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Government borrowing threatens global financial system,IMF

Babajide Komolafe
The increasing level     of government borrowing poses new threats to global financial system, says International Monetary Fund.In Nigeria, government borrowing dominated banks credit to the economy in the first quarter of the year.

Credit to government (net), which grew by 17.84 per cent, was the major contributor to the growth in aggregate credit (net) in February 2010, as credit to the private sector declined, by 1.97 per cent.

The annualized growth rate of credit to the private sector as at February 2010, was 11.82 per cent, as against the provisional benchmark of 31.54 per cent for 2010.

The substantial growth of credit to government (net) reflects the risk aversion of the DMBs and suggests the possible crowding out of private sector credit.
A report by the IMFSurvey Magazine released yesterday said “The global financial system and the world economy are slowly regaining their health, thanks in large part to unprecedented interventions by governments, but the sharp rise in government debt during the economic crisis from already elevated levels helped create what the IMF says is the newest threat to the financial system: growing sovereign risk.

That is not to say that the private financial sector is fully recovered. Indeed, the recovery in the financial sector remains “fragile,” according to José Viñals, Financial Counselor and Director of the IMF’s Monetary and Capital Markets Department.

Bank balance sheets still contain bad assets, consumers and businesses remain stretched, and credit recovery is some time off, the IMF said in its latest Global Financial Stability Report (GFSR), released April 20.

Moreover, a large part of the financial system continues to rely in varying degrees upon the extraordinary measures governments began to introduce two years ago – such as purchasing bad assets from, and injecting capital into, troubled institutions.

But the biggest threats have moved from the private to the public sectors in advanced economies. Governments not only took on many of the bad assets from private institutions but due to the recession face continuing heavy borrowing needs for the next few years.

Slow growth in the real economy and high unemployment will retard tax revenues and require higher government spending – such as on unemployment benefits and job creation activities.

“In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured,” Viñals said a news conference April 20.

“If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the very real risk of undermining the recovery and extending the financial crisis into a new phase.”

In a wide-ranging assessment of the state of the global financial conditions, the IMF report said:
Improving economic and financial conditions have helped private bank balance sheets in advanced economies.
The IMF sharply reduced its estimate of the writedowns or loan loss provisions banks will have to take – or have taken – to account for bad loans and securities on their books.

The improving quality of bank assets means that banks will probably need less capital than previously estimated to absorb losses.

But banks still will face funding difficulties in the next few years, as their bonds mature and the special government assistance programs are withdrawn.

Credit recovery will be “slow, shallow and uneven,” as heavy government borrowing soaks up available funds and banks continue their reluctance to lend to repair their balance sheets.

There is little evidence, at least so far, of bubbles in asset prices in emerging markets, despite strong portfolio flows to Asian and Latin American countries from investors seeking higher returns.

Authorities must address a number of policy issues, including how to manage borrowing and spending to minimize sovereign risk.
The IMF warned that the increase in sovereign risk can hit banking systems and the real economy that produces goods, services, and jobs.
Even with weaker private credit demand, governments could crowd out business and household borrowers, retarding recovery.

Moreover, if jittery investors worried about long-run government solvency cause a decline sovereign bond prices in the advanced economies, still-recovering banks, which are major investors in government debt, could face new hits to the value of assets on their balance sheets.

And rising interest rates on public debt could also flow through to the private sector raising borrowing costs for businesses, consumers, and banks.


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