July’s Phenomenal Fiscal Deficit Pushes Government Size to Historic Highs as Debt Servicing Rockets!

Interventionism aims at confiscating the "surplus" of one part of the population and at giving it to the other part. Once this surplus is exhausted by total confiscation, a further continuation of this policy is impossible—Ludwig von Mises

In this issue

July’s Phenomenal Fiscal Deficit Pushes Government Size to Historic Highs as Debt Servicing Rockets!

-Bullseye! July’s Record Deficit Sends Government Size to a Record, Affirms the Socialization of the Philippine Economy!

-Breakneck Speed in Public Spending and Revenues Pushes July and 7-Month Deficit to Historic Levels

-July Public Debt Servicing Soars

July’s Phenomenal Fiscal Deficit Pushes Government Size to Historic Highs as Debt Servicing Rockets!

Bullseye! July’s Record Deficit Sends Government Share of GDP to a Record, Affirms the Socialization of the Philippine Economy!

The multiple records shattered by July’s fiscal deficit have led to a rocketing of the National Government’s expenditure to (nominal) GDP ratio, the largest since 1998

Lo and behold! The most earthshaking chart representing the political economic transformation of the Philippines: A Bull Market in Government!

Figure 1

As of July 2018, the public spending to GDP ratio hit 20.1%, 12.4% more than 2017’s 17.87%, and 17.4% above the 17.12% average ratio since 1998. 

Public expenditures are supposed to represent recorded real activities, whereas econometric models which inputs are derived mostly from surveys constitute the statistical economy or the GDP. That being the case, an inflated GDP would understate the real contribution of the government on the economy. Or, the public spending or government share of the economy could significantly be more!

Besides, the public spending to GDP ratio represents a direct measure of the size of the government. This ratiodoesn't capture the indirect participation of the government.  For instance, in many of Public-Private Partnership (PPP) projects, it is the private sector that spends on political projects.  The $3.7 billion Makati subway project is an example.

Political interventions affect the economy in many ways. These interventions may impact prices, operations, distributions, and output.

For instance, the National Government (NG) restricts supply of the Transport Network Vehicle Services (TNVS) industry, as well as, imposes demand control through the price channel or the ability of these firms to set prices.

Having been stripped of entrepreneurial role through repressive and intrusive regulations, firms of the industry transform into quasi-managers or department heads of National Government. In essence, the NG directs the operating spectrum of these privately owned firms as extensions of its tentacles.  The result of which is to weigh down the industry’s contribution to uplifting consumer welfare and generally on the economy.

The record deficit spending, which in part increases bureaucratic involvement (through the expansion of manpower, logistics and enforcement capabilities), has reduced output, employment, and capital accumulation for the TNVS industry.

At the end of the day, an increase in the share of the statistical GDP pie by the government translates to a proportional decrease in the participation of the private sector. A larger government entails a smaller private sector.

And because there is no free lunch, not only will the trend of record deficits supported by massive interventions shrink the productive sectors of the economy, it embeds higher taxes into the future, weakens spending power (inflation), underwrites the erosion of the domestic currency and upsizes economic and financial risks.

That said, the transformation towards the socialization of the political economy has now manifested itself in government’s statistics.

What I have been predicting all along has been validated!

And economic opportunities will increasingly involve establishing ties with the government at the expense of the marketplace. One has to be an insider or connected with the insiders.

Exemplified by the transition towards a centrally planned and centrally directed economy have been experiences of the PPP and TNVS industries.

What more if the proposed bill on the imposition of the 14-month pay to employees of the private sector, which has now been in the Senate’s third reading, be ratified? Would that not constitute the troika of rigorous labor mandates that would penalize the economy following higher minimum wages and anti-endo practices?

Sutton’s Law becomes increasingly plays a relevant role in crafting financial strategy.

According to Wikipedia, The law is named after the bank robber Willie Sutton, who reputedly replied to a reporter's inquiry as to why he robbed banks by saying "because that's where the money is."

The government is where the money is!

Breakneck Speed in Public Spending and Revenues Pushes July and 7-Month Deficit to Historic Levels

Let us dig down on the booming government bubble.

July’s fiscal conditions produced a stunning set of records.

Figure 2

July’s deficit of Php 84.4 billion was the largest in at least 11 years.  A breakthrough pace in revenue and expenditure growth of 24.21% and 33.9%, respectively, crafted the July record, unmatched since 2009 at the very least. (see figure 2)

July’s phenomenal fiscal expansion helped set landmarks in spending and revenue activities over a 7-month period

Figure 3

At breakneck speed, revenue growth dashed at 20.52% while expenditure growth sprinted at a faster 22.57%. (upper window figure 3)

The outcome: the seven-month deficit bolted to a milestone Php 279 billion! The 7-month deficit represents 80% of 2017’s full-year Php 350.64 billion with 5 months to go!  (lower window figure 3) Another deficit in the scale of July or March (Php 110.7 billion) would wipe off the gap in a month!

The National Government set a target deficit of 3% of the GDP or about Php 530 billion.

The 7-month deficit has accounted for about 3.3% of the first semester nominal GDP. At the current pace, the government’s programs seem on track to reach its objective. 

 

Figure 4

And if the NG hits its deficit target, the spending share of GDP could be expected to rise by even more!

To emphasize, while nominal expenditures are about to break beyond the recent highs, revenues are currently being bolstered by the expanded tax base from TRAIN 1.0. (figure 4 upper window)

Or, authorities have programmed public expenditures in contrast to revenues which depend on economic performance as well as administrative efficiency on collections. More pointedly, expenditures are fixed, revenues are variable. A slowdown in the economy will blow the deficits through the roof.

The rate of current and proposed spending indicates that TRAIN 2.0, which should add to the expansion of the tax base, as noted before, will have to be enacted.

July Public Debt Servicing Soars

Since fiscal deficits are no free lunches, how was the July record financed? Has it been through debt or the BSP’s monetization or a combo?

The BSP and the Bureau of Treasury has yet to publish the relevant statistics

So far, the debt service data from the Bureau of Treasury provides a clue. (lower window, figure 4)

And the numbers are just phenomenal!

The 7-month debt service at Php 463.11 billion has accrued to about 94% of the annual Php 490.31 billion of interest payments and amortization spent in 2017.  

Debt service as a share of total government revenues, which was at 28.03% in July, appears to have reversed its downtrend.

The debt service to revenue ratio hit a low of 19.83% in 2017.  In June 2018, public domestic debt grew by 9.34%. The burden of debt servicing must have increased by the recent acquisitions of debt

At the current pace, the annual debt service for 2018 will likely approach Php 800 billion, Php 54.4 billion shy of the record established in 2006.

With rising interest rates and with record deficit spending in part financed by debt, the National Government’s debt service should be expected to increase significantly.

And rising financing costs will not only add to the deficits it will compound on the National Government’s competition with the private sector for access to people’s savings. Expanded debt and debt servicing should magnify the crowding out syndrome.

The repercussion would be to amplify upside pressures on interest rates!

And not only will the government’s broadening role in the economy require significant amounts of financing, it will bring about substantial rearrangement in the economy’s production and distribution structure that should affect earnings and the GDP.

Until it becomes evident, current statistics will hardly capture such changes.

Instead, what has been conspicuous has been the fast-expanding role of the government in the economy as noted above.

Nevertheless, government policies set the directions.

The monumental shift in the nation’s tax regime from income tax to a broad-based consumption tax is a depiction of such pivotal change.

The goal, as declared by officials of the Department of Finance, is to become investment-led.

As the record fiscal deficit and public expenditure to GDP shows, a government ‘investment led’ economy it is, to be precise.  

Bereft of market prices and economic calculation, what the government sees as an investment is in reality consumption

Attachments area

Bullseye! The Mainstream Finally Sees the Unsustainable Philippines’ Corporate Debt Problem!

What I have been saying here has finally been picked up by the mainstream!

From the Businessworld's “Big firms hard-pressed amid rising interest rates” August 21, 2018

(bold added with comments in italics)

‘A HARD TIME ONWARDS’

Natixis economists Alicia Herrero and Gary Ng said overall financial conditions have “worsened” especially for large companies and could signal deteriorating fiscal health for these firms.

“All in all, when push comes to shove, the Philippines’ firms are not in the best of circumstances to handle rate hikes.Externally, the Fed is hiking and the BSP will have to increase rates in the light of higher inflation and to stem off capital outflows,” the economists said in a report published last week.

“With the high corporate leverage, firms could face a hard time onwards in the rate cycle.”

Natixis said segments of the economy have been under pressure from a weaker peso, an “underperforming” stock market, a growing trade gap and a potentially bigger budget deficit as the government spends more on infrastructure. (my comment: record budget deficit is no free lunch, someone pays for it; that's you and me)

“The top 25 firms by asset size have high leverage, low repayment ability and worsening financial health,” the France-based research group said, noting that the peso’s depreciation has also driven up business costs as they absorb rising prices. (my comment: the peso dilemma is a symptom, not the cause)

“As a consequence, profit margin is down even though they are divesting. On the basis of structurally low revenue stream, a lack of capex and much higher leverage in a higher interest rate period, their prospects are poorer.” (my comment: price instability affects margins)

The 25 biggest companies in the country had an average leverage ratio — or debt against equity — of 228% in 2017, against a 114% average of smaller counterparts, according to Natixis.

Remember this?

Coming up: the Philippine banking system was in a bad shape in the 1H of 2018.

Metro Retail Stores Group’s Orwellian Press Release; the Unintended Consequences of Anti-Smuggling Regulations: Rice Shortages!

Here is an example of an Orwellian press release.

From Metro Retail Stores Group:

9.5% increase in sales! Php 344 million in profits!

Here is MRSGI Financial Statement (2Q/1H) 17Q published at the PSE:

Lower Sales. Reduced profits. 

Although they could be referring to stores unaffected by the January fire accident, the numbers above don't seem to support such an idea. Look at the lower pane in the above chart, MRSGI’s revenue % change has been in a decline since 2016. Hardly has TRAIN 1.0’s wondrous income tax cuts helped.  The 1H drop was a continuation of a 2 and a half year trend! 

Or, could they, perhaps, be alluding to old records or performance of competitors?

These are signs of times. It is related to endless price fixing. Misinformation. Manipulation. To push up stocks. Whatever it takes.

How Smuggling Regulations Spurred Rice Shortages

Below is an example of the law of unintended consequences:

Agriculture Secretary Emmanuel Piñol said the successful campaign against rice smuggling had led to rice shortage here, sending rice prices skyrocketing to more than P50 per kilogram.

“It’s a good job gone bad,” Piñol said.

“Good job because smuggling (of rice has) stopped. But bad because Zamboanga is experiencing rice shortage,” Piñol said at a visit in Zamboanga City.

By raising the cost of inventories, unilateral anti-smuggling edicts reduce the available supply of rice in the face of increased demand financed by the BSP. Result: Shortages! 

Will Financial Tremors in China and Hong Kong Lead to the Big One?

Bankruptcy comes in stages. In the early stages, it is barely visible. Income does not keep pace with expenditures. The spendthrift borrows. "No problem." This is seen as a temporary anomaly. Then the borrowing speeds up, but there is sufficient capital to justify the increased debt. The accountants warn of trouble ahead. The debtor responds: "So far, so good!" "There's more where that came from!" The process continues. Then the accountants say: "The future is now." The spendthrift responds: "Eat, drink, and be merry, for tomorrow we die." —Gary North

In this issue

Will Financial Tremors in China and Hong Kong Lead to the Big One?

-Mounting Stress on China Yuan and the Hong Kong Dollar; Will the Hong Kong’s USD Peg be Broken?

-From Convergence to Divergence: China’s Stocks Leads The Rest of the World Lower as US Tests Record High!

-Will China’s Government Launch Xi Jinping Put 2.0?

-Has Financial and Economic Rescues Reached its Natural Limits?

Will Financial Tremors in China and Hong Kong Lead to the Big One?

From Turkey back to China.

Mounting Stress on China Yuan and the Hong Kong Dollar; Will the Hong Kong’s USD Peg be Broken?

After hitting a 15-month low, the Chinese yuan rallied most since January by .79% last Thursday, on rumors that US-Chineseofficials reopened doors for trade discussions.  In spite of the rally, the USD yuan firmed by .45% this week. (see figure 1, upper pane)

 

Figure 1

Like the yuan, the Hong Kong dollar’s US dollar peg has been under pressure. Hong Kong's de facto central bank, the Hong Kong Monetary Authority (HKMA), reportedly bought more than $2 billion worth of local currency to maintain a long-held peg to the US dollar leaving just $12 billion in its reserves by the end of the week.

Tremors in the yuan appear to have diffused into Hong Kong. Should the USD-HKD peg break, not only will the yuan’s fall accelerate, tensions may intensify in Hong Kong and China’s financial markets that could prick both China and Hong Kong’s property bubbles.

From Convergence to Divergence: China’s Stocks Leads The Rest of the World Lower as US Tests Record High!

 

Figure 2

Strains in the currency markets have been reverberating on China and Hong Kong’s stock markets.

The national benchmark, the Shanghai Composite (SSEC), tumbled by a staggering 4.52% this week, to hit the lowest level of the 2015 crash in January 2016. Hong Kong’s HSI sank 4.07% to a one year low.

From its zenith in January, the SSEC has lost 24.99% and posted a year to date performance of -19.3%, Asia’s worst. Meanwhile, Hong Kong’s HSI which has been down 17.92% from the January peak may likely drop into the bear market’s lair.  

Pressures on the Chinese stock market appear to have truncated the recent rally of ASEAN stocks. Excluding the Vietnamese benchmark, which closed almost unchanged (+.04%), the national indices of Indonesia (-4.83%) and the Philippines (-2.84%) led ASEAN benchmarks down.  

Only six (31.6%) of the nineteen national bourses defied selling pressures in Asia. The region’s weekly performance had an average of -1.35%.

Bank Indonesia raised rates for the fourth time since mid-May this week to stanch the hemorrhaging rupiah (-.79% week on week, -7.66% in 2018). The Philippine peso slid .55% to 53.43.

Since the January acme, the complexion of the performance of global equities experienced a radical change.

While US stocks represented by the S&P 500 (+.59, week, +6.6% year to date) continues to climb to its January highs, the MSCI World ex-US (MSWORLD), China’s Shanghai Composite and the Emerging Market iShares ETF have fallen to reach more than a year’s depths.

Convergence in global equity market performance has morphed into a divergence. Yet how sustainable can this seminal divergence be?

Have global investors been rotating into the US? If world national benchmarks have been signaling an economic downshift, will US stocks follow suit? Or will the US power the global economy higher? But how can the latter be if the trade war will remain in place or if it will intensify?

Such divergent dynamic has also emerged in parts of Asia.

With most of the region’s markets under pressure, the Pacific benchmarks of Australia and New Zealand ironically hit milestone highs.

Bifurcating markets have also appeared in India. While the Indian rupee’s free fall plumbed a fresh low, its equity benchmarks raced to landmark heights!

Will China’s Government Launch Xi Jinping Put 2.0?

The plunge in China’s stock markets should be a concern to Asia. The Middle Kingdom has significant links with latter which functions primarily as its supply chain network. China has likewise been a significant source of Asia’s financing, fund flows, and a market for tourism

In 2015, a slew of draconian measures had been implemented by the Xi administration to arrest the stock market crash.

Aside from imposing assorted bans and limits on equity sales, the government infused cash to brokers and state-owned enterprises to put a floor on the stock market. 197 people, including journalists, were reportedly incarcerated for spreading rumors. “Spreading rumors” carries a three-year jail sentence after its introduction in 2013

The Xi administration’s stock market rescue efforts had been known as the Xi Jinping Put.

Nevertheless, the SSEC still crashed by 48% in 6 months.

The crash exposes how meddling and manipulating the markets will fail to attain its intended objectives. Though perhaps China’s markets could have gone lower, the present stress highlights the fact that kick the can down the road may have reached its end.

China’s stock markets may likely bear the brunt of the accrued imbalances caused by the 2015-2016 Xi Jinping Put.

All actions have consequences.

 

Figure 3

That episode caused the Chinese government to panic!

It launched a considerable amount of fiscal stimulus (see above), accelerate interest rate cuts and infused massive amounts of credit to stabilize and insulate the economy from the aftermath of the stock market crash. According to Federal Bank of New York’s Liberty Street Economics, “In 2016 alone, credit outstanding increased by more than $3 trillion, with the pace of growth still roughly twice that of nominal GDP” (bold and italics mine)

Since the stock market crash, the bank loan share of M2 continues to bulge.

Some of the global central banks responded by implementing negative interest rates in 2016 (e.g. ECB, Bank of Japan, Denmark and Sweden).

Under introduction of the corridor system, the Philippine Bangko Sentral ng Pilipinas slashed rates to a historic low in June 2016(also partly in response to domestic downside price pressures or “disinflation”).  Remember the erstwhile BSP chief Amado Tetangco Jr’s spiel on deflation or disinflation?

If stocks continue to crumble, will the Chinese government respond in the same way as they did in 2015?

Will interest rate cuts be the next move for global central banks?

Has Financial and Economic Rescues Reached its Natural Limits?

But here is the thing.

China’s property markets continue to burn the road.

New home prices and property investment growth have rocketed at the fastest pace in 2 years which had been financed by a rapid buildup in household debt which soared 15.14% in June month on month.

So rescue operations will only accelerate the meltup in the housing market which the Chinese government has been attempting to control, although at local levels.

Figure 4

And weakness in stocks or properties may aggravate its fragile offshore dollar/eurodollar conditions in part by rekindling capital flight and mainly from growing scarcity of access to US liquidity and collateral. China’s international reserves have begun to fall again last July. [upper window]

China’s monetary system, like the Philippines, is built upon mainly forex or international assets (mostly US dollars). [lower window]

China has been experiencing tremendous economic and financial tensions. The snowballing strains appear to be spreading. It has been ventilated on the currency markets (the yuan and Hong Kong dollar) first and then has spread to the stock market. Will credit be next? Then housing?

Unless Chinese authorities will be able to pull a rabbit out of a hat soon, a major financial and economic tremblor may be upon us, with the epicenter in China.