Does Fiscal Consolidation Affect Non-Performing Loans? Global Evidence from Heavily Indebted Countries (HICs)

Abstract

This study explores fiscal consolidations’ impact on non-performing loans (NPLs) in highly indebted countries (HICs) following the global financial crisis (GFC) and subsequent sovereign debt crisis. A dynamic panel data estimator was applied to obtain the unbiased estimator due to NPLs’ time persistence. The findings reveal that fiscal consolidation measures increase NPLs since they limit the household and business loan-serving capacity. Extended analysis categorises fiscal consolidation episodes into (1) the fiscal consolidation weak form (FCWE) and (2) the fiscal consolidation strong form (FCSE). The extended analysis results reveal that the FCWE and FCSE improve NPLs by 1.55% and 31.10%, respectively. The weak-to-strong form transition of the fiscal consolidation analysis resulted in improving NPLs by 28.55 percentage points. NPL definition challenges, the potential influence of loan restructuring and regulatory restrictions, and implications for policymakers and financial institutions in managing NPLs in highly indebted economies were explored. Investigating the potentially different effects of both forms of fiscal consolidation (FCWE and FCSE) on NPLs in countries with different definitions of NPLs, including a comparison study between different definitions, was identified as an implication for future research. Finally, future studies should examine how restrictions on IFRS 9 may affect the FCWE and NPL as well as FCSE and NPL associations.