• Bubble or no bubble?

    Ben D. Kritz

    Ben D. Kritz

    If noted “bubble analyst” Jesse Colombo was not aware of the Filipino hypersensitivity to perceived put-downs, he no doubt certainly is now; his November 21 Forbes article, “Here’s Why the Philippines’ Economic Miracle is Really a Bubble in Disguise,” elicited a predictably negative reaction.

    In a rebuttal posted on his website, Financial Planning Consultant Randell Tiongson wrote that, “The analysis is rather thin and not very accurate,” and “truth be told, his [Colombo’s] analysis seems to be delinked from our reality.”

    In a similar dissent from the Department of Finance (DOF) (which Tiongson thoughtfully included with his own commentary), the government pointed out that a current accounts surplus, relatively stable exchange rate, and abundant international reserves, among other things, all tend to refute Colombo’s conclusions. A third rebuttal, posted on the Philippine Economist website (www.phileconomist.com), asserted that Colombo may have misread the Philippines’ credit and banking environments.

    So is the Philippine economy a bubble or not? To some extent, that depends on the perspective. Jesse Colombo is a bubble expert; while the events of 2008 were a fundamental object lesson for all of us, he was one of the few who could see it coming before it actually happened, and he has honed his talent and reputation for spotting the conditions that create economic bubbles in the years since. By the same token, he doesn’t have a monopoly on that particular knowledge set, and economies are sensitive to observer effects; a credible observation of a risky trend, even if it is not entirely accurate, tends to alter its trajectory. And Colombo’s outside perspective, while freeing him from vested interests that might cloud his judgment (something which cannot be said of domestic analyses made from the points of view of policymakers, or those whose livelihoods are rather dependent on promoting investment of one sort or another), probably limits him from taking into account or even being aware of specific peculiarities that make the standard models an ill fit for the Philippine economy.

    With that in mind, the short answer to the question is: Yes. The Philippine economy is a bubble, just not in quite the way Colombo says it is; he is more right than wrong in his analysis, but he did miss the mark in a few instances. Here’s a breakdown of his major points, the arguments against them, and the things both he and his critics overlooked:

    • A credit bubble? Colombo points out that domestic credit expansion is growing at 13 percent to 14 percent annually. That is roughly double the rate of the gross domestic product (GDP) growth, but even so, according to the Bangko Sentral ng Pilipinas (BSP) Governor Armando Tetangco (quoted in the article from which Colombo sourced his figures), the credit-to-GDP ratio is only about 51 percent; therefore, the credit growth rate seems appropriate. Also noteworthy is that the nonperforming loan ratio for banks is at a healthy low level, only around 2.7 percent across the whole banking sector.

    Credit expansion at double the GDP growth rate looks like a bubble; low credit-to-GDP and nonperforming 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, retail and service sector expansion (which is driven by consumer spending), and residential real estate development (which hopes to cash in on 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 encouraging lending as a tool to soak up the country’s unhealthy levels of international reserves.

    That results in a big M3 (domestic) 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.

    • A debt bubble? Critics of Colombo are quick to point out that the Philippines’ debt-to-GDP ratio has declined to an admirable level, and that his analysis of increasing external debt is simply wrong. That is true of government debt, and since that is what Colombo was talking about, he was in fact off the mark. Roughly 89 percent of the government’s debts are domestically sourced; this is partly why the politically motivated calls for “debt relief” from Left-leaning congressmen in the wake of Typhoon Yolanda were pointedly ignored.

    But this is an instance of Colombo getting it right for the wrong reason. He pointed out the rapid decline in government bond yields and the even faster rise of the stock market, and it’s no coincidence that those two things go together; stocks and bonds almost always have an inverse relationship. Even though the low yields on bonds (corporate bonds tend to track in the same direction as government bonds) make debt cheaper, the local bond market is saturated; to get the financing they need, Philippine corporations are racking up huge foreign-currency debts. In April, for instance, San Miguel Corp. raised a whopping $800 million in offshore bond financing, the first installment in a $2-billion medium-term funding program (which didn’t include a $1.3-billion bullet loan the conglomerate was shopping for as well). There is an external debt bubble growing, but it’s commercial rather than institutional; it is indeed a bubble, because it is relying on the low interest rate/high consumer spending environment remaining relatively stable over the medium term, which as noted above (and more than once in previous columns) is becoming an increasingly bigger gamble.
    • Real estate bubble? Colombo bases his assessment largely on rapidly increasing real estate prices, while the DOF attributes rising prices to low vacancy rates of 9.8 percent and 4.3 percent for residential and commercial property, respectively (property prices increase once vacancies drop to around 10 percent). The problem here for both sides of the argument is that the scope of the analysis is too limited; the Manila-Makati central business district is not a reasonable proxy for the entire country. Outside the metropolis, it does seem there is a growing real estate bubble; residential vacancies in particular—worrisome, because that is one critical area where the Philippines’ hyperactive consumers should be spending their money—are well into double-digit percentages and while commercial real estate is doing better in these areas, supply still significantly outweighs demand.

    One thing that does give us pause about the apparently rosy property market in Metro Manila is that it is eerily similar to other pre-crash periods in recent memory—Bangkok or Hong Kong before the Asian Crisis or San Francisco before the dot-com crash. The awareness of those conditions might actually help; the bubble may not burst, exactly, but go flat in a more gradual way. As a friend of mine who’s spent 27 years in the Asian financial sector recently pointed out, banks, monetary authorities, and investors alike have acted with a great deal more caution after 1997, which has helped the region weather the nagging aftermath of the 2008 crisis still plaguing the West. By the same token, a long period of low interest rates has perhaps fueled more optimism than is reasonable; rates will inevitably go up, and that is going to change everyone’s assumptions.

    That could be dangerous for the Philippines, which is why Colombo’s assessment that this economy is a bubble is basically correct, even if some of the details are a bit off-target. No matter how optimistic domestic analysts might be, there is no getting around the inconvenient facts of increasing unemployment and a widening income gap. With industrial growth stagnant at best and exports relative to GDP actually shrinking, the economy has little to fall back on if a shock to its consumption-driven growth happens—which may have just occurred with the spectacular destruction wrought by Typhoon Yolanda. As I said earlier, though, the act of observation tends to alter that which is observed; perhaps knowing what the risks are, the country’s policymakers and private sector, who have done a fairly good job making a success out of an economy that by any conventional reckoning should have fallen flat on its face a year or two ago, can find a way to a soft landing instead.



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    1. Marley Harrison on

      Sometimes the failure the economy or the acceleration of it happening is influenced a lot by impression, do i do not want to add to that. But I agree with a lot of things in this article. There’s credit expansion alright but where is it going? Definitely not on manufacturing. This is the reason why there is still high unemployment rate. Salary and wages levels have remained stagnant in the past years but prices of basic needs steadily rising, thereby eroding purchasing power of the majority of the population. Retail consumption rising? Yes, but by whom? Mostly families of OFWs on goods and services that don’t have multiplier effect on the economy, at best on imported consumables. Our country not competitive enough to produce similar consumer goods. With the rapid widening of incomes and poor government leadership, plus massive natural calamities, a bubble may be mild, a social unrest is inevitable. Do we have time to reverse this Mr. Kritz? I hope we do.

    2. This topic interest me so much. It’s quite hard to understand if you’re not going to read it slow and do some research on your own. Even without so much knowledge about it, many people are wondering why despite the GDP and economic growth there’s an increasing unemployment, widening income gap ( also mentioned in this article) and inflation. Ive read that causes of inflation are also causes of bubbles. I’m trying to understand equilibrium in economics, inflation, GDP, intrinsic values or fundamental value (summing the future income generated by the asset and discounting it to the present value). It’s so complicated. A lot to read to fully understand. I’m actually still reading more related to this topic.

      Does this mean if bubble is true, those overvalued assets ( like in the Philippines case, our booming real estate) once it contracts or burst will result to cut in discretionary spending at the same time hindering economic growth and worst is slowdown in economy? When this happens central bank will take measures by increasing the interest rate?

      Will this also cause bail out and recession?

      • The Philippines is a bit of an odd situation, which is why I said the standard models don’t exactly fit. In the case of real estate, there’s both a glut of residential property and a big need (not necessarily a demand, though, because “demand” assumes capability or desire to buy) for low-cost housing. In other words, most of the population is the D demographic, and they are the ones who need housing, but developers keep producing properties for C and B customers – and if those customers are spending their discretionary incomes on housing at all (most aren’t), they’re moving into metro areas. The housing market is tight in Metro Manila, for instance, but travel to the suburban provinces (Cavite, Bulacan, Laguna, Rizal), and there are vast developments of empty housing.

        What is beginning to happen, and it’s been a slow process because consumer lending is actually quite restricted, particularly for mortgages, is that in order to move those properties, developers are coming up with gimmicks to try to work lower-income customers into these empty homes — low down payments, low front-end terms on mortgages, etc. It’s exactly the same problem as happened in the US, only on a much smaller scale, and without the extra driver of mortgages being commoditized in the investment markets.

        As long as interest rates continue to remain low, that’s not a problem, and this is essentially the basis of the argument that “there’s not a bubble”. What could happen, however, is that if interest rates are raised (which they will be sooner or later), even if that increase has nothing to do with real estate at first, the too-easy terms for some customers are going to suddenly disappear; then we’ll see an increase in foreclosures, credit tightening even further, and spending retracting — pretty much the same scenario as what happened in the US. Where real estate could cause the “burst” itself is if a large number of the unreasonably-easy mortgages all reach their balloon payments at the same time, and there are a sudden increase in mortgage defaults. Personally, I think that’s a less likely scenario because property sales have been slow enough (outside the metro areas) that there aren’t large groups of buyers who will be in that position at the same time.

        The thing is, we don’t really know; we are in unmapped territory to some degree here. We can see the clear indications of several bubbles, we know how these things should progress, but there’s a large degree of uncertainty. What’s more worrisome is that we might already be too late — the damage caused by Typhoon Yolanda may very well have been (I believe it was) the big external shock we needed to protect ourselves against, and failed to do so. Time will tell.