BSP's Reserve Requirement Ratio Cut Is Undeniably Very Procyclical at the Top of the Business Cycle

On February 15, 2018, the BSP said that it would lower bank's reserve requirement ratio from 20% to 19%, a move that is projected to inject at least Php 80 billion (US$ 1.53 billion) into the financial system.

This move was ostensibly done to mitigate the effects of global market volatility in the first two weeks of February 2018. But it is easy to get the impression that BSP panicked because the announcement was a surprise and was made after an unscheduled policy meeting.

This move is also undeniably pro-cyclical, coming near the top of the business cycle:

"Such an infusion of funds would risk adding to inflationary pressures in the booming economy. Some market watchers fear it is already at risk of overheating..."

It will also serve to boost asset inflation even further. Philippine interest rates are already negative as it is and have been for some time. Since 2010, anyone investing in Philippine T-Bills would have seen negative to marginal real returns after accounting for inflation. As of January 2018, the real interest rate on the 364 day T-Bill was a negative 1.12%. Increasing the money multiplier by 5.3% will only serve to lower negative real interest rates even further - at least in the short run.

 To boost real returns, investors will have to pile into physical and financial assets which are already at record high prices.

To wit, the Philippine Stock Market is already at or near record highs:

 And so is the real estate market:

 It is no coincidence that the greatest increases in asset inflation took place at a time when real interest rates were profoundly negative - as much as 2.3% during a four year period from 2011 to 2014 and in the last two years (beginning in 2016 to present).

To seek yield, investors will have to pile into even more economically marginal investments. When the business cycle turns, as it always does, expect the NPLs to pile up and put our banking system and the Philippine economy on the brink of collapse once again. A pro-cyclical macro policy taking place at the top of the business cycle will only make the bottom of the cycle that much worse. Policy makers should consider macro policies that moderate the top of the economic cycle: counter-cyclical at the top and pro-cyclical at the bottoms. In this way, the tops are less overheated and the bottoms are not as traumatic for the economy as a whole.

Do Philippine House Prices Have More Room to Run?

Philippine House Prices continued their relentless climb in the 4th quarter of 2014, climbing 1.03% over the third quarter. To date, prices have risen over 110.23% since the fourth quarter of 2004, outpacing inflation which has caused prices to climb by a corresponding 58.21% for the same period.

Given this substantial increase, do Philippine House Prices still have more room to run?

On the face of it, the answer is yes.  Why? Because House Price Cost per Sq. M. amounts to just US$ 3,084, well below the Asian average of US$ 8,257.  Out of 10 countries listed in the Global Property Guide, Philippine House Prices rank the third lowest in the region, just ahead of Cambodia (US$ 2,913) and just behind Thailand (US$ 3,952).

According to Global Property Guide, these prices are for residential properties in the center of the most important city of each country - either the administrative or financial capital of each country.

Source: Global Property Guide


But these prices ignore affordability.  Different countries have different income levels.  Therefore, countries that have a higher income on a per capita basis can afford pricier properties.


Unfortunately, there is a dearth of data when it comes to a city by city income statistics.  The closest and most widely available data is GDP per capita, the latest of which is for the year 2013.

Source: www.worldbank.org


Based on this data, the Philippines has the third lowest GDP per capita for 2013: US$ 2,765, ahead of India (US$ 1,499) but below Indonesia (US$ 3,475).  Naturally, both Singapore and Hong Kong boast of the highest incomes and therefore have the highest property prices.

Using GDP per capita as a proxy for income, on a house price to income ratio, the Philippines does not look so reasonably priced.  After India (764 times income) and Cambodia (289 times income), the Philippines house price to income ratio comes in at 112 times income.  This is higher even that bubblelicious China, which comes in at 102 times income.  The Philippine House Price to Income Ratio is double the regional average of 50 times income.

Country	Housing Cost Per Sq. M. in Prime CBD (in USD $)	Cost of 100 Sq. M. Residential Condo in CBD (in USD $)	2013 GDP Per Capita (Current USD $)	Residential Price/GDP Per Capita (in USD $)
Cambodia	2,913	291,300	1,007	289
China	6,932	693,200	6,807	102
Hong Kong	22,814	2,281,400	38,124	60
India	11,455	1,145,500	1,499	764
Indonesia	2,766	276,600	3,475	80
Japan	10,784	1,078,400	38,634	28
Malaysia	2,616	261,600	10,538	25
Philippines	3,084	308,400	2,765	112
Singapore	15,251	1,525,100	55,183	28
Thailand	3,952	395,200	5,779	68
Average	8,257	825,670	16,381	50
Source:	Global Property Guide

According to the Global Property Guide, Low Middle Income and Low Income countries like India and Cambodia generally have higher price to income ratios.

On a global basis, the Philippines has the third highest House Price to Income Ratio, behind India (764 times income), Cambodia (289 times income), Gambia (137 times income). It is tied with Madagascar (112 times income) and just ahead of Russia (108 times income).  Among the Lower Middle Income countries, the Philippines ranks second behind India and just ahead of Indonesia (80 times income).

Country	Housing Cost Per Sq. M. in Prime CBD (in USD $)	Cost of 100 Sq. M. Residential Condo in CBD (in USD $)	2013 GDP Per Capita (Current USD $)	Residential Price/GDP Per Capita (in USD $)	Income Class
Russia	15,772	1,577,187	14,612	108	High Income
United Kingdom	33,993	3,399,339	41,788	81	High Income
Hong Kong	22,814	2,281,400	38,124	60	High Income
France	18,128	1,812,848	42,503	43	High Income
USA	18,499	1,849,900	53,042	35	High Income
Japan	10,784	1,078,400	38,634	28	High Income
Singapore	15,251	1,525,100	55,183	28	High Income
Israel	9,511	951,100	36,051	26	High Income
Antigua	3,501	350,100	13,342	26	High Income
St. Kitts and Nevis	3,496	349,600	14,133	25	High Income
Italy	7,882	788,195	35,926	22	High Income
Switzerland	15,028	1,502,754	84,815	18	High Income
Chile	2,749	274,900	15,732	17	High Income
Finland	8,259	825,943	49,147	17	High Income
Bahamas	3,632	363,200	22,312	16	High Income
Canada	8,288	828,800	51,958	16	High Income
Uruguay	2,562	256,200	16,351	16	High Income
Sweden	9,292	929,219	60,430	15	High Income
Spain	4,575	457,499	29,863	15	High Income
New Zealand	5,611	561,100	41,556	14	High Income
Netherlands	6,522	652,221	50,793	13	High Income
Trinidad & Tobago	2,334	233,400	18,373	13	High Income
Germany	5,420	542,033	46,269	12	High Income
United Arab Emirates	5,037	503,700	43,049	12	High Income
Australia	7,626	762,600	67,458	11	High Income
Ireland	5,524	552,401	50,503	11	High Income
Denmark	5,711	571,142	59,832	10	High Income
Puerto Rico	1,365	136,500	28,529	5	High Income
China	6,932	693,200	6,807	102	Upper Middle Income
Thailand	3,952	395,200	5,779	68	Upper Middle Income
South Africa	4,101	410,100	6,618	62	Upper Middle Income
Belize	2,322	232,200	4,894	47	Upper Middle Income
Lebanon	3,693	369,300	9,928	37	Upper Middle Income
Dominican Republic	2,078	207,800	5,879	35	Upper Middle Income
Brazil	3,751	375,100	11,208	33	Upper Middle Income
Colombia	2,379	237,900	7,831	30	Upper Middle Income
Peru	1,810	181,000	6,662	27	Upper Middle Income
Jamaica	1,404	140,400	5,290	27	Upper Middle Income
Mexico	2,635	263,500	10,307	26	Upper Middle Income
St. Lucia	1,860	186,000	7,328	25	Upper Middle Income
Malaysia	2,616	261,600	10,538	25	Upper Middle Income
Jordan	1,282	128,200	5,214	25	Upper Middle Income
Ecuador	1,278	127,800	6,003	21	Upper Middle Income
Argentina	2,813	281,300	14,715	19	Upper Middle Income
Panama	2,001	200,100	11,037	18	Upper Middle Income
Costa Rica	1,642	164,200	10,185	16	Upper Middle Income
India	11,455	1,145,500	1,499	764	Lower Middle Income
Philippines	3,084	308,400	2,765	112	Lower Middle Income
Indonesia	2,766	276,600	3,475	80	Lower Middle Income
Nicaragua	1,342	134,200	1,851	72	Lower Middle Income
Morocco	2,015	201,500	3,093	65	Lower Middle Income
Cape Verde	1,300	130,000	3,767	35	Lower Middle Income
El Salvador	1,193	119,300	3,826	31	Lower Middle Income
Egypt	831	83,100	3,315	25	Lower Middle Income
Cambodia	2,913	291,300	1,007	289	Low Income
Gambia	667	66,700	489	137	Low Income
Madagascar	520	52,000	463	112	Low Income
Tanzania	700	70,000	695	101	Low Income
Kenya	900	90,000	1,246	72	Low Income

Source: www.worldbank.org

So do Philippine Housing Prices still have more room to run?  Maybe so.  But the odds looked stacked against it.

Singapore, Malaysia, and Thailand Post Flat to Declining Housing Prices, Can the Philippines and Indonesia be Not Far Behind? - 3rd Qtr 2014

Almost all countries discussed in this blog post, with the exception of Thailand, have been experiencing rapid growth in home prices that have outstripped inflation by a wide margin.  The gap between home prices and their inflation adjusted levels are at the widest ever, particularly in Singapore and the Philippines.


Singapore


Singapore's home prices slid for four straight quarters, which, according to Bloomberg, is the longest losing streak in five years.  Home prices are still  81% above their year end 2004 levels. Overall prices levels, as measured by inflation have just increased by 30.37% since year end 2004.  In other words, for the past ten years, Singaporean home prices have outpaced inflation by more than 50 percentage points.

Malaysia


Neighboring Malaysia's House Price Index actually topped out at 135.44% in the second quarter of 2011 and has posted a 3.37% decline since then to 130.87% as of the fourth quarter of 2013.  In the first quarter of 2014, home prices rebounded to 133.03% and have continued to march higher to 134.22% as of the third quarter 2014, reducing the overall decline from the peak to just 1.02%.  Home prices are just 34.22% above their year end 2004 levels.  General price levels are only around six percentage points lower, at 28.26% above their year end 2004 levels.

Thailand



In Thailand, which has been experiencing political turmoil for some time, home prices have remained essentially flat since the end of 2004. Home Prices ended 2013 with the index at 100.54%, just 054% higher than the end of 2004, but showing a substantial recovery since the recent low of 74.08% posted in the third quarter of 2009. In the third quarter of 2014, home prices have rebounded to 106.23%, or 6.23% higher than its year-end 2004 levels, way below its expected inflation adjusted levels. General Price levels are 34.68% above their year end 2004 levels.

Indonesia


Meanwhile in Indonesia, home prices have showed no signs of slowing down their upward trajectory.  In fact, prices seem to have gone parabolic, climbing 4.63% in the last quarter of 2013, from a base of 121.49% as of the third quarter of 2013 to 127.11% as of year end 2013.  In the third quarter of 2014, home prices have climbed an additional 6.64% to reach 133.75%.  Since the first quarter of 2007, home prices have risen 33.75%. Indonesian Home Prices, like Thailand, have lagged inflation since 2007.

Philippines


Philippine house price index stands at 208.08% at the end of the third quarter 2014 or over 108.08% above their year-end 2004 levels.  Philippine home prices have posted the largest 10 year gains among all the countries considered in this blog post.  Like Singapore, Philippine home prices have outstripped inflation by more than fifty percentage points.  Like Indonesia, Philippine home prices have so far no signs of slowing down their upward trajectory for the foreseeable future.   The question is, is this momentum sustainable?  Or will the Philippines and Indonesia follow its ASEAN neighbors, Singapore, Malaysia, and Thailand, in exhibiting plateauing or declining house prices?  That remains to be seen.

Source: Global Property Guide, World Bank, Trading Economics

The Philippine Consumer Has Not Peaked - Yet

Quite a few previous blog posts have detailed how the Philippine Real Estate Market may have already peaked in terms of sales volume and loans to the residential real estate sector.  The Philippine Real Estate Market has yet to peak in terms of price, although some of our ASEAN neighbors have already showed signs of plateauing to declining prices for residential real estate, notably including Singapore and Malaysia.

The two charts below indicate a slowdown in terms of loan growth in the real estate sector.

Since home prices have still continued their relentless climb, this  has not yet translated to a sharp uptick in Non-Performing Loans (NPLs) in the sector.

However, there was a slight uptick in NPLs from 3.15% of residential real estate loans in 2013 to 3.34% as of March 2014.

Negative Real Interest Rates

The persistence of negative real interest rates in the Philippines has led, unsurprisingly, to a sharp drop in Gross Domestic Savings Rate as a percentage of GDP since 2010.

Uptick in Consumer Loans

With negative real interest rates, it makes sense for consumers to buy tangible goods, such as real estate and cars, as a store of value.  Correspondingly, there was a sharp uptick in total consumer loans both as a percentage of GDP and as a percentage of the Total Loan Portfolio.

The uptick seems to have leveled off since 2012. Most of the increase, it seems, can be attributed to residential real estate loans and auto loans.  Again, the leveling off has not yet translated to any notable increase in consumer loan NPLs - yet.

Another Sign that the Philippine Real Estate Bubble May Have Already Peaked?

In a technical analysis of the price trends of financial securities, volume is a very important technical indicator. If the volume moves with the trend, the volume confirms the trend. When price and volume diverge, it is often indicative of a shift in the trend. For example, if an uptrending stock price is accompanied by lower and lower volumes, it may indicate that the price trend is weak and that prices may start to decline.

The same holds true for the real estate market.

US Real Estate Market

In the US, sales volumes peaked for US Total Home Sales (New and Existing Home Sales) at 8,4 million homes in 2005, a year before the US Median Sales Price peaked at US$ 225K in 2006.  By 2007, the US Median Sales Price slipped by only 1% to US$ 223K while sales volumes had already dropped an astonishing 30.58% from the peak sales volume in 2005, to 5.8 million in 2007.

From then on, the US Median Sales Prices continued to decline year after year, bottoming out at $170K in 2011, or some 25% below the peak price level.  By then sales volumes had already bottomed out a year earlier in 2010 to 4.5 million homes, or some 46% below peak volumes.

Sources: Realtor.org, St. Louis Fed

Median Sales Price is a weighted average of the median sales prices of New Home Sales and Existing Home Sales

The same dynamic played out in both segments of the US Residential Real Estate Market: New Home Sales and Existing Home Sales.

Here is the chart for New Home Sales:

And here is the chart for Existing Home Sales, the much larger market segment.

Philippine Real Estate Market

Might the same dynamic be playing out in the Philippine residential real estate market?  One problem bedevilling such an analysis is the dearth of data.

To my knowledge, the Philippines does not have adequate market data.  For instance, there seem to be no published figures for sales volumes for residential homes.  The best approximation of such data is HLURB's statistics for licenses to sell residential homes.  This statistic represents only new homes and only represents licenses to sell for each residential unit and not the actual sales volumes.

Another issue is that there seems to be no price data on residential sales.  The best data is assembled here, which in turn, is assembled from the Philippine Office of Colliers International, a global real estate agency.  These prices, in turn, are based on the average prices of a prime 3 bedroom condominium unit in the heart of the Makati Central Business District.  This is like basing nationwide US housing prices on the price of a prime 3 bedroom coop unit in Manhattan in New York, one of the priciest real estate markets in the US.  The data available in the Philippines is not representative of the true state of the entire national residential real estate market.  At best, it is an approximation of the Philippine Real Estate Market.  The BSP has stepped into the picture to overcome this deficiency by developing their own real estate index, which would be more comprehensive in scope. Here is a possible candidate for such an index.

But based on the data available, we arrived at this chart:

Based on this data, volumes (as indicated by Residential HLURB licenses to sell) may have already peaked in 2012, while prices have continued their upward climb to date.  Volume seems to have peaked at 264,237 units in 2012 and dropped 15% to 225,051 units in 2013.  In the first quarter of 2014, volumes declined further on an annualized basis, to just 189,668 units or 28% below peak volumes. 

Prices though, have continued to climb since 2012, another 14% in 2013 and another 2% in the first quarter of 2014, representing a 16% increase over 2012 prices.

Is the same dynamic that played out in the US Residential Real Estate Market playing out in the Philippines?  It looks like it, but it may still be too early to tell.

Is the Philippine Real Estate Bubble About to Burst?

In a previous blog post, we noted that Philippine House Prices have outpaced inflation by a wide margin.

Real Estate as a Store of Value:

In the Philippines, as is true in many other countries, real estate is often seen as a store of value, as a hedge against the relatively high inflation that characterizes so many emerging markets.  The investment options available and trustworthy to the general public tend to be few: government securities such as Treasury Bills, Bank Deposits, etc. As recently as 2012, less than 1% of the population own stocks because it is seen as too complex, or as investment vehicle only for the affluent, or a form of gambling. So to many Filipinos, the equity market is no place to be.

Negative Real Interest Rates

Unfortunately, the safest form of investing open to the general public, Philippine government securities, has been a money loser, inflation-wise, for the past several years.  Philippine Treasury Bill Yield Rates have continued their steady long-term decline to a point that they have barely hovered above zero in 2013.

Although yield rates have climbed in 2014, they do not compensate for the inflation underlying the economy.  As a result, real interest rates have been negative for almost four years running: from 2011 onwards.  Despite the recent rise in yields, real interest rates have dropped even further to a -2.68% as of July 2014.

The prolonged presence of negative real intest rates have increased the impetus to invest in real estate.  Construction as a percentage of GDP is the highest it has ever been since 1997 (the year the Asian Financial Crisis hit the Philippines).  Back in 1997, construction as a % of GDP was 11.14%.  As of the first semester of 2014, this ratio now stands at 11.20%, well above the historic average of 9.48%.

Construction Overhang

As a result, construction as a ratio of GDP has been well above this historic average of 9.48% since 2009.  The gains in construction spending have eaten away at the cumulative underhang or underinvestment in construction that has taken place since 2004, wherein the excessive spending that took place in the late 1990s was being absorbed.  As of now, in the first semester of 2014, the cumulative investment in construction of 0.4% is now at or slightly above equilibrium. But given the momentum of investment, construction investment is likely to surpass equilibrium in the coming years.

Real Estate Loans

The push into real estate is also reflected in Real Estate and Construction Loans.  Beginning sometime in 2010, Real Estate and Construction Loans as a % of Total Loan Portfolio broke out of its historic range of 12.5% to 17.0% from 1999 to 2010.  The percentage share of such loans peaked at 20.52% in September 2013 and has since dropped to just 18.65% as of June 2014.  Although the drop is significant, this ratio still has to drop even further to just reach the top end of its historic range.

Residential Real Estate and Commercial Real Estate Loans as a % of GDP have also begun to level off after climbing sharply since 2010.  Residential Real Estate Loans and Commercial Real Estate Loans now stand at 4.37% and 2.67% of GDP, respectively, as of March 2014.

As it stands, investment in construction and real estate have seem to reach equilibrium.  But the continued and prolonged presence of negative real interest rates will continue to drive investors to seek real estate as a store of value, a safe haven to protect their money against the vagaries of inflation.  The recent jump in Treasury Bill rates may dampen this enthusiasm for real estate but rates have to climb further for such market euphoria to disappear.