfolio stumbled to multi-year lows last July.
The growth of the banking system’s total loan portfolio (TLP-gross excluding IBL and RRP) skidded to 5.63% last July slightly lower than the bank lending reported by the BSP’s depository survey of 6.94%. The growth of TLP net (inclusive of IBLs and RRPs) fell to 4.07% in July. (Figure 2) All growth rates cited are at multi-year lows. IBLs are Interbank Loans while RRPs are Reverse Repurchases.
The growth slowdown of bank credit, whether from the banking system’s balance sheet or the Depository survey, emanated since July 2017.
From CNN (August 11): More businesses were able to secure loans from banks as of July which should help them get back on their feet, the Bangko Sentral ng Pilipinas said Tuesday. In a statement, the central bank reported a surge in loans granted to micro, small, and medium enterprises or MSMEs since local lenders were allowed to charge fresh loans to their required reserves. The BSP said 97 banks have granted loans to small firms as of July 23, which pushed the average daily balance of loan take-ups to ₱84.2 billion. In late April, the average daily balance of MSME loans charged to the reserve portfolio was just at ₱9.9 billion.
If banks did charge the issuance of fresh loans to the MSMEs from the reduced required reserves, then we’d see the growth rate of the industry’s aggregate credit portfolio tick up. Instead, it has been trending down. The extension of loans to the SMEs might have been placed off-balance sheets since, instead of reserve requirements, such loans were 50% guaranteed by the NG’s STATE-RUN Philippine Guarantee Corp (Philguarantee).
In short, some banks cooperated, not because MSME lending was a viable, less risky business, but rather, the NG took half of the risk away and transferred it to the people. Privatize profits, socialized losses.
Ultimately, economics, not political charity, will determine the outcome of such policies.
Secondly, the banking system’s sharply slowing credit portfolio expansion may have likely emanated from borrowings of elite firms. After all, the elites own most of the biggest banks. And as previously shown, despite the deep recession in the 2Q, listed firms of the PSYEi 30 dug deep into the bank’s pockets for survival.
The Medical Gulag Experiment: PSYEi Revenue and Income Crashed in 2Q as Debt Zoomed! COVID-19 Death Toll Mounts! Say’s Law In Action August 23,2020
Third, while rural banks and cooperatives have yet to submit their reports (by quarter), bank lending to the MSMEs have barely been from thrift banks. The credit portfolio of thrift banks has been in a deflationary territory since July 2019 or for 12-consecutive months. The sector’s loans and receivables shed (-) 6.2% in July, -14.94% in June, and -14.13% in May. (Figure 2 middle pane)
Thrift banks accounted for 7.18% share of the 1Q TLP net inclusive of IBLs and RRPS, rural and cooperatives have a 1.28% share while Universal and commercial banks control a substantial majority share of 91.54%.
In any event, most of the credit subsidies extended to the MSMEs originated from Universal and Commercial banks, despite reports suggesting the participation of rural and cooperative banks.
To put it more broadly, low bank credit expansion in the face of the surging delinquent loans highlights the tightening of the money supply. Banks add to the money supply when they issue loans. In contrast, when loans are paid back or defaulted upon, the money supply shrinks. Furthermore, because of lending impairment growth, the low bank credit expansion signals reluctance by banks to lend.
From the BSP (July 7, 2020): Results of the Q2 2020 Senior Bank Loan Officers’ Survey (SLOS) showed that most of the respondent banks tightened their overall credit standards for loans to both enterprises and households during the quarter based on the modal approach. This is the first time that the majority of respondent banks reported tighter credit standards following 44 consecutive quarters of broadly unchanged credit standards.
Mounting delinquencies and low lending have weighed on the industry’s liquidity. Banks are, thus, likely to conserve resources than take risks.
IV. BSP’s Bailouts: Massive Liquidity Injections from Cuts in Reserve Requirements and Quantitative Easing! QE Reaches Php 400 Billion!
But unknown to most, the banking system’s liquidity issues started way back in 2013.
And to address the liquidity drought, the BSP used two major tools.
First, it has slashed Reserve Requirement Ratio (RRR) by 200 bps in 2018, 400 bps in 2019, and 200 bps in 2020. It may use another 200 bps before the year ends.
Popularly known as Quantitative Easing or Large Scale Asset Purchases (LSAP) in central banks of advanced economies, debt monetization represents the BSP’s next most important tool.
From the BSP (September 4): Albeit slower, net borrowings by the central government expanded by 51.7 percent in July from 53.2 percent (revised) in the previous month, reflecting in part the government’s funding requirement for its initiatives against the COVID-19 health crisis.
Rationalized as part of the COVID-19 mitigation policies, the BSP announced the monetization of the Php 300 billion of the National Government’s liabilities by acquiring debt (repo) securities from the banking system last March.
As of July, the BSP’s debt deficit financing has reached Php 400 billion, over and above the initial self-imposed quota! (Figure 2 lowest pane)
Figure 3
In short, the BSP has been injecting a tsunami of cash into the banking system, a form of bailout, in the hope that liquidity would be sufficient enough to counterbalance solvency issues.
Growth of the banking system’s cash reserves has vaulted by 43.53% to a record Php 3.457 trillion last July.
According to the BSP chief, the banking industry received massive liquidity infusions from the BSP amounting to some Php 1.3 trillion, or about 6.7% of the GDP!
The avalanche of liquidity from the QE, plus cuts in ONRRP or overnight policy rates, has pulled down Philippine Treasury yields across the curve. (Figure 3 upmost window)
But, the BSP has been monetizing debt since 2015. COVID-19 gave it a convenient cover for the BSP to expand and accelerate its usage.
Now the growing scale of the BSP’s use of QE has raised concerns from the establishment experts.
Manila Standard (September 8): “A bank economist warned that the Bangko Sentral ng Pilipinas may lose its “sterling” credibility in the long run and its independence will be questioned with the implementation of Bayanihan to Recover as One Act, or the Bayanihan 2, which has a provision on de facto “debt monetization.”
Have we not repeatedly warned about this?
For instance, an excerpt from July 1, 2018 (bold original)
In 2004, former Governor Rafael Buenaventura* assuaged the public on financing deficit spending with, “Let me also emphasize that the Philippines has enough institutional safeguards against excessive deficit financing and seigniorage that help ensure the BSP’s independence from fiscal sector constraints. The New Central Bank Act of 1993 (R.A. 7653) sets out clear limits on the size and the repayment period of the BSP’s financial assistance to the National Government.” (bold added)
*Governor Rafael Buenaventura, Some Thoughts on the Budget Deficit, speech at the Regular Membership Meeting Rotary Club of Makati Central, April 6, 2004, bsp.gov.ph
…
And former Governor Buenaventura was right. The more the involvement of the BSP in the financing of the deficit, the more the BSP has become subordinate to the National Government’s whims.
Extensive deficit financing means that whatever "independence" the BSP was supposed to have, had been severely compromised. This episode shows that the notion of central bank independence is mostly a myth.
And once again an excerpt from UP Professor and the BSP Sterling Chair Dr. Dante Canlas’ 2012 paper**: “Money shocks, however, often have fiscal origins. If the government has a persistent deficit in its budget that is accommodated by the monetary authority, money growth tends to become excessive. In this context, money shocks stem from fiscal shocks.”
**Dante B. Canlas, Business Fluctuations and Monetary Policy Rules in the Philippines: Lessons from the 19841985 Contraction April 30, 2012, bsp.gov.ph
Deficit Spending Finance: The BSP Unleashes a Staggering Php 101 Billion QE in May! July 1, 2018
V. Banks Raise Borrowing From Bonds, To Join Ranks of Property Sellers? Has the Real Estate Bubble Been Popped?
Aside from the QE and RRR cuts, the BSP has extended many regulatory and operational relief measures, another form of implicit bailouts to the industry.
As the growth of deposits, the primary source of funding, has been diminishing, banks have increasingly been obtaining funds from bonds.
As an aside, after climbing to a 2-year high last May at 13.13%, the growth of peso deposits eased to 11.34% last July. In the meantime, the deluge of foreign borrowing by the NG has pushed up the banking system’s FX deposit growth to a 15-month high of 6.19%. In total, the growth of the banking system’s deposit liabilities decelerated to 10.48%, down from 11.74% last May, representing a two-year high. (Figure 3, middle pane)
Bond payables, which grew by 58.31% last July, pushing its share of total liabilities to an all-time high of 4.56%. Banks have been shifting its funding base to more expensive but longer-term commitments. (Figure 3 lowest pane)
Oddly, the BSP will begin to issue bills and bonds in Q3.
So the BSP prints money and then sop up liquidity through their securities while competing with banks, non-bank financials, and non-banks and non-financial entities in the marketplace for funds?
Figure 4
Since NPLs not only contribute to the diminishment of the money supply, unless discounted significantly, these represent illiquid assets.
So another way for banks to increase liquidity for the banks is to sell assets.
From ABS-CBN News (September 10): The Philippine National Bank on Thursday said it would sell its prime properties to strengthen the company’s financial position. PNB president and CEO Wick Veloso said the planned sale was part of the bank’s strategy to reduce its low earning assets, improve earnings and boost its capital.
So banks, in addition to distressed speculators, will be net sellers of properties too! How will these affect the property markets?
From ABS-CBN News (September 10): Some of the biggest property developers in the Philippines said homebuyers should take advantage of low interest rates, prices and flexible terms currently being offered by developers amid the disruptions caused by the COVID-19 pandemic. At a webinar organized by online real estate platform Lamudi, Julius Guevara, vice president for corporate planning at DM Wenceslao and Associates said "developers have become more flexible in terms of their payment terms." "There are a lot of discounts, some are even deferring the payments down the road just to compel some home buyers to make that decision," Guevarra added
Bank lending growth to the supply side of the real estate sector plunged to 11.5% in July from 16.5% in June.
Has COVID-19 popped the property bubble?
Property Boom amidst a Recession? 2Q Property GDP, PSE Property Firms Revenues, Sales and Income Crash! BSP Bailouts Bank-Real Estate Sector August 30, 2020
VI. How will the BSP Manage the Asset-Collateral Reflexive Cycle?
Tumbling asset prices may force banks to ask borrowers to add more collateral to support their debt levels. Otherwise, they would be forced into a call loan or require liquidations of such assets.
The reflexivity process of bank lending and collateral, according to billionaire and financial wizard George Soros. (bold and italics mine)
“In the early stages of a reflexive process of credit expansion the amount of credit involved is relatively small so that its impact on collateral values is negligible. That is why the expansionary phase is slow to start with and credit remains soundly based at first. But as the amount of debt accumulates, total lending increases in importance and begins to have an appreciable effect on collateral values. The process continues until a point is reached where total credit cannot increase fast enough to continue stimulating the economy. By that time, collateral values have become greatly dependent on the stimulative effect of new lending and, as new lending fails to accelerate, collateral values begin to decline. The erosion of collateral values has a depressing effect on economic activity, which in turn reinforces the erosion of collateral values. Since the collateral has been pretty fully utilized at that point, a decline may precipitate the liquidation of loans, which in turn may make the decline more precipitous. That is the anatomy of a typical boom and bust.
Booms and busts are not symmetrical because, at the inception of a boom, both the volume of credit and the value of the collateral are at a minimum; at the time of the bust, both are at a maximum. But there is another factor at play. The liquidation of loans takes time; the faster it has to be accomplished, the greater the effect on the value of the collateral. In a bust, the reflexive interaction between loans and collateral becomes compressed within a very short time frame and the consequences can be catastrophic. It is the sudden liquidation of accumulated positions that gives a bust such a different shape from the preceding boom.
*George Soros, The Alchemy of Finance (p.87)
And are these more signs of the spreading of deflationary impulses in the financial system?
Importantly, the BSP has been pushing for a direct rescue of the banking system through the FIST Act.
Manila Bulletin (September 3): Bangko Sentral ng Pilipinas (BSP) Governor Benjamin E. Diokno warned senators that banks’ soured assets will grow worse with delays in the passage of the proposed Financial Institutions Strategic Transfer Act (FIST) which would help banks avoid liquidity issues brought on by the pandemic.
If the banks are sound as so-asserted, why ram down the throats of taxpayers, and currency holders, a massive bailout of the banking system? Or again, why privatize profits for bankers, socialize losses through FIST?
Why is the BSP using tools reminiscent of the 1997 Asian crisis, through the FIST Act, and the degree of RRR cuts and even more?
What is the BSP not telling us, in the context of embedded NPLs, in the banking system?
To avoid a meltdown of collateral values, will the BSP be pushed to accelerate the monetization of Public debt? Will the BSP expand to cover the private sector's debt, similar to its advanced economy peers? Will the BSP be buying stocks too?
Will the BSP be able to print away bankruptcies? Or how will liquidity settle the problem of solvency? And what are the costs of sustained money printing and the dramatic expansion of debt?
To what extent will more money printing, deficit spending, and massive debt accumulation contribute to the misallocation of economic and financial resources?
Or what are the hidden or unforeseen ramifications of bailouts?
How will recovery take place when economic and financial issues plaguing the system remain in place while various interventions have aggravated further the implanted imbalances?
The first-ever yield curve inversion of 2019 in decades emitted recessionary signals, which prompted a dramatic response by the BSP. Despite the cumulative rescue measures, the yield curve has barely moved in the BSP’s direction of normalization. Why?
Issues that I raised long before have gotten the attention of the mainstream.
VII. The BSP Acknowledges Some of the Critical Shortcomings of MacroPrudential Policies!
Interesting notes from the BSP led Financial Stability Coordinating Council’s (FSCC) MACROPRUDENTIAL POLICY STRATEGY FRAMEWORK: THE CASE OF THE PHILIPPINES published last June.
First, that bank capital have little predictive power on the probability of a crisis…
This difference in purpose is fundamental but it leaves open the possibility that the policy instruments principally used under banking supervision – capital and liquidity – would adequately address the concerns of macroprudential policy over systemic risks. On this point, Haldane (2017) reports that various studies find that the predictive power of bank capital on the probability of a crisis is virtually indistinguishable from zero. Masera (2012) provides a critical review of the adequacy of bank capital although there are various micro-econometric studies in the advanced economies which suggest that higher bank capital reduces bank failure (Vasquez and Federico, 2015). P. 5
Most importantly, the BSP recognizes the shortcomings of statistics, and their knowledge problem…
Now formalized as one of four mandates of the Bangko Sentral ng Pilipinas that is inscribed in law, the agenda of financial stability is essentially about guarding against financial market failure due to connectedness, contagion, complementarities, correlation, and fire sales, as externalities. Its ultimate objective is sustained economic growth and we do this acting pre-emptively so that normal functions of the financial market are not disrupted and the costs to society are minimized. Systemic risk management and the introduction of calibrated macroprudential policies is a challenge at many levels. The risk outlook has to be pre-emptive, which requires us to raise concerns even before conventional market indicators manifest outright disruptions. The fact that financial stability has no intermediate policy target as monetary policy does necessitates getting a sense of risk behaviors that may not immediately translate into the data. (p.13)
Unless causality is established, there can be no policy of preemption to address a looming crisis from the business or credit cycles.
Let us help the BSP. From the great Ludwig von Mises’ magnum opus, Human Action:
But today credit expansion is exclusively a government practice. As far as private banks and bankers are instrumental in issuing fiduciary media, their role is merely ancillary and concerns only technicalities. The governments alone direct the course of affairs. They have attained full supremacy in all matters concerning the size of circulation credit. While the size of the credit expansion that private banks and bankers are able to engineer on an unhampered market is strictly limited, the governments aim at the greatest possible amount of credit expansion. Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.
The first step to avoid a boom-bust cycle is to avoid a central bank directed credit boom. Policies of preemption are, thus, unnecessary.
VIII. Copper Prices Breakout of 10-year Resistance!
Figure 5
The USD price of copper broke its long term or 10-year resistance level last week.
A dearth of supply has been the principal factor for its rise.
Some say that China’s strategic thrust to boost strategic metal holdings may be a force to reckon with. Even if true, I doubt that such a dynamic would be sustainable, given the tumultuous state of the global economy.
Nevertheless, in the interim, should its price trend be reinforced, shares of local copper mines are about to benefit.
