GIVEN the evident health of the Philippine economy and the enthusiasm with which most analysts view it, a suggestion that there is a possibility that things may not be as rosy as they appear is certainly unwelcome. But there were two interesting developments this week that may be the first signs of an economic crisis in the near future.
On Wednesday, HSBC published its outlook for the Philippines’ bond market in 2017, taking a stance that the bank described as “mildly bearish.” According to HSBC, higher funding needs for the government’s push to develop infrastructure, together with the likelihood that any significant increase in revenues from new and improved tax programs will not be felt any time soon, will oblige the government to issue more bonds, or in other words, take on more debt.
HSBC’s forecast is for P465 billion in Treasury bond issuances in 2017, about 30 percent higher than the amount expected for 2016 by the time this year ends. HSBC also noted that the bond redemption amount—the total amount of bonds reaching the end of their term—will decline by about 27 percent in 2017 (P227 billion from P310 billion this year), which will drive up net bond supply by nearly four times from P63 billion to P238 billion. HSBC also concluded there is a possibility that given all these factors, the Bureau of the Treasury might increase the size of the monthly bond auction from the P25 billion level it has maintained throughout this year.
The second development was the significant undersubscription—for the first time since the program was launched in June—of the Bangko Sentral ng Pilipinas’ (BSP) term deposit facility auction on Thursday. The BSP awarded just P129 billion of the P180 billion offer, with a corresponding increase in interest rates for both the six- and 27-day tenors.
The BSP attributed the rather surprising result of the TDF auction to two factors. First, banks may be holding back cash for the holiday season, and second, the upcoming implementation of a rule that trust entities cannot use BSP deposit facilities as investment vehicles (which will go into effect on July 1 next year) may have pulled some players out of the TDF auction.
The impact of trust entities pulling away from the TDF is likely not as significant as the explanation from the BSP hinted, but banks holding back cash from the liquidity management outlet does make sense. Banks’ needs for immediate cash for customer withdrawals are high at this time of the year, but looking beyond that, an observation in HSBC’s bond outlook provides another clue. Commercial banks’ average lending rate right now is 5.9 percent, which makes lending a more attractive investment than government bonds (Philippine 10-year bonds are currently yielding just slightly over 4.7 percent). A sign that banks are shifting toward more lending is the increase in the loan-to-deposit ratio, which rose to 71.2 percent in August from 68.9 percent a year earlier; the increase has not been drastic, but it has been steady.
Other indicators, such as the consistent increase in real estate lending (about 20 percent month-to-month and year-on-year) also show growth in overall debt in the country.
Despite indications to the contrary released on Friday, the longer-term outlook is that government debt is set to increase, not only in terms of principal (more bonds), but in higher interest rates the government must eventually pay on those bonds. Government debt has already increased this year; on Friday, the Department of Finance reported the debt-to-GDP ratio for the nine months ending September improved year-on-year from 44.2 percent from 44.7 percent, but the September figure was 1.2 percent higher than the year-on-year six months’ debt-to-GDP ratio of 43 percent at the end of June; what has helped to keep the ratio in check is that the expansion of the economy at this point still outpaces the growth of government liabilities. A massive spending program in the 2017 budget will likely reverse that trajectory.
Meanwhile, private sector debt is increasing as well. In both cases, the income needed to pay those debts at some point is uncertain. HSBC is forecasting 6.8 percent GDP growth this year and 6.5 percent in each of the next two years, which, while still robust, is not an acceleration matching the growth of outstanding debt. In the government’s case, even if it was implemented immediately, the tax reform package—which is at this point still a proposal being vetted by Congress—would not increase revenues enough to cover this year’s bond redemption amount; estimates of new revenue range from about P100 billion to about P140 billion, versus the P227 billion in bonds coming due this year. One key part of the tax package, a higher vehicle excise tax, has already been pushed forward to 2018 at the earliest, according to earlier comments by Finance Secretary Carlos Dominguez.
Of course, if infrastructure development proceeds as hoped, and if income growth in the private sector follows, increased debt in the short-term will not be much of a problem later. But the risk level of the entire country is now much higher; continued economic stability could be thwarted by a variety of causes—for instance, growing political instability or further degradation of public safety, a large-scale natural disaster, or capricious trade or investment policy changes in the US. Because that risk level has increased, unless the government is extremely energetic in rolling out development, some investment is going to be held back until results become clearer, which only serves to increase the risk.
A debt crisis is by no means inevitable. But the probability that it could occur is increasing, and that is something the economic brains of the country need to account for in their plans if they wish to avoid creating a problem in the future.