MONDAY MACRO: At a record low of -54.5%, this metric explains why monetary policy actions haven’t worked yet
October 5, 2020
This year has been dry for businesses. With businesses constrained by the pandemic in how they conduct their day-to-day operations, generating sales, or at least breaking even, has become a challenge.
Managements in larger corporations such as Philippine Airlines, Cebu Pacific, and Okada have engaged in big cost-cutting initiatives to ensure their survival—and one of the largest fixed costs for businesses is payroll.
While a lot of people are fortunate enough to retain their current jobs, there is still a lot of uncertainty surrounding the business environment amid the pandemic, both locally and globally. This uncertainty creates future income concerns for households as low economic activities pressure management to further cut costs as a way to save their businesses.
This economic metric is one of the leading indicators we look at to gauge when we should be expecting economic activities to return to pre-pandemic levels.
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On our September 14th Monday Macro report, we mentioned that in the absence of increased consumer demand, inflation will likely remain below its 3-year average level of 3.5%. However, once we see consumer demand increase, it’s likely that we’ll also see prices of goods and services increase. This is because one of the key drivers of inflationary pressures is consumer demand.
Consumer demand, however, is partly dependent on consumer confidence, which the Bangko Sentral ng Pilipinas (BSP) cannot directly control in order to manage inflation. If consumers do not feel confident about their personal finances, or even of the economy as a whole, then they are more likely to defer spending on non-urgent, non-essential items.
What the BSP can do to address the issue of low consumer demand is to produce an environment that stimulates increased consumer spending.
One of the ways to do this is by increasing demand for business and household loans to address short-term cash problems. Banks would be able to lend at more flexible terms, and businesses or consumers would be able to borrow at those relaxed terms. With financing as one less thing to worry about, businesses can focus on operating and thriving.
Stable businesses mean stable income for both the business and its employees. Once consumers are less worried about their income, they become more confident about their own finances. This means eventually, they would be willing to spend for more than just their necessities.
To create this ideal lending environment, the central bank focused on relaxing certain rules it had set for banks: a lower reserve requirement ratio, an increase in the allowed housing loan exposure to the banks’ total portfolio from 20% to 25%, and a 175bps reduction in policy rate reduced so far this year to 2.25%.
However, what we saw in the Q2 2020 Senior Bank Loan Officers’ Survey (SLOS) was the opposite of the intended result. The survey showed that 60% of bank correspondents have actually tightened credit standards for consumer loans. These banks cited less favorable economic outlook, reduced tolerance for risk, and a deterioration in borrower profiles and profitability of banks’ portfolios as reasons for their conservative actions.
Thus, the BSP’s efforts to inject liquidity into the financial system with the help of banks to stimulate economic growth were unsuccessful.
The banks aren’t wrong to be risk-averse at this time, especially with so much uncertainty surrounding the pandemic. Even if banks were to give out more loans, it is worth noting that they actually saw weaker demand for consumers loans in the same period. This lower demand is primarily attributed to lower household consumption and housing investment.
The lower consumption is a result of the increase in the number of unemployed seen in the first two quarters of 2020. In Q3 2020, the number of unemployed people declined to 4.6 million from 7.3 million in the previous quarter. Although the unemployment rate improved in Q3, it’s still over twice last year’s 2.3 million during the same period.
The recent retrenchment activities aren’t just making consumers less likely to take on loans. No matter how low interest rates are, without a steady source of income, consumers have limited ability to repay any loans. The high unemployment rate has also resulted in increased consumer pessimism as income or job security is now more uncertain than in the pre-pandemic environment.
These two factors make consumers more conservative with their funds these past two quarters as they reallocate their resources to the essentials and contingencies.
To understand the relationship between consumer demand and inflation, we use the consumer confidence index, a leading indicator of inflation, to look at deeper insights on expected short-term inflation trends.
Using the chart below, we can see the relationship between inflation and consumer confidence. For example, in the month of November 2018, the consumer confidence level reached a three year low of -22.5% while inflation started to drop strongly a few months later. For the Q3 2020 survey, consumer confidence sharply dropped to a new low of -54.5%.
Will inflationary pressures continue to be weak despite BSP’s efforts to spur spending?
The answer is likely to be yes as signaled by this leading indicator.
It’s not just the high unemployment rate that is keeping consumer demand low. The appreciation of the Philippine Peso against the US Dollar has made it more expensive to export rather than to import.
With a stronger peso, the costs of imported goods have become cheaper, which improves the quantity demanded on them. Meanwhile, exports have become more expensive, which reduces the quantity sold and makes these products less competitive internationally.
There was a short respite in July 2020, though. Exports declined by 10% while imports had a larger contraction of 24%, resulting in a lower trade deficit of $1.8bn as a result of a weak domestic economy.
Once the Philippine economy improves and business activities return to pre-pandemic levels, the trade balance will likely widen again resulting in lower aggregate demand—this includes disposable income, investment, government spending, and net exports.
With imports expected to improve and exports expected to contract more in the following months, the aggregate demand could still further decline this year.
Moreover, OFW remittances, as an additional disposable income to households, is expected to stay low given persistent global weakness this year.
To sum up, high unemployment rate, relatively weaker economy, and vulnerable OFW remittances explain why the inflation rate is slow to pick up despite the BSP’s efforts.
Fortunately, the aggregate demand can be improved by government spending. Put in another way, a lot more fiscal spending. This is necessary now in a recession if the government wants consumers and investors to regain confidence and start spending again.
For now, fiscal prudence is seen as the government is still committed to the “Build, Build, Build” infrastructure program to stimulate the economy out of recession.
Moreover, as the economy slowly opens and businesses are having an easier time conducting their operations, the BSP’s monetary policy actions will become one of the drivers in fueling inflation. As mentioned in our September 21st article, we continue to expect aggregate Uniform earnings or GDP growth to make its full recovery by next year.
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