The Impending US recession

Irrational anxiety. That’s how Prof. Solita Monsod (aka Mareng Winnie) of the UP School of Economics appraised the current panics and crashes at the NYSE and other stock markets around the world (including our very own PSE), sparked by talks about the coming US recession.

In an interview with Mike Enriquez this morning on dzBB, Mareng Winnie informed the public that there was nothing to worry about the impending US recession, and that all the panicking and sell-offs at stock markets worldwide are merely the result of too much worrying on the part of stockholders. It’s like losing your head in the movies simply because someone cried “fire!” when there’s really none. In effect, the stock market panic is a self-fulfilling problem. And given its inherent instability and volatility, the stock market reacts very much to exogenous events, even though they’re purely speculative.

Although the recession has not fallen upon the US economy yet, chief economists and policymakers there are wary about its coming. They admit that their economy, the largest in the world, is very much heading for a recession, an event it last experienced in 2001 right after the 9/11 tragedy. In fact, the impending recession has been the hottest new topic in the ongoing presidential debates and sorties there. Both Democrat and Republican parties have come up with tax packages and preemptive programs against the recession.

The Federal Reserve has cut its interest rates

Why is the reduction of interest rates important? Because during recessions the economy becomes less productive than before. Firms find it unprofitable to continue their businesses, their production halts and entire industries falter, leading to massive lay-offs and unemployment. By reducing interest rates the Fed aims to revive the economy by enticing businesses to continue their production, spend more, and make more investments.

And according to studies, a large part of corrective measures against recessions is accounted for by reductions in interest rates by the central bank; fiscal policy from the government – where the government uses its control on spending and borrowing to revive the economy – is considered only a “last resort” and a “strategy of desperation” once monetary action from the central bank does not work too well. Here’s how economist Paul Krugman put it:

When monetary expansion is ineffective, fiscal expansion…must take its place. Such a fiscal expansion can break the vicious circle of low spending and low incomes, “priming the pump” and getting the economy moving again. But remember this is no by any means an all-purpose policy recommendation; it is essentially a strategy of desperation, a dangerous drug to be prescribed only when the usual over-the-counter remedy of monetary policy has failed.

The US is in for a big economic event that will inevitably affect the world at large in the coming weeks. Let’s see how the problem gets debated on and solved not just by US politicians and economists but also by actors from around the world (possibly including the Philippines) as well.

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The Economy in Retrospect

Highlights of the Philippine economy this 2007:

Robust Macroeconomy 

1. Strong currency supported by:

• steady inflows from OFWs
• portfolio and direct investments
• export earnings
• income investments abroad

2. Strong rally of peso against dollar shielded domestic prices from rising because of escalating world oil prices (which should’ve fanned a rise in the inflation rate).

Money and Inflation 

3. Strong flow of foreign exchange fueled acceleration in domestic liquidity. More pesos in the system led to rise in domestic demand, higher probability of rise in prices, rise in inflation (inflationary pressure).

4. Growth in domestic money supply surged, led to easing of monetary policy by several basis pts. and threatened possible runaway inflation. BSP kept all policy settings unchanged and introduced special deposit accounts to trust entities for first time. Immediate result was decrease in liquidity.

5. US credit market trouble developed into a full-blown crisis. Fed cut its key policy rates to ward off economic recession from US credit crisis. BSP also cut its rates.

Strong Peso at Expense of Exporters

6. Peso appreciated to seven-year high with very modest real increase. Effects included:

• allowed treasury (public sector) to clean up NG debt portfolio
• private sector also prepaid much of their foreign obligations
• casualties out of very people funding the economy since 1970s when first OFWs deployed
• eroded income of OFWs
• exporters & BPO enterprises losing competitiveness, loud in complaining about their tightening margin

7. Strong peso beginning to cause stress to RP economy, would require immediate intervention. Remittances, in particular, could be contributing the most to negative side of strong forex inflows.

8. Exporters and operators of BPO enterprises/firms complained about their losing competitiveness and their tightening margin at the strengthening peso. Asked the government to intervene because industry is taking a beating and it’s becoming steadily expensive to do business in the country – might discourage businessmen from investing in the country.

9. Billions of pesos lost by exporters per month as:

• local goods become more expensive for foreigners
• missed opportunities and foregone orders arise

10. Small and medium-sized firms cut their orders to cope with the exchange rate. Also, as selling abroad became more expensive as costs rose, firms in the food and esp. the handicraft export business laid off jobs as much as 30%. Industries mostly affected by strong currency include:

• food exports
• handicraft exports
• semiconductor exports

11. Attempts of the government to curb the effects of the strong currency on the exporters included:

• lowering the power (generation) costs imposed on semiconductor industries in economic zones
• creation of a hedge fund facility managed by the DBP to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions and to help at filling in orders

But only big firms have availed the hedge. Small firms find it too complicated, so there are efforts at making it less so. Hedge still not enough to help the entire industry. Government should look at decreasing foreign borrowing, paying foreign-denominated debt, and strengthening the country’s reserves.

Negative Side of Strong Peso

12. Early studies indicate economy showing symptoms of the Dutch Disease which, if not addressed properly, could result in sharp contraction of the economy. Dutch Disease refers to harmful effects of strong forex inflows (from investments and remittances) starting with loss of competitiveness that could trigger a decline in the manufacturing sector, which engages in export activities.

13. Signs of real appreciation of peso against basket of currencies of competitors in world export market; also, a relative reduction in external price competitiveness.

14. BSP resisted urge to interfere with forex market to peg the rate to a level less harmful to both exporters and OFWs, like increasing interest rates or establishing a special exchange rate. In the end it will mean subsidizing the difference between the market-determined exchange rate and whatever different sectors want it to be — there are no funds to subsidize such and BSP is not even allowed by its mandate to peg the peso. Instead:

• BSP might help families to learn how to hedge against movements and volatilities in forex rates and how to invest earnings instead of using it for consumption.
• Exporters must resort to fundamental business of increasing productivity and efficiency to compete with rest of the world, instead of relying on shield of forex rate. This depends on capability of NG to provide infrastructure advantage lost by RP industries to other countries with better infrastructure support.

Stock Market Boom
15. Return of boom of IPO market sent local stock market to record levels. Causes were:

• strong and growing economic conditions, GDP growth (6.6% for Q3)
• robust remittances
• low interest rate regime
• bullish sentiment of investors
• market’s vigor and resilience
• market reforms to assure integrity and efficiency
• improvements in government’s fiscal position
• growing maturity of political leaders in handling differences

16. PSEi, the main barometer for local share price movements, rose 21% year-on-year.

17. US subprime credit problem prevented local bourse from further reaching new highs, investors opted to lock in gains and stay on sidelines before taking positions. But IPO mania likely to stay barring any collapse in the global markets given the liquidity crisis in US financial markets.

18. Nine companies that went public this year from 4 last year, raising P18.7B in fresh capital. Overall new capital raised increased 57% from last year.

19. Prices of stocks listed on PSE also on a roll. Total market capitalization of all listed companies up 14% from last year. Investors also generating higher earnings per share; jumped 18 times from 2004-2007.

20. Local market’s share of ASEAN market grew from 1% to 3.5% October this year.

21. Can entice investors to bring more funds to the stock market, lead them to sell shares to the public, and improve confidence to tap the capital market for funds if a more enabling business environment is put in place. PSE plans to expand its menu of stocks and develop new products and services for investors.

22. PSE actively supports enactment into law of a capital market-friendly legal and regulatory framework and plans to introduce more global best practices.

23. Value turnover more than doubled this year, and seen to significantly increase with the approval of the securities borrowing and lending program. Securities lending can bring in as much as 30% more value turnover to our stock market. They’re also strengthening market education programs and conducting seminars to increase awareness in benefits of investing in the stock market and to expand their domestic investor base.

24. PSEi expected to reach anywhere between 4,000-5,000 next year as listed stocks continue to lag that of neighboring bourses in terms of price earning multiples (PEMs).

Promising Telecom Industry

25. The telecom industry continued to be among the biggest, most promising and fastest-growing industries in the country, registering significant growth rates throughout the year and coming up with major innovations for their customers. The Philippines remains the top texting capitals of the world, with 53 million cellular phone subscribers sending messages everyday. Cut-throat competition among major telecom players have brought prices down to record lows to the benefit of their consumers.

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