Indebted

As the numbers run, the Philippines could nose out China as the fastest growing economy in Asia.

That does not make us a miracle economy, however. It makes us a mysterious economy.

Philippine domestic economic expansion defies the laws of gravity. It happens without any serious improvement in our infra gap. Poverty continues to widen. Unemployment rises. Agriculture remains stagnant. We get the smallest share of investment flows into the region.

Some analysts say the growth figure is exaggerated because it fails to take into account the massive smuggling of goods during the past four years. Smuggling flows create a mirage of economic activity.

Others say the semblance of growth is due to property speculation. Property development is the hottest sector of the economy. There is debate over the possibility of a property bubble similar to what hit Thailand in 1997, sparking the Asian financial crisis.

Still others say Philippine growth is pushed up by indebtedness.

During the seventies, we will recall, a semblance of development was produced by way of massive public borrowing. That produced the severe debt crisis of the early eighties that distorted our economy and deepened poverty.

This time, the borrowing is done by the large conglomerates to finance acquisitions, bid for PPP projects and sink into expensive property development projects. The low interest rate regime might have created a moral hazard: a large appetite to borrow recklessly.

Should the interest rate regime change dramatically, frantic financial recalculations will be made. What might seem sustainable today may become unsustainable tomorrow.

For months now, there has been much discussion over San Miguel Corporation’s (SMC) propensity to borrow. The discussion revived after it was announced the conglomerate acquired a third of the stocks of media giant GMA.

SMC has gained a reputation as a strong bidder for PPP projects. When it bid for the airport connector road, many thought the conglomerate’s hefty offer might be difficult to recover.

Had SMC not been disqualified on what some say is a minor deficiency, it would have handily won the bidding for the Cavite-Laguna Expressway project. SMC put in a bid about P8 billion more than the second-best bid.   

The growth of SMC’s corporate debt may easily be considered risky.

At the end of 2012, SMC had debts of P375.5 billion. By the end of 2013, this rose to P450.7 billion. After the first quarter of 2014, this ballooned further to P463.6 billion.

During this period, SMC posted an operating income growth rate of 7%. It’s interest-bearing debt, however, ballooned by 20%.

During the first quarter of 2014, the conglomerate’s income from regular operations grew by only 1%. Its debt, however, jumped by 2.8% during this period — a nominal growth of P12.9 billion. Interest payments accounted for 26.6% of the company’s gross profits in 2013. That share will, of course, increase this year.

Like the country as regards its sovereign debt, SMC borrows in order to refinance previous borrowing. In 2013, proceeds from SMC’s long- and short-term borrowing accrued to over P1 trillion.

According to the BSP, total assets of the Philippine banking system add up to about P10.09 trillion. SMC’s trillion-peso annualized debt rollover is equivalent to 10% of the size of our entire banking system. Should something go seriously wrong with SMC’s finances, this will have grave implications for the banking system, the lifeblood of our national economy.

At the end of 2013, SMC held P450.7 billion in interest bearing debt. That accounts for 38% of the conglomerate’s asset valuation.

For 2013, SMC reported a 42% jump in profits to P38.1 billion. A large portion of this, however, is due to the one-off non-recurring income generated by the sale of SMC shares in Meralco to JG Summit. Income from the sale of those shares amount to P30.717 billion.

If we take out this one-time spike in income, SMC’s income from routine business operations growth is far overshadowed by the growth in debt.

The debate in business circles these days is where the threshold of sustainability lies. For the moment, the conglomerate manages to diminish the significance of its debt holdings because of a sharp increase in the price of its stocks. Should the stock market correct significantly, as most analysts expect, the conglomerate’s financial standing might deteriorate significantly.

Financial sustainability could likewise be compromised by a significant rise in the interest rate regime.

At the moment, our monetary authorities are under intense pressure to adjust policy rates upwards in order to curb rising inflation.  They have so far resisted pressure to do so. Should inflation continue to surge, they might not be able to resist adjusting rates.

Higher interest rates will make credit tighter and the cost of servicing debt more expensive. These will have adverse implications on the ability of corporations to service their debts as well as on a whole range of economic endeavors, including the PPP projects.

From the numbers mentioned above, SMC appears to be the most vulnerable to changes in the financial climate. The inordinately low interest rate regime now prevailing appears to be a form of subsidy to large conglomerates consuming much of the funds available for lending in our system. Those subsidies abetted a high degree of economic concentration that, in turn, deepens polarization in wealth.

There seems to be something unhealthy in the way the large conglomerates have inflated their valuations through subsidized borrowing. In the same way, there seems to be something unhealthy in an economic growth rate driven by inflation in asset valuations.