The International Monetary Fund (IMF) has cautioned that increasing domestic government borrowing from banks in Nigeria and other arising markets could jeopardize the country’s financial stability.
According to the IMF, the pandemic has boosted the amount of government debt emerging-market banks are holding, increasing the pressures on public-sector finances and threatening financial stability.
The Washington-based lender revealed this in a report titled, ‘Emerging-Market Banks’ Government Debt Holdings Pose Financial Stability Risks.’ It added that authorities should act to minimize the risk.
It said, “Governments worldwide have spent aggressively to help households and employers to weather the economic impact of the pandemic. Public debt has mounted as governments have issued bonds to cover their budget deficits
“The average ratio of public debt to the gross domestic product—a key measure of a country’s fiscal health—rose to a record 67 per cent last year in emerging market countries, according to Chapter 2 of the IMF’s April 2022 Global Financial Stability Report.”
It added, “Emerging-market banks have provided most of that credit, driving holdings of government debt as a percentage of their assets to a record 17 percent in 2021. In some economies, government debt amounts to a quarter of bank assets.
“The result: emerging-market governments rely heavily on their banks for credit. These banks rely heavily on government bonds as an investment that they can use as collateral for securing funding from the central bank.
“Economists have a name for this interdependence between banks and governments. They call it the ‘sovereign-bank nexus,’ because government debt is also known as sovereign debt—a vestige of the Middle Ages when kings and queens did the borrowing.”
According to the IMF, the large holding of sovereign deficit could expose banks to losses if government finances come under pressure and the market value of government debt drops, forcing banks, especially those with less capital, to reduce their lending to companies and homes, weighing on economic activity.
As the economy slows and tax incomes reduce, government finances will fall under pressure, threatening banks. It stated that this could eventually lead to a government default.
The IMF said, “Now, emerging-market economies are at greater risk than advanced economies for two reasons. Their growth prospects are weaker relative to the pre-pandemic trend compared with advanced economies, and governments have less fiscal firepower to support the economy.
“For another, external financing costs have generally risen, so governments will have to pay more to borrow. What could trigger the doom loop in a country? A sharp tightening of a global financial condition resulting in higher interest rates and weaker currencies on the back of monetary policy normalization in advanced economies and intensifying geopolitical tensions caused by the war in Ukraine—could undermine investor confidence in the ability of emerging-market governments to repay debts.
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