The soil for green shoots

Last week, National Economic and Development Authority (NEDA) Secretary Karl Chua cited three signs that could point to a pickup in economic activity. These indicators come at the heels of relaxed quarantine measures in several areas:

First, NEDA highlighted a slower decline in external trade performance. Year on year, May’s total external trade (exports plus imports) declined by 38.7%. This is lower than April’s drop of 59.5%.

However, the trade balance (exports minus imports) actually deteriorated from a shortfall of $448.7 million to a bigger shortfall of $1,865 million. This was driven by the decline in imports which was much bigger than the decline in exports. Given the leads and lags, the decline in imports could presage a further correction in domestic demand as well as in exports. The decline was also true for the period January-May 2020 versus January-May 2019 external trade. Without doubt, the trade outlook remains overwhelmingly dependent on how soon the global economy could bounce back.

Second, NEDA quoted the Philippine Statistics Authority data on the production index for May against April, both in value and volume terms, to show a softer decline in manufacturing output. The May value index declined by 42.1% in contrast to April’s 45.5% drop. Volume-wise, production decline slowed down from April’s 43.6% to May’s 40.1%. These smaller losses were also reflected in the decline in volume and value indices of sales from April to May 2020. This the first time we are seeing this as another sign of possible reversal of economic fortune.

Finally, NEDA highlighted the expansion in capacity utilization in May. This is based on a survey of 20 manufacturing industry groups. Average capacity utilization rose from 71.2% in April to 73.4% in May 2020. More than one-fifth of the respondents operated at full capacity, with five out of 20 reporting 80% use. This is good news. Any reading above 50% indicates economic expansion. The survey also shows that more firms expanded their capacity in May even as most of the country remained in a lockdown.

Could these be “green shoots?”

“Green shoots” is a colloquial phrase referring to signs of economic recovery during an economic crisis. Green shoots normally appear after a recession, or when a recession is about to end. The term optimistically conjures vivid imagery of life struggling to rear its head.

Former UK Chancellor Norman Lamont first coined it during the UK’s economic decline in 1991. At that time, Britons found Lamont’s positive assertion to be highly insensitive as many were still experiencing extremely difficult financial straits.

The term was heard again when Former US Fed Chairman Ben Bernanke appeared on 60 Minutes, citing signs of economic recovery at the height of the financial crisis. Similar to the UK reaction, many criticized Bernanke as a wishful thinker. His words did not then resonate with the public’s realities of deep recession, high unemployment, and long queues for social security benefits.

Then, as it is now, when civil society has yet to fully feel and benefit from a more decisive reversal of economic recession, skepticism will naturally hold stronger sway. This is a reality and challenge that public authorities face when using early indicators to rally positive market sentiment.

Aristotle poetically cautioned against premature judgment: “One swallow does not a summer make, nor one fine day; similarly one day or brief time of happiness does not make a person entirely happy.”

The thing about green shoots is that ascertaining their potency requires much looking backward. In short, we can only tell if a green shoot has taken root, if in the future, they flourish and thrive despite obstacles to growth.

For instance, while Bernanke was indeed right about the green shoots, it took years before the US economy held more firmly. Economic contraction slowed down and did not immediately cease. In fact, the scale of financial market collapse surpassed the 1930’s Great Depression. House prices tanked and job losses continued.

In our case, more time and more parameters are needed to cement confidence that the signs cited by NEDA are indeed green shoots for the Philippine economy. We have yet to see the decline for the second quarter to ascertain whether we have already hit the bottom.

To assess how we fare, we can also take stock of the vibrancy and fertility of our economic soil, our planting grounds.

For perspective, at the height of the Global Financial Crisis, the Philippines kept real GDP at 4.3% in 2008 and 1.4% in 2009. Production and sales, both value and volume indices, exhibited sizeable declines. Yet, average capacity utilization was relatively high at 81.7% in 2008 and 81.1% in 2009. From 2015-19, real GDP averaged 6.5% produced at an average capacity of 83.86%.

With downbeat imports across all types — capital goods, intermediate goods, and raw materials as well as consumer goods, it will be difficult to show good progress in output production. The huge drops in both production and sales indices and historic lows in average capacity utilization are challenging soil for green shoots.

The business expectations survey (BES) and consumer expectations survey (CES) of the Bangko Sentral for the first quarter 2020 give an idea of potential business and consumer activity for the second quarter 2020 and the next 12 months.

BES data indicate that for the second quarter, business outlook was more favorable than the first quarter of the year; that is, from 40.3% to 42.3%. However, the business confidence index was less favorable for the next 12 months. Business sentiment declined from 59.6% as surveyed in the previous quarter to only 55.8%.

As to consumer expectations for the second quarter 2020 and the next 12 months, consumers were less optimistic. Although still positive, the confidence index declined from the previous survey’s 15.7% to 9.2% relative to the second quarter outlook. Outlook for the next 12 months also declined from 26.4% to 19.9%.

Over the years, the BSP has found significant correlation between BES/CES results and output performance. Therefore, these market sentiments are rather ominous, as they were polled before the pandemic. The BES was conducted from Jan. 24 to March 13 with a response rate of 72.5%. The CES was done from Jan. 29 to Feb. 10 with a higher response of 97.3%. The results of the second quarter surveys should be more revealing.

This point is consistent with NEDA’s estimate that given the strict lockdown in the second quarter, output growth would be much deeper than the first quarter’s 0.2% decline.

With the gradual easing of the quarantine restrictions on economic activities including public transport and domestic travel, the third quarter report should look up. Actual data support this sense of the green shoots as early as the second quarter 2020. The Purchasing Managers’ Index based on either the Philippine Institute for Supply Management or the IHS markit for manufacturing alone indicates some good gains in inventory build-up.

But what could make matters more complicated is Moody’s recent observation that “banks in Southeast Asia, including the Philippines, face rising bad loans and weakening profitability as businesses grapple with the economic fallout from the pandemic.”

The banks could be the tipping point. They have the flexibility to take advantage of the sustained monetary easing. They should know that monetary and credit conditions could quickly change when the BSP realizes that the monetary policy rate at 2.25% is now negative in real terms given the January-June average inflation of 2.5% and the BSP’s new forecasts of 2.3% and 2.6% in 2020 and 2021, respectively. Yet banks have yet to reflect this in their lending rates.

Banks remained procyclical based on the BSP’ latest senior bank loan officers’ survey. They either maintained their credit standards or even tightened them despite the BSP and the National Government granting them concessions in terms of low interest rates and regulatory forbearance. This situation could deteriorate depending on how quickly the pandemic is mitigated, lockdowns are relaxed, and economic activities are resumed.

While we share the contagious optimism of Secretary Chua, if the financial cycle finally catches up with the projected economic recession, the economic downcycle might be prolonged. With the pandemic still raging, and as our public health leaders remain clueless and confused, our green shoots are threatened.

Scripture reminds that man shall reap what he has sown. We have tilled and diligently fertilized the soil. This is evident in our strong economic record of 21 years, historical gains in investment efficiency and productivity. We also enjoy favorable young demographics. Our nearly three decades of institution building capped by the pursuit of comprehensive infrastructure projects for inclusive and self-sustaining economic growth grant us resiliency against external headwinds.

But present nurturing of the soil is crucial. As our previous columns have posited, we must diligently rid it of toxins, destructive weeds, and harmful thorns if we are to cultivate growth despite the pandemic.

Diwa C. Guinigundo is the former Deputy Governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was Alternate Executive Director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.