Constraints of the Property Investment Market by iah20351

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									Cost and access to capital as
   constraints to growth
      Elena Ianchovichina
           PRMED
        March 25, 2009
                                                Growth diagnostics
                     Problem: Low levels of private investment and entrepreneurship




            Low return to economic activity                                                High cost of finance




   Low social returns                      Low appropriability                        bad international   bad local finance
                                                                                          finance



                                           government                   market
                           poor natural      failures                   failures
                           resource
                           management

   poor                                                              information      coordination
                   bad infra                                         externalities:
geography          structure                                                          externalities
                                                                   “self discovery”
                               - micro risks:    macro risks:                                           low          poor
          low
         human                 property rights,   financial,           -                              domestic      inter
         capital                 corruption,    monetary, fiscal                                       saving      mediation
                                    taxes         instability
                                                                                                                              -
    Source: Hausmann, Rodrik, Velasco (2005)
How do we assess whether a country is liquidity
                constrained?
   Misleading to rely on the popular measure of the
    amount of credit to the private sector as a share of
    GDP
   Low quantity of credit to the private sector is not
    necessarily a signal of scarcity of the factor
       Quantity of finance may be low because of scarce supply,
        in which case the country is considered liquidity-
        constrained (e.g. Brazil, 2000-07)
       But it may be low because of low demand, in which case
        the economy is not liquidity constrained, it is a case of
        low returns (e.g. Zambia, 2000-07)
                                            Domestic Credit to Private Sector (% of GDP) vs Per Capita
                                                                GDP. 2000-2007
                                          250
Domestic Credit to private Sector / GDP




                                          200
                                                         y = 20.291x - 110.49
                                                              R² = 0.5118
                                          150



                                          100
                                                                Mongolia

                                                    Benin
                                           50
                                                                                                            Brazil
                                            Tajikistan
                                                                                                        Zambia
                                            0
                                                4           5          6        7        8         9             10   11   12

                                                                                LN(GDPpc Current US$)
              What measures do me use?
   The way to distinguish between one case and another is the
    price – in the case of finance, the price to look at is the real
    interest rate
       Low quantity and high price indicate scarcity of supply relative to
        demand
       Look at international comparisons and the distance of the price from
        the mean
           if the price signal is an outlier and is several standard deviations outside
            the expected range it is difficult to reject the hypothesis
   It is important to look at investment by sector – investment
    may be adequate at the aggregate level but it may be
    concentrated in one sector or a few sectors
       Investment allocation tells us about the type of growth process
        occuring in the country and the likelihood that growth will be broad
        based and inclusive
                                                          Domestic Credit to Private Sector (% of GDP) vs Real
                                                           Interest Rate. Constrained Countries 2000-2007
                                                                   Mean Real Lending Rate = 8.4%
(Domestic Credit to private Sector / GDP)*100




                                                50
                                                                                                 Mean Dom Cred to Priv / GDP = 49.5%
                                                40
                                                                               Mean Real Lending Rate + 1 std Dev = 15%
                                                                                                                     Brazil
                                                30
                                                                                    Mongolia
                                                20    Tajikistan

                                                10        Benin
                                                                    Zambia
                                                                                       (Mean Dom Cred to Priv / GDP) -1 Std Dev= 3.8%
                                                0
                                                     0%      5%     10%      15%   20%     25%      30%    35%    40%     45%    50%

                                                                                     Real Lending Rates
                           Objective data
   Look at objective data over time and cross-country:
       Average real lending rates as a proxy of real cost of capital – time
        series data
       Benchmark to comparators
       Bank‟s lending rates by maturity and by borrower
           The range tells us a lot about the costs faced by different types of firms
   Investigate the reasons for the change in the cost of capital
       Is it due to changes in inflation?
       Is it due to changes in deposit rates?
       Is it due to changes in risk premiums?
   Benchmark deposit rates and risk premiums
       What are the determinants of deposit rates and risk premiums?
                         Subjective data
   Use firm survey data to see what are the perceptions about the
    cost and access to capital
   Match perceptions with reality, find out:
       The percentage of firms complaining about the cost and access to
        finance as a severe constraint to firms‟ growth
       The percentage of firms that did not apply for a loan because of the
        high cost of capital
       The percentage of firms that either obtained a loan or did not need a
        loan
   Distinguish between loans of different maturity
       Access to long-term financing is typically a big problem
   Even when the cost of capital is high, and the credit to the
    private sector is low, if the majority of firms do not need
    loans to expand operations then the country may not be
    liquidity constrained
Why is a country liquidity constrained?
   Inadequate access to savings
       Both access to foreign borrowing and domestic savings
        must be limited
           High spreads on foreign borrowing due to high country risk and
            low credit ratings
           Domestic capital controls
           Poverty traps
           High tax burden
       Important to understand who is not saving: firms or
        households
   Inefficient process of financial intermediation
Three case studies
    Mongolia
    Benin
    Zambia
The case of Mongolia
    Was Mongolia liquidity constrained in 2005?
          Was private investment too low in Mongolia?

   Gross domestic investment in Mongolia was
    high for its level of development
       Averaged 35% of GDP between 1996 and 2005
   However, most of investment was official
    foreign aid and loans
       59% of investment in 2004
    Was Mongolia liquidity constrained in 2005?
Did the composition of investment in Mongolia support inclusive
                            growth?

   The bulk of private investment went into a limited
    number of firms in mining and construction
       FDI was high and averaged 5.2% of GDP in 1996-2005
       Domestic private investment was financed mainly by own
        funds (72 percent in 2004), and not bank loans
       Domestic credit to the private sector was growing at high
        rates, but most of the loans were short term and financed
        trade, not productive investments
   Were real interest rates in Mongolia high?
                      Real interest rates came down substantially…

     80

     70

     60

     50
 %




     40

     30

     20

     10

      0
            1996      1997      1998      1999   2000   2001   2002   2003   2004   2005

                     Mongolia             Cambodia      Vietnam       Kyrgyz Republic
Source: Ianchovichina and Gooptu (2007)
What was the reason for the fall in the real cost of capital?
The fall in the real cost of capital was due to inflation rate increases rather than risk
                                  premium declines…

           18

           16

           14

           12

           10

             8

             6

             4

             2

             0
                       2001               2002             2003              2004             2005
            -2

                                     Interest rate spread (lending rate minus deposit rate)
                                     Inflation, consumer prices (annual %)

          Source: Ianchovichina and Gooptu (2007)
                         and Mongolia‟s cost of capital was still high relative to
                         other developing countries

                                                                                                                            Real interest rate
                                                                                                                                                                                                                 Mongolia
14
12
10
 8
 6
 4
 2
 0
-2
-4
-6




                                                                                                                                                                                                                                                                        Oman




                                                                                                                                                                                                                                                                                                             Romania
                                                                                                                                                                                                                                                                               Pakistan
     Turkey




                                                                                                                                                                                                         India
                                  China




                                                                                                                                                                                                                                                                                                    Poland
                                                                                                       Croatia




                                                                                                                            Estonia
                                                                      Russia




                                                                                                                                                          Czech
                                                              Egypt




                                                                               Indonesia




                                                                                                                                                                                                                  Moldova
                                                                                                                                                                                Slovakia
                                                                                           Morocco00




                                                                                                                                      Morocco04




                                                                                                                                                                                                                                                   Nicaragua




                                                                                                                                                                                                                                                                                          Ecuador
                                                                                                                                                                  El Salvador
                         Brazil




                                                    Hungary




                                                                                                                                                                                           Philippines
                                                                                                                                                  Kenya




                                                                                                                                                                                                                                                               Bosnia
              Slovenia




                                                                                                                 Bulgaria




                                                                                                                                                                                                                                      Bangladesh
                                          Albania




                                                                                                                                                                                                                            Algeria
 Source: Ricardo Hausman, “A framework for Growth Diagnostics”, Kennedy School of Government, Harvard University, May 2006.
and given the availability of credit
to the private sector
                                                             Domestic Credit to Private Sector (% of GDP) vs Real
                                                              Interest Rate. Constrained Countries 2000-2007
                                                                      Mean Real Lending Rate = 8.4%
   (Domestic Credit to private Sector / GDP)*100




                                                   50
                                                                                                    Mean Dom Cred to Priv / GDP = 49.5%
                                                   40
                                                                                  Mean Real Lending Rate + 1 std Dev = 15%
                                                                                                                        Brazil
                                                   30
                                                                                       Mongolia
                                                   20    Tajikistan

                                                   10        Benin
                                                                       Zambia
                                                                                          (Mean Dom Cred to Priv / GDP) -1 Std Dev= 3.8%
                                                   0
                                                        0%      5%     10%      15%   20%     25%      30%    35%    40%     45%    50%

                                                                                        Real Lending Rates
 Why was the cost of capital still high in Mongolia?
Cost of capital was high because of high bank deposit rates and
                         risk premiums

    25



    20


    15


    10


      5


      0
            Mongolia       Azerbaijan        Cambodia     Kyrgyz        Vietnam        Uruguay
                                                         Republic

               Deposit interest rate    Interest rate spread (lending rate minus deposit rate)


   Source: Ianchovichina and Gooptu (2007)
                                                Growth diagnostics

                     Problem: Low levels of private investment and entrepreneurship




            Low return to economic activity                                               High cost of finance




   Low social returns                      Low appropriability                        bad international bad local finance
                                                                                         finance



                                           government                   market
                           poor natural      failures                   failures
                           resource
                           management

   poor                                                              information      coordination
                   bad infra                                         externalities:
geography          structure                                                          externalities
                                                                   “self discovery”
                               - micro risks:    macro risks:                                           low        poor
          low
         human                 property rights,   financial,           -                              domestic    inter
         capital                 corruption,    monetary, fiscal                                       saving    mediation
                                    taxes         instability
                                                                                                                            -
    Source: Hausmann, Rodrik, Velasco (2005)
Why were bank deposit rates and risk premiums
                  high?
    Were they high because of bad international finance?
   International finance was good
       Mongolia‟s official debt was primarily concessional, and
        long-term
       FDI inflows were strong at the time of analysis
   Outlook was also good
       The spread on „B+‟ Fitch rated countries was 280 to 300
        basis points
       Collateral could be used to bring down the spread
        further down
       The outlook has changed since then due to the sudden
        negative TOT shock
                                                Growth diagnostics
                     Problem: Low levels of private investment and entrepreneurship




            Low return to economic activity                                                High cost of finance




   Low social returns                      Low appropriability                        bad international   bad local finance
                                                                                          finance




                           poor natural    government                   market
                           resource          failures                   failures
                           management


   poor                                                              information      coordination
                   bad infra                                         externalities:
geography          structure                                                          externalities
                                                                   “self discovery”
                               - micro risks:    macro risks:                                           low         poor
          low
         human                 property rights,   financial,           -                              domestic     inter
         capital                 corruption,    monetary, fiscal                                       saving     mediation
                                    taxes         instability
                                                                                                                          -
    Source: Hausmann, Rodrik, Velasco (2005)
Why were bank deposit rates and risk premiums
                  high?
 Was bad local finance the reason for the high cost of capital?

     Domestic saving were rising in Mongolia
      due to strong growth and BOP position
     Rising official reserves and commercial
      bank assets pushed the 2006 liquidity
      ratio to 600% and credit growth was
      highest since 1992
                                                Growth diagnostics
                     Problem: Low levels of private investment and entrepreneurship




            Low return to economic activity                                                High cost of finance




   Low social returns                      Low appropriability                        bad international   bad local finance
                                                                                          finance



                           poor natural    government                   market
                           resource          failures                   failures
                           management


   poor                                                              information      coordination
                   bad infra                                         externalities:
geography          structure                                                          externalities
                                                                   “self discovery”
                               - micro risks:    macro risks:                                           low         poor
          low
         human                 property rights,   financial,           -                              domestic     inter
         capital                 corruption,    monetary, fiscal                                       saving     mediation
                                    taxes         instability
                                                                                                                          -
    Source: Hausmann, Rodrik, Velasco (2005)
    Why were bank deposit rates and risk premiums high?
     Poor financial intermediation was responsible for the high cost of capital

    Bank deposit rates were high due to intensive
     competition among financial institutions in
     Mongolia
    Spreads were high due to a combinations of
     factors:
        Difficulty in assessing credit risk;
        High bank operating costs;
        Low profitability of banks‟ non-lending assets;
   Were the high cost of capital and limited access to
capital the reasons for the large number of firms without
                   loans in Mongolia?
                                               All firms
                 Loan                           100%
               Maturity of
                 1 year             With a loan        Without a loan
                  27%
                                        27.9%                       72.1%
                 Loan
               Maturity >                         Applied                           Did not apply
                5 years
                 0.9%
                                                  4.0%                                    68.1%
                                                  Why?                                            Did not need a
                                                                   Discouraged
                                                                                                       loan
                                       Lack          Low return
                                     Collateral      To capital?    25.9%                              42.2
                                        3%l             1%
                                                                      Why?                                 Why?
                                                       High cost of          Collateral              Low return
                                                          Capital                                    To capital?
                                                          22.0%               18.7%                    42.2%

  Source: Ianchovichina and Gooptu (2007)
    Discrepancy between subjective and
        objective data in Mongolia
    Cost of capital
        Whereas 56% of the firms in the ICA complained that the cost of
         capital is a severe obstacle to business growth
        Only 22% of the firms in the survey did not apply for a loan because
         of the high cost of capital
    Access to capital
        Whereas 42% of firms claim that access to credit was a severe
         obstacle
        70% either obtained a loan (28% of firms) or did not need a loan
         (42% of firms)
        Access to long-term financing is limited
            Collateral requirement is excessive due to problems with assessing
             credit risk
    Conclusion: while the cost of capital was high, it was not the
     primary reason for the small number of firms with loans
The case of Benin
Was Private Investment Low in Benin?
   Gross domestic investment has been low by international
    standards, averaging 18.2% of GDP in the last 10 years
   Nearly all of private foreign investment was FDI, averaging just
    1.7% of GDP in the past decade
     In line with WAEMU, but much below SSA, HIPCs and
        LICs averages
   Private domestic investment was a smaller share of domestic
    investment than the average in WEAMU, HIPC, LICs
   Only a small share of firms had loans in 2004 and most of the
    loans to the private sector were short- to medium-term
   As in other HIPCs a large share of investment in Benin was
    funded by foreign aid
Were there signs that credit to the private
            sector was tight?
   Broad money rose by more than 22 percent in
    2005, considerably higher than nominal GDP
   No signs of crowding out
       There was a 20 percent expansion of credit to the
        private sector.
       As net bank credit to the government has declined,
        growth of credit to the private sector has remained at
        nearly 10 percent, with some shift towards longer term
        credit and lending to non-trade services, especially
        telecommunications.
Benin Monetary Developments
    (CFA Francs billions)




Source: International Monetary Fund, Article IV Consultation, January 2007
    Was the low level of private investment in Benin a
    signal of low supply or low demand for finance?
                                                                  Real average cost of capital
   Average real cost of
    capital was lower          20
    compared to other
    developing countries       15
   It has risen during the
    past 3 years               10

   But in 2007, the cost of
                                5
    capital for small
    enterprises was close
    to 8 percent – much         0




                                                                                                                                                                                                                                        Developing EAS
                                                                                                                                                China
                                                                          Nigeria

                                                                                    Tanzania
                                    Benin




                                                                                                                                                                               Thailand
                                                                                                              Mauritius

                                                                                                                          India




                                                                                                                                                                                                                                 HIPC
                                                                                                                                                                    Malaysia




                                                                                                                                                                                                     Egypt
                                                                                                                                  Bangladesh
                                                                  Kenya
                                            Uganda




                                                                                                                                                        Indonesia
                                                                                               South Africa




                                                                                                                                                                                                             ECOWAS other than
                                                     Madagascar




                                                                                                                                                                                          Honduras
    lower than the rates




                                                                                                                                                                                                                WAEMU
    faced by SMEs in           -5

    many developing
    countries
                                                                                                                          2005                 2006

                               Source: SIMA and Government of Benin.
                         Benin did not appear to be finance constrained…

                                                                                                                             Real interest rate
                                                                                                                                                                                                                  Mongolia
14
12                                                                                         Benin
10
 8
 6
 4
 2
 0
-2
-4
-6




                                                                                                                                                                                                                                                                         Oman




                                                                                                                                                                                                                                                                                                              Romania
                                                                                                                                                                                                                                                                                Pakistan
     Turkey




                                                                                                                                                                                                          India
                                  China




                                                                                                                                                                                                                                                                                                     Poland
                                                                                                        Croatia




                                                                                                                             Estonia
                                                                      Russia




                                                                                                                                                           Czech
                                                              Egypt




                                                                               Indonesia




                                                                                                                                                                                                                   Moldova
                                                                                                                                                                                 Slovakia
                                                                                            Morocco00




                                                                                                                                       Morocco04




                                                                                                                                                                                                                                                    Nicaragua




                                                                                                                                                                                                                                                                                           Ecuador
                                                                                                                                                                   El Salvador
                         Brazil




                                                    Hungary




                                                                                                                                                                                            Philippines
                                                                                                                                                   Kenya




                                                                                                                                                                                                                                                                Bosnia
              Slovenia




                                                                                                                  Bulgaria




                                                                                                                                                                                                                                       Bangladesh
                                          Albania




                                                                                                                                                                                                                             Algeria
 Source: Ricardo Hausman, “A framework for Growth Diagnostics”, Kennedy School of Government, Harvard University, May 2006.
Cost of finance was low given the availability
of credit to the private sector…
                                                              Domestic Credit to Private Sector (% of GDP) vs Real
                                                               Interest Rate. Constrained Countries 2000-2007
                                                                       Mean Real Lending Rate = 8.4%
    (Domestic Credit to private Sector / GDP)*100




                                                    50
                                                                                                     Mean Dom Cred to Priv / GDP = 49.5%
                                                    40
                                                                                   Mean Real Lending Rate + 1 std Dev = 15%
                                                                                                                         Brazil
                                                    30
                                                                                        Mongolia
                                                    20    Tajikistan

                                                    10        Benin
                                                                        Zambia
                                                                                           (Mean Dom Cred to Priv / GDP) -1 Std Dev= 3.8%
                                                    0
                                                         0%      5%     10%      15%   20%     25%      30%    35%    40%     45%    50%

                                                                                         Real Lending Rates
    Perceptions differed from reality in Benin

   78 % of the firms                                    Access to capital in Benin, 2004 (ICA)
    complained that the                    Loan                                 All firms
    cost of capital was a               Maturity of                           191 (100%)
                                       1 year or less
    severe obstacle to                  16 (8.4%)
                                                           With a loan                  Without a loan
    business growth, but
    only 10 % of the                                              49                             142
                                           Loan
    firms were                        1<Maturity <=
                                                                  (25.7)                         (74.3%
    discouraged and did                   5 years                                 Applied                  Did not apply
                                        26 (13.6%)

    not apply for a loan                                                          49                                      93
    because of the high                                                           (25.7%)                                 (48.7%
                                          Loan
    cost of capital                     Maturity >
                                         5 years                                                                 Discouraged            Did not need a loan
   70 percent of firms                 7 (3.7%)                                                                    Why?
    claimed that access to                                             Rejected
                                                                                        Not
    credit was a severe                                                   15
                                                                        (7.9%)
                                                                                        rejected 34             65 (34%)                28 (14.7%)
    obstacle, 60 percent                                                                (17.8%)
    of the firms either
                                                           Lack of          Project
    obtained a loan, were        Other:                    collatera        not             High cost of    Collateral/
    approved for a loan or       5 (2.6%)                  l: 8             feasible:         Capital      Insufficient
                                                                                                                          Process too
                                                                                                                            Difficult
                                                                                                                                            Other
                                                                                                                                             16
                                                                                             19 (9.9%)      guarantee
    did not need a loan.                                   (4.2%)           2 (1.1%)                        8 (4.2%)
                                                                                                                          22 (11.5%)       (8.4%)


                        Source: Ianchovichina (2008) based on Benin
                        Investment Climate Survey 2004.
          Real cost of capital by type of
                borrower in Benin
Nature of borrower                   Credit   Deposit    Credit    Deposit      Credit    Deposit
                                           2005                   2006                2007
State or para-state organizations       1.5       -1.1      0.3          0.5        1.7       2.1
Private individuals                     5.8       -1.5      6.9          0.6        8.3       1.7
Financial customers                     2.4       -0.3      8.6          1.8        2.7       3.3
State companies and EPIC                2.3       -0.2      4.1          1.4        5.7       3.2
Retirement Insurance fund               4.1       -0.4      7.0          1.5        4.4       2.7
Private companies in productive         3.5       -0.6      5.9          1.2        8.1       2.5
sector
Small enterprises                       7.5       -1.5      8.1          -0.1       9.8       0.8
Village cooperatives and groups         5.9       -1.2      6.2           1.5       6.7       1.1
Other (NGO, Friends, Unions, etc.)      5.3       -1.3      5.1          -0.1       4.4       1.3
Personnel of banks                     -2.6       -5.4     -1.0           0.2       0.5       1.3
Total                                   3.7       -0.7      5.8           1.1       7.6       2.2
Source: SIMA and Government of Benin

  Real cost of capital for small enterprises was rising and was much higher
  than the average, but still lower than in many countries and access to
  microfinance did not appear to be a problem
Microfinance in Benin is a dynamic sector

   Microfinance has grown tremendously in the last decade
   Benin has the largest number of microfinance institutions in the
    WAEMU region.
   In 2002, there were more than 600 retail microfinance
    organizations belonging to about 85 programs or networks
    reaching about 500,000 people
   A penetration rate of about 15 percent of the total active
    population
   However, access to long term capital that can fund productive
    investment, not short-term trade-related activities, is very
    limited
The case of Zambia
      Average cost of finance declined in recent
                        years
                                        Figure 1: Real cost of capital (average)

                        100.0
                         90.0
                         80.0
                         70.0
                         60.0
              Percent




                         50.0
                         40.0
                         30.0
                         20.0
                         10.0
                          0.0
                                1995   1996   1997   1998   1999       2000    2001    2002   2003     2004   2005

                                               Zambia       Mongolia          South Africa    Uganda

Source: Authors‟ own calculations using World Bank data.
Ianchovichina and Lundstrom (2008)
          But, cost and access of capital
            differentials were sizable
   Access and cost of capital varied with firms‟ size
       In 2003, nearly 50 percent of larger firms had a loan, while only 19 percent
        of small firms had a loan
       The cost of capital differential between large and small firms was more
        than 10 percentage points
       Similar differentials existed between the cost of capital of exporters and
        non-exporters, domestic and foreign companies
       Micro firms faced even steeper constraints
   Access and cost of capital varied by area
       Rural areas had very limited access to capital
       Access to capital through informal channels at prohibitively high cost
What were the reasons for the poor access to and high
     cost of finance for small and micro firms?
   Poor financial intermediation rather than low domestic savings or bad
    international finance
       Domestic savings as a share of GDP climbed up from 6% in 1990s to 18.1% in 2006,
        a share higher than the SSA average
       FDI and aid were higher than the average for SSA and LICs both in 1990s and 2000s
   Financial intermediation was limited by small size of banking sector,
    and an inadequate supporting financial infrastructure
                          Percentage of population with a bank deposit account




         Ianchovichina and Lundstrom (2008)
Despite limited use, there were signs of improvement
   Only 5 to 8 percent of business owners used microfinance (FinTrust 2007)
   Signs of improvement:
       the percentage of people identifying the cost of finance as the main reason for
        their poverty status halved in the period 2002-06
       Some micro finance institutions operated by NGOs and outgrowers schemes
        successful in providing credit to farmers but limited coverage
                                Number of commercial banks' branches

                       185

                       180

                       175

                       170

                       165

                       160

                       155

                       150

                       145

                       140
                             2001   2002   2003    2004   2005       2006   2007


                                    Source: Bank of Zambia (2007).
Top reason for not using financial service
          was lack of income
              Reasons for not having a bank account




          Source: FinTrust (2007). FinScope data from 2005.

								
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