Fitch: Frontier markets loan slowdown shows pockets of stress

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Fitch: Frontier markets loan slowdown shows pockets of stress

11:08 CAT | 01 Apr 2017

Credit growth has slowed sharply in many frontier markets, reflecting a normalisation to more sustainable levels in some countries but pockets of heightened systemic stress in others, Fitch Ratings says.

A slowdown can help reduce systemic risk if it comes early enough in the credit cycle and real credit growth remains positive, but a sharp deceleration in credit growth can be a sign of severe stress in the financial sector.

The deceleration reflects some broader emerging-market challenges including global economic activity weakness, persistent subdued commodity prices (despite the pick-up) and tightening international financing conditions.

Continued potential for financial market volatility, particularly as the US embarks on a new phase of monetary policy normalisation, may weigh on financing conditions and credit growth in frontier markets in 2017.

The slowdown also reflects idiosyncratic factors in some countries with damaged economic growth and/or lender and borrower confidence. These include the revelation of previously undisclosed debt in Mozambique, rising external liquidity risk in Mongolia, and elections and high fiscal deficits in Ghana.

Credit growth slowed for 20 of 28 Fitch-rated frontier countries, according to our estimates for 2016.

Median real credit growth dropped from 9.1% in 2015 to 4.7% in 2016, well below the average growth of 10.4% in 2010-2015.

This is similar to the trend for all emerging markets, although the frontier market subsector has slightly higher median growth. The widespread slowdown in credit growth is reflected in Fitch’s Macro-Prudential Indicator (MPI) scores. The number of frontier markets with a high or moderate vulnerability to potential systemic stress (an MPI score of 2 and above) has fallen to nine from 13 a year ago.

One frontier sovereign, Ethiopia, has high vulnerability and eight have moderate vulnerability.

Real private credit growth exceeded 15% on average across two successive years in 2013-2016 for these countries.

Credit booms should also be gauged in light of the starting level of credit relative to GDP. Credit/GDP has increased by double digits in the last three years for all but one of the frontier markets with MPI 2 or above, but some of those countries have among the lowest levels of credit/GDP worldwide. For example, the sub-Saharan African sovereigns in this category had a median credit/GDP ratio of 26.5% in 2016.

Rising credit penetration is generally positive for frontier markets, reflecting a natural part of the development process, and is a pre-requisite for strong economic growth. But MPI scores of 2 and above signal that too rapid an increase may cause credit problems in the future. Ethiopia’s strong real effective exchange rate appreciation in 2014 and 2015 triggered its MPI 3 designation.

However, we believe the risk of systemic stress in the financial system is only moderate. Rapid credit growth was from a very low base, with credit/GDP only 29%, still below the frontier market median of 32%. Credit growth reflects the heavy infrastructure programme and ambitious development path, and slowed considerably in 2016 to 5.7% as real GDP growth slowed.

The credit slowdown may also be related to the severe drought.

The closed capital account and the central bank’s tight control on foreign exchange allocation reduce the risks of disorderly adjustment.

There is no stress evident in the banking sector’s financial metrics.

We rate 28 frontier sovereigns included in JP Morgan’s Next Generation Emerging Markets (NEXGEM) index.

We systemically monitor developments in bank lending, house prices, equity prices and real effective exchange rates in more than 80 countries.

See “Macro-Prudential Risk Monitor – January 2017” for our latest scores.

Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong

Rob Shearman Director Sovereigns +44 20 3530 1759

Cynthia Chan Head of Fitch Wire Credit Policy +44 20 3530 1655

Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: [email protected].

The above article originally appeared as a post on the Fitch Wire credit market commentary page.

The original article can be accessed at www.fitchratings.com.