Published on November 21, 2013, Forbes.com:
Written by Jesse Colombo
I am reluctant to write about the Philippines’ economic bubble after the devastation that the country has endured due to the recent typhoon. My heart goes out to all of the victims and their families. Please visit this page to learn how you can donate and help the victims of typhoon Haiyan. I have been writing a series of reports about bubbles in Southeast Asia, and the Philippines is one of the economies that I have been warning about even before the typhoon. My goal is to warn about economic bubbles to prevent humanitarian crises that result when bubbles pop.
The archipelago nation of the Philippines is part of the overall emerging markets bubble that has been inflating since 2009 after China launched a $586 billion economic stimulus plan to counter the negative effects of the global financial crisis on their economy. China’s stimulus plan called for an aggressive credit-driven infrastructure and residential real estate-based economic growth strategy that resulted in the building of scores of cities and other projects – many of which are still empty or unused – across the entire country. The stimulus plan succeeded in temporarily boosting economic growth, and drove a global raw materials boom (and bubble) that benefited commodities exporters such as Australia and emerging market nations. Very soon, investors the world over were clamoring into emerging market investments to diversify away from investments in troubled Western economies.
Record-low interest rates in the West and Japan, along with the U.S. Federal Reserve’s multi-trillion dollar quantitative easing or QE programs led to an epic $4 trillion surge of speculative “hot money” into emerging market investments from 2009 to 2013. A global carry trade developed in which traders borrowed large amounts of capital at cheap interest rates from the U.S. and Japan, and reinvesting the proceeds into high-yielding assets in emerging markets for the purpose of earning the “spread” or favorable interest rate differential. The explosion of demand for emerging market investments helped to inflate bubbles in those countries’ assets, particularly in bonds, which resulted in incredibly low borrowing costs for EM governments and corporations. Ultra-low interest rates have enabled government-driven infrastructure booms, as well as dangerous credit and property bubbles across the emerging world.
Soaring capital inflows into the Philippines after the global financial crisis caused the peso currency to rise 25 percent against the U.S. dollar:
The Philippines has been a major beneficiary of the emerging markets bond bubble, which has pushed the country’s 10-year government bond yield down to an unprecedented 3.61 percent (the U.S. 10-year Treasury bond yield is 2.79 percent):
Investors’ insatiable hunger for emerging market debt has caused the Philippines’ external debt to spike in recent years:
Foreign direct investment (net inflows, current dollars) has boomed in the past ten years:
The Philippines Stock Market has more than tripled since 2009 as interest from foreign investors has grown significantly, making it the most richly-valued stock market in Asia, with an approximate price to earnings ratio of 19:
The Philippines’ Economy Is Driven By A Credit Bubble
Growing by over 7 percent for the past four quarters, and by similar amounts for the past several years, the Philippines’ $250 billion economy is Southeast Asia’s fastest growing major economy, and is one of the fastest growing major economies in the entire world.
The Philippines’ benchmark interest rate, which is set by the country’s central bank, is at an all time low and is fueling an asset and credit bubble that is growing at a 13 to 14 percent annual rate:
Interbank interest rates show the same pattern:
The country’s credit boom is also enabled by record low bank lending interest rates (for loans to private individuals and companies):
The Philippines’ M3 money supply, a broad measure of total money and credit in the economy, has more than doubled since 2008, and sharply accelerated in 2013 as interest rates hit new lows:
As is typical during credit bubbles, consumer spending is growing at a rapid rate:
Decreasing personal savings rates are another hallmark of credit-driven consumption binges, and the Philippines’ current bubble is no exception:
Plunging personal savings rates and double-digit auto loan growth has helped Philippine car registrations (a proxy for auto sales) to soar by 50 percent since 2008:
The Philippines’ economy is far less reliant upon exports than most Asian countries, while it is one of the most consumer-driven economies in the region, with household consumption growing to nearly three-quarters of the country’s GDP from 63 percent a decade ago, according to World Bank data. Domestic consumption is now the largest expenditure component of the Philippines’ GDP.
As the Philippines’ consumer economy grew during the course of their inflating bubble, exports as a percentage of the country’s GDP fell significantly (even as exports grew):
Cheap credit and soaring asset prices, which are known for creating times of good feelings, are a major reason why Filipinos are currently the world’s second most optimistic consumers. Unsurprisingly, Western financial services firms are looking to get a piece of the country’s credit bubble action, including Citigroup, which is expanding its local credit card business. While household debt levels are fairly low at 35 percent of GDP, Bangko Sentral ng Pilipinas, the Philippines’ central bank, has been using this as an excuse to encourage banks to lend even more aggressively to consumers and businesses in order to spur further rapid economic growth. Simply stated, the Philippines’ central bank is actually trying to inflate a credit bubble, which is very alarming and reminiscent of the pro-credit growth policies of the Greenspan Fed during the 2002 to 2007 credit bubble.
The surge in the Philippines’ consumer spending has led to a bubble in shopping mall development, and the country now hosts 9 of the world’s 38 largest malls – beating even the U.S., China, and most other developed countries. Global consumer brands are now flocking to the country’s malls, and luxury goods companies are looking to become players in the consumer market, including Rolls Royce and Bentley.
The two most common, but flawed, explanations given for the Philippines’ growing middle class and consumer spending boom are the rise of the business process outsourcing or BPO sector (call centers are the most common form of BPO) and remittances from overseas Filipino workers. While the BPO sector has grown healthily in the past decade, it only accounts for $11 billion or 4.4 percent of the Philippines’ $250 billion economy. Similarly, remittances have grown at a high rate, but they only account for $26 billion or 10.4 percent of the country’s economy. These two popular explanations for the economic boom only account for a combined 14.8 percent of the Philippines’ economy, so are overstated in their impact, while the role of cheap credit and asset bubbles is greatly understated.
There is also reason for skepticism about the growth and sustainability of remittances to the Philippines because 53 percent of remittances originate from the United States, with much of it sent from Filipino nurses who are benefiting from an unsustainable healthcare bubble that is driving salary and employment growth in the U.S. healthcare industry.
The Philippines Has An Inflating Property Bubble
As with most other emerging markets now, the Philippines has a property bubble in addition to its credit bubble, which is creating a wealth effect that is boosting economic growth and optimism.
In the first six months of 2013, the average price of a 3-bedroom luxury condominium in Makati CBD rose by a frothy 12.92 percent (9.98 percent inflation-adjusted), after rising 5.6 percent in Q1 2013, 8 percent in Q4 and 8.3 percent in Q3 2012. The average price of a premium 3-bedroom condominium in Bonifacio Global City surged by 12.4 percent y-o-y, while secondary residential property prices in Rockwell Center rose by 10.6 percent y-o-y.
Philippines’ housing prices, as measured by prices in the Makati CBD, have nearly doubled since 2004:
Rising by a scorching 42 percent in 2012, mortgage loans are growing at an even faster rate than consumer credit. According to the World Bank, lending standards have been relaxed, with some local banks raising their loan-to-value ratio to 80 or even 90 percent in addition to waiving requirements such as proof of income. The proof of income requirement has been waived for many overseas Filipino workers or OFWs who are unable to provide proof of income, yet are able to pay the 20 percent down payment. There is also evidence that easy-pay mortgages are being offered to home buyers, such as those with zero down payment or low payments in the first few years of loan amortization.
The IMF has warned that “real estate developers may (have been applying) less-stringent lending standards and more-generous loan terms than required of banks, including (a higher cap than the standard 60 percent loan-to-value) and by offering initial teaser terms.” The IMF explained that “about 80 percent of new residential construction (by number of units) is in the low middle price bracket. Of these, about half are reported to be purchased pre-construction by overseas foreign workers.” This poses a risk because “possible non-renewal of OFWs’ short-term employment contracts” could spell doom for some real-estate projects. According to the IMF, another reason for concern is the fact that “no institution has oversight responsibility for the housing sector from a macro-financial perspective.”
There are also reasons for concern about residential real estate overbuilding because many developers only start construction projects after receiving 60 percent in pre-sales, but only 10 percent of Filipino households have non-passive disposable income (excluding remittances) of at least 30,000 pesos or $648 dollars per month. According to the World Bank, “If 10 percent of these households are prospective end-user buyers, this leads to a projected demand of around 50,000 units, which is much less than the current and pipeline supply.”
Thanks to the growing property bubble, the Philippines’ construction sector is expected to expand by double digits in 2014, and account for nearly half of the country’s economic growth.
Due to concerns about a property bubble, Bangko Sentral ng Pilipinas mandated a 20 percent limit on banks’ exposure to real estate loans, though many banks have already exceeded that limit.
The Philippines’ growing asset bubble, which includes property and stocks, is a primary reason why the collective wealth of the 40 richest Filipino families soared by 37.9 percent in 2011, which accounted for an incredible 76.5 percent of the country’s overall increase in GDP that year, leading to the highest income disparity in Asia.
Government Spending Is Boosting The Philippines’ Economy
The emerging markets bond bubble has helped to dramatically reduce the Philippines’ government’s borrowing costs, which has enabled more spending on infrastructure and social services to boost economic growth. In the first eight months of 2013, infrastructure spending rose by 38.5 percent, and the government plans to increase infrastructure spending in 2014 by nearly 60 billion pesos or $1.4 billion (worth 3.5 percent of GDP) to counter the effects of typhoon Haiyan on the economy.
Government spending has risen significantly in recent years:
The Philippines’ government has been running a budget deficit since 1999:
The Philippines’ government’s debt-to-GDP ratio fell to 50 percent in 2012 from 70 percent in 2004, though a very good portion of this improvement is due to unsustainable, credit-fueled economic growth. The Philippines was upgraded to investment-grade status this year by all three major credit ratings agencies thanks to its booming economy and ultra-low government borrowing costs.
How Typhoon Haiyan Will Effect The Economy
Though typhoon Haiyan exacted a terrible human toll, its economic impact is expected to be muted because it bypassed Manila, which is the economic heart of the country. Total typhoon-related costs are expected to reach $14 billion or 5.6 percent of the country’s economy, which should reduce 2014 GDP growth by about 1 percent. Philippines’ economic planning chief Arsenio Balisacan estimates that reconstruction costs may reach $5.8 billion. Remittances are expected to rise significantly as overseas Filipinos increase their support for their family members as well as donations to help the country’s rebuilding efforts. Rice prices have skyrocketed after large portions of the Philippines’ rice crop were destroyed in the storm.
How The Philippines’ Bubble Economy Will Pop
The Philippines’ bubble will most likely pop when China’s economic bubble pops and/or as global and local interest rates continue to rise, which are what caused the country’s credit and asset bubble in the first place. The resumption of the U.S. Federal Reserve’s QE taper plans may put pressure on the Philippines’ financial markets in the near future. Another global economic crisis (as I expect) also puts remittances at risk.
As I’ve been saying even before this summer’s EM panic, I expect the ultimate popping of the emerging markets bubble to cause another crisis that is similar to the 1997 Asian Financial Crisis, and there is a strong chance that it will be even worse this time due to the fact that more countries are involved (Latin America, China, and Africa), and because the global economy is in a much weaker state now than it was during the booming late-1990s.
In the coming months, I will be publishing more reports on other countries that I consider to be part of the emerging markets bubble. Please follow me on Twitter, Google+ and like my Facebook page to keep up with the latest bubble news and my related commentary.