Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession!

 

The total wealth of a country is the total value of goods and services it produces. When real estate prices rise much faster than this value, there has effectively been a large wealth transfer from those who don't own real estate to those who do—Michael Pettis 

In this issue: 

Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession!

I. Q3 2024: Philippine Real Estate Sees First Deflationary Spiral Since the Pandemic Recession! 

II. A Brief Insight into the Differences Between Pandemic-Recession Real Estate Deflation and Today’s Economic Landscape 

III. Despite Declines in New Housing Loans, Total Real Estate Consumer and Supply-Side Loans Surge, Unaffected by High Cap Rates 

IV. Real Estate’s Falling GDP Contribution and Increased Bank Lending Share Point to Heightened Concentration Risks 

V. Q3 2024 Real Estate Deflation Means Lower Sectoral and National GDP; Slower Retail Sales Amidst Greater Supply Side Expansion Translates to More Vacancies 

VI. Real Estate Deflation Amidst Near Full-Employment? What Happens When Unemployment Soars? 

VII. Property Sector Woes: From Price Deflation to Income Losses and Increased Debt Loads 

VIII. Property Sector Woes: From Liquidity Strains to Soaring Bank NPLs? 

IX. Will the BSP Launch QE 2.0 Soon? 

X. Conclusion: Two Ways to Bankruptcy: Gradually, then Suddenly

Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession! 

Philippine real estate prices experienced their first deflationary spiral in Q3 2024 since the pandemic recession, highlighting worsening imbalances in the sector. We explore the potential economic implications and possible policy responses. 

I. Q3 2024: Philippine Real Estate Sees First Deflationary Spiral Since the Pandemic Recession!

The Philippine consumer economy is hurting—and hurting badly. 

This pain is being reflected across several fronts, including the country’s most popular investment: real estate. 

Businessworld, December 30: HOUSING PRICES nationwide declined in the third quarter, the first contraction in over three years, data from the Bangko Sentral ng Pilipinas (BSP) showed. The Residential Real Estate Price Index (RREPI) fell by 2.3% year on year in the July-to-September period. This was a reversal of the 2.7% growth in the second quarter and 12.9% expansion in the same period a year ago. This was also the first time the RREPI posted a decline since the 9.4% drop recorded in the second quarter of 2021. (bold added)

And more news excerpts (all bold mine)

GMANews.com December 12, 2024: The oversupply of condominium units has shot up to an equivalent of 34 months as of November amid the sudden increase in availability of units, according to data released by Leechiu Property Consultants (LPC)… There were 4,971 new units launched in October and November, versus the 4,375 units sold during the period. Year-to-date, condominium take up was recorded at 25,565 units, equivalent to 63% of that recorded in the comparable period of 2023 while project launches stood at 13,226 or half of the previous year. Golez earlier also noted that the oversupply was due to a mix of high interest rates and external concerns, as well as a shift in preference to single-detached homes and properties in nearby provinces. 

Inquirer.net November 16, 2024: Vacancies in Metro Manila’s prime and grade A office market hit a 20-year high as of the end of the third quarter this year, with rental rates declining for the fourth straight quarter. A report from global commercial real estate services firm Cushman and Wakefield puts the average office vacancy rate at 18.2 percent, the highest since the second quarter of 2004. “The Metro Manila office market is exhibiting a slower-than-expected recovery in Q3 2024,” Cushman & Wakefield director and head of tenant advisory group Tetet Castro said in a statement.

Businessworld, November 12, 2024: DEMAND for office space outside Metro Manila has been “less robust” as office occupiers now have smaller space requirements, real estate services firm JLL Philippines said. “After the pandemic, I think the demand has weakened in general because for the key cities outside Metro Manila like Cebu and Iloilo, we’re still seeing a bit of takeup, but for the other peripheral areas, it’s not as robust anymore,” JLL Philippines Head of Research and Strategic Consulting Jan-Loven C. de los Reyes said at a briefing last week…

Businessworld, October 30, 2024: THE OFFICE VACANCY rate in Metro Manila is projected to reach 20.5% by the end of the year, driven by the influx of new office space and the departure of Philippine offshore gaming operators (POGOs), according to property consultancy firm Colliers Philippines…As of the end of the third quarter, Colliers data showed that office space vacancy rose to 18.6% from 18.3% the previous quarter due to space resulting from POGO lease terminations and non-renewal of pre-pandemic leases.

My Initial Insights: 

1. Polls indicate that the challenges faced in Q3 are likely to extend throughout the rest of 2024 and beyond. 

2. Mounting mismatches between weakening demand and rising supply have led to either increasing vacancies or a glut. 

3. Even the most bullish industry advisors have been forced to admit or confront the harsh reality facing the sector. However, they often put on a cosmetic face or a polished façade, promoting hope of recovery with little explanation beyond reliance on GDP growth. 

4. While real estate prices may seem "sticky," they are actually sensitive to liquidity and interest rates. Consequently, price declines reflect intensifying liquidity strains. In other words, vacancies have drained liquidity from many leveraged landlords and real estate owners, forcing them to sell properties at lower prices. 

5. The inflationary boom has morphed into a deflationary bust, where fear has replaced greed. 

6. Mainstream thinking has consistently overlooked the root of the issue: trickle-down policies that foster a "build-and-they-will-come" ideology, relying on the assumption of perpetual credit-driven demand fueled by low inflation and interest rates-or an everlasting regime of easy money.

Although we have been addressing this topic for some time, I will be quoting extensively from my May 2023 article: (bold and italics original)

There has been little realization that the industry has invested primarily in the foundation of the so-called "integrated community structure," anchored on urbanization and its extension of "satellite communities." 

Espousing the contortion of Say's Law, "supply creates its own demand," through "build and they will come," the race to build became the industry’s bedrock. 

Yet, the dynamic preference of consumers became one of the challenges of this model. 

And so, influenced by digitalization and pandemic policies, the transformation to hybrid/remote work has rendered a massive "sunk cost" or capital decumulation—signified by oversupply.  

… 

The thing is, though office spaces are the concern here, all other segments of the property sector constitute part of such "integrated communities," which therefore extrapolates to interconnection.  

By extension, it also means that the paradigm of "integrated community" is codependent not only on the vibrancy of the office properties but also residential, shopping malls, hotels, logistics and commercial hubs, and other related structures.   

Indeed, the dilemma of the office segment, the weakest link of the commercial real estate sector (CRE), should spread to other areas. 

Aside from the misallocation of capital, financing these imbalances through debt signifies a double whammy or the acceleration of capital consumption. 

The point having been made, these clusters of entrepreneurial errors are products of the distortion of money via the BSP's easy money regime. 

II. A Brief Insight into the Differences Between Pandemic-Recession Real Estate Deflation and Today’s Economic Landscape

Here’s a deeper dive into this developing seismic event.

The first article noted: "This was also the first time the RREPI posted a decline since the 9.4% drop recorded in the second quarter of 2021."

Figure 1

The last time deflation plagued the BSP’s Real Estate Price Index was in Q3 2020 (-0.4%), Q1 2021 (-4.2%), and Q2 2021 (-9.4%).  (Figure 1, upper window)

However, the difference between then and now is that policymakers responded to the pandemic-induced economic shutdown that led to five consecutive quarters of GDP contraction—a full-blown recession with aggressive measures.

Authorities reacted to this unprecedented disruption with a record fiscal deficit. Simultaneously, the BSP flooded the banking system with a historic Php 2.3 trillion of liquidity, aggressively cut interest rates to historic lows (2% from November 2020 to April 2022), significantly reduced the banking system’s Reserve Requirement Ratio (RRR) from 14% to 12%, implemented unprecedented capital, operational, and regulatory relief measures and subsidies, and placed a cap on the US dollar-Philippine peso exchange rate. The Finance Chief even ordered the SSS and GSIS to buy stocks and support the PSEi 30. 

All these collective actions were taken to prevent credit deflation and support collateral values—which back bank-issued loans—by reflating the bank-dominated financial system.

Fast forward to today, there has been no recession yet. Despite elevated interest rates, bank credit flows have been oozing.

III. Despite Declines in New Housing Loans, Total Real Estate Consumer and Supply-Side Loans Surge, Unaffected by High Cap Rates

Still, the RREPI fell into deflationary territory, led by properties in Metro Manila, which posted a 14.6% contraction—the second-largest decline since the 18.3% shrinkage in Q2 2021. (Figure 1, lower chart)

Areas outside the National Capital Region (AONCR) have experienced a sharp slowdown but remain on a growth path. 

Importantly, AONCR was barely affected by deflation during the pandemic era. Given the recent dynamics, it might not be exempt this time.

Figure 2

The BSP tacitly attributed this turn of events to the shrinking demand for new housing loans. (Figure 2, topmost table)  

In Q3 2024, the number of residential real estate loans (RRELs) granted for all types of new housing units in the Philippines contracted by 15.7 percent y-o-y. Specifically, loans granted in the NCR and AONCR decreased by 20.3 percent and 13.0 percent, respectively. Notably, the double-digit y-o-y contraction in RRELs in the Philippines, NCR, and AONCR in Q3 2024 was significant, yet not as severe as the decline in housing loan availment observed during the pandemic, which began in Q2 2020. (BSP, 2025) [bold added] 

However, a mere lack of demand for new loans is insufficient to cause a contraction. 

Nevertheless, theoretically, since real estate prices are duration-sensitive and influenced by changes in long-term interest rates, these shifts also impact capitalization rates (cap rates), which in turn affect property values.

Rising interest rates typically lead to higher cap rates, as investors demand a higher return to compensate for the increased cost of borrowing and the higher risk associated with interest rate changes. 

Consequently, higher cap rates generally lead to lower property values, as expected returns must adjust to match the new rates. Therefore, the adverse impact of higher cap rates on property values translates to diminished demand from investors. 

Notwithstanding the contraction in new property consumer loans, aggregate real estate consumer loans hit a record high of Php 1.061 trillion in Q3, although its growth rate fell from 13.5% in Q2 2024 to 8.07%. (Figure 2, middle graph) 

On the supply side, real estate bank loans reached a record Php 2.686 trillion in Q3 2024, with quarterly YoY growth accelerating from 3.86% in Q2 2023 to 13.9% in Q3 2024. 

In aggregate, total bank loans (net of interbank lending) rose to a record Php 13.24 trillion, with quarterly YoY growth also accelerating over the past five quarters. 

Thus, higher cap rates were hardly a factor; instead, the vibrant growth in supply-side bank lending likely contributed to more "build-and-they-will-come" supply. 

IV. Real Estate’s Falling GDP Contribution and Increased Bank Lending Share Point to Heightened Concentration Risks 

Furthermore, reports like this can be misleading: "Banks’ real estate exposure ratio dropped to 19.55% at end-September from 19.92% at end-June and from 20.55% at the end of September 2023—the lowest real estate exposure ratio recorded in five years, or since the 19.5% level as of September 2019." 

This is because the data on Real Estate Loans (REL) as a share of the Total Loan Portfolio (TLP) can signify many things. In this instance, the decline in REL/TLP is not primarily due to banks lending less to the sector or becoming more judicious or cautious. Rather, banks have been lending more aggressively to other sectors, particularly consumer credit cards and salary loans. 

In the realm of consumer loans, the share of real estate loans fell from a record high of 45.06% in Q4 2021 to 36.4% in Q3 2024, despite record peso real estate consumer loans. The 8.6% gap was filled by credit cards, which increased their share from 22.3% in Q4 2021 to 29% in Q3 2024. (Figure 2, lowest diagram) 

Meanwhile, the share of salary loans jumped from 8.3% to 13.22% over the same time frame. 

In statistics, there are many ways to "skin a cat." 

Unless funds are designated through escrow accounts, banks have virtually no control over how loan proceeds are spent. Some of the credit card and salary loans—or even loans declared for production purposes—could have been diverted to real estate mortgage payments, property purchases, or even stock investments. 

The fact that real estate credit growth remains buoyant suggests that most of the borrowed money may have been used for refinancing, with modest amounts allocated to acquiring second-hand properties (for consumer loans) and for property development expansion (supply-side loans). 

This also tells us that while new buyers played a smaller role in borrowings, more experienced buyers and property developers significantly contributed to the sector’s bank borrowings. 

On this note, despite lackluster growth, the real estate sector’s relative strength—compared to the overall weaker performance of other sectors—prompted a surge in its share of GDP in Q3 2024. 

The value-added contribution of the sector, which posted a 5.4% real GDP growth, amounted to 5.9% of national GDP. 

In the meantime, the real estate sector’s share of Universal-Commercial bank portfolios amounted to 20.46% in Q3.

Figure 3

Thus, a sector contributing 5.9% of GDP holds a 20.5% share of UC bank portfolios—representing significant concentration risks. (Figure 3, topmost chart)

Notably, this is based on the official definition of the banks’ real estate portfolios, whose actual exposure may already be understated. 

V. Q3 2024 Real Estate Deflation Means Lower Sectoral and National GDP; Slower Retail Sales Amidst Greater Supply Side Expansion Translates to More Vacancies

Of course, we’d also argue that the price deflation in Q3’s RREPI, which indicates slower spending across the industry, means less than the advertised GDP. Again, the sector reported 8.8% nominal GDP and 5.4% real GDP. (Figure 3, middle image) 

A lower real estate GDP should shave off a few more percentage points from Q3’s GDP of 5.2%. 

But here’s another potential discrepancy: According to the BSP, buyers of new properties have been less influential in driving demand for real estate. 

In particular, condominium prices plummeted by 9.4% in Q3 2024—the third largest of the five quarterly contractions from 2020 to the present. 

However, as a proxy, the performance of the top five listed developers (SM Prime, Ayala Land, Megaworld, Robinsons Land, and Vista Land) tells a different story. Their Q3 2024 real estate sales surged by 19.76% YoY, suggesting no signs of retrenchment in new property sales. 

This raises a critical question: Were the BSP numbers inaccurate, or have property developers been overstating their real estate sales? (Figure 3 lowest graph) 

As a side note, the property sales of the top five developers are not limited to residential condos; however, the comparison provided is for estimation purposes only.

Figure 4

But there’s more. 

The slowing rental income growth of the top four developers (SM Prime, Megaworld, Robinsons Land, and Vista Land) appears to align with the moderating revenue growth of the top six non-construction retail chains (SM Retail, Puregold, Robinsons Retail, Metro Retail, SSI Group, and Philippine Seven).  (Figure 4, topmost diagram)

In Q3, rental income for developers increased by 7.12%, while retail chains saw 6% growth. Both figures peaked in 2022 (Q2 and Q3, respectively) and have been on a downtrend since. 

This slowdown also reflects the growing mismatch between sales growth rates and the expansion of selling areas for retail chains and shopping malls, which has resulted in increasing vacancies. 

VI. Real Estate Deflation Amidst Near Full-Employment? What Happens When Unemployment Soars?

Intriguingly, despite unprecedented consumer bank borrowing rates and levels, the data signals intensifying signs of strained consumers—despite the supposedly near-full employment rate. (Figure 4, middle window) 

This also suggests that either the government’s labor data has been significantly stretched, or that consumers are increasingly burdened by the sustained loss of purchasing power in their wages and incomes, or by escalating balance sheet leverage. 

Worst of all, it could be both. 

What happens when the employment rate falls? 

Even more important, what happens when consumer credit slows or even retreats?

VII. Property Sector Woes: From Price Deflation to Income Losses and Increased Debt Loads 

Of course, deflation in the industry translates to weakened demand.

While property firms may attempt to mask this through possible overstatements of sales, internal pressures—such as diminishing liquidity, rising debt burdens, and increasing servicing costs—are likely to result in the eventual emergence of losses. 

When deflation gripped the industry in 2020–2021, the top five developers recorded net income losses over four quarters.(Figure 4, lowest chart) 

Currently, while net incomes are at all-time highs, their growth rate has been eroding.

Figure 5

Furthermore, debt levels continue to climb to record highs, accompanied by rising interest rate expenses. On the other hand, cash reserves have recently dropped and stagnated. (Figure 5, topmost and middle graphs) 

Coming down the pike, the likelihood of income deficits combined with a drain in business liquidity may result in even greater reliance on debt financing to sustain operations—even as collateral values deteriorate. 

If these developments have already impacted the top five developers, what more for marginal industry players—the mom-and-pop operators? 

VIII. Property Sector Woes: From Liquidity Strains to Soaring Bank NPLs?

Considering that banks hold significant exposure to real estate, the next phase will likely result in a surge in non-performing loans (NPLs). 

When deflation engulfed the sector in 2020-2021, real estate consumer NPLs surged and continued to rise even when the RREPI index peaked at 14.1% in Q2 2023. (Figure 5, lowest chart) 

NPLs hit a record Php 21.7 billion in Q2 2024 but slightly declined to Php 21.28 billion in Q3 2024. 

Due to credit expansion outpacing NPL growth, these numbers have been obscured as a function of ratios. They will likely become more prominent once credit expansion materially slows. 

Or what is likely to follow, after mounting losses and the depletion of liquidity, is a rise in NPLs—starting with smaller players and gradually affecting larger industry participants, in a "periphery-to-core" dynamic. 

IX. Will the BSP Launch QE 2.0 Soon?

In addition to surging public debt, the RREPI Q3 2024 deflation provides context for the BSP’s recent actions, which mirror a shadow of the pandemic recession playbook. These include the reduction of the Reserve Requirement Ratio (RRR) from 9.5% to 7%, effective October 2024, and the ongoing easing cycle, marked by the second and third interest rate cuts in the ONRRP in Q4 2024.

Furthermore, it explains the record-high 11-month public expenditures, reflecting the "Marcos-nomics" fiscal stimulus aimed at offsetting the decline in private sector demand.

Figure 6 

These policies have combined to momentarily bolster liquidity, which had been eroding from 2021 to 2023, as reflected in the YoY changes in M1. (Figure 6, topmost visual) 

Lastly, the Php 2.3 trillion injections by the BSP were partly channeled through its net claims on the central government (NCoCG). 

Interestingly, despite the supposed economic normalization, the BSP’s NCoCG remains elevated, prompting the IMF to request that the BSP become more transparent about its "balance sheet strategy." 

For instance, notes Inquirer.net, "the IMF said the BSP may want to publish more information about the size of its portfolio of government securities (GS), which remains 'substantial' despite declining since the central bank’s large purchases of state bonds during the COVID-19 pandemic." 

The BSP’s NCoCG stood at Php 650 billion as of November 2024, which is vastly above its 2002-2019 monthly average of Php 32.7 billion. (Figure 6, middle chart)

The BSP also holds Php 1.178 trillion worth of domestic securities (as of September 2024), accounting for 14.6% of its total portfolio. (Figure 6, lowest graph) 

The essence here is that by partly maintaining its quantitative easing (QE), the BSP remains heavily involved in controlling liquidity conditions in the banking system, where the real estate industry represents a significant counterparty.

This signifies the 'ratchet effect theory' in action, where temporary solutions to address specific problems become a permanent part of the legal landscape. (Matulef, 2023)

The Php 64 trillion question is: should current developments in the real estate sector deteriorate, would the BSP launch QE 2.0?

X. Conclusion: Two Ways to Bankruptcy: Gradually, then Suddenly

All told, despite the profusion of liquidity and the embrace of easy money policies, deflation in the Philippine real estate industry has emerged and could worsen.

This highlights the widening mismatch between vigorous debt-financed supply-side growth and weakening consumer demand—primarily driven by the erosion of the peso's purchasing power and the extended balance sheet leverage resulting from trickle-down policies, including the crowding-out effect. 

Although the challenge for policymakers would be to allow market forces to take command—cleansing household, corporate, and government balance sheets while rebuilding savings through productive undertakings—this would translate to a vastly diminished GDP and, more importantly, reduced political boondoggles. As such, this route is unlikely to occur. 

Nonetheless, authorities are likely to "fight the last war" by pursuing path-dependent, free-money policies aimed at boosting aggregate demand and GDP, while ignoring all other factors. 

Lastly, because the consensus believes these trends represent a temporary phenomenon, isolated from the pandemic's events and previous easy money policies, the "build-and-they-will-come" mentality is likely to prevail, driving an even greater debt-financed "race-to-build supply"—thereby exacerbating existing imbalances. 

As American novelist Ernest Hemingway wrote in The Sun Also Rises:

"How did you go bankrupt? Two ways. Gradually, then suddenly."

___

References: 

Prudent Investor, Philippine Real Estate:Mainstream Expert Worried Over Increasing Demand-Supply Gap; Q1 2023 Data ofTop 5 Listed RE Firms and the Property Index, May 28, 2023  

Bangko Sentral ng Pilipinas, Residential Real Estate Prices Decline in Q3 2024, December 27, 2024, bsp.gov.ph  

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

Ernest Hemingway, The Sun also Rises Chapter 13, 1926 Project Gutenberg Canada

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

 

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

In this issue

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

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

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

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

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

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

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

VII. Rising Foreign Denominated Debt Payments!

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

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

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

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

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

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

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

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

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

That is to say, since VAT payments are made at the end of each quarter but recorded in the first month of the following quarter, this quarterly revenue cycle inflates reported revenues for January, April, July and October, often resulting in a narrowed deficit or even a surplus for these months. 

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

Figure 1 

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

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

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

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

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

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

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

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

1.    Enactment of new laws,

2.    Adjustments to macroeconomic parameters, and

3.    Changes in resource availability. 

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

Figure 2

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

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

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

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

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

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

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

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

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

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

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

Let us now examine the details.

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

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

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

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

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

Figure 3

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

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

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

In its September disclosure, the Bureau of the Treasury cited changes in the VAT schedule as a key factor boosting tax collections: " The increase in VAT collections in 2024 is partly due to the impact of the change in payment schedule introduced by the TRAIN law provision which allows the tax filers to shift from monthly to quarterly filing of VAT return" (Bureau of Treasury, October 2024) [bold added] 

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

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

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

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

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

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

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

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

But what about expenditures? 

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

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

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

Figure 4

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

VII. Rising Foreign Denominated Debt Payments!

There's more to consider.

Figure 5

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

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

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

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

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

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

Authorities are scheduled to announce public debt data next week.

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

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

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

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

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

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

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

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

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

Today, however, this is no longer the case.

Figure 6

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

___

References 

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

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

Bureau of Treasury, September 2024 Budget Deficit at P273.3 Billion Nine-Month Deficit Narrowed to P970.2 Billion, October 24, 2024, treasury.gov.ph

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

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