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, OECD Chairman
In this issue
As the BSP Resists From Tightening, Long-Term ROP Yields Soar!
-Monetary Policies: Limiting the Sphere of Conversation to the CPI
-The Hidden Lessons from the BSP’s Inflation Targeting
-The Peso as Exhaust Valve of Policy Errors
-ROP Yields as Indicators of Interest Rates
-BSP’s ALL or NOTHING Policies Redux
As the BSP Resists From Tightening, Long-Term ROP Yields Soar!
In line with consensus expectations, the Bangko Sentral ng Pilipinas (BSP) kept policy interest rate levels at record low for February
Monetary Policies: Limiting the Sphere of Conversation to the CPI
In predicting the BSP’s move, the focal point of the mainstream debate has always been the CPI data. For the consensus, rising CPI represents a temporal episode, thereby justifying the BSP’s stance of maintaining the current level. On the other hand, the minority thinks that since the CPI has reached the topmost level of the policy target, the BSP should tighten to reduce risks of inflation.
The CPI is a government constructed statistic. The Philippine Statistics Authority noted that the CPI represents “a major statistical series used for economic analysis and as a monitoring indicator of government economic policy.” Being a monopoly, neither has there been competition from the private sector nor has such numbers been subjected to third-party audit to scrutinize its validity.
Needless to say, a statistic which accuracy is unclear plays a crucial role in shaping government’s economic policy. And to reinforce its importance, mainstream discussions of the prospective changes in policy have been confined to such unauthenticated spectrum
Lost in the conversation has been the necessity of the adaption of the unprecedented level of policy interest rates
In a November speech, BSP Governor Nestor A Espenilla, Jr touted*,
The Philippines is one of the world's fastest growing investment-grade economies. We registered a 6.9 percent GDP growth in the third quarter of 2017 and we have enjoyed 75 quarters of uninterrupted economic growth. Last December, acknowledging the sustained robust growth and macroeconomic regulatory environment, Fitch upgraded the Philippines to a solid investment grade rating of BBB.
*Nestor A Espenilla, Jr: Generativity January 17, 2018 BIS.org
If the Philippines have attained “sustained robust growth and macroeconomic regulatory environment” why has the BSP’s ICU or emergency policy measures remained in place? In fact, why did the BSP cut interest rates in 2016? It is not because of the “Corridor” system which it made as justification. They could have used the 2014 rates as a baseline for the new system.
Most importantly, why the need for the permanence of stimulus? Is a person considered standing normally if he/she cannot do away with crutches?
The Hidden Lessons from the BSP’s Inflation Targeting
Will the BSP admit to the public that the National Government’s (NG) lifeblood, its revenue collection, heavily depends on the banking system’s credit growth? Will it thereby admit that raising interest rates will likely hamstring resources for public expenditures?
Will the BSP admit to the public that it is receiving interest rate subsidies through inflation targeting’s negative real rate regime? When ROPs (Republic of the Philippines treasury markets) underprice CPI, the negative spread between CPI and yields translates to an effective indirect transfer of funds to the NG. And once rates rise above CPI, not only does this signal monetary tightening but likewise translates to the end of the invisible subsidies. Will the BSP confess to this?
What are the ramifications of the sustained embrace of artificially low-interest rates?
Will the BSP admit to the public that by keeping interest rates below the market level, it effectively subsidizes borrowers at the expense of savers, thereby increasing systemic credit leverage?
Ever since the BSP panicked to deploy the zero bound in 2008-9 systemic credit has exploded:
Total production and consumer bank loans reached Php 6.945 trillion in 2017 which amounted to 43.95% of the Nominal GDP of Php 15.8 trillion.
Total domestic and foreign public debt tallied to Php 6.65 trillion in 2017 or 42% of the NGDP
Combined, nominal banking Loans PLUS public sector debt portfolio stood at Php 13.595 trillion which would accrue to 86.044% of the NGDP!
And that’s just part of it.
NGDP grew by 9.1% in 2017 while bank credit expanded by 18.39%. That is, for every 1% NGDP generated, 2% of bank credit growth was required.
Seen from a different lens, NGDP has become heavily dependent on bank credit growth, such that the substantial reduction in credit growth would cause NGDP (and taxes) to swoon!
And there is the asymmetric distribution of debt to consider. But we will skip this.
Needless to say, the BSP has been incorrigibly hooked or addicted to the easy money regime.
The Peso as Exhaust Valve of Policy Errors
Yet the CPI is a distraction. The PSA and the BSP can produce CPI data that would conform to its desired policy which no one would know.
Though the government may design CPI to meet its political agenda, price pressures manifest itself in many ways. These can also be seen through the financial performance of listed corporate firms or industry surveys or as political news (e.g. rising rice prices as of the moment: Inquirer.net Gov’t says rice enough but prices say otherwise February 11, 2018)
Another channel from which economics may vent a buildup of concealed imbalances is the currency markets.
Perhaps in anticipation of a possible increase in interest rates, the USD-Philippine peso fell to 51.12 a day before the BSP announcement.
But with the BSP keeping steady its policy rates, the response to the late Thursday announcement sent the USD-php surging. It tested the previous high of 51.77 in the morning. But then, a big Peso buyer/USD seller emerged during the afternoon. The entity sold the USD Php down from the 51.70s to a low of 51.43 from which it closed at 51.48, almost unchanged from last week
Sure, the BSP can intervene to prevent the USD php from rocketing, preventing a “meltdown”. But such Band-Aid treatment would have ephemeral effects that wouldn’t stop an eventual market clearing process.
Further maladjustments would be the likely outcome of bailouts. That said, market prices will again eventually adjust to reflect on the USD Php’s natural (equilibrium) levels
The USD php rose 2.73% month on month in January 2018. The BSP’s GIR for the month was down by US$ 364.3 million to US$ 81.2 billion, mainly from sales of foreign investment holdings. The BSP’s tactical support of the peso emanated from the offloading of foreign investment holdings. The increase in gold prices alleviated the GIR dilemma. The BSP also pruned their record forex asset holdings.
ROP Yields as Indicators of Interest Rates
Hidden beyond the public’s perspective have been the raging yields of Philippine (ROP) treasuries.
While the BSP has kept interest rates at present levels, ROPs have been intensely sold off which means rocketing yields.
As of Friday, both the 10- and 25-year yields spiked to 2012 levels at 6.533% and 7.016%, respectively! The 20-year yield was substantially down to 6.001% from 6.632% on Thursday. (above and bottom charts)
Although long-end yields have climbed to 2012 levels, such would account for an apples-to-oranges comparison. That’s because in 2012, yields were crumbling or bonds were bid (along with the peso and stocks). A genuine bull market would see domestic assets, specifically the peso, bonds, and stocks in a simultaneous uptrend, which is unlike today.
Present rising yields should be one for the history books. That’s because yields have risen from monumental low levels.
Moreover, a “rounded bottom” appears to be emerging from the 10-year yield trend. If validated, a secular inflection point is at hand. That is, the long-term trend of interest rates would reverse course and head upwards.
And by keeping interest rates at current levels, embedded imbalances will only mount. Thus, the BSP’s easy money regime will reinforce the formative trend dynamics.
And this process will be exacerbated by an equally significant force.
This force is no other than the political-economic transition to corporatist-state capitalism.
The umbrella of immense spending activities on socio-political programs, such as Build, Build and Build, free college, public utility and police and armed forces modernization programs, DOST’s public wifi program, enhanced conditional cash transfers, expanded bureaucracy and etc…, would compete with the private sector for scarce resources.
Such competition, known as the “crowding out” dynamic, would further inflame pressures on the ROPs and consequently interest rates
Related to the political-economic transition would be the dislocations from the structural shift in the nation’s economic profile. Aside from the BSP’s inflation tax, the main conduit for financing such lavish political spending sprees would be the expanded consumption taxes (reduced VAT exemptions and excise taxes)
The uncertainty from the displacements in the transitional economic framework should spur constraints on the liquidity environment. A good example, Coca-Cola’s response to the excise tax. [HB 10963 TRAIN’s Initial Victim: Coca-Cola Will Be Laying Off Workers! The Back Shifting Effect of Excise Taxes Validated! February 8, 2018]
The coagulation of these forces will fortify this secular trend
Pulling this all together, the end of the easy money regime has dawned.
Yes, it’s a bye bye for inflation targeting, as inflation pressures will escalate.
And it’s welcome for STAGFLATION! Stagflation is a condition of economic stagnation characterized by high inflation rates accompanied by high unemployment.
And that’s from the local dimension only.
And if the streak of rising yields around the world continues, domestic woes will be compounded. That’s because access to liquidity will become more costly even abroad!
As a matter of current events, even as yields of 10 year US Treasury notes have been surging, the ROP counterpart continues to outsprint it. (middle window)
So funds will be scarce here and abroad. And how will the record streak of deficit spending by the NG be financed?
Going back to basics, higher yields typically incorporate greater expectations of inflation pressures, a higher cumulative path of short-term rates and a term premium, viz extra yield to hold long-term bonds and credit risk premium “changes in the perceived riskiness of longer-term securities” (Ben Bernanke 2015).
As coupon rates move upwards, the influences of these forces will weigh on the BSP’s inflation targeting policies.
BSP’s ALL or NOTHING Policies Redux
And another thing.
As I have pointed earlier, the BSP’s policies signify “ALL or NOTHING” or “Winner take ALL”. In the face of a shock, it has very limited elbow room for conducting emergency operations. And thus, the BSP operates virtually with little margin for error.
Remember, the BSP has yet to normalize its emergency policies of record low-interest rates (Zero Bound Policy) and record debt monetization (Quantitative Easing/Large Scale Asset Purchases).
And as a refresher, once a slowdown in the domestic economy becomes apparent, capital flight will play a role in vacuuming up of liquidity.
And if the BSP cuts rate further and or uses its printing press to finance NG, this is when the peso MELTS DOWN! BSP on the Peso: NO “Meltdown”! BSP’s Winner Take ALL Policies Magnifies the Risks of a Peso “Meltdown”! February 4, 2018
