Financial Deepening in economic development: theory and lessons from Tunisia

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					                        Financial Deepening in economic development:
                               theory and lessons from Tunisia

                                    Naceur Ben Zina & Borhen Trigui
                                              DEFI- FSEG -Sfax,
                                         P.O.B.1088, Sfax 3018, Tunisia.

          Abstract : The paper presents a Post-Keynesian view of the financial deepening in economic
          development. The main hypothesis on which this approach is based states that the financial
          system is more than an intermediary that insures the optimal allocation of savings to
          investment in that it creates savings (through finance) as much as it allocates it (through
          funding). In this Post-Keynesian viewpoint, the efficiency of such a system is achieved if it
          makes greater use of the resources available for development with as little increase as possible
          in financial fragility and other imbalances that may impede the development process for
          merely financial reasons. According to this approach, the deepening of the Tunisian financial
          system that occurred after the liberal financial reforms carried out within the structural
          adjustment program created a less efficient system than the one prior to the reforms.
          Institutional arrangements are therefore required to promote funding and maintain the
          financial stability of the economic development process.

          Re sume : Léarticle pre sente une approche Post-Keyne sienne de léapprofondissement financier
          dans une e conomie en de veloppement. Léhypoth`se principale sur laquelle se base cette
          approche stipule que le syst`me financier est plus quéun interme diaire assurant léallocation
          optimale de lée pargne a léinvestissement en ce sens quéil cre e lée pargne (a travers le
          financement) autant quéil la re partit (atravers le funding). De ce point vue Post-Keynesian,
          léefficience déun tel syst`me se re alise séil augmente léutilisation des ressources disponibles
          pour le de veloppement avec le minimum déaccroissement possible de fragilite financi`re et
          déautres de se quilibres susceptibles de bloquer le processus de de veloppement pour des raisons
          purement financi`res. Selon cette approche, léapprofondissement du syst`me financier
          Tunisien qui a suivi les re formes financi`res libe rales engage es dans le cadre du programme
          déajustement structurel, a cre e un syst`me moins efficient que celui qui a existe avant les
          re formes. Des arrangements institutionnels sont alors ne cessaires pour promouvoir le funding
          et maintenir la stabilite financi`re du processus de de veloppement e conomique.


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                 Development economists have long recognized that the financial system plays a
          decisive role in the process of economic development (Stiglitz,1998). However, they remain
          attached to the conventional view according to which the financial system is a mere
          intermediary that insures the optimal allocation of saving for investment (Chick, 1998).
                 The fact that this view of the role of the financial system is a pre-Keynesian concept is
          recognized today by the Post-Keynesians whether they are Structuralists, Horizontalists or
          Circuitists - French, Canadian or Italian - (Rochon, 1999). When returning to Keynesé
          distinction between finance and funding1, and developing its institutional origins, these Post-
          Keynesians, especially Davidson (1986, 1996), Chick (1983, 1998) and Wray (1990, 1998),
          revealed that the financial system is more than an intermediary between saving and
          investment since it actually creates saving (through finance) as much as it allocates it (through
                 The present paper fits in this Post-Keynesian logic of financial system deepening. If
          the Post-Keynesian approach developed initially from a specific market-based financial
          system, it may be used, however, for a credit-based financial system, just as the system being
          carried out in most developing countries (Chick, 1998 ; Dutt, 1990-1 ; Burkett & Dutt, 1991).
          Incidentally, the Tunisian experience is used to show the relevance of the Post-Keynesian
          procedure in the field of deepening the financial systems. This paper may be outlined as
          follows: the first section deals with the Post-Keynesian view relative to the role of the
          financial system in economic development. The second section analyses the Tunisian
          experience and indicates the lessons that may be taken into account.

                                     A POST-KEYNESIAN VIEW
                 Keynesé hypothesis according to which finance precedes saving has brought about a
          lot of controversies and misunderstandings (see Trigui, 1999). In the 1930s, it was already the
          core of the debate which involved Keynes (1937a, 1937b, 1938, 1939), Ohlin (1937) and
          Robertson (1937). This debate has never been properly settled. Modern Post-Keynesians
          resumed it in an outlook that is well known now, started by Asimakopulos (1983) and
          followed by reactions coming mainly from Kregel (1984-5), Davidson (1986), Richardson
          (1986) and Terzi (1986).
                 To clarify Keynesé hypothesis, the Post-Keynesians have developed a sequential
          analysis in which saving appears as a by-product of the income creation process. Thereby


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          setting up the sequence «finance-investment-saving-fundingé, which they have used to
          demonstrate the logical antecedence of investment in relation to saving and to develop an
          alternative view of the role of banks, saving and financial markets in the growth process
          (Chick, 1983, 1998 ; Davidson, 1996; Wray, 1998). This is the basic element of the
          Post-Keynesian approach proposed in this paper.

          I1 ‘ The outstanding role of banks in investment finance
                 Focusing on the institutional origins of Keynesé demonstration concerning the
          distinction between finance, saving and funding, the Post-Keynesians, such as Terzi (1986),
          Chick (1998), Davidson (1996) and Wray (1998) state that in an economy characterized by a
          developed financial structure, finance is insured by banks regardless of any prior-saving
          constraint. In this case, investment finance should be distinguished from saving which
          depends precisely on the incomes already created in the production process. Thus, investment
          is dependent on the entrepreneursé expected profits and on the finance cost, but no longer on
          the consumersé inter-temporal preferences, as advocated by the neoclassic economists.
          Nevertheless, a statistician economist could easily contest this hypothesis since, in most
          developed economies, the firmsé finance statistics show a higher self-finance proportion (or
          non-distributed profits) as a source of investment finance. Therefore, why donét we assume
          that finance comes entirely from the non-distributed profits or other types of prior-saving ?
                 Keynesé reply was straightforward: » The rate of prior saving only tells us how much
          of the current investment can find a permanent home beforehand without upsetting the
          liquidity position and the long-term rate of interest, and without time lag. Subject to these
          conditions, the increment of current investment over prior investment (or saving) can only be
          cared for permanently out of the increment of current saving ; and the period during which
          current savings are kept liquid by their owners must be bridged by an increase in the
          revolving fund of «financeé, i.e. of liquid funds provided by the banking system or by
          hoarding. It is the role of the credit system to provide the liquid funds which are required first
          of all by the entrepreneur during the period before his actual expenditure, and then by the
          recipients of this expenditure during the period before they have decided how to employ it –
          (Keynes,1939 : 284-5). Therefore, it is banks and not savers, that » hold a key position in the
          transition from a lower to a higher scale of activity – (Keynes,1979 : 212). This cannot be true
          unless banks share the firmsé optimism during the growth period or are led, for any other
          reason, to satisfy the demand for investment finance. This conclusion would seem not to give
          any role to saving, but that is far from being the case.


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                   In fact, the bank-based investment finance process is inherently fragile. Firstly,
          borrowing from banks to finance investment increases short-term indebtedness. In addition,
          the firmsé ability to reimburse using their own funds must wait until the investment project is
          mature and their production capacity expands, which keeps the firms in a vulnerable financial
          situation. Secondly, by increasing the supply of investment finance, banks reduce increasingly
          their margin of safety. Ultimately, through this investment finance process, both banks and
          firms increase the vulnerability of their businesses and their potential dependence on
          alternative sources of liquidity.
                   Although financial fragility may disturb economic growth, it is not in itself a major
          constraint on it. If a rise in financial fragility causes debt-deflation - exhaustion of financial
          commitments - it may in fact generate financial instability (Minsky, 1982). This means that
          debt-inflation may be brought about by the units which try to sell their liquid assets in order to
          increase their liquidity (indebted firms), restore their liquid position (banks and other financial
          institutions) or realize some changes at the fall of expectations (speculators). This race for
          liquidity affects expenditures through its effects on interest rates, on the availability of funds
          to finance and consolidate investment and on the entrepreneursé long-term expectations. Thus,
          the fact that banks can finance investment through a pure bookkeeping creation of money
          does not insure the financial stability of the growth process. Growth increases financial
          fragility and financial instability may impede growth. This enables us now to introduce the
          role of saving and financial markets in the growth process.

          I2 - Microeconomic and Macroeconomic Roles of Saving and Financial Markets:
                   Although in the Post-Keynesian theory, individual saving and financial intermediation
          do not play an outstanding role in determining the global supply of investment finance, they
          have a crucial importance in another field, which is funding. From a microeconomic
          perspective, entrepreneurs and bankers wish to consolidate their long-term commitments on a
          solid basis because of the incertitude relative to the future conditions of credit and interest
                   Thus, the reason for appealing to funding, that is, the change of short-term debts into
          long-term securities, may be interpreted as a reply to the increasing threat from both the
          entrepreneursé and lendersé risks. For this reason, in a world characterized by incertitude,
          investment finance, as already emphasized by Keynes (see note 1) and recalled several times
          by Post-Keynesian economists, appears as a twofold process of finance and funding where
          finance makes it possible to carry out investment, and funding assumes a counterpart for the


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          resulting capital stock in financial portfolios (Keynes, CW, 1979 : 217). If funding works
          properly, the financial markets will then have a crucial role in maintaining the financial
          stability of the growth process. At the micro-economic level, financial markets can enhance
          the bankersé and firmsé predisposition to get involved in financing long-term projects since
          they can provide information for the issuers and buyers of bonds and shares. This informative
          role may be summarized by saying that secondary markets :
                 1) communicate the price of the new issues of securities;
                 2) help the specialized financial institutions perform subscribing operations at lower
                 3) enable investors to evaluate the future profitability of newly issued bonds through
                     improving the flow of information.
                4) provide liquidity and insure a lower risk exchange for the wealth holders to have
                     long-term securities.
                 From a macro-economic point of view, funding and therefore financial markets will
          then have a crucial role in mitigating the increasing financial fragility and maintaining the
          financial stability of the growth process. Such a macroeconomic role will be based on two
          characteristics of the financial markets: size and stability. A thin financial market is unlikely
          to be able to increase its operation levels without any important change in the prices of assets.
          Besides, a volatile financial market may often cause changes in interest rates which are likely
          to impede rather than support the growth process. However, it is worth stating that the short-
          term capital movements are as speculative and volatile as the thin financial markets.
                 To conclude with, financial markets have an important role - though ambiguous- in
          maintaining the stability of the growth process. This ambiguity arises from the instability
          inherent to the speculative nature of financial markets which nobody can deny and which
          raises the problem of efficiency of the financial system from a Post-Keynesian point of view.

          I3 -Efficiency of the financial structure : a Post-Keynesian view
                 Any financial structure is actually an institutional environment which must be able to
          create new means of financing and preserving its robustness throughout the growth process.
          As Chick (1986) has already pointed out, any financial structure is expected to insure two
          functions which are finance and funding, and whose importance depends on the current stage
          of evolution of the financial structure itself. In addition, Chick recalled that historically, the
          evolution of these two functions is not always spontaneous, mainly in connection with


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                 For example, a fast growing economy will normally tend to develop a credit-based
          financial system for three main reasons. Firstly, growth finance depends on supplementary
          credits, whatever the type of financial structure available may be. Secondly, in case of high
          growth, the long-term funds are not available to consolidate all the outstanding debt unless the
          marginal propension to purchase bonds from household savings is equal to one. Thirdly, if
          development creates a constant excess demand to finance short-term operations (for example
          turnover), financial institutions (particularly banks) are not likely to have any competitive
          stimulus to finance long-term projects or to promote funding.
                 Therefore, any credit-based financial system cannot support high levels of growth
          unless other financial arrangements are created in order to overcome the shortcomings
          resulting from the lack of funding. Thus, for example in many less developed countries
          (LDCs), the growth and structural change process is faster than financial deepening,
          especially regarding the ability to consolidate the investment being carried out. In such
          countries, growth is constantly held back by the lack of funding and the resulting shock of
          financial instability unless there are other institutional arrangements to bridge the gap between
          the financial and economic developments (Chick, 1998). In this respect, it is worth recalling
          that historically, in some countries where the financial markets are not sufficiently developed
          to support a financially stable growth, as is the case today in most LDCs, institutional and
          financial arrangements have been set up - such as the very strong commitment of private
          banks (for example, the German Universal Banks), the development of conglomerates of
          financial institutions and firms (for example, Japanese conglomerates) or the close
          interference of the government which has created development banks and the use of selective
          credit mechanisms (for example, the case of South Korea). In the light of these experiences,
          the LDCs as well as the international financial institutions can learn more from the
          institutional arrangements than from the market-based paradigm of an efficient financial
          structure. Therefore, the financial reform aiming at deepening the financial structure for
          economic development should emphasize an appropriate financial policy as much as an
          institutional development.
                 As far as the financial policy is concerned, in a fast growing economy with a constant
          pressure on financing, private financial institutions can benefit from a profitable growth
          simply by granting short-term credits to the firms that have a strong need for it. In case neither
          private banks nor other financial institutions have competitive stimuli to finance long-term
          projects, the firms will then have to resort to short-term credits, self-finance or foreign
          indebtedness in order to carry out their investment projects.


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                 As regards institutional development, it has to be a long-term policy. Thin financial
          markets (that is, weakly developed), which constitute the general rule of the LDCs, tend to be
          highly speculative and handled by a few big insiders2. This creates a total distrust among most
          of the small savers and even a few potential institutional investors (mutual funds). Therefore,
          such a development must be realized by a careful regulation from the authorities - a regulation
          that may be lightened according to the development of such markets -. However, it is unlikely
          that some day, a total deregulation will be compatible with a financially stable growth.
          Besides, it seems that the faster the pace of growth and structural changes in the productive
          sector is, the less likely investment finance and its funding develop spontaneously.
          Historically, this materialized in some countries, such as Germany, through the use of the
          Universal Banks which had insured the financing and funding of its industrialization process
          (Chick, 1998).
                 Following the above mentioned institutional analysis, it would be inadmissible to
          assume that the financial arrangements outside the market-based paradigm are less efficient or
          to expect financial liberalization itself, including the positive real interest rates, to be
          sufficient to sort out the problem of funding, which is the problem of insufficient long-term
          finance. Within the Post-Keynesian institutional approach, which constitutes the corner stone
          of the analysis dealt with in this paper, the quest for any financial arrangements or proposals
          of financial policies cannot be undertaken without a thorough and detailed examination of the
          existing institutions in the functions of finance and funding regarding the capital accumulation
          process. This is the course to be taken for the study of the Tunisian case, which is the object
          of the following section. However, it is most important to introduce and further clarify the
          method of analysis.

          I4 - A Post-Keynesian method of efficiency analysis
                 In any social science, it is widely admitted that the choice of a method cannot be
          separated from the paradigm which underlies the theoretical analysis. For instance, within the
          mainstream approach, it is only natural that the method should involve a precise specification
          of the hypothesis and test it, or alternatively, that two competing hypotheses should be
          specified in such a way that the data can discriminate conclusively between them. But as Dow
          ( 1985 : 2) points out:
                 » Leaving aside the methodological problem with this procedure when applied to a
                 short-period analysis, it has severe shortcomings when applied to a long-period
                 analysis. Over the long period, the very changes in economic structure, institutions and


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                 behavior which are the object of a study of economic development evade capture by
                 formal mathematics or observation by consistent data series –.
                 As a result, the relationship between financial structure and economic development,
          which is the subject matter of our research, cannot be grasped through mathematical
          formulations or observations of consistent data series, for it is strongly dependent on the
          institutional evolution through time and on the behavior of the main protagonists in the
          economic development process. Both of these phenomena as pointed out by Dow (1985)
          evade capture by formal mathematics or observation by consistent data series. In this case,
          more than ever,
                 » The scope for universal laws in economics is restricted by the capacity of the
                 economic system to evolve over time; the majority of the general statements must be
                 conditional on the environment in which they are formulated. In particular, as Hicks
                 points out, the time element in statements of cause and effect becomes important if
                 structural change can occur during that time period. In order to retain the causal
                 statement, therefore, it must incorporate a statement about behavior reacting to the
                 structural change, as well as the initial cause. This requirement to account for
                 historical development further, impedes the ability of an economist to conform to the
                 traditional rules of scientific enquiries – Dow (1985 : 35).
                 Therefore, in our case, where the financial reforms fundamentally change the
          conventions of economic agents, an economic approach seems more suitable to the analysis of
          the development process. This approach » forgoes precision in the narrow sense of
          amenability to mathematical expression, in the interests of depth and breadth of understanding
          of complex causal process – (Dow, 1985 : 3). The causal process to be analyzed in this paper
          is the complex relation between financial and economic development in Tunisia before and
          after the financial reform. This analysis will be centered on the Post Keynesian concept of
          efficiency applied to the financial structure.
                 The main question that is addressed by the empirical analysis adopted in this paper is
          how the financial reforms changed the efficiency of the system to finance and fund
          accumulation. Testing the efficiency of the financial system is analyzing the behavior of
          separate, and yet integrated financial institutions and markets, and their role in financing and
          funding accumulation. In the Tunisian case, the financial reforms that have been implemented
          since the end of 1986 constitute a turning point for the evolution of the financial system. The
          self-imposed question then consists in finding out whether these reforms have really improved


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          the efficiency of the Tunisian financial system from a Post-Keynesian standpoint. This is what
          we will endeavor to work on in the following section.

                                    FROM THEORY TO EVIDENCE
                     This section is the transition between the theoretical and practical parts of our research
          work. It summarizes the evolution of the role of the various Tunisian institutions in
          connection with financing accumulation and its funding over the period before and after the
          reform. Above all, it debates the effects of the financial reforms on the subsequent evolution
          of the financial system and on the countryés economic development.

          II1 ‘ A brief review of the period before the reform•
                     The first decade of the Tunisian economic development (1962-1971) “ a few years
          after independence - was marked by an intensive industrial process designed to be a substitute
          for imports and strongly supported by a powerful public sector. According to the three-year
          plan (1962-1964) as well as the two four-year plans (1965-1968) and (1969-1972), the
          countryés infrastructure and consumer goods industries developed rapidly. Such a
          development required a fast capital accumulation. Indeed, investment increased by 12% on
          average. This guided boom of investment allowed an average GDP rise of 8.6% (Hergli &
          Belhareth, 1993 : 143).
                     However, this intensive industrialisation process was not followed by a financial
          development. While preparing the first ten-year plan, the Tunisian authorities sought to be
          endowed with a powerful banking system that could insure financing investments which were
          required for development3. In this respect, they adopted the principle of banking
          specialization. Thus, BNA was entrusted with the particular task of meeting the needs of
          financing agriculture using its own resources in addition to the government loans obtained
          from the World Bank and the American Agency for International Development (AID).
          Likewise, STB (just like SNI) was, in turn, entrusted with financing industrial projects. It
          could insure most of the industrial and commercial loans, both short and medium terms,
          thanks to the governmentés special resources and those borrowed from the World Bank and
          the AID program.

              This review draws on Hergli & Belharethés research work (1993).


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                 Thus, this vital role granted to the banking system in financing development was
          further strengthened by working out a unified institutional environment which allowed banks
          to join the governmentés economic policy (Hergli & Belhareth, 1993 : 98-99). In addition to
          the current working rules4 with which all the banks had to comply, this particular financial
          environment was based on an administrative policy of interest rates and a system of monetary
          incentives, such as the low interest rates and especially the appeal to rewarding rates in favor
          of the priority sectors. In this respect, on October 10, 1958, the Central Bank of Tunisia
          instituted the system of Prior Authorisation and Rediscount Agreement imposed on a wide
          variety of banking loans in order to exert a direct and selective control on credit supply. Thus,
          a banking refinancing process was then instituted. It was exclusively restricted to rediscount
          at least until 1974 since the monetary market had not started playing its role as a source of
          finance for banks until January 1974.
                 As in most developing countries, the Tunisian financial market is very thin. This
          arises, on the one hand, from the fact that the Tunisian firms were then unable to attract
          private savings because they could not honor their subtantial commitments in terms of
          dividend distribution which was so much claimed by private customers. On the other hand,
          most of the firms were of small size and/or owned by families that were reluctant to any
          opening to shareholding and to the anonymous appropriation of all or part of their social
          capital. These two facts show that the promotion of contribution of the financial markets in
          the long-term investment finance turns out to be a long-lasting action.
                 In this way, the Tunisian financial system remains largely dominated by banks. In this
          respect, as a result of the Post-Keynesian conclusions that we have already put forward,
          institutional arrangements are required to compensate for the shortcomings of funding. Being
          conscious of this problem, the Tunisian monetary authorities instituted a Global Ratio of
          Development Financing in April 1975. This aimed at enabling banks to devote a given share
          of their loans to long-term investment finance both in the public and private sectors. Until
          1986, this ratio had reached 43% of the deposits. In the same context, they also opted for the
          creation of new financial institutions specialized in granting long-term credit. This was one of
          the aims to which the Tunisian authorities gave priority just before the second decade (1972-
          1981), especially that the exports promotion strategy (to be adopted from 1971), which was
          then the new development policy, required a massive support of finance from the banking
          system. Therefore, since then, specific financial and banking institutions have been created by
          the law 76-36 of July 12, 1976 to satisfy the needs for credit expressed by the firms created by
          the laws of 1972. These were essentially Off-Shore banks5 which had to perform all sorts of


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          operations with foreign countries and provide the necessary financial support to the export
                    Besides, since 1980, and always within the institutional arrangement context, the
          Tunisian authorities have encouraged the rise of Tunisan Arab banks of development to
          enable the banking system to grant further long-term loans for the purshase of foreign
          equipment especially that, in those days, the Tunisian economy had financial difficulties in
          terms of foreign currency. Among these development banks, the three most important ones
          (BNDT, BDET and BTKD) had portfollios consisting of more than 65% of private
          investments in tourism, including the portfolio of BNDT, which is a development bank almost
          exclusively specialised in granting loans to the tourist sector.
                    To sum up, the Tunisian financial system until then had been marked by the
          prevalence of banks and the underdevelopment of the financial markets. Over the period
          1974-1980, most of the credits were granted by deposit banks, 82% on average. Short-term
          credits ranked first with an average of 70.4%. As indicated in table 1, the prevalence of short-
          term credits went on to reach 65.3% in 1985 while the medium and long-term credits of the
          monetary system constituted, on average, just 25% of the overall credits of the banking
          system. Incidentally, the role of development banks in the countryés domestic financing kept
          growing during that period, precisely because of the creation of several development banks.
                              Table 1 : Credits of the banking system for the economy (out of total)

                                                    1981    1982    1983     1984     1985     1986

                    Monetary system                 95.2    91.6     91.3     90.7    90.6     84.8
                     Short-term credits             71.2    65.0     64.4     63.9    65.3     61.6
                     Medium credits                 21.8    20.8     21.0     20.8    19.3     16.9
                     Long-term credits               2.2      5.8      5.9     6.0     6.0      6.3
                    Development banks                4.8      8.4      8.7     9.3     9.4     15.2
                    Banking system (total)          100      100      100     100      100     100
                    Source : Bouaziz and Guermazi,1997

                    The various institutionnal financial arrangements initiated by the Tunisian authorities
          during this period could certainly support the capital accumulation process. In fact,
          investment went up from 20% to 30% of the GDP over the period 1972-1982. This guided
          investment boom allowed the GDP to rise 7.4% on average (11% for industrial output and
          5.4% for agriculture) and domestic savings 12% a year7. On the other hand, these very
          institutional arrangements had side effects : inflation and constant budget deficit. Thus,


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          between 1982 and 1984, both the rate of inflation and that of the budget deficit growth were,
          on average, 10.13% a year and 16.13% a year respectively.
                   In other respects, the financial fragility inherent to these institutional financial
          arrangements which focused on banks can be measured by the firmsé indebtedness ratios and
          their ability to reimburse the outstanding deficits, both of which must then be available and
          accessible. This is really a hard task in itself since it implies having accurate data about the
          firmsé balance sheets and some subjective prediction of the firmsé ability to manage liquidity
          in the future in order to pay back their debts. Such data are seldom availble with the Tunisian
          firms, which restricts considerably the analysis of fragility. However, we can only put forward
          a few theoretical elements of the relationship between financial fragility inherent to economic
          development and the evolution of the financial system in Tunisia during that period (1970-
                   In fact, in the credit-based financial system, like the one in Tunisia, an increase in
          long-term commitments will be followed by an increasing banking indebtedness of firms.
          This financing process inevitably entails a higher degree of general financial fragility
          expressed by the high leverage ratios arising from banks and firms. In Tunisia, such fragility
          was mixed over the period 1970-1980 because the firms used profit inflation as a means of
          funding. However, as inflation increased and aggregate demand decreased, this mechanism
          became increasingly inefficient. This is what actually happened in Tunisia in the first half of
          the 1980s. In those days, foreign payments worsened and thus speeded up the liquidity crisis
          which became unbearable at the end of 1985 : the foreign currency stock was exhausted in
          June 1986 and did not cover more than 9 days of imports ( Delmasure, 1990 : 14).
                   Nevertheless, we should point out that this deterioration of foreign payments was
          largely due to exogenous factors which occurred at the same time. Firstly, the agricultural
          sector witnessed a disastrous crop resulting from a severe drought, which gave rise to an
          increase in food imports evaluated then at $ 28 million. Secondly, tourism suffered from
          regional political tensions triggered off by the American attack against Libya. Lastly, the
          value of oil exports was cut back drastically following the drop in oil prices.


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                  Table 2 : Evolution of some macroeconomic agregates(in % at 1980 prices)

                                                                  1985          1986
                     -   Agricultural production                   +18           -12.4
                     -   Food imports                             -22.7          +23.6
                     -   Oil incomes                               -1.4           -2.9
                     -   Incomes from tourism                     +22.3           -0.7
                     -   Transfer incomes                         -14.5         +17.3
                     Source : World Bank, Country Economic Memorandum, March 1990
                             ( Delmasure, 1990 : 14).
                 Just like other developing countries and in order to remedy the external imbalances,
          Tunisia adopted, under the auspices of the International Monetary Fund and the World Bank,
          a stabilization program of a liberal trend - a mixture of tight fiscal, monetary and wage
          policies -. As early as August 19, 1986, when this program was first enforced, the measures
          taken soon produced their effects. In 1987, the GNP progressed only by 5.8% in real terms - a
          fall of 1.6% in comparison with the previous year -. This was mainly due to the substantial
          growth achieved in the agricultural sector (especially thanks to the favourable weather
          conditions which prevailed throughout the campaign over the period 1986-1987), and in
          tourism (thanks to the devaluation of the Dinar and the political stability that Tunisia
          witnessed following the political change in 1987).
                 As for industrial production, however, it resumed slightly in 1987 thanks to exports
          - that is, the production activities designed for foreign markets - and above all in textile, shoe-
          making and phosphate processing. On the contrary, the domestic market-oriented activities
          were affected by the tightening of internal demand. This is the case of mechanical and
          electrical industries, housing and public works ( Annual Report, Central Bank, 1987).
                 In addition to this stabilization program, another project was the financial reform
          which is analysed next.

          II2 ‘ The financial reform
                 Since 1986, the widespread and prevalent idea among the experts of the successive
          governments in Tunisia has stated that the deterioration of the social, financial and economic
          situation has arisen from most of the evils of the previous development and that the discipline
          of the market should be imposed so as to correct the shortcomings in Tunisiaés development.
          In fact, the stabilization program carried out by the seventh plan of economic and social
          development constituted a step towards this discipline of the market. It was made up of tight


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          fiscal, monetary and wage policies. Besides, the logic behind the new wage policy was
          exactly the opposite of the one applied to the financial reform, especially regarding the
          financial market. In the labor market, inefficiency was caused by the excessive popularity of
          the previous government who allowed wages to increase beyond labor productivity, while in
          the financial market, inefficiency was brought about by the excessive regulation of the
                  Moreover, the new wage policy has redefined the method of readjusting wages
          (minimal wage, salaries of the civil service and those of the employees in the private sector)
          which has become dependent on collective negotiations per sector between the government,
          management and the labor unions every three years. The outcome of these negotiations is
          expected to see to it that the wage agreements do not exacerbate the rate of inflation and that
          they do not raise the labor unit costs beyond those of the main competitive countries.
                  As far as the fiscal policy is concerned, the budget should normally be balanced and
          the conventional inflationary financing of the public deficit should be abolished by
          introducing mechanisms to finance it through public debt. However, in spite of the
          considerable decrease in the importance of the domestic banking system as a source of
          financing the public deficit during the period 1986-1993, the budget remained always in
          deficit between 2.4% and 5.5% of the GNP (World Bank, 1996 : 12). In this respect, a Value
          Added Tax was introduced in July 1988 followed by a common income tax not to exceed
          35% of the profits for firms and of the income for individuals, both of which were designed to
          facilitate tax collection.
                  As early as 1987, and in order to complement its efforts of financial stabilization of the
          Tunisian economy, the government undertook an ambitious reform program of the banking
          system. Thus, deposit banks became exempt from any prior authorization of the Central Bank
          to grant credit and therefore were allowed, whithin certain limits, to decide on their deposit
          and loan rates of interest. This liberalization of interest rates and of credit was followed by a
          boost of the monetary market.
                  One of the essential objectives of this banking system reform was to enable the
          monetary market to facilitate the flow of sufficient short-term liquidity with variable rates to
          meet the banksé current needs for liquidity. It was then necessary to expand the market
          potentials by making it accessible to new operators and more particularly to those who
          benefited from excess of liquidity, such as insurance companies, social security institutions as
          well as investment banks. In this context, some firms were allowed to operate in this market
          in order to get some liquidity or to deposit their excess of liquidity, if any. This widening of


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          the range of operators on the monetary market was followed by the creation of new financial
          products, such as deposit certificates, treasury bills and treasury bonds which are naturally
          negotiable bonds.
                 On the other hand, and in order to promote long-term finance, the bank law was
          modified in 1994. Deposit and development banks were now allowed to perform a wide range
          of overlapping activities. According to this law, deposit banks were allowed to grant loans
          regardless of the maturity and to become shareholders. Moves towards closer ties were then
          increasingly encouraged between deposit banks and development banks in order to produce
          synergies in the field of finance and funding which may result from their complementarity.
          Thus, such moves between these banks led to a new configuration of the Tunisian banking
          sector marked by the merger on Dec. 21, 2000 between BNDT, BDET (development banks)
          and STB (deposit bank). The latter became the first bank in Tunisia and the fourth in Africa
          (Annual Report, Central Bank, 2000).
                  Therefore, thanks to its new size, the new bank, STB, was now able to finance the
          required investments and insure their funding through the possibility of providing its
          customers with the most appropriate financial products. Besides, according to this new bank
          law, all banks were allowed to provide services of financial advice which made up the main
          activity of investment banks. This ultimately strengthened the universal aspect of the banking
          activities and still increased competition between banks.
                 This widening of the range of banking activities gave rise to a strengthening of the
          prudential control (more in line with international norms) especially own funds, obligatory
          reserve, liquidity ratio and risks in general. According to the law 94-95 of Feb. 7, 1994, the
          deposit bank must not attribute more than 10% of its own funds to a participation in the same
          firm nor hold over 30% of the capital in the same firm.
                 Furthermore, the stabilization program consisted of financial market reforms as well.
          It was argued that the market for long-term funds did not develop in Tunisia due to the lack of
          stimulus to save. This shortcoming was brought about by three inter-related factors : inflation,
          interest rate ceilings and inefficiency of the existing financial institutions and markets.
          According to the same perspective, saving in Tunisia was not scarce but was not properly
          channelled towards investment because of the above mentioned factors.
                 Being aware of these shortcomings in the field of funding, that is, the difficulties in
          channelling saving towards investment, the Tunisian authorities made several laws between
          1988 and 1989 aiming at defining the functionality of the financial market, the regulation of
          the sale and purchase of bonds, and the conditions for the creation of investment companies.


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          In this respect, a new law was passed in Nov.1994 which reinforced the modernization of the
          juridical and regulatory environment through creating three main institutions: 1) The CMF
          (Conseil du Marche Financier), which is a supervision institution responsible for protecting
          savings invested in securities and organizing the financial market; 2) The BVM (Bourse des
          Valeurs Mobili`res), which is the Stock Exchange supervised by the CMF; 3) The SDCR
          (Socie te de De po de Compensations et de R`glements), which is an administrative
          institution responsible for operations concerned with settling and transferring property.
                 Following this new legislation, the Tunisian Stock Market has recorded an important
          development of its activities since 1990. The Stock Market capitalization went up from 5% to
          16% between 1991 and 1994. However, this evolution of the Stock Market activities reflected
          the activity of the secondary market much more than that of the primary market. Few new
          issues in public subscription in the primary market occurred during the period 1990-1994.
                 In other respects, this development of the Stock Market activities did not escape from
          the imbalance between supply and demand. In fact, demand exceeded supply from 200% to
          500% and caused a strong artificial appreciation of the Stock Market, which obviously created
          a speculative bull. In addition, in the Tunisian financial market, as is the case in most of these
          markets in the developing countries, many firms, most of which belong to families, are
          reluctant to be open to the public.
                 To sum up, the financial reform was guided by the view which had been called earlier
          the conventional view. That is, the ultimate source of finance is saving, which has to be
          stimulated by the provision of positive interest rates to savers and channelled to productive
          investment through the financial system. Now, the main impediments to the achievement of
          this aim, according to the opinion behind the stabilization program in Tunisia, are inflation,
          financial repression and the existence of inefficient financial institutions. The solution then
          consisted in stabilizing prices, dismantling the mechanisms of financial repression and
          stimulating competition between financial intermediaries (see Hergli & Belhareth, 1995).

          II3 ‘ Shortcomings of the reformed financial system
                 Perhaps one of the most important achievements of the financial reform was the
          export-led boom (Mokadem, 1992 : 146). In fact, during the period 1986-1993, the current
          account balance, which was 4% of the GDP on average, realized an improvement in
          comparison with that of the early 1980s and which was then around 8.5% of the GDP.
          Although the physical capital investment in relation to the GDP was weaker in 1987-1994
          than in 1981-1986, this did not prevent the GDP from growing. Indeed, the annual growth rate


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          of the GDP per capita went up on average from 1.15% during the period 1981-1986 to 2.44%
          over the period 1987-1994. The origin of this evolution was marked notably by the
          considerable progress made in agriculture and tourism.
                     However, after this short period of export-led boom, the economy was beginning to
          show signs of weakness in its productive capacity. This meant that if growth was to continue,
          immediate increases in investment were required. Thus, after the Gulf crisis in 1991,
          invesments were beginning to grow again stimulated by the projects achieved within the
          program of upgrading ( programme de mise a niveau ), especially in industry. In 1996,
          investment expenditures increased in fact by 11.1% at the current price (Annual Report,
          Central Bank, 2000). In this resumption of investments, the effort of the public sector
          remained important since its share was 52.6% in 1996 against 51.6% the year before, although
          the structural adjustment program in Tunisia aimed to reinforce private initiative.
                     Most importantly, we should highlight the fact that this fast accumulation process
          made the shortcomings of the reformed financial structure emerge fully to the surface and
          which can be summed up as follows:
               1. Maturities of both assets and loans continued to be very short ;
               2. The existence of new financial products constituted a fertile field for speculation,
                     which was unfavorable for the development of the long-term security markets ;
               3. Financial fragility increased.
                     In fact, the logic of financial liberalization behind the financial reform in Tunisia
          aimed basically at : firstly, stimulating saving with positive real interest rates. Secondly,
          enabling banks and other financial institutions to lengthen the maturities of their loans.
          Indeed, interest rates in Tunisia rose and became positive (see Table 3); the diversification of
          financial assets witnessed a considerable rise, too.
                                                  Table 3 : Evolution of interest rates ( in %)
                                         1981 1982 1983       1984    1985    19 86       1987   1988    1989    1990   1991 1992      1993 1994

          nominal loan interst rate      7.8    7.7    7.6    7.9     8.3         8.6    10.3    11.6   14.3    14.8    14.8   14.5    13.8 13.8

          nominal deposit interst rate   6.8    6.8    6.8    6.8      6.8        7.8     7.8     6.6    9.3     9.8    9.8     9.6    7.3     6.8

          inflation rate                  9     13.6    9     8.6     7.8         6.8     8.2     6.7    7.7      6.5   7.8     5.6     4.2    4.6

          real loan interst rate         -1.2   -5.9   -1.4    -0.7   + 0.5       +1.8   2.1     4,09     6.6     8.3    7       8.9     9.6    9.2

          real deposit interest rate     -2.2   -6.8   -2.2    -1.8   -1          +1     -0.4    0.1     1.6      3.3   2       4       3.1 2.2

          Source : Fatma Siala Guermazi,1996

                     As regards the holding of assets, from 1987 to 1999, the stock of time deposits
          increased on average by 29% a year and the pass-book savings deposits by 10%. From the


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          asset side of the financial system, there was no substantial change in the maturities of loans :
          they continued to be of very short term. This may be illustrated through the allocation of
          industrial credit according to maturities as shown in Table 4, which reveals that about 2/3 of
          the credits granted to the industrial sector are short-term.
                          Table 4 : Allocation of industrial credits according to maturities ( in %)
                         Year                      1985     1986    1987       1988   1989    1990
                         Short-term credits         62       65      66         68    71       70
                Medium and long-term credits        38       35      34        32     29       30
                 Source : National Statistics Institute (Mokadem,1992 : 143)
                 In addition, the governmentés attempts to develop a long-term private financial market
          mainly through both fiscal encouragements to acquire bonds and shares and facilitating the
          creation of investment companies were not very successful. For instance, investment
          companies have not always acted entirely as long-term fund suppliers or constituted an
          important stimulus for the development of long-term security markets. In fact, after the Stock
          Market euphoria which prevailed over the period 1993-1995, the thin Stock Exchange in
          Tunis witnessed a collapse in 1996 deeply felt by all the operators. More particulary, savers
          could not manage their portfolios on account of insufficient demand and therefore were
          subject to decreases in value for their securities. Besides, the mixed-SICAVs witnessed acute
          problems concerning liquidity and the flight of their customers due to the sharp decline in the
          values of their products. Consequently, banks were bound to support the mixed-SICAVs in
          trouble and the value of their securities on the market (Annual Report, Central Bank, 1996).
                 Despite the modernisation program of the Stock Exchange in Tunis started up in 1996,
          the financial market activities have remained affected by its structural weaknesses both in
          supply and demand in particular. However, this market has not been subject to the vicissitudes
          of speculative foreign investments thanks to the prudential attitude of the exchange authorities
          towards these types of invesment. This partly accounts for the fact that Tunis Stock Exchange
          was not affected by the impacts of the financial crises which happened in the inernational
          financial markets in the late 1990s.
                 To sum up, the failure to develop a private capital market and the increase in
          speculation created a financial system which was more of a short-term nature than the one
          before the reform. In fact, in 1999, the share of the short-term, medium and long-term credits
          was 62%, 16% and 14% respectively. However, since BNDT and BDET were absorbed by
          STB, the share of the medium and long-term credits kept consolidating every year to reach
          43% in 2000 against 42% the year before (Annual Report, Central Bank, 2000). This is an


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          additional argument for the Tunisian authorities to further consolidate mergers mainly
          between deposit and development banks so as to promote funding instead of believing
          constantly in the market-based Anglo-Saxon paradigm, inasmuch as the Tunisian financial
          market has remained permanently thin and struggling with the structural weaknesses at the
          level of both supply and demand.

          CONCLUSION :
                 This paper has presented a Post-Keynesian view of the role of banks, saving and the
          financial markets in the process of development and investment finance. The argument
          focuses on an alternative which re-defines the efficiency concept of financial structure in
          connection with the development process. Thus, from a Post-Keynesian standpoint, a
          financial system is efficient to the process of economic development when it increases the use
          of the resources available through the finance process with as little increase as possible in
          financial fragility through the funding process.
                 Efficiency so defined can be achieved in several ways depending on the countryés
          institutional structure. For instance, Keynesés finance/funding process of investment is based
          on a financial structure characterized by a developed banking system and dynamic and
          organized financial markets. Furthemore, the history of financial evolution in the developed
          countries reveals the existence of institutional arragements that can sort out the problems
          caused by the lack of funding in the credit-based finacial systems. This is why, nowadays, the
          developing countries which have inherited credit-based financial structures had better take
          into account the experiences of the developed countries in terms of institutional and financial
          arrangements. For this purpose, these developing countries ought to have compensatory
          financial structures or a logical financial policy or preferably both. Nevertheless, there are
          theoretical reasons for which it is recommended to develop financial markets and notably
          those which consider financial markets as a means of consolidating investment and avoiding
          the financial fragility which follows growth. But the shortcomings of fast development in
          such markets must be respected if financial stability is also a target of economic policy.
                 The Tunisian financial reform has been used in this paper to illustrate the way in
          which a reform that attempts the fast development of private financial markets at all costs can
          be a source of financial instability towards development perspectives. In Tunisia, the
          governmentés efforts to modernize the financial market have increased speculation rather than
          decreased the risk aversion of financial institutions and wealth-owners, which has perpetuated
          the prevalence of short-term operations in the countryés financial system. As for the longer


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          term finance, such as the industrial investment and housing finance, the State has been
          continuously in charge of it through STB and other development banks. This is why the
          current tendency advocates mergers.
                     The analysis of the Tunisian experience from the Post-Keynesian viewpoint permits to
          say that any financial reform applied to the financial systems characterized by
          underdeveloped structures of funding must be based as much on an appropriate financial
          policy as on an insitutional development policy. As far as the financial policy is concerned, it
          must be recalled that financial institutions ( especially banks ) will prefer to be involved in
          shorter term financing because of the structure of their liabilities. Thus, from the Post-
          Keynesian standpoint, we can not expect financial liberalization in itself, including positive
          interest rates, to be adequate to solve the problem of insufficient long-term finance. In fact,
          the Post-Keynesian approach followed in this paper points out that in a credit-based financial
          system, the rise in interest rates in itself does not enhance efficiency in allocating internal
          financial resources. In somes cases, though, it may cause financial instability delaying
          financial deepening and impeding the development process itself.
                     Lastly, there results from the Post-Keynesian conclusions that any reform of the
          financial system is expected to strengthen complementarity between the financial markets and
          banks. How to achieve this reform depends on the institutional and historical framework
          specific to every country and in which the various mechanisms of finance and funding evolve
          unevenly. Therefore, developing countries and perhaps multinational agencies (such as the
          World Bank and the International Monetary Fund ) can learn more from the Post-Keynesian
          approach on the deepening of the financial system than from the Anglo-Saxon paradigm
          based on financial markets.

          NOTES :
              This distinction between finance and funding was developed by Keynes in the light of the structural and
          institutional changes that have occurred in Great Britain since the end of the eighteenth century. Thus, he wrote:
          ” The entrepreneur when he decides to invest has to be satisfied on two points: firstly, that he can obtain
          sufficient short-term finance during the period of producing the investment; and secondly, that he can eventually
          fund his short-term obligations by a long-term issue on satisfactory conditions„ (Keynes,CW, t.XIV,1989: 217)
              » Insider – refers to a person with access to confidential information because of his position or his rank in an
          organisation. In the stock exchange, the concept applies to the staff or the leaders of a firm or the holders of more
          than 10% of the value of the listed shares of a firm.
              At the end of 1963, the banking structure was made up of the Central Bank (founded on November 4, 1958) in
          addition to the eight banks managed by a Tunisian juridical status and which are: BNA (Banque Nationale


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          Agricole), STB (Socie te Tunisienne de Banque), BT (Banque de Tunisie), UIB (Union Internationale de
          Banque), BECI (Banque déEscompte et de Cre dit aléIndustrie), BFT (Banque Franco-Tunisienne), BP (Banque
          du Peuple created in 1964 and merged with BS (Banque du Sud) in 1968), SNI (Socie te Nationale
          déInvestissement) and five foreign banks, three of which are French and two of other nationalities (Hergli &
          Belhareth, 1993 : 92).
              At the level of the operating current rules, the monetary authorities instituted the solvency coefficient set at 10%
          (circular of July 27, 1961). It is necessary to wait until 1968 to have two new ratios of banking managment
          added to this coefficient : the liquidity ratio ( instituted by the BCT circular nî 68-12 of March 12, 1968) and the
          risk covering ratio (instituted by the BCT circular nî 82-23 of Dec.31, 1982). It must be stressed that a new
          selective credit policy was adopted on the basis of implementing a system of AR (Accords de Re escompte) and
          AP (Autorisations Pre alables) following BCT circular nî 85-15 of April 15, 1985.
              This includes UTB (Union Tunisienne de Banque), TIB (Tunis International Bank), TAAB (Tunis Arab
          African Bank), BEST (Beıt-Ettamouil Saoudi-Tounsi), City Bank (CB), Loan And Investment Company (L.I.C),
          North African International Bank (NAIB) and Alu Baf International Bank (ABIB).
              These institutions can get deposits of non-residents or from abroad. They grant any type or form of credit to
          non-residents and have a share in the capital of non-resident firms. They are exempt from the authorization of the
          Central Bank to receive funds from abroad and grant credits to non-resident firms.
              Source : World Bank, data base : STARS and Country Economic Memorandum, March 1990.

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Description: The paper presents a Post-Keynesian view of the financial deepening in economic development. The main hypothesis on which this approach is based states that the financial system is more than an intermediary that insures the optimal allocation of savings to investment in that it creates savings (through finance) as much as it allocates it (through funding). In this Post-Keynesian viewpoint, the efficiency of such a system is achieved if it makes greater use of the resources available for development with as little increase as possible in financial fragility and other imbalances that may impede the development process for merely financial reasons. According to this approach, the deepening of the Tunisian financial system that occurred after the liberal financial reforms carried out within the structural adjustment program created a less efficient system than the one prior to the reforms. Institutional arrangements are therefore required to promote funding and maintain the financial stability of the economic development process