The Philippines: Reduced liquidity uncovers excessive corporate leverage at the largest companies

It has not been a good year for the Philippines. Weaker pes o, underperforming equities pushed by a vanishing current account surplus and a potentially larger fiscal deficit have made the country looks miserable . More specifically, t he Phil ippine peso (PHP) depreciated 6.5 % and the Philippines S tock Exchange PSEi Index fell 15 % in 2018, only better than China . Such developments should not be so surprising. Beyond the worsening economic fundamentals, the financial health of the Philippines’ firms has also worsened . We look at the worrisome situation from two angles: i ) where the expenditure binge is heading to (consumption or investment, and if the latter, how productive such investment might be), and ii) how systemic is the deterioration of financial health by looking at differences by company size and sectors. Regarding the first question, t he Phil ippines’ growth prospects are favorable thanks to demographics. However, the external sector is becoming a constraint due to the increasing dependence on imports . The key question is whether the government expenditure binge will ease the existing constraints to the production to reduce the country’s dependence on imports. In Q2 2018, the contribution of government consumption was a vital part of growth. However, even though public construction expense picked up, we have not seen enough evidence to conclude that investment is driving public expenditure. For corporate health, overall financial conditions have worsened with the key deterioration concentrated in large corporates. The top 25 firms by asset size have high leverage, low repayment ability and worsening financial health . The smaller ones, though, are only half as leveraged with a lower interest burden, which allows them to maintain nearly double repayment ability. Even though small firms are in a better position, they are way too small to change the overall picture. All in all, when the push comes to shove, the Philippines’ firms are not in the best of circumstances to handle rate hikes. Externally, the FED is hiking and the BSP ( Bangko Sentral ng Pilipinas ) will have to increase rate s in the light of higher inflations and to ste m off capital outflows. With the high corporate leverage, firms could face a hard time onwards in the rate cycle.