WDP50 April 1989 50 U World Bank Discussion Papers Lessons of Financial Liberalization in Asia A Comparative Study Yoon-Je Cho Deena Khatkhate RECENT WORLD BANK DISCUSSION PAPERS No. 1. Public Enterprises in Sub.-Saharan Africa. John R. Nellis No. 2. Raising School Quality in Developing Countries: What Investments Boost Learning? 13ruce Fuller No. 3. A System for Evaluatinq the Performance of Government-Invested Enterprises in the Republic of Korea. Young C. Park No. 4. Country Commitment to Development Projects. Richard Heaver and Arturo Israel No. 5. Public Expenditure in Latin America: Effects on Poverty. Guy P. Pfeffermann No. 6. Community Participation in Development Projects: The World Bank Experience. Samuel Paul No. 7. International Financial F'lows to Brazil since the Late 1960s: An Analysis of Debt Expansion and Payments Problems. Paulo Nogueira Batista, Jr. No. 8. Macroeconomic Policies, Debt Accumulation, and Adjustment in Brazil, 1965-84. Celso L. Martone No. 9. 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Agricultural Trade Protectionism in Japan: A Survey. Delbert A. Fitchett No. 29. Multisector Framework for Analysis of Stabilization and Structural Adjustment Policies: The Case of Morocco. Abel M. Mateus and others No. 30. Improvins the Ouality of Textbooks in China. Barbara W. Searle and Michael Mertaugh with Antnony Reaa ana Fniiip Conen (Continued on the inside back cover.) 5 0 World Bank Discussion Papers Lessons of Financial Liberalization in Asia A Comparative Study Yoon-Je Cho Deena Khatkhate Thc World Bank Washington, D.C. Copyright © 1989 The World Bank 1818 H Street, N.W. Washington, D.C. 20433, IJ.S.A. All rights reserved Manufactured in the United States of America First printing April 1989 Discussion Papers are not formal publications of the World Bank. They present preliminary and unpolished results of country analysis or research that is circulated to encourage discussion and commnent; citation ancl the use of such a paper should take account of its provisional character. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. Any maps that accompany the text have been prepared solely for the convenience of readers; the designations and presentation of material in them do not imply the expression of any opinion vvhatsoever on the part of the World Bank, its affiliates, or its Board or member countrics concerning the legal status of any country, territory, city, or area or of the authorities thereof or concerning the delimitation of its boundaries or its national affiliation. 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The complete backlist of publications from the World Bank is shown in the annual Index !f Publications, which contains an alphabetical title list and indexes of subjects, authors, and countries and regions; it is of value principally to libraries and institutional purchasers. The latest edition of each of these is available free of charge from Publications Sales Unit, Department F, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'rna, 75116 Paris, France. Yoon-Je Cho is an economist in, and 1Deena Khatkhate a consultant to, the Industry, Trade, and Finance Division of tlhe World Bank's Asia 'rechnical Department. Library of Congress Cataloging-in-Publication Data Cho, Yoon-Je, 1953- Lessons of financial liberalization in Asia. (World Bank discussion papers ; 50) Bibliography: p. 1. Monetary policy---Asia, Southeastern--Case studies. 2. Monetary policy--Korea (South) 3. Monetary policy-- Sri Lanka. 4. Monetary policy--Southern Cone of South America. I. Khatl.hate, Deena R. II. Title. III. Series. HG1230.8.C48 1989 332-4'95 89-5772 ISBN 0-8213-1209-X iii Table of Contents Page No. Executive Summary .................................................. v I. Introduction ............................................... 1 II. Macroeconomic Background and the Financial Sector on the Eve of Financial Liberalization .................. 4 III. Instrumentality of Financial Reform ........................ 18 IV. The Conseguences of Financial Liberalization ............... 23 Overview Macroeconomic Background The Consequences of Financial Liberalization Level and Structure of Interest Rates Growth of the Financial Sector Competitiveness, Profitability and Efficiency of Financial Institutions Availability of Long-term Credit Integration of Domestic Interest Rates with Foreign Interest Rates Quality of Banks' Portfolios The Corporate Sector's Financial Structure Intercountry Experiences: Divergence and Similarity Summing Up V. Financial Liberalization in Chile. Argentina and Uruguay: A Comparative PersDective ..................... 72 1. Macroeconomic Environment and the Status of the Financial Sector 2. The Main Elements of the Financial Liberalization Programs 3. Impact of Financial Reforms 4. Adjustment Policy Implementation and Its Linkage with Financial Liberalization 5. Financial Liberalization Experience in Southern Cone and Asian Countries: A Comparative View iv Page No. VI. Lessons of Countries' Experiences from Financial Liberalization ................................ 101 Bibliography .107 Statistical Appendix .117 ACKNOWLEDGMENT The authors would like to acknowledge comments and suggestions on the earlier drafts of this paper by Messrs. Oktay Yenal, V.S. Raghavan, V.V. Bhatt, Vicente Galbis, Sergio Leite, Edgardo Barandiaran, David Kochav, Heywood Fleisig, Zdenek Drabek, Kenichi Ohashi, Richard Berney and Roberto Zagha. v Executive Summary 1. This paper provides empirical examination of financial liberaliza- tion in five Asian countries: Korea, Malaysia and Sri Lanka, which have been relatively successful, the Philippines, which has not done well, and Indonesia, which has a mixed record. The experiences of these countries are contrasted with those of the Southern Cone countries of Latin America: Chile, Argentina and Uruguay. The paper will answer some of the questions raised about the nature, content and scope of financial liberalization strategy and policies in developing countries, and it will draw pertinent lessons for those countries which desire to strengthen their liberalization process as well as for those which will undertake similar programs for the first time. 2. For the purpose of this paper, financial sector means the banking sector because of its dominant position in developing countries, though nonbank financial institutions, when important, are covered to the extent that data are available. The term financial liberalization means substantial reduction of government intervention in setting interest rates and allocating credit, either by doing away entirely with the interventionist regime as in the Southern Cone countries or by gradually phasing it out as in Korea, Sri Lanka and partly in Indonesia. It may also be mentioned that this paper does not discuss allocative efficiency of the liberalized system both because of the complexity of issues involved and the scarcity of data. II. Macroeconomic Background and the Financial Sector on the Eve of Financial Liberalization 3. Korea undertook financial reforms in 1981-82; Malaysia, towards the end of 1978; the Philippines, in 1980; Indonesia, in 1983; and Sri Lanka, in late 1977. Though nuances of motivation varied according to the particular circumstances of each country, reform was basically a response to the realiza- tion by authorities that the interventionist regimes then prevailing were inefficient and ineffective because the impact was largely circumvented by financial institutions through various devices. Korea 4. Korea's economy grew rapidly in the 1960s and 1970s, spurred by strong performance of the export sector. Following the first oil shock in the early 1970s, the balance of payments deteriorated, and investment was financed by massive foreign borrowing. Expansionary monetary policy during these years resulted in a high average annual rate of inflation of around 20%. The nominal exchange rate was pegged to the US dollar during 1974-79; there was a 23.6% appreciation in the real effective exchange rate between 1973 and 1979. The capital account was tightly controlled by the Government to prevent vi capital flight. By the end of the 1970s the export sector, the main engine of growth, had slowed considerably. With the second oil shock, the terms of trade deteriorated further and the increase in international interest rates posed serious problems when f'oreign debt was already large. 5. The financial system in Korea, dominated by the Government during the 1960s and 1970s, had lbeen used as an instrument of development policy. There was a thriving informal credit market estimated to account for around 30% of total bank credit in the 1970s. Nonbank financial institutions (NBFIs) such as investment and finance companies and mutual savings companies were allowed to be set up in the early 1970s. The securities market's role in financing investment was marginal. 6. Most interest rates in the organized credit market were regulate' by the Government through a strict interest rate ceiling. With the inflation rate relatively high and volatile, the real deposit rates were usually negative in the 1970s, and lending rates followed a similar pattern. Preferential credits with low interest rates were estimated to account for almost 30-40% of total bank credit. Malaysia 7. Unlike Korea, Malaysia had a very stable macroeconomic environment during the 1970s. Inflation was stable, and the current account was in a comfortable position during most of the period, especially the latter half of the 1970s, owing to the improvement in the terms of trade. However, Malaysi'a had a chronic fiscal deficit of about 6-7% of GDP during the 1970s, owing to large development expenditures and subsidized public enterprises. Malaysia had a fairly open capital account with a floating exchange rate. 8. The financial institutions in Malaysia operated under predominantly competitive conditions. The share of commercial banks in total assets of ihe financial system was about 40%, while the shares of nonbank financial institutions together with the Central Bank totaled about 30%; the rest belonged to provident, pension and insurance funds, savings institutions and development finance institutions (DFIs). The operations and management of commercial banks were, by and large, autonomous, and there was considerable freedom of competition. Malaysia had a relatively large securities market in the 1970s, but it was dominated by the issuance of government securities. 9. The growth of the financial sector was accelerated in the 1970s by the stable rate of real return on deposits, which in turn owed to a stable and low inflation rate. The Malaysian financial sector was considerably deepened, and the instruments were diverse and sophisticated. Before October 1978, Bank Negara of Malaysia (BNM) determined the maximum deposit rates and minimum lending rates of commercial banks, but BNM's control did not adversely affect interest rates. vii The PhilipDines 10. The Philippine economy in the 1970s was relatively stable, with a rate of growth of between 6% and 6.5% per year. The Philippines had a chronic deficit on current account of the balance of payments of around 5% of GNP during the period 1974-1980, although the nontraditional export sector grew quite impressively. Major external shocks affected the Philippines during the turbulent 1970s. The first oil shock occurred in 1974 and caused high domestic inflation, The inflation rate was kept stable until the second oil shock of 1980, when it again escalated. The fiscal deficit remained modest during the 1970s, fluctuating around 1.0% of GDP. The macroeconomic situation was precarious on the eve of financial reform. 11. The banking sector in the Philippines was relatively free. The entry of financial institutions was easy until 1970. Between 1970 and 1979, no new banks have been allowed to enter the system. Since then the policy regarding new banks has become liberal. The nonbanking segment of the financial system expanded in the 1970s, mainly due to the expansion of money market activities. There was not a strong capital market. By the mid-70s, the development of money market instruments accelerated and attracted substantial financial savings. Interest rates were fixed and remained negative in real terms during most of the period prior to financial liberalization. Indonesia 12. Indonesia's economy was in good shape because it was an oil- exporting country during the 1970s. The rate of growth of its real GDP was around 7% on average during 1973-83 because of burgeoning oil revenues and large amounts of foreign aid, and Indonesia had an open capital account. But Indonesia faced serious problems when the oil price boom abated at the beginning of the 1980s. The external payments position worsened and the Government's fiscal deficit ran as high as 2% of GNP during 1980-83. Inflationary pressures, however, were not as serious: the rate was around 11%, much lower than the 20% rate prevailing in the 1970s. 13. The Indonesian financial system had considerable depth and breadth on the eve of financial reform in 1982. Though the financial system consisted of deposit money banks including state-owned banks, development banks, insurance companies, saving banks and credit institutions of all types, the latter accounted for barely 7% of total financial assets. Regulations governing the financial system were numerous. There were ceilings on the interest rates on deposits and loans of the 8 state banks which accounted for almost 40% of the total gross financial assets in Indonesia until 1983. There were credit ceilings on individual private and foreign banks, and within the overall credit ceilings there were subceilings differentiated by various categories of loans. Furthermore, the most comprehensive regulation was the system of subsidized liquidity credits made available to banks to refinance low-interest-rate loans to priority sectors. Sri Lanka 14. Until 1977, Sri Lanka was the only country among the five which had experienced prolonged stagnation. The inflation rate was as high as 14%, viii induced by a large and growing fiscal deficit amounting to almost 8% of nominal GNP. The balance of payments remained precarious, even with stringent exchange and trade controls. 15. Sri Lanka had a fairly modern financial sector in 1977, with a variegated institutional pattern. Commercial banks, and two state-owned banks with a 35% share in total financial assets, dominated. The relative importance of development banks and insurance companies was small. Regulation of the financial system wits pervasive. III. Instrumentality of Financial Reform Korea 16. Financial reforn in Korea was gradual. In 1981, the Government began to privatize the natiornwide commercial banks by divesting its shareholdings; by 1983, it had privatized all nationwide city banks. However, the Government maintained de facto monitoring of bank management and credit allocation. Entry of foreign banks was permitted to motivate domestic banks to improve their services and operations through modern banking practices. New financial instruments were introduced to promote the development of short- and long-term financial markets and enhance the capacity of the financial institutions to mobilize savings. 17. The interest rate ceiling was adjusted upward in 1979 to yield positive real interest rates, although this was frustrated by high inflation in 1980 and 1981 caused by the second oil shock. In 1982, the Government abolished all preferential lending rates and unified the bank loan rate at 10%; however, preferential access to credit for specific groups of borrowers continued. The Korean government has maintained the interest rate ceilings except in special markets such as interbank, unguaranteed commercial bills and corporate bond markets. The capital account was not liberalized. Malaysia 18. Commercial banks were allowed to determine their own interest rates on deposits and loans after a new interest rate regime was instituted in October 1978. However, the prime rate was controlled by the monetary authority during 1978-81. Late in 1981, a new interest rate mechanism based on the base lending rate (BLR) was introduced. Its introduction signaled the virtual disappearance of control on the lending rates. From November 1, 1983, all interest rates on loans and advances other than those prescribed by maximum ceiling rates andL the law were linked to the BLR of the respective banks. However, a ceilirng on lending rates was continued for special categories of borrowers and for housing loans. The Philippines 19. In the Philippines, a universal banking system patterned on the German model was introduc:ed in March 1980. To facilitate the change, the ceiling on various categories of bank lending and deposit rates was first relaxed and then removed. Banks which became unibanks were required to broaden their ownership base. To encourage term lending, controls on interest ix rates on long-term loans and deposits were removed first, and later the interest rates on short-term deposits were removed. The ceiling on rates for deposits with maturity of two years or less was eliminated in mid-1984, and the last lending ceilings on short-term loans were removed in January 1983. However, the interest rate subsidy for preferential credit programs was continued. In 1985 the Central Bank finally eliminated the subsidy when the rate on rediscounting of preferential loans was aligned to the market rate. Indonesia 20. Indonesia's financial reform was implemented in two stages. The beginning was made in June 1983, and the second stage commenced in 1984. The June 1983 reform had three principal components: (a) elimination of ceilings on bank credits; (b) gradual narrowing of loan categories from access to Bank Indonesia (BI) liquidity credits; and (c) deregulation of state banks' interest rates on most categories of deposits and on all loans except a few priority loans. The two elements of the subsequent reform, which was more in a nature of a follow-up, were: (a) introduction of rediscount facilities and BI certificates called Servifikats Bank Indonesia (SBI); and (b) introduction of new money-market instruments, Surat Berharga Pasar Uang (SBPU), in February 1985. Sri Lanka 21. The emphasis of the financial reform in Sri Lanka was on removal of restrictions on interest rates. This was done by first raising the bank rate from 8.5% to 10% p.a., thereby giving a signal to other market rates of interest. This was followed by sharply raising the interest rates on deposits of the National Savings Bank (NSB), a pace-setter. The Central Bank of Ceylon restricted access of banks to its credit to 4% of selected items of assets as of September 30, 1977; the limit was subsequently raised to 7%, and any borrowing beyond this limit was charged a penalty rate of 15%. At the same time, the basic exchange rate and the premium value (FEEC) were first unified at an initial rate of SLR 16 to the US dollar, and then the rate was allowed to float. Exchange controls, too, were considerably diluted. IV. Consequences of Financial Liberalization 22. The consequences of liberalization for the financial systems in the five countries are discussed at a disaggregated level. The areas chosen for disaggregation are: (a) the level and structure of interest rates; (b) growth of the financial sector; (c) competitiveness, profitability and efficiency of financial institutions; (d) availability of long-term credit; (e) integration of domestic interest rates with foreign interest rates; (f) quality of banks' loan portfolios; and (g) the corporate sector's financial structure. Interest Rates 23. The expected impact of deregulation on interest rates in all the five countries was in a desired direction. In Korea, interest rates remained substantially positive, mainly because of a decline in the inflation rate and flexibility in interest-rate management. The approach to deregulation of interest rates was pragmatic, as evident from the fact that the banks' x interest rates were quickly adjusted downward, even in the face of high inflationary expectations, when the financial vulnerability of the corporate sector seemed to react adversely on the banks. On the other hand, dismantling of preferential interest rates and partial. liberalization of interest rates in the nonbanking sector have facilitated the integration of formal and informal markets. The impact of liberalization on domestic interest rates in Malaysia was modest at the beginning because market: forces before liberalization had a strong influence on them and the difference to be made up by a further rise in interest rates was limited. After the new interest rate mechanism based on BLR was introduced in 1981, bank deposit rates became more sensitive to international interest rates. The integration of interest rates was more conspicuous in regard to deposit rates. However, the segmentation of interest: rates between those for banks' assets and liabilities and those for government securities was limited. The term structure of interest rates changed significantly, particular:Ly due to a stable inflation rate. In the Philippines, though the nominal interest rates on bank deposits and loans increased marginally at first, the real interest rates became positive as the inflation rate declined. But: the upward movement of interest rates was induced in part by the severe monetary contraction following the liquidity squeeze and in part by the high yield on Central Bank bills with which the banks had to compete. During 1984-86, market-determined interest rates were higher than the real return on investment. Domestic interest rates were largely well integrated. In Indonesia, t!he main impact of liberalization was on the interest rates on assets and liabilities of the state banks, since the other banks' rates were freely determined even before liberalization. Real interest rates became positive and remained high. Domestic interest rates were well integrated. Sri Lanka followed other countries in regard to deposit interest rates, which became strongly positive after liberalization. Though government intervention was continued, market forces were given greater influence on the level of interest rates. Financial Sector Growth 24. The beneficial consequences of financial reform can be seen in the faster growth of the financial sector relative to the period before reform, In Korea, the ratio of M3 to GNP rose sharply after 1981 and faster than the M2/GNP ratio, implying that nonbank financial assets, particularly corporate bonds and commercial papers, expanded rapidly. In Malaysia, the ratio of M3/GNP, which included time and savings deposits of nonbanks, more than doubled. In the first flush of financial reform, the financial system in the Philippines expanded moderately. Since 1984, however, its growth rate has turned negative in the context of an adverse macroeconomic environment, a liquidity crisis and widespread bank failures. In Indonesia, the gross assets of the organized financial sector almost tripled since 1982, and the range of noncredit financial services widened considerably. Only in Sri Lanka did the financial system not record any perceptible growth, but financial reforms succeeded in stemming the decline of the financial system. 25. From the above, it is clear that growth of the financial sector in Korea, Malaysia and, to some extent, Indonesia has been rapid when the level of real interest rates has been high and stable. This again points to the importance of stable inflation rates. The Philippines, which had highly fluctuating inflation during 1983-85, experienced contraction of the financial sector despite the high 'evel of real interest rates. However, financial xi sector growth was rapid during 1980-83 when inflation was relatively stable. Sri Lanka's financial sector did not grow fast, presumably due to fluctuating and high inflation in the later stages of reform. Japan and Taiwan, which have achieved rapid financial sector growth during the last two or three decades despite their controlled banking systems, also had a very low and stable inflation rate. This suggests that a relative price stability may be as crucial as the deregulation of the interest rates per se to the achievement of sustained financial sector growth. Competitiveness of the Financial System 26. Following liberalization, competitiveness of the banking system increased in all the five countries, though the degree of increase varied from country to country. In Korea, use of new financial instruments by privatized banks and NBFIs, expansion of the direct credit market and freer entry of foreign banks were the main catalysts in promoting competition. In Malaysia, competitive forces were boosted by liberalizing banks' interest rates, making the competition between banks and NBFIs more intense. The expansion of branches by banks and the relative increase of the share of small banks when the prime rate was controlled also contributed to greater competition. The entry of foreign banks was another contributory factor. In the Philippines, where the bank concentration was prevalent even before liberalization, it was reduced after the advent of universal banking and, to some extent, the restructuring of two largest government-owned banks. However, the basic oligopolistic structure persisted even after financial liberalization. In Indonesia, the main factor that spurred competition among banks was the abolition of controls on deposits and loan interest rates of state banks which had major share in total financial assets. In Sri Lanka, the interbank market acquired new strength as new instruments emerged and foreign currency banking units (FCBUs) were established and foreign banks were allowed to operate. Term Credit 27. The impact of liberalization on availability of term credit was not uniform across the five countries. In Korea, there was a distinct improvement in the flow of term credit from nonbanks such as insurance, investment and trust companies (whose growth was accelerated) and the securities market. In Malaysia, however, the securities market as a source of long-term funds remained marginal: it was crowded out by the issue of government bonds sold to captive markets. In addition, the share of development finance institutions in total credit was very small. The Philippines' experience was mixed. Long-term funds from banks were augmented when reserve requirements on longer term deposits were lowered and bank loan rates were deregulated, thereby attenuating mat4irity risks. With the extension of the average maturity of deposits, the banks' ability to provide such funds was greatly enhanced, though since 1985 political turbulence, adverse macroeconomic developments and financial fragility of banks have reduced the banks' role in this area. In contrast, in Indonesia the banks were constrained to lend medium and long by the pronounced volatility of interest rates and the mismatch of maturities between liabilities, predominantly of short-term nature, and the loans required for investment financing. The capital market did not develop due to lack of infrastructure facilities. In the more liberal financial conditions in Sri Lanka, banks and development banks made up the single largest source of capital funds to the private sector. A limiting xii factor was the relative shortage of demand for long-term funds in view of the lack of bankable projects. The capital market could not develop for want of, among other things, an appropriate legal framework. 28. Thus, the liberalization of intetrest rates does not seem to have significantly improved the availability of long-term credit, mainly because the maturity of loans tended to be shortened whenever the inflation rate was high and volatile, as in Indonesia and the Philippines. Further, if the banks have to consider medium- cnd long-term lending (Indonesia), interest rates have to remain stable. To enhance the availability of long-term credit and risk capital, the encouragement of new instruments and new markets seems to be necessary along with stable inflation and interest rates. Intermediation Cost 29. The experience of these five cotntries in regard to intermediation cost was diverse to a degree that nothing definitive can be said about how liberalization influenced it. In Korea, the cost of intermediation might have, on balance, fallen, determined as it was by two factors opposed to each other such as the scaling down of reserve requirements and increasing losses from nonperforming loans. In Malaysia, there was evidence that the intermediation margin widened slightly after reform (instead of narrowing as expected) because of the perpetuation of the oligopolistic banking structure. In addition, the widened margin could be explained by the rise in the overhead costs of banks caused by rapid branch expansion and continuation of selective credit programs. In the Philippines, the cost of intermediation rose, but the reason was different. The increase was due to fiscal imposition, such as high reserve requirements, the substantial tax on gross receipts and huge nonperforming assets. In Indonesia, the efficiency of intermediation appears to have increased, judging it: by the reduction in the interest rate margin. The interest rate margin narrowed because of the reduction in the interest rate margin on both performing and nonperforming loans. In Sri Lanka, the interest rate margin declined slightly after financial reform. Considering that reserve requirements were quite high, even a small downward change in the interest rate margin could be interpreted as an efficiency gain. Integration of Domestic Financial Markets with Foreign Markets 30. The consequences of financial reform for the integration of domestic interest rates with foreign :interest rates were different for each of the countries and were not always in a direction which could have been expected on a priori grounds. Following financial reforms and a substantial devaluation of the currency, the gap between the domestic and foreign interest rates in Korea declined and reversed, and foreign interest rates exceeded domestic ones, a situation quite opposite the one prevailing in the 1970s. However, the Korean interest rates could not be considered sensitive to the extent expected to international interest rates because of the control on capital movements, a distinguishing feature of Korea's financial reform. While domestic interest rates in Malaysia were quite sensitive to interest rate differentials between that country and abroad, the degree of sensitivity was not as high as expected, presumably because the nonbank public had little access to foreign markets. The Philippines' experience was mixed. The cost of borrowing domestically exceeded that of borrowing abroad in the 1980s, and the gap widened due to the volatile movement of the exchange rate, residual xiii controls on exchange rates and uncertainty about inflationary pressures. In Indonesia, the reverse happened and the foreign interest rates, when adjusted for depreciation, were lower than those in the domestic markets, though the gap was narrow. The situation turned around after financial reform, and the cost of borrowing abroad exceeded that in the domestic markets as a result of a series of devaluations. In Sri Lanka, the domestic interest rates matched foreign rates except in two years, 1985 and 1986, when the foreign interest rates rose more sharply than domestic ones. On the whole, it is possible to conclude that following financial liberalization, although the influence of foreign factors on domestic interest rates increased, full integration of rates did not take place even when capital movement was almost free, as in Indonesia, Malaysia, and the Philippines. Ouality of Bank Portfolio 31. All five countries were saddled with nonperforming loans to varying degrees, with the Philippines bearing the greatest burden and Malaysia the lightest. The manner in which the problem of nonperforming loans was handled also was different. In Korea, the problem of nonperforming loans was gradually resolved without major impact on the solvency of banks. This was largely due to substantial financial support from the Government, tax allowances for writing off bad debts, concessional credit by the Central Bank to commercial banks, restructuring measures adopted to rescue the corporate sector, and also partly because of the onset of a strong economic recovery. Nonperforming loans never assumed large dimensions in Malaysia, and nominal interest rates were never too high. The corporate sector was less exposed to the shocks of higher interest rates. However, since 1985, as real interest rates increased and the economy slowed, the burden of arrears has grown. In the Philippines, the banking system virtually collapsed, and the Central Bank had to undertake a sizeable bail-out operation. The Indonesian financial system also faced the serious problem of a growing volume of bad and doubtful assets in bank portfolios. The main reason for this was the high level of interest rates in relation to the productivity of capital. This had an adverse impact on the corporate sector first and later on the financial sector. In Sri Lanka, also, the poor quality of bank portfolios posed a serious problem, but it remained manageable partly because regulation of the financial system was prudent and strict, and the Government's other actions were timely. Corporate Financial Structure 32. The impact of interest rate deregulation affected each of the five countries differently because of the difference in the leverage of the corporate structure. Of the five countries, the corporate sectors in two, the Philippines and Indonesia, had a high gearing ratio on the eve of financial liberalization. The ratio increased, mainly due to distress borrowing, thereby making it more sensitive to changes in interest rates. In Korea's case, the debt/equity ratio declined from its prereform-period level in response to the receding government commitment as a risk partner following privatization of banks. In Malaysia, the corporate debt/equity ratio was relatively low and declined somewhat after the reform. xiv V. Financial Liberalization in Chile. Argentina and Uruguay: A Comparative PersRective 33. For a comparative view of financial liberalization in the five Asian countries, three countries of Latin America's Southern Cone, Chile, Argentina and Uruguay, were studied. They pursued similar financial liberalization strategies and up-front stabilization policies, with minor differences in their timing. In Chile, 'both policies were initiated concurrently in 1974, while in Argentina and Urugualy financial reform policies preceded the stabilization policies. 34. On the eve of the financial reform, these three countries were in an economic doldrum. Chile had an economic growth rate of 0.7% p.a. during 1971- 73; inflation was 150% p.a., and there were large fiscal and current-account deficits. The economy suffered from repressive policies. Price and exchange controls were pervasive, and the financial sector suffered from heavy intervention. Argentina had had growth of real GDP of 2.8% p.a. during 1971- 75, and the rate of inflation was around 82% p.a. in the same period. The fiscal deficit was 12% of' GDP. The balance of payments was also under serious constraint. Uruguay's economy was equally severely afflicted by macroeconomic imbalances. The average growth rate of GDP during 1971-75 was 1.6% p.a., and terms of trade declined. The fiscal situation was serious enough to spark off capital flight. The average annual balance of payments deficit was 1.6% of GDP. 35. In such a milietu, the financial sectors in all three countries were stunted by repressive intervention. In Chile, the regulated interest rates did not respond to changes in the inflation rates and were negative in real terms since the 1950s. Argentina's financial system was repressed and antediluvian. Real interest rates were grossly negative at minus 10-11% during 1974-76, with the result that the financial sector shrivelled greatly. Uruguay's macroeconomy wais in a precarious condition, and the financial sector was stagnant and distorted. Interest rates were negative in real terms. The Main Elements of the Financial Liberalization Programs 36. Chile started in 1974 with a big-bang approach to liberalization: banks were denationalized at: one go, and interest rates were freed. Reserve requirements were simplifiecl and progressively scaled down, and other constraints which were instrumental in repressing the financial structure were eliminated. Preferential credits from the Central Bank were drastically curtailed, and the refinancing rate on remaining credit was raised to the market level. All categories of financial institutions were progressively permitted to compete for business, and access for new entrants to the financial sector was made ealsy. Controls on capital movement were not effectively phased out until 1979. Strong stabilization policies were adopted to reduce the fiscal deficit and slow the depreciation of the exchange rate. Argentina and Uruguay followed a similar path toward reforms. Both interest rates and capital movements were decontrolled. In Argentina, minimum legal requirements were lowered in two stages between 1977 and 1979. Financial institutions were given full freedom to manage their liabilities, selective credit policies were substantially reduced, and active measures were taken to ensure that financial intermediaries adjusted smoothly to competitive conditions. Entry restrictions were relaxed gradually. Adjustment policies xv which came later, with an accent on eliminating the balance of payments disequilibrium, effected a steady exchange rate depreciation through scheduled removal of reserve requirements on foreign loans. Uruguay's reform was a cross between gradual intervention and the full and complete deregulation in Chile and Argentina, respectively. Along with a flexible exchange rate policy designed to attain a sustainable balance of payments, the authorities began to unravel the ceilings on interest rates in stages, the first in April 1976 when a uniform ceiling of 62% replaced all existing ceilings on liabilities and assets of financial institutions. The ceilings were raised to 90% in November 1977, and reserve requirements were gradually reduced in 1978. Impact of Financial Reforms Growth of Financial Assets 37. Financial assets expanded rapidly in Chile beginning in 1975. The ratio of total financial assets (including paper issued by banks, development banks and financiers) to GNP more than doubled between 1975 and 1982. Even more important, financial assets other than M2 as a proportion of total financial assets expanded to as much as 71% in 1982, from 16% in 1975. Perhaps a more enduring result of financial reform was the greater role of financial institutions relative to the Government in mobilizing savings. While the process of financial intermediation became vigorous, the average maturity of financial instruments shrivelled. In the initial flush of reforms, the Argentine financial system reacted well to the market incentives of higher interest rates and competitive conditions. The ratios of M3/GDP and M2/GDP increased substantially during 1977-79. In Argentina too, the impact of financial reform on the financial intermediation process was magnified by the substantially increased inflow of foreign capital. 38. Liberalization benefited the growth of financial assets in Uruguay. The ratio of M2/GDP rose by ten percentage points between 1976 and 1979 and continued upward until 1982. However, as in Chile and Argentina, the spurt in the M2/GDP ratio was induced by the dollarization of the financial system. Level of Interest Rates 39. With the reform in motion, in 1979 real interest rates in Chile became positive for the first time since the 1950s, and they remained so until 1984. Loan rates were substantially higher in both nominal and real terms, reflecting the oligopolistic nature of the banking system and its bank holding structure dominated by a limited number of economic "groups" despite growing competition between banks and nonbanks following liberalization. Though nominal interest rates were even higher than Libor after adjustment for devaluation which emphasized a weak link with the international financial markets. Nominal interest rates in Argentina increased very sharply but, with the inflation rate running ahead of nominal interest rates in most of the years after 1976, positive real interest rates were attained only in 1977 and again during 1981-83. The ex Rost peso/dollar spread was positive except in 1971 and in 1981-82. This indicates that both nominal and real domestic interest rates were higher in Argentina than foreign rates. Bank nominal deposit and loan rates surged up in Uruguay, but loan rates recorded a much higher rise than nominal deposit rates. With rapid escalation of inflation, bank deposit rates turned negative in real terms until 1980, while real loan xvi rates remained positive since 1976. The ex post peso/dollar spread indicated that domestic interest rates, both nominal and real, were usually higher than foreign interest rates. Nonperforming loans 40. Since Chile's financial system was liberalized, the single most important development has been the staggering growth of debt accumulation by the private sector. The ratio of debt to the banking system shot up from 5.0% of GDP in 1974 to 61.7% in 1982. Once it got going, the debt developed its own momentum, spurred by t:he intrusion of factors such as the dominance of the financial and manufacturing conglomerates. Banks lent to the firms which owned the banks, and such loans constituted around 20% of the banks' portfolios. With excessively high interest rates and continuous overvaluation of the peso, bankruptcies became common and the banks' portfolios soured. The authorities reacted to the crisis by taking a series of measures: an outright bail-out of affected banks, provision of emergency loans and subsidized credit, purchase of risky loans by the Central Bank, and a host of other rescue measures, including the return of :Lnterest rate guidance by the Central Bank. The genesis of the nonperforming loans and their rapid expansion in Argentina was similar to that in Chile. The basic cause, again, was the unsustainably high level of interest rates, both nominal and real, which, together with the appreciated real exchange rate, made it unrewarding for borrowing firms to continue production activities. The situation was aggravated by the high gearing ratios of firms. This high ratio magnified the impact of high interest rates on profit margins of firms, and their distress borrowing raised indebtedness to banks. As a result, bad and doubtful debts as a percentage of total bank loans accelerated from 1.95% in 1975 to 9.13% in 1980. Here again, as in Chi:Le, the Central Bank played a crucial role through injecting Central Bank credit into the affected banks through a refinancing and subsidy scheme and by fixing interest rates to make them negative in real terms. The basic causes in Uruguay, i.e., high interest rates and the overvaluation of the real exchange rate, were similar to those in Chile and Argentina, and the economric and institutional conditions were also very similar. The adverse impact of this development was not assessed properly by Uruguay's banks, and they continued to finance the purchase of overpriced assets. When the borrowing firms could not repay their loans on time, the nonperforming loans began to mount. The result of these factors, the financial systems in these countries collapsed. Inevitably, the Central Bank injected its credit into the systems to revive them. Lessons from Financial Liberalization 41. Several important lessons can be drawn from financial liberalization across countries. First, price stability and, more broadly, macroeconomic stability, is the linchpin of successful liberalization, not the deregulation of interest rates Rer se. especially when the countries undergoing financial reforms have shallow financial markets. In the Philippines, Malaysia and Chile, the control of inflation was a determining factor in attaining positive interest rates. The adjustment in real interest rates lagged when inflation was declining with interest rates fully liberalized, and this adversely affected the profitability of firms and at second remove the stability of the financial system. In Korea, by contrast, interest rates were administered by the Government by adjusting nominal interest rates according to the movement xvii of inflation. This together with the capacity of firms to repay their debt helped to preserve the stability of the financial system. It is also clear that financial liberalization, if not properly designed, may cause instability of the financial system, which in turn may magnify macroeconomic instability, as in Chile, Argentina and Uruguay. Among the Asian countries, the experiences of Indonesia and the Philippines reflect the two-way effects of the macro environment and financial reforms on each other. Indonesia's macroeconomic imbalances were severe when reforms were initiated, but they were corrected by the initial impact of the reform. However, its troubles were later accentuated when continually high domestic interest rates led to an increasing loan default rate. In the Philippines, macro- and microeconomic policies combined to accentuate the financial crisis. Second, when capital movements are completely free in an economy where the financial market is relatively small, liberalization of domestic interest rates makes them upwardly sensitive to the pressures of expectations of exchange rate. On the other hand, if a government attempts to control domestic interest rates, it may risk massive capital flight. The best approach may be to achieve a stable macroeconomic environment which will eliminate any abrupt changes in expectations about exchange rate movement. When this is not possible, a country with a small and vulnerable financial market and an unstable economy may choose a second-best approach of continuing some restrictions on the capital account and on interest rates, as in Korea. If a country has already liberalized the capital account, it should maintain macroeconomic stability at all costs. 42. Third, financial liberalization based on the banking system has inherent limitations. Interest rates cannot be raised without inviting undue adverse risk selection among borrowers and creating moral hazards for the banking system. This is particularly so when a monetary policy directed towards control of inflation needs to be tightened considerably. 43. Fourth, the excessively high positive real interest rates are as disequilibrating as the heavily repressed negative real interest rates. In the imperfect and oligopolistic money and credit markets characteristic of developing countries, a sudden dose of liberalization often leads to the overshooting of both nominal and real interest rates, unwarranted by the "fundamentals" when financial reform, especially interest rate deregulation, is undertaken amid high and fluctuating inflation rates and leads to increasing arrearage of the banking system as borne out by experiences in the Southern Cone countries, the Philippines and Indonesia. Fifth, a M2 or M3/GDP ratio as an indicator of deepening or broadening as a consequence of financial liberalization may at times be misleading. To the extent that the ratio reflects the impact of the short-term inflow of foreign savings, as happened in the Latin American countries, Indonesia and the Philippines, the upward changes in that ratio cannot be taken to represent enhanced efficiency of resources mobilized by siphoning them away from less productive uses. In Latin America, the so-called dollarization after capital controls were removed spotlighted both the weakness of the financial system and the efficacy of monetary policy. Sixth, it should be recognized that in economies which have a long history of financial repression, the participating actors, be they bank managers, borrowers, lenders or public servants, are not trained in new ways of dealing with a liberal and competitive system. For instance, it was suggested that in Chile's case some of the blame for a disastrous financial crisis resided in little experience existing in the country in the management of a freer financial system. Closely related to this is the lesson that the xviii need to set up a well-planned. financial infrastructure with provision for information flow, legal and aLccounting systems and an appropriate regulatory system to monitor it careEully and continuously. Otherwise, financial liberalization will fail Ln its main purpose: to orient the financial system towards greater competition amd efficiency. In the case of banks, it is not always possible to distinguish a necessary control for monetary stability purposes from a supernumerary regulation affecting credit allocation, but it is imperative that regulation and supervision be strictly enforced. 44. Seventh, financial liberalization in developing countries should not be considered a replica of liberalization of financial markets in the highly industrialized countries because of important differences in the financial system as a major source of fiscal revenue and nonbank capital market development in the industrial countries. In view of these structural differences, liberalization in developing countries brings about greater prudential risk, concentration of ownership and moral hazards. The implication is that a gradual process of liberalization in developing countries is to be preferred to the sudden dismantling of all regulations considered repressive. Eighth, the financial reform experience in different types of economies shows tha,t a pragmatic solution may be to evolve a certain set of market oriented indicators based on fuller information from domestic and foreign sources while taking steps to build the financial infrastructure, reducing the monopoly element in the financial and industrial sectors, etc. Finally, financial reform, whether comprehensive and sweeping or measured and gradual, does not seem to make any significant difference to the volume of saving and investment activities in the liberalized economies. No systematic trend or pattern in regard to the size of saving and investment is discovered in the countries surveyed, though reform seems to have greatly contributed to the financialization of savings. I. INTRODUCTION 1.1 Debate on financial reform and financial sector development in less- developed countries (LDCs) has come a full circle. Initial enthusiasm greeted experiments of financial liberalization during the 1970s and early 1980s in several LDCs, but there is now skepticism about the effectiveness of such reforms because of the economic and noneconomic circumstances prevailing (V. Galbis, 1986; J. Galvez, and J. Tybout, 1985; R. Mckinnon and D. Mathieson, 1981; R. McKinnon, 1986 and 1988). Growing mistrust about financial liberalization triggered by unsavory experiences in Argentina, Chile, and Uruguay, (V. Corbo and J. de Melo, 1985; V. Corbo, 1985) can be traced to the questioning of its analytical underpinnings, even though some Asian countries such as Indonesia, Korea, Malaysia, the Philippines and Sri Lanka have benefitted from financial liberalization. It is therefore rewarding to analyze the experiences of these countries to understand the anatomy of successes and failures. Appropriate lessons can be drawn for replicating similar reform policies in other financially repressed economies. 1.2 The nature and content of financial liberalization policies have evolved by way of reaction to the financial repression policies that were in vogue in many less-developed countries during the 1950s and 1960s. In the context of growth, money is treated as part of wealth, which is considered in the earlier economic literature to compete with accumulation of physical capital. Since output growth is crucially dependent on physical capital, accumulation of money balances is deemed unproductive, and an appropriate policy contributing to output and growth is to tax the accumulation of money balances by expanding the money supply. Chile monetary expansion was the central focus in policy formulation, there had been widespread recourse in most developing countries to the maintenance of low interest rate policies through ceilings on interest rates and credit allocation by guidance of the central banks of Governments concerned. Both of these approaches to credit policy were motivated by the "market failure" arguments and the inadequacy of the existing financial environment to facilitate sharing the risks involved in new investment. Social rates of return on investment tend to diverge from the private rates of return, and they can be equalized only through interventions of one kind or another. Likewise, the type of financial system the developing countries have does not permit risky investment. As a result, ceilings on nominal interest rates paid and received by banks and the allocation of credit were managed to benefit socially productive activity. 1.3 There was also a fiscal twist to these monetary policy objectives. Governments in developing countries are perpetually short of resources because of their narrow tax base and of lack of expertise in tax administration and expenditure controls. Governments typically bolster their finances by using an inflation tax imposed through monetary expansion, reserve requirements imposed on banks (which adversely affect their profitability or is passed on to banks' customers in the form of lower deposit rates or higher loan rates), and subsidized interest rates to reduce returns on depositors' balances. 1.4 However, the inflationary explosion in many developing countries during the 1960s and early 1970s, particularly in some Latin American countries, eroded the growth of their financial systems. This erosion 2 ricocheted on the real economy, slowed growth and caused deterioration in external accounts. In 1973, a new paradigm in the design of financial policies emerged. Its theoretical underpinnings were provided by the work of McKinnon and Shaw (R. McK:Lnnon, 1973; E. Shaw, 1973). According to their theory, pervasive government and central bank regulation tends to distort financial markets, and thls distortion in turn adversely affects saving and investment decisions of market participants. Subsidized interest rates depress saving by depositors and promote inefficient investment through low borrowing cost of scarce capital. In the same way, credit allocation decisions are unduly influenced by political and other noneconomic considerations. All this leads to fragmentation of financial markets and even to financial disintermediation to the extent that financial assets become unremunerative. This phenomenon has now come to be known as financial repression. It can be attenuated if authorities liberalize the regulatory regime by allowing interest rates to attain their true equilibrium level and by determining credit allocation on the basis of viability and productivity oE projects bearing market-determined interest rates. 1.5 The new orthodoxy has held sway since the mid-1970s. Several countries in Latin America, Argentina, Chile and Uruguay in particular, and Asian countries like Indonesia, Korea, Malaysia, the Philippines and Sri Lanka have embarked on financial reforms of varying intensity as part of a broader liberalization strategy. If there were differences among these countries in their quest for liberalization, they were only in regard to speed, mode and magnitude. 1.6 The outcome, diverse and differently patterned, was not sufficiently uniform to make confident predictions about the advisability or inevitability of financial liberalization in the countries where financial repressions once prevailed. There liberalization appeared to have succeeded according to the usual criteria of rate of growth, stability of the financial system, mobilization of savings and the attainment of positive real interest rates, the financial liberalization process was elementally different from that in countries where it failed. In the latter category were Argentina, Chile, Indonesia and the Philippines, where real interest rates no doubt became positive but either their level remained too high or they were so volatile that they deterred new investment. Bank loans went to nonviable and unproductive projects and, as a result, bad debts became rampant and unsustainable. Businesses and banks experienced widespread bankruptcies. To save depositors, financial institutions and indebted industries from the resulting financial distress, the very government interventions thought to be responsible for financial repression in the first place were reinstituted (D. Cavallo and J. Cottani, 1987; P. deGrauwe, 1987). 1.7 The failure of financial liberalization in several countries, and success in only a few like Korea, Malaysia, Sri Lanka and Indonesia (with Korea an outstanding success, and Indonesia a modest one) have necessitated a reassessment of the philosophy of financial 'Liberalization. Two kinds of reaction are prominent. The dominant of these emphasizes the benign character of financial reform. Though liberalization experiments have failed in many countries, their failure was due to adverse factors which supervened in the process. First, some macroeconomic policies such as exchange rate and fiscal policies ran counter to the direction of financial reform. (V. Corbo, 3 J. de Melo and J. Tybout, 1985). Second, it is believed that reform in only one sector of the economy (such as the financial sector) unaccompanied by similar reforms in trade, industry, and the labor market had a limited chance of success and in fact might have been counterproductive. Third, the design and sequencing of reform measures might have been wrongly formulated (A. Swoboda, 1986; R. McKinnon, 1982 and 1988). Finally, the regulatory apparatus might not have functioned in a manner conducive to the smooth progression of reform policy implementation (M. Dooley and D. Mathieson, 1987; A. Swoboda, 1986). In short, this kind of reaction does not question the logic of reforms but implies that other policies could well have delivered what was expected of financial reform. 1.8 From another perspective, there has been pronounced disillusionment with financial liberalization, though this view is confined to a minority of policy makers and academicians. This sober view implies that a degree of state intervention is inevitable in the institutional structure of developing countries. Even financial liberalization cannot dispense with it, as was shown by the experiences of Chile, Argentina and Uruguay (C. Diaz-Alejandro, 1985; V. Galbis, 1986). 1.9 These reactions to relative successes in a few countries and widespread failures for a variety of reasons in many others have reopened the debate about the nature, content and scope of financial liberalization strategy and policies in developing countries. Several questions are raised: Is financial liberalization interpreted in a right way, or is it merely a theoretical abstraction unrelated to the objective conditions prevailing in the financial markets of developing countries. Is financial liberalization supposed to remove the restrictive regime at one fell swoop in order to create a competitive financial structure? Is the design of financial liberalization that has been applied simply a transplant from the industrialized countries with their well-developed money and capital markets? Are financial liberalization objectives thwarted by the unfavorable outcome in macroeconomic policies, or are such inconsistencies unavoidable because of the intrinsic oligopolistic character of the LDCs' financial systems? 1.10 Answers to these questions will determine the worth and usefulness of financial liberalization strategy and may unravel its inner strength and rationality. Answers can be given only if there is a convincing and sound empirical validation of these policies. The purpose of this paper is to do precisely that by analyzing the experiences of countries where financial liberalization has succeeded (Korea, Malaysia and Sri Lanka), a country which has overtly not done as well (the Philippines), and a country which has a mixed record (Indonesia). 1.11 Three issues need to be clarified at the outset. For the purpose of this paper, financial sector means the banking sector, since banks are the dominant financial intermediaries in developing countries. This does not mean that nonbank financial institutions are excluded. Wherever such institutions play an important role, they are covered to the extent that data are available. The second issue concerns how financial liberalization is to be defined, particularly when the term financial liberalization is subject to various interpretations. In the broad sense in which Professor McKinnon used it in his work referred to earlier, financial liberalization means substantial 4 reduction of government intervention in regard to interest rates and credit allocation. This may mean either doing away entirely with the interventionist regime, as was done in Southern Cone countries, or gradually phasing it out, as was done in Korea, Sri Lanka and partly in Indonesia. The third issue relates to the allocative efficiency of tlhe liberalized credit system. Though this is important, it is not discussed in this paper in view of its complexity and the scarcity of relevant data essential for its analysis. 1.12 Section II focuses briefly on the macroeconomic and financial sector background and on the motivation behind financial liberalization in Korea, Indonesia, Malaysia, the Philippines and Sri Lanka to see whether initial conditions influenced the consequences of liberalization in any important way. Section III dealt with the instrumentality of financial reform. Section IV discusses the consequences of financial liberalization measures in terms of their impact on the level of real interest rates, growth of the financial sector, resource mobilization, intermediation costs, integration of various domestic interest rates between banks and nonbanks and domestic interest rates with foreign interest rates, progress in regard to term credit and the competetiveness of the banking system. This discussion is detailed to the extent that necessary information is available for each of the countries. The impact of financial reforms will be seen against the backdrop of relevant macroeconomic developments. 1.13 Section V places what has been observed in the countries concerned in the course of financial liberalization into a comparative perspective by drawing attention to the salient features of the financial liberalization experiences of some Latin American countries like Argentina, Chile, and Uruguay, where the macroeconomic and institutional circumstances were different. Section VI spells out what can be learned from the empirical evidence in regard to financial liberalization policies and the instruments of their implementation in the countries covered. This section will draw general analytical conclusions about why the outcome of financial liberalization was not always as expected according to the economic rationale embodied in financial liberalization literature. II. MACROECONOMIC BACKGROUND AND THE FINANCIAL SECTOR ON THE: EVE OF FINANCIAL LIBERALIZATION 2.1 This section spe'lls out briefly the macroeconomic background and financial systems prevailing in each of the five Asian countries to be discussed so that the financial reforms and their consequences can be understood in perspective. Korea embarked on financial reforms in 1981-82, Malaysia towards the end of 1978, the Philippines in 1980, Indonesia in 1983, and Sri Lanka in late 1977. Though nuances of motivation varied according tc, circumstances particular to each of the countries, reform was a response by the authorities to the realization that the interventionist regime was inefficient and ineffective: its impact was largely circumvented by banks through various devices. 5 Korea 2.2 The Korean economy grew rapidly in the 1960s and 1970s. Real GNP growth averaged 9.1% per year during 1963-72 and 8.2% during 1973-1987 (Table 1), spurred by a strong performance of the export sector. The main instruments used to achieve this growth rate were special tax incentives and a preferential credit program. Following the first oil shock in the early 1970s, the balance of payments deteriorated and investment was financed by massive foreign borrowing. An expansionary monetary policy during these years resulted in a high average annual rate of inflation of around 21 (Table 1). The nominal exchange rate was pegged to the US dollar during 1974-1979, and there was a 23.6% appreciation of the real effective exchange rate between 1973 and 1979 (V. Corbo and S. Nam 1986). With the balance of payments in bad shape, transactions on the capital account were tightly controlled by the Government to prevent capital flight. The end of the 1970s saw Korea at a crossroad. The export sector, the main engine of growth, had slowed considerably, massive investment in the heavy and chemical industries had resulted in a wasteful excess of capacity. With the second oil shock, the terms of trade deteriorated further and the increase in international interest rates posed serious problems since foreign debt was already large. The inflation rate accelerated, resulting in negative real interest rates. In order to correct this situation, the Government adopted comprehensive measures for economic stabilization and financial reform in the spring of 1979. These included tight control of monetary expansion, reduction in fiscal expenditure, and a large devaluation of currency (soon followed by a managed float). 2.3 The financial system in Korea was dominated by the Government during the 1960s and 1970s. It was used as an instrument of development policy and included various types of Government intervention. Korea's financial system was composed of the Central Bank (Bank of Korea), commercial banks (nationwide city banks, local banks and foreign banks), special banks such as development banks and small and medium-size industry banks, nonbank financial institutions (NBFIs) (investment and finance companies, mutual savings companies, merchant banking corporations, life insurance companies, etc.). Of these, nationwide city banks had a majority shareholding by the Government, while local banks and other nonbanks were privately owned. The relative shares of these institutions are shown in Appendix Table Korea 5. Besides, there was a thriving informal credit market estimated to account for around 29% of total bank credit (D. Cole and Y. Park, 1983). The NBFIs such as investment and finance companies and mutual savings companies were allowed to be set up in the private sector to support the informal credit markets. The securities market developed rapidly since 1972, though its role in financing investment was marginal. 2.4 Most interest rates in the organized credit market were regulated through a strict interest rate ceiling. With the inflation rate relatively high and volatile, both the real deposit and lending rates were usually negative in the 1970s, and lending rates followed a similar pattern (Appendix Table Korea 3). Preferential credits, the interest on which was even lower than the rates charged on general bank loans, were estimated to account for almost 50% of total bank credit. It was not surprising, therefore, that the growth of the Korean financial sector relative to the real sector was stagnant despite a sharp increase in the national saving rate in the 1970s. The M2/GNP A41 IS31&S19Z.S WT1~9311 1vaoli1YU3a5 Us1ow - - 2S 1Z 2t-91 21-11 Oteu 10e03 191 29S6 s2091 Is' 10s 23 t 209 VI vuv INS 211 261i 2 16tl * l9t 2ol 21'11 It6Is 19t1 2-36 X11 t 216 29 tZ1 - 109 1 S9ll u21d:u 299e- *S 1- 219 29 113 2 1 1 29.9 1131I 100 2Ol 113 1tI I'- *t1Zl - 211 vzsary - 211't 2611 3Z'1 2*11 XC-I 123Z 2131 10oll 263-1 *C-1 it931 23 -9 2c1 3 s i uJOzVIA MIz3 209l 291t 29-91 s209t 26 01 6T1 21t99 3 t 1 Z01 3 1 1 21 *li tC'ZI - 11 S IVB 29'0 2113 1101 10*01 2301 O 1s1 2361I ilLI tlL 66 6 399 tZ -2 2 *O SI#110I1110d ' tC't Xs r xt z wb 't na i CI tO t'll is' V sZ'O1 it-Sl rc s r 9961 1961 6961 1961 Z961 1961 0961 6161 9161 1161 9161 1161 9161 1161 11-9t EAW NOl1iNif :1 31wis 84f1 'SDlLSl1VZS W1:IJ Wl=otLx l. '3_ 39'01 291 2t Z sS@Z s*t te{ Z992 212 i1 293 3012 3ce311 *2102 2911 391 Z - it'l lV I 2 - - 319 t 31 3t1 c is' 3s' t99 Solt Sol 399 it 39 309 - * 29' mVU 9-m91 21u 3o,2 32t1 3109 2921 1911 t'l 1 1 32s2 :2't C116 3o091 36,11 2t'11 3o'9t - it1l Zt Im. Xt'l 2t99- IO'C- z6o0 36 ss 3 O29 39I9 I,13: suuukMIlina 511- 112t- 399b1 2211 399 31i's 399 213 1111 31t 392l t 21- 212t - *Z11 CYUINOmt 201t 3t1- 36to I 2 30 9 26 9 3191 319 I1I It so911t 39w0 3t'9 - 3t1 1m9 33:r 2991 296' 362t1 211C1 3C11 3092 1912E 39l2 1991s 21c9 269 311 t'1s 96'1C - 3t1C1 mIlIUI' 26'11 3* St'9 2601 3t's 3e91 zo30- 3t' 301 3601 3211t 2191 31 - 296 1,13I 3619 ts6 isle 30391 3s1 361Z 36IT1 3909 39'61 3622 32 31 29 - 3101s 19311406 - '261 32t' 9 39 222 Z 61 3660 2619 21*1 369 26 3 - 211 191IC vssauozI 9nt 361t 961t 1361 z2t6 1961 0961 6161 9161 1161 9161 S161 9161 1161 t 11-9t lA 31V8 HUL8NO dC! l 21W9S TABLE 3: BALANCE OF PAYKENT LVI 74-77 i973 974 1975 19?6 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I .CURIEN? ACCOT/IGDP INDOhESIA -0.971 -2.921 2.321 -3.641 -2.441 -0.101 -2.761 1.901 4.15Z -0.671 -5.651 -7.771 -2.181 -2,161 &OREA -5.171 -2.261 -10.831 -5.811 -1.071 0.021 -2.121 -6.441 -0.531 -6.721 -3.701 -2.011 -1.501 -1.061 4.581 MALAYSIA -0.621 1.371 -5.741 -5.311 5.271 3.311 0.642 4.38X -1.161 -9.941 -13.441 -11.671 -4.931 -2.351 -1.061 WHILIWIMES -4.31 4.412 -1.411 -5.8131 -6.061 -3.971 -4.801 -5.071 -5.391 -5.411 -8.021 -7.961 -3.861 MA 3.311 SRI LANKA -0.871 -0.081 -3.801 -2.882 -0.111 3.A61 -2.301 -6.741 -16.281 -10.001 -11.541 -9.031 0.061 -6.93 -0653X 2.CAPITAL ACCOUNT/CDP INDOOESIA 2.621 4.531 1.571 1.161 5.351 2.441 3.321 1.691 1.831 2.041 5.941 7.451 4.141 2.531 - KOREA 7.791 4.451 9.311 11.673 6.441 3.761 4.191 0.311 9.531 6.801 5.541 2.961 3.321 2.201 4.011 MALAYSIA 5.511 4.451 8.601 7.011 4.651 2.001 3.991 0.911 5.041 10.461 13.971 12.871 8.921 6.18i 4.561 PHILIPPINES 6.01 2.411 5.821 6.911 6.571 4.791 9.151 5.521 7.771 5.011 7.191 3.061 4.401 -2.391 0.311 SRI LANKA 1.551 1.831 2.041 2.261 1.251 -0.141 5.201 6.421 9.391 0.421 12.261 3.64Z 4.601 5.971 5.311 OO SOURCE: BALANICE OF PAYMENT STATISTICS, IMF. 9 ratio was 33.9% during 1970-74 but declined to 31.6% at the end of 1979. On the other hand, the nonbanking financial sector grew faster than the banking system, as revealed in the ratio of M3 (which includes deposits of nonbanks) to GNP, which increased from 39% in 1976 to 42.1% in 1979 (Appendix Table Korea 8). 2.5 Liberalization of Korea's financial sector in 1981-82 was implemented in conjunction with overall economic liberalization and adjustment policies. The realization that government intervention tended to yield a diminishing return as the economy became more complex was the leitmotif behind liberaliza- tion. There was a growing feeling among the policy makers in the 1970s that government ownership of the commercial banking system and excessive interven- tion in the financial sector operations were causing inefficiency in resource allocation and a consequent waste of resources through rent-seeking activi- ties. The control mechanism was increasingly ineffective because the Korean economy had become more sophisticated (V. Park, 1984). Malaysia 2.6 Malaysia had a stable macroeconomic environment during the 1970s. Inflation was relatively low and steady and the current account of the balance of payments was in a comfortable position, especially during the latter half of the decade, owing to improved terms of trade. The CPI growth rate was less than 5% per year on average during the latter half of the 1970s, and the current account surplus was about 3-5% of GNP during 1976-1979 (Table 3). Domestic saving as a ratio to GNP was high, around 30%, and reached 39% in 1979. The domestic investment ratio, though high, was lower than the domestic saving ratio. However, Malaysia had a chronic fiscal deficit of about 6-7% of GDP during the 1970s. The deficit was financed domestically through the issue of Government securities to institutions other than banks (Table 5) to finance large development expenditures and subsidized public enterprises. 2.7 Financial institutions in Malaysia operated under more competitive conditions than those of Korea. The share of commercial banks in total assets of the financial system was about 40%, while the shares of NBFIs and the Central Bank were about 10% and 20%, respectively; the remainder was shared by provident, pension and insurance funds, savings institutions and development finance institutions (DFIs) (Appendix Table Malaysia 4). Domestic banks became active, and by the end of the decade they accounted for one third of the total financial assets of banks. Three government-supported banks claimed as much as 80% of total deposits and 74% of loans of domestic banks (S. Lee and Y. Jao, 1982). The operations and management of commercial banks (including the government-owned commercial banks) were largely autonomous, and there was considerable freedom of entry of new banks and branch expansion. Malaysia had a relatively large securities market compared to those of other developing countries in the 1970s. However, the public sector dominated the net funds raised in this market by way of issuances of Government securities; the private sector took only a small part of the net funds (e.g., 6.7% in 1977-1979) by way of issues of new shares and debentures (S. Lee and Y. Jao, 1982). 2.8 The growth of the financial sector accelerated in the 1970s owing to the stable rate of real return on deposits, which in turn owed to a stable and 10 low inflation rate. The M2/GNP ratio grew from 38% in 1970 to 57% in 1979, and M3/GNP grew from 42% to 66% in the same period. Such growth implies that the NBFIs kept pace with t:he banks (Appendix Table Malaysia 2). Compared to the other four Asian countries under discuLssion, Malaysia's financial sector was considerably deepened, and the instruments were diverse and sophisticated (Appendix Table Malaysia 3). Before October 1978, Bank Negara of Malaysia (BNM) determined the maximum deposit rates; and the minimum lending rates of commercial banks, but this did not adversely affect the level of interest rate in real terms owing to the low inflation rate (CPI); the average annual real deposit rate was about 3% during 1975-1979 and compared favorably with real deposit rates in industrialized countries such as Japan, Germany and the US during 1950-60. Malaysia also had selective credit programs since 1976 as part of a new economic policy to support small-scale enterprises. This credit was estimated at 30% of total bank credit; the subsidy involved, however, was small. 2.9 The liberalization of interest rates in Malaysia was a logical consequence of the development of a wide range of interlinked financial intermediaries. These made use of new financial instruments and rendered the administered interest rate system much less effective than before. Unlike the rates in Korea, the real interest rates were not low in Malaysia despite interest rate controls. Foreign factors had major influence in determining domestic interest rates. Interest rate controls were retained mainly to ensure the stability of domestic interest rates in an environment of an open capital account and a floating exchange rate regime and to promote the indigenous banks by limiting price competition with dominant foreign banks. Thus, financial liberalization did not have the same significance as in other countries. The Philippines 2.10 The Philippine economy in the 1970s was relatively stable, with a comfortable rate of growth between 6% and 6.5% per year. Gross domestic investment as a ratio of GDP rose from 25.1% in 1974 to 29.0% in 1975, and the gross domestic saving ratio rose from 22.0% in 1970 to 22.7% in the same period (Table 10-I and II). The Philippines had a chronic deficit on the current account of its balance of payments of around 5% of GNP during 1974-1980, although the nontraditional export sector grew impressively. Major external shocks affected the Philippines and other oil-importing developing countries during the turbulent period of 1970s. The first oil shock in 1974 caused the domestic inflation rate to jump to 34.2%. The inflation rate was kept below 10% until the second oil shock of 1980, when it escalated to 18% (Table 1). The fiscal deficit remained modest during the 1970s, fluctuating around 1.0% of GDP. There was no major macroeconomic imbalance in the Philippines until the late 1970s and the early 1980s when financial reform was introduced. However, thet current account of the balance of payments remained in the red, a dominant feature of this period. 2.11 Of the banking sectors in the five Asian countries under discussion, that of the Philippines was relatively less oliogopolistic. Entry of financial institutions was not severely restricted until 1970; since then, and following the recommendations of the joint IMF/CBP Banking Survey Commission of 1972, no new banks have been allowed to enter the system, and an effort has TABLE 4: TOTAL EXTERNAL DEBT AVR 74-77 193 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I-TOTAL EXTERNAL DEBT (IN NIL OF USS) INDONESIA - - - - - - - - 1923 2451 2876 3037 3077 3581 4120 KOREA - - - - - - - - 29750 33362 37755 40900 43201 47581 45108 MALAYSIA - - - 1843 - _ - - 5196 7318 11336 14557 16094 18056 19650 PHILIPPINES - - - - - - 17387 20752 24316 24057 24593 26207 28173 SRI LANKA - - - - - - - - 1923 2451 2876 3037 3077 3581 4120 2.TOTAL EXTERNAL DEBT(AS I OF CDP) INDONESIA - - - - - - - - 2.651 2.661 3.041 3.751 3.611 4.141 5.291 KO.REA - - - - - - 47.661 48.32X 52.161 52.011 50.561 54.821 45.961 MALAYSIA - - - 19.76X - - 21.221 29.27X 42.311 48.57X 47.411 57.811 70.711 PHILIPPINES - - - - - - 49.351 53.701 60.971 69.601 75.991 80.011 91.64Z SRI LANKA - - - - - 47.801 55.50X 60.311 58.761 50.911 59.901 64.301 SOURCE: WORLD DEBT TABLE, WORLD BANK. TABLE 5: FISCAL DEFICIT(PATIO TO CGP) AVt 74-77 1973 1914 1915 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 i.TOTAL FISCAL DEFICIT iNDONESIA -1.21X -2.101 -0.971 -3.351 -1.57Z 1.041 -0.561 -0.521 -2.531 -1.411 -2.331 -1.481 -0.601 -0.311 - KOREA -1.841 -0.501 -2.191 -2.001 -1.39Z -1.781 -1.251 -1.771 -2.311 -3.511 -3.26; 1.121 -1.39X -1.301 -1.621 KMALYSIA -7.48! -5.501 -5.991 -8.361 -7.061 -8.501 -8.001 -8.301 -13.601 -19.741 -18.68X -14.021 -9.521 -8.351 -11.291 PHILIPPINES -1.08X -1.171 0.45X -1.191 -1.75! -1.81X -1.231 -0.161 -1.281 -4.00! -4.301 -1.971 -i.89; -..e: -4.57! SRI LAMKA -7.981 -5.831 -4.83! -8.921 -11.35! -6.811 -15.371 -14.551 -21.971 -15.681 -17.43X -13.701 -9.13! -11.611 - 2.DOHESTIC FINANCING INDONESIA -0.082 0.021 -0.141 - -0.18X - 0.001 0.011 0.09! 0.00! 0.00! -0.041 -0.051 - KOREA .0.36X -0.701 0.921 0.461 -0.161 0.211 -0.271 0.881 1.43! 2.32! 1.92! 0.441 0.817 0.69X 1.47Z MALAYSIA 5.231 4.63! 3.621 5.34X 6.73X 4.98! 3.221 5.651 4.48! 8.271 10.171 6.77Z 4.291 5.01X 7.411 P8ILIPPINES 0.931 0.821 -0.631 0.971 1.721 1.67Z 0.201 -1.27! 0.441 2.04! 2.901 0.54! 1.54X i.90X ;.2.; SRI LANBA 3.971 3.021 3.12! 4.151 5.861 2.75! 4.38! 5.701 13.68X 6.311 7.99Z 4.34! 1.59! 7.961 - 3.FOREIGN FINANCING INDONESIA 1.571 2.171 1.24! 3.461 1.89! -0.331 0.511 0.99X 2.361 1.531 2.23! 1.781 0.66! 0.38! 2.84! KOREA 1.48! 1.201 1.26! 1.55! 1.55! 1.571 1.52! 0.89! 0.89! 1.19! 1.34! 0.68! 0.52! 0.61! 0.35! MALAY41A 1.91! 0.361 0.99! 4.00! 1.311 1.64! 1.50X 1.53X 0.60! 5.211 8.182 6.981 4.16X 1.09! 2.03! PHILIPPINES 0.151 0314! 0.191 0.22! 0.04! 0.161 1.02! 1.431 0.84X 1.971 1.39! 1.43X 0.35! -0.031 0.32! SRI LAMIA 3.14X 153X 1.76X 3.02! 3.78! 4.02! 10.12! 7.15! 9.131 8.99! 8.10! 8.09! 6.55! 6.44! - SOURCE: INTERNATIONAL FINANCIAL STATISTICS IHF. TABLE 6: TERMS OF TRADE AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 INDONESIA(1980-100) - - - - - 75.0 66.0 82.0 100.0 105.0 101.0 97.0 98.0 96.0 82.1 KORIA(1980-100) 110.0 132.0 100.0 104.0 114.0 120.0 131.0 122.0 100.0 99.0 101.0 102.0 104.0 106.0 125.0 HALAYSIA(1970-100) - - - - - - - - 95.0 71.7 69.9 77.3 80.6 75.2 72.2 PHILIPPINES(1972-100) 87.8 113.3 114.5 87.8 77.7 71.0 78.2 81.6 68.6 60.4 58.7 61.3 59.8 55.9 - SRI LANKA(1981-100) - - - - - - - 115.6 105.8 100.0 91.7 114.2 138.7 107.4 - SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. PHILIPPINE STATISTICAL YEARBOOK 1987. TABLE 7: REAL EFFECTIVE EXCHANGE RATE(1980-100) AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 INDONESIA - - - _ - - 119.4 92.5 100.0 108.6 117.5 95.3 92.4 19.7 69.1 90 m - - - _ - - 97.6 107.4 100.0 104.4 106.9 102.7 101.3 95.5 60.6 NALAYSIA - - - - 108.5 105.9 101.4 103.8 100.0 100.4 106.7 111.5 116.1 110.3 92.6 PHILIPPINES - - - - - - 87.7 95.0 100.0 103.2 107.1 90.1 89.2 97.6 76.2 SRI LANKA - - - - 131.2 125.8 80.6 86.9 100.0 106.3 112.8 112.2 124.8 116.7 103.9 SOURCE: WORLD 8A11. 4:- 15 been made to improve the efficiency of banks already in existence. The nonbanking pact of the Philippine financial system expanded in the 1970s, mainly due to the expansion of money market activities and a wide variety of new services offered by the nonbank financial intermediaries (Appendix Table Philippines 2). 2.12 The growth of the financial sector (comprising commercial banks, small rural unit banks, savings banks, development banks, savings and loan associations, finance companies, investment institutions and pawnbrokers) was steady during the 1970s. The M2/GNP ratio grew from 16.8% in 1974 to 21.0% in 1980 (Appendix Table Philippines 3). By the mid-70s, money market development accelerated and attracted substantial financial savings. The Philippines had a long tradition of antiusury laws. During the period 1974-1980, the Monetary Board prescribed maximum deposit and lending rates. Although the rates were often adjusted to reflect market conditions, nominal interest rates were in fact fixed below market rates and were mostly negative in real terms. The interest rate structure did not display a normal yield curve. The differen- tials between short- and long-term rates did not encourage term transformation of maturities by the commercial banks. However, interest rates in the money market (whose main constituents were the finance companies, investment houses, etc.) were not regulated; the market prospered until it collapsed in 1981. The Philippines had various directed credit programs which often involved banks in losses. In addition to the directed credit programs, the Government influenced the allocation of credit of two major government-owned banks, the Philippine National Bank (PNB) and the Development Bank of the Philippines (DBP). 2.13 There was since early 1970 an awareness in the Philippines of the inevitability of some liberalization, particularly regarding the need to reduce the irksomeness of interest rate controls. This awareness was strengthened by the growing need towards the end of the 1970s to raise long- term finance, the unavailability of which was traced to the restrictive interest rate policy. Under the interest rate ceiling, the real return on bank deposits and loans fluctuated with the inflation rate. This prevented depositors from choosing longer maturities for their assets and banks from engaging in long-term credit contracts. Meanwhile, the money market, dealing with short-term finance to the industrial sector, tended to appropriate a growing share of bank deposits since it was free from interest rate controls. Against this background, the IMF-World Bank Study (1979) outlined the contours of financial reform, the main elements of which were: (a) liberalization of the interest rates; and (b) introduction of a "universal" banking system to reduce fragmentation of financial intermediation and encourage broader access to financial resources for meeting long- and medium-term credit needs. The commercial banks circumvented the interest rate ceiling by raising fees and other charges to the borrower, and the growth of the money market was not affected by interest rate controls. Recognizing that interest rate control was not only inefficient but also ineffective, the Philippine authorities abolished it. Indonesia 2.14 Indonesia's economy was in good conditions during the 1970s; Indonesia was an oil exporter. The rate of growth of its real GDP was very 16 high, around 12% p.a. on average during ]L973-83, a result of burgeoning oil revenues and large amounts of foreign aid. The rate of domestic investment averaged 27.6% of GDP during, 1973-83, and the gross domestic saving ratio averaged of 30.0%; both government saving (9.3% of GDP) and private saving (14.8% of GDP) were impressive compared not only to other Asian countries but: also to the industrialized nations (Table 1). Indonesia had an open capital account, and residents enjoyed freedom to borrow in foreign markets. 2.15 Indonesia began to experience serious problems when the oil price boom abated in the early 1980s. This was reflected largely in the deteriora- tion in the external payments position, with the GoverDnment's fiscal deficit reaching up to 2.2% of GNIP during 1980-83 (Table 3). Inflationary pressures, however, were not as ser:ous. The rate was around 11%, much lower than the 20% rate which prevailed during the 1970s. The decline in oil revenues and the consequent worsening of the balance of payments put pressure on the resources of the Government and the private sector. The mobilization of domestic resources thus became a matter of great urgency. 2.16 On the eve of financial reform in 1982, the Indonesian financial system had considerable depth as well as breadth. In addition to the Bank of Indonesia, it consisted of deposit money banks (DMBs) which included state- owned banks, development banks, insurance companies, savings banks, and credit institutions of all types. The relative importance of NBFIs for the financial markets was limited: their total financial assets amounted to barely 7% (Appendix Table Indonesia 6). 2.17 An elaborate system of regulations governed Indonesia's financial system before 1983. The financial sector was left untouched by an earlier wave of economic liberalization in 1977. First of all, there were ceilings on the interest rates on deposits and loans of 8 state banks which accounted for almost 40% of total gross financial assets in Indonesia until 1983; private commercial banks and foreign banks were excluded from regulation. The distor- tion in the pattern of interest rates was a consequence of the restrictions on interest rates paid by the state banks. These restrictions rendered the rate of return on the major part of financial savings negative and increased the gap between interest rates paid by the state banks and nonstate banks (Appendix Table Indonesia 2). Second, there were credit ceilings on individual banks including the private and foreign banks, and within the over- all credit ceilings there were subceilings differentiated by various categor- ies of loans. Third, perhaps the most comprehensive regulation was the system of liquidity credits which were given at subsidized interest rates to banks to refinance low-interest-rate loans to priority sectors. Refinancing was automatic, but the subsidized rates and the proportions of refinanced credits varied according to the type of loan (Appendix Table Indonesia 13). 2.18 The financial system became the main vehicle for raising and mobiliz- ing domestic savings and an instrument to finance domestic investment. These repressive financial measures had a dampening impact on Indonesia's financial. system. The ratio of M3 to GNP hovered around 18% during 1975-83 (Appendix Table Indonesia 4) despite rapid economic strides made by raising saving and investment through expanding oil revenues. 17 2.19 The motivation for initiating the financial reform in Indonesia was to mobilize domestic resources to finance investment. The spurt in domestic savings, which was largely attributed to the growing oil revenues, facilitated the financial system's growth in terms of assets and other financial services. However, the saving arising from the oil revenue was mainly government saving and, this being the case, it slackened when oil prices declined as they did from the beginning of the 1980s. This decline also affected adversely the foreign account position of the country. Sri Lanka 2.20 Before 1977, Sri Lanka experienced a prolonged period of stagnation. The inflation rate as measured by the GDP deflator (a more reliable indicator than the CPI) ran as high as 22% during 1974-77, spurred by a large and grow- ing fiscal deficit amounting to almost 8% of nominal GDP. The balance of payments remained precarious, even with stringent exchange and trade controls (D. Khatkhate, 1983). In fact, all the macroeconomic imbalances--fiscal deficit, excessive monetary expansion, inflationary pressures and deterioration in the balance of payments--were traceable to the elaborate government-directed machinery which allocated foreign exchange and regulated investment and consumption. 2.21 Sri Lanka had, in 1977, a fairly modern type of financial markets with a variegated institutional pattern; the commercial banks' share of total financial assets was 35%. Sri Lanka had three major state-owned banks--one a commercial bank, the Bank of Ceylon, and the National Savings Bank, the People's Bank, the main vehicle to mobilize savings. Other commercial banks and development banks together with insurance companies were operating, but their assets as a proportion of total financial assets were small. There was little competition because the government-owned banks were dominant (Appendix Table Sri Lanka 7). 2.22 The financial system of Sri Lanka was financially repressed, with negative real interest rates and relatively slow expansion of financial assets, as reflected in their low ratio to GDP. The nominal rates were in the range of 7-7.5% on one-year time deposits mostly held by the two state-owned banks. Bank lending rates were higher than deposit rates, ranging between 9.5% and 14%, and, in the context of the prevailing inflation rate, they were negative in real terms. Most credit to priority sectors was subsidized through selective credit policies. The subsidy was financed by the Central Bank through the liberal and unrestricted accommodation the banks enjoyed, with the latter at a concessional refinance rate. The growth rate of the financial system declined sharply during 1968-75 compared to 1961-67. The growth rate of real financial assets of the commercial banks fell from 6.6% during 1961-67 to barely 1.1% during 1968-75 (D. Khatkhate, 1983). This was also true of the NBFIs' assets, whose rate of growth declined from 22% to 1.7% in the same period. There was evidence that financial disintermediation was taking place in Sri Lanka (D. Khatkhate, 1983). 2.23 Financial reform was hastened by the coming to power of a new Govern- ment with a different economic policy from that of its predecessor. The new Government's intention was to give free reign to the private sector and market forces to the extent possible so that resource allocation would be more effi- 18 cient and have a beneficial impact on the growth of the economy. The authori- ties believed that their adjustment policLes would be considerably strength- ened if combined with the micropolicy accommodations which their reform policies implied. III. INSTRUMENTALITY OE' FINANCIAL REFORM 3.1 Against the background of macroeconomic and financial sector develop. ments described in Section II, the authorities in the five Asian countries under discussion initiatedi financial reform policies. Korea 3.2 Financial reform in Korea was gradual. In 1981, the Government began to privatize the nationwide commercial banks by divesting its shareholding; by 1983, it had privatized aLl nationwide city banks. Furthermore, the Govern- ment revised the General Banking Act toward the end of 1982 to give banks a freer hand in dealing with their own affairs by formally abolishing various regulations on the operation and management of banks. However, it maintained de facto monitoring of bank management ani credit allocation. One of the major reasons for this was that timing of the reform coincided with the onset of economic recession which severely affected the overseas construction, shipping and shipbuilding industries. 3.3 Entry barriers to the banking sector were lowered with the denation- alization of the nationwide commercial banks. Two additional nationwide city banks were allowed to be established. But the real beneficiary of the relaxa- tion of entry barriers was the nonbank financial sector. The number of investment and finance companies increased from 20 in 1980 to 32 in !982, and the number of savings and finance companies from 191 to 249 in the same period. The entry of foreign banks was also relaxed. Sixteen foreign banks were allowed to open business during 1981-1984, bringing their total number to 49. The primary purpose of permitting entry of foreign banks was to encourage foreign capital inflows; it was also felt that foreign banks would motivate domestic banks to improve the quality of their service and operation through competition and modern banking practices. 3.4 Along with the expansion in the number of financial institutions, various new financial instruments were introduced to promote the development of short- and long-term financial markets and to enhance the capacity of the financial institutions as mobilizers of savings. Some of the new.instruments were used by more than one type of financial institution to encourage the competition among them. 3.5 The interest rate ceilings were adjusted upward in 1979 to yield positive real interest rates, although this intent was frustrated by high inflation in 1980 and 1981, a1 result of the second oil shock. From 1982, however, bank interest rates became significantly positive in real terms, owing to stabilized inflation. In 1982, the Government abolished all preferential lending rates and unified the bank loan rate at 10%. Preferential access to credit: by specific groups of borrowers continues, however. 19 3.6 In November 1984, a band of 10% to 11.5% for bank lending rates was introduced to reflect the differential in creditworthiness of borrowers and the maturity of loans. However, the Korean Government still maintained the interest rate ceilings except in special markets such as the interbank, unguaranteed commercial bills and corporate bond markets. It is noteworthy that no significant steps were taken to liberalize external capital flow except for a few closed-end foreign-fund programs such as the Korea Fund. Malaysia 3.7 The Central Bank of Malaysia introduced a new interest rate regime in October 1978. Commercial banks were allowed to determine their own interest rates on deposits and loans. However, the prime rate was controlled by the monetary authority during 1978-1981. Late in 1981, a new interest rate mech- anism based on the base lending rate (BLR) was introduced, signalling a virtual disappearance of the last vestiges of control on lending rates. Accordingly, the commercial banks began to shift away from the use of the prime rate. They pegged their lending rates to their own BLR based on their cost of funds after provisions for the cost of holding cash, statutory reserves, liquid assets requirements and overhead. The margin charged on each loan was based on the customer's credit standing, the nature of the project to be financed, the repayment schedule and the security offered. From Novem- ber 1, 1983, all interest rates on loans and advances other than those prescribed by maximum ceiling rates and the law were linked to the BLRs of the respective banks. 3.8 However, the Central Bank of Malaysia continued to impose a ceiling on the lending rates for three special categories of borrowers: the Bumiputera community for loans not exceeding M$500,000 each, small-scale enterprises where the loans did not exceed M$250,000 each, and housing loans where the cost of land and house did not exceed M$100,000 each, compared with M$200,000 previously. For small loans, the Special Loan Scheme was introduced in January 1981. 3.9 When the new economic policy was initiated, no significant steps were taken to alter the selective credit programs in existence in Malaysia since 1975. On the contrary, directed credit programs seem to have increased for various sociopolitical reasons since mid-1970. Malaysia has had an open capital market since the 1960s. The PhilipRines 3.10 In the Philippines, the banking laws were amended in March 1980 to permit the adoption of a universal banking system patterned on the German model. To facilitate the change, the ceilings on various categories of bank lending and deposit rates were first relaxed and then removed. The interest rates on the long-term loans and deposits were removed first in order to encourage term lending; later, the interest rates on short-term deposits were removed. The last deposit rate ceiling (or deposit with maturity of two years or less) was eliminated in mid-1984, and the last lending ceilings on short- term loans were eliminated in January 1983. However, the interest rate subsidy for preferential credit programs was continued. It was not until 1985 that the Central Bank finally eliminated the subsidy element by aligning the rate of rediscounting of preferential loans to the market rate. 20 3.11 Under the amended banking law, commercial banks which achieved a capital level of P 500 miLllion could apply to the Central Bank of the Philippines (CBP) to become "unibanks" and, upon approval, were authorized to expand their activities to include near-banking activities such as those asso- ciated with investment houses, leasing companies and finance companies that had not previously been open to commercial banks. Nine commercial banks were converted to unibanks initially, but later one of them stopped functioning. Unibanks were also permitted to make equity investments in allied and nonallied enterprises and were authorized to issue credit guarantees. There was a conspicuous concentration of bank shares in the hands of a few families. Capital adequacy was gracluated to require a 10% capital-to-risk asset ratio for banks capitalized at less than P 500 million, an 8% ratio for banks capitalized at P 500 million but less than P 700 million. and a 6% ratio for banks capitalized at P 700 million or more, effectively increasing the lending ceilings for unibanks. Thrift banks, which comprise savings and loan associations, mortgage banks and the private development banks, were permitted to provide full domestic commercial banking services including (with prior CEP authorization based on the applicant thrift bank's good standing) acceptance of demand deposits. 3.12 Banks that became unibanks were required to broaden their ownership base so that no one family or business group could retain control. No single domestic owner or group of owners within 3 levels of consanguinity were permitted to have more than 20% of the voting stock, and ownership by foreign interests was limited to 40%. Ownership concentrations that existed prior to the enactment of the new laws could continue until reduced voluntarily but could not be increased above the new limits. Investments in nonallied enter- prises were restricted to 35% of voting stock, but in practice all but one of the private commercial banks were still closely allied with one or more of the leading families. 3.13 There was no further relaxation of entry barriers to the banking system. On the contrary, the minimum capital requirement for commercial banks was raised to P 100 million. There was already a large number of small banks, and further entry has been barred since 1972. No further steps have been taken on the capital flows. The capital account had been quite open in the Philippines despite formal restrictions on foreign exchange. Indonesia 3.14 Indonesia's financial reform was far-reaching in both content and coverage. The reform was implemented in two stages, the first in June 1983 and the second in 1984. The June 1983 reform had three principal parts: (a) elimination of ceilings on bank credits; (b) gradual narrowing of loan categories from access to Bank Indonesia (BI) liquidity credits; and (c) deregulation of state banks' interest: rates on most categories of deposits and on all loans except a few priority loans. The two elements of the subse- quent reform, which was miore in the nature of a follow-up, were: (a) introduction of rediscount facilities and the BI certificates called Servifikats Bank Indonesia (SBI); and (b) the introduction of new money-market instruments, Surat Berharga Pasar Uang (SBPU), in February 1985 (T. Balino and V. Sundararajan 1984; V. Sundararajan and L. Molho 1986). The second phase of 21 reform called for creation of new instruments to absorb the excess liquidity of banks which otherwise was being diverted to foreign assets. These instru- ments were useful for developing open market operations and were a more effec- tive alternative monetary policy control weapon than the earlier policy of imposing reserve requirements. 3.15 The elimination of credit ceilings facilitated a switch to indirect regulation of credit through reserve money management. This switch, and its consequent impact on the functioning of the money market, oriented the banking system to manage its loan portfolio on the basis of cost-benefit criteria. As a result, competitive forces were given greater leeway. The elimination of ceilings on interest rates which were applicable only to the state banks--the dominant institutions in the banking system--was necessitated by the need to make them compete more vigorously with the private banks as well as with off- shore financial centers such as Hong Kong and Singapore. The reliance of the state banks on liquidity credits, the size of which was determined more by demand, was expected to decline. Sri Lanka 3.16 The main accent of Sri Lanka's financial reform was on the removal of restrictions on interest rates. This was done first by raising the bank rate from 8.5% to 10% p.a., thereby giving a signal to other market rates of interest. This was followed by raising sharply the interest rates on deposits of the National Savings Bank (NSB), the most dominant mobilizer of financial savings. In fact, deposit rates paid by this bank were announced to be the key rates for other banks and the financial institutions to follow. At the same time, the basic exchange rate and the premium value (FEEC) were first unified at an initial rate of SLR 16 to the US dollar, and then the exchange rate was allowed to float. The depreciated exchange rate and the increased domestic interest rates ensured that the illicit outflow of financial assets would decline and the domestic financial intermediation process would be strengthened. 3.17 The higher level of interest rates by itself would not have resulted in positive real interest rates if monetary expansion (which was very large) had not been contained. The Central Bank of Ceylon achieved this by restrict- ing access of banks to its credit to 4% of selected items of assets as of September 30, 1977. This limit which was subsequently raised to 7%, and borrowing over the limit was charged a penalty rate of 15%. The selective control policy, however, was continued, although it was made even more selec- tive, and the concessional element in interest rates was scaled down. Banks were given more freedom to determine lending rates to the final borrowers. 3.18 Two features of the financial reform in Sri Lanka stand out. First, the financial reform was much milder than might have been expected. Second, Government intervention did not evaporate, though the form and direction it had assumed in the past were market determined. What was important, there- fore, was not the dimensions of the financial reform but the break it marked from the dirigistic traditions of previous Sri Lanka policy makers. The reforms of 1977 carried the interest rates to a level at which depositors found it rewarding to hold wealth in financial assets, and borrowers could use scarce capital resources to raise allocative efficiency of their investments. 22 The reforms also permitted t:he financial system to operate in a more competi-. tive environment, since more banks, particularly foreign banks and other deposit-taking nonbanks, could freely enter the field. This was evident from the subsequent establishnent: of the foreLgn currency banking units (FCBUS) which could transact in foreign currency with nonresident enterprises in the free trade zone and accept foreign currency deposits from nonresidents. 3.19 Exchange controls were considerably diluted. Measures for decontroL of prices and allocation of credit through interest rates were introduced when the budget was presented to the parliament. This matching liberalization in other sectors of the economy reflected favorably on the financial sector and contributed to its competitiveness and operational efficiency. 23 IV. THE CONSEOUENCES OF FINANCIAL LIBERALIZATION Overview 4.1 The impact of financial reforms on the financial system depends not only on the principal elements constituting the reforms and their modus operandi but also on how these reforms interact with the macroeconomic policies of the countries concerned. The financial reforms by themselves may be well designed and sound, but they may fail to accomplish what they were intended to accomplish if macroeconomic policies are not in tune with them or if they cause undesirable changes in the real economy. It is therefore essential to view the consequences of financial reforms in the context of the macroeconomic environment. Macroeconomic Environment Korea 4.2 From this perspective, changes in the macroeconomic environment since 1980-82 contributed greatly to the achievements of financial liberalization. Korea's terms of trade have improved significantly since 1980, substantially more than other countries in this study except Sri Lanka (Table 6). Inflation has been very stable and low since 1982; the real effective exchange rate was relatively stable until 1985 since when it appreciated. The current account deficit gradually declined from its peak in 1980-1982 and turned into a large'' surplus by 1986 (Table 3). This encouraging macroeconomic environment was brought about partly by external factors such as declining commodity prices and partly by Korea's determined fiscal and monetary stabilization policy. The fiscal deficit was reduced from 3.5% of GNP in 1981 to 1.1% by 1983 (Table 5). Monetary policy was tight in general, although it remained largely flexible in response to changes in the financial and real sectors. As of 1987, the Korean economy remains one of the fastest growing, and it has great macroeconomic stability (see V. Corbo and S. Suh, 1988). 4.3 With such a happy conjuncture of circumstances, the financial liberalization policy took hold. In consequence, the earlier pattern of financial segmentation changed perceptibly, and a sharp drop in the inflation rate helped convert the interest rates of banks and NBFIs from negative to significantly positive levels in real terms. As a result, the financial system as a whole recorded dramatic growth in the first half of the 1980s. The focal point of growth was the nonbank financial intermediaries such as investment and insurance companies and direct markets for corporate bonds and commercial bills. These institutions were not much constrained as to the size or allocation of their funds to particular industries and were either free from or able to circumvent interest rate ceilings on both sources and uses of funds. They were the real beneficiaries of reform insofar as they could attract, unhindered, a large amount of financial savings. In contrast, the commercial banking segment of the financial system could not derive as much advantage from financial reform because it was constrained by the restrictive monetary policy in force during this period. TABLE 8-1: INTEREST RATES(DEPOSIT RATE) AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.DEPOSIT RATE 1.NCHINAL INDONESIA 11.25 12.00 12.00 12.00 12.00 9.00 6.00 6.00 6.00 6.00 6.00 6.00 16.00 18.00 - KOREA 15.28 12.00 14.80 15.00 15.50 15.80 16.40 18.60 22.80 19.30 10.90 8.00 9.00 10.00 10.00 MALAYSIA 7.63 8.00 9.00 7.50 7.50 6.50 6.50 7.00 9.00 11.00 10.00 9.00 10.75 7.50 7.00 PHILIPPINES 9.75 8.00 9.50 9.50 10.00 10.00 10.00 12.00 14.00 16.74 14.67 16.51 32.13 15.52 11.25 SRI LANKA - - - 7.25 7.25 14.50 14.50 14.50 20.00 21.00 18.50 20.50 18.00 15.00 11.25 2.REAL(CALCULATED BY Ci'I) INDONESIA -8 69 - -20.59 -5.74 -6.63 -1.78 -2.03 -12.09 -10.54 -5.53 -3.23 -5.19 5.07 12.65 - KOREA -2.65 8.53 -7.78 -8.15 0.20 5.11 1.69 0.28 -4.58 -1.65 3.40 4.47 6.54 7.35 7.56 MALAYSIA 0.54 - -7.15 2.88 4.81 1.61 1.52 3.25 2.19 1.19 3.95 5.11 6.59 7.13 6.22 1 PHILIPPINES - - -18.39 2.56 0.73 0.09 2.48 -4.71 -3.56 3.24 4.04 5.89 -12.11 -6.16 10.42 ". SRI LANKA - - - 0.57 5.97 13.39 2.27 3.75 -6.10 3.10 7.64 6.50 1.36 13.56 3.25 SOURCE: INTERNATIONAL FINANCIAL STATISTICS AND STAFF ESTIKATES. TABLE 8-II: INTEREST RATES(LENDING RATE) AVR 74-77 1973 1974 1975 1976 1977 1976 1979 1980 1981 1982 1983 1984 1985 1986 II.LENDING RATES I.OHIKAL INAOD6SIA - - - - - 9.00 9.00 9.00 9.00 9.00 9.00 9.00 12.00 12.00 _ U011 15.85 15.50 15.50 15.50 16.10 16.30 16.90 13.50 22.90 19.30 12.30 10.00 10.30 10.80 10.60 NALATSIA - - - - - 9.47 9.34 9.42 10.17 11.98 12.33 11.64 13.14 12.11 12.02 FNILIPFINES 12.00 - 12.00 12.00 12.00 12.00 12.00 14.00 14.00 17.12 19.18 20.67 36.41 18.70 17.53 SRI LAMA - - - - - 16.00 18.00 19.00 19.00 14.00 11.00 13.80 13.00 9.30 2.REAL(CALCULATED BY CPI) INDONESIA - - - - - -1.78 0.75 -9.60 -8.00 -2.85 -0.49 -2.50 1.44 6.93 - KO11 -2.17 11.92 -7.22 -7.75 0.72 5.56 2.13 0.20 -4.51 -1.65 4.70 6.40 7.82 8.13 8.34 NALAYSIA - - - - - 4.44 4.23 5.53 3.28 2.08 6.16 7.65 8.89 11.73 11.20 PgILIPPINES -1.79 - -16.52 4.90 2.57 1.91 4.34 -3.01 -3.56 3.57 8.13 9.67 -9.27 -3.58 16.66 SRI LAMU - - - - - 5.15 6.54 -5.63 0.93 2.84 -2.63 -2.44 11.40 1.67 SOURCE: INTERNATIONAL FINANCIAL STATISTICS AND STAFF ESTIKATES. 26 4.4 Competition among banks and nonbanks generally increased, and there occurred a fair degree of integration of the financial markets; the unregulated markets were brought in closer alignment with the organized credit markets; the cost of intermediation fell and the availability of term credit from NBFIs and direct financing increased. Against these favorable effects of liberalization, the banks were confronted with a large and potentially disruptive volume of nonperforming loans, which increased partly because of the liberalization policies and partly because of past excessive government intervention and external shocks during the reform period. Malaysia 4.5 After financial reform, Malaysia's economy faced a sharp deterioration in the terms of trade. Its national income fell in 1979 by 4.5%, and a sizeable deficit in its current account of the balance of payments emerged (Table 3). The Government's initial response was a countercyclical policy directed towards aggressive expansion of public investment in both infrastructure and directly productive activities. This soon became financially unsustainable as large deficits emerged in both the external current and fiscal accounts. The scale of fiscal expansion in 1981 and 1982 was unprecedented and resulted in an increase in the government deficit to 19.7% and 18.7% of GNP in 1981 and 1982, respectively; the current account deficit reached 10% and 13.4% of GDP in the same years. Since 1983, the Government has tried to cut its expenditures drastically. The cuts coincided with a slowdown in private investment: overall, investment declined, and with it, the economic growth rate. Gross domestic investment as a ratio of GNP slipped from 39.1% in 1982 to 27.8% in 1986, narrowing the current account deficit to 1% of GDP. Due to all these adjustment efforts, Malaysia experienced negative growth (-1.1%) in 1985 and grew by only 1% in real terms in 1986. 4.6 Despite the disc:ouraging macroec:onomic environment, the financial sector in Malaysia developed rapidly, owing to the increased real interest rates ensured by liberalization of interest rates and sustained price stability. The extent of the rise in nominal bank deposit and lending rates remained modest, reflecting initial conditions which themselves were nonconstraining, but their level in real term was substantially high due to further deceleration in the inflation rate since 1984. There was some progress towards integration of domestic interest rates, mainly on the deposit side, but the gap in lending rates charged by different groups of financial institutions widened to some extent. When small-sized banks could appropriate a growing share of the credit market, the spread between deposit and lending rates increased, indicating the persistence of a strong oligopolistic element in the banking structure; long-term funds became more ample than before. The banking system faced a problem of nonperforming loans. Since 1985, when the economy was in deep recession and there was a collapse of the real estate market (to which the banking system had large exposure), it weathered the storm more skillfully. In Malaysia's case, the macroeconomic policies appeared to have been as helpful as the liberalization policies in the financial deepening process. 27 The PhiliRRines 4.7 The Philippine economy was considerably weakened by the second oil shock of 1979. It experienced a major macroeconomic imbalance starting in October 1983. The economy contracted, mainly because of the inability of the Philippines to continue to borrow abroad to finance its current account balance of payment deficits. Since the late 1970s, the Government has pursued countercyclical expansionary policies to sustain high economic growth against the background of world recession. The government deficit rebounded from 0.2% of GNP in 1979 to 4.3% in 1982, and the current account deficit rose from 5.1% to 8.0% of GNP in the same period (Table 3). A gradual loss of confidence in the Philippine economy combined with the political events of autumn 1983 propelled a large outflow of funds and withdrawal of suppliers' credits. As a result, the Government introduced a rationing system for foreign exchange and a moratorium on capital repayments abroad. The practical consequence of these events was that for the next two years the economy could not obtain foreign resources. There was a current account deficit of 7.96% of GDP in 1983, and a reduction in the gap in international payments could be achieved only by a sharp reduction in imports. With real consumption spending unchanged, there was a sharp decline in capital formation. 4.8 The process of adjustment over 1983 and 1984 involved a large devaluation of the peso, which together with a large fiscal deficit contributed to the;escalation of the inflation rate from 19% in 1983 to 50% in 1984. In order to counter inflation, an aggressive policy of monetary contraction was followed in 1984; this took the form, among others, of the sale of new, high-yield instruments by the Central Bank. A modest resumption of external funding and a reversal of capital flight facilitated economic recovery beginning in 1986. 4.9 During the initial years of financial liberalization, 1981-83, developments in the financial sector showed promising movement toward the intended goals of liberalization. Nominal interest rates were adjusted upward, though not substantially. However, real interest rates were positive, in the range of 3-5%, mainly because of deceleration in inflation immediately after the reforms. After 1984, the rise in nominal interest rates induced by the issue of high-yield instruments reached 39-44%, up from 14-15% in previous years. This coincided with monetary contraction and led to a decline in inflation. The growth of the financial sector was impressive by the standards of earlier years (1977-80) when the ratio of financial assets to GNP remained almost constant. 4.10 With high nominal and real interest rates after 1984, the highly leveraged corporate borrowing sector was enmeshed in financial difficulties because of its distress borrowing. The arrearage rate of banks, particularly the government bank, rose sharply to 30-90% of total assets, and the Central Bank had to intervene to bail out several of them. As a result, in 1980-86 the banking system experienced a contraction of real assets to the tune of 44%. TABLE 9-I: CROWTH OF FINANCIAL SECTOR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.CHANGE IN I21SAVINGS INDONESIA 0.136 - 0.146 0.165 0.147 0.085 0.109 0.116 0.140 0.102 0.078 0.172 0.122 0.196 0.137 KOREA 0.330 - 0.303 0.366 0.313 0.338 0.298 0.221 0.301 0.281 0.322 0.180 0.084 0.167 0.175 NALAYSIA 0.210 - 0.160 0.214 0.280 0.187 0.218 0.240 0.325 0.295 0.295 0.166 0.166 0.121 0.238 PHILIPPINES 0.147 - 0.125 0.095 0.173 0.195 0.184 0.091 0.152 0.133 0.178 0.225 0.155 0.137 0.102 SRI LANKA 0.269 - 0.251 0.075 0.370 0.380 0.425 0.687 0.638 0.426 0.554 0.400 0.200 0.266 0.073 2.CHANCE IN K2/PRIVATE SAVINGS INDONESIA - - - - - - 0.201 0.224 0.271 0.171 0.151 0.498 0.355 0.478 0.278 KOREA 0.389 - 0.336 0.424 0.390 0.407 0.368 0.290 0.406 0.387 0.454 0.252 0.113 0.221 0.219 MALAYSIA 0.321 - 0.260 0.323 0.417 0.284 0.313 0.332 0.427 0.470 0.529 0.355 0.4'3 0=263 0.378 PHILIPPINES - - - - - - - - - - - - - - - SRI LANKA _ _ _ _ _ _ 0.389 0.696 0.476 0.372 0.498 0.405 0.252 0.338 - 3.CHANGE IN M31PRIVATE SAVINGS INDONESIA - - - - - - - 0.232 0.285 0.180 0.163 _ _ _ _ KOREA 0.384 - - 0.380 0.603 0.552 0.483 0.472 0.678 0.670 0.829 0.555 0.483 0.547 0.595 XALAYSIA 0.404 - 0.356 0.402 0.500 0.358 0.398 0.412 0.532 0.661 0.692 0.633 0.788 0.475 0.467 PHILIiPINES - - - - - - - - - - - - - - SRI LANXA - 0.593 0.985 0.720 0.545 0.863 0.743 0.525 0.651 - MOTE: H2 - MONEY + QUASI-MONEY, M3 - K2 + DEPOSITS OF NON-BANK FINANCIAL INSTITUTIONS SOURCE: INTERNATIONAL FINANCIAL STATISTICS AND STAFF ESTIMATES. TABLE 9-11: GROWTH OF FINANCIAL SECTOR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.M2/GNP INDONESIA 16.4 15.3 14.3 16.7 17.6 17.1 17.5 16.9 17.7 17.3 18.3 20.9 21.5 25.6 - KOREA - - - 31.2 30.3 32.4 32.7 31.6 33.7 34.2 38.4 39.3 37.7 39.2 40.4 MALAYSIA 45.3 41.6 39.9 46.3 47.3 47.8 48.4 49.0 53.4 58.2 63.0 63.2 61.8 68.1 81.6 PHILIPPINES 18.4 19.4 16.8 16.8 18.6 21.2 22.8 20.8 21.0 21.6 23.5 25.3 20.9 20.9 22.2 SRI LANKA 23.6 24.5 21.5 20.2 24.6 28.2 29.7 31.7 31.7 30.2 31.9 32.0 30.0 31.3 29.3 2.H3/GNP INDONESIA - - - - - - 18.0 17.4 18.4 18.0 19.1 - - - - KOREA - - - 36.0 38.7 38.1 45.5 42.1 42.8 47.8 50.9 59.9 64.7 75.2 82.5 MALAYSIA 53.7 47.5 46.7 54.7 56.1 57.2 58.5 59.5 65.2 72.6 79.2 82.3 84.4 94.8 112.3 PHILIPPINES - - - 25.2 - - - - 25.6 27.0 28.4 29.8 23.0 22.3 22.9 SRI LANIA - - - - - 53.9 54.0 53.7 52.5 49.1 52.6 53.7 52.1 55.0 - SOURCE: INTERNATIONAL FINANCIAL STATISTICS AND STAFF ESTIMATES. 30 Indonesia 4.11 The Indonesian economy did not bask in the glow of financial reform. The GDP growth rate rose substantially to 6.2% in 1984 immediately after reform but declined equalLy sharply to 1.9% in 1985 (Table 2). Of course, the external shock of a rapid decline of 15% in the terms of trade from 1983-1986 was the principal reason (Table 6). Desp:Lte the depreciation in the rupiah's real effective exchange rate, the current account deficit in the balance of payments, though half what it was in 1983, was still large enough to reverse the market's expectations of further rupiah devaluation. This was not surprising, as the fiscal deficit, though declining, was still large at 2.9% of GDP. The only favorable turn was in regard to the inflation rate, which was halved from 12% in 1983 to 6% in 1986. The total domestic savings rate rose 2.5 percentage points in 1984 to 32.1% but fell to 25.5% in 1986, lower than in the first year of financial reform. Total investment declined even more precipitously than domestic savings, from 26.7% in 1983 to 21.1% in 1986, because of a fall in domestic and foreign savings (Table 10). Even more significant was the fact that both public and private investment declined, as did public and private-sector savings. 4.12 The consequences of financial reform in Indonesia seemed to be favorable when judged by growth in M3, competitiveness of the state banks, and the attairunent of positive real interest rates during most of the period. The M2/GNP ratio rose sharply from 20.9% in 1984 to 29.4% in 1986 (Appendix Table Indonesia 4). The deposit rates of all categories of banks remained not only positive but very high in real terms (Appendix Table Indonesia 2). Since the state banks were given considerable latitude in regard to fixing interest rates, competition among banks became more intense and boosted the efficiency of the banking system as a whole. Though domestic interest rates were well integrated with foreign interest rates, the influence of foreign factors on domestic interest rates became stronger, somewhat to the detriment of domestic investment. The introduction of new financial instruments like the Sertificat Bank Indonesia (SBI) and Surat Berhanga Pasar Uang (SBPU) imparted strength, vigor and competitiveness to the money markets. In addition, the range of noncredit financial services widened considerably. Sri Lanka 4.13 Sri Lanka emerged from economic stagnation with a robust economy. The GDP growth in 1978, immediately after financial deregulation, was the highest at 7% and thereafter averaged about 5.5% until 1985, not substantially different from the average growth rate during 1975-77. Total investment as a proportion of GDP increased sharply from 16% on the eve of financial reform to 28% during 1978-85; domestic saving, however, was around 15.5% during the same period. The rate of inflation as measured by the GDP deflator declined initially but increased subsequently to 14%, more or less the same level as in 1975-77. The fiscal deficit remained unaffected during 1978-79, increased sharply to 23.0% of GDP in 1980 and hovered around 13% until 1985. The balance of payments deficit declined to 6.3% of GDP before rocketing to 6.7% in 1979 and to 16.3% in 1980. The average payments deficit as a proportion of GDP during 1981-85 remained high at 7.49%. TABLE 10-1: SAVINGS AND INVESTMENT (CONTINUED) AVR 74-77 1973 1974 1975 1976 1977 1976 1979 1980 1981 1982 1983 1984 1985 1986 I.SAVINGS 1 GROSS DOMESTIC SAVINGS/CGP INDONESIA 29.71 24.71 30.91 28.51 28.5X 30.91 28.91 37.81 41.81 35.01 28.9X 29.71 32.1X 29.51 25.51 oREa 20.9X 21.41 19.31 16.81 22.22 25.41 27.31 26.51 20.8X 20.51 20.92 25.32 27.92 2$.62 32.82 NALAYSIA 33.62 33.61 34.02 27.92 36.62 35.91 33.71 39.61 34.2X 29.81 30.02 32.92 38.0x 35.32 34.0X PHILIPPINES 23.72 23.71 22.02 22.71 24.9X 25.12 24.01 25.5 25.02 25.31 21.92 20.21 17.31 17.42 19.7X SRI LANKA 13.92 13.72 9.11 9.11 16.32 21.12 16.7Z 13.82 11.12 11.81 11.8x 13.92 19.82 11.21 12.13 2.PU8LIC SAVINGSIGNP INOCIESIA - - - - - - 6.0X 7.22 7.3X 6.91 5.91 7.5X 8.01 6.2Z 2.42 KOREA 3.22 2.81 1.93 2.31 4.42 4.32 5.2Z 6.33 5.42 5.61 6.11 7.21 7.11 6.92 6.63 MALAYSIA 3.92 2.91 4.02 2.41 4.6X 4.61 5.31 3.22 1.52 4.51 5.93 9.1X 9.81 0.03 0.0O PHILIPPINES - - SRI LANMA - - - - - - -1.53 0.21 -3.83 -1.72 -1.22 0.21 3.51 0.61 1.7Z 3.PRIVATE SAVINGSIGNP INDONESIA - - - - - - 15.72 19.53 21.71 20.81 I5.O 10.31 II.OX 12.11 12.61 KREa 17.73 18.62 17.42 14.52 17.8X 21.12 22.1X 20.22 15.4X 14.92 14.82 18.13 20.82 21.7X 26.21 MALAYSIA 21.92 23.0X 21.02 18.51 24.61 23.71 23.51 28.63 26.03 18.82 16.71 15.33 15.3X 16.23 21.4X PHILIPPINES - - - - - - - _ _ _ _ _ _ _ _ SRI LANKA - - - - - - 18.21 13.62 14.82 13.53 13.02 13.71 16.31 10.6X 10.31 SoURCE: INTSRMATIOKAL FINANCIAL STATISTICS AND STAFF ESTIMATES. TABLE 10-11: SAVINGS AND INVESTKENT AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1i. INVESTMEET 1.GROSS DOMESTIC INVESTMENTIGNP INDONESIA 25.1X 22.68 21.61 26.11 26.21 25.68 25.88 26.71 27.2S 28.22 26.7S 26.01 21.3X 20.31 21.11 KOREA 28.2X 24.71 31.81 27.51 25.71 27.71 31.91 36.01 32.11 30.3i 2i.68 29.9; ;;.9;: NALAVSIA 28.71 27.71 33.68 27.31 25.71 28.01 27.98 30.38 31.68 36.31 39.18 38.58 36.01 29.72 27.08 PHILIPPINES 28.78 20.28 25.11 29.58 31.38 29.01 29.01 31.11 30.78 30.71 28.81 27.18 17.48 14.4i 13.41 SRI LANKA 17.78 15.18 17.48 17.58 19.08 16.88 21.98 25.88 33.48 28.08 30.48 28.98 26.61 23.9X 23.81 2.PUULIC IrVESTMENTIGNP INMDOESIA - - - - - - 5.28 5.68 4.O 6.01 9.48 9.9S 6.6S 7.31 7.08 KOREA - - - - - - - - - - - - - - - YALAYSIA - - - - - - - - PHILIPPINES - - - - - 5.68 6.08 8.71 7.08 7.78 4.61 3.68 S.O8 - _ SRI LANKA - - - - - - 6.68 7.78 9.78 5.2X 4.98 4.98 4.7X 4.61 5.41 3.PRIVATZ INVESTMENTIGNP INDONESIA - - _ _ - 20.51 21.18 23.21 22.18 17.31 16.1S 14.7S 13.02 14.12 KOREA - - - - - - - - NALAYSIA - - - - . - - PUILIPPIMES - - - - - 23.48 23.08 22.48 23.78 23.08 24.21 23.51 12.41 - _ SRI LAVMA - - - - - 15.31 18.18 23.78 22.78 25.58 24.08 21.88 19.18 18.41 SOURCE: INTEREAYIONAL FINANCIAL STATISTICS AND STAFF ESTIMATES. 33 4.14 The first-impact effects of reform on Sri Lanka's financial system were impressive. Both the M2/GDP and M3/GDP ratios recorded a rise, the latter increasing from 40% in 1977 to almost 50% in 1985. Both deposit rates and lending rates turned positive except during 1980 and 1984. Though interest rates were determined through regulation, market considerations were given due weight. The most conspicuous achievement was in regard to enhanced competitiveness among banks because of an increase in the number of domestic banking units and offshore foreign banking units (FCBUs). 4.15 The Consequences of Financial Liberalization. The consequences of liberalization for the financial systems in the five countries are discussed in greater detail at a disaggregated level. The areas chosen for disaggregation are: (a) the level and structure of interest rates; (b) growth of the financial sector; (c) competitiveness, profitability and efficiency of financial institutions; (d) availability of long-term credit; (e) integration of domestic interest rates with foreign interest rates; (f) quality of banks' loan portfolios; and (g) the corporate sector's financial structure. The consequences should be seen in the context of overall macroeconomic develop- ments in each of the countries, as sketched in the overview. (a) Level and Structure of Interest Rates Korea 4.16 Bank loan and deposit rates in Korea, which were consistently negative in real terms throughout the 1974-80 period, turned increasingly positive after the 1981 financial reform (Appendix Table Korea 3 and Chart K1). Thus real bank deposit rates reached about 5-7% and real bank loan rates about 7-10%, during 1982-1986. The positive real interest rates stemmed mainly from a decline in the inflation rate, but unlike the case during the 1970s, equally important was the Government's commitment to maintaining a positive real interest rate, made clear by its constant watch over movements of inflation rates in order to adjust bank interest rates. A distinguishing feature of Korea's interest rate policy was that it remained market oriented although the Government continued to intervene in determination of interest rates. This approach was, however, pragmatic, as borne out by the fact that the nominal deposit and loan rates were adjusted downward frequently in 1982 (in the face of persistently high inflation expectations), because it was felt at the time that many corporate firms had difficulties meeting their debt repayment obligations and it was necessary not to aggravate the arrearage problem. Although this induced some shift in deposits away from banks to NBFIs, it contributed substantially to the reduction of the corporate debt burden while keeping real interest rates substantially positive. If the Government had not readily adjusted the lending and deposit rates when inflation started to decelerate, there might have been more massive bankruptcies of the corporate firms, and the problem of the banks' nonperforming loans might have become more acute. The Korean experience in regard to a timely adjustment in interest rates (see Appendix Korea, Chart Kl) through government intervention may be seen in contrast to events in the Philippines in 1986 and in Malaysia in the 1980s, where market-determined interest rates lagged behind the decline in the inflation rate. This issue will be taken up later. TABLE 11: MOVEMENT OF DOMESTIC AND FOREIGN INTEREST RATES AND EXCHANGE RATES (CONTINUED) YEAR AV 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.UNO DOLLAR : 6 MONTH 7.77 9.40 10.84 7.75 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.93 11.29 8.64 6.85 2.DONESTIC LENDING RATE IWDONESIA - - - - - 9.00 9.00 9.00 9.00 9.00 9.00 9.00 12.00 12.00 - KOREA 15.85 15.50 15.50 15.50 16.10 16.30 16.90 18.50 22.90 19.30 12.30 10.00 10.30 10.80 10.80 MALAYSIA - - - - - - 10.45 10.23 10.39 11.76 12.33 12.01 12.23 14.66 13.96 pUlLIIPIMES 12.00 12.00 12.00 12.00 12.00 12.00 12.00 14.00 14.00 16.00 1.1i3 2i.;S 32.10, 1 3.- SRI LANKA - - - 9.75 10.25 15.00 15.00 15.00 17.00 20.50 20.50 20.50 21.00 20.50 20.00 3.DGMESTIC DEPOSIT RATE IXDONESIA - - - - - - 15.70 16.80 18.20 18.10 18.40 18.80 20.70 17.80 15.50 KOREA 15.30 12.00 14.80 15.00 15.50 15.80 16.40 18.60 22.80 19.30 10.90 8.00 9.00 10.00 10.00 MALAYSIA 6.06 6.25 7.00 6.00 6.00 5.25 5.75 5.75 8.50 10.50 9.25 8.50 10.50 7.50 6.75 PHILIPPINES 9.75 - 9.50 9.50 10.00 10.00 10.00 12.00 14.00 16.74 14.67 16.51 32.13 15.52 8.37 SII LAMA - - - - - - 8.50 8.50 14.30 17.88 17.50 18.25 19.79 17.33 12.21 4.EFFECTIVE COST ON EURODOLLAR INDONESIA 7717 - 10.84 7.75 6.12 6.37 16.30 58.09 14.75 17.61 18.93 51.12 25.57 17.60 23.40 KOREA 5.30 - 12.55 28.94 6.12 6.37 9.20 12.15 43.11 30.86 21.95 16.65 15.63 17.27 8.25 Ma1AYPIA 8.01 - 9.20 7.15 12.67 3.01 2.75 5.97 13.43 23.54 15.14 9.27 12.36 15.10 11.08 PMILIVPINES 10.36 - 11.36 15.05 8.94 6.09 8.39 12.33 16.10 22.75 22.81 43.05 67.23 21.06 17.06 SRI LANKA 17.06 - 15.13 13.52 27.40 12.20 92.12 11.87 21.07 35.87 22.84 24.28 20.32 16.01 10.21 5.(. 1 - 2) IXDONESIA - - - - - -2.63 0.20 3.15 5.03 7.72 4.60 0.93 -0.71 -3.36 6.85 KOREA -8.08 -6.10 -4.66 -7.75 -9.98 -9.93 -7.70 -6.35 -8.87 -2.58 1.30 -0.07 0.99 -2.16 -3.95 MALAYSIA - - - - - - -1.25 1.92 3.64 4.96 1.27 -2.08 -0.94 -6.02 -7.11 PUILIPPIRNS -4.23 -2.60 -1.16 -4.25 -5.88 -5.63 -2.80 -1.85 0.03 0.72 -3.53 -11.25 -27.81 -9.03 -7.03 SRI LANKA - - - -2.00 -4.13 -8.63 -5.80 -2.85 -2.97 -3.78 -6.90 -10.57 -9.71 -11.86 -13.15 SCORCES: INTERNATIONAL FINANCIAL STATISTICS, IMF. NOTE: 4.EFFECTIVE COST=(I4EUROS RATE)(l+rf GROWTH RATE)-l TABLE 11: HODVEENT OF DOMESTIC AND FOREIGN INTEREST RATES AND EXCHANGE RATES YEAR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 6.(- 1 - 3) INDONESIA - - - - - - -6.50 -4.65 -4.17 -1.38 -4.80 -8.87 -9.41 -9.16 -8.65 KOREA -7.53 -2.60 -3.96 -7.25 -9.38 -9.43 -7.20 -6.45 -8.77 -2.58 2.70 1.93 2.29 -1.36 -3.15 MALAYSIA 1.71 3.15 3.84 1.75 0.12 1.12 3.45 6.40 5.53 6.22 4.35 1.43 0.79 1.14 0.10 PHILIPPINES -1.98 - 1.34 -1.75 -3.88 -3.63 -0.80 0.15 0.03 -0.02 -1.07 -6.58 -20.84 -6.68 -1.52 SRI LAN-KA - - - - - 0.70 3.65 -0.47 -1.16 -3.90 -8.32 -8.50 -8.69 -5.36 7.(- 4 - 3) INDONESIA - - - - - - 0.60 41.29 -3.45 -0.49 0.53 32.32 4.87 -0.20 7.90 KOREA -10.00 - -2.25 13.94 -9.38 -9.43 -7.20 -6.45 20.31 11.56 11.05 8.65 6.63 7.27 -1.75 MALAYSIA 1.95 - 2.20 1.15 6.67 -2.24 -3.00 0.22 4.93 13.04 5.89 0.77 1.86 7.60 4.33 PHILIPPINES 0.61 - 1.86 5.55 -1.06 -3.91 -1.61 0.33 2.10 6.01 8.13 26.53 35.10 5.54 8.69 SRI LANKA - - - - - - 83.62 3.37 6.57 17.99 5.34 6.03 0.53 -1.32 -2.00 8.(- 4 - 2) INDONESIA - - - - - -2.63 7.30 49.09 5.75 8.61 9.93 42.12 13.57 5.60 23.40 1 KOREA -10.55 - -2.95 13.44 -9.98 -9.93 -7.70 -6.35 20.21 11.56 9.65 6.65 5.33 6.47 -2.55 MALAYSIA - - - - - - -7.70 -4.26 3.04 11.78 2.81 -2.74 0.13 0.44 -2.88 MUILIDPINES -1.64 - -0.64 3.05 -3.06 -5.91 -3.61 -1.67 2.10 6.75 5.68 21.87 28.13 3.39 3.18 SRI LANKA - - - 3.77 17.15 -2.80 77.12 -3.13 4.07 15.37 2.34 3.78 -0.68 -4.49 -9.79 9.NWIiNAL EXChUACE RATE(rf) CROWTH RATE INDONESIA 0.00 - 0.00 0.00 0.00 0.00 6.11 29.06 0.63 0.76 4.48 27.26 11.37 7.62 13.41 KOREA 4.49 - 1.52 16.43 0.00 0.00 0.00 0.00 20.32 10.81 6.85 5.76 3.75 7.36 1.30 MALAYSIA 0.12 - -1.50 -0.56 5.82 -3.26 -6.27 -5.83 -0.53 5.52 1.34 -0.61 0.95 5.61 3.01 PHILIPPINES 2.28 - 0.47 6.35 2.59 -0.26 -0.75 0.16 1.78 4.92 7.50 23.15 33.45 10.26 8.72 SRI LANKA 7.68 - 3.73 5.08 16.70 5.20 43.16 -0.25 5.82 14.09 7.52 11.55 7.50 6.35 3.05 10.REAL EFFECTIVE EXCHANGE RATE INDONESIA - - - - - - 119.4 92.5 100.0 108.6 117.5 95.3 92.4 89.7 69.1 KOREA - - - - - - 97.6 107.4 100.0 104.4 106.9 102.7 101.3 95.5 80.6 MALAYSIA - - _ _ 108.5 105.9 101.4 103.8 100.0 100.4 106.7 111.8 116.1 110.3 92.6 PHILIPPINES _ - - - - 7.7 95.0 100.0 103.2 107.1 90.1 89.2 97.6 76.2 SRI LANKA - - _ 131.2 125.8 80.6 86.9 100.0 106.3 112.8 112.2 124.8 116.7 103.9 SOURCES: INTERNATIONAL FINANCIAL STATISTICS, IMF. 36 4.17 An important policy change introduced in June 1982 was to eliminate low preferential bank loan rates for priority activities such as exports. This was accomplished primarily by curtailing the number of such loans and lowering general loan interest rates in consonance with a fall in the inflation rate to the prevailing level of preferential loan rates (Appendix Table Korea 4). Since 1986, Korea has begun to phase out even the preferential export credit, especially to large firms, as the current account of the balance of payments began to record large surpWuses. With slow but steady attenuation of government intervention and positive interest rates in the organized markets, the unregulated markets have been brought in closer alignment with the former since 1982-83 (Appendix Table Korea 6 and Chart K2). As of 1986 the spread between the bank lending rates and the informal credit market rates was only about 11-12%, vice 20% during the 1970s. 4.18 The term structure of bank interest rates as well as their level was determined by the Government, There was not, however, significant movement toward a normal term structure of interest rates except that the range of the lending rates widened slightly. Malaysia 4.19 Two features of Malaysia's experience with interest rate liberalization stand out. FiLrst, while nominal interest rates increased slightly, real interest rates increased substantially because of price stability, and second, real rates were very sensitive to the liquidity situation of banks and to monetary policy. The impact of liberalization on domestic interest rates in Malaysia was modest at the beginning, despite the fact that international interest rates adjusted for exchange rate changes were rising sharply. The moderate movements of the deposit and lending rates reflected in part the initial conditions preceding liberalization, which gave a greater play to market forces, and to some extent also the policy of the Central Bank to control the prime rate. Even before 1978, when bank deposit rates were subject to ceilings, the lending rates were subject only to a floor set by the prime rate. As a result, banks were able to charge higher rates to nonprime borrowers depending upon demand conditions; this caused the average lending rate to remain about two percentage points above the prime rate in the three years prior to liberalization, and at a positive real level. Moreover, during most of the 1975-80 period, banks 'held substantial excess liquidity. In such circumstances, financial liberalization did not have any perceptible influence on lending rates and resulted in only a slight upward adjustment in the deposit rates of individual banks. 4.20 The control of the prime rate and hence of the lending rate structures of the larger banks, whose share of loans to prime borrowers was substantial, not only prevented the full extent of downward adjustment in the deposit rates warranted by the surplus 'banlc liquidity, but also changed the structure of the banking industry. Since late 1980, bank liquidity has come under increasing pressure from rising international interest rates and the gradual upsurge in domestic credit demand. 'Under these circumstances, many small banks, whose share of lending to prime customers (the Government and public enterprises) was not large, found it attractive to raise deposit rates and lend to nonprime borrowers at rates that ensured profits. This in turn put upward pressure on the average deposit rates of the entire banking industry. From the end of 37 1980 to the third quarter of 1981, deposit rates of commercial banks rose steadily and were above the prime rate during most of this period. Reflecting these developments, the share in total deposits of the five largest banks declined sharply during 1978-81, while the share of small banks showed a corresponding increase (Appendix Table Malaysia 6). 4.21 The introduction in late 1981 of the new interest rate mechanism based on the base lending rate (BLR) marked the beginning of a new phase in the liberalization process and was a response to the pressures discussed above. Overall, the average level of real deposit and lending interest rates was substantially higher after liberalization, especially during 1982-1986, compared to the period before liberalization. Thus, during 1982-86 the average lending rate in real terms was above 10-12% annually in commercial banks and 10-14% in finance companies (Appendix Table Malaysia 5). The loan to deposit ratio of the banking system rose from 86.8% in 1980 to a peak of 94.0% in 1985 (Appendix Table Malaysia 8) and continued its upward march in the next two years, due in part to large loan commitments by banks to property and the corporate sector (in view of its serious cash-flow problems). Since 1987, interest rates have fallen very rapidly following the easing of bank liquidity, a combined result of lowering liquidity requirements, an increase in private financial savings and low demand for credit due to economic recession. 4.22 There was some progress in Malaysia toward the integration of the various domestic interest rates, mainly on the deposit side. The 12-month deposit rate of banks was about 1-1.5% lower than the 12-month deposit rate of finance companies during 1978-1980 when the prime rate of banks was controlled. This gap narrowed to 0.5-0.75% in recent years (Appendix Malaysia Chart Ml). With an increase in the interest rate sensitivity of depositors following the liberalization, and with growing public confidence in finance companies, deposits with finance companies became closer substitutes for bank deposits. However, the gap between commercial bank lending rates and finance company rates has widened recently (Appendix Malaysia Chart M2), presumably due to the higher risks of borrowers from finance companies, which deal with consumer and housing loans. 4.23 However the segmentation of interest rates between banks and finance company's assets and liabilities and government securities and treasury bills remains immune from the impact of liberalization because the government securities were sold in a captive market, to commercial banks, which used them to fulfill liquidity requirements. 4.24 Compared to the period prior to interest rate liberalization, the term structure of deposit rates became flatter, perhaps the result of the removal of the maximum rate ceiling on short-term deposits. Data on the term structure of lending rates charged by commercial banks are not published. However, trends in the merchant bank lending rates by maturity indicate that there were no significant changes in the term structure of interest rates after liberalization, probably traceable to the stable inflation rate prevailing in Malaysia. Another reason was that there was no basic change in loan rates: before liberalization, only the minimum lending rate was controlled, so banks could charge different rates for different maturities of loans. - 38 - TABLE 12: PERFORMANCE OF ILANKS 1.INDONESIA: INCOME, EXPENDITURES AND PROFITS OF TOTAL BANKING SYSTEM(CONTINUED) (AS % OF TOTAL ASSETS) ESTIMATED 1982 1983 1984 1985 1985 (JAN.) (NOV.) OPERATIONAL INCOME 12.8% 11.7% 13.3% 12.2% 11.2% RUPIAH INTEREST REVENUES 7.0% 7.2% 9.1% 9.0% 8.2% FOREIGN CURRENCY INTEREST REVENUES 0.8% 0.6% 0.5% 0.3% 0.3% FOREIGN EXCHANGE TRANSACTOINS REVENUES 4.0% 2.9% 2.6% 1.9% 1.8% OTHERS 1.0% 1.0% 1.1% 1.0% 0.9% OPERATIONAL COSTS 10.1% 9.6% 11.0% 10.4% 9.6% RUPIAH INTEREST COSTS 3.8% 4.0% 5.8% 6.1% 5.6% FOREIGN CURRENCY INTEREST COSTS 0.9% 0.8% 0.8% 0.6% 0.6% FOREIGN EXCHANGE TRANSACTIONS EXPENSES 1.1% 0.8% 0.6% 0.3% 0.3% LABOR COST 1.9% 1.7% 1.8% 1.5% 1.4% OTHERS 2.4% 2.2% 2.0% 1.8% 1.7% OPERATIONAL PROFITS AND LOSS 2.7% 2.1% 2.3% 1.7% 1.6% NONOPERATIONAL INCOME 1.6% 1.4% 2.0% 2.4% 2.2% NONOPERATIONAL COSTS 1.5% 1.2% 2.0% 2.2% 2.1% NONOPERATIONAL PROFIT AND LOSS 0.0% 0.2% 0.0% 0.2% 0.2% CURRENT PROFIT AND LOSS 2.7% 2.3% 2.4% 1.9% 1.8% AVERAGE TOTAL ASSETS 16050200 21018450 26777450 33868140 33868140 - 39 - 2.KOREA: PROFITABILITY OF FINANCIAL INSTITUTIONS (CONTINUED) (PROFIT RATIOS)/a PERIOD 1977-79 1980-82 1983 1984 NATIONWIDE CITY BANKS 0.95 0.55 0.13 0.26 LOCAL BANKS 1.26 0.83 0.25 0.74 INVESTMENT & FINANCE COMPANIES 4.47 4.13 1.50 - MERCHANT BANKING COMPANIES 3.93 5.03 2.70 - INVESTMENT & TRUST COMPANIES 0.88 8.83 9.40 - /a NET PROFITS DIVIDED BY TOTAL ASSETS SOURCE: FEDERATION OF KOREAN BANKS, THE ANALYSIS OF THE EFFICIENCY OF BANKING INDUSTRY AND SUGGESTIONS FOR HIGHER EFFICIENCY (KOREA), 1985. 3.MALAYSIA: PERFORMANCE OF DOMESTIC BANKS, 1975-1980 AND 1982 (CONTINUED) (AS % OF TOTAL ASSETS) -----------------------------------------------------_______---__------------__------------------- 1975 1976 1977 1978 1979 1980 1982 -----------------------------------------------------_______-------__--------__------------------- AS A RATIO OF TOTAL ASSETS INTEREST MARGIN 2.40 1.82 2.11 3.40 2.19 2.20 2.33 EARNING MARGIN 3.24 2.52 2.88 4.25 2.90 2.94 2.88 OPERATING COSTS 1.25 1.15 1.19 1.37 1I97 0.96 0.99 PERSONAL EXPENSES 1.07 0.95 0.97 0.92 0.85 0.78 0.77 NET INCOMES 1.99 1.37 1.70 2.88 1.83 1.98 1.89 DEPRECIATION AND PROVISION FOR BAD DEBTS 0.26 0.23 0.23 0.35 0.31 0.43 0.36 GROSS PROFITS 1.37 1.02 1.11 2.12 1.23 1.18 1.21 NET PROFITS 1.24 0.83 0.91 1.89 1.02 0.84 0.86 AS A RATIO OF EARNING MARGIN o NONINTEREST INCOME 26.11 27.91 26.72 19.02 24.38 25.11 19.02 OPERATING COSTS 38.53 45.55 41.16 32.28 36.83 32.73 34.29 SOURCE:---------------------BANK------------NEGARA__________-----__-MALA_______--____SIA--________ SOURCE: BANK NEGARA MALAYSIA. 4.PHILIPPINES: PROFITABILITY OF COMMERCIAL BANKS (CONTINUED) (AS % OF TOTAL ASSETS) YEAR GROSS INTEREST NONINTEREST PROFITS PROFITS MARGIN OPERATING INCOME BEFORE TAX AFTER TAX 1970 2.62 2.70 1.49 1.49 1975 1.90 2.76 1.99 1.47 1980 1.90 2.02 1.16 1.08 1981 2.09 2.28 1.10 1.00 1982 1.88 2.15 0.96 0.91 1983 1.65 2.65 1.06 0.98 1984 1.01 3.11 0.51 0.42 1985 -0.28 2.48 -1.52 1.62 1986 0.44 2.50 -0.99 -1.11 *1987 2.65 2.01 1.37 1.11 *FIRST HALF SOURCE: CENTRAL BANK OF THE PHILIPPINES 5.SRI LANKA: BANKING COSTS OF COMMERCIAL BANKS, 1980-1984 (CONCLUDED) (AS % OF ASSETS) 1980 1981 1982 1983 1984 INTEREST RECEIVED i0.i ii.8 12.5 11.8 N1 1 INTEREST PAID -6.4 -8.6 -8.9 -8.4 -8.1 INTEREST MARGIN 3.7 3.2 3.6 3.4 3 OTHER INCOME 3.9 3.3 2.3 2.7 2.1 GROSS MARGIN 7.6 6.5 5.9 6.1 5.1 OPERATING COSTS 3.4 3.7 3.8 3.8 3.7 PROFITS BEFORE TAXES AND PROVISIONS 4.3 2.8 2.1 2.4 1.4 SOURCE: CENTRAL BANK OF SRI LANKA. 43 The Philippines 4.25 Contrary to expectations, after interest rate deregulation the nominal deposit and lending rates inched up only a little from 1981 to 1983 (Appendix Table Philippines 5). However, a declining inflation rate meant that real interest rates in fact increased substantially. Considering that the share of fee income in total operating income of banks between 1975 and 1985 fell from 12% to 4% (implying that the banks were partly evading the interest rate ceilings before 1981 liberalization), the effective interest rate to the borrower could have risen only marginally during the initial two years of liberalization (P. Honohan, 1988). 4.26 A spurt in interest rates began in 1984. To ensure a sharp monetary contraction as required by an agreement with the IMF, the Central Bank issued CB bills at interest rates that peaked at 43% in October 1984, up from 14-15% in previous years. This led to a full-scale run on the banking system: private banks were beseiged by premature withdrawal of time deposits for conversion into CB bills, which were high-yield, risk-free assets. The commercial banks inevitably were compelled to increase the deposit and lending rates, but they did not fully match CB-bill rates. It is significant that since 1985 nominal interest rates have not fallen in step with the decline in the rate of inflation and so yield very high real interest, reaching more than 20% annually in 1985 and early 1986. 4.27 Domestic interest rates in the Philippines were relatively well integrated. Because of the market determination of most of the interest rates, borrower creditworthiness was graded by the difference in the interest rates charged. The exception to this was the government-directed credit program, the interest rate on which was controlled by the Central Bank rediscount rate until 1985; since then, however, a market-oriented unitary discount rate has been introduced by the Central Bank. These developments since liberalization may have contributed to the integration of the domestic interest rates, though this could not be corroborated for want of relevant statistics. 4.28 The term structure of interest rates in the Philippine widened after deregulation (Appendix Table Philippines 6) and thereby facilitated the lengthening of the maturity of both deposits and loans (to be discussed later in this section). Indonesia 4.29 In Indonesia, the interest rates charged by the state banks (the ceilings on which were removed) began to rise and, as a result the state banks' competitive capacity was strengthened vis-a-vis that of private and foreign banks. Appendix Table Indonesia 2 shows the changes in various interest rates paid by banks. The state banks' deposit rates shot up immediately to about 15% in September 1983 and brought their deposit rates more or less in line with those of foreign and other domestic banks. Pari Dassu, loan rates, too, increased. This increase had an impact on the lending rates charged by private domestic commercial banks and foreign banks, whose rates were significantly higher before than those of the state banks. They tended to decline, though their level remained somewhat higher than the corresponding rates of the state banks. 44 4.30 A conspicuous feature of the interest rates in Indonesia in the wake of liberalization was the very high level and volatility of real interest rates. These qualities are interrelated. There was downward rigidity in the real interest rate level because market participants continued to expect devaluation of the rupiah; this expectation tended to generate inflationary expectations. Nominal interest rates therefore remained high despite subdued inflationary pressure. 4.31 One of the offshoots of financial reform was the emergence of new money market instruments, SBIs and SBPUs, the former issued by Bank Indonesia and the latter by the customers in connection with borrowing from banks or nonbank financial intermediaries, and also by banks and NBFIs in connection with interbank borrowing. As a result, the money market gained breadth and depth and became a vehicle to reflect changes in market interest rates. However, interest rates on both SBIs and SBPUs were not entirely market determined, despite the semblance of market influence seen in the weekly SBI auctions. The degree of integration of domestic interest rates in the wake of liberalization increased between the deposit and loan rates of state banks and other banks, but rates on these new money market instruments, the interbank rate and the deposit and loan rates of commercial banks did not follow. This lack of congruence among the various domestic rates had two causes. For one thing, rates on the new money market instruments were contrived by the Central Bank and did not respond to market conditions. It was not surprising, therefore, that the rates on these instruments remained almost unchanged during 1985-86 despite sharp movements in the banks' deposit rates (Appendix Table Indonesia 2). For another, interbank rates had always been below the rates on SBIs and SBPUs, though the margin varied from time to time since late 1984 because these rates were governed by the changing role of the interbank market as a source of funds to finance reserve requirements (V. Sundararajan and L. Molho, 1988). It could be mainta:Lned, however, that domestic interest rates in Indonesia were largely integrated after reform because bank assets constituted the overwhelming majority of total financial assets in Indonesia. 4.32 The term structure of interest rates in Indonesia displayed a (more or less) normal yield curve prior to 1983 but became flat after the reform. The interest rate on 6-, 12- and 24-month deposits was at the same level, around 14-15%, in 1986. Again, this could be traced to the volatility of interest rates, which increased risk on long-term deposits. Sri Lanka 4.33 In Sri Lanka, the real interest rates on deposits--a minimum rate on commercial banks' one-year deposits and the actual rate on similar deposits of the National Savings BarLk (NSB)--remained positive after 1977 except during 1980 and 1984 (only for commercial banks) (Appendix Table Sri Lanka 10 and Chart 1). Since 1977, though market considerations acquired importance with the increase in the number of banks and the emergence of finance companies, the level and structure of interest rates could not be said to be market determined. The guiding hand of the monetary authorities often signalled changes in the interest rates charged by commercial banks and finance companies. A major indicator of how the authorities intended the interest rates to move was provided by the treasury bill rate, the yield on TABLE 13: BANKING INDUSTRY STRUCTURE 1.INDONESIA: GROWTH AND STRUCTURE OF THE FINANCIAL SYSTEM (CONTINUED) GROWTH IN ASSETS GROSS ASSETS (ANNUAL %) …---------- ------------- ----------------- --------- ---- - - TYPE OF INSTITUTION 1981 1982 1983 1984 1987 78-82 82-87 BANK INDONESIA 43.3% 43.4% 41.2% 41.8% 38.4% 26.4 20.3 DEPOSIT HONEY BANKS 51.5% 50.5% 51.5% 53.6% 51.8% 31.8 24.0 NATIONAL FOREIGN EXCHANGE BANKS 42.2% 40.2% 40.3% 41.8% 40.9% 32.6 23.7 @ FOREIGN BANKS 3.6% 3.7% 4.2% 4.2% 3.0% 23.4 17.6 OTHER COMMERCIAL BANKS 2.0% 2.3% 2.7% 3.2% 4.0% 29.5 38.8 DEVELOPMENT BANKS 3.7% 4.2% 4.3% 4.4% 3.9% 33.1 21.9 SAVINGS BANKS 1.0% 1.4% 1.7% - 2.1% 86.5 30.6 NONBANK FINANCIAL INTERMEDIARIES 2.2% 2.5% 2.7% 2.6% 2.3% 42.6 21.3 INSURANCE COMPANIES 1.5% 1.7% 1.7% - 3.3% 35.0 33.8 LEASING COMPANIES 0.2% 0.4% 0.9% 0.7% 1.6% 44.0 69.5 STATE PAWNSHOPS 0.2% 0.1% 0.1% 0.1% 0.0% 29.4 - OTHER CREDIT INSTITUTION - 0.2% 0.2% - 0.4% - 32.0 TOTAL 100.0% 100.0% 100.0% 100.0% 100.0% 30.0 23.1 SOURCE: BANK INDONESIA AND INDONESIAN INSURANCE COUNCIL. 2.KOREA: SHARES OF KOREAN FINANCIAL INSTITITIONS (CONTINUED) (IN PERCENT) LOANS AVERAGE DEPOSITS AVERAGE ........ . INCREASE ........ .. .......... .INCREASE 1971 1976 1983 1984 RATES 1971 1976 1983 1984 RATES DEPOSIT MONEY BANKS 76.3 68.2 53.4 51.i 30.0 83.7 74.8 55.9 52.7 29.4 COMMERCIAL BANKS 47.2 44.2 31.0 29.6 29.4 54.4 49.6 33.5 31.7 28.6 (NATIONWIDE COMMERCIAL BANKS) (42.7 (35.3 (23.8 (22.0 (27.5) (49.2 (40.9 (27.1 (25.4 (27.4) SPECIALIZED BANKS 29.1 24.1 22.4 21.5 31.0 29.3 25.2 22.4 21.0 30.7 .................................................................................................. NON-BANK FINANCIAL INSTITUTIONS 23.7 31.8 46.6 48.9 41.8 16.3 25.2 44.1 47.3 45.6 DEVELOPMENT INSTITUTIONS 13.9 15.9 16.5 15.8 35.4 1.3 0.7 0.5 0.4 23.3 3 SAVINGS INSTITUTIONS 9.0 6.4 10.6 11.4 36.6 11.3 10.9 13.8 13.8 36.2 INVESTMENT COMPANIES 0.1 8.7 14.6 15.8 74.7 - 10.1 21.9 23.8 94.1 LIFE INSURANCE COMPANIES 0.7 0.7 4.9 5.9 58.7 3.7 3.5 7.9 9.3 44.0 SOURCE: FINANCIAL SYSTEM IN KOREA, BOK, 1985. 3.MALAYSIA: ASSETS OF VARIOUS FINANCIAL SECTORS (CONTINUED) AS AT END OF SECTOR 1960 1970 1980 1985 1986 BANKING SYSTEM 66.31% 64.15% 73.29% 70.30% 69.19% MONETARY INSTITUTIONS 66.03% 59.22% 60.93% 54.28% 53.57% CENTRAL BANK 5.18% 19.16% 17.52% 9.82% 10.80% CURRENCY BOARD 26.18% 1.68% - - - COMMERCIAL BANKS 34.67% 38.38% 43.40% 44.46% 42.77% NON-MONETARY INSTITUTIONS 0.28% 4.93% 12.36% 16.02% 15.62% FINANCE COMPANY 0.28% 4.57% 7.60% 10.60% 10.49% MERCHANT BANKS - - 3.01% 3.74% 3.41% DISCOUNT HOUSES - 0.36% 1.74% 1.68% 1.72% CREDIT GUARANTEE CORP, rION - - 0.01% - - NON-BANK FINANCIAL INTERMEDIARIES 33.69% 35.85% 26.71% 29.70% 30.81% PROVIDENT, PENSION AND INSURANCE FUNDS 23.53% 27.16% 18.67% 19.40% 19.89% EMPLOYEES PROVIDENT FUND 17.82% 19.49% 12.79S 14.68% 15.21% OTHER PROVIDENT FUNDS 2.81% 3.89% 2.55% 1.73% 1.74% LIFE INSURANCE FUNDS 2.34% 2.79% 2.23% 2.17% 2.18% GENERAL INSURANCE FUNDS 0.56% 0.99% 1.10% 0.82% 0.76% DEVELOPMENT FINANCE INSTITUTIONS 0.03% 1.14% 2.96% 2.40% 2.32% SAVINGS INSTITUTIONS 7.51% 5.55% 3.32% 4.42% 3.51% OTHER FINANCIAL INTERMEDIARIES 2.62% 2.00% 1.76% 3.48% 4.02% TOTAL 100.00% 100.00% 100.00% 100.00% 100.00% SOURCE: BANK NEGARA MALAYSIA. - 48 - 4.PHrILIPPINES: STRUCTUR O0 WIAEACIAL SYSTSE (CONTINUED) (PERCENTAGE DISTRIBUTION o0 AsSrEs oF TBE FINANCIAL SYSTEM) 1970 1975 1980 1981 1982 1983 1984 1985 1986 JUN.1987 I.CENTRAL BANK 19.4 21.2 20.9 19.9 21.1 23.6 29.7 33.4 43.4 42.9 II.SANKING SYSTEM 60.8 57.0 60.3 62.6 61.9 59.8 56.5 52.4 41.0 41.1 COMMERCIAL BANKS 45.6 43.4 44.2 45.6 44.9 43.4 41.7 37.3 33.4 33.7 PRIVATE 26.8 28.6 27.2 28.7 26.6 24.2 23.2 22.3 22.1 23.4 GOVERNMENT 14.9 14.8 11.0 11.2 12.2 11.8 11.6 9.3 4.8 4.0 FOREIGN 3.9 - 6.0 5.7 6.1 7.4 6.9 5.9 6.5 6.3 THRIFT BANKS 2.9 1.7 3.4 3.2 2.9 2.9 2.2 2.0 2.4 2.4 SAVINGS 2.3 1.1 2.4 1.9 1.4 1.3 1.1 0.9 1.1 1.2 PRIVATZ DmELOP?U 0.6 0.3 0.5 0.7 0.8 0.8 0.7 0.7 0.8 0.7 STOCK SAVINGS & LOAN ASSOCIATION - 0.3 0.5 0.6 0.7 0.8 0.4 0.4 0.5 0.5 RURAL LAMlS 2.3 2.3 1.8 1.8 1.9 1.7 1.3 1.2 1.3 1.3 SPECIALIZED GOVERNKENT BANKS 10.0 9.6 10.9 12.0 12.2 11.8 11.3 11.7 3.9 3.7 III.NONBANK FINANCIAL INTERMDIARIES 19.8 21.8 18.8 17.5 17.0 16.6 13.8 14.2 15.6 16.0 INSURANCE COMPANIE 19.1 9.7 9.4 9.2 9.3 8.1 7.2 8.1 9.8 10.1 GOVERNMENT /a 12.9 6.3 6.2 6.1 6.2 5.6 5.2 5.7 7.0 7.4 PRIVATE 6.2 3.4 3.2 3.1 3.1 2.3 2.0 2.4 2.8 2.7 INVESTMENT INSTITU - 8.4 8.2 6.5 5.9 4.5 2.9 3.1 3.2 3.2 FINANCING COMPANI - 2.9 3.8 3.4 3.0 2.1 1.4 0.8 0.8 0.8 INVESTMENT COMPAN - 1.6 1.6 1.5 1.3 1.1 0.4 1.4 1.4 1.3 INVESTMENT HOUSES - 3.9 2.8 1.6 1.6 1.3 1.1 0.9 1.0 1.1 TRUST OPERATIONS - 2.1 0.5 0.2 0.2 0.3 0.1 0.2 0.2 0.2 OTHER FINANCIAL INTERMZDIARIES 0.7 1.6 0.7 1.6 1.6 3.7 3.6 2.8 2.4 2.5 TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 la INCLUDES GSIS AND SSS. SOURCE: CENTRAL BANK OF THE PHILIPPINES. 5.SRI LANKA: TOTAL ASSETS OF FINANCIAL SYSTEM, 1977-1985 (CONCLUDED) (AS % OF TOTAL ASSETS) ~~~~-==----- -=z========…=S3=========S========-== 1977 1978 1979 1980 1981 1982 1983 1984 1985 CENTRAL BANK 44.9 44.3 42.0 40.5 39.2 35.8 32.9 29.3 33.1 COMMERCIAL BANKS 33.5 34.9 37.1 37.4 38.0 38.3 40.2 40.5 42.1 FCBUs, NET OF FOREIGN LIBILITIES - - - 1.3 1.9 2.5 2.3 3.2 3.4 NATIONAL SAVINGS BANK 9.1 8.9 9.2 7.8 7.1 8.3 8.7 9.2 9.8 FINANCE COMPANIES - - - 0.9 1.0 1.6 1.8 2.6 - NATIONAL DEVELOPMENT BANK - - - 1.1 1.1 1.2 1.2 1.2 - STATE MORTGAGE AND INVESTMENT BANK - - - 0.2 0.3 0.3 0.3 0.5 - DFCC - - - 0.4 0.5 0.5 0.6 0.6 0.6 s EMPLOYEES' PENSION FUND 8.6 8.4 8.2 7.4 7.4 7.7 7.9 8.7 10.1 EMPLOYEES' TRUST FUND - - - - 0.1 0.3 0.5 0.8 1.0 INSURANCE COMPANIES 3.9 3.5 3.4 3.0 2.9 2.8 2.9 2.6 - LEASING COMPANIES - - _ _ 0.4 0.5 0.6 0.8 - …---------------------------------------------------------------------_____--__---------------------. TOTAL ASSETS (GROSS) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 FCBU: FOREIGN CURRENCY BANKING UNITS DFCC: DEVELOPMENT FINANCE COMPANY OF CEYLON 50 the Central Bank's own securities and on government securities, fixed de facto by the Central Bank. Further, the Nation,al Savings Bank (NSB) fixed its deposit rates under the guidance of the authorities, as did also the other state-owned commercial banks. In practice, the treasury bill rate represented the lower end of the range of what the authorities considered to be the desirable level of intereist rates, and the rate paid by the NSB on its deposits was its upper erLd. 4.34 Detailed information on lending rates is not available, but it is believed that the weighted average cost of credit of commercial banks was 12-14% in nominal terms and barely reached a positive level. This was because the state banks, with a large share in credit, and also the development finance institutions (DFIs), often lent under the influence of the Government to the most risky and least profitable borrowers at low interest rates determined by political criteria, thereby perpetuating distortions in the lending rate structure. However, the extent of this factor was limited since such credit constituted only 5% of total domestic bank credit. Though the interbank market has emerged and has operated actively (reflecting market conditions to some extent), the rates prevailing in that market rarely have gone beyond the range which the authorities preferred. There was very little information on the term structure of interest rates in Sri Lanka, but in general the rates on deposits varied according to the maturity of deposits--3 months to 24 months--and according to their size. 4.35 The abolition of ceilings on interest rates seems to have slightly narrowed the differential in interest rates charged by different commercial banks and nonbank financial intermediaries. The evidence, though not strong, throws some light on these aspects. At the end of 1985, the rate on 12-month NSB deposits was 15% net of tax as against 12-13% on similar deposits of commercial banks; the deposit rates paid by finance companies were believed to be even higher than NSB rates on corresponding deposits. As a result, the market share of finance companies and NSB in total financial savings increased substantially. Lending rates ranged from 15% per year for prime customers to 30%, the rate finance companies charged their customers. (b) Growth of the Financial Sector Korea 4.36 The growth of the financial sector in Korea since 1981 was very rapid, stimulated as it was by the expanding proportion of private savings going into holdings of f'inancial assets with high and stable real rates of return (D. Kim, 1987). However, this growth was confined predominantly to NBFIs. As a consequence, the relative importance of banks declined, with their share in total financial assets going down from two thirds during the 1970s to one half toward the end of 1986 (Appendix Table Korea 9). In recent years, the informal market also seemed to decline in relative importance, although this cannot be quantified with precision. There was a moderate increase in M2 and a near doubling of M3 as a ratio to GNP since 1981, a remarkable performance by any standard (Appendix Table Korea 8 and Chart K5). M3 included certificates of deposit and bank debentures as well as deposits with all NBFIs; therefore the difference betwean M2 and M3 is not a precise measure of nonbank liabilities although it roughly approximates the size of TABLE 14: DOMESTIC tE)IThIC P FOR FIVE COUNTRIES AVE 74-77 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 INDONESIA 19.91 16.51 20.51 19.51 23.3Z 20.41 15.81 12.41 10.21 13.91 15.71 14.41 16.01 - KOREA 39.31 42.21 41.71 57.21 36.01 38.71 40.91 48.21 51.41 57.21 57.01 57.31 61.51 61.2Z MALAYSIA 31.91 28.51 34.21 31.91 32.81 34.91 31.41 43.51 54.31 61.51 65.41 68.11 74.41 87.51 PHILIPINES 30.71 26.21 30.01 32.51 34.11 36.71 37.3X 38.71 41.81 46.61 53.61 40.71 33.61 27.01 SRI LANKA 28.41 25.31 24.71 29.71 33.71 33.81 35.51 54.21 53.21 53.11 50.81 40.11 40.01 4O.O0 SO---------------------------------:---- _T ---_______ STATISTICS____--________________________,________________________________________________ S I T I llSOT^:ITURTO"VIACA TATSTICS.IM. 52 NBFI deposits. These accounted for much of the growth of the M3 to GNP ratio and again confirmed the important role of NBFIs in the growth of the regulated financial system. Within the NBFIs, investment and finance companies were the most important, followed by life insurance and investment trust companies. The investment and finance companies dealt in short-term commercial paper, whereas the insurance and investment trust companies employed longer term funds in corporate bonds or in providing direct loans to business. 4.37 The markets for corporate bonds and commercial paper also grew rapidly in the 1980s. The growth of these markets was facilitated by several factors. First, the corporate bond and commercial paper markets were not subjected to government price regulation. Interest rates on these financial assets were determined relatively freely, depending on the market situation, and were higher than the deposit rates of banks. Second, the tight control of domestic credit of the banking sector forced firms to take recourse to either the direct credit market or NBFIs. Third, guarantees of corporate bonds by banks reduced the risk and facilitated the growth of these assets. The institutionalization of bond transactions on repurchase agreements in 1980 also encouraged the rapid growth of a secondary market. Compared to bond issues, new stock issues were sluggish du,ring 1980-1985 despite government efforts to boost the market. However, it has boomed since 1986 in the wake of expanding exports and an economic boom. The market volume of listed stock expanded very rapidly during 1986-88. Malaysia 4.38 The growth of the financial sector in Malaysia since interest rate liberalization was quite impressive despite a low national saving rate in the early 1980s. Growth of the M2/GNP ratio from 48.4% in 1978 to 81.6% in 1986 (Appendix Table Malaysia 2 and Chart M4) was the result of an attractive return on bank deposits. The NBFIs, interest rates on whose assets and liabilities had been deregulated since 1973, also grew very rapidly during the 1970s, and their growth accelerated in the 1980s. The ratio of M3/GNP (M3 includes time and savings deposits of NBFIs) more than doubled from 47.5% in 1973 to 82.3% by 1983 (Appendix Table Malaysia 2), attesting to a high degree of financial deepening compared to other countries at a similar stage of development (Appendix Table Malaysia 3). Philippines 4.39 In the Philippines, the financial sector responded well in the first: few years after liberalization. During 1980-1983, M2 grew by about 20% p.a. and M3 by about 19% p.a., whiile the nominal GNP rose by about 13% p.a. As a result, the M2/GNP ratio increased from 21% in 1980 to 25.3% in 1983, and the M3/GNP ratio rose from 25.6a; in 1980 to 29.8% in 1983 (Appendix Table Philippines 3 and Chart P4). In view of a falling gross domestic saving rat:Lo during 1981-83, the increase of financial savings can be considered a good achievement, Since 1984, however, growth of the financial system has been interrupted, and in fact it experienced negative growth in real terms, M2/GNP declined to 20.9%, and M3/GNP fell to 22.3% in 1985. 4.40 The contraction of domestic credit since 1984 was more dramatic. Total domestic credit as a ratio of GNP fell from 45.1% in 1983 to 31.% in 53 1984, 26.4% in 1985 and 14.7% in June of 1987 (Appendix Table Philippines 4); the private sector shared this decline. The consequent contraction of the financial sector in this period can be explained largely by two factors. First, in the context of the adverse overall macroeconomic environment during 1983-1986, the financial sector could not have expanded with a high inflation rate, devaluation of domestic currency, the failure of many financial institutions including banks and nonbanks, and the fall in domestic saving rate. Second, the aggressively contractionary monetary policy designed to contain inflation during this period was a drag on the financial sector, especially the banking sector. Sales of CB bills and treasury bills (T-bills) at very high interest rates to mop up liquidity led to pretermination of bank deposits, since the rate on bank deposits could not catch up with the T-bill rate, even after a time lag, without jeopardizing the profitability of banks, Financial institutions lost resources. However, if T-bills and CB bills are added to M3, the overall ratio of financial assets to GNP, i.e., M4/GNP, has remained relatively stable since 1983 (P. Honohan, 1988; and Appendix Table Philippines 3). Indonesia 4.41 In Indonesia, financial reform had a substantial impact on financial sector growth from the outset. Gross assets of the organized financial sector have almost tripled since 1982--a growth rate of nearly 23% p.a. in nominal terms. The M2/GNP ratio shot up from 21.5% in 1983 to 29.4% in 1986 (Appendix Table Indonesia 4, 6-a, 6-6 and Chart I-4). In addition, the range of noncredit financial services widened with the establishment of several new insurance and leasing companies. These increased, respectively, from 83 and 34 in 1982 to 100 and 83 in 1987. Apart from this, new financial instruments such as SBIs and SBPUs emerged and led to diversification of the menu of financial assets. Furthermore, they helped erase regulation-induced segmentation in the loan markets. Sri Lanka 4.42 In Sri Lanka, liberalization policies did not seem to influence the financial system in the desired direction. The M2/GNP ratio increased in 1986 by only 2 percentage points, from 28.2% in 1977 to 29.3% in 1986. The same held true of the M3/GNP ratio, which included insurance funds (Appendix Table 4 Sri Lanka and Chart 3). Segmentation in Sri Lanka's credit market was one characteristic of the prereform period which persisted despite liberalization. (c) Competition and Profitability of the Financial Institutions Korea 4.43 The Korean financial system appeared to become more competitive in the 1980s, especially when commercial banks (after privatization) and NBFIs directly competed for new financial instruments. In addition, foreign banks whose branches had expanded could compete with domestic banks more freely than in the past. The profitability of commercial banks, which was always low and was sustained by payment of interest by the Central Bank on the required reserves or through other subsidies was substantially reduced in the 1980s (Appendix Table Korea 10), though this decline in profitability could be 54 attributed more to the increase of nonperforming loans than to competition per se. Intermediation cost as represented by the spread between average deposit and lending rates may have narrowed on balance, though no definitive conclusion can be drawn for want of necessary data. Two factors can be adduced as influencing the interest rate margin. One is a significant reduction in reserve requirements (Appendix Table Korea 7) together with the narrowing of the gap between rates on general loans and those on preferential credits; the other is the accumulation of nonperforming loans. The cost reduction due to the first factor might have been larger than the cost increase accounted for by the second, since the cost due to nonperforming loans was subsidized through the Central Bank's special rediscount facility. Malaysia 4.44 The degree of competition among banks and between banks and NBFIs in Malaysia was strengthened by the deregulation of interest rates. Concentration among banks was gradually diluted since 1978 (Appendix Table Malaysia 6). However, as mentioned earlier, one of the reasons for the declining share of large banks in deposits during 1978-1981 was the control of the prime rate. Large banks, which lent more to prime borrowers, could not increase interest rate on deposits as much as smaller banks could. The consequent diffusion of c:oncentration implied a greater degree of competition in the banking sector, which received an additional fillip from the branch expansion of commercial banks (Appendix Table Malaysia 10). Accordingly, the profit rate of the banking sector represented by the ratio of gross profits to total assets declined from 2.66% in 1978 to 2.03% in 1982 (Appendix Table Malaysia 6). The ratio was high even by the standard of advanced countries like the US, France and Germany (F. Pussac-Contando, 1984). 4.45 The interest rate spread widened slightly instead of narrowing after interest rate deregulation in both the banking system and the finance companies. The interest rate margin in interest income minus interest payments (as a proportion of total bank assets) was 2.19%. This figure may not necessarily be a good indicator of the degree of competition and efficiency, but even after widening it compared favorably with corresponding ratios in the US (Appendix Table Malaysia 9). The statutory reserve requirement ratio was quite low and, although the liquidity requirement ratio was close to 20%, it did not entail high costs to banks since these could be held in the form of interest-bearing securities. Despite intense competition, the interest rate margin increased after liberalization because of two factors. One was the branch expansion of banks and finance companies, which raised their overhead cost, and the other was extension of selective credit programs. The first of these would be weakened as the branches became profitable, but the perpetuation of selective credit programs might widen the gap between deposit and lending rates. PhiliRpines 4.46 One of the major purposes of the 1980 financial reform was to encourage competition through the introduction of universal banking both within the banking system and between banks and nonbanks. However, it is difficult to assess the precise impact of the reform on competition, inasmuch as recent economic and financial crises have caused financial institutions to 55 be concerned more with survival than competition. However, in the context of reduced concentration in the banking system, as discussed below, it is reasonable to surmised that financial reform afforded greater scope for competition in the banking system. 4.47 The average size of the commercial banks in the Philippines is much smaller than that in other Asian countries; the largest, PNB, was ranked 82nd in a recent survey of the 200 largest banks in Asia (FSS, 1988). The number of banks in the Philippines was very large compared to other Asian countries, and the authorities restricted new entry in 1974. Concentration was therefore not a serious problem. As of June 1987, the 3-bank concentration ratio of total assets was 31.4%, and the 5-bank ratio was only 47%, down from 41.1% and 50.0%, respectively, in 1979 (Appendix Table Philippines 8). The reciprocal of the Herfindahl Index, which purports to show the number of equal-sized banks, rose to 10.0 in 1986 compared to 8.8 in 1979, implying that concentration has decreased somewhat. However, it seems that the banks were interrelated as they were held by a few families. Perhaps the advent of universal banking in 1980 might have paved the way for more competition. 4.48 Profitability measured by the ratio of profits before tax to total assets was lower after financial liberalization (Appendix Table Philippines 10). Similar trends were observed in profits after tax. The higher deposit rates and the low return on loans carried over from the period of repressed interest rates together caused a severe squeeze of bank profits (Remolena and Lamberte, 1986). 4.49 The cost of intermediation, measured by the difference between the average cost of funds and the average interest rate on loans and investments other than reserve requirements, increased after liberalization. The factors that influenced intermediation cost were (a) the government tax, (b) high reserve requirements and the directed credit programs, and (c) bank profit margins (Appendix Table Philippines 7). The government tax applied to all gross receipts including interest and capital gains of banks, and the withholding tax applied to all deposit interest income except that on overnight interbank deposits. The reserve requirement was 21%, and it was often raised during economic turbulence. The increase in the intermediation cost since 1983 seems due more to tax and reserve requirements than to a lack of competition or low efficiency. Indonesia 4.50 Financial reform in Indonesia emphasized interest rate deregulation and boosted competition in financial markets. Segmentation of loan markets was considerably lessened when private and foreign banks were permitted to engage in business forbidden them before reform. After reform, the private banks could extend term loans up to a limit of one billion rupiah per loan, while foreign banks could provide export credits to businesses outside Jakarta. Likewise, national banks could extend low-interest export credits to foreign companies and joint ventures. Also the establishment of a market for new instruments such as SBPUs (referred to earlier) helped integrate various loan markets. As a result, banks made a greater effort to improve organizational efficiency and choose clients on the basis of creditworthiness. Yet there remained great segmentation in Indonesia's loan market. The large 56 regulatory apparatus allowed some banks to undertake business in particular areas but denied the same privileges to others. Banks with substantial access to liquidity credits, which are essentially a discriminatory device, could offer lower loan rates on nonpriority credit than other banks by passing on part of the subsidy they received. This apart, the state banks, by virtue of their ownership structure, enjoyed a specLal relationship with public enterprises and government agencies and had a competitive edge over the rival private banks. 4.51 The profitability of banks declined after the reform, and all the groups of banks--state banks, private national and foreign banks except the development banks--were affected. Current profit as a ratio of total assets for all banks declined from 2.7% in 1982 to 1.8% in 1985 mainly as a result of a sharp decline in operational income and a rise in nonoperational cost. The interest rate margin declined, reflecting a narrowing of spread on performing loans which was induced by growing competition, as well as losses resulting from nonperforming loans (Appendix Table Indonesia). Sri Lanka 4.52 In Sri Lanka, after financial liberalization there was freer entry of new foreign banks, foreign currency banking units (FCBUs), and a variety of new domestic financial institutions. In consequence, there was a more congenial atmosphere for competition, but Sri Lanka's financial markets remained state-dominated and highly concentrated. State-controlled institutions claimed almost 80-85% of total assets of the financial system. The stifling influence of the state-owned banks on competition was exemplified by operations of the NSB, whose privileged position tended to distort the financial markets. It could attract deposits at whatever interest rates it thought fit despite the fact that its operating costs often exceeded the yield on its assets; the negative differential was covered by a government subsidy., 4.53 The persistence of several market imperfections caused the lending rates to remain relatively high and thus to maintain, if not increase, a large spread between average deposit and lending rates. High operating costs as a proportion of total assets were the result of high government taxes and reserve requirements, approximately 1.5%. The interest rate margin as a proportion of total assets declined from 3.3% in 1980-81 to 3.0 in 1984, but operating costs rose in the same period from 3.5% to 3.7%; profit before tax, on the other hand, was almost halved from 2.7% to 1.4%. However, the decrease was due more to the fall in income from foreign exchange business and commissions (Appendix Table Sri Lanka 2) than to keener competition. The evidence thus is not unambiguous as in other Asian countries where a reduced spread could be attributed to liberalization. (d) Availability of Term Credit Korea 4.54 With the development of corporate bonds, stocks and a venture capital market in Korea, the availability of long-term and risk capital seemed to improved greatly. Appendix Table Korea 11 shows the sources of funds of corporate business in Korea. The distinctive change between the 1970s and the 57 1980s was that the share of bank credit and foreign loans went down significantly with the corresponding rise in share of loans from NBFIs and direct financing in the form of corporate bonds and stocks. It is not possible, however, to know how much term credit flowed from the banking system because data on average maturity of bank deposits and loans are not available. Malaysia 4.55 Since liberalization in Malaysia, there was a shift away from demand and savings deposits toward fixed-term deposits, as evident from the rise in their share in total deposits from 22.2% in 1978 to 55.1% in 1986 (Appendix Table Malaysia 11). Even among fixed deposits, those with a maturity of more than 12 months increased substantially in the aftermath of liberalization. However, during 1981-1982 the share of longer-term deposits declined, probably because of high inflation and uncertainty about the real rates of interest, but since 1982 the share of longer-term deposits has begun to increase. The share of long-term loans by banks also increased gradually. The share of loans of maturity of 4 years and more increased from 24.7% in 1978 to 31.5% in 1983 (Appendix Table Malaysia 12). Thus the amount of long-term credit from the commercial banks after liberalization became ample. However, the overall availability of long-term, industrial credit did not improve after liberalization. The poor functioning of the corporate securities market (which may have been crowded out by the dominance of government securities issues) and stagnant stock market in recent years placed the burden of provid- ing industrial credit mainly on the banks. Pension funds, insurance funds, etc., were harnessed as captive sources of funds to the Government. The sectoral allocation of bank credit reveals that less bank credit was allocated to the manufacturing sector, even though it requires more long-term capital than other sectors (Appendix Table Malaysia 13). Philippines 4.56 Since one of the major goals of the 1980 reform in the Philippines was to augment longer-term lending by banks, the level of reserve requirements against deposits of more than two years' maturity was lowered to reduce liquidity risk. Also, liberalization of the bank loan rate seemed to reduce interest rate risk and extend the average maturity of loans. As a result, the share of short-term loans in total bank credit declined but was made up by the corresponding increase in the share of longer-term loans in total bank credit. However, this trend seemed to reverse after 1985, presumably'due to economic and political disturbances which affected not only the banks willingness to lend long-term, but also the demand for such credit (P. Honohan, 1988). This implies that if the economy remains unstable (for whatever reason), no amount of financial liberalization alone is likely to motivate banks to lengthen the average maturity of their loans. In the adverse macroeconomic environment after 1985, several nonbank financial intermediaries failed. This was also the reason why the principal universal banks, which were supposed to be actively channeling funds into riskier ventures, shied away from such risks. Indonesia 4.57 In Indonesia, financial reforms did not alleviate the shortage of term credit or improve the bond and equity market. Long-term bank loans of 58 maturity of, say, over 12 months as a proportion of total bank credit in local currency fell from 41.2% i.n 1983 to 39.8% in 1987, though these statistics should be interpreted circumspectly in view of their shortcomings. The reluctance of banks to countenance term credit covering the entire period of investment was principally attributed to the volatility of interest rates, a direct result of financia:L reform (as discussed earlier), and the mismatch of maturities between liabilities, with the bulk of them very short-term investment financing. The maturity of term loans was on average 10 years, as against the maximum maturity of deposits of 24 months. This mismatch posed an even more serious problem when the share of longer-term deposits in total deposits decreased. Thus the proportion of 18-24 month deposits slipped from 68.9% in 1982 to 7.7% in 1986; on the other hand, deposits with maturity between 6 and 12 months increased from 27% to 67% (Appendix Table Indonesia 7). The shift to shorter maturity observed in all categories of banks was due to the fact that interest rates, though high in real terms, were volatile because of expectations of devaluation. 4.58 Though the impact of interest-rate volatility on the flow of term credit from the banking system was severe, it was mitigated to some extent by the term loan contracts with adjustable rates which constituted a bulk of nonpriority term loans. Other essentially structural factors accounting for the aversion of banks to undertaking term lending were the poor credit appraisal capabilities of banks and their faulty collateral practices. 4.59 The equity market was slow to develop in Indonesia, largely because of the unfavorable tax treatment of equities vis-a-vis alternative financial instruments such as bank deposits, low disclosure standards, and the poor quality of auditing and accounting. Recently there has been renewed interest in reviving the moribund capital market. The authorities initiated a package of measures directed toward mobilizing savings for purchase of divested financial assets, newly issued securities of enterprises, new avenues for public participation in high-return equities of profitable businesses, and restructuring of ownership of industrial enterprises to reduce their dependence on short-term funds. It may be quite some time before the new plan for securities development takes concrete shape. Sri Lanka 4.60 At the end of 1985, term credit with maturity of over one year constituted approximately 30% of total bank credit, and credit with maturity of over 5 years formed about 10%. The flow of such credit has increased since the financial reform. In addition to banks, other institution such as development banks participate in term credit. It is estimated that around 30% of all institutional credit to the private sector was medium- and long-term. If term credit is constrained, it is from the demand side, since bankable projects have not been forthcoming because of political uncertainty. 4.61 The equity market in Sri Lanka opened during the 1960s has gained strength in the aftermath of financial liberalization. At present there are about 170 companies listed on the stock exchange, of which almost one third were traded at least once a week. The development of an equity market was 59 stymied by the high interest rate (as in some other Asian countries), a lack of attractive stock offerings, political uncertainties and, most important, the absence of a well-designed legal framework. On the supply side, a large proportion of stock was in the hands of closely held companies, and the tendency of these to divert profits from shareholders made it difficult for a secondary market to emerge. (e) The Integration of Domestic Interest Rates with Foreign Interest Rates Korea 4.62 The exchange rate of Korean currency with respect to the US dollar was fixed during 1974-1979. With a substantially higher domestic inflation rate than the rest of the world during this period, Korea's exchange rate appreciated significantly. Domestic bank interest rates, although high in nominal but not in real terms, were also higher than those prevailing abroad and were sustained at that level because of stringent foreign exchange controls and the expectation of exchange rate depreciation. Since 1980, however, despite continued control on capital flows, the gap between domestic and foreign interest rates was reduced. The effective cost of foreign currency loans was higher during 1980-1985 than in the 1970s (Appendix Table Korea 12). This trend has been reversed since 1986, however, as the won appreciated against the US dollar with the emergence of a current account surplus. On the whole, the level of domestic interest rates was not sensitive to foreign interest rates to the extent expected because of the insulation of the domestic financial markets from the international markets. On the other hand, it could be argued that capital controls were instrumental in preventing capital flight from Korea in the early 1980s when the public's confidence in the Government's ability to manage the economy was very low, the political situation was volatile, and there was widespread distrust of the domestic banking system spawned by scandals and financial vulnerability. With free capital movement, Korea might have lost control over the deposit base of domestic financial intermediaries, as happened in other countries like the Philippines, Indonesia and the Southern Cone countries in Latin America. Malaysia 4.63 Malaysia's foreign exchange system was virtually free of restrictions, and short-term capital movements were quite responsive to interest rate differentials between Malaysia and overseas, particularly Singapore and the US. However, the level of domestic deposit rates was not as sensitive to international interest rates as had been expected, perhaps because participants in the foreign exchange market were mainly commercial banks (general depositors did not have easy access to this market). Interest rates in the interbank market were an exception to this pattern. The level of domestic deposit rates has remained well below the Eurodollar rate adjusted for exchange rate changes during the last 15 years (Appendix Table Malaysia 8). PhiliRRines 4.64 Financial liberalization did not seem to contribute much to the integration of domestic and foreign interest rates in the Philippines. During 60 the 1970s, when the nominal exchange rate was stable, the cost of domestic loans was consistently higher than that of foreign loans (Appendix Table Philippines 12). This was completely reversed in the 1980s when the cost of foreign loans remained much higher and the gap in fact widened, due mainly to the volatile movement of the exchange rate, residual controls on foreign exchange and uncertainty about inflation. The Philippine experience was by no means unique, as even in the most efficient financial markets of industrial countries such as those in Japan and the US, interest rate parity has not held when exchange rates have been most volatile. However, domestic interest rates were not immune from changes in the exchange rates. Indonesia 4.65 The gap between domestic interest rates and foreign interest rates, when adjusted for actual depreciation of the exchange rate, was narrow in Indonesia even before financial liberalization because of lack of restrictions on capital flows. Before the large devaluations of rupiah, it was generally cheaper to borrow in the foreign markets (Appendix Table Indonesia 11). Since 1983, however, the effective cost of borrowing abroad increased sharply as a result of a series of devaluations. Interest rate parity generally held but was weakened when expectations did not always correspond to actual changes in the exchange rate. Other factors influenced domestic interest rates even under conditions of complete capital mobility, as evidenced by experiences in many industrialized countries. A lag in the downward movement in real interest rates was induced by expectations about exchange rate depreciation, which in turn could heighten inflationary expectations. In part, these expectations were fueled by the large swap premium offered by Bank Indonesia in providing forward exchange cover for approved private-sector foreign-debt obligations (V. Sundararajan and L. Molho, 1988). Sri Lanka 4.66 In Sri Lanka, domestic deposit rates moved with foreign interest rates adjusted for actual changes in the nominal exchange rates. The gap between the two rates has been narrow since 1977, except for 1985-86 when foreign borrowing was more expensive than domestic. (f) Ouality of Banks' Portfolios: Nonperforming Loans Korea 4.67 Following financial reform, Korea's banking system suffered from heavy nonperforming loans in the 1980s. Although the precise total is not known, their impact was sufficient to threaten the solvency of the main banks. The Government could not further liberaLize the banking system (despite its avowed objective) and in fact supported the banks financially. The large nonperforming loans of Korean banks were not mainly a result of financial liberalization; they were in some measure the legacy of excessive government intervention in credit allocation in the 1970s combined with the effects of external shocks which hit the industrial sector. The problem of nonperforming loans was eased by the Central Bank's low-cost funds to support the commercial banks' outstanding nonperforming loans, a tax exemption to facilitate write- offs and restructuring of corporate firms, and above all a strong economic recovery. 61 Malaysia 4.68 Heightened interest rate competition among banks in Malaysia following liberalization did not per se significantly affect the quality of their loan portfolios. But the combined effects of liberalized lending rates, which in real terms rose substantially, and economic downturns since 1984 have been adverse to the commercial banks' portfolios, as reflected in the sharp increase in provisions for bad and doubtful loans since 1984 (Appendix Table Malaysia 15). High real lending rates placed heavy pressure on corporate profitability and performance when the economy faced a downturn during 1984-86 and led to increased arrearage. However, in Malaysia, the size of nonperform- ing loans was not large enough to trigger as serious a financial crisis as in the Philippines and elsewhere. There are several reasons for this. First, nominal interest rates were not high, although real interest rates were substantially high owing to stable inflation. Second, the corporate sector's financial structure was less vulnerable to changes in interest rate levels because of its low debt/equity ratio. Third, government intervention in banks' portfolios prior to reform was not pervasive and, except for guided lending programs, loans were generally based on the decisions of very conservative bank managers. Therefore, unlike banks in Korea, the Philippines and Indonesia, Malaysia's commercial banks did not have poor portfolios to begin with. Fourth, the Central Bank devised supervisory regulations which were implemented with efficiency and speed. In the early 1980s it undertook a series of reforms to strengthen the basic structure of the banking system, institute better controls and ensure regular monitoring (A. Sheng, 1987). Philippines 4.69 In contrast, in the Philippines a majority of private sector companies of all sizes experienced actual or potential financial difficulties. Nearly half of all private development banks had arrearage rates of 20% or more on their loan portfolios. In the case of government-owned banks, the problem was even worse. In 1986, the Philippine National Bank (PNB), the largest commercial bank, and the Development Bank of Philippines (DBP), became de facto insolvent and were bailed out by transfer of nonperforming assets amounting to 80% and 90%, respectively, of total assets, to the government established Asset Privatization Trust (APT). Loan portfolios of private commercial banks was seriously affected, although their position was relatively better than that of the two government-owned banks. As a result, during 1980-86 the total assets of the banking system contracted by 44% in real terms; loans to the private sector contracted even more sharply, by 63%. Between 1980 and mid-1987, 3 commercial banks, 147 rural banks and 32 thrift institutions failed completely. Total assets involved were P 14 billion. Indonesia 4.70 Indonesia's financial system also faced a serious problem of non- performing loans. Though no precise figures are available, it is widely believed that the banks had heavy arrearages which made them financially vulnerable. This was particularly true of state-owned banks, whose loan 62 exposure was so large that they could not have recovered their principal and interest through asset trans:Eer or sales in the event of foreclosure of borrowing firms. Besides, cumbersome legal procedures to recover loans removed liquidation as a viable option. Under such circumstances, banks with heavy and mounting arrears tended to compensate themselves by increasing loan rates as much as two percentage points. Apart from the inherent inefficiency of industrial firms fostered by a long history of protection and subsidy, the main cause of nonperforming loans was the impact of the exceedingly high interest rates. It was paradoxical that creditor institutions tried to salvage their position through further increases in the interest rates, thereby accelerating the growth of nonperforming loans. Sri Lanka 4.71 Sri Lanka too was afflicted by large nonperforming loans, though precise figures are not available. The government corporations were among the defaulters on loan repayment to banks. The Government understood the gravity of the situation and set up a committee to devise appropriate legal and administrative procedures to expedite loan recovery by banks and also to impel banks to augment their provision for bad and doubtful debts, something they had become lax in doing in view of the nonexemption of such provisions for tax purposes. The Central Bank, too, was seized of the need to strengthen its supervisory machinery so that bank balance sheets would reflect their true financial worth. (g) Corporate Sector's Financial Structure Korea 4.72 With low-interest-rate policies and government control of the banking system (which reduced the cost of debt and the risk of investment), the corporate sector, especially large government-favored firms, became highly leveraged (Y. Cho, 1986). The debt/equLty ratio peaked at more than 400% in 1980 (Appendix Table Korea 2). As a result, Korean firms became very vulnerable to changes in interest rates. With increasing real interest rates and receding government commitment as a risk partner following privatization of banks and gradual phasing out of government intervention in the credit allocation, the debt/equity ratio of Korean firms declined slightly in the 1980s. Malaysia 4.73 The corporate sector in Malaysia was much less susceptible to changes in the level of interest rates than that in Korea, the Philippines and Indonesia. The debt/equity ratio of Malaysian firms was relatively low, a little higher than 100%, while the ratios for Korea and Philippines were in the range of 300-400%. This ratio had increased during 1972-1978 but decreased after liberalization, reflecting the higher cost of bank debt (Appendix Table Malaysia 14). 63 The PhilipRines 4.74 The Philippine corporate sector was highly leveraged to begin with, and the extent of leverage even increased recently due to distress borrowing at high interest rates. The ratio of total liabilities to total assets for the top 1,000 corporations rose from 78% in 1979 to 84% in 1985, equivalent in terms of debt/equity ratio to 315% in 1979 and 442% in 1986 (Appendix Philippines Chart P2). The highly leveraged financial structure of the corporate sector was the principal reason for the financial crisis after financial reform. Indonesia and Sri Lanka 4.75 Data on financial corporation structure in Indonesia and Sri Lanka are scarce. The debt/equity ratio of firms in Indonesia was estimated to be around 900%, much higher than in Korea, the Philippines and Malaysia. Often, what passed as equity was in fact a debt. It might be inferred that the corporate sector was hurt considerably by both high interest rates and frequent significant rupiah devaluations, but in the absence of necessary statistics no firm conclusions can be drawn. Intercountrv Experience: Divergence and Similarity 4.76 After observing the impact of financial liberalization on financial systems, it might be useful to know, in an overall sense, why the consequences of financial reform across these five countries lacked uniformity and whether their divergence might be related to differences in the approach and modality of the reforms undertaken in each of the countries. Of all the five countries, Korea and Malaysia both exhibit the beneficial impact of financial liberalization, but for different reasons. The main emphasis in Korea's financial reform policies was on gradualness in the speed of reform. Government intervention was made purposive and market-oriented. Furthermore, the thrust of the reform policies was directed toward the nonbanking sector, which was relatively late to arrive in Korea and was much less regulated to begin with. In contrast, liberalization of the banking sector was much slower. In addition, care was taken to continue the controls on the capital account, which rendered interest rate arbitrage relatively difficult. Consequently, domestic influence on interest rate determination remained much stronger than foreign influences. Progress in orienting the financial sector to competitive conditions without abandoning government intervention was made concurrent with positive macroeconomic developments such as the favorable turn in the terms of trade, stable inflation, a declining deficit in the current account of the balance of payments, and a lower fiscal deficit. The inter- action between macro and micro aspects of economic policy strengthened to both. One feature of Korea's financial reform experiment which contrasts with those in other countries was what the Korean authorities accomplished in regard to the banking system's nonperforming loans. It became apparent in the early part of the 1980s that the already large size of nonperforming loans was expanding and threatened the survival of the banking system. The authorities did not force the pace of reform but in fact retracted it by (a) providing low-cost funds through prompt downward adjustment in banks' nominal interest rates as inflation began to decelerate, and (b) taking determined steps toward corporate financial structuring. Thus, the authorities bought time until 64 economic recovery was well on its way. By following this pragmatic approach, Korea succeeded not only in strengthening the macroeconomic environment, which had already benefitted from vigorous adjustment policies in force, but also in avoiding unfavorable fallout from the reform. 4.77 Malaysia, on the other hand, succeeded in its main objective of financial reform, though its approach and its macroeconomic conditions were different. Malaysia's so-called reform, unlike Korea's, was confined to only those banks whose interest rates were freed from prevailing restrictions; there were no controls on interest rates of finance companies (they were liberalized in 1973), the capital account was free, and competition among banks was intense. Governmetnt interventLon was minimal and there was pervasive market determination of interest rates and other financial transactions even prior to interest rate deregulation. In a way, the financial reform in Malaysia was only a continuation (with greater emphasis) of the well-established tradition of restraint in interference with the financial system. Despite umfavorable macroeconomic developments--here too, the contrast with Korea is striking--of adverse terms of trade, large fiscal and external-accounts deficits (the negative effects of which were mitigated by a stable inflation rate), Malaysia maintained the momentum of its financial liberalization without untoward consequences, largely because of a stable inflation rate. Malaysia dLd not escape a rising burden of bad and doubtful debts, a consequence mainly of the severe economic recession which coincided with interest rate deregulation, but they were not as burdensome as in Korea for a variety of reasons, and the banking system could live with them without much difficulty. For one thing, nominal interest rates did not escalate as much as elsewhere, though real interest rates remained high and even inched up slightly due to the stable inflation rate. Second, the financial structure of the corporate sector was less sensitive to interest rate changes because of a low debt/equity ratio compared to that in Korea, the Philippines, and Indonesia. Third, the banking system had a very low level of bad and doubtful debts to start with because of the Central Bank's effective supervision and because the banks had autonomy in determining loan allocation before and after the reform. Malaysia thus could maintain vigorous expansion of its financial sector, deepening and w:Ldening it, with a policy of pronounced market orientation. It was therefore all the more commendable that it accomplished this despite adverse macroeconomic circumstances at the beginning of its financial reform. 4.78 Philippines and Indonesia present quite different situations. The dismantling of interventionist regimes was telescoped and was even more far- reaching in the context of capital mobility. At the start of the liberalization programs, the Philippine and Indonesian financial sectors reacted well to the removal of phasing out of government intervention, as seen in the attainment of positive real interest rates and faster growth in the financial sector. But macroeconomic developments turned sharply adverse for both countries. The Philippines was enfeebled by the second oil shock at the end of the 1970s, political turmoil and a balance of payments crisis. In late 1983, the situation deteriorated further with the freezing of foreign credit, severe import reductions leading to a decline in investment, and a consequent deep recession. Goverrnment intervention became imperative to bail out several banks and take over some private commercial banks. The situation continued until 1985. A similar pattern of events took place in Indonesia. Because the 65 fiscal and balance of payments deficits remained large, persistent expectations of rupiah depreciation kept domestic real interest rates intolerably high. Thus, both in the Philippines and Indonesia, the high level of real interest rates greatly aggravated the vulnerability ef the financial system, particularly due to the highly leveraged corporate financial structure in both countries, and the size of nonperforming loans ballooned. In the Philippines, both private and government-owned banks were severely affected by high and growing arrearages. The authorities were eventually forced to bail them out. 4.79 In Indonesia, the financial crisis was more or less of the same intensity as in the Philippines. First of all, in the wake of general liber- alization, nominal and real interest rates rose sharply. Though inflation remained stable after reform, expectation of currency depreciation raised the expectation of inflationary pressures, which added to the high level of real interest rates. Naturally, business firms groaned under the heavy burden of high interest rates, and the high rates in turn adversely affected the loan portfolios of banks, The profitability of financial institutions was affected in two ways. The magnitude of problem loans reduced the average return on bank assets, and new avenues for lending shriveled. It is estimated that the return on assets of banks ranged from 0.2% to 4.3%, with larger state banks at the lower end of this range. On the other hand, rapid growth of high-interest deposits raised the banks' costs and squeezed profits Second, the state banks bore the major brunt of nonperforming loans. The state banks dominated the financial scene and accounted for about 70% of all loans. By virtue of their ownership, they had preferential access to captive deposits from public entities and liquidity credits from Bank Indonesia. This enabled them to wield excessive power in the loan market without having to put in efforts to mobilize deposits. With such monopoly power, there was no compelling need for banks to discard outdated operational practices or improve the management of their loan portfolios. Even where competition prevailed, as in the other sectors of the financial system, it had a deleterious impact on the banking system's soundness because small and average-sized banking units indulged excessively in deposit-mobilizing activities by offering very high nominal interest rates even though they could not use those funds for profitable loan operations. Third, though there was an attempt to reduce liquidity credits, their proportion in the total outstanding credit of banks remained the same as it was at end-March 1983, i.e., 30% at end-1987 (V. Sudararajan and L. Molho, 1987). Easy access by the state banks to this liquidity-backed credit led to large bad debts. One of the offshoots of financial deregulation was that, with the shortening of the average maturity of bank's time deposits (presumably because of the volatility of interest rates dissuaded depositors from holding long-term deposits), the banks could not continue to extend longer-term credit and starved the economy of investment finance even more than before financial reform. 4.80 Sri Lanka's liberalization regime was comprehensive and embraced all sectors of the economy, though in contrast to the Philippines and Indonesia, deregulation of the financial sector was more limited and gradual. The main reform of the financial sector was the removal of interest rate ceilings and watering down of the selective credit programs. However, the full effects of liberalization were not as beneficial as expected because they were offset by external and internal shocks beyond the control of the authorities. But 66 unlike Korea and Malaysia, and far from easing the impact of the shocks through appropriate adjustments in the macroeconomic policies, Sri Lanka in fact thwarted its liberalization strategy by following a dissonant macroeconomic policy. When government savings were negative, the authorities jacked up the investment rate through infusion of borrowed foreign resources, and this led to appreciation of the real exchange rate. However, the resulting consequences for the financial system were not as severe as in the Philippines or even Indonesia. Nonperforrning loans no doubt increased, but they did not reach the relative dimensions seen in the Philippines and Indonesia, owing to Sri Lanka's strict adherence to prudential regulations. 4.81 What emerges clearly is that there was little doubt about the need of financial liberalization as an antidote to financial repression. Disagreement is more in regard to the timing and sequencing of reforms. Discretionary policy adjustments proved to be superior to the fixed and inflexible rules. D. Summing UR 4.82 The consequences of financial liberalization in all these countries may be broadly summarized in specific areas. Interest Rates 4.83 The expected impact of deregulation on interest rates in all five countries was in the desired direction, i.e., upward adjustment. In Korea, although interest rates were controlled by the Government, they generally moved to a positive level mainly because of a decline in the inflation rate and flexibility in administering that policy. The Korean authorities adopted a pragmatic approach to interest rate deregulation as evident from the fact that the banks' interest raties were adjusted downward even in the face of high inflationary expectations and even though the financial vulnerability of the corporate sector could have had an adverse impact on the banks. On the other hand, dismantling of preferential interest rates and a partial liberalization of interest rates in the nonbanking sector have facilitated the integration of formal and informal markets. The impact of liberalization on domestic interest rates in Malaysia was modest at the beginning, if only because before liberalization market forces had strong influence on them and the gap to be made up was limited. By late 1981, after the new interest rate mechanism based on the BLR was introduced, bank deposit rates became more sensitive to international interest rates. The integration of various interest rates applied more to the deposit rates because deposits with finance companies were perceived to be close substitutes for bank deposits. However, the segmentation of interest rates between those on bank assets and liabilities on the one hand and government securities on the other remained immune from the impact of liberalization. The term structure of interest rates changed significantly, particularly due to a stable inflation rate. In Philippines. though the nominal interest rates on bank deposits and loans increased slightly at first, real interest rates became positive with declining inflation. But the upward movement of interest rates later received a powerful impetus because of a severe monetary contraction to mop up liquidityr through issue of high-yield Central Bank bills with which the banks had to compete. During the period 1984-86, the market-determined interest rates were very high, higher than the real return on investment. The domestic interest 67 rates were largely well integrated. In Indonesia, the main impact of liberalization was on the interest rates on assets and liabilities of the state banks, since the other banks' rates were freely determined even before liberalization. The real interest rates became positive and substantially higher than even the marginal rate of return on investment. The domestic interest rates were well integrated. Sri Lanka followed other countries in regard to deposit interest rates: they became highly positive (except in two years) after liberalization. Though government intervention continued, market forces were given greater scope to influence the level of interest rates. The treasury bill rate was used as an indicator of the authorities' intention as to how other interest rates in the market should move. This ensured that interest rates would change in the desired direction in response to a change in the inflation rate. Financial Sector Growth 4.84 The beneficial consequences of financial reform were seen in the faster growth of the financial sector. In Korea, the ratio of M3 to GNP rose sharply after 1981 and faster than the M2/GNP ratio, implying that nonbank expansion of the financial sector was greater than bank expansion. Also, the markets for corporate bonds and commercial paper recorded rapid growth, facilitated by the absence of government nonintervention in that sphere and by the unavailability of bank finance due to tightened credit control. There was clear evidence that a growing portion of private savings was held in financial assets in view of the very attractive return on them. In Malaysia. the ratio of M3/GNP, which includes time and savings deposits with nonbanks, more than doubled. In the first flush of financial reform, the financial system in the Philippines expanded too, though moderately. Since 1984, however, its growth rate turned negative in the context of an adverse macroeconomic environment, a liquidity crisis and widespread bank failures. In Indonesia. the gross assets of the organized financial sector almost tripled since 1982, a growth rate of almost 23% p.a. in nominal terms. In addition, the range of noncredit financial services widened considerably. Only in Sri Lanka did the financial system not record any perceptible growth. Financial reforms succeeded more in stemming the prereform decline of the financial system than in inducing rapid growth. 4.85 It is clear from the above that the growth of the financial sector has been rapid when the level of real interest rates is high and stable. This again points to the importance of stable inflation rates. Korea, Malaysia and, to some extent, Indonesia had quite stable inflation rates during 1982-86 and experienced rapid growth of the financial sector. The Philippines, which had highly fluctuating inflation during 1983-85, experienced contraction of the financial sector, although the average real interest rate was quite high during this period. However, the financial sector grew rapidly during 1980-83 when inflation was relatively stable. Sri Lanka's financial sector did not grow fast, presumably due to fluctuating and high inflation in the later stages of reform. Japan and Taiwan, which achieved rapid financial sector growth during the last two or three decades despite their controlled banking system, also had a very low and stable inflation rate. This suggests that a relative price stability may be as crucial as (or even more crucial than) the liberalization of the banking system and the interest rate Rer se to the achievement of rapid and sustained growth of the financial sector. 68 Competitiveness of the Financial System 4.86 Competitiveness of the banking system following liberalization increased perceptibly in all five countries, though it varied in degree from country to country. In Korea, dealing in new financial instruments by privatized banks and NBFIs, expansion of the direct credit market and allowing freer entry of foreign banks were the main catalysts in promoting competition. In Malaysia. competitive forces were boosted by liberalizing banks' interest rates and making competition between banks and NBFIs more intense. The expansion of branches by banks and the relative increase of small banks' share during the period of control of the prime rate also contributed to greater competition, and the entry of foreign banks helped reduce the inertia among banks which had characterized their operations before reform. In Philippines. bank concentration was not muich of a problem even before liberalization, and competition was enhanced by universal banking. The restructuring of two largest government-owned banks led to some reduction in the market concentration ratio though bank ownership continued to remain in the hands of few families. The main factor that spurred competition among banks in Indonesia was the abolition of control on deposits and loan interest rates of state banks which had a major share in total financial assets. Once these bank were free to compete for funds in the market, the private and other banks became more alert to profit possibilities than before. In Sri Lanka. the interbank market acquired new strength as new instruments emerged and FCBUs were established. Term Credit 4.87 The impact of liberalization on availability of term credit was not uniform across the five countries. In Korea, there was distinct improvement in the flow of term credit from nonbanks such as insurance, investment and trust companies and from the securities market because the growth of NBFIs was vigorous in the aftermath of liberalization and the market for bonds and stocks developed rapidly in the more competitive environment. In Malaysia. the banks continued to be a major source of investment funds, as their capacity to supply such funds increased with the faster growth of longer term deposits following interest rate deregulation. Unlike Korea, however, the securities market remained marginal as a source of long-term funds because it was crowded out by the issue of government bonds sold in captive markets. In addition, the share of development financial institutions in total credit was very small in Malaysia. The PhiliRpine experience was mixed. Long-term funds from banks were augmented when reserve requirements against longer-term deposits were lowered and when bank loan rates were deregulated, thereby attenuating the maturity risks. With the extension of the average maturity of deposits, the banks' ability to provide such funds was greatly enhanced, though political turbulence, adverse macroeconomic developments and the financial fragility of banks have combined to reduce the role of banks in this area since 1985. In contrast, in Indonesia. the banks were constrained to lend medium- and long-term because of the pronounced volatility of interest rates and the mismatch of maturities between liabilities, predominantly of short-term nature, and loans required for investment financing. The capital market was stifled by the absence of infrastructure required for vigorous development and by the cliscriminatory taxation policy. Sri Lanka paralleled the Philippines and Malaysia in respect of the availability of long-term 69 funds. In more liberal financial conditions, commercial banks together with development banks came to be the single largest source of capital funds to the private sector. A real limiting factor in Sri Lanka was the relative shortage of demand for long-term funds, in view of the lack of bankable projects. Unlike Korea but like Indonesia and Malaysia, the capital market could not develop for want of, among other things, an appropriate legal framework. 4.88 Liberalization of interest rates does not seem to have significantly improved the availability of long-term credit. In two countries (Malaysia and the Philippines) in which interest rates were liberalized, the average maturity of loans and deposits of the banking sector increased. Yet the major part of bank loans (more than 70%) was short-term (less than one year's maturity). Also, the maturity of loans tended to be shortened when the inflation rate was high and volatile: it is essential that interest rates remain stable if banks are to consider lending medium and long (Indonesia). In order to enhance the availability of long-term credit and risk capital, the encouragement of new instruments and new markets seems necessary along with stable inflation and interest rates. There is an apparent limit for commercial banks to provide long-term industrial credit. In addition, a stable inflation rate may be important not only to encourage the development of those instruments and markets, but also to increase the maturity of bank loans. Korea's experience of the 1980s was liberalization through the expansion of NBFIs and the securities market, while the Philippine experience was through liberalization of bank interest rates and allowing commercial banks a wider range of activity. Korea seems to have achieved more significant progress toward mobilizing long-term credit and risk capital in the industrial sector than did the Philippines and Indonesia. Intermediation Costs 4.89 The experience of these five countries in regard to intermediation cost was diverse to a degree that nothing definitive can be said about how liberalization influenced it. In Korea, the cost of intermediation fell, determined as it was by two factors opposed to each other. One, the downward influence, was the scaling down of reserve requirements and narrowing the gap between rates on preferential and general loans; this was counterbalanced by the rise in losses from nonperforming loans. It could be argued that if the nonperforming loan problem had not arisen, intermediation costs would have declined as a consequence of growing competition after liberalization. Insofar as Malaysia is concerned, there is evidence that the intermediation margin widened slightly instead of narrowing, as expected after the reform. Perhaps this could be attributed to the perpetuation, though in somewhat weakened form in recent years, of the oligopolistic banking structure in Malaysia. Additionally, it could be explained by the rise in overhead costs of banks in the context of rapid branch expansion as well as by the continuation of selective credit programs. In Philippines, the cost of intermediation rose as in Malaysia, but the reason was different. The increase was due to fiscal impositions such as high reserve requirements as well as the substantial tax on gross receipts and huge nonperforming assets. In Indonesia. the efficiency of intermediation appears to have increased, judging it by the reduction in the interest rate margin. This margin narrowed because of reduction in the interest rate margin on both performing and nonperforming loans. The first of these was a clear indication of the impact 70 of a growing competition among banks. The latter was more a reflection of the financial difficulties in,to which banks were dragged by high and volatile real interest rates. In Sri Lanka, the interest rate margin declined slightly since financial reform. Considering that reserve requirements were quite high, even a small downward change in the interest rate margin could be interpreted as an efficiency gain resulting from growing competitiveness in the financial markets. 4.90 The liberalization of interest rate has not significantly reduced the intermediation spread in the Asian countries. After liberalization, the relatively high spread continued (Philippines) or even slightly increased (Malaysia). This is because a substantial part of the interest rate spread was caused by high government taxes, reserve requirements (Philippines), and the burdens of selective cretdit program (Malaysia, Philippines, Indonesia). The costs of these increased as inflation pushed up the opportunity cost of funds. The increase in nonperforming loans and the oligopolistic nature of the banking system might also have been the reasons for the sustained high spread. This suggests that liberalization of interest rates and promotion of competition among financial institutions alone are not sufficient to ensure reduced intermediation cost. Fiscal imposition on the financial sector such as administering selective credit programs (or portfolio restriction) should also be reduced in order to narrow the intermediation margin substantially. Integration of Domestic Financial Markets with Foreign Markets 4.91 The consequences of financial reform for the integration of domestic interest rates with foreign interest rates were different for each of the countries and were not always in the direction expected a priori. Following financial reforms and a substantial depreciation of the currency, the gap between the domestic and foreign interest rates in Korea declined and reversed, with the foreign interest rates exceeding the domestic ones, a situation quite opposite the one that prevailed during the 1970s. For all this, however, the Korean interest rates could not be considered to be sensitive, to the extent expected, to international interest rates. Domestic financial markets were insulated from the foreign markets through effective controls on capital movement, and direct interest rate control ruled out the applicability of parity conditions. Indeed, the shielding of the capital account prevented capital flight in the early 1980s and ensured relative success of financial reforms. In Malaysia, while the domestic interest rates were quite sensitive to interest rate differentials between Malaysia and abroad, the degree of sensitivity was not as high as expected, presumably because the nonbank public had little access to foreign markets. The Philippine experience was mixed. The cost of borrowing domestically exceeded that of borrowing abroad in the 1980s, and the gap widened due to the volatile movement of the exchange rate, residual controls on foreign exchange transactions and uncertainty about inflation. In Indonesia. the reverse happened. Before reform, foreign interest rates adjusted for depreciation were lower than domestic rates, though the gap was small. The situation turned around after financial reform, with the cost of borrowing abroad exceeding that in domestic markets after a series of devaluations. Parity conditions generally held, but much too weakly. This was not surprising viewed in the wider international perspective. In Sri Lanka, the domestic 71 interest rates generally moved with foreign interest rates adjusted for actual changes in the nominal exchange rate except in 1985 and 1986, when foreign interest rates rose more sharply than domestic rates. On the whole, it is possible to conclude that, following financial liberalization, though the influence of foreign factors on domestic interest rates increased, full integration of rates did not take place even when capital movement was almost free, as in Indonesia, Malaysia, and the Philippines. Ouality of Bank Portfolio 4.92 All five countries were saddled with nonperforming loans in varying degrees, with the Philippines bearing the greatest burden and Malaysia the lightest. The manner in which the problem of nonperforming loans was handled also was different. In Korea, the problem of the nonperforming loans was resolved gradually and without deleterious impact on the solvency of banks, largely due to substantial financial support from the Government, tax treatment for writing off bad debts, concessional credit by the Central Bank to commercial banks, and other restructuring measures adopted to rescue the corporate sector, and also partly because of the onset of a strong economic recovery. Nonperforming loans never assumed a large dimension in Malaysia. and the nominal interest rates were never too high; the corporate sector was less exposed to shocks of higher interest rates because of stable inflation and a prudent Government. The less-interventionist regime prior to deregulation of interest rates did not permit nonperforming loans to accumulate on a large scale. However, since 1985, as real interest rates increased and the economy slowed, banks ended up with a growing burden of arrears. In PhilipRines, of course, the banking system virtually collapsed and the Central Bank had to undertake a sizable bailing-out operation. The Indonesian financial system also faced the serious problem of a growing volume of bad and doubtful assets in bank portfolios. The main reason for this was the high and volatile level of interest rates in relation to the productivity of capital. This adversely affected the corporate sector first, and then the financial sector. In Sri Lanka, too, the poor portfolios of banks posed serious problems, but they scarcely reached the levels experienced in the Philippines or even Indonesia and remained manageable, partly because the regulation of the financial system was strict and the Government's other actions were timely. Corporate Financial Structure 4.93 Interest rate deregulation affected each of the five countries differently, depending on the nature of the initial financial structure of the corporate sector and the changes brought about. In PhilipRines and Indonesia, the corporate sector's high gearing ratio on the eve of financial liberalization increased even further, due mainly to distress borrowing. This rendered it more sensitive to changes in interest rates. In Korea's case, the debt/equity ratio declined from its prereform-period level in response to the privatization of banks, the phasing out of selective credit programs, and high real interest rates. The government's commitment as a risk partner receded. In Malaysia. the corporate debt/equity ratio was relatively low and declined somewhat after the reform. 72 V. FINANCIAL LIBERALIZATION IN CHILE. ARGENTINA AND URUGUAY Ak COMPARATIVE PERSPECTIVE 5.1 Analysis of the impact and modus operandi of financial liberalization will gain depth, breadth and relevance if the Asian countries' experiences are contrasted to the experiences of other developing countries such as Chile, Argentina and Uruguay, the so-called Southern Cone countries of Latin America, where financial deregulation assumed a different modality and instrumentality and consequently yielded different outcomes. All three countries had broadly similar macroeconomic backgrounds, social structures, cultural heritage and historical circumstances. They had, to begin with, long records of high inflation, fiscal imbalances, perpetual balance of payment crises, pervasive and long-lasting interventionist regimes embracing all the sectors of the economies, lopsided production structures, and so on. They pursued financial liberalization strategies more or less similar in design. In Chile, both macroeconomic stabilization and financial reform policies were initiated concurrently, while in Argentina and Uruguay financial reform preceded stabilization. The main thrust of the stabilization policies was to reduce real exchange-rate fluctuations and de-escalate the raging inflation which had distorted relative prices and increased concentration of financial transactions in instruments with short-term maturities in the context of uncertainty about future inflation. 5.2 In what follows, the macroeconomies of these countries prior to liberalization will be described briefly, and attention will be drawn to prominent features of their financial systems on the eve of financial liberalization. Since there was close and continuing interaction between stabilization and financial r-eform policies, key elements of the stabilization policies will be scrutinized to ascertain the truth of the proposition that inconsistent macroeconomic policies interfered with financial reform (L. Sjaastad, 1983; S. Edward, 1982; R. Dornbusch, 1984; V. Corbo, J. de Melo, J. Tybout, 1983). The broad picture of the financial systems emerging after liberalization will be presented. This discussion will not be detailed as in the case of the Asian countries. Financial reforms in the Southern Cone countries of Latin America have been extensively analyzed and commented upon, and this paper has leaned considerably upon these analyses for important stylized facts, if not analytical perspective. Towards the end of the section, the experiences of the Southern Cone countries will be juxtaposed to those in the Asian countries. 1. Macroeconomic Environment and the State of the Financial Sectors 5.3 When financial reform was introduced in Chile in 1974, the country was in economic doldrum. The average annual growth rate of real GDP was barely 0.7% during 1971-73% and the fixed investment growth rate was minus 9.8% (V. Corbo, J. de Melo, J. Tybout, 1985). Inflation assumed serious proportions: the average annual rate was 150%, fueled by average fiscal deficits of 12.5% of GDP and financed mainly by borrowing from the Central Bank. The current account deficit of the balance of payments in relation to GDP was at an average annual rate of 3.2% (Table 17). Economic stagnation in Chile was a hangover from past severely repressive government policies. Price and exchange controls were pervasive, and the financial sector was heavily 73 intervened. Multiple exchange rate practices prevailed with a pronounced bias toward import substitution. When the new Government took over in 1973, it initiated economic policies aimed at freeing commodity markets and enforcing fiscal discipline. Since the change in economic policy coincided with the rise in copper prices Chile's economy absorbed the first oil shock without much difficulty (V. Corbo, 1985). After the economic policies changed gear, inflationary pressures measured by the GDP deflator surged, reaching almost 1,000% in 1974. The price rise was large, as latent inflation was transformed into open price increases with the elimination of all controls. In 1974, the authorities launched a sweeping program of financial liberalization. 5.4 Argentina, on the eve of financial reforms in 1976, was in no better shape than Chile. The average rate of growth of real GDP was 2.8% during 1971-75, and gross investment as a ratio of GDP was 20.5% (Table 24-I). The rate of inflation was around 82% in the same period, a fact that is by no means surprising in the context of a high fiscal deficit at 12% of GDP, mainly financed by Central Bank credit (V. Corbo, J. de Melo, J. Tybout, 1985). The balance of payments was also under serious pressure. 5.5 Uruguav's economy was equally severely afflicted by macroeconomic imbalances. The average growth rate of GDP during 1971-75 was only 1.6%. The gross fixed. investment/GDP ratio was, at an average of 10.8%, the lowest among the three countries; the domestic savings at average 12.3% of GDP was higher than domestic investment (Table 24-I). Terms of trade, already adverse, declined further during 1971-75. The fiscal situation was also unfavorable, but compared to Chile and Argentina, the fiscal deficit at 3.5% of GDP was relatively low. It was, however, sufficiently serious to spark capital flight because it raised expectations of inflationary pressures (Harberger, 1975). The loss of foreign exchange reserves was moderate only because of stringent restrictions on capital flows and trade. The average balance of payments including capital account was in moderate surplus at 1.6% of GDP (Table 17). 5.6 In such a milieu, the financial sectors in all the three countries were stunted by one type of repressive intervention or another. In Chile, the regulated interest rates did not respond to changes in the inflation rates and were negative in real terms almost throughout the 1970s, and, in fact, had been so since the 1950s (M. Garces, 1985; V. Corbo, 1985). This naturally slowed the growth of financial savings. The average M2/GDP ratio hardly changed during 1971-74.1] Domestically, the state agencies were a conduit for channeling funds to finance investment, with the banks assuming a very minor role. 5.7 Of all three countries in Latin American, Argentina's financial system was by for the most repressed. Banks merely transmitted the public's financial savings to the Central Bank and confined themselves to lending out .1/ An alternative view prevalent in some quarters was that M2/GDP in fact increased because of an artificial bloating of money as a result of conversion of physical assets into money for the purpose of capital flight. TABLE 15: INFLATION ----------------------------------------__------------------------------------------------------------------------------------------------------------------------ AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.CPI ARGENTIA 51.21 29.92 170.61 444.15 133.32 171.41 163.21 100.01 104.01 165.21 344.21 626.71 672.21 90.12 CHILE - 600.01 371.41 212.11 92.2S 40.21 33.31 35.1X 19.7Z 9.91 27.31 19.81 30.71 19.51 URUGUAY 65.752 77.32 81.3Z 50.72 58.22 44.62 66.92 63.52 34.12 19.01 49.21 55.31 72.21 76.41 2.CDP DEFIATOR ARGENTINA - 100.02 200.02 400.G0 160.02 157.71 154.72 95.3X 107.9X 180.32 353.52 CHILE - 1000.0S 327.32 253.22 103.62 56.52 46.32 29.2X 12.22 13.32 26.6S 14.32 32.82 19.22 URUGUAY 66.671 75.0S 57.11 45.52 62.52 46.21 73.7Z 51.51 30.01 16.21 53.01 61.51 76.72 70.92 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IWf. TABLE 16: GDP GROwTH RATE AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 ARGENTINA :REAL 2.931 5.0S 0.02 0.0S 5.92 -2.6Z 6.52 1.72 -7.02 -3.81 2.02 3.12 -4.92 5.92 :NOMIMAL 63.1S 37.32 193.82 430.6X 175.71 150.0Z 172.31 98.71 93.71 169.6S 362.52 673.52 649.71 87.72 CHILE :REAL 0.72 1.02 -12.92 3.51 9.92 8.22 8.3X 7.8Z 5.52 -14.11 -0.71 6.32 2.4X 5.72 :N0OINAL 200.02 666.7Z 285.92 262.52 123.62 69.41 58.42 39.32 18.71 -2.92 25.71 21.62 36.12 26.02 URUGUAY :REAL -0.42 3.12 5.92 4.02 1.2Z 5.32 6.2S 6.02 1.92 -9.42 -5.92 -1.52 0.02 6.3X :NOKINAL 66.12 77.5Z 79.62 54.82 57.62 55.31 86.31 60.02 32.82 5.11 43.82 59.11 76.72 81.72 …__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ---- _ _ _ _ _ -- -__ _ _ --- -__ _ _ _ -- _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IKF. ABLE 17: BALANCE OF PAYMENT ------------------------------------------------------------------__---------__-----------------------------------------------------------------__---------__----- YEAR UNIT AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.CURRENT ACCOUNT/CDP ARGENTINA - - - 1.50X 2.652 2.86X -0.461 -3.121 -3.73X -4.181 -3.761 -3.261 -1.46Z -3.941 CHILE -3.28 -2.64Z -6.75X 1.55X -4.10Z -7.06S -5.73Z -7.152 -14.47Z -9.47Z -5.65X -10.741 -8.30X -6.49Z URUGUAY 0.521 -3.10X -5.23Z -1.95X -3.761 -2.49X -4.871 -7.00X -4.081 -2.54Z -1.12X -2.46Z -2.111 1.47Z 2.CAPITAL ACCOUNTICDP ARGENTINA - - - 1.12X 1.041 0.47X 4.158 1.61X 1.448 3.69Z 0.63Z 3.51X 3.42X 2.711 CHILE 2.88 1.85X 4.371 1.238 4.611 12.74Z 10.89X 11.75X 14.571 4.25Z 2.63Z 10.69X 7.83X 5.288 URUGUAY 2.001 4.208 4.57X 4.221 7.141 1.908 6.18Z 7.061 5.73X 11.691 5.318 3.58X -1.508 -0.21X 3.TOTAL EXTERNAL DEBTIGDP ARGENTINA - - - 0.00X 0.00X 0.00X 0.00X 7.72X 12.62X 30.44X 28.07S 25.571 30.74X - CHILE _- - 40.92X 43.942 47.991 71.28X 92.13X 104.00X 126.421 - URUGUAY - 16.38X 19.211 28.61X 61.46Z 62.691 76.251 - SOURCE:____________A________________O_____________E___TS____ST_____TISTICS________________________O___L_______________TA____L______________________AN____._______ SOUIRCE: BALANCE OF PAYWENTS STATISTICS. IMF. WORLD DEBt TABLE, WORLD BANK. 76 of their capital and reserves. The nationalization law required that banks secure deposits for the Central Bank, which then allocated them to different sectors according to predetermined priorities. Thus, there was no linkage between the deposit-mobilizing activities of banks and their loan operations, and so they were discouraged from exerting themselves to attract deposits. Real interest rates were grossly negative at minus 10-11% during 1974-76, with the result that the financial sector shrivelled greatly. (For a fuller discussion, see T. Balino, 1988.) The M2/GNP and M3/GNP ratios declined sharply. Shrinkage of the financial sector was also caused by the issuance of indexed government bonds which competed with bank deposits since they were a better hedge against inflation (T. Balino, 1988). 5.8 With Uruguay's macroeconomy in a precarious condition, the financial sector was distorted. Interest rates on both bank deposits and loans were negative in real terms (V. Galbis, 1981). The only redeeming feature of the financial system was the impressive growth of financial assets in the form of treasury bills and bonds (V. Galbis, 1981). 2. The Main Elements of the Financial Liberalization Programs 5.9 Chile started in 1974 with a big-bang approach to liberalization by ushering in a new development strategy with a basic thrust toward freer markets. Following this broad framework, the Chilean authorities emphasized the primacy of private enterprise, openness to the world economy and market determination of all prices (interest rates, commodity prices and exchange rates) except perhaps wages. Insofar as the financial markets were concerned, the banks were denationalized. Reserve requirements were scaled down over five to six years to 4% of savings and time deposits and 10% of demand deposits. Preferential credits from the Central Bank were drastically curtailed, and the refinancing rate on the remaining credit was raised to the market level (V. Galbis, 1981). All categories of financial institutions (banks, development banks and other financial intermediaries) were permitted to compete for any type of business, and access to the financial sector was made progressively easy for new entrants. Capital controls were effectively liberalized in 1979. Until late 1981, capital flows of less than two years were allowed only to finance foreign trade operations, and medium-term capital inflows were subject to reserve requirements. Halting progress was made in dismantling capital controls because of the fear that a massive inflow of outside capital induced by high interest rates would be destabilizing. However, despite restrictions, capital flowed in on a large scale. Between 1977 and 1979, net capital inflow was estimated around US$8 billion (G. Fort, 1985) and it increased even further in 1981 when further liberalization took place. 5.10 Financial liberalization was accompanied by equally sweeping reforn in most other spheres of the economy. Domestic prices were deregulated, and tariff and nontariff barriers to trade were eliminated. Over 5 years beginning in 1974, the average tariff was scaled down from 90% to a uniform 10%. This was followed by adoption of strong stabilization polices, reducing the fiscal deficit which had aggravated inflation, and by adjusting the nominal exchange rate to restore the balance of payments equilibrium. The peso was eventually pegged to the US dollar in July 1979. TABLE 18: FISCAL DEFICIT --------------------------------------------------------------__-------------__-------------------------------------------------------------__-------------__----- YEAR UNIT AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1. FISCAL DEFICITIGDP ARGENTINA - - - -12.50X -4.76S -3.85S -2.801 -3.531 -8.21X -7.18X -12.74X -5.061 - - CHILE -10.61 -5.432 0.141 1.37X -1.11 -0.111 4.821 5.412 2.592 0.98X -2.631 -2.97X -2.362 - URUGUAY -3.171 -3.83X -4.40X -2.07X -1.332 -0.911 0.001 0.031 -1.50X -9.061 -3.93Z -5.201 -2.241 - 2.DOMESTIC FINANCING/GDP ARGENTINA - - - 12.50X 4.761 1.921 2.101 3.531 6.752 6.712 11.852 5.001 - - CHILE - 6.411 5.411 3.252 5.842 1.352 -0.42Z -3.971 -3.001 -0.27Z 2.641 2.221 -0.21X - URUGUAY 0.042 2.291 2.691 2.76Z 1.241 1.371 0.891 1.121 0.241 6.53X 3.021 7.39Z 3.521 - 3.FOREIGN FINANCING/GDP ARGENTINA - - - - - 1.921 - 1.462 0.471 0.89X 0.061 - - CHILE - 0.981 -2.68X -2.042 -1.191 -0.471 -0.972 -0.752 -0.521 -0.301 -0.021 0.75X 2.571 - URUGUAY 0.301 2.131 3.21X 1.65Z 0.42Z 0.22Z 0.711 0.88X 0.831 0.912 -0.11X 2.141 3.281 - S------URCE:---------------I----------E---------ATIONAL------------------__--_IN------------CI--------------STATISTICS---------------------------------__--__----- SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. 78 5.11 Argentina and Uruaw followed a somewhat different path toward reform. Interest rates and capital movements were unfettered from restrictions, in contrast to Chile, where this was done over five years. In Argentina, interest rates weria allowed to be determined by market forces; the only exception was saving deposit rates, on which the ceiling was continued. Even that ceiling was soon adjusted upward and finally removed. Later, minimum legal requirements were lowered in two stages between 1977 and 1979. Financial institutions were given more freedom to manage their liabilities; selective credit policies were eliminated and active measures were taken to ensure that financial intermediaries adjusted smoothly to the competitive conditions unleashed by deregulation, reorganization and mergers, and several new institutions were created. Entry restrictions were relaxed gradually. The adjustment policies, with an accent onI eliminating the balance of payments disequilibrium, effected a steady exchange rate depreciation through an announced schedule for removal of reserve requirements on foreign loans. However, adjustment in the fiscal deficit and domestic credit was less than in Chile, causing persistently high inflation and concomitant depression of real interest rates. 5.12 As regards other aspects of liberalization in Argentina, there was a stop-and-go approach to price controls: prices were deregulated in 1976 and then recontrolled in 1977. The exchange rate was initially unified with a sharp devaluation accompanied by a reduction in tariffs and taxes on traditional exports. However, some relics of protective tariffs remained until 1979. 5.13 Argentina's financial reform experiment differed from Chile's or Uruguay's (and, for that matter, any other country's) in that it reintroduced even more pronounced and stringent intervention in 1980 when its financial markets were on the brink of collapse. As the solvency problem of some banks first exploded, the Central Bank offered its credit to these banks to meet the crisis. Later in 1980, when the size of bad debt grew large, the Central Bank announced its readiness to advance credit to the financial institutions having bad portfolios for a period longer than their deposit maturities so that they could in turn extend the maturity of their doubtful loans. With the disparity between enterprise and household liabilities and real assets widening in the face of high real interest rates, there was a complete volte face 1982 from financial reform for a limited time when the authorities generated, as a deliberate policy, negative real interest rates to facilitate scaling down of private debts. The financial sector was segmented into three parts. The first was a regulated one having deposits of less than 90-day maturity, on which a 100% reserve requirement was imposed. These institutions were given Central Bank credit at a concessional 5.6% to 6% rate to enable them to refinance their existing debts. The other segment, a free-rate segment with nontransferable term deposits with maturities of over 90 days, could pay any interest rate provided the volume of deposits they could garner did not exceed a proportion each institution held on June 30, 1982; this proportion varied from 6% to 20% over 3 months. The third segment consisted of institutions with indexed deposits carrying a free interest rate. Though no limit was imposed on these deposits, they attracted 100% reserve requirements. All this was a total reversal of the reform policies. TABLE 19: TERMS OF TRADE AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 ARGENTINA(1980-100) - - - - - 83.5 88.4 100.0 113.8 98.5 94.1 101.7 88.8 78.4 C8ILE(1980-100) - - - - - - 99.4 100.0 84.3 80.4 87.5 83.2 78.5 - URUGUAY(1974-100) 146.3 100.0 71.4 68.6 76.2 82.9 87.6 69.5 64.8 63.8 49.2 - - _ -------------------------------------------------------------------------__--__------------------------------------------------------------------------__--__----- SOURCE: COUNTRY ECONOMIC REPORT. TABLE 20: REAL EFFECTIVE EXCHANGE RATE(1980-100) ------------------------------------------------------------__---------------__-----------------------------------------------------------__---------_-----__---__ AVR 71-73 1974 1975 1976 19)7 1978 1979 1980 1981 1982 1983 1984 1985 1986 ARGENTINA - - - - - 54.5 76.7 100.0 91.1 50.6 42.7 49.7 44.0 44.1 1 CHILE _ _ _ 93.7 102.1 85.2 86.1 100.0 118.0 106.7 86.8 85.3 68.8 58.1 URUGUAY _- - 71.9 79.4 100.0 112.3 117.5 72.2 69.2 66.9 65.9 SOURCE: WORLD BANK. t-(3LVXf ILUKrnE J2J,)I(VHO4l) - 31V86 ±S3)I3lNZ1V ~OI10_V'tY - A,4VIS wtIN S9S111VlS IV19NVN1A 1TWLVNI3NI 3:9flOs 8S'Uo 66^t1 96'at 9iW6 Il'!! 99,61 16'1 3t10 UE'Bt S9' 11 ESt - - - A' VW - 61, 1 11St lZ'ZT 50'6 0O't 888 K'tZ t8'gE 69'9E M1 3t SZ'6E 9S'1t- - _ 0_ O Z£ O 1'S- tS'11 1 SZ-11 93 3969- - _ _ YN19 t'6 9'`6 Z'18 91t6 5'0 3'09 9*99 1t89 Z1t oZ - -A - tl'9S t'8S 8'33 6'9 0'Z5 1Z9' 1'Z9 I9'v Z'91 - _ _ lJ £'391 '>TL - - C U1T 8'6 L'Z(1 60VT 10t1 Z'9 9 - _ _ WX V m6 86ot tW1 1t6 Z86! 186t 086T 6116t oi61 161 916? cSZ I 61 f!-It aAV (ZVLd O*I 1)S11VR 1 133161 Il-IT 3rUVZ t-(1133N UMN) 91t)/ (vN1I +t) - 31V8 &$3MMI 1- U01IZlm7V AAYZS 0mm SmISXLVLS 7wax1n w011v3ztJ1 S 'WV *;':I W'! "8tl St'9Z 96'6 90'8- *t'6- SS'T- Of I- c'E1- _ AVRAU Ct- ze's 6t'0 £SS W9IT WE1 C8's 91'91 ZO - - _ _1 t8't- W60z- 9.36- Z."t V. 0 61'6 00'9- St'Z- Witl- I419V - - _ _ VfIISv (Ua A% 1Y 3J ' 119 6'19 I99 t'1t 1'0S It £0! E O O 9 93Zt VtV Z'0 - - O- f3M - CS'6' S 9Z 6'LtZ 6'CIV 93 VILE 1'SV *Z S'S6 - - - - 31W.) 9'9 cS015 0'U££ ss I L* 8l 2Z?t 0'89 0'66 Z'Qt 3'13 - - - - IuUm 9161 cut 3961 £T1 Z961 I061t 061 6161 8161 1161 9M61 St61 316T EL-1 lAY (31V8 ISOaO)SI31V 1S3U31 tI-TZ 3188 81 5.14 Uruguay's reform was a cross between the gradual intervention and the full and complete deregulation as in Chile and Argentina. Along with a flexible exchange rate policy designed to attain a sustainable balance of payments, the authorities began to unravel the ceilings on interest rates in stages, the first in April 1976 when uniform ceiling of 62% replaced all existing ceilings on liabilities and assets of the financial institutions. When these ceilings could not ensure positive interest rates in the face of galloping inflation, the ceilings were raised to 90% in November 1977; reserve requirements were also gradually reduced in 1978 (after having been raised in 1977), partly for monetary policy purposes, partly for assisting the allocative credit programs, and also for relieving credit stringency arising from constraints on foreign borrowings (V. Galbis, 1981). 5.15 On other fronts of liberalization, Uruguay abolished price controls by end-1979 but progress in regard to commercial policy reform was much less than in Chile and Argentina. Import quotas were eliminated in 1975 along with taxes on traditional exports, but direct subsidies were retained on non- traditional exports until 1979. Tariffs were reduced by 50%, though they were still high at 150%. Since tariffs were related to prices, often higher than the landed prices induced by the appreciating real exchange rate, realized protection was much higher than the nominal protection. 3. Impact of Financial Reforms 5.16 This section will concentrate on the impact of financial reform on three principal aspects of the financial systems in the three countries: the growth of financial assets, level and integration of interest rates, and the emergence of nonperforming loans. The changes in other areas will be mentioned to the extent that necessary information is available. (a) Growth of Financial Assets Chile 5.17 Financial assets expanded rapidly in Chile from 1975. The ratio of total financial assets (which included paper issued by banks, development banks and financiaras) to GNP more than doubled between 1975 and 1982. Even more important, financial assets other than M2 as a proportion of total financial assets expanded to 71% in 1982, from only 16% in 1975 (A. Velasco, 1988). However, this ratio plummeted after 1982 as a result of the financial crisis, but the ratio of change in financial assets (M2) to private saving showed a different trend. After rising to 1.0 in 1979, it fell and remained at 0.27 in 1986, a level even lower than it had in 1979 (Table 23), but the M3/GDP ratio showed a sustained increase. (This figure is based on Velasco Study (1988) and differs from that in Table 23. It seems more reliable since it is from a Central Bank source.) These movements had two important implications: one was that the relative importance of nonmonetary financial assets increased after financial reform, and the other was that the extent of financialization of savings was greater than before. This was consistent with TABLE 22: GROITH OF MONETARY SYSTEM AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 l.Ml/GDP ARGENTINA 14.22 18.32 18.22 12.21 10.02 10.82 9.7S 9.71 8.42 10.12 10.2Z 8.21 7.61 7.5Z CHILE - 8.72 8.51 6.82 6.42 6.31 6.52 7.32 5.92 6.5S 6.6: 6.1S 5.0X S.6X URUGUAY 16.52 13.02 10.21 10.92 9.72 11.62 10.72 9.82 8.02 10.62 8.12 7.52 8.82 9.11 2.M2/GDP ARGENTINA 24.22 29.82 23.72 19.2Z 23.92 27.42 30.22 28.42 29.22 26.02 28.42 22.6X 19.31 21.82 CHILE - 21.72 21.12 15.52 15.92 18.02 17.42 18.72 23.7X 25.71 19.32 20.72 20.12 19.82 URUGUAY 24.92 20.2S 19.7X 25.6Z 29.32 35.92 35.72 38.6Z 43.5Z 56.32 44.22 *5.12 49.92 51.1X 3.M3/GDP ARGENTINA 34.22 42.62 29.12 26.2X 37.9S 44.02 50.72 47.12 50.02 41.9X 46.52 37.0S 30.92 36.22 CHILE - 29.22 31.0X 25.62 27.82 27.92 28.82 URUGUAY - SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. TABLE 23: GROWTH OF FINANCIAL SESTOR AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.CHANGE IN H2/SAVINGS ARGENTINA 0.398 0.492 0.718 0.626 0.612 0.703 0.912 0.678 0.820 0.754 1.182 1.070 0.911 0.782 CHILE - 0.791 1.291 0.571 0.643 0.572 0.404 0.371 0.637 0.140 -0.088 0.386 0.293 0.213 URUGUAY 0.757 0.943 0.856 0.912 1.063 1.260 1.283 1.384 1.261 1.321 0.436 1.350 2.000 - 2.CHANGE IN H2/PRIVATE SAVINGS ARGENTINA 0.433 0.496 0.537 0.656 0.868 0.895 1.070 0.720 0.647 0.551 0.871 0.825 0.910 0.897 CHILE - - - - - - 1.010 0.998 1.158 0.129 -0.088 0.403 0.382 0.279 URUGUAY - - - - - - 3.CHANGE IN H3/PRIVATE SAVINGS ARGENTINA 0.616 0.725 0.581 0.921 1.453 1.450 1.834 1.178 1.142 0.850 1.432 1.349 1.455 1.525 CHILE - - - - - - - - - 0.095 0.073 0.561 0.591 0.473 URUGUAY LO SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IHF. 84 the imperceptible change in domestic savings.2/ However, the effects of financial reform on the banking systems were exaggerated by the inflow of foreign funds, both on account of banks an,d the nonbank public, which bolstered the deposit liab-ilities of banks. Considering that this level of financial assets could rise or fall depeneling on the external conditions, the growth in financial assets; could not be seen as implying a long-term trend in the financial intermediation process. Perhaps a more enduring change following financial reform was seen in the greater role of the financial institutions in mobilizing savings than before liberalization. Earlier, the Government was the main instrument to mobilize and channel savings. That function was subordinated to that of the financial institutions, with the Government's resources declining and its reliance for funds placed on the financial system. 5.18 While the process of financial intermediation became vigorous, the average maturity of financial instruments shrivelled. Longer-term assets languished. They accounted for 54% of total assets in 1975, and for only 44.4% and 37.2% in 1980 and 1981, respectively" (A. Velasco, 1988). However, the equity market thrived; transactions on that market were more a "speculative bubble, as the prices of stocks traded and the yield were unrelated to the rate of return on investments" (Meller and Solimano, 1980 as quoted by A. Velasco, 1988). Argentina 5.19 In the initial flush of reforms, the Argentine financial system reacted well to market incentives of higher interest rates and competitive conditions. The M3/GDP and M2/GDP ratios increased substantially during 197779 (Table 22). The difference between M3 and M2 clearly demonstrates that new nonmonetary financial instruments emerged, partly as a consequence of the diversification of the activities of banks and partly due to the setting up of new institutions such as finance companies. Commercial banks almost doubled by 1979, but what was even more impressive was the increase in the proportion of saving in the form of financial assets. Both the ratios of change in M2/private saving and M3/private savings increased much faster immediately after reform (Table 23). This is all the more significant when the financialization of savings is seen in the context of a decline in private savings in the same period. The impact of financial reform on financial intermediation was magnified by the substantially increased inflow of foreign capital at the outset of financial liberalization with the opening out of the economy and removal of all restrictions on capital movement. Between 1977 arLd 1980, capital inflow was of the order of $3.2 billion (R. Fernandez, 1985). 2/ This was somewhat a different explanation from C. Diaz Alejandro and E. Bacha (1982), who posit an inverse relationship between financial asset accumulation and real capital accumulation, a la McKinnon (1981); see also A. Velasco (1988). TABLE 24-I: SAVINGS AND INVESTMENT (CONTINUED) __________________________________________----________________________________________________________________________________________----_____--__________________ AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I SAVINGS 1.GROSS DOMESTIC SAVINGSIGDP ARGENTINA 21.22 20.9Z 18.82 23.61 27.7X 25.41 22.1X 19.42 17.72 20.1X 19.21 17.71 17.82 14.82 CHILE 10.02 22.02 12.02 17.01 14.02 15.0X 15.02 16.8X 12.32 9.42 12.52 12.62 16.52 18.42 URUGUAY 12.4X 8.92 9.92 14.1X 12.31 13.5S 12.82 11.72 11.42 11.32 11.62 12.81 12.22 - 2.PUBLIC SAVINGSIGDP I w- ARGENTINA 1.82 0.22 -6.32 1.12 8.22 5.42 3.32 1.12 -4.72 -7.42 -6.92 -5.2Z 0.02 1.92 CHILE _ _ _ - - - 9.02 10.62 5.52 -0.82 -0.12 0.62 3.82 4.42 URUGUAY - - - 3.PRIVATE SAVINGSIGDP ARGENTINA 19.42 20.71 25.22 22.5Z 19.51 19.92 18.82 18.3X 22.52 27.52 26.12 22.9X 17.9X 12.92 CHILE-- - 6.02 6.31 6.82 10.22 12.62 12.02 12.61 14.02 URUGUAY - - - SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. TABLE 24-II: SAVINGS AND INVESTHENT AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 II. INVESTKENT l.GROSS DOESTIC INVESTMENTIGDP ARGENTINA 20.21 19.81 20.31 21.7Z 24.61 21.41 22.11 24.11 19.41 16.42 14.31 12.41 10.42 11.61 C8ILE 11.52 21.22 13.12 12.81 13.31 12.4Z 17.71 21.02 22.6Z .11.31 9.82 13.62 13.72 14.62 URUGUAY 12.32 11.52 13.51 14.82 15.22 16.02 17.31 17.32 15.41 14.41 10.02 8.71 8.1X - 2.PUBLIC INVESTHENTIGDP ARGENTIRA 7.61 6.81 9.82 11.72 12.21 110.9 8.62 7.9X 7.22 6.8X 7 6X 6.42 6.21 5.8X CHILE 12.41 12.82 8.51 5.42 6.91 6.72 5.21 5.41 5.22 4.72 4.91 6.42 7.02 7.61 URUGUAY 2.42 2.62 4.62 6.5Z 7.01 8.0X 6.51 5.31 5.02 7.21 4.12 2.72 2.8Z - 3.PRIVATE INVESTMENTIGDP ARGENTINA 12.3X 12.62 1.61 15.22 15.01 13.42 14.22 14.32 11.52 9.92 6.01 4.92 2.51 3.32 CHILE -0.92 8.42 4.62 7.42 6.42 5.82 12.52 15.61 17.5X 6.62 5.02 7.3Z 6.72 7.02 S URUGUAY 9.91 9.02 8.92 8.32 8.22 8.02 10.82 12.02 10.32 7.22 5.91 6.02 5.22 - Go …----------------------------------------------------------------------__----__----------------------------------------------------------------------__----__----- SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. TABLE 25: NOVEMENT OF DOMESTIC AND FOREIGN INTEREST RATES AND EXCHANGE RATES (CONTINUED) -------------------------------------------------------------------------__--__------------------------------------------------------------------------__--__----- AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.EURO DOLLAR: 6 NMNTH 7.60 10.84 7.75 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.93 11.29 8.64 6.85 2.LENDING RATE ARGENTINA - - - 65.2 307.5 140.9 132.7 93.8 170.3 - - - 117.3 164.7 CHILE - - - - 163.2 86.1 62.1 47.1 52.0 63.9 42.8 38.3 36.17 - URUGUAY - - - 62.0 76.6 71.2 68.1 66.6 60.4 58.5 93.6 83.2 94.6 94.7 3.DEPOSIT RATE ARGENTINA - - - - 242.4 125.2 99.0 88.0 122.7 166.2 407.8 558.0 510.5 86.6 CHILE - - - - 93.8 62.8 45.1 37.5 40.8 47.9 27.9 26.8 28.9 - URUGUAY - - - 30.2 51.4 42.6 50.6 50.3 47.4 50.1 71.4 68.4 81.9 61.7 4.EFFECTIVE COST ON EURODOLLAR ARGENTINA - - - 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.94 11.37 9.29 7.86 1 CHILE 7.65 11.76 13.04 19.97 29.27 43.77 53.92 58.50 62.24 71.43 96.60 121.08 183.64 213.09 CO URUGUAY 8.19 12.17 10.18 9.66 11.35 15.82 20.97 24.41 29.35 29.40 47.90 73.75 118.83 169.25 5.(-1-2) ARGENTINA - - - -59.08 -301.13 -131.70 -120.55 -79.77 -153.58 - - - -108.66 -157.85 CHILE - -156.78 -76.94 -49.96 -33.11 -35.30 -50.27 -32.89 -27.04 -27.53 - URUGUAY - - - -55.88 -70.23 -62.00 -55.95 -52.57 -43.68 -44.90 -83.67 -71.91 -85.96 -87.85 …__ _ _ _ _ _ _ _ - _ _ _ _ _ _ _ _ _ - _ _ _ _ _ _ _ _ -- _ _ -- _ _ -- _ -------- - -- _ - -- - - -- - - - _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. * 4.EFFECTIVE COST-(1+EURODOLLAR)(l+rf GROWTH RATE)-1. * rf..LOCAL CURRENCY : US$, PERIOD AVERAGE. TABLE 25: MOVEMENT OF DOKESTIC AND FOREIGN INTEREST RATES AND EXCHANGE RATES AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982' 1983 1984 1985 1986 6.(-1-3) ARGENTINA - - - - -236.03 -116.00 -86.85 -73.97 -105.98 -152.60 -397.87 -546.71 -501.86 -79.75 CHILE - - - - -87.43 -53.60 -32.95 -23.47 -24.08 -34.30 -17.97 -15.51 -20.26 - URWUGUAY - - - -24.08 -45.03 -33.40 -38.45 -36.27 -30.68 -36.50 -61.47 -57.11 -73.26 -54.85 7.(-4-3) ARGENTINA - - - - -236.03 -116.00 -86.85 -73.97 -105.98 -152.60 -397.86 -546.63 -501.21 -78.74 CHILE - - - - -64.53 -19.03 8.82 21.00 21.44 23.53 68.70 94.28 154.74 - URUGUAY _ _ - -20.54 -40.05 -26.78 -29.63 -25.89 -18.05 -20.70 -23.50 5.35 36.93 107.55 8.(-4-2) ARGENTINA - - - -59.08 -301.13 -131.70 -120.55 -79.77 -153.58 - - - -108.01 -156.84 CHILE - - - - -133.88 -42.37 -8.19 11.36 10.22 7.56 53.78 82.75 ;47.47 - OD URUGUAY - - - -52.34 -65.25 -55.38 -47.13 -42.19 -31.05 -29.10 -45.70 -9.45 24.23 74.55 00 9. NOINAL EXCHANGE RATE(rf) GROWTH RATE ARGENTINA - - - 0.00001 0.00004 0.00008 0.00013 0.00018 0.00044 0.00259 0.01053 0.06765 0.60181 0.94303 CHILE 0.047 0.832 4.911 13.054 21.529 31.656 37.246 39.000 39.000 50.909 78.842 98.656 161.081 193.016 UkUGUAY 0.552 1.196 2.254 3.336 4.678 6.060 7.861 9.099 10.820 13.909 34.540 56.122 101.431 151.993 10.REAL EFFECTIVE EXCHANGE RATE(1980-100) ARGENTINA - - - - - 54.5 76.7 100.0 91.1 50.6 42.7 49.7 44.0 44.1 CHILE - - - 93.7 102.1 85.2 86.1 100.0 118.0 106.7 86.8 85.3 68.8 58.1 URUGUAY - - 71.9 79.4 100.0 112.3 117.5 72.2 69.2 66.9 65.9 -------------------------------------------------------------------------__---_------------------------------------------------------------------------__--__----- SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. (CONCLUDED) * 4.EFFECTIVE COST=(l+EURODOLLAR)(l+rf GROWTH RATE)-1. * rf=LOCAL CURRENCY : US$, PERIOD AVERAGE. 89 Uruguay 5.20 Liberalization influenced the growth of financial assets in Uruguay in a most beneficial fashion. The ratio of M2/GDP rose by 10% between 1976 and 1979 and continued upward until 1982. The ratio of change in financial assets (M2) to total domestic savings grew from 0.9 to 1.28 in 1979 and to 1.32 in 1982, reflecting a healthy trend in financialization of savings. Domestic savings increased during this period by 20%, which meant that the degree of financialization of savings was even larger than was reflected in this ratio. However, in Uruguay too, as in Chile and Argentina, the spurt in the M2/GDP ratio was induced by the dollarization of the financial system, as is evident from the fact that foreign-currency-denominated deposits as a proportion of total bank deposits increased from 0.48 to 0.67 between 1976 to 1982 (J. de-Melo and J, Tybout, 1985). The infusion of foreign currency deposits began in 1976 when the reform policy was initiated, but it accelerated substantially when the tablita, a preannounced devaluation schedule designed to break pressures for further devaluation was introduced as the main instrument of stabilization policy in 1978. (b) Level of Interest Rates Chile 5.21 With reform in motion, the level of nominal interest rates increased faster than the inflation rate, thereby ensuring positive real interest rates for the first time in recent years. From 1974, the real interest rates on deposits were positive until 1984 (in a range of 1% to 17%), and loan rates were substantially higher in both nominal and real terms. Despite growing competition among banks and nonbanks following liberalization, the oligopolistic nature of the banking system and the bank holding structure continued. 5.22 High nominal interest rates were expected after reform, but they were even higher than LIBOR after adjustment for devaluation. This was understandable for the period until 1979 because capital controls were in existence and they were quite effective. But the higher level of domestic interest rates after 1979 when capital controls were progressively dismantled and when the parity conditions were subject to a market test remained somewhat of a puzzle. Explanations for this phenomenon include imperfect substitution between domestic and foreign financial assets, costliness of arbitrage activity by banks, and market segmentation, but none provides a satisfactory answer for why parity conditions did not hold in Chile or why domestic interest rates rose so high. The peso/dollar spread was in favor of Chile until 1982, when it turned adverse. Argentina 5.23 The nominal interest rates in Argentina increased very sharply but, with the inflation rate running ahead of nominal interest rates in most years after 1976, positive real interest rates obtained only in 1977 and again during 1981-83 (Tables 21-I and 21-II). The ex Rost peso/dollar interest spread was positive except in 1971 and in 1981-82, indicating again that both 90 nominal and real interest rates were higher in Argentina (as in Chile) than the foreign rates. Uruguay 5.24 The banks' nominal deposit and loan rates surged in Uruguay, but the latter recorded a much higher rise than the former (Table 21-I and 21-II and II). With rapid escalation of inflation, bank deposit rates turned negative in real terms until 1980, while the real loan rates have remained positive since 1976. As in the case of Chile and Argentina, the ex Rost peso/dollar interest spread indicated that both nominal and real domestic interest rates were higher than foreign initerest rates most of the time. This phenomenon will be analyzed in depth later in connection with the linkage of stabilization policies and financial reform policies. (c) Nonperforming Loans Chile 5.25 Since the financia:L system was liberalized, the single most important development in Chile was the staggering debt accumulated by the private sector. The ratio of debt to the banking system shot up from 5.0% of GDP in 1974 to 61.7% in 1982 (A. Velasco, 1988). Such sharp growth was fueled by optimistic expectations generated in the initial stages when Chile achieved rapid growth. Once the debt got going, it developed its own momentum, spurred by the intrusion of other factors such as the dominance of the financial and manufacturing conglomerates. Banks lent to the firms belonging to the owners the banks, and such loans constituted around 20% of the banks' portfolios (Luders, 1985; D. Hanna, 1987; A. Velasco, 1988). Lending on such a scale when interest rates were excessively high and the peso overvalued made production activities highly unremunerative and brought widespread bankruptcies. As a result, and the banks' portfolios soured. The demand for new loans should have declined, but instead it rebounded. Harberger (1985) described it as "a false demand" consisting of rollover of essentially bad loans and capitalization of interest estimated to be around 72% of outstanding peso loans by end-1982 (A. Velasco, 1988). As a result, loan default as a proportion of total financial assets soared from 1.4% to almost 19& by 1983. 5.26 The authorities reacted to the crisis by taking a series of measures ranging from outright bail-out through the provision of emergency loans and subsidized credit, purchase of risky loans by the Central Bank, and a host of other rescue measures. All these resulted in an enormous increase in Central Bank financing of commercial banks. Between June 1982 and June 1985 such financing as a ratio of the total commercial bank assets rose from 3.4% to 50% (A. Velasco, 1988). Such a sizeable infusion of Central Bank credit naturally fomented macroeconomic disturbances, since market participants interpreted it as abdication of the authorities' responsibility to maintain stability in the economy. The stabilization policies lost all credibility. Argentina 5.27 The genesis of the nonperforming loans and their rapid expansion in Argentina was similar to that in Chile except for the absence of interlocking 91 ownership among banks and the manufacturing sector. The basic cause, again, was the unsustainably high level of interest rates, both nominal and real, which together with the appreciated real exchange rate made it unrewarding for firms to continue production. The situation was accentuated by the high gearing ratios of firms, which magnified the impact of high interest rates on their profit margins (A. Petrei and J. Tybout, 1985), and also by their distress borrowing which raised their indebtedness to banks. As a result, bad and doubtful debts as a ratio of total bank loans accelerated from a mere 1.95% in 1975 to 9.13% in 1980. Here again, as in Chile, the Central Bank played a crucial role by injecting credit to help the crisis-affected banks through a refinancing subsidy. Later, the authorities totally reversed the financial reform policies in order to generate negative real interest rates, and the real value of the bank loans and deposits was drastically eroded. This response had two consequences, both unfavorable to the macroeconomy: one was the loss of credibility of the financial reform policies, and the other was the loss of credibility of the stabilization policies. The latter was evidenced by the fact that between 1979 and 1984 the Central Bank's claims on financial institutions as a proportion of total Central Bank liabilities rebounded from 4.40% to 45.0%; it once reached 63.52%. Uruguay 5.28 The basic causes of an increase in nonperforming loans in Uruguay were high interest rates and the overvaluation of the real exchange rate as in Chile and Argentina. The domestic interest rates could not converge with the international rates, and in fact the spread generally remained unchanged. Because of the dollarization of the economy and the encouragement of the authorities, the productive sectors borrowed heavily in dollars to buy manufacturing equipment. The adverse impact of this development was not assessed properly by banks, which continued to finance the purchase of overpriced assets. Inevitably, the Central Bank injected its credit into the system. 5.29 The Central Bank intervened in 1981 by offering subsidized refinancing facilities to banks whose conditions varied according to whether their loans were denominated in pesos or foreign currency. The Central Bank also provided assistance in buying the loan portfolios of failing banks and the nonperforming loans of other banks. All these increased Central Bank credit and therefore increased monetary expansion with an adverse macroeconomic outcome similar to that in Chile and Argentina. 4. Adiustment Policy Implementation And its Linkage with Financial Liberalization 5.30 Adjustment policies employed to deal with macro imbalances in the short run need to be eased into liberalization programs since they are concerned with gradual elimination of structural rigidities in the economy which impede efficient resource allocation and factor use. These two sets of policies interact with each other, and unless they are mutually reinforcing, 92 neither can succeed or acquire credibility.3j Stabilization policies implemented in the Latin American countries will be viewed from this perspective in the subsequent discussion. 5.31 The main macro imbalances facing these countries, surging inflation and the debilitating external account deficit, cried out for immediate attention, though the relative urgency of each varied from country to country. The stabilization policies were implemented in two stages: first, they were focused on curtailing inflation drastically through both monetary contraction and reining in the fiscal deficit (V. Corbo, J. de Melo and J. Tybout, 1985). However, the anti-inflationary measures by themselves could not have eliminated the external account deficit. Devaluation became inevitable to switch expenditures from domestic to foreign markets. Only in Uruguay was devaluation combined with other emphatic measures to develop nontraditional exports. 5.32 The first phase of stabilization commenced in Chile in 1974 and in Argentina and Uruguay after 1976. With policies in full swing, the rate of inflation declined in all these countries--in Chile to 40.2% in 1978 from 600% in 1974; in Argentina to 171% from 444% in 1976; in Uruguay moderately to 44.6% from 51% in 1976. Inflation remained stubbornly high (Table 15). 5.33 The overall balance of payments position improved in all three countries. The fiscal deficit in Chile was almost eliminated in 1978, down from an average of 10.6% during 1971-73 and eventually there was a surplus beginning in 1979; in Argentina, the fall was substantial--from 12.5% in 1976 to 3.8% of GDP in 1978--though not as sharp as in Chile. In Uruguay, the fiscal deficit was within tolerance limits by the standard of Chile and Argentina at 3.5% of GDP on the eve of the reform. It dropped to 0.9% by the end of 1978 and was eliminated in 1979. (Table 18) 5.34 As expected, the stabilization policies directed at clamping down on inflation through reduction of aggregate demand had adverse consequences in terms of a shortfall in output, increased unemployment and reduction of real wage rates. Chile suffered most, with a negative GDP growth rate of 13% in 1975, partly a result of stabilization policy but largely a consequence of world recession. Still, the average growth rate of its GDP was 1.9% during 1974-78, higher than the bare 0.7% preceding adjustment. In Argentina, GDP fell sharply to almost zero initially but recovered after 1977. Uruguay recorded a somewhat higher growth rate of 4% (Table 16). The impact of stabilization policies on employment and wages was severe, its extent varying from country to country. Chile's unemployment rate rose sharply from 4.6% during 1971-73 to 20% in 1976. Though it declined to 10% by 1978, it was still higher than in the prestabilization period. The real wage rate index followed the same trend, declining from 98 to 69 in 1976 and rising slightly j/ L. Sjaastad (1983), for instance, argued that the credibility of the liberalization program came to depend upon the success of stabilization policies. However, the reverse was also true: the credibility of the stabilization policies also depended on the success of the financial reform policies. 93 to 82 in 1978 (V. Corbo, J. de Melo, J. Tybout, 1985). In Argentina, the unemployment rate increased only slightly between 1975 and 1978, and real wages declined by about 33%. Uruguay followed a similar pattern. 5.35 The basic objective of the stabilization policies in these countries, viz., control of inflationary pressures, was not accomplished. Since adherence to the same strategy would have meant more of the same, it was not politically feasible in the face of high and unabating unemployment. In Argentina, the stabilization strategy was therefore modified to accommodate emerging political imperatives. Since inflationary pressures and devaluation were thought to be linked, it was believed that inflationary expectations could be lessened if devaluation of the domestic currency were planned and gradual. This consideration paved the way for adoption of a preannounced exchange rate, or what came to be called the tablita. As Sjaastad (1983) pointed out, the rationale behind it was that "... the rate of devaluation was intended to influence the rate of inflation, rather than vice versa. Thus the exchange 'tables' were intended to convey information concerning the future evolution of the price level rather than merely providing a more or less stable real exchange rate." 5.36 The immediate impact of the shift to this new system of planned devaluation and away from the earlier emphasis on containment of fiscal deficit and monetary contraction appeared in a reduction in the cost of raising funds abroad in relation to the cost of domestic funds. Interest rate arbitrage became profitable in all three countries (Appendix Tables Chile 3, Argentina 3 and Uruguay 3). In the earlier period, when anti-inflationary policies were combined with financial liberalization, real interest rates rebounded, and though they occasionally became negative as in Argentina and Uruguay, they tended to remain very high. With the adoption of a tablita as the main instrument of stabilization policies, interest rates came under further upward pressure because of expectations that the resulting exchange rate levels would be unsustainable and even further exchange rate changes beyond what the tablita indicated would be required. At the time the tablita was introduced, Chile had considerable restrictions on its capital account, unlike Argentina and Uruguay where such controls had already been done away with. Chile eliminated capital control in the belief that a freer inflow of funds from abroad would help bring down real interest rates. However, far from such a denouement, the high interest rates persisted. The tablita induced inflows increased absorption and drove up the prices of nontradeables, thereby raising the real exchange rate. Though inflation went down substantially as an initial reaction to these measures, inflationary expectations resurged as capital inflows raised monetary aggregates. This made market participants believe that the exchange rate was unsustainable, and consequent expectations of devaluation edged real interest rates up in domestic financial markets. Two other factors made the situation even worse in Chile, First, the real wage rate rose because of the way wage indexation was contrived (V. Corbo, 1985); second, the tablita worked at cross purposes with the export-based strategy of generating growth by trade liberalization (V. Corbo, 1985). Thus, the costs which normally figure in the profit calculus of businessmen, viz., the appreciated exchange rate, high real interest rate and a high wage rate, contributed to business failures and jeopardized both the financial reform and adjustment policies (V. Calbis, 1988). 94 5.37 A similar explanation about the failure of stabilization reform policies holds, more or less, in the case of Argentina. The devaluation schedule no doubt helped pare down inflationary pressures and encouraged the inflow of foreign funds. However, the fall in the inflation rate was neither precipitous nor large enough to prevent the peso's real exchange rate from appreciating. Furthermore, the persistence and widening of the fiscal deficit, which in Chile and lJruguay was not only eradicated but also transformed into a surplus, heightened market participants' expectations that the exchange rate changes, preplanned though they might be, would fail to materialize. High real interest rates persisted (L. Sjaastad, 1983; R. Fernandez, 1985), and' the fiscal deficit sustained them in yet another way. Since the Government s deficit crowded out the private sector (whose credit demand remained unsatisfied), upward pressure on the market rates of interest increased. 5.38 Uruguay's experience with stabilization was no different from Chile's and Argentina's, except that Uruguay's difficulties were exacerbated by its close economic and trade links with Argentina and Brazil, which were devaluing frequently and substantially. Uruguay did not keep pace but devalued in small steps (J. Hanson and J. de Melo, 1985), thereby slowing export growth. At the same time, the Government's deficit expanded. These two factors, the renewed fiscal deficit and the constraint emanating from the decline in exports, induced large recourse to foreign borrowing to shore up international reserves. As a consequence, devaluation expectations were fueled, further escalating domestic real interest rates. 5.39 The question to ask is why stabilization policies in the Southern Cone countries did not succeed to the extent anticipated by policy makers and economic rationalizers. The high level of real interest rates in these countries depressed domestic investment by squeezing the profit margins of firms. This in turn damaged the financial system, particularly banks (the main lending agencies), and brought on a widespread financial crisis. The most commonly offered explanation for the continuation of high real interest rates and the consequent larger spread between rates on peso/dollar deposits and loans, was the exchange rate policy. The tablita generated capital inflows which caused appreciation of the real exchange rate and expectation of further exchange rate depreciation beyond the preannounced schedule. This contributed to the continuation of high real interest rates, but this explanation is more a truism than a causal factor. Those who first rationalized preannounced exchange rates as an instrument of anti-inflationary adjustment policies were fully aware that: they would induce short-run capital inflows and consequent appreciation of the real exchange rate (C. Rodriguez, 1982). What was not realized, however, was that the effect of the preannounced exchange rates would be prolonged, not transient. It is therefore pertinent to ask why the expected did not materialize and the capital inflows and the real exchange rate appreciation continued unabated, with all they implied for the high level of real interest rates. 5.40 The often-cited cause for these unexpected consequences of the tablita policy and their long duration is the inconsistency of the macroeconomic policies (M. Khan and R. Zahler, 1985; V. Corbo, 1985; Tybout, etc. V. Carbo, J. de Melo; J. Tybout, 1985; L. Sjaastad, 1983; M. Dooley and 95 D. Mathieson, 1988). By inconsistency was meant a large fiscal deficit and credit expansion and a rise in the wage rate, which together nullified the effects of the tablita. However, the fiscal deficit was not much of a problem before or after tablita except in Argentina; Chile had a surplus in 1977-78, and Uruguay almost balanced its budget (Table 18). Monetary expansion was not an independent factor, as the source of it in these countries was the fiscal deficits (in addition to inflow of foreign capital). It therefore seems that neither the fiscal nor the monetary policy could be blamed for the perverse effects of the preannounced exchange rate policy, in Chile and Uruguay at any rate. The same could be said of the real wage rate. In Chile, the large (almost 100%) backward wage indexation made the wage rate rise, and in Argentina, it rose as a reaction to a burgeoning fiscal deficit. The real wage rate did not create any particular difficulties in Uruguay: in fact, it declined. 5.41 Another inconsistency referred to in the context of the failure of the tablita was its lack of credibility. In support of this argument, Corbo et al. (1985) pointed to Argentina, where the spread between domestic interest rates and foreign interest rates widened as doubts began to mount about the sustainability of the tablita. At the beginning of 1979, this spread tended to narrow when confidence in the tablita was highest, but it started increasing when confidence waned with a steady shortening of the remaining period of the devaluation schedule. In Uruguay, the credibility argument was somewhat modified to suggest that, in addition to the exchange risk, loans denominated in dollars were imperfect substitutes for loans denominated in pesos (J. Hanson and J. de Melo, 1983; Fernandez, 1985). However, this rationalization is not convincing. For one thing, if the vagueness surrounding the devaluation schedule (creating uncertainty in the minds of the market agents about the sustainability of the exchange rate) were all that mattered, then one needs to provide an equally convincing rationale why in Uruguay, where no such ambiguity shrouded the tablita. the spread between domestic and foreign interest rates was virtually unaffected. To be valid, any analytical explanation of such occurrences has to be sufficiently general to explain other situations. Furthermore, while the argument of imperfect substitutability between domestic assets and foreign assets might be valid, it has a very tenuous link to exchange rate risk. The degree of substitutability between domestic and foreign assets is a function of several variables such as institutional rigidities in domestic markets, absence of long traditions, familiarity with market-related transactions, and the exchange risks. Apart from this, the argument of imperfect substitutability of assets runs counter to the accepted premise that tablita-induced capital inflows, by facilitating the appreciation of the real exchange rate, resulted in high real rates of interest. 5.42 The foregoing discussion shows clearly that the unanticipated consequences of the tablita in Chile, Argentina and Uruguay and its impact on domestic real interest rates cannot be ascribed merely to inconsistencies in macroeconomic policies, though lapses such as the lack of control on the fiscal deficit in Argentina or the rise in real wages in Chile were serious. In point of fact, if these inconsistent macroeconomic policies, e.g., overvaluation of the currency and the rise in real wage rates, were of overriding importance, their effects should have been to lower real interest rates rather than raise them or maintain them at high levels. As Galbis has 96 persuasively argued, the consequences of macroeconomic policies, inconsistent or counterproductive though they were corLsidered to be, "should have led, under competitive conditions, to a decline in the demand for credit on the part of the firms, and also to a more selective approach in the supply of credit by the financial institutions, because of the higher risks involved in lending during a cyclical downturn. In these circumstances, the rate of interest should have tendled to decrease, especially after the authorities abolished all capital inflow restrictions, a measure which was directly intended to increase the supply of credit and thus to reduce the domestic rates of interest to the international level." (V. Galbis, 1986). There are therefore reasons in add:Ltion to inconsistencies in macroeconomic policies for the high interest rates. Several authors have offered varying explanations in support of their particular viewpoints, but none completely resolves the riddle. The actual situation was much too complicated to lend itself to a clear and definitive conclusion on the factors making for the high real interest rates. 5.43 Among the medley of hypotheses about the high level of real interest rates (see, for summary of some of the hypotheses, A. Velasco, 1988), two which can be applicable in varying degree to these three countries should be singled out. The first is linked to the oligopolistic structure of the banking system, particularly in Chile and to some extent in Argentina, and to market imperfections. When financial liberalization was going full steam, with the concomitant restoration of the holding company structure to the banking system, groups of industrial and trading firms closely linked with financial institutions constantly exerted fierce pressure on the latter to appropriate even larger credit resources to finance their business activities. This raised credit demarLd and, hence, interest rates. Banks, for their part, were driven equally, to compete for deposits regardless of the price. The profitability of the groups' productive operations could not have been sustained for long in the face of very high interest rates. Yet it happened that, because of the interlinking of ownership, the banks continued to lend at high interest rates to the borrowing groups. This accelerated the accumula- tion of arrears of bad and doubtful debts but did. not deter banks from aggressively competing for deposits at still higher rates following abolition of all controls on their operations (V. Galbis, 1986; C. Diaz Alejandro, 1985; V. Corbo, 1985 and D. Hanna, 1987). The oligopolistic structure was not as prominent a feature of Argentina's financial system, though the residue of monopoly power which alLowed banks to appropriate monopoly rent in the form of higher interest rates was not insignificant (T. Balino, 1988; D. Barandiaran, 1988). To some extent, the level of interest rates reflected a large risk premium on loans given to newly emerged clients whose credit background was unknown and who, in securing new avenues of profit sharing, were not daunted by the riskiness of projects so long as the expected returns were thought to be high. As Stiglitz and Weiss (1981) have argued, in the event of bankruptcy such borrowers have nothing more to lose than the collateral against loans if the business fails, but they can claim the entire profit if it succeeds. 5.44 The second hypothesis about the high level of real interest rates is has to do with distress borrowing, implying that the borrowing firms under financial stress and with serious cash-flow problems will borrow at any interest rate rather than sell assets to meet losses. Distress borrowing was more typical of Argentina: "During the late 1970s, firms appear to have 97 substituted dollar debt for peso debt, keeping their overall leverage stable. But beginning in 1980, when earning rates fell sharply, firms steadily increased their reliance on debt finance so this year and thereafter, some of the increase in firms' financial riskiness many have been due to distress borrowing. The beginning of the upward leverage trend corresponds to the emergence of banking sector crises, and may well have been a causal factor" (A. Petrei and J. Tybout, 1985). Dreizzen's conclusion was similar to that of Petrei and Tybout, when he found that the firms with high ratio of debt amortization plus interest prepayment to their self generated funds came under judicial surveillance (G. Dreizzen as quoted in T. Balino, 1988). 5.45 While it was recognized that the financial crisis in these countries emanated from wrong and inconsistent macro policies, the reverse question whether financial sector disequilibrium following financial reform also adversely affected the macroeconomic outcome is rarely asked. If real interest rate reached intolerable limits because of the oligopolistic banking structure or distress borrowing, with the damaging consequences for the financial systems, it could be due to the initiation of financial reforms in the imperfect financial markets in the Southern Cone countries. Therefore financial liberalization, far from leading to an equilibrium level of interest rates, had a severe adverse impact on profitability of firms and generated a disastrous financial crisis. This in turn necessitated injection of Central Bank credit into the system when macroeconomic imbalances were serious. Thus, the inappropriateness of the liberalization design under an imperfect financial structure reinforced inconsistencies in macroeconomic policies and aggravated the economic and financial disequilibrium. 5.46 A more rewarding approach to stabilization policies might have been to pursue a conventional stabilization policy, vigorously adapting it to local conditions in the long-term perspective of a liberalized economy. After price stability and external equilibrium--essentially short-term goals--are achieved, a beginning might have been made in gradually phasing out the interventionist regime. It should be recognized that there is nothing basically wrong with government intervention per se when market failures in the financial and product markets are pervasive and pronounced. The difficulty lies more with the manner in which intervention is implemented. Experience has shown that in most countries intervention is arbitrary and has no predetermined plan or criteria. Government intervention can be market- creating or market-destroying; what is required is to shift intervention away from the latter. But dismantling it altogether and at one stroke is to offer hostages to very repressive institutional agents the weakening or elimination of which was the principal objective of financial liberalization policies. This was also the reason liberalization became counterproductive, insofar as it took away the bite from stabilization policies despite their alleged shortcomings. 5.47 Financial reforms unsuited to economies with imperfect market structures and inconsistencies of macroeconomic policy were the most basic causes of the high real interest rates. Failure to put in place a well conceived and well-organized supervisory apparatus capable of wielding effective prudential control over the banking system during liberalization made the situation worse by allowing banks to raise interest rates as they pleased. As Corbo (1985) rightly pointed out in the context of Chile, '...the 98 deregulation of domestic financial markets gave commercial banks and financial institutions too much freedom. The financial intermediaries took undue risks by inadequate evaluation of their loans as well as by concentrating their loans in clients connected to the banks through cross-ownership. And without appropriate supervision, Lntermediaries in financial difficulty were able to increase interest rates just to attract new deposits and make up the shortfall on interest payments to depositors created by their nonperforming loans." It was this lack of prudential regulation of the financial system which led banks to misuse the explicit an-d implicit deposit insurance to raise deposits by fair means or foul to conceal their nonperforming loans and eventually caused the financial crisis. The difficulty lay thus not so much "in the inconsistency between the proclaimed reliance on the free market mechanism and the de facto treatment of the financial intermediaries" as in not comprehending the paramount importance of closely monitoring and regulating the operations of the sensitive money-creating institutions. Here again, the rent-seeking behavior of financial intermediaries should not be attributed to deposit insurance as such but rather to the mistaken notion that financial liberalization meant dismantling the most essential type of prudential regulation. 5. Financial Liberalization Experience in Southern Cone and Asian Countries: A Comparative View 5.48 Financial liberalization in the Southern Cone countries in Latin America went awry for several reasons. First of all, financial liberalization was initiated in an unstable macroeconomic environment which was made even worse by inconsistencies in macroeconomic policy. In addition, the way financial reforms were designed and implemented contributed to financial disequilibrium and thus rmagnified macroeconomic disturbances. Second, it was not realized that financial liberalization in imperfect and oligopolistic financial markets had certain inherent limitations. Therefore, when control on interest rates was eliminated and the operations of financial institutions were freed from government intervention, the outcome was not as expected. Real interest rates were extremely high in relation to marginal rates of return on capital in all the three countries, Chile, Argentina and Uruguay. As a result, firms were involved in financial difficulties which in turn created a crisis in the financial system and engulfed their economies in an economic crisis. Third, abolition of restrictions on the capital account were clearly premature. With macroeconomic imbalances as severe as ever (Chile, however was an exception) freedom of capital movement proved to be disequilibrating insofar as it generated expectations of further currency devaluation, which in turn raised domestic interest rates even further. Finally, the crucial importance of supervision of the financial institutions was virtually overlooked. Financial liberalization was mistakenly equated with elimination of the most essential regulations required to maintain sensitive credit institutions on an even keel. The latitude so given was used by the oligopolistic banking firms to jack up the interest rates and intensify a scramble for new deposits even when loans were failing. 5.49 Of the five Asian countries, the experience of the Philippines and Indonesia could be considered to be close to that of the Southern Cone countries. The Philippines had no capital controls to speak of, and interest rates were freed, though over time. The country had to face serious problems 99 of high interest rates leading to a profit squeeze and consequent enlargement of the nonperforming loans. The Central Bank's actions, too resembled those in the Southern Cone countries inasmuch as the infusion of central bank credit to bail out failing financial institutions interfered with stabilization policies directed toward curtailing inflation and restoring the balance of payments. Indonesia's financial reform strategy, though not fully comparable to that of the Southern Cone countries, retained its liquidity credit programs with subsidized credit almost intact (despite the proclaimed objective of phasing it out) with similar but less severe consequences. Among these were the debilitating volume of bad and doubtful debts which followed in the wake of high and volatile interest rates, and destabilizing capital flows with constant expectations of devaluation put upward pressure on domestic interest rates. But the financial crisis did not reach the Latin American proportions only because the authorities could lessen the impact of high interest rates on the industrial sector by enlarging liquidity credits and supporting the fragile banks. The economy weathered the storm but could not surmount it. 5.50 In contrast, Korea, Malaysia, and Sri Lanka came out bruised as severely but not as battered as the Southern Cone Countries and the Philippines. Of the three, Korea and Malaysia can be considered to have come out well after reforms. Korea passed through adverse macroeconomic conditions but made flexible and pragmatic adjustments to the main elements of its reform strategy. When the high level of real interest rates, following reform made the business sector financially vulnerable, the Central Bank reduced nominal interest rates even though inflationary expectations were high. Korea kept its capital account under a tight leash and so was not confronted with destabilizing capital flows either inward or outward. In short, its approach to financial reform was gradual rather than sudden, and its sequencing was tailored to the exigencies of the changing macroeconomic situation. Besides, it did not dismantle the directed credit programs all at once, and as a consequence the impact of high real interest rates on investment was moderated; but once the economy went into an upswing, directed credit was eased out. The problem of nonperforming loans was quite serious, but it was contained because de facto control of the banking system remained, and subsidized credits were made available by the Central Bank to enable banks to bear the burden of nonfunctioning loans. 5.51 Malaysia too was free from serious disturbances, but the reasons were different from those in Korea. For one thing, Malaysia's deregulation had been narrow in scope. Reform eliminated only ceilings on bank deposit rates. However, this made little difference to the determination of interest rates since foreign factors played a significant role. Malaysia had an open capital account, but capital flows did not prove to be disequilibrating because the exchange rate was stable. Of course Malaysia had its share of nonperforming loans, but their size was limited because trained and conservative bank management and efficient, effective and pervasive bank supervisory machinery minimized the default rate. But the real reason was that Malaysia persisted with its selective credit policy, which softened the impact of high interest rates on the business sector. In fact, through a measured and gradual approach to financial liberalization, Malaysia even turned around its macroeconomy even though it was afflicted by external shocks. Finally, the Malaysian economy was accustomed to functioning in competitive conditions even before reform, unlike the economies of the Southern Cone countries. 100 5.52 In Sri Lanka's case, financial liberalization was gradual. It reduced intervention in interest rates, selective credit, etc., but never really eliminated it. In particular , the selective credit program covered a large part of the total banking system's credit ,which to some extent could contain the problem of nonperforming loans. 5.53 It is clear from the comparative picture of the Southern Cone and Asian financial liberalization experiences that abrupt removal of government intervention in the midst of pronounced macroeconomic instability, imperfect and oligopolistic financial structures and a completely open capital account does not yield optimal results. 101 VI. LESSONS FROM FINANCIAL LIBERALIZATION 6.1 This survey of financial liberalization has focused on the experiences of five Asian countries and drawn attention to events in the Southern Cone countries of Latin America in regard to the implementation of their reform policies. This section outlines the lessons that may be learned from these countries' experiences. 6.2 One of the most important lessons to be drawn from financial liberalization across countries is that price stability and, more broadly, macroeconomic stability, is the linchpin of successful liberalization, not the deregulation of interest rates per se, especially when the countries undergoing financial reforms have shallow financial markets. The experiences of the Philippines and Malaysia and the Southern Cone countries underscore the importance of price stability in two different ways. In the first two countries, the level of inflation was a determining factor in attaining positive interest rates. The adjustment in real interest rates lagged when inflation was declining, although the interest rates were fully liberalized. The resulting high interest rates may lead to widespread insolvency of firms with high gearing ratios, as in Indonesia, or to an economy on a downward slope, as in the Philippines. In Korea, however, although interest rates were administered by the Government, interest rates were substantially positive and stable because of price stability and the flexibility with which nominal interest rates were adjusted according to the movement of inflation. At the other extreme, in the Southern Cone countries inconsistent macroeconomic policies rendered their economic system unstable and vulnerable to shocks, and their economies did not prove congenial to the whiff of financial liberalization policies. The resulting adverse expectations led to unsustain- ably high real interest rates. 6.3 It is also clear that financial liberalization, if not properly designed, may cause instability of the financial system, which in turn may magnify macroeconomic instability, In Chile, Argentina and Uruguay, the preannounced exchange rate policies were reasonably credible at the beginning, but once the monetary consequences of financial-sector instability became clear, credibility began to evaporate. In Chile's case, it was clear that the Government could buttress the financial position of banks by borrowing abroad, but once it reached its limit (in 1981 when Chile began losing its foreign reserves), the Central Bank extended massive financial assistance to the financial institutions and contributed to the growth in base money. As a result, the inflationary expectations, curtailment of which was the main objective of the stabilization policy, resurged. It is true that in Argentina, the fiscal deficit was an important factor, but its impact was magnified when the Central Bank had to infuse a large amount of credit to bail out the financial institutions. 6.4 Among the Asian countries, the experiences of Indonesia and the Philippines reflect the two-way effects of the macro environment and financial reforms on each other. Indonesia's macroeconomic imbalances were severe when reforms were initiated, but they were corrected initially after the reform. However, its troubles were later accentuated when continually high domestic interest rates led to an increasing loan default rate. In the Philippines, macro- and microeconomic policies combined to accentuate the financial crisis. 102 6.5 Second, when capital movement is completely free in an economy where the financial market is relatively small, liberalization of domestic interest: rates makes them very sensitive to the pressures of expectations of foreign exchange movement. This often leads to volatile and high domestic interest rates, which may significantly diverge from the long-run equilibrium level. On the other hand, if a government attempts to control domestic interest rates, it may risk massive capital flight. The best approach may be to achieve a stable macroeconomic enzvironment which will eliminate any abrupt changes in expectations about exchange rate movement. When this is not possible, a country with a small and vulnerable financial market may choose a second-best approach of continuing some restrictions on the capital account and maintaining interest rates. For example, whet; Korea faced major macroeconomic imbalances and political uncertainty in the very early 1980s, if the Government had fully liberalized the capital account and domestic interest rates, it might have faced very high domestic interest rates, if not massive capital flight, and even more serious macroeconomic financial-system instability. This suggests that when the domestic economy is unstable or when domestic financial-sector depth is inadequate, a country may maintain control over its capital account and domestic interest rates while flexibly adjusting the latter to the inflation rate and attempting to stabilize the inflation rate. If, on the other hand, a country has already liberalized the capital account and domestic interest rates, it should maintain macroeconomic stability at all cost. It is worth recalling that Japan (until recently) anid several other industrialized countries retained capital controls and removed them only when their financial markets developed maturity and flexibility. 6.6 Third, financial liberalization centered on the banking system seems to have limitations. These are related to an important feature of banking institutions, i.e., that the banking sector performs both the monetary and the financial intermediation function. These two functions do not work in the same direction, especially when macroeconomic imbalances arise. Often, the growth of liabilities and assets of the banking system is constrained by a tight monetary policy. When the financial liberalization policy is pursued concurrently with a stabilization policy, the intended goal of the policy, to enhance the financial intermediation role of banks, is weakened by the monetary policy directed towards containing inflation. In Korea, the Government constrained domestic credit and controlled the growth of M2, although the banks were privatized and allowed greater management autonomy and competition. However, owing to the policy of encouraging the competition and innovations in the NBFIs and securities market, growth of the financial sector was achieved through the expansion of the nonbanking financial sector. In Philippines, the aggressive monetary policy to mop up liquidity by issuing high-yield treasury bills and Central Bank bills pushed the interest rates of the banking system to very high levels, since the banks had to match their interest rates in order to avoid massive disintermediation. The growth of the banking system was also directly limited by the tight monetary policy of the Government. In Malaysia, the liquidity of the banking system, which was greatly influenced by the restrictive monetary policy, determined the level of interest rates to a large extent, and the resulting high level of these rates was detrimental to new investment. In Indonesia, a shrinkage of liquidity credits at the beginning of the reform accentuated the rise in interest rates, which in turn led to the expansion of nonperforming loans via the profit squeeze on the borrowing corporate sector. 103 6.7 The second feature of the banking system stems from the banks' debt intermediation function whereby short-term fixed-fee liabilities (deposits) are transformed into long-term fixed-fee assets (loans). This function places banks at the risk of runs and insolvencies in the absence of appropriate government supervision and regulation. In addition, the dominance of debt intermediation in the financial markets makes corporate firms (when they are highly leveraged) vulnerable to economic downturns and increases in interest rates. This has continuously called for some kind of government intervention in bank-oriented financial systems (Cho, 1984). The Korean Government, despite its intention, maintained control over bank interest rates and intervened in credit allocation to prevent massive bankruptcies of corporate firms in the early 1980s when its economy was shaky and banks were burdened with increasing arrears. At the other extreme were the Latin American countries and the Philippines, which were involved in the massive restructuring of banks and corporate firms and experienced sharp credit and monetary expansion. 6.8 This does not imply that a policy of financial liberalization is unjustified. The point is that a complete liberalization of the banking system when inflation is high and variable has severe limitations. The resulting high level of real interest rates, when banks are the only financial intermediaries lead to adverse selection in the quality of borrowers and in the banks' own behavior and these problems assume serious proportion when the monetary authorities attempt to impose a stringent monetary contraction, as was experienced in several Asian and Latin American countries to restore macroeconomic imbalances. It is worth remembering that Japan refrained from fully liberalizing its financial system until financial intermediation by insurance companies and other nonbank institutions developed to a great extent (McKinnon 1988; A. Horinchi, 1984). 6.9 A fourth important lesson to be drawn from financial reform experiences is that the excessively high positive real interest rates are as disequilibrating as the heavily repressed negative real interest rates. Experiences in the financially reformed countries have dramatized the contra- diction which was often slurred over in the debate on financial liberalization between the need to maintain a high and positive real interest rate as a reward for savers and the imperative to lower the cost of funds to finance new investment (D. Khatkhate, 1980 and 1983; W. Coats, Jr. and D. Khatkhate, 1985). In the imperfect and oligopolistic money and credit markets characteristic of developing countries, a sudden dose of liberalization often leads to the overshooting of both nominal and real interest rates, unwarranted by the "fundamentals" when financial reform, especially interest rate deregulation, is undertaken amid high and fluctuating inflation rates. The resulting real interest rates often exceed the marginal return to capital, as happened in the Latin American countries, the Philippines and Indonesia and led to increasing arrearage of the banking system. There is a moral hazard when firms borrow to pay interest or simply to stave of bankruptcy rather than to invest or to finance working capital (A. Velasco, 1988). Domestic investment tends to become a hostage to high interest rates and, consequently, what was first the corporate sector's crisis becomes a systemwide crisis. Korea tried to soften the impact of high interest rates by slowing implementation of reform and maintaining interest rate controls and selected credit programs, although the latter were gradually phased out. Indonesia 104 backtracked in regard to phasing out liquidity credits under which loans to certain sectors were subs'Ldized, and Sri Lanka persists with special credit programs to the present. 6.10 The Asian countrLes were not free from the dilemma arising from high real interest rates exceeding the margina:L return to capital, but most, except: perhaps the Philippines, softened the impact in different ways. Korea, for instance, went slowly in implementing reform by maintaining interest rate controls and selective credit programs, though the latter were gradually phased out. Indonesia backtracked in regard to phasing out liquidity credits under which loans to certain sectors were subsidized, and Sri Lanka persists with special credit programs to the present. 6.11 Fifth, in order to gauge how or how much the financial system is deepened or broadened as a consequence of financial liberalization, one of the indicators often used is the M2 or M3/GDP ratio, However, the indicator may at times be misleading. To the extent that the ratio reflects the impact of the short-term inflow of foreign savings, as happened in the Latin American countries, Indonesia and the Philippines, the upward changes in that ratio cannot be taken to represent enhanced efficiency of resources mobilized by siphoning them away from less productive uses. It may not suggest either deepening or broadening, as the ratio will fluctuate depending upon factors totally unrelated to the long-term development of the financial system. In Latin America, the so-called dollarization after capital controls were removed spotlighted both the weakness of the financial system and the efficacy of the monetary policy. Furthermore, a mere increase in the deepening, even when it is governed by endogenous factors, does not necessarily mean that well- developed financial markets have been established. As observed in all the Asian countries and in Chile, availability of long-term finance from the banking system did not show any systematic trend and, in fact, in Indonesia, Chile and the Philippines such funds from the banking system declined. There was strong evidence that the high and volatile interest rates drained off the sources of such credit. A shift from short-term to long-term transactions is time-consuming and may call for a supply-leading policy of financial market development. Financial deepening, as conventionally interpreted, does not by itself bring "relative prices close to any conceivable range with social optima." 6.12 Sixth, financial liberalization assumes that the fully liberalized financial system will function optimally. However, it should be recognized that in economies which have a long history of financial repression, the participating actors, be they bank managers, borrowers, lenders or public servants, are not trained in new ways of dealing with a liberal and competi- tive system. For instance, it was suggested by Arellano (1983) that in Chile's case some of the blame for a disastrous financial crisis resided "in little experience existing in the country in the management of a freer financial system' (quoted in D. Hanna, 1987). The concept of "an associative heuristic" implies that the individual s caution is pronounced in the immediate aftermath of a disaster and tends to diminish as time passes and memory of disaster fades. Inability to size up risk and lack of capacity to cope with adverse situations prevented the liberalization program from succeeding to the desired extent in Chile! and other Latin American countries. If, on the other hand, these policies wer-e unleashed gradually, those at the 105 helm of the financial institutions (and others associated with them in some capacity) would have adjusted and become familiar with these new tasks over time. Training Indonesian public servants and financial managers before full and comprehensive liberalization might have improved results (D. Cole and R. McLeod). 6.13 Closely related to the above is the need to set up a well-planned financial infrastructure with provision for information flow, legal and accounting systems and an appropriate regulatory system to monitor it carefully and continuously. Otherwise, financial liberalization will fail in its main purpose--to orient the financial system towards greater efficiency, competition and effectiveness. In the case of banks, it is not always possible to distinguish a necessary control for monetary stability purposes from a supernumerary regulation affecting credit allocation, but it is imperative that essential regulation be strictly enforced because of the oligopolistic nature of the banking system in several developing countries. It is now generally acknowledged that there is widespread concentration of banking in developing countries. What is more, in some countries like Chile, the bank holding-company structure is more prominent and adversely affects competition, in opposition to the avowed objective of financial liberalization and deregulation. In the presence of such oligopolistic financial and industrial structures, freedom in transactions is often harnessed to increase the market share by price war. For instance, bank holding companies increase interest rates on deposits to make inroads in the market for funds, and this in turn results in higher loan rates. Since loans are provided to the interlocking firms in which banks have close interest, high interest rates do not affect credit demand. This encourages banks to be even more imprudent because they know that the government cannot allow them to go bankrupt without jeopardizing the entire monetary system. There is thus a moral hazard which provides incentive to banks to lend at very high interest rates in order to reduce liquidity strains. As McKinnon (1986) put it, "the bank is beneficiary of an unfair bet against the government; it gets to keep extraordinary profits without having to pay the full social costs of unusually large losses from risky lending." This underscores the need to strengthen the supervisory apparatus in liberalizing countries so that banks are disciplined in mobilizing deposit and lending operations. 6.14 Seventh, another important lesson is that financial liberalization in developing countries should not be considered a replica of liberalization of financial markets in the highly industrialized countries. What can succeed in highly industrialized countries may not be suited to the financial systems in developing countries. The important differences are: (a) in industrial countries, the financial system is not a major source of fiscal revenue, as it is in developing countries. This implies that liberalization in developing countries deprives the governments of resources, and therefore their fiscal practices are adversely affected; (b) in industrial countries there are other more important institutional sources of credit such as equity markets with a well-established rule of their own, a good credit-rating system, accounting standards and wide exposure of financial agents to the array of investment opportunities. Because of this, there is not the same close link between banks and industrial firms as prevails in developing countries. In view of these structural differences, liberalization in developing countries brings about greater prudential risk, concentration of owner@hip and moral hazard@ 106 (Dooley and Mathiesson, 1987). The implication is that a gradual process of liberalization in developing countries is to be preferred to the sudden dismantling of all regulations considered repressive. 6.15 Eighth, the financial reform experience in different types of economies raises a question about how the authorities should proceed in removing the repressive characteristics of intervention without the disequilibrating shocks that emanate from the complete, once-for-all type of financial reforms. A praLgmatic solution may be to evolve a certain set of market oriented indicators based on fuller information from domestic and foreign sources while taking steps to build the financial infrastructure, reducing the monopoly element in the financial and industrial sectors, etc. In this respect, a great deal can be learned from the Korean and Japanese strategies of financial reform. It also should be recognized that liberalization, even in the developed cotntries, has not brought unmixed blessings. For one thing, after financial liberalization real interest rates have reached very high levels by historical standards and have afflicted their economies and those of the borrowing developing countries. For another, interest rates have been most volatile in recent years. As a result, interest rate risks have been transmitted from financial intermediaries to borrowers to a greater extent than before (V. Galbis, 1987). The implication is that a gradual process of liberalization in developing countries is preferable to the sudden dismantling of all regulations recognized to be repressive. 6.16 Finally, financial reform, whether comprehensive and sweeping or measured and gradual, does not seem to have made any significant difference to the saving and investment activities in the liberalized economies. It was believed until recently that removal of the repressive policies would boost saving. The survey in this paper of the consequences of reforms does not reveal any systematic trend or pattern in regard to saving (and also investment), though it clearly demonstrates that reform has greatly contributed to the financialization of savings. In most of these countries, saving changed in a random fashion. There were, of course, shifts in the magnitude of saving and investment as between the public and private sectors. Though this study has not analyzed the factors determining saving, it lends support to the by now well-acknowledged conclusion that decisions to save are determined by several factors and the relationship between savings and real interest rates is at best ambiguous (Leff and Sato, 1980; A. Giovannini, 1983; D. Khatkhate, 1980). 6.17 A broad conclusion is that although financial liberalization is desirable, its modality, design and phasing are no less important. In shallow financial markets, full liberalization does not appear to be the first best policy. 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Ratios 130 8 Growth of financial Sector 131 9 Deposit Share of Banks and NBFIS 132 10 Profitability of Financial institutions 133 11 External Fund of the Corporate Business Sector 134 12 Movement of domestic and foreign interest rates 135 Charts Kl Movement of CPI, Lending rate 136 K2 Integration of interest rate 137 K3 Interest rates spread 138 K4 Movement of Interest Rates 139 K5 Growth of Financial Sector 140 - 118 - Page No. Malaysia 1-a Macroeconomic Indicators; 141 1-b " " 142 2 Growth of the financial Sector 143 3 Growth of the M2/GNP in five countries 144 4a Assets of various financial institutions 145 4b Shares of Assets of various financial Institutions 146 5 Interest rates in Malaysia 147 6 Banking industry structure 1975-1983 148 7 Movement of domestic and foreign interest rates 149 8 Growth of Loan Deposits in the banking system 150 9 Operating cost of Malaysian banks 151 10 Expansion of bank branches in Malaysia 152 11 Deposits by maturity 153 12 Term distribution of commercial bank lending 1970-85 154 13 Allocation of bank credits 155 14 Debt/Equity Ratios of firms 156 15 Interest in suspense and provisions of - Commercial Banks 157 Charts Ml Movement of interest rates. Malaysia 158 (Deposit rates 12 months) M2 Movement of interest rates in Malaysia 159 (12-month lending rates) M3 Movement of interest rates 160 (Commercial bank 12 months deposit rate. Average lending rate; CPI growth rate M4 Growth of financial sector 161 - 119 - Page No. Philippines 1-a Macroeconomic indicators 162 1-6 " " 163 2 Financial system of Philippines 164 3 Growth of Financial Sector in Philippines 165 4 Domestic credit 1980-86 166 5 Bank interest rates 167 6 Term structure of interest rates 168 7 Components of the Average Intermediation cost 1983-86 169 8a Philippines Commercial Bank: Measures 70 of Concentration 8-6 Required reserve ratios 170 9 Total assets of the financial system 1980-86 171 10 Profitability of commercial banks 172 (as % of total assets) 11 Outstanding loans by maturity of 173 financial institutions 12 Movement of domestic and foreign interest rates 174 13a Holders of Government Securities 175 13-b Holders of Government Securities 175 (Percentage Distribution) - 120 - Page No. Charts P1 Bank lending rates CPI 176 P2 Liabilities/assets ratio of top 1000 firms 177 P3 Movement; of interest rates 178 P4 Growth of financial sector 179 Indonesia 1-a Macroeconomic indicators 180 1-b " i 181 2 Selected deposit rates of state and private banks 182 3 Movement of interest rates 183 4 Growth of financial sector in Indonesia 184 5 Share of bank credit by economic sectors 1974-1986 185 6-a Growth and structure of the financial system 186 6-b " It 187 7-a Time deposits by maturity with state banks 1981-86 188 (Rupiah) 7-b " " (percentage distribution) 188 8 Income Expenditure and profits:State banks 189 9 Income, Expenditure and profits: 190 Private National Banks - 121 - Page No. 10 Income, Expenditure and profits: Total banking system 191 11 Movement of domestic and foreign interest rates 192 12 Liquid assets in excess of required reserves of 193 deposit money banks 13-a Liquidity Credits of Bank Indonesia 194 13-b " " 195 14-a Rupiah Time deposits by maturity and type of banks 196 14-b " " 197 15 Level and structure of money market rates 198 Charts I-1 Movement of 12 month deposit rate 199 I-2 Movement of interest rate and CPI growth 200 I-3 Growth of Financial Sector 201 Sri Lanka 1-a Macroeconomic Indicators 202 l-b " " 203 2-a Banking costs of all commercial banks 1980-84 204 2-b Banking costs of State Banks 1980-84 204 2-c Banking costs of Private Banks, 1980-84 205 3 Interest rates of major credit and savings 206 institutions 1970-86 4 Growth of Financial Sector 207 5-a Sectoral Credit Allocation 1980-85 208 5-b Sectoral Credit Allocation 1980-85 208 (percentage Distribution) 6 Distribution of bank credit by maturity, 1976-85 209 - 122 - Page No,. 7 Total Assets of Financial System, 1977-1985 210 8 Interest Rates and CPI Growth Rate (%) 211 9 Movement of Domestic and Foreign Interest Rates 212 Charts S-1 Movement of Interest Rates 213 S-2 Deposit and T-Bill Rate 214 S-3 Growth of Financial Sector 215 Argentina 1-a Macroeconomic Indicators 216 1-b i" 217 2 Macroeconomic Performance 218 3 Exchange Rates, Prices and Interest Rates 219 Chile 1-a Macroeconomic Indicators 220 1-b " " 221 2 Macroeconomic Performance 222 3 Exchange Rate, Prices and Interest Rates 223 Uruguay 1-a Macroeconomic Indicators 22' 1-b "22 2 Macroeconomic Performance 226 3 Exchange Rates, Prices and Interest Rages 227 APPENDIX KOREA TABLE 1-a: MACROECONOMIC INDICATORS YEAR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE 9.6S - 7.9X 6.5S 13.21 10.91 10.9X 7.41 -3.0X 7.81 5.2X 10.9X 8.6Z 5.42 11.92 NOMINAL GDP GROWTH RATE 35.1X - 39.82 35.12 36.92 28.51 34.82 28.82 21.41 24.01 12.51 15.31 12.91 9.62 14.62 rr.zNvEsTMENT AND SAVINGS(RATIO TO GNP) SOURCE : KOREAN ECONOMIC INDICATORS GROSS DOMESTIC INVESTMENT (X) 28.2 24.7 31.8 27.5 25.7 27.7 31.9 36.0 32.1 30.3 28.6 29.9 31.9 31.1 30.2 GROSS DOMESTIC SAVINGS (X) 20.9 21.4 19.3 16.8 22.2 25.4 27.3 26.5 20.8 20.5 20.9 25.3 27.9 28.6 32.8 PUBLIC (X) 3.2 2.8 1.9 2.3 4.4 4.3 5.2 6.3 5.4 5.6 6.1 7.2 7.1 6.9 6.6 PRIVATE (X) 17.7 18.6 17.4 14.5 17.8 21.1 22.1 20.2 15.4 14.9 14.8 18.1 20.8 21.7 26.2 III.CHANGE IN M2/SAVING 0.330 - 0.303 0.366 0.313 0.338 0.298 0.221 0.301 0.281 0.322 0.180 0.084 0.167 0.175 CHANGE IN K2/PRIVATE SAVING 0.389 - 0.336 0.424 0.390 0.407 0.368 0.290 0.406 0.387 0.454 0.252 0.113 0.221 0.219 CHANGE IN M3/ PRIVATE SAVING 0.384 - - 0.380 0.603 0.552 0.483 0.472 0.678 0.670 0.829 0.555 0.483 0.547 0.595 IV.ICOR-NGDI/GGDP/RCDP GROWTH RATE 3.15 - 4.02 4.17 1.92 2.50 2.89 4.80 -10.26 3.71 5.22 2.64 3.56 5.55 2.46 V.BALANCE OF PAYMENT CURRENT ACCOUNT/GDP -5.17% -2.26% -10.83% -8.81X -1.07X 0.02X -2.121 -6.44X -8.53Z -6.72X -3.702 -2.01X -1.582 -1.06X 4.581 CAPITAL ACCOUNT/GDP 7.79% 4.45% 9.31% 11.67X 6.442 3.76X 4.19X 8.31X 9.531 6.80X 5.542 2.962 3.321 2.202 4.011 TOTAL EXTERNAL DEBT - _- - - - 29749.7 33362.1 37755 40900.3 43200.5 47581.1 45108.4 EXTERNAL DEBT/GDP _ _ _ - 47.66Z 48.321 52.162 52.01X 50.56Z 54.821 45.965 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. (CONTINUED) APPENDIX KOREA TABLE 1-b: MACROECONOMIC INDICATORS YEAR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VI.FISCAL DEFICITIGNP -1.845 -0.50X -2.191 -2.00S -1.39S -1.78S -1.25Z -1.771 -2.311 -3.51X -3.26X -1.121 -1.39X -1.302 -1.82S DOMESTIC FINANCING/GNP 0.36Z -0.701 0.921 0.46X -0.161 0.21X -0.271 0.88S 1.43X 2.32Z 1.921 0.441 0.87X 0.69S 1.471 FORZICG FINANCINGIGNP 1.481 1.201 1.261 1.551 1.551 1.571 1.521 0.891 0.891 1.19S 1.34Z 0.68 0.521 0.611 0.35Z VII. INFLATION CPI 18.81 - 24.5S 25.2X 15.3X 10.21 14.51 18.3l 2S.7X 21.31 7.3X 3.45 2.32 2.51 2.31 GDP DEFLATOR 23.1Z - 29.2Z 25.8Z 20.5S 17.0S 21.82 19.41 25.02 15.02 7.02 4.12 3.92 3.82 2.22 VIII.TERKS OF TRADE(BY PRICE) 1.1 1.32 1 1.04 1.14 1.2 1.31 1.22 1 0.99 1.01 1.02 1.04 1.06 1.25 IX.EXCBANGE RATE A.SDR: rb 549.49 474.85 486.43 587.65 558.79 565.08 605.97 625.33 790.59 803.04 807.12 829.27 826.13 883.37 1034.10 I.US$: rf 464.12 398.32 404.47 484.00 484.00 484.00 484.00 484.00 607.43 681.03 731.08 775.75 805.98 870.02 881.45 X.RZAL EFFECTIVE EXCHANGE INDICES(1980-100) - - - - - 97.6 107.4 100 104.4 106.9 i02.7 i0;.3 95.5 80.6 XI.DEPOSIT RATE A.NOMINAL (X) 15.3 12.0 14.8 15.0 15.5 15.8 16.4 18.6 22.8 19.3 10.9 8.0 9.0 10.0 10.0 B.REAL(CPI) (X) -2.65 8.53 -7.78 -8.15 0.20 5.11 1.69 0.28 -4.58 -1.65 3.40 4.47 6.54 7.35 7.56 SOURCE: INTERNATIONAL FINANCIAL STATISTICS. IMF. BALANCE OF PAYMENTS STATISTICS, IMF. (COUCLUDED) - 125 - APPENDIX KOREA TABLE 2: DEBT/EQUITY RATIO OF MANUFACTURING FIRMS (%) YEAR 1961 1965 1969 1971 1972 1973 1974 1975 1976 RATIO 135.9 93.7 270.0 313.4 313.4 272.7 316.0 339.5 364.6 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 367.2 366.8 377.1 487.9 451.5 385.8 360.3 342.7 348.4 350.9 SOURCE: FINANCIAL STATEMENT ANALYSIS, BOK, VARIOUS ISSUES. APPENDIX ROREA TABLE 3: INTEREST RATES AND CPI GROWTH RATE(X) YEAR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 DEPOSIT RATE 15.3 12.0 14.8 15.0 15.5 15.8 16.4 18.6 22.8 19.3 10.9 8.0 9.0 10.0 10.0 LENDINC RATE 15.9 15.5 15.5 15.5 16.1 16.3 16.9 18.5 22.9 19.3 12.3 10.0 10.3 10.8 10.8 CPI GROWTH RATE 18.8 3.2 24.5 25.2 15.3 10.2 14.5 18.3 28.7 21.3 7.3 3.4 2.3 2.5 2.3 SOURCE: ECONOMIC STATISTICS YEARBOOK, BOK, VARIOUS ISSUES APPENDIX KOREA TABLE 4: VARIOUS LENDING INTEREST RATES (% p.a.) --------------------------------------------------------------------__-------__-- 1969 1974 1979 1980 1982 -------------------------------------------------------------------__--------__-- I.COMMERCIAL BANKS DISCOUNT OR BILLS UP TO 1 YEAR 24.5 15.5 18.7. 24.5 10.0 EXPORTS 6.0 9.0 9.0 15.0 10.0 INTERMEDIATE PURCHASES IN FOREIGN CURRENCY 6.0 9.0 9.0 15.0 10.0 EQUIPMENT FOR EXPORT INDUSTRIES - 12.0 15.5 21.0 10.0 EQUIPMENT FOR MACHINERY INDUSTRIES 12.0 12.0 15.0 21.0 10.0 II.KOREA DEVELOPMENT BANK POWER, SHIPBUILDING, COAL, SHIPPING 7.5 7.5 7.5 7.5 10.0 INDUSTRIES: EQUIPMENT 12.0 12.0 15.0 21.0 10.0 LOANS FROM FOREIGN FUNDS 9.1 9.0 9.1 9.1 7.5 III.MEDIUM INDUSTRIY BANK EQUIPMENT FOR MEDIUM INDUSTRIES (OWN FUNDS) 20.0 15.5 19.0 24.5 10.0 EQUIPMENT FOR MEDIUM INDUSTRIES (GOVERNMENT FUNDS) 12.0 10.0 13.5 19.5 10.0 EQUIPMENT FOR MEDIUM INDUSTRIES (FOREIGN FUNDS) 8.0 8.0 8.5 8.5 12.7 --------------------------------------------------------------------__-------__-- SOURCE: BANK OF KOREA, ECONOMIC STATISTICS YEARBOOK. AND MONTHLY ECONOMIC STATISTICS. APPENDIX KOREA TABLE 5: SHARES OF KOREAN FINANCIAL INSTITITIONS (IN PERCENT) LOANS AVERAGE DEPOSITS AVERAGE ................................. INCREASE . ................................. INCREASE 1971 1976 1983 1984 RATES 1971 1976 1983 1984 RATES DEPOSIT MONEY BANKS 76.3 68.2 53.4 51.1 30.0 83.7 74.8 55.9 52.7 29.4 COHYERCIAL BANKS 47.2 44.2 31.0 29.6 29.4 54.4 49.6 33.5 31.7 28.6 (NATIONWIDE COMHERCIAL BANKS) (42.7) (35.3) (23.8) (22.0) (27.5) (49.2) (40.9) (27.1) (25.4) (27.4) SPECIALIZED BANKS 29.1 24.1 22.4 21.5 31.0 29.3 25.2 22.4 21.0 30.7 NON-BANK FINANCIAL INSTITUTIONS 23.7 31.8 46.6 48.9 41.8 16.3 25.2 44.1 47.3 45.6 DEVELOPMENT INSTITUTIONS 13.9 15.9 16.5 15.8 35.4 1.3 0.7 0.5 0.4 23.3 SAVINGS INSTITUTIONS 9.0 6.4 10.6 11.4 36.6 11.3 10.9 13.8 13.8 36.2 INVESTMENT COMPANIES 0.1 8.7 14.6 15.8 74.7 - 10.1 21.9 23.8 94.1 LIFE INSURANCE COMPANIES 0.7 0.7 4.9 5.9 58.7 3.7 3.5 7.9 9.3 44.0 SOURCE: FINANCIAL SYSTEM IN KOREA, BOK, 1985. - 129 - APPENDIX KOREA TABLE 6: VARIOUS INTEREST RATES GENERAL LOAN CORPORATE CURB YEAR RATE BOND MARKET 1973 15.5 33.3 1974 15.5 - 40.6 1975 15.5 20.1 41.3 1976 17.0 20.4 40.5 1977 18.0 20.1 38.1 1978 19.0 21.1 41.2 1979 19.0 26.7 42.4 1980 20.0 30.1 44.9 1981 18.0 24.4 35.3 1982 10.0 17.3 33.1 1983 10.0 14.2 25.8 1984 10.8 14.1 24.8 1985 10.8 14.2 24.0 1986 10.8 12.8 23.1 SOURCE: ECONOMIC STATISTICS YEAR BOOK, BANK OF KOREA. INTERNATIONAL FINANCIAL STATISTICS, IMF. - 130 - APPENDIX KOREA TABLE 7: CHANGE IN MINIMUM RESERVE REQUIREMENT RATIOS EFFECTIVE FROM DEMAND DEPOSITS TIME AND SAVINGS DEPOSITS 1978 JAN. 1 24.0(17.0)[17.0] 17.0(12.0)[12.0] FEB.23 25.0(18.0)[14.0] 18.0(14.0)[13.0] MAR.23 26.0(21.0)[19.0] 19.0(16.0)[14.0] APR.23 27.0(22.0)[20.0] 20.0(17.0)[15.01 1980 JAN. 8 20.0(15.0)[13.0] 11.0( 8.0)[ 6.0] SEP.23 14.0(10.0)[ 8.0] 10.0( 7.0)[ 5.0] 1981 JUL. 1 5.5 5.5 NOV.23 3.5 3.5 1982 MAY 23 5.5 5.5 1984 SEP. 8 4.5 4.5 1985 JUL.23 4.5 4.5 NOTE: FIGURES IN ( ) REPRESENTS THE RATIO APPLICABLE TO AGRICULTURAL COOPERATIVES, AND THOSE IN [ ] REPRESENTS THE RATIOS APPLICABLE TO FISHERIES COORPERATIVES. SOURCE: MONTHLY BULLETIN, BANK OF KOREA, VARIOUS ISSUES. APPENDIX KOREA TABLE 8: GROWTH OF FINANCIAL SECTOR 1965 1968 1970 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 11/GNP NA 10.8 NA 12.0 11.0 12.0 11.0 11.0 10.0 9.0 11.0 12.0 10.0 10.0 11.0 N2IGNP 12.1 25.2 35.0 31.2 30.3 32.4 32.7 31.6 33.7 34.2 38.4 39.3 37.7 39.2 40.4 M31GNP - - - 36.0 38.7 38.1 45.5 42.1 42.8 47.8 50.9 59.9 64.7 75.2 82.5 CORPORATE BOND/GNP - - - - 0.93 1.61 2.46 3.58 5.02 5.71 6.73 7.66 8.27 10.15 10.43 DOMESTIC CREDIT/GNP - - - - 37.24 35.98 38.75 40.94 53.69 51.38 57.18 57.03 57.29 61.48 61.21 CREDIT SHARE BANKs - - 77.8 65.2 66.7 66.1 63.2 61.1 59.8 58.0 55.3 54.3 - NBFIs - - 22.2 34.8 33.3 33.9 36.8 38.9 40.2 42.0 44.7 45.7 NATIONAL SA7ING (AS X OF GNP) 7.4 15.1 15.7 19.1 23.7 27.5 28.5 28.1 21.9 21.7 22.4 24.8 27.4 28.6 32.5 STOCK MARKET CAPITALIZATION/GNP - - - - - - 6.89 6.56 6.51 5.92 7.75 9.02 14.31 SOURCE: FISCAL AND FINANCIAL STATISTICS, MINISTRY OF FINANCE, KOREA. FACTBOOK, WORLD BANK, 1986. - 132 - APPENDIX KOREA TABLE 9: DEPOSIT SHARE OF BANKS AND NBFIs (100 MILl.IONS OF WON)/a 1974 1978 1980 1982 1983 1984 JUN. 1985 BANK/b 21933 68831 115375 188474 220956 248188 275127 (85.7) (79.3) (73.3) (64.6) (60.9) (57.6) (58.6) NON-BANK 3666 18014 42085 103305 144745 182679 194714 (14.3) (20.7) (26.7) (35.4) (39.1) (42.4) (41.4) INVESTMENT AND FINANCE COMPANIES 1622 9407 20984 42273 54971 70118 64990 INVESTMENT AND TRUST COMPANIES 53 2413 6351 27683 36536 43129 49027 MUTURAL SAVINGS & FINANCE COMPANIES 507 1607 4000 9566 14743 19917 23878 LIFE INSURANCE COMPANIES 978 3514 9427 22087 33634 47383 54368 OTHERS 506 1073 1323 1696 1861 2286 2451 TOTAL 25599 86845 157460 291779 365701 430867 469841 a/ FIGURES IN ( ) ARE PERCENTAGE SHARES. b/ INCLUDES MONEY TRUST, COMMERCIAL BILLS AND DEMAND DEPOSITS. SOURCE: MINISTRY OF FINANCE, "FISCAL AND FINANCIAL STATISTICS." - 133 - APPENDIX KOREA TABLE 10: PROFITABILITY OF FINANCIAL INSTITUTIONS (PROFIT RATIOS)/a PERIOD 1977-79 1980-82 1983 1984 NATIONWIDE CITY BANKS 0.95 0.55 0.13 0.26 LOCAL BANKS 1.26 0.83 0.25 0.74 INVESTMENT & FINANCE COMPANIES 4.47 4.13 1.50 - MERCHANT BANKING COMPANIES 3.93 5.03 2.70 - INVESTMENT & TRUST COMPANIES 0.88 8.83 9.40 - /a NET PROFITS DIVIDED BY TOTAL ASSETS SOURCE: FEDERATION OF KOREAN BANKS, THE ANALYSIS OF THE EFFICIENCY OF BANKING INDUSTRY AND SUGGESTIONS FOR HIGHER EFFICIENCY (KOREA), 1985. - 134 - APPENDIX KOREA TABLE 11: EXTERNAL FUND OF CORPORATE BUSINESS SECTOR UNIT: MILLION WON 1965-69 1970-74 1975-79 1980-84 INDIRECT FINANCING 87.8 391.2 1885.7 5284.4 (RATIO TO TOTAL) 47.4% 55.9% 56.5% 53.0% BORROWING FROM 87.8 387.9 1883.7 5001.8 FINANCIAL INSTITUTIONS 47.4% 55.4% 56.5% 50.2% BANKS 69.5 282.8 1197.9 2372.9 (RATIO TO TOTAL) 37.5% 40.4% 35.9% 23.8% NON-BANKS 18.3 105.1 685.8 2628.9 (RATIO TO TOTAL) 9.9% 15.0% 20.6% 26.4% GOVERNMENT LOANS - 3.3 2.0 282.6 (RATIO TO TOTAL) ( - ) 0.5% 0.1% 2.8% DIRECT FINANCING 27.1 145.3 767.9 4083.7 (RATIO TO TOTAL) 14.6% 20.8% 23.0% 41.0% STOCK 26.4 124.6 458.0 2059.3 (RATIO TO TOTAL) 14.3% 17.8% 13.7% 20.7% BONDS 0.7 12.0 216.5 1441.9 (RATIO TO TOTAL) 0.4% 1.7% 6.5% 14.5% COMMERCIAL PAPER - 8.7 93.4 582.5 (RATIO TO TOTAL) ( - ) 1.2% 2.8% 5.8% FOREIGN DEBTS 70.2 163.3 681.1 601.6 (RATIO TO TOTAL) 37.9% 23.3% 20.4% 6.0% TOTAL 185.2 699.8 3334.7 9969.7 (RATIO TO TOTAL) 100.0% 100.0% 100.0% 100.0% SOURCE: FLOW OF FUND ACCOUNTS, BANK OF KOREA. APPENDIX KOREA TABLE 12: MOVEMENT OF DOMESTIC AND FOREIGN INTEREST RATES YEAR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.EURO DOLLAR 6 MONTH 7.77 9.40 10.84 7.75 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.93 11.29 8.64 6.85 2.DWMESTIC LENDING RATE 15.9 15.5 15.5 15.5 16.1 16.3 16.9 18.5 22.9 19.3 12.3 10.0 10.3 10.8 10.8 3.EFFECTIVE COST 5.30 - 12.55 28.94 6.12 6.37 9.20 12.15 43.11 30.86 21.95 16.65 15.63 17.27 8.25 4.NONINAL EXCHANGE RATE : 464.12 398.32 404.47 484.00 484.00 484.00 484.00 484.00 607.43 681.03 731.08 775.75 805.98 870.02 881.45 5. - 1 - 2 -8.08 -6.10 -4.66 -7.75 -9.98 -9.93 -7.70 -6.35 -8.87 -2.58 1.30 -0.07 0.99 -2.16 -3.95 6. - 3 - 2 -2.36 - -2.95 13.44 -9.98 -9.93 -7.70 -6.35 20.21 11.56 9.65 6.65 5.33 6.47 -2.55 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, VARIOUS ISSUES UL CHART Kl: MOVEMENT OF CPI,LENDING RATE KOREA do0- 501 40 - 10 E3 B ---a S E3,E 30 -10 0J 2 3 4 81.123 4 82.1 2 3 4 83.1 2 3 4 54.1 2 3 485J 2 3 4 QUARTER o LENDING RATE + CPI OROWTH RATE CHART K2: INTEGRATION OF INTEREST RATES KOREA 50 40 J 30 -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~- 20 - 10 1974 1975 1970 1Q77 1978 1979 10 19Q 1082 1983 1084 1 1 YEAR 0 GENERAL LOAN RATE + CORPORATE BOND RATE O CURB MARKET RATE CHART K3: INTEREST RATES SPREAD KOREA 30 - 28 - 26 24 - 22 20 18 14J ~ 1 16 14 1974 1975 1976 1977 1978 1079 1Q60 106 198 1Q63 1984 106 196 YEAR o BANK LOAN RATE + TIME DEPOSIT RATE CHART K4: MOVEMENT OF INTEREST RATES 30 - 28- 26- 24 22 20 18 1 6 14 12 - 10 8 6 4 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 YEAR 0 DEPOSIT RATE + LENDING RATE O CPI GROWTH RATE CHART K5: GROWTH OF FINANCIAL SECTOR KOREA 90- 80 70 - 60 30~~~~~~~~~~~~~~~~~~~~ 50 40- 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 YEAR 0 M2/GNP + M3/GNP APPENDIX MALAYSIA TABLE 1-&: MACROECONONIC INDICATORS YEA SOURCE AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE 7.11 - 8.41 0.81 11.6S 7.71 6.52 9.32 7.51 6.91 6.0S 6.2Z 7.8S -1.11 1.0S NOKINAL GDP GROWTH RATE 15.2S - 22.1S -2.31 25.81 15.21 17.11 22.51 14.81 8.1S 8.6Z 11.2Z 14.4Z -2.51 -7.51 II.rINvESTMENT SAVINGS(RATIO TO GNP) GROSS DOMESTIC INVESThENT 28.7X 27.7Z 33.61 27.31 25.71 28.01 27.9S 30.32 31.61 36.32 39.12 38.51 36.01 29.72 27.81 GROSS DOMESTIC SAVINGS 33.6S 33.6Z 34.0X 27.9X 36.61 35.91 33.7S 39.61 34.2S 29.82 30.01 32.91 38.02 35.31 34.01 PUBLIC 3.92 2.9S 4.02 2.4S 4.62 4.62 5.31 3.22 1.51 4.52 5.91 9.11 9.82 0.02 0.01 PRIVATE 21.92 23.02 21.02 18.52 24.62 23.72 23.51 28.62 26.02 18.82 16.72 15.31 15.31 16.21 21.42 III.CHANGE IN M2/SAVING 0.210 - 0.160 0.214 0.280 0.187 0.218 0.240 0.325 0.295 0.295 0.166 0.166 0.121 0.238 CHANGE IN K2/ PRIVATE SAVING 0.321 - 0.260 0.323 0.417 0.284 0.313 0.332 0.427 0.470 0.529 0.355 0.413 0.263 0.378 CHANGE IN M3/ PRIVATE SAVING 0.404 0.356 0.402 0.500 0.358 0.398 0.412 0.532 0.661 0.692 0.633 0.788 0.475 0.467 IV.ICOR-NGDI/NGDP/RGDP GROWTH RATE 10.60 - 3.84 32.95 2.13 3.49 4.11 3.10 4.07 5.07 6.22 5.78 4.31 -26.09 26.71 V.BALANCE OF PAYMENT CURRENY ACCOUNT/GDP -0.622 1.37X -5.74X -5.31X 5.27Z 3.312 0.64Z 4.381 -1.161 -9.94X -13.445 -11.67Z -4.931 -2.35Z -1.062 CAPITAL ACCOUNT/GDP 5.572 4.452 8.602 7.012 4.65Z 2.002 3.99Z 0.912 5.842 10.462 13.972 12.871 8.921 6.181 4.562 LONG TERM DEBT IN USS MIL - - - 1843 - - - 5196 7318 11336 14557 16094 18056 19650 LONG TERM DEBT/GDP _ _ - 19.82 - - _ - 21.22 29.32 42.32 48.62 47.41 57.81 70.72 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IM. WORLD DEBT TABLE, WORLD BANK. (CONTINUED) 4I- APPENDIX MALAYSIA TABLE 1-b: MACROECONOMIC INDICATORS YEAR SOURCE AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VI.FISCAL DEFICIT/GNP -7.48 -5.501 -5.991 -8.36S -7.06S -8.501 -8.002 -8.301 -13.601 -19.741 -18.681 -14.021 -9.521 -8.3SZ -11.29X DOMESTIC FINANCING/CNP 5.2S 4.6Z 3.61 5.31 6.71 5.01 3.22 5.71 4.51 8.31 10.21 6.8X 4.31 5.01 7.41 FOREIGN FINANCINGIGNP 1.91X 0.36Z 0.99S 4.001 1.311 1.641 1.502 1.531 0.601 5.211 8.181 6.981 4.161 1.09X 2.031 VII.INFLATION CPI 7.32X - 17.41 4.51 2.61 4.8Z 4.9X 3.61 6.71 9.72 5.81 3.71 3.92 0.32 0.71 GDP DEFLATOR 7.291 - 12.71 -3.1S 12.72 6.92 10.02 12.11 6.81 1.12 2.51 4.61 6.12 -1.52 -8.42 VIII.TERMS OF TRADE(1970 -100) - - - - - - - - 95.0 77.7 69.9 77.3 80.6 75.2 72.2 IX.EXCHANGE RATE A.SDR :rb 2.9023 2.9128 2.8948 2.9064 2.9343 2.8736 2.8997 2.8275 2.8333 2.7169 2.5783 2.4814 2.4023 2.5211 3.0285 B.USS :rf 2.4510 2.4433 2.4071 2.3938 2.5416 2.4613 2.3160 2.1884 2.1769 2.3041 2.3354 2.3213 2.3436 2.4830 2.5814 X.REAL EFFECTIVE EXCHANGE INDICES(1980-100) - - - 108.5 105.9 101.4 103.8 100.0 100.4 106.7 111.8 116.1 110.3 92.6 XI.DEPOSIT RATE A.NOKINAL 7.63 8.00 9.00 7.50 7.50 6.50 6.50 7.00 9.00 11.00 10.00 9.00 10.75 7.50 7.00 B.REAL(CPI) 0.54 - -7.15 2.88 4.81 1.61 1.52 3.25 2.19 1.19 3.95 5.11 6.59 7.13 6.22 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. (CONCLUDED) 4I- APPENDIX MALAYSIA TABLE 2: GROWTH OF THE FINANCIAL SECTOR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 M2tGNP (1) 45.3 41.6 39.9 46.3 47.3 47.8 48.4 49.0 53.4 58.2 63.0 63.2 61.8 68.1 81.6 M31GNP (X) 53.7 47.5 46.7 54.7 56.1 57.2 58.5 59.5 65.2 72.6 79.2 82.3 84.4 94.8 112.3 GROSS NATIONAL SAVINGSIGNP (X) 32.3 25.9 25.0 20.9 29.2 28.3 28.6 34.8 30.7 26.4 25.2 26.5 30.0 28.5 26.0 NOTE: M3 - K2 + MERCRANT COMPANY'S AND FINANCE COMPANY'S DEPOSITS SOURCE: QUARTERLY BULLETIN, BANK NEGARA MALAYSIA, VARIOUS ISSUES. 2s APPENDIX MALAYSIA TABLE 3: GROWTH OF K21GNP OF FIVE COUNTRIES AVR 74-77 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 INDONEISA 16.4 14.3 16.7 17.6 17.1 17.5 16.9 17.7 17.3 18.3 20.9 21.5 25.1 - KOREA 31.9 32.7 31.3 30.4 33.1 33.1 32.1 34.2 34.7 39.2 38.9 40.9 39.2 40.4 MALAYSIA 45.3 39.9 46.3 47.3 47.8 48.4 49.0 53.4 58.2 63.0 63.2 61.8 68.1 81.6 PHILIPPINES 18.4 16.8 16.8 18.6 21.2 22.8 20.8 21.0 21.6 23.5 25.3 20.9 20.9 22.2 SRILANKA 23.6 21.5 20.2 24.6 28.2 29.7 31.7 31.7 30.2 31.9 32.0 30.0 31.3 29.3 SOURCE: IRTERNATIONAL FINANCIAL STATISTICS, IMF, 1987. 4I SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF, 1987. 4 - 145 - APPENDIX MALAYSIA TABLE 4-a: ASSETS OF VARIOUS FINANCIAL SECTORS UNIT: MI1L OF RINGGIT AS AT END OF SECTOR 1960 1970 1980 1985 1986 BANKING SYSTEM 2356 7455 54346 118293 129470 MONETARY INSTITUTIONS 2346 6882 45180 91342 100237 CENTRAL BANK 184 2227 12994 16525 20201 CURRENCY BOARD 930 195 - - - COMMERCIAL BANKS 1232 4460 32186 74817 80036 NON-MONETARY INSTITUTIONS 10 573 9166 26956 29233 FINANCE COMPANY 10 531 5635 17833 19635 MERCHANT BANKS - - 2229 6296 6374 DISCOUNT HOUSES 42 1292 2827 3224 CREDIT GUARANTEE CORPORATION - - 10 - - NON-BANK FINANCIAL INTERMEDIARIES 1197 4167 19807 49977 57656 PROVIDENT, PENSION AND INSURANCE FUNDS 836 3156 13846 32643 37225 EMPLOYEES PROVIDENT FUND 633 2265 9481 24708 28467 OTHER PROVIDENT FUNDS 100 452 1889 2904 3265 LIFE INSURANCE FUNDS 83 324 1657 3646 4080 GENERAL INSURANCE FUNDS 20 115 819 1385 1413 DEVELOPMENT FINANCE INSTITUTIONS 1 133 2193 4044 4348 SAVINGS INSTITUTIONS 267 645 2463 7434 6565 OTHER FINANCIAL INTERMEDIARIES 93 233 1305 5856 7518 TOTAL 3553 11622 74153 168275 187126 SOURCE: BANK NEGARA MALAYSIA. (CONTINUED) - 146 - APPENDIX MALAYSIA TABLE 4-b: SHARES OF ASSETS OF VARIOUS FINANCIAL SECTORS AS AT END OF SECTOR 1960 1970 1980 1985 1986 BANKING SYSTEM 66.31% 64.15% 73.29% 70.30% 69.19% MONETARY INSTITUTIONS 66.C)3% 59.22% 60.93% 54.28% 53.57% CENTRAL BANK 5.18% 19.16% 17.52% 9.82% 10.80% CURRENCY BOARD 26.18% 1.68% - - - COMMERCIAL BANKS 34.67% 38.38% 43.40% 44.46% 42.77% NON-MONETARY INSTITUTIONS 0.28% 4.93% 12.36% 16.02% 15.62% FINANCE COMPANY 0.28% 4.57% 7.60% 10.60% 10.49% MERCHANT BANKS - - 3.01% 3.74% 3.41% DISCOUNT HOUSES - 0.36% 1.74% 1.68% 1.72% CREDIT GUARANTEE CORPORATION - - 0.01% - - NON-BANK FINANCIAL INTERMEDIARIES 33.69% 35.85% 26.71% 29.70% 30.81% PROVIDENT, PENSION AND INSURANCE FUNDS 23.53% 27.16% 18.67% 19.40% 19.89% EMPLOYEES PROVIDENT FUND 17.82% 19.49% 12.79% 14.68% 15.21% OTHER PROVIDENT FUNDS 2.81% 3.89% 2.55% 1.73% 1.74% LIFE INSURANCE FUNDS 2.34% 2.79% 2.23% 2.17% 2.18% GENERAL INSURANCE FUNDS 0.56% 0.99% 1.10% 0.82% 0.76% DEVELOPMENT FINANCE INSTITUTIONS 0.03% 1.14% 2.96% 2.40% 2.32% SAVINGS INSTITUTIONS 7.51% 5.55% 3.32% 4.42% 3.51% OTHER FINANCIAL INTERMEDIARIES 2.62% 2.00% 1.76% 3.48% 4.02% TOTAL 100.00% 100.00% 100.00% 100.00% 100.00% SOURCE: BANK NEGARA MALAYSIA. (CONCLUDED) APPENDIX MALAYSIA TABLE 5: INTEREST RATES IN MALAYSIA ( X p.a.) 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 SEP COMMERCIAL BANKS DEPOSIT RATES: FIXED - 1 MoNTH 4.50 3.50 3.50 3.00 5.00 5.25 8.50 9.00 9.00 8.25 10.00 7.25 6.00 2.00 6 MDNTHS 7.00 6.00 6.00 5.50 5.75 5.75 8.50 10.50 9.25 8.50 10.50 7.50 6.75 3.0/3.25 12 MONTHS 9.00 7.50 7.50 6.50 6.50 7.00 9.00 11.00 10.00 9.00 10.75 7.50 7.00 4.00 SAVING - - - 5.00 5.00 5.00 6.00 7.00 6.50 6.00 7.50 6.00 6.00 3.50 LOAN RATES: PRIME RATES /b 10.00 8.50 8.50 7.50 7.50 7.50 8.50 8.50 8.50 8.50 8.50 10.75 10.00 7.50 AVRAGE LENDING RATE lc - - - 9.47 9.34 9.42 10.13 11.99 12.30 11.60 12.81 12.11 12.02 9.82/d FINANCE COMPANIES DEPOSIT RATES: FIXED - 1 MONTH - - - - - - 9.50 10.50 9.00 9.00 10.75 8.00 7.50 3.00 6 MONTHS - - - - 6.00 7.00 9.50 11.00 9.25 9.50 11.00 8.00 7.50 3.50 12 MONTHS - - - - 7.30 8.00 10.50 12.00 10.00 9.75 11.00 8.25 7.75 4.50 SAVING - - - - 7.00 7.00 7.00 7.00 8.00 8.00 9.00 7.00 7.00 5.50 LOAN RATES: AVRAGE LENDING RATE /c - - - - 10.45 10.23 10.39 11.76 12.33 12.01 12.23 14.66 13.96 12.93/d GENERAL TREASURY BILL RATES Ic 3 MONTHS 4.886 4.973 4.379 3.564 4.212 3.470 4.460 4.500 5.124 5.196 5.060 4.129 3.887 2.615 INTERBANK RATES /f OVERNIGHT 2.728 4.205 2.623 4.829 2.470 4.372 3.308 3.467 5.237 8.354 5.931 4.973 1.653 3.010/d SEVEN-DAY 5.025 7.849 4.941 5.681 4.116 5.258 5.946 6.297 7.947 9.412 9.087 6.594 3.038 2.625/d 3 MONTHS - - - - - - 9.367 8.628 8.628 9.256 9.210 7.785 6.350 2.992/d MEMO INFLATION RATE /g 17.4 4.4 2.6 4.7 5.0 3.6 6.6 9.7 5.8 3.7 3.9 0.3 0.7 1.5 - -- --- - -- -- -- --- - - -- -- _--- - -- - - - - - - - - -- - - - -- - - -- - - - - --_- - -------__----- ---------------__ --- ------- ---- ---- -_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ /a MAY 1985, EXCEPT FOR CONSUMER PRICE INDEX WHICH HAS BEEN ESTIMATED FOR 1985. /b ON ADVANCES /c REFERS TO WEIGHTED AVERAGE LENDING RATE AGGREGATED FROM QUARTERLY DATA. PRIOR TO SEPTEMBER 1986 ONLY QUARTERLY ARE AVAILABLE. /d AUGUST 1987 /e AVERAGE DISCOUNT RATE ON 3-MONTHS BILLS /f DAILY AVERAGE FOR WEEK, REFERS TO INTERBANK LENDING RATES OF TEN BANKS. /g ANNUAL PERCENTAGE CHANGE IN CONSUMER PRICE INDEX. SOURCE: BANK NEGARA MALAYSIA, QUARTERLY ECONOMIC BULLETIN, MARCH-JUNE 1986, TABLE IV.2, IV.3, IV.4, rV.5: DATABASE TABLE 6.1 FOR INFLATION RATE. - 148 - APPENDIX MALAYSIA TABLE 6: BANKING INDUSTRY STRUCTURE, 1975-1983 (IN PERCENT) 1975 1978 1981 1982 1983 1984 JUNE SHARE IN TOTAL DEPOSITS OF: TOP 3 BANKS 44.3 43.9 4399 43.9 42.1 39.4 TOP 5 BANKS 63 61.9 57.8 57.5 54.9 53.8 TOP 10 BANKS 83.7 81.7 78 77.5 76.2 75.9 SMALLER BANKS 16.3 18.3 22 22.5 23.8 24.1 RATIO OF PROFIT TO TOTAL ASSETS 2.15 2.66 1.91 2.03 - - SOURCE: BANK NEGARA MALAYSIA. APPENDIX MALAYSIA TABLE 7: MOVEMENT OF DOMESTIC AND FOREIGN INTEREST RATES AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.EURO DOLLAR: 6 MOHuT 7.77 9.40 10.84 7.75 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.93 11.29 8.64 6.85 2.DOEESTIC BANK DEPOSIT RATE:6m - 6.25 7.00 6.00 6.00 5.25 5.75 5.75 8.50 10.50 9.25 8.50 10.50 7.50 6.75 3.EFPECTIVE COST - - 9.20 7.15 12.67 3.01 2.75 5.97 13.43 23.54 15.14 9.27 12.36 15.10 11.08 4.NONIMAL EXCHANGE RATE:rf 2.4510 2.4433 2.4071 2.3938 2.5416 2.4613 2.3160 2.1884 2.1769 2.3041 2.3354 2.3213 2.3436 2.4830 2.5814 5. - 1 - 2 - 3.15 3.84 1.75 0.12 1.12 3.45 6.40 5.53 6.22 4.35 1.43 0.79 1.14 0.10 6. - 3 - 2 - - 2.20 1.15 6.67 -2.24 -3.00 0.22 4.93 13.04 5.89 0.77 1.86 7.60 4.33 SOURCE: QUARTERLY BULLETIN, BANK NEGARA MALAYSIA, VARIOUS ISSUES. - 150 - APPENDIX MALAYSIA TABLE 8: LOANS-DEPOSITS GROWTH IN THE BALNKING SYSTEM UNIT: $ MILLION 1975 1980 1983 1985 1986 I.LOANS COMMERCIAL BANKS 892.8 5771.3 7116.2 5477.4 3347.0 FINANCE COMPANIES 178.9 920.6 1710.8 2259.5 675.2 MERCHANT BANKS 150.6 346.2 944.4 345.3 -80.9 TOTAL 1222.3 7038.1 9771.4 8082.2 3941.3 II.DEPOSITS COMMERCIAL BANKS 1069.6 4915.8 5450.1 4100.8 3791.8 FINANCE COMPANIES 236.7 1250.5 1752.5 1894.3 1491.6 MERCHANT BANKS 80.8 158.8 1027.5 560.2 -228.8 TOTAL 1387.1 6325.1 8230.1 6555.3 5054.6 LOANS-DEPOSITS 164.8 -713.0 -1541.3 -1526.9 1113.3 GAP(-) SURPLUS(+) LOANS-DEPOSITS RATIO (%) 77.9 86.8 90.6 94.0 92.9 SOURCE: BANK NEGARA MALAYSIA. APPENDIX MALAYSIA TABLE 9: THE OPERATING COSTS OF MALAYSIAN BANKS (1984) ( IN PERCENT ) MALAYSIA FRANCE GERMANY ITALY SPAIN PERFORMANCE AS RATIO OF TOTAL ASSETS INTEREST MARGIN 2.19 2.64 2.24 3.09 4.14 EARNING MARGIN 3.06 3.06 2.91 4.33 4.95 OPERATING COST 1.04 2.03 2.20 2.41 3.10 PERSONNEL EXPENSES 0.95 1.39 1.52 1.92 2.28 NET INCOME 2.02 1.03 0.71 1.92 1.85 GROSS PROFITS 1.37 0.43 0.49 0.70 0.76 DEPRECIATION AND PROVISION FOR BAD DEBT 0.31 0.60 0.22 1.25 1.09 AS RATIO OF EARNING MARGIN NET NONINTEREST INCOMES 28.49 13.87 23.16 28.82 16.29 OPERATING COSTS 34.07 66.27 75.55 55.71 62.59 /a FDIC banks only. /b Data refers to 1979. SOURCE: BANK NEGARA MALAYSIA. FRANCO PASSACANTANTO, "COST AND MARGINS I ITALIAN BANKING SYSTEM: A COMPARATIVE ANALYSIS," ITALIAN CREDIT S STRUCTURE, BANC D'ITALIA, 1984. - 152 - APPENDIX MALAYSIA TABLE 10: THE EXPANSION OF BRANCHES: MALAYSIA NO. OF COMMERCIAL BANKS NUMBER OF NUMBER OF ---------------------------- FINANCE COMPANIES FINANCE COMPANIES OF TOTAL ----------------- ----------------- WHICH NO. OF NO. OF NO. OF YEAR-END TOTAL FOREIGN BRANCHES TOTAL BRANCHES TOTAL BRANCHES 1970 38 15 336 29 168 1 - 1971 37 15 344 30 169 2 - 1972 37 16 356 31 173 3 - 1973 36 16 369 32 174 5 - 1974 35 16 386 32 175 8 - 1975 36 16 403 32 175 11 - 1976 36 16 429 33 180 12 1 1977 37 16 461 33 189 12 1 1978 37 16 509 33 197 12 1 1979 38 16 529 36 206 12 1 1980 38 16 546 37 214 12 1 1981 38 16 573 39 230 12 2 1982 38 16 608 40 248 12 3 1983 38 16 664 41 275 12 4 1984 38 16 716 43 303 12 4 1985 38 16 770 47 372 12 5 SOURCE: BANK NEGARA MALAYSIA. APPENDIX MALAYSIA TABLE 11: MATURITY OF DEPOSITS (IN MILLION OF RINGGITS AND PERCENT) TOTAL DEMAND SAVING FIXED PERCENTSHARE OF EACH MATURITY IN TOTAL FIXED DEPOSITS DEPOSITS DEPOSITS DEPOSITS DEPOSITS 1 MONTH 3 MONTH 6 MONTH 9 MONTH 12 MONTH 12m. > 1973 6078 2030 1067 2981 33.4X 17.62 49.02 2.9X 13.92 13.92 8.42 54.12 6.82 1975 8099 2197 1583 4319 27.1X 19.52 53.32 2.22 7.8X 11.62 4.52 66.62 7.22 1976 10508 2728 1905 5875 26.02 18.12 55.92 1.02 5.72 12.22 7.1X 64.22 9.72 1977 12220 3191 2444 6586 26.1X 20.02 53.92 1.1X 5.62 8.32 1.7X 69.82 13.32 1978 14700 3802 2972 7926 25.92 20.22 53.92 5.82 5.92 7.22 1.2X 57.72 22.22 1979 19141 4549 3567 11026 23.82 18.62 57.6X 4.02 6.92 7.32 1.22 59.12 26.52 1980 23326 5326 4184 13817 22.8X 17.9X 59.22 10.82 8.82 6.52 2.52 42.4X 28.82 1981 28107 6235 4214 17658 22.22 15.02 62.82 23.52 26.9X 5.62 1.62 25.62 16.82 1982 33043 7224 4674 21145 21.92 14.1X 64.02 18.02 18.72 11.62 2.62 32.5X 16.52 1983 37124 8063 5630 23431 21.72 15.22 63.12 20.62 13.62 10.82 1.32 30.52 23.2X 1984 42575 8088 5534 28953 19.02 13.02 68.02 22.52 19.42 7.32 1.12 24.02 25.62 1985 45853 7950 6246 31657 17.32 13.62 69.02 15.12 17.62 11.72 4.62 20.9Z 30.12 1986 48478 7598 7162 33718 15.7X 14.82 69.62 14.22 12.52 6.62 2.32 9.32 55.12 1987 52038 8087 8019 35932 15.52 15.4X 69.02 8.22 13.8X 9.1% 2.62 10.12 56.22 SOURCE: BANK NEGARA MALAYSIA. - 154 - APPENDIX MALAYSIA TABLE 12: TERM DISTRIBUTION OF COMMERCIAL BANK LENDING, 1970-85 UNIT: MIL OF RINGGIT 1970 1975 1980 1983 1984 1985 TOTAL LOAN AND ADVANCES 2359.6 6468.4 21031.1 36781.8 43504.3 48981.7 TRADE BILLS 284.1 717.0 2570.9 3979.7 3923.8 4375.4 OVERDRAFT AND LOANS LESS THAN 1 YEAR 1917.0 4228.3 11876.6 18627.9 22276.7 24912.9 TERM LOANS 1-4 YEARS 56.3 268.1 1167.7 2537.8 2916.2 3383.8 TERM LOANS OVER 4 YEARS 102.2 1255.0 5415.9 11636.4 14387.6 16309.6 TERM LOANS OVER 4 YEARS/TOTAL(%) 4.3 19.4 25.8 31.6 33.1 33.3 SOURCE: BANK NEGARA MALAYSIA. APPENDIX MALAYSIA TABLE 13: ALLOCATION OF BANK CREDIT/a 1979 1980 1981 1982 1983 1984 1985 1986 AGRICULTURE 7.96% 8.66% 8.54% 8.44% 7.95% 7.56% 7.03% 6.97% MINING &QUARRYING 0.92% 1.02% 1.09% 1.53% 1.62% 1.13% 1.01% 0.88% MANUFACTURE 20.63% 20.40% 21.47% 19.44% 19.05% 16.51% 15.50% 15.05% CONSTRUCTION 6.74% 6.52% 6.70% 6.40% 6.61% 7.26% 7.39% 7.15% REAL ESTATE 5.88% 8.11% 10.34% 11.64% 12.47% 14.23% 15.07% 15.34% HOUSING 13.57% 13.81% 14.09% 14.96% 14.54% 14.76% 15.48% 16.33% t GENERAL COMMERCE 18.66% 18.48% 18.26% 17.04% 16.45% 15.79% 15.28% 15.66% BUSINESS SERVICES 0.00% 2.35% 2.20% 2.06% 2.41% 3.06% 3.12% 3.08% TRANSPORT & STORAGE 2.32% 2.39% 2.95% 2.87% 2.46% 2.20% 0.84% 1.75% CONSUMER CREDIT 0.00% 3.42% 3.50% 3.70% 3.91% 4.34% 4.32% 3.75% OTHER 23.31% 14.84% 10.85% 11.91% 12.53% 13.16% 14.95% 14.05% TOTAL 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% /a INCLUDES COMMERCIAL BANKS, FINANCE COMPANIES AND MERCHANT BANKS SOURCE: BANK NEGARA MALAYSIA. APPENDIX MALAYSIA TABLE 14: DEBT/EQUITY RATIO UNIT: MIL OF RINGGIT YEAR DEBT EQUITY DEBT/EQUITY 1974 3837.916 3123.103 1.23 1975 4658.812 3654.213 1.27 1976 5580.754 4339.968 1.29 1977 6606.752 4663.629 1.42 1978 7649.247 5417.729 1.41 1979 7343.216 5248.889 1.40 1980 9260.182 6736.968 1.37 1981 10550.055 8339.861 1.27 1982 11382.253 9837.185 1.16 1983 15711.902 12230.917 1.28 1984 18272.076 15647.725 1.17 1985 21918.259 16981.336 1.29 SOURCE: FINANCIAL SUEVEY, DEPARTMENT OF STATISTICS, MALAYSIA. APPENDIX MALAYSIA TABLE 15: INTEREST IN SUSPENSE AND PROVISIONS OF COMMERCIAL BANKS UNIT: MIL OF RINGGIT A.INTEREST IN B.PROVISIONS FOR C.TOTAL LOANS D. A/C E. B/C SUSPENSE B/D DEBTS AND ADVANCES 1980 132.3 205.4 21031.1 0.63% 0.98% 1981 186.3 309.9 25521.4 0.73% 1.21% 1982 245.4 372.9 29665.6 0.83% 1.26% 1983 345 461.9 36781.8 0.94% 1.26% 1984 515.8 724.1 43504.3 1.19% 1.66% 1985 1063.4 1070.3 48981.7 2.17% 2.19% 1986 2130.2 1696 52328.7 4.07% 3.24% AUG. 1987 2983.7 2828.1 51233.9 5.82% 5.52% SOURCE: JABATAN PENGAWALAN BANK. BANK NEGARA MALAYSIA. CHART M1: MOVEMENT OF INTEREST RATE:MALAYSIA (DEPOSIT RATE 12 DS) 14 13- 12 11 10 8 7t-n 6 4 3 2 0- l l 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986SEP.1987 YEAR O BANK DEPOSIT + FNIAN. DEPOSIT ° TfS.BILL3mn. CHART M2: MOVEMENT OF INTEREST RATE:MALAYSIA (LENDING RATE 12 MONTH) 15 - 14- 12 11 10 5 4 3 2 0 1977 1978 1979 1 980 1 981 1982 1983 1984 1985 1986 SEP.1987 YEAR iJ BAW4 LENDING + FINAN. LENDING 0) CPI GROWTH RATE CHART M3: MOVEMENT OF INTEREST RATES MALAYSIA 15- 14 13- 12- 10 8 7 6 4 3 1977 1978 1979 1950 1981 1982 1983 1984 1985 1986 1987 SEP YEAR 0 CONNERCrAL 12 MONTH DEPOSIT RkTE + AkVRAGk LENING RATE (> CPI GROWTH -RAT CHART M4: GROWTH OF FINANCIAL SECTOR MALAYSIA 120 - 110 100 / I-~ 0 80 - 0~~0 760 50 40 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 YEAR 0 M2/GNP + M3/GNP APPENDIX PHILIPPINES TABLE 1-a: NACROECONOMIC INDICATORS YEAR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE 6.4X - 4.9i 6.51 7.9^ 6.2Z 5.5X 6.61 5.0X 3.81 2.9X 0.9X -6.0n -6.41 1.1l NOMINAL GDP GROWTH RATE 21.2Z - 37.61 15.3X 17.9X 14.0X 15.21 22.4X 21.7X 15.3X 11.61 12.8X 40.7X 12.81 2.81 II.INVESTMENT AND SAVINGS(RATIO TO GNP) GROSS DOMESTIC INVESTMENT 28.7X 20.2S 25.1X 29.5Z 31.3Z 29.0X 29.0X 31.1X 30.7Z 30.71 28.81 27.12 17.4Z 14.41 13.41 PUBLIC - - - - 5.6X 6.01 8.7X 7.0X 7.7X 4.6X 3.61 5.01 - - PRIVATE - - - - - 23.4X 23.01 22.4X 23.7X 23.01 24.2X 23.51 12.41 - - GR-OSS DOMESTIC SAVINGS 23.7X 23.7X 22.0X 22.7X 24.9X 25.1X 24.0X 25.5X 25.01 25.3X 21.9X 20.21 17.3X 17.41 19.71 III.CHANGE IN M2/SAVING 0.147 - 0.125 0.095 0.173 0.195 0.184 0.091 0.152 0.133 0.178 0.225 0.155 0.137 0.102 CHANGE IN M3/SAVING - - - - - - - - - 0.186 0.180 0.232 0.090 0.112 0.067 IV.ICOR=NGDI/NGDP/RGDP GROWTH RATE 4.558 - 5.16 4.51 3.94 4.62 5.27 4.69 6.16 8.10 9.73 29.38 -2.83 -3.21 11.78 V.BALANCE OF PAYMENT CURRENT ACCOUNTJGDP -4.32 4.43X -1.41X -5.831 -6.062 -3.972 -4.802 -5.071 -5.39SZ -5.412 -8.022 -7.96X -3.881 - 3.31X CAPITAL ACCOUNTIGDP 6.01 2.41X 5.822 6.91X 6.57X 4.791 9.151 5.522 7.771 5.812 7.19X 3.06X 4.402 -2.391 0.311 TOTAL EXTERNAL DEBT(US$ MIL) - - - - - - - 17387 20752 24316 24057 24593 26207 28173 EXTERNAL DEBT/GDP - -- 49.32 53.72 61.02 69.62 76.02 80.02 91.6Z (CONTINUED) SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENT STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. APPENDIX PHILIPPINES TABLE 1-b: MACROECONOMIC INVICATORS YEAR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VI.FISCAL DEFICITSIGNP -1.081 -1.171 0.45X -1.19X -1.75X -1.83X -1.231 -0.16X -1.28X -4.00X -4.30X -1.97X -1.89X -1.88X -4.572 DOMESTIC FINANCING/GNP 0.93X 0.82X -0.63X 0.972 1.72X 1.67X 0.202 -1.27X 0.442 2.041 2.902 0.54X 1.54X 1.90X 4.26X FOREIGN FINANCING/GNP 0.15X 0.341 0.19X 0.22Z 0.04X 0.16X 1.02X 1.43X 0.84X 1.971 1.39X 1.43X 0.352 -0.03X 0.32Z VII.INFLATION CPI 15.0X - 34.22 6.8X 9.21 9.92 7.3X 17.52 18.22 13.12 10.21 10.02 50.32 23.12 0.82 GDP DEFLATOR 14.0X - 31.22 8.22 9.32 7.31 9.22 14.8X 15.91 11.1 8.42 11.82 49.72 17.92 1.72 VIII.TERMS OF TRADE 87.8 113.3 114.5 87.8 77.7 71.0 78.2 81.6 68.6 60.4 58.7 61.3 59.8 55.9 - (1972 - 100) IX.EXCHANGE RATE A.SDR :rb 8.5491 8.0544 8.1634 8.8000 8.5899 8.6429 9.2219 9.5318 9.7764 9.3150 9.4282 11.8795 17.1163 18.8928 23.9159 B.USS :rf 7.2242 6.7563 6.7879 7.2479 7.4403 7.4208 7.3658 7.3776 7.5114 7.8997 8.5400 11.1127 16.6987 18.6073 20.3857 X.REAL EFFECTIVE INDICES(1980-100) - - - - - - 87.7 95.0 100.0 103.2 107.1 90.1 89.2 97.6 76.2 XI.DEPOSIT RATE A.NOKEINAL 9.7500 8.000 9.500 9.500 10.000 10.000 10.000 12.000 14.000 16.743 14.674 16.512 32.129 15.520 11.253 B.REAL - - -18.388 2.563 0.734 0.092 2.481 -4.707 -3.556 3.239 4.038 5.892 -12.115 -6.158 10.422 (CONCLUDED) SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENT STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. - 164 - APPENDIX PHILIPPINES TABLE 2:FIANACIAL SYSTEM OF PHILIPPINES (PERCENTAGE DISTRIBUTION OF ASSETS OF THE FINANCIAL SYSTEM) 1970 :1975 1980 1981 1982 1983 1984 1985 198ti JUN.1987 I.CENTRAL BANK 19.4 21.2 20.9 19.9 21.1 23.6 29.7 -33.4 43.4 42.9 II.BANKING SYSTEM 60.8 57.0 60.3 62.6 61.9 59.8 56.5 52.4 41.0 41.1 COMMERCIAL BANKS 45.6 43.4 44.2 45.6 44.9 43.4 41.7 37.5 33.4 33.7 PRIVATE 26.8 28.6 27.2 28.7 26.6 24.2 23.2 22.3 22.1 23.4 GOVERNMENT 14.9 14.8 11.0 11.2 .2.2 11.8 11.6 9.3 4.8 4.0 FOREIGN 3.9 - 6.0 5.7 6.1 7.4 6.9 5.9 6.5 6.3 THRIFT BANKS 2.9 1.7 3.4 3.2 2.9 2.9 2.2 2.0 2.4 2.4 SAVINGS 2.3 1.1 2.4 1.9 1.4 1.3 1.1 0.9 1.1 1.2 PRIVATE DEVELOPMENT 0.6 0.3 0.5 0.7 0.8 0.8 0.7 0.7 0.8 0.7 STOCK SAVINGS & LOAN ASSOCIATIONS - 0.3 0.5 0.6 0.7 0.8 0.4 0.4 0.5 0.5 RURAL BANKS 2.3 2.3 1.8 1.8 1.9 1.7 1.3 1.2 1.3 1.3 SPECIALIZED GOVERNMENT BANKS 10.0 9.6 10.9 12.0 12.2 11.8 11.3 11.7 3.9 3.7 III.NONBANK FINANCIAL INTERMEDIARIES 19.8 21.8 18.8 17.5 17.0 16.6 13.8 14.2 15.6 16.0 INSURANCE COMPANIES 19.1 9.7 9.4 9.2 9.3 8.1 7.2 8.1 9.8 10.1 GOVERNMENT /a 12.9 6.3 6.2 6.1 6.2 5.6 5.2 5.7 7.0 7.4 PRIVATE 6.2 3.4 3.2 3.1 3.1 2.5 2.0 2.4 2.8 2.7 INVESTMENT INSTITUTIONS - 8.4 8.2 6.5 5.9 4.5 2.9 3.1 3.2 3.2 FINANCING COMPANIES - 2.9 3.8 3.4 3.0 2.1 1.4 0.8 0.8 0.8 INVESTMENT COMPANIES - 1.6 1.6 1.5 1.3 1.1 0.4 1.4 1.4 1.3 INVESTMENT HOUSES - 3.9 2.8 1.6 1.6 1.3 1.1 0.9 1.0 1.1 TRUST OPERATIONS - 2.1 0.5 0.2 0.2 0.3 0.1 0.2 0.2 0.2 OTHER FINANCIAL INTERMEDIARIES 0.7 1.6 0.7 1.6 1.6 3.7 3.6 2.8 2.4 2.5 TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 la INCLUDES GSIS AND SSS. SOURCE: CENTRAL BANK OF THE PHILIPPINES. APPENDIX P8ILIPPINES TABLE 3: GROTHB OP FINANCIAL SECTOR IN PBILIPPINES AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 M21CNP (X) 18.4 19.4 16.8 16.8 18.6 21.2 22.8 20.8 21.0 21.6 23.5 25.3 20.9 20.9 22.2 H3/GNP (X) - - - 25,2 25.6 27.0 28.4 29.8 23.0 22.3 22.9 MAIGNP(X) - - - - - - - - - 28.6 29.5 31.2 26.4 29.4 32.6 GROSS DOMESTIC SAVING/CNP 23.7 23.7 22.0 22.7 24.9 25.1 24.0 25.5 25.0 25.3 21.9 20.2 17.3 17.4 19.7 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. PATRICK HONOHAN. l' APPENDIX PHILIPPINES TABLE 4: DOMESTIC CREDIT 1980-86 UNIT: BIL OF PESOS …-------------------------------------------------------------------__-------__------------ 1980 1981 1982 1983 1984 1985 1986 JUN 1987 …--------------------------------------------______-----------------__-------_____--------- GOVERNMENT 5.2 9.6 16.9 15.7 13.3 14.3 11.9 -20.7 OTHER PUBLIC SECTOR 2.5 2.0 4.1 11.0 14.5 17.8 13.3 11.5 PRIVATE SECTOR 86.1 103.7 118.1 144.1 138.3 124.6 97.3 108.8 TOTAL 93.8 115.3 139.1 170.8 166.1 156.7 122.5 99.6 …-----------------------------------------------------------------__---- % OF GNP GOVERNMENT 3.0 3.2 5 4.1 2.6 2.4 1 9 -3.1 OTHER PUBLIC SECTOR 0.9 0.7 1.2 2.9 2.7 3.0 2.2 1.7 PRIVATE SECTOR 32.5 34.2 35.2 38.1 26.2 21.0 15.8 16.1 TOTAL 36.4 38.1 41.4 45.1 31.5 26.4 19.9 14.7 …-----------___------------------------------------------___-------__--- 1980-PESOS(BIL) GOVERNMENT 5.2 5.6 8.9 7.6 5.8 4.1 2.9 -5.0 OTHER PUBLIC SECTOR 2.5 1.2 2.2 5.3 6.3 5.2 3.3 2.8 PRIVATE SECTOR .86.1 60.4 62.3 69.9 60.0 36.1 23.9 26.3 TOTAL 93.8 67.2 73.4 82.8 72.1 45.4 30.1 24.1 SOURCE:------_---------___--__--____H---------------OF-----C-------B_N--OF-THE_-H_---_--__. SOURCE: STAFV FqTIMATES ,ASED) ON^ THE PUJBLICAT-IONS OF TIIE CE^.L BAW, OF THE PHILIPPINES . APPENDIX PHILIPPINES TABLE 5: BANK INTEREST RATES (%) YEAR DEPOSIT RATE LENDING RATE CPI GROWTH RATE 1974 9.500 12.000 34.20 1975 9.500 12.000 6.80 1976 10.000 12.000 9.20 1977 10.000 12.000 9.90 1978 10.000 12.000 7.30 1979 12.000 14.000 17.50 1980 14.000 14.000 18.20 1981 16.743 17.119 13.10 1982 14.674 19.184 10.20 1983 16.512 20.673 10.00 1984 32.129 36.405 50.30 1985 15.520 18.696 23.10 1986 8.370 13.880 0.80 SOURCE: CENTRAL BANK OF THE PHILIPPINES. APPENDIX PHILIPPINES TABLE 6: TERM STRUCTURE OF INTEREST RATE (INTEREST RATES, 1970-87) 1970 1975 1980 1981 1982 1983 1984 1985 1986 SEP.1987 TREASURY BILLS:3 MONTH 13.1 10.3 12.1 12.6 13.8 14.2 40.9 26.2 16.3 10.7 :6 MONTH 13.9 10.8 12.5 13.1 14.5 14.8 30.5 24.8 14.4 12.2 :12 MONTH 13.7 10.9 12.8 13.2 14.9 14.9 41.5 35.2 13.2 13.7 CENTRAL BANK BILLS - - - - - - 35.3 27.0 19.1 - SAVINGS DEPOSITS 6 6 7 - 9.8 9.7 9.9 10.8 8.6 6 TIME DEPOSITS< 1 YEAR 6.7 8.7 14.0 - 14.1 13.7 23.2 21.8 12.3 7.0 TIME DEPOSIT> 1 YEAR - - - - 16.9 16.4 26.2 21.8 15.6 9.5 BANK LOANS < 1 YEAR 12 12 14 16 16.8 18.8 26.7 28.3 17.1 12.2 BANK LOANS > 1 YEAR - - - - 21.6 21.5 26.8 26.3 19.1 14.1 F- 0% INPLATION - 9.5 10.5 8.4 12 49.8 17.7 1.8 5 5 (GNP DEFL YEAR AHEAD) REAL 12 MDNTH T-BILLS - 1.3 2.1 4.4 2.6 -23.3 20.2 32.8 7.8 8.3 SOURCE: CENTRAL BANK OF THE PHILIPPINES. - 169 - APPENDIX PHILIPPINES TABLE 7:COMPONENTS OF THE AVERAGE INTERMEDIATION COST, 1983-86 (%) 1983 1984 1985 1986 TAXES 20% FINAL TAX 2.00 2.60 2.19 1.46 5% GROSS RECEIPTS TAX 0.75 0.99 0.94 0.73 2.75 3.59 3.13 2.19 RESERVES AND AGRI/AGRA 2.65 3.82 3.02 1.60 BANK MARGIN 1.59 1.90 3.92 4.97 TOTAL 6.99 9.31 10.07 8.76 SOURCE: STAFF ESTIMATES. - 170 - APPENDIX PHILIPPINES TABLE 8-a: PHILIPPINES COMMERCIAL BANKS MESIJRES OF CONCENTRATION TOTAL ASSETS 1979 1986 1987 CONCENTRATION RATIOS THREE 'BANKS 41.1 41.1 31.4 FIVE BANKS 50.0 52.0 47.0 HERFINDAHL INDEX 0.11 0.10 0.06 RECIPROCAL 8.8 10.0 15.8 (CONTINUED) MID-YEAR DATA. SOURCE: PATRICK HONOHAN. "PHILIPPINES: INTEREST RATE AND CREDIT CONDITIONS", CECFP, 1988. APPENDIX PHILIPPINES TABLE 8-b: REQUIRED RESERVE RATIOS (IN % p.a) PERIOD RESERVE RATIO 1982 18 1983 23 1984 24 1985 23 1986 21 JUN.1987 21 (CONCLUDED) NOTE:DEPOSITS FOR LESS THAN 730 DAYS SOURCE:CENTRAL BANK OF THE PHILIPPINES - 171 - APPENDIX PHILIPPINES TABLE 9: TOTAL ASSETS OF THE FINANCIAL SYSTEM 1980-86 UNIT: BIL OF PESOS 1980 1986 --------------- --------------- GROWTH AMOUNT % AMOUNT % % CBP 65.4 21 313.9 43 380 BANKING SYSTEM 188.8 60 297.0 41 57 COMMERCIAL BANKS 138.4 44 248.5 34 80 PRIVATE DOMESTIC BANKS 85.1 27 166.6 23 96 GOVERNMENT BANK 34.6 11 34.8 5 1 FOREIGN BANKS 18.7 6 47.1 7 152 THRIFT INSTITUTIONS 10.6 3 17.6 2 66 RURAL BANKS 5.6 2 9.3 1 66 SPECIALIZED GOVERNMENT BANKS 34.2 11 28.6 4 -16 NONBANK 58.9 19 112.9 16 92 TOTAL 313.1 100 723.8 100 131 SOURCE: CENTRAL BANK OF THE PHILIPPINES. - 172 - APPENDIX PHILIPPINES TABLE 10: PROFITABILITY OF COMMERCIAL BANK (AS % OF TOTAL ASSETS) YEAR GROSS INTEREST NONINTEREST PROFITS PROFI:TS MARGIN OPERATING INCOME BEFORE TAX AFTER TAX 1970 2.62 2.70 1.49 1.49 1975 1.90 2.76 1.99 1.47 1980 1.90 2.02 1.16 1.08 1981 2.09 2.28 1.10 1.00 1982 1.88 2.15 0.96 0.91 1983 1.65 2.65 1.06 0.198 1984 1.01 3.11 0.51 0.42 1985 -0.28 2.48 -1.52 1.62 1986 0.44 2.50 -0.99 -1.11 *1987 2.65 2.01 1.37 1.11 *FIRST HALF SOURCE: CENTRAL BANK OF THE PHILIPPINES. APPENDIX PHILIPPINES TABLE ll:LOANS OUTSTANDING OF FINANCIAL INSTITUTIONS BY MATURITY - - - - - - - - - - - - - - - - -- -- = = = = = = = _ = 1980 1981 1982 1983 1984 1985 1986 SHORT-TERM 72803 76760 82256 95667 89266 71894 71079 :SHARE 72.5% 69.0% 65.4% 65.5% 59.4% 61.4% 60.1% INTERMEDIATE 9964 17156 20843 21171 30931 18092 21067 :SHARE 9.9% 15.4% 16.6% 14.5% 20.6% 15.5% 17.8% LONG-TERM 17658 17286 22582 29316 30127 27031 26108 :SHARE 17.6% 15.5% 18.0% 20.1% 20.0% 23.1% 22.1% TOTAL 100425 111202 125681 146154 150324 117017 118254 SOURCE: CENTRAL BANK OF THE PHILIPPINES. APPENDIX PHILIPPINES TABLE 12: MDVEMENT OF DOMESTIC AND FOREIGN INTEREST RATES (X) AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.EURO DOLLAR: 6 MUNTH 7.77 9.40 10.84 7.75 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.93 11.29 8.64 6.85 2.DOMESTIC DEPOSIT RATE 9.75 - 9.500 9.500 10.000 10.000 10.000 12.000 14.000 16.743 14.674 16.512 32.129 15.520 8.370 3.EFFECTIVE COST 10.36 - 11.36 15.05 8.94 6.09 8.39 12.33 16.10 22.75 22.81 43.05 67.23 21.06 17.06 4.NOMINAL EXCHANGE RATE:rf 7.2242 6.7563 6.7879 7.2479 7.4403 7.4208 7.3658 7.3776 7.5114 7.8997 8.5400 11.1127 16.6987 18.6073 20.3857 5. - 1 - 2 -i.98 - 1.34 -1.7S -3.88 -3.63 -0.80 0.15 0.03 -0.02 -1.07 -6.58 -20.84 -6.88 -1.52 6. - 3 - 2 0.61 - 1.86 5.55 -1.06 -3.91 -1.61 0.33 2.10 6.01 8.13 26.53 35.10 5.54 8.69 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. CENTRAL BANK OF THE PHILIPPINES. APPENDIX PHILIPPINES TABLE 13-a: HOLDERS OF GOVERNMENT SECURITIES UNIT : MIL OF PESOS 1986 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 3td qt. CENTRAL BANK 4190 4426 4764 5156 4889 4958 6079 6424 9168 7841 40145 47158 34783 CQOMERCIAL BANK 4400 6043 6773 8864 11730 12376 12969 14452 16232 18275 77453 86320 70945 FOREIGN HOLDERS 23 1260 1257 1188 1179 542 262 262 262 590 1360 3306 3245 SOURCE: CENTRAL BANK OF THE PHILIPPINES. APPENDIX PHILIPPINES TABLE 13-b: HOLDERS OF GOVERNMENT SECURITIES (PERCENTAGE DISTRIBUTION) LA 1986 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 3rd qt. CENTRAL BANK 48.62 37.72 37.21 33.92 27.51 27.71 31.52 30.42 35.7Z 29.4Z 33.72 34.52 31.92 CWMERCIAL RANK 51.12 51.52 52.92 58.32 65.92 69.22 67.22 68.42 63.32 68.45 65.1X 63.12 65.12 FOREIGN HOLDERS 0.32 10.72 9.82 7.82 6.62 3.02 1.42 1.22 1.02 2.2S 1.12 2.42 3.01 SOURCE: CENTRAL BANK OF THE PHILIPPINES. CHART PI:LEVEL OF BANK LOAN RATE,CP1 PHIUPPINES N00-, do 50 40- 30~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 20 I0 1074 1975 1976 1977 1976 1979 i1 1Q9& iQW *093 1Xa54 195 19 YEAR o BANK LANDING RArE + CPI GROWTH RATE CHART P2: LIABILITY/ASSET RATIOS (TOP 1,000 CORPORATIONS 2) All Industries - .-_ Manufacturing 65 so~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~s 75 70 ~N 1979 1960 1961 1921 1963 1964 1965 YEARS CHART P3: MOVEMENT OF INTEREST RATES PHILIPPINES 60- 50- 40- 30\ 20 10 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 0 DEPOSIT RATE ~~~+ INWDXNG RATS C CPZ GROWM! RATE CHART P4: GROWTH OF FINANCIAL SECTOR PHILIPPINES 30 - 29- 28- 27- 26 - 25 24- 0 ~23- 22 21- 20- 19 is 17 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 YEAR 0 M2/GNP + M3/GNP APPENDIX INDONESIA TABLE 1-a: M&CROECONONIC INDICATORS YEAR SOURCE AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE 7.1X - 7.6X 5.0X 6.9X 8.91 7.7Z 6.31 9.92 7.9X 2.2Z 4.2Z 6.21 1.9X - N0hINAL GDP GROwTH RATE 30.5X - 58.6Z 18.1X 22.31 22.9X 19.6Z 40.81 41.91 27.91 7.51 18.0X 18.81 9.71 3.92 iI.IfiVESTNENT AnD SAVIN"S(PATIO TO GAP) GROSS DW£STIC INVESTMENT 25.12 22.82 21.61 26.12 26.2Z 25.61 25.81 26.71 27.2X 28.22 z6.71 26.u; .:. .. 20.3! 21.1t PUBLIC INVESTMET - - 5.21 5.62 4.02 6.02 9.42 9.92 6.6X 7.3X 7.02 PRIVATE INVESTMENT - - - - 20.5X 21.1X 23.22 22.12 17.3X 16.11 14.7Z 13.01 14.12 GROSS DOMESTIC SAVINGS 29.72 24.72 30.92 28.52 28.52 30.92 28.9Z 37.82 41.82 35.02 28.92 29.72 32.12 29.52 25.52 PUBLIC SAVINGS - - - - 6.0X 7.22 7.32 6.9Z 5.92 7.51 8.0X 6.21 2.42 PRIVATE SAVINGS - - - - - - 15.7Z 19.51 21.7X 20.82 15.02 10.31 11.0X 12.11 12.6X III.CHANcE IN H2/SAVING 0.136 - 0.146 0.165 0.147 0.085 0.109 0.116 0.140 0.102 0.078 0.172 0.122 0.196 0.137 CHANGE IN H2/PRIVATE SAVINGS - - - - - 0.201 0.224 0.271 0.171 0.151 0.498 o.355 0.478 0.278 1 CHANGE IN M3/ PRIVATE SAVINGS - - - - - - 0.232 0.285 0.180 0.163 - - - - - ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~OD 00 IV.ICOR-NGDI/NGDP/RGDP GROWTH RATE 3.03 - 0.65 5.02 3.69 2.78 3.21 4.07 2.63 3.43 11.56 5.91 3.29 9.93 - V.BALANCE OP PAYMENT CURRENT ACCOUNT/GDP -0.971 -2.92X 2.321 -3.64Z -2.44X -0.102 -2.76X 1.90X 4.151 -0.672 -5.651 -7.772 -2.182 -2.161 - CAPITAL ACCOUNT/GDP 2.62X 4.53X 1.572 1.161 5.35Z 2.402 3.32Z 1.692 1.831 2.042 5.942 7.451 4.141 2.53X - TOTAL EXTERNAL DEBT - - - - - - - - 1923.4 2451.3 2875.8 3036.8 3077 3580.6 4119.5 EXTERNAL DEBT/ GDP - - - - - - - - 2.651 2.661 3.041 3.751 3.61X 4.141 5.292 (CONTINUED) SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IHF. BALANCE OF PAYMENT STATISTICS, IHF. INDONESIA, SELECTED ISSUES OF PUBLIC RESOURCE MANAGEMENT(REPORT NO.7007-IND). WORD DEBT TABLE, WORLD BANK. APPENDIX INDONESIA TABLE l-b: MACROECONCOC INDICATORS YEAR SOURCE AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VI.FISCAL DEFICITIGNP -1.211 -2.10X -0.971 -3.35X -1.57X 1.04X -0.56S -0.52X -2.531 -1.41S -2.33S -1.485 -0.601 -0.31 - DOMESTIC FINANCING -0.081 0.02X -0.141 - -0.18X - 0.00X 0.01X 0.09X 0.00X 0.001 -0.041 -0.051 - - FOREIGN FINANCING 1.57S 2.172 1.245 3.466 1.892 -0.33S 0.51X 0.99X 2.361 1.53S 2.232 1.78S 0,662 0.381 2.845 VII.INFLATION CPI 22.71 - 41.01 18.82 20.02 11.01 8.22 20.62 18.52 12.21 9.51 11.81 10.41 4.71 5.91 GDP DEFIATOR 21.72 - 47.21 12.42 14.51 12.91 11.01 32.52 29.21 18.51 5.11 13.2X 11.91 7.71 - VIII.TERMS OF TRADE(1980-100) - - - - - 75 66 82 100 105 101 97 98 96 82.1 IX. EXCHANGE RATE A.SDR :rb 491.66 494.73 499.10 503.87 479.13 484.52 553.44 804.89 816.05 744.94 730.22 972.00 1051.60 1127.62 1504.66 1 B.US$ :rf 415.00 415.00 415.00 415.00 415.00 415.00 462.00 623.06 626.99 631.76 661.42 909.26 1025.94 1110.58 1282.56 F' X.REAL EFFECTIVE INDICES(1980-100) - - - - - - 119.4 92.5 100 108.6 117.5 95.3 92.4 89.7 69.1 XI.DEPOSIT RATE A.NOWINAL 11.25 12.0 12.0 12.0 12.0 9.0 6.0 6.0 6.0 6.0 6.0 6.0 16.0 18.0 - B.REAL(CPI) -8.69 -20.59 -5.74 -6.63 -1.78 -2.03 -12.09 -10.54 -5.53 -3.23 -5.19 5.07 12.65 - (CONCLUDED) SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENT STATISTICS, IMF. INDONESIA, SELECTED ISSUES OF PUBLIC RESOURCE MANAGEMENT(REPORT NO. 7007-IND). WORD DEBT TABLE, WORLD BANK. APPENDIX INDONESIA TABLE 2: SELECTED DEPOSIT RATES OF STATE AND PRIVATE BANKS 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 6-MOUTH DEPOSIT RATE STATE BANKS (SD) 9.0 6.0 6.0 6.0 6.0 6.0 13.1 17.2 16.0 14.5 PRIVATE NATIONAL BANKS - 15.7 16.8 18.2 18.1 18.4 18.8 20.7 17.8 14117 PRrVATE FOUEIGN BANKS - 8.4 9.8 8.7 10.2 14.3 17.0 21.4 17.0 15.0 12-NONTH DEPOSIT RATE STATE BANKS (SB) 12.0 9.0 9.0 9.0 9.0 9.0 17.5 18.7 17.8 15.0 PRIVATE NATIONAL BANKS - 17.9 18.1 20.0 19.8 19.4 19.7 20.5 19.8 14/18 PRIVATE FOREIGN BANKS - 10.0 9.7 12.1 11.9 15.5 17.0 19.1 16.6 - 24-3"1TH DEPOSIT RATE STATE BANKS (SB) 18.0 15/12 15112 15/12 15/12 15/12 12.5 17.2 18.3 14/15 PRIVATE NATIONAL BANKS - 21.0 20.1 19.5 19.2 18.5 19.3 21.0 21.3 15.5/17 MErORANDUM ITEMS: WEIGHTED AVERAGE INTEREST RATE STATE BANKS - 8.7 9.1 9.0 9.6 9.4 13.5 - - - PRIVATE RANKS - 15.7 16.8 17.9 18.3 18.1 18.0 - - - INFLATION(Z) CONSUMER PRICES 11.1 8.1 22.0 18.4 12.2 9.5 11.8 10.4 4.7 5.9 WHOLESALE PRICES 14.1 2.1 49.7 26.7 11.1 7.4 17.9 11.0 4.5 - SOURCE: BANK INDONESIA APPENDIX INDONESIA TABLE 3: MOVEMENT OF INTEREST RATES 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 12-HDNTH DEPOSIT RATE STATE BANKS (SB) 12.0 9.0 9.0 9.0 9.0 9.0 17.5 18.7 17.8 15.0 PRIVATE NATIONAL BANKS - 17.9 18.1 20.0 19.8 19.4 19.7 20.5 19.8 16.0 PRIVATE FOREIGN BANKS - 10.0 9.7 12.1 11.9 15.5 17.0 19.1 16.6 - AVERALGE LENDING RATE 9.0 9.0 9.0 9.0 9.0 9.0 9.0 12.0 12.0 - CPI GROWTH RATE 11.1 8.1 22.0 18.4 12.2 9.5 11.8 10.4 4.7 5.9 SOURCE: BANK INDONESIA. INTERNATIONAL FINANCIAL STATISTICS, IMF. APPENDIX INDONESIA TABLE 4: GROWTH OF FINANCIAL SECTOR IN INDONESIA AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 M/lGNP (X) 11.6 10.3 11.4 13.4 14.2 7.2 7.3 13.2 12.9 16.3 17.2 13.2 18.6 10.3 M21GNP (Z) 16.4 15.3 14.3 16.7 17.6 17.1 17.5 16.9 17.7 17.3 18.3 20.9 21.5 25.6 M3/GNP (X} - - - - - - 18.0 17.4 18.4 18.0 19.1 - - - GROSS DOEESTIC SAVINGICNP 29.7 24.7 30.9 28.5 28.5 30.9 28.9 37.8 41.8 35.0 28.9 29.7 32.1 29.5 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. INDONESIA: SELECTED ISSUES OF PUBLIC RESOURCE MANACEMENT(REPORT NO.7007-IND). OD. APPENDIX INDONESIA TABLE 5: SHARE OF BANKING SYSTEMS CREDITS BY ECONOMIC SETOR, 1974-1986 (IN PERCENT) 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 AGRICULTURE 7.41 8.02 7.51 6.9Z 6.42 7.0X 6.8Z 8.02 7.91 8.02 7.02 7.52 7.92 MINING 0.72 26.92 29.12 27.02 31.52 30.22 23.72 16.72 11.32 5.32 2.02 1.22 1.52 MANUFACTURING INDUSTRY 22.82 26.12 27.82 29.42 30.12 30.82 28.12 27.22 30.12 34.02 35.42 34.32 32.32 TRADE 39.82 27.92 24.12 23.22 20.72 21.32 25.12 30.12 31.72 33.52 33.71 32.72 31.82 SERVICE RENDERING F' OD INDUSTRY 7.82 6.32 7.32 8.12 7.22 6.72 12.02 13.62 14.32 14.92 16.82 18.92 18.22 OTHERS 21.52 4.82 4.42 5.6X 4.12 3.92 4.22 4.42 4.7Z 4.32 4.9X 5.52 8.22 TOTAL 100.02 100.02 100.02 100.02 100.02 100.02 100.02 100.02 100.02 100.02 100.02 100.0X 100.02 SOURCE: BANK INDONESIA. APPENDIX INDONESIA TABLE 6-a: GROWTH AND STRUCTURE OF THE FINANCIAL SYSTEM GROSS ASSETS GROWTH IN ASSET NUMBER (IN BIL OF RUPIAH) (ANNUAL %) TYPE OF INSTITUTION 1982 1984 1987 1981 1982 1983 1984 1987 78-82 82-R7 BANK INDONESIA 1 1 1 11067 13707 16740 21618 34500 26.4 20.3 DEPOSIT MONEY BANKS 113 113 110 13153 15952 20918 27768 46600 31.8 24.0 NATIONAL FOREIGN EXCHANGE BANKS 15 15 15 10764 12724 16369 21634 36800 32.6 23.7 FOREIGN BANKS 11 11 11 918 1172 1696 2192 2700 23.4 17.6 OTHER COMMERCIAL BANKS 59 59 56 517 720 1096 1666 3600 29.5 38.8 DEVELOPMENT BANKS 28 28 28 954 1336 1757 2276 3500 33.1 21.9 SAVINGS BANKS 3 3 3 256 452 683 - 1900 86.5 30.6 NONBANK FINANCIAL INTERMEDIARIES 13 14 14 557 805 1108 1327 2100 42.6 21.3 INSURANCE COMPANIES 83 89 100 386 528 708 - 3000 35.0 33.8 LEASING COMPANIES 34 38 83 60 114 380 386 1400 44.0 69.5 STATE PAWNSHOPS 471 474 - 42 44 54 59 - 29.4 - OTHER CREDIT INSTITUTION 5809 5826 5789 - 69 83 - 400 - 32.0 TOTAL 6106 6556 6100 25530 31615 40606 51773 89900 30.0 23.1 SOURCE: BANK INDONESIA AND INDONESIAN INSURANCE COUNCIL. (CONTINUED) APPENDIX INDONESIA TABLE 6-b: GROWTH AND STRUCTURE OF THE FINANCIAL GROWTH IN ASSETS GROSS ASSETS (ANNUAL %) …-- - - - - - - - - - - - - - - - - - - - -- -- - - - -- - - - - - - - - - - - - - - - TYPE OF INSTITUTION 1981 1982 1983 1984 1987 78-82 82-87 BANK INDONESIA 43.3% 43.4% 41.2% 41.8% 38.4% 26.4 20.3 DEPOSIT MONEY BANKS 51.5% 50.5% 51.5% 53.6% 51.8% 31.8 24.0 NATIONAL FOREIGN EXCHANGE BANKS 42.2% 40.2% 40.3% 41.8% 40.9% 32.6 23.7 FOREIGN BANKS 3.6% 3.7% 4.2% 4.2% 3.0% 23.4 17.6 OTHER COMMERCIAL BANKS 2.0% 2.3% 2.7% 3.2% 4.0% 29.5 38.8 DEVELOPMENT BANKS 3.7% 4.2% 4.3% 4.4% 3.9% 33.1 21.9 SAVINGS BANKS 1.0% 1.4% 1.7% - 2.1% 86.5 30.6 NONBANK FINANCIAL INTERMEDIARIES 2.2% 2.5% 2.7% 2.6% 2.3% 42.6 21.3 INSURANCE COMPANIES 1.5% 1.7% 1.7% - 3.3% 35.0 33.8 LEASING COMPANIES 0.2% 0.4% 0.9% 0.7% 1.6% 44.0 69.5 STATE PAWNSHOPS 0.2% 0.1% 0.1% 0.1% 0.0% 29.4 - OTHER CREDIT INSTITUTION - 0.2% 0.2% - 0.4% - 32.0 TOTAL 100.0% 100.0% 100.0% 100.0% 100.0% 30.0 23.1 SOURCE: BANK INDONESIA AND INDONESIAN INSURANCE COUNCIL. (CONCLUDED) - 188 - APPENDIX INDONESIA TABLE 7-a: TIME DEPOSITS WITH STATE BANKS, 1981-1986 UNIT: BILLIONS OF RUPIAH 1981 1982 1983 1984 1985 1986 24 MONTHS 748.3 848.5 565.8 280.4 411.1 518.5 12 MONTHS 81.5 79.1 885.9 1721.0 2794.5 3867.1 6 MONTHS /a 106.8 121.8 549.3 720.9 725.8 950.1 MATURED 103.4 125.6 142.9 10.0 10.9 13.1. OTHERS 10.9 11.3 7.6 91.9 87.9 58.2 TOTAL /b 1093.0 1230.8 2830.8 3496.9 5336.9 6729.7 /a INCLUDES SOME 9 MONTH DEPOSITS DURING 1984 (CONTINUED) /b INCLUDES INTERBANK TIME DEPOSITS AND RESIDENTS' TIME DEPOSITS SOURCE: BANK INDONESIA. APPENDIX INDONESIA TABLE 7-b: TIME DEPOSITS WITH STATE BANKS, 1981-1986 (SHARE) 1981 1982 1983 1984 1985 1986 24 MONTHS 68.5% 68.9% 20.0% 8.0% 7.7% 7.7% 12 MONTHS 7.5% 6.4% 31.3% 49.2% 52.4% 57.5% 6 MONTHS /a 9.8% 9.9% 19.4% 20.6% 13.6% 14.1% MATURED 9.5% 10.2% 5.0% 0.3% 0.2% 0.2% INTERBANK AND RESIDENTS' TIME DEPOSITS 3.9% 3.6% 24.0% 19.2% 24.5% 19.7% OTHERS 1.0% 0.9% 0.3% 2.6% 1.6% 0.9% TOTAL 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% /a INCLUDES SOME 9 MONTH DEPOSITS DURING 1984 (CONCLUED) SOURCE: BANK INDONESIA. - 189 - APPENDIX INDONESIA TABLE 8: INCOME, EXPENDITURES AND PROFITS STATE BANKS (AS % OF TOTAL ASSETS) ESTIMATED 1982 1983 1984 1985 1985 (JAN.) (NOV.) OPERATIONAL INCOME 11.5% 10.1% 11.5% 10.5% 9.6% RUPIAH INTEREST REVENUES 5.5% 5.9% 7.2% 7.3% 6.7% FOREIGN CURRENCY INTEREST REVENUES 0.8% 0.5% 0.5% 0.2% 0.2% FOREIGN EXCHANGE TRANSACTOINS REVENUES 4.4% 2.8% 2.8% 2.0% 1.9% OTHERS 0.9% 0.8% 1.0% 0.9% 0.8% OPERATIONAL COSTS 9.1% 8.3% 9.3% 8.9% 8.1% RUPIAH INTEREST COSTS 3.0% 3.1% 4.6% 5.1% 4.7% FOREIGN CURRENCY INTEREST COSTS 0.9% 1.0% 0.7% 0.6% 0.5% FOREIGN EXCHANGE TRANSACTIONS EXPENSES 1.3% 0.7% 0.7% 0.3% 0.3% LABOR COST 1.7% 1.5% 1.7% 1.3% 1.2% OTHERS 2.2% 2.0% 1.7% 1.5% 1.4% OPERATIONAL PROFITS AND LOSS 2.4% 1.7% 2.2% 1.6% 1.5% NONOPERATIONAL INCOME 1.7% 1.5% 2.0% 2.3% 2.1% NONOPERATIONAL COSTS 1.6% 1.2% 1.9% 2.2% 2.1% NONOPERATIONAL PROFIT AND LOSS 0.05% 0.22% 0.02% 0.09% 0.09% CURRENT PROFIT AND LOSS 2.5% 2.0% 2.2% 1.7% 1.6} AVERAGE TOTAL ASSETS 12821700 16277000 20497500 25463400 25463400 …- …-… .. .-- - ------ -__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ SOURCE: BANK INDONESIA AND STAFF ESTIMATES. - 190 - APPENDIX TABLE INDONESIA 9: INCOME, EXPENDITURES AND PROFITS :PRIVATE NATIONAL BANKS (AS % OF TOTAL ASSETS) ESTIMATED 1982 1983 1984 1985 1985 (JAN.) (NOV.) OPERATIONAL INCOME 11.5% 10.1% 11.5% 10.5% 9.6% RUPIAH INTEREST REVENUES 5.5% 5.9% 7.2% 7.3% 6.7% FOREIGN CURRENCY INTEREST REVENUES 0.8% 0.5% 0.5% 0.2% 0.2% FOREIGN EXCHANGE TRANSACTOINS REVENUES 4.4% 2.8% 2.8% 2.0% 1.9% OTHERS 0.9% 0.8% 1.0% 0.9% 0.8% OPERATIONAL COSTS 9.1% 8.3% 9.3% 8.9% 8.1% RUPIAH INTEREST COSTS 3.0% 3.1% 4.6% 5.1% 4.7% FOREIGN CURRENCY INTEREST COSTS 0.9% 1.0% 0.7% 0.6% 0.5% FOREIGN EXCHANGE TRANSACTIONS EXPENSES 1.3% 0.7% 0.7% 0.3% 0.3% LABOR COST 1.7% 1.5% 1.7% 1.3% 1.2% OTHERS 2.2% 2.0% 1.7% 1.5% 1.4% OPERATIONAL PROFITS AND LOSS 2.4% 1.7% 2.2% 1.6% 1.5% NONOPERATIONAL INCOME 1.7% 1.5% 2.0% 2.3% 2.1% NONOPERATIONAL COSTS 1.6% 1.2% 1.9% 2.2% 2.1% NONOPERATIONAL PROFIT AND LOSS 0.05% 0.22% 0.02% 0.09% 0.09% CURRENT PROFIT AND LOSS 2.5% 2.0% 2.2% 1.7% 1.6% AVERAGE TOTAL ASSETS 12821700 16277000 20497500 25463400 25463400 SOURCE: BANK INDONESIA AND STAFF ESTIMAATES. - 191 - APPENDIX TABLE INDONESIA 10: INCOME, EXPENDITURES AND PROFITS :TOTAL BANKING SYSTEM (AS % OF TOTAL ASSETS) ESTIMATED 1982 1983 1984 1985 1985 (JAN.) (NOV.) OPERATIONAL INCOME 12.8% 11.7% 13.3% 12.2% 11.2% RUPIAH INTEREST REVENUES 7.0% 7.2% 9.1% 9.0% 8.2% FOREIGN CURRENCY INTEREST REVENUES 0.8% 0.6% 0.5% 0.3% 0.3% FOREIGN EXCHANGE TRANSACTOINS REVENUES 4.0% 2.9% 2.6% 1.9% 1.8% OTHERS 1.0% 1.0% 1.1% 1.0% 0.9% OPERATIONAL COSTS 10.1% 9.6% 11.0% 10.4% 9.6% RUPIAH INTEREST COSTS 3.8% 4.0% 5.8% 6.1% 5.6% FOREIGN CURRENCY INTEREST COSTS 0.9% 0.8% 0.8% 0.6% 0.6% FOREIGN EXCHANGE TRANSACTIONS EXPENSES 1.1% 0.8% 0.6% 0.3% 0.3% LABOR COST 1.9% 1.7% 1.8% 1.5% 1.4% OTHERS 2.4% 2.2% 2.0% 1.8% 1.7% OPERATIONAL PROFITS AND LOSS 2.7% 2.1% 2.3% 1.7% 1.6% NONOPERATIONAL INCOME 1.6% 1.4% 2.0% 2.4% 2.2% NONOPERATIONAL COSTS 1.5% 1.2% 2.0% 2.2% 2.1% NONOPERATIONAL PROFIT AND LOSS 0.0% 0.2% 0.0% 0.2% 0.2% CURRENT PROFIT AND LOSS 2.7% 2.3% 2.4% 1.9% 1.8% AVERAGE TOTAL ASSETS 16050200 21018450 26777450 33868140 33868140 SOURCE: BANK INDONESIA AND STAFF ESTIMATES. APPENDIX INDONESIA TABLE 11: MOVEMENT OF DOMESTIC AND FOREIGN INTEREST RATES, INDONESIA. SOURCE AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.EURO DOLLAR: 6 MONTH 7.77 9.40 10.84 7.75 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.93 11.29 8.64 6.85 2.DOMESTIC DEPOSIT RATE: 6 MONTH - - - - - - 15.70 16.80 18.20 18.10 18.40 18.80 20.70 17.80 15.50 (PRIVATE NATIONAL BANKS) 3.EFFECTIVE COST 7.77 - 10.84 7.75 6.12 6.37 16.30 58.09 14.75 17.61 18.93 51.12 25.57 17.60 23.40 4.No(INAL EXCHANGE RATE: rf 415.00 415.00 415.00 415.00 415.00 415.00 442.00 623.06 626.99 631.76 661.42 909.26 1025.94 1110.58 1282.56 5. - 1 - 2 - - - - - - -6.50 -4.65 -4.17 -1.38 -4.80 -8.87 -9.41 -9.16 -8.65 6.=.23 - _ _ - 0.60 41.29 -3.45 -0.49 0.53 32.32 4.67 -0.20 7.90 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, VARIOUS ISSUES. I APPENDIX INDONESIA TABLE 12: LIQUID ASSETS IN EXCESS OF REQUIRED RESERVES OF DEPOSITS NDNEY BANRS (IN BILLIONS OF RUPIABS AND PERCENT: END OF PERIOD) 1978 1979 1980 1981 1982 1983 SEP.1984 SEP.1985 SEP.1986 EXCESS RUPIAH RESERVES BILLIONS OF RUPIAH 228 353 475 420 102/a 369 521 178 -57 PERCENT OF CURRENT RUPIAH LIBILITIES 10.7 12.2 10.6 6.9 1.7 4.8 5.8 1.5 - LIQUID ASSETS RATIO - - - - - 19.7 20.8 16.5 - EXCESS FOREIGN CURRENCY RESERVES BILLIONS OF RUPIAH 265 427 459 377 381 712 707 - - '0 PERCENT OF CURRENT EXCHANGE LIABILITIES 48.0 41.4 27.5 21.2 17.6 21.6 19.7 - - SOURCE: INDONESIAN FINANCIAL STATISTICS. la EXCLUDES SPECIAL RUPIAH DEPOSITS. NOTE: EXCESS RESERVES - LIQUID ASSETS MINUS 15S OF CURRENT LIABILITIES APPENDIX INDONESIA TABLE 13-a: LIQUIDITY CREDITS OF BANK INDONESIA UNIT: BILLIONS OF RUPIAH MARCH MARCH MARCH MARCH MARCH MARCH MARCH MARCH 1980 1981 1982 1983 1984 1985 1936 I987 STATE BANKS 1333 1769 2769 3876 4012 5009 5795 6739 INVESTMENT CREDIT 414 623 987 1500 588 - - - PRIORITY SECTOR - - - 502 588 656 - NONPRIORITY SECTOR - - - 631 879 1034 - WORKING CAPITAL 275 470 756 1113 1407 - - PRIORITY SECTOR - - - 1074 1407 3135 - NONPRIORITY SECTOR - - - 554 253 224 - OTHERS 644 676 1026 1263 2017 - - - LOCAL DEVELOPMENT BANKS 8 35 67 119 116 138 159 223 PRIVATE NATIONAL BANKS 46 75 119 208 232 298 415 631 TOTAL 1387 1879 2955 4203 4360 5445 6369 7593 (CONTINUED) SOURCE: BANK INDONESIA. APPENDIX INDONESIA TABLE 13-b: LIQUIDITY CREDITS OF BANK INDONESIA (AS % OF TOTAL) MARCH MARCH MARCH MARCH MARCH MARCH MARCH MARCH 1980 1981 1982 1983 1984 1985 1986 1987 STATE BANKS 96.1% 94.1% 93.7% 92.2% 92.0% 92.0% 91.0% 88.8% INVESTMENT CREDIT 29.8% 33.2% 33.4% 35.7% 13.5% - - - PRIORITY SECTOR - - - 11.9% 13.5% 12.0% - NONPRIORITY SECTOR - - - 15.0% 20.2% 19.0% - WORKING CAPITAL 19.8% 25.0% 25.6% 26.5% 32.3% - - PRIORITY SECTOR - - - 25.6% 32.3% 57.6% - NONPRIORITY SECTOR - - - 13.2% 5.8% 4.1% - OTHERS 46.4% 36.0% 34.7% 30.0% 46.3% - - LOCAL DEVELOPMENT BANKS 0.6% 1.9% 2.3% 2.8% 2.7% 2.5% 2.5% 2.9% PRIVATE NATIONAL BANKS 3.3% 4.0% 4.0% 4.9% 5.3% 5.5% 6.5% 8.3% TOTAL 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% (CONCLUDED) SOURCE: BANK INDONESIA. - 196 - APPENDIX INDONESIA TABLE 14-a: RUPIAH TI1l(E DEPOSITS BY MATURITY AND TYPE OF BANK UNIT: BILLIONS OF RUPIAH DUE 1 mo. 3 mo. 6 mo. 9 mo. 12 mo. 18 mo. 24 mo. OTHERS DATED TOTAL JUNE 1980 ALL BANKS 76.6 72.9 153.4 1.9 122.3 1.5 632.6 14.9 71.8 1147.9 STATE BANKS 2.4 19.2 73.2 - 46.7 - 600.1 3.0 67.4 812.0 PRIVATE NATIONAL BANKS 6.9 19.1 38.8 1.3 55.9 1.5 28.6 5.7 0.6 158.4 FOREIGN BANKS 67.3 34.6 40.2 0.6 17.1 - - 5.7 3.7 169.2 LOCAL DEVELOP- MENT BANKS - - 1.2 - 2.6 - 3.9 0.5 0.1 8.3 JUNE 1981 ALL BANKS 106.8 113.5 232.5 0.9 183.8 2.6 762.6 19.4 102.4 1524.4 STATE BANKS 8.7 37.3 105.5 - 64.6 - 701.6 2.4 92.9 1013.0 PRIVATE NATIONAL BANKS 12.2 36.3 83.2 0.8 1.01.2 2.6 53.4 9.6 0.7 300.0 FOREIGN BANKS 85.9 39.9 41.9 0.1 13.2 - - 6.7 8.7 196.4 LOCAL DEVELOP- MENT BANKS - - 1.7 - 4.8 - 7.7 0.7 0.1 15.0 JUNE 1982 ALL BANKS 196.0 156.4 238.5 6.2 287.1 3.4 904.3 39.8 127.4 1959.1 STATE BANKS 17.0 30.5 108.1 - 76.3 - 798.5 3.9 108.6 1142.9 PRIVATE NATIONAL BANKS 30.6 58.6 86.5 2.2 180.3 1.9 88.5 20.6 2.6 471.8 FOREIGN BANKS 148.4 67.0 41.2 4.0 23.3 1.5 3.0 14.4 16.2 319.0 LOCAL DEVELOP- MENT BANKS - 0.3 2.7 - 7.2 - 14.3 0.9 - 25.4 JUNE 1983 ALL BANKS 496.8 451.6 474.8 6.1 457.0 10.3 896.5 56.9 153.0 3003.0 STATE BANKS 170.2 136.3 285.3 - 182.3 - 760.2 11.4 135.9 1681.6 PRIVATE NATIONAL BANKS 102.7 136.1 144.6 5.3 252.1 10.3 98.5 29.7 4.2 783.5 FOREIGN BANKS 223.5 178.5 41.1 0.8 13.0 - 8.7 14.6 12.8 493.0 LOCAL DEVELOP- MENT BANKS 0.4 0.7 3.8 - 9.6 - 29.1 1.2 0.1 44.9 JUNE 1984 ALL BANKS 804.0 821.5 1166.6 2.3 1980.3 8.6 480.4 107.5 27.6 5398.8 STATE BANKS 271.6 394.4 797.0 0.8 1407.4 1.7 373.7 19.1 10.8 3276.5 PRIVATE NATIONAL BANKS 297.6 402.5 336.2 3.5 572.3 1.9 89.7 36.2 10.4 1750.3 FOREIGN BANKS 348.8 139.6 66.0 0.1 24.5 - - 67.3 49.5 695.8 LOCAL DEVELOP- MENT BANKS 3.4 3.8 9.1 - 33.9 - 25.8 3.0 - 79.0 JUNE 1985 ALL BANKS 1118.9 1041.4 1246.0 30.1 3328.1 6.6 397.8 146.2 58.0 7373.1 STATE BANKS 424.5 379.4 654.0 26.7 2516.2 1.1 283.1 49.6 11.0 4345.6 PRIVATE NATIONAL BANKS 311.0 480.5 531.2 2.9 737.0 5.5 95.2 21.7 6.8 2191.8 FOREIGN BANKS 379.8 178.2 50.6 0.5 28.0 - - 71.8 40.0 748.9 LOCAL DEVELOP- MENT BANKS 3.6 3.3 10.2 - 46.9 - 19.5 3.1 0.2 86.8 SOURCE: BANK INDONESIA. (CONTINUED) - 197 - APPENDIX INDONESIA TABLE 14-b: RUPIAH TIME DEPOSITS BY MATURITY AND TYPE OF BANK (AS 2 OF TOTAL) DUE 1 mo. 3 mo. 6 mo. 9 mo. 12 mo. 18 mo. 24 mo. OTHERS DATED TOTAL JUNE 1980 ALL BANKS 6.72 6.4X 13.4X 0.22 10.7% 0.1X 55.1X 1.32 6.32 100.0% STATE BANKS 0.3% 2.4X 9.02 - 5.82 - 73.92 0.4X 8.32 100.0% PRIVATE NATIONAL BANKS 4.4X 12.12 24.52 0.82 35.3X 0.92 18.12 3.62 0.42 100.0% FOREIGN BANKS 39.8% 20.4X 23.8% 0.4% 10.12 - - 3.42 2.2Z 100.0% LOCAL DEVELOP- MENT BANKS - - 14.52 - 31.3Z - 47.0 6.02 1.22 100.0% JUNE 1981 ALL BANKS 7.02 7.4X 15.32 0.12 12.12 0.22 50.02 1.32 6.72 100.02 STATE BANKS 0.9X 3.72 10.42 - 6.42 - 69.32 0.2Z 9.22 100.0% PRIVATE NATIONAL BANKS 4.1X 12.1% 27.72 0.32 33.72 0.92 17.8% 3.22 0.22 100.0% FOREIGN BANKS 43.72 20.32 21.3X O.1X 6.72 - - 3.42 4.4X 100.02 LOCAL DEVELOP- MENT BANKS - - 11.3% - 32.02 - 51.32 4.72 0.72 100.0% JUNE 1982 ALL BANKS 10.02 8.02 12.22 0.3% 14.72 0.22 46.22 2.02 6.52 100.0% STATE BANKS 1.52 2.72 9.52 - 6.72 - 69.92 0.32 9.52 100.02 PRIVATE NATIONAL BANKS 6.52 12.42 18.32 0.52 38.22 0.42 18.82 4.42 0.62 100.0% FOREIGN BANKS 46.52 21.02 12.92 1.3% 7.32 0.52 0.9% 4.5Z 5.1X 100.OX LOCAL DEVELOP- MENT BANKS - 1.2X 10.62 - 28.32 - 56.32 3.52 - 100.0% JUNE 1983 ALL BANKS 16.52 15.02 15.82 0.22 15.22 0.32 29.92 1.92 5.1X 100.02 STATE BANKS 10.12 8.1X 17.0% - 10.8% - 45.2% 0.7X 8.1X 100.02 PRIVATE NATIONAL BANKS 13.12 17.4X 18.52 0.72 32.22 1.32 12.62 3.82 0.5X 100.02 FOREIGN BANKS 45.32 36.22 8.32 0.2% 2.62 - 1.8% 3.02 2.62 100.0% LOCAL DEVELOP- MENT BANKS 0.9X 1.6X 8.5% - 21.42 - 64.8% 2.7% 0.2% 100.0% JUNE 1984 ALL BANKS 14.92 15.2% 21.6% 0.02 36.72 0.22 8.92 2.02 0.52 100.0% STATE BANKS 8.32 12.02 24.3% 0.0% 43.02 0.1% 11.4% 0.62 0.3% 100.0% PRIVATE NATIONAL BANKS 17.02 23.02 19.22 0.2X 32.72 0.12 5.12 2.1% 0.6% 100.0% FOREIGN BANKS 50.12 20.12 9.5% 0.02 3.5X - - 9.7% 7.12 100.02 LOCAL DEVELOP- MENT BANKS 4.32 4.82 11.52 - 42.92 - 32.72 3.8% - 100.0% JUNE 1985 ALL BANKS 15.22 14.1X 16.92 0.42 45.12 O.1X 5.4X 2.02 0.82 100.02 STATE BANKS 9.8X 8.72 15.02 0.62 57.92 O.OX 6.52 1.12 0.32 100.02 PRIVATE NATIONAL BANKS 14.22 21.92 24.22 0.12 33.62 0.32 4.32 1.02 0.32 100.02 FOREIGN BANKS 50.72 23.82 6.82 0.1X 3.7X - - 9.62 5.3X 100.02 LOCAL DEVELOP- MENT BANKS 4.12 3.82 11.82 - 54.0X - 22.52 3.62 0.2X 100.02 SOURCE: BANK INDONESIA. (CONCLUED) APPENDIX TABLE INDONESIA 15: LEVEL AND STRUCTURE OF MONEY MARKET RATES 1984 1985 1986 15 DAYS 15.68 14.95 - CUTOFF RATE IN SBI 30 DAYS 16.13 15.18 14.00 AUCTIONS 90 DAYS 16.52 15.91 15.00 …---------------------------------------_____--------------------__----- SBPU 1 MONTH - 15.525 14.35 SELLING RATES OF FICOR 3 MONTH - 15.33 INVEST 6 MONTH - 16.15 -----------------------------------___------------____---------------__- INTERBANK RATE 18.58 10.34 13.20 BASIC DISCOUNT RATE 18.86 19.83 18.50 …---------------------------------------_--____----------------------__- SB 17.20 16.00 14.50 6 MONTH DEPOSIT RATE PNB 20.70 17.80 14/17 FB 21.40 17.00 15.00 …----------------------------------------------------------------__----- SB 18.70 17.80 15.00 12 MONTH DEPOSIT RATE PNB 20.50 19.80 14/18 FB 19.10 16.60 - *SB: STATE BANKS. PNB: PRIVATE NATIONAL BANKS. FB: FOREIGN BANKS. SOURCE: BANK INDONESIA. CHART I1:MOVEMENT OF DEPOSIT RATES:12m. INDONESIA 30 - 28 - 26 - 24- 22 - 20 16 - 164 14 10 -~ ~ ~ ~ ~ ~ ~ ~~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~' 0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 4B- 1 2 10 0- I I I 1977 1978 1979 1980 19U1 1982 -193 1984 196 1aw YEAR 0 E(l F BANKS + PRI.NATIONAL BANKS ° PRI.FOREION BANK CHART 12: MOVEMENT OF INTEREST RATES INDONESLIA 22 - 21- 20- 19 18 17 156 15- 5- - 13 10 9 8 7 6 5 4 1977 1978 1979 1980 1981 1 g 2 1983 1984 1985 1986 YEAR 0 STATE BANK 12m.DPST 0 CPI GROWTH RATE CHART I3: GROWTH OF FINANCIAL SECTOR INDONESIA 26 25 24 23 22 21 20 19 18 17 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 YEAR 0 M2/GNP + M3/GNP APPENDIX SRI LANKA TABLE 1-a: MACROECONOMIC INDICATORS AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE 4.2X - 4.0X 4.72 4.4X 3.8X 7.02 6.42 5.82 5.82 5.12 5.02 4.11 - - NOMINAL GDP GROWTH RATE 18.8X - 29.22 11.82 13.6X 20.52 17.22 22.82 27.02 27.82 16.72 22.52 26.42 5.6X 10.62 II.INVESTMENT AND SAVINGS(RATIO TO GNP) GROSS DOMESTIC INVESTMENT 17.72 15.12 17.42 17.52 19.02 16.82 21.92 25.82 33.42 28.02 30.42 28.92 26.62 23.92 23.82 PUBLIC INVESTMENT - _ - - - - 6.62 7.7X 9.72 5.22 4.92 4.92 4.71 4.82 5.42 PRIVATE INVESTMENT - - - - 15.32 18.1X 23.72 22.72 25.52 24.02 21.82 19.12 18.42 GROSS DOMESTIC SAVINGS 13.9% 13.7% 9.12 9.1X 16.32 21.1% 16.72 13.82 11.12 11.82. 11.82 13.92 19.82 11.22 12.12 PUBLIC SAVINGS - - - - -1.52 0.22 -3.82 -1.72 -1.22 0.22 3.5Z 0.6X 1.72 PRIVATE SAVINGS - - - - - 18.22 13.62 14.8X 13.5X 13.02 13.72 16.32 10.62 10.32 I;;CHANGE IN M2:SAVING 0.269 - 0.251 0.075 0.370 0.380 0.425 0.687 0.638 0.426 0.554 0.400 0.200 0.266 0.073 CHANGE IN M2/PRIVATE SAVINGS - - - - - 0.389 0.696 0.476 0.372 0.498 0.405 0.252 0.338 - CHANGE IN M3/ PRIVATE SAVINGS - - - - - 0.593 0.985 0.720 0.545 0.863 0.743 0.525 0.651 - o IV.ICOR=GDI/NGDP/RGDP GROWTH RATE 3.68 - 3.97 3.32 3.65 3.78 2.87 4.03 5.82 4.79 6.02 5.82 6.35 - - V.BALANCE OF PAYMENT CURRENT ACCOUNT/GDP -0.87X -0.882 -3.80X -2.88X -0.172 3.36X -2.382 -6.742 -16.28X -10.00X -11.541 -9.03X 0.062 -6.93X -6.532 CAPITAL ACCOUNT/GDP 1.552 1.83X 2.842 2.262 1.25X -0.142 5.202 6.422 9.392 8.422 12.262 8.642 4.602 5.972 5.312 TOTAL EXTERNAL DEBT - - - - - - - - 1923.4 2451.3 2875.8 3036.8 3077 3580.6 4119.5 EXTERNAL DEBT/GDP - - - - - - - - 47.82 55.52 60.32 58.82 50.92 59.92 64.32 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. (CONTINUED) CENTRAL BANK OF CEYLON. APPENDIX SRI LANKA TABLE 1-b: MACROECONOMIC INDICATORS AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VI.FISCAL DEFICIT/GNP -7.981 -5.83X -4.83S -8.921 -11.35S -6.81S -15.372 -14.551 -21.97X -15.68S -17.431 -13.70S -9.13S -11.61S - DOMESTIC FANANCING 4.02 3.022 3.122 4.15X 5.861 2.75S 4.38S 5.70S 13.68S 6.31S 7.99S 4.34Z 1.59S 7.96Z - FOREIGN FINANCING 3.12 1.532 1.76S 3.02S 3.782 4.02X 10.122 7.15S 9.13X 8.992 8.10S 8.09X 6.55Z 6.445 - VII. INFLATION CPI 5.3S - 12.32 6.72 1.32 1.12 12.22 10.82 26.12 17.92 10.92 14.02 16.62 1.42 8.01 GDP DEFLATOR 14.02 - 24.22 7.01 8.8X 16.02 9.62 15.42 20.02 20.82 11.12 16.72 21.52 - - VIII.TERMS OF TRADE - - - - - - - 115.6 105.8 100 91.7 114.2 138.7 107.4 - (1981=100) IX.EXCHANGE RATE A.SDR :rb 9.144 7.633 7.998 8.508 9.712 10.359 19.545 20.119 21.520 22.694 22.977 25.152 26.074 27.579 32.869 B.US$ :rf 7.736 6.403 6.651 7.007 8.412 8.873 15.611 15.572 16.534 19.246 20.812 23.529 25.438 27.163 28.017 O X.REAL EFFECTIVE INDrcES(1980o100) - - - - 131.2 125.8 80.6 86.9 100.0 106.3 112.8 112.2 124.8 116.7 103.9 XI.DEPOSIT RATE A.NOMINAL - - - 7.25 7.25 14.5 14.5 14.5 20.0 21.00 18.50 20.50 18.00 15.00 11.25 B.REAL : BY CPI - - - 0.54 5.89 13.24 2.03 3.38 -4.84 2.63 6.89 5.70 1.16 13.37 3.01 XII.REAL WAGE RATE 75.3 63.2 68.0 73.8 74.5 85.0 100.8 109.7 106.7 95.9 98.2 90.9 86.2 91.8 90.1 (1978=100, AVR FOR AGRICULTURE, SERVICE AND INDUSTRY) SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANRK. (CONCLUDED) CENTRAL BANK OF CEYLON. - 204 - APPEN.DIX SRI LANKA TA'BLE 2-a: SRI LANKA: BANKING COSTS, 1980-1984 ALL COMMERCIAL BANKS (AS % OF ASSETS) 1980 1981 1982 1983 1984 INTEREST RECEIVED 10.1 11.8 12.5 11.8 11.1 INTEREST PAID -6.4 -8.6 -8.9 -8.4 -8.1 INTEREST MARGIN 3.7 3.2 3.6 3.4 3 OTHER INCOME 3.9 3.3 2.3 2.7 2.1 GROSS MARGIN 7.6 6.5 5.9 6.1 5.1 OPERATING COSTS 3.4 3.7 3.8 3.8 3.7 PROFITS BEFORE TAXES AND PROVISIONS 4.3 2.8 2.1 2.4 1.4 *MEMORANDUM ITEM: UNIT: MIL OF RUPEES TOTAL AVERAGE ASSETS 22297 29712 37335 45193 53453 SOURCE: CENTRAL BANK OF SRI LANKA. (CONTINUED) APPENDIX SRI LANKA TABLE 2-b: SRI LANKA: BANKING CO)STS, 1980-1984 STATE BANKS (AS % OF ASSETS) 1980 1981 1982 1983 1984 INTEREST RECEIVED 10.2 11.4 12.1 11.4 10.9 INTEREST PAID -6.6 -8.5 -8.7 -7.7 -7.6 INTEREST MARGIN 3.6 3.0 3.5 3.7 3.2 OTHER INCOME 3.4 2.5 1.6 2.0 1.7 GROSS MARGIN 7.0 5.4 5.0 5.6 4.9 OPERATING COSTS 3.4 3.6 3.8 3.8 3.7 PROFITS BEFORE TAXES AND PROVISIONS 3.6 1.8 1.3 1.8 1.2 *MEMORANDUM ITEM: UNIT: MIL, OF RUPEES TOTAL AVERAGE ASSETS 16510 21723 25663 29618 35097 SOURCE: CENTRAL BANK. OF SRI LANKA. (CONTINUED) - 205 - APPENDIX SRI LANKA TABLE 2-c: SRI LANKA: BANKING COSTS, 1980-1984 PRIVATE BANKS (AS % OF ASSETS) 1980 1981 1982 1983 1984 INTEREST RECEIVED 10.0 12.7 13.2 12.6 11.4 INTEREST PAID -5.9 -8.9 -9.3 -9.6 -8.9 INTEREST MARGIN 4.1 3.9 4.0 3.0 2.5 OTHER INCOME 5.4 5.7 4.0 4.2 2.8 GROSS MARGIN 9.5 9.6 8.0 7.2 5.3 OPERATING COSTS 3.2 4.2 3.9 3.7 3.5 PROFITS BEFORE TAXES AND PROVISIONS 6.3 5.4 4.0 3.5 1.8 *MEMORANDUM ITEM: UNIT: MIL OF RUPEES TOTAL AVERAGE ASSETS 5787 7989 11672 15575 18357 SOURCE: CENTRAL BANK OF SRI LANKA. (CONCLUDED) APPENDIX SRI LANKA TABLE 3: INTEREST RATES OF MAJOR CREDIT AND SAVINGS INSTITUTIONS, 1970-1986 1970 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 GOVERNMENT TREASURY BILLS 4.75 5.00 5.00 9.00 9.00 9.00 13.00 13.00 13.50 12.00 14.00 11.52 11.20 CENTRAL BANK RATES /a 6.50 6.50 6.50 10.00 10.00 10.00 12.00 14.00 13.00 12.00 14.00 11.00 11.00 A.DEPOSIT RATES COMKMERCIAL BANKS 12 MONTH FIXED DEPOSITS /b 4.63 7.25 7.25 14.50 14.50 14.50 20.00 21.00 18.50 20.50 18.00 15.00 11.25 SAVINGS DEPOSITS 4.50 5.50 5.50 7.20 7.20 5.0-9.0 10-14 10-14 10-14.5 10-15 10-15 10-13.5 6.0-13 SAVINGS INSTITUTIONS 0 NATIONAL SAVINGS BANK SAVINGS DEPOSITS 3.5-4.0 7.20 7.20 8.40 8.40 8.40 12.00 12.00 12.00 12.00 12.00 12.00 12.00 12 MONTH FIXED DEPOSITS 4.50 7.50 7.50 15.00 15.00 15.00 20.00 20.00 20.00 20.00 18.00 15.00 13.00 10-YEAR SAVINGS CERTIFICATES 5.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 B.LENDING RATES COMMERCIAL BANKS SECURED 6.5-12.0 6.5-13.0 6.5-14.0 10-20 10-20 10-20 11-23 11-30 11-30 11-30 12-30 11-30 10-30 UNSECURED 8.5-12.0 9.5-14.0 9.5-14.0 18-20 18-20 18-21 19-30 19-32 14-32 11-30 13-33 13-30 10-30 LONG-TERM CREDIT INSTITUTIONS STATE MORTGAGE BANK 5-10.5 5-12 5-12 5-12 5-12 5-18 5-20 12-24 12-24 12-24 12-24 10-24 8-20 NATIONAL SAVINGS BANK 10-12 10-12 9-12 9-12 9-13 9-13 9-17 12-17 12-17 12-17 12-17 12-21 12-21 /a Rate at vhich central bank provides advances to commercial banks secured by Goverinment and Government guranteed securities. /b Midpoint of maximim and mini,mi SOURCE: CENTRAL BANK OF CEYLON. APPENDIX SRI LANKA TABLE 4: GROWTH OF FINANCIAL SECTOR AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 M2/GCP 23.62 24.5X 21.5S 20.2X 24.62 28.2X 29.7Z 31.7X 31.72 30.2Z 31.92 32.02 30.01 31.32 29.32 M3/GNP - - - - - 53.92 54.02 53.72 52.52 49.12 52.62 53.72 52.1S 55.02 - GROSS NATIONAL SAVINGS/GNP - - - - - - 16.92 14.72 13.81 14.2S 15.22 16.5Z 22.82 15.1S 17.7S SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. CENTRAL BANK OF SRI LANKA. 04 - 208 - APPENDIX SRI LANKA TABILE 5-a: SECTORAL CREDIT ALLOCATION, 1980-1985 /a UINT: MILLIONS OF RUPEES END OF PERIOD 1980 1981 1982 1983 1984 1985 COMMERCIAL 8772 10181 12120 15262 17365 18128 FINANCIAL 447 301 551 711 788 824 AGRICULTURAL 2271 2777 3054 3418 3386 3088 INDUSTRIAL /b 3838 4624 6171 8033 8605 8889 TOURISM - 294 455 607 700 761 HOUSING 769 1181 1539 1982 2519 2595 CONSUMPTION 354 397 425 488 480 585 OTHER LOANS 686 1241 950 916 1076 1503 TOTAL 17137 20996 25265 31417 34919 36373 (CONTINUED) SOURCE: CENTRAL BANK OF CEYLON AND STAFF ESTIMATES APPENDIX SRI LANKA TABLE 5-b: SECTORAL CREDIT ALLOCATION, 1980-1985 (PERCENTAGE DISTRIBUTION) END OF PERIOD 1980 1981 1982 1983 1984 1c 5 COMMERCIAL 51.2% 48.5% 48.0% 48.6% 49.7% 49.8% FINANCIAL 2.6% 1.4% 2.2% 2.3% 2.3% 2.3% AGRICULTURAL 13.3% 13.2% 12.1% 10.9% 9.7% 8.5% INDUSTRIAL /b 22.4% 22.0% 24.4% 25.6% 24.6% 24.4% TOURISM - 1.4% 1.8% 1.9% 2.0% 2.1% HOUSING 4.5% 5.6% 6.1% 6.3% 7.2% 7.1% CONSUMPTION 2.1% 1.9% 1.7% 1.6% 1.4% 1.6% OTHER LOANS 4.0% 5.9% 3.8% 2.9% 3.1% 4.1% TOTAL 100.0% 100.0% 100.0% 100.0% 100.0% (CONCLUDED) - 209 - APPENDIX SRI LANKA TABLE 6: DISTRIBUTION OF BANK CREDIT BY MATURITY, 1976-1985 (PERCENTAGE DISTRIBUTION) 1976 1980 1981 1982 1983 1984 1985 LESS THAN 1 YEAR 73.6 70.2 68.9 68.9 71.0 72.2. 71.4 ONE TO 5 YEARS 19.6 21.2 20.9 22.2 20.4 18.6 18.3 OVER 5 YEARS 6.8 8.6 10.2 9.0 8.6 9.2 10.3 TOTAL 100.0 100.0 100.0 100.1 100.0 100.0 100.0 SOURCE: CENTRAL BANK OF CEYLON AND STAFF ESTIMATES. APPENDIX SRI LANKA TABLE 7: TOTAL ASSETS OF FINANCIAL SYSTEM, 1977-1985 (AS % OF TOTAL ASSETS) 1977 1978 1979 1980 1981 1982 1983 1984 1985 CENTRAL BANK 44.9 44.3 42.0 40.5 39.2 35.8 32.9 29.3 33.1 COMMERCIAL BANKS 33.5 34.9 37.1 37.4 38.0 38.3 40.2 40.5 42.1 FCBUs, NET OF FOREIGN LIBILITIES - - - 1.3 1.9 2.5 2.3 3.2 3.4 NATIONAL SAVINGS BANK 9.1 8.9 9.2 7.8 7.1 8.3 8.7 9.2 9.8 FINANCE COMPANIES - - - 0.9 1.0 1.6 1.8 2.6 - NATIONAL DEVELOPMENT BANK - - - 1.1 1.1 1.2 1.2 1.2 - STATE MORTGAGE AND INVESTMENT BANK - - 0.2 0.3 0.3 0.3 0.5 - DFCC _- - 0.4 0.5 0.5 0.6 0.6 0.6 EMPLOYEES' PENSION FUND 8.6 8.4 8.2 7.4 7.4 7.7 7.9 8.7 10.1 EMPLOYEES' TRUST FUND - - - - 0.1 0.3 0.5 0.8 1.0 INSURANCE COMPANIES 3.9 3.5 3.4 3.0 2.9 2.8 2.9 2.6 - LEASING COMPANIES - - - - 0.4 0.5 0.6 0.8 - …________________________________________________________________________________________________________ TOTAL ASSETS (GROSS) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 SOURCE: CENTRAL BANK OF CEYLON AND STAFF ESTIMATES. FCBU: FOREIGN CURRENCY BANKING UNITS. DFCC: DEVELOPMENT FINANCE COMPANY OF CEYLON. APPENDIX SRI LANKA TABLE 8: INTEREST RATES AND CPI GROWTH RATE (1) 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 A.DEPOSIT RATES COMMERCIAL BANKS 12 MONTH FIXED DEPOSITS 7.0-7.5 7.0-7.5 14-15 14-15 14-15 20.00 20-22 15-22 16-25 14-22 12-18 8.5-14 SAVINGS DEPOSITS 5.50 5.50 7.20 7.20 5.0-9.0 10-14 10-14 10-14.5 10-15 10-15 10-13.5 6.0-13 B.LENDING RATES COMMERCIAL BANKS SECURED 6.5-13.0 6.5-14.0 10-20 10-20 10-20 11-23 11-30 11-30 11-30 12-30 11-30 10-30 UNSECURED 9.5-14.0 9.5-14.0 18-20 18-20 18-21 19-30 19-32 14-32 11-30 13-33 13-30 10-30 CPI GROWTH RATE 6.7 1.3 1.1 12.2 10.8 26.1 17.9 10.9 14.0 16.6 1.4 8.0 SOURCE: CENTRAL BANK OF CEYLON. APPENDIX SRI LANKA TABLE 9: MOVEMENT OF DOMESTIC AND FOREIGN INTEREST RATES AVR 74-77 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1.EUR0 DOLLAR: 6 MDNTH 7.77 9.40 10.84 7.75 6.12 6.37 9.20 12.15 14.03 16.72 13.60 9.93 11.29 8.64 6.85 2.DOMESTIC DEPOSIT RATE 8.50 8.50 14.50 ;7.oo 17.50 18.25 19.?9 17.33 12.21 3.EFFECTIVE COST 17.06 - 15.13 13.52 27.40 12.20 92.12 11.87 21.07 35.87 22.84 24.28 20.32 16.01 10.21 4.NOMINAL EXCHANGE RATE: rf 7.736 6.403 6.651 7.007 8.412 8.873 15.611 15.572 16.534 19.246 20.812 23.529 25.438 27.163 28.017 5. - 1 - 2 - - - - - - 0.70 3.65 -0.47 -1.16 -3.90 -8.32 -8.50 -8.69 -5.36 6. - 3 - 2 - - - - - - 83.62 3.37 6.57 17.99 5.34 6.03 0.53 -1.32 -2.00 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, VARIOUS ISSUES. CHART Si: MOVEMENT OF INTEREST RATES Sfa LANKA 28 - 26- 24- 22- 20- 16- 1 4 12 1 0 4- 2- 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 YEAR D COMMERCIAL 12 MONTH DEPOSIT RATE + COMMERCIAL LENDING RATE(UNSECIRED) ) CPI GROWTH RATE (MIDPOINT OF MAX. AND MIN. RATE) (MIDPOINT OF MAX. AND MIN. RATE) CHART S2:DEPOSIT RATE AND TRS.BILL RATE 10 18 -__ 17- ?5- 'o 13 12 141 10 "K M~~~~~~E 7 - a 4 3 2- 1070 1975 1976 1977 1078 1070 1Q60 1061 10&2 1Q6 104 1065 10aw YETAR LI TREASURY BILLS 4f NATIONAL SAVINGS BANK SAVINGS SAVINGS DEPOSIT 0 COMMERCIAL BANK SAVINGS SAVINGS DEPOSIT CHART S3: GROWTH OF FINANCIAL SECTOR SR LMNKA 60- 55- 50 45 40 35 30 25 20 - 1975 1976 1977 1978 '1979 1980 1981 1982 19M 1984 1985 1986 YEAR 0 M2/GNP + M3/GNP APPENDIX ARGENTINA TABLE I-a: MACROECONONIC INDICATORS --------- - --- - - -- -- - -- - --- -- -- -- -- -- -- ---- -- --- ---_- --_- --- -- -- --- --- - ---- - -- --- - -- -- --- --- - - -- - - --- - - - -- - -- - - - ----- - -- -- -- - - - -- -- - - - - - --- -- - - -- -- -- --- AVR 71-75 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE 2.75X 5.0Z 0.01 0.01 5.91 -2.6Z 6.51 1.71 -7.0X -3.8Z 2.01 3.11 -4.91 5.92 NOMINAL GDP GROWTH RATE 84.11 37.31 193.8X 430.61 175.71 150.01 172.3X 98.7X 93.71 169.61 362.51 673.51 649.71 87.71 il.INVESTMHEt Air. SAVINGS(PATIO TO GDP) GROSS DOHESTIC INVESTMENT 20.11 19.8X 20.3Z 21.71 24.61 21.42 22.12 24.11 19.42 16.4X i4.31 12.41 :10.4Z iY PUBLIC 7.91 6.82 9.81 11.71 12.22 11.01 8.62 7.91 7.21 6.82 7.61 6.41 6.21 5.81 PRIVATE 10.22 12.62 1.62 15.22 15.01 13.41 14.22 14.32 11.52 9.91 6.02 4.92 2.52 3.31 GROSS DOMESTIC SAVINGS 20.71 20.92 18.82 23.62 27.71 25.42 22.12 19.42 17.71 20.12 19.22 17.71 17.82 14.82 PUBLIC -0.1X 0.21 -6.32 1.lX 8.22 5.42 3.3Z 1.12 -4.7S -7.45 -6.92 -5.21 0.01 1.92 PRIVATE 20.82 20.72 25.22 22.51 19.52 19.92 18.82 18.32 22.52 27.52 26.12 22.91 17.91 12.92 III.MONEY M1/GDP 15.82 18.31 18.22 12.21 10.01 10.8S 9.72 9.7Z 8.42 10.11 10.2Z 8.2Z 7.61 7.51 M2/GDP 25.22 29.82 23.72 19.21 23.92 27.42 30.22 28.4X 29.21 26.02 28.41 22.61 19.31 21.81 K3/GDP 34.92 42.6S 29.12 26.22 37.92 44.02 50.72 47.11 50.02 41.91 46.5Z 37.02 30.92 36.22 IV.CHANGE IN M2/SAVING 0.481 0.492 0.718 0.626 0.612 0.703 0.912 0.678 0.820 0.754 1.182 1.070 0.911 0.782 CHANGE IN K2/PRIVATE SAVING 0.466 0.496 0.537 0.656 0.868 0.895 1.070 0.720 0.647 0.551 0.871 0.825 0.910 0.897 CHANGE IN M3/ PRIVATE SAVING 0.631 0.725 0.581 0.921 1.453 1.450 1.834 1.178 1.142 0.850 1.432 1.349 1.455 1.525 V.ICOR-NGDI/NGDP/RGDP GROWTH RATE 4.997 3.970 - - 4.158 -8.201 3.386 14.252 -2.790 -4.319 7.213 3.987 -2.119 1.956 VI.BALANCE OF PAYMENT CURRENT ACCOUNT/GDP - - - 1.50X 2.65X 2.861 -0.46X -3.12X -3.731 -4.181 -3.76X -3.262 -1.46Z -3.941 CAPITAL ACCOUNT/GDP - - - 1.12X 1.04X 0.47X 4.15X 1.61X 1.44X 3.692 0.63X 3.512 3.422 2.71X EXTERNAL DEBT/GDP - - - 0.00X 0.002 0.002 0.00X 7.72S 12.62X 30.44Z 28.071 25.57S 30.74Z - SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANX. (CONTINUED) APPENDIX ARGENTINA TABLE 1-b: MACROECONOMIC INDICATORS --_______--------___---______-----_-___--------__---__--_--------------------__---------------------------------------------------__-----------------------__----- YEAR AVR 71-75 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VII.FISCAL DEYICITIGDP - - - -12.502 -4.76Z -3.85X -2.80X -3.53Z -8.212 -7.18X -12.741 -5.061 - - DOMESTIC FINANCING/GDP - - - 12.50X 4.761 1.92X 2.10X 3.532 6.751 6.712 11.851 5.001 - - FOREIGN YINANCING/GDP - - - - - 1.921 - - 1.46X 0.47Z 0.892 0.061 - VIII.INFLATION CPI(1980-100) 70.82 29.92 170.62 444.12 133.32 171.42 163.22 100.01 104.02 165.2X 344.22 626.72 672.22 90.12 GDP DEFIATOR(1980-100) - 100.02 200.0X 400.02 160.0X 157.72 154.72 95.31 107.92 180.32 353.51 IX.TERKS OF TRADE(1980-100) - - - - - 83.5 88.4 100.0 113.8 98.5 94.1 101.7 88.8 78.4 X.EXCBANGE RATE A.SDR: rb - - - 0.00002 0.00005 0.00010 0.00017 0.00024 0.00052 0.00286 0.01126 0.06934 0.61104 1.10634 B.US$: rf - - - 0.00001 0.00004 0.00008 0.00013 0.00018 0.00044 0.00259 0.01053 0.06765 0.60181 0.94303 XI.REAL EFFECTIVE EXCHANGE INDICES(1980-100) - - - - 54.5 76.7 100.0 91.1 50.6 42.7 49.7 44.0 44.1 XII.DEPOSIT RATE A.NOKINAL - - 242.4 125.2 99.0 88.0 122.7 166.2 407.8 558.0 510.5 66.6 B.REAL(DEFLATED BY CPI)/- - - - - 46.74 -17.03 -24.38 -6.00 9.17 0.38 14.32 -9.45 -20.94 -1.84 XIII.LENDING RATE A.NOKINAL - - - 65.2 307.5 140.9 132.7 93.8 170.3 - - - 117.3 164.7 B.REAL(DEFLATED BY CPI)/a - . - -69.64 74.64 -11.25 -11.57 -3.10 32.50 - - - -71.86 39.25 XIV.UNENPLOYMENT RATE 5.2 3.9 3.4 5.3 3.8 3.8 3.6 5.8 6.0 6.4 5.9 5.9 7.2 7.3 XV.REAL WAGE RATE (1980-100) - - - - - 80.3 83.6 100.0 114.3 109.9 159.0 167.6 124:5 155.8 /a REAL INTEREST RATE = (l+NOMINAL)/(l+CPI GROWTH RATE)-1 SOURCE. (CONCLUDED) INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. APPENDIX ARGENTINA TABLE 2: MACROECONOMIC PERFORMANCE UNIT: % ---------------------------------------------------------------------__--_________-__----------- REAL GDP GROSS CPI FISCAL CURRENT UNEMPLOY- REAL YEAR GROWTH FIXED GROWTH DEFICIT ACCOUNT MENT WAGE RATE INVESTMENT RATE /GDP /GDP RATE RATE (1980=100) 71-75 2.8 20.5 70.8 - - 5.2 - 1971 3.2 22-1 34.7 - - 6.2 - PRE- 1972 2.2 21.9 58.7 - - 6.9 - REFORM 1973 3.4 19.6 60.1 - - 5.6 - PERIOD 1974 5.0 19.3 29.9 - - 3.9 - 1975 0.0 19.5 170.6 - - 3.4 - -----------------------------------------------------------------------__----__----------------- 76-78 1.1 22.6 249.6 -7.04 2.34 4.3 - PHASE 1 1976 0.0 21.5 444.1 -12.50 1.50 5.3 - 1977 5.9 24.4 133.3 -4.76 2.65 3.8 - a REFORMS --------- 1978 -2.6 22.0 171.4 -3.85 2.86 3.8 0.3 78-80 1.9 22.3 144.9 -3.39 -0.24 4.4 88.0 PHASE 2 1979 6.5 22.0 163.2 -2.80 -0.46 3.6 83.6 1980 1.7 22.8 100.0 -3.53 -3.12 5.8 100.0 -------------------------------------------------------------------__--------__----------------- 81-83 -2.9 16.5 204.5 -9.38 -3.89 6.1 127.7 POST- 1981 -7.0 20.1 104.0 -8.21 -3.73 6.0 114.3 REFORM 1982 -3.8 15.3 165.2 -7.18 -4.18 6.4 109.9 RECESSION 1983 2.0 14.1 344.2 -12.74 -3.76 5.9 159.0 ------------------------------------------------------------___----__--------__----------------- 1984 3.1 12.5 626.7 -5.06 -3.26 5.9 167.6 1985 -4.9 11.8 672.2 - -1.46 7.2 124.5 1986 5.9 12.4 90.1 - -3.94 7.3 155.8 SOURCE: BALANCE OF PAYMENT STATISTICS, IMF. INTERNATIONAL FINANCIAL STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. - 219 - APPENDIX ARGENTINA TABLE 3: EXCHANGE RATES, PRICES AND INTEREST RATES REAL CHANGE IN DEPOSIT U.S.TREAS. EX-POST YEAR INFLATION EXCHANGE NOMINAL RATE BILL PESO/$ INDICES EXCHANGE (PESO) RATE SPREAD (1980-100) RATE (DOLLAR) (A) (B) (C) (D) (E) (F) UNIT 1974 29.9 7.87 1975 170.6 5.82 1976 444.1 4.99 1977 133.3 300.0 242.40 5.27 -18.69 1978 171.4 54.5 100.0 125.20 7.22 5.02 1979 163.2 76.7 62.5 99.00 10.04 11.29 1980 100.0 100.0 38.5 88.00 11.62 21.61 1981 104.0 91.1 144.4 122.70 14.08 -20.13 1982 165.2 50.6 488.6 166.20 10.72 -59.15 1983 344.2 42.7 306.6 407.80 8.62 14.98 1984 626.7 49.7 542.5 558.00 9.57 -6.53 1985 672.2 44.0 789.6 510.50 7.49 -36.16 1986 90.1 44.1 56.7 61.20 5.97 -2.92 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. NOTE: (A):CPI GROWTH RATE(1980-100). (E): U.S. TREASURY BILL RATE. (F)-(l+D)/[(l+C)(l+E)]-1. APPENDIX CHILE TABLE 1--: NACROECONOMIC INDICATORS YEAR AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE 0.71 1.0S -12.91 3.52 9.9X 8.22 8.32 7.8J 5.52 -14.12 -0.72 6.3X 2.42 5.72 NOMIRAL GDP GROWTH RATE 200.0X 666.71 285.91 262.52 123.61 69.42 58.41 39.32 18.71 -2.91 25.7Z 21.62 36.12 26.02 IT.INVESTMENT AND SAVINGS(AS RATIO OF GDP) GROSS DOMESTIC INVESTMENT 11.5S 21.22 13.12 12.82 13.31 12.4X 17.7X 2i.0X 22.61 11.31 9.82 13.62 13.72 14.61 PUBLIC 12.42 12.81 8.52 5.42 6.92 6.7X 5.2Z 5.4X 5.21 4.71 4.91 6.42 7.01 7.61 PRIVATE -0.92 8.42 4.6X 7.42 6.41 5.82 12.51 15.61 17.5Z 6.61 5.02 7.31 6.71 7.01 GROSS DOMESTIC SAVINGS 10.02 22.0X 12.02 17.01 14.01 15.02 15.01 16.8X 12.32 9.41 12.51 12.62 16.51 18.42 PUBLIC - - - - - - 9.01 10.62 5.51 -0.82 -0.12 0.62 3.82 4.42 PRIVATE - - - - - - 6.01 6.32 6.81 10.22 12.62 12.02 12.61 14.02 III.H0NEY MIIGDP - 8.71 8.52 6.82 6.42 6.32 6.51 7.31 5.92 6.51 6.6X 6.11 5.01 5.6X K2/GDP - 21.72 21.12 15.52 15.91 18.02 17.42 18.72 23.72 25.71 19.31 20.72 20.11 19.82 M3/GDP - - - - - - - - 29.21 31.01 25.61 27.82 27.91 28.81 IV.CHANGE IN K21SAVING - 0.791 1.291 0.571 0.643 0.572 0.404 0.371 0.637 0.140 -0.088 0.386 0.293 0.213 CHANGE IN M21PRIVATE SAVING - - - - - - 1.010 0.998 1.158 0.129 -0.088 0.403 0.382 0.279 CHARGE IN M3/ PRIVATE SAVING - - - - - - - - - 0.095 0.073 0.561 0.591 0.473 V.ICOR-NGDI/NGDPYRGDP GROWTH RATE - 21.744 -1.014 3.630 1.352 1.516 2.142 2.698 4.100 -0.802 -13.878 2.148 5.596 2.579 VI.BALANCE OF PAYMENT CURRENT ACCOUNTIGDP -3.22 -2.64Z -6.75Z 1.552 -4.102 -7.061 -5.73Z -7.151 -14.47Z -9.471 -5.652 -10.74X -8.301 -6.492 CAPITAL ACCOUNTIGDP 2.82 1.851 4.372 1.232 4.61X 12.74X 10.89S 11.752 14.57X 4.25Z 2.63X 10.69X 7.832 5.281 EXTERNAL DEBTIGDP _ _ _ _ _ _ 40.922 43.942 47.992 71.281 92.132 104.001 126.421 - …-- - - - - -- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - -_ _ - - - -- - - -_ _ - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -_ _ _ _ _ _ -- - - - -- - - - - - - - - - - - - - - - - - _ _ - - - - - - - -_ _ - - - - - SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. (CONTINUED) APPENDIX CHILE TABLE 1-b: MACROECONOMIC INDICATORS ------------------------------------- X-_--___--_________________________________________________________________________________________________ YEAR XAVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VII.FISCAL DEFICIT/GDP -10.60S -5.432 0.14X 1.37Z -1.11 -0.11X 4.821 5.411 2.591 -0.981 -2.63X -2.97Z -2.36X - DOMESTIC FINANCINICODP - 6.41X 5.41X 3.251 5.841 1.351 -0.42X -3.971 -3.00X -0.27Z 2.64X 2.221 -0.21X - FOREIGN FINANCINGIGDP - 0.982 -2.68X -2.04X -1.191 -0.472 -0.97Z -0.75Z -0.521 -0.301 -0.021 0.75X 2.57Z - VIII.INFLATION CPI(1980-100) - 600.02 371.42 212.11 92.22 40.22 33.32 35.11 19.72 9.92 27.32 19.81 30.72 19.52 GDP DEFLATOR(1980-0oo) - 1000.02 327.32 253.22 103.62 56.52 46.31 29.22 12.22 13.32 26.6X 14.3Z 32.82 19.22 IX.TERHS OF TRADE E(BY PRICE) - - - - - - 99.4 100.0 84.3 80.4 87.5 83.2 78.5 - X.EXCbANCE RATE A.SDR: rb 0.055 1.000 5.962 15.071 25.136 39.633 48.122 50.760 45.987 56.204 84.282 101.123 163.552 226.440 B.US$: rf 0.047 0.832 4.911 13.054 21.529 31.656 37.246 39.000 39.000 50.909 78.842 98.656 161.081 193.016 XI.REAL EFFECTIVE EXCHANGE INDICES(1980=100) - - 93.7 102.1 85.2 86.1 100.0 118.0 106.7 86.8 85.3 68.8 58.1 XII.DEPOSIT RATE A.NC)INAL - - - - 93.8 62.8 45.1 37.5 40.8 47.9 27.9 26.8 28.9 - B.REAL(DEFLATED BY CPI)Ia - - - - 0.82 16.16 8.83 1.75 17.63 34.53 0.49 5.82 -1.37 - XIII.LENDING RATE A.NOIAL - 163.2 86.1 62.1 47.1 52.0 63.9 42.8 38.3 36.17 - B.REAL(DEFLATED BY CPI)/a - - - - 36.89 32.81 21.58 8.88 27.00 49.05 12.21 15.45 4.19 - XrV.UNEHPLOYKENT RATE(Z) 4.6 9.7 16.2 16.8 13.2 14.0 13.6 10.4 11.3 19.6 14.6 13.9 12.0 8.8 XV.WAGES AND SALARIES INDEX (DEC. 1982=100) - - - - - 43.4 66.7 86.9 95.3 108.3 130.0 162.6 198.3 …__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ la REAL INTEREST RATE - (1+NOMINAL)/(l+CPI GROWTH RATE)-1 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. (CONCLUDED) CHILE TABLE 2: MACROECONOMIC PERFORMANCE UNIT: % ---------------------------------------------------------------------__------__---------------- REAL GDP GROSS CPI FISCAL CURRENT UNEMPLOY- REAL YEAR GROWTH FIXED GROWTH DEFICIT ACCOUNT MENT WAGE RATE INVESTMENT RATE /GDP /GDP RATE RATE/a 71-73 0.7 13.4 - -10.56 -3.17 4.6 - PRE- 1971 9.0 - - -10.00 -2.36 5.5 - REFORM 1972 -1.2 - - -15.00 -4.56 3.7 - PERIOD 1973 -5.6 - 100.0 -6.67 -2.57 4.7 - 74-78 1.9 14.3 263.2 -1.03 -3.80 14.0 - 1974 1.0 17.4 600.0 -5.43 -2.64 9.7 - PHASE 1 1975 -12.9 15.4 371.4 0.14 -6.75 16.2 - 1976 3.5 12.7 212.1 1.37 1.55 16.8 - 1977 9.9 13.3 92.2 -1.11 -4.10 13.2 - --------- 1978 8.2 12.4 40.2 -0.11 -7.06 14.0 - REFORMS 79-81 7.2 16.7 29.4 4.27 -9.12 11.8 65e6 1979 8.3 14.9 33.3 4.82 -5.73 13.6 43.4 PHASE 2 1980 7.8 16.6 35.1 5.41 -7.15 10.4 66.7 1981 5.5 18.6 19.7 2.59 -14.47 11.3 86.9 …-----------------------------------_------------------------------__--------__---------------- POST- 82-83 -7.4 13.3 18.6 -1.81 -7.56 17.1 101.8 REFORM 1982 -14.1 14.6 9.9 -0.98 -9.47 19.6 95.3 RECESSION 1983 -0.7 12.0 27.3 -2.63 -5.65 14.6 108.3 …--------------------------------------------------------------------__------__---------__----- 1984 6.3 12.3 19.8 -2.97 -10.74 13.9 130.0 1985 2.4 14.2 30.7 -2.36 -8.30 12.0 162.6 1986 5.7 14.6 19.5 - -6.49 8.8 198.3 …----------------------------------------------------------------_-__--------__---------------- SOURCE BALANCE OF PAYMENT STATISTICS, IMF. INTERNATIONAL FINANCIAL STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. /a Dec. 1982 = 100. - 223 - CHILE TABLE 3: EXCHANGE RATES, PRICES AND INTEREST RATES REAL CHANGE IN LENDING LENDING EX-POST YEAR INFLATION EXCHANGE NOMINAL RATE RATE PESO/$ INDICES EXCHANGE (PESO) (DOLLAR) SPREAD (1980-100) RATE (A) (B) (C) (D) (E) (F) UNIT % % % % % 1974 600.0 11.80 1975 371.4 490.3 8.86 1976 212.1 93.7 165.8 7.84 1977 92.2 102.1 64.9 163.20 7.82 48.04 1978 40.2 85.2 47.0 86.10 10.06 15.03 1979 33.4 86.1 17.7 62.10 13.67 21.16 1980 35.1 100.0 4.7 47.10 16.27 20.84 1981 19.7 118.0 0.0 52.00 19.87 26.80 1982 9.9 106.7 30.5 63.90 15.86 8.40 1983 27.3 86.8 54.9 42.80 11.79 -17.53 1984 19.8 85.3 25.1 38.30 13.04 -2.20 1985 30.7 68.8 63.3 36.17 10.93 -24.83 1986 19.5 58.1 19.8 9.35 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. NOTE: (A):CPI GROWTH RATE(1980-100). (E): U.S. LENDING RATE(PRIME RATE) + 1% (F)-(l+D)/[(l+C)(l+E)]-l. APPENDIX URUGUAY TABLE 1--: MACROECONOMIC INDICATORS AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 I.REAL GDP GROWTH RATE -0.45 3.12 5.9S 4.05 1.21 5.31 6.21 6.0X 1.91 -9.41 -5.91 -1.52 0.0X 6.31 NOMINAL GDP GROWTH RATE * 66.1Z 77.5Z 79.61 54.8X 57.61 55.31 86.31 60.0X 32.81 5.11 43.81 S9.11 76.72 81.7X II.INVESTMENT AND SAVINGS(AS X OF GDP) GROSS DOMESTIC INVESTMENT 12.32 11.5 13.51 14.8S 15.21 16.01 17.3Z 17.3X 15.4X 14.41 10.01 8.71 8.11 - PUBLIC 2.42 2.6X 4.6S 6.5S 7.01 8.01 6.52 5.31 5.02 7.22 4.11 2.71 2.81 - PRIVATE 9.9X 9.02 8.9S 8.32 8.21 8.02 10.81 12.01 10.31 7.21 5.91 6.01 5.2X - GROSS DOMESTIC SAVINGS 12.42 8.9X 9.91 14.12 12.31 13.52 12.82 11.71 11.41 11.32 11.61 12.81 12.22 - PUBLIC - - - - PRIVATE - - - - - - - - - - - - - III.MONEY M1IGDP 16.51 13.01 10.21 10.92 9.71 11.61 10.7X 9.81 8.01 10.62 8.12 7.51 8.82 9.1X M2/GDP 24.9Z 20.2Z 19.71 25.61 29.31 35.91 35.72 38.62 43.51 56.31 44.21 45.11 49.92 51.11 IV.CHANGE IN M2/SAVING 0.757 0.943 0.856 0.912 1.063 1.260 1.283 1.384 1.267 1.321 0.436 1.350 2.000 - CHANGE IN M21PRIVATE SAVING - - - - - - - - - - - - - - CHANGE IN M31 PRIVATE SAVING - - - - - - - - - - - - - V.ICOR-NGDIINGDPIRGDP GROWTH RATE 43.631 3.674 2.301 3.715 12.954 3.043 2.606 2.892 8.085 -1.535 -1.702 -5.971 -454.740 - VI.BALANCE OF PAYMENT CURRENT ACCOUNT/GDP 0.521 -3.10X -5.231 -1.951 -3.761 -2.49Z -4.871 -7.001 -4.082 -2.541 -1.121 -2.461 -2.112 1.471 CAPITAL ACCOUNT/CDP 2.001 4.20X 4.57X 4.22X 7.14X 1.90X 6.181 7.061 5.732 11.69Z 5.311 3.58X -1.501 -0.211 EXTERNAL DEBTIGDP - - - - - - - 16.381 19.211 28.612 61.46X 62.69X 76.25X - …__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _-_ _ _ _ _ _ _ _ _ _ _ _- -__ _ _ _ - - _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. (CONTINUED) APPENDIX URUGUAY TABLE 1-b: MACROECONOMIC INDICATORS AVR 71-73 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 VII.FISCAL DEFICIT/GDP -3.171 -3.83S -4.401 -2.071 -1.33X -0.912 0.00X 0.031 -1.50S -9.061 -3.93S -5.20X -2.24X - DOMESTIC FINANCINGIGDP 0.045 2.292 2.691 2.762 1.242 1.37S 0.892 1.122 0.242 6.532 3.021 7.39Z 3.521 - FOREIGN FINANCING/GDp 0.302 2.131 3.212 1.652 0.425 0.222 0.71S 0.88S 0.831 0.91S -0.11 2.14X 3.282 - VIII.INFLATION CPI(1980-100) 65.75S 77.32 81.32 50.72 58.22 44.62 66.92 63.51 34.12 19.02 49.22 55.32 72.22 76.42 GDP DEFLATOR(1980-loo) 66.672 75.0S 57.12 45.52 62.5X 46.22 73.72 51.52 30.01 16.22 53.02 61.52 76.72 70.91 IX.TERMS OF TRADE(1974-100) 146.3 100.0 71.4 68.6 76.2 82.9 87.6 69.5 64.8 63.8 49.2 - - - X.EXCHANGE RATE A.SDR: rb 0.623 1.439 2.737 3.851 5.462 7.587 10.156 11.843 12.759 15.356 36.923 57.525 102.987 178.314 B.US$: rf 0.552 1.196 2.254 3.336 4.678 6.060 7.861 9.099 10.820 13.909 34.540 56.122 101.431 151.993 XI.REAL EFFECTIVE EXCHANGE INDICES(1980-100) - - 71.9 79.4 100.0 112.3 117.5 72.2 69.2 66.9 65.9 XII.DEPOSIT RATE A.NOHINAL (S) - - - 30.2 51.4 42.6 50.6 50.3 47.4 50.1 71.4 68.4 81.9 61.7 B.REAL(DEFLATED BY CPI)/- - - - -13.58 -4.30 -1.35 -9.74 -8.06 9.96 26.15 14.88 8.43 5.62 -8.33 XIII.LENDING RATE A.NROINAL (S) - - - 62.0 76.6 71.2 68.1 66.6 60.4 58.5 93.6 83.2 94.6 94.7 B.REAL(DEFLATED BY CPI)Ia - - - 7.53 11.63 18.43 0.74 1.91 19.66 33.21 29.76 17.96 12.99 10.38 XIV.UNEMPLOYMENT RATE (S) 8.07 8.1 8.1 12.9 11.8 10.1 8.4 7.4 9.3 11.9 15.5 12.7 - - XV.REAL WAGE RATE(1978-100) - 136.2 124.7 118.7 104.2 100.0 91.5 92.0 98.5 97.9 77.7 70.5 81.5 - - - - - -- - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - - - - ----- --- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -_-- - - _ _- - - /a REAL INTEREST RATE - (1+NOMINAL)/(1+CPI GROWTH RATE)-1 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. BALANCE OF PAYMENTS STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. (CONCLUDED) APPENDIX URUGUAY TABLE 2: MACROECONOMIC PERFORMANCE UNIT: % …--------------------------------------------------------------------__------__----------------- REAL GDP GROSS CPI FISCAL CURRENT UNEMPLOY- REAL YEAR GROWTH FIXED GROWTH DEFICIT ACCOUNT MENT WAGE RATE INVESTMENT RATE /GDP /GDP RATE RATE (1978=100) 71-75 1.6 10.8 71.2 -3.55 -1.61 8.1 - PRE- 1971 0.1 11=5 23.4 -5.82 -3.52 7.6 - REFORM 1972 -1.6 9.7 76.8 -2.50 2.54 7.7 - PERIOD 1973 0.4 8.9 97.0 -1.21 1.26 8.9 138.4 1974 3.1 10.2 77.3 -3.83 -3.10 8.1 136.2 1975 5.9 13.3 81.3 -4.40 -5.23 8.1 124.7 -------------------------------------------------------------------__--------__----------------- PHASE 1 76-78 3.5 15.5 51.2 -1.44 -2.73 11.6 107.6 1976 4.0 15.4 50.7 -2.07 -1.95 12.9 118.7 1977 1.2 15.2 58.2 -1.33 -3.76 11.8 104.2 REFORMS --------- 1978 5.3 16.0 44.6 -0.91 -2.49 10.1 100.0 79-81 4.7 16.2 54.8 -0.49 -5.32 8.4 94.0 1979 6.2 16.2 66.9 0.00 -4.87 8.4 91.5 PHASE 2 1980 6.0 16.7 63.5 0.03 -7.00 7.4 92.0 1981 1.9 15.7 34.1 -1.50 -4.08 9.3 98.5 --------------------------------------------------------------------__-------__----------------- POST- 82-83 -7.6 13.0 34.1 -6.50 -1.83 13.7 87.8 REFORM 1982 -9.4 15.1 19.0 -9.06 -2.54 11.9 97.9 RECESSION 1983 -5.9 11.0 49.2 -3.93 -1.12 15.5 77.7 -------------------------------------------------------------------__--------__----------------- 1984 -1.5 8.3 55.3 -5.20 -2.46 12.7 70.5 1985 0.0 7.7 72.2 -2.24 -2.11 - 81.5 1986 6.3 - 76.4 - 1.47 - - -------------------------------------------------------------------------__--__----------------- SOURCE: BALANCE OF PAYMENT STATISTICS, IMF. INTERNATIONAL FINANCIAL STATISTICS, IMF. WORLD DEBT TABLE, WORLD BANK. - 227 - APPENDIX URUGUAY TABLE 3: EXCHANGE RATES, PRICES AND INTEREST RATES REAL CHANGE IN LENDING LENDING EX-POST YEAR INFLATION EXCHANGE NOMINAL RATE RATE PESO/$ INDICES EXCHANGE (PESO) (DOLLAR) SPREAD (1980-100) RATE (A) (B) (C) (D) (E) (F) UNIT % % % % 1974 77.3 38.1 11.80 1975 81.3 88.5 8.86 1976 50.7 48.0 62.00 7.84 1.50 1977 58.2 40.2 76.60 7.82 16.83 1978 44.6 71.9 29.5 71.20 10.06 20.12 1979 66.9 79.4 29.7 68.10 13.67 14.02 1980 63.5 100.0 15.7 66.60 16.27 23.84 1981 34.1 112.3 18.9 60.40 19.87 12.54 1982 19.0 117.5 28.5 58.50 15.86 6.46 1983 49.2 72.2 148.3 93.60 11.79 -30.25 1984 55.3 69.2 62.5 83.20 13.04 -0.27 1985 72.2 66.9 80.7 94.60 10.93 -2.92 1986 76.4 65.9 49.8 94.70 9.35 18.86 SOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF. NOTE: (A):CPI GROWTH RATE(1980-100). (E): U.S. LENDING RATE(PRIME RATE) + 1% (F)-(l+D)/[(l+C)(l+E)]-l. 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Small Farmers in South Asia: Their Characteristics, Productivity, and Efficiency. Inderjit Singh No. 32. Tenancy in South Asia. Inderjit Singh No. 33. Land and Labor in South Asia. Inderjit Singh No. 34. The World Bank's Lending for Adjustment: An Interim Report. Peter Nicholas No. 35. Global Trends in Real Exchange Rates. Adrian Wood No. 36. Income Distribution and Economic Development in Malawi: Some Historical Perspectives. Frederic L. Pryor No. 37. Income Distribution and Economic Development in Madagascar: Some Historical Perspectives. Frederic L. Pryor No. 38. Quality Controls of Traded Commodities and Services in Developing Countries. Simon Rottenberg and Bruce Yandle No. 39. Livestock Production in North Africa and the Middle East: Problems and Perspectives. John C. Glenn LAlso available in French (39F)j No. 40. Nongovernmental Organizations and Local Development. Michael M. Cernea No. 41. Patterns of Development: 1950 to 1983. Moises Syrquin and Hollis Chenery No. 42. 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