

By Masood Ahmed


How did we get there?

Understanding the reasons behind the credit slowdown is important for getting the policy response right. In the Caucasus and Central Asia, three were dominant.

First, balance of payments pressures led to depreciation in several countries. With high levels of dollarization and exposure to currency risk, the depreciation contributed to a significant weakening of balance sheets of banks and unhedged borrowers. Most countries experienced reductions in their capital/asset ratios by more than 2 percentage points and increases in their nonperforming loans ratios by more than 4 percentage points. Kazakhstan and Tajikistan were particularly hard hit: the nonperforming loans ratio increased by 14–16 percentage points.

Second, the crisis subjected banks to a sharp reduction in funding—deposits, remittances, and external borrowing—which had fueled rapid and above-trend credit growth in previous years.

And third, the slowdown in economic activity may have resulted in a tightening of credit supply as well as a contraction in demand for credit due to heightened macroeconomic uncertainty.

With impaired balance sheets, lackluster funding growth, and heightened uncertainty, credit to the economy has slumped—since end-2007, real credit growth has fallen by about 63 percentage points on average.

What can policymakers do?

Policies should aid banks in the process of repairing their balance sheets by recognizing losses and supplementing bank capital if needed. Where banks are fundamentally healthy and mainly affected by a lack of funding, temporary government or central bank liquidity injections may help restore credit growth. Of course, adequate fiscal room is a precondition for such actions.

Over the medium term, macroeconomic and macroprudential policies should promote dedollarization to reduce vulnerabilities to sudden exchange rate movements and currency risk; high levels of dollarization of 40 to 80 percent were a key transmission channel of the global crisis to the region. Precrisis trends in Caucasus and Central Asia countries, as well as the international experience, have shown that macroeconomic stability is the most successful conduit for sustained dedollarization. In addition, the regulatory framework should encourage a proper pricing of currency risk, for example, by requiring higher capital charges for foreign exchange loans to unhedged borrowers, thus addressing indirect currency risk. In some countries, allowing greater exchange rate flexibility may also help banks and the corporate and household sectors to better internalize the risks of dollarization.

Developing local debt markets can contribute to dedollarization by giving domestic agents access to a wider range of domestic-currency financial instruments. Moreover, local debt markets allow banks to diversify their funding base and thus become less vulnerable to swings in individual funding sources.

What else might policymakers in the Caucasus and Central Asia do to revive credit? What lessons can be learned from other countries’ experience? We'd like to hear from you.

2017-04-15T14:36:56-05:00June 7, 2010|


  1. Saha June 16, 2010 at 8:20 am

    How important is the role of discount rates in promoting private sector credit? For instance, in Pakistan, where the Central Bank has been unable to control price levels and is hence reluctant to reduce Discount Rate. Can reduction in DR actually promote economic growth?

  2. Peter June 24, 2010 at 2:59 am

    In the case of Tajikistan, where I have been working with commercial banks and their SME clients for the past 6 months, I agree that credit growth has stagnated in banks for several reasons, related to after-effects of both political and economic factors since the crisis.

    Lack of a robust depositor insurance system, coupled with increasing PAR rates due to capricious lending policies within commercial banks in Central Asia, does little to encourage domestic investors, let alone Western institutional investors, to making term deposits in the region of substantial value.

    For Tajikistan, political risk factors related to instability in neighboring Afghanistan and Kyrgystan, in addition to Uzbekistan’s virtual blockade of inbound commercial rail and truck shipments, have caused several Tajik businessmen to put investment decisions (as well as related borrowing applications) on hold: a wait-and-see attitude is prevalent within the country.

    Finally, even though dollar-somon convertibility is fairly easy, with a tight spread (currently 4.45-4.47 to the dollar), Tajik entrepreneurs actually prefer to “deposit” their current capital funds with “valyutchiki” (FX exchange houses), rather than commercial banks. The interest earned in banks’ short-term current accounts is miniscule, and service fees of 1-1.5% for withdrawal of FX cash funds from commercial accounts is a further detractor. The preference of Tajik entrepreneurs is to deposit operating capital with the “valyutchiki”, who can maintain both USD and local currency accounts on a demand basis, and then even offer an addtional exchange rate discount of 1% or more to the entrepreneur, in exchange for use of entrepreneur’s capital. In this instance, commercial banks are losing the opportunity of use of business capital, suffer lower capitalization, due to their (comparatively) unfavorable fee structures.

  3. iMFdirect June 25, 2010 at 12:06 pm

    Axel Schimmelpfennig and Jaroslaw Wieczorek at the IMF respond:
    The role of the discount rate in promoting private sector credit depends on the specific institutions and the workings of financial markets in a particular country. In general, by changing the discount rate, the central bank changes the cost of short-term funding for commercial banks. If short-term funding becomes cheaper, commercial banks can, in turn, lower the interest rate they charge, making credit more attractive to potential borrowers. This is often referred to as (one part of) the monetary transmission channel. A number of factors can influence how well this channel works. For example, during 2008-09, many banks suffered heavy losses on loan defaults and were so pre-occupied with restoring their own financial health that they did not pass on the benefits of a lower discount rate to potential borrowers.

    Turning to the second part of your question, whether credit can raise growth, the answer is yes. There is a large body of academic research that finds that credit growth supports medium-term growth. So in this sense, the central bank has an instrument to influence growth by lowering its monetary policy rate, e.g. the discount rate, to stimulate private sector credit and ultimately economic activity.

    Of course, there are also examples of very high and ultimately excessive credit growth episodes that lead to a growth slowdown or even a recession. This is the case when too much credit finances projects that are very risky and ultimately do not yield the expected return, which can lead to loan defaults and eventually a sudden stop of credit extension and economic activity. As I said in the beginning, the exact working of these linkages depends very much on country specific circumstances and institutions.

    In the case of Pakistan, in theory, the mechanism by which the discount rate policy can affect growth is the same as anywhere else. However, at present, a confluence of factors in Pakistan (see below) is impeding private sector credit growth and limits the scope for using the discount rate to stimulate credit. It should be noted that the discount rate was reduced significantly in the second half of 2009, yet private sector credit remained flat. Instead, inflation rebounded.

    Cyclical factors:
    • Pakistan is still recovering from a crisis. (Credit growth was very high prior to the crisis and contributed to the financial difficulties that Pakistan experienced in 2007/08–08/09). Weak credit growth is part of the adjustment process.
    • The world economy is still recovering from a crisis: demand for exports is weak (export-oriented manufacturing, such as textiles, account for a great share of credit to the private sector).

    Supply constraints:
    • Electricity shortages and insecurity depress demand for credit.

    • Non-performing loans continue to increase and banks are reluctant to extend credit.

    Crowding out:
    • Loose fiscal policy: credit is largely absorbed by government financing needs. This increases the cost of borrowing for all credit users.
    • Moreover, a large share of credit is being directed to commodity operations (e.g., wheat procurement).

    • Inflation has rebounded in recent months and this limits central bank’s ability to lower the discount rate further, as this could exacerbate the imbalances that caused inflation to increase in the first place: negative interest rates can cause a confidence crisis like that which led to a sharp depreciation and a surge in inflation in 2008.

  4. editorial financearticles July 22, 2011 at 9:54 pm


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