People always look for political solutions to economic problems. Economic solutions are individually based; they amount to producing more and consuming less. Political solutions are collectively based; they amount to some people deciding how much wealth to take from some other people. The question is, how do political solutions manifest themselves?—Doug Casey
In this
issue
Oil Shock Meets Systemic Fragility: How War, Inflation,
and Liquidity Strains Are Converging on Philippine Banks
I. War, Oil, and Markets: The Shock Transmission Spreads
II. Stagflation Ahoy! Employment Weakens as Inflation
Surges
III. The Financial Plumbing: Liquidity Is Tightening Beneath the Surface
IIIA. Bank Liquidity Buffers Are Thinning
IIIB. The Depository Corporations Survey: Credit Transmission Is Stalling
IIIB.1 Liquidity Detaches From Credit
IIIB.2 External Liquidity Replaces Domestic Credit
IIIB.3 Fiscal Absorption in Bank Balance Sheets
IIIC. The Monetary Authority Survey (MAS): Liquidity Without Transmission
IIID. A Financial System Becoming Balance-Sheet Driven
IV. The Yield Curve’s Hidden Message
V. Oil Shock as the Catalyst for a Banking System Test
VI. The Policy Dilemma Ahead
VII. Conclusion: The Oil Shock Exposes Pre-Existing Fragility
Oil Shock Meets Systemic Fragility: How War, Inflation,
and Liquidity Strains Are Converging on Philippine Banks
The oil shock from the Middle East war exposes underlying financial strains in the Philippine economy, evident in the weakening peso, tightening bank balance sheets, and a shifting yield curve.
I. War, Oil, and Markets: The Shock Transmission Spreads
Figure 1
Since the latest outbreak of the Middle East conflict involving US, Israel on Iran, global oil markets have repriced sharply. The US WTI and Brent Oil benchmarks have traded slightly below and above the $100/barrel. (Figure 1, topmost chart)
For an import-dependent economy like the Philippines, the transmission mechanism was immediate.
Three domestic market reactions stand out. The ‘oil shock’ aggravates the structural pressure from persistent external deficits from the deepening savings-investment gap imbalances
First, the peso plunged to a record low against the dollar, with the USD/PHP exchange rate surging to 59.735, the highest level on record. (Figure 1 middle graph)
The move reinforced the breach of the Bangko Sentral ng Pilipinas’ (BSP) 59-level “Maginot Line,” a ceiling the central bank had defended from 2022 through late 2025.
The March 13 breakout was accompanied by interbank trading volume jumping 16% to roughly $2.23 billion, marking the fifth-largest turnover since 2025 amid the pair’s sharp upward spiral this March.
Notably, earlier breakouts were rarely accompanied by comparable surges in trading volume, likely reflecting BSP interventions in the market. (Figure 1, lowest image)
In contrast, the current episode appears to signal strong underlying demand for the US dollar, suggesting that momentum could soon put the 60 level to an immediate test.
The oil shock further aggravates these pressures, compounding the peso’s weakness alongside persistent external deficits stemming from a widening savings–investment gap.
Second, domestic equities began to unravel.
The PSEi erased most of its early-year gains (+0.1% YTD
as of March 13), as the prospect of higher energy costs—on top of rising
inflation, weaker GDP growth, currency volatility, tighter financial
conditions, and continued foreign selling—dampened sentiment and offset earlier
orchestrated pumps of the index.
Figure 2
Third, the domestic bond market began adjusting to mounting inflation risks. Philippine government securities sold off across the curve, while the yield curve reshaped itself through a bearish flattening—a configuration that typically signals rising financial stress rather than healthy growth expectations. (Figure 2, top and middle visuals)
In short, markets quickly priced the oil shock not as a temporary disturbance, but as a binding macroeconomic constraint.
II. Stagflation Ahoy! Employment Weakens as Inflation Surges
The ‘oil shock’ arrives precisely as the domestic economy is already emitting stagflationary signals.
Inflation accelerated again in February. Philippine CPI
rose to 2.4%, marking the fourth consecutive monthly increase and a 13-month
high.
Figure 3
More alarming was the surge in food inflation for vulnerable households. Food CPI for the bottom 30% income group spiked from 0.6% in January to 2.2% in February, suggesting rising hunger and worsening self-rated poverty among a substantial share of families—despite the rollout of Php 20 rice programs and government-mandated maximum suggested retail prices (MSRPs). (Figure 3, topmost window)
Crucially, these developments occurred before the oil
shock. Yet the first wave of its impact is already visible:
- staggered ‘jumbo’ fuel price increases
- ferry operators beginning to raise fares
- gasoline stations reportedly hiking prices ahead of authorized adjustments
- the Department of Trade and Industry (DTI) warning against hoarding and profiteering
- Meralco announcing another power rate hike on top of January’s GEA-related increase
- Water Utilities, Maynilad and Manila Water to raise rates in the second quarter
A further inflation risk lies in agricultural inputs. The Philippines remains heavily dependent on imported urea fertilizer, much of it sourced from the Gulf region. (Figure 3, middle diagram)
Any disruption to supply chains or price spikes linked to Middle East tensions could raise production costs for domestic agriculture, creating second-round pressures on food prices in the months ahead.
And more drastic adjustments are likely to follow. The snowballing effects and feedback loops from higher energy costs could feed into what may become the third wave of Philippine CPI cycle.
Figure 4
At the same time, as the GDP wobbles, labor market conditions are deteriorating. Unemployment rose to 2.96 million in January 2026—a pandemic era high, while underemployment also increased. Employment rate fell to 94.2%, lowest since June 2022 (Figure 4, topmost image)
More concerning are the sectoral shifts beneath the
headline numbers:
- agricultural employment contracted (Figure 4, middle chart)
- trade employment declined sharply
- labor force participation fell, suggesting that official unemployment figures may understate actual labor slack (Figure 4, lowest image)
- displaced workers increasingly moved into lower-productivity informal sectors
Rising fertilizer costs also threaten agricultural employment and output, compounding the deterioration already visible in rural labor markets.
These shifts are critical because they indicate weakening household income capacity precisely as prices for essential goods—fuel, electricity, and water—are rising.
Moreover, with conflict in the Middle East ongoing, more overseas Filipino workers (OFWs) are being repatriated. This is not merely a humanitarian issue—it also carries macroeconomic consequences.
As repatriations increase, returning workers expand the domestic labor pool, potentially pushing unemployment or underemployment higher.
At the same time, fewer workers abroad could mean weaker remittance inflows, widening the Philippines’ balance-of-payments (BoP) deficit—a consequence of its savings-investment gap—and intensifying pressure on the peso.
Remittances are a key pillar of household consumption and savings formation, so disruptions could dampen domestic demand.
This combination—rising costs colliding with weakening income growth—is the textbook definition of stagflationary pressure.
For a banking system heavily exposed to consumer lending, mortgages, and corporate leverage, such an environment gradually erodes balance-sheet quality.
III. The Financial Plumbing: Liquidity Is Tightening Beneath the Surface
The real story, however, lies beneath the macro headlines—in the financial plumbing of the banking system.
Recent balance-sheet data from the Bangko Sentral ng
Pilipinas reveal a system quietly tightening.
IIIA. Bank Liquidity Buffers Are Thinning
Key indicators already show signs of intensifying pressure.
Figure 5
Both cash-to-deposit and liquid-assets-to-deposit ratios have been trending downward, indicating that banks are operating with thinner liquidity buffers relative to their funding base. (Figure 5, topmost pane)
At the same time, although the non-performing loan (NPL) ratio ticked higher in January from its May 2025 lows, the percentage metric masks a deeper Wile E. Coyote velocity dynamic.
While the NPL ratio appears relatively contained, gross NPLs measured in pesos have actually climbed to fresh record highs in January. The expansion of bank credit—through the denominator effect—suppresses the ratio even as the absolute level of distressed loans continues to rise. (Figure 5, middle graph)
To recall, aside from this denominator effect, the
suppression of the NPL ratio can also arise from a combination of factors:
- loan restructurings
- charge-offs
- regulatory relief measures
- reclassification effects
- inaccurate reporting
Viewed from the peso lens, NPLs reveal mounting distress within the system. Viewed from the ratio perspective, the deterioration appears modest. Yet the direction of travel remains critical. Historically, NPL ratios lag economic stress rather than lead it.
If GDP weakens further while employment softens and energy prices help erode the purchasing power of the peso, this deterioration could accelerate.
The dynamic resembles what Hyman Minsky described as the transition from hedge finance toward speculative finance. During periods of easy liquidity, borrowers accumulate obligations under the assumption that refinancing will remain available. But when shocks—such as an oil spike, fiscal strain, or currency depreciation—raise costs while eroding incomes, balance sheets that once appeared stable can quickly become fragile.
IIIB. The Depository Corporations Survey: Credit Transmission Is Stalling
The Bangko Sentral ng Pilipinas Depository Corporations Survey (DCS) provides a system-wide view of balance sheets across the banking sector. Recent data suggest that the traditional transmission mechanism between liquidity and credit creation is beginning to weaken.
IIIB.1 Liquidity Detaches From Credit
Historically, money supply growth in the Philippines has closely tracked bank lending. In a bank-dominated financial system, loans create deposits, and deposit expansion feeds directly into the growth of broad money.
Recent data, however, show that this relationship has broken down.
Universal and commercial bank loan growth has been rolling over since mid-2025 even as broad money (M3) continues to expand. The divergence suggests that liquidity creation is increasingly being driven by balance-sheet channels other than private credit expansion. (Figure 5, lowest visual)
In other words, liquidity is still growing—but the mechanism generating that liquidity is shifting.
IIIB.2 External Liquidity Replaces Domestic Credit
The shift becomes clearer when examining the external
side of the banking system’s balance sheet.
Figure 6
Even as domestic lending slows (claims on Private sector), net foreign assets within the financial system have expanded. Higher gold prices, reserve valuation effects, and external borrowing have all contributed to rising foreign asset positions. Net foreign assets were up 5.9% and 10.2% in the first two months of 2026, while claims on the private sector posted hefty gains of 10.7% and 10.6% respectively. (Figure 6, topmost window)
These external balance-sheet gains inject liquidity into the domestic financial system despite slowing private credit growth.
The implication is that a growing share of monetary expansion is being supported by external balance-sheet dynamics rather than internal credit creation.
IIIB.3 Fiscal Absorption in Bank Balance Sheets
Another structural shift appears in the composition of bank assets.
As lending to the private sector slows, banks’ claims on the national government (NCoCG) continue to expand. This suggests that sovereign borrowing is increasingly absorbing liquidity within the financial system. (Figure 6 middle chart)
When government borrowing begins to dominate balance-sheet expansion, it crucially reflects a crowding-out mechanism, in which the state becomes the primary absorber of financial resources while private credit growth weakens.
This dynamic creates a paradoxical condition: liquidity remains abundant within the monetary system, yet the flow of credit into productive economic activity begins to substantially slow.
From the perspective of Austrian capital theory, this
shift reflects the kind of structural
distortion that prolonged liquidity accommodation can generate. As the late
Austrian economist Roger W. Garrison argued, credit expansions can redirect financial resources toward sectors or
activities that appear viable only under persistently easy financial conditions.
When lending momentum slows or
funding conditions tighten, the underlying structure of investment begins to
reveal its fragilities.
IIIC. The Monetary Authority Survey (MAS): Liquidity Without Transmission
If the Depository Corporations Survey reveals the evolving structure of bank balance sheets, the Monetary Authority Survey (MAS) shows how the central bank’s own balance sheet is shaping liquidity conditions.
Recent MAS data point to a subtle but important change in the character of monetary expansion.
One revealing indicator is the divergence between currency in circulation and broad money growth.
Currency issuance has slowed even as M3 continues to expand. Normally, expanding deposits eventually translate into greater currency usage as money circulates through the broader economy.
When currency growth decelerates while deposits continue rising, it suggests that liquidity is remaining within the bank dominated financial system rather than circulating through real economic activity.
This pattern suggests a financial environment in which monetary liquidity expands while bank balance-sheet liquidity tightens.
Sovereign borrowing increasingly absorbs bank asset capacity while external balance-sheet dynamics inflate monetary aggregates.
The result is a divergence: liquidity appears abundant in the monetary statistics even as credit transmission to the private economy weakens.
IIID. A Financial System Becoming Balance-Sheet Driven
Taken together, the signals from the DCS and MAS point to a financial system undergoing a structural transition.
Bank lending growth is slowing. Domestic credit expansion is weakening. Currency circulation is decelerating.
Yet monetary liquidity continues to expand—supported by external asset accumulation, sovereign borrowing, and balance-sheet adjustments within the financial system.
In other words, system liquidity is still growing, but it is increasingly detached from private credit creation and real economic activity.
Importantly, these shifts were already visible in the data before the oil shock emerged. The system entered the current energy shock with underlying financial imbalances already developing beneath the surface.
The oil shock therefore did not create the stress now appearing across markets. It merely accelerated and exposed the structural strains that had already begun to form within the country’s financial architecture.
IV. The Yield Curve’s Hidden Message
Finally, the government bond market is beginning to reflect these tensions.
Figure 7
Since the outbreak of the Middle East conflict, the Philippine yield curve has shifted toward a bearish flattening, led by a selloff in the belly of the curve—particularly the 5- to 10-year segment. (Figure 7, upper chart)
Even the front end, which typically reflects expectations about future monetary policy, has begun to rise. (Figure 7, lower graph)
The increase in short-term Treasury bill yields suggests that markets are beginning to reassess expectations for monetary easing, reflecting growing concern that inflationary pressures and fiscal risks may constrain policy flexibility.
Yet, such movements in the yield curve often emerge when
markets begin pricing a combination of risks:
- inflation pressures
- weakening economic growth
- rising fiscal borrowing needs
- duration risk
Recent policy responses reinforce these concerns. Authorities have begun rolling out subsidies for tricycle and jeepney drivers, and the fisherfolks, including a proposed Php 3.5-billion program to subsidize commuters and partially finance the fuel costs of public utility vehicles (PUVs).
In the world of “free-lunch politics,” such subsidies risk widening fiscal deficits. The Treasury curve increasingly appears to be pricing the possibility that oil-shock relief measures could translate into larger borrowing requirements and once again inflationary pressures.
In other words, the curve is not signaling healthy economic expansion.
Instead, it points toward tightening financial conditions and rising interest-rate pressures. Most importantly, it reflects financial stress emerging under inflation constraints.
For banks, this shift in the yield curve is not merely a
market signal. It directly affects
funding costs, asset valuations, and the profitability of maturity
transformation—the core business model of the banking system.
V. Oil Shock as the Catalyst for a Banking System Test
Taken individually, each of these developments might appear manageable.
Taken together, however, they form a reinforcing loop.
Higher oil prices worsen the trade deficit and weaken the peso—an outcome that organically reflects the widening savings-investment gap in the domestic economy.
A weaker peso raises the cost of imports and intensifies inflationary pressures.
Rising prices compress real household incomes, while employment weakens as economic growth slows.
The deterioration of household balance sheets eventually translates into rising loan stress within the banking system.
As risks increase,
banks respond by tightening lending standards and slowing credit
growth. The resulting credit contraction then further dampens economic
activity, reinforcing the cycle.
This is the mechanism through which macroeconomic shocks propagate through financial systems.
VI. The Policy Dilemma Ahead
The challenge for policymakers is that the traditional policy response may no longer be readily available.
If inflation remains elevated due to oil prices and currency pressures, the central bank cannot easily deploy aggressive monetary easing.
Yet if economic growth slows and credit conditions
tighten, the usual policy reflex is to rely on easy-money support from the
banking system.
If recession risks become imminent, the increasingly crowded fiscal space not only limits the scope for government intervention but may itself amplify financial fragility.
This is the classic emerging-market policy trap: inflation constrains monetary easing just as financial fragility begins to demand it.
The dilemma is not purely economic but also institutional. Public choice economists such as James M. Buchanan emphasized that policymakers face incentives to favor short-term stabilization over long-term adjustment.
Over time, as Mancur Olson observed, institutional arrangements tend to accumulate rigidities that make meaningful reform increasingly difficult.
VII. Conclusion: The Oil Shock Exposes Pre-Existing Fragility
The current oil shock is not creating the Philippines’ financial vulnerabilities. It is revealing them.
Years of debt expansion, fiscal deficits, and reliance on liquidity support have already stretched balance sheets across households, corporations, banks, and even the government itself.
The war-driven surge in oil prices simply adds another layer of stress to an already fragile system.
If energy prices remain elevated and the peso continues weakening, the Philippine banking sector may soon face a test not seen since the pandemic period—this time under far less accommodating global financial conditions.
The coming months will determine whether the financial system can absorb the shock.
Or whether the oil spike ultimately becomes the catalyst that exposes deeper structural strains within the country’s financial architecture.
Caveat Emptor.
