The Philippines’ limited debt space leaves the economy on unstable footing, making it inflexible and constrained during economic downturns, according to Japanese financial giant MUFG Bank Ltd.

The country is among economies with “constrained fiscal capacity,” which renders them more vulnerable to economic shocks, MUFG said in a Dec. 8 foreign-exchange outlook report. India and Thailand were also cited.

“Economies with ample debt space may use fiscal levers to fund strategic investments, supporting growth and forex resilience,” MUFG wrote. However, the Philippines' narrow debt space reduces its flexibility.

MUFG said economies with heavy debt or limited fiscal space may find it harder to respond to potential downturns, making their currencies more vulnerable.

The government is targeting to reduce its fiscal deficit to 5.5 percent of gross domestic product (GDP) this year from the actual 5.7 percent in 2024, based on the Budget of Expenditures and Sources of Financing (BESF) for fiscal year 2026. It aims to narrow the deficit further to 5.3 percent of GDP next year.

However, MUFG warned that “optimistic growth assumptions and heavy social spending leave little flexibility, exposing the peso to fiscal slippage risks.”

The Philippine peso plunged to a fresh weakest-ever level of ₱59.22 against the U.S. dollar on Tuesday, Dec. 9, on the back of heightened expectations of another Bangko Sentral ng Pilipinas (BSP) easing on Thursday.

MUFG expects the country’s full-year output growth to average 4.7 percent, falling significantly short of the government's goal of at least 5.5 percent. The bank also anticipates growth to clock in at 5.1 percent next year, still far below the six-to-seven percent target.

Growth averaged five percent in the first three quarters of the year, due in part to dampened business sentiment stemming from flood control graft concerns.

To buoy the slowing economy, the Japanese bank has forecast the policy-setting Monetary Board (MB) to deliver two additional quarter-point cuts, bringing the policy rate to 4.25 percent by early 2026, which the bank also sees as the terminal rate.

Recent corruption cases allegedly involving flood-control projects have renewed concerns about governance in the Philippines, “even as tax revenues are less of a constraint in the Philippines relative to Indonesia.”

The government aims to rake in ₱4.21 trillion this year, up from ₱3.8 trillion last year. It has programmed tax revenues to increase to ₱4.63 trillion in 2026, ₱5.09 trillion in 2027, and ₱5.61 trillion in 2028.

“For now, we do not see a meaningful reversal in structural reform momentum in the Philippines, and the silver lining is that perhaps the Philippines could ultimately lower corruption and raise efficiency in government spending over the medium term,” MUFG said.