MADAGASCAR ECONOMIC UPDATE Fostering Financial Inclusion June 2018 CONTENTS Acronyms iii Foreword iv Acknowledgements v Part One: Recent Economic Developments 1 The Real Sector 2 The External Sector 7 Monetary Policy 9 Fiscal Policy 14 Part Two: Economic Outlook 17 Part Three: Leveraging Technology to Promote Financial Inclusion 19 Why does financial inclusion matter? 20 What is driving the growth in mobile money? 21 How can other financial services get on the digital bandwagon? 22 i. Opportunities for Microfinance Institutions 22 ii. Opportunities for Banks 26 Where next for financial inclusion in Madagascar? 28 Conclusions 29 References 30 FIGURES Figure 1 The services sector was the most important contributor to growth in 2017 2 Figure 2 Improved rainfall is boosting hydroelectric production 3 Figure 3 Global oil prices have been rising since June 2017, but changes to pump prices have been sporadic 3 Figure 4 The return on equity compares favorably with other countries in the region (%in 2017) 5 Figure 5 The return on assets is also one of the best performing in the region (% in 2017) 5 Figure 6 The capital adequacy ratio is at the lower end compared with peers (%in 2016) 5 Figure 7 While the ratio of nonperforming loans is similar to comparator countries (%in 2016) 5 i Figure 8 The current account deficit remains low 7 Figure 9 Exports are becoming increasingly concentrated 7 Figure 10 Exports are dominated by vanilla, garments and nickel 8 Figure 11 Imports increased in 2017 compared with previous years 8 Figure 12 Inflation spread within main towns narrowed down in 2017 9 Figure 13 Inflation rate in neighboring countries eased from the 3rd quarter of 2017 9 Figure 14 Higher rice prices have been the largest contributor to inflation 10 Figure 15 The price of locally produced rice accelerated throughout the country 10 Figure 16 The price of imported rice is higher in the capital and in the north of the country 10 Figure 17 Market intermediaries capture more than half of profits along the value chain 11 Figure 18 The ariary has been following a largely depreciating trend 12 Figure 19 Lending to the private sector has picked up 12 Figure 20 After a fall in commercial banks’ interest rates at the beginning of the year, there is now an increase 12 Figure 21 Long term lending has been declining 13 Figure 22 Higher export earnings are contributing to an increase in currency in circulation 13 Figure 23 Type of institution and average effective interest rates in Madagascar 13 Figure 24 Interest rates in comparator countries 13 Figure 25 There has been a steady improvement in tax revenue collection 15 Figure 26 In 2018, capital expenditures are expected to increase, and current spending decline 15 Figure 27 While the number of mobile money accounts in Madagascar is still below peer countries… 21 Figure 28 There has been exponential growth in the number of mobile money outlets over the last few years 21 Figure 29 Financial exclusion is particularly prevalent in rural areas 22 Figure 30 Females are more likely to use informal financial services compared with males 22 Figure 31 Less than 10 percent of Malagasies have a deposit account – one of the lowest levels in Africa 26 BOXES Box 1 Madagascar’s Highly Profitable Banking Sector 4 Box 2 Rice: What Lies Behind the Price Surge? 9 Box 3 Buy now… and pay later: What determines interest rates in Madagascar? 13 Box 4 Microfinance institutions harnessing digital technology in Kenya and Malawi 24 Box 5 Key Regulatory Changes in the Financial Sector 25 Box 6 How Banks in Kenya are Innovating to Increase Financial Inclusion 27 Box 7 Madagascar – National Strategy for Financial Inclusion (2018-2022) 28 TABLES Table 1 Selected Macroeconomic Data 6 Table 2 Balance of Payments (in US$ millions) 8 Table 3 Fiscal Operations of the Central Government (% GDP) 15 Table 4 The Microfinance Sector – Fast Facts 23 ii ACRONYMS AGOA African Growth and Opportunities Act ATM Automated-teller machine CBM Central Bank of Madagascar CGAP Consultative Group to Assist the Poor CPI Consumer Price Index DPO Development Policy Operation DSA Debt Sustainability Analysis FAS Financial Access Survey G2P Government to Person GDP Gross Domestic Products IMF International Monetary Fund INSTAT National Institute of Statistics (Institut National de la Statistique) JIRAMA State-Owned Electricity and Water Company (Jiro sy Rano Malagasy) MEP Ministry of Economy and Planning MFB Ministry of Finances and Budget MFIs Microfinance Institutions MIS Management Information System MSME Micro, Small and Medium Enterprises PASEF Projet D'Appui aux Services Financiers P2G Person to Government PPCG Partial Portfolio Guarantee for Credits PPP Public Private Partnership SMS Short Message Services SSA Sub-Saharan Africa WB World Bank WBG World Bank Group WEO World Economic Outlook iii FOREWORD Welcome to the June 2018 edition of the World Bank’s Madagascar Economic Update, which reports on recent economic developments and presents our medium-term outlook.1 Overall, the economy has been performing well, with growth estimated at 4.2 percent in 2017 and projected at 5.0 percent in 2018. There are numerous drivers of growth, including increased demand for transport services, a profitable banking sector and strong performance of goods and services produced in economic processing zones, contributing to solid export earnings and the accumulation of reserves. However, despite this rather robust macro-economic performance, the poor especially in Madagascar were hit by unfavorable weather conditions which resulted in a contraction in the agriculture sector, where the production of domestically produced rice fell, and prices soared. These events contributed to an increase in food inflation, directly eroding the purchasing power of the poor, and those who rely on subsistence farming for their food security. These developments underscore the importance of bringing the spoils of growth closer to the poor, so that improved living conditions are felt more broadly across a wide range of the population. And here I turn to the Special Focus Section of this Economic Update, which discusses Financial Inclusion. Over the past years, a quiet success story has been developing, where mobile money has been expanding to increase access to financial services for individuals and firms. These opportunities provide a means for safely storing money, as well as increasing access to other services such as credit in times of crisis and insurance to prepare for bad days. Over the medium-term we maintain a positive economic growth forecast. We project growth at 5.4 percent in 2019 and at an average of 5.1 percent over the medium-term. This growth outlook hinges on advanced economies realizing projected growth rates of around 3.0 percent of GDP over the medium-term, which should support steady demand for Malagasy goods and services. The outlook also assumes that the economy benefits from the realization of the government’s ambitious investment plan and that the political environment remains stable. We hope that this edition of the Madagascar Economic Update will help inform the public debate on the country’s current economic performance, and the types of policies that could stimulate inclusive growth to the benefit of all parts of the Malagasy society. Coralie Gevers Country Manager, Madagascar World Bank 1 The cut-off date for all data in this document is May 2018. iv ACKNOWLEDGEMENTS This edition of the Madagascar Economic Update was prepared by a team led by Natasha Sharma (Senior Economist, GMTA4). The team included Faniry Razafimanantsoa (Economist, GMTA4) and Prisca Mamitiana (Consultant, GMTDR). The special focus on financial inclusion has been prepared by a team consisting of Francesco Strobbe (Senior Financial Sector Specialist, GFCAE), Natasha Sharma (Senior Economist, GMTA4), Christoph Theodor Friedrich Ungerer (Economist, GMTE3), Noro Aina Andriamihaja (Senior Financial Sector Specialist, GFCAS), and Tenin Fatimata Dicko (Young Professional, GFCAW). The report was prepared under the overall guidance and supervision of Mark Lundell (Country Director, AFCS2), Mathew Verghis (Practice Manager, GMTA4), Coralie Gevers (Country Manager, AFCS2), Carolin Geginat (Program Leader, AFCS2), Ajai Nair (Senior Financial Sector Specialist, GFCAS), and Douglas Pearce (Practice Manager, GFCAS). The team would also like to express gratitude to our counterparts from the government for communicating the data used for the analysis, Norosoa Rakotomena for translation activities, Cybil Maradza for design work, Dia Styvanley (AFREC) for communications support, and Rondro Rajaobelison (Program Assistant, AFMMG) for logistics support. v PART ONE RECENT ECONOMIC DEVELOPMENTS 1 The Real Sector 1. Economic growth over the last four years has been services in economic processing zones, where investors are consistently improving. GDP accelerated from 2.3 taking advantage of generous tax incentives as well percent in 2013 to an estimated 4.2 percent in 2017, as affordable labor. However, the performance of the and is further projected at 5.0 percent in 2018.2 Since primary sector continues to be disappointing, where 2015, the most important driver of growth has been the output contracted by one percentage point in 2017. The services sector, which is characterized by a small but following sections consider developments in each of the dynamic private sector. Manufacturing related activities major sectors in the economy. have been bolstered by the production of goods and Figure 1: The services sector was the most important contributor to growth in 20173 Contribution to growth by sector, 2010-2018 6 5 4 3 2 1 0 -1 -2 -3 2010 2011 2012 2013 2014 2015 2016 2017e 2018p Primary Secondary Tertiary Taxes on products GDP growth Source: INSTAT, MEP, and WB staff calculations, May 2018 2. The consistently poor performance of the agriculture use of modern farming techniques, lack of connectivity sector means that the gains from economic growth have to markets to facilitate the transportation of goods, and not been felt by most of the population. Approximately high vulnerability to climatic fluctuations. Rural households 80 percent of the population are engaged in agricultural have minimal off-farm income generating activities to help activities, largely in rural areas where subsistence buffer the impact of weather shocks. farming is the main source of livelihoods. Between 2001 and 2012 (latest available data), 77 percent of the rural 3. Madagascar’s climatic conditions can be both a population lived below the national poverty line – a figure blessing and a curse for agricultural performance. that remained unchanged. And between 2014 and 2017, The country’s unique climate has led certain cash crops the agricultural sector contracted by an average of 0.8 such as vanilla, cloves and other spices to thrive, which percent, suggesting that the rural population are unlikely is supporting the livelihoods of farmers engaged in these to see significant improvements to their well-being from agri-businesses. Despite the effect of cyclones Ava and economic growth in recent years. The agricultural sector Eliakim in early 2018, receipts from vanilla production is constrained by low productivity due to the minimal remained strong as prices continue to be high, which is 2 The government have recently re-based their GDP figures, which are being reviewed. The new calculations are expected to be incorporated in late 2018. 3 The most common indicator used to measure economic activity is Gross Domestic Product (GDP). GDP can be estimated in three ways: the production approach, the expenditure approach or the income approach. The chart above shows GDP estimated through the production approach, which is concerned with value of all goods and services produced in the economy. The first step is to calculate the generation of value added on a production basis in basic prices. To convert this estimate into market prices taxes on products need to be added and subsidies on products need to be subtracted. 2 likely to attract new farmers seeking to also benefit from telecommunications undertaken in export processing zones high prices. However, the severe drought in 2017 combined continues to realize steady growth. Favorable rainfall is with cyclones reduced the supply of locally produced rice also boding well for hydro-electric production, where (the country’s main staple) by an estimated 20 percent. the ratio of hydro to total energy generation in the first Consequently, the agriculture sector (as a subset of the four months of 2018 rose to 57.6 percent on average, primary sector) contracted by an estimated 6.6 percent compared with 44.2 percent during the same period in 2017. in 2017. More favorable rainfall in 2018 is expected to result However, as there is still overall reliance on thermal energy, in improved performance of rice production, where a particularly through expensive diesel-based generators, better harvest should improve food security for the most the global increase in fuel prices is contributing to rising vulnerable. Overall, the agriculture sector is expected to production costs, which is increasing costs of production experience year-on-year growth of 4.5 percent in 2018. for industry. A shift to increasingly renewable sources of energy that take advantage of Madagascar’s significant 4. Industrial activities are performing well. Growth in hydro resources will help in the long run to reduce secondary sector activities is estimated at 8.9 percent in reliance on thermal energy and increase supply in an 2017 and projected at 6.7 percent in 2018. The production environmentally sustainable manner. of goods for export, and offshore services such as Figure 2: Improved rainfall is boosting hydroelectric Figure 3: Global oil prices have been rising since production June 2017, but changes to pump prices Gigawatt hours have been sporadic 160 90 4 Monthly diesel price change (%) 140 80 3 70 2 (Brent crude oil $) 120 Global oil prices 60 1 100 50 0 80 40 -1 60 30 -2 40 20 -3 20 10 -4 - 0 -5 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Hydraulic Thermal Global oil prices Diesel pump prices Source: INSTAT (TBE) and JIRAMA Source: World Bank, Madagascar Hydrocarbons Agency and World Bank staff calculations 5. A steady demand for services such as commerce and commerce, which expanded by 4.1 percent in 2017 and is transport have contributed to a moderate expansion projected to grow by 4.5 percent in 2018. Value added in the of tertiary sector activities. Year-on-year growth of highly profitable banking sector continues to grow (see box the services sector was estimated at 5.2 percent in 2017, 1), with the banking sector contributing to an estimated and is projected at 5.4 percent in 2018. Rising demand 0.43 percent of GDP in tax revenues in 2017. However, most for transport-related services is most likely explained of the population do not have access to banking services, by developing domestic tourism. One component of the and largely rely on alternative means of financial services services sector that is performing particularly well is (see Part 3). 3 Box 1: Madagascar’s Highly Profitable Banking Sector Going back centuries, banks have always played an profits. Ten out of eleven banks are foreign owned, where important role in the economy. Banks can help to look the state has shareholdings in three major banks. This after your money, by keeping cash stored safely in an concentration can be a source of vulnerability, because if account, to reduce the risk of having your money get lost a few large firms are unable to service their loans there or stolen. Banks lend money to customers such as private could be major consequences. However, strong foreign individuals and businesses, which comes at a cost known ownership is generally considered as a source of strength as interest rates (see Box 3). And banks can help to pay since the parent company can usually support a subsidiary for goods and services, for example, by providing their in case of difficulties. customers with cash or a credit or debit card. However, in Madagascar the use of banking services is low: less than Overall, the banking sector is financially sound. During ten percent of the population have a deposit account; a the global financial crisis, the vulnerabilities of the financial figure comparable with South Sudan and Guinea (see part sector created significant costs to governments worldwide, 3 on financial inclusion). which is why it is essential to regularly assess performance and potential areas of weakness. In Madagascar, all banks Despite the limited reach of the banking services, the fulfill the minimum capital adequacy requirement, with sector is highly profitable. Between 2013 and 2017, the an overall capital to risk-assets ratio of 13.6 percent on return on equity increased from 30 percent to close to 42 aggregate, well above the required minimum of 8 percent. percent, meaning that the amount of profit generated as Subject to seasonal fluctuations, liquidity is generally ample, a percentage of shareholder’s equity increased by close with banks’ aggregate deposits exceeding loans, although to 30 percent. This level of profitability compares favorably some banks are more exposed than others to liquidity risks. with other countries in the region, but may also reflect While the risk of insolvency is low, the capital adequacy ratio the risk adverseness to lend to new clients. Similarly, (which is based on a risk assessment for each type of bank the return to assets in Madagascar also performs well asset) is at the lower end compared with other countries compared with other countries. in the region. The ratio of nonperforming loans to overall loans stands at about 8 percent, and is at a similar level to High profitability means that the government has been other countries in the region. able to capture sizeable dividends. The state has shares ranging from 9.4 to 32.5 percent of the bank’s capital. Potential vulnerabilities in the banking sector could Dividends from all financial sector institutions comprised arise from credit risks and a sharp deterioration of 52 percent of total dividends in 2016 and 34.2 percent of the macroeconomic situation. In June 2017 stress test total dividends in 2017. The falling share of the financial undertaken by the Central Bank to assess possible pressure sector’s contribution to government dividends in 2017 was points showed that the financial indicators remained above due to non-financial sector companies paying dividends to the minimum requirements. Credit risk is the most dominant the government and an insurance company failing to pay source of risk, which could lead to banks being under- dividends on time. Banks also contributed 0.43 percent of capitalized but still remaining solvent. A significant fall in GDP in tax revenues in 2017. economic performance could also affect the performance of local banks, where for example borrowers may not be The banking sector is highly concentrated. While there able to service their loans or make regular deposits. As part are eleven banks operating in the country, the sector is of its mandate to maintain financial stability and inform highly concentrated around four banks, which own 87 supervision decisions, the Central Bank regularly updates percent of total banking sector assets, 88 percent of and publishes the financial soundness assessment. total deposits and share between them 94 percent of 4 Figure 4: The return on equity compares favorably Figure 5: The return on assets is also one of the best with other countries in the region performing in the region (%in 2017) (% in 2017) 160 14.0 140 12.0 120 10.0 100 8.0 80 6.0 60 40 4.0 20 2.0 - 0.0 Djibouti Mauritius Guinea Chad Ghana South Africa Lesotho Namibia Malawi Madagascar Cameroon Gabon Djibouti Mauritius South Africa Chad Guinea Namibia Lesotho Ghana Madagascar Cameroon Malawi Gabon Figure 6: The capital adequacy ratio is at the lower Figure 7: While the ratio of nonperforming loans is end compared with peers (%in 2016) similar to comparator countries (%in 2016) Defined as the capital-to-risk weighted assets Value of nonperforming loans divided by the total ratio (%) value of the loan portfolio (%) 20 25 18 16 20 14 12 15 10 8 10 6 4 5 2 0 0 Gabon Cameroon Lesotho Madagascar Djibouti Namibia Ghana South Africa Guinea Chad Mauritius Malawi Namibia South Africa Lesotho Madagascar Mauritius Malawi Gabon Guinea Cameroon Djibouti Ghana Chad Source: IMF Financial Soundness Indicators, extracted in 2018 Sources: Financial System Stability Assessment, IMF 2016 and Report on Financial Sector Stability, Central Bank of Madagascar 2016 While the economy is growing, the agriculture sector which engages 80% of the population, continues to fall behind. 5 Table 1: Selected Macroeconomic Data 2013 2014 2015 2016 2017 2018* 2019 2020 2021 2022 Actuals Est Projections Real sector GDP (billions of ariary) 23,397 25,775 28,585 31,769 35,835 40,548 45,809 51,251 56,857 62,717 Real GDP growth 2.3 3.3 3.1 4.2 4.2 5.0 5.4 5.3 5.2 4.9 GDP per capita (USD) 462 453 402 401 449 475 501 525 547 566 GDP per capita growth -0.5 0.6 0.4 1.4 1.4 2.2 2.6 2.6 2.4 2.2 Unemployement rate (ILO definition) 0.9 1.2 1.8 1.8 1.8 1.8 1.8 1.9 1.9 1.9 GDP deflator (annual % change) 5.1 6.6 7.6 6.7 8.3 7.8 7.2 6.3 5.5 5.2 Inflation, consumer prices 6.3 6.0 7.6 7.0 9.0 7.7 6.4 6.0 5.4 5.0 (annual %, end of year) Public Finance (%GDP) Revenues, excluding Grants 9.6 10.1 10.4 11.2 11.8 12.2 12.5 13.0 13.4 13.6 o/w: Tax Revenues 9.3 9.9 10.1 10.9 11.5 12.0 12.3 12.8 13.2 13.4 Grants 1.3 2.3 1.5 3.5 2.9 3.4 2.7 1.4 1.4 1.4 Total spending (commitment basis) 14.9 14.7 15.1 16.0 17.1 18.0 19.6 19.8 20.0 19.8 o/w: Capital spending 3.1 3.9 3.5 5.2 5.5 7.3 9.8 9.8 9.9 9.5 Overall balance (cash basis) -2.0 -2.4 -3.7 -2.0 -2.3 -3.3 -4.6 -5.5 -5.2 -4.8 Total public debt 33.9 34.7 41.3 38.4 36.0 35.1 36.5 39.0 41.3 43.4 Monetary accounts (annual % change) Money Supply (M2) 9.0 9.8 15.8 21.3 19.3 13.4 13.7 17.3 16.8 14.2 Net Foreign Assets -12.7 17.3 20.9 37.4 23.2 9.5 8.8 17.1 16.3 12.3 Net Domestic Assets 8.0 8.3 11.4 10.8 14.1 15.1 15.7 15.4 15.5 14.2 o/w: Credit to the Private Sector 16.7 18.4 16.5 8.2 18.4 14.0 15.4 15.0 14.4 14.0 External sector (%GDP) Exports of goods 18.1 20.6 21.0 21.6 24.4 23.6 23.1 23.1 23.2 23.3 Imports of goods 30.7 30.2 28.7 28.6 31.4 32.1 31.5 32.2 32.6 32.6 Current account balance -5.9 -0.3 -1.9 0.6 -0.3 -2.2 -3.4 -4.3 -4.6 -4.8 Foreign Direct Investment 5.2 2.9 4.5 4.5 3.1 3.1 3.2 3.3 3.4 3.4 Overall Balance 0.7 0.2 1.0 2.9 2.0 0.4 0.3 1.0 1.0 0.6 Foreign Reserves (months of imports) 2.2 2.5 2.9 3.9 4.0 4.1 4.1 4.2 4.3 4.3 External debt 22.8 24.4 28.4 26.7 25.3 25.5 27.8 30.7 33.3 35.5 Terms of Trade (percent change) -0.1 -0.7 1.2 22.3 17.7 -1.8 0.7 0.9 0.6 0.3 Exchange Rate LCU/USD(average) 2,207.0 2,414.8 2,933.5 3,176.5 3,116.0 … … … … … *Projections based on the rectified budget law draft, published on the MFB website Source: Malagasy authorities, IMF and WB staff calculations, May 2018 6 The External Sector 6. The current account deficit has remained at a low 8. Exports are increasingly concentrated around a level. Significantly higher vanilla prices and growing limited number of goods. Export performance has been exports of labor-intensive manufactured goods boosted improving in recent years, where the export-to-GDP ratio export revenues in 2017. Imports also grew for food (in has increased from 30 percent in 2013 to 35 percent in particular, for rice to make up for the shortfall in domestic 2017, also reflecting higher vanilla prices. This upward trend production) and capital items for investment projects. indicates that the economy is increasingly open, access Overall, the current account deficit is estimated at 0.3 to external markets is widening and that export earnings percent of GDP in 2017. The same trend is observed over have improved. However, the export concentration index is the first quarter of 2018, with export earnings continuing trending upward, which means that fewer goods dominate to benefit from high vanilla prices. External financing from the export basket.4 Over the past five years, 58 percent project loans and grants have financed the modest deficit. on average of the country’s total exports have been In 2018, the deficit is projected at 2.2 percent, as imports dominated by vanilla, nickel, and garments, which have are expected to increase for capital investment projects. also been the main drivers of export growth. 7. Strong export earnings have enabled the central bank 9. This export concentration can be a source of to accumulate more foreign exchange reserves than vulnerability. An unexpected fall in demand or a sharp originally projected. Madagascar has a floating exchange change in prices could have a significant impact on export rate, where the central bank only intervenes to manage receipts. To mitigate potential risks, measures could be undue volatility in exchange rates and to ensure adequate undertaken to diversify exports and strengthen domestic levels of liquidity. In line with those objectives, the central demand. The development in service exports observed bank purchased foreign exchange in the second half of recently, including in business process outsourcing, for 2017 to moderate the exchange rate fluctuations, which example through call centers and telecommunications increased the import coverage of foreign exchange activities, as well as tourism is encouraging.5 reserves to four months at the end of the year. Figure 8: The current account deficit Figure 9: Exports are becoming increasingly remains low concentrated Current account balance, 2009-18 (US$ millions) Export Concentration Index (Herfindahl-Hirrschmann) 500 0.300 0 0.250 -500 0.200 0.150 -1,000 0.100 -1,500 0.050 -2,000 0.000 2013 2014 2015 2016 2017 2018 2009 2010 2010 2011 2012 2013 2014 2015 2016 2017e 2018p HHI Trendline Exports are performing well, but are dominated by a small number of goods: nickel, garments and vanilla. 4 The export concentration is measured here by the Herfindahl-Hirrschmann Index. An index closer to 1 indicates a country’s exports are highly concentrated on a few products. Calculations were made based on the value of exports. 5 Between 2014 and 2016, more than 70 new ICT firms were created in Madagascar, most of which operating in off-shore activities (Source: Economic Development Board of Madagascar). 7 Figure 10: Exports are dominated by vanilla, Figure 11: Imports increased in 2017 compared garments and nickel with previous years Exports Goods, 2013-2018 (US$ millions) Imports Goods, 2013-2018 (US$ millions) 3,000 4,000 2,500 3,500 3,000 2,000 2,500 1,500 2,000 1,000 1,500 1,000 500 500 0 0 2013 2014 2015 2016 2017 2018 (Jan-May) 2013 2014 2015 2016 2017 2018 (Jan-May) Vanilla Cloves Cobalt Nickel Rice Foods (Other than rice) Garments Others Petroleum products Equipment Raw materials Other Source: MFB, CBM, IMF and WB staff calculations Table 2: Balance of Payments (in US$ millions)6 2016Q1 2016Q2 2016Q3 2016Q4 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 1 – Current transactions 60.5 -141.2 -99.7 230.8 119.9 -54.8 -249.1 146.4 105.7 1.1 Goods and services -12.6 -144.7 -158.9 85.8 27.0 -98.9 -327.0 -21.6 -58.1 Trade balance -9.6 -107.3 -141.9 -7.4 -10.9 -135.3 -314.2 10.3 -47.0 Exports FOB 524.6 501.5 483.2 651.2 670.9 628.0 588.5 917.9 752.8 Imports FOB 524.6 501.5 483.2 651.2 670.9 628.0 588.5 917.9 752.8 Services nets -534.2 -608.8 -625.0 -658.5 -681.8 -763.3 -902.6 -907.6 -799.7 1.2 Income -3.0 -37.4 -17.0 93.1 37.9 36.4 -12.9 -31.9 -11.1 1.3 Current transfers -70.5 -145.7 -88.4 -103.2 -69.7 -98.0 -84.3 -102.4 -37.9 143.6 149.3 147.7 248.2 162.6 142.1 162.2 270.4 201.7 2 – Capital and financial account -38.8 168.3 202.5 -55.2 -135.9 2.4 349.7 83.0 -57.6 2.1 Capital account 55.7 29.7 73.0 117.8 40.4 52.5 55.8 85.6 34.8 2.2 Financial account -94.6 138.6 129.5 -173.0 -176.4 -50.1 293.9 -2.7 -92.4 3 - Errors and omissions 9.9 -40.8 -22.0 15.5 -2.7 -17.7 14.1 -14.6 -58.0 4 – Overall balance 31.6 -13.7 80.8 191.1 -18.8 -70.0 114.7 214.8 -10.0 Source: Central Bank, May 2018 6 FOB refers to ‘free on board,’ a trade term that indicates whether the seller or the buyer has liability for goods that are damaged or destroyed during shipment between the two parties. 8 Monetary Sector 10. Rising inflation in 2017 has strained the purchasing poor from higher prices. Prices have evolved at different power of many households. Year-on-year inflation rates between the main cities in Madagascar, with the peaked at 9 percent at end 2017. Inflation in 2017 has been inflation differential narrowing in times of higher inflation associated with higher food prices, particularly for rice, as observed in 2017. and more expensive gas, utilities and housing. The index of fuel and lubricant price rose sharply in the second quarter 11. While inflationary pressures have started to ease in of 2017 with an average monthly increase of 16.2 percent, the first quarter of 2018, prices are still high compared compared to a monthly decline of 2 percent in the previous with neighboring countries. Inflationary pressures have 12 months. Higher fuel prices on the domestic market started to ease in the first quarter of 2018, largely due to coincides with the global rise in fuel prices, which has been improvements in the supply of domestically produced rice. reflected in some adjustments to pump prices. Higher In the first semester of 2017, inflation in Madagascar was prices for these products have been mostly hurtful for the comparable to countries such as Kenya. While inflation poor given the high share of spending on fuel compared to has started to ease in several neighboring countries, it the household budget and limited measures to protect the still remains relatively high in Madagascar. Figure 12: Inflation spread within main towns Figure 13: Inflation rate in neighboring countries narrowed down in 2017 eased from the 3rd quarter of 2017 Inflation rate % Inflation rate % 14 250 12 200 10 8 150 6 100 4 50 2 0 - Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Kenya Tanzania South Africa Sources: INSTAT and WB staff calculation Mozambique Madagascar Box 2: Rice: What Lies Behind the Price Surge? In a nation where rice is the dominant staple for each (World Bank, 2016). And in urban areas, where rice is largely major meal, the effects of a near 30 percent increase purchased rather than produced, an increase in prices in rice prices in 2017 has been acutely felt following the has significantly reduced households’ purchasing power. reduction in local supply due to climatic shocks. In rural While the first three months of 2018 have seen overall areas, the high poverty gap rate of 36.7 percent, means inflation decrease by 7.6 percent compared with the same that even small changes in the purchasing price of key period the previous year, higher rice prices still prevail, consumer goods can lead a family to fall into poverty and accounts for half of the increase in overall inflation.7 7 Inflation is calculated by measuring changes in the prices of a basket of goods and services over two periods in time, where each item in the basket is weighted according to its importance. In Madagascar, locally produced goods account for 76 percent of the total basket. Rice comprises 15 percent of the basket of goods, of which 90 percent is produced locally. 9 Figure 14: Higher rice prices have been the largest contributor to inflation Contribution to Inflation (Major Items in the Consumption Basket) % 10 8 6 4 2 0 2013 2014 2015 2016 2017 Mar-18 Foods (excl. rice) Rice Housing, Water, Electricity, Gas and other fuels Fuel and cost of transportation Fabrics & clothing Others Annual inflation Source : INSTAT While the rice market has been liberalized since the 1980s, Imported rice is mainly consumed by urban households, there are still only a limited number of net rice sellers. whereas in times of reduced local supply, rural households Some rice-producing households sell their produce to are more likely to decrease consumption. Both local meet urgent needs for cash or because they cannot and imported rice benefit from tax expenditures, which afford to store rice during the harvest period, and then effectively act as a transfer from the rural poor to urban buy rice later at a higher cost during the lean season. households. The establishment of a Rice Observatory to share market information is a welcomed measure, but the use of the Carefully targeted policies could help in bringing the information could be improved. Poor productivity of rice is benefits of higher rice prices to smallholder farmers. affected by low use of fertilizers, as well as lack of access Presently, more than half of the retail price is captured to irrigated farms and input markets. by market intermediaries, where high costs of logistics resulting from poor transport infrastructure exacerbates While Madagascar is a rice producing country, it is a net costs. Other measures to improve productivity through the rice importer since domestic production cannot keep targeted use of fertilizers, mitigating the effects of climate up with population growth. The price of imported rice is related hazards, and eliminating the tax expenditure for cheaper than local rice in all regions, where the reduction imported rice to incentivize domestic production could in local supply in mid-2017 led the gap in prices to widen. also be considered. Figure 15: The price of locally produced rice Figure 16: The price of imported rice is higher in the accelerated throughout the country capital and in the north of the country Ariary Ariary 2,700 2,700 2,200 2,200 1,700 1,700 1,200 1,200 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 2013 2014 2015 2016 2017 2018 2013 2014 2015 2016 2017 2018 Antananarivo Toamasina Antananarivo Toamasina Mahajanga Antsiranana Mahajanga Antsiranana Sources: Food and Agricultural Organization, INSTAT, WB staff calculations 10 Figure 17: Market intermediaries capture more than half of profits along the value chain Paddy and milled rice - MGA/kg 2,500 2,000 1,500 1,000 500 0 Sofia Boeny Alaotra Mangoro Atsimo Andrefana Haute Matsiatra Menabe Ihorombe Itasy Vakinankaratra Analamanga Atsimo Atsinanana Vatovavy Fitovinary Paddy Rice - Wholesale price Rice- Retail price Source: Rice Observatory, prices available from May 14th to 20th, 2018 Sources: FAO, 2017; World Bank, 2016; World Bank, 2018; Rice Observatory, 2018; Ministry of Finance, 2017; INSTAT, 2018. 12. Monetary policy formulation has been reinforced in 13. The ariary has been on a depreciating trend. There recent years. The central bank act that was updated in are multiple factors affecting the exchange rate in 2016 (i) includes a tighter limit on the access to statutory Madagascar. In general, end-of-year festivities are advances for fiscal deficit financing and (ii) established marked with an increase in imports which contributes a monetary policy committee that is in charge of to a weakening of the ariary. The opening of the vanilla reviewing the monetary policy every six months to ensure season in May and June, usually sees the ariary following consistency with the government’s macroeconomic an appreciating trend as demand for the local currency targets and manage liquidity in the banking system. In increases to purchase locally produced goods. To manage line with those reforms, the central bank’s lending to the volatility in the market, the central bank may intervene government progressively retracted as statutory advances to a limited extent either to buy or sell foreign currency. are being reimbursed (Figure 19). As of the decision of the The recent depreciating trend of the ariary in nominal monetary policy committee in May 2018, the level of policy terms continues to bode well for the competitiveness rate and mandatory reserves rate remain unchanged.8 of exporters. Inflation has started to ease in the first quarter of 2018, supported by improvements in the supply of domestically produced rice. 8 Central bank of Madagascar. Decision on monetary policy on May 4th, 2018. 11 Figure 18: The ariary has been following a largely depreciating trend 10 5 0 -5 -10 -15 01/02/2018 01/06/2017 01/07/2017 01/08/2017 01/09/2017 01/10/2017 01/11/2017 01/12/2017 01/01/2018 01/04/2018 01/03/2018 01/05/2018 EUR USD Source: CBM, and WB staff calculations, May 2018 14. Lending to the private sector has picked up, driven stocks, mainly related to vanilla transactions. There was mainly by short-term credits. Lending to the private sector a fall in the average interest rates at the beginning of the increased on average by 15 percent on y-o-y basis between year, but this has since reversed. Several factors influence September 2017 to March 2018, compared with the previous commercial banking rates including risk levels, cost of six months. New loans were largely short-term in nature, operations and cost of financing (see Box 3). for the overdraft facility and advances on merchandise Figure 19: Lending to the private sector has picked up Figure 20: After a fall in commercial banks’ interest Credit to the government and to the economy rates at the beginning of the year, there (%change y-o-y) is now an increase Rate (in percent) 40 16 35 15 30 14 25 13 20 12 15 11 10 5 10 0 9 -5 8 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Credit to the government Central Bank policy rate Credit to the economy Weighted average overdraft rate Weighted average borrowing rate Source: CBM 12 Figure 21: Long term lending has been declining Figure 22: The pre-export season is associated with Annual variation (millions of MGA) an increase of money in circulation9 Annual variation in percentage 700,000 35 600,000 30 500,000 25 400,000 300,000 20 200,000 15 100,000 10 0 -100,000 5 -200,000 0 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18e Short term credit Medium term credit M3 Monetary basis Long term credit Source: CBM Box 3: Buy now… and pay later: What determines interest rates in Madagascar? Interest rates are referred to as the privilege of borrowing banks and then conventional banks (Figure 23). However, money that has to be repaid later. In Madagascar, effective high interest rates are by no means unique to Madagascar. interest rates vary from 11 to 127 percent, depending on Financial institutions in countries such as Zambia, the type of financial institution that is lending money. At Ghana, Malawi and Tanzania charge higher rates than in the very top end, the highest interest rates are charged Madagascar (Figure 24). by micro finance institutions, followed by micro finance Figure 23: Type of institution and average effective Figure 24: Interest rates in comparator countries interest rates in Madagascar Range of effective interest rates on products (%) Conventional banks 400 300 200 Microfinance banks 100 0 Microfinance-not banks Ethiopia (2011) Madagascar (2015) Rwanda (2013) Mozambique (2011) Uganda (2013) Kenya (2013) Tanzania (2013) Malawi (2013) Zambia (2011) Ghana (2013) All 0 50 100 150 200 Average interest rate in the country (%) 9 Broad money is a measure of money supply that includes more than just physical money such as currency and coins but also demand deposits at commercial banks, and any monies held in easily accessible accounts. 13 Interest rates are largely determined by the cost of • Mobilizing larger volumes of savings that could be operations, the level of risk and the cost of financing. channeled to banks as liquidity. Microfinance institutions charge higher interest rates because small loans are costlier to manage and are Reducing risks can be supported by: covered by little or no guarantees, thereby increasing operating costs and risk levels. Banks on the other hand, • Improving the justice system; largely offer credit to a smaller segment of the population. • Establishing a centralized system for registering Nevertheless, risks are still high due to institutional guarantees; weaknesses related to recovering credit losses and • Strengthening the power of land certificates as insolvency, which means that in the case of default, collateral for accessing credit; collection procedures are considered slow, uncertain • Improving and integrating the Central Banking Risk and costly to the creditor. The cost of using bailiffs to Unit and the Microfinance Risk Unit; and collect debts in Madagascar is considered high by financial • Improving credit risk management (analysis, institutions. Other credit risks arise due to the unreliability monitoring, recovery). of financial statements for small and medium enterprises, the lack of information provided by the Central Risk Office, Improving competition and transparency could also help to portfolio concentration and the ability of credit institutions reduce interest rates by increasing the power of consumers to assess risk. to make comparisons and exert pressure to lower rates. Banks are generally more competitive than microfinance institutions Setting interest rates at the right level is important for and provide greater transparency on the rates offered. financial institutions to maintain profits and be sustainable. However, by improving the operational and institutional Finally, there is scope to improve the institutional environment, there are other ways that interest rates framework for determining commercial interest rates. could be lowered. Key measures to reduce operational Currently, Instruction No. 001 - CR / 08 of 28 April 2008 gives and financial costs include: banks the freedom to set lending rates. Further, Ordinance No. 62-016 of 10 August 1962 fixes the legal interest rate • Using technology for electronic transactions to and the maximum conventional interest rates, as well as follow up on credits; the regulation of loans. However, this Ordinance has not • Improving productivity through training staff and been implemented due to a lack of application decrees, using more efficient ways to provide credit; as well as challenges in interpretation and weaknesses in • Increase control over administrative costs; and supervisory capacity and should be eliminated. Source: Study on the Determinants of Interest Rates in Madagascar, Project for the Support of Financial Services, World Bank, May 2017 Fiscal Policy 15. Tax collection performed well in the first quarter of the the GDP in 2018, which is still low compared to the average year, with revenues exceeding targets by approximately for Sub-Saharan Africa (15.8 percent of GDP10) but shows 0.3 percent of GDP. All major taxes (VAT and income taxes), nonetheless a steady improvement. contributed to this good performance, largely due to improvements in tax administration. The revised taxation 16. Overall, expenditures are expected to increase from effective since January 2018 on petroleum products also 17.1 percent of GDP in 2017 to 18.0 percent of GDP in 2018. contributed to higher revenue earnings. Overall, tax revenue The composition of expenditures is expected to change, collection reached 11.5 percent of GDP in 2017, an estimated with a reduction in current expenditures and higher capital increase of 0.6 percentage point of GDP compared with spending. Current expenditures are expected to reduce the previous year. Provided the reform momentum stays from 11.7 percent of GDP in 2017 to 10.7 percent of GDP on track, tax revenue collection could reach 12.0 percent of in 2018, largely due to a fall in the transfer provided to 10 World Development Indicators, latest data available. 14 JIRAMA, which has benefited from increased hydro-power 17. The fiscal deficit in 2017 is estimated at 2.3 percent generation. Capital expenditures are expected to increase of GDP, and is expected to widen to 3.2 percent of GDP from 5.5 percent of GDP in 2017 to 7.3 percent of GDP in in 2018. The deficit is largely financed through foreign 2018, where externally financed projects accounts for 4.8 borrowing, which is projected at 2.5 percent of GDP in percent of GDP. These expenditure trends are consistent 2018. These loans are for externally financed investment with the government’s policy to scale-up publicly financed projects. Domestic borrowing is estimated at 0.7 percent investments and reduce transfers to state-owned of GDP in 2018, which is a slight reduction from 0.9 percent enterprises. However, there has been minimal progress of GDP the previous year. Domestic borrowing is largely in improving expenditures on social priority expenditures through the issuance of government bonds, which are which has stayed consistently at around 1 percent of GDP. mostly subscribed to by commercial banks. Figure 25: There has been a steady improvement in Figure 26: In 2018, capital expenditures are expected tax revenue collection to increase, and current spending decline Percentage of GDP Percentage of GDP 14 18 12 16 10 14 12 8 10 6 8 4 6 4 2 2 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2017e 2018p 2009 2010 2011 2012 2013 2014 2015 2016 2017e 2018p Custom revenues Current expenditure Capital expenditure Domestic taxes Total expenditure Wages and salaries Source : MFB, IMF and WB staff calculation and projection Tax collection performed well in the first quarter of the year. Table 3: Fiscal Operations of the Central Government (% GDP) 2014 2015 2016 2017 2018 2018 Actuals Estimations LFI Projections* Total revenue and grants 12.4 11.8 14.7 14.7 15.1 15.7 Total revenue 10.1 10.4 11.2 11.8 12.1 12.2 Tax revenue 9.9 10.1 10.9 11.5 11.9 12.0 Non-tax revenue 0.2 0.3 0.3 0.3 0.2 0.2 Grants 2.3 1.5 3.5 2.9 3.0 3.4 Total expenditure 14.7 15.1 16.0 17.1 18.0 18.0 Current expenditure 10.8 11.7 10.8 11.7 9.9 10.7 Wages and salaries 5.6 5.5 5.6 5.8 5.7 5.8 Interest payments 0.6 0.8 0.9 0.8 1.0 0.9 Goods and services 0.9 0.5 0.6 0.8 0.9 0.9 15 2014 2015 2016 2017 2018 2018 Actuals Estimations LFI Projections* Transfers and subsidies 3.2 3.4 3.1 4.1 2.2 2.6 Treasury operations (net) 0.6 1.4 0.6 0.2 0.1 0.4 Capital expenditure 3.9 3.5 5.2 5.5 8.1 7.3 Domestic financed 1.2 1.0 1.2 2.0 2.4 2.5 Foreign financed 2.8 2.5 4.0 3.5 5.7 4.8 Overall balance (commitment basis) -2.3 -3.3 -1.3 -2.4 -3.0 -2.3 Float (variation of accounts 0.6 0.1 0.5 0.7 … … payable, + = increase) Variation of domestic arrears -0.7 -0.5 -1.2 -0.6 -0.6 -0.6 (+ = increase) Overall balance -2.4 -3.7 -2.0 -2.3 -3.5 -3.2 (including grants, cash basis) Total financing 2.4 3.7 2.0 2.3 3.5 3.2 Foreign borrowing (residency principle) 1.2 2.2 0.7 1.4 3.1 2.5 Domestic borrowing (residency principle) 1.2 2.0 1.4 0.9 0.4 0.7 * Projections based on the rectified budget law draft, published on the MFB website Source: Malagasy authorities, IMF and WB staff projections, May 2018 18. Overall, the level of debt distress remains moderate. Africa are experiencing risks to their debt sustainability. In Madagascar’s risk of external debt distress is moderate, 2013, eight countries in SSA had a high risk of debt distress, which means that while overall levels of debt are currently compared with 18 countries in 2018. Looking at the continent manageable if there is a shock to the economy, such as as a whole, public debt increased from an average of 37 reduction in growth, the capacity of the country to repay its percent of GDP in 2013 to 56 percent in 2016, with more debt services is under moderate risk. The latest assessment than two-thirds of the countries experiencing an increase of Madagascar’s debt was undertaken in March 2018, and of more than 20 percentage points.11 A number of countries shows that the ratio of public debt to GDP fell from 38.4 are using alternative sources of debt financing, moving away percent of GDP in 2016 to an estimated 36.0 percent of GDP in from concessional financing to market-based external debt, 2017. The main sources of vulnerabilities to the debt outlook which has higher rates of interest. While Madagascar has could arise from slower than expected economic growth a moderate risk of debt distress, as the country prepares and unexpected debt arising from the materialization of to scale-up public investments, it is important to learn contingent liabilities from under-performing SOEs. from these regional trends by carefully considering the implications of debt financing in line with the Medium-Term 19. In contrast, a number of other countries in Sub-Saharan Debt Strategy, and prioritizing concessional borrowing. While Madagascar’s risk of debt distress remains moderate, high levels of debt for certain state-owned enterprises continue to present a risk, highlighting the need to improve their financial performance. 11 Africa Pulse, World Bank, April 2018. 16 PART TWO ECONOMIC OUTLOOK 17 20. The overall medium-term economic growth outlook is 23. Over the medium-term, public expenditures are positive. Favorable global growth prospects are expected expected to remain steady, but with a changing to maintain strong demand for Malagasy goods and composition toward lower current spending and higher services, contributing to an increase in export earnings capital expenditures. Public spending is projected to and international reserves. Positive weather conditions increase from 18.0 percent of GDP in 2018 to 19.6 percent are expected to bode well for rice production and hydro- of GDP in 2019, and then average 19.9 percent of GDP over power generation. The current boom in vanilla prices is the period 2020 to 2022. Public expenditures are expected expected to encourage new smallholder farmers to the to be supported by both an increase in tax revenues and vanilla growing industry, which can boost local incomes. higher external borrowing for projects that have already Ongoing reforms aiming to improve connectivity of rural been identified. Current expenditures are projected to zones are also expected to contribute to increasing off- decline from 10.7 percent of GDP in 2018 to 9.8 percent of farm activities, where secondary income generated could GDP in 2019, based on the assumption that the transfer act as a buffer to variations in agricultural output, which to JIRAMA falls as the utility’s operational performance are subject to changing weather conditions. The tertiary improves and commitment to avoiding fuel subsidies is sector is projected to continue being a source of growth, maintained. On the other hand, capital expenditures are with services to companies and commerce expected to projected to increase from an estimated 7.3 percent of GDP follow a positive trend. Growth is projected at 5.4 percent in 2018 to a projected 9.8 percent of GDP in 2019, as the in 2019 and to average 5.1 percent over the medium-term. government plans to scale-up investment expenditures. 21. Reflecting the country’s significant external financing 24. This positive macroeconomic outlook provides needs, the pressure on the current account deficit is opportunities to reduce poverty. The projected growth expected to heighten over the medium-term. The deficit of the economy means that the proportion of the is projected at 3.4 percent in 2019, and then average 4.6 Malagasy population living under the poverty line is likely percent of GDP over the period 2020 to 2022, as a scale-up to decrease. The poverty headcount, based on US$1.90 a in public investments should drive the demand for imports. day line is projected to lower from 75 percent in 2018 to 73 The current account deficit will be offset by the related percent in 2020.12 Higher fiscal revenues and a reduction in surpluses in the capital and financial accounts from public transfers to poorly performing SOEs mean that there are sector loans and foreign direct investment. more resources available to deliver public services such as education, health and public infrastructures. However, 22. Monetary policy is expected to maintain its focus on the evidence shows that while growth is important, it controlling inflation. Inflation is estimated at 6.4 percent in must be inclusive to have an impact on poverty reduction, 2019, and is projected to average around 5.4 to 6.0 percent supported by sound public institutions. Addressing the over the 2020 to 2022 period. Assumptions are based on constraints to rice productivity identified in the part one an increase in the supply of domestically produced rice, of this report figures among one of the channels that following favorable climatic conditions, and moderate could contribute to more inclusive growth in Madagascar. increases in energy prices. While international supply The third part explores how increasing access to financial conditions for oil remain uncertain, overall a reduction in services can also bring the benefits of growth closer to Brent crude oil prices is projected in 2019, provided that the poor. the US shale industry develops as expected. While the economy is projected to continue expanding over the medium-term, focusing on inclusive growth is essential for poverty reduction. 12 Poverty Outlook, 2018 (with updated growth projections). 18 PART THREE LEVERAGING TECHNOLOGY TO PROMOTE FINANCIAL INCLUSION • Penetration levels for banks in Madagascar are to 18 percent in 2017) but it is still far below the SSA amongst the lowest in Africa. Increasing access to average of 43 percent. the financial system for 41 percent of the population who are currently unbanked will allow individuals to • A rapid expansion in mobile money is offering store and send money more safely in the future. It opportunities to increase financial inclusion. Growth will also open opportunities for accessing credit to of the sector is being facilitated by a new e-money start or grow a business for those who were formerly regulation which allows financial institutions other not able to access this type of financial service. than banks to issue e-money. • The newly released Findex data show that the • Digital partnerships between the growing market percentage of adults with an account at a financial segment of microfinance institutions and mobile institution or mobile money service in Madagascar money operators will be an opportunity for increasing doubled over the past 3 years (from 9 percent in 2014 the outreach of mobile network operators. 19 • One of the current obstacles for those trying to be an important source of information for banks access credit is that banks find it hard to assess seeking to expand their client base. the creditworthiness of prospective clients due a lack of information on these future borrowers. Credit • A new National Strategy for Financial Inclusion (2018- bureaus play an important role in collecting data 2022) has been adopted to support current changes on the repayment behavior of the population, to in the financial services landscape of Madagascar. provide insights on how likely a person is to repay It prioritizes reforms around increasing financial a loan. A newly enacted Credit Bureau Law provides education, promoting the use of financial services and the foundation for private credit bureaus to enter strengthening the infrastructure for financial services. the market in Madagascar. These credit bureaus will Why does financial inclusion matter? Meet Tantely, a 28-year-old school teacher working in to services such as transaction accounts, credit, and Tsihombe, in Madagascar’s deep South. Each month, Tantely insurance among others is creating opportunities for is obliged to travel for two days to retrieve her salary. As individuals and businesses that have been left out of the a result, she cannot fulfill her obligation of teaching in formal banking system. the local school, has to spend money on transportation, and turns to her mother for childcare support during her Nevertheless, the 2016 Finscope14 survey data indicated absence, reducing the family’s time for farming activities. that 41 percent of Malagasy households are completely Mobile banking is about to change this. Through a new pilot disconnected from the financial system, suggesting that initiative, Tantely will soon receive her salary through her there is still a long way to go before the benefits of digital mobile phone, increasing her time in the classroom, and innovations become more broad-based and inclusive. her availability to engage in productive activities. Improving access to financial services for women remains a priority, where female entrepreneurs are more likely to And Tantely is not alone. Despite being one of the poorest report access to credit as a constraint. This piece explores countries in the world, the use of mobile money has the role that technology and innovation are playing to increased dramatically in Madagascar – a near 5 times increase financial inclusion, particularly through mobile increase in just three years – although from a very banking, and how other segments of the market such as low base.13 Through the rise of mobile banking access microfinance institutions (MFIs) and banks can catch up. Increasing access to financial services for 41% of the population who are currently left behind is essential for storing, saving and sending money safely, as well as accessing credit and other services. 13 In 2016 there were 54.2 active mobile money accounts per 1,000 adults compared with 10.7 in 2013(Financial Access Survey, IMF, 2017). 14 Finscope is a survey methodology developed by FinMark Trust, an independent trust, for analyzing the financial aspects of the life of the population. 20 What is driving the growth in mobile money? Around 40 percent of the Malagasy population currently Orange Money and Mvola, were authorized to operate as have access to a mobile phone, while only 4 percent of intermediaries in banking. A range of services started the population are active internet users. As the country to become available such as deposits and withdrawals grows, the demand for mobile phones and the potential through electronic money (e-money), transfer of money, customer base to be served by the financial system also mainly between people, purchase of communication credit, increases. In 2010, three mobile operators, Airtel Money, and the payment of invoices. Figure 27: While the number of mobile money Figure 28: There has been exponential growth in the accounts in Madagascar is still below number of mobile money outlets over the peer countries… last few years Mobile accounts active per 1,000 adults (2016) Mobile money agent outlets registered in Madagascar per 100,000 adults Guinea-Bissau 100 Niger 90 92 Nigeria Madagascar 80 77 Zambia 70 Guinea Burkina Faso 60 55 Togo 50 Mali 40 Zimbabwe 34 Cote d'Ivoire 30 25 Rwanda 20 Ghana 16 Botswana 10 7 Namibia 0 0 200 400 600 800 2010 2011 2012 2013 2014 2015 2016 Source: IMF, Financial Access Survey, 2017 A lack of available income to purchase a mobile phone services, including credit, because they require lower does not necessarily present a barrier to using mobile screening costs and are therefore more affordable than money. Meet Andry, a 17-year-old student who helps his banks. Furthermore, e-money accounts can act as a type mother sell merchandise to supplement the family income. of insurance mechanism by providing a safe method of Andry’s goal is to save for his college education. He realizes storing money, and by presenting a mechanism to receive that storing cash is risky, but opening a bank account is remittances in times of need. not an option as the nearest bank is too far away, costly to open, and requires identification documents that are Following the rapid rise of mobile banking, in December cumbersome to acquire. In response, mobile phone 2016 Parliament adopted a new law to govern e-money operators have adapted their business model to offer and related institutions. The enactment of this law allows services to a range of clientele. By purchasing a SIM card, mobile network operators to issue e-money without customers can use cash-in-cash-out services, through partnering with a formal financial institution such as using the mobile phone of a mobile money agent. For most a bank or microfinance network, thereby increasing of the population who do not have access to electricity, opportunities for new market entrants and encouraging mobile solar panels are increasingly being used as an competition. The e-money law has put the sector on a alternative source of recharging mobile phones. solid legal footing, providing the foundation for further expansion of the sector (see Box 5 on changes to the Developing access to and usage of e-money accounts regulatory framework). is a first step toward using more advanced financial 21 The ease of opening an e-money account is contributing to a rise in mobile banking services. How can other financial services get on the digital bandwagon? i Opportunities for Microfinance Institutions Microfinance institutions (MFIs) are increasingly providing The potential for MFIs in Madagascar to serve a broader financial services to low-income entrepreneurs to access customer base remains significant, particularly in more services such as group lending schemes, micro and rural and remote areas, where the number of people who short-maturity credit, reinforced by financial education do not have access to financial services is much higher. The programs to stimulate consumer demand. In just five 2016 financial access survey showed that 46 percent of the years, the number of households utilizing services of rural population are fully excluded from the financial system, MFIs grew by 55 percent.15 The outstanding loan-to-GDP compared with 31 percent of the urban population. Moreover, ratio in the MFI sector stands at 1.9 percent, higher than a mere 7 percent of the rural population use formal banking the sub-Saharan African average of 0.55 percent.16 The services, far lower than urban population where over 25 reach of the MFI subsector is particularly important for percent are banked (see Figure 29). And while similar number women, whose membership has been steadily increasing of males and females are financially excluded, the number from 46 percent in 2011 to close to 50 percent of the total of female entrepreneurs using formal financial services is outstanding portfolio of MFIs in 2017. lower than males, indicating another potential area for growth. Figure 29: Financial exclusion is particularly Figure 30: Females are more likely to use informal prevalent in rural areas financial services compared with males Percentage of the population with access to Percentage of the population with access to financial services financial services 50 45 Urban Rural Male Female 45 40 40 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 Banked Other Informal Excluded Banked Other Informal Excluded formal only formal only Source: Finscope 2016 15 The household penetration rate of MFIs increased from 19.5 percent in 2011 to 31.6 percent by 2016, National Commission for Financial Inclusion, 2016. 16 Convergences (2016) Baromètre de la Microfinance 2016. 22 Table 4: The Microfinance Sector – Fast Facts 2011 2012 2013 2014 2015 2016 Number of points of service 739 784 820 890 937 949 Household Penetration rate (%) 19.50 22.69 24.60 28.10 29.60 30.40 Women clients/members (%) 45.91 45.92 47.03 48.33 48.51 48.88 Outstanding loans (million Ar) 246,925 314,791 387,682 444,144 506,946 562,322 Credit (% of GDP) 0.84 1.07 1.23 1.40 1.75 1.90 Outstanding savings (million Ar) 195,492 233,530 309,434 382,182 487,462 510,473 Savings (% of GDP) 0.666 0.794 0.98 1.21 1.69 1.72 Source: National Commission for Financial Inclusion (2016), WDI and WB staff estimates Experience in other countries shows that the expansion of that are mostly located in the center of the island near the MFIs to more rural areas can provide significant benefits. capital and in the area connecting the capital to the port of For instance, the availability of financial services in rural Tamatave, with access to road infrastructure (Analamanga, areas in India was associated with an increase in savings Vakinankaratra, Alaotra Mangoro, Analanjirofo, Atsinanana, and credit provision and a 17 percent reduction in the Sava and Itasy) host more than 65 percent of microfinance poverty headcount ratio.17 The development of an extensive points of service. rural branch network, in turn, allowed rural households to accumulate more capital and to obtain loans for longer- Understanding the potential of e-money, three MFIs have term productive investments. established digital partnerships with mobile network operators, focusing initially on the reimbursement of One of the key barriers to the expansion of MFIs in loans. SMS is used by some MFIs to remind customers of Madagascar is a business model based on physical branches, their credit repayment terms, communicate new products, as the basis for undertaking financial transactions. Since and encourage savings. A study in Tanzania showed that two-thirds of the population live in rural areas, combined clients who received messages encouraging savings are with low population density (an average of 42 people per five times more likely to save compared to those who do squared kilometer),18 poor transport connections and not receive such messages.19 Using e-money also presents insecurity, it remains challenging for the rural population opportunities for MFIs to broaden their reach and limit the to access MFIs. A large number of ‘inactive’ deposit accounts potential for fraud, potentially saving 80 to 90 percent of are reported by MFIs, which they attribute to high transport operating costs20 (see Box 4 on how digital solutions are fees and insecurity. Seven of the 21 regions in the country being utilized by MFIs in Kenya and Malawi). Increasing the presence of microfinance institutions in rural areas can be facilitated through leveraging digital partnerships with mobile network providers. 17 Robin Burgess and Rohini Pande, 2005. Do rural Banks matter? Evidence from the Indian Social Banking Experiment. The American Economic Review, Vol.95, no.3. 18 World Bank, World Development Indicators, 2015. 19 http://www.cgap.org/blog/interactive-sms-drives-digital-savings-and-borrowing-tanzania 20 McKinsey & Company, 2016. 23 Box 4: Microfinance institutions harnessing digital technology in Kenya and Malawi Launched in 2009 in Kenya, Musoni Microfinance its clients to receive and repay their loans using institution pioneered early in 2012 the use of M-PESA and Airtel Money; b) an SMS Module which mobile applications as tools to replace its brick enables sending payment re¬minders. In addition, and mortar branches. Musoni has used two Musoni equipped its staff with tablets and the KENYA models in its digital finance journey: a) Partnering Musoni App replacing paper forms. As of 2015, with the two Mobile Network Operators, 75,000 loans were disbursed by Musoni for a total Safaricom & Airtel, to go “cash¬less” allowing amount of 23 million US$. To deepen outreach to rural areas and mobilize in under ten minutes at the clients’ doorstep, low-cost deposits, NBS Bank developed the and no paperwork is required, enabling female Pafupi product, a mobile savings account clients to bank in their own neighborhoods. designed to remove the barriers to formal Clients can withdraw or deposit cash at any MALAWI savings for low-income people in rural areas, shop that serves as an NBS Bank agent. especially women. Accounts can be opened Source: Getting Digital Toolkit 1, United Nations Capital Development Fund, 2016 (Kenya) and MicroLead Handout VSLA, United Nations Capital Development Fund, 2017 (Malawi) One of the key factors holding back the expansion of MFI of the loan value, and group caution, which may be complicated digital finance services in Madagascar is the lack of a well- to demonstrate. Under these circumstances, an individual’s developed Management Information System (MIS), which can past repayment history can serve as “reputational collateral” monitor payments in real time. The lack of an automated to induce financial institutions to accept loan applications. To MIS limits the ability of MFIs to integrate mobile services increase the availability of information to creditors, a law has and contributes to the limited reach of internal controls. For recently been enacted on Credit Bureaus to digitally collect certain MFIs an upgrade to an existing MIS is required with and share information on credit and payment history among minor adaptation to allow integration with mobile network participating financial institutions. This new law could increase operators. However, for other MFIs, the MIS is not automated the potential for the largely rural population to gain visibility to and requires a complete overhaul. However, without external financial institutions (see Box 5 for more information.) support, most MFIs cannot afford to upgrade their MIS. As the sector is currently undergoing a restructuring, many MFIs are While the growth of the MFI subsector has undoubtedly also dissuaded from committing to significant investments created opportunities, the pace at which services have in infrastructure as long as there is no clarity on the future expanded has come at the expense of a deterioration of of their institution. credit portfolio quality at some MFIs. The sector has recently seen the failure of one important MFI network while another A further constraint to undertaking a loan is the requirement one is under temporary administration. A consolidation of the to provide collateral, which is estimated to apply to 82 sector is expected as well as the introduction of risk-based percent of the clients, and for the first credit can reach up supervision. A new microfinance law approved by Parliament to 120 percent of the value of the loan. Collateral can include in December 2017 is expected to lead to a more stable and materials constituted by the non-possessory21 of inventory better supervised financial sector, with higher levels of trust of (cereal bank credit), professional equipment, land titles and microfinance clients in the system particularly for the safety non-material possessions such as deposits of 10 to 30 percent of their deposits (see Box 5 for more information). 21 Non-possessory pledge of the inventories: in this situation the borrower retains the ownership and possession of the collateral securing a loan during the repayment period. 24 Box 5: Key Regulatory Changes in the Financial Sector Since 2016, three new laws in the financial sector have healthy credit reporting market). Furthermore, the been enacted by Parliament, helping to bring stability and law text is perfectly harmonized with the existing clarity, which is expected to set the foundation for further Data Privacy law enforced in Madagascar and expansion. A summary of the regulatory changes is set related jurisprudence. out below. • Impact on financial inclusion: The law has been conceived to support the fast change imposed E-money law (Loi n°2016-056 sur la monnaie électronique by new data technologies and typologies, and to et les établissements de monnaie électronique) was approved anticipate the participation to the PCB mechanism by Parliament on February 2, 2017, and the secondary of every sector (financial and commercial, supervised regulation (decrets d’application) were published in and non-supervised, traditional lenders and new September 2017. fintech lenders), therefore exponentially increasing • Objective of the law: defines e-money, how it can the opportunities to access credit and become visible be used, how the user is protected, who can issue for the informal economy. e-money, and how e-money issuers are regulated. • Key innovative features: creates a framework to Micro finance law Loi No. 025/2017 du 27 septembre 2017 was allow non-banks to issue e-money, in order to open promulgated on February 2018 and approved by Parliament the market and promote competition. on December 7, 2017. • Impact on financial inclusion: contributes to financial • Objective of the law: improve supervision of MFIs inclusion by using technology to give access to a by strengthening the powers of the regulator and transaction account. defining a new licensing strategy. • Key innovative features: reviews the process of Credit Bureau Law (Loi N 045-2017: Loi regissant l’activité dealing with MFIs in difficulty, through introducing et le controle des bureaux d’information sur le credit) was restructuring, resolution, and forced closure. put into effect on February 2018. Supported by accompanying decrees the law • Objective of the law: regulates the full life cycle of reinforces risk based management, improved Private Credit Bureaus (PCB) (licensing, establishment, governance through reporting to the supervisor operations, management, governance, supervision, and shareholders, and improve internal controls liquidation, etc.) and gives special consideration within MFIs. Finally, the law introduces a Deposit to consumers’ rights in respect of the privacy of Insurance Fund in the event that resources are personal data. needed to pay back money resulting from the • Key features: the law fully echoes the WBG Credit failure of a financial institution. Reporting General Principles (for example, data • Impact on financial inclusion: MFIs provide accuracy and comprehensiveness; rigorous system financial services to those who are excluded by security and reliability; sound governance of the formal banks. Strengthening the regulation and private credit bureau through transparency and supervision of MFIs, the law (and accompanying supervision; ample clear and non-discriminatory texts) will contribute to improve the quality and borrowers’ rights, possibility of cross-border durability of MFIs and the services they offer to an sharing, as well as multiple licensing to create a unserved or underserved population. Source: Central Bank of Madagascar Regulatory changes with the passing of the e-money law, credit bureau law and micro finance law are helping to bring stability and clarity to the financial sector. 25 ii Opportunities for Banks Banks can play an important role in promoting financial penetration. For example, compared to peer countries in inclusion, particularly through providing financial and Africa, there are only an estimated 97.3 deposit accounts credit services to medium and large enterprises, which for every 1,000 adults, a level comparable with countries can further spur growth and generate employment. At such as South Sudan and Chad. And less than 3 percent of present, Madagascar’s banking sector is characterized the population have access to bank credit (IMF FAS 2017). by high levels of profitability but low levels of banking Figure 31: Less than 10 percent of Malagasies have a deposit account – one of the lowest levels in Africa Deposit accounts at commercial banks per 1,000 adults Chad Guinea South Sudan Madagascar Zimbabwe Comoros Mauritania Equatorial Guinea Rwanda Uganda Zambia Mozambique Gambia, The Swaziland Ghana Nigeria Botswana Sao Tome and Principe Namibia Kenya South Africa Seychelles Mauritius 0 500 1,000 1,500 2,000 2,500 IMF FAS 2017 Several factors contribute to low banking penetration. The factors affecting penetration have a knock-on effect Banks in Madagascar charge high account fees, which acts on bank credit. First, because banks have a hard time as a deterrent for potential depositors, particularly given attracting deposits, the cost of funding for banks is high pervasive poverty levels. The requirements for opening an and lending is risky, banks - in turn - offer credit only at high account also present a barrier, such as the need to present interest rates.22 Second, banks are deterred from offering identification documents that can be costly. Similar to credit to applicants that lack a formal credit history and MFIs, the business model for banks is also based on who cannot offer financial statements of sufficient quality, physical branches, which are clustered in urban areas. a situation that the Private Credit Bureau should help to The cost of expanding to rural areas is high for banks, address. Third, many Malagasies cannot offer sufficient particularly since the potential customer base is low. collateral or - if they do - enforceability of this collateral in 22 A 2016 interest rate study in Madagascar found spreads for effective loan interest rates between 11% and 127%. Spreads were even higher and more variable among MFIs. The financial sector supervisor has not put in place interest rate caps or restrictions. Interest rates are set at market-determined rates 26 the courts is in doubt. Concerns about collateral have been between banks through linked software platforms) funds heightened by the lack of a centralized collateral registry. could be withdrawn through the branch or Automated- Fourth, credit demand is limited, given that many micro teller machine (ATM) of another bank, which would help enterprises either do not have a business model that can to overcome the challenge of a sparse banking network. be scaled profitably or do not have the entrepreneurial In countries such as Kenya, banks have found new ways mindset to move forward with expansion. to compete and collaborate in an increasingly digital and mobile financial services market, working closely with Experience in other countries shows that banks can mobile network operators (see Box 6). Banks can also be adapt their business model, and utilize technology to instrumental in promoting a savings culture by providing promote financial inclusion. For example, by investing in access to transaction accounts as a first step to the interoperability (which refers to information exchange provision of other financial services. Box 6: How Banks in Kenya are Innovating to Increase Financial Inclusion The rapid growth of mobile money has been a key feature and instantly. A sender simply designates a recipient by of the financial sector in Kenya, with a large part of the entering his or her phone number (or account number population using their phones to send, receive and store if the recipient doesn’t have a registered phone). money. Building on this success, banks have adapted their This intuitive payment system moves the business of business models, where the number of bank accounts interbank payments one step closer to the world of now exceed mobile money accounts. M-PESA and Kenya’s increasingly mobile-native, low- income population. The Kenya Banker Association introduced a small dollar interoperability scheme through the roll-out of PesaLink, The PesaLink system is part of a broader effort to improve a real-time payments system that enables small-value coordination between banks, such as improved ATM transfers between institutions. The scheme is now connectivity and fraud services. By working with M-PESA, managed by a newly created, bank-owned entity called the PesaLink system is able to increase its reach (banks Integrated Payment Systems Limited, which operates the in Kenya have around 15,000 access points compared with payments switch that supports the transactions. 65,000 mobile money agents). While PesaLink is still in its early days, a clear lesson is emerging on how mobile The new scheme allows customers with accounts at money can incentivize innovation in the banking sector, participating banks to send money to each other easily to increasingly serve lower-income customers. Source: Consultative Group to Assist the Poor, World Bank, 2017 Banking penetration in Madagascar is low, but learning from other countries, technology can help to adapt business practices to overcome the challenge of a sparse banking network. 27 The recently enacted law on the Private Credit Bureau PPCG Fund guarantees 50 percent of credits extended to should help to reduce risk for banks lending to new eligible borrowers. The eligibility criteria are agreed upon customers through providing information on potential between the lender and the Fund. A portfolio guarantee customers. A partial portfolio guarantee for credits is characterized by automaticity as each credit meeting (PPCG) by banks and MFIs to MSMEs in operation now eligibility criteria must be registered on the guarantee. for over three years has been successful in increasing Eligible claims on the guarantee for delinquent loans are bank and MFI lending to MSME.23 Under the scheme, the paid by the Fund within thirty days. Where next for financial inclusion in Madagascar? The National Strategy for Financial Inclusion, 2018-2022 financial education and consumer protection; (ii) access has been adopted with the objective of increasing the and use of financial services; and (iii) strengthening the number of adults with access to formal financial services regulatory and institutional framework. (See Box 7 for from 29 percent in 2016 to 45 percent in 2022.24 The strategy further information on the strategy). is based on three strategic pillars, centered around (i) Box 7: Madagascar – National Strategy for Financial Inclusion (2018-2022) The financial inclusion strategy is based on three strategic pillars, to prioritize reforms around a shared vision. 1 Financial Education and Consumer Protection: through an promote financial inclusion; and (iii) protection of (i) improved financial education of all categories consumers service to create a climate of trust of the population for better financial inclusion; between the population and suppliers. (ii) information and communication campaign to 2 Access and use of financial services: (i) savings optimize the use of a payment system to promote mobilization to deal with shocks and build trade and resilience and (iv) offer targeted credit productive capital; (ii) develop niche of insurance to expand economic opportunities. opportunities for resilience and productivity; (iii) 3 Strengthening policies, legal and institutional for Financial Inclusion and the Financial Sector framework: (i) enabling environment conducive Regulator; and (iii) establishing a climate of trust to financial inclusion; (ii) strengthening the between financial service providers and the institutional capacity of the National Commission judiciary system. The implementation of the NFIS is coordinated by the National Commission of Financial Inclusion, which holds the secretariat of the steering committee and ensures the coordination of different technical and strategic working groups, including the monitoring and evaluation framework on financial inclusion. Source: National Strategy for Financial Inclusion (2018-2022) 23 This Fund has been introduced and supported by the World Bank through the ‘Projet d’Appui aux Services Financiers (PASEF)’ project with a 4 million US dollars which supported credits of over 46 million US dollars to MSMEs. The new World Bank financial inclusion project added 8 million US dollars to the endowment. 24 This figure refers to the percentage of the total population that have access to banks and other formal financial institutions. 28 The rise of mobile banking offers great opportunities for increasing financial inclusion and sets an example for how microfinance institutions and banks can also use technology to promote access. The strategy seeks to improve both the supply of financial And finally, improvements to the overall financial system services, and demand for financial products. Improved infrastructure are expected through modernizing provision of financial services is envisaged through the use the existing Automated Clearing House and large- of new and existing sources of data to appraise borrowers value payment systems, as well as implementing a in innovative ways, making it possible to manage the credit national SWITCH for cards and e-money transactions risk of MSMEs that may otherwise be un-bankable. The to enhance interoperability. The national payment use of an automated management information system system is expected to facilitate transactions between is also expected to improve the transparency and accounts at different financial institutions. The financial governance of financial institutions, especially for MFIs. sector infrastructure is also expected to be enhanced Digital payments are envisaged for government payments through the establishment of a collateral registry. to enhance financial inclusion through both Government There is currently no structured secured transaction to Person and Person to Government payments. Demand system in Madagascar, which creates uncertainty for financial services is expected to improve by investing in about the enforceability of collateral rights in case of financial education, so that individuals and businesses can default and acts as a deterrent to lending. To develop a make informed decisions on financial services. Promoting collateral registry a broad based secured transactions financial consumer protection is expected to further reform should be established, followed by a centralized increase trust in formal financial services and encourage electronic web based registry. financial inclusion. Conclusion While 41 percent of the population are excluded from the and a reflection of innovation in practice when companies financial system, there have nevertheless been important are willing to adapt and there is a supporting enabling developments in the sector to increase access. Notably, environment. Key opportunities include scaling up mobile mobile network operators have successfully been able to banking, encouraging MFIs and banks to also leverage increase mobile banking, including for those individuals technology, and increasing financial literacy to support the who cannot afford a mobile phone and do not have access uptake of financial services to promote entrepreneurship to electricity. 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