Economic interventionism is a self-defeating policy. The individual measures that it applies do not achieve the results sought. They bring about a state of affairs, which—from the viewpoint of its advocates themselves—is much more undesirable than the previous state they intended to alter—Ludwig von Mises
In this issue:
Stagflation Part 10: The Politics of Contradiction—Rate
Hikes, Liquidity Addiction, and External Constraint Under Balance-Sheet Stress
I. The Contradiction Nobody Wants to Discuss
II. The Market Rally That Allowed the BSP to Blink
III. BSP: Tightening with One Hand, Accommodating with the
Other
IV. Economic Fragility, Political Fragility
V. Mounting External Constraints Under Balance-Sheet Stress
VI. USD 2.5 Billion Borrowing, Refinancing Risk, and the
Deepening Dollar Short
VII. Conclusion: Stagflation and the Political Economy of Deferred Adjustment
Stagflation Part 10: The Politics of Contradiction—Rate Hikes, Liquidity Addiction, and External Constraint Under Balance-Sheet Stress
The BSP tightened, markets celebrated, and the government borrowed another $2.5 billion abroad. What appears as stability increasingly depends on intervention, leverage, and external financing.
I. The Contradiction Nobody Wants to Discuss
The BSP raised rates for a second time.
It also raised its inflation forecasts for both 2026 and 2027. The peso rallied. Treasury yields fell. The PSEi posted one of its strongest advances of the year.
Authorities extended salary-loan maturities.
Domestic liquidity continued expanding.
The government returned to international markets for another USD 2.5 billion in dollar borrowing.
Meanwhile, regulators openly warned about rising foreign exchange exposure and a growing wall of corporate refinancing obligations over the next several years.
Viewed individually, each development appears manageable.
Viewed together, something does not fit.
If inflation risks are rising, why are financial conditions easing?
If tighter monetary policy is necessary, why are new forms of credit accommodation being introduced?
If external conditions are improving, why is additional foreign borrowing required?
If peso stability is fundamentally secure, why is increasing attention being paid to foreign exchange behavior and refinancing risk?
The contradiction is becoming difficult to ignore because it is increasingly the structure of policy itself.
Officially, authorities acknowledge inflation pressures, external vulnerabilities, slowing growth, and rising financial risks.
Operationally, policy continues to prioritize liquidity preservation, leverage maintenance, and the postponement of adjustment.
Figure 1
Even the government's own think tank, the Congressional Policy and Budget Research Department, has begun openly discussing conditions consistent with stagflation and warning against further expansionary spending. (Figure 1, upper image)
That admission is an affirmation of this series' thesis: the symptoms — persistent inflation alongside weakening economic activity — have become too visible to dismiss even from within the policy establishment itself.
When official diagnostics begin to register stagflation-like conditions while policy continues to operate in a mixed tightening–accommodation regime, the gap between competing explanations narrows in practice even if it remains formally unresolved. The direction of causality is therefore asymmetrical: lived and financial conditions shift first, institutional recognition follows.
This is where stagflation is often misunderstood.
It is treated as a statistical condition—inflation plus stagnation plus unemployment. Yet statistics are not lived reality. They are delayed summaries of processes already unfolding.
What matters is not when the data finally “recognizes” stagflation, but what produces it.
As previously discussed, the Philippine experience of the 1970s makes this clear.
After the 1973 and 1979 oil shocks, the economy did not immediately register a textbook stagflationary outcome. There was no clean recession. Output did not collapse on cue. On paper, the system remained functional. (Figure 1, lower window)
But lived conditions told a different story.
Prices rose. Shortages emerged. Purchasing power eroded. Rationing and administrative allocation became more visible. Household welfare deteriorated even as aggregate statistics continued to suggest motion.
But policies that suppress adjustment in order to preserve activity do not remove imbalances. They relocate them forward in time.
External borrowing expanded. Credit was extended. State intervention deepened. Financial accommodation smoothed over the gaps. Adjustment was not eliminated; it was deferred and financed.
The system continues to operate, but increasingly on the basis of accumulated leverage, external dependence, and postponed correction.
The 1983 debt crisis manifested through financial distress, tightening external constraints, and systemic funding breakdown, with its statistical expression—recession, inflation pressures, and broader financial stress—appearing only in the subsequent data as a lagging record of developments already underway.
The lesson is not that stagflation suddenly “arrived” in 1983.
It is that it had already been produced long before, and was merely waiting for the mechanisms of suppression to fail.
The issue is not simply empirical—whether inflation is high, growth is weak, or unemployment is rising. Those are late or lagging indicators.
The issue is causal.
A system that repeatedly uses policy to preserve liquidity, stabilize financial conditions, and defer balance-sheet adjustment does not eliminate economic constraints. It attenuates the feedback mechanism and the economy's innate ability to cope with changes. Instead, imbalances accumulate.
Each intervention may stabilize the present. Collectively, they reduce the economy’s adaptive capacity. Over time, fragility increases.
This is why focusing exclusively on whether the current data meets the textbook definition of stagflation misses the point.
By the time the statistics confirm it, the adjustment process is already well underway.
Recent developments suggest this same pattern is re-emerging.
Stagflation, in this sense, is not a starting point. It is a late-stage expression of a deeper political economy problem—the attempt to maintain stability in the face of constraints that are no longer fully compatible.
II. The Market Rally That Allowed the BSP to Blink
The PSEi 30 posted its biggest one-day gain of 6.14% on June 15th since May 27 2021’s 5.11%, while its 3.81% weekly advance was the largest in 2026.
Yet beneath the headline, the rally was remarkably
narrow.
Figure 2
Over the week, the three largest banks accounted for more than half—or ~50.94%—of the index's gain. Their cumulative market share of the PSEi 30 bounced from 18.35% in June 11 to 19.28% in June 18. (Figure 2, topmost pane)
Adding ICTSI raised that contribution to nearly two-thirds, or ~62.96% of the entire advance.
Concentration was not limited to index leadership, but
extended to participation and trading activities as well.
For the week, while ICT commanded 23.84% of main board volume, the top 3 banks accounted for an average of 17.9%. Top 10 brokers averaged about 64% of main board volume—underscoring the degree to which price formation was concentrated in a small number of dominant institutional channels responsible for setting marginal prices across the index.
This was not a broad-based repricing of Philippine growth prospects.
It was a liquidity-driven, orchestrated repricing concentrated in heavyweight financial issues — sufficient to move the index while leaving much of the broader market still lagging, despite this week's broad-based gains. (Figure 2, second to the highest graph)
As an aside, outsized one-day gains—as statistical tails—rarely emerge under ordinary market conditions. They tend to cluster near:
- major bottoms, where panic is exhausted
- major tops, where liquidity temporarily overwhelms deteriorating fundamentals
- or regime transitions, where expectations reprice abruptly
- Jan 22, 2001 +17.6% (EDSA II / Estrada ouster)
- Aug 21, 2007 +9.82% (Great Financial Crisis credit panic rebound)
- Mar 26, 2020 +7.44% (COVID collapse rebound)
The bond market delivered a similar signal.
Treasury yields declined across the curve, particularly in the belly and long end, producing another episode of bullish flattening. (Figure 2, second to the lowest and bottom images)
Figure 3
Global markets interpreted the collapse in oil prices following the US-Iran ceasefire as increasing the probability of easier monetary conditions.
The PSE’s financials responded accordingly.
In theory, banks benefit mechanically from declining yields: improved credit demand conditions, stronger mark-to-market positions, easing funding stress, and higher collateral values.
Yet this is where the sequence becomes more revealing.
For months, the BSP had signaled openness to stronger ‘anti-inflation’ responses, including larger rate hikes and potential off-cycle action.
Inflation risks were repeatedly emphasized.
Instead, the BSP delivered another modest increase last week while simultaneously raising inflation forecasts for both 2026 (from 6.3% to 6.4%) and 2027 (from 4.3% to 4.5%). (Figure 3, upper image)
Taken at face value, and using the BSP’s own internal trajectory assumptions, this implies CPI pressures approaching roughly 8% on a near-term horizon (remaining eight months) as cumulative effects of past policy and external shocks propagate through the system.
The significance is not the precision of any single point estimate, but the directional signal embedded in successive forecast revisions despite incremental tightening.
The significance is not the magnitude of the revision alone.
It is the coexistence of three signals:
- incremental tightening on the policy rate side
- upward revision of inflation expectations
- and easing in broader financial conditions
That combination reflects a policy regime operating under conflicting constraints.
Containing inflation requires tighter financial conditions.
Preserving growth, managing sovereign financing, and preventing financial stress increasingly require easier ones.
This is where the market move becomes analytically relevant—as a temporary offset to policy.
The rally in equities, decline in yields, and strengthening peso collectively loosened financial conditions at precisely the moment policy communication was attempting to maintain an anti-inflation stance.
In effect, markets temporarily absorbed part of the tightening dilemma by easing financial conditions through asset price and yield movements—functioning as an indirect signal transmission channel for BSP policy expectations.
This gave policymakers additional room to avoid a sharper trade-off between inflation control and financial stability, thus, the modest rate hike that effectively buys time and reduces the immediacy of the further policy tightening.
The BSP’s reaction function therefore remains constrained not only by domestic inflation dynamics, but by the sensitivity of asset markets and funding conditions to policy signaling.
And this reveals the contradiction increasingly visible throughout the framework.
While monetary authorities continue speaking in inflation-hawk language, the system continues to rely on liquidity-sensitive transmission channels that behave as if easing conditions remain structurally necessary.
Inflation pressures, however, did not begin with the recent oil shock.
- Monetary aggregates had already accelerated.
- Credit growth remained strong.
- Asset markets continued to reflect dependence on accommodative financial conditions.
Oil shocks can catalyze inflation dynamics, but they do not create them in isolation.
Sustained broad based or general inflation requires demand pressure—and in this case, that demand pressure has been increasingly supported by financial accommodation embedded in the system itself.
The recent spike in CPI has been accompanied by a surge in M3 ahead of the oil shock. (Figure 3 lower chart)
Despite tightening rhetoric, that accommodation remains visible across credit, liquidity, and asset pricing channels.
III. BSP: Tightening with One Hand, Accommodating with the Other
Perhaps the clearest example emerged from the BSP's decision to extend the maximum repayment period for salary-based general purpose loans from five years to seven years.
Authorities described the measure as improving affordability without encouraging excessive borrowing.
Yet extending maturities is itself a form of accommodation—a subsidy delivered through time.
Lower monthly amortizations increase borrowing capacity.
Borrowers qualify for larger loans. Existing debts become easier to service.
Financial stress is reduced not by repayment, restructuring, or liquidation, but by stretching obligations further into the future.
In an environment of persistent inflation, this matters.
As purchasing power erodes, households increasingly resort to balance-sheet expansion to maintain consumption and bridge the gap between stagnant real incomes and rising living costs. What cannot be financed through income growth is financed through leverage.
The policy therefore addresses symptoms while reinforcing the mechanism that produced them.
This is the great economist Frédéric Bastiat’s “Seen and Unseen” at work.
The seen effect is immediate relief. Monthly payments fall. Borrowers gain breathing room. Delinquencies may temporarily stabilize.
The unseen effects emerge gradually. Household leverage increases. Financial resilience weakens. Future income becomes increasingly encumbered by past borrowing decisions. Lenders become more exposed to a deteriorating credit cycle. Economic growth slows.
Stress is not eliminated. It is redistributed across time.
In many respects, the measure mirrors earlier interventions involving credit-card lending interest rate caps.
Temporary relief mechanisms gradually evolved into semi-permanent features of the financial landscape.
Credit expanded.
Non-performing loans expanded alongside it.
The appearance of stability was maintained through
continued balance-sheet growth.
Figure 4
Salary loans now appear to be moving along a similar trajectory.
Outstanding
salary loans in pesos reached record highs during the first quarter of
2026. At the same time, peso non-performing loans continue to rise and have
already neared the record set in Q2 2024. (Figure 4, topmost graph)
Along with credit card non-performing loans, salary loans
have powered consumer NPLs to record highs. (Figure 4, middle window)
Rapid credit growth can temporarily suppress delinquency ratios through a "Wile E. Coyote dynamic" operating through the denominator effect. Bad loans continue rising, but total loans rise even faster. The result is a statistical mirage in which headline indicators appear manageable even as underlying stress accumulates.
April's universal and commercial (UC) banking data revealed a similar pattern.
Universal and commercial bank lending accelerated to its
fastest pace in nine months.
Meanwhile, M3 growth remained above 12%, sustaining the double-digit expansion that has persisted since before the February oil shock.
At first glance, the numbers appeared reassuring.
Yet the composition of liquidity tells a different story.
- Cash in circulation growth slowed.
- Transactional money steadied.
- Savings deposits accelerated.
Liquidity increasingly migrated toward precautionary balances and interest-bearing instruments. (Figure 4, lowest diagram)
In other words, money continued expanding significantly even as
economic behavior became more defensive.
Figure 5
On the other hand, universal and commercial bank credit
continued growing, but where that credit flowed into continues to be revealing:
- Net claims on the national government in pesos reached another record high in April along with the banking system’s Held to Maturity (HTM) presently reclassified as Debt Securities—net of amortization (Figure 5, topmost window)
- Electricity-sector lending maintained its high-octane record setting growth.
- Consumer credit growth remained robust despite signs of plateauing demand.
- Manufacturing lending barely recovered despite persistent narratives of industrial ‘recovery’. (Figure 5, middle visual)
A growing share of credit creation appears directed toward sovereign financing, consumption maintenance, utilities, and stabilization or (energy) bailout mechanisms rather than broad-based productive investment.
Why this matters.
Credit expansion can sustain spending and support asset prices. It can generate the appearance of activity. It cannot, by itself, expand productive capacity.
Debt can temporarily substitute for income.
It cannot substitute for real savings.
And ultimately it is real savings—not liquidity, leverage, or credit expansion—that determine an economy's capacity to sustain investment, absorb shocks, adapt to changing conditions, and expand productive output over time.
IV. Economic Fragility, Political Fragility
This is where the present policy contradiction becomes most visible.
Even as authorities acknowledge inflation risks and tighten at the margin, the broader policy response continues to favor accommodation, balance-sheet preservation, and the postponement of adjustment.
Yet, politics dominates mainstream incentives. Record-low approval ratings for the national administration are not merely a consequence of weaker growth, high inflation, and fragmented institutions — they are also the reason policymakers keep choosing accommodation over adjustment. (Figure 5, lowest graph)
A government with cratering approval cannot afford the short-term pain that genuine adjustment requires.
The objective is clear: preserve status quo activities, maintain confidence, and avoid financial stress.
The consequence is equally clear. The longer adjustment is deferred, the more resources remain committed to existing arrangements rather than reallocated toward productive conditions. Credit sustains the structure of the economy as it exists, not necessarily as it needs to evolve.
The result is apparent stability.
The cost is declining adaptive capacity, rising fragility, and a widening gap between reported conditions and underlying economic reality. That gap does not stay statistical indefinitely. When lived experience and official narrative diverge long enough, confidence erodes because the data stopped describing what people feel.
That erosion is itself a political risk. A population that no longer trusts the official account of its own conditions does not simply vote differently. It begins disengaging from the institutional channels through which grievances are normally mediated and resolved. As that gap widens, political fragility compounds economic fragility, increasing the risk that future shocks are expressed through social instability rather than orderly adjustment.
This is the convergence this series has been tracking from the start: economic fragility and political fragility are not parallel risks. They share a single root cause. Both are downstream of the same decision — to repeatedly postpone adjustment while the underlying constraints continue to build.
Stagflation, in this sense, was never just a statistical condition. It is what postponement looks like once it has run long enough for the costs to surface in both the balance sheet and the body politic.
V. Mounting External Constraints Under Balance-Sheet Stress
The external sector increasingly reveals the same
contradiction visible elsewhere in the economy.
Figure 6
One of the more curious developments during the first quarter of 2026 was the easing in external debt growth despite a record balance-of-payments deficit. Although the BoP registered a marginal $131 million surplus in April, the cumulative deficit remained at roughly USD 7.28 billion, still higher than the 2022 annual of USD 7.26 billion. (Figure 6, topmost pane)
Persistent external deficits imply greater dependence on external financing because they must be financed, through borrowing, through capital inflows or through reserve deployment or a combination of these.
If external debt remained relatively stable despite a record deficit, reserves likely absorbed a larger share of the adjustment burden.
That said, authorities remain actively engaged in managing peso stability.
Gross international reserves fell to USD 103.99 billion in May, their lowest level since January 2025.
Despite the modest (+.42% YoY) growth in external debt during the Q1 2026, total external obligations continue to exceed reserve levels. (Figure 6, middle image)
At the same time, the economy remains structurally dependent on imported fuel, imported capital goods, and external financing.
The problem is not merely the stock of obligations. It is the growing uncertainty surrounding both the flow of dollars needed to sustain them, and importantly, the domestic conditions upon which expectations of profits, refinancing, and repayment ultimately depend.
Organic sources of foreign exchange are showing signs of strain.
- OFW remittance growth slowed to 2% in April, the weakest pace in nearly four years. Middle East tensions create additional uncertainty for overseas workers. (Figure 6, lowest chart)
- Tourism continues to underperform expectations.
- Global growth is slowing.
- The BPO industry increasingly faces pressure from the diffusion of AI-driven automation across segments of its business model.
Taken as a whole, these developments suggest that future foreign-exchange generation may become less certain amid an insufficient domestic stock of dollar liquidity, precisely when demand for dollars remains elevated.
The BSP’s latest Financial Stability Report offers a
glimpse into the harsh reality of external dependence.
Figure 7
Regulators cited potential market risk involving roughly Php 1.6 trillion in debt maturities and foreign-exchange obligations—a “wall of maturities” concentrated among major conglomerates between 2027 and 2029. This includes “US dollar-denominated debt averaging 37.6 percent of conglomerate debt over the next five years” (Figure 7, upper graph)
The largest exposures are concentrated in real estate, power, energy, and ICT. (Figure 7, lower chart)
These sectors benefited enormously from years of abundant liquidity, low financing costs, stable exchange rates, and favorable refinancing conditions.
They are also among the most exposed to higher energy costs, tighter global dollar liquidity, elevated interest rates, and refinancing risk.
This configuration matters because it links past conditions of abundant external liquidity to future vulnerabilities under tighter global financial conditions.
It is within this context that the BSP’s concern over activity in non-deliverable forwards (NDFs) becomes particularly revealing.
Authorities have warned banks against speculative peso positioning using NDFs.
Yet firms facing refinancing needs, energy exposure, and
substantial foreign-currency liabilities increase their demand for dollar
protection.
Under conditions of uncertainty—rather than quantifiable risk in the Knightian sense—the distinction between hedging, insurance, liquidity management, and speculation becomes inherently blurred. The same action can simultaneously function as protection against loss, adjustment to perceived funding constraints, and positioning for potential gain.
What matters is not the label attached to the behavior, but the environment that makes increased demand for dollar assets a rational response across multiple motives at once.
The BSP may discourage specific transactions.
Yet it cannot eliminate the underlying conditions that generate reflexive demand for protection.
That demand emerges endogenously from the structure of the system: persistent external deficits, refinancing obligations, exposure to foreign-currency liabilities, limited domestic dollar buffers, and uncertainty over future dollar availability.
In that sense, dollar demand is not a discrete behavioral category. It is a system-wide reflex under conditions of uncertainty.
Speculation thus becomes the visible symptom—or a political scapegoat—of deeper underlying pressures.
VI. USD 2.5 Billion Borrowing, Refinancing Risk, and the Deepening Dollar Short
The contradiction becomes clearer when viewed alongside the government’s latest USD 2.5 billion bond issuance.
Officials highlighted strong demand and oversubscription.
But oversubscription only indicates willingness to lend. It does not address why continued external borrowing remains structurally necessary.
Foreign borrowing functions as a balance-sheet extension
mechanism:
- It supports reserve adequacy.
- It finances fiscal and external gaps.
- It smooths rollover pressures.
- It maintains access to foreign-currency liquidity.
Yet each issuance also expands the stock of foreign-currency liabilities that must eventually be serviced through foreign-exchange earnings.
The result is not simply higher debt, but a progressively more leveraged external balance sheet in which refinancing becomes a recurring requirement rather than a contingent event.
This is the logic of a rising “dollar short” at the economy-wide level: a structural condition in which foreign-currency liabilities increasingly exceed the economy’s internally generated and reliably convertible foreign-exchange capacity.
In such a configuration, external borrowing is not a policy choice operating in isolation. It is a response to an underlying constraint: a persistent record savings–investment gap in which domestic spending and investment requirements exceed domestically generated savings, particularly in foreign-currency form.
For an extended period, this gap was accommodated by abundant global liquidity, low interest rates, and stable capital flows. Under those conditions, refinancing appeared routine rather than fragile.
That regime condition is no longer stable.
As external liquidity tightens, the underlying balance-sheet structure is revealed more clearly.
Balance-of-payments deficits, repeated external issuance, and growing reliance on FX-linked financing mechanisms all point to the same configuration: external obligations accumulating faster than reliable foreign-exchange generation capacity.
In this setting, the exchange rate does not determine the constraint. It reflects it.
USDPHP movements are the price signal of a balance sheet increasingly exposed to FX mismatch and refinancing dependence.
The vulnerability is not created by exchange rate movements or external liquidity shifts. Those are transmission channels.
The vulnerability is created and nurtured internally, through the accumulation of FX-denominated obligations against a constrained and uneven foreign-exchange earning base.
External liquidity conditions do not determine the existence of the vulnerability, but they shape its expression, timing, and intensity by affecting refinancing terms, rollover capacity, and the pricing of FX risk. Even in periods of abundant global liquidity, as seen post-2008, balance-sheet fragilities in several emerging markets (e.g., Pakistan, Sri Lanka) still culminated in stress when domestic constraints became binding despite favorable external conditions.
This is also the mechanism through which sudden-stop dynamics emerge: not as an exogenous shock, but as a binding constraint on an already leveraged external position when refinancing and rollovers can no longer be smoothly refinanced.
VII. Conclusion: Stagflation and the Political Economy of Deferred Adjustment
The contradiction is increasingly difficult to ignore.
Authorities acknowledge inflation risks, domestic and external vulnerabilities, and slowing growth. Yet policy remains focused on preserving liquidity, extending credit, supporting asset prices, and securing additional external financing.
None of these measures eliminate underlying constraints. They merely postpone their recognition.
Rising inflation, a weakening peso, and growing debt are not the disease. They are symptoms — the visible residue of a policy regime that increasingly relies on accommodation to manage the consequences of earlier accommodation. Each round of intervention treats the damage from the last one, while leaving the underlying constraint untouched.
That is the central lesson of stagflation. Stability purchased through ever-greater intervention becomes progressively more costly to maintain — in finance, in adaptability, in wealth generation, and eventually in social order.
The feedback loop compounds. Interventions beget further Interventions, and the economy that results is not stable but sclerotic: rigid, slow to adjust, and increasingly dependent on the next intervention to avoid confronting the constraints the previous one deferred.
Left to run, this is a trajectory toward socio-political decay, not merely economic stagnation.
The timing of any inflection point cannot be known. What can be known is the direction. As imbalances accumulate and adaptive capacity weakens, the gap between official stability and underlying conditions widens — quietly, then not quietly at all.
Markets do not ease into that recognition. They reprice it. Political-economic reality reasserts itself. It always does.
____
References:
Stagflation Part 9: The Good News Mirage — Statistical Stability Amid Structural Fragility
Stagflation Then and Now: Why Philippine Markets Are Repricing Like the 1970s (Part 4)
Stagflation by Design: Policy Contradictions and the Return of the Pandemic Rescue Playbook
Stagflation Is Already Here—Emergency Policies Are Now Entrenching It
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