IMF warns Nigeria and other emerging economies of “doom loop”

The Washington based lender, International Monetary Fund, has raised concerns about a potential “doom loop” for Nigeria and other emerging economies.

This was disclosed in a recently released IMF report, titled “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.

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 jeopardize financial stability.

What the IMF is saying

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 Bank 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 Bank added that “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 normalize monetary policy might make emerging-market debt less attractive and put upward pressure on borrowing prices.

What could cause a doom loop

• A doom loop 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. Other names for the doom loop include the “diabolic loop” and “vicious circle”.
• The IMF stated that “A sharp tightening of global financial conditions—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.“
• Domestic shocks, such as an unanticipated economic slowdown, might also have the same effect, according to the World Bank.

What you should know

• 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.
• Nairametrics reported that the Debt Management Office revealed that Nigeria became the first African country to raise USD1.25 billion through the issuance of Eurobonds in the International Capital Markert.
• 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.
• 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.
• 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.
• Emerging-market banks have given the majority of the lending, pushing government debt holdings as a proportion of assets to a new high of 17%  in 2021.