PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

 

History will not be kind to central bankers fixated on financial economy and who created serial speculative booms to sustain the illusion of prosperity. It will also be critical of governments unwilling to address weaknesses, who deflected shifting hard policymaking to independent, unelected and largely unaccountable central banks—Satyajit Das 

In this issue 

PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

I. PSEi 30 Craters on Signs of Re-Tightening Amid Rising Dollar and Higher UST Yields

II. Despite the Market Carnage: Financials Share of the PSEi 30 Zoom to All-time High!

III. Financialization: The Expanding Role of Banks in Achieving Political Goals

IV. "National Team?" In Q2, Other Financials Corporations Sold, the PSEi 30 Plunged

V. In Q3, Mismatch Between Financial Index-Bank Fundamentals Reached a Blow-off Phase!

VI. Worsening Bank Liquidity Conditions as Cash-to-Deposits Hit Milestone Low

VII. Liquidity and Collateral Crunch? Bank Borrowings, Focused on Bills, Zoomed to Record Highs in September, as Repos also Hit All-time Highs!

VIII. Despite Lower Rates Held to Maturity Assets Near All-time Highs, Record Bank QE

IX. A Snapshot of Q3 and 9-Month Performance of PSE Listed Banks

X. Highlights, Summary and Conclusion

PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

Even as the PSEi plummeted due to signs of global and local re-tightening, the Financials outperformed, widening the mismatch between share prices and fundamentals. Will a reckoning come soon?

I. PSEi 30 Craters on Signs of Re-Tightening Amid Rising Dollar and Higher UST Yields"

Figure 1

The Sage of Omaha, Warren Buffett, once said, "Only when the tide goes out do you discover who's been swimming naked."

Have the signs of tightening upended the dream of easy money’s "goldilocks" economy, or have they exposed those who have been "swimming naked?"

The surging US dollar index, coupled with rising 10-year Treasury yields—both largely attributed to Trump's policies— has sent global risk assets tumbling. Yet, these developments took shape two months before the US elections. (Figure 1, topmost graph)

This includes the Philippine PSEi 30, which plunged by 4.31%, marking its largest weekly decline in 2024 and the steepest drop since the week of September 30, 2022, when it fell by 8.3%.

As of Thursday, November 14, the headline index broke below the 6,600 level, closing at 6,557.09.

A notable oversold rebound in industrials, led by Meralco (up by 7.78%) and Monde (up by 7.52%), along with financials from BPI (up by 3.7%) and CBC (up by 4.58%), contributed to a low-volume rally of 1.82% on Friday.

Year-to-date, the PSEi 30 is struggling to maintain its narrowing return of 3.5%.

II. Despite the Market Carnage: Financials Share of the PSEi 30 Zoom to All-time High!

The Financial Index, down by only 1.86%, was the least affected in this week’s market carnage. BPI was the only member of the PSEi 30 component to withstand the foreign-driven selloff, while Jollibee ended the week unchanged. (Figure 1, middle pane)

Interestingly, this outperformance has propelled the aggregate free-float market capitalization weighting of the three major banks of the headline index to an all-time high. (Figure 1, lowest chart)

Figure 2

Furthermore, financials accounted for 41.7% of the mainboard's volume on Friday—the third-highest share since October. (Figure 2, topmost diagram)

Meanwhile, October’s cumulative 29.92% accounts for the sector’s highest share since July 2023, which also translates to a 2017 high.

In a related note, the Bangko Sentral ng Pilipinas (BSP) has suspended its free publication of non-BSP-generated data, including PSE data on monthly price-earnings ratios (PER), market capitalization by sector, index data, and volume distribution by sector. This suspension hampers our ability to track critical developments in market internals. (Yes, I wrote them)

The point being, the increasing share of mainboard volume by the financial sector has pillared the rising share of the sector’s market cap share of the PSEi 30.

However, this dynamic also implies growing concentration risk in the stock market.

III. Financialization: The Expanding Role of Banks in Achieving Political Goals

Businessworld, November 13: THE PHILIPPINE banking system’s net profit jumped by 6.4% at end-September as both net interest and non-interest income grew, data from the Bangko Sentral ng Pilipinas (BSP) showed. The combined net income of the banking industry rose to P290 billion in the first nine months of 2024 from P272.6 billion in the same period a year ago.

The PHP 290 billion profit and a 6.4% growth rate represent the Q3 figures year-over-year (YoY).

Continuing from last week’s discussion, the diverging dynamics in the Philippine Stock Exchange (PSE) have also been reflected in the GDP figures. 

Although the financial sector has been on an upward trajectory since the new millennium, its share of the real GDP has rapidly deepened during the BSP’s historic rescue of the sector. 

This was notably influenced by the BSP historic intervention to rescue the sector, which included an unprecedented PHP 2.3 trillion quantitative easing package, historic cuts in official and reserve ratios, as well as unparalleled subsidies and relief measures. 

In line with the rising share of money supply-to-GDP, the financial sector's share of GDP reached its third highest level at 10.8% in Q3. (Figure 2, middle image) 

It even hit an all-time high of 10.9% when considering the 9-month real GDP data. 

While this evolution may be labeled as "financialization," the essential message is clear: BSP policies have led to an economy increasingly immersed (or heavily reliant) in credit and liquidity, primarily channeled through an elite-owned and controlled banking system. 

This deepening dependence comes at the expense of the development of other competing financial conduits, such as capital markets. 

The underlying reason for this is political: the bank-led financial sector serves as the primary non-BSP financier of the government’s deficit spending. 

As a result, the government's calls for improvements in the capital markets appear to be mere lip service. 

However, judging by their "demonstrated preference" in policy choices, it appears that inflating bank shares may serve to camouflage the adverse consequences of this deepening and complex political-economic arrangement. 

IV. "National Team?" In Q2, Other Financials Corporations Sold, the PSEi 30 Plunged

The developments in Other Financial Corporations (OFCs) provide valuable insights. 

In Q2, OFCs eased their holdings of equities.  According to the BSP, "The other financial corporations’ claims on the other sectors dropped as their holdings of equity shares issued by other nonfinancial corporations fell." 

The Non-bank financial institutions and OFCs "includes the private and public insurance companies, other financial institutions that are either affiliates or subsidiaries of the banks that are supervised by the BSP (i.e., investment houses, financing companies, credit card companies, securities dealer/broker and trust institutions), pawnshops, government financial institutions and the rest of private other financial institutions (not regulated by the BSP) that are supervised by the Securities and Exchange Commission (SEC)" (Armas, 2014) 

In the same quarter, OFC claims on the private sector decreased by 0.5% quarter-over-quarter (QoQ), while the PSEi 30 index plunged by 7.1%. (Figure 2, lowest visual) 

My guess is that some of these OFCs are part of what could be considered the Philippine version of the "national team." 

V. In Q3, Mismatch Between Financial Index-Bank Fundamentals Reached a Blow-off Phase!

Nevertheless, the deviation between the fundamentals of banks and their share prices has reached "blow-off" proportions!

Figure 3 

In Q3, the banking system reported a modest growth of 6.4%, slightly higher than Q2’s 4.1%. However, the financial index skyrocketed by 19.4% quarter-over-quarter (QoQ). 

From another angle, 9-month profit growth was up by 5.07%, even as the financial index surged by a stunning 23.4% year-on-year in Q3.

Worst of all, profit trends and the financial index have moved in opposite directions. 

Since profit growth peaked in Q3 2022 and subsequently eased, shares of the seven-member bank stocks (excluding the eighth member: PSE) within the financial index have continued to accelerate. (Figure 3, topmost window) 

Meanwhile, given that universal and commercial banks account for 93.9% of total bank assets, their profit growth largely mirrors the entire banking system. In Q3, profit growth was 7.03%, and on a 9-month basis, it stood at 6%. 

These figures underscore the increasing monopolization of the financial industry by banks validated by the BSP’s Total Financial Resources (TFR) data. 

Total financial resources grew by 10.07% to a record PHP 33.08 trillion. 

The banking sector’s share surged to an all-time high of 83.3%, driven mainly by universal and commercial banks, whose contribution reached a record 78.1%. (Figure 3, middle image) 

So let us get this straight: banks have increased their share of trading activities in the PSE, as well as their slice of both the PSEi 30 and the GDP pie. They now command 83.3% of total financial resources and are continuing to rise. 

This dominance doesn’t even account for their substantial role in the local bond markets, where they act as issuers, intermediaries, and holders. 

Even without the BSP acknowledging this, what we are witnessing is the intensifying risks within the Philippine financial-economic system. 

VI. Worsening Bank Liquidity Conditions as Cash-to-Deposits Hit Milestone Low

Have you ever seen any experts or establishment analysts address the developing contradiction between the banks' reported profits and their liquidity conditions? 

Cash and due from banks, or bank cash reserves, plummeted by 13.6% in September 2024, following a brief 4% rebound in August. This decline brought cash reserves to their lowest level since 2019. (Figure 3, lowest graph) 

To address the emerging liquidity shortfall, the BSP previously reduced the bank reserve requirement ratio (RRR) from 19% to 14%, implemented in seven installments from March 2018 to December 2019. 

Cash reserves saw a temporary spike in 2020 when the BSP injected Php 2.3 trillion into the system, accompanied by an RRR cut from 14% to 12% in April 2020. 

However, facing diminishing returns, cash reserves resumed their downward trend. 

Once again, doing the same thing and expecting different results, the BSP reduced the RRR by a larger margin than in 2020, lowering it from 12% to 9.5% in June 2023. 

Despite these efforts, the challenges within the banking system's cash reserve position have persisted.

Figure 4

Moreover, while the growth in peso deposit rates increased from 6.9% in August to 7.07% in September—the slowest growth rate since July 2023—the BSP’s cash-to-deposit ratio plummeted to 12.44%, its lowest ratio since at least 2013! (Figure 4, topmost and second to the highest graphs) 

Yet, with the record bank credit expansion, why the sluggish growth in deposits? Where did the money flow into? 

Even with the recent decline in inflation rates, have a minority of "banked" households continue to draw from their savings? 

Furthermore, the banks' liquid asset-to-deposit ratio, which includes both cash reserves and financial assets, fell to 50.34%, reverting to levels seen during the BSP's rescue efforts in July 2020. 

Incredible. 

And this is just one facet of the mounting liquidity challenges that banks seem to be facing. 

VII. Liquidity and Collateral Crunch? Bank Borrowings, Focused on Bills, Zoomed to Record Highs in September, as Repos also Hit All-time Highs! 

More eye-catching data emerged last September. 

Bank borrowings—primarily in short-term bills—skyrocketed to an all-time high! Borrowings surged by 49.7%, reaching a record PHP 1.7 trillion, with their share of total liabilities climbing to 7.3%, the highest since 2021. (Figure 4, second to the lowest and lowest charts) 

The liquidity shortfall is most pronounced over the short-term, this is why bank’s bills payable zoomed to unscaled heights.

Figure 5

Not only that, bank short-term repo (repurchase agreements) or RRP (reverse repurchase) operations with the BSP and other banks have also launched into the stratosphere!

With record repo operations, the RRP’s 3.72% share of the bank’s total assets surged to the highest level since at least 2015! (Figure 5, upper image) 

Could this rampant use of repurchase agreements (repos) be underlying growing collateral issues in the financial system? As banks increasingly depend on repos for short-term liquidity, are we witnessing a decline in the quality of collateral or a shortage of high-quality assets available for these transactions? 

These developments likely explain the BSP's abrupt announcement of the latest series of RRR cuts, which took effect last October. 

However, such actions resemble a Hail Mary pass, with RRR ratios now headed toward zero. 

VIII. Despite Lower Rates Held to Maturity Assets Near All-time Highs, Record Bank QE

Another paradox: banks reported that credit delinquencies—across the board—marginally declined in September. (Figure 5, lower diagram) 

If this is true, then higher profits combined with lower non-performing loans (NPLs) should result in more, not less liquidity 

Figure 6

Additionally, the easing of interest rates, as indicated by declining treasury yields, should have reduced banks' held-to-maturity (HTM) assets. As noted repeatedly, HTM assets drain liquidity because they lock up funds. (Figure 6, topmost graph)

Yet, there hasn’t been significant improvement in this area. 

Moreover, since authorities aim to meet year-end spending targets, boost GDP, and finance the upcoming elections, it is expected that the government will ramp up its deficit spending in Q4. 

This increase in public spending will likely lead to a rise in banks' and the financial sector’s net claims on central government (NCoCG), which may translate to higher HTM assets. (Figure 6, middle chart) 

Furthermore, if the current trend of declining inflation reverses, or we experience a third wave of rising inflation, banks might resort to accounting maneuvers to shield themselves from potential mark-to-market losses by shifting these assets into HTMs. 

That is to say, increases in debt-financed government spending and rising inflation rates could therefore result in higher levels of HTM assets.

Above all, banks are not standalone institutions; they have deep exposure to counterparties. As noted last week, 

Led by banks, the financial sector is the most interconnected with the local economy.  Its health is contingent or dependent upon the activities of its non-

financial counterparties. 

Alternatively, the sector’s outgrowth relies on political subsidies and is subject to diminishing returns. 

Yet ultimately, this should reflect on its core operational fundamentals of lending and investing. (Prudent Investor, October 2024) 

The transformational shift in the banking system’s business model—from production and consumption—could be ominous. Part of this shift has been motivated by pandemic-era subsidies and relief measures, as well as a move away from unproductive industry loans. 

As a result, the consumer share of total bank loans (excluding real estate) reached an all-time high of 14.9% in September 2024, while the share of production loans declined to 82.7%. The remaining 2.4% comes from non-resident loans. (Figure 6, lowest image) 

Banks have embraced the government’s belief that spending drives the economy, neglecting the balance sheet health of individuals, as well as the potential misallocations as a result of artificially low rates. 

But what happens to the consumer economy once their balance sheets have been tapped out? 

This should not surprise to our readers, given that the "inverted belly" of the Treasury yield curve has already been signaling these concerns.

IX. A Snapshot of Q3 and 9-Month Performance of PSE Listed Banks

Finally, here is a snapshot of the micro aspects of the financials.

Table 7

The performance of PSE-listed banks indicates that while all-bank profits grew by 14% to Php 226 billion in the first nine months of 2024, bills payable jumped by 79%, or Php 579 billion, reaching Php 1.31 trillion. This increase in bills payable signifies more than double the net profits generated over the same period. The data excludes the small-scale Citystate Savings Bank [PSE: CSB]. [Table 7]

PSEi banks accounted for 84% of the nine-month increase in bills, relative to their 73% share of net income growth. Metrobank [PSE: MBT] represented the most aggressive borrower, with a 61% share. 

We have yet to reconcile the stark divergence between the reported BSP bank performance and the aggregate activities of listed firms. 

Nonetheless, through aggressive lending, banks boosted their top and bottom lines in Q3, positively impacting the nine-month performance. 

Fueled by a 29.7% growth in non-PSEi banks, the net income growth of all banks soared by 22%. 

X. Highlights, Summary and Conclusion 

In the end, we can summarize the banking sector as having the following attributes: (as of September or Q3) 

1. all-time highs in:

-Financial Index

-market cap share of the PSEi 30 (3 biggest banks)

-turnover of financial sector to mainboard volume (near)

-nominal or Philippine peso and % share of total financial resources

-nominal net claims on central government

-nominal Held-to-Maturity assets

-total bank lending in Philippine pesos

-percentage share of consumer bank lending

-nominal bank borrowing (mainly Bills)

-nominal repo operations

- nominal net financial assets

2. Historical lows in:

-cash-to-deposits

-production pie of total bank lending

-reserve requirement ratio

3. Declining trend in:

-cash reserves

-profit growth

-deposit growth

-liquid asset-to-deposit ratio

How is it that the supposedly "profitable" financial institutions, supported by the recent slowdown in non-performing loans, have been accompanied by sustained declines in deposit and savings rates, as well as a massive hemorrhage in liquidity that compelled them to rapidly access short-term financing via bills and repos?

Have profits been overstated? Have NPLs been understated?

To what extent have the BSP’s relief measures and subsidies caused distortions in banks’ reporting of their health conditions?

Why the flagrant disconnect between stock prices and the actual conditions of the banks?

Could the "national team" have been tasked with camouflaging recent developments through a panicked pumping of the sector’s shares?

Does the ongoing shortfall in liquidity portend higher rates ahead?

Given all these factors, what could possibly go wrong?

As we recently pointed out,

To be clear, we aren’t suggesting that CBC and other record-setting bank shares, such as BPI, are a simulacrum of Lehman; rather, we are pointing to the distortive behavior of speculative derbies that may hide impending problems in the sector. (Prudent Investor, October 2024)

____

References 

Satyajit Das, Central banks: The legacy of monetary mandarins, New Indian Express, November 15, 2024 

Jean Christine A. Armas, Other Financial Corporations Survey (OFCS): Framework, Policy Implications and Preliminary Groundwork, BSP-Economic Newsletter, July-August 2014, bsp.gov.ph 

Prudent Investor, Q3 2024 5.2% GDP: Consumers Struggle Amid Financial Loosening, PSEi 30 Deviates from the GDP’s Trajectory, November 10, 2024 

Prudent Investor, Important Insights from the Philippine PSEi 30’s Melt-Up! October 7, 2024

  

Has the Philippine Government Won Its Battle Against Inflation? SWS Self-Poverty Survey Disagrees, Unveiling Its Hidden Messages

There is no escape from debt. Paying for the government’s fictitious promises in paper money will result in a constantly depreciating currency, thereby impoverishing those who earn a wage or have savings. Inflation is the hidden tax, and it is very convenient for governments because they always blame shops or businesses and present themselves as the solution by printing even more currency. Governments want more inflation to reduce the impact of the enormous debt and unfunded liabilities in real terms. They know they can’t tax you more, so they will tax you indirectly by destroying the purchasing power of the currency they issue—Daniel Lacalle

 In this issue

Has the Philippine Government Won Its Battle Against Inflation? SWS Self-Poverty Survey Disagrees, Unveiling Its Hidden Messages

I. Unveiling the Likely Hidden Messages Behind the Declaration of Victory Over Inflation

II. Treasury Curve was Spot On about Inflation, Short-Term Treasury Yields Plunge! Will the BSP Cut by 50 bps?

III. Supply-Side Disinflation? Despite Strong Credit Growth, Manufacturing Remains in the Doldrums, as Reflected by PPI Deflation and Output Sluggishness

IV. Supply-Side Disinflation? Lethargic Consumer Imports and July FDI Reflect Frail Capital Goods Imports

V. Demand-Side Disinflation? September CPI Plunged Despite Vigorous August Consumer Bank Lending, Liquidity Growth Dived

VI. Disinflation with Employment at Near Historic Highs Backed by a Credit Boom? Slower Deficit Spending Puts Pressure on Liquidity Strains

VII. SWS’s Self-Rated Poverty Survey versus the Government’s CPI 

Has the Philippine Government Won Its Battle Against Inflation? SWS Self-Poverty Survey Disagrees: Unveiling Its Hidden Messages

A Philippine media outlet proclaimed that the Philippine government won its battle against inflation, while a private survey contradicted this view. Who's right?

I. Unveiling the Likely Hidden Messages Behind the Declaration of Victory Over Inflation

Figure 1 

Two interesting headlines that hallmark this week’s conflicting message on inflation. 

Inquirer.net, October 7, 2024: The Philippines may now declare victory in its long and painful fight against inflation after price growth last month eased to a four-year low, helping create the perfect economic condition for gradual interest rate cuts…The BSP is now at a point where it has to undo its most forceful tightening actions in two decades, which had sent the benchmark rate to its highest level in 17 years to tame stubbornly high inflation. Cutting borrowing costs is necessary amid market predictions that the economy may grow below the government’s target for this year after consumption showed signs of weakening…Moving forward, Governor Eli Remolona Jr. said the central bank would take “baby steps” until the key rate falls to 4.5 percent by the end of 2025, suggesting that monetary authorities would unlikely resort to jumbo cuts that may stir up market fears that the economy is headed for a hard landing. (bold mine)

SWS.org.ph, October 9, 2024: The national Social Weather Survey of September 14-23, 2024, found 59% of Filipino families rating themselves as Mahirap or Poor, 13% rating themselves as Borderline (by placing themselves on a line dividing Poor and Not Poor), and 28% rating themselves as Hindi Mahirap or Not Poor. The September 2024 percentage of Self-Rated Poor families rose by 1 point from 58% in June 2024, following a significant 12-point rise from 46% in March 2024. This was the highest percentage of Self-Rated Poor families since June 2008. The estimated numbers of Self-Rated Poor families were 16.3 million in September 2024 and 16.0 million in June 2024. The percentage of respondent households rating themselves as poor was applied to the Philippine Statistics Authority medium-population projections for 2024 to arrive at the estimated numbers of Self-Rated Poor families… The September 2024 survey found the percentage of Borderline families at 13%, up by 1 point from the record low 12% in June 2024 following an 18-point decline from 30% in March 2024… As of September 2024, the percentage of Not Poor families was at 28%, 2 points below the record high 30% in June 2024. (bold mine)

First and foremost, what does "declare victory in its long and painful fight against inflation" mean? (Figure 1, upper tweet)

The Philippine CPI posted two straight months of DEFLATION (statistical price decreases) in September (-0.37%) and October (-0.19%) 2015; yet, the media and establishment experts barely made such a brazen pronouncement until now.

Yes, Q3 2024 statistical inflation of 3.2% has dropped to its 9-year support level, but this doesn’t mean that the inflation cycle has been broken.

Figure 2 

In Q3 2015, the CPI slipped into deflation at -0.1%, which prompted banks to accelerate their net claims on central government (NCoCG) or indirect QE. Ironically, this germinated the current inflation cycle, which is now on its ninth-year.  (Figure 2 upper image)

Despite its recent decline, given that the CPI has remained on an uptrend since 2015 and appears to have settled at the support levels, what assurances does the establishment hold that it won’t be subject to a third wave?

Second, the September CPI of 1.9% doesn’t translate to the evisceration of inflation; it only means that GENERAL prices have risen at REDUCED rates (or have dropped to within the BSP’s target), but they are still RISING!

In fact, BSP data tell us that even in the context of the understated inflation rate, over 99% of the purchasing power of the peso has been eroded since 1957! How is that for "declaring victory over inflation"? (Figure 2, lower chart)

On the other hand, while authorities and media bask in this pretentious statistical feat, a private sector survey tell us a different story: slower inflation has exposed the persistent and growing burden of a lower standard of living! (More on this below.) (Figure 1, lower tweet)

Third, "declaring victory over inflation" was NEVER a goal of the BSP’s monetary policy anchored on inflation targeting.

From the BSP: The primary objective of the BSP's monetary policy is “to promote price stability conducive to a balanced and sustainable growth of the economy” (Republic Act 7653). The adoption of inflation targeting framework of monetary policy in January 2002 is aimed at achieving this objective. Inflation targeting is focused mainly on achieving a low and stable inflation, supportive of the economy’s growth objective. This approach entails the announcement of an explicit inflation target that the BSP promises to achieve over a given time period. (bold mine)

There is no defined quantification or qualification of "low and stable inflation" because statistical inflation has always been a subjective measure, arbitrarily defined by the BSP.

That said, the goal of the politics behind inflation targeting has been to keep the inflation "genie" confined within the boundaries of the BSP’s proverbial "lamp."

That’s because inflation, as a hidden tax, benefits the government most.

However, the inflation genie has been set loose, or has gone beyond its bounds, marking the difference between the previous era and today.

In this way, the BSP can be conservatively said to have been "asleep at the wheel."

At worst, and unbeknownst to the public, the BSP’s policies have unleashed the inflation genie!

Or, although authorities continue to push the narrative of supply-side-driven inflation to shift the blame onto the private sector, the current inflation cycle signify an unintended consequence of their policies!

Yet, has anyone among the array of establishment experts, including those in government, been correct in predicting the incumbent inflation cycle? 

Fourth, the CPI is just a statistic. While its intent is to approximate changes in general prices, it neither reveals the full accuracy nor explains the causes of those changes. 

The fact is that inflation statistics are misleading.

My inflation rate and yours are different.  This is because of dynamic individual spending habits and ever-changing preferences that vary not only over time but also differs across individuals. 

Is it not the averaging a Netflix subscription and rice an exercise of apples-to-oranges comparison?  If so, would this not be applied to the CPI? 

Or, not only is the weighted averaging of goods and services across different groups of people a flawed metric, but people’s spending preferences are constantly changing! 

How accurate is an inflation rate derived from averaging the spending patterns of billionaires with those of the bottom 30%? 

Even on a personal level, my preferences are always changing. If I prefer sautéed prawns with bread this moment, adobo with rice later, and only sinigang for tomorrow, how could the inputs used to create these meals be accurately averaged? How would this apply to a population of 110 million people? 

Furthermore, because the CPI is a politically sensitive statistic—created and calculated by politically sensitive institutions—it is prone not only to errors (in assumptions, inputs, etc.) but also to political biases. 

For instance, changing the base year of the CPI can lead to different outcomes. If I’m not mistaken, using the now-defunct 2006 base would produce a much higher CPI today than the current 2018 base. 

Since the CPI is used as a primary benchmark for the market’s pricing of interest rates, wouldn’t the government—as the biggest borrowers—have the incentive or motivation to suppress it to influence the cost of borrowing? 

Fifth, what happened to journalism? 

Isn’t journalism about "seeking truth and providing a fair and comprehensive account of events and issues"? 

When media outlets use ambiguous qualifications like " declare victory against inflation" to describe the "perfect economic condition for gradual interest rate cuts" intended to support "consumption (which) showed signs of weakening," could this not signify cheerleading or an advocacy for a biased policy stance? For whose benefit? 

Might this be seen as advancing the interests of vested groups, particularly the primary beneficiary, the government and the politically connected elites? How is this different from propaganda, misinformation, or disinformation? 

Importantly, if an alleged news article makes an economic generalization, why would it lack narratives supported by economic logic? 

Or, are low rates a GUARANTEE of an INCREASE in consumption? How so, and based on what theory and evidence? 

Why cite partisan and non-sequitur explanations from "establishment experts" whose principal-agent problems have hardly been laid bare to the public? 

Have media outlets distilled such insights or selected statements for print that only promote their biases? I’ve seen this happen (personally) before, which is why I refuse interviews. 

Sixth, if media pronouncements reflect exuded marketplace confidence, could such article/s signify a manifestation of the magazine/headline cover indicator or express an extreme state of sentiment? 

Or have the media’s declarations echoed the "overconfidence" stemming from recent euphoria over the price spikes in Philippine assets (stocks, bonds, and the peso)? 

Seventh and lastly, could this be related to the upcoming elections? 

Will declaring 'victory in its long and painful fight against inflation' be part of the campaign to promote the electoral chances of the administration’s national slate in the 2025 midterm elections? 

Ultimately, the establishment's obsession has been to promote a regime of easy money, using the declaration of triumph over inflation as justification. 

As the great Austrian economist Ludwig von Mises once explained 

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last (Mises, 2019)  

II. Treasury Curve was Spot On about Inflation, Short-Term Treasury Yields Plunge! Will the BSP Cut by 50 bps? 

While the headline CPI plummeted from 3.3% in August to 1.9% in September—its lowest monthly rate since May 2020—excluding food and energy, the core CPI slipped to 2.4%, signifying 17 of 18 months of decline (one unchanged) since peaking at 8% in March 2023. 

Before that, we showed how changes in the Philippine yield curve have accurately predicted the CPI slump. 

despite the 4.4% CPI bump in July (and Q2 6.3% GDP), the Philippine treasury market continues to defy inflationary expectations by maintaining a deep inversion of the curve’s belly, which again signals slower inflation, upcoming BSP cuts, and increased financial and economic uncertainty. (Prudent Investor, August 2024) 

… 

Moreover, the curious take is that despite all the massive stimulus, the belly’s inversion in the Philippine treasury market has only deepened at the close of August.  

This does not suggest a build-up of price pressures or a strong rebound in the private sector. On the other hand, rising short-term rates indicate intensifying liquidity issues.   

In the end, while Marcos-nomics stimulus seems to have reaccelerated liquidity, a resurgence of inflation is likely to exacerbate "stagflationary" pressures and increase the likelihood of a bust in the Philippines’ credit bubble. (Prudent Investor, September 2024) 

Volatility has crescendoed in the Philippine treasury curve.

Figure 3

The present slope exhibits an astounding collapse in short-term rates (STIR), manifesting institutional market expectations of substantial cuts in BSP rates. Will the BSP cut by 50 bps this October? (Figure 3, upper graph) 

Yet, the curve’s magnified volatility has been incredible: following the gradual transition from flat to an inverted curve, then swiftly to a bullish steepening, and next to the current abrupt regression to a partial belly inversion—even with the plunge in STIR—how could this not be conducive to the rising risks of stagflation?

III. Supply-Side Disinflation? Despite Strong Credit Growth, Manufacturing Remains in the Doldrums, as Reflected by PPI Deflation and Output Sluggishness 

While we perceive government statistics with cynicism, we still use them because almost every financial market participant does.

Instead of focusing on the potential factors for the drop, the mainstream fixates on the prospective policy easing by the BSP.

Could the plunge in inflation have been a supply-side phenomenon marked by a glut?

In a word: Barely.

Manufacturing value grew by 2.9% in June, 6.45% in July, and 1.78% in August, while volume was up by 3.2%, 6.9%, and 2.8% over the same period.

Meanwhile, despite strong Universal Commercial Bank (UCB) loan growth to this sector—rising by 8.9%, 9.5%, and 9.8%—the Producer Price Index (PPI) deflated by -0.2%, -0.4%, and -1%. (Figure 3, lower chart)

Here’s the question: Why has robust credit growth not been reflected in output performance?

Worse yet, why is the deflation in the PPI escalating? PPI defined by the Philippine Statistics Authority, "measures the average change over time in the prices of products or commodities produced by domestic manufactures and sold at factory gate prices."

Where has all the credit money generated gone?

Has it been diverted to real estate or other undeclared allocations? Or has it been used for refinancing existing liabilities?

IV. Supply-Side Disinflation? Lethargic Consumer Imports and July FDI Reflect Frail Capital Goods Imports

If manufacturing growth has been unimpressive or sluggish, the situation is even worse for imports.

Imports in USD posted a 7.3% YoY contraction in June, then rose by 7.3% in July and 1.8% in August.

Converted to average pesos, imports were down by 2.63% YoY in June, surged by 14.3% in July, and grew by 4.6% in August, with the last month’s growth reflecting revaluation effects from a strong peso.

Figure 4

Here’s the thing: Consumer goods USD imports contracted by 7.3% in June, increased by 3.1% in July, and remained unchanged in August. (Figure 4, topmost pane)

Meanwhile, capital goods imports shrank by 8.8% in June but surged by 9.5% and 9.6% in the next two months. A substantial segment of the YoY changes reflects base effects. (Figure 4, middle diagram)

Nonetheless, the growth in capital goods imports partly reflected foreign direct investment (FDI).

The prosaic July FDI growth of 5.5% YoY (7.5% year-to-date) resonated with mediocre import growth. (Figure 4, lowest graph)

Yet, debt accounted for 74.3% of total FDI inflows and 63.5% of year-to-date FDI inflows. How much of this represent actual investments?

Still, why is the growth rate of FDIs declining?

Importantly, where are the investment pledges from the US-NATO allies?

V. Demand-Side Disinflation? September CPI Plunged Despite Vigorous August Consumer Bank Lending, Liquidity Growth Dived

Was the CPI slump a function of demand?

In short, yes!

We should put into context the seismic transformation of the Philippine banking system, with its recent focus on consumer loans coming at the expense of the supply side.

Figure 5

Universal Commercial (UC) bank consumer lending slowed from 24.3% year-over-year (YoY) in July to 23.7% in August, marking its slowest pace since November 2023. (Figure 5, topmost chart)

Consumer loan growth was strong across all segments in August: credit cards +27.44%, auto loans +19.3%, salary loans +16.4%, and others +26.8%.

Meanwhile, production loans continue to accelerate, expanding from 8.8% in July to 9.4% YoY in August, primarily in the real estate and trade sectors.

Overall, UC bank lending grew from 10.4% to 10.9% in August (Figure 4, second to the highest graph)

Despite mainstream claims of "restrictiveness" or "tightness" due to elevated rates, UC Bank's loan growth has been on an uptrend. Still, the CPI continues its downward trajectory!

Worse yet, despite this, financial liquidity plummeted in August.

M3 growth, which was 7.3% in July, dived to 5.5% in August. Incredible.

Incidentally, the yield curve inversion reflected this!

Once again, what happened to all the record money creation by the banking system and the BSP? Why the black hole?

VI. Disinflation with Employment at Near Historic Highs Backed by a Credit Boom? Slower Deficit Spending Puts Pressure on Liquidity Strains

Why could this be happening when employment rates are near all-time highs?

It was 96% last August, only a smidgen lower than the 96.9% record set last December 2023. (Figure 5, second to the lowest window)

Could it be that, aside from trade, government jobs were the primary source of growth in August? (Figure 5, lowest image)

Or could it also have been that employment growth has been mostly about low-quality labor? Alternatively, could the employment data also have been embellished?

Figure 6

Moreover, as we previously noted, because Philippine public spending has slowed, the fiscal deficit slightly "narrowed" year-to-date (YTD) as of August. Public spending has tracked the CPI over the long-term. (Figure 6, topmost diagram) 

As a result, aided by the strong peso, public debt marginally weakened in August.

Moreover, has the stalling growth in system leverage (UC bank credit + public debt) contributed to the demand pressures reflected in the CPI? (Figure 6, second to the highest graph)

Consequently, net claims on the central government (NCoCG) by banks and the BSP plateaued or consolidated. (Figure 6, second to the lowest chart)

Or, aside from the BSP, liquidity injections channeled through banks have slowed slightly.

This, combined with a stealth rise in bank non-performing loans (NPLs) and elevated levels of held-to-maturity assets (HTMs), has contributed to the liquidity squeeze.

And this has occurred despite the record nominal bank credit expansion and historically high employment rates. The plunge in September’s CPI might reflect a downturn in public and private demand, possibly worsened by mounting signs of a liquidity shortfall.

VII. SWS’s Self-Rated Poverty Survey versus the Government’s CPI 

Things don’t happen in a vacuum.

The BSP suddenly announced a massive reduction of the banking system’s reserve requirement ratio (RRR) on September 20th, obviously in response to such developments. The adjustment takes effect on October 25.

The PSA’s September CPI data exhibits a broad-based decline in price growth. While food prices had the biggest influence on the CPI’s significant downside volatility, slowing aggregate demand reflected the diminishing pace of price increases across most sectors. (Figure 6, lowest image)

All these factors point to the SWS Q3 data indicating an increase in self-rated poverty, which not only highlights the decline in living standards for a significant majority of families but also emphasizes the widening gap between the haves and the have-nots.

As a caveat, survey-based statistics are vulnerable to errors and biases; the SWS is no exception.

Though the proclivity to massage data for political goals is higher for the government, we can’t discount its influence on private sector pollsters either.

In any case, we suspect that a phone call from the office of the political higher-ups may compel conflicting surveys to align as one.

____

References 

Ludwig von Mises, The Boom Is Worse than the Bust, November 30, 2018 Mises.org 

Prudent Investor, The Philippines' July 4.4% CPI: Stagflation Remains a Primary Political, Economic, and Financial Risk August 12, 2024

 

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

  

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

 

The short end of the UST curve is highly influenced by the Federal Reserve’s monetary policies while the long end clarifies those policies through the prism of risk/return. A steep yield curve…is one that suggests a low rate, accommodative monetary policy that is likely to work over time. This accounts for the curve’s steepness. A flat and inverted curve is the opposite. Whatever monetary policy is being conducted, the long end is interpreting that policy as well as other conditions as being highly suspect—Jeffrey P Snider 

In this issue:

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion!

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion? 

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion! 

The Philippine yield curve inverts as the BSP significantly reduces the Bank RRR, while the US Fed embarks on a "Not in Crisis" 50-bps rate cut. 

The BSP has been telegraphing cuts to the banking system’s Reserve Requirement Ratio (RRR) since its last reduction in June 2023. 

For instance, Philstar.com, May 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking at a significant reduction in the level of deposits banks are required to keep with the central bank after it starts cutting interest rates this year, its top official said. BSP Governor Eli Remolona Jr. said the Monetary Board is planning to cut the reserve requirement ratio (RRR) of universal and commercial banks by 450 basis points to five percent from the existing 9.5 percent, the highest in the region. 

Four months later. 

GMANews.com, September 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking to cut the reserve requirement ratio, the amount of cash a bank must hold in its reserves against deposits, “substantially” this year and reduce it further in 2025. BSP Governor Eli Remolona Jr. said on Wednesday that the cut in the reserve requirement is being considered, with the timing being discussed. He earlier said this can be reduced to 5% from the present 9.5% for big banks. 

Two days after. 

ABSCBNNews.com, September 20, 2024: The Bangko Sentral ng Pilipinas is reducing the reserve requirement ratio (RRR) for universal and commercial banks by 250 basis points (bps).  This RRR reduction will also apply to non-bank financial institutions with quasi-banking functions, the BSP said… The reduction shall bring the RRRs of universal and commercial banks to 7 percent; digital banks to 4 percent; thrift banks to 1 percent; and rural and cooperative banks to zero percent, the central bank said. The new ratios take effect on October 25 and shall apply to the local currency deposits and deposit substitute liabilities of banks and NBQBs. (bold mine) 

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity 

Bank lending growth has been accelerating, while broad economic liquidity measures have been rising, so why would the BSP opt to inject more liquidity through Reserve Requirement Ratio (RRR) cuts? 

The following data set may provide some answers.

Figure 1

Although lending by Universal and Commercial Banks is at a record high in nominal peso terms, the growth rate remains far below pre-pandemic levels. (Figure 1, topmost image) 

The RRR cuts from 2018 to 2020 appeared to have worked, as the loans-to-deposit ratio rose to an all-time high in February 2020 but the pandemic-induced recession eroded these gains. (Figure 1, middle graph) 

It took a combination of historic BSP policies—record rate cuts, an unprecedented Php 2.3 trillion liquidity injection, and extraordinary relief measures—to reignite the loans-to-deposits ratio. Nonetheless, it still falls short of the 2020 highs. 

A likely, though unpublished, explanation is that bank liquidity continues to decline. 

As of July, the cash and due-to-bank deposits ratio was at its lowest level since at least 2013. The BSP policies of 2020 and subsequent RRR cuts bumped up this ratio from 2020-21, but it resumed its downtrend, which has recently worsened. (Figure 1, lowest chart)

Figure 2

After a brief recovery from the RRR cuts of 2018-2020—further aided by the BSP’s historic rescue measures in 2020—the liquid assets-to-deposits ratio has started to deteriorate again. (Figure 2, topmost pane) 

Additionally, Q2 2024 total bank profit growth has receded to its second-lowest level since Q2 2021. (Figure 2, middle diagram) 

From this perspective, liquidity boost from increased bank lending, RRR cuts, and reported profit growth has been inadequate to stem the cascading trend of cash and liquid assets. 

Furthermore, despite subsidies, relief measures, and a slowing CPI, Non-Performing Loans (NPLs) and distressed assets appear to have bottomed out in the current cycle. (Figure 3, lowest visual) 

Increasing NPLs in the face of a slowing CPI is indicative of demand. Refinancing has taken a greater role in the latest bank credit expansion. 

To wit, rising NPLs contribute significantly to the ongoing drain on the banking system’s liquidity. 

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

Figure 3

A primary source of the downtrend in the cash-to-deposits ratio has been the banking system's Held-to-Maturity (HTM) securities. (Figure 3 upper image)

Once again, the BSP has acknowledged this. 

Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtM losses. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity. [BSP, 2018] (bold mine) 

Even though rates have dropped, HTM (Held-to-Maturity) assets remain at record levels but appear to be plateauing. Falling rates in 2019-2020 barely made a dent in the elevated HTM levels at the time. 

Yet, a principal source of HTMs continues to be the bank's net claims on central government (NCoCG). (Figure 3, lower graph) 

That is, banks continue to finance a substantial portion of the government's deficit spending, which has represented an elementary and major contributor to the deterioration in bank liquidity. 

Why has the BSP been doing the same thing over and over again, expecting different results? Some call this "insanity." 

If the goal is to remove distortions—however ambiguously defined—why not eliminate the RRR entirely? 

It seems the BSP is merely buying time, hoping for a magical transformation of unproductive loans into productive lending. Besides, a complete phase-out of the RRR would leave the BSP with fewer "tools," or bluntly speaking, strip them of excuses. 

Thus, they’d rather have banks continue to accumulate unproductive loans in their portfolios and gradually subsidize them with relief from RRR cuts, rate cuts, various subsidies, and later direct injections—a palliative/band-aid treatment. 

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion! 

Figure 4

Rather than steepening, the Fed's "not in a crisis" panic 50-basis-point cut also helped push the Philippine Treasury yield curve from an "inverted belly" to a "full inversion" on September 20! (Figure 4, tweet)

Figure 5

While yields across the entire curve plunged over the week, T-bill yields declined by a lesser degree relative to medium- and long-term Treasuries. (Figure 5, topmost window)

As a result, yields on Philippine notes and bonds have now fallen below T-bills!

Although one day doesn’t make a trend, this current inversion is the culmination of a process that began with a steep slope, then an inverted belly, and now a full inversion since June 2024. (Figure 5, middle chart)

The spreads between the 10-year bonds and their short-term counterparts are at the lowest level since March 2019! (Figure 5, lowest graph) 

And an inverted curve could serve as a warning signal/alarm bell for the economy.

From Investopedia: 

>An inverted yield curve forms when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile.

>The inverted curve reflects bond investors’ expectations for a decline in longer-term interest rates, a view typically associated with recessions.

Further, it is a sign of tight liquidity: short-term borrowing costs rise or remain elevated, leading to higher yields on short-term debt instruments compared to long-term yields.

Moreover, expectations of slowing growth or economic recessions can also lead to decreased demand for riskier assets and increased demand for safer long-term bonds.

Again, the inverted curve must have resulted from the BSP’s announcement of a sharp reduction in the RRR in October, along with the Fed’s 50-basis point rate cuts.

Bottom line: cuts in the banks’ RRR were meant to address the banking system’s liquidity challenges as manifested in the Philippine treasury markets. The Fed’s 50-bps rate cut has exacerbated these distortions.

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion?

Figure 6

Finally, it is interesting to observe that following the PSEi 30's intraday push above 7,300 last Friday, September 20, foreigners sold off or "dumped" SMC’s shares by 5% during the pre-closing five-minute float, contributing to the sharp decline in SMC’s share price and diminishing gains for the PSEi 30. (Figure 6, tweet) 

While we can’t directly attribute this to the inversion of the Philippine term structure of interest rates (yield curve), SMC’s intensifying liquidity challenges—evidenced by deteriorating cash reserves relative to soaring short-term debt in Q2 2024—should eventually influence its slope. (Figure 6, lower chart) 

In sum, as a "too big to fail" institution, SMC’s difficulties will inevitably reflect on the government’s fiscal and monetary health as well as the banks and the economy. 

____

references

FINANCIAL STABILITY COORDINATION COUNCIL, 2017 FINANCIAL STABILITY REPORT, p. 24 June 2018, bsp.gov.ph