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.

The Unbearable Volatility of BSP's Residential Real Estate Price Index

Perhaps because the index has been in its infancy but according to BSP's Residential Real Estate Price Index (RREPI) investors in residential real estate have been experiencing a nausea-inducing roller-coaster ride in terms of asset prices.

The swings in the areas outside the National Capital Region (Ex-NCR) are particularly problematic. Within the past two years, RREPI - All Types for the Ex-NCR area has swung from a high of 125.7 in the second quarter of 2016 from a low of 106.2 as of the 2nd Qtr. of 2015, an increase of 15.51% in just one year. Then in the next quarter, the index drops by 10.74% to 112.2 as of the 3rd Qtr of 2016. The RREPI - All Types index for the Ex-NCR area now rests at 116.8 as of the 1st Qtr 2017 or 4.10% higher than what it was just two quarters ago.

This volatility of the Ex-NCR RREPI-All Types has influenced large swings in the overall Philippine RREPI-All Types. Since its inception, the nationwide index has swung 10.18% from bottom to top. No doubt, the volatility of the Philippine-wide RREPI-All Types was tempered by the low volatility of the NCR RREPI - All Types, which fluctuated by only 2.63% from peak to trough.

The same dynamic has been playing out as you drill down into the index's sub-sectors, whether they be Single Detached Homes, Duplex, Townhouses, or Condominiums. Ex-NCR is volatile while NCR has smoother fluctuations, leading to a more volatile nationwide index for each sub-sector.

The Philippines was one of the last countries in the ASEAN to institute a National Residential Real Estate Index. Other countries have done this much sooner. However, late is better than never. In the meantime, for planning purposes, the index has limited utility.

What Gives in the Philippine Real Estate Market? Sales Volumes Are Up Yet House Prices Decline in 2016

According to the HLURB, sales volume increased by a dramatic 17.59% to reach 255,115 units sold in 2016 from only 216,503 units sold in 2015.  Yet prices stayed flat or declined slightly year-on-year in 2016.  The Philippine House Price Index, computed from changes in house prices in the Makati CBD as published in the Global Property Guide, fell by a slight 0.75% from year-end 2015 to reach 218.47 in 2016.

According to the Residential Real Estate Price Index put out by the BSP, prices for all types of housing grew by a marginal 0.3% year-on-year 2016, the slowest pace since the index came out in the second quarter of 2015.

Metro Manila saw a significant 8.6% year-on-year decline in the single detached housing market. In areas outside the NCR, the decline was marginal - only 0.18% in 2016. Overall, the market for single detached homes declined by 1.00% in 2016.

Price declines in the duplex market were also very significant, droppng 12.32% in 2016 alone.  The NCR singlehandedly contributed to this decline, dropping 8.80% in 2016, more than offsetting all of the gains in duplex prices outside Metro Manila, which grew by a respectable 5.50% in 2016.

The townhouse market remained healthy.  Townhouse prices increased by 6.24% in 2016 overall.  But almost all of this increase came outside Metro Manila.  Ex-NCR, townhouse prices increased by 16.31% in 2016. In the NCR, townhouse prices increased by a barely perceptible 0.08% in 2016.

Ex-NCR was also the bright spot in the condominium market.  Outside the NCR, condo prices increased by 6.24% in 2016. NCR condo prices also grew, albeit more slowly: 1.27% in 2016, bringing up the Philippine average by 1.79% in terms of condo prices in 2016.

Much of the growth, therefore, is coming not from the over-saturated NCR, but from outside of it, indicating that the benefits of economic growth are spreading out to the rest of the Philippine economy, which could result in a much healthier real estate market.