Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟

 

An ever-weaker private sector, weak real wages, declining productivity growth, and the currency’s diminishing purchasing power all indicate the unsustainability of debt levels. It becomes increasingly difficult for families and small businesses to make ends meet and pay for essential goods and services, while those who already have access to debt and the public sector smile in contentment. Why? Because the accumulation of public debt is printing money artificially—Daniel Lacalle 

Nota Bene: Unless some interesting developments turn up, this blog may be the last for 2024. 

In this issue 

Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟

I. MSMEs: The Key to Inclusive Growth

II. The Politicization of MSME Lending

III. Bank's MSME Loans: Low Compliance Rate as a Symptom of the BSP’s Prioritization of Banking Interests

IV. Suppressed MSME Lending and Thriving Shadow Banks: It’s Not About Risk Aversion, but Politics

V. Deepening Thrust Towards Banking Monopolization: Rising Risks to Financial System Stability  

VI. How PSEi 30's Debt Dynamics Affect MSME Struggles

VII. The Impact of Bank Borrowings and Government Debt Financing on MSMEs’ Challenges 

VIII. How Trickle-Down Economics and the Crowding Out Effect Stifle MSME Growth 

IX. Conclusion: The Magna Carta for MSMEs Represents a "Symbolic Law," Possible Solutions to Promote Inclusive MSME Growth 

Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟ 

Despite government mandates, bank lending to MSMEs reached its third-lowest rate in Q3 2024, reflecting the priorities of both the government and the BSP. This highlights why the Magna Carta is a symbolic law.

I. MSMEs: The Key to Inclusive Growth 

Inquirer.net December 10, 2024 (bold added): Local banks ramped up their lending to micro, small and medium enterprises (MSMEs) in the third quarter, but it remained below the prescribed credit allocation for the industry deemed as the backbone of the Philippine economy. Latest data from the Bangko Sentral ng Pilipinas (BSP) showed total loans of the Philippine banking sector to MSMEs amounted to P500.81 billion in the three months through September, up by 3 percent on a quarter-on-quarter basis. But that amount of loans only accounted for 4.6 percent of the industry’s P11-trillion lending portfolio as of end-September, well below the prescribed credit quota of 10 percent for MSMEs. Under the law, banks must set aside 10 percent of their total loan book as credit that can be extended to MSMEs. Of this mandated ratio, banks must allocate 8 percent of their lending portfolio for micro and small businesses, while 2 percent must be extended to medium-sized enterprises. But many banks have not been compliant and just opted to pay the penalties instead of assuming the risks that typically come with lending to MSMEs. 

Bank lending to the MSME sector, in my view, is one of the most critical indicators of economic development. After all, as quoted by the media, it is "deemed as the backbone of the Philippine economy." 

Why is it considered the backbone?

Figure 1

According to the Department of Trade and Industry (DTI), citing data from the Philippine Statistics Authority, in 2023, there were "1,246,373 business enterprises operating in the country. Of these, 1,241,733 (99.63%) are MSMEs and 4,640 (0.37%) are large enterprises. Micro enterprises constitute 90.43% (1,127,058) of total establishments, followed by small enterprises at 8.82% (109,912) and medium enterprises at 0.38% (4,763)." (Figure 1 upper chart) 

In terms of employment, the DTI noted that "MSMEs generated a total of 6,351,466 jobs or 66.97% of the country’s total employment. Micro enterprises produced the biggest share (33.95%), closely followed by small enterprises (26.26%), while medium enterprises lagged behind at 6.77%. Meanwhile, large enterprises generated a total of 3,132,499 jobs or 33.03% of the country’s overall employment." (Figure 1, lower graph) 

Long story short, MSMEs represent the "inclusive" dimension of economic progress or the grassroots economy—accounting for 99% of the nation’s entrepreneurs, and providing the vast majority of jobs. 

The prospective flourishing of MSMEs signifies that the genuine pathway toward an "upper middle-income" status is not solely through statistical benchmarks, such as the KPI-driven categorization of Gross National Income (GNI), but through grassroots-level economic empowerment. 

Except for a few occasions where certain MSMEs are featured for their products or services, or when bureaucrats use them to build political capital to enhance the administration’s image, mainstream media provides little coverage of their importance.

Why?

Media coverage, instead, tends to focus disproportionately on the elite.

Perhaps this is due to survivorship bias, where importance is equated with scale, or mostly due to principal-agent dynamics. That is, media organizations may prioritize advancing the interests of elite firms to secure advertising revenues, and or, maintain reporting privileges granted by the government or politically connected private institutions. 

II. The Politicization of MSME Lending 

Yet, bank lending to the sector remains subject to political directives—politicized through regulation. 

Even so, banks have essentially defied a public mandate, opting to pay a paltry penalty: "The Bangko Sentral ng Pilipinas shall impose administrative sanctions and other penalties on lending institutions for non-compliance with provisions of this Act, including a fine of not less than five hundred thousand pesos (P500,000.00)." (RA 9501, 2010)

Figure 2 

With total bank lending amounting to Php 10.99 trillion (net of exclusions) at the end of Q3, the compliance rate—or the share of bank lending to MSMEs—fell to 4.557%, effectively the third lowest on record after Q1’s 4.4%. (Figure 2, upper window) 

That’s primarily due to growth differentials in pesos and percentages. For instance, in Q3, the Total Loan Portfolio (net of exclusions) expanded by 9.4% YoY, compared to the MSME loan growth of 6.5%—a deeply entrenched trend.(Figure 2, lower image) 

Interestingly, "The Magna Carta for Micro, Small and Medium Enterprises (MSMEs)" was enacted in 1991 (RA 6977), amended in 1997 (RA 8289), and again in 2008 (RA 9501). The crux is that, as the statute ages, industry compliance has diminished 

Most notably, banks operate under cartel-like conditions. They are supervised by comprehensive regulations, with the BSP influencing interest rates through various channels—including policy rates, reserve requirement ratios (RRR), open market operations, inflation targeting, discount window lending, interest rate caps, and signaling channels or forward guidance. 

In a nutshell, despite stringent regulations, the cartelized industry is able to elude the goal of promoting MSMEs. 

III. Bank's MSME Loans: Low Compliance Rate as a Symptom of the BSP’s Prioritization of Banking Interests 

Yet, the record-low compliance rate with the Magna Carta for MSMEs points to several underlying factors: 

First, banks appear to exploit regulatory technicalities or loopholes to circumvent compliance—such as opting to pay negligible penalties—which highlights potential conflicts of interest. 

Though not a fan of arbitrary regulations, such lapses arguably demonstrate the essence of regulatory capture, as defined by Investopedia.com, "process by which regulatory agencies may come to be dominated by the industries or interests they are charged with regulating" 

A compelling indication of this is the revolving-door relationship between banks and the BSP, with recent appointments of top banking executives to the BSP’s monetary board. 

Revolving door politics, according to Investopedia.com, involves the "movement of high-level employees from public-sector jobs to private-sector jobs and vice versa" 

The gist: The persistently low compliance rate suggests that the BSP has prioritized safeguarding the banking sector's interests over promoting the political-economic objectives of the Magna Carta legislation for MSMEs.

IV. Suppressed MSME Lending and Thriving Shadow Banks: It’s Not About Risk Aversion, but Politics

Two, with its reduced lending to MSMEs, banks purportedly refrain from taking risk. 

But that’s hardly the truth.

Even with little direct access to formal or bank credit, MSME’s are still borrowers, but they source it from the informal sector. 

Due to the difficulty of accessing bank loans, MSMEs in the Philippines are borrowing from informal sources such as the so-called 5-6 money lending scheme. According to an estimate, 5-6 money lending is now a Php 30 billion industry in the Philippines. These lenders charge at least 20% monthly interest rate, well above the 2.5% rate of the government’s MSME credit program. The same study by Flaminiano and Francisco (2019) showed that 47% of small and medium sized enterprises in their sample obtained loans from informal sources. 

...

An estimate by the International finance Corporation (2017) showed that MSMEs in the Philippines are facing a financing gap of USD 221.8 billion. This figure is equivalent to 76% of the country’s GDP, the largest gap among the 128 countries surveyed in the IFC report. (Nomura, 2020)

The informal lenders don’t print money, that’s the role of the banks, and the BSP.

Simply, the Nomura study didn’t say where creditors of the informal market obtained their resources: Our supposition: aside from personal savings, 5-6 operators and their ilk may be engaged in credit arbitrage or borrow (low interest) from the banking system, and lend (high interest) to the MSMEs—virtually a bank business model—except that they don’t take in deposits.

The fact that despite the intensive policy challenges, a thriving MSME translates a resilient informal credit arbitrage market—yes, these are part of the shadow banking system.

As an aside, uncollateralized 5-6 lending is indeed a very risky business: collections from borrowers through staggered payments occur daily, accompanied by high default rates, which explains the elevated interest rates.

Figure 3

That is to say, the shadow banks or black markets in credit, fill the vacuum or the humungous financing gap posed by the inadequacy of the formal financial sector. (Figure 3, upper diagram)

The financing gap may be smaller today—partly due to digitalization of transactional platforms—but it still remains significant. 

This also indicates that published leverage understates the actual leverage in both the financial system and the economy. 

Intriguingly, unlike the pre-2019 era, there has been barely any media coverage of the shadow banking system—as if it no longer exists.

As a caveat, shadow banking "involves financial activities, mainly lending, undertaken by non-banks and entities not regulated by the BSP," which implies that even formal institutions may be engaged in "unregulated activities." 

Remember when the former President expressed his desire to crack down on 5-6 lending, vowing to "kill the loan sharks," in 2019? 

If such a crackdown had succeeded, it could have collapsed the economy. So, it’s no surprise that the attempt to crush the informal economy eventually faded into oblivion. 

The fact that informal credit survived and has grown despite the unfavorable political circumstances indicates that the suppressed lending to MSMEs has barely been about the trade-off between risk and reward. 

It wasn’t risk that has stymied bank lending to MSMEs, but politics (for example, the artificial suppression of interest rates to reflect risk profiles). 

More below. 

Has the media and its experts informed you about this?

Still, this highlights the chronic distributional flaws of GDP: it doesn’t reflect the average experience but is instead skewed toward those who benefit from the skewed political policies. 

In any case, mainstream media and its experts tend to focus on benchmarks like GDP rather than reporting on the deeper structural dynamics of the economy.

V. Deepening Thrust Towards Banking Monopolization: Rising Risks to Financial System Stability

Three, if banks have lent less to MSMEs, then who constituted the core of borrowers?

Naturally, these were the firms of elites (including bank borrowings), the consumers from the "banked" middle and upper classes, and the government.

Total Financial Resources (TFR) reached an all-time high of Php 32.8 trillion as of October, accounting for about 147% and 123% of the estimated real and headline GDP for 2024, respectively. (Figure 3, lower pane)

TFR represents gross assets based on the Financial Reporting Package (FRP) of banking and non-bank financial institutions, which includes their loan portfolios.

The banking system’s share of TFR stood at 83.2% last October, marking the second-highest level, slightly below September’s record of 83.3%. Meanwhile, Universal-Commercial banks accounted for 77.8% of the banking system’s share in October, marginally down from their record 78% in September.

These figures reveal that the banking system has been outpacing the asset growth of the non-banking sector, thereby increasing its share and deepening its concentration.

Simultaneously, Universal-Commercial banks have been driving the banking system’s growing dominance in TFR. 

The significance of this lies in the current supply-side dynamic, which points towards a trajectory of virtual monopolization within the financial system. As a result, this trend also magnifies concentration risk. 

VI. How PSEi 30's Debt Dynamics Affect MSME Struggles

From the demand side, the 9-month debt of the non-financial components of the PSEi 30 reached Php 5.52 trillion, the second-highest level, trailing only the all-time high in 2022. However, its share of TFR and nominal GDP has declined from 17.7% and 30.8% in 2023 to 16.7% and 29.3% in 2024.

Figure 4

Over the past two years, the PSEi 30's share of debt relative to TFR and nominal GDP has steadily decreased. (Figure 4, upper chart) 

It is worth noting that the 9-month PSEi 30 revenues-to-nominal GDP ratio remained nearly unchanged from 2023 at 27.9%, representing the second-highest level since at least 2020. (Figure 4, lower image) 

Thus, the activities of PSEi 30 composite members alone account for a substantial share of economic and financial activity, a figure that would be further amplified by the broader universe of listed stocks on the PSE. 

Nevertheless, their declining share, alongside rising TFR, indicates an increase in credit absorption by ex-PSEi and unlisted firms. 

VII. The Impact of Bank Borrowings and Government Debt Financing on MSMEs’ Challenges

Figure 5

On the other hand, bank borrowings declined from a record high of Php 1.7 trillion (49.7% YoY) in September to Php 1.6 trillion (41.34% YoY) in October. Due to liquidity concerns, most of these borrowings have been concentrated in T-bills. (Figure 5, topmost visual) 

As it happens, Philippine lenders, as borrowers, also compete with their clients for the public’s savings. 

Meanwhile, the banking system’s net claims on the central government (NCoCG) expanded by 8.3% to Php 5.13 trillion as of October. 

The BSP defines Net Claims on Central Government as including "domestic securities issued by and loans and advances extended to the CG, net of liabilities to the CG such as deposits." 

In October, the banks' NCoCG accounted for approximately 23% of nominal GDP (NGDP), 18% of headline GDP, and 15.6% of the period’s TFR. 

Furthermore, bank consumer lending, including real estate loans, reached a record high of Php 2.92 trillion in Q3, supported by an unprecedented 22% share of the sector’s record loan portfolio, which totaled Php 13.24 trillion. (Figure 4, middle graph) 

Concomitantly, the banking system’s Held-to-Maturity (HTM) assets stood at nearly Php 3.99 trillion in October, just shy of the all-time high of Php 4.02 trillion recorded in December 2023. Notably, NCoCG accounted for 128.6% of HTM assets. HTM assets also represented 15.1% of the banking system’s total asset base of Php 26.41 trillion. (Figure 4, bottom chart) 

This means the bank’s portfolio has been brimming with loans to the government, which have been concealed through their HTM holdings.

Figure 6

Alongside non-performing loans (NPLs), these factors have contributed to the draining of the industry’s liquidity.  Despite the June 2023 RRR cuts and the 2024 easing cycle (interest rate cuts), the BSP's measures of liquidity—cash-to-deposits and liquid assets-to-deposits—remain on a downward trend. (Figure 6, upper window)

VIII. How Trickle-Down Economics and the Crowding Out Effect Stifle MSME Growth 

It is not just the banking system; the government has also been absorbing financial resources from non-banking institutions (Other Financial Corporations), which amounted to Php 2.34 trillion in Q2 (+11.1% YoY)—the second highest on record. (Figure 6, lower graph)

These figures reveal a fundamental political dimension behind the lagging bank lending performance to MSMEs: the "trickle-down" theory of economic development and the "crowding-out" syndrome affecting credit distribution. 

The banking industry not only lends heavily to the government—reducing credit availability for MSMEs—but also allocates massive amounts of financial resources to institutions closely tied to the government. 

This is evident by capital market borrowings by the banking system, as well as bank lending and capital market financing and bank borrowings by PSE firms. 

A clear example is San Miguel Corporation's staggering Q3 2024 debt of Php 1.477 trillion, where it is reasonable to assume that local banks hold a significant portion of the credit exposure. 

The repercussions, as noted, are significant: 

Its opportunity costs translate into either productive lending to the broader economy or financing competitiveness among SMEs (Prudent Investor, December 2024)

Finally, in addition to the above, MSMEs face further challenges from the "inflation tax," an increasing number of administrative regulations (such as minimum wage policies that disproportionately disadvantage MSMEs while favoring elites), and burdensome (direct) taxes.

IX. Conclusion: The Magna Carta for MSMEs Represents a "Symbolic Law," Possible Solutions to Promote Inclusive MSME Growth 

Ultimately, the ideology-driven "trickle-down" theory has underpinned the political-economic framework, where government spending, in tandem with elite interests, anchors economic development. 

Within this context, the Magna Carta for MSMEs stands as a "Symbolic Law" or "Unenforced Law"—where legislation "exists primarily for symbolic purposes, with little to no intention of actual enforcement." 

Politically, a likely short-term populist response would be to demand substantial increases in penalty rates for non-compliance (to punitive levels, perhaps tied to a fraction of total bank assets). However, this approach would likely trigger numerous unintended consequences, including heightened corruption, reduced transparency, higher lending rates, and more. 

Moreover, with the top hierarchy of the BSP populated by banking officials, this scenario is unlikely to materialize. There will be no demand for such measures because only a few are aware of the underlying issues. 

While the solution to this problem is undoubtedly complex, we suggest the following:

1 Reduce government spending: Roll back government expenditures to pre-pandemic levels and ensure minimal growth in spending.

2 Let markets set interest rates: Allow interest rates to reflect actual risks rather than artificially suppressing them.

3 Address the debt overhang through market mechanisms: Let markets resolve the current debt burden instead of propping it up with unsustainable liquidity injections and credit expansions by both the banking system and the BSP.

4 Liberalize the economy: Enable greater economic and market liberalization to reflect true economic conditions.

5 Adopt a combination of the above approaches.

The mainstream approach to resolving the current economic dilemma, however, remains rooted in a consequentialist political scheme—where "the end justifies the means."

This mindset often prioritizes benchmarks and virtue signaling in the supposed pursuit of MSME welfare. For example, the establishment of a credit risk database for MSMEs is presently touted as a solution.

While such measures may yield marginal gains, they are unlikely to address the root issues for the reasons outlined above.

_____

References 

Republic Act 5901: Guide to the Magna Carta for Micro, Small and Medium Enterprises (RA 6977, as amended by RA 8289, and further amended by RA 9501), p.17 SME Finance Forum 

Margarito Teves and Griselda Santos, MSME Financing in the Philippines: Status, Challenges and Opportunities, 2020 p.16 Nomura Foundation 

Prudent Investor, Is San Miguel’s Ever-Growing Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE? December 02, 2024

 

 

October’s Historic Php 16.02 Trillion Public Debt: Insights on Spending, Employment, Bank Credit, and (November’s) CPI Trends

 

The essence of public debt, as a financing institution, is that it allows the objective cost of currently financed expenditure projects to be postponed in time. For the taxpayer, public debt delays the necessity of transferring command over resource services to the treasury. —James M. Buchanan, “Confessions of a Burden Monger” 

In this issue

October’s Historic Php 16.02 Trillion Public Debt: Insights on Spending, Employment, Bank Credit, and (November’s) CPI Trends

I. Preamble: The Perils of a Credit-Financed Economy

II. Analyzing Fiscal Policy: A Critical Perspective of the Record Php 16.02 Trillion Public Debt

III. Why Public Debt Will Continue to Rise: The Continuing Burden of the Military and Uniformed Personnel Pension (MUP) System 

IV. Pre-Election Labor Data? Declining Labor Participation Boosts Employment, While Agriculture Jobs Rise Despite Typhoons

V. Debt-Driven Consumption: The Risks of Unsustainable Household Borrowing

VI. Near Full Employment and Record Leverage, Yet a Tepid CPI Bounce in October: What Happened to Demand? 

VII. Philippine Public Debt Hits Record Highs in October 2024: Rising FX and Fiscal Risks Ahead!

October’s Historic Php 16.02 Trillion Public Debt: Insights on Spending, Employment, Bank Credit, and (November’s) CPI Trends 

Philippine public debt hit a record Php 16.02 trillion last October. Here are the reasons why it is likely to maintain its upward trajectory.

I. Preamble: The Perils of a Credit-Financed Economy

This week’s outlook builds on last week’s exposition, "Debt-Financed Stimulus Forever? The Philippine Government’s Relentless Pursuit of 'Upper Middle-Income' Status."

But here’s a brief preamble that encompasses our economic analysis over time—dedicated to our new readers. 

1 Spending reflects the ideology underpinning the Philippine approach to economic development. 

2 This Keynesian-based framework has been built on a "top-down" or "trickle-down" model, relying on the elites and the government to drive growth. 

3 Consequently, the nation's political and economic structures have been significantly shaped by this approach.

Figure 1

For instance, the elite owned universal-commercial banks have restructured their operations to prioritize consumer lending over industrial loans. Banks have also controlled 83.3% of the Total Financial Resources (TFR) as of September (or Q3). (Figure 1, top and middle charts) 

4 A key outcome of this credit-driven spending is the historic savings and investment gap (SIG), manifested by the "twin deficits." These deficits reached unprecedented levels during the pandemic recession in 2020–2021, as the National Government and the Bangko Sentral ng Pilipinas (BSP) stepped in to rescue the banking system and protect elite interests. (Figure 1, bottom window) 

5 Credit-financed private sector investments have also included speculative activities based on a "build it, and they will come" or "race-to-build supply" dogma.  These activities span sectors such as real estate, infrastructure, construction, retail, and accommodations. 

6 Since these deficits require substantial funding—and with the government, non-financial corporations (including PSEi-listed firms), and even banks now acting as net borrowers—households and external savings have become critical sources for bridging this economic gap. 

7. In addition to the erosion of the peso's purchasing power, the depletion of savings is clearly reflected in the scale of financing requirements. 

Figure 2 

Even by mainstream measures, the nation’s gross savings rate has been on a downward trend since 2009, despite a brief two-year recovery in 2022 and 2023, from the lows of 2021. (Figure 2, topmost graph) 

8. Trends in motion tend to stay in motion—until a crisis emerges. 

Thus, it comes as no surprise that the serial expansion of systemic leverage—encompassing public debt and bank credit growth—has become the cornerstone of the "top-down" spending-driven GDP architecture. 

II. Analyzing Fiscal Policy: A Critical Perspective of the Record Php 16.02 Trillion Public Debt

Bureau of Treasury, December 3:  The NG's total outstanding debt stood at P16.02 trillion as of end-October 2024, reflecting a 0.8% or P126.95 billion increase from the end-September 2024 level. The increase was primarily driven by the valuation impact of peso depreciation against the US dollar from 56.017 at end-September 2024 to 58.198 at end-October 2024. Of the total debt stock, 67.98% is composed of domestic securities, while 32.02% consists of external obligations. (bold added) 

Bureau of Treasury, October 1: The National Government’s (NG) total outstanding debt stood at P15.55 trillion as of the end of August 2024, reflecting a 0.9% or P139.79 billion decrease from the end July 2024 level. This decline was primarily attributed to the revaluation effect of peso appreciation and the net repayment of external debt (bold added) 

“Look,” the establishment analyst might argue, “strong revenues have led to a declining fiscal deficit, and consequently, increases in debt have also decreased.” (Figure 2, middle diagram) 

We counter, "Yes, but that view is backward-looking." As economist Daniel Lacalle observed, "Deficits are always a spending problem because receipts are, by nature, cyclical and volatile, while spending becomes untouchable and increases every year."

That is to say, analyzing public balance sheets is more about theory than statistical analysis.

First, despite the hype surrounding the supposed ‘multipliers’ of deficit spending, diminishing returns are a natural outcome of political policies and are therefore unsustainable. 

Why has Japan endured an era known as the "lost decades" if this prescription worked? And if public spending is so successful, pushing this reasoning with reductio ad absurdum logic, why not commit 100% of resources or embrace full socialization of the economy?

Second, as long as public spending rises—which is mandated by Congress—economic slowdowns or recessions magnify the risks of a fiscal blowout. The pandemic recession exemplifies this. (Figure 2, bottom image) 

Briefly, the embedded risks in fiscal health arise from the potential emergence of volatility in revenues versus political path dependency in programmed spending. 

Third, cui bono? Are the primary beneficiaries of spending not the political elites, bureaucrats, and the politically connected private sector? Without a profit-loss metric, there is no way to determine whether these projects hold positive economic value. 

For instance, government fees from infrastructure projects do not reflect market realities but are often subsidized to gain public approval. 

How much economic value is added, or what benefit does a newly erected bridge in a remote province or city provide relative to its costs?

Fourth, in a world of scarcity, government activities not only compete with the private sector but also come at its expense—resulting in the crowding-out effects. 

Since the government does not generate wealth on its own but relies on extraction from the productive sectors, how can an increase in government spending not reduce savings and, therefore, investments?

Figure 3

Have experts been blind to the fact that these "fiscal stabilizers" or present-day "Marcos-nomics" stimulus have been accompanied by declining GDP? (Figure 3, topmost chart)

Lastly, who ultimately pays for activities based on "concentrated benefits and dispersed costs," or political transfers through the Logic of Collective Action?

Wouldn’t that burden fall on present day savers and currency holders or the peso (through financial repression—inflation tax) as well as future generations?

III. Why Public Debt Will Continue to Rise: The Continuing Burden of the Military and Uniformed Personnel Pension (MUP) System

A segment of the government’s October jobs report offers valuable insights into the trajectory of public spending. 

The basic pay for personnel in the Philippine military or Armed Forces is higher than, or on par with, the salaries of top-tier positions in the private sector. (Figure 3, middle graph) 

This is remarkable. 

The data reflects the political priorities of the government. 

After the overthrow of the Marcos 1.0 regime, the civilian government sought to pacify a restive military bureaucracy by granting pay increases and other benefits or perquisites. 

The previous administration implemented across-the-board pay raises to maintain favor with the military.

These actions have contributed to significant excesses in the unfunded Military and Uniformed Personnel (MUP) pension system, which now poses an increasing risk of "fiscal collapse. The system’s unfunded pension liabilities are estimated at Php 9.6 trillion, equivalent to 53% of the Philippines’ gross domestic product (GDP).

Yet, even after the Department of Finance (DoF) proposed reforms in 2023 to address these issues, the reform bill remains pending in Congress and could remain unresolved due to internal dissent.

It goes without saying that the recent pay increases affirm a subtle transition to a war economy, which will be publicly justified in the name of "defense" or under the guise of "nationalism." 

Yet, by setting pay scales higher than those in the private sector, the government have been prioritizing political appeasement over fostering the productive economy. This misalignment could lead to further erosion of the private sector. 

Consequently, this egregious pay disparity may incentivize individuals to seek government employment over private-sector jobs, potentially crowding out labor from the productive economy. 

These developments contradict the government’s stated goal of positioning the Philippines as a global investment hub. 

Perhaps partly due to MUP operating under unprogrammed funding, public debt increases have risen disproportionately above public expenditures. (Figure 3, lowest image) 

Needless to say, due to the protection of entrenched interest groups, public debt will continue to rise. 

IV. Pre-Election Labor Data? Declining Labor Participation Boosts Employment, While Agriculture Jobs Rise Despite Typhoons 

As an aside, authorities reported a slight increase in the unemployment rate, rising from 3.7% in September to 3.9% in October. Conversely, the employment rate declined slightly from 9.63% to 9.61%. Both figures remain close to the milestone rates of 3.1% and 9.69%, respectively, achieved in December 2023.

Figure 4

The increase in the employment rate, however, was driven by a drop in labor force participation. (Figure 4, upper visual)

Despite the population aged 15 and above increasing by 421,000 month-on-month (MoM) in October, the number of employed individuals decreased by 1,715,000, while the labor force shrank by 1,643,000. 

The Philippine Statistics Authority (PSA) explains that the non-labor force population includes "persons who are not looking for work because of reasons such as housekeeping, schooling, and permanent disability." 

This highlights how arbitrary qualifications can inflate the employed population figures. 

Interestingly, among the three major employment sectors, only agriculture recorded a MoM increase (+282,000). Industry (-48,000) and services (-1,950,000) both experienced significant declines. Of the 21 employment subcategories, only seven posted expansions, led by agriculture (+323,000), construction (+234,000), and accommodation (+163,000). (Figure 4, lower chart) 

Notably, government and defense jobs saw a sharp drop of 358,000. 

The near all-time highs in labor data appear to be strategically timed for the upcoming elections. 

V. Debt-Driven Consumption: The Risks of Unsustainable Household Borrowing

Figure 5

On a related note, the BSP reported all-time highs in universal and commercial (UC) consumer lending last October, driven by credit card, auto, and salary loans in nominal or peso amounts. (Figure 5, topmost window) 

Household borrowings surged with 23.6% year-on-year (YoY) growth, fueled by increases of 27.8%, 18.34%, and 18.5%, respectively. (Figure 5, middle graph) 

This blazing growth rate has pushed the share of these loans in the bank’s portfolio to unprecedented heights. 

This dynamic indicates that "banked" households have been steadily increasing their leverage to support consumption and, possibly, to refinance existing debt. 

However, as the PSEi30’s Q3 data reveals, despite high employment rates and the rapid rise in household leverage, consumer spending remained sluggish. 

This suggests three possibilities: wage growth has been insufficient to keep up with current price levels, households are increasingly reliant on debt to bridge the gap and maintain their lifestyles, or it is a combination of both factors. 

Additionally, despite the BSP implementing a second rate cut, UC total bank lending growth showed early signs of slowing, decelerating from 11.32% in September to 10.7% in October. 

Do these trends imply a productivity-driven or credit-driven economy? 

At the current pace of unsustainable household balance sheet leveraging, what risks loom for consumers, the banking system, and the broader economy? 

VI. Near Full Employment and Record Leverage, Yet a Tepid CPI Bounce in October: What Happened to Demand? 

Still, despite near full employment, increases in household and production loans have failed to boost liquidity, savings, and inflation. 

October M3 growth remained stagnant at 5.5% from a month ago.

Also, the October CPI rose marginally from 2.3% to 2.5%, while core inflation increased from 2.4% to 2.5% over the same period. (Figure 5, lowest chart)

Additionally, could the CPI be nearing its bottom?

Might this signal the onset of the third wave in the inflation cycle that began in 2015?

Will a fiscal blowout fuel it?

Figure 6

Ironically, what happened to the correlation between systemic leveraging and the CPI? While systemic leveraging has been rising since Q3 2024, the CPI has failed to recover since peaking in Q1 2023. (Figure 6, topmost pane) 

Or, what happened to the record consumer leveraging, rising production debt, and near all-time highs in government spending? Why has demand slowed in the face of milestone-high systemic leveraging (public spending + bank credit expansion)?

Have the balance sheets of the private sector become a barrier to 'spending-based GDP'?

Intriguingly, while the government attributes the rise in the October CPI to typhoons (Typhoon Kristine and Typhoon Leon), which have caused price increases due to supply-side disruptions in food, jobs data indicate that such natural calamities have actually bolstered agricultural employment.

This possibly suggests a belief in the "broken window fallacy"—the misconception that growth can be driven by disasters or war!

These are incredible contradictions!

VII. Philippine Public Debt Hits Record Highs in October 2024: Rising FX and Fiscal Risks Ahead!

Circling back to the unparalleled Php 16.02 trillion debt, which—according to the BTr report—has risen due to the decline of the peso.

In contrast, when public debt declined last August, the improvement was also attributed to the strengthening of the Philippine peso.

While changes in the USDPHP exchange rate influence the nominal amount of public debt, the government continues to borrow heavily from both local and international capital markets. For instance, in Q3, the BSP approved state borrowings amounting to USD 3.81 billion. (Figure 6, middle image)

Following the surge in Q1 2023, foreign exchange (FX) borrowings by the public sector have continued to climb.

Moreover, since reaching a low of 28.12% in March 2021, the share of FX borrowings has been on an upward trend, with October’s share of 32.02% approaching May 2020's level of 32.13%. (Figure 6, lowest diagram)

This trend also applies to foreign debt servicing, as demonstrated last week, where FX-denominated servicing for the first ten months increased from 18.08% in 2023 to 21.9% in 2024.

Figure 7

In the face of fiscal stabilizers (deficit spending), the external debt of the Philippines continues to reach record highs in Q2, primarily due to state borrowings, which accounted for 57% of the total. Borrowing by banks and non-banks has also been on the rise. (Figure 7, topmost visual)

Debt levels in Q3 are likely to hit a new milestone given the approval of state FX loans by the BSP. 

Inadequate organic FX resources—reflected in revenues and holdings—have led to "synthetic dollar shorts," as highlighted last November. 

Meanwhile, the BSP appears to be rebuilding its FX reserves to restore the 85-88% range, which likely represents its USD anchor (de facto US dollar standard) for stabilizing the USDPHP exchange rate and domestic monetary operations. (Figure 7, middle image)

As of August, the BSP’s international reserves remain below this anchor level, as well as below its domestic security holdings. These holdings were used to inject a record Php 2.3 trillion to stabilize the banking system in 2020-2021.

While the liquidity injected remains in the system, it seems insufficient, as a 'black hole' in the banking sector appears to be absorbing these funds.

Compounding the issue, the lack of domestic savings to finance the widening savings-investment gap (SIG)—manifested through the "twin deficits"—necessitates more borrowing, both domestic and FX-denominated.

This deepening reliance on spending driven by the savings-investment gap increases the risk of a fiscal deficit blowout, accelerating the pace of debt accumulation 

Because the establishment peddles the notion that links public debt conditions to the USDPHP exchange rate, the BSP has recently been intensively intervening to bring the exchange rate below the 59 level.

These interventions are evident in the 5.6% year-on-year drop in November’s gross international reserves (GIR), which fell to USD 108.47 billion—well below the Q2 external debt figure of USD 130.18 billion. (Figure 7, lowest graph)

Yet, the wider this SIG gap becomes, the greater the pressure on the government, the BSP, and the economy to borrow further to meet FX requirements.

Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth

 

The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance— Taylor Caldwell, (often misattributed to Marcus Tullius Cicero) 

In this issue

Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth  

I. The Radio Silence on Last Week’s Collapse of the Philippine Treasury Yield Curve

II. What a Bullish Flattener Implies

III. How Rate Cuts Could Affect the Health of the Philippine Banking System

IV. Mounting Economic Fragility: Higher May Unemployment Rate and the Rising Dependence on Government Jobs

V. Mounting Economic Fragility: Elevated Trade Deficit, Softened FDI Flows in April, and Stagnant Manufacturing Sales

VI. "Marcos-nomics stimulus:" The Turbocharging of Pre-Election Liquidity Growth  

Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth

The collapse in the yields of the Philippine Treasury Markets highlights the BSP's upcoming rate cuts, which, along with May's spending and liquidity growth spike, represents the "Marcos-nomics stimulus."

I. The Radio Silence on Last Week’s Collapse of the Philippine Treasury Yield Curve

Last week, significant developments in the Philippine treasury markets went largely unreported by the media and the echo chamber. Despite this, the implications of these changes are significant for the country's economy.

Figure 1

One. T-bill rates remained steady, while yields on Philippine notes and bonds plunged, deepening the "bullish flattening" process that we have been pointing out. (Figure 1, topmost window)

Two.  The entire Philippine treasury curve has traded below the Bangko Sentral ng Pilipinas' (BSP) overnight reverse repurchase rate (ON-RRP). (Figure 1, middle image) 

Figure 2

Three.  The steep drop in 10-year Philippine treasury notes last week was the most pronounced in the (ASEAN) region, even surpassing the recent declines seen in US Treasury counterparts. (Figure 1, lowest diagram, Figure 2, upper graph)

In essence, treasury traders have reinforced indications that the BSP is preparing to lower rates.

You heard this first here.

II. What a Bullish Flattener Implies

Yet, a bullish flattener can be seen as a sign of different things depending on the context.

In the BSP’s latest Financial Stability Report (FSR), a bullish flattening curve represents "Longer-term outlook is improving and investors price-in lower rates. This gives the central bank room to lower the policy rate" (BSP, 2023)

For Wellspring Financial Advisors, "We have historically seen bull flattening leading into a recession. This can often happen because of a flight to safety trade and/or a lowering of inflation expectations " (Bruss, 2023)

Last we noted that "T-bill rates have been coming off their recent highs, and the narrowing of the treasury curve or a "bullish flattening" has highlighted weaker inflation and slower GDP growth, supporting the BSP's desired rate cuts" (Prudent Investor, 2024)

The point is, while not a direct indicator of economic conditions or inflation, the treasury yield curve provides a crucial insight depending on prevailing economic and financial circumstances.

Nonetheless, the following factors may be relevant to the present conditions:

First, the fact that rates have been tumbling translates to the treasury markets expecting an easing of monetary policy. Rate cuts can only be justified by diminishing inflation rates.

Second, lower inflation expectations increase the demand for longer-term securities. (ceteris paribus)

Third, it could also signify slowing economic growth or increasing risk aversion (even flight to safety).

Fourth, it may imply accruing imbalances in the supply and demand for Philippine treasuries.

III. How Rate Cuts Could Affect the Health of the Philippine Banking System

How will this affect the banking system?

One. The illusion of debt-financed spending utopia.

While lower rates could boost the GDP in the immediate term through increased credit expansion, allowing for expanded financing of Keynesian desired spending, this is contingent upon the capacity of balance sheets to absorb higher leverage.

For instance, unlike in 2008-2017, the serial BSP rate cuts in pre-pandemic 2019 haven’t exactly bolstered bank lending, which in contrast, declined due to the scourge of hidden NPLs. (Figure 2, lower pane)

Only the BSP’s historic Php 2.3 trillion liquidity injections backed by the unprecedented relief measures reversed it in 2021.  

Powered mostly by consumer loans, universal commercial bank lending soared by 10.2% in May 2024—the strongest growth since March 2023.

Much of the current strength in bank lending is due to 'refinancing' or debt 'rollovers,' which is why the Consumer Price Index (CPI) remains subdued.

Ironically, the establishment brands this debt expansion as 'restrictive.' Incredible.

In the absence of this vigorous credit expansion, think of what would happen to inflation and GDP.

The thing is, spending will be determined by balance sheet conditions over time, rather than just rates alone.

Two. A temporary boost on investments.

With surging fixed-income prices, it may also boost the banking industry’s investment side of the balance sheets.

Figure 3

It may also temporarily lower the industry’s camouflaged mark-to-market losses in the context of held-to-maturity (HTM) assets. (Figure 3, topmost chart)

However, HTMs showed minimal improvement when 10-year yields plummeted in 2022-2023, confirming the trend observed from 2019 to 2022, where a crash in rates resulted in negligible progress for the bank’s HTM assets.

Three. An adverse impact on the bank’s interest margins.

Furthermore, the narrowing bond spreads should also lead to tighter interest margins for banks as the 2019-2020 experience showed, which means lesser incentive to lend. (Figure 3, middle graph)

Lastly, falling rates expose disguised credit risks.

During 2019-2020, the BSP rate cuts were in response to mounting pressures from credit delinquencies in the banking system. While the pandemic recession exacerbated the situation, BSP's comprehensive measures—combining rate cuts, liquidity injections, and various relief efforts—masked the true extent of NPLs. (Figure 3, lowest pane)

Despite some of these relief measures and subsidies in place, the recent resurgence of NPLs have been pressuring the BSP to consider such rate cuts.

Figure 4

In short, the BSP rate cuts would whet the speculative appetite of banks and financial institutions for "investments," while reducing their core "lending" operations (similar to the rate cuts of 2019-2020) (Figure 4, topmost image)

Most importantly, higher interest rates have exacerbated the servicing costs associated with record-high levels of public debt, indicating a potential reduction in GDP growth driven by lower public spending over time.

IV. Mounting Economic Fragility: Higher May Unemployment Rate and the Rising Dependence on Government Jobs

Despite its ever-shifting or ambivalent stance, the BSP has been advocating for lower rates. Several economic data released last week help explain this push.

Firstly, despite the recent record-high employment rates, labor markets continue to face challenges.

While the unemployment rate rose from 4% in April to 4.1% in May, this increase was primarily due to a rise in the labor force participation rate. The employed population actually increased by 510,000 month-over-month (MoM), but a larger increase in the labor force by 576,000 led to an uptick in the unemployment rate. (Figure 4, middle visual)

However, a broader analysis reveals emerging tensions in labor participation rates. 

It seems odd to see a job boost in the investment-starved agricultural sector reportedly suffering substantial losses from El Nino. Yet, the government bannered Php 9.6 billion in investment gains this month (mostly from the elites). 

Furthermore, the government was the largest contributor to job gains. Aside from construction jobs stemming partly from government infrastructure projects (including PPPs), the government and defense sectors saw significant gains in both May and March. (Figure 4, lowest chart) 

Even assuming its accuracy, this data provides clues as to why consumers have been struggling, contradicting the headline trend of "full employment." 

V. Mounting Economic Fragility: Elevated Trade Deficit, Softened FDI Flows in April, and Stagnant Manufacturing Sales 

Next, external trade retraced much of its April advances in May.

Figure 5

Import growth fell from a 13.01% increase in April to a negative 0.03% in May, primarily due to an 11.5% plunge in capital goods imports, while consumer goods imports only rose by a meager 0.42%. Capital and consumer goods accounted for 25.6% and 19.6% of the total share, respectively. (Figure 5, topmost pane)

Export growth also dived from a 27.9% growth spike in April to a 3.08% contraction in May. 

While Artificial Intelligence (AI) has boosted global semiconductor trade, with exports increasing by 19.3% year-over-year (YoY) and 4.1% month-over-month (MoM) in May, Philippine semiconductor exports saw an incredible collapse from a 30.7% YoY growth spike in April to a 13.3% contraction in the same month! Microchip exports accounted for 43.4% of the total share. (Figure 5, middle graph) 

Thirdly, despite periodic junkets by the leadership, which reportedly led to significant investment pledges from key geopolitical partners like the US and NATO, April's Foreign Direct Investments (FDI) fell by 36.9%, but overall YTD growth was up still 18.7%. Debt made up significant proportions of both April's and YTD FDIs: 73.2% and 63.5%, respectively. What happened to these investment promises? (Figure 5, lowest chart) 

Also, debt-driven FDI flows do not automatically translate into 'investments' and could serve other purposes. Some might declare it as such to the government to avail of incentives. 

Lastly, FDI flows exhibit a downtrend.

Figure 6

Finally, domestic manufacturing remains stagnant, with production values and volumes increasing by 2.2% and 3.2% respectively in May (YTD: -0.1% and +0.9%). However, these gains may be offset by declining sales values and volumes, which saw decreases of -1.5% and -0.3% in May (YTD: -1.4% and -0.3%). (Figure 6, topmost graph) 

Imports have partially filled the slack in domestic production, which is the essence of the trade deficit. 

Overall, weak imports and a manufacturing stupor manifest a fragile domestic demand. 

In a nutshell, despite optimistic projections by the echo chamber, even government data suggests a critical shortage of investments and an increasing dependence on debt supporting the real (not statistical) economy.  

Moreover, deepening dependence on the government to stimulate GDP growth, evidenced by near-record "twin deficits," could lead to heightened inflation, higher future taxes, and magnified reliance on external debt. (Figure 6, middle chart)

It is not helpful when the establishment confuses the GDP with the overall economy, for the simple reason that the GDP has been skewed to reflect the growth of the government and the elites—the "trickle-down syndrome." 

VI. "Marcos-nomics stimulus:" The Turbocharging of Pre-Election Liquidity Growth

Could the public spending spike observed in May 2024 signify a potential precursor to a "Marcos-nomics stimulus" program? 

Meanwhile, infrastructure, public defense-related projects, pre-election expenditures, and bureaucratic spending were likely funded by the national government, which saw a 22.3% spike in disbursements in May. 

This contributed to a 14.8% surge in national government spending over the first 5 months, reaching an all-time high nominal level of Php 1.443 trillion! 

So if we are not mistaken, "Marcosnomics" will be heavy on political expenditures but sold to the public as a "stimulus." (Prudent Investor, 2024)

May 2024 marked the fourth highest spending on record, which significantly boosted the BSP’s principal measure of liquidity, M3, to 6.5%, a six-month high.

Figure 7

A substantial portion of this liquidity growth stemmed from cash in circulation, which surged to its second-highest level on record, surpassing the zenith of December 2022. (Figure 7, topmost image) 

Traditionally, December has been the peak for M3 annually. However, this time could be different. If May’s spending trend continues, nominal cash levels may surpass the historic highs of December 2023 even before year-end! 

May’s cash growth rate of 6.1% YoY was the highest since December 2022’s 7.6%. 

For want of doubt, the administration has begun injecting large amounts of cash into the financial system. 

Together with the accelerating growth in the banking system’s loans, the BSP’s net claims on the central government (NCoCG) surged by 89.21% in May, while the bank's NCoCG slowed to 12.2%. (Figure 7, middle graph) 

This combined financing of government deficit spending and private sector borrowing or formal credit expanded by 9.44% to a record Php 27.02 trillion in May! 

And yet, all we can hear from the consensus is that this represents a “restrictive environment!” 

The thing is, if May’s deficit spending-driven liquidity growth will be sustained, it should put a floor on the present private sector-powered disinflationary impulses—with a time lag. 

The Philippine treasury markets have signaled that the BSP may be about to confirm the unannounced "Marcos-nomics stimulus" with upcoming rate cuts. 

However, such stimulus could also reinvigorate the third wave of the incumbent inflation cycle. (Figure 7, lowest chart) 

Stay tuned.

___ 

References

FINANCIAL STABILITY COORDINATION COUNCIL, 2023 FINANCIAL STABILITY REPORT December 2023, p.35 bsp.gov.ph

Kevin Bruss Steepening and Flattening of the Yield Curve, Wellspring Financial Advisors, August 10, 2023; wellspringadvisorsllc.com

Prudent Investor, June CPI’s Decline Reflects Demand-Side Slowdown: Will the BSP Join Global Peers in Easing Policies, and Will the Government Pursue 'Marcos-nomics Stimulus'? July 7, 2024

Prudent Investor, Could the Philippine Government Implement a 'Marcosnomics' Stimulus Blending BSP Rate Cuts and Accelerated Deficit Spending? Substack.com June 30, 2024