Fiscal contraction linked to lower NPLs in the long run

What the study found: Fiscal contraction, meaning an improvement in the primary balance from deficit toward surplus, was associated with lower non-performing loans (NPLs) in the long run, but with a temporary increase in the short run.

Why the authors say this matters: The authors say the study extends industrial organization theory of banking to the fiscal policy–NPL relationship in a developing, resource-rich economy, and they note that their finding differs from literature that often suggests fiscal consolidations increase credit risk.

What the researchers tested: The study proposes a generalized theoretical framework that combines industrial organization theory of banking with liquidity preference theory. It uses bank-level quarterly data from Guyana from 2009: Q4 to 2024: Q4 and estimates a Panel Autoregressive Distributed Lag Pooled Mean Group (ARDL-PMG) model.

What worked and what didn't: A one-percentage-point improvement in the seasonally adjusted primary balance as a share of GDP was associated with a 0.473 percentage point decrease in NPLs in the long run. In the short run, fiscal contractions were associated with a temporary increase in NPLs, with a coefficient of 0.103, while higher oil prices and bank efficiency were found to significantly lower NPLs; GDP growth, inflation, the real effective exchange rate, and the COVID-19 pandemic were statistically insignificant in this framework.

What to keep in mind: The abstract does not describe additional limitations beyond the study’s country and data scope. The reported associations come from bank-level data in Guyana and are presented within the model used in the paper.

Key points

• Fiscal contraction was associated with lower NPLs in the long run.
• In the short run, fiscal contraction was associated with a temporary increase in NPLs.
• A one-percentage-point improvement in the primary balance was linked to a 0.473 percentage point long-run decrease in NPLs.
• Higher oil prices and bank efficiency were found to significantly lower NPLs.
• GDP growth, inflation, the real effective exchange rate, and COVID-19 were statistically insignificant in the model.