Every time concerns about the Philippine economy resurface, the same indicators usually dominate the discussion. Investors worry about the fiscal deficit, the national debt, the current account deficit, or whether the government’s borrowings have become too large. These measures are important, but according to a recent study by economists from De La Salle University, they may not always provide the earliest warning that a financial crisis is approaching.
In their paper, Lessons from Sectoral Financial Balances for Philippine Crises, Distinguished Professor Jesus Felipe and Associate Professor Mariel Monica Sauler argue that economists and market observers have often overlooked a critical part of the economy: the financial position of the domestic private sector, which includes households, corporations, and financial institutions. Instead of looking at fiscal and external balances in isolation, they suggest examining how these three sectors interact because they are connected through an accounting identity that always balances.
Looking Beyond Government Deficits
Their central argument challenges one of the most common assumptions in economic commentary. While government deficits frequently receive the most attention, the authors contend that previous Philippine crises were more closely associated with periods when the domestic private sector was spending beyond its means and accumulating unsustainable debt.
The study revisits two of the country’s most significant economic crises. Before the severe recession of 1984 and 1985, the Philippines was running both fiscal and current account deficits. Conventional analysis often points to these imbalances as the primary cause of the crisis. Felipe and Sauler argue, however, that the more important development was the growing financial deficit of the domestic private sector. Households and businesses were collectively spending more than their income, increasing debt while reducing their financial resilience. When confidence weakened, the economy became vulnerable to a sharp contraction.
The authors reach a similar conclusion regarding the Asian Financial Crisis of 1998. During the years leading up to the crisis, the domestic private sector again shifted into deficit while the government pursued fiscal surpluses. This combination, together with persistent current account deficits, weakened the economy before external shocks eventually triggered the downturn. According to the paper, it was once again the deterioration of private sector finances, rather than government deficits, that played the more decisive role.
Why Sectoral Financial Balances Matter
For investors, the implication is significant. Market participants often react whenever the government announces a wider fiscal deficit or rising public debt. Yet the study suggests that these figures should not be interpreted in isolation. A government deficit may coexist with a healthy private sector if it supports household savings and corporate balance sheets. Conversely, a seemingly disciplined fiscal position may conceal growing financial stress if businesses and households are becoming increasingly leveraged.
The paper is built around the concept of sectoral financial balances, which divides the economy into three sectors: the domestic private sector, the government, and the rest of the world. By accounting identity, the financial balances of these three sectors must sum to zero. The authors argue that focusing on only one of these sectors, such as the fiscal deficit, without considering the others can produce misleading conclusions about the health of the economy.
One observation is particularly relevant for long-term investors. The authors note that the domestic private sector generally prefers to maintain a financial surplus because persistent deficits imply that households and businesses are spending more than they earn and gradually increasing their debt burden. Such a situation cannot continue indefinitely. As leverage rises, both consumers and companies become more vulnerable to economic shocks, rising interest rates, or declines in income.
What Investors Should Watch
This perspective also changes how investors might interpret economic data. Instead of monitoring only fiscal deficits, it may be equally important to observe trends in household borrowing, corporate leverage, private sector credit growth, consumer spending financed by debt, and business investment funded through increasing liabilities. These indicators can provide early clues about whether financial imbalances are quietly building beneath otherwise stable economic conditions.
The paper does not argue that fiscal deficits are irrelevant or that government debt never matters. Rather, it encourages policymakers and investors to examine the economy more comprehensively instead of relying on a single indicator. As the authors write, analyzing any one of the three financial balances in isolation “is not very meaningful” and can even be “dangerous” because the balances are interconnected.
For stock market investors, the message extends beyond macroeconomic theory. Corporate earnings ultimately depend on the financial health of households and businesses. If consumers become overleveraged or companies accumulate excessive debt, spending, investment, and profitability can weaken long before official economic statistics signal a recession. By the time GDP begins to contract, financial stress within the private sector may already have been developing for years.
A Broader Way To Assess Risk
Every economic cycle has its own unique characteristics, and no single framework can predict every crisis. Nevertheless, the work of Felipe and Sauler offers an important reminder that investors may benefit from broadening the set of indicators they monitor. Fiscal deficits and national debt remain important, but they tell only part of the story.
Sometimes the earliest warning signs of financial instability may not be found in government accounts at all. They may be quietly emerging within the balance sheets of households and businesses, long before they become visible in headline economic statistics.
