The International Monetary Fund has raised concerns about a potential “doom loop” for Nigeria and other emerging economies, noting that government financial pressure could endanger the over-stretched banks and squeeze them even further.
The Washington-based lender has, therefore, cautioned Nigeria alongside other emerging markets to take practical steps to curtail fiscal excesses that could create more adverse conditions for their economies.
This warning was disclosed in a recently released IMF report entitled “Emerging-Market Banks’ Government Debt Holdings Pose Financial Stability Risks.”
Nigeria’s bank credit to the government surged to N14.9 trillion as of February 2022, an uptick from the N14.2 recorded in January 2022.
The report noted that as a result of the pandemic, emerging-market banks now hold unprecedented levels of government debt, raising the risk that public-sector financial pressures would jeopardise financial stability.
The IMF stated that there is a reason to worry about this nexus between banks and governments.
“Large holdings of sovereign debt expose banks to losses if government finances come under pressure and the market value of government debt declines”, it stated.
The Washington-based IMF stated that a crisis with the credit to the government could force banks, especially those with less capital “to curtail lending to companies and households, weighing on economic activity.“
“The sovereign-bank nexus could lead to a self-reinforcing adverse feedback loop that ultimately could force the government into default. There is a name for that, too—the “doom loop”, It happened in Russia in 1998 and in Argentina in 2001-02.”
The IMF also noted that rising returns in advanced countries as central banks start to normalise monetary policy might make emerging-market debt less attractive and put upward pressure on borrowing prices.
Experts explain that the IMF’s concerns relate to a possible “doom loop” which is a negative spiral that can occur when banks hold sovereign bonds and governments with weak public finances bail out such banks.
Governments are exposed to bank risk, as well as banks are exposed to sovereign risk by holding government bonds in their portfolios leading to “diabolic loop” and “vicious circle”, other names for the doom loop.
“A sharp tightening of global financial conditions—resulting in higher interest rates and weaker currencies on the back of monetary policy normalisation 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,“ the IMF has said.
Domestic shocks, such as an unanticipated economic slowdown, might also have the same effect, according to the World Bank.
Emerging-market governments rely significantly on their banks for lending, while banks rely heavily on government bonds as an investment that they can use as collateral to secure central bank funding.
In Nigeria, bank credit to the government increased by N1.33 trillion in 2021, rising to N13.73 trillion as of December 2021 from N12.4 trillion recorded the previous year.
The Debt Management Office (DMO) has revealed that Nigeria’s total public debt has risen to N39.55 trillion as of December 2021.
This represents an N1.55 trillion or 4.1% increase in 3 months when compared to the N38 trillion total public debt that was recorded as of September 2021.
According to the IMF’s April 2022 Global Financial Stability Report, 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% in emerging market countries last year.
