Special report: PH struggles with trillions in idle cash

(First of 3 parts)

On Jan. 3, 2013, Governor Amando Tetangco Jr. of the Bangko Sentral ng Pilipinas gave his first policy speech of the year, which he traditionally delivered before the Rotary Club of Manila. His speech was upbeat, coming off the strong economic growth experienced in 2012 and emerging signs that the Philippines would finally earn a key credit-rating upgrade.

It was the usual positive speech predicting a positive year ahead—until the question and answer portion. “Governor, given what you have just told us, what should we be worried about?” asked Rotary Club member Jimmie Policarpio from the floor. It was an unusual question whose tone ran against the grain of Tetangco’s bullish prognosis. But the governor’s reply was just as unusual and managed to hush up the lunchtime crowd at the Manila Polo Club. “We have to guard against a sudden reversal of capital flows,” he said. “This is the danger that faces us today.”

Early warning

It was not the first time that the central bank chief had warned of the danger that excessive inflows from overseas (or their sudden exit) posed on the local economy. He had, in fact, been warning since the second half of 2010 about the pressure that “too much capital” would put on the Philippine financial system.

The phenomenon was inevitable. Buoyed by renewed confidence in the country after President Aquino assumed office, foreign investors channeled massive amounts of capital into the Philippines, anticipating the investment boom that the administration’s economic managers had been promising from day one.

This decision was made easier by the US Federal Reserve’s move to release hundreds of billions of dollars—at record low interest rates—into the American financial system to help revive what was then a stagnant US economy. Looking for higher asset yields, these cheap funds found their way into promising emerging markets like the Philippines, boosting stocks, pushing up property prices and waiting for opportunities to invest in infrastructure projects.

Together with record levels of dollar remittances from expatriate Filipino workers and earnings of the booming business process outsourcing (BPO) industry, the liquidity parked in the BSP’s vaults ballooned to P1.91 trillion in February 2013. For context, the total value of the Philippine economy as measured by the gross domestic product (GDP) stood at only P10.5 trillion in 2012. This meant that almost a fifth of the value of the local economy was in the form of cash, sitting idly in the vaults of the central bank, and costing the government billions of pesos annually in interest payments.

“That’s money that could be better used to fund other investment outlets,” Tetangco said in an interview. “Instead, the money is in our SDA (special deposit account) facility.”

High cost

The BSP chief explained that monetary authorities had no choice but to “mop up” the excess liquidity by keeping much of it in the central bank’s vaults (and paying interest to their owners), lest the funds slosh around the economy and push inflation higher.

“If we don’t do this, there will be too much money going around the economy chasing after the same amount of goods and services,” Tetangco explained. “The result will be a faster rate of increase in prices, and everyone will suffer.”

The cost to the central bank, so far? Total losses of P189 billion over the last three years, pushing what was once the government agency with the healthiest income statement deep in the red. Ideally, the money should be out circulating in the economy, being used productively to build new highways, airports, seaports and funding just about every capital need in the country.

“If credit demand is strong, the money in our vaults will move out,” Tetangco explained.

And what kind of credit demand could possibly push fund managers to withdraw their cash from the central bank’s SDA facility? “New investment outlets like financial products or big-ticket infrastructure projects,” he said.

But now, the US Federal Reserve—the biggest source of cheap capital for the entire world since 2009—has indicated that its “quantitative easing” policy meant to combat the effects of the global financial crisis was nearing its end. And trillions of idle cash previously available cheaply for infrastructure projects, factories, job creation and poverty alleviation are set to become more expensive or more difficult to access.

Six months after his Rotary Club speech, the warnings of the central bank governor—made at a time when the stock market was rising to dizzying heights due to the sustained inflow of “hot money”—have begun to look eerily prescient.

Asked what prompted him to ask what then sounded like an odd question to the BSP governor that day in January, Policarpio said: “I used to be a banker. I’ve seen these things before.”

(To be continued)