The Anatomy of Philippine Stagflation: BSP Rate Hikes, Record External Deficits, and Fiscal Expansion (Part 3)

 

What we have here is the Keynesian error that inflation cannot emerge while widespread excess capacity exists. Underpinning this error are two dangerous fallacies: The first error treats inflation as a case of rising prices. In fact, rising prices are a symptom of inflation and one that is not always present if we think of prices in absolute terms. The second error treats capital as homogeneous. What this means is that Treasury and Reserve officials are arguing that stagflation is impossible. Mainstream economists have never grasped the fact that it is the heterogeneous nature of capital that makes stagflation possible—Gerard Jackson 

The Anatomy of Philippine Stagflation: BSP Rate Hikes, Record External Deficits, and Fiscal Expansion (Part 3) 

In this issue

I. The Stagflation Trap Tightens

II. The BSP’s Rate Hike and the Return of Monetary Tightening

III. The Record Balance-of-Payments Deficit

IV. The Yield Curve’s Warning Signal

V. Liquidity Is Not Confidence

VI. Fiscal Expansion and the Demand Leak

VII. Inflation Is Being Politically Managed

VIII. Mounting Social Stress Signals

IX. The Emerging Policy Trap

X. Conclusion: Stagflation 3.0: Cure is Worse than the Disease 

The Anatomy of Philippine Stagflation: BSP Rate Hikes, Record External Deficits, and Fiscal Expansion (Part 3) 

Rate hikes, fiscal expansion, and politically managed inflation are pushing the Philippine economy deeper into a stagflationary policy trap.

I. The Stagflation Trap Tightens 

In two earlier essays—“Stagflation Is Already Here—Emergency Policies Are Now Entrenching It” and “Stagflation by Design: Policy Contradictions and the Return of the Pandemic Rescue Playbook”—we argued that the Philippines was drifting toward policy configurations that increasingly reinforces the feedback loop between inflation and weakening growth. 

The Bangko Sentral ng Pilipinas’s (BSP) rate hike, the country’s record first-quarter balance-of-payments deficit, and widening fiscal pressures all point to the same underlying tension: policymakers are attempting to stabilize inflation, manage external vulnerabilities, sustain growth, and preserve financial stability in the banking and credit system simultaneously. 

This last constraint is often understated but central. 

Monetary policy in practice does not operate in a binary space between inflation and growth. 

It also operates through the credit channel: low interest rates support liquidity, asset valuations, and leveraged expansion, while higher rates trigger repricing of risk, debt service stress, and potential balance sheet compression. 

In this sense, policy is not only balancing macroeconomic objectives—it is also managing the fragility created by prolonged credit expansion—now worsened by supply dislocation. 

This is why tightening cycles are rarely clean. 

Higher rates are used to defend the currency and anchor inflation expectations, but they also risk exposing leverage accumulated during extended periods of low rates and accommodative liquidity conditions. 

Conversely, prolonged easing supports growth and asset markets but increases internal and external vulnerability through accumulated malinvestments and artificial inflation inertia. 

The result is not a simple trade-off between inflation and growth, but a multi-layered constraint between: 

• price stability
• external balance
• growth momentum
• financial system stability 

Instead of resolving these tensions, policy actions across fiscal, monetary, and regulatory fronts are increasingly interacting in ways that amplify them. 

This article—the third installment in the stagflation series—examines how those pressures are now converging across three fronts: 

• monetary tightening
• external financing stress
• administrative management of inflation 

Together, they reveal an economy gradually slipping into a policy trap. 

II. The BSP’s Rate Hike and the Return of Monetary Tightening 

The BSP’s decision to raise policy rates marks a significant pivot after nearly two years of easing and liquidity support.

While the move is formally framed as an inflation response, its immediate macro function is increasingly linked to exchange rate stabilization under external pressure. 

This distinction matters.

Figure 1

Inflation pressures had already been building before the Iran war’s oil shock—adding a new external impulse. (Figure 1, upper window) 

After the record 60.748 closing at the end of March, the USDPHP reached an intraday all-time high of 60.8, then closed at 60.7 per dollar last April 24—the second highest, possibly due to BSP interventions. 

All this shows that at this threshold, the policy constraint is no longer just price stability. It becomes external financing stability. 

A weakening peso increases the domestic cost of:

• imported fuel
• food inputs
• industrial commodities 

But more importantly, it raises the cost of servicing external obligations and financing import dependence, particularly in energy. 

This puts the central bank in a constrained position. 

Higher interest rates are used to:

• defend the currency by narrowing interest differentials
• reduce capital outflow pressure
• stabilize expectations in FX markets 

But these same rate increases risk tightening domestic credit conditions in an economy already facing weak external demand and rising import costs. 

The BSP therefore faces a dual transmission problem: 

• defend the peso to contain imported inflation
• avoid over-tightening that weakens domestic growth and financial stability 

The fact that the BSP is tightening policy while imposing regulatory relief for banks reflects this intensifying tension between external stabilization and internal fragility management. 

And it is not only the central bank responding to these pressures. 

Citing risks related to the Middle East conflict and global energy uncertainty, a major domestic bank—Bank of the Philippine Islands—recently indicated that it has begun tightening consumer credit standards. 

While framed as a precaution against external shocks, the move may also reflect mounting stress within household balance sheets, particularly after credit-card non-performing loans reached record highs as of December 2025— reinforcing what we describe as the Wile E. Coyote “denominator effect” dynamic. (Figure 1, lower image) 

This is no longer a pure inflation cycle. It is increasingly a balance-of-payments-sensitive monetary tightening regime. 

III. The Record Balance-of-Payments Deficit 

The external sector is now the primary amplifier of domestic macro stress.

Figure 2

The Philippines recorded a record first-quarter balance-of-payments (BoP) deficit, reflecting sustained net dollar outflows. (Figure 2, topmost pane) 

At its core, the balance of payments measures whether the country is accumulating or depleting foreign currency buffers. A deficit signals persistent dollar leakage. 

The immediate drivers are familiar:

• rising energy import costs and persistent trade deficits
• weaker portfolio inflows amid higher global interest rates
• capital outflows and elevated external debt repayments 

But the more important mechanism is how the system actually finances external shocks. 

Energy and oil price spikes do not simply show up as higher import bills. They are absorbed through a layered financing structure: external borrowing, portfolio inflows into government securities, and—crucially—drawdowns of foreign reserves. 

Gross International Reserves (GIR) function as the first shock absorber, temporarily covering imbalances before adjustment shows up in the exchange rate. This buffer, however, is not neutral. The BSP reported that GIR fell by over USD 6.6 billion in March 2026 to USD 106.6 billion—the largest monthly decline since at least 2012—driven partly by valuation effects from gold prices, but also by intervention pressures and external payment financing needs. (Figure 2, middle and lowest graphs) 

This is where recent bond market dynamics and index-related inflows become relevant: they operate less as signals of confidence and more as temporary financing channels for external imbalances that the reserve buffer alone cannot fully absorb. 

The result is sustained pressure on the peso. 

Exchange rate movements reflect underlying imbalances—particularly when dollar inflows are insufficient to cover import demand and debt-related outflows—while also serving as the primary adjustment mechanism. 

That adjustment then feeds directly into domestic inflation, given the Philippines’ structural dependence on imports for:

• fuel and energy inputs
• food commodities
• intermediate industrial goods
• consumer goods 

The causal chain is therefore not simply: 

BoP deficit → peso depreciation → inflation 

but, more comprehensively, can be framed as: 

external shock (energy) → higher import bill and financing needs → increased reliance on borrowing, portfolio inflows, and reserve drawdowns → depletion of GIR buffers → widening BoP deficit → FX market pressure → peso depreciation → imported inflation → monetary tightening

At that point, monetary policy is no longer setting conditions independently. It is reacting to external financing constraints embedded in the energy import structure of the economy. 

In effect, economic growth itself becomes constrained by the availability of external financing. When an economy relies heavily on imported energy and persistent trade deficits, expansion requires a steady inflow of foreign capital or reserve drawdowns to finance those gaps. Once those inflows weaken, growth becomes limited not by domestic capacity alone, but by the system’s ability to secure foreign currency. 

IV. The Yield Curve’s Warning Signal 

Financial markets reacted immediately to the rate hike. 

Figure 3

Philippine government bond yields spiked at the belly of the curve, producing a bearish flattening. 

In practical terms:

• mid-term yields rose sharply, reflecting inflation risk and policy tightening expectations
• long-term yields rose less, suggesting markets expect weaker growth and eventual policy easing or constraint 

This pattern is not neutral.

A bearish flattening typically emerges when investors believe tightening will compress economic activity faster than it resolves inflation pressures. 

But in the current context, the signal is more specific than a standard cycle interpretation. 

The yield curve now reflects a system where three constraints are converging simultaneously:

• monetary tightening aimed at defending inflation credibility and the currency
• widening fiscal deficits increasing sovereign issuance and duration pressure
• external financing stress amplifying currency risk and imported inflation 

In that sense, the curve is not simply pricing slower growth. 

It is pricing policy collision with structural imbalances. 

When fiscal expansion, external deficits, and monetary tightening operate simultaneously, bond markets begin to shift from pricing inflation expectations to pricing sustainability constraints—particularly the ability of the system to finance itself without continuous external support. 

This is the point where yield curves begin to reflect not just cyclical tightening, but the kind of debt and financing sustainability concerns highlighted in the work of Reinhart and Rogoff on emerging market stress episodes. 

In this environment, the BSP’s rate hike may still anchor short-term inflation expectations, but the curve suggests markets are increasingly focused on the medium-term interaction between fiscal expansion, inflation, external vulnerability, and growth deceleration. 

The message is therefore not only that tightening may slow growth. 

It is that policy tightening is occurring inside a system where fiscal and external constraints are already binding. 

V. Liquidity Is Not Confidence 

One development that risks obscuring these structural weaknesses is the Philippines’ expected inclusion in a major emerging-market bond index administered by JPMorgan Chase. 

Index inclusion is widely celebrated by authorities as a vote of investor confidence. 

But the mechanics are more prosaic. 

Funds that track such indices must purchase Philippine bonds once the country enters the benchmark. The resulting inflows are technical reallocations, not necessarily discretionary investment decisions based on improving fundamentals. 

In other words, passive flows can create liquidity without signaling confidence. 

In some cases, they can even mask underlying fragility by making it easier for governments to finance deficits. 

Indeed, the Philippines’ inclusion appears to have followed a liquidity surge rather than a return surge. 

Based on ADB data, secondary-market trading volume in Philippine government securities jumped more than 60% in 2025, while foreign holdings climbed to around 4.9%—roughly returning to 2019 levels. (Figure 3, middle and lowest charts) 

Yet despite heavy positioning during the Treasury rally, bond investors have seen limited gains. 

Liquidity arrived—but returns did not. 

That distinction matters. 

Markets can become liquid for many reasons—index rebalancing, regulatory shifts, or global liquidity spillovers—but sustained investor confidence usually reveals itself through returns, not merely trading volume. 

Meanwhile, the macro backdrop tells a different story. 

Fitch Ratings recently revised the Philippines’ sovereign outlook from stable to negative, citing the country’s exposure to energy price shocks and rising external vulnerabilities. 

A negative outlook does not immediately change the country’s investment-grade rating. But it signals growing concern about medium-term macroeconomic risks. 

If fiscal deficits continue widening while the balance-of-payments gap expands, the inflows triggered by index inclusion may end up financing deeper imbalances rather than resolving them. 

And if stagflation pressures intensify, the same liquidity that entered mechanically could leave just as mechanically.  

In that scenario, investors who mistook liquidity for confidence may discover that liquidity works both ways. 

VI. Fiscal Expansion and the Demand Leak 

Fiscal dynamics form the third pillar of the stagflation risk. 

Government spending continues to support domestic demand, but part of that demand inevitably leaks into imports—particularly energy and capital goods. 

The macro mechanism is straightforward:

• Fiscal expansion boosts domestic spending.
• Higher spending increases imports.
• Imports widen the trade deficit.
• The trade deficit worsens the balance-of-payments gap.
• Currency depreciation raises inflation. 

In effect, fiscal stimulus partially leaks into the external sector and returns as inflation through the exchange rate. Monetary tightening must then offset not only domestic demand pressures but also external price transmission through the peso. 

Recent fiscal data confirm that this dynamic is already unfolding. 

March 2026 expenditures reached Php 654.8 billion, the second-largest March spending level on record and the largest outside December, traditionally the peak disbursement month.

Figure 4

Despite a seemingly modest 5.23% year-on-year increase, the government still posted a Php 349.7 billion deficit, the third-largest monthly deficit historically and the largest outside December. (Figure 4, topmost visual) 

For Q1 2026, total expenditures reached Php 1.49 trillion, up 3.2% year-on-year and the largest first-quarter spending level on record. The deficit for the quarter reached Php 355.5 billion, the second-largest first-quarter deficit historically, even though headline narratives emphasized that the deficit had “narrowed” relative to last year. (Figure 4, middle diagram) 

A closer look at revenues reveals additional fragility. 

Total revenues rose 9.25% in March and 13.74% in Q1, but this growth was heavily skewed toward non-tax revenues, which jumped 45.5% in March and more than doubled (149%) in Q1. 

Much of this increase reflects early dividend remittances from Government-Owned and Controlled Corporations (GOCCs)—a timing maneuver rather than evidence of strengthening economic activity. 

As a result, non-tax revenues accounted for roughly 14.6% of total collections, the second-highest share since 2020 when emergency pandemic measures inflated similar inflows. (Figure 4, lowest image)

Figure 5

By contrast, the core signal of economic momentum—tax revenues—showed clear weakness.

Q1 tax collections grew only 4.04% year-on-year, the slowest pace since the pandemic recovery year of 2021 and comparable to the subdued 4.21% growth recorded in 2023. (Figure 5, upper pane) 

In other words, fiscal revenues are increasingly being supported by extraordinary transfers rather than organic economic expansion. 

Meanwhile, spending pressures are likely to intensify. 

The 2026 national budget totals Php 6.793 trillion. With Php 1.49 trillion already disbursed in Q1, roughly 22% of the annual program has been spent. 

This leaves Php 5.30 trillion to be disbursed over the remaining nine months of the year—equivalent to an average of roughly Php 589 billion per month, implying materially higher spending ahead. 

Several forces could accelerate that pace: 

• emergency energy spending amid global supply risks
• catch-up infrastructure disbursements after a slow start to the year
• election-cycle fiscal pressures
• seven consecutive years of spending allocation exceeding enacted budgets (Figure 5, middle graph) 

Debt servicing is already reflecting the cumulative impact of these dynamics.

Total debt servicing—interest and amortization combined—soared 115.6% year-on-year in Q1 to Php 737.4 billion, marking the second-largest quarterly debt service burden since 2024. (Figure 5, lowest chart) 

This increase reflects the combined effects of:

• higher borrowing levels
• elevated global interest rates
• weaker peso conditions
• the compounding impact of repeated deficits 

As fiscal spending accelerates through the remainder of the year, additional borrowing will likely intensify this trend. 

All told, the fiscal accounts reveal a pattern consistent with stagflationary stress: 

• slowing tax revenue growth pointing to weaker economic momentum
• rising programmed public spending, alongside emergency spending increases responding to energy shocks and slowing economic momentum
• increasing debt service tightening fiscal constraints 

The result is a familiar macroeconomic configuration: weakening growth alongside expanding deficits and rising public debt. 

And because much of that fiscal stimulus ultimately leaks into imports, the adjustment returns through the exchange rate—feeding the very inflation pressures the central bank is now attempting to contain. 

VII. Inflation Is Being Politically Managed 

Perhaps the most revealing aspect of the current environment is how authorities are attempting to manage rising costs. 

Instead of relying primarily on monetary policy, the government has increasingly turned to administrative interventions across sectors.

Examples include: 

• price caps on essential food items such as canned sardines—even as producers warn that sardine prices will soon rise
• pressure on oil companies to implement fuel rollbacks
• regulatory threats that the state could intervene or even take over segments of the petroleum industry for non-compliance
• sustained fare suppression for domestic transport operators 

Yet policy treatment is far from uniform. 

Aviation regulators recently allowed airlines to raise fuel surcharges, pushing up ticket prices. Meanwhile, land transport operators remain subject to fare suppression even as fuel and operating costs climb. 

The result is an asymmetric price system. 

Some sectors are allowed to pass on costs. Others are forced to absorb them. 

Such asymmetry reveals that inflation is increasingly being managed politically rather than economically. 

Sectors with concentrated market power or stronger institutional leverage are allowed to adjust prices, while politically sensitive sectors—particularly those affecting mass consumers—are subjected to administrative controls. 

The result reflects a familiar political-economy pattern: concentrated benefits and dispersed costs, a dynamic long observed in the work of economist Mancur Olson. 

At the same time, price caps and administrative rollbacks distort the information function of markets. Prices cease to transmit signals about scarcity, costs, and demand conditions. Instead, they become political variables. 

As Friedrich Hayek argued, when price signals are suppressed, economic coordination deteriorates. 

Producers respond by cutting output, delaying investment, or reducing quantity (shrinkflation)—or quality adjustments (skimpflation) that eventually reappear as shortages or service deterioration. 

Recent reports of domestic carriers cutting routes after prolonged fare suppression illustrate how supply eventually adjusts when prices cannot. 

Ironically, the policy contradictions are now visible even in official inflation projections.

Figure 6

The BSP itself now expects inflation pressures to rise toward around 6.3% in 2026, despite the growing use of price caps and administrative interventions. (Figure 6, topmost image) 

With inflation averaging just 2.83% in Q1, the BSP’s 6.3% inflation outlook for 2026 implies roughly 7.5% inflation over the remaining nine months of the year. For example, sardine producers have already warned about price increases despite the DTI’s implicit price cap. 

In other words, the authorities appear to be tightening monetary policy while simultaneously acknowledging that inflation will remain elevated. 

As a side note, an average inflation rate of around 7.5% over the remaining nine months would reinforce our earlier prognostication of a third wave in the inflation cycle. (Figure 6, middle chart) 

That is to say, if inflation is expected to rise even under expanding price controls, the implication is difficult to ignore: the controls are not suppressing inflation—they are merely redistributing it across sectors and over time. 

What disappears from official price indices today often reappears tomorrow in the form of higher subsidies or balance sheet transfers, deteriorating service quality, or supply shortages.

Inflation, in this sense, is not being eliminated. It is being reallocated.  

Blunt truth: Price controls inevitably fail. 

VIII. Mounting Social Stress Signals 

The macroeconomic pressures described above are no longer confined to fiscal accounts, bond markets, or exchange rates. 

They are increasingly visible at the household or even at the grassroots levels. 

A recent SWS survey on perceived quality of life suggests a spike in the share of Filipinos reporting worsening financial conditions, potentially reflecting the cumulative impact of rising living costs, stagnant real incomes, eroding savings and weakening economic momentum. This trend has been gradually rising since 2018. (Figure 6, lowest image) 

At the same time, localized crises are multiplying. 

Within a span of roughly two weeks, three separate state-of-calamity declarations were issued: first in Cagayan de Oro, then in the City of Baguio, and most recently the Cagayan Valley region. Officials attribute these emergencies to a mix of drought conditions, energy costs, and disruptions to local livelihoods. 

But the clustering of such declarations raises a broader macroeconomic question. 

Natural shocks occur regularly in the Philippines. What appears to be changing is the economy’s ability to absorb them. 

When food prices surge, fuel costs rise, or weather shocks disrupt production, the system increasingly responds with emergency fiscal transfers, price interventions, and regulatory measures. Each episode becomes another localized crisis requiring state intervention. 

This deepening reliance on interventions suggests that the country’s economic shock absorbers—household savings, business buffers, and fiscal space—are eroding.

In a healthy expansion, localized shocks remain contained. In a fragile macro environment, they propagate outward. 

Seen in this context, the recent wave of calamity declarations may be less a series of isolated events than symptoms of a broader stagflationary environment: rising costs colliding with weakening growth. 

If that trajectory continues, the risk is not only persistent inflation but also a gradual drift toward recessionary conditions, where policy interventions attempt to cushion economic stress but worsen underlying imbalances. 

IX. The Emerging Policy Trap 

Overall, the week’s developments reveal a difficult macroeconomic configuration. 

The Philippines is confronting simultaneous and deepening pressures from three fronts:

• inflation driven by energy costs and currency depreciation
• fiscal deficits sustaining domestic demand
• external imbalances weakening the peso 

These forces are not independent. They interact in ways that constrain policy choices and reflect a self-reinforcing macroeconomic feedback loop. 

Large fiscal deficits sustain spending and credit expansion, but they also widen the country’s savings-investment gap. That gap must be financed through external borrowing and capital inflows. When those inflows weaken—as reflected in the record balance-of-payments deficit—pressure shifts directly onto the currency. 

Peso depreciation then feeds back into the domestic economy through imported inflation, particularly in energy and food. 

At that point, policymakers face increasingly uncomfortable and complex trade-offs with intertemporal and unintended consequences. 

• Higher interest rates may provisionally stabilize the currency but risk slowing already fragile growth.
• Fiscal support may momentarily sustain activity but widens external imbalances and inflation pressures.
• Administrative price controls may temporarily suppress headline inflation but distort supply and investment decisions. 

Each intervention therefore displaces stress elsewhere in the system—often with unintended consequences. 

What emerges is not a single policy mistake but a policy trap—a configuration where the available tools begin to undermine one another. 

Economist Hyman Minsky observed that prolonged periods of credit-supported stability often evolve into fragile financial structures. When shocks arrive, policymakers attempt to stabilize the system through further intervention, but each intervention can deepen the underlying imbalance. 

The result is a system that becomes increasingly dependent on policy management even as the effectiveness of those policies declines—effectively the law of diminishing returns at work. 

X. Conclusion: Stagflation 3.0: Cure is Worse than the Disease 

While earlier inflation episodes in the Philippines were largely associated with supply disruptions, concealed beneath the headlines were the fiscal, credit, and liquidity effects reinforcing them.

Yet the current environment appears structurally different.

The pressures now emerging reflect deeper forces:

•  persistent and deepening fiscal deficits
•  chronic external imbalances
•  currency weakness feeding imported inflation
•  populist policy interventions increasingly shaping price signals across sectors

 These dynamics are precisely what this Stagflation 3.0 series seeks to examine. 

Although we have long discussed the historical rhyme of Philippine CPI cycles, the term here does not describe a chronological phase of inflation. Rather, it refers to a series of analyses examining how current policy responses—fiscal expansion, administrative controls, and reactive monetary tightening—interact with structural imbalances in the Philippine economy. 

Viewed through this lens, the emerging risk is not simply higher inflation or slower growth. It is the interaction of both—stagflation. 

• Rising costs erode household purchasing power, leading to demand destruction.
• Slowing growth weakens investment and employment. 

Policy responses attempt to cushion these pressures but simultaneously constrain the policy space available to address them. 

In such an environment, macroeconomic management gradually shifts from preventing imbalances to managing their consequences—worsening socio-economic maladjustments. 

The cure becomes worse than the disease. 

And that dynamic may ultimately define the conditions this series describes as Stagflation 3.0.