Stagflation Part 14: Q2 GDP at 2.3% and Falling — A GDP Built on Suppression and Debt

  

Public choice theory predicts exactly this: concentrated benefits and dispersed costs produce political pressure for expansion. Sovereign credit makes the expansion financially viable. The opacity makes it politically sustainable—Michael Dioguardi

In this issue

Stagflation Part 14: Q2 GDP at 2.3% and Falling — A GDP Built on Suppression and Debt

I. Introduction: The GDP Number Is Not Neutral: When Policy Intervention Becomes the GDP Story

II. From Countercyclical Buffer to Debt Dependence

III. The Credit Boom That Households Aren't Feeling

IV. Net Primary Income: When the External Cushion Starts to Fail

V. Real estate and tourism: the visible cracks behind a still-solid labor market

VI. Electricity's Engineered Strength Versus Transport's Engineered Weakness

VII. Construction: a government-led downward spiral

VIII. Trade: exports without manufacturing depth, and a historic deficit

IX. The external financing loop closes on itself

X. The Two Precarious Trends Beneath the Headline

XI. Confusing Stagflation with an Event Rather Than a Process

XII. Conclusion: GDP Is the Symptom, Not the Diagnosis 

Stagflation Part 14: Q2 GDP at 2.3% and Falling — A GDP Built on Suppression and Debt 

How debt, credit, price suppression and external financing are sustaining growth while weakening adaptive capacity

I. Introduction: The GDP Number Is Not Neutral: When Policy Intervention Becomes the GDP Story 

The Philippine economy grew 2.3% in the second quarter of 2026, down from 2.8% in Q1, bringing first-half growth to 2.6% — the weakest non-pandemic print since Q4 2009. 

The consensus reception treated this as a simple story of "as is, where is": inflation is high, investment is weak, ergo growth slows. What that framing consistently misses is that the 2.3% figure is not a passive reading of an economy left alone. It is the visible residue of a set of policy choices that concentrated benefits on a narrow set of interests while dispersing the costs across consumers, savers, and the fiscal balance sheet — Bastiat's seen and unseen, playing out in real time in the GDP release itself. 

Two suppression mechanisms did the heaviest lifting in keeping the headline number in positive territory at all. 

One. EO 110's emergency interventions in electricity and energy markets, layered on the earlier round of rice and fuel price interventions, suppressed some of the immediate price pass-through directly. 

Two. BSP's regulatory relief cascade — the NPL grace periods, the mark-to-market waiver, the capital reliefs — combined with a soft-peg regime and NDF restrictions, limited the extent to which the exchange rate and bond yields could reprice the oil shock into the real economy. 

These measures did not eliminate the shock; they altered its transmission, absorbing some of its immediate effects and shifting others onto consumers, savers, bank balance sheets, and the fiscal balance sheet. 

The 2.3% print therefore cannot be read as evidence that the underlying economy absorbed the Iran-oil-shock and flood-control-scandal disruptions well. It is the measured outcome after policy intervention had already changed the channels through which those shocks propagated. 

II. From Countercyclical Buffer to Debt Dependence 

The PSA data confirms what our Stagflation Parts 12 and 13 flagged as an emerging pattern: government spending is no longer a countercyclical buffer but a permanent, entrenching share of output.

Figure 1

Government final consumption expenditure grew 8.3% year-on-year in Q2 2026 — decelerating only slightly from 8.7% in Q2 2025 — and its share of real GDP rose to 18.6%, up from 17.5% a year earlier and 16.3% in Q1 2026. 

For the first half, GFCE's constant-price share climbed to 17.4% from 16.8% in 1H 2025—an all time high. (Figure 1, topmost visual) 

The significance is not merely that government consumption is rising, but that an increasing share of economic activity is being allocated through the state rather than through decentralized private demand. And GFCE captures only the direct component: it excludes the broader private-sector activity sustained by government procurement, construction, PPPs, contractors, and supply chains serving government agencies nationwide. The state's effective economic footprint is therefore larger than the GFCE ratio alone suggests—a sign of deepening centralization. 

That expansion in the numerator was financed the way it always is now: through debt. 

The national government's first-half fiscal deficit hit Php 786.8 billion, the largest January–June shortfall on record. Net public borrowing for the half reached Php 1.357 trillion — the second-highest first-half figure on record, trailing only 2021's Php 1.371 trillion, a year defined by pandemic emergency financing. 

The parallel is not comforting: what was once crisis-contingent borrowing has become the ordinary operating mode of the fiscal accounts. National government debt closed June at Php19.07 trillion, and the debt-to-GDP ratio breached 66% — a 22-year high, last seen in the Arroyo-era aftermath of the early-2000s fiscal crisis. (Figure 1, middle graph) 

The nominal debt-growth-versus-GDP-growth gap is the cleaner way to see the mechanism. Nominal debt has grown faster than nominal GDP in every year since 2019; the 1H 2026 gap between nominal debt growth and NGDP/rGDP growth is now at its widest since 2020! 

Public debt is not tracking the economy's expansion — it is outrunning it! (Figure 1, lowest chart) 

Sustained divergence of this kind changes the character of sovereign finance ex ante: as the debt stock grows faster than the income base from which it is ultimately serviced, continued refinancing becomes increasingly central to meeting existing obligations. 

The government may continue to roll over that debt without immediate distress, but the system becomes more exposed to a ‘sudden stop’ in financing or a sharp repricing of risk. In Minskyan terms, that is the sovereign analogue of a shift away from hedge finance and toward a speculative posture — not because default has already occurred, but because continued solvency increasingly depends on the uninterrupted availability of new credit.

III. The Credit Boom That Households Aren't Feeling 

Despite EO 110 subsidies, sector-specific relief, and what the earlier parts of this series have already documented as record consumer and electricity-sector bank lending, household final consumption expenditure grew only 2.8% in Q2 2026 — down from 5.2% a year earlier — while per-capita HFCE growth in real terms slowed to 1.9% for the half, a rate not far from the pandemic-adjacent trough. The deceleration is not evenly spread.

Figure 2

Transport spending within the household basket contracted outright, falling 7.5% year-on-year in Q2, the single largest drag on HFCE growth, a direct product of fare structures that remain administratively restricted even as fuel and operating costs were not similarly controlled for operators. 

Restaurants and hotels (-0.2%) and recreation and culture (-0.8%) also contracted — consumption categories that track discretionary income most closely, and the ones collapsing first. (Figure 2, topmost pane) 

That households are cutting discretionary and mobility spending while credit to the household and electricity sectors keeps expanding at record pace is the seen/unseen split of the credit channel: the lending shows up in bank balance sheets and, through the electricity sector's credit-financed "recovery," in industrial GDP; the squeeze shows up in what households actually do with their own cash flow. 

The aggregate consumption data make that squeeze visible: credit is expanding, but the purchasing power and discretionary spending of households are not keeping pace. (Figure 2, middle chart) 

IV. Net Primary Income: When the External Cushion Starts to Fail 

A quieter but structurally important number in the release: Net Primary Income from the Rest of the World grew just 1.0% year-on-year in Q2 2026, against 31.7% in Q2 2025 — but the more important signal is the deterioration underneath the quarterly number. (Figure 2, lowest image) 

Since its 2023 peak, the growth of the external-income stream has been in a sustained waterfall, with both compensation income and property-income flows seeing their growth rates materially weaken through Q2 2026. This line is the GNI-side counterpart to the remittance-shield thesis developed earlier in this series (Part 7.0): OFW compensation and other primary-income flows have functioned as a standing subsidy that allowed vested domestic interests to defer structural reform. The income stream remains positive, but its growth impulse is rapidly disappearing. 

With that external shield now materially weaker, GNI growth (2.2%) fell below already-weak GDP growth (2.3%), while the external cushion that historically absorbed part of the consequences of domestic policy failures is thinning at precisely the moment domestic demand is weakening. The significance is therefore not that external income has already disappeared, but that a once-reliable source of support is no longer expanding fast enough to offset the deterioration elsewhere in the economy. 

V. Real estate and tourism: the visible cracks behind a still-solid labor market 

Real estate and ownership of dwellings grew only 1.3% in Q2 2026, down sharply from 5.9% a year earlier — the weakest print since Q4 2009 outside the pandemic. 

Accommodation and food service activities similarly decelerated to 1.7% from 6.8%.

Figure 3

Neither figure is disaggregated regionally in the national accounts release, but the Cebu office market offers a live, granular preview of what a real-estate demand air-pocket looks like on the ground: CBRE reported first-half 2026 office demand in Cebu crashed 68.2% year-on-year to 20,200 sq.m., a reversal from 2025's "bull run," with vacancy climbing to 13.9% and expected to reach 18–22% by year-end as AI-driven BPO consolidation and a wave of new supply collide. 

The accommodation-food deceleration is consistent with, and reinforces, the tourism slowdown already noted across Baguio, Boracay, the Hundred Islands, and Eastern Visayas — destinations where softer discretionary household spending (recreation, restaurants and hotels both contracting per the HFCE breakdown above) is now visible in occupancy and footfall. (Figure 3, topmost diagram) 

What makes this genuinely puzzling rather than simply confirmatory is that it sits alongside labor force data that has not (yet) cracked in the same way. 

The dissonance between a resilient headline employment picture and visibly weakening real estate, hospitality, and discretionary consumption sub-sectors is itself a data point: it suggests the labor market is a lagging rather than a leading indicator here, or that "benchmarkism" — embellishing a stable unemployment rate as evidence the economy is fine — risks missing where the stress is actually accumulating. (Figure 3, middle image) 

VI. Electricity's Engineered Strength Versus Transport's Engineered Weakness 

Electricity, steam, water and waste management was the one industry sub-segment that meaningfully accelerated: 4.0% in Q2 2026, up from 0.7% a year earlier, with electricity itself growing 4.5%. This is not simply organic demand recovery. It is the GDP-side signature of the redistribution machinery this series has tracked since Q4 2025: the tacitly officiated SMC-AEV-MER and Prime Infra-FGEN bilateral consolidations, the suspension of real property taxes (RPT) on generation assets, the FIT-ALL-to-GEA-ALL transition, and record bank lending concentrated in the electricity sector, all of which function as implicit and direct bailouts routed through regulated utility balance sheets. (Figure 3, lowest chart) 

Averch-Johnson dynamics apply directly here: regulated firms with an assured allowable return on capital have an incentive to expand the regulated asset base, particularly where the regulatory framework permits those investments to earn an allowed return regardless of whether underlying demand is strong enough to justify them on an unregulated-market basis. That expansion has partly supported measured GDP even as the households ultimately paying for the system see no corresponding improvement in affordability. 

The same investment bias is reinforced by the (Department of Energy) DOE's broader supply-side architecture: the lifting of foreign-ownership restrictions for renewable energy, successive rounds of the Green Energy Auction Program (GEA), fast-tracking mechanisms for priority projects, and planned expansion of transmission and energy-storage infrastructure, all aimed at accelerating renewable capacity toward the government's 35% generation-mix target by 2030. These measures deliberately lower barriers to entry, accelerate project development, and create investable opportunities in the electricity sector. Combined with regulated returns, sector-specific relief, tax concessions, and concentrated credit, they help explain why electricity-related capital formation can remain a source of measured GDP growth even while the household affordability constraint remains unresolved. 

The mirror image is the transport sector, where fare adjustments remain administratively suppressed even as input costs were not. Transport equipment capital formation collapsed 27.2% in nominal and 32.2% in real terms year-on-year in Q2 2026 — the largest single component drag on gross fixed capital formation for durable equipment, alongside HFCE transport's outright contraction. 

One regulated sector was bailed into growth; the adjacent sector, denied the same price-adjustment mechanism, is disinvesting. Both outcomes are administrative rather than market-determined, which is the point: the "growth" and the "decline" are two faces of the same suppression architecture, not independent market signals. 

VII. Construction: a government-led downward spiral

Figure 4

Construction contracted 13.9% year-on-year in Q2 2026 (constant prices, production side) and gross fixed capital formation in construction fell 14.8%, the single largest driver of industry's overall 2.4% decline. General government construction collapsed 32.4% — the flood-control-scandal hangover working through the capital formation accounts a full year after the scandal broke, as officials remain reluctant to greenlight infrastructure disbursement amid ongoing accountability proceedings. Private construction did not step into the gap: financial and non-financial corporations grew a modest 3.8% and households/NPISH just 0.8%, both far too small to offset the public-sector collapse. This is not a diversified construction sector experiencing a public-led correction while private activity compensates; it is a sector where the public sector was effectively the only source of growth, and where withdrawing it exposes how little organic private capital formation exists underneath. (Figure 4, topmost window) 

VIII. Trade: exports without manufacturing depth, and a historic deficit 

The headline expenditure-side bright spot was net exports: exports of goods and services grew 12.2% (goods +17.0%, services +6.9%), comfortably outpacing 5.5% import growth and contributing 1.2 percentage points to GDP. (Figure 4, middle graph) 

But the composition matters. Export growth was overwhelmingly a semiconductor and AI-hardware story — consumer electronics up 230.3%, components/devices up 13.4%, office equipment up 77.6% — while broad-based manufacturing growth (2.6% for the sector overall) remains muted relative to that electronics surge. This is a narrow, AI-cycle-dependent export engine, not a diversified manufacturing recovery. 

Should the AI capex cycle slow — a real possibility given how concentrated the growth in a handful of product lines already is — the one clean bright spot in this release loses its main support. 

Meanwhile, the trade-in-goods deficit for the first half hit $30.81 billion, the widest since PSA's series began in 1991, even as both exports (+13.1%) and imports (+17.8%) posted record first-half nominal levels. (Figure 4, lowest diagram) 

A widening deficit funded by strong headline trade volumes is still a widening deficit: it means the economy's dollar liabilities from imports are growing faster than its dollar receipts from exports, precisely the imbalance that eventually forces itself onto the external accounts. 

IX. The external financing loop closes on itself

Figure 5

That imbalance, plus slowing organic dollar revenue from OFW compensation (per the Net Primary Income data above), means BSP's soft-peg regime and its effort to rebuild gross international reserves via Net Foreign Assets (NFA) accumulation increasingly runs through borrowing rather than organic inflow. (Figure 5, topmost window) 

The July GIR print, released the same week as the GDP data, showed reserves falling to $103.4 billion — an 18-month low — down from $104.74 billion in June, driven by BSP's own FX operations and the national government's drawdowns on foreign-currency deposits to service external debt. The reserve buffer built earlier this year via eurobond and World Bank inflows (documented in Part 13) is now being spent down to meet obligations those same inflows were meant to be seen as covering. (Figure 5, middle graph) 

And as government borrowing accelerates to fund both the fiscal deficit and the electricity-sector and BSP-relief bailouts, the crowding-out is not confined to private investment. It extends into savings. 

CMEPA-assisted flows are channeling household and institutional savings into government securities; banks and elite conglomerates are competing alongside the government itself for a shrinking pool of savings, rather than the government crowding out only private borrowers. 

It is not that bank lending is contracting — this series has already documented that lending continues at a record pace, even as signs of peaking emerge — but that banks are simultaneously amassing government securities as an ever-larger share of their balance sheets, reinforcing the sovereign-bank doom loop already flagged in Parts 11 through 13: banks funding the sovereign, the sovereign's creditworthiness increasingly resting on banks that are themselves increasingly exposed to the sovereign. 

X. The Two Precarious Trends Beneath the Headline 

First, on timing: headline year-on-year GDP growth has been decelerating in trend since Q2 2021 — the quarter immediately following BSP's historic pandemic-era bank rescue measures — with that deceleration visibly accelerating from Q2 2025 onward, when the flood-control scandal surfaced, and again through 2026 as the Iran-oil shock compounded. This is not a one-quarter air pocket; it is a five-year decay curve with two discrete accelerant events layered onto it. (Figure 5, lowest visual) 

Second, on the trend itself: both nominal and real GDP now sit at what should be read as precarious trend support. If either the year-on-year growth trend or the nominal-GDP trend breaks decisively from here, a technical recession moves from a tail risk to a live scenario — not because of a single bad quarter, but because the growth that has been recorded through 2025–2026 has been substantially manufactured through price suppression, debt-financed government consumption, and administratively engineered sectoral wins (electricity) offsetting administratively engineered sectoral losses (transport, construction). Remove the suppression and the debt financing, and the underlying trend has already been decelerating for five years. 

XI. Confusing Stagflation with an Event Rather Than a Process 

The recurring objection to this series is that “stagflation” has a technical definition—a threshold combination of low growth and high inflation, sometimes with high unemployment—and that 2.3% growth with 6.2% inflation may or may not clear that bar depending on which textbook is consulted. This misunderstands what the term is doing analytically.

Figure 6

As I put it recently: stagflation isn't a one-off event or merely a set of statistics. It's a cumulative process. GDP, CPI and employment are symptoms, not causes. The 1970s oil shocks exposed and intensified underlying imbalances that had already been building. (Figure 6, topmost window) 

Applied today, the economy could continue posting positive GDP growth even as shocks generate severe price pressures and distortions, with debt accumulation and policy accommodation allowing the underlying imbalances to persist rather than forcing immediate adjustment. 

The fact that the statistics did not necessarily satisfy the later textbook definition of stagflation at every point does not mean the underlying process was absent. 

By 1983, the accumulated imbalances had produced the combination of recession, inflation and unemployment that made the diagnosis technically unambiguous. 

That is the link between this quarter's headline GDP number and the debt-growth-outpacing-GDP-growth gap documented above. See previous discussion in Part 7 and Part 4. 

Leveraged GDP is fragile in a specific, mechanical sense: it depends on the state's ability to keep borrowing at a pace that outstrips nominal output and on the central bank's ability to keep suppressing the price signals through which the economy would otherwise adapt. The Philippine response today is not simply monetary easing. It is a combination of balance-sheet transfers, administrative controls, and BSP easing and relief measures that suppress or redistribute the signals of stress across the financial system and the real economy. 

Those interventions can buy time, but they do not create adaptive capacity. Market adjustment may be difficult and disruptive, but it forces prices, capital and balance sheets to adjust to underlying conditions. 

Suppression does the opposite: it delays adjustment, redistributes the resulting imbalances and uses borrowed time to keep the existing structure operating. The longer that process continues, the more deeply the economy becomes dependent on the interventions themselves. 

Growth built this way can appear stable until it fails abruptly. 

It can hold—as it has, barely, for several quarters now—until financing conditions tighten or a ‘sudden stop’ occurs, at which point the accumulated imbalance can compress quickly. The current Iran oil shock is only five months old: it is the third wave of the inflation cycle, following the Russia-Ukraine oil shock of 2022 as the second wave. (Figure 6, middle graph) 

The important point is therefore not the latest shock itself, but the structure it has hit. As in the 1970s, an oil shock has been layered onto pre-existing imbalances and met with political responses that suppress adjustment and buy time. 

The result is visible in the record first-half fiscal deficit, the record first-half trade deficit, the second-highest first-half debt level on record, and a strained GIR-BOP position—all against a GDP growth trend that has not merely weakened but has been decelerating for five years, with that deterioration visibly accelerating through 2025 and 2026. (Figure 6, lowest chart) 

That is the significance of the 1983 episode: the crisis did not begin when the statistics finally satisfied every technical criterion. The crisis was the CULMINATION of a process that had been building for years. 

The 2.3% print is not evidence that the process is absent; it is what that process looks like while the economy is still being financed and the underlying adjustment is still being suppressed. 

XII. Conclusion: GDP Is the Symptom, Not the Diagnosis 

None of the individual figures in this release are, by themselves, damning. A quarter of soft growth, the Iran war oil shock, a construction contraction tied to a corruption scandal, a temporary dip in remittance-linked income — any one of these could be read as noise. 

What makes the Q2 print diagnostic rather than incidental is that the mechanisms keeping the headline number positive is the same mechanism this series has been tracking since Part 11: administrative price suppression flattering the deflator, debt-financed government consumption substituting for private demand, and a handful of politically favored sectors (electricity, exports concentrated in AI-linked electronics) carrying industries that are otherwise contracting or stagnant. 

Stagflation is not a reading you take off a single quarter's GDP-and-CPI print. It is what you see when you trace how that print was produced — and 2.3% growth built this way is not evidence the process has stalled. It is evidence the process is still running, and that the bill for running it is still being deferred rather than paid. 

___

Last four stagflation series

-Stagflation Part 13: Record Twin Deficits Signal the Cost of Deferred Adjustment

-Stagflation, Part 12: The Philippines' Balance-Sheet Origins of Inflation

-Stagflation Part 11: The Intervention Ecosystem Behind Moody's and Fitch's Banking Warnings

-Stagflation Part 10: The Politics of Contradiction—Rate Hikes, Liquidity Addiction, and External Constraint Under Balance-Sheet Stress

 

 

Phisix: Plagued By Domestic Politics

``The interventionist doctrinaires and their followers explain all these undesired consequences [of government intervention] as the unavoidable features of capitalism. As they see it, it is precisely these disasters that clearly demonstrate the necessity of intensifying interventionism. The failures of the interventionist policies do not in the least impair the popularity of the implied doctrine. They are so interpreted as to strengthen, not to lessen, the prestige of these teachings. As a vicious economic theory cannot be simply refuted by historical experience, the interventionist propagandists have been able to go on in spite of all the havoc they have spread."-Ludwig von Mises, Human Action

One of the risks we mentioned in today’s marketplace, aside from external recessionary environment, is domestic political risk.

Considering that foreign money has not been much of a driver of late, the Phisix has been subjected to mainly domestic sentiment, which has gyrated from the flux of events dominated by politics as the inopportune MERALCO affair.

Political Grandstanding Amidst Global Inflation

While external markets have mainly recovered from the other week’s selloff (see figure 4), the Phisix closed .77% lower over the week weighed by the seeming “tightening of the noose” by government officials on the marketplace as seen in the sordid Meralco imbroglio aside from the “free texting” and Banking industry’s forex deals.

Figure 4: stockcharts.com: Phisix versus the World

As we have repeatedly noted, the rising prices of consumer goods and services have spurred officials to do “something” in the face of public pressure if not as a deflection from controversial issues surrounding the administration. Essentially officials have vented the blame on public utilities for such dilemma.

Our public officials have not been forthright though; in an interview over an international business network we even hear the chief of our central bank claim that “inflation pressures” arose from “supply shocks”. This isn’t exactly the picture.

Like the rice crisis, these supposed “shocks” have been exacerbated by knee jerk political reactions (e.g. restriction of exports by surplus food producers or panic buying from the Philippines abroad) than the genuine causality. To date, since the rice crisis emerged, there has been no indication of a rice crisis for the commercial rice, but in the past-on NFA or government subsidized rice level. What was featured as a nationwide crisis in media was certainly true for some areas but not all.

Figure 5 ino.com: July Rough Rice

Of course, since many governments have now regained their composures and tempered their trading curbs aside from supply side responses to high prices in terms of more harvests (Bloomberg), rice prices have moderated (see figure 5)—for now.

With a sharp correction in major commodity prices this week, it is likely that goods and services inflation will probably have a “reprieve” in the coming weeks or months. But it is highly unlikely that these inflationary trends will meaningfully subside given the penchant for governments to “socialize” under the present landscape.

However, the fact is every part of the world today has been experiencing “goods and services” inflation, even among developed countries suffering from a credit squeeze due to the recent housing industry bubble bust. This means that goods and services inflation has basically been IMPORTED and not simply due to a domestic/global “supply” shock. Rising demand from emerging markets as China and India represents similarly a “demand” shock.

What policymakers have eluded to say is that monetary (monetary pegs, negative interest rates, bridge liquidity provisions for the credit affected financial sectors in the developed worlds, currency debasement or “competitive devaluation” programs in emerging markets) and fiscal policies (subsidies, high taxes and tariffs, trading curbs, non-transparency, nationalization, et. al.) have severely distorted the functions of price discovery, price transparency, pricing efficiency as allocators of resources in the marketplace, pushed a tsunami of money into the financial system, which has been finding a refuge at hard assets, where others superficially interpret as “market fundamentalism”, a.k.a. speculation.

Yet because most people don’t understand what is truly going on, for simplification purposes, somebody or some entity would have to take the blame.

This means that the first line of assault would be on the public utility providers, where “profits” are scrutinized and condemned as “unjust” and contributing to “inequality” and “poverty” thus requiring redistribution. Bolivia is an example of this recent movement, as it recently nationalized energy and telecom companies. Could we be smelling the same pattern here?

The popular notion is, if you squeeze public utility operators of profits or “nationalize” them, prices of basic services will go down. Baloney. Yes, this will happen over the short period of time. You can party for as long as the booze will last, but not when it gets depleted.

The basics is that the government can only afford to “subsidize” for as long as the revenues it gets is enough to compensate for this, which is the same as saying picking from taxpaying (productive) Pedro and doling out to non-taxpaying (non-productive) Juan. The problem is that the source of looting is limited while the demand for financing is unlimited.

The key question now is “Can a country’s productive sector permanently sustain a non productive sector?” The obvious answer is no. Eventually the country which undertakes heavy socialization or welfare programs will pay for the political mountebank when it enters into a financial crisis or sees its standard of living decline.

That’s why politics is always about short term convenience at the expense of the long term pain. The fundamental problem is that the public is easily directed away from the true causes.

A Snippet on Meralco’s Controversies

Energy issues have been taking the brunt with monopoly distributor Meralco down 3.91% over the week (down 25% from the week ending May 2^nd), aside from First Philippine Holdings (14% w-o-w) and Petron (10.53%-it’s a wonder if foreign investors are now anticipating a political spillover to this issue).

Fortunately enough, the strong performances in Friday ended the week positive for telecom issues and banking issues (led by Banco De Oro up 7.45% and Union Bank up 11.11%-could some prospective deals be brewing between them?).

As for Meralco we have not scrutinized on the nitty-gritty of the ongoing controversy but have construed the recent developments as possibly emanating from the following motivations:

One, a political retribution or a ruse to engage a vocal supporter of a well entrenched political adversary or

Two, an attempt to sidetrack the controversies surrounding the recent government scandals by redirecting the public attention to “goods and services” inflation by effectively focusing on utility providers as culprits, or

Three, a possible economic opportunity for certain interests group to wrest the management in order to benefit from the ongoing changes under the Electric Power Industry Reform Act (EPIRA) in the power sector. As a distribution monopoly, grabbing hold of this strategic network by any of the power producers ensures of a captive market.

Lastly, a combination of any of the three.

What are the major points of contention we can observe of in the corporate dispute:

-Take or Pay provision, a derivative of the 1993 Electric Power Crisis Act of the Ramos Regime which is the source of the wrangling over the charging of system losses.

-Royalty taxes and VAT charges

-alleged conflict of interest from cross ownership

So essentially you have a technical LEGAL spat over a government monopoly franchise operating under an intensely regulated industry.

Since the Lopezes have not been cordial or in good graces with the administration, the present environment of rising good and services inflation makes them susceptible targets for politicking.

But of course, other tangential concerns have brought upon by left leaning groups as;

-Subsidies
-market abuses from operators
-regulatory capture or regulators overwhelmed by those regulated
-corruption
-high rates required to sell Napocor assets
-“high prices breed inefficiency”

…our unsolicited comments;

-subsidies-see above
-market abuses (because of the monopoly), corruption and regulatory capture (the latter two are intertwined-regulators get controlled because they can be bought) are principally offshoots to overregulation. They represent the symptoms and not the cause.
-high prices in itself do not “breed” inefficiency but reflects on demand and supply even if they have been contorted with misaligned or skewed policies (e.g. high taxes) or lousy management. Simply said, high prices are the result of accrued inefficiencies. High prices DO NOT create, breed or foster inefficiencies; policies do. You put the horse before cart, and not the other way around.
-high rates needed to sell NPC assets accounts for a slippery slope argument. Investors invest because of the attractiveness of returns relative to risks not because of high prices. High prices do not guarantee returns. It’s the net margins or the ROI that counts!

Yes while a new management maybe able to trim down rates to achieve so called “efficiency” (which is highly doubtful), the fact that our problems is basically one of “imported inflation” ensures that over the long term energy prices will continue to rise unless:

One- demand destruction overtakes the global economy via ‘stagflation’ or

Two- alternative energy or unconventional energy sources will be able to generate sufficient economies of scale to overhaul the energy dynamics of the global transport and energy consumption infrastructure.

Three-policies will be undertaken to remove excess liquidity in the global financial system (meaning a policy induced recession)

Next, for the local energy sector, I’d like to give the EPIRA a chance to be fully implemented compared to a centralized energy policy since 1972 (Presidential Decree 40 - “Establishing Basic Policies For The Electric Power Industry”), where Napocor’s unwieldy P 600 billion debt should be enough lesson for us.

Risks of Owning Public Utilities

Figure 6: PSE: Industrials Taking the Heat

Of course, the major risk of owning “sensitive” public utilities today is that political powers will probably use them as scapegoats to pass populist policies which should be detrimental to the industry or to the society. The least is to harass them for publicity purposes as we might be probably witnessing today.

Figure 6 shows how the PSE Industrials have been buffeted by political volatility (aside from the recent bearmarket pressures) and is seen in a continued downdraft, where Meralco (26% of the Index) and other energy and public utilities are benchmarked. Overall the Industrials have been a sizeable drag to the “recovering” Phisix.

Besides, the risks of nationalization or instituting price caps or government takeover are enough reasons to dissuade foreign investors from owning these issues, even if it were just mere rhetoric. The problem is that it could be seen as an attempted assault on private ownership rights which tarnishes our credibility and takes sometime to restore.

Of course we don’t discount that there is a possibility that all these could also signify tactical moves of a facelift poop and scoop operation where investors flee from anxiety while giving entry opportunities for those fostering such scenario.

But on the contrary, we also understand that a declining Phisix isn’t a good reflection for the administration (especially if world markets begin to markedly advance) which habitually likes to take credit or bask in the glory of its past successes.

This means that if the Phisix will lag the world because of continued politicking, the meddling into these industries might suddenly or surprisingly fade! But this is being hopeful.

Important Disclosure:

This is not to say that you should own or not own public utilities shares. Instead, this is to evaluate on the risks of owning public utility shares given today’s “inflation” driven politicized environment. It represents risks or opportunities to gain from such risks. This is a market critically dependent on the path of government action.

Besides, not all of the public utilities share the same or equal measure of risks.

Writer owns shares of First Gen (FGEN).