Back in November of last year, Forbes writer Jesse Colombo set off a completely predictable firestorm of indignation here in the Philippines with an article entitled, “Here’s Why the Philippines’ Economic Miracle is Really a Bubble in Disguise,” which has, somewhat oddly, found an audience again this past week.
When Colombo asked me why I thought his article was suddenly attracting attention again, I could not really provide a good explanation, apart from suggesting that it might be attributable to the growing general discontent with the management of the economy (and just about everything else) by the current Administration, and the somewhat discouraging recent reports of concerns over the region’s expanding debt levels.
One thing the minor resurgence of interest in Colombo’s assessment does indicate, however, is that the points he made almost a year ago still do have some resonance. Obviously, things have not changed, or not changed enough, to make his previous observations seem outdated. Of course, those who reacted negatively the first time around could also point out, correctly, that almost none of the doom Colombo predicted would or could happen has come to pass, or seems likely to in the near future.
All of which simply means that this is probably a good time to revisit Colombo’s original warnings, and see if they are really any more or less valid now than they were at the end of last year. (For my original reaction to Colombo’s article and the criticisms leveled against it, see my column “Bubble or no bubble?” in the November 30, 2013 edition of the Manila Times.) Colombo’s article essentially identified three different “bubbles” in the Philippine economy: A credit bubble; a debt bubble, which is a natural complement to a credit bubble; and a real estate bubble, which often forms and grows as a result of the first two.
• The Credit Bubble: Last year, Colombo cited domestic credit expansion, which had been growing at between 13 and 14 percent annually, as a big risk factor, although the BSP downplayed the significance of that as the credit-to-GDP ratio toward the end of last year was only about 51 percent, a manageable level. Another thing that seemed to argue against credit growth being a serious problem is the low non-performing loan ratio for Philippine banks, which has actually declined from about 2.7 percent at the end of the third quarter of last year to about 2.1 percent now.
At the time I observed that, “Credit expansion at double the GDP growth rate looks like a bubble; low credit-to-GDP and non-performing loan ratios do not. But what Colombo picked up on—and what misguided economic fanboys in this country mistakenly regard as a good thing—is where that money is going: Consumer spending, [and]retail and service sector expansion (which is driven by consumer spending). The credit expansion, which to be fair to the optimists is not yet anywhere near the dire levels seen in the US prior to 2007, though it is slowly but steadily heading in that direction, is being driven by low interest rates, which are in turn being kept low by the central bank to encourage lending as a tool to soak up the country’s unhealthy levels of international reserves.
“That results in a big M3 money supply and an overvalued peso; if the BSP did not act as it does, the overvaluation would become extreme. Consumers are spending because the prices of things relative to their money supply are much lower—which is a Cantillon Effect that will inevitably adjust itself through higher prices, higher interest rates, or both.”
What has changed since then is that the inflow of hot money has begun to dry up as a result of the impending end of the US Fed’s quantitative easing program; the M3 supply; while still growing, is not growing as fast as it was; inflation has obliged the BSP to raise interest rates; and the peso has decreased in value. The BSP has also been rather aggressive this year in tightening bank credit by requiring bigger reserve ratios and implementing more stringent vetting of banks’ exposure to loans, particularly in real estate.
On the one hand, all of that appears to be movement in a direction away from higher risk. On the other, all of it also means that consumer spending power has been reduced; by just how much will probably become apparent over the next three months once the results of the all-important Christmas retail season are known. If consumer spending has been curtailed to a significant degree (say, anything beyond 8 to 10 percent), the problems of credit overextension and short liquidity may start to become obvious.
• The Debt Bubble: As I wrote earlier this week (“Hints of trouble for Asia’s bustling economy,” October 9) concerns are growing, and for good reason, about the levels of debt throughout the region, including the Philippines, where corporate debt is rising at the fastest rate among the 10 Asean countries. Colombo’s original article focused on sovereign debt more than corporate debt; given the circumstances at the time, with the Philippines’ debt-to-GDP ratio on a sovereign level steadily declining, I characterized his assessment as a “right conclusion, but the wrong cause.”
None of that has changed from last November until now; the Philippines’ sovereign debt, almost 90 percent of which is domestically sourced, is at a manageable level and poses no real threat. Corporate debt, on the other hand, has gone from worrisome to alarming; as I pointed out in Thursday’s column, in five years’ time between 2008 and 2013, the median ratio of net debt to EBITDA (earnings before interest, tax, depreciation, and amortization expenses) rose from 1.9 to 3.5, while median revenue growth, which hit a high of about 17 percent in 2010, has since halved to 8 percent.
• The Real Estate Bubble: As August’s Philippine Economic Update by the World Bank noted, much of the country’s growth in credit and outstanding debt is being driven by the real estate sector, where credit is expanding at about 21 percent annually—“not including the shadow banking sector,” the WB report adds ominously, a largely unregulated and poorly measured segment of the business that, at least as far as residential real estate is concerned, actually accounts for somewhere between 60 and 90 percent of outstanding credit.
The standard definition of “real estate bubble” describes a situation in which prices are speculatively driven higher than levels that can be sustained by buyers’ income, which has a number of negative effects including credit tightening, increased risk of mortgage defaults, and ultimately, a dramatic decline in demand for real estate, with a corresponding collapse in prices. That is not happening now in the Philippines, and might not for some time to come; all available evidence points to a supply deficit in the biggest part of the real estate market— the middle-income segment—keeping prices at a healthy high level, while fierce competition among developers helps to keep prices from getting out of hand. In addition, there is not a high level of speculation in residential real estate; most buyers are end users, people buying houses to occupy as their own homes.
Yet the growth of in-house financing—the “shadow banking” referred to by the World Bank—is cause for worry that the Philippines might be creating something slightly different than, but just as dangerous as the conventional sort of real estate bubble. With a steady recent trend of declining economic indicators, the risk of the real estate sector being a real source of trouble for the Philippines appears to be increasing. I’ll explain why in my next column on Tuesday.