Key Takeaways

• Tunisian banks' exposure to their sovereign has more than doubled over the past decade along with a sharp increase in government indebtedness.
• Understanding the cost of a hypothetical sovereign default for Tunisia's banks is therefore becoming increasingly relevant, especially in light of the damage that the COVID-19 pandemic has wreaked on the Tunisian economy and the ongoing political divide between the country's three branches of power.
• Although we think a sovereign default remains highly unlikely over the next 12 months, we estimate the cost of such a default for Tunisian banks at $4.3 billion-$7.9 billion, equivalent to 55%-102% of the banking system's total equity or 9.3%-17.3% of forecast 2021 nominal GDP.

The COVID-19 pandemic and the ongoing political divide between Tunisia's three branches of power--the president, prime minister, and speaker of the parliament--are putting significant pressure on Tunisian banks. The economy remains weak, with the IMF forecasting average GDP growth of 2.4% per year for the next five years, following a sharp recession of 8.8% in 2020. S&P Global Ratings believes that future growth will depend on the resolution of the political divisions and on how the government implements reforms. At the same time, Tunisia's indebtedness has increased significantly, with gross debt reaching 87.6% of GDP at year-end 2020 compared with 39.2% at year-end 2010, based on publicly available information. High twin deficits and the absence of decisive reforms to reduce spending are making the country highly dependent on multilateral financing. We think multilateral support should be forthcoming, assuming the country is able to implement the necessary reforms, which would ultimately require a resolution of the political divide. As long as Tunisia receives that support, we do not expect it to default over the next 12 months.

However, questions about the potential cost of a hypothetical sovereign default for Tunisian banks are becoming increasingly relevant. The banks have increased their exposure to the sovereign along with the sharp rise in government indebtedness. On Nov. 30, 2020, Tunisian banks' exposure to their sovereign reached 13.2% of total assets--83.5% of their equity--from 5.1% at year-end 2010. This exposure is much lower than we have observed for Tunisia's peers. In Egypt, for example, the banking system's total exposure to the sovereign stood at 49.5% at year-end 2020. That said, we view Tunisian banks' exposure as a major source of risk should Tunisia default on or restructure its financial obligations.

Overall, we calculate that the cost of a Tunisian sovereign default for the Tunisian banking system could reach $4.3 billion-$7.9 billion, which is equivalent to 55%-102% of the banking system's total equity, or 9.3%-17.3% of forecast nominal GDP at end-2021. Our calculations exclude the potential effect of a sharp depreciation of the Tunisian dinar, which could add to the cost of the default.

We estimated the cost of a hypothetical sovereign default under different scenarios using publicly available information. We first looked at the respective haircuts on 17 emerging market sovereign loss-given defaults or restructurings between 1999 and 2010. The average haircut in these defaults was 42%, ranging from 4% to 89% depending on the case. For Tunisia, our assumptions include a 40%-70% haircut on government exposures and a 5%-10% write-down on loans. We used this write-down for loans, since Tunisian banks' asset quality indicators are already weak.

The Pandemic's Effect On The Economy Is Much Worse Than The 2011 Revolution

According to the IMF's most recent estimates, the pandemic's effect on Tunisia's vital economic sectors, combined with government measures to contain the spread of the virus, led the Tunisian economy to contract by 8.8% in 2020. That is almost 4.5x the contraction Tunisia experienced after the 2011 revolution (see chart 1).

Chart 1

Tunisia's economy, which is small and open, depends on a few economic sectors and exports. Its pre-pandemic economic growth was already low, primarily due to political fragmentation due to its divided parliaments and weak governments. These political differences have impeded much needed economic reforms. In the meantime, high twin deficits have resulted in large external and government indebtedness (see chart 2), leading to an increased reliance on multilateral financial support. The divide between Tunisia's three branches of power has exacerbated the situation, further delaying reform.

Chart 2

A Hypothetical Sovereign Default Could Cost Banks 55%-102% Of Their Total Equity

Tunisian banks' exposure to their sovereign has increased over the past decade, increasing the link between the banks' and the sovereign's creditworthiness (see chart 3). On Nov. 30, 2020, Tunisian banks' direct exposure to the sovereign reached 13.2% of their total assets or 83.5% of total equity. In addition to government bonds, this exposure reflects bank lending to the central government, but it does not account for loans to state-owned enterprises (SOEs). The Central Bank of Tunisia (CBT) does not disclose SOE exposure, but the IMF estimates it at about 9% of banks' total lending.

Chart 3

In light of mounting pressures on Tunisian banks, we have stress tested their exposure to the sovereign under two scenarios. We designed these scenarios based on 17 emerging market sovereign defaults between 1999 and 2010. The average haircut in these defaults stood at 42%, ranging from 4% to 89%. With regard to lending, given that nonperforming loans are already high for Tunisian banks, we capped the potential write-down of the lending book at 10%. Overall, we calibrated our assumptions as follows:

• Scenario 1: A 40% haircut on government exposures and a 5% haircut on the lending book. Under this scenario, the government and banks negotiate to restrict the consequences of the default.
• Scenario 2: A 70% haircut on the sovereign and a 10% write-down on the lending book. We assume that continuing political deadlock results in little or no support from multilateral institutions and leads to a disorderly default. We consider this to be consistent with a scenario of very high stress.

We calculate that the cost for the Tunisian banking system of a sovereign default is $4.3 billion-$7.9 billion, which is equivalent to 55%-102% of the system's total equity or 9.3%-17.3% of the forecast 2021 nominal GDP (see table 1).

Our scenarios do not account for the consequences of a significant depreciation of the Tunisian dinar because the CBT does not report banking system exposures by currency. Depreciation of the Tunisian dinar could put significant additional pressure on the banking system because its net external debt reached 14.5% of total loans on Nov. 30, 2020. Our scenarios also exclude a default or write-down of the banks' exposure to the CBT because the CBT already contributes TND9.0 billion toward the banks' refinancing needs, as of May 7, 2021, which we consider sufficient to cover their exposure on the asset side.

Table 1

Related Research

• Three Tunisian Banks Downgraded On Deepening Economic Risks; Outlooks Stable, May 10, 2021
• Will COVID-19 Trigger The Long Awaited Consolidation Of The Tunisian Banking System? May 6, 2020
• Tunisian Election To Have No Immediate Effect On Banking Sector Ratings, But Implementing Reforms Could Be Challenging, Oct. 16, 2019