Wow. Philippine November GIR Fell $2.38 billion to February Levels as Forex Position Spiked Anew!

Oh, have you seen how the PSEi was pumped yesterday? Like clockwork, immediately right after lunch, the afternoon delight went into operations. So from unchanged, the PSEi rocketed to .71% just right before the runoff. The marking pump brought the end of the day gains to .89%. This would have been larger considering huge pumps on SMPH and GTCAP, except that there had been offsetting forces. With US stocks on a meltup, more of this can be expected today.

It's more evidence how the stock market function of PSE has been lost and perverted. And in its place, a price fixing mechanism.

And a relevant lesson from artificiality can be seen below.

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The BSP reported that its November’s GIR position “stood at US$82.73 billion as of end-November 2016”.

But first the bad news: “This level was lower by US$2.38 billion than the end-October 2016 GIR of US$85.11 billion…”. Then the spin “…but higher by US$2.06 billion compared to the end-December 2015 figure of US$80.67 billion”

As always, there has been that itching need to compare with something to project the current state as still maintaining the G-R-O-W-T-H theme.

During the October GIR report last November, there was no such comparison.

It’s the second month for GIRs to fall. And the decline had been from record highs. But this month was the second biggest month on month decline since January 2014.

Yet the reasons for the present conditions? Again, the BSP: “The decline from October to November was due mainly to outflows arising from the foreign exchange operations of the BSP, revaluation adjustments on the BSP’s gold holdings resulting from the decrease in the price of gold in the international market, and payments made by National Government (NG) for its maturing foreign exchange obligations. These were partially offset by the NG’s net foreign currency deposits along with the BSP’s income from investments abroad.”

Yes, GIRs fell mainly due to a big (US $ 2.131 billion) drop in foreign investments, and in gold ($726.9 million).

The lower gold position was most likely due to gold price adjustments. Gold prices plummeted by 7.7% last November.

But forex positions continued to spiral higher by $ 492.7 billion to reach another record amount at $4.22 billion (see below window).

The surge in forex positions reveals that BSP’s GIR have been increasingly tenuous.

As far back in December 2015, I was already suspicious of the sudden surge in forex positions. Back then I wrote*,

So time will tell if government’s GIR has been another hall of mirrors.

*Phisix 6750: Update on the Seven Reasons Why the PSEi is Headed South! Why The Popular Clamor for a Strongman Rule is a Bubble December 14, 2015 (Before its news link available online)

I repeatedly asked the same concern that GIRs were mainly “window dressed” in March and in April.

I obtained proof from the IMF that a segment of advertised reserves constituted nothing more than (forward book derivatives)*…

The BSP has about $3 billion of forward long positions in fx swaps mostly over a short term 1 month of maturity. I suspect that these forward positions could have represented hedges on US dollars acquired from swap markets (fx loans and securities) and which was sold on the spot markets to support the peso.

Again these (FX Swaps and forwards) derivatives do not represent “reserves” in the context of savings (Benjamin Franklin US dollars), instead they represent liabilities or future drains in reserves for the simple reason they are borrowed “US dollars”.

*The Wilting Philippine Peso: Increased Signs of Pressures from US Dollar Shorts? July 10, 2016

And also last month when the yuan was reportedly incorporated as part of the GIR by the BSP, I wrote*,

The intensity of the buildup of forex position can be seen not only in nominal US dollar figures (upper window) but also on year to year changes (lower left window).

Yes, RECORD buildup!

Forex positions have topped the November 2013 highs last March. From then, the BSP continued to pile on more. I believe that the BSP’s GIR position has been substantially window dressed. The GIR has been bolstered by forward book or derivatives (swap, options or forward hedges). The BSP has been borrowing pages from the China and other central banks who have used the forward book strategies to aggressively shore up their domestic currency.

*3Q RGDP 7.1%, Really? Government Revenues Increased by Only 3.01% as Spending and Deficits Surged! November 20, 2016

Today, it has been record upon record!

As I have been saying, what has been borrowed will have to be paid, thus, reserves that have been statistically spiffed up by borrowings will eventually have to fall.

Even the BSP admitted to this…“payments made by National Government (NG) for its maturing foreign exchange obligations”

For now, this has been about non-forex holdings or through GIR’s foreign investments positions

I believe that part of the extinguishment of foreign investments may have been channeled through the selling of US treasury holdings by the BSP, which I also pointed out here last month (see above—upper window).

That chart has only been as of September. And this has not yet been updated by the US government’s Department of Treasury’s TIC.

The likelihood is that the UST liquidations intensified as the peso weakened in October and November. And if I’m right, then this amplifies a USD liquidity drain for the BSP.

And yet while the BSP may have sold US treasuries to buy the peso, it has used forward book (derivatives) as seen in its continuing amassment or stockpile of record forex holdings to cushion the fall of reserves. And surely as the peso falls, the cost of hedging should rise. Global costs of wholesale finance or USD dollar borrowings through currency swaps continue to soar! (Bloomberg, December 5)

Eventually, intensifying competition or scramble for Benjamin Franklin US dollars around the world would entail prohibitive costs or could lead to an acute shortage. And this means that the BSP’s fx swaps, that constitute part of present reserves, will have to fall.

The real translation from the November report was that the BSP has engaged in massive interventions in support of the peso, hence, the sharp decline in foreign exchange reserves. Additionally, the decrease should have been larger if not for record forex positions.

Another insight here is that the cosmetics from the padding of statistics eventually will be unmasked. And it seems to have started.

I’m reminded of the taper tantrum in 2013 when so called “experts” shouted “Forex reserve! Forex reserve! Forex reserve!” like a charm used to combat and to exorcise (financial) demons out of the markets. Unfortunately, in a world of eurodollars, those reserves don’t play the role which had been intended.

The coming period or days will put to a test on the true health of the BSP’s GIR positons.

And more importantly, this provides more clues to the fate of the peso—the unfortunate principal victim of politics.

Bloomberg Analyst Warns Developments in Philippine Bonds Signal Trouble!

So, the mainstream appears to be catching up to what I’ve been saying all along.

Bloomberg’s Andy Mukherjee* noted that Philippine creditors have become more anxious as to demand more bond covenants to buttress or backup Philippine debts.

*Bloomberg Philippine Bond Jitters Bode Ill December 6, 2016

A bond covenant, notes the Investopedia, represents an agreement between creditor and borrower which either defines limits or proscriptions of the issuer from undertaking specific activities (restrictive) or for issuer to meet specific requirements (affirmative) covenants

This entails requirements for possible additional collateral (higher rates?), or again, restrictions on certain activities (too much expansion??).

In short, this means credit tightening. Yes, it’s US dollar short in motion!

 

The article attributes this to “deteriorating credit profiles of Philippine companies” which tightening could be “self-fulfilling” and consequently “could drag on earnings next year”

“And leverage is already an issue”, says Mr. Mukherjee, noting that “San Miguel Corp.'s obligations” which are as “high as 77 percent of its market capitalization, compared with the average for the MSCI Asia index ex-Japan of 27 percent”. He added that “Ayala Corp.'s net debt is approaching five times Ebitda, the most in more than a decade”.

These have all been too obvious.

 

I pointed out in November 2015 [see above chart from Gavekal as I showed in the Phisix 7,100: Surprise! ICTSI Chief Enrique Razon Warns: Another Financial Crisis is COMING!!!! SM Plays with Fire!; available online via Before Its News Link) that cash flows have become a problem primarily because of the increased reliance on real estate-retail industry as the main engine of economic activities, or the principal source of the BSP’s Keynesian aggregate demand.

The real estate, retail and construction industry according to the Philippine 3Q (year to date) GDP accounted for 39% share. Manufacturing came in second at 18%.

Don’t forget the frenzied race to build shopping malls comprise a significant role in the real estate industry.

More than this, the same industries accounted for 38% share of the banking loans to the industry (as of October)! There is yet the non-banking loans (as above)!

The article further noted that even the most creditworthy Philippine issuers, e.g. AC and ALI, has “seen default risk risen by one notch over the past month, according to a Bloomberg metric”.

While this might not be much, as an old saw goes, “a journey of a thousand miles begins with a single step”. It’s evidence of progressing entropy that has now spread from the periphery to the core.

Remember the tightening yield curve in 2015????

Importantly, the costs of debt-financed expansions or borrowing from the future for previous and current spending binge has ARRIVED:

“Loading up on debt was a good idea when it helped carve out a return on equity of 15 to 16 percent for the Philippine Stock Exchange PSEi composite index, from a return on assets of 3.5 to 4 percent.But those days are over. Profit margins have shrunk from four years ago for the 19 nonfinancial companies in the benchmark gauge, even as their assets are still producing roughly the same revenue. Leverage can mask the problem for a while. But with debt investors becoming cautious, the moment of reckoning for equities might arrive sooner rather than later.”

What is seen as analysis, from the above, has really functioned as a narrative description of current events more than they function as an economic explanation.

The article glossed over an increase in credit risks by noting that big problems from “some terrible mismatch between dollar liabilities and assets will “unlikely” produce problems because they are “hedged”, AGI and SM, are just two of  “the four Philippine conglomerates…among the 10 Southeast Asian companies with the most dollar bonds due in the next 12 months”

The “moment of reckoning for equities” and “terrible mismatch” in maturity transformation have been entwined. So to disregard its relationship will serve as a significant sin of omission.

And currency hedging won’t be a free lunch. Once these hedges expire they have to be rolled over, at evidently, a higher cost. And the higher cost will pressure profits, and thus, amplify credit risks.

And again, the superficial observation of sterilized risks, because SM and AGI have been “switching to local-currency debt” since “local banking system is flush with funds”. 

Yet the same article alluded to political obstacles particularly from Mr. Duterte’s “deadly anti-drug campaign, liberal spending policies, foreign policy flip-flops and bungling of domestic politics end up curtailing lenders' access to dollars.”

I have no quibble on the political issue which I think would function as aggravating, but not a primary factor.

The falling peso already equates to an implicit tightening.

That’s not only from increasing demand for more covenants and potential higher hedging costs, but on the impact of weak peso on USD liabilities, and from the alternate, debt shuffling.

Weaker peso means MORE peso required to pay existing USD debt. So if NGDP weakens this would amplify USD liabilities. And decaying NGDP translates to enhanced credit risks and a downturn in credit activities. It’s self fulfilling.

Furthermore, the switch to local-currency debt will not have a prophylactic effect IF debt continues to balloon. And aggressive credit expansion will lead to a bigger the fall of the peso as explained last weekend.

In short, credit expansion NEEDS to dramatically slow. But such would take the steam out of the statistical GDP (thereby raising the cost of credit) and curtail (tax and debt) subsidies to political ambitions and agenda of the leadership.

And since that’s not politically palatable, this is why the peso will serve as the unfortunate sacrificial lamb to the altar of false political glory.

More interesting has been the observation that “stocks look dangerously out of breath: Only 20 percent of the shares in the benchmark index are above their 200-day moving average, which makes the Philippines the second-weakest Asian market after Mongolia.”

See now why the Philippine stock market has transmogrified into a price fixing platform? The idea that is if sinking stocks has contributed to credit tightening, then stocks MUST be pumped at all cost to revive the “animal spirits”!

Unfortunately, doing so misses the point. Why? Because it will only exacerbate the “deteriorating credit profiles of Philippine companies”

The chicken has come home to roost!

We are witnessing an epic historical turning point.