Inflation (Part II)

The previous post referred to inflation trends as indicated by long-tenor government bonds. There is corroborative evidence, however slight, shown by corporate bonds issuance in the first half of the year. The trend in bond yields is unmistakably upward. 

The chart above shows the coupons on Peso-denominated corporate bonds issued in each month up to June 2014. Not included are subordinated bonds issued by banks, and one bond which had a tenor of 1 year only. What is left are either Senior Unsecured or Unsecured bonds, either unrated or rated PRSAaa, and issued in the domestic market. In other words, they share almost the same credit risk profile, and the difference in their yields at issuance (or coupons) preponderantly accounts for market conditions and not individual credits of the issuers. 

What can be seen in evidence is the jump in yields, particularly among 7-year bonds. Whereas in January a 7-year PLDT bond printed below a 5.5-year ABS-CBN paper, by March, a 7-year paper by MNTC was higher by 43bps compared to ITS OWN 5.5-year callable note. The 5-5-year (apparently a favorite among issuers, as this tenor was the most numerous of all issuances this year) line shows month-to-month volatility, but adding a trend line shows a perceptible rise throughout the first six months of the year, led by the San Miguel Brewery issuance in April. 

That there is a jump in corporate bond yields this year can be clearly seen in the charts, and is even more in evidence compared to government bond yields. That this is caused by inflationary concerns is also not in doubt. What is subject to debate is the cause of inflation: is it a product of too-high GDP growth, or is there another factor that analysts have not yet grasped? 

Looking at the chart from the prior post it can be clearly seen that the fall in GDP growth rates coincides with inflation concerns. At first glance, the data do not show that higher economic growth expectations are leading to higher inflation. In addition -- and more important for analysts -- inflation is not “caused by” higher economic growth. Inflation is caused by too much money chasing too few goods, as the saying goes, but it bears emphasis that it is not only “too much money” that needs to be factored in, but also “too few goods”. If there is too much money but there are too few goods, then there would be a problem of inflation. But if there is high money growth that this is matched by a boost in production, then there would be no inflation. Producing more goods -- also known as economic growth -- would not, ipso facto, lead to inflation; in fact, it dampens inflation.

That is the reason why observers and analysts have to look elsewhere for a cause of inflation. One such possible cause will be explored in a succeeding post.

Inflation for July at 4.9%, the highest in nearly three years

Inflation is a self-fulfilling prophecy. If you believe that prices will rise in the near future, you will buy now before they actually do. Multiply this action by countless other economic actors, and you will have artificially shifted the aggregate demand curve rightward by simply moving or “advancing” purchases across time. The end result is higher prices, and, therefore, inflation.

It is to guard against precisely this development that the governor of the central bank consistently, at the risk of not being taken seriously, assures literally everyone he meets and talks to, that his institution will vigorously fight inflation as soon as he detects the merest hint of it.

So it was that on the morning of the 28th of May, 2014, BSP Governor Amando Tetangco Jr. arrived to deliver the opening remarks at the first Philippine Retail Investment Conference organized by the CFA Society of the Philippines. Governor Tetangco has received numerous awards in his career, among them “Central Banker of the Year for Asia-Pacific” in 2012, given by The Banker; 2012 Emerging Markets Central Bank Governor for Asia, given by Euromoney magazine; and an “A” rating from Global Finance magazine, again for 2012. These internationally reputable magazines have cited his “considerable skill” in managing the monetary policy of the Philippines, and it is no mystery: his task consists of emphasizing and repeating to the public that the central bank – under his direction – will never allow inflation to run out of control.

He began by noting the remarkable economic growth exhibited by the Philippines over the past 2 years, averaging 7 percent and never going below 6 percent in a quarter. This growth, he said, is “underpinned by solid anchors” of “low and stable inflation due to credible monetary policy and a sound banking system maintained through responsive regulation,” even  if the man in charge of managing monetary policy and maintaining the soundness of the banking system does say so himself.

But, the Governor said, this rosy economic picture is threatened by the prospect of higher inflation, already visible in the horizon that morning at the end of May. After a volatile 2013 during which bond yields at first fell due to impressive headline GDP growth and then soared due to Fed tapering concerns, there was a noticeable jump in the 20-year and 10-year PDST-F rates from November 2013 to January 2014 on the back of inflationary concerns. Worse than the rise in government-bond yields is that inflation rose even higher: in the month of December 2013, the year-on-year increase in the consumer price index was 4.1%, but the 10-year PDST-F average for that month was only 3.7% and at year end was only 3.8038% (see chart).

What is tipped to cause this staggering negative return? The BSP Governor could point to only one thing, and that is the “potential increases in power rates and higher food prices resulting from an expected El Niño episode in the second half of 2014.” By August, the news was out that the prior month’s inflation was the highest since October 2011. The inflation rate for July 2014 clocked in at 4.9%, near the top end of the BSP’s own estimates, and confirmed the Governor’s diagnosis of elevated “food and non-alcoholic beverages index” prices.

The likeliest cause of these price rises is a fascinating admixture of bureaucratic corruption and economic mismanagement ... and will be explored in the next post.