It is not just an accident that in our age inflation has become the accepted method of monetary management. Inflation is the fiscal complement of statism and arbitrary government. It is a cog in the complex of policies and institutions which gradually lead toward totalitarianism--Ludwig von Mises
In this Issue
BSP’s Php 300 Billion Record QE last April Boosted Liquidity Dramatically, Raising Stagflation Risks
I. BSP Embarked on a Php 300 Billion Record QE last April!
II. BSP’s QE Funded April’s Record Deficit and Pumped Up Bank Deposits
III. Despite Record Bailout Measures, Banking Loans Decelerate; More Signs of Panics from Fraud and Swindles?
IV. BSP’s Financial Repression: Fighting Deflation with Negative Real Rates!
V. BSP’s QE: Boost Aggregate Demand by Public Spending Increasing Stagflation Risks
BSP’s Php 300 Billion Record QE last April Boosted Liquidity Dramatically, Raising Stagflation Risks
As part of the many bailout measures, the BSP escalated the use of debt monetization last April.
By pumping enormous amounts of currency into the system, the record QE provided funding to the National Government’s record deficit, as well as greased the banking system’s cash reserves and deposit liabilities.
Nevertheless, as bank credit expansion continues to slow, a German payment firm scandal implicated local banks, which were denied by the latter and the BSP. Fraud and swindles hallmark the end of the credit bubble era.
The BSP also combats deflationary impulses from the recession by using QE to attain negative real rates and attempts to boost aggregate spending via public spending, thereby raising the risks of stagflation.
I. BSP Embarked on a Php 300 Billion Record QE last April!
To justify the bailouts of the banking system and the national government, in the third week of March, the BSP made official and explicit its use of its printing press. From the BSP, March 23: “To further support the Filipino people during the COVID-19 pandemic, the Monetary Board authorized the Bangko Sentral ng Pilipinas (BSP) to purchase government securities from the Bureau of Treasury (BTr) under a repurchase agreement in the amount of Php 300 billion with a maximum repayment period of 6 months. The fund generated from the said agreement shall be used to support the National Government’s (NG) programs to counter the impact of Coronavirus Disease 2019 (COVID-19)”
The BSP implemented this unprecedented monetization of the public debt last April. For the first time, one media outfit acknowledged this. From the Philstar, March 23: “The Bangko Sentral ng Pilipinas (BSP) has joined central banks from the US to Japan in a massive bond-buying scheme that will see it balloon its balance sheet by P300 billion to unleash credit in the financial system battered by the coronavirus disease-2019 (COVID-19) outbreak.”
The record injections of high-powered money into the financial system incited a spike in money supply growth or domestic liquidity, as reported by the BSP, “Net claims on the central government grew by 45.5 percent in April, faster than the 21.6-percent growth in the previous month, reflecting the increased borrowings by the National Government.”
Figure 1
The BSP’s net claim on central government surged by a record Php 338 billion on a monthly basis to reach Php 2.5 trillion, about 13% of the projected 2020 NGDP of Php 14.3 trillion, another milestone!
April’s M3 advanced by 16.2% from the previous month’s 13.34% on the back of the hike of M1 to 26.44% from 23.6% in March, supported by the growth in cash in circulation, which rocketed to 30.2% from 19.5%.
And because the banking system played a crucial role in it, cash reserves of the industry jumped by a stunning 25.5%, a 6-year high growth rate! Cash and due banks reached a record Php 2.97 trillion, or about 14% of April’s aggregate resources of the financial system amounting to Php 23.174 trillion.
All of a sudden, the Philippine banks transformed from a cash-famished into a cash-rich system, courtesy of the BSP.
QE was not the only factor that prompted the avalanche in cash growth; the BSP supplemented it with a 200 bps cuts in Reserve Requirement Ratio, declared on March 24th.
Aside from the QE, the 200 bps RRR, and the 75 bps in ONRRP or official rates, a slew of other technical adjustments supported the unprecedented rescue of the banking system. That’s aside from the reprieves on regulatory and capital reserves requirements through the Capital Countercyclical Buffer mandated adapted in December 2018. Note 2018.
The BSP’s resorting to the monetary nuclear option had been recharged way back in the 4Q of 2015, as part of the rescue of the banking system. To justify its accelerated operations, Covid-19 served as a politically convenient pretext.
And because the BSP pulled back some of its record Php 453 billion of treasury monetization in 2019 in the 1Q of 2020, year-to-date net claims totaled Php 140.24 billion, inclusive of April’s record.
But the outcome from today’s recession won’t be like the Asian Crisis, assured the BSP, because “this expected increase in borrower defaults will be nowhere near the levels seen during the 1997 East Asian financial crisis” (Inquirer, June 18).
Oddly, not only has the scale of current interventions been unparalleled in history, but the BSP has even proposed to the Congress the revival of an Asian Crisis platform of transferring the banking system’s bad debt to a public Special Purpose Vehicle (SPV).
The PH Progreso stimulus bill submitted by the Department of Finance to the Congress incorporates this BSP banking bailout platform called the Financial Institutions Strategic Transfer (FIST).
II. BSP’s QE Funded April’s Record Deficit and Pumped Up Bank Deposits
The QE operation benefitted both the National Government and the banking system.
With tax revenues plunging in the face of an economic shutdown, the QE provided bridge financing for the National Government’s emergency spending missions. The Php 164 billion month-on-month increase in cash in circulation must have been mainly from distribution of the cash transfer program, Php 200 billion the Social Amelioration Program.
Figure 2
With the unprecedented scale of disruptions in the economy, and thereby translating into dislocation in credit operations, the same record injections ensured that banks had sufficient liquidity to cover credit transactions.
Aside from the sudden profusion of cash reserves, the QE pumped up the banking system’s deposit liabilities, mainly due to peso deposits. Growth of April’s deposit liabilities increased to 11.2% from 9.63% supported by the jump in peso deposits to 12.6% from 10.72% a month ago.
With the downpour of cash/liquid assets into the coffers of banks and financial institutions, the domestic financial assets rallied significantly.
Or, the avalanche of BSP liquidity pushed bond treasury yields lower, helped strengthened the peso, and provided the buying power to financial institutions to push the stock market higher. For instance, 10-year Treasury yield slumped to 3.5% in April from 5.07% in March. Again, this helped boost the assets of the banking system.
As a side note, aside from the massive injections, BSP forex interventions helped prop up the peso (as indicated last week).
III. Despite Record Bailout Measures, Banking Loans Decelerate; More Signs of Panics from Fraud and Swindles?
Unfortunately, banking loans have made unimpressive improvements despite the massive injections on the banking system.
Figure 3
Yes, the economic shutdown can be blamed for it. Partly. But NO, the doldrums in bank credit activities have been in place even before Covid-19 or 2020. Recent cuts in policy rates and RRR have barely been a factor for improvements.
And consumers have made up the recent increase in bank lending, as industry loans have barely made substantial progress. Consumer lending was up 33.3% in April down from 36.5% in March. Industry loans decelerated to 11.1% from 11.6% over the same period.
Bank lending in March or April, for both consumers and must be for defensive cash-raising purposes than for expansion.
Besides, statistics can’t be trusted to represent facts.
For instance, auto purchases made up 42% of consumer loans last April.
While published auto sales crashed to only 133 units or by 99.5% in April, the banking system’s auto loans jumped 30.84% to Php 390 billion pesos! Auto lending increased by a stunning Php 432 million month-on-month, which translates to Php 3.2 million per vehicle. So did the elite bankroll their auto purchases with bank credit?
Have banks been declaring their accurate loan picture to the BSP? Are loans being diverted elsewhere? Or have there been fudging with statistics?
With the BSP providing regulatory and capital requirement reliefs, to what extent have bad loans been gnawing at its capital base?
Upon the expiration of the Bayanihan law, one can expect further corrosion of the banking system's capital base with the deluge of defaults.
With the BSP keeping one eye blind, who would know of the extent of impairments? Only the banks themselves, right?
Has this not been the incentive behind the BSP’s appeal to Congress pass enact legislation allowing for the bailout of the banking system through a bad loan SPV?
Last week, a scandal afflicting German fintech payment services provider Wirecard emerged, where the firm’s funds worth USD 2.1 billion went missing. The German firm had allegedly had ties with two of the biggest local banks. But the banks disavowed on this relationship. And the BSP claims that Wirecard’s money did not enter the Philippines. Yet certain employees of these banks were considered rogue and fired.
Aside from the increased surfacing of malfeasances in the financial industry around the world, how has this scandal been related to the constant price manipulation of the domestic stock market index and the possible statistical chimera of banking data?
Have these incidences not served as classic signals to the end of credit bubbles?
As historian Charles P. Kindleberger and Robert Z. Aliber wrote in Manias, Panics and Crashes, 5th edition (p.165-167)
The implosion of an asset price bubble always leads to the discovery of fraud and swindles…
The supply of corruption increases in a procyclical way much like the supply of credit. Soon after a recession appears likely the loans to firms that were fueling their growth with credit declines as the lenders became more cautious about the indebtedness of individual borrowers and their total credit exposure. In the absence of more credit, the fraud sprouts from the woodwork like mushrooms in a soggy forest…
Swindles that involve falsified statements about the value of inventories can be tested when the promises are made
And with delinquencies and defaults expected to surge, why would banks not play a defensive role too? Will such not lead to a tightening of money, thereby sending rates higher?
Will the BSP use its printing press to offset the deflationary impulses from the waves of default on the banking system?
IV. BSP’s Financial Repression: Fighting Deflation with Negative Real Rates!
And have BSP’s QE been engineered to achieve this through financial repression?
Figure 4
To cover the projected unparalleled 8.4% deficit-to-GDP, the government has been on a borrowing spree. Public debt soared by a record Php 423 billion (month-on-month) in April, to reach a milestone Php 8.6 trillion or 44.5% of the 2018 Nominal GDP.
As I have been saying elsewhere, public sector debt should never be seen or interpreted in isolation. That is, when banking credit expansion slows, the public sector takes over.
At the end of the day, despite the economy in a tailspin, total system leverage (bank and public debt) jumped by 11.74% in April from 9.3% in March to Php 17.76 trillion or 92.2% of the projected 2020 NGDP. Public debt grew by 10.5% in April more than double the 4.8% rate in March, while bank credit expansion increased by 12.99% down from 13.68% over the same period.
With QE, the BSP is attempting to attain negative real rates that implicitly subsidizes the recent and coming debt spike with a mild depreciation of pesos’ purchasing power.
Characterized by nominal rates lower than the CPI, governments benefit from negative real interest rates through an indirect tax on savers or the inflation tax by lowering the real value of debt. Negative real rates policies represent part of the toolbox of Financial Repression employed by governments.
V. BSP’s QE: Boost Aggregate Demand by Public Spending Increasing Stagflation Risks
Figure 5
And finally, injections in the money supply has been designed, not only as bridge financing, a liquidity buffer, and negative real rates, but also to cushion the fall of aggregate spending.
Authorities embrace the Keynesian precept that spending drives the economy, where the reduction of spending by the private sector should be replaced with public sector spending. Hence, the so-called stimulus relies heavily on infrastructure projects.
In the current setting, aside from debt, the BSP provides the NG, through QE, with the purchasing power to engage in it.
But the BSP is playing with the inflation fire!
Once the inflation genie is released, the general idea is that the BSP has the necessary tools to contain it.
Unfortunately, the current dilemma is not only about the shortfall of demand, but the massive disruptions on production leading to the former.
That said, the sharp increases in domestic money supply has spurred spikes in statistical inflation or the CPI in the past (2016-2017).
Today, combined with the reopening of the economy where income streams have been reactivated even as supply dislocations remain, the BSP’s enormous liquidity injections are likely to amplify price pressures, particularly on basic needs.
Besides, under the variant phases of the Community Quarantine, the imposition of price controls has rendered the CPI a meaningless number. With political measures used to suppress market prices to reflect on the actual balance of demand and supply, statistical inflation will naturally register inputs from such mandates.
Price controls seemed to have worked, only because the private sector demand has been severely depressed. However, the longer-term consequences of such price caps will add to the complications of the economy’s health.
Also, aside from the Bayanihan law, the house has passed two stimulus bills (ARISE and CURES) while the DOF has pushed its own CREATE bill. The National Government will at least utilize one of these. The financing of these political projects would come to the fore. How?
Of course, through debt and the BSP’s QE.
And here’s the thing.
Once the initial balming effect from the BSP injections fade, the financial markets will seek out the level of liquidity based mainly on the banking system’s conditions. Credit deflation should rear its ugly head anew. Again, since the BSP is averse to deflation, its path-dependent approach would be to extend its engagement in QE.
While treasury spreads have begun to widen, one of the first to test the resistance is the 20-year/1-year, 2-year, and 6-month spread. A breakout from this curve could spread to the others, such as the 10-year benchmark. The widening of spreads will likely reinforce the direction towards higher inflation or the rising risk of stagflation.
Stagflation is defined by rising inflation amidst high levels of unemployment (economic stagnation). Given the current historic debt levels, overtime, this recession will morph into stagflation that spurs a domestic financial crisis tied to its global brethren.
What is required is for authorities to allow the markets to clear balance sheet imbalances, and a buildup of savings enough to finance productive undertakings.
Sadly, this is not about to happen.
