As the economies of Central America, Mexico, Panama and the Dominican Republic contracted steeply in 2020 in the face of COVID-19, their governments and central banks rose to face unprecedented challenges in maintaining liquidity and credit and keeping businesses and households afloat. They set lower policy rates and reserve requirements, devised more flexible regulations for the financial sector, introduced moratoriums on debt payments, and established liquidity facilities to help refinance debt. Governments also supported the private sector by providing subsidies and credit lines, and permitting delays in tax payment.
All these measures were fundamental in helping to prop up economies badly hurt by supply side restrictions and reductions in tourism. They allowed businesses to keep paying suppliers and other fixed expenses while retaining their workers. They facilitated spending by households, and, crucially, they bought time for the pandemic to ease, mobility to return, and, with it, the capacity to generate income and cover liabilities.
An Agile Response to Credit Challenges
The agility of the authorities in responding to this unique challenge made an immense difference, not least in maintaining bank credit and preventing defaults. In Honduras and Panama, for example, more than 40% of households indicated in a survey that they would not have been able to pay their loans without the payment flexibilities that the authorities granted. In El Salvador, Guatemala, Costa Rica and the Dominican Republic that percentage ranged from 36% to 20%. Indeed, without such measures, the contraction in bank credit to the private sector would have been double what it was and there would have been a much larger increase in non-performing loans with greater threats to the stability of financial institutions.
Now, with recovery from the pandemic on the move, an equally big challenge looms in both ensuring that credit is available on favorable terms to households and businesses and that the level of indebtedness remains at an acceptable level that will contribute to financial stability. There needs, in short, to be a healthy balance between loan repayment and recovery that allows for job creation and economic development.
A New Report with Key Recommendations on Business and Household Credit
It is with that goal in mind that the IDB recently released a report entitled In Search of Better Debt Conditions for Companies and Households, which offers deep historical analysis of regional household and private sector debt and recommendations on policies that can contribute to household well-being and promote entrepreneurship, formal employment, and economic development in the countries under study.
The report observes that when levels of credit are high relative to their historical trend then an economic contraction generates a larger and more prolonged increase in delinquency than when credit is below its historical trend. It shows how macro- and micro-prudential policies can mitigate such risk. It also shows that when credit is high in historical terms then formal job creation is lower. To that end, the report advocates evaluating where individuals and economic sectors are overindebted and directing policies to them that can help in the post-pandemic recovery.
The majority of households in the region under study do not have debts to pay off, or if they do, that debt represents a low percentage of their income. Between 8% and 30% of households, depending on the country are overindebted, however, (meaning that 30% or more of their income goes to debt service payments) and those are concentrated in low-income households, households headed by young people or the unemployed, and those with a higher burden of dependents. In several countries of the region, this vulnerability is related to the limited savings capacity of households, and the report recommends several types of behavioral interventions that can incentivize formal savings and debt repayment. It also advocates for policies directed at better financial education, financial inclusion, and the provision of clear information on financial products.
Small businesses often depend on loans acquired by their owners, which tend to have higher interest rates than those obtained in the corporate sector. Overindebtedness among such businesses can have a negative impact on their investment plans. Here, the report emphasizes incentives for financial education and training, as well as for greater financing of female entrepreneurship and the financial inclusion of women.
Tackling the Twin Problems of Overindebtedness and Financial Inclusion
Overindebtedness can serve as a brake on households, businesses, and the economy generally, as can the relatively low financial inclusion of both individuals and companies prevalent in the region. The many recommendations in the report offer ways to tackle these two problems, help the region emerge more successfully from the pandemic and promote investment, productivity and economic growth.