Layna MosleyDept. of Political Science

UNC Chapel Hillmosley@unc.edu

Regulatory Choices for Low Income Countries

IntroductionRecent trend: increased private capital flows

to AfricaPolicy question: How can low-income nations

best take advantage of private capital flows?Concerns: benefits of capital account

openness are contingent on macroeconomic stability and regulatory capacity.

Recommendation: gradual transition to capital account openness.Sequence: regulation prior to liberalizationRequires increased technical capacity, as well

as political will to regulate.

Private Capital Flows to AfricaHigh growth rates (>5% on average) in Africa in recent

yearsStrong growth predicted to continue.

Decline/leveling off in ODA flows (excluding debt relief) to African nations

Private investors attracted to high returns, growth foreceasts, diversification (uncorrelated with other markets),

Private capital flows2006: net private capital flows exceeded bilateral aid

grants.FDI increased by 44% in 2006 (extractive sector)Increased foreign participation in local bond markets (i.e.

Kenya, Nigeria, Zambia)17 nations now have sovereign credit ratings (local & foreign

currency)Development of local stock exchanges (albeit often small)

Legal Capital Account Liberalization

Based on Chinn and Ito

scores

Legal Capital Account Liberalization

Actual Capital Account Openness

12

34

12

34

1990 1995 2000 2005 1990 1995 2000 2005 1990 1995 2000 2005

East Asia & Pacific Europe & Central Asia Latin America & Caribbean

Middle East & North Africa South Asia Sub-Saharan Africa

(mea

n)

ass

ets

an

dlia

bili

tiesg

dp

yearGraphs by WB Region

by regionAssets and Liabilties as a percentage of GDP

Data from Lane & Milesi-Ferretti (2006)

Actual Capital Account Openness

Data from Beck et al (2000)

How to benefit from openness?

A large literature on the effects of capital account openness on economic growth.

Mixed findingsDifferent sample countries, time periods, and

measurements.Variation across type of capital (FDI and equity flows

vs. debt)Importance of “pull factors,” sometimes generating

contagion.Central issue: contingent effects

Thresholds matter (i.e. Kose et al 2006)Strong macroeconomic fundamentals » » growth (i.e.

Edwards 2008)Weakly regulated financial sectors lack capacity to

absorb (and manage) inflows (i.e. Prasad et al 2007)Central issue for this paper: regulatory challenges

Regulatory Issues in AfricaBackground

International attention to standards and codes.Issues of compliance (political will) and capacity

How do African countries, as a group, compare with other countries?Standards example: SDDS (1 subscriber); vs. GDDSGovernance indicators (Kaufman et al 2007)

Regulatory quality, rule of law, control of corruptionThree groups:

EMBI-Global countries (excluding 6 African EMBI-G)Eight African nations w/ increased participation in public

debt markets (Botswana, Gabon, Ghana, Kenya, Nigeria, Tanzania, Uganda and Zambia)

All other African nations.

-.8

-.6

-.4

-.2

0-.

8-.

6-.

4-.

20

1995 2000 2005 2010

1995 2000 2005 2010

African nations Africa -- Recent Bond Market Access

EMBI - Global

Mean for all low & middle income (2006): -0.47

year

Figure 4c: Average Control of Corruption

Regulatory Issues in Africa

Regulatory Issues in AfricaROSCs/FSAPs

~650 completed since 1999.15 percent have involved African nations28African nations; most frequent participants are Tunisia

(13 ROSCs covering six areas), Uganda (10 ROSCs, 6 areas) and Mozambique (9 ROSCs, 5 areas).

Most frequently assessed areas (for Africa) are data dissemination and fiscal transparency, followed by banking supervision.

A subset of recent ROSCs is summarized in the paperSix FSAPs (Uganda 2003, Tanzania 2003, Ghana 2003,

Mozambique 2004, Madagascar 2006 and Namibia 2007).ROSCs for Botswana (2007, data quality) and Kenya

(2008, fiscal transparency).

Regulatory Issues in AfricaLessons and patterns from these ROSCs:

Progress: banking system supervision (Tanzania); banking sector diversification (Madagascar); well-developed financial system (Namibia)

Many challenges, includingBanking sector developmentBanking sector weaknessesCapital market developmentDebt managementFinancial sector supervision and regulationLegal system and corporate governanceNational statistics and accounting systems

ConclusionsImprove data on the extent, maturity and

composition of capital flows.Maintain an awareness of volatility often

associated with (short-term) capital flows.Debt management officesRollover and currency risk.How to attract longer-term investors?

Take sequencing seriouslyNeed for targeted, substantial technical

assistance.Avoid “one size fits all” prescriptions.

ConclusionsTime horizons

Some international codes and standards may be inappropriate for the least developed countries (i.e. Basel II).

Meeting international standards may mean foregoing the shorter-term benefits of capital account openness.

Policy issue: might capital account openness facilitate regulatory improvements? Domestic politics: will the “losers” from

openness use regulatory issues as a justification for continued closure?

SDDS Subscribers

GDDS Subscribers

Total Countries

Income CategoryLow 3 42 56Lower Middle 16 23 52Upper Middle 17 16 36High OECD 22 0 23High non-OECD 4 4 15

RegionEurope & C. Asia 36 6 48M. East & N. Africa 4 7 18Asia and Pacific 8 8 23South Asia 1 5 8Latin America & Caribbean

10 20 34

Sub-Saharan Africa 1 41 47

Participation in IMF-Sponsored Data Standards

Area Number of ROSCs(Number of Countries)

Most Recent ROSC

Anti-Money Laundering/CFT

5 (5) Madagascar (2006)

Banking Supervision 17 (13) Namibia (2007)

Data Dissemination 27 (19) Chad, Botswana (2007)

Fiscal Transparency 22 (17) Kenya (2008)

Insurance Supervision 5 (5) Morocco (2003)

Monetary and Financial Policy Transparency

13 (10) Rwanda, Namibia (2005)

Payments Systems 5 (5) Mozambique (2004)

Securities Regulation 6 (5) Uganda, Morocco, Kenya (2003)

Total 100 (28)

ROSC Assessments, African Nations

Broad Category Specific IssuesBanking sector development Limited role for banking sector in the economy (Ghana,

Tanzania, Uganda)Access to financial services very limited (Ghana, Madagascar)Highly concentrated banking system; finances only 10% of new loans (Mozambique)Weak competition in banking sector, but public concerns about foreign participation (Ghana)Tendency toward short-term bank loans (Uganda)

Banking sector weaknesses High level of past due loans (Ghana)Banks tend to invest in short-term government securities (Ghana)High ratio of non-performing loans (Madagascar, Mozambique)Lack of diversity in bank holdings; holding a large proportion of government securities, therefore exposed to interest rate risk (Uganda)

Capital market development Credit to private sector is very small, short-term (Tanzania)Limited investment opportunities in domestic financial markets, perhaps suggesting a need for asset securitization (Namibia)Lack of liquidity in domestic stock market (Uganda, Tanzania, Mozambique)Financial system provides little long-term financing to the economy (Madagascar)Public pension fund heavily invested in government securities (Tanzania); in short-term bank deposits and treasury bills (Uganda); or in assets abroad (Namibia)Underdeveloped payments systems (Madagascar, Uganda)

Debt Management Very underdeveloped markets for medium and long term debt; little market for treasury bills with maturities greater than 91 days (Ghana)Lack well-developed market for longer-term bond issues, or for secondary trading in government debt (Tanzania, Uganda)Small interbank lending market; scarcity of credible counterparties (Tanzania, Uganda)Need to develop a strong government securities market (Mozambique)

Monetary and fiscal policy management Need a sterilization plan to deal with effects of foreign capital inflows (Tanzania)

Financial sector regulation and supervision

Political independence of bank regulator sometimes questionable; some scope for intervention from Minister of Finance (Tanzania, Uganda).Financial regulator lacks technical resources and skilled staff (Madagascar, Namibia, Tanzania, Mozambique)Weak enforcement of prudential regulations (Ghana)Lack of regulatory capacity in NBFI sector (Namibia); or in pensions and insurance (Madagascar, Mozambique)Loan classification regulations do not meet international standards (Mozambique)Banks require greater guidance on prudential requirements (Uganda)

Legal system and corporate governance

Weak corporate governance procedures (Ghana, Mozambique)Local firms’ financial reporting practices need improvement (Ghana, Madagascar, Mozambique)Efficiency of legal system, contract enforcement (Tanzania)Need stronger minority shareholder protections (Uganda)

National statistics and accounting systems

Moving toward, but not in, conformity with international fiscal transparency standards (Kenya)Timeliness and periodicity of economic data (Botswana)IAS not yet implemented, and may not be appropriate for smaller firms (Mozambique)