Trade and Investment Project

1. Trade and Investment Project Overcoming Financial Sector Constraintsto Private Sector Development in MozambiquePresentation to CTA, Maputo -- 22 February, 2007 Bruce Bolnick Alistair Tite

2. Overview and Trends

3. Central issues raised by the business community • Access to credit and cost of credit as major constraints to private sector development • Restrictive foreign exchange regulations as impediment to trade • Absence of banking services in many regions • Need to identify practical steps to address these problems. • But no magic solutions!

4. Starting point : Principles of Finance • Core purpose of the financial sector: Intermediate financial resources and manage risks • Paramount importance of sound banking system • But sound banks can also be innovative banks! • Financial market imperfections  Supporting role for government

5. Recent trends • Progress in development of the financial system • Rapid growth of lending and deposits • Interest rates still very high • High fees • Financial sector reform programs

6. Credit to the economy (% GDP)

7. Forex/MT loans & deposits

8. Interest rate trends

9. Real interest rates

10. Access to Banking Source: World Bank working paper, Banking for Everyone, December 2006

11. Access to Finance

12. View from the banks • Rapid growth of loan books since 2005. • Banks actively seeking viable customers • Leading constraint: high interest rates • Also serious risk factor (“adverse selection”) • Other major constraints – quality of loan applications • Poorly prepared business plans • Evidence of weak management • Viability of repayment not demonstrated • Lack of creditable financial information • Need for equity contribution • Finally, security for the loan

13. Enhancing creditworthiness • Traditional route to creditworthiness • Commitment by businesses to improve quality of financial information • Establish CTA credit mentoring system • Establish new credit bureau with more comprehensive information • Use of insurance as credit enhancement • Examine African Trade Insurance network for export credit insurance • Pressure government on payment arrears !

14. Creating a Development Bank • Fundamental issue: access to development finance for viable productive investment • Lessons from international experience • Cases of success • Cases of failure • Implications for Mozambique • Strengths of DFI proposal • But serious structural weakness • The critical test: Are investors willing to put their money at stake? • Example: GAPI - Rabobank

15. Access to Term Finance (2) • Alternative avenues of term financing • Create regional DFI • Promote asset based lending • Establish “second-tier” bond market • Provide TA for risk capital deals • And on the supply side • Fundamental pension reform

16. Outreach to new clients • Old news: • Lower interest rates • Microfinance • Suppliers’ credit networks, outgrower schemes • Temporary, limited credit guarantees as catalyst for outreach to new markets • New news: mobile phone banking • Technology to the rescue • Low cost, broad outreach • No new legislation needed

17. Legal/judicial foundations for finance • Important recent reforms • Other reforms underway • Pensions, Bankruptcy, Forex Controls. Also Labor Law. • Need to lobby for appropriate outcomes • Other work to do, including: • Focus on enforcement of banking laws • Management Assisted Judicial Execution to deal with key bottleneck in foreclosing collateral • Clarify role of “correspondentes” as agents • Legal foundations for small claims court

18. Cost of financial services

19. Cost of financial services Key problem: Why are MT interest rates so high? • Usual explanations don’t explain gap between MT and USD interest rates • Core issue: monetary policy  Why are T-bill rates? • Market concentration also likely factor

20. Cost of financial services (2) • Recommendations • Expand access to the primary market for T-bills • Reduce reserve requirement, or allow government securities as reserves • Support government in maintaining fiscal discipline! • Let “crowding out” fade away

21. Other cost issues • Extremely high interest rates on microfinance • Excessive banking fees • Need for consumer protection laws, transparency in lending and fees

22. Foreign exchange issues

23. Foreign exchange transactions • General problem with excessive red tape • New forex law in process, but no information yet on content • Basic issue of exchange rate risk • Central bank exchange rate management

24. Aviso 5/2005 • Justifications: • Systemic risk from unhedged positions – nip it in the bud! • Monetary management • Effect on exchange rate policy • Effect • Recommendations: • 50% appears to be too high as risk provision • Broaden the definition of hedged position • Use this to create incentives to develop forward market

25. Aviso 2/2006 - Situation • Justification: shaky! • It won’t solve the problem! • “Fighting against an avalanche” • Perverse incentive to hold money offshore – • A major lesson from international experience! • Yet sand in the gears of international trade • costs, delays, contract restrictions • And heavy administrative burden on banks • In any case, banks are strictly monitored • And major banks appear to be complying with current regulation

26. Aviso 2/2006 - Implications • Also process problem - no prior consultation • Recommendations • Scrap Aviso 2/2006 • Strictly enforce the existing regime, with serious penalties for non-compliant bank • But ease “exceptional” condition for pre-payments • Streamline the role of banks in trade facilitation • Consider further liberalization of cross-border payments to reduce incentives for capital flight

27. Conclusions • Need to identify concrete steps to get things done! • Priorities = important problem + political feasibility + solid analysis • Analysis points to recommendations for action in the short run • And important issues for dialogue to seed deeper reforms in the longer run