The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists—Ernest Hemingway, “Notes on the Next War: A Serious Topical Letter,” Esquire, Sept. 1935.
In this issue
BSP on the Peso: NO “Meltdown”! BSP’s Winner Take ALL Policies Magnifies the Risks of a Peso “Meltdown”!
-The BSP’s NO Meltdown Palaver
-No Peso Meltdown (Yet), BSP’s Massive Interventions
-More Tenuous Defense of the Peso
-Philippine Peso and Bonds: Asia’s Odd Man Out
-The BSP’s Inflation Targeting has Only Fostered Huge Imbalances
-The Biggest Currency Risk: BSP’s “Winner Take ALL” or “All or Nothing” Policies
BSP on the Peso: NO “Meltdown”! BSP’s Winner Take ALL Policies Magnifies the Risks of a Peso “Meltdown”!
The plunging peso has prompted the Bangko Sentral ng Pilipinas (BSP) to dismiss concerns over a “meltdown” in public
The BSP’s NO Meltdown Palaver
From the Philstar: [No peso meltdown despite 3-month low vs $, says BSP February 2, 2018] (bold added)
The Bangko Sentral ng Pilipinas (BSP) said the Philippines is far from any foreign exchange crisis, dismissing concerns of a peso meltdown as the local currency hit a fresh three-month low.
In a text message to reporters, BSP Governor Nestor Espenilla Jr. said a peso meltdown is not expected because the country’s underlying economic fundamentals are healthy.
“The peso is just fine. Demonstrating flexibility, reflecting day-to-day market conditions,” he said. Espenilla, however, said the global financial market conditions remain volatile. “There will be volatility, runs and corrections, and the public should plan accordingly and factor in exchange risk in their decisions. But the peso is not expected to melt down because the underlying economic fundamentals of the economy are healthy,” he said.
The BSP has denied strains exhibited by the struggling peso for the second time since 2Q of 2017
In August 2017, ABS-CBN reported: [Bangko Sentral assures public: No peso free fall August 13, 2017] (bold mine)
The peso will not "free fall" against the dollar despite breaching the P51-level last week, Bangko Sentral ng Pilipinas Governor Nestor Espenilla said Sunday, citing "very strong" economic fundamentals. Espenilla said the peso's fall was due to uncertainties in North Korea, whose leader, Kim Jong Un, had been trading threats of nuclear attacks with US President Donald Trump.
In announcing that it would openly intervene (Business Times August 21 and Malaya August 22), the BSP engaged in a signaling channel. The threat to intervene translated into action (Businessworld August 23)
These are media accounts. Yet, media’s coverage of the conduct of operations has been limited
No Peso Meltdown (Yet), BSP’s Massive Interventions
There are many ways to monitor the BSP’s actions of containing the peso’s fall.
Here are a few.
The BSP’s foreign exchange position in its Gross International Reserves surged to record highs in September 2017 and remains at such levels through the yearend. (lower chart) The BSP’s foreign exchange holdings consist of US dollar loans and derivatives (futures and swaps or forward book).
So the BSP borrowed enormous amounts of USD which it used to dump into the market. Ironically, borrowing USDs to defend the peso translates to increased short positions on the USD! To contain the peso’s fall today by increasing USD liabilities represents a tradeoff of the USD-PHP across time. Or the BSP has only been adding to the peso’s future strains. And even if these were hedged, there will be fees to pay for such positions. And the larger the exposure, the bigger the fees to bankroll these positions
There is no such thing as a free lunch.
Moreover, the Philippine government’s holdings of US sovereign bonds, at US $ 35.8 billion in November, fell to 2014 lows, according to the US Treasury. (middle window below). The reduced holdings of USTs of the Philippine government have been consistent with the BSP’s foreign investments, which dropped to 2012 lows. The BSP’s December foreign investment position stood at $ 65.763 billion.
The USD Peso was about to test the August highs of 51.77 last Friday when a big buyer suddenly appeared at the closing session. The big buyer prompted for a furious rally of the peso. (middle chart). At 51.45, the USD Php closed the week up 1.2% and 3.04% year-to-date. Surprisingly, as of February 2, the year-to-date returns of the USD-PHP has bested the Phisix +2.95% due to the latter’s 2.55% decline this week
If there indeed has been little cause of concern for the peso, then why these massive interventions???
More Tenuous Defense of the Peso
The BSP also hardly defines or quantifies a free fall or a meltdown. Or, at what rate of decline would the peso be considered in a “meltdown”?
Won’t a peso meltdown be mechanically denied for the simple reason that will reflect on the BSP’s failure?
Next, for the BSP to publicly address the issue of a peso free fall or meltdown signifies concerns raised by certain quarters with political-economic clout.
In such context, the peso’s accelerating descent appears to be fraying on the confidence level of these entities. Nevertheless, the nature of politics will mean that the BSP will intervene to show that it is doing something!
Furthermore, is the BSP setting up the segments of free markets as the fall guy?
From the Inquirer: “Periodic bouts of volatility in the peso-dollar exchange rate, more than what financial markets have been accustomed to in recent years, is expected to be the new norm under the laissez faire regulatory framework of Bangko Sentral ng Pilipinas Gov. Nestor Espenilla Jr.” [BSP says volatility is new norm as peso gyrates February 2, 2018]
Huh? Does deregulation equal a weak currency? Whatever happened to prices set by demand and supply?
Or are these signs of the coming reversal of BSP liberalization?
Or has media been mischaracterizing the BSP’s explanation?
Moreover, the BSP makes a logical contradiction about the causal linkage between the peso and the economic conditions: “the peso is not expected to melt down because the underlying economic fundamentals of the economy are healthy”
If the underlying economic fundamentals have been “healthy”, then there would be robust demand for the peso, thusly, the peso shouldn’t be falling. The peso significantly strengthened in 2008-2013 as the economy blossomed in response to the BSP’s accommodation.
In contrast, the feeble peso is a manifestation of lesser demand for the peso from residents compared to the demand for the USD.
The apparent question is WHY???? What makes residents prioritize the USD more than the peso?
Could it be because of a supply-side problem?
Hasn’t the BSP and the banking system been issuing more peso, which effectively debases the currency’s purchasing power and thus, the spurring DEMAND by residents to hold foreign exchange?
Hasn’t the BSP been funding the National Government aggressively in 2015-2016 to prevent risks of deflation, as well as, spruce the incumbent government’s performance? (upper window)
Or for the sake of simplicity, has the desire to preserve the purchasing power of their savings by residents prompted the increased demand for the USD?
As one would note from the BSP’s net claim on the national government chart, a slowdown in the BSP’s direct financing of NG liabilities has led to the November-December rally of the peso
Yet, have you noticed of the self-contradictions in the policies employed by the BSP?
On the one hand, to keep up with its inflation target, the BSP uses debt monetization to goose up prices in the real economy but this incites downside pressure on the peso.
On the other hand, to relieve the downside pressure on the peso, the BSP has resorted to an assortment of currency interventions.
Such is the circular reasoning behind the BSP’s policies
So the colliding goals and means to attain such goals will on itself create unintended consequences.
Philippine Peso and Bonds: Asia’s Odd Man Out
Another pretext that the BSP has used for the attenuated peso: external forces.
Or, the BSP annexed the involvement of exogenous forces “global financial market conditions remain volatile” as responsible for conditions of the peso
Volatility should be defined. Does volatility imply the conformity or the diversity of price actions?
On that note, curiously, instead of the conforming to the regional trend, the Philippine peso has been the odd man out.
The Philippine peso has not just been the weakest relative to its peers it has defied the region’s uptrend!
Yes, Asian currencies have in general rallied hard but the peso continues to fumble.
For instance, the USD has tumbled against the Malaysian ringgit and the Thai baht and has remained in a trading range relative to the Indonesian rupiah.
The kernel is the strong Asian currencies have mitigated the peso’s woes. And in a different light, should the US dollar rebound against Asian currencies, the peso will fall harder!
And the financial peculiarity hasn’t been limited to the currency sphere.
Philippine bonds have also been the worst performer in Asia! As expanded risk appetite has prompted massive inflows towards emerging market bonds, the Philippines has not partaken of such 3-year high bonanza in 2017.
Or, rallying yields of contemporary bonds in advanced economies has only reverberated in the Philippines. So far.
Worst, Philippine ROP 10 year yields spiked to 6.21% last Friday, a 2012 high!
Interestingly, spiking yields in US Treasuries have percolated into US home mortgage rates!
The dramatic spikes in UST yields are likely to diffuse into the global bond markets in the coming days.
That is to say, convergence in bond markets will likely occur where the yields of Asian counterparts will resonate with US bonds!
It stands to reason that spiraling yields of Philippine long-end ROPs will become pronounced!
ROPs and USTs have been rising almost in tandem.
What used to be a yield convergence through the narrowing of spreads in USTs and ROPs have now transformed into a yield divergence trade.
The widening yield spread between 10-year ROPs and USTs highlights such divergence (lower window)
An important message embedded in these.
Domestic bonds have been PRESSURING the BSP to raise its rates or to tighten the financial system. Otherwise, the pressure on the peso will intensify!
As the US FED continues to raise rates, their money supply will slow further. But if BSP insists on maintaining current policies, the domestic money supply will significantly outperform.
Thus, bigger price pressures in the Philippine economy will compound on the weakening of the peso.
Eventually, markets by itself will force the BSP’s hands
Haven’t you noticed the contradictions? While bonds and the peso have been sold, stocks have been bought! Which among them will be wrong???
The BSP’s Inflation Targeting has Only Fostered Huge Imbalances
From Governor Nestor A Espenilla, Jr in a speech last November 27, 2017: [Nestor A Espenilla, Jr: Why the Philippines speech at the Philippines Investment Forum, Euromoney Conferences 27 November 2017, BIS.org] (bold added)
To maintain price stability, the BSP adopted the Inflation Targeting framework in 2002. This has served us well. We continuously refine monetary policy conduct. The implementation of the interest rate corridor system in July 2016 is a manifestation of our commitment. More refinements are coming. These changes are enhancing the transmission channels of monetary policy.
IF the BSP tightens, the GDP will weaken as credit growth ebbs. The outcome will be capital flight which amplifies the exchange rate risks.
In 2012-2014, the financial markets underpriced inflation relative to financial instruments which signified negative real rates. Negative real rates, a tool of financial repression, represent an invisible transfer of money and resources to the government and to their political clients.
Yet, the salad days or the sweet spot of negative real rate is HISTORY.
In response to the money supply’s 10 successive months of an explosive 30%+++ growth rate in 2H 2013-1H 2014, the BSP was forced to partially tighten in the wake of a surge in headline inflation.
The outcome of which, positive real rates, led to a fall in credit expansion thus a decline in GDP, earnings and the surge in store vacancies in shopping malls in 2015
Though bank credit growth slowed in 2015 (+13.84% upper window), bank leverage as measured by credit intensity surged (the ratio of bank credit to NGDP: 2.54 lower window)
As an aside, in 2017, bank credit grew by 18.39% that’s twice the amount of Nominal Gross Domestic Product (NGDP). Or the Philippine economy borrows Php 2 for every Php 1 output it generates.
The statistics mislead though. Since only a few segment of the population has access to formal credit, the concentration of bank borrowings translates to larger systemic leverage
Rewinding back to 2015, the positive real rates spurred deflation spiels from erstwhile BSP Governor Tetangco.
Eventually, speeches transformed into actions as the BSP undertook the emergency measure of monetizing NG’s liabilities in 2015.
Since debt monetization couldn’t be relied on permanently, as this will crush the peso, the BSP further slashed rates to historic lows in June 2016 under the camouflage of corridor system
The BSP effectively passed the baton to the Department of Finance to raise funding through the capital markets. Nevertheless, by keeping rates at historic lows, the depressed carrying costs of private and public debt signified as invisible subsidies. Thus, systemic debt accumulation, mostly in the private sector, exploded.
Low rates also represented an indirect subsidy to taxes. Low rates boost credit use which in turn magnifies “demand”. Credit distribution affects relative demand. Demand increase, relatively speaking, is transmitted to higher real economy prices. Since price increases impact nominal GDP or business gross revenues, such translates to higher taxes in favor of the government. Such embodies the transmission mechanism of negative rates.
That is aside from the depressed interest rates charged to public debt.
Today such invisible transfers through negative real rates have been limited.
In realization of these, the DOF instituted a new tax regime while the BSP has steadfastly been resisting to tighten.
The Biggest Currency Risk: BSP’s “Winner Take ALL” or “All or Nothing” Policies
But here’s the thing. The current monetary framework of the BSP represents “putting the pedal to the metal”! As it stands, the BSP operates with LITTLE or NO margin for error!
The spread between 1 year ROP notes and the CPI was a paltry -.395% in December. It was even a positive .111% in November.
The BSP can’t afford a deceleration in credit growth. Because this will likely dampen CPI, leading to positive real rates and its second order effects.
Additionally, consistent use of emergency measures presumes two things: a time consistency of the impact of such policies (or the effects will be the same) and the invulnerability of the Philippine economy.
Yet, should an economic slowdown or even a recession or a financial shock emerge, the BSP would have little or limited ammunition to use without destabilizing the peso!
Aggressive rate cuts and or the next series of stealth deployment of QE would tailspin the peso! And a recession or a financial shock may be triggered by internal or exogenous forces. Capital flight will be a critical factor too.
HB 10963, for instance, could have unintended consequences which may significantly slow the economy.
The ING noted that the BSP suddenly raised inflation targets which go in contrast to the DOF’s expectations, “The central bank of the Philippines (BSP) expects January inflation at between 3.5% and 4%, the highest inflation forecast since November 2014, due to higher excise taxes.”
Is this the first among the many proverbial cockroaches to surface (Cockroach Theory)?
Moreover, the makeover to the corporatist-state capitalism paradigm will likely undermine the present structure, thus compounding possible strains within the system
As for external sources, there are many. Rising bond yields, divergent central bank policies, overvalued global financial markets, maladjusted economies and geopolitical strains could become triggers. Yes, rising yields in the face of a RECORD $233 trillion DEBT in 2017, which was $16 trillion higher than 2016, should be an interesting development for 2018
Carried to its logical conclusion, the USD-PHP stands to benefit from policy errors, arising from the entwined follies of overconfidence, fatal conceit and political hubris, presumptuous knowledge, addiction to credit-financed spending, excessive dependence on political solutions, manipulation of markets and falsification of prices, and the narrowing of society’s time orientation or increased preference for instant gratifications
While a currency crisis is neither imminent nor inevitable, the direction of policies ultimately determines the fate of the USD-PHP.Under the current fiscal and monetary regime, the odds of a peso “meltdown”, a “free fall” or a “tailspin” has only been increasing.
In a recent note to a foreign friend, I wrote, I expect the Philippine peso to fall big time!
Buy the USD-Php!
