Economics does not say that isolated government interference with the prices of only one commodity or a few commodities is unfair, bad, or unfeasible. It says that such interference produces results contrary to its purpose, that it makes conditions worse, not better, from the point of view of the government and those backing its interference—Ludwig von Mises
In this issue
9-Month Balance of Payment Deficit Soars to Record! Incipient Signs of Capital Flight? As Expected, Peso Rallied; Price Controls Magnifies Inflation!
-Record 9-Month Balance of Payment Deficit: Incipient Signs of Capital Flight???
-How International Reserve Influences the BSP’s Domestic Policies
-USD Dollar Tightening Equals Domestic Peso Tightening?
-Conclusion: The Peso’s Rally is Temporary
-Lower CPI? Price Controls Would Destabilize the Supply Chain! Build, Build and Build Prices Show No Sign of Reprieve!
-IMF on the Remittance Trap: OFW Remittances Benefit the Government and Not the Economy!
9-Month Balance of Payment Deficit Soars to Record! Incipient Signs of Capital Flight? As Expected, Peso Rallied; Price Controls Magnifies Inflation!
Record 9-Month Balance of Payment Deficit: Incipient Signs of Capital Flight???
As expected, the peso staged a significant rally. [See The BSP in a Panic: Drastically Hikes Policy Rates and Slashes Deficit Financing To Curb Demand as M3 Growth Plunges! (October 1, 2018)]
The peso was this week’s best performer in Asia. The USD peso dropped .79% to 53.7.
But policies that paved the way for this week’s rally came at a significant price.
From the Inquirer: With the central bank forced to cushion the fall of the peso, the Philippines experienced a surge in dollar outflows last month that aggravated the already yawning trade gap caused by the country’s large imports and weak exports, authorities said on Friday. The Bangko Sentral ng Pilipinas (BSP) said that the overall balance of payments (BOP) position posted a deficit of $2.7 billion in September, marking a reversal of the $24-million surplus recorded in the same month last year. These outflows “stemmed mainly from foreign exchange operations of the BSP and payments made by the national government for its foreign exchange obligations,” the BSP said, the former referring to the monetary authority’s selling of dollars in the open market to meet the foreign currency demand from investors or end-users.”
Figure 1
The September BOP deficit was the second biggest monthly deficit since January 2014 and the largest year-to- date deficit since at least 1999. (figure 1, topmost pane)
The Bangko Sentral ng Pilipinas defined its Balance of Payment as “a summary of the economic transactions of a country with the rest of the world for a specific period.” Economic transactions of which are “grouped into three major categories: (1) current account, (2) capital account, and (3) financial account.”
The current account includes merchandise and services trade (e.g. BPOs), primary income which constitutes OFW, and profit remittances along with gifts, grants and donations.
The capital account captures the investment aspects consisting of capital transfers and acquisition and disposal of nonproduced, nonfinancial assets between residents and nonresidents, as well as grants and donations investment (i.e., machinery and equipment, buildings and structures).
Direct investments, portfolio investments and other investments comprise the Financial account.
From the current account perspective, the following may have influenced the spike in the September BOP deficit:
The trade deficit, which was last at USD 3.514 billion in August, could have swelled materially in September. (I showed the chart last week) If it hasn’t then other factors may be at work
Surpluses from services exports provided little in alleviating the onus of burgeoning trade deficits. Put bluntly, BPOs haven’t been of help.
The declining growth trend of OFW remittances has been VALIDATING what I have been predicting here for some time. OFW remittances contracted in August which reduced year to date growth to a paltry 2.4% for personal and 2.5% for cash. (figure 1, lower window).
OFW remittances may have contracted by more in September! The plunging peso has hardly encouraged increased remittances. The health of the global economy may be deteriorating. (see the IMF’s take on OFW remittances discussion below)
The current account has been on a steep downtrend, which was last updated in June, the September spike entails a sharper downside. (figure 1 middle window)
If so, growth in the efflux through “profit remittances” and “gifts, grants and donations”, may have been material. If this is accurate, then a likely principal contributor to the September’s current account deficit may have been CAPITAL FLIGHT!
The National Government, the BSP, and media have been crowing about FDIs. True or not, inflows from the Financial Account have been insufficient to offset the current account deficit. And what if Financial Account has also posted a deficit, where domestic residents invested overseas more than the opposite?! If so this should be another channel for CAPITAL FLIGHT!
What does a current account deficit, the biggest contributor to the BOP deficit mean?
From the BSP: “If the current account balance is in surplus, the country is a “net lender” to the rest of the world in the amount of the surplus or the excess in the current account transactions. Net lending occurs when the national saving is more than the country’s investment in real assets. If in deficit, the country is said to be a “user of funds” and thus, is considered asnet borrower from abroad in order to fill in the shortage. In this case, the country invested more than what its national saving can finance.” (bold mine)
So to finance investments (mostly public through build, build and build), the public and the private sector went into a borrowing spree in foreign exchange (of course)!!!!
That said, the Philippines exposure to US dollar shorts continue to amass!
Incredibly, this entails that the free lunches have become even more deeply entrenched in the actions of the mainstream!
How International Reserve Influences the BSP’s Domestic Policies
Figure 2
The BSP expended significant amounts of international reserves to fund domestic dollar requirements and to intervene in the currency markets to shore up the peso. $6.4 billion or 7.9% of USD reserves have drained off the BSP in 2018. (see figure 2, topmost pane)
(Think where the USD peso would have been without it!)
And it is more than the record 9-month BOP deficit and the sharp fall GIR.
The sharp drop in forex reserves has also affected BSP’s domestic policies.
International reserves constituted 87% of the BSP assets (August 2018) exhibiting the ‘dollarization’ of the peso. The world operates on a de facto dollar standard, with the offshore dollar as its principal source of funding.
It also reveals that conditions of international reserve holdings influence significantly how the BSP conducts its domestic policies.
Having peaked in September 2016, the growth rate of BSP assets has been in a declining trend. BSP assets were down by 1.41% last August. (figure 2, center pane)
And BSP’s Reserve Deposits of Other Depository Institutions (or the banking system) have resonated with the declining trend in international reserves. The growth rate of the banking system’s deposit reserves slowed to a paltry .02% last August. (see figure 2, lowest window)
Figure 3
To further reinforce the diminished access to offshore dollars, US Treasury data reveals that US bank lending of various dollar instruments to domestic counterparties have been in decline since peaking in 2013. This downdraft in credit intermediation by US banks has coincided with the fall of the peso. The peso firmed when US banks expanded exposure on its domestic counterparties from 2009 to 2013. [see figure 3, upper window]
Reduced ‘dollars’ means either diminished expansion or a contraction of the BSP’s balance sheet.
Theoretically, there are three options available for the BSP. It may increase its domestic (peso) assets at the cost of the peso. It may allow the monetary base to decline to reflect on the reduced dollar supply. Lastly, it may decrease bank reserves through the trimming of the reserve requirement ratio (RRR), thereby allowing banks to use them to inject liquidity into the financial system.
The BSP has cut RRR twice this year. Since the February announcement of the first RRR cut, the BSP’s reserve deposits declined by Php 61.47 billion or by 3.3%
Aside from reduced dollar supply, those RRR cuts were designed to ease the rapid draining of banking system’s liquidity. The banking system’s most liquid assets cash and due banks fell by 11.67% (year-on-year), but improved 2.62% (month-on-month) or by Php 63.5 billion in August. [figure 3, lower window]
Aside from RRR cuts, the marginal improvement of liquidity may have emanated from the banking system’s massive financing programs. [See The Crowding-Out: Wave of Announcements for Another Round of Massive Bank Financing! The Minsky Cycle to the Minsky Moment September 23, 2018]
Along with the government’s increased Treasury issuance to finance record deficit, these have resulted to the continuing decline in the growth rates peso deposits (+10.12% in August, +10.37% July and +10.77% June) and foreign currency deposits (+4.78% in August, +8.43% July and +7.81% June)
USD Dollar Tightening Equals Domestic Peso Tightening?
And the reduced availability of offshore dollars has been mirrored by domestic liquidity.
Figure 4
Domestic Treasury yields continue to surge to underscore ongoing strains in local financial liquidity. IF the BSP-led Financial Stability Coordinating Council issued a warning in their Financial Stability Report on the escalating 3Rs based on lower rates to have “caused dislocations of crisis proportions have come as a surprise”, what more at the current pace of rate surges!
And there’s more.
The mid-curve has inverted with the 10-year benchmark to 2015 levels. Such inversion wouldn't be helpful to the banking system's margins.
But it gets worst, surging Treasury yields means that the NG will have to pay more for its aggressive deficit financing. And this would compound on the cycle of higher deficits and rate increases.
What truly breathtaking developments!
Conclusion: The Peso’s Rally is Temporary
Back to the BSP.
For as long as the BSP aligns the conditions of its domestic assets with international reserves, liquidity in both USD and the peso will continue to tighten.
And the tightening of USD liquidity translates to an amplified US dollar ‘shorts’. US dollar shorts translate to an inadequate supply of offshore US dollars to satisfy the maturity transformation used by the financial system in carrying out commercial activities. For instance, the cost of servicing of US dollar liabilities increases substantially.
If the BSP expands its domestic assets relative to its international reserve materially, the peso will drop.
Aside from massive interventions by the BSP in support of the peso, signs of capital flight may have worsened the BOP deficit in September
Importantly, in spite of the domestic tightening from market forces and belatedly from the BSP, the growing scarcity of cheap USD financing in the face of mounting external liabilities should translate to a weaker peso,
In both instances, the USD-Php’s fall or the peso’s rally should be temporary.
Buy the USD-Php!
Lower CPI? Price Controls Would Destabilize the Supply Chain! Build, Build and Build Prices Show No Sign of Reprieve!
If NG doesn’t cease from disrupting price discovery in the marketplace the publicized efforts to contain the CPI would have the opposite results.
The leadership tells the public that they would wonderfully allow “anyone can import rice”. However, demonstrated preferences reveal that such an assertion hasn’t been true.
In a bidding last week, only four companies, reported the Inquirer, “were able to qualify in the National Food Authority’s (NFA) bidding process yesterday for the purchase of 250,000 metric tons (MT) of rice as most companies were not able to meet the agency’s reference price”.
Disputing claims that the leadership authorized “unimpeded importation”, the NFA enforced his authority over rice imports as revealed by last week's bidding.
Really? A neo-socialist government would embrace liberalization?
But the more significant aspect has been the imposition of direct and implied price controls.
After bread prices started to increase in early October, officials of the Department of Trade and Industry ‘met separately…with flour and bread associations”, where the latter “committed to hold on to prevailing prices”.
The DTI has also been reported to impose controls on prices of Noche Buena goods. From Philstar: “The Department of Trade and Industry (DTI) has released the suggested retail price (SRP) for Noche Buena products to allow consumers to plan their purchases for the Christmas season... Castelo added that manufacturers need to submit data to DTI for price analysis and confirmation before any new adjustment on SRP may be made.”
But why the heck would they have to do this?
From the Inquirer: “Starting next Tuesday (Oct. 23), rice could only be labeled as local or imported regular-milled rice and well-milled rice, and special rice. “There will be no more use of Sinandomeng, fake Dinorados, no more Super Angelica, no more yummy rice. Everybody is selling fake Dinorado, people are claiming Sinandomeng, which we don’t have a rice variety of such kind,” the secretary said. Local regular-milled and well-milled rice will be sold at P39 and P44 a kilogram, respectively, while imported regular-milled and well-milled rice will be sold at P37 and P40 a kilo, respectively. Special or fancy rice variants such as Jasmine and Japanese, however, will not be regulated…This is not the first time that the agency resorted to imposing SRPs to regulate prices. Earlier this year, DA imposed a price point for regular-milled rice at P39 a kilo with the help of private traders. This was in response to the call of President Duterte to provide an affordable option for rice.”
So if earlier price controls didn’t work, doubling down would do the trick then?
And price controls will extend to other commodities: “Other commodities with imposed SRPs include chicken and sugar. A kilo of chicken will be sold based on its farm-gate price with an additional mark-up of P50, while a kilo of sugar will be sold at P55.Traders and retailers who will sell beyond the 10-percent margin allowed on the SRP face a jail term of five to 15 years and fines of up to P1 million, based on the Price Act of 1992.”
While a monetary induced demand shock can ripple through the supply chain and cause a second order supply shock, price interdictions will exacerbate supply chain disruptions even when demand goes down. Differently put, price controls cause supply shocks that incite price dislocations.
The President pretentiously calls for the axing of inflation inducing executives, but then aside from money printing and price controls, this week the Land Transportation Franchising and Regulatory Board (LTFRB) increased fare prices of jeepneys andbuses. Ironically, one LTFRB official said that fare increases would have inflationary effects.
As I predicted last June,
When the going gets tough, palpably, implicit price controls will morph into explicit policies.
See Inflation Has Hardly Been About the TRAIN Law; The Credit and Liquidity Cure Can Be Worse Than The Tax Disease! June 4, 2018
Because the mainstream sees inflation as a statistical construct rather than real life developments, political measures have been directed to address such statistics.
Figure 5
What they sorely miss is how those money printing operations from the banking system and from the BSP to finance build, build and build have functioned as the epicenter of the inflation.
Despite the bank induced M3 decline, “build, build and build” construction material wholesale prices have even inched higher to8% in September from 7.9% in August. (figure 5, upper window).
The CPI has been highly correlated with build, build and build prices. (figure 5, middle window). Both sprinted up at the same time!
Money spent on grand infrastructure boondoggles, the first recipients of credit expansion, spread like wildfire in the economy.
Plagued by lack of investments and by inherent obstacles as protectionism, the surge in demand from the “build, build and build” exposed the deficiency and upset the supply side response of the food industry.
Such should be an example of how demand shock had been transmitted into supply shock.
In contrast, to build, build and build, the private sector, construction material retail prices remained steady at 2.0% in September.
Yet, what an amazing price gap: 8.0% wholesale prices vis-Ã -vis 2% retail prices!
It is like having a parallel world.
If the statistics are accurate then it shows that there is little sensitivity by the public sector on prices to bid away resources against the private sector. More than that, the vast differentials exhibit the pricing dysfunction in the construction industry which showcases seismic imbalances.
Free markets would have arbitraged away such enormous chasm.
Finally, the Philippine Statistics Authority published the Gross Revenue Index of Industries of the 2Q. To get the inflation-adjusted or real revenues and compensation numbers, I applied the 2012 CPI.
The statistics say that revenues and compensation in real terms have been declining sharply since 2016!
If one applies the 2006 CPI, compensation would have even contracted!
Whatever gains seen have from higher prices have been an illusion.
IMF on the Remittance Trap: OFW Remittances Benefit the Government and Not the Economy!
Let me now move back to remittances
Here are their reasons. I have reservations to some of them, but given the time constraints, I’d leave this for future discussion.
It does little help to the economy: “here is increasing evidence of a remittance trap that causes economies to get stuck on a lower-growth, higher-emigration treadmill….Lebanon is not an isolated example. Of the 10 countries that receive the largest remittance inflows relative to their GDP—such as Honduras, Jamaica, the Kyrgyz Republic, Nepal, and Tonga—none has per capita GDP growth higher than its regional peers.
It promotes higher price levels through the Dutch disease: “The flood of foreign exchange, along with higher prices, makes exports less competitive, with the result that their production declines. Some have referred to this syndrome as Dutch disease”
Dependency stifles entrepreneurial activities: “Part of the remittance trap thus appears to be the use of this source of income to prepare young people to emigrate rather than to invest in businesses at home. In other words, countries that receive remittances may come to rely on exporting labor, rather than commodities produced with this labor”
Dependency reduces the work force: “by increasing the so-called reservation wage—that is, the lowest wage at which a worker would be willing to accept a particular type of job. As remittances increase, workers drop out of the labor force, and the resulting increase in wages puts more upward pressure on prices, further reducing the competitiveness of exports.”
It contributes to the inflation of asset bubbles: “To make matters worse, remittances are often spent on real estate, causing home prices to rise and in some cases stoking property bubbles.” Hmm sounds familiar?
It diminishes the political involvement of the recipient families: “The reasoning is simple: families that receive remittances are better insulated from economic shocks and are less motivated to demand change from their governments;government in turn feels less obligated to be accountable to its citizens.”
It rewards poor governance: “To the extent that governments tax consumption—say through value-added taxes—remittances enlarge the tax base. This enables governments to continue spending on things that will win them popular support, which in turn helps politicians win reelection. Given these benefits, it is little wonder that many governments actively encourage their citizens to emigrate and send money home, even establishing official offices or agencies to promote emigration in some cases. Remittances make politicians’ job easier, by improving the economic conditions of individual families and making them less likely to complain to the government or scrutinize its activities. Official encouragement of migration and remittances then makes the remittance trap even more difficult to escape.” Amen to this!
