Everything is fine until inflationary pressures or something else shocks up the interest rates. And the minute they go up, it becomes obvious that government debt service has gone high enough so they will have no recourse but to have the central bank finance still more. And when that happens the writing is on the wall, the currency collapses and the inflation becomes essentially uncontrollable. This is a highly non-linear process that cannot be captured by the econometric models that are in widespread use. They are essentially linear—William R White, chairman of the Economic and Development Review Committee (EDRC) at the OECD
Peso Crucified Anew: Why the BSP Maintained Policy Rates; Overcapacity Plagues the Energy Sector too!
Why The BSP Maintained Policy Rates
The Philippine central bank, the Bangko Sentral ng Pilipinas, maintained policy rates at the landmark lowest level in history.
Of course, I expected that they would.
Under the cover of interest rate corridor, they just cut policy rates June 2016. It would make them look silly to raise rates just 8 months after. They would rather tinker with the CPI statistics.
In reality, the BSP did not only cut policy rates in 2016, they financed the record Php 353 billion in fiscal deficits, hardly through debt issuance, but through a phenomenal record monetization of government debt!
And yet it would be best to understand the reason behind the current set of actions by the BSP.
As I explained earlier, the BSP got “cold feet” over the repercussions from its previous tightening episode in 2014. That was in response to a surge in real economy prices or a spike in statistical inflation brought about by 10 months of 30%++ money supply growth. [See The Mainstream Finally Embraces the Weak Peso… March 12, 2017]
Hooked on narcotic effects from sustained credit expansions, withdrawal syndromes won’t be tolerated.
Again such has been WHY the peso has reached a 10 year low. Inflationism is NO free lunch.
And given the huge capacity buildup which has been concentrated to the real estate, shopping mall, construction and hotel industries over the past few years, the impact from the reversal or even just a slowdown of credit growth should be GREATER—the second time around.
Because of the trauma from the previous ‘deflation risk’ experience, they have now decided to gamble with the peso.
This serves as more proof that the peso will function as the sacrificial lamb in the altar of Philippine politics.
The peso, anyway, can be blamed on many other factors…but hardly ever to the government. Well, that’s way they see it.
The BSP, and the government, essentially believes in free lunches.
The BSP hopes that their recourse to the Pandora’s Box of debt monetization combined with the serial blowing asset bubbles can only have a positive influence on the economy.
So they tell the public that expected inflation will go down due to a retreat in oil prices. While oil prices do have a factor, it signifies a lesser influence on real economy prices or statistical inflation compared to supply side expansion of money.
Yet for them, oil prices serve as a monopoly ‘get out of jail’ card to give free money away to the government and to the privileged few, who has access to not only bank accounts, but to bank credit, as well as the capital markets.
The USD was under heavy pressure this week.
In Asia, all regional currencies rallied. Of course, that’s with the exception of the Philippine peso. With official rates at 50.325 last March 24, that’s a .29% increase week on week and 1.22% year to date!
The ADXY, the JP Morgan-Bloomberg Asian dollar index, where the peso has a 1.83% share, rallied .3% week on week. The ADXY has been up 2.41% year to date.
As one can see above, the Philippine peso sticks out like a sore thumb (upper window) in the panoply of Asian currencies
Yet more proof in the belief in free lunches.
An example from Bloomberg: “In terms of economic fundamentals, there is no reason why the peso should be as weak as it is now,” Deputy Governor Diwa Guinigundo said at a briefing in Manila after the decision. Bangko Sentral participates in the foreign-exchange market whenever it needs to curb extreme volatility even as the currency remains market-determined, he said.”
Wouldn’t this comment be an irony? If such an implied strength in economic fundamentals exists, then just why the continued dependence on subsidies through the inflation tax or the stealth transfer of resources from the public to the government? Can’t the BSP not just get rid of these as proof of their acclaimed robustness? Apparently, they can’t. As said above, they’re hooked on it. Worst, they have taken the gambit to crucify the peso with deepening use of debt monetization which eventually could lead to a currency crisis.
And given the weak peso since 2013, it’s either the BSP has totally been clueless as to the reasons for its conditions, or they have been equivocating to conceal their real activities.
I understand it isn’t the role of the policymaker to say: we are just instituting a transfer of resources from Pedro, Juan and Maria to the Duterte government (and previously the Aquino government too) and their cronies through the BSP. And hope that part of the financial repression filters into the system.
Though to give them partial credit, “trickle down” has been described to present policies many times by no less than the outgoing BSP chief. Example in a 2016 speech*
How do we enable a greater trickle-down effect so that opportunities and benefits of a healthy and growing economy are cascaded to the grassroots?
Although in fairness, it’s only the top officials of the BSP who most likely knows about this.
And to back the BSP’s view, this scintillating opinion from a mainstream expert…“Growth is robust, domestic demand is strong and the economy is reaching its full capacity,” said Michael Wan, an economist at Credit Suisse Group AG in Singapore. “It’s prudent for them to tighten policy in the next few months to contain risks.”
Similar to the recitation of pious chants, this represents no more than a mechanistic response to statistical observations. The view is that statistics equals economics which resonates on the creed of the Phillips curve or “decreased unemployment, (i.e., increased levels of employment) in an economy will correlate with higher rates of inflation”.
The expert ought to visit the Philippines and look at the various shopping malls. Here, ivory tower economists will see that this has not been about “reaching its full capacity”, but about the deepening EXCESS capacity!
And it’s even about the rising unemployment if one believes government’s January data (unemployment rate 6.6% 2017 versus 5.7% 2016) and the SSS survey!
Yet for as long as both the banking system and the government has been pushing for free money into the system, the massive bidding of resources in the race to build supply will continue to impact real economy prices.
And this will extrapolate to the peso’s sustained degeneration.
*Amando M Tetangco, Jr: Tapping into our strengths - opportunities, threats and challenges for 2016 and beyond in the Philippines and Asia Bank for International Settlements 18 March 2016
Oops, Overcapacity Hounds the Energy Sector too!
And I gather that excess or surplus capacity hasn’t been limited to my bubble sectors, in specific, the real estate, shopping malls, hotels (casinos) and construction industry financed by banks.
The energy sector has reportedly been plagued by overcapacity!
Forgive me, I haven’t checked this out yet. Once I have time I will delve into it.
Nevertheless, the following striking excerpts from Bloomberg’s Gadfly Asian columnist Andy Mukherjee**: (bold mine)
Yet statistics point to a glut. Prices in the spot market, where distribution companies buy electricity from producers, are down to a record 2 pesos (4 cents) per kilowatt hour, Cusi says.
Producers, which include a Who's Who of the Filipino business elite, are complaining about a dangerous oversupply of capacity. Nonetheless, they have to finish what they've started…
Everyone's a little jittery. The rate of return on new power plants has slid to below 10 percent. At least one group has already put the brakes on fresh investment. If all projects that were on the table when the last administration left office in June are completed by 2021, it may take nine years for demand to catch up with supply.
And since the estimated nine years of demand most likely stems from current credit fueled conditions, once credit growth hits the wall, then this posits that the present pace of demand will drop by a significant degree. Ergo, the gap between supply and demand will be extended further!
Yet what’s the source of present energy supply saturation?
Consumers should still brace for bill shocks. The reason is partly the country's challenging topography. In an archipelago of 7,000 islands, transmission is a big challenge. Increasingly, a bigger reason may be an unsustainable quest for sustainable energy.
Renewables account for 31 percent of dependable power capacity, a close second to coal's 36.5 percent share. More than half comes from hydro, with solar making up roughly a tenth. But in the island group of Visayas, which spans the middle of the Philippines, a quarter of renewable energy capacity -- and almost 12 percent of the total -- is now solar.
Five years ago, the government guaranteed to absorb power generated by renewable sources at what now appear to be highly lucrative long-term prices. That's especially the case for solar, where panel prices have crashed. The extra cost is recouped from customers. It's no different from Germany, except that an average Filipino's income is a fraction of the average German's.
The transmission sector shouldn’t be a problem. That’s if the government allowed competition to flourish…unfortunately, this has hardly been the case.
Yet the real or prime reason for the growing risk from industry saturation has been the politicization of the energy industry, particularly the “unsustainable quest for sustainable energy”.
Why? Because the “government guaranteed to absorb power generated by renewable sources”.
In so many words, the government subsidized power generators. The government represented these firms only buyer (monopsony). That’s because the government guaranteed to buy electricity or power at rates presently HIGHER than current prices. It’s like a price floor. Taxpayers and the peso, thus, shoulder the burden of paying for the price differentials brought about by such subsidies. It’s called privatize profits and socialize losses.
This leads to a concise narrative of the origins of industry’s conundrum
At first, media has constantly warned the public of a looming power crisis. Then this turned out as justification for the oligarchy to acquire political projects from the government. It was either that the government blindly acceded to this, or had been part of the stratagem or collusion to allow a wave of crony investment deals into the sector.
And as part of such deals, the government provided guarantees or subsidies to power firms to ensure their survival.Because subsidized high prices results to increases in quantity supplied, a supply glut has thus emerged. But then again, this hasn’t been driven by market forces but by government’s picking of winners and losers. Yetstill, economic forces gravitate to where prices were.
And government guarantees may not be limited to buying power or electricity from privileged firms, they can extend to “credit enhancements” and to “credit guarantees”.
This brings us to the second major source: easy money. But let me expound on this later.
Yet Mr. Mukherjee insinuates of a possible reason behind the administration's war on mining.
Environment Secretary Gina Lopez, while awaiting senate confirmation, gladdened many a green heart -- and earned many powerful enemies -- by cancelling 75 mining permits in February.
With her family's company a prominent energy investor, rivals worry about bias.
So it’s possible that the war on mining may not have been just about the environment but to enhance the Lopez family’s power business. Use the government’s repressive actions to promote one’s commercial interest by suppressing competition in the name of the environment. Splendid!
This brings us back to the second source of saturation: easy money
It’s interesting to see how the government has reckoned with the sector’s extremely volatile growth conditions. Nevertheless, as the popular bubble sectors absorbed most of the resources through the years, this sector’s contribution to the government’s GDP continues to shrivel (top window)
But money talks. Credit growth to the sector surged in 2013-2014 (PSIC 1994, lower left) and has remained elevated in 2015-2016 (PSIC 2009) even as GDP trended lower. In other words, the sector has consumed so much credit relative to its GDP contribution.
And credit growth appears to have plateaued in 2015 and continues to shrivel
At any rate, the above shows why the BSP needs to keep the money flowing via low interest rates.
First, the government needs to fund the power firms hence the added pressure on deficits. Lower rates, thus, give the government access to cheaper debt. Of course, credit enhancements and guarantees to the energy sector will best be supported by a low interest environment too.
Second, the BSP needs to finance end user “demand” via an increase in systemic leverage. Need more manufacturing demand for power? Flood the manufacturing sector with credit! Need more demand from consumers? Inundate consumers with free money!
Third, power generators need access to cheap credit too to cover any financing shortfalls or to bridge gaps in the decreases in their firms’ rate of return.
At the end of the day, this has not been about “reaching full capacity” but about EXCESS capacity. It’s a symptom of aggregations of massive malinvestments. And since all actions have consequences, malinvestments will eventually face its economic destiny.
The crux, the BSP’s consternation or trepidation of the aftereffects from a credit slowdown via deflation risks means that they will sacrifice the peso for political convenience.
**Andy Mukherjee Power Plight Needs Duterte's Energy, March 23, 2017 Bloomberg.com
