The perils of a politically influenced Bangko Sentral

THE CORNER ORACLE - Andrew J. Masigan - The Philippine Star

Despite widespread corruption, a rubber stamping congress and populist political leaders, the Philippines continues to be considered a “serious nation” on the fast-track to economic prosperity. Our finances remain strong to a point where our sovereign debts have been classified as “investment-grade” for nearly a decade – an undeniable validation of the strength of the economy.

How is this possible? Beneath the many shortcomings of government is conservative, competent financial management. This is because the Bangko Sentral remains politically independent and operates with the highest degree of professionalism. This is true not only under the leadership of incumbent BSP Governor Felipe Medalla, but all those who preceded him since the late 1980’s. The Department of Finance and Department of Budget and Management are equally astute, both having fulfilled their mandates with proficiency through the decades.

Allow me to share a story of a country that committed the grave mistake of politicizing their financial institutions. You will find that doing so leads to economic collapse and social anarchy.

This is the story of Lebanon.

Through the 90s up to the early 2000’s, Lebanon had a stable, growing economy fueled by tourism and financial services. Their banking system was renowned for its sophistication and rigid secrecy laws that rivaled Switzerland itself. With this, Lebanese banks attracted billions of dollar deposits from international oligarchs, politicians and high net worth individuals.

Lebanon’s manufacturing sector is practically non-existent and this has made her severely import dependent. The Lebanese pay for their imports with incomes derived from OFW remittances, tourism and banking. Her currency, the Lebanese Pound (LBP), was pegged to the US dollar at LBP15,000 to US$1, a rate that remained unchanged for 30 years. Although Lebanon suffered budget deficits year after year, it continued to operate with relative stability.

Problems arose in 2011 when the Syrian war broke out. Within one year, 1.5 million refugees fled to Lebanon, increasing mouths to feed by 33 percent. That same year, the country got caught in the middle of the Saudi Arabian and Iranian conflict. This was followed by several high profile terrorist attacks by ISIS. It was the perfect storm. In one fell swoop, travel bans were raised and tourists quickly dried up. Lebanon also lost her status as a safe haven for banking.

With dwindling dollar revenues, one would think that the government would cut its imports to tame the deficits. It did the contrary and Lebanon’s Central Bank played ball with government’s populist, albeit reckless, policies.

To maintain political popularity, government continued to import goods on the same scale as the good old days. It refused to lift subsidies on fuel and electricity. Naturally, budget deficits skyrocketed and the country’s forex reserves quickly depleted.

Despite all these, the government refused to depreciate the LBP to reflect its true value. Without currency devaluation, there remained no mechanism to curtail imports. So the spending continued.

Cracks began to show in 2018 when commercial banks imposed daily limits to the amount of US dollars its depositors could withdraw. In the black market, the greenback was already trading at LBP38,000. In other words, the LBP lost 96 percent of its value. This led depositors to distrust the banking system and this triggered a spate of bank runs across the country.

Banks tried to stave off the mass withdrawals by offering high interest rates but it was too late. The trust was gone. Desperate, banks imposed a maximum withdrawal of $100 per depositor, per month.

Central Bank’s Ponzi scheme

Instead of swallowing the bitter pill and instituting austerity measures, the government, through its Central Bank, implemented an elaborate scheme to keep the spending going. This is how it worked.

The Lebanese government sold dollar-denominated sovereign bonds to investors through its network of commercial banks. The Central Bank printed Lebanese Pounds by the billions. The Central Bank swapped the US dollar-denominated bonds with bonds denominated in LBP (which would not be a problem if the value of the LBP was indeed LBP15,000 to one US dollar, as pegged by the Central Bank. But remember, it had already lost 96 percent of its value). With US dollars in hand, the government could continue financing its imports and subsidies.

Still short of dollars, the Central Bank borrowed greenbacks from the commercial banks at interest rates as high as 15 percent. The catch – it would repay in LBP, which the government could simply print. High interest rates incentivized banks to sell more dollar-denominated bonds offering returns as high as 10 percent.

This scheme allowed the central bank to convert its printed money into dollars. These dollars were used to repay holders of dollar-denominated bonds. But once the dollars were consumed for bond repayments, the banking system was left with no more greenbacks to pay for imports. So it needed to sell even more dollar-denominated bonds. Meanwhile, the country’s foreign debts ballooned to a whopping 300 percent of GDP.

World Bank described this financial mechanism as a Ponzi scheme. Lebanese bonds turned worthless soon after.

Exacerbating matters was the 2020 explosion of a stockpile of ammonium nitrate in downtown Beirut which caused $15 billion in damages. Evidently, government allowed a boatload of ammonium nitrate, an unstable explosive substance, to be kept in the port for several years. It was a disaster waiting to happen and an outright display of government’s incompetence. This led to the resignation of Prime Minister Hassan Diab and his Cabinet. The country remained leaderless until a new PM was named.

As everything unraveled, inflation soared to 180 percent and the economy contracted by 40 percent. Food scarcity followed, with eight of 10 Lebanese living in hunger.

Even today, depositors are unable to access their life savings from banks. This has led to nationwide protests, looting and bank robberies. The country is in anarchy. Lebanon is considered a failed state.

May our very own Bangko Sentral always maintain its independence from politicians and their agendas.

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Email: [email protected]. Follow him on Twitter @aj_masigan

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