Spread, growth, and credit 11-10-2022

Well-known economist Irving Fischer once said that it is good for a bank to be prudent, but it is bad for the economy if all banks become prudent.

One indicator of prudence is the spread (difference) between the lending and deposit rates that banks pay and receive. Another is the ratio of domestic credit to the private sector as a percentage of the GDP. There are other measures, of course, but I will stick to these two simple ones, and ask the following questions: Is the spread between the interest rate on loans and deposits high, and if it is high, then by how much? Has lending expanded to spur growth or moved in tandem with it? And how, based on these two indicators, did the private banks react to economic growth rates in the past two decades?

Let us look at the past quarter century, 1997-2021. Official data shows that during a period of low economic growth (1997-2003), domestic credit to the private sector as a percentage of the GDP was 72 percent, and the spread was 4.8 percent. During 2003, a year of uncertainty and regional turmoil, the spread was extremely high: 6.2 percent. There is no evidence that banks may have caused the slow growth rates; however, clearly, banks reacted with great trepidation by raising the spread and reducing lending.

On the other hand, during 2004-2009, the domestic credit to the private sector as a percentage of GDP rose to 83 percent and the spread decreased to 4.2 percent. Interestingly, the average growth rate of the real GDP during this period was close to 8 percent. Hence, the growth that was spurred by the invasion of Iraq and resulted in an influx of wealthy Iraqi immigrants caused greater lending and a lower spread rate.

With the growth rate slowing down slightly in 2008, amidst an unjustified fear of a bubble (which later resulted in a self-fulfilled prophecy), and the resultant prudent policy adopted by the private banks, the domestic credit to the private sector as a percentage of the GDP dropped from 92 percent in 2007 to 78 percent in 2008, and then to 73 percent in 2009, the year Jordan entered, by own design, into the Global Credit Crisis — note that the world by then had announced in Istanbul that it exited the crisis.

One cannot but be surprised that no one was later held accountable for causing Jordan to unnecessarily jump into the crisis.

Enter the last period for which data is available (2010-2021). During this period, the domestic credit to the private sector as a percentage of the GDP became 73 percent, and the spread increased to 4.6 percent. The highest spread was in 2010, a year that witnessed a collapse of the growth rate from 5.3 percent in 2009 to 2.2 percent in 2010.

Another peak emerged in 2016 when the spread became 5.1 percent. Note that the Arab Spring had little to no effect on the spread. In 2020, the COVID year, the spread fell to 3.4 percent and the domestic credit to the private sector as a percentage of the GDP increased from 77 percent in 2019 to 83 percent.

The austerity programs of the IMF led to increased taxes and reduced public expenditures. At the same time, private expenditures were squeezed due to a tight monetary policy.

Given that, consistent with unregulated capitalism doctrines, only big businesses have the capacity to borrow, micro and small enterprises will not be able to obtain credit. Consequently, a combination of tight fiscal and monetary policies will reduce potential growth to a trickle.  Solution: there needs to be a complete shift in economic governance if the economy is to turn around.

Published on Jordan News:

https://www.jordannews.jo/Section-36/Opinion/Spread-growth-and-credit-22992