Four questions about the debt and financing risks of COVID-19 in the Middle East and North Africa
A man walking through the Pakistan Stock Exchange building. The pandemic has increased funding needs in Pakistan and other countries in the region. (photo: IMF)
By Jeta Menkulasi, Cesar Serra and Suchanan Tambunlertchai
IMF Middle East and Central Asia Department
In the Middle East, North Africa, Afghanistan and Pakistan (MENAP), countries have responded to the COVID-19 pandemic with unprecedented scale and urgency. While this vigorous response saved lives and cushioned the economic shock, it also exacerbated existing debt vulnerabilities and led to increased financing needs.
With limited access to external finance, governments and large state-owned enterprises have turned to domestic banks. This has widened the exposure of banks to the public sector in several of MENAP’s emerging markets, ranging from over 20% of total bank assets in Iraq, Jordan and Qatar, to over 45% in Algeria, Egypt and Pakistan, and up to 60 percent in Lebanon. In contrast, banks in other emerging markets had public sector exposure of 12%.
The excess liquidity of banks in some countries and an underdeveloped institutional investor base in others, as well as the absence of a more dynamic private sector, have prompted banks to hold government bonds until ‘at maturity, hampering liquidity and the development of the domestic debt market.
Although a third of MENAP countries tapped into international financial markets, accounting for 25.5% of global emerging market emissions, domestic financing played a critical role, particularly during the first phase of the crisis, when international markets have been disrupted. For example, the governments of Egypt, Jordan, Pakistan and Tunisia have covered more than 50% of their gross public financing needs with domestic bank financing in 2020.
As the prospects for intensive exploitation of international markets are limited, banks’ exposure to the state is expected to accelerate in the coming years. This could crowd out credit to the private sector at a time when private financing is essential to spur recovery. In addition, the Regional economic outlook estimates that fiscal needs could be further exacerbated by 3% of GDP in a potential shock scenario involving a rapid tightening of global financial conditions as well as delayed fiscal adjustment due to a protracted recovery. If national banks were to finance these unforeseen needs, in addition to the expected financing needed in 2021-2022, Egypt, Oman, Pakistan and Tunisia would absorb an additional 10-23% of bank assets in the form of public debt by the end. 2022. As a result, Egyptian and Pakistani banks could achieve levels of public sector exposure similar to those currently seen in Lebanon.
Countries with limited or no fiscal space will need to initiate growth-friendly consolidation plans as the crisis subsides. In countries with market access, policymakers should seek to proactively mitigate refinancing and refinancing risks. Engaging in liability management operations (such as lengthening maturities) can improve existing debt conditions and the medium-term debt profile. In countries where market access is more limited, governments might consider reshaping their commercial and bilateral debt.
The development of domestic capital markets, the gradual broadening of the investor base and the widening of opportunities for banks to diversify their assets, including through further progress in financial inclusion, would help reduce risks. linked to the banks’ overexposure to the State. In the medium term, policymakers could introduce changes in banking regulations to reduce the existing bias of banks’ asset portfolios towards government bonds.