The boom brought about by the banks' policy of extending credit must necessarily end sooner or later. Unless they are willing to let their policy completely destroy the monetary and credit system, the banks themselves must cut it short before the catastrophe occurs. The longer the period of credit expansion and the longer the banks delay in changing their policy, the worse will be the consequences of the malinvestments and of the inordinate speculation characterizing the boom; and as a result the longer will be the period of depression and the more uncertain the date of recovery and return to normal economic activity—Ludwig von Mises, "The 'Austrian' Theory of the Trade Cycle"
In this issue
The IMF Warns Of “Systemic Solvency Distress”! Deflationary Forces Emerge as T-Bill Yields Soar!
I. The BSP’s Ghost OFW Remittances?
II. The IMF Warns Of “Systemic Solvency Distress”; Bond Spread Tightens on Surging T-Bill Yields
III. The BSP as the Primary Source of Liquidity of the Banking System
IV. The BSP’s Bailout Policy as the Principal Source of Banking Revenues/Income
V. Why Increased Speculative Activity of Banks Will Weigh on their Balance Sheets
The IMF Warns Of “Systemic Solvency Distress”! Deflationary Forces Emerge as T-Bill Yields Soar!
I. The BSP’s Ghost OFW Remittances?
In September 2020, I questioned the validity of the BSP’s data on OFW remittances…
Because OFW remittances reportedly increased by 7.6% YoY last July, the following factors could have been in motion for this number to occur.
1. 500k displaced OFWs represents fake news. It never happened.
2. 500k workers, initially retrenched, were rehired immediately and simultaneously.
3. Employers of the remaining 1.7 million OFWs increased their wages substantially, which offset income losses of those unemployed. Or incomes of these OFWs flourished from having moonlighting jobs.
4. The remaining OFWs dug deep into their savings and sent these home.
5. The remaining OFWs borrowed money extensively to send these home.
6. The BSP has inflated the remittance numbers to paint a sound macroeconomic picture of the Philippine economy. They probably did these by declaring part of the USD borrowings of banks and or the National Government as remittances.
Essentially, the implication has been that a global recession hadn’t affected remittance flows at all, and thus, the nation’s macro picture has been immune from economic shocks. Really?
On the July OFW Remittance Bounce, What the BSP’s Record Gross International Reserves Means, More on Unemployment Statistics September 21, 2020
Here is an update.
Figure 1
From the BSP (April 15): Personal remittances from overseas Filipinos (OFs) amounted to US$2.761 billion in February 2021, higher by 5.3 percent than the US$2.623 billion recorded in February 2020. The increase in personal remittances was attributed to the 7.8 percent growth in remittances from land-based workers with work contracts of one year or more to US$2.152 billion from the US$1.997 billion recorded in February 2020.
From the Philstar (April 6, 2021): Filipino migrant workers deployed last year plunged to their lowest in 3 decades blocked by coronavirus lockdowns that prevented them from seeking greener pastures abroad. A total of 549,841 overseas Filipino workers (OFWs) were deployed in 2020, plummeting by 74.5% from a record-high of 2.16 million in 2019, data from the Philippine Overseas Employment Administration (POEA) showed. The figure was the lowest since 446,095 OFWs flew abroad in 1990.
From the International Labor Organization (January 25, 2021): In 2020, 8.8 per cent of global working hours were lost relative to the fourth quarter of 2019, equivalent to 255 million full-time jobs.1 Working-hour losses were particularly high in Latin America and the Caribbean, Southern Europe and Southern Asia. Working-hour losses in 2020 were approximately four times greater than during the global financial crisis in 2009.
So if the number of deployed OFWs plunged by 74.5% in 2020, and if a substantial number of Filipino immigrant workers, as part of the global workforce, were also displaced, how did the BSP arrive at a measly .8% decline in remittances in 2020 and a bounce of 5% this February?
Which entities were responsible for the FX flows in place of the massive dislocations of OFWs and the migrant workforce? And from where?
Simply put, if the labor participation of Filipino nationals in the global pool shrunk, how and who was responsible for elevating FX remittance flows?
Have the remittance data been inflated by FX borrowings of banks and the National Government? And have such embellishments been part of the informational campaign to boost confidence to influence the markets positively?
Long story short, the domestic financial system requires a vigorous peso to forestall credit problems from increased systemic leverage (including FX exposures). As such, given the priority of restoring confidence in the economic realm, the padding of statistics may not be an improbable political option.
However, when a higher standard of living, signified by bountiful job and earnings opportunities, as well as, highly competitive wages, and affordable prices on quality lifestyles, induces locals to stay home, that is the sign of genuine social progress.
Though it buys time, toying with statistics only worsens the embedded imbalances.
II. The IMF Warns Of “Systemic Solvency Distress”; Bond Spread Tightens on Surging T-Bill Yields
Defying the streak of downgrades from most establishment institutions, the IMF has provided the most bullish forecast on the Philippine economy.
But their optimism comes with a caveat.
Here it is. From the IMF Staff Report (April 9, 2021): Findings: The economic contraction is elevating credit risks, especially from the corporate sector. While banks can withstand the severe baseline scenario, they could experience systemic solvency distress in a much more severe adverse scenario. The second-round effects from such distress might reduce GDP even more. Regulatory forbearance that delays loss recognition could harm economic recovery by limiting credit growth, as observed after the AFC. However, prompt loss recognition and non-performing loan (NPL) restructuring can prevent sharp deleveraging and boost GDP.
Is the IMF hedging its position?
Bringing back where we left, two weeks ago…
And climbing yields of T-bills translates to costlier short-term/bridge financing, which if sustained, spells trouble to small and medium enterprises and heavily levered big companies.
And if borrowers are under stress, so are the lenders.
See March CPI Declines as Pork Price Controls Suspended, Global Inflation Soars! April 11, 2021
Figure 2
It is no coincidence that surging T-Bill rates have accompanied the sluggish activities in the PSE. The benchmark BVAL 1-month rates surged 7.3 bps this week to 1.3218%, a nine-month high as the headline index wobbled by 1.8%, registering the second week of decline. Despite the recent surge, 1-month T-Bills remain close to the all-time lows reached last February 2021.
As noted before, higher rates on short-term loans, frequently used for financing cash flow and bridge-finance requirements, will only aggravate the IMF’s "systemic solvency distress" scenario, representing a downside loop spiral of the deterioration of credit profile of borrowers and lenders.
And as previously presented, the appeal by the top 1,200 corporations to the Senate last March for a Php 625 bailout bolsters such systemic solvency distress or the coming wave of insolvencies scenario.
To reinforce this setting, aside from Phoenix Petroleum, another firm owned by the most favored political entrepreneur raised concerns over debt repayments.
From the Inquirer (April 24): The logistics group of Davao-based businessman Dennis A. Uy cut jobs, sought loan waivers and shed other assets apart from selling affiliate 2GO Group Inc. in a bid to stay afloat this COVID-19 pandemic…To address swelling debts that were used to finance its rapid expansion in recent years, Chelsea said the group “continued to negotiate with banks to refinance or restructure its existing loans.” It also requested waivers from lenders not to demand immediate payment for its loans. This was after the group’s finances fell below certain ratios, including those measuring its ability to settle its debts. (bold added)
And despite the historic emergency measures undertaken by the BSP to ensure the banking system’s easy access to liquidity, surging T-Bill rates have occurred as yields of Treasury notes and bonds have been dropping.
The tightening spreads across the curve are likely signs of the continuing erosion of financial liquidity, principally a manifestation of attenuating demand.
Nonetheless, despite the recent tightness, spreads of the BVAL 10-year bonds relative to the T-Bills and Notes remain on a two-year uptrend.
Importantly, the scale of economic contraction in the face of the massive degree of leverage entrenched into the system, even a slight increase may be enough to trigger a "systemic solvency distress".
Remember this warning from the late BSP Governor Nestor Espenilla led FSCC’s 2017 Financial Stability Report? From the BSP: “While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner
Rings a bell?
III. The BSP as the Primary Source of Liquidity of the Banking System
Paradoxically, the cash reserves of banks are at record highs.
Growth of cash and due banks spiked 40.8% last February to a milestone Php 3.61 trillion or 18.7% of the industry's total assets.
Figure 3
Meanwhile, diminishing growth of deposits liabilities, as well as, external borrowings showcases the natural constraints from organic sources of funding.
Since 2013, deposit liabilities, composed of the peso and FX, have trended south. Ironically, the trend of deposit growth has deviated from bank lending growth.
In the meantime, deposit growth bounced 10.6% last February compared with 9.4% in January. This growth emanated mainly from peso liabilities (up 10.6%) even as FX deposits have almost been flat (.64%). Record GIRs are inconsistent with the falling trend of FX bank deposits.
Also, bills payable slumped 41% last February, reducing its share of liabilities to 2.6%. The growth of bonds payable also slowed to 16% to reflect on its 4.16% share. That said, the only way for banks to raise funds is through the BSP. Again, such a dynamic existed even before this pandemic.
This brings up another irony, while the BSP provides liquidity, banks compete with the National Government for access to public savings.
And so, rising T-bill rates must also reflect on the intensifying competition for scarce savings.
Figure 4
IV. The BSP’s Bailout Policy as the Principal Source of Banking Revenues/Income
Further, with core operations or bank lending in deflation, speculative activities have recently bolstered the banking sector’s operations.
As of February, the banking system’s Total Loan Portfolio (inclusive of Interbank and Repos, Net) shriveled by 4.6% as Net Investments (Financial Assets and Equity Investments in Subsidiaries and Direct Investments) jumped by 13.73%. As a share of assets, TLP dipped to 52.8%, while investments increased to 24.5%.
Oddly, of the 23 of the 26 PSE non-financials that have been reported so far, accrued debt surged by a startling 9% in 2020, despite massive income slump! Once their annual reports are complete, we shall expound on this.
Nevertheless, if the BSP’s report of bank conditions is accurate, then the economy is suffering from intense credit deflation. That’s because the credit conditions of the general economy have weighed immensely on the banking system’s credit portfolio for it to register a contraction or deflation, despite the landmark credit expansion of the PSEi 30.
The thing is, the sharp slump in credit translates to the aggravation of supply bottlenecks.
It is important to note that aside from asset speculations, the near halving of deposit expenses from the BSP’s record reduction of its overnight rates has been instrumental in boosting operating margins.
In 2020, such sizeable cuts in deposit expenses (-37.55%) marvelously cushioned bank losses (-32.82%).
With BSP's (ON RRPs) official rate at 3.25% in the 1Q 2020 compared with the current 2%, such interest rate subsidies extend to the 1Q 2021.
Nonetheless, the narrowing spread between the current and last year’s rates translates to the diminishing returns from such subsidies, which should become apparent in the latter semester of 2021.
Here is a clue.
From the Businessworld (April 23): THE Bangko Sentral ng Pilipinas’ (BSP) accommodative monetary policy stance remains appropriate to support the economy’s recovery, officials said, vowing to keep a close eye on inflation. “Looking ahead, the BSP will continue to look closely in the near term for signs of inflation becoming broader based in order to safeguard the public’s inflation expectations,” BSP Governor Benjamin E. Diokno said at a virtual briefing. “The overall stance of monetary policy will remain oriented towards preserving ongoing policy support and helping to ensure the sustainability of economic recovery, while also guarding against emerging threats to the BSP’s price and financial stability objectives,” he added.
In reality, the BSP’s obstinacy on preserving current policy levels exhibits that inflation is a subsidiary concern than to provide subsidies for the banking system.
And that’s why more policy rate and bank reserve cuts are on the table, regardless of the state of inflation or the currency's loss of purchasing power, which is its genuine definition.
And that why in the pipeline are more QEs.
And that’s why instead of solving price pressures by allowing "price discovery" to reflect on the actual state of the economic balance, the official position will be to manage or spiff up statistics and or manipulate prices either through edicts (e.g. price controls), or direct/indirect market interventions, all designed to bolster the Keynesian "animal spirits" or confidence.
Adding these together, banks haven’t been generating profits from organic operations but the BSP’s liquidity injections or monetary support and relief operations. Instead of allowing the markets to thresh out embedded imbalances through the IMF’s “prompt loss recognition and non-performing loan (NPL) restructuring” recommendation, central planning is popularly thought of as the solution and the likely path-dependent route.
However, kicking the proverbial can down the road will hardly lead to recovery of the banking system.
Finally, the IMF took note of this.
So attractive the domestic banking system has been for Citigroup, the world’s 13th largest bank as of April 2020, declared that it is scaling down its operations and pulling out of the retail industry in Asia, including the Philippines.
From the Inquirer (April 23): The country’s financial regulators are “closely monitoring developments” following the announcement of global financial giant Citigroup that it would withdraw from retail banking in smaller markets around the world, including the Philippines, as part of broader strategy shift…As a result of this new strategy, Citigroup plans to exit from its retail banking business which covers credit cards, personal loans, retail deposits and other consumer-related services.
Broader strategy shift! What an awesome euphemism or pretext for unprofitable or suboptimal operations!
Citigroup’s history in the Philippines dates back to July 1902, when the International Banking Corporation, forerunner of Citibank, first established a branch in Manila, according the Citibank’s website. With over 110 years in the Philippines, Citi is the largest foreign commercial bank in terms of customers, assets, and revenues, providing Corporate Banking, Treasury, Transactional Banking, Consumer Banking, and Trust services, among others.
They are going to change this soon.
V. Why Increased Speculative Activity of Banks Will Weigh on their Balance Sheets
Circling back to the speculative activities of banks.
Figure 5
As of February, as yields rose, prices of fixed income fell securities fell, the drop in bank investments exhibits a reduction of exposure on speculation from the implied losses. The PSEi 30 has rolled over along with it.
Two crucial factors are likely to emerge from the current tightening.
One, slower demand will likely pull down the CPI in the interim. The CPI remains in an uptrend nonetheless. An ascendant CPI has anchored most of the gains of the PSEi 30.
Two, more credit delinquencies should emerge from reduced access to cheap credit.
Bank credit delinquencies, via Net NPLs, began their ascent coincidentally with the surge in the CPI since 2016. Net NPLs accelerated when the BSP raised rates in late 2018 to wring statistical inflation. To be sure, the uptrend in published Net NPLs is two years old! The pandemic has only accelerated its upside spiral. And how about the undeclared ones or NPL skeleton in the closets?
Finally, since speculation from BSP’s free money has inflated its assets, what happens to the cumulative balance sheet of the banking system if deflation should prevail over the Philippine capital markets (fixed-income securities and the equity markets)?
And why wouldn’t such speculative activities affect the balance sheets of the banking system, when the BSP’s free money policy has only been compounding on malinvestments and mispricing in the economy?
For instance, as of end-March or at 6,443, or about 1% above from Friday’s close, the PSEi 30s PER remained at a pre-Asian crisis 1996 high of 22.6!
Aside from the speculative mania, since all actions have consequences, the 1996 highs of the PSEi 30 have been a product of massive end-session pumps!
Importantly, are we supposed to believe that the sustained push for the centralized control of the division of labor, in the name of health protocols, will have a scanty impact on capital and investments necessary for recovery?
From our end, the current lockdown socialism has and will continue to exacerbate the grandiose credit-induced malinvestments from the pre-pandemic era that would tilt the economy towards a financial crisis.
And capital consumption will manifest itself through higher rates.
Figure 6
According to Austrian economist Dr. Frank Shostak,
whilst the increase in the pool of real wealth is likely to be associated with a lowering in the interest rate, the opposite is likely to take place with a fall in the pool of real wealth. People are likely to be less eager to increase their demand for various assets thus raising their demand for money relative to the previous situation. Within all other things being equal, this will manifest in the lowering of the demand for assets thus lowering their prices and raising their yields.
Dr. Frank Shostak, Time Preference, Interest Rates, and Stagflation, Mises.org January 20, 2021
Stagflation, or the strengthening in price inflation amidst a decline in economic activity, are signs of capital erosion or diminishment of the pool of real wealth.
Interest rates, thus, will eventually reflect not just inflation but also the rate of capital consumption manifested through mounting credit delinquencies.
At any rate, deflationary signs have appeared on the PSE.
Though the average main board volume rose by 2.4% this week, the nominal levels have dropped to pre-4Q 2020 levels of Php 5 billion a day.
Total traded issues have also tumbled to 1Q 2020 levels.
And expect deflationary forces to percolate into the Philippines once the global “everything bubble” implodes.
And expect the BSP to intensify the use of its balance sheet to “protect” the banking system and the economy.
Yours in Liberty,
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