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Mobilization of Savings through Increased Monetization of African .ppt

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					Mobilization of Savings through
  Increased Monetization of
      African Economies


              by
         Jean K. Thisen
         ESPD – UNECA


                                  1
Contents
     I. Introduction: An Overview
    II. Financial Intermediaries and Degree       of
  Monetization in Africa
   III. Increasing Monetization through Bank
     Credit Creation
IV      Applications to the Poor: Micro-Finance
V. Framework of Monetization and Savings Link
VI.     Monetary, Fiscal and Exchange Rate
      Policy
VII Conclusion


                                                   2
   I. Introduction: An Overview

   SSA Africa’s savings rates vary widely
    between countries, but remain comparatively
    low averaging around 15 per cent of GDP
    during the 1990s. This is not commensurable
    with the investment needs of 25 per cent of
    GDP required to reduce the poverty by 2015
    One way to increase the new opportunities
    and incentives for poor households and
    business firms to save a greater part of their
    income for the future in the forms of financial
    assets is to increase the monetization of the
    African economies through bank credit.

                                                  3
 II. Financial Intermediation and Degree of
  Monetization
Banking institutions. The African banking
  intermediary is weak and underdeveloped
  and is characterized as “shallow, narrow,
  and undiversified.” (Ayeerty, 1994) Table 1
  in Annex I and figure 1 show that the
  average ratio of M2 to GDP has remained
  constantly at the rate of 27.3 per cent for
  Africa as a whole, against 40 per cent for
  East Asia, 50 per cent for South Asia, 67 per
  cent for Latin America, 87 per cent for
  Europe and 91 per cent for North America.

                                                  4
         Table 1: Comparison of the Level of Savings and (Percent)
         Monetization

                   1980                 1990                  2000            2002
Region       S/Y       M2/Y S/Y             M2/Y S/Y            M2/Y S/Y           M2/
                                                                                   Y

Sub-           20.8       30.8      14.1       32.9     13.9         35.3   15.9     37.9
Saharan
Africa
East           30.8       28.8      34.1       59.2     33.0     122.3      37.9   129.8
Asia
South
Asia           15.8       31.8      19.4       37.9     21.8         49.3   25.8     55.8
Latin          20.0       19.2      18.9       15.8     17.4         27.6   18.9     34.7
America
Middle         37.8       34.4      23.4       55.6     28.5         54.4   34.7     58.7
East
 Source: World Bank: CD ROM 2003: World Economic Indicators                           5
   Low deposits may also be due to low rate of returns
    on savings with financial institutions. The average
    rate of returns or the average deposit rates offered by
    financial institutions range between 12 and 18 per
    cent while the average rate of return on commercial
    banks time deposits was 6-8 per cent. The financial
    institutions are also to blame that they did not create
    savings culture in the continent commensurable with
    its huge investment needs. Traditional culture of
    large extended family reduces the incentive of
    households to save. Likewise the huge capital flight
    that occurred after CFA devaluation has severely
    curtailed the saving deposits in the financial
    institutions. The financial systems with slow speed
    of business transactions and a low level of
    intermediations will not be able to attract substantial
    savings into institutions so as to allow them to
    provide substantial loans to the private sector.
                                                          6
   FIGURE 1:

        Comparison of the Level of Savings and Monetization
       (Percent)
         8

         7

         6                                             Series5
                                                       Series4
         5
                                                       Series3
         4
                                                       Series2
         3                                             Series1

         2

         1

             0   20   40   60   80   100   120   140



      Series 1: Sub-Saharan Africa (Bleu); Series 2: East Asia
      (Red); Series 3:South A sia (Yellow); Series 4:
      Latin America (Green); and Series 5: Middle East (Black).



                                                                 7
   The financial services to low income households and
    entrepreneurs in the remote urban and rural areas
    may be the most effective way to increase
    monetization and savings and reduce poverty and
    achieve broad-based economic growth. Yet in Africa
    fewer than 2 per cent of low income producers have
    access to financial services from the moneylenders.
    Therefore, financial intermediaries need to adopt
    new paradigms and take on new and aggressive roles
    in building financial infrastructure that serves the
    majority of people and enable the poor to share
    economic growth. For example, if 10 per cent of all
    low income entrepreneurs are to be served by
    financial institutions by the year 2005 and 30 per cent
    by the year 2025, the total amount of portfolios in
    micro-loans will need to increase from US$2,5 billion
    to about m, US$12.5 billion by 2005 and about US$90
    billion by 2025, servicing about 180 million of low
    income entrepreneurs.                                 8
   The financial services to low income households and
    entrepreneurs in the remote urban and rural areas
    may be the most effective way to increase
    monetization and savings and reduce poverty and
    achieve broad-based economic growth. Yet in Africa
    fewer than 2 per cent of low income producers have
    access to financial services from the moneylenders.
    Therefore, financial intermediaries need to adopt
    new paradigms and take on new and aggressive roles
    in building financial infrastructure that serves the
    majority of people and enable the poor to share
    economic growth.




                                                      9
   For example, if 10 per cent of all low income
    entrepreneurs are to be served by financial
    institutions by the year 2005 and 30 per cent
    by the year 2025, the total amount of
    portfolios in micro-loans will need to
    increase from US$2,5 billion to about m,
    US$12.5 billion by 2005 and about US$90
    billion by 2025, servicing about 180 million
    of low income entrepreneurs. The main
    challenges of this increase in lending levels
    will be in expanding the capacity and
    resources of those retail intermediaries
    committed to providing financial services to
    low income entrepreneurs.[1]
                                               10
   The underdevelopment of African Banks is rooted
    in historical failure of indigenous privately owned
    banks to emerge in most African countries.
    Commercial banks were initially created in colonies
    to finance the export of the raw material proceeds
    (cotton, coffee, tea, cocoa, etc) back to Metropolis.
    The legacy of colonialism has largely developed the
    current state of financial infrastructure in Africa. In
    post-independence period, many governments tried
    to remedy to this situation by nationalizing the
    commercial banks. (Like the case in Tanzania,
    Guinea, Ethiopia, etc.). The State owned a majority
    stake in more than half of the banks in Africa. But
    the State did rather liit the credit allocation to the
    private sector for sectoral development.

                                                         11
12
   Usually, some governments are not ideal credit
    instruments. State banks were not interested in
    granting credit neither to the poor urban classes nor
    to the rural sectors, as these were not more often
    able to provide collateral guarantee.          Small
    stakeholders continued to be served by the
    informal     sector    or     the    non-government
    organizations (NGOs). Central Banks could
    increase lending by the banks by reducing the
    statutory   reserve     requirements.    But    their
    independence to do so is scrutinized by the
    government.




                                                       13
   Small stakeholders continued to be served by the informal
    sector or the non-government organizations (NGOs). Central
    Banks could increase lending by the banks by reducing the
    statutory reserve requirements. But their independence to do
    so is scrutinized by the government.               Deposit
    mobilization is one of the most effective means for
    intermediaries to mobilize resources. Savings
    mobilization     makes       financial   institutions
    accountable to local shareholders. Thus all financial
    intermediaries should be encouraged to build
    savings mobilization arrangements for their clients,
    either by providing these services directly or by
    making arrangements with non-governmental
    institutions (NGOs). Banking regulations need to
    be adapted to encourage those micro-financing
    institutions with the capacities to legally mobilize
    savings from clients or the general public.
                                                              14
   Financial markets with the aim to attracting more
    private financial resources to complement public
    funds have emerged. Hence, in addition to the
    banking systems, a number of initiatives were
    undertaken to assist the African countries enhance
    their capacity in financial intermediation and
    development of bonds, stock, and money markets.




                                                    15
III. Increasing Monetization through Bank Credit
    Creation
   The establishment and extension of banking systems
  can create new opportunities and incentives for
  households and firms to save part of their income for
  the future. The extension of a bank network can have
  an effecting attracting new money into system. It is
  not a level playing field when industry in developing
  countries operates at lower cost, not because of
  cheaper labour, but because it can get access to
  finance, the lifeblood of the economy, at low (2-3%)
  interest rates




                                                     16
   College economics textbooks provide descriptions of money
    creation by the banking system via the "money multiplier"
    mechanism, and even of "fractional reserve deposit expansion.”
    It states unequivocally that the commercial banks create more
    than 90 per cent of M2 or M3. Credit that can be accessed by
    credit card, overdraft check or bank loan represents nothing
    more than a bank's promise to pay.

    Exactly this can be done for African bankers by increasing
    savings mobilization through increased monetization; that is,
    through creation of bank credit that increases deposits for
    households and business community while respecting the anti-
    inflation rules. - Money must chest the production of goods and
    services - that is, the volume of money credits created and put in
    circulation should correspond to the volume of goods and
    services in the economy or the velocity of money should be
    stable or declining.


                                                                   17
   Africa did not lack industrial capacity, fertile
    farmland, or skilled, industrious, and willing
    workers, residing in both the city and countryside.
    Already, extensive systems of reasonably efficient
    transport and communications are in place in some
    countries. There remained plenty of development
    work to be done in Africa. The one thing that
    industry and commerce lacked was a sufficient
    supply of money. Bankers, who were the only source
    of new money credit, deliberately refused loans to
    industry, commerce, and agriculture.




                                                      18
   Several African countries approved the Micro-finance
    Development Strategy to expand financial services to the poor
    and low-income households and their micro-enterprises.
    Despite the high level of the domestic banking penetration,
    the banks in Africa find it difficult to render full banking
    services to the remote areas of urban and rural sectors The
    range of micro-financial services, which enable cash flow
    smoothening for poor, should be wide enough to cater for
    short, medium and long-term needs, and they must be
    delivered in ways, which are: convenient, appropriate and
    accessible, safe and affordable. Providing poor people with
    effective financial services helps them deal with vulnerability
    and thereby helps reduce poverty. The relationship between
    poverty and access to financial services is driven by complex
    livelihood imperatives and is not simple.




                                                                 19
 “Banking with the Poor”[1] is an attempt to
  explore, demonstrate and publicize the scope for
  increase access to credit for the poor on a sound
  commercial basis through increased monetization
  of African economies. Banks need to study how to
  target their credit to the poor, how to reduce the
  transaction costs on the very small loans to the
  poor, how to find substitutes for collateral on such
  loans, and whether the poor can pay market rate of
  interest to enable loan schemes to recover their
  costs.
  [1] G.B. Thapa, Jennifer Chalmers,K.W. Taylor and
  John Conroy [1992], Banking with the Poor ,
  http://www.bwtp.org/publications/pub/bwtp.html.


                                                     20
  In Europe and Asian countries, the banking sector
   has led in providing both short-term and long-term
   credit to the private sector for growth and poverty
   alleviation
Some Success Stories from History:
    the Saracen Empire forbade interest on money
   1,000 years ago to its poor population and at that
   time its wealth outshone even Saxon Europe;
 Mandarin China issued its own money, interest and
   debt free, and historians and collectors of art today
   consider those centuries to be China's time of
   greatest wealth, culture, and peace;
 Germany financed its entire government and war
   operation from 1935 to 1945 without gold and
   without debt,


                                                      21
   American colonies issued debt-free and
    interest-free money as colonial script in the
    1700's and their wealth soon rivaled that of
    England, provoking restrictions from
    Parliament, which in turn led to the
    Revolutionary War. The basic cause of the
    revolt of the American colonies against the
    British Government was the fact that the
    colonists were creating their own money
    and enjoying comparative prosperity
    compared with conditions in Britain.
    American Banks printed 400 million dollars
    worth of interest and debt free Greenbacks
    in 1863 to successfully finance the Civil
    War, only after being asked to pay 24% to
    36% interest by the banks.                  22
   V.     Framework of Monetization and Savings
    Link
      A simple model is used to find out the effect of
    monetization on savings applying the following
    simultaneous equations:

   (1) S/Y = ao + a1M2/Y                      a1 > 0

   (2a)   M2/Y = bo + b1Y + b2r or        b1>0 b2>0

   (2b)    M2/Y = co + c1Y + c2 Π              Π>0

   (3)    Y = C + If + (X – M)

                                                    23
     – Table 2



                                             Adj     SD   F-     N
                                             R2.          Test
Savings        = -1.43 + 0.33 M2/Y           0.026 75.    13.9 316
S/Y                (-.46) (3..7)*                  8
Monetization = 29.1 + 0.22 Y + 0.26 R        0.262 98.    57.4 320
M2/Y           (29.2)* (9.8)* (3.0)*               1
Monetization = 30.8       + 0.22Y - 0.09 Π   0.257        0.34 320
M2/Y          (27.4)       (9.6)   (-4.3)



          Data Source: WDI CD
          ROM, 2004.
             *t significant at 5                                 24
          per cent
   VI. Monetary, Fiscal, and Exchange
    Rate Policy

   (a) Monetary Policy. In several African countries,
    there is a limited room for an independent
    monetary policy to expand money supply for
    development purposes, particularly in the currency
    zone countries (i.e. CFA zone). The credit policy
    was primarily designed to maintaining an
    appropriate level of foreign reserves. The main
    policy instruments used were: National and bank-
    by-bank credit targets; a ceiling on access to central
    bank financing to maintain aggregate demand at all
    level consistent with balance of payments and
    domestic growth objectives; a rediscount rate; the
    inter-bank money markets, and a liquidity ratio.

                                                        25
    Other monetary policy instruments for the poor:
1.   Government Issuing Debt Free Credit
2.   Nationalizing private Banks to create “People
     Banks” so that poor people will share bank
     profits:
3.   Islamic Banking: Use of paper money is illegal
     according to Islamic law; so another Islamic
     initiative is a return to the use of coins made of
     precious metal.
4.   Income Velocity of Money. The role of income
     velocity of money in monetary expansion is
     crucial, because the capacity of financial
     institutions to issue money to finance
     development (without fear of inflation) is greater
     when velocity is falling than when it is constant
     or rising                                          26
    (b) Fiscal Policy. Many African
    countries have continued to make
    gradual progress in public financial
    management reform via the adoption
    and improved implementation of
    medium-term fiscal frameworks to
    improve fiscal accountability and
    transparency. This has allowed the
    linkage between fiscal resources and
    development and poverty reduction
    goals to be strengthened.

                                           27
   Tobin proposed a currency transactions tax to
    combat financial volatility. The potential of the
    currency transactions tax as a generator of revenue
    for development is well known and it is referred to
    as “Tobin Tax”. It can be raised to as high as 0.25
    per cent on a transaction to discourage excess
    currency speculation. The issue is around the
    technical feasibility of this currency transactions tax
    as the financial markets are continuously
    developing, with new financial instruments being
    devised. The market structure is evolving with
    technological progress and in response to
    competitive pressures and regulation. Even at low
    rates of, say, 0.01 or 0.02 per cent, the tax may shift
    financial activity and encourage banking
    consolidation.
                                                          28
   Tobin proposed a currency transactions tax to
    combat financial volatility. The potential of the
    currency transactions tax as a generator of revenue
    for development is well known and it is referred to
    as “Tobin Tax”. It can be raised to as high as 0.25
    per cent on a transaction to discourage excess
    currency speculation. The issue is around the
    technical feasibility of this currency transactions tax
    as the financial markets are continuously
    developing, with new financial instruments being
    devised. The market structure is evolving with
    technological progress and in response to
    competitive pressures and regulation. Even at low
    rates of, say, 0.01 or 0.02 per cent, the tax may shift
    financial activity and encourage banking
    consolidation.


                                                         29
   (c) Exchange Rate Policy
With regard credit expansion, both monetary and
 exchange rate policy play an important role, having
 as objective price stability and low rate of inflation,
 in addition to preventing financial crises and
 ensuring sustained growth and full employment.
 For exchange rate policy, countries are concerned
 with stable real exchange that is the relative price of
 tradable with respect to no tradable goods. The
 value of money depend on the interaction between
 supply and demand, but money supply (increase in
 money credit) can easily changed by policy which
 itself depend on convention and institutions, on
 what people expect about institutional policy
 credibility (e.g. independence of the Central Bank
 to create money credit).
                                                      30
VII     Conclusion

But in developing countries, particularly in Africa,
  the role of financial systems should strive non-
  only on the routine banking services like in
  developed countries, but rather they should play a
  more active and aggressive role in fighting against
  the underdevelopment and the promotion of
  poverty reduction. Since the level of saving in
  Africa is low for any meaningful and
  transformational investment, the alternative
  weapon they may have among others is through
  increased monetization or credit creation.



                                                   31
If Sub-Saharan African Africa is to achieve the goal of reduction of
    poverty by 2015, it should strive to grow by 7 per cent per
    annum, as spelled out in the various UN programme objectives
    (MDGs, Copenhagen Social Summit, LDCs, etc.). ECA
    calculated the baseline resource requirements to achieve this
    growth, which is 63.9 per cent of GDP for the investment rate
    each year during the baseline period 1999-2000. Considering the
    fact that domestic savings can only finance 17.1 per cent of it,
    the remaining resource gap to be financed by external resources
    would be 46.8 per cent. However, on the base of historical
    trends the external resources combined (ODA, FDI, Bond issues,
    and equity portfolio) will only contribute 20.5 per cent. How to
    finance the remaining gap? The financial intermediaries can
    intervene to finance it through bank credit. With external aid,
    the bank credit would amount to 26.3 per cent of GDP, and
    without external finance, the bank credit will finance the whole
    resource gap amounting to 46.8 per cent of GDP (See Annex 1
   Table   A1).
                                                                32
ANNEX A
Table A1: SSA Resource Requirements to Reduce Poverty by a Half in 2015



                               Baseline:    2000-2005    2006-      2011-
SSA GDP Growth Rate:            1999-                    2010       2015
7 per cent per annium            2000
SSA ICOR                              9.0         6.7        4.4           2.9
  Investment Rate                    63.3        51.7       33.9          22.0
  Savings Rate                       17.1        19.6       23.9          29.1
  External Finance Rate              46.8        32.1       10.0          -7.1
Gap Financing:


  Net ODA Rate                        6.1         6.0        6.5           6.8
  FDI                                 0.5         0.8        1.5           2.0
  Portfolio Equity                    1.4         1.6        1.8           1.9
 Bond Issues                          1.2         1.1        0.9           1.8
Financing Overall Gap
Bank Credit with External            37.6        22.6        -1.2         -8.2
Aid
Bank     Credit      without         46.8        32.1       10.0          -7.1
External Aid

Source: UNECA, Economic Report on Africa 1999; Our own Projections: J.K. Thisen,
                                                                                   33
“Hypothesis of BankCredit Spiral” Unpublished paper.

				
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