Zimbabwe’s banks have slowed down on lending to the private sector while accumulating more sovereign paper, an undertaking which clearly shows the relationship between government debt, private sector lending and banks’ sovereign paper holding.
A reality check: over the past few years, the government has been struggling to meet its financial obligations with some issued Treasury Bills (TBs) being rolled over. However, banks have been increasing their holdings of these TBs despite clear signs that the government may default.
In his 2019 budget statement, Finance minister Mthuli Ncube indicated that, apart from the 2019 budget deficit of ZW$1,6 billion, financing needs may reach ZW$6,5 billion as a result of maturing TBs and the projected overdraft. In recent months TB issuances have increased to over ZW$1,5 billion since reintroduction of the auction system against a revised expected budget deficit of -ZW$6 billion. Given the constrained fiscal space, government is most likely to roll-over some maturing TBs or replace them with a longer-dated sovereign paper.
This is a technical default which otherwise would act as a warning to banks that are holding TBs. Government default on TBs and any sovereign paper damage banks and the real economy as banks respond by slowing down on lending to private sector. Commercial banks’ exposure to government has grown above the ZW$10 billion mark whilst lending to private sector has remained stagnant at ZW$5 billion. This clearly shows how government debt and default can be transmitted to the private sector.
A closer look at the banking sector shows that sovereign paper holdings is large for those banks that issue fewer loans. When the government defaults or roll-over the TBs, average holdings increase but more concentrated in large banks. It is the large banks such as CBZ, Standard Chartered and Stanbic that are holding the majority of sovereign paper. It is not a problem for banks to be heavily exposed to government.
However, it should be noted that during defaults, there is a large, negative and statistically significant correlation between banks’ sovereign paper holdings and subsequent lending activity. A one dollar increase in sovereign paper is associated with as high as a 0,60 dollar decrease in bank loans to private sector.
Furthermore, about 90% of this decline is accounted for by the average paper held by banks before the default takes place. Only 10% of this decline is explained by the additional paper acquired in the run-up to and during default.
These observations […]