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Debt Instruments and Philippine Economic Recovery
Interest Rates Co-integration Closely Tracks the Economy's Roller Coaster Ride vis-ŕ-vis the Country's Political Developments and Debacles
by Cesar C. Rufino, DBA |
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About the Author Dr. Cesar C. Rufino, DBA, MS Econ, M Stat, BS Math, AA is a full-time Associate Professor of the Economics Department, College of Business and Economics of the De La Salle University-Manila. He holds the Don Rufino Deeunhong Chair in Business Administration at CBE-DLSU and a Senior Research Fellow of the Angelo King Institute of Economic and Business Studies (AKIEBS). He also sits at the Editorial Advisory and Review Board of the DLSU Journal of Business and Management – the academic research journal of the DLSU Graduate School of Business.
Dr. Rufino is a holder of two master’s degrees – Master of Science in Economics from DLSU and Master of Statistics (Philippine Statistical Association Scholar) from the University of the Philippines. He completed his Bachelor of Science in Mathematics degree and Associate in Arts title from Pamantasan ng Lungsod ng Maynila. Among the non-degree courses he completed are the U.S. Grains Marketing System Short Course at Kansas State University, and the Commodities Futures Trading Course at the Memphis State University. He is a member of the International Association of Survey Statisticians, Philippine Statistical Association and the Philippine Economic Society.
He received his Doctor of Business Administration from the GSB De La Salle University – Professional Schools, Inc. in 2001. During the school year 2002-2003, he spent his sabbatical by serving as a Visiting Professor in Economic Statistics at the International Program of the Department of Economics, Soka University in Tokyo, Japan. His areas of specialization include econometric model building and economic & business forecasting. He is currently working on the Agricultural Distribution and Price Transmission Dynamics Project under AKIEBS commissioned by the Department of Agriculture. ___________________ This timely article delves into the dynamism of interest rates for Treasury bills (public debt) and commercial lending instruments (private debt) to indicate the dynamics of Philippine economy. Government regulates interest rates precisely to influence market conditions, particularly during times of uncertainty in order to maintain overall stability and economic security. In times of political crises, much of the market players' confidence goes south, and the market (economy) performs badly. The exercise of controlling interest rates to mitigate the ill effects of these political crises on the market is an art, and the exemplar in this is Alan Greenspan of the U.S. In the Philippines, there are a lot persons and agencies involved in the matter of interest rates. Whether or not you believe that many heads are better than one, your appreciation of the econometrics of interest rates will be enhanced by this paper. (Webslinger)
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Introduction
Two of the most important interest rate measures that are used frequently in representing the time value of money in economic and financial analyses are Treasury bills and commercial lending rates. Treasury bills are short-term instruments issued by the government under varying tenors to partly finance its operations, while interest-bearing commercial papers are usually short-term unsecured promissory notes issued by large corporations to credit-worthy issuers. These measures are by themselves vital indicators of the financial soundness of the economy, but an even more useful measure is their differential value. Such spread has traditionally been considered as one of the exceptional leading indicators of the country’s economic performance.
The strong predictive performance of the Treasury bills and commercial paper spread over the years prompted leading economists to advocate its use in planning and policy making. Friedman and Kuttner (1992, 1993) demonstrated its predictive power throughout the ‘80s and even suggested its use in place of monetary aggregates as a leading predictor of economic activity. Bernanke (1990), in a follow-up study on the work of Stock and Watson (1989) showed that even after controlling for the growth in money supply, this indicator is still highly significant statistically. They stated that amongst interest rates it is the best single leading predictor of the economy’s performance.
Traditionally, the T-bills—commercial paper spread has been regarded as the normal market risk premium. Ordinarily, this spread is relatively stable over time. However, during times of uncertainty, the rate differential becomes unusually large and volatile to reflect the growing concern of market participants over safety against defaults. Also during inflationary periods, when both T-bill rates and commercial paper yields are highly unpredictable, their spreads are also very erratic, prompting risk-averse investors to stay away from the market.
The problem this study addresses is whether there exist empirical bases on the general belief that a long-run equilibrium relationship between the Treasury bill rates and commercial lending rates exists in the Philippine setting. Furthermore, this study will also establish the co-integrating equation between the two rates, as well as the error correction mechanism that governs this relationship when short-run disequilibrium are smoothed out to bring the rates back to their long run path.
The paper is organized as follows: after this introduction, a discussion on the time series properties of the two series will be undertaken, focusing on the assessment of the departure of the time series from “stationarity”. The next section will be the econometric analysis of the co-integration of the T-bill rates and the commercial paper rates to establish their long-run linkage. Included in this section is the examination of the stability of the T-bills—commercial paper rates spread, as well as the short-run dynamics of the spread. The final section will deal with the discussion of the insights and other predictive information uncovered in the study.
Data Used in the Analysis
Monthly historical data from the Bangko Sentral ng Pilipinas database on both the benchmark 91-day Treasury bill rates and average commercial lending rates (all maturities) are used in the study. Period covered is from October 1981 to December 2003, involving 266 monthly observations – substantial enough to undertake long-run analysis. The figure below (Figure 1) shows the line graph of the two series as they move together over time.
Also shown in the figure is the differential value of the two time series, which is aptly, called the spread. A visual inspection of the behavior of the line graphs reveals that both rates follow each other closely, as if one is shadowing the other across the whole time horizon. The movement of the series seems to be sideways without any recognizable long-term trend except for some brief periods in the mid- to late-'80s. Commercial lending rate ( CLr ) appears to be on top of the Treasury bill rate ( Tbr ) most of the time. During most of the 80s, both rates exhibit wide variability, with the plateaus reached during the late 1984 and the troughs attained in the early 1987. It was also during this time span when the spread between the two rates widely fluctuated, in sharp contrast with the rest of the sample period when the rates differential was generally stable at a shade above zero.
The figure shows that the series does not exhibit mean reversion, with the spread displaying a basically well-behaved pattern. Such observed tendencies are graphical indications that the level series are non-stationary, while their spread is stationary. Additional pictorial evidence that CLr and Tbr are difference stationary (ds) stochastic processes can be gleaned from the plot of their first differenced series, shown below.
Figure 2 intensifies our suspicion that CLr and Tbr are I(1). The figure reveals that the line graphs of ΔCLr and ΔTbr (the first differenced series) fluctuate around a zero mean and appear to be stationary. These findings are in accordance with the conjecture made by Engle and Granger (1987) that interest rates are generally non-stationary time series variables.
Visual inspection however is not very reliable at times since different people may see different patterns when looking at the same graphic material. In this study we employ three different unit root tests to empirically check our graphical analysis of the line graph of the series.
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