SWP753 Interest Rate Policies in Selected Developing Countries, 1970- 1982 James A. Hanson Craig R. Neal WORLD BANK STAFF WORKING PAPERS Number 753 HG 3881.5 .W5 W6- F E p 3) WORLD BANK STAFF WORKING PAPERS Number 753 e.3 Interest Rate Policies in Selected Developing Countries, 1970-1982 INTERNATIONAL MONETAIIY FUND JOINT LIDRARY OCfv, ( 11985 James A. Hanson INTrMNATIONAL BAprUC FOR rs @ 1 I~~~~IECONST110C7.1;01 AND beiR'LCPME'.T Craig R. Neal WAFIENGTON. D.C. 20431 The World Bank Washington, D.C., U.S.A. Copyright (C 1985 The Intemational Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing September 1985 This is a working document published informally by the World Bank. To present the results of research with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The publication is supplied at a token charge to defray part of the cost of manufacture and distribution. The World Bank does not accept responsibility for the views expressed herein, which are those of the authors and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the delimitation of its boundaries, or national affiliation. The most recent World Bank publications are described in the annual spring and fall lists; the continuing research program is described in the annual Abstracts of Current Studies. The latest edition of each is available free of charge from the Publications Sales Unit, Department T, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from the European Office of the Bank, 66 avenue d'1ena, 75116 Paris, France. James A. Hanson is a senior financial economist and Craig R. Neal a researcher in the Financial Development Unit of the World Bank's Industry Department. Library of Congress Cataloging-in-Publication Data Hanson, James A. Interest rate policies in selected developing countries, 1970-1982. (World Bank staff working papers ; no. 753) Bibliography: p. 1. Interest rates--Developing countries--Case studies. I. Neal, Craig R., 1954- . II. Title. III. Series. HG1623.D44H36 1985 332.8'2'091724 85-17878 ISBN 0-8213-0608-1 ABSTRACT This paper examines the level and structure of interest rates for the period 1970-82 in ten developing countries: Bangladesh, Kenya, Korea, Morocco, Nigeria, Pakistan, Peru, Thailand, Turkey and Uruguay. In addi- tion, the paper briefly examines the countries' broader financial and economic policies. In most cases nominal interest rates were controlled by the governments and varied substantially less than inflation during this period. As a result, real interest rates rose (or fell) with declines (or increases) in inflation; hence, highly negative real rates were a direct reflection of high inflation. A simple grouping of nine of the ten sample countries into two categories demonstrates this clearly: the first group (six countries) had low inflation and mildly negative real rates, which averaged within a few percentage points of the corresponding averages for the industrialized countries; and the second group (three countries) had high inflation and highly negative real rates, which averaged ten to twenty-five percentage points, below rates in the industrialized countries. The tenth country, Uruguay, switched from the high inflation, highly nega- tive real rate group to a high inflation, highly positive and volatile real rate category about half way through the period, due to a major liberaliza- tion, and thus did not fall into either category. Aside from controlling interest rates, governments in the sample countries intervened extensively in financial markets to affect the alloca- tion of resources. Besides direct and indirect interest rate controls, other forms of intervention included large directed credit programs, public ownership of financial institutions and sizeable public sector borrowing. The paper's principal conclusion is that the narrow concern for raising real interest rates to positive levels, so often voiced in develop- ment policy dialogues, should give way to broader concerns for improvements in the financial system as a whole and for greater consistency between financial and macroeconomic policies. There are three basic reasons for this shift in emphasis: (1) unless real rates are considerably out of line, i.e., highly negative and well below those prevailing in inter- national capital markets, the scope for and thus the impact of raising real rates would be fairly limited; (2) even if real rates are considerably out of line, the focus of attention should be on the problem of high inflation and the economic imbalances driving it, since otherwise it will be diffi- cult to achieve genuine progress on real interest rates; and (3) in and of themselves, positive real interest rates are no assurance that the finan- cial system is efficiently allocating resources. Intervention in financial markets commonly fragments markets, distorts incentives with explicit and implicit subsidies, and burdens the system with counter-productive taxes. Moreover, economic and financial rates of return often diverge due to macroeconomic and pricing policies. Accordingly, interest rate policies must be part of a consistent economic policy framework, and the level of real rates should not be considered in isolation. Table of Contents Summary and Conclusions .......... ........................ .... vii I. INTRODUCTION .................I.................... .* 1 II. THE SAMPLE COUNTRIES, DATA SOURCES AND SOME METHODOLOGICAL CONSIDERATIONS ................... e...o.*............................ 2 III. THE AVERAGE LEVEL OF REAL INTEREST RATES: THE INTEREST RATE REGIME ................................................. IV. THE DETERMINATION OF INTEREST RATES: NOMINAL AND REAL ...... 18 V. FINANCIAL SECTOR LIBERALIZATION: THE "NEW" VIEW ............ 32 VI. FINANCIAL SECTOR REFORMS: THE RECORD ..... .................. 36 SOURCES AND REFERENCES ....... ................. .. . ............. 44 ANNEX 1 SUMMARY AND COUNTRY TABLES ............ ............ 49 ANNEX 2 COUNTRY STUDY: BANGLADESH ......................... 87 ANNEX 3 COUNTRY STUDY: KENYA .. ....... ... o ................ . 97 ANNEX 4 COUNTRY STUDY: NIGERIA ........................... 109 ANNEX 5 COUNTRY STUDY: PERU .............................. 119 ANNEX 6 COUNTRY STUDY: THAILAND ........................... 133 ANNEX 7 COUNTRY STUDY: TURKEY ............... I ............ 143 ANNEX 8 COUNTRY STUDY: URUGUAY ........................... 155 List of Text Tables and Figures Table 1 Average Real Interest Rates, 1970-82 .............. 7 Figures 1A-D Nominal Term Deposit Rates versus Inflation ........ 8-11 Table 2 Major Policy Changes in Nominal Deposit Rates..... 14 Table 3 Average Real Interest Rates, 1970-76 and 1977-82 16 Table 4 Average Real Interest Rates, 1970-80 and 1981-82 Deposit1Rates7versus Inflation ........... 17 Figure 2A-D Real Term Deposit Rates versus Inflation 22-25 Figure 3A-D Nominal Term Deposit Rates versus Devaluation Adjusted U.S. Treasury Bill Rate .... ............. 26-29 Figure 4 Nominal Term Deposit Rates in Domestic and Foreign Currency: Uruguay, 1978-82 ............. 30 Table 5 Nominal Interest Rate Differentials, 1982 40 - vii - Summary and Conclusions A. Purpose and Organization i. This paper examines the financial sector policies in a representative sample of developing countries over the period 1970 to 1982, focusing on the evolution of interest rate policies. The objective of this study is to assess the policies pursued by these countries in relation to the standard policy advice to maintain positive real rates and the recommendations made by a growing number of proponents of greater market-orientation in the financial sector. ii. The financial sector policy advice most often given developing countries is to maintain positive real interest rates, i.e., nominal interest rates in excess of inflation. This recommendation is now beginning to give way to concerns for increased market-orientation in the full range of financial sector policies. As opposed to simply a mechanical insistence on positive real interest rates, the market oriented perspective stresses, among things, the need to reduce the size of subsidies passed through the financial sector and to increase the reliance on interest rates for the mobilization and allocation of resources, paying attention not only to the real levels of rates, but to the need for differentials which reflect differences in risk, maturity and cost. iii. Reflecting this shifting policy perspective, the paper is organized into two parts: first, an examination of the development of real interest rates in a sample of ten developing countries (Bangladesh, Kenya, Korea, Morocco, Nigeria, Pakistan, Peru, Thailand, Turkey and Uruguay); and second, an investigation of the patterns of financial market intervention and liberalization in seven of the ten countries (Bangladesh, Kenya, Nigeria, Peru, Thailand, Turkey and Uruguay). The first half of the paper focusses on the questions: "Have interest rates been positive in real terms?" and, "Was there movement towards higher real interest rates over time?" The second half of the paper examines a broader set of financial sector policies, focussing on the questions: "What are the forms and extent of government intervention?" and "Is there evidence of a decline in the scope and degree of intervention, suggesting growing acceptance of the newer, market-oriented policy perspective?" B. Principal Conclusions iv. In terms of interest rate policies, the principal conclusions of this study are: (1) The observed nominal interest rates were predominantly set by governments, although there was some latitude for financial institutions to adjust effective interest rates through such practices as compensating balances on loans and more frequent compounding on deposits. (2) Administered interest rates were very "sticky," There was very little change in nominal rates over time, particularly in comparison to fluctuations in inflation rates. (3) The "stickiness" of the nominal rates meant that year-to-year variations in the real rates were primarily determined by variations in the inflation rates. (4) Real deposit rates were predominantly negative throughout the 1970-82 period. However, it should be noted that slightly negative real deposit rates also prevailed in most of the industrialized market economies, including the U.S., during this period. (5) Real lending rates on general credits were between 2 to 7 percentage points higher than deposit rates in the sample countries. These rates were also generally negative during the 1970-82 period, although in six of the ten sample countries average real rates ranged between -1.3% and +2.9%. (6) The sample countries' interest rate policies fell into three distinct groups: six countries had low average inflation rates and real rates that were not very negative on average, three countries had relatively high inflation rates and quite low average real rates, and one country (Uruguay) had high inflation but, in the middle of the sample period, moved to market determined interest rates, which swung from low to high real levels. (7) Countries with relatively high average inflation rates also generally had relatively low average real rates, indicating that the governments were unwilling or unable to set nominal rates in line with high rates of inflation. The exception is Uruguay after its reforms. (8) Uruguay was not the only country to undertake reforms. In most of the sample countries, nominal rates in the second half of the period tended to be somewhat higher and there was generally some increase in the average level of real interest rates. This suggests that the authorities took some measures to raise real rates--in accordance with "traditional" Bank recommendations. (9) However, most of the improvement in the average real rates in the 1976-82 period was attributable to a decline in inflation rates in the sample countries, especially during 1981-82, and, only to a lesser extent, the upward shift in the nominal rates. (10) Real rates in all the countries (including the U.S.) generally rose together in 1981 or 1982 and declined together during 1973 or 1974 and again in 1979 or 1980. These contemporaneous movements suggest similar factors were at work in the sample countries. In fact, the common element is the contemporaneous movements in inflation. (11) The hypothesis that interest rates are determined in the short run by flows of international capital, and thus are tied to industrialized country interest rates adjusted for devaluation, is not supported by the record of the ten developing countries studied. v. The principal conclusions from the investigation of financial sector intervention and liberalization, in the seven countries are: (12) All the countries maintained substantial directed credit programs. Three types of instruments typically were used: (a) regulations on the portfolio composition of intermediaries; e.g., requirements to devote a certain portion of lending to specific activities; (b) Central Bank rediscounting of credits to priority sectors, usually at subsidized rates; and (c) control of financial intermediaries through direct ownership. (13) Public sector borrowing to finance the fiscal deficit and public enterprises was an important factor in the sample countries. Regulations often existed which forced the financial system to hold low-interest government debt, thereby imposing substantial cost on the rest of the system. (14) The directed credit programs and the public sector borrowings combined to reduce the supply of credit available to non-preferred borrowers--the well known "crowding out" phenomenon. Increased competition for the remaining credit drove up interest rates when these were free, in some cases producing very high rates on non-preferential credits. When interest rates were constrained, crowding out greatly complicated the overall allocation of credit. (15) All of the sampled countries also maintained some form of administered interest rate regime, with the exception of Uruguay after 1978. The principal differences between the countries were in the relative size of the directed credit programs and in the interest rate differentials between preferential and non-preferential credits. (16) All countries exercised control over the allocation of credit. Among the three low real interest countries the fraction of credit affected by directed allocation in 1982 ranged from almost 100% in Nigeria to nearly 55% in Peru. In Uruguay, which underwent sweeping reforms during the 1974-1979 period, 37% of credit was still extended by the two government banks in 1982. Even among the higher real rate-low inflation countries there was substantial government control of credit allocation, from as much as 70% to figures in the neighborhood of 33%. (17) In general terms, at the end of 1982 the differentials between rates on deposits, general lending and preferential lending rates were fairly small in the low inflation-high real rate countries, with the exception of one or two programs. In the three high inflation-low real rate countries, the differentials were quite large. This difference can probably be explained by the simple fact that low inflation and low nominal interest rates effectively place a ceiling on the absolute size of the subsidies. High inflation provides more room for subsidies through large differentials, and because subsidizes can be larger there is a greater incentive to demand them. Also preferential rates were often lower than deposits rates in the high inflation-low real rate countries, an interest rate structure which encourages diversion of directed credit. (18) In all but one of the seven sample countries there were definite moves towards greater market-oriented financial sector policies, from major reform movements to more limited realignments in the structure of nominal interest rates and directed credit programs. This movement could well be interpreted as a growing acceptance of value of financial sector liberalization, in accordance with the "new market-oriented perspective. However, the scope of market determination still remains quite constrained by many factors, including a wide array of government regulations. C. Sample Country Experience vi. A closer look at the evidence on the development of the real interest rates in the ten sample countries shows: Over the period 1970-82, the countries' policies toward real interest rates fell into three distinct groups. In the first six countries--Pakistan, Morocco, Thailand, Korea, Bangladesh and Kenya (in descending order of their average real deposit rates)--the average real interest rates on deposits (defined as the ex-post real rate) were somewhat negative during the period 1970-82, ranging from roughly zero to negative 7 percent. Average non-preferential loan rates were just negative or slightly positive in real terms. Preferential rates typically were above or just below deposit rates. While not exactly conforming to the standard policy advice, these deposit and loan rates were similar to the comparable average U.S. real rates during the same period, which were negative one percent and positive two percent, respectively. vii. A second set of three countries--Nigeria, Turkey and Peru--maintained real deposit rates which were, on average, quite negative over the period, ranging from -16.5% to -18.6%. Their non-preferential lending rates also tended to be highly negative, although various financial devices such as discounting and compensating balances kept these rates above deposit rates. Preferential loan rates were often substantially below deposit rates. The last country, Uruguay, undertook a significant financial reform starting in 1974, switching from highly negative real deposit and lending rates to a regime in which interest rates were determined in an open capital market by 1978. viii. Uruguay was not the only country in the sample to reform its interest rate policy. Turkey, after 1980, increased the permissible nominal level for many interest rates and permitted market determination of some others. In combination with a sharp decline in inflation, this resulted in unprecedented high real rates, rates that reached +34% on short term credits at the end of 1982. Bangladesh, Pakistan, and even Nigeria achieved higher real rates during the second half of the period, but primarily though a reduction in the average rate of inflation. Peru increased the permissible ceilings on nominal interest rates beginning in 1978, however this increase was insufficient to compensate for the sharp escalation in inflation, producing lower average real rates in the second half of the period than the first. ix. The Uruguayan reforms included an opening up of the domestic financial markets to the international capital markets. However, the spread between nominal rates on domestic currency and foreign currency deposits remained relatively constant, despite the (preannounced) decline in the rate of devaluation. These results are at variance with the standard theories that suggest convergence between world and domestic interest rates (adjusted for devaluation) once the capital market is opened. Either the public's expectations were for a constant rate of devaluation, rather than the actual rate (which was preannounced during most of the period), or a growing risk premium was required on peso deposits to cover the growing threat of a maxi-devaluation, a devaluation which finally occurred in November 1982. Thailand also provided a test for the interest parity model, since it has a long history of an open financial market and a fully convertible currency. In the Thai case the model works reasonably well as the nominal term deposit rate remains fairly close to the devaluation adjusted U.S. Treasury Bill Rate, and some of the small difference in the two rates probably could be attributed to the differences in the two instruments. In all the other countries, however, neither expected devaluation nor expected inflation seemed to have much to do with the setting of interest rates. Thus real rates were largely determined by inflation. x. A country-by-country look at the wider question of financial sector policy reforms, in the seven country sub-sample shows: (a) Bangladesh raised most ceilings on interest rates in late 1980. The government also loosened its institution-specific ceiling on credit expansion, relaxing some of the restrictions which had prevented the transfer of funds to banks constrained by their credit ceiling with a surplus of investment opportunities, from banks below their credit ceiling but without good investment opportunities. (b) In Kenya, the minimum deposit rates and the maximum lending rates were increased between 1980 and 1982. Beyond these readjustments, Kenya did not undertake any sweeping reforms. In large part, this lack of reforms was attributable to the country's history of relative price stability and relatively market-oriented economic policies, which kept pressures from building to a level that would require major reforms. (c) Due to Thailand's long history as an open and relatively price stable economy, its policy makers were not forced to undertake massive reforms. However, the government's overriding policy commitment to a freely convertible currency did require the authorities to make some macroeconomic policy changes to manage developments which threatened convertibility. In particular, after roughly five years of increasing protectionism and in the face of sharply rising world interest rates, the authorities instituted a set of reforms in 1980, which included an upward adjustment in the interest rate structure. (d) Since 1978, Nigeria has been raising its interest rate structure slowly, though rates have remained far below historical inflation. Credit allocation remained highly controlled by the government, through a complex and sometimes inconsistent set of regulations. Up until 1981, when the countries oil revenues collapsed, the Nigerian authorities apparently felt little need to promote the domestic financial sector, as most of the country's investments were undertaken directly by the government with the oil earnings. The softening of the long term outlook for oil is likely to increase pressures for greater domestic resource mobilization, and improved financial intermediation in general. (e) In Turkey the financial sector was highly controlled by the authorities. Among the important government policy instruments were large directed credit programs and a highly complex set of interest rate controls. In 1980 some these interest rates were liberalized, including term deposit rates and the ceiling rates on general credits. In addition, the size of the directed credit programs were scaled back somewhat. By 1982, the newly liberalized interest rates reached extraordinarily high levels--up to +22.1% on term deposits and +34.3% on general credits--causing some serious difficulties for the heavily indebted firms in the corporate sector. These high real rates are due, in part, to the rapid decline in inflation and probably reflect subsidies required to cover the cost of large share of total credit which is still extended at unliberalized rates. In addition, fears of a devaluation may have pushed up rates in local currency. However, the authorities have made it a matter of announced policy to continue reducing the scope and complexity of preferential credit schemes. This should help rationalize the credit allocation process, reduce the amount of the cross-subsidization, and lower intermediation costs. (f) Peru initiated a shift in interest rate policy in 1978, which continued through 1982. Despite the massive upscaling of the interest rate structure, the adjustments in the ceiling rates lagged well behind the increases in inflation, so real interest rates on deposits remained quite negative, with the exception of 1981. The adjustments in the interest rates were also part a set of major reforms expressly aimed at giving market forces a larger role in the economy, which included opening of both the goods and capital markets, the legalization of dollar transactions such as deposits and loans, a reduction in the vast number of controlled interest rates through a simplification of the preferential lending categories. Reserve requirements on deposits in local currency were also reduced and interest was paid on the remaining part. This led to a reduction in the inflation tax base, thereby increasing the inflation resulting from a given increase in central bank credit. In view this potentially explosive situation and the lack of progress towards higher real interest rates, the Peruvian reforms must be judged to have been of rather limited success. (g) Uruguay, much like Peru and Turkey, had a history of extremely high inflation rates, though its experience began much earlier. The combination of a stagnating economy, balance of payments problems and high inflation prompted the authorities to begin a liberalization process in 1974 that was almost without precedent in its dimensions. By the end of 1978 virtually all interest rate controls had been dismantled, the fiscal deficit was closed, sectoral credit guidelines and reserve requirements on domestic currency deposits were eliminated, and foreign currency transactions were legalized, including bank deposits and dollar loans. With the important exceptions of the operations of the publicly owned Banco de la Republica and the Banco Hipotecario del Uruguay and the authorities' control over the exchange rate, control over the financial sector resided primarily in the hands of the private sector in 1982. xi. It is very important to note that, based on the evidence, financial sector liberalization is neither a simple matter, nor a painless one. Specifically, the success of the financial sector liberalization process is highly dependent on the mix of domestic fiscal, monetary, exchange, commercial and trade policies, particularly when the domestic financial market is open to international capital flows. For example, inconsistencies between fiscal and monetary policies, on the one hand, and exchange rate policies, on the other, can cause major disruptions of financial markets through inflows and outflows of capital. In countries where significant protection exists, financial liberalization may have the undesirable effect of providing additional credit to economically inefficient firms or, as in Uruguay, a boom-bust cycle based on credit. xii. On this point, the record shows that both Peru and Uruguay made major changes in their financial sector policies in the latter part of the seventies which, among things, opened the financial sector to international markets. However, when the exchange rate policy became inconsistent with domestic monetary, fiscal, and wage policies, a common pattern emerged of either high real interest rates in the local currencies, and/or "dollarization" and capital flight. This experience can be contrasted to that of Thailand, which also began to experience large capital out flows through its very open financial system at the end of the seventies. However, Thailand was able to escape the full impact of the crisis which struck Peru, Uruguay and much of the rest of Latin America, because its initial macro-policy framework was much more consistent, and because it adjusted its monetary, fiscal and trade policies more rapidly to the changing conditions. While a full exploration of these two experiences lies beyond the scope of this paper, there is general agreement that one of the crucial lessons of the financial liberalization process in Latin American was the necessity of a consistent macroeconomic policy package when the capital account is "open." Thus, both policy makers contemplating financial sector liberalizations and proponents of such reforms must take serious note of this lesson. D. The Call For Greater Market-Oriented Financial Sector Policies xiii. The growing consensus among development policy analysts for greater market-orientation of financial sector policies has received its impetus from a number of sources including: (1) an increasing appreciation of the social costs imposed by large scale government intervention in financial markets, (2) a greater sense of the importance of the well-functioning financial markets for development, and (3) a growing doubt as to the effectiveness of many forms of intervention in achieving the professed policy goals. In particular, government policies such as interest rate controls and large directed credit programs severely distort the pattern of incentives in the economy and thus affect the allocation of resources, often with questionable efficiency and distributional implications. The very administration of such programs also absorbs a great deal of scarce resources, particularly skilled labor. Furthermore, the fungibility of financial resources and the politicized nature of the "non-price" rationing mechanisms result in substantial leakages of resources away from the targetted sectors or groups, making it difficult for credit programs to achieve their stated objectives. xiv. Briefly, the market-oriented perspective suggests that there should be three broad objectives of financial sector policies: (1) the mobilization of adequate amounts of resources, both domestically and internationally; (2) the allocation of credit to its socially most productive uses; and (3) the promotion of stability in the financial system, which will encourage development. In terms of interest rates, these objectives can best be achieved by allowing rates to vary according to the state of the business cycle, pressures on the foreign exchange market, and the risk, maturity and administrative cost of the individual transaction. Also subsidies and complex systems of directed credit should be avoided. This "new perspective" does, however, recognize the need for better financial market supervision to control fraud and mismanagement and for regulations which promote greater competitiveness in the financial system. The new perspective also emphasizes the importance of narrowing the differences between economic and financial rates of return, by reducing price distortions through a more consistent fiscal, monetary, exchange, commercial and trade policy mix. E. Implications For Development Financial Policy xv. Financial sector policy should shift its emphasis from a mechanical insistence on positive real rates to promotion of broad based improvements in the functioning of the financial system and greater consistency in the macroeconomic policy framework. While real interest rates are important, they are only an imperfect indicator of the general health of the financial system. The concept of the "real" interest rate simply does not permit any but the broadest judgment about the functioning of the financial system. Slightly negative real interest rates in a given year, or even over a period of time, can be explained by the composition of the country's price index, by taxation, by differences between nominal and effective interest rates, or by expectations regarding the future. Moreover, even tying local interest rates to world rates does not guarantee positive real rates. The evidence presented in this paper suggests that, even in developing countries with open capital markets, real interest rates may vary sharply from year-to-year, and may even be negative in real terms for a number of years. xvi. Despite the foregoing qualifications, it is possible to identify situations when interest rates are excessively negative in real terms. However, the evidence of the paper indicates that negative real rates are generally not a problem, in and of themselves, but a symptom of much larger problems: that the whole macroeconomic framework--monetary, fiscal, exchange rate and tariff policies, as well as the interest rate--are out of line. Moreover, abnormally high real rates, as well as abnormally low real rates, may be indicators of these problems. For example, as shown in the paper, very low real rates typically reflect high inflation, which in turn reflects the government's use of inflationary finance to cover large public sector deficits. The paper suggests that liberalizing financial markets, without closing the deficit, could actually produce higher inflation and higher nominal interest rates if the government continues to resort to inflationary finance. Alternatively, if the public sector tries to finance its deficit with debts at market rates, or if the government tries to shield some sectors from the effects of higher interest rates by providing low-interest, directed credit, then interest rates in the rest of the market may become abnormally high, as in the Turkish case. Judging from the experience of Uruguay, and perhaps Turkey, abnormally high real interest rates may also develop in open capital markets due to expectations of a maxi-devaluation, which in turn reflect a perceived inconsistency between the exchange rate policy and the other macroeconomic policies. The above cases suggest that liberalization of real rates, without paying sufficient attention to the underlying imbalances in the economy, could well destabilize the corporate and banking sectors, by creating significant cash flow and liquidity problems. xvii. The scope and scale of low interest, directed credit programs should be reduced, in order to improve the functioning of the financial system. The sources surveyed for this paper indicate a number of problems associated with large amounts directed credit. In particular, the fungi- bility of financial resources and the politicized nature of the credit allocation process often lead to substantial leakages of resources from the target groups or sectors. Attempts to prevent such leakages are also problematic, since they necessitate imposing a degree of fragmentation on financial markets that thwarts the markets' role as efficient, decentra- lized allocators of resources. The evidence also suggests that the distortions produced by the directed credit programs often have question- able efficiency and distributional consequences, particularly when account is taken for the ultimate bearers of the implicit and explicit taxes inherent in such programs. Finally, the administration of these programs and the efforts taken to circumvent their regulations tend to absorb large amounts of scarce human resources without generating any social benefit. xviii. Two final points are worth noting: First, the urgency of such policy reforms is directly related to both the size of the programs and the size of the interest differentials. Small interest differentials and small programs simply cannot create large distortions. Second, even if financial distortions are small, the financial system may be efficiently allocating resources to economically inefficient projects if the price and profita- bility signals that it receives do not reflect economic efficiency. This problem once again highlights the need for a link between macroeconomic policy, trade and pricing policy, and financial sector policy in order to achieve development goals. INTEREST RATE POLICIES IN SELECTED DEVELOPING COUNTRIES I. INTRODUCTION 1.01 Broadly speaking, the recommendations for financial sector policies in developing countries have evolved along the following lines: The orthodoxy of the fifties and sixties was that interest rates should be kept low to stimulate investment. Rising world inflation in the late sixties and the seventies focussed attention on the detrimental effects of negative real interest rates on the allocation of resources, the distribu- tion of income, and the mobilization of savings. As a result, policy recommendations often emphasized that lending and deposit rates should be positive in real terms and intermediation spreads should provide an ade- quate return to financial institutions. In recent years, a growing consen- sus has developed regarding the need for greater reliance on market forces in the determination of interest rates and in the financial sector in general. 1.02 Several factors have contributed to the growing recognition of the need for more market-oriented financial sector policies. First, it has become exceedingly difficult either to prescribe a fixed structure of interest rates, or to expect that governments could adjust interest rates with sufficient speed to maintain stability in the financial markets and avoid massive flows of international capital, given the sharp increases in the level and variability of local inflation and of world interest rates. Second, there has been an increasing perception that well-functioning financial markets are an important factor in development. As evidence has accumulated on the functioning of financial markets in developing coun- tries, it has become increasingly clear that the distortions introduced by many government financial sector policies, particularly interest rate controls, were substantial. Moreover, the effectiveness of many of these policies in attaining the intended policy objectives was also cast into doubt. 1.03 Another growing perception in the development literature is that financial markets and interest rates cannot be considered in isolation; they are greatly influenced by what goes on in the rest of the economy. In particular, the importance of factors such as openness and distortions in the real side of the economy have been rather rudely brought to light in the last couple of years. For example, in some developing countries unprecedented high real interest rates have appeared, producing a crisis in the corporate sector by sharply increasing debt service burdens. To some extent these high real rates simply reflect the higher real rates in the world financial markets and capital market openness. However, the high real interest rate problem has been most acute in historically high infla- tion countries which have undertaken interest rate and exchange rate reforms. In some cases these high real rates appear to be related to inconsistencies between fiscal and monetary policy, exchange rate and trade policy, and expectations; in other cases they seem to be related to distress borrowing and/or the poor performance of a substantial portion of -2 - outstanding credits, which in turn are largely a reflection of poor performance in the real economy. No clear consensus has formed on either the explanations for these high rates, or the optimum policy response. Nonetheless, the whole problem underscores the fact that formulating an ".appropriate" interest rate policy is an exceedingly difficult task and involves far more than the real rate of interest. 1.04 This paper examines interest rate policies in developing countries by asking the following two questions: "Have interest rates been positive in real terms?" and, in light of the growing consensus over the need for more market-oriented policies, "Have market forces been important factors in the financial sectors of the developing countries?" 1.05 To answer these questions the paper proceeds as follows: Section 2 discusses the selection of the countries used in the investigation, the time frame, the interest rate series collected and the data sources. Section 2 also discusses two important methodological issues: (1) whether to focus on lending or deposit rates, and (2) the calculation of the "real" interest rate, i.e., either "ex-ante" using lagged inflation or "ex-post " using the actual inflation rate. Section 3 addresses the first question, using evidence on the real and nominal interest rates in the sample countries. Section 4 examines whether interest rates were set according to two well-known models: the Fisherian Model and the Uncovered Interest Rate Parity Model. Section 5 begins the discussion of the paper's second question--the degree of market orientation of financial sector policies-- with a brief statement of the arguments for greater reliance on market forces. Section 6 summarizes the evidence relating to the changing role of the market in the financial sectors of developing countries. II. THE SAMPLE COUNTRIES, DATA SOURCES AND SOME METHODOLOGICAL CONSIDERATIONS 2.01 This paper examines the financial sector policies pursued by a sample of ten developing countries over the period 1970 to 1982. These countries are: Bangladesh, Kenya, Korea, Morocco, Nigeria, Pakistan, Peru, Thailand, Turkey and Uruguay. To investigate the question of positive real interest rates, evidence is presented on nominal and real interest rates on term deposits, general short term credits, and a preferential lending category in each of the ten countries. The second issue investigated in this paper--the extent of financial market liberalization--is treated through a broad, qualitative examination of financial sector policies in a subset of seven of the ten countries. These analyses appear as Annexes 2 through 8 and are summarized in Section 7, which focuses on government intervention in financial markets, financial sector reforms,, the structure of lending and deposit rates, and the relation between interest rate and exchange rate policies. 2.02 The ten countries were selected on the basis of: (1) diversity, both geographical and developmental; (2) the availability of interest rate series covering the 1970-82 period; and (3) the availability of data on the holdings of financial assets, specifically demand, savings and term accounts, plus other forms of widely held near-monies. The sample contains countries from East Asia, South Asia, Sub-Saharan Africa, North Africa, Latin America and an OECD member. It is fairly representative of develop- ing countries in general, as it contains countries at very low income, low income and middle income levels. There are countries with inward looking economic policies and countries pursuing export-oriented growth strategies, and there is a major oil-exporter. 2.03 For inclusion in the seven-country sub-sample, an additional criteria was used: the availability of a reasonably up-to-date World Bank study of the financial sector, permitting a characterization of the broader policy setting. These seven countries are: Bangladesh, Kenya, Nigeria, Peru, Thailand, Turkey and Uruguay. 2.04 In addition to the World Bank financial sector studies, the sources for the data used in this study include the bulletins of the central banks for the interest rate and asset data, and the IMF's International Financial Statistics for the consumer prices, exchange rates and national income data. The interest rates quoted in the central bank publications typically are the rates established by governments, e.g., minimum or maximum deposit rates and maximum lending rates. The published figures usually do not reflect various common financial practices such as compounding, compensating balances required of borrowers, or free services rendered to depositors; nor do they reflect the impact of taxes on interest rates. Whenever the information was available, effective interest rates were used or computed: for example, rates were adjusted for compounding or discounting. Unfortunately, for most countries only unadjusted rates were available. Thus the figures presented here should be used primarily to identify the range of actual interest rates and should not be taken as overly precise. 2.05 Bearing this in mind, the first important methodological question is whether to cast the discussion in terms of lending rates or deposit rates. Some technical considerations suggest focusing on deposit rates. First, it is relatively easy to identify a "standard" deposit rate that is comparable across countries, but there is no similar "standard" lending rate; in a free market lending rates vary substantially by risk and matur- ity. Moreover, in the controlled markets of developing countries varying degrees of credit rationing occur, making direct comparisons of lending rates difficult. Second, the available data predominantly refer to official rates and in practice, compensating balances, commissions, grace periods and taxes allow effective lending rates to diverge further from the official lending rates than compounding and taxes allow effective deposit rates to differ from official deposit rates. Again this makes it prefer- able to compare deposit rates. Third and finally, the standard deposit rate provides a reasonable amount of information about the loan rates. This is because the standard deposit rate and a comparable loan rate should differ by a fairly constant margin within a country, reflecting country - 4 - specific intermediation costs and reserve requirements.l/ Across countries the differences in these margins are also likely to be small, relative to differences in the levels of interest rates. For these reasons most of the discussion of real rates will be focus on deposit rates, although lending rates also will be mentioned. 2.06 The second methodological issue is the appropriate calculation of the "real" rate. While a wide range of policy discussions express concern that interest rates be positive in real terms, i.e., in excess of the rate of change in prices, little is said about what price index should be used in comparison. In the conventional model of the demands for financial assets or credit, agents are assumed to make their decisions based on a comparison of interest rates with their expectations about future prices (including possibly the price of foreign exchange). However, such expecta- tions are not observable, nor is there general agreement regarding the "relevant" array of prices or interest rates. The typical proxy for the "real" rate involves a single interest rate adjusted either by some average of past changes in the consumer price index (and, for the exchange rate, past changes in the official exchange rate) or by some projection of declining inflation. However, in periods of rising inflation (or major devaluations) such as the 1970-80, such procedures systematically under- state investors' expected returns on credit and systematically overstate depositors' expected returns on financial assets, assuming the public understands that inflation is rising. In effect, using lagged inflation to calculate a real rate implicitly assumes that economic agents are system- atically fooled by rising inflation. 2.07 Such an assumption is highly unsatisfactory, particularly since many of the important conclusions to be drawn from a study of interest rates relate to the allocation of financial resources and the mobilization of financial savings, both of which depend heavily on the public's expecta- tions. In an attempt to provide a better proxy for the expected real interest rates, this paper concentrates its analysis on the "ex-post" realized rate, i.e., the nominal interest rate deflated by the actual price change over the relevant period. For example, the real interest rate for 1982 was calculated by deflating the nominal interest rate in effect in December 1982 by the annualized rate of change in consumer prices (or the exchange rate, when applicable) from December 1982 to June 1983. While not imputing perfect foresight, the authors feel that this method provides a better proxy for the expectations of depositors and borrowers than the usual method of averaging past inflation, particularly in periods of rising 1/ For a profit maximizing bank, the interest rate on a standard loan, R, should cover the marginal interest cost of deposits used to make the loan, D, multiplied by an adjustment for the reserve requirement, RR, plus intermediation costs expressed as a percentage of the loan, C, i.e., R = C + [ D/(1 - RR) ]. inflation.2/ A six month time horizon was utilized in these calculations to reflect the short maturities of portfolios which characterize the finan- cial markets of the developing countries. However, in view of all the questions regarding both the interest rates and the appropriate choice of proxy for expectations it is worth repeating the warning that the figures in this study should not be interpreted as a precise estimate of the real rate but only as a general indicator of the range of real interest rates.3/ III. THE AVERAGE LEVEL OF REAL INTEREST RATES: THE INTEREST RATE REGIME 3.01 The real interest rates policy regimes of the ten countries fall into three distinct groups, as measured by the average ex-post real interest rates for the period 1970-82. This division shows up in Table 1, which presents averages 4/ of year-end real interest rates in local currency on term deposits, general short term credits and preferential 2/ The ex-post real rate has become a standard approach for studying the extent to which inflationary expectations are incorporated into the interest rate. See for example E. Fama, "Short Term Interest Rates as Predictors of Inflation," American Economic Review, June 1975, pp. 269-82 and R. Saracoglu, "Expectations of Inflation and Interest Rate Determination," IMF Staff Papers, March 1984, pp. 141-178 and the works cited there. 3/ It should also be noted that the analysis is affected very little by the choice of lagged or future inflation as the deflator for the calculation of the real rates. While the choice does affect the real rates on a year to year basis, it has little impact on the broad picture over a longer period of time. First, nominal interest rates were fairly constant over time in the sample, thus real rates were primarily determined by the inflation rates. Second, inflation tended to move contemporaneously across the countries, thus the choice of lagged or future inflation primarily shifted the point in time at which real interest rates rose or fell, but made little impact on the relative levels of average real rates across countries. On this point, the interested reader is encouraged to compare Figures 1A - ID in Section 3, which plot the nominal deposit rates against the inflation rates six months forward from December of the current year, to Figures 1A - ID in Annex 1, which plot the nominal deposit rates against the rates of inflation over the twelve months preceding December of the current year. In addition, see Footnote 16 which also relates to this issue. 4/ The average is defined as the average compound real interest rate over the period. Thus it is the average growth of the real purchasing power of a one unit deposit over the period, or the average real cost of one unit of credit over the period. For the exact formula see Table 1, Note 1. - 6 - credits for each country for the period 1970 to 1982.5/ The groupings also shows up in Figures IA - ID, which chart the end-year nominal term deposit rates and inflation rates over the same period.6/ The ex-post real term deposit rates can be read off the charts as roughly the difference between the two lines. The real rate is negative when the inflation rate lies above the deposit rate and positive when the opposite is true. 3.02 The first group of countries--Pakistan, Morocco, Korea, Thailand, Bangladesh and Kenya, in descending order of their average real deposit rates--maintained real rates which were only slightly negative when averaged over the whole period. These rates ranged from roughly zero in Pakistan to -6.8%, in Kenya. Real lending rates for short term credits were 2 to 7 percentage points above these rates, depending on the country, and ranged from about +3% to -1%. Preferential lending rates generally fell between the average deposit and the average lending rate. 3.03 Even though real deposit rates were, on average, not positive in these six countries, they did approximate the average real deposit rates prevailing in developed countries. In particular, the average real deposit rates for these countries ranged from rough equivalence to six percentage points below the comparable U.S. real deposit rate of -0.7%, which is displayed in the last line of Table 1.7/ Moreover, one would not expect 5/ As shown in the Annexes, Uruguay and Peru, recently allowed deposits and credit denominated in foreign currency. These deposits and credits represented a substantial portion of total financial assets and liabilities, and rates on them approximated international levels. 6/ Annex 1 presents the raw data for Tables 1 through 4 and Figures 1A through 2D. As shown in Figures 1A - ID in Annex 1, the countries fall into the same three groups if past inflation is used to calculate real interest rates. 7/ Using a more complicated methodology, Saracoglu estimated that real interest rates in the Federal Republic of Germany, France, Japan and the U.K. were also negative during most of the 1970's. See Saracoglu op. ci. -7 - Table 1 Average Real Interest Rates a/ (% p.a.) Deposit Lending Representative Rate Rate Preferential Rate e/ Pakistan 1970-82 0.1 2.2 1.5 Morocco 1974-82 -1.7 2.7 -1.8 Korea 1970-82 -4.1 -1.1 -8.3 Thailand 1970-82 -4.1 2.9 -4.6 Bangladesh 1971-82 -5.4 -1.3 -3.4 Kenya 1970-82 -6.8 -1.0 b/ _4.4 Uruguay 1970-82 -11.1 14.7 c/ #N/A Turkey 1974-82 -16.2 -13.6 -20.5 Nigeria 1970-82 -16.5 -11.8 -7.8 d/ Peru 1970-82 -18.6 -9.1 -24.8 U.S. 1970-82 -0.7 1.9 #N/A Sources: Annex 1 Tables. U.S. figures are based on Federal Reserve Bulletin nominal rates and IMF CPI data. a/ Average refers to the average compound real interest rate over the period, i.e., Antilog([Ut( ln(l+rt) - ln(l+pt)) I/n ) - 1 where rt = nominal rate of interest at end of year t, Pt - annualized inflation rate from end of year t to the following June, n = number of years. b/ 1977-82; the corresponding average real deposit rate was -4.7% and the average preferential lending rate was -3.8%. c/ 1976-82; the corresponding average real deposit rate was 0.9% and the prime lending rate was 4.6%. d/ 1978-82; the corresponding average real deposit rate was -10.8% and the average real general lending rate was -6.0% e/ Specifically, the preferential rates were as follows: loans against jute, jute goods and tea, Bangladesh; loans from the Agricultural Finance Corp., Kenya; preferred sector maximum, Nigeria; rediscounts from the Banco Agrario, Peru; export credits, Thailand; and agricultural credits, Turkey. FIGURE IA NOMINAL INTEREST RATE ON TERM DEPOSITS CS MONTH) ----- INFLATION RATE (DECEMBER TO JUNE, ANNUALIZED) 80- 30- , X 209 -19- BANGLADESH -20-,, , , , 40- 309 x 0- 40- 30 -.' .'."'. X 20- _ 0- KOREA 1970 1972 1974 1878 1978 1980 1982 - 9 - FIGURE 1B NOMINAL INTEREST RATE ON TERM DEPOSITS (6 MONTH) *- INFLATION RATE (DECEMBER TO JUNE, ANNUALIZED) 25- 20- 10- - MOROCCO -o - 80- NIGERIA -20-l 30-_ I s 60 __ PAKISTAN 1070 1972 1074 1976 1078 lose 1982 - 10 - FIGURE IC NOMINAL INTEREST RATE ON TERM DEPOSITS (6 MONTH) ------INFLATION RATE CDECEMBER TO JUNE, ANNUALIZED) 150- 120- 90- 30- ------------ ---- 0- PERU -30 I- 40 30- 2 - ''' ,"'' '''" THAILAND 120- . ' 0- TURKEY -30 - 1970 1972 1974 1976 1978 1980 1982 - 11 - FIGURE ID NOMINAL INTEREST RATE ON TERM DEPOSITS (6 MONTH) ------ INFLATION RATE (DECEMBER TO JUNE, ANNUALIZED) 100- ,. X 0 4 0- URUGUAY -20- 25- 20- _5_ UNITE STATES -0- 1970 1972 1974 197e 1978 1980 1982 - 12 - the real rates to be exactly the same, even if financial markets were integrated or if both individual preferences and investment opportunities were the same across countries, because of cross-country differences in the composition of the price index.8/ Also, differences in the tax treatment of deposit interest affect any comparison between U.S. and developing country interest rates. For example, a pre-tax real rate of -1% is equivalent to about -3.4% after taxes, given a nominal interest rate of 8% and a tax rate of 30%.9/ Since effective tax rates were probably much higher in the U.S.--because interest is often legally free of taxation in developing countries and, in any case, is often unreported to the tax officials--a comparison of pre-tax real returns exaggerates the relative attractiveness of U.S. deposits. 3.04 The last line of Table 1 also displays the average real U.S. Prime Rate, which can be used to roughly estimate an intermediation spread for the U.S. A comparison of the differences between lending and deposit rates in the first six developing countries and the corresponding spread for the U.S. indicates that spreads in these six developing country were reasonable--roughly one to three percentage points greater than the U.S. margin. Also, the preferential lending rates in the six countries were, by-and-large, above the deposit rates. In sum, the evidence suggests that in these six countries interest rate policy was similar to policies in developed countries. 3.05 The second group of countries--Turkey, Peru, and Nigeria--clearly pursued policies of low interest rates. The average real deposit rates over the period were -16.2%, -18.6% and -16.5% respectively, substantially negative in real terms. While the lending rates shown in Table 1 are somewhat above the deposit rates, the true spreads probably were much larger, since the full effects of commissions, compensating balances and discounting could not be accurately factored into the ceiling rates. Finally, in two of the three cases the reported preferential lending rates actually fell below the deposit rates. Thus, over much the 1970-82 period these three countries followed an interest rate policy directly opposed to standard policy advice to maintain positive real rates. However, it must 8/ For example, the rapid escalation in petroleum and transport prices would produce higher measured inflation rates in countries where these goods and services have larger weights in the consumer price index and where these prices changes were more fully reflected in higher prices to consumers. 9/ The real interest rate after taxes is (1 + (1-tx)*r/(l+p), where tx is the tax rate, r is the nominal rate, and p is the rate of inflation. This is approximately (1-tx)*r-p or using the text numbers (1.0 - 0.3)*0.08 - 0.09 = -3.4%. For a further discussion of the impact of taxes see M. Darby, "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, June 1975, pp. 266-276 and V. Tanzi, "Inflationary Expectations, Economic Activity, Taxes and Interest Rates," American Economic Review, March 1980, pp. 12-28. - 13 - be pointed out that under the pressures of serious economic crisis both Turkey and Peru recently attempted interest rate liberalizations.10/ 3.06 The remaining country--Uruguay--is set apart from the other two groups, first because it had an average real deposit rate over the period that fell between the two groups, and second, but most importantly, because it undertook a major interest rate policy shift in 1975, about the middle of the sample period. This shift is obscured in the average figures but appears clearly in Figure 1D. Between 1971 and 1973, Uruguayan real interest rates were among the lowest recorded of the ten countries. How- ever, beginning in 1974 the Uruguayan capital market was opened and interest rate controls were lifted gradually, so that by 1978 most interest rates were determined by market forces and closely linked to international rates. One rather interesting observation should be made here: The policy of market determination of interest rates did not imply positive real deposit rates in Uruguay in every year. Real deposit rates shifted back and forth between positive and negative levels after the reforms, as shown in Figure ID. Some of the factors behind this outcome will be discussed in Sections 4 and 6. 3.07 Aside from Uruguay, a number of the other sample countries also changed their interest rate policies, as shown in Figures IA - 1D. Table 2 summarizes the major changes in the nominal deposit rates.11/ Bangladesh raised nominal rates between 1974 and 1976, and again in 1980. Kenya and Thailand raised nominal rates in 1981 and 1980, respectively. Pakistan and Morocco raised rates gradually. In contrast to the other five countries, Korea adjusted its interest rates frequently throughout the period, with nominal term deposit rates ranging from 8% to 17%. In the high inflation- low real rate group, all three countries made some changes in the level of nominal rates: Turkey embarked on a policy of greater reliance on market forces for determining rates on deposits and some credits in 1980; Peru shifted to a policy of higher nominal rates between 1978 and 1982; and Nigeria raised rates a few percentage points between 1978 and 1982. As in Uruguay, these changes generally followed periods of substantially negative real rates: e.g. Bangladesh (1972-73 and, to a much lesser extent, 1976-79); Kenya (1972-80); Thailand (1978-79); Pakistan (1971-75); Turkey (1973-78); Peru (1972-77); and Nigeria (1970-77). 3.08 The upward adjustments in the nominal rates were in apparent response to the problems created by the low real rates and in line with standard policy advice. However, the results of the adjustments were mixed, either in terms of achieving positive real rates, or even higher real rates. Generally speaking, the nominal rates were not raised enough to even exceed past inflation. Thus, it would be hard to argue that the 10/ See Section 6 and Annexes 7 and 5 for more complete descriptions. 11/ More detailed discussions of these reforms are contained in Section 6 and in the Country Annexes. In each case, these changes were accompanied by similar changes in the nominal rates for general credits. - 14 - interest rates were reset to produce positive real rates ex-ante. Instead the reforms relied heavily, and not always successfully, on falling infla- tion for achieving subsequent positive real rates, ex-post. In Bangladesh (1974-75, and 1981), Morocco (1979 and 1982), Pakistan (1975-78) and Thailand (1981-82) real rates became positive after the changes in the nominal rates largely due to declines in inflation, as shown in Figures 1A - 1C. In Korea the role of declining inflation is even clearer; nominal rates were lowered slightly in 1981 and sharply in 1982, but inflation dropped so swiftly that real rates shifted from slightly negative to fairly positive levels. Among the low inflation-high real rate group, only in Kenya (1982) was the rise in the nominal rates the principal factor in achieving positive real rates. Table 2 MAJOR POLICY CHANGES IN NOMINAL DEPOSIT RATES a/ (in percent per annum) Reform Pre-reform Post-reform Period Interest Rate b/ Interest Rate c/ Bangladesh 1974-76 4.8 7.5 Bangladesh 1980 7.5 13.0 Kenya 1980-82 5.4 13.2 Pakistan 1973-75 5.6 8.9 Morocco 1978-82 4.5 8.5 Thailand 1980 7.0 10.0 Uruguay 1974-79 18.0 50.6 Turkey 1980-82 12.0 50.0 Nigeria 1978 3.0 5.0 Nigeria 1982 6.0 8.5 Peru 1978-82 14.0 71.2 Sources: Annex 1, Summary Table 4. a/ Each of these increases in nominal deposit rates were accompanied by a similar increase in the rates for general credits. See Annex 1, Summary Table 5. b/ The "pre-reform" rates refer to the rates prevailing at the end of the year preceding the reform period. c/ The "post-reform" rates refer to the rates prevailing at the end of the last year of the reform period. 3.09 Among the high inflation-low real rate group, the experience with interest rate reforms was even more mixed. In Nigeria, as in the first group, the decline in the rate of inflation was more important than the - 15 - increase in the nominal rates in raising the level of real rates. In Turkey the increase in the nominal rates was much larger than in Nigeria, and correspondingly was a more important factor in the appearance of higher real rates, ex-post. Together with the rapid decline in inflation during 1980-82, the Turkish interest rate reforms resulted in markedly higher real rates in 1980-82, rates that reached as high as +22.1% for term deposits and +34.3% for general credits at the end of 1982. These high rate were in striking contrast to the extraordinarily negative real rates --about -60.0 percent--that prevailed at the end of 1978. However, it must be pointed out that these liberalized rates applied only to a rela- tively small fraction of all financial transactions, particularly on the lending side. Thus, to some degree, the high real rates on general credits reflected the large amount of low interest, directed credit which the banks were required to extend. In addition, fears of devaluation may have pushed up rates in local currency. Finally, Peru also switched to a policy of substantially higher nominal rates during the 1978-82 period, but surging inflation generally kept real rates negative, rendering the reforms fairly ineffective in raising real rates. 3.10 In sum, over most or all of the 1970-82 period, six of the ten countries studied followed reasonable interest rate policies and two others--Uruguay and Turkey--switched to policies of the type of policies which are typically recommended. Thus, overall, there was a fair degree of concordance with the standard interest rate policy advice in the ten sampled countries. 3.11 It is also worth inquiring whether acceptance of this policy perspective has increased over the period, i.e., whether real rates were on average higher during the second half of the period (1977-82) than the first half (1970-76). As shown in Table 2, the major changes in nominal rates generally occurred after 1977. Judging from the increases in average real deposit and lending rates in the 1977-82 period over the 1970-76 period, which are displayed in Table 3, the interest rate performance improved on average between the two periods. This improvement occurred through the combined effects of the steady rise in nominal rates and, most importantly, lower average inflation. 3.12 The improvements in interest rate performance were strongest in Uruguay, due to the sweeping reforms of 1974-79, and in Bangladesh and Nigeria, due to marked declines in inflation. However, Nigerian real rates remained very low despite this improvement. Table 3 also shows that the two other low real rate countries--Peru and Turkey--suffered sharp declines in the average levels of real interest rates for the second half of the 1970-82 period. However, these figures mask two very different patterns in the development of real interest rates. In Turkey, the lower average is largely due to the extraordinary negative levels reached in 1977-79, before the 1980 reforms. In Peru, the decline in the average reflects the failure of the interest rate reforms to keep pace with rising inflation. This is clearly evident in Table 4, which displays the average rates for the 1970-80 and 1981-82 periods. The real rates show an sharp increase in Turkey and a slight decline in Peru. - 16 - Table 3 AVERAGE REAL INTEREST RATES a/ IN 1970-76 AND 1977-82 (in percent per annum) 1970-76 1977-82 Term Gen. Pref. Term Gen. Pref. Deposit Credit Credit Deposit Credit Credit Pakistan -2.3 0.3 -0.7 3.0 4.4 4.1 Morocco b/ -3.2 1.7 -2.2 -0.9 3.2 -1.6 Korea -4.4 -0.4 -9.6 -3.8 -1.9 -6.8 Thailand -4.6 2.5 -4.1 -3.5 3.3 -5.1 Bangladesh c/ -9.9 -5.0 -6.8 -0.8 2.6 0.1 Kenya -8.7 - -6.0 -4.5 -1.0 -2.6 Uruguay -10.9 - - 5.3 18.0 - Turkey d/ -10.9 -8.0 -9.0 -19.5 -17.2 -27.3 Nigeria -20.4 -15.4 - -11.7 -7.4 -7.8 Peru -11.5 -3.8 -14.1 -26.2 -14.9 -35.7 Sources: Annex 1, Tables 1-3. a/ See Table 1, Note 1 for definition of average real rate and Note 5 for the specific categories of preferential credits. A dash indicates less than two observations. b/ All Moroccan series begin in 1974. c/ All Bangladesh series begin in 1971. d/ All Turkish series begin in 1974. 3.13 An examination of Figures 1A - ID reveals another interesting pattern. Each of the ten countries, and the U.S., experienced a notice- able decline in its annual real interest rates around 1973-74 and again around 1979-80, and a noticeable rise around 1981-82. Table 4 highlights the 1981-82 upswing by comparing the average real interest rates over the years 1970-80 to those of 1981-82 for each of the ten countries and the U.S. As shown there, real interest rates rose sharply in all the countries except Peru. These contemporaneous swings in the annual real interest rates suggest that common factors were at work in all of the countries, despite their seemingly different economies and degrees of financial open- ness. The following section offers some explanations for these contem- poraneous movements and provides a discussion of the determination of interest rates on a year-to-year basis. - 17 - Table 4 Averase Real Interest Rates a/ in 1970-80 and 1981-82 (in percent per annum) 1970-80 1980-82 Term Gen. Pref. Term Gen. Pref. Deposit Credit Credit Deposit Credit Credit Pakistan -0.8 1.4 0.7 5.4 6.2 6.3 Morocco b/ -2.9 1.7 -2.7 2.6 6.2 1.5 Korea -5.8 -2.6 -10.8 5.8 7.8 6.8 Thailand -5.9 1.2 -5.8 6.1 12.8 2.3 Bangladesh C/ -7.7 -3.3 5.2 6.8 9.6 5.6 Kenya -7.9 -2.4 d/ -5.6 -0.5 2.0 -0.6 Uruguay -15.3 11.2 e/ - 15.6 23.9 - Turkey f/ -23.0 -22.0 -23.6 17.9 29.6 -6.5 Nigeria -17.6 -12.9 -8.4 g/ -10.2 -5.6 -7.0 Peru -18.1 -9.4 -21.8 -21.7 -7.2 -39.6 U.S. -1.6 0.8 - 4.6 7.9 - Sources: Annex 1, Tables 1-3, and the U.S. "Federal Reserve Bulletin," for the U.S. data. a/ See Table 1, Note 1 for definition of average real rate and Note 5 for the specific categories of preferential credits. Also a dash indicates less than two observations. b/ All Moroccan series begin in 1974. c/ All Bangladesh series begin in 1971. d/ 1977-80; the corresponding rates for term deposits and preferential credits were -6.4% and -3.4%, respectively. e/ 1976-80; the corresponding rate for term deposits was -4.5%. f/ All Turkish series begin in 1974. L/ 1978-80; the corresponding rates for term deposits and general credits were -11.3% and -6.4%, respectively. - 18 - IV. THE DETERMINATION OF INTEREST RATES: NOMINAL AND REAL 4.01 As stated in Section 2, the interest rates quoted in this study are not market rates, with the exception of the post-78 Uruguayan figures. Instead the rates were either set by the government or reflect such statu- tory rate ceilings or floors.12/ Thus, the movement of interest rates discussed in this study is principally the movement of government adminis- tered interest rates. An investigation into the determinants of these interest rates is therefore really an examination of government behavior in setting interest rates. 4.02 Before proceeding with this investigation, it is necessary to point out that government intervention in financial markets is pervasive, even in the industrialized countries. First, reserve requirements and taxes affect the levels of interest rates in all countries. Second, controls are often placed on interest rates. For example, even the U.S. financial system, which is among the most market-oriented, was subject to Regulation Q until 1983. This regulation established ceilings on the interest rates paid on many important classes of deposits. Since interven- tion exists everywhere, the relevant issue is its impact not its existence. 4.03 A useful basis for investigating the impact of government rate setting is a comparison between the observed rates and those that might have occurred had a free market prevailed. This standard is useful because it provides a convenient benchmark for comparison, and because recent financial sector work has increasingly called for greater reliance on market forces in the determination of interest rates. Thus the question is: "Did governments set rates so as to simulate market rates." 4.04 To answer this question, it is necessary to have a broad under- standing of what determines market rates. Here there are basically two theories. The most well known theory, and the one that forms the basis of the standard recommendations on real interest rates, argues that competi- tive financial markets would establish nominal interest rates on deposits that are positive in real terms, because savers must be induced to hold financial rather than real assets, and, on average, real assets grow in nominal terms at the rate of inflation. Thus, the nominal deposit interest rate must equal the expected inflation rate plus a small underlying real rate. This real rate provides the incentive to hold financial rather than real assets. Lending rates, in turn, will also be positive in real terms, since they are based on the cost of deposits--the rate paid to depositors--plus a margin covering the cost of intermediation: reserve 12/ In the case of Pakistan a weighted average of rates subject to government controls was reported and in the cases of Turkey and Peru an attempt was made to capture the effect of discounting and compounding on the ceiling rates. - 19 - requirements, taxes, risk, administrative costs, overhead and the return to equity. This theory is know as Fisher's Theorem.13/ 4.05 An alternative, more recent theory suggests that the foregoing Fisher theorem--Nominal Rate = Real Rate + Expected Inflation--is not the appropriate model for market determined interest rates in an open economy. The more recent theory stresses the potential substitutions between assets denominated in domestic currency and assets denominated in foreign currency, rather than the substitution between goods and assets that forms the basis of the Fisher Equation. This theory predicts that the nominal interest rate on domestic assets will equal the "world" interest rate, adjusted for the expected rate of devaluation (and for risk). According to the theory, this condition--Uncovered Interest Parity--is assured by fluid international capital flows, which rapidly respond to any divergence in the domestic and world rates. For example, suppose expectations of a larger devaluation were to develop, because of an expansionary monetary and fiscal policy or a decline in export prices. An incipient capital outflow would raise local interest rates until the marginal asset holders were just indifferent between foreign and local currency assets, i.e., until the interest differential or spread between local currency and foreign currency assets just covered their expectation of devaluation.LV 4/ 4.06 Notice that the interest parity theory and the Fisher theory may yield significantly different results if the expected rate of devaluation is not equal to the expected difference between local and world inflation.15/ In particular, if the expected rate of devaluation substan- tially exceeds the expected inflation differential, because the currency had become obviously overvalued, then local interest rates might reach extremely high real levels. Such high real rates simply would reflect the public's increased desire to borrow in local currency and to lend or deposit in dollars. Thus, the effects of expected devaluation provides one explanation of the abnormally high real rates recently observed in some middle income countries. 13/ It is worth noting that (1) Fisher actually did not claim that positive real rates would prevail in each and every year, nor even on average, see I. Fisher, The Theory of Interest (MacMillian, 1930), and (2) that the effect of inflation would differ, depending on whether it was foreseen or unforeseen. Fama's work op. cit. suggests that expected inflation was fully incorporated into U.S. Treasury Bill rates. However, recent evidence has raised some questions about the general empirical validity of the theory, see L. Summers, "The Non-adjustment of Nominal Interest Rates: A Study of the Fisher Effect," in J. Tobin Macroeconomics: Prices and Quantities, Brookings, Washington, DC, 1983 and R. Saracoglu 2. cit. and works cited there. 14/ A similar argument can be made for lending rates, although that spread is not investigated in detail here. 15/ The two theories also could yield different results if the risk premium on one of the currencies is significant. - 20 - 4.07 In addition to the case where expectations of devaluation exceed the differential in inflationary expections, an alternative case exists, namely: If the expected rate of devaluation became significantly less than the expected differential in inflation rates, then market-clearing interest rates in local currency rates would become depressed, possibly even negative in real terms according to the Fisher equation. This would reflect the public's increased desire to borrow in foreign currency and lend or deposit in local currency. The point here is that recommendations for market determined interest rates and recommendations for positive real interest rates can be inconsistent if market interest rates are determined in accordance with the Uncovered Interest Rate Parity Model. 4.08 "Do governments set interest rates in accordance with either the Fisherian Model or the Uncovered Interest Parity Model?" Judging by the data collected this study, the answer is no. In general, the administered rates were at best only partially adjusted to maintain real returns and real costs of credit in the face of actual inflation or devaluation. 4.09 Figures 2A - 2D illustrate the relationship between the real rate of interest and inflation. If nominal rates had been set according to the Fisher Model, then the real rates would have remained stable and would show up in the graphs as horizontal lines or, given errors in expectations, would vary randomly around a constant level. A quick glance at Figures 2A - 2D reveals that real interest rates do not follow this pattern (the U.S. included). Instead they are basically a mirror image of the inflation rate. This means that governments typically adjusted the nominal interest rate by much less than actual inflation, leaving variations in the real rate to be largely determined by variations in inflation.16/ 4.10 The observation that the inflation rate predominantly determined the real rates also explains the contemporaneous variation in the annual real interest rates across countries (Again see Figures 2A - 2D). Specifically, real rates moved together because domestic inflation rates moved together, and because domestic nominal rates were not fully adjusted for future inflation. In particular, real rates declined sharply around 1973-74 and again around 1979-80 in both the sample countries and the U.S., 16/ This pattern also shows up in some regression analyses of nominal interest rates undertaken as background for this paper. Regressions of the nominal interest rates on future and lagged inflation yielded statistically insignificant coefficients for both variables, rather than coefficients summing to one, as would be implied by the Fisherian Theory. In other words, the nominal interest rate was fairly independent of the inflation rate, whether future or lagged. This, in turn, implies the real rate is largely a function of the inflation rate. These regression results also support the view that it matters little whether lagged or future inflation is used as a proxy for expectations; since nominal rates were fairly constant over the period, the difference between using lagged and future inflation rates only affects the timing of the variation in real rates, not the average real rate. (See also Footnote 3). - 21 - due to the oil-price shocks and.the rise in worldwide inflation.17/ In 1981, and in most cases 1982, real rates were sharply higher. This was primarily due to a general decline in world inflation, although increases in local nominal rates also played a role (See Sections 3 and 6). 4.11 Finally, differences in average real interest rates over the period largely reflect differences in average inflation rates: Countries with higher average real rates tended to be countries with lower average inflation. Lower rates of inflation permitted these countries to maintain low nominal interest rates without having real rates which were excessively negative. Countries with highly negative real rates on average tended to be countries with higher average inflation. This indicates that in these countries governments were typically unwilling or unable to set nominal interest rates in line with average inflation. The exception is in Uruguay after 1978, when rates were set in the free market. Given this historical pattern of government policies toward nominal interest rates it seems that maintaining a low rate of inflation is critical to maintaining a stable real interest rate policy. 4.12 If anything, the Uncovered Interest Parity Model fares even worse than the Fisher equation as a theory of government rate setting. Figures 3A - 3D graph the local nominal deposit rate in each country and the U.S. Treasury bill rate adjusted for the ex-post rate of devaluation. If uncovered interest parity had held, then the two lines would have moved roughly in parallel. However, Figures 3A - 3D show that the gap between the two rates fluctuated wildly. This fluctuation indicates governments did not adjust the deposit rate to reflect future devaluation as would have occurred with more open capital markets. 4.13 As mentioned above, Uruguay, from 1978 onward, was the only case in the sample where interest rates were allowed to be freely determined in an open capital market. After the reforms, Uruguayans could deposit and borrow locally in either dollars or pesos and there were no restrictions in capital flows. In addition, reserve requirements were eliminated in 1979 and there were no taxes on interest rates. Thus, an examination of Uruguay in this period provides an idea of the behavior of a free market interest rate in a financially open, developing economy. The following discussion suggests that the uncovered interest parity model works tolerably well, provided it is assumed that expectations of devaluation were fairly constant. 4.14 Figure 4 plots the nominal interest rates on peso and dollar deposits in Uruguay in each quarter between 1978 and 1982. As shown there, it took a few quarters for the market to adjust to its new freedom, but afterwards the spread between peso and dollar deposit rates remained fairly 17/ It could be argued that governments kept nominal interest rates low in an effort to manipulate inflationary expectations, i,e., not to be seen as admitting that inflation will be higher in the future. Clearly, such a policy is extremely limited in its potential effectiveness, since its credibility is rapidly eroded by negative and real rates, ex-post. - 22 - FIGURE 2A EX-POST REAL INTEREST RATE ON TERM DEPOSITS CO MONTH) --- - INFLATION RATE CDECEMBER TO JUNE, ANNUALIZED) tee- 130- 100- 78- X 40- -20- -50s BANGLADESH -80- 1 60- 130- toe- 7e- X 40- |0_ . , ,, .... ,.~~~~~~~-- -----------------. . -20- -so0- KENYA 160 130- 100- 70- -2 0- 1 1 1 9 19 -50- KOREA 1 970 1 972 1 974 1 976 1 978 1lose 1 982 - 23 - FIGURE 2B EX-POST REAL INTEREST RATE ON TERM DEPOSsrTS CO MONTH) I--- INFLATION RATE CDECEMSER TO JUNE, ANNUALIZED) leo-- 138- 18- X 40- 10- , ~.. .-''-...----------........... '''*-...... . . . .. . . . . .. . . . .. . . . . -20-,- MOROCCO 138- lee- 70- X-40- _= -5- NIGERIA i3O- 160- 130- 10- 78- 40- -20- -st PAKISTAN 1970 1972 1974 1976 1978 1980 1982 - 24 - FIGURE 2C EX-POST REAL INTEREST RATE ON TERM DEPOSITS CO MONTH) --.- INFLATION RATE CDECEMBER TO JUNE, ANNUALIZED) 160- 130- 70- 40- ,........ ................ 10- ......,..---''' -20- ____ -50- PERU -80- 160 - 130- 100- 70 - 40- X 0 t__ .- .................. _ , -20- -60- THAILAND -80 130 - , 70 - , 40 - ,, ,.*... ^''*.... '''' X~~~~~~~~~~~~~~~~~~ ~ 40 -20- -50- TURKEY -80 - 1978 1972 1 974 1970 1978 1 988 1982 - 25 - FIGURE 2D - EX-POST REAL INTEREST RATE ON TERM DEPOSITS CO MONTH) .-- INFLATION RATE (DECEMBER TO JUNE. ANNUALIZED) 160 - 130 - X 40 _, ,, 70 -\ -20 -80 - 160- 130- 198- 708 X 40- 1-,..--- '- --- ------ '''' - -20- -60- UNITED STATES se- 0 1970 1972 1974 1976 1978 1980 1982 - 26 - FIGURE 3A NOMINAL INTEREST RATES ON TERH DEPOSITS CO MONTH) ----- NOMINAL O MO. US T-BILL RATE, ADJUSTED FOR DEVALUATION 168- .' '.. 90- .'' ' X 80- 3m3 O~~~~~~~~~- .,. --. , - - -- - -- - -30- BANGLADESH 10- 120- 98 - X 60- 30- "' -30- KENYA 00- 1280- so0- X 68- ."' 38- -38- KOREA -eo- , . . . lose . . X Q70 1 972 1 974 1 976 1 978 1 980 1 982 - 27 - FIGURE 3B NOMINAL INTEREST RATES-ON TERM DEPOSITS CO MONTH) .- -NOMINAL 8 Mo. US T-BILL RATE, ADJUSTED FOR DEVALUATION 130 120 x 69- 38- X eo . ..-. -30 MOROCCO 10- 120- 30- ~~~~~~~. . . . . . . . .. . . -38- NIGERIA 159 ' ' 129 ' ' 90-9 0-39 . Z . @-- -39 _RPAKISTAN -60 - I X 1970 1972 1974 1976 1978 197 8 1982 - 28 - FIGURE 3C NOMINAL INTEREST RATES ON TERM DEPOSITS C6 MONTH) ----- NOMINAL 6 MO. US T-BILL RATE, ADJUSTED FOR DEVALUATION I sQa 90- '",, X 360_ 0 _ ...... ~ ~ ~ ~ ............ ~310 -30- PERU -60- 150- 90- X 60- 30- -30- THAILAND -60- 90- .'. 300- ~~~~~~~~~~~~~~~~~......... ..... -30 TURKEY 07917 1 970 1 972 1 974 1 976 1 978 lose0 1 98z - 29 - FIGURE 3D NOMINAL INTEREST RATES ON TERM DEPOSITS C6 MONTH) -- - NOMINAL 6 MO. US T-BILL RATE, ADJUSTED FOR DEVALUATION 30- .. -30- URUGUAY 19710 1972 1.974 1976 1978 1980 1982 - Ju - FIGURE 4 URUGUAY: NOMINAL INTEREST RATES ON DOMESTIC CURRENCY AND DOLLAR TERM DEPOSITS C6 MO.) 80- 70 60 - so 30- 20- .................... 0 - I I I I I I I I I I I I I I II I 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1978 1979 1980 1981 1982 DOMESTIC CURRENCY RATES . - DOLLAR RATES - 31 - constant from the end of 1978 through the end of 1981.18/ In particular, the spread fell from around 40%, in the first three quarters of 1978, to the 30-35% range in the last quarter, where it generally remained until mid-1982. After mid-1982, the spread shot up, reflecting the public's growing expectations of a maxi-devaluation--one that finally took place in November. Three of the observations with spreads outside the 30-35% range (below) occurred in the second and third quarters of 1981 and the first of 1982, when the Central Bank and the Banco de la Republica respectively offered inexpensive forward contracts for peso depositors.19/ 4.15 The relatively constant spread between peso and dollar deposit rates implies that the real interest rate in local currency rose over most of this period. This rise was due to (1) the rise in dollar interest rates worldwide, and (2) the falling rate of inflation in Uruguay. By the end of 1981, the real deposit rate in pesos had reached 32.9%, ex-post. This experience illustrates the point that an open capital market may produce exceptionally high positive real interest rates. 4.16 It should also be noted that the relatively constant spread between peso and dollar deposit rates in fact did not reflect the ex-post rate of devaluation. Between 1978 and mid-1982, the Uruguayan government slowed the rate of devaluation as an anti-inflationary measure. However, the spread did not decline by the same amount, as might have been expected from the theory. Moreover, during much of this period the rate of devalua- tion was pre-announced for the following six months. Thus, the uncovered interest rate parity theorem can only be said to hold if it is assumed that the public's expectations were constant. This implies that either (1) expectations were incorrect for about two and one-half years; or (2) the public's expectations of devaluation reflected not only the pre-announce- ment, but what was perceived as an increasing risk of a maxi-devaluation in 18/ The actual percentage point spreads between the nominal 6 month peso deposit and the nominal 6 month dollar deposit, from 1978 Ql to 1980 Q4, are as follows: 41.4, 38.8, 42.8, 34.6, 34.0, 30.3, 32.4, 38.7, 34.2, 39.7, 36.7, 35.7, 33.5, 27.8, 29.2, 34.3, 28.6, 33.1, 45.7, and 56.0. 19/ In J. Hanson and J. Demelo, "External Shocks, Financial Reforms and Stabilization Attempts in Uruguay: 1974-1983," World Development, 1985 regression analysis is presented which statistically supports the hypotheses of a constant spread between the peso and dollar deposit rates in this period, and of the spread-reducing effects of the guarantees. - 32 - excess of the schedule, owing to an increasing overvaluation of the Uruguayan peso.20/ V. FINANCIAL SECTOR LIBERALIZATION: THE "NEW" VIEW 5.01 A growing consensus has been forming in the development litera- ture regarding appropriate financial sector policies.21/ This "new" view eschews the "standard" policy prescription of simply maintaining positive real interest rates. Instead it emphasizes the need to achieve a general improvement in the functioning of the financial sector, through greater reliance on market forces. With respect to interest rate policies, the new view recognizes that in most developing countries interest rates do not fully reflect market forces but are influenced substantially by government interventions. These interventions often prevent interest rates from effectively performing the allocative and incentive functions of market determined prices. Instead, non-price rationing of credit at below-market rates plays an important role in financial markets and a large number of transactions either occur in fragmented or foreign markets or are supplanted by inefficient forms of self-finance. A growing recognition of the economic costs of the distortions and market failures induced by many forms of government intervention in financial markets, plus increased doubts as to the effectiveness of many such programs, have provided much of the impetus behind the wider acceptance of the more market-oriented approach to financial sector policy. 5.02 The objections raised to extensive and complex regimes of finan- cial sector interventions center on: (1) the rationality of the implicit incentive structure which develops, (2) the real costs associated with the 20/ This overvaluation reflected many factors: (1) the maintenance of a rate of devaluation below the rate of inflation; (2) the 1979 terms of trade shock; (3) the potential collapse of the Argentine export market--a loss which actually occurred after 1981; (4) the dependence on volatile foreign capital inflows to maintain the schedule of devaluations--an inflow which slowed sharply after the Mexican suspension of foreign debt service in August 1982; and 5) the risk that the Uruguayan fiscal deficit could explode at any time and require inflationary finance--an explosion which actually occurred in late 1981. See J. Hanson and J. DeMelo, "The Uruguayan Experience with Stabilization and Liberalization,1974-1981", Journal of Interamerican Studies and World Affairs, Nov. 1983 pp. 477-508 for a discussion of the pre-announcement policy and its relation to the overvaluation. 21/ Two seminal books for this perspective are Ronald I. McKinnon, Money and Capital in Economic Development, (Washington, D.C.: Brookings Institute, 1973); and Edward Shaw, Financial Deepening in Economic Development, (New York: Oxford University Press, 1973). Much of this "new" perspective, as it relates to World Bank work, can be found in Millard Long, "Review of Financial Sector Work," INDFD, 1983. - 33 - administration of such regimes, and (3) the effectiveness of the regimes in attaining their professed policy goals. Complex financial sector interven- tions are likely to generate an irrational incentive structure, since administered credit schemes, and the rationing mechanisms embodied in them, cannot be expected to effectively manage all the information necessary to ensure that available financial resources are matched with the socially most productive set of real investment opportunities. In particular, directed credit schemes bias the credit allocation process towards per- ceived low-risk investments, i.e., capital intensive projects taken on by large firms (often parastatals) operating behind high tariff barriers or with local monopolies. The same credit rationing limits the amount of resources allocated to more labor intensive investments and to smaller enterprises with less collateral, uses of credit which would be economic- ally more efficient. The maintenance of such distortions can add up to large efficiency losses and worsen the distribution of income. 5.03 In addition, the distributional impact of such regimes is ques- tionable. Non-preferential borrowers, tax payers and depositors end up bearing the burden of directed credit at below-market rates. Non-preferen- tial borrowers pay through queueing costs and, when non-preferential rates are allowed to rise, through higher borrowing rates. Tax payers ultimately pay any direct sudsidies granted by the treasury. When the subsidies are covered through inflationary finance, all holders of financial assets bear the burden of the inflation tax. Moreover, depositors are often forced to subsidize preferential borrowers through interest rate ceilings on deposits. Thus, the net distributional impact of directed credit is uncertain. In addition, the lower real returns implied by the ceilings on deposit rates induce savers to hold wealth in non-financial forms. Thus some of the potential efficiency gains from formal financial intermediation are lost. 5.04 Administrative costs associated with large scale intervention are also important. The sheer paper work associated with extensive regulations and the application and screening process absorbs a great deal of scarce skilled human resources, as do the various methods of evading control, such as overbranching to compete for deposits in the presence of deposit rate ceilings and sending capital abroad illegally. Other economic losses associated with intervention include the unintended suppression of equity markets, promotion of "groups" of interlocking banking and industrial concerns, and promotion of abuses of discretionary power. 5.05 The development of equity markets is suppressed by low lending rate ceilings, which makes formal credit artificially cheap for those firms that can obtain it. As mentioned previously, low lending rate ceilings cause credit to be allocated to the large, established firms with greater collateral. However, it is precisely these firms which would be best suited to raise capital in equity markets, as opposed to the small and medium enterprises. As a result, large firms refrain from equity finance and the equity markets do not develop. This overdependence on debt finance is potentially destabilizing--as recent Latin American experience has made very clear. - 34 - 5.06 Low ceilings on lending rates and large directed credit programs also promote the formation of "groups" of banking and industrial concerns. These "groups" form either because the firms buy up the banks to assure themselves of access to cheap credit, or the banks buy up the firms to recapture the transfers to borrowers that are implicit in low lending rates. These "groups" are potentially destabilizing, because they stimulate less-than-arms-length lending practices. Moreover, the provision of low interest credit to the "groups" worsens the income distribution. 5.07 The mere act of "administering" financial transactions grants tremendous discretionary power to individuals and/or official bodies. Often this power provides too great an opportunity for abuses. These abuses can have tremendous moral as well as economic costs. While the total losses in equity and efficiency due to corruption and other by- products of financial market intervention are of course unfathomable, they do represent a potentially serious drain on the country's development effort, and thus every attempt must be made to weigh them against the anticipated gains from intervention. 5.08 In addition to the growing recognition of the costs associated with the distortions introduced by government intervention, there are growing doubts as to the effectiveness of many government programs in attaining such professed policy objectives as: (1) directing resources into a sector or subsector deemed by the authorities to have high social rates of return, and (2) increasing the flow of income towards identifiable groups in the population. In particular, the fungibility of financial resources allows substantial "leakages" of directed credit from targetted sectors into other non-targetted ones. Also, the politicized nature of the non-price rationing mechanism apparently often leads to income enhancement of politically powerful groups, rather than those ostensibly targetted in the programs. For example, credit which is supposedly directed to small farmers for grain production might wind up in the hands of large, politically influential farmers for the purchase of mechanized harvesting equipment. Or the credit provided by the programs might free up resources that otherwise would have been invested in the sector for investment in such areas as urban luxury housing. 5.09 In recognition of the above concerns, the market-oriented policy perspective suggests a multidimensional approach to financial sector policy. According to this view there are three broad objectives of financial sector policies: (1) to mobilize adequate amounts of resources, - 35 - both domestically and internationally;22/ (2) to allocate credit to its socially most productive uses; and (3) to provide a stable financial environment, which will encourage development. 5.10 In terms of interest rates, these objectives can best be achieved by allowing rates to vary according to the state of the business cycle, pressures on the foreign exchange market and the risk and maturity of the individual transactions. Accordingly: (1) Interest rates need not be always positive in real terms, as local and international pressures may cause markets to clear at nominal rates below expected inflation. (2) There should be some correspondence between local interest rates and foreign rates adjusted for expected devaluation, lest exchange markets and capital flows become unstable. (3) Given that there is not one but many interest rates, greater reliance should be placed on market forces for interest rate determination, so as to adequately reflect all the multiple combinations of maturity, risk and administrative cost. 5.11 The new perspective recommends that subsidies and below-market rates generally should be avoided, since they encourage an inefficient allocation of resources, discourage resource mobilization, and have uncertain distributional implications. Correspondingly, complex systems of directed credit also should be avoided, since the interest rate differentials which are established are unlikely to adequately reflect the relative productivities of financial resources across the sectors. Moreover, the fragmentation of financial markets necessary to make such a differentiation effective is neither feasible nor desirable. 5.12 The new perspective also recognizes the need for greater financial market supervision and greater consistency in the mix of fiscal, monetary, exchange, commercial and trade policy. A re-allocation of skilled human resources into the supervisory arm of the monetary authority is essential, since fraud and mismanagement are antithetical to the development of a well-functioning financial market. Their potential negative externalities create a legitimate role for constructive regulation of the financial market place. 5.13 Lastly, the new perspective recognizes the complex and pervasive interrelationships between the real economy and the financial markets. Given these interrelationships it is crucial that the government closely 22/ Preliminary regression estimates of the demand for financial assets using the data gathered for this study gave statistically significant positive real interest rate elasticities, both in the time series equations for each country and in a cross-sectional equation utilizing pooled period-average data. Given the important policy implications of the numerical values of these elasticities, and the possibility of imprecision given the small size of the data sample used here, the authors have decided to undertake a broader study of the demand for financial assets, involving more countries over a longer time period. See also A. Lanyi and R. Saracoglu, Interest Rate Policies in Developing Countries, IMF Occasional Paper, 1983, for a recent analysis of the effects of higher real interest rates. - 36 - coordinate its monetary, fiscal, exchange rate and trade policies. Even the best financial sector policy regime is unlikely to function properly in the face of contradictory signals coming from the real-side of the economy, i.e., where financial and economic rates of return differ widely. VI. FINANCIAL SECTOR REFORMS: THE RECORD 6.01 This section assesses the financial sector policies of Bangladesh, Kenya, Nigeria, Peru, Thailand, Turkey, and Uruguay, in terms of the growing consensus regarding the importance of a well-functioning financial system and the need for greater reliance on market forces. Evaluating the correspondence between this "new" view and the countries' policies is obviously much more difficult than comparing real interest rates. Both the "new" policy prescription and the evaluation of its impact require qualitative judgments of many factors, not simply a mechani- cal application of an interest rate formula. Moreover, all countries, even market-oriented, developed countries, intervene in financial markets to some extent, typically with government-imposed ceilings on interest rates and with programs to provide credit on preferential terms to sectors such as agriculture, housing, and small business. Thus, the central task of this analysis is to judge the degree to which such common interventions distort the mobilization and allocation of financial resources. 6.02 This section draws on the individual country analyses contained in Annexes 2-8, and the references cited there. It takes the following form: First the most common types of financial market interventions are discussed. Second, the degree of intervention across countries is assessed by evaluating the impacts of both the size of directed credit programs and the distortions implied by the structure of interest rates. Third, the progress toward greater reliance on market determination of financial markets in the seven countries is assessed in terms of increases in ceiling rates, simplifications and reductions in the scope of directed credit programs, and other market-oriented reforms. 6.03 Each of the seven countries maintained directed credit programs. Three types of instruments typically were used: (1) regulations on the portfolio composition of intermediaries; e.g., requirements to devote a certain portion of lending to specific activities; (2) Central Bank redis- counting of credits to priority sectors, usually at subsidized rates; and (3) control of financial intermediaries through direct ownership. These government controlled financial institutions included: commercial banks, mortgage banks, agriculture or industrial finance companies, export credit agencies, and institutions specializing in parastatal lending. 6.04 Public sector borrowing to finance the fiscal deficit and public enterprises was also an important factor in developing countries. Regula- tions often existed forcing the system to hold low-interest government debt; either directly, in the intermediaries' portfolios, or indirectly, through Central Bank reserve requirements, which in turn were used to pro- vide low-interest Central Bank credit to the public sector. - 37 - 6.05 Both the directed credit programs and the public sector borrow- ings tended to reduce the supply of credit available to non-preferred borrowers, i.e., the well known "crowding out" phenomena. Increased competition for the remaining credit drove up interest rates, in some cases produced very high rates on non-preferential credits. Moreover, the spreads between unsubsidized credits and deposit rates tended to widen, unless the preferential credits were at near-market rates, or the govern- ment compensated the financial sector for its lost revenues on low interest credits with direct subsidies. 6.06 Each of the seven countries also maintained some form of adminis- tered interest rate regime, with the exception of Uruguay after 1978. While these regimes varied substantially from country to country, they typically established ceiling deposit rates and some control over other interest rates, including those on both preferential and general bor- rowers. Thus the principal differences between the countries were in the relative size of the directed credit programs and in the interest rate differentials between the various types of preferential credits, between preferential and general credits, and between preferential credits and deposits. 6.07 While it is difficult to produce a precise estimate of the size of the directed credit programs, a rough idea can be derived from the following observations from Annexes: In Nigeria, government control of financial resources was almost total, via establishment of detailed credit allocation guidelines for each of the sixteen sectors into which the economy was divided. In addition the government directly controlled the country's large oil revenue, much of which it channelled into the priority sectors.23/ In Turkey, a recent World Bank study estimated that seventy five percent of total credit was subject to government regulations of the type described above. In Peru, the Banco de la Nacion, a public institution which functions primarily to finance the government and the public enterprises, accounted for 21% of total credits in June 1982. This large figure was, nonetheless, less than half of the Banco's average share of credit during the period 1976-78. In addition, in 1981 the State Banks and COFIDE, the government's apex industrial development institution, accounted for another 34% of total credit. Thus, the Peruvian authorities had substantial 23/ In oil-based economies the government typically plays a dominant role in credit allocation, not only through control of oil revenues but often through financial intermediation in foreign capital markets. For example, in Ecuador and in Indonesia after 1974, the government undertook foreign borrowings which exceeded its actual needs. The excess was allowed to accrue as deposits in the central bank while the central bank simultaneously expanded its lending. - 38 - influence in the allocation of more than half the country's credit. Even in Uruguay, despite the far-reaching liberalization measures, the publicly owned Banco de la Republica and Banco Hipotecaria accounted for 37% of all credit in 1982. While much of this credit was at market terms, a large share remained in targetted lending. Bangladesh allocated as much as 60-70% of all domestic credits to the public sector. In Thailand commercial banks were required to lend 15% of the previous year's deposits to agriculture. The share of directed credit in total credit was about 33%. In Kenya the commercial banks were required to commit 17% of their deposits to agricultural lending, though estimates are that the actual compliance was only about 13%. Moreover, in Kenya the government channelled a substantial amount of credit to the parastatals via the development banks, financing both investments and operating losses. In sum, government intervention in credit allocation was substantial, even in the countries with low inflation and relatively high real interest rates. 6.08 To get a better picture of the extent to which such directed credit policies distorted financial markets, it is necessary to analyze the differentials between rates on the directed credit and rates on general credits and deposit rates. Clearly, the data cannot provide a precise estimate of these distortions. However, a rough sense can be gathered from Table 5, which displays a sample of these differentials as of year-end 1982. Moreover, it should be noted that interest rate ceilings limited deposit rates in all the countries except Uruguay, as discussed in Section 5. 6.09 A word of caution is required before interpreting the figures in Table 4. Since the preferential rates cited for each country are quite dissimilar and the effective rates cannot be accurately computed, the calculated spreads are not overly precise. Moreover, there are numerous preferential rates and only one is cited here. Bearing these warnings in mind, it nonetheless seems that the countries fall into three distinct groups. The first group--Bangladesh, Kenya, Nigeria--appear to have limited the degree of subsidization, since the differential between the preferential rate and the rate on general credits was relatively small. However, this is not to say subsidization was absent, since subsidization may take the form of quantity rationing, longer grace periods, easier collateral requirements, or other adjustments to the lending terms. The middle country--Thailand--appears to have engaged in some subsidization through interest rates. In the third group--Peru and Turkey--subsidization was extreme. The countries also breakdown along the same lines when comparing preferential rates to deposit rates. Since the differentials in - 39 - the first group were positive--preferential credit cost more than the returns on term deposits--their preferential rates were less likely to distort investment incentives and encourage diversion of directed credit than the preferential rates of the second or third groups. 6.10 In addition to the differentials between preferential lending rates, non-preferential rates and deposit rates, the differentials between various categories of preferential rates establish important incentives which may, or may not, be consistent with relative productivities of investments or overall policy objectives. There was considerable diversity among the countries in the complexity of preferential lending rates and in the degree of detailed specification of the targetted subsectors. This detail is difficult to summarize concisely, but some idea can be obtained from the tables in the Annexes (see Table 4, "The Pattern of Lending Rates" in each of the respective Country Annexes, 2-8). As shown there, the degree of specificity and the interest differentials vary widely. In general terms, the countries of the low-inflation group maintained relatively small differentials between the different sectors, although in some cases they did apply detailed breakdowns of subsidized credits. 6.11 The small differentials in the low inflation-high real rate countries probably reflect the fact that interest rates are low in these countries and thus the differentials simply could not be very great. In contrast, nominal rates in the high inflation countries tended to be somewhat higher. These higher nominal rates allowed more room for interest differentials particularly in Turkey and Peru.24/ In Uruguay after the liberalization, however, the existence of market determined deposit rates limited the extent to which the state-owned financial institutions could subsidize credit, despite the important role of these institutions in the market. 25/ 24/ The larger differential possible during inflationary periods also increase the "demand" for such subsidies. Given the politicized nature of the credit allocation process in most developing countries, this dynamic should be recognized as an important social cost of inflation. 25/ The Banco de la Republica has been accused of price leadership on interest rates--setting rates which provided a profitable cushion for the other banks. However, the evidence suggests that if this oligopolistic behavior did exist, then it was largely eliminated by the end of restraints on the entry of new financial intermediaries. See P. Spiller and E. Favaro, "The Effect of Entry Regulation on Oligopolistic Interaction: The Uruguayan Banking Sector", Bell Journal of Economics, 1984. - 40 - Table 5 Nominal Interest Rate Differentials a/ Year-end 1982 (in percent per annum) Preferential over Preferential over General Credits Term Deposits Bangladesh -4.0 1.0 Kenya -4.0 1.2 Nigeria -1.5 4.0 Thailand -11.0 -3.0 Peru -69.0 -42.2 Turkey -37.0 -32.0 Sources: Annex 1, Tables 4-6. a/ See Table 1, Note 5 for the specific categories of preferential lending. 6.12 Most of the seven countries in the sample initiated financial sector reforms in recent years, reducing the complexity of the preferential rate systems, raising nominal rates to accommodate market pressures and even releasing control over selected credits and deposits. On a country by country basis, starting with the three countries in the low inflation-high real rate group--Bangladesh, Kenya, Thailand--followed by the four higher inflation countries--Nigeria, Turkey, Uruguay and Peru--the reforms are summarized below: 6.13 Bangladesh markedly raised most ceilings on interest rates in late 1980. Recently the government also moved to ease the rigidities of its institution-specific ceiling on credit expansion. This was done by modifying some of the restrictions which previously prevented the trans- ferral of banks' resources to banks constrained by their credit meilings but with a surplus of investment opportunities, from banks below their credit ceilings but lacking good investment opportunities. 6.14 In Kenya, the structure of interest rates was substantially raised over the 1980-82 period. Beyond these readjustments, Kenya did not undertake any sweeping reforms. In large part, this was attributable to the country's history of relative price stability and relatively market- oriented economic policies, which kept pressures from building to a level that would force major reforms. However, the consequences of nearly a decade of fiscal imbalance and an abrupt constriction in the availability of foreign credits have resulted in a serious economic crisis, out of which some financial sector and macroeconomic policy reforms can be expected in the future. In particular, the authorities must find a way to finance - 41 - scaled-down public sector deficits domestically without stimulating infla- tion or burdening the relatively well-functioning financial system with larger quantities of forced lending. 6.15 Due to the country's long history as an open and relatively price stable economy, the policy makers in Thailand were not forced to undertake massive reforms. However, the government's overriding policy commitment to a freely convertible currency did require the authorities to make some policy changes to manage developments which threatened convertibility. In particular, after roughly five years of increasing protectionism and sharply rising world interest rates, the authorities instituted a set of reforms, in 1980, which included an upward adjustment in the interest rate structure. 6.16 Since 1978, Nigeria has been raising its interest rate structure slowly, but rates have remained far below historical inflation. Up until 1981, when the countries oil revenues collapsed, the Nigerian authorities apparently felt little need to promote the domestic financial sector, as most of the country's investments were undertaken directly by the govern- ment with the oil earnings. However, since the long term outlook has soften for the oil sector, the need to stimulate domestic resource mobili- zation, and financial intermediation in general, probably will provide the impetus for further financial sector reforms in the near future. 6.17 In Turkey the financial sector was highly controlled by the authorities. Among the important government policy instruments were large directed credit programs and a highly complex set of interest rate con- trols. (A description of this regime is provided in Annex 7, Table 4.) In 1980 some these interest rates were liberalized, including term deposit rates and the ceiling rates on general credits. In addition, the share of total credit committed to the directed credit programs was scaled back somewhat. Moreover, the authorities have announced a policy of continuing to reduce the scope and complexity of the preferential credit schemes. 6.18 Peru initiated a shift in interest rate policy in 1978, which continued through 1982. The shift included higher ceiling rates and allowed compounding on deposits and discounting on loans. These adjust- ments were part of a set of major reforms expressly aimed at giving market forces a larger role in the economy, which also included an opening of both the goods and capital markets and the legalization of dollar transactions such as deposits and loans. As part of these reforms,- the Peruvian authorities reduced the vast number of controlled interest rates by simpli- fying the preferential lending categories (see Annex 5, Table 4 for a description of this scheme as of year-end 1982). They also reduced the reserve requirements and began paying interest on them. 6.19 Despite Peru's massive upscaling of its interest rate structure, the adjustments in the ceiling rates lagged behind increases in inflation, so real interest rates generally remained quite negative, with the excep- tion of 1981. While much of the increase in inflation was attributable to the government's use of the inflation tax to finance its deficit, this tax was simultaneously being rendered less effective by the decline in reserve requirements. The lower reserve requirements reduced the base of the tax - 42 - and thereby increased the inflation resulting from a given increase in central bank credit.26/ Given this potentially explosive situation and the lack of progress towards higher real rates, the Peruvian reforms were of rather limited success. 6.20 Uruguay, like Peru and Turkey, had a history of extremely high inflation, though its experience began much earlier. The combination of a stagnating economy, balance of payments problems and high inflation prompted the authorities to begin a liberalization process in 1974 that is almost without precedent in its dimension. By 1979 virtually all interest rate controls were dismantled, the fiscal deficit was closed, sectoral credit guidelines and reserve requirements on domestic currency deposits were eliminated, foreign currency transactions were legalized, including bank deposits and dollar loans. With the important exceptions of the operations of the publicly-owned Banco de la Republica and the Banco Hipotecario del Uruguay and the authorities' control over the exchange rate, control over the financial sector resided primarily in the hands of the private sector. 6.21 In sum, the above evidence indicates that in each of the seven sample countries, with the possible exception of Nigeria, there were definite moves toward greater market-oriented financial sector policies. These ranged from major reform movements, such as in Uruguay, to more limited realignments in the structure of nominal interest rates and directed credit programs. This could well be interpreted as a growing acceptance of the value of financial sector liberalization, in accordance with the "new" market-oriented perspective. However, it must be emphasized the influence of market forces still remains quite constrained by many factors, including a wide array of government regulations. 6.22 A final point which the authors wish to strongly emphasize is that, based on the evidence presented above, financial sector liberaliza- tion is neither a simple matter, nor a painless one. Specifically, the success of the financial sector liberalization process is highly dependent on the mix of domestic fiscal, monetary, exchange, commercial and trade policies, particularly when the domestic financial market is open to international capital flows. 6.23 On this point, the record shows that both Peru and Uruguay made major changes in their financial sector policies in the latter part of the seventies which, among things, opened the financial sector to international 26/ See D. Mathieson and R. McKinnon, "Foreign Exchange and Financial Policies for Repressed and Liberalizing Economies," IMF Staff Papers, 1983 for a discussion of the difficulties created by cutting reserve requirements when the fiscal deficit is not under control. The dollarization of the Peruvian economy also reduced the base of the inflation tax. - 43 - markets.27/ However, when the exchange rate policy became inconsistent with domestic monetary, fiscal, and wage policies, a common pattern emerged of either high real interest rates in the local currencies, and/or "dollarization" and capital flight. This experience can be contrasted to that of Thailand, which also began to experience large capital outflows at the end of the seventies through its very open financial system. However, Thailand was able to escape the full impact of the crisis which struck Peru, Uruguay and much of the rest of Latin America, because its initial macro-policy framework was much more consistent, and because it adjusted its monetary, fiscal and trade policies more rapidly to the changing condi- tions. While a full exploration of these two experiences lies beyond the scope of this paper, there is general agreement that one of the crucial lessons of the liberalization process in Latin American was the centrality of a consistent macroeconomic policy package when the capital account is "open." Policy-makers contemplating financial sector liberalizations and proponents of such reforms should take note of this lesson. 27/ A similar opening-up occurred in many of the other major Latin American countries at roughly the same time. While a full discussion of these experiences and of the pros and cons of financial opening-up is beyond the scope of this paper, it is worth noting that these opening-ups were motivated not only by the potential benefits of tying the local capital market to the international market, but also by the potential anti-inflationary aspects of the linkage. See N. Ardito Barletta, M. Blejer, and L. Landau, Economic Liberalization and Stabilization Policies in Argentina, Chile, and Uruguay...", World Bank, and J. Hanson, and J. DeMelo (1983,1984) for more extensive discussions of these experiences. - 44 - Sources and References Ardito Barletta, N., M. Blejer, and L. Landau (1983), Economic Liberalization and Stabilization Policies in Argentina, Chile, and Uruguay: Applications of the Monetary Approach to the Balance of Payments, World Bank. Banco Central de Reserva del Peru (various dates) Boletin, (Lima: Banco Central de Reserva del Peru, various issues). Banco Central de Reserva del Peru (various dates), Memoria, (Lima: Banco Central de Reserva de Peru, various isses). Banco Central del Uruguay (various dates), Boletin Estadistico (Uruguay: Banco Central del Uruguay, various issues). Bank of Thailand (various dates), Quarterly Bulletin (Bangkok: Bank of Thailand, various issues). Bangladesh Bank (various dates), Bangladesh Bank Bulletin (Dhaka: Bangladesh Bank, various issues). Bangladesh Bank (various dates), Economic Trends (Dhaka: Bangladesh Bank, various issues). Bangladesh Bureau of Statistics, Ministry of Finance and Planning (various dates), Monthly Statistical Bulletin of Bangladesh (Dhaka: Government of the People's Republic of Bangladesh, various issues). Central Bank of Kenya (various dates), Economic and Financial Review, (Nairobi: Central Bank of Kenya, various issues). Central Bank of Nigeria (various dates), Annual Report, (Lagos: Central Bank of Nigeria, various issues). Central Bank of Nigeria (various dates), Economic and Financial Review, (Lagos: Central Bank of Nigeria, various issues). Central Bank of Nigeria (various dates), Monthly Report, (Lagos: Central Bank of Nigeria, various issues). - 45 - Central Bank of the Republic of Turkey (various dates), Quarterly Bulletin (Ankara: Central Bank of the Republic of Turkey, various issues). Darby, M. (1975), "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Enquiry, June 1975, pp. 266-276. Fama, E. (1975), "Short Term Interest Rate as Predictors of Inflation," American Economic Review, April 1975, pp. 325-338. Fisher, I. (1930), The Theory of Interest (MacMillan, 1930). Hanson, J. and J. DeMelo (1983), "The Uruguayan Experience with Stabilization and Liberalization,1974-1981", Journal of Interamerican Studies and World Affairs, Nov. 1983 pp. 477-508. Hanson, J. and J. Demelo (1985), "External Shocks, Financial Reforms and Stabilization Attempts in Uruguay: 1974-83," World Development, August 1985 (forthcoming). Lanyi, A and R. Saracoglu (1983), Interest Rate Policies in Developing Countries, IMF Occasional Paper #22, Oct. 1983. Long, M. (1983), "Review of Financial Sector Work," World Bank, INDFD, 1983. Mathieson, D. and R. McKinnon (1981), "How to Manage a Repressed Economy," Essays in International Finance, No 145, (Princeton: Princeton University, Dept. of Economics, December 1981). Mathieson, D. and R. McKinnon (1983), "Foreign Exchange and Financial Policies for Repressed and Liberalizing Economies", IMF Staff Papers, 1983. Ministry of Economic Planning and Community Affairs (1979) Development Plan 1979 to 1983, (Nairobi: Ministry of Economic Planning and Community Affairs, 1979). Ministry of Economic Planning and Community Affairs (1983) Development Plan 1983 to 1988, (Nairobi: Ministry of Economic Planning and Community Affairs, December 1983). - 46 - McKinnon, R. (1973), Money and Capital in Economic Development, (Washington, D.C.: Brookings Institute, 1973). Saracoglu, R. (1984), "Expectations of Inflation and Interest Rate Determination," IMF Staff Papers, March 1984, pp. 141-178. Shaw, E. (1973), Financial Deepening in Economic Development, (New York: Oxford University Press, 1973). Spiller, P. and E. Favaro (1984), "The Effect of Entry Regulation on Oligopolistic Interaction: The Uruguayan Banking Sector", Bell Journal of Economics, 1984. Summers, L. (1983), "The Nonadjustment of Nominal Interest Rates: A Study of the Fisher Effect," in J. Tobin Macroeconomics: Prices and Quantities, (Brookings, Washington, DC, 1983). La Superintendencia de Banca y Seguros (various dates), Boletin Estadistico, (Lima: La Superintendencia de Banca y Seguros, various issues). Tanzi, V. (1980), "Inflationary Expectations, Economic Activity, Taxes, and Interest Rates," American Economic Review, March 1980, pp.12-21. World Bank (1982), Economic Memorandum on Uruguay, Report No. 3652-UR, (Washington, D.C.: World Bank, March 1982). World Bank (1982), Bangladesh: Financial Sector Review, Report No. 4098-BD, (Washington, D.C.: World Bank, December 1982). World Bank (1982), Thailand: Perspectives for Financial Reform, Vol. I-III, Report No. 4085-TH, (Washington, D.C.: World Bank, December 1982). World Bank (1983), Peru: Brief Review of the Financial Sector, Report No. 4316-PE, (Washington, D.C.: World Bank, February 1983). World Bank (1983), Turkey, Special Economic Report: Policies for the Financial Sector, Report No. 4459-TU, (Washington, D.C.: World Bank, September 1983). - 47 - World Bank (1983), Financial Intermediation in Nigeria, Report No. 4051-UNI, (Washington, D.C.: World Bank, February 1983). World Bank (1984) Kenya: Review of Industrial Finance, Report No. 5246-KE, (Washington, D.C.: World Bank, August 1984). World Bank (1984, draft), Kenya: Agricultural Credit Policy Review, Washington, D.C.: World Bank, April 1984, draft). ANNEX 1 SUMMARY TABLES AND COUNTRY TABLES - 50 - ANNEX 1 Summary Tables: Table 1. Ex-Post Real Return on Term Deposits ............ 51 Table 2. Ex-Post Real Interest Rates on General Credits ........ 52 Table 3. Ex-Post Real Interest Rates on Preferential Credits .... 53 Table 4. Nominal Term Deposit Rates .... .............. oo ........ ..54 Table 5. Nominal Interest Rates on General Credits ... .........55 Table 6. Nominal Preferential Lending Rates .o..o .. ......56 Table 7. Devaluation Adjusted Yields on U.S. T-Bills ............ 57 Table 8. Devaluation Six Months Forward ........................ 58 Table 9. Inflation Six Months Forward ......................... 59 Table 10. Inflation over Previous Twelve Months ......o..o..o.....60 Table 11. Weighted Average of Real Return on Financial Assets ....61 Table 12. Ratio of Financial Assets to GNP (GDP) ................. 62 Figure 1A-D Nominal Term Deposit Rates versus Inflation over the Previous Twelve Months ..o.oo*oo.oooo.ooo......63-66 Country Tables: Bangladesh Table 1. Selected Interest Rates . ...... o ...............67 Table 2. Levels of Selected Financial Assets ...........68 Kenya Table 1. Selected Interested Rates . . . ..... 69 Table 2. Levels of Selected Financial Assets ......... 70 Korea Table 1. Selected Interest Rate ........................71 Table 2. Levels of Selected Financial Assets ..........72 Morocco Table 1. Selected Interest Rates ... *.o.o ......... 73 Table 2. Levels of Selected Financial Assets o.........74 Nigeria Table 1. Selected Interest Rates ................75 Table 2. Levels of Selected Financial Assets .......... 76 Pakistan Table 1. Selected Interest Rates ..............oo........77 Table 2. Levels of Selected Financial Assets ........ 78 Peru Table 1. Selected Interest Rates ......................79 Table 2. Levels of Selected Financial Assets oo........80 Thailand Table 1. Selected Interest Rates .... -................. 81 Table 2. Levels of Selected Financial Assets ..........82 Turkey Table 1. Selected Interest Rates ..............o.......83 Table 2. Levels of Selected Financial Assets .ooo......84 Uruguay Table 1. Selected Interest Rates ......................85 Table 2. Levels of Selected Financial Assets .. ......o86 -51- ATNEX 1 K H! H H H Ho Hs H 4 H H (N C^ IA 0 IA ( ~ IA %D 0% _ I 0 * * * * * * * *0 _% 0 ( t I PS (N StN - 4 (N~~~~~~~~~~~~~~~~~~~~~~~4 L _YA co *n o - * 0 0 o * a - I I I I .4 en He H H H H H H H H 14 PS: (N S -~ 0% 0% ( 00 St '0 tb Ch (N IA O0 0 0(N ' - . Q0S HF H H, H Ht Hts Ho H Ho Ho O 0% .00 a: u'~ 0 IA -< PS PS IA cco PS * * 0 * * . * * * . Cr% IA 00 '.0 0 T C| (O '. % (N H H H H H H H H H H ~~~~~~r- LT 1 D LT I O~ O LT CS Sc c00 IA co0 %D C) 0' 0 cn (N ( 0% .5 PS * * * . * . . * * * mON 0; co - 0 Cu (N ('r 00 08 PS. St ST IA IA 0% -4 _S ( '.0 ON C* * * * . * * * * * $4 -4 vfi o N f o Y N e ( t -4 -4-t ( 4 ,~~~~~~~~~~~a N D tn eq - 4 Wa co 0% A 8 L 4 H H H H H° H H H H H - W I 0 O 0 N t P -D C t4 > X >^ % 0 - 0 - IA ° I. 0) A H H H H Ho H Ho H H H 0 0 w m LA 0 r: .4 _A 0 _) g. b N N o S S _ S S S k _ T , , , ' , LT' TCo - - 14 11 --4I0 v~~~~~~~C O H H HL c H Hs H H H X .,. °\ C°S , e i; S S S S S eS 5 CO _ C., I (N I C - (N O .' - I O 4 _ _IX I I I I a Q H: H H < H H H H0< 8 (N 0 0 S Z % * . 0 * . * . Z *0 o I: oI ,_ u r~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~- -r 8 0) >. -52 - ANNEX 1 Go o" o . . .a. e oCL 0 c Uo 0 Z % _ % co % U, % r- en(5 ~ - t I I W o% . . . . . . . . . S _~~0 o N 0% So m co ~ ~ ~ ~ ~ 0% N N cs N N Nh N N N Nr 48 0% * . . . * * . . . 48_ -4 T fS u, - N 0 0 0 4 r- r co (f rO - N - O - O S ~ ~~ ~ ~ ~~~ 0S * . * * . . . * 1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ _4 (b 1- 0 .4 1 - U -~ .-4 0 CO o ~ * N *I * * *t I | _ Y | ur t | < 4 < t_ ¢>8 10~~~~~~~~~~~~~~~~ ta tO * * * * * * * * O- 0 4 0% N r- tX 00^ 0 N Co 44. 48 ii v I K K IM K 0b 0 4-'S ts 0 vo < 0 < trs o tc - < a Ch * * * * * *CA CA 1 8 . 2 _ | e o v N < _ ~~~~~~~~~~~~~~~~(N o 0 0 -t N I N N N N N N N 4 0 48 I. I- 1- 1. w0 0 0% 0% 0% - ESI Ir I 0 a e K~~ I N ¢ N Ns N Ns iS ¢5 6 0 0 00 _ -. -t - t 1_ Y' t _ b ~~~0% * * 5 * * * . 0 . N -4 I - I W .I I X 0 N N IN b rNrN_ co 0% 5 5 5 t. S 5 0 Z Z U, < NS8'0 O ~ ~ ~ ~~~~. ¢ I K ¢ ¢t _% * 0 0 * _ * t: i; { t -t 8 N , -t 00 U, 8 -4 'El 64Zit ,t N;ft C OD 4nf 0~~~~~~~~~~~~~~ I~~~~~~~~~~~~~~~~~~~~~~~~~~~~I -53- ANNEX 1 N K H H H ! U! H H H < co %O 0 T - m %D O S tS 0 0 0 O - %O -t .t e NC A %4 | _ I * V .4 (A 44 cnl tn co o _ R H H H H H H H H < 4141. _ 0S tS '4-I s O 0* _% * * * * *e * * * * 2 * -4~~ l4 N 0%*-.I. % I I I 4 2 0s H H H H H H H! HF H * 8i 00 -t - U, C4 'D 'D 1- K. ' 4- Eg 08 * * * * * * * * 2 O1 0 H H9 1 N K H H H Ft H m r- o 0 - % U 0 -4 N co x, S _ e s e o | ^ 2 T > @2 '. W ~ ~~, U, , W ~4 V4 LA81 0 8l o C*- I , & H H H , H H H H "4 4 0; cq co _4 ao%, F N _C 4 4 r- - - OD _- - a -. C#) ON N ; _ N '4.4 W 0 IA .4 ~ - l -4 c _.0 .0 ~ 0 11 P~I f- V%.4 .0U U, N -. - 41 ..w-40 go rz 0% 9 0 * . lu a 0 f- co u @ >@ h< * % _C cn U, Cf 0 C f 44 4 O 4. -T H H H H I H H H H CO 4 24 0% . * * * * * * * 2Z . . 0 S 1 N o N N 'm ' - O -l - C). 0 .4: T e H H H < I H H N H@X q ~ ~ - * > -40. - OV 0 - * r- -. - I N I . 4 N I *' ..3 H Hn H w I HD 0 H o q Ai C14 _ U, N. -s U: _ _ _ e* :> o * *0 * 2 * * . Z Z2 fl Z ZM* - 4 -4 g .~~~~~~~~~~~~~~ I ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ 0 41. - . *. '0 -~~~ -. 4- _at:t*: ot s rN S * * Gl o4 LA H CA eI H HI?4 N. 4 0 .0' I I~~~~~~~~~t 'I 0 t' 4 g g a a 2 X t X g 2 4 -54- ANNEX 1 N o H H H H _ ^ e b o0 00 o _ _ O o D _n _ U o NN° s 0 .,o wE H e bo H s _. * _ - s; * 0 - - -4 . 00 - - .D _ * - - 0~~~~~~~~~~~~n- .0 - H H H H H° H H° H H° H° 0*. O 0 . 0 O S 0 U _ ) -T U . .0 0 - o 0 O .4 - .4 ~~ ~~~ ~ ~ ~~4 .0) 4 4 08 "°H' H H' H< H H^ Ho Hs H5 w un cor _ n oD un_ oo _~~0 a. iJ 0 N0 &rr O 0 C V a. H° H H Hs Hs H< H H H0 H 1f) 4. .< 0 U US O 0 .0q: C~~~~ ~ ~~~~ - _~ -4 tf °-b 0 In 4~~~~~~~~~~~4 .0b Ho H He H< HM Hls Hs H H H p. 4. 00 mOD 0 . 0 0. 0 0 O 0 .4 _ 4 un e < ^ o *:r oo _ E~~~~~~~ S g~~~~. Cf _i - te N a. - Ib . 44~~~~~~~~~4- g S e Ho H Ho H H H H H H HO x O~~~O 4. LA CA a. 0 0. 0 C < Ho {fs, H0 BM 1ts° bR° ls H° aKs o 0 Fo. M E o o~~~~~~~~L ; O. en %D , O. O .1 c. O ) 0- 0 c * S * * o . o. 00NOO 0 a. * u oo o * *D * *0 * tS H H H < H H H H H H co~~~~~~~~~~~~~~~~~~~~~~~ co _ en LA - 0 0 0o -t C h$ 00 > Ce _0 o% o. -t 0 O Hg Hs Hw t Hs Hs H< Ht H 00 0 $ t $ . > °. 0 0. O. 0 . _. * * * ^ * n * * D * uZ -4cn -4 0 0 4 . . 0 .4 0 0 *.t0 a. * * * Z° * * Z * M - 55- ANNEX 1 _ %D %DO 0 S C' _t 0 0 Un L _ _ - _ _ _ 0o - 'C !- 0 O. o~ o .1 -N 0 o oA 0 _ sD ' ' _ - O 0% 04 '0 U O H H H HHHHH HSr H 0% 0o _. _. . _ . . 0..I '.0 -o 0o -o - -I CJ r '0 LA .-4 . 4 * , * - * - * ~ * A * * ~ . N0 80 0 80 0 80 * 0 O H0 a} ~ ~ ~ r 0 0% 0 s -~ - o' IA 0 - 4 4 .- 4 .4 LA . - . S rs Fl!H H H F H NE H H H 0 0 ~~ ~~0 0 * 0 C4 0 0% 0~~- -4 "4 0 A 0 - o . .4 .4 .4 .4 .A . .- !V _ g _N H H H H H H H H H -I C@ 0 '.0 0 '.0 ('.1 -t LA0 -4 4 -4 P4 ' . . .4 . CX _ ^-0 0 0 - - 0 Ln CY8 IAs W - H I H H H H H N 4 4 N r- 0 U) IA 0 .4 0n 0% . . 0 . * * . *0 -4.LA O 0% -4 LA 0% nim P . 41 40 4 _ N 0 zU 51 0 K I K ¢ IFt 1S Ke U LA *2 < @I 0% a0 .S z * * * * S Z M ~ ~ ~ ~ ~ I o 00 -4 '. oA 0% X -4 -4 ~~-4 -4 -4 -4 4J 0~~- _ H I Ho 4 ¢¢ 0% * * ^ 0 0 0 * C H° I H 4 H 0~~~0 _ * Z qb ~~~~~~0 0 0D 5 0% 0 5 0 2 * 4 Z Z s . 0 ~ ~ 0 ~~ '.c - 4 4 - 4. Cd ~ ~ ~ ~ ~ ~ ~ ~ .. 8~~~~~~~~~~~ 56 ANNEX 1 N H Ho H H H H Ho H Hw < OD 0 0 0 U, 0 0 0 0 S _ N N 0 N - _ r _ K K K K Ft "! K K K co < tz " co O n u 4 .4 LA -z 4 _% *S *S *n * s _ C * ** * * - % N Ln Uc o _ _ 0% k 0 Q fg - _ O - N _N 8 N H 0 0 , U8 0 0 0 'A S., 0~~~0 * 0 * . * . * . * Z @ X~ ~ .- _ -4X N - 0~~~~~~~~~~~~~~~~~~~~~~~~~~~ bf 0 % H H He H H H H H H 4 r ~~r in C) L OCOD O O so U, 0; 0 LA 0 0 0 0, U, s a o O o % 0% _, 0% - - ^ *. 4 0~~~~ - N - . o .o . o ^ X~~~~~~~~~~~~~~~~~~~~4 C W~ ~ H@ H H H H H H H 4 W E~~U 0 0 U, o 0 0 0 so 0 X - 0 0% 0% U, 0 0 C 0 1.4 r-. H H HE H I H H H H < LE R ~ ~ ~ U 0 0 U, 0 0 0 0. -. o. o ':i-Uo -z0C c U , N 0 % O 0r w~~~~~~~~~~~~~~~~~~~~~~ 4 W i _ K H H H I H H H H ;0 0 U, 01 0 , 0. 0 0. 0 W Q X O -^ s r 0 oK < U, K - Oe 80 *C < a o . %O~ ~ >4 . .% 7: . * * S S * .. o - ,j r- ^.' O : ve u~~~~~~~~~ -* H H H H I H H H H U, 0 0g cf 0i 0i 0 0} * -57- ANNEX 1 N H H H ev .4 " H " H _ 0 % - - D o _ e : f -~~~~E e _ ,_~ '. %-cUr. N - X M H - - N M - r- U MH -4 ao * * * * * * * v " _ s o b e o v o o N ES o _ '4_.4 tS o o e _ b - o H 0% 0 0 0 S o O- l--4 -~~~~~~~~~~~~~~~~ C o K K t > . H H N H o rs aE > ur- Ch S n u"n 4 < ~~~0% 0 * * 0 * * * * * * * O 4i _ _ o _ tr .4 - _ - _ '.0 -4 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~- te - - _<_ g ooH H H H H N HNN CH H X I_ Un ^ o U'1 o UN n~~~L"n "n 04~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. - 0% N - 0% 0 i & t4 - -4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. N b S H HHHNNHH N 0) g , PZ ~ ~ ~ 0 0 * * * * * . * * * * , s | 0 H N H H N H H H 0 @ b U) D ur < n @ ns X Ij> , CC LA V.- zo W * . . . . .4 . C..- Ai . , co In C; C4 Ai o o o s ~~~~~~~~~~~~~44 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~5 0~~~ 0 I"nH0 0 - 4-4 Ai C --L 4 A L LA LA I 1-4 0).~~~~~-4L I > 4 H H H H H N H H N H e 0) ;~~~~~~~~~~U '- - _~ Cb -4 - - .4 0 _,_)o uz ~ ~ ~ ' g o %. .A r. r. V.. .' V.. .- r. .% N 4 P ) 0 _ '- _ 0 o sW> 04. 4.3 44.4 U)~~~~~~~~~~~~~~~~~~~~~~4 o H H b 4 H H H H H H M H 'W I-a * cr . .4 .A . . U. . j-. V. . :) -4 v -4 I s.d co C; 1; C4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 'A T vU)- co~~~~~~~0 o > eoH H Ho H H Ho U Ho H H H X. 8 4. X~~~0 * o * r 0 * * * * * < * 0 0 0)< ,< _ _ I ,< I _ - - I s40 0% * Z * * * *N .2 . ) .84. P~~~~~- 4J K pz In4. -58 - ANNEX 1 S H° K H H° K Hw H H° H H co D cn %D O OD eS A C 9 ( 'J, 8 r - 0% * * * * * * co as co 0% - StI O 0 _ H H H H Hw Hs Hs H° H H 0 _ % o oo _ . 0% o 0 - C J 0% A * * * * 0 - - c - - C4 O OD 0 ( c.a - - ~~~~~~, -T u* L- if -4 0% .~ * * . * e 0 Cn C1 OD% 04 r _% 0 0n 0 0 0 0 0 O 0 U U4 U, - co IK K IK K K° K K Ko _~ 0 - O 0 0 0 0 0 0 0 | I Ln I S I H H H1< Hx Hs H Hs H H H 0% * * 0 * * * * * * 0 -_ ( (c 0 0 U, 0 -_ 0 %0 - 11 en 0 0 N- - 0% * * * * * *0 z~~~c 0 Uo (.Ol 0 <0 0 S N0 '0 H0 Hw< H H H< Hs Hw H H tH° N- (N 0 s - cr 0 '0 0 U, - _ 0 0 0 0 0 0D 0 co .0 = a) .0 C U, H < H° H H Hs H H H H0 H EZ ~ N N- Ll(> N 0 't 0 0 '0 0 00 - 0% * . * . * . . . . 0 ..~~~ -4 t 0 ( O N 0 0 00 0 ^ 0 - 4: 4 0 0 0 ) ) 0 0 2:~~~~~~~~~~~~~~~L P: v o uA o o; o o S LA Cfl ( a) - U 0 0 e (' 0 0 0 eN 00 00 - I 0 H~ ~~ _ b) e K 1R H H H H° Hs Hs HM H r cD r1 C00 0 0 0 0 0 - - A o . * . . . . * * * ~~~~~~~~~~~~~~~~o O X _ I - O n CS I -t (N H H- H H H Hv H H0 Hx Hi I- Nf - 0 '0 0 U, 0 0 0 U, 0% 04 0 00 Q 0 _d O 0 - O O N- 0 0% 0 ~~d) 0 d I I$4 I - N- ¢4 0e Nw K 0s N- &0 H0 -K 0- 0% 0 O. - - O. 0 0. O. 0. 4.I _ ~ ~~. I °N C41 ° I ° ° t~~~~ N- S £ S W 8 t M Z M S W ..~~~~- -59- ANNEX 1 csJ H H H 0 H H H H H H %D U, Un cn C4 as m 0% ( 0% v D u s U fS 0O 0 5 - %D 04 f- C%l - N % o,C~JU _ N ° e N H N N H N H r m O~~N- en -; 0% 0% 4 -4 en Ln(~ _ H H H H K H K N N N _% L', o U --0 O0 14 '.0 C%1 N- -- %D - _.4 4 o% H N H N K N H H H H N- N CJ 0% 0 - -I O r - n .4 _ 0o 0 0; 0 0 A 0 _ _ .4 < - UD ChJ N- t 0 0O H N H HR H9 H H HR H H Nl- U, 0 4 U, C4 I %a U, CO) 0% 0 0 0 0 0 0 - 0 5 0 _ - '.0 CO -t U, '. 0% 0 0 U, _ '.0 _- ND - - 0 $.7 - _ % '0 -0 0 C 0 r- U O co S 5 0 0 K K 0 0 0 0 1-4.- C 0 ~ s [4 & 4 N- CO CO 4 Ce _- Ce - a ~ . C _ Hs N N N N N H N co >-4 N~~~~~~~~~~~-- 0 I% ~Z4 -4 N- asc 4 8 -1 K K N- - C . . . . . - * 4 *3 * . c '-4 .~~~~~~~~~~ 14c . _ 5 _ 0 SS 5 0 0_ 5 N 0 .1 U, U)J ~ 0% N- C~ N- (--4 ~ C4 0 S O X N < -4,U% _ (- _ _ N- N- N _l~~~~~~~~~~~~~~~~~~~~~~~~~~b O' 0 ~~~~~~14 I~~~~~C co 4 -4 (-. ('3 '-4~~ ~~~~~~ m! :z :n rzZ C H H H N H H H H -4 O C U, -- -41 l~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~C N- 0 . 0 N- . . c _- C" r-Z ,, < e £ Z LA0 r N- -4 -t CO '.0 0 0 N- N- (~~~~~~~~~~~~~~~~~~~~~ .C4 4( -i~~~~~~~~~~~~~~~~~~~~~~~~~c _i co co 0 o o S - C 04 04~~~~~ e | es es cs es 0 w~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~4.1 _ K K K K K eK o 19 ItE K t~~ -60 ANNEX 1 S eH n N H H H H H CO . S . 0 . 9 0 0D CO v _ 4 cn Z _C en A _ 4 - H H H IH H H H H H H Go Vn -a. .4 r- ~ m t ( o% * . . . . . . . . _. - ( _ _ 'o _ 0 o NH.H H HoH o H oH esJ - '0p.sp-s-4~Ln 4 _ 'd 0* 0 0 nu 0% H H H H H F H H H He 08 tD b < s ^ Un b OD v~~~~~~~~~D CO _08 - CJ 0 O~ 0 0 .- - co - - oK - K K K o~~~ H H H H H H H H H p.- '0 PI .4 PI c' W PI- OD '0 co n~~~~~~~~~~~~~~~~~~~~ cn 8n .. t _ N a ~~~~~~~~~~~~n .4 cn r < o :- 2 0 Ch * *0 * * 0 * * * * -4 -4 - _ s @ 8 < o -4 -s . r V 0~ ~ H H HK H H H H H H $4 r~- 4 0 0 - r- U 0 % D' ' _l CiY% * * * * 0 * * 0 * X~~ ~ ~~~~ C1 en N en -: as r ^ a £ _C -4 C'-) CN -4 %a 0H K r- Cj) 1- 0 coJ OD co co0 .0 0 0 Z 8 t ! 3 t .. en -4~~~4 4 J.' ' .4 C0 U*) '4 0%n '0 4 0% p. LA - 0 ' '0 r-'c4% n % LA r. A' LA 0% - ' ' ..4 .4 .~~~~~'4 0n o ~~~~~~~~~~~W Ln% H -4 .~~~~~~~4 0 ~ ~ ~ ~ ~ ~ 44 4.1 C'-) 9~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~c 00 00 00 (N 00 '0 0~~~~~~~~c -61- ANNEX 1 0o o 0 -N N. O-tc*J- 0%~~~~~~~~~~~~~~~ to * * *4 - * N 0 . - m a 0 0 ~ ~ I _ N N N | N N N N N N 4 co CA A M. 0% co, 7 Ch K NtH t K F f n N - co g~ L r- 0 In N r 0% - vD 0 < 0 S 0 5 0 S _ 0 r- e ^ ^ N 0% -0 e4 LMO~~~~- ' I I I I I _% N N N N N 7 N N N N, I N- C1~~~~~~ 0 c 00 '. 0 co t ~ 4 a" b0 H Ho 0 H 0 0 * * 0 0 W o- N .t .* .~ - . -. . . u en 8 r- 0 _ n CA CA0 Q~~ ~~~~~~~~~~~~ - VW ~ -' I I- I C 00 00 0% < < 08 ~~~~~~~~~. . * * * * * N-N I 0 . C 04C1 F | I | | II I I I I _- T n 4 V.N- - - 4 N N - - Co- XSs < 00 ~ s N D- 43 43 .- - I - LW co ~ ID r % 0 PI I% W I I% N 0 0* 0 0% 0 0 5 0 ~~~~~~~~~~~~~~~~~4 0 -4 N- %-00 0% -4 0% 0 @~~~N 'C N-, '0 'C N- 0 '. n 0 8 VB - oN N O N N N N N N a z o ~~~~~~ * S * 0 5 0 .. ¢ _ b T - Y 0, e o% 00 -4 0 C4 N t .- In 43~~~~~~~~~1 >d~~~~~~~~~~~~~~~~~~~~" > fi~~~~~~~~~~~~~~~~e .1c cn CAAn z 44 te r- sD t- vo qa 1s o sD S) o 61 _l~~~~~~~~~~~~~~M 4 M ~ ~ N 'C _C C 0 00 N - S N- 0 0 -. N- _% * 0 8 0 * - Z ^ I I I ~~~~~~I I I I I - X co ~ ~ ~ ~ w c 0 'o N N * 4 N N N t 0 c c I I I I _ _ a F tHF 9< I X II i eo __ Iiis -62- ANNEX 1 Go Ln - - % ' 0% 11 C ~ 0 90 0 80 , Dv HNo KoD >, CO r- N 0 ON cC W I- i v- o0 r- 0% * * * * . * * * * *. -4 r- en -t -: en (n 0% -. ' _ b e co N u~ -4 n es oN %O - - T en .4 en 4.1 a, Q CC - Ns° I° %0r %0. r. 00 ' W O 4 en t e o n en o - 0~C)P Ln 0 co 0% en it, .T -: 0% * * * * * * * * * * U) b - c en C4 en .-' en - r- -t N Cn 0% ~~~~~~~~~co rl .-4 0S r-. a c% 80 s * 0s s H0 0 0e 0s b0 LA e W - 4 - - 0 N W LA N -4 C N n - N en -4 en N N 0 _0 N NS N N N NS NC N %O KOv KO NO KO 0 H 0 0 lrD 1lsO3 > N1 U) r-. co (cl % -4 co co in en '0 co 4 a,W - I ts D W 0 ' - -4 4.10% * * * . . . * * *0 a, ~ U) - N O' ~ .- 4 - 4 Cn Ni N C- a, a, - j- _- ^4 in N NS N N N N_ N W E1 1< -- Ln a% WI n en 0% N en _ ' 0. c r4 44 0% . . * * . . * * 0 r4 0 0 .. CC '0 LA LA CZ CZ en -t '0 -4 N 0'4 N '-4 CNen N R; _ N N N N_ N _ N N N N O ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~) 4._ N . * * * . MI * . . * O C _ tF~~~~~~~~~~~~%D L_ *o % o - n c0 %D -4 O 4 m _ en N S N e N N N N N 44 m~~~% 0 MO* * * 0 0 0 r- Ci - 0 -t -t "4 '4 en - C N en N o-4 V4 0% CC -" 0 0 '0 .4 - 0 ' ..CC O% N N eUn N o N ^ 4 0 .-4 Ni _ en en _I e - _ e- N 2i 14 -t K K. Kt '0 en N KO - V] H > * *0% * * . * * * * Z . _ . 0 0 n 0 E - n o - t _ - . m W~~~~~~~~~~~~~~~~- c 9 04 e _ e4 e s _ 4J ~ CC 0 0% ~b - '' 0% '0 ) N en N -* N > < u4 N N b e o . . . . . . . .~ . -.. 8 a 0o - 63 - FIGURE 1 A ANNEX 1 NOMINAL INTEREST RATES ON TERM DEPOSITS CO MONTH) .-- INFLATION RATE CPAST DEC. TO DEC. OF THE CURRENT YEAR) .1: 2S-~~~~~~~~~~~~~~ 45- ." . * ' BANGLADESH 48- K ~ ~ EY -15- I lII I III IIII - - 48- 30- 01- 0-KOREA 1 9710 1 972 1 974 1 976 1 978 1 980 1 98z - 64 - ANNEX 1 FIGURE I B - NOL iTEREST RATES ON TERM DEPOSITS CO MOTh) †*W NFLATON RATE CPAST DEC. TO DEC. OF THE CURRENT YEAR) 3-. 28- 20- .. ' X .' ...... " . .. . . . . . 415 K~~~~~~~~~~~ .S Se- ........ OS- 4.~ ~ ~~!' 30. 48- PAKISTAN; 1 97B 1972 1974 1 97B 1978 1980 1982 - 65 - ANNEX 1 FIGURE I C - NOMINAL INTEtEST RATES ON TERM DEPOSITS CO MONTH) . IFLATION RATE CPAST DEC. TO DEC. Of THE CURRENT YEAR) 40- 80- PERU -20-i I I I I I 40- 30- 20- lee- 0 - ,,... ' ~ ~ ........ THAILAND 6 00 40- 0- TURKEY -20- , , , , , , , , ; 1970 1972 1974 1976 1978 1 980 1982 - 66 - ANNEX 1 FIGURE I D - NOMINAL INTEREST RATES ON TERM DEPOSITS CO MONTH) -. IFLATION RATE CPAST DEC. TO DEC. OF THE CURRENT YEAR) lee *2l -. a' 80 X 40- 0- URUGUAY -20- 1970 1972 1974 1978 1978 1980 1982 ANNEX 1 - 67 - BANUAES: Table I Selected N1inal and Er-pot Real Interest Rates in sd9 ed Barik Eed of Year (aualiz) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, daetic denam. Dmd Nbinal #W/A O.C0 o.XX O.0% 0.0 : 0.0% 0 .% 0. O0.0t O. %. 0.K% 0. 0.0% DL-post real #/A -0.2 -0.2 -0.4 0.1 0.1 -0.1 -0.1 -0.1 -0.1 -0.1 0.0 -0.1 SaVils (na-hicdtg) Nnal #W/A 4.5% 4.5X 4.5Z 6.0% 6.% 7.X M 7.M 7.0% 7.M 1O.C0% 10.0% 10.0% Er-post real #W/A -18.4% -20.1% -32.4% 16.9% 11.9% -8.9% -0.8S -8.9% -6.3% -5.3% 10.67 -2.3% Temn, 6 mKnth Nominal N/A 4.8% 4.8 4.8Z 6.5% 6.5S 7.5% 7.5% 7.5X 7.5Z 13.0% 13.0% 13.0% rt-post real iN/A -18.2% -20.0% -32.2% 17.5% 12.4% -8.5% -0.4% -8.5% -5.8% -2.7% 13.6% 0.3% Weighted averae rate of return m abowe assets Er-pOSt real IN/A -20.8% -22.6% -34.4% 12.6% 7.9% -12.4% -4.4% -12.3% -9.5% -8.5% 7.2% -5.0% lsndixrg, danstic dern. NbnMal Nwl.nal fN/A 10.0% 10.0% 10.0C 13.0% 13.0% 13.MC 12.0% 12.0% 12.0% 16.0% 16.0% 16.0% D -poet real fN/A -14.1% -15.9% -28.8% 24.7% 19.3% -3.8% 3.8% -4.7% -1.9% -0.2% 16.6% 3.% Against jute, jute gxxs and tea Nninal #H/A 8.5% 8.5% 7.5% 10.5% 10.5% 10.5% 10.5% 10.5% 10.5% 12.0% 12.0% 12.0% Ex-pst real #N/A -15.32 -17.1% -30.4% 21.9% 16.7% -6.0% 2.4% -5.9% -3.2% -3.6% 12.6% -0.6% Inflatian ((PI) 6 mntlu Forsrd fran Deamer -4.1% 28.0% 30.9% 54.6X -9.4% -5.3% 17.5% 7.9% 17.52 14.22 16.2t -0.6% 12.6% Devaluaticu 6 mths Forwwrd franl Deaember #/A 9.1% -17.3% -5.6% 185.6% 1.7% 7.8% 9.5% 2.6% -11.4% 24.0% 24.1% 3.6% Iaflaticm (CPI) over Prior December #W/A 15.3% 46.1% 34.2% 76.1% -12.6% -0.1% 17.1% 9.6% 14.0% 13.2X 14.3% 4.9% SoLrwes: Intereat rates are fran the Bsgadesz h Bark, Ecunac Trends. (PI data are fran the nM, bS, data tape. Weights for wev htal awerage are fran BaTgladesh Table 2. (See note regkrdirg dispositi aof savirgs.) Note: Real rates mere caladated ex-pot, i.e., they reflect the inflation rate six nmnths fonard fran Decembr. In 1977, 1978 ard 1979, prea!m were paid to rural depositors of .75 & 1.5 perentge points an seaVIrs ard tem daosits, reseptively. ANNEX 1 - 68 - UANULAUM: Mfhle 2 Levels of Selected Finanial AMets Erd of Year (in billions of Taka) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 2 domestic#WN/A 2.1 2.9 3.2 4.0 3.7 3.9 5.0 6.6 7.2 8.7 9.7 9.9 In 1980 prices N/A 10.3 9.9 8.2 5.8 6.2 6.4 7.1 8.5 8.2 8.7 8.5 8.3 X of QIP UN/A IN/A 5.9% 4.2% 2.9% 3.3 3.52 3.7% 4.0% 3.9% 3.9% 3.8% 3.6% % of total assets UN/A 37.8X 31.0% 27.8% 29.42 26.6% 22.C% 23.3X 25.2% 22.9% 23.1% 21.7% 18.72 Deposits, dotic currency Ninal #N/A 1.8 3.9 4.9 5.4 5.5 6.8 7.5 8.8 10.2 10.6 12.3 14.8 In 1980 prices UN/A 9.0 13.3 12.4 7.7 9.2 11.3 10.6 11.3 11.6 10.6 10.8 12.4 % of (2P 1N/A UN/A 7.9% 6.3% 3.9% 4.9% 6.1% 5.4% 5.4% 5.4% 4.8X 4.9% 5.4% % of total assets UN/A 33.1% 41.7% 42.3% 39.1% 39.5% 38.8X 34.7% 33.52 32.3% 28.4S 27.5% 27.9% nlrm Noinal UN/A 1.6 2.5 3.4 4.3 4.8 6.9 9.1 10.8 14.2 18.2 22.8 28.5 In 1980 prices iN/A 7.9 8.7 8.8 6.2 7.9 11.4 12.9 13.9 16.0 18.2 19.9 23.7 2 of (GNP UNA UN/A 5.2% 4.5% 3.1% 4.2% 6.2% 6.6% 6.6% 7.6% 8.2% 9.0% 10.4S X of total assets UN/A 29.0I 27.3% 29.9% 31.5% 33.9% 39.2% 42.1% 41.2% 44.8% 48.51 50.8% 53.5X Tbtal Nominal VN/A 5.5 9.3 11.5 13.7 14.0 17.6 21.6 26.2 31.7 37.5 44.9 53.2 In 1980 pries UN/A 27.3 31.9 29.3 19.8 23.2 29.1 30.6 33.8 35.8 37.5 39.3 44.4 X of GIP UN/A UN/A 18.9% 15.C0 9.9% 12.4% 15.8% 15.7% 16.0X 16.9% 17.C0 17.7% 19.5S CPI, Deemr (Dec.80-100) 17.4 20.0 29.3 39.3 69.2 60.5 60.4 70.8 77.5 88.4 100.0 114.3 119.9 QGP, Dec., 'bminal UN/A IUN/A 49.3 76.8 137.9 112.8 111.3 138.0 163.9 187.8 221.0 253.9 273.3 Sxrwces: Asset data are from the Bagladesh Bank, Bgladesh Bank &illetin and Ecnomic Trends. G(P data are fran B1ngladesh Bzreau of Statistics, E=mic Irdicators of Bw'gladesh, and fran the Pangladesh Bait, Ecoanic Treins. CPI data are fran the IMF, IF, data tape. Nbtes: (N' data are for the fiscal year beginffrg in the current year, therefore incaie is expressed in Deanr*,er prices. ANNEX 1 - 69 - Dld of Yeer (4nUn) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 198D 1981 1982 -igta, -lia Dmd 1z,l O.QX 0.1X 0MM OO OOS 0. O.X 0UN O.S O.S 0US 0UR 0.02 ERpost rel -3.3X -3.72 -9.3 -174 -22.2X -11.02 -21.2S -15.7S -5.7S -13.7 -1. -13.02 -9.5S S-L 1M L 3.0S 3.0X 3.2 30S 5.0S 5.0 5.02 541 5.02 5.0S 6.QS 10.02 12.52 b-pmt red -0.4U -0.82 -6.62 -14.5S -18.31 -6.62 -17.2X -11.5S -0.9Z -.92 -5.8S -4.3 1.9S Tazm, 6 anth Ibl 3.8 3.8 3.82 3.92 5.4S 5.42- 5.4S 5.42 5.42 5.4S 5.4S 6.8S 11.02 13.22 cxmw real 0.31 0.02 -5.9Z -12.5S -18.0S -6.2X -16.92 -11.12 -0.6a -8.52 -5.2X -3.5S 2.5S Private P-*l ttit IbL0 O.OS 0.02 O 0.2X O.OS O.OS O.02 0.0 0.02X 0.02 O.02 O.QX 0.02 E-pot ral -3.13 -3.7Z -9.3 -17.02 -22.2X -11.0Q -21.2X -15.72 -5.7Z -13.2X -11.2X -13.02 -9.52 Fml 3.02 3.02 3.02 3.02 5.02 5.0 5.0 5 5. 5.0 5.0 8.0S 10.0Q 12.5S E-post re-l -0.42 -0.89 -6.6S -14.5S -18.31 -6.6S -17.2S -11.52 -0.9S 4.92 -4.02 -4.31 1.92 Th1 at c g bE-oat ral 2.52 2.1U -3.9Z -10.8S -16.42 -4.42 -14.9S -4.31 2.6S -5.62 -1.42 -0.4U 5.2S Pos Ofice S,gup Bank t l 3.02 3.02 3.0X 3.0X 3.0S 5.02 5.0S 5M 5.02 5.02 6.0Q 10.0S 10.0 b-poet real -0.4 8 -0.92 -6.62 -14.52 -19.9X -6.62 -17.32 -11.5S -0.92 -8.92 -5.8S -4.3X -0.4U =eghad anowenE rate of tetun 0 e-c bE-rt rel -1.4X -2.7S -6.6X -14.6S -18.7Z -9.72 -16.5X -13.8X -4.0S -10.S -7.62 -8.2S -2.8X lA,ivg dmastic din. 1maz (less tiwk 3 yr.) N I - - - - - - - 10.02 10.02 10.02 11.02 14.02 16.02 ho-pot red - - - - -7.2X 3.82 -4.5X -1.42 -0.9S 5.QX N1omi 7.02 7.0 7. 7.02 8.02 8.02 - - - - - - - E-poet ral 3.52 3.12 -3.02 -11.2S -16.Q2 -3.92 - - - - - - - N1 nonw Cor 7.52 7.52 7.52 7.5S 8.Q2 8.02 9.02 9.02 9.Q2 9.0X 9.02 12.02 12.02 b-pet real 4.02 3.62 -2.52 -10.82 -16.02 -3.92 -14.1U -8.U1 2.8X -5.4X -3.2S -2.62 1.4U TnlFl(P) 6 mmw lbnad f Dmm1 3.4U 3.8S 10.3X 2.52 28.52 12.4X 26.8S 18.62 6.02 15.2Z 12.6X 15.02 10.52 Dalutim 6 sutha Fimwd frcm bi.L . 0.02 0.02 -6.7S 7.72 0.02 4.2S -0.2t -3.52 2.02 -0.5 35.2X 13.92 8.3t Tfntm(CI) OMr Prior 1.52 7.2S 3.31 15.2S 16.02 2.3. 7.62 21.02 13.72 9.12 13.12 19.31 13.31 So : Interet rame ar from Mm Ctul as* 1 Kaf, Ew c od Placal sview, hepot ad Ib of statiatic pi aid Plrmdfg. F c b y. CPI data awe fm the DW, t ,da e.ta for tmited avr ap w e I r l hM 2. Note: Rml ram e calaiate we-poet, i.e., tey reflect the Inflation rte six stim fordard from Deeber. Tlhe awrWe rate of retum im oelai awud% mdh asset yiedte the tIrdmn rate and th t all taen daite in the Pvate F1aia lztituin e m in the laWt te= cateory. '-' ridicet mt defirad. - 70 - ANNEX 1 KENYA: Table 2 Levels of Selected Financial Assets Frd of Year (in billions of Shlllirgs) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currnc, danestic C denal 0.7 0.7 0.9 1.0 1.1 1.2 1.6 2.2 2.3 2.7 3.0 3.6 3.7 In 1980 prices 2.3 2.2 2.6 2.5 2.4 2.3 2.8 3.1 2.8 3.0 3.0 3.0 2.8 % of GP 5.8% 5.6% 6.0% 5.6% 5.2X 4.9% 5.2Z 5.8% 5.6% 5.7% 5.57 5.77 5.2% Z of total assets 20.2% 19.5% 20.1% 17.8% 18.1% 17.3Z 18.9% 17.5% 16.0% 16.3Z 16.6% 17.3% 15.8% Deposits, danestic currency Ccxmarcial Bank Demand Nomnal 1.2 1.3 1.5 2.0 2.1 2.4 3.0 4.3 4.7 5.6 5.2 5.6 6.0 In 1980 prices 3.9 3.9 4.5 5.0 4.7 4.4 5.1 6.1 5.8 6.3 5.2 4.7 4.4 % of QP 9.9% 9.7% 10.2% 11.2% 10.1% 9.7% 9.5% 11.6% 11.4% 11.8% 9.6% 9.0% 8.3X % of total assets 34.4% 34.0% 34.1% 35.5% 35.4% 34.0% 34.7% 34.8% 32.8% 33.8% 28.6% 27.1% 25.5% Savings Nmdnal 0.7 0.8 0.9 1.0 1.2 1.3 1.5 2.1 2.4 2.7 3.0 3.5 3.9 In 1980 prices 2.2 2.3 2.5 2.6 2.6 2.4 2.6 2.9 3.0 3.0 3.0 2.9 2.9 % of GNP 5.7% 5.7% 5.8% 5.7% 5.6% 5.2% 4.9% 5.6% 5.8% 5.6% 5.4% 5.6% 5.5% X of total assets 19.9% 19.9% 19.4% 18.2% 19.6% 18.3% 17.8% 16.8% 16.6Z 16.2Z 16.2% 16.9% 16.7% Term Noidnal 0.5 0.6 0.6 0.9 0.8 1.1 1.4 2.3 3.0 3.1 3.7 4.1 5.6 In 1980 prices 1.7 1.8 1.8 2.2 1.8 2.0 2.3 3.3 3.6 3.5 3.7 3.5 4.2 2 of GNP 4.5% 4.4% 4.2Z 4.9% 3.9% 4.5% 4.4% 6.2Z 7.1% 6.5% 6.8% 6.6% 7.8% 2 of total assets 15.4% 15.5% 14.0% 15.7% 13.7% 15.7% 16.0% 18.6% 20.5% 18.6% 20.4% 20.0% 24.C% Private Financial Inst. Nmnal 0.0 0.0 0.0 0.0 0.0 0.1 0.0 0.3 0.2 0.3 0.1 0.2 0.2 In 1980 prioes 0.1 0.1 0.0 0.0 0.0 0.2 0.0 0.5 0.2 0.3 0.1 0.2 0.2 Z of GNP 0.3% 0.2% 0.1% 0.1% 0.0% 0.4% 0.1% 0.9% 0.4% 0.5% 0.2Z 0.4% 0.3% % of total assets 1.1% 0.6% 0.4% 0.3% 0.1% 1.3% 0.3Z 2.8% 1.3% 1.6% 0.5% 1.1% 1.0% Savings a/ NornaT 0.1 0.1 0.1 0.2 0.2 0.1 0.3 0.2 0.5 0.5 0.6 0.6 0.6 X of QW 0.62 0.8% 0.9% 1.1% 1.0% 0.6% 0.9% 0.6% 1.1% 1.0% 1.1% 0.9% 0.9% % of total assets 2.0% 2.6% 3.1% 3.5% 3.5 2.1% 3.2% 1.9% 3.3% 2.7% 3.2Z 2.8% 2.7% Tenn a/ onmnal 0.1 0.2 0.3 0.4 0.4 0.7 0.6 0.8 1.2 1.5 2.3 2.6 2.9 In 1980 prices 0.4 0.6 0.8 1.0 1.0 1.2 1.0 1.1 1.4 1.7 2.3 2.2 2.1 % of GNP 1.1% 1.4% 1.9% 2.1% 2.1% 2.7% 2.0% 2.1% 2.8% 3.2% 4.2% 4.2% 4.0% % of total assets 3.8% 5.0% 6.2% 6.8% 7.3Z 9.3% 7.2% 6.3% 8.0% 9.3% 12.7% 12.7% 12.2% Post Office Savins 8ank ?ii eSnSl 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.2 0.3 0.3 0.4 0.5 In 1980 prices 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.4 0.4 % of (IW 0.9% 0.8% 0.8% 0.7% 0.7% 0.6% 0.5% 0.5% 0.5% 0.5% 0.6% 0.7% 0.7% Z of total assets 3.1% 2.9% 2.6% 2.3% 2.3X 2.0% 1.9% 1.5% 1.5% 1.5% 1.9% 2.1% 2.1% Total Nxinal 3.4 3.8 4.4 5.5 6.0 7.1 8.6 12.5 14.4 16.4 18.3 20.6 23.6 In 1980 price 11.2 11.5 13.0 14.1 13.2 13.0 14.6 17.5 17.8 18.6 18.3 17.3 17.4 2 of QGP 28.9% 28.5% 29.8% 31.4% 28.6% 28.5% 27.3% 33.4% 34.7% 34.8% 33.4% 33.2t 32.7% CPI, Dember (Dec.80-100) 30.8 33.0 34.1 39.3 45.5 54.8 58.9 71.3 81.0 88.4 100.0 119.3 135.2 GNP, Dec. adJusted, nnainal 11.9 13.3 14.9 17.6 21.0 25.0 31.4 37.4 41.5 47.2 54.8 62.2 72.1 Saorces: Asset data are frm The Central Bhi of Kena, EFrxnic mid Finaal Paview. (N and CPI data are frmn the 11F, US, data tape. btes: The QGP data ha. been logrithrically interpolated between the current year ad am year fornard so as to be expressed in December pricas. a/ Savings and term deposits in the Private Financl Institutions were assued to be distributed 1:2 for the years 1970-72, and in all other years as reported. - 71 - KFL Mbe I Selected inl a l-ot Peal Intereft Re ANNEX 1 ai of Year (anmalized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 pqxaits. dcmatic dec. dod Noinal 0.0% 0.0% 0.0% 0.0% 0.0% o.0x 0.0C 0.0% 0.0% 0.0% 0.0% o.os O.% E-pt rel -12.9% -14.31 -3.3 -25.31 -26.7% -1t.61 -12.1 -17.77 -22. 1 -26.52 -14.8% -6.61 -3.4% NLtn 1.8% 1.81 1.61 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% &-pt real -11.1% -12.8% -1.42 -24.11 -25.42 -10.0% -10.6a -16.2 -20.7% -27.31 -13.31 -4.92 -1.61 Temporary Ninal 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0; 1.0% 1.0% 1.8% 1.8% b-Et rea -12.0C -13.52 -2.1 -24.61 -26.0% -10.7% -11.42 -16.9% -21.31 -27.8% -14.0% -4.9% -1.61 SWA arl term¢ Nomrli 9.61 8.7% 4.8% 4.8% 4.8% 0.0% o.a% .0 0.0% - - - - fr-vat rel -4.51 -6.9% 1.52 -21.72 -23.1 -11.61 -12. -17.7% -22.1% - - - - Notice N Xml 5.0% 5.0% 3.7% 3.7% 3.7% 6.0% 6.0% 10.0% 10.O 10.0% 10.5% 12.0% - ft-vot real -8.5% -10.11 0.4% -22.62 -24.11 -6.31 -7.0% -9.52 -14.31 -21.4% -5.9% 4.61 - InstaU2rnt aavinga Nmimi U23.02 23.0% 12.0% 12.0% 13.1 13.1 14.7 14.1 15.a 18.1 19.5% 16.1 8.02 ex-post real 7.1 5.4% 8.52 -16.4% -17.12 0.11 o.a -6.0% -10.31 -15.52 1.8% 8.52 4.31 Wbriumn's prnperty a/ NmMa - - - - - - 19.1 19.1 20.21 23.21 24.52 21.3 21.0% Ex-pt real - - - - - - 4.61 -1.9% -6.4% -12.0% 6.0% 13.1 16.9% Savinp NDminl - - - - - - - 13.25 12.61 12.61 12.35 14.42 8.0% Elbr.t real - - - - - - - -6.9% -12.31 -19.52 -4.31 6.8% 4.31 Term, 6 wrnth N1dml 16.8% 14.4U 8.U 8.4% 15.0% 13.8% 15.6% 13.8% 17.1% 17.12 16.9% 14.61 7.6% EPz t rea 1.8% -2.0% 5.0% -19.11 -15.8% 0.61 1.52 -6.4% -8.8% -16.31 -0.4% 7.0% 4.0J Depoits, foreign d-. Residentt expotrs Nlunal(in U.S.$) II.0% 11.0% 8.0% 9.0% 15.02 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 17.62 14.5% E-Soat rel (in wo) 32.61 9.11 4.61 -18.0% -15.8% 1.7% 0.9% -5.4% -10.4% 27.52 5.61 22.8% 19.0% a~A rate of F-post rel -2.11 -4.7% 2.b% -20.8% -20.61 -4.31 -4.1 -10.8% -14.8% -20.7% -5.8% 2.2 1.7% aidn, dastic dAm. Ninal 24.0% 22.0% 15.51 15.52 15.51 15.52 18.0% 16.0% 19.0% 19.0% 20.0% 17.0% 10.0% ex-post real 8.0% 4.52 11.91 -13.8% -15.42 2.11 3.6% -4.61 -7.3t -15.0% 2.21 9.1 6.31 Err exports Nlnal 6.0% 6.0% 6.0% 7.0% 9.0% 7.0% 8.0% 8.0% 9.0% 9.0% 15.0% 15.0% 10.0% fE-jast real -7.62 -9.1 2.7% -20.12 -20.1 -5.4U -5.1 -It.lU -15.11 -22.11 -2.0% 7.4% 6.31 Inflatin (CP1) 6 mmk. Mnmrd frcig rDOnter 14.8% 16.7% 3.31 33.92 36.5S 13.12 13.92 21.61 28.4% 39.9% 17.4 7.1 3.5S Devaluation 6 itbne For.zd froma DaS. 37.12 14.7% 0.0% 0. OS 0.0% 0.0% 0.0% 0.2% 0.0 55.1 7.82 11.8% 7.6% il or n r 10.5S 12.32 7.8% 8.5S 26.5S 25.4% 10.5% 11.0% 16.4% 21.2 34.62 11.72 4.82 Suojm: Interet rame data are frc aI fl rk of ICra, ?xthly Etx8c Statistis. CI, bdtaz Pate am lIt data are fron the Df, IF, datA tape. loea: Rl ratm ere caloiatl ex-post, i.e., they reflect thr inflation rate six mmtkr formrd frm er. a/ For 1976-61, th intereat rnte paid an Wlrkmm's Prperty Forstion aots m md to b thU rate paid on Installmnt S8ir acounts plus 5 perceta poiants. In 1982, th rae a Us thaai1 uxia. bi The omigtei marp we calculate asaeAila all IUstallnt eaonmt were paid the rate an Iutallbant Snr nt -* 'mlg * erm darivle fr gores Table 2. KOREA: Table 2 ANNEX 1 Levels of Selected Financial Assets in Deposit Money Banks End of Year (In billions of Won) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currenc domeatic NOmin l 133.7 162.1 217.7 311.4 410.5 507.2 676.8 953.4 1364.4 1604.0 1856.4 2025.0 2573.7 In 1980 prices 647.7 699.4 871.8 1149.6 1198.4 1180.4 1425.4 1809.8 2225.0 2158.2 1856.4 1812.7 2197.6 2 of GNP 4.42 4.3X 4.62 4.92 4.72 4.32 4.32 4.62 5.02 4.72 4.52 4.22 4.72 X of total assets 14.51 14.32 14.22 15.32 16.52 15.92 16.02 15.62 15.32 14.22 13.02 10.72 10.92 Deposits, domestic currency Demnd Checking Nominal 27.0 28.8 45.9 74.4 104.4 125.8 143.7 238.9 353.8 307.9 541.4 710.6 772.0 In 1980 prices 130.6 124.3 183.8 274.6 304.6 292.9 302.6 453.4 577.0 414.3 541.4 636.1 659.2 2 of GNP 0.92 0.82 1.02 1.22 1.22 1.12 0.92 1.12 1.32 0.92 1.32 1.52 1.42 Z of total assets 2.92 2.52 3.02 3.72 4.22 4.02 3.42 3.92 4.02 2.72 3.82 3.82 3.32 Passbook Nominal 103.9 117.4 165.5 246.7 291.8 349.4 429.0 623.4 840.4 900.4 979.8 1105.4 1905.8 tn 1980 prices 503.2 506.6 662.6 910.8 851.7 813.1 903.5 1183.3 1370.5 1211.5 979.8 989.5 1627.3 2 of GNP 3.42 3.12 3.52 3.9X 3.42 3.02 2.72. 3.02 3.12 2.62 2.42 2.32 3.52 2 of total assets 11.32 10.32 10.82 12.12 11.72 11.02 10.22 10.22 9.42 8.02 6.92 5.82 8.12 Tesporary NomInal 73.0 110.2 181.4 173.3 201.8 277.0 395.4 739.8 1323.5 1869.0 2145.3 3403.9 4303.6 In 1980 prices 353.5 475.7 726.2 639.6 589.1 644.8 832.7 1404.3 2158.3 2514.8 2145.3 3047.0 3674.7 2 of GNP 2.42 2.92 3.82 2.72 2.32 2.32 2.52 3.52 4.82 5.52 5.22 7.02 7.82 2 of total asets 7.92 9.72 11.82 8.52 8.12 8.72 9.42 12.12 14.82 16.62 15.12 18.02 18.22 Savings and Term New Household Nominal 30.8 37.4 58.6 68.9 43.2 0.6 0.1 0.1 - - - - - in 1980 prices 149.0 161.3 234.5 254.5 126.1 1.5 0.3 0.2 - - - - - 2 of GNP 1.02 1.02 1.22 1.12 0.52 0.02 0.02 0.02 - - - - - Z of total assets 3.32 3.32 3.82 3.42 1.72 0.02 0.02 0.02 - - - - - Notice Nominal 17.5 11.1 20.1 38.7 39.2 78.8 139.3 247.8 418.5 592.3 803.2 815.7 In 1980 prices 84.9 47.9 80.7 142.7 114.4 183.4 293.3 470.4 682.5 797.0 803.2 730.2 - 2 of GNP 0.62 0.32 0.42 0.62 0.52 0.72 0.92 1.22 1.52 1.72 1.92 1.72 - l of total assets 1.92 1.02 1.32 1.9S 1.62 2.52 3.32 4.02 4.72 5.32 5.62 4.32 Instalments Nominal 203.4 255.7 335.4 495.0 649.5 889.2 1121.1 1386.5 1902.3 2506.3 2722.6 3173.6 3044.2 In 1980 prices 985.5 1103.5 1342.9 1827.4 1896.0 2069.4 2361.2 2631.9 3102.3 3372.3 2722.6 2840.8 2599.3 2 of GNP 6.72 6.82 7.12 7.82 7.52 7.52 7.12 6.62 6.92 7.42 6.62 6.52 5.52 2 of total assets 22.12 22.52 21.92 24.32 26.12 27.92 26.62 22.62 21.32 22.22 19.12 16.82 12.92 Workman's Property Nominal - - - - - - 25.8 102.2 205.1 283.6 426.4 626.0 1083.6 In 1980 prices - - - - - - 54.4 194.0 334.5 381.6 426.4 560.4 925.2 2 of GNP - - - - - - 0.22 0.52 0.72 0.82 1.02 1.32 2.02 2 of total assets - - - - - - 0.62 1.72 2.32 2.52 3.02 3.32 4.62 Savings Nominal - - - - - - - 102.3 339.3 505.1 694.4 1593.7 3260.0 In 1980 prices - - - - - - - 194.2 553.3 679.6 694.4 1426.6 2783.6 2 of GNP - - - - - - - 0.52 1.22 1.52 1.72 3.32 5.92 2 of total assets - - - - - - - 1.72 3.82 4.52 4.92 8.42 13.82 Term Nominal 318.0 395.8 486.4 595.5 704.6 930.4 1242.9 1615.3 2108.4 2631.4 3923.2 5285.7 6269.0 In 1980 prices 1540.5 1708.0 1947.3 2198.5 2056.9 2165.4 2617.8 3066.3 3438.4 3540.6 3923.2 4731.4 5352.9 2 of GNP 10.52 10.62 10.32 9.42 8.12 7.92 7.82 7.72 7.72 7.72 9.52 10.92 11.42 2 of total assets 34.52 34.82 31.72 29.32 28.42 29.22 29.42 26.42 23.62 23.32 27.52 27.92 26.52 Daposto , fordign currency NMil in dollar) 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.1 0.2 0.3 0.6 Nominal (in won) 13.9 18.3 20.9 29.1 39.0 24.6 47.3 113.6 82.9 71.9 150.5 189.0 445.2 In 1980 prices 67.2 78.8 83.6 107.3 113.8 57.3 99.6 215.6 135.2 96.7 150.5 169.2 380.1 2 of GNP 0.52 0.52 0.42 0.52 0.42 0.22 0.32 0.52 0.32 0.22 0.42 0.42 0.82 2 of total assets 1.52 1.62 1.42 1.42 1.62 0.82 1.12 1.92 0.92 0.6X 1.12 1.02 1.92 Total Nominal 921.0 1136.7 1531.9 2032.9 2484.0 3183.1 4221.4 6123.2 8938.6 11271.9 14243.2 18928.6 23657.1 In 1980 prices 4462.1 4905.5 6133.3 7504.9 7251.2 7408.1 8890.8 11623.4 14577.0 15166.7 14243.2 16943.7 20199.9 2 of GN? 30.32 30.4% 32.42 32.02 28.52 26.92 26.62 29.22 32.52 33.12 34.52 38.92 43.12 CFI. December (Dec.80-100) 20.6 23.2 25.0 27.1 34.3 43.0 47.5 52.7 61.3 74.3 100.0 111.7 117.1 lbtbange rate. December 316.7 373.2 398.9 397.5 484.0 484.0 484.0 484.0 484.0 484.0 659.9 700.5 748.8 CNP. Dec. adiusted, nominal 3038.7 3744.4 4726.8 6352.6 8701.9 11836.0 15857.5 20948.8 27513.8 34097.0 41268.2 48688.2 54937.3 Sourcesz Asset data are from The Bank of Korea. Monthly Economic Statistics. GNP nd CPI data ere from the IMW. IFS, data tape. Notes: The CNP data hbve been logrithLically interpolated between the currant year and one year forward so " to be expressed in Deceber prices. Installments Include Installment Savings, Mutual Installment and Housing Installments. '-' Indicates not defined. - 7 3 - ANNEX 1 MO__ ilUe I Selected tNoinal awd Ex-poet 1a1 Interest Rates End of Year (amualized) 1970 1971 1972 1973 1974 1975 1976 1917 *1978 1979 1980 1981 1982 Deposits, dametic dem. Daun Nominal o.0% o.0% o.0% 0.0% 0.0% o.0% 0.0% 0.ci 0.0% 0.0a% 0.0% o0( 0.ox E-poet real -3.5% 0.0% 3.0% -13.0% -4.0% -8.6% -9.1% -7.7% -4.3% -5.7% -14.5% -7.1% -2.7% Tenn, 6 ionths Ex-post real #Ntl/A ON/A #'N/A IN/A -0.1% -4.5% -5.0% -3.5% 1.4% 0.0% -8.1% -0.1% 5.5% Importation tminal ON/A ON/A #/A #N/A 2. 2.3X 2.3t 2.3% 3.0% MM- 3.8% 3.8% 4.3% EK-post real #N/A ON/A lN/A OIN/A -2.1% -6.6% -7.1% -5.6% -1.5% -2.8% -11.3X -3.6% 1.4X Weighted &erge rate of return m above assets plus currency. Ex-post real ON/A #N/A #N/A ON/A -3.6% -8.2% -8.7% -7.2X -3.6% -4.8% -13.4% -5.9% -1.2X tadirg, domestic dernm. General sthrt term (max) Nominal O/N/A N/A O/N/A ON/A 8.0% 10.5% 10.5% 10.5% 10.5% 10.5X 11.5% 11.5% 12.0% i-poet real ON/A ON/A ON/A ON/A 3.7% 1.0% 0.4% 2.0% 5.7% 4.2% -4.7% 3.6% 8.9% Cotton wrrants Nrinal ON/A ON/A OIN/A ON/A 5.31 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 6.5% 7.0% ER-pst real #N/A ON/A ON/A ON/A 1.1% -3.6% -4.1% -2.6X 0.9% -0.5% -9.8% -1.1% 4.U% Inflation (CPI) 6 months Forward fron Detembr 3.6X 0.0% -2.9% 14.9% 4.1% 9.4% 10.1% 8.31 4.5% 6.0% 17.0% 7.7% 2.8% Devaluatin 6 wmiths Forward from DecEmber -0.1% -8.3% -30.6% 3.0% -13.5% 12.4% -0.1% -5.4% 0.92 3.2% 58.1% 34.1% 19.8% Inlatidn (CPI) over Prior D er 2.6% 4.7% 2.6% 8.7% 14.4% 6.1% 13.4% 9.0% 9.7% 9.0% 9.7% 13.2% 6.7% SaLroes: Interest rate data are fran le Baswqe ci Mroc, CPI ard Exdharge Rate data are frao the DT, FS, dta tape. eights for weighted average are frun MDroea Table 2. Notes: Peal rates were calailated ex-post, i.e., they reflect the inflation rate six arnithe forward frm Decer. The interest rate paid o Inportation Deposits were aslmd to be haLf the rate paid on 6 month term deposits. - 74 - ANNEX 1 M)ROCO: Table 2 Levels of Selected Financial Assets End of Year (in billions of Dirhams) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, docestic Nominal 2.3 2.5 2.9 3.4 4.1 4.7 5.7 6.7 7.7 9.0 9.8 11.1 12.0 In 1980 prices 5.2 5.4 6.3 6.7 7.0 7.5 8.2 8.7 9.2 9.9 9.8 9.8 10.0 % of GNP 11.0% 11.1% 12.2% 11.5% 11.2Z 11.6% 12.3% 12.4% 12.8% 13.4% 13.2% 13.4Z 13.0% % of total assets 38.0% 36.8% 37.3% 37.1% 34.3X 32.6% 33.9% 33.2% 31.6% 32.5% 31.8% 31.3% 30.4% Deposits, domestic currency Nboinal 3.3 3.7 4.4 5.2 6.8 8.2 9.4 11.2 13.0 14.3 15.5 17.9 19.9 In 1980 prices 7.6 8.2 9.4 10.2 11.6 13.3 13.5 14.7 15.5 15.7 15.5 15.8 16.5 % of GNP 16.0% 16.9% 18.2% 17.3% 18.7% 20.32 20.1% 20.9% 21.6% 21.3% 20.9% 21.5% 21.5% % of total assets 55.1% 56.0% 55.7% 56.1% 57.1% 57.4% 55.7% 55.9% 53.3% 51.6% 50.3% 50.2% 50.4% Term Nadrnal 0.4 0.5 0.5 0.6 1.0 1.4 1.8 2.2 3.0 3.7 4.6 5.9 7.3 In 1980 prices 0.9 1.0 1.2 1.2 1.7 2.3 2.5 2.9 3.5 4.0 4.6 5.2 6.1 % of GbP 2.0% 2.1% 2.3% 2.1% 2.8% 3.6% 3.7% 4.1% 4.9% 5.5% 6.3% 7.1% 7.9% % of total assets 6.9% 7.1% 6.9% 6.7% 8.5% 10.1% 10.4% 10.9% 12.2% 13.2% 15.1% 16.5% 18.5% Inportation Noinal 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.7 0.8 0.9 0.7 0.3 In 1980 prices 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.9 0.8 0.9 0.6 0.2 % of GNP 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 1.2% 1.1% 1.2% 0.8% 0.3% % of total assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 2.9% 2.7% 2.8% 2.0% 0.7% Total Noninal 6.0 6.7 7.9 9.2 11.8 14.3 16.9 20.0 24.3 27.8 30.8 35.6 39.6 In 1980 prices 13.7 14.7 16.9 18.1 20.4 23.2 24.2 26.3 29.1 30.5 30.8 31.4 32.7, % of GNP 29.-0 30.1% 32.6% 30.9% 32.7% 35.5% 36.1% 37.3% 40.6% 41.2% 41.5% 42.8% 42.6% CPI, ecrer (DBc.80=100) 43.4 45.5 46.7 50.8 58.1 61.6 69.9 76.2 83.7 91.2 100.0 113.2 120.8 GNP, Dec. adjusted, nomnal 20.5 22.2 24.2 29.8 36.2 40.2 46.8 53.8 59.9 67.4 74.3 83.2 92.9 Sources: Asset data are fram le Baqlue cd Maroc, Rapport N GN anl CPI data are frxm the IF, I data tape. Notes: Tte GON data have been logritmiically interpolated between the oarrent year and ale year forward so as to be expressed in December prices. - 75 - ANNEX 1 NIGIA: Tabe I Selected Nominal ard Em--post Real Interest Rates End of Year (arnaized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979- 1980 1981 1982 Deposits, danstic dewfn. Dax Nominal 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% .0% 0.0% 0.0% Ec-post real -27.0% -6.7% -20.8% -13.1% -42.6% -14.7% -28.9% -17.9% -13.3Z -8.5% -25.4% -7.9% -23.8% Savings Nominal 3.C% 3.07. 3.0% 3.0% 3.0% 4.0% 4.0% 4.0% 5.0% 5.0% 6.0% 6.0% 8.5% Ex-post real -24.8% -3.9% -18.4% -10.5% -40.9% -11.3% -26.1% -14.6% -9.0% -4.0% -20.9% -2.4% -17.3% Term, 6 nnnth tnal MM3.0 3.0% 3.5% 3.57. 3.5% 3.0% 2.5% 3.0% 5.0% 5.5% 6.0% 6.0% 8.5% Ex-"ost real -24.8% -3.9% -18.0% -10. 1% -40.6% -12.2% -27.2% -15.5% -9.0% -3.5% -20.9% -2.47 -17.3% Wighted average rate of return an above assets plus -wrency Ex-ost real #1N/A -5.6% -19.8% -11.9% -41.7% -13.5% -28.1% -17.0% -11.8% -6.7% -23.8% -5.8% -21.2% lexdxg, dmaestic dern. Gereral advances Nlinal 8.0% 10.0% 10.0% 10.0% 10.0% 9.0% 10.0% 6.0% 11.0% 11.0% - - - Ex-post real -21.1% 2.7% -12.9% -4.4% -36.8% -7.0% -21.8% -13.0% -3.7% 1.5% - - - First class advances Nlkinal 7.C% 7.0% 7.0% 7.0% 7.(0 6.0% 6.0% 6.0% 7.0% 7.5% - - - EK-post real -21.9% -0.1% -15.3% -7.0% -38.6Z -9.6% -24.7% -13.0% -7.2% -1.7% - - - Geral ssidmn Nlnal - - - - - - - - 11.0% 11.0% 11.5% 11.5% 14.0% Ex-post real - - - - - - - - -3.7% 1.5% -16.8% 2.7% -13.2% Perfered sector maxdmm Noninal - - - - - - - - 9.C% 9.0% 9.5% 9.5% 12.5% Ex-post real - - - - - - - - -5.5% -0.3% -18.3% 0.9% -14.3% Inflation (CPI) 6 nths Forward ftrm le- r 37.0% 7.1% 26.3% 15.1% 74.2% 17.2% 40.7% 21.8% 15.3% 9.3% 34.1% 8.6% 31.3% Devaluaticn 6 umths Forward frao December 0.0% 0.0% 0.0% -12.0% -3.6% 0.0% 5.9% -2.5% -15.0% -6.4% 40.9% 12.5% 21.8% Inflation (CPI) over Prior De r 13.0% 15.0% -3.5% 17.8% 9.9% 43.1% 12.4% 31.3% 10.3% 11.5% 13.7% 17.4% 6.7% Scurces: All pre-1982 interest rates are fron tle Central Bark of Nigeria, Elcnmc and Firacial Paview or Anmal Peprt exispt the gerneal mxmum and prefered sector maxdmn lerdirg rates and all 1982 figres, Uli are from the lbrld Bank, Financial Intermadiation in Nigeria, report# 4051-NI. CPI data are fron the IMF, IF data tape. Notes: Real rates wre calculated ex-post, i.e., they reflect the inflation rate six unths forward fron December. TMh w-ighted average uses w-ights fran Nigeria Table 2 ard a88ue8 all tim deposits yield at the 6 wnnth rate. '-' indicates not defined. - 76 - ANNEX 1 NIGERIA: Table 2 levels of Selected Financial Assets Ehd of Year (in billicns of Naira) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, danestic Noninal I/N/A 0.4 0.4 0.4 0.6 1.0 1.4 1.9 2.2 2.4 3.2 3.9 4.2 In 1980 prices I/N/A 1.3 1.5 1.4 1.7 2.1 2.5 2.7 2.7 2.7 3.2 3.3 3.4 % of GDP #N/A 4.8% 4.6% 3.5% 3.1% 4.5% 5.1% 6.8% 6.4% 5.7% 7.3X 8.7% 9.2% % of total assets I/N/A 34.9% 33.2% 30.8% 26.4% 28.5% 25.6% 27.5% 29.2% 23.9% 22.0% 24.8% 25.0% Deposits, daimstic currency Noimnal I/N/A 0.3 0.3 0.4 0.6 1.0 1.9 2.9 2.6 3.8 6.0 5.9 5.8 In 1980 prices //N/A 1.1 1.2 1.3 1.8 2.1 3.6 4.0 3.3 4.3 6.0 5.0 4.7 % of GDP I/N/A 3.9X 3.8X 3.2X 3.3 4.4% 7.3% 10.1% 7.8% 9.1% 13.9% 13.3% 12.7% % of total assets IIN/A 28.1% 27.1% 27.7% 28.2% 28.0% 36.8% 40.4% 35.5% 38.5% 41.87. 37.8% 34.5% Savings Nominal itN/A 0.2 0.2 0.2 0.3 0.5 0.7 0.9 1.1 1.3 1.7 2.0 2.3 In 1980 prices //N/A 0.6 0.8 0.7 0.9 1.1 1.3 1.3 1.4 1.5 1.7 1.7 1.9 % of GDP ltN/A 2.2% 2.4% 1.9% 1.6% 2.3 2.7% 3.3 3.2% 3.1% 3.8X 4.5% 5.0% % of total assets #tN/A 16.2Z% 17.3% 16.2Z 13.5% 14.6% 13.6% 13.3X 14.77% 13.1% 11.5% 12.8% 13.7% Term NIniral I/N/A 0.2 0.3 0.4 0.7 1.1 1.3 1.3 1.5 2.4 3.6 3.8 4.5 In 1980 prices I/N/A 0.8 1.0 1.2 2.0 2.2 2.3 1.9 1.9 2.7 3.6 3.3 3.6 % of GDP /WN/A 2.9X 3.1% 2.9% 3.7% 4.6% 4.8% 4.7% 4.5X 5.8% 8.2% 8.6% 9.8% Total Noninal //N/A 1.0 1.2 1.4 2.2 3.6 5.3 7.1 7.4 9.9 14.5 15.5 16.9 In 1980 prices #/N/A 3.8 4.4 4.6 6.4 7.5 9.7 9.9 9.4 11.2 14.5 13.2 13.5 % of GDP MIN/A 13.7% 13.9% 11.4% 11.6% 15.9% 19.8% 24.9% 21.8% 23.7% 33.3X 35.2% 36.7% CPI, December (Dec.80=100) 23.6 27.1 26.1 30.8 33.9 48.4 54.4 71.5 78.8 87.9 100.0 117.4 125.2 GDP, Dec. adjusted, ninal 6.3 7.4 8.3 12.4 18.6 22.8 26.7 28.4 33.9 41.6 43.4 44.2 46.0 Sources: Asset data are fran the Central Bark of Nigeria, M(nthly Report CPI and GDP data are frao the ]MF, IFS, data tape. Notes: The G(P data have been logrithmically interpolated between the current year and one year forward so as to be expressed in December prices. - 77 - ANNEX 1 PAKISTAN: Table I Selected Nominal and Ex-post Real Intereat Rates end of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, domestic denom. Demand Nominal 0.0 0.0% 0.01 0.1% 0.1% 0.1% 0.1% 0.1% 0.3% 0.1% 0.1% 0.1% O.OX Ex-post real -5.7% -3.3% -17.3% -11.7% -14.5% -3.0% -3.3% -3.2% -6.1% -12.1% -7.4% -1.6% -6.7% Savings Nominal 4.2% 4.1% 4.9% 5.8% 6.1% 6.6% 6.7% 7.6% 7.6% 7.6% 7.6% 7.6% 7.6% Ex-post real -1.7% 0.6% -13.2% -6.7% -9.3% 3.3% 3.1% 4.0% 0.7% -5.6% -0.5% 5.8% 0.4% Term, 6 montha Nominal 5.2% 5.1% 5.6% 6.7% 8.2% 8.9% 9.12 9.6% 10.0% 10.1% 10.2% 10.2% 9.9% Ex-post real -0.8% 1.62 -12.7% -5.9% -7.6% 5.4% 5.4% 5.9% 3.0% -3.4% 1.9% 8.4% 2.5% Weighted average rate of return on above assets plus currency Ex-post real -3.8% -1.3% -15.2% -9.2% -12.0% 0.4% 0.4% 0.87 -2.2% -8.5% -3.6% 2.7% -2.4% Lending, domestic denom. Weighted average of all advances from the Scheduled Banks Nominal 8.1% 8.3% 8.7% 9.4% 11.2% 11.1% 11.22 12.1% 11.7% 11.6% 11.9% 10.9% 11.0% Ex-post real 1.9% 4.7% -10.1% -3.4% -5.0% 7.6% 7.4% 8.3% 4.5% -2.1% 3.5% 9.0% 3.5% Short term credits from the Ag. Development Bank Nominal 7.0% 7.0% 7.0% 9.0% 10.0% 10.0% 11.0% 12.0% 11.0% 11.0% 11.0% 11.0% 11.0% ex-post real 0.9% 3.5% -11.5% -3.8% -6.0% 6.5% 7.3% 8.3% 3.9% -2.6% 2.7% 9.2% 3.6% Inflation (CPI) 6 months Forward from December 6.0% 3.4% 20.9% 13.3% 17.1% 3.2% 3.5% 3.4% 6.8% 13.9% 8.1% 1.7% 7.2% Devaluation 6 months Forward from December -2.2% 429.7% -19.5% 0.0% O.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 51.9% 5.2% Inflation (CPI) over Prior December 5.2% 5.8% 7.8% 37.8% 20.6% 12.7% 10.3% 7.3% 5.5% 9.0% 15.1% 10.4% 3.8% Sources: Interest rates are from The State Bank of Pakistan, Bulletin. CPI and exchange rate data from the IMF, IFS, data tape. Weights for the weighted average of returns are from Pakistan Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation rate six months forward from December. Deposit rates are weighted averages of interest actually paid of all deposits. -78- ANNEX 1 PAKISrAN: Table 2 Levels of Selected Financial Assets Erhd of Year (in billiors of Rupees) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, domestic Nominal 8.1 7.3 6.5 8.6 10.6 11.7 13.8 17.3 21.0 26.4 32.5 34.5 41.1 In 1980 prices 27.0 23.3 19.0 18.4 18.7 18.4 19.6 22.9 26.3 30.4 32.5 31.2 35.9 % of GNP 16.4% 14.1% 10.7% 11.2% 10.6% 9.57 9.5% 10.0% 10.4% 11.3% 11.6% 10.6% 11.0% % of total assets 39.8% 34.8% 28.5% 30.9% 35.1% 32.4% 29.8% 31.4% 30.8% 32.8% 34.3% 32.3% 31.9% Deposits, domestic currency Daemnd NomLnal 3.6 4.0 5.2 6.0 6.4 7.0 9.1 9.5 11.7 14.1 16.4 17.1 18.8 In 1980 prices 12.0 12.8 15.2 12.7 11.3 11.0 12.9 12.5 14.7 16.2 16.4 15.5 16.4 % of Q1P 7.3% 7.7% 8.6% 7.8% 6.4% 5.7% 6.2Z 5.5% 5.8Z 6.1% 5.9% 5.2% 5.0% % of total assets 17.6% 19.1% 22.9% 21.4% 21.3% 19.4% 19.6% 17.2% 17.2% 17.5% 17.3X 16.0% 14.6% Savings Nomnnal 4.3 5.5 6.5 7.9 8.3 10.5 14.0 17.2 22.0 25.3 28.6 34.2 41.8 In 1980 prices 14.4 17.4 19.0 16.9 14.6 16.5 19.9 22.7 27.6 29.1 28.6 31.0 36.4 % of CmP 8.7% 10.5% 10.7% 10.3% 8.3% 8.5% 9.6% 9.9% 11.0% 10.9% 10.2Z% 10.5% 11.2Z % of total assets 21.1% 26.1% 28.5% 28.4% 27.5% 29.0% 30.2% 31.3 32.3% 31.5% 30.2% 32.1% 32.4% Tenm Nkminal 4.4 4.2 4.6 5.4 4.8 6.9 9.4 11.0 13.4 14.6 17.3 20.9 27.1 In 1980 prices 14.6 13.3 13.4 11.5 8.5 10.9 13.4 14.6 16.8 16.9 17.3 19.0 23.6 % of GNP 8.9% 8.1% 7.6% 7.0% 4.8% 5.6% 6.5% 6.4% 6.7% 6.3% 6.2% 6.4% 7.2% % of total assets 21.5% 19.9% 20.2% 19.3% 16.1% 19.2Z% 20.4% 20.0% 19.7% 18.2% 18.2% 19.6% 21.0% Total Noiral 20.3 21.1 22.7 27.9 30.1 36.2 46.3 54.9 68.1 80.4 94.8 106.7 128.8 In 1980 prices 68.0 66.8 66.7 59.5 53.2 56.7 65.8 72.7 85.5 92.6 94.8 96.6 112.4 % of GNP 41.3% 40.4% 37.6% 36.4% 30.2 29.2Z% 31.8% 31.8% 33.9% 34.6% 33.9% 32.7% 34.4% CPI, December (Dec.80=100) 29.8 31.6 34.0 46.9 56.6 63.8 70.3 75.5 79.7 86.9 100.0 110.4 114.6 GNP, Dec. adjusted, ninal 49.1 52.2 60.4 76.7 99.6 123.8 145.6 172.9 200.7 232.6 279.6 326.1 374.4 Sources: Asset data are from The State Bark of Pakistan, Balletin. GNP and CPI data are fram the IMF, IFS, data tape. Notes: The GNP data have been logrithmically interpolated between the current year and one year forwad so as to be expressed in December prices. - 79 - ANNEX 1 PERU: Table I Selected Effective and Ex-Post Real Interest Rates a/ End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, domestic denom. Demand Nominal 0.0% 0.0X 0.0% 0.0% 0.0% 0.02 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 10.0% Ex-post real -5.4% -6.5 -15.02 -20.8% -22.5% -21.6% -28.0S -48.22 -39.7% -33.0% -47.5% -39.6X -59.2% Savings Nominal 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 9.0% 11.5% 29.0X 30.5% 30.5% 50.5% 55.0% Ex-post real -0.7% -1.9% -10.7% -16.92 -18.7% -17.7% -23.12 -43.4% -23.7% -14.3% -32.8% -10.9X -42.6X Term, 6 month Nominal 7.0% 7.0% 7.0% 7.0% 7.0% 7.02 11.0% 14.0% 31.5% 31.5% 31.5% 63.0X 71.22 Ex-poat real 1.22 0.0% -9.0% -15.3% -17.1% -16.1% -21.7% -42.1% -22.3% -13.7% -32.3% -3.4% -36.6% Norgage bank certificates Nominal 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 11.0% 14.0% 31.5% 33.0% 33.0% 61.6% 71.2X Ex-post real 3.1% 1.9% -7.3% -13.7% -15.6% -14.6% -21.7% -42.1X -22.3% -12.7X -31.5% -4.3% -36.6% Deposits, foreign denom. Nominal (in U.S.$) 5.0% 5.0% 5.0% 5.02 5.0% 5.0% 5.0% 4.6% 9.1% 11.4% 14.9% 11.0% 6.7% Ex-poet real (in Soles) -0.7% *1.9% -10.7% -16.92 -18.7% 71.7% -1.8% -25.4% -15.02 -5.1% -10.8% 17.22 1.62 Weighted average rate of return on above assets plua currency Ex-post real -3.1% -4.0% -12.7% -18.7% -20.6X -19.1% -26.4% -45.8% -31.4% -21.7% -32.6% -12.0% -30.0% Lending, domestic denom. General Nominal 16.3% 16.3% 16.3% 16.3% 16.3% 16.3% 21.22 24.22 50.4% 52.7% 52.7% 98.0% 98.0% Ex-post real 10.0% 8.7% -1.1% -7.9% -9.9% -8.92 -14.5% -36.9% -11.1% 0.2X -21.4% 17.32 -26.6X Rediscount rates to the Banco Agrario Nominal 4.02 4.0% 4.0% 4.0% 4.0% 4.0% 7.0% 9.0% 20.0% 21.0% 21.0% 29.0% 29.0% Ex-post real -1.6% -2.8% -11.6% -17.7% -19.4% -18.5% -24.5% -44.7% -29.1% -20.6% -37.7% -23.6% -52.22 Inflation (CPI) 6 months Forward from December 5.7% 7.0% 17.6% 26.3% 29.1% 27.6% 41.8X 97.0% 69.1% 52.3% 94.31 68.8% 169.9% Devaluation 6 months Forward from December 0.0% 0.0% 0.0% 0.0% 0.0% 108.6% 32.6% 40.6X 31.7% 29.8% 50.8% 78.3% 156.8% Inflation (CPI) over Prior December 5.8% 7.6% 4.4% 13.8% 19.1% 23.9% 44.7% 32.5% 73.7% 65.8% 60.8% 72.7% 65.6% Sources: 1970-77 interest rates are from La Superintendencia de Banca y Seguros, Boletin Eatadistico. 1978-82 interest rates are from El Banco Central de Reserva del Peru, Boletin, CPI, exchange rate and LIBOR rate data are from the IMF, IFS. data tape. Weights for the weighted average are from Peru Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation rate six months forward from December. a/ The 1982 ceiling rate on demand deposits was 55%, actual rates paid were typically 10%, with 20% paid on large deposits. For 1981, term deposits and morgage bank certificates were compounded quarterly. For 1982. compounding was monthly. For 1970-76, dollar deposits were assumed to yield 5%. For 1977-82, the yield was assie- to be LIBOR minus three percentage points. The effective, general lending rates were the ceiling rates plus 2 percentage points commission adjusted for 100% prepayment of interest and comissions. - 80 - ANNEX 1 PEW: Table 2 Levels of Selected Financial Assets in the Banking System Ehd of Year (in billisns of Soles) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, damestic NIm.nal 16.3 18.9 21.9 27.2 33.5 42.6 49.6 60.8 91.0 162.0 273.4 436.2 627.9 In 1980 prices 272.7 294.0 326.2 356.1 368.2 377.9 304.0 281.4 242.5 260.4 273.4 252.6 219.6 Z of GNP 6.5% 6.8% 6.8% 6.8% 6.87. 6.6% 5.6% 4.7% 4.2% 4.3% 4.3% 4.17. 3.3% % of total assets 31.2% 31.6% 30.7% 31.8% 32.0% 34.5% 34.1% 32.0% 29.1% 25.8% 22.3% 20.0% 16.6% Deposits, damestic currency Demard Nominal 16.7 17.4 22.0 25.9 33.9 37.2 47.5 60.3 86.0 154.3 268.5 367.8 461.0 In 1980 prices 279.4 270.6 327.7 339.1 372.6 330.0 291.1 279.0 229.2 248.1 268.5 213.0 161.2 X Of Gd 6.7% 6.3% 6.8% 6.5% 6.9% 5.8% 5.4% 4.7% 3.9% 4.1% 4.3Z 3.5% 2.5% % of total assets 31.9% 29.1% 30.9% 30.3% 32.4% 30.1% 32.7% 31.7% 27.5% 24.6% 21.9% 16.9% 12.2% S-ings Nobinal 8.0 8.9 10.0 11.3 12.8 15.0 17.1 21.6 30.2 67.0 137.8 355.7 680.2 In 1980 prices 133.8 138.4 149.0 148.0 140.7 133.1 104.8 100.0 80.5 107.7 137.8 206.0 237.9 Z of GNP 3.2% 3.2% 3.1% 2.8% 2.6% 2.3M 1.9% 1.7% 1.4% 1.8% 2.2% 3.3% 3.6% 2 of total assets 15.3% 14.9% 14.0% 13.2% 12.2% 12.2% 11.8% 11.4% 9.6% 10.7% 11.2% 16.3% 18.0% Term Noinal 5.8 7.3 7.6 8.6 9.1 9.7 9.9 16.4 24.4 39.5 60.8 114.5 222.1 In 1980 prices 97.0 113.5 113.2 112.6 100.0 86.1 60.7 75.9 65.0 63.5 60.8 66.3 77.7 % of GE 2.3% 2.6% 2.4X 2.2% 1.8% 1.5% 1.1% 1.3% 1.1% 1.0% 1.0% 1.1% 1.2% % of total assets 11.1% 12.2% 10.7% 10.1% 8.7% 7.9% 6.8% 8.6% 7.8% 6.3% 5.0% 5.3% 5.9% Morgage bark certificates Ntoinal 5.1 7.1 9.5 12.1 14.6 18.2 19.8 23.8 30.8 59.1 107.1 242.4 322.3 In 1980 prices 85.3 110.4 141.5 158.4 160.5 161.5 121.4 110.1 82.1 95.0 107.1 140.4 112.7 % of GNP 2.0% 2.6% 2.9% 3.0% 3.0% 2.8% 2.2% 1.8% 1.4% 1.6% 1.7% 2.3% 1.7% % of total assts 9.8% 11.9% 13.3% 14.2% 13.9% 14.7% 13.6% 12.5% 9.8% 9.4% 8.7Z 11.1% 8.5% Deposits, foreign acrrency Noniral in dollars 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.4 0.7 1.5 1.9 2.9 nomrnal in soles 0.4 0.2 0.3 0.4 0.8 0.7 1.5 7.2 50.6 146.6 378.2 662.1 1470.4 in 1980 prices 6.7 3.1 4.5 5.2 8.8 6.2 9.2 33.3 134.8 235.7 378.2 383.4 514.2 % of total assets 0.8% 0.3X 0.4% 0.5% 0.8% 0.6% 1.OX 3.8% 16.2% 23.3% 30.9% 30.4% 38.9% TDtal Niminal 52.3 59.8 71.3 85.5 104.7 123.4 145.4 190.1 313.0 628.5 1225.8 2178.7 3783.9 In 1980 prices 874.9 930.1 1062.1 1119.5 1150.8 1094.7 891.2 879.7 834.1 1010.4 1225.8 1261.6 1323.3 % of GNP 21.0% 21.6% 22.1% 21.5% 21.3% 19.3% 16.5% 14.7% 14.3% 16.6% 19.4% 20.5% 20.2% CPI, nber (Dec.80-100) 6.0 6.4 6.7 7.6 9.1 11.3 16.3 21.6 37.5 62.2 100.0 172.7 285.9 lxcth re rate, I r 38.7 38.7 38.7 38.7 38.7 38.7 45.0 69.4 130.4 196.2 250.1 341.2 506.2 GNP, Dec. adjusted, rninal 249.6 277.0 322.2 397.2 492.1 640.6 882.7 1290.4 2188.6 3790.7 6308.5 10639.2 18760.0 Sources: Asset data are from the Banco Central de Reserva del Peru, Manoria. GNP and CPI data are fram the DMF, IFS, data tape. Notes: Tne GE data hav been logrithmically interpolated between the oirrent year ard cne year forward so as to be expressed in December prices. The figures exclude the nrn-bark financial sector, except for deposits in the banking systen. - 81 - ANNEXi THAILAND: Table I Selected Ncinal and Ha-Post Real Interest Rate Oeilinga End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, demestic denoa. Demand Nominal 0.02 0.0 0.0 0.02 0.02 0.0% 0.0% 0.0% 0.02 O.O O.O 0.02 0.0% Ha-post real -0.6% -7.12 -17.6% -26.0% -3.61 -2.6% -12.2% -11.0% -9.5S -22.12 -15.3% -3.3% -5.52 Savings Nominal 3.51 3.52 3.52 3.5% 4.52 4.52 4.52 4.52 4.52 5.52 8.0% 9.0% 9.0% Ex-post real 2.8S -3.9% -14.7% -23.52 0.82 1.8% -8.3% -7.02 -5.42 -17.9% -8.52 5.42 3.1% Term, 6 months Nominal 6.02 6.02 6.0% 6.0% 7.0% 7.02 7.02 7.02 7.0% 7.02 10.02 11.0% 11.0% Ha-poet real 5.3% -1.6% -12.6% -21.6% 3.22 4.22 -6.1% -4.7% -3.22 -16.7Z -6.8Z 7.4% 4.92 return on a5ove assets plus currency Ex-post real 2.4% -4.1% -14.8% -23.5% 0.52 1.8% -8.22 -6.8S -5.3S -18.5S -9.4% 4.52 2.42 Lending. domestic denom., General loam & overdrafts Nominal 14.02 14.02 14.02 14.0% 15.0% 15.02 15.02 15.0% 15.02 15.02 18.0% 18.0% 18.0% Ex-post real 13.2% 5.9% -6.12 -15.7% 10.9% 12.0% 1.0% 2.4% 4.12 -10.5% 0.02 14.12 11.62 Export (discount rate) Nominal 7.02 7.02 7.02 7.02 7.02 7.02 7.02 7.02 7.02 7.0% 7.02 7.02 7.0% Ex-poet reel 6.32 -0.6% -11.8% -20.9% 3.22 4.2% -6.12 -4.7% -3.2% -16.7% -9.3% 3.52 1.2% Inflation (CPI) 6 months Forward from December 0.72 7.72 21.32 35.22 3.7% 2.6% 13.92 12.3% 10.5% 28.4% 18.02 3.42 5.82 Devaluation 6 months Forward from Decemier 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.42 -0.2S 3.61 0.02 0.02 Inflation (CPI) over Prior December -1.32 1.32 8.82 20.22 17.92 4.42 3.42 8.92 7.82 15.02 16.42 12.32 2.62 Sources: Interest rates are from the Bank of Thailand, Monthly (Quarterly) Bulletin. CPI data are from the DIP, TFS, data tape. Weights for weighted average are from Thailand Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation rate six months forward from December. - 82- ANNEX 1 THAILAND: Table 2 levels of Selected Financial Assets Erd of Year (in billios of Baht) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 eurrancy, daiestic lNoinal 11.9 13.1 15.3 18.6 20.4 22.3 25.7 28.5 33.0 40.6 45.7 47.5 53.7 In 1980 prices 31.4 34.2 36.7 37.3 34.7 36.2 40.3 41.2 44.2 47.3 45.7 42.3 46.6 % of (GP 8.4% 8.5% 8.1% 7.7% 7.2% 7.0% 7.1% 6.7% 6.5% 6.7% 6.4% 6.0% 6.2% % of total assets 28.7% 27.1% 25.5% 25.5% 22.9% 21.3% 20.6% 19.1% 18.4% 19.9% 18.3X 16.4% 14.9% Deposits, damstic currency Damnad Nainal 6.9 7.7 8.8 10.6 12.5 13.0 15.1 16.4 21.1 22.2 25.1 25.0 23.5 In 1980 prices 18.4 20.2 21.2 21.1 21.1 21.2 23.8 23.7 28.2 25.8 25.1 22.3 20.4 % of GNP 4.9% 5.0% 4.7% 4.4% 4.4% 4.1% 4.2X 3.8% 4.2% 3.7% 3.5% 3.2% .2.7% % of total assets 16.8% 16.0% 14.8% 14.4% 13.9% 12.5% 12.1% 11.0% 11.8% 10.9% 10.0% 8.6% 6.5% Savinp Nominal 2.7 3.0 3.9 4.9 6.3 7.2 8.9 10.7 14.2 17.2 27.1 36.8 60.0 In 1980 prices 7.2 7.7 9.3 9.8 10.7 11.8 14.0 15.4 19.1 20.0 27.1 32.7 52.1 % of GNP 1.9% 1.9% 2.0% 2.0% 2.2% 2.3X 2.4% 2.5% 2.8% 2.8% 3.8% 4.6% 7.0% % of total assets 6.6% 6.1% 6.4% 6.7% 7.1% 6.9% 7.1% 7.1% 8.0% 8.4% 10.8% 12.7% 16.6% Term Nominal 19.8 24.5 31.9 39.1 50.1 62.1 74.9 94.1 110.7 124.0 152.3 181.1 223.3 In 1980 prices 52.4 64.2 76.6 78.2 85.1 100.9 117.7 135.8 148.3 144.4 152.3 161.3 193.9 % of total assets 47.9% 50.9% 53.3X 53.4% 56.1% 59.3X 60.1% 62.9% 61.9% 60.8% 60.9% 62.4% 61.9% Total Inal 41.3 48.3 59.8 73.2 89.3 104.6 124.6 149.7 179.1 204.0 250.3 290.4 360.5 In 1980 prices 109.5 126.3 143.8 146.4 151.7 170.1 195.8 216.0 239.7 237.5 250.3 258.6 313.0 % of (IP 29.4% 31.3Z 31.7% 30.2% 31.3% 33.0% 34.3 35.1% 35.5% 33.7% 34.9% 36.7% 41.9% CPI, Decester (Dec.80-100) 37.7 38.2 41.6 50.0 58.9 61.5 63.6 69.3 74.7 85.9 100.0 112.3 115.2 (CP, Dec. adjusted, rzninal 140.5 154.2 188.4 242.5 285.1 316.9 362.7 426.2 503.8 606.2 716.9 791.6 860.1 Sorces: Asset data are fran the Bark of Thailand, Quarterly (fnthly) Bulletin. QIP and CPI data are fram the lDF, IFS, data tape. Notes: The GNP data have been logrithmically interpolated between the airrent year and oae year forward so as to be expressed in Deoenber prices. Deposits are nonr-gvertmnt deposits in the cmamercial banks, whidc are 80-90% of all private deposits. - 83 - ANNEX 1 TURKEY: Table I Selected Nominal and Ec-post Real Interest Rates erd of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, domestic denam. Demand Nominal tN/A IN/A tN/A 0.0% 2.0X 2.0% 2.0% 2.0% 0.0% 0.0 0.0% 0.0% 0.0% Ex-post real DN/A *N/A tN/A -12.8% -17.5% -10.0% -16.7% -24.2% -43.3% -63.9% -24.6Z -24.21 -18.6X Savings Nominal DN/A M/A tN/A 2.5% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 5.0% 5.0% 5.0X E-epost real tN/A DN/A DN/A -10.7% -16.7% -9.1% -15.8% -23.4% -41.6% -62.8% -20.8% -20.4% -14.5% Term, 6 month Nominal tN/A DN/A DN/A 4.0% 6.0% 6.0% 6.0% 6.0% 9.0X 12.0% 92.0% 50.0% 50.0% Ex-post real DN/A *N/A DN/A -9.3% -14.3% -6.5% -13.4X -21.2% -38.2% -59.5% -0.4% 13.8% 22.1% Weighted average rate of return on above assets plus currencf Ex-post real DN/A DN/A DN/A -11.2% -16.9% -9.4% -16.2% -23.9% -42.1% -62.9% -18.8% -8.2% 1.2% Landing*, domestic dona. General, short term Nominal DN/A DN/A DN/A 8.8% 9.0% 9.0% 9.0% 9.0% 10.0% 10.8% 26.0% 65.0%a/ 65.0%a/ Ex-post real DN/A RN/A DN/A -5.2% -11.9% -3.8% -10.9% -19.0% -37.7% -60.0% -5.0% 25.1% 34.3% Ag. credits, short term Nominal DN/A DN/A DN/A 7.0% 8.0% 8.0% 8.0% 8.0% 8.0% 11.5% 13.5% 20.0% 18.0% ex-post real DN/A DN/A DN/A -6.7% -12.7% -4.7% -11.82 -19.7% -38.8% -59.7% -14.4% -9.0% -4.0% Inflation (CPI) 6 months Forward from December 20.3% 6.4% 22.6% 14.7% 23.7% 13.3% - 22.4% 34.5% 76.5% 176.8% 32.6% 31.9% 22.9% Devaluation 6 months Forward from December 172.6% -10.1% 0.0% -7.1% 2.2% 13.8% 12.5% 68.7% 96.0% 396.7% 50.8% 53.7% 40.7% Inflation (CPI) over Prior December 12.3% 17.6% 9.2% 16.8% 16.7% 19.6% 17.0% 44.6% 36.6% 81.1% 86.2% 30.3% 32.8% Sources: Interest rates are from the Central Bank V erly Buletin, and the World Bank, Turkey, Special Economic Report: Policies for the Financial Sector, Report 59_lU. I data are from the IMF, IFS, data tape. Weights for weighted average are from Turkey Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation rate six months forward from December. a/ World Bank staff estimate, see page 16 of Report /4459-IU. - 84 - ANNEX 1 TURIY: Table 2 Levels of Selected Financial Assets End of Year (In billions of Turkish Lira, TL) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, domestic Nominal 11.9 13.9 16.0 20.7 26.2 32.9 42.5 63.0 93.8 143.7 217.5 280.6 411.9 In 1980 prices 194.1 192.7 203.2 225.0 244.1 256.3 283.0 290.1 316.3 267.5 217.5 215.4 238.1 % of QIP 7.1% 6.5% 5.92 5.7Z 5.52 5.52 5.52 5.92 5.62 4.62 4.02 3.72 4.12 2 of total assets 27.02 24.62 22.62 23.02 23.2X 22.52 23.52 25.9% 28.62 27.42 24.7X 17.2X 16.1% Deposits, domestic currency Demand Nanal 6.6 8.7 11.8 16.0 22.6 32.1 44.9 63.0 86.0 154.5 286.0 458.5 651.3 In 1980 prices 107.7 120.6 149.8 173.9 210.5 250.1 299.0 290.1 290.0 287.7 286.0 352.0 376.5 2 of GNP 3.92 4.02 4.32 4.4% 4.72 5.32 5.82 5.92 5.12 4.9% 5.32 6.12 6.52 2 of total assets 15.02 15.42 16.72 17.8% 20.02 22.02 24.8% 25.92 26.32 29.42 32.52 28.12 25.52 Savings Noidnal 16.8 20.9 24.9 32.9 39.7 52.2 62.7 82.4 103.3 143.7 197.4 228.5 275.5 In 1980 prices 274.0 289.8 316.2 357.6 369.8 406.6 417.5 379.5 348.3 267.5 197.4 175.4 159.3 X of GNP 10.02 9.72 9.12 9.02 8.32 8.72 8.22 7.82 6.12 4.6% 3.72 3.02 2.82 2 of total assets 38.12 37.02 35.22 36.52 35.12 35.72 34.72 33.92 31.52 27.42 22.52 14.02 10.82 Term Nominal 8.8 13.0 18.0 20.5 24.6 29.0 30.8 34.4 44.4 83.3 177.9 665.1 1212.2 2 of GNP 5.22 6.02 6.62 5.62 5.12 4.8% 4.02 3.22 2.62 2.72 3.3% 8.8% 12.12 2 of total assets 20.02 23.02 25.52 22.82 21.82 19.82 17.02 14.22 13.62 15.92 20.22 40.72 47.52 Total Nominal 44.1 56.5 70.7 90.1 113.1 146.2 180.9 242.8 327.5 525.2 878.8 1632.7 2550.9 In 1980 prices 719.3 783.4 897.8 979.3 1053.5 1138.9 1204.6 1118.1 1104.2 977.8 878.8 1253.3 1474.7 2 of GNP 26.12 26.22 25.92 24.82 23.62 24.32 23.62 22.92 19.42 16.82 16.3% 21.62 25.52 CPI, December (Dec.80-100) 6.1 7.2 7.9 9.2 10.7 12.8 15.0 21.7 29.7 53.7 100.0 130.3 173.0 CNP, Dec. adjusted, nominal 168.7 215.4 273.1 363.8 478.3 601.3 767.6 1061.4 1684.9 3123.3 5391.5 7560.5 10017.9 Sources: Asset data are from the Central Bank of the Republic of Turkey, Q.uarterly Bulletin. CPI and GNP data are from the 1MF, IFS, data tape. Notes: The GNP data have been logrithmically interpolated between the current year and one year forward so as to be expressed in December prices. - 85 - URUWGUAY: Table I ANNEX 1 Selected Ntinal and tx-post Real Interest Rates End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 a/ 1982 Deposits, doestic denom. Demand Nominal 0.0% 0.0% 0.0% 0.0% 10.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Ex-post real -16.9% -49.2% -46.2% -44.8% -30.5% -15.5% -40.2% -28.9% -43.1% -32.1% -23.8% -9.8% -39.5% SaviWSs Nominal 6.0% 6.0% 6.0% 8.0% 18.0% 18.0% 21.6% 25.5% 22.8% 24.0% 25.2% 24.0% 24.2% Yx-oost real -12.0% -46.2% -43.0% -40.4% -25.4% -0.2% -27.3% -10.R% -30.1% -15.9% -4.6% 11.8% -24.9% Term, 6 nth Nominal 15.0% 15.0% 15.0% 18.0% 30.0% 30.0% 30.2% 51.4% 42.6% 50.6X 50.3% 47.4% 66.2% Ex-poet real -4.5% -41.6% -38.1% -34.9% -17.8% 9.9% -22.1% 7.6% -18.9% 2.2% 14.6% 32.9% 0.5% Deposits, foreign denam. Demnd Nominal (in U.S.$) 4N/A 4N/A 5.5% 5.5% 5.5% 5.5% 5.6% 5.4% 5.5% 5.5% 5.7% 5.5% 5.8% Ex-post real (in NS) fN/A 5N/A -18.5% -15.3% 32.0% 30.3% -14.7% -10.0% -24.4% -19.0% -7.7% 10.5% -41.4% Tenm, 6 month Nominal (in U.S.S) #N/A 4N/A 8.0% 8.0% 8.0% 8.0% 7.4% 7.5% 8.0% 11.9% 14.6% 13.1% 10.2% Ex-post real (in NS) IN/A #N/A -16.6% -13.3% 35.2% 33.4% -13.2% -8.2% -22.6% -14.1% 0.1% 18.5% -39.0% Weighted average rate of return on above assets plus currency Ex-post real (1) *N/A 5N/A -43.7% -40.5% -21.2% 0.5% -27.4% -13.6% -28.9% -17.0% -4.2% 13.3% -33.4% Ex-post real (2) #N/A #N/A -43.7% -40.4% -20.8% 1.1% -26.9% -12.8% -28.2% -15.1% -1.5% 16.9% -31.7% Lening domestic denom. d term up to 6 mo.) Average Nominal 5N/A 4N/A #N/A 4N/A 4N/A 4N/A 62.0% 76.6% 71.2% 68.1% 65.1% 59.8% 76.3% tx-post real ON/A 4N/A 4N/A 4N/A 4N/A ON/A -3.1% 25.5% -2.6% 14.1% 25.9% 44.1% 6.6% Prim Nominal 4N/A 4N/A 4N/A 4N/A 4N/A 5N/A 47.6% 65.8% 59.7% 49.9% 49.8% 46.5% 56.7% Ex-post real ON/A 4N/A 4N/A tN/A 4N/A ON/A -11.7% 17.9% -9.1% 1.7% 14.2% 32.1% -5.2% Preferential Nominal 4N/A 5N/A 4N/A 4N/A 4N/A 4N/A 4N/A 4N/A 5N/A 4N/A 4N/A 5N/A 4N/A tx-post real 5N/A 4N/A 4N/A 4N/A 5N/A 4N/A 5N/A ON/A 5N/A ON/A 4N/A 4N/A 5N/A Lendi forel denom. (comcial) Average Nonal (in U.S.-) 49N/A 5N/A 5N/A 5N/A ON/A 5N/A 12.0% 13.8% 14.2% 16.3% 18.5% 18.4% 18.2% tx-post real (in NS) ON/A 4N/A 4N/A 4N/A 4N/A 4N/A -9.5% -2.8% -18.1% -10.3% 3.5% 24.1% -34.57 Primp Ntaminal (in U.S.S) ON/A ON/A 4N/A ON/A *N/A 4N/A 5N/A 5N/A #N/A 15.8% 17.4% 16.8% 17.2% tx-post real (in N$) 4N/A 5N/A 5N/A 4N/A 4N/A 5N/A 4N/A 4N/A iN/A -11.1% 2.5% 22.4% -35.1% Tnflation (CPI) 6 months Forward from December 20.4% 97.0% 85.8% 81.2% 58.2% 18.3% 67.2% 40.7% 75.8% 47.4% 31.2% 10.9% 65.3% Devaluation 6 months Forvard from December 0.0% 139.0% 43.5% 45.4% 98.0% 46.1% 35.1% 20.1% 26.0% 13.1% 14.6% 16.2% -8.4% Inflation (CPI) over Prior December 20.1% 35.2% 95.6% 77.6% 106.8% 67.3% 39.4% 57.6% 45.8% 83.1% 42.9% 29.3% 20.5% Sources: Interest rate data are from Banco- Central del Uruguay, Boletin Estadistico. CPI and excharge rate data are from the IHF, IFS, data tape. Weights for the weighted average are from Uruguay Table 2. Notes: Real rates were calculated ex-poet, i.e., they reflect the inflation (and devaluation) rate six months forward from December. Weighted average (1) assumes that all foreign assets are savings deposits; (2) assume all time deposits. a/ Since the real rates look forward six months from December, the 1981 figures do not reflect the November 1982 devaluation. - 86 - ANNEX 1 URtIY: Table 2 levels of Selected Financial Assets End of Year (levels in billicns of Ne Pesos or U.S.$) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 a/ Currency, domestic Nominal 0.1 0.1 0.2 0.2 0.3 0.5 0.8 1.1 1.8 3.2 5.1 6.1 7.8 In 1980 prices 7.8 8.5 10.4 5.8 4.4 3.9 4.7 4.2 4.7 4.5 5.1 4.7 5.0 % of GDP #N/A WN/A 11.3 5.9% 5.2% 4.6% 4.9% 4.5% 4.3 4.3 4.6% 4.8% 5.1% % of total assets ON/A #N/A 54.8% 39.6% 34.2% 28.8% 23.8% 19.6% 16.8% 15.6% 14.7% 11.7% 8.5% Deposits, danestic currency Noinal 1/N/A ON/A 0.1 0.1 0.2 0.4 0.5 0.8 1.3 2.6 3.6 3.6 3.6 In 1980 prices #N/A ON/A 3.6 3.8 3.2 3.0 3.3 2.9 3.3 3.7 3.6 2.8 2.3 % of GP #N/A tN/A 3.9% 3.8% 3.7% 3.5% 3.4% 3.0% 3.0% .3.6% 3.3Z 2.8% 2.4% % of total assets OtN/A O/N/A 18.8% 25.6% 24.6% 21.7% 16.6% 13.32 11.8% 12.9% 10.5% 6.8% 3.9% Savinges Nkadnal #N/A #N/A 0.0 0.0 0.1 0.1 0.3 0.4 0.8 1.5 *2.7 3.9 4.3 In 1980 prices ON/A #N/A 1.6 1.4 1.0 1.2 1.7 1.5 2.0 2.2 2.7 3.0 2.8 % of GP #N/A /tN/A 1.8% 1.4% 1.2% 1.4% 1.8% 1.6% 1.8% 2.1% 2.5% 3.0% 2.8% % of total assets OtN/A #N/A 8.7% 9.6% 8.0% 8.7% 8.7% 7.2Z% 7.1% 7.6% 7.9% 7.4% 4.7% Term Nominal WN/A tN/A 0.1 0.1 0.2 0.3 0.6 0.8 2.4 5.3 11.4 15.1 15.5 In 1980 prioes ON/A ltN/A 2.6 2.7 2.5 2.8 3.4 3.2 6.2 7.6 11.4 11.7 9.9 % of GDP #N/A ON/A 2.9% 2.7% 2.9% 3.2Z 3.6% 3.4% 5.6% 7.2% 10.4% 11.8% 10.0% % of total assets lN/A OtN/A 13.9% 18.3Z 19.5% 20.1% 17.1% 15.0% 22.2% 26.1% 32.9% 28.9% 16.8% Subtotal, dasestic assets No~miinal ON/A tN/A 0.4 0.5 0.8 1.3 2.2 3.1 6.2 12.6 22.8 28.7 .31.3 In 1980 prices OtN/A ON/A 18.2 13.7 11.1 10.8 13.1 11.9 16.2 18.1 22.8 22.2 20.1 % of GP #N/A #N/A 19.8% 13.9% 13.0% 12.7% 13.7% 12.5% 14.7% 17.2% 20.9% 22.3% 20.3Z % of total assets #N/A ON/A 96.2% 93.1% 86.3Z 79.2Z% 66.2% 55.1% 57.9% 62.2% 65.9% 54.8% 33.9% Deposits, foreign currency Dmard ard term WEmTiial U.S.$ XtN/A #N/A 0.0 0.0 0.1 0.1 0.3 0.5 0.6 0.9 1.2 2.0 1.8 Ncinal, dcestic OtN/A ON/A 0.0 0.0 0.1 0.3 1.1 2.5 4.5 7.7 11.8 23.7 61.1 In 1980 prices ON/A N/.A 0.7 1.0 1.8 2.8 6.7 9.7 11.8 11.0 11.8 18.3 39.2 % of GP ON/A OtN/A 0.8% 1.0% 2.1% 3.3% 7.0% 10.2% 10.7% 10.4% 10.8% 18.4% 39.5% #N/A tNi/A 0.4 0.5 0.9 1.6 3.3 5.6 10.7 20.3 34.6 52.4 92.4 In 1980 prioes N/A OtN/A 18.9 14.7 12.9 13.7 19.8 21.5 28.1 29.0 34.6 40.5 59.3 % of GrP tWA #N/A 20.6% 14.9% 15.1% 16.0% 20.8% 22.7% 25.4% 27.6% 31.7% 40.7% 59.8% CPI, Deeer (Dec.80-100) 0.7 1.0 1.9 3.4 7.1 11.9 16.6 26.2 38.2 70.0 100.0 129.3 155.9 ftdvnge rate, 0.3 0.4 0.7 0.9 1.7 2.7 4.0 5.4 7.1 8.5 10.0 11.6 33.8 GDP, Dec. adjusted, rmnal #N/A #N/A 1.8 3.4 6.1 10.2 15.9 24.8 42.2 73.6 109.1 128.7 154.5 Sources: Asset and GP data are fran the Banc Central del Uruguay, Boletin altadistico. EDcdal=e rate and (PI data are fran the IW, I, data tape. Notes: The QGP data hawe been logritnically interpolated between the current year and one year forward so as to be e pressed in nmcer prices. a/ The dramatic rise in assets for 1982 is a result of a nassive devaluation. This shculd not be interpreted as finecial deepenig, sin forei liabilities have also risen. ANNEX 2 BANGLADESH - 89 - ANNEX 2 II. BANGLADESH Government Intervention in Financial Markets 1. Since Independence, the authorities in Bangladesh have assumed a large and influential role in virtually every aspect of the country's financial system. Shortly after December 1971, when Bangladesh was formally severed from West Pakistan, many of the major enterprises were nationalized. Through the government's jurisdiction over the nationalized commercial banks and the central bank, the authorities controlled the creation and allocation of nearly all formal credit. The demand for credits was also largely under the control of the authorities, through the jurisdiction over the public enterprises. This situation has changed only slightly in recent years. Despite the growth in private demand for credit, claims on the public sector still represent 60-70% of domestic credit, down from 70-80% in the first half of the 1970's. 2. The monetary authorities at the central bank--The Bangladesh Bank--managed the quantity and allocation of credit with the standard policy instruments found in most developing countries. Among them were reserve requirements on the commercial banks' total deposits (5%) and liquidity requirements on demand and time deposits (25%), in the form of cash, deposits with the Bangladesh Bank, and "unencumbered approved securities," i.e., government securities and debentures of either the public enterprises or financial institutions. Other policy instruments included an administered regime of interest rates and a comprehensive set of credit expansion ceilings for each financial institution. These ceilings were issued on a quarterly basis for the commercial banks and annually for the Bangladesh Shilpa Bank, an industrial development finance institution, and for the Bangladesh Krishi Bank, an agricultural development bank. 3. In addition to the above instruments, the Bangladesh Bank was heavily involved in the allocation of credit by way of its directed credit programs. These programs designated priority sectors, imposed compulsory lending targets and established refinancing facilities. Among the sectors receiving preferential treatment in some form, were agriculture, small industry, exports, residential housing, transportation, public enterprises and the private jute trade. 4. Although the regime of interest rate and credit ceilings was by-and-large quite rigid, there was some limited moves toward financial sector liberalization recently. Since the institution-by-institution credit ceilings created rigidities which discouraged inter-bank transfers, the authorities recently introduced three categories of bank credits, making the credit ceilings more flexible and freeing-up this important channel for transferring resources among intermediaries. The three categories of bank credits were: (1) advances not subject to the ceilings--primarily government securities and public sector debentures; (2) advances that can be made in excess of the ceiling, if the bank can meet certain liquidity requirements; and (3) advances that are - 90 - ANNEX 2 strictly subject to the ceilings. The effect of establishing the second category was to allow banks with surplus funds to lend to banks with a surplus of investment options, even though the recipient bank had extended its maximum allowance of credit. In light of the economy's heavy reliance on bank intermediation for savings mobilization this was a constructive change. 5. A large upward shift in the level of the interest rate ceilings which occurred in October of 1980 can also be viewed as an important financial sector reform, one that was in response to market pressures and in the direction of market-determined interest rates. However, the fact that some lending rates were reestablished at levels below those paid on time deposits is an indication of how far the system remains from market determinated rates (see Table 1, also Tables 3 and 4). The Development of Interest Rates 6. Despite the upward ratcheting of the nominal levels in the interest rate regime, which is evident in Table 1, rates were fairly rigid over time. The nominally fixed rates, together with large changes in the rate of inflation, produced wide swings in the real rates ex-post. From 1971 up until the 1975 stabilization program, Bangladesh experienced high and rising inflation rates. The resultant highly negative real deposits and lending rates can be seen in Table 1, extending from the end of year rates for 1971 through 1973. The 1975 devaluation of the Taka and reduction of the government deficits produced a deflationary period from 1975 through 1976. As a result, the ex-post real rates swung highly positive in December 1974 and December 1975. From 1976 to 1980 the real rates remained a few points negative, as inflation fluctuated between 8% and 18%. A sharp drop in inflation during 1982, produced relatively high positive real rates at the end of 1981 (13.6% and 16.6%, for term deposits and normal credits, respectively), which declined as inflation accelerated during the first half of 1983. 7. Despite the predominance of negative real deposit rates, beginning in 1975 financial assets grew steadily, doubling in real terms from 1974 to 1982, and growing from 9.9% of GNP to 19.5% (see Table 2) There seems to be some evidence that remittances from Bangladesh nationals working in the oil producing regions and elsewhere played an important part to the growth in financial assets. Between 1974 and 1982 remittances totaled about 30 billion Taka, versus an increase in financial assets of about 40 billion. However, the yearly increments in financial assets do not correlate well with the yearly remittances, suggesting that the linkage is not strong. In particular, an examination of the growth in financial assets reveals a pattern of steady but moderately accelerating growth. Remittances, on the other hand, had a very steep growth path. Thus, in the early part of the period, annual remittances were much less than the increment to financial assets, while, in the latter part, remittances substantially exceeded asset growth. In sum, the causal link between remittances and growth of financial assets is unclear. - 91 - ANNEX 2 BMUANA: Table I Selected Ninal rd Er-post Real Interest Rates in Sde&,ed Barks End of Year (amialized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 198D 1981 1982 Dposits, domestic deaxn. Nomlnal ON/A O.% O.C .0% .0% .0% .0% 0.0% 0.0% 0.0% O.% 0.0% 0.0% tx-oet real 1N/A -0.2 -0.2 -0.4 0.1 0.1 -0.1 -0.1 -0.1 -0.1 -0.1 0.0 -0.1 S-VirV (non-checirg) Nominal WN/A 4.5% 4.5% 4.5% 6.C% 6.0% 7.0% 7.0% 7.C% 7.C% 1O.C% 10.0% 10.0% Ex-post real #N/A -18.4% -20.1% -32.4% 16.9% 11.9% -6.9% -0.82 -6.9% -6.3% -5.3% 10.6% -2.3% Tenr, 6 month Nominal #N/A 4.E 4.A 4.8X 6.5X 6.5% 7.5% 7.5X 7.5% 7.5X 13.0% 13.0% 13.0% x-post real #WA -18.2% -20.0% -32.2% 17.5% 12.4% -6.5% -0.4% -6.5% -56. -2.7% 13.6% 0.3% Weighted average rate of return on above sets plus currency tx-poet real ONA -20.a -22.6% -34.4% 12.6% 7.9% -12.4% -4.4% -12.3% -9.5% -8.5% 7.2% -5.0% lanxlig, damstic dem. Nbnnal Nanal N/A 1O.C% 10.0% 10.0% 13.0% 13.0% 13.0% 12.0% 12.0% 12.0% 16.0% 16.0% 16.0% Dx-poet real #WA -14.1% -15.9% -28.82 24.7% 19.3% -3.8% 3.8% -4.7% -1.9% 4.2% 16.6% 3.0% Agairst jute, jute Hids aid tea Nxninal ONA 8.5% 8.5% 7.5% 10.5% 10.5% 10.5% 10.5% 10.5% 10.5% 12.0% 12.0% 12.0% Ex-post real ON/A -15.3% -17.1% -30.4% 21.9% 16.7% -6.0% 2.4% -5.9% -3.2% -3.6% 12.6% -0.6% Inflation (CPI) 6 mnths Forwrd fram Denember -4.UI 28.0% 30.9% 54.6% -9.42 -5.3% 17.5% 7.9% 17.5% 14.2% 16.2% -0.6% 12.6% Devaluation 6 months Forward fran Dloember #NA 9.1% -17.3% -5.6% 185.6% 1.7% 7.8% 9.5% 2.6% -11.4% 24.0% 24.1% 3.6% Inflation (CPI) over Prior December ON/A 15.3% 46.1% 34.2% 76.1% -12.62 -0.1% 17.1% 9.6% 14.0% 13.2% 14.3% 4.9% Soarces: Interest rates are fran the Bmgladesh Bak, Eeoc Trends. (PI data are fran the IMF, IFS, data tape. kI'ights for weihted average are fran Barglaesh Table 2. (See note reprditg dispositicn af savirgs.) Notes: Real rates were caluilated ex-pent, i.e., they reflect the inflation rate six nniths forward fran Decermbr. In 1977, 1978 ard 1979; prium were paid to rural depositors of .75 & 1.5 peroeetage points on savirga ard tenm depoeits, respectively. - 92 - ANNEX 2 BANIAEM: Table 2 Levels of S4ected Ftnancial Assets Ehd of Year (in bdll.ins of Taka) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 N sl domestic N14/A 2.1 2.9 3.2 4.0 3.7 3.9 5.0 6.6 7.2 8.7 9.7 9.9 In 1980 prices #1N/A 10.3 9.9 8.2 5.8 6.2 6.4 7.1 8.5 8.2 8.7 8.5 8.3 % of GNP #N/A #1/A 5.9% 4.2Z 2.9% 3.3 3.5% 3.7% 4.0% 3.9% 3.9% 3.8% 3.6% % of total assets #N/A 37.8% 31.0% 27.8% 29.4% 26.6% 22.0% 23.3 25.2 22.9% 23.1% 21.7% 18.7% Dposits, daoestic currency Noiinrl #N/A 1.8 3.9 4.9 5.4 5.5 6.8 7.5 8.8 10.2 10.6 12.3 14.8 In 1980 prices #N/A 9.0 13.3 12.4 7.7 9.2 11.3 10.6 11.3 11.6 10.6 10.8 12.4 % of GIP #1/A 1/N/A 7.9% 6.39 3.9% 4.9% 6.1% 5.4% 5.4% 5.4% 4.8% 4.9% 5.4% % of total assets #1N/A 33.1% 41.7% 42.3 39.1% 39.5% 38.8% 34.7% 33.5% 32.3 28.4% 27.5% 27.9% Term Nnal WN1A 1.6 2.5 3.4 4.3 4.8 6.9 9.1 10.8 14.2 18.2 22.8 28.5 In 1980 prices #4N/A 7.9 8.7 8.8 6.2 7.9 11.4 12.9 13.9 16.0 18.2 19.9 23.7 % of Q4P #1N/A #N/A 5.2Z 4.5% 3.1% 4.2% 6.2% 6.6% 6.6% 7.6% 8.2% 9.0% 10.4% % of total assets 1N/A 29.0% 27.3 29.9% 31.5% 33.9% 39.2% 42.1% 41.2% 44.8% 48.5% 50.8% 53.5% Total Noiinal #1/A 5.5 9.3 11.5 13.7 14.0 17.6 21.6 26.2 31.7 37.5 44.9 53.2 In 1980 prices 14N/A 27.3 31.9 29.3 19.8 23.2 29.1 3D.6 33.8 35.8 37.5 39.3 44.4 % of Q1P #14/A 17N/A 18.9% 15.0% 9.9% 12.4% 15.8% 15.7% 16.0% 16.9% 17.0% 17.7% 19.5% CPI, December (Dec.8O-100) 17.4 20.0 29.3 39.3 69.2 60.5 60.4 70.8 77.5 88.4 100.0 114.3 119.9 (2P, Dec., rinal #14/A 14N/A 49.3 76.8 137.9 112.8 111.3 138.0 163.9 187.8 221.0 253.9 273.3 Souroes: Asset data are fran the Banegladesh Bank, h Bank &iuetin, and Econoic Trends. GNP data are from Bangladesh Bureau of Statistics, Econoic Indicators of Bamgladesh ard from the Bangladesh Bak, Economic Trerds. CPI data are fran the DM, IFS, data tape. Notes: GNP data are for the fiscal year beginning in the current year, therefore incois is expressed in Decm er prices. ANNEX 2 8. Overall, the interest rate regime was not sufficiently flexible to dampen the movement of the real rates by adjusting the nominal rates to accommodate swings in inflation. Although, some positive real rates occurred, these were only in deflationary periods. The Pattern of Deposit Rates, year-end 1982 9. Table 3 displays the nominal interest rates, as of December 1982, on savings and term deposits of various maturities. At first glance, it seems that the two percentage point spread between six month and three year deposits was inadequate to compensate asset holders for the additional risk of committing funds long term, particularly in light of the country's recent experience with inflation rates in the teens. However, long term deposits remained a very large share of all term deposits. In fact, term deposits with maturities in excess of three years were roughly 60% of all term deposits throughout the 1978-82 period, rising from 34% in 1975. Furthermore, the figures show an eleven-fold increase in deposits of 3+ year maturities over deposits with 2-3 year maturities, where there is only a 0.5 percentage point spread. This suggests that the explanation for the popularity of the 3+ year term deposits involves issues beyond the interest rates. Precisely what these issues are and what part, if any, remittances play remains an open question. Table 3 The Pattern of Deposit Rates, end of year 1982 Savings deposits nominal with checking 8.5% without checking 10.0% Time deposits 3-6 months 12.0% 6-12 months 13.0% 1-2 years 14.0% 2-3 years 14.5% 3+ years 15.0% Source: The Bangladesh Bank, "Economic Trends." The Pattern of Lending, year-end 1982 10. The first observation that can be made regarding the lending rates displayed in Table 4 is that many were at or below rates the paid on time deposits. Thus, even without accounting for reserve and liquidity requirements or the cost of intermediation, it appears that the lending rates were well below the marginal cost of the funds and a substantial amount of subsidization of borrowers was taking place. - 94 - ANNEX 2 11. As far as the structure of the lending rates is concerned, the most concessional rate charged, the rate on non-traditional export credits, was approximately two thirds of the rate charged for general lending. Such a disparity may be questioned on efficiency grounds, particularly if a substantial portion of the concessionary credits were merely diverted into deposits paying rates higher than the borrowing rate. However, an assessment the size of the distortions introduced by the credit programs requires a close examination of the returns on the actual uses of the funds and those foregone by the diversion of the funds and the cost of administering the programs, including the subsidies. Table 4 The Pattern of Lending Rates, year-end 1982 nominal Agricultural production 12.0% Industry 14.5% Specific industries in less developed areas 13.0% Export credit traditional items 12.0% non-traditional items 11.5% Loans for Socio-economic objectives 13.0% Loans given in the Chittagong Hill Tracts 13.0% General loans 16.0% Source: The Bangladesh Bank, "Economic Trends." - 95 - ANNEX 2 Sources: Bangladesh Bank (various dates), Bangladesh Bank Bulletin (Dhaka: Bangladesh Bank, various issues). Bangladesh Bank (various dates), Economic Trends (Dhaka: Bangladesh Bank, various issues). Bangladesh Bureau of Statistics, Ministry of Finance and Planning (various dates), Monthly Statistical Bulletin of Bangladesh (Dhaka: Government of the People's Republic of Bangladesh, various issues). World Bank (1982), Bangladesh: Financial Sector Review, Report No. 4098-BD, (Washington, D.C.: World Bank, December 1982). ANNEX 3 KENYA - 99 - ANNEX 3 III. KENYA Government Intervention in Financial Markets 1. The financial sector in Kenya is quite well developed in comparison to most countries in its income range ($340 U.S. per capita in 1982). It is vigorous and sophisticated and, as measured by the ratio of financial assets to GNP, relatively deep (see Table 2). Institutionally, the financial sector contains a number of financial institutions of various types, with some of the more advanced forms, such as insurance companies, having an importance not usually associated with countries at Kenya's income level. In contrast with many developing countries, this institutional diversity is not associated with badly fragmented financial markets, but rather there appears to be a fair amount of competition across institutional types and between institutions in each category. 2. While the authorities have allowed market forces to play a relatively influential role in the financial system, the government maintained a formidable presence in the financial market place. The most important facets of the government's intervention in the financial sector were: (1) ownership of commercial banks, finance companies, the largest pension fund, and an insurance company, which provided the government with extensive direct control over credit alpcation; (2) a regime of minimum interest rates on deposits and maximum-iending rates; and (3) extensive borrowing by the government to finance its deficit and to relend to the parastatal enterprises. Other imporfant policy instruments used by the authorities included such traditional measures as: reserve requirements, liquidity requirements and regulations governing the financial institutions' portfolio composition, including the share of deposits committed to agricultural lending and the share held. as low yielding government securities. The government also guaranteed many of the credits extended to the parastatals, and placed some restrictions on foreign owned enterprises' access to domestic credit. 3. By imposing ceilings on the lending rates the authorities reduced the amount of credit that the financial intermediaries could profitably extend by: (1) preventing intermediaries from charging a premium to cover the additional costs and risks of term finance and of lending to smaller borrowers and those with little collateral, thereby reducing such lending, and by (2) limiting the interest rates payable on deposits, thereby suppressing the mobilization of financial savings and thus restricting the pool of loanable funds. As a direct result, the commercial banks maintained loan portfolios composed primarily of short term credits to the major private firms and the parastatals. While the finance companies enjoyed somewhat looser regulation and were able to extend a larger share of their loans to the smaller firms, the interest rate ceilings were generally binding on such lending and formal credits to these enterprises remained far less than demanded. - 100 - ANNEX 3 4. The bias towards short term lending to the large firms and the parastatals has serious distributional and efficiency implications. Investments undertaken by the major firms tended to produce relatively fewer low-skilled employment opportunities than investments by smaller concerns, and tended to enhance the earnings of the groups which owned the firms. In addition to the questionable distributional impact of channelling an exceptionally large share of the country's financial resources to the parastatals, these enterprises were also notoriously inefficient. Economic efficiency was further diminished by the scarcity of long term credits. Despite the regularity with which short term obligations were rolled-over, the inability of firms to lock-in the terms of their borrowings greatly increased the risk of undertaking projects with long gestation or payback periods. 5. The volume of borrowing by the government also threatened to hold back Kenya's growth potential by placing a severe strain on the financial system and shifting the allocation of the country's resources excessively towards the public sector. Between 1976 and 1982, government expenditures rose dramatically, from approximately one quarter to one third of GNP. A large fraction of this growth came through the expansion of the parastatals, financed by government intermediation between the public enterprises and the financial system and foreign capital markets--often with negative spreads. By engaging in intermediation on such a large scale, the authorities, in effect, established a system of directed credit comparable to that which many developing countries implement through regulation of their banking systems. This led to substantial crowding out of private investment, through both the reduction in available credit and the preemption of private investments opportunities by the parastatals. 6. The massive public sector financing requirements are also a serious impediment to interest rate reforms. While the recent increase in interest rates raised the allowable returns on private deposits and loans, it also placed upward pressure on the yields the government had to pay on its securities, raising government debt service and increasing pressures on the fiscal deficit. This presents the authorities with a serious dilemma, since the abrupt decline in the country's access to foreign credits (due to Kenya's large foreign debt of $2.4 billion in 1982, and the general constriction of credits to the developing countries), has placed a premium on mobilizing domestic resources and allocating them more efficiently, suggesting the need for further interest rate liberalization. 7. As noted, such reforms would however increase the public sector deficit, forcing the authorities to resort to either: (1) increased inflationary finance, or (2) increased forced holding of government securities, or (3) a reduction in public expenditures. Each of these policy options has its costs. Increased inflation would jeopardize the country's tradition of relative price stability, upon which the successful development of the financial sector has depended. An increase in forced holding of government securities at below market rates would increase intermediation costs, possibly resulting in high real lending rates and/or lower real deposit rates. This would tend to depress the economy further and partially defeat the purpose of the initial reforms--increased domestic - 101 - ANNEX 3 resource mobilization. Finally reductions in public expenditures would result in lower short term employment levels, if cuts were made in current expenditures, or lower long term growth, if the cuts were out of development expenditures. Apparently, the authorities have chosen to limit the increases in the level of interest rates, lower expenditures primarily through lower development expenditures, and resort to some inflationary finance. Clearly, this solution is going to be costly in the long term if it is maintained, and the government is faced with a great challenge to its political and management skills, a challenge with very serious consequences for the country's current and future welfare. The Development of Interest Rates 8. Since 1977, the low ceilings on lending rates provided little incentive to raise deposit rates much above the minimum set by the government. These minimums, which are displayed in Table 1, were predominantly negative in real terms ex-post. Only recently did this pattern change, due to the combined effect of declining inflation and higher minimum deposit rates. Table 1 shows that at the end of 1982 term deposits and savings accounts in the commercial banks and private finance companies yielded positive returns ex-post. In addition to the upward adjustment in the deposit rate ceilings, the maximum nominal lending rates were increased over the period, reaching 16.0% in 1982. 9. The ceilings on lending rates implied slightly negative real rates on average over the period. The evidence also suggests that the effective rates were commonly increased a couple of percentage points above the ceiling rates by compensating balances and various other adjustments to the repayment schedules. This was true particularly on loans from the less well regulated Finance Companies, which accounted for a growing share of the market. However, these effective rates were not sufficient to encourage substantial lending at term or to non-blue chip entities. 10. A comparison between the rates on loans for land purchases from the Agricultural Finance Corporations and the ceiling rates on general credits from the commercial banks reveals that the land purchase loans were only a couple of percentage points lower than the general category. Thus these rates were also only slightly negative in real terms on average, and were not exceptionally concessional. However, the terms of these loans may have been considerably easier than those on general credits, making the spread in effective rates somewhat wider and the land purchase lending correspondingly more concessionary. 11. Although the ceilings on lending rates were increased, the minimum rates for deposits were increased more. Thus the spread between term deposits and the ceilings on general credits declined from 4.6% in 1979 to 2.8% by 1982. This decline suggests that the profitability of intermediation was reduced, and financial institutions increasingly had to resort to devices such as fees and compensating balances to maintain profits. This squeezing of margins tends to restrict formal finance and encourage expansion of less efficient forms of informal or self-finance. - 102 - A4NNEX 3 WfL Teh1 1 Sel 1*z.l a b-pot pAl 1nteet teR Ad of Year ( daazed) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Dpsts, -14-rts CAMdrail Books }md N1 rA 0.0 0.0 0.0 O.02 0.0 0.OX 0.0 O.OX O4X O.X 04.O O.O 0.0 l-past real -3.13 -3.7% -9.3% -17.0 -22.2% -11.02 -21.2X -15.7% -5.7% -13.72 -11.2X -13.02 -9.52 Sw,dqp 1ral 3.02 3.02 3.02 3.0 5.0X 5.02 5.02 5.02 5.02 5.02 6.0X 10.02 12.52 t-past zeal -0.4X -0.8X -6.6X -14.5% -18.31 -6.6X -17.2% -11.5X -0.9% -8.9X -5.82 -4.3X 1.9X Term, 6 wath NIznal 3.82 3.82 3.8X 5.42 5.4X 5.42 5.42 5.42 5.4X 5.4X 6.8X 11.02 13.2X l-pout real 0.31 0.02 -5.9% -12.5% -18.02 -6.7% -16.9% -11.1 -0.62 -8.5X -5.7% -3.5% 2.5% Private F1noial lzstitutiau Dmu Nominl O.O O.0X O.02 O.0X O.02 0.0X O.0X O.02 O.02 O.02 O.02 O.2. 0.0 h-post real -3.31 -3.77 -9.31 -17.02 -22.7% -11.02 -21.2X -15.7% -5.7% -13.2% -11.7% -13.02 -9.5X SWJ Nndiral 3.02 3.02 3.02 3.02 5.02 5.02 5.02 5.02 5.02 5.0 8.02 10.0 12.52 t-past real -0.42 -0.82 -6.62 -14.5% -18.3X -6.62 -17.2X -11.5% -0.9% -8.9% -4.02 -4.31 1.9% Tem, lnest category h-post real 2.5% 2.12 -3.9% -10.82 -16.42 -4.4X -14.9% -8.31 2.62 -5.62 -1.42 -0.42 5.2% Post OIffic Savings B1k NoadmLl 3.02 3.0X 3.02 3.02 3.02 5.02 5.02 5.0X 5.02 5.02 6.02 10.02 10.02 h-past real -0.42 -0.82 -6.62 -14.5% -19.9% -6.62 -17.7% -11.5% -0.9% -8.9% -5.82 -4.3X -0.42 1 ghted !W rate of returon abm assets plus curscy EKpost real -1.42 -2.7% -6.62 -14.62 -18.7% -9.7% -16.5% -13.82 -4.02 -10.02 -7.6% -8.2% -2.82 E bdig domestic denm. Clomercial Boank Mmdmn (less than 3 yr.) Nml3 - - - - - - - 10.02 10.02 10.02 11.02 14.02 16.02 h-past real - - - - - - - -7.Z% 3.82 -4.52 -1.42 -0.9% 5.02 Miniman Nir 7.02 7.0X 7.02 7.02 8.02 8.02 - - - - - - - E-ost real 3.5% 3.12 -3.02 -11.2X -16.02 -3.9% - - - - - - - Aj; al Finmxe Corp 7.5X 7.52 7.5% 7.52 8.02 8.02 9.02 9.2 9.2 9.02 9.02 12.02 12.02 b-post real 4.02 3.62 -2.5X -10.8X -16.0X -3.9% -14.12 -8.1U 2.82 -5.4X -3.2X -2.62 1.42 Inflatlim (Q1) 6 umths Foxrmr4 frtn Deer 3.4X 3.82 10.31 20.5% 28.52 12.42 26.82 18.62 6.02 15.Z% 12.62 15.02 10.5Z Devaluation 6 mnths For¶mrd Tram Deeber 0.0 0.0 -6.7% 7.2% 0.02 4.2X -0.2X -3.5% 2.02 -0.5% 35.2% 13.9% 8.31 inflati (CPI) over Prior December 1.5% 7.2% 3.3% 15.2% 16.0% 20.3. 7.62 21.02 13.7% 9.12 13.1U 19.31 13.32 Sources: Ienrt rates are frm The CGetal Bwk of Kerya, EYoc and lancial 1eview. hrual, axN 1z of Statistics FYnance ard Plannrgd,Y & ey.CI data arae from the W, IFS, data tape. 1WMgts for wlghted avewra we frms Kena Mable 2. tbtes: Pl rates were calcjatel e-past, i.e., they reflect the inflation rate slx ithe forwrd from er. Th e arae rate of return calailated aaarng, each asset yielded the mtnimm rate and that all term deposits in the Private Finail Imtiflt± aere In the lhest tezn category. '- indcteA not defind. - 103 - ANNEX 3 In fact, the formal financial sector appears to have contracted slightly (See Table 2). The ratio of total financial assets to GNP declined from approximately 34.8%, in 1979, to 32.7% by the end of 1982. 12. Alternative explanations for the decline in the ratio of financial assets to GNP between 1979 and 1982 include: (1) portfolio adjustments the post-coffee boom years; (2) capital flight associated with the growing economic crisis; and (3) a drawing-down of parastatal deposits which are not netted out of the asset data. In contrast to that decline, Table 2 reveals a sharp upward shift in the ratio of total financial assets to GNP from 27.3% in 1976 to 33.4%. in 1977, and 34.7% in 1978. This shift corresponds to large foreign exchange inflows associated with the coffee boom in these years and probably reflects a substantially more optimistic economic outlook. The softening of the economic picture in the post-boom years could then have accounted for the subsequent decline in the ratio over 1979 to 1982. The growing economic crisis and the associated internal and external imbalances could also have been responsible for the decline in the ratio, as agents with access to foreign asset markets--legal or otherwise--shifted capital offshore, thereby reducing the relative amount of domestically mobilized resources. Finally, the parastatals, under the pressure of rising losses, drew down accounts built-up during earlier years. Thus, a variety of factors contributed to the reduction in the depth of the formal financial system. The Pattern of Deposit Rates, year-end 1982 13. At the end of 1982, the official minimum deposit rates displayed in Table 3 indicated a rather small spread for maturity--only one percentage point between deposits of one month and deposits up to twenty four months. As discussed in paragraph 8, the ceiling on lending rates and the cost of intermediation combined to limit the rates financial intermediaries paid on short term deposits to roughly the minimums. Given uncertainties over future interest rates, banks also had little incentive to offer rates above the minimums on longer term deposits. In combination with a liquidity squeeze, this caused a switch into maturities of almost exclusively less than three months. 14. A couple of difficulties arise from a predominantly short term deposit base. First, it discourages term financing, since banks must keep a shorter loan portfolio to match the greater volatility of their liabilities (Of course, firms may not desire term finance if there is a reasonable chance that interest rates will decline). Second, the banks suffer greater exposure to potentially destabilizing out-flows of funds. This can have serious repercussions for the entire financial system if the system does not have adequate institutional resources to cope with a major banking crisis. Since the short maturity of the deposit base can be related to the lack of an adequate premium for long term deposits, which in turn can be traced partly to the lending ceilings, these dangers add weight to the argument for allowing interest rates to move toward market-determined levels. - 104 - ANNEX 3 KM: Table 2 levels of Selected Fnmicial Assets End of Year (in hilUlcns of 9 1 six) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 9M damstic 0.7 0.7 0.9 1.0 1.1 1.2 1.6 2.2 2.3 2.7 3.0 3.6 3.7 In 1980 prices 2.3 2.2 2.6 2.5 2.4 2.3 2.8 3.1 2.8 3.0 3.0 3.0 2.8 % of GNP 5.8% 5.6% 6.0% 5.6% 5.2% 4.9% 5.2% 5.8% 5.6X 5.7% 5.5% 5.7% 5.2 % of total assets 20.2t 19.5% 20.1% 17.8% 18.1% 17.3% 18.9% 17.5% 16.0% 16.3% 16.6% 17.3% 15.8% Depoeits, damestic currncy Camercial Bflk Dnwd Nomiml 1.2 1.3 1.5 2.0 2.1 2.4 3.0 4.3 4.7 5.6 5.2 5.6 6.0 In 1980 prices 3.9 3.9 4.5 5.0 4.7 4.4 5.1 6.1 5.8 6.3 5.2 4.7 4.4 % of QGP 9.9% 9.7% 10.22 11.2% 10.1% 9.7% 9.5% 11.6% 11.4% 11.8% 9.6% 9.0% 8.32 % of total assets 34.4% 34.0% 34.1% 35.5% 35.4% 34.0% 34.7% 34.8% 32.8% 33.8% 28.6% 27.1% 25.5% Savings Nominal 0.7 0.8 0.9 1.0 1.2 1.3 1.5 2.1 2.4 2.7 3.0 3.5 3.9 In 1980 prioes 2.2 2.3 2.5 2.6 2.6 2.4 2.6 2.9 3.0 3.0 3.0 2.9 2.9 % of GWP 5.7% 5.7% 5.8% 5.7% 5.6% 5.2X 4.9% 5.6% 5.8% 5.6% 5.4% 5.e6 5.52 % of total assets 19.92 19.9% 19.42 18.22 19.6% 18.3% 17.8% 16.8% 16.6% 16.22 16.22 16.9% 16.7% Term Noinal 0.5 0.6 0.6 0.9 0.8 1.1 1.4 2.3 3.0 3.1 3.7 4.1 5.6 In 1980 prices 1.7 1.8 1.8 2.2 1.8 2.0 2.3 3.3 3.6 3.5 3.7 3.5 4.2 X of QGP 4.5% 4.4% 4.2% 4.9% 3.9% 4.5% 4.4% 6.22 7.1% 6.5% 6.8% 6.6% 7.8% % of total assets 15.4% 15.5% 14.0% 15.7% 13.7% 15.7% 16.0% 18.6% 20.5% 18.6% 20.4% 20.0% 24.0% Private Financial Inst. N&rntnal 0.0 0.0 0.0 0.0 0.0 0.1 0.0 0.3 0.2 0.3 0.1 0.2 0.2 In 1980 prices 0.1 0.1 0.0 0.0 0.0 0.2 0.0 0.5 0.2 0.3 0.1 0.2 0.2 2 of QNP (.3X 0.22 0.1% 0.1% 0.0% 0.4% 0.1% 0.9% 0.4% 0.5% 0.22 0.4% 0.3% Z of total assets 1.1% 0.62 0.4% 0.3X 0.1% 1.3% 0.3X 2.8% 1.3% 1.62 0.5% 1.IU 1.0 Savirn a/ NominaT 0.1 0.1 0.1 0.2 0.2 0.1 0.3 0.2 0.5 0.5 0.6 0.6 0.6 2 of GE 0.6% 0.8% 0.9% 1.12 1.0% 0.6% O.92 0.6% 1.1% 1.0% 1.1% 0.9% 0.9% 2 of total assets 2.0% 2.6% 3.1% 3.5% 3.5% 2.1% 3.22 1.9% 3.3% 2.7% 3.22 2.8% 2.7% Temn a/ Niinal 0.1 0.2 0.3 0.4 0.4 0.7 0.6 0.8 1.2 1.5 2.3 2.6 2.9 In 1980 prices 0.4 0.6 0.8 1.0 1.0 1.2 1.0 1.1 1.4 1.7 2.3 2.2 2.1 2 of GNP 1.12 1.4% 1.92 2.1% 2.L% 2.7% 2.0% 2.12 2.8% 3.2% 4.2% 4.2% 4.0% X of total assets 3.8% 5.0% 6.2% 6.8% 7.32 9.32 7.22 6.32 8.0% 9.32 12.7% 12.7% 12.22 Ftst Office Savins Bank Noinal 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.2 0.3 0.3 0.4 0.5 In 1980 prices 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.4 0.4 2 of GNP 0.92 0.8% 0.8% 0.7% 0.7% 0.6% 0.5% 0.5% 0.5% 0.5% 0.6% 0.7% 0.7% 2 of total assets 3.1% 2.9% 2.6% 2.3% 2.32 2.0% 1.9% 1.5% 1.5% 1.5% 1.9% 2.1U 2.1% Total Niunal 3.4 3.8 4.4 5.5 6.0 7.1 8.6 12.5 14.4 16.4 18.3 20.6 23.6 In 1980 prices 11.2 11.5 13.0 14.1 13.2 13.0 14.6 17.5 17.8 18.6 18.3 17.3 17.4 % of GNP 28.9% 28.5% 29.8% 31.4% 28.62 28.5% 27.32 33.4% 34.7% 34.8% 33.4X 33.2% 32.7% CPI, Deceber (Dec.80-100) 30.8 33.0 34.1 39.3 45.5 54.8 58.9 71.3 81.0 88.4 100.0 119.3 135.2 GNP, Dec. adiJusted, naninal 11.9 13.3 14.9 17.6 21.0 25.0 31.4 37.4 41.5 47.2 54.8 62.2 72.1 Sources: Asset data are fran hme Central Bait of Keya, Ecci1 and Firixial Review. QP and CPI data are fram the DIP.IF, data tape. Notes: The Qp data have ben logrithlicelly interpolated betwem the cArrent year and me year forwerd so as to be expressed in DeoaSbr prices. a/ Savirg and tern deposits in the Private Fincal Inatitutions xere assmd to be dstribated 1:2 for the years 1970-72, and in all other year as reported. - 105 - ANNEX 3 Table 3 Commercial Bank Minimum Deposit Rates, On account less than Shs 1 million, year-end 1982 Nominal Savings deposits 12.5% Term deposits 7 day call free one month 12.5% 1-3 months 12.5% 3-6 months 12.7% 6-9 months 13.2% 9-12 months 13.4% 12-24 months 13.5% Source: Central Bank of Kenya, "Economic and Financial Review." The Pattern of Lending Rates, year-end 1982 15. The strucure of lending rates in Kenya at the end of 1982 does not appear to have been particulary complex nor highly distortionary, as evidenced by the array of lending rates displayed in Table 4. Outside of the rates established for direct credits from the Central Bank, the number of specified lending categories and rates were few and the spreads relatively small. Thus, while other "non-price" rationing mechanisms may have introduced substantial distortions, the margins within the regime of interest rates do not generate the massive subsidies typically found in statutory interest rate regimes. This is not to say that subsidization was absent, but merely that interest rate subsidies and the distortions they produce were low in comparison to most developing countries. 16. The agricultural sector benefited most from the preferential lending rates, i.e., the rates on rediscounts and advances from the Central Bank and loans from the Agricultural Finance Corporation. In addition, the Kenya authorities required the commercial banks to commit 17% of their net deposit liabilities to agricultural lending; the corresponding figure for the non-bank financial institutions was 10%. However, the evidence suggests that enforcement of these requirements was loose and that compliance was less than full (World Bank 1984, p. 21). Evidence also indicates that much of the "agricultural" lending was, in fact, only marginally related to agriculture, and that there was substantial diversion of agricultural credits from the agricultural sector. This suggest that - 106 - ANNEX 3 targetted lending in reasonably well integrated capital market is likely to be limited in effectiveness or to require large expenditures to monitor. Moreover, even monitoring could not prevent potential investors in targetted sectors from borrowing subsidized funds to replace their own and subsequently investing their funds elsewhere. Table 4 The Pattern of Lending Rates, year-end 1982 Central Bank of Kenya Rediscount Rate for T-Bills 13.48% Advances against T-Bills 14.50% Bills and Notes Under Crop Finance Scheme Rediscounts and Advances CSFS & AFC 13.75% Finance of Export Bills 14.00% Other Bills and Notes Rediscounts 14.50% Advances 15.00% Advances against Government Securities 14.50% Kenya Commercial Banks Loans and Advances (minimum) free (maximum) 16.00% Other Financial Institutions Agricultural Finance Corporation Land Purchase Loan 12.00% Seasonal Crop Loan 14.00% All other loans 13.00% Hire Purchase Companies and Merchant Banks Loans 16.00% Building Societies Loans 16.00% Source: Central Bank of Kenya, "Economic and Financial Review." 17. In sum, the financial system in Kenya is one of the most market oriented in the developing countries and among the freest from interest rate induced distortions. However, the size and growth of public sector borrowing has placed a large strain on the system, one that threatens to limit its development. - 107 - ANNEX 3 Sources: Central Bank of Kenya (various dates), Economic and Financial Review, (Nairobi: Central Bank of Kenya, various issues). Mi-nistry of Economic Planning and Community Affairs (1979) Development Plan 1979 to 1983, (Nairobi: Ministry of Economic Planning and Community Affairs, 1979). Ministry of Economic Planning and Community Affairs (1983) Development Plan 1983 to 1988, (Nairobi: Ministry of Economic Planning and Community Affairs, December 1983). Ministry of Economic Planning and Community Affairs (1983) Development Plan 1983 to 1988, (Nairobi: Ministry of Economic Planning and Community Affairs, December 1983). World Bank (draft), Kenya: Review of Industrial Finance, Report No. 5246-KE, (Washington, D.C.: World Bank, draft). World Bank (1984, draft), Kenya: Agricultural Credit Policy Review, (Washington, D.C.: World Bank, April 1984, draft). ANNEX 4 NIGERIA ANNEX 4 IV. NIGERIA Government Intervention in Financial Markets 1. The Nigerian authorities' intervention in the financial markets was among the most extensive of all the market-oriented developing countries, during the 1970-82 period. In addition to extensive use of such commonly encountered policy instruments, as administered interest rates, directed credit, minimum reserve and liquidity ratios, and mandatory bank holdings of government securities, the Nigerian government exercised direct and indirect control over a large portion of the country's financial resources and financial transactions. This was primarily due to the government's control over the country's oil revenues and its ownership position in the commercial banks. 2. The public sector used the country's oil revenues to undertake a major fraction of total investment, by-passing the financial sector. In addition, the government used its privileged borrowing position to engage in extensive intermediation between sources of foreign and domestic capital and the Nigerian public and private sectors. Finally, the authorities maintained extensive indirect influence over the financial resources not under their direct control by virtue of the government's ownership of most of the large commercial banks. In short, the authorities exerted substantial control over virtually all of the financial savings available to the economy. 3. The government also intervened in the financial markets through a wide ranging and complex system of directives and guidelines. The monetary authority annually established a regime of interest rates, which covered all deposit and lending rates in the formal financial market. This regime included a maximum and minimum lending rate and a set of differential rates involving a number of preferential categories. 4. Policy goals relating to the financial sector typically were pursued through credit allocation guidelines or specific lending directives. The Central Bank of Nigeria issued guidelines to the commercial banks specifying, among things, the aggregate credit expansion, the share of credit allocated to each of 16 sectors into which the economy was divided, the share of credit allocated to indigenous borrowers (which is further subdivided by size of enterprise and other criteria), and the share of credits by term. So complex and internally inconsistent was the system that it defied compliance and violations occurred regularly. The Development of Interest Rates 5. Ceilings on nominal interest rates in Nigeria were set below inflation rates, which averaged about 15% during the 1970 to 1982 period. In fact, none of the rates paid on deposits yielded positive returns ex-post during the entire period, judging from Table 1, which displays a selection of deposit and lending rates in Nigeria from 1970 to 1982. This - 112 - ANNEX 4 NIGRA: Table I Selected 1Wnal ard & -post Peal Interest Rates End of Year (arnualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 198D 1981 1982 Deposits, dczlstic deim. Deman Norinal 0.0% 0.0% 0.0% o.ce 0.0% o.c% 0.0% 0.0% o.c% 0.0% 0.0% 0.0% 0.0% D-,ost real -27.0% -6.7% -20.8% -13.1% -42.6% -14.7% -28.9% -17.9% -13.3% -8.5% -25.4% -7.9% -23.8% Savings Noxunal 3.0% 3.0% 3.0% 3.0% 3.0% 4.0% 4.0% 4.0% 5.0% 5.0% 6.0% 6.0% 8.5% Rx-post real -24.8% -3.9% -18.4% -10.5% -40.9% -11.3% -26.1% -14.6% -9.0% -4.0% -20.9% -2.4% -17.3t Term, 6 nDnth tNoinal 3.0% 3.0% 3.5% 3.5% 3.5% 3.0% 2.5% 3.0% 5.0% 5.5% 6.0% 6.0% 8.5% EK-post real -24.8% -3.9% -18.0% -10.1% -40.6% -12. 2% -27.2% -15.5% -9.0% -3.5% -20.9% -2.4% -17.3% Weighted average rate of return an aboe asets plws lrrency Ex-post real t'N/A -5.6% -19.8% -11.9% -41.7% -13.5% -28.1% -17.0% -11.8% -6.7% -23.8% -5.8% -21.2% ladirg, dczestic denn. General advans Nomlial 8.0% 10.0% 10.0% 10.0% 10.0% 9.0% 10.0% 6.0% 11.0% 11.0% - - - Ex-Tost real -21.1% 2.7% -12.9% -4.4% -36.8% -7.0% -21.8% -13.0% -3.7% 1.5% - - - First class adyances Nlnal 7.0% 7.0% 7.0% 7.0% 7.0% 6.0% 6.0% 6.0% 7.0% 7.5% - - - Ebc-post real -21.9% -0.1% -15.3% -7.0% -38.6% -9.6% -24.7% -13.0% -7.2% -1.7% - - - General nadmn tNomnal - - - - - - - - 11.0% 11.0% 11.5% 11.5% 14.0% Ex-post real - - - - - - - - -3.7% 1.5% -16.8% 2.7% -13.2% Perfered sector maxdmum Nominal - - - - - - - - 9.0% 9.0% 9.5% 9.5% 12.5% Ec-pot real - - - - - - - - -5.5% -0.3% -18.3% 0.9% -14.3% Inflation (CPI) 6 mnths Forward frao Decemr 37.0% 7.1% 26.3% 15.1% 74.2% 17.2% 40.7% 21.8% 15.3Z 9.3% 34.1% 8.6% 31.3% Dmvaluation 6 nmths Forward frao Deoember 0.0% 0.0% 0.0% -12.0% -3.6% 0.0% 5.9% -2.5% -15.0% -6.4% 40.9% 12.5% 21.8% Inflation (CPI) over Prior DecPer 13.0% 15.0% -3.5% 17.8% 9.9% 43.1% 12.4% 31.3% 10.3% 11.5% 13.7% 17.4% 6.7% Sorces: AU pre-1982 interest rates are from the Central Berk of Nigeria, Ecxnoic and Fiancial Peview or Am Report, empt the mral maximza and preferel sector maxdmm lending rates and all 1982 figwres, whidc are frm the Ibrld Bank, Financial Intermdiation in Nlgeria, report# 4051.-UNL CPI data are fran the IMF, IFS, data tape. Notes: Real rates were calaclated ex-post, i.e., they reflect the inflation rate six mnths forward fran De Ier. The weAghted average uses weights fran Nigeria Table 2 and assues all tim deposits yield at the 6 unnth rate. '-' indicates not defined. - 113 - ANNEX 4 interest rate policy reflected a view held in the government that with its oil revenues the country had little need to mobilize domestic savings. On the lending side, the rates charged for general credits were positive in real terms only in three of thirteen years, in 1971, 1979 and 1981. Only once, in 1981, did the real rate charged on preferential credits become positive ex-post. 6. Despite the repressed level of deposit rates, the holdings of financial assets grew rapidly between 1971 and 1982. The total of currency, demand, savings and time deposits rose from 13.7% of GDP in 1971 to 36.7% of GDP in 1982, an average annual growth rate of over 12% (see Table 2). This growth can be attributed to steady increases in the monetization of the economy, as well as unsterilized capital inflows (1974-76, 1979-80) and monetization of the government deficits (1977-78, 1981-82). The Pattern of Deposit Rates, year-end 1982 7. At the end of 1982 the interest rate spreads between deposits of short and longer maturities were very small, as displayed in Table 3. As a result, the term structure of bank liabilities was quite short, with about 80% of total deposits having maturities of less than one year in 1981. (World Bank, 1983, p.27). In concert with the low ceiling rates on lending, the shortness of bank liabilities discouraged long term finance. This could become a matter of concern, if the decline in oil revenues is sustained and the private sector is then expected to increase its total investment. - 114 - ANNEX 4 NI(ERIA: Table 2 Levels of Selected Financial Assets Ehd of Year (in billions of Naira) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, dcmestic Nomi nal fiN/A 0.4 0.4 0.4 0.6 1.0 1.4 1.9 2.2 2.4 3.2 3.9 4.2 In 1980 prices 1/N/A 1.3 1.5 1.4 1.7 2.1 2.5 2.7 2.7 2.7 3.2 3.3 3.4 % of G(P ltN/A 4.8% 4.6% 3.5% 3.1% 4.5X 5.1% 6.8% 6.4% 5.7% 7.3% 8.7% 9.2% % of total assets 1/N/A 34.9% 33.2% 30.8% 26.4% 28.5% 25.6% 27.5% 29.2X 23.9% 22.0% 24.8% 25.0% Deposits, dompstic currency Deanud Noxanal 1/N/A 0.3 0.3 0.4 0.6 1.0 1.9 2.9 2.6 3.8 6.0 5.9 5.8 In 1980 pries lN/A 1.1 1.2 1.3 1.8 2.1 3.6 4.0 3.3 4.3 6.0 5.0 4.7 % of (wP 1/N/A 3.9% 3.8% 3.2% 3.32 4.4% 7.3% 10.1% 7.8% 9.1% 13.9% 13.M 12.7% % of total assets 1/N/A 28.1% 27.1% 27.77 28.2Z 28.0% 36.8% 40.4% 35.5% 38.5% 41.87. 37.8% 34.5% Savinr NkmLnal llN/A 0.2 0.2 0.2 0.3 0.5 0.7 0.9 1.1 1.3 1.7 2.0 2.3 In 1980 prices tN/A 0.6 0.8 0.7 0.9 1.1 1.3 1.3 1.4 1.5 1.7 1.7 1.9 % of GJP iWN/A 2.2% 2.4% 1.9% 1.6% 2.3 2.7% 3.3Z 3.2% 3.1% 3.8% 4.5% 5.0% % of total assets MIN/A 16.2% 17.3 16.2% 13.5% 14.6% 13.6% 13.3X 14.7% 13.1% 11.5% 12.8% 13.7% Term Nooinal I/N/A 0.2 0.3 0.4 0.7 1.1 1.3 1.3 1.5 2.4 3.6 3.8 4.5 In 1980 prices 1/N/A 0.8 1.0 1.2 2.0 2.2 2.3 1.9 1.9 2.7 3.6 3.3 3.6 % Of ( P J/NA 2.9% 3.1% 2.9%. 3.7% 4.6% 4.87 4.7% 4.5% 5.8% 8.2% 8.6% 9.8% Tbtal Nbuinal I/N/A 1.0 1.2 1.4 2.2 3.6 5.3 7.1 7.4 9.9 14.5 15.5 16.9 In 1980 prices 1/N/A 3.8 4.4 4.6 6.4 7.5 9.7 9.9 9.4 11.2 14.5 13.2 13.5 % of GDP 1/N/A 13.7% 13.9% 11.4% 11.6% 15.9% 19.8% 24.9% 21.8% 23.7% 33.3Z 35.2% 36.7% CPI, Deber (Dec.80-100) 23.6 27.1 26.1 30.8 33.9 48.4 54.4 71.5 78.8 87.9 100.0 117.4 125.2 GDP, Dec. adjusted, raainal 6.3 7.4 8.3 12.4 18.6 22.8 26.7 28.4 33.9 41.6 43.4 44.2 46.0 Sources: Asset data are from the Central Bark of Nigeria, Mthly Report. (PI and GDP data are frao the 1IF, IFS, data tape. Notes: The GNP data have been logrithalcally interpolated between the current year and one year forward so as to be expressed in December prices. - 115 - ANNEX 4 Table 3 Deposit rates effective end of year 1982 nominal Savings deposits 8.5% Time deposits 7 day notice 7.5% one mnth 8.0% 1-3 months 8.25% 3-6 months 8.5% 6-12 months 8.75% over 12 months 9.0% Source: World Bank, "Financial Intermediation in Nigeria." 8. Capital flight is another problem which arises out of the overall low level of the deposit rates, vis-a-vis inflation and vis-a-vis rates paid in the international markets. Although the authorities administered a system of exchange controls, the large size of the external sector presented plentiful opportunities for capital flight, such as over-invoicing of imports. The Pattern of Lending Rates, year-end 1982 9. All of the lending rates at the end of 1982 were highly negative ex-post, given a December 1982 to June 1983 inflation rate of 31.3%. Thus, despite the upward adjustment of the nominal rates since of 1981, real lending rates continued their historically negative real levels. 10. The negative real rates were, however, only a small part of a much larger problem relating to the efficiency of the whole financial system. The heavy reliance on a wide ranging regime of quantity controls introduced a series of distortions into credit allocation. Moreover, the level and structure of lending rates, in comparison to deposit rates, retarded the growth of financial intermediation by limiting the profitability of intermediation. In addition, with a six month term deposit rate of 8.5% and concessional rates of 7.0% to 8.0%, there was a distinct possibility that funds targetted for investment in the priority sectors were being diverted into deposits or other uses. The likelihood of such leakages was particularly high, given effective interest rates in informal credit markets which ran as high as 100% (World Bank, 1983, p.41). 11. Such high informal rates also indicate a demand for credits by borrowers who were excluded from the formal markets by its rationing mechanisms. Their willingness to pay such high rates also indicates the existence of investment opportunities with rates of return well above the lending rates in the formal sector. These rates cast doubt on the - 116 - ANNEX 4 efficiency of the formal credit allocation scheme. Furthermore, the efficacy of the credit allocation scheme in achieving social or economic objectives can also be questioned, given evidence that a large portion of directed credit wound up in the hands of either the large enterprises, or large farmers, who had access to credit through ordinary channels in the formal credit markets and tended to invest in capital intensive production methods. (World Bank, 1983, p.55). Table 4 Lending Rates Effective year-end 1982 nominal General Minimum 10.5% General Maximum 14.0% Preferred sector maximum 12.5% Less preferred sector maximum 14.0% Agricultural credit guarantee scheme 7.0-8.0% Residential housing costing less than 100,000 Niara 8.0% Agricultural production 8.0% Source: World Bank, "Financial Intermediation in Nigeria." - 117 - ANNEX 4 Sources: Central Bank of Nigeria (various dates), Annual Report, (Lagos: Central Bank of Nigeria, various issues). Central Bank of Nigeria (various dates), Economic and Financial Review, (Lagos: Central Bank of Nigeria, various issues). Central Bank of Nigeria (various dates), Monthly Report, (Lagos: Central Bank of Nigeria, various issues). World Bank (1983), Financial Intermediation in Nigeria, Report No. 4051-UNI, (Washington, D.C.: World Bank, February 1983). ANNEX 5 PERU - 121 - ANNEX 5 V. PERU Government Intervention in Financial Markets 1. The Peruvian government played a dominant role in the country's financial system throughout the 1970 to 1982 period. In the early and mid-70s, the government relied heavily on a system of directed credit to achieve a wide range of policy objectives, controlling both the allocation and cost of credit. Two important components of this system were a regime of detailed interest rate ceilings and an array of publicly owned, specialized financial institutions. A large percentage of the country's credit was channelled through these institutions by the central bank, through extensive rediscounting of loans made to target borrowers, such as agriculture, housing, public enterprises, etc. Other, though lesser, components of the system included preferential rediscounting of commercial bank lending to targetted sectors and restrictions on the composition of the bank portfolios. 2. A growing economic crisis in the mid-70s led to a shift in economic policy towards greater emphasis on market-oriented allocation. In 1978 a number of reforms were introduced, aimed at controlling inflation and ending economic stagnation by giving market forces a larger role in the economy. These reforms included the liberalization of interest rate policies, the easing of reserve requirements, the opening of the capital markets, the legalization of dollar denominated financial transactions, plus a reduction in tariffs and trade restrictions. Beginning in late 1978, a series of large upward shifts were made in the nominal interest rate ceilings. The permissible compounding periods were also progressively shortened starting in 1981. 3. The escalation of domestic inflation in 1983, to levels exceeding 100%, offset most of these reforms producing negative real deposit rates once again. The rise in inflation reflected both the effects of adverse weather conditions on output and the necessity of increased inflationary financing to cover the rising government deficit. In addition, the rate of inflation was increased by the capital market reforms themselves. These reforms reduced the base of the inflation tax, and thus increased the inflation which would result from a given amount of inflationary finance. This reduction occurred in two ways: (1) by cutting required reserves and paying interest on them and (2) by allowing the "dollarization" of the economy, which reduced the demand for sol denominated financial assets and thus the demand for base money (See para. 6). This interaction between rising inflation and capital market reforms is a good example of the difficulties that can arise when financial sector liberalization occurs before the fiscal deficit is under control. (See Mathieson and McKinnon for a discussion.) 4. In a country with a fair degree of capital market openness, such as Peru, interest rate policy must be judged in terms of expected devaluation as well as expected inflation. Serious complications can - 122 - ANNEX 5 arise in the financial sector from misalignment between domestic interest rates and foreign rates adjusted for expected devaluation. In particular, if the domestic currency becomes overvalued, then expectations of devaluation will raise the expected returns, in local currency, on foreign currency assets. This will produce a shift away from domestic currency assets towards foreign currency assets, unless the interest rates on domestic currency assets are permitted to rise to a competitive level. This situation has occurred to some degree in Peru. Unless expectations of devaluation decline, the government is confronted with two rather unpleasant options. Either it can allow sol deposit rates to rise in line with the expected return on dollar denominated assets and thereby stem the flow out of soles into dollars. Or it can hold down the sol deposit rates and let "dollarization" or capital flight continue. 5. Either choice is likely to exert negative pressure on domestic output. If, on the one hand, interest rates on sol assets were to rise, then banks' costs of sol deposits would also rise, placing upward pressure on sol denominated lending rates in real terms. This would produce a contractionary impact on the already depressed economy. In addition, if rates were allowed to rise, then the government would face higher borrowing costs to service its local debts. On the other hand, if the interest rates on sol assets were not allowed to rise, then funds would move into dollar assets, shrinking the supply of sol credit. This too would have a contractionary impact, since a reduction in the supply of sol credit would force many firms to either take-on expensive dollar liabilities, or borrow in the expensive informal credit market, or restrict their operations. 6. Besides reducing available domestic credit, the shift into dollar assets shrinks the size of the domestic monetary base as mentioned above. This reduces the quantity of assets that the government can tax through seigniorage. This loss can produce a potentially explosive increase in inflation as follows: A decrease in the domestic monetary base reduces the government's yield from seigniorage, increasing the need for financing for a given deficit. A larger need for financing implies more inflationary finance and more rapid inflation. Faster inflation, relative to foreign inflation, raises the rate of devaluation required to maintain the real exchange rate. More rapid devaluation, or an increasingly misaligned currency, raises the expected sol return on dollar assets. Higher expected returns on dollar assets promote capital flight and "dollarization," which, coming full circle, shrinks the domestic monetary base, reinitializing the entire process. Because the process feeds back on itself, increasing the required inflationary finance with each cycle, the government must be very cautious about pursuing financial reform before its deficit is under control. 7. As of late 1982, the government appeared to be following a path somewhere between the two extreme options. Effective interest rate ceilings were set quite high relative to past inflation rates. However, ex-post, the yields on sol denominated assets remained well below the the ex-post yields on dollar assets assets and "dollarization" steadily increased. By the end of 1982, dollar holdings amounted to nearly 40% of total assets. In an attemot to capture some of these dollar resources, the - 123 - ANNEX 5 government imposed a 90-100% reserve requirement on the banks' dollar deposits. The central bank invested these dollars overseas at a yield equal to LIBOR, paying the banks approximately LIBOR minus 2 percentage points, which turned around and payed depositors LIBOR minus 3. 8. By legalizing dollar transactions and maintaining the high reserve requirement, the government established some control over funds that would have leaked out in illegal capital flight to Panama or Miami. However, since the funds were invested overseas, and, thus, not available domestically, the process was essentially capital flight through the central bank, although it did help the country's measured reserve position. As previously noted, such a policy does not improve the domestic credit situation and can be highly destabilizing. With surging inflation and lagging devaluation "dollarization" and its hazards are bound to escalate, underscoring the need (1) to allow interest rates on sol denominated assets to move to levels more competitive with the expected return on dollar assets, (2) to reduce expectations of devaluation, and (3) to "de-dollarize." 9. In sum, responding to mounting inflationary and other economic pressures, the Peruvian government recently moved away from a highly controlled system of directed credit, toward a more market-oriented policy in the financial sector. It did this by substantially raising the effective interest rate ceilings, reducing the importance of the directed credit schemes and initiating discussions on banking law reforms. However, while some financial market liberalization did take place, government intervention remained quite extensive: Interest rate ceilings remained binding on many financial transactions; the authorities retained control over many of the country's financial institutions; and the directed credit programs remained large. In addition, the system continued to be subjected to the strain of high inflation. In particular, high inflation rates lead to unwarranted appreciation of the currency, which, in turn, raised expectations of devaluation and therefore the exchange risk of holding sol denominated assets and dollar liabilities. The Development of Interest Rates 10. As can be seen from the nominal interest rate ceilings displayed in Table 1A and the corresponding effective ceiling rates displayed in Table 1, there was a major upward shift in the structure of sol denominated interest rates in the 1978-82 period, as compared to the 1970-77 period. Despite the upward shift in the effective rates for sol deposits, which reflected the higher nominal ceilings and more frequent allowable compounding, the ex-post real rates for sol deposits remained predominantly negative during 1978-82. In fact, the year-end figures displayed in Table 1 were negative throughout 1972-82. However, the adjustments did permit real sol deposit rates to reach positive levels at times during the early 1981 to mid-1982 period. In particular, a six month term deposit made in January 1982 (after the adoption of a 55% uniform deposit rate) yielded an effective rate of 71% and an ex-post return of 2.0%, if compounded monthly. After mid-1982 real deposit rates moved highly negative once again with the resurgence of inflation. Thus, over the 1970-82 period - 124 - ANNEX 5 PERUI: Table IA Selected Nominal Interest Rate Ceilings End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, domestic denom. Demand Nominal 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 55.0% SaviNgs Nominal 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 9.0% 11.5% 29.0% 30.5% 30.5% 50.5% 55.0% Term, 6 month Nominal 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 11.0% 14.0% 31.5% 31.5% 31.5% 52.0% 55.0% Morgage bank certificates Nominal 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 11.0% 14.0% 31.5% 33.0% 33.0% 51.0% 55.0% Lending, domestic denam. General Noinal 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 15.5% 17.5% 31.5% 32.5% 32.5% 47.5% 47.5% Rediscount rates to the Banco Agrario Nominal 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 7.0% 9.0% 20.0% 21.0% 21.0% 29.0% 29.0% Sources: 1970 to 1977 figures are from La Superintendencia de Banca y Seguros, Boletin Estadistico. 1978 to 1982 figures are from El Banco Central de Reserva del Peru, Boletin. - 125 - ANNEX 5 PERW: Table I Selected Effective and Ex-Post Real Interest Rates a/ End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, domestic denom. Demand Nominal 0.0% 0.0% 0.0S 0.0% 0.0% 0.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 10.02 Ex-post real -5.4% -6.5% -15.0% -20.8% -22.52 -21.62 -28.0% -48.22 -39.72 -33.0% -47.52 -39.62 -59.2% Savings Nominal 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 9.0% 11.5% 29.02 30.52 30.5% 50.5% 55.02 Ex-post real -0.7% -1.9% -10.7% -16.9% -18.7% -17.7% -23.12 -43.42 -23.72 -14.3% -32.82 -10.9% -42.6% Term, 6 month Nominal 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 11.0% 14.0% 31.5% 31.5% 31.5% 63.0% 71.2% Ex-post real 1.2% 0.0% -9.0% -15.3% -17.1% -16.1% -21.7% -42.1X -22.3% -13.7% -32.3% -3.4% -36.6% Morgage bank certificates Nominal. 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 11.0% 14.0% 31.5% 33.0% 33.0% 61.6% 71.2% Ex-post real 3.1% 1.9% -7.3% -13.7% -15.6% -14.6% -21.7% -42.1S -22.32 -12.7% -31.5% -4.32 -36.6% Deposits, foreign denom. Nominal (in U.S.S) 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 4.6% 9.1% 11.4% 14.9% 11.0% 6.7% Ex-post real (in Soles) -0.7% -1.9% -10.7% -16.92 -18.7% 71.7% -1.8% -25.4% -15.0% -5.1% -10.8% 17.2% 1.6% Weighted average rate of return on above assets plus currency Ex-post real -3.1% -4.0% -12.7% -18.7% -20.6% -19.1% -26.4% -45.8% -31.4% -21.7% -32.6% -12.0% -30.0% Lending, dompatic denom. General Nominal 16.3% 16.3% 16.3% 16.3% 16.3% 16.3% 21.2% 24.2% 50.4% 52.7% 52.7% 98.0% 98.0% Ex-post real 10.0% 8.7% -1.1% -7.9% -9.9% -8.9% -14.52 -36.9% -11.1% 0.2% -21.4% 17.3% -26.6% Rediscount rates to the Banco Agrario Nominal 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 7.0% 9.0% 20.0% 21.0X 21.0% 29.0% 29.0% Ex-post real -1.6% -2.8% -11.6% -17.7% -19.4% -18.5% -24.5% -44.7% -29.1% -20.6% -37.7% -23.6% -52.2% Inflation (CPI) 6 months Forward from December 5.7% 7.0% 17.6% 26.3% 29.1% 27.6% 41.8% 97.0% 69.1% 52.3% 94.3% 68.8% 169.9% Devaluation 6 months Forward from December 0.0% 0.0% 0.0% 0.0% 0.0% 108.6% 32.6% 40.6% 31.7% 29.8% 50.8% 78.3% 156.8% Inflation (CPI) over Prior December 5.8% 7.6% 4.4% 13.8% 19.1% 23.9% 44.7% 32.51 73.7% 65.8% 60.8% 72.7% 65.6% Sources: 1970-77 interest rates are from La Superintendencia de Banca y Seguros, Boletin Estadistico. 1978-82 interest rates are from El Banco Central de Reserva del Peru, Boletin. CPI, exchange rate and LIBOR rate data are from the IMF, IFS, data tape. Weights for the weighted average are from Peru Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation rate six months forward from December. a/ The 1982 ceiling rate on demand deposits was 55%, actual rates paid were typically 10%, with 20% paid on large deposits. For 1981, term deposits and morgage bank certificates were compounded quarterly. For 1982, compounding was monthly. For 1970-76, dollar deposits were asammed to yield 52. For 1977-82, the yield was assumed to be LIBOR minus three percentage points. The effective, general lending rates were the ceiling rates plus 2 percentage points cocdission adjusted for 100% prepayment of interest and comiissions. - 126 - ANNEX 5 savers utilizing sol denominated instruments were greatly punished by inflation; correspondingly these assets shrank as a percentage of GNP (see Table 2). 11. In comparison, the ex-post rate of return, in soles, of dollar denominated assets remained much higher than the return on sol denominated assets. The dollar denominated assets even turned positive in 1981 and 1982. As can be seen in Table 2, this produced a massive shift into dollars, which climbed from 16.2% of total assets in 1978 to 38.9% in 1982. The growth in dollar assets was primarily responsible for the rise in the ratio of financial assets to GNP, rising from 14.3% in 1978 to 20.2% in 1982, a level which was much closer to the share of GNP that prevailed during the low inflation period, 1970-1975. 12. The ceiling rates for general sol credits also underwent an upward revision over the 1978-82 period. As a result, the effective real rate on sol credits became positive at the end of 1979 and 1981 (but not year-end 1980, as the December 1980 to June 1981 inflation rate surged to 94%). In early 1981, the nominal lending rate ceiling was raised to 47.5%. This rate, plus a two percentage point commission, together with the common practice of requiring borrowers to prepay interest and commissions, made possible an effective lending rate of 98.0%. For January 1981, this meant the real cost of borrowing for six months could have been as high as 18.2% (17.9% in January 1982). 13, In contrast to the general lending rates, the rate at which the central bank rediscounted loans through the Banco Agrario was highly concessionary during the entire period, remaining highly negative in real terms ex-post throughout. Moreover, despite the Central Bank's efforts to reduce its rediscounting activity and move towards more market-oriented rates, a wide variety of special rediscounting categories were maintained. Each category had its own particular interest rate ceiling. These rates ranged between the rate to the Banco Agrario up to the rate on general sol credits. However, the bulk of these credits were extended at highly negative real rates ex-post. The Pattern of Deposit Rates, Year-end 1982 14. In early 1982, the authorities adopted a uniform 55% nominal interest rate ceiling on all sol denominated deposits. This ceiling also included demand deposits, although the rate actually paid on these accounts was typically 10%, and ranged up to 20% on large accounts. By varying the length of the compounding period, the banks were able to pay effective rates higher than the nominal ceilings and provide some differential between types of accounts. Typically, term deposits and mortgage certificates were compounded quarterly and savings deposits were not compounded. Dollar deposits were not subject to a ceiling, but were paid roughly LIBOR minus three percentage points, in dollars. Thus the expected yield on dollar assets, in sol terms, depended on the expected rate on devaluation. These factors combined to generate the following structure of deposit rates: - 127- ANNEX 5 PERlU: Table 2 Levels of Selected Financial Assets in the Banking System End of Year (in bilions of Soles) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, domestic NomLkial 16.3 18.9 21.9 27.2 33.5 42.6 49.6 60.8 91.0 162.0 273.4 436.2 627.9 In 1980 prices 272.7 294.0 326.2 356.1 368.2 377.9 304.0 281.4 242.5 260.4 273.4 252.6 219.6 % of GNP 6.5% 6.8% 6.8% 6.8% 6.8% 6.6% 5.6% 4.7% 4.2% 4.3X 4.3% 4.1X 3.3% % of total assets 31.2% 31.6% 30.7% 31.8% 32.0% 34.5% 34.1% 32.0% 29.1% 25.8% 22.3% 20.0% 16.6% Deposits, dcmestic currency Dand Nmlnal 16.7 17.4 22.0 25.9 33.9 37.2 47.5 60.3 86.0 154.3 268.5 367.8 461.0 In 1980 prices 279.4 270.6 327.7 339.1 372.6 330.0 291.1 279.0 229.2 248.1 268.5 213.0 161.2 % of GNP 6.7% 6.3% 6.8% 6.5% 6.9% 5.8% 5.4% 4.77 3.9Z 4.1% 4.3Y 3.5% 2.5% % of total assets 31.9% 29.1% 30.9% 30.3% 32.4% 30.1% 32.7% 31.7% 27.5% 24.6% 21.9% 16.9% 12.2% Savings Nominal 8.0 8.9 10.0 11.3 12.8 15.0 17.1 21.6 30.2 67.0 137.8 355.7 680.2 In 1980 prices 133.8 138.4 149.0 148.0 140.7 133.1 104.8 100.0 80.5 107.7 137.8 206.0 237.9 % of GNP 3.2% 3.27 3.1% 2.8% 2.6% 2.3% 1.97 1.7% 1.4% 1.8% 2.2% 3.3% 3.6% % of total assets 15.3% 14.97 14.0X 13.2% 12.2% 12.2% 11.8% 11.4% 9.6% 10.7% 11.2% 16.3% 18.0% Term Noidnal 5.8 7.3 7.6 8.6 9.1 9.7 9.9 16.4 24.4 39.5 60.8 114.5 222.1 In 1980 prioes 97.0 113.5 113.2 112.6 100.0 86.1 60.7 75.9 65.0 63.5 60.8 66.3 -77.7 % of (l2 2.3Y 2.6% 2.4% 2.2% 1.8% 1.5Y 1.1% 1.3% 1.1% 1.0% 1.0% 1.1% 1.2% % of total assets 11.1% 12.2% 10.7% 10.1% 8.7% 7.9% 6.8% 8.6% 7.8% 6.3% 5.0% 5.3% 5.9% Morgpge bark certificates Nlomnal 5.1 7.1 9.5 12.1 14.6 18.2 19.8 23.8 30.8 59.1 107.1 242.4 322.3 In 1980 prices 85.3 110.4 141.5 158.4 160.5 161.5 121.4 110.1 82.1 95.0 107.1 140.4 112.7 % of GINP 2.0% 2.6% 2.9X 3.0% 3.0% 2.8% 2.2% 1.8% 1.4% 1.6% 1.7% 2.3% 1.7% % of total assets 9.870 11.9% 13.3X 14.2% 13.9% 14.7% 13.6% 12.5% 9.8% 9.4% 8.7% 11.1% 8.5% Deposits, foreign currency N mdnal in dollars 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.4 0.7 1.5 1.9 2.9 Nomdnal in soles 0.4 0.2 0.3 0.4 0.8 0.7 1.5 7.2 50.6 146.6 378.2 662.1 1470.4 in 1980 prices 6.7 3.1 4.5 5.2 8.8 6.2 9.2 33.3 134.8 235.7 378.2 383.4 514.2 % of total assets 0.8% 0.3% 0.4% 0.5% 0.8% 0.6% 1.0% 3.8% 16.2Y 23.3% 30.9% 30.4% 38.9% Total Nominal 52.3 59.8 71.3 85.5 104.7 123.4 145.4 190.1 313.0 628.5 1225.8 2178.7 3783.9 In 1980 prices 874.9 930.1 1062.1 1119.5 1150.8 1094.7 891.2 879.7 834.1 1010.4 1225.8 1261.6 1323.3 % of GNP 21.0% 21.6% 22.1% 21.5% 21.3% 19.3% 16.5% 14.7% 14.3% 16.6% 19.4% 20.5% 20.2% CPI, December (Dec.80-100) 6.0 6.4 6.7 7.6 9.1 11.3 16.3 21.6 37.5 62.2 100.0 172.7 285.9 Ewc ige rate, December 38.7 38.7 38.7 38.7 38.7 38.7 45.0 69.4 130.4 196.2 250.1 341.2 506.2 GNP, Dec. adjusted, nominal 249.6 277.0 322.2 397.2 492.1 640.6 882.7 1290.4 2188.6 3790.7 6308.5 10639.2 18760.0 Sources: Asset data are from the Banco Central de Reserva del Peru, Memria. GNP and CPI data are from the DMF, IF5, data tape. Notes: The GNP data have been logrithmically interpolated between the current year and one year forward so as to be expressed in Decemher prices. The figures exclude the non-bark financial sector, except for deposits in the banking system - 128 - ANNEX 5 Table 3 The Pattern of Effective Deposit Rates, year-end 1982 Deposits in Soles: nominal ex-post real demand 20% -59.2% savings 55% -42.6% term 71.2% -36.6% mortgage bank certificates 71.2% -36.6% Deposits in Dollars: 6.7% 1.6% Source: Table 1. 15. Even with the shortest allowable compounding period, the real effective interest rate ceiling on 801 deposits at the end of 1982 was highly negative ex-post and well below the yield on dollar deposits. Thus, the primary issue for savers was not whether to make long term sol deposits or not, but whether to shift their financial assets into dollars from soles. Judging from the ex-post yields, it seems clear that those who switched into dollars by the end of 1982, and held them for the six months, did extremely well compared to those that did not. The Pattern of Lending, year-end 1982 16. Due to the Peruvian government's traditional reliance on directed credit, the financial sector contains a large number of specialized financial institutions, each established to channel credit to particular areas in accordance with perceived needs. To support this institutional framework, the authorities maintained a regime of nominal lending rate ceilings. A sense of the breadth and complexity of the regime can be derived from Table 4, which displays the regime in effect as of December of 1982. Moreover, it should be noted that this regime represented a simplification of the system of directed credit which prevailed before 1978. - 129 - ANNEX 5 Table 4 Lending rate ceilings effective end of year '82 Loans in Soles: Credit institutions Mortgage and Housing Banks and Credit Unions 55.5% Loans for single dwellings Mortgage, Housing and Savings Banks 48.5% Credit Unions 52.0% Financial Enterprises 54.0% Insurance Co. loans to policy holders with policy guarantees 10.0% Inter-financial institution loan and deposit rate 60.0% Other loans short term 47.5% long term 54.0% Readjustment loans in accordance with Law 23327 for single dwellings 17.0% with present rates up to 47.5% 17.0% with present rates over 47.5% 22.5% Lines of Credit: Selective Regional Credit to financial intermediaries 41.5% to final users 44.5% Selective Agrarian Credit to financial intermediaries 43.5% to final users 49.5% Agricultural Promotion Credit to financial intermediaries 5.0% to final users 10.0% Promotional Funds: FONCAP and FIRE in soles to financial intermediaries 49.0% to final users 54.0% in U.S. $ to financial intermediaries 12.0% to final users 15.0% - 130 - ANNEX 5 FONEX in U.S. $ to financial institutions up to 1 year 6.0% up to 2 years 7.0% up to 3 years 9.0% up to 5 years 10.0% Loans from the Central Bank to: Commercial and Savings Banks 44.5% Regional Banks 43.5% Financial Enterprises 52.5% Agrarian Bank 29.0% Bank of the Nation 37.0% Bank of Industry FENT line in U.S. $ 0.0% in Soles 40.0% other loans 42.0% Mining Bank mining acceptances 3.0% other loans 42.0% COFIDE 42.0% FONAPS 42.0% Loan for subsidized single dwellings 31.0% Source: Banco Central de Reserva del Peru. 17. Without a better understanding of how the ceiling rates in Table 4 translated into actual costs of borrowed funds, it is not possible to pass final judgement on the interest rate regime either in terms of equity or efficiency. However, it is likely such a complex system fell far short on both accounts, either through the incidence of various implicit taxes, or through built-in rigidities. 18. A very serious consequence of the directed credit schemes and the resultant proliferation of financial institutions was the high degree of market fragmentation. The operations of many of the financial institutions were narrowly restricted, but they also enjoyed special sanctions that inhibited other institutions from entering their markets. The result was a marked lack of competition in many sub-markets and a limitation on the inter-sectoral mobility of financial resources. 19. These factors, in combination with the lack of scale economies and the high labor costs, contributed to excessive intermediation costs. Intermediation costs in Peru were high, even by developing country standards. Operating costs of Peru's commercial banks recently were estimated at 13.3% of total assets, which is far in excess of estimates for the OECD countries and substantially above estimates for Turkey and - 131 - ANNEX 5 Colombia (World Bank, 1983, p.l4), developing countries which have fairly high-cost financial markets. Such inefficiencies place a serious drag on the Peru's ability to mobilize financial resources and thus lower its growth potential. - 132 - ANNEX 5 Sources Banco Central de Reserva del Peru (various dates) Boletin, (Lima: Banco Central de Reserva del Peru, various issues). Banco Central de Reserva del Peru (various dates), Memoria, (Lima: Banco Central de Reserva de Peru, various isses). Mathieson, D. and R. McKinnon, "How to Manage a Repressed Economy," Essays in International Finance, No 145, (Princeton: Princeton University, Dept. of Economics, December 1981). La Superintendencia de Banca y Seguros (various dates), Boletin Estadistico, (Lima: La Superintendencia de Banca y Seguros, various issues). World Bank (1983), Peru: Brief Review of the Financial Sector, Report No. 4316-PE, (Washington, D.C.: World Bank, February 1983). ANNEX 6 THAILAND - 135 - ANNEX 6 VI. THAILAND Government Intervention in Financial Markets 1. In comparison to most developing countries, Thailand's financial sector is quite advanced, open and deep. Market forces, in particular, international market forces, govern the financial sector to a much greater degree than most countries at Thailand's income level. Correspondingly, the Thai government plays a relatively less important role, although it is far from a passive participant. 2. The relative importance of the market and intervention swung back and forth during the 1970 to 1982 period. Since 1970, the economy passed through episodes of relatively liberal economic policy (70-75) and of increasing intervention (75-80), Recently more market-oriented policies have again become the rule. 3. Despite a financial system on the free market end of the spectrum of developing countries, government intervention remained an important feature of the financial markets. However, the latitude for intervention was constrained in many areas by the government's overall policy objective of a stable and freely convertible currency. 4. Although the authorities imposed interest rate ceilings, these ceilings could not be set so low as to push the domestic deposit rates or the lending rate to prime borrowers much below the corresponding international rates. Due to free convertibility, such a disparity would induce capital flows that would worsen the mobilization of financial resources and threaten the stability of the Baht. In other words, if deposit rates were set too low, savers would be induced to place their deposits overseas, reducing the pool of domestically available resources and running down exchange reserves. Low lending ceilings would either pressure banks to lower the deposit rates to maintain their spreads, sending depositors overseas, or squeeze the profitability of domestic lending operations. Such a profit squeeze would cause the banks to constrict their domestic lending, and shift towards greater net foreign lending. Moreover, borrowers who obtain credit would find it profitable simply to deposit the funds abroad. Thus, low interest rate ceilings would adversely affect the mobilization of domestic and foreign resources and would put pressure on international reserves. 5. Even though the lending ceilings did not bind on short term credits to prime borrowers, i.e., the large and medium sized enterprises, the ceilings were set too low to adequately compensate for riskier and more costly lending operations, such as, term finance and lending to smaller enterprises. As a result, most term finance was undertaken through continuous refinancing short term debt, and many enterprises were forced to go into the informal credit market or queue up for rationed credit through the directed credit programs maintained by the Thai authorities. - 136 - ANNEX 6 6. These directed credit programs were quite sizable. They accounted for as much as a third of total credit extended and involved a majority of the country's financial institutions including the central bank, the commercial banks, plus a number of specialized lending institutions. The Bank of Thailand (the central bank) participated in these schemes in a number of ways and is an important source of funds. It did so by providing cheap rediscounting on bills of target borrowers with the commercial banks and the specialized lending institutions, such as the Government Housing Bank and the Bank for Agriculture and Agricultural Cooperatives (BAAC). 7. The authorities also required the commercial banks to lend 13% of their previous year's total deposits to agriculture, either by direct lending, by purchasing government bonds or by making deposits in BAAC. Since the rates of return to the commercial banks on these assets were less than the market rate on bank lending, they also formed a source of subsidized funds to the directed credit schemes. However, again the need to maintain domestically mobilized savings in the commercial banking system limited the amount of subsidization the authorities could impose. Otherwise, forced investments in low interest credits would force the commercial banks to lower their deposit rates, driving away some depositors. At the end of 1981, the average return to the commercial bank on assets connected with the agricultural credit schemes was about three quarters the ceiling rate on general commercial bank lending. Although this represented a healthy subsidy, it was close to the marginal cost of bank deposits, represented by the rate paid to long term deposits. 8. Other forms of government intervention in the financial markets included compulsory holding of government securities by the banks and a requirement that committed 60% of bank deposits gathered from a rural region to lending in that region. 9. In short, while the Thai financial sector could be counted among the developing world's most market-oriented, and certainly among the most open, the authorities maintained important institutional controls. However, the distortions created by these controls were limited by the overriding policy objective of maintaining a convertible currency and an open economy. The Development of Interest Rates 10. The regime of interest rate ceilings met with somewhat limited success in adjusting to inflationary developments and maintaining positive real rates ex-post--judging from Table 1, which displays a selection of nominal interest rate ceilings and the corresponding ex-post real rates, for the 1970-82 period. During this period, two waves of moderately high inflation swept through the Thai economy, in 1972-74, and again in 1977-81. These two surges closely corresponded to the movements of world inflation, both in timing and magnitude, with the Thai inflation running a little above world rate in the first, and approximately the world rate in the second. The impact of these inflationary episodes is readily apparent in the ex-post real - 137 - ANNEX 6 rates, for they moved decidedly negative during both the 1971-73 and 1976-80 periods. However, in comparison with most developing countries, the regime's performance was quite respectable, as measured by the frequency of positive real rates. Taken as a group, the year end figures for the ex-post real ceiling rates on savings deposits, 6 month term deposits, general loans and concessional export credits, were positive in 24 out of 52 instances, for the years 1970 to 1982. 11. Of all the interest rate ceilings displayed in Table 1 the rate on general loans and overdrafts remained positive in real terms most frequently. Of the thirteen end year figures, from 1970 to 1982, the real rate moved significantly negative only three times, in 1972, 1973 and 1979. This could be attributed to the fact that this rate must stay in line with the corresponding international rate, as discussed earlier. 12. In contrast to the rate on general credit, the ceilings on the discount rate on export bills, the savings and term deposit rate was negative, in real terms, more frequently. They all dropped below the rate of inflation in the same eight years, during the two inflationary surges, a common pattern worldwide. Moreover, after a couple of years of accelerated inflation the interest rate ceilings were moved upwards and maintained even after inflation fell off somewhat. This upward ratcheting process contributed to the subsequent appearance of positive real rates. The late 1980 reforms were clearly an example of this process. Table 1 shows a substantial increment of the ceiling rates for deposits and general lending. Savings deposits shifted upward from 5.5% to 8.0%, six month term deposits from 7.0% to 10.0%, and the general loans and overdrafts rose from 15.0% to 18.0%. These increases were sustained, and in some cases augmented, through 1981 and 1982 while inflation declined. 13. Conspicuously absent in 1980 was an upward adjustment of the discount rate for export bills. Also, the discount rate charged for agricultural bills, although it is not displayed in Table 1, was unaffected by the reforms, remaining unchanged at 10.0% since 1972. Despite the authorities' announced intentions to pursue more market oriented rates, apparently the reform program had its limitations. 14. In Table 2, which displays the levels of financial assets held in the commercial banks by the private sector, the effects of the 1980 reforms show up markedly. Total assets grew 32.1%, in real terms, from the end of 1979 to the end of 1982, and, as a share of GNP, rose to 41.9% in 1982, compared to 33.7% in 1979. The increase in the ceiling rates also affected the composition of asset holdings, accelerating the ongoing shift into quasi money from Ml. Thus, the 1980 reforms generated significant financial deepening. The Structure of Deposit Rates, year-end '82 15. The ceiling rates for various deposit accounts in the commercial banks at the end of 1982 are shown in Table 3. Some spread exists between maturities, but it is questionable whether that spread was adequate to - 138 - ANNEX 6 TRAILAND: Table I Selected Nominal and Ex-Post Real Interest Rate Ceilings End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, domestic denom. Demand Nominal 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Ex-post real -0.6% -7.1% -17.6% -26.0% -3.6% -2.6% -12.2% -11.0% -9.5% -22.1% -15.3% -3.3% -5.5% Savings Nominal 3.5% 3.5% 3.5% 3.5% 4.5% 4.5% 4.5% 4.5% 4.5% 5.5% 8.0% 9.0% 9.0% Ex-post real 2.8% -3.9% -14.7% -23.5% 0.8% 1.8% -8.3% -7.0% -5.4% -17.9% -8.5% 5.4% 3.1% Term, 6 months Nominal 6.0% 6.0% 6.0% 6.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 10.0% 11.0% 11.0% Ex-post real 5.3% -1.6% -12.6% -21.6% 3.2% 4.2% -6.1% -4.7% -3.2% -16.7% -6.8% 7.4% 4.9% Weighted average rate of return on above assets plus currency Ex-pNst real 2.4% -4.1% -14.8% -23.5% 0.5% 1.8% -8.2% -6.8% -5.3% -18.5% -9.4% 4.5% 2.4% Lending. domestic denom., General loans & overdrafts Nominal 14.0% 14.0% 14.0% 14.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 18.0% 18.0% 18.0% Ex-post real 13.2% 5.9% -6.1% -15.7% 10.9% 12.0% 1.0% 2.4% 4.1% -10.5% 0.0% 14.1% 11.6% Export (discount rate) Nominal 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% Ex-post real 6.3% -0.6% -11.8% -20.9% 3.2% 4.2% -6.1% -4.7% -3.2% -16.7% -9.3% 3.5% 1.2% Inflation (CPI) 6 months Forward froa December 0.7% 7.7% 21.3% 35.2% 3.7% 2.6% 13.9% 12.3% 10.5% 28.4% 18.0% 3.4% 5.8% Devaluation 6 mDnths Forward from December 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% O.OX 0.4% -0.2% 3.6% 0.0% 0.0% Inflation (CPI) over Prior December -1.3% 1.3% 8.8% 20.2% 17.9% 4.4% 3.4% 8.9% 7.8% 15.0% 16.4% 12.3% 2.6% Sources: Interest rates are from the Bank of Thailand, Monthly (Quarterly) Bulletin. CPI data are fran the INt, IFS, data tape. Weights for weighted average are from Thailand Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation rate six months forward from December. - 139 - ANNEX 6 THALAND: Table 2 Levels of Selected Financial Assets End of Year (in billions of Baht) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, dcxrnatic ?Iaiidnal 11.9 13.1 15.3 18.6 20.4 22.3 25.7 28.5 33.0 40.6 45.7 47.5 53.7 In 1980 prices 31.4 34.2 36.7 37.3 34.7 36.2 40.3 41.2 44.2 47.3 45.7 42.3 46.6 % of GNP 8.4% 8.5% 8.1% 7.7% 7.2% 7.0% 7.1% 6.7% 6.5% 6.7% 6.4% 6.07 6.2% % of total assets 28.7% 27.1% 25.5% 25.5% 22.9% 21.3% 20.6% 19.1% 18.4% 19.9% 18.3% 16.4% 14.9% Deposits, dmestic currency Dand Nlominal 6.9 7.7 8.8 10.6 12.5 13.0 15.1 16.4 21.1 22.2 25.1 25.0 23.5 In 1980 prices 18.4 20.2 21.2 21.1 21.1 21.2 23.8 23.7 28.2 25.8 25.1 22.3 20.4 % of CP 4.9% 5.0% 4.7% 4.4% 4.4% 4.1% 4.2% 3.8% 4.2% 3.7% 3.5% 3.2X 2.7% % of total assets 16.8% 16.07. 14.8% 14.4% 13.9% 12.5% 12.1% 11.0% 11.8% 10.9% 10.0% 8.6% 6.5% Saving omiLnal 2.7 3.0 3.9 4.9 6.3 7.2 8.9 10.7 14.2 17.2 27.1 36.8 60.0 In 1980 prices 7.2 7.7 9.3 9.8 10.7 11.8 14.0 15.4 19.1 20.0 27.1 32.7 52.1 % of GNP 1.9% 1.9% 2.0% 2.(0 2.2X 2.3% 2.4% 2.5% 2.8% 2.8% 3.8% 4.6% 7.0% % of total assets 6.6% 6;1% 6.4% 6.7% 7.1% 6.9% 7.1% 7.1% 8.0% 8.4% 10.8% 12.7% 16.6% Term N1xolnal 19.8 24.5 31.9 39.1 50.1 62.1 74.9 94.1 110.7 124.0 152.3 181.1 223.3 In 1980 prices 52.4 64.2 76.6 78.2 85.1 100.9 117.7 135.8 148.3 144.4 152.3 161.3 193.9 % of total assets 47.9% 50.9% 53.3% 53.4% 56.1% 59.3% 60.1% 62.9% 61.9% 60.8% 60.9% 62.4% 61.9% Total Nominal 41.3 48.3 59.8 73.2 89.3 104.6 124.6 149.7 179.1 204.0 250.3 290.4 360.5 In 1980 prices 109.5 126.3 143.8 146.4 151.7 170.1 195.8 216.0 239.7 237.5 250.3 258.6 313.0 % of GNP 29.4% 31.3X 31.7% 30.2% 31.3% 33.0% 34.3% 35.1% 35.5% 33.77 34.9% 36.7X 41.9% CPI, De er (Dec.80-100) 37.7 38.2 41.6 50.0 58.9 61.5 63.6 69.3 74.7 85.9 100.0 112.3 115.2 QlP, Dec. adjusted, onmLnal 140.5 154.2 188.4 242.5 285.1 316.9 362.7 426.2 503.8 606.2 716.9 791.6 860.1 Scrces: Asset data are fran the Bark of Thailand, Quarterly (Mithly) Alletin. GlP and CPI data are fran the fMF, IFS, data tape. Notes: The GNP data have been logrithmnicay interpolated between the acrrent year and one year forward so as to be expressed in Deceber prices. Deposits are nan-governint deposits in the caxrcial banks, whidch are 80-9M of all private deposits. - 140 - ANNEX 6 mobilize longer term deposits. In particular, the 3% spread between six month and two year deposits was probably not sufficient to cover the risk of committing funds for an additional year and a half, especially when inflation occasionally reached 20%. The banks, however, moved to reduce this risk somewhat by offering lower early- withdrawal penalties. Table 3 Interest Rate Ceilings on Deposits, year-end '82 nominal Demand deposits 0.0% Savings deposits 9.0% Time deposits 3 to 6 months 11.0% 6 to 12 months 12.0% 1 to 2 years 13.0% over 2 years 14.0% Source: Bank of Thailand, "Quarterly Bulletin." The Pattern of Lending Rates, year-end '82 16. In comparison with the 19% ceiling rate, which binds on most borrowers, and the 15% to 60% rates paid in the informal credit market for up to half of all credit (World Bank, 1982, V.I, p.15, V.III, p. 75), the preferential lending rates displayed in Table 4, of 7% to 10%, were difficult to justify on efficiency grounds. Judging from the large volume and widespread credit transactioned at rates well above the preferential rates many investment opportunities existed at rates much higher than those offered preferentially. This makes it difficult to argue that the net effect of the preferential credit programs was to mitigate capital market imperfections and direct resources to applications with the highest return. 17. It is also possible to question the credit programs on distributional grounds. By their nature, rationing schemes at below market rates tend to favor the higher income, more creditworthy borrowers in both the target and general markets. Furthermore, the suppressed cost of funds promotes investment in overly capital intensive method of production. Both of these phenomena have been observed in Thailand. Clearly, these results is at odds with the stated objectives of poverty alleviation. - 141 - ANNEX 6 Table 4 Commercial Bank Lending Rates, year-end '82 nominal Loans and overdrafts 19.0% Discount rates (rediscounted from the Bank of Thailand) export bills 7.0% bills from industrial undertakings 7.0% bills from purchases of agricultural products 7.0% agricultural bills 10.0% Source: The Bank of Thailand, "Quarterly Bulletin." 18. The development of "groups" that hold ownership interests in both the firms and the banks also reduce the potential improvements in equity and efficiency which originally motivated the programs. Much of the incentive for the formation of such groups can be traced to intervention and the credit rationing process. Firms may try to gain access to under priced credit by owning the bank, or the banks may attempt to recapture the transfer from creditor to borrower, implicit in negative real rates, by owning its borrowers. 19. Comparing the 11% rate paid on six month time deposits, a good benchmark for the interest cost of commercial banks deposits, (World Bank, 1982, Vol. 3, p. 68) to the general lending ceiling rate of 19% reveals a healthy gross spread of 8%. In contrast, the spread for concessional lending was much smaller. Since these discount rates were offered on credits, which were, in turn, rediscounted by the Bank of Thailand, the cost of these funds to the commercial banks was the rediscount rates of 5%. Thus, on credits discounted at 7% the spread was a rather small 2%. Such a small spread was unlikely to fully cover the cost of the lending operation, and some of the cost must have been borne by the non-preferential borrowers. This transfer, in addition to the direct cost borne by the government through the central bank, must be included in an assessment of the economic cost of the funds used in the preferential credit program. - 142 - ANNEX 6 Sources Bank of Thailand (various dates), Quarterly Bulletin (Bangkok: Bank of Thailand, various issues). World Bank (1982), Thailand: Perspectives for Financial Reform, Vol. I-III, Report No. 4085-TH, (Washington, D.C.: World Bank, December 1982). ANNEX 7 TURKEY - 145 - ANNEX 7 VII. TURKEY Government Intervention in the Financial Markets 1. Throughout the 1970 to 1983 period, the Turkish government intervened extensively in the financial markets, directing much of the credit allocation process through administered interest rates and subsidized credit channelled to numerous sectors in the economy--public enterprises, agriculture, housing, exports, artisans and small traders, etc. A number of additional instruments were used to manipulate the cost of credit including: specific quantity directives; specialized financial institutions; interest surcharges and rebates; preferential tax treatments; reserve requirements; and the rate of interest paid on reserves. As recently as 1983, it was estimated that only about one quarter of total credit was free of government controls, and these were generally lent at comparatively high interest rates. 2. Beginning in the second half of the 1970s, the system of administered nominal interest rates was placed under a great deal of stress by sharp increases in inflation rates. During the 1977-80 period, inflation surged from less than 20% to in excess of 80%, driving virtually all real (ex-post) lending and deposit rates to significantly negative levels. In June 1980, term deposit rates and some lending rates were liberalized, granting market forces a freer hand, and allowing some rates to mDve upwards sharply. 3. By 1982, the success of the anti-inflationary policies, combined with the loosening of interest rate controls and the large amounts of directed credit at low interest rates, produced abnormally high real interest rates in the small part of the credit market with free rates. With the government's strong commitment to anti-inflationary policy, the authorities responded to the sharp rise in the real cost of lending by seeking to reduce the cost of deposits, rather than pursuing expansionary monetary policy. In January 1983, the authorities lowered reserve requirements, raised the ceiling on savings deposit rates, and reimposed ceilings on term deposit rates. In some respects, the reimposition of the deposit ceilings represents a partial retreat from the liberalization of 1980. 4. At the end of 1982, the Turkish financial market still contained many elements characteristic of financially repressed economies, such as credit rationing, compensating balances, and movements into short term assets. Thus, in spite of the 1980 liberalization, market forces had only a limited role in determining interest rates and non-price mechanisms remained major outlets for market pressures. - 146 - ANNEX 7 The Development of Interest Rates 5. Table 1 shows the development of various interest rates, nominal and ex-post real. Here the most striking feature is the absence of positive real interest rates from 1973 until 1981. At that point the rate on six month term deposits and the rates charged for general credits became abruptly positive. In 1982 these same rates became highly positive; the real rate paid for general short term credits reached 34.3% and the six month deposit rate rose to 22.1%. In contrast, the real rate charged for short term agricultural credit and the rate paid on savings deposits remained negative throughout 1973-82. 6. The 1977-80 inflationary surge broke the 1973 to 1982 period into three distinct episodes of interest rate behavior: 1973-77, 1977-80, and 1980-82. During the 1977-80 period, real rates reached extraordinarily negative levels, as low as -60%. These highly negative rates greatly stressed the financial system and prompted the reforms of June 1980. However, it is important to note that highly negative real rates were not merely a result of this surge. They were, in fact, a long standing condition, since they were also present prior to 1977. 7. The post-1980 development of the nominal rates for general lending and for term deposits reflected the 1980 liberalization, with rates moving up sharply. The combination of higher nominal rates and declining inflation produced an abrupt upward shift in the real rates; the term deposit and general lending rates both moved directly positive. In contrast, the unliberalized rates for agricultural credits and sight savings only moved back up to roughly the same negative real levels that prevailed during the pre-1977 period. Thus, the 1980 liberalization of term deposit and general credit rates notwithstanding, the system of administered interest rates only partially adjusted to inflationary pressures, and did not provide a wide ranging mechanism for allocating credit. 8. The combined effect of the high positive real rate on term deposits and the massive shift into these assets carried the weighted average of returns on financial assets to a positive level in 1982, relieving a long standing pattern of financial repression. As shown in Table 2, the 1980 easing of financial repression sparked a reversal of the general flight from financial assets. The ratio of total assets to GNP rebounded from the extremely depressed level of 16.3% in 1980 to 25.5% in 1982. The bulk of this upswing was caused by the massive rise in time deposits, which increased from 15.9% of total assets in 1979 to 45.7% in 1982 in direct response to the high real rates paid on such deposits: 13.8% in 1981 and 22.1% in 1982. Although the liberalization program was highly successful in mobilizing financial savings, the negative side of this development was the high average cost of deposits and the resultant high real lending rates on the portion of credit subject to the liberalized lending rates. - 147 - ANNEX 7 TURKEY: Table I Selected Niminal and Ex-post Real Interest Rates End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Deposits, domestic dencm. Demand Nominal #N/A tN/A #N/A 0.0% 2.0% 2.0% 2.0% 2.0% 0.0% 0.0 0.0% 0.0% 0.02 Ex-post real #N/A #N/A tN/A -12.8% -17.5% -10.0% -16.7% -24.2% -43.3% -63.9% -24.6% -24.2% -18.62 Savings Nominal #N/A UN/A UN/A 2.5% 3.02 3.0% 3.0% 3.0% 3.0% 3.0% 5.0% 5.0% 5.02 Ex-post real UN/A #N/A UN/A -10.7% -16.7% -9.1% -15.8% -23.4% -41.6% -62.8% -20.8% -20.42 -14.5% Term, 6 month Nominal #N/A #N/A UN/A 4.0% 6.0% 6.0% 6.0% 6.0% 9.0% 12.0% 32.02 50.0% 50.0% Ex-post real tN/A #N/A UN/A -9.3% -14.3% -6.5% -13.4% -21.2% -38.2% -59.5% -0.4% 13.8% 22.1% Weighted average rate of return on above assets plus currency Ex-post real UN/A #N/A UN/A -11.2% -16.9% -9.4% -16.2% -23.9% -42.1% -62.9% -18.82 -8.2% 1.2% Lending, domestic denam. General, short term Nominal UN/A UN/A #N/A 8.8X 9.0% 9.0% 9.0% 9.0% 10.0% 10.8% 26.0% 65.0%a/ 65.02 a/ Ex-post real UN/A UN/A UN/A -5.2% -11.9% -3.82 -10.9% -19.0% -37.7% -60.0% -5.0% 25.12 34.32 Ag. credits, short term Nominal UN/A UN/A UN/A 7.02 8.02 8.02 8.02 8.02 8.02 11.5% 13.5% 20.0% 18.0% Ex-post real UN/A UN/A UN/A -6.7% -12.7% -4.7% -11.8% -19.7% -38.8% -59.7% -14.42 -9.0% -4.0% Inflation (CPI) 6 months Forward from December 20.3% 6.42 22.6% 14.72 23.7% 13.32 22.42 34.52 76.52 176.82 32.62 31.92 22.92 Devaluation 6 months Forward from December 172.62 -10.12 0.0% -7.12 2.22 13.8% 12.52 68.7% 96.02 396.72 50.82 53.7% 40.72 Inflation (CPI) over Prior December 12.32 17.6% 9.22 16.82 16.7% 19.6% 17.0% 44.6% 36.6% 81.1% 86.2% 30.3% 32.82 Sources: Interest rates are from the Central Bank /&arterly Bulletin, and the World Bank, Turkey, Special Economic Report: Policies for the Financial Sector, Report #4459-7U. CPI data are from the IMF, IFS, data tape. Weights for weighted average are from Turkey Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation rate six months forward from December. a/ World Bank staff estimate, see page 16 of Report t4459-TU. - 148 - ANNEX 7 TURKEY: Table 2 Levels of Selected Financial Assets End of Year (In billions of Turkish lira, TL) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 Currency, domestic Nominal 11.9 13.9 16.0 20.7 26.2 32.9 42.5 63.0 93.8 143.7 217.5 280.6 411.9 In 1980 prices 194.1 192.7 203.2 225.0 244.1 256.3 283.0 290.1 316.3 267.5 217.5 215.4 238.1 X of GNP 7.1% 6.5% 5.92 5.7% 5.5% 5.5% 5.52 5.9% 5.6% 4.62 4.0% 3.72 4.1Z X of total assets 27.0% 24.62 22.6% 23.0% 23.2% 22.5% 23.5% 25.9% 28.6% 27.4% 24.7% 17.2% 16.12 Deposits, domestic currency Demand Nominal 6.6 8.7 11.8 16.0 22.6 32.1 44.9 63.0 86.0 154.5 286.0 458.5 651.3 In 1980 prices 107.7 120.6 149.8 173.9 210.5 250.1 299.0 290.1 290.0 287.7 286.0 352.0 376.5 % of GNP 3.9% 4.0% 4.32 4.42 4.72 5.32 5.82 5.9% 5.12 4.9% 5.3% 6.12 6.5X 2 of total assets 15.0% 15.42 16.7% 17.8% 20.0% 22.0% 24.8% 25.9% 26.32 29.4% 32.5% 28.1% 25.51 Savings Nominal 16.8 20.9 24.9 32.9 39.7 52.2 62.7 82.4 103.3 143.7 197.4 228.5 275.5 In 1980 prices 274.0 289.8 316.2 357.6 369.8 406.6 417.5 379.5 348.3 267.5 197.4 175.4 159.3 2 of GNP 10.02 9.7% 9.12 9.02 8.3% 8.72 8.22 7.82 6.12 4.62 3.72 3.02 2.8Z % of total assets 38.1% 37.02 35.2% 36.52 35.12 35.72 34.72 33.92 31.52 27.42 22.5% 14.0X 10.8X Term Nominal 8.8 13.0 18.0 20.5 24.6 29.0 30.8 34.4 44.4 83.3 177.9 665.1 1212.2 2 of GNP 5.2% 6.0X 6.62 5.62 5.12 4.82 4.0% 3.2% 2.6% 2.72 3.3% 8.8% 12.1% 2 of total assets 20.02 23.02 25.52 22.82 21.82 19.82 17.02 14.22 13.62 15.92 20.2X 40.7% 47.5X Total Nominal 44.1 56.5 70.7 90.1 113.1 146.2 180.9 242.8 327.5 525.2 878.8 1632.7 2550.9 In 1980 prices 719.3 783.4 897.8 979.3 1053.5 1138.9 1204.6 1118.1 1104.2 977.8 878.8 1253.3 1474.7 2 of GNP 26.12 26.2% 25.92 24.82 23.62 24.32 23.62 22.92 19.4X 16.8% 16.3% 21.62 25.5% CPI, December (Dec.80-100) 6.1 7.2 7.9 9.2 10.7 12.8 15.0 21.7 29.7 53.7 100.0 130.3 173.0 GNP, Dec. adjusted, nominal 168.7 215.4 273.1 363.8 478.3 601.3 767.6 1061.4 1684.9 3123.3 5391.5 7560.5 10017.9 Sources: Asset data are from the Central Bank of the Republic of Turkey, Quarterly Bulletin. CPI and GNP data are from the DIF, IFS, data tape. Notes: The GNP data have been logrithmically interpolated between the current year and one year forward so as to be expressed in December prices. - 149 - ANNEX 7 Deposit Rates, year-end 1981 9. Judging from the array of deposit rates shown in Table 3, the real return on deposits was positive only on fixed term deposits of 6 months or longer maturity. Although the real rate on 6 month deposits rose to a rather high 13.8%, there was no incentive to commit funds for longer periods than 6 months, as the interest rate ceilings provided no additional spread for maturity. The size of the risk premium which savers required to commit funds long term, given the volatility of the past inflation, and the risk to financial institutions of accepting such long-term liabilities made it unlikely that longer term deposits would have been important even in a free market. Table 3 Deposit Rate Ceilings, year-end 1981 Term Deposits nominal ex-post real 1 month 25.0 -25.5 2 months 35.0 -29.8 3 months 45.0 -18.2 6 months 50.0 13.8 1 year 50.0 13.2 2 years 50.0 #N/A 3 years 50.0 #N/A 4 years 50.0 #N/A over 4 years 50.0 #N/A Source: The World Bank, Turkey, Special Economic Report...," #4459-TU. Lending Rates, year-end 1982 10. In the following table, a sample of the wide variety of lending terms is presented. The nominal rate charged appears in the left column, and the effective rate charged, net of the surcharge or subsidy of the IRRY, the transactions tax and bank commission, appears in the right. However, the effective rate does not reflect the effects of compensating balance requirements or other taxes. - 150 - ANNEX 7 Table 4 Lending Rate Ceiling, year-end 1982 in percent per annum Short Term Credits: nominal effective Credit from Central Bank to TMO for agricultural support purchases 10.0 11.0 Agricultural Credits 20.0 20.0 Artisan and small traders 20.0 20.0 Export Credit Industrial products 31.5 28.8 Other credits 31.5 35.1 General Credits 36.0 47.3 Commercial bank credits to SEE's 36.0 42.3 Medium and Long Term Credits: Investment credits to SEE's by State Investment Bank 21.5% 21.5% Agricultural credit from the Agricultural Bank 22.0 22.0 Artisan and small traders credit from the Halk Bank 22.0 22.0 Housing credits form the housing bank, construction savings system and social housing credit 16.0 18.4 Housing credit scheme and cooperative Society credit 22.0 25.3 Commercial housing 35.5 44.4 Export oriented, in Underdeveloped regions 29.0 20.8 Other regions 29.0 25.2 Other loans in underdeveloped regions 38.0 28.6 Rediscountable loans for manufactures of investment goods 31.5 28.5 Rediscountable working capital loans In underdeveloped regions 38.0 40.3 In other regions 38.0 46.0 Other Medium and Long Term Loans nominal effective Investment Loans Export oriented In underdeveloped regions 45.0 29.3 In other regions 45.0 36.0 - 151 - ANNEX 7 (Table 4 continued) Other medium and Long Term Loans nominal effective Other In underdeveloped regions 45.0 31.5 In other regions 45.0 45.0 Working capital loans In underdeveloped regions 45.0 45.0 In other regions 45.0 51.8 Source: The World Bank, "Turkey, Special Economic Report...," #4459-TU. 11. Despite recent efforts to rationalize the pattern of lending rates, there obviously remained a wide dispersion of rates in 1982, both nominal and effective. The importance of the subsidies, taxes and commissions on the structure is also quite apparent, as they resulted in an effective rate of 47.3% on general short term credits, compared to the nominal rate of 36.0%, and an effective rate of 29.3% on investment loans for export oriented enterprises in underdeveloped regions, compared to a nominal rate of 45.0%. Additional disparities between nominal and effective rates were produced by compensating balance requirements and other practices, generally to the detriment of non-preferential borrowers. 12. The most preferential lending rates were offered to the agriculture sector, artisans and small traders, with housing, state economic enterprises and export promotion following. Non-preferential borrowers were left to compete for the small amount of remaining credit, while paying effective rates of 65% or more when accounting for the costs of compensating balances. These high real rates threatened many firms with insolvency. 13. Taken as a system, the rationality of the array of rates is suspect. First, even at the government's optimistic inflation projection of 20% for 1983, there were a number of effective interest rates that were negative in real terms. Second, the differences in the rates probably did not accurately reflect the relative social rates of returns, or the social cost of the funds. While the policy objective of steering income towards a particular group in the economy may have been served by an interest rate differential in excess of 27% between credit to agriculture and general borrowers, it was unlikely this differential was well grounded in relative productivities. The same can be said for almost any pair of rates in the array. Furthermore, the absence of a pronounced spread in the long term lending rates, necessary to cover additional costs and risks associated with term finance, dampened the incentive for financial intermediaries to make such loans. 14. In conjunction with an estimate for the average cost of funds, the lending rates in Table 4 can also be used to roughly approximate the various intermediation spreads. For the first quarter of 1983, the average - 152 - ANNEX 7 cost of deposits available for commercial bank lending was estimated to be 30.4% (World Bank, 1983, p.21). This figure included the interest paid on the different types of deposits, and the net cost of reserve and liquidity requirements. While more precise calculations would require estimates of all the commissions, compensating balances, tax adjustments, etc., the calculations based on Table 4 indicate that a large number of rates were nominally below average costs of deposits. Clearly, a great deal of back door adjustment and government intervention was required to sustain this system, casting substantial doubt on the system's effectiveness in achieving its policy objectives. 15. It has been also estimated that, in 1982, the cost of intermediation added six percentage points to the average lending rate (World Bank, 1983, p.26). This was about two times that of other OECD countries. High administration costs, associated with large quantities of directed credit and the rapid turnover of funds due to high inflation contributed to this cost of intermediation, as did "over-branching" by the banks. Such over-branching is a typical response to ceilings on deposits rates. While the lending rate ceilings can be more easily evaded through compensating balances, commissions, etc., deposit limits cannot be so easily bent, and banks therefore compete for deposits by branching. The resulting excessive staff and overhead costs contribute to high intermediation costs. 16. In sum, as of early 1983 continued progress towards rationalizing financial sector policies in general, and interest rates policies in particular, was sorely needed. Furthermore, such progress could be expected to yield substantial economic gains in terms of the mobilization of financial savings and the efficiency of their allocation, by stabilizing the financial system and by reducing market fragmentation, subsidization and the cost of intermediatation, - 153 - ANNEX 7 Sources: Central Bank of the Republic of Turkey (various dates), Quarterly Bulletin (Ankara: Central Bank of the Republic of Turkey, various issues). World Bank (1983), Turkey, Special Economic Report: Policies for the Financial Sector, Report No. 4459-TU, (Washington, D.C.: World Bank, September 1983). ANNEX 8 URUGUAY - 157 - ANNEX 8 VIII. URUGUAY Government Intervention in Financial Markets 1. The period 1970 through 1983 witnessed a thoroughgoing overhaul of the government's role in Uruguayan financial markets. The first few years of the period were marked by a regime of administered interest rates, credit rationing and the pervasive use of quantity directives. Then, between 1974 and 1979, government intervention was systematically reduced, as part of a major shift in economic policy towards liberalization. These reforms led to a financial market which is among the most free and open in the developing world. 2. The principal aspects of the 1974-79 financial sector liberalization included: the legalization of foreign currency denominated contracts and assets, including bank deposits (1974); the successive lifting of interest rate ceilings towards levels in line with market conditions--with their final abolishment in 1979; the elimination of sectoral credit allocation guidelines (1975); and the termination of reserve requirements on commercial banks (1979). During the same period, the government's budget deficit was closed, eliminating the need for the government to capture resources through seigniorage. 3. In the post-reform period, the market, however imperfect, became the principal determinant of the interest rates. This is not to say, however, that the government abandoned the field entirely. It retained a substantial role in credit allocation, through the publicly owned Banco de la Republica and the Banco Hipotecario del Uruguay (Mortgage Bank). In addition, attempts were made to influence the cost of credit through the foreign exchange markets. 4. The government's participation in the allocation of credit declined sharply in the seventies. The share of the Central Bank in total credit fell dramatically, from about 70% of total credit in 1974 to only 12% in 1980. To a large extent this fall reflected the elimination of the government's budget deficit. The other government financial intermediaries-- the Banco de la Republica and the Banco Hipotecario--also declined in importance. For example their combined share of private sector credit in 1982 was 37%, compared to 64% in 1974. Correspondingly, private financial intermediaries extended 63% of private sector credit in 1982, versus 36% in 1974. Thus, the government's role, though substantially reduced, remained large and influential. Moreover, the terms on which credit was extended from the publicly owned financial institutions to the priority sectors--agriculture, exports and housing--steadily approached those prevailing in the market. 5. With the opening of the financial markets and the elimination of reserve requirements and interest rate ceilings, the government abandoned most of its control over money creation and interest rates. However, it did attempt to reduce the rate of inflation and the interest differential between credits denominated in domestic and foreign currency through exchange market policies. - 158 - ANNEX 8 6. During the 1979-1981 period, the government sought to reduce inflation by preannouncing the rate of devaluation. This was a switch from the 1975-79 policy of a more or less passive crawling peg, which moved at a rate roughly equal to the difference between local and foreign inflation. The shift to an active exchange policy was to be accompanied by a reduction in the level of protection--a reduction that actually occurred quite slowly. The government's objective was to limit the future rate of inflation in import prices, and to remove the impression from the minds of domestic producers that they could count on the exchange rate and the system of protection to passively validate price increases. The intended result was to reduce domestic inflation to approximately worldwide rates, without suffering any loss of employment. 7. The authorities also tried to lower the difference between dollar and peso interest rates by providing inexpensive foreign exchange guarantees during the second and third quarters of 1981 and the first part of 1982. The guarantees were intended to increase arbitrage between foreign funds and domestic credit, thereby reducing the interest rate differential between financial transactions denominated in dollars and those denominated in pesos. 8. Both policies did meet with some success; the rate of inflation did decline, though it remained above the devaluation adjusted world rate; and the interest rate differential was reduced somewhat, although the peso interest rates did not actually decline due to the rise in foreign rates. However, both policies had to be abandoned as unsupportable, victims of the increasingly overvalued real exchange rate, the sudden changes in world financial markets, the sharp changes in the Argentine economy, and a rapid increase in the the public sector deficit. In November 1982 the exchange rate was allowed to depreciate more than 100%; since then the exchange rate regime has been a "dirty" float. This massive devaluation, combined with the large build-up of dollar credits before 1982, produced significant financial pressures on borrowers and the financial intermediaries themselves. The Central Bank has been forced to intervene in various banks and support them through purchases of some of their liabilities. Meanwhile, the economy remains in the recession that has gripped Latin America. 9. In sum, during the last decade the Uruguayan government moved decisively to relinquish its control of the country's financial markets, leaving them predominantly in the hands of the private sector and open to international forces. However, rapidly changing world and local conditions interacted with the "dollarization" of the financial system to generate serious financial difficulties. The Evolution of Interest Rates 10. Table 1 displays an array of Uruguayan interest rates, nominal and ex-post real, for the period 1970 to 1982. Table 2 shows the development of financial assets during the same period. A few words are warranted regarding the numbers presented. First, all the numbers were year-end figures, and second, the real rates were calculated ex-post, i.e., - 159 - ANNEX 8 URUGUAY: Table 1 Selected Nominal and ex-post Real Interest Rates End of Year (annualized) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 a/ 1982 Deposits, domestic denom. Demand Nominal 0.0% 0.0% 0.0% 0.0% 10.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Ex-post real -16.9% -49.2% -46.2% -44.8% -30.5% -15.5% -40.2% -28.9% -43.1% -32.1% -23.8% -9.8% -39.5% Savings Nominal 6.0% 6.0% 6.0% 8.0% 18.0% 18.0% 21.6% 25.5% 22.8% 24.0% 25.2% 24.0% 24.2% FE-post real -12.0% -46.2% -43.0% -40.4% -25.4% -0.2% -27.3% -10.8% -30.1% -15.9% -4.6% 11.8% -24.9% Term, 6 month Nominal 15.0% 15.0% 15.0% 18.0% 30.0% 30.0% 30.2% 51.4% 42.6% 50.6% 50.3% 47.4% 66.2% Ex-post real -4.5% -41.6% -38.1% -34.9% -17.8% 9.9% -22.1% 7.6% -18.9% 2.2% 14.6% 32.9% 0.5% Deposits, foreign deanm. Demand Nominal (in U.S.$) ON/A #N/A 5.5% 5.5% 5.5% 5.5% 5.6% 5.4% 5.5% 5.5% 5.7% 5.5% 5.8% Ex-post real (in N$) #N/A ON/A -18.5% -15.3% 32.0% 30.3% -14.7% -10.0% -24.4% -19.0% -7.7% 10.5% -41.4% Term, 6 month Nominal (in U.S.$) ON/A #N/A 8.0% 8.0% 8.0% 8.0% 7.4% 7.5% 8.0% 11.9% 14.6% 13.1% 10.2% Ex-post real (in N$) EN/A ON/A -16.6% -13.3% 35.2% 33.4% -13.2% -8.2% -22.6% -14.1% 0.1% 18.5% -39.0% Weighted average rate of return on above assets plus currency Ex-post real (1) #N/A ON/A -43.7% -40.5% -21.2% 0.5% -27.4% -13.6% -28.9% -17.0% -4.2% 13.3% -33.4% Ex-post real (2) ON/A EN/A -43.7% -40.4% -20.8% 1.1% -26.9% -12.8% -28.2% -15.1% -1.5% 16.9% -31.7% Lending, domestic denom. (fixed tem up to 6 mo.) Average Nominal ON/A ON/A ON/A ON/A #N/A #N/A 62.0% 76.6% 71.2% 68.1% 65.1% 59.8% 76.3% Ex-post real fN/A ON/A ON/A #N/A #N/A ON/A -3.1% 25.5% -2.6% 14.1% 25.9% 44.1% 6.6% Primae Nominal ON/A #N/A ON/A ON/A ON/A #N/A 47.6% 65.8% 59.7% 49.9% 49.8% 46.5% 56.7% Ex-post real ON/A ON/A ON/A ON/A #N/A ON/A -11.7% 17.9% -9.1% 1.7% 14.2% 32.1% -5.2% Preferential Nominal ON/A ON/A ON/A ON/A ON/A ON/A ON/A ON/A #N/A #N/A ON/A ON/A ON/A Ex-post real ON/A ON/A ON/A ON/A ON/A #N/A ON/A ON/A ON/A ON/A ON/A #N/A ON/A Lmenig foreign denom. ( olerciat) Average Nominal (in U.S.$) ON/A ON/A ON/A ON/A #N/A ON/A 12.0% 13.8% 14.2% 16.3% 18.5% 18.4% 18.2% Ex-post real (in NS) #N/A #N/A #N/A N/A ON/A ON/A -9.5% -2.8% -18.1% -10.3% 3.5% 24.1% -34.5% Prime Nominal (in U.S.S) ON/A #N/A ON/A ON/A #N/A #N/A ON/A ON/A ON/A 15.8% 17.4% 16.8% 17.2% Ex-post real (in NS) #N/A #N/A ON/A ON/A ON/A ON/A ON/A ON/A ON/A -11.1% 2.5% 22.4% -35.1% Inflation (CPI) 6 months Forward from December 20.4% 97.0% 85.8% 81.2% 58.2% 18.3% 67.2% 40.7% 75.8% 47.4% 31.2% 10.9% 65.3% Devaluation 6 months Forward from December 0.0% 139.0% 43.5%1 45.4% 98.0% 46.1% 35.1% 20.1% 26.0% 13.1% 14.6% 16.2% -8.4% Inflation (CPI) over Prior December 20.1% 35.2% 95.6% 77.6% 106.8% 67.3% 39.4% 57.6% 45.8% 83.1% 42.9% 29.3% 20.5% Sources: Interest rate data are from Banco-Central del Uruguay, Boletin Estadistico. CPI and exchange rate data are from the I?1, IFS, data tape. Weights for the weighted average are from Uruguay Table 2. Notes: Real rates were calculated ex-post, i.e., they reflect the inflation (and devaluation) rate six months forward from December. Weighted average (1) assuma that all foreign assets are savings deposits; (2) assumes all time deposits. a/ Since the real rates look forward six months from December, the 1981 figures do not reflect the November 1982 devaluation. - 160 - ANNEX 8 URUt71AY: Table 2 levls of Seleted Finan l Assets Ed of Year (leyels in bdllions of NEw Pesos or U.S.$) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 a/ Curr, daestic Nmdnal 0.1 0.1 0.2 0.2 0.3 0.5 0.8 1.1 1.8 3.2 5.1 6.1 7.8 In 1980 prices 7.8 8.5 10.4 5.8 4.4 3.9 4.7 4.2 4.7 4.5 5.1 4.7 5.0 % Of GDP OIN/A ON/A 11.3Z 5.9% 5.2% 4.6% 4.9% 4.5% 4.3 4.3 4.6% 4.8% 5.1% Z of total assets fN/A #N/A 54.8% 39.6% 34.2% 28.8% 23.8% 19.6% 16.8% 15.6% 14.7% 11.7% 8.5% Deposits, donestic awrency Da-d Noinal WN/A ON/A 0.1 0.1 0.2 0.4 0.5 0.8 1.3 2.6 3.6 3.6 3.6 In 1980 prices GN/A dN/A 3.6 3.8 3.2 3.0 3.3 2.9 3.3 3.7 3.6 2.8 2.3 Z of a!' ON/A ON/A 3.9% 3.8% 3.7% 3.5% 3.4% 3.0% 3.0% 3.6% 3.3% 2.8% 2.4% Z of total assets ON/A ON/A 18.8% 25.6% 24.6% 21.7% 16.6% 13.3Z 11.8% 12.9% 10.5% 6.8% 3.9% Savings tnaxml #N/A 1N/A 0.0 0.0 0.1 0.1 0.3 0.4 0.8 1.5 2.7 3.9 4.3 In 1980 prices ON/A ON/A 1.6 1.4 1.0 1.2 1.7 1.5 2.0 2.2 2.7 3.0 2.8 % of GP ON/A ON/A 1.8% 1.4% 1.Z2 1.4% 1.8% 1.6% 1.8Z 2.1% 2.5% 3.0% 2.8% 2 of total assets ON/A ON/A 8.7% 9.6% 8.0% 8.7% 8.7% 7.2% 7.1% 7.6% 7.9% 7.4% 4.7% Term lNinal IN/A ON/A 0.1 0.1 0.2 0.3 0.6 0.8 2.4 5.3 11.4 15.1 15.5 In 1980 prioes ON/A ON/A 2.6 2.7 2.5 2.8 3.4 3.2 6.2 7.6 11.4 11.7 9.9 2 of (1P ON/A ON/A 2.9% 2.7% 2.9% 3.2% 3.6% 3.4% 5.6% 7.2% 10.4% 11.8% 10.0% % of total assets ON/A ON/A 13.9% 18.3 19.5% Z2.1% 17.1% 15.0% 22.2Z% 26.1% 32.9% 28.9% 16.8% Subtota daesatic asssets Lbna domesticast N/A #N/A 0.4 0.5 0.8 1.3 2.2 3.1 6.2 12.6 22.8 28.7 31.3 In 1980 prices ON/A #N/A 18.2 13.7 11.1 10.8 13.1 11.9 16.2 18.1 22.8 22.2 20.1 % of GOP O/A ON/A 19.8% 13.9% 13.0% 12.7% 13.7% 12.5% 14.7% 17.2% 20.9% 22.3Z 20.3 % of total assets ON/A ON/A 96.2% 93.1% 86.3 79.2% 66.2% 55.1% 57.9% 62.2% 65.9% 54.8% 33.9% Depsits, foreign careacy Damr rMad tem lNal UMI.S #O/A O/A 0.0 0.0 0.1 0.1 0.3 0.5 0.6 0.9 1.2 2.0 1.8 Naiunal, domestic ON/A OIN/A 0.0 0.0 0.1 0.3 1.1 2.5 4.5 7.7 11.8 23.7 61.1 In 1980 prices ON/A ON/A 0.7 1.0 1.8 2.8 6.7 9.7 11.8 11.0 11.8 18.3 39.2 % of (MP ON/A OI/A 0.8% 1.0% 2.1% 3.3% 7.0% 10.2% 10.7% 10.4% 10.8% 18.4% 39.5% RMV.i tic and foreign #N/A ON/A 0.4 0.5 0.9 1.6 3.3 5.6 10.7 20.3 34.6 52.4 92.4 In 1980 prices ON/A N/A 18.9 14.7 12.9 13.7 19.8 21.5 28.1 29.0 34.6 40.5 59.3 % of GP ON/A ON/A 20.6 14.9% 15.1% 16.0% 20.8% 22.7% 25.4% 27.6% 31.7% 40.7% 59.8% CpI, Decenmer (Dec.80-100) 0.7 1.0 1.9 3.4 7.1 11.9 16.6 26.2 38.2 70.0 1OD.0 129.3 155.9 thange rate, r r 0.3 0.4 0.7 0.9 1.7 2.7 4.0 5.4 7.1 8.5 10.0 11.6 33.8 GM, Dec. adjusted, rmnall ON/A ON/A 1.8 3.4 6.1 10.2 15.9 24.8 42.2 73.6 109.1 128.7 154.5 Surces: Asset ard GP data are frue the Bco Gentral del Uruo.ay, Boletin Estadistico. ExcarW rate ad C'I data are frue the D1P, IF data tape. Notes: Ihe GP data have ben logritlUically interpolated bebeen the ourrent year and one year forward so as to be expressei in reea~er prices. a/ 7he dr-utic rise in assets for 1982 is a result of a massive devaluation. This stohld not be interpreted as financial deepenin, aince foreign liabilities hav also risen. - 161 - ANNEX 8 they reflect the inflation rate (and the rate of devaluation, in the case of foreign denominated accounts) six months forward. As a result, the real interest rate figures shown for 1981 and 1982 do not capture the impact of the massive devaluation that occurred at the end of November 1982. This devaluation produced enormous ex-post rates of returns for holders of dollar assets up to November 1982. In contrast, the ex-post real rates on peso denominated assets remained only slightly positive during this period. 11. Judging from Table 1, the effect of the liberalization program was to permit relatively high and flexible nominal interest rates in pesos, from 1975 onward, and dollar rates which approximated rates in world markets. Despite the free movements of the interest rates and the elimination of controls in 1979, real rates were often negative ex-post. Since 1975, the ex-post lending and deposit rates in Table 1, taken as a group, are negative somewhat more often than positive. In fact of the nine interest rates shown in Table 1, negative real rates appeared 39 times out of 65. Generally speaking, the rates were positive only when inflation subsided in 1976, 1981 and 1982. Apparently, free interest rates in an open capital market do not guarantee positive real interest rates ex-post at every point in time; other factors, such as expectations and capital flows, matter. But, in comparison to most other highly inflationary developing countries, where positive real rates were quite rare, positive rates were common in Uruguay. Moreover, one must recall that real rates were negative in most developed countries during much of the seventies. 12. As measured by the ex-post rate of return, the most attractive financial asset was the six month term deposit. Since 1975 the real rate on six month term deposits was positive six times. No other saving instrument, denominated in domestic or foreign currency, was positive in real terms more than three times. As one might expect, in response to favorable returns domestic currency term deposits have risen dramatically, both in real terms or as a percent of GDP (see Table 2). 13. Given the predominately negative ex-post real rates on foreign currency denominated deposits from 1976 to 1982 and the positive real returns on peso denominated assets, one might not expect a massive shift towards dollar assets. Nonetheless, Table 2 shows such a shift. Between December 1979 and December 1981 the amount of dollar deposits doubled, this translated into a tripling, in peso terms, through the change in the exchange rate. While a large inflow of funds from Argentina constituted an important part of the increase in dollar assets, it also seems that domestic asset holders switched into dollars, apparently anticipating that the peso would be devalued faster than it was, even during the pre-announcement period. In late November, 1982, a precipitous devaluation of over 100% did take place, contributing to a 200% devaluation between December 1981 and December 1982. As a result, dollar asset holders made extremely large profits. Correspondingly, debtors in foreign currency were badly battered. 14. In the loan market, pessimistic expectations regarding the value of the peso were reflected in an aversion to assuming the exchange risk of foreign liabilities. Evidence for this can be seen in Table 1, where the - 162 - ANNEX 8 real rates for foreign currency denominated loans, i.e., the rate adjusted for devaluation and domestic inflation, remain about twenty percentage points or more, below the rates on credits in pesos (ten or more points for preferential credits). Apparently, there were not enough agents willing to take on the foreign currency risk of borrowing in dollars or lending in pesos to bring down this spread, even though both activities were consistently profitable through 1982. The banks, in particular, did not engage in dollar to peso arbitrage, instead they maintained roughly balanced net positions. 15. Like the deposit rates, the real lending rates were often negative during the 1976-82 period. Of the four rates displayed in Table 1 (domestic and foreign, prime and normal), the rate charged on normal borrowing in domestic currency was positive most often. It was last negative 1978, and did not become negative in 1982 despite surging inflation, as did the other three lending rates. 16. With respect to credits denominated in foreign currency, during most of the period an appreciating real exchange rate applied downward pressure on the real cost of credit, keeping the real rate negative and low in comparison to peso credits, up until the devaluation. By the mid-1982, the real exchange rate had appreciated to the point where, given the changing international conditions, a massive devaluation was required. As mentioned at the beginning of this section, this devaluation does not show up in the figures in Table 1 because the real rates were calculated looking six months forward from December. Thus, the 1981 figures did not catch the shift and the 1982 figures reflect developments occurring after the shift. However, for those dollar liabilities taken on before and due after the devaluation the real rate was very high ex-post. 17. In sum, although the liberalized Uruguayan credit markets had a respectable record of adjustment to price and exchange rate developments, relative to most developing countries, the volatility of the real rates created some major difficulties for the economy. In particular, the highly positive real lending rates in local currency and the recent devaluations generated large debt service burdens for the Uruguayan firms. Debt-equity ratios also increased as a result of refinancing this debt service and the massive increase in the peso equivalent of the firms' dollar liabilities. Moreover, while the corresponding high deposit rates encouraged financial savings, they also made equity finance unattractive. These financial market difficulties combined with a sharp fall in external demand, particularly from Argentina, have left a large portion of the private sector in Uruguay in a precarious financial position. The Pattern of Deposit Rates, year-end 1982 18. As evidenced in Table 3, there was virtually no incentive for depositors to commit funds for longer than six months at the end of 1982. Although the spread between saving and six month term deposits was substantial, the spread between term deposits of six months and those of over a year was negligible. Since these rates were market determined, this level yield curve indicates that neither the banks nor depositors were interested in long term commitments. - 163 - ANNEX 8 Table 3 Deposit rates, year-end 1982 Domestic denomination: Savings 24.2% Term 6 mo. or less 66.2% Term over 1 year 67.3% Source: Banco Central del Uruguay, "Boletin Estadistico." The Pattern of Lending, year-end 1982 19. At the end of 1982, publicly owned lending institutions provided about forty percent of all credits extended to the private sector (Banco de la Republica, 6/83). Most of these credits were extended to priority sectors on near market terms, though some subsidized credits continued to be made available. In particular, credits for agriculture and for housing appear to have borne below market rates. The remaining credits were lent largely at short terms by private institutions (World Bank, 1982, p.103-9). The average lending rates were about twenty percentage points above the prime rates for credits in domestic currency, and about one percentage point above the prime rates for credits in foreign currency. 20. Among the features that permitted the public institutions to lend at below market rates are: tax exempt status; large non-interest bearing deposits from the public sector; special fees and commissions relating to customs charges; and the backing of the Treasury on some priority lending. these factors reduced the public intermediaries' cost of funds and required spreads. With respect to private lending, a very rough measure of the spreads can be derived from Table 4. Ignoring possible currency arbitrage and using the term deposit rates as proxies for the marginal cost of funds, the intermediation spreads on average loans were as follows: Table 4 Intermediation Spreads, year-end 1982 nominal Domestic denominations average credits 76.3% 6 month term dep. 66.2% "spread" 10.1% Foreign denominations average credits 18.2% 6 month term dep. 10.2% "spread" 8.0% Source: Table 1. - 164 - ANNEX 8 The spread for intermediation in domestic currency exceeded that for intermediation in foreign currency by about two percentage points, a difference which largely reflects the expectations of devaluation. It is also worth noting that the spread between the prime lending rates and the deposit rates (in pesos) declined sharply after 1978, reflecting the increased competition in banking (see Spiller and Favaro). However, spreads on average loans were high and increased somewhat over the same period. 65 - ANNEX 8 Sources: Banco Central del Uruguay (various dates), Boletin Estadistico (Uruguay: Banco Central del Uruguay, various issues). Hanson, James and Jaime de Melo (1983), "The Uruguayan Experience with Liberalization and Stabilization: 1974-1981," Journal of InterAmerican Economic Affairs, November 1983. Spiller, P. and E. Favaro (1984), "The effects of Entry Regulation on Oligopolistic Interation: The Uruguayan Banking Sector,", The Bell Journal of Economics, 1984. World Bank (1982), Economic Memorandum on Uruguay Report No. 3652-UR, (Washington, D.C.: World Bank, March 1982). Wortd Bank An Analysis of Developing NEW Country Adjustment lpublications Experiences in the 1970s: Low- Compounding and Discounting of Related Income Asia Tables for Project Analysis of Related Christine Wallich (with a Guide to Their Interest Staff Working Paper No. 487. 1981. 43 Applications) pages (including references). Second Edition, Revised and Stock No. WP 0487. $3. Expanded Adjustment Experience and Aspects of Development Bank J. Price Gittinger Growth Prospects of the Semi- Management Project planners and analysts will find Industrial Countries William Diamond and V. S this book a convenient and time-sav- Frederick Jaspersen Raghavan ing reference for the preparation and Staff Working Paper No. 477. 1981. 132 Deals exclusively with the manage- analysis bleoforI percent through 50 pages (including 3 appendixes). ment of development banks. 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ISBN 0-8018-2803-1, Stock 69 pages (including 4 annexes). No. JH 2803, $35 hardcover; ISBN 0- LC 68-8701. ISBN 0-8018-0338-1, Stock 8018-2804-X, Stock No. JH 2804, $12.95 Prices subject to change without notice No. IH 0338. $5 paperback. paperback. and may vary by country. State Finances in India A three-volume set of papers that ex- plores a range of issues relating to the / nature of intergovernmental fiscal rela- X tions in India. * nThe primary source for W rld Debt Tables Vol. 1: Revenue Sharing in India medium- and long-term E. Christine Wallich e d o m Vol. I1: India-Studies in State Fi- extemal debt of many nances developing countries." Christine Wallich Vol. III: The Measurement of Tax Ef- Suhas Ketkar, Asia-Pacific fort of State Govemments, 1973-1976 Economist and Vice President, Raja J. Chelliah and Narain Sinha Marine Midland Bank, N.A. Staff Working Paper No. 523. 1982. vol. 1, 85 pages, vol. II, 186 pages, vol. III, 85 pages. 4NOften the only reliable ISBN 0-8213-0013-X. vol. I, Stock No. .. WP 1523, $3, vol. II, Stock No. WP source of information for 2523, $5, vol. III, Stock no. WP 3523, S3. countries for which data is hard to come by ... Used quantitatively for macroeconomic detail as well as qualitatively in Structural Adjustment Policies reports discussing the debt picture. I find the in Developing Economies projected servicing payments a strong feature.9 Bela Balassa Bela Balassa ~~~~~~~~~~~~~~~~Jonathan Kayes. Intemnational Staff Working Paper No. 464. 1981. 36 Economist, Republic pages. cnms,Rpuz National Bank of New York Stock No. WP 0464. $3. Structural Aspects of Turkish World Debt Tables, 1983-84 Edition Inflation: 195041979 The World Bank's invaluable reference Also available for the first time.. M. Ataman Aksov guide to the external debt of develop- Summfre .e.o. Staff Working Paper No. 540. 1982. 118 ing countries. Essential planning tool ummary Report pages. for economists, bankers, country risk Debt and the Developing ISBN 0-8213-0098-9. Stock No. WP 0540. analysts, financial consultants and all World: Current Trends $5. those interested in the global system of trade and payments. Provides data and Prospects on the external debt of 103 developing Includes an overview and summary ta- Thailand: An Analysis of countries augmented by information, bles from the 1983-84 edition. Structural and Non-Structural where available, on major economic 1984 64 pa es Adjustments aggregates plus indicators used to ana- 1 Ame Drud, Wafik Grais, and lyze debt and creditworthiness. Shows Stock No. BK 0319, $6.50. Dusan Vujovic statistical tables by country, including Companion computerized data figures for external public debt out- Staff Working Paper No. 513. 1982. 93 standing, commitments, disburse- base pages (including appendix). ments, service payments, and net bor- Includes all debt information given in ISBN 0-8213-0023-7. Stock No. WP 0513. rowings. Reports on private the unabridged volume, and, where $3. nonguaranteed debt of 19 countries. available, offers continuous historical Gives aggregate position of 13 major series for 1970-82 and projected debt- borrQwers-countries with disbursed service payments for 1983-92. Write for Trends in Rural Savings and and outstanding medium- and long- sample purchase agreement. Private Capital Formation in term total debt in excess of $13.5 bi- (9-track, phase-encoded, recording India lion at the end of 1982. 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