Overcoming Financial Sector Constraintsto Private Sector Development in Mozambique

Presentation to CTA, Maputo -- 22 February, 2007

Trade and Investment Project

Bruce Bolnick Alistair Tite

2

Overview and Trends

3

Central issues raised by the business community

• Access to credit and cost of credit as major constraints to private sector development

• Restrictive foreign exchange regulations as impediment to trade

• Absence of banking services in many regions• Need to identify practical steps to address

these problems. But no magic solutions!

4

Starting point : Principles of Finance

• Core purpose of the financial sector: Intermediate financial resources and manage risks

• Paramount importance of sound banking system

• But sound banks can also be innovative banks!

• Financial market imperfections Supporting role for government

5

Recent trends

• Progress in development of the financial system

• Rapid growth of lending and deposits• Interest rates still very high• High fees• Financial sector reform programs

6

Credit to the economy (% GDP)

15.5

10.47.6

10.4 12.1

15.9

0

5

10

15

20

25

30

35

Mozambique Tanzania Zambia LIA Median LI Median

Perce

nt

Expected value and margin of error

7

Forex/MT loans & deposits

Foreign Exchange Loans and Deposits

0%

10%

20%

30%

40%

50%

60%

70%

2002Q1

2002Q2

2002Q3

2002Q4

2003Q1

2003Q2

2003Q3

2003Q4

2004Q1

2004Q2

2004Q3

2004Q4

2005Q1

2005Q2

2005Q3

2005Q4

2006Q1

2006Q2

2006Q3

Perc

ent

Ratio of foreign exchange loans to total loans Ratio of foreign exchange deposits to total deposits

8

Interest rate trendsMozambique Nominal Interest Rates

0

5

10

15

20

25

30

Dec-04Mar-05

Jun-05Sep-05

Dec-05Mar-06

Jun-06Sep-06

Perc

ent 180 day T-bill rate

180 day lending rate180 day deposit rate

9

Real interest ratesReal Interest Rates

-10

-5

0

5

10

15

20

25

30

35

2002

Q1

2002

Q2

2002

Q3

2002

Q4

2003

Q1

2003

Q2

2003

Q3

2003

Q4

2004

Q1

2004

Q2

2004

Q3

2004

Q4

2005

Q1

2005

Q2

2005

Q3

2005

Q4

2006

Q1

2006

Q2

2006

Q3

2006

Q4

Perc

ent

Real 180 day lending rate Real 180 day deposit rate

10

Access to Banking

Days to process SME loan applications(number of days)

25.8

4.5

12.0

4.1n/a0

5

10

15

20

25

30

Mozambique Malawi Uganda Low-Income SSAMedian

South Africa

Days

Source: World Bank working paper, Banking for Everyone, December 2006

11

Access to Finance

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View from the banks

• Rapid growth of loan books since 2005. • Banks actively seeking viable customers• Leading constraint: high interest rates

Also serious risk factor (“adverse selection”)• Other major constraints – quality of loan applications

Poorly prepared business plans Evidence of weak management Viability of repayment not demonstrated Lack of creditable financial information Need for equity contribution Finally, security for the loan

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Enhancing creditworthiness

• Traditional route to creditworthiness• Commitment by businesses to improve

quality of financial information• Establish CTA credit mentoring system• Establish new credit bureau with more

comprehensive information• Use of insurance as credit enhancement

Examine African Trade Insurance network for export credit insurance

• Pressure government on payment arrears !

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Creating a Development Bank

• Fundamental issue: access to development finance for viable productive investment

• Lessons from international experience Cases of success Cases of failure

• Implications for Mozambique Strengths of DFI proposal But serious structural weakness

• The critical test: Are investors willing to put their money at stake? Example: GAPI - Rabobank

15

Access to Term Finance (2)

• Alternative avenues of term financing Create regional DFI Promote asset based lending Establish “second-tier” bond market Provide TA for risk capital deals

• And on the supply side Fundamental pension reform

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Outreach to new clients

• Old news: Lower interest rates Microfinance Suppliers’ credit networks, outgrower schemes Temporary, limited credit guarantees as catalyst

for outreach to new markets• New news: mobile phone banking

Technology to the rescue Low cost, broad outreach No new legislation needed

17

Legal/judicial foundations for finance

• Important recent reforms• Other reforms underway

Pensions, Bankruptcy, Forex Controls. Also Labor Law.

Need to lobby for appropriate outcomes• Other work to do, including:

Focus on enforcement of banking laws Management Assisted Judicial Execution to deal

with key bottleneck in foreclosing collateral Clarify role of “correspondentes” as agents Legal foundations for small claims court

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Cost of financial services

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Cost of financial services

Key problem: Why are MT interest rates so high?

• Usual explanations don’t explain gap between MT and USD interest rates

• Core issue: monetary policy Why are T-bill rates?

• Market concentration also likely factor

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Cost of financial services (2)

• Recommendations Expand access to the primary market for

T-bills Reduce reserve requirement, or allow

government securities as reserves Support government in maintaining fiscal

discipline! Let “crowding out” fade away

21

Other cost issues

• Extremely high interest rates on microfinance

• Excessive banking fees• Need for consumer protection laws,

transparency in lending and fees

22

Foreign exchange issues

23

Foreign exchange transactions

• General problem with excessive red tape

• New forex law in process, but no information yet on content

• Basic issue of exchange rate risk Central bank exchange rate management

24

Aviso 5/2005

• Justifications: Systemic risk from unhedged positions – nip it in

the bud! Monetary management Effect on exchange rate policy

• Effect• Recommendations:

50% appears to be too high as risk provision Broaden the definition of hedged position Use this to create incentives to develop forward

market

25

Aviso 2/2006 - Situation

• Justification: shaky! It won’t solve the problem!

“Fighting against an avalanche” Perverse incentive to hold money offshore –

A major lesson from international experience! Yet sand in the gears of international trade

costs, delays, contract restrictions And heavy administrative burden on banks

• In any case, banks are strictly monitored• And major banks appear to be complying

with current regulation

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Aviso 2/2006 - Implications

• Also process problem - no prior consultation• Recommendations

Scrap Aviso 2/2006 Strictly enforce the existing regime, with serious

penalties for non-compliant bank But ease “exceptional” condition for pre-

payments Streamline the role of banks in trade facilitation Consider further liberalization of cross-border

payments to reduce incentives for capital flight

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Conclusions

• Need to identify concrete steps to get things done!

• Priorities = important problem + political feasibility + solid analysis

• Analysis points to recommendations for action in the short run

• And important issues for dialogue to seed deeper reforms in the longer run